Thursday, April 22, 2010
Since Sarbanes-Oxley gave the SEC the authority to distribute civil penalties to investors harmed by a corporation's fraud (the "Fair Fund" provision), the GAO has issued a number of reports and a series of recommendations on improving the collection and disbursement of these funds. It just issued another such report -- Securities and Exchange Commission: Information on Fair Fund Collections and Distributions. Here's its summary conclusion:
Since 2007, fewer Fair Funds have been established and the collection and distribution of Fair Funds have increased, but many Fair Funds continue to remain open and active for years. From 2002 through February 2010, $9.5 billion in Fair Funds were ordered, with the majority of this total ordered prior to May 2007. Since that date, only $521 million, or less than 6 percent, of total Fair Funds have been ordered. Of the $9.5 billion total Fair Funds ordered, $9.1 billion (96 percent) has been collected and $6.9 billion (76 percent) of the Funds collected has been distributed. In comparison, in 2007, only 21 percent of Fair Funds had been distributed. Although the percentage of Fair Funds distributed has increased, there are many Fair Funds that remain open and active for years. For example, our analysis of SEC data shows that of the 128 ongoing Fair Fund cases, over half have been ongoing for more than 4 years. SEC officials offered several reasons why Fair Funds remain open, including difficulties in obtaining investor information and legal objections and appeals that must be settled. To improve its management of Fair Fund cases, SEC proposed a performance metric of tracking the number of cases that have completed distribution within 2 years of the appointment of a Fund administrator. However, to date, SEC has not started collecting the data in a manner necessary to track this measure.
SEC has taken steps to increase efficiency and assess Fair Fund distribution, but a number of actions that are necessary to improve tracking of distribution related information are still pending. In response to our recommendations, SEC centralized the administration of collections and distributions under OCD and subsequently eliminated the dual reporting structure that initially existed in this new office. According to SEC, the creation of OCD has allowed the opportunity to build institutional knowledge and decreased inefficiencies by developing key administrative aspects of the program. SEC officials also told us that they have implemented other operational and administrative changes that are designed to improve Fair Fund distribution. For example, SEC established a working group to share information and to coordinate between functions on distribution plans and to identify problems that may slow distribution. However, SEC officials acknowledged that Fair Fund information and data tracking still need improvement. SEC officials said they have not implemented any major improvements to Fair Fund-related data management since 2007 and that additional improvements are needed in recording and monitoring of Fair Fund data. For instance, Fair Fund data are housed in several different databases that have not been reconciled and aggregate information on Fair Fund administrative expenses is unavailable. According to SEC officials, an extensive review of the Fair Fund program is under way, the findings of which may result in changes to workflow, procedures, and information systems. While SEC is taking steps to better capture, report, and manage the programmatic and financial impact of the collections and distribution process, it is too early to determine the impact and ultimate success of these efforts.
The GAO released a report entitled Clearer Goals and Reporting Requirements Could Enhance Efforts by CFTC and SEC to Harmonize Their Regulatory Approaches. Perhaps that title says it all, but here is the GAO's summary:
The conference report accompanying the Consolidated Appropriations Act of 2010 directed GAO to assess the joint report of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) on harmonization of their regulatory approaches. In October 2009, CFTC and SEC issued this report in response to the Department of the Treasury’s recommendation that the two agencies assess conflicts in their rules and statutes with respect to similar financial instruments. GAO’s objectives were to review (1) how CFTC and SEC identified and assessed harmonization opportunities, (2) the agencies’ progress toward implementing the joint report’s recommendations, and (3) additional steps the agencies could take to reduce inconsistencies and overlap in their oversight.
To meet these objectives, GAO reviewed the joint report and related documentation, interviewed agency officials, and obtained and analyzed written comments on the report from market participants.
What GAO Recommends
GAO recommends that CFTC and SEC establish clearer goals for harmonization, including time frames for implementing the joint report’s recommendations, and develop requirements for reporting and evaluating progress toward these goals. CFTC and SEC generally agreed with our conclusions and concurred with our recommendation
The White House released the transcript of President Obama's speech on financial reform in New York City today. In it the President set forth his vision of financial reform -- what he described as "a set of updated, commonsense rules to ensure accountability on Wall St. and to protect consumers in our financial system:"
- A way to protect the financial system and the broader economy in the event a large financial firm begins to fail, without taxpayer cost
- The Volcker rule, i.e., place limits on the size of banks and the kinds of risks they can take
- Transparency and regulation in the trading of derivatives
- A dedicated agency looking out for ordinary people in our financial system and providing them with clear and concise information about financial decisions
- More power to shareholders -- say on pay, SEC authority to give shareholders more say in corporate elections
The President also urged an end to "cynical politics" and for the industry to work with the administration on reforms.
The SEC charged Detroit-based Onyx Capital Advisors LLC and its founder Roy Dixon, Jr. with participating in a fraudulent scheme through which they stole more than $3 million invested by three Detroit-area public pension funds. The SEC alleges that defendants raised $23.8 million from the three pension funds for a start-up private equity fund created to invest in small and medium-sized private companies. Dixon illegally withdrew money invested by the pension funds from the bank accounts of the private equity fund. Assisting in the scheme was Dixon’s friend Michael A. Farr, who controls three companies in which the Onyx fund invested millions of dollars. Farr diverted money invested in these entities to another company he owned, withdrew the money from that bank account, and gave the cash to Dixon. Farr also kept some money for himself, and used investor funds to make payments to contractors building a multi-million dollar house for Dixon, who lives primarily in Atlanta.
The SEC’s complaint, filed in federal district court in Detroit, also alleges that Dixon and Onyx Capital made a number of false and misleading statements to defraud the three pension funds about the private equity fund and the investments they were making. According to the SEC’s complaint, shortly after the three pension funds made their first contributions to the Onyx fund in early 2007, Dixon and Onyx Capital began illegally siphoning money. Dixon and Onyx Capital took more than $2.06 million under the guise of management fees, and Farr assisted in diverting approximately $1.05 million through the Onyx fund’s purported investments in companies Farr controlled. Dixon used the money to pay personal and business expenses, including construction of his house in Atlanta and mortgage payments on more than 40 rental properties Dixon owns in Detroit and Pontiac, Mich.
The SEC is seeking a court order for emergency relief, including temporary restraining orders, asset freezes and accountings. The complaint seeks permanent injunctions, disgorgement of ill-gotten gains and financial penalties.
FINRA settled charges with two additional firms relating to the sale of auction rate securities (ARS) that became illiquid when auctions froze in February 2008 – HSBC Securities (USA) and US Bancorp Investments, Inc. To date, FINRA has concluded ARS-related settlements with 14 firms, imposing a total of nearly $5 million in fines. Firms that have reached settlements with FINRA have returned more than $2 billion to investors. Investigations continue at a number of additional firms.
HSBC, which was fined $1.5 million, had by July 2008 repurchased more than 90 percent of its then current customers' ARS holdings and in October 2008 it offered to repurchase all of the remaining ARS held in those customers' HSBC accounts. In total, HSBC repurchased more than $562 million of ARS held by its customers. As part of the settlement announced today, HSBC has agreed to offer to repurchase additional ARS sold to certain customers who transferred accounts before its previous buy-backs and to customers who chose not to participate in its prior offers.
US Bancorp Investments, which was fined $275,000, has already completed a repurchase of more than $150 million of ARS held in customer accounts.
Wednesday, April 21, 2010
The Senate Agriculture Committee voted 13-8 to approve a bill that would require tough regulation of the derivatives market. Charles Grassley was the lone Republican to vote in favor of the bill. The bill would require most derivatives to be traded on a public exchange and cleared through a third party. It would also require big banks to put their derivatives trading operation in a separate subsidiary.
The U.S. Department of the Treasury today announced that General Motors (GM) has fully repaid its debt under the Troubled Asset Relief Program (TARP). GM paid the remaining $4.7 billion of the total $6.7 billion in debt owed to Treasury. The repayment comes five years ahead of the loan maturity date and ahead of the accelerated repayment schedule the company announced last year.
Total TARP repayments now stand at $186 billion – well ahead of last fall's repayment projections for 2010. With this repayment, less than $200 billion in TARP disbursements remain outstanding.
Treasury continues to own $2.1 billion in preferred stock and 60.8 percent of the common equity of GM.
The SEC filed an injunctive action against Nevin K. Shapiro, the president, Chief Executive Officer and sole shareholder of Capitol Investments USA Inc., (Capitol), a Miami Beach, Florida-based grocery diverter, alleging that he conducted a $900 million fraud targeting more than 60 investors nationwide.
The SEC's complaint alleges that from February 2003 through November 2009, Shapiro offered promissory notes claiming annual returns of 10 to 26% purportedly backed by purchase orders and receivables generated by Capitol's food brokerage business. In reality, Capitol was operating at a loss since late 2004 with virtually no operations by 2005. Beginning in January 2005 through November 2009, Shapiro operated a Ponzi scheme using new investor funds to pay principal and interest to earlier investors.
The SEC's Complaint further alleges that Shapiro also misappropriated at least $38 million of investor funds to finance outside business ventures unrelated to the grocery business, including a sport representation business and real estate ventures, and to fund his lavish lifestyle. He also used investor funds to pay large commissions to individuals who attracted additional investors.
The SEC seeks a permanent injunction, sworn accounting, disgorgement of ill-gotten gains with prejudgment interest, and a civil money penalty against the defendant. The SEC coordinated the filing of these charges with the United States Attorney for the District of New Jersey who charged Shapiro today with securities fraud and money laundering. Shapiro surrendered this morning to special agents of the Federal Bureau of Investigation and the Internal Revenue Service criminal investigation unit.
Tuesday, April 20, 2010
More from the House Financial Services Hearing today on the Lehman Examiner's Report:
Treasury Secretary Tim Geithner Written Testimony before the House Financial Services Committee
Treasury Secretary Tim Geithner Opening Statement as Prepared for Delivery before the House Committee on Financial Services
The U.S. Department of the Treasury announced that it has voted its approximately 7.7 billion shares of Citigroup Inc. common stock at the Citigroup Annual Meeting held today. According to its release:
Treasury has exercised its discretionary voting power by voting only on matters that directly pertain to its responsibility under EESA to manage its investments in a manner that protects the taxpayer.
Treasury voted in favor of all 15 director nominees at the annual meeting. Since Treasury invested in Citigroup in the fall of 2008 through TARP, there has been a substantial change in the composition of the board. In the spring of 2009, when Treasury was considering whether to convert its CPP investment into common shares, Citigroup's Chairman assured Treasury that a majority of the board would be comprised of new, independent directors. Citigroup has now accomplished that task, as eight out of the fifteen directors have joined the board since that time.
Treasury also voted in favor of two Citigroup proposals that fall within its discretionary voting rights. One is to permit the company to issue common shares to settle $1.7 billion of "common stock equivalent" awards to employees in lieu of cash incentive compensation. Citigroup committed to the Federal Reserve that it would issue such shares as part of the terms under which it was permitted to repay a portion of its TARP assistance last December. The second proposal is to permit a reverse stock split which will address the fact that the company has a much larger number of shares outstanding than is necessary to ensure adequate trading liquidity.
Treasury voted its shares proportionately with respect to all other issues on the ballot. These included two proposals to amend the charter and by-laws on matters of broader corporate governance. These proposals raise important issues of corporate governance that deserve careful consideration as a matter of public policy. Indeed, the Securities and Exchange Commission has promulgated a rule on proxy access and Treasury has expressed and will continue to express its views on many issues of corporate governance in connection with regulatory reform. However, Treasury believes that it would be inappropriate to use its power as a shareholder to advance a position on matters of public policy and believes such issues should be decided by Congress, the SEC or through other proper governmental forums in a manner that applies generally to companies. For this reason, and because voting on such matters was not necessary in order to fulfill its EESA responsibilities, Treasury refrained from exercising a discretionary vote.
Treasury also voted proportionately on the "say on pay" resolution, under which shareholders may cast an advisory vote as to whether they approve of Citigroup's 2009 executive compensation. The Treasury strongly supports the concept that shareholders should have the ability to vote on executive compensation, and included the "say on pay" requirement in its regulatory reform legislative proposal. Treasury has the responsibility to oversee compensation for the highest paid employees at companies that received exceptional assistance under TARP, and the Office of the Special Master set the compensation (or the compensation structures) for the highest-paid 100 employees of Citigroup in 2009. Treasury's proportional vote enabled other Citigroup shareholders to have a more meaningful opportunity to vote on the say on pay resolution. Executive compensation matters are also outside of the core areas on which Treasury retained discretionary voting rights.
Testimony Concerning the Lehman Brothers Examiner's Report, by SEC Chairman Mary L. Schapiro Before the House Financial Services Committee, April 20, 2010
On April 19, 2010, The Honorable Jed S. Rakoff, United States District Judge, United States District Court for the Southern District of New York, issued an order approving a settlement with Schottenfeld Group, LLC ("Schottenfeld Group") in SEC v. Galleon Management, LP, et al., an insider trading case the Commission filed on October 16, 2009. Schottenfeld Group, a New York limited liability company and registered broker-dealer based in New York, New York, has consented to the entry of a final judgment.
The Commission charged Schottenfeld Group with violations of the antifraud provisions of the federal securities laws, alleging:
Schottenfeld Group proprietary trader Gautham Shankar obtained inside information about a July 2007 earnings announcement at Google, Inc. Shankar traded on such information in Schottenfeld Group accounts.
Schottenfeld Group proprietary traders Shankar and Zvi Goffer obtained inside information about The Blackstone Group's 2007 purchase of Hilton Hotels Corp. Goffer and Shankar traded on such information in Schottenfeld Group accounts.
Schottenfeld Group proprietary traders Shankar, Goffer and David Plate obtained inside information about a March 2007 announcement regarding Hellman & Friedman's acquisition of Kronos Inc. Shankar, Goffer and Plate traded on such information in Schottenfeld Group accounts.
The final judgment against Schottenfeld Group permanently enjoins it from violating the antifraud provisions of the federal securities laws and orders Schottenfeld Group to disgorge $460,475.28, representing its share of profits gained and/or losses avoided as a result of the conduct alleged, together with prejudgment interest thereon in the amount of $72,202.72. In addition to disgorgement of profits, the judgment orders a civil penalty representing fifty percent of the disgorgement amount, a discount from a one-time penalty, in recognition of Schottenfeld Group's agreement to cooperate in the Commission's investigation.
In addition, Schottenfeld Group has agreed to implement enhanced policies and procedures to prevent securities law violations such as those alleged. It will retain an independent consultant to review its policies and procedures within 1 year, and to report its findings to the Commission staff.
The SEC charged Gryphon Holdings Inc., a Staten Island, N.Y.-based investment advisory firm, its owner, and four associates with operating an Internet-based scam that misleads investors into paying fees for phony stock tips and investment advice from fictional trading experts. The SEC obtained an emergency court order to freeze the assets of the firm and individuals involved.
The SEC alleges that Gryphon Holdings Inc., owner Kenneth E. Marsh, and the Gryphon associates induced investors to pay fees of up to $250,000 for securities recommendations that they falsely claim are based on sound research and successful strategies of trading experts with superior knowledge. In an effort to lend legitimacy to the firm's advisory business, Gryphon touts trading experts with fake names who boast millions of dollars in trading riches as well as top-notch educational backgrounds and prominent experience at major Wall Street firms. Gryphon representatives even fabricated glowing testimonials from George Soros and purported clients who profited by trading securities the firm recommended.
According to the SEC's complaint, filed in U.S. District Court for the Eastern District of New York, investors who followed the guidance of Gryphon's purported experts have suffered significant losses by trading on those tips or, in at least one instance, by allowing Gryphon to trade on their behalf.
The Honorable Jack B. Weinstein of the U.S. District Court for the Eastern District of New York granted the SEC's request for a temporary restraining order and asset freeze against the Defendants and six others named as Relief Defendants.:
FINRA announced the publication of guidance for FINRA-registered firms about their obligations regarding customer suitability, disclosures and other requirements for selling private placements to customers. FINRA Regulatory Notice 10-22 reinforces and details a broker-dealer's obligation to conduct a reasonable investigation of an issuer and its securities that it recommends in offerings made pursuant to Regulation D under the Securities Act of 1933, also known as "private placements." The Notice also highlights private placement red flags and supervisory requirements, and suggests practices to help ensure that firms adequately investigate the private placements that they recommend.
According to a recent estimate by the Securities and Exchange Commission (SEC), in 2008, companies intended to issue approximately $609 billion of securities in Regulation D offerings. Private placements under Regulation D are usually sold to "accredited" investors and a limited number of non-accredited investors. While accredited investors must meet certain income or asset tests, the Notice emphasizes that a broker-dealer's suitability obligations require it to conduct a reasonable investigation whenever it makes a recommendation in a private placement under Regulation D.
Recent problems uncovered by FINRA in Regulation D offerings have resulted in firms being sanctioned for providing private placement memoranda and sales materials to investors that contained inaccurate statements or omitted information necessary to make informed investment decisions.
FINRA has brought three enforcement actions in recent months involving private placement offering violations. They include a complaint charging McGinn, Smith & Co. of Albany and its president with securities fraud in the sales of tens of millions of dollars in unregistered securities; the expulsion of Dallas-based Provident Asset Management for marketing a series of fraudulent private placement offered by an affiliate in a massive Ponzi scheme; and, fines totaling $750,000 against Pacific Cornerstone Capital, Inc. of Irvine, CA, and its former CEO for failing to include complete information in private placement offering documents and marketing material, as well as for advertising violations and supervisory failures.
Monday, April 19, 2010
Richard Fuld, former Lehman CEO, will testify tomorrow before the House Financial Services Committee. Here is an excerpt from his written testimony about the much-criticized Repo 105:
The Examiner did take issue, though, with Lehman’s “Repo 105” sale transactions.
As to that, I believe that the Examiner’s report distorted the relevant facts, and the press, in turn, distorted the Examiner’s report. The result is that Lehman and its people have been unfairly vilified.
* * *
The Examiner himself acknowledged that the Repo 105 transactions were not inherently improper and that Lehman vetted those transactions with its outside auditor. He also does not dispute that Lehman appropriately accounted for those transactions as required by Generally Accepted Accounting Principles.
Bankruptcy Examiner Anton Valukas' written statement has unflattering words about the SEC:
We believe it clear, then, that the SEC was in fact Lehman’s primary regulator. The SEC told us that were constantly monitoring Lehman’s risk and liquidity. But there was little if any actual regulation; we observed no instance in which the SEC did anything, in Chairman Cox’s words, to “act quickly in response to
financial or operational weaknesses” at Lehman.
The SEC made a few recommendations or directions here and there, but in general it simply collected data; it did not direct action, it did not regulate.
It is one thing for Lehman to have exercised the business judgment, although in retrospect clearly bad judgment, to forge ahead and take on excessive risk. But it was quite another for the supposed regulator – a regulator who had been told by Lehman that its risk controls were binding and not meant to be exceeded under any circumstances – to stand by idly and simply acquiesce to management’s decision. The SEC’s mission – clearly stated on its own website – is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” The SEC’s role was not to simply absorb and acquiesce to Lehman’s decisions; the SEC’s role was to supervise and regulate to protect investors and
Written statements from other scheduled witnesses are available at the Financial Services Committee website.
More on the Goldman fraud charges, from the Wall St. Journal:
The SEC split 3-2 on whether to bring the fraud charges, with Chair Schapiro joining Democrats Walter and Aguilar and Republican Commissioners Casey and Paredes voting against. WSJ, SEC Split on Party Lines over Goldman Case
WSJ also has posted on its website Goldman's submissions last Sept. in response to the SEC's Wells Notice. Essentially, it argued: no material misrepresentations; no evidence of negligence, much less scienter; and broker-dealers owe their clients a duty not to disclose their positions and strategy.
The SEC reached settlements in SEC v. Collins & Aikman Corp., et al., No. 07-CV-2419 (SAS) (S.D.N.Y.) with defendants David A. Stockman ("Stockman"), J. Michael Stepp ("Stepp"), Elkin B. McCallum ("McCallum"), David R. Cosgrove ("Cosgrove"), and Paul C. Barnaba ("Barnaba"), all former executives or board members of Collins & Aikman Corporation ("C&A"), an auto parts supplier that went bankrupt in 2005. The proposed settlements are subject to Court approval.
The SEC's complaint alleges that Stockman participated in fraudulent rebate transactions, joined by Stepp, McCallum, Cosgrove, and Barnaba, to inflate C&A's reported income between 2001 and 2004. The complaint alleges that Stockman and other defendants obtained false documents from suppliers designed to mislead C&A's external auditors and caused C&A to file financial statements with the SEC that materially misrepresented C&A's financial results. According to the complaint, during the time Stockman was engaged in this conduct, he was collecting millions of dollars in management fees C&A paid Stockman's private equity fund, Heartland Industrial Partners.
Pursuant to the settlement, Stockman has agreed to pay $7.2 million, comprised of $400,000 in civil penalties, disgorgement of $4,424,000, and prejudgment interest of $2,376,000, with the disgorgement and prejudgment interest obligations subject to an offset of up to $4.4 million for payments Stockman makes to settle two securities class action lawsuits against him seeking recovery of the same money as the Commission. Stepp and McCallum have each agreed to pay a civil penalty of $75,000, Cosgrove has agreed to pay a civil penalty of $40,000, and Barnaba has agreed to pay a civil penalty of $20,000.
State securities regulators urge the Senate to protect investors by amending the Banking Committee's recently approved reform package to stop securities law violators from conducting private securities offerings under the SEC's Regulation D Rule 506 provisions.
The bill's current language offers an unworkable regulatory review process ...,
Rather, we believe the legislation should instead reinstitute the authority of states to use their so-called ‘bad boy’ provisions to disqualify recidivist securities violators who are now legally allowed to conduct private securities offerings under Regulation D Rule 506.
Sometimes I wonder how Geithner, Bernanke and Schapiro can ever get any work accomplished, since they spend so much of their time testifying before Congressional committees and panels. Tomorrow the House Financial Services Committee will hold a hearing on “Public Policy Issues Raised by the Report of the Lehman Bankruptcy Examiner.” Additional witnesses are the banruptcy examiner himself, Anton R. Valukas, and two former Lehman people, Richard S. Fuld, Jr., former Chairman and Chief Executive Officer, and Thomas Cruikshank, former member of the Board of Directors and chair of Lehman Brothers’ Audit Committee.
Here is Bernanke's written testimony, Lessons from the failure of Lehman Brothers Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. April 20, 2010