Securities Law Prof Blog

Carlyle Group to Offer Fund to the Public

The Carlyle Group, a private equity firm that has $56 billion invested in 48 different funds, will offer shares in one of its funds to the public this summer.  It plans to raise up to $1 billion for investment in mortgage-backed securities.  See WPost, Carlyle Group Prepares First Public Offering.

Who are the Bancrofts?

It's been apparent since Murdoch made his bid for Dow Jones that the controlling group, usually referred to as the "secretive" Bancroft family, is not a unified group.  A front page story in the Saturday Wall St. Journal gives a long history of the various branches of the family (a good example of the long, detailed story Murdoch says he's impatient with).  What is relevant on the issue of control is that the Bancroft family's Dow Jones shares is held in more than twenty trusts, each with its own set of beneficiaries that overlap with beneficiaries of other trusts.  Most of the trust have two to four trustees and require unanimous decision-making.  The trusts do not generally require that the trustees maximize the value of their holdings.  See WSJ, For Bancrofts, Dow Jones Offer Poses Challenge.

Eliminating EPS in the Works

Accounting rule makers are working on a massive rewrite of how information is presented in financial statements.  The goal is to provide investors with more meaningful information that that would  eliminate the focus on the "bottom line" -- the earnings per share figure.  A report outlining the group's preliminary views is expected later this year; meanwhile, the Wall St. Journal posts a side-by-side comparison of a proposed and current Statement of Financial Position circulated by FASB. See WSJ, Profit as We Know It Could Be Lost With New Accounting Statements.

Atkins on FPA v. SEC

The brokerage industry has been urging the SEC to seek a rehearing in FPA v. SEC, where the D.C. Circuit (2-1 vote) invalidated the SEC's rule that exempted brokers offering fee-based accounts from regulation under Investment Advisers Act.  Commissioner Paul Atkins expressed his views on this in a speech on May 10 before the Financial Services Lawyers Roundtable Council:

We owe it to the financial services industry and the investors that you serve to take a consistently careful approach to regulation. Regulatory unpredictability undermines innovation and growth. One ongoing issue brings the importance of predictability to mind. On March 30, the D.C. Federal Circuit Court of Appeals rejected an SEC rule that excepted from the Advisers Act broker-dealers providing advice that is solely incidental to brokerage, but charging an asset-based or fixed fee for its services. Unlike the other recent decisions affecting mutual funds and hedge funds, this was a split decision. The Court found that the SEC had exceeded its authority, but the dissenting judge found the SEC's interpretation of the Advisers Act to be "a reasonable interpretation of an ambiguous statute."

I certainly think that the SEC would be well justified to ask for this ruling to be heard by the full DC Circuit - unlike the other vacated rules, this rule was adopted by a unanimous Commission. At the very least, as an interim measure, we need to ask the Court for a stay to allow for an orderly transition and appropriate rulemaking consistent with the Court's decision. Otherwise, I am afraid of confusion in the marketplace. Now that many firms have shifted customers into fee-based accounts in reliance on our actions -- and, one could argue, at our strong urging -- we should be striving to provide as much certainty as is in our power to provide to affected investors.

In the longer term, bigger questions are at issue and will have to be resolved. There are strong feelings about where and how to draw appropriate lines between broker-dealer and investment advisory activities and regulatory regimes. The SEC recognized the difficult questions in this area and their far-reaching importance at the time it adopted the rule. Indeed, the adopting release announced that the staff would undertake a further examination of the broker-dealer and investment advisor regulatory regimes. Last September, the SEC commissioned the RAND Corporation to do the fact-gathering and empirical research that will form the basis for the SEC's next steps in this area. RAND is looking at how financial products and services are marketed, sold, and delivered to retail investors. The study will investigate, among other things, how financial professionals are compensated and what investor perceptions are. This study will provide the raw material for the SEC's further action in the area. Ultimately, it is probably Congress that should resolve this issue of uncertainty between two sixty-year-old statutes governing an area that has changed so much over that time.

Chicago Exchanges Revise Merger Agreement

Chicago Mercantile Exchange Holdings and CBOT Holdings announced a revised merger agreement valued at $9.8 billion and involving a $3.5 billion share buyback by CME after the merger.  Some CBOT members expressed dissatisfaction that the price was not higher in response to IntercontinentalExchange's unsolicited offer for CBOT valued at $10.5 billion.  See WSJ, CME Raises Bid for CBOT To Fend Off Rival Offer.

Former McAfee CFO Convicted of Accounting Fraud

The former CFO at McAfee, Prabhat Goyal, was convicted of 15 counts of securities fraud for misstating sales and earnings in SEC filings from 1998 to 2000.  See WSJ, McAfee Ex-Finance Chief Is Convicted in Fraud Case.

Chrysler's Future Includes a Russian Gangster?

Will a Russian gangster own Chrysler?  Magna International, the Canadian auto-parts maker that is the leading contender to bid for Chrysler, announced that Oleg Deripaska, a Russian aluminum magnate who has been linked to organized crime, is buying a $1.54 billion stake in Magna.  The U.S. has previously revoked Deripaska's visa to enter the country.  See WSJ, How a Russian May Complicate Chrysler Auction.

Paulson's Deregulatory Campaign

Treasury Secretary Paulson continues his deregulatory campaign.  He plans to create an advisory committee to develop recommendations about how to make life better for accounting firms, including recommendations about limiting their liability.  According to the Treasury Dept., accounting firms face too much liability if they fail to spot problems, forcing them to take a rigid approach in their audits which, in turn, makes the businesses being audited less liable to take risks that will result in better mousetraps, more productivity, etc.  (Can anyone name a single financial fraud case that was motivated by anything other than management's desire to manage earnings and improve the appearance of short-term profitabilty?) See WSJ, Paulson Plan Is Taking Shape.

SEC Settles Action on False 10Q, SOX Certification

The Securities and Exchange Commission today announced that it has settled its enforcement action against Penthouse International, Inc., Charles Samel, a former Director and Executive Vice-President of Penthouse, and Jason Galanis, a former shareholder. The Commission's complaint alleged that Penthouse, Samel and Galanis engaged in accounting fraud and financial reporting violations at Penthouse in connection with the company's Form 10-Q for the quarter ended March 31, 2003. According to the complaint, Penthouse improperly included as revenue on the financial statements for that quarter $1 million received as an up-front payment in connection with a five-year website management agreement. The inclusion of the $1 million payment under the agreement increased Penthouse's reported revenue by approximately 9%, from $11,072,000 to $12,072,000 and changed a quarterly net loss of $167,000 to a purported net profit of $828,000. The Complaint alleged that Penthouse's Form 10-Q was materially misleading in several other respects. For example, the Commission alleged that it bore an unauthorized electronic signature of Robert C. Guccione, Penthouse's principal executive officer and principal financial officer, and thus represented that Guccione had reviewed and signed it, and the accompanying Sarbanes-Oxley certification. According to the complaint, this representation was false, as Guccione had not seen or approved the filing of the Form 10-Q or the Sarbanes-Oxley certification. Further, according to the complaint, Penthouse's auditors and outside counsel also had not reviewed the filing, a fact that also was not disclosed in the filing.  The Comission's complaint alleged that Samel and Galanis prepared and filed the false Form 10-Q, and they did so knowing or recklessly disregarding that Guccione had not seen or approved it, that Penthouse's auditor had not performed its required review of the Form 10-Q, and that it would be improper to include the $1 million payment as revenue for the quarter ended March 31, 2003.

SEC Charges Morgan Stanley Employee with Insider Trading

Securities and Exchange Commission today charged Jennifer Xujia Wang, an employee of Morgan Stanley & Co., Inc., and her husband, Ruben Chen a.k.a. Ruopian Chen, a former employee of ING Investment Management Services, LLC, with insider trading.

In an emergency civil action filed in the United States District Court for the Southern District of New York, the Commission charged Chen and Wang with using online brokerage accounts in Wang's mother's name, Zhiling Feng, to purchase securities of three companies on the verge of announcing they would be acquired. Wang and Chen used material non-public information from Wang's employer, Morgan Stanley, which was contacted to provide services in connection with the acquisitions.

The Commission's complaint alleges that Wang and Chen obtained illegal profits of more than $600,000 by trading on the basis of material nonpublic information before the public announcements of three acquisitions: Morgan Stanley Real Estate's (MSRE) Dec. 19, 2005 announcement of its acquisition of Town & Country Trust; MSRE's Aug. 21, 2006 announcement of its acquisition of Glenborough Realty Trust; and Formation Capital, LLC and JER Partners' Jan. 16, 2007 announcement of its agreement to acquire Genesis HealthCare Corporation.

The complaint further alleges that Wang was privy to material nonpublic information concerning each of these pending acquisitions. Since Aug. 29, 2005, Wang has been employed as a Vice President of Morgan Stanley in a group that supported the Principal Transaction Group, which provides financing for MSRE and other entities' potential acquisitions. In this position, Wang received documents via e-mail and had access to documents on a shared network drive which demonstrated that the firm was providing financing on certain acquisitions before they were publicly announced.

SIFMA's Campaign Against FPA v. SEC

SIFMA (the trade association previously known as the Securities Industry Association) is putting pressure on the SEC to seek rehearing of FPA v. SEC, the D.C. Circuit's invalidation of the SEC rule exempting brokers that offer fee-based accounts from regulation as investment advisers.  It released a survey of investors showing that investors prefer choice of investment options instead of being forced into "cookie-cutter" accounts.  See SIFMA, Poll: Investors Value Choice FPA Lawsuit Could Limit Consumer Options.

Former Comverse GC Sentenced to Prison

William F. Sorin, former GC at Comverse Technologies, is the first executive to be sentenced to prison in the stock options backdating scandals.  Sorin pleaded guilty last November and today was sentenced to one year in prison, as well as restitution of $51.8 million.  Comverse's CEO, Kobi Alexander, is still in Namidia.  See WSJ, Former Comverse Lawyer Sentenced to One Year in Jail.

No Securities Fraud Convictions in Squawk Box Case

A jury deadlocked on the securities fraud charges in the much-publicized "squawk box" case, where prosecutors charged that three brokers allowed day traders at A.B. Watley to eavedrop on block orders by institutional clients so that the day traders could jump ahead of them.  One broker was convicted on charges of witness tampering and making false statements. See WSJ, Jury Reaches Partial Verdict In 'Squawk Box' Case.

CVS/Caremark Directors Re-Elected with Sizeable Shareholder Opposition

CVS/Caremark dodged a bullet.  While all 14 nominees for the board were elected, shareholders expressed dissatisfaction with the way the merger negotiations were handled by casting significant percentage of votes against two directors, former Caremark directors who oversaw the process.  About 44% was cast against one director, and 33% against another.  In addition, the vote on two shareholder proposals was too close to call; one called for an independent chair, the other for an investigation into stock option backdating.  See WPost, CVS/Caremark Dissidents Fail To Defeat Directors; WSJ, CVS/Caremark Directors Narrowly Win Election .

More on Dow Jones Insider Trading Charges

Since the SEC's charge of insider trading in Dow Jones stock against a Hong Kong couple, the focus has been on who knew of Murdoch's bid and when.  The Wall St. Journal constructs a timeline which provides a good illustration of why leaks of big deals are so commonplace.  On March 29, Murdoch had breakfast with CEO Zannino and made the first overture, without naming a price.  Zannino immediately told Dow Jones GC, outside counsel, and several key Board members about the conversation.  Soon thereafter, Murdoch had a conversation with another Board member, who advised him to put it in writing.  A special meeting of the Board was then called for April 13 -- this is the date when the Hong Kong couple began their purchases.  The board received a written offer on April 17, and the public announcement was made on May 1.  Nothing about any of this sounds improper, but think of all the investment bankers, attorneys, journalists, executive assistants, secretaries, etc. who may have heard something about the deal prior to the public announcement.  See WSJ, Murdoch Approached Dow Jones March 29.  The Hong Kong connection is focusing attention on its business community, described as "clubby," and its system of securities regulation, where no one has been prosecuted for insider trading since it became a crime in 2003.  See NYTimes, Prominent in Hong Kong and, Perhaps, in the Dow Jones Inquiry; WSJ, SEC to Lift Veil on Clubby Hong Kong.

Motorola Settles SEC Charges in Connection with Adelphia

On May 8, the SEC settled charges against Motorola, Inc. relating to its involvement in Adelphia's accounting fraud.  The Order finds that, in 2001, Motorola, Inc.entered  into  a  round-trip  cash   transaction  with  Adelphia.  Under  a  purported  marketing  support agreement, Adelphia paid  money  to  Motorola  which  was  immediately returned to Adelphia in the form of marketing  support payments.  The agreement, which was backdated and applied retroactively to the  prior fiscal year, provided  that  Motorola  would  increase  the  price  of digital cable television set-top boxes it was selling to Adelphia  and pay the amount of the price increase back to Adelphia in the  form  of  payments to market Motorola's cable television set-top boxes. Adelphia  did not use the marketing support payments to market Motorola's  cable television  set-top  boxes.  Instead,  Adelphia  recorded  the   price increase it paid Motorola as a capital  expense,  and  recognized  the marketing support payments as  a  contra  marketing  expense,  thereby artificially reducing its marketing expense  and  increasing  EBITDA.  The Order also finds that Motorola employees were aware of a number of unusual and unique facts that together demonstrated that Adelphia  was misusing the marketing support agreement.

    The  Order  requires Motorola to pay $25 million in disgorgement  and  prejudgment interest.  Such funds will be held pending the approval of a  plan  to distribute the funds to the victims of the Adelphia fraud.

   

Morgan Stanley Settles Best Execution Charges

The United States Securities and Exchange Commission today announced settled fraud charges against Morgan Stanley & Co. Incorporated (Morgan Stanley) for its failure to provide best execution to certain retail orders for over-the-counter (OTC) securities. In particular, Morgan Stanley embedded undisclosed mark-ups and mark-downs on certain retail OTC orders processed by its automated market-making system and delayed the execution of other retail OTC orders, for which Morgan Stanley had an obligation to execute without hesitation. Morgan Stanley will pay $7,957,200 in disgorgement and penalties to settle the Commission's charges. All of Morgan Stanley's revenue from its undisclosed mark-ups and mark-downs will be distributed back to the injured investors through a distribution plan.
From Oct. 24, 2001, through Dec. 8, 2004, Morgan Stanley, a registered broker-dealer, failed to seek to obtain best execution for certain orders for OTC securities placed by retail customers of Morgan Stanley, Morgan Stanley DW, Inc. and third party broker-dealers that routed orders to Morgan Stanley for execution. As a result of this conduct, Morgan Stanley breached its duty of best execution with respect to these retail customers' orders.

Dueling Lawsuits at Dow Chemical

You will recall that Dow Chemical fired two longtime officers (and one is a director) about a month ago, because, it said, they engaged in unauthorized talks to sell the company.  Earlier this week Dow filed a law suit against the two charging them with breach of duty, and the officers, J. Pedro Reinhard and Romeo Kreinberg, responded, each with his individual lawsuit against Dow for defamation.  They say that they were fired because of longstanding disagreements with the CEO over corporate policy.  See WSJ, Dow Chemical Rift Grows With Dueling Lawsuits.

Dow Jones Director Possible Source of Leak

The SEC complaint charging a Hong Kong husband and wife with trading in Dow Jones stock while in possession of information about the Murdoch bid did not name the source of the information.  Instead, it focuses on the amount and the timing of the purchases, which it describes as "highly suspicious." Newspapers, however, report that the couple has a connection to a Dow Jones director, David K.P. Li, a banker in Asia.  The wife's father, and the source of some of the funding for the purchase, is a Hong Kong business man and business associate of Li.  See NYTimes, Scrutiny Seen of Trading in Dow Jones; WSJ, Insider Trading Alleged in Shares Of Dow Jones.

Outback Postpones LBO Vote, Cancels Bonds

Outback Steakhouse postponed for one week the shareholder vote on its LBO because it does not yet have the necessary shareholder approval for the deal.  Shareholders expressed unhappiness with the $40 stock price.  In an unusual move, the company also cancelled a $550 million bond financing sold two weeks ago to finance the LBO.  See WSJ, Steak Sent Back:Buyout SnubCancels Bonds.