Securities Law Prof Blog

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

Saturday, April 17, 2010

Goldman Defense: We Lost $90 Million on the Deal

From the Goldman Sachs press release about the SEC allegations:

We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact.

We want to emphasize the following four critical points which were missing from the SEC’s complaint.

• Goldman Sachs Lost Money On The Transaction.  Goldman Sachs, itself, lost more than $90 million.  Our fee was $15 million.  We were subject to losses and we did not structure a portfolio that was designed to lose money.

• Extensive Disclosure Was Provided.  IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities.  The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.

• ACA, the Largest Investor, Selected The Portfolio.  The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions.  ACA had the largest exposure to the transaction, investing $951 million.  It had an obligation and every incentive to select appropriate securities. 

• Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor.  The SEC’s complaint accuses the firm of fraud because it didn’t disclose to one party of the transaction who was on the other side of that transaction.  As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor.

April 17, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC's Inspector General: Fort Worth Enforcement Knew of Stanford's Ponzi Scheme Since 1997

I mentioned yesterday that the SEC Chair issued a response to the SEC Inspector General's critical report on the handling of the Stanford matter.  Here is the report itself.  The OIG was charged with looking into what, if any, indications the agency had prior to 2006 that Stanford was operating a Ponzi scheme and what, if any, were its responses.  Here's a brief summary of the sad saga:

Examination teams at the SEC's Fort Worth office suspected illegal activity at Stanford as early as 1997, two years after the Stanford Group Company registered with the SEC.  Over the next eight years the examiners conducted four examinations of Stanford's operations, finding in each examination that it was "highly unlikely" that the returns Stanford claimed could have resulted from the purported investment strategy and concluding that Stanford was likely running a Ponzi scheme.  While the examination group endeavored to persuade the Fort Worth enforcement office to conduct an investigation, no meaningful effort was made by Enforcement until late 2005.  However, even then, Enforcement missed an opportunity to bring an enforcement action against SGC, in part because the new head of Fort Worth enforcement was not apprised of the findings in earlier examinations.  The report states:

The OIG did not find that the reluctance on the part of the SEC’s Fort Worth
Enforcement group to investigate Stanford was related to any improper professional,
social or financial relationship on the part of any former or current SEC employee. We
found evidence, however, that SEC-wide institutional influence within Enforcement did
factor into its repeated decisions not to undertake a full and thorough investigation of
Stanford, notwithstanding staff awareness that the potential fraud was growing. We
found that senior Fort Worth officials perceived that they were being judged on the
numbers of cases they brought, so-called “stats,” and communicated to the Enforcement
staff that novel or complex cases were disfavored. As a result, cases like Stanford, which
were not considered “quick-hit” or “slam-dunk” cases, were not encouraged.

The OIG goes on to make serious allegations against the former head of Enforcement in Fort Worth:

The OIG investigation also found that the former head of Enforcement in Fort
Worth, who played a significant role in multiple decisions over the years to quash
investigations of Stanford, sought to represent Stanford on three separate occasions after
he left the Commission, and in fact represented Stanford briefly in 2006 before he was
informed by the SEC Ethics Office that it was improper to do so.

The report states the former head of enforcement in Fort Worth apparently violated state bar rules:

The OIG investigation found that the former head of Enforcement in Fort Worth’s
representation of Stanford appeared to violate state bar rules that prohibit a former
government employee from working on matters in which that individual participated as a
government employee. Accordingly, we are referring this Report of Investigation to the
Commission’s Ethics Counsel for referral to the Office of Bar Counsel for the District of
Columbia and the Chief Disciplinary Counsel for the State Bar of Texas, the states in
which he is admitted to practice law.

April 17, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Friday, April 16, 2010

Schapiro Releases Response to Agency's Performance in Stanford Fraud

The SEC's Office of Inspector General has apparently released a report critical of the agency's performance in failing to detect the Stanford fraud earlier.  I can't find the report on the OIG website, but Chair Schapiro has released a response to it -- essentially, "long ago and far away":

This report recounts events that occurred at the Commission between 1997 and 2005. Since that time, much has changed and continues to change regarding the agency's leadership, its internal procedures and its culture of collaboration. The report makes seven recommendations, most of which have been implemented since 2005. We will carefully analyze the report and implement any additional reforms as necessary for effective investor protection.

It also released a Fact Sheet.

April 16, 2010 in SEC Action | Permalink | Comments (1) | TrackBack (0)

SEC Charges Goldman with Fraud in Structuring and Marketing CDO Tied to Subprime Mortgages

The big news this afternoon is the SEC complaint filed in S.D.N.Y. raising serious allegations about Goldman Sachs in structuring and marketing a synthetic CDO that hinged on the performance of subprime residential mortgage-backed securities.  According to the complaint, Goldman failed to disclose the role that a major hedge fund, Paulson & Co., played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.  The SEC alleges that Paulson & Co. paid Goldman $15 million to structure and market a transaction in which the fund could take short positions against mortgage securities chosen by Paulson & Co.  The SEC alleges that Goldman VP Fabrice Tourre was principally responsible for the CDO known as ABACUS 2007-AC1.  Investors are alleged to have lost more than $1 billion.  The SEC is seeking injunctive relief, penalties and disgorgement of profits.

April 16, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Schapiro Makes the Case for SEC Self-Funding

Here is Mary Schapiro's recent statement making the case for self-funding.

I was recently asked what I thought about self-funding for the SEC, and I confess that I am undecided on the issue.   Certainly in the past the agency has gone through periods of substantial under-funding, and even when Congress ups its funding, as it did post-Enron, the budget will be cut when money gets tight and the Congressional focus shifts.  However, I am somewhat concerned about decreasing the level of Congressional oversight and accountabililty that control over the purse strings provides.  I'd be interested in hearing other views on this.

April 16, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Business Groups Oppose Corporate Governance Measures

A number of influential business groups, including the U.S. Chamber of Commerce, have signed on to a Multi-industry letter regarding the so-called "corporate governance" provisions of the "Restoring American Financial Stability Act."  According to the signatories, a right to proxy access, a say-on-pay advisory vote, and other corporate goverance measures would:  federalize corporate law, threaten shareholder wealth creation, unleash an onslaught of shareholder activists, and saddle the SEC with additional responsibilities.

April 16, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Thursday, April 15, 2010

SEC Proposes a Large Trader Reporting System

The SEC posted on its website the proposed new rules to establish a large trader reporting system. The proposal is intended to assist the Commission in identifying and obtaining certain baseline trading information about traders that conduct a substantial amount of trading activity, as measured by volume or market value, in the U.S. securities markets. The proposed large trader reporting system is designed to facilitate the Commission’s ability to assess the impact of large trader activity on the securities markets, to reconstruct trading activity following periods of unusual market volatility, and to analyze significant market events for regulatory purposes. It also should enhance the Commission’s ability to detect and deter fraudulent and manipulative activity and other trading abuses, and should provide the Commission with a valuable source of useful data to study markets and market activity.

April 15, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Private Equity Firm in New York Pension Plan Kickback Scheme

The SEC today announced charges against Quadrangle Group LLC and Quadrangle GP Investors II, L.P. in connection with the Commission's ongoing investigation into a multi-billion dollar kickback scheme involving New York's largest pension fund. The Quadrangle defendants agreed to settle the SEC's charges and pay a penalty of $5 million.

The SEC previously charged Henry Morris, the top political advisor and chief fundraiser for former New York State Comptroller Alan Hevesi, and David Loglisci, the former New York State Deputy Comptroller, for orchestrating a fraudulent scheme that extracted kickbacks from investment management firms seeking to manage the assets of the New York State Common Retirement Fund. In today's complaint, filed in federal district court in Manhattan, the Commission alleges that the Quadrangle defendants entered into undisclosed financial arrangements that benefited Morris and Loglisci in order to win investment business from the Retirement Fund.

Specifically, the SEC alleges that the Quadrangle defendants secured a $100 million investment from the Retirement Fund only after a former Quadrangle executive arranged for a Quadrangle affiliate to distribute the DVD of a low-budget film called "Chooch" that Loglisci and his brothers had produced and after that executive agreed to pay more than $1 million in sham "finder" fees to Morris. The scheme corrupted the integrity of the Common Fund's investment processes and resulted in the Retirement Fund's assets being invested with the undisclosed purpose of enriching Morris and Loglisci's brother.

April 15, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Proposes Rule for Increased Fairness and Efficiency in Options Market

The SEC posted on its website proposed amendments to Rule 610 under the Securities Exchange Act of 1934 relating to access to quotations in listed options as well as fees for such access. The proposed rule would prohibit an exchange from imposing unfairly discriminatory terms that inhibit efficient access to quotations in a listed option on its exchange and establish a limit on access fees that an exchange would be permitted to charge for access to its best bid and offer for listed options on its exchange.

This amendment is designed to increase transparency in the markets and promote greater fairness and efficiency.  The SEC's proposal would extend the same measures to listed options that currently apply only to transactions involving exchange-listed stocks. By expanding the protections that are available in the options markets, the SEC's proposal would help provide investors with the ability to achieve best execution for their orders and remove barriers that an exchange might erect to keep non-members from accessing a quotation on the exchange.

April 15, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, April 14, 2010

Financial Reform Anytime Soon?

The New York Times has a handy comparison of the House and Senate Banking Committee versions of financial reform legislation. 

It does not appear that the While House session today with Congressional leaders produced any bipartisan momentum for reform.  NYTimes, Obama Meets Resistance From G.O.P. on Finance Bill

April 14, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Senate Agriculture Committee Considers Ban on Banks' Trading Financial Derivatives

Wall Street is nervously following the Senate Agriculture Committee's proposals to regulate financial derivatives.  The Chair, Blanche Lincoln, is considering banning banks from trading financial derivatives, a proposal that goes beyond what the Obama Administration proposed. Stay tuned. WPost, Sen. Lincoln forges ahead on financial derivatives reform

April 14, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Bernanke Testifies on Economic Outlook

Fed Chairman Ben S. Bernanke testified on the Economic Outlook today before the Joint Economic Committee, U.S. Congress, Washington, D.C.

April 14, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Proposes A Large Trader Reporting System

The SEC today voted to issue a proposal to establish a large trader reporting system, and separately proposed to put in place two investor protection measures in options markets that currently exist in stock markets.  In her opening statement, Chair Schapiro described the large trader reporting system proposal as follows:

The Commission’s need to better monitor these entities is heightened by the fact that large traders, including high-frequency traders, appear to be playing an increasingly prominent role in the securities markets.

To enhance the Commission’s ability to identify large traders and collect information on their trading activity, the Commission will now consider whether to propose a new Rule under Section 13(h) of the Securities Exchange Act. The rule would allow the Commission to exercise its authority to establish a large trader reporting system.

Traders who engage in substantial levels of trading activity would be required to identify themselves to the SEC through a filing with the Commission. It is proposed that a “large trader” would generally be defined as a person, including a firm or individual, whose transactions in exchange-listed securities equal or exceed (i) two million shares or $20 million during any calendar day, or (ii) 20 million shares or $200 million during any calendar month.

By providing the Commission with prompt access to information about large traders and their trading activity, the proposed rule is intended to help the Commission reconstruct market activity, analyze trading data, and investigate potentially manipulative, abusive, or otherwise-illegal trading activity.


April 14, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, April 13, 2010

SEC Announces Policy of Unscheduled Adviser Visits

An SEC compliance official recently announced that OCIE is indefinitely suspending its regularly-scheduled examinations of investment advisers and instead is conducting unannounced inspections based on tips of wrong-doing.  Obviously in response to the Madoff scandal, the new policy leads industry people to worry that competitors may plot to make their lives miserable.  InvNews, SEC's new adviser exam schedule: 'We simply show up'

April 13, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

PCAOB Takes on Auditor's Role in Detecting Fraud

The investing public generally thinks that the accounting profession performs an important gate-keeping role in detecting and deterring fraud.  Yet accountants insist that's not their job.  The PCAOB (at least so long as it continues in existence, until the Supreme Court declares it's unconstitutional) is charged with the task of dealing with this "expectations gap."  See, What Is the Auditor's Role in Finding Fraud?

April 13, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Agenda for SEC's April 14 Meeting

At the April 14 SEC Open Meeting, the Commission will consider the following:

Item 1: Large Trader Reporting System
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: Proposed Amendments to Rule 610 of Regulation NMS
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 13, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Files Brief in Cuban Insider Trading Case

The SEC has posted at its website its recently filed reply brief in SEC v. Cuban, its appeal to the Fifth Circuit of the district court's opinion that Cuban did not violate Rule 10b-5 when he sold his stock after the CEO told him he was being given information about its plans for an offering in confidence.  According to the SEC's brief, "[t]he key question whether an agreement to keep information confidential encompasses an agreement not to trade on the information, such that trading without prior disclosure is deceptive."  The SEC says the answer is clearly yes.

April 13, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

PWC Releases 2009 Securities Litigation Study

PriceWaterhouseCoopers released its 2009 Securities Litigation StudyDownload PWC2009ClassActionStudy recently.  It finds a drop in the total number of federal filings (155 filings in 2009, compared to 210 in 2008) as well as a drop in financial-crisis-related filings (51 financial-crisis-related filings in 2009, compared to 99 in 2008). Financial services, however, continues to be the most frequently sued industry.  A total of 93 settlements were made in 2009, compared with 95 in 2008.  Total settlement value decreased 21%, from $3.9 billion in 2008 to $3.1 billion in 2009.  The average settlement value in 2009 was 20% less than in 2008.  The Study is full of many other interesting statistics.

April 13, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

District Court Denies Schwab Summary Judgment in Fund Class Action Involving Mortgage-Backed Securities

In re Charles Schwab Corp. Securities Litigation (No. C 08-01510 WHA, Apr. 8, 2010)Download Schwab.040810 provides an entertaining read and a rare victory for plaintiffs in defeating defendants' motion for summary judgment.  Mutual fund holders alleged that the fund represented that the fund was diversified and never concentrated more than 25% in a single industry, but in fact it had concentrated more than 50% in residential housing and/or commercial real estate industry.  Defendants' defense centered on a 3-sentence disclosure included in the SAI (which, you will recall, is not included in the prospectus but must be requested by investors):

 The funds have determined that mortgage-backed securities
issued by private lenders do not have risk characteristics that are
correlated to any industry and, therefore, the funds have
determined that mortgage-backed securities issued by private
concentration policies. This means that a fund may invest more
than 25% of its total assets in privately-issued mortgage-backed
securities, which may cause the fund to be more sensitive to
adverse economic, business or political developments that affect
privately-issued mortgage-backed securities. Such developments
may include changes in interest rates, state or federal legislation
affecting residential mortgages and their issuers, and changes in
the overall economy.

The court placed these three sentences in the context of the 35-pages of "Investments, Risks and Limitations" contained in the SAI and found that, apart from the three sentences, the disclosure left the distinct impression that fund was diversified and that its plan was never to concentrate more than 25% in a single industry.  Viewing the record most favorably to the plaintiffs, a jury could reasonably find that the three sentences had a low profile compared to the much higher profile of the attractive features of the fund.  "In short, if defendants are going to define away the problem, a jury could reasonably find that they did not do so plainly enough."

The court also denied defendants' motion for summary judgment on loss causation.  "If a mutual fund holds itself out as investing no more than 25% in a single industry but then, as actually planned, invests 50% in a single industry, there is no escape by blaming the industry rather than the promoter."

April 13, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, April 12, 2010

FINRA Fines Firm for Failing to Protect Confidential Customer Information

FINRA announced that it has fined D.A. Davidson & Co., of Great Falls, MT, $375,000 for its failure to protect confidential customer information by allowing an international crime group to improperly access and hack the confidential information of approximately 192,000 customers.  FINRA found that prior to January 2008, D.A. Davidson did not employ adequate safeguards to protect the security and confidentiality of customer records and information stored in a database housed on a computer Web server with a constant open Internet connection. The unprotected information included customer account numbers, social security numbers, names, addresses, dates of birth and other confidential data. Furthermore, the firm's procedures for protecting that information were deficient in that the database was not encrypted and the firm never activated a password, thereby leaving the default blank password in place.

As a result, in Dec. 25 and 26, 2007, D.A. Davidson's database was compromised when an unidentified third party downloaded confidential customer information through a sophisticated network intrusion. To breach D.A. Davidson's system, the hacker employed a mechanism called "SQL injection," an attack in which computer code is repeatedly inserted into a Web page for the purpose of extracting information from a database. The hacker was able to access and download the affected customers' confidential information. While these attacks were visible on Web server logs, the firm failed to review those logs.

 The breach was discovered through an email that was sent by the hacker on Jan.16, 2008, blackmailing the firm. Upon receiving the threat, D.A. Davidson reported the incident to law enforcement and assisted the Secret Service in identifying four members of an international group suspected of participating in the hacking attack of the firm. Three of those individuals have been extradited from Eastern Europe, arrested and are facing charges in federal court in Montana.

 FINRA took into consideration the firm's quick response to protect its customers and cooperation with law enforcement authorities and the fact that do date, no customer has suffered any instance of identity theft when assessing the fine in this matter.  In settling this matter, the firm neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

April 12, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)