Securities Law Prof Blog

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

Friday, October 16, 2009

SEC Charges Three with Running Ponzi Scheme Targeting Haitian-Americans in Florida

The SEC filed a civil injunctive action on October 16, 2009 against HomePals Investment Club, LLC and HomePals, LLC (together, “HomePals”), and their principals, Ronnie Eugene Bass, Jr., Abner Alabre and Brian J. Taglieri, alleging that they ran a Ponzi scheme and affinity fraud that targeted Haitian-American investors residing primarily in South Florida.  The SEC’s complaint alleges that from April 2008 through December 2008, the defendants raised at least $14.3 million through the sale of unsecured notes to hundreds of Haitian-American investors by promising guaranteed returns of 100% every 90 days. The defendants claimed they were able to generate such spectacular returns through Bass’ purported successful trading of stock options and commodities. The SEC’s complaint further alleges that, in reality, Bass traded no more than $1.2 million of the $14.3 million raised, generated trading losses of 19 percent, and that HomePals used the bulk of the investor funds to repay earlier investors in typical Ponzi scheme fashion. The SEC also alleges that Bass, Alabre and Taglieri misappropriated at least $668,000 of investor funds for personal use.

The SEC’s complaint, filed in the United States District Court for the Southern District of Florida, charges each of the defendants with violating Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933, Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 and, with respect to Bass, Sections 206(1), (2) and (4) and Rule 206(4)-8 of the Investment Advisers Act of 1940. The Commission seeks permanent injunctions, disgorgement of ill-gotten gains and financial penalties against all defendants.

Separately, on October 16, 2009, the U.S. Attorney’s Office for the Southern District of Florida announced the unsealing of indictments charging Bass, Alabre and Taglieri with securities fraud, conspiracy to commit securities fraud, wire fraud and money laundering.

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

SEC Charges Hedge Fund Advisor with Inside Trading

The SEC charged billionaire Raj Rajaratnam and his New York-based hedge fund advisory firm Galleon Management LP with engaging in a massive insider trading scheme that generated more than $25 million in illicit gains. The SEC also charged six others involved in the scheme, including senior executives at IBM, Intel and McKinsey & Company. The SEC’s complaint, filed in federal court in Manhattan, alleges that Rajaratnam tapped into his network of friends and close business associates to obtain insider tips and confidential information about corporate earnings or takeover activity at several companies, including Google, Hilton and Sun Microsystems. He then used the non-public information to illegally trade on behalf of Galleon.

In addition to Rajaratnam and Galleon, the SEC’s complaint charges:

Danielle Chiesi of New York, N.Y. — a portfolio manager at New Castle Funds.
Rajiv Goel of Los Altos, Calif. — a managing director at Intel Capital, an Intel subsidiary.
Anil Kumar of Saratoga, Calif. — a director at McKinsey & Company.
Mark Kurland of Mount Kisco, N.Y. — a Senior Managing Director and General Partner at New Castle.
Robert Moffat of Ridgefield, Conn. — a senior vice president at IBM.
New Castle Funds LLC — a New York-based hedge fund 

 The complaint seeks a final judgment permanently enjoining the defendants from future violations of the above provisions of the federal securities laws, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and ordering them to pay financial penalties. The complaint also seeks to permanently prohibit Goel, Kumar and Moffat from acting as an officer or director of any registered public company.

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

SEC & CFTC Issue Report on Harmonizing Regulation of Futures and Securities

The SEC and the CFTC issued a joint report identifying areas where the agencies' regulatory schemes differ and recommending actions to address those differences, where appropriate.  In June, the White House released a White Paper on Financial Regulatory Reform calling on the SEC and CFTC to "make recommendations to Congress for changes to statutes and regulations that would harmonize regulation of futures and securities." Today's report includes 20 recommendations to enhance enforcement powers, strengthen market and intermediary oversight and improve operational coordination.

Over the past several months, the SEC and the CFTC have engaged in extensive discussions, including their first ever joint public meetings last month. The meetings solicited views from members of the investor community, academics, industry experts and market participants on the current regulatory scheme, harmonization of the agencies' rules and recommendations for changes to statutes and regulations. The agencies also solicited written comments to further assist their deliberations.

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

Thursday, October 15, 2009

Schwab Receives Wells Notice over Bond Funds

Charles Schwab said it received a Wells notice from the SEC about two bond funds that are the subject of a class action suit and numerous arbitrations.  Investors in the two funds, Yield Plus Fund andTotal Bond Market Fund, allege that the funds were marketed as conservative investments, but lost substantial amounts of their value because of their investments in mortgage-backed securities.  InvNews, Schwab slapped with SEC warning; YieldPlus settlement may be on the horizon.

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

House Committee Approves Legislation to Regulate OTC Derivatives

The House Financial Services Committee today approved legislation that would, for the first time ever, require the comprehensive regulation of the over-the-counter (OTC) derivatives marketplace. Today’s bill, which was approved by a vote of 43-26, represents a key part of a broader effort by Congress and President Obama to modernize America’s financial regulatory system in response to last year’s financial crisis.

Under the bill, all standardized swap transactions between dealers and large market participants, referred to as “major swap participants,” would have to be cleared and must be traded on an exchange or electronic platform. A major swap participant is defined as anyone that maintains a substantial net position in swaps, exclusive of hedging for commercial risk, or whose positions creates such significant exposure to others that it requires monitoring. OTC derivatives include swaps, which are contracts that call for an exchange of cash between two counterparties based on an underlying rate, index, credit event or the performance of an asset.

The legislation then sets out parallel regulatory frameworks for the regulation of swap markets, dealers, and major swap participants.  Rulemaking authority is held jointly by the Commodity Futures Trading Commission (CFTC), which has jurisdiction over swaps, and the Securities and Exchange Commission (SEC), which has jurisdiction over security-based swaps.   The Treasury Department is given the authority to issue final rules if the CFTC and SEC cannot decide on a joint approach within 180 days. Subsequent interpretations of rules must be agreed to jointly by the Commissions.

Here's SIFMA's press release on the legislation:

“Bringing greater regulatory transparency and oversight to derivatives markets and products is a key component of reforming our financial system. That oversight must also recognize the important role these risk management tools play for countless companies across the country and for our broader economy. Mandating particular transaction modes, as this bill does, could raise transaction costs while not necessarily reducing risk in a commensurate amount—results that we believe are contrary to our shared reform goals. As the legislative process continues we look forward to working with the Congress toward a bill that strikes a balance between the need for transparency and risk management efficiency.”

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

Wednesday, October 14, 2009

Former United Rental Officer Settles SEC Accounting Fraud Charges

The SEC announced that John N. Milne, a former Vice Chairman, President and Chief Financial Officer of United Rentals, Inc. (“URI”) has agreed to settle pending fraud charges filed against him by the Commission. The SEC alleged that, from 2000 through 2002, Milne engaged in a series of fraudulent transactions undertaken in order to meet URI’s earnings forecasts and analyst expectations. The complaint alleges that Milne and others carried out the fraud through a series of interlocking three-party transactions, structured as “minor sale-leasebacks,” to allow URI to recognize revenue prematurely and to inflate profits generated from the sales. As a result of the fraud, URI materially overstated its financial results in its Forms 10-K for fiscal years 2000 and 2001, and its Forms 10-Q for the periods ended June 30, 2001 and March 31, 2002, as well as in other public releases.

The complaint further alleges that shortly after URI announced 2001 and 2002 year-end results, Milne sold URI stock that he owned, knowing that the company’s announced financial results were materially overstated.

Without admitting or denying the allegations in the complaint, Milne consented to the entry of a Final Judgment, subject to the court’s approval, permanently enjoining him from future violations of Section 17(a) of the Securities Act of 1933, and Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934, and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and from aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20, 13a-1, and 13a-13, thereunder, imposing a permanent officer and director bar against him, and ordering him to pay disgorgement and prejudgment interest of $6.25 million

The U.S. Attorney’s Office for the District of Connecticut also announced that Milne today pleaded guilty to one count of conspiracy to falsify the books and records of URI while he served as its CFO, and that he has agreed to a term of incarceration of 24–30 months.

October 14, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC's Next Open Meeting Will Discuss "Dark Pools"

The SEC's next Open Meeting is Wednesday, October 21, 2009 at 10:00 a.m.  The subject matter of the Open Meeting will be:

The Commission will consider recommendations to propose amendments to the regulatory requirements that apply to non-public trading interest, including so-called "dark pools" of liquidity. The recommended proposals are to: (1) amend the definition of "bid" or "offer " in Regulation NMS under the Securities Exchange Act of 1934 (Exchange Act) to address actionable indications of interest; (2) amend the display obligations of alternative trading systems in Regulation ATS under the Exchange Act; and (3) amend the joint-industry plans for disseminating consolidated trade data.

October 14, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Posts Rules on Internal Controls for Non-Accelerated Filers

The SEC posted on its website its final rules regarding INTERNAL CONTROL OVER FINANCIAL REPORTING IN EXCHANGE ACT PERIODIC REPORTS OF NON-ACCELERATED FILERS.  The agency is amending temporary rules that require companies that are non-accelerated filers to include in their annual reports, pursuant to rules implementing Section 404(b) of the Sarbanes-Oxley Act of 2002, an attestation report of their independent auditor on internal control over financial reporting for fiscal years ending on or after December 15, 2009. The amendments will extend the compliance date for filing attestation reports, so that a non-accelerated filer will be required to file the auditor’s attestation report on internal control over financial reporting when it files an annual report for a fiscal year ending on or after June 15, 2010.

October 14, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

U.S. Supreme Court Will Hear Jeff Skillings' Appeal

The U.S. Supreme Court accepted certiorari in Enron executive Jeffrey Skilling's appeal from his conviction on two issues:  (1) prejudicial pretrial publicity prevented him from getting a fair trial, and (2) the statute that makes it a crime "to deprive another of the intangible right of honest services" is unconstitutionally vague.  (The Supreme Court has accepted Conrad Black's appeal on the latter ground as well.)

October 14, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Madoff Victims Sue SEC

The New York Times reports that two Madoff victims have filed a complaint in federal court in S.D.N.Y.  against the SEC for its failure to uncover the Madoff scheme, despite numerous tips that should have aroused its suspicion.  The complaint alleges that the doctrine of sovereign immunity should not apply to shield the agency from the consequences of its "serial, gross negligence."  NYT, Suit Accuses S.E.C. of Failing to Detect Madoff Scheme.

October 14, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, October 13, 2009

New York AG Posts Letter regarding Waiver of BofA Attorney-Client Privilege

The New York Attorney General has posted on its website the Oct. 12 letter from Cleary Gottlieb, written on behalf of Bank of America, in which the Bank agrees to waive the attorney-client privilege or the attorney work product doctrine with respect to certain subjects connected to the Bank of America-Merrill Lynch merger.  It will also produce privileged information to federal regulators and to Congress.  It expects to be able to effect the waiver by October 16.

October 13, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, October 12, 2009

Companies Awarded Execs Pre-Takeover Stock Options

Another stock options scandal?  Many corporations awarded stock options to their senior executives while they were engaged in undisclosed discussions about being taken over, the Wall St. Journal reports today.  As a result, the executives received a bigger payout when the takeover is announced.  Academic researchers examined over 100 deals between 1999-2006 in which target company CEOs received unscheduled stock options prior to the public announcement of the takeover, and the WSJ found 6 more since 2007, including options issued to Marvel Entertainment CEO before its acquisition by Disney.  This is a variation of the practice of "spring-loading," which received quite a bit of attention a few years back.  Companies are supposed to disclose in their proxy statements whether they have engaged in options timing practices.  WSJ, Option Grants Draw Scrutiny.

October 12, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

BofA Agrees to Turn Over Documents About Merrill Lynch Legal Advice

The Bank of America, in a sharp reversal of strategy, has agreed to waive the attorney client privilege and turn over to the New York Attorney General documents concerning the legal advice it received in connection with the Merrill Lynch merger, according to the Wall St. Journal.  It is expected that this is the first step toward settlement.  WSJ, BofA to Hand Over Documents Related to Its Merrill Deal

October 12, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Fines Citigroup for Failure to Supervise Complex Trading Strategies

FINRA announced that it has fined Citigroup Global Markets Inc. $600,000 and censured the firm for failing to supervise complex trading strategies designed in part to minimize potential tax liabilities. The firm also failed to report to an exchange trades executed under these strategies and to adequately monitor Bloomberg messages.  Specifically, Citigroup failed to supervise and control trading activities by lacking procedures designed to detect and prevent improper trades between the firm and certain counterparties, and among entities within the firm.

In settling this matter, Citigroup neither admitted nor denied the charges, but consented to the entry of FINRA's findings. In determining the appropriate sanction, FINRA noted that Citigroup discovered and self-reported the violations giving rise to this matter; that the firm hired a law firm to conduct a review of these trades and to assist in remedial efforts; and that the firm and its outside counsel provided substantial assistance to FINRA staff during the investigation

October 12, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Capital University Law School's 6th Annual Business & Tax Institute Focuses on Corporate Governance

Capital University Law School’s Sixth Annual Business and Tax Institute is shifting its focus this year from tax and estate planning to new corporate governance issues emerging out of the financial crisis, and transaction options for distressed companies trying to stay afloat in choppy economic waters.  The conference topic is “The Financial Crisis: New Administration Initiatives and How Practitioners Should Advise Clients as a Result.” It will be held Friday, Oct. 16, from 8:30 a.m. to 5 p.m. at the State Teachers Retirement System of Ohio, 275 E. Broad St., in downtown Columbus.
The morning sessions will focus on the financial crisis and the governance of private and publicly held for-profit and nonprofit corporations. Afternoon sessions will address financial transactions for distressed companies, including bankruptcy, restructuring and raising capital. Featured speakers and panelists include nationally recognized practicing attorneys, business financial advisors and academics.  

Up to 7.0 continuing legal education credits are available.  More information is found at the school's website. 

October 12, 2009 in Professional Announcements | Permalink | Comments (0) | TrackBack (0)

Sunday, October 11, 2009

Columbo on Trust and Finanical Regulation

Trust and Financial Regulation, by Ronald J. Colombo, Hofstra University - School of Law, was recently posted on SSRN.  Here is the sbstract:

Trust is a critically important ingredient in the recipes for a successful economy and a well-functioning financial services industry. Due to scandals, ranging in nature from massive incompetence, to massive irresponsibility, to massive fraud, investor trust is in shorter supply as 2009 comes to a close. This is troubling, and commentators, policy makers, and industry leaders have all recognized the need for trust’s restoration.

As in times of similar crises, many have turned to law and regulation for the answers to our problems. The imposition of additional regulatory oversight, safeguards, and remedies, some advocate, can help resuscitate investor trust. These advocates have it half right.

For trust is complicated, existing in a variety of forms. Some forms, predicated primarily upon reasoned calculation, respond well to law and regulation. But other forms, predicated primarily upon relationship and emotion, respond poorly to law and regulation. In fact, these latter forms of trust can be seriously harmed by legal intervention. Wise policymakers would carefully assess the nature of whatever particular trust relationship he or she wishes to strengthen before taking action to ostensibly strengthen the trust in that relationship.

This Article applies trust scholarship to examine the current U.S. financial regulatory regime, and proposed reforms thereto. It concludes that, for the most part, the existing financial regulatory regime comports well with our understanding of trust. Unfortunately, current reform proposals comport less well with this understanding.

October 11, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Johnsen on Mutual Fund Fees

Myths About Mutual Fund Fees: Economic Insights on Jones v. Harris, by D. Bruce Johnsen, George Mason University - School of Law, was recently posted on SSRN. Here is the abtract:

Mutual funds stand ready at all times to sell and redeem common stock to the investing public for the net value of their assets under management. In the language of transaction cost economics, they are open-access common pools subject to virtually free investor entry and exit. The Investment Company Act (1940) requires mutual funds to be managed by an outside advisory firm pursuant to a written contract, which normally pays the adviser a small share of net asset value, say, one-half of one percent per year. Following 1970 amendments to the Investment Company Act imposing a fiduciary duty on advisers with respect to their receipt of compensation, a large number of private civil suits attempting to recover excessive fees have been filed against advisory firms. By failing to account for the transaction costs inherent in mutual fund organization, Congress, securities regulators, financial scholars, and even courts have misidentified a conflict of interest with respect to fund advisory fees, encouraging these frivolous suits. With free investor entry and exit and rational expectations, fund flows endogenize investor returns. Regardless of the level of the advisory fee, any expected abnormal return to a manager’s superior stock-picking skill will be competed away by investors chasing the prospect of capturing the associated rents. With shareholders having a common claim to fund assets, all expected rents will be either transferred to the manager in the form of higher total fee payments on a larger asset base or dissipated by added administrative costs. As a first approximation, the level of advisory fees is therefore irrelevant to fund shareholders. The best they can expect from placing their money in a managed fund is a normal competitive return after adjusting for risk and other factors. With the U.S. Supreme Court having recently granted certiorari in an excessive fee case appealing an arguably maverick opinion by Judge Frank Easterbrook of the Court of Appeals for the Seventh Circuit, it is essential that various myths about mutual fund fees be exposed to careful economic analysis.

October 11, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Strauss on the PCAOB Case

Free Enterprise Fund v. Public Company Accounting Oversight Board, by Peter L. Strauss, Columbia Law School, was recently posted on SSRN.  Here is the abstract:

This is the introductory essay in an electronically published roundtable sponsored by the Vanderbilt Law Review on the Supreme Court's forthcoming consideration of Free Enterprise Fund v. Public Company Accounting Oversight Board, a case raising important separation of powers questions and thought by some to foreshadow overruling or limiting of such precedents as Humphrey's Executor v. United States (sustaining independent regulatory commissions) and Morrison v. Olson (sustaining the independent counsel). The PCAOB is an unusual independent government authority appointed by the Commissioners of the SEC and subject to its oversight; PCAOB members are only by the Commission, and only for one of several defined causes. This essay is intended to "set the table" for competing essays by other scholars, that will appear in November.

October 11, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Horwich & Siekkinen on PSLRA & 7th Amendment

Pleading Reform or Unconstitutional Encroachment? An Analysis of the Seventh Amendment Implications of the Private Securities Litigation Reform Act, by Allan Horwich, Schiff Hardin LLP; Northwestern University - School of Law, and Sean Siekkinen, Northwestern University - School of Law, was recently posted on SSRN.  Here is the abstract:

The Private Securities Litigation Reform Act of 1995 (PSLRA) is a hurdle for securities fraud litigation intended to weed out at the motion to dismiss phase cases that lack merit. But the PSLRA’s protections are not without cost, which is borne by defrauded investors with meritorious claims who nevertheless cannot meet this increased obstacle to pursuing a claim. This Article addresses whether some courts are applying the PSLRA in a way that violates the Seventh Amendment by impeding a plaintiff’s ability to present his case to a jury. The PSLRA’s language is problematically vague, which has led to circuit splits on several important points, most significantly the extent to which the PSLRA requires securities fraud plaintiffs to aver detailed facts supporting the rule 10b-5 cause of action element of scienter. The more stringent of these varying interpretations, reflected in decisions in the Ninth and Tenth Circuits, raises Seventh Amendment concerns. The Sixth and Seventh Circuits have acknowledged these concerns without passing on the constitutionality of the dubiously stringent interpretation. This Article endeavors to answer the question posed by these courts, analyzing the intersection of the PSLRA with Seventh Amendment jurisprudence. This Article concludes that the more stringent interpretations of the heightened pleading requirement for scienter violate the Seventh Amendment by usurping the jury’s prerogative to resolve disputed questions of material fact and, in particular, the inferences to be drawn from those facts.

October 11, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Horwich on Rule 10b5-1

The Origin, Application, Validity, and Potential Misuse of Rule 10b5-1, by Allan Horwich, Schiff Hardin LLP; Northwestern University - School of Law, was recently posted on SSRN.  Here is the abstract:

The SEC adopted Rule 10b5-1 to define what it means to trade securities “on the basis of” material nonpublic information. This was to address decisions and commentary that found no insider trading violation of Rule 10b-5 where the defendant did not “use” inside information in deciding to trade, even if one “possessed” the information when the decision was made. Rule 10b5-1 specifies exclusive affirmative defenses for one charged with trading on the basis of material nonpublic information, the essence of which are that there is no violation if the trade was made pursuant to a pre-arranged plan, even if the seller or buyer later became aware of the information before the trade was made. There is, however, a substantial argument that the SEC exceeded its powers in adopting exclusive criteria for what it means to trade “on the basis of” material nonpublic information, rather than creating a safe harbor. Non-use of inside information in deciding to trade remains a defense even if the trade was not made pursuant to a Rule 10b5-1 plan. Although the SEC abandoned a proposal to require detailed disclosure of some Rule 10b5-1 plans, other SEC rules require disclosure of a plan in some circumstances, although compliance may be deficient. Irrespective of mandated disclosure, there are reasons both for and against voluntary disclosure of a Rule 10b5-1 plan. Some have suggested that Rule 10b5-1 is being misused in that executives establish such plans, know when a trade will occur under the plan and then, in order to maximize their profits when the trade is made, delay or accelerate disclosure of corporate news that would affect the stock price. In most situations, any such timing of corporate disclosure would not violate the securities laws.

October 11, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)