Securities Law Prof Blog

D.C. Circuit Throws Out SEC Rule on Fee-Based Accounts

Financial Planning Association v. SEC, 2007 WL 935733 (Mar. 30, 2007):

The D.C. Circuit (by a 2-1 decision) threw out the SEC's rule that exempted broker-dealers offering fee-based accounts to their customers from regulation as investment advisers.  Because broker-dealers have an exemption under section 202(a)(11)(C) of the Investment Advisers Act where their advice is "solely incidental" to their business as broker-dealers and they receive no "special consideration" for their advice [i.e., for commission-based accounts], the SEC has no authority to grant broker-dealers another exemption under section 202(a)(11)(F), which gives the SEC authority to exempt "other" persons not within the intent of the statute.  The court relied principally on the statutory language,  but it also looked to the legislative history of the IAA and the agency's longtime policy prior to adopting this rule, initially on a temporary basis to allow broker-dealers to offer fee-based accounts.  In recent years, brokerage firms have heavily marketed fee-based accounts as revenues from commissions have dropped.

More Allegations in TXU Insider Trading Case

On March 28, the U.S. District Court  for  the  Northern  District  of Illinois in Chicago entered a  Temporary  Restraining  Order  freezing assets of Sunil and Seema Sehgal, a married  couple  residing  in  the United Kingdom. The Court issued the order following the  Commission's filing of an Amended Complaint, which added the Sehgals to the insider trading case that was previously  filed  on  March  2,  2007,  against certain Unknown Purchasers of TXU call options. The Amended Complaint alleges that the Sehgal's made highly profitable and suspicious purchases of 700 call option contracts for  the  common stock of TXU Corp. in January and February 2007. These  purchases  were made in  advance  of  a  public  announcement  that TXU  had  executed  a  merger  agreement  with private equity groups headed by Kohlberg Kravis Roberts &  Co.,  Texas Pacific Group and Goldman Sachs & Co.    The complaint alleges that as a result of the increase  in  price  of  TXU  stock  following  the  Announcement, the illicit profits on  the  Sehgal's  option  contracts total approximately $270,000.

  The Commission's complaint against the Unknown Purchaser alleges  that between February 21 and February 23 - prior to the  public  disclosure of the merger agreement - the  Unknown  Purchasers, using overseas accounts, purchased over 8,020  call  option  contracts  for  TXU  stock.  The  unrealized  illicit  profits  on  these  option contracts total approximately $5.4 million. On  March  28,  2007,  the District Court also approved an extension of the asset  freeze  as  to the Unknown Purchasers who purchased  TXU  securities  through  CreditSuisse in Zurich and Fimat Banque  Frankfurt  Zweigniederlassung.  The Court also approved a 60-day extension of the asset freeze as  to  the   Unknown Purchaser who traded through UBS AG London.

Form U-5 Statements Have Absolute Privilege, New York Court Rules

The New York Court of Appeals held that brokerage firms have an absolute privilege against defamation suits with respect to statements made on the U-5 Forms filed upon termination of a broker's employment.  Previously, the law was unclear whether the privilege was absolute or qualified.  Answering a question certified to it by the 2d Circuit, New York's highest court (in a 4-2 decision) said that absolute privilege followed from the "Form U-5's compulsory nature and its role in the NASD's quasi-judicial process, together with the protection of public interests."  Rosenberg v. MetLife, 2007 WL 922920 (Mar. 29, 2007).

Tribune Receives a Higher Bid

Ronald Burkle and Eli Broad, two L.A. billionnaires, have made a last minute bid for the Tribune Co. of $34, topping Sam Zell's offer by one dollar.  Like Zell's, it involves the use of an ESOP.  The Tribune board has been considering bids for some time and meets on Friday to consider the bids.  See NYTimes, 2 Billionaires Make Offer for Tribune ; WSJ, Tribune Suitor Zell Is Used to Bucking Trends.

Dell Finds "Evidence of Misconduct" in Accounting Practices

Dell announced that its internal investigation found "evidence of misconduct" in its accounting practices over the past several years and that its 10-K filing would be delayed.  Both the SEC and DOJ are investigating its accounting practices.  See NYTimes, Dell Reports It Has Found ‘Misconduct’ ; WSJ, Dell's Internal Accounting Probe Uncovers Evidence of Misconduct.

Take Two Shareholders Vote for Change

A shareholder group led by Oppenheimer Funds voted in five (or 6, depending on whose account you read) new directors at the annual meeting of Take-Two yesterday.  The new board then met and fired the CEO.  Take-Two has been unprofitable and in the midst of a back-dating options scandal.  Its previous CEO pled guilty last month on charges related to back-dating.  See NYTimes, Stockholders Oust Chief at Take-Two ; WSJ, Take-Two Holders Succeed in Board Coup.

SEC Open Meeting on Proposed 404 Auditing Standard

The Securities and Exchange Commission announced it will hold an open meeting on April 4, 2007, to discuss the Public Company Accounting Oversight Board’s (PCAOB) proposed auditing standard for Section 404 of the Sarbanes-Oxley Act and the coordination of that proposed standard with the Commission’s related pending proposal to provide guidance for management of public companies implementing Section 404. Both proposals were published for public comment in December 2006, and the comment periods for both proposals ended on Feb. 26, 2007.

Nicor Settles Fraud Charges

The Securities and Exchange Commission today announced that Nicor, Inc., a major Chicago-area natural gas distributor, and Jeffrey Metz, its former Assistant Vice President and Controller, will pay more than $10 million to settle charges that they engaged in improper transactions, made material misrepresentations, and failed to disclose material information regarding Nicor's gas inventory in order to meet earnings targets and increase the company's revenues under a performance-based rate plan administered by the Illinois Commerce Commission.

NYSE President Goes to Paris

NYSE President Catherine Kinney is relocating to Paris to oversee operations in Europe, as the merger with Euronext NV is completed next week.  The merger creates the largest market operator in the world.  See WSJ, NYSE Veteran Heads to Paris To Oversee Euronext Integration.

TXU Faces $210 million Fine from Texas

The $32 billion buyout of Texas utility TXU by KKR and other investors may be more difficult after Texas energy regulators recommended a $210 million payment for allegedly manipulating the energy market two years ago.  See WSJ, TXU Could Face $210 Million Payment.

SEC Initiatives on Short Sale Regulation

Speech by SEC Staff: Short Sale Regulation: A Targeted Approach for Efficient Markets
by James A. Brigagliano Associate Director, Office of Trading Practices and Processing, Division of Market Regulation ,U.S. Securities and Exchange Commission -- is available on the SEC website.  He discusses initiatives to modernize the regulation of short sales, specifically proposed amendments to Regulation SHO, Rule 105 of Regulation M and short sale price tests.

SEC Charges Two Enron Inhouse Counsel

On March 28, the SEC charged two former in-house  attorneys  of  Enron Corp., Jordan H.  Mintz,  a  former  Enron  Vice  President  and General Counsel of Enron's Global  Finance  group  (EGF)  and  Rex  R. Rogers, a former Enron Vice President and Associate  General  Counsel, in  connection   with   a   fraudulent   scheme   to   make   material misrepresentations in, and to omit material disclosures from,  Enron's public filings. The Commission's complaint charges  Mintz  and  Rogers with violating the antifraud  and  other  provisions  of  the  federal securities laws, and aiding and abetting  Enron's  violations  of  the antifraud  and  periodic  reporting  provisions.  In   addition,   the complaint charges Mintz with violating the books and records and lying to auditors provisions, and Rogers with aiding and abetting violations of  the  insider  stock  sale  reporting  provision  by  Enron's  then Chairman, Kenneth  Lay.  Mintz,  as  General  Counsel  of  EGF,   was responsible for managing the related party disclosures in Enron's 2000 Proxy Statement (incorporated  in  its  2000  Form  10-K)  and  second quarter 2001  Form  10-Q,  and  closing  a  fraudulent  related  party transaction  while  knowingly  or  recklessly  disregarding  that  the transaction was in  fulfillment  of  a  secret  oral  side  agreement.  Rogers, as Enron's top securities  lawyer,  was  responsible  for  the timing and content of all Enron's SEC filings.

Tellabs Oral Argument

Tellabs, Inc. v. Makor Issues & Rights was argued today before the U.S. Supreme Court.  Here's the link to the transcript.

Testimony at Black and Nacchio Trials

At the criminal trial of Lord Conrad Black,  former head of Hollinger International, a lawyer for a buyer of some newspapers from Hollinger Int'l testified that he saw co-defendant Mark Kipnis, a Hollinger Int'l lawyer, write a note directing payment of $9.5 million of the purchase price directly to Black.  See NYTimes, Hollinger Trial Witness Tells of Payment Note .  Meanwhile, at the criminal inside trading trial of Joseph Nacchio, former head of Qwest Communications, a government witness testified that Nacchio told her he had classified information that the corporation would get lucrative government contracts.  Nacchio's defense is expected to be that he did not sell his stock based on inside information that the corporation did not meet its forecasted earnings, because he had confidential information about government contracts.  See NYTimes, Qwest Chief Knew U.S. Fiber Optic Needs .

$14 Million Arbitration Award Upheld Against Merrill

A federal district court refused to vacate a $14 million defamation award by a NYSE arbitration panel to three former Merrill Lynch brokers who said that they were fired as scapegoats in the market-timing scandal.  The court cited the narrow grounds for vacating an arbitration award.  See WSJ, Court Upholds Award to Brokers Fired by Merrill.

Supreme Court hears oral argument in Credit Suisse Antitrust Case

Oral argument was held yesterday before the Supreme Court in Credit Suisse Securities v. Billings, where plaintiffs are attempting to sue underwriting firms under the antitrust laws for IPO practices that defendants say should be exclusively regulated under the securities laws.  The Justices' questions suggested that they might decide the case on "primary jurisdiction" grounds.  See WSJ, Wall Street Appeals to High Court.

SEC and FASB Reach Accord on SEC Role in Appointments

The Foundation that oversees the Financial Standards Accounting Board signed an agreement that gives the SEC advance notice and consultation rights about appointments to FASB, concluding several months of negotiations about the SEC's role.  Opinions are divided whether this mark a shift toward a more political FASB or just confirmation of the SEC's existing role.  See WSJ, SEC Is to Get More Sway Over FASB

SEC Chief Accountant Profiled

The Washington Post profiles SEC Chief Accountant, Conrad W. Hewitt, 70, who previously was a bank regulator, partner at an accounting firm, and director of a number of public companies that were implementing Sarbanes Oxley controls.  He is now working on streamlining those regulations and caused a flap by calling for a cap on damages for accountants.  See WPost, A Businessman Who Keeps the Books.

SEC Final Rule on Foreign Private Issuer's Deregistration

The SEC's Final Rule, Termination of a Foreign Private Issuer's Registration of a Class of Securities under section 12(g) and Duty to File Reports under sections 13(a) or 15(d), is now posted on its website.  The rule permits a foreign private issuer to terminate its registration requirements by meeting a quantitative benchmark designed to measure U.S. market interest for its equity securities that does not depend on a head count of the issuer's U.S. securities holders (designed to eliminate the "Hotel California" problem).

SEC Testimony on Appropriations Request

SEC Chair Christopher Cox's Testimony Concerning Fiscal 2008 Appropriations Request is available on the SEC website.

Atkins on SEC Regulation

Excerpts from SEC Commissioner Paul Atkins' speech at Finance Dublin:

[discussing the three recent reports discussing the competitiveness of US capital markets]

Although the perspectives and findings of each group were unique, there is a common thread of very important SEC-related issues among them. Among other things, each report recommended: (1) quick and substantial changes to the rules and guidance implementing section 404 of the Sarbanes-Oxley Act, (2) streamlined and coordinated regulatory processes that require meaningful cost benefit analyses, and (3) involvement jointly by the President's Working Group (which is made up of the Secretary of the Treasury and the chairmen of the Board of Governors of the Federal Reserve System, the Securities and Exchange Commission, and the Commodity Futures Trading Commission) to provide transparency and predictability in the enforcement process.

We at the SEC cannot and should not ignore these findings and recommendations. We must clear the cobwebs and incorporate how the world has changed through technology and innovation when we consider whether to shed some of our weighty regulatory precedent. We need to ask ourselves a question that Secretary Paulson has recently posed: "Have we struck the right balance between investor protection and market competitiveness - a balance that assures investors the system is sound and trustworthy, and also gives companies the flexibility to compete, innovate, and respond to changes in the global economy?"The reports can help us answer this question.

Former Monster General Counsel Settles Back-Dating Charges

The SEC today announced that it has settled its enforcement action against Myron F. Olesnyckyj, the former general counsel of Monster Worldwide, Inc. In a parallel criminal action, Olesnyckyj pleaded guilty to one count of securities fraud and one count of conspiracy to commit securities fraud and has agreed to pay a forfeiture of $381,000. Olesnyckyj has not yet been sentenced in the criminal action.

On February 15, 2007, the Commission filed its action against Olesnyckyj. The complaint alleged that, from 1997 through 2003, Olesnyckyj backdated stock options grants to coincide with the dates of low closing prices for the Company's common stock, resulting in grants of in-the-money options to numerous individuals. Olesnyckyj personally profited by receiving backdated options. The complaint further alleged that Olesnyckyj misled Monster's outside auditors in an attempt to hide the backdating scheme by providing documentation to them that misrepresented the grant date of the stock option awards.

SEC Re-opens Reg SHO Amendment Comment Period

The SEC is re-opening the comment period on the "Amendments  to Regulation SHO" it proposed in Securities  Exchange  Act  Release  No. 54154 (July 14, 2006), 71 FR 41710 (July  21,2006).  Publication  is expected in the Federal Register during the week  of  April  2,  2007.     (Rel. 34-55520; File No. S7-12-06).

NYSE Guidance on Portfolio Margin Requirements

NYSE Regulation has posted on its website guidance concerning portfolio margin requirements.

SEC Will Review Rule 12b-1 Fees

The year's agenda at the SEC includes review and possible revision of Rule 12b-1 that regulates the sales fees that mutual funds charge to pay for distribution costs, says Andrew Donohue, the Director of Investment Management division.  See WSJ, SEC Will Review Mutual-Fund Sales Fee.

Shareholder Proposals at Goldman Sachs Complain about Nature Preserve

Two Goldman Sachs shareholders have included shareholder proposals on the management proxy statement, complaining that the company's donation of land in Chile to a nature preserve is a waste of corporate assets.  Goldman Sachs has made big money in the energy field while becoming known as Wall St.'s "green" investment banker.  See WSJ, Goldman's Green Streak Is Questioned As Two Investors Seek Focus on Profit.

New Century's Bankruptcy Expected

New Century Financial Corp., the poster child for the collapse of the subprime mortgage industry, is expected to file for bankruptcy soon, as both Barclays Bank and Morgan Stanley took back loans that secured New Century's financing and plan to auction them off.  See WSJ, Analysts Say Bankruptcy Filing
From New Century Is Imminent.

Supreme Court Set to Hear Securities Cases This Week

The Supreme Court will hear oral argument tomorrow in the Credit Suisse case (whether SEC regulation of IPOs displaces antitrust regulation) and, on Thursday, in the Tellabs case (the standard for pleading scienter under PSLRA).  The Wall St. Journal reviews these, as well as other decisions that have gone against the plaintiffs in recent years.  See WSJ, Securities Suits on Trial.

SEC Files Securities Fraud Charges against Stockman

The SEC filed civil  fraud  charges  against  auto  parts  manufacturer Collins & Aikman Corporation  (C&A),  David  A.  Stockman (Stockman), who served as C&A's former  Chief  Executive  Officer  and    Chairman of the  Board  of  Directors,  and  eight  other  former  C&A directors and officers.   The SEC's complaint alleges  that  between  2001  and  2005,  Stockman personally directed  fraudulent  schemes  to  inflate  C&A's  reported income by accounting improperly for supplier payments. In  furtherance of those schemes,  the  complaint  alleges  that  Stockman  and  other defendants obtained false documents from suppliers designed to mislead C&A's external auditors. According to the complaint, when  aspects  of the schemes were discovered in March  2005,  Stockman  embarked  on  a public campaign to mislead investors, potential financiers and  others by minimizing the extent of the fraudulent accounting and hiding C&A's dire financial condition. During the time Stockman was engaged in this fraudulent conduct, he was  collecting  millions  of  dollars  of  the management fees C&A paid to Stockman's private equity fund,  Heartland Industrial Partners. The other former officers,  including  the  Chief Financial Officer, Corporate Controller, and Treasurer, and  a  former member of C&A's Board of Directors, are alleged to  have  participated in the accounting schemes or the campaign to  mislead  investors.  (This is in addition to criminal charges also filed today.)

Ernst & Young Consents to Sanction

The SEC issued  an  Order  Instituting  Public Administrative and Cease-and-Desist Proceedings  Pursuant  to  Section 21C of the Securities Exchange Act of 1934  and  Rule  102(e)  of  the Commission's Rules of Practice, Making Findings, and Imposing Remedial Sanctions against Ernst & Young, LLP. In  the  Order,  the  Commission sanctioned E&Y for conduct arising out of  the  firm's  violations  of auditor independence  standards.  Without  admitting  or  denying  the Commission's findings, E&Y consented to the issuance of the Order.  In its Order, the Commission found that, throughout 2001, E&Y, through National Office partner Michael S. Joseph, helped develop  and  market
an accounting product for one client,  American  International  Group, Inc., and advised an audit client, The PNC Financial  Services  Group, Inc., on the accounting treatment for a version of that  product  that PNC purchased. The Commission found  that  as  a  result  of  Joseph's actions,  E&Y  compromised  its  auditor  independence.  Because E&Y was  not  independent, the firm did  not  conduct  independent  reviews  of  PNC's  financial statements for the second and third quarters of 2001  and,  therefore, was a cause of PNC's violations of reporting provisions of the federal securities laws that require quarterly reviews of financial statements to be conducted by an independent accountant.

NASD's Schapiro Speaks

Mary Schapiro, Chair and CEO of NASD, spoke before SIFMA's Compliance and Legal Division's 38th Annual Seminar, on the effects of the consolidation of the NYSE and NASD regulatory arms, as well as principles-based regulation and other issues.  See Remarks by Mary L. Schapiro Chairman & CEO, NASD.

Two Former Execs Indicted

Two former executives were indicted today on securities fraud charges.  Gary Gerhardt, former CFO of Engineered Support Systems Inc., was indicted in connection with allege backdating of stock options from 1996-2002.  See WSJ, Engineered Support Ex-CFO Is Indicted in Options Case.  David Stockman, former CEO of Collins & Aikman, was indicted on charges related to alleged improper accounting of rebate transactions.  See WSJ, David Stockman Is Indicted In Securities-Fraud Case.

Supreme Court Accepts Cert in Aiding and Abetting Case

The U.S. Supreme Court accepted certiorari in an aiding and abetting securities fraud claim.  Specifically the question presented is:  Does the Central Bank decision foreclose claims for deceptive conduct under Rule 10b-5 (a) and (c) when respondents engaged in transactions with a public corporation with no legitimate business or economic purpose except to inflate artificially the public company's financial statements, but made no public statements concerning these transactions?  The lower court decision is Stoneridge Investment Partners LLC v. Scientific-Atlanta Inc., 443 F.3d 987 (8th Cir.)  The Docket Number is 06-43.

Auction for Tribune Co. Nearing End

The board of Tribune Co. is scheduled to meet this week to consider offers to buy the company, which put itself on the auction block last fall.  Two bidders have criticized the process, saying that Sam Zell, whose offer is currently the favorite, got an unfair advantage by receiving more detailed information to assist him in structuring his proposal.  See WSJ, Tribune Suitors Criticize Auction.

Blackstone Warns of Risks

Many have warned that if the public is invited to the party, it must be over.  The SEC filing in The Blackstone Group IPO gives warnings that its years of peak performance may be over and cites the drying up of low-cost debt in the global financial markets as a risk.  See WSJ, Funding Deals On the Cheap Grows Harder.

Perspective on The Past Week's Stories

The long-awaited Blackstone Group IPO offering 10% for $4 billion was filed this week.  Other news comes from the courts:  the 5th Circuit held that investors could not sue the investment banks in Enron for aiding and abetting; the district court dismissed the constitutional challenge to PCAOB; and two high-profile trials began -- Lord Conrad Black (Hollinger Int'l) for looting, and Josph Nacchio (Qwest Communications) for insider trading.

6th Circuit Decides NSMIA Preemption Issue

Brown v. Earthboard Sports USA, 6th Circuit Mar. 16, 2007, 2007 WL 777491:

NSMIA preempts state registration of "covered securities" issued "pursuant to" a Reg D exemption.  Federal and state courts have split on the conditions for establishing the applicability of the NSMIA preemption to unregistered offerings purportedly exempt under Reg D.  Specifically, must the offering actually meet the conditions for an exemption under Reg D, or is it enough that the offering was purportedly made under Reg D?  Reversing the district court, the 6th Circuit held that the offering must actually qualify for the Reg D exemption for NSMIA preemption to apply.  The court relied on the statutory language to reach this conclusion.

The 6th Circuit also reversed the district court on its conclusion that, as a matter of law, a non-reliance clause in the subscription agreement precluded the purchaser from establishing reliance on the broker's misrepresentations, since determining reasonable reliance requires a contextual analysis.