Securities Law Prof Blog

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

Friday, August 20, 2010

BofA Deny Fraud Charges in New York AG's Action

Bank of America Corp. and its former CEO Ken Lewis filed aggressive responses to the New York AG's civil fraud suit involving the BofA-Merrill Lynch merger, calling the merger "an unmitigated financial and strategic success."  Defendants did not make a motion to dismiss the charges.  WSJ, Bank Of America, Ex-CEO Lewis Deny Fraud Charges

August 20, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Thursday, August 19, 2010

Former Ernst & Young Partner Settles Insider Trading Charges

On August 16, 2010, the United States District Court for the Southern District of New York entered final judgments against James E. Gansman and Donna B. Murdoch in SEC v. Gansman et al., 08-CV-4918, an insider trading case the Commission filed on May 29, 2008.  The Commission charged Gansman, who was an attorney and partner in the Transaction Advisory Services group at Ernst & Young, with having tipped Murdoch, who was a stockbroker and close friend of Gansman, concerning the identities of at least seven different acquisition targets of Ernst & Young valuation services clients. The complaint further alleged that two of the seven acquisitions were tender offers; that Murdoch used Gansman’s tips to trade in the securities of all seven of the acquisition targets; and that Murdoch also tipped her father, Gerald Brodsky, concerning one of the acquisitions and recommended trading in two of the acquisition targets to two other persons; and, finally, that all three persons then traded on Murdoch’s communications.

To settle the Commission’s charges, Gansman and Murdoch each consented, without admitting or denying the allegations in the Commission’s complaint, to a separate final judgment that permanently enjoins each, respectively, from violating Exchange Act Sections 10(b) and 14(e) and Rules 10b-5 and 14e-3 thereunder.  The final judgment to which Gansman consented further orders him to pay disgorgement of $233,385 together with $16,470 in prejudgment interest thereon, and $145 in post-judgment interest, but allows him one year from the entry of the final judgment to satisfy this payment obligation—with $200,000 due within ten days, and the remainder due within one year, of the entry of the final judgment.  The final judgment to which Murdoch consented further orders that she is liable for disgorgement of $339,110 together with $64,943.52 in prejudgment interest thereon, but, based on her demonstrated inability to pay, waives payment of disgorgement and prejudgment interest and does not impose a civil penalty.  Because a default judgment was previously entered against the sole other defendant in the Commission’s case, Gerald Brodsky, the settlements announced today conclude this litigation.  Additionally, Gansman and Murdoch each consented, in related administrative proceedings, to the entry of a Commission order that, in the case of Gansman, suspends him from appearing or practicing before the Commission as an attorney, and in the case of Murdoch, bars her from association with any broker or dealer.

Gansman and Murdoch were also each prosecuted criminally by the United States Attorney’s Office for the Southern District of New York.  In that parallel criminal prosecution, Gansman was convicted by a jury on May 15, 2009, following a two-week trial, on six felony counts of having tipped Murdoch; he was sentenced in February 25, 2010 to a year-and-a-day in prison, six months probation, and a $600 special assessment, and is currently incarcerated.  For her part, Murdoch pled guilty to seventeen counts of a superseding information on December 23, 2008—including fifteen counts of securities fraud, one count of false statements, and one count of obstructing the Commission’s investigation—and is awaiting sentencing.

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

SEC Takes up Proxy Access on August 25

The SEC announced that its next open meeting will be August 25, at which the agenda item is:

The Commission will consider whether to adopt changes to the federal proxy and other rules to facilitate director nominations by shareholders.

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

FiNRA Fines HSBC Securities (USA) for Unsuitable Sales of Risky CMOs

FINRA fined HSBC Securities (USA) Inc. $375,000 for recommending unsuitable sales of inverse floating rate Collateralized Mortgage Obligations (CMOs) to retail customers. HSBC failed to adequately supervise the suitability of the CMO sales and fully explain the risks of an inverse floating rate or other risky CMO investment to its customers.  As a result of HSBC not implementing an adequate supervisory system and procedures relating to the sale of inverse floating rate CMOs to retail customers, six of its brokers made 43 unsuitable sales of inverse floaters to retail customers who were unsophisticated investors and not suited for high-risk investments. In addition, HSBC's procedures required a supervisor's pre-approval of any sale in excess of $100,000; FINRA found that 25 of the 43 CMO sales were in amounts exceeding $100,000 and that in five of these instances, customers lost money in their inverse floating rate CMO investments. HSBC has paid these customers full restitution totaling $320,000.

 A CMO is a fixed income security that pools mortgages and issues tranches with various characteristics and risks. CMOs make principal payments throughout the life of the security with the maturity date being the last date by which all of the principal must be returned. The timing of the return of principal payments can vary depending on interest rate changes.  One of the more risky CMO tranches is the inverse floater, a type of tranche that pays an adjustable rate of interest that moves in the opposite direction from movements of an interest rate index, such as LIBOR. Since 1993, FINRA has advised firms that inverse floating rate CMOs "are only suitable for sophisticated investors with a high-risk profile."

In concluding this settlement, HSBC neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

August 19, 2010 in Other Regulatory Action | Permalink | Comments (1) | TrackBack (0)

Wednesday, August 18, 2010

Treasury Named as Selling Shareholder in GM Registration Statement

The U.S. Department of the Treasury today announced that it has agreed to be named as a selling shareholder of common stock in General Motors Company's (GM) registration statement on Form S-1 filed with the Securities and Exchange Commission (SEC) for a proposed initial public offering.  Treasury will retain the right, at all times, to decide whether and at what level to participate in the offering.

Treasury owns 60.8 percent of the common stock of GM as well as $2.1 billion of Series A preferred stock.  The proposed initial public offering will not include the Series A preferred stock held by Treasury.

August 18, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Fines Merrill Lynch $500,000 for UIT Sales Discounts Failures

FINRA fined Merrill Lynch $500,000 for failing to provide sales charge discounts to customers on eligible purchases of Unit Investment Trusts (UITs). FINRA also found that Merrill Lynch failed to have an adequate supervisory system in place to ensure customers received appropriate UIT discounts. The firm also agreed to provide remediation of more than $2 million to affected customers.

 A UIT is a type of investment company that offers redeemable units, of a generally fixed portfolio of securities, that terminate on a specific date. UIT sponsors generally offer sales charge discounts to investors, known as "breakpoint discounts" and "rollover and exchange discounts."  A breakpoint discount is a reduced sales charge based on the dollar amount of the purchase – the higher the amount the greater the discount. Breakpoints generally function as a sliding reduction in the sales charge percentage available for purchases, usually beginning at $25,000 or $50,000 (or the corresponding number of units).  A rollover or exchange discount is a reduced sales charge that is offered to investors who use the termination or redemption proceeds from one UIT to purchase another UIT.

 On March 31, 2004, FINRA issued a Regulatory Notice to firms titled, Unit Investment Trust Sales. The Notice reminds broker-dealers that they should develop and implement procedures to ensure customers receive appropriate sales charge discounts for UITs.

Prior to May 2008, however, Merrill Lynch's written supervisory procedures had little to no information or guidance regarding UIT sales charge discounts. Even after the firm established procedures addressing UIT sales charge discounts, the procedures were inaccurate and conflicting.  Merrill Lynch's procedures lacked substantive guidelines, instructions, policies or steps for brokers or their supervisors to follow to determine if a customer's UIT purchase qualified for and received a sales charge discount. As a result of its defective procedures, between October 2006 and June 2008, the firm failed to appropriately apply discounts on rollover and breakpoint purchases resulting in customers being overcharged on their UIT purchases.

Merrill Lynch settled this matter without admitting or denying the allegations, but consented to the entry of FINRA's findings.

August 18, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

New Jersey Settles SEC Charges of Misleading Disclosures about Pension Funding

The SEC today charged the State of New Jersey with securities fraud for misrepresenting and failing to disclose to investors in billions of dollars worth of municipal bond offerings that it was underfunding the state's two largest pension plans. New Jersey is the first state ever charged by the SEC for violations of the federal securities laws. New Jersey agreed to settle the case without admitting or denying the SEC's findings.

According to the SEC's order, New Jersey offered and sold more than $26 billion worth of municipal bonds in 79 offerings between August 2001 and April 2007. The offering documents for these securities created the false impression that the Teachers' Pension and Annuity Fund (TPAF) and the Public Employees' Retirement System (PERS) were being adequately funded, masking the fact that New Jersey was unable to make contributions to TPAF and PERS without raising taxes, cutting other services or otherwise affecting its budget. As a result, investors were not provided adequate information to evaluate the state's ability to fund the pensions or assess their impact on the state's financial condition.

Among New Jersey's material misrepresentations and omissions:

  • Failed to disclose and misrepresented information about legislation adopted in 2001 that increased retirement benefits for employees and retirees enrolled in TPAF and PERS.
  • Failed to disclose and misrepresented information about special Benefit Enhancement Funds (BEFs) created by the 2001 legislation initially intended to fund the costs associated with the increased benefits.
  • Failed to disclose and misrepresented information about the state's use of the BEFs as part of a five-year "phase-in plan" to begin making contributions to TPAF and PERS.
  • Failed to disclose and misrepresented information about the state's alteration and eventual abandonment of the five-year phase-in plan.

August 18, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, August 17, 2010

Third Circuit: Fraud Created the Market Theory Makes No Sense

The Third Circuit rejected the fraud-created-the market theory of presumed reliance in federal securities class actions, holding that it "lacks a basis in common sense, probability, or any of the other reasons commonly provided for the creation of a presumption."  Malack v. BDO Seidman, LLP (3d Cir. Aug. 16, 2010)(Download MalackvBDOSeidman)

The class consisted of investors that purchased notes directly from the issuer American Business in registered offerings.  The notes promised to pay above-market rate interest, were non-transferable, could only be cashed in after they matured, and had no resale market.  They brought this action against the accounting firm after the company's bankruptcy filing, alleging that its audits were deficient.  The district court denied class certification, concluding that the proposed class did not meet the predominance requirement of Rule 23 because the investors could not establish a presumption of reliance. 

In affirming, the Third Court rejects the fraud-created-the market theory, as set forth in the Fifth Circuit's 1981 Shores v. Sklar opinion, that allows investors to rely on the integrity of the market to the extent that the offered securities are entitled to be in the marketplace.  Unlike the fraud on the market theory, which is based on the efficient market thesis, the fraud-created-the market theory has no underlying economic justification.  The Third Circuit cited the Supreme Court's 2008 Stoneridge opinion as casting doubt on the legitimacy of expansive presumptions of reliance and also recited concerns over frivolous Rule 10b-5 litigation:  A a frivolous class action becomes much more troublesome when it is aided by a presumption of reliance and defendants may seek to settle early and often to avoid litigation costs and the risk of getting hit with a large verdict at trial."

The Third Circuit joins the Seventh Circuit in rejecting the fraud-created-the-market theory.

August 17, 2010 in Judicial Opinions | Permalink | Comments (2) | TrackBack (0)

Monday, August 16, 2010

Judge Refuses to Approve SEC's Settlement with Citigroup

Courts have typically approved SEC settlements under a lenient "fair and reasonable" standard, but Judge Jed Rakoff may have started a trend when he initially refused to approve the agency's settlement with Bank of America involving misstatements about the Merrill Lynch merger.  Today Judge Ellen Segal Huvelle, also of the S.D.N.Y., refused to approve the SEC's proposed settlement with Citigroup involving allegations that the bank failed to disclose the extent of its exposure to subprime assets in 2007.  The judge stated she did not have sufficient information and requested further briefing from the parties.  In the hearing, she specifically questioned why the SEC singled out two individuals -- the former CFO and the head of investor relations -- as well as the corporation and questioned how the amount of the penalty had been calculated.  WSJ, Judge Won't Approve Citi-SEC Pact

August 16, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

What is the Future of Securities Arbitration Post Dodd-Frank?

On August 11 I was a panelist at the PLI-Securities Arbitration 2010 program held in New York City, an annual event that reviews recent developments in FINRA's arbitration rules and practice, as well as updates on judicial developments.  The concluding panel, in particular, was of great interest, as it dealt with the Future of Securities Arbitration.  The various panelists offered their predictions on the future of mandatory securities arbitration since the SEC now has explicit authority, under section 921 of Dodd-Frank, to prohibit predispute arbitration agreements with respect to federal securities claims and claims based on SRO rules.  Linda Fienberg, the head of FINRA Dispute Resolution, stated that FINRA will fight to maintain FINRA Rule 12200, which gives customers the right to demand arbitration of their claims (even in the absence of a PDAA), because of the protection it provides investors.  She also expressed the following concerns if the SEC bans mandatory securities arbitration:

  • years of litigation if the SEC takes action
  • higher costs and long delays for investors if the FINRA forum does not remain an option for them
  • viability of small claims if FINRA arbitration is not an option
  • the impact on investors' ability to collect arbitration awards (FINRA requires broker-dealers and RRs to pay awards as a condition of remaining in the industry)
  • bifurcation of claims, if some investors' claims go to court and others to arbitration

August 16, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

How Independent is Funded Academic Research?

The WSJ's Personal Finance section has an article on academic financial research sponsored by industry and focuses, in particular, on a study of annuities conducted by University of Pennsylvania's Wharton School and funded by New York Life; Beware of 'Independent' Investing Research.  (Full disclosure:  I was co-author of a study on investors' perceptions of arbitration financed by FINRA .)

August 16, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Empowers and Emphasizes Enforcement Division

SEC Chair Mary Schapiro has consistently stated that enhancing and improving the agency's Enforcement Division was one of her priorities in restoring the SEC's reputation.  Two recent examples of this commitment:

1.  Zachary Goldfarb reports that the SEC has made permanent Enforcement's power (previously granted on a temporary basis) to subpoena documents and testimony in an investigation without obtaining approval from the Commissioners; WPost, SEC enforcement division granted permanent subpoena powers.

2.  The SEC's website now prominently displays an icon for the Enforcement Division on the upper right-hand corner, with links to its "headline" cases (e.g., Wyly Brothers, Citigroup, Goldman Sachs).

August 16, 2010 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Sunday, August 15, 2010

Fitzpatrick on Attorneys Fees

Do Class Action Lawyers Make Too Little?, by Brian T. Fitzpatrick, Vanderbilt Law School, was recently posted on SSRN.  Here is the abstract:

Class action lawyers are some of the most frequently derided players in our system of civil litigation. It is often asserted that class action lawyers take too much from class judgments as fees, that class actions are little more than a device for the lawyers to enrich themselves at the expense of the class. In this Article, I argue that some of this criticism of class action lawyers is misguided. In particular, I perform a normative examination of fee percentages in class action litigation using the social-welfarist utilitarian account of litigation known as deterrence-insurance theory. I argue that in perhaps the most common class action – the so-called “small stakes” class action – class action lawyers not only do not make too much, but actually make too little. Indeed, I argue that it is hard to see as a theoretical matter why lawyers should not receive 100% of class judgments in small-stakes cases. Of course, it is unlikely that judges in the current political climate will feel comfortable awarding class action lawyers fees equal to 100% of judgments in any type of class action, small stakes or otherwise. Moreover, it is not entirely clear that judges have the legal authority to award fees at such a level. Nonetheless, even if judges cannot award 100% of small-stakes judgments to class action lawyers due to political or legal constraints, deterrence-insurance theory nonetheless suggests that they should award fee percentages as high as they can in small-stakes cases, which, by any measure, are much higher than the percentages they tend to award now. Unfortunately, deterrence-insurance theory is unable to provide judges with as much guidance in large-stakes and mixed-stakes class actions.

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

Blair on Financial Innovation

Financial Innovation and the Distribution of Wealth and Income, by Margaret M. Blair, Vanderbilt Law School, was recently posted on SSRN.  Here is the abstract:

Now that Congress has passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, regulators promulgating the rules under this new bill must tackle a major problem that the reform bill addresses only indirectly. This is the problem of excessive “leverage” – financing with too much debt. Leverage permeates the modern financial system. Leverage makes the system too large, in the sense that large parts of the system operate outside the reach of regulators, and the system has a tendency to create vastly too much money and credit, thereby causing asset bubbles. Asset bubbles create the illusion that the financial sector is adding substantially more value to the global economy than it really is, and expose the rest of the economy to too much risk. Moreover, too much of society’s resources go to compensate the people in the system who are causing this to happen.

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

Armour et alia on Comparative Analysis of Hostile Takeovers

A Comparative Analysis of Hostile Takeover Regimes in the US, UK and Japan (with Implications for Emerging Markets), by John Armour, University of Oxford - Faculty of Law; Oxford-Man Institute of Quantitative Finance; European Corporate Governance Institute (ECGI); Jack B. Jacobs, Government of the State of Delaware - Court of Chancery; and Curtis J. Milhaupt, Columbia Law School, was recently posted on SSRN.  Here is the abstract:

In each of the three largest economies with dispersed ownership of public companies - the United States, the United Kingdom, and Japan - hostile takeovers emerged under a common set of circumstances. Yet the national regulatory responses to these new market developments diverged substantially. In the United States, the Delaware judiciary became the principal source and enforcer of rules on hostile takeovers. These rules give substantial discretion to target company boards in responding to unsolicited bids. In the UK, by contrast, a private body consisting of market professionals was formed to adopt and enforce the rules on hostile bids and defenses. In contrast to those of the US, the UK rules give the shareholders primary decision making authority in responding to hostile takeover attempts. The hostile takeover regime in Japan, which developed recently and is still evolving, combines substantive rules with elements drawn from both the US (Delaware) and the UK, while adding distinctive elements, including an independent enforcement role for Japan’s stock exchange.

This Article provides an analytical framework for business law development to explain the diversity in hostile takeover regimes in these three countries. The framework focuses on the universal supply and demand dynamics that drive the evolution of business law in response to new market developments. It emphasizes the common role of subordinate lawmakers in filling the vacuum left by legislative inaction, and it highlights the prevalence of “preemptive lawmaking” to avoid legislation that may be contrary to the interests of important corporate governance players.

Extrapolating from the analysis of developed economies, the framework also illuminates the current state and future trajectory of hostile takeover regulation in the important emerging markets of China, India, and Brazil, where corporate ownership structures may be changing. An important pattern revealed by the analysis is the ostensible adoption - and adaptation - of “best practices” for hostile takeover regulation derived from Delaware and the UK in ways that protect important interests within each emerging market’s national corporate governance system.

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

SEC & CFTC Seek Public Comment on Mixed Swaps

The SEC and CFTC published a joint advance notice of proposed rulemaking that requests public comment to assist the agencies in further defining certain key terms and prescribing regulations regarding "mixed swaps" as required by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Title VII provides for the comprehensive regulation of swaps and security-based swaps and includes definitions of key terms relating to such regulation. It requires the CFTC and the SEC, in consultation with the Board of Governors of the Federal Reserve System, to jointly further define the terms "swap," "security-based swap," "swap dealer," "security-based swap dealer," "major swap participant," "major security-based swap participant," "eligible contract participant" and "security-based swap agreement."

Title VII also requires the CFTC and SEC to jointly prescribe regulations regarding "mixed swaps" as necessary to carry out the purposes of Title VII.

The CFTC and SEC invite public comment with respect to all aspects of the statutory definitions of these key terms. The agencies also invite commenters to express views on the regulation of "mixed swaps."

This request for comment is in addition to the series of email links on the CFTC's and SEC's websites to facilitate public comment regarding regulatory reform rulemaking under the Dodd-Frank Act.

August 15, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC and CFTC Schedule Roundtable on Swaps

The SEC and CFTC staffs will hold a public roundtable on August 20 to discuss issues related to governance and conflicts of interest in the clearing and listing of swaps and security-based swaps.  The roundtable will assist both agencies in the rulemaking process to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Agenda for the Joint CFTC-SEC Public Roundtable Discussion

 Panel One — Types of Conflicts

Securities Clearing Agencies and Derivatives Clearing Organizations
Access to clearing
Determination of swaps eligible for clearing
Risk management
Security-Based Swap Execution Facilities and Swap Execution Facilities
Access to trading
Determination of swaps eligible for trading
Potential for competition with respect to the same swap
Designated Contract Markets and National Securities Exchanges
Listing of swaps
Comparison with conflicts of interest for Swap Execution Facilities and Security-Based Swap Execution Facilities: similarities and differences 
 Panel Two — Possible Methods for Remediating Conflicts

Ownership and voting limits
Structural governance arrangements
Independent or public director requirements for Board and Board committees
Consideration of market participant views: Derivatives Clearing Organizations and Designated Contract Markets
Fair representation requirement in the Securities Exchange Act
Other governance matters (e.g., transparency)
Substantive requirements
Membership standards
Impartial access requirements
Appropriateness of applying the same methods to each type of entity

August 15, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC, FiNRA and NASAA Update Best Practices for Senior Investors

The SEC, FINRA and NASAA pdated a joint report that outlines practices being used by financial services firms to strengthen their policies and procedures for serving senior investors as they approach and begin retirement.   The SEC, FINRA and NASAA first published the report in 2008 to highlight proactive steps being taken by some financial services firms in serving senior customers. It was intended to assist the overall industry in enhancing compliance, supervisory and other practices related to older investors. The 2010 Addendum summarizes additional practices now being used by financial services firms and securities professionals in serving senior investors.

Nearly 40 million Americans are 65 or older, and this number is expected to more than double to 89 million by 2050. As a result of the economic downturn, many older investors find themselves with smaller nest eggs than they anticipated. Estimates show that total retirement assets decreased by $4.5 trillion (25 percent) from 2007 to the first quarter of 2009.

The 2010 Addendum focuses on the following categories when describing the latest practices being used by firms and securities professionals when serving senior investors:

  • Communicating effectively with senior investors.
  • Training and educating firm employees on senior-specific issues.
  • Establishing an internal process for escalating issues and taking next steps.
  • Obtaining information at account opening.
  • Ensuring appropriateness of investments.
  • Conducting senior-focused supervision, surveillance and compliance reviews.


August 15, 2010 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)