Securities Law Prof Blog

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

A Member of the Law Professor Blogs Network

Friday, September 10, 2010

NY Investment Adviser Starr Pleads Guilty to Stealing Clients' Funds

Kenneth I. Starr, a New York investment adviser to the stars, pleaded guilty in Manhattan federal court to one count each of wire fraud, money laundering and investment adviser fraud, for misappropriating $20-50 million of clients' funds to support his lavish life style.  He awaits sentencing.  NYTimes, Financial Adviser to Stars Pleads Guilty to Fraud

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

SEC Announces Agenda for Sept. 17 Open Meeting

The SEC will hold an Open Meeting on September 17, 2010.  The subject matter of the Open Meeting will be:

The Commission will consider whether to propose rules that would require a public company to provide certain disclosures about its short-term borrowings in its filings with the Commission. The Commission will also consider whether to publish an interpretive release to provide guidance regarding the Commission's current disclosure requirements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" relating to liquidity and capital resources.

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

The SEC approved new rules submitted by the national securities exchanges and FINRA to expand a recently-adopted circuit breaker program to include all stocks in the Russell 1000 Index and certain exchange-traded funds. The SEC also approved new exchange and FINRA rules that clarify the process for breaking erroneous trades.

The circuit breaker pilot program was approved in June in response to the market disruption of May 6 and currently applies to stocks listed in the S&P 500 Index. Trading in a security included in the program is paused for a five-minute period if the security experiences a 10 percent price change over the preceding five minutes. The pause gives the markets an opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion. The circuit breaker program is in effect on a pilot basis through Dec. 10, 2010.

A list of the securities included in the Russell 1000 Index, which was rebalanced on June 25, is available on the Russell website. The list of exchange-traded products included in the pilot is available on the SEC's website. The SEC anticipates that the exchanges and FINRA will begin implementing the expanded circuit breaker program early next week.

The markets will continue to use the pilot period to make appropriate adjustments to the parameters or operation of the circuit breakers as warranted based on their experience.

The erroneous trade rules were developed in response to the market disruption of May 6. The rules will make it clearer when — and at what prices — trades will be broken by the exchanges and FINRA. As with the circuit breaker program, these rules will be in effect on a pilot basis through Dec. 10, 2010.

For stocks that are subject to the circuit breaker program, trades will be broken at specified levels depending on the stock price:

  • For stocks priced $25 or less, trades will be broken if the trades are at least 10 percent away from the circuit breaker trigger price.
  • For stocks priced more than $25 to $50, trades will be broken if they are 5 percent away from the circuit breaker trigger price.
  • For stocks priced more than $50, the trades will be broken if they are 3 percent away from the circuit breaker trigger price.

Where circuit breakers are not applicable, the exchanges and FINRA will break trades at specified levels for events involving multiple stocks depending on how many stocks are involved:

  • For events involving between five and 20 stocks, trades will be broken that are at least 10 percent away from the "reference price," typically the last sale before pricing was disrupted.
  • For events involving more than 20 stocks, trades will be broken that are at least 30 percent away from the reference price

On May 6, the markets only broke trades that were more than 60 percent away from the reference price in a process that was not transparent to market participants. By establishing clear and transparent standards for breaking erroneous trades, the new rules should help provide certainty in advance as to which trades will be broken, and allow market participants to better manage their risks.

At Chairman Schapiro's request, the SEC staff is also:

  • Considering whether market makers should be subject to more meaningful obligations to promote fair and orderly markets.
  • Working with the exchanges to prohibit the use by market makers of "stub" quotes that are not intended to indicate actual trading interest.
  • Studying the impact of multiple trading protocols at the exchanges, including the use of trading pauses and self-help rules.

The SEC staff also intends to work with the markets and CFTC staff to consider recalibrating market-wide circuit breakers currently on the books — none of which was triggered on May 6. These circuit breakers apply across all equity trading venues and the futures markets.

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

Thursday, September 9, 2010

Former Fortune 500 Company Settles SEC Backdating Allegations

It's been some time since we've thought about the backdating stock options scandal, but today the SEC charged Affiliated Computer Services, Inc. ("ACS"), a former Fortune 500 company in the business of providing business process and information technology services, alleging that during the period 1995 to 2006, ACS backdated stock option grants to its officers and employees and falsely denied that officers at the company had engaged in intentional backdating. ACS was later acquired by Xerox Corporation on February 5, 2010.

The SEC's complaint also alleges that while the company was conducting an internal investigation of the backdating ACS, through its former CEO and former CFO, made false denials that intentional backdating by officers had occurred at ACS. As alleged in the complaint, the former CEO read a statement during an April 27, 2006 earnings call for investors denying "the intentional granting of look-back stock options to executive officers and directors in order to achieve lower option exercise prices." ACS made similar false disclosures in its May 10, 2006 Form 12b-25 and in Note 3 to its May 15, 2006 Form 10-Q stating that, "ACS does not believe that any director or officer of the Company has engaged in the intentional backdating of stock option grants in order to achieve a more advantageous exercise price." Both the former CEO and the former CFO reviewed drafts of the filings and the former CFO signed the filings. On August 7, 2006, ACS filed a Form 8-K with the Commission attaching a press release, which stated that information set forth in Note 3 to its May 15, 2006 Form 10-Q concerning its stock option investigation "can no longer be relied upon."

In January 2007, ACS restated its historical financial statements. ACS's restatement recorded $51 million in compensation expenses for 72 of the 73 option grants it awarded between 1994 and 2005.

Without admitting or denying the SEC's allegations, ACS consented to a permanent injunction, subject to court approval. The Commission took into account the cooperation that ACS provided the Commission staff during its investigation.

September 9, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

A First: ARS Buyers State Fraud Claim Against Raymond James

I have followed the ARS lawsuits quite closely, and until recently plaintiffs have been consistently unsuccessful in surviving the motion to dismiss stage, because courts find they have failed to plead scienter with the requisite scienter required by the PSLRA..  In essence, the courts think the firms were negligent, or stupid, but not deceitful.  Recently, however, Judge Lewis Kaplan allowed some of plaintiffs' allegations against Raymond James Financial, Inc.to go forward.  In that case ARS buyers allege that the firm failed to disclose that auction brokers routinely intervened to maintain the liquidity of the market.  The judge did dismiss many of the complaint's allegations.  Defer v. Raymond James Financial, Inc. (S.D.N.Y. Sept. 2, 2010) 

September 9, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Wednesday, September 8, 2010

Goldman Reported to Settle Charges with UK Regulator Involving Trader Tourre

The financial press is reporting that UK's Financial Services Authority (FSA) and Goldman Sachs have agreed to settle charges that Goldman failed to disclose that its trader Fabrice Tourre was under SEC investigation when he relocated from New York to London. Tourre, you will recall, is a defendant in a SEC enforcement action for his role in creating and selling a CDO. Goldman reportedly will pay 20 million pounds (about $30.9 million) and confess error.  The settlement is expected to be announced tomorrow.  This would be one of the largest fines imposed by the FSA, which does not have a reputation for aggressive enforcement.  WSJ, Goldman Sachs Hit With U.K. Fine

September 8, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

SIPC Schedules Online Forums to Focus on Modernization

The Securities Investor Protection Corporation (SIPC) will hold its first-ever online forum at 8 p.m. EDT/5 p.m. PDT on September 14, 2010.  The "listening post" session is the first of two major national public forums focused on soliciting input about the modernization of SIPC and are part of a full-scale review of the operations of SIPC, which has not been the focus of major new legislation in 30 years.

The input from the online forums will be reviewed by the 13-member SIPC Modernization Task Force, which is meeting in person and via the Internet to review and discuss the mission and operations of the Securities Investor Protection Corporation. For further information, see the SIPC website.

September 8, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC & CFTC Announce 2 Public Roundtables on Swaps

Staff from the SEC and CFTC will hold two joint public roundtables in September on issues relating to implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The first roundtable on September 14 will be on issues related to swap data repository (SDR) registration, functions and responsibilities, the mechanics of data reporting, models for real time public reporting and the effect of transparency on liquidity of block trades and large transaction sizes. The second public roundtable on September 15 will be on issues related to swap execution facilities and security-based swap execution facilities.

See the SEC website for additional information, including how to participate and file comments.

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

Tuesday, September 7, 2010

SEC Announces Field Hearings on Municipal Bond Market

The SEC announced today that it is launching a series of field hearings to examine the municipal securities markets, starting in San Francisco on September 21. Topics will include disclosure and transparency, credit ratings, and internal controls.  Among participants will be California State Treasurer Bill Lockyer, Washington State Treasurer James McIntire, and Stanley Keller, Independent Consultant and Monitor of the City of San Diego. A panel of investors, both individuals and institutions, will also share their experiences in this market.

The series of hearings, which Chairman Schapiro first announced in May, will take place across the country and address a wide range of issues that focus on the needs of investors in this market. Commissioner Elisse B. Walter will lead the hearings along with fellow Commissioners and staff from multiple offices across the agency.  Other hearings will be conducted in Chicago, Ill., Washington, D.C., Tallahassee, Fla., and Austin, Texas

At the conclusion of all hearings, the Commission will release a staff report containing information learned as well as making recommendations for regulatory changes and industry "best practices," as well as legislative changes, if any.

The SEC invites members of the public and other interested parties to submit comments related to field hearing topics. 

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

SEC Charges Colorado Adviser with Fraud in Marketing Hedge Funds to Senior Citizens

The SEC charged Boulder, Colo.-based investment adviser Neal R. Greenberg with fraud and breach of fiduciary duty in the marketing and recommendation of his firm's hedge funds to investors, including many elderly clients.  According to the SEC, Greenberg falsely stated that the Agile hedge funds offered and managed by his two investment advisory firms were suitable for conservative investors who were retired or nearing retirement. However, the Agile hedge funds used leverage and concentrated in a small number of investments. The funds suffered substantial losses in September 2008 and ceased redemptions to investors. The SEC Division of Enforcement further alleges that the Agile hedge funds improperly collected approximately $2 million in management and performance fees that were not adequately disclosed to investors.

According to the SEC's order, the majority of Greenberg's advisory clients were generally conservative, older investors who wanted low-risk investments offering significant capital protection. The Division of Enforcement alleges that Greenberg failed to ensure that adequate compliance policies and procedures were developed or implemented for determining when it would be suitable for advisory clients to invest in complex hedge fund products, particularly for unsophisticated investors or elderly clients on limited incomes who were risk-averse. Greenberg also failed to ensure that adequate supervisory procedures were developed or implemented relating to those determinations.

With regard to fees, the SEC's order notes that when one Agile hedge fund invested in another Agile hedge fund, investors were assessed performance and management fees on the leveraged portion of their investment. These fees, which totaled approximately $2 million between 2003 and 2006, were not disclosed to investors.

September 7, 2010 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Seventh Circuit Addresses Arbitrability Issues in Brokerage Customer's Agreement

The Seventh Circuit recently issued an interesting opinion on the "who decides" question in the securities arbitration context.  In Janiga v. Questar Capital Corp. (7th Cir. Aug. 2, 2010), the investor Janiga was a Polish immigrant who, despite having lived and worked in Illiniois for more than 20 years, understood only limited English.  Janiga opened an account with his brother, Hessek, who ran his own financial services company (Hessek Financial) and was a registered representative of Questar, a securities broker-dealer.  One year after opening the account, and unhappy with his returns, Janiga sued Hessek, Hessek Financial and Questar.  Defendants, in turn, sought to refer the matter to FINRA arbitration, relying on the PDAA in the customers' agreement.  Although Janiga admitted that he signed the page of the New Account Form that gave conspicuous notice of the PDAA, as required by FINRA rules, he asserted that he did not receive the other pages of the agreement and that, in any event, because of his limited understanding of English, there was no "agreement to arbitrate."  The district court denied the motion to arbitrate without prejudice, to allow for additional fact-finding on the issue.

The Seventh Circuit, acknowledging that "the division of labor between courts and arbitrators is a perennial question," agreed with the district court that the issue of whether a contract exists is a question for the court.  It noted that the Supreme Court, in both Buckeye Check Cashing and Rent-A-Center, distinguished the issue of a contract's validity from the issue whether any agreement existed at all and addressed only the first situation in those two opinions.  Moreover, in Granite Rock the Supreme Court stated that it was "well-settled that where the dispute at issue concerns contract formation, the dispute is generally for courts to decide."  Nevertheless, the Seventh Circuit disagreed with the district court that additional fact-finding was needed on this issue.  Applying the objective theory of contract law and rejecting the necessity of a subjective "meeting of the minds," the appeals court noted that Janiga signed a contract and the paper he signed refers to arbitration.  Since he admitted that he signed the document voluntarily, he was bound by its terms.  Arguments regarding the enforceablity of the contract could be raised before the arbitration panel.

The above analysis is straight forward.  What is more intriguing is that the appeals court expresses doubt about whether the arbitration agreement between Janiga and Questar also applies to Hessek and Hessek Financial.  Although recognizing that agents can receive the benefits of an arbitration agreement between their principal and a third party, the court remanded for the district court to determine (1) whether Hessek and Hessek Financial were agents of Questar and (2) whether the claims asserted were within the scope of their authority. These issues go to the arbitrabililty of the claims and so should be decided by the court.

(Thanks to William Wang for calling this opinion to my attention.)

September 7, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Sunday, September 5, 2010

Albert on Howey

The Howey Test Turns 64: Are the Courts Grading this Test on a Curve?, by Miriam Albert, Hofstra University - School of Law, was recently posted on SSRN.  Here is the abstract:

Sixty-four years ago, the Supreme Court decided SEC v. W.J. Howey, crafting a definition for one form of security, known as an investment contract. The Supreme Court’s definition of investment contract in Howey is flexible, consistent with the Congressional approach to defining the broader concept of what constitutes a security. This choice of adopting a flexible definition for investment contract is not without cost, and raises the specter of inconsistent interpretation and/or application by the lower courts that threatens to undermine the utility of the Howey test itself as a trigger for investor protection. The intentional breadth and adaptability of the definition of investment contract necessarily leads to complex and fact-intensive judicial inquiries in the application thereof, and allows the possibility of inconsistent results between and among the various courts engaging in such inquiries, creating the possibility of similarly-situated litigants winding up with dissimilar outcomes.

Examples of these disparate outcomes are present in a number of industries, including the viatical settlement industry. Viatical settlements are a form of “asset-backed securities” under which purchasers buy the right to receive death benefits under life insurance policies from policyholders. These days, the very words “asset-backed security” may cause the public to recoil in horror, thinking of the sub-prime mortgage debacle and Bernard Madoff being led off in handcuffs while his devastated victims sob on the evening news. But not all asset-backed securities are problematic, and when undertaken legally and ethically, these interests can be solid investment vehicles, providing needed liquidity to the capital markets.

As the financial markets continue to grow and innovate, new forms of asset-backed securities will likely be created, and the potential for inconsistent treatment of similarly-situated investors in these asset-backed securities arguably increases, prompting the question explored herein of whether the definition of investment contract in the Howey test is too flexible to further the underlying legislative intent of the federal securities laws to protect investors through mandatory disclosure and anti-fraud liability. At present, investors and issuers can have no certainty as to the absolute parameters of the test or how any given court will articulate or interpret the definition of investment contract. The test has been burdened by judicially-imposed nuances, as judges try to give meaning to the Supreme Court’s words, and as a consequence, has triggered uneven applications.

This Article will challenge the Howey test in light of today’s increasingly complicated and volatile securities markets, focusing on whether the underlying legislative goals of the federal securities laws are still met by the Howey test, as currently construed by the courts. The Article provides an overview of the legislative history and current status of the U.S. law on the definition of investment contracts, with a brief examination of the component parts of the Howey test, followed by a discussion of the current regulation of the purchase of insurance policies from insurance policy holders in viatical settlement transactions, as background for the analysis highlighting the shortcomings of the Howey test discussed therein. The Article examines the resale of interests in life insurance policies purchased in viatical settlements, focusing on the inconsistent characterization of viatical settlements by the federal courts, specifically in the D.C. Circuit’s decision in SEC v. Life Partners, Inc. and the 11th Circuit’s decision in SEC v. Mutual Benefits Corp. then offering recommendations to further the underlying goals of the securities laws with respect investor protection through disclosure and anti-fraud requirements in an effort to honor these goals without sacrificing consistency for the very investors these laws were enacted to protect. The Article ultimately concludes that the benefits of the flexibility of the Howey test outweigh the costs in terms of dissimilar results for similar investments and that the uneven applications of the Howey test by courts should be considered necessary collateral damage acceptable in light of the significant protections still triggered by the Howey test.

September 5, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bebchuk & Jackson on Corporate Political Speech

Corporate Political Speech: Who Decides?, by Lucian A. Bebchuk, Harvard University - Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI), and Robert J. Jackson Jr., Columbia Law School, was recently posted on SSRN.  Here is the abstract:

As long as corporations have the freedom to engage in political spending - a freedom expanded by the Supreme Court’s recent decision in Citizens United v. FEC - the law will have to provide rules governing how corporations decide to exercise that freedom. This paper, which was written for the Harvard Law Review’s 2010 Supreme Court issue, focuses on what rules should govern public corporations’ decisions to spend corporate funds on politics. Our paper is dedicated to Professor Victor Brudney, who long ago anticipated the significance of corporate law rules for regulating corporate speech.

Under existing corporate-law rules, corporate political speech decisions are subject to the same rules as ordinary business decisions. Consequently, political speech decisions can be made without input from shareholders, a role for independent directors, or detailed disclosure - the safeguards that corporate law rules establish for special corporate decisions. We argue that the interests of directors and executives may significantly diverge from those of shareholders with respect to political speech decisions, and that these decisions may carry special expressive significance from shareholders. Accordingly, we suggest, political speech decisions are fundamentally different from, and should not be subject to the same rules as, ordinary business decisions.

We assess how lawmakers could design special rules that would align corporate political speech decisions with shareholder interests. In particular, we propose the adoption of rules that (i) provide shareholders a role in determining the amount and targets of corporate political spending; (ii) require that political speech decisions be overseen by independent directors; (iii) allow shareholders to opt out of - that is, either tighten or relax - either of these rules; and (iv) mandate disclosure to shareholders of the amounts and beneficiaries of any political spending by the company, either directly or indirectly through intermediaries. We explain how such rules can benefit shareholders. We also explain why such rules are best viewed not as limitations on corporations’ speech rights but rather as a method for determining whether a corporation should be regarded as wishing to engage in political speech. The proposed rules would thus protect, rather than abridge, corporations’ First Amendment rights.

We also discuss an additional objective that decisional rules concerning corporations’ political speech decisions may seek to serve: protecting minority shareholders from forced association with political speech that is supported by the majority of shareholders. We discuss the economic and First Amendment interests of minority shareholders that lawmakers may seek to protect. We suggest that decisional rules addressing political spending opposed by a sufficiently large minority of shareholders are likely to be constitutionally permissible, and we discuss how such rules could be designed by lawmakers.

September 5, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bullard on The Fiduciary Study

The Fiduciary Study: A Triumph of Substance Over Form?, by Mercer Bullard, University of Mississippi - School of Law, was recently posted on SSRN.  Here is the abstract:


In the months preceding the enactment of the Dodd‐Frank Wall Street Reform and Consumer Protection Act of 2010, public interest groups and financial planners lobbied Congress to impose a fiduciary duty on broker-dealers that provide investment advice. Congress deflected this issue to the Securities and Exchange Commission, however. The Act requires the Commission to conduct a six-month study of the regulation of investment advisers and broker-dealers and grants it rulemaking authority to act on the study’s findings. Although the issue of broker-dealers’ fiduciary duties has long been framed as a problem of different standards of conduct applying to advisers and broker-dealers with respect to their investment advisory activities, this essay argues that this should not be the guiding principle for the SEC’s study. Rather, the focus of the study should be the efficacy of principles‐based regulation as to broker-dealers’ investment advisory activities. Furthermore, the Commission should consider the broker-dealer fiduciary duty in the context of other traditional models of legal analysis, including: public versus private rights of action, allocation of regulatory oversight authority, comparative dispute resolution mechanisms, federalism, procedural rules, and separation of powers.

September 5, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Gelter on Comparative Shareholder-Stakeholder Debates

Taming or Protecting the Modern Corporation? Shareholder-Stakeholder Debates in a Comparative Light, by Martin Gelter, Fordham University School of Law; European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:

In this article, I provide a comparative historical account on the debate of whether corporations should exclusively be run by the company in the interest of shareholders, or whether managers should be permitted or required to take the interests of others groups (stake-holders) into account. The comparison focuses on the US, Germany and France and traces the debates through the most important formative periods of these countries’ corporate governance systems.

It is generally assumed that shareholder primacy has a stronger following in the US and the UK than in Continental Europe, where the stakeholder view is thought to be more influential. Without doubt, the respective political histories and cultures of these countries have influenced this divergence. Without ignoring the significance of these factors, this article emphasizes a core issue that has so far been largely overlooked in comparative analysis. I argue that the respective historical debates exhibited important differences that can be attributed to the shareholder-manager balance of powers and differences in stock ownership structure across countries. Scholars in the US, Germany and France were therefore arguing about different issues due to different economic circumstances, which is why it is problematic to equate adherents of shareholder primacy or a stakeholder view of the firm with their counterparts in other corporate governance systems.

In the US, Berle and Means famously identified the prevalence of a strong separation of ownership and control in 1933. US-style dispersed ownership has always generated debates about the question of how to best address what is today described as an agency cost problem, but also to what extent managerial power is legitimate.

By contrast, larger blocks of share ownership prevailed around 1930 in Continental Europe, as they still do today. Participants in the German and French debates were therefore concerned with issues of controlled companies and corporate groups, which undermined the power of the board of directors. At the same time, the comparatively strong influence of shareholders raised other concerns that were rarely an issue in large US corporations, such as blockholders’ private benefits of control and conflicts between competing groups of shareholders that arguably harmed business development. Institutional theories of the corporation, which are traditionally hospitable to stakeholder concerns, seemed to provide a defense of the corporation against its shareholders.

The different nature of the main issues put pro-management and pro-shareholder on different sides of the shareholder-stakeholder debate on the two sides of the Atlantic. In the US, reformers typically had the goal of limiting the power of management to the benefit of shareholders, thereby “taming” the large corporations, whose power was (and is) often identified with that of top management. In France and Germany, critics of the prevailing allocation of control advocated an institutional theory of the corporation to protect the “business in itself” in Continental Europe, and by proxy, its stakeholders from destructive shareholder influence. Continental critics of the status quo therefore sought to limit allegedly excessive influence of shareholders and capital on corporate management.

September 5, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Gross on Mandatory Securities Arbitration

The End of Mandatory Securities Arbitration?, by Jill Gross, Pace Law School, was recently posted on SSRN.  Here is the abstract:

In this essay, I examine recent Congressional efforts to ban pre-dispute arbitration clauses in securities brokerage account agreements and thus eliminate mandatory arbitration of customer-broker disputes. In the proposed Arbitration Fairness Act, Congress would ban such clauses in all consumer contracts, including in the securities industry. However, securities arbitration - whose fairness is regulated with substantial oversight by the Securities and Exchange Commission - does not suffer from the same features and flaws that critics of arbitration in other forums have excoriated as oppressively unfair. In the recently-enacted Dodd-Frank Act, Congress delegated to the SEC the authority to prohibit arbitration clauses in customer agreements through admininstrative rule-making. After examining these regulatory efforts, I argue that neither Congress nor the SEC should prohibit mandatory securities arbitration because it would have significant adverse consequences for investors and for the vitality of the dispute resolution mechanism. The essay concludes by asserting that regulators should not enact arbitration reform that needlessly and without foundation brands securities arbitration as the evil twin of adhesive consumer arbitration.

September 5, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Gross on Mandatory Securities Arbitration

The End of Mandatory Securities Arbitration?, by Jill Gross, Pace Law School, was recently posted on SSRN.  Here is the abstract:

In this essay, I examine recent Congressional efforts to ban pre-dispute arbitration clauses in securities brokerage account agreements and thus eliminate mandatory arbitration of customer-broker disputes. In the proposed Arbitration Fairness Act, Congress would ban such clauses in all consumer contracts, including in the securities industry. However, securities arbitration - whose fairness is regulated with substantial oversight by the Securities and Exchange Commission - does not suffer from the same features and flaws that critics of arbitration in other forums have excoriated as oppressively unfair. In the recently-enacted Dodd-Frank Act, Congress delegated to the SEC the authority to prohibit arbitration clauses in customer agreements through admininstrative rule-making. After examining these regulatory efforts, I argue that neither Congress nor the SEC should prohibit mandatory securities arbitration because it would have significant adverse consequences for investors and for the vitality of the dispute resolution mechanism. The essay concludes by asserting that regulators should not enact arbitration reform that needlessly and without foundation brands securities arbitration as the evil twin of adhesive consumer arbitration.

September 5, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Painter et alia on Morrison

When Courts and Congress Don’t Say What They Mean: Initial Reactions to Morrison v. National Australia Bank and to the Extraterritorial Jurisdiction Provisions of the Dodd-Frank, by Richard W. Painter, University of Minnesota Law School; Douglas Dunham, Skadden, Arps, Slate, Meagher & Flom LLP; and Ellen Quackenbos, Skadden, Arps, Slate, Meagher & Flom LLP; was recently posted on SSRN.  Here is the abstract:

This article explores two issues that arise from a case decided by the Supreme Court this term: Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010), which held that the Securities Exchange Act antifraud provisions do not apply to claims brought by foreign investors against foreign defendants over securities transactions outside the United States (so called f-cubed securities litigation).

First, throughout the opinion Justice Scalia defined the reach of the federal securities laws based on a single inquiry: whether the United States was the place of the securities transaction. Then in summarizing the holding he said that Exchange Act Section 10(b) applies only to “transactions in securities listed on domestic exchanges . . . and domestic transactions in other securities.” The problem is that the National Australia Bank (NAB) securities at issue in the case were in fact listed in the United States, which was required so NAB could have American Depository Receipts (ADRs) trade in New York. For other issuers that list the same securities both in the United States and in another country, as many issuers do, the confusion created by Justice Scalia’s summary of the holding could be problematic. As discussed more fully in this article, the Court did not intend to grant a right to sue in the United States when such securities are bought outside the United States, but this will not stop some plaintiffs from claiming otherwise. This article explains why this argument is incorrect.

Next Congress has had its own drafting problems. In the Dodd-Frank Act, Congress wanted to respond to Morrison by giving the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) power to pursue fraudulent conduct inside the United States that affects securities transactions outside the United States. For SEC and DOJ suits, Congress intended to reverse Morrison and make United States securities laws apply. Congress drafted the Dodd-Frank provisions based on the assumption that the question they were addressing – whether the securities laws applied to transactions outside the United States – was a question of subject matter jurisdiction, which is how courts of appeals had analyzed the issue for the past forty years. The Dodd-Frank provisions responded to Morrison by expressly giving federal courts jurisdiction in certain circumstances over SEC and DOJ suits concerning securities transactions outside the United States. The problem is that the Supreme Court in Morrison had already decided that under existing law federal courts had jurisdiction over these cases and that jurisdiction thus was not the issue. Rather, securities transactions outside the United States were not covered by the language of Section 10(b), a question of the merits.

It seems obvious what Congress intended to do. The problem is that a credible case can be made that Congress didn’t do it. Indeed, the day the Dodd-Frank Act was signed by the President, George Conway, the lawyer who had argued and won the Morrison case for NAB, published a memo to his firm’s clients stating that Congress in the Dodd-Frank provisions may have done nothing meaningful at all. The Dodd-Frank provisions merely restated what Morrison clearly said – that the federal courts had jurisdiction. Because Dodd-Frank only approached this as a question of jurisdiction and did not address the substantive reach of Section 10(b), the Dodd-Frank provisions left the SEC and DOJ with no more power then they had the day Morrison was decided. This article observes that the SEC would have some good arguments in litigation on this issue, but that the statutory language is problematic and should be changed.

September 5, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

SEC Charges NRSRO with Violation of 10% Rule

The SEC issued an administrative Order against LACE Financial Corporation, a registered Nationally Recognized Statistical Rating Agency (NRSRO), and Barron Putnam, its founder and majority owner during the relevant time period. The Order finds that LACE made misrepresentations in its application to become registered as an NRSRO and its accompanying request for an exemption from a conflict-of-interest provision.  Pursuant to the Order, LACE is censured and ordered to pay a $20,000 penalty, and LACE and Putnam are ordered to cease-and-desist from committing or causing any violations and any future violations of these provisions. LACE and Putnam consented to the issuance of the Order without admitting or denying the findings.

Exchange Act Rule 17g-5(c)(1) (the Ten Percent Rule) prohibits an NRSRO from issuing or maintaining a credit rating solicited by a person that, in the most recently ended fiscal year, provided the NRSRO with net revenue equaling or exceeding ten percent of the NRSRO’s total net revenue for the fiscal year. In its NRSRO application and request for an exemption from the Ten Percent Rule, LACE materially misstated the amount of revenue it received from its largest customer during 2007.  LACE also violated certain other provisions governing NRSROs by failing to disclose in its NRSRO application that it performed an extra layer of review when determining credit ratings for certain issuers whose securities made up the pools of asset-backed securities managed by LACE’s largest customer, failing to maintain written policies and procedures governing this extra layer of review, furnishing inaccurate audited financials to the Commission for 2008, failing to maintain all e-mails concerning its credit ratings, and permitting Putnam to participate in determining the credit rating for an entity whose stock he owned.

The SECalso issued an Order against LACE’s former president, Damyon Mouzon. In the Mouzon Order, the Division of Enforcement alleges that as LACE’s president, Mouzon was responsible for ensuring the accuracy of the information provided to the Commission in connection with LACE’s NRSRO application and its request for an exemption from the Ten Percent Rule, and that he knew or should have known that LACE’s representations regarding the amount of revenue received from its largest client during 2007 were inaccurate. The Division of Enforcement further alleges that Mouzon knew or should have known that LACE was required to disclose the extra layer of review performed for certain issuers in its NRSRO application and maintain written policies and procedures governing this extra layer of review, but failed to ensure that LACE did so. The Division of Enforcement also alleges that, as LACE’s president, Mouzon was responsible for managing the firm’s operations and knew or should have known that, as a registered NRSRO, LACE was required to retain all e-mails relating to its credit ratings, but failed to ensure that LACE did so.

The Division of Enforcement alleges that, as a result of this conduct, Mouzon was a cause of LACE’s securities violations.  A hearing in this matter will be scheduled before an Administrative Law Judge, who will hear evidence from the Division of Enforcement and Mouzon.

September 5, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)