Securities Law Prof Blog

SEC Staff Issues Warning on Cal. IOUs

The SECstaff today issued the following statement:

The staff of the Securities and Exchange Commission has expressed its belief that California’s recently-issued IOUs are “securities” under federal securities law. As such, holders of these IOUs and those who may purchase them are protected by the provisions of the federal securities laws that prohibit fraud in the purchase or sale of securities.

California began issuing the IOUs (called “registered warrants” by California) on July 2 to certain individuals and entities, including citizens who were entitled to a tax refund or vendors who were entitled to payments. The IOUs are obligations of the State of California, are negotiable, and bear interest. The staff’s view that the IOUs are securities does not affect California’s right to issue or repay the IOUs.

In addition to the antifraud provisions of the federal securities laws, other parts of the federal securities laws also apply to the purchase and sale of the IOUs. Persons acting as intermediaries between buyers and sellers of the warrants may need to register as brokers, dealers or municipal securities dealers, or as alternative trading systems or national securities exchanges.

Broker-dealers, as well as any potential secondary markets, should be aware that the requirements of the securities laws and the rules of the Municipal Securities Rulemaking Board apply to the IOUs.

Finally, although the IOUs are labeled “registered warrants,” they are not registered with the SEC. There is no registration requirement that applies because the IOUs are municipal securities.

SEC Charges Russian Firm with Manipulating Stocks Through Innocent Victims' Accounts

The SEC filed a complaint in the United States District Court for the Southern District of New York charging Russian entity Pointer Worldwide Ltd and its officer, Tatiana Badmaeva, with participating in a fraudulent scheme to manipulate the prices of four New York Stock Exchange and Nasdaq traded securities through the unauthorized use of innocent victims' online brokerage accounts between June 18, 2008 and June 20, 2008.  In just three days of trading involving a combination of buys, sales and short sales, Pointer Worldwide and Badmaeva generated a net profit of $33,113.75 trading in the four securities.

The Commission's action charges Pointer Worldwide and Badmaeva with violations of the antifraud and seeks permanent injunctive relief, disgorgement and civil money penalties.

Pace Investor Rights Clinic Investor's Guide to Securities Industry Disputes

The Pace Law School Investor Rights Clinic has published an Investors' Guide to Securities Industry Disputes( Securities Dispute Guide).  This extremely useful guide first provides basic information on how to avoid disputes with brokers and sets forth investors' rights and responsibilities.  It then provides information on the dispute resolution process, including both arbitration and mediation.  The Guide contains practical information in a very readable format.  Kudos to its editors Jill Gross and Alice Oshins. 

SEC's Investor Advisory Committee Announces Public Meeting

The SEC's newly-formed Investor Advisory Committee will hold a public meeting on July 27, 2009, at the SEC's main offices at 10 a.m. It will be open to the public and webcast. The public is invited to submit written statements to the Committee.  The agenda for the meeting includes opening remarks, introduction of Committee members, discussion of Committee agenda and organization, and discussion of investor views of possible refinements to the disclosure regime.

Former CFO of UCI Medical Affiliates Settles Fraud, Embezzlement Charges with SEC

The SEC filed a Complaint in the United States District Court for the District of South Carolina against Jerry F. Wells, Jr. ("Wells"), a former Executive Vice President and Chief Financial Officer of UCI Medical Affiliates, Inc. ("UCI" or the "Company"), a provider of nonmedical management and administrative services based in South Carolina.  The Complaint alleges that between 2003 and 2008, Wells embezzled approximately $2.97 million from UCI through a variety of measures, including submitting unsupported check requests for non-business expenses, including construction work on Wells' personal residences and personal credit card accounts. The Complaint further alleges that Wells capitalized the expenses as fixed assets on the Company's balance sheet, causing UCI to overstate its net earnings in the affected periods. According to the Complaint, to justify capitalizing these expenses, Wells altered invoices from contractors performing work on his personal residences to suggest that the work was for one of UCI's facilities, and provided fraudulent work descriptions on the related check requests. The Complaint also alleges that Wells signed each of the Company's Forms 10-Q and 10-K and accompanying Sarbanes-Oxley certifications, thereby misrepresenting that they did not contain any untrue statements of material fact. The Complaint further alleges that, in connection with the audit of the Company's annual financial statements, Wells also signed multiple management representation letters to UCI's auditors, thereby misrepresenting that the Company's financial statements were prepared in conformity with GAAP.

 Without admitting or denying the allegations in the complaint, Wells consented to the entry of an order (1) enjoining him from violating these statutes and rules and (2) barring him from serving as an officer and director of a public company.

SEC Charges New York Broker-Dealer with $61 Million Boiler Room Fraud

On July 8, 2009, the SEC filed a civil injunctive action in the United States District Court for the Southern District of New York alleging that a New York based broker-dealer, Sky Capital LLC a/k/a Granta Capital LLC (Sky Capital) used fraudulent boiler room tactics between September 2002 and November 2006 to raise more than $61 million from investors in two related companies — Sky Capital Holdings Ltd. and Sky Capital Enterprises, Inc. (the Sky Entities). The Commission also charged Sky Capital's founder, former President and CEO, Ross Mandell, the firm's former COO, Stephen Shea, and four registered representatives, Adam Harrington Ruckdeschel, Arn Wilson, Michael Passaro, and Robert Grabowski, for orchestrating and participating in the fraudulent scheme designed to fraudulently induce numerous individuals to invest in the Sky Entities.

According to the Commission's complaint, Mandell orchestrated the fraudulent scheme with the assistance of Shea and the other defendants. According to the complaint, Mandell directed Sky Capital brokers to make material misrepresentations, and fail to disclose material information, to induce their Sky Capital customers to purchase stock in the Sky Entities. Mandell also personally made material misrepresentations to his customers. Additionally, the defendants implemented and enforced a "no-net sales" policy, which had the effect of preventing investors from selling their Sky Entities' stocks that were otherwise publicly traded on the Alternative Investment Market of the London Stock Exchange. The no-net sales policy had the effect of artificially inflating the price of the Sky Entities' stocks. Moreover, as a result of the "no-net sales" policy, which the defendants did not disclose to their customers, numerous Sky Capital investors were unable to sell their shares in the Sky Entities before trading in those stocks was suspended thereby rendering the investments worthless.

The SEC's complaint charges each of the defendants with violations of the antifraud provisions and seeks a final judgment permanently enjoining the defendants from future violations of the above provisions of the federal securities laws, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and ordering them to pay civil penalties. The complaint also seeks to permanently prohibit Mandell from acting as an officer or director of any registered public company.

SEC Obtains Asset Freeze in Alleged $485 Million Ponzi Scheme

On July 2, 2009, the SEC obtained a temporary restraining order and emergency asset freeze in yet another alleged Ponzi scheme, this one a $485 million offering fraud run by three individuals (Paul R. Melbye, Brendan W. Coughlin and Henry D. Harrison) through a company they owned and controlled, Provident Royalties LLC. In addition to the asset freeze, the court has appointed a receiver to preserve and marshal assets for the benefit of investors.

The Commission alleges that from at least June 2006 through January 2009, Provident made a series of fraudulent offerings of preferred stock and limited partnership interests for the purpose of generating promised returns through investments in oil and gas assets. The complaint alleges the sales were made through 21 affiliated entities to more than 7,700 investors throughout the United States. It is also alleged that Provident Asset Management, LLC, an affiliated broker-dealer, made some direct retail sales of securities, but primarily solicited unaffiliated retail broker-dealers to enter into placement agreements for each offering, and those retail broker-dealers sold the stock to retail investors nationwide.

According to the Commission's complaint filed in U.S. District Court for the Northern District of Texas, Provident falsely promised yearly returns of up to 18 percent and misrepresented to investors that 85 percent of the funds raised through the offerings would be used to purchase interests in oil and gas real estate, leases, mineral rights, and interests, exploration and development. The Commission alleges that, in fact, less than 50 percent of investor funds were used for their stated purpose, and the proceeds from later offerings were used to pay expenses related to earlier offerings and returns to investors in those offerings.

The complaint seeks a temporary restraining order and preliminary and permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest and financial penalties. Officer and director bars are sought against Melbye, Harrison and Coughlin. Five affiliated entities that did not sell securities are named as relief defendants for purposes of disgorgement.

New York AG Announces Two More Assurances of Discontinuance in ARS Settlements

The New York Attorney General announced Assurances of Discontinuance with Credit Suisse Securities LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated relating to the auction rate securities settlements reached last summer. The Assurances detail how the firms have and will continue to provide liquidity to investors who purchased auction rate securities.  Last year the New York AG and other regulators settled allegations with eleven securities firms that theymade misrepresentations in their marketing and sale of auction rate securities.  The New York AG's website has posted the eleven Assurances. The settling firms are Banc of America Securities LLC and Banc of America Investment Services, Inc., Citigroup Global Markets, Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., Goldman, Sachs & Co., JPMorgan Chase & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley & Co. Inc., RBC Capital Markets Corporation, UBS Securities LLC and UBS Financial Services LLC, and Wachovia Securities LLC and Wachovia Capital Markets LLC.

Former HealthSouth CFO Speaks on Ethics

CFO.com runs an interview with Aaron Beam, a former HealthSouth CFO who admitted to cooking the books during 1996-97 and who served three months in a minimum security prison.  He is currently mowing lawns and speaking to business students on ethics.  The bottom line -- "I Should Have Said No."

Schwartz on Mutual Fund Conflicts

Mutual Fund Conflicts of Interest in the Wake of the Short-Term Trading Scandals: Encouraging Structural Change Through Shareholder Choice, by Jeff Schwartz, California Western School of Law, was recently posted on SSRN.  Here is the abstract:

This piece contends that the way mutual funds are typically organized incentivizes fund managers to put their own interests ahead of fund shareholders. It goes on to argue that the legal regime in place to protect investors from such abuse is flawed, and that the late trading and market timing scandals that came to light several years ago, among other harms that shareholders have endured, illustrate the need for substantive reform.

Investors would be best served, I argue, if mutual funds were organized in an alternate fashion - one which alleviates the conflicts of interest motivating management overreaching. The article concludes that a restructuring is possible through informed shareholder choice, but for this to occur the SEC must take steps to create a more knowledgeable investor base.

Vega on SOX Whistleblowers

The Sarbanes-Oxley Act & the Culture of Bribery: Expanding the Scope of Private Whistleblower Suits to Overseas Employees, by Matt A Vega, Faulkner University, Thomas Goode Jones School of Law, was recently posted on SSRN.  Here is the abstract:

This Article makes a case for using a private right of action to protect overseas employees from retaliation by their employers for reporting or opposing the bribery of foreign officials. After surveying public enforcement efforts, voluntary corporate initiatives, and existing private causes of action that may be predicated on FCPA violations, the Article finds that they all have their shortcomings and recommends several legal and legislative solutions. First, a private cause of action for retaliation should be implied under the FCPA. Second, section 806 of the Sarbanes- Oxley Act of 2002 should be read to protect whistleblowers who disclose FCPA violations by publicly held U.S. companies. Third, the territorial scope of section 806 should be expanded to cover employees working overseas. The Article takes issue with the First Circuit’s decision in Carnero v. Boston Scientific Corp., which declined to extend section 806 whistleblower protection to a foreign employee of a foreign subsidiary of a publicly held U.S. company. The Article then explores two alternative approaches to extraterritoriality suggested in the Southern District of New York court’s recent decision in O’Mahony v. Accenture Ltd. to support prescriptive jurisdiction in such cases: the 'conduct' and 'effects' tests. Alternatively, it argues section 806 and the administrative complaint procedures from AIR21 it incorporates by reference should be amended to provide specific procedures for employees overseas to bring whistleblower complaints. Finally, the Article endorses the Foreign Business Bribery Prohibition Act of 2008, H.R. 6188, which is expected to be reintroduced by Congressman Ed Perlmutter in the 111th Congress, to authorize private suits for treble damages against foreign concerns whose bribery costs American businesses and their employees.

SEC Blew Chance to Expose Madoff's Fraud in 2004

Fascinating article in today's Washington Post: Zachary Goldfarb reports that in 2004 an SEC staff attorney in Compliance, Inspections and Examinations (who previously worked at the American Stock Exchange and understood complicated trading strategies) figured out that there was something wrong with the way Madoff was running his business and submitted a list of detailed questions to her supervisor to pursue the investigation.  However, her supervisor told her to turn her attention to mutual funds; at that time the SEC was feeling the heat because the New York Attorney General's market-timing investigations made the SEC look bad.  The Madoff inquiry went nowhere, and the SEC attorney left the agency in 2006, complaining of a hostile work environment.  WPost, Staffer at SEC Had Warned Of Madoff Lawyer Raised Alarm, Then Was Pointed Elsewhere.

SEC Proposes Revisions to Proxy Disclosures on Compensation and Corporate Governance

The SEC proposed a set of rule revisions intended to improve the disclosure provided to shareholders of public companies regarding compensation and corporate governance matters in proxy and information statements.  They include information about:

• The relationship of a company's overall compensation policies to risk.
• The qualifications of directors, executive officers and nominees.
• Company leadership structure.
• Potential conflicts of interests of compensation consultants.

In addition, the proposals are aimed to improve the reporting of annual stock and option awards to company executives and directors as well as to require quicker reporting of election results. The Commission also proposed amendments to the proxy rules intended to clarify how they operate.

SEC Votes to Eliminate Broker Discretionary Voting for Uncontested Directors' Elections

The SEC voted to approve an NYSE proposal that would eliminate broker discretionary voting for all elections of directors, whether contested or not. Currently, NYSE Rule 452 and corresponding Listed Company Manual Section 401.08 permit brokers to vote on behalf of their beneficial owner customers in uncontested elections of directors if the customers have not returned voting instructions.  While the NYSE filed this proposed rule change with the SEC years ago, the SEC did not publish it for public comment until March 6, 2009.  It received 153 comment letters from issuers, transfer agents, institutional investors, proxy advisory firms and others.

The NYSE's proposal is designed to enhance corporate governance and accountability by helping assure that investors with an economic interest in the company vote on the election of directors. It also would address concerns that broker discretionary voting for directors has impacted election results.

Specifically, the NYSE proposal would add "election of directors" to the list of enumerated items for which a member generally may not give a proxy to vote without instructions from the beneficial owner. The proposal contains a specific exception for companies registered under the Investment Company Act of 1940. In addition, the NYSE proposes to codify two previously published interpretations that do not permit broker discretionary voting for material amendments to investment advisory contracts with an investment company.

The NYSE's proposal will apply to shareholder meetings held on or after Jan. 1, 2010. The SEC's approval order will be published in the Federal Register and posted on the SEC Web site as soon as possible.

SEC Charges Former Beazer Homes Accounting Officer with Multi-Year Fraud

The SEC filed a civil complaint against Michael T. Rand, the former chief accounting officer of Atlanta-based home builder Beazer Homes, USA, Inc., alleging that he conducted a multi-year fraudulent earnings management scheme and misled Beazer’s outside auditors and internal Beazer accountants in order to conceal his wrongdoing.

The Commission alleges that Rand fraudulently decreased Beazer’s reported net income by recording improper accounting reserves during certain periods between 2000 and 2005 in order to meet or exceed analysts’ expectations for Beazer’s diluted earnings per share (EPS) and maximize yearly officer and senior employee bonuses. Rand began reversing these improper reserves beginning in the first quarter of fiscal year 2006 in order to offset Beazer’s declining financial performance.

The Commission’s Complaint also alleges that in fiscal year 2006 and the first two quarters of fiscal year 2007, Rand improperly recognized revenue from the sale and leaseback of certain model homes on Beazer’s financial statements and used secret side agreements in order to hide his misconduct from Beazer’s outside auditors. Cumulatively, Rand’s actions caused Beazer to understate its income in SEC filings by approximately $63 million during fiscal years 2000 to 2005, representing approximately 7 percent of Beazer’s cumulative actual restated net income of $955 million for the period. Rand’s fraudulent actions caused Beazer to overstate its income and understate its loss by a total of $47 million during fiscal 2006 and the first two quarters of fiscal 2007, representing 20 percent of Beazer’s cumulative actual restated net income of $232 million for the period.

The Commission’s complaint seeks a permanent injunction, disgorgement of Rand’s ill-gotten gains plus prejudgment interest, and a financial penalty.  The SEC also seeks a court order barring Rand from acting as an officer or director of any public issuer.

SEC Proposes Shareholder Approval of Exec Compensation Rule Applicable to TARP Recipients

The SEC proposed amendments to the proxy rules to set forth certain requirements for U.S. registrants subject to Section 111(e) of the Emergency Economic Stabilization Act of 2008, which requires companies that have received financial assistance under the Troubled Asset Relief Program (“TARP”) to permit a separate shareholder advisory vote to approve the compensation of executives, as disclosed pursuant to the compensation disclosure rules of the Commission, during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding. The proposed amendments are intended to help implement this requirement by specifying and clarifying it in the context of the federal proxy rules. Comments on the proposed rule are due 60 days after publication in the Federal Register.

SEC Brings Action Alleging Sales of Fraudulent and Unsuitable Variable Annuities Through Free-Lunch Seminars

The SEC today instituted an enforcement action against Prime Capital Services (PCS), a Poughkeepsie, N.Y.-based firm, and several representatives and supervisors for their alleged roles in fraudulent and unsuitable sales of variable annuities to senior citizens who were lured through free-lunch seminars at restaurants in south Florida.  The SEC alleges that PCS recruited elderly investors to attend the seminars, after which the seniors were encouraged to schedule private appointments with PCS representatives who then induced them to buy variable annuities. The sales pitches allegedly concealed high costs, lock-in periods, and other material information. While the firm and its representatives earned millions of dollars in sales commissions, the Division alleges that many of the variable annuities were unsuitable investments for the customers due to their age, liquidity, and investment objectives.

According to the SEC's order instituting proceedings, PCS is a registered broker-dealer and wholly-owned subsidiary of Gilman Ciocia, Inc. (G&C), an income tax preparation business headquartered in Poughkeepsie that offers financial services in New York, New Jersey, Pennsylvania and Florida. The individuals named in the SEC's order were G&C employees during the time of the alleged misconduct.

An administrative law judge will determine whether the allegations against the respondents are true and, if so, whether they should be ordered to cease and desist from future violations and whether remedial sanctions and penalties are appropriate and in the public interest.

Merkin's Art Collection to be Sold and Funds Placed in Escrow Pending Resolution of New York AG's Suit

STATEMENT FROM ATTORNEY GENERAL ANDREW CUOMO ON THE SALE OF J. EZRA MERKIN'S ART COLLECTION:

"Earlier this morning in New York State Supreme Court, my Office submitted a stipulation and order regarding the impending sale of J. Ezra Merkin's art collection for $310 million. The art was owned by Mr. Merkin and his wife. This sale will yield, after liens, taxes, and fees, approximately $191 million that will be restrained and frozen in an escrow account pending resolution of the case against Mr. Merkin. This will preserve assets that, if our litigation is successful, will provide restitution to victims of Mr. Merkin's alleged fraud.

The art sale order submitted today was the product of weeks of extensive negotiation. Based on an appraisal performed by Christie's at the request of my Office, we believe the sale price of $310 million is fair, appropriate, and in the best interests of investors. I want to thank Christie's for their work on this matter.

We believe it is only fair that Mr. Merkin liquidate his valuable art collection, which he purchased with the fees he earned from his investors, and keep the proceeds in escrow pending resolution of our lawsuit. The $191 million that will be preserved in this way will not by itself make investors whole, but this is an important step in the right direction for investors.

We will continue to seek full recovery for investors' losses through the ongoing action against Mr. Merkin, which charges him with concealing from his clients the investment of more than $2.4 billion with Bernard L. Madoff. As detailed in the 54-page complaint we previously filed, investors, including several prominent charities and non-profits, entrusted their investments to Mr. Merkin, who then steered the money to Madoff without their permission, in exchange for $470 million in management and incentive fees."

FINRA Fines Firm and Former Broker for Improper Communications with Interdealer Brokerage Firms

FINRA announced that it has fined ICAP Corporates LLC, of Jersey City, $2.8 million and sanctioned a former broker for numerous improper communications with other interdealer brokerage firms about customers' proposed brokerage rate reductions in the wholesale credit default swap (CDS) market. 

Jennifer Joan James, a former ICAP broker and manager of ICAP's CDS desk, was fined $350,000 and suspended from working in the securities industry in all capacities for six months for attempting to improperly influence other interdealer brokerage firms and their employees. ICAP was fined $1.8 million for its supervisory failures — specifically, failing to detect and prevent improper inter-firm communications — and $1 million for engaging in conduct through its CDS desk manager that was designed to improperly influence other firms and their employees. 

CDS instruments generally enable counterparties to purchase and sell "risk protection" associated with certain credit events (such as bankruptcies, defaults or credit downgrades in underlying instruments). The risk protection purchaser generally pays a periodic fee to the seller, and the seller agrees to pay the purchaser an agreed-upon amount should one of those credit events occur. Interdealer brokerage firms provide an intermediary brokerage service to commercial and investment banks in the wholesale markets to identify and match counterparties for such CDS transactions. The firm receives brokerage fees for successfully introducing buying and selling counterparties (its brokerage customers) but is not a party to the CDS transactions themselves.

 FINRA found that James engaged in repeated improper communications with personnel at other interdealer brokerage firms that improperly attempted to influence those firms and individuals. These communications generally occurred after individual customer firms sought to renegotiate their CDS brokerage fees, sending schedules of proposed rate reductions separately to a number of individual interdealer brokers. James's communications with personnel at other interdealer brokers included reactions to customers' proposed rate reductions, statements concerning actual or contemplated interdealer broker responses or counter-positions to the customers' proposed rate reductions, and discussions about the interdealer brokers creating identical or similar, individual counter proposals to rate reduction requests.

 FINRA also found that while James's communications typically involved one-to-one discussions with personnel from one other CDS interdealer brokerage firm, the communications frequently referred to similar discussions about the proposed fee-reduction schedules with additional interdealer brokerage firms.

ICAP and James settled these matters without admitting or denying the allegations, but consented to the entry of FINRA's findings.

FINRA's investigation into misconduct by the other interdealer brokerage firms and individuals involved is continuing.

FINRA Announces Initiatives Involving Municipal Securities

Concerns have been expressed that municipal securities would be the next big headline fraud, as retail investors engage in the perennial search for safety with higher returns than CDs.  Today FINRA announced initiatives to survey retail sales practices in the municipal securities market, promote investor protection in that market and give retail investors online tools and information that will help them make informed investment decisions when trading in that market.

FINRA investigators currently are conducting sweeps to gather information in three distinct areas. One broad sweep is looking at industry sales and supervisory practices with respect to sales of municipal bonds to retail investors. Firms are being asked to provide FINRA with detailed data on a range of retail muni bond transactions during the first quarter of this year. The requested information includes sales data, marketing data, pricing data and procedures, disclosure practices, customer complaints and supervisory procedures and practices.

 A second, more targeted sweep is examining potential conflicts, disclosure practices and marketing by firms underwriting municipal securities involving swaps and derivatives for small municipalities. These highly complex instruments typically allow municipalities to finance debt with lower variable interest rates than they would receive through a fixed offering, but involve significant interest rate and repayment acceleration risks through the swap contracts - something that has recently caused much-publicized financial distress for municipalities such as Jefferson County, AL, and the Erie, PA, School District. A third, narrowly targeted sweep is seeking information from firms that engaged in retail sales of certain so-called municipal Gas Bonds that were underwritten and guaranteed by the now-defunct Lehman Brothers and quickly became distressed.

 Also as part of its municipal bond initiative, FINRA today issued a Regulatory Notice to securities firms and brokers reminding them of their ongoing obligation to disclose material information to customers - including changes in the financial condition of the issuing municipality - as well as their obligations regarding suitability of recommendations to customers and supervision of the firm's municipal securities activities. At the same time, to help the investing public better understand and mitigate the risks of investing in municipal bonds, FINRA today issued an Investor Alert called Municipal Bonds — Staying on the Safe Side of the Street in Rough Times, as well as an online Muni Bond Check List, which provides a step-by-step guide to help investors avoid the most common pitfalls of muni bond investing.