Securities Law Prof Blog

SIFMA's White Paper on Securities Arbitration

SIFMA's Oct. 25 testimony before House Subcommittee on Commercial and Administrative Law on the "Arbitration Fairness Act" is posted on its website, a more concise version of its White Paper on Securities Arbitration, subtitled "the success story of an investor protection focused institution that has delivered timely, cost-effective, and fair results for over 30 years."

The Arbitration Fairness Act is the most recent Congressional expression of concern about the securities arbitration process that dates back to the McMahon decision itself.  My objections to the White Paper are not so much with its position; I have previously written that, with all its flaws, the securities arbitration process is reasonably fair and that most investors are probably better off in arbitration than in court.  I just wish that SIFMA had invested its resources into contributing new research or new insights to this perennial debate.  Instead, the White Paper is principally a rehash of the old arguments and relies heavily on old studies – e.g., a 1988 study comparing arbitration and litigation, the 1992 GAO study, the 1999 Tidwell study based on NASD party evaluations. The most argumentative portion of the White Paper is devoted to a critique of the recently released Solin Report.  While I have previously pointed out difficulties with the analysis in the Solin Report, its authors base their arguments on an empirical examination of a substantial number of arbitration awards.

The White Paper, for example, faults the Solin Report for its failure to account for what the White Paper characterizes as the “particularly aggressive claimants’ bar” in the early 2000s which filed, in its view, a large number of meritless claims, specifically, the tainted research claims.  I think, however, that the poor rate of success of the tainted research cases in arbitration is a topic worthy of more dispassionate study.  Given the public exposure of statements by analysts that they were lying about their expectations for the stocks, why were the arbitrators apparently so willing to blame the investors instead of the firms?  Contrary to the White Paper, I personally do find it surprising that arbitrators awarded damages in fewer than one-third of the analyst cases.  Unlike the White Paper, I have doubts that the explanation lies with the aggressive claimants’ bar. 

FINRA Censures UBS for Late CRD Disclosures

FINRA announced today that it has censured and fined UBS Financial Services, Inc. (UBS) $370,000, for making hundreds of late disclosures to FINRA's Central Registration Depository (CRD) of information about its brokers, including customer complaints, regulatory actions and criminal disclosures. Those reporting violations occurred over a three-year period, from January 2002 through December 2004.  FINRA's findings included:

From January 2002 through December 2004, UBS failed to report on time 559 required disclosures on Forms U4 and U5 relating to reportable customer complaints, regulatory actions and criminal disclosures, representing a non-compliance rate of over 18 percent. During the same time period, the firm failed to have supervisory systems and procedures in place reasonably designed to achieve compliance with reporting obligations for timely disclosures.

From January 2002 through December 2004, UBS failed to disclose on Forms U4 and U5 at least 24 reportable written customer complaints that the firm had received.

As part of the settlement, UBS agreed to conduct an internal audit to evaluate the effectiveness of its system for timely compliance with certain Forms U4 and U5 reporting obligations. In addition, the firm agreed that an officer of the firm will certify that such audit has occurred and that recommendations from the audit have been or will be implemented.  In settling this matter, UBS neither admitted nor denied the allegations, but consented to the entry of FINRA's findings.

Former CEO of DHB Industries Arrested for Insider Trading

David Brooks, the former CEO of body armor-maker DHB Industries (n/k/a Point Blank Solutions) was arrested on conspiracy, insider trading, and other charges involving an alleged scheme to inflate the company's performance from 2000-2006.  The indictment also alleges that Brooks used company funds (about $ 5 million) for a whole array of personal and family expenses, including expenses related to his children's Bat/Bar Mitzvahs and his wife's cosmetic surgery.  WSJ, Former DHB Industries Chief Is Charged With Insider Trading.

The SEC also brought civil charges against Mr. Brooks.  At the time of the alleged conduct, Brooks was subject to an SEC injunction entered by a federal court in December 1992 against future violations of the antifraud provisions.

Tyco Executives Appeal Convictions

Former Tyco executives Dennis Kozlowski and Mark Swartz have appealed their convictions that they looted the company, arguing that they were entitled to the money under the company's executive compensation plan.  Each man has already served two years of his sentence.  WSJ, Tyco Ex-Officers Seek to Reverse Convictions.

SIFMA Releases White Paper on Securities Arbitration

SIFMA has released a White Paper on Arbitration in the Securities Industry, which it subtitles "the success story of an investor protection-focused institution that has delivered timely, cost-effective and fair results for over 30 years."  I'll report more on this later when I have a chance to read its 70 pages.

Is Merrill's CEO Long for the Job?

The actual loss reported by Merrill Lynch yesterday was $8.4 billion, up from the expected $5 billion figure of two weeks ago and up from the $7 billion figure that was floated early yesterday morning.  Merrill Lynch gets the dubious distinction of the largest loss ever on Wall St., surpassing the $6 billion loss by hedge fund Amaranth in 2006.  In a telephone call with analysts, CEO Stanley O'Neal concedes that "some mistakes were made."  Everyone else is wondering how the firm's exposure to risky mortgages got so out of hand and whether O'Neal will hold onto the CEO spot.  WSJ, Merrill Takes $8.4 Billion Credit Hit.

Sovereign Wealth Funds in the Spotlight

The growing size and influence of sovereign wealth funds has become a topic of concern.  Currently these funds are operated by more than twenty countries, including China and Saudi Arabia, and are buying stakes in U.S. companies.  Both the Group of Seven and the IMF recently asked whether there should be standards addressing risk management, transparency and accountability for the funds.  Chair Cox last night in a speech said that the rise of the funds "challenges us to ask whether these many benefits of markets and private ownership will be threatened if government ownership in the economy...becomes more significant -- or whether, alternatively, the world will be better off."   WSJ, Cox Cites Concern Over Sovereign Funds.

Cablevision Shareholders Vote Down Dolans' Going Private Offer

Will James Dolan give up on plans to take Cablevision private, now that, as expected, the public shareholders voted down the $10.6 billion offer ($36.26 per share)?  Several large shareholders announced that they would vote against the plan.  Stay tuned .... WSJ, Cablevision Shareholders Reject Dolans' Bid to Take Firm Private.

Merrill Expected to Announce $7 Billion Losses

The word is that Merrill Lynch will soon announce that its third quarter losses are even greater than the previously announced $5 billion and will, in fact, exceed $7 billion.  Merrill CEO Stanley O'Neal joins Citigroup CEO Charles Prince on the hot seat, as doubts continue about Merrill's ability to manage its risk.  WSJ, Merrill Loss May Be Wider Than Projected;NYTimes, Merrill Lynch to Report $2.5 Billion in Added Loss.

Where's the Rescue Plan?

Since Citigroup, Bank of America and JPMorgan Chase announced, with great fanfare, its "rescue plan" for SIVs (structured investment vehicles), they have not released much information about how the plan would work or where the rescue funds would come from.  Indeed, some have said the plan is just window-dressing.  Meanwhile, the SIVs need to find investors for about $100 billion in debt coming due soon.  SIVs sell short-term debt and use the proceeds to buy longer-term, higher-yielding securities.  They are a popular investment vehicle for money market funds and municipalities that viewed SIVs as loss-risk investments.  In the wake of the credit crunch, however, SIVs have had difficulty selling the debt, and much of their approximately $350 billion in assets is backed by U.S. mortgages.  WSJ, SIV Situation:Will RescuersArrive in Time?

Atkins Calls for Review of SEC Enforcement Program

In a recent speech, SEC Commmissioner Paul Atkins, reviews the history of the Wells Committee and says:

I welcome the idea of new advisory committees to review the functions of our divisions and offices. In light of the many issues raised in the three recent capital market competitiveness reports, the 2006 Chamber of Commerce report on the SEC enforcement program, and the Congressional and GAO reports, I think it is clear that this would be a good time for a new "Wells-like" advisory committee to review the policies and procedures of our enforcement program. The Commission and the staff should welcome, not fear, such a review.

Remarks at the Eighth Annual A. A. Sommer, Jr. Corporate, Securities and Financial Law Lecture, Fordham University Law School, New York, New York, October 9, 2007.

SEC Gets TRO in Ponzi Scheme

The SEC announced that on October 19, 2007, the United Stated District Court for the Northern District of Illinois, Eastern Division issued a Temporary Restraining Order and Asset Freeze against Robert A. Loffredi (Loffredi) and Raymond Financial Group, Inc. (Raymond Financial) temporarily enjoining Loffredi and Raymond Financial from securities law violations and freezing their assets. The SEC alleges that from at least August 2003 to the present, Loffredi, a registered representative and the President of Raymond Financial, raised at least $2.8 million from at least fourteen customers by falsely representing that he would invest their funds in securities, primarily in the form of purported certificates of deposit (CDs). Instead, Loffredi used the customers' funds to pay his personal and business expenses and to make payments to other customers who had invested in fictitious securities.

FINRA Warns Investors About Energy Stock Frauds

FINRA issued an Investor Alert today warning investors to be wary of energy-related stock "pump-and-dump" scams that entice investors to purchase stocks that promise exponential price growth.

The new Investor Alert, "Save Your Energy and Money—Don't Fall for Energy Stock Scams," explains these energy stock scams typically involve small unknown companies, using a combination of baseless price predictions, misrepresentations and hyperbole. The goal of these scams is to inflate the price of the stock through false and misleading statements that create unwarranted demand for the company's shares. The con artists behind the scam can then sell off their shares, leaving investors with worthless stock.

The Alert warns investors about fax, email and even cell phone text message scams that promise high returns in exchange for little risk. In a spam message, one outfit trumpets that a certain Texas energy firm has "teamed up with China's $23 billion oil monopoly," and promises that huge returns are in store for those with the wisdom and foresight to invest 'RIGHT NOW!'

Applebee's Director Plans to Seek Appraisal of Shares If IHOP Deal is Approved

Appraisal proceedings are rare -- the procedure is too cumbersome, and the cost/benefit analysis rarely points to filing the proceeding.  Even rarer is a director of the acquired corporation filing an appraisal proceeding, but that is what Burton "Skip" Sack, a director and the largest individual shareholder of Applebee's International, says he plans to do if the other shareholders approve IHOP's acquisition at $25.50 per share.  The Applebee's board split 9-5 over whether to approve the deal, and the proxy advisory firms are also split.  WSJ, Applebee's Director Says IHOP Is Paying Too Little for Chain.

Government Disputes Nacchio's Claim that Government Retaliated Against Qwest

You will recall that former Qwest CEO Joseph Nacchio has filed an appeal in his criminal insider-trading conviction.  Among the grounds cited, he points to the exclusion of certain evidence by the district court that, he says, shows that the government retaliated against the company by leaving its name off a list of subcontractors for a lucrative government project, after Qwest questioned the legality of an earlier government plan.  While it's not clear to me what this has to do with the insider-trading charges, the allegations received a great deal of press.  Prosecutors yesterday filed papers that, it says, show that Qwest in fact was part of a group that secured the government contract.  WPost, Papers Contradict Nacchio's Defense.

Dispute Over Sallie Mae Likely to Go to Trial

The attorneys for the buying group led by J.C. Flowers and Sallie Mae held a conference call with Vice Chancellor Victor Strine over Sallie Mae's request for an expedited hearing, because it says that the restrictive covenants in the merger agreement interfere with its business operations and prevent it from shopping the company.  The Chancellor repeatedly asked why the parties did not agree to terminate the agreement.  Finally, the buyers agreed to waive the restrictive covenants so as to avoid the expedited hearing. A trial is likely for early next year, unless the parties arrive at a settlement. NYTimes, Provision Is Waived in Sallie Mae Merger Case, but Underlying Dispute Remains ; WSJ, Flowers Drops Sallie Proviso.

Sales of B Shares Continue to Decline

In a few years Class B shares in mutual funds may be extinct, thanks to regulatory pressure to thwart brokers' sales of B shares in lieu of more suitable A shares, as well as (perhaps) better investor education as to the differences.  In recent years, investors have pulled out more money from B shares than they have invested; last year, net outflows were more than $57 billion, according to an industry source.  Brokers frequently pushed more expensive B shares as an alternative for "no-load" funds because the sales charge was at the back end.  In addition, B shares were frequently sold to customers whose dollar amounts made A shares a better deal.  InvNews, Sales of B shares continue to wane.

Joe Torre and Performance-Based Pay

Was Joe Torre right to feel insulted by the Yankees' offer of a one-year contract that cut his base salary (from $7.5 million to $5 million) and replaced it with performance-based bonuses -- $1 million for each level of postseason play reached in 2008?  Not according to many CFOs, who view performance-based incentives as completely appropriate for senior management.  CFO.com, Torre's Pay Offer Is a Hit with CFOs.

A $6 Million Verdict Against Merrill Lynch in Customer Dispute

A Florida jury found that a Merrill Lynch broker took advantage of the late philanthropist George Rothman (who died in 2004 at the age of 86) and his wife and awarded $6 million in damages.  The jury will decide whether to award punitive damages.  The allegations are representative of the kind of "senior investor" case we can expect to see more of: the broker took advantage of the deteriorating mental condition of the couple and placed them in high-commission variable annuities, while assuring them they were in low-load funds.  There is no explanation why this case was in court instead of in arbitration.  A Merrill Lynch spokesperson called the verdict "astonishing," because the couple were wealthy sophisticated investors who lost no money on the investment.  NYTimes, Jury Finds Merrill Lynch Bilked Couple.

Coke Resists Class Action Certification Citing Lerach

Will Bill Lerach's guilty plea be grounds to terminate pending class actions brought by his former law firm, Coughlin Stoia?  Coca-Cola seeks to deny class-action certification in an action alleging accounting fraud that was instituted in 2000 on that ground.  A federal judge in another securities fraud class action has already rejected the argument, because Lerach had retired from the firm and the law firm itself is not under indictment -- as is the case with Milberg Weiss.  WSJ, Coke Tries New Defense.

KKR and Goldman Negotiate Settlement of Harman LBO

KKR and Goldman Sachs terminated its $8 billion takeover for Harman International Industries and avoided both litigation and a $225 million termination fee.  The takeover, like so many others, fell victim to the credit crunch.  Instead, KKR and Goldman will buy $400 million in convertible debt securities and appoint a representative to the Harman board.  WSJ, Harman Takeover Canceled, Fight Avoided.

Bear Stearns Plans Joint Venture in Asia

Bear Stearns and Citic Securities, a state-controlled investment bank in China, plan a joint venture in Asia that involves each company investing $1 billion in the other.   NYTimes, Bear Stearns and Chinese Bank to Form Joint Venture ; WSJ, Bear Stearns, Citic Near a Deal.

Cunningham on Gatekeepers' Rewards

Beyond Liability: Rewarding Effective Gatekeepers, by LAWRENCE A. CUNNINGHAM, George Washington University Law School, was recently posted on SSRN.  Here is the abstract:

This Article adds to the emerging literature on rewards to promote effective capital market gatekeeping. Capital market gatekeeping theory traditionally relies heavily on threats of legal liability for failure to perform legally mandated functions (along with a presumed constraint imposed by reputation effects). The ineffectiveness of many gatekeepers in the past decade revealed limitations of the liability strategy and yet reforms continue to emphasize legal duties and liability for gatekeepers. This emphasis also has the negative side-effect of discouraging gatekeepers from willingness to perform desired functions - such as to detect for fraud. Using rewards can induce gatekeepers to perform desired functions and add positive incentives to encourage them to be more effective in vetting enterprises seeking access to capital.

Barzuza on Cross-Listing

Lemon Signaling in Cross-Listing, by MICHAL BARZUZA, University of Virginia - School of Law, was recently posted on SSRN.  Here is the abstract:

This paper develops a model of signaling of private benefits of control and applies it to the decision to cross-list. It suggests that cross-listing signals that a manager or a controlling shareholder can not extract large amounts of private benefits.
This signaling effect creates opposite incentives for managers and controlling shareholders. While the opportunity to bond and signal limited extraction encourages managers to cross-list, it discourages controlling shareholders from cross-listing, since such a signal decreases the control premium they receive if they sell their control block.
The paper derives implications for the cross-listing market, the desirability of international regulation and the likelihood of international convergence of corporate law and structures.
Since this paper is the first to develop a signaling model of private benefits, it also has implications for other issues in corporate law and corporate finance such as the desirability of mandatory corporate law and dividend distribution.

Alexander and Hanley on Regulatory Monitoring

Regulatory Monitoring Under the Sarbanes-Oxley Act , by CINDY R. ALEXANDER and KATHLEEN WEISS HANLEY, both from the SEC, was recently posted on SSRN.  Here is the abstract:

This paper examines the economic relevance of the factors set forth under Section 408 of the Sarbanes-Oxley Act to guide the enhanced regulatory scrutiny of public company financial disclosures, as required under the Act. We interpret two of the factors, volatility and firm size, as predictors of a public company's relative risk of non-compliance or the prospective loss to investors, conditional upon non-compliance. We use disclosures of material weaknesses in internal controls under Section 404 as indicators of the potential for non-compliance. Our evidence is that the Section 408 factors that we associate with a relatively high risk of non-compliance – high stock-price volatility, and whether a company is emerging with a disparate PE ratio – are good predictors of reported material weaknesses in internal controls. In addition, while Section 408 calls for enhanced review of large firms – those with high market capitalization and a material affect on the economy – we find that relatively few large firms have disclosed material weaknesses in internal controls. The large firms that have disclosed material weaknesses, however, comprise 92% of the market capitalization of all companies disclosing a material weakness. In contrast with the focus of the public debate on the compliance problems of smaller public companies, our evidence points to high volatility as a stronger predictor of compliance problems under the Act than small firm size. Finally, we discuss alternate explanations for our findings and the potential for unintended consequences for shareholders.

Bratton and Wachter on "The Modern Corporation"

Shareholder Primacy's Corporatist Origins: Adolf Berle and 'The Modern Corporation,' by WILLIAM W. BRATTON, Georgetown University Law Center; European Corporate Governance Institute (ECGI), and MICHAEL L. WACHTER, University of Pennsylvania Law School, was recently posted on SSRN.  Here is the abstract:

Many corporate law discussants think of themselves as picking up where Adolf Berle and E. Merrick Dodd left off in a famous, precedent-setting debate in the 1930s. The generally accepted historical picture puts Berle in the position of the original ancestor of today's shareholder primacy position while Dodd is cast as the original ancestor of today's corporate social responsibility (CSR). This Article shows that both categorizations amount to mistaken readings of old material outside of its original context. The Article corrects the mistakes, offering new readings of some of corporate law's fundamental texts, texts that recently reached their 75th anniversaries and include Berle's famous book with Gardiner C. Means, The Modern Corporation and Private Property. Seventy-five years ago the normative issue of the day was the appropriate policy response to the crisis of the Great Depression. Both Berle and Dodd addressed the issue from a corporatist perspective which views the corporation as an entity that operates as an organ of the state and assumes social responsibilities. In so doing Berle took on the fundamental question “for whom is the corporation managed” at a time when the answer had crucial implications for social welfare. In answering the question, Berle articulated a political economy that integrated a theory of corporate law within a theory of social welfare maximization. It was a great accomplishment, but it was in a context very different from today's debates about corporate management and responsibility. Accordingly, Berle was not advocating shareholder primacy as we understand it today. Nor is there a strong claim that Berle was a CSR advocate; he never did make the final jump of advocating reorganization of the legal firm as a social welfare maximizer. His unqualified statements on the subject all presupposed a strong regulatory state and a public consensus against a corporate profit maximand. Dodd does not present a clear picture either. Dodd's Depression-era writing, once contextualized, offers only indirect support to today's CSR advocates. He is most plausibly read as a managerialist, and social responsibility within management's discretion is not what CSR tends to be about. The biggest lesson from this analysis is that the shareholder primacy school impairs its own position by making a claim on Berle.

Black on Stoneridge

Stoneridge Investment Partners v. Scientific-Atlanta (8th Cir. 2006) What Makes it the Most Important Securities Case in a Decade?, by BARBARA BLACK, University of Cincinnati - College of Law, was recently posted on SSRN.  Here is the abstract:

Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. is scheduled for oral argument before the U.S. Supreme Court on October 9, 2007. It has been described as “arguably the most important securities law case to reach the Court in a decade” and as securities lawyers' “Roe v. Wade.” What is the legal issue that has occasioned this much attention? Phrased as a technical legal argument, plaintiff asserts that it may establish that outside actors committed a Rule 10b-5 violation on a theory of “scheme liability;” in contrast, defendants assert that Central Bank of Denver v. First Interstate Bank of Denver, which found no statutory basis for aiding and abetting liability, precludes plaintiff's theory of liability.

What is on trial before the Supreme Court, however, may be the future of private securities fraud litigation. Beyond the legal issue, the parties' positions reflect the differing views in the ongoing debate on the value of private securities fraud litigation. Does scheme liability enhance the compensatory and deterrent functions of private litigation or does it contribute to abusive private litigation that jeopardizes the US markets' competitive position? Thirty one amicus briefs have been filed in the case, about equally divided between the plaintiff's and the defendant's position. There was disagreement within the executive branch as to which side the Solicitor General should support. Most recently, the SEC announced that it would hold a spring 2008 roundtable to debate the various positions on private securities litigation.

This paper will first analyze the legal issue in Stoneridge, describe the policy issues from the perspective of the amicus briefs and then provide some commentary on the case's significance to the law and policy of private securities fraud litigation. This paper is a work-in-progress, to be continued upon the Court's opinion.

Khanna and Dickinson on Corporate Monitors

The Corporate Monitor: The New Corporate Czar?, by VIKRAMADITYA S. KHANNA, University of Michigan at Ann Arbor - Law School, and TIMOTHY DICKINSON, Paul, Hastings, Janofsky & Walker, LLP - Washington, DC, was recently posted on SSRN.  Here is the abstract:

Following the recent spate of corporate scandals, government enforcement authorities have increasingly relied upon corporate monitors to help ensure law compliance and reduce the number of future violations. These monitors also permit enforcement authorities, such as the Securities & Exchange Commission and others, to leverage their enforcement resources in overseeing corporate behavior. However, there are few descriptive or normative analyses of the role and scope of corporate monitors. This paper provides such an analysis. After sketching out the historical development of corporate monitors, the paper examines the most common features of the current set of monitor appointments supplemented by interviews with monitors. This is followed by a normative analysis that examines when it is desirable to appoint monitors and what powers and obligations they should have. Based on this analysis, we provide a number of recommendations for enhancing the potential of corporate monitors to serve a useful deterrent and law enforcement function without being unduly burdensome on corporations. This involves, among other things, discussion of the kinds of powers monitors should have and the fiduciary duties monitors should owe to the shareholders whose businesses they are monitoring.