Saturday, April 17, 2010
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.
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.
Friday, April 16, 2010
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.
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.
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.
Thursday, April 15, 2010
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.
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.
Wednesday, April 14, 2010
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
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
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.
Tuesday, April 13, 2010
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.
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."
Monday, April 12, 2010
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.