November 14, 2008
Treasury's Kashkari Testifies Before House Oversight Committee
Interim Assistant Secretary for Financial Stability Neel Kashkari testified today before the House Committee on Oversight and Government Reform, Subcommittee on Domestic Policy to provide an update on the Treasury Department's actions to stabilize the financial markets and restore the flow of credit to the economy. He reported that the government has taken action with "the following three critical objectives: one, to provide stability to financial markets; two, to support the housing market by preventing avoidable foreclosures and supporting the availability of mortgage finance; and three, to protect taxpayers."
SEC Obtains Judgment Against Unregistered Principal of Broker-Dealer
On November 14, 2008, the U.S. District Court for the Southern District of New York entered a final judgment against defendants Michael W. Crow, Duncan Capital LLC, Duncan Capital Group LLC and Robert David Fuchs. The court found that Crow and Duncan Capital Group LLC had unlawfully acted as an unregistered principal of Duncan Capital LLC, a registered broker-dealer, and were aided and abetted by the registered broker-dealer's principal, Robert David Fuchs.
The SEC's complaint alleges that from late 2003 through at least December 2004, Crow controlled virtually every significant aspect of Duncan Capital's operations and received the vast majority of the firm's profits. Duncan Capital's regulatory filings, however, failed to identify Crow as an officer, director or "control affiliate" of the firm, and falsely stated that (1) no court had ever enjoined any of Duncan Capital's control affiliates in connection with an investment-related activity; and (2) the Commission had never entered an order against any of the firm's control affiliates in connection with an investment-related activity. The SEC's complaint also alleged that Fuchs, the owner and nominal president of Duncan Capital, made false regulatory filings on behalf of Duncan Capital and otherwise facilitated Crow's undisclosed control of the firm by, among other things, transferring Duncan Capital's profits to other entities Crow controlled.
The court ordered that:
Crow and Duncan Capital Group LLC disgorge ill-gotten gains of $1,562,337, plus prejudgment interest in the amount of $437,415.87, for a total of $1,999,752.87;
Fuchs disgorge ill-gotten gains of $221,000, plus prejudgment interest of $61,874.95, for a total of $282,874.95;
Crow, Fuchs, Duncan Capital and Duncan Capital Group disgorge ill-gotten gains of $3,903,474, plus prejudgment interest of $1,092,877, for a total of $4,996,351;
Relief defendant M.W. Crow Family LP disgorge ill-gotten gains of $831,624, plus prejudgment interest of $232,834.46, for a total of $1,064,458.46;
Relief defendant Santal Holdings LLC disgorge ill-gotten gains of $42,162, plus prejudgment interest of $11,804.17, for a total of $53,966.17.
The court further ordered Crow and Fuchs to pay penalties of $250,000 and $125,000 respectively, and ordered Duncan Capital LLC and Duncan Capital Group LLC to each pay a penalty of $50,000.
SEC Announces Agenda for Small Business Capital Formation
The SEC announced the agenda and expected panelists for its November 20 forum on small business capital formation. The forum will focus on the impact of recent capital market events on small business capital formation in the United States. Topics for discussion will include the current credit crisis, regulatory initiatives to facilitate small business capital formation, and intermediaries assisting small businesses with raising capital and M&A activities.
Roundtable Panel on Small Business Capital Formation and the Current Credit Crisis
Karen Kerrigan, Small Business & Entrepreneurship Council
Chad Moutray, Office of Advocacy, U.S. Small Business Administration
David A. Bochnowski, Peoples Bank SB, NorthWest Indiana Bancorp
Tom W. Burke, Wells Fargo & Company
Daniel M. Covitz, Board of Governors of the Federal Reserve System
James W. Hammersley, U.S. Small Business Administration
Kenneth R. Pelowski, Pinnacle Ventures
Edward Pollock, Office of Comptroller of the Currency
Andrew J. Sherman, Dickstein Shapiro LLP
Roundtable Panel on Current Issues in Securities Regulation for Smaller Companies
Steven E. Bochner, Wilson Sonsini Goodrich & Rosati
Gerald J. Laporte, SEC Office of Small Business Policy
David A. Bochnowski, Peoples Bank SB, NorthWest Indiana Bancorp
Brian V. Breheny, SEC Division of Corporation Finance
Aaron M. Gurewitz, Roth Capital Partners, LLC
Kara B. Jenny, Bluefly, Inc.
William D. Lutz, SEC 21st Century Disclosure Initiative
E. Rogers Novak, Jr., Novak Biddle Venture Partners
Roundtable Panel on Private Placement and M&A Brokers
Brian A. Bussey, SEC Division of Trading and Markets
Gregory C. Yadley, Shumaker, Loop & Kendrick, LLP
Faith Colish, Carter Ledyard & Milburn
Denise Voight Crawford, Texas State Securities Board
Kristina A. Fausti, SEC Division of Trading and Markets
Shane B. Hansen, Warner Norcross & Judd, LLP
Mike Ribet, Focus Capital Advisors
Dennis Roberts, The McLean Group
SEC, CFTC & Fed Reserve Enter MOU on Credit Default Swaps
The SEC, the CFTC, and the Federal Reserve Board entered into a Memorandum of Understanding dealing with central counterparties for over-the-counter credit default swaps. PWG Announces Initiatives to Strengthen OTC Derivatives Oversight and Infrastructure.
November 13, 2008
FINRA Fines Citigroup Global Markets for Overcharges on Commissions
FINRA announced today that it has fined Citigroup Global Markets, Inc. of New York $300,000 for failing to reasonably supervise the commissions its brokers charged on stock and option trades. Although not part of the formal sanctions, the firm has offered to reimburse affected customers. FINRA found that between 2002 and 2007, Citigroup utilized a "Commission Calculator" that computed commission charges on stock and options trades, taking into account certain factors such as the price of the security and the number of shares or options in the transaction. But FINRA found that prior to October 2007, Citigroup did not formally communicate the existence of its calculated commission rates to its brokers, nor did it ever communicate that the firm generally did not permit brokers to charge commissions that exceeded the rates the firm determined to be reasonable. In addition, there was effectively no firm-imposed limitation on the commissions a registered representative could charge for options trades. A sample of trading, including options trades, revealed commissions in excess of 20 percent for a small number of option trades.
In the case of those commissions which exceeded the firm's calculated rates, Citigroup had no policies or procedures to identify and determine the appropriateness of the commissions pursuant to FINRA rules regarding the factors to consider in determining the fairness of commissions. Those factors include the price of the security and the amount of money involved in the transaction.
Citigroup also had no related supervisory procedures for its branch or regional supervisory employees. Branch management at the three branches investigated by FINRA Enforcement did not supervise for excessive commissions on individual trades on a regular basis.
As a consequence of the firm's inadequate supervision, during the period from April 2002 to January 2006, one registered representative charged approximately 27 customers commissions that were substantially in excess of the firm's calculated rate for appropriate charges. He overcharged one customer approximately $1.2 million. Two other registered representatives in different branch offices also overcharged commissions on a repeated basis, but on a smaller scale.
In concluding this settlement, Citigroup neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
SEC Charges Two Former McKesson Employees with Misappropriating Inside Information
The SEC has instituted two separate enforcement actions against former employees of McKesson Corp. for insider trading in connection with its 2005 acquisition of D&K Healthcare:
It filed a complaint against William M. Gallahair, a former Vice President of Sales, for insider trading in advance of McKesson Corporation's public announcement on July 11, 2005 that it intended to acquire D&K Healthcare Resources. According to the complaint, filed in the United States District Court for the Northern District of California - San Francisco Division, Gallahair misappropriated material, non-public information from McKesson about its planned acquisition of D&K through a tender offer and purchased shares of D&K stock based on that information. The SEC alleges that Gallahair first learned about the planned acquisition eighteen days before McKesson publicly announced its tender offer for D&K when he overheard a telephone conversation by his supervisor about McKesson's integration plans for D&K. According to the Commission's complaint, Gallahair's supervisor had been selected to lead the team of McKesson employees preparing to integrate D&K's operations into McKesson. The complaint alleges that shortly after overhearing his supervisor's conversation, Gallahair purchased 20,000 shares of D&K stock and, when McKesson publicly announced its tender offer for D&K, Gallahair placed orders to sell all of his shares of D&K stock and realized profits of over $120,000. The complaint also alleges that on several occasions when he has been questioned about his trading, Gallahair has given conflicting explanations of his reasons for purchasing shares of D&K stock.
The SEC also filed a settled civil injunctive action against Jonathan Wilson, a former senior manager in McKesson's finance department, for insider trading in advance of McKesson Corporation's public announcement that it intended to acquire D&K Healthcare Resources, Inc. The complaint alleged that Wilson misappropriated material, non-public information from McKesson about its planned acquisition of D&K through a tender offer and purchased shares of D&K stock in several accounts belonging to his family members based on that information. According to the SEC, Wilson learned about McKesson's acquisition plans for D&K through his supervisor, who along with others conducted due diligence on D&K in April and May 2005. Wilson worked close to and regularly visited his supervisor's cubicle. The complaint alleges that while Wilson did not personally receive official advance notice of McKesson's acquisition of D&K, Wilson learned about the acquisition by overhearing his supervisor's meetings and phone calls about D&K and viewing documents regarding D&K left in plain view on his supervisor's desk. According to the complaint, after learning of McKesson's anticipated acquisition of D&K, Wilson purchased 17,530 shares of D&K in 12 different brokerage accounts belonging to various members of his family.
Wilson consented upon the filing of the Commission's complaint to the entry of a final judgment permanently enjoining him from violating the antifraud and tender offer provisions of the federal securities laws and requiring him to pay disgorgement of $117,045.87.
SEC Will Consider Credit Ratings and Mutual Fund Disclosure at Next Meeting
The SEC announced the agenda for its Nov. 19 Open Meeting as follows:
Item 1: The Commission will consider whether to adopt rule amendments that would impose additional requirements on nationally recognized statistical rating organizations in order to address concerns about the integrity of their credit rating procedures and methodologies.
Item 2: The Commission will consider whether to adopt rule amendments to improve mutual fund disclosure by providing investors with a summary prospectus containing key information in plain English in a clear and concise format, and by enhancing the availability on the Internet of more detailed information to investors. The Commission also will consider whether to adopt related amendments to Form N 1A, including amendments that address exchange-traded funds.
Former Aspen Technology Officers Settle Revenue Inflation Charges
The United States District Court for the District of Massachusetts entered final judgments by consent against former Aspen Technology, Inc. ("Aspen") founder and Chairman of the Board of Directors Lawrence B. Evans and former Chief Executive Officer David L. McQuillin in a case filed by the SEC in January 2007. According to the SEC, Evans and McQuillin participated in a fraudulent revenue inflation scheme with another senior officer of Aspen. Without admitting or denying the allegations in the Commission's complaint, McQuillin and Evans each consented to the entry of a final judgment enjoining them from violating the anti-fraud and other provisions of the securities laws. McQuillin was also ordered to pay an $85,000 civil penalty, $28,381.61 in disgorgement and pre-judgment interest, and was barred from serving as an officer or director of any public company, and Evans was ordered to pay a $75,000 civil penalty and $21,478.01 in disgorgement and pre-judgment interest.
According to the Commission's complaint, Evans and McQuillin, along with former Aspen Chief Financial Officer Lisa W. Zappala, caused Aspen to report inflated revenue in the company's publicly-filed financial statements and in press releases on at least six software transactions during fiscal years 1999 through 2002. The Complaint alleged that the three defendants caused Aspen to recognize revenue during the relevant period despite knowing that Aspen was prohibited from doing so under Generally Accepted Accounting Principles because contracts were not signed within the appropriate quarter and/or the earnings process was incomplete due to contingency arrangements which changed the terms of the customers' payment commitments under the contracts. The Complaint alleged that, as a result of the fraudulent scheme, Aspen overstated license revenue for its fiscal year ended June 30, 2000 by 5.5% and for the fiscal year ended June 30, 2001 by 9.3%. The Complaint further alleged that, as a result of prematurely recognized revenue from those earlier periods, license revenue for the fiscal years ended June 30, 2002, 2003, and 2004 was understated by 1.8%, 13.9%, and 4.0% respectively.
The Commission's action against Zappala remains pending.
November 12, 2008
SEC and Blue Coat Systems Settle Backdating Charges
The SEC settled charges alleging that network security company Blue Coat Systems, Inc. and its former chief financial officer Robert P. Verheecke backdated stock option grants to executives and employees and reported false financial information to shareholders. According to the SEC, from approximately 2000 through 2005, Blue Coat concealed nearly $50 million in compensation expenses associated with valuable "in-the-money" options by backdating paperwork to make it appear as if the options had been granted on earlier dates. Blue Coat and Verheecke have agreed to settle the SEC's charges without admitting or denying the allegations. Verheecke will pay more than $185,000 in disgorgement, penalties, and prejudgment interest.
Cox on Regulatory Reform
SEC Chairman Christopher Cox spoke on 'Building on Strengths in Designing the New Regulatory Structure' at the PLI 40th Annual Securities Regulation Institute, in New York, New York, on November 12, 2008. Here is an excerpt from his speech:
One tangible outcome of appointing a [Congressional] Select Committee on Financial Services Regulatory Reform could be a consolidation of the SEC and the Commodity Futures Trading Commission into a single agency with a clear mandate to protect investors by regulating the markets in all financial investments, including securities, futures, and derivatives. Similar consolidation is needed in the banking arena, were a half-dozen federal regulators overlap not only with each other but with state agencies.
The lessons of the credit crisis all point to the need for strong and effective regulation, but without major holes and gaps. They also highlight the need for a strong SEC, which is unique in its arm's-length independence from the institutions and persons it regulates. For example, banks regulated by the Federal Reserve Bank of New York elect six of the nine seats on the board of the New York Fed. Both the CEOs of J.P. Morgan Chase and Lehman Brothers served on the New York Fed board at the beginning of the credit crisis. In contrast, the SEC's regulation and enforcement are completely institutionally independent.
Some have tried to use the current market crisis as an argument for replacing the SEC in a new system that relies more on supervision and less on regulation and enforcement. That same recommendation was made before the current crisis a year ago, for a very different and inconsistent reason: that the U.S. was at risk of losing business to less-regulated markets. But what happened in the mortgage meltdown and the ensuing credit crisis demonstrates that where SEC regulation is strong and backed by statute, it is effective. And where it relies on voluntary compliance, or simply has no jurisdiction at all, it is not.
Not only the current crisis, but the significant corporate scandals such as Enron and WorldCom earlier this decade, have amply demonstrated the need for independent, strong securities regulation and enforcement. That's why an independent SEC, regulating at arm's length, will remain as important in the future as ever it has been before. If the SEC did not exist, Congress would have to create it.
November 11, 2008
CFTC Chair Outlines Reform Proposal
CFTC Acting Chairman Walter L. Lukken gave the keynote speech before FIA Futures and Options Expo, in Chicago today and put forth his vision of regulatory reform. Specifically:
I believe the United States should scrap the current outdated regulatory framework in favor of an objectives-based regulatory system consisting of three primary authorities: a new Systemic Risk Regulator, a new Market Integrity Regulator and a new Investor Protection Regulator. This objectives–based framework is similar in concept to the reforms advanced by Treasury Secretary Paulson’s Blueprint and Paul Volcker’s Group of Thirty Report.
A new Systemic Risk Regulator would have the responsibility of policing the entirety of the financial system for “black swan” risks that could cause a contagion event and take preventative action against such occurrences. Such a regulator does not exist in the current framework but is absolutely necessary given the witnessed interconnections of our financial markets and the speed of the current global crisis. A new Market Integrity Regulator would oversee the safety and soundness of key financial institutions, including exchanges, investment firms and commercial banks whose failure may jeopardize the integrity of the markets. A new Investor Protection Regulator would broadly oversee investor protection and business conduct across all firms in the marketplace. This objectives-based framework focuses on risks from the macro to micro levels and would be a radical departure from the current structure. The different functions of the CFTC, as well as the SEC and the various banking regulators, would be dispersed among these three regulatory authorities.
The CFTC Chairman disagreed with SEC Chairman Cox's proposal for a merger of the CFTC and SEC:
One idea that has been put forth as both a permanent and interim reform step is a simple merger of the CFTC and the SEC. In Washington, this is code for the larger SEC—along with its rules-based model and culture—taking over the principles-based CFTC. In my view, this would be ineffective and would only reinforce our outdated regulatory structure. Simple merger is a recycled idea when bold solutions are needed.
November 10, 2008
SIFMA Holds TARP Summit
SIFMA held on Summit on TARP on November 10, at which Interim Assistant Secretary for Financial Stability Neel Kashkari presented remarks. In addition, the SIFMA website has webcasts of both Kashkari's remarks and Senator Charles Schumer's speech.
NASAA Reminds ARS Investors of Redemption Deadlines
NASAA reminded ARS investors of their redemption opportunities, which were reached as part of the settlements between securities regulators and several prominent Wall Street firms, and urged investors to contact the firms from which they originally purchased their ARS.
Some firms have established ARS hotlines. Those firms and their ARS hotlines are: Bank of America (866-638-4183), Citi (866-720-4802), Deutsche Bank (866-926-1437), Goldman Sachs (888-350-2857), JP Morgan (866-450-8470), Merrill Lynch (888-706-1381), Morgan Stanley (800-566-2273), UBS (800-253-1974) and Wachovia (866-283-7943).
In settlements reached with state and federal securities regulators, 11 firms have agreed in principle to repurchase more than $50 billion of auction rate securities. In consideration of the settlements, securities regulators agreed to terminate their investigations into the marketing and sale of auction rate securities to individual investors.
SEC Charges Individual with Fraudulently Obtaining Investors' Funds
The SEC filed an injunctive action in the United States District Court for the Southern District of Illinois against Jeffrey Laumbattus, alleging that he fraudulently obtained approximately $150,000 from at least twelve individuals who believed that he would invest their monies in the U.S. stock market for their benefit. In fact, the Commission alleges, Laumbattus never invested in the stock market any of the monies he received from those investors and used them for his personal use. The SEC also filed an application for a temporary restraining order in order to freeze Jeffrey Laumbattus' assets.
The Commission's complaint alleges that Laumbattus sought out investor funds by holding himself out as a consultant with "Moriah Group," a fictitious investment firm. Laumbattus falsely represented to investors that Moriah Group had been managing millions of dollars for large institutional investors since 1950 with average annual returns of 300 percent, and falsely represented to investors that their money would be pooled with large sums invested by institutional investors, in order to achieve a greater return on their money. The complaint further alleges that Laumbattus signed correspondence to investors on Moriah Group letterhead under a fictitious name as the purported "managing director" of Moriah Group, to further the appearance of a legitimate investment firm
The complaint seeks a permanent injunction, disgorgement of ill-gotten gains with prejudgment interest, and civil money penalties. On November 4, 2008, Laumbattus was indicted and charged with securities, wire and mail fraud.
SEC Sets Aside NASD Findings & Sanctions as to Two Brokers
The SEC set aside NASD's findings of violation and sanctions against registered representatives James Wade Browne and Kevin Calandro. NASD had previously found that Browne and Calandro violated NASD Conduct Rules 3040 and 2110 by engaging in private securities transactions involving the securities of e2 Communications, Inc. without prior notice to, and prior written approval from, their member firms. NASD concluded that Browne and Calandro "participated" in the purchases of e2 stock by fourteen investors, for which NASD imposed upon Browne a six-month suspension and $25,000 fine and imposed upon Calandro a three-month suspension and $5,000 fine.
In setting aside NASD's findings of violation, the SEC found that, with respect to several investor purchases, "the record before us does not establish by a preponderance of the evidence . . . a factual nexus between the conduct of Browne or Calandro and the specific [stock] purchases at issue" sufficient to satisfy the definition of "participation" in a securities transaction as established by Commission precedent. With respect to other investor purchases, the Commission found that the "evidence is insufficient to find Applicants liable under Rule 3040 for participating" in those purchases as charged.
November 9, 2008
Aguilar on SEC Enforcement
Newly appointed SEC Commissioner Luis A. Aguilar made his first publicly available speech before the 14th Annual Securities Litigation and Regulatory Practice Seminar in Atlanta, Georgia on October 31, 2008. Among other things, he stated:
While I applaud the tireless work of our staff, I do think the Commission can do more to fulfill its law enforcement role. I am particularly concerned by the potential drop off in large investigations, and by the dramatic decline in the past few years in the amount of penalties the Commission seeks and collects. In light of recent events, it is important now more than ever for the Commission’s enforcement staff to focus resources on cases involving the most egregious behavior with broad market effect and to be able to clearly send a message of deterrence.
Cox Speaks on International Enforcement Cooperation
SEC Chairman Christopher Cox spoke on The Importance of International Enforcement Cooperation in Today's Markets at the SEC International Enforcement Institute, Washington, DC, on November 7, 2008. Among other things, he reported that:
At this moment, the SEC is working on 12 open subprime investigations with our foreign regulatory counterparts. Some of these are large scale and complex investigations that require cooperative access to each other's files. In some of these matters there is also an ongoing criminal investigation, both here in the United States and abroad.
Choi on Lead Plaintiffs
Motions for Lead Plaintiff in Securities Class Actions, by Stephen J. Choi, New York University - School of Law, was recently posted on SSRN. Here is the abstract:
Using a dataset of securities class actions filed from 2003 to 2005, this paper assesses the effect of the lead plaintiff presumption enacted as part of the Private Securities Litigation Reform Act of 1995 (PSLRA) on agency costs between lead counsel for the class and class members. Examining the pre-trial motions for lead plaintiff status for each class action, the paper reports evidence that plaintiffs' attorneys retain significant control over the selection of lead plaintiff, forming groups of plaintiffs to ensure their selection as lead counsel and cutting side deals to determine the selection of lead plaintiff and thereby lead counsel. Using proxies for where plaintiffs' attorneys have relatively greater influence over the selected lead plaintiff, the paper reports that plaintiffs' attorneys with greater power are able to negotiate higher attorneys' fees as a percentage of the recovery and work fewer hours.
Heminway & White On Branson
WANTED: Female Corporate Directors (A Review of Professor Douglas M. Branson's No Seat at the Table), by Joan MacLeod Heminway, University of Tennessee College of Law, and Sarah White, University of Tennessee College of Law, was recently posted on SSRN. Here is the abstract:
In his 2007 book No Seat at the Table, Professor Douglas Branson aptly describes how patterns of male dominance inherent in the legal structures of corporate governance reproduce themselves again and again to keep women out of executive suites and boardrooms, and then he offers a practical way to break this cycle of dominance-through paradigm shifting. A central value of Professor Branson's book derives from this thesis, as well as his use of nontraditional empirical data and interdisciplinary literature (in addition to more traditional decisional law and legal scholarship) to support the positions he takes. Moreover, No Seat at the Table is an invaluable resource because it collects in one volume varied research materials and related information at the intersection of women and corporate boards and because it offers further support for diversification of boards of directors as part of the overall effort to strengthen corporate governance practices and promote more productive, efficient, and trustworthy corporations.
This review is designed to explore these strengths-and a few related weaknesses-in Professor Branson's approach. Specifically, the review highlights three key strengths of Professor Branson's work: his thorough and useful report of 2001 and 2005 proxy data from public company filings with the U.S. Securities and Exchange Commission, his account of the effects of tokenism in the boardroom, and his analysis of the obstacles women face in climbing the rungs to the top of the corporate ladder. The review then evaluates the strengths and weaknesses of his proposed paradigm shifting as an effective way to procure female advancement to executive ranks and board positions. Finally, the review examines the potential shortcomings of Professor Branson's observation and suggestion that the differences between men and women are inconsequential and should be minimized and, further, how these statements (when taken out of context) conflict with his efforts to keep women in the pipeline toward upper management.