Securities Law Prof Blog

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

Thursday, August 20, 2009

Will Proxy Access Be Here Soon?

Yesterday I attended a Directors' Roundtable program here in Cincinnati sponsored by the law firm KMK and others.  The program was excellent, with panels discussing developments in securities regulation, risk management and D&O insurance.  What I found particularly interesting were comments by one speaker, Martin Dunn, a D.C. attorney and former SEC staff member, on the SEC's Proxy Access Proposal.  The comment period has just ended (and why, Dunn wonders, does the comment period end in the middle of August, when no one is in D.C.?), and he was surprised that only about 150 comments were filed, running 2 to 1 in favor of the proposal.  He senses that the consensus view is that it is "a done deal." 

Has the controversy over proxy access really died down?  Given the prolonged history of proxy access proposals at the SEC, it's like a fantasy to imagine one in place.  Let's wait and see.

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

SEC & CFTC Announce Public Meetings on Harmonization of Market Regulation

The SEC and the CFTC announced that the two regulatory agencies will hold joint meetings to seek input from the public on harmonization of market regulation. President Barack Obama in June called on the two regulators to recommend changes to statutes and regulations that would eliminate differences with respect to similar types of financial instruments.  The first meeting, on Sept. 2, 2009, will be held at the CFTC. The second meeting, on Sept. 3, 2009, will be held at the SEC.  The deadline for public comments is set for Sept. 14.

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

Tuesday, August 18, 2009

Financial Firms Pay Big Bucks to Lobby Congress

Investment News reports on the big bucks paid by financial firms in the second quarter on lobbying Congress.  SIFMA paid $1.25 million, the Investment Company Institute paid $1.23 million, and the American Council of Life Insurers paid $2 million.  InvNews, Groups opened wallets to influence financial reforms in second quarter.

Mutual funds also spent large sums.  InvNews, Fidelity, Vanguard, others spent big bucks on 2Q lobbying.

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

FPA Asks SEC to Clarify FINRA's Authority over Financial Planning Activities of Broker Dealer

On August 17 the Financial Planning Association (FPA) wrote to the SEC questioning the authority of FINRA to bring an enforcement action against a dual registrant (Ameritas) relating to its marketing of misleading financial plans.  According to FPA, financial planning  is investment advisory activity subject to the Investment Advisers Act and over which FINRA has denied authority to regulate.  Thus, FPA asks two questions:

1. On what basis of statutory authority, and to what extent, does the SEC permit FINRA to take enforcement action for misleading or fraudulent financial planning activities of brokerage firms separate from the IAA; and
2. Where financial planning activity is clearly under the jurisdiction of the IAA, does the SEC have a policy in place for FINRA to refer cases?

FPA also notes that in congressional hearings on the Madoff scandal, FINRA testified that it had no authority over Madoff's investment advisory business: "We do not believe FINRA can have it both ways, claiming on the one hand that it had no authority over a highly publicized regulatory failure, Madoff, and on the other, clear and unambiguous oversight over the development and marketing of financial plans by an Ameritas broker."

FPA raises good questions that again illustrate the importance of devoting serious attention to the appropriate regulation of all financial professionals.  Let's hope it does not play out as just another turf war. 

August 18, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Two with Defrauding Brokers to Manipulate Penny Stocks

On July 21, 2009 the SEC filed an emergency enforcement action against Eric Todd Seiden to halt an ongoing scheme in which Seiden fraudulently induced at least fifteen broker-dealers to buy over $1.8 million worth of thinly traded stock. On August 14, 2009, the Commission amended its complaint and added Kamal Abdallah as a second defendant.

The Commission's amended complaint, filed in the Eastern District of New York, alleges that on numerous occasions, Seiden, a former securities professional, telephoned broker-dealers, falsely identified himself as a customer or customer representative, and placed large orders to purchase a thinly traded stock for the customer's account. In many instances, Seiden's false representation caused the broker-dealers to execute the orders, which resulted in purchases totaling more than $1.8 million.

The amended complaint also alleges that Abdallah conspired with Seiden to manipulate the prices of penny stocks. Abdallah, the former CEO of Universal Property Development & Acquisition Corp. ("UPDV"), paid Seiden to create artificial demand for UPDV stock and inflate its stock price. Seiden and Abdallah worked in concert to manipulate the market price of UPDV stock, enabling Abdallah to dump his UPDV stock in the public market at an inflated price.

The Complaint charges Seiden with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Abdallah with violating Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

On July 21, 2009, the Court issued a temporary restraining order. On July 30, 2009, the Court issued a preliminary injunction which, among other things, prohibits Seiden from further violations of the federal securities laws. The Commission seeks a final judgment enjoining Seiden and Abdallah from committing future violations of the foregoing federal securities laws and ordering them to disgorge ill-gotten gains plus prejudgment interest thereon and assessing civil penalties. The Commission also seeks a final judgment prohibiting Seiden and Abdallah from participating in any offering of penny stock and barring Abdallah from serving as an officer or director of a public company.

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

FINRA and SEC Issue Alert on Leveraged and Inverse ETFs

FINRA and the SEC have issued an Investor Alert called Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors warning retail investors of the risks associated with investing in these highly complex financial products. This Investor Alert follows a recent FINRA Regulatory Notice reminding securities firms and brokers of their sales practice obligations relating to leveraged and inverse exchange-traded funds (ETFs).

 Traditional ETFs are designed to track an index, such as the S&P 500, or the price of an individual asset. Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark (such as commodities or currencies) they track. Inverse ETFs (also called "short" funds) seek to deliver the opposite of the performance of the index or benchmark they track and are often marketed as a way for investors to profit from, or at least hedge their exposure to, downward moving markets. Both leveraged and inverse ETFs pursue a range of investment strategies through the use of swaps, futures contracts and other derivative instruments.

 Most leveraged and inverse ETFs "reset" daily. This means that they are designed to achieve their stated objectives on a daily basis. Their performance over longer periods of time — over weeks, months or years — can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets. For example, between December 1, 2008, and April 30, 2009, a leveraged ETF seeking to deliver three times the daily return of the Russell 1000 Financial Services Index fell 53 percent, while the underlying index actually gained approximately 8 percent. A leveraged inverse ETF seeking to deliver three times the inverse of the Russell 1000 Financial Services Index's daily return declined by 90 percent over the same period.

 The SEC and FINRA are advising investors to consider leveraged and inverse ETFs only if they are confident the product can help meet their investment objectives and they are knowledgeable about and comfortable with the risks associated with these specialized ETFs.  


August 18, 2009 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Expels Maximum Financial Investment Group for Forex Violations

FINRA announced that it has expelled Maximum Financial Investment Group, Inc. of Southfield, MI, for violations arising out of its retail foreign currency (forex) business, as well as for repeated violations of FINRA registration and related rules.  FINRA also permanently barred Maximum's Chief Executive Officer and Chief Compliance Officer, Christopher T. Paganes, from ever serving in any principal capacity at a securities firm and suspended him from associating with a securities firm in any capacity for nine months. No fine was imposed because Paganes evidenced an inability to pay.

 FINRA found that in September 2007, Maximum entered into an agreement with a non-registered entity — Boston Trading & Research (BTR) — to engage in a retail forex trading business. Maximum agreed to act as a counterparty to the forex transactions. Beginning in January 2008, and continuing through May 2008, more than $15 million in customer funds to be used for retail forex transactions were deposited in Maximum's bank accounts. The receipt of these funds created a liability for Maximum, which it failed to record on its own books and records. This failure led to the firm having insufficient minimum net capital, in violation of federal securities laws and FINRA rules. The firm also failed to calculate the amount it had to deposit on behalf of the forex customers in a reserve bank account to safeguard the funds. In addition, FINRA found that Maximum failed to establish systems and procedures to monitor for money laundering while engaging in the forex transactions.

 FINRA also found that on three occasions, Maximum failed to timely file an application for approval of a material change in its business.  

In settling this matter, the firm and Paganes neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

August 18, 2009 in Other Regulatory Action | Permalink | Comments (2) | TrackBack (0)

Monday, August 17, 2009

SEC Proposes Alternative Uptick Rule

The SEC announced that it is seeking public comment on an alternative approach to short selling price test restrictions that may be more effective and easier to implement than previously proposed price test restrictions currently under consideration.  The alternative uptick rule would allow short selling only at an increment above the national best bid. As a result, the Commission has determined to reopen the comment period for 30 days in order to receive input specifically on this alternative.

In April, the Commission proposed two approaches to restricting short selling. One approach would apply on a market-wide and permanent basis, and would implement short sale restrictions based on either the last sale price or the national best bid. The other approach, considered a "circuit-breaker," would apply only to a particular security during severe declines in the price of that security. Once triggered, the circuit breaker would impose a short sale halt or short sale restriction based on either the last sale price or the national best bid.

Unlike proposals in April, the alternative uptick rule would not require monitoring of the sequence of bids (that is, whether the current national best bid is above or below the previous national best bid), and as a result the alternative uptick rule would be easier to monitor. It also may be possible to implement this approach more quickly and with less cost than the prior proposals.

The initial comment period for the April proposals ended on June 19, 2009. The comment period will now be extended for 30 days from the date of publication of an associated notice in the Federal Register. The Commission particularly seeks comments on the alternative uptick rule as a permanent market-wide approach, as well as whether the alternative uptick rule should be combined with a circuit breaker approach.

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

New York AG Sues Schwab over ARS

Attorney General Andrew M. Cuomo today filed a lawsuit against Charles Schwab & Co. (“Schwab”) charging the discount brokerage firm for falsely representing auction rate securities as liquid, short-term investments without discussing the risks. According to the Attorney General, Schwab brokers repeatedly and persistently misrepresented the liquidity risks in auction rate securities, comparing them to money market funds or certificates of deposit, selling auction rates as suitable for cash management purposes, or otherwise telling customers they would always be able to retrieve their cash.

The Attorney General referred to audio recordings obtained during the investigation that allegedly confirm that Schwab brokers repeatedly misled investors about the risks of investing in auction rate securities. One Schwab broker “guaranteed” that his customer would be able to “get out of [his auction rate security] on the auction date.” Another assured a customer that she just needed to “call me … and then the next month I’ll stop the auction and all the cash [invested in auction rate securities] will come back to your account.” Another Schwab broker described preferred auction rate securities as a “short-term institutional holding instrument” that was particularly suitable for managing the customer’s cash balances:

If you need to have that access to them at any time, that’s a good place for those to be. You know if you think you might need to get into that money, that’s probably as good a place if not better than anywhere to leave them.

Another broker represented that the hardest part of investing in an auction rate security “is getting into it. That would be the tough part. I mean, getting out is something as easy as just selling it.”

According to the Attorney General, while Schwab publicly touted its “extensive fixed-income research,” “expertise” and “seasoned bond traders, who have an average of 15 years of industry experience,” Schwab’s persistent fraud was possible because Schwab failed to train or otherwise ensure that its brokers had even a basic understanding of auction rate securities. Brokers interviewed during the investigation all confirmed that they received no formal training from Schwab relating to auction rate securities. As a result, many Schwab brokers misunderstood or knew little about the auction rate securities they were selling to Schwab’s customers. While Schwab sold customers on its fixed income “expertise,” one broker stated: “I don’t know what measuring scale you would want to use to assess my knowledge about auction rate securities … but on whatever measuring scale my knowledge was pretty low.” The lack of training and understanding at Schwab proved devastating to Schwab’s customers. When one broker was asked if his customers adequately understood the risks of auction rate securities, the broker replied: “No. . . . They probably didn’t know that here is a product you might not be able to sell. It wasn’t conveyed by myself or the financial consultant because we didn’t know either.” Just one week before the auction rate securities market collapsed, during a call with another broker-dealer, one Schwab broker still did not understand the risks that were about to haunt Schwab’s customers, asking “how could an auction fail?”

Today’s action seeks, among other things, to compel Schwab to buy-back auction rate securities from the Schwab investors still holding illiquid securities, penalties, costs, disgorgement, restitution, and other equitable relief.

Here is the complaint.

August 17, 2009 in Other Regulatory Action, State Securities Law | Permalink | Comments (1) | TrackBack (0)

FINRA Officer's Senate Testimony on Stanford Oversight

On August 17, 2009 Daniel M. Sibears, Executive Vice President, FINRA Market Regulation Programs, testified before the Senate Committee on Banking, Housing and Urban Affairs on FINRA's oversight over Stanford's broker-dealer operations.  Mr. Sibears stated that the broker-dealer operations have been subject to regular inspections every other year for the past ten years.  Since 2007 there have been 4 formal disciplinary actions, each resulting in a censure and modest fines.  In addition, FINRA received and reviewed 9 complaints and 7 regulatory tips since 2001.  In conclusion, he states:

Recent frauds, including Stanford, and the financial crisis of the last two years have made it painfully clear that the current regulatory structure is weakened by gaps, inconsistencies and, at times, jurisdictional limitations that should be remedied. In the Stanford case, while FINRA examined Stanford's broker-dealer, it did not examine the investment adviser, nor did it have the clear ability to compel information from Stanford's foreign bank affiliate. Such limitations are frustrating in practice and in the aftermath of this kind of fraud, no regulator can be happy with the status quo.

 Individual investors are the most important players in the financial markets, and we need to earn back the confidence of those investors by closing the gaps in our current U.S. regulatory system and strengthening oversight of all financial firms and professionals regardless of how they are registered. As FINRA's CEO, Rick Ketchum, testified before this committee earlier this year, we believe that one of the most important gaps to close in terms of investor protection is the disparity in oversight between broker-dealers and investment advisers. Between the SEC and self-regulatory organizations, more than half of the approximately 4,900 registered broker-dealer firms are examined each year. By contrast, the SEC projects that fewer than 10 percent of the more than 11,000 registered investment adviser firms will be examined during fiscal years 2009 and 2010. The authorization of an independent regulatory organization for investment advisers would augment the SEC's ability to oversee those financial firms with more frequent exams and expanded enforcement resources would enhance protections provided to all customers of investment advisers.

 As we have learned over the last two years, a system of fragmented regulation provides opportunities to those who would cynically game the system to do so at great harm to investors. FINRA is committed to working with other regulators and this Committee as you consider how best to restructure the U.S. financial regulatory system.

August 17, 2009 in Other Regulatory Action | Permalink | Comments (1) | TrackBack (0)

Sunday, August 16, 2009

Black on Reputational Damages

Reputational Damages in Securities Litigation, by Barbara Black, University of Cincinnati - College of Law, was recently posted on SSRN.  Here is the abstract:

This short paper, originating in remarks made at the Institute for Law and Economic Policy's 15th Annual Conference on Compensation of Plaintiffs in Mass Securities Litigation, addresses an issue that has surfaced post-Dura Pharmaceuticals: can investors recover damages resulting from declines in stock price attributable to the market's reassessment of the integrity of management or the corporation's internal controls? Some finance scholars label these damages as non-recoverable 'collateral damage' that are not attributable to the original fraudulent disclosure. I argue that this position is based on a mischaracterization of the original fraudulent disclosure and that there is no basis in law or policy for denying plaintiffs recovery for what are properly considered as reputational damages.

August 16, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Buxbaum on Personal Jurisdiction in Cross-Border Securities Litigation

Personal Jurisdiction Over Foreign Directors in Cross-Border Securities Litigation, by Hannah L. Buxbaum, Indiana University School of Law-Bloomington, was recently posted on SSRN.  Here is the abstract:

Securities litigation against non-U.S. companies – on the rise over the past decade – forces U.S. courts to address a variety of procedural and jurisdictional issues. This article considers one such issue: the circumstances under which the directors of foreign companies that engage in U.S. securities markets may be subject to the personal jurisdiction of U.S. courts. It argues that jurisdictional standards are sometimes applied in a way that undermines the effectiveness of private litigation in enforcing director accountability norms. This result is particularly problematic in cases based upon a director’s failure to meet an accountability obligation expressly imposed upon it by statute. The article considers possible ways of resolving this tension, and ultimately advocates that courts adopt a two-part presumption: (1) In a claim against a foreign director based upon a corporate filing with respect to which Congress has expressly created a director accountability requirement, there should be a strong presumption that the director is subject to the personal jurisdiction of the U.S. court; and (2) In a claim against a foreign director based only upon allegations that the director failed to meet his or her oversight responsibilities over management, there should be a strong presumption that the director is not subject to the personal jurisdiction of the U.S. court. The article argues that these presumptions will satisfy the due-process protections embodied in jurisdictional law while bringing that law into better alignment with regulatory expectations regarding the responsibility of corporate directors for an issuer’s securities activity.

August 16, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Frankel on Fiduciary Duties of Securities Professionals

Fiduciary Duties of Brokers-Advisers-Financial Planners and Money Managers, by Tamar Frankel, Boston University School of Law, was recently posted on SSRN.  Here is the abstract:

Broker dealers and investment advisers form the lifeline of the financial markets. While in the past their functions were separate, and their regulation differed, throughout the years their functions were allowed to merge but their regulation remained separate. Advisers are their clients’ fiduciaries. Brokers are not, with some exceptions. It is recognized that the law has to change, and the question is how. In this Article I argue for imposing the fiduciary duty of loyalty and limiting conflict of interest all financial intermediaries, including broker dealers, and suggest a process for establishing the details of the law that should apply to them. Section One of the Article outlines the principles on which fiduciary law is based. Section Two offers a short overview of the past and current practice of broker dealers. Section Three highlights the fiduciary aspects of broker dealers and the risks posed to their clients from their conflicts of interest Section Four proposes changes in the current law and a process to achieve future changes. The law should impose principles; the financial intermediaries should seek the specificity.

August 16, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bainbridge on STOCK Act

The Stop Trading on Congressional Knowledge Act, by Stephen M. Bainbridge, University of California, Los Angeles - School of Law, was recently posted on SSRN.  Here is the abstract:

A 2004 study of the results of stock trading by United States Senators during the 1990s found that that senators on average beat the market by 12% a year. In sharp contrast, U.S. households on average underperformed the market by 1.4% a year and even corporate insiders on average beat the market by only about 6% a year during that period. A reasonable inference is that some Senators had access to - and were using - material nonpublic information about the companies in whose stock they trade.

Under current law, it is uncertain whether members of Congress can be held liable for insider trading. The proposed Stop Trading on Congressional Knowledge Act addresses that problem by instructing the Securities and Exchange Commission to adopt rules intended to prohibit such trading.

This article analyzes present law to determine whether members of Congress, Congressional employees, and other federal government employees can be held liable for trading on the basis of material nonpublic information. It argues that there is no public policy rationale for permitting such trading and that doing so creates perverse legislative incentives and opens the door to corruption. The article explains that the Speech and Debate Clause of the U.S. Constitution is no barrier to legislative and regulatory restrictions on Congressional insider trading. Finally, the article critiques the current version of the STOCK Act, proposing several improvements.

August 16, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)