Tuesday, December 30, 2008
On December 29, the SEC issued an Order Instituting Administrative Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing a Cease-and-Desist Order (Order) against Stewart Enterprises, Inc. (Stewart), Kenneth C. Budde, CPA (Budde) and Michael G. Hymel, CPA (Hymel). The Order finds that, from 2001 through 2005, Stewart, the second largest publicly traded provider of death care services in the United States, and Budde, Stewart's former chief financial officer and chief executive officer, and Hymel, Stewart's former chief accounting officer, made repeated public filings with the Commission that materially misrepresented Stewart's revenue recognition policies and methodologies with respect to the sale of cemetery merchandise made prior to the need for a funeral (pre-need cemetery merchandise). Stewart misleadingly represented that it utilized a straightforward delivery method to recognize revenue for the sale of pre-need cemetery merchandise, by which, upon delivery, Stewart would recognize as revenue the full contract amount paid by the customer. However, Stewart could not actually identify the pre-need contract amount and instead created an estimate of the amount of revenue to be recognized. Stewart's failure to disclose this methodology of estimating revenues in its public filings with the Commission rendered its financial statements not in conformity with Generally Accepted Accounting Principles. Only when required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and informed by its outside auditor that it would no longer issue unqualified audit opinions if this estimated methodology continued to be used did Stewart finally shift to a revenue recognition system no longer reliant on estimates. Errors arising from the assumptions underlying Stewart's methodology for estimating revenues resulted in an overstatement of net revenue from 2001 through 2005 by more than $72 million, overstated annual net earnings before taxes during this period by amounts ranging from 10.76% to 38.76%, and were the primary basis for a subsequent material restatement of earnings.
Based on the above, the Order ordered Stewart to cease and desist from committing or causing any violations and any future violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder; ordered Budde to cease and desist from committing or causing any violations and any future violations of Exchange Act Rule 13a-14 and cease and desist from causing any violations and any future violations of Section 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder; and ordered Hymel to cease and desist from causing any violations and any future violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder. Stewart, Budde and Hymel consented to the issuance of the Order without admitting or denying any of the findings contained therein. In the Matter of Stewart Enterprises, Inc., Kenneth C. Budde, CPA, and Michael G. Hymel, CPA.
The SEC delivered to Congress its Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-To-Market Accounting that recommends against the suspension of fair value accounting standards. Instead the report recommends improvements to existing practice, including reconsidering the accounting for impairments and the development of additional guidance for determining fair value of investments in inactive markets, including situations where market prices are not readily available.
As mandated by the Act, the report addresses the following six key issues:
the effects of such accounting standards on a financial institution's balance sheet;
the impacts of such accounting on bank failures in 2008;
the impact of such standards on the quality of financial information available to investors;
the process used by the Financial Accounting Standards Board in developing accounting standards;
the advisability and feasibility of modifications to such standards; and
alternative accounting standards to those provided in such Statement Number 157.
Among key findings, the report notes that investors generally believe fair value accounting increases financial reporting transparency and facilitates better investment decision-making. The report also observes that fair value accounting did not appear to play a meaningful role in the bank failures that occurred in 2008. Rather, the report indicated that bank failures in the U.S. appeared to be the result of growing probable credit losses, concerns about asset quality, and in certain cases, eroding lender and investor confidence.
The Emergency Economic Stabilization Act of 2008 directed the SEC, in consultation with the Board of Governors of the Federal Reserve System and the Secretary of the Treasury, to study mark-to-market accounting standards as provided by the FASB Statement of Financial Accounting Standards No. 157, Fair Value Measurements. The Act, which was signed into law on Oct. 3, required that the study be completed within 90 days.
While the report does not recommend suspending existing fair value standards, it makes eight recommendations to improve their application, including:
Development of additional guidance and other tools for determining fair value when relevant market information is not available in illiquid or inactive markets, including consideration of the need for guidance to assist companies and auditors in addressing:
How to determine when markets become inactive and whether a transaction or group of transactions are forced or distressed;
How the impact of a change in credit risk on the value of an asset or liability should be estimated;
When should observable market information be supplemented with and/or reliance placed on unobservable information in the form of management estimates;
How to confirm that assumptions utilized are those that would be used by market participants and not just a specific entity;
Enhancement of existing disclosure and presentation requirements related to the effect of fair value in the financial statements.
Educational efforts, including those to reinforce the need for management judgment in the determination of fair value estimates.
Examination by the FASB of the impact of liquidity in the measurement of fair value, including whether additional application and/or disclosure guidance is warranted.
Assessment by the FASB of whether the incorporation of credit risk in the measurement of liabilities provides useful information to investors, including whether sufficient transparency is provided currently in practice.
The report also recommends that FASB reassess current impairment accounting models for financial instruments, including consideration of narrowing the number of models under U.S. GAAP. The report finds that under existing accounting requirements, information about impairments is calculated, recognized and reported on basis that often differs by asset type. The report recommends improvements, including: reducing the number of models utilized for determining and reporting impairments, considering whether the utility of information available to investors would be improved by providing additional information about whether current declines in value are consistent with management expectations of the underlying credit quality, and reconsidering current restrictions on the ability to record increases in value (when market prices recover).
The SEC filed an emergency action to halt a Ponzi scheme and affinity fraud conducted by Creative Capital Consortium, LLC and A Creative Capital Concept$, LLC (collectively, Creative Capital), and its principal, George L. Theodule. According to the Commission's complaint, the defendants raised at least $23.4 million from thousands of investors in the Haitian-American community nationwide through a network of purported investment clubs Theodule directs investors to form. The U.S. District Court for the Southern District of Florida issued an order placing Creative Capital under the control of a receiver to safeguard assets, as well as other emergency orders, including temporary restraining orders and asset freezes. In addition to the emergency relief obtained today, the Commission's complaint seeks disgorgement of the defendants' ill-gotten gains, civil penalties, and permanent injunctions barring future violations of the antifraud provisions of the federal securities laws.
Monday, December 29, 2008
The SEC today announced that it has unanimously approved revisions to modernize its oil and gas company reporting requirements to help investors evaluate the value of their investments in these companies. It has been over 25 years since the SEC last reviewed its rules in this area.
The new disclosure requirements include provisions that permit the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The new requirements also will allow companies to disclose their probable and possible reserves to investors. Currently, the Commission’s rules limit disclosure to only proved reserves. The new disclosure requirements also require companies to report the independence and qualifications of a reserves preparer or auditor; file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and report oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices. The use of the average price will maximize the comparability of reserves estimates among companies and mitigate the distortion of the estimates that arises when using a single pricing date.
The full text of the adopting release concerning these amendments will be posted to the SEC Web site as soon as possible.
Must reading in today's Wall St. Journal is the article on the last days of Lehman Brothers; the title says it all: The Weekend That Wall Street Died. It reports how it was every firm for itself as Lehman Brothers collapsed; Lehman's CEO Fuld couldn't even get Bank of America CEO Lewis to return his phone calls for help! In a separate story, Alvarez & Marsal, the restructuring adviser for Lehman, reports that as much as $75 billion of Lehman's value was destroyed by Lehman's "unplanned and chaotic" bankruptcy filing in September. Billions could have been saved if an orderly and less-rushed process had been followed. Estimates are that unsecured creditors will receive 10 cents on the dollar. WSJ, Lehman's Chaotic Bankruptcy Filing Destroyed Billions in Value.
Sunday, December 28, 2008
Shopping in Securities Class Actions?: Doctrinal and Empirical Analyses, by James D. Cox, Duke University School of Law; Randall S. Thomas, Vanderbilt University - School of Law and Vanderbilt University - Owen Graduate School of Management; and Lynn Bai, University of Cincinnati - College of Law, was recently posted on SSRN. Here is the abstract:
Federal appellate courts have promulgated divergent legal standards for pleading fraud in securities fraud class actions after the Private Securities Litigation Reform Act (PSLRA). Recently, the U.S. Supreme Court issued a decision in Tellabs v. Makor Issues & Rights that could have resolved these differences, but did not do so. This article provides two significant contributions. We first show that Tellabs avoids deciding the hard issues that confront courts and litigants daily in the wake of the PSLRA's heightened pleading standard. As a consequence, the opinion keeps very much alive the circuits' disparate interpretations of the PSLRA's fraud pleading standard. To be sure, Tellabs might ultimately be applied by lower courts to narrow the range of permissible approaches to satisfying the strong inference standard, but leaves a good deal of room within which wide variations in approach will continue.
Our second contribution is empirical in that we seek to answer the question: do plaintiffs' attorneys take advantage of the differences among the circuits' interpretation of the pleading standard to select more favorable venues to file their cases as some scholars have claimed? We find that 85% of the securities fraud class actions in our sample are filed in the home circuit of the defendant corporation. In the remainder of cases, those that are filed outside the defendant's home jurisdiction, our analysis shows that differences in the pleading standards do not explain a statistically significant amount of the reason for that decision.
While the differences in the circuits' pleading standards do not have a statistically significant impact on the plaintiffs' choice of venue, we find that plaintiffs are more likely to file low value cases in jurisdictions other than the one in which the defendants' headquarters is located. In particular, we find that cases with smaller provable losses and without an accompanying SEC investigation are statistically significantly more likely to be filed in circuits other than where the defendant's principal place of business is located. We interpret the former result as consistent with the hypothesis that in lower value cases, plaintiffs' counsel is more likely to select jurisdictions that are convenient to themselves rather than to the defendant. Conversely, when an SEC investigation is proceeding on the basis of the same operative facts, our results are consistent with the claim that plaintiffs' counsel will avoid filing outside of the defendant corporation's home jurisdiction to avoid procedural delays.
The Foreign Corrupt Practices Act, SEC Disgorgement of Profits, and the Evolving International Bribery Regime: Weighing Proportionality, Retribution, and Deterrence, by David C. Weiss, University of Michigan at Ann Arbor, was recently posted on SSRN. Here is the abstract:
The international framework governing foreign bribery has been in a state of flux during the preceding decade. For the first time since the passage of the Foreign Corrupt Practices Act, countries besides the United States are enforcing statutes prohibiting foreign bribery. Practitioners and academics have not yet analyzed foreign implementing legislation and enforcement levels nor the United States' changing enforcement strategy that has occurred simultaneously with the rise in foreign enforcement. In particular, the Securities and Exchange Commission's use of disgorgement damages has received scant attention despite the fact that it has begun to eclipse the importance of the SEC's express fining authority.
While disgorgement of ill-gotten gains has clear attractions from both retribution and deterrence perspectives, it raises new questions in the Foreigh Corrupt Practices Act context. In addition, as an increasing number of foreign statutes authorize disgorgement of profits in cases of foreign bribery and leverage the extraterritorial application of those laws, foreign enforcement raises serious questions regarding the propriety of disgorgement damages and suggests the necessity for foreign enforcement agencies to work together if multinational firms are to receive fair treatment when facing foreign bribery charges. Ultimately, the SEC's use of disgorgement damages has yet to cause firms unjustifiable multiple exposure for the same conduct, but as each SEC settlement seemingly sets a new benchmark for the size of disgorgement, multinational firms, corporate counsel, international regulators, and Congress should closely monitor the shifting enforcement climate with an eye toward fostering predictability, uniformity, and fairness for firms operating on a transnational scale.
Tuesday, December 23, 2008
The SEC today approved temporary exemptions allowing LCH.Clearnet Ltd. to operate as a central counterparty for credit default swaps with the expectation of stabilizing financial markets by reducing counterparty risk and helping to promote efficiency in the credit default swap market. The Commission developed these temporary exemptions in close consultation with the Board of Governors of the Federal Reserve System (FRB), the Federal Reserve Bank of New York, the Commodity Futures Trading Commission (CFTC), and the U.K. Financial Services Authority.
The President's Working Group on Financial Markets has stated that the implementation of central counterparty services for credit default swaps was a top priority. In furtherance of this goal, the Commission, the FRB and the CFTC signed a Memorandum of Understanding in November 2008 that establishes a framework for consultation and information sharing on issues related to central counterparties for credit default swaps.
The temporary exemptions will facilitate central counterparties such as LCH.Clearnet and certain of their participants to implement centralized clearing quickly, while providing the Commission time to review their operations and evaluate whether registrations or permanent exemptions should be granted in the future. The conditions that apply to the exemptions are designed to provide that key investor protections and important elements of Commission oversight apply, while taking into account that applying all the particulars of the securities laws could have the unintended consequence of deterring the prompt establishment and use of a central counterparty.
Well-regulated central counterparties should help promote stability in financial markets by reducing the counterparty risks posed by the default or financial distress of a major market participant. This, in turn, should reduce the potential for disruption in financial markets attributable to credit default swaps. They should also promote operational efficiencies and transparency, which are lacking currently in the over-the-counter market for credit default swaps.
The SEC is soliciting public comment on all aspects of these exemptions.
Monday, December 22, 2008
The SEC today settled charges against UnitedHealth Group Inc. relating to the backdating of stock options. The SEC also settled charges against former UnitedHealth General Counsel David J. Lubben relating to his participation in the stock option backdating scheme. Lubben consented to, among other things, an antifraud injunction, a $575,000 penalty, and a five-year officer and director bar.
The Commission alleges that between 1994 and 2005, UnitedHealth concealed more than $1 billion in stock option compensation by providing senior executives and other employees with “in-the-money” options while secretly backdating the grants to avoid reporting the expenses to investors.
In December 2007, the SEC announced a record $468 million settled enforcement action against William W. McGuire, M.D., the former Chief Executive Officer and Chairman of the Board of UnitedHealth. The settlement, which is pending before U.S. District Judge James M. Rosenbaum, was the first to deprive corporate executives of their stock sale profits and bonuses earned while their companies were misleading investors pursuant to the “clawback” provision (Section 304) of the Sarbanes-Oxley Act. McGuire consented to anti-fraud and other injunctions; disgorgement plus prejudgment interest of approximately $12.7 million; a $7 million penalty (the largest penalty against an individual in a stock option backdating case); and reimbursement to UnitedHealth under Section 304 of the Sarbanes-Oxley Act of approximately $448 million in cash bonuses, profits from the exercise and sale of UnitedHealth stock and unexercised UnitedHealth options. McGuire also agreed to be barred from serving as an officer or director of a public company for ten years.
The Commission declined to charge the company with fraud or seek a monetary penalty, based on the company’s extraordinary cooperation in the Commission’s investigation, as well as its extensive remedial measures. UnitedHealth’s cooperation included an independent internal investigation, the company’s release in a Form 8-K of a report detailing the investigation’s findings and conclusions, and the sharing of the facts uncovered in the internal investigation with the government. The company also took significant remedial actions in response to the findings of its internal investigation, including the implementation of new controls designed to prevent the recurrence of fraudulent conduct, removal of certain senior executives and board members, and the recoupment of nearly $1.8 billion in cash, options value and other benefits from several former and current officers, through, among other things, derivative litigation and the voluntary re-pricing and cancellation of retroactively-priced options.
According to the Commission’s complaint, Lubben or others acting at his direction created false or misleading company records indicating that the grants had occurred on dates when the company’s stock price had been at a low. Lubben personally received numerous backdated grants of options, representing as many as 3.8 million shares of UnitedHealth stock on a split adjusted basis. He exercised approximately 1.8 million of those options for approximately $1.1 million in gains attributable to improper backdating.
Lubben consented to the entry of an order permanently enjoining him from violating or aiding and abetting violations of the antifraud, reporting, record-keeping, internal controls, proxy statement, and securities ownership reporting provisions of the federal securities laws, and barring him from serving as an officer or director of a public company for a period of five years. Lubben will disgorge ill-gotten gains of $1,403,310 with $347,211 in prejudgment interest and pay a $575,000 penalty.
Under the terms of the settlement, Lubben’s disgorgement and prejudgment interest would be deemed satisfied by his voluntary repricing of his UnitedHealth stock options, which reduced the value of those options by approximately $2.7 million, and his payment of approximately $630,000 in pending settlements to resolve derivative and shareholder lawsuits related to options backdating filed against Lubben in state and federal courts in Minnesota.
In addition, Lubben agreed to resolve a separate administrative proceeding against him by consenting to a Commission order that suspends him from appearing or practicing before the Commission as an attorney for three years.
The Commission’s settlements with UnitedHealth and Lubben in the civil actions are subject to the approval of the U.S. District Court for the District of Minnesota.
The SEC today filed Foreign Corrupt Practices Act books and records and internal controls charges against Fiat S.p.A. and CNH Global N.V. in the U.S. District Court for the District of Columbia. Fiat S.p.A., an Italian company, provides automobiles, trucks and commercial vehicles. CNH Global N.V., a majority-owned subsidiary of Fiat, provides agricultural and construction equipment. The Commission's complaint alleges that from 2000 through 2003, certain Fiat and CNH Global subsidiaries made approximately $4.3 million in kickback payments in connection with their sales of humanitarian goods to Iraq under the United Nations Oil for Food Program (the "Program"). The kickbacks were characterized as "after sales service fees" ("ASSFs"), but no bona fide services were performed. The Program, intended to provide humanitarian relief for the Iraqi population, required the Iraqi government to purchase humanitarian goods through a U.N. escrow account. The kickbacks paid by Fiat's and CNH Global's subsidiaries diverted funds out of the escrow account and into Iraqi-controlled accounts at banks in countries such as Jordan.
Fiat and CNH Global failed to maintain adequate systems of internal controls to detect and prevent the payments and their accounting for these transactions failed properly to record the nature of the payments. Fiat and CNH Global, without admitting or denying the allegations in the Commission's complaint, consented to the entry of a final judgment permanently enjoining Fiat and CNH Global from future violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and ordering Fiat to disgorge $5,309,632 in profits plus $1,899,510 in pre-judgment interest plus a civil penalty of $3,600,000. Fiat will also pay a $7,000,000 penalty pursuant to a deferred prosecution agreement with the U.S. Department of Justice, Fraud Section. The Commission considered remedial acts promptly undertaken by Fiat and CNH Global and the cooperation the companies afforded the Commission staff in its investigation.
In a fine example of closing the barn door etc.:
The SEC announced that on December 18, 2008, the federal district court in the Southern District of New York entered a preliminary injunction order, by consent, against Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC ("BMIS"). The judge also, by consent, ordered that assets remain frozen until further notice, continued the appointment of a receiver for two entities owned or controlled by Madoff in the United Kingdom (while defendant BMIS remains subject to oversight by a SIPC trustee), and granted other relief. The preliminary injunction order continues the relief originally obtained on December 12, 2008, in response to the Commission's application for emergency preliminary relief that sought a temporary restraining order, an order freezing assets, and other relief against Madoff and BMIS based on his alleged violations of the federal securities laws.
The Commission continues to seek, among other things, a permanent injunction, disgorgement of ill-gotten gains plus pre-judgment interest, and civil money penalties.
On December 22, the SEC issued an administrative Order Imposing Remedial Sanctions (Order) against George L. Phelps (Phelps), finding that on December 2, 2008, an order of permanent injunction was entered by consent against Phelps, permanently enjoining him from future securities violations. The SEC alleged that Phelps participated in a massive fraud orchestrated by Michael E. Kelly that victimized thousands of investors across the United States by raising at least $428 million through the offer and sale of fraudulent and unregistered securities called Universal Leases. Universal Leases were timeshares in several hotels in Cancun, Mexico, coupled with pre-arranged servicing agreements with a purportedly independent leasing agent that promised investors a safe investment and guaranteed returns. Phelps agreed to the issuance of the Order without admitting or denying any of the factual findings.
Sunday, December 21, 2008
Moving Beyond Gartenberg: A Process-Based and Comparative Approach to Section 36(b) of the Investment Company Act of 1940, by John Greabe, Vermont Law School; Michael Brickman; James C. Bradley; and Nina H. Fields, was recently posted on SSRN. Here is the abstract:
Section 36(b) of the Investment Company Act of 1940 imposes on mutual fund advisers a fiduciary duty with respect to their receipt of compensation from fund assets for the advisory services they provide. For the past quarter century, courts adjudicating claims for breaches of this fiduciary duty have relied heavily on a rubric proposed in Gartenberg v. Merrill Lynch Asset Management Trust, 694 F.2d 923 (2d Cir. 1982). But in doing so, courts have tended to read Gartenberg to require them to serve as rate setters and to make substantive economic judgments about the fairness of mutual fund advisory fees. As a consequence, there has not been a single liability finding under section 36(b), even as the compensation paid to mutual fund advisers has skyrocketed. In this paper, the authors propose that courts enforce the fiduciary duty that section 36(b) creates through a process-based and comparative approach that is rooted in the common law of trusts and relies on judicially administrable guideposts. If section 36(b) is to serve the role Congress envisioned for it, it is imperative that courts move beyond the Gartenberg approach.
Credit Default Swaps: So Dear to Us, So Dangerous, by Eric Dickinson, Fordham University - School of Law, was recently posted on SSRN. Here is the abstract:
Credit-default swaps (CDS) are a valuable financial tool that has created system-wide benefits. At the same time, however, these derivative contracts have also created the potential for relatively few market participants to destabilize the entire economic system. This Paper will explore (1) how CDS could hypothetically create systemic risk, (2) how CDS have recently exacerbated the current financial crisis, and (3) how the U.S. legislature could best regulate CDS to minimize systemic risk in the future.
In theory, CDS could foster systemic crisis by means of (1) encouraging the growth of dangerous asset bubbles, (2) causing the collapse or failure of an institution that is systemically significant, and (3) creating perverse incentives that subvert policies underpinning business law on a system-wide scale. This Paper will question whether CDS helped support the growth of the sub-prime mortgaged-backed securities asset bubble that has been blamed for igniting the current financial crisis. Ultimately, there is evidence cutting both ways, thereby encouraging further research into the issue. The second of these theoretical risks has certainly come into realization within the last few months when the trillion-dollar company, AIG, destroyed itself by blundering in the CDS market and causing system-wide instability. As for the third theoretical risk, there is currently no empirical evidence that CDS has created perverse incentives on a system- wide scale.
How should the government regulate CDS to minimize systemic risk? After examining seven distinct proposals, this Paper recommends that legislators require CDS market participants to (1) maintain increased capital reserve requirements when involved in the purchase or sale of CDS tied to highly speculative debt; and (2) confidentially disclose their CDS positions to the Federal Reserve. Increasing the capital reserve requirements for companies that trade in junk-grade CDS is essential for two reasons. First, higher capital reserve requirements protect the solvency of systemically significant institutions that attempt to profit from the riskiest CDS. Second, specifically targeting CDS that are associated with the junk lending business will discourage banks from extending cheap credit to unworthy borrowers, thereby reducing the potential for markets to generate precarious asset bubbles. As a second regulatory measure, confidential disclosure of CDS positions to the Federal Reserve is an efficient but relatively non- intrusive way to greatly facilitate the monitoring of systemic risk going forward.
While the proposed legislative action would invariably impose costs on both market participants and society in general, the benefits of enhanced economic stability are incalculable.
Thursday, December 18, 2008
The SEC voted to require public companies and mutual funds to use interactive data for financial information. With interactive data, all of the facts in a financial statement are labeled with unique computer-readable "tags," which function like bar codes to make financial information more searchable on the Internet and more readable by spreadsheets and other software. Investors will be able to find specific facts disclosed by companies and mutual funds, and compare that information with details about other companies and mutual funds to help them make investment decisions.
For public companies, interactive data financial reporting will occur on a phased-in schedule beginning next year. The largest companies who file using U.S. GAAP with a public float above $5 billion will be required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2009. This will cover approximately 500 companies. The remaining companies who file using U.S. GAAP will be required to file with interactive data on a phased-in schedule over the next two years. Companies reporting in IFRS issued by the International Accounting Standards Board will be required to provide their interactive data reports starting with fiscal years ending on or after June 15, 2011.
Companies will be able to adopt interactive data earlier than their required start date. All U.S. public companies will have filed interactive data financial information by December 2011 for use by investors.
Mutual funds will be required to begin including data tags in their public filings that supply investors with such information as objectives and strategies, risks, performance, and costs. A mutual fund also would be required to post the interactive data on its Web site, if it maintains one.
The SEC earlier this year unveiled its new financial reporting system — IDEA (Interactive Data Electronic Applications) — to accept interactive data filings and give investors faster and easier access to key financial information about public companies and mutual funds. The new IDEA system is supplementing and eventually replacing the agency's 1980s-era EDGAR database, marking the SEC's transition from collecting forms and documents to making financial information itself freely available to investors.
The SEC filed insider trading charges in another "pillow-talk" case, alleging that a former registered representative at Lehman Brothers misappropriated confidential information from his wife, a partner in an international public relations firms, and tipped a number of clients and friends. The SEC's complaint alleges that from at least March 2004 through July 2008, Matthew Devlin, then a registered representative at Lehman Brothers, Inc. ("Lehman") in New York City, traded on and tipped at least four of his clients and friends with inside information about 13 impending corporate transactions. According to the complaint, some of Devlin's clients and friends, three of whom worked in the securities or legal professions, tipped others who also traded in the securities. The complaint alleges that the illicit trading yielded over $4.8 million in profits. Because the inside information was valuable, some of the traders referred to Devlin and his wife as the "golden goose." The complaint further alleges that by providing inside information, Devlin curried favor with his friends and business associates and, in return, was rewarded with cash and luxury items, including a Cartier watch, a Barneys New York gift card, a widescreen TV, a Ralph Lauren leather jacket and Porsche driving lessons.
The complaint alleges that, based on the information provided by Devlin, the defendants variously purchased the common stock and/or options of the following public companies: InVision Technologies, Inc.; Eon Labs, Inc.; Mylan, Inc.; Abgenix, Inc.; Aztar Corporation; Veritas, DGC, Inc.; Mercantile Bankshares Corporation; Alcan, Inc.; Ventana Medical Systems, Inc.; Pharmion Corporation; Take-Two Interactive Software, Inc.; Anheuser-Busch, Inc.; and Rohm and Haas Company. At the time that Devlin tipped the other defendants about these companies, each company was confidentially engaged in a significant transaction that involved a merger, tender offer, or stock repurchase.
The SEC's complaint names nine defendants as well as three relief defendants. The U.S. Attorney's Office for the Southern District of New York filed related criminal charges today against some of the defendants named in the SEC's complaint.
Wednesday, December 17, 2008
The Wall St. Journal reports that President-Elect Obama will appoint Mary Schapiro as Chair of the SEC. Ms. Schapiro is currently CEO of FINRA; she has previously served on both the SEC and CFTC -- useful if consideration will be given to merging the two agencies. She is widely respected among all constituencies. WSJ, Obama Names Schapiro SEC Chief.
Today the SEC approved a rule, 151A, that will bring most, if not all, indexed annuities within the definition of "security" and subject them to the registration and antifraud provisions of the securities laws. The distributors of indexed annuities took the position that indexed annuities were excluded from the definition of "security" by reason of the "insurance products" exclusion in section 3(a)(8), and the SEC apparently acquiesced to this interpretation until this rule-making process. Rule 151A was proposed in June, which makes this a speedy adoption process by SEC standards, and thousands of letters, principally from the insurance industry and its agents, were filed in opposition. In his opening remarks, Christopher Cox emphasized that indexed annuities are complicated products that are difficult to understand; their sales are frequently aimed at senior investors, and that regulators have been concerned about abusive tactics used in using these products. (It has been reported that Cox's interest in this area stems, at least in part, from his mother's purchase of an indexed annuity that was unsuitable for her needs.)
The SEC's new rule provides that an indexed annuity is not an "annuity contract" under the insurance exemption if the amounts payable by the insurer under the contract are "more likely than not" to exceed the amounts guaranteed under the contract. (I confess that I found the methodology set forth in the proposing release on how to determine the "more likely than not" question virtually incomprehensible; others more knowledgeable than I told me that it would encompass virtually all indexed annuities. We must await the publication of the final rule and accompanying release to see if the concept is expressed more clearly.)
Troy Paredes, the newest SEC Commissioner and former law professor at Washington University at St. Louis, filed a dissent, stating that the rule exceeds the scope of the SEC's statutory authority by eliminating indexed annuities from the "insurance product" exemption.
We can expect a judicial challenge from the insurance industry.
Christopher Cox's mea culpa on the SEC's failure to heed "credible and specific allegations," going back to 1999, about Madoff's fraud:
Since Commissioners were first informed of the Madoff investigation last week, the Commission has met multiple times on an emergency basis to seek answers to the question of how Mr. Madoff's vast scheme remained undetected by regulators and law enforcement for so long. Our initial findings have been deeply troubling. The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action. I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them. Moreover, a consequence of the failure to seek a formal order of investigation from the Commission is that subpoena power was not used to obtain information, but rather the staff relied upon information voluntarily produced by Mr. Madoff and his firm.
In response, after consultation with the Commission, I have directed a full and immediate review of the past allegations regarding Mr. Madoff and his firm and the reasons they were not found credible, to be led by the SEC's Inspector General. The review will also cover the internal policies at the SEC governing when allegations such as those in this case should be raised to the Commission level, whether those policies were followed, and whether improvements to those policies are necessary. The investigation should also include all staff contact and relationships with the Madoff family and firm, and their impact, if any, on decisions by staff regarding the firm.
The Commission believes strongly that it is vital that SEC investigators, examiners, and enforcement staff be above reproach while conducting their duties, in order to ensure the integrity and effectiveness of the SEC. In addition to the foregoing investigation, I have therefore directed the mandatory recusal from the ongoing investigation of matters related to SEC v. Madoff of any SEC staff who have had more than insubstantial personal contacts with Mr. Madoff or his family, under guidance to be issued by the Office of the Ethics Counsel. These recusals will be in addition to those currently required by SEC rules and federal law.
Charlie Gasparino, in the Daily Beast, reports that Eric Swanson, an assistant director in the SEC inspections division and part of the team that examined the Madoff firm in 1999 and 2004, married Shana Madoff in 2007. Ms. Madoff is the niece of Bernard and the Madoff firm's compliance counsel.
Tuesday, December 16, 2008
FINRA announced details of a special arbitration procedure for investors seeking recovery of consequential damages related to their investments in Auction Rate Securities (ARS). Customers entitled to file for consequential damages under ARS-related settlements that firms have concluded with FINRA or the SEC may use this special procedure. Consequential damages equate to the harm investors suffered from their ARS transactions - such as opportunity costs or losses that resulted from investors' inability to access their funds because their ARS assets were frozen. Use of this special arbitration procedure is at the investor's sole option. Investors also have the option of bringing a case under standard arbitration rules or in any other forum where they may have the right to seek redress.
Under the special procedure, firms will pay all fees related to the arbitration, including filing fees, hearing session fees and all the fees and expenses of arbitrators. Firms cannot contest liability related to the illiquidity of the ARS holdings, or to the ARS sales, including any claims of misrepresentations or omissions by the firm's sales agents. Further, the firm cannot use in its defense an investor's decision not to sell ARS holdings before the relevant ARS settlement date or the investor's decision not to borrow money from the firm if it made a loan option available to ARS holders.
With the special arbitration procedure, investors now have the option of selling their ARS holdings back to the firms under the regulatory settlements and, at the same time, pursuing consequential damages. Investors who wish to seek punitive damages or attorneys' fees have the option to do so under FINRA's standard arbitration procedures.
To speed the arbitration process under the special procedure, cases claiming consequential damages under $1 million will be decided by a single, chair-qualified public arbitrator. In cases with consequential damage claims of $1 million or more, the parties can, by mutual agreement, expand the panel to include three public arbitrators.
For investors who opt for the standard FINRA arbitration process, disputes will be heard by a typical three-arbitrator panel consisting of two public arbitrators and one non-public arbitrator. However, under rules created by FINRA four months ago, that non-public arbitrator cannot have been associated with ARS since Jan. 1, 2005. That is, that non-public arbitrator cannot have worked for a firm that sold ARS, cannot have sold ARS him- or herself and cannot have supervised an individual who sold ARS since Jan. 1, 2005.
Also in the standard forum, ARS damage claims up to $50,000 will be heard by a single public arbitrator. In cases where damages claimed are over $50,000, the panel will consist of two public arbitrators and one non-public arbitrator who has had no association with ARS since Jan. 1, 2005.
As of the end of November, 275 ARS arbitrations claims have been filed in FINRA's Dispute Resolution forum under its standard arbitration procedure. Investors with pending claims against settled firms can switch to the special arbitration procedure as long as they are willing to limit their claims to consequential damages.
The SEC has announced final ARS settlements with Citigroup Global Markets, UBS Financial Services and UBS Securities, while FINRA has reached final settlements with WaMu Investments and First Southwest Company. The SEC has reached agreements in principle with Bank of America, Merrill Lynch, RBC Capital Markets and Wachovia. FINRA has reached agreements in principle with Mellon Capital Markets, City National Securities, Comerica Securities, Harris Investor Services, SunTrust Investment Services, SunTrust Robinson Humphrey and NatCity Investment, Inc. Formal settlements in those cases are expected to be announced soon. Additionally, FINRA is actively investigating an additional two dozen firms for ARS-related misconduct.