Securities Law Prof Blog

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

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Friday, January 22, 2010

Customers' Arbitration Claims Up 43% in 2009

FINRA reports 7137 arbitration claims were filed in 2009, up 43% from 2008.  Not surprisingly, the most common complaints against brokers were breach of fiduciary duty, misrepresentations, negligence, breach of contract, failure to supervise, omissions and unsuitability.

January 22, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Thursday, January 21, 2010

Brooklyn Law Symposium on The Law and Morality of Punishing Collective Entities

On February 5, Brooklyn Law School is holding a fascinating symposium entitled Sharing the Blame: The Law and Morality of Punishing Collective Entities.  Panels will include psychologists (Tom Tyler, among others), theorists and philosophers (Meir Dan Cohen), and corporate and criminal law scholars, including Peter Henning (Wayne State), Jayne Barnard (W&M), James Fanto (Brooklyn).  The program is free for those who do not want CLE credit, but RSVPs are required.  See the brochure ( Download BLS TragerSymposium ) for more information.

January 21, 2010 in Professional Announcements | Permalink | Comments (0) | TrackBack (0)

President Proposes Additional Banking Reforms

President Obama announced two additional proposals for reforming the nation's banks.  The first, which he named the Volcker Rule after its proponent, Paul Volcker (who stood behind the President at the press briefing), would prohibit banks from owning, investing, or sponsoring hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers.  The second would  prevent the further consolidation of our financial system.  There has long been a deposit cap (10%) in place to guard against too much risk being concentrated in a single bank.  Under the proposed reform, the same principle would apply to wider forms of funding employed by large financial institutions in today's economy. 
Continuing with his verbal campaign against big banks, the President said:

So if these folks want a fight, it's a fight I'm ready to have.  And my resolve is only strengthened when I see a return to old practices at some of the very firms fighting reform; and when I see soaring profits and obscene bonuses at some of the very firms claiming that they can't lend more to small business, they can't keep credit card rates low, they can't pay a fee to refund taxpayers for the bailout without passing on the cost to shareholders or customers -- that's the claims they're making.  It's exactly this kind of irresponsibility that makes clear reform is necessary.

Some early press coverage of his announcement:

NYTimes, Obama Moves to Limit ‘Reckless Risks’ of Big Banks

WPost, Obama proposes tough new limits on large banks' size and investments 

From SIFMA President Tim Ryan's response to the President's proposals:

“Like the President proposed last year, we continue to believe the best way of achieving those goals is to establish a tough, competent and accountable systemic risk regulator. We believe providing for strengthened regulatory oversight and flexibility like that originally proposed by the Administration, as opposed to arbitrary restrictions on growth and activities, is a more effective way of mitigating systemic risk and ending ‘too big to fail’.

January 21, 2010 in News Stories | Permalink | Comments (1) | TrackBack (0)

Wednesday, January 20, 2010

SEC Posts Text of Proposed Rule on Risk Management Controls for Broker-Dealers with Market Access

The SEC posted on its website the text of its previously announced proposed rule Rule 15c3-5 under the Securities Exchange Act of 1934 (“Exchange Act”) that would require brokers or dealers with access to trading directly on an exchange or alternative trading system (“ATS”), including those providing sponsored or direct market access to customers or other persons, to implement risk management controls and supervisory procedures reasonably designed to manage the financial, regulatory, and other risks of this business activity. Given the increased speed and automation of trading on securities exchanges and ATSs today, and the growing popularity of sponsored or direct market access arrangements where broker-dealers allow customers to trade in those markets electronically using the broker-dealers’ market participant identifiers, the Commission is concerned that the various financial and regulatory risks that arise in connection with such access may not be appropriately and effectively controlled by all broker-dealers. The Commission believes it is critical that broker-dealers, which under the current regulatory structure are the only entities that may be members of exchanges and, as a practical matter, constitute the majority of subscribers to ATSs, appropriately control the risks associated with market access, so as not to jeopardize their own financial condition, that of other market participants, the integrity of trading on the securities markets, and the stability of the financial system.  Risk Management Controls for Brokers or Dealers with Market Access AGENCY: Securities and Exchange Commission

January 20, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Settles Insider Trading Charges Against Former Mutual Fund Insider

The SEC settled insider trading charges against Charles J. Marquardt, a former Senior Vice President and Chief Administrative Officer for operations of Boston-based Evergreen Investment Management Company, LLC ("Evergreen").  The SEC charged Marquardt with insider trading in the shares of the Evergreen Ultra Short Opportunities Fund (the "Ultra Fund"), a mutual fund that invested primarily in mortgage-backed securities. Marquardt has agreed to pay approximately $40,000 to settle the charges.

The Commission's complaint alleges that, on June 11, 2008, Marquardt learned that the Ultra Fund might soon reduce the value it assigned to several of its mortgage-backed securities holdings, a move that would likely decrease the Fund's per-share net asset value ("NAV") and might cause the Fund to close. The complaint further alleges that, on the next day, June 12, 2008, Marquardt redeemed all of his Ultra Fund shares and caused a family member to do the same. Over the next several days, the Fund did, in fact, decrease the value it assigned to its holdings, triggering significant reductions of the Fund's NAV. On June 19, 2008, Evergreen publicly announced that the Ultra Fund would be liquidated. The Commission's complaint alleges that, by redeeming their Ultra Fund shares prior to the closing of the Fund on June 19, Marquardt and his family member avoided losses of approximately $4,803 and $14,304, respectively.

To settle the Commission's charges, Marquardt consented, without admitting or denying the allegations in the Commission's complaint, to the entry of a final judgment permanently enjoining him from violating Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Marquardt also agreed to pay $19,107 in disgorgement, representing the losses that he and his family member avoided, $1,242 in prejudgment interest, and a $19,107 civil penalty. In separate administrative proceedings to be instituted after the entry of the permanent injunctions, Marquardt has also consented to be barred from association with any broker, dealer or investment adviser, with a right to reapply after two years.

The Commission's action against Marquardt follows the Commission's enforcement action against Evergreen and an affiliated distributor, filed in June 2009, in which the Commission charged Evergreen with violating the federal securities laws in connection with, among other things, overvaluing holdings in the Ultra Fund from February 2007 to June 2008. Evergreen agreed to pay more than $40 million to settle those charges.

January 20, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Agenda for SEC Jan. 27 Open Meeting

The SEC's next Open Meeting is scheduled for January 27, 2010.  The subject matter of the Open Meeting will be:

Item 1: The Commission will consider a recommendation to adopt new rules, rule amendments, and a new form under the Investment Company Act of 1940 governing money market funds, to increase the protection of investors, improve fund operations, and enhance fund disclosures.

Item 2: The Commission will consider a recommendation to publish an interpretive release to provide guidance to public companies regarding the Commission's current disclosure requirements concerning matters relating to climate change.

January 20, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC and General Re Settle Accounting Fraud Allegations at AIG and Prudential Finance

The SEC and General Re Corporation settled fraud charges relating to General Re's alleged involvement in separate schemes by American International Group and Prudential Financial, Inc. to manipulate and falsify their reported financial results.  According to the SEC's complaint, a foreign subsidiary of Gen Re entered into two sham “reinsurance” transactions with AIG in 2000 to improperly allow AIG to reverse the declining reserve trend and falsely report additions to both loss reserves and premiums written. Senior officials at Gen Re helped AIG structure the two sham transactions. The contracts show reinsurance transactions that appeared to transfer risk to AIG, but the transactions did not transfer risk.

The complaint further alleges that Gen Re separately entered into a series of sham reinsurance contracts with Prudential’s property and casualty division from 1997 to 2002. The contracts had no economic substance and purpose other than to allow Prudential to build up and then draw down on an off-balance sheet asset or “finite bank” parked with Gen Re. As a result of the sham transactions, Prudential improperly recognized more than $200 million in revenues in 2000, 2001, and 2002. Gen Re received fees totaling $8.1 million for structuring and executing the scheme with Prudential.

Without admitting or denying the allegations in the complaint, Gen Re has consented to a judgment enjoining it from aiding and abetting violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and directing it to pay $12.2 million in disgorgement and prejudgment interest. The settlement is subject to court approval.

In determining to accept Gen Re’s settlement offer, the SEC took Gen Re’s remediation efforts and cooperation into account. Among the efforts SEC considered: Gen Re’s comprehensive, independent review of its operations conducted at the outset of the government’s investigations the results of which were shared with investigators; Gen Re’s substantial assistance in the government’s successful civil and criminal actions against individuals involved in the scheme with AIG; and Gen Re’s internal corporate reforms designed to strengthen oversight of its operations. Those reforms entail dissolving a subsidiary involved with the AIG transactions, appointing an independent director to its Board of Directors, forming a committee consisting of senior managers to review and approve complex transactions, requiring legal review of proposed finite or loss mitigation contracts, and fortifying its internal audit functions and underwriting rules.

The SEC previously charged AIG with securities fraud and improper accounting, and the company settled the charges by paying more than $800 million among other remedies. The SEC also previously charged AIG former chairman Maurice R. “Hank” Greenberg and former chief financial officer Howard I. Smith, as well as former senior executives of Gen Re for their roles in connection with the scheme with AIG. The Commission separately charged Prudential with securities laws violations in 2008.

January 20, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, January 19, 2010

POGO Blogs on Loops in Derivatives Legislation

The Project on Government Oversight blog has a great post today exploring the initial testimony of the Financial Crisis Inquiry Commission and specifically the loopholes in the proposed regulation of derivatives.  Unfortunately, the FCIC's report is not due until year-end, at which point Congress may have already enacted legislation addressing the financial crisis.

January 19, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

USD Law School Establishes its Center for Corporate and Securities Law

The University of San Diego School of Law announces the establishment of its Center for Corporate and Securities Law under the directorship of Professor Frank Partnoy.  The Center describes its mission as helping to "enrich scholarly and popular debate on a wide range of issues related to corporate governance, financial regulation and other business law topics. The center hosts academic and public conferences, publishes papers and discussions from those conferences, provides point-of-contact for popular and business media on issues of broad public interest, supports faculty and student research, and sponsors public lectures."  Congratulations to Frank and USD on this endeavor.  Its inaugural program includes a presentation by Delaware Chancellor Leo Strine.  For information on its programming, see its website

January 19, 2010 in Professional Announcements | Permalink | Comments (0) | TrackBack (0)

SEC Charges BofA with Failure to Disclose Merrill's Losses

Here is the complaint the SEC filed against the Bank of America, charging that the company failed to disclose Merrill Lynch's fourth quarter losses in its proxy solicitation seeking approval for the merger.  You will recall the Judge Rakoff refused to allow the agency to amend its complaint to add this count, but said it could bring a separate action, which it has now done.  The trial in the first action, dealing with the failure to disclose the Merrill Lynch bonuses, is scheduled to begin March 1.

According to the SEC’s complaint, filed in U.S. District Court for the Southern District of New York, Bank of America learned prior to the Dec. 5, 2008, shareholder vote that Merrill Lynch had incurred a net loss of $4.5 billion in October 2008 and estimated billions of dollars of additional losses in November. Bank of America erroneously and unreasonably concluded that no disclosure concerning these extraordinary losses was required as shareholders were called upon to vote on the proposed merger with Merrill Lynch. The lack of any disclosure about the losses deprived shareholders of up-to-date information that was essential to their ability fairly to evaluate whether to approve the merger on the terms presented to them. Bank of America’s failure to disclose this information violated its undertaking to update shareholders concerning fundamental changes to previously disclosed information, and rendered its prior disclosures materially false and misleading.

According to the SEC’s complaint, the actual and estimated losses at Merrill Lynch for the fourth quarter of 2008 together represented approximately one-third of the value of the merger at the time of the shareholder vote and more than 60 percent of the aggregate losses that the firm sustained in the preceding three quarters combined. The SEC’s complaint further alleges that Merrill’s deteriorating performance represented a fundamental change to the financial information that Bank of America provided shareholders in the proxy statement used to solicit votes for approval of the merger. In connection with the merger, Bank of America also publicly filed a registration statement in which it represented that it would update shareholders about any fundamental changes in the information previously disclosed.

The SEC’s complaint charges Bank of America with violating Section 14(a) of the Securities Exchange Act of 1934 and SEC Rule 14a-9 by failing to make any disclosure to its shareholders of the losses that Merrill Lynch incurred in the two-month period leading to the Dec. 5, 2008 shareholder vote.

January 19, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

D.C. Circuit Vacates Restitution Order in NASD Disciplinary Proceeding for Lack of Causation

The D.C. Circuit's opinion in Siegel v. SEC (No. 08-1379, Jan. 12, 2010) contains at least two lessons.  First, the D.C. Circuit continues its longstanding practice of stridently criticizing the agency's decisionmaking.  Second, causation principles, which have been used so effectively since Dura to limit recovery of private plaintiff's' damages, also limit the ability of regulators to impose restitution as a remedy in brokers' disciplinary proceedings.  Calling the SEC's decision "incomprehensible" and "border[ing] on whimsical"and its reasoning "nonsense," the court vacated the SEC's affirmance of a NASD (now FINRA) order awarding restitution to investors who purchased investments from a registered representative, even though it affirmed the finding that the broker violated the SRO's selling away and suitability rules.  The court also confirmed the order that the six-month suspensions for each violation would run consecutively, and not concurrently.

Principle 5 of NASD's Sanction Guidelines permits restitution as an appropriate remedy to remediate misconduct and specifically provides that:

Adjudicators may order restitution when an identiable person ... has suffered a quantifiable loss as a result of a respondent's misconduct, particularly where a respondent has benefitted from the misconduct.

In this case, the broker recommended to two sophisticated investors that they invest in a speculative start-up investment with whom the broker had a relationship that he did not disclose to his firm.  The broker did not review the offering documents provided by the start-up, which were deficient in describing the nature of the investment.  Ultimately, the venture failed.  None of the investors nor the broker made any money from the venture.  While the NASD Hearing Panel declined to award restitution, the NASD appellate body ordered the broker to pay restitution to the investors in the amount of their losses, and the SEC affirmed the order.  The D.C. Circuit, however, agreed with the broker that the SEC failed to assess the "cause" of the losses suffered by the investors, and thus the agency's decision to uphold the NASD order was an abuse of discretion.

The opinion makes clear that "but for" causation, or reliance, is not sufficient to establish the requisite causation to justify restitution.  "If the plaintiffs would have lost their investment regardless of the fraud, any award of damages to them would be a windfall...."  While the court does not go so far as to require "loss causation" under Dura and its progeny, the SEC must offer some test of causation to establish a meaningful causal connection to justify restitution under Principle 5.  It also noted that it had found no SEC precedent to support restitution in these circumstances:

...[T]his case involves wealthy and sophisticated customers, who were not pressed to decide whether to invest; customers who invested in furtherance of their specific desires to speculate in a high risk venture; and a broker who did not profit from his wrongdoing and who has been fined and suspended for his violation.  The SEC has never ordered restitution in a situation such as this.  Indeed, all of the cases cited by the SEC indicate that restitution has been ordered only in situations in which causation is clear, i.e., there has been proof that the amount charged in restitution is closely and inextricably tied to the amount lost as a result of the broker's wrongdoing.


January 19, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Sunday, January 17, 2010

Barzuza on State Antitakeover Law

The State of State Antitakeover Law, by Michal Barzuza, University of Virginia - School of Law, was recently posted on SSRN.  Here is the abstract:

This Article is the first to examine systematically state antitakeover law outside Delaware. It conducts a research of all available cases to find whether states with pill endorsement and other constituency statutes follow Delaware’s enhanced fiduciary duties or replace them with weaker standards. It finds substantial variations from Delaware’s law. Unlike Delaware, most of the states with relatively strong other constituency and pill endorsement statutes do not impose enhanced fiduciary duties on managers in change-of-control situations. Instead, they apply only the ordinary business judgment rule to management’s use of antitakeover tactics.

This Article has implications for antitakeover law, the market for corporate law, and the desirability of federal intervention. In particular, it provides support for adopting Delaware’s enhanced fiduciary duties - Unocal, Revlon, and Blasius - as federally imposed minimum standards. This would not only improve state antitakeover law outside Delaware, but may also result in improvements to Delaware law since Delaware is currently dragged down by other states.

January 17, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bebchuk & Fried on Paying for Long-Term Performance

Paying for Long-Term Performance, by Lucian A. Bebchuk, Harvard University - Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI), and Jesse M. Fried, Harvard Law School, was recently posted on SSRN.  Here is the abstract:

Firms and regulators around the world are now seeking to ensure that the compensation of public company executives is tied to long-term results to avoid creating incentives for excessive risk-taking. This paper analyzes how this objective can be best achieved. Focusing on equity-based compensation, the primary component of executive pay packages, we identify how such compensation could be best structured to tie remuneration to long-term results rather than short-term gains that might turn out to be illusory. We also analyze how equity compensation could be best designed to prevent the gaming of equity grants at either the front-end or the back-end.

January 17, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Listokin & Taibleson on Improving Credit Rating Accuracy

If You Misrate, then You Lose: Improving Credit Rating Accuracy Through Incentive Compensation, by Yair Jason Listokin, Yale Law School, and Benjamin Taibleson, Yale Law School, was recently posted on SSRN.  Here is the abstract:

Credit rating agencies (CRAs) serve many roles in maintaining properly functioning debt markets. Their contribution to both Enron-era financial scandals and the 2008-2010 financial crisis, however, has led to many calls for credit rating reform. This Essay proposes an incentive compensation scheme in which CRAs are paid with the debt they rate. If a CRA overrates debt, then the CRA suffers a financial penalty because the debt the CRA receives as compensation is less valuable than the cash compensation that the debt is replacing. We believe that this reform, though imperfect, would be more likely to generate accurate ratings than other credit rating reform proposals. We also discuss extensions of our basic debt compensation proposal that mitigate some of debt compensation’s weaknesses, though at the cost of greater complexity.

January 17, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)