Securities Law Prof Blog

The SEC's Policies on Disclosure

The New York Times has an article today that illustrates the SEC's schizophrenic approach toward disclosure.  Chair Cox is working with Pfizer to design a user-friendly format for executive compensation disclosure, and the company unveiled a mock-up at a conference in D.C. hosted by Chair Cox.  At the same time, Division of Market Regulation was criticizing the substance of Pfizer's disclosure.  Indeed, just this week the SEC staff released a report on companies' compliance with the new executive compensation rules and found many deficiencies.

More generally, Chair Cox has been pushing "plain English" and interactive data in disclosure documents, which makes sense only if it is realistic to expect that most investors will read these documents.  But most investors don't and rely on getting information from other sources -- their brokers, friends, neighbors, etc.  Unless and until the SEC undertakes a serious investor education campaign, most investors won't read these documents and probably shouldn't even bother to try.  Instead, the disclosure should be directed toward those intermediaries, who can understand and transmit the information to the general public.  The information is complicated, and plain English and attractive graphs won't make it less so.  NYTimes, Pfizer’s Attempt at Financial Clarity Gets Blurred.

SEC Opens Inquiries into Overseas Sales of Orthopedic Devices

Several manufacturers of orthopedic devices say that the SEC has opened informal investigations into possible violations of the Foreign Corrupt Practices Act in connection with overseas sales of medical devices.  Johnson & Johnson previously reported to federal authorities that it believed improper payments had been made in two unidentified countries.  WSJ, Several Orthopedic-Device Makers Get SEC Letters on Foreign Sales.

HSBC Bank Settles SEC Fraud Charges

The SEC announced judicial approval of its settlement of its action against HSBC Bank USA, N.A. ("HSBC"), imposing a $10 million penalty and ordering HSBC to pay disgorgement in the amount of $463,893, with prejudgment interest of $36,667, for allowing its name and logo to be used in connection with a Florida-based offering fraud by Pension Fund of America, L.C. (Pension Fund). The SEC alleged that from August 2003 to March 2005, HSBC served as trustee for the investment component of Pension Fund and its affiliated entities' trust plans. Since at least 1999, Pension Fund sold retirement and college "trust plans" that purportedly provided term life insurance and the opportunity to invest in one or more pre-selected mutual funds. However, Pension Fund failed to disclose, among other things, that it was taking up to 95 percent of the investors' funds to pay commissions and fees. Pension Fund raised at least $127 million from more than 3,400 investors, primarily from Central and South America. In 2005, the SEC filed an emergency action against Pension Fund and its principals to halt the offering fraud. According to the SEC's Complaint, HSBC allowed the use of its name and logo in Pension Fund's offering materials. HSBC also allowed Pension Fund to use marketing materials that falsely suggested that the trust plans were co-developed by HSBC and Pension Fund, and that investors' funds would be "totally safe" because the money would be deposited in a trust account at HSBC. In reality, Pension Fund deposited investors' funds in an ordinary checking account in its name at HSBC. Additionally, HSBC actively participated in the selection of offshore, high front-load mutual funds to be offered to prospective investors under a negotiated fee arrangement between HSBC and Pension Fund. However, neither the amount of the funds' sales loads, nor HSBC's role in the funds' selection, were disclosed to investors. In October 2003, shortly after HSBC became trustee for Pension Fund's plans, HSBC drafted a letter on its own letterhead announcing the new relationship and inviting certain of Pension Fund's existing investors to transfer their funds to HSBC. Pension Fund sent the letter to approximately half of its existing investors, and enclosed a form bearing HSBC's logo that listed new mutual fund selections available upon transfer to HSBC. Neither the letter nor the enclosure disclosed that investors would incur new front-load fees in connection with such transfers, or the amounts of those prospective costs.

SEC Investigates State Pension Plans

The SEC, in recent months, has opened inquiries into two state pension funds -- New York and New Jersey.  In New York, allegations involve payments made by investment firms to friends and family of Alan G. Hevesi, the former Comptroller.  The state's Comptroller serves as sole trustee of the $154 billion fund.  The state of New York previously opened an investigation into the charges.  The New Jersey plan is being investigated for accounting practices that allegedly overstated the amount of state contributions.  NYTimes, New York Pension Fund Faces a Federal Inquiry.

Merrill's Risk Management Ability in Doubt

The announcement that Merrill Lynch will write down $4.5 billion in COS and another $463 million in leveraged loans has upset the confidence in the firm's ability to manage risk and in its CEO Stanley O'Neal.  Since O'Neal became CEO, the stock price has lagged behind that of its competitors and the broker-dealer index.  NYTimes, Merrill Painfully Learns the Risks of Managing Risk.

SEC's Donohue on Closed End Funds

Andrew J. Donohue, Director, Division of Investment Management, Securities and Exchange Commission, spoke on closed end fund issues at the 2007 ICI Closed End Fund Workshop, New York, New York, on October 11, 2007.

SEC Charges Misappropriation Scheme Against Seniors

The SEC charged Robert Ray White Samples ("Samples")with misappropriating investor funds through two fraudulent investment schemes. According to the Commission's complaint, filed October 4 in federal district court in Denver, Colorado, from at least September 2002 through September 2006, Samples, operating through his company, Pot O' Gold Financial Services, LLC ("POG"), used material misrepresentations to raise at least $1,033,597 from 31 investors, including seniors, in two pooled investments. On October 11, the Court entered an order, with the defendants' consent, granting a preliminary injunction against Samples and POG, and freezing their assets and ordering an accounting.

The complaint alleges that Samples represented to investors that funds placed in Private Capital Accounts would be pooled together and invested primarily in fixed income securities and secondarily in an auto loan program under Samples' management to generate returns. The complaint also alleges that Samples sold interests worth almost $65,000 in POG's Golden Investment Club ("Club"). Samples represented to Club investors that he would pool their funds together in a brokerage account for investment in securities, which he would manage in exchange for an advisory fee. According to the Commission's complaint, Samples' representations to investors were false and he misappropriated a large portion of the funds he received to pay for personal expenses such as a new home, two timeshare condominiums, automobiles, and personal credit cards.

SEC Asked to Investigate Countrywide CEO's Stock Sales

The SEC has previously stated that it was looking into Rule 10b5-1 plans that allow corporate executives to sell their company's shares under a prearranged plan.  North Carolina's State Treasurer, who is trustee of state pension plans, has asked the SEC to investigate stock sales made by Countrywide Financial CEO Angelo Mozilo in the months before the Countrywide stock price dropped because of the subprime mortgage collapse.  Beginning in October 2006, Mozilo sold shares under a Rule 10b5-1 plan and twice raised the number of shares that could be sold.  Last week the company said that Mozilo would sell almost all his remaining shares before the plan expired.  NYTimes, Stock Sales by Chief of Lender Questioned. 

OFHEO Hearing Against Former Freddie Mac CEO Set to Begin

The Office of Federal Housing Enterprise Oversight (OFHEO)'s administrative hearing against Leland C. Brendsel, Freddie Mac's former CEO, is set to begin next week.  OFHEO alleges that Brandsel is responsible for the financial manipulation of Freddie Mac exposed in 2003 and seeks fines and repayment of compensation and benefits.  Brandsel denies that he is responsible.  The parties' witness list includes Warren Buffett and C.E. Andrew, currently CEO of Sallie Mae, who was audit partner at Arthur Andersen at the time.  WPost, For Brendsel, Court Wait Is Almost Over.

Morgan Stanley Settles SEC Charges Involving Noncompliant Trade Confirmations

On   October   9,   the   SEC entered a settled Order against Morgan Stanley & Co. Incorporated.  The order finds  that  from as early as 2000 until 2005, Morgan Stanley DW Inc., then  a  registered  broker-dealer, failed to provide to its customers accurate  and  complete  written trade confirmations for certain fixed income  securities. The Order further finds that Morgan Stanley & Co., a registered  broker-dealer,  also  provided  its  customers  with noncompliant  trade confirmations for certain fixed income securities.  The Order censures Morgan Stanley & Co.,imposes a  $7.5  million  penalty,  and requires it to retain an independent  consultant  to review its policies and procedures. 

Hedge Fund Settles Improper Short Sales Allegations

The SEC today announced a settled enforcement action against New York hedge fund adviser Sandell Asset Management Corp. (SAM), its chief executive officer, and two other employees for engaging in improper short sales in connection with trading in the securities of Hibernia Corporation in the immediate aftermath of Hurricane Katrina.

Hibernia was a New Orleans-based bank holding company and the subject of an acquisition agreement with Capital One Financial Corporation at the time Katrina occurred. As part of its merger arbitrage investment strategy, SAM held a large long position in Hibernia. According to the Commission's Order, SAM personnel believed that Capital One would lower its offering price for Hibernia shares in the wake of Katrina. In an attempt to offset an anticipated loss to a client, SAM personnel began to sell short as many shares of Hibernia stock as possible, improperly marking certain sales orders as "long" or misrepresenting to the broker-dealers executing some of the trades that they had located stock to borrow.

Without admitting or denying the Commission's findings, SAM agreed to pay more than $8 million to settle the charges, including $6,716,683.93 in disgorgement, $730,811.74 in prejudgment interest, and a $650,000 civil penalty. Also charged were the firm's CEO Thomas Sandell, senior managing director Patrick Burke, and head trader Richard Ecklord, all of whom consented to the Commission's Order without admitting or denying wrongdoing. Sandell, Burke and Ecklord were ordered to pay civil penalties of $100,000, $50,000 and $40,000, respectively

Former Qwest CEO Appeals Insider-Trading Conviction

Joseph Nacchio, former Qwest CEO, filed his appeal brief before the 10th Circuit, seeking to overturn his conviction on insider-trading charges.  The brief argues that Nacchio did not know at the time he sold his stock that the company's projections of future earnings were wrong.  It also argues that Nacchio was not permitted to introduce classified evidence as part of his defense that he knew the company had entered lucrative defense contracts.  WSJ, Nacchio Appeal Argues Qwest Woes Unforeseeable.

Former Milberg Weiss Partner Pleads Guilty

Steven Schulman, a former partner at Milberg Weiss, pleaded guilty in Los Angeles for his role in the firm's payment of kickbacks to individuals to serve as lead plaintiffs in securities class actions.  NYTimes, Ex-Partner at Law Firm Pleads Guilty in Kickback Case.   

Stoneridge Oral Argument

The transcript of the oral argument in Stoneridge Investors is posted at the Supreme Court website.  There is very little in the questioning of the Justices that could give the petitioners any basis for encouragement.  Chief Justice Roberts made it clear that the Court wasn't in the business of implying causes of action anymore and asked petitioners' attorney why the Court shouldn't be guided by what Congress's decision to create an aiding and abetting cause of action for the SEC only.  Justice Alito said he saw absolutely no difference between the petitioners' theory and aiding and abetting.  Justice Kennedy expressed concern that he saw no limitation on petitioners' theory, because there are any number of kickbacks and mismanagements and petty frauds that go on in business that affect stock prices.  Only Justice Ginsberg, in her questioning of respondent's attorney, wanted to explore a possible third category between primary liability and the Central Bank facts.   

SEC Staff Issues Report on Executive Compensation Disclosure

The SEC staff published a report discussing the principal themes that emerged from its initial review of the disclosure of 350 public companies for compliance with the Commission’s new and enhanced rules for executive compensation and related disclosure.  Two principal themes emerged from these reviews. First, companies should provide more focused disclosure of how and why they made specific executive compensation decisions. Second, the manner of presentation is important, and companies can use it to provide more direct, specific, clear and understandable executive compensation disclosure.

The staff’s reviews of the 350 companies are ongoing. Not less than 45 days after it completes each review, the staff will post the correspondence containing the comments and company responses to comments on the SEC’s EDGAR system.

SEC Appoints a Director of Interactive Disclosure

SEC Chair Christopher Cox continues his campaign for interactive financial reporting by announcing the creation of a new office to lead the transformation to interactive financial reporting by public companies, and tapping an 11-year veteran of McGraw-Hill, whose career includes seven years with the firm’s Standard & Poor’s division, as the agency’s Director of Interactive Disclosure.

David Blaszkowsky, 45, of Boston, served S&P in New York, starting in 2001, as Director of Global Market Development for Institutional Market Services, and as a Senior Director in Equity Research Services led S&P’s Corporate Markets and Investor Relations Services businesses.

At the SEC, Blaszkowsky will coordinate the agency-wide disclosure modernization program, and will work with investor groups, analysts, journalists, and preparers of financial statements as well as other key public and private sector stakeholders in the United States and around the world to advance the use of interactive data in financial reporting.

Stoneridge Oral Argument Today

Oral argument is today before the Supreme Court in Stoneridge Investors, and the Wall St. Journal has a front-page story about the campaigns conducted by both the plaintiffs' bar and business groups to influence opinion.  Over thirty amici briefs were filed in the case.  WSJ, Big-Money Battle Pits Business vs. Trial Bar.  SEC Commissioner Paul Atkins has an op-ed piece in the WSJ, the title of which summarizes his view, Just Say 'No' to the Trial Lawyers.

Sallie Mae Sues Over Buyout

Sallie Mae filed suit in Delaware Chancery Court to compel the consortium of private equity firms and banks that agreed to buy the company for $25 billion to go through with the deal or pay the $900 termination fee.  Citing the "material adverse effect" clause based on the federal government's cut of student loan subsidies, the buyers have sought to renegotiate the price.  NYTimes, Sallie Mae Sues to Force a Buyout; WSJ, SLM Escalates Battle, Sues J.C. Flowers Group.

Former Dynergy Exec Cites Prosecutors' Misconduct in Appeal

Attorneys for Jamie Olis, a former Dynergy executive convicted of fraud and conspiracy in 2003, filed a writ of habeas corpus, citing new evidence of prosecutorial misconduct.  They are relying on Judge Korman's actions in the KPMG case, dismissing charges against a number of KPMG employees after finding that the government pressured the firm to cut off their attorneys' fees.  Olis's attorneys allege comparable misconduct in his case.  WSJ, Attorneys Seek Release Of Former Dynegy Official.

15 Firms Fined for Failure to Deliver Prospectuses

NYSE Regulation announced today that as a result of an industry–wide review of prospectus delivery procedures, it has censured and fined 14 member firms and one former member firm a total of $10.425 million. The firms’ violations include failures to ensure delivery of prospectuses to customers who purchased securities and mutual funds, to deliver product descriptions to customers who purchased Exchange Traded Funds (“ETFs”), and to establish and maintain appropriate procedures of supervision and control with respect to these activities. Two of the firms also failed to ensure delivery of certain documents to customers, such as trade confirmations.  The individual fines ranged from $375,000 to $2.25 million. The NYSE website sets forth the names of the firms and the amount of the fines. In addition, each firm member agreed to certify that its current policies and procedures are reasonably designed to ensure compliance with the current federal securities laws and NYSE rules in these areas.

From July 1, 2003 to October 31, 2004 (the “relevant period”), and in certain cases continuing through 2005, firms experienced varying deficiencies relating to the delivery of prospectuses and/or product descriptions to many customers who purchased securities, stemming in part from the failure to have appropriate policies and procedures in place.

Enforcement conducted this review after it learned in other investigations that prospectuses were not being sent to customers as required by federal securities laws and NYSE rules. As detailed in the decisions announced today, numerous firms experienced one or more deficiencies in connection with one or more offerings and/or products. The nature and extent of the misconduct, in conjunction with other aggravating or mitigating circumstances unique to each firm, such as the level of cooperation, the self-reporting of the deficiencies, and the remediation efforts undertaken by the firms determined the level of the penalties.

NYSE Regulation Enforcement staff that was responsible for these cases has now transferred to the Financial Industry Regulatory Authority (“FINRA”).  In settling these charges brought by NYSE Regulation, the firms neither admitted nor denied the charges.

Change in Lead Counsel in Fannie Mae Fraud Class Action

The role of political donations in the appointment of lead counsel in private securities litigation is in the spotlight, as the Ohio Attorney General changes law firms in the Fannie Mae class action.  The Attorney General's office says there was a professional difference on strategy and tactics, but others wonder if political donations by plaintiffs' securities attorneys played a part.  WSJ, Lead Counsel In Fannie Suit Is Switched Out.

O'Hare on Retail Investor Remedies

Retail Investor Remedies Under Rule 10b-5, by JENNIFER O'HARE, Villanova University School of Law, is posted on SSRN.  Here is the abstract:

This paper assesses the private remedies available under Rule 10b-5 to retail investors who have been defrauded by false corporate disclosures. After comparing the treatment received by retail investors to the treatment received by institutional investors, I identify several areas in which the federal securities laws disfavor retail investors who have been defrauded by false corporate disclosures, including the creation of a two-tiered system of investor remedies for securities fraud. Institutional investors are permitted to pick and choose which law and forum offers them the most attractive chance for recovery, but retail investors typically do not have this opportunity. They are forced to sue under federal law in federal court. I then show that disfavored treatment could lead retail investors to question the fairness of the federal securities laws, contributing to a loss of investor confidence in U.S. markets. I conclude by exhorting policymakers to recognize that the securities fraud class action significantly disadvantages retail investors. Policymakers need to become much more aware of the plight of the defrauded retail investor when considering reforms to private securities fraud litigation and when determining enforcement initiatives.

Lambert on Insider Trading

A Middle Ground Position in the Insider Trading Debate: Deregulate the Sell Side, by THOMAS A. LAMBERT, University of Missouri at Columbia - School of Law, is posted on SSRN.  Here is the abstract:

Participants in the forty-year debate over whether insider trading should be liberalized have generally treated insider sales the same as insider purchases - they have argued that all such insider transactions should be either regulated or liberalized. This article contends that there is a principled basis for treating price-decreasing insider trading (e.g., insider sales) more leniently than price-increasing insider trading (e.g., insider purchases). Because equity overvaluation is more likely than equity undervaluation to occur and persist and is more likely to occasion harm to the corporate enterprise when it does occur, corporate constituents (managers and shareholders) would likely value a policy that permits price-decreasing insider trading more than a policy that permits price-increasing insider trading. Thus, the majoritarian default rule may be an asymmetric policy under which price-decreasing insider trading is generally permitted while price-increasing insider trading is generally forbidden.

 

Karmel on FINRA

Is the Financial Industry Regulatory Authority a Government Agency?, by ROBERTA S. KARMEL, Brooklyn Law School, is posted on SSRN.  Here is the abstract:

The National Association of Securities Dealers, Inc. (“NASD”) and NYSE Group, Inc. (“NYSE”) have combined their regulatory operations into a new entity called the Financial Industry Regulatory Authority (“FINRA”). Although both the NASD and the NYSE have long histories as self-regulatory organizations (“SROs”), subject to increasingly pervasive and statutorily based SEC regulation, the creation of FINRA poses a question long lurking in the structure and operation of the NASD: was the NASD for all practical purposes a government agency, and if so, what are the constitutional and administrative law ramifications of such a conclusion for its new incarnation, FINRA? This article will discuss a number of issues in an attempt to answer these questions: the constitutional issues inherent in the FINRA's status as an SRO; cases addressing the NASD's or NYSE's immunity from suit for their regulatory decisions and functions; the right of persons under NASD investigation to claim deprivation of their Fifth Amendment rights; the status of NASD arbitration facilities; the constitutional and administrative due process rights of persons subject to FINRA investigations and enforcement actions and FINRA rule-making; and the status of SRO rules in cases posing preemption and antitrust issues. The article will conclude that as long as the securities industry, rather than the SEC, controls the governance of FINRA and the selection of its Board of Governors, FINRA will not be a government entity, but since FINRA will be exercising delegated governmental functions with regard to discipline and rule-making, fundamental constitutional and administrative law protections should be afforded to persons affected by these activities.

Seyhun on Insider Trading

Insider Trading and Effectiveness of Chinese Walls in Securities Firms, by HASAN NEJAT SEYHUN, University of Michigan at Ann Arbor - Finance , is posted on SSRN.  Here is the abstract:

This study investigates the profitability of insider trading around the times when investment bankers appoint their representatives to the board of directors. If Chinese Walls at security firms are somewhat porous, then the presence of investment bankers on the boards is expected to increase the information efficiency of the clients' stocks and reduce the profitability of insider trading. Consistent with expectations, arrival of investment bankers on the boards of directors eliminates the profitability of insider trading, and reduces both the bid-ask spreads and volatility. These effects are temporary and they are reversed when the representatives depart. The finding that Chinese Walls are porous has a number of important economic, legal, and regulatory implications.