Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Tuesday, May 8, 2007

SEC Obtains TRO, Charges Hong Kong Couple with Inside Trading in Dow Jones Stock

The SEC obtained a TRO freezing the account of a Hong Kong couple who allegedly purchased 415,000 shares of Dow Jones common stock from April 13 through April 30, prior to the May 1 announcement of Murdoch's bid for the company, and then sold the shares on May 4 for approximately $8 million profit.  The SEC papers (available at its website) provide no information about how the couple may have obtained inside information about the bid and rely on the highly suspicious nature of the purchases -- the large number of shares and the fact that the couple had never previously purchased Dow Jones stock.  Most of the press reports have mentioned unusual trading in Dow Jones options, so we will await further news.  See SEC v. Kan King Wong and Charlotte Ka On Wong Leung.

May 8, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

NASD and State Regulators Support Suitability Rule for Fixed Annuities

Fixed annuities are considered insurance products and regulated by the insurance industry, while variable annuities are considered securities and are regulated as such.  Thus, there has been confusion about whether insurance salesmen have a suitability obligation in recommending fixed annuities.  NASD and state regulators from North Dakota, Iowa and Minnesota announced today that they have signed a joint statement supporting a new rule to require that insurance companies and agencies recommend only suitable annuity products to their customers.

May 8, 2007 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

NASD Disciplines Brokers in Mutual Fund Sales to Military Personnel

One of the most egregious examples of investor abuse was the marketing of periodic payment mutual fund plans to military personnel.  These plans are so expensive that marketing of them to the general public stopped over fiften years, yet mutual funds continued to promote sales to military personnel until Congress prohibited it last fall after the media exposed the practice.  NASD announced today that it has fined two Fidelity broker-dealers $400,000 for preparing and distributing misleading sales literature promoting Fidelity's Destiny I and II Systematic Investment Plans, which were sold primarily to U.S. military personnel. Issuance and sales of new systematic investment plans (also known as periodic payment plans), which typically require investors to make a fixed number of monthly payments over a 10- to 15-year period, were prohibited by Congress last fall. Previously sold plans remain in force.

As part of the settlement, for the next five years, the two broker-dealers - Fidelity Investments Institutional Services Company, Inc. of Smithfield, RI and Fidelity Distributors Corporation of Boston - are required to notify Destiny Plan holders who want to increase their investments in existing Destiny Plans that additional shares of the underlying fund can be purchased outside the Destiny Plans without paying the additional creation and sales charges of up to 50 percent on the first year's payments.

NASD found that between January 2003 and January 2006, the two broker-dealers violated NASD advertising rules by preparing and distributing various pieces of misleading sales literature. For instance, from May 2003 through January 2006, the Fidelity broker-dealers prepared and distributed a brochure entitled "Time is Money" that included misleading performance claims about the Destiny Plans. According to "mountain charts" contained in the brochures, Destiny Plans significantly outperformed the S&P 500 Index over a 30-year period. But during the most recent 10- and 15-year periods—the time frame most relevant to current and prospective investors - Destiny Plans substantially underperformed the S&P 500 Index. The 30-year time period masked the underperformance of the Destiny Plans over the most recent 15 years.  See NASD Fines Two Fidelity Broker Dealers $400,000 for Distributing Misleading Sales Literature About Systematic Investment Plans Sold to Military Personnel.

May 8, 2007 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

WSJ Held News of Murdoch Bid

As the regulators and prosecutors investigate the heavy trading in Dow Jones options prior to the public announcement of Murdoch's bid, a key question is who knew about the offer before the public announcement.  Among those who apparently knew about it is the editor of the Wall St. Journal, who decided not to break the news.  The New York Times raises the question of a news organization's responsibility to report on news-worthy events involving itself -- a question it must have pondered recently with all the coverage of its shareholders' unhappiness with its poor financial performance and its dual-class stock structure that puts control of the corporation in the hands of the Sulzberger family.  See NYTimes, Wall St. Journal Editors Held News of Murdoch Bid.

May 8, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Merger Mania Analyzed

The Wall St. Journal surveys the scene of the latest boom in deal-making and describes how previously-existing obstacles are no longer there -- international barriers, antitrust regulation, board resistence, limits on debt financing.  It's the "wild West out there," says one investment banker.  What could make it stop?  Higher interest rates.  See WSJ, As Deal Barriers Fall, Takeover Bids Multiply.

May 8, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Marvell Technologies Shake-Up Results from Stock Option Probe

Heads are rolling at Marvell Technologies Group, as a special board investigation found numerous instances of stock options back-dating.  Matthew Gloss, General Counsel of the U.S. subsidiary, wa fired, the CFO has resigned, and the board has urged the CEO to give up the position as chairman of the board.  The COO will step down to a lower position in the company and resign as director.  See WSJ, Marvell's Finance Chief Resigns in Wake of Probe.

May 8, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Clear Channel Postpones Meeting Again

Clear Channels Communications postponed its shareholders meeting for the third time to allow shareholders time to consider the revised bid by two equity firms for the company.  Last week the board said it wouldn't postpone the meeting because it was clear the shareholders would reject the bid.  Some major shareholders, however, made clear that they wanted to consider the revised deal.  The offer is for $39.20 per share (still below the $40 some shareholders said they wanted) and an opportunity to participate ("stub equity").  See NYTimes, Clear Channel Postpones Vote, Giving Suitors’ Bid More Time;  WSJ, Clear Channel Delays Vote on Buyout Bid.

May 8, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Ichan's Proxy Fight for Motorola Board Seat Fails

At Motorola's annual shareholders' meeting yesterday, Carl Icahn's proxy fight for a seat on the Motorola board failed, as the big investors decided to give management's plan time to work.  Icahn said his fight was a "wake-up call," and that he'll keep his 2.9% interest.  See NYTimes, Icahn Appears to Fall Short at Motorola; WSJ, Icahn Fails to Win Motorola Board Seat.

May 8, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, May 7, 2007

SEC Post Information on Audit Independence

Just posted on the SEC website:

The Sarbanes-Oxley Act of 2002 mandates that audit committees be directly responsible for the oversight of the engagement of the company's independent auditor, and the Securities and Exchange Commission (the Commission) rules are designed to ensure that auditors are independent of their audit clients. The purpose of this brochure is to highlight certain Commission rules and other authoritative pronouncements relevant to audit committee oversight responsibilities regarding the auditor's independence. More information on this topic is available in the Commission's rules and on the Commission's web site at

Audit committees should also be aware that the PCAOB has Ethics and Independence Rules Concerning Independence, Tax Services, and Contingent Fees.

May 7, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Citigroup Settles Auction Rate Securities Markets Violations

On May 7, the Commission  announced  the  institution  of  proceedings concerning Legg Mason Wood Walker Inc.'s  violative  practice  in  the $200  billion  plus  auction  rate  securities  market.  Auction  rate securities are municipal bonds, corporate bonds  or  preferred  stocks with interest rates or dividend yields that  are  periodically  re-set through Dutch auctions.  The  named  respondent  is  Citigroup  Global Markets Inc. as the successor by merger to Legg Mason Wood Walker, but the proceeding concerns Legg Mason Wood Walker's conduct prior to  the merger.  Simultaneously  with  the  institution  of  the  proceedings, Citigroup Global Markets consented  to  the  entry  of  an  SEC  order providing for a censure and a $200,000 penalty, without  admitting  or denying the findings in the order.  The SEC order finds that, between January 2003  and  June  2004,  Legg Mason  Wood  Walker  intervened  in  auctions  by  bidding   for   its proprietary  account  to  prevent  failed  auctions  without  adequate disclosure. In those instances when this practice lowered the clearing rate of an auction, investors received a lower rate of return on their investments. Also,  because  Legg  Mason  Wood  Walker  was  under  no obligation to guarantee against a failed auction,  investors  may  not    have been aware of the liquidity  and  credit  risks  associated  with certain securities. By  engaging  in  this  practice,  the  respondent  willfully violated Section 17(a)(2) of the  Securities  Act  of  1933, which prohibits material misstatements and omissions in any  offer  or sale of securities.  Citigroup Global Markets already  is  subject  to  a  cease-and-desist order from a settlement that  it  and  fourteen  other  broker-dealers entered into last year  with  the  SEC  concerning  violative  auction practices.

May 7, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Zurich Capital Markets Settles Market-Timing Action

The Securities and Exchange Commission today announced a settled administrative proceeding against Zurich Capital Markets Inc. (ZCM) for its role in providing financing to hedge fund clients that engaged in market timing of mutual funds and facilitating the hedge funds' deceptive trading tactics. The Commission ordered ZCM, a New York-based subsidiary of Zurich Financial Services, to pay $16.8 million consisting of $12.8 million in disgorgement and prejudgment interest and a $4 million penalty. The money will be distributed to the mutual funds that were harmed as a result of market timing ZCM facilitated.  See SEC, Settled Administrative Proceeding Against Zurich Capital Markets Inc. for Financing of Hedge Funds' Illegal Market Timing.

May 7, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

CFTC, NASAA Warn About Forex Fraud

The Commodity Futures Trading Commission (CFTC) and the North American Securities Administrators Association (NASAA) today issued a joint investor alert to warn of the dangers facing retail investors who are lured into foreign currency (forex) trading frauds.  The regulators cautioned investors that off-exchange forex trading by retail investors is at best extremely risky, and at worst, plagued by outright fraud. 

“The damage forex fraud has caused the investing public and the victims of forex scams is incalculable. If you have a phone or an internet connection, you are a potential target of fraudulent forex shops,” says Commissioner Michael V. Dunn, Chair of the CFTC’s Forex Outreach and Education Task Force. “While the CFTC, NASAA and other state and federal regulators are working hard to stop and prevent forex scams from occurring, the first line of defense is an educated consumer and caution in the face of unknown investments."

See Regulators Join Forces to Warn Public of Foreign Currency Trading Frauds.

May 7, 2007 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Two Attorneys Will Plead Guilty in Insider Trading Case

In March 2007 federal prosecutors and the SEC charged 13 individuals in one of the largest insider-trading rings since the 1980s.  Two of those individuals are expected to plead guilty later this week -- Randi Collotta, a former compliance officer and attorney at Morgan Stanley, and her husband, Christopher Collotta, also an attorney.  See WSJ, Ex-Morgan Employee, Husband To Plead Guilty in Insider Case.

May 7, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Journalists Plan to Sue HP Over Surveillance

Hewlett Packard won't be putting its past behind it just yet.  Three journalists whose phone records were obtained by private investigators hired by the company to investigate board leaks announced that they will sue for invasion of privacy.  They say they will seek punitive damages.  See NYTimes, Journalists Intend to Sue Hewlett-Packard Over Surveillance.

May 7, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Sunday, May 6, 2007

Ottaway Family Opposes Murdoch Bid for WSJ

Jim Ottaway, Jr., and his son, Jay Ottaway (the Ottaway family is the other large family group owning Dow Jones stock -- approximately 6.2% of the supervoting Class B stock) issued statements fiercely opposing Murdoch's acquisition of the Wall St. Journal.  Jim Ottaway stated:

"The sale of Dow Jones to Rupert Murdoch and his News Corp. global media giant would lead to loss of the unique news quality and integrity of The Wall Street Journal and other Dow Jones publications and Internet services, and loss of the independence and integrity of a leading national editorial voice."

He also said that to Murdoch the WSJ is the equivalent of a "trophy wife."  See Major Dow Jones Shareholder Opposes Bid From News Corp.

May 6, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Perspective on The Past Week's Stories

The big story (of course) is Rupert Murdoch's surprise bid for Dow Jones & Co., the parent of the Wall Street Journal.  First, there is the tremendous interest generated by the names and personalities -- the media mogul Murdoch, the prestigious WSJ, and the Bancroft family (who have generally been described as "secretive," but that seems to mean "low profile") who, as a group, control Dow Jones through its ownership of the supervoting class of stock.  Second, there are the knotty legal issues that have already  arisen -- like the Revlon duty, with others almost certainly to follow.  And, of course, there are allegations of insider trading.

Insider trading is the second-biggest story this week, as both the DOJ and the SEC brought charges against a Credit Suisse junior investment banker for trading in options of TXU before the public announcement of its LBO (and allegations of other insider trading as well) through a confederate in Pakistan.

May 6, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Booth on Insider Trading and Securities Fraud

The Missing Link between Insider Trading and Securities Fraud, by RICHARD A. BOOTH, University of Maryland School of Law, was recently posted on SSRN.  Here is the abstract:

In a recent article, I argued that diversified investors - the vast majority of investors - would prefer that securities fraud class actions under the 1934 Act and Rule 10b-5 be dismissed in the absence of insider trading or similar offenses during the fraud period. See Richard A. Booth, The End of the Securities Fraud Class Action as We Know It, 4 Berk. Bus. L. J. 1 (2007), In this article, I draw on the classic case, SEC v. Texas Gulf Sulfur Company, to show that the federal courts originally viewed securities fraud as inextricably connected to insider trading and that the recognition of separable causes of action has caused much of the difficulty in this area. I argue that the federal law of insider trading fails to capture many of ways that insiders can misappropriate stockholder wealth. For example, timing and backdating in connection with stock option grants likely do not constitute insider trading but likely do constitute misappropriation. Thus, I here address the question of how to define misappropriation of stockholder wealth in the context of a derivative action based on securities fraud. I conclude that the question is essentially one of state law fiduciary duty that should be decided by state courts under the emerging duty of candor. Although this solution raises potential conflicts with federal law in general and SLUSA in particular, I argue that these conflicts are no different from conflicts that arise in many state law cases that touch on issues of disclosure. Moreover, I argue that handling such claims under state law is more consistent with the federal statutory scheme and ultimately preferable to developing or maintaining a separate body of federal law addressing either securities fraud or insider trading.

May 6, 2007 in Law Review Articles | Permalink | Comments (0) | TrackBack (1)

6th Circuit Dismisses 10b-5 "Class B Shares" Class Action Against Morgan Stanley

Broker-dealers have frequently sold Class B mutual fund shares to their customers instead of Class A shares because the higher Class B fees make it more profitable for the broker.  In recent years NASD has brought many enforcement actions against securities firms for this practice and issued warnings to investors.  The Sixth Circuit, however, recently dismissed a class action brought by customers purchasing at least $50,000 in mutual funds against Morgan Stanley for placing them in Class B shares, when, according to plaintiff (and accepted as true by the court for purposes of deciding the motion to dismiss) at this level of investment, Class A shares was always a better choice.  The Robert N. Clemens Trust v. Morgan Stanley DW, Inc., 2007 WL 1263964 (6th Cir. May 2, 2007). 

A bit of background: a customer's claim against his broker for an unsuitable recommendation is almost always brought in arbitration; generally, unsuitability claims are not amenable to class action because of the predominance of individual questions of fact such as the nature of the recommendation made by the broker to his customer and the individual investor's investment objectives (NASD rules exclude class actions from arbitration, one of the few exceptions to mandatory arbitration under the customers' agreement.) Plaintiffs occasionally attempt to bring class actions by alleging that their brokers engaged in common practices such as illegal business practices or widely disseminated misstatements that have the same impact on numerous customers.  Plaintiffs' attempt to do so here, however, failed, largely because of the stringent pleading requirements of PSLRA.  Specifically, plaintiffs (1) failed to state specific factual allegations that Morgan Stanley and its brokers knew or were reckless in not knowing that Class B shares were inferior to Class A shares; (2) failed to state sufficient facts to allow the court to draw an inference that MS knew that Class B shares were inferior to Class A shares; and (3) failed to state sufficient facts to establish that MS brokers knewe that Class B shares were unsuitable for plaintiffs.  After all, the court reasoned, MS could have legitimately offered only the more expensive Class B shares, so how could it be fraudulent to offer their customers a choice?  While recognizing hypothetically that MS could have engaged in a scheme to defraud its customers, the court did not believe that plaintiffs provided enough specific factual allegations facts that MS was steering its investors into Class B shares regardless of each investor's personal investment goals.  In addition, it finds that plaintiffs abandoned their claims under Rule 10b-5(a) and (c) because they did not specifically refer to these subsections of the Rule in their opening brief.

As an investors' advocate, I have frequently argued that whatever the failures of SRO arbitration, it offers one great advantage to investors -- the arbitrators don't have to apply federal securities laws that have become increasingly anti-investor over the years.  This case provides an excellent illustration for my argument.  In arbitration a customer can base his claim on the unsuitability of the recommendation without having to establish scienter. 

The 6th Circuit opinion is also noteworthy in that it is one of the few opinions (and perhaps the first from a federal appellate court) that cites an arbitration award to support its analysis.  This is not a trend to be encouraged -- arbitrators do not have to apply the law, they do not have to give reasons, and arbitration awards have no precedential value -- the arbitrators' task is to resolve the dispute before them.

May 6, 2007 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)