Securities Law Prof Blog

SEC's Proposed Modernization of Smaller Company Capital Raising

On May 23, the SEC announced that it was proposing a series of measures to modernize and improve its capital raising and reporting requirements for smaller companies.  This week it issued two releases setting forth some of the specifics.  Release 33-8812 proposes modification of the eligibility requirements for use of Form S-3 so that companies with a public float below $75 million can use Form S-3 and can also take advantage of shelf registration.  Release 33-8813 proposes revisions to Rule 144 to shorten the holding period for resales of restricted securities and revisions to Rule 145 to eliminate the presumptive underwriter doctrine.

When Form S-3 was revised in 1992, the SEC stated that the $75 million float requirement would limit use of Form S-3 principally to corporations traded on the NYSE or NASDSQ who were generally followed by at least three analysts.  (In today's dollars, $75 million would be between $100-110 million).  Indeed, the SEC's heavy reliance on the efficient markets hypothesis was the guiding principle behind the adoption of the tiered registration system, including Form S-3 and its incorporation by reference of 34 Act filings into the 33 Act registration statement.  Today, the SEC believes that more companies should benefit from the greater flexibility and efficiency in accessing capital markets afforded by Form S-3.  Citing the great advances in electronic dissemination and accessibility to company information since the last revisions to Form S-3, the SEC has dramatically expanded the use of Form S-3 and the periodic takedowns of securities permitted by shelf registration.  The proposed rule would permit registrants (other than shell companies) to use Form S-3 for primary offerings, whether or not they satisfy the $75 million public float requirement, so long as they do not sell more than 20% of their public float over any twelve-month period and otherwise satisfy the Form S-3 requirements (i.e., the company must be a reporting company and must have timely filed all required 34 Act reports in the past 12 months).  This would include companies quoted on the OTC Bulletin Board and the Pink Sheets quotation services.  The cap of 20%, the SEC states, should be large enough to help issuers meet their financing needs but small enough to take into account the effect the issuances could have on the market for thinly traded securities.  In the release the SEC emphasizes the advantages to smaller companies of shelf registrations.  While it recognizes the concern that this would allow periodic takedowns without any further SEC staff review since the initial filing of the registration statement, it believes this risk is justified by the benefits for smaller companies.  Comments are due August 27.  The release contains a number of questions on which the SEC would like to receive comment.  To me an important one, as stated by the SEC, is:  in what way is market following an important criterion in light of technological changes?

There are two principal proposed revisions to Rule 144 to ease the restrictions of the Rule and to increase the liquidity of restricted securities and thus decrease the cost of capital.  First, the Rule would reduce the holding period for restricted securities of 34 Act companies to six months (currently, it is one year), subject to increasing the holding period, for up to six months, if the holder engaged in hedging transactions during that time.  The SEC believes that six months is a reasonable indication that an investor has assumed the economic risk of the investment and is therefore not an "underwriter."  Second, the Rule would substantially reduce restrictions on resales by non-affiliates after they have satisfied the holding period.  Non-affiliates of reporting companies would only be subject to the current public information requirement for one year after the acquisition of the securities.  Non-affiliates of both reporting and non-reporting companies could resell their securities after one year without any other conditions.  As is usual with Rule 144, there are plenty of technicalities, and the SEC has a two very useful charts (at p. 12 and p. 26 of the release) tracking the changes.  The SEC has rewritten the Preliminary Note in "plain English," and it is startling in its brevity.  As a securities law professor, I found the Preliminary Note's discussion of the principles behind the Rule and, in particular, its discussion of "when a person is deemed not to be engaged in a distribution" very helpful.  I will be sorry to see it go.

Finally, the proposed changes to Rule 145 would, first, eliminate the presumptive underwriter position in paragraph (c), except for transactions involving shell companies.  This is a long overdue change to my mind, since the presumptive underwriter doctrine did not make much sense in this context.  Second, the resale provisions in paragraph (d) would be changed to conform with the changes in Rule 144.

Dow Jones Independence Proposal a Non-Starter

If people thought the Dow Jones board's involvement in the negotiations with Murdoch would speed matters up, they must think again.  The Dow Jones board has proposed to Rupert Murdoch a Special Committee on Editorial and Journalistic Independence and Integrity -- how pompous can you get?  The proposal is apparently about the same as the one that the Bancroft family proposed in early June, and Murdoch's reaction was reported to be frustration.  See NYTimes, Latest Plan From Dow Jones Is Said to Frustrate Murdoch; WSJ,Dow Jones Sends News Corp. Its Plan To Protect Editorial Independence.

Dubai Fashion Sense?

Forget the ports deal -- I can't get used to the idea of the investment arm of Dubai owning Barneys!  I remember when Barneys was a discount men's store owned by Barney Pressman and watched with bemusement as it transformed itself into a symbol of edgy, too-cool-for-most-of-us New York fashion.  Now Jones Apparel, struggling to remain afloat, sold Barneys for $825 million to Istithmar -- a good deal considering Jones bought the stores in 2004 about half that amount.  See WSJ, Jones Apparel to Sell Barneys To Dubai Firm for $825 Million.
 

Lear Postpones Vote on Icahn Buyout

Lear Corp. postponed its special meeting to vote on Carl Icahn's $36 per share buyout offer, for which it reaffirmed its support.  Postponement seems to be a more common tactic these days, in face of shareholders' resistance.  Both Proxy Governance and ISS recommend that shareholders vote against the deal.  The new meeting date is July 12 (originally June 27). See WSJ, Lear Affirms Support for Buyout  By Icahn, Delays Annual Meeting.

Fannie Mae Wants to Pay Incentive Bonuses

Fannie Mae plans to pay millions of dollars in incentive compensation to current and former officers and employees based on corporate performance since 2003, including the periods in which earnings were misstated and regulators say the company was mismanaged.  The payments are subject to the approval of oversight agency OFHEO.  The company did not disclose whether former CEO Franklin D. Raines would receive any payments.  OFHEO and Raines are fighting over whether Raines has to return some of his previously paid compensation.  See WPost, Fannie Proposes Releasing Executive Incentive Payments.

Dow Jones Board Will Start Negotiations with Murdoch

GE and Pearson announced that they have decided not to bid for Dow Jones, leaving Murdoch's $60 bid the only one out there.  The Dow Jones board is reviewing the Bancroft family's proposal for an independent editorial board and is expected to begin its negotiations with Murdoch soon. See NYTimes, 2 Companies Drop Pursuit of Dow Jones; WSJ, Murdoch's Bid for Dow Jones Gets a Boost.

LSE and NYSE Bid For Borsa Italiana

Italy's markets operator Borsa Italiana SpA is considering competing bids from the London Stock Exchange and NYSE Euronext.  Each is valued at around $2 billion.  See WSJ, Borsa Italiana's Decision: LSE or NYSE?

Blackstone Goes Public

Despite calls this week from Congressmen to postpone its IPO because of tax and security concerns, Blackstone Group goes public today, having sold its shares at $31 per share, for a total of $4.3 billion.  The speculatation is that rival Kohlberg Kravis Roberts will be next.  See NYTimes, Blackstone Rival Plans Own I.P.O.; WSJ, Blackstone's Green Day.

Cambrex Settles SEC Charges Involving Improper Accounting

On  June  20, the SEC settled enforcement proceedings against Cambrex Corporation (Cambrex)  for  violations  of the recordkeeping and internal controls provisions of  Section  13  of the  Securities  Exchange  Act  of  1934  (Exchange   Act).   Cambrex is  a  life  sciences company whose common stock trades on the New York  Stock Exchange.  From at least 1997 through 2001, Cambrex failed to properly  reconcile its  intercompany  accounts,  thereby   accruing   an   imbalance   of approximately  $17.1  million.  Of  that  amount,  approximately  $3.5 million was erroneously reflected as income when  in  fact  it  should have been accounted for as an operating expense, and Cambrex could not ascertain whether another $2.6 million was also improperly  booked  as income. As a result, Cambrex  issued  erroneous  periodic  and  annual reports, and, in January 2003, Cambrex restated its financial  results for  the  five-year  period,  reducing  net  income  after  taxes   by approximately $5 million.  The complaint alleges that the officers were aware of the problem but failed to reconcile  its  intercompany  accounts until its  executives  were  faced  with  the  new  executive  officer certification requirements  under  the  Sarbanes-Oxley  Act  of  2002.
   

SEC Issues Interpretive Guidance on Internal Controls

On June 20, the SEC issued interpretive  guidance,  unanimously approved on May 23, to help public companies strengthen their internal control over financial reporting  while  reducing  unnecessary  costs, particularly at smaller  companies.  The  new  guidance  will  enhance compliance under Section 404 of the  Sarbanes-Oxley  Act  of  2002  by focusing company management on the internal controls that best protect against the risk of a material financial misstatement.  The SEC also issued final  rule  amendments  providing  that  a company that performs an evaluation of internal control in  accordance with  the  interpretive  guidance  satisfies  the  annual   evaluation required by Exchange Act Rules 13a-15(c) and 15d-15(c),  defining  the term "material weakness," and revising the requirements regarding  the auditor's attestation report on the effectiveness of internal  control over  financial  reporting.  The  Commission  also  issued  a  release requesting comment on a proposed definition of the  term  significant deficiency."

SEC Commissioners to Testify Before House Committee

Chairman Cox and Commissioners Atkins,  Campos,  Nazareth,  and  Casey will appear before  the  House  Committee  on  Financial  Services  on Tuesday, June 26, concerning a variety of SEC-related  policy  issues.  The hearing will begin at 2:00 p.m. in Room 2128 of the Rayburn  House Office Building.

SEC Tightens Rule on Short-Selling Prior to Offering

The SEC adopted on June 20, 2007 amendments to strengthen Rule 105 of Regulation M.  Rule 105 helps prevent abusive short selling and market manipulation. When a trader expects to receive shares in an offering, there is an incentive to sell short prior to pricing an offering and then cover that short position with shares bought at the reduced offering price. By doing so, the trader can cover the short sale with minimal risk, and generally lock in a guaranteed profit — to the detriment of the issuer and the other shareholders.

The amendments change the way the rule works to prevent this from happening. They replace the rule's current limitation on covering the short sales in the offering with a prohibition on purchasing in the offering after a short sale in the securities. This change was triggered by persistent non-compliance with the rule and a string of strategies to conceal the prohibited covering. Under the amended rule, if a person sells short during the restricted period prior to pricing, that person is prohibited from purchasing the offered security. See SEC Votes to Adopt Final Amendments to Rule 105 of Regulation M, Short Selling in Connection With a Public Offering.

NASD Fines Wachovia for Fee-Based Accounts Practices

NASD announced today that it has fined Wachovia Securities LLC of Richmond, VA, $2 million for failing to adequately supervise its fee-based brokerage business between 2001 through 2004.  In addition, NASD ordered Wachovia to identify and pay restitution to approximately 1,300 customers who were inappropriately allowed to continue maintaining fee-based accounts, or who were inappropriately charged account fees on Class A mutual fund share holdings for which they had already paid a sales load.  The firm also is required to retain an outside consultant to review its process of identifying and paying restitution to customers.

"Firms must have systems and procedures which are tailored to reasonably supervise their business activities," said NASD James Shorris, Executive Vice President and Head of Enforcement. "In the case of fee-based accounts, firms had an obligation to their customers to assess the appropriateness of such accounts both when the accounts were opened and periodically thereafter. Here, Wachovia failed to implement a system designed to ensure that an assessment of the appropriateness of the fee-based account occurred. This failure was compounded by the firm's failure to prevent certain fee-based customers from being charged both an account fee and a sales charge for the same mutual fund investments."

Abuses in fee-based accounts became prevalent in an era where competitive pressures reduced the profitability of commission-based accounts, so it's good to see the regulators bringing these actions.  See NASD Fines Wachovia Securities $2 Million for Fee-Based Account Violations.

Tellabs v. Makor Issues & Rights

The Court's task, as framed by Justice Ginsburg in her majority opinion, was to resolve the disagreement among the Circuits on whether, and to what extent, a court must consider competing inferences in determining whether a securities fraud complaint gives rise to a "strong inference" of scienter, the PSLRA requirement.  The "strong inference" requirement "unequivocally raise[d] the bar for pleading scienter" and signalled Congress' purpose to promote greater uniformity among the Circuits, according to Justice Ginsburg.  Thus, the Court must set forth a "workable construction of the strong inference standard ... geared to the PSLRA's twin goals: to curb frivolous, lawyer-driven litigation, while preserving investors' ability to recover on meritorious claims."

Justice Ginsburg thus proceeds to set forth the roadmap.  First, as with any motion to dismiss, the court must accept all factual allegations in the complaint as true.  Second, the court must consider the complaint in its entirety, as well as other sources courts ordinarily consider when ruling on motions to dismiss -- documents incorporated by reference and other matters of which the court may take judicial notice.  The inquiry is whether all of the alleged facts, taken collectively, give rise to a strong inference of scienter.  Third, in determining whether the pleaded facts give rise to a "strong" inference of scienter, the court must take into account plausible opposing inferences.  The inference of scienter must be cogent and compelling, thus strong in light of other explanations.  In sum, the court must ask: when the allegations are accepted as true and taken collectively, would a reasonable person deem the inference of scienter at least as strong as any opposing inference?

Justice Scalia and Justice Alito each wrote concurring opinions, expressing the view that "strong inference" required that the test should be whether the inference of scienter is more plausible than the inference of innocence because this is the natural reading of the statute. Justice Stevens was the lone dissenter, arguing that the standard should be analogous to the probable-cause standard from criminal law.

In my view, the majority opinion was quite predictable and, indeed, inflicted probably the least amount of damage on plaintiffs, given the statute and the pro-business tendencies of this Court.  Under the majority's test, the plaintiff "only" has to demonstrate that the inference of scienter was at least as likely as any plausible opposing inference.  In contrast, if Justices Scalia and Alito had their way, the "strong inference" test would have constructed an even higher obstacle to private securities fraud cases, requiring that the inference of scienter be more plausible than the contrary inference.  These days, the majority's rejection of that view can count as a victory.

Supreme Court Rules Against Plaintiffs in Tellabs

To probably no one's surprise, the Supreme Court ruled (8-1) that plaintiffs in private securities fraud actions must meet a high standard for pleading scienter. 

"To qualify as strong....we hold an inference of scienter must be more than merely plausible or reasonable," Justice Ginsburg wrote. "It must be cogent and at least as compelling as any opposing inference of nonfraudulent intent."

More to follow, after reading the opinion.  For now, see WSJ, Court Sets Securities Suit Standard.

Paulson Confirms His Involvement in Opposing Pro-Plaintiff "Scheme Liability" Position

Treasury Secretary Paulson confirmed that he personally initiated the contact with the Justice Dept. to voice opposition to filing an amicus brief in support of plaintiffs in the "scheme liability" case pending before the Supreme Court.  Testifying at a Senate Financial Services hearing, he said he was concerned about exposing to liability companies that "happened to do business" with a firm that committed securities fraud.  See WPost, Paulson Behind Opposition to Third-Party Suits.

ISS Says No to Icahn-Lear Deal

ISS recommends a no vote on Carl Icahn's proposed $2.75 billion takeover of Lear Corp, which management supports.  ISS questions the strategic rationale for the takeover and says the $36 per share price is not much of a control premium.  The shareholders' meeting is scheduled for June 27.  See WSJ, ISS Recommends Lear Holders Reject Icahn Bid.

More Inside Info on Dow Jones Board Discussions

Today the Wall St. Journal has a long front page story on yesterday's announcement that the Dow Jones board was taking over the discussions with Rupert Murdoch about his offer for the company.  What is fascinating about the WSJ articles on this subject is trying to figure out who within the company is talking, since the stories give us unusually detailed accounts of conversations within the boardroom.  The WSJ reports that on Tuesday the five-member board committee heard an update from Michael Elefante, a director and the Bancroft family's trustee, who reported that the family would soon be sending a proposal to Murdoch.  On Wednesday, when the full board heard the update, several independent directors raised questions about their liability if Murdoch withdrew his bid.  See WSJ, Dow Jones Board Takes Over Talks On Firm's Future.

Does Blackstone IPO Jeopardize National Security?

As the Blackstone Group's IPO approaches, Congress has been debating the tax treatment of private equity firms.  Yesterday Senator Jim Webb (D. Va) raised another concern and asked the SEC to delay the IPO. citing national security concerns stemming from China's $3 billion investment.  In a letter, he asked how the US "would prevent the transfer of sensitive national security information associated with the transaction."  See WPost, Efforts Grow To Waylay Blackstone Stock Sale; WSJ, Proposed Higher Tax Rate Aimed At Buyout Shops May Get Sterner. The WSJ website has the letter.

Greenberg Sues AIG Officers and Directors

Last week AIG sued its former CEO Maurice "Hank" Greenberg for $1 billion damages resulting from its regulatory difficulties with the New York Attorney General and the SEC.  Yesterday Greenberg filed his own law suit against 16 current and former directors and officers of the company, saying that the company's financial restatement and $1.64 billion settlement were unnecessary.  See NYTimes, In Suit, Ex-A.I.G. Chief Says Others Are Liable for Restatement; WSJ, Greenberg Says Directors Are 'Seriously Damaging' AIG.

Dow Jones Board Steps Up

The Dow Jones board of directors says it will take over negotiations over the future of the company.  Reportedly, it is frustrated by the slowness of the Bancroft family's discussions with Murdoch over the independence of the newspaper.  See WSJ, Dow Jones Board Takes Over Talks.

SEC Will Consider Proposal to Allow Non-US Companies to Use Int'l Accounting Rules

The SEC voted to put out for public comment a proposed rule that would allow non-US companies to report its financial information using international accounting rules instead of GAAP.  See WSJ, SEC Backs Plan to Accept International Accounting.

Former Enron CFO Settles SEC Charges

The SEC charged former Enron Treasurer and Chief Financial Officer Jeffrey McMahon with violating the antifraud provisions of the federal securities laws and with aiding and abetting Enron's violations of the reporting and record keeping provisions. McMahon simultaneously settled with the Commission without admitting or denying the allegations in the Complaint. As part of the settlement agreement, which is subject to the approval of the U.S. District Court, McMahon has agreed to a permanent injunction and to be barred from acting as an officer or director of a public company for five years. In addition, McMahon will pay disgorgement and prejudgment interest in the amount of $150,000 and a civil penalty of $150,000.

Specifically, the Commission's Complaint alleges that McMahon participated in a fraudulent transaction involving the "sale" of an interest in Nigerian power generating barges to Merrill Lynch that allowed Enron to improperly report $12 million in earnings in the fourth quarter of 1999. The Complaint also alleges that while serving as Enron's Treasurer from April 1998 through March 2000, McMahon made false and misleading statements to the national credit rating agencies regarding Enron's financial position and cash flow. In addition, the Complaint alleges that McMahon made additional false and misleading statements to the rating agencies after he became Enron's Chief Financial Officer on October 24, 2001 through Enron's bankruptcy filing in December 2001.

Schapiro Announces New Name for Consolidated Regulatory Arm

Mary Schapiro, CEO and Chair of NASD, announced that the name of the consolidated regulatory arm will be Securities Industry Regulatory Authority or SIRA.  She says her first choice was Vanguard, but that name was taken.  See Remarks, The Exchequer Club, Washington, DC, June 20, 2007.

Expedia, Home Depot Announce Stock Buybacks

Two big stock buybacks were announced yesterday:  Expedia and Home Depot.  Expedia will buy back one-third of its outstanding shares; after the buyback, Chair Barry Diller will control 41% of the stock.  Home Depot increased its buyback program by $22.5 billion, financed by the sale (to a consortium of private equity firms) of a supply unit that was associated with its former CEO Nardelli, cash on hand, and sale of $12 billion in notes.  See NYTimes, Big Buyback of Shares Is Set by Expedia and  Home Depot Sells a Unit That Never Fit.

Profile of Alleged Pakistani Insider Traders

Did Hafiz Muhammed Zubair Naseem, a Credit Suisse analyst living in suburban New York, tip his friend, Ajaz Rahim, a self-described "rupee billionaire" made rich by the post Sept. 11 Pakistani bull market, or is the government's case "plainly inferential," as Judge James C. Francis IV recently said?  According to the government, on nine occasions Naseem told Rahim about US companies that were soon to announce that they were takeover targets, including, in February, TXU.  The New York Times article gives us an insight into the business world in Pakistan.  See NYTimes Insider Trading Can Now Touch Many Corners of the World.

SIFMA Study in Support of Rule 12b-1 Fees

The Securities Industry and Financial Markets Association (SIFMA) has prepared a white paper on the history and purpose of Rule 12b-1 under the Investment Company Act of 1940.  Rule 12b-1 permits mutual funds to use fund assets to finance the distribution of their shares.  The white paper has been provided to the Securities Exchange Commission (SEC) as background material for panelists participating in a roundtable event on Rule 12b-1 being held today in Washington D.C. by the SEC.

“While we appreciate the SEC’s efforts to undertake a review of Rule 12b-1, we ultimately believe that the rule is important to both firms and investors,” points out Ira Hammerman, senior managing director and general counsel for SIFMA.  “For broker-dealers and other intermediaries, 12b-1 plans support important marketing, advertising, and administrative and shareholder servicing functions.”

The report is available at the SIFMA website.

SEC Settles Insider Trading Case Against Former Sadia Director

The SEC filed a settled civil injunctive action in the United States District Court for the District of Columbia against Romano Ancelmo Fontana Filho, a former Director at Sadia S.A. ("Sadia"), a Brazilian food products company. The Commission charged Fontana with engaging in illegal insider trading both by purchasing securities of Perdigão S.A. ("Perdigão") prior to Sadia's tender offer for Perdigão and by selling the same securities of Perdigão prior to Sadia's subsequent revocation of the tender offer. Without admitting or denying the allegations in the Commission's complaint, Fontana has consented to the entry of a final judgment imposing injunctive and monetary relief and barring him from acting as an officer or director of a publicly traded company for a period of five years.  The Commission's complaint alleges that Fontana learned of the contemplated tender offer on April 26, 2006, through a conversation with the chairman of Sadia's board of directors. According to the complaint, Fontana subsequently purchased 18,000 American Depositary Shares ("ADSs") of Perdigão at an average cost of $19.12 per ADS through three transactions executed between July 5 and 12, 2006, on the basis of material, nonpublic information concerning the proposed acquisition, and in breach of a duty of trust and confidence he owed to Sadia. On Sunday, July 16, 2006, Sadia announced the tender offer for Perdigão. The following day, the price of Perdigão ADSs increased to $24.50, up $4.25 (21%) from the previous closing price. On the morning of July 21, 2006, Fontana participated by conference call in a meeting at which Sadia's board of directors decided to revoke the tender offer. As the complaint alleges, after this meeting — but before Sadia announced the revocation later that day — Fontana sold all 18,000 ADSs of Perdigão at an average selling price of $26.85 per ADS. By selling in advance of the public announcement of the revocation, the complaint alleges, Fontana again engaged in illegal insider trading, in breach of a duty of trust and confidence he owed to Sadia. The complaint alleges that Fontana realized ill-gotten profits of $139,114.50 from his unlawful trading.

SEC Charges Wife with Trading In Information Obtained from Husband

We've seen a number of insider trading cases involving married couples, and here's another one:

On June 18, the SEC filed a settled  civil  action  in  federal district court against Terese Dearmin (Dearmin) and her father Richard Harris (Harris), alleging violations of  federal  securities  laws  in   separate instances of insider trading in the securities of U.S. Home & Garden, Inc. (USHG) ahead of the public  announcement  of  its  merger with Ionatron, Inc. (Ionatron).  The Commission's complaint  alleges  that  Dearmin  learned  from  her husband, the former CEO of a privately-held company  called  Ionatron, that it would merge with USHG approximately one  month  prior  to  the Feb. 25, 2004, public  announcement  of  the  merger.  Dearmin  tipped Harris, her  mother,  and  her  business  partner,  according  to  the complaint, and all three purchased USGH stock in advance of the merger    announcement.  Without admitting or denying the allegations in the complaint, Dearmin and Harris consented to entry of a final  judgment  that  imposes  an  injunction, disgorgement of profits, and penalties.
   

Things Not To Say Out Loud

The Federal Trade Commission, in its suit to block the Whole Foods-Wild Oats merger, says that the Whole Foods CEO told his board the merger was necessary to "avoid nasty price wars" among natural foods grocers.  See WSJ, Whole Foods CEO Says Merger With Wild Oats Avoids Price War.

Big Deals Provides Lots of Opportunities for Insider Trading

Are there widespread systematic abuses of trading on inside information involving private equity deals?  The Wall St. Journal profiles KKR's $25.6 billion buyout of First Data Corp. as it explores this question.  Senate Arlen Specter and Federal Reserve Board Chairman Ben Bernanke call for crack-downs on misuse of inside information.  See WSJ, Secrets to Keep:Insider Trading Hits Golden Age.

Corporate Executives on Trial

The first criminal case involving backdating stock options began in San Francisco against Gregory L. Reyes, former CEO of Brocade Communications.  It is expected to be a test of what the government must prove to establish that backdating is a securities fraud crime.  See NYTimes, Trial Starts for Former Chief in Options-Backdating Case; WSJ, Trial Opens in Brocade Backdating Case.

Meanwhile, in Chicago, the three-month trial of Lord Conrad Black, accusing of looting Hollinger International, is wrapping up.  The prosecutor presented closing arguments, and the case is expected to go to the jury soon.  See NYTimes, Closing Arguments Begin in Black Trial.

SEC Solicits Additional Comments on Auditing Standard 5

The SEC  published  a  notice  of  additional  solicitation  of comments on proposed rules (PCAOB-2007-02)  submitted  by  the  Public Company Accounting Oversight Board which were previously published  on June 12, 2007. These rules establish requirements that apply  when  an auditor is engaged  to  perform an  audit  of  the  effectiveness  of internal control over financial reporting that is integrated  with  an audit of the financial statements (Auditing Standard No. 5,  An  Audit of Internal Control Over Financial Reporting That Is  Integrated  with An Audit of Financial Statements), a related independence  rule  (Rule 3525, Audit Committee Pre-Approval of Non-Audit  Services  Related  to Internal Control Over Financial Reporting), and conforming  amendments to its auditing standards. Publication of  the  notice  of  additional solicitation of comment is expected in the Federal Register during the week of June 18. The comment period will close on July 12, 2007.

Supreme Court Holds Securities Laws Prevent Antitrust Claims Against Underwriters

The Supreme Court (7-1 vote) held, in Credit Suisse First Boston v. Billing, that the federal securities laws prevent private antitrust claims against several underwriters of IPOs in connection with tie-in arrangements that required firms to purchase additional securities in the aftermarket.  The decision reversed the Second Circuit.   Justice Thomas dissented.

Study on SRO Arbitration of Customers' Disputes

Edward S. O'Neal, Securities Litigation and Consulting Group, and Daniel R. Solin, a securities arbitration attorney representing investors, released their report, Mandatory Arbitration of Securities Disputes: A Statistical Analysis of How Claimants Fare, this week.  The report is available at http://www.smartestinvestmentbook.com or http://www.slcg.com.  Here are the report's major  findings:

The raw win rate for investors in arbitration has dropped from a high of 59 percent in 1999 to 44 percent in 2004. This overall figure includes a lower win rate (39 percent) at the three largest brokerage firms that do business with the largest numbers of investors.

Award percentages reached a high in 1998 of 68 percent and have steadily declined to stabilize at approximately 50 percent in the 2002-2004 time period.

Investors in arbitration were awarded 22 cents on the dollar in 2004 (as a percentage the amount claimed) versus 38 cents on the dollar in 1998.

The larger the award and the brokerage firm involved, the smaller the recovery. Claimants in arbitrations against top 20 brokerage firms face an expected recovery percentage that is approximately 28 percent in claims under $10,000. The expected recovery percentage plunges to approximately 12 percent in claims over $250,000.

Award requests increased significantly over the entire period while average awards remained nearly constant. In 1998, the average award was $56,000 while in 2004 it was $59,000. This 6 percent increase in real awards is dwarfed by the difference in award requests, which rose over 300 percent from $168,000 in 1998 to $540,000 in 2004.

This is a significant research effort that is an important contribution to the literature on the fairness of securities arbitration of customers' disputes.  The authors collected information on NASD and NYSE arbitrations that occurred between January 1995 and December 2004.  Their database consisted of 13,810 arbitration awards, 90% from NASD and the remaining 10% from the NYSE.  Their conclusions about the drop in investors' win rates and the decrease in the percentage recovery are not new information; SRO statistics reveal the same trend.  No previous study, to my knowledge, has focused on correlations between the size of the requested damages and the size of the brokerage firms and the percentage recovery. 

I remain unconvinced, however, that these statistics demonstrate the existence of a serious "repeat player" problem that advantages major brokerage firms.  The problem with any study of awards is that it excludes the great numbers of cases that are settled and do not result in an award.  Thus, we are left with what may ultimately be an unrepresentative sampling.  In addition, any assessment of the fairness of a system without any examination of the merits of the claim and the assessment of damages (an impossible undertaking given the absence of meaningful information in the awards) must necessarily be incomplete.  The authors argue that brokerage firms have an advantage here because they have greater familiarity with the merits of settled claims than do claimants, but most claimants, at least those claimants seeking recovery of large amounts of damages, are represented by experienced claimants' attorneys who are equally knowledgeable about the system.

Finally, the authors' endorsement of the view that SRO arbitration is "a damage containment and control program masquerading as a juridical proceeding" is not supported by their findings and seems overblown.

Corporate Women Scholar's Conference

The Corporate Women Scholar's Conference was held Saturday June 16 at the Seattle University School of Law.  Presenters included Jill Fisch (Fordham), Loss Causation in Securities Fraud; Donna Nagy(Indiana), The Demise of the Fiduciary Principle in Insider-Trading Law; Hillary Sale(Iowa), The Gatekeeping Role of Judges in Approving Settlements; Janis Serra (British Columbia), Legal and Governance Principles in Cross-Border Corporate Group Insolvencies; Cheryl Wade (St. John's), SOX Five Years Later: Calls for Repeal or Rollback, anad What the Public Does Not Know; Lynne Dallas (San Diego), Implications of the Post-SOX Changes in the Composition and Culture of Boards; and Barbara Black (Cincinnati), Should the SEC be a Collection Agency for Defrauded Investors?  Other participants include Renee Jones (Boston College), Elizabeth Nowicki (Tulane), Claire Moore Dickinson (Rutgers/Tulane), Cristine Hurt (Illinois), Faith Kahn (New York Law School).  Many thanks go to Dean Kellye Testy for hosting this wonderful conference at her beautiful law school!

Perspectives on the Past Week's News

The Department of Justice did not file an amicus brief on the side of investors in the "scheme liability" case that the Supreme Court will hear next term, reflecting the division of opinion between the SEC (in favor of plaintiffs) and the Treasury Dept. (in favor of defendants) that President Bush decided, saying the SEC's position was bad policy.  It remains to be seen whether the government will file on behalf of the defendants or sit this one out.  Still waiting for the Tellabs decision ....

Sjostrom on PIPEs

PIPEs, by WILLIAM K. SJOSTROM Jr., Northern Kentucky University - Salmon P. Chase College of Law, was recently posted on SSRN.  Here is the abstract:

The Article examines Private Investments in Public Equity (PIPEs), an important source of financing for small public companies. The Article describes common characteristics of PIPE deals, including the types of securities issued and the basic trading strategy employed by hedge funds, the most common investors in small company PIPEs. The Article argues that by investing in a PIPE and promptly selling short the issuer's common stock, a hedge fund is essentially underwriting a follow-on public offering while legally avoiding many of the regulations applicable to underwriters. This “regulatory arbitrage” makes it possible for hedge funds to secure the advantageous terms responsible for the market-beating returns they have garnered from PIPE investments. Additionally, the article details securities law compliance issues with respect to PIPE transactions and explores recent SEC PIPE-related enforcement actions and regulatory maneuvers. The Article concludes that a more measured and transparent SEC approach to PIPE regulation is in order.

Barnard on Securities Fraud Professionals

Securities Fraud Professionals, by JAYNE W. BARNARD, College of William and Mary - Marshall-Wythe School of Law, was recently posted on SSRN.  Here is the abstract:

This article examines the phenomenon of securities fraud professionals – the con artists who sell bogus stock on the Internet, orchestrate elaborate pump-and-dump schemes, and create a never-ending array of purportedly “risk free” investment opportunities. Collectively, and in a cruel mockery of capitalism, these offenders extract hundreds of millions dollars from investors every year.

The article explores some of the common characteristics of these offenders, with a particular focus on those who orchestrate fraudulent schemes three, four, or more times in their careers. I theorize that this group – much like sex offenders – are “hard wired” to engage in fraudulent behavior.

I then propose several changes to the Securities and Exchange Commission's approach to these offenders. The escalating use of civil sanctions, and the imposition of multiple “obey-the-law” injunctions, simply are not enough to deal with this population. I also propose a research agenda that would teach us much more about these harmful predators.