Securities Law Prof Blog

Court Enjoins Affinity Ponzi Scheme

On May 12, 2008, the federal district court for the Central District of California entered an order preliminary enjoining Safevest, LLC and its principals, Jon G. Ervin, Sr. and John V. Slye from future violations of the antifraud provisions of the federal securities laws. The SEC's complaint, filed in federal court in Santa Ana, California on May 1, 2008, alleges that since at least May 2007, the defendants have raised more than $25 million from more than 500 investors, including many from the Christian community, misrepresenting that investor funds would be pooled and invested in commodity futures trading, that the investment would generate daily profits ranging from 1.5% to 1.9%, and that investors could receive their money back within 72 hours of requesting it. In reality, according to the complaint, no investor money was invested in futures trading, and requests by investors for withdrawal of their funds have either not been honored or have only been partially honored. The complaint further alleges that, undisclosed to investors, the defendants paid more than $18 million to investors in Ponzi-like fashion. The defendants also allegedly misappropriated investor funds for the personal use of Ervin, Slye, and their family members.

SEC Obtains Freeze of Assets in Alleged Insider Trading Case

The SEC filed an emergency civil action in the United States District Court for the Southern District of New York against Cristian De Colli, a machinery engineer residing in Rome, Italy, alleging that he engaged in insider trading from which he reaped more than $2.1 million in illicit profits from highly suspicious trading in his U.S. brokerage account in the securities of DRS Technologies, Inc., prior to the public disclosure of advanced merger negotiations.  The SEC also filed an application for a temporary restraining order in order to freeze De Colli's assets in the United States, and the court issued a temporary restraining order freezing De Colli's assets in the U.S., including his brokerage account.

According to the Complaint, De Colli purchased 5,700 shares of DRS common stock from April 10 to April 29, 2008, and 3,116 call options for the common stock of DRS between April 15 and May 7, 2008. De Colli purchased more than 2,400 of the call options on May 6 and May 7, including certain options that were out-of-the-money by over $6 and which expired ten days after purchase. On April 28, 2008, De Colli liquidated securities that he had purchased in two other companies a week earlier in order to purchase additional DRS options. At that point, 100 percent of the holdings in De Colli's U.S.-based brokerage account consisted of DRS call options and DRS stock.

The SEC's complaint further alleges that immediately following a May 8th Wall Street Journal article reporting the advanced merger negotiations and after confirmation by DRS that it was engaged in talks regarding a potential strategic transaction, De Colli liquidated all of his call options and made his ill-gotten profit of more than $2.1 million on his initial investment of approximately $422,000. Finmeccanica later announced on May 12, 2008 that it would acquire DRS for $5.2 billion, or $81 a share.

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Yahoo Responds to Icahn

The Yahoo board responded to Carl Icahn's proxy contest to replace Yahoo's ten directors in a letter stating that:

Unfortunately, your letter reflects a significant misunderstanding of the facts about the Microsoft proposal and the diligence with which our board evaluated and responded to that proposal. A fair-minded review of the factual record leads to one conclusion: that Yahoo!'s ten-member board, comprised of nine independent directors along with Yahoo! CEO Jerry Yang, remains the best and most qualified group to maximize value for all Yahoo! stockholders.

Conversely, we do not believe it is in the best interests of Yahoo! stockholders to allow you and your hand-picked nominees to take control of Yahoo! for the express purpose of trying to force a sale of Yahoo! to a formerly interested buyer who has publicly stated that they have moved on. ...

From the beginning of the process with Microsoft, Yahoo!'s independent directors focused on one central goal: how best to maximize stockholder value.

The letter goes on to detail the process of the Yahoo board's deliberations about the Microsoft bid and concludes:

In short, Yahoo!'s board was at every point in this process prepared to enter into a transaction with Microsoft that would maximize stockholder value--and included certainty of value and closing. What Yahoo!'s independent board refused to do was to allow control of this company to be acquired for less than its full value.

PurchasePro Founder Convicted of Stock Fraud

PurchasePro founder Charles E. Johnson Jr. was found guilty of stock fraud and obstruction of justice after a federal court found he misled investors by inflating revenues at the software company in 2001.  In his opinion the judge relied on the testimony of two convicted PurchasePro executives, which he found credible.  In addition to stock fraud charges, Johnson was found to have fabricated emails to support his defense.  WPost, Ex-PurchasePro Chief Found Guilty of Fraud, Obstruction.

Former NBTY Director Settles Insider Trading Charges

A final judgment was entered on May 8, 2008, by the United States District Court for the Southern District of New York against Nathan Rosenblatt, a former director of NBTY, Inc., and member of its three-person audit committee. Rosenblatt consented to the entry of final judgment, without admitting or denying the allegations of the SEC's complaint.  The complaint alleged that Rosenblatt tipped his close friend Morris Gad with material, nonpublic information concerning the company's significant revenue and earnings shortfall for the third quarter of 2004, prior the company's public release of its financial results. With this information in hand, Gad sold his entire position of NBTY stock, sold the stock short, purchased put contracts, and sold call contracts through the custodial accounts of his three children prior to NBTY's release of its 2004 third quarter financial results. In so doing, Gad made $399,187.40 in trading profits and losses avoided.  Gad previously settled with the Commission.

The final judgment against Rosenblatt orders him to pay a civil penalty of $399,187.40, and permanently bars him from acting as an officer or director of any public company.

SEC Amends Rule 2a-46 of Investment Co. Act

The SEC broadened small business financing opportunities by amending Rule 2a-46 under the Investment Company Act to increase the availability of capital to certain smaller companies that may not have ready access to the public capital markets or other forms of conventional financing.

Congress in 1980 established business development companies (BDCs) to help make capital more readily available to small, developing, and financially troubled businesses. To accomplish this purpose, the Investment Company Act generally prohibits a BDC from making any investment unless, at the time of the investment, at least 70 percent of its total assets are invested in securities of certain specific types of companies, including "eligible portfolio companies."

The Commission has amended Rule 2a-46 to expand the definition of eligible portfolio company to include any domestic operating company with securities listed on a national securities exchange, if the company has a market capitalization of less than $250 million.

The Investment Company Act defines eligible portfolio company to include a domestic operating company that, among other things, does not have any class of securities that are marginable under rules issued by the Federal Reserve Board. In 1998, for reasons unrelated to small business capital formation, the Federal Reserve Board amended its margin rules to include all publicly traded equity securities and most debt securities. These 1998 amendments had the unintended consequence of substantially reducing the number of companies that met the definition of eligible portfolio company.

In 2006, the Commission adopted new rules under the Investment Company Act to address the effect of the Federal Reserve Board's 1998 amendments on the definition of eligible portfolio company. The Commission adopted Rule 2a 46 to include in the definition of eligible portfolio company all private companies and public companies whose securities are not listed on a national securities exchange. This is the rule that the Commission has amended today. The Commission in 2006 also adopted Rule 55a-1 to conditionally permit a BDC to include in its 70 percent basket any follow on investments in a company that met the new definition of eligible portfolio company at the time of the BDC's initial investment in it.

FINRA Fines 3 Firms for OATS violations

FINRA fined TradeStation Securities, Inc., E*Trade Securities, LLC and CIBC World Markets Corp. a total of $1.6 million for multi-year violations relating to FINRA's Order Audit Trail System (OATS) rules and related supervisory failures.  Under the OATS rules, firms must report information related to the handling and execution of customer orders, as well as for certain proprietary orders for Nasdaq and OTC Equity securities. This information allows FINRA to recreate the life cycle of an order and is critical to effective regulation.

TradeStation Securities, Inc. was fined $750,000 for failing to report approximately 23.5 million Reportable Order Events relating to orders received. E*Trade Securities was fined $500,000 for failing to report "New Order Reports" and "Route Reports." CIBC was fined $350,000 for failing to report to OATS over 28 million orders which were generated by an affiliate.

FINRA further found that the three firms did not have adequate systems of supervision in place to monitor their OATS reporting compliance.  The fine for CIBC was reduced in recognition of the firm's actions in reporting the problem to FINRA and taking prompt remedial actions to correct the problem. In settling these matters, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

Icahn Seeks to Replace Yahoo Directors

As expected, Carl Icahn launched a proxy contest to replace all ten directors on the Yahoo board at its upcoming shareholders' meeting, saying that the current board has "acted irrationally and lost the faith of shareholders."  Among the nominees is Harvard Law Professor Lucian Bebchuk.  WSJ, Icahn Moves to Oust Yahoo Board.

Merrill Reforms its Stock Rating System

Merrill announced a new system for rating stocks that requires its analysts to assign "underperform" ratings to 20% of the stock they cover and "buy" ratings to no more than 70%.  Even after the Global Analysts' Settlement that mandated industry reforms to improve research, analysts remain reluctant to advise investors to sell.  According to Bloomberg, only about 5% of all stock recommendations today are "sell."  NYTimes, Merrill Tries to Temper the Pollyannas in Its Ranks.

Moody's Will Restrict Bond Analysts' Talks with Issuers

Moody's Investors Service said it would revise its code of conduct to limit bond-rating analysts' discussions with issuers to "credit issues."  The independence of debt-rating agencies has been doubted, and there are calls for regulatory reform.  The SEC is expected to propose new rules for rating agencies shortly.  WSJ, Moody's Aims to Buff Image By Revising Policies.

Freddie Reports Quarterly Loss

As evidence that the housing market crisis is not over, Freddie Mac reported a loss for the first quarter of 2008 of $151 million (66 cents per share), compared with a loss of $133 million (35 cents per share) for the first quarter of 2007.  Freddie reported $1.45 billion of credit-related expenses in the quarter.  Its estimated asset value was negative $5.2 billion on March 31, compared with a positive $12.6 billion on December 31.  The March estimated loss would have been about $4.6 billion more, except for changes in valuation methods.  Freddie said it planned to raise an additional $5.5 billion in capital through sales of common and preferred shares, a commitment it made to its regulator.  WPost, Freddie's Quarterly Loss Widens.

Indiana Businessman Charged with Criminal Securities Fraud

The SEC announced that on May 9, 2008, the United States Attorney's Office for the Northern District of Illinois filed a 14-count criminal information against Michael E. Kelly ("Kelly"), a former South Bend, Indiana businessman that the SEC previously charged with securities fraud in a civil action filed in September 2007. The information alleges that Kelly engaged in a fraudulent investment scheme by offering and selling through fraudulent means approximately $34 million in promissory notes and more than $450 million in investments called Universal Leases. The criminal information charges Kelly with 10 counts of mail fraud, two counts of wire fraud and two counts of securities fraud and also seeks the forfeiture of approximately $500 million. Kelly was initially charged in a criminal complaint when he was arrested in December 2006.

Court Enjoins Pump & Dump Scheme Involving Nutraceutical

On April 25, 2008, the U.S. District Court for the Middle District of Florida granted the SEC's motion for summary judgment and entered an order and final judgment against Kerry P. Kennedy, a stock promoter who orchestrated the fraudulent promotion of the securities of Nutraceutical Clinical Laboratories International, Inc. ("Nutraceutical" or the "Company").  The Court's judgment (1) enjoins Kennedy from violating the anti-fraud provisions of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), Exchange Act Rule 10b-5, and the registration provisions of Section 5(a) and (c) of the Securities Act of 1933 ("Securities Act"); (2) orders Kennedy to disgorge $1,685,413.71 in ill-gotten gains (including prejudgment interest) from his participation in the pump-and-dump scheme; (3) imposes a $400,000 civil money penalty; and (4) bars Kennedy from participating in any offering of penny stock.

The SEC's complaint, filed on November 15, 2004, alleged that in 2000 and 2001 Kennedy, along with fellow stock promoter Stanley Siciliano, attorney John Zankowski and Nutraceutical CEO Paul Simmons and CFO Rodney Gilbert, engaged in a multi-faceted pump-and-dump scheme involving the securities of Nutraceutical, which now, under different management, operates as Preservation Sciences, Inc. and EFUEL Network, Inc. As part of a reverse merger transaction Kennedy helped to arrange, CEO Simmons, CFO Gilbert, promoter Kennedy and attorney Zankowski secretly purchased nearly all of Nutraceutical's purportedly free trading stock through their offshore nominee accounts. They did so in order to make a public market for the illegal, unregistered distribution of their stock.

To drum up interest in the Company and to facilitate their anonymous distribution, Simmons disseminated false and misleading publicity about Nutraceutical, while, at the same time, stock promoters Kennedy and Siciliano falsely touted the stock on an Internet message board and manipulated the market for the Company's stock through fraudulent stock trading via matched and washed buy and sell orders. According to the Court's order, "Kennedy's actions showed that he was aware of the true value of Nutraceutical's stock, while simultaneously deceiving potential investors to increase the profit of his stock sale." During the course of the pump, Kennedy unlawfully dumped Nutraceutical stock through nominee accounts, reaping $1,144,583.95 in profits.

Icahn Will Run Slate for Yahoo Board

Carl Icahn plans to launch a proxy contest to replace all ten of Yahoo's directors, with the goal of pressuring the company to resume merger negotiations with Microsoft.  The Yahoo deadline for board nominations is Thursday.  WSJ, Icahn Will Launch Proxy Contest To Unseat Yahoo's Entire Board.

SEC Charges Ponzi Scheme Targetted to African-American Community in Los Angeles

The SEC filed securities fraud charges against the promoters of an $18 million real estate investment scheme targeting the African-American community in the Los Angeles area and other locations in Nevada and Georgia.  The SEC's complaint, filed in U.S. District Court in Los Angeles, charges Jeanetta M. Standefor and Accelerated Funding Group (AFG) with operating a fraudulent "foreclosure reinstatement" scheme that attracted more than 600 investors between 2005 and 2007. The scheme purported to use investors' funds to cure defaults on distressed properties owned by others. The SEC alleges that while soliciting investor money and promising returns of up to 50 percent within 30 to 45 days, Standefor and AFG were instead operating a Ponzi-like scheme that used money from new investors to pay previous investors. Standefor also used more than $1.9 million of investor funds for personal expenses such as her lavish wedding and honeymoon, cars, jewelry, tickets to entertainment events, and home renovations. Standefor and AFG also misused investor funds to pay $121,000 in "consulting fees" to Standefor's husband, Darrell R. Dansby.

SEC Charges Broadcom Officers with Backdating

The SEC charged two current and two former top officers of Broadcom Corporation for their alleged participation in a five-year scheme to secretly backdate stock options granted to virtually all Broadcom officers and employees.  The SEC's complaint, filed in federal district court for the Central District of California, alleges that Broadcom's former chief executive officer Henry T. Nicholas, chairman and chief technology officer Henry Samueli, former chief financial officer William J. Ruehle, and general counsel David Dull perpetrated a scheme from 1998 to 2003 to fraudulently backdate stock option grants, failing to record billions of dollars of compensation expenses and falsifying documents to further the fraud. As a result of the scheme, Broadcom restated its financial results in January 2007 and reported more than $2 billion in additional compensation expenses.

According to the SEC's complaint, Nicholas and Samueli served on the two-member option committee that had authority to approve options to employees and all but the most senior officers. The SEC alleges that the option committee approved as many as 88 grants during the relevant period, but for many of the grants the committee neither held meetings nor made decisions on the dates the grants were supposedly approved. Instead, Ruehle allegedly selected most of the grant dates retroactively based on a comparison of Broadcom's historical stock prices, and Nicholas and Samueli allegedly concealed the backdating by signing false committee written consents stating that the grant had been approved "as of" the retroactive date.

In addition, the SEC alleges that Nicholas, Samueli, and Ruehle - not the compensation committee - decided on option grants to Broadcom's senior officers and used hindsight to select the dates for them. Dull allegedly knew about and participated in the backdating scheme and was involved in the preparation, review, and approval of false board and compensation committee meeting documents to conceal two backdated grants in 2001, one of which awarded him options to purchase 300,000 shares. The SEC is alleging that Ruehle and Dull each personally benefited from the backdating scheme by receiving and exercising backdated grants that were in-the-money by more than $100,000 for Ruehle and $1.8 million for Dull.

The SEC is seeking permanent injunctions, civil monetary penalties, and officer-and-director bars against each of the individuals, disgorgement with prejudgment interest against Ruehle and Dull, and reimbursement of bonuses and profits from stock sales from Nicholas and Ruehle pursuant to Section 304 of the Sarbanes-Oxley Act of 2002.

SEC Settles FCPA Charges Against Willbros Group

The SEC filed a settled civil action against Willbros Group, Inc. and several former employees alleging that they violated the anti-bribery provisions of the Foreign Corrupt Practices Act (FCPA) and the antifraud provisions of the federal securities laws. According to the complaint, the company also violated the reporting, books and records and internal controls provisions of the Securities Exchange Act. Willbros Group agreed to settle the charges, without admitting or denying the Commission's allegations.

According to the SEC's complaint, the Willbros Group engaged in multiple schemes to bribe foreign officials in Nigeria and Ecuador and also implemented a fraudulent tax avoidance scheme in Bolivia. Willbros Group agreed to consent to the entry of a judgment that permanently enjoins it from future violations of these provisions and that orders it to pay disgorgement of $8.9 million, plus prejudgment interest of $1.4 million.

SEC Proposes Requirement of Interactive Data Format

The SEC voted to propose a rule that would require all U.S. companies to provide financial information using interactive data beginning next year for the largest companies, and within three years for all public companies.  The interactive data tags uniquely identify individual items in a company's financial statement so they can be easily searched on the Internet, downloaded into spreadsheets, reorganized in databases, and put to other comparative and analytical uses by investors, analysts, and journalists.  Since 2005, many companies have voluntarily submitted to the SEC financial information in interactive data format.

"This is all about bringing investors better, faster, more meaningful information about the companies they own," said SEC Chairman Christopher Cox. "It would transform financial disclosure from a 1930s form-based system to a truly 21st century model that taps the power of technology for the benefit of investors."

The SEC's proposed schedule would require companies using U.S. Generally Accepted Accounting Principles with a worldwide public float over $5 billion (approximately the 500 largest companies) to make financial disclosures using interactive data formatted in eXtensible Business Reporting Language (XBRL) for fiscal periods ending in late 2008. If adopted, the first interactive data provided under the new rules would be made public in early 2009. The remaining companies using U.S. GAAP would provide this disclosure over the following two years. Companies using International Financial Reporting Standards as issued by the International Accounting Standards Board would provide this disclosure for fiscal periods ending in late 2010. The disclosure would be provided as additional exhibits to annual and quarterly reports and registration statements. Companies also would be required to post this information on their websites.

The required tagged disclosures would include companies' primary financial statements, notes, and financial statement schedules. Initially, companies would tag notes and schedules as blocks of text, and a year later, they would provide tags for the details within the notes and schedules.

Public comment on the proposed rule should be received by the SEC no later than 60 days after its publication in the Federal Register.

IAC and Liberty Settle Dispute over Spin-offs

Liberty Media (controlled by John Malone), which has majority voting power in IAC/Interactive Corp. (controlled by Barry Diller), went to court in Delaware to block IAC's planned restructuring that would have diluted its voting power.  After a lower court decision largely favoring IAC, the two now have settled their differences, and Liberty's spin-off of four businesses, including Ticketmaster, LendingTree and home-shopping network HSN, will go forward.  The businesses will have a single-tier voting structure, as IAC wanted, and Liberty will have the right to appoint 20% of the directors.  IAC will keep its Internet businesses, including Ask.com and Match.com.  WSJ, Liberty Media Ends Its Opposition to IAC Spinoffs.

Icahn Purchases Yahoo Stock and Considers Proxy Contest

Carl Icahn reportedly has purchased about 50 million shares of Yahoo stock since Microsoft withdrew its bid and is trying to decide whether to launch a proxy campaign to replace some or all of the directors at the upcoming July 3 shareholders' meeting.  Yahoo's deadline for board nominations is Thursday.  WSJ, Icahn Enters Microsoft-Yahoo Fray.

SEC Settles Manipulation Charges in OTC BB Stock

The United States District Court for the District of Columbia entered a Final Judgment of permanent injunction and other relief, including a bar against participating in offerings of penny stocks, against Jeffrey A. Hayden on May 7, 2008. Without admitting or denying the Commission's allegations, Hayden consented to the entry of the Final Judgment. The judgment settles the Commission's claims against Hayden in a civil action filed on August 16, 2007, in which the Commission alleged that Hayden had participated in a fraudulent scheme to manipulate the stock price of Nationwide Capital Corporation, a now-defunct company whose shares traded on the Over-the-Counter Bulletin Board.  The SEC alleged that, in August and September 2002, Hayden and others carried out a scheme to manipulate the price of Nationwide's stock that artificially inflated Nationwide's stock price from pennies to $9.35 per share. The scheme collapsed on October 1, 2002, when the SEC suspended trading in Nationwide securities.

Hayden was liable for disgorgement of $290,798, together with prejudgment interest of $116,330, but payment of these amounts was waived based upon Hayden's sworn Statement of Financial Condition. A civil penalty was not imposed for the same reason.

SEC Settles Insider Trading Charges Involving U.S. Foodservice

The SEC settled insider trading charges against John Turchetta of Naples, Florida. The complaint alleges that Turchetta purchased securities of U.S. Foodservice (USF) after he acquired material, nonpublic information concerning a proposed tender offer by Royal Ahold (Koninklijke Ahold N.V.) for the outstanding shares of USF common stock. Turchetta received the inside information from a USF vendor, who had been tipped by a senior officer of the company.

Turchetta has agreed to settle the Commission's action, without admitting or denying the allegations in the complaint. The final judgment orders Turchetta to pay disgorgement of $553,000 plus prejudgment interest thereon in the amount of $162,069, as well as a civil penalty of $553,000, for a total of $1,268,069. The settlement is subject to approval by the Court.

SEC Settles Fraud Charges Against Former U.S. Foodservice VP

The SEC settled charges against Brian Spears, a former Vice President of Purchasing at U.S. Foodservice (USF). The SEC alleged that Spears and others at USF, then a subsidiary of Royal Ahold (Koninklijke Ahold N.V.) (Ahold), engaged in a large-scale fraud that, for fiscal years 2001 and 2002, materially overstated operating income by an aggregate amount of approximately $700 million.

The Commission's complaint further alleged that Spears and others at USF induced third parties to confirm false information to USF's outside auditors. Spears and others at USF did this to make it falsely appear that amounts recorded on USF's books and records as accounts receivable were earned. As alleged in the complaint, Spears called vendors at USF's 2001 fiscal year-end and 2002 fiscal year-end and worked with others at USF to convince the vendors to sign the confirmation letters and return them to USF's auditors.

Spears has agreed to settle the Commission's action, without admitting or denying the allegations in the complaint. The final judgment orders disgorgement of $45,000 and prejudgment interest thereon in the amount of $15,547, but waives payment of all disgorgement and prejudgment interest and does not impose a civil penalty, based on the sworn representations in Spears' Statement of Financial Condition and other documents and information submitted to the Commission. The final judgment also bars Spears from serving as an officer or director of a public company for five years. The settlement is subject to approval by the Court.

SEC Investigates Wachovia's ARS Practices

Wachovia disclosed that the SEC and other regulators are seeking information about the underwriting, sale, and auctions of municipal auction-rate securities and auction-rate preferred securities.  In addition, a lawsuit was filed in March in New York by customers who purchased ARS alleging misrepresentations about the quality and risk of the securities.  Wachovia's CEO said the company hired a consultant to review its financial controls and risk management practices.  NYTimes, Wachovia Faces S.E.C. Inquiry Over Auction-Rate Securities.

Exxon Urges Investors to Reject Corporate Governance Proposal

Exxon Mobile asked its institutional investors to reject a shareholder's proposal, introduced by activist shareholder Robert A.G. Monks, to separate the positions of CEO and Chair at the May 28 shareholders' meeting.  The resolution received 40% of the vote at last year's meeting and is supported by some influential shareholders, including members of the Rockefeller family.  In emails, Exxon said that there is no "one size fits all" model of corporate governance.  WSJ, Exxon Email Opposes Shareholder Measure.

Broker Sentenced in First Criminal Case Against Hedge Fund for Market-Timing

Beacon Rock Capital LLC ("Beacon Rock"), a hedge fund located in Portland, Oregon, and Thomas J. Gerbasio ("Gerbasio"), a former registered representative with a registered broker-dealer based in Philadelphia, have been sentenced in connection with the first U.S. criminal case brought against a hedge fund for deceptive market timing. On May 7, 2008, the United States District Court for the Eastern District of Pennsylvania sentenced Gerbasio to one year and one day in prison, two years of supervised release, and ordered him to pay a fine of $7,500. The Judge further sentenced Beacon Rock to three years of probation, and ordered the hedge fund to forfeit $475,905 and to pay a fine of $600,000.

The criminal action began with an Information filed on March 20, 2007, by the U.S. Attorney for the Eastern District of Pennsylvania, charging Beacon Rock and Gerbasio with securities fraud. According to the Information, from December 1999 through November 2003, Gerbasio, while associated with two brokers registered with the Commission, provided brokerage services to Beacon Rock. The Information charged that the primary purpose of this relationship was to permit Beacon Rock, whose primary trading strategies involved market timing, to evade and circumvent controls implemented by mutual funds seeking to restrict market timing or other excessive trading. Gerbasio and others at his direction, engaged in a number of deceptive and fraudulent practices designed to conceal the identity of Beacon Rock and the nature of its trading activity, resulting in more than 26,000 Beacon Rock market timing trades. The U.S. Attorney charged Beacon Rock and Gerbasio with, and the defendants pled guilty to, securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §78j(b)] and Rule 10b-5 thereunder [17 C.F.R. 240.10b-5].

Greenberg Calls for Postponement of AIG Annual Meeting

Maurice Greenberg, who was forced out as AIG's CEO after an accounting scandal and who remains CEO of AIG's largest shareholder, C.V. Starr & Co., filed a 13D with the SEC, stating that AIG is "in crisis" and calling for a postponement of the annual meeting scheduled for this week.  Last week AIG announced a first quarter net loss of $7.81 billion, the largest loss in the company's history. 

Banks Agree to Fund Clear Channel Buyout at Reduced Price

A settlement is imminent between Wall St. banks and Thomas H. Lee Partners and Bain Capital, the two private equity firms that agreed to buy out Clear Channel Communications.  The buyers sued the banks to force them to fund the deal.  Under the settlement, the banks would fund the deal at $36 per share, down from the previously agreed $39.20.  WSJ, Settlement in Clear Channel Case Imminent.

Principles for Distribution of Structured Products to Individual Investors Released

Five leading trade associations, co-sponsors of the Joint Associations Committee (JAC), today released an exposure draft of “Structured Products: Principles for Managing the Distributor-Individual Investor Relationship.” The global, non-binding, Principles address a wide range of issues affecting distribution of structured products to individual investors and reflect "collective industry expectations of integrity, professionalism, and ethical conduct in the retail structured products market,” according to Timothy Hailes, managing director and associate general counsel at JPMorgan Chase in London who is Chairman of the joint-associations working group that developed the Principles.

The Principles are the product of a coalition of trade associations that form the JAC, which comprises:  European Securitisation Forum (ESF), International Capital Market Association (ICMA), London Investment Banking Association (LIBA), the International Swaps and Derivatives Association (ISDA®) and SIFMA.  The principles were based on extensive work and collaboration with the associations’ member firms, and on consultation with distributor associations.  The JAC invites public comments on the Principles until June 16, 2008. 

Hedge Fund Manager Settles Insider Trading Charges

The SEC announced that on May 8, 2008, the Massachusetts federal district court entered final judgments by consent against the remaining defendants in an insider trading case arising out of Rhode Island-based Citizens Bank's May 4, 2004 announcement that it was acquiring Charter One Financial, Inc., a Cleveland-based bank. The settling parties are former hedge fund manager, Michael K.C. Tom of Waltham, Massachusetts, former Burlington, Massachusetts-based investment adviser, Global Time Capital Management, LLC, and former Burlington, Massachusetts-based hedge fund, GTC Growth Fund, L.P..  The SEC alleged that a then-Citizens employee conveyed certain material, non-public information relating to Citizens' planned acquisition to Global Time Capital Management portfolio manager Michael Tom, a former Citizens employee who ran the GTC Growth Fund. The complaint further alleged that between April 29, 2004 and May 4, 2004, Michael Tom purchased numerous Charter One call options, for his personal account and for the GTC Growth Fund. In addition, Michael Tom traded Charter One securities prior to Citizens' announcement in a joint account he held with his wife and in accounts he managed for his wife and in-laws. Michael Tom also tipped his brother about Citizen's acquisition plan. According to the complaint, Michael Tom's illegal insider trading in Charter One securities resulted in total profits of approximately $743,505.

Michael Tom and Global Time Capital Management, without admitting or denying the allegations contained in the Commission's complaint, each consented to the entry of final judgments against them and permanent injunctions against future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Michael Tom also agreed to pay disgorgement of $543,875.07 plus prejudgment interest of $107,381.63, and a civil money penalty of $150,000. Global Time Capital Management has agreed to pay a civil money penalty of $39,056.93. Relief defendant GTC Growth Fund has agreed to pay disgorgement of $189,868.39 plus prejudgment interest of $23,145.67.

SEC Charges Three Florida Doctors with Insider Trading

The SEC filed a civil action in the United States District Court for the Southern District of Florida charging three doctors, Dr. Zachariah P. Zachariah (Zachariah), Dr. Mammen P. Zachariah (M. Zachariah), and Dr. Sheldon Nassberg, with illegal insider trading from which they reaped a total of more than a half-million dollars in profits. All three defendants reside and practice medicine in the Ft. Lauderdale, Florida area.

The SEC alleges illegal trading in the shares of two unrelated companies. In the first, the complaint alleges that Zachariah, shortly after being appointed to serve as a company director, learned that IVAX's then-chairman and CEO had agreed with the then-CEO of Teva Pharmaceuticals Ltd. on preliminary terms for Teva to acquire IVAX and placed the first of four separate IVAX stock purchase orders that he made in his online brokerage account that day. Zachariah purchased 35,000 shares of IVAX stock at a cost of approximately $730,000.  The SEC further alleges that Zachariah later tipped his brother, M. Zachariah, who purchased 2,000 shares of IVAX stock at a total cost of approximately $46,000 on the last trading day before IVAX announced on July 25, 2005 that Teva would acquire it.

In addition, according to the SEC's complaint, Zachariah also misappropriated material, non-public information about Sarasota, Fla.-based Correctional Services Corporation, which operated correctional and detention facilities.  The SEC's complaint alleges that from May through July 2005, Zachariah bought over $200,000 worth of Correctional shares and his brother and close friend, Nassberg, each made multiple purchases of Correctional stock in the week leading up to a public announcement on July 14, 2005, by The GEO Group, Inc., that it would acquire Correctional. Zachariah was a GEO consultant. The complaint seeks a judgment against all defendants providing for injunctions, disgorgement of their ill-gotten gains with prejudgment interest, and civil money penalties. The complaint also seeks an order prohibiting Zachariah from serving as an officer or director of a public company.

Cablevision Set to Acquire Newsday

The Dolan family, who failed in its effort to take Cablevision private last year, seems to have prevailed with its $650 million bid for the Long Island newspaper, Newsday, after Rupert Murdoch pulled the News Co's $580 million bid and said it would not raise its price.  Cablevision consists of the cable company and a mix of sports and entertainment businesses, including Madison Square Garden, the Knicks and the Rangers.  Sam Zell, who controls the Newsday's parent company Tribune after taking its private last year, needs to sell assets to pay down the debt from the LBO.  Analysts view Cablevision's acquisition of the newspaper with skepticism, saying shareholders would be better off if the company repurchased its shares.  NYTimes, Cablevision Offer Baffles Wall Street (Again); WSJ, Cablevision Closes In On Deal for Newsday.

Mitchell on Morals of the Marketplace

The Morals of the Marketplace, by LAWRENCE E. MITCHELL, George Washington University - Law School, was recently posted on SSRN.  Here is the abstract:

This brief essay explores the economic and social legitimacy of modern financial markets, with particular attention to the relationship between risk and responsibility. Using the markets for corporate common stock and mortgaged-backed securities as illustrations, and modern portfolio theory as its theoretical base, it raises questions about the links between capital markets and the real economy, and their effects upon each other. It concludes that capital markets largely have become disconnected from the real economy and have created a context in which finance finances finance rather than production.

This theoretical essay introduces a larger empirical project in progress in which I am attempting to understand in detail and nuance the relationships between capital markets and the formation of productive capital.

Heminway on SOX and Ethics

Does Sarbanes-Oxley Foster the Existence of Ethical Executive Role Models in the Corporation?, by JOAN MACLEOD HEMINWAY, University of Tennessee College of Law, was recently posted on SSRN.  Here is the abstract:

If compliance with, or the efficacy of, Sarbanes-Oxley and other corporate governance initiatives requires that executives (or other firm leaders) be good ethical role models, then it is important to ask whether Sarbanes-Oxley - or any other attribute of existing corporate governance regulation - in fact promotes or permits the production or preservation of ethical role models in the executive ranks of public companies. An absence of support for ethical role models in public companies may signal the failure of broad-based federal corporate governance initiatives like Sarbanes-Oxley.

This Article assumes that ethical roles models may be important to the maintenance of good corporate governance (in general) and the success of Sarbanes-Oxley as a corporate governance initiative (in specific). With that in mind, the Article preliminarily analyzes, using legal and social sciences literature, whether Sarbanes-Oxley may encourage or discourage the existence of ethical role models in the corporation.

Bartlett on Going Private

Going Private But Staying Public: Reexamining the Effect of Sarbanes-Oxley on Firms' Going-Private Decisions, by ROBERT P. BARTLETT III, University of Georgia Law School, was recently posted on SSRN.  Here is the abstract:

This article examines whether the cost of complying with the Sarbanes-Oxley Act of 2002 (SOX) contributed to the rise in going-private transactions after its enactment. Prior studies of this issue generally suffer from a mistaken assumption that by going private, a publicly-traded firm necessarily immunizes itself from SOX. In actuality, the need to finance a going-private transaction often requires firms to issue high-yield debt securities that subject the surviving firm to SEC-reporting obligations and, as a consequence, most of the substantive provisions of SOX. This paper thus explores a previously unexamined natural experiment: To the extent SOX contributed to the rise in going-private transactions, one should observe after 2002 a transition away from high-yield debt in the financing of going-private transactions towards other forms of SOX-free finance.

Using a unique dataset of going-private transactions, this paper examines the financing decisions of 468 going-private transactions occurring in the eight year period surrounding the enactment of SOX. Although SOX-free forms of subordinated debt-financing were widely available during this period, I find no significant change in the overall rate at which firms used high-yield debt in structuring going-private transactions after SOX was enacted. Cross-sectional analysis, however, reveals that the use of high-yield financing marginally declined after 2002 for small- and medium-sized transactions, while significantly increasing for large-sized transactions. These findings are consistent with the hypothesis that the costs of SOX have disproportionately burdened small firms. They also strongly suggest that non-SOX factors were the primary impetus for the name brand buyouts commonly evoked as evidence that SOX has harmed the competitiveness of U.S. capital markets.

Karmel on SROs as Government Agencies

Should Securities Industry Self-Regulatory Organizations be Considered Government Agencies?, by ROBERTA S. KARMEL, Brooklyn Law School, was recently posted on SSRN.  Here is the abstract:

Securities industry self-regulatory organizations (SROs) began as private sector membership organizations of securities industry professionals. This article addresses the questions of whether, and to what extent, securities industry SROs have become government agencies, and whether, and to what extent, they should be subject to constitutional and statutory controls on government agencies. It focuses principally on the Financial Industry Regulatory Agency (FINRA), a new entity which combined the National Association of Securities Dealers, Inc. (NASD) and the member regulation functions of NYSE Group, Inc. (NYSE).

The cases addressing these critical issues are contradictory, and generally not based on any overriding constitutional law principles. In some areas, the courts have just stated that an SRO is exercising delegated governmental power. In other areas, the courts have just stated that an SRO is a private membership organization. Sometimes, courts have distinguished between the commercial and regulatory functions of SROs, in order to draw lines separating the laws applicable to government agencies from private sector organizations.

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 should not be held to be a government entity. This conclusion may be surprising to scholars and lawyers who have not considered the implications of changed SRO governance. Nevertheless, when FINRA is exercising investigative and disciplinary functions it should be treated like a government agency. Furthermore, to the extent practicable FINRA should operate according to transparency standards applicable to government bodies. Striking the right balance between private sector flexibility and constitutional and administrative law protections is critical to the future operation of FINRA and other securities industry SROs.

Krawiec on Risk Management

Operational Risk Management: An Emergent Industry, by KIMBERLY D. KRAWIEC, University of North Carolina at Chapel Hill - School of Law, was recently posted on SSRN.  Here is the abstract:

Financial institutions have always been exposed to operational risk - the risk of loss from faulty internal controls, human error or misconduct, external events, or legal liability. Only in the past decade, however, has operational risk risen to claim a central role in risk management within financial institutions, taking its place alongside market and credit risk as a hazard that financial institutions, regulators, and academics seriously study, model, and attempt to control and quantify. This newfound prominence is reflected in the Basel II capital accord, in numerous books and articles on operational risk, and in the emergence of a rapidly expanding operational risk management profession that is expected to grow at a compound annual rate of 5.5%, from US$992 million in 2006 to US$1.16 billion in 2009.

This increased emphasis on operational risk management corresponds to a much wider trend of responsive or enforced self- regulation, both in the United States and internationally, that attaches significant importance to the internal control and compliance mechanisms of business and financial institutions. Driven by legal changes and well-organized compliance industries that include lawyers, accountants, consultants, in-house compliance and human resources personnel, risk management experts, and workplace diversity trainers (hereafter, legal intermediaries), internal compliance expenditures have increased substantially throughout the past decade, assuming an ever-greater role in legal liability determinations and organizational decision-making, and consuming an ever-greater portion of corporate and financial institution budgets.

This chapter situates operational risk management - particularly those components of operational risk related to legal risk and the risk of loss from employee misconduct - within the broader literature on enforced self-regulation, internal controls, and compliance, arguing that the increased focus on operational risk management portends both positive and negative effects. On the one hand, business and financial institutions that are law abiding and avoid unforeseen and unaccounted for disasters are an obvious positive. At the same time, however, all operational risk management is not created equally. Some operational risk expenditures may prove more effective at enhancing the profits or positions of particular firm constituencies and legal intermediaries, or luring regulators and firm stakeholders into a false confidence regarding operational risk management, than at significantly reducing operational risk losses. Indeed, recent rogue trading losses such as those at Société Générale and MF Global Ltd. demonstrate that operational risk measures such as those embraced in Basel II are no substitute for sound firm management and regulatory oversight.