Securities Law Prof Blog

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

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Tuesday, September 16, 2008

SEC Charges Attorney in Bogus PIPES Scheme

The SEC charged an attorney and two other promoters for conducting a $52.7 million Ponzi scheme in which they sold investors bogus PIPE (private investment in public equity) investments, promised unrealistic profits, and misappropriated more than $20 million of investors' funds to function as their own personal piggy bank.  The SEC's complaint alleges that attorney Jeanne M. Rowzee, James R. Halstead, and Robert T. Harvey told investors that Rowzee was an experienced securities attorney who personally screened and selected each PIPE investment after thorough due diligence. However, they did not place investor funds in PIPE investments, but instead used new investor funds to pay principal and returns to earlier investors, and to finance their own personal endeavors.

The SEC's complaint, filed in federal court in Santa Ana, Calif., alleges that from at least March 2004 through December 2006, the defendants sold the purported PIPE investments to investors, promising returns of 19 to 54 percent within 12 to 16 weeks. The complaint seeks permanent injunctions, disgorgement of ill-gotten gains, and civil penalties against each defendant.

September 16, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former Apple GC Suspended from SEC Practice under Rule 102(e)

The SEC issued an Order Instituting Administrative Proceedings Pursuant to Rule 102(e) of the Commission's Rules of Practice, Making Findings and Imposing Remedial Sanctions (Order) against former Apple GC Nancy R. Heinen. Previously the SEC filed a lawsuit against Heinen in connection with the backdating of Apple stock, which resulted in a court order permanently enjoining Heinen, by consent, from future securities law violations. In addition, the court order required Heinen to pay disgorgement of $1,575,000 (representing the in-the-money portion of the proceeds she received from exercising backdated options) plus $400,219.78 in interest, and a $200,000 civil penalty.

Based on the above, the Order suspends Heinen, effective immediately, from appearing or practicing before the Commission as an attorney for three (3) years. Heinen consented to the issuance of the Order without admitting or denying any of the findings in the Order.

September 16, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Investment Adviser Censured for Reg M Violations

The SEC issued an Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order Pursuant to Section 21C of the Securities Exchange Act of 1934 and Section 203(e) of the Investment Advisers Act of 1940 (Order) against Moon Capital Management, LP (Moon Capital). The Order finds that Moon Capital participated in an offering in May 2005, in which it sold securities short during the restricted period before the pricing of the offering and then covered its short positions with securities purchased in the offering. These transactions violated Rule 105 of Regulation M and allowed Moon Capital to earn profits of $88,100 for the fund it advised.  The Order censures Moon Capital, requires it to cease-and-desist from committing or causing any violations, and any future violations, of Rule 105 of Regulation M, requires Moon Capital to disgorge $88,100 plus prejudgment interest of $20,971.67 and pay a $30,000 civil money penalty. Moon Capital consented to the issuance of the Order without admitting or denying any of the Commission's findings

September 16, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Investment Adviser for Misrepresenting Value of Clients' Investments

The SEC charged investment adviser Cornerstone Capital Management, Inc. for misrepresenting the value of its clients' investments in what turned out to be a series of Ponzi schemes.  In an order instituting administrative proceedings against the firm and its president, Laura J. Kent, the SEC alleges that, despite knowing that certain programs in which they had invested approximately $15 million of their clients' funds turned out to be scams, Cornerstone and Kent continued to assure their clients that the investments retained their full value. Even after the principals behind some of those investments were convicted of criminal fraud, Kent continued to charge an assets-under-management fee based on the original cost of the failed investments, collecting more than a half-million dollars in inflated fees from her clients.

The Division of Enforcement seeks a cease-and-desist order, recovery of ill-gotten fees, and other remedial actions. An administrative hearing will be scheduled to determine whether remedial actions are appropriate.

September 16, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, September 15, 2008

FINRA Investor Alert on Lehman Brokerage Accounts

A FINRA Investor Alert, If A Brokerage Firm Closes Its Doors, reminds that

the firm's U.S. regulated broker-dealer subsidiaries, Lehman Brothers, Inc. and Neuberger Berman, LLC, are still solvent and functioning. The broker-dealer subsidiaries have not filed for bankruptcy, and are expected to close only after the orderly transfer of customer accounts to another registered and SIPC-insured broker-dealer.

September 15, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Regulator Blocks Severance Pay to Former Freddie and Fannie CEOs

The recently-created Federal Housing Finance Agency applied a rule adopted just last week and blocked payment of an estimated $24 million in severance pay to the former CEOs of Fannnie Mae and Freddie Mack.  CFO.com, Feds Snip Fannie, Freddie Parachutes.

September 15, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SIFMA's Website on Lehman

SIFMA has set up a useful website devoted to Information on Lehman Bankruptcy and Related Issues, with links to other relevant sites.  There I found an announcement about a group of global commercial and investment banks, including Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Merrill Lynch, Morgan Stanley, and UBS, that initiated a series of actions "to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets."

September 15, 2008 in Professional Announcements | Permalink | Comments (0) | TrackBack (2)

American Italian Pasta Settles Accounting Fraud Charges

The SEC filed several actions charging American Italian Pasta Company ("AIPC"), and its senior executives with securities fraud and other violations of the federal securities laws. The Commission's complaints allege that, from its fiscal year 2002 through the second quarter of its fiscal year 2004, AIPC, AIPC's former chief executive officer Timothy S. Webster, former chief financial officer Warren B. Schmidgall, and former executive vice president of corporate development and strategy David E. Watson, engaged in a fraudulent scheme to mislead the investing public about the growth of the company's earnings and to increase artificially the company's stock price. According to the Commission's complaints, the fraudulent accounting and other errors arising from inadequate internal controls, resulted in the overstatement of AIPC's pre-tax income for the relevant period by approximately $59 million, or 66 percent.

In a related criminal action, the U.S. Attorney's Office for the Western District of Missouri announced today that it resolved its investigation of AIPC and that Webster and Schmidgall both pled guilty to one count of conspiracy to commit wire fraud for their roles in concealing AIPC's true financial condition and filing materially false reports with the Commission. AIPC agreed to resolve the criminal investigation of the company by paying a $7.5 million monetary penalty.

Without admitting or denying the allegations in the Commission's complaints, AIPC, Webster, and Ruskey agreed to settle the matters. The Commission's case against Schmidgall and Watson is ongoing.

September 15, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former KB Home CEO Settles Backdating Charges

The SEC filed settled civil fraud charges against Bruce E. Karatz, the former chairman and CEO of Los Angeles homebuilder KB Home, Inc., for his participation in a multi-year scheme to backdate stock options to himself and other KB Home officers and employees.  The Commission's complaint, filed in federal court in Los Angeles, alleges that from at least 1999 through 2005, Karatz enriched himself and others at KB Home by using hindsight to pick advantageous grant dates for KB Home's annual stock option grants. The complaint alleges that Karatz continued to use hindsight for stock option grant dates even after the Sarbanes-Oxley Act of 2002 imposed stricter reporting requirements on officers of public companies. Karatz received backdated annual stock option awards amounting to 2,860,000 shares of KB Home stock and profited more than $6 million from exercising many of these options.

Karatz agreed to settle the Commission's charges without admitting or denying the allegations in the complaint. Under the settlement, Karatz is required to pay $6,714,819.27 in disgorgement and interest and a civil penalty of $480,000 and is barred from serving as an officer or director of a public company for five years.

September 15, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Begins Voluntary Online Filings of Form D

The SEC began accepting filings of Form D through the Internet.  The new rules providing for online filing and simplification of Form D notices were approved by Commission at the end of last year. Form D filings are made mostly by smaller companies and notify the SEC of sales of securities in private and certain other non-registered offerings of securities. Many states also require Form D notice filings.

The SEC's new Form D online filing system is voluntary until March 16, 2009. Companies and funds required to file Form D notices may continue to file them on paper until that date, following either the old or new information requirements. Form D filers are encouraged to use the voluntary system and inform SEC staff about their experiences. The SEC staff is also working with the North American Securities Administrators Association to link its Form D filing system with a system built by state securities regulators that would accept state Form D filings.

September 15, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Statement on Lehman Bankruptcy Filing

The latest from the SEC on Lehman:

The decision by Lehman Brothers Holdings Inc. to file for protection under Chapter 11 of the bankruptcy laws is expected to lead to the winding down of Lehman Brothers Inc., its U.S. regulated broker-dealer, outside of bankruptcy. The accounts of Lehman’s U.S. retail securities customers are with the broker-dealer. In cases such as this, Lehman Brothers’ customers will benefit from their extensive protections under SEC rules, including segregation of customer securities and cash as well as insurance by the Securities Investor Protection Corporation. These safeguards are designed to ensure that a broker-dealer’s customers will be protected.

In the weeks ahead, SEC staff who have been on-site at the U.S. broker-dealer will remain in place to oversee the orderly transfer of customer assets to one or more SIPC-insured brokerage firms. The holding company bankruptcy filing does not affect in any way the SIPC protection applicable to the firm’s customers.

The SEC is also coordinating with overseas regulators to protect Lehman’s customers and to maintain orderly markets.

September 15, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Bank of America Will Acquire Merrill Lynch

Bank of America Corporation announced it has agreed to acquire Merrill Lynch & Co., Inc. in a $50 billion all-stock transaction. Under terms of the transaction, Bank of America would exchange .8595 shares of Bank of America common stock for each Merrill Lynch common share. The price is 1.8 times stated tangible book value.  The transaction is expected to close in the first quarter of 2009. It has been approved by directors of both companies and is subject to shareholder votes at both companies.

Under the agreement, three directors of Merrill Lynch will join the Bank of America Board of Directors.

By adding Merrill Lynch’s more than 16,000 financial advisers, Bank of America would have the largest brokerage in the world with more than 20,000 advisers and $2.5 trillion in client assets.  After the acquisition, Bank of America would be the number one underwriter of global high yield debt, the third largest underwriter of global equity and the ninth largest adviser on global mergers and acquisitions based on pro forma first half of 2008 results.

September 15, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Lehman Files for Bankruptcy

Lehman Brothers Holdings Inc. (“LBHI”) announced today that it intends to file a petition under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. According to the press release, none of the broker-dealer subsidiaries or other subsidiaries of LBHI will be included in the Chapter 11 filing and all of the broker-dealers will continue to operate.

LBHI is exploring the sale of its broker-dealer operations and is in discussions with a number of potential purchasers to sell its Investment Management Division (“IMD”).

September 15, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC's Announcement about Lehman

The Securities and Exchange Commission announced Sunday evening that, together with the Treasury and the Federal Reserve, it is working with Lehman Brothers to address the issues that it faces. In particular, the SEC is taking actions to ensure that customers of Lehman Brothers Inc., the U.S. regulated broker-dealer subsidiary of Lehman Brothers Holdings Inc., which holds the accounts of Lehman’s U.S. securities customers, will not be adversely affected by recent market events. SEC staff who have been on-site at the U.S. broker-dealer will remain in place in coming weeks. The SEC is also coordinating with overseas regulators to protect Lehman’s customers and to maintain orderly markets.

September 15, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Sunday, September 14, 2008

Thomas on International Executive Pay

International Executive Pay: Current Practices and Future Trends, by Randall S. Thomas, Vanderbilt University - School of Law; Vanderbilt University - Owen Graduate School of Management, was recently posted on SSRN.  Here is the abstract:

This article compares executive pay practices in the U.S. with those employed elsewhere in the world. After providing an overview of current practices, it goes on to analyze whether there is likely to be a convergence of these practices. It first examines the influence of market based factors, such as evolving share ownership patterns, cross-border hiring, transnational mergers and acquisitions, and the growth of multinational enterprises, on the likelihood of convergence occurring. It concludes that these factors point in the direction of increasing convergence in executive pay. Next, the paper discusses the influence of legal regulations, including corporate law, judicial interpretations of fiduciary principles, shareholder voting requirements, restrictions on stock option plans and disclosure rules on comparative executive pay practices. Other legal regimes, such as, tax law, labor law, and "soft" law that might also influence executive compensation are also scrutinized to see how they will affect pay convergence. In its final section, the article considers the effects of culture in several countries and how it impacts compensation levels and practices.

September 14, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Dent on Business Lawyers

Business Lawyers as Enterprise Architects, by George W. Dent Jr., Case Western Reserve Law School, was recently posted on SSRN.  Here is the abstract:

In 1984 Ronald Gilson published Value Creation by Business Lawyers: Legal Skills and Asset Pricing. It began: "What do business lawyers really do? Embarrassingly enough, at a time when lawyers are criticized with increasing frequency as nonproductive actors in the economy, there seems to be no coherent answer." He dismissed lawyers' own answer that "they 'protect' their clients, that they get their clients the 'best' deal." He also rejected the academic literature which offered a laundry list of roles the business lawyer plays: "a counselor, planner, drafter, negotiator, investigator, lobbyist, scapegoat, champion, and, most strikingly, even as a friend." Dissecting the corporate acquisition as his specimen, Gilson concluded that lawyers add value as "transaction cost engineers." In particular, lawyers bridge the parties' divergent expectations about returns on the asset to be transferred by drafting an earnout which makes the price contingent on its returns between the signing of the deal and the closing; and overcome lack of information (principally of the buyer) by arranging efficient production and verification of information. From these findings Gilson also recommended that legal education for business practice downgrade traditional subjects (like analysis of appellate cases and knowledge of relevant regulatory law) in favor of corporate finance and transaction cost economics.

In the succeeding 24 years Gilson and others refined his thesis, but no one fundamentally challenged it. This literature about what corporate lawyers do (the "received model") is too narrow. This article takes a wider and deeper perspective. Part I describes the received model. Part II exposes several problems with that model. Part III offers a fuller vision showing that business lawyers perform a greater range of activities using a larger set of skills than in the received model. Although these activities and skills are extremely varied, it is less accurate to say that business lawyers are transaction cost engineers than that they are enterprise architects. Part IV discusses the implications of this revised model for legal education. It argues that, although a knowledge of corporate finance and transaction cost economics is useful for some business lawyers, it is more important that they understand the obstacles to optimizing the performance of business entities and the contractual mechanisms available to overcome these obstacles. They also need specific behavioral skills, including how to negotiate when all parties are trying to build mutual trust and confidence.

September 14, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Kahn on Delaware's Stake in Corporate Law

Regulatory Competition, Venue and Delaware's Stake in Corporate Law, by Faith Stevelman Kahn, New York Law School, was recently posted on SSRN.  Here is the abstract:

Disagreement persists about the effects of regulatory competition on corporate law, but there's consensus that Delaware's has "won" the race. Most public companies are incorporated in Delaware, and this success yields enormous tax revenue, income for Wilmington's corporate bar and great prestige for the judges on the Court of Chancery and Supreme Court. There are signs that Delaware's future preeminence in corporate law may be threatened, however.

The most obvious threat is external. The burgeoning array of federal statutes, SEC regulations, listing standards and shareholder activists' best practices threaten to eclipse the importance of state corporate law, including Delaware's. Their growing influence might erode out of state managers' incentives to charter in Delaware.

The second threat arises from the growing "interstate travel" of Delaware corporate lawsuits. In sum, venue is heating up as a critical issue for Delaware's control over its crown jewel - its fiduciary case law. Though the internal affairs doctrine makes Delaware (substantive) law "stick" in corporate litigation against Delaware companies and/or their affiliates, it does not limit plaintiffs' venue choices, or provide a meaningful basis for courts or law makers to do so - recent protestations of the Court of Chancery notwithstanding.

Charter and bylaw provisions, judicial doctrine and legislative action all could be employed to limit Delaware corporate shareholders' venue choices. The Article concludes, however, that forcing venue is risky, likely to backfire and to erode the prestige, intellectual coherence and value arising from Delaware's corporate law.

September 14, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Canova on Return to Marginalist Analysis

Legacy of the Clinton Bubble: The Crisis in the Washington Consensus and the Return to Marginalist Analysis, by Timothy A. Canova, Chapman University - School of Law, was recently posted on SSRN.  Here is the abstract:

This article, an early draft of which was published in the summer 2008 issue of Dissent magazine, analyzes the Clinton administration's record of financial deregulation, the continuities in policies between Democratic and Republican administrations, and the relationship between deregulatory policy and market developments in housing, credit and currency markets. Deregulation is examined on several levels: (1) selective credit controls in housing, consumer and stock market sectors, with particular attention to rules on minimum down payments (otherwise known as margin requirements); (2) the regulatory barriers between financial entities, with particular attention to the Glass-Steagall Act firewalls that had separated commercial banking, investment banking, insurance and securities; and (3) the regulation of financial instruments, with particular attention to derivatives. The analysis concludes that all three deregulation trends interacted in ways that undermined that safety and soundness of the entire financial system: deregulation of margin requirements contributed to speculative lending in housing and securities; deregulation of derivatives contributed to the securitization of shaky mortgage loans, particularly in the subprime sector; and the demise of Glass-Steagall permitted banks to load up on such derivatives in off-balance sheet entities.

The deregulation agenda of the Clinton and Bush administrations is placed in the larger context of the Washington Consensus agenda of central bank autonomy, fiscal austerity, privatization, and trade liberalization. The autonomy of the Federal Reserve was a euphemism for agency capture, making margin regulation a political impossibility and leaving the central bank reliant on one and only one monetary policy instrument, the short-term interest rate. This led to a stop-and-go monetary policy that contributed to an ever larger bubble economy. The article raises important questions about the nature of financial regulation. Some scholars, such as Cass Sunstein, reflecting Chicago School thinking, have called for increased disclosure and transparency. The Securities and Exchange Commission's recent decision to abandon Generally Accepted Accounting Principles (GAAP) for the London-based International Financial Reporting Standards (IFRS) gives support to this approach. But the SEC timetable of waiting until 2016 for this move from GAAP to IFRS suggests that disclosure alone is insufficient at a time when many large financial institutions are sitting on mountains of bad debt and would likely be insolvent under IFRS. Canova's approach combines a return to the "command and control" bright line approach of margin requirements with the neutralization of monetary policy and reinvigoration of fiscal policy. The Marginalist school (the pre-Keynesian school which founded economics as a science) is thereby seen as providing the necessary corrective to the excesses of financial deregulation while opening the way to a new Keynesian agenda.

September 14, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Brummer on Corporate Law Preemption

Corporate Law Preemption in an Age of Global Capital Markets, by Chris Brummer, Vanderbilt University - School of Law, was recently posted on SSRN.  Here is the abstract:

At the heart of the extensive literature on corporate law federalism is the belief that federalism engenders regulatory competition and federalization eliminates it. Federalism, a mode of governance where states act as providers of corporate law, is said to drive states to compete for charters. By contrast, federalization, which occurs when the federal government promulgates law, preempts state-level competition. Consequently, scholars who believe that regulatory competition promotes the provision of "good" laws have long railed against federal securities statutes like Sarbanes-Oxley that nationalize elements of traditional (state) corporate law. Meanwhile, other scholars have lauded preemptive securities regulation arguing that federal intervention prevents the dismantling of regulatory standards and a race to the bottom.

This Article argues that both sides of the debate mistake the impact of federalization on the market for corporate law. Drawing on recent legal and empirical scholarship, this Article shows that as a descriptive matter the domestic market for corporate law is in some regards animated less by competition than what is an increasingly international market for securities law. States do not generally compete vigorously to attract charters due to Delaware's longstanding domination of the market and other supply-side disincentives. On the other hand, national securities regulators face intense pressure to provide cost-effective rules to draw foreign issuers to their home markets. These observations suggest that where federal regulators preempt, they are engaged in what can be considered a "doubled race." First, they must monitor for market failure and ensure that Delaware, the dominant supplier of corporate charters, provides sound corporate law. And second, they must themselves cope with the onslaught of competition from other national regulators seeking to attract securities transactions. As a result, preemption is a weaker counterweight to any competition arising among states than many scholars have anticipated.

September 14, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)