Securities Law Prof Blog

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

Saturday, December 4, 2010

SEC & CFTC Propose Definitions for Swaps Market Terms

At its December 3 open meeting the SEC voted unanimously to propose joint rules with the Commodity Futures Trading Commission (CFTC) that would further define a series of terms related to the security-based swaps market, including “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant” and “eligible contract participant.”  The rules seek to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which among other things established a comprehensive framework for regulating the over-the counter swaps market.

The SEC is seeking public comment on the proposed rules for a period of 60 days following their publication in the Federal Register.

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

Friday, December 3, 2010

FINRA Seeks Temporary Emergency Relief Against Alleged Boiler Room Operation

FINRA announced today that it filed a notice seeking a Temporary Cease and Desist Order (TCDO) against San Antonio-based brokerage Pinnacle Partners Financial Corporation and its President, Brian K. Alfaro. The TCDO would halt allegedly fraudulent and illegal sales activities at the firm relating to eight unregistered private placement offerings selling interests in oil and gas joint ventures. FINRA is seeking the order based on belief that customer harm and depletion of customer assets will likely continue before a formal disciplinary proceeding against Pinnacle and Alfaro can be completed. 

In its related underlying complaint against Pinnacle Partners and Alfaro, FINRA alleges that from August 2008 to the present Alfaro and Pinnacle have operated a "boiler room" in which numerous brokers place thousands of cold calls every week to solicit investments in Alfaro's oil and gas drilling joint ventures. The operators of the ventures are entities owned or controlled by Alfaro. Through the boiler room Alfaro and Pinnacle have raised more than $10 million from over 100 investors for offerings that are alleged to materially misrepresent or omit material facts. In addition, FINRA charges Alfaro with misusing customer funds by collecting funds from investors for drilling and testing of wells, and then spending those funds for unrelated business and personal expenses.

Under FINRA rules, a hearing shall be conducted not later than 15 days after service of the notice and filing that initiates the temporary cease and desist proceeding, unless extended, and the Hearing Panel shall issue a decision not later than 10 days after receipt of the hearing transcript. If the temporary cease and desist order is granted, it will generally remain in effect until the underlying disciplinary action against the firm for this misconduct has been resolved. FINRA may seek to suspend or expel a firm for violating a TCDO.


As to the related underlying complaint, under FINRA rules, the individuals and firms named in a complaint can file a response and request a hearing before a FINRA disciplinary panel. Possible sanctions include a fine, an order to pay restitution, censure, suspension, or bar from the securities industry.

December 3, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Judge Rakoff on the "Wonderous Alternative to the Rule of Reason"

Judge Jed Rakoff (S.D.N.Y.) denied Goldman Sach's motion to vacate a $20.580 million arbitration award obtained by the Official Unsecured Creditors' Committee of Bayou Group on Nov. 8, 2010 and promised that a written opinion would follow.  The opinion was filed on Nov. 30, and Judge Rakoff offers some observations about, and comparisons between, the arbitration process and the courts.

In the arbitration, the Creditors Committee challenged certain transfers between the Bayou Fund LLC margin account and the margin accounts of four new hedge funds in the Bayou family, made at the direction of Samuel Israel.  After Israel closed the hedge funds, it was revealed that he had been operating a Ponzi scheme.  The Committee alleged that these transfers were fraudulent conveyances and that Goldman Sachs, because of its failure to conduct due diligence, was jointly and severally liable.  The arbitration panel issued an award in favor of the Creditors Committee the full amount it sought from Goldman Sachs and, as is typical, did not provide any reasons for its award.

Judge Jed Rakoff essentially tells Goldman that it got what it asked for -- since it "voluntarily chose[] to avail itself of this wonderous alternative to the rule of reason," it "must suffer the consequences."  Noting that "a court, unlike an arbitrator, must state its reasons and subject them to appellate scrutiny," the Judge describes the "high hurdle" a party seeking vacatur must clear to meet the "manifest disregard of the law" standard (which standard, as he notes, is in some doubt itself after the Supreme Court's Hall St. Associates decision, although the Second Circuit has concluded that "manifest disregard" remains a valid ground for vacatur). 

After setting forth the Second Circuit test, he reviews the record and the applicable law on fraudulent conveyances and finds that Goldman has not even come close to establishing "manifest disregard of the law."  At most Goldman disputes the arbitration panel's likely factual findings from which there is no judicial relief.

December 3, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

SEC Defers Some Dodd-Frank Initiatives because of Budget Uncertainty

The SEC announced it will defer certain initiatives mandated by Dodd-Frank because of budget uncertainty:

The following activities are being deferred due to budget uncertainty. Additional information will be provided upon adoption of a 2011 FY budget.

Section 342 Creation and Staffing of Office of Women & Minority Inclusion Activities regarding diversity in hiring and small business contracting continuing to be performed by staff in existing EEO Office
Section 911 Creation of new Investor Advisory Committee  
Sections 915 and 919D Creation and Staffing of Office of Investor Advocate Activities regarding investor perspectives in rulemaking continuing to be performed by staff in existing Office of Investor Education & Advocacy
Section 924 Creation and Staffing of Whistleblower Office Functions temporarily assigned to existing staff within the Division of Enforcement
Section 932 Creation and staffing of Office of Credit Ratings Rulemaking functions remain with staff within the Division of Trading and Markets; examination functions continuing to be performed by existing Office of Compliance Inspections & Examination
Section 979 Creation and staffing of Office of Municipal Securities Functions continue to be assigned to staff within the Division of Trading and Markets


December 3, 2010 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Thursday, December 2, 2010

SEC Proposes to Extend Temporary IAA Rule Regarding Principal Trades

The SEC is proposing to amend rule 206(3)-3T under the Investment Advisers Act of 1940, a temporary rule that establishes an alternative means for investment advisers who are registered with the Commission as broker-dealers to meet the requirements of section 206(3) of the Investment Advisers Act when they act in a principal capacity in transactions with certain of their advisory clients. The amendment would extend the date on which rule 206(3)-3T will sunset from December 31, 2010 to December 31, 2012.  According to the release:

... [U]nder section 913 of the Dodd-Frank Act, we are required to conduct a study and provide a report to Congress concerning the obligations of broker-dealers and investment advisers, including the standard of care applicable to those intermediaries. We are required to deliver the report concerning this study no later than six months after the enactment of the Dodd-Frank Act, in January 2011.

Section 913 of the Dodd-Frank Act also authorizes us to promulgate rules concerning, among other things, the legal or regulatory standards of care for broker-dealers, investment advisers, and persons associated with these intermediaries for providing personalized investment advice about securities to retail customers. In enacting any rules pursuant to this authority, we are required to consider the findings, conclusions, and recommendations of the mandated study. The study and our consideration of the need for further rulemaking pursuant to this authority are part of our broader consideration of the regulatory requirements applicable to broker-dealers and investment advisers in connection with the Dodd-Frank Act.

As part of this study and any rulemaking that may follow, we expect to consider the issues raised by principal trading, including the restrictions in section 206(3) of the Advisers Act and our experiences with, and observations regarding, the operation of rule 206(3)-3T. We will not, however, complete our consideration of these issues before December 31, 2010, rule 206(3)-3T’s current expiration date.

We believe that firms’ compliance with the substantive provisions of rule 206(3)3T as currently in effect provides sufficient protections to advisory clients to warrant the rule’s continued operation for an additional limited period of time while we conduct the study mandated by the Dodd-Frank Act and consider more broadly the regulatory requirements applicable to broker-dealers and investment advisers.

December 2, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Settles Account Intrusion Scheme Charges

The SEC, on December 2, 2010, settled civil charges against BroCo Investments, Inc. and its president Valery Maltsev arising out of an account intrusion scheme that manipulated the shares of over 100 public companies.  The SEC alleged that BroCo and Maltsev controlled an omnibus account that was used to turn $2,080 into $627,633 in a six-month period by repeatedly buying and selling securities contemporaneously with unauthorized trades that had been placed in compromised accounts at various U.S. broker-dealers.  BroCo and Maltsev ignored several red flags that should have alerted them to the fraudulent activity including the massive short term trading gains being realized in the account, internal memoranda that identified the suspicious trading, and the constant repatriation of funds.

In settling the SEC’s charges without admitting or denying the allegations, BroCo agreed to pay $627,633 in disgorgement plus prejudgment interest and a $627,633 penalty. In settling the SEC’s charges without admitting or denying the allegations, Maltsev agreed to pay a $50,000 penalty and consented to the entry of a judgment that permanently enjoins him from violating Sections 17(a)(2) and (3) of the Securities Act of 1933. Both settlements are subject to court approval.

December 2, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 30, 2010

Madoff Trustee Seeks Clawbacks from Net Winners

The trustee for Bernard Madoff's bankruptcy estate filed about 100 lawsuits against Madoff investors who he asserts were "net winners," seeking to clawback their fictitious profits.  He faces a December 11 deadline for filing lawsuits.  WSJ, Madoff Trustee Goes After 'Net Winners'

November 30, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Schedules Second Field Meeting on Municipal Securities Markets

The SEC will hold its second field hearing to examine the municipal securities markets on Tuesday, Dec. 7, 2010 at 9:00 a.m. at its DC offices. The hearing will include panel discussions focusing on market stability and liquidity, investor impact, self-regulation, accounting and Build America Bonds

November 30, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Meets Dec. 3 to Consider Proposed Rules on Swaps Dealers

The SEC's next Open Meeting is December 3.  The subject matter of the Open Meeting will be:

The Commission will consider a recommendation to propose joint rules with the Commodity Futures Trading Commission relating to the definitions of "Swap Dealer," "Security-Based Swap Dealer," "Major Swap Participant," Major Security-Based Swap Participant," and "Eligible Contract Participant."


November 30, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Recent New York State and Federal Court Decisions Reject "Martin Act Preemption" Doctrine

A persistent and unresolved question in New York state investor protection law is whether common-law causes of action for breach of fiduciary duty and gross negligence are preempted by the state's Martin Act.  A majority of the federal courts in the Southern District of New York have, in recent years, held that, except for fraud, the Martin Act forecloses any private common-law causes of action.  Recently, however, Judge Victor Marrero, in a scholarly analysis of the history of the Martin Act and the preemption doctrine, held that the Martin Act does not preclude any private common law causes of action; Anwar v. Fairfield Greenwich Limited, No. 09 Civ. 01 18 (VM) (S.D.N.Y. July 29, 2010).

New York's Supreme Court, Appellate Division, First Dept. has now addressed the issue and also concluded that common-law causes of action for breach of fiduciary duty and gross negligence are not preempted by the Martin Act; Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management Inc. (Appel. Div. First Dept. Nov. 23,2010). In reaching this conclusion, the First Department quoted Judge Marrero's "cogent and forceful" argument that to find Martin Act preemption would "leave [ ] the marketplace arguably less protected than it was before the Martin Act's passage, which  can hardly have been the goal of its drafters."  The court also relied on the New York Attorney General's amicus brief that argued that "the purpose or design of the Martin Act is in no way impaired by private common-law claims that exist independently of the statute, since statutory actions by the Attorney General and private common-law actions both further the same goal, namely, combating fraud and deception in securities transactions."

The First Department now joins the Second Department and the Fourth Department in rejecting the argument that the Martin Act preempts properly pleaded common-law causes of action.  While definitive word must come from the New York Court of Appeals, it is encouraging to see that both the federal and state courts in New York are finally rejecting this pernicious preemption doctrine that has denied many investors their right to bring claims for the harm caused by negligent conduct or breach of fiduciary duty of their investment advice providers.

(Hat tip:  Jill Gross)

November 30, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former Deloitte Tax Partner with Insider Trading Scheme

The SEC today charged Arnold McClellan, a former Deloitte Tax LLP partner, and his wife Annabel with repeatedly leaking confidential merger and acquisition information to family members overseas in a multi-million dollar insider trading scheme.  According to the SEC's complaint, Arnold McClellan had access to highly confidential information while serving as the head of one of Deloitte's regional mergers and acquisitions teams. He provided tax and other advice to Deloitte's clients that were considering corporate acquisitions.

The McClellans allegedly provided advance notice of at least seven confidential acquisitions planned by Deloitte's clients to Annabel's sister and brother-in-law in London. After receiving the illegal tips, the brother-in-law took financial positions in U.S. companies that were targets of acquisitions by Arnold McClellan's clients. His subsequent trades were closely timed with telephone calls between Annabel McClellan and her sister, and with in-person visits with the McClellans. Their insider trading reaped illegal profits of approximately $3 million in U.S. dollars, half of which was to be funneled back to Annabel McClellan.

The UK Financial Services Authority (FSA) has announced charges against the two relatives — James and Miranda Sanders of London. The FSA also charged colleagues of James Sanders whom he tipped with the nonpublic information in the course of his work at his London-based derivatives firm. Sanders's tippees and clients made approximately $20 million in U.S. dollars by trading on the inside information.

The SEC alleges that between 2006 and 2008, James Sanders used the non-public information obtained from the McClellans to purchase derivative financial instruments known as "spread bets" that are pegged to the price of the underlying U.S. stock. The trading started modestly, with James Sanders buying the equivalent of 1,000 shares of stock in a company that Arnold McClellan's client was attempting to acquire. Subsequent deals netted significant trading profits, and eventually James Sanders was taking large positions and passing along information about Arnold McClellan's deals to colleagues and clients at his trading firm as well as to his father.

The SEC's complaint charges Arnold and Annabel McClellan with violating the antifraud provisions of the federal securities laws. The complaint seeks permanent injunctive relief, disgorgement of illicit profits with prejudgment interest, and financial penalties.


November 30, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Madoff Investors Fail to Show Uncontroverted Evidence of Peter Madoff's Involvement in Bernie's Fraud

An interesting case in the federal district court in New Jersey involves the attempt by some of Bernie Madoff's investors to recover damages from Bernie's brother Peter Madoff on a control person theory.  Peter Madoff worked at Bernard L. Madoff Investment Securities (BMIS) for almost forty years, serving as its senior managing director, director of trading, chief compliance officer and general counsel.  According to the Uniform Application for Investment Adviser Registration filed by BMIS with the SEC, Peter Madoff was listed as a control person.  The court earlier denied defendant's motion to dismiss the complaint in The Lautenberg Foundation v. Madoff (D.N.J. Sept. 9, 2009) (Civ. Act. 09-816(SRC)).

In a recent opinion (Nov. 19, 2010), the court denied plaintiffs' motion for a summary judgment on the count alleging control person liability under section 20(a) of the Securities Exchange Act.  Applying the Third Circuit precedent, Rochez Brothers v. Rhoades, 527 F.2d 880 (3d Cir. 1975), the court set forth the elements of a 20(a) claim as follows: (1) the defendant controlled another person or entity; (2) the controlled person or entity committed a primary violation of the securities laws; and (3) the defendant was a culpable participant in the fraud.  For purposes of the summary judgment motion, the court assumed that the first and second elements were met and focused on the element of culpable conduct. 

Under Third Circuit precedent, inaction that intentionally furthers the fraud committed by the controlled person or entity establishes culpable participation, but mere inaction is insufficient.  The court notes that plaintiff's argument was essentially that Peter Madoff, because of his position in the firm, must be at fault for not implementing appropriate safeguards.  However, the court stated that the record contained "a dearth of evidence as to what controls and procedures are considered standard or even minimally requisite in the industry."  Moreover, "we know very little of what Bernard Madoff did and how he did it."  While Peter's long association in his brother's business, his corporate positions, and the scope of the fraud  cast "substantial suspicion" about Peter's involvement, that is insufficient to impose control person liability.  Accordingly, because there is insufficient specific evidence of Peter's conduct and responsibilities, plaintiffs' motion for summary judgment fails.

November 30, 2010 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

SEC's Inspector General Find No Improper Conduct in SEC's BofA Investigation

The SEC's Inspector General has posted its Semi-Annual Report to Congress Apr. 1  -- Sept. 30, 2010 on its website.  Among the items discussed is its Investigation of the Circumstances Surrounding the SEC’s Proposed Settlements with Bank of America, Including a Review of the Court’s Rejection of the SEC’s First Proposed Settlement and an Analysis of the Impact of Bank of America’s Status as a TARP Recipient (Report No. OIG-522).  During its investigation, OIG analyzed the SEC enforcement actions against BofA, including the first proposed settlement and its rejection by the Court; the second proposed settlement and its acceptance by the Court; and what role, if any, BofA's status as a TARP recipient played in the SEC's investigation, charging decisions and settlement discussions.

OIG reports its findings, including:

  1. Despite the Court's rejection of the SEC's first proposed settlement with BofA, the evidence did not show that SEC staff failed to diligently and zealously investigate potential securities law violations.
  2. OIG did not find evidence of improper conflicts of interest that formed the basis of the initial Congressional inquiry, but it did find that BofA's status as a TARP recipient had an impact on the favorable settlement that the staff first recommended to the Commission. 
  3. The OIG found that the enforcement staff felt pressure to bring a case against BofA promptly because of the internal interest in the case and its high-profile nature.
  4. Greater coordination and collaboration among law enforcement agencies would have more efficiently utilized government resources and sped up the investigation.

In a fascinating discussion, the Report recounts at length the SEC's decision not to name individual defendants.  It notes the differences in legal theory that were considered by the enforcement attorneys negotiating the first settlement and those who negotiated the second settlement (the first team was unaware that individuals could directly violate Rule 14a-9 and thought that Rule 10b-5, and its requirement of scienter, was the only viable theory; the second team did not suffer the same confusion), as well as difficulties created by ongoing investigations by the New York AG and the TARP Inspector General.  According to the SEC attorneys, the NYAG refused to share information and provide witness transcripts requested by the SEC; because the Court had limited the number of depositions the SEC could take, the SEC was not always able to remedy the refusal to produce transcripts and had to rely on attorney proffers.


November 30, 2010 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Harvard Business Law Review Launches Online Edition

The Harvard Business Law Review, which will publish its inaugural print edition in the spring, has just launched its online supplement, HBLR Online.  Updated frequently, it will feature brief essays by leading practitioners, academics, and policymakers on a variety of topics.  My comment, FINRA Proposed Rule Change Would Give Customers Option of All-Public Arbitration Panels, appears here.

November 30, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Monday, November 29, 2010

Labor Dept. Proposes Rule to Improve Disclosure on Target Date Retirement Funds

The U.S. Department of Labor's Employee Benefits Security Administration today announced a proposed rule on target date retirement funds and other similar investments offered in 401(k)-type pension plans. The proposed rule would amend the "qualified default investment alternative regulation" and the "participant-level disclosure regulation" to enhance and provide more specificity regarding the information that must be disclosed to participants and beneficiaries concerning investments in target date funds.

The proposed amendments require new disclosures about the design and operation of target date or similar investments, including an explanation of:

The investment's asset allocation.
How that allocation will change over time, with a graphic illustration.
The significance of the investment's "target" date.
The proposed amendments also require a statement concerning the risk that a participant investing in a TDF may lose money in that investment, even close to retirement.

The comment period on the proposed regulation will run until Jan. 14, 2011.

The SEC also has pending a proposed rule relating to the marketing of target date funds.

November 29, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Sunday, November 28, 2010

Black on Behavioral Economics and Securities Arbitration

Can Behavioral Economics Inform Our Understanding of Securities Arbitration?, by Barbara Black, University of Cincinnati - College of Law, was recently posted on SSRN.  Here is the abtract:

The classical economic approach assumes that parties take rational account of the effects of ADR on the likely disposition of their disputes and adopt predispute arbitration agreements (PDAAs) when they mutually benefit the parties. Accordingly, there should be a presumption in favor of enforcing PDAAs so long as the parties have entered into them knowingly and voluntarily, but there is generally no reason for the state to favor PDAAs. In contrast, critics of mandatory consumer arbitration believe that, as a practical reality, consumers cannot bargain over PDAAs and have little choice but to accept the deal offered by the business. In addition, relying on the behavioral economics literature, they assert that consumers typically are not as rational as classic economic theory supposes.

The opposing positions in this debate over consumer arbitration have been well fleshed out in the academic literature. This paper will focus specifically on securities arbitration in the FINRA forum, where there are unique differences in the FINRA process that add complexity to this issue. I pose three questions regarding the staying power of PDAAs and explore whether classic or behavioral economic theory can help answer them. I then explore what would happen if the SEC or Congress prohibited PDAAs in customers' agreements. I conclude that if Congress or the SEC prohibits PDAAs in securities arbitration, the effect on the FINRA arbitration forum may not be beneficial to investors withsmall claims.

November 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Wang & Steinberg on Insider Trading

Introduction: Insider Trading, by William K. S. Wang, University of California, Hastings College of the Law, and Marc I. Steinberg, Southern Methodist University (SMU) - Dedman School of Law, from INSIDER TRADING, Third Edition, Oxford University Press, 2010, was recently posted on SSRN.  Here is the abstract:

This paper is the introductory chapter to Insider Trading (Oxford University Press 3d ed. 2010). This treatise analyzes the application of various laws to stock market insider trading and tipping. Among the federal laws are Exchange Act section 10(b), SEC Rule 10b-5, mail/wire fraud, SEC Rule 14e-3, Exchange Act section 16, and Securities Act section 17(a). The state law discussed is both state common law and a state law claim by the issuer.

Another chapter addresses government enforcement of the insider trading/tipping prohibitions. A chapter on compliance programs deals with how firms can try to prevent illegal insider trading and tipping. Two chapters compare the harmful and allegedly beneficial effects of stock market insider trading and discuss the harm to individual investors from each specific insider trade.

November 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bartlett & Poulsen on Buyout Returns

The Determinants of Buyout Returns: Does Transaction Strategy Matter?, by Robert P. Bartlett III, University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy, and Annette B. Poulsen, University of Georgia - Department of Banking and Finance, was recently posted on SSRN.  Here is the abstract:

This paper reexamines one of the most studied questions in the scholarship of leveraged buyouts (LBOs): how do LBO sponsors create value for their investors in take-private acquisitions? In so doing, the paper makes two significant contributions to our understanding of LBOs. Most importantly, the paper provides the first-ever analysis of the equity returns to LBO sponsors. Due to data limitations, prior studies have traditionally relied on total returns to an LBO (that is, returns to both debt and equity investors) to analyze the source of LBO value creation. Drawing on a unique database of LBO transactions, this paper examines instead the actual internal rates of return (IRRs) realized by LBO sponsors on a deal-by-deal basis, thereby permitting a direct analysis of how LBO sponsors create value for their investors in leveraged buyouts. Second, the paper demonstrates how the traditional approach to examining the determinants of LBO returns overlooks a number of important LBO transaction strategies that are used to enhance a sponsor’s equity returns. In particular, the paper demonstrates that a significant component of LBO sponsor returns stems not from operating performance changes but from timing tactics that LBO sponsors use to accelerate the liquidation of their investments and thereby increase their IRRs. Among other things, this latter finding helps explain the gradual bias of private equity firms away from IPOs as an exit strategy for their portfolio investments and towards cash acquisitions.

November 28, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)