October 17, 2008
NYAG and AIG Issue Statement on AIG's Expenditures
The New York Attorney General and AIG issued a joint statement a day after the AG expressed strong displeasure with some of AIG's expenditures since taking government money. According to the statement,
Mr. Liddy [AIG's CEO] agreed to take several significant actions with respect to expenditures at AIG. First, AIG has agreed to provide the New York Attorney General’s Office with an accounting of all compensation paid to its senior executives and has agreed to assist the Attorney General’s Office in recovering any illegal expenditures. This includes all forms of compensation paid to former CEO Martin Sullivan and the former head of the Financial Products Unit, Joseph Cassano.
Second, AIG has agreed to establish a Special Governance Committee within AIG which will institute new expense management controls. Also, AIG will be issuing today a new Expense Policy Guidebook. These controls and protections will be designed at the Board level to prevent any future unwarranted expenditures, such as salaries, bonuses, stock options, severance payments, gratuities, benefits, junkets, and perks. The new controls will include direct supervision by Chief Administrative Officer Richard Booth.
Third, AIG has agreed to take +several immediate actions. Effective today, AIG will not make any payments pursuant to the multi-million dollar employment agreement of Steven Bensinger, the company’s Chief Financial Officer, who will be leaving AIG. Attorney General Cuomo has specifically asked AIG not to make payments pursuant to that agreement in light of the Attorney General’s ongoing review of the propriety of such payments.
AIG has also agreed to immediately cancel all junkets or perks which are not strictly justified by legitimate business needs. AIG will be canceling more than 160 conferences and events, some exceeding more than $750,00 per event, for a total savings of more than $8 million.
SEC Adopts Four Rules on Short-Selling
The SEC adopted four rules dealing with short-selling that go into effect October 17.
It adopted an interim final temporary rule to address abusive “naked” short selling in all equity securities by requiring that participants of a clearing agency registered with the Commission deliver securities by settlement date, or if the participants have not delivered shares by settlement date, immediately purchase or borrow securities to close out the fail to deliver position by no later than the beginning of regular trading hours on the settlement day following the day the participant incurred the fail to deliver position. Failure to comply with the close-out requirement of the temporary rule is a violation of the temporary rule. In addition, a participant that does not comply with this close-out requirement, and any broker-dealer from which it receives trades for clearance and settlement, will not be able to short sell the security either for itself or for the account of another, unless it has previously arranged to borrow or borrowed the security, until the fail to deliver position is closed out.
It also adopted amendments to Regulation SHO that are intended to further reduce the number of persistent fails to deliver in certain equity securities by eliminating the options market maker exception to the close-out requirement of Regulation SHO. As a result of the amendments, fails to deliver in threshold securities that result from hedging activities by options market makers will no longer be excepted from Regulation SHO’s close-out requirement. The Commission is also providing guidance regarding bona fide market making activities for purposes of the market maker exception to Regulation SHO’s locate requirement.
It adopted an antifraud rule to address fails to deliver securities that have been associated with “naked” short selling. The rule will further evidence the liability of short sellers, including broker-dealers acting for their own accounts, who deceive specified persons about their intention or ability to deliver securities in time for settlement (including persons that deceive their broker-dealer about their locate source or ownership of shares) and that fail to deliver securities by settlement date.
Finally, the SEC adopted an interim final temporary rule requiring certain institutional investment managers to file information on Form SH concerning their short sales and positions of section 13(f) securities, other than options. The new rule extends the reporting requirements established by our Emergency Orders dated September 18, 2008, September 21, 2008 and October 2, 2008, with some modifications. The extension will be effective until August 1, 2009. Consistent with the Orders, the rule requires an institutional investment manager that exercises investment discretion with respect to accounts holding section 13(f) securities having an aggregate fair market value of at least $100 million to file Form SH with the Commission following a calendar week in which it effected a short sale in a section 13(f) security, with some exceptions.
October 16, 2008
FINRA Fines Banorte Securities Int'l for Unsuitable Class B Stock Sales
FINRA imposed a $1.1 million fine on Banorte Securities International, Ltd. for unsuitable sales of Class B shares in off-shore mutual funds as well as failing to have adequate supervisory systems to monitor those sales. As part of this settlement, the firm agreed to a remediation plan that will address over 1,400 transactions in the accounts of more than 300 customer households. Banorte Securities International, which is headquartered in New York, is part of an affiliated group of companies that includes a Mexican broker-dealer and a Mexican bank. The majority of the firm's customers live in Mexico.
FINRA found that Banorte Securities International recommended Class B shares of off-shore mutual funds to its customers in certain transactions where the customers would have financially benefited from purchasing Class A shares - particularly since the firm had negotiated lower front-end sales charges for off-shore mutual fund Class A shares with several mutual fund companies. FINRA further found that the firm's written policies and procedures did not require its registered representatives to weigh the economic consequences of purchasing different share classes or to explain those consequences to customers. Moreover, Banorte Securities failed to provide guidelines that instructed registered representatives that Class A share off-shore mutual fund purchases eligible for these low front-end loads were generally cheaper for customers than Class B shares.
During 2003 through May 2004, most mutual fund sales at Banorte Securities were in Class B shares, despite the fact that the low front-end loads available to the firm's customers meant that an investment in Class A shares generally yielded a higher return than a similar investment in the Class B shares.
The firm settled this matter without admitting or denying the allegations, but consented to the entry of FINRA's findings.
SEC Files Manipulation Complaint against Excellency Investment Realty Trust
The SEC filed a civil injunctive action in the United States District Court for the District of Connecticut against Excellency Investment Realty Trust, Inc., a publicly-traded real estate investment trust located in Hartford, Connecticut, and its chief executive officer, David D. Mladen, of Scarsdale, New York, in connection with an alleged fraudulent market manipulation scheme. The Commission's complaint, filed on October 16, 2008, alleges that during at least July 2006 through September 2006, Mladen and Excellency engaged in a market manipulation scheme to defraud Excellency investors. According to the complaint, Mladen, acting in his capacity of CEO of Excellency and acting through a brokerage account that was owned and controlled in part by Excellency and Mladen, traded in Excellency stock in such a way as to artificially increase the price of Excellency stock. The complaint alleges that Mladen purchased Excellency stock in small quantities at progressively higher prices and executed wash or match trades in order to create the appearance of an active market for Excellency shares. Mladen's trading activity systematically manipulated the stock price of Excellency, causing it to increase from $8 per share to $24.35 per share.
According to the complaint, Excellency and Mladen violated the antifraud provision of the Securities Exchange Act of 1934, including Section 10(b) and Rule 10b-5 thereunder. The Commission is seeking injunctive relief against both, and the imposition of civil penalties against Mladen and an order barring Mladen from serving as an officer or director of a publicly traded company.
SEC Administrative Orders On NYSE Specialist Interpositioning Cases
The SEC issued three separate Orders Making Findings and Imposing a Cease-and-Desist Order Pursuant to Section 21C Securities Exchange Act of 1934 as to Todd J. Christie, Kevin M. Fee, and Thomas J. Murphy, Jr., and an Order Dismissing Administrative and Cease-and-Desist Proceedings Instituted against P. Murphy Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b), 21C and 11(b) of the Securities Exchange Act of 1934 And Rule 11b-1 thereunder. The four cases all involved NYSE specialists who allegedly engaged in interpositioning.
The Christie Order finds that during the period from January 1, 1999 to approximately March 2003, Christie, a former specialist on the New York Stock Exchange and Chief Executive Officer, managing director, and partner at Spear Leeds & Kellog L.P., executed hundreds of trades that constituted interpositioning, which generated thousands of dollars in profit for his firm's proprietary account at the expense of customer orders, and hundreds of trades that constituted trading ahead, which generated thousands of dollars in customer harm, and, in doing so, violated Section 11(b) of the Exchange Act and Rule 11b-1 thereunder.
Based on the above, the Christie Order orders Christie to cease and desist from committing or causing any violations and any future violations of Section 11(b) of the Exchange Act and Rule 11b-1 thereunder.
The Fee Order finds that during the period from at least 1999 through June 30, 2003, Fee, a former specialist on the New York Stock Exchange at Bear Wagner Specialists LLC and a predecessor firm, executed hundreds of trades that constituted interpositioning, which generated thousands of dollars in profit for his firm's proprietary account at the expense of customer orders, and hundreds of trades that constituted trading ahead, which generated thousands of dollars in customer harm, and, in doing so, violated Section 11(b) of the Exchange Act and Rule 11b-1 thereunder.
Based on the above, the Fee Order orders Fee to cease and desist from committing or causing any violations and any future violations of Section 11(b) of the Exchange Act and Rule 11b-1 thereunder.
The T. Murphy Order finds that during the period from at least 1999 through June 30, 2003, T. Murphy, a former specialist on the New York Stock Exchange at Fleet Specialist, Inc. (now known as Banc of America Specialist, Inc.) and a predecessor firm, executed hundreds of trades that constituted interpositioning, which generated thousands of dollars in profit for his firm's proprietary account at the expense of customer orders, and hundreds of trades that constituted trading ahead, which generated thousands of dollars in customer harm, and, in doing so, violated Section 11(b) of the Exchange Act and Rule 11b-1 thereunder.
Based on the above, the T. Murphy Order orders T. Murphy to cease and desist from committing or causing any violations and any future violations of Section 11(b) of the Exchange Act and Rule 11b-1 thereunder.
The P. Murphy Order
The P. Murphy Order finds that in light of the administrative record developed since the institution of the Administrative Proceeding against P. Murphy, a former NYSE specialist at Spear Leeds & Kellogg L.P, the Commission deems it appropriate and in the public interest to dismiss the Order Instituting Public Administrative and Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b), 21C and 11(b) of the Securities Exchange Act of 1934 and Rule 11b-1 thereunder (OIP) against him.
Alexander & Wade Sanctioned for Section 5 Violations
Alexander & Wade, Inc. (AWI), has been ordered to cease and desist from violations of the registration provisions of the securities laws and to disgorge $2,866,375 of ill-gotten gains. From 2002 to 2005, AWI advised and guided several microcap issuers in raising millions of dollars by selling their common stock to the public in violation of the registration requirements of the federal securities laws and thereby caused violations of Sections 5(a) and 5(c) of the Securities Act of 1933. From mid-2002 through mid-2005, AWI introduced at least fourteen clients (the Issuers) to so-called employee stock option programs, under which the Issuers sold billions of shares of common stock in unregistered offerings. Under the programs, the Issuers improperly registered the shares underlying the stock options on Form S-8 registration statements and then received the bulk of the sales proceeds as payment for the options’ exercise price. The programs functioned as public offerings in which the Issuers’ employees were used as conduits to the market so that the Issuers could raise capital without complying with the registration requirements of the Securities Act. AWI introduced the programs to the Issuers, helped implement the programs, and provided advice on how to administer the programs, even though it knew, or should have known, that its conduct was contributing to the Issuers’ registration violations. The sanctions were ordered in an administrative proceeding before an administrative law judge.
SEC Schedules Mark to Market Roundtable for Oct. 29
The SEC announced that on Oct. 29, 2008, it will host the first of two roundtables on "mark-to-market" accounting and current market conditions. The roundtables will provide input to the SEC as part of a Congressionally mandated study pursuant to the Emergency Economic Stabilization Act of 2008. The date and time of the second roundtable will be announced at a later date.
The first roundtable will consist of two panels. The first panel will discuss the interaction between mark-to-market accounting for financial institutions and the current economic situation. The second panel will focus on potential improvements to the current accounting model and implications of possible changes. The panel discussions will focus on:
The effects of mark-to-market accounting on financial reporting by financial institutions.
Potential market behavior effects from mark-to-market accounting.
The usefulness of mark-to-market accounting to investors and regulators.
Aspects of the current accounting standards that can be improved.
A final agenda including a list of participants and moderators will be announced at a future date. The roundtable will be open to the public with seating on a first-come, first-served basis. The roundtable also will be webcast on the SEC Web site.
SEC Settles "Portfolio Pumping" Charges Against Medcap Management
The SEC settled charges that San Francisco investment adviser MedCap Management & Research LLC (MMR) and its principal Charles Frederick Toney, Jr. reported misleading results to hedge fund investors by engaging in a practice known as "portfolio pumping." The SEC alleged that Toney made extensive quarter-end purchases of a thinly-traded penny stock in which his fund was heavily invested, more than quadrupling the stock price and allowing him to report artificially inflated quarterly results to fund investors. Without admitting or denying the SEC's allegations, MMR and Toney have agreed to settle the charges by paying financial penalties and agreeing to an order barring Toney from acting as an investment adviser for at least one year.
According to the SEC's order, MedCap Partners L.P. (MedCap), a hedge fund run by MMR and Toney, was suffering from dramatic losses and facing increasing redemptions from fund investors by September 2006. Over the last four days of the month, Toney — through a separate fund that MMR managed — placed numerous buy orders for a thinly-traded over-the-counter stock in which MedCap already was heavily invested. Toney's buying pressure caused the stock price to more than quadruple, from $0.85 to $3.72.
The SEC alleges that because the stock represented over one-third of MedCap's holdings, the brief boost in its price inflated MedCap's reported value by $29 million, masking what would otherwise have been a 40 percent quarterly loss for MedCap. Immediately after the quarter ended, Toney reported to MedCap's investors that the fund's investments had begun to "bounce" and that the fund's performance was improving. Toney failed to disclose that this "bounce" was almost entirely the result of his four-day purchasing spree. Following MMR's brief buying activity, both the stock price and MedCap's asset value declined to their previous levels.
October 15, 2008
SEC Settles Insider Trading Charges Involving Georgia-Pacific Corp.
The United States District Court for the Northern District of Illinois entered Final Judgments as to defendants Jim W. Dixon ("Dixon") and Lance D. McKee ("McKee") on October 9, 2008, enjoining them from future violations of Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and Rules 10b-5 and 14e-3 thereunder.
The Commission's Complaint alleged fraud by Dixon, McKee and others in connection with insider trading in the securities of Georgia-Pacific Corporation. The Complaint alleged that James D. Zeglis ("Zeglis") misappropriated material nonpublic information from his brother, a member of Georgia-Pacific's board of directors, and further alleged that on November 10, 2005, three days before a public announcement that Georgia-Pacific had agreed to be acquired by Koch Industries, Inc., Zeglis tipped Dixon and Gautam Gupta ("Gupta"), both of whom purchased Georgia-Pacific securities. Gupta, in turn, tipped McKee, who also purchased Georgia-Pacific securities. Further, the Complaint alleged that on Sunday, November 13, 2005, Koch Industries, Inc. ("Koch") publicly announced a definitive agreement for a Koch subsidiary to make a cash tender offer for all shares of Georgia-Pacific. The following day, Georgia-Pacific's stock price increased 36% in response to the announcement. McKee then sold his Georgia-Pacific securities, realizing a profit of $7,157.60. Dixon also realized a profit of $116,000 from the sale of Georgia-Pacific options. Thereafter, over the course of several months, Dixon paid Zeglis kickbacks from his ill-gotten gains of approximately $25,000.
The Court ordered disgorgement and prejudgment interest against Dixon in the respective amounts of $116,324.84 and $22,074.03 and also imposed a civil penalty against Dixon in the amount of $50,000. The Court ordered disgorgement, prejudgment interest and post judgment interest against McKee in the respective amounts of $7,157.60, $1,383.17, and $73.41. The Court also imposed a civil penalty and post judgment interest against McKee in the respective amounts of $7,157 and $73.4. Dixon and McKee each consented to the entry his respective judgment without admitting or denying the allegations of the Commission's Complaint.
NYAG Tells AIG to Account for Fraudulent Conveyances
The New York Attorney General sent AIG expressing its displeasure with certain of the company's recent expenditures even as the company is being bailed out by the U.S. taxpayers and calling them "fraudulent conveyances." Here, to give you the flavor, is the first paragraph of the letter:
Over the past several months, this Office has become aware of unwarranted and outrageous expenditures by American International Group, Inc. ("AIG") even as the company slipped towards insolvency. As you of course know, the taxpayers of this country are now supporting AIG through rescue financing, which makes such expenditures even more irresponsible and damaging. As described below, we demand that the Board of Directors (the "Board") cease and desist any such further expenditures, and review, rescind, and recover all past unreasonable expenditures. The Board must also immediately institute new protections to prevent future abuses, and provide this Office with an accounting of executive compensation and benefits. We hereby place AIG and its Board on notice that this Office will seek appropriate sanctions and remedies if the Board does not comply.
FINRA Fines SunTrust Investment Services for Fee-Based Account Violations
FINRA fined SunTrust Investment Services, Inc., $700,000 for supervisory violations relating to its fee-based brokerage business and commissions on certain low-priced stocks. In assessing the fine announced today, FINRA took into account SunTrust's voluntary refunding of more than $713,000 in fees and interest to affected accountholders. SunTrust terminated its fee-based accounts - called Portfolio Choice accounts - on Dec. 31, 2006.
FINRA found that during the period from November 2002 through December 2005, SunTrust opened over 2,644 Portfolio Choice accounts without adequately assessing whether the accounts were appropriate for its customers. SunTrust further failed to adequately monitor the activity in the Portfolio Choice accounts to ensure that they remained appropriate for its customers. FINRA identified at least 36 Portfolio Choice accounts that conducted no trades for at least eight consecutive quarters -- and those 36 accounts were charged over $129,000 in fees during the last four inactive quarters.
In addition, certain Portfolio Choice accountholders paid both a commission on transactions and an asset-based fee on those same assets. In more than 900 instances, SunTrust erroneously failed to exclude a customer asset purchased with a commission from the asset base used to calculate the account fee. In these cases, the customers were double- charged, as they paid both a commission on the transaction as well as an ongoing fee on the asset. The double charges resulted in approximately $437,500 in excess fees and/or commissions paid by SunTrust customers.
FINRA also found that SunTrust inappropriately allowed numerous customers to maintain accounts in the program and to pay for those accounts even though they had not traded in years. For example, in December 2003 one customer transferred to SunTrust an account in which there had been no trading activity for almost two years and set up a Portfolio Choice fee-based account. There was no trading activity in this account through March 2006, yet during that period the firm charged the account approximately $8,170 in asset-based fees. In another example, a customer transferred an IRA account to SunTrust in November 2003. This account was set up as a Portfolio Choice fee-based account. From November 2003 through January 2006, the account had no trading activity, but the customer was charged $8,672 in fees from its inception until March 2006.
During the period from Jan. 1, 2002 through Sept. 2, 2005, SunTrust also failed to establish a supervisory system, including written procedures, reasonably designed to ensure that its registered representatives charged its customers fair and reasonable commissions on securities transactions. SunTrust employed an automated commission system that allowed commissions over five percent to be charged when low-priced and/or low quantities of stocks were bought or sold. As a result, certain customers were charged excess commissions totaling nearly $100,000.
In settling this matter, the firm neither admitted nor denied the charges, but consented to the entry of FINRA's findings. Under the terms of the settlement, SunTrust agreed to certify to FINRA that it has refunded $713,362 in fees and interest to affected accountholders.
SEC's Sirri Testifies on CDS
Erik Sirri, Director, Division of Trading and Markets, SEC, presented Testimony Concerning Credit Default Swaps before the House Committee on Agriculture on October 15, 2008.
October 14, 2008
Paulson's Statement on Government's Investment in Banks
Today I am announcing that the Treasury will purchase equity stakes in a wide array of banks and thrifts. Government owning a stake in any private U.S. company is objectionable to most Americans – me included. Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable. When financing isn't available, consumers and businesses shrink their spending, which leads to businesses cutting jobs and even closing up shop.
To avoid that outcome, we must restore confidence in our financial system. The first step in that effort is a plan to make capital available on attractive terms to a broad array of banks and thrifts, so they can provide credit to our economy. From the $700 billion financial rescue package, Treasury will make $250 billion in capital available to U.S. financial institutions in the form of preferred stock. Institutions that sell shares to the government will accept restrictions on executive compensation, including a clawback provision and a ban on golden parachutes during the period that Treasury holds equity issued through this program. In addition, taxpayers will not only own shares that should be paid back with a reasonable return, but also will receive warrants for common shares in participating institutions. We expect all participating banks to continue and to strengthen their efforts to help struggling homeowners who can afford their homes avoid foreclosure. Foreclosures not only hurt the families who lose their homes, they hurt neighborhoods, communities and our economy as a whole.
While many banks have suffered significant losses during this period of market turmoil, many others have plenty of capital to get through this period, but are not positioned to lend as widely as is necessary to support our economy. Our goal is to see a wide array of healthy institutions sell preferred shares to the Treasury, and raise additional private capital, so that they can make more loans to businesses and consumers across the nation. At a time when events naturally make even the most daring investors more risk-averse, the needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it.
Nine large financial institutions have already agreed to participate in this program. They have agreed to sell preferred shares to the US government, on the same terms that will be available to a broad array of small and medium-sized banks and thrifts across the nation. These are healthy institutions, and they have taken this step for the good of the U.S. economy. As these healthy institutions increase their capital base, they will be able to increase their funding to U.S. consumers and businesses.
October 13, 2008
U.S. Will Buy Stock in Banks
There is no announcement on the Department of Treasury's website, but the Wall St. Journal reports the expected news that the government will make direct investments in nine finanicial services institutions through the purchase of preferred shares. WSJ, U.S. Set to Buy Preferred Stock in Nine Top Banks.
Mitsubishi Financial Completes Purchase of Morgan Stanley Stake
Mitsubishi UFJ Financial Group, Inc. (“MUFG”), Japan’s largest financial group and the world’s second largest bank holding company with $1.1 trillion in bank deposits, and Morgan Stanley today announced that MUFG has closed on a $9 billion equity investment in Morgan Stanley that gives MUFG a 21 percent ownership interest in Morgan Stanley on a fully diluted basis. Under the revised terms of the transaction, MUFG has acquired $7.8 billion of perpetual non-cumulative convertible preferred stock with a 10 percent dividend and a conversion price of $25.25 per share, and $1.2 billion of perpetual non-cumulative non-convertible preferred stock with a 10 percent dividend. MUFG will receive a Morgan Stanley Board seat; the companies will establish a Steering Committee to maximize the strategic benefits of their alliance.
Quoting verbatim from the Morgan Stanley press release:
The MUFG investment further bolsters Morgan Stanley's already strong capital position. Morgan Stanley's Tier 1 Capital Ratio is now estimated to be more than 15.5 percent on a pro-forma basis as of August 31, 2008. This is far in excess of the 6 percent required by the Federal Reserve to be treated as well-capitalized and is one of the highest Tier 1 Capital Ratios among bank holding companies peers. The MUFG investment also reduces Morgan Stanley's leverage ratio to just under 20 times and its adjusted leverage ratio to just over 10 times on a pro-forma basis at August 31, 2008. In addition, Morgan Stanley has continued to reduce the size of its balance sheet since the end of the third quarter. As of today, total assets are now under $900 billion, down from $987 billion at August 31, 2008.
Pildes on Separation of Powers & SOX
Separation of Powers, Independent Agencies, and Financial Regulation: The Sarbanes-Oxley Act, by Richard H. Pildes, New York University School of Law, was recently posted on SSRN. Here is the abstract:
In the aftermath of the last financial crisis, involving the collapse of Enron, WorldCom, and others, Congress enacted the Sarbanes-Oxley Act of 2002. The Act's centerpiece was a new regulatory body, located within the Securities and Exchange Commission, with the power to regulate and oversee the accounting industry in the United States.
The constitutionality of the novel administrative structure Sarbanes-Oxley created is now being challenged. One judge has called this challenge "the most important separation-of-powers case regarding the President's appointment and removal powers to reach the courts in the last 20 years." The issues pit Congress' desire to insulate regulatory bodies from Presidential control against unitary-executive branch theories of the Constitution. Judicial resolution of this conflict will determine not only the constitutionality of regulatory oversight of the accounting industry that Sarbanes-Oxley sets up. That resolution will determine the kinds of options Congress has for designing politically-insulated administrative structures to deal with the current financial crisis and with other major regulatory needs in the coming years.
This article argues that the administrative institutions created in Sarbanes-Oxley are consistent with the constitutionally-defined relationship between Congress, the President, and administrative agencies.