Friday, February 6, 2009
Excerpts from SEC Chairman Mary Schapiro's Address to Practising Law Institute's "SEC Speaks in 2009" Program, Feb. 6, 2009:
As a first, but significant, step in empowering our Enforcement staff, I am this week taking action to end the Commission's two-year "penalty pilot" experiment, which had required the Enforcement staff to obtain a special set of approvals from the Commission in cases involving civil monetary penalties for public companies as punishment for securities fraud.
In speaking to our Enforcement staff, I've been told that these special procedures have introduced significant delays into the process of bringing a corporate penalty case; discouraged staff from arguing for a penalty in a case that might deserve a penalty; and sometimes resulted in reductions in the size of penalties imposed.
At a time when the SEC needs to be deterring corporate wrongdoing, the "penalty pilot" sends the wrong message. The action I am taking to end the penalty pilot is designed to expedite the Commission's enforcement efforts to ensure that justice is swiftly served to those public companies who commit serious acts of securities fraud.
Another immediate change I am putting in place to bolster the SEC's enforcement program is to provide for more rapid approval of formal orders of investigation — the permission slips given out by the Commission that allow SEC staff to use the power of subpoenas to compel witness testimony and the production of documents. When I was a Commissioner, formal orders were routinely reviewed and approved within a couple of days by written approval of the Commission or by "duty officer" — a single Commissioner acting promptly and on behalf of the entire Commission.
Today, however, many formal orders of investigation are made subject to full review at a meeting of all five Commissioners, necessitating that they be placed on the calendar sometimes weeks in advance. In investigations that require use of subpoena power, time is always of the essence, and every additional day of delay can be costly. To ensure that subpoena power is available to SEC staff when needed, I've given direction for the agency to return to the prior policy of timely approval of formal orders by seriatim approval or where appropriate, by a single Commissioner acting as duty officer.
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The crisis facing our capital markets will require aggressive and timely action to restore investor trust and confidence. To this end, allow me to highlight a few of the initiatives that I hope to pursue as priorities:
Improving the quality of credit ratings by addressing the inherent conflicts of interest credit rating agencies face as a result of their compensation models and limiting the impact of credit ratings on capital requirements of regulated financial institutions.
Reducing systemic risk to investors and markets by promoting — and regulating appropriately — centralized clearinghouses for credit default swaps.
Strengthening risk-based oversight of broker-dealers and investment advisers.
Improving the quality of audits for nonpublic broker-dealers and promoting the safe and sound custody of customer assets by any broker-dealer or investment adviser.
Thursday, February 5, 2009
After four senior staff members of the SEC were unable to answer the House Subcommittee's questions about Madoff, citing ongoing invetigations, SEC Chair Mary Schapiro sent a letter to the committee, stating that “Today's testimony before your subcommittee could not have been satisfactory.” Indeed, Committee members made clear their displeasure. InvNews, Schapiro: SEC testimony not satisfactory.
The SEC charged Brian V. Prendergast of Castle Rock, Colorado, and his entity Enterprises, LLC, a Colorado limited liability company, with conducting a fraudulent prime bank offering scheme in coordination with Donald R. Smith of Aurora, Colorado, Yuail I. Enwia of Ceres, California, and Worldwide Equity Corporation ("WEC"), a Nevada corporation. The Commission alleges that Prendergast, who has previously been convicted of criminal securities fraud in Colorado and is currently on court-supervised release, purported to raise $2.5 million from investors, several of whom are senior citizens. On February 4, 2009 the Court entered an order granting a temporary restraining order against the defendants, requiring accountings, and freezing the defendants' assets derived from investor funds obtained in the fraudulent scheme.
The SEC and the New York Attorney General separately announced the finalization of the settlement with Wachovia Securities, LLC that will provide more than $7 billion in liquidity to thousands of customers who invested in auction rate securities (ARS) before the market for those securities collapsed. The regulators charged that Wachovia misled investors regarding the liquidity risks associated with ARS that it underwrote, marketed and sold.
The SEC filed complaints in the United States District Court for the Southern District of New York alleging that seven individuals engaged in insider trading, which generated a combined total of over $11.6 million in illegal profits and losses avoided. The Commission's complaint further alleges that two mergers and acquisitions professionals, Nicos Achilleas Stephanou at UBS Investment Bank, and Ramesh Chakrapani at Blackstone Advisory Services, L.P., tipped five individuals, including Joseph Contorinis, a portfolio manager for a Jefferies Group, Inc. hedge fund, and residents of Greece and Cyprus with material nonpublic information about three impending corporate acquisitions. More dtails are found in the SEC's release.
Wednesday, February 4, 2009
The SEC has extended the comment period for a release proposing a Roadmap for the potential use of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board by U.S. issuers for purposes of their filings with the Commission and amendments to various regulations, rules and forms that would permit early use of IFRS by a limited number of U.S. issuers [Release No. 33-8982; 73 FR 70816 (Nov. 21, 2008)]. The original comment period for Release No. 33-8982 is scheduled to end on February 19, 2009. The Commission is extending the time period in which to provide the Commission with comments on that release for 60 days until Monday, April 20, 2009.
A House subcommittee of the Financial Services Committee held a hearing today on the SEC's failure to uncover the Madoff ponzi scheme. Here is a link to the webcast. The star witness was Harry Markopolos, an independent fraud investigator, who has not previously testified on his efforts, going back to 2000, to get the SEC, the New York Attorney General, and the Wall St. Journal to investigate his allegations that Madoff was running a ponzi scheme. Here is a link to his written testimony. In addition, various members of the SEC staff testified yet again and cited ongoing investigations as the reason for their inability to discuss the matter. Here is a link to their written testimony. Stephen Luparello, Interim Chief Executive Officer, FINRA, also testified. Here is a link to his written testimony.
Here is some press coverage of the hearing:
SEC Evasion On Madoff Infuriates Lawmakers (WPost)
The SEC announced that the United States District Court has entered a stipulated judgment against Eugene Melnyk, Biovail Corporation's former chairman and chief executive officer, with respect to violations of the stock accumulation disclosure provisions of the federal securities laws alleged by the Commission in a civil enforcement action filed in March 2008. The Commission's securities fraud charges against Melnyk in that action remain pending.
The Commission's complaint alleges, among other things, that Melnyk violated the stock accumulation disclosure provisions by failing to include in his Schedule 13D filings Biovail shares held in several off-shore trusts that Melnyk controlled. The complaint further alleges that, because Melnyk exercised both investment and trading authority over the shares in the trusts, Melnyk was a beneficial owner of the securities and was required to disclose the trust holdings in his Schedule 13D filings with the Commission.
The Commission's complaint also alleges that Melnyk, other senior Biovail executives, and Biovail violated the antifraud and other provisions of the securities laws. Biovail previously settled with the Commission by consenting to a judgment that, among other things, permanently enjoined it from violating antifraud and other provisions of the federal securities laws, imposed a $10 million civil penalty, and ordered it to pay disgorgement of $1. The Commission's allegations of violations of the antifraud and other provisions of the federal securities laws remain pending against Melnyk and three other former Biovail executives: former chief financial officer Brian Crombie; former controller John Miszuk; and former chief financial officer Kenneth G. Howling.
The stipulated judgment against Melnyk permanently enjoins him from future violations of Section 13(d) of the Exchange Act and Rules 13d-1 and 13d-2 and imposes a civil penalty in the amount of $1,000,001. It states explicitly that the securities fraud charges against Melnyk remain pending and are not resolved by the stipulated judgment announced today.
The SEC filed an emergency enforcement action against Scott M. Ross, charging that Ross fraudulently obtained at least $10 million from approximately 300 investors. The SEC has obtained an emergency court order freezing Ross's assets and appointing a receiver from the federal district court in the Northern District of Illinois.
The SEC's complaint alleges that, beginning in 2007, Ross solicited investments in three purported private investment funds that Ross managed. Specifically, according to the complaint, Ross raised approximately $2 million from investors for the Elucido Fund LP ("Elucido"), telling investors that Elucido would invest in life settlement contracts. In connection with the second fund, the SEC alleges that Ross raised approximately $2 million from investors that was to be used to purchase stock in a company called Moondoggie Technologies. Finally, the complaint alleges that Ross raised between $6 million and $7 million for the Maize Fund LP, telling investors that their money would be pooled and invested in a Forex Account in which traders would engage in arbitrage currency trading.
The SEC complaint alleges that, in reality, Ross misappropriated approximately $2 million from Elucido and an undetermined sum in connection with the Moondoggie Technology stock purchases. Among other things, Ross used misappropriated funds to purchase a skybox at the Indianapolis Colts stadium, and pay purported returns to investors.
Ross consented to the emergency relief sought by the SEC, and the Honorable James B. Zagel, United States District Court, Northern District of Illinois, issued an order permanently enjoining Ross from further violations, freezing his assets and appointing a Receiver in the matter.
The SEC took emergency action to stop what it describes as "a massive and ongoing international boiler room scheme" that allegedly sold penny stocks to investors located in Europe by misrepresenting that investors paid no sales commissions. The SEC alleges that, in fact, investors paid commissions exceeding 60 percent of the amount invested, and the fraudulent scheme raised at least $44.2 million from 1,400 investors since March 2007.
The SEC's complaint alleges that four Chicago residents and their entities have worked in concert with sales agents based in Europe who make fraudulent cold calls to solicit investors. The SEC charged Chicago residents Stefan H. Benger, Jason B. Meyers, Frank I. Reinschreiber, and Philip T. Powers as well as four entities through which they operated the boiler room scheme: SHB Capital Inc., International Capital Financial Resources LLC, Global Financial Management LLC, and Handler, Thayer & Duggan, LLC. Handler Thayer is a Chicago law firm that employs Powers.
The SEC alleges that the multi-faceted boiler room scheme victimized residents of the United Kingdom, Germany, and other European countries. According to the SEC's complaint, Benger, Meyers, SHB Capital, and International Capital acted as distribution agents for at least eight different U.S. penny stock issuers, agreeing to solicit foreign investors in exchange for commissions that collectively exceed 60 percent of the investor proceeds. The SEC alleges that Benger, Meyers, SHB Capital, and International Capital, in turn, retained foreign sales agents to solicit investors. The foreign sales agents worked for boiler room operations and made cold calls to investors utilizing high pressure sales tactics. The SEC alleges that in connection with these sales, investors were not informed of the exorbitant commissions being collected or were told that no commissions would be charged. The SEC further alleges that Powers, Reinschreiber and Global Financial provided knowing and substantial assistance to the scheme by acting as escrow agents in exchange for a share of the commissions. The escrow agents took custody of approximately $44.2 million in investor funds, disbursed nearly $29 million in investor funds as undisclosed commissions and the remainder to the stock issuers. The SEC also alleges that Handler Thayer acted as an unregistered broker-dealer in connection with its activities as an escrow agent.
The SEC filed its emergency action in the U.S. District Court for the Northern District of Illinois, seeking a temporary restraining order, preliminary and permanent injunctions, disgorgement plus prejudgment interest, penny stock bars and civil money penalties. On February 3, the court granted, on an ex parte basis, all of the emergency relief requested by the SEC and scheduled a preliminary injunction hearing for February 13, 2009.
Tuesday, February 3, 2009
The SEC approved a proposed rule change submitted by FINRA to amend the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes to raise the amount in controversy that will be heard by a single chair-qualified arbitrator to $100,000. Publication is expected in the Federal Register during the week of February 2.
The SEC is adopting rule amendments that impose additional requirements on nationally recognized statistical rating organizations (“NRSROs”) in order to address concerns about the integrity of their credit rating procedures and methodologies. The effective date is April 10, 2009.
In addition, in a separate release, the SEC is proposing amendments which would require the public disclosure of credit rating histories for all outstanding credit ratings issued by an NRSRO on or after June 26, 2007 paid for by the obligor being rated or by the issuer, underwriter, or sponsor of the security being rated. The Commission also is soliciting detailed information about the issues surrounding the application of a disclosure requirement on subscriber-paid credit ratings. The Commission is re-proposing for comment an amendment to its conflict or interest rule that would prohibit an NRSRO from issuing a rating for a structured finance product paid for by the product’s issuer, sponsor, or underwriter unless the information about the product provided to the NRSRO to determine the rating and, thereafter, to monitor the rating is made available to other persons. The Commission is proposing these rules to address concerns about the integrity of the credit rating procedures and methodologies at NRSROs. Comments should be received on or before March 26, 2009.
Henry Markopoulos, an independent fraud investigator who warned the SEC repeatedly since 2000 of Madoff's fraud, to no avail, is expected to testify tomorrow before the House Financial Services Committee. The Wall St. Journal has posted his written testimony.
Monday, February 2, 2009
The SEC announced that it filed a complaint in the United States District Court for the Southern District of New York alleging that Forest Resources Management Corp. ("Forest"), Chaim Justman ("Justman"), William J. Reilly ("Reilly"), and Pinchus Gold ("Gold") defrauded investors and reaped approximately $800,000 in unlawful profits by fraudulently procuring unlegended, purportedly free-trading shares of Forest stock and then selling these shares to the investing public after Forest's false and misleading material misrepresentations and omissions about its business operations artificially increased demand for that stock.
According to the Complaint, Forest is and was a public shell company that at all relevant times had no income or assets. From June through October 2006, Reilly, Justman and Gold acted together to make material misrepresentations to Forest's transfer agent that provided false justification for the transfer agent to issue millions of restricted shares to Justman, Reilly, Gold, their nominees and others without the required restrictive legend. Justman, Reilly, Gold and their nominees were thus free to, and did, place these unlegended shares in brokerage accounts they controlled, and sold many of these shares in the open market, falsely holding them out to the public as free-trading shares, when in fact the shares were restricted stock. A registration statement was never in effect for these transactions in Forest's stock
The Complaint further alleges that Justman, Reilly and Gold sold more than a million shares of the improperly unlegended shares to the investing public, after Forest, Justman, and Reilly began issuing a series of false statements to the investing public regarding Forest's assets and commercial prospects. For example, Forest, through Justman and Reilly, misrepresented in a filing with the Commission and in press releases that Forest, based on a share exchange agreement that it had purportedly entered into with a company called Opus Management Group, Ltd., held valuable timber properties in Central and South America. These statements were false because Forest had not entered into any signed agreement with Opus, and because Opus had not direct or indirect ownership of timber properties.
Reilly is a New York City attorney living in Boca Raton, Florida. Justman and Gold both live in Brooklyn, New York.
The Commission's complaint charges Forest, Justman, Reilly, and Gold with violations of Sections 5(a) and 5(c) of the Securities Act of 1933, 15 U.S.C. §§ 77e(a) and 77e(c), and with violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 77j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5.
The SEC announced that a final judgment by consent was entered on September 9, 2008 by the United States District Court for the Southern District of New York against Kevin Morano, the former Chief Financial Officer of Lumenis, Ltd., in a previously-filed action alleging that Morano participated in a series of fraudulent transactions that resulted in the publication of materially false financial statements by Lumenis in 2002 and 2003. The final judgment against Morano permanently enjoins Morano from violating the antifraud and other provisions of the federal securities laws and orders him to pay a $55,000 civil penalty. More recently, on January 15, 2009, the Court determined not to enter an order barring Morano from serving as an officer or director of a publicly traded company.
The Commission's complaint, filed on April 26, 2006, alleged that from at least late 2001 through early 2003, Morano and other defendants engaged in a fraudulent scheme to inflate revenue and misrepresent other important financial metrics so as to deceive investors as to the company's true financial condition. According to the complaint, the scheme involved the improper recognition of a series of sales transactions that resulted in Lumenis' publication of materially false and misleading financial statements in six consecutive financial reporting periods, starting with those for the year ended December 31, 2001. The complaint alleged that Morano allowed Lumenis to recognize revenue and profits from a number of the improper transactions while knowingly or recklessly disregarding the various conditions that should have precluded recognition.
On January 27, 2009, after a six-day bench trial, the Hon. Gerard E. Lynch of the U.S. District Court for the Southern District of New York issued an opinion and order that held defendant James N. Stanard, the former chief executive officer of reinsurer RenaissanceRe Holdings Ltd. ("RenRe"), liable for securities fraud, including making false or misleading statements to auditors, providing false officer certifications, and violating and aiding and abetting violations of reporting, books-and-records, and internal controls provisions of the securities laws.
The SEC charged Stanard and the other defendants with fraud in connection with a sham transaction whose purpose and effect was to fraudulently defer more than $26 million of RenRe's earnings from 2001 to later periods. With Stanard's knowledge, RenRe fraudulently accounted for the sham transaction as "reinsurance," when in fact, as Stanard knew, the transaction transferred no risk and could not properly be accounted for as reinsurance. As a result of RenRe's fraudulent accounting treatment, RenRe materially understated income in 2001 and materially overstated income in 2002.
The court found that Stanard violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 10b-5, 13a-14, 13b2-1, and 13b2-2 and that Stanard aided and abetted violations of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13. The court permanently enjoined Stanard from violating or aiding and abetting violations of all these provisions of the securities laws and imposed a civil penalty of $100,000 but denied the Commission's request for an officer and director bar.
Sunday, February 1, 2009
Insider Trading and the Gradual Demise of Fiduciary Principles, by Donna M. Nagy, Indiana University School of Law-Bloomington, was recently posted on SSRN. Here is the abstract:
Recent SEC enforcement actions, such as the case filed against Dallas Mavericks' owner Mark Cuban, raise the question whether deception by a fiduciary is essential to the Rule 10b-5 insider trading offense. Under the Supreme Court's classical and misappropriation theories, the answer is clearly yes - each theory has a fiduciary principle at its core. Yet lower courts and the SEC frequently disregard the Court's explicit dictates, and a consensus is emerging that insider trading rests simply on the wrongful use of material nonpublic information, regardless of whether a fiduciary-like duty is breached. Although this view of insider trading can be justified by the policy objectives underlying the Court's decision in United States v. O'Hagan, it currently lacks a solid doctrinal foundation. To resolve this anomaly, this Article offers specific suggestions that would bring much needed coherence and legitimacy to the law of insider trading.
The Future of Securities Litigation, by Richard A. Booth, Villanova University School of Law, was recently posted on SSRN. Here is the abstract:
In this article, I analyze the implications of the Supreme Court's 2008 decision in Stoneridge Investment Partners v. Scientific-Atlanta. The case arose as a result of a scheme to increase reported advertising earnings of a struggling cable television company involving two suppliers who agreed to sell set-top boxes to the cable company at inflated prices and then to use the excess to buy advertising from the cable company. While it seems clear that the cable company was guilty of securities fraud under SEC Rule 10b-5, the issue in Stoneridge was whether the suppliers could be held liable for damages in a private action as participants in the fraud. The Court ruled that because the plaintiffs did not rely on any statement made by the suppliers, the case should be dismissed. Although the circuit courts were split on the question, it would have been easy for the Supreme Court to rule that the allegations amounted to a claim of aiding and abetting and were prohibited by precedent as codified by Congress. The question is why did the Court go out of its way to base its holding on lack of reliance? The ruling is all the more curious because it also required the Court to explain that conduct may nonetheless be deceiving. As I argue in this piece, in light of other recent decisions, the answer appears to be that the Court is particularly interested in causation as it relates to securities fraud. This suggests that the Court may be receptive to arguments that securities fraud under Rule 10b-5 is a zero-sum game and that for diversified investors - the vast majority of investors - the costs of securities litigation are a deadweight loss that reduces portfolio returns because the company pays. Thus, diversified investors would prefer a rule that prohibits securities fraud class actions except in cases in which officers or agents of the corporation have appropriated or reduced stockholder wealth. And in such cases they would prefer that the action be prosecuted as a derivative action - or an action by the corporation - to recover from the wrongdoers for the benefit of the corporation. In short, because securities fraud causes no net harm to most investors, Stoneridge may signal that the Supreme Court is inclined to reconsider whether there exists a private cause of action under Rule 10b-5 by disgruntled investors against non-trading issuers.