Securities Law Prof Blog

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

A Member of the Law Professor Blogs Network

Thursday, April 1, 2010

Court Dismisses ARS Class Action Against Merrill -- Again

Investment News reports that Merrill Lynch has succeeded, for the seventh time, in getting an investors class action relating to its sales of auction rate securities dismissed.  The Judge said that the firm had fully disclosed its activities in the bidding on the ARS.  Merrill Lynch has auction rate securities suit dismissed

April 1, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Daimler--SEC Settlement on FCPA Charges Announced

It has been already reported, but SEC today officially announced a settlement with Daimler AG for violations of the Foreign Corrupt Practices Act (FCPA).  The SEC alleged that the German automobile manufacturer engaged in a repeated and systematic practice of paying bribes to foreign government officials to secure business in Asia, Africa, Eastern Europe and the Middle East.  Daimler agreed to pay $91.4 million in disgorgement to settle the SEC's charges and pay $93.6 million in fines to settle charges in separate criminal proceedings announced today by the U.S. Department of Justice.

The SEC alleges that Daimler paid at least $56 million in improper payments over a period of more than 10 years. The payments involved more than 200 transactions in at least 22 countries. Daimler earned $1.9 billion in revenue and at least $90 million in illegal profits through these tainted sales transactions, which involved at least 6,300 commercial vehicles and 500 passenger cars. Daimler also paid kickbacks to Iraqi ministries in connection with direct and indirect sales of motor vehicles and spare parts under the United Nations Oil for Food Program.

According to the SEC's complaint, the bribery permeated several major business units and subsidiaries, was sanctioned by members of Daimler's management, and continued during the course of the SEC's investigation.

Without admitting or denying the SEC's allegations, Daimler has consented to the entry of a court order permanently enjoining it from future violations of Sections 30A, 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act. The court order also requires Daimler to comply with certain undertakings regarding its FCPA compliance program, including a provision that requires the company to retain an independent consultant for three years.

April 1, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Fires Scottrade for Violating Margin and Credit Rules

FINRA fined Scottrade, Inc. $200,000 for violating pattern day trading margin rules and for extending credit to customers in violation of federal securities laws and banking regulations.  FINRA determined that Scottrade allowed certain margin account customers who executed a high volume of trades to continue to trade after the value of their accounts fell below the minimum equity requirement.  FINRA rules require margin account customers who meet the definition of "pattern day traders" to maintain at least $25,000 in their margin accounts. A pattern day trader is generally defined as a customer who day trades four or more times in five business days

FINRA found that from February 2006 through October 2007, Scottrade did not properly restrict pattern day traders' trading activities when the value of those customers' accounts fell below the required $25,000. Instead, Scottrade sent first-time violators a written notice advising them to restore their account value to at least $25,000 before continuing trading.  But customers who failed to restore their account values were allowed to continue day trading without restrictions. Customers who violated this margin requirement after the first warning were sent a second written notice, giving them five additional business days to meet the $25,000 requirement. Scottrade did not take action to restrict those customers' margin until after the customers failed to heed the second notice.

In all, Scottrade permitted customers in 11,708 margin accounts in which pattern day trading was being conducted to execute 171,910 day trades when the values of their accounts were below the minimum equity requirement.

FINRA also found that from February 2006 through January 2007, Scottrade improperly extended credit to certain cash account customers by failing to obtain timely cash payment from the customers for their purchases and by failing to cancel or liquidate those transactions within the time period specified by Federal Reserve Regulation T.  When a customer did not have sufficient funds to cover the cost of the stock purchase in a cash account, Scottrade sent the customer a "sellout" letter on the date the funds were due. This had the effect of allowing the customer additional days to pay for the transactions, in violation of Regulation T.

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

April 1, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, March 31, 2010

Ponzi Schemer Who Targeted Haitian-American Community Ordered to Disgorge $5 Million

On March 26, 2010, the United States District Court for the Southern District of Florida entered a Final Judgment of Disgorgement, Prejudgment Interest and Civil Penalty against George L. Theodule. The Final Judgment orders Theodule, the engineer of a Ponzi scheme that targeted Haitan-American investors, to pay disgorgement in the amount of $5,099,512, prejudgment interest of $202,638 and imposes a civil penalty of $250,000. The disgorgement represents amounts Theodule personally received or funneled to friends and relatives from the fraudulent scheme.  The Complaint alleged violations of the antifraud provisions of the federal securities laws in connection with a Ponzi scheme through which the defendants raised at least $23.4 million from thousands of investors in the Haitian-American community nationwide.

March 31, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Takes Up Rules on Asset-Backed Securities at April 7 Meeting

The agenda for the SEC's April 7 Open Meeting is:

The Commission will consider whether to propose revisions to Regulation AB and other rules regarding the offering process, disclosure and reporting for asset-backed securities. The proposed amendments would revise the shelf offering process and eligibility criteria for asset-backed securities and require asset-backed issuers to provide enhanced disclosures including information regarding each asset in the underlying pool in a standardized, tagged format. The Commission will also consider proposed revisions to Securities Act Rule 144A and other rules for privately-placed asset-backed securities.

March 31, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

GAO Finds Continuing Deficiencies in SEC Internal Controls

The GAO released today another report, Management Report: Improvements Needed in SEC's Internal Controls and Accounting Procedures, on its audits over SEC's internal controls and found that previously identified deficiencies had not been corrected.  It also noted new problems.  The report sets forth a number of recommendations to cure these deficiencies.  In an attached letter, SEC Chair outlines improvements that are underway at the agency to correct the failings.

Specifically, the report states:

During our fiscal year 2009 audit of SEC’s controls over financial reporting, we identified six significant deficiencies:
• information security,
• financial reporting process,
• fund balance with Treasury,
• registrant deposits,
• budgetary resources, and
• risk assessment and monitoring processes.
These deficiencies collectively represented a material weakness in internal control. ...

We identified weaknesses in SEC’s information security controls over key financial reporting systems. Specifically, we found that SEC did not adequately:
• segregate computer-related duties and functions;
• restrict user privileges;
• implement patches and current software versions;
• use approved, secure means to transmit data;
• implement configuration management; and
• complete a certification and accreditation of its general ledger system and supporting processes during the fiscal year.
These control weaknesses jeopardize the confidentiality, availability, and integrity of automated information processed by SEC’s financial reporting systems, thereby increasing the risk of material misstatement in financial reporting and the risk of unauthorized modification or destruction of data.

March 31, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

GAO Finds Continuing Deficiencies in SEC Internal Controls

The GAO released today another report, Management Report: Improvements Needed in SEC's Internal Controls and Accounting Procedures, on its audits over SEC's internal controls and found that previously identified deficiencies had not been corrected.  It also noted new problems.  The report sets forth a number of recommendations to cure these deficiencies.  In an attached letter, SEC Chair outlines improvements that are underway at the agency to correct the failings.

Specifically, the report states:

During our fiscal year 2009 audit of SEC’s controls over financial reporting, we identified six significant deficiencies:
• information security,
• financial reporting process,
• fund balance with Treasury,
• registrant deposits,
• budgetary resources, and
• risk assessment and monitoring processes.
These deficiencies collectively represented a material weakness in internal control. ...

We identified weaknesses in SEC’s information security controls over key financial reporting systems. Specifically, we found that SEC did not adequately:
• segregate computer-related duties and functions;
• restrict user privileges;
• implement patches and current software versions;
• use approved, secure means to transmit data;
• implement configuration management; and
• complete a certification and accreditation of its general ledger system and supporting processes during the fiscal year.
These control weaknesses jeopardize the confidentiality, availability, and integrity of automated information processed by SEC’s financial reporting systems, thereby increasing the risk of material misstatement in financial reporting and the risk of unauthorized modification or destruction of data.

March 31, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, March 30, 2010

U.S. Supreme Court Hears Oral Argument in Morrison v. National Australia Bank

The U.S. Supreme Court heard oral argument yesterday in Morrison v. National Australia Bank(Download Morrison Transcript), the securities class action involving foreign plaintiffs that purchased shares of a foreign issuer abroad suing foreign defendants for Rule 10b-5 fraud.  The Second Circuit dismissed the plaintiffs' claim, relying on a balancing test developed by Judge Friendly over 30 years ago.

The difficulty that petitioners faced from the outset was that, as Justice Ginsburg expressed it, this case "has 'Australia' written all over it."  Petitioners' attorney argued that, to the contrary, this case has "'Florida' written all over it because Florida is where the numbers were doctored, Florida is where the fraudulent conduct in putting the phony assumptions into the valuation portfolio were done," but it does not appear (from my reading of the transcript) that the Justices were persuaded.  As several Justices noted, the communication of the doctored numbers took place in Australia, where the documents were prepared by the Australian bank.

The hard question put to respondents' attorney was suppose that Schmidt, a citizen of Germany, flies to New York and meets Jones in a New York hotel, where Jones persuades him that he owns the Brooklyn Bridge,  and Schmidt buys shares in Jones' company on the German exchange.  Should the U.S. courts not take jurisdiction over this dispute?  Petitioners' attorney appeared to waffle on this, but ultimately argued that any balancing test that would allow application of U.S. law would infringe the sovereign authority of other nations.  Judge Breyer wondered how it would hurt the interests of a foreign nation if the court asserted jurisdiction over a case that involved terribly bad conduct that took place in the U.S.

Finally, the United States argued as amicus curiae.  The government's position is driven by its concern that it would not be able to go against those who hatch a fraud in the U.S. that is directed against foreign investors -- e.g., boiler rooms operating here that target only foreign investors.  Thus, it argued for a distinction between government actions and private claims.  The Justices worried that sorting out significant from insignificant frauds, and domestic from overseas conduct, might not prove so easy. 

Finally, I'd like to applaud Professor Margaret V. Sachs (UGeorgia), whose groundbreaking scholarship in this area was repeatedly referenced by Justice Breyer, who took an active role in questioning all three attorneys.  Justice Breyer asked each attorney to square their positions with Professor Sachs'.  In 1990, Professor Sachs took on the "received wisdom" of Judge Friendly, who believed that Congress did not address the question of extraterritoriality in the 34 Act.  To the contrary, asserts Professor Sachs, Congress was aware, in 1934, of overseas securities markets, and Congress made a deliberate choice not to extend federal securities laws to overseas transactions.

March 30, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

U.S. Supreme Court Uphelds Gartenberg Standard; Sends Message of Judicial Deference to Mutual Fund Board's Fee Decisions

The U.S. Supreme Court decided Jones v, Harris Associates L.P. (Download Jones v. harris associates sup ct opinion) today and, in an unanimous decision (Justice Thomas wrote a brief concurrence), upheld the Gartenberg standard for determining excessive mutual fund fees under section 36(b) of the Investment Company Act of 1940.  This decision is not a surprise, since by the time of the oral argument no one was supporting the 7th Circuit's test -- that specifically disapproved the Gartenberg approach and replaced it with a "full disclosure and no tricks" approach.  Instead, both petitioners and respondents generally endorsed the Gartenberg standard, although they disagreed about its meaning and application.

The opinion, written by Justice Alito, does not provide much, if anything, that will be of assistance to shareholders in mutual funds that seek to challenge fees as breach of the investment adviser's fiduciary duty.  The Court adopts the Gartenberg standard, which the district court in this case had relied upon in dismissing petitioners' claims.  (Indeed, at least as of a few years ago, no shareholder has ever persuaded a court that mutual fund fees were excessive under the Gartenberg standard.)  Thus, plaintiff bears the burden of establishing that an investment adviser charged a fee "that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's length bargaining."  The Court then goes on to make clear that plaintiff's burden is considerable.  Thus, the judgment of the mutual fund's board is entitled to judicial deference.  The Court discounts the significance of comparisons between the fees that an adviser charges a captive mutual fund (high) and the fees that it charges its independent clients (lower), because there may be significant differences between the nature of the services provided.  Moreover, "[e]ven if the services provided and fees charged to an independent fund are relevant, courts should be mindful that the Act does not necessarily ensure fee parity between mutual funds and institutional clients contrary to petitioners' contentions."  By the same token, "courts should not rely too heavily" on comparisions with fees charged to mutual funds by other advisers; these comparisions may be "problematic" because they may not be the product of arm's length negotiations.

In addition, the U.S. Supreme Court sounds much like the Delaware Suprem Court in discussing the deference afforded to the mutual fund board's judgment.  It extols the value of independent directors; it rewards good process.  "Thus, if the disinterested directors considered the relevant factors, their decision to approve a particular fee agreement is entitled to considerable weight, even if a court might weigh the factors differently."  And to reinforce the point -- "It is also important to note that the standard for fiduciary breach under section 36(b) does not call for judicial second-guessing of informed board decisions."

Justice Thomas concurred because he was worried that by endorsing the Gartenbergy standard the Court might be misunderstood as "countenanc[ing] free-ranging judicial 'fairness' review of fees that Gartenberg could be read to authorize" even though lower courts, in fact, had not done so. 

Don't worry, Justice Thomas, we get it -- plaintiffs can't win 36(b) cases.  Gartenberg deference prevails.

March 30, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, March 29, 2010

Corp Fin Seeks Info on Repurchase Agreements

The SEC has posted on its website a sample letter that Corporation Finance sent this month to public companies asking for information related to repurchase agreements, securities lending transactions, or other transactions involving the transfer of financial assets with an obligation to repurchase the transferred assets.

March 29, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Unregistered Adviser in Ohio with Misappropriating Clients' Funds

The SEC today filed fraud charges against an unregistered investment adviser for misrepresenting the safety and nature of his investment strategy, and for misappropriating millions of dollars in funds from investors in California, Illinois, Ohio, Tennessee, and Washington.  According to the SEC's complaint, Enrique F. Villalba, Jr., of Cuyahoga Falls, Ohio, misappropriated approximately $6 million of client funds. The complaint alleges that Villalba touted an investment strategy he developed that he falsely claimed was conservative, relatively risk free and would preserve his clients' principal capital while still earning them returns of 8% to 12% annually. To substantiate the safety of his investment strategy, the complaint alleges that Villalba falsely claimed that he placed stop orders approximately 2% above or below the entry price of the investments. The complaint also alleges that Villalba further enticed prospective clients by assuring them their money would only be used for investments in securities, including S&P 500 Index contracts, treasury bills or interest earning money market accounts, and that his management fees would be limited to between 12% and 15% of the profits he generated on their behalf.

According to the SEC's complaint, from 1996 through June 2009, Villalba attracted over $39 million in client funds, and from 1998 through 2009, Villalba lost, through trading, over $17 million of his clients' money. The SEC's complaint also alleges that Villalba misappropriated client funds by (i) paying over $4.1 million for Villalba's management fees, salary and his company's overhead, (ii) purchasing over $700,000 in real property, (iii) investing over $1.2 million in two start-up coffee businesses Villalba owned, and (iv) making Ponzi-like payments. The complaint further alleges that Villalba, to hide his investment failures and his misappropriation of client funds, prepared and provided his clients with false quarterly accounts statements, which always showed that his clients' accounts had overall increased in value. The complaint also alleges that Villalba provided one investor with falsified brokerage statements using the letterhead of a brokerage firm.

March 29, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Treasury Announces Plan to Sell Citigroup Shares in 2010

The U.S. Department of the Treasury today announced its intention to fully dispose of its approximately 7.7 billion shares of Citigroup, Inc. common stock over the course of 2010 subject to market conditions. Treasury received these shares of common stock pursuant to the June 2009 Exchange Agreement between Treasury and Citigroup, which provided for the exchange into common shares of the preferred stock that Treasury purchased in connection with Citigroup's participation in the Capital Purchase Program. Treasury has engaged Morgan Stanley as its capital markets advisor in connection with its Citigroup position.

Treasury intends to sell its Citigroup common shares into the market through various means in an orderly and measured fashion. Treasury intends to initiate its disposition of the common shares pursuant to a pre-arranged written trading plan. The manner, amount and timing of the sales under the plan is dependent upon a number of factors.

This disposition does not affect Treasury's holdings of Citigroup trust preferred securities or warrants for its common stock.

March 29, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Treasury and White House Council Sponsor Women in Finance Symposium

Today, the U.S. Department of the Treasury, in partnership with The White House Council on Women and Girls, convened a Women in Finance Symposium in celebration of Women's History Month, bringing together senior officials from across the government's economic agencies, private sector leaders and women entering the field for a series of panel discussions to recognize the contributions of women and to discuss the best means to foster success among future generations of women in the finance sectors. 

Following opening remarks from Secretary Geithner and Treasurer Rosie Rios, the symposium featured a panel discussion – "Women Drivers of the Economic Recovery: Pathways to Success" – with Federal Deposit Insurance Corporation Chairman Sheila Bair, Securities and Exchange Commission Chairman Mary Schapiro, Council of Economic Advisors Chair Christina Romer, Small Business Administration Administrator Karen Mills and Congressional Oversight Panel Chair Elizabeth Warren and moderated by Maria Bartiromo of CNBC. A second panel, moderated by Liz Claman of Fox Business Network and designed to address the landscape and challenges for women in finance, included President of the American Council on Education Molly Broad, Senior U.S. Investment Strategist for Goldman Sachs Abby Joseph Cohen, Director in the Strategic Client Group of Morgan Stanley Carla Harris, CEO of Citi Personal Wealth Management Deborah McWhinney and President's Economic Recovery Advisory Board member Laura Tyson. The symposium's closing session featured White House Senior Advisor and Assistant to the President Valerie Jarrett. 

The proceedings can be viewed at Treasury's website.

March 29, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Sunday, March 28, 2010

Levitin on Bailouts

In Defense of Bailouts, by Adam J. Levitin,Georgetown University Law Center, was recently posted on SSRN.  Here is the abstract:

Systemic risk - the possibility that an individual firm’s failure will result in broad damages to the economy as a whole - is the epitome of financial crisis. Bailouts of troubled firms have long been the standard response to systemic risk. Yet, bailouts suffer from problems of political legitimacy.

Bankruptcy is often presented as more legitimate alternative to bailouts because its loss allocation system is preset and determined in the abstract. This Article argues that the choice between bailouts and bankruptcy is illusory. Bailouts and bankruptcy are not alternative choices, but an integrated system; any preset resolution system will be abandoned for a bailout if it would produce socially unacceptable loss allocations. Therefore, bailouts’ political legitimacy is critical.

Accordingly, the Article proposes a framework for analyzing bailouts’ legitimacy. It identifies and explores two fundamental questions involved in all bailouts. First, should bailouts be done ad hoc through Congress or should bailout authority be institutionalized in an agency? And second, should creditors of bailed out firms be forced to accept less than full payment (or take a “haircut”) as part of the bailout? Ensuring accountability and fairness in resolving these issues is essential for bailouts’ political legitimacy and ultimate efficacy.

March 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bai et alia on Securities Class Action Settlements

Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settelments on Targeted Firms, by Lynn Bai, University of Cincinnati - College of Law, James D. Cox, Duke University School of Law, and Randall S. Thomas, Vanderbilt University - School of Law, was recently posted on SSRN.  Here is the abstract:

Private suits have long been championed as a necessary mechanism not only to compensate investors for harms they suffer from financial frauds but also to enhance the deterrence of wrongdoing. But many critics have claimed that there a hidden dark side to the successful prosecution of a securities class action. In this paper, we shed light on these issues by examining whether the revelation of earlier misstatements, the initiation of private suit, and the payment of a substantial settlement, weaken the defendant firm so that the firm is permanently worse off as a consequence of the settlement.

We find that defendant firms that settle securities class actions experience no significant declines in sales opportunities as a result of the lawsuit and settlement, but do experience a reduced level of operating efficiency while the lawsuit was pending (but not after it is settled). Most significantly, we also observe that defendant firms experience liquidity problems post-settlement and worsening Altman Z-scores (and a greater propensity to file bankruptcy) during that time period as well. Beginning with the filing of the class action, firm share prices are punished to the extent that investor returns do not recover.

We conclude that there is something in our results for both sides of the debate regarding the effects of securities litigation. One side could point toward our findings as evidence that the litigation is not a zero sum game for wrongdoers where only the insurer pays. On the other hand, others would claim that settlements, if not the entire litigation process, are a menace because they drain funds from the corporation that could better be directed toward strengthening its financial position.

March 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Davidoff on SEC Regulation of Foreign Private Issuers

Rhetoric and Reality: A Historical Perspective on the SEC's Regulation of Foreign Private Issuers, by Steven M. Davidoff, University of Connecticut School of Law, was recently posted on SSRN.  Here is the abstract:

Rhetoric can drive reform. Watch-words like “mutual recognition” and “global competition” have masked a political economy story which has driven the SEC’s deregulation of foreign private issuers. While the substantive result may have been appropriate, the over-all SEC regulatory process did not produce a nuanced and holistic regulatory product. Instead, this process resulted in one-size fits all regulation for foreign private issuers. Filipino or Chinese issuers listed only in the United States are now regulated in equal measure as a U.K. issuer listed on the London Stock Exchange and New York Stock Exchange. This is despite the differing risk profiles and regulatory posture of these issuers. This essay's historical analysis highlights these issues as well as the difficulty of implementing more rigorous and insulating regulatory techniques such as cost-benefit analysis as rhetoric and the politics of regulation overwhelm such approaches. The relevance of this story is front and center as we face coming SEC regulatory reform in light of the financial crisis under new watch-words such as “investor protection”.

March 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Franco on Mutual Fund Disclosure

A Consumer Protection Approach to Mutual Fund Disclosure and the Limits of Simplification, by Joseph A. Franco, Suffolk University Law School, was recently posted on SSRN.  Here is the abstract:

The SEC’s recently adopted summary disclosure initiative for mutual funds improves disclosure for average investors by making fund disclosure more understandable and accessible, but it also reveals a fundamental defect in the SEC’s entire approach to policy in this area. The initiative–the latest in a series of fund disclosure initiatives stretching over a 30 year period–seeks to improve the quality of fund offering disclosure for average investors by embracing what the SEC has dubbed a “layered disclosure” approach. The key elements of this approach are: (i) funds may use a radically simplified and standardized offering document in lieu of a statutory prospectus; and (ii) investors obtain enhanced electronic access to a full range of more comprehensive fund disclosure documents. The goal is to reduce disclosure costs for funds and enable each investor to choose the level of disclosure detail that best suits his or her inclinations. While these changes will undoubtedly provide some benefits for average investors, it is doubtful that these refinements will produce dramatic improvements in the quality of investor’s investment decisions. This article instead advances an alternative approach toward fund disclosure policy that embraces a more assertive consumer protection orientation. This approach differs from the SEC’s in giving priority to strategies designed to improve the quality of average investors’ fund investment decisions rather than merely making disclosure more understandable. The assertive consumer protection approach advocated in this article seeks regulatory policies to change investor behavior by counteracting known behavioral biases of average investors (a policy goal sometimes knows as “debiasing”), including policies aimed directly at investor decision-making and other policies aimed at enhancing the utility of third parties who are in a position to influence investors (a form of structural debiasing). The article presents several concrete recommendations for implementing such an approach: (i) the SEC should impose tighter content restrictions on Internet sales literature and supplement existing content requirements for summary disclosure; (ii) the SEC should rethink its approach to layered disclosure (i.e., the current scheme that requires average investors to choose their desired level of disclosure detail) and instead move toward a scheme tailored to the distinct information needs of two different end-user constituencies: average investors and investment professionals; and (iii) the SEC should impose heightened procedural accountability standards for investment professionals to improve the advice received by clients regarding fund selection recommendations and to promote competition among funds based on investment merit.

March 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Fisch on Mutual Fund Regulation

Rethinking the Regulation of Securities Intermediaries, by Jill E. Fisch, University of Pennsylvania Law School, was recently posted on SSRN.  Here is the abstract:

This Article argues that existing regulation of mutual funds has serious shortcomings. In particular, the Investment Company Act, which is based primarily on principles of corporate governance and fiduciary duties, fails to support and, in some cases impedes, market forces. Existing evidence suggests that retail investing behavior and the dominance of sales agents with competing financial incentives further weakens market discipline.

As a solution, the Article proposes that funds should be treated primarily as financial products rather than corporations and, correspondingly, investors should be treated primarily as consumers rather than corporate shareholders. To implement this approach, the Article proposes the creation of a new federal agency that would develop standardized financial products coupled with corresponding disclosure principles. Sellers of retail products would be required either to conform their products to these standards or to explain material differences. The goal is to enhance market discipline while making retail funds less complicated and more understandable for individual investors.

March 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Griffin et alia on Regulation FD

Regulation Fair Disclosure: An Analysis of SEC Enforcement Actions, by Paul A. Griffin, University of California, Davis - Graduate School of Management, David H. Lont, University of Otago - Department of Accountancy, and Benjamin Segal, INSEAD - Accounting & Control Area, was recently posted on SSRN.  Here is the abstract:

This paper assesses the market impact of the enforcement cases brought by the SEC alleging a violation of Regulation Fair Disclosure (ten so far). Our analysis offers insight into the consequences of FD by estimating the market-adjusted losses suffered by public investors in the violation window and the change in company market value upon SEC announcement. In contrast to total penalties paid by companies or executives of $1.92 million, public investors lost more that $278 million in the violation window, calculated as the reverse of the market-adjusted gains to investors subject to FD (covered investors). We also find that an SEC action associates with an average market-adjusted price drop of 6.11 percent over announcement days -1 to 1. Public investors, therefore, suffer in two ways from an alleged FD violation: first from unfair gains to covered investors and, second, because an FD enforcement action hurts the market value of their shares.

We preface our analysis by discussing the literature on analysts’ and investors’ responses around FD adoption, and reason that this evidence, while varied, supports the view that most registrants disclose the same mix of information as before, despite an increase in conference calls and other disclosures. In contrast to the varied results on FD adoption, we do observe a clear market response to an FD disclosure, primarily on the day of filing, since most issuers file within the 24-hour rule. A significant number, however, miss the deadline. In these situations, our data show elevated trading and a market price response ahead of public disclosure. This suggests that public investors may suffer at the expense of covered investors in a third way, namely, when a registrant posts an untimely FD filing not subject to an enforcement action.

March 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)