Securities Law Prof Blog

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

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Friday, April 9, 2010

Massachusetts Charges Merrill with Violating Rule 144A in Sales of ARS

The Massachusetts securities regulators charged Merrill Lynch with improperly selling unregistered auction rate securities to two cooperative banks that did not qualify as "Qualified Institutional Buyers" under SEC Rule 144A.  The complaint alleges that the firm did not follow its own procedures for determining if the banks were qualified, and the banks are now left with illiquid investments that they never should have been sold.  Secretary Galvin Charges Merrill Lynch with Improper Sale of Unregistered Auction Rate Securities to Banks

April 9, 2010 | Permalink | Comments (0) | TrackBack (0)

The D.C. Circuit's Anti-Regulation Attitude

Steven Pearlstein, of The Washington Post, has an excellent column today on the D.C. Circuit's anti-regulation attitude as reflected in its frequent vacating of agency rules on questionable grounds.  Regulatory failure? Blame the D.C. Circuit.  Other recent examples include Fin. Planning Ass'n v. SEC, 482 F.3d 481 (D.C. Cir. 2007) (vacating the SEC's rule excluding broker-dealers that charged asset-based fees from definition of investment adviser if certain conditions met) and Amer. Equity Life Ins. Co. v. SEC, 572 F.3d 933 (D.C. Cir. 2009) (holding that SEC failed to consider adequately effect on competition of rule that state fixed indexed annuities were securities).

April 9, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Thursday, April 8, 2010

Prince and Rubin Testify at Financial Crisis Inquiry Commission Hearing

Today Charles Prince, former Citigroup CEO, and Robert Rubin, former chair of the executive committee, testified before the Financial Crisis Inquiry Commission.  According to the account in the New York Times, they took contrasting strategies in their testimony.  Prince repeatedly apologized and appeared "dignified, sympathetic and even statesmanlike."  In contrast, Rubin downplayed his involvement and appeared "drawn and demoralized."  NYTimes, Panel Criticizes Oversight of Citi by 2 Executives.

See the FCIC website for full coverage.

April 8, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Financial Crisis Inquiry Commission Hears from Greenspan

The Financial Crisis Inquiry Commission is holding hearings this week, and Alan Greenspan defended his actions in the face of aggressive questioning from the panel, including Brooksley Born, former CFTC Chair whose warnings about unregulated OTC derivatives went unheeded.  According to Greenspan, there's no point in second-guessing past decisions, and in his 21 years of service, he was right 70% of the time. WPost, Greenspan defends decisions before panel investigating crisis.

The Commission's website has live coverage, as well as videos and written statements, if you can stand it.

April 8, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

At its next Open Meeting, April 14, the SEC will consider:

Item 1: The Commission will consider whether to propose a large trader reporting requirement, pursuant to Section 13(h) of the Securities Exchange Act of 1934, which would require large traders to identify themselves to the Commission and require broker-dealers to maintain certain related transaction records.

Item 2: The Commission will consider whether to propose rule amendments regarding (a) prohibiting unfairly discriminatory terms that inhibit efficient access to quotations in a listed option on exchanges, and (b) placing limits on fees for the execution of an order against any quotation in an options series that is the best bid or best offer of an exchange.

April 8, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Proposes New Rules for Asset-Backed Securities

The SEC has proposed significant revisions to the rules regarding the offering process, disclosure and reporting for asset-backed securities. The proposal would: 

  • revise filing deadlines for ABS offerings to provide investors with more time to consider transaction-specific information, including information about the pool assets.
  • repeal the current credit ratings references in shelf eligibility criteria for asset-backed issuers and establish new shelf eligibility criteria that would include, among other things, a requirement that the sponsor retain a portion of each tranche of the securities that are sold and a requirement that the issuer undertake to file Exchange Act reports on an ongoing basis so long as its public securities are outstanding.
  • require that, with some exceptions, prospectuses for public offerings of asset-backed securities and ongoing Exchange Act reports contain specified asset-level information about each of the assets in the pool. The asset-level information would be provided according to proposed standards and in a tagged data format using eXtensible Markup Language (XML).
  • require, along with the prospectus filing, the filing of a computer program of the contractual cash flow provisions expressed as downloadable source code in Python, a commonly used open source interpretive programming language.

The SEC is also proposing new information requirements for the safe harbors for exempt offerings and resales of asset-backed securities.

April 8, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA, SEC and State Regulators Charge Morgan Keegan with Misleading Investors about Bond Funds

FINRA, SEC and NASAA all announced the initiation of proceedings against Morgan Keegan for misleading investors about bond funds that were heavily invested in subprime mortgages.  FINRA filed a complaint against Morgan Keegan & Company, Inc., charging the firm with marketing and selling seven affiliated bond funds to investors using false and misleading sales materials – costing investors well over $1 billion. In addition to an unspecified fine, FINRA is seeking disgorgement of all ill-gotten profits and full restitution for affected investors.  According to the FINRA release, from Jan. 1, 2006, through Dec. 31, 2007, Morgan Keegan sold over $2 billion of the bond funds. The funds were invested heavily in risky structured products – particularly, subordinated tranches of asset- and mortgage-backed securities, including sub-prime products. Those investments caused the funds to experience serious financial difficulties beginning in early 2007 and led to their collapse later that year.

 The Securities and Exchange Commission announced administrative proceedings against Morgan Keegan & Company and Morgan Asset Management and two employees accused of fraudulently overstating the value of securities backed by subprime mortgages.  In addition, securities regulators in Alabama, Kentucky, Mississippi and South Carolina announced that they are jointly filing an administrative action as the result of a multistate investigation of Morgan Keegan & Co. Inc. At the center of the investigation were six bond mutual funds sold by Morgan Keegan broker dealers to approximately 13,000 customers. Those six bond mutual funds lost approximately $2 billion dollars from March 31, 2007 to March 31, 2008.

April 8, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, April 6, 2010

How is the SEC's Reform of Enforcement Division Going?

FINRA Fines Citigroup Because of Stock Borrow Program Violations

 In its first enforcement action involving a broker-dealer stock borrow program, the Financial Industry Regulatory Authority (FINRA) announced today that it has fined Citigroup Global Markets, Inc. $650,000 for disclosure and supervisory violations relating to the operation of its Direct Borrow Program (DBP).  FINRA's investigation found that between Jan. 1, 2005, and Nov. 30, 2008, Citigroup's DBP borrowed fully paid hard-to-borrow securities owned by the firm's customers, who were in large part retail customers. The borrowed securities went into a pool of securities used, among other things, to facilitate Citigroup's clients' short-selling strategies. The DBP arranged for more than 4,000 loans involving more than 770 different securities borrowed from more than 2,300 customers. The average annual value of outstanding loans from customers was approximately $301 million.

 FINRA found that Citigroup failed to disclose adequately certain material information to customers participating in the DBP, including that the securities were hard-to-borrow; that the interest rates could be reduced by the firm; that the brokers received commissions for the duration of the loan; that while the securities were on loan, dividends were paid as "cash-in-lieu" of dividends and were therefore subject to higher tax rates; and, that shares on loan could be sold by the customers at any time.

In addition, FINRA found that the DBP operated without a system or procedures specifically designed to supervise the activities of the DBP staff and the firm's brokers and to adequately monitor the accounts of customers who participated in the DBP.

 FINRA also found that Citigroup distributed three versions of marketing materials to the public regarding the DBP that were not fair and balanced and did not provide a sound basis for evaluating the facts in regard to the DBP.  

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

April 6, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, April 5, 2010

Black on Fiduciary Duty, Professionalism and Investment Advice

I recently posted on SSRN my latest paper, Fiduciary Duty, Professionalism and Investment Advice.  Because it is a work-in-progress, I welcome comments and criticisms.  Here is the abstract:

Although broker-dealers and investment advisers provide virtually identical services, they are subject to different regulatory schemes and standards. These sharp legal distinctions that do not comport with reality have led to investor confusion and concern about the adequacy of investor protection. The Obama administration’s Financial Regulatory Reform includes proposals that would “establish a fiduciary duty for broker-dealers offering investment advice and harmonize the regulation of investment advisers and broker-dealers.” In addition, the Obama proposal calls for the SEC to study the use of predispute arbitration arguments in securities arbitration and to invalidate them if it would be in the best interests of investors. As of March 25, 2010 Congress has not enacted financial reform legislation. Although the bill passed by the House and the bill approved by the Senate Banking Committee reflect different approaches, any legislation that Congress ultimately enacts is likely to address both these issues in some fashion, probably by calling on the SEC to study them further.

Despite their consensus on the general concept of harmonized regulation, the broker-dealer and investment adviser industry groups are bitterly divided over how to accomplish this. In addition, the broker-dealer industry supports mandatory securities arbitration, while other groups call for its abolition. This paper seeks both to shed some light and remove some heat from these contentious debates. I make four arguments: 1. The fiduciary duty standard is not a useful standard for regulating the conduct of broker-dealers or investment advisers; the standard should be based on professionalism. 2. There are established standards of care and competence that should be applicable to both broker-dealers and investment advisers. 3. Without an explicit federal remedy for negligence, investors do not have adequate protection. 4. If Congress directs or encourages the SEC to invalidate predispute arbitration agreements, small investors are likely to be worse off.

April 5, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

SEC's Inspector General Critical of Agency's Whistle-Blower Bounty Program

The SEC's Office of Inspector General recently completed an Assessment of the SEC’s Bounty Program.  Here is an excerpt from the summary:

Although the SEC has had a bounty program in-place for more than 20 years for rewarding whistleblowers for insider trading tips and complaints, our review found that there have been very few payments made under this program. Likewise, the Commission has not received a large number of applications from individuals seeking a bounty over this 20-year period. We also found that the program is not widely recognized inside or outside the Commission. Additionally, while the Commission recently asked for expanded authority from Congress to reward whistleblowers who bring forward substantial evidence about other significant federal securities law violations, we found that the current SEC bounty program is not fundamentally well-designed to be successful.

More specifically, we found that improvements are needed to the bounty application process to make it more user-friendly and help ensure that bounty applications provide detailed information regarding the alleged securities law violations. We also found that the criteria for judging bounty applications are broad and the SEC has not put in place internal policies and procedures to assist staff in assessing contributions made by whistleblowers and making bounty award determinations. Additionally, we found that the Commission does not routinely provide status reports to whistleblowers regarding their bounty applications, even if a whistleblower’s information led to an investigation.  Moreover, we found that once bounty applications are received by the SEC and forwarded to appropriate staff for review and further consideration, they are not tracked to ensure they are timely and adequately reviewed. Lastly, we found that files regarding bounty referrals did not always contain complete documentation, such as a copy of the bounty application, a memorandum sent to the whistleblower to acknowledge receipt of the application, and a referral memorandum showing the office or division and official to whom the bounty application was referred for further consideration.

We wish to note that the SEC has begun to take steps to correct the deficiencies identified in its whistleblower/bounty program. The SEC has had consultations with the Department of Justice (DOJ), Internal Revenue Service (IRS), and other agencies, as well as the Financial Industry Regulatory Authority, to identify best practices from existing well-defined whistleblower programs. The SEC has also attempted to incorporate some of these best practices into legislation which it is seeking from Congress to include expanded authority to reward whistleblowers for securities law violations. The proposed legislation also takes into account some issues identified in this report in connection with the existing insider trading
bounty program.

We believe that it is critical for the SEC to implement the following recommendations to ensure that it has a fully-functioning and successful whistleblower program in place as its authority is potentially expanded.

April 5, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Sale of Stanford Assets Nets Fraud Victims $14 Million

The SEC announced today that approximately $14.2 million has been secured for the benefit of the worldwide victims of R. Allen Stanford's alleged multi-billion dollar fraud scheme. The Receiver expects these funds to be returned to the receivership estate by June 2010.

R. Allen Stanford is the sole stockholder of an entity that wholly owned a bank and brokerage business in Panama City, Republic of Panama, known as Stanford Bank (Panama) S.A. (SPB) and Stanford Casa de Valores, S.A. (SCV). On February 17, 2009, after the Commission filed its enforcement action against R. Allan Stanford and others, the Superintendencia de Bancos de Panamá, the Panamanian banking regulator, and the Comisión Nacional de Valores, the Panamanian securities regulator, assumed control, operation and subsequent reorganization of SBP and SCV, with a perspective of bringing those entities under new ownership and reopening them

Ultimately, with the approval of the Superintendencia de Bancos de Panamá, the Receiver negotiated and concluded a contract to sell SBP, SCV and certain other assets in Panama to the third party purchasers. This contract specifically conditioned the sale on the approval of the U.S. Court, and the unfreezing of SBP accounts in foreign jurisdictions in which SBP depositor accounts were located. The sale of SBP and SCV was approved by United States District Judge David C. Godbey, Northern District of Texas, on February 10, 2010 and the sales contract was closed on March 31, 2010.

April 5, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former Symbol Executive Settles SEC Accounting Charges relating to Acquisition

The SEC settled its enforcement action against Michael DeGennaro (DeGennaro), former Senior Vice President of Finance at Symbol Technologies, Inc. (Symbol) that alleged that Symbol and eleven former Symbol executives, including DeGennaro, committed and/or aided and abetted violations of various provisions of the Securities Exchange Act of 1934 (Exchange Act) in connection with Symbol's financial reporting from 1999 through 2002.

As part of the settlement, DeGennaro will (subject to court approval) pay a civil monetary penalty of $40,000. In addition, the Commission issued an administrative cease-and-desist order.  DeGennaro consented to the penalty and the Order without admitting or denying the findings..

According to the SEC, Symbol, a public company during the relevant period that was later acquired by Motorola, Inc., recorded non-recurring charges in connection with, inter alia, Symbol's: (i) acquisition of Telxon Corporation, which resulted in a $185.9 million restructuring charge recorded in the fourth quarter of 2000; and (ii) relocation of manufacturing operations to new facilities, which resulted in a $59.7 million restructuring charge recorded in the third quarter of 2001 (the Charges). The Charges and certain associated reserves were not recorded in accordance with generally accepted accounting principles (GAAP) because, among other things, they misclassified certain expenses, included amounts unrelated to the purpose of the Charge and, in some cases, were used in later periods for unrelated purposes. As a result, Symbol violated the financial recordkeeping and internal control provisions embodied in Sections 13(b)(2)(A) and (B) of the Exchange Act.

DeGennaro, together with others, determined how the Charges were recorded and accounted for on Symbol's internal books and records and in its financial statements. DeGennaro failed to take requisite steps to ensure that Symbol's internal books and records and financial statements accurately reflected each element of the Charges and the uses of associated reserves, and that the Charges and the uses of associated reserves were accounted for in accordance with GAAP. As a result, DeGennaro was a cause of Symbol's violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act.

April 5, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)