November 20, 2009
SEC Charges Former Shuffle Master Executive with Insider Trading
On November 19, 2009, the Securities and Exchange Commission filed a civil injunctive action in the United States District Court for the District of Nevada against R. Brooke Dunn, a former executive at Shuffle Master, Inc., and Nicholas P. Howey for illegal insider trading in Shuffle Master stock and options prior to an announcement of disappointing financial results by Shuffle Master.
The SEC's Complaint alleges that, on February 26, 2007, after he first learned that Shuffle Master would announce disappointing preliminary financial results, Dunn called Howey and provided him with material nonpublic information relating to Shuffle Master's anticipated announcement. Howey then immediately sold all of his previously-purchased Shuffle Master stock and calls and purchased Shuffle Master puts. The next day, after Shuffle Master announced its disappointing financial news, Howey sold all of the Shuffle Master puts he purchased the previous day. Through the foregoing transactions, Howey profited by (or avoided losses of) approximately $237,000.
The Complaint charges Dunn and Howey with violating Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and seeks permanent injunctions, disgorgement of illegal trading profits, prejudgment interest, and civil penalties. The Complaint also seeks an order barring Dunn from serving as an officer or director of a public company.
Henry Hu's Testimony on Derivatives Legislation
Testimony Concerning the Over-the-Counter Derivatives Markets Act of 2009 by Henry T. C. Hu, Director of the Division of Risk, Strategy, and Financial Innovation, U.S. Securities and Exchange Commission, Before the House Committee on Financial Services, October 7, 2009.
SEC Finds Broker-Dealer Orchestrated Lating Trading Fraud
The SEC, in an administrative proceeding, found that Joseph John VanCook, a former salesperson and partial owner of Pritchard Capital Partners, LLC, a registered broker-dealer, willfully violated Section 10(b) of the Securities Exchange Act of 1934 and Exchange Act Rule 10b-5 by orchestrating a fraudulent scheme involving "late trading" of mutual fund shares, i.e., "the unlawful practice of permitting mutual fund orders received after the 4:00 p.m. [fund share] pricing time to receive the [net asset value, or "NAV"] calculated at or as of 4:00 p.m. that day, instead of 4:00 p.m. the following trading day." The Commission found that VanCook accepted and recorded orders to trade mutual fund shares from clients before 4:00 p.m. but permitted three hedge fund clients to change or cancel those orders after the markets closed at 4:00 p.m. without recording the time at which they made those final trading decisions. The Commission found that, in submitting those orders to his firm's clearing broker, VanCook created "the false impression that final orders associated with [those] accounts were placed before 4:00 p.m. and were therefore entitled to that day's NAV when in fact they were not."
The Commission concluded that, as a result of VanCook's scheme, his "late-trading clients obtained an undisclosed advantage, at the expense of other shareholders of the relevant mutual funds, when they learned of market-moving information and were able to buy, exchange, or sell mutual fund shares at NAVs set before the market-moving information was released. The mutual funds at issue were deceived into providing improper prices for those orders contrary to their prospectus language and transmitting and effecting orders contrary to their published policies and procedures, as well as applicable rules and regulations, thereby harming or causing the risk of harm to shareholders who made investment decisions premised upon improper prices and suffered dilution to the value of their shares." The Commission also found that VanCook aided and abetted and willfully caused the Firm to violate Exchange Act Section 17(a)(1) and Exchange Act Rule 17a-3(a)(6) by failing to make and keep current certain books and records in that he established the order-taking system by which the time of receipt of his late-trading clients' final trade decisions was not recorded.
For these violations, which the Commission noted involved "nearly 5,000 late mutual fund orders effecting the purchase and sale of billions of dollars' worth of mutual fund shares," VanCook was barred from association with any broker or dealer and ordered to cease and desist from committing future violations of the antifraud provisions, to pay disgorgement plus prejudgment interest, and to pay a civil money penalty. (Rel. 34-61039; File No. 3-12753)
House Financial Services Committee Passes Amendment to Dismantle Firms "Too Large to Fail"
On Nov. 18 the House Financial Services Committee passed an amendment offered by Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, to the Financial Stability Improvement Act by a vote of 38-29. The Kanjorski amendment would empower federal regulators to rein in and dismantle financial firms that are so large, inter-connected, or risky that their collapse would put at risk the entire American economic system, even if those firms currently appear to be well-capitalized and healthy. Therefore, American taxpayers should no longer be on the hook for bailouts, as financial companies would not be able to become “too big to fail.” The Kanjorski amendment outlines clear and objective standards for regulators to examine financial companies and reduce the level of risk their activities pose to our financial stability and our economy.
The Kanjorski amendment expands on a segment of the Financial Stability Improvement Act, by enabling federal action to address financial companies that are deemed “too big to fail” before resolution authority is needed. The amendment transfers such mitigatory action from the Federal Reserve to the Financial Services Oversight Council and establishes objective standards for the Council to effectively evaluate companies to determine whether they are systemically risky. Additionally, the amendment provides clear checks and balances by requiring the Council to consult with the President before taking extraordinary mitigatory actions. A financial company also has the right to appeal any actions.
SEC Sues Investor Relations Firm and Others for Illegal Sales of Securities
The SEC filed a civil action in the U.S. District Court for the Middle District of Florida, alleging that investor relations firm Big Apple Consulting USA, Inc. ("Big Apple"), its wholly-owned subsidiary MJMM Investments, LLC ("MJMM"), and four of its executives-CEO Marc Jablon, vice president Matthew Maguire, MJMM president Mark Kaley, and Keith Jablon, vice president of another Big Apple subsidiary-made public misrepresentations and material omissions about the financial state of CyberKey Solutions, Inc., ("CyberKey") while the two entities sold hundreds of millions of CyberKey shares. These CyberKey shares were sold under no registration statement and no legitimate exemption from registration. The SEC also charged Big Apple and MJMM with acting as unregistered broker-dealers, and Marc Jablon, Maguire, and Kaley with aiding and abetting the two entities' violations in that respect.
According to the SEC's complaint, the Big Apple executives learned by August 8, 2006, that CyberKey's only significant source of revenue, a supposed $25 million purchase order from the U.S. Department of Homeland Security ("DHS"), could not be located by DHS itself and almost certainly did not exist. Despite this knowledge, the Big Apple team continued to promote CyberKey and its business relationship with DHS and sold hundreds of millions of CyberKey shares into the public market. In addition to planning and editing press releases, Big Apple used a telephone calling room of 14 to 50 callers to promote CyberKey stock, including the company's relationship with DHS, to registered brokers. In doing so, Big Apple and MJMM acted as dealers in connection with the distribution of CyberKey stock and as brokers by participating in securities transactions at key points in the chain of distribution of CyberKey shares.
The SEC's complaint requests permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest, and civil penalties against all of the defendants. The complaint also seeks penny stock bars against Big Apple, MJMM, Maguire, and Marc Jablon.
SEC & CFTC Issue Joint Orders on Security-Based Futures Contracts
The SEC and the CFTC issued two joint orders related to security-based futures contracts that clarify each Commission's respective jurisdiction and allow additional products to underlie security futures.
The first joint order excludes certain foreign and domestic volatility indexes that are based on broad-based security indexes from the definition of "narrow-based security index". As a result of the joint order, futures on foreign and domestic volatility indexes that meet the criteria contained in the joint order are treated as "broad-based security indexes" and subject to the exclusive jurisdiction of the CFTC. Options on such volatility indexes are subject to the federal securities laws and the jurisdiction of the SEC. The joint order, contained in SEC Release No. 34-61020, became effective on November 17.
The second joint order allows security futures products to be based on any security that is eligible to underlie an exchange-listed security option, including certain unregistered debt securities. This joint order, which is contained in SEC Release No. 34-61027, became effective on November 19.
NY AG and AES Agree on Climate Change Disclosures
New York Attorney General Andrew M. Cuomo today announced an agreement that requires the AES Corporation (AES) - a global energy company operating in 29 countries with annual revenues exceeding $16 billion - to disclose timely and relevant information to investors about financial risks associated with the production of global warming pollution. Today’s agreement with AES follows the landmark settlements Cuomo reached last year with two other major energy companies, Dynegy, Inc. and Xcel Energy, to protect investors by ensuring disclosure of potential financial risks for carbon-intensive companies from new and upcoming regulatory efforts related to climate change.
Under the Attorney General’s agreement, AES must disclose material risks associated with climate change in its annual summary report on the company’s performance (Form 10K) to the Securities and Exchange Commission (SEC). These required disclosures include an analysis of material financial risks from climate change related to:
Present and probable future climate change regulation and legislation
Climate-change related litigation
Physical impacts of climate change
Through the agreement, AES has committed to a broad array of additional climate change disclosures including:
Current carbon emissions
Projected increases in carbon emissions from planned coal-fired power plants
Company strategies for reducing, offsetting, limiting, or otherwise managing its global warming pollution emissions and expected global warming emissions reductions from these actions
Corporate governance actions related to climate change, including if environmental performance is incorporated into officer compensation.
New regulatory efforts to reduce global warming pollution, including New York’s regulation of carbon emissions from power plants, as well as pending federal actions, can impact a carbon-intensive company’s financial outlook through the costs incurred to comply. Potential investors must be aware of such material risks in order to make an informed investment decision.
AES generates and distributes energy in 29 countries and reported revenues of $16.1 billion in 2008. The company has a worldwide total power generation capacity of approximately 43,000 megawatts and an international distribution network serving more than 11 million people.
In the U.S., AES operates 17 power facilities, the majority of which are fueled by coal, with a total generation capacity of almost 12,000 megawatts. The company’s U.S. plants emitted a reported 42 million tons of carbon dioxide in 2006, placing AES among the top 20 of the largest emitters of global warming pollution by energy companies in the country.
In New York state, the company operates four coal-fired power plants generating more than 1,200 megawatts under the name AES Eastern Energy: AES Cayuga (Lansing, Tompkins County), AES Greenridge (Dresden, Yates County), AES Somerset (Barker, Niagara County) and AES Westover (Johnson City, Broome County).
In September 2007, Attorney General Cuomo subpoenaed five major energy companies for information on whether disclosures to investors in filings with the SEC adequately described their financial risks related to emissions of global warming pollution. The subpoenas were issued under New York State’s Martin Act, a 1921 state securities law that grants the Attorney General broad powers to access the financial records of businesses. The Attorney General reached agreements with Xcel and Dynegy in 2008. Cuomo’s inquiry into the disclosures of the remaining companies subpoenaed in 2007 - Dominion Resources and Peabody Energy - is ongoing.
The Attorney General noted that AES cooperated fully with his office’s inquiry.
Ohio AG Sues Rating Agencies
Ohio Attorney General Richard Cordray today filed a lawsuit against Standard & Poor’s, Moody’s and Fitch. The lawsuit, filed in United States District Court for the Southern District of Ohio on behalf of five Ohio public employee retirement and pension funds, charges the rating agencies with wreaking havoc on U.S. financial markets by providing unjustified and inflated ratings of mortgage-backed securities in exchange for lucrative fees from securities issuers.
The lawsuit alleges the rating agencies gave many of these exotic investments the highest investment-grade credit rating. This rating – often referred to as “AAA”– is consistent with the credit ratings given to the safest corporate bonds, and it assured institutional investors, including the Ohio funds, that the investments were extremely safe with a very low risk of default. According to preliminary estimates, the improper ratings cost the Ohio Funds losses in excess of $457 million.
(Hat tip: Darrell Miller)
November 18, 2009
SEC Approves Expansion of BrokerCheck DisclosureHere is the link to the SEC's Order Approving a Proposed Rule Change Relating to Availability of Information Pursuant to FINRA Rule 8312 (FINRA BrokerCheck Disclosure). I blogged yesterday about the amendment to maintain the information on broker dealers permanently available, even if the individuals left the industry.
SEC Website Links to Short Sale Volume and Transaction Data
The SEC now posts on its website SHORT SALE VOLUME AND TRANSACTION DATA. It states that:
To increase the transparency surrounding short sale transactions, several self-regulatory organizations (SROs) are providing on their websites daily aggregate short selling volume information for individual equity securities. The SROs are also providing website disclosure on a one-month delayed basis of information regarding individual short sale transactions in all exchange-listed equity securities. For short sale data provided by a specific SRO, you can click on the hyperlinks below.
SEC's Small Business Capital Formation Program Will be Held Nov. 19The Program for the 28th Annual SEC Government-Business Forum on Small Business Capital Formation (November 19, 2009) is posted at the SEC website.
Wells Fargo Settles ARS Charges with State Securities Regulators
NASAA today announced another settlement (in principle) with a securities firm over its sales of auction rate securities (ARS). Wells Fargo Investments LLC agreed to return approximately $1.3 billion to the firm's clients who have had their funds frozen in the ARS market. The settlement requires Wells Fargo Investments to extend offers to repurchase ARS from all customers nationwide by approximately February 18, 2010. Wells Fargo Investments is a brokerage unit of San Francisco-based Wells Fargo & Company.
The settlement is the result of an investigation led by the Securities Division of the Washington State Department of Financial Institutions into allegations that Wells Fargo misled clients by falsely assuring them that ARS securities were a safe, liquid alternative to cash, certificates of deposit or money market funds. The ARS markets froze in February 2008, triggering complaints from investors who could not withdraw money from their accounts. At the time of the market failures, customers of Wells Fargo Investments nationwide held an estimated $2.95 billion in ARS.
Under the terms of the settlement, Wells Fargo agreed to buy back at par value by approximately April 18, 2010 all auction rate securities purchased through its brokerage unit by investors before February 13, 2008. The settlement agreement also calls for Wells Fargo to:
- Fully reimburse certain investors who sold their auction rate securities at a discount after the market failed;
- Consent to a special, public arbitration procedure to resolve claims of consequential damages suffered by investors covered by the settlement as a result of their inability to access their funds; and
- Pay to the states monetary penalties of $1.9 million.
FINRA Fines MetLife for Supervisory Failures over Brokers' Email
FINRA announced today that it has fined MetLife Securities, Inc., and three of its affiliates a total of $1.2 million for failing to establish an adequate supervisory system for the review of brokers' email correspondence with the public. The fine also resolves charges of failing to establish adequate supervisory procedures relating to broker participation in outside business activities and private securities transactions. Those failures allowed two MetLife Securities brokers to engage in undisclosed outside business activities and private securities transactions without detection by the firm, costing some firm customers millions of dollars.
The three MetLife Securities affiliates are New England Securities Corp., Walnut Street Securities, Inc. and Tower Square Securities, Inc. All are headquartered in New York.
From March 1999 to December 2006, MetLife Securities and its affiliate broker-dealers had in place written supervisory procedures mandating that all securities-related emails of brokers be reviewed by a supervisor. However, the firms did not have a system in place that enabled supervisors to directly monitor the email communications of brokers. Instead, the firms relied on the brokers themselves to forward their emails to supervisors for review. To monitor compliance with the email-forwarding requirement, the firms encouraged — but did not require — managers to inspect brokers' computers for any emails that had not been forwarded as required. But brokers were able to delete their emails from their assigned computers, thus rendering spot-checks unreliable.
The firms also conducted annual branch audits, which were likewise ineffective because they did not allow for timely detection of email-forwarding failures. Moreover, the method employed by the auditors to identify email-forwarding deficiencies (prior to July 2005) was itself flawed, consisting mainly of a review of hard-copy files for any correspondence (including emails) that had not been forwarded. Brokers were therefore able to withhold emails without detection by the firm and conceal evidence or "red flags" of misconduct contained in their emails.
FINRA also found that the firms' inability to ensure compliance with the email-forwarding requirement meant they could not adequately enforce their own supervisory procedures relating to outside business activities and private securities transactions.
In concluding this settlement, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
November 17, 2009
Davidoff on BofA-ML Merger TestimonyGreat blog by NYTimes Deal Professor Steven Davidoff on the mysteries contained in former BofA GC Mayopoulos's testimony today before the House committee investigating the BofA-ML merger. His bottom line -- to which I heartily concur -- move on to more serious issues. Some Mysteries in the BofA-Merrill Deal
Walters' Testimony on House Financial Stability Improvement Act Discussion Draft
Testimony Concerning the Discussion Draft of The Financial Stability Improvement Act of 2009, by Commissioner Elisse B. Walter, SEC, Before the Committee on Agriculture, United States House of Representatives. November 17, 2009
SEC Charges Two Former Officers of Tivia with Accounting Fraud
The SEC charged two former Silicon Valley executives for improperly inflating the reported financial results at Santa Clara, Calif., semiconductor company Tvia, Inc. The SEC alleges that Tvia's former Vice President of Worldwide Sales, Benjamin Silva III, made side deals with customers and concealed the terms from Tvia's executives and auditors, which fraudulently caused the company to report millions of dollars in excess revenue. The SEC further alleges that Tvia's former Chief Financial Officer Diane Bjorkstrom also played a role in Tvia's improper accounting, allowing Tvia to recognize revenue on merchandise shipped to a customer weeks before the customer had agreed to accept it, and failing to act on red flags surrounding Silva's misconduct. Bjorkstrom agreed to settle the SEC's charges against her by paying a $20,000 penalty.
The SEC's complaint, filed in federal district court in San Jose, alleges that Silva's side agreements illegally inflated Tvia's revenue by approximately $5 million from September 2005 through June 2006. This caused the company's quarterly revenue to be consistently overstated, including by as much as 165 percent in one quarter. The SEC further alleges that in order to divert auditors' attention from delinquent customer payments, Silva fraudulently applied payments from new customers to old receivables.
According to the SEC's complaint, Silva's misconduct allowed him to meet his revenue targets at the company. For his efforts in meeting those targets, Silva received an award of options to buy 70,000 shares of Tvia stock. Before the fraud was discovered in early 2007, Silva exercised and sold all of his available Tvia options for a profit of $300,000.
The SEC's complaint against Silva charges him with violations of the antifraud, reporting, books and records and internal control provisions of the federal securities laws, and seeks a permanent injunction, disgorgement of Silva's ill-gotten gains plus prejudgment interest, and a financial penalty. The SEC also seeks a court order permanently barring Silva from acting as an officer or director of any public issuer.
In the settled enforcement action against Bjorkstrom, she consented without admitting or denying the SEC's allegations to an order requiring her to pay the penalty and banning her from appearing or practicing before the SEC as an accountant for a period of two years.
SEC Approves Major Expansion of BrokerCheck Disclosure
FINRA announced that the SEC has approved a major expansion of its BrokerCheck service — to make records of final regulatory actions against brokers permanently available to the public, regardless of whether they continue to be employed in the securities industry. Under current rules, a broker's record generally becomes unavailable to the public two years after he or she leaves the securities industry and is therefore no longer under FINRA's jurisdiction. Disclosure records for former brokers will be available on BrokerCheck beginning November 30.
"It is possible that a (former broker) could become a financial planner or work in another related field where his securities record would help members of the public decide if they should accept his financial advice or rely on his advice or expertise," the SEC said in its order approving the BrokerCheck expansion. It added that providing information on final regulatory actions against former brokers "will help members of the public to protect themselves from unscrupulous people and thus….should help prevent fraudulent and manipulative acts and practices, and protect investors and the public interest."
BrokerCheck is a free online service through which investors can instantly see the employment, qualifications and disciplinary history of more than 650,000 brokers under FINRA's jurisdiction. FINRA estimates there are more than 15,000 individuals who have left the securities industry after being the subject of a final regulatory action and whose disciplinary history is not currently available on BrokerCheck.
Records for those individuals will become available on November 30 and will include any final sanction (such as bars, suspensions and fines) imposed by the SEC, the Commodity Futures Trading Commission, any federal banking agency, the National Credit Union Administration, any other federal regulatory agency, any state regulatory agency, any foreign financial regulatory authority or any self-regulatory organization (such as FINRA). Those individuals' records generally will also disclose administrative information such as employment and registration history, the individual's most recently submitted comments and the dates and names of qualification examinations passed by the individual.
TARP Special Inspector General Releases Report on Payments to AIG Counterparties
As noted earlier, the Office of the Special Inspector General for TARP released its report on Factors Affecting Efforts to Limit Payments to AIG Counterparties (SIGTARP report on AIG). Here are its summary conclusions (note in particular the last sentence):
(1) the original terms of federal assistance to AIG, including the high interest rate it adopted from the private bank’s initial term sheet, inadequately addressed AIG’s long term liquidity concerns, thus requiring further Government support; (2) FRBNY’s negotiating strategy to pursue concessions from counterparties offered little opportunity for success, even in light of the willingness of one counterparty to agree to concessions; (3) the structure and effect of FRBNY’s assistance to AIG, both initially through loans to AIG, and through asset purchases in connection with Maiden Lane III effectively transferred tens of billions of dollars of cash from the Government to AIG’s counterparties, even though senior policy makers contend that assistance to AIG’s counterparties was not a relevant consideration in fashioning the assistance to AIG; and (4) while FRBNY may eventually be made whole on its
loan to Maiden Lane III, it is difficult to assess the true costs of the Federal
Reserve’s actions until there is more clarity as to AIG’s ability to repay all of its
assistance from the Government. SIGTARP also draws lessons that should be
learned regarding the importance of transparency and the enormous impact that ratings agencies had on the AIG bailout (emphasis added).
Obama Administration Creates New Interagency Financial Fraud Enforcement Task Force
The Obama Administration announced today the creation of an interagency Financial Fraud Enforcement Task Force to strengthen efforts to combat financial crime. The Department of Justice will lead the task force and the Department of Treasury, HUD and the SEC will serve on the steering committee. The task force's leadership, along with representatives from a broad range of federal agencies, regulatory authorities and inspectors general, will work with state and local partners to investigate and prosecute significant financial crimes, ensure just and effective punishment for those who perpetrate financial crimes, address discrimination in the lending and financial markets and recover proceeds for victims.
The task force replaces the Corporate Fraud Task Force established in 2002
GAO Reports SEC's Continuing Lack of Effective Internal Controls over Financial Reporting
The GAO released today its audit of the SEC's Financial Statements for Fiscal Years 2009 and 2008. In the GAO’s opinion, SEC’s fiscal years 2009 and 2008 financial statements are fairly presented in all material respects. However, in GAO’s opinion, SEC did not have effective internal control over financial reporting as of September 30, 2009.
The report goes on to state:
During this year’s audit, we identified six significant deficiencies that collectively represent a material weakness in SEC’s internal control over financial reporting. The significant deficiencies involve SEC’s internal control over (1) information security, (2) financial reporting process, (3) fund balance with Treasury, (4) registrant deposits, (5) budgetary resources, and (6) risk assessment and monitoring processes. These internal control weaknesses give rise to significant management challenges that have reduced assurance that data processed by SEC’s information systems are reliable and appropriately protected; impaired management’s ability to prepare its financial statements without extensive compensating manual procedures; and resulted in unsupported entries and errors in the general ledger.
In connection with its prior audits, GAO made numerous recommendations to SEC to address the internal control issues that continued to persist during fiscal year 2009. GAO will continue to monitor SEC’s progress in implementing the recommendations that remain open as of the date of this report.