Securities Law Prof Blog

SEC Pubishes Final Rule and Guidance on SRO Rulemaking Process

The SEC published on its website the final rule and new interpretive guidance to improve the rulemaking process for exchanges and other self-regulatory organizations (SROs).  The SEC previously voted to approve the final rule and issue the guidance to help increase the competitiveness of U.S. markets, the speed with which new products and services can be made available to investors, and the effectiveness of measures designed to protect investors.

Under the Securities Exchange Act of 1934, when a proposed rule change is submitted by an SRO for Commission review, the Commission is required to approve it or institute proceedings to disapprove it within 35 days of its publication. This 35-day deadline can be extended for up to 90 days in certain cases.  To address concerns from market participants and others about rule-processing delays, the Commission has amended its internal rules of procedure to require that any proposed rule change filed by an SRO for review be published within 15 business days. In the rare instance when a rule change is unusually complex or raised novel issues, the Director of the Division of Trading and Markets would be able to make exceptions to this 15-day requirement.

The Commission also is issuing new interpretive guidance to elaborate on the Commission’s views regarding proposed rule changes that may properly be filed for immediate effectiveness, and specifically, those proposed rule changes filed pursuant to Exchange Act Rule 19b-4(f)(6), under which “non-controversial” rule changes may be filed. The guidance and rules will be effective upon their publication in the Federal Register.

SEC Announces Participants in Round Table on Fair Value Accounting and Auditing Standards

The SEC announced the panelists and agenda for its July 9 roundtable on fair value accounting and auditing standards. The roundtable will be organized into two panels. The first panel will focus on fair value accounting issues from the perspective of larger financial institutions and the needs of their investors. The second panel will discuss these issues from the perspective of all public companies, including small public companies, and the needs of their investors.

The following panelists are scheduled to participate and discuss topics related to the benefits and potential challenges associated with existing fair value accounting and auditing standards.

9:15 a.m. — Panel One: Large Financial Institutions
Jane B. Adams, Maverick Capital
Russell B. Mallett, III, PricewaterhouseCoopers LLP
Kathy Petroni, Michigan State University
Joseph Price, Bank of America Corporation
Kurt N. Schacht, CFA Institute Centre for Financial Market Integrity
Matthew Schroeder, The Goldman Sachs Group, Inc.
James S. Tisch, Loews Corporation
11 a.m. — Panel Two: All Public Companies
Leonard W. Cotton, Centerline Capital Group
Sam Gutterman, American Academy of Actuaries
Charles Holm, Federal Reserve Bank
Gary R. Kabureck, Xerox Corporation
Kenneth B. Robins, Fidelity Investments — Equity and High Income Funds
R. Harold Schroeder, Carlson Capital
Wes Williams, Crowe Chizek and Company LLC
John B. Wojcik, Bank of the West
In addition, the following individuals are scheduled to participate in both panel discussions as observers:

Thomas J. Linsmeier, Financial Accounting Standards Board
James J Leisenring, International Accounting Standards Board
Mark W. Olson, Public Company Accounting Oversight Board
The roundtable will take place on July 9, 2008, from 9 a.m. to approximately 12:30 p.m. ET at the SEC's headquarters.

Industry Initiatives to Increase Transparency in European Securitisation Markets Released

Nine European and global trade associations, including SIFMA, released Ten Industry Initiatives to Increase Transparency in the European Securitisation Markets in response to the European Council of Finance Ministers’ (ECOFIN) call, in its October 2007 Roadmap, to “enhance transparency for investor, markets and regulators” by “mid-2008”. 

The ten initiatives are broad in scope and include (1) a Draft Industry Good Practice Guidelines on Securitisation Disclosures under Pillar 3 of the Capital Requirements Directive (CRD), and (2) the creation of a new industry Quarterly Securitisation Data Report, which provides comprehensive, frequent and relevant statistical data on EU and US securitisation markets.  In addition, the industry initiatives go beyond the transparency requests specifically listed in the ECOFIN Roadmap, with eight additional issuer and investor focused initiatives designed to standardise issuer disclosure practices, broaden and facilitate investor access to transaction information, enhance usability and comparability of information, and strengthen investor good practice.  The nine associations are: Commercial Mortgage Securities Association; European Association of Co-operative Banks; European Association of Public Banks and Funding Agencies; European Banking Federation; European Savings Banks Group; European Securitisation Forum; International Capital Market Association; London Investment Banking Association and the Securities Industry and Financial Markets Association.

Paulson Calls for Expanded Role for Fed Reserve

Treasury Secretary Paulson, in a speech in London, refined his vision for a modern U.S. financial regulatory structure, first outlined in the Treasury Dept's Blueprint released in March.  Noting that the Bear Stearns collapse illustrated the outdated nature of the U.S. financial structure with separate regulation of commercial and investment banks, the Treasury Secretary called for an expanded role for the Federal Reserve:

First, whether it was Long Term Capital Management in 1998 or Bear Stearns this year, it is clear that Americans have come to expect the Federal Reserve to step in to avert events that pose unacceptable systemic risk. But, as we noted in our Blueprint, the Fed has neither the clear statutory authority nor the mandate to attempt to anticipate and prevent risks across our entire financial system. Therefore we should consider how most appropriately to give the Federal Reserve the information and authority necessary to play its expected role of market stability regulator. The Fed would need the authority to access necessary information from complex financial institutions -- whether it is a commercial bank, an investment bank, a hedge fund, or another type of financial institution -- and the tools to intervene to mitigate systemic risk in advance of a crisis.

To complement regulatory efforts, he called for "strong market discipline to reinforce the stability of our markets."

New York Court Throws Out Remaining Claims Against Grasso

It looks like former NYSE CEO Richard Grasso gets to keep all his money.  A week after the New York Court of Appeals threw out four claims against him, the state's intermediate appellate court threw out the remaining two.  It ruled that the Attorney General no longer had the power to pursue the claims against Grasso under the state's not-for-profit statute since the NYSE has become a public for-profit corporation.  The New York Attorney General's Office stated that it would not appeal the decision.  WSJ, Court Overturns Ruling That Grasso Must Return Part of Compensation.

Court Enters Fraud Judgment Against Investment Adviser

The federal district court in the Southern District of New York entered a final judgment against defendant Francis J. Saldutti ("Saldutti"), permanently enjoining Saldutti from violating the antifraud provisions of the federal securities laws and requiring him to pay more than $5,082,138 in disgorgement and prejudgment interest. Saldutti consented to entry of the final judgment without admitting or denying the allegations of the Commission's Second Amended Complaint.SEC v. Northshore Asset Management, et al., CV 05-2192 (WHP) (S.D.N.Y.).

The SEC's original complaint alleged that, in April 2003, defendant Northshore Asset Management LLC ("Northshore") and its three principals, defendants Kevin Kelley ("Kelley"), Glenn Sherman ("Sherman"), and Robert Wildeman ("Wildeman") (together, the "Northshore Defendants"), purchased Saldutti Capital Management, L.P. ("SCM") from Saldutti and thereby obtained control over two hedge funds, Ardent Research Partners L.P. and Ardent Research Partners Ltd. (together, the "Ardent Funds"). Kelley, Sherman, and Wildeman proceeded fraudulently to divert tens of millions of dollars of the Ardent Funds' cash assets to their own personal use, including purported personal loans and self-dealing investments. Consequently, by early 2005, the Ardent Funds became illiquid and were unable to meet investor redemption requests.  Subsequently the SEC amended its complaint to add securities fraud and investment adviser fraud claims against Saldutti, the Ardent Funds' founder and investment adviser, and Douglas Ballew, Northshore's former CFO. The SEC alleged that after his sale of SCM to the Northshore Defendants, Saldutti remained as the portfolio manager of the Ardent Funds and became a part owner, creditor, and employee of Northshore. The Commission alleged that Saldutti failed to disclose adequately, and made affirmative misrepresentations regarding, the sale of SCM to Northshore and his numerous conflicts of interest to the Ardent Funds and the Ardent Funds' investors. The Commission also alleged that Saldutti failed to disclose adequately, and made affirmative misrepresentations regarding, his transfer of tens of millions of dollars of Ardent Funds' cash from their prime brokerage accounts to Northshore-controlled accounts. The Commission further alleged that Saldutti failed to disclose certain material facts to two new investors that he welcomed to the Ardent Funds in late 2004, including the fact that Kelley had been arrested and charged with unrelated investment advisers fraud in early December 2004.

SEC Files Backdating Charges Against Microtune and its former CEO and CFO/GC

The SEC filed civil fraud charges relating to backdating stock options against Microtune, Inc. and two former senior officers—former Chairman and Chief Executive Officer Douglas J. Bartek and former Chief Financial Officer and General Counsel Nancy Richardson. The SEC alleged that Bartek and Richardson perpetrated a fraudulent and deceptive stock option backdating scheme that awarded themselves and other employees millions of dollars in undisclosed compensation. The SEC's complaint, filed in the federal district court for the Northern District of Texas, alleges that Bartek, with assistance from Richardson, routinely backdated the date on which he granted stock options to senior executives and other employees. To conceal the scheme, as alleged, Bartek directed others to backdate employment records, including offer letters, to establish falsified start dates and grant dates that preceded the actual dates the new hires began working for Microtune.

The SEC's complaint further alleges that Bartek and Richardson caused Microtune to grant backdated options, cancel those options after the company's stock price dropped precipitously, and subsequently re-grant the same options at a substantially lower exercise price. According to the SEC's complaint, the re-grants were not, as required, accounted for using variable accounting, in part because, as alleged, Richardson and Bartek concealed the nature of the re-grants from Microtune's outside auditors and others.

Without admitting or denying the SEC's allegations, Microtune agreed to an permanent injunction. The SEC's litigated action against Bartek and Richardson seeks injunctive relief, disgorgement of wrongful profits, civil monetary penalties, officer and director bars, and reimbursement of profits from stock sales pursuant to Section 304 of the Sarbanes-Oxley Act of 2002

SEC Releases Text of Proposed Changes to SEC Rules Relating to Credit Ratings

The SEC published for public comment proposed rule changes that are intended to make the limits and purposes of credit ratings clear to investors and to ensure that the role assigned to ratings in SEC rules is consistent with the objectives of having investors make an independent judgment of credit risks.  The SEC voted on June 25, 2008, to issue for public comment this third set of proposed recommendations to bring increased transparency to the credit ratings process and curb practices that contributed to recent turmoil in the credit markets. The Commission voted to propose the first two sets of recommendations on June 11, 2008.

Today's proposed rule changes are set forth in three releases:

Rel. 34-58070

Rel. 33-8940

Rel. IC-28327

9th Circuit Decides Misappropriation Case in Favor of SEC

In an important case on the scope of the misappropriation theory of inside trading under Rule 10b-5, the 9th Circuit held that a director of a corporation could be held liable when he purchased shares in another corporation because of information that he learned about that corporation in his capacity as director of the first corporation, even though the SEC did not establish that the director's corporation had promised the other corporation to keep the information confidential.  Talbot sat on the board of Fidelity, which owned a 10% interest in Lending Tree.  At a Fidelity board meeting Talbot learned that Lending Tree was going to be acquired (or might be acquired) by a third party at a very attractive price.  Two days later, Talbot began purchasing Lending Tree shares, which he subsequently resold at a profit when a Lending Tree acquisition was announced.

The lower court granted summary judgement for defendant, because it interpreted the misappropriation theory as requiring a duty of confidentiality between Lending Tree and Fidelity as well as between Fidelity and Talbot.  In contrast, the SEC agreed with the SEC that the misappropriation theory focused on the duty that Talbot owed to Fidelity to keep the information confidential and his secret violation of that duty.  As a member of Fidelity's board of directors, Talbot was in a relationship of trust and confidence with Fidelity and could not use the information for his own personal benefit.  The 9th Circuit's opinion relies heavily on Professor Barbara Aldave's influential Hofstra Law Review article that the Supreme Court also cited in the O'Hagan case.

However, the 9th Circuit did not agree with the SEC that the information about Lending Tree's acquisition was material as a matter of law and instead agreed with the district court that its materiality presented a genuine issue of material fact, since there was evidence that the acquisition talk was just a rumor.  SEC v. Talbot (9th Cir. June 19, 2008).

No Venture IPOS in Second Quarter

There were no venture-based companies making IPOs in the second quarter, for the first time in 30 years, according to a report by the National Venture Capital Associates and Thomson Reuters.  The reasons -- nervous investors and lack of available funding.  WPost, Venture-Backed IPO Tally: Zero.

Auction Rate Securities Cases Lead to Uptick in Arbitration Filings

The number of new arbitration filings at FINRA are up somewhat over 2007, after dramatic decreases since the peak of 2003, and the increase in customer disputes has been largely attributed to auction rate securities (ARS) cases, where customers allege that they were sold the ARS on the representation that these were liquid securities and were not told of liquidity risks.  Last week, as we reported, the Massachusetts Securities Division brought a complaint against UBS for its sales practices and conflicts of interest involving ARS, complete with internal memoranda where UBS employees spell out the aggressive sales efforts used to sell the ARS underwritten by UBS in the face of market resistence to them.  Investment News reports that plaintiffs' tort attorneys are heavily advertising their services to represent investors whose ArS have become illiquid, much to the ire of the brokerage firms, who insist that they are trying to work out the difficulties with their customers.  InvNews, Attorneys see gold in auction rate mire.  The last time personal-injury lawyers sought out investors' arbitration claims was the tainted analysts scandal, when Eliot Spitzer released investment banks' internal emails that disparaged the securities the analysts were promoting.  To the surprise of some attorneys, who saw these cases as easy picking, the outcomes did not go well for investors, as arbitration panels generally were skeptical that investors' losses were due to the analysts' reports, rather than the tech crash.  It remains to be seen how the ARS claims will work themselves out.

Davidoff on The Failure of Private Equity

The Failure of Private Equity, by STEVEN M. DAVIDOFF, University of Connecticut School of Law; Ohio State University - Michael E. Moritz College of Law, was recently posted on SSRN.  Here is the abstract:

Throughout the Fall 2007 and into the new year 2008 private equity firms repeatedly attempted to terminate pending acquisitions. The litigation surrounding these purported terminations and heightened scrutiny directed upon the terms of private equity agreements opened a revealing window on a number of supposed "flaws" in the private equity structure. This Article seeks to understand whether these failures existed, and if so, what caused them. It does so by examining the forces driving the construct and evolution of private equity and the rationale for private equity's structure and specific contractual terms. I find that the private equity contract, the structure of private equity, is a rich, textured environment. The terms of the contractual relationships between the private equity firm and the acquired company are analogous to an iceberg; they form only the publicly available view of a much deeper understanding between the parties. In the non-public sphere, parties to private equity contracts utilize norms, conventions, reputational constraints, language and relational bonding to fill contractual gaps, override explicit contractual terms, and achieve a negotiated solution beyond the four corners of the contract. The attorney as transaction cost engineer in the private equity context consequently structures the private equity contract by paying heed both to contractual terms and law, contractually created forces and non-legal factors. But attorney reliance on these extra-contractual factors and forces makes the private equity structure path dependent and resistant to change. In light of these findings, the failures of the pre-Fall 2007 private equity structure were particularly a failure by attorneys to innovate and negotiate terms in full contemplation of such events. Reliance upon extra-legal forces permitted attorneys to leave private equity contracts incomplete and otherwise justified sloppy and ambiguous drafting. The result was a number of contract breaches and purported terminations by private equity firms with uneconomic consequences for targets subject to these failed acquisition attempts.

Fed Releases Minutes of Bear Rescue

The Fed released the minutes of its March 14 and March 16 meetings, in which it approved the rescue of Bear Stearns, which show that the members felt that its actions were necessary to prevent further instability in the markets.

Senate Confirms New SEC Commissioners

Apparently the Senate confirmed the nominations of Troy Paredes, Luis Aguilar and Elisse Walter to the SEC today, since Chairman Cox referred to three new Commissioners, although it seems odd that he didn't name them:

"The President and the Senate have given the SEC three outstanding Commissioners. I look forward to welcoming them to their important positions of leadership in the finest securities regulatory agency in the world. The SEC has laid out an ambitious agenda to improve investor protection and financial markets regulation, and a full complement of Commissioners will help us achieve those important objectives."

Note the Chairman's reference to the SEC's "ambitious agenda."  CFO.com has an interesting article disclosing internal SEC memoranda from Mr. Cox that express his displeasure at recent criticism of his less-than-central involvement in the bailout of Bear Stearns and reports of the agency's demise.  CFO.com, Angry Cox Expects SEC to Grow, Not Die.

SEC Proposed Amendments to Rule 15a-6 (Foreign Broker-Dealers)

The SEC has posted to its website the text of its proposed amendments to Rule 15a-6, which provides conditional exemptions from broker-dealer registration for foreign entities engaged in certain activities involving certain U.S. investors. The purpose of the amendments, according to the SEC, is to reflect increasing internationalization in securities markets and advancements in technology and communication services.  The proposed amendments would update and expand the scope of certain exemptions for foreign entities. 

FINRA's Messages on Weathering Tough Times

FINRA appears to be taking a broader view of its investor protection and education roles and has recently taken to giving investors advice/warnings about weathering tough financial times.  In a recent Investor Alert, for example, FINRA warns about the dangers of excessive debt and cash-strapped individuals making ill-advised decisions such as prematurely deleting their retirement accounts, tapping into home equity through reverse mortgages, or selling their life insurance through life settlements.  It also offers tips such as keeping track of expenses and paying off high-interest debt.  FINRA CEO Mary Schapiro expressed similar warnings in a recent speech to a Women in Housing and Finance meeting in Washington, DC.

I have to confess I have a great deal of skepticism about FINRA's efforts.  First, the message seems unlikely to reach its intended audience.  Are cash-strapped individuals reading the FINRA website or paying attention to speeches in Washington D.C.?  Second, I suspect that cash-strapped individuals who may have lost their homes to foreclosure, may be unable to pay for increasing food, gas and health costs, don't need to be told that cashing out their retirement savings (if any)and entering into life settlements or reverse mortgages are bad ideas.  They make these decisions because they do not see any other solutions.  Similarly, suggestions to cut expenses or pay down credit card debt are probably not feasible for many individuals.  While these attempts at investor education may be benign, I think they are misguided.  FINRA can't solve the problem of people who, for whatever reason, don't have enough money to live and don't know how to fund their retirement. Instead, FINRA should focus on its primary responsibility -- eliminating the financial professionals who prey on the financially insecure.

Seventh Circuit Affirms Conviction of Conrad Black

The U.S. Court of Appeals for the Seventh Circuit affirmed the convictions of Conrad Black and other senior executives of Hollinger International for mail and wire fraud.  In an opinion authored by Judge Posner, the court rejected all of the defendants' arguments, finding that there was sufficient evidence for the jury to find that the defendants committed a conventional fraud, a theft of money from Hollinger by misrepresentations.  The opinion focused, in particular, on defendants' arguments that they could not be convicted for scheming to deprive Hollinger of its right to the "honest services" of its corporate officers, for the purpose of "private gain," because their objective was to achieve a gain at the expense of the Canadian government (favorable tax treatment), not at the expense of Hollinger.  The court rejected this as a "no harm-no foul" argument that "usually fare badly" in criminal cases.  There was "no doubt that the defendants received money ... and very little doubt that they deprived Hollinger of their honest services."  U.S. v. Black (7th Cir. June 25, 2008).

SEC Approves One-Year Extension of Auditor Attestation for Non-Accelerated Filers

On June 26 the SEC approved a one year extension of temporary rule and form amendments that postpone the date by which companies that are non-accelerated filers must begin to comply with the auditor attestation report on internal control over financial reporting (ICFR) mandated by Section 404(b) of the Sarbanes-Oxley Act of 2002. Under the extension, a non-accelerated filer will need to provide its first auditor's attestation report on internal control over financial reporting in an annual report for a fiscal year ending on or after December 15, 2009.  The effective date of the amendments will be 60 days from their publication in the Federal Register.

SEC Proposes Standards for Determining When Equity-Indexed Annuities are Securities

The SEC released the text of its proposed rule that would set forth the standards for determining whether equity-indexed annuities (EIAs) are securities or insurance products.  As the SEC describes in the release, the proposed rule would prospectively define certain indexed annuities as not being “annuity contracts” or “optional annuity contracts” under the statutory insurance exemption if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract.  According to the release:

The proposed definition would hinge upon a familiar concept: the allocation of risk. Insurance provides protection against risk, and the courts have held that the allocation of investment risk is a significant factor in distinguishing a security from a contract of insurance. ...

Individuals who purchase indexed annuities are exposed to a significant investment risk – i.e., the volatility of the underlying securities index. ... Indexed annuities are attractive to purchasers because they promise to offer market-related gains. Thus, these purchasers obtain indexed annuity contracts for many of the same reasons that individuals purchase mutual funds and variable annuities, and open brokerage accounts.

The federal interest in providing investors with disclosure, antifraud, and sales practice protections arises when individuals are offered indexed annuities that expose them to securities investment risk. Individuals who purchase such indexed annuities assume many of the same risks and rewards that investors assume when investing their money in mutual funds, variable annuities, and other securities. However, a fundamental difference between these securities and indexed annuities is that – with few exceptions – indexed annuities historically have not been registered as securities. As a result, most purchasers of indexed annuities have not received the benefits of federally mandated disclosure and sales practice protections.

Massachusetts Files Complaint Against UBS for Marketing of Auction Rate Securities

The Massachusetts Securities Division has filed a complaint against UBS Securities LLC and UBS Financial Services, alleging violations of the Massachusetts Uniform Securities in connection with the sale of auction rate securities (ARS) to retail customers.  According to the complaint, the sales were typically made with the express representation that the investments were liquid, safe, money-market instruments, whose interest rates would reset at periodic auctions, and that they could be sold at the next auction.  Instead, as UBS knew, no true auctions existed for many of these securities.  In addition, UBS failed to disclose to its customers the conflicts of interest because of UBS's dual role in underwriting the securities and selling them to their customers.  The requested relief includes requiring UBS to offer rescission of the ARS sales at par, censure, and administrative fines.  In re UBS Securities, LLC (filed June 26, 2008).