Securities Law Prof Blog

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

Saturday, May 8, 2010

SEC and CFTC Statement on Unusual Trading Activity

Yesterday the SEC and the Commodity Futures Trading Commission released the following statement:

“We are continuing to review the unusual trading activity that took place briefly yesterday afternoon to pinpoint its cause and contributing factors.

“Since yesterday, we have been in regular contact with other financial regulators and our respective exchanges. We also have been in touch with our foreign counterparts around the world.

“Our market oversight units are reviewing trading and market data from the exchanges, self regulatory organizations and market participants to examine yesterday's unusual trading activity. We are scrutinizing the extent to which disparate trading conventions and rules across various markets may have contributed to the spike in volatility.

“We are devoting significant resources and expertise to this effort.

“As we determine the cause and contributing factors, we will make our findings and any recommendations public.

“Thursday’s unusual trading activity included extreme volatility for a number of individual securities. This is inconsistent with the effective functioning of our capital markets and we will make whatever structural or other changes are needed.

“Market clearance and settlement processes functioned well and without incident."

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

Friday, May 7, 2010

Schapiro Addresses Transparency in Muni Markets at ICI Meeting

SEC Chairman Mary Schapiro gave a speech today (as delivered by Andrew J. Donohue, Director, Division of Investment Management) on increasing transparency in the municipal markets at Investment Company Institute 2010 General Membership Meeting.

May 7, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC-CFTC Statement on Yesterday's Market Conditions

Here is a brief joint statement from SEC and CFTC released yesterday on the volatile trading conditions:

“The SEC and CFTC are working closely with the other financial regulators, as well as the exchanges, to review the unusual trading activity that took place briefly this afternoon. We are also working with the exchanges to take appropriate steps to protect investors pursuant to market rules.

“We will make public the findings of our review along with recommendations for appropriate action.”

May 7, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Head Addresses Market Reg Issues at SIFMA Seminar

Richard G. Ketchum, FINRA Chairman & Chief Executive Officer, spoke today at the SIFMA Compliance & Legal Division's Annual Seminar in Washington, DC.  According to his prepared remarks, he spoke about market regulation and audit trails, product reviews, modifications to our examination and enforcement programs, the fiduciary standard, and point of sale.

May 7, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Thursday, May 6, 2010

GAO Releases Report on Leverage at Financial Institutions

Excerpt from GAO, Financial Crisis Highlights Need to Improve Oversight of Leverage at Financial Institutions and across System:

In 2009 GAO conducted a study on the role of leverage in the recent financial crisis and federal oversight of leverage, as mandated by the Emergency Economic Stabilization Act. This testimony presents the results of that study, and discusses (1) how leveraging and deleveraging by financial institutions may have contributed to the crisis, (2) how federal financial regulators limit the buildup of leverage; and (3) the limitations the crisis has revealed in regulatory approaches used to restrict leverage and regulatory proposals to address them.
* * *

What GAO Recommends
As Congress considers establishing a systemic risk regulator, it should consider the merits of assigning such a regulator with responsibility for overseeing systemwide leverage. As U.S. regulators continue to consider reforms to strengthen oversight of leverage, we recommend that they assess the extent to which reforms under Basel II, a new risk-based capital framework, will address risk evaluation and regulatory oversight concerns associated with advanced modeling approaches used for capital adequacy purposes.

May 6, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Schapiro Speaks at SIFMA Compliance & Legal Society

SEC Chairman Mary Schapiro, Keynote Address at the Compliance and Legal Society of the Securities Industry and Financial Markets Association 2010 Annual Seminar, Harbor Place, Maryland, May 6, 2010

May 6, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Fines Westpark Capital for Supervisory Failures in Long Island Branches

FINRA has ordered Los Angeles-based Westpark Capital, Inc. to pay a total of $400,000 for supervisory system failures and has suspended two officers for failing to supervise brokers in two now-closed Long Island branches who churned customer accounts and engaged in unauthorized and unsuitable trading in multiple accounts. The monetary sanction includes a $100,000 fine and $300,000 in restitution to affected customers. 

FINRA suspended Westpark's former Chief Compliance Officer, William A. Morgan, for four months in any principal capacity and ordered him to pay a $5,000 fine. Chief Operations Officer Jason S. Stern has been suspended for three months in any principal capacity and fined $20,000.

In related actions, FINRA has barred and/or fined two brokers and a branch manager who were previously employed in Westpark's Long Island branch offices, and has filed a complaint against another former broker involved in the misconduct, charging him with churning accounts and other violations. Two additional former brokers involved have already been barred, by FINRA or the Securities and Exchange Commission, for misconduct at other firms prior to or after their employment with Westpark.

Several of the brokers involved came to Westpark from broker-dealers that had lengthy disciplinary records and that FINRA has expelled from the securities industry, such as Stratton Oakmont, Inc., LH Ross & Co., Salomon Grey Financial Corp. and Continental Broker-Dealer Corp. When Westpark hired them, several of the brokers themselves had histories that included multiple customer complaints and/or disciplinary actions.

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

Wednesday, May 5, 2010

Criminalizing Breaches of Fiduciary Duty?

In the aftermath of the SEC's complaint against Goldman Sachs and the recent Congressional hearing, there is talk of imposing a fiduciary standard on broker-dealers, not only in their dealings with retail customers, but in their dealings with institutional investors.  In addition, a proposal is floating to criminalize breaches of fiduciary duty.  Senator Arlen Specter is out in front on these issues.

As I have written before, retail customers who rely on their broker-dealers for investment advice are entitled to expect that their brokers will act as professionals and live up to professional standards of care and competence.  They are also entitled to upfront clear and specific disclosures about conflicts of interest.  These are professional standards, and referring to fiduciary duty concepts confuses the issue; "fiduciary duty" is simply too indeterminate to provide guidance.  In contrast, institutional investors are entitled to expect that their brokers do not lie to them, but unless the sophisticated customer has engaged the broker as an investment adviser (in which case there is already a fiduciary duty), he is not entitled to assume that the broker is putting his interests first (whatever that phrase means in the context of a profit-seeking relationship).

As to criminalizing a breach of "fiduciary duty," this is truly a dreadful idea.  Criminal statutes must, under the constitution, provide fair notice of the wrongdoing that is being criminalized.  The law can and does criminalize certain forms of  misconduct that would be categorized as breach of fiduciary duty -- lying and embezzlement come to mind.  But the courts have had enough trouble determining what is securities fraud under section 10(b) and Rule 10b-5; "fiduciary duty" is simply too amorphous a concept to use in a criminal statute.

I have thought for some time that "fiduciary duty" is one of those fancy phrases we lawyers like to use because it sounds so impressive, but it really encourages lazy thinking.  Let's think about what obligations investment advice providers should be held to and recognize the distinctions between different kinds of investors.  When broker-dealers engage in criminal conduct, prosecute them under the securities fraud, mail fraud, wire fraud and other criminal statutes.  But let's not add a lot of rhetoric to the financial reform legislation and persuade ourselves that anything has been accomplished.

May 5, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

FCIC Conducts Hearings on Shadow Banking

The Financial Crisis Inquiry Commission is holding two days of hearings on the Shadow Banking System.  Today's witnesses include a number of former Bear Stearns people, including former CEO James Cayne, as well as SEC folks, including former Chairs Cox and Donaldson.  Tomorrow's witnesses include former Treasury Secretary Paulson and current Treasury Secretary Geithner.  Hearings can be viewed at the Commission's website.

May 5, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Dodd Announces Agreement to Drop Industry Liquidation Fund

Senator Dodd announced that he and Senator Shelby have reached agreement to drop the provision calling for an industry-paid fund for future liquidations of financial services firms and, in his words, "With this agreement there can be no doubt that this Senate is unified in its commitment to end taxpayer funded bailouts.”  You will recall that some Republicans made the assertion that this provision would somehow encourage future bailouts.

May 5, 2010 in News Stories | Permalink | Comments (1) | TrackBack (0)

Tuesday, May 4, 2010

Goldman Sachs Settles SEC Charges Relating to Short Sales

The SEC and Goldman Sachs settled administrative charges alleging that Goldman Sachs Execution & Clearing LLC (GSEC) willfully violated Rule 204T of Regulation SHO by failing to deliver certain securities or immediately purchase or borrow securities to close out the fail to deliver position by no later than the beginning of regular trading hours on the required date.  The charges relate to GSEC’s response to the Commission’s September 17, 2008 emergency order enacting temporary Rule 204T to Regulation SHO (“Rule 204T” or the “Rule”). That Rule was in response to concerns about the effects of “naked” short selling upon securities prices. The Rule required participants of a registered clearing agency to either deliver securities by a trade’s settlement date or, in connection with short sales, immediately purchase or borrow securities to close out the fail to deliver position by no later than the beginning of regular trading hours on the trading day following the settlement date. GSEC initially responded to the Rule by implementing procedures that were inadequate in that they relied too heavily on individuals to perform manual tasks and calculations, without sufficient oversight or verification of accuracy. As a result, on certain occasions in December 2008 and January 2009 (“the relevant time period”), GSEC violated Rule 204T by failing to timely close out fail to deliver positions.

The settlement censures GSEC and imposes a civil money penalty in the amount of $225,000. 


May 4, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Will Take Over NYSE Reg Surveillance and Enforcement Functions

NYSE Euronext (NYSE: NYX) and the Financial Industry Regulatory Authority (FINRA) today announced that they have agreed that FINRA will assume responsibility for performing the market surveillance and enforcement functions currently conducted by NYSE Regulation. The agreement is subject to review by the Securities and Exchange Commission.  Under the agreement announced today, FINRA would assume regulatory functions for NYSE Euronext's U.S. equities and options markets – the New York Stock Exchange, NYSE Arca and NYSE Amex. FINRA currently provides regulatory services to the NASDAQ Stock Market, NASDAQ Options Market, NASDAQ OMX Philadelphia, NASDAQ OMX Boston, The BATS Exchange and The International Securities Exchange.

The final agreement is expected to be completed in the next several weeks, with an effective date anticipated to be at or prior to the end of June.

 NYSE Euronext, through its subsidiary NYSE Regulation, will remain ultimately responsible for overseeing FINRA's performance of regulatory services for the NYSE markets. It will also retain staff associated with rule interpretations, and oversight of listed issuers' compliance with the NYSE markets' financial and corporate-governance standards. The agreement involves approximately 225 staff, most of whom will be transferred to FINRA.

May 4, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Fiduciary Duty and Sophisticated Investors

The Goldman hearings raised, front and center, the question whether broker-dealers should owe fiduciary duties to sophisticated investors.  In his talk to Berkshire Hathaway over the weekend, Warren Buffett gave a robust defense of Goldman Sachs and expressed his own lack of sympathy with the investors on the other side of the deal. CNBC, Warren Buffett Defends Goldman Sachs At Berkshire Shareholders.  In contrast, SEC Commissioner Aguilar recently gave a talk in which he asserts that all advice-givers should be fiduciaries, whatever the sophistication of the customer they are dealing with.  Aguilar, Protecting Investors by Requiring that Advice-Givers Stay True to the Fiduciary Framework.

I confess, as a diehard advocate for retail investors, that I don't have much concern for sophisticated investors either.  But the debate about whether Goldman was a fiduciary provides another illustration of overbroad, and unnecessary, misuse of the fiduciary duty standard.  As I read the SEC's allegations against Goldman, the SEC is alleging that Goldman made material misrepresentations to the counterparties because it misrepresented that the portfolio was selected by ACA Management when in fact it was selected by Paulson.  The SEC has serious obstacles in proving its case, as others have pointed out, principally materiality, but this is a straight-forward misrepresentation case and if the SEC can prove its allegations, it should win.  If Goldman had made no representations about who assembled the portfolio and the counterparties asked no questions about it, then only a fiduciary standard would impose liability on Goldman; to win this hypothetical case, the SEC would have to establish that Goldman was acting as an investment adviser to the investors.  But that is not the theory of its case.  

Moreover, going back to Commissioner Agular's premise, there are good reasons not to extend a fiduciary duty to broker-dealers when they are not acting as investment advisers to sophisticated investors.  Broker-dealers interact with sophisticated investors as underwriters and market dealers, and in those roles they are likely to provide some sales talk and advice.  But, unless the investor and broker-dealer agree that the broker-dealer is acting as an investment adviser, sophisticated investors should be  able to understand the self-interested nature of the broker-dealer's role, ask the appropriate questions, and negotiate the terms and conditions of their relationship.  Retail investors, in contrast, need greater legal protection because they are likely to be confused and are not able to bargain for better protection. 

May 4, 2010 in News Stories, SEC Action | Permalink | Comments (1) | TrackBack (0)

Amendment to Harmonize Broker-Dealer/Investment Adviser Regulation Will be Introduced in the Senate

Senators Menendez and Akaka plan to introduce an amendment (Download Menendez amendment) to the Senate's version of the financial reform legislation that will require the SEC to enact rules to provide that broker-dealers that offer personalized investment advice about securities to retail customers are subject to the same standard of conduct applicable to investment advisers.  However, the law would not require broker-dealers to have a continuing duty of care or loyalty to the customer after providing personalized investment advice.  In addition, an amendment to the Investment Advisers Act would provide that the standard of conduct for all brokers, dealers and investment advisers, when providing personalized investment advice about securities to retail customers, shall be "to act in the best interest of the customer without regard to the financial or other interest of the advice giver."  The receipt of compensation based on commission or other standard compensation for the sale of securities shall not, by itself, be considered a violation of the standard.  The section specifically provides that any material conflicts of interest must be disclosed and consented to in advance by the customer.  The SEC would have the authority to extend the standard to other customers as well.This amendment would replace the current language in the Senate bill that calls for the SEC to conduct a study. 

As I have discussed in a recent paper, there is a consensus that applying different standards of conduct for those who provide investment advice to retail customers makes no sense; the battle (and it is a fierce one) is what the common standard should be.  Unfortunately, the debate is generally framed as whether broker-dealers should be subject to a fiduciary duty as investment advisers are.  Framing the issue this way is an unfortunate simplication since it is based on two basic misunderstandings: (1) there is a clear understanding of what a fiduciary standard requires of investment advice providers, and (2) brokers do not currently owe their customers standards of care and loyalty. 

I argue in my paper that retail customers will benefit from improved protection if the law gave full effect to the existing professional standards of care and  competence (due diligence, suitability) recognized under SRO rules.  In addition, the disclosure rules with respect to conflicts of interest need to be strengthened; the boilerplate after-the-fact disclosure of possible conflicts of interest on confirmations is manifestly inadequate.  All this can be accomplished by the SEC through its existing rule-making authority without mention of the confusing amorphous "fiduciary duty" language.

Moreover, the Akaka/Menendez amendment has one serious deficiency -- it would not permit the SEC to adopt rules that would extend the broker's duties to the customer after the time of the transaction.  This reflects the current law that generally the broker's duty is transaction-specific and does not include monitoring the customer's portfolio.  However, many brokers sell their services to the customer on the basis of their ongoing attention to the customer's needs.  Where brokers represent that they are monitoring the account, they should be held to their word.

Finally, if Congress is serious about improving investor protections, it should adopt a federal private cause of action for negligent adviser advice.  Unless there is an explicit private federal remedy, brokers can recite the current law that there is no private cause of action for breach of SRO and SEC rules (apart from Rule 10b-5, which requires scienter), to limit their liability.  Fortunately, under SRO arbitration, arbitrators are not required to apply legal tests about the limits of implying private causes of action and frequently will allow customers to recover.  Whatever the deficiencies in manddatory SRO arbitration, this is its great benefit to investors.  However, if Congress determines that mandatory SRO arbitration should be prohibited, investors will be forced to bring their claims in either state or federal court, which will apply the current anti-investor law. There is nothing in the proposed legislation that would give investors any right to recover damages based on any SEC conduct rules adopted pursuant to this legislation.

May 4, 2010 in News Stories, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)