Securities Law Prof Blog

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

Saturday, May 15, 2010

Branson on SEC Enforcement

Trekking Toward Über Regulation: Prospects for Meaningful Change at SEC Enforcement?, by Douglas M. Branson, University of Pittsburgh School of Law, was recently posted on SSRN.  Here is the abstract:

Whether used in analysis of Senator Christopher Dodd’s, the administration’s, or anyone else’s regulatory reform proposals, a phrase often heard in Washington, D.C., is über regulation. Large, or very large, (über) regulators of banks and financial institutions are thought to be necessary for at least three reasons. First, large financial institutions (Goldman Sachs, Bank of America, Citigroup) need to counterbalanced with large, all powerful regulators. Second, broad (large) grants of subject matter jurisdiction are necessary to eliminate possibilities for regulatory arbitrage which currently exist (banks, for example, may be able to chose from among the Office of Comptroller of the Currency, the Federal Reserve, or various state’s departments of banking or financial institutions as their principal regulator). Third, only an über regulator would have the overview to detect and the powers to curb unacceptable levels of systemic risk which may lurk over the horizon from time to time. This article recounts some of those arguments, also documenting the downside of über regulation, such as loss of historic camaraderie and high morale in certain smaller regulatory agencies such as the SEC.

May 15, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Branson on Stock Borrowing Programs

More Muscle Behind Regulation SHO? Short Selling and the Regulation of Stock Borrowing Programs, by Douglas M. Branson, University of Pittsburgh School of Law, was recently posted on SSRN.  Here is the abstract:

Recent amendments to SEC Regulation SHO (originally adopted in 2004) have implemented hard close requirements for fails to deliver which often follow the naked short selling of stock (selling short without having borrowed the shares). Naked short selling is frequently a central plank in a program designed to manipulate (illegally) securities prices. Hard close requirements have cut the fails to deliver by 50 percent, or more, from considerably over 1 billion shares per day. Those requirements have also created, however, before the fact, added impetus for the borrowing of stock. Recently, a middleman for a stock borrowing agency was convicted of securities fraud in the Eastern District of New York. By and large, though, regulation of stock borrowing and stock borrowing programs are unregulated, with the result that individual investors who lend shares of stock receive little or no disclosure and are often pigeons waiting to be plucked by short sellers and others. This article advocates regulation by the SEC of stock borrowing programs. Alternatively, the article argues that under existing law, stock borrowing programs and participation in them are investment contracts, and therefore securities. The ramification is that as a matter of common law stock lenders are entitled to full and fair disclosure by those who offer to borrow, or do borrow, shares.

May 15, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Webber on Individual Investors in Securities Class Actions

The Plight of the Individual Investor in Securities Class Actions, by David H. Webber, Center for Law & Business at New York University School of Law and Stern School of Business, was recently posted on SSRN.  Here is the abstract:

Individual investors victimized by securities fraud have no voice in directing class actions brought on their behalf once institutional investors obtain lead plaintiff appointments. The same holds for securities class actions brought at the state level claiming breaches of fiduciary duty by boards of directors in connection with mergers and acquisitions. In theory, the interests of institutional investors align with those of individual investors, nullifying the need for a separate voice for individuals; one rationale for the lead plaintiff reforms of the Private Securities Litigation Reform Act of 1995 was that individual investors would benefit from the sophistication of institutional investor lead plaintiffs. But in practice, individual investors’ interests in securities class actions often differ from, and may directly conflict with, those of institutional lead plaintiffs. The steady appointment of institutional lead plaintiffs without regard to these conflicts effectively elevates the interests of institutional over individual investors, running afoul of procedural requirements that the lead plaintiff be adequate and typical of the class. This paper examines the recurrent conflicts between institutional and individual investors in the securities class action context, and suggests that the best remedy for such conflicts is for courts to appoint an individual investor as co-lead plaintiff with an institutional investor. The paper proposes a procedure for selecting such an individual co-lead plaintiff from the pool of sophisticated individuals who are likely to be class members.

May 15, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Friday, May 14, 2010

Senate Votes to Create a Credit-Rating Board to Deal with Conflicts

Yesterday the Senate, by a 64-35 vote, included a provision in the financial reform package to deal with the conflicts of interest of credit rating agencies.  It would create a credit-rating board, under SEC oversight, to act as a middleman between issuers of structured bonds and rating agencies.  The board would select which rating agency would provide the initial rating.  NYTimes, Senate Amends Financial Overhaul Bill; WSJ, Rating Agencies Face Curbs.

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

CEOs Seek to Kill "Proxy Acess" Provision

The Washington Post reports that CEOs are intensifying their lobbying efforts to eliminate the provision in the financial reform package that would authorize the SEC to adopt "proxy access."  WPost, CEOs from far and wide band against financial bill provision.

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

FCIC Issues Preliminary Staff Report on Shadow Banking

The Financial Crisis Inquiry Commission has posted on its website a preliminary staff report on Shadow Banking and the Financial Crisis.  The public can comment on the report until June 18.

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

Thursday, May 13, 2010

FINRA Fines Deutsche Bank Securities for Short-Sales Violations

FINRA fined two broker-dealers a total of $925,000 for executing numerous short sale orders in violation of Regulation SHO and for related supervisory violations. FINRA fined New York's Deutsche Bank Securities $575,000 and Boston's National Financial Services (NFS) $350,000.

Regulation SHO requires that a broker or dealer may not accept or effect a short sale order in an equity security without reasonable grounds to believe that the security can be borrowed, so that it can be delivered on the date delivery is due. Identifying a source from which to borrow such security is generally referred to as obtaining a "locate." Locates must be obtained and documented prior to effecting a short sale.

 Both Deutsche Bank and NFS implemented Direct Market Access trading systems for their customers that were designed to block the execution of short sale orders unless a "locate" had been obtained and documented. But FINRA found that Deutsche Bank disabled its system in certain instances and NFS created a separate system for certain customers – so that in both instances, the systems no longer blocked some short sale orders that did not have valid, associated locates.

FINRA also found that both firms implemented inadequate supervisory systems in connection with their Regulation SHO compliance. Deutsche Bank was aware that its system to block short sale orders in the absence of locates was periodically disabled over a period of more than four years (from January 2005 through September 2009), but failed to devise or implement a replacement procedure. Similarly, NFS created a flawed system for certain customers that failed to ensure that certain short sale orders had valid and timely locates associated with them. NFS's flawed system operated for nearly four years (from January 2005 through August 2008).

May 13, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

New York AG Investigates Whether Big Banks Deceived Rating Agencies

The New York Times reports this morning that the New York Attorney General has issued subpoenas to eight banks, investigating whether they provided false information to rating agencies to obtain higher ratings for mortgage-related securities.  The banks include the usual suspects -- Goldman Sachs, Morgan Stanley, UBS, Citigroup, and Merrill Lynch.  NYTimes, Prosecutors Ask if 8 Banks Duped Rating Agencies.

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

Wednesday, May 12, 2010

Morgan Stanley and its Deals Now Under Government Scrutiny

The Wall St. Journal reports today that the DOJ (out of its New York office) is investigating Morgan Stanley and mortgage-related deals that it designed and marketed (called "Dead President" deals after Presidents Buchanan and Jackson).  Similar to the charges brought by the SEC against Goldman Sachs, the prosecutors are investigating whether there was adequate disclosure of Morgan Stanley's role and that it may have bet against these deals?  The investigation is reportedly in the early stages.  WSJ, U.S. Probes Morgan Stanley; WPost, Justice investigating mortgage-related transactions at Morgan Stanley.

May 12, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, May 11, 2010

Senate Calls for Audit of Fed Reserve

Expressing its frustration with the secretive policies of the Fed, the Senate voted unanimouslyfor a onetime audit to learn details of the emergency funding made by the Fed during the financial crisis.  The Fed would have to post information on its website about firms that received funding.  This measure is a compromise from previous proposals that would have required regular audits.  For details, see WPost, Senate passes measure for increased Fed oversight.

May 11, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Schapiro Testifies on Market Disruption

Here is SEC Chair Schapiro's written testimony submitted for the Capital Markets Subcommittee on the Severe Market Disruption on May 6, 2010.  Her bottom line:

"The sudden evaporation of meaningful prices for many major exchange-listed stocks in the middle of a trading day is unacceptable...."

But no answers yet -- "The SEC is engaging in a comprehensive review and will take necessary steps to implement additional safeguards ...."

May 11, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Settles Short-Selling Charges Against Individuals with no Securities Industry Background

The SEC charged two Boca Raton, Fla., residents for engaging in illegal short selling of securities in advance of participating in numerous secondary offerings to make illicit profits.  These mark the first enforcement actions brought by the SEC under Rule 105 of Regulation M against individuals with no securities industry background.

In separate orders issued by the Commission, Peter G. Grabler was charged with repeatedly violating Rule 105 over a period of more than two years for gains of $636,123. Leonard Adams was charged with similarly violating Rule 105 for gains of $331,387. According to the orders, Grabler and Adams engaged in a strategy of participating in numerous secondary offerings of stock in public companies in order to improve their access to initial public offerings underwritten by the same broker-dealers through which they participated in the secondary offerings.

Grabler and Adams agreed to pay a combined total of more than $1.5 million to settle the SEC's charges. In settling the SEC's charges without admitting or denying the SEC's findings, Grabler and Adams separately consented to cease and desist from violating Rule 105.

May 11, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC and CFTC Announce Joint Advisory Committee on Emerging Regulatory Issues

The SEC and the CFTC announced the formation of a joint committee that will address emerging regulatory issues. The joint committee will develop recommendations on emerging and ongoing issues relating to both agencies. The first item on the committee's agenda is conducting a review of last Thursday's market events and making recommendations related to market structure issues that may have contributed to the volatility, as well as disparate trading conventions and rules across various markets.

The Committee's charter provides for a broad scope of interest, including:

  • Identifying of emerging regulatory risks.
  • Assessing and quantifying of the impact of such risks and their implications for investors and market participants.
  • Furthering the SEC's and CFTC's efforts on regulatory harmonization.

Members of the Joint Committee include:

Brooksley Born, Former Chair of the CFTC
Jack Brennan, Former Chief Executive Officer and Chairman, Vanguard
Robert Engle, Michael Armellino Professor of Finance at the NYU Stern School of Business
Richard Ketchum, Chairman and Chief Executive Officer, FINRA
Maureen O’Hara, Professor of Management, Professor of Finance, Cornell University
Susan Phillips, Dean and Professor of Finance, The George Washington University School of Business
David Ruder, Former Chair of the SEC

May 11, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

NY AG Sues Bank of New York Mellon Adviser Alleging Madoff-Related Fraud

New York Attorney General Cuomo today filed a lawsuit against Ivy Asset Management, LLC (“Ivy”), its former Chief Executive Officer Lawrence Simon, and its former Chief Investment Officer Howard Wohl, alleging that they deliberately misled clients about investments tied to Bernard L. Madoff. The complaint alleges that Ivy and the two principals kept their clients in the dark about damaging financial information about Madoff so Ivy could bring in millions in advisory fees.

Ivy is a New York-based investment adviser that is wholly owned by Bank of New York Mellon. Between 1998 and 2008, Ivy was paid over $40 million to give advice and conduct due diligence for clients with large Madoff investments. The lawsuit alleges that while conducting this due diligence, Ivy learned that Madoff was not investing funds as advertised. However, internal e-mails reveal that Ivy did not disclose this information to clients for fear of losing revenue from fees. As a result, Ivy’s clients lost over $227 million after Madoff’s Ponzi scheme collapsed. Among the victims were hundreds of investors as well as dozens of New York union pension and welfare plans.

Specifically, the complaint alleges that:

  • In 1997, Ivy learned that there were not enough options to support Madoff’s purported trading strategy. Specifically, the volume of Standard and Poor’s 100 Index options (“OEX”) available would only support half of the amount of assets Ivy believed Madoff had under management. This strongly suggested that the trades Madoff had been reporting were not actually being made.
  • Between 1997 and 1998, Madoff gave Ivy three vastly different explanations as to where and with whom he traded OEX options, all of which were inconsistent with Ivy’s observations and understanding of OEX options.
  • Ivy received information from industry contacts indicating that Madoff was misusing client assets to fund his broker-dealer business instead of investing the money as he claimed he was doing.

In addition, the complaint quotes from Internal documents that allegedly show that the defendants knew that investing with Madoff was too much of a risk:

An internal Ivy memorandum from 1997 about Madoff states, “[t]his is a clear example of our inability to make sense of Madoff’s strategy, and one where his trades for our accounts are inconsistent with the independent information that is available to us.”
  • When writing to a subordinate in 2002, Wohl wrote “Ah, Madoff, You omitted one possibility - he’s a fraud!”
  • When listing managers who should be recommended to a prospective client in 2003, Wohl wrote, “Madoff (NOT!).”
  • Attorney General Cuomo’s lawsuit seeks payment of restitution, damages, and penalties from Ivy, Simon, and Wohl, as well as the disgorgement of all fees that Ivy received. The lawsuit also seeks to bar Simon and Wohl from acting as investment advisors.

    May 11, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

    Monday, May 10, 2010

    House Capital Markets Subcommittee Schedules Hearing on Market Plunge

    The House Financial Services Committee, Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, has scheduled a hearing for tomorrow at 3 p.m. on The Stock Market Plunge:  What Happened and What Is Next?  It will be webcast.

    Here is the Witness List:

    Panel One

     The Honorable Mary L. Schapiro, Chairman, U.S. Securities and Exchange Commission
    Accompanied by Mr. Robert W. Cook, Director, Division of Trading and Markets, U.S. Securities and Exchange Commission

    The Honorable Gary Gensler, Chairman, U.S. Commodity Futures Trading Commission

    Panel Two

    Mr. Lawrence Leibowitz, Chief Operating Officer, NYSE Euronext
    Mr. Eric Noll, Executive Vice President, NASDAQ Transaction Services
    Mr. Terrence A. Duffy, Executive Chairman, CME Group Inc.

    May 10, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

    SEC Investor Advisory Committee Will Discuss Mandatory Arbitration

    Here's the agenda for the May 17 meeting of the SEC's Investor Advisory Committee.  I'm pleased to say that I will be speaking on the experts panel on mandatory securities arbitration (item vi) along with Professor Jennifer Johnson (Lewis & Clark), Linda Fienberg (FINRA) and Patricia Cowart (Wells Fargo Advisors).  Professor Mercer Bullard (Mississippi) chairs the Committee.

    The agenda for the meeting includes: (i) remarks by Dan Ariely, behavioral economist, on investor reaction to disclosure; (ii) update on recommendations previously adopted by the Committee; (iii) briefing on the Investor as Owner Subcommittee's environmental, social, and governance disclosure workplan; (iv) update on certain issues involved in financial reform legislation; (v) discussion of fiduciary duty, in the context of investment advisers and registered broker-dealers, including a presentation by SEC staff; (vi) discussion with an expert panel on mandatory arbitration; (vii) discussion of money market funds and the issue of net asset value (NAV), including a presentation by SEC staff; (viii) recommendation by Investor Education Subcommittee of an investor education campaign; (ix) reports from Subcommittees on other activities; and (x) discussion of next steps and closing comments.

    May 10, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

    SEC & Exchanges Agree to Strengthen Circuit Breakers

    There still is a great deal of mystery surrounding the unusual trading activity last Thursday afternoon.  Here is today's brief statement from the SEC:

    This morning, SEC Chairman Mary Schapiro had a constructive meeting with the leaders of six exchanges — the New York Stock Exchange, NASDAQ, BATS, Direct Edge, ISE and CBOE — and the Financial Industry Regulatory Authority to discuss the causes of Thursday's market events, the potential contributing factors, and possible market reforms.

    "As a first step, the parties agreed on a structural framework, to be refined over the next day, for strengthening circuit breakers and handling erroneous trades."

    May 10, 2010 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)

    Sunday, May 9, 2010

    Reiffen & Robe on Demutualization of Exchanges

    Demutualization and Customer Protection at Self-Regulatory Financial Exchanges, by David Reiffen, U.S. Commodity Futures Trading Commission (CFTC), and Michel A. Robe, American University - Kogod School of Business, was recently posted on SSRN.  Here is the abstract:

    In the past decade, many of the world’s largest financial exchanges have demutualized, i.e., converted from mutual, not-for-profit organizations to publicly-traded, for-profit firms. In most cases, these exchanges have substantial responsibilities with respect to enforcing various "trade practice" regulations that protect investors from dishonest agents. We examine how the incentives to enforce such rules change as an exchange demutualizes. In contrast to oft-stated concerns, we find that, in many circumstances, an exchange that maximizes shareholder (rather than member) income has a greater incentive to aggressively enforce these types of regulations.

    May 9, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

    Bondi on Arbitrating Securities Class Actions

    Facilitating Economic Recovery and Sustainable Growth Through Reform of the Securities Class-Action System: Exploring Arbitration as an Alternative to Litigation, by Bradley J. Bondi, Securities and Exchange Commission (SEC); Georgetown University Law Center; George Mason University - School of Law, was recently posted on SSRN.

    May 9, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)