Securities Law Prof Blog

Going Fishing

I will be on vacation until August 7.  Please check back then!

Former Qwest CEO Sentenced for Insider Trading Convictions

Former Qwest Communications CEO Joseph Nacchio was sentenced today to six years in prison, fined $19 million, and ordered to forfeit $52 million in stock trading profits.  He was convicted in April of 19 counts of insider trading.  He is appealing his conviction.  WSJ, Former Qwest CEO Nacchio Is Sentenced to Six Years.

Happy Birthday to Paul Caron!

It's the big 50 for my good friend and colleague, Paul Caron, the Blog Emperor!

Law Firm Sued Over its Role in Collapse of Refco

Thomas H. Lee Partners, which purchased a controlling interest in failed commodities firm Refco in 2004, is suing the law firm Mayer Brown for allegedly misleading it about Refco's financial condition.  Building on allegations in the bankruptcy examiner's report, Lee alleges that the law firm handled bogus loan transactions for Refco that concealed customers' losses and misled Lee when it was conducting its due diligence.  While ordinarily the lawyers for the seller owe no duty to the buyer, the complaint alleges that Mayer Brown  made misstatements to Lee. WSJ, A Big Backer of Refco Sues.

SEC Approves Consolidation of NYSE and NASD Regulatory Arms

The SEC formally gave its blessing to the consolidation of the regulatory arms of NASD and NYSE.  The new organization will be known as the Financial Industry Regulatory Authority (FINRA) and will be responsible for regulating all securities firms that do business with the public, including professional training, testing and licensing of registered persons and arbitration and mediation. FINRA also will be responsible, by contract, for regulating The Nasdaq Stock Market, Inc., the American Stock Exchange LLC, and the International Securities Exchange, LLC. Finally, FINRA will be responsible for operating industry utilities, such as trade reporting facilities and other over-the-counter operations. NYSE Regulation, Inc. will continue to be responsible for the regulatory oversight of trading on the NYSE.

SEC Releases Final Rule on Internet Access to Proxy Materials

The SEC published its final rule on "Shareholder Choice Regarding Proxy Material" today (Rel. 34-56135).  The rule requires issuers and other soliciting persons to post their proxy materials on a website and provide shareholders notice of their availability.  The issuer or soliciting person may elect to provide a paper copy of the materials along with the notice.  If it chooses not to deliver hard copies, a shareholder may request them.

Cardinal Health Settles Accounting Charges

The SEC today announced that Cardinal Health, Inc., a pharmaceutical distribution company based in Dublin, Ohio, has agreed to pay $35 million to settle charges that it engaged in a nearly four-year long fraudulent revenue and earnings management scheme, as well as other improper accounting and disclosure practices.  The Commission's complaint alleges that, from September 2000 through March 2004, Cardinal engaged in this conduct in order to present a false picture of its operating results to the financial community and the investing public - one that matched Cardinal's publicly disseminated earnings guidance and analysts' expectations, rather than its true economic performance. Through these practices, Cardinal materially overstated its operating revenue, earnings and growth trends in certain earnings releases and filings with the Commission.

Cox Releases White Paper on Municipal Securities Markets

Following up on his July 18 speech on "Integrity in the Municipal Market," Chair Cox delivered to Congress a SEC staff White Paper that calls for improvements in accounting and disclosure in the municipal securities market.  While the paper does not call for the full-scale regulatory system, including SEC review, applicable to non-municipal securities, it proposes a number of reforms designed expressly for the needs of the municipal market, including:

Requiring that offering documents and periodic reports provided to investors contain information similar to what is required for all other securities offerings;
 
Making information on municipal securities available on a more timely basis, for example, by tapping the power of the Internet to provide an easily accessible, free source for the display of that information, similar to the SEC's interactive data systems for corporations and mutual funds;
 
Mandating municipal issuer use of generally accepted governmental accounting standards;
 
Providing for an independent funding mechanism and SEC oversight of the independent accounting standards board in this area, the Government Accounting Standards Board, just as the Sarbanes-Oxley Act provided for the Financial Accounting Standards Board;
 
Ensuring that private companies who access the municipal market indirectly by using municipal issuers as conduits meet the same requirements that corporate issuers must meet;
 
Requiring large, complex, and frequent issuers of municipal securities to have policies and procedures for disclosure; and
 
Clarifying the legal responsibilities of issuer officials, underwriters, bond counsels and other participants.

More Executives Indicted on Stock Options Charges

Carole D. Argo, former President and COO of SafeNet, was indicted in federal court in Manhattan on charges of backdating stock options from 2000-2006.  In Boston federal court, Robert Therrien, former CEO of Brooks Automation, was charged with tax evasion in connection with the exercise of stock options.  According to the Wall St. Journal, 24 former executives at 11 companies have been charged with criminal or civil offenses involving stock options.  NYTimes, Federal Indictment in Options Grants; WSJ, KLA, SafeNet, Brooks Ex-Executives Face Backdating Charges.

SEC Votes to Consider Competing Proposals on Shareholders' Access

The SEC voted today to solicit public comments on two competing proposed rules dealing with shareholders' access to the management proxy statement to nominate directors.  One (favored by Republican Commmissioners Atkins and Casey) would allow management to keep shareholders' proposals off the management proxy statement.  The other (favored by Democrat Commissioners Campos and Nazareth) would allow five percent shareholders to place proxy-access proposals before the shareholders for their approval. Chair Cox voted for both and expressed a preference for the second.  He also stated his intention to have a "clear, unambiguous rule" in place for the 2008 proxy seasion.  WSJ, SEC to Consider Proposals On Shareholder Influence.  Chair Cox's opening remarks at the SEC meeting provide a description of the background and further information about the two proposals.

SEC Approves Concept Release on IFRS

The SEC today voted unanimously to publish a Concept Release for public comment on allowing U.S. issuers, including investment companies, to prepare their financial statements using International Financial Reporting Standards (IFRS) as published by the International Accounting Standards Board.

Under the SEC's current rules, U.S. issuers are required to prepare financial statements in accordance with accounting principles that are generally accepted in the United States (U.S. GAAP). The Concept Release is an information-seeking document that describes the policy issues and, in the form of questions, seeks public input regarding the possibility of allowing U.S. issuers to report under IFRS.

"Having a set of globally accepted accounting standards is critical to the rapidly accelerating global integration of the world's capital markets," said SEC Chairman Christopher Cox. "Today nearly 100 countries require or allow the use of International Financial Reporting Standards. Through this Concept Release, we will be soliciting public comment on the role of International Financial Accounting Standards in the U.S. capital markets and on whether U.S. companies, like many of their competitors around the world, should be permitted to use International Financial Accounting Standards."

SEC Approves New Auditing Standard

The SEC today voted unanimously in favor of a new auditing standard and other measures to increase the accuracy of financial reports while reducing unnecessary costs, especially for smaller public companies.  The Commission expects the new auditing standard, in combination with the Commission's new management guidance, will make Section 404 audits and management evaluations more risk-based and scalable to company size and complexity.

"In approving Auditing Standard No. 5, the Commission has strengthened investor protection by refocusing resources on what truly matters to the integrity of financial statements. This is an exceptionally positive step for both investors and for America's capital markets," said SEC Chairman Christopher Cox. "This standard and the Commission's interpretive guidance for management represent the culmination of two years' work by the Commission and the PCAOB and our respective staffs to make the implementation of Section 404 more effective and efficient. I want to thank everyone involved for their hard work in responding to and addressing the concerns created by the unduly expensive and inefficient Auditing Standard No. 2."

The full text will be published soon on the SEC's website.

Con Agra Settles SEC Accounting Charges

The SEC continues to bring financial accounting cases.  Here is the latest:

The SEC filed civil charges against ConAgra Foods, Inc., alleging that it engaged in improper, and in certain instances fraudulent, accounting practices during its fiscal years 1999 through 2001, including the misuse of corporate reserves to manipulate reported earnings in fiscal year 1999.  Linda Thomsen, Director of the Commission's Division of Enforcement, noted that "The facts here are particularly troubling because of the number of different improprieties engaged in by Con Agra, the length of time over which they occurred, and the fact that senior management was involved in the misconduct."

In addition, the Commission alleges that during fiscal years 2002-2005, ConAgra's corporate tax department made numerous tax errors, causing the company to improperly account for tax benefits and understate its income tax expense. ConAgra has restated its financial statements for the years 1999 through 2005.

According to the Commission's complaint, without engaging in the improper and at times fraudulent accounting practices, ConAgra would have missed the Wall Street analysts' consensus estimates of the company's earnings per share for at least six of eleven fiscal quarters in fiscal years 1999, 2000 and 2001. To settle the charges, ConAgra has agreed to pay a $45 million penalty, which the SEC will seek to place into a Fair Fund for distribution to harmed investors.

SEC Files Backdating Charges Against KLA-Tencor and Former CEO

The SEC continues to bring backdating charges.  The latest:

The SEC filed charges against Silicon Valley semiconductor company KLA-Tencor Corporation (KLA) and its former Chief Executive Officer, Kenneth L. Schroeder, alleging that they engaged in an illicit scheme to backdate stock option grants.  The Commission alleges that, since 1997, KLA concealed more than $200 million in stock option compensation by providing employees and executives with potentially lucrative "in-the-money" options while secretly backdating the grants to avoid reporting the expenses to investors. The Commission further alleges that Schroeder repeatedly backdated options between 1999 and 2002, and once in 2005 - even after he received advice from company counsel that retroactively selecting grant dates without adequate disclosure was improper.

The Commission's complaint against KLA alleges that former company executives routinely used hindsight to issue options to employees priced at or near KLA's lowest stock price of the preceding weeks. Although pricing the options below current prices required the company to report a compensation charge under well-settled accounting principles, former KLA officials avoided reporting the charges by falsely documenting that the options had been granted on an earlier date. The backdated grants resulted in materially misleading disclosures, with the Company overstating its net income in fiscal years 1998 through 2005 by as much as 156 percent.

In a separate complaint filed against Schroeder, the Commission charges that he repeatedly engaged in backdating after becoming CEO in 1999, including pricing large awards of options to himself that were "in the money" by millions of dollars. According to the complaint, Schroeder received a legal memorandum in March 2001 cautioning that "the Board and its committees are limited in their ability to grant options at a retroactive price without exposing the company to risk of an accounting charge." The memo further warned that "[a]ny attempt to set a price before such a grant is made raises substantial risks under securities and tax laws [and] accounting rules and gives rise to disclosure obligations." The Commission alleges that Schroeder nonetheless continued to backdate options.

KLA-Tencor agreed to settle the matter by consenting to a permanent injunction.  The Commission declined to charge the company with fraud or seek a monetary penalty, based in part on the company's  cooperation in the Commission's investigation, as well as its far-reaching remedial measures.

The Commission is seeking injunctive relief, disgorgement of ill-gotten gains, and monetary penalties against Schroeder, in addition to an order barring him from serving as an officer or director of a public company. In addition, the complaint seeks reimbursement of bonuses and profits from stock sales pursuant to Section 304 of the Sarbanes-Oxley Act.

SEC Will Consider Election-Related Proposals Today

The SEC will consider two proposals dealing with shareholders' access to the management proxy statement for directors' elections at its meeting today.  The first would allow 5% shareholders to propose changes in election-related bylaws so long as they are consistent with state law.  The other proposal is maintaining the status quo and would not allow shareholders to include their own nominees in the management proxy statement.  NYTimes, S.E.C. to Weigh Easing the Path of Rivals in Board Elections; WSJ, SEC Proxy Plan May Spur Debate.

SEC Charges Former Expanets Officers with Accounting Fraud

The SEC yesterday filed actions against two former officers of Expanets, Inc. ("Expanets"), a former Colorado-based telecommunications subsidiary of NorthWestern Corporation ("NorthWestern"). The Commission's complaints allege that John C. Charters, Expanets' former chief executive officer, and Richard E. Fresia, Expanets' former chief financial officer, overstated the performance of Expanets in 2002 during the same period that NorthWestern completed securities offerings totaling more than $800 million. The Commission's complaints further allege that, after restating its financial results for the first three quarters of 2002, and disclosing Expanets' true financial position and results of operations, NorthWestern declared bankruptcy in 2003.  Charters consented to the entry of a final judgment permanently enjoining him from violating or aiding and abetting violations of the provisions he allegedly violated, and also consented to pay $50,000 in civil penalties.

SEC Charges Couple with Insider Trading

Lately the SEC has filed a number of insider trading cases involving married couples.  Here is another:  it announced that it has filed insider trading charges against a former MDS Inc. employee who allegedly stole confidential information about MDS's impending tender offer for the shares of Molecular Devices Corp. (Molecular) and, along with his wife, used that information to trade in Molecular securities ahead of the merger's public announcement. The SEC alleges that Shane Bashir Suman, 34, of Toronto, learned about secret merger negotiations through access he had to electronic data in his job as an information technology specialist at MDS, then gave that information to his wife, Monie Rahman, 36. In the days before the tender offer became publicly known, Suman and Rahman made just over $1 million by trading in the securities of Molecular.

SEC Settles "Autosurfing" Ponzi Scheme

The Securities and Exchange Commission today settled securities fraud charges against the operators of an Internet-based Ponzi scheme that raised $41.9 million in just four months from more than 20,000 investors worldwide.  The SEC alleged that from Feb. 22, 2006, through May 21, 2006, four defendants operated a Web site — Phoenixsurf.com — that offered investors a 120% return in just eight days on investments ranging from $8 to $6,000 in a purported "traffic exchange program."

The Commission's complaint alleges that under the purported program, to receive the promised return, investors had to purchase advertising and view at least 15 web pages of advertising per day during the eight-day period. Although the defendants represented that they would pay the promised returns with funds received from investors and other "businesses/programs within the NME/Phoenix network," they operated Phoenixsurf.com primarily as a pure Ponzi scheme — using for the most part only new investor funds to pay the promised returns to existing investors. The complaint alleges that the defendants paid investors $36.7 million, almost all of which came from advertising purchases from new investments in the scheme.

NYSE censures Citigroup for Market-Timing

NYSE Regulation, Inc. announced today it has censured and fined the Smith Barney Division of Citigroup Global Markets Inc. (“CGMI”) for failing to supervise trading of mutual fund shares and variable annuity mutual fund sub-accounts, failing to prevent violative market timing by its brokers, and failing to maintain adequate books and records. 

Between January 2000 and September 2003, CGMI failed to adequately supervise its branch offices and certain financial consultants (“FCs”), who engaged in market timing, including the use of deceptive trading practices to conceal their own identities or the identities of their timing customers, as well as their excessive trading. CGMI was on notice that its FCs were engaged in market timing activity that was potentially harmful to the mutual funds and the long-term shareholders, many of whom were also non-timing customers of the firm. While the firm had compliance policies in place, the enforcement of its policies and procedures was ineffective.

Of the $50 million total payment, $35 million in disgorgement and one-half of the $10 million penalty to be paid to NYSE Regulation will be placed in a distribution fund to compensate injured customers of the firm who invested in the affected mutual funds. Five million dollars will be paid to the State of New Jersey regarding a separate regulatory matter arising out of the same conduct.

Here is the decision: Citigroup Global Markets Inc.

Wall St. Firms Will Start Competing Electronic Trading Platform

Merrill Lynch, Lehman Brothers, Morgan Stanley, and Citigroup are working to develop an electronic trading platform for unregistered securities that would compete with Goldman Sach's.  Nasdaq Stock Market is waiting for SEC approval for its own market for unregistered securities.  WSJ, Wall Street Firms to Launch Electronic-Trading Platform.

Hartford Group Settles Market-Timing Charges

The Hartford Financial Services Group announced that it had settled charges involving market-timing and other improper practices with state regulators.  It will pay $115 million, including $84 million to investors harmed by the practices.  It also said the SEC had closed its market-timing investigation without bringing charges.  NYTimes, Hartford Group Pays $115 Million to Settle a Claim of Illegal Trading; WSJ, Hartford Settles 'Market-Timing' Cases.

Allison LBO Postponed

In another sign of difficult conditions in the debt-financing market, the LBO of Allison Transmission (a GM unit) to two private equity firms was postponed because of problems in selling the $3.1 billion in bonds to pay for the deal.  WSJ, GM's Allison Hits a Financing Snag.

Expedia Reduces Size of Stock Buyback

Expedia scaled back its stock repurchase plan, from 116.7 million shares (more than one-third of the outstanding shares) to 25 million shares, citing the cost of borrowing.  WSJ, Expedia Is Knocked for a Loop; NYTimes, Expedia Reduces Its Buyback Plan

Commissioner Atkins on SEC's New Fraud Rule For Advisers to Pooled Investment Vehicles

In his Remarks at the July 11 SEC Open Meeting: An Antifraud Rule For Advisers To Pooled Investment Vehicles, Commissioner Paul S. Atkins disagreed with the text of the SEC press release that stated that the new Rule is negligence-based:

If implemented properly and reasonably, this rule will be a benefit to investors and the marketplace. If, on the other hand, we overreach and turn this rule into nothing more than a negligence-based rule designed to make a federal case out of unintentional mistakes, it will advance no one's interests, and the rule may well end up to be the subject of a legal challenge that will test the bounds, and our interpretation of Sections 206(4) and 15(c)(2).

Chair Cox's Statement on SEC Terrorism Link

For those wishing to read Chair Cox's statement about why the SEC took down the controversial link that was supposed to help investors become informed about companies that were doing business with state sponsors of terrorism, see Statement by Securities and Exchange Commission Chairman Christopher Cox Concerning Companies' Activities in Countries Known to Sponsor Terrorism.

Bancroft Family Meets to Consider Murdoch's Offer for Dow Jones

Members of the Bancroft family will hold a meeting today in Boston to discuss the News Corp's offer to buy Dow Jones.  They are expected to take several days to think over the deal; Rupert Murdoch has said he expects the family to decide promptly.  At $60 per share, their entire shareholdings are worth more than $1.2 billion, compared to less than $750 million before the bid.  If the public shareholders overwhelmingly approve the deal, it may be that less than one-third of the Bancroft family votes are needed to approve the deal. NYTimes, A Family Meets Today to Hear the Complexities of a Bid for Dow Jones.

Cerberus and United Rentals Expected to Announce Deal

Cerberus Capital Management and United Rentals are expected to announce that Cerberus will acquire the largest equipment-rental company for $4 billion ($34.50 per share).  United Rentals announced in April that it was looking for a buyer.  Reports that the private equity deals are over may be premature.  WSJ, Cerberus Nears Deal for United Rentals.

Thel on Free Writing

Free Writing, by STEVEN THEL, Fordham University - School of Law, was recently posted on SSRN.  Here is the abstract:

In 2005 the SEC effectively ended most restrictions on the use of written offering materials in public distributions of securities. Previously, the only written offering materials permitted were terse announcements and dense statutory prospectuses. Less formal written offering material, known as free writing, could be distributed at the end of the offering process but only to people who had previously been sent a copy of the final statutory prospectus

Under the Commission's new regime, all sorts of written offering material may be distributed much earlier in the process. Offering participants are now permitted to communicate with a new disclosure device - modeled on free writing - called the free writing prospectus. They may now, from a very early date, disseminate free writing prospectuses - containing almost any kind of information in whatever form they choose - and often without any requirement that they deliver a statutory prospectus at all.

Free writing is not subject to liability under section 12(a)(2) of the Securities Act, but free writing prospectuses are. This paper shows that the exemption of free writing from liability, generally taken to be a drafting error, operates as a carrot to encourage security sellers to disseminate statutory prospectuses. Noting that security sellers have been reluctant to use free writing prospectuses broadly because of liability concerns, it then argues that free writing prospectuses containing false statements should not be subject to liability under section 12(a)(2) unless they are widely distributed before a final statutory prospectus is available. This conclusion does not depend on any particularly controversial view of market efficiency or morality, but follow from the premises that led the SEC to permit free writing prospectuses in the first place. Moreover Congress recognized as much in 1933 when it exempted free writing. Despite substantial questions about the rulemaking authority that the SEC relied upon to allow the use of free writing prospectuses and to extend liability for their use to issuers in firm commitment offerings, it does have authority to exempt them from section 12(a)(2). The paper concludes with a reexamination of Gustafson v. Alloyd Co.

Gordon on The "Prudent Retiree Rule"

The 'Prudent Retiree Rule': What to Do When Retirement Security is Impossible? , by JEFFREY N. GORDON, Columbia Law School, was recentlly posted on SSRN.  Here is the abstract:

Policy debates about the appropriate risk levels for individual retirement plans and social retirement plans (like social security) often pay insufficient attention to the inescapable trade-off between “payment risk” (the risk of insufficient funding for anticipated benefits) and “short fall risk” (the risk of insufficient benefits for a satisfactory retirement). Thus a “prudent retiree rule” would permit a prudent level of “contingent funding” of retirement payouts. Contingent funding - basing benefit expectations on funding sources that may not materialize - increases payment risk, yet pension systems without some contingent funding will produce inferior benefits in most states of the world, increasing shortfall risk. Contingent funding can take different forms: underfunding (in an actuarial sense) of defined benefit promises, which means reliance on the firm's continued profitability; a tilt toward equity investments in a defined contribution plan, including an appropriate level of employer own stock, and reliance on pay-as-you-go (PAYGO) funding of social security benefits in which each generation funds its predecessor's benefits. The case for the prudent retiree rule is strengthened through a better appreciation of the underlying risks to retirement security: demographic risk (too many retirees relative to workers); economic risk (insufficient economic growth) and distributional risk (non-effort-based individual economic outcomes). Policies that address these risks can significantly reduce the risks associated with contingent funding.