Friday, April 30, 2010
This is what the debate over financial reform legislation has come down to: is an orthodontist a "significant financial player"? You decide -- read the statements by Richard Shelby and Chris Dodd on this critical issue.
Dodd: are you nuts?
FINRA announced that it intends to increase the number of arbitrators available for selection when parties pick arbitration panels, to 10 from the current eight, for each type of arbitrator on a three-member panel – public chair-qualified, public and non-public. Lists of available arbitrators for cases involving less than $100,000, which are heard by a single, chair-qualified public arbitrator, would also expand from eight to 10 names.
The proposed expansion, made in a recent rule filing with the Securities and Exchange Commission (SEC), is designed to increase the likelihood that all arbitrators appointed to a case will have been selected by the parties. A frequent complaint of both claimants' and respondents' attorneys is that the lack of mutually agreeable names means that FINRA ends up filling the panel through random selection. In those instances, the arbitrator can be striken only for cause.
While the proposed change would increase the number of arbitrators on each list by two, the number of available strikes would remain at four per party. If the SEC approves the new procedure, it would ensure that at least two proposed arbitrators will remain on each list of 10 potential arbitrators – thus significantly increasing the likelihood that the parties will get panelists they chose and rank, as opposed to extended list appointments. It would also reduce the need for extended list appointments when vacancies occur in a panel later in a case.
Thursday, April 29, 2010
On April 28, 2010, the SEC brought another FCPA complaint, this time charging four former employees of Dimon, Inc., now Alliance One International, Inc. All four defendants agreed to settle the Commission's charges against them. According to the complaint, during the period 1996 through 2004, Dimon's subsidiary in Kyrgyzstan paid more than $3 million in bribes to various Kyrgyzstan government officials to purchase Kyrgyz tobacco for resale to Dimon's largest customers. In addition, the Commission's complaint alleges that, from 2000 to 2003, Dimon paid bribes of approximately $542,590 to government officials of the Thailand Tobacco Monopoly in exchange for obtaining approximately $9.4 million in sales contracts.
Without admitting or denying the allegations in the Commission's complaint, defendants Elkin, Myers, Reynolds, and Williams consented to the entry of final judgments permanently enjoining each of them from violating the anti-bribery provisions of the FCPA, codified as Section 30A of the Securities Exchange Act of 1934 ("Exchange Act"), and aiding and abetting violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. Defendants Myers and Reynolds also agreed to pay civil monetary penalties of $40,000 each. The settlement with defendant Elkin takes into account his cooperation with the Commission's investigation.
FINRA announced today that it has permanently barred Tod Bretton, former Chief Compliance Officer and Head Trader for Prestige Financial, Inc., of New York, for engaging in a fraudulent trading scheme that generated approximately $1.3 million in profits for him and his firm at the expense of customers by subjecting their orders to improper and undisclosed additional charges. To conceal the scheme, Bretton falsified order tickets and created inaccurate trade confirmations. Bretton also failed to cooperate with FINRA's investigation.
FINRA found that, from at least September 2006 through June 2009, Bretton, working from the firm's New York office, engaged in a fraudulent trading scheme in which he took advantage of customers placing large orders (generally 1,000 shares or more) to buy or sell stocks. Rather than effecting the trades in the customers' accounts, FINRA found, Bretton first placed the orders in a firm proprietary account. He would then increase the price per share for securities purchased by approximately $.02 to $.05 above the market price before allocating the shares to the customers' accounts. Similarly, he would decrease the price per share for securities sold by approximately $.02 to $.05 below the market price before allocating the proceeds to the customers' accounts. This improper price change was not disclosed to or authorized by the customers. Bretton's trading scheme generated approximately $1.3 million in profits for the proprietary accounts, in which he had a 33 percent interest. Bretton personally earned approximately $429,000 from this scheme.
In settling this matter, Bretton neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
Wednesday, April 28, 2010
In Pacific Investment Management Co. v. Mayer Brown (2d Cir. Apr. 27, 2010)(Download MayerBrownopinion), the Second Circuit affirms the district court's dismissal of investors' complaint against the law firm Mayer Brown and its partner Joseph Collins for their role in the securities fraud committed by Refco Inc. The Court holds that a secondary actor (defined as parties who are not employed by the issuer whose securities are the subject of allegations of fraud) can be held liable in private Rule 10b-5 damages actions only for false statements attributed to the secondary actor at the time of dissemination. Absent attribution, plaintiffs cannot establish that they relied on the defendants' own false statements, and the secondary actors' participation in the creation of the false statements amounts to, at best, aiding and abetting securities fraud. The Court rejects the plaintiff's argument (supported in an SEC amicus brief) in favor of a creator standard as inconsistent with Supreme Court precedent (Central Bank, Stoneridge) and the Second Circuit's "bright line" test adopted in Wright v. Ernst & Young (2d Cir. 1998), which held that an outside accountant could not be held liable for public statements not attributed to it.
The Court acknowledges the confusion in the Circuit created by Wright and its later decision in In re Scholastic Corp. Securities Litigation (2d Cir. 2001), where it held that a corporate officer could be liable for misrepresentations made by the corporation, even though none of the statements was specifically attributable to him. That opinion did not cite Wright and led to confusion about whether Wright's attribution standard was relaxed. However, in 2007, the Second Circuit applied the attribution standard again in a case involving an outside accounting firm in Lattanzio v. Deloitte & Touche. While emphasizing the Wright attribution standard and rejecting the creator standard, the Second Circuit does not entirely clear up the confusion. While its definition of secondary actors to exclude the issuer's employees would logically point to reconciling Wright/Lattanzio and Scholastic on this basis, the Court explicitly declines to do so: "because this appeal does not involve claims against corporate insiders, we intimate no view on whether attribution is required for such claims or whether Scholastic can be meaningfully distinguished from Wright and Lattanzio."
The Court also affirms the district court in rejecting plaintiffs' alternative argument based on "scheme liability" because Stoneridge foreclosed this theory. The Court does acknowledge that after Stoneridge it is "somewhat unclear" how the deceptive conduct of a secondary actor could be communicated to the public and yet remain "deceptive," but it nevertheless finds it clear after Stoneridge that the "mere fact that the ultimate result of a secondary actor's deceptive course of conduct is communicated to the public through a company's financial statements is insufficient to show reliance on the secondary actor's own deceptive conduct."
After Stoneridge, some have argued that the Supreme Court's opinion should not be read as foreclosing the "scheme liability" theory where the secondary actors play a role that is more closely connected to the securities or capital-raising process, such as those professionals who advise securities issuers, in contrast to the suppliers named as defendants in Stoneridge. I always thought that argument to be wishful thinking, and at least in the Second Circuit, it will not fly.
Tuesday, April 27, 2010
I personally am skeptical about the value of financial literacy websites, but the Treasury Dept. has announced the launch of its redesigned financial literacy education website, www.MyMoney.gov. Treasury says the new site has "enhanced interactive features and utility to provide more resources to Americans seeking information that can inform their personal financial decisions."
On April 23, 2010, a federal district court jury found Carl W. Jasper, former Chief Financial Officer of Maxim Integrated Products, liable for securities fraud and other charges in connection with a scheme to backdate stock option grants to company personnel. Following an eight-day trial in U.S. District Court in San Jose, Calif., the eight-member jury found Jasper liable for, among other violations, fraud, lying to auditors, and aiding Maxim's failure to maintain accurate books and records. The jury found for Jasper on certain remaining claims, including proxy rule violations. The Judge will determine remedies and sanctions at a later date. The SEC's complaint seeks, among other things, disgorgement and repayment of bonuses, monetary penalties, and a bar from serving as an officer or director of a public company.
According to the SEC, evidence introduced at trial established that Maxim, with Jasper's knowledge, routinely granted stock options by using hindsight to identify dates with historically low stock prices. Jasper's staff then drafted false documents to make it appear that the options had been granted on the earlier date. This practice allowed Maxim to conceal hundreds of millions of dollars in expenses that it was required to report in its SEC filings. The evidence further showed that Jasper, with awareness of the backdating practices, repeatedly signed and certified Maxim's false quarterly and annual reports provided to the investing public.
The SEC previously settled its charges against Maxim and former CEO John Gifford, with Gifford (since deceased) paying over $800,000 in disgorgement, interest and penalties.
Both FINRA and the SEC announced enforcement actions against broker-dealers involving sales of unregistered penny stocks by their customers, although there is no indication in the releases that they are related.
FINRA fined five broker-dealers a total of $385,000 for the illegal sale of more than 8 billion shares of penny stock on behalf of their customers. Most of those illegal sales involved one penny stock company, Universal Express Inc. Together, the five firms sold more than 7.5 billion shares of that company's unregistered stock, for proceeds of approximately $8.4 million. The firms failed to take appropriate steps to determine whether the securities could be sold without violating federal registration requirements – despite certain red flags indicating that illegal stock distributions might be taking place, including a major enforcement action by the Securities and Exchange Commission (SEC) involving Universal Express's unregistered stock.
The firms are Fagenson & Co., Inc., of New York, which reported earning $44,000 in commissions from the sale of unregistered Universal Express stock and was fined $165,000; RBC Capital Markets Corporation, of New York, which earned $68,000 in commissions and was fined $135,000; Alpine Securities Corporation, of Salt Lake City, which earned $47,000 in commissions and was fined $40,000; Equity Station, Inc., of Boca Raton, which earned $13,575 in commissions and was fined $25,000; and, Olympus Securities, LLC., of Montville, NJ, which earned $5,200 in commissions and was fined $20,000. In settling these matters, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
The SEC announced administrative proceedings against five securities professionals accused of facilitating unlawful sales of penny stocks to investors and failing to act as "gatekeepers" as required under the federal securities laws. The SEC's Division of Enforcement alleges that three registered representatives and two supervisors at Leeb Brokerage Services allowed customers to routinely deliver large blocks of privately obtained shares of penny stocks into their accounts at the firm. The customers would then sell them to the public in transactions that were not registered with the SEC under the securities laws. The accused securities professionals allowed these sales without sufficiently investigating whether they were facilitating illegal underwriting, and they also caused the firm's failure to file Suspicious Activity Reports (SARs) as required under the Bank Secrecy Act to report potential misconduct by their customers. A hearing will be scheduled before an administrative law judge to determine whether the accused individuals committed the alleged violations and provide them an opportunity to defend the allegations. The hearing also will determine what sanctions, if any, are appropriate in the public interest.
I'm missing the theater that's going on at the Senate, as Senators take delight at expressing umbrage at Goldman Sachs banker for "shorting the residential housing market," which has become the current dirty phrase. Far be it for me to defend Goldman -- they pay too many lawyers, lobbyists, and consultants to need my help in that regard -- but I'm tired about the phony outrage from Congressional leaders who actively participated in the deregulation of the financial markets. The Committee's website has all the information you need about the hearings -- a live feed and plenty of documents, including 900 pages of exhibits (those stupid emails we've seen quoted in the press) and written testimony.
Fabrice Tourre (who, you will recall, is the only individual defendant in the SEC's enforcement action) testified earlier today. In his written statement ( Download STMTTOURREFabrice), he emphasized that the two investors in the ABACUS 07 AC-1 deal were two of the most sophisticated investors in the world and he never lied to them. In fact, he recalls informing one of the investors that Paulson's fund was expected to buy credit protection on some of the tranches of the transaction. If they were confused, they could have asked questions. ACA selected the portfolio of securities, and not Paulson. Finally, the transaction was not designed to fail.
The star of the show, of course, will be Goldman's CEO, Lloyd Blankfein, who is the last scheduled speaker today. In his succinct written statement(Download STMTBLANKFEINLloyd), which is long on generalities and short on specifics, he expresses gratitude for the government's investment (fully paid off with 23% annualized return for taxpayers, he notes), and states that "while we strongly disagree with the SEC's complaint, I also recognize how such a complicated transaction may look to many people." He emphasized that Goldman did not have a "massive" short against the housing market and "we certainly didn't bet against our clients. Rather, we believe that we managed our risk as our shareholders and our regulators would expect."
Merck Majority Says Actual or Constructive Knowledge Required to Start Limitations Period for Securities Fraud
Today, in Merck & Co., Inc. v. Reynolds(Download Merckopinion), a majority of the Justices held that the statute of limitations for securities fraud begins to run once the plaintiff actually discovered, or a reasonably diligent plaintiff would have discovered, the "facts constituting the violation" -- whichever comes first. This is contrary to the language of the statute, which states that the two-year period begins "after discovery of the facts constituting the violation" (with an outside limit of five years after the violation), as Justices Scalia and Thomas note in a concurrence. (Justice Stevens also concurred because he saw no need, in the facts of this case, to focus on the difference between actual and constructive knowledge.) While I can't explain why the majority felt the need, through some rather convoluted analysis, to include a constructive knowledge alternative to cut off a plaintiff's time for filing a complaint, at least I take comfort that the court did not adopt the anti-plaintiff "inquiry notice" standard argued by Merck. As the majority notes, the statute's knowledge standard cannot be stretched to include inquiry notice.
The majority does strongly refute two of Merck's arguments: first, that the statute does not require "discovery" of scienter-related facts, and, second, that even if "discovery" requires scienter-related facts, facts that tend to show a materially false or misleading statement (or material omission) are sufficient to show scienter as well. Both these arguments are counter to the scienter requirement of Rule 10b-5, not only the necessity of plaintiff's proving a wrongful intent but also meeting the hightened pleading requirement of PSLRA. How could plaintiff's statute of limitations begin to run when it had insufficient knowledge to file a complaint that would withstand a motion to dismiss? Only the most plaintiff-unfriendly court could so hold (as some did). But the majority reminds the defendant (just as courts frequently remind plaintiffs in granting defendants motions to dismiss) that the fact that an earnings statement is false does not neccessary mean that the defendants have lied; the misstatement may be the product of negligence.
Will the interpretation of "knowledge" to include constructive knowledge -- i.e., when a reasonably diligent plaintiff plaintiff would have discovered the facts constituting the violation -- make a meaningful difference in any significant number of cases? I don't know, but it is unfortunate that defendants are given a greater opportunity to argue that the complaint is timely, given the statute's plain meaning and the many advantages defendants currently have to get a complaint dismissed for failure to plead fraud with the requisite specificity. I fear this will give district courts freedom to find complaints untimely based on some Platonic notion of what an idealized "reasonably diligent" investor would do.
Monday, April 26, 2010
Tomorrow the Senate's Permanent Subcommittee on Investigations, chaired by Senator Carl Levin, will hold another hearing on the causes of the financial crisis. This one focuses on The Role of Investment Banks, and every single witness will be from Goldman Sachs. Interest will center on two speakers, Fabrice Tourre, the only individual defendant in the SEC's enforcement action, and Lloyd Blankfein, the CEO.
Last week Goldman posted on its website a 12-page document, Goldman Sachs: Risk Management and the Residential Mortgage Market, in order to, as it said, to put the matter in context. According to Goldman, it "did not engage in some type of massive 'bet' against our clients," it "maintained appropriately high standards with regard to client selection, suitability and disclosure as a market maker and underwriter," and "never created mortgage-related products that were designed to fail."
The hearing should be interesting.
The U.S. Department of the Treasury today announced the next steps in its plan to sell approximately 7.7 billion shares of Citigroup common stock. Citigroup filed a prospectus supplement with the SEC covering Treasury's sale of this common stock. Treasury will begin selling its common shares in the market in an orderly fashion under a pre-arranged written trading plan with Morgan Stanley, Treasury's sales agent. Initially, Treasury will provide Morgan Stanley with discretionary authority to sell up to 1.5 billion shares under certain parameters. Treasury expects to provide Morgan Stanley with authority to sell additional shares after this initial amount.
Treasury received the shares of common stock last summer as part of the exchange offers conducted by Citigroup to strengthen its capital base. Treasury exchanged the $25 billion in preferred stock it received in connection with Citigroup's participation in the Capital Purchase Program for common shares at a price of $3.25 per common share. These sales do not cover Treasury's holdings of Citigroup trust preferred securities or warrants for its common stock, which will be disposed of separately.
Treasury required Morgan Stanley to provide opportunities for participation by small broker-dealers, including minority- or women-owned broker-dealers.
Thursday, April 22, 2010
Since Sarbanes-Oxley gave the SEC the authority to distribute civil penalties to investors harmed by a corporation's fraud (the "Fair Fund" provision), the GAO has issued a number of reports and a series of recommendations on improving the collection and disbursement of these funds. It just issued another such report -- Securities and Exchange Commission: Information on Fair Fund Collections and Distributions. Here's its summary conclusion:
Since 2007, fewer Fair Funds have been established and the collection and distribution of Fair Funds have increased, but many Fair Funds continue to remain open and active for years. From 2002 through February 2010, $9.5 billion in Fair Funds were ordered, with the majority of this total ordered prior to May 2007. Since that date, only $521 million, or less than 6 percent, of total Fair Funds have been ordered. Of the $9.5 billion total Fair Funds ordered, $9.1 billion (96 percent) has been collected and $6.9 billion (76 percent) of the Funds collected has been distributed. In comparison, in 2007, only 21 percent of Fair Funds had been distributed. Although the percentage of Fair Funds distributed has increased, there are many Fair Funds that remain open and active for years. For example, our analysis of SEC data shows that of the 128 ongoing Fair Fund cases, over half have been ongoing for more than 4 years. SEC officials offered several reasons why Fair Funds remain open, including difficulties in obtaining investor information and legal objections and appeals that must be settled. To improve its management of Fair Fund cases, SEC proposed a performance metric of tracking the number of cases that have completed distribution within 2 years of the appointment of a Fund administrator. However, to date, SEC has not started collecting the data in a manner necessary to track this measure.
SEC has taken steps to increase efficiency and assess Fair Fund distribution, but a number of actions that are necessary to improve tracking of distribution related information are still pending. In response to our recommendations, SEC centralized the administration of collections and distributions under OCD and subsequently eliminated the dual reporting structure that initially existed in this new office. According to SEC, the creation of OCD has allowed the opportunity to build institutional knowledge and decreased inefficiencies by developing key administrative aspects of the program. SEC officials also told us that they have implemented other operational and administrative changes that are designed to improve Fair Fund distribution. For example, SEC established a working group to share information and to coordinate between functions on distribution plans and to identify problems that may slow distribution. However, SEC officials acknowledged that Fair Fund information and data tracking still need improvement. SEC officials said they have not implemented any major improvements to Fair Fund-related data management since 2007 and that additional improvements are needed in recording and monitoring of Fair Fund data. For instance, Fair Fund data are housed in several different databases that have not been reconciled and aggregate information on Fair Fund administrative expenses is unavailable. According to SEC officials, an extensive review of the Fair Fund program is under way, the findings of which may result in changes to workflow, procedures, and information systems. While SEC is taking steps to better capture, report, and manage the programmatic and financial impact of the collections and distribution process, it is too early to determine the impact and ultimate success of these efforts.
The GAO released a report entitled Clearer Goals and Reporting Requirements Could Enhance Efforts by CFTC and SEC to Harmonize Their Regulatory Approaches. Perhaps that title says it all, but here is the GAO's summary:
The conference report accompanying the Consolidated Appropriations Act of 2010 directed GAO to assess the joint report of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) on harmonization of their regulatory approaches. In October 2009, CFTC and SEC issued this report in response to the Department of the Treasury’s recommendation that the two agencies assess conflicts in their rules and statutes with respect to similar financial instruments. GAO’s objectives were to review (1) how CFTC and SEC identified and assessed harmonization opportunities, (2) the agencies’ progress toward implementing the joint report’s recommendations, and (3) additional steps the agencies could take to reduce inconsistencies and overlap in their oversight.
To meet these objectives, GAO reviewed the joint report and related documentation, interviewed agency officials, and obtained and analyzed written comments on the report from market participants.
What GAO Recommends
GAO recommends that CFTC and SEC establish clearer goals for harmonization, including time frames for implementing the joint report’s recommendations, and develop requirements for reporting and evaluating progress toward these goals. CFTC and SEC generally agreed with our conclusions and concurred with our recommendation
The White House released the transcript of President Obama's speech on financial reform in New York City today. In it the President set forth his vision of financial reform -- what he described as "a set of updated, commonsense rules to ensure accountability on Wall St. and to protect consumers in our financial system:"
- A way to protect the financial system and the broader economy in the event a large financial firm begins to fail, without taxpayer cost
- The Volcker rule, i.e., place limits on the size of banks and the kinds of risks they can take
- Transparency and regulation in the trading of derivatives
- A dedicated agency looking out for ordinary people in our financial system and providing them with clear and concise information about financial decisions
- More power to shareholders -- say on pay, SEC authority to give shareholders more say in corporate elections
The President also urged an end to "cynical politics" and for the industry to work with the administration on reforms.
The SEC charged Detroit-based Onyx Capital Advisors LLC and its founder Roy Dixon, Jr. with participating in a fraudulent scheme through which they stole more than $3 million invested by three Detroit-area public pension funds. The SEC alleges that defendants raised $23.8 million from the three pension funds for a start-up private equity fund created to invest in small and medium-sized private companies. Dixon illegally withdrew money invested by the pension funds from the bank accounts of the private equity fund. Assisting in the scheme was Dixon’s friend Michael A. Farr, who controls three companies in which the Onyx fund invested millions of dollars. Farr diverted money invested in these entities to another company he owned, withdrew the money from that bank account, and gave the cash to Dixon. Farr also kept some money for himself, and used investor funds to make payments to contractors building a multi-million dollar house for Dixon, who lives primarily in Atlanta.
The SEC’s complaint, filed in federal district court in Detroit, also alleges that Dixon and Onyx Capital made a number of false and misleading statements to defraud the three pension funds about the private equity fund and the investments they were making. According to the SEC’s complaint, shortly after the three pension funds made their first contributions to the Onyx fund in early 2007, Dixon and Onyx Capital began illegally siphoning money. Dixon and Onyx Capital took more than $2.06 million under the guise of management fees, and Farr assisted in diverting approximately $1.05 million through the Onyx fund’s purported investments in companies Farr controlled. Dixon used the money to pay personal and business expenses, including construction of his house in Atlanta and mortgage payments on more than 40 rental properties Dixon owns in Detroit and Pontiac, Mich.
The SEC is seeking a court order for emergency relief, including temporary restraining orders, asset freezes and accountings. The complaint seeks permanent injunctions, disgorgement of ill-gotten gains and financial penalties.
FINRA settled charges with two additional firms relating to the sale of auction rate securities (ARS) that became illiquid when auctions froze in February 2008 – HSBC Securities (USA) and US Bancorp Investments, Inc. To date, FINRA has concluded ARS-related settlements with 14 firms, imposing a total of nearly $5 million in fines. Firms that have reached settlements with FINRA have returned more than $2 billion to investors. Investigations continue at a number of additional firms.
HSBC, which was fined $1.5 million, had by July 2008 repurchased more than 90 percent of its then current customers' ARS holdings and in October 2008 it offered to repurchase all of the remaining ARS held in those customers' HSBC accounts. In total, HSBC repurchased more than $562 million of ARS held by its customers. As part of the settlement announced today, HSBC has agreed to offer to repurchase additional ARS sold to certain customers who transferred accounts before its previous buy-backs and to customers who chose not to participate in its prior offers.
US Bancorp Investments, which was fined $275,000, has already completed a repurchase of more than $150 million of ARS held in customer accounts.
Wednesday, April 21, 2010
The Senate Agriculture Committee voted 13-8 to approve a bill that would require tough regulation of the derivatives market. Charles Grassley was the lone Republican to vote in favor of the bill. The bill would require most derivatives to be traded on a public exchange and cleared through a third party. It would also require big banks to put their derivatives trading operation in a separate subsidiary.