Business Law Prof Blog

Investment Shopping on Cyber Monday? As Always, Buyer Beware

The SEC announced last week that a federal court granted a request for an asset freeze related to a suspected Denver-based Ponzi scheme that offered both European bank notes trading and "diamond trading."  The defendants -- Richard Dalton and Universal Consulting Resources LLC -- apparently raised $17 million from investors who received monthly payments that were claimed as profits from the “Trading Program” and the “Diamond Program.” The payments, the SEC claims, were actually funded through monies received from new investors in the programs.  

Here's the promise made to investors, as per the SEC press release:

According to the SEC’s complaint [pdf here] filed in U.S. District Court in Denver, Dalton told investors in UCR’s Trading Program that their money would be held safely in an escrow account at a bank in the United States, and that a European trader would use the value of that account — but not the actual funds — to obtain leveraged funds to purchase and sell bank notes. According to Dalton, the trading was profitable enough that he was able to guarantee returns of 4 to 5 percent per month — or 48 to 60 percent per year — to investors. Dalton claimed that he had successfully run the Trading Program for nine years. 

The Diamond Program promised even better returns (everyone knows actual diamonds are better than trading bank notes, right?). The SEC says that Dalton promised investors "a guaranteed 10 percent monthly return — or 120 percent annual return."  

Of course, the "business" was not nine years old; it apparently began in 2009.  Nice timing, too -- the market's down, people are looking for promising investments outside the stock market, and here comes someone providing monthly payments based on money held "safely" in escrow.  To make the program work, Dalton used prior investors to find friends or family members. These new investors, as you might expect, were wooed by both this connection and the regular monthly payments.  

Obviously, if all of this is true, it's fraud and the defendants should be punished severely.  But I can't help but wonder, does anyone have deals like this that actually work?  I know some people have made 120% annual returns (and more) on investments in a variety of settings, but I'm curious of any situation when that kind of return was promised, virtually risk free, and then delivered.  I cannot imagine any such scenario.  

Then again, maybe it's just that I don't have the kind of money to invest to find out.  But I rather doubt it.

--JPF

"Don't Ask, Don't Tell": The Securitization Version

Mike Konczal posts a nice chart here showing some of the many things that went wrong during the mortgage securitization feeding frenzy.  Money quote:

[I]t appears that during the worst excesses of the mortgage bubble the very basic rules of property transfer and record-keeping were ignored. . . . Key point: . . . Even at this late stage, the actions of the trust, servicers and depositors are opaque to regulators and investors.

Hat tip to Frank Pasquale for this item, and for his analysis here--which includes the following:

Adam Levitin argues that most legal observers are slow to recognize how bad things have gotten, because they believe “there’s no way there were massive screw-ups because thousands of top Wall Street legal minds were working on securitization deals.” Levitin responds: “the best legal minds in the country weren’t doing diligence on endorsements on securitization deals.”

SJP

Is "Trickle Down" a Myth?

Warren Buffett says he wants his taxes raised because "trickle down" economics don't.  Frank Pasquale offers an explanation for why that may well be the case here.  Meanwhile, bonus checks are being cashed while soup kitchens are struggling to meet demand.

Happy Thanksgiving.

SJP

SEC Hearing on Municipal Securities Markets

The SEC recently announced it would be holding its second hearing on the state of municipal securities markets.  According to the press release:

The Securities and Exchange Commission announced today that it will hold its second field hearing to examine the municipal securities markets at its Headquarters in Washington, D.C., on December 7. Topics will include market stability and liquidity, investor impact, and self-regulation.

That's a pretty broad set of topics, warranting the long hearing, which will last from 9 a.m. to 4:50 p.m. 

The SEC is holding the hearings because "[i]nvestors in municipal securities lack many of the protections afforded to investors in public companies and other sectors of our financial markets."  The hearings are in part to determine whether new legislation, regulations, and/or improved industry best practices recommendations are needed. 

I have to imagine something should be done, although the hearings themselves may help raise awareness of the limited oversight. Personally, I'd like to see the SEC focus on the last one first, and see where that leads.

--JPF

Do They Serve "Equal Access" Kool-Aid at the SEC?

If you ask me to give you a quick summary of illegal insider trading, you are going to hear me talk first and foremost about two things: duty and deception.  Did the trade in question involve deception in the form of a violation of a duty to disclose the non-public material information--either to the source of the information or the counterparty to the trade?  Or, was the non-public material information being traded upon acquired deceptively via some form of affirmative misrepresentation?  If the information came via a tip, did the source of the tip violate a duty not to disclose in exchange for some personal benefit, and should the recipient of the tip have known this?

Now, contrast the above summary with the summary given by Harvey L. Pitt, a former chairman of the Securities and Exchange Commission, in the interview provided here.  You will not hear one mention of duty or deception.  Rather, you'll hear that our law says "you're not supposed to cheat by having information that the rest of the market doesn't have."  In fact, Mr. Pitt claims that it would be improper to trade on information you overhear standing in line next to someone who is blabbing away on their cell phone.  This is simply not correct since, at the very least, the necessary personal benefit to the "tipper" is missing.  While I want to give people every benefit of the doubt when critiquing their live interviews, the view being advanced here by Mr. Pitt seems to me to clearly be the "equal access" theory of insider trading that has been repeatedly and sternly rejected by the Supreme Court.

Now, time will tell whether the current insider trading dragnet is targeting individuals who are violating the law of insider trading as it is currently understood, or whether at least some part of this offensive will be aimed at once again trying to re-establish some form of the equal access norm--either via the courts or legislative action following judicial rejections.  But either way, it's sometimes hard not to get the sense that when it comes to the equal access theory of insider trading--the SEC, for better or worse, is like a dog on a bone.

SJP

Giving Thanks and Asking Questions

With Thanksgiving about to come, I have much to be thankful for.  A great family, immediate and extended, a great job, and great colleagues.  Beyond that, I have thoughtful and insightful students, who go on to to become thoughtful and insightful lawyers (for the most part), and I appreciate that I have a small role in their futures.  (Student evaluations are long completed, just so you know). 

Here are a few things I hope to be thankful for: (1) Safe completion of a 4-mile race tomorrow; (2) A safe drive home this weekend; (3) A solid exam for (and from) my BA students; and (4) A Detroit Lions victory tomorrow. 

At least I have a reasonable expectation of the first three. Looking forward, here's one other thing to keep an eye on - of the General Motors executives who bought shares in the IPO, only one, CEO Dan Akerson, bought more than 3000 shares, according to SEC reports. I don't know if that's low, but it kind of seems like it.

 Regardless, a happy and safe Thanksgiving to all.

--JPF

Investing in Baseball Futures

The New York Times ran a haunting piece last week that detailed American investment in the future salaries of baseball prospects from the Dominican Republic.  See Michael S. Schmidt, "New Exotic Investment: Latin American Baseball Futures,"  NY Times (Nov. 17, 2010).  As the article summed up the financial arrangement:

Recognizing that major league teams are offering multimillion-dollar contracts to some teenage prospects, the investors are either financing upstart Dominican trainers, known as buscones, or building their own academies.  In exchange, the investors are guaranteed significant returns - sometimes as much as 50 percent of their players' bonuses - when they sign with major league teams.  Agents in the United States typically receive 5 percent.

The article also details the greatly varying living conditions at these academies while weighing the advantages and disadvantages they provide for the prospects, who range in age from 13-19 and often "forgo formal schooling."  A professor of international law is quoted as saying that the buscones "are in the business of selling children."  The referenced investments are said to range from $15,000 to $400,00; the investors ranged from a relative of a major leaguer to a former U.S. ambassador.  The Mets' new general manager, who previously helped upgrade baseball operations in the Dominican Republic, is quoted as saying that he "hoped the American investors realized their investments were teenagers, many who will never reach the major leagues."

Which highlights one of the many legal questions occasioned by this surprising fact pattern.  Under U.S. law, it's hard to see this arrangement as anything other than a "security", the next inquiry being whether an offshore, de minimis or other exemption somehow negates the need for registration.  After Life Partners, it took over a decade for federal courts to agree upon SEC jurisdiction over viatical settlements.  If children are truly being exploited (and their U.S. investors not appreciating these and other risks), let's hope the Howey test takes root faster this time.

---JSC, 11/23/10  

1% Ownership Does Not an Issuer Make

The North Dakota Supreme Court recently determined in State v. Hager (here) that a seller of LLC "member units" was not exempt from registering as an agent under North Dakota securities law even though the member units were exempt under Rule 506 of SEC Regulation D.  The seller (Hager) in question was selling these  securities while serving a suspended prison sentence through electronic home monitoring.  Hager had previously been convicted of selling unregistered securities and acting as an unregistered agent. 

Hager owned 1% of the member units and claimed that he was an issuer under the National Securities Markets Improvement Act of 1996 (NSMIA), and thus exempt from registration.  He argued that as an owner and employee, he was an issuer.  However, Hager never did anything other than offer services usually "performed by the those in a sales capacity."  The court thus determined he was not an issuer. This seems right -- he did not seem to have any control over the LLC, and appeared to be more of a facilitator than an insider. 

Hager then argued that if he wasn't an issuer, he still was not required to register as an agent. The North Dakota Century Code, however, requires agents to register or be otherwise exempt to act as a sales agent. Hager claimed this law only applied to third-party individuals, but the statute covers as an agent, "an individual . . . who represents a . . . an issuer . . .in effecting or attempting to effect purchases or sales of securities." Thus, the court found, Hager thus failed to register when required.

Hager had a tough case from the start.  The court below stated that

most troubling of all is the simple fact that the new violations are of the exact kind and nature as the original violations. Clearly, the message was not received. . . .The people who entrust their financial well-being to the people who are selling securities and providing financial advice need to know that they will not be misled. They need to know that the appropriate laws will be followed.   

Add to this that "Hager admitted he possessed firearms in violation of the conditions of his probation," it's hard to be surprised that the court was skeptical Hager took his first conviction very seriously. 

--JPF

 

Are these two news items related?

Item 1: Insurers Gave U.S. Chamber $86 Million Used to Oppose Obama's Health Law

Item 2: Americans More Likely to Skip Health Care and Battle Insurers, Survey Says

SJP

More on the Materiality of Statistical Significance

Jay Brown has a post up summarizing some of the amicus brief in Matrixx v. Siracusano filed by 36 law and business faculty--he describes the case as "perhaps the most significant business case in the Supreme Court this term."  I signed on to this brief and posted some additional thoughts here.  You should check out the entire summary, but the part that jumped out at me was this quote from the brief:

Statistical significance assumes away, at least in the first instance, any contextual examination of the available information and presupposes that the market singularly relies on the presence or absence of a mathematically validated association between the drug and the adverse events at issue. The approach treats investors – whether analysts, institutional owners, or market professionals – as “nitwits unable to appreciate” the importance of any other information that could affect investment decisions.

SJP

We're Rich (Sort of)

General Motors IPO raised more than $20 billion, and the stock price stayed stable today, although it stayed near the issue price.  Some are touting this a success validating the government's support of the company.  Others are arguing we got away with one.  Either way, this is a better outcome than many thought possible, so I consider a good day.

--JPF

Creative Destruction & Too-Big-to-Fail

A former student of mine (who shall remain nameless) sent me the following:

Hooray!  We’ve now passed 2009 in number of bank failures: 146 in 2010, versus 140 total in 2009!  And just think – there’s seven more weeks in 2010!  Thank goodness we’re in a recovery! Did you hear that CEOs can look forward to salary increases this year?

Now, this may all fall under "creative destruction"--but will what is ultimately created be too big to fail?  Here's a related prediction I made elsewhere:

The financial crisis of 2008 is blurring the lines between the State and the private sector. While painful, this process may facilitate a re-examination of the state action doctrine. This Article argues that corporations have for some time been increasingly taking on roles as pseudo-governmental actors without incurring the accountability to the people generally associated with state action. This is happening via new governance, and while the recent financial crisis may suggest that the problems associated with new governance are waning, the reality is that the corporate consolidations likely to follow in the wake of the downturn - together with the government's oft-stated desire to divest its bailout stakes in private companies as soon as possible - will result in even more powerful corporate actors with an even greater ability to govern.

In arguably related news, the Bank of England has concluded that what banks need now is a "less intrusive" regulator while the FDIC "is conducting about 50 criminal investigations of former executives, directors and employees at U.S. banks that have failed since the start of the financial crisis."

SJP

Recreating Old Forms + Not Disclosing It = Bad Idea

The SEC today charged two New York firms, along with their former chief compliance officer, with "failing to have adequate policies and procedures to prevent misuse of nonpublic information."  According to the SEC press release,

In its order instituting administrative proceedings, the SEC found that when BCM began preparing for an SEC examination in 2006, the firm discovered that it was missing pre-approval forms for more than 100 employee trades. Instead of producing the incomplete employee trading records to the SEC exam staff, BCM created new forms to replace the missing ones. BCM then produced the existing records along with the newly-created forms to the SEC examination staff without telling the staff what it had done. BCM also replaced incomplete compliance logs with newly-created completed logs and turned the completed logs over to SEC staff without disclosing what had been done. These compliance documents were particularly important because they were intended to address deficiencies identified in an earlier SEC exam of the firm.

Whether it's employment law, securities regulation or a note to get out of school, it's always a bad idea to make things up after the fact.  Yet, given all the times when people get in trouble for doing such things, you have to wonder, how many people get away with it? I suspect it's more than we'd like to think.

--JPF

The Creeping Bias For/Against Mandatory Arbitration...

As previously discussed on this site, the SEC (tasked with over 300 studies/rulemakings under Dodd-Frank) will not be anytime soon limiting the use of predispute, mandatory arbitration clauses in securities account agreements.  See "SEC Chiefs Past and Present at Fordham," Sept. 28th.  Shall other agency decisions slowly force mandatory arbitration into irreversible disrepute?  Conversely, shall the Supreme Court exalt the practice at the expense of a time-honored exception thereto?

As it stands right now, Dodd-Frank flatly bans mandatory arbitration in whistleblower suits, while compelling studies that could lead to similar bans in securities and other forms of disputes.  Thus, both the law's administrative mandates and express provisions serve to animate the White House's distrust of alternative dispute resolution in certain types of cases. 

Meanwhile, on November 9th, the Supreme Court heard oral arguments on AT & T Mobility v. Concepcion, a class action that has survived two efforts by the telecommunications company to invoke the Federal Arbitration Act to preempt state laws.  That decision could possibly kill the class action "out" in cases set for mandatory arbitration.    

Clearly, something will soon tilt the balance for/against the practice.  Yet, apart from marketing campaigns advanced by aggrieved litigants, little has been conclusively demonstrated that a policy favoring mandatory arbitration in commercial disputes hinders justice at the expense of the consumer or, in the aggregate, makes economic sense to the huge corporation.  In short, there simply is no way of calculating how many settlements are encouraged by the status quo, nor how many dollars could have been gained/lost by taking the route of a jury trial.  Noteworthy here is that just last week the S.D.N.Y. refused to vacate a $20.5 million award rendered in June by a FINRA panel against a Goldman Sachs subsidiary. 

In the main, expertised arbitration panels can be said to hazardously lower the cost of entry to litigation while concurrently deterring frivolous claims. Meanwhile, unpredictable jury verdicts in commercial disputes may take years to occur but as a threat nonetheless often nudge corporations into compromise with their customers.  Accordingly, the conventional wisdom on who benefits most from a jury trial or its alternative speaks more of faith than fact, and any rush to expand/condemn mandatory arbitration sounds more hazardous than doing nothing at all. 

As Woody Allen once said, "More than any other time in history, mankind faces a crossroads.  One path leads to despair and utter hopelessness.  The other, to total extinction.  Let us pray we have the wisdom to choose correctly." My Speech to the Graduates, from Side Effects (1975).  Personally, until the collective advantages and disadvantages of arbitration can be made universally known, I hope neither road is taken.  
---JSC, 11/16/10

General Motors Ups IPO Offering

Following its strong performance in the last few quarters, the New York Times reports that General Motors has upped its planned offering price from the initial range of $26 to $29 to a new range of $32 to $33.  This could lead to GM raising more than $11.8 billion.

To break even, the federal government needs to get an average price of about $44 per share for the 17.5% of GM the government owns.  The Obama administration says it wants to sell the government's shares quickly, but to try and get full recovery for the American people.  

Sounds like a good idea, but sometimes you can't get everything.  In the past few years, trying to get yourself whole in the stock market has not been a very effective strategy for most.  I just hope no one gets too greedy on this one.  

--JPF

 

 

Should Statistical Significance = Materiality?

A while back, Jay Brown asked me to sign on in support of a professors' brief in the upcoming Matrixx case arguing that statistical significance should not equate to materiality for purposes of Rule 10b-5.  I agreed, and received a copy of the brief today.  Meanwhile, I've been thinking a bit about presumptions, having just finished a short piece suggesting that the Supreme Court may have implicitly adopted a nexus-of-contracts presumption in terms of the theory of the corporation in CItizens United.  (I'll hopefully have a link for that shortly.)  So, while I predicted a while back that SCOTUS would find a failure to disclose facts not rising to the level of statistical significance to be immaterial, I now wonder whether the Court might not adopt some sort of presumption--recognizing the wide acceptance of statistical analysis (though it is clearly not without its critics), but also allowing the presumption to be rebutted where, for example (and as was apparently the case in Mattrix), the stock price falls by 24% upon disclosure of the previously omitted information.  I'm not sure how much of a practical diference such a presumption would make in the end, but it would allow the Court to avoid having to either adopt a bright line rule of materiality (which would be contrary to its admonition against bright line rules in Basic) or appear to be "anti-science" by not giving some very meaningful weight to statistical analysis.

SJP

The Quantum Mechanics of Delusion

Which assertion is more delusional?

1.  When government enacts problematic laws we should focus on the government.

2.  When government enacts problematic laws we should focus on the corporations that lobbied for the laws.

Geoffrey Manne asserts the latter is delusional here.  Personally, I think the most delusional view may be that government and corporations can be neatly isolated from each other, so that our only choice is to pick one or the other. I've written a bit about that here.

SJP

Not Business as Usual this November 12

I turned 40 today and frankly did not spend a lot of time with business law issues. 

In a few spare moments, though, I took a quick look at significant legal cases from today. That search yielded exactly one:  Epperson v. Arkansas, 393 U.S. 97 (1968), in which the Supreme Court declared unconstitutional an Arkansas law banning teaching evolution in public schools.  Not bad, in my view.

Back to business law on Monday. 

--JPF

Koehler on the Foreign Corrupt Practices Act

Mike Koehler has posted The Facade of FCPA Enforcement on SSRN with the following abstract:

The rise in Foreign Corrupt Practices Act ("FCPA") enforcement actions has been well documented. Against the backdrop of aggressive enforcement and the resulting multi-million dollar fines and penalties is the undeniable fact that, in most instances, there is no judicial scrutiny of the FCPA enforcement theories. The end result is that the FCPA often means what the enforcement agencies say it means. Because of the "carrots" and "sticks" relevant to resolving a government enforcement action, FCPA defendants are nudged to accept resolution vehicles notwithstanding the enforcement agencies’ untested and dubious enforcement theories or the existence of valid and legitimate defenses. The end result is often the facade of FCPA enforcement.

This article discusses various pillars that contribute to the facade of FCPA enforcement and highlights that the FCPA, during its decade of resurgence, is being enforced like no other law. This article does not argue, or even suggest, that every FCPA enforcement action is unwarranted or that no company or individual has ever violated the FCPA. Rather, this article demonstrates that a significant majority of recent FCPA enforcement actions are a facade"including those that allege clear instances of corporate bribery"yet are resolved without FCPA anti-bribery charges.

The facade of FCPA enforcement matters. Even though the resolution vehicles typically used to resolve an FCPA enforcement action are not subject to judicial scrutiny and the vehicles do not necessarily reflect the triumph of the enforcement agencies’ theories, in the absence of substantive FCPA case law, these privately negotiated resolution vehicles have come to represent de facto FCPA case law. The facade of FCPA enforcement also breeds inefficient overcompliance by risk averse business actors fearful of enterprise–threatening liability because of the enforcement agencies’ untested and dubious theories. Because the factors that contribute to the facade are being modeled by other nations when enforcing their own bribery laws, the facade of FCPA enforcement is a global issue affecting a broad segment of the marketplace.

Identifying and acknowledging the existence of a problem is a necessary first step to crafting solutions. This article exposes the facade of FCPA enforcement, argues that addressing the facade and subjecting FCPA enforcement actions to greater judicial scrutiny is in the public interest, and encourages more FCPA defendants to challenge the enforcement agencies and further expose the facade of FCPA
enforcement.

ECC

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SJP