Securities Law Prof Blog

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

Friday, February 15, 2008

AXM Pharma Settles Improper Revenue Recognition Charges

The SEC imposed a Cease-and-Desist Order against AXM Pharma, Inc. (AXM). The Order finds that AXM fraudulently recognized approximately $2.8 million in revenues on a series of sales to a distributor in Asia for the quarter ended June 30, 2005, although the sales failed to meet several of the fundamental criteria for revenue recognition under Generally Accepted Accounting Principles. As a result, AXM reported revenues of over $3.2 million for the quarter, overstating its revenue by over 970 percent, and reported net income for the quarter of approximately $179,000, instead of a net loss of approximately $1.46 million.

AXM Pharma consented to the issuance of the Order without admitting or denying the Commission's findings.

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

SEC Launches "Financial Explorer"

The SEC  announced the launch of the “Financial Explorer” on the SEC Web site which, according to Chair Cox, will help investors analyze the financial results of public companies.  According to the press release, Financial Explorer paints the picture of corporate financial performance with diagrams and charts, using financial information provided to the SEC as “interactive data” in eXtensible Business Reporting Language (XBRL).

“XBRL is fast becoming the universal language for the exchange of business information and it is the future of financial reporting,” said Chairman Cox. “With Financial Explorer or another XBRL viewer, investors will be able to quickly make sense of financial statements. In the near future, potentially millions of people will be able to analyze and compare financial statements and make better-informed investment decisions. That’s a big benefit to ordinary investors.”

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

Comcast Announces Plans to Return Cash to Shareholders

Comcast made two announcements designed to placate investors unhappy with its drop in stock price.  It announced a 25 cents per year dividend -- its first since 1999 -- and plans to buy back $7 billion of its shares by the end of 2009.  It also announced more competitive marketing tactics.  Comcast also recently announced that its founder Ralph Roberts' compensation would be reduced and executives would not take their full bonuses.  WSJ, Comcast Plans $7 Billion Buyback.

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

Criminal investigation into Bear Stearns Funds Focuses on Conference Call

A criminal investigation into two failed Bear Stearns funds is focusing on an April 25, 2007 conference call with investors by fund manager Ralph Cioffi.  Two comments in particular: Cioffi said he was "cautiously optimistic" about the funds, while internal emails expressed concern about the funds' ability to withstand the credit crunch.  In addition, Cioffi said he didn't have time to teach "CDO 101" in response to a question about whether the CDOs in the High-Grade Fund were tied to subprime loans.  Cioffi also withdrew $2 million of his own money from one of the funds in March.  WSJ, Bear Probe May Center on Investor Call.

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

Thursday, February 14, 2008

Cox Testifies on Ratings Agencies

Chair Christopher Cox testified today on The State of the United States Economy and Financial Markets before the U.S. Senate Committee on Banking, Housing and Urban Affairs.  Below are excerpts from his testimony on the SEC's examination of the role of credit agencies' ratings:

we are also re-examining the wisdom of the legislative and regulatory provisions that have granted a central role to the rating agencies in our markets. More than just providing the markets one view of the likelihood of default, the past several months have demonstrated the power of credit ratings to move markets, and their potential to create cascading effects in those markets. For example, the precipitous downgrade of the ratings of residential mortgage-backed securities and CDOs affected not only the rated securities but the funds and institutions that held and sponsored them; and now, the actual and anticipated ratings downgrades of the monoline insurers has impacted the ability and willingness of money market funds to hold certain assets, and contributed to a retrenchment from risk as some market participants have lost faith in the ratings.

This sensitivity to changes in credit ratings (which extends to the monoline insurers, whose own ratings determine the degree to which investors and issuers are willing to rely on them) is perhaps nowhere more pronounced than in the municipal securities market. In the municipal market, the lack of uniform, timely, and robust disclosure can leave investors with little more than a credit rating to rely on when making an investment decision. In a letter to the Chairman and Ranking Member of this Committee in July 2007, I proposed a more comprehensive disclosure regime to ensure that investors have access to the same high-quality disclosure from municipal issuers that is already required of corporate issuers. The recent problems reinforce the need for such disclosures. I hope the Committee will seriously consider those proposals to provide investors with better information in this important sector of the market.

Government's contribution to the widespread market reliance on credit ratings, by incorporating them into the regulatory and legal framework, has a long history. But the need to revisit the issue was recognized several years ago. In the Sarbanes-Oxley Act of 2002, the Congress rightly focused on whether the government imprimatur for the ratings agencies was wise. The Sarbanes-Oxley Act required the Commission to study and report on the role of the rating agencies — and that report, in turn, contributed in part to the Credit Rating Agency Reform Act, which has now given the SEC the opportunity to write new rules that can create greater competition and transparency in this area.

During the past 30 years, regulators, including the Commission, have increasingly used credit ratings as a proxy for objective standards for monitoring the risk of investments held by regulated entities. We have also used them as a shorthand to determine what securities may be sold through a streamlined registration process. For example, since 1975 the Commission has relied on credit ratings to distinguish among grades of investment safety in various regulations under the federal securities laws. In addition, a number of federal, state, and foreign laws and regulations today use credit ratings in this and analogous ways. The recent market disruptions highlight the limitations of this arrangement. As a result, I have directed the Commission staff to explore alternatives to Commission regulatory reliance on credit ratings where feasible.

I have also directed the staff to develop proposals for new, more detailed rules under the new Credit Rating Agency Reform Act that respond directly to the shortcomings we have seen through the subprime experience. Among the proposals that the Commission may consider as early as this spring are rules that would require credit rating agencies to make disclosures regarding past ratings, in a format that would improve the comparability of track records and promote competitive assessments of the accuracy of the agencies' past ratings. In addition, new rules could be aimed at enhancing investor understanding of important differences between ratings for municipal and corporate debt and for structured debt instruments.

February 14, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Westinghouse Air Brake Technologies Settles FCPA Charges

The SEC filed two settled enforcement proceedings charging Westinghouse Air Brake Technologies Corporation ("Wabtec") with violations of the Foreign Corrupt Practices Act ("FCPA") in connection with certain improper payments that Wabtec's Indian subsidiary, Pioneer Friction Limited ("Pioneer"), made to employees of the government of India in order to obtain or retain business from the Indian national railway system. Wabtec manufactures, among other things, brake subsystems and related products for locomotives, freight cars and passenger vehicles.

The Commission filed a civil action in the United States District Court for the Eastern District of Pennsylvania charging Wabtec with violating the anti-bribery, books-and-records and internal controls provisions of the FCPA and seeking a civil penalty. The Commission also issued an administrative order finding that Wabtec violated the same provisions of the FCPA. In the administrative proceeding, the Commission ordered Wabtec to cease and desist from such violations, and to disgorge $259,000, together with $29,351 in prejudgment interest. The Commission also required Wabtec to retain an independent consultant to review and make recommendations concerning the company's FCPA compliance policies and procedures. In the federal civil action, Wabtec agreed to the entry of a final judgment requiring it to pay a civil penalty in the amount of $87,000.

February 14, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Charges Broker with Misappropriating Funds From Elderly Client

FINRA announced it has charged registered representative John Edward Mullins, of Margate, NJ, with misappropriating almost $400,000 from a 97-year-old nursing home resident who was a Mullins' client for more than 20 years, as well as from her charitable foundation. The customer has recently passed away. Broker Kathleen Maria Mullins, John Mullins' wife, was also charged with wrongdoing.

In its complaint, FINRA alleges that shortly after the customer's husband died in December 1999, the customer established a charitable foundation to receive and administer funds for the benefit of charities devoted to the promotion of musical arts in Philadelphia and the New Jersey Shore. From its creation, the Mullins both served as trustees and officers of the foundation. When the customer initially entered a nursing home in 2000, the Mullins were provided power of attorney over the customer's assets, including the ability to conduct banking transactions and withdraw funds.

FINRA further alleges that from about April 2006 through July 2006 - when the customer became ill and was hospitalized - Mr. Mullins misappropriated almost $400,000 from his longstanding client. With the elderly customer's health deteriorating, he took advantage of her condition by using her checking account and debit cards to pay for his and his wife's personal expenses, including paying down $375,000 in their joint mortgage credit-line account.  In addition to the customer's personal assets, the complaint charges, funds were also misappropriated from the charitable foundation account, set up by the customer at the brokerage firm that employed the Mullins'.

Under FINRA rules, a firm or individual named in a complaint can file a response and request a hearing before a FINRA disciplinary panel. Possible remedies include a fine, censure, suspension, or bar from the securities industry, disgorgement of gains associated with the violations, and payment of restitution. The issuance of a disciplinary complaint represents the initiation of a formal proceeding by FINRA in which findings as to the allegations in the complaint have not been made and does not represent a decision as to any of the allegations contained in the complaint.

February 14, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC, FBI Subprime Investigations in Early Stages

It may be a while before we see major enforcement or criminal actions stemming from the subprime mortgage collapse and credit crunch.  The FBI has 16 criminal investigations, the SEC has another two dozen, all in early stages, and the SEC has 100 lawyers in its nationwide subprime mortgage working group.  These investigations are slow-going because of the complexity of the issues and the piles of paperwork that need to be sifted through.  Investigators may still be looking for the case that will be straightforward enough to play to a jury.  WPost, A Labyrinthine Path to Justice.

February 14, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Unhappy Investors Left Holding Auction Rate Bonds

Auction-rate bonds are longterm bonds with interest rates reset regularly at monthly auctions.  For over 20 years they were regarded as cashlike investments because of their liquidity, but with a higher rate of return than money market funds, and used to fund college loan programs and municipal building projects.  With the credit crunch, auction bonds become the latest form of exotic security to go south, and unhappy  investors are left with illiquid securities of uncertain value.  Some are seeking redress from their brokers, as the Wall St. Journal recounts in today's page-one story.   WSJ, Debt Crisis Hits a Dynasty.

February 14, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Wednesday, February 13, 2008

SEC Proposes a Plain English Brochure for Investment Advisers

The SEC voted to propose rule amendments requiring investment advisers to prepare and deliver to clients and prospective clients a narrative brochure written in plain English.  Brochures would be made available to the general public through the SEC sponsored Investment Adviser Public Disclosure Web site. The narrative would publicly disclose to investors more detailed information about an investment adviser's business practices, conflicts of interest, and disciplinary history.

The Commission is proposing amendments to Part 2 of Form ADV, the adviser brochure, and related rules under the Investment Advisers Act of 1940. If adopted, more than 10,000 investment advisers registered with the SEC would be required to provide clear, current, and meaningful disclosure in narrative form to nearly 20 million advisory clients.  Most advisers currently use a check-the-box, fill-in-the-blank form for their brochures. The plain English narrative brochure being proposed by the Commission would provide investors with more detailed information about an adviser's business practices, including the types of advisory services they provide, fees they charge, and the risks that clients can anticipate. The narrative also would disclose the disciplinary history of an investment adviser including any violation of the securities laws, as well as conflicts of interest such as the use of affiliates to execute transactions, the use of client brokerage to obtain "soft dollars benefits," and the adviser's interests in certain transactions.

The SEC proposal also would address developing areas of concern, including conflicts of interest arising from the side-by-side management of clients who pay performance fees (such as hedge funds) and those who do not; conflicts of interest arising from an adviser's receipt of compensation from issuers of financial products the adviser recommends to clients; and qualifications of a firm's employees who give advice to clients.

February 13, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Proposes New Disclosure Rules for Foreign Private Issuers

The SEC voted to propose amendments to modernize its disclosure requirements for foreign companies, including eliminating all requirements for paper submissions. Many of the proposed SEC rule changes are designed to update the Commission’s rules, reflect advancements in technology, and respond to the increasing globalization of the capital markets.  One set of proposals, known as the Foreign Issuer Reporting Enhancements, would update Exchange Act filing requirements and enhance disclosure required by foreign private issuers in response to changes in foreign filing requirements, market practices, and other areas of the Commission’s regulation. Another proposal would amend Exchange Act Rule 12g3-2(b), which exempts a foreign private issuer from having to register a class of equity securities under Section 12(g) of the Exchange Act based on the submission to the Commission of certain information published outside the United States, in order to reflect advances in technology and other recent global changes.

February 13, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

NYSE Disciplines Credit Suisse Analyst for Tipping

The NYSE disclosed a disciplinary action against Adam Galeon, a research analyst with Credit Suisse, alleging that he obtained and disseminated certain information before public release. An NYSE hearing officer found that on May 24, 2005, Galeon obtained certain information from the CEO of a publicly traded company, referred to only as XYZ, relating to XYZ’s expected updated earnings guidance. That was the day before the official public release of the company’s updated earnings guidance. Galeon selectively disseminated emails to 17 Firm clients and 31 Firm sales personnel, conveying the information the CEO had disclosed to him. Subsequently, Credit Suisse and two clients of Credit Suisse who received the information in Galeon’s email traded in shares of XYZ, prior to the public release of such information. Without admitting or denying the findings, Galeon agreed to a censure, four-month bar, and a $50,000 fine.

February 13, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

AIG's New ACcounting Troubles Affect Market

AIG's new accounting problems are causing consternation on Wall St. just as the criminal trial involving a past AIG accounting fraud, involving phony loss reserves, is about to go to the jury.  NYTimes, At Trial, Lawyer Says Buffett Gave Approval.  PricewaterhouseCooper's report of a "material weakness" in the valuing of AIG's subprime mortgage-linked securities resulted in a $5 billion writedown and concern that further writedowns are still ahead.  WSJ, Is AIG on Slippery Slope?

February 13, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Senator Bayh Urges More Regulation of SWFs

Senator Evan Bayh, Chair of the Senate Banking Subcommittee of the Security and International Trade & Finance Committee, in an op-ed piece in today's Wall St. Journal, warns about sovereign wealth funds and urges Congress to establish standards for transparency and behavior to prevent unwarranted interference in our economy by foreign governments.  He mentions two specifics:  require passive investment in U.S. corporations and lower the percentage of ownership (currently 10%) that triggers review for national security concerns by the Committee on Foreign Investment.  He specifically cites Citigroup where the foreign investment was under 5%.  WSJ, Time for Sovereign Wealth Rules.

February 13, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, February 12, 2008

SEC Settles Fraud Charges Against Former OCA CFO

The SEC settled charges against Bartholomew F. Palmisano, Jr., the former Chief Financial Officer of OCA, Inc. ("OCA").  The SEC alleged that during twelve different quarters during 1998 through 2001, Palmisano recorded eighteen fraudulent journal entries on OCA's general ledger that had the cumulative effect of creating approximately $71 million of fictitious revenue. The fictitious revenue created by these journal entries was always at least the amount OCA needed to meet that quarter's Wall Street analysts' consensus earnings per share expectations. The false financial information resulting from Palmisano's misconduct was included in at least twelve Forms 10-Q and four Forms 10K for each of the years ended December 31, 1998 through 2001. In May 2005, Palmisano tried to cover-up his fraud and provided false information and documents in response to an inquiry by OCA's independent auditors concerning a fixed asset balance related to one of the fraudulent journal entries.

Palmisano, without admitting or denying the allegations of the Commission's Complaint, consented to the entry of a permanent injunction against future violations, agreed to pay a civil penalty in the amount of $100,000 and will be barred from acting as an officer or director of a public company for ten years. The settlement is subject to the Court's approval.

February 12, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Recent and Past Interviews with Lerach

The Wall St. Journal published excerpts of an interview with William Lerach after his sentencing, in which he states: "I regret that I did not have the strength of character and will to resist doing what I did." WSJ, 'I Was Guilty'. reprints a 2002 interview with Mr. Lerach, when he was at the top of his game.  In response to the question: How widespread do you think these [corporate] scandals will get?, he replied: It really can't get worse than this, can it?, Then and Now: What Lerach Told Us.

Oh Bill.

February 12, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

AIG's Auditors Find Material Weaknesses in Valuing Complex Instruments

More news that calls in question the risk management systems at leading financial institutions -- AIG reported a $4.88 billion charge (5 times more than it predicted in December) resulting from "material weaknesses" identified by its auditor PricewaterhouseCoopers that understated its losses on credit default swaps, or complex financial instruments linked to mortgages and corporate debt.  NYTimes, New Losses at A.I.G. Trouble Wall Street; WSJ, AIG Is Forced To Write Down Mortgage Links.

February 12, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, February 11, 2008

Advisory Committee Urges Mandatory XBRL

The SEC Advisory Committee on Improvements to Financial Reporting (CIFR) voted to submit to Chair Cox a report that urges the SEC to require corporations to filed audited XBRL financial statements in three years., SEC Told to Mandate XBRL.

February 11, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Settles Rule 102(e) Proceeding Against Take-Two's Audit Partner

The SEC settled a Rule 102(e) administrative proceeding against Robert A. Fish, CPA (Fish), the former PricewaterhouseCoopers (PwC) audit engagement partner responsible for the fiscal year end 2000 audit of video game publisher and distributor Take-Two Interactive Software, Inc. (Take-Two).  The Order finds that Fish failed to exercise due professional care during the 2000 audit.  Take-Two fraudulently inflated its revenues and after-tax earnings by arranging with several distributors to "park" several hundred thousand computer and video game units at or near the end of fiscal quarters or the fiscal year.   In addition, Fish failed to test the adequacy of Take-Two's 5% reserve for estimated sales returns at October 31, 2000 as required by GAAS. The Order finds that Fish engaged in improper professional conduct pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice.  Fish consented to the issuance of the Order without admitting or denying the findings contained therein.

February 11, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC's Atkins on Materiality

SEC Commissioner Paul S. Atkins, at the SEC Speaks in 2008 conference, chided the agency for its failure to achieve predictability.  Here is an excerpt on his discussion of the always troublesome definition of "materiality:"

One of the most glaring examples of lack of predictability is determining what constitutes materiality. The crux of our federal disclosure system is that all material information must be disclosed — with an emphasis on material. Yet the age-old question is: What does it mean to be "material"?

Issuers, investors, and regulators have struggled with applying the materiality test since the enactment of the securities laws. Materiality is an objective test: the Supreme Court has said that something is material if "there is a substantial likelihood that a reasonable shareholder would consider it … as having significantly altered the 'total mix' of information made available."

It is not enough that some investors may view a fact as important; rather, it must be important to the reasonable investor. ...In TSC Industries, the Supreme Court clearly understood the problem of materiality. In the unanimous opinion written by Justice Thurgood Marshall, the Court observed that "[s]ome information is of such dubious significance that insistence on its disclosure may accomplish more harm than good." The potential liability for a fraud violation can be great and, so Justice Marshall explained, "If the standard of materiality is unnecessarily low, not only may the corporation and its management be subjected to liability for insignificant omissions or misstatements, but also management's fear of exposing itself to substantial liability may cause it simply to bury the shareholders in an avalanche of trivial information — a result that is hardly conducive to informed decisionmaking."

February 11, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)