Securities Law Prof Blog

SEC Charges Dallas Trader with Front-Running

The SEC announced fraud charges and an asset freeze against Daniel Bergin, a senior equity trader at Cushing MLP Asset Management, a Dallas-based investment advisory firm, who allegedly profited by placing his own trades before executing large block trades for firm clients that had strong potential to increase the stock's price.

According to the SEC, Bergin secretly executed hundreds of trades through his wife's accounts in a practice known as front running. Bergin illicitly profited by at least $520,000 by routinely purchasing securities in his wife's accounts earlier the same day he placed much larger orders for the same securities on behalf of firm clients. Bergin concealed his lucrative trading by failing to disclose his wife's accounts to the firm and avoiding pre-clearance of his trades in those accounts. Bergin also attempted to hide his wife's accounts from SEC examiners.

According to the SEC's complaint, Bergin realized at least $1.7 million in profits in his wife's accounts from 2011 to 2012 as a result of his illegal same-day or front-running trades. More than $520,000 of the $1.7 million represents profits from approximately 132 occasions in which Bergin placed his initial trades in his wife's account ahead of clients' trades.

The SEC's complaint names Bergin's wife Jacqueline Zaun as a relief defendant for the purpose of recovering Bergin's illegal trading profits in her accounts.

Obama Nominates Piwowar and Stein to SEC

The White House announced that it is nominating two individuals to seats on the SEC:

Michael Sean Piwowar, of Virginia, to be a Member of the Securities and Exchange Commission for a term expiring June 5, 2018, vice Troy A. Paredes, term expiring.  Mr. Piwowar is the chief Republican economist for the Senate Banking Committee.

Kara Marlene Stein, of Maryland, to be a Member of the Securities and Exchange Commission for a term expiring June 5, 2017, vice Elisse Walter, term expired.  Ms. Stein is a legal counsel and senior policy adviser to Sen. Jack Reed (D-R.I.).

 

Former Goldman Banker Settles SEC "Pay-to-Play" Charges

Neil M.M. Morrison, a former VP in the investment banking division of Goldman, Sachs, settled SEC charges that he engaged in a "pay-to-play" scheme.  The SEC alleged that starting in July 2008 Morrison was employed by Goldman to solicit municipal underwriting business from the Massachusetts Treasurer's Office, among others.  During the period from November 2008 to October 2010, Morrison was also substantially engaged in the political campaigns of Timothy Cahill, then-Treasurer of Massachusetts, and worked on the campaign during Goldman Sach work hours and using Goldman Sachs resources.  The SEC found that Morrison's campaign activities constituted valuable undisclosed "in-kind" campaign contributions to Cahill attributable to Goldman Sachs.  At the same time he was working on the campaign, he actively solicited municipal securities business from the Treasurer's Office.

The SEC barred Morrison from the securities industry with the right to apply for reentry after five years and also imposed a $100,000 fine.  In re Neil M.M. Morrison, Sec. Exch. Act Rel. 69627 (May 23, 2013)

ISS Settles SEC Charges that Employee Sold Confidential Proxy Voting Results for Tickets

The SEC charged proxy adviser Institutional Shareholder Services (ISS) with failing to safeguard the confidential proxy voting information of clients participating in a number of significant proxy contests. ISS, which is registered with the SEC as an investment adviser, agreed to settle the charges by paying $300,000 and retaining an independent compliance consultant.

According to the SEC, an ISS employee provided a proxy solicitor with material, nonpublic information revealing how more than 100 ISS institutional shareholder advisory clients were voting their proxy ballots. In exchange for voting information, the proxy solicitor provided the ISS employee with meals, expensive tickets to concerts and sporting events, and an airline ticket. The breach was made possible in part because ISS lacked sufficient controls over employee access to confidential client vote information, as this employee gathered the data by logging into the ISS voting website from home or work and using his personal e-mail account to communicate details to the proxy solicitor. The employee no longer works at ISS.

According to the SEC's order instituting settled administrative proceedings, the breach occurred from approximately 2007 to 2012. ISS failed to establish or enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information by ISS employees. Specifically, ISS lacked sufficient controls over employee access to databases of confidential client vote information.

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Today's Wall St. Journal has an article, by Joann S. Lublin and Kirsten Grind, on For Proxy Advisers, Influence Wanes, reporting that the influence of ISS and Glass Lewis is waning, as the management of companies are increasingly reaching out to institutional investors for support on key votes and money managers are increasingly relying on their own research.  For example, both ISS and Glass Lewis recommended voting for the shareholder proposal to split the CEO and Chairman positions at JP Morgan Chase, yet it received only 32% of the vote.  The SEC settlement certainly creates additional reputational problems for ISS.

Five Broker-Dealers Settle with Massachusetts over Improper Sales of REITs

The Massachusetts Securities Division announced a settlement with five independent broker-dealers for improper sales of REITs that will return over $11 million to Massachusetts investors.  The firms are Ameriprise Financial Services, Commonwealth Financial Services, Lincoln Financial Advisors, Securities America, and Royal Alliance Associates.

South Miami Settles SEC Charges of Defrauding Bond Investors

The SEC charged the City of South Miami, Fla., with defrauding bond investors about the tax-exempt financing eligibility of a mixed-use retail and parking structure being built in its downtown commercial district.  According to its release:

An SEC investigation found that the city of 11,000 residents located in Miami-Dade County borrowed approximately $12 million in two pooled, conduit bond offerings through the Florida Municipal Loan Council (FMLC). South Miami's participation in those offerings enabled it to borrow funds at advantageous tax-exempt rates. The city represented that the project was eligible for tax-exempt financing in various documents for the second offering that were relied upon by bond counsel in rendering its tax opinion. However, South Miami failed to disclose that it had actually jeopardized the tax-exempt status of both bond offerings by impermissibly loaning proceeds from the first offering to a private developer and restructuring a lease agreement prior to the second offering.

South Miami agreed to settle the charges and retain an independent third-party consultant to oversee its policies, procedures, and internal controls for municipal bond disclosures.

FINRA Will Provide Surveillance Oversight of More than 90% of U.S. Equities Trading Volume

FINRA issued an announcement that Direct Edge®, the third largest stock exchange operator in the U.S., and FINRA have agreed that FINRA will provide market surveillance services on behalf of Direct Edge's two licensed stock exchanges.  Under this agreement, FINRA will have surveillance oversight of more than 90% of U.S. equities trading volume. Direct Edge expects the new arrangement will become operative in the fourth quarter of 2013. Currently, FINRA performs examination and disciplinary services on behalf of Direct Edge. With this agreement, all of Direct Edge's third-party regulatory services will be consolidated with FINRA.

Lew Reiterates Need for Money Market Fund Reform in Senate Testimony

Treasury Secretary Lew testified today before the Senate Banking Committee on the Financial Stability Oversight Council (FSOC) Annual Report to Congress.  His written testimony identified seven areas of risks to U.S. financial stability:

·         First, market participants and regulatory agencies should take steps to reduce vulnerabilities in wholesale funding markets that can lead to destabilizing fire sales. 
·         Second, significant reform in the housing finance system is still needed.
·         Third, government agencies, regulators, and businesses should take action to address operational risks from internal control and technology failures, natural disasters, and cyber-attacks, which can cause major disruptions to the financial system.
·         Fourth, as recent developments with the London Interbank Offered Rate (LIBOR) have demonstrated, reforms are needed to address the reliance on voluntary, self-regulated, and self-reported reference interest rates.
·         Fifth, financial institutions and market participants should be cognizant of interest rate risk, particularly given the historically low interest rate environment of the past few years. 
·         Sixth, long-term fiscal imbalances that have potential economic and financial market impacts should be addressed.
·         Finally, regulators need to continue to keep a close eye on potential threats to U.S. financial stability from adverse developments in the global economy.

With respect to the first risk, Wholesale Funding Markets, the Secretary's written testimony focused on the need for additional reforms related to money market mutual funds:

The Council remains concerned that vulnerabilities in wholesale funding markets could lead to destabilizing fire sales.  Specifically, run-risk vulnerabilities related to money market mutual funds (MMFs), which became apparent during the financial crisis, still remain, despite an initial set of reforms implemented in 2010.  In November 2012, the Council issued proposed recommendations for public comment to implement structural reforms of MMFs to reduce the likelihood of runs.  Council members should also examine whether similar reforms are warranted for other cash management vehicles. 

 The Secretary's testimony noted that:

The Council is also authorized to issue recommendations to a regulatory agency when financial activities and practices are creating risk for U.S. financial markets.  In November 2012, the Council issued for public comment proposed recommendations to the SEC with three alternatives for reform to address the structural vulnerabilities of MMFs.  The Council is currently considering the public comments on the proposed recommendations.  If the SEC moves forward with meaningful structural reforms of MMFs before the Council completes its process, the Council expects that it would not issue a final recommendation to the SEC.  However, if the SEC does not pursue additional reforms that are necessary to address MMFs’ structural vulnerabilities, the Council should use its authorities to take action in this area.

SEC's Walter: No Review of Mandatory Arbitration Before 2014

SEC Commissioner Elisse Walter personally thinks that the SEC should take a hard look at mandatory arbitration of investors disputes with their broker-dealers and financial advisers, but says that the SEC will not have time to undertake a review before 2014.  Reuters, SEC review of brokerages use of arbitration not seen in 2013.  The agency continues to be busy with Dodd Frank and JOBS Act reforms, as well as money market fund reform.

FINRA Fines LPL for Systemic Email Failures & Misstatements to FINRA

FINRA fined LPL Financial LLC (LPL) $7.5 million for 35 separate, significant email system failures, which prevented LPL from accessing hundreds of millions of emails and reviewing tens of millions of other emails. Additionally, LPL made material misstatements to FINRA during its investigation of the firm's email failures. LPL was also ordered to establish a $1.5 million fund to compensate brokerage customer claimants potentially affected by its failure to produce email.

FINRA found that:

As LPL rapidly grew its business, the firm failed to devote sufficient resources to update its email systems, which became increasingly complex and unwieldy for LPL to manage and monitor effectively. The firm was well aware of its email systems failures and the overwhelming complexity of its systems. Consequently, FINRA found that from 2007 to 2013, LPL's email review and retention systems failed at least 35 times, leaving the firm unable to meet its obligations to capture email, supervise its representatives and respond to regulatory requests. Because of LPL's numerous deficiencies in retaining and surveilling emails, it failed to produce all requested email to certain federal and state regulators, and FINRA, and also likely failed to produce all emails to certain private litigants and customers in arbitration proceedings, as required.

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FINRA also found that

In addition, LPL made material misstatements to FINRA concerning its failure to supervise 28 million DBA emails. In a January 2012 letter to FINRA, LPL inaccurately stated that the issue had been discovered in June 2011 even though certain LPL personnel had information that would have uncovered the issue as early as 2008. Moreover, the letter stated that there weren't any "red flags" suggesting any issues with DBA email accounts when, in fact, there were numerous red flags related to the supervision of DBA emails that were known to many LPL employees.

In addition, LPL likely failed to provide emails to certain arbitration claimants and private litigants. LPL will notify eligible claimants by letter within 60 days from the date of the settlement and the firm will deposit $1.5 million into a fund to pay customer claimants for its potential discovery failures. Customer claimants who brought arbitrations or litigations against LPL as of Jan. 1, 2007, and which were closed by Dec. 17, 2012, will receive, upon request, emails that the firm failed to provide them. Claimants will also have a choice of whether to accept a standard payment of $3,000 from LPL or have a fund administrator determine the amount, if any, that the claimant should receive depending on the particular facts and circumstances of that individual case. Maximum payment in cases decided by the fund administrator cannot exceed $20,000. If the total payments to claimants exceed $1.5 million, LPL will pay the additional amount.

 

NASAA Releases Report on IA Switch

NASAA released a report on the regulatory transfer of more than 2100 investment advisers from federal to state oversight, IA Switch Report, The IA Switch: A Successful Collaboration to Enhance Investor Protection.  According to NASAA, the IA Switch "was one of the most significant achievements in the history of the North American Securities Administrators Association (NASAA)."  The Switch stemmed from Section 410 of the Dodd-Frank Act, which raised the assets under management threshold for state regulation of investment advisers from $25 million to $100 million.

The report documents the work that went into the successful completion of the Switch. It draws from a survey completed by state securities regulators on the effect of the Switch;  detailed interviews with NASAA members who were key players throughout the Switch;  and industry feedback.

 

SEC Charges Atlanta Resident with Fraud in Prime Bank Investment Scheme

The SEC recently filed an emergency action in federal court in Atlanta, charging Robert Fowler (Fowler) and his company, US Capital Funding Series II Trust 1 (US Capital), with violations of the federal securities laws for defrauding investors in a “prime bank” investment scheme.

The Commission's complaint alleges that, since at least August 2012, Fowler and US Capital have raised at least $350,000 from investors by falsely promising high profits for investing in standby letters of credit or bank guarantees that would purportedly grant the investors loans, the proceeds of which would be invested for a significant profit. Fowler and US Capital instead misappropriated investor funds for personal and business uses. Fowler was actively soliciting additional investors for his scheme, the complaint alleged.

According to the complaint, Fowler targeted foreign-born small business owners with little or no experience in finance or investing.

 

Bullard on the 401(k) Plan Large Menu Defense

The Social Costs of Choice, Free Market Ideology and the Empirical Consequences of the 401(k) Plan Large Menu Defense, by Mercer Bullard, University of Mississippi - School of Law, was recently posted on SSRN.  Here is the abstract:

Regulatory reforms have recently improved 401(k) plan participation rates, but recent decisions by certain courts threaten to reverse that trend. These courts have substituted their free market ideology for fiduciary duties under ERISA in dismissing claims against plan sponsors on the ground that the menu offered was so large as to abrogate the sponsors’ ERISA duties. Under the “large menu defense,” courts have held that, even assuming a failure to exercise due care in selecting plan options, the employer can nonetheless claim the protection of the employee-control safe harbor under ERISA because, when the plan’s menu is sufficiently large, the plan participant is deemed to have exercised legal control over the relevant investment decision. The courts’ interpretation of the control safe harbor contradicts the plain meaning of the statute. Far worse, the courts’ free market assumption that large menus will increase participants’ wealth is empirically false. Research has shown that large 401(k) menus result in lower participation rates, overly conservative allocations, inferior investment options and other adverse effects that, collectively, cost workers billions of dollars every year.

Schwab Eliminate Class Action Waiver in Customers' Agreements -- At Least For Now

As regular readers of this Blog know, Charles Schwab includes in its brokerage agreements with its customer a provision that purports to prohibit customers from bringing class actions against the firm.  This class action waiver violates FINRA rules, but recently a FINRA hearing officer ruled that FINRA could not enforce its rule because of the Federal Arbitration Act, as interpreted by the Supreme Court in AT&T Mobility v. Concepcion.  That decision is currently on appeal before the FINRA appellate body.  Yesterday, Charles Schwab issued a statement that it was modifying its account agreements to eliminate the class action waiver until the issue is resolved:

Effective immediately, Schwab is modifying its account agreements to eliminate the existing class action lawsuit waiver for disputes related to events occurring on or after May 15, 2013 and for the foreseeable future.

While the company believes that dispute resolution is best handled via FINRA arbitration, we have chosen to voluntarily remove the waiver going forward until the issue is resolved by the appropriate regulatory and/or court decisions.  Given that the process will likely take considerable time to resolve, and may leave clients with a degree of uncertainty about their dispute resolution options in the meantime, we have elected to remove that uncertainty until the legal and regulatory process is completed.

To help ensure that small investors have access to pursue any claims they consider appropriate within the arbitration forum available to them, we will continue our existing policy of paying for the arbitration fees of any investor electing to pursue an arbitration claim under $25,000 against Schwab.

 

SEC Chair White Testifies on Oversight of the SEC before House Committee

SEC Chair White testified today on Oversight of the SEC before the U.S. House of Representatives Committee on Financial Services.

SEC Charges Chicago Investment Advisers with Cherry-Picking Trades

The SEC charged Charles J. Dushek and his son Charles S. Dushek and their Chicago-area investment advisory firm with defrauding clients through a cherry-picking scheme that garnered them nearly $2 million in illicit profits, which they spent on luxury homes, vehicles, and vacations.  According to the SEC, the Dusheks placed millions of dollars in securities trades without designating in advance whether they were trading personal funds or client funds. They delayed allocating the trades so they could cherry pick winning trades for their personal accounts and dump losing trades on the accounts of unwitting clients at Capital Management Associates (CMA). CMA misrepresented the firm’s proprietary trading activities to clients, many of whom were senior citizens.

According to the SEC’s complaint filed in federal court in Chicago, the scheme lasted from 2008 to 2012. During that period, the Dusheks made more than 13,500 purchases of securities totaling more than $350 million. The Dusheks typically waited to allocate the trades for at least one trading day – and often several days – by which time they knew whether the trades were profitable. The Dusheks ultimately kept most of the winning trades and assigned most of the losses to clients. At the time of the trading, they did not keep any written record of whether they were trading client funds or personal funds.

The SEC’s complaint charges the Dusheks and CMA with fraud and seeks final judgments that would require them to return ill-gotten gains with interest and pay financial penalties.

Maryland Court Upholds Arbitration Bylaw in Publicly Traded REIT

Last month Steven Davidoff (the New York Times' Deal Professor) wrote a column on the hostile takeover bid for CommonWealth REIT by two hedge funds:  What’s at Stake in the Fight Over a REIT (Apr. 18, 2013).  He highlighted the fact that CommonWealth has a bylaw provision that requires arbitration of any shareholders' disputes.   Apparently when the REIT filed its registration statement for its public offering with the SEC, the agency, consistent with its longstanding position that such arbitration provisions in public corporations violate the antiwaiver provisions in federal securities laws, required the REIT to delete the provision.  But not to be thwarted, after the offering, the CommonWealth board amended the bylaws and reinstated the arbitration clause.  As Davidoff nicely frames the issue:

"If the Maryland court upholds CommonWealth's arbitration provision, more companies like Commonwealth can simply adopt these bylaws.  They can then take aggressive positions to resist a takeover, and the results will be sent to the black hole of an arbitration conducted in secret and with no timeline for an outcome."

At least as of now, CommonWealth is victorious.  On May 8, 2013, the Circuit Court for Baltimore City held that the arbitration bylaw is enforceable.  In a case of first impression for the Maryland courts, the court emphasized that arbitration is strongly favored as a matter of public policy and applied contract law principles to determine that there was both mutual assent and consideration to make the arbitration bylaw enforceable as a contract term.  Although the court's language is broad and states that constructive knowledge is sufficient, the court also found that the plaintiffs -- who, the court noted, were "two very sophisticated parties" -- had actual knowledge of the arbitration bylaw and assented to it by their stock purchases. The court also rejected plaintiffs' arguments that defendants' unilateral power to amend the bylaws made the agreement unfairly one-sided, citing case law that courts should not look beyond the "four corners" of the arbitration agreement in determining whether it is valid and enforceable.  "Because the Trustees' power to amend or revoke the Arbitration Bylaws springs from legitimate, legal sources, outside the "four corners" of the Arbitration Agreement -- namely, the company's Declaration of Trust and Maryland REIT law -- Plaintiffs' argument must fail."

So, to quote Professor Davidoff again, we now have our first ruling on this critical issue, "with real consequences for the takeover market."  I suspect that an appeal is under serious consideration.

Corvex Management LP v. CommonWealth REIT (Baltimore City Circuit Court 5/8/13)

GAO Releases Testimony on Elder Fraud

The GAO released recent testimony on Federal Government Has Taken Some Steps but Could Do More to Combat Elder Financial Exploitation (GAO-13-626T, May 16, 2013).  Here is what the GAO found:

Older adults are being financially exploited by strangers who inundate them with mail, telephone, or Internet scams; unscrupulous financial services professionals; and untrustworthy in-home caregivers. Local law enforcement authorities in the four states GAO visited indicated that investigating and prosecuting the growing number of cases involving interstate and international mass marketing fraud--such as "grandparent scams," which persuade victims to wire money to bail "grandchildren" out of jail or pay their expenses--is particularly difficult. In addition, older adults, like other consumers, may lack the information needed to make sound decisions when choosing a financial services provider. As a result, they can unknowingly risk financial exploitation by those who use questionable tactics to market unsuitable or illegal financial products. Local officials also noted that it is difficult to prevent exploitation by in-home caregivers, such as home health or personal care aides, individuals older adults must rely on.

The GAO goes on to identify ways that federal agencies could support state and local efforts to combat elder fraud.

Executives of China-Based Company Settle SEC Charges of Using Offering Proceeds to Buy House

The SEC charged China-based RINO International Corporation’s chief executive officer Dejun “David” Zou and chairman of the board Jianping “Amy” Qiu with engaging in a scheme to overstate the company’s revenues and divert proceeds from a securities offering for their personal use.

The SEC alleges that Zou and Qiu (who are husband and wife) diverted $3.5 million in company money to purchase a luxury home in Orange County, Calif., without disclosing it to investors. Conflicting information was provided to RINO’s outside auditor when questions were raised about the expenditure. Zou and Qiu also used offering proceeds to pay for automobiles as well as designer clothing and accessories without recording them as personal expenses or otherwise disclosing them in RINO’s public filings.

The SEC issued a trading suspension in 2011 against RINO, which is a holding company for subsidiaries that manufacture, install, and service equipment for the Chinese steel industry. The company became a China-based U.S. issuer through a reverse merger in 2007. The trading suspension was based on questions raised about RINO’s public filings — signed and certified by Zou and Qiu — overstating company revenues by including false sales contracts.

Zou and Qiu agreed to settle the SEC’s charges by paying penalties and consenting to decade-long bars from serving as officers or directors of any company publicly traded in the U.S.

Sen. Warren Asks Fed, DOJ & SEC for Analysis on Settling without Admission of Guilt

Senator Elizabeth Warren (D-Mass.) posed this question to Ben Bernanke, Eric Holder and Mary Jo White in a May 14 letter: 

Have you conducted any internal research or analysis on trade-offs to the public between settling an enforcement action without admission of guilt and going forward with litigation as necessary to obtain such admission and, if so, can you provide that analysis to my office?

She previously asked the same question to Thomas J. Curry, Comptroller of OCC, at a hearing.  The OCC subsequently stated it did not have any such internal research or analysis.

In her letter Senator Warren stated that "I believe strongly that if a regulator reveals itself to be unwilling to take large financial institutions all the way to trial -- either because it is too timid or because it lacks resources -- the regulator has a lot less leverage in settlement negotiations and will be forced to settle on terms that are much more favorable to the wrongdoer."

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