Securities Law Prof Blog

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

Friday, November 13, 2009

SEC Announces Speakers for Forum on Small Business Capital Formation

The SEC announced the agenda, speakers and panelists for its November 19 forum on small business capital formation. The morning forum panels will focus on the state of small business capital formation and the SEC's "accredited investor" definition. In the afternoon, forum breakout groups will develop recommendations to facilitate small business capital formation.

Participants include:

The State of Small Business Capital Formation

Todd Flemming, Infrasafe, and Small Business and Entrepreneurship Council
Anna T. Pinedo, Morrison & Foerster
Andrew J. Sherman, Jones Day, and Adjunct Professor, Smith School of Business, University of Maryland
Barry E. Silbert, SecondMarket
Eric R. Zarnikow, Office of Capital Access, U.S. Small Business Administration 
Academic Perspectives on the SEC's "Accredited Investor" Definition

Prof. Rutheford B. Campbell, Jr., University of Kentucky College of Law
Prof. Jill E. Fisch, University of Pennsylvania Law School
Prof. Donald C. Langevoort, Georgetown University Law Center
Prof. William K. Sjostrom, James E. Rogers College of Law, University of Arizona 

November 13, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Two Computer Programmers with Assisting Madoff's Fraud

The SEC charged two computer programmers for their role in helping convicted Ponzi schemer Bernard L. Madoff cover up the fraud at Bernard L. Madoff Investment Securities LLC (BMIS) for more than 15 years.  The SEC alleges that Jerome O'Hara of Malverne, N.Y., and George Perez of East Brunswick, N.J., provided the technical support necessary to produce false documents and trading records and took hush money to help keep the scheme going.

According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, Madoff and his lieutenant Frank DiPascali, Jr., routinely asked O'Hara and Perez for their help in creating records that, among other things, combined actual positions and activity from BMIS' market-making and proprietary trading businesses with the fictional balances maintained in investor accounts. O'Hara and Perez wrote programs that generated many thousands of pages of fake trade blotters, stock records, Depository Trust Corporation (DTC) reports and other phantom books and records to substantiate nonexistent trading. They assigned file names to many of these programs that began with "SPCL," which is short for "special."

A separate computer internally known as "House 17" was used to process BMIS investment advisory account data at the direction of Madoff, DiPascali and others. The SEC alleges that O'Hara and Perez knew that the House 17 computer was missing a host of functioning programs necessary for actual securities trading and reporting. According to the SEC's complaint, they recognized that the trades being entered into House 17 and the account statements and trade confirmations being sent to investors did not reflect actual trades.

The SEC alleges that O'Hara and Perez had a crisis of conscience in 2006 and tried to cover their tracks by attempting to delete approximately 218 of the 225 special programs from the House 17 computer. But they did not delete the monthly backup tapes. O'Hara and Perez then cashed out hundreds of thousands of dollars each from their personal BMIS accounts before confronting Madoff and refusing to generate any more fabricated books and records.  The SEC's complaint alleges that Madoff responded by telling DiPascali to offer O'Hara and Perez as much money as necessary to keep quiet and not expose the misrepresentations. O'Hara and Perez considered the offer and demanded a salary increase of nearly 25 percent along with one-time bonuses in late 2006 of more than $60,000 each. They stated to DiPascali at the time that they did not ask for more because a greater amount might appear too suspicious. DiPascali then managed to convince O'Hara and Perez to modify computer programs so that he and other 17th floor employees could create the necessary reports themselves.

The SEC's complaint specifically alleges that O'Hara and Perez aided and abetted violations of Sections 10(b), 15(c) and 17(a) of the Exchange Act and Rules 10b-3, 10b-5 and 17a-3 thereunder, and Sections 204, 206(1) and 206(2) of the Advisers Act and Rule 204-2 thereunder. Among other things, the SEC's complaint seeks financial penalties and a court order requiring O'Hara and Perez to disgorge their ill-gotten gains.

November 13, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Thursday, November 12, 2009

SEC Settles Regulation G Charges against SafeNet, Former Officers and Former Accountants

The SEC settled charges against SafeNet, Inc., its former Chief Executive Officer, Anthony Caputo, its former Chief Financial Officer, Kenneth Mueller, and three former SafeNet accountants, Clinton Ronald Greenman, John Wilroy, and Gregory Pasko. The SEC alleged that, during the period from the fourth quarter of 2000 through May 2006, SafeNet engaged in two fraudulent schemes — one involving the backdating of options and the other earnings management. Each scheme resulted in SafeNet materially misstating its financial results and disseminating materially false and misleading information concerning its financial condition. According to the complaint, Mueller and Caputo were involved in both schemes, while Greenman, Wilroy and Pasko were involved only in the earnings management scheme.

The SEC release states that this is the agency's first enforcement action brought pursuant to Regulation G. Regulation G applies whenever a reporting company discloses publicly any material information that includes a "non-GAAP financial measure." Non-GAAP financial measures, which are not calculated in conformity with Generally Accepted Accounting Principles, often exclude non-recurring, infrequent, or unusual expenses. Regulation G requires companies to reconcile the non-GAAP financial measure to the most directly comparable GAAP financial measure. Regulation G also prohibits companies and their employees from disseminating false or misleading non-GAAP financial measures or presenting the non-GAAP financial measures in such a manner that they mislead investors or obscure the company's GAAP results.

All defendants have agreed to settle this matter, without admitting or denying the allegations in the complaint.  Besides injunctive relief, SafeNet will pay a civil penalty of $1,000,000.  The individual defendants will pay civil penalties ranging from $15,000 to $250,000.

The settlements with SafeNet, Greenman, and Pasko take into account the cooperation with the SEC's investigation by SafeNet and these individuals. All of the settlements of the civil action are subject to the approval of the United States District Court for the District of Columbia.

November 12, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 11, 2009

Senate Proposed Legislation More Investor Protective than House Version

Senator Dodd, Chair of the Senate Banking Committee, released yesterday a discussion draft of proposed financial reform legislation, entitled Restoring American Financial Stability Act of 2009.Download SenateBankingRegulatoryReformProposal It is a more comprehensive and investor protective reform package than the version recently approved by the House Financial Services Committee, and therefore, we can surmise, is less likely to be passed in its current form.

As one example:  the House proposed legislation contains language that would require the SEC to enact rules to harmonize the regulation of investment advisers and broker-dealers that provide individualized advice to retail customers.  In contrast, the Senate version proposes simply to eliminate the broker-dealer exception from the definition of "investment adviser" in the Investment Advisers Act. Thus, the requirements of the Investment Advisers Act would apply to all broker-dealers and their dealings with all customers.  To deal with the problem of the IAA's prohibition against trading with a customer as a principal without pre-transaction approval, the proposed legislation would give the SEC authority to exempt persons or transactions from this prohibition so long as the adviser provides investors with "adequate protection" against conflicts of interest. 

The Senate legislation would also provide for aiding and abetting liability in private securities fraud actions, unlike the House version.

November 11, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 10, 2009

SEC Charges Former Hedge Fund CFO with Securities Fraud

The SEC charged Ezra C. Levy, the former chief financial officer of New York-based hedge fund Boston Provident LP, with securities fraud for arranging secret sales of securities from his personal trading account to the hedge fund accounts at inflated prices to generate his own illicit profits.  According to the SEC's complaint, Levy's job responsibilities required that he have access to the firm's electronic trade entry system. He did not, however, have the authority to make trading decisions for Boston Provident's accounts, and was merely authorized to execute the trading decisions of the firm's chief executive officer. The SEC alleges that Levy made unauthorized, fraudulent trades that resulted in financial losses to the hedge fund accounts while he made a personal profit of more than a half-million dollars. The SEC is seeking a court order to freeze Levy's assets.

The SEC alleges that on two days in June 2009, Levy secretly entered "sell" orders for securities at above-market prices for his personal account. At approximately the same time, he entered "buy" orders for Boston Provident's accounts, for the same securities at the same above-market prices. By placing these matched orders, Levy caused sales of securities from his personal account to Boston Provident's accounts at inflated prices. Levy's profit from these fraudulent trades exceeded $537,000.

November 10, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Bear Hedge Fund Managers Acquitted of Fraud Charges

Ralph Cioffi and Matthew Tannin, two former Bear Stearns hedge fund managers, were found not guilty of all federal securities fraud charges today in Manhattan.  The government charged that they misled investors by failing to disclose that the funds were declining in value.  In addition, Mr. Cioffi was charged with not disclosing that he was selling off portions of his own investments in the fund.  NYTimes, Bear Stearns Managers Acquitted of Fraud Charges.

November 10, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Senate Banking Committee Chair Introduces Regulatory Reform Proposal

Today Senate Banking Committee Chairman Chris Dodd (D-CT) introduced  draft legislation  to reform the way that our financial system is regulated.  When questioned about his bill Dodd told reporters “This is not a time for timidity.”


Consumer Financial Protection Agency: Creates an independent watchdog to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, while prohibiting hidden fees, abusive terms, and deceptive practices.

Ends Too Big to Fail: Prevents excessively large or complex financial companies from bringing down the economy by: creating a safe way to shut them down if they fail; imposing tough new capital and leverage requirements and requiring they write their own “funeral plans”; requiring industry to provide their own capital injections; updating the Fed’s lender of last resort authority to allow system-wide support but not prop up individual institutions; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.

Protects Against Systemic Risks: Creates an independent agency with a board of regulators to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the financial system. The agency could require companies that threaten the economy to divest some of their holdings.

Single Federal Bank Regulator: Eliminates the convoluted system of multiple federal bank regulators to increase accountability and end unnecessary overlap, conflicting regulation, and “charter shopping;” keeps in place the healthy dual banking system that governs community banks.

Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation and director nominations.

Closes Loopholes in Regulation: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated - including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders.

Protects Investors: Provides tough new rules for transparency and accountability from investment advisors, financial brokers and credit rating agencies to protect investors and businesses.

Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefit special interests at the expense of American families and businesses.

November 10, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, November 9, 2009

Attorney Pleads Guilty for Role in Dreier Securities Fraud

Robert Miller, a former SEC enforcement attorney, pleaded guilty to conspiracy in the securities fraud scheme perpetrated by Manhattan attorney Marc Dreier.  InvNews, Ex-SEC lawyer pleads guilty in Dreier fraud case.

November 9, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

More on ARS Arbitrations

In a blog yesterday on ARS arbitrations, I remarked that my impression was that purchasers of auction rate securities were not faring well in claims for damages resulting from the freezing of the credit markets in early 2008.  Today Investment News has an article that provides some support for this.  It reports that both Smith Barney and Raymond James have prevailed in major arbitrations involving both institutional and retail investors.  Smith Barney won against a $118.7 million claim brought by Banco Industrial De Venezuela.  InvNews, Smith Barney, Raymond James victorious in auction rate cases.

November 9, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Sunday, November 8, 2009

Miller & Rosenfeld on Intellectual Hazard

Intellectual Hazard: How Conceptual Biases in Complex Organizations Contributed to the Crisis of 2008, by Geoffrey P. Miller, New York University - School of Law, and Gerald Rosenfeld, New York University - School of Law, was recently posted on SSRN.  Here is the abstract:

This paper identifies an important but previously unrecognized systemic risk in financial markets: intellectual hazard. Intellectual hazard, as we define it, is the tendency of behavioral biases to interfere with accurate thought and analysis within complex organizations. Intellectual hazard impairs the acquisition, analysis, communication and implementation of information within an organization and the communication of such information between an organization and external parties. We argue that intellectual hazard was a cause of the Crisis of 2008 and suggest that this risk may be an important factor in all financial crises. We offer tentative suggestions for reforms that might mitigate intellectual hazard going forward.

November 8, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Morgenson on ARS Arbitration

Gretchen Morgenson, the New York Times financial columnist, addresses the plight of investors in auction rate securities (ARS) whose investments, sold on the basis of their liquidity and safety, became illiquid as a result of the credit crisis. A Way Out of the Deep Freeze. Ms. Morgenson, who has been harsh in her assessments of mandatory securities arbitration in the past, finally sees value in arbitration.  She notes the judicial hostility toward class action ligitations involving ARS and recognizes that individual arbitrations may provide the only recovery for investors.  Those of us who have studied this area closely have long recognized that whatever the faults of arbitration, in a legal reality where investor rights are so meager and difficult to enforce, securities arbitration, and its appeal to equity, may be the best solution for investors.  However, my initial assessments of investor recovery in arbitration are less sanguine than Ms. Morgenstern's.  The reported awards, at least, have not shown a willingness on the part of arbitrators to award consequential damages resulting from the investors' inability to liquidate their investments -- to make a down payment on a residence, for example, or pay a child's college tuition.  While it is true that most arbitrations are settled and thus the terms are not publicly disclosed, I have not heard anecdotally that investors are faring well.  If any readers have heard differently or can speak from personal experience, I would appreciate hearing.

November 8, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC's Aguilar on Investor Protection

This week the House Financial Services Committee, in the now somewhat ironically called "Investor Protection Act of 2009," added an amendment that would permanently exempt companies with $75 million or less market capitalization from the SOX 404(b) certification requirement, despite the fact that the SEC Chair announced earlier this fall that the current exemption would expire so that investors of these companies would finally receive the protections against accounting fraud that SOX contemplated when it was enacted since 2002.  Can anyone seriously argue that post-SOX events have shown that internal controls are not needed for all publicly traded corporations?  SEC Commissioner Aguilar addressed the problem eloquently in a recent speech:

Everyone knows about the Sarbanes-Oxley Act, which contains a set of hard-won reforms made necessary by Enron, WorldCom, and other frauds. One clear lesson learned from those frauds was that many public companies had weak internal controls. The Sarbanes-Oxley Act tackled these problems by requiring the top executives of all public companies to take responsibility for their internal controls, and, importantly, for an independent auditor to come in and examine these controls. In the financial press, this independent audit requirement is referred to as "404(b)," after the section of Sarbanes-Oxley that requires the audit.

The Investor Protection Act of 2009 in its current form would repeal this important requirement of an independent audit for public companies with a market cap under $75 million. Some are describing this repeal of Sarbanes-Oxley as relief for "small businesses." I think people are confused when they hear the words "small business." The companies that would be exempted are not mom and pop neighborhood stores. These are publicly traded companies that offer their shares to all types of investors. And just so you know, this repeal has wide-ranging ramifications and would appear to affect the majority of public companies. Although the SEC generally does not track companies based on market cap, the SEC does have data on companies that generally have $75 million or less in public float, and our staff estimates that over 6,000 public companies may fall under that threshold.

To repeal this part of Sarbanes-Oxley now is to throw away a substantial amount of work done by regulators, companies, and private organizations to make compliance with 404(b) more cost-effective. Since the passage of Sarbanes-Oxley, the SEC has repeatedly deferred smaller public company compliance with the independent internal control audit requirement. During the period of the SEC deferrals, the SEC and the Public Company Accounting Oversight Board (PCAOB) were active in developing rules and guidance to allow 404(b) to be implemented in a manner that would work for both large and small public companies. A central goal of this work focused on making sure that costs for smaller public company were not overly burdensome.

The SEC alone has held roundtables, chartered an advisory committee, and engaged in a number of other regulatory and staff actions targeted at applying 404(b) to smaller public companies, and followed all of that with a staff study which found these efforts made compliance more cost-effective. In addition, private organizations like the Committee of Sponsoring Organizations of the Treadway Commission (COSO) have published guidance on internal control frameworks specifically targeted at smaller public companies. It is particularly ironic that, if 404(b) is undercut now, we will never see the benefits for investors of all the work by the SEC, PCAOB, COSO and others, and the opportunity for smaller public companies to take advantage of the practical lessons learned from companies that are already complying.

November 8, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)

SEC Division of Risk, Strategy & Financial Innovation Announces 3 Senior Appointments

No doubt in response to criticisms that the SEC lacks expertise, the agency announced three senior appointments in the fields of risk management, structured finance and corporate transactions to its newly created Division of Risk, Strategy, and Financial Innovation, headed by University of Texas Law professor Henry Hu.  The Division was created in September to enhance the agency's capabilities and help identify developing risks and trends in the financial markets.

The Division's new senior officials are:

Richard Bookstaber has been appointed a Senior Policy Advisor to the Director. Dr. Bookstaber served as the managing director in charge of firm-wide risk management at Salomon Brothers, director of risk management at Moore Capital Management, and Morgan Stanley's first market risk manager. 

Adam Glass has been appointed a Counsel to the Director. Mr. Glass comes to the SEC from Linklaters LLP, where he founded its Structured Finance and Derivatives Practice. During his tenure at Linklaters, he represented banks, investment banks, monoline insurance companies, and hedge funds. 

Bruce Kraus has been appointed a Counsel to the Director. Mr. Kraus comes to the SEC from Willkie Farr & Gallagher LLP, where he practiced corporate and securities law for more than 20 years. His practice included mergers and acquisitions transactions and other corporate finance work.

The Division of Risk, Strategy, and Financial Innovation combines the Office of Economic Analysis, the Office of Risk Assessment, and other functions to provide the Commission with sophisticated analysis that integrates economic, financial, and legal disciplines. The Division's responsibilities cover three broad areas: risk and economic analysis; strategic research; and financial innovation.

November 8, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)