September 19, 2007
Appeals Court Revives Suit Against NYSE
The Second Circuit reversed in part a district court's dismissal of Calpers' lawsuit against the NYSE involving its role in the specialists trading scandal. The appeals court held that the plaintiff had standing to bring misrepresentation charges, but could not sue the exchange for regulatory failure, because of immunity. Regulators previously fined all seven specialist firms, and the SEC censured the NYSE. WSJ, NYSE Lawsuit Partly Revived.
Lerach Pleads Guilty
The rise and fall of William Lerach is recounted in the press, a day after he agreed to pay fines and penalties of $8 million, plead guilty to one charge of conspiracy to obstruct justice and serve between one and two years in prison. (The agreement is subject to court approval.) Joel Seligman summed it up:
"Bill Lerach transformed the securities class action in ways that both benefited many investors through compensation and deterrence and contributed to some backlash. It is very rare for any individual to have had so profound an impact on litigation and legislation."
SEC Asks for More Information from Hedge Fund Advisors
The SEC has increased its scrutiny on hedge funds and insider trading. In its routine examinations, it is asking hedge fund advisers for information about relationships between their employees and investors and public companies. WSJ, SEC Pushes for Hedge-Fund Disclosure.
September 18, 2007
SEC Obtains TRO Against Hawaii-Based Investment Adviser
The SEC announced that on September 14, 2007, following a hearing on the Commission's application for a temporary retraining order, the Honorable Helen Gillmor, Chief Judge of the United States District Court for the District of Hawaii, issued the order against a Honolulu-based investment adviser representative and his company. The SEC filed an emergency action on September 7 against Mark K. Teruya ("Teruya")and his company, Senior Resources of Hawaii, Inc. ("Senior Resources"), alleging that the defendants' engaged in fraudulent activities targeted at seniors and received substantial undisclosed commissions. According to the SEC's complaint, since at least 2004 and continuing as recently as August 2007, Teruya, through Senior Resources, has on multiple occasions fraudulently induced clients to sign a series of pre-printed, fill-in-the-blank forms by misrepresenting the purpose of the forms. The complaint alleges that Teruya used the signed forms to sell the seniors' existing securities holdings without their knowledge or authorization. The complaint also alleges that Teruya, who is also a licensed insurance agent, then used the proceeds of the unauthorized sales to purchase equity-indexed annuities for which he received substantial, undisclosed commissions. Since 2004, defendants have earned $2 million in undisclosed commissions on EIA sales.
The Court's order temporarily restrains the defendants from future violations of the antifraud provisions of the federal securities laws, Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Section 206(1) and (2) of the Investment Advisers Act of 1940. The order also prohibits the destruction of documents.
SEC Files Charges Against University Lab Technologies
The SEC announced that on September 12, 2007, it filed an emergency civil action against University Lab Technologies, Inc. (ULT) of Boca Raton, Florida and George Theodoropoulos, a/k/a George Theodore (Theodore), in connection with a fraudulent and unregistered offering of ULT securities. The SEC alleges that from at least December 2006 through May 2007, ULT and Theodore raised over $1 million from approximately 46 investors nationwide and in Canada. Among other things, the SEC's complaint alleges that the defendants made false and misleading representations and omissions regarding the use of the ULT offering proceeds. The defendants failed to tell investors that the company was paying commissions to its telemarketers of up to 55% of the proceeds raised plus up to 30% in ULT stock of the securities sold to new investors, according to the allegations in the Complaint. The Complaint further alleges that the defendants misrepresented the percentage of ULT ownership the investors would receive through their participation in the offering.
On September 12, 2007, the Honorable Donald M. Middlebrooks, United States District Judge for the Southern District of Florida granted the SEC's request and entered an emergency order temporarily freezing the assets of ULT, prohibiting the destruction of documents, and providing for expedited discovery and a sworn accounting. A show cause hearing has been set for September 20, 2007, in West Palm Beach, Florida, to determine whether the emergency asset freeze and other relief should remain in effect. On the SEC's motion for a receiver, the Court appointed Michael Goldberg, an attorney with the law firm of Akerman Senterfitt, as receiver over ULT. Among other things, Mr. Goldberg is responsible for taking control of ULT and marshalling and safeguarding its assets.
Swiss Re Financial Products Settles Short-Selling Charges
On September 18, 2007, the SEC filed a settled civil action charging that Swiss Re Financial Products Corporation ("SRFP") violated Rule 105 of Regulation M by selling securities short within five business days before the pricing of following-on offerings and covering the short sales, in whole or in part, with shares purchased in the offerings. SRFP has agreed to settle the case, without admitting or denying the Commission's allegations, and has agreed to the entry of a final judgment directing it to pay a $95,000 penalty. In a related administrative proceeding, SRFP has consented, without admitting or denying the Commission's findings, to the issuance of a Commission order requiring it to cease and desist from causing or committing any violations and any further violations of Rule 105 of Regulation M and to pay disgorgement and prejudgment interest of $457,605.
The Commission's complaint, filed in federal court in Manhattan, alleges that over a period of approximately eighteen months, from mid-2003 until early 2005, in connection with thirteen public offerings by eleven issuers, SRFP engaged in short sales and covering transactions prohibited by Rule 105, and that SRFP profited on all but one of the thirteen transactions, realizing total profits of $380,517 on the profitable transactions. The complaint alleges that by engaging in this conduct, SRFP violated Rule 105 of Regulation M.
Nasdaq Has Considered Foreign Investors
According to the Wall St. Journal, Nasdaq has considered selling a stake in itself to Dubai or Qatar as part of its strategy to acquire the Nordic exchange operator OMX AB. Borse Dubai is competing with Nasdaq for OMX, so an investment in Nasdaq may facilitate that acquisition. WSJ, Nasdaq Weighed Partial Sale to Aid Deal.
Groups Petition SEC to Require Climate Change Disclosure
A group of state officials, state pension fund managers and environmental groups are petitioning the SEC to require meaningful disclosure on the impact of climate change on business. A January report by Ceres, a group that promotes environmental standards, and the Calvert Group, an asset management firm, said that more than one-half of S&P 500 firms do a "poor job" of disclosing climate change risk. WPost, SEC Pressed to Require Climate-Risk Disclosures; NYTimes, Effort to Get Companies to Disclose Climate Risk; WSJ, SEC Pressed on Climate-Change Disclosures.
September 17, 2007
Lerach Will Plead Guilty
The Wall St. Journal reports that William Lerach will plead guilty to one count of conspiracy in the criminal case against his former law firm Milberg Weiss. The plea agreement calls for a one or two year prison term and does not involve Lerach's coooperating with the government. WSJ, Securities Lawyer Lerach Is Set To Plead Guilty in Milberg Case.
GAO Report on SEC Enforcement Division Sees Need for Further Improvement
The GAO was asked to evaluate the SEC Enforcement Division's (1) investigation planning and information systems and (2) oversight of Fair Funds program. Among its findings:
In March 2007 the SEC established a centralized process for reviewing and approving new investigations. It has not yet established written procedures and assessment criteria for reviewing and approving new investigations.
By late 2007 Enforcement plans to update its current information system for managing investigations. It has not yet taken sufficient steps to help ensure that data are entered in a timely and consistent basis.
In May 2007 Enforcement announced plans to better ensure the prompt closure of investigations. Enforcement's plans will not fully resolve the potentially large backlog.
Atkins' Remarks on Reg NMS
SEC Commissioner Paul Atkins' view of Reg NMS:
In my view, Reg. NMS represents a massive regulatory intrusion into our secondary trading markets that was completely unwarranted, given the lack of evidence of market failure and the availability of substantially less-intrusive means to advance the purported goals. Reg. NMS has the potential to do significant harm to our markets by unduly interfering with the operation of competitive forces. Over the years, these forces have benefited investors immensely by reducing trading costs and increasing market efficiency. Whatever its justification, Reg. NMS is a carte blanche for unsupervised meddling by the SEC staff in the marketplace for years to come.
See Remarks Before the Security Traders Association of Boston by Commissioner Paul S. Atkins, Boston, Massachusetts, September 13, 2007.
SEC Charges Two Former Penn Traffic Executives with Accounting Fraud
The SEC today announced that it filed civil fraud charges against two former officers of the Penn Traffic Company, a Syracuse-based retail and wholesale food company, for repeatedly inflating reported income by improperly accounting for vendor rebates and other promotional allowances. The SEC alleges that the former Senior Vice President and Chief Marketing Officer, Leslie H. Knox, and a former Vice President, Linda J. Jones, orchestrated a scheme to inflate Penn Traffic's income and other financial results by prematurely recognizing promotional allowances at Penn Traffic. Promotional allowances — also referred to as rebates, slotting fees, or vendor allowances — are fees paid from vendors in exchange for various marketing and promotional activities, such as inclusion in a supermarket's weekly circular. According to the complaint, from approximately the second quarter of Penn Traffic's Fiscal Year 2001 through at least the fourth quarter of FY 2003, Penn Traffic prematurely recognized promotional allowances in advance of Penn Traffic's performance of certain key, contingent activities. Knox and Jones orchestrated, directed, and participated in this scheme in an effort to meet internal budget plans. The complaint alleges that as a result of the willful misconduct of Knox and Jones, Penn Traffic pulled forward approximately $10 million in operating income, and these falsified financials were included in Penn Traffic's public filings.
The U.S. Attorney for the Northern District of New York, Glenn T. Suddaby, today separately announced that a federal grand jury impaneled within the Northern District of New York has returned an indictment against Knox and Jones on related criminal charges.
Qatar May Acquire Nasdaq's Stake in LSE
Qatar's investment arm is close to finalizing a deal for Nasdaq's 30% interest in the London Stock Exchange, a move that would increase the country's profile among world trading centers. Qatar and Dubai compete for the role of the Middle East's dominant investment center. Dubai is competing with Nasdaq to acquire the Nordic market operator OMX AB. WSJ, Qatar Nears Deal to Acquire Stake in LSE.
New Fair-Value Pricing Rules Will Affect Mutual Funds
Concerns about whether mutual funds report their holdings at current fair value are perennial, but especially now in the collapse of the subprime lending market. New accounting rules require funds to disclose more information about how they value their holdings, and the SEC's staff is expectd to present guidance on fair-value pricing for the Commission's consideration by year end. WSJ, Funds Struggle With Pricing Pitfalls.
Raines Seeks Documents from White House in His Defense
Former Fannie Mae CEO Franklin Raines' defense in the shareholders' suit against him involving the company's improper accounting practices apparently involves allegations that the White House was out to get him. He has served a subpoena on the White House seeking any information of the 2004 OFHEO probe of Fannie Mae's accounting. WPost, Raines Tries To Broaden Defense in Fannie Suit.
September 16, 2007
Kettering on Securitization
Securitization and Its Discontents: The Dynamics of Financial Product Development, by KENNETH C. KETTERING, New York Law School, was recently posted on SSRN. Here is the abstract:
This article takes as its point of departure the financing technique referred to as “securitization,” a close cousin of secured lending that has grown to enormous size since its origin more than two decades ago. The article pursues two themes. One is a critique of the legal foundations of securitization, which includes a perspective on aspects of fraudulent transfer law that are well established historically but have been neglected in recent decades. The other is exploration of the implications of this product growing so vast despite its dubious legal foundations. In that regard, the article explores two points of legal sociology that apply to new financial products generally. The first is that a product can become so widely used that it cannot be permitted to fail, notwithstanding its dubious legal foundations. The second is that the debt rating agencies have become de facto lawmakers, because it is their decision to give a favorable rating to a financial product the credit quality of which depends on a debatable legal judgment that allows the product to grow too big to fail. Two nascent products are identified as candidates for the operation of a similar dynamic. The article ends with a normative assessment of securitization from a pragmatic perspective, concluding that legislative action is appropriate to ratify the product's object, with constraints.
Dammann on Majority Freezeouts
Majority Freezeouts, by J. C. DAMMANN, University of Texas at Austin - School of Law, was recently posted on SSRN. Here is the abstract:
One of the most central questions of corporate law is how to deal with controlling shareholders. On the one hand, the presence of a controlling shareholder can benefit the corporation, particularly by subjecting managers to better monitoring. On the other hand, there is always the risk that the controller will abuse his influence and enrich himself at the expense of the other shareholders.
Traditionally, corporate law has tried to solve this dilemma by focusing on individual transactions suspected of being unfair. However, such a transaction-centered approach has significant drawbacks. Most importantly, it strikes the wrong balance between the interests of the controller and those of the other shareholders. From an efficiency perspective, the amount of benefits that the controller should be able to extract from the corporation depends both on how valuable his presence is to the corporation and on the extent to which the controller bears costs of control that he cannot share with the other shareholders. However, the transaction-centered approach fails to take these factors into account because it only focuses on the fairness of individual transactions. As a result, the level of benefit extraction is bound to be too high in some corporations while being too low in others.
The present article, therefore, presents an alternative to the transaction-centered approach: Minority shareholders should be given the right to expel the controller, and at the same time, corporations should be allowed to opt out of the transaction-centered protections that existing law imposes. The proposed regime would ensure that controllers cannot extract benefits in excess of what their presence yields. Moreover, it would allow controllers to receive sufficient compensation for those costs of control that they cannot presently share with the other shareholders.
Davidoff on Black Market Capital
Black Market Capital, by STEVEN M. DAVIDOFF, Wayne State University School of Law, was recently posted on SSRN. Here is the abstract:
Hedge funds and private equity offer unique investing opportunities, including the possibility for diversified and excess returns. Yet, current federal securities regulation prohibits the public offer and purchase in the United States of these investments. Public investors, foreclosed from purchasing hedge funds and private equity, instead seek to replicate their benefits. This demand drives public investors to substitute less-suitable, publicly available investments which attempt to mimic the characteristics of hedge funds or private equity. This effect, which this Article terms black market capital, is an economic spur for a number of recent capital markets phenomena, including fund adviser IPOs, special purpose acquisition companies, business development companies, structured trust acquisition companies, and specialized exchange traded funds all of which largely attempt to replicate private equity or hedge fund returns and have been marketed to public investors on this basis. Black market capital has not only altered the structure of the U.S. capital market but has shifted capital flows to foreign markets and engendered the creation of U.S. private markets such as Goldman Sachs' GSTrUE. This Article identifies and examines the ramifications of black market capital. It finds this effect to be an irrational by-product of current hedge fund and private equity regulation, one that is likely harmful to U.S. capital markets. A solution is to restore equilibrium in U.S. markets and enhance their global competitiveness by amending the Investment Company Act and Investment Advisers Act to permit public offerings of hedge funds and private equity funds. Though further study is warranted, the economic benefits of such a regime prospectively outweigh objections previously raised by regulators and others. Current market volatility and distress does not affect this conclusion. Black market capital is also an example of the unintended effects of regulating under the precautionary principle and difficulty of regulating in an era of market proliferation.
Greenwood on Dividends
The Dividend Puzzle: Are Shares Entitled to the Residual?, by DANIEL J.H. GREENWOOD, University of Utah - S.J. Quinney College of Law; Hofstra University College of Law, was recently posted on SSRN. Here is the abstract:
Everyone knows that shares receive dividends because they are entitled to the residual returns of a public corporation. Everyone is wrong. Basic principles of market competition, applied to the actual law of corporations, sharply contradict the conventional wisdom. First, shareholders are not residual claimants in any legal or economic sense so long as the corporation remains in existence. Second, standard economic theory implies that shareholders should receive dividends only under non-competitive conditions, and not often even then.
Instead, shareholder returns depend on shareholder power-more the soft power of ideology than the hard power of law and the legally structured market-at least as much as on underlying business success. If current trends continue, we can expect the shareholder share of corporate returns to diminish, as managers find shareholder-centered ideologies less congenial. Moreover, because the struggle is largely over rents, if the current results are unattractive, we can change the rules, modify the power of the various players, or seek to persuade them to accept different views of their ethical rights and obligations.
Padfield on Puffery
Is Puffery Material to Investors? Maybe We Should Ask Them, by STEFAN J. PADFIELD, University of Akron School of Law, is posted on SSRN. Here is the abstract:
In securities litigation, the puffery doctrine stands for the proposition that vague statements of corporate optimism are not actionable because no reasonable investor would rely on them in deciding whether to purchase or sell securities. In other words, puffery is immaterial as a matter of law. Courts routinely rely on the puffery doctrine to dismiss securities claims pre-trial. However, the doctrine has been the subject of much academic criticism. In order to test who is correct about how investors react to alleged puffery, a group of actual investors was surveyed. The survey results showed that when actual investors were confronted with statements deemed immaterial puffery by courts, anywhere from 33% to 84% of them found the statements to be material. This may well be the first direct empirical support for the assertion that the puffery doctrine is being too liberally applied by judges. The paper goes on to argue that surveys should play a role in materiality determinations in securities litigation similar to the role they already play in Lanham Act cases.