Securities Law Prof Blog

Langevoort on Entity vs. Individual Liability

On Leaving Corporate Executives Naked, Homeless and Without Wheels: Corporate Fraud, Equitable Remedies, and the Debate Over Entity Versus Individual Liability, by DONALD C. LANGEVOORT, Georgetown University Law Center, was recently posted on SSRN.  Here is the abstract:

There is a lively debate about the relative merits of entity versus individual liability in cases involving securities fraud. After reviewing this debate in the context of both private securities litigation and SEC enforcement, this paper considers whether the legal tools available against individual executives are adequate, and if not, what changes might be made. The main focus is on equitable remedies, especially rescission and restitution, under both state and federal law. As to the former, Vice Chancellor Strine's opinion in In re Healthsouth offers an interesting template, although there are limits on the usefulness of derivative suits to police aggressively in this area. Federal law probably offers the more powerful tools, which could be used more effectively than they are at present.

Tabak on Inflation and Damages Post-Dura

Inflation and Damages in a Post-Dura World, by DAVID TABAK, National Economic Research Associates, Inc. (NERA), was recently posted on SSRN.  Here is the abstract:

There are three commonly used methodologies for modeling inflation in securities fraud cases: the “index method,” the “constant percentage method,” and the “constant dollar method.” I have previously argued that the index and constant percentage methods, if applied without adjustment as the measure of damages under the out-of-pocket rule, generally result in an overstatement of damages under certain interpretations of loss causation. The Supreme Court's ruling in Dura did in fact endorse an interpretation of loss causation that requires that an adjustment be made to the index and constant percentage methods in the process of going from inflation to damages. The need for an adjustment has been addressed in various ways by experts and the courts, most recently with a ruling finding that the index method (without adjustment) “collides directly with loss causation doctrine” and that the constant percentage method (with what we argue is an inadequate adjustment) creates damages with properties for which even the expert proffering the methodology could provide “no ‘economic or logical reason'” and also impermissibly provides investors with a “partial downside insurance policy.” Here we address the type of adjustment to certain inflation models necessary to comport with the loss causation doctrine in Dura in a consistent and logical fashion

Mitchell on The Speculation Economy

The Speculation Economy: How Finance Triumphed Over Industry, by LAWRENCE E. MITCHELL, George Washington University - Law School, was recently posted on SSRN. Here is the abstract:

The Speculation Economy identifies the moment in American history when finance triumphed over industry. It shows how the birth of the giant modern corporation spurred the rise of the stock market and how, by the dawn of the 1920s, the stock market left behind its business origins to become the very reason for the creation of business itself. The consequent widespread distribution of intrinsically speculative common stock embedded speculation into the capital structures of most large American corporations.

The stock market become the driving force of the American economy in the first decade of the 20th century as a result of the birth of the giant modern corporation. The Speculation Economy tells the story of the legal, financial, economic and social transformations that allowed financiers to collect companies and combine them together into huge new corporations for the main purpose of manufacturing stock and dumping it on the market. Businessmen started to make more money from legal and financial manipulation than from practical business improvements like innovations in technology, management, distribution, and marketing.

The Speculation Economy explains how and why, at the turn of the 20th century, the stock created by the giant modern corporation became dispersed throughout the market. It shows the shift in attitudes of ordinary Americans from cautious bond buyers into eager stock speculators. At the same time, it shows how a federal government wedded to an outdated economic model and struggling to expand its own power failed to regulate finance and thus missed the chance to control corporations. While politicians argued, finance came to dominate industry, and as stock ownership spread widely throughout society, the stock market came to dominate finance.

The Speculation Economy examines this history in detail from the perspectives of the economic history of the growth of the market, the social history of early stockholding, the intellectual history of financial analysis of the era, the federal regulatory attempts to control the giant combinations, and the roots of modern securities regulation that emerged from the antitrust debate of the first decade of the 20th century.

The downloadable paper includes the Table of Comments and Prologue of The Speculation Economy.

 

SEC Charges Spouse With Insider Trading

On September 28, the SEC announced  the  filing  of  a  settled action  against  the  spouse  of  a former   officer   of   Triangle Pharmaceuticals, Inc. (Triangle)  for  illegal  insider  trading.  The Commission's complaint, filed in the United States District  Court  of the Eastern District of North Carolina, alleges that, between  October 2002 and November 2002, Daniel  Joseph  McKay  (McKay)misappropriated from  his  spouse,  who  was  then  an executive  vice  president  of  Triangle,   the material   nonpublic information that Triangle  had  received  an  acquisition  offer  from another company. The  Commission's  complaint  further  alleges  that, after misappropriating  this  information,  McKay  purchased  Triangle stock and tipped two of his  siblings,  who  also  purchased Triangle stock. As a result of this illegal conduct,  McKay  and  his  siblings obtained a total of $11,416 in ill-gotten gains. With filing of the Commission's  action,  McKay  has  agreed,  without admitting or denying the allegations in the Commission's complaint, to the  entry  of  a  final  judgment  permanently  enjoining  him   from violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, thereunder, and ordering him to pay (i)  disgorgement  and prejudgment interest totaling $12,458.98 and (ii) a civil  penalty  of $11,416.

SEC Files Insider Trading Charges Against Former Dell Accountants

On September 28, the SEC filed an insider trading action in the United States District Court for the Western District of Texas against Salvador Chavarria, Glenn D. Leftwich and John A. Nieto. At  the  time of the alleged misconduct, Chavarria, Leftwich and Nieto were employed as accountants in Dell Inc.'s (Dell) Americas  Business  Unit  at  its corporate headquarters in Round Rock, Texas.  The  Commission  alleges that the three accountants engaged in unlawful insider trading in  the securities of Dell in advance of a public  announcement  on  Aug.  11,2005, that Dell's second quarter 2006 revenues had fallen short of the company's earlier guidance and analysts'  expectations.  In  addition, the Commission alleges  that  Leftwich  engaged  in  unlawful  insider trading when he  purchased  Dell securities  in  advance  of  a  Dell earnings release on Oct. 31, 2005, announcing Dell's  failure  to hit its earnings target for the third quarter 2006.

In its complaint, the Commission alleges  that,  in  July  and  August 2005, Chavarria, Leftwich and Nieto purchased Dell put  options  while in possession of material,  non-public  information  regarding  Dell's financial performance for the second quarter  of  2006.  Specifically, the Defendants knew, in advance of the Aug. 11, 2005 release, that the company's second quarter revenues had fallen short  of  the  company's earlier guidance and analysts' expectations.  On  the  day  after  the announcement of the revenues miss, Dell's  stock  price  dropped  more than 7% on the news. By selling their Dell put options, the Defendants profited as  follows:  Chavarria,  $153,240;  Leftwich,  $81,658;  and Nieto, $16,677.

In addition, on Oct. 31, 2005, Leftwich bought Dell put options  prior to a negative Dell earnings announcement. The negative news caused  an 8.3% decline in Dell's stock price. Leftwich  sold  the  puts  on  the following day and profited $24,769.

Without  admitting  or  denying  the  allegations  in  the  complaint, Chavarria and Nieto have agreed to settle the Commission's charges  by consenting  to  the  entry  of  a  final  judgment  that  would:   (i)permanently enjoin them from further violations of  Section  10(b)  of the Securities Exchange Act of 1934, and Rule 10b-5  thereunder;  (ii)order them to pay $153,240 and $16,677, respectively, in disgorgement; (iii)  order  them  to  pay  $16,673  and  $2,059,  respectively,   in prejudgment interest; and (iv) order them to pay a  civil  penalty  of $153,240 and $16,677,  respectively.  With  regard  to  Leftwich,  the Commission alleges in its complaint  that  Leftwich  violated  Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. In its complaint, the  Commission  seeks  against  Leftwich  a   permanent   injunction, disgorgement plus prejudgment interest, and  a  civil  money  penalty.

SEC Obtains Summary Judgment Against E-Brain Solutions

The SEC announced today that the federal district court for the Northern District of Georgia granted the Commission's renewed motion for summary judgment and entered a final judgment against Peter Warren and Exo-Brain, Inc. ("Exo-Brain"), formerly known as E-Brain Solutions, LLC ("E-Brain LLC") on September 27, 2007. Warren and Exo-Brain were each ordered to pay disgorgement of $6,400,000, pre-judgment interest in the amount of $1,981,734.50 and civil penalties of $75,000. The defendants were ordered to pay these amounts within 30 days from the entry of the judgment. The Court made specific findings of fact and conclusions of law regarding Warren's conduct in the fraudulent offer and sale of unregistered Exo-Brain securities.

The court's order found that in 2000 and 2001, the defendants raised up to $12.4 million from investors in a series of fraudulent, unregistered offerings of securities. The court concluded that the defendants made misrepresentations and omissions of material facts to investors in connection with the offer and sale of securities including, among other things, misrepresenting the capabilities and developmental status of the technology, misrepresenting the company's financial condition, and that the defendants disregarded warnings of legal counsel recommending against further efforts to raise funds from investors. Additionally, the court found that in their May 2000 financial statement, the defendants failed to disclose to investors that E-Brain LLC lost money at a considerably faster pace than depicted in the limited financial statements provided to investors, and that the statement only reflected the results of operation for the first month of the company's existence. The court also found that E-Brain LLC, in order to fund its operation, had to seek investor funds six times in calendar year 2000. The court concluded that in the defendants' first offer to investors dated December 10, 1999, Warren falsely claimed that a prototype had been developed which could, among other things, send e-mails and faxes and browse the Internet, when, in fact, no prototype with these abilities had been developed.

Buca Settles SEC Fraud Charges

The SEC today announced the filing of a settled civil injunctive action against Buca, Inc. (Buca), the Minneapolis-based corporate parent of the Buca di Beppo restaurant chain. The Commission's complaint, filed yesterday in federal court in Minneapolis, alleges that from 2000 to 2004, Buca materially understated the compensation of its top two officers, omitted significant related party transactions involving the company's former CEO and former CFO, and reported inflated income due to an earnings management scheme.

Specifically, the Commission's complaint alleges that Buca failed to disclose in its proxy statements and Forms 10-K for 2000 to 2003 that its former CEO improperly obtained reimbursement from Buca for personal expenses totaling nearly $850,000, including ATM cash withdrawals, duplicate airline tickets, family wedding expenses, dog kenneling, and home remodeling costs and that its former CFO improperly obtained reimbursement of more than $111,000 for vacations and visits to strip clubs and other personal expenses. The complaint further alleges that Buca reported inflated pre-tax income from 2000 to 2004 in amounts ranging from 18.8% to 36.9% due to a scheme orchestrated by its former CFO and former controller to meet earnings targets through improperly capitalizing approximately $11.9 million in expenses. Finally, the Commission's complaint alleges that Buca failed to disclose in its Forms 10-K for 2000 and 2001 its former CEO's and former CFO's participation in various related party transactions, including the former CEO's purchase of an Italian villa with Buca's funds and the former CFO's ownership interest in a vendor with which Buca transacted more than $1 million of business.

SEC Settles Charges Relating to Municipal Bond Offerings

The SEC continues its crackdown on the municipal bond industry as it today announced settled enforcement actions against two California companies for their failure to disclose a fee agreement that created a risk to investors that interest on $650 million of municipal bonds might lose its tax-exempt status. The charges against CDR Financial Products, Inc. (formerly known as Chambers, Dunhill, Rubin & Co.) and Anchor National Life Insurance Company, (now doing business under the name of AIG SunAmerica Life Assurance Company) relate to three separate municipal bond offerings in Florida in 1999 and 2000. The Commission's Orders find that Anchor served as the credit enhancement provider, and that CDR served various roles, in the three offerings. The Commission's Orders further find that the existence of the fee agreement between CDR and Anchor was material for several reasons. Among other things, the bond proceeds were to be used for originating loans, and therefore CDR's receipt of payment on unloaned bond proceeds created a potential conflict with the offerings' purpose.

In addition, tax regulations require bond issuers to have a reasonable expectation that most of the bond proceeds would be loaned out within three years. Without knowledge of the fee agreement, the issuers made calculations, disclosures and certifications relating to their reasonable expectation regarding loan origination within the required time without having all information that was material to that issue. Moreover, the fee agreement also created a risk that the Internal Revenue Service would declare the bonds to be arbitrage bonds, with accompanying potential negative tax consequences.

The Commission's Orders also find that in one bond offering, CDR executed a certificate that was misleading in light of the undisclosed fee agreement.

A Big Oops! for Martha Stewart

Martha Stewart Living Omnimedia earlier reported a 125% sales growth for its "soft home" products at KMart stores for the one-week period following the line's relaunch, as compared to the same week last year.  Yesterday the company announced that was an error -- the actual number is 28%.  CFO.com, Martha Stewart's 97-Point Mistake.

New Securities Regulation Goes into Effect in Japan

Japan's Financial Instruments & Exchange Law (FIEL) marks the biggest change in the country's financial regulation in 20 years, covering everything from corporate disclosure to securities trading practices.  The regulations will bring Japan's regulation closer to international standards.  The Japanese public, well-known as savers, is expected to start shifting savings into investments.  WSJ, Japan Securities Law Targets Local Savers.

KPMG Judge Speaks Out on Government's Investigative Powers in Corporate Criminal Cases

Judge Lewis Kaplan, the federal district court judge presiding over the government's prosecution of bogus tax shelters marketed by KPMG said it may be time to curb the government's investigative powers in cases alleging corporate criminal liability.  "I question whether placing virtually unchecked power in the hands of any branch of government" is the right thing, Judge Kaplan said,  WSJ, KPMG Judge Questions Laws, Tactics Used in Corporate Cases.

SEC Cracks Down on Municipal Bond Market Fraud

The SEC instituted settled enforcement actions against two broker-dealers and their CEOs for fraudulent auction practices in the municipal bond market.  The Commission issued Orders against Philadelphia-based Regional Brokers, Inc., and its CEO Patrick Lubin; and against Cherry Hill, N.J.-based D.M. Keck & Company, Inc. (doing business as Discount Munibrokers), CEO Donald Michael Keck, and a supervisor, Patricia Ann Sealaus. The firms served as "broker's brokers" in auctions by providing brokerage services exclusively for municipal securities dealers.

The Orders make the following findings:

Regional was placing bids on municipal bonds in auctions where Regional was acting as the broker's broker, without the intent of ever purchasing the bonds. Often, these bids were placed as the second highest bid, known as the "cover bid," after the high bid had already been made, and right before the close of the auction. Regional deceived its customers by fraudulently giving the appearance that Regional was conducting municipal bond auctions with tighter spreads and by creating the illusion of additional interest in the bonds.
 
Regional consistently accepted late bids in "Sharp Time" auctions with knowledge that the bidding broker-dealer's late bid was the highest — and therefore the winning — bid in the auction. This conduct favored the late bidder and disadvantaged other auction participants who had submitted their bids within the required Sharp Time and who had less time to prepare their bids in accordance with the explicit terms of the auction.
 
Similar to the conduct at Regional, Discount Munibrokers disseminated fake bids in auctions it conducted in an effort to convince the high bidders that the auctions were more competitive than they really were or to meet minimum bid requirements imposed by certain broker-dealers attempting to sell securities through the auction process.
 
Discount Munibrokers also engaged in an "adjusted trading" scheme with a municipal securities trader at another broker-dealer. Specifically, on certain municipal bond sales brokered by Discount Munibrokers the firm paid the other broker-dealer proceeds from sales that were substantially greater than the actual prices paid by the purchasers in those transactions. To make up Discount Munibrokers' losses on those transactions, on other sales, the same selling broker-dealer received proceeds that were substantially less than what was paid by the purchasers. Discount Munibrokers reported the fictitious prices used in the adjusted trading scheme to the market as the actual prices paid on the transactions.
 

Freddie Mac Settles Fraud Charges

The SEC today charged the Federal Home Loan Mortgage Corporation (Freddie Mac) with securities fraud in connection with improper earnings management beginning as early as 1998 and lasting into 2002. To settle the SEC’s charges, Freddie Mac agreed to pay a $50 million penalty, which is expected to be distributed to injured investors through a Fair Fund.  The SEC’s complaint alleges that Freddie Mac engaged in a fraudulent scheme that deceived investors about its true performance, profitability, and growth trends. According to the complaint, Freddie Mac misreported its net income in 2000, 2001 and 2002 by 30.5 percent, 23.9 percent and 42.9 percent, respectively. Furthermore, Freddie Mac’s senior management exerted consistent pressure to have the company report smooth and dependable earnings growth in order to present investors with the image of a company that would continue to generate predictable and growing earnings.

The charged former Freddie Mac executives are David W. Glenn (president, chief operating officer, and vice chairman of the board); Vaughn A. Clarke (chief financial officer); and former senior vice presidents Robert C. Dean and Nazir G. Dossani.

According to the Commission’s complaint, Freddie Mac’s violations were the direct result of a corporate culture that placed great emphasis on steady earnings, and a senior management that fostered a corporate image that was touted as “Steady Freddie” to the marketplace. Among the violations alleged in the complaint is the use of certain transactions to nullify the transitional effects of the company’s implementation of accounting standard SFAS 133 (which relates to accounting for derivative instruments and hedging activities); the improper change in valuing the company’s “swaptions” portfolio at year-end 2000; the improper use of derivatives to shift earnings between periods; the improper use of a reserve in connection with the company’s application of SFAS 91 (which relates to accounting for loan origination costs); the use of certain transactions to nullify the effects of an accounting pronouncement known as Emerging Issues Task Force Issue 99-20; and the maintenance and reporting of a reserves for losses on loans materially in excess of probable losses.

The four former executives, who were charged with negligent conduct, agreed to settle the case without admitting or denying the allegations. Glenn agreed to pay a $250,000 civil penalty and $150,000 in disgorgement. Clarke agreed to pay a $125,000 civil penalty and $29,227 in disgorgement. Dossani agreed to pay a $75,000 civil penalty and $61,663 in disgorgement. Dean agreed to pay a $65,000 civil penalty and $34,658 in disgorgement.

In its settlement with the Commission, the company agreed, without admitting or denying the allegations, to the entry of a final judgment that permanently enjoins the company from violations of the anti-fraud provisions of the federal securities laws. Without admitting or denying the allegations in the Commission’s complaint, Glenn, Clarke, and Dossani agreed to the entry of a final judgment that permanently enjoins them from violating Sections 17(a)(2) and (3) of the Securities Act. In a separate proceeding, Dean consented to the entry of a Commission Order requiring him to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act.

Morgan Stanley Pays $12.5 Million to Settle Charges of Failure to Produce Emails

FINRA today announced a settlement with Morgan Stanley & Co. to resolve charges that the firm's former affiliate, Morgan Stanley DW, Inc. (MSDW), failed on numerous occasions to provide emails to claimants in arbitration proceedings as well as to regulators - while representing that the destruction of the firm's email servers in the Sept. 11, 2001 terrorist attacks on New York's World Trade Center resulted in the loss of all pre-9/11 email. In fact, the firm had millions of pre-9/11 emails that had been restored to the firm's active email system using back-up tapes that had been stored in another location.

The settlement also resolves additional charges relating to the firm's failure to provide required supervisory materials to numerous arbitration claimants. The settlement announced today is the first of its kind - in that it provides for distribution of $9.5 million to two groups of customers who had arbitration claims against the firm. FINRA estimates that several thousand customers may be eligible to receive payments. FINRA also imposed a $3 million fine on the firm for its failure to provide pre-9/11 emails and updates to a supervisory manual.

Under the terms of the settlement, Morgan Stanley will deposit $9.5 million into a fund to pay arbitration claimants for the discovery failures. All fund expenses, as well as the cost of hiring and compensating a fund administrator acceptable to FINRA, will be borne by the firm. The fund administrator will identify and notify potentially eligible arbitration claimants. Eligible claimants in the email aspect of the case can elect to receive a standard payment estimated to be between $3,000 and $5,000, or may choose to require Morgan Stanley to produce relevant emails still in its possession. A claimant who demands email production can decide to accept the standard payment - or waive that payment and have the fund administrator determine the amount, if any, that the claimant should receive depending on the particular facts and circumstances of that individual case. Maximum payment in cases decided by the fund administrator cannot exceed $20,000.

Eligible claimants who were denied the required supervisory materials will receive payments expected to be between $1,500 and $2,500. Some claimants may be eligible for payments as to both the pre-9/11 email and the failure to receive supervisory materials.

Detailed information about which arbitration claimants are eligible for fund payments, and about the claims process itself, can be found on the Arbitration Discovery Fund page of FINRA's Web site.

FINRA found that MSDW failed to provide pre-9/11 emails to claimants in numerous arbitration proceedings and in response to three regulatory inquiries during the period from October 2001 through March 2005. FINRA found that MSDW made statements in numerous arbitration proceedings and to the former NASD, New York Stock Exchange Regulation and the Massachusetts Securities Division that those emails had been destroyed. Those statements were not true. In fact, MSDW possessed millions of pre-9/11 emails that had been restored to the firm's system shortly after Sept.11, 2001 using backup tapes. Many other emails were maintained on individual users' computers and had not been affected by the events of 9/11. Among the matters where MSDW failed to produce e-mail was an NASD investigation that resulted in an August 2005 settlement with the firm.

FINRA also found that MSDW later destroyed many of the pre-9/11 emails it did possess. The firm did so in two ways - by overwriting backup tapes that had been used to restore the emails from 11 of its 12 servers to the firm's system, and by allowing users of the firm's email system to permanently delete the emails over an extended period of time. As a result, between September 2001 and March 2005, MSDW deleted millions of pre-9/11 emails from the firm's systems.

In addition, FINRA found that MSDW failed to provide updates to the firm's supervisory manual for branch office managers to claimants in numerous arbitration proceedings over a period of years. The Branch Manager's Manual was issued in 1994 and was subsequently supplemented with numerous updates. FINRA found, however, that MSDW repeatedly failed to provide updates to the manual in discovery in numerous arbitration proceedings from late 1999 through the end of 2005.

In settling this matter, Morgan Stanley neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

Buffett May Invest in Bear Stearns?

Bear Stearns stock rose yesterday on reports that a group of investors led by Warren Buffett might buy a stake in the investment firm.  The investment bank reportedly is talking to other possible buyers as well.  Bear Stearns has been hit hard by the credit market collapse and had to shut down two hedge funds because of it.  Buffett rescused another investment bank, Salomon Brothers, in 1991 when John Gutfreund resigned because of a bond trading scandal.  WPost, Buffett May Buy Stake in Bear Stearns; NYTimes, Buffett Said to Consider Bear Stake.

Senate Banking Committee Holds Hearing on Rating Firms

At a Senate Banking Committee hearing on the role of the rating firms in the subprime mortgage market collapse, SEC Chair Cox said that the SEC had opened an investigation into whether the credit-rating firms inflated their ratings of mortgage-backed bonds because they were also advising the investment banks on packaging the securities.  Representatives from S&P and Moody's denied that conflicts of interest played any role in inflating ratings.  The hearings continue for a second day.  NYTimes, S.E.C. Inquiry Looks for Conflicts in Credit Rating.

Buyers Call Off Buyout of Sallie Mae

Buyers (headed by J.C. Flowers) backed out of the $25.3 billion buyout of Sallie Mae deal at the current price, invoking the MAC clause and citing cuts in federal subsidies and the  credit markets.  They suggested the possibility of renegotiating the price.  In the last sentence of its statement, the consortium said, “We have told representatives of the Sallie Mae board that we are open to discussing a revision of the transaction that reflects this new environment.”  Sallie Mae, however, vows to fight.  Other private equity deals that have collapsed recently include KKR's buyout of Harman International and the Fine Line-Genesco merger.  WPost, Investors End Deal To Buy Sallie Mae; NYTimes, Deal at Risk, Buyers Warn Sallie Mae; WSJ, Buyout Group Balks at Sallie Mae.

Cox Testifies on Credit Rating Ratings' Role in Subprime Markets

Testimony:The Role and Impact of Credit Rating Agencies on the Subprime Credit Markets, by Chairman Christopher Cox, U.S. Securities & Exchange Commission, Before the U.S. Senate Committee on Banking, Housing and Urban Affairs, September 26, 2007.

SEC Settles FCPA Charges Against Bristow Group

The SEC today announced the institution of a settled enforcement action against Bristow Group Inc., a Houston-based and New York Stock Exchange-listed helicopter transportation services and oil and gas production facilities operation company, for violations of the Foreign Corrupt Practices Act (FCPA). Among other things, the FCPA prohibits bribery of foreign government officials.

The Commission's Order finds that a Nigerian affiliate of Bristow Group made improper payments to Nigerian state government officials in return for the officials' reduction of the affiliate's employment taxes owed to the Nigerian state governments. The Order also finds that the same affiliate and another Nigerian affiliate of Bristow Group also underreported their expatriate payroll expenses in Nigeria.

Without admitting or denying the Commission's allegations, Bristow Group consented to entry of an Administrative Order that requires Bristow Group to cease and desist from committing violations of the antibribery, internal controls and books and records provisions of the Securities and Exchange Act of 1934 (Exchange Act).

SEC Announces Initiative on Alerting Investors About Fraud

The SEC announced a new Internet-based initiative to alert investors worldwide about problems with certain unregistered entities engaged in solicitations of securities transactions. By more immediately sharing information received in complaints about particular unregistered soliciting entities, the SEC is aiming to give retail investors, before they invest, a new tool to help them avoid questionable investment solicitations, including solicitations from online boiler room and advance fee scheme operations.

Through its "Public Alert: Unregistered Soliciting Entities" (PAUSE) program, the Commission will publish on its Web site certain factual information about unregistered soliciting entities that have been the subject of complaints forwarded by investors and others around the globe, including foreign securities regulators. The Commission is seeking public comments on the PAUSE program before it begins.

To implement the PAUSE initiative, the Commission will post on its public Web site specific information about unregistered soliciting entities that have been the subject of complaints. For each of these entities, the Commission's staff will have determined either (1) that there is no U.S. registered securities firm with that name, or (2) that there is a U.S. registered securities firm with the same or similar name, but that solicitations appear to have been made by people not affiliated with the U.S. registered securities firm. A second PAUSE list will name fictitious government agencies and international organizations referred to by entities that are subjects of complaints.

Generally, entities that solicit purchases or sales of securities for the accounts of other people in the United States are required to register with the SEC. It is important for prospective investors to consider whether a soliciting entity is, in fact, registered with the SEC. A large number of investor complaints received by the Commission concern solicitations of investors by unregistered entities that appear to be involved in boiler room and secondary advance fee schemes, which, in most instances, claim a nexus to the United States, but, in truth, are located outside of the United States and target non-U.S. investors.

The comment period extends for 30 days after the Release is published in the Federal Register.

SEC Charges Hedge Fund Manager with Fraud

The SEC charged a San Francisco hedge fund manager with defrauding investors by dramatically overstating the fund's profitability and misusing fund assets. The Commission alleges that Alexander James Trabulse sent account statements to investors in his Fahey Fund that inflated the fund's returns by as much as 200 percent, while using investor money to purchase cars and finance shopping sprees for his family members.  According to the Commission's complaint, filed today in federal district court in San Francisco, Trabulse founded the Fahey Fund in 1997 and raised about $10 million from approximately 100 investors. He told investors the fund invested in financial instruments like stocks, derivatives, and foreign currency. The complaint alleges that Trabulse lured investors by touting the fund's spectacular performance, when in reality the statements he provided to investors bore no relation to the fund's actual performance.

The Commission also alleges Trabulse misused fund assets to pay for a wide variety of personal expenses, using the fund's bank account to pay for cars, a home theater system, and his ex-wife's overseas shopping allowance. He even gave one relative free reign to use the fund's bank accounts for personal use, according to the Commission.

The Commission's complaint alleges Trabulse violated the antifraud and registration provisions of the federal securities laws, and seeks disgorgement, penalties, and other relief. The Commission also has named as relief defendants several entities associated with Trabulse that received assets through Trabulse's fraud.

FINRA Proposes Rule to Limit Dispositive Motions in Arbitration

FINRA announced today that its Board of Governors approved rule amendments designed to limit significantly the number of dispositive motions - more commonly known as motions to dismiss -- filed in its arbitration forum and to impose strict sanctions against parties who engage in abusive motions practices. Under FINRA's proposal, if a party (typically a respondent firm) files a dispositive motion before a claimant finishes presenting its case, the arbitration panel would be limited to three grounds on which to grant the motion: if the parties settled their dispute in writing; "factual impossibility," meaning the party could not have been associated with the conduct at issue; or the existing 6-year time limit on the submission of arbitration claims. The rule proposal also would require that arbitrators hold a hearing on such motions and that any decision to grant a motion to dismiss be unanimous, and be accompanied by a written explanation.

The proposed amendments also would require the panel to assess against the filing party all forum fees associated with hearings on dispositive motions if the panel denies the motion, and would require the panel to award costs and attorneys' fees to the party that opposed a dispositive motion deemed frivolous by the panel. Under the rule proposal, when a respondent files a dispositive motion after the conclusion of the claimant's case, the provisions above would not apply. However, the rule would not preclude the arbitrators from issuing an explanation or awarding costs or fees.

The rule amendments now go to the Securities and Exchange Commission for review and approval.

Treasury Appoints Two Panels to Study Hedge Funds

The Treasury Dept. announced two groups that will study hedge funds and propose voluntary good practices to minimize risks and improve disclosure.  One committee is composed of asset managers, the other, investors.  They are supposed to release their guidance by year-end.  WPost, U.S. Aims to Limit Funds' Risk; NYTimes, Two Panels to Advise on Hedge Funds

Clear Channel Shareholders Approve Buyout

Clear Channel shareholders finally approved the company's buyout by a private equity firm.  The deal was announced last November, but the price was renegotiated more than once as shareholders deemed it too low.  A two-thirds shareholder vote was required under state law.  The final price was $39 in cash or stock of the private company.  WPost, Clear Channel Shareholders OK Buyout; NYTimes, Clear Channel Shareholders Approve Buyout

Borse Dubai Raises Bid for OMX

Borse Dubai and Nasdaq continue to compete with Qatar Investment Authority for control of Nordic exchange operator OMX AB.  Yesterday Borse Dubai increased its bid to the equivalent of $40.76 per share and reduced its minimum acceptancce from more than 90% to more than 50%.  WSJ, Borse Dubai Raises Cash Offer for OMX.

SEC Adopts Temporary Rule on Principal Trades

On September 24, the SEC issued a release adopting  an  interim final temporary rule under the Investment Advisers Act of 1940 as part of its response to a recent  court  decision  of  the  U.S.  Court  of Appeals for the District of Columbia  Circuit  in  Financial  Planning Association v. SEC (482 F.3d 481 (D.C.  Cir.  2007)),  which  provided that fee-based brokerage accounts were not advisory accounts and  were thus not subject to the Advisers Act. The temporary rule  provides  an alternative method for investment advisers that  are  registered  with the Commission as broker-dealers to meet the requirements of  Advisers Act section 206(3) when they act in a principal capacity with  respect to transactions with certain of their advisory clients.

The effective date of the rule  is  Sept.  30,  2007.  Absent  further Commission action, the temporary rule will expire  and  no  longer  be effective on Dec. 31, 2009.

SEC Proposes Interpretive Rule for Broker Dealers and Investment Advice

The SEC released for public comment an interpretive rule that would reinstate three interpretive provisions of a rule recently vacated by the D.C. Circuit.  (1) A broker dealer that exercises investment discretion or charges a separate fee for advisory services provides investment advice that is not "solely incidental to" the broker dealer business; (2) a broker dealer does not receive "special compensation" because it has a two-tier pricing system, one for discount brokerage business and another for full-service brokerage business; (3) a broker dealer is an investment adviser solely with respect to those accounts for which it provides services or compensation.

SEC Settles Bribery Charges Against EDS and Former President of Subsidiary

The SEC announced today that it filed a settled civil action against Chandramowli Srinivasan, the former president of A.T. Kearney India (ATKI), which was a subsidiary of Electronic Data Systems Corp. (EDS) at the time, relating to his role in a bribery scheme. The Commission's complaint against Srinivasan states that between early 2001 and September 2003, ATKI made at least $720,000 in illicit payments to senior employees of Indian state-owned enterprises to retain its business with those enterprises. ATKI made these payments at the direction of Srinivasan after the senior employees threatened to cancel the contracts with ATKI. Srinivasan, on a neither admit nor deny basis, consented to the entry of a final judgment enjoining him from violating Sections 13(b)(5) and 30A of the Securities Exchange Act of 1934 (Exchange Act) and ordering him to pay a $70,000 penalty.

In a separate but related action, the Commission today instituted administrative proceedings against EDS for various violations of the issuer reporting and books-and-records provisions of the federal securities laws. Simultaneously with the institution of the proceedings, EDS consented to the entry of an SEC cease-and-desist order that provides for disgorgement and prejudgment interest of $490,902. The Commission order found that EDS engaged in the following misconduct:

SEC Announces Data Tags for GAAP

SEC Chairman Christopher Cox announced the completion of all work on developing data tags for the entire system of U.S. generally accepted accounting principles. The announcement came at a New York press conference attended by Chairman Cox, whose agency has strongly supported the use of data tags in financial reporting by U.S. public companies.  "What colloquially is termed "interactive data" is the use of computer-coded "tags", written in the XBRL computer language, that each correspond to a unique accounting concept. The use of the tags makes it possible for investors, analysts, and others to download financial reports filed with the SEC directly into spreadsheets in Excel and other popular software, and to use other web tools and specialty software to do instant financial comparisons across entire industries. The SEC has committed to transform its vast database of financial information, nicknamed EDGAR, into interactive data format.

For over two years, the SEC has permitted public companies to file their financial reports with the agency in interactive data format, as part of a pilot program. Recently, the market capitalization of companies participating in the voluntary program topped $2 trillion. The collection of data tags being used for current filings on the SEC's EDGAR system, however, is relatively simplistic, using approximately 2,500 unique elements. That has required many companies to write their own custom tags, called extensions, to accurately represent their statements.

The work that was completed today has mapped every element of the entire system of U.S. Generally Accepted Accounting Principles, administered by the Financial Accounting Standards Board in Norwalk, CT, to a unique data tag. The achievement of this milestone means that public companies can more easily tag their financials. And it brings automated financial reporting to the SEC — as well as increased usability of financial statement for investors — one step closer to reality.

A review for GAAP compliance by the FAF (Financial Accounting Foundation) is nearing completion, and critical stakeholder groups including analysts, public company preparers and software providers will be reviewing the draft taxonomies first, before a broad-based public review is initiated.

SEC Approves 7 Ratings Agencies

Securities and Exchange Commission issued orders granting the registrations of seven credit rating agencies as nationally recognized statistical rating organizations (“NRSRO”). The firms are the first to be registered with the Commission under the Credit Rating Agency Reform Act of 2006.  The seven firms registered as NRSROs are:

A.M. Best Company, Inc.
DBRS Ltd.
Fitch, Inc.
Japan Credit Rating Agency, Ltd.
Moody’s Investors Service, Inc.
Rating and Investment Information, Inc.
Standard & Poor’s Ratings Services

The Credit Rating Agency Reform Act and the Commission’s new rules require registered credit rating agencies to disclose their procedures and methodologies for assigning ratings. The NRSROs are also required to make public certain performance measurement statistics including historical downgrades and default rates.

Under the Credit Rating Agency Reform Act, an NRSRO may be registered with respect to up to five classes of credit ratings: (1) financial institutions, brokers, or dealers; (2) insurance companies; (3) corporate issuers; (4) issuers of asset-backed securities; and (5) issuers of government securities, municipal securities, or securities issued by a foreign government. A.M. Best Company, Inc., is registered with respect to the first four classes of credit ratings; the other six firms are registered with respect to all five classes.

By October 8, 2007, each of these NRSROs is required to make public on its web site its current Form NRSRO and non-confidential exhibits.

In a related story, the SEC is looking into the rating agencies' procedures and policies and their slow response to the subprime mortgage crisis.  CRO.com, Fresh Start? SEC Re-anoints Rating Agencies

Different Views on SEC Proposal to Allow International Accounting Standards

The SEC's proposal to allow foreign companies to use international accounting standards in SEC filings is under criticism by two groups.  The European Association of Listed Companies says the SEC proposal does not go far enough and should accept modifications from the European Commission.  In contrast, the Investors Technical Advisory Committee  says there is not yet sufficient similarity between GAAP and international standards and that confusion will result without reconciliation of differences.  NYTimes, A Plan to Let S.E.C. Accept Foreign Rules Is Opposed.

Corporations Don't Disclose Greenhouse Gas Emissions

The Carbon Disclosure Project, a nonprofit group that monitors corporate disclosure related to climate change, released its Fifth Annual Report to great fanfare, with a keynote address by Bill Clinton.  The Report says that corporate efforts to curb greenhouse gas emissions has improved, but few companies include climate-related data in their SEC filings.  NYTimes, Gas Emissions Rarely Figure in Investor Decisions.  Last week a number of groups filed a petition with the SEC asking the agency to issue an interpretive release clarifying that material climate-related information must be included in corporate disclosures.

SEC and FRB Adopt Final Broker Exceptions for Banks

The SEC and Board of Governors of the Federal Reserve System (Board) on Monday announced the adoption of final joint rules to implement the "broker" exceptions for banks under Section 3(a)(4) of the Securities Exchange Act of 1934. These exceptions were adopted as part of the Gramm-Leach-Bliley Act of 1999 (GLB Act). The SEC and the Board approved the final rules at separate open meetings held on September 19, 2007, and September 24, 2007, respectively.  The rules are found in two SEC Releases: 34-56501 and 34-56502.

SEC Settles Market Manipulation Charges Involving Brokerage Firm

The SEC filed a settled enforcement action against Florida residents Paul Harary and Douglas Zemsky for their involvement in an alleged $4.4 million market manipulation and kickback scheme that defrauded customers of a Boca Raton brokerage firm.

The SEC's complaint alleges that in 2004 and 2005:

Harary, 43, and a Florida stockbroker defrauded the stockbroker's customers by acquiring control of two shell companies, creating an artificial market for those companies' common stock, and manipulating the price of that stock using pre-arranged matched orders.
 
Another perpetrator, Zemsky, 44, identified and purchased the shell companies and coordinated matched orders to start the trading in one of them at a pre-arranged, artificial price.
 
The Florida stockbroker created the demand for the stock in the two firms by purchasing it for his firm's customers, while Harary controlled the supply of the unrestricted shares and sold them.
 
Other investors, who purchased shares of one of the shell companies on the open market but who were not customers of the brokerage firm, also lost money because Harary manipulated the share price of that company's stock.
 
Harary made more than $4.4 million in proceeds on his sales of these stocks and then provided the Florida stockbroker more than $1 million in kickbacks through a series of cash handoffs and checks.
 
The customers of the Florida stockbroker were left with worthless shares of the shell companies and lost approximately $3.8 million.
According to the SEC's complaint, the two shell companies were Secure Solutions Holdings, Inc. (SSLX) and American Financial Holdings, Inc. (AFHJ). Each traded on the over-the-counter market and was quoted on the Pink Sheets.

The U.S. Attorney for the District of Columbia announced that Harary pleaded guilty to conspiracy to commit mail and wire fraud in a parallel criminal action brought in the United States District Court for the District of Columbia. See United States v. Harary, Crim. No. 07-Cr.-209 (EGS) (D.D.C.).

SEC Settles Charges in Bank Conversion Fraud

The SEC charged Mark Ristow, a retired Indiana real estate entrepreneur, and two of his relatives with securities fraud for defrauding savings banks and their depositors in connection with the banks' conversion from mutual to stock ownership.

When banks convert to stock ownership, depositors receive priority rights to purchase shares at a low price. Banking regulations and offering terms limit the number of shares a depositor may purchase and prohibit transfer of the depositor's purchase rights.

The SEC's complaint alleges that, from 1994 to 2007, Ristow orchestrated a scheme to circumvent the limitations on stock purchases in 23 bank conversions. Ristow's scheme generated more than $3 million in profits through the sale of the bank stock that he had illegally obtained. The other defendants are Ristow's cousin Andrew Crabb and Ristow's sister-in-law Susan Gitlin. In return for a share of the profits, they assisted Ristow by acting as his nominees, thus enabling Ristow to purchase even more shares. Because the offerings were oversubscribed, the defendants' fraud harmed legitimate depositors who received fewer shares than they otherwise would have. All three of the defendants have agreed to settle the SEC charges in whole or in part.

Earlier today, Ristow pled guilty to parallel criminal charges filed by the United States Attorney's Office for the District of New Jersey. In connection with his guilty plea, Ristow agreed to pay a total of $2.85 million in forfeiture, representing his own illegal profits from the scheme

SEC Charges Former Football Player with Destroying Investment Advisory Records

The SEC today charged investment adviser and former NFL player Dwight Sean Jones with failing to allow the Commission staff to examine his business records, as required by the federal securities laws.  In the administrative proceeding instituted today, the Commission's Division of Enforcement alleges that Jones — who at one point claimed to manage more than $40 million in assets for his clients (primarily athletes) — refused to produce or allow the inspection of his advisory business records. After repeatedly failing to respond to the Commission staff, the Division alleges, Jones ultimately claimed that all his records had either been destroyed in a fire or inadvertently sold by a storage company.

In the Order Instituting Proceedings, the Division of Enforcement alleges that Jones and his firm, Amaroq Asset Management, failed to make documents available for review by the Commission's staff as required by law. The Order also alleges that although Jones claims that Amaroq discontinued business in 2004, Amaroq continued to maintain a website until mid-2007 touting its wealth management programs and that it was "subject to periodic SEC examinations." However, the Order alleges that Jones (a resident of Missouri City, Texas, although Amaroq purports to maintain a Beverly Hills, Calif. address) failed to permit the examination of Amaroq's records and later told the Commission staff that the $44 million advisory business no longer possessed any records whatsoever.

An administrative hearing will be scheduled to determine whether remedial actions are appropriate.

Bausch & Lomb Shareholders Approve Buyout

Bausch & Lomb shareholders approved a $3.7 billion buyout by Warburg Pincus, a week after four proxy advisers recommended shareholder approval, with reservations, of the $65 per share all-cash offer.  Advanced Medical Optics had previously made a $4.3 billion offer ($45 cash, $30 stock), but withdrew the offer after the B&L board refused its request for more time.  WSJ, Bausch Shareholders Approve
Takeover by Warburg Pincus.

Birdthistle on ETFs

The Fortunes & Foibles of Exchange-Traded Funds, by WILLIAM A. BIRDTHISTLE, Chicago-Kent College of Law, was recently posted on SSRN.  Here is the abstract:

One of the most dynamic and complex new investment vehicles on the market today is the exchange-traded fund, a security that provides the diversification of a mutual fund but trades on an exchange like a stock. In just over a decade, the number of ETFs has proliferated to well over 500, attracting almost half a trillion dollars in investment. Most of that growth has occurred in just the past two years, and ETFs are projected to continue growing at a pace far faster than hedge funds and mutual funds in the coming years. Yet for all this extraordinary growth, legal scholars have virtually ignored ETFs.

This Article seeks to establish a descriptive and conceptual framework for the scholarly discussion of these funds as they gain ever-greater prominence, for good or for ill, in the coming years. By exploring the structure, advantages, and shortcomings of ETFs, this Article explains the implications of the dramatic growth of ETFs.

Using a novel pricing mechanism that harnesses the utility of arbitrage, ETFs provide investors with accuracy, efficiency, tax advantages, and a range of investment choices, while insulating investors from the structural problems with mutual funds. Yet critics decry their brokerage fees and their vulnerability to harmful short-term trading. This article argues that the mutual fund industry and its recent spate of dramatic scandals contributed to the growth of ETFs and concludes that mutual funds offer vivid warnings of the conflicts of interest that may come to afflict the ETF industry as it continues to grow.

Stout on Dodge v. Ford

Why We Should Stop Teaching Dodge v. Ford, by LYNN A. STOUT, University of California, Los Angeles - School of Law, was recently posted on SSRN.  Here is the abstract:

What is the purpose of a corporation? To many people the answer to this question seems obvious: corporations exist to make money for their shareholders. Maximizing shareholder wealth is the corporation's only true concern, its raison d'etre. Devoted corporate officers and directors should direct all their efforts toward this goal.

Some find this picture of the corporation as an engine for increasing shareholder wealth to be quite attractive. Nobel Prize-winning economist Milton Friedman famously praised this view of corporate purpose in his 1970 essay in the New York Times, The Social Responsibility of Business Is to Increase Its Profits (Friedman 1970). To others, the idea of the corporation as a relentless profit-seeking machine seems less appealing. In 2004, Joel Bakan published The Corporation: The Pathological Pursuit of Profit and Power, a book accompanied by an award-winning film documentary of the same name. (Bakan 2004). Bakan's thesis is that corporations are indeed dedicated to maximizing shareholder wealth, without regard to law, ethics, or the interests of society. This means, Bakan argues, corporations are dangerously psychopathic entities.

Whether viewed as cause for celebration or for concern, the idea that corporations exist only to make money for shareholders is rarely subject to challenge. (Although there is a tradition of scholarly debate on this point among legal academics, it has attracted little attention outside the pages of specialized journals.) (Stout at 1189-90 (2002).) Much of the credit - or perhaps more accurately, the blame - for this state of affairs can be laid at the door of a single judicial opinion. That opinion is the 1919 Michigan Supreme Court decision in the case of Dodge v. Ford Motor Co.
 

Prentice on Scheme Liability

Scheme Liability, Federal Securities Fraud, and John Wayne's I-Pod, by ROBERT A. PRENTICE, University of Texas at Austin - McCombs School of Business, was recently posted on SSRN.  Here is the abstract:

The Supreme Court held in Central Bank that if Congress had wanted to include an aiding and abetting form of secondary liability in Section 10(b of the 1934 Securities Exchange Act), it would have done so. Strictly construed, this is a defensible holding. After Central Bank, defrauded investors have been forced to (a) argue for a broad view of primary liability, and (b) assert "scheme liability" claims under subsections (a) and (c) of Rule 10b-5. Most lower courts have rejected both these approaches and thereby excused from liability many parties, particularly investment banks, that knowingly participated in issuers' securities fraud.

This article initially demonstrates that Congress did not include an aiding and abetting provision as a form of secondary liability under Section 10(b) because it necessarily expected "aiding" or "aiding and abetting" of securities fraud to constitute a primary violation of Section 10(b) with or without any explicit mention in the statute. In 1934, the common law of fraud and virtually every statutory antecedent of Section 10(b) imposed liability upon those who "participated" in fraud. The law of intentional torts in 1934 made virtually no distinction between primary and secondary liability. Aiding and abetting as a form of secondary activity in the field of securities fraud was invented by the lower federal courts in 1966. It became meaningful only after 1994 when lower courts began applying Central Bank's reasoning in a narrow way. Lower courts have been able to justify their narrow interpretation of Central Bank's holding only by committing the anachronistic error of assuming that the law of deceit was the same in 1934 as in 1994. The Supreme Court has often warned against the making of such anachronistic errors.

This article then demonstrates the unquestionable validity of "scheme liability" under subsections (a) and (c) of Rule 10b-5. The lower courts that have rejected scheme liability have misread Central Bank, ignored the plain language of both Section 10(b) and Rule 10b-5, and committed a host of other mistakes.