Securities Law Prof Blog

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

Saturday, May 1, 2010

Choi et alia on Judicial Ability and Securities Class Actions

Judicial Ability and Securities Class Actions, by Stephen J. Choi, New York University - School of Law; G. Mitu Gulati, Duke University - School of Law; and Eric A. Posner, University of Chicago - Law School, was recently posted on SSRN.  Here is the abstract:

We exploit a new data set of judicial rulings on motions in order to investigate the relationship between judicial ability and judicial outcomes. The data set consists of federal district judges’ rulings on motions to dismiss, to approve the lead plaintiff, and to approve attorneys’ fees in securities class actions cases, and also judges’ decisions to remove themselves from cases. We predict that higher-quality judges, as measured by citations, affirmance rates, and similar criteria, are more likely to dismiss cases, reject lead plaintiffs, reject attorneys’ fees, and retain cases rather than hand them over to other judges. Our results are mixed, providing some but limited evidence for the hypotheses.

May 1, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bai on Credit Rating Agencies

On Regulating Conflict of Interests in the Credit Rating Industry, by Lynn Bai, University of Cincinnati - College of Law, was recently posted on SSRN.  Here is the abstract:

This paper discusses issues giving rise to conflict of interest concerns in the credit rating industry and examines whether and how those issues are addressed in the current regulation that builds on the guidelines of the Credit Rating Agency Reform Act of 2006, the SEC rules that were initially adopted in 2007 and recently amended in 2009, and the internal code of conducts of rating agencies. The examination leads to a conclusion that conflict of interest at the individual rating analyst level and some concerns of conflict of interest at the agency level have been largely addressed in the current regulation, but conflict of interest arising from the issuer-pay business model and influences of large subscriber clients of rating agencies remains a concern. To address this concern, the paper proposes changes to the current regulation to enhance ex-ante risk disclosure and sharpen ex-post performance reporting requirements.

May 1, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Friday, April 30, 2010

Orthodontists and Financial Reform

This is what the debate over financial reform legislation has come down to: is an orthodontist a "significant financial player"?  You decide -- read the statements by Richard Shelby and Chris Dodd on this critical issue.

Shelby:  yes

Dodd:  are you nuts?

April 30, 2010 in News Stories | Permalink | Comments (1) | TrackBack (0)

DOJ Started Investigating Goldman Before SEC Action Filed

According to the Washington Post, the Justice Dept. opened a criminal investigation into possible securities fraud violations involving mortgage trading at Goldman Sachs prior to the SEC's filing of its civil action.  It has been widely reported that the SEC referred its case to DOJ for possible criminal violations.  It is not clear if the DOJ is investigating the same ABACUS deal that the SEC action focuses on.  WPost, Justice Department opens Goldman Sachs criminal investigation, sources say.

April 30, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Proposes to Increase Number of Arbitrators Available for Selection

FINRA announced that it intends to increase the number of arbitrators available for selection when parties pick arbitration panels, to 10 from the current eight, for each type of arbitrator on a three-member panel – public chair-qualified, public and non-public.  Lists of available arbitrators for cases involving less than $100,000, which are heard by a single, chair-qualified public arbitrator, would also expand from eight to 10 names.

The proposed expansion, made in a recent rule filing with the Securities and Exchange Commission (SEC), is designed to increase the likelihood that all arbitrators appointed to a case will have been selected by the parties.  A frequent complaint of both claimants' and respondents' attorneys is that the lack of mutually agreeable names means that FINRA ends up filling the panel through random selection.  In those instances, the arbitrator can be striken only for cause.

 While the proposed change would increase the number of arbitrators on each list by two, the number of available strikes would remain at four per party. If the SEC approves the new procedure, it would ensure that at least two proposed arbitrators will remain on each list of 10 potential arbitrators – thus significantly increasing the likelihood that the parties will get panelists they chose and rank, as opposed to extended list appointments. It would also reduce the need for extended list appointments when vacancies occur in a panel later in a case.

April 30, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Thursday, April 29, 2010

Fomrer Tobacco Company Execs Settle FCPA Charges

On April 28, 2010, the SEC brought another FCPA complaint, this time charging four former employees of Dimon, Inc., now Alliance One International, Inc.  All four defendants agreed to settle the Commission's charges against them.  According to the complaint, during the period 1996 through 2004, Dimon's subsidiary in Kyrgyzstan paid more than $3 million in bribes to various Kyrgyzstan government officials to purchase Kyrgyz tobacco for resale to Dimon's largest customers. In addition, the Commission's complaint alleges that, from 2000 to 2003, Dimon paid bribes of approximately $542,590 to government officials of the Thailand Tobacco Monopoly in exchange for obtaining approximately $9.4 million in sales contracts.

Without admitting or denying the allegations in the Commission's complaint, defendants Elkin, Myers, Reynolds, and Williams consented to the entry of final judgments permanently enjoining each of them from violating the anti-bribery provisions of the FCPA, codified as Section 30A of the Securities Exchange Act of 1934 ("Exchange Act"), and aiding and abetting violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. Defendants Myers and Reynolds also agreed to pay civil monetary penalties of $40,000 each.  The settlement with defendant Elkin takes into account his cooperation with the Commission's investigation.

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

FINRA Bans Former Compliance Officer for Cheating Customers

FINRA announced today that it has permanently barred Tod Bretton, former Chief Compliance Officer and Head Trader for Prestige Financial, Inc., of New York, for engaging in a fraudulent trading scheme that generated approximately $1.3 million in profits for him and his firm at the expense of customers by subjecting their orders to improper and undisclosed additional charges. To conceal the scheme, Bretton falsified order tickets and created inaccurate trade confirmations. Bretton also failed to cooperate with FINRA's investigation.

FINRA found that, from at least September 2006 through June 2009, Bretton, working from the firm's New York office, engaged in a fraudulent trading scheme in which he took advantage of customers placing large orders (generally 1,000 shares or more) to buy or sell stocks. Rather than effecting the trades in the customers' accounts, FINRA found, Bretton first placed the orders in a firm proprietary account. He would then increase the price per share for securities purchased by approximately $.02 to $.05 above the market price before allocating the shares to the customers' accounts. Similarly, he would decrease the price per share for securities sold by approximately $.02 to $.05 below the market price before allocating the proceeds to the customers' accounts. This improper price change was not disclosed to or authorized by the customers.  Bretton's trading scheme generated approximately $1.3 million in profits for the proprietary accounts, in which he had a 33 percent interest. Bretton personally earned approximately $429,000 from this scheme. 

In settling this matter, Bretton neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

April 29, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, April 28, 2010

Second Circuit Rejects Extending Private Rule 10b-5 Liability to Attorneys Who "Created" the Fraud

In Pacific Investment Management Co. v. Mayer Brown (2d Cir. Apr. 27, 2010)(Download MayerBrownopinion), the Second Circuit affirms the district court's dismissal of investors' complaint against the law firm Mayer Brown and its partner Joseph Collins for their role in the securities fraud committed by Refco Inc.  The Court holds that a secondary actor (defined as parties who are not employed by the issuer whose securities are the subject of allegations of fraud) can be held liable in private Rule 10b-5 damages actions only for false statements attributed to the secondary actor at the time of dissemination.  Absent attribution, plaintiffs cannot establish that they relied on the defendants' own false statements, and the secondary actors' participation in the creation of the false statements amounts to, at best, aiding and abetting securities fraud.  The Court rejects the plaintiff's argument (supported in an SEC amicus brief) in favor of a creator standard as inconsistent with Supreme Court precedent (Central Bank, Stoneridge) and the Second Circuit's "bright line" test adopted in Wright v. Ernst & Young (2d Cir. 1998), which held that an outside accountant could not be held liable for public statements not attributed to it.

The Court acknowledges the confusion in the Circuit created by Wright and its later decision in In re Scholastic Corp. Securities Litigation (2d Cir. 2001), where it held that a corporate officer could be liable for misrepresentations made by the corporation, even though none of the statements was specifically attributable to him.  That opinion did not cite Wright and led to confusion about whether Wright's attribution standard was relaxed.  However, in 2007, the Second Circuit applied the attribution standard again in a case involving an outside accounting firm in Lattanzio v. Deloitte & Touche.  While emphasizing the Wright attribution standard and rejecting the creator standard, the Second Circuit does not entirely clear up the confusion.  While its definition of secondary actors to exclude the issuer's employees would logically point to reconciling Wright/Lattanzio and Scholastic on this basis, the Court explicitly declines to do so:  "because this appeal does not involve claims against corporate insiders, we intimate no view on whether attribution is required for such claims or whether Scholastic can be meaningfully distinguished from Wright and Lattanzio."

The Court also affirms the district court in rejecting plaintiffs' alternative argument based on "scheme liability" because Stoneridge foreclosed this theory.  The Court does acknowledge that after Stoneridge it is "somewhat unclear" how the deceptive conduct of a secondary actor could be communicated to the public and yet remain "deceptive," but it nevertheless finds it clear after Stoneridge that the "mere fact that the ultimate result of a secondary actor's deceptive course of conduct is communicated to the public through a company's financial statements is insufficient to show reliance on the secondary actor's own deceptive conduct."

After Stoneridge, some have argued that the Supreme Court's opinion should not be read as foreclosing the "scheme liability" theory where the secondary actors play a role that is more closely connected to the securities or capital-raising process, such as those professionals who advise securities issuers, in contrast to the suppliers named as defendants in Stoneridge.  I always thought that argument to be wishful thinking, and at least in the Second Circuit, it will not fly.

April 28, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Tuesday, April 27, 2010

Treasury Launches Redesigned Financial Literacy Website

I personally am skeptical about the value of financial literacy websites, but the Treasury Dept. has announced the launch of its redesigned financial literacy education website,  Treasury says the new site has "enhanced interactive features and utility to provide more resources to Americans seeking information that can inform their personal financial decisions." 

April 27, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Reports on Administrative Proceedings

The SEC's Report on Administrative Proceedings For Period October 1, 2009 through March 31, 2010, required by Rule 900 of the Commission’s Rule of Practice, is posted on the SEC's website.

April 27, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former Maxim Integrated Produdcts CFO Liable for Backdating Stock Options

On April 23, 2010, a federal district court jury found Carl W. Jasper, former Chief Financial Officer of Maxim Integrated Products, liable for securities fraud and other charges in connection with a scheme to backdate stock option grants to company personnel.  Following an eight-day trial in U.S. District Court in San Jose, Calif., the eight-member jury found Jasper liable for, among other violations, fraud, lying to auditors, and aiding Maxim's failure to maintain accurate books and records. The jury found for Jasper on certain remaining claims, including proxy rule violations.   The Judge  will determine remedies and sanctions at a later date. The SEC's complaint seeks, among other things, disgorgement and repayment of bonuses, monetary penalties, and a bar from serving as an officer or director of a public company.

According to the SEC, evidence introduced at trial established that Maxim, with Jasper's knowledge, routinely granted stock options by using hindsight to identify dates with historically low stock prices. Jasper's staff then drafted false documents to make it appear that the options had been granted on the earlier date. This practice allowed Maxim to conceal hundreds of millions of dollars in expenses that it was required to report in its SEC filings. The evidence further showed that Jasper, with awareness of the backdating practices, repeatedly signed and certified Maxim's false quarterly and annual reports provided to the investing public.

The SEC previously settled its charges against Maxim and former CEO John Gifford, with Gifford (since deceased) paying over $800,000 in disgorgement, interest and penalties.

April 27, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Regulators Crack Down on Broker-Dealers Involved in Sales of Unregistered Penny Stocks

Both FINRA and the SEC announced enforcement actions against broker-dealers involving sales of unregistered penny stocks by their customers, although there is no indication in the releases that they are related.

FINRA fined five broker-dealers a total of $385,000 for the illegal sale of more than 8 billion shares of penny stock on behalf of their customers. Most of those illegal sales involved one penny stock company, Universal Express Inc. Together, the five firms sold more than 7.5 billion shares of that company's unregistered stock, for proceeds of approximately $8.4 million.  The firms failed to take appropriate steps to determine whether the securities could be sold without violating federal registration requirements – despite certain red flags indicating that illegal stock distributions might be taking place, including a major enforcement action by the Securities and Exchange Commission (SEC) involving Universal Express's unregistered stock.

 The firms are Fagenson & Co., Inc., of New York, which reported earning $44,000 in commissions from the sale of unregistered Universal Express stock and was fined $165,000; RBC Capital Markets Corporation, of New York, which earned $68,000 in commissions and was fined $135,000; Alpine Securities Corporation, of Salt Lake City, which earned $47,000 in commissions and was fined $40,000; Equity Station, Inc., of Boca Raton, which earned $13,575 in commissions and was fined $25,000; and, Olympus Securities, LLC., of Montville, NJ, which earned $5,200 in commissions and was fined $20,000.  In settling these matters, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

The SEC announced administrative proceedings against five securities professionals accused of facilitating unlawful sales of penny stocks to investors and failing to act as "gatekeepers" as required under the federal securities laws.  The SEC's Division of Enforcement alleges that three registered representatives and two supervisors at Leeb Brokerage Services allowed customers to routinely deliver large blocks of privately obtained shares of penny stocks into their accounts at the firm. The customers would then sell them to the public in transactions that were not registered with the SEC under the securities laws. The accused securities professionals allowed these sales without sufficiently investigating whether they were facilitating illegal underwriting, and they also caused the firm's failure to file Suspicious Activity Reports (SARs) as required under the Bank Secrecy Act to report potential misconduct by their customers.  A hearing will be scheduled before an administrative law judge to determine whether the accused individuals committed the alleged violations and provide them an opportunity to defend the allegations. The hearing also will determine what sanctions, if any, are appropriate in the public interest.

April 27, 2010 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)

Beating up on Goldman

I'm missing the theater that's going on at the Senate, as Senators take delight at expressing umbrage at Goldman Sachs banker for "shorting the residential housing market," which has become the current dirty phrase.  Far be it for me to defend Goldman -- they pay too many lawyers, lobbyists, and consultants to need my help in that regard -- but I'm tired about the phony outrage from Congressional leaders who actively participated in the deregulation of the financial markets.  The Committee's website has all the information you need about the hearings -- a live feed and plenty of documents, including 900 pages of exhibits (those stupid emails we've seen quoted in the press) and written testimony. 

Fabrice Tourre (who, you will recall, is the only individual defendant in the SEC's enforcement action) testified earlier today.  In his written statement ( Download STMTTOURREFabrice[1]), he emphasized that the two investors in the ABACUS 07 AC-1 deal were two of the most sophisticated investors in the world and he never lied to them.  In fact, he recalls informing one of the investors that Paulson's fund was expected to buy credit protection on some of the tranches of the transaction.  If they were confused, they could have asked questions.  ACA selected the portfolio  of securities, and not Paulson.  Finally, the transaction was not designed to fail.

The star of the show, of course, will be Goldman's CEO, Lloyd Blankfein, who is the last scheduled speaker today.  In his succinct written statement(Download STMTBLANKFEINLloyd[1]), which is long on generalities and short on specifics, he expresses gratitude for the government's investment (fully paid off with 23% annualized return for taxpayers, he notes), and states that "while we strongly disagree with the SEC's complaint, I also recognize how such a complicated transaction may look to many people."  He emphasized that Goldman did not have a "massive" short against the housing market and "we certainly didn't bet against our clients.  Rather, we believe that we managed our risk as our shareholders and our regulators would expect."

April 27, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Merck Majority Says Actual or Constructive Knowledge Required to Start Limitations Period for Securities Fraud

Today, in Merck & Co., Inc. v. Reynolds(Download Merckopinion), a majority of the Justices held that the statute of limitations for securities fraud begins to run once the plaintiff actually discovered, or a reasonably diligent plaintiff would have discovered, the "facts constituting the violation" -- whichever comes first.  This is  contrary to the language of the statute, which states that the two-year period begins "after discovery of the facts constituting the violation" (with an outside limit of five years after the violation), as Justices Scalia and Thomas note in a concurrence.  (Justice Stevens also concurred because he saw no need, in the facts of this case, to focus on the difference between actual and constructive knowledge.)  While I can't explain why the majority felt the need, through some rather convoluted analysis, to include a constructive knowledge alternative to cut off a plaintiff's time for filing a complaint, at least I take comfort that the court did not adopt the anti-plaintiff "inquiry notice" standard argued by Merck.  As the majority notes, the statute's knowledge standard cannot be stretched to include inquiry notice.  

The majority does strongly refute two of Merck's arguments: first, that the statute does not require "discovery" of scienter-related facts, and, second, that even if "discovery" requires scienter-related facts, facts that tend to show a materially false or misleading statement (or material omission) are sufficient to show scienter as well.  Both these arguments are counter to the scienter requirement of Rule 10b-5, not only the necessity of plaintiff's proving a wrongful intent but also meeting the hightened pleading requirement of PSLRA.  How could plaintiff's statute of limitations begin to run when it had insufficient knowledge to file a complaint that would withstand a motion to dismiss?  Only the most plaintiff-unfriendly court could so hold (as some did).  But the majority reminds the defendant (just as courts frequently remind plaintiffs in granting defendants motions to dismiss) that the fact that an earnings statement is false does not neccessary mean that the defendants have lied; the misstatement may be the product of negligence.

Will the interpretation of "knowledge" to include constructive knowledge -- i.e., when a reasonably diligent plaintiff plaintiff would have discovered the facts constituting the violation -- make a meaningful difference in any significant number of cases?  I don't know, but it is unfortunate that defendants are given a greater opportunity to argue that the complaint is timely, given the statute's plain meaning and the many advantages defendants currently have to get a complaint dismissed for failure to plead fraud with the requisite specificity.  I fear this will give district courts freedom to find complaints untimely based on some Platonic notion of what an idealized "reasonably diligent" investor would do.

April 27, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, April 26, 2010

Goldman Sachs Center Stage at Senate Hearing Tomorrow

Tomorrow the Senate's Permanent Subcommittee on Investigations, chaired by Senator Carl Levin, will hold another hearing on the causes of the financial crisis.  This one focuses on The Role of Investment Banks, and every single witness will be from Goldman Sachs.  Interest will center on two speakers, Fabrice Tourre, the only individual defendant in the SEC's enforcement action, and Lloyd Blankfein, the CEO. 

Last week Goldman posted on its website a 12-page document, Goldman Sachs: Risk Management and the Residential Mortgage Market, in order to, as it said, to put the matter in context.  According to Goldman, it "did not engage in some type of massive 'bet' against our clients," it "maintained appropriately high standards with regard to client selection, suitability and disclosure as a market maker and underwriter," and "never created mortgage-related products that were designed to fail."

The hearing should be interesting.

April 26, 2010 in News Stories | Permalink | Comments (1) | TrackBack (0)

Treasury Announces Plan to Sell Citigroup Common Stock

The U.S. Department of the Treasury today announced the next steps in its plan to sell approximately 7.7 billion shares of Citigroup common stock.  Citigroup filed a prospectus supplement with the SEC covering Treasury's sale of this common stock.  Treasury will begin selling its common shares in the market in an orderly fashion under a pre-arranged written trading plan with Morgan Stanley, Treasury's sales agent.  Initially, Treasury will provide Morgan Stanley with discretionary authority to sell up to 1.5 billion shares under certain parameters.  Treasury expects to provide Morgan Stanley with authority to sell additional shares after this initial amount.

Treasury received the shares of common stock last summer as part of the exchange offers conducted by Citigroup to strengthen its capital base.  Treasury exchanged the $25 billion in preferred stock it received in connection with Citigroup's participation in the Capital Purchase Program for common shares at a price of $3.25 per common share.  These sales do not cover Treasury's holdings of Citigroup trust preferred securities or warrants for its common stock, which will be disposed of separately.

Treasury required Morgan Stanley to provide opportunities for participation by small broker-dealers, including minority- or women-owned broker-dealers.

April 26, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)