Securities Law Prof Blog

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

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Friday, September 5, 2008

SEC Settles Accounting Fraud Charges Against Retail Pro and Former Officers

The SEC filed securities fraud charges against Retail Pro, Inc. (formerly known as Island Pacific, Inc.), and two former CEOs and a former CFO for their roles in an accounting fraud scheme designed to falsely inflate Island Pacific's revenues. The Commission's lawsuit names Retail Pro, Inc., Barry M. Schechter, Ran H. Furman, and Harvey Braun.  Island Pacific, Schechter, and Braun have agreed to settle the charges.

The complaint alleges that Schechter, the former CEO, Furman, the former CFO, and Braun, another former CEO, caused Island Pacific to improperly record and report $3.9 million in revenue from a barter transaction. As alleged in the complaint, the barter transaction had little economic purpose or business substance aside from manipulating Island Pacific's financial statements. The complaint further alleges that as a result of improperly recognizing and reporting the $3.9 million as revenue, Island Pacific overstated its revenues by 140% for the second quarter of 2004, 29% for the nine months ending the third quarter of 2004, and 22% for the 2004 fiscal year. In addition, Island Pacific reported a small profit instead of a massive loss for the second quarter of 2004. In addition, the complaint alleges that Schechter sold 637,750 shares of Island Pacific stock for more than $1.5 million during the fraudulent scheme.

September 5, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former National Health Trends Officers Settle Securities Fraud Charges

On September 3, 2008, the SEC settled charges that two former officers of Natural Health Trends Corp. ("NHT") committed securities fraud and other violations arising from undisclosed related party transactions from 2001 through 2005. The defendants are Mark D. Woodburn, of Southlake, Texas, NHT's former president, director and CFO, and Terry LaCore, of Flower Mound, Texas, the former president of NHT's chief subsidiary and an NHT director.  According to the complaint, from 2001 through August 2005, NHT's top distributor paid Woodburn and LaCore, directly and indirectly, approximately $2.5 million in undisclosed payments. The complaint also alleges that, in February 2004, Woodburn caused NHT to loan $256,200 to a Woodburn family-controlled company, and later took steps to conceal related party nature of the loan when it was discovered by NHT's new accounting management in the fall of 2004. As a result of Woodburn and LaCore's activities, the complaint continues, NHT failed to disclose, or inadequately disclosed, the related party transactions in periodic filings, registration statements, and proxy statements.

Woodburn and LaCore agreed to settle the SEC's charges without admitting or denying the allegations of the complaint. Each agreed to a permanent injunction and to a five-year officer and director bar. Woodburn agreed to pay a $60,000 civil penalty, and LaCore agreed to pay a $50,000 civil penalty.

September 5, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Publishes Amended Rule Exempting Foreign Private Issuers from Registration

The SEC published the final rule that amends the rule that exempts a foreign private issuer from having to register a class of equity securities under Section 12(g) of the Securities Exchange Act of 1934 ("Exchange Act") based on the submission to the Commission of certain information published by the issuer outside the United States. The exemption allows a foreign private issuer to have its equity securities traded in the U.S. over-the-counter market without registration under Section 12(g). The adopted rule amendments will eliminate the current written application and paper submission requirements under Rule 12g3-2(b) by automatically exempting from Exchange Act Section 12(g) a foreign private issuer that meets specified conditions. Those conditions will require an issuer to maintain a listing of its equity securities in its primary trading market located outside the United States, and require it to publish electronically in English specified non-United States disclosure documents. As a result, the adopted amendments should make it easier for U.S. investors to gain access to a foreign private issuer’s material non-United States disclosure documents and thereby to make better informed decisions regarding whether to invest in that issuer’s equity securities through the over-the-counter market in the United States or otherwise. As is currently the case, issuers must continue to register their securities under the Exchange Act to have them listed on a national securities exchange or traded on the OTC Bulletin Board.

September 5, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Thursday, September 4, 2008

FINRA Disciplines Brokers for Unsuitable Sales of CMOs

FINRAhas barred two brokers from the Boca Raton branch office of the now defunct brokerage firm, SAMCO Financial Services, Inc. - and suspended a third broker for two years - for misconduct in connection with selling complex mortgage-backed securities called Collateralized Mortgage Obligations (CMOs) to retail customers.  In making the announcement, FINRA emphasized that these are its first enforcement actions arising from ongoing investigations into abuses in the marketing and sales of mortgage-backed securities such as CMOs to retail customers. The brokers here failed to fulfill their suitability obligations when they recommended 'inverse floaters' to retail customers with little or no investment experience.

A CMO is a security that pools together mortgages and issues shares - called "tranches" - with various characteristics and risks. The underlying mortgages serve as the collateral for the CMO and provide principal and interest payments to shareholders.  One of the most volatile and risky CMO tranches is the "inverse floater CMO," a thinly traded mortgage-backed security which is typically highly leveraged and vulnerable to a high degree of price volatility. Rising interest rates reduce the interest earned and also may decrease the principal payments to the investor. The reduction in the repayment of principal extends the maturity date, potentially for as much as 30 years. Furthermore, since each inverse floater is uniquely structured and thinly traded, prices used for valuation purposes are determined using theoretical pricing models. These prices are strictly best estimates of value and can vary substantially from prices obtained through actual bidding or market offerings. As a result, buying inverse floaters on margin further heightens the risk of investing in the product.

Since 1993, FINRA (formerly NASD) has published warnings that inverse floaters are suitable only for sophisticated investors willing to take on high levels of risk.

September 4, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Former KBR CEO Settles FCPA Charges with SEC

The SEC charged former KBR executive Albert Jackson Stanley with violating the anti-bribery provisions of the Foreign Corrupt Practices Act (FCPA) and related provisions of the federal securities laws. The Commission alleges that over a ten-year period, Stanley and others participated in a scheme to bribe Nigerian government officials in order to obtain construction contracts worth more than $6 billion. The contracts were awarded to a four-company joint venture of which The M.W. Kellogg Company, and later KBR, was a member.  The Commission alleges that beginning as early as 1994, Stanley and other members of the joint venture determined that it was necessary to pay bribes to individuals within the Nigerian government in order to obtain contracts to build liquefied natural gas facilities (LNG Trains) in Bonny Island, Nigeria. Stanley and others met with high-ranking Nigerian government officials and their representatives on at least four occasions to arrange the bribe payments. To conceal the illicit payments, Stanley and others approved entering into sham contracts with two "agents" to funnel money to the Nigerian officials. Thereafter, as the joint venture was paid for its work building the LNG Trains, the joint venture paid the agents over $180 million. In turn, substantial payments were made to various Nigerian government officials.

Without admitting or denying the allegations in the complaint, Stanley has consented to the entry of a final judgment that permanently enjoins him from violating the anti-bribery, record-keeping and internal control provisions of Securities Exchange Act of 1934 (Sections 30A and 13(b)(5) and Rule 13b2-1). Stanley has also agreed to cooperate with the SEC's ongoing investigation. The proposed settlement with Stanley is subject to the court's approval.

In a related criminal proceeding announced today, the United States Department of Justice filed criminal charges against Stanley for conspiring to violate the FCPA and conspiring to commit mail and wire fraud. Stanley has pleaded guilty to one count of conspiring to violate the FCPA and one count of conspiring to commit mail and wire fraud (unrelated to the FCPA charge). He faces seven years in prison and payment of $10.8 million in restitution.

September 4, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, September 3, 2008

Tracinda Settles Charges It Violated Section 13(d) in Sales of GM Stock

The SEC instituted proceedings against Tracinda Corporation for violations of the reporting provisions of Section 13(d) of the Securities Exchange Act of 1934 concerning its plan and proposal to sell General Motors shares in 2006. Simultaneously with the institution of the proceedings, Tracinda, without admitting or denying the findings in the order, consented to the entry of an SEC cease-and-desist order.

According to the order, on Nov. 16, 2006, Kirk Kerkorian, the sole shareholder and director of Tracinda, met with his advisors to discuss Tracinda's significant investment in GM. In that meeting, Tracinda's key advisor expressed his view that the price of GM stock would likely fall in the future. This led to a discussion as to whether Tracinda should sell half (28 million shares) of its GM holdings.  The order further finds that, on Nov. 20, 2006, Tracinda offered to sell 28 million shares of GM stock to a broker-dealer. That firm was willing to buy 28 million shares, but only at a significant discount to the then-current market price. Tracinda was not willing to sell at that price at that time but requested a bid on 14 million shares. The price was higher for 14 million shares and Tracinda executed the transaction that day. Subsequently, on Nov. 28, 2006, Tracinda sold an additional 14 million shares of GM to another broker-dealer.

On Nov. 22, 2006, Tracinda filed an amendment to its Schedule 13D announcing the sale of 14 million shares of GM stock. In that filing, Tracinda did not disclose that it had a plan to sell half of the GM shares it owned or that it had made a proposal to sell 28 million GM shares. Tracinda violated Section 13(d)(2) of the Exchange Act and Rule 13d-2(a) thereunder, because the amendment that was filed did not disclose the plan and proposal to sell 28 million shares of GM stock and no other amendment was promptly filed to disclose this material change to a previously filed Schedule 13D. In addition, according to the SEC, that amendment was materially misleading because it stated that Tracinda might purchase or sell more GM stock, when there was only a remote possibility that it would buy any GM stock at that time

September 3, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Expels Broker Dealer for Illegal Sales of Unregistered Penny Stocks

FINRA expelled Barron Moore, Inc. and took disciplinary action against seven individuals for violations arising from the illegal sale of unregistered penny stocks. Those sanctions range from fines and suspensions to permanent bars from the securities industry.  The individuals include five registered representatives formerly associated with three different firms — Barron Moore, Midas Securities LLC and Milestone Group Management, which is no longer in business — and supervisors from Barron Moore and Milestone. One registered representative was barred for failing to provide documents and testimony in FINRA's investigation.

FINRA found that four of the registered representatives sold large quantities of unregistered stock into the public markets on behalf of customers; neither the representatives nor the supervisors took appropriate steps to determine whether the securities could be sold without violating the registration requirements of the federal securities laws. FINRA found that this conduct occurred despite the presence of numerous red flags indicating that illegal stock distributions might be taking place.

FINRA found that Barron Moore sold more than 6.75 million shares of unregistered stock of three companies, on behalf of seven customers, resulting in unlawful proceeds of more than $975,000. Barron Moore opened accounts for numerous customers who repeatedly deposited large numbers of unregistered shares of thinly-traded securities into those accounts, sold those securities and then wired the proceeds out of the accounts.  FINRA also found that Barron Moore and Katherine Moore failed to develop and implement a reasonable anti-money laundering compliance program, and failed to detect and report suspicious activities by a convicted money launderer as well as in accounts ostensibly controlled by a 20-year-old who washed and detailed the cars of Barron Moore employees.

In settling these matters, Barron Moore, Katherine Moore, Lankford, Centeno, Santohigashi, and Kassar neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

September 3, 2008 in Other Regulatory Action | Permalink | Comments (1) | TrackBack (0)

SEC Charges Two Brokers with Subprime ARS Fraud

The SEC charged two Wall Street brokers, Julian Tzolov and Eric Butler, with defrauding their customers when making more than $1 billion in unauthorized purchases of subprime-related auction rate securities. The SEC alleges that Tzolov and Butler misled customers into believing that auction rate securities being purchased in their accounts were backed by federally guaranteed student loans and were a safe and liquid alternative to bank deposits or money market funds. Instead, the securities that Tzolov and Butler purchased for their customers were backed by subprime mortgages, collateralized debt obligations (CDOs), and other non-student loan collateral.

The SEC's complaint, filed in federal court in Manhattan, alleges that Tzolov and Butler, while employed at Credit Suisse Securities (USA) LLC in New York, deceived foreign corporate customers in short-term cash management accounts by sending or directing their sales assistants to send e-mail confirmations in which the terms "St. Loan" or "Education" were added to the names of non-student loan securities purchased for the customers. Tzolov and Butler also routinely deleted references to "CDO" or "Mortgage" from the names of the securities in these e-mails. As a result, the complaint alleges that customers were stuck holding more than $800 million in illiquid securities after auctions for auction rate securities began to fail in August 2007. Those holdings have since significantly declined in value.

The Commission charges Tzolov and Butler with securities fraud in violation of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The Commission seeks permanent injunctive relief, disgorgement of ill-gotten gains, if any, plus prejudgment interest on a joint and several basis, and civil money penalties.

September 3, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, September 2, 2008

SEC Announces Third Seniors Summit

The SEC announced its Third Annual Seniors Summit, which will focus on helping older investors make difficult decisions about their finances and learn new ways to protect their assets as they age.  It will be held on September 22.

Chairman Cox said the event will not only help educate senior citizen investors and their families, but also the investment advisers or brokers who serve them. An afternoon session tailored to financial services professionals will unveil new practices that firms use when advising senior investors, including those with diminishing capacity. The morning session, geared toward senior attendees, will present tips and advice to help senior investors ensure their money is protected and used as desired after they retire or in the event of illness or incapacity.

September 2, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, September 1, 2008

Nagareda in Class Certification

Class Certification in the Age of Aggregate Proof, by Richard A. Nagareda, Vanderbilt University School of Law, was recently posted on SSRN.  Here is the abstract:

Few pre-trial motions in our civil justice system elicit as much controversy as those for the certification of class actions. This Article offers the first account in the literature of the challenges faced today by courts in light of an important series of federal appellate decisions that direct the courts to resolve competing expert submissions on the class certification question in the pre-trial stage - even when the dispute overlaps with the merits of the litigation - in the course of determining the application of Rule 23.

Across broad swaths of class action litigation today, proponents of class certification invoke aggregate proof - evidence, typically of an economic or statistical nature, that presupposes the cohesiveness of the aggregate unit for litigation and, from that perspective, seeks to reveal quantitatively a common wrong attributable to the defendant. Debates over the proper role of aggregate proof unite what otherwise might seem disparate disputes over class certification today across securities, antitrust, RICO, consumer fraud, and employment discrimination litigation. Too often, however, courts have taken at face value the evidentiary form that aggregate proof assumes in class certification.

This Article urges a new conceptualization of the challenges facing courts in class certification today. The real question about aggregate proof in class certification is not one that speaks to the relationship between the court and the fact finder in the (usually, purely hypothetical) event of a class-wide trial. Rather, the institutional relationship that really matters is the one between the court and the legislature as expositors of governing law. Properly understood, aggregate proof offers not so much a contested view of the facts but, more fundamentally, a contested account of governing law - one eminently suited for judicial resolution and appellate correction de novo, without concern about possible intrusion into the role of the fact finder.

This Article exposes how renewed attention to the judicial role to say what the law is can lend coherence to the law of class certification, offering the first extended assessment of such controversial recent litigation as the civil RICO class action against the tobacco industry concerning its marketing of light cigarettes and the largest employment discrimination class action in history against Wal-Mart concerning the pay and promotion of its hourly female employees. The Article concludes by relating the analysis of class certification to larger changes in the civil justice system to grapple with the reality of settlement, rather than trial, as the endgame of litigation.

September 1, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Kahan & Rock on Bear Stearns and Delaware Courts

How to Prevent Hard Cases from Making Bad Law: Bear Stearns, Delaware and the Strategic Use of Comity, by Marcel Kahan, New York University - School of Law, and Edward B. Rock, University of Pennsylvania Law School, was recently posted on SSRN.  Here is the abstract:

The Bear Stearns/JP Morgan Chase merger placed Delaware between a rock and a hard place. On the one hand, the deal's unprecedented deal protection measures - especially the 39.5% share exchange agreement - were probably invalid under current Delaware doctrine because they rendered the Bear Stearns shareholders' approval rights entirely illusory. On the other hand, if a Delaware court were to enjoin a deal pushed by the Federal Reserve and the Treasury and arguably necessary to prevent a collapse of the international financial system, it would invite just the sort of federal intervention that would undermine Delaware's role as the de facto provider of U.S. corporate law.

Faced with a choice between undermining the delicate and subtle balance struck between managers and shareholders and standing in the way of the imperatives of national and international economic policy, Delaware found a third way that avoided both horns of the dilemma: it took advantage of a pending New York action to stay the Delaware action and avoid making any decision at all. In this article, we tell this story, analyzing the doctrinal issues under Delaware corporate and procedural law, and discussing the implications of this episode for our understanding of the landscape of US corporate law making.

September 1, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Manns on Rating Credit Risk

Rating Risk after the Subprime Mortgage Crisis: A User Fee Approach for Rating Agency Accountability, by Jeffrey Manns, Latham & Watkins, was recently posted on SSRN.  Here is the abstract:

This article argues that rating agencies succumbed to temptations to compromise their role as screeners of credit risk due to an absence of accountability, which paved the way for the subprime mortgage crisis. It will suggest how enlisting the purchasers of debt issues, the primary beneficiaries of ratings, as self-interested monitors of rating agencies may help to heighten rating agency accountability in the future. The combination of rating agency autonomy and interconnections of interests with their clients, issuers of debt, led rating agencies to provide false assurances on the risk exposure of subprime mortgage collateralized debt obligations (CDOs). Purchasers of subprime mortgage CDOs suffered significant losses due in part to their reliance on inaccurate ratings, yet lacked any means to hold rating agencies accountable. For this reason, the article suggests how creditors may bear both the burdens and benefits of rating agency accountability by financing ratings through an SEC-administered user fee system in exchange for enforceable rights. This innovative approach would create a principal-agent relationship between the beneficiaries of screening roles and gatekeepers. It will show how subjecting certification and mandatory reporting duties to creditors to a gross negligence standard and an earnings-based cap on liability exposure will create incentives for rating agency compliance, yet pose a manageable burden.

September 1, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)