Saturday, May 16, 2009
The SEC's reputation suffers another blow, as both the Wall St. Journal and the New York Times report that the U.S. Attorney in D.C. is investigating whether some SEC enforcement division attorneys violated the insider-trading laws. A report by the SEC's Inspector General (which is available in a partially redacted version at the WSJ's website although it is designated nonpublic by the SEC) describes the trading activities of three unnamed enforcement division attorneys and finds that these activities may violate SEC internal rules. One attorney was a frequent trader, making 247 trades in a two-year period. All three met regularly to discuss trading and used their SEC email accounts to send personal messages about stocks. The report finds that the SEC has "essentially no" compliance systems to detect improper trading by its employees. WSJ, Insider Trading Probe at SEC; NYTimes, S.E.C. Lawyers Investigated for Insider Trading.
Friday, May 15, 2009
The SEC and Gary A. Ray, the former vice president of human resources at KB Home, Inc., a Los Angeles-based homebuilder, settled options backdating charges. The SEC's complaint alleges that Ray used hindsight to pick advantageous grant dates for KB Home's annual stock option grants in order to enrich himself and others at KB Home. On many occasions, the grant dates coincided with dates of low monthly closing prices for the company's common stock. The SEC's complaint further alleges that Ray continued to use hindsight for stock option grant dates even after the Sarbanes-Oxley Act of 2002 imposed stricter reporting requirements. The complaint alleges that, because of the backdating scheme, KB Home filed proxy statements with the SEC that inaccurately stated that KB Home granted options at market value on the date of the grant. In addition, the complaint alleges that, by concealing his knowledge about stock option backdating at KB Home, Ray contributed to KB Home's filing of a false and misleading quarterly report with the SEC in 2006. Ray received backdated annual stock option awards amounting to 380,000 shares of KB Home stock and profited more than $480,000 from exercising many of these options.
Ray agreed to settle the Commission's charges without admitting or denying the allegations in the complaint. Under the settlement, Ray consented to the entry of an order that (i) permanently enjoins him from future violations of Sections 10(b), 13(b)(5), and 16(a) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 10b-5, 13b2-1, and 16a-3 thereunder, and aiding and abetting violations of Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a) of the Exchange Act and Rules 12b-20, 13a-13, and 14a-9 thereunder; (ii) requires him to pay $540,651.58 in disgorgement and interest and a civil penalty of $50,000; and (iii) bars him from serving as an officer or director of a public company for five years. The settlement is subject to approval by the court.
On May 14, 2009, the SEC filed an emergency civil injunctive action in the United States District Court for the District of New Jersey charging two investment firms and their two owner-managers with securities fraud. The Commission alleged that Paul G. Bultmeyer, Arthur J. Piacentini, Sherbourne Capital Management, Ltd. and Sherbourne Financial, Ltd. orchestrated an offering fraud in connection with the sale of "Prime Certificates of Participation." The court granted the Commission's application for emergency relief and, among other things, froze the assets of the defendants and appointed a receiver over Sherbourne Capital, Sherbourne Financial, and Relief Defendant Ameripay, LLC.
The Commission alleged that at least since 2004, Bultmeyer and Piacentini have operated the investment firms Sherbourne Capital Management, Ltd. and Sherbourne Financial, Ltd. Bultmeyer and Piacentini also operate Ameripay, LLC, a payroll services company based in Rochelle Park, NJ, that has numerous New Jersey municipalities and small businesses as clients. Bultmeyer is also Chief Executive Officer of Equitair, Ltd., a charter aviation company. The Complaint alleges that Sherbourne Financial, on its website, offered investors "Prime Certificates of Participation" and claimed that Sherbourne would use the proceeds to invest in private placement debt, high-grade corporate bonds, preferred stock, and government securities. Sherbourne claimed that its investments were safe and in some cases insured. The complaint also alleges that Sherbourne, however, did not invest in any such securities. Rather, Sherbourne transferred a net of over $900,000 to Ameripay, Bultmeyer, Piacentini, and Equitair.
Thursday, May 14, 2009
The SEC proposes rule amendments to substantially increase protections for investors who entrust their money to investment advisers. The SEC is seeking public comment on the proposed measures, which are intended to ensure that investment advisers who have “custody” of clients’ funds and securities are handling those assets properly. Unlike banks or broker-dealers, investment advisers generally do not have physical custody of their clients’ funds or securities. Instead, client assets are typically maintained with a broker-dealer or bank (a “qualified custodian”). The adviser still may be deemed to have custody, however, because the adviser has authority to withdraw their clients’ funds held by the qualified custodian, or the qualified custodian may be affiliated with the adviser, which may give the adviser indirect access to client funds.
The SEC’s proposed rule amendments, if adopted, would promote independent custody and enable independent public accountants to act as third-party monitors.
One proposed amendment would require all registered advisers with custody of client assets to undergo an annual “surprise exam” by an independent public accountant to verify those assets exist.
Another proposed amendment would apply to investment advisers whose client assets are not held or controlled by a firm independent of the adviser. In such cases, the investment adviser will be required to obtain a written report — prepared by a PCAOB-registered and inspected accountant — that, among other things, describes the controls in place, tests the operating effectiveness of those controls, and provides the results of those tests. These reports are commonly known as SAS-70 reports. This review would have to meet PCAOB standards — providing an important level of quality control over the accountants performing the review.
The proposed measures also would include reporting requirements designed to alert the SEC staff and investors to potential problems at an adviser, and provide the Commission with important information for risk assessment purposes. An adviser would be required to disclose in public filings with the Commission, among other things, the identity of the independent public accountant that performs its “surprise exam,” and amend its filings to report if it changes accountants. The accountant would have to report the termination of its engagement with the adviser and, if applicable, any problems with the examination that led to the termination of its engagement. If the accountants find any material discrepancies during the surprise examination, they would have to report them to the Commission.
The proposed amendments also would require that all custodians holding advisory client assets directly deliver custodial statements to advisory clients rather than through the investment adviser, and that advisers opening custody accounts for clients instruct those clients to compare account statements they receive from the custodian with those received from the adviser. These additional safeguards would make it more difficult for an adviser to prepare false account statements, and more likely that clients would find discrepancies.
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The full text of the proposed rule amendments will be posted to the SEC Web site as soon as possible.
On March 13 2009 Treasury Secretary Geithner sent to Congress a proposal to regulate OTC Derivatives. The Objectives of Regulatory Reform of OTC Derivatives Markets, as set forth in that proposal, include:
- The Commodity Exchange Act (CEA) and the securities laws should be amended to require clearing of all standardized OTC derivatives through regulated central counterparties (CCP):
- CCPs must impose robust margin requirements and other necessary risk controls and ensure that customized OTC derivatives are not used solely as a means to avoid using a CCP.
- All OTC derivatives dealers and all other firms who create large exposures to counterparties should be subject to a robust regime of prudential supervision and regulation, which will include:
Conservative capital requirements
Business conduct standards
Initial margin requirements with respect to bilateral credit exposures on both standardized and customized contracts
This new framework includes:
- Amending the CEA and securities laws to authorize the CFTC and the SEC to impose:
Recordkeeping and reporting requirements (including audit trails).
Requirements for all trades not cleared by CCPs to be reported to a regulated trade repository.
CCPs and trade repositories must make aggregate data on open positions and trading volumes available to the public.
CCPs and trade repositories must make data on individual counterparty's trades and positions available to federal regulators.
The movement of standardized trades onto regulated exchanges and regulated transparent electronic trade execution systems.
The development of a system for the timely reporting of trades and prompt dissemination of prices and other trade information.
The encouragement of regulated institutions to make greater use of regulated exchange-traded derivatives.
- The Commodity Exchange Act (CEA) and securities laws should be amended to ensure that the CFTC and the SEC have:
Clear and unimpeded authority for market regulators to police fraud, market manipulation, and other market abuses.
Authority to set position limits on OTC derivatives that perform or affect a significant price discovery function with respect to futures markets.
A complete picture of market information from CCPs, trade repositories, and market participants to provide to market regulators.
- Current law seeks to protect unsophisticated parties from entering into inappropriate derivatives transactions by limiting the types of counterparties that could participate in those markets. But the limits are not sufficiently stringent.
The CFTC and SEC are reviewing the participation limits in current law to recommend how the CEA and the securities laws should be amended to tighten the limits or to impose additional disclosure requirements or standards of care with respect to the marketing of derivatives to less sophisticated counterparties such as small municipalities.
The SEC held an open meeting on May 14, 2009 to consider a recommendation from the Division of Investment Management that the Commission propose rules to strengthen the custody controls that apply to investment advisers. The proposal is in response to major investment scams — such as Madoff — and many other potential Ponzi schemes. As explained by Chair Schapiro in her opening remarks:
At its core, the proposal would effectively require that client assets be maintained with a qualified custodian that is independent of the adviser. But, in the case where an adviser or its affiliate maintains custody of client assets, then a PCAOB-registered and inspected public accountant would have to perform an annual custody control examination.
That accountant would also be required to prepare a report describing the custody controls in place and the tests conducted of their operating effectiveness. This report is commonly referred to as a Type II SAS 70 report.
Commissioner Paredes, in his opening remarks, expressed concern about the increased costs the proposal would impose.
I want to emphasize that the new rules that we are considering today are part of a larger package of reforms — all of which are intended to better protect investors from fraud.
Related reforms include improvements to our exam process designed to better identify potential fraud, improvements to the agency's risk assessment process, improvements in the agency's ability to handle complaints and tips, and improvements in the enforcement program designed to ensure that the Commission's enforcement cases are, in the words of our Enforcement Director, "strategic, swift, smart and successful."
Regulatory Reform in the Wake of the Financial Crisis of 2007-2008, by Andrew W. Lo, MIT Sloan School of Management; National Bureau of Economic Research (NBER), was recently posted on SSRN. Here is the abstract:
Financial crises are unavoidable when hardwired human behavior - fear and greed, or “animal spirits” - is combined with free enterprise, and cannot be legislated or regulated away. Like hurricanes and other forces of nature, market bubbles and crashes cannot be entirely eliminated, but their most destructive consequences can be greatly mitigated with proper preparation. In fact, the most damaging effects of financial crisis come not from loss of wealth, but rather from those who are unprepared for such losses and panic in response. This perspective has several implications for the types of regulatory reform needed in the wake of the Financial Crisis of 2007-2008, all centered around the need for greater transparency, improved measures of systemic risk, more adaptive regulations including counter-cyclical leverage constraints, and more emphasis on financial literacy starting in high school, including certifications for expertise in financial engineering for the senior management and directors of all financial institutions.
Measuring Insider Trading Damages for a Private Plaintiff, by William K.S. Wang, University of California, Hastings College of the Law, was recently posted on SSRN. Here is the abstract:
This article discusses various measures of the damages of a private plaintiff who sues a stock market insider trading defendant. The measures are: “pure” out of pocket, “expedient” out of pocket, rescissory, and cover.
The “pure” out of pocket measure is the difference between the transaction price and the real or actual share value. Implicitly, this measure assumes that but-for the defendant's fraud, the plaintiff would have traded at the same time anyway, but at a better price.
The so-called "expedient" out of pocket measure accepts the "pure" out of pocket measure in principle. Nevertheless, to avoid the practical difficulty of determining the real value of the stock at the time of the plaintiff's trade, the "expedient" out of pocket measure substitutes for this "true value" the market price after dissemination of the correct or previously nonpublic information. A variant of the "expedient" out of pocket measure would look to the either dollar or percentage price change at curative dissemination and use this change as a measure of the damages to the plaintiff. The price change at dissemination could be applied to the plaintiff's transaction price to estimate the true value at the time of the plaintiff's trade. To correct for the effects of extraneous factors, more complex variations exist.
The rescissory measure attempts to undo the fraudulent transaction and to return the defrauded party to her position before the fraudulent inducement to enter into the trade. In other words, rescissory damages award a plaintiff the dollar amount at the time of judgment necessary to put her back in her original position at the time of her transaction. This measure implicitly assumes that the plaintiff would not have traded but-for the defendant’s fraud.
For the rescissory measure, courts usually require the plaintiff to prove a contractual relationship with the defendant. Most stock market insider trading plaintiffs are not in contractual privity with the defendant. The rescissory measure would give such plaintiffs an unjustified “free ride” to gain speculative profits from stock price changes until the date of judgment without risking any money. Conceivably, however, rescissory damages might be available to a plaintiff in contractual privity with an insider trading defendant, especially one liable under the classical relationship theory.
Like the rescissory measure, the cover measure implicitly presumes that the plaintiff would not have traded but-for the defendant's fraud. This approach also implicitly assumes that the plaintiff is entitled to a rescissory measure of damages. Nevertheless, the cover measure imposes on the plaintiff the obligation to mitigate damages by reversing her trade within a "reasonable" time after curative disclosure.
Although this article briefly discusses two additional damage measures, “disgorgement of windfall profits” and “benefit of the bargain,” these two measures are not appropriate in stock market insider trading cases.
To select a “fair” measure of damages, one must know what the plaintiff would have done absent the defendant’s fraud. When the plaintiff has bought or sold a publicly traded security, she had an almost infinite number of alternatives. If the plaintiff would have traded at the same time anyway, but at a different price, the "pure" out of pocket or "expedient" out of pocket measures would be appropriate. If the plaintiff would not have traded and would have maintained that position until the time of judgment, the rescissory measure might be proper; but fairness might require the plaintiff to mitigate damages, in which case the cover measure would be appropriate.
Knowing what the plaintiff would have done is difficult because any plaintiff testimony may be self-serving. With class actions, the members of the plaintiff class are not even available to give self-serving testimony and, in any event, are not uniform and would have pursued different courses of action absent the fraud. Therefore, no one measure of damages is “fair.”
The Three or Four Approaches to Financial Regulation: A Cautionary Analysis Against Exuberance in Crisis Response, by Lawrence A. Cunningham, George Washington University Law School, and David T. Zaring, University of Pennsylvania - Legal Studies Department, was recently posted on SSRN. Here is the abstract:
Unprecedented interest in financial regulation reform accompanies the nearly-unprecedented scale of financial calamity facing the world. Dozens of elaborate reform proposals are in circulation, most determined to revolutionize financial regulation. No doubt, the crisis makes reevaluation essential, but we contribute a cautionary analysis amid the exuberant atmosphere. Reforms should not discount the value of traditional financial regulation, overlook the functional regulatory reform that has already occurred, or overstate ultimate differences between contending reform proposals.
Despite proliferation of dozens of reform proposals, our analysis leads us to conclude that there are ultimately only three or four principal alternatives: (1) the traditional fragmented model that divides power and presided over the generation of substantial wealth, yet signally failed to prevent the crisis of 2008; (2) the on-the-fly reforms effected by Treasury and Fed’s massive and unorthodox intervention into and extensive renovation of all financial services industries; and (3) seemingly radical proposals, one by Republicans at the onset of crisis (Treasury Secretary Paulson’s Blueprint), the other by Democrats after financial markets imploded (former Fed Chair Volcker’s Group of Thirty reports).
These three or four alternative approaches pose tests of our relative commitments to markets, organization, globalization and political control. Although each was developed in different circumstances by architects with different purposes, they cannot co-exist. One of them will provide the approach we take into the next crisis - and perhaps to pull us out of the current one. We provide a framework to consider each alternative and evaluate their respective advantages and disadvantages. Our analysis leads us to conclude that limited reform is best, recognizing the quasi-centralization that has occurred and the need to add protective regulation to particular areas that manifestly contributed to the global economic crisis that began in 2008.
Direct and Derivative Claims in Securities Fraud Litigation, by Richard A. Booth, Villanova University School of Law, was recently posted on SSRN. Here is the abstract:
In the typical securities fraud class action under Rule 10b-5, the plaintiff class consists of buyers who seek damages equal to the difference between the price paid for the stock during the fraud period and the lower price that prevails after corrective disclosure. The argument here is that this claim is really an amalgam of direct and derivative claims and that the derivative claims should result in recovery by the corporation for the benefit of all stockholders. There are three types of losses that arise in the typical stock-drop action. First, part of the loss may be attributable to lower expected earnings (fundamental loss). Second, part of the loss may be attributable to an increase in the cost of equity because of increased risk associated with the corporation (capitalization loss). Third, part of the loss may be attributable to the class action itself which if successful will result in a payout by the corporation to settle the litigation (feedback loss). It is not clear that fundamental loss should be actionable since it is a loss that will occur whether or not there is fraud. Capitalization loss may or may not be actionable. If it arises because of harm to the reputation of the corporation as a result of fraud or similar wrongful acts that cause the market to lose trust in the corporation resulting in an increased cost of capital for the corporation, the loss is derivative because it affects the corporation as a whole and affects all stockholders in the same way. On the other hand, the corporation may also suffer a capitalization loss in the absence of any fraud because the market learns new information about firm-specific risk. This loss - like fundamental loss - arises whether or not there is fraud. It should not be actionable. Finally, feedback loss arises only because the corporation pays if the class action is successful. But if the only actionable loss is capitalization loss for which the corporation should recover, there is no justification for a class action, no reason for the corporation to pay, and no feedback loss. In other words, feedback loss goes away if the class action goes away. In short, the only genuine loss in a stock-drop action under Rule 10b-5 is attributable to claims that should be characterized as derivative.
The mystery is why the courts and litigants have failed to characterize such claims as derivative rather than direct. Although there is some doubt whether capitalization loss is actionable as a matter of federal securities law, such claims are clearly actionable under the state law of fiduciary duty, particularly when there is insider misappropriation involved. The fact that such claims are litigated as direct class claims rather than derivative claims is especially puzzling because most stock is held by well-diversified institutional investors that lose from class actions. Such investors are equally likely to sell (gain) as to buy (lose) during the fraud period. Gains and losses net out over time. So the cost of litigation is a deadweight loss that reduces portfolio return. Moreover, because the corporation pays if the action is successful, the net effect is that holders pay buyers. A diversified investor who buys a few shares during the fraud period to add to existing holdings may lose more on its holdings than it gains from any recovery. Thus, diversified investors should be opposed to direct class actions in principle. They should favor derivative actions that seek recovery by the corporation for any loss such as capitalization loss from fraud. But each of the constituencies that might advocate for derivative actions - institutional investors, defendant corporations, and the plaintiff bar - is afflicted by a disabling conflict that discourages reform. An institutional investor cannot afford to opt out of securities fraud class action because by doing so it would effectively pay as a holder without the benefit of an offsetting recovery as a buyer. Defendant corporations may be reluctant because insurance may not cover claims made in the context of a derivative action. And the plaintiff bar may be disinclined to prosecute derivative actions with much vigor because attorney fees are likely to be significantly greater in a class action. As a result, reform is unlikely unless the courts take the initiative. But this is arguably as it should be. It is well settled that procedure is a matter for the courts. And the characterization of claims as direct or derivative is a judicial function governed by the rules of procedure. Besides, the securities fraud class action is a judicial invention. Thus, the courts have the power and the duty to clean up the mess.
The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis, by Arthur E. Wilmarth Jr., George Washington University Law School, was recently posted on SSRN. Here is the abstract:
Since the subprime financial crisis began in mid-2007, banks and insurers around the world have reported $1.1 trillion of losses. Seventeen large universal banks account for more than half of those losses, and nine of them either failed, were nationalized, or were placed on government-funded life support. Central banks and governments in the U.S., U.K. and Europe have provided $9 trillion of support to financial institutions to prevent the collapse of global financial markets.
Given the massive losses suffered by universal banks, and the extraordinary governmental assistance they have received, they are clearly the epicenter of the global financial crisis. They were also the main private-sector catalysts for the credit boom that precipitated the crisis. During the past two decades, governmental policies in the U.S., U.K. and Europe encouraged consolidation and conglomeration within the financial services industry. Domestic and international mergers among commercial and investment banks produced a dominant group of large, complex financial institutions (LCFIs). By 2007, seventeen LCFIs held leading positions in domestic and global markets for securities underwriting, syndicated lending, asset-backed securities (ABS), over-the-counter (OTC) derivatives, and collateralized debt obligations (CDOs).
Universal banks pursued an “originate to distribute” (OTD) strategy, which included (i) originating consumer and corporate loans, (ii) packaging loans into ABS and CDOs, (iii) creating OTC derivatives whose values were derived from loans, and (iv) distributing the resulting securities and other financial instruments to investors, including off-balance-sheet conduits. LCFIs used the OTD strategy to maximize their fee income, reduce their capital charges, and transfer to investors the risks associated with securitized loans.
Securitization enabled LCFIs to extend huge volumes of home mortgages and credit card loans to nonprime borrowers. By 2006, LCFIs turned the U.S. housing market into a system of “Ponzi finance,” in which nonprime borrowers kept taking out new loans to pay off old ones. When home prices fell in 2007, and nonprime homeowners could no longer refinance their loans, defaults skyrocketed and the subprime financial crisis began.
Universal banks also followed reckless lending and securitization policies in the commercial real estate and corporate sectors. LCFIs included many of the same aggressive loan terms (including interest-only provisions and high loan-to-value ratios) in commercial mortgages and leveraged corporate loans that they included in nonprime home mortgages. In all three markets, LCFIs believed that they could (i) originate risky loans without properly screening borrowers and(ii) avoid costly post-loan monitoring of the borrowers’ behavior, because the loans were transferred to investors. In addition, LCFIs retained residual risks from their securitization programs due to (1) “warehoused” holdings of loans, ABS and CDOs, and (2) contractual and reputational commitments. Accordingly, when securitization markets collapsed in mid-2007, universal banks were exposed to significant losses.
Current regulatory policies – which rely on “market discipline” and LCFIs’ internal “risk models” – are plainly inadequate to control the proclivities in universal banks toward destructive conflicts of interest and excessive risk-taking. As shown by repeated government bailouts during the present crisis, universal banks receive enormous subsidies from their status as “too big to fail” (TBTF) institutions. Regulation of financial institutions and financial markets must be urgently reformed in order to eliminate (or greatly reduce) TBTF subsidies and establish effective control over LCFIs.
Tuesday, May 12, 2009
The SEC instituted settled cease-and-desist proceedings against Ingram Micro Inc. (Ingram Micro), a computer technology distribution company based in Santa Ana, California, finding that the company violated the books and records and internal controls provisions of the securities laws in the course of its business dealings with McAfee, Inc., formerly known as Network Associates, Inc. (McAfee) during a period when McAfee was engaged in a financial fraud. As part of the settlement with the Commission, Ingram Micro will pay disgorgement of $15 million.
This is the final enforcement action arising out of the Commission's investigation into the McAfee financial fraud. In January 2006, the Commission charged McAfee with carrying out a channel-stuffing scheme from 1998 through 2000, in which it employed various manipulative accounting artifices and secretly provided its distributors with substantial cash payments, price discounts, rebates and other concessions to continue buying and to not return excess inventory. . The Commission found that, from the second quarter of 1998 through the third quarter of 2000, Ingram Micro engaged in a variety of highly irregular transactions with McAfee, many lacking economic substance, that enabled McAfee to oversell its products to Ingram Micro and report materially inflated revenues from those sales in its public statements and Commission filings. Ingram Micro, which was McAfee's single largest source of sales, was compensated by McAfee for engaging in these irregular transactions through the payment of millions of dollars of unearned profits, cash payments, and excess inventory fees.
The Commission found that Ingram Micro's books, records, and accounts failed to accurately and fairly reflect its transactions with McAfee, and that Ingram Micro failed to devise and maintain a system of internal controls sufficient to provide reasonable assurance that its transactions were executed in accordance with management's general or specific authorization. Ingram Micro was ordered to cease and desist from committing or causing any violations and any future violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934, and ordered to pay disgorgement of $15 million.
Ingram Micro, in agreeing to the settlement, neither admitted nor denied the Commission's findings.
The SEC settled Foreign Corrupt Practices Act books and records and internal controls charges against Novo Nordisk, a Danish company that specializes in the manufacture and development of pharmaceutical products and is a leading supplier of insulin worldwide. The Commission's complaint alleged that from 2000 through 2003, Novo Nordisk paid $1,437,946 in kickbacks and agreed to pay an additional $1,315,454 in kickbacks in connection with its sale of humanitarian goods to Iraq under the United Nations Oil for Food Program (the "Program"). The kickbacks were characterized as "after-sales service fees" ("ASSFs"), but no bona fide services were performed. The Program was intended to provide humanitarian relief for the Iraqi population, which faced severe hardship under international trade sanctions. The Program required the Iraqi government to purchase humanitarian goods through a U.N. escrow account. The kickbacks paid by Novo Nordisk diverted funds out of the escrow account and into Iraqi-controlled accounts at banks in countries such as Jordan.
Novo Nordisk, without admitting or denying the allegations in the Commission's complaint, consented to the entry of a final judgment permanently enjoining it from future violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and ordering Novo Nordisk to disgorge $4,321,523 in profits plus $1,683,556 in pre-judgment interest, and a civil penalty of $3,025,066. Novo Nordisk will also pay a $9,000,000 penalty pursuant to a deferred prosecution agreement with the U.S. Department of Justice, Fraud Section. The Commission considered remedial acts promptly undertaken by Novo Nordisk and the cooperation the company afforded the Commission staff in its investigation.
The SEC and the U.S. Department of Labor will hold a joint one-day hearing on June 18 to explore issues relating to target date or lifecycle funds and other similar investment options. Details concerning the hearing will be announced by the agencies in the next few weeks. The hearing will focus generally on issues facing investors in these types of products, and will explore topics such as portfolio composition, risk, and disclosure. The agencies anticipate that witnesses will include representatives of plan participants and beneficiaries, plan sponsors, investor organizations, academia and the financial services industry.
The SEC charged West Palm Beach, Fla.-based INTECH Investment Management LLC and its former chief operating officer David E. Hurley with violating the SEC's proxy voting rule for investment advisers by not sufficiently describing its proxy voting policies and procedures and failing to address a material potential conflict of interest. The proxy voting rule requires registered investment advisers to adopt proxy voting policies and describe them to clients, including procedures to address material conflicts of interest that may arise between the adviser and its clients. The rule is designed to ensure that advisers vote proxies in their clients' best interests, and provide clients with information about how their proxies are voted. This is the first enforcement action taken by the SEC for a proxy voting rule violation.
In a settled administrative proceeding against INTECH and Hurley, the Commission's order finds that INTECH exercised voting authority over client securities without including in its policies and procedures how it would address material potential conflicts of interests. Specifically, INTECH chose a particular set of voting recommendations for all clients without addressing and describing in the policies and procedures its potential effect on INTECH's ability to retain and obtain business from a particular subset of its clients. INTECH and Hurley consented to the issuance of a Commission order without admitting or denying any of the findings. INTECH agreed to pay a penalty of $300,000 and Hurley agreed to pay a $50,000 penalty.
According to the Commission's order, INTECH managed institutional portfolios for pension plans, foundations, unions, public funds and public corporations. As part of its investment advisory services, INTECH exercised voting authority over many of its clients' securities or proxies. In connection with the proxy voting rule, which became effective March 10, 2003, INTECH adopted and implemented written proxy voting policies and procedures and provided them to its clients. Hurley reviewed and edited counsel's drafts of those policies and procedures.
The SEC's order finds that after receiving complaints from some of its union-affiliated clients about pro-management proxy votes, INTECH selected a third-party proxy voting service provider's guidelines to vote in accordance with AFL-CIO-based proxy voting recommendations for all clients' securities. INTECH selected the guidelines that followed the AFL-CIO proxy voting recommendations at a time when it was participating in the annual AFL-CIO Key Votes Survey that ranked investment advisers based on their adherence to the AFL-CIO recommendations on certain votes.
When INTECH advised its clients about its proxy voting policies and procedures, it told clients that because it relied on a third-party proxy voting service, it did not expect that any conflicts would arise in the proxy voting process.
Accordingly, the Commission order finds that INTECH's policies and procedures did not include how INTECH would address material potential conflicts of interests that may have arisen between its interests and those of its clients. INTECH also did not sufficiently describe its proxy voting policies and procedures to clients.
The Commission's order finds INTECH willfully violated, and Hurley willfully aided and abetted and caused violations of, Section 206(4) of the Investment Advisers Act of 1940 and Rules 206(4)-6(a) and (c) thereunder. In addition to the financial penalties, the order censures INTECH and Hurley and requires them to cease and desist from committing or causing any violations and any future violations of those provisions.
New York's Attorney General Andrew M. Cuomo announced that Julio Ramirez, an unlicensed placement agent formerly associated with Wetherly Capital Group, has pled guilty to securities fraud under New York’s Martin Act in Cuomo’s ongoing investigation into corruption involving the New York State Common Retirement Fund (“the CRF”). Ramirez’s plea arises from his participation in fraudulent schemes involving multiple investment transactions with the CRF while he was an unlicensed placement agent associated with Wetherly Capital, a placement agent and broker-dealer. Between 2003 and 2006, Ramirez entered into corrupt arrangements with Hank Morris, the top political adviser to then Comptroller Alan Hevesi, to secure investments from the CRF for Wetherly clients and others. Transactions included FS Equity Partners V, the Ares Corporate Opportunities Fund II, and the Aldus/NY Emerging Fund.
Attorney General Cuomo has also charged former state Liberal Party Chairman Ray Harding with allegedly obtaining over $800,000 in illegal fees on State pension fund investments as a reward for over 30 years of political support to Hevesi. Additionally, hedge fund manager Barrett Wissman pleaded guilty last month to a felony charge under the Martin Act for conduct related to the pension fund.
In addition, the SEC filed civil charges against Ramirez relating to his alleged participation in the fraudulent scheme. The SEC has previously charged Morris and David Loglisci with orchestrating this wide-ranging scheme to enrich Morris and others and has alleged that Aldus and one of its founding principals, Saul Meyer, also participated in the scheme by agreeing to pay kickbacks to Morris. The SEC's amended complaint alleges that Ramirez aided and abetted violations of Section Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. The complaint seeks permanent injunctions against future violations of the federal securities laws, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties.
FINRA announced that it ordered Ramon Luis Dominguez, President of RD Capital Group in Puerto Rico, to pay restitution of $950,000 plus interest to three customers victimized when Dominguez and the firm charged undisclosed, excessive and fraudulent markups on the sale of United States Treasury STRIPS. Dominguez and the firm were fined $50,000. Dominguez was suspended as a principal for 30 days and in all capacities for five business days. Dominguez and the firm agreed to the sanctions to resolve charges first brought against them in a FINRA complaint in November 2007.
FINRA found that between August 2005 and October 2005, RD Capital and Dominguez sold over $34 million in U.S. Treasury STRIPS to the three customers, charging total markups of $1,289,727. STRIPS, an acronym for Separate Trading of Registered Interest and Principal Securities, are zero-coupon U.S. Treasury fixed-income securities generally sold at a significant discount to face value. FINRA found that Dominguez failed to disclose to his customers the amounts of the markups, which ranged from 3.5 percent to 6.2 percent. These markups were excessive and fraudulent because the amount charged was greater than the amount warranted by market conditions, the cost of executing the transactions and the value of the services rendered to the customers.
In concluding these settlements, RD Capital and Dominguez neither admitted nor denied the allegations in the complaint.