Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Saturday, November 17, 2007

Analyzing SEC Enforcement Actions Against General Counsel in the Backdating Cases

The UC Corporate Law Center recently co-sponsored, with Association of Corporate Counsel, Southwest Ohio chapter, a program on The Role of Corporate Counsel in Fostering an Ethical Corporate Environment."  For that program, I reviewed recent SEC enforcement actions against inhouse corporate counsel, particularly those relating to backdating stock options.  Here are my findings:

To date the SEC has filed six complaints against general counsel for their alleged involvement in backdating stock options.   Two of the actions have already been settled, and in both those cases the general counsel also pleaded guilty to criminal charges (SEC v. Olesnyckyj; SEC v. Alexander).  The other four actions are ongoing (SEC v. Berry; SEC v. Mercury Interactive; SEC v. Heinen; SEC v. Roberts).

There are common allegations in each SEC complaint, and I want to emphasize that what follows are the allegations as taken from the SEC's complaints.  First, the GC was actively involved in selecting the dates for the purported issuance of the options.  Second, the GC was involved in the preparation of false documentation (written consents or minutes of the Compensation Committee) and the false SEC filings.  Third, the GC had an understanding of the accounting implications.  Finally, the GC in each instance received backdated stock options.

What do we know about the GC?  Their ages at the time the backdating began ranged from mid-30s to mid-40s; most were also either an officer or a director of the company; and they all appear to be well-educated and well-qualified for their positions.

If the allegations are substantially true -- a big if -- then, contrary to previous reports on SEC enforcement actions, the SEC does not appear to be using these cases to argue for novel theories of liability or increased gatekeeping responsibilities for inhouse counsel.  Rather, the SEC appears to have been cautious in its selection of cases and gone after inhouse attorneys who it thinks were active participants in the fraud and significantly benefited financially from the backdating.  One of the lawyers who pleaded guilty allegedly realized more than a $14 million gain from the sale of stock underlying the exercises of backdated stock options.

The larger question that goes beyond the backdating cases is what factors can drive inhouse counsel allegedly to risk their professional reputation and license to embrace a corrupt corporate culture?  Is it just greed?  Is it pressure exerted by management to "enable" deals and not to question them?   How can the inhouse lawyer be the "can do" person and maintain sufficient independence to say no when he has to?

November 17, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Friday, November 16, 2007

Jury Returns Verdict against Former Chancellor Corp. CEO

The SEC announced that a federal court jury returned a verdict today in the SEC's favor on all securities fraud charges against Brian M. Adley, who is the former chairman, chief executive officer and controlling shareholder of Chancellor Corporation, a defunct Boston-based transportation equipment-leasing company.  Adley was found liable for using fabricated documents and fraudulent accounting from 1998 through 2000 to orchestrate a scheme that inflated Chancellor's reported assets, revenue and income, and paid unwarranted fees to entities that he controlled. The verdict followed a three-week trial in Boston before the Honorable Patti B. Saris, U.S. District Court Judge for the District of Massachusetts.  The Commission previously settled with 10 other defendants: Chancellor Corporation; the former President and Chief Operating Officer; the former acting Chief Financial Officer; the former treasurer; two former Chancellor directors and audit committee members; Chancellor's outside auditing firm and three members of its audit team.

November 16, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Securities Arbitration Filings Continue to Decline

FINRA's new securities arbitration case filings through October 2007 are 2642, down 35% from 2006.  Mediation cases in agreement are also down --18%.  Dispute Resolution Statistics.

November 16, 2007 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Adopts New Rules for Smaller Businesses

The SEC voted to adopt three measures to modernize and improve its capital-raising, reporting and disclosure requirements for smaller companies. These measures address some of the key recommendations made by the SEC's Advisory Committee on Smaller Public Companies in its final report.  The final rules:

make scaled disclosure regulations available to an additional 1,500 smaller companies;
 
shorten the holding periods under Securities Act Rule 144 for restricted securities of public companies from one year to six months to reduce the cost of capital and to increase access to capital; and
 
create two new exemptions for compensatory employee stock options so that the Exchange Act registration requirements will not be triggered solely by a company's compensation decisions.

The new rules should be published and available at the SEC website soon.

November 16, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Proposes New Rules for Mutual Fund Disclosure

Chair Cox continues his dual quests for "plain English" disclosure and increased use of the internet, as the SEC voted to propose rule changes to improve mutual fund disclosure, requiring that all mutual fund investors receive a "clear, concise summary of key information." In addition, funds would be encouraged "to harness the power of the Internet" to allow investors to choose the format in which they receive more detailed information and to use and compare mutual fund information more effectively.  The proposed rules will be published for public comment shortly.

November 16, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Allows Foreign Issuers to Use International Accounting Standards

The SEC decided unanimously that foreign corporations that use the International Financial Reporting Standards (IFRS) set by the International Accounting Standards Board will no longer have to reconcile their financial statements to conform to GAAP.  The new rule will take effect immediately.  Chair Cox said that the agency would consider allowing U.S. issuers to adopt IFRS as well.  Commissioner Nazareth expressed concern about how to assure that IFRS is consistently applied.  NYTimes, S.E.C. Says Foreign Companies Do Not Have to Adjust to U.S. Accounting; WSJ, Global Accounting Effort Gains a Step.

November 16, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Thursday, November 15, 2007

Massachusetts Charges Bear Stearns with Improper Trading with Hedge Funds

Massachusetts regulators have accused Bear Stearns of fraud, charging that it improperly made principal trades for the firm's proprietary account with two hedge funds, without obtaining the approval of the funds' independent directors.  Investors lost $1.6 billion when the funds collapsed this summer.  Bear Stearns declined to comment.  WSJ, Bear Faces First Loss, Fraud Complaint.

November 15, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

London Success Story

The London Stock Exchange reported a 32% increase in first-half net income, reflecting an increase in trading volume and new issues.  LSE said it had 52 international IPOs, exceeding the number at NYSE, Nasdaq and Deutsche Borse combined.  WSJ, LSE's Net Income Rises 32% On Higher Trading Volume.

November 15, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Former Bear Stearns Trader Expected to Plead Guilty to Insider Trading

Ken Okada, a former broker at Bear Stearns, is expected to plea guilty in insider-trading charges,  the ninth person (out of 13 charged) to do so in the insider-trading scheme that also involved employees at UBS and Morgan Stanley.  NYTimes, Broker Is Expected to Plead Guilty.

November 15, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Ohio Federal Judge Finds Fatal Flaw in Securitization Pool

A federal district court judge in Ohio, one of the states with the highest number of foreclosures, dismissed 14 foreclosure cases brought by a Deutsche Bank affiliate that is the trustee for the securitization pool.  The judge held that the trustee failed to prove that it owned the notes and mortgages on the properties it was trying to seize.  The lawyers for the bank were not able to file copies of the loan assignments, only papers showing an intent to convey the rights in the mortgages.  The judge rejected the bank's argument that this was customary lending practice.  An recent academic study found that 40% of creditors foreclosing on property did not show proof of ownership.  NYTimes, Foreclosures Hit a Snag for Lenders.

November 15, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 14, 2007

NYSE's Thain Moves to Merrill

John Thain leaves the NYSE Euronext CEO position and moves to take the top job at Merrill Lynch.  Duncan Niederauer, co-COO and President of NYSE, is expected to become CEO.  Thain, a former Goldman Sachs executive, has a great deal of familiarity with mortgage bonds, a useful skill these days.  WSJ, Thain to Take Top Job at Merrill.

November 14, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Distributes Funds to Investors in Pump and Dump Scheme

The SEC enjoys trumpeting its success with collecting and distributing funds to investors under the Fair Funds provision of SOX and here's one in which it can justly take pride.  It announced the mailing of checks totaling more than $2.7 million to 833 investors who were victims of the fraudulent promotion and sale of illegally issued shares of Bio-Heal Laboratories, Inc. The Fair Fund distribution represents a 100 percent return of the defrauded investors' money.

In April 2005, the Commission sued Bio-Heal, a publicly-held company that claimed to develop topical natural healing products in Nicaragua, and five other corporate entities that received the illegally issued shares and sold them in a classic pump and dump scheme.  It obtained an emergency asset freeze against Bio-Heal and the other entities, freezing their proceeds from the sale of the illegally issued shares.  The SEC's complaint against Bio-Heal alleged the company improperly issued 12 million shares of its stock to several entities without a restrictive legend based on a fraudulent attorney opinion letter claiming they were exempt from registration with the Commission. The complaint further alleged that two of those entities then dumped their Bio-Heal shares on the market at the same time as the stock was being fraudulently touted to investors over the Internet.

November 14, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Cox Testifies on Proxy Access Bylaw Proposals

SEC Chair Christopher Cox testified today concerning Bylaw Proposals to Establish Director Nomination Procedures before the U.S. Senate Committee on Banking, Housing, and Urban Affairs.  While stating he could not predict what the Commission would do with the two competing proposals before it, he stated his personal support for strengthening the proxy rules to vindicate state law shareholder rights.  He also acknowledged the difficulty of the task ("if it were easy, my predecessor would have done it") and said that the SEC should go back to the drawing board and take a fresh look.

November 14, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Chevron Settles FCPA Charges Involving Iraq Oil for Food Program

Chevron Corp. becomes the fifth company that the SEC has gone after for violations of the FCPA in connection with illegal kickback payments that were made to Iraq in 2001 and 2002 in connection with the company's purchases of crude oil under the U.N. Oil for Food Program.  Chevron agreed to pay $30 million to settle the charges without admitting or denying the SEC's allegations.

The U.N. Oil for Food Program was intended to provide humanitarian relief to the Iraqi people while Iraq was subject to international trade sanctions. According to the Commission's complaint, third parties under contract with Chevron made approximately $20 million in illicit payments that bypassed the Oil for Food escrow account and were paid directly to Iraqi-controlled bank accounts in Jordan and Lebanon. The SEC alleged that Chevron knew, or should have known, that third parties were using portions of the premiums they received from Chevron's oil purchases to pay illegal surcharges to Iraq. The SEC also alleged that Chevron failed to have in place a system of internal accounting controls to detect and prevent such illicit payments.

November 14, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Aguilar and Walter Expected to be Nominated to SEC

Luis A. Aguilar, a corporate attorney from Atlanta, and Elisse D. Walter, former COO of NASD (n/k/a FINRA), are expected to be nominated to fill the two Democratic vacancies on the SEC.  Aguilar has been quoted in interviews as critical of SOX.  Walter has also been GC of the CFTC and spent more than a decade as a staff attorney at the SEC.  WPost, Democrats Nominate 2 for SEC Vacancies.

November 14, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Skilling's Attorneys Seek to Overthrow His Conviction

Many Enron-related convictions have not held up on appeal -- e.g., Arthur Andersen.  Now federal prosecutors and defendants for Jeffrey Skilling are vigorously contesting whether Skilling's 19 convictions should be thrown out.  (Skilling has already served one year of his sentence.)  His attorneys argue that a 2006 5th Circuit opinion -- throwing out some convictions in another Enron-related case that involved the "barge" transactions-- that limited the scope of  the "theft of services" conspiracy claims is applicable to Skilling. WPost, A Year Later, Prosecutors Fight To Keep Enron's Skilling in Prison.

November 14, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Firms Bail Out Their Money Market Funds

Several investment firms -- including Bank of America, Wachovia, Credit Suisse, and Merrill Lynch -- have announced that they will bill bail out their money market funds that have suffered losses because of mortgage-related investments.  Money market funds are considered to be ultra-safe investment vehicles that invest in short-term securities and maintain a NAV of $1 per share.  Many investors consider them the equivalent of CDs, although money market funds are not FDIC-insured.  NYTimes, Investor Safe Haven Becomes a Concern.

November 14, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Specialist Firm Complains About Odd-Lot Abuses

Specialist firm LaBranche & Co. complained to regulators that certain professional traders are abusing the odd-lot trading rules -- designed to protect small traders -- at its expense.  In response, the NYSE has imposed volume limits to stop manipulation.  It has also brought regulatory actions against abuses of the odd-lot system.  WSJ, NYSE Moves to Prevent Abuses in Odd-Lot Trades.

November 14, 2007 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 13, 2007

Nazareth Speaks on Globalization

SEC Commissioner Annette L. Nazareth spoke at the Securities Industry and Financial Markets Association Annual Meeting in Boca Raton, Florida, on November 9, 2007, on issues relating to globalization of the securities markets, including the need for foreign access and mutual recognition approaches for exchange and broker-dealers.

November 13, 2007 in SEC Action | Permalink | Comments (0) | TrackBack (0)

NASAA Proposes a Model Rule to Deal with Senior Designations

NASAA has requested public comment on a proposed model rule on the use of senior-specific certifications and professional designations.  Some brokers and advisers use bogus "credentials" to claim expertise in providing investment advice to senior citizens.  FINRA has warnings about this practice on its website, and some state regulators (Massachusetts and Nebraska, in particular) have been active in cracking down on the practice.  The proposed rule prohibits the misleading use of senior designations and also provides a way that regulators can recognize accredited designations.

November 13, 2007 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)