Securities Law Prof Blog

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

Thursday, July 2, 2009

SEC Blew Chance to Expose Madoff's Fraud in 2004

Fascinating article in today's Washington Post: Zachary Goldfarb reports that in 2004 an SEC staff attorney in Compliance, Inspections and Examinations (who previously worked at the American Stock Exchange and understood complicated trading strategies) figured out that there was something wrong with the way Madoff was running his business and submitted a list of detailed questions to her supervisor to pursue the investigation.  However, her supervisor told her to turn her attention to mutual funds; at that time the SEC was feeling the heat because the New York Attorney General's market-timing investigations made the SEC look bad.  The Madoff inquiry went nowhere, and the SEC attorney left the agency in 2006, complaining of a hostile work environment.  WPost, Staffer at SEC Had Warned Of Madoff Lawyer Raised Alarm, Then Was Pointed Elsewhere.

July 2, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Wednesday, July 1, 2009

SEC Proposes Revisions to Proxy Disclosures on Compensation and Corporate Governance

The SEC proposed a set of rule revisions intended to improve the disclosure provided to shareholders of public companies regarding compensation and corporate governance matters in proxy and information statements.  They include information about:

  • The relationship of a company's overall compensation policies to risk.
  • The qualifications of directors, executive officers and nominees.
  • Company leadership structure.
  • Potential conflicts of interests of compensation consultants.

In addition, the proposals are aimed to improve the reporting of annual stock and option awards to company executives and directors as well as to require quicker reporting of election results. The Commission also proposed amendments to the proxy rules intended to clarify how they operate.

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

SEC Votes to Eliminate Broker Discretionary Voting for Uncontested Directors' Elections

The SEC voted to approve an NYSE proposal that would eliminate broker discretionary voting for all elections of directors, whether contested or not. Currently, NYSE Rule 452 and corresponding Listed Company Manual Section 401.08 permit brokers to vote on behalf of their beneficial owner customers in uncontested elections of directors if the customers have not returned voting instructions.  While the NYSE filed this proposed rule change with the SEC years ago, the SEC did not publish it for public comment until March 6, 2009.  It received 153 comment letters from issuers, transfer agents, institutional investors, proxy advisory firms and others.

The NYSE's proposal is designed to enhance corporate governance and accountability by helping assure that investors with an economic interest in the company vote on the election of directors. It also would address concerns that broker discretionary voting for directors has impacted election results.

Specifically, the NYSE proposal would add "election of directors" to the list of enumerated items for which a member generally may not give a proxy to vote without instructions from the beneficial owner. The proposal contains a specific exception for companies registered under the Investment Company Act of 1940. In addition, the NYSE proposes to codify two previously published interpretations that do not permit broker discretionary voting for material amendments to investment advisory contracts with an investment company.

The NYSE's proposal will apply to shareholder meetings held on or after Jan. 1, 2010. The SEC's approval order will be published in the Federal Register and posted on the SEC Web site as soon as possible.

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

SEC Charges Former Beazer Homes Accounting Officer with Multi-Year Fraud

The SEC filed a civil complaint against Michael T. Rand, the former chief accounting officer of Atlanta-based home builder Beazer Homes, USA, Inc., alleging that he conducted a multi-year fraudulent earnings management scheme and misled Beazer’s outside auditors and internal Beazer accountants in order to conceal his wrongdoing.

The Commission alleges that Rand fraudulently decreased Beazer’s reported net income by recording improper accounting reserves during certain periods between 2000 and 2005 in order to meet or exceed analysts’ expectations for Beazer’s diluted earnings per share (EPS) and maximize yearly officer and senior employee bonuses. Rand began reversing these improper reserves beginning in the first quarter of fiscal year 2006 in order to offset Beazer’s declining financial performance.

The Commission’s Complaint also alleges that in fiscal year 2006 and the first two quarters of fiscal year 2007, Rand improperly recognized revenue from the sale and leaseback of certain model homes on Beazer’s financial statements and used secret side agreements in order to hide his misconduct from Beazer’s outside auditors. Cumulatively, Rand’s actions caused Beazer to understate its income in SEC filings by approximately $63 million during fiscal years 2000 to 2005, representing approximately 7 percent of Beazer’s cumulative actual restated net income of $955 million for the period. Rand’s fraudulent actions caused Beazer to overstate its income and understate its loss by a total of $47 million during fiscal 2006 and the first two quarters of fiscal 2007, representing 20 percent of Beazer’s cumulative actual restated net income of $232 million for the period.

The Commission’s complaint seeks a permanent injunction, disgorgement of Rand’s ill-gotten gains plus prejudgment interest, and a financial penalty.  The SEC also seeks a court order barring Rand from acting as an officer or director of any public issuer.

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

SEC Proposes Shareholder Approval of Exec Compensation Rule Applicable to TARP Recipients

The SEC proposed amendments to the proxy rules to set forth certain requirements for U.S. registrants subject to Section 111(e) of the Emergency Economic Stabilization Act of 2008, which requires companies that have received financial assistance under the Troubled Asset Relief Program (“TARP”) to permit a separate shareholder advisory vote to approve the compensation of executives, as disclosed pursuant to the compensation disclosure rules of the Commission, during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding. The proposed amendments are intended to help implement this requirement by specifying and clarifying it in the context of the federal proxy rules. Comments on the proposed rule are due 60 days after publication in the Federal Register.

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

Tuesday, June 30, 2009

SEC Brings Action Alleging Sales of Fraudulent and Unsuitable Variable Annuities Through Free-Lunch Seminars

The SEC today instituted an enforcement action against Prime Capital Services (PCS), a Poughkeepsie, N.Y.-based firm, and several representatives and supervisors for their alleged roles in fraudulent and unsuitable sales of variable annuities to senior citizens who were lured through free-lunch seminars at restaurants in south Florida.  The SEC alleges that PCS recruited elderly investors to attend the seminars, after which the seniors were encouraged to schedule private appointments with PCS representatives who then induced them to buy variable annuities. The sales pitches allegedly concealed high costs, lock-in periods, and other material information. While the firm and its representatives earned millions of dollars in sales commissions, the Division alleges that many of the variable annuities were unsuitable investments for the customers due to their age, liquidity, and investment objectives.

According to the SEC's order instituting proceedings, PCS is a registered broker-dealer and wholly-owned subsidiary of Gilman Ciocia, Inc. (G&C), an income tax preparation business headquartered in Poughkeepsie that offers financial services in New York, New Jersey, Pennsylvania and Florida. The individuals named in the SEC's order were G&C employees during the time of the alleged misconduct.

An administrative law judge will determine whether the allegations against the respondents are true and, if so, whether they should be ordered to cease and desist from future violations and whether remedial sanctions and penalties are appropriate and in the public interest.

June 30, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Merkin's Art Collection to be Sold and Funds Placed in Escrow Pending Resolution of New York AG's Suit


"Earlier this morning in New York State Supreme Court, my Office submitted a stipulation and order regarding the impending sale of J. Ezra Merkin's art collection for $310 million. The art was owned by Mr. Merkin and his wife. This sale will yield, after liens, taxes, and fees, approximately $191 million that will be restrained and frozen in an escrow account pending resolution of the case against Mr. Merkin. This will preserve assets that, if our litigation is successful, will provide restitution to victims of Mr. Merkin's alleged fraud.

The art sale order submitted today was the product of weeks of extensive negotiation. Based on an appraisal performed by Christie's at the request of my Office, we believe the sale price of $310 million is fair, appropriate, and in the best interests of investors. I want to thank Christie's for their work on this matter.

We believe it is only fair that Mr. Merkin liquidate his valuable art collection, which he purchased with the fees he earned from his investors, and keep the proceeds in escrow pending resolution of our lawsuit. The $191 million that will be preserved in this way will not by itself make investors whole, but this is an important step in the right direction for investors.

We will continue to seek full recovery for investors' losses through the ongoing action against Mr. Merkin, which charges him with concealing from his clients the investment of more than $2.4 billion with Bernard L. Madoff. As detailed in the 54-page complaint we previously filed, investors, including several prominent charities and non-profits, entrusted their investments to Mr. Merkin, who then steered the money to Madoff without their permission, in exchange for $470 million in management and incentive fees."

June 30, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Fines Firm and Former Broker for Improper Communications with Interdealer Brokerage Firms

FINRA announced that it has fined ICAP Corporates LLC, of Jersey City, $2.8 million and sanctioned a former broker for numerous improper communications with other interdealer brokerage firms about customers' proposed brokerage rate reductions in the wholesale credit default swap (CDS) market. 

Jennifer Joan James, a former ICAP broker and manager of ICAP's CDS desk, was fined $350,000 and suspended from working in the securities industry in all capacities for six months for attempting to improperly influence other interdealer brokerage firms and their employees. ICAP was fined $1.8 million for its supervisory failures — specifically, failing to detect and prevent improper inter-firm communications — and $1 million for engaging in conduct through its CDS desk manager that was designed to improperly influence other firms and their employees. 

CDS instruments generally enable counterparties to purchase and sell "risk protection" associated with certain credit events (such as bankruptcies, defaults or credit downgrades in underlying instruments). The risk protection purchaser generally pays a periodic fee to the seller, and the seller agrees to pay the purchaser an agreed-upon amount should one of those credit events occur. Interdealer brokerage firms provide an intermediary brokerage service to commercial and investment banks in the wholesale markets to identify and match counterparties for such CDS transactions. The firm receives brokerage fees for successfully introducing buying and selling counterparties (its brokerage customers) but is not a party to the CDS transactions themselves.

 FINRA found that James engaged in repeated improper communications with personnel at other interdealer brokerage firms that improperly attempted to influence those firms and individuals. These communications generally occurred after individual customer firms sought to renegotiate their CDS brokerage fees, sending schedules of proposed rate reductions separately to a number of individual interdealer brokers. James's communications with personnel at other interdealer brokers included reactions to customers' proposed rate reductions, statements concerning actual or contemplated interdealer broker responses or counter-positions to the customers' proposed rate reductions, and discussions about the interdealer brokers creating identical or similar, individual counter proposals to rate reduction requests.

 FINRA also found that while James's communications typically involved one-to-one discussions with personnel from one other CDS interdealer brokerage firm, the communications frequently referred to similar discussions about the proposed fee-reduction schedules with additional interdealer brokerage firms.

ICAP and James settled these matters without admitting or denying the allegations, but consented to the entry of FINRA's findings.

FINRA's investigation into misconduct by the other interdealer brokerage firms and individuals involved is continuing.

June 30, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Announces Initiatives Involving Municipal Securities

Concerns have been expressed that municipal securities would be the next big headline fraud, as retail investors engage in the perennial search for safety with higher returns than CDs.  Today FINRA announced initiatives to survey retail sales practices in the municipal securities market, promote investor protection in that market and give retail investors online tools and information that will help them make informed investment decisions when trading in that market.

FINRA investigators currently are conducting sweeps to gather information in three distinct areas. One broad sweep is looking at industry sales and supervisory practices with respect to sales of municipal bonds to retail investors. Firms are being asked to provide FINRA with detailed data on a range of retail muni bond transactions during the first quarter of this year. The requested information includes sales data, marketing data, pricing data and procedures, disclosure practices, customer complaints and supervisory procedures and practices.

 A second, more targeted sweep is examining potential conflicts, disclosure practices and marketing by firms underwriting municipal securities involving swaps and derivatives for small municipalities. These highly complex instruments typically allow municipalities to finance debt with lower variable interest rates than they would receive through a fixed offering, but involve significant interest rate and repayment acceleration risks through the swap contracts - something that has recently caused much-publicized financial distress for municipalities such as Jefferson County, AL, and the Erie, PA, School District. A third, narrowly targeted sweep is seeking information from firms that engaged in retail sales of certain so-called municipal Gas Bonds that were underwritten and guaranteed by the now-defunct Lehman Brothers and quickly became distressed.

 Also as part of its municipal bond initiative, FINRA today issued a Regulatory Notice to securities firms and brokers reminding them of their ongoing obligation to disclose material information to customers - including changes in the financial condition of the issuing municipality - as well as their obligations regarding suitability of recommendations to customers and supervision of the firm's municipal securities activities. At the same time, to help the investing public better understand and mitigate the risks of investing in municipal bonds, FINRA today issued an Investor Alert called Municipal Bonds — Staying on the Safe Side of the Street in Rough Times, as well as an online Muni Bond Check List, which provides a step-by-step guide to help investors avoid the most common pitfalls of muni bond investing.

June 30, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, June 29, 2009

FINRA Files Proposed Changes to Arbitration Code

FINRA has filed with the SEC a proposed rule change to amend Rules 12100(r), 12506(a), and 12902(a) of the Code of Arbitration Procedure for Customer Disputes (“Customer Code”) and Rule 13100(r) of the Code of Arbitration Procedure for Industry Disputes (“Industry Code”) to amend the definition of “associated person,” streamline a case administration procedure, and clarify that customers could be assessed hearing session fees based on their own claims for relief in connection with an industry claim.  According to the accompanying releases, these amendments are necessitated by inadvertent deletions of language from the previous Code. 

Comments are due 21 days after publication in the Federal Register.

June 29, 2009 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Supreme Court Upholds Power of State Banking Regulators to Enforce State Law

In an important case for state regulators, the Supreme Court held (5-4), in Cuomo v.Clearing House, that the federal Comptroller of the Currency’s regulation under the National Bank Act purporting to pre-empt state law enforcement is not a reasonable interpretation of the NBA.  This case arose out of an investigation initiated in 2005 by the New York Attorney General to determine whether various national banks had violated New York’s fair-lending laws.  The AG sent the banks letters requesting “in lieu of subpoena” that they provide certain nonpublic information about their lending practices. Both the Comptroller or OCC and a banking trade group brought this action to enjoin the information request, claiming that the Comptroller’s regulation prohibits that form of state law enforcement against national banks. The lower courts agreed with the Comptroller and issued an injunction prohibiting the AG from enforcing the state fair-lending laws through demands for records or judicial proceedings.  A majority of the Justices, however, affirmed the injunction as applied to the AG's threatened issuance of executive subpoenas, but vacated it as it prohibits the AG from bringing judicial enforcement actions. 

The relevant provision of the NBA provides: “No national bank shall be subject to any visitorial powers except as authorized by Federal law, vested in the courts . . . , or . . . directed by Congress.” Among other things, the Comptroller’s implementing regulation forbids States to “exercise visitorial powers with respect to national banks, such as conducting examinations, inspecting or requiring the production of books or records,” or (the language at issue here) “prosecuting enforcement actions” “except in limited circumstances authorized by federal law.” 

The majority noted the ambiguity in the NBA’s term “visitorial powers” and recognized that, under Chevron, the Comptroller can give authoritative meaning to the term within the bounds of that uncertainty. However, the majority stated, "the presence of some uncertainty does not expand Chevron deference to cover virtually any interpretation of the NBA."  The Court goes on to find that evidence from the time of NBA's enactment, the Court's precedents, and ordinary principles of construction make clear that the NBA does not prohibit ordinary enforcement of state law.

Moreover, the Court noted that the regulation’s consequences also cast its validity into doubt.  Even the OCC acknowledges that the NBA leaves in place some state substantive laws affecting banks, yet the Comptroller’s rule says that the State may not enforce its valid, non-pre-empted laws against national banks. “To demonstrate the binding quality of a statute but deny the power of enforcement involves a fallacy made apparent by the mere statement of the proposition, for such power is essentially inherent in the very conception of law.” ... In contrast, channeling state attorneys general into judicial law-enforcement proceedings (rather than allowing them to exercise “visitorial” oversight) would preserve a regime of exclusive administrative oversight by the Comptroller while honoring in fact rather than merely in theory Congress’s decision not to pre-empt substantive state law.

SCALIA, J., delivered the opinion of the Court, in which STEVENS, SOUTER, GINSBURG, and BREYER, JJ., joined. THOMAS, J., filed an opinion concurring in part and dissenting in part, in which ROBERTS, C. J., and KENNEDY and ALITO, JJ., joined.

June 29, 2009 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Madoff Sentenced to 150 Years

Federal District Court Judge Denny Chin threw the book at Bernie Madoff today, imposing the maximum sentence of 150 years, exactly what the prosecutors asked for and what Madoff's defense attorney called as "defying reason" (he suggested 12 years).  The judge said that symbolism is important and "a message must be sent that Mr. Madoff's crimes were extraordinarily evil."  The judge also noted the long duration of the fraud.

During what all reports describe as an emotional hearing nine victims were permitted to make statements, after which Madoff made a statement.  Turning to face the people in the courtroom, he apologized and denied that he and his wife Ruth were not sympathetic to the victims:  "she cries herself to sleep every night."  (Ruth Madoff, who was not in the courtroom, released a statement that, like the victims, she felt betrayed and confused.  Ruth Madoff has reached a settlement with the SEC that will allow her to keep $2.5 million, at least until other regulators or victims seek to recover it.)

Judge Chin also observed that he sensed that Madoff has not been as cooperative as he could be (a complaint that the prosecutors and SIPC have made) and that no one had submitted letters on behalf of Madoff.

NYTimes, Madoff Is Sentenced to 150 Years for Ponzi Scheme

WSJ, Madoff Is Sentenced to 150 Years in Multibillion-Dollar Ponzi Scheme

WPost, Madoff Sentenced to Maximum 150 Years in Prison 

June 29, 2009 in News Stories | Permalink | Comments (1) | TrackBack (0)

Sunday, June 28, 2009

Reiss on Fannie & Freddie

Coming Out of Conservatorship: Developing an Exit Strategy for Fannie and Freddie, by David J. Reiss, Brooklyn Law School, was recently posted on SSRN.  Here is the abstract:

This brief article reviews the various policies that the Obama Administration can choose from as it considers how Fannie Mae and Freddie Mac should exit conservatorship. It first reviews the benefits and costs associated with the two companies. It then reviews four broad positions regarding the appropriate role of Fannie and Freddie in the housing finance market. It argues that the two companies should be privatized because Fannie and Freddie pose a systemic risk to the financial system, unfairly benefit from their regulatory privilege and do not create net benefits for the American people. Finally, it reviews four concrete plans to fundamentally change Fannie and Freddie’s structure, each involving different degrees of government involvement. It concludes that the two companies should be converted into generic financial holding companies and their public functions be reassigned to various federal instrumentalities.

June 28, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Schwartz on Investment Management Regulation

Reconceptualizing Investment Management Regulation, by Jeff Schwartz, California Western School of Law, was recently posted on SSRN.  Here is the abstract:

This Article looks at mutual funds, hedge funds, and similar financial instruments as making up a single market - one whose operation is potentially marred by flawed investor decision-making born of imperfect information and bounded rationality. The piece then analyzes whether the current regulatory regime, which sharply divides this market into a heavily regulated sector that is accessible to all investors and a lightly regulated sector that is accessible only to the wealthy, is a well-reasoned response to this threat. I conclude that the current scheme is an ill-fit to the problems of incomplete information and irrationality, and that, in fact, the rules significantly reshape this marketplace to the detriment of ordinary investors.

To better respond to these concerns, I propose a reform agenda based on the libertarian-paternalist notion that government intervention should aim to bolster consumer decision-making without undermining freedom of choice. Under this revised framework, regulators would provide investors with information and guidance designed specifically so that investors are better situated to make sound financial decisions even though they are not perfectly rational. The rules, however, would not restrict investor alternatives. Instead, investors would be free to choose from an array of funds subject to varying levels of regulatory oversight. This system unwinds the deleterious aspects of the current regime and responds directly to the flaws in this marketplace, which creates an environment conducive to the type of robust competition that is in the public's interest.

June 28, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Simkovic on Open Market Stock Repurchases

The Effect of Enhanced Disclosure on Open Market Stock Repurchases, by Michael Simkovic, Harvard Law School - John M. Olin Center for Law and Economics, was recently posted on SSRN.  Here is the abstract:

Publicly traded companies distribute cash to shareholders primarily in two ways - either through dividends or through anonymous repurchases of the companies' own stock on the open market. Companies must announce a repurchase authorization, but do not actually have to repurchase any stock, and until recently did not have to disclose whether or not they were in fact repurchasing any stock. Scholars and regulators noticed that companies frequently announced repurchases but then appeared not to complete them. Scholars and regulators became concerned that such announcements might be used by insiders to exploit public investors. To increase transparency and reduce opportunities for exploitive behavior, the SEC required that companies disclose their repurchase activity for the past quarter in their 10-Q and 10-K filings beginning in January 2004. This paper tracks the 365 repurchase programs announced in 2004 and finds that since the SEC disclosure requirement went into effect, companies are more likely to complete their announced repurchases and do so within a shorter time period after the repurchase announcement.

June 28, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)