June 11, 2009
Riverstone Settles Pay-to-Play Charges with New York AG
New York Attorney General Andrew M. Cuomo today announced an agreement with private equity firm Riverstone Holdings LLC (“Riverstone”) to reform the public pension fund investment system and to resolve Riverstone’s role in Cuomo’s investigation of corruption involving the New York State Common Retirement Fund (“the CRF”). Under the terms of today’s agreement, Riverstone will adopt Cuomo’s Public Pension Fund Code of Conduct and pay $30 million in restitution to the CRF.
Attorney General Cuomo’s code of conduct bans investment firms from hiring, utilizing, or compensating placement agents, lobbyists, or other third-party intermediaries to communicate or interact with public pension funds to obtain investments. To avoid pay-to-play schemes, the Code prohibits investment firms (and their principals, agents, employees and family members) from doing business with a public pension fund for two years after the firm makes a campaign contribution to an elected or appointed official who can influence the fund's investment decisions. This provision would also bar all firms currently doing business with the pension fund from making such campaign contributions. Investment firms must also disclose any conflicts of interest to public pension fund officials or law enforcement authorities, to increase transparency and avoid abuse of the fund for personal gain.
Riverstone is the second company to sign on to Cuomo’s Code of Conduct and will pay $30 million in restitution to the CRF. This brings to $50 million the total amount collected by Attorney General Cuomo on the Carlyle/Riverstone investments. The Carlyle Group (“Carlyle”) signed onto the code last month and paid $20 million to the State of New York to resolve its role in the Attorney General’s ongoing investigation.
SEC v. Bear Stearns & Co.
I am pleased to introduce Professor Jill Gross (Pace) as an occasional guest blogger. Today Jill analyzes SEC v Bear Stearns & Co. (S.D.N.Y. June 10, 2009), the final installment in the Global Research Analyst Settlement:
Yesterday, in the SEC enforcement action that resulted in the well-known $1.4 billion Global Research Analyst Settlement of 2003, United States District Judge William H. Pauley III of the Southern District of New York issued an opinion addressing the “quandary” of what to do with the “undisbursable,” residual settlement funds. In the underlying action, the SEC alleged that research analysts employed by numerous investment banks failed to disclose conflicts of interest in their research reports. The consent judgments originally provided for, among other things, monetary payments by the named investment banks of $460 million for independent investment research, $528.5 million in disgorgement and penalties to the states, $432.75 million in federal disgorgement and penalties, and $85 million for investor education programs.
However, as the opinion notes, the SEC provided no detailed plan for the distribution of the federal disgorgement monies as restitution to aggrieved investors, instead leaving it to the district court to work out. Judge Pauley heavily criticized the SEC and the settling investment banks for their lack of specificity and forethought as to the “destiny of the disgorgement and penalties,” which led them to submit a proposed Distribution Plan. Following the approval of the plan, Judge Pauley appointed a Distribution Fund Administrator, who embarked on five-year effort to identify and locate potential claimants for the monies. Judge Pauley then details the torturous history of the Fund Administrator’s efforts and difficulties in locating claimants for the $432.75 million. In the end, $75 million still remained undistributed.
After skewering the SEC for its misstep in agreeing to monetary settlements with no mathematical or formulaic connection to identifiable investor losses, Judge Pauley addresses and rejects various third party requests (including a consortium of investor justice law school clinics) for a cy pres distribution of the residual funds. Notably, Judge Pauley expressly declines to authorize payment to FINRA because of the “disappointing performance” of FINRA’s Investor Education Foundation in awarding grants for investor education programs, and the SEC’s failure to properly oversee the Foundation. He asks: “When will the SEC exercise its responsibility to ensure that these substantial sums are expended to educate the investing public?” With no other entity available as worthy to him, Judge Pauley orders that the residual funds be transferred to the United States Department of Treasury “to be used by the Government for its operations. Pragmatism, simplicity and the need for finality also counsel this denouement.” Judge Pauley cynically concludes his lengthy opinion with this observation:
In the final analysis, this Court does not question the SEC’s interest in bringing to an end improper conduct. Nor does it question the SEC’s interest in recompensing investor victims and deterring future violations. However, whether the SEC has the institutional resolve and commits adequate resources to reach these goals is an open question. (emphasis added)
SEC Publishes Proposed Rules on Shareholder Nominations
The SEC posted on its website the proposed rules on Facilitating Shareholder Nominations. According to the release, the SEC is proposing changes to the federal proxy rules to remove impediments to the exercise of shareholders’ rights to nominate and elect directors to company boards of directors. The new rules would require, under certain circumstances, a company to include in the company’s proxy materials a shareholder’s, or group of shareholders’, nominees for director. The proposal includes certain requirements, key among which are a requirement that use of the new procedures be in accordance with state law, and provisions regarding the disclosures required to be made concerning nominating shareholders or groups and their nominees. In addition, the new rules would require companies to include in their proxy materials, under certain circumstances, shareholder proposals that would amend, or that request an amendment to, a company’s governing documents regarding nomination procedures or disclosures related to shareholder nominations, provided the proposal does not conflict with the Commission’s disclosure rules – including the proposed new rules.
Comments may be submitted through the SEC's website and are due 60 days after the proposal is published in the Federal Register.
June 10, 2009
SEC Charges Husband of Former Merrill Employee and Two Others with Insider Trading
The SEC charged three Canadian citizens, Phillip Macdonald, Martin Gollan, and Michael Goodman, with insider tipping and trading in the securities of several companies ahead of public announcements of business combinations. According to the SEC, between January and June 2005, Goodman's wife, while employed as an administrative assistant with Merrill Lynch Canada, Inc., learned the identities of a number of companies involved in contemplated, but unannounced, business combinations. When they were discussing what was happening at her job, Goodman's wife sometimes mentioned the information to Goodman, expecting that he would keep it confidential. Goodman instead misappropriated the information by disclosing it to his friend and business associate, Macdonald and to another business associate, Gollan. On the basis of the information, Macdonald and Gollan then purchased securities ahead of announcements of business combinations, including the securities of Creo Inc., Masonite International Corporation, Eon Labs, Inc., Performance Food Group Company, Great Lakes Chemical Corporation, Shopko Stores, Inc., Electronics Boutiques Holdings Corp., and Commercial Federal Corporation. As a result of their illegal trading, Macdonald made over $900,000 in ill-gotten gains, and Gollan made over $90,000 in ill-gotten gains.
Without admitting or denying the allegations in the Commission's complaint, Goodman has consented to entry of a proposed final judgment permanently enjoining him from further violations of Sections 10(b) and 14(e) of the Exchange Act and Rules 10b 5 and 14e 3 thereunder. Additionally, the final judgment finds Goodman liable for disgorgement of the trading profits of Macdonald and Gollan in the amount of $1,023,054, plus prejudgment interest of $251,301.42, but waives payment of those amounts and does not impose a civil penalty, based on his sworn Statement of Financial Condition. Goodman's settlement is subject to approval by the District Court.
The Commission seeks a final judgment ordering Macdonald and Gollan to disgorge all ill-gotten gains, with prejudgment interest thereon; imposing civil money penalties; and enjoining Macdonald from future violations of Sections 10(b) and 14(e) of the Exchange Act and Rules 10b 5 and 14e 3 thereunder and Gollan from future violations of Section 10(b) of the Exchange Act and Rule 10b 5 thereunder.
SEC Will Review Compensation Disclosure Again
SEC Chairman Schapiro announced that the agency is considering proposals for additional disclosure regarding executive compensation:
[T]he SEC is actively considering a package of new proxy disclosure rules that will provide further sunshine on compensation decisions. While these proposals would not dictate particular compensation decisions, they would lead companies to analyze how compensation impacts risk taking and the implications for long term corporate health of the behavior they are incenting.
“To achieve this, we will be considering several proposals requiring greater disclosure:
• About how a company — and its board — manages risks.
About a company’s overall compensation approach. Incentive structures that rewarded short term risk taking without taking into account the potential long term effects on the company are widely believed to have contributed to the economic crisis.
About potential conflicts of interest by compensation consultants, including disclosure of relationships between the consultants and the company and their affiliates, so both compensation committees and investors will be better able to assess the advice the consultants provide.
And, about director nominees, including their experience and qualifications to serve on the board or on particular board committees — and about why a board has chosen its particular leadership structure.
“Knowing this kind of information can be of great benefit to investors, but even disclosure only takes us so far. If investors don’t like what they learn, they have two choices: sell their shares or use the proxy process to vote for change. Unfortunately, neither of these options is easy. Selling their stock deprives the investor of the upside value that change can bring. And, under current rules, shareholders who wish to nominate their own candidates must typically launch a costly proxy fight.
“It is for this reason that last month the SEC proposed rules that would enhance the ability of shareholders to exercise their legal rights to nominate directors on corporate boards. Of course, these proposals are just that — “proposals” — and we fully expect to receive many comments about them. I believe the meaningful ability of shareholders to nominate directors is intricately linked to the ability of shareholders to hold directors accountable for their compensation decisions.
“I firmly believe that better disclosure of compensation leads to more informed shareholders and in turn to more accountable corporate directors. This is the foundation of our capital markets.”
Meanwhile, Kenneth Feinberg has been appointed compensation czar to set executive compensation at seven of the largest corporations that have received federal rescue funds. NYTimes, Obama Names Overseer to Set Pay at Rescued Companies.
Finally, Treasury Secretary Geithner released a statement on Compensation today, in which he stated that he met with Schapiro, Federal Reserve Governor Dan Tarullo, and top experts to examine how to better align compensation practices – particularly in the financial sector – with sound risk management and long-term growth:
In considering these reforms, we start with a set of broad-based principles that – with the help of experts like those we assembled today – we expect to evolve over time. By outlining these principles now, we begin the process of bringing compensation practices more tightly in line with the interests of shareholders and reinforcing the stability of firms and the financial system.
SEC Settles Fraud Charges Against New York Adviser
The SEC settled charges against Matthew D. Weitzman, an investment adviser who lives in Armonk, N.Y., for allegedly orchestrating a scheme in which he stole more than $6 million in investor funds for his own personal use, in some instances victimizing clients who were terminally ill or mentally impaired. According to the SEC's complaint, Weitzman is the co-founder and a principal of AFW Wealth Advisors, the business name for AFW Asset Management, Inc., a registered investment adviser located in Purchase, N.Y., with an office in Natick, Mass. Weitzman also served as AFW's compliance officer.
The SEC alleges that Weitzman sold securities in clients' brokerage accounts and illegally funneled their money to a bank account that he secretly controlled. While Weitzman spent the money on a multi-million dollar home, cars, and other luxury items, he provided false account statements to clients often showing inflated account balances and securities holdings. Weitzman also submitted to a broker-dealer phony letters from clients that purported to authorize the money transfers. When clients questioned Weitzman about the transfers they did not authorize, he misrepresented that he was withdrawing their funds to make legitimate investments.
The SEC's complaint charges Weitzman with violating Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940, and with aiding and abetting violations of Section 204 and Rules 204-2(a)-3 and 204-2(a)(7) also of the Advisers Act. The complaint seeks a permanent injunction, disgorgement of ill-gotten gains plus prejudgment interest, financial penalties, an asset freeze, a sworn accounting, an order prohibiting the destruction of documents, and a requirement that Weitzman notify the SEC and obtain approval of the court before he files for bankruptcy protection.
Weitzman agreed to settle the SEC's claims and, without admitting or denying the allegations, consented to the entry of a judgment that will grant the SEC the full relief that it seeks, but will defer the determination of the financial amounts of the settlement until a later date. The agreement to resolve the SEC's action is subject to approval by the court.
June 9, 2009
Reforms, Past and Present
Two interesting articles on regulatory reform, present and past, in today's Wall St. Journal:
1. An article expands on the rumor I reported on yesterday, that the Obama administration is paring down its reform proposals and will not propose a consolidation of some regulators, such as a merger of the SEC and CFTC. Instead, the approach will be on authorizing tougher ruling. Sounds like a gigantic missed opportunity for meaningful reform. WSJ, Finance Reforms Pared Back.
2. And speaking of past reforms -- the subsidy of independent research by major securities firms, an important component of the 2003 Conflicted Analysts Settlement principally negotiated by then-New York AG Spitzer, is about to end, and perhaps no one will miss it. Recent reports are that retail investors are not using the independent research and indeed may be unaware of its existence. WSJ, Stock-Research Reform to Die?
SEC Charges Wyoming Company with Oil & Gas Fraudulent Offerings
The SEC filed charges against Berkshire Resources, L.L.C. ("Berkshire"), a Wyoming company purportedly involved in oil and gas exploration, its principals, Jason T. Rose and David G. Rose, the six companies through which Berkshire carried out a securities offering - Berkshire (40L), L.L.P., Berkshire 2006-5, L.L.P., Passmore-5, L.L.P., Gueydan Canal 28-5, L.L.P., Gulf Coast Development #12, L.L.P., Drilling Deep in the Louisiana Water, J.V. (collectively, the "Berkshire Offerings")- alleging securities fraud in connection with an oil and gas offering fraud. In its complaint, the Commission alleges that from April 2006 through December 2007, Berkshire raised approximately $15.5 million from about 265 investors in the U.S. and Canada through a series of unregistered, fraudulent offerings of securities in the form of "units of participation." The defendants marketed the offerings to the public through cold call sales solicitations, and at trade shows and "wealth expositions." The purported purpose of the offerings was to fund oil and gas development projects that Berkshire was to oversee. According to the complaint, Jason Rose was the public face of Berkshire and was held out as its lead manager with significant experience in the oil and gas industry. In reality, Jason Rose had no experience managing an oil and gas company, and David Rose, Jason's father, ran the company behind the scenes. David Rose has an extensive disciplinary history for securities fraud and is facing a criminal indictment in connection with another similar but unrelated oil and gas scam.
SEC Charges Swiss National with Insider Trading in connection with 2006 GlaxoSmithKline Merger
The SEC filed charges against Lorenz Kohler (Kohler), a resident of Mels, Switzerland, and Swiss Real Estate International Holding AG (Swiss Real Estate) alleging that they engaged in insider trading in advance of the October 9, 2006 public announcement of a $566 million merger between CNS and GlaxoSmithKline plc. The Complaint alleges that Kohler purchased out-of-the-money call options in CNS in his personal account and in an account in the name of Swiss Real Estate, a company controlled by Kohler, based on material non-public information relating to the company's potential acquisition. The Commission alleges that Kohler and Swiss Real Estate realized illicit gains of approximately $387,566. The Commission further alleges that Kohler tipped his wife and his brother-in-law, who then traded in CNS options in advance of the announcement of the acquisition of CNS and realized significant illicit gains. According to the Complaint, Kohler has engaged in a pattern of highly suspicious trading both prior to and immediately after the trades in CNS securities that are charged in the Complaint. During late 2005 and 2006, Kohler and a group of his friends and relatives also traded in the securities of five other public companies in advance of acquisitions or earnings announcements. The Complaint alleges that Kohler and his circle of traders realized over $5 million in profits on these trades.
SEC Files Charges Alleging Ponzi Scheme Aimed at Korean Americans
And still another ponzi scheme -- this one operating out of California and directed at Korean-Americans:
The SEC charged two California men and two companies they control for conducting an $80 million Ponzi scheme that targeted Korean-American investors with false promises of extraordinarily high returns from foreign currency (forex) trading. The SEC alleges that Peter C. Son and Jin K. Chung lured approximately 500 investors in the United States, South Korea, and Taiwan into their investment scheme in which funds were not traded in the forex market as claimed, but instead used to pay cash "returns" to certain investors in Ponzi-like fashion. They also misappropriated investor money for their own personal use, including mortgage payments on Son's multi-million dollar home. The SEC is seeking an emergency court order to freeze the defendants' assets.
According to the SEC's complaint, filed in federal district court in San Francisco, Son and Chung operated their scheme through SNC Asset Management, Inc. (SNCA) and SNC Investments, Inc. (SNCI), which maintained offices in Pleasanton, Calif., and New York City. Son and Chung promised investors spectacular annual returns of up to 36 percent from forex trading, and told investors that SNCA had generated 50 percent profits from such trading each year since 2003. Among other relief, the SEC seeks court orders prohibiting the defendants from engaging in future violations of these provisions; freezing their assets and compelling them to return overseas assets to the U.S.; and requiring them to disgorge their ill-gotten gains and pay financial penalties.
Yesterday, Son appeared in federal court in Oakland, Calif., on federal criminal charges. Separately today, the Commodity Futures Trading Commission announced civil fraud charges against Son, Chung, SNCA, and SNCI.
June 8, 2009
SEC Charges Warrior Energy Director with Tipping Information about Merger
On June 8, 2009, the SEC filed a Complaint for Injunctive and Other Relief ("Complaint") in the United States District Court for the Western District of Louisiana against Robert L. Hollier ("Hollier") and Wayne A. Dupuis ("Dupuis"). This matter involves insider trading in the securities of Warrior Energy Services Corporation ("Warrior Energy") by Dupuis, who received tips directly or indirectly from Hollier, a member of Warrior Energy's board of directors.
The Complaint alleges that during the latter part of August 2006, Hollier had knowledge of pending merger talks between Warrior Energy and Superior Energy Services, Inc. ("Superior Energy"). The information constituted material nonpublic information. Hollier tipped Dupuis about the pending merger during a Canada hunting trip that Hollier and Dupuis both attended. The Complaint further alleges that on September 18, 2006, the day he returned from the hunting trip, Dupuis purchased 5,000 shares of Warrior Energy stock for approximately $85,000. Dupuis, who had no prior history of trading Warrior Energy shares, sold the only two stocks in his portfolio to buy the Warrior Energy shares. The Complaint further alleges that on September 25, 2006, Warrior Energy announced a definitive merger agreement with Superior Energy. The Warrior Energy shares, which were then traded on the Nasdaq National Market, increased in price by almost 70% on the news that day. The Complaint also alleges that on October 3, 2006, Dupuis sold all of his Warrior Energy stock for a profit of approximately $41,800.
The Complaint alleges that the defendants have violated the antifraud provisions of the federal securities laws, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The Commission's Complaint seeks (i) a permanent injunction against future violations; (ii) disgorgement of ill-gotten gains plus prejudgment interest; and (iii) imposition of civil penalties.
Madoff Investors Dispute SIPC Trustee's Calculation of Damages
Lawyers for some victims of the Madoff ponzi scheme are arguing that the SIPC Trustee should recalculate investors' losses to increase the investors' recovery, according to the New York Times. The Trustee is using the conventional method of calculating damages in a ponzi scheme -- the difference between what the investor invested and what the investor withdrew, over the life of the account. Instead, the investors argue, damages should be based on a total inflated fictitious account value. The difference in the two methods is sizable. Since some investors made substantial withdrawals from their accounts over the years, they may not be eligible for any recovery under the SIPC method. Meanwhile, the deadline for filing claims is fast approaching -- July 2. NYTimes, Victims of Madoff Seek Claims Overhaul.
SEC & Massachusetts Settle Charges That Evergreen Overstated Value of Fund
The SECC settled charges that Boston-based Evergreen Investment Management Company LLC and an affiliate overstated the value of a mutual fund that invested primarily in mortgage-backed securities, and then only selectively told shareholders about the fund’s valuation problems. Evergreen agreed to pay more than $40 million to settle the SEC’s charges without admitting or denying the findings in the SEC’s order. This enforcement action is the result of the joint efforts of the SEC and the Massachusetts Securities Division, which also brought related charges against the Evergreen entities today.
The SEC’s enforcement action against Evergreen’s investment advisory arm and its distributor, Evergreen Investment Services, Inc., found that the value of its Ultra Short Opportunities Fund, which was consistently ranked as a high performer in its class in 2007 and 2008, was inflated by as much as 17 percent due to Evergreen’s improper valuation practices. Had Evergreen properly valued the fund, it would have ranked near the bottom of its category during this time, the SEC found.
According to the SEC’s order, when Evergreen began to address the fund’s overstated value by re-pricing certain holdings, it only disclosed the reasons and the likelihood for additional re-pricings to select shareholders, who were then able to cash out before incurring any additional drop in the value of their fund shares. Meanwhile, other shareholders were left uninformed.
The SEC’s order found that Evergreen overstated the fund’s value by failing to properly take into account readily available information about certain mortgage-backed securities in the valuation process. The fund’s portfolio management team also withheld negative information about certain of the fund's securities from an Evergreen committee responsible for valuations. Evergreen closed the Ultra Fund in June 2008 in the wake of substantial redemptions by fund shareholders following the firm’s re-pricing of the fund’s holdings.
The two Evergreen entities agreed to pay $33 million to compensate fund shareholders as well as penalties totaling $4 million and disgorgement of ill-gotten gains of approximately $3 million. All of the money will be distributed to Ultra Fund shareholders pursuant to the provisions of the SEC’s Order. The Evergreen entities also were censured and ordered to cease and desist from any further violations of certain federal securities laws.
The SEC’s order took into account the remedial acts and cooperation of the Evergreen adviser and distributor.
Obama Won't Propose Merger of SEC & CFTC, Says SIFMA
SIFMA, in its daily news alert, says that the Obama administration has dropped the idea of proposing a merger of the SEC and CFTC. If true, this signals the importance of politics in any reform proposal. The merger of the two agencies is a sensible and modest proposal that has been raised before and is always shot down in part because politicians like having two agencies with two different oversight committees; it increases the number of politicians who will be courted by the industry.
June 7, 2009
Birdthistle on Mutual Fund Jurisprudence
Investment Indiscipline: A Behavioral Approach to Mutual Fund Jurisprudence, by William A. Birdthistle, Chicago-Kent College of Law, was recently posted on SSRN. Here is the abstract:
Next Term, in Jones v. Harris, the Supreme Court will be called upon to resolve philosophical divergences on a massive, critical, yet academically slighted subject: the dysfunctional system through which almost one hundred million Americans attempt to save more than ten trillion dollars for their retirement. When this case was in the Seventh Circuit, two of the foremost theorists of law and economics, Chief Judge Frank Easterbrook and Judge Richard Posner, disagreed vociferously on competing analyses of the investment industry. The Supreme Court’s ruling will not only resolve the intricate fiduciary and doctrinal issues of this dispute but also have profound implications upon several major theoretical debates in contemporary American jurisprudence: the clash of classical versus behavioral economics; the judicial capacity to evaluate increasingly sophisticated econometric analyses of financial systems; and the determination of the legal constraints - if any - upon executive compensation decisions.
In this Article, I advance a positive account of the economic and legal context of this dispute and then argue normatively for a behavioral approach to its resolution. Because of the unique structure and history of the personal investment industry in the United States, the architecture of this segment of the economy is singularly bereft of beneficial market forces and thus vulnerable to significant fiduciary distortions. The ultimate judicial resolution of this dispute should take full account of the behavioral constraints upon individual investors and their advisors to avoid nullifying a federal statute and to impose discipline in a vital segment of the U.S. economy.
Boehmer & Al. on 2008 Short-Selling Ban
Shackling Short Sellers: The 2008 Shorting Ban, by Ekkehart Boehmer, University of Oregon - Charles H. Lundquist School of Business; Texas A&M University - Mays Business School, and Charles M. Jones, Columbia Business School, and Xiaoyan Zhang, Cornell University - Samuel Curtis Johnson Graduate School of Management, was recently posted on SSRN. Here is the abstract:
In September 2008, the U.S. Securities and Exchange Commission (SEC) surprised the investment community by adopting an emergency order that temporarily banned most short sales in nearly 1,000 financial stocks. In this paper, we study changes in stock prices, the rate of short sales, the aggressiveness of short sellers, and various liquidity measures before, during, and after the shorting ban. We match banned stocks to a control group of non-banned stocks in order to identify these effects. Shorting activity drops by about 65%. Stocks subject to the ban suffered a severe degradation in market quality, as measured by spreads, price impacts, and intraday volatility. Prices of stocks subject to the ban increase sharply, but it is difficult to assign this effect to the ban because the Troubled Asset Relief Program (TARP) and other programs were announced the same day. In fact, we find no positive share price effects in stocks that were added to the ban list later, suggesting that the ban may not have provided much of an artificial price boost.