Securities Law Prof Blog

SEC Opens Inquiry into Whole Foods CEO's Postings

It is reported that the SEC has opened an investigation into Whole Foods CEO John Mackay's online postings.  WSJ, SEC Opens Informal Inquiry Of Whole Foods CEO Postings.  Would any of them constitute "material misstatements" for purposes of Rule 10b-5? While many of them are opinions (he likes the new Whole Foods salad dressing), statements of obvious facts (Whole Foods is not WalMart's), or just stupid or silly (his views on politics, equal opportunity, his haircut) a few do involve very specific predictions of future performance (will hit $10 million sales target by end of decade) which could be actionable if found to be false and misleading.

What if these statements differ materially from official public statements from the company?  Several news accounts have speculated that there could be a Regulation FD violation here.  Regulation FD prohibits selective disclosure of corporate information by senior corporate officers.  It was enacted to deal with management's disclosures to favored analysts ahead of the market.  The rule is quite specific in its application and identifies the recipients of the information -- brokers and dealers, investment advisers, investment companies, or someone who is a "holder of the issuer's securities, under circumstances in which it is reasonably foreseeable that the person will purchase or sell the issuer's securities on the basis of the information."  Would the latter cover readers of the bulletin board on which these messages were posted?  The few judicial interpretations of Regulation FD have not embraced an aggressive interpretation of the rule. 

I agree with others who have said the serious issue here goes to the quality of Mackey's judgment and whether he has the appropriate temperament to manage a public corporation.  It has been reported that the postings stopped sometime last year; does this mean that Mackey came to realize how inappropriate these postings were?  In any event, I hope the board of directors of Whole Foods is spending some substantial time in reviewing this situation and assessing Mackey's leadership abilities.

NASAA Testifies on Risks to Retail Investors of Hedge Fund Offerings

North American Securities Administrators Association (NASAA) President Joseph P. Borg told a Congressional panel on July 11 that allowing public offerings of private equity and hedge fund management firms without appropriate regulatory protections puts retail investors at risk.

“Due to a lack of transparency, the level of individual and systemic risk attached to these investments remains unknown to the individual investor. Their fee structures and lack of full disclosure obscure real returns. The structure of these new instruments places investors in a vulnerable position, subject to the whims of controlling persons and literally without recourse.  In light of the complexity and uncertainty surrounding these instruments, allowing them to be offered to the public without appropriate regulatory protections poses serious risks to investors,” Borg said.

Borg’s remarks came during testimony before the U.S. House of Representatives Committee on Oversight and Government Reform Subcommittee on Domestic Policy during a hearing examining the possible risks presented to retail investors by the recent Blackstone Group L.P. and similar upcoming initial public offerings of the management entities of hedge funds and private equity funds.  His testimony is on the NASAA website.

Conrad Black Guilty on Four Counts

Former Hollinger Internatonal CEO Conrad Black was found guilty today of three counts of mail fraud and one count of obstruction of justice.  He was acquitted of nine other counts, including racketeering and misuse of corporate perquisites.  He faces a maximum sentence of 35 years in prison and a $1 million penalty.  While there were Tyco-like allegations of fancy parties and vacations at the company's expense, the central allegations related to payments made by buyers of newspapers from Hollinger International in exchange for its promises not to compete.  These payments instead went to Black and other corporate executives.  The government's case was by no means an easy one to prove, as Black's attorney presented evidence that the payments to the individuals were disclosed in documents approved by the board and as the testimony of individual directors raised serious questions about their due diligence.  Earlier in the week the jury informed the judge that it was deadlocked on one or more counts, and she urged them to continue deliberations.  See WSJ, Jury Delivers Mixed Verdict In Fraud Trial of Conrad Black.

New York State Court Dismisses Some Charges Against H&R Block

H&R Block announced that a New York state court had dismissed allegations against the corporate parent and five units in a lawsuit brought by the New York Attorney General charging excessive fees in IRA accounts.  It says it plans to appeal the court's decision to allow some charges against H&R Block Financial Advisers to go forward.  See NYTimes, Judge Mostly Clears Block.

Merger of Chicago Exchanges Complete

The merger of CBOT Holdings (Chicago Board of Trade) and CME (the Chicago Mercantile Exchange) was completed, and the combined company will trade on the NYSE as CME Group.  See WSJ, CME-CBOT Deal Complete.

SIRA Becomes FINRA

SIRA, or the Securities Industry Regulatory Authority, was going to be the new name for the consolidated regulatory arm of NASD and NYSE, it was annoounced about a month ago.  However, the name has been changed to FINRA, or Financial Industry Regulatory Authority, because of concerns that SIRA sounded too much like the Arabic word Sirah, which refers to the biographies of the Prophet Mohammed.  See WSJ, NASD Arm's Name Lands Regulator In Alphabet Soup.

SEC Testimony on Cross-Border Exchange Mergers

Now available on the SEC website:

Written Statement of the U.S. Securities and Exchange Commission, A Global View: Examining Cross-Border Exchange Mergers, Before the Subcommittee on Securities, Insurance, and Investment of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, July 12, 2007.

SEC Allows Mutual Funds to Use Tagged Risk/Return Summary Information

The SEC published final rule amendments to enable mutual funds to submit risk/return summary information from their prospectuses using interactive data under the Commission's voluntary program. The risk/return summary at the front of every mutual fund prospectus includes information about a fund's investment objectives and strategies, risks, costs, and historical performance. The Commission voted unanimously on June 20, 2007, to adopt the rule amendments.  The submission of tagged risk/return summary information will be supplemental and will not replace the required official versions of the information. Any mutual fund submitting tagged risk/return summary information will be required to include this information as an amendment to a filing on Form N-1A, the registration form for mutual funds. Volunteers can begin submitting tagged risk/return summary information on Aug. 20, 2007

SEC Files Backdating Charges Against former Engineered Support Systems Directors

The SEC today filed a civil injunctive action against Michael F. Shanahan, Sr. (Shanahan), the former Chief Executive Officer and Chairman of the Board of Engineered Support Systems, Inc., and his son, Michael F. Shanahan, Jr. (Shanahan Jr.), a former member of Engineered Support's Compensation Committee of its Board of Directors, alleging that they participated in a fraudulent scheme in which they granted undisclosed, in-the-money stock options to themselves and to other Engineered Support officers, employees, and directors. According to the complaint, Engineered Support employees and directors received approximately $20 million in unauthorized and undisclosed compensation as a result of the backdating, $16 million of which was received by top executives and directors. Shanahan personally profited from the backdating scheme by more than $8.9 million.

Whole Foods CEO's Bloggings Front-Page News

The Wall St. Journal broke the story last night about the weird behavior of Whole Foods CEO John Mackay, and both the WSJ and the New York Times have long print articles about it today.  For a period of about seven years Mackay posted, under a pseudonym, blogs that denigrated the performance of rival Wild Oats and praised Whole Foods' management, including his own hair cut.  Whole Foods and Wild Oats are now seeking to merge, and the postings, and Mackay's identity, became public in filings with the FTC.  (A few weeks ago, we learned about an internal e-mail by Mackay, saying the merger would destroy its competition, which is exhibit number one in the FTC's review of the merger.)  Since Mackay apparently stopped the blogging last August, well before the merger discussions started, there does not appear to be any attempt to manipulate the price of Wild Oats stock.  Whether anything he said about his own company or failing to reveal his identity could make him liable for securities fraud is more problematic, but courts may well treat these statements as "puffery" or mere opinion, that reasonable investors would not take seriously.  Reasonable investors might well have lowered their opinion of Whole Foods if they knew the postings were from its CEO, because it demonstrates such poor judgment, but there is some indication that at least other bloggers guessed his identity.  But it is another example of poor impulse control from senior management; at least it's different, and more entertaining, than the run-of-the-mill sexual indiscretion.  See WSJ, Whole Foods Is Hot, Wild Oats a Dud --So Said 'Rahodeb' ; NYTimes, Whole Foods Executive Used Alias. 

NYSE Margin Debt At Record High

Margin debt at the NYSE increased by 11% in May to $353 billion (up from $318 billion in April), according to a NYSE report.  Under a pilot program with eight brokerage firms begun in April, brokers can determine a customer's margin based on the overall portfolio instead of each specific investment, allowing customers to borrow more.  According to a spokesperson for one firm participating in the program, this type of financing is just for sophisticated, options traders "at this point."  See WSJ, 'Margin Debt' Hits Record $353 Billion on NYSE.

Refco Examiner Says Accountants, Law Firm Were Negligent

The examiner appointed to investigate the collapse of commodities firm Refco in 2005 has issued his report and says that the accounting firms of Grant Thornton and Ernst & Young, as well as the law firm of Mayer, Brown, should be sued for professional negligence.  Refco's collapse allegedly resulted from the fraud of its CEO.  See WSJ, Refco Bankruptcy Examiner Names Firms Likely to Face Lawsuits.

SEC Adopts Anti-Fraud Rule for Money Managers of Pooled Investment Vehicles

As a result of Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006), which invalidated a SEC rule requiring registration of hedge fund advisers because it viewed the investors (and not the fund) as the client, the SEC voted today to adopt a broad anti-fraud rule aimed at money managers who mislead or defraud investors in pooled-investment vehicles, including hedge funds.  Chair Cox said the new rule would be "an important tool" to help police hedge funds.  While voting in favor of the rule, Commissioner Atkins wished it could have been more narrowly tailored.  See WSJ, SEC Adopts Fraud Rule Affecting Hedge Funds.

SEC Files Emergency Action Against Investment Scam

The SEC filed an emergency action on May 22, 2007, against  two Californians and their company to halt an  ongoing  fraudulent  scheme operated in Orange County, Calif., in which the defendants  raised  at least $3.7 million from approximately 33 investors.  The court entered a temporary restraining order freezing the assets of TG Capital, LLC, a  Nevada  limited  liability  company, Thanh Viet Jeremy Cao, age 26, of Orange County, Calif. and Las Vegas, Nev., and Lodavina Grosnickle, age 51,  of  Chula  Vista,  Calif.  The complaint alleges that from February 2007 to the present, Cao and Grosnickle lured investors to invest in TG Capital by  falsely promising rates of return between 28% and 30% on their investment  and assuring investors that  TG  Capital's  investments  were  secured  by guarantees from major banks or  gold.  The complaint also alleges that Cao forged at least one  bank guarantee to support his false claims.  The  complaint  further  alleges  that  Cao  and  Grosnickle  recently transferred $1.78 million of investor funds to a bank  in  Hong  Kong, purportedly to make a personal loan from Cao  to  an  individual.  The Commission alleges that defendants falsely  represented  the  overseas transfer was a legitimate TG Capital  investment  when  in  fact,  Cao personally loaned the money, leaving  TG  Capital  investors  with  no recourse if the individual borrower defaults.

SEC Obtains Default Judgment Against Intrusion into Online Accounts

The SEC announced that on June 20, 2007, a U.S. District Judge  for  the  Middle  District  of  Florida entered  a  default  judgment  against  twenty-one  year  old  Aleksey Kamardin.  The complaint  alleges that between July 13 and Aug.  25,  2006,  Kamardin commandeered  the  online  trading  accounts  of unwitting investors at  various  broker-dealers,  liquidated  existing equity positions and, using the resulting proceeds,  purchased  thinly traded stocks in order to create the appearance  of trading  activity and pump up the price of the stocks.  The  complaint  further  alleges that in seventeen instances, Kamardin,  in  his  own  account,  bought shares in the thinly traded issuer just prior to or at the  same  time that compromised accounts were made to buy shares, creating the  false appearance of market activity. Shortly after the intrusions,  Kamardin sold all of his shares at the inflated prices. In  all  but  three  of these instances, Kamardin realized a profit from his trading,  netting a total profit of $82,960.

NASD Fines Brokerage For Sharing Directed Commissions with Broker

In the first case of its kind, NASD announced today that it has fined Securities America, Inc. of Omaha, NE, $375,000 for improperly sharing directed brokerage commissions from a mutual fund company with Michael Bullock, a former Securities America broker in the Los Angeles, CA area. NASD also found that Securities America failed to adequately supervise Bullock's communications with his union-sponsored retirement plan clients to ensure that Bullock disclosed his additional compensation to those clients.

In a separate complaint, NASD charged Bullock with improperly receiving directed brokerage commissions and other compensation of more than $280,000. Bullock was also charged with misrepresenting and failing to disclose this compensation to his union retirement plan clients - at the same time he was advising those clients to maintain or include the fund company's mutual funds in the retirement plans they offered to working and retired union members.

The actions announced today differ from previous disciplinary actions involving directed brokerage in several important respects. Previous actions involved firms receiving directed brokerage in exchange for providing "shelf space" for specific mutual funds - that is, promoting those funds to the investing public and among their own brokers in exchange for directed brokerage from those funds. In this case, the fund company directed brokerage specifically for the benefit of an individual broker - a first. NASD rules prohibit registered firms from granting a participation in directed brokerage to sales personnel.

In settling these matters, Securities America neither admitted nor denied the charges, but consented to the entry of NASD's findings.

Milberg Client Pleads Guilty to Accepting Kickbacks

Steven G. Cooperman pled guilty in California to taking $6.1 million in kickbacks from Milberg Weiss to serve as lead plaintiff in a number of class action law suits brought by the firm.  David Bershad, a former name partner in the firm, pled guilty last week in New York.  The trial of the firm and another former partner, Steven Schulman, is scheduled to begin in January.  See NYTimes, Milberg Client Pleads Guilty to Taking Pay to File Suits.

Black's Jury Tells Judge It Is Deadlocked

The jury in Conrad Black's criminal trial advised the judge, during its ninth day of deliberations, that it was unable to reach an unanimous verdict in the former Hollinger International CEO's looting trial.  The judge reread the instructions to the jury and asked them to continue deliberations.  See WPost, Black's Jury Deadlocks, Seeks Help From Judge.

SEC Plans to Propose Proxy Access Rule

The SEC is circulating a draft proposal that would allow 5% shareholders to nominate candidates for the board of directors and may present the plan at its open meeting scheduled for July 28.  Chair Cox has previously promised to propose a proxy access rule this year.  A 5% threshold will certainly be viewed as too high by shareholder advocates.  See WSJ, SEC Proxy-Access Proposal Draws Fire From Investors.

SEC Open Meeting Agenda July 11

SEC, Open Meeting Agenda, Wednesday, July 11, 2007

Item 1: Prohibition of fraud by advisers to certain pooled investment vehicles
Office:  Division of Investment Management
Staff:  Robert Plaze, David Blass, Daniel Kahl, and Vivien Liu

The Commission will consider whether to adopt a new antifraud rule under the Investment Advisers Act of 1940. The new rule would prohibit advisers to certain pooled investment vehicles from making false or misleading statements to, or otherwise defrauding, investors or prospective investors in those pooled vehicles.

Judge Considers Dismissal of Brocade Backdating Charges

In the closely watched Brocade Communications stock options backdating criminal case in San Francisco, the judge is considering whether to dismiss the charges against former CEO Gregory Reyes, because, as the defendant asserts, the government failed to introduce sufficient evidence to show that the executive understood the options accounting rules.  See WSJ, Judge Mulls Brocade Dismissal.

Is NASD Arbitration Biased Against Rich Investors?

The Wall St. Journal puts the spotlight on a recent NASD arbitration brought by trusts established by Subway co-founder Frederick DeLuca against brokerage firm UBS.  The arbitration panel rejected in its entirety the trusts' claim that UBS was responsible for $190 million losses from investments in tech and telecom stocks in 1998-2001.  According to the reporter, it demonstrates that wealthy people have difficulty winning the sympathy of arbitration panels.  However, the outcome may not reflect any supposed biases on the part of the arbitrators, but the application of legal principles that require all investors to show "reasonable reliance" on their brokers' recommendations and that the recommendations caused the investors' loss (and not the market crash).  In addition, as the article mentions, the panel may have determined that the trusts waited too long in bringing the claim.  In any event, because arbitration hearings are private and the awards provide no reasons for their outcomes, it's mere conjecture why the panel decided as they did.  See WSJ, Why a Billionaire Lost on Wall Street.    

Gemstar is on the Auction Block

Gemstar, best known as the publisher of TV Guide, put itself up for sale.  The company, which is 41% owned by Rupert Murdoch's News Corp., was previously the subject of a SEC accounting fraud investigation, which led to its former CEO Henry Yuen being found civilly liable for his role in inflating the company's revenues.  See WSJ, Gemstar-TV Guide Puts Itself Up for Sale.

NYSE Investigates Trading in ABN ADRs

NYSE is investigating trading in the ADRs of ABN Amro Holding NV prior to the Dutch bank's March 19 announcement that it was in negotiations to sell itself to Barclays Bank.  A consortium of three European banks is competing with Barclays for ABN.  See WSJ. NYSE Investigates Trading in ABN
As Bank Held Talks With Barclays.

SEC Gets TRO in Promissory Notes Offering

The SEC announced that on July 5, 2007 the United States District Court for the Western District of New York entered a temporary restraining order against defendants The Hockey Barn LLC and Jeffrey J. Coleman, Hockey Barn's Chief Executive Officer. The Court's order temporarily freezes defendants' assets and orders them to provide sworn accountings. In addition, the order prohibits the destruction of records, and permits the Commission to conduct expedited discovery. The Court scheduled a hearing on the Commission's request for a preliminary injunction for July 19, 2007 in Buffalo, New York.

In the complaint, the Commission alleged that from approximately October 2006 through the present, Coleman and the Hockey Barn defrauded investors through an offering of promissory notes and other investment contracts. Among other things, Coleman falsely told investors that they could obtain a return of at least 400% within 60 days [!]from an investment in a purported bond trading program.

CBOT Shareholders Approve Merger with CME

CBOT Holdings shareholders approved a merger with Chicago Mercantile Exchange, which will result in the largest derivatives exchange.  Last week CME improved its offer for the third time, which was sufficient to win sufficient shareholders' votes to eliminate IntercontinentalExchange's competing offer.  See WSJ, CBOT Shareholders Approve CME Deal.

Butler Settles Misappropriation Charges

The SEC announced today that defendant Graham J. Lefford, a former butler to entertainment industry entrepreneur Robert F.X. Sillerman, has agreed to settle the insider trading charges pending against him and to disgorge his trading profits of $31,450, plus prejudgment interest of $3,280, and pay a penalty of $31,450.  According to the SEC's complaint, Lefford engaged in unlawful insider trading while employed as the house manager for Sillerman's South Hampton, New York residence. The complaint alleged that in the summer of 2004, Sillerman was in the process of negotiating the acquisition of a controlling interest in a publicly-traded company named Sports Entertainment Enterprises, Inc. ("SPEA") to use as the vehicle for acquiring the commercial rights to Elvis Presley's name and likeness. Lefford learned material non-public information about Sillerman's intended acquisition of SPEA from documents faxed between Sillerman's office in Manhattan and his South Hampton residence and used that information to purchase 5,000 shares of SPEA stock at 12 cents per share. Sillerman's acquisition of SPEA and SPEA's concurrent acquisition of the commercial rights to Elvis Presley name and likeness were jointly announced on the morning of December 16, 2004, and SPEA stock closed at $6.41 that day, an increase of over 6,400% from the prior day.

SEC Obtains Jury Verdict in Finite Insurance Scheme

The SEC announced that on July 6, 2007, following a jury verdict, the United States District Court for the Southern District of New York entered a Final Judgment against Timothy Harcharik (Harcharik), former director of risk management for Brightpoint, Inc. (Brightpoint) enjoining Harcharik for a period of five years from future violations of the antifraud, books-and-records, and internal controls provisions of the federal securities laws and ordering him to pay $50,000 in civil penalties. Harcharik played a key role in a fraudulent scheme involving a purported insurance policy that enabled Brightpoint to conceal $11.9 million in losses that it sustained in 1998.  The SEC alleged that Harcharik and other co-defendants devised and executed an accounting fraud scheme in order to keep escalating losses at Brightpoint within a previously announced range. Specifically, the complaint alleged that Harcharik negotiated and executed a sham insurance policy issued by American International Group, Inc. (AIG) for the sole purpose of allowing Brightpoint to write off these losses as covered by insurance. The complaint further alleged that the purported policy was simply a vehicle that masked a round trip of cash between Brightpoint and AIG, rather than real insurance. As a result of the scheme, Brightpoint's pre-tax net income for 1998 was overstated by 61 percent.  This was the first case to go to trial involving the fraudulent use of finite insurance.

SEC Charges Two in Botnet Fraud

The SEC has filed securities fraud charges against two Texas individuals in a high-tech scam that hijacked personal computers nationwide to disseminate millions of spam emails and cheat investors out of more than $4.6 million. The scheme involved the use of so-called computer "botnets" or "proxy bot networks," which are networks comprised of personal computers that, unbeknownst to their owners, are infected with malicious viruses that forward spam or viruses to other computers on the Internet. The SEC alleges that Darrel Uselton and his uncle, Jack Uselton, both recidivist securities law violators, illegally profited during a 20-month "scalping" scam by obtaining shares from at least 13 penny stock companies and selling those shares into an artificially active market they created through manipulative trading, spam email campaigns, direct mailers, and Internet-based promotional activities. In related enforcement actions, the Attorney General's Office for Texas and the Harris County District Attorney's Office indicted the Useltons for engaging in organized criminal activity and money laundering. The Texas criminal authorities also have seized more than $4.2 million from bank accounts associated with the Useltons.  See SEC Charges Two Texas Swindlers In Penny Stock Spam Scam Involving Computer Botnets.

Icahn Raises Bid for Lear

Carl Icahn raised his bid for Lear Corp. to $37.25 per share (up from $36), in response to the opposition from some large shareholders, and the company postponed the shareholders' vote until July 19. Richard Pzena, the largest shareholder after Icahn, said the increased price did not change his mind and criticized the company's agreement to pay a termination fee if the deal is rejected.  See WSJ, Icahn Affiliate Increases Bid For Lear to $37.25 a Share.

Bershad, Formerly with Milberg Weiss, Pleads Guilty

David Bershad, formerly a name partner at Milberg Weiss & Bershad, agreed to plead guilty to conspiring to keep secret from judges payments to class-action name plaintiffs and to cooperate with federal prosecutors in their investigation of the firm for paying illegal kickbacks.  Because of Mr. Bershad's knowledge of the finances at the law firm, this is expected to be a "big break" in the case.  See WSJ, Bershad of Milberg Weiss Agrees to Plead Guilty.

Hedge Fund Advisers Deregister

Since the D.C. Circuit struck down a SEC rule requiring registration of hedge fund advisers last year, 525 advisers have deregistered, out of  2479 previously registered advisers.  The rule was meant to shed some light on the secretive hedge fund industry, but the court said the rule was arbitrary.  See WSJ, Fund Advisers Deregister.

Dow Jones Board Still Looking for Other Bidders

The Dow Jones board is still looking for alternative bidders for the Wall St. Journal, urged on by members of the Bancroft family who do not want to sell the newspaper to Rupert Murdoch.  Ronald W. Burkle, a California billionaire, is meeting today with the special committee formed to consider the sale, and MySpace co-founder, Brad Greenspan, is said to be working on putting together a proposal.  So far no one has emerged who can match the News Corp.'s $60 per share price.  Meanwhile negotiations with News Corp. continue.  See NYTimes, Dow Jones Continues Hunt for an Alternative Bid; WSJ, Dow Jones Makes Late Push To Find Other Buyers.