Securities Law Prof Blog

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

Friday, December 11, 2009

SEC Enforcement Director Testifies on BofA -- Merrill Merger

Robert Khuzami, Director, SEC Division of Enforcement, testified today before the House Oversight and Government Reform Committee and Domestic Policy Subcommittee, on Events Surrounding Bank of America’s Acquisition of Merrill Lynch.  His prepared testimony defends the proposed settlement rejected by Judge Rakoff and discusses the Bank's assertion of attorney-client privilege. 

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

House Defeats Amendment Subjecting B-D Investment Advisers to FINRA Regulation

An amendment to the House financial regulation legislation that would have subjected investment advisers associated with broker-dealers to FINRA regulation was defeated by voice vote.  This is a battle of the titans among influential lobbyists, as the broker-dealer groups go against the investment advisory groups.  The broker-dealers might have expected more support since FINRA's former CEO, Mary Schapiro, is now SEC Chair, but that isn't how it played out.  InvNews,House scraps plan to place B-D advisers under Finra (UPDATED).  (hat tip:  Jill Gross)

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

House Passes Financial Regulation Overhaul

After three days of floor debate, the House voted, 223-202, to overhaul government regulation of the financial markets.  Among the bill's notable features:

  • Heightened supervision of large financial institutions, including higher capital and liquidity requirements (through a newly created Financial Stability Council);
  • New goverenment authority to break up institutions "too big to fail;"
  • New government authority to handle failures of large financial services firms;
  • Establishment of a Consumer Financial Protection Agency (despite a Democratic bid to kill it);
  • Regulation of OTC derivatives;
  • Shareholder advisory vote on executive compensation;
  • Registration of hedge fund advisors.

No Republicans supported the legislation, and 27 Democrats voted against it. The focus now turns to the Senate and its consideration of parallel legislation.

The House Financial Services Committee press release describing the legislation is here.

For media coverage, see:

WSJ, House Passes Sweeping Financial Oversight Bill

NYTimes, House Passes Far-Reaching Bill Tightening Financial Rules

WPost, House approves sweeping regulatory reform package  

December 11, 2009 in News Stories | Permalink | Comments (1) | TrackBack (0)

Thursday, December 10, 2009

Former Ropes & Gray Attorney Charged in Insider Trading Scheme

The SEC today announced insider trading charges against Brien P. Santarlas — a former attorney at Ropes & Gray LLP — for his alleged role in the insider trading ring that made over $20 million trading ahead of corporate acquisition announcements using inside information tipped by Santarlas and his colleague at Ropes & Gray, Arthur J. Cutillo, in exchange for cash kickbacks. The SEC alleges that Santarlas misappropriated from his law firm material, nonpublic information concerning at least two corporate acquisitions involving Ropes & Gray clients — 3Com Corp. and Axcan Pharma Inc.  The U.S. Attorney's Office for the Southern District of New York also announced today criminal charges against Santarlas in connection with the above insider trading scheme.

The complaint alleges that Santarlas gained access to material, nonpublic information by, among other means, accessing Ropes & Gray's computer network and viewing confidential deal documents. The SEC alleges that, using attorney Jason Goldfarb as a conduit, Santarlas and Cutillo tipped inside information concerning these corporate acquisitions to Zvi Goffer ("Zvi"), a proprietary trader at Schottenfeld Group, LLC ("Schottenfeld"). The complaint further alleges that Zvi traded on this information for Schottenfeld, and had numerous downstream tippees who also traded on the information, including other professional traders and portfolio managers at hedge fund advisers. The SEC previously charged Cutillo, Goldfarb, Zvi, and six others in connection with this insider trading scheme on November 5, 2009. See SEC v. Cutillo, et al., 09-CV-9208 (S.D.N.Y.) (LAK)/Lit. Rel. 21283.

The Commission's complaint seeks permanent injunctive relief, disgorgement of illicit profits with prejudgment interest, and the imposition of civil monetary penalties.

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

SEC Settles Fraud Claims Involving How-to-Trade Workshops

The SEC today filed a settled civil injunctive action against Investools Inc., Michael J. Drew and Eben D. Miller. According to the SEC's complaint, from 2004 to approximately June 2007, at Investools how-to-trade-securities workshops former Investools employees Drew and Miller misleadingly portrayed themselves as expert investors who made their living trading securities. They did so to mislead investors into believing that they too would make extraordinary profits trading securities if they purchased expensive Investools instructional courses and other products and followed Investools' securities trading strategies. The complaint further alleges that in reality, neither Drew nor Miller made the trading profits they claimed.

The complaint also alleges that Investools is liable for the fraudulent conduct of its sales personnel as a "controlling person" under the federal securities laws.

Investools agreed to a civil injunction and to pay a $3 million civil penalty. Drew and Miller agreed, respectively, to pay civil penalties of $380,000 and $130,000, and to be enjoined from violating the antifraud provisions of the federal securities laws. Drew and Miller additionally agreed to be enjoined, for five years, from receiving compensation for their participation in, among other related activities, the sale of classes, workshops, or seminars given to actual or prospective securities investors concerning securities trading. In settling the matter, Investools, Drew and Miller neither admitted nor denied the allegations in the Commission's complaint.

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

SEC Enforcement Director Testifies on Mortgage Fraud

Robert Khuzami, SEC Director, Division of Enforcement, testified yesterday on Mortgage Fraud, Securities Fraud, and the Financial Meltdown: Prosecuting Those Responsible before the United States Senate Committee on the Judiciary.

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

Wednesday, December 9, 2009

SEC Open Meeting Dec. 16

The SEC announced an Open Meeting - Wednesday, December 16, 2009 - 10:00 a.m.  The subject matter of the Open Meeting will be:

Item 1: The Commission will consider whether to adopt amendments to rules and forms under the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Company Act of 1940 to enhance the disclosures that registrants are required to make about compensation and other corporate governance matters.

Item 2: The Commission will consider whether to adopt amendments to the investment adviser custody rule (rule 206(4)-2) under the Investment Advisers Act of 1940) and related forms and rules. The amendments would enhance the protections provided advisory clients when they entrust their funds and securities to an investment adviser.

December 9, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)

SEC Delays Effective Date of Rule 151A

In a court filing, the SEC stated that it would delay the effective date of Rule 151A, which makes indexed annuities securities, for two years.  The D.C. Circuit had previously upheld the SEC's legal analysis but remanded the Rule for consideration of the economic impact, which the court found deficient.  InvNews, Indexed annuities as securities? Not until 2013, says the SEC.

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

SEC Proposes Some Increased Recovery for Early Madoff Investors

The House Capital Markets Subcommittee, chaired by Rep.Kanjorski, held another hearing today on the Madoff fraud, specifically dealing with SIPC.  In honor of the occasion, the New York Times today ran an article featuring the head of SIPC, Stephen P. Harbeck, whom critics have charged with being too conservative in his interpretation of the statute.  Critics object to the failure of SIPC to recognize claims from investors whose withdrawals at least equaled their deposits and from investors through feeder funds.    NYTimes, Protection Chief Struggles With Madoff Claims.  At the hearing Michael Conley, an SEC official, proposed that the claims of early investors be adjusted to reflect inflation, a recommendation it will make to the bankrupty court.  Here are excerpts from his testimony on this point:

The Madoff case raises difficult issues. Based on an analysis of SIPA, its legislative history, and cases that have applied it, the Commission is recommending to the bankruptcy court that customer claims should be determined through the cash-in/cash-out method advocated by the Trustee and SIPC — with an additional adjustment to ensure that the investors' claims in this long-running scheme are valued most accurately and fairly.

The Commission is basing its recommendation on the conclusion that the claims of the Madoff investors cannot be valued based on the balance shown on their final account statements. Although this approach would allow most Madoff account holders to receive payments on their claims, those payments would be based on account balances reflecting amounts that Madoff himself concocted that bear no relation to reality. ... Neither SIPA nor any of the cases interpreting that statute can be read to support an approach that would value claims based on the fictitious investment returns of such a scheme.

.... Therefore, the Commission has concluded that the most reasonable way to measure the value of the Madoff customers' net equity is to look to the money those customers invested with Madoff as a proxy for the unspecified investments in securities (the split-strike conversion strategy) Madoff told them he would make for their accounts.

The Commission's recommendation resembles what would likely be the outcome in a private suit by a customer challenging the distribution of assets on the same facts. Although the customer could establish that the broker had committed fraud, and could recover her initial investment (less withdrawals), she would not be able to recover as damages the amounts shown on the final account statements because they were based on fraudulent backdating of trades through hindsight. The fraud did not cause the customer to lose actual proceeds that were (or could have been) the product of legitimate trading. The same principles are relevant in calculating the Madoff customers' net equity under SIPA. In this case, the only reliably determinable transactions are the cash deposits and withdrawals those customers made to and from their brokerage accounts....

In addition, it is important to note that basing customers' net equity on the fictitious balances on their final account statements would do nothing to increase the fund of customer property — it would simply reallocate it. It is clear that there will not be enough money in the fund of customer property to pay out the $65 billion that Madoff falsely reported was in customer accounts when the firm failed. The Trustee has estimated that he may be able to recover as much as $8 billion to distribute to claimants. Using the final account statement approach would have the effect of favoring early investors-many of whom withdrew all or more than the principal they invested with Madoff — over later investors — some of whom withdrew little or none of what they invested and will not receive a distribution equal even to their principal.

While the final account statement approach favors earlier customers at the expense of later customers, the SEC is also sensitive to the corresponding fairness concerns under the cash-in/cash-out method. That method of calculating net equity favors later customers at the expense of earlier customers by treating a dollar invested in 1987 as having the same value as a dollar invested in 2007. ...

In the SEC's view, to achieve a fair and economically accurate allocation among Madoff customers who invested and withdrew funds in different historical periods, it is appropriate to convert the dollars invested into "time-equivalent" or constant dollars. This constant-dollar approach is rooted in the classic economic concept of the time value of money and will result in greater fairness across different generations of Madoff investors — in effect, treating early investors and later investors alike in terms of the real economic value of their investments.

The issue of calculating net equity in constant dollars has not arisen before in SIPA cases, probably because many Ponzi-type schemes are of relatively short duration, and the inequity among those who invested at different points in time is less striking. But the Madoff fraud — which lasted for 20-plus years — puts this issue into stark relief. ... Under the facts of this case, the Commission believes that the use of constant dollars can be distinguished from the payment of interest discussed in that Sixth Circuit case and that the best reading of SIPA and the cases interpreting it is that net equity here should be calculated in constant dollars.

It also is the Commission's view that the constant-dollar method will have limited application to the calculation of net equity in other liquidations under SIPA. ...

Here is the prepared testimony of Mr. Harbeck that does not address this damages calculation issue.

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

Tuesday, December 8, 2009

Treasury Plans Offering of JPMorgan Chase Warrants

The U.S. Department of the Treasury today announced that it has commenced a secondary public offering of approximately 88,401,697 warrants to purchase the common stock of JPMorgan Chase & Co. (the "Company").  The offering is expected to price through a modified Dutch auction.  Deutsche Bank Securities Inc. is the sole book-running manager and Ramirez & Co., Inc., The Williams Capital Group, L.P. and Utendahl Capital Group, LLC are the co-managers for the offering.

Deutsche Bank Securities Inc., in its capacity as auction agent, has specified that the auction will commence at 8 a.m., Eastern Time, on December 10, 2009, and will close at 6:30 p.m., Eastern Time, on that same day  (the "submission deadline").  During the auction period, potential bidders will be able to place bids at any price (in increments of $0.25) at or above the minimum bid price of $8.00 per warrant. 

The auction procedures, and the strike price, expiration, and other terms of the warrants are described in the preliminary prospectus supplement.

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

SEC Obtains Asset Freeze Against Alleged Ponzi Schemer

The SEC today halted a Ponzi scheme involving a New York firm that solicited investments involving personal injury lawsuit settlements but instead shipped the money overseas. The SEC obtained a court order freezing the assets of the firm, Rockford Funding Group LLC, its president, and several companies holding money from the scam that began several months ago.  The SEC alleges that Rockford used cold calling and a Web site to raise at least $11 million from more than 200 investors in 41 different states and Canada since March 2009. Rockford Group falsely touted itself as a leading private equity firm with an $800 million pipeline of investments and many Fortune 500 companies as clients, and told investors their money would be safely invested in structured settlements in private lawsuits.

According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, Rockford Group does not appear to engage in any investment activity that would generate any returns for investors, let alone its claimed returns of at least 15 percent annually. Instead, dividend payments made to investors have been funded by other investors' contributions, and Rockford Group transferred most of the money collected from investors to banks in Latvia and Hong Kong.

"The SEC alleges that Rockford Group lured investors by promising high returns and falsely assuring investors that it is a member of the Securities Investor Protection Corporation (SIPC) with up to $4 million in insurance to meet customer claims. According to the SEC's complaint, however, Rockford Group is not a member of SIPC.

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

SEC Charges Brookstreet Securities and CEO with Unsuitable Sales of CMOs

The SEC today charged Brookstreet Securities Corp. and its President and CEO Stanley C. Brooks with fraud for systematically selling risky mortgage-backed securities to customers with conservative investment goals. The fraud cost many Brookstreet investors their savings, homes, or retirement cushions, and eventually caused the firm to collapse. The SEC alleges that Brookstreet and Brooks developed an internal program through which the firm’s registered representatives sold particularly risky and illiquid types of Collateralized Mortgage Obligations (“CMOs”) to more than 1,000 seniors, retirees, and others for whom they were unsuitable. The SEC further alleges that Brookstreet continued to promote and sell risky CMOs to retail investors even after Brooks received numerous indications and personal warnings that these were “dangerous” investments that could become worthless overnight. Finally, in a last-ditch effort to save Brookstreet from failing during the financial crisis, Brooks directed the unauthorized sale of CMOs from Brookstreet customers’ cash-only accounts, causing substantial investor losses.

According to the SEC’s complaint, filed in federal district court in Santa Ana, Calif., Brookstreet customers invested approximately $300 million through the firm’s CMO program between 2004 and 2007. The SEC previously charged 10 Brookstreet registered representatives with making misrepresentations to investors related to the sale of risky CMOs.

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

FINRA Expels Meeting Street Brokerage for Market Manipulation

FINRA announced today that it expelled Meeting Street Brokerage, LLC of Palm City, FL from the securities industry for market manipulation of Relay Capital Corporation stock — as well as for violations of Regulation T, Anti-Money Laundering (AML) rules, instant message retention requirements, registration requirements and net capital requirements.  In addition, FINRA barred Meeting Street broker Lisa A. Esposito for participating in the manipulation and for violating Regulation T. FINRA sanctioned her husband, Vincent A. Esposito, the firm's owner, principal and AML Compliance Officer, for those same violations and for violations of his AML obligations. Vincent Esposito was suspended from associating with a securities firm in any capacity for 90 days, suspended from associating with a securities firm in a principal capacity for two years and fined $15,000.

 FINRA found that in 2005, Meeting Street and the Espositos participated in a manipulative scheme designed to increase and/or maintain artificially the price and volume of a Pink Sheet-traded stock issued by Relay Capital. Relay Capital was first incorporated in Canada in 2002 as First Canadian American Credit Services, later relocating to Nevada and changing its name to Galloway Oil and Gas, Inc. Relay Capital currently reports that it is in the business of marketing pre-paid financial services.  In its investigation, FINRA found that Meeting Street and the Espositos participated in the manipulation of Relay Capital stock by:

placing approximately 100 matched orders for the firm's customers — i.e., prearranged orders for the purchase and/or sale of the stock for the purpose of creating the false appearance of high trading volume and inflating or maintaining the stock's price;

transferring free shares of the stock to customers who had purchased or agreed to purchase additional shares of the stock;

continually allowing customers to purchase the stock without sufficient funds to do so and without a good faith belief that they would pay for their purchases before selling the stock; and

effecting nearly 100 purchases for customers in which the cost to buy the stock was met by the sale of the same stock. 

FINRA also found that Meeting Street and the Espositos effected certain agency cross trades between customers at prices in excess of the price at which Relay Capital stock traded on the date of the transactions. FINRA further found that a consulting company owned and controlled by Lisa Esposito received over 1.2 million shares of Relay Capital stock as payment for consulting services and that Meeting Street generated $289,000 in commissions in 2005 for placing Relay Capital stock trades.

FINRA also found that Meeting Street and the Espositos committed numerous violations of Regulation T, many of which were in furtherance of the manipulation, and that Meeting Street and Vincent Esposito, the firm's AML Compliance Officer, violated their AML obligations by failing, in several instances between 2005 and 2007, to investigate and report suspicious activity.

In concluding this settlement, Meeting Street and the Espositos neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

December 8, 2009 in Other Regulatory Action | Permalink | Comments (1) | TrackBack (0)

Adviser Group Releases Survey of Financial Professionals' Views on Fiduciary Standard

The SEI Advisor Network and The Committee for the Fiduciary Standard recently conducted a survey of financial advisers and brokers to determine the level of support and understanding of the fiduciary standard.  The survey was completed by 890 RIAs, IARs and registered broker-dealers, who self-identified their compensation structures as follows:  commission (132), commission-fee (510) and fee-based and fee-only (242).  The findings include:

A majority of brokers (53%) believe that "all financial professionals who give investment and financial advice should be required to meet the fiduciary standard;"  twenty-seven percent disagree with the statement.  Among those who identified themselves as fee-based and fee-only advisers, 86% agreed with the statement.

Eighty percent of brokers stated that they understood the fiduciary standard either "fairly well" or "very well."  Nearly all (98%) of advisers stated they understand the standard "fairly well" or "very well."

Respondents were asked if they believed that they should be allowed to meet a fiduciary standard in providing advice and then revert to a suitability standard when recommending products.  Ninety-three percent of fee-based and fee-only advisers disagreed with that statement, as did fifty-five percent of commission-fee brokers.  In contrast, thirty-seven percent of commission-only brokers disagreed with that statement.

As to compensation, fifteen percent of advisers said that they believe investors do not care how they are compensated, in contrast to fifty-six percent of commission-fee brokers and sixty-three percent of commission-only brokers.

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

Emory Law Conference on Teaching Transactional Law and Skills Seeks Proposals

Emory University School of Law’s Center for Transactional Law and Practice will hold its second biennial conference on the teaching of transactional law and skills, Transactional Education:  What’s Next?  The conference will be held at Emory Law on Friday, June 4, and Saturday, June 5, 2010.

The Steering Committee is soliciting proposals immediately, but in no event later than 5:00 p.m., February 1, 2010. It welcomes proposals on any subject of interest to current or potential teachers of transactional law and skills.


December 8, 2009 in Professional Announcements | Permalink | Comments (0) | TrackBack (0)

Monday, December 7, 2009

FINRA Proposes Rule Change on Communications about Variable Annuities

The SEC noticed a proposed rule change (SR-FINRA-2009-070) submitted by FINRA pursuant to Rule 19b-4 under the Securities Exchange Act of 1934 related to communications with the public about variable life insurance and variable annuities. Publication is expected in the Federal Register during the week of December 7. (Rel. 34-61107)

December 7, 2009 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Extends Exemptions to Permit ICE Trust to Operate as Central Couunterparty for CDSs

On Dec. 4, 2009, the SEC approved an extension and modification of temporary exemptions that allow ICE Trust U.S. LLC (f/k/a ICE US Trust LLC) to operate as a central counterparty for clearing credit default swaps. On March 6, 2009, the SEC previously granted ICE Trust a similar exemption that was scheduled to expire on Dec. 7, 2009. The SEC's December 4th action extends the exemptions that were set to expire and expands them to address additional credit default swap clearing arrangements.

The SEC is soliciting public comment on all aspects of these exemptions to assist in its consideration of any further action that may be needed in this area. (Rel. 34-61119)

December 7, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Releases Enforcement and Market Data for Fiscal 2009

The SEC posted on its website its Select SEC and Market Data for Fiscal 2009, which includes information on enforcement actions.  The SEC reports that it obtained disgorgement orders of approximately $2.09 billion and penalty orders of about $345 million.  It also sought orders barring 90 individuals from serving as officers or directors of public companies.

December 7, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former New Century Financial Officers with Securities Fraud

The SEC today charged three former top officers of New Century Financial Corporation with securities fraud for misleading investors as New Century’s subprime mortgage business was collapsing in 2006. At the time of the fraud, New Century was one of the largest subprime lenders in the nation. The SEC’s complaint names as defendants: former CEO and co-founder Brad A. Morrice, former CFO Patti M. Dodge, and former Controller David N. Kenneally.  In its complaint, the SEC alleges that New Century disclosures generally sought to assure investors that its business was not at risk and was performing better than its peers. Defendants, however, failed to disclose important negative information, including dramatic increases in early loan defaults, loan repurchases, and pending loan repurchase requests. Defendants knew this negative information from numerous internal reports they regularly received, including weekly reports that Morrice ominously entitled “Storm Watch.”

The complaint also alleges that Dodge and Kenneally fraudulently accounted for expenses related to bad loans that it had to repurchase. In the face of dramatically increasing loan repurchases and a huge, undisclosed backlog of repurchase demands, Kenneally, with Dodge’s knowledge, made changes to New Century’s accounting for loan repurchases in both the second and third quarters of 2006. These undisclosed accounting changes violated generally accepted accounting principles and resulted in New Century’s improperly avoiding substantial repurchase expenses and materially overstating its financial results.

The complaint, filed in federal court in the Central District of California, seeks permanent injunctions against future violations, disgorgement with prejudgment interest, officer and director bars, and civil penalties.

December 7, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Sunday, December 6, 2009

Hill & Painter on Investment Bankers' Personal Liability

Berle's Vision Beyond Shareholder Interests: Why Investment Bankers Should Have (Some) Personal Liability, by Claire A. Hill, University of Minnesota, Twin Cities - School of Law, and Richard W. Painter,
University of Minnesota Law School, was recently posted on SSRN.  Here is the abstract:

This paper, published in a symposium on the work of Adolf Berle, approaches the Berle-Dodd debate from the perspective that corporate managers have responsibilities beyond pursuing the interests of shareholders. Stock based executive compensation, designed to align managers’ interests with those of shareholders, has, in the investment banking industry in particular, failed to avert, and may have caused, managers to take excessive risks that in the 2008 financial crisis inflicted great damage on creditors and on society as a whole. We describe here the broad outlines of a proposal that we will discuss in future publications in more detail to impose some measure of personal liability for a bank’s debts on the most highly paid bankers. The proposal would revive two mechanisms that imposed such personal liability in an earlier era: general partnership, which was common for investment banks prior to the 1980s, and assessable stock, which was relatively common in corporations including some commercial banks through the 1930s. One proposal is that bankers earning over $3 million per year be required to enter into a partnership/joint venture agreement with the employing bank that would make them personally liable for some of the bank’s debts. The other proposal is that compensation in excess of $1 million per year be paid to bankers only in stock that is assessable in the event of the bank’s insolvency in an amount equal to the book value of the stock on the date of issue. In either case, the bankers’ liability would not be unlimited: they would be allowed to shield $1 million from creditors. Imposing genuine downside risk through these or other vehicles for personal liability may be the best way to make bankers approach risk in a manner that reflects the potential for externalities of the sort the crisis has so dramatically demonstrated.

December 6, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)