Securities Law Prof Blog

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

Friday, November 7, 2008

Corporate Finance Issues Legal Bulletin on Shareholder Proposals

The SEC's Division of Corporation Finance issued a Staff Legal Bulletin No. 14D (CF) on Shareholder Proposals.  The Bulletin is part of a continuing effort to identify and provide guidance on issues that commonly arise under rule 14a-8. Specifically, this bulletin contains information regarding:

shareholder proposals that recommend, request, or require a board of directors to unilaterally amend the company’s articles or certificate of incorporation;
a new e-mail address established for the receipt of rule 14a-8 no-action requests and related correspondence;
whether a company must send a notice of defect if the company’s records indicate that the proponent has not owned the minimum amount of securities for the required period of time as set forth in rule 14a-8(b); and
the requirement that a proponent send copies of correspondence to the company and the manner in which the company and a proponent should provide additional correspondence to us and to each other.

November 7, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 5, 2008

South Dakota Votes Down Naked Short Selling Ban

South Dakota citizens voted down a measure that would have banned all naked short selling in the state. The resolution was voted down by 56.6% of the 338,000 citizens of that state who voted in yesterday's election. InvNew, Naked short-selling ban nixed in S. Dakota.

November 5, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 4, 2008

Cox on Regulating Credit Default Swaps

Christopher Cox has an Op-Ed for the Washington Post on Reinventing a Markets Watchdog.

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

Monday, November 3, 2008

SEC Approves FINRA Rule Change on Expungement Procedures

The SEC approved FINRA's Proposed Rule Change Amending the Codes of Arbitration Procedure to Establish Procedures for Arbitrators to Follow When Considering Requests for Expungement Relief. Rules 12805 and 13805 set forth procedures that arbitrators must follow before granting expungement of information from an associated person's CRD record. Specifically, in order to grant expungement of customer dispute information under Rule 2130, the panel must: (i) hold a recorded hearing session by telephone or in person regarding the appropriateness of expungement, even if a claimant did not request a hearing on the merits; (ii) for cases involving settlements, review the settlement documents to examine the amount paid to any party and any other terms and conditions of the settlement that might raise concerns about the associated person's involvement in the alleged misconduct before awarding expungement; (iii) indicate in the arbitration award which of the grounds for expungement in Rule 2130(b)(1)(A)-(C) serves as the basis for the expungement order and provide a brief written explanation of the reason(s) for its finding that one or more grounds for expungement exists; and (iv) assess forum fees for hearing sessions in which the sole topic is the determination of the appropriateness of expungement against the parties requesting expungement.

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

Two Former Putnam Fiduciary Trust Officers Settle Fraud Charges

On October 31, 2008, the United States District Court for the district of Massachusetts entered a final judgment by consent imposing permanent injunctions and other relief against two former executives of transfer agent Putnam Fiduciary Trust Company (PFTC) in a case filed by the SEC.  The Complaint alleged that the defendants engaged in a scheme beginning in January 2001 by which they and other executives of PFTC defrauded a defined contribution plan client and group of mutual funds of approximately $4 million. Karnig H. Durgarian, Jr., a former senior managing director and chief of operations of PFTC, and Ronald B. Hogan, a former vice president who had responsibility for new business implementation, each consented to imposition of the final judgment without admitting or denying the allegations of the Commission's Complaint. The Court issued orders of permanent injunction against both defendants and imposed civil money penalties of $100,000 and $35,000, respectively.

The Commission's Complaint against Durgarian, Hogan, and four other defendants alleged that the defendants' misconduct arose out of PFTC's one-day delay in investing certain assets of a defined contribution client, Cardinal Health, Inc., in January 2001. The markets rose steeply on the missed day, causing Cardinal Health's defined contribution plan to miss out on nearly $4 million of market gains. According to the Complaint, rather than inform Cardinal Health of the one-day delay and the missed trading gain, the defendants decided to improperly shift approximately $3 million of the costs of the delay to shareholders of certain Putnam mutual funds through deception, illegal trade reversals, and accounting machinations. The Complaint also alleged that the defendants improperly allowed Cardinal Health's defined contribution plan to bear approximately $1 million of the loss without disclosing to Cardinal Heath that they had done so.

The case against the remaining defendant, Donald F. McCracken, a former head of global operations services for PFTC, is proceeding.  An appeal of a court ruling dismissing three other defendants from the case is currently pending before the United States Court of Appeals for the First Circuit.

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

Former Magnum Hunter Resources Director Settles Insider Trading Charges

On October 31, 2008, the United States District Court for the Northern District of Texas entered a final judgment against Donald A. Erickson (Erickson), the former audit committee chairman and a former director of Magnum Hunter Resources, Inc. (MHR) for unlawful insider trading in the securities of MHR ahead of the January 26, 2005 announcement of merger between MHR and Cimarex Energy Company (Cimarex). The judgment permanently enjoins Erickson from violating the antifraud provisions and certain reporting provisions of the federal securities laws (Sections 10(b) and 16(a) of the Securities Exchange Act of 1934 and Rules 10b-5, 16a-3(a), and 16a-3(g)(1)) and finds Erickson liable for disgorgement of $46,200, plus prejudgment interest of $11,399.67. Erickson consented to the entry of the judgment regarding the injunction and disgorgement without admitting or denying the allegations in the Complaint. Further, the Court found Erickson liable for a civil penalty of $46,200 based on Erickson's illegal insider trading and permanently barred Erickson from acting as an officer or director of a public company.

In its complaint the SEC alleged that in late December 2004, Donald A. Erickson, while serving as audit committee chairman and a director of MHR, purchased MHR call options during the time MHR was exploring a possible merger or sale of the company. The Complaint alleged that Erickson was briefed regularly on the status of negotiations and participated in key decisions regarding the Cimarex deal. The Complaint also alleged that in mid-January 2005—just two trading days before the public announcement of the merger, and one day after he attended a board meeting addressing the status of negotiations with Cimarex—Erickson exercised his call options and acquired 30,000 shares of MHR stock. According to the Commission, Erickson purchased and exercised the options based on material, nonpublic information about MHR's merger negotiations and, ultimately, the Cimarex deal.

Further, the Commission alleged that Erickson failed to report to the Commission his purchases of MHR call options, a requirement for corporate insiders. In addition, the Commission alleged that Erickson was late in disclosing to the Commission the exercise of his options, and further alleges that his ultimate disclosure was materially false—indicating, incorrectly, that he had exercised the options after the merger announcement.

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

Sunday, November 2, 2008

Second Circuit Addresses Subject Matter Jurisdiction in "Foreign-Cubed Action"

The Second Circuit recently re-examined subject matter jurisdiction over Rule 10b-5 actions in In re National Australia Bank Ltd (2d Cir. Oct. 23, 2008).  In what the court described as a "foreign-cubed action," foreign plaintiffs sued a foreign issuer in federal district court alleging Rule 10b-5 violations based on securities transactions in foreign countries.  Specifically, plaintiffs (purchasers of National Australia Bank (NAB) stock on foreign exchanges) alleged that HomeSide Lending, a Florida-based mortgage service provider and wholly-owned subsidiary of NAB, engaged in accounting fraud that inflated NAB's stock price.  In affirming the lower court's dismissal of foreign plaintiffs' claims for lack of subject matter jurisdiction, the Second Circuit referred to the "conduct" and "effects" tests previously developed by the Second Circuit: (1) whether the wrongful conduct occurred in the U.S. and (2) whether the wrongful conduct had a substantial effect in the U.S. or upon U.S. citizens.  In this case, however, plaintiffs relied solely on the conduct test. 

Under the conduct test, the critical distinction is whether the defendant's activities in the U.S. were "more than merely preparatory" to the allegd fraud and "directly caused" losses to investors abroad.  This involves a comparison of how much of the fraud was done in the U.S. and how much was done abroad.  In this case, Homeside allegedly manipulated its books and records in Florida and sent the inflated numbers to NAB in Australia.  NAB, in turn, created and distributed its public filings from its headquarters in Australia.

The Second Circuit rejected the adoption of a "bright-line" test urged by defendants and some of the amicus curiae filed in this case (including the U.S. Chamber of Commerce) that domestic conduct alone would never be enough to find subject matter jurisdiction.  It minimized the argument that the current tests created potential conflict between U.S. and foreign antifraud laws, noting that "anti-fraud enforcement objectives are broadly similar."  Moreover, the Court reiterated the importance of the goal of "preventing the export of fraud from America." The court, however, rejected the SEC's position as amicus curiae and found that HomeSide's manipulation of the numbers in Florida was less central to the fraud than NAB's actions in Australia.  It emphasized that NAB's responsibilities include preparation and dissemination of the financial statements and other statements to the investing public.  In addition, the court relied on the absence of any allegations that U.S. investors or U.S. financial markets were harms and what it saw as the "lengthy chain of causation" between the Florida manipulation of numbers and the harm to investors -- NAB had numerous opportunities to detect and correct the improper numbers.

Finally, the Court observes that:

(1) The D.C. circuit has misconstrued the Second Circuit test as requiring the domestic conduct to comprise all elements necessary to establish a Rule 10b-5 violation, and

(2)  It would help the courts if Congress and the SEC address the appropriate scope of the statute to overseas transactions.

November 2, 2008 in Judicial Opinions | Permalink | Comments (0) | TrackBack (4)

Baer on Corporate Fraud

Linkage and the Deterrence of Corporate Fraud, by Miriam H. Baer, Brooklyn Law School, was recently posted on SSRN.  Here is the abstract:

Corporate fraud is often presumed to be the type of crime that can be deterred. Those who embrace deterrence as a goal of law enforcement, however, often ignore the tradeoffs between the deterrence of potential offenders and the deterrence of those "mid-fraud perpetrators" who are already mid-way through illicit schemes when the government announces a change in policy. Unlike potential offenders, mid-fraud perpetrators have no incentive to cease criminal conduct in response to increases in sanctions or likelihood of detection. This is true because a "link" exists between the offenders' cessation of future misconduct and the probability that their prior conduct will be detected and punished. If a CFO has lied to a company's shareholders in Quarter 1 about the company's profits, his cessation of lying in Quarter 2 substantially increases the chances that someone will focus on and detect his previous lies in Quarter 1. The problem with this linkage between cessation of conduct and increased probability of punishment is that criminal sanctions aimed primarily at deterring new offenders may also encourage perverse reactions from perpetrators in the midst of frauds. Policymakers contemplating changes in law enforcement policy therefore should consider the linkage problem in calculating the benefits and drawbacks of different law enforcement strategies.

November 2, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Barnard on Investor Education

Deception, Decisions, and Investor Education, by Jayne W. Barnard, College of William and Mary - Marshall-Wythe School of Law, was recently posted on SSRN.  Here is the abstract:

Tens of millions of dollars are spent each year to fund educational programs aimed at elderly investors. Many of these programs focus on fraud prevention. In this Article, Professor Barnard questions the effectiveness of these programs. Drawing on recent studies from marketing scholars, neurobiologists, social psychologists, and behavioral economists examining the ways in which older adults process information, she offers a model of decision making (the "deception/decision cycle") that explains why older adults are disproportionately vulnerable to investment fraud schemes. She then suggests that many of the factors that contribute to fraud victimization are unlikely to be influenced by investor education. She suggests some alternative uses for the money now spent on investor education that would better achieve the goal of fraud prevention.

November 2, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Okamoto on Regulating Systemic Moral Hazard

After the Bailout: Regulating Systemic Moral Hazard, by Karl S. Okamoto, Drexel University College of Law, was recently posted on SSRN.  Here is the abstract:

How do we make our financial world safer? This Article offers a strategy for regulating financial markets to better prevent the kind of disaster we have seen in recent months. By developing a model of risk manager decision-making, this Article illustrates how even "good people" acting in utterly rational and expected ways brought us into economic turmoil.

The assertion of this Article is that the root cause of the current financial crisis is systemic moral hazard. Systemic moral hazard poses a unique challenge in crafting a regulatory response. The challenge lies in that the best response to systemic moral hazard is "preventive prediction." It is inherently difficult to reward individuals for producing preventive prediction. Therefore markets fail to produce it at optimal levels, and thus prevent systemic moral hazard and the kind of crisis we are facing.

The difficulty in valuing preventive prediction is seen when we model how risk managers make decisions regarding the prevention of excessive risk. The model reveals that the balance is easily tipped in favor of risk-taking that leads to systemic failure and broad social harm. The model also reveals how regulation might work to reset the balance to one that is superior for society. We achieve this by imposing two requirements on all asset managers in the market: we require them to put their own money at risk in their trading decisions, and we require them to use "best practices" in managing risk. These prescriptions arise out of a regulatory strategy that accepts the need to balance the benefits of risk-taking in financial markets (and the consequent inevitability of some financial failure) with the desire to avoid excessive risk-taking and the costs of systemic collapse. It is a strategy that focuses on those instances where we cannot trust ourselves to be prudent.

November 2, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Mitchell on the Stock Market

Who Needs the Stock Market? Part I: the Empirical Evidence, by Lawrence E. Mitchell, George Washington University - Law School, was recently posted on SSRN.  Here is the abstract:

Data on historical and current corporate finance trends drawn from a variety of sources present a paradox. External equity has never played a significant role in financing industrial enterprises in the United States. The only American industry that has relied heavily upon external financing is the finance industry itself. Yet it is commonly accepted among legal scholars and economists that the stock market plays a valuable role in American economic life, and a recent, large body of macroeconomic work on economic development links the growth of financial institutions (including, in the U.S, the stock market) to growth in real economic output. How can this be the case if external equity as represented by the stock market plays an insignificant role in financing productivity? This paradox has been largely ignored in the legal and economic literature.

This paper surveys the history of American corporate finance, presents original and secondary data demonstrating the paradox, and raises questions regarding the structure of American capital markets, the appropriate rights of stockholders, the desirable regulatory structure (whether the stock market should be regulated by the Securities and Exchange Commission or the Commodities Futures Trading Commission, for example), and the overall relationship between finance and growth.

The answers to these questions are particularly pressing in light of a dramatic increase in stock market volatility since the turn of the century creating distorted incentives for long-term corporate management, especially trenchant in light of the recent global financial collapse.

A second paper in this series will examine the theoretical justifications for the importance of the stock market as perhaps the central financial institution in the United States.

November 2, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Okamoto on SEC 16(b)

Rereading Section 16(B) of the Securities Exchange Act, by Karl S. Okamoto, Drexel University College of Law, was recently posted on SSRN.  Here is the abstract:

This Article suggests a rereading of section 16(b)of the Securities Exchange Act of 1934. The rereading is based on a new statement of the provision's purpose. Although largely unquestioned, the conventional statement of purpose has led the reading of the section astray. The new statement of purpose offered here finds its theoretical and empirical foundation in modern finance economics. The new purpose also reads the statute in light of the historical context of its adoption. It reads the statute as a response to the types of market abuses which incited the public outcry for federal securities legislation in the early 1930s. Above all, a new reading of section 16(b) allows the statute to make better sense.

November 2, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Branson & Okamoto on Definition of Security

The Supreme Court's Literalism and the Definition of 'Security' in the State Courts, by Douglas M. Branson, University of Pittsburgh School of Law, and Karl S. Okamoto, Drexel University College of Law, was recently posted on SSRN.  Here is the abstract:

This Article argues that the Court should not have rejected an overarching economic realities approach to the scope of the federal securities laws. By viewing the developing standards under the famous Howey test as a movement toward a global standard for identifying "securities" rather than simply the subpart "investment contracts," the Court could have allowed for a more coherent doctrinal development.

November 2, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)