Securities Law Prof Blog

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

Friday, June 19, 2009

Stanford & Antiguan Regulator Charged with Fraud

Last February the SEC charged that R. Allen Stanford ran a $7 billion Ponzi scheme through two entities, Stanford International Bank and Stanford Financial Group.  Today Stanford was arrested, and federal prosecutors filed federal fraud and obstruction charges against Stanford, Laura Pendergest-Holt, the chief investment officer, and two accountants who allegedly fabricated accounting statements.  In addition, Leroy King, the administrator of the Financial Services Regulatory Commission in Antigua and Barbuda, was charged with accepting $100,000 in bribes to look the other way and to provide Stanford with information about the SEC investigation.

The SEC also amended its complaint to bring charges against the two accountants and King.  According to the complaint, King holds both U.S. and Antiguan citizenship and has a residence in Atlanta.

Mr. Stanford's attorney, in a written statement, said his client will fight the charges and is confident of being found not guilty and that he blames the SEC for the investors' losses.

WSJ, U.S. Files Criminal Charges in Stanford Case

NYTimes, Texas Financier and Antiguan Official Charged With Fraud  

June 19, 2009 in News Stories | Permalink | Comments (1) | TrackBack (0)

Thursday, June 18, 2009

Ulticom and Former Executive Settle Backdating Charges with SEC

The SEC today filed settled civil charges against Ulticom, Inc. and a former executive, Lisa M. Roberts, for two separate fraudulent schemes, involving improper options backdating practices and certain improper accounting practices. The Commission's Complaint against Ulticom alleges the misconduct began in 1996, when Ulticom was a wholly-owned subsidiary of Comverse Technology, Inc. ("Comverse"), and continued after Ulticom became a publicly-traded company, while still majority-owned by Comverse, in 2000.

June 18, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Comverse Technology Settles Backdating, Accounting Charges with SEC

The SEC today filed a settled civil action in the United States District Court for the Eastern District of New York against Comverse Technology, Inc. ("Comverse") alleging that it engaged in two separate fraudulent schemes, during the course of more than a decade, to materially misstate its financial condition and performance metrics. According to the Complaint, as a result of its improper conduct, Comverse was able to portray itself as a company with steady, but measured growth, which regularly met analysts' earnings targets. 

According to the Commission's Complaint, the first scheme involved improper backdating of Comverse stock options granted between 1991 and 2001. With respect to the backdating scheme, the Complaint alleges:

Comverse routinely backdated grants of stock options made to the Company's employees, officers, and others to coincide with historically low closing prices for the Company's common stock, distributing options from at least 26 backdated grants. Comverse also made grants to fictitious employees in order to establish an illegal pool of options thereby creating a slush fund of "in-the-money" stock options to later use in circumvention of the approved stock option grant process.

Comverse's second fraudulent scheme involved several improper accounting practices. According to the Complaint:

Comverse improperly built up, and subsequently improperly released, certain reserves to meet earnings targets, improperly reclassified certain expenses to manipulate other performance metrics, and made false disclosures about its backlog of sales orders.  The manipulation of earnings allowed Comverse to meet or exceed Wall Street analysts' consensus earnings estimates in every quarter between 1996 and the first quarter of 2001.

Without admitting or denying the allegations of the Commission's Complaint, Comverse has consented to the entry of a final judgment permanently enjoining it from violating the antifraud, reporting, record-keeping, and internal controls provisions of the federal securities laws. The Commission previously charged former Comverse Chairman and CEO Jacob "Kobi" Alexander, former Comverse Chief Financial Officer David Kreinberg, and former Comverse General Counsel William F. Sorin. Kreinberg and Sorin each settled with the Commission.

June 18, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)

NYSE Euronext & Depository Trust Create Joint Venture for Clearing U.S. Fixed Income Derivatives

NYSE Euronext and The Depository Trust & Clearing Corporation today agreed to create a joint venture for clearing U.S. fixed income derivatives. The new clearing house, New York Portfolio Clearing , “NYPC”, will combine the capabilities of NYSE Euronext’s U.S. futures exchange (NYSE Liffe U.S.) and DTCC’s Fixed Income Clearing Corporation (FICC) to offer risk management, clearing and settlement efficiencies for U.S. fixed income securities and derivatives. The initiative has been approved by the Boards of both companies and is expected to be operational in the second quarter of 2010, subject to definitive documentation and regulatory approval.

NYSE Euronext and DTCC have entered into an exclusive arrangement to pursue a 50/50 joint venture.  NYSE Euronext plans to commit a $50 million financial guarantee as an additional contribution to reinforce the safety and soundness of the NYPC default fund.

Pending Registered Derivatives Clearing Organization status approval from the U.S. Commodity Futures Trading Commission as well as other required regulatory approvals, NYPC initially will clear interest rate products traded on NYSE Liffe U.S.  , with the ability to add other exchanges in the future.  NYPC will be powered by NYSE Euronext’s market leading clearing technology, TRS/CPS , which currently facilitates member position management for the NYSE Liffe market in London and ICE Clear Europe. DTCC will provide FICC’s market-leading capabilities in risk management, settlement, banking and reference data systems.

June 18, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Treasury Secretary Testifies in Senate on Financial Reform

Treasury Secretary Tim Geithner testified today before the U.S. Senate Banking Committee on the Administration's Financial Regulatory Reform.  Here is his Opening Statement – As Prepared for Delivery.

June 18, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC-DOL Hold Hearing on Target Date Funds

SEC-DOL held its joint Hearing on Target Date Funds today.  Here is the opening statement from Chairman Schapiro.

June 18, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former Enron Broadband CEO Settles Insider Trading Charges

Enron never seems to go away -- the SEC announced that, on June 15, 2009, the U.S. District Court in Houston entered a final judgment in the Commission's pending civil action against Joseph Hirko, former Chairman and Chief Executive Officer of Enron Broadband Services ("EBS"). On May 1, 2003, the Commission charged Hirko and other EBS executives with securities fraud and insider trading. Without admitting or denying the allegations in the Commission's complaint, Hirko has now agreed to be permanently enjoined from violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, to be permanently barred from serving as an officer or director of a public company, and to pay a $1 million civil money penalty.

The Commission settled this action in coordination with the Department of Justice, which entered into a plea agreement with Hirko on related charges in October 2008. In the criminal action, Hirko agreed to forfeit $7 million that, along with the Commission's disgorgement and civil penalties, will contribute over $8 million for the benefit of injured investors through the Commission's Enron Fair Fund.

June 18, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Files Amicus Brief in Mutual Fund Case

The SEC filed an amicus brief in Jones v. Harris Associates in favor of the petitioners.  The case, which will be argued next term before the Supreme Court, addresses the appropriate test for determining the fees investment advisors charge mutual funds and the correct interpretation of section 36(b) of the Investment Company Act.  The Seventh Circuit found in favor of the investment adviser, finding it had not lied to the mutual fund and that "market forces" should determine fees.

June 18, 2009 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Obama's No FDR

Needless to say, there have been many news articles on the Obama Financial Plan, with various assessments of its merits.  I commend to readers Joe Nocera's article on the front page of today's New York Times, because he says what I would say if I could write like a journalist:

[T]he Obama plan is little more than an attempt to stick some new regulatory fingers into a very leaky financial dam rather than rebuild the dam itself. Without question, the latter would be more difficult, more contentious and probably more expensive. But it would also have more lasting value.

NYTimes, Only a Hint of Roosevelt in Financial Overhaul

June 18, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Scrushy Ordered to Pay $2.8 Billion to HealthSouth

An Alabama state court judge found that Richard Scrushy, ex-CEO of HealthSouth Corp., has to pay $2.8 billion in a state action brought by shareholders who sued alleging accounting fraud, unethical dealings and sweetheart deals.  Scrushy was acquitted of federal securities fraud charges in 2005, but is serving time for an unrelated government bribery conviction.  During the trial, Scrushy continued to deny that he had any knowledge of any financial fraud at the company.  NYTimes, Ex-Chief Ordered to Pay $2.8 Billion to HealthSouth.

June 18, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Wednesday, June 17, 2009

SEC Charges Former Quest CEO & CFO with Stealing Corporate Funds

On June 17, 2009, the SEC charged two former Quest officers with securities fraud and other violations in connection with a scheme in which they misappropriated millions of dollars from Quest Resource Corporation, Quest Energy Partners, L.P. and their affiliates while they were executives at the company.

The SEC alleges that Quest's then-chief executive officer and board chairman Jerry D. Cash and then-chief financial officer David E. Grose caused Quest to make a series of transfers to a separate company that Cash controlled. Cash tried to conceal the transfers by, among other things, ostensibly transferring the funds back to Quest at the end of each quarter. The SEC alleges, however, that Cash took progressively greater amounts from Quest over time that he used to support his lavish lifestyle, including spending more than $5 million on his Oklahoma City mansion. Grose was complicit in Cash's wrongdoing by, among other things, initiating wire transfers to Cash's company and creating a false cover story to explain the transfers to Quest's employees and auditors.

The SEC's enforcement action was filed in U.S. District Court in Oklahoma City concurrently with criminal charges against Grose filed by the U.S. Attorney's Office for the Western District of Oklahoma.

The SEC alleges that the scheme, which began in June 2004, collapsed in August 2008 after other Quest executives discovered and began questioning the legitimacy of the transfers. By that time, Cash had misappropriated a total of $10 million from Quest. Cash subsequently resigned from Quest and Grose was terminated.

According to the SEC's complaint, Grose also took advantage of Quest's lax internal controls to siphon more than $1.8 million from the company for his own benefit. From December 2005 through August 2008, one of Quest's equipment vendors kicked back approximately $850,000 to Grose from equipment purchases that Quest had made. The SEC also contends that Grose used $1 million of Quest's money to fund his personal investment in a small Oklahoma start-up company.

The SEC's complaint states that none of these transactions were disclosed in the multiple quarterly and annual filings Quest made with the SEC during the periods in question, even though Cash and Grose each certified in these filings that they had disclosed any fraud involving management. Cash and Grose also signed numerous Quest filings in which such related party transactions were required to be disclosed, but were not. Lastly, the SEC claims that Cash and Grose signed multiple representation letters to Quest's auditor attesting that all related party transactions had been disclosed and that there had been no fraud involving management.

The SEC's complaint charges, among other things, that Cash and Grose violated the anti-fraud provisions of the Securities Act of 1933 and the anti-fraud, internal controls, proxy statement, record-keeping and reporting provisions of the Securities Exchange Act of 1934. The SEC seeks injunctive relief, financial penalties, disgorgement of ill-gotten proceeds with prejudgment interest, and permanent bars from serving as officers or directors of public companies.

June 17, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Fines Two Firms for Stock Loan Improprieties

FINRA announced that as part of its in-depth investigation of stock loan practices in the industry, it has imposed a fine of $1 million against Raymond James & Associates, Inc. of St. Petersburg, FL, and a fine of $400,000 against RBC Capital Markets Corporation of New York, for various stock loan improprieties.

 Raymond James was sanctioned for making unjustified and improper payments to finder firms that provided no service in locating securities or had no involvement in the stock loan transaction for which they were paid. Raymond James and RBCCMC were both fined for using a non-registered individual, who had been convicted in federal court of securities law violations and had been barred from the securities industry by the Securities and Exchange Commission (SEC), to perform stock loan functions requiring registration.

 In concluding these settlements, neither Raymond James nor RBCCMC admitted nor denied the charges, but consented to the entry of FINRA's findings.

June 17, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

First Look at the Administration's Financial Regulatory Reform

The Administration has released its Download Final financial reform plan061709,  Preliminarily, it confirms what the news reports have stated -- that the Plan is the result of extensive discussions among various constituencies.  As a result, it has something for everyone and is something of a mishmash, with proposals ranging from overarching to mundane.  It is not a radical proposal for restructuring financial regulation, but it is more than a reshuffling of functions.  How it will all play out is anyone's guess at this point. 

I expect there will be many blogs on the Plan in the next few months, but here is a first look at some of the proposals from an investor protection perspective -- warning this is a somewhat idiosyncratic summary, reflecting "my" issues (numbers in parentheses refer to pages in Plan):

All hedge fund advisers should be required to register with the SEC.(12, 37-38)

The SEC should move forward to plans to reduce the susceptibility of money market funds to runs. (12, 38-39)

All OTC derivatives markets, including credit default swaps, should be subject to comprehensive regulation. (13, 46-49)

The CFTC and SEC should work together to harmonize the regulation of futures and securities (14, 49-51), i.e., no merger of the two agencies.  The Plan recommends that the two agencies complete a report by Sept. 30, 2009 identifying all possible conflicts and either explaining why they are necessary or making recommendations to eliminate them.  If the two agencies cannot reach agreement by Sept. 30, their differences would be referred to the new Financial Services Oversight Council to address the differences and report its recommendations to Congress within six months. (50-51)  [good luck with that!]

The creation of a new consumer financial protection agency one of the central reform measures, established to protect consumers in consumer financial products and services, such as credit, savings, and payment products, but not including mutual funds [big victory for the SEC].  The federal agency's rules would be a floor, not a ceiling; states are free to adopt stricter laws.  (14, 55-63)

The creation of a Financial Services Oversight Council with a broad membership of federal and state consumer protection agencies and a permanent role for the SEC's Investor Advisory Committee. (15) This Plan does contemplate a number of new agencies, councils and coordinating committees, which raises the possibility of the very problems the reform was trying to cure -- turf battles, delays because of coordination difficulties, and the very real possibility that important matters can fall between the cracks.

Oversight over credit rating agencies should be tightened.  (18)

With respect to the SEC (70-73), the Plan notes that the agency has already begun to strengthen and steamline its enforcement process.  The Plan urges the adoption of point-of-sale disclosures if the SEC finds it would improve investor understanding of the financial products.  Point-of-sale disclosure has been a contentious issue for years, with significant broker-dealer resistance.

Another hotly debated issue in recent years has been the different regulation and different standards of conduct for broker dealers and investment advisers.  The Plan recommends establishing a fiduciary duty for broker-dealers offering investment advice and harmonization of the regulation of brokers and advisers. (71)

Somewhat buried in the Plan are two proposals relating to arbitration clauses:

The new consumer protection agency should have the power to restrict or ban mandatory arbitration clauses. (62-63)

The SEC should study the use of mandatory arbitration clauses in investor contracts.  "We recommend legislation that would give the SEC clear authority to prohibit mandatory arbitration clauses in broker-dealer and investment advisory accounts with retail customers.  The legislation should also provide that, before using such authority, the SEC would need to conduct a study on the use of mandatory arbitration clauses in the contracts." (72)

June 17, 2009 in News Stories | Permalink | Comments (1) | TrackBack (0)

Administration Releases Plan to Reform Financial Regulation Today

President Obama willl announce the administration's plan to reform financial regulation.  Here are some previews from major newspapers:

WSJ, Draft Details New Rules for Markets

NYTimes, Obama Sought to Enlist a Wide Consensus on Finance Rules

WPost, Obama Blueprint Deepens Federal Role in Markets

The websites of the newspapers also have posted an 85-page draft of the plan.  

As described in the press reports, the plan will give the Federal Reserve additional powers over large financial institutions and will create a council of regulators to fill in regulatory gaps.  There will be a new consumer protection agency for financial instruments, which, in a significant victory for the SEC, will not include mutual funds.  The SEC and CFTC will not be merged.

June 17, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, June 16, 2009

SEC Charges Convicted Felon with Running a Ponzi Scheme

I frankly have become bored with the SEC's recent proliferation of enforcement actions against ponzi schemes, but here is an interesting one:

The SEC announced that on June 15, 2009, it filed an emergency civil action in the United States District Court for the Northern District of Illinois against David J. Hernandez, also doing business as “NextStep Financial Services, Inc.,” for conducting a Ponzi scheme which raised more than $11 million from investors in at least 12 states with false promises that their investments would earn guaranteed returns of 10% to16% per month with no risks. The SEC’s complaint alleges that between at least February 2008 and the present, Hernandez, a convicted felon, solicited investors to purchase “guaranteed investment contracts” by making false and misleading statements about his background, the existence of the company that issued the investments, the uses of investor proceeds and the safety of the investments. The complaint alleges that Hernandez sold the “guaranteed investment contracts” in person and through NextStep Financial’s website and claimed that he had an extensive background in banking and business, including having business and law degrees, and that NextStep Financial was a successful company that invested in payday advance stores. The complaint further alleges that Hernandez told investors that their investments were safe because they were covered by insurance. According to the complaint, however, none of this was true; indeed, his “banking experience” included a prior federal conviction for wire fraud.

The SEC’s complaint charges Hernandez with multiple securities violations and seeks injunctive relief, disgorgement plus prejudgment interest and civil penalties against Hernandez. The SEC also seeks to recover assets from several relief defendants.

June 16, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Law Professors File Brief in Mutual Fund Fees Supreme Court Case

William A. Birdthistle (Chicago-Kent College of Law) has posted on SSRN the Supreme Court Amicus Merits Brief of Law Professors in Support of Petitioners in Jones v. Harris Associates, No. 08-586, filed with the U.S. Supreme Court.  William is the Counsel of Record and the principal drafter of the brief.  The issue is the appropriate test for determining the reasonableness of the fees investment advisors charge to mutual funds under Section 36(b) of the Investment Company Act of 1940, which imposes a fiduciary duty on advisers with respect to fees. The Seventh Circuit (527 F.3d 627) diluted the fiduciary duty language of the statute and held that the fiduciary "must make full disclosure and play no tricks but is not subject to a cap on compensation" and asserted that "market forces" would sufficiently regulate the fees.  This is certain to be an important case in mutual fund regulation.

June 16, 2009 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, June 15, 2009

Geithner & Summers Outline Financial Reform

In today's Washington Post, Timothy Geithner and Lawrence Summers offer a preview of the financial reform package that President Obama is expected to outline on Wednesday.  WPost, A New Financial Foundation.  They outline five principles, including:

[O]ur current regulatory regime does not offer adequate protections to consumers and investors. Weak consumer protections against subprime mortgage lending bear significant responsibility for the financial crisis. The crisis, in turn, revealed the inadequacy of consumer protections across a wide range of financial products -- from credit cards to annuities.

Building on the recent measures taken to fight predatory lending and unfair practices in the credit card industry, the administration will offer a stronger framework for consumer and investor protection across the board.

Leaks to the media on the package, however, indicate that the SEC has prevailed, and mutual fund regulation will remain with that agency and not, as initially suggested, be included in any new investor protection agency.  In addition, the package reportedly will not deal with reconciling the regulation of investment advisers and broker dealers, an issue that has been much discussed in the wake of the Madoff scandal. 

June 15, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Announces Investor Education Initiatives

FINRA announced today new initiatives aimed at protecting and educating investors, including a national advertising campaign and a 60-minute video, "Tricks of the Trade: Outsmarting Investment Fraud," as well as grassroots campaigns in Colorado, Florida, North Carolina, Vermont and Washington state to protect seniors from investment fraud.  The video, "Tricks of the Trade: Outsmarting Investment Fraud," is a 60-minute broadcast-quality presentation on preventing investment fraud. Using profiles of victims and perpetrators, the video highlights the persuasion tactics that con artists use to defraud their victims and the basic tools investors need to defend against fraud. It is a project of the FINRA Investor Education Foundation. 

The video is part of the FINRA Foundation's new "fraud-fighting" education series for investors, which also includes in-person workshops and events in five states across the country this year: Colorado, Florida, North Carolina, Vermont and Washington state. These state-wide campaigns, which will be expanded to five additional states next year, are being presented in partnership with AARP, state securities regulators and other fraud-fighting organizations to help senior citizens identify and steer clear of investment fraud.

June 15, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

PIABA Submits Petition to SEC to Eliminate Requirement of Industry Arbitrator in Customer Disputes

The Public Investors Arbitration Bar Association ("PIABA") submitted to the SEC, pursuant to SEC Rule of Practice 192A, a rule change petition to eliminate the requirement that an arbitrator affiliated with the securities industry sit on all customer cases in which the amount in controversy exceeds $100,000 which are arbitrated before the Financial Industry Regulatory Authority ("FINRA"). PIABA proposes that investors and industry parties be given the choice to decline to have an industry arbitrator sit on panels that hear and decide their cases.  PIABA believes that FINRA Dispute Resolution (FINRA-DR) Code of Arbitration Rule 12402, mandating one industry arbitrator on all three person panels in arbitration actions between customers and industry members, unfairly and systemically shifts the balance of justice against customers and that requiring customers who believe they have been wronged by the securities industry to have claims decided by panels that must include a representative of that securities industry creates at the least the appearance of bias, if not outright bias. 

(thanks to Jill Gross for calling this to my attention)

June 15, 2009 in Securities Arbitration | Permalink | Comments (1) | TrackBack (0)

Sunday, June 14, 2009

Cicero on Stock Option Exercise Strategies

The Manipulation of Executive Stock Option Exercise Strategies: Information Timing and Backdating, by David C. Cicero, University of Delaware - Lerner College of Business and Economics, was recently posted on SSRN.  Here is the abstract:

I identify three option exercise strategies executives engage in, including (i) exercising with cash and immediately selling the shares, (ii) exercising with cash and holding the shares, and (iii) delivering some shares to the company to cover the exercise costs and holding the remaining shares. Stock price patterns suggest executives manipulate option exercises. They use private information to increase the profitability of all three strategies, and likely backdated some exercise dates in the pre-Sarbanes-Oxley period to enhance the profitability of the latter two strategies, where the executive’s company is the only counterparty. Backdating is associated with reporting of internal control weaknesses.

June 14, 2009 in Law Review Articles | Permalink | Comments (1) | TrackBack (0)