Securities Law Prof Blog

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

Wednesday, November 26, 2008

Former Diebold Sales Rep Settles Inside Trading Charges

On November 19, 2008, the United States District Court for the Western District of Oklahoma entered final judgment against Robert G. Cole in SEC v. Cole, Civ 08-265 C (W.D. Okla.), an insider trading case the Commission filed on March 13, 2008. The Commission’s complaint alleged that Cole, a former sales representative for Diebold, Inc., made over $500,000 in illegal profits by using material, nonpublic information to trade Diebold securities. Diebold is an Ohio-based public company that manufactures and sells automated teller machines, bank security systems, and electronic voting machines.

The Commission’s complaint alleged that on September 15, 2005, shortly after learning from his sales manager that revenues and orders in Diebold’s North American regional bank business were significantly below target, Cole began purchasing hundreds of soon-to-expire Diebold put options contracts, at a total cost of $70,110, anticipating that Diebold would lower its earnings forecast and the price of Diebold stock would fall. As alleged in the complaint, on September 21, 2005 — one day after Cole completed purchasing these Diebold put option contracts — Diebold announced that it was lowering its earnings forecasts, primarily because of a revenue shortfall in the company’s North American regional bank business. After this public announcement, Diebold’s stock price dropped sharply, closing at $37.27 per share, which was a 16% drop from the previous day’s closing price of $44.13. As the complaint alleged, Cole immediately sold the Diebold put option contracts for $579,190, realizing illicit profits of $509,080 (a 700% return).

The Commission alleged that Cole violated Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. Without admitting or denying the allegations in the complaint, Cole consented to the entry of a final judgment that permanently enjoins him from future violations of these provisions, and orders him to disgorge his illicit profits of $509,080, which will be deemed satisfied by a forfeiture order entered in a related criminal case. In that case, U.S. v. Robert Cole, No. 5:08-CR-327 (N.D. Ohio), Cole pled guilty to a felony charge of securities fraud, and was sentenced to a prison term of 1 year and 1 day, two years of supervised release, forfeiture of $509,080, and a $180,000 fine.

November 26, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 25, 2008

IOSCO Technical Committee Studies Regulatory Reform

The International Organization of Securities Commissions (IOSCO) Technical Committee launched three task forces to support G-20 aims following a meeting by teleconference today. The Technical Committee Task Forces will consider the following issues:

Short Selling — the Task Force will work to eliminate gaps in various regulatory approaches to naked short selling, including delivery requirements and disclosure of short positions. In this connection, the Task Force will also examine how to minimize adverse impacts on legitimate securities lending, hedging and other types of transactions that are critical to capital formation and to reducing market volatility. The Task Force will be chaired by the Securities and Futures Commission of Hong Kong;
Unregulated Financial Markets and Products — given the impact unregulated financial markets and products have had on global capital markets, the Task Force will examine ways to introduce greater transparency and oversight to unregulated market segments, such as OTC markets for derivatives and other structured financial products. The Task Force will be co-chaired by the Australian Securities and Investments Commission and the Autorité de Marché Financiers of France; and
Unregulated Financial Entities — the Task Force will examine issues surrounding unregulated entities such as hedge funds, including the development of recommended regulatory approaches to mitigate risks associated with their trading and traditional opacity. The Task Force will be chaired by the CONSOB of Italy and the Financial Services Authority of the United Kingdom.

The Task Forces will present their reports at the next Technical Committee meeting in February 2009 and to the next G-20 summit in spring 2009.


November 25, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

AIG Announces Restrictions on Executive Compensation

In response to New York AG Cuomo's inquiry last week, AIG announced voluntary restrictions on executive compensation that include a $1 salary for its Chief Executive Officer; no 2008 annual bonuses and no salary increases through 2009 for AIG's top-seven-officer Leadership Group; and no salary increases through 2009 for the 50 next-highest executives, in addition to other bonus, severance and retention award restrictions.  In a letter to Mr. Cuomo, CEO Edwary Liddy noted the importance of "fair and reasonable incentives" to retain staff.  He also stated that no taxpayer dollars would be used for annual bonuses or future cash performance awards for the top 60 members of management.

November 25, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, November 24, 2008

Prosper Marketplace Settles Charges It Offered Unregistered Securities

The SEC settled administrative proceedings against Prosper Marketplace, Inc. (Prosper). The SEC Order finds that Prosper violated the registration provisions of the Securities Act of 1933 during the period January 1, 2006 through October 14, 2008, by engaging in the unregistered offering of securities via Prosper's online lending platform. Prosper offers loans in a double-blind, auction-like process wherein multiple lenders bid to fund loans to borrowers. Since the inception of its platform in January 2006, Prosper has initiated approximately $174 million in loans.

The loans are non-recourse in nature and in amounts between $1,000 and $25,000. Lenders and borrowers register on the website and create Prosper identities. Potential lenders bid on funding all or portions of loans for specified interest rates, which are typically higher than rates available from financial institutions. Individual lenders do not actually lend money directly to the borrower; rather, the borrower receives a loan from a bank with which Prosper has contracted. The interests in a given loan are then sold and assigned through Prosper to the lenders, with each lender receiving an individual non-recourse promissory note in the amount of the lender's bid. Prosper collects an origination fee from each borrower of one to three percent of loan proceeds and collects servicing fees from each lender of one percent of loan payments. Prosper administers the collection of loan payments from the borrower and the distribution of such payments to the lenders. Prosper also initiates collection of past due loans from borrowers, assigns delinquent loan accounts to collection agencies and sells defaulted loans to debt purchasers. Lenders and borrowers are prohibited from transacting directly and from learning each others' true identities.

Based on the above, the Order orders Prosper to cease and desist from committing or causing any violations and any future violations of Sections 5(a) and (c) of the Securities Act of 1933. Prosper consented to the issuance of the Order without admitting or denying any of the findings in the Order.

November 24, 2008 in SEC Action | Permalink | Comments (2) | TrackBack (0)

Sunday, November 23, 2008

Massachusetts Securities Division Charges Oppenheimer in ARS Downstream Sales and Inside Trading

The Massachusetts Securities Division brought an administrative complaint charging Oppenheimer & Co. and several of its executives with violations of the Massachusetts securities law in connection with its "downstream" sales of auction rate securities (ARS).  The complaint alleges that Oppenheimer significantly misrepresented the nature of the ARS and the overall stability and health of the ARS market when marketing the product to its customers.  In addition, key Oppenheimer executives sold their own ARS when they learned the market was in danger of imploding, without disclosing this information to investors.  Specifically, the complaint alleges that CEO Albert Oppenheimer sold $1.77 million of his personal holdings in January and February 2008, and Greg White, Managing Director of ARS Dept., sold $400,000 of his own and his wife's business ARS holdings in the same time period.   

November 23, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Jones on Regulatory Redundancy

Legitimacy and Corporate Law: The Case for Regulatory Redundancy, by Renee M. Jones, Boston College - Law School, was recently posted on SSRN.  Here is the abstract:

This article provides a democratic assessment of the corporate law making structure in the United States. It draws upon the basic democratic principle that those affected by legal rules should have a voice in determining the substance of those rules. Although other commentators have noted certain undemocratic aspects of corporate law, this Article is the first to present a comprehensive assessment of the corporate regulatory structure from the perspective of democracy. It departs from prior accounts by looking past the states' role to consider the ways that federal regulation shores up the legitimacy of the overarching structure.

This focus on the federal role provides some comfort on a democratic account, but also counsels caution with respect to continuing efforts to limit the scope of the federal role within the corporate governance structure. At the federal level, Congress has chosen to regulate corporate matters by setting broad policy objectives and delegating administrative tasks to the Securities and Exchange Commission ("SEC"). The democratic legitimacy of the corporate regulatory regime thus requires proper respect for the discretion that Congress has vested in the agency.

The Article therefore urges skepticism toward efforts to constrain the SEC's regulatory role through judicial challenges to its rulemaking authority. It argues that the SEC's ability to respond deftly to market crises and scandals has been unnecessarily hampered by a tradition of aggressive judicial review of agency rulemaking. While rooted in concerns for preserving democratic accountability for agencies, this tradition has undermined the very values it seeks to protect. Because the procedures for SEC rulemaking comport well with democratic values, the agency deserves more deference than courts have been willing to allow.

The analysis has implications for current proposals to reform regulation of the national financial markets. Recent calls to weaken the SEC's role in financial regulation should give pause to those concerned with the democratic integrity of our regulatory processes. It is the SEC's political independence that strengthens its ability to navigate the rough terrain of regulating the powerful industries within its jurisdiction. Bolstering rather than diminishing the agency's independence should therefore be a central element of any proposal to improve our financial regulatory system.

November 23, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Haslem on Disclosure to Mutual Fund Directors

What Independent Directors Should "Request" of Mutual Fund Advisers, by John A. Haslem, University of Maryland - Robert H. Smith School of Business, was recently posted on SSRN.  Here is the abstract:

The expenses, costs, and practices of mutual fund
advisers are not disclosed with normative transparency to
independent directors and shareholders. Such complete
disclosure is absolutely essential if independent directors are to
be vigorous and effective monitors of fund advisers.
To this end, directors should "request" advisers to provide
them with normative disclosure, especially with respect to fund
costs and expenses.

This disclosure requires a new "total expense ratio" that includes the many "hidden" costs and expenses. This comprehensive disclosure has four major components, each with specified categories and subcategories,and discussion: (1) management fees, (2) distribution fees, (3) "other" fund expenses, and (4) transaction costs.

However, there are several major impediments to
independent directors requesting normative transparency of
disclosure. Independent directors are not adequately
empowered under the 40Act, and they have been generally
ineffective in preventing use of numerous (often improper)
adviser practices designed to increase their profits. In fact, for
various reasons, directors often take positions sympathetic to
the profit motives of fund advisers.

November 23, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Schwarcz on Securitization

The Future of Securitization, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN.  Here is the abstract:

This essay examines the future viability of securitization in light of its causal involvement in the subprime-mortgage financial crisis. Securitization has many positive attributes. It efficiently allocates risk with capital, it enables companies to access capital markets directly (in most cases at lower cost than the cost of issuing direct debt), and it avoids middleman inefficiencies. When the securitized assets are loans, securitization helps to transform the loans into cash from which banks and other lenders can make new loans. These positives might be outweighed, however, by four negatives of securitization revealed by the subprime crisis: subprime mortgages were a flawed asset type that should not have been securitized; the originate-and-distribute model of securitization can create moral hazard; securitization can create servicing conflicts; and securitization can foster overreliance on mathematical models. This essay examines these negatives and the extent to which they can be remedied in the future.

November 23, 2008 in Law Review Articles | Permalink | Comments (1) | TrackBack (0)

Macey, O'Hara & Rosenberg on Subprime Mortgage Brokers

Helping Law Catch Up to Markets: Applying Broker-Dealer Law to Subprime Mortgages, by Jonathan R. Macey, Yale Law School; Maureen O'Hara, Cornell University - Samuel Curtis Johnson Graduate School of Management; Gabriel D. Rosenberg, Yale University - Law School, was recently posted on SSRN.  Here is the abstract:

Much of the blame for the current financial crisis is attributable to problems in the subprime mortgage market. In this Article we argue that changes in the nature of the mortgage contract make it both legally plausible and normatively desirable that subprime mortgages brokers be treated as securities broker-dealers for the purposes of the Securities Act of 1933 and the Securities and Exchange Act of 1934. Modern subprime mortgages are, in large part, investments that contain imbedded options and are not subject to any alternative comprehensive regulatory regime. Thus, they should qualify as "notes" under the Securities Act definition and the Supreme Court's Reves test, and expose their brokers to Rule 10b-5 oversight. In the alternative, we argue that the emergence of securitization as the primary process by which mortgages are financed provides a second, independent analytical basis for our theory that subprime mortgages financings should be subject to securities law: Mortgage financings qualify for the protections of rules such as SEC Rule 10b-5 because they occur "in connection with the purchase or sale of a security," the mortgage-backed security that is created and funded on the basis of the cash flows from the mortgagors' payments on their subprime mortgages.

Were the SEC to take control of subprime mortgages brokers, rules that forbid the sale of financial instruments to any person unless investing in those instruments is appropriate (suitable) to the investment needs and risk tolerance of that investor would come into play, oversight that would have avoided or greatly mitigated the current crisis. In describing what suitability would do for the mortgage market, we make a novel distinction between "product" and "transaction form" suitability in our analysis of the suitability rules. We argue that transaction form suitability is the appropriate legal theory to use when pursuing people who have unscrupulously sold subprime mortgages to unsophisticated investors. In closing, we discuss reasons why we believe the SEC has not tried to exert this authority to date.

November 23, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)