January 1, 2010
Ford on Financial Regulation
New Governance in the Teeth of Human Frailty: Lessons from Financial Regulation, by Cristie L. Ford, University of British Columbia Faculty of Law; Columbia Law School, was recently posted on SSRN. Here is the abstract:
New Governance scholarship has made important theoretical and practical contributions to a broad range of regulatory arenas, including securities and financial markets regulation. In the wake of the global financial crisis, question about the scope of possibilities for this scholarship are more pressing than ever. Is new governance a full-blown alternative to existing legal structures, or is it a useful complement? Are there essential preconditions to making it work, or can a new governance strategy improve any decision making structure? If there are essential preconditions, what are they? Is new governance “modular” – that is, does it still confer benefits when applied partially or imperfectly, or does it fail to achieve good regulatory results unless all the elements are in place? This article starts from the conviction that new governance is a promising response to the fluidity and complexity of contemporary regulatory environments. It then draws on three essentially unhappy narratives from recent financial markets regulation (around securities law enforcement, capital adequacy, and the impact of securitization), in an attempt to identify lessons for new governance scholarship at the level of practical implementation. These are not narratives about the failure of new governance structures. However, central to each narrative are components, or incomplete versions of components, that are also central to new governance structures. The paper considers the significance of incrementalism, regulatory capacity, and destabilization and complexity for regulatory design. It closes with some preliminary recommendations for making new governance structures effective, even as implemented by flawed human actors.
Choi et al. on Pay to Play in Securities Class Actions
The Price of Pay to Play in Securities Class Actions, by Stephen J. Choi, New York University - School of Law; Drew T. Johnson-Skinner, New York University School of Law; and Adam C. Pritchard, University of Michigan Law School, was recently posted on SSRN. Here is the abstract:
This paper studies the effect of campaign contributions to lead plaintiffs — “pay to play’’ — on the level of attorneys’ fees in securities class actions. We find that state pension funds generally pay lower attorneys’ fees when they serve as lead plaintiffs in securities class actions than do individual investors serving in that capacity. This differential disappears, however, when we control for campaign contributions made to officials with influence over state pension funds. Thus, pay to play appears to increase agency costs borne by shareholders in securities class actions
December 31, 2009
SEC Adopts Custody and Recordkeeping Rules for Investment AdvisersThe SEC adopted amendments to the custody and recordkeeping rules under the Investment Advisers Act of 1940 to provide additional safeguards when a registered adviser has custody of client funds or securities. The final rules require the adviser, among other things: to undergo an annual surprise examination by an independent public accountant to verify client assets; to have the qualified custodian maintaining client funds and securities send account statements directly to the advisory clients; and unless client assets are maintained by an independent custodian (i.e., a custodian that is not the adviser itself or a related person), to obtain, or receive from a related person, a report of the internal controls relating to the custody of those assets from an independent public accountant that is registered with and subject to regular inspection by the Public Company Accounting Oversight Board. Finally, the amended custody rule and forms will provide the Commission and the public with better information about the custodial practices of registered investment advisers. The rules go into effect 60 days after publication in the Federal Register.
Telecommunications Company Settles FCPA Charges Relating to Asian Business
The SEC charged Alameda, Calif.-based telecommunications company UTStarcom, Inc. with violations of the Foreign Corrupt Practices Act (FCPA) for authorizing millions of dollars in unlawful payments to foreign government officials in Asia. UTStarcom agreed to settle the SEC's charges and pay a $1.5 million penalty among other remedies. In a related criminal case, the U.S. Department of Justice announced today that UTStarcom agreed to pay an additional $1.5 million fine.
The SEC alleged that UTStarcom's wholly-owned subsidiary in China paid nearly $7 million between 2002 and 2007 for hundreds of overseas trips by employees of Chinese government-controlled telecommunications companies that were customers of UTStarcom, purportedly to provide customer training. In reality, the trips were entirely or primarily for sightseeing. The SEC further alleges that UTStarcom provided lavish gifts and all-expenses paid executive training programs in the U.S. for existing and potential foreign government customers in China and Thailand. UTStarcom also purported to hire individuals affiliated with foreign government customers to work in the U.S. and provided them with work visas, when in reality the individuals did no work for UTStarcom. According to the SEC's complaint, UTStarcom also made improper payments to sham consultants in China and Mongolia while knowing that they would pay bribes to foreign government officials.
December 29, 2009
SEC Charges Broker with Defrauding Two Florida Municipalities
The SEC today charged Harold H. Jaschke, a Houston-based broker, with engaging in unauthorized and unsuitable trading on behalf of two Florida municipalities, putting them at risk of losing millions of dollars while he reaped commissions of more than $14 million for himself. According to the agency, Jaschke, while associated with the brokerage firm First Allied Securities, Inc., churned the accounts of the City of Kissimmee, Fla., and the Tohopekaliga Water Authority and lied to both customers about his trading practices on their behalf.
The SEC's complaint, filed in federal court in Orlando, Fla., alleges that Jaschke engaged in a high-risk, short-term trading strategy involving zero-coupon U.S. Treasury bonds that were very sensitive to interest rate changes. According to the SEC's complaint, Jaschke's risky trading strategy involved buying and selling the same bond within a matter of days, and sometimes within the same day. Jaschke exposed the municipalities to greater risks when he leveraged their accounts using repurchase agreements to finance the bond purchases that they otherwise would not have been able to afford. This strategy dramatically increased the risks as Jaschke caused the municipalities to borrow large sums of money to hold larger bond positions.
The SEC alleges that Jaschke knew the municipalities' ordinances prohibited his trading strategy and required that their funds be invested with the paramount consideration to be safety of capital. Jaschke also knew that the municipalities' ordinances prohibited the use of repurchase agreements for investment. According to the SEC's complaint, had the bond market not swung sharply in Jaschke's favor allowing the municipalities to close their accounts with a modest profit, they could have lost approximately $60 million over a two-year period as a result of his misconduct.
The SEC's complaint alleges that Jaschke violated the antifraud provisions of the federal securities laws, 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 aided and abetted violations of the broker-dealer books and records provisions, Section 17(a) of the Exchange Act and Rule 17a-4(b)(4) thereunder. The SEC's complaint seeks a permanent injunction and disgorgement with prejudgment interest and a financial penalty.
In a related enforcement action, the SEC charged Jeffrey C. Young, First Allied's former vice president of supervision, for failing to reasonably supervise Jaschke, failing to respond adequately to red flags relating to Jaschke, and failing to take reasonable steps to ensure that First Allied's procedures regarding suitability were followed. Young agreed to settle the SEC's enforcement action without admitting or denying the findings. The SEC's order instituting settled administrative proceedings against Young suspends him from acting in a supervisory capacity for nine months and orders him to pay a $25,000 penalty.
Stifel Settles ARS Charges with State Securities Regulators
NASAA today announced that a settlement in principle has been reached between Stifel, Nicolaus & Co., Inc. and state securities regulators to provide relief for the firm’s clients who have had their funds frozen in the auction rate securities (ARS) market. The settlement with St. Louis-based Stifel, Nicolaus calls for the firm to buy back from its investors more than $100 million in auction rate securities. The settlement is the result of a task force investigation led by the Colorado Division of Securities, the Securities Division of the Indiana Office of the Secretary of State and the Securities Division of the Missouri Office of the Secretary of State.
Under the terms of the settlement, Stifel will significantly accelerate the unendorsed repurchase plan it announced in April, and all Stifel investors holding auction rate securities will receive a payout by January 15, 2010. Additionally, Stifel will accelerate its planned 2011 partial repurchase event to December 2010, and make additional payments at that time. As a result of this acceleration and these additional payments, every investor who had $150,000 or less in auction rate securities holdings will be made whole by the end of next year. The payouts to be made in 2010 will be worth up to $41 million and will lead to full buybacks for 80 percent of investors nationwide.
Stifel will also accelerate its final buyback previously scheduled for June 2012 so that all auction rate holders receive a full buyback and are made whole no later than the end of 2011. The average overall account size of investors receiving the accelerated 2011 full repurchase is more than $5 million.
The settlement also requires Stifel to work with a bank affiliate to make its best efforts to offer interim loans on investor-friendly terms, and to hire a securities industry expert to make recommendations on supervision, training, marketing and selling nonconventional products. Stifel will also pay a penalty of $525,000, to be divided among the states, and will be charged with failure to supervise and train its agents in the sale of auction rate securities. Stifel also agreed to reimburse Missouri and Indiana for costs associated with the investigation and make quarterly reports on repurchases and other auction rate securities activity.
December 28, 2009
SEC Makes Permanent Investment Advisers Rule on Principal Trades
The SEC adopted as final Rule 206(3)-3T under the Investment Advisers Act of 1940, the interim final temporary rule that establishes an alternative means for investment advisers who are registered with the Commission as broker-dealers to meet the requirements of Section 206(3) of the Investment Advisers Act when they act in a principal capacity in transactions with certain of their advisory clients. As adopted, the only change to the rule is the expiration date. Rule 206(3)-3T will sunset on December 31, 2010.
According to the SEC release, Rule 206(3)-3T was designed to continue to provide the protection of transaction-by-transaction disclosure and consent to advisory clients when investment advisers seek to trade with them on a principal basis, subject to several conditions. Specifically, Rule 206(3)-3(T) permits an adviser, with respect to non-discretionary advisory accounts, to comply with Section 206(3) of the Advisers Act by, among other things, meeting the following conditions:
(i) providing written, prospective disclosure regarding the conflicts arising from principal trades;
(ii) obtaining written, revocable consent from the client prospectively authorizing the adviser to enter into principal transactions;
(iii) making certain disclosures, either orally or in writing, and obtaining the client’s consent before each principal transaction;
(iv) sending to the client confirmation statements disclosing the capacity in which the adviser has acted and disclosing that the adviser informed the client that it may act in a principal capacity and that the client authorized the transaction; and
(v) delivering to the client an annual report itemizing the principal transactions made during the year.
FINRA Proposes Change to Arbitration Rules Regarding Hearing Location
The SEC noticed a proposed rule change (SR-FINRA-2009-073) submitted by FINRA related to the hearing location rules of the Codes of Arbitration Procedure for customer and industry disputes. Publication is expected in the Federal Register during the week of December 28. As FINRA explains in the release,
Currently, Rule 12213(a) of the Customer Code states that generally, the Director of FINRA Dispute Resolution (“Director”) will select the hearing location closest to the customer’s residence at the time of the events giving rise to the dispute. FINRA has determined that its policy concerning selection of a hearing location under the Customer Code may be broader than the rule describes.
Under the current rule in the Customer Code, for example, if a customer in an arbitration proceeding lives in Hoboken, New Jersey, the Director will select the New York City hearing location, because this hearing location is closer to the customer’s residence, Hoboken, than FINRA’s Newark, New Jersey hearing location. There have been instances, however, in which the Director has granted customers’ requests to select a hearing location in their state of residence at the time of the events. ... Thus, in the example above, if the customer requests the Newark, New Jersey hearing location, the Director generally will grant the request, even though the closest hearing location is the New York City location. The Director typically attempts to honor such requests as a convenience to public customers.
FINRA is proposing, therefore, to amend Rule 12213(a) of the Customer Code to add this criterion for selecting a hearing location. The proposed amendment to the rule would state that the Director will select the hearing location closest to the customer’s residence at the time of the events giving rise to the dispute, unless the hearing location closest to the customer’s residence is in a different state. In that case, the customer may request a hearing location in the customer’s state of residence at the time of the events giving rise to the dispute.
.... FINRA believes the proposal is customer-friendly because it gives customers more control over the arbitration process, by providing them with a choice of hearing locations.
Ohio Investment Adviser Settles Allegations of Misappropriating Funds from Elderly Clients
Julie M. Jarvis, of Columbus, Ohio, and her financial advisory firm, Crossroads Financial Planning, Inc, have agreed to settle the SEC's pending civil action against them that alleged that Jarvis misappropriated at least $2.3 million from two elderly clients between June 2000 and March 2009. In a related criminal proceeding, on October 14, 2009, the United States District Court for the Southern District of Ohio sentenced Jarvis to 66 months incarceration based upon her plea of guilty to criminal charges stemming from the same conduct alleged in the Commission's complaint. The Court also ordered her to pay restitution in the amount of $2,663,681.44.
SEC Permanently Disqualifies Former GC of Universal Express
The SEC permanently disqualified Chris G. Gunderson, an attorney and former general counsel for Universal Express, Inc., a Nevada corporation, from appearing or practicing before it pursuant to Rule of Practice 102(e). The Commission found that Gunderson had been permanently enjoined by the United States District Court for the Southern District of New York for issuing and distributing unregistered shares of Universal Express, Inc., in violation of Section 5 of the Securities Act of 1933, and for creating and disseminating materially misleading press releases concerning Universal Express, Inc.'s business operations, in violation of Securities Act Section 17(a) and Section 10(b) and Rule 10b 5 of the Securities Exchange Act of 1934. The Commission further found that it was in the public interest and necessary to preserve the integrity of its registration and disclosure processes to permanently disqualify Gunderson from practice before the Commission. (Rel. 34-61234; File No. 3-12653)
Former CEO and Securities Counsel Settle Financial Fraud Charges
The SEC settled financial fraud charges against Richard E. McDonald, former President, CEO and Chairman of World Health Alternatives, Inc. ("World Health"), a now defunct medical staffing company previously located in Pittsburgh, Pennsylvania. The Commission's complaint alleges that McDonald was the principal architect of a wide-ranging financial fraud at World Health by which McDonald misappropriated approximately $6.4 million for his personal benefit. Other defendants, who also settled charges, are Deanna Seruga, the company's former controller and a CPA, Marc D. Roup, a former CEO of World Health, and Joseph I. Emas, World Health's former outside securities counsel. The settlements are pending final approval by the court.
The complaint alleges that, from at least May 2003 through August 2005, McDonald, along with Seruga and Roup, engaged in a wide array of fraudulent and improper conduct. A key aspect of the fraud involved the manipulation of World Health's accounting entries. McDonald and Seruga repeatedly falsified accounting entries in World Health's financial books and records, understating expenses and liabilities. This made the Company appear more financially sound, and masked McDonald's misappropriation of funds. During the relevant period, every annual and quarterly report that World Health filed with the Commission contained false financial statements.
As alleged in the complaint, McDonald also improperly attempted to issue and register for immediate sale millions of shares of World Health stock by misusing a Form S-8 registration statement. In addition, McDonald also caused World Health to file with the Commission two false post-effective amendments drafted by Emas, World Health's outside securities counsel.
McDonald has consented to the entry of an order permanently enjoining him from violating Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933, Sections 10(b), 13(b)(5) and 16(a) of the Securities Exchange Act of 1934 and Rules 10b-5, 13b2-1, 13b2-2 and 13a-14 thereunder, and aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11 and 13a-13 thereunder. The order will also bar McDonald from serving as an officer or director of a public reporting company. The order finds McDonald liable for disgorgement of approximately $6.4 million plus prejudgment interest. Based on sworn financial statements and other documents and information submitted to the Commission, payment of disgorgement and prejudgment interest will be waived and civil penalties not imposed.
Roup has consented to the entry of an order permanently enjoining him from violating Sections 5(a), 5(c) and 17(a) of the Securities Act, Sections 10(b) and 16(a) of the Exchange Act, and Rules 10b-5 and 13a-14 thereunder, and aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder. The order will also bar Roup from serving as an officer or director of a public reporting company. Roup will also be ordered to pay disgorgement and prejudgment interest of $5,324,187, and a $120,000 civil penalty. Roup consented to transfer his assets to a court-appointed receiver to satisfy payment of these amounts.
Seruga has consented to the entry of an order permanently enjoining her from violating Section 17(a) of the Securities Act, Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b-5, 13b2-1 and13b2-2 thereunder, and aiding and abetting violations of Section 13(a) of the Exchange Act, and Rules 12b-20, 13a-1 and 13a-13 thereunder. The order finds Seruga liable for disgorgement of $383,662 plus prejudgment interest. Based on sworn financial statements and other documents and information submitted to the Commission, payment of disgorgement and prejudgment interest will be waived and civil penalties not imposed. In addition, Seruga agreed to settle a related administrative proceeding by consenting to the entry of an order suspending her from appearing or practicing before the Commission as an accountant.
Emas has consented to the entry of an order permanently enjoining him from violating Sections 5(a), 5(c), 17(a)(2) and 17(a)(3) of the Securities Act. Emas will also be ordered to pay disgorgement and prejudgment interest of $163,083, and a $15,000 civil penalty. In addition, Emas agreed to settle a related administrative proceeding by consenting to the entry of an order suspending him from appearing or practicing before the Commission as an attorney for two years.
SEC Obtains Emergency Relief In Connection with Alleged Trading on Inside Information
On Dec. 23 the SECobtained an emergency asset freeze against two French men it charged with insider trading the day after they tried to illegally profit from a Paris-based manufacturer’s acquisition of another health care products company located in Chattanooga, Tenn. The SEC alleges that Nicolas Patrick Benoit Condroyer and Gilles Robert Roger, who reside in Brussels, Belgium, purchased hundreds of "out-of-the-money" call option contracts for stock in Chattem, Inc., which manufactures and markets over-the-counter health care products. Condroyer and Roger purchased the contracts in newly-opened U.S. option brokerage accounts while in possession of material, nonpublic information regarding the impending acquisition of Chattem by Sanofi-Aventis, one of the world's largest health care products companies. According to the SEC's complaint, when the $1.9 billion acquisition was announced publicly on December 21, Condroyer and Roger immediately sold all of their options for illicit profits of approximately $4.2 million. The SEC filed insider trading charges against them the very next day.
The SEC's enforcement action was filed in federal court in Atlanta. The court order, also obtained on December 22, freezes approximately $4.2 million in assets and prohibits Condroyer and Roger from destroying evidence.
The SEC alleges that Condroyer was in possession of material, nonpublic information regarding the Chattem acquisition by Sanofi while he purchased, from December 7 to 18, more than 1,900 option contracts for Chattem stock that were set to expire on January 15, within weeks of the purchase date. The SEC similarly alleges that on December 17 and 18, Roger purchased 940 contracts for Chattem in an account he opened at the beginning of that week while in possession of material, nonpublic information regarding the acquisition. These contracts also were set to expire on January 15. The SEC further alleges that there have been no transactions in either Condroyer's or Roger's account other than the purchase and sale of Chattem call options.