Sunday, February 28, 2010
Toward a New Law and Economics: The Case of the Stock Market, by Lawrence E. Mitchell, George Washington University - Law School, was recently posted on SSRN. Here is the abstract:
Do the public equity markets play the macroeconomic role we believe them to play? What is the relationship between the U.S. public equity markets and American economic growth? What do these conclusions teach us about the approaches we take and should take in evaluating and designing the laws of corporate governance and securities regulation?
The law and economics paradigm of the last forty years may be mistaken in assuming that economic efficiency on an individual (or institutional) level is sufficient to ensure economic welfare on a macroeconomic level. While legal scholars have carefully and usefully examined the effects of a wide range of regulations on individual and institutional behavior, they have largely done so without considering the broader economic roles individuals and institutions play in building a growing and sustainable economy that creates wealth and jobs. Asking these broader questions may lead to reexamination of the ways in which we encourage the creation of economic institutions and incentives for economic behavior.
This paper exemplifies this new approach through an examination of the role of the U.S. public equity markets, concluding that their contribution to economic growth is highly limited. Public equity markets do not generally finance the formation of productive capital except in the limited, but important, role they play in providing exit opportunities for entrepreneurs and venture capitalists. But I do not accept this conclusion uncritically, noting that even claims for the importance of public equity markets for business creation may well be overstated, and that there is considerable research yet to be done. Moreover, even if the conclusion holds, an overall appraisal of this contribution in the broader context of the public equity markets raise important questions for corporate governance, financial regulation, and the structure of market institutions.
Gartenberg, Jones, and the Meaning of Fiduciary: A Legislative Investigation of Section 36(b), by Amy Yeung, ZeniMax Media Inc., and Kristen J. Freeman, was recently posted on SSRN. Here is the abstract:
Section 36(b) of the Investment Company Act of 1940 creates a “fiduciary duty” on the part of an investment adviser with respect to the receipts of compensation for services or of payments of a material nature. The term “fiduciary,” however, conveys a range of obligations, the breadth of which comes before the Supreme Court in Jones v. Harris, as two circuits diverge on the meaning of fiduciary duty under Section 36(b), and by doing so, call into question whether a fund’s investment adviser breached its fiduciary duty by charging an excessive fee.
Notably absent from the language of Section 36(b) is any description of substantive or procedural application of the term “fiduciary.” Justice Kennedy pressed for such analysis in the Jones oral arguments: “Is Harris a fiduciary in the same sense as a corporate officer and a corporate director? Or does his fiduciary duty differ?” This article provides a comprehensive review of the legislative history creating the “fiduciary” obligation under Section 36(b) of the Investment Company Act. It identifies key Congressional and industry themes, and draws conclusions on the legislative intent of Section 36(b), in an attempt to clarify the use of “fiduciary.”
The SEC's New Resale Rules: A Major Advance in Intelligibility and Sound Policy, by Rutheford B. Campbell Jr., University of Kentucky - College of Law, was recently posted on SSRN. Here is the abstract:
Over the decades, the Securities and Exchange Commission has had trouble formulating sensible rules regarding the resales of securities purchased by investors (holders) from issuers. Often acting through no-action letters, the Commission constructed an approach to holder resales that was murky, ephemeral, and seemingly lacking in sound core principles and theoretical consistency. The most problematic of all the Commission's holder resale rules were in Rule 145, which governed the resale of securities acquired in connection with acquisitions and recapitalizations and which, perhaps more than any other of its resale rules, led to unprincipled outcomes and created interpretative nightmares for the Commission and reselling holders.
The Commission's 2008 amendments to Rule 144 and Rule 145, however, mark an important shift in the substantive rules governing holder resales. The amended Rules, when considered with the Commission's resale "rules" one finds in no-action letters, suggest a significantly improved overall regime for holder resales, one that better balances competing policies, enhances consistency and intelligibility, and reduces transaction costs by eliminating complex and overly burdensome resale conditions.
Friday, February 26, 2010
The SEC announced that on February 12, 2010, after a three week jury trial prosecuted by the United States Attorney’s Office in Philadelphia, Pennsylvania, George Georgiou, of Toronto Ontario, was convicted of securities fraud, conspiracy, and wire fraud for his role in manipulating the market in four separate microcap stocks – Avicena Group, Inc., Neutron Enterprises, Inc., Hydrogen Hybrid Technologies, Inc., and Northern Ethanol, Inc. Sentencing is scheduled for May 7, 2010. Georgiou faces a maximum sentence of 165 years in prison and $21.25 million in fines.
The Commission previously filed a civil injunctive action against Georgiou based on similar conduct. According to the Commission’s complaint, from 2004 through September 2008, Georgiou, who controlled the publicly-traded stock of each company, manipulated the market for the purpose of artificially inflating each company’s stock price or to create the false appearance of an active and liquid market. In order to do so, Georgiou used many nominee accounts that he either directly or indirectly controlled at offshore broker-dealers and banks, and used a variety of manipulative techniques, including matched orders and wash sales. The Complaint alleges that ultimately, Georgiou realized at least $20.9 million in ill-gotten gains from his manipulation schemes through sales of artificially inflated stock and by using the artificially inflated stock as collateral to fraudulently obtain “margin” and other cash loans from Bahamian brokerage firms. The Commission’s action, filed in the Eastern District of Pennsylvania on February 12, 2009 seeks a permanent injunction, disgorgement, prejudgment interest, civil penalties, and a penny stock bar against Georgiou. The action has been stayed pending resolution of the criminal charges.
Thursday, February 25, 2010
The SEC today filed settled insider trading charges against four individuals--a former Deloitte tax professional, John A. Foley, and three others, Aaron M. Grassian, Timothy L. Vernier, and Bradley S. Hale--for their respective roles in an alleged pattern of insider trading and tipping in the securities of four public companies over a 22-month period that yielded illegal profits totaling $210,580.62. The four public companies involved are Crocs, Inc., YRC Worldwide, Inc., Spectralink Corporation and SigmaTel, Inc. All four defendants have agreed to settle the Commission's charges without admitting or denying the allegations in the Commission's Complaint.
According to the Complaint, which was filed in federal court in the District of Columbia, Foley served as an employee benefits specialist at Deloitte between July 2005 and May 2007, and learned, through his work on Deloitte client engagements, material, non-public information concerning (i) Crocs' first earnings release after going public; (ii) a potential acquisition of YRC by a third party (that ultimately was not consummated); and (iii) the acquisition of Spectralink, via tender offer, by another public company. According to the Complaint, Foley traded in all three issuers' securities based on this material, non-public information through nominee accounts; Foley also tipped his friend Vernier concerning all, and Grassian concerning part, of this information; and both men traded on Foley's communications.
The Complaint further alleges that Grassian later reciprocated by, in turn, tipping Foley concerning the acquisition of SigmaTel by Freescale Semiconductor, Inc., after learning of that pending acquisition from his friend and former colleague, Hale, who worked on the acquisition for Freescale. According to the Complaint, Grassian traded on Hale's tips for himself, and also passed them on to Foley, who, in turn, both traded in SigmaTel for himself, and also tipped Vernier and recommended SigmaTel to others, who likewise traded. The Complaint further alleges that Vernier substantially assisted Foley's insider trading violations as to Crocs by allowing Foley to trade in Crocs securities through Vernier's account, while knowing of or recklessly disregarding Foley's breaches of duty to Deloitte and to Crocs. Finally, the Complaint alleges that, since Crocs was a Deloitte audit client and Foley served on the Crocs audit team at the time of his Crocs trading and tipping, Foley also committed, and caused his firm to commit, an auditor-independence violation, and caused related issuer-reporting violations by the issuer.
The four defendants' signed Consents--which are subject to approval by the Court--provide that, without admitting or denying the Commission's allegations, each defendant would be permanently enjoined against future violations of the statutes and rules each is alleged to have violated, with the monetary portions of each settlement being as follows: (i) Foley would pay disgorgement of $125,538.61, plus prejudgment interest thereon in the amount of $18,697.89, with no civil penalty being imposed against him based on his demonstrated inability to pay; (ii) Vernier would pay disgorgement of $50,285.08, plus prejudgment interest thereon in the amount of $6,320.29 and a civil penalty of $23,138.07, with no further civil penalty being imposed based on his demonstrated inability to pay; (iii) Grassian would pay disgorgement of $34,756.93, plus prejudgment interest thereon in the amount of $4,768.39 and a civil penalty of $34,756.93; and (iv) no civil penalty would be imposed upon Hale, based on his demonstrated inability to pay.
The SEC today charged Bernard Madoff's Director of Operations, Daniel Bonventre, with falsifying accounting records. According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, Bonventre disguised Madoff's fraud and the financial losses at Madoff's firm by misusing and improperly recording investor money to create the false appearance of legitimate income.
As Madoff's Director of Operations, Bonventre ran the back office at Bernard L. Madoff Investment Securities LLC (BMIS) and oversaw the firm's accounting and securities clearing functions for at least 30 years. The SEC alleges that Bonventre knew that billions of dollars in investor funds were not being used to purchase securities on behalf of investors. The SEC further alleges that Bonventre made at least $1.9 million in illicit personal profits from the scheme through fake, backdated "trades" in his own investor account at BMIS.
According to the SEC's complaint, Bonventre was responsible for the firm's general ledger and financial statements that were materially misstated because they did not reflect the manner in which investor funds were maintained and used. Bonventure ensured that BMIS financial reports did not reflect the firm's massive liabilities to investors or the corresponding assets received from investors. To hide the fact that BMIS normally operated at a significant loss, the firm used more than $750 million in investor funds to artificially improve reported revenue and income.
The SEC alleges that Bonventre also helped Madoff, his lieutenant Frank DiPascali, Jr., and others orchestrate lies to investors and regulators when investment advisory operations at BMIS came under review. With Bonventre's assistance, they made serial misrepresentations to external reviewers by manufacturing reams of false reports and data.
The SEC further alleges that Bonventre personally siphoned $1.9 million from the scheme by directing that profits from fake, backdated trades be put into his own investor account at BMIS. One of these trades was backdated by 12 years. Bonventure instructed another fake, backdated trade in a handwritten note to a BMIS employee that read: "Hi … As per our phone conversation, I need a long term capital gain of $449000.— on an investment of $129000- for a sale proceed of $578000.— I'll be back in NY on March 30th but if you need to speak to me before then, call me…. Thanks[,] Dan."
The SEC's complaint seeks financial penalties and a court order requiring Bonventre to disgorge his ill-gotten gains.
Wednesday, February 24, 2010
The New York AG has been aggressive in getting securities firms to settle auction rate securities investigations, and today Oppenheimer & Co. did so, agreeing to buy back from investors $31 million in ARSs. As in the previous settlements, eligible investors include individuals, charities, non-profits, and small businesses and institutions. Since the value of its customers’ frozen auction rate securities exceeds the resources Oppenheimer can presently pledge to a buy-back offer under regulatory requirements, Oppenheimer has committed to extending additional buy-back offers as soon as it obtains additional capital or access to credit. The Attorney General retains the right to charge Oppenheimer under New York’s Martin Act should it determine that Oppenheimer’s future efforts are insufficient.
All individuals, charities, and small businesses with accounts of less than $1 million at Oppenheimer will be eligible for $25,000 in liquidity.
In addition to Oppenheimer, the other firms that have agreed to buy-backs to date as part of the Attorney General’s investigation are Banc of America Securities LLC and Banc of America Investment Services, Inc.; Citigroup Global Markets Inc.; Credit Suisse Securities (USA) LLC; Deutsche Bank Securities Inc.; Fidelity Investments; Goldman Sachs & Co.; JPMorgan Chase & Co.; Merrill Lynch; Pierce, Fenner & Smith Inc.; Morgan Stanley & Co. Inc. and RBC Capital Markets Corporation; TD Ameritrade, Inc.; UBS Securities LLC and UBS Financial Services, Inc.; and Wachovia Securities LLC and Wachovia Capital Markets Inc.
At its open meeting today, the SEC also adopted a Statement in Support of Convergence and Global Accounting:
SUMMARY: The Securities and Exchange Commission (the “Commission”) is publishing this statement to provide an update regarding its consideration of global accounting standards, including its continued support for the convergence of U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) and International Financial Reporting Standards (“IFRS”) and the implications of convergence with respect to the Commission’s ongoing consideration of incorporating IFRS into the financial reporting system for U.S. issuers.
Short selling is a convenient scape goat for market volatility and downward spiraling of stock prices, so it was to be expected that the SEC would adopt new restrictions on the practice, which it did at today's open meeting. The SEC's new rule will place certain restrictions on short selling when a stock is experiencing significant downward price pressure and is intended to promote market stability and preserve investor confidence. According to SEC Chair Mary Schapiro, "the rule is designed to preserve investor confidence and promote market efficiency, recognizing short selling can potentially have both a beneficial and a harmful impact on the market. It is important for the Commission and the markets to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility."
This alternative uptick rule (Rule 201) is designed to restrict short selling from further driving down the price of a stock that has dropped more than 10 percent in one day. It will enable long sellers to stand in the front of the line and sell their shares before any short sellers once the circuit breaker is triggered. Rule 201 imposes restrictions on short selling only when a stock has triggered a circuit breaker by experiencing a price decline of at least 10 percent in one day. At that point, short selling would be permitted if the price of the security is above the current national best bid.
Commissioner Paredes dissented with a thoughtful statement:
My comments center around two related themes. First, the essential rationale behind the rule is that the short sale restriction, if implemented, will bolster investor confidence. This claim is rooted in conjecture and is too speculative to form a properly cognizable basis for adopting the alternative uptick rule. Indeed, a more thorough analysis indicates that the rule amendments are just as likely, if not more so, to erode investor confidence instead of boosting it. Second, there is an insubstantial empirical basis to support the Commission in adopting the rule, especially in light of the rigorous economic analysis that led the SEC to repeal the “original” uptick rule in 2007 after years of study. The Commission bears the burden to justify its rules. It has not done so in this instance.
Rule 201 includes the following features:
Short Sale-Related Circuit Breaker: The circuit breaker would be triggered for a security any day in which the price declines by 10 percent or more from the prior day's closing price.
Duration of Price Test Restriction: Once the circuit breaker has been triggered, the alternative uptick rule would apply to short sale orders in that security for the remainder of the day as well as the following day.
Securities Covered by Price Test Restriction: The rule generally applies to all equity securities that are listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market.
Implementation: The rule requires trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale.
Tuesday, February 23, 2010
The SEC today charged two Sacramento-area men with misappropriating approximately $10 million from more than 100 investors who were falsely promised that their money would be loaned to homebuyers and secured by real estate deeds of trust. The SEC alleges that Lawrence “Lee” Loomis solicited investments in investment funds managed by his father-in-law John Hagener. Loomis told investors they were investing in safe “liquid high-yield accounts” that would earn 12 percent returns guaranteed by a third party. The SEC’s complaint alleges that Loomis and Hagener instead used the money primarily to prop up Loomis’ other failing businesses. The SEC further alleges that Loomis paid himself hundreds of thousands of dollars from companies that received investor money and Hagener received more than $190,000 for managing the funds even though he was misappropriating investors’ money to fund other businesses.
In its federal court action against Loomis, Hagener, Loomis Wealth Solutions, LLC (“LWS”), and Lismar Financial Services, LLC (“Lismar”), the SEC alleges Loomis, LWS, Hagener and Lismar violated Sections 5(a), (c), and 17(a) of the Securities Act of 1933 (“Securities Act”) and Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder. The SEC also alleges Hagener and Lismar violated Sections 206(1), 206(2), and 206(4) of the Advisers Act and rule 206(4)-8 thereunder, and, in the alternative, that Hagener aided and abetted LWS, Loomis and Lismar’s violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Lismar’s violations of Sections 206(1), 206(2), and 206(4) of the Advisers Act, and Rule 206(4)-8 thereunder. The SEC seeks injunctive relief, disgorgement of ill-gotten gains, and monetary penalties.
XBRL was a big enthusiasm of the prior SEC Chair, but I've not heard much about it recently until today. The SEC announces that its staff will conduct a public seminar next month to help companies and preparers comply with rules that require financial reports to be filed using eXtensible Business Reporting Language, (XBRL). The seminar will help answer frequently asked questions about the rules and technology requirements. The seminar will be held on March 23.
SEC Open Meeting Agenda, February 24, 2010
Item 1: Amendments to Regulation SHO
The Commission will consider whether to adopt amendments to Rules 201 and 200(g) of Regulation SHO relating to short sale restrictions.
Item 2: Commission Statement in Support of Convergence and Global Accounting Standards
The Commission will consider whether to publish a statement regarding its continued support for a single-set of high-quality globally accepted accounting standards and its ongoing consideration of incorporating International Financial Reporting Standards into the financial reporting system for U.S. issuers.
Monday, February 22, 2010
The SEC settled charges instituted against Salvatore F. Sodano, the former Chairman and CEO of the American Stock Exchange LLC. The Order finds that the Amex failed adequately to enforce certain order handling rules and to comply with its record keeping obligations. As the Amex's Chairman and Chief Executive Officer (CEO), Sodano was one of the individuals who had an obligation to enforce compliance during the relevant period by the Amex's members and associated persons with the Exchange Act, the Exchange Act rules and regulations, and the Amex's own rules. From at least 1999 through June 2004, the Amex had critical deficiencies in its surveillance, investigative, and enforcement programs for assuring compliance with its rules as well as the federal securities laws. These regulatory deficiencies resulted in part from Sodano's failure to take adequate steps to ensure that he and the Amex were meeting their regulatory obligations. As a result of the Amex's failure adequately to surveil for and investigate violations of, and to enforce, certain options order handling rules, the Amex violated Section 19(g) of the Exchange Act. The Order finds that Sodano, as CEO, without reasonable justification or excuse, failed to enforce compliance by Amex's members and associated persons with the Exchange Act, the Exchange Act rules and regulations, and the Amex's own rules, within the meaning of Section 19(h)(4) of the Exchange Act. No penalties or sanctions are imposed on Sodano.
The SEC's adoption of "notice and access" e-proxy rules has resulted in decreased voting by retail investors. With the NYSE's elimination of the rule that gave brokers the discretion to vote customers' shares in uncontested elections when the customers did not provide instructions, there is the additional concern that issuers may not have a quorum at annual meetings. In response, the SEC has launched several initiatives to increase voting by retail investors. The series of measures include amending the SEC’s e-proxy rules, issuing an Investor Alert, and creating new Internet resources that explain the proxy voting process in plain language.
To support shareholder participation in corporate elections and help educate investors about how the voting process works, the Commission has:
- Amended the SEC’s proxy rules to clarify and provide additional flexibility when companies and other persons are relying on the “e-proxy rules.” Those rules allow a notice to be sent to shareholders indicating that the proxy materials are online and available upon request, rather than requiring a full package of materials containing a proxy card, annual report and proxy statement be sent. The new rule amendments will, among other things, allow shareholders to be provided with additional materials explaining the e-proxy rules. The Commission issued an adopting release related to the amended rules.
- Published a new Investor Alert entitled New Shareholder Rules for the 2010 Proxy Season. The Alert provides investors with information related to the recent changes to broker voting rules and the impact of those new rules on proxy voting.
- Launched a new Spotlight page that provides investors with information on the mechanics of proxy voting, the e-proxy rules, corporate elections and proxy matters generally.
"While shaking its head," the Court (i.e., Judge Rakoff) approved the proposed consent judgment between the SEC and Bank of America settling the two enforcement actions, one of which was scheduled to begin trial on March 1. Finding that the settlement was "half-baked justice at best," nevertheless the judge felt constrained by the law's requiring the court to give substantial deference to the SEC as the regulatory agency having principal responsibility for policing the securities markets. Even more weighty in his view were considerations of judicial restraint:
We can balk when a bank tries to escape the implications of hiding material information from its shareholders, and we can protest when the regulatory agency in charge of deterring such misconduct seems content with modest and misdirected sanctions; be, in the words of a great former Justice of the Supreme Court, Harlan Fiske Stone, "the only check upon our own exercise of power is our own sense of self-restraint."
The opinion (Download SEC V BOA) is well worth reading in its entirety, but here are some specifics:
It is clear to the court that the BofA proxy statement failed adequately to disclose the Bank's agreement to let Merrill pay $5.8 billion in bonuses and also failed adequately to disclose the Bank's ever-increasing knowledge that Merrill was suffering historically great losses during the fourth quarter.
It is also obvious to the court that these failures to disclose were material.
What is not obvious is whether these material nondisclosures resulted from negligence or from more culpable conduct. Because the New York AG's complaint alleges the latter, the court was obliged to review deposition testimony provided by the AG to determine if the SEC's conclusions were unreasonable. Specifically, the court reviewed the testimony concerning the termination of BofA GC Mayopoulos' employment. While the SEC and the Bank assert his firing was done to move current CEO Brian Moynihan into the position, the New York AG alleges Mayopoulos was fired because he was pressing for more disclosure. The court, after its review, concludes that "none of the evidence directly contradicts the Bank's assertion that Mayopoulos' termination was unrelated to the nondisclosures or to his increasing knowlege of Merrill's losses." The judge, however, makes it clear that he is not making any determination as to which of the two competing versions of the events is the correct one.
As to the prophylactic measures designed to prevent nondisclosures in the future, the court finds that the remedial steps "should help foster a healthier attitude of 'when in doubt, disclose."
As to the $150 million penalty, the court continues to find it problematic. The amount is very modest, indeed "paltry." A bigger problem, and one that the judge emphasized in his disapproval of the first proposed settlement, is that payment of the penalty by the corporation means that innocent shareholders bear the loss caused by the managers, rather than those managers themselves. Because the distribution will be structured so that former Merrill shareholders who are now BofA shareholders will not receive a distribution, the effect serves as a renegotiation of the price paid to Merrill shareholders by the BofA shareholders. But the effect is "very modest."
Judge Rakoff signed off on the proposed settlement of the two enforcement actions brought by the SEC against Bank of America in connection with the BofA-Merrill merger. Here is the SEC's description of the settlement:
Under the terms of the proposed settlement, which are subject to approval by the Honorable Jed S. Rakoff, the $150 million penalty will be distributed to Bank of America shareholders harmed by the Bank’s alleged disclosure violations. The Commission will propose a distribution plan at a later date.
The proposed settlement requires Bank of America to implement and maintain seven remedial undertakings for a period of three years:
Retain an independent auditor to perform an audit of the Bank’s internal disclosure controls, similar to an audit of financial reporting controls currently required by the federal securities laws.
Have its Chief Executive and Chief Financial Officers certify that they have reviewed all annual and merger proxy statements.
Retain disclosure counsel who will report to, and advise, the Board’s Audit Committee on the Bank’s disclosures, including current and periodic filings and proxy statements.
Adopt a “super-independence” standard for all members of the Board’s Compensation Committee that prohibits them from accepting other compensation from the Bank.
Maintain a consultant to the Compensation Committee that would also meet super-independence criteria.
Provide shareholders with an annual non-binding “say on pay” with respect to executive compensation.
Implement and maintain incentive compensation principles and procedures and prominently publish them on Bank of America’s Web site.
The proposed settlement includes a Statement of Facts describing the details behind the allegations in the actions based on the discovery record.
According to the New York Times, Judge Rakoff approved the settlement without enthusiasm, describing it as "half-baked justice at best." NYT, Judge Accepts S.E.C.’s Deal With Bank of America.
Sunday, February 21, 2010
Bankers and Brokers and Bricks and Clicks: an Evaluation of FINRA’s Proposal to Modify the 'Bank Broker-Dealer Rule, by Jill Gross, Pace Law School, and Edward Pekarek, Pace Law School, was recently posted on SSRN. Here is the abstract:
This article evaluates the Financial Industry Regulatory Authority’s (FINRA) proposal to adopt a modified version of NASD Rule 2350, known as the “bank broker-dealer rule,” which, if approved by the SEC, would be designated as FINRA Rule 3160 within FINRA’s Consolidated Rulebook (the proposed rule change). The proposed rule change ostensibly seeks to prevent FINRA member firms, who offer broker-dealer products and services through contractual “networking arrangements” with financial institutions – both on and off the premises of those institutions – from undertaking certain business practices that might tend to confuse or harm financial institution customers. The proposed rule change also aims to prevent customer confusion by, inter alia, ensuring that certain disclosures are made to affected customers so they can understand and appreciate the distinction(s) between the financial institution’s products and services and those sold by the broker-dealer affiliate.
In a recent S.D.N.Y. opinion, UBS Securities, LLC v. Voegeli (Jan. 26, 2010), Judge Cote held that a lockup agreement between the underwriter for an issuer in an IPO and an investor in the issuer did not make the investor a "customer" under the FINRA Rules entitled to comepl arbitration of its claims. In deciding the case for the firm, the judge addressed several important issues: (1) subject matter jurisdiction, when a securities firm brings an action in federal court to enjoin a securities arbitration, (2) the test for granting an injunction against proceeding with a pending arbitration, (3) the definition of "customer" under FINRA Rule 12100(i). Judge Cote held:
(1) Since the investor alleges Rule 10b-5 violations in the underlying dispute, subject matter jurisdiction exists. (Complete diversity was lacking, so it was necessary to find federal subject matter jurisdiction.)
(2) Since the firm would suffer "irreparable harm" if required to arbitrate a non-arbitrable claim, injunctive relief was appropriate.
(3) The lockup agreement did not contain an arbitration agreement and did not make the investors UBS customers. "Customer" under FINRA Rule 12100(i) refers to one involved in a business relationship with a FINRA member that is related directly to investment or brokerage services. The investors' broad interpretation of the rule -- that anyone not a broker or a dealer is a customer -- is "absurd."