Securities Law Prof Blog

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

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Tuesday, November 24, 2009

Boston Jury Finds Former Fidelity Investments Trader Engaged in Insider Trading

The SEC announced that a federal jury in Boston returned a verdict on Nov. 20, 2009 in favor of the SEC against a former Fidelity Investments trader for insider trading. David K. Donovan, of Massachusetts, was found to have engaged in insider trading in stock of Covad Communications Group, Inc. ("Covad"). The jury found Donovan's co-defendant, David R. Hinkle of Texas, not liable for insider trading.

In its complaint, the SEC had alleged that, between July and Sept. 2003, Donovan obtained confidential information on Fidelity's internal order database that Fidelity was purchasing a substantial amount of Covad common stock for its advisory clients. The Commission's complaint alleged that after viewing Fidelity's orders and being denied permission by Fidelity to buy Covad stock in his own personal account, Donovan caused purchases of the stock to be made in early August 2003 in the account of his mother. According to the Commission's complaint, Donovan's mother profited after later selling the Covad stock in early Sept. 2003, after the price of Covad stock had increased.

The jury heard closing arguments in the seven-day trial on Nov. 19, 2009 and announced its verdict the next day. In rendering its verdict, the jury found that David Donovan engaged in insider trading by knowingly giving to his mother material, nonpublic information concerning Covad stock in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Although the jury found that Donovan tipped his mother to inside information about Covad, it did not find that he tipped co-defendant David Hinkle to inside information, and did not find Hinkle liable for insider trading.

November 24, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Obtains Asset Freeze Against Minnesota Foreign Currency Trading Venture

On November 23, 2009, the federal district court for the District of Minnesota issued an Asset Freeze Order against all assets of Trevor G. Cook (Cook), Patrick J. Kiley (Kiley), both Minnesota residents, and UBS Diversified Growth LLC, Universal Brokerage FX Management LLC, Oxford Global Advisors LLC, and Oxford Global Partners LLC (the Defendant Companies), four shell companies owned or controlled by them. The court also issued an asset freeze order against several Relief Defendant Companies: Basel Group LLC, Crown Forex LLC, Market Shot LLC, PFG Coin and Bullion, Oxford FX Growth L.P., Oxford Global FX LLC, Oxford Global Managed Futures Fund L.P, UBS Diversified FX Advisors LLC, UBS Diversified FX Growth L.P., and UBS Diversified FX Management LLC. The court also entered a freeze order against certain assets of relief defendants Clifford and Ellen Berg, who received investor funds from Cook. In addition, Judge Davis issued an order appointing a receiver over all of these assets. The court issued the freeze and receivership orders under seal while the assets were being secured, and the seal has now been lifted.

The SEC alleges that from at least July 2006 through at least July 2009, Cook and Kiley, through the Defendant Companies, raised at least $190 million from at least 1,000 investors through the sale of unregistered investments in a purported foreign currency trading venture by misrepresenting that they would deposit each investor's funds into a separate account in the investor's name to trade in foreign currencies and generate annual returns of 10 percent to 12 percent. They also misrepresented that their foreign currency trading program involved little or no risk and that investors' principal would be safe and could be withdrawn at any time. The SEC alleges that Cook and Kiley did not place each investor's money into a segregated account in the name of the investor. Instead, they pooled the investors' funds in bank and trading accounts in the names of entities that they controlled, including the Defendant and Relief Defendant companies. The SEC alleges that Cook and Kiley misappropriated $42.8 million of investors' money, including $18 million that Cook used to buy ownership interests in two trading firms; $12.8 million that Cook and Kiley transferred to Panama to purportedly finance the construction of a casino; $2.8 million that Cook used to acquire the Van Dusen Mansion and $4.8 million that Cook lost through gambling. Cook and Kiley also misspent approximately $51 million to make Ponzi-like payments to earlier investors. The SEC further alleges that Cook and Kiley placed $108 million of investors' funds into banking and trading accounts in the names of their various shell companies and used some of this money to trade foreign currencies, resulting in losses of at least $48 million.

The SEC's complaint charges Cook, Kiley, and the Defendant Companies with violating Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In addition to the emergency relief already obtained, the complaint seeks preliminary and permanent injunctions and disgorgement from all defendants as well as financial penalties from Cook and Kiley, and disgorgement of ill-gotten gains from the relief defendants. A hearing on the SEC's motion for preliminary injunction has been set for December 4, 2009 at 9:30 a.m. at 300 South Fourth Street, 202 U.S. Courthouse, Minneapolis, MN.

None of the entities named in this action using the UBS name are affiliated with UBS, AG, the Switzerland-based global financial services firm.

November 24, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

More SEC Rulemaking on NRSROs

The SEC continues its rulemaking to improve rating agencies.  Today it adopted rule amendments that impose additional disclosure and conflict of interest requirements on nationally recognized statistical rating organizations (“NRSROs”) in order to address concerns about the integrity of the credit rating procedures and methodologies at NRSROs.

In addition, the agency is proposing rule amendments and a new rule that would impose additional requirements on nationally recognized statistical rating organizations (“NRSROs”). The proposed amendments and rule would require an NRSRO: (1) to furnish a new annual report describing the steps taken by the firm’s designated compliance officer during the fiscal year with respect to compliance reviews, identifications of material compliance matters, remediation measures taken to address those matters, and identification of the persons within the NRSRO advised of the results of the reviews; (2) to disclose additional information about sources of revenues on Form NRSRO; and (3) to make publicly available a consolidated report containing information about revenues of the NRSRO attributable to persons paying the NRSRO for the issuance or maintenance of a credit rating.

Finally, the SEC announced that it is deferring consideration of action with respect to a proposed rule that would have required an NRSRO to include, each time it published a credit rating for a structured finance
product, a report describing how the credit ratings procedures and methodologies and credit risk characteristics for structured finance products differ from those of other types of rated instruments, or, alternatively, to use distinct ratings symbols for structured finance products that differentiated them from the credit ratings for other types of financial instruments.

The SEC is also soliciting comments regarding alternative measures that could be taken to differentiate NRSROs’ structured finance credit ratings from the credit ratings they issue for other types of financial instruments through, for example, enhanced disclosures of information. The Commission also is soliciting comment on whether the rule amendments being adopted today in a separate release designed to remove impediments to determining and monitoring non-issuer-paid credit ratings for structured finance products should be extended to create a mechanism for determining non-issuer-paid credit ratings for structured finance products that were issued prior to the rule becoming effective (e.g., to allow for non-issuer-paid credit ratings for structured finance products of the 2004-2007 vintage).

November 24, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, November 23, 2009

FINRA Fines Terra Nova Financial for Improper Soft Dollar Payments

FINRA fined Terra Nova Financial, LLC, of Chicago, $400,000 for making more than $1 million in improper soft dollar payments to or on behalf of five hedge fund managers, without following its own policies to ensure the payments were proper.  Terra Nova was also charged with failing to properly supervise its soft dollar program, failing to implement adequate supervisory procedures and failing to retain its business-related electronic instant messages. Terra Nova also failed to timely respond to FINRA's requests for productions of various documents, including emails and instant messages, thus delaying FINRA's investigation.

 As part of the settlement, Terra Nova is required to retain an independent consultant to review and enhance its policies, systems and procedures relating to its soft dollar operations.

 FINRA found that starting in 2004, Terra Nova set up soft dollar accounts for eight hedge funds to encourage the funds to execute trades with the firm. Terra Nova collected a portion of the commissions generated by the funds' trading in separate soft dollar accounts and from those accounts paid invoices from the fund managers or third parties for various services. Federal securities laws allow advisors to use soft dollars to pay for research or brokerage-related expenses. But advisors may only use soft dollars to pay for personal expenses or other non-research or non-brokerage related expenses if those types of payments were previously disclosed to investors and if they are made in accordance with the terms of the fund's organizing documents.   

FINRA found that in 2004 and 2005, Terra Nova made numerous improper soft dollar payments to or on behalf of five hedge fund advisors totaling more than $1 million. Some payments (for estate planning fees, administrative staff and accounting expenses) were not allowed by the fund documents. Other payments made directly to the funds' managers were improper because Terra Nova did not receive written authorization from a third party evidencing that the payments were appropriate, as required by fund documents that the firm had or should have obtained under its own policies.

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

Fifth Circuit Holds Stanford Receiver Could Not "Clawback" Interest Payments from Innocent Investors

The Fifth Circuit, in Janvey v. Adams (No. 09-10761 Nov. 13, 2009)(Download Opinion_of_Appeals_Court_from_Hearing_Regarding_Claw_Backs), recently held that the receiver for the Stanford interests, appointed to conserve, hold, manage and preserve the value of the receivership estate, had no authority to recover payments of interest from investors who received the payments prior to the receivership.  The receiver wanted to recover the payments as assets of the estate and distribute them pro rata to all victims of the fraud.  The SEC, however, argued that it would be inequitable to allow the receiver to bring "clawback" claims against innocent investors.  The court agreed with the SEC.

The Court examined the lightly-analyzed issue of who may be named as a "relief defendant" in SEC enforcement actions and applied a two-prong test: a relief defendant (1) has received ill-gotten funds, and (2) does not have a legitimate claim to those funds.  While the investors certainly received ill-gotten funds, the receiver failed to establish that the investors lacked a legitimate claim to the proceeds.  It was undisputed that the investors received the payments as interest pursuant to written CD agreements with the Stanford Bank.  Since the investors could not be considered proper relief defendants, the district court lacked authority to freeze their accounts. 

While the Fifth Circuit's opinion does not discuss issues under fraudulent conveyance law, the holding suggests that this court would not consider such theories favorably.

November 23, 2009 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

SEC's Inspector General Makes Recommendations on Inspection of Investment Advisers

The SEC's Office of Inspector General released its final report on its investigation into why the SEC did not discover Madoff's Ponzi scheme, even after his investment advisory business registered with the SEC. The Review of the Commission’s Processes for Selecting Investment Advisers and Investment Companies for Examination (Nov. 19, 2009) contains 11 recommendations designed to improve OCIE’s process for selecting investment advisers and investment companies for examination:

We recommend that OCIE implement a procedure requiring, as part its process for creating a risk rating for an investment adviser, that OCIE staff perform a search of Commission databases containing information about past examinations, investigations, and filings related to the investment adviser.

We recommend that OCIE change the risk rating of an investment adviser based on pertinent information garnered from all Divisions and Offices of the Commission, including information from OCIE examinations and Enforcement nvestigations, regardless of whether the information was learned during an examination conducted to look specifically at a firm’s investment advisory business.

Further, Enforcement and OCIE should establish and adhere to a joint protocol providing for the sharing of all pertinent information (e.g., securities laws violations, disciplinary history, tips, complaints and referrals) identified during the course of an investigation or examination or otherwise.

We recommend that OCIE establish a procedure to thoroughly evaluate negative information that it receives about an investment adviser and use this information to determine when it is appropriate to conduct a cause examination of an investment adviser, and when it becomes aware of negative information pertaining to an investment adviser, it examine the investment adviser’s Form ADV filings and document and investigate discrepancies existing between the adviser’s Form ADV and information that OCIE previously learned about the registrant.

We further recommend that OCIE establish a procedure to thoroughly evaluate an investment adviser’s Form ADV when OCIE becomes aware of issues or problems with an investment adviser.

We also recommend that OCIE re-evaluate the point scores that it assigns to advisers based on their reported assets under management and their reported number of clients to which they provide investment advisory services and assign progressively higher risk weightings to firms accordingly.

Further, we recommend that a Commission rulemaking be instituted that would require additional information to be reported as part of Form ADV and that the proposed rule providing for Amendments to Form ADV be finalized. We also recommend that OCIE develop and adhere to policies and procedures for conducting third party verifications, such that OCIE verifies the existence of assets, custodian statements, and other relevant criteria.

We believe that implementation of the recommendations contained in this report will significantly improve OCIE’s operations and its process for selecting investment advisers and investment companies for examination.

The OIG also asks the SEC to provide a written corrective action plan within 45 days.

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

Sunday, November 22, 2009

Bhagat & Romano on Executive Compensation

Reforming Executive Compensation: Simplicity, Transparency and Committing to the Long-Term, by Sanjai Bhagat, University of Colorado at Boulder - Department of Finance, and Roberta Romano, Yale Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:

This Article advances an executive compensation reform proposal that is specifically addressed to firms receiving government financial assistance and thought to pose a systemic risk, although we think that all firms should consider its adoption. Executive compensation reform should lead to policies that are simple, transparent, and focused on creating and sustaining long-term shareholder value. With these criteria in mind, we suggest that incentive compensation plans should consist only of restricted stock and restricted stock options, restricted in the sense that the shares cannot be sold nor the options exercised for a period of at least two to four years after an individual resignation or last day in office. We would permit a minor amount to be paid out to executives currently to address tax, liquidity, and premature turnover concerns that the proposal could induce. We believe that this approach will provide superior incentives for executives(and traders whose actions can substantially impact an organization) to manage firms in investors longer-term interest, and diminish their incentive to make public statements, manage earnings, or accept undue levels of risk, for the sake of short-term price appreciation. By reducing management incentive to take on unwarranted risk, our proposal would therefore also decrease the probability that public resources will be dissipated in bailouts of financial firms, particularly those deemed by public officials as “too big to fail.”

November 22, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Higginbotham on Developing Policy for Disclosure

'See No Evil, Hear No Evil, Speak No Evil' - Developing a Policy for Disclosure by Counsel to Public Corporations, by F. Michael Higginbotham, University of Baltimore School of Law, was recently posted on SSRN.  Here is the abstract:


The purpose of this article is to develop policy and guidelines for counsel to observe when deciding whether and in what fashion he or she should disclose previously undisclosed information concerning an ongoing or future illegality committed by his or her corporate client. In developing these policies and guidelines, this article will discuss the current (1982) ABA policy and the relevant case law concerning corporate counsel's duty of disclosure, and proposed rules 1.13(b) and (c) of the 1980 ABA Discussion Draft and the 1981 Final Draft of Rules of Professional Conduct.

November 22, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)