Securities Law Prof Blog

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

Thursday, July 23, 2009

Treasury Sends Proposed Systemic Risk Legislation to Congress

On July 22 Treasury sent to Congress proposed Systemic Risk Legislation that would require strong, consolidated supervision and regulation for all financial firms. The legislation also provides a regulatory regime to monitor, mitigate, and respond to risks in the financial system. 

July 23, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Approves Exemptions for Central Counterparties for CDSs

The SEC approved conditional exemptions that will allow ICE Clear Europe Limited and Eurex Clearing AG to operate as central counterparties (CCPs) for clearing credit default swaps.  These conditional exemptions provide the SEC with regulatory oversight of the central counterparty, and should enhance the quality of the credit default swap market and the Commission's ability to protect investors.

On Dec. 24, 2008, the SEC approved temporary exemptions allowing LCH.Clearnet Ltd. to operate as a central counterparty for credit default swaps. On March 6, 2009 and March 13, 2009, respectively, the SEC approved similar temporary exemptions for ICE US Trust LLC and the Chicago Mercantile Exchange, Inc. The SEC is soliciting public comment on all aspects of these exemptions to assist in its consideration of any further action that may be needed in this area.

July 23, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Proposes "Pay to Play" Rules for Investment Advisers

The SEC voted unanimously to propose measures intended to curtail "pay to play" practices by investment advisers that seek to manage money for state and local governments. The measures are designed to prevent an adviser from making political contributions or hidden payments to influence their selection by government officials.  The proposals relate to money managed by state and local governments under important public programs, including public pension plans that pay retirement benefits to government employees, retirement plans in which teachers and other government employees can invest money for their retirement, and 529 plans that allow families to invest money for college.

The rule being proposed for public comment by the SEC includes prohibitions intended to capture not only direct political contributions by advisers, but other ways advisers may engage in pay to play arrangements.

July 23, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Fines 5 Bank Broker-Dealers for Improper Variable Annuities Sales

FINRA announced today that it fined five bank broker-dealers a total of $1.65 million for deficient supervision and procedures related to variable annuity (VA), mutual fund or unit investment trust (UIT) transactions.  Brokers at each of the firms operated out of branches of affiliated banks, selling VAs, mutual funds or UITs to bank customers, who, in many instances, were elderly. The brokerage customers were referred by bank personnel, and sales of these financial products represented a significant portion of each firm’s business.

 The five firms that FINRA fined for deficient systems and procedures relating to VA, mutual fund or UIT sales, and the amount of their fines, are:

McDonald Investments (now KeyBanc Capital Markets, Inc.) - $425,000
IFMG Securities - $450,000
Wells Fargo Investments, LLC - $275,000
PNC Investments - $250,000
WM Financial Services, Inc. (now Chase Investment Services Corp.) - $250,000

July 23, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, July 22, 2009

FINRA Fines NEXT Financial Group for Supervisory Violations

FINRA) announced today that it fined NEXT Financial Group, Inc., headquartered in Houston, TX, $1 million for supervisory violations that primarily involved the failure to supervise its approximately 130 Office of Supervisory Jurisdiction (OSJ) branch managers, who typically supervise transactions and sales activity for individual brokers or branches within a particular region. OSJ branch managers' transactions and sales activities are then supposed to be supervised by another registered principal designated by the firm.  Between January 2005 and November 2006, the firm allowed its OSJ branch managers to self-supervise their own handling of customer accounts without adequate review. In November 2006, the firm adopted a Regional Manager supervisory system to provide principal review of the OSJ managers’ transactions. Through at least December 2007, however, this new system was also unreasonable because, among other reasons, it required three Regional Managers to review thousands of transactions each month with limited access to client suitability information.

The lack of reasonable policies and written procedures resulted in the firm’s failure to detect churning of customer accounts and excessive markups and markdowns on corporate bond trades.  

FINRA further found that the firm’s systems and procedures governing variable annuity exchanges were not reasonable. Variable annuity sales accounted for approximately 33 percent of the firm’s revenue during the relevant period. The firm’s written supervisory procedures, however, failed to provide adequate guidance concerning the criteria that should be considered in recommending variable annuity exchanges to its customers including, for example, a comparison between the features, costs and benefits of the old and new products. 

As part of the settlement, the firm must certify that it has implemented new systems and procedures reasonably designed to achieve compliance with the federal securities laws and FINRA Rules described above and in other areas identified in the settlement agreement.  In settling this matter, NEXT and Eyster neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

July 22, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

GAO Issues Report on Leverage at Financial Institutions

The GAO issued a report on Financial Crisis Highlights Need to Improve Oversight of Leverage at Financial Institutions and across System.  It explains that the purpose of the report is to study the role of leverage in the current financial crisis and federal oversight of leverage. GAO’s objectives were to review (1) how leveraging and deleveraging by financial institutions may have contributed to the crisis, (2) regulations adopted by federal financial regulators to limit leverage and how regulators oversee compliance with the regulations, and (3) any limitations the current crisis has revealed in regulatory approaches used to restrict leverage and regulatory proposals to address them. To meet these objectives, GAO built on its existing body of work, reviewed relevant laws and regulations and academic and other studies, and interviewed regulators and market participants.

What GAO Recommends

As Congress considers establishing a systemic risk regulator, it should consider the merits of assigning such a regulator with responsibility for overseeing systemwide leverage. As U.S. regulators continue to consider reforms to strengthen oversight of leverage, we recommend that they assess the extent to which reforms under Basel II, a new risk-based capital framework, will address risk evaluation and regulatory oversight concerns associated with advanced modeling approaches used for capital adequacy purposes. In their written comments, the regulators generally agreed with our conclusions and recommendation.

July 22, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Seeks Clawback from Former CEO of CSK Auto

The SEC asked the U.S. District Court for the District of Arizona to order the former chief executive officer of CSK Auto Corporation to reimburse the company and its shareholders more than $4 million that he received in bonuses and stock sale profits while CSK was committing accounting fraud.  The SEC's enforcement action charges Maynard L. Jenkins with violations of the Sarbanes-Oxley Act (SOX). It is the first action seeking reimbursement under the SOX "clawback" provision (Section 304) from an individual who is not alleged to have otherwise violated the securities laws. The SOX "clawback" provision deprives corporate executives of money that they earned while their companies were misleading investors.

According to the SEC's complaint, Jenkins made $2,091,020 in bonuses and $2,018,893 in company stock sales that should have been reimbursed to CSK pursuant to SOX Section 304.  While Jenkins served as CEO, CSK filed two such restatements related to its overstated vendor allowances.  The SEC's complaint does not allege that Jenkins engaged in the fraudulent conduct.

July 22, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

D.C. Circuit Remands SEC Fixed Indexed Annuity Rule for Further Consideration

The D.C. Circuit continues its practice of being tough on the SEC's compliance with the requirements for federal rulemaking .  Yesterday the Circuit remanded to the agency the SEC's controversial rule 151A that stated that fixed indexed annuities (FIAs) are not annuity contracts within the meaning of the Securities Act (and therefore are treated as securities under the securities laws and not regulated solely by state insurance laws).  American Equity Investment Life Ins. Co. v. SEC (D.C. Cir. 7/21/09)(Download D.C.OpiniononIndexAnnuities).  According to the Court (1) the SEC's interpretation of "annuity contract" is reasonable under Chevron, but (2) the SEC failed to consider properly the effect of the rule on efficiency, competition and capital formation under section 2(b) of the Act.  Therefore, the SEC must either complete an analysis sufficient to satisfy its obligations under section 2(b) or explain why that section does not govern this rulemaking.

On the SEC's interpretation of "annuity contract," the Court found that the statute is ambiguous on the scope of the phrase and that the prior Supreme Court decisions did not set forth a test that determined the treatment of FIAs.  Accordingly, under Chevron, the SEC's interpretation of the statute will be upheld if it is reasonable.  Because FIAs have characteristics that "involve considerations of investment not present in the conventional contract of insurance," a "variability in the potential return that results in a risk to the purchaser," the SEC's interpretation was reasonable.

As to the SEC's inadequate section 2(b) analysis, the Court first rejected the SEC's argument that the agency was not required to conduct a section 2(b) analysis, since the agency purported to conduct just such an analysis.  It then found that the agency's analysis of the effect of the rule on efficiency, competition and capital formation was arbitrary and capricious, because it did not provide a reasoned basis for its conclusion that the rule would increase competition.  The agency could not justify the rule on the ground that it would bring clarity to an uncertain area of law, since this reasoning would support any rule that the SEC adopted in a previously unregulated area.  The SEC must provide an analysis of why this specific rule would promote competition.  The SEC's analysis was also deficient because it did not make any finding on the existing level of competition under state regulation.  Its efficiency and capital formation analyses were similarly deficient because it failed to analyze the efficiency of the current state regulation.

July 22, 2009 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Tuesday, July 21, 2009

Perry Corp. Settles SEC Charges for Failure to Disclose Stock Purchases

The SEC settled charges that New York-based investment adviser Perry Corp. violated securities laws by failing to report that it had purchased substantial stock in a public company in order to vote them in favor of a merger from which Perry stood to profit.  Perry agreed to pay a $150,000 penalty to settle the SEC's charges without admitting or denying the Commission's findings.

According to the SEC, the firm failed to disclose that it had acquired nearly 10 percent of the common stock of Mylan Laboratories, Inc. At the time, Mylan had announced a proposed acquisition of King Pharmaceuticals, Inc. that was subject to shareholder approval. Perry had entered into an investment strategy known as "merger arbitrage" and would profit from a Mylan-King merger. To increase the likelihood of the merger, Perry separately purchased the Mylan voting shares and entered into a series of "swap" transactions — hedging transactions through the use of derivative instruments — designed to avoid any financial exposure from its ownership of those shares. The securities laws require institutional investors like Perry to report the acquisition and ownership of more than 5 percent of the common stock of a public company.

July 21, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Brings ARS Action Against Morgan Keegan

The SEC announced that it filed a complaint in the U.S. District Court for the Northern District of Georgia against Morgan Keegan & Company, Inc. (“Morgan Keegan”), a Tennessee-based broker-dealer, for misleading investors regarding the liquidity risks associated with auction rate securities (“ARS”) that the firm underwrote, marketed, or sold. The Commission’s complaint alleges that Morgan Keegan misrepresented to customers that ARS were safe, highly liquid investments that were comparable to money-market funds. According to the complaint, in 2007 and early 2008, Morgan Keegan was aware that the ARS market was deteriorating. Specifically, the complaint alleges that investor concerns about the creditworthiness of ARS insurers, auction failures in certain segments of the ARS market, increased clearing rates for auctions managed by Morgan Keegan and other broker-dealers, and higher than normal ARS inventories at Morgan Keegan collectively indicated that the risk of auction failures had materially increased. The SEC alleges that Morgan Keegan sold approximately $925 million of ARS to its customers between November 1, 2007, and March 20, 2008, but failed to inform its customers about liquidity risks for ARS, even after the firm decided to stop supporting the ARS market in February 2008.

The complaint also seeks (i) permanent injunctions against Morgan Keegan for future violations; (ii) disgorgement of ill-gotten gains with prejudgment interest; (iii) imposition of civil penalties; and (iv) an order requiring Morgan Keegan to repurchase ARS sold to its customers.

July 21, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Treasury Proposes Credit Rating Agency Reforms

The Treasury Dept. announced that it has sent to Congress proposed reform to credit rating agencies.  (Although the announcement refers to a link to the legislative language, in fact I couldn't link to it.)  The announcement says that:

Continuing its push to establish new rules of the road and make the financial system more fair across the board, the Administration today delivered proposed legislation to Capitol Hill to increase transparency, tighten oversight, and reduce reliance on credit rating agencies. The legislation would also work to reduce conflicts of interest at credit rating agencies while strengthening the Securities and Exchange Commission's (SEC) authority over and supervision of rating agencies. In recent years, investors were overly reliant on credit rating agencies that often failed to accurately describe the risk of rated products. This lack of transparency prevented investors from understanding the full nature of the risks they were taking. The Administration's legislation would tighten oversight of credit rating agencies, protect investors from inappropriate rating agency practices, and bring increased transparency to the credit rating process. 

Fact Sheet: Administration’s Regulatory Reform Agenda Moves Forward Credit Rating Agency Reform Legislation Sent to Capitol Hill.

At a quick glance at Treasury's description of the provisions, I did not see a fix to a major inadequacy in the current law -- the SEC has no authority to review the substance or methodology of the ratings. Instead, the SEC will require each rating agency to document its policies and procedures for the determination of ratings.  The SEC will examine the internal controls, due diligence, and implementation of rating methodologies for all credit rating agencies to ensure compliance with their policies and public disclosures.

July 21, 2009 in News Stories | Permalink | Comments (1) | TrackBack (0)

Monday, July 20, 2009

SEC Charges Former Qualcomm Employee with Insider Trading

The SEC today filed an insider trading action in the United States District Court for the Southern District of California against Andres Leyva, a former Director of Strategic Marketing Analysis at San Diego-based Qualcomm Incorporated. The SEC's complaint alleges that Leyva realized more than $34,000 in illegal profits by trading on the basis of confidential information about Qualcomm's new licensing agreement with Nokia Corporation and the settlement of all litigation between the companies.

According to the SEC's complaint, Qualcomm and Nokia were set to begin trial on July 23, 2008 in a key Delaware case to determine whether Nokia owed Qualcomm substantial royalty revenues when the companies' licensing agreement expired in April 2007. The complaint alleges that on July 22, 2008, at approximately 7:30 a.m. (PT), the senior Qualcomm executive leading negotiations with Nokia representatives in Delaware informed Leyva that Nokia had surprised Qualcomm with a significant settlement offer and conveyed the key terms of that offer to Leyva, including Nokia's proposal to increase an upfront payment to Qualcomm from $500 million to $2.5 billion. Approximately two hours later, the complaint alleges, Leyva purchased 80 Qualcomm call option contracts priced at $.39 each with a strike price of $50.

After the market closed on July 23, 2008, Qualcomm and Nokia announced their new licensing agreement and a global settlement of all litigation between them. On July 24, 2008, Qualcomm's stock price increased 17 percent to $52.43, and its trading volume increased 394 percent. That same day, the complaint alleges, Leyva sold the 80 Qualcomm call option contracts for a profit of $34,739.98.

The SEC's complaint charges Leyva with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The SEC seeks a permanent injunction, disgorgement of Leyva's illegal trading profits, and civil penalties.

July 20, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Morgan Stanley Settles SEC Charges Involving Recommendations about Money Managers

The SEC and Morgan Stanley settled charges that the firm and one of its former investment adviser representatives misled clients about the money managers being recommended to them and failing to disclose conflicts of interest.  According to the SEC’s orders in the case, Morgan Stanley breached its fiduciary duty to advisory clients in its Nashville, Tenn., branch office by making material misstatements about a program through which the firm assisted clients in developing investment objectives and in selecting properly vetted money managers. Contrary to its disclosures, Morgan Stanley recommended some money managers who had not been approved for participation in the firm’s advisory programs and had not been subject to the firm’s due diligence review. William Keith Phillips of Nashville, then a top producer at Morgan Stanley, steered clients to three unapproved managers in particular. Unbeknownst to investors, Morgan Stanley and Phillips received substantial brokerage commissions or fees from these three unapproved managers.

Morgan Stanley has agreed to pay a $500,000 penalty.

July 20, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

TD Ameritrade Latest Firm to Settle ARS Charges with Regulators

The SEC, NASAA and the New York AG each separately announced a settlement with TD Ameritrade regarding auction-rate securities (ARS).  Similar to other ARS settlements, the firm agrees to purchase illiquid ARS from individuals, charities, non-profits and small businesses and institutions purchased from TD Ameritrade before February 13, 2008 (collectively “retail investors”). TD Ameritrade will purchase the ARS from retail investors with accounts of $250,000 or less within seventy-five (75) days; by March, 2010, for all other eligible TD Ameritrade customers. TD Ameritrade will also fully reimburse all eligible investors who sold their auction-rate securities at a discount after the market failed and consent to a special arbitration procedure to resolve claims of consequential damages suffered by eligible investors as a result of not being able to access their funds.

In the same announcement, the New York AG also announced "imminent legal action" against Charles Schwab & Co. (“Schwab”) for deceptively selling auction-rate securities as safe, liquid, short-term investments.


July 20, 2009 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)