Friday, February 5, 2010
In a major speech today, the SEC's Chair Schapiro reviews the agency's accomplishments of the past year and looks ahead to future actions. Among those she identified of particular interest to retail investors are:
Point of Sale: Retail investors should be provided clear, simple, meaningful disclosure at the time they are making an investment decision — disclosure that includes comprehensible and comparable information about the securities products and services being offered — as well as the compensation and conflicts of the person making the recommendation....
In the past, there has been significant industry resistance to this seemingly level-headed concept. I am hopeful, however, that a focus on the needs of retail investors will prevail.
12(b)-1 Fees: Directly related to the concept of point of sale, is the issue of 12b-1 fees. These are fees that are automatically deducted from mutual funds to compensate securities professionals for sales and services.
The problem is that investors may have no idea these fees are being deducted, what services they are paying for, or who they are ultimately compensating. That's why I believe we need to critically rethink how 12b-1 fees are used and whether they continue to be appropriate....
So, I have asked the staff for a recommendation on 12b-1 fees for Commission consideration in 2010.
Proxy Access: And, I am hopeful that we will adopt rules to facilitate the effective exercise of the rights of shareholders to nominate directors to the Boards of the companies they own. This so-called proxy access rule is designed to increase shareholders' ability to hold boards accountable.
Money Market Funds: More recently, we adopted rules that will make money market funds more resilient by strengthening their credit quality, liquidity and maturity standards. ...Importantly, our money market fund reforms are not yet done. Looking ahead, we will be considering yet more measures to address money market fund risk, especially the risk of a run on money market funds.
In particular, I have directed our staff to examine the merits of a floating, mark-to-market NAV for money market funds, rather than the stable $1 price.
The SEC announced that it has dropped its case involving stock options backdating against current and former Broadcom officers. Last year one defendant was acquitted of criminal charges, and the charges were dismissed against another. In addition, the presiding judge discouraged the SEC from proceeding with its civil action. As explained in the SEC's release:
On January 28, 2010, at a hearing on the Commission's motion to clarify the order dismissing its complaint, the Court expressed its view that the evidence adduced during Ruehle's criminal trial and the courts ruling precluding the testimony of Broadcom's former vice president of human resources would result in insufficient evidence for the Commission to withstand summary judgment motions from the defendants.
Given the Court's sua sponte dismissal of the Commission's complaint on December 15, 2009, and the Court's explanatory comments during the January 28, 2010 hearing, the Commission does not intend to proceed further in this action.
Concerns have been expressed for some time about whether FINRA will be able to handle the deluge of customers' complaints against brokers resulting from the financial meltdown. The Wall St. Journal, for example, reports today that FINRA is reaching out to its arbitrators and asking them to handle cases in locations where arbitration hearings on Morgan Keegan mutual funds are centered, including Atlanta, Birmingham, New Orleans and Orlando. More than 400 complaints have been filed against the firm, whose funds dropped in value by as much as 82% after the financial meltdown. WSJ, Arbitrator Out of Work? Call Finra.
What would have been the effect on the judicial system if these cases had been filed in court? Would investors' needs have been better met?
Thursday, February 4, 2010
Of course, like so many others, I'm wondering what Judge Rakoff will think of the proposed settlement between the SEC and Bank of America, which would settle both of the SEC's enforcement actions against BofA stemming from the alleged deficiencies in the proxy statement -- the failure to disclose the Merrill bonuses (the first action which the previous settlement attempted to settle) and the failure to disclose Merrill's worsening condition. The latter charges are the primary focus of the New York AG's suit also filed today, which, unlike the SEC's actions, does name individual defendants, the former CEO Kenneth Lewis and former CFO Joseph Price.
Judge Rakoff's principal objections seemed to stem from (1) his frustration at not being able to get to the bottom of the matter and learn what really happened and who made the critical decisions. In addition, he was critical that the action (2) did not name any indidivual defendants and that (3) the $33 million penalty would only be paid by the corporate defendant. Thus, the very people harmed by the alleged wrongdoing -- the shareholders misled in casting their vote for the merger -- would also be harmed by the payment of the penalty from the corporate treasury.
The SEC attempts to deal with (1) by attaching a detailed Statement of Facts which BofA acknowledges as the evidentiary basis for the settlement, and (3) by providing that the $150 million penalty will be distributed solely to BofA shareholders harmed by the nondisclosure. As noted above, however, the SEC continues (2) not to name individuals, despite the fact that the New York AG apparently found enough evidence to draft a complaint that sets forth a narrative of intentional deception committed by the former CEO and former CFO. (Of course, these are only allegations that must be proved by the AG.)
As to the remedial undertakings to improve disclosure and corporate governance standards, frankly, to me these sound like window-dressing and somewhat pro forma measures designed to bolster a "get-tough" posture. Does giving BofA shareholders "say on pay" for three years accomplish any meaningful remediation?
Maybe Judge Rakoff would like to free up his calendar -- the first action is scheduled to go to trial in March -- and so he'll sign off on this. But the second proposed settlement is not likely to alleviate his frustration with the SEC's settlement process.
The SEC and Boston-based State Street Bank and Trust Company settled charges that State Street misled its investors about their exposure to subprime investments while selectively disclosing more complete information to specific investors. State Street has agreed to settle the SEC's charges by paying more than $300 million that will be distributed to investors who lost money during the subprime market meltdown in 2007. This payment is in addition to nearly $350 million that State Street previously agreed to pay to investors in State Street funds to settle private claims.
The enforcement action is the result of joint efforts by the SEC with the Massachusetts Securities Division and the Massachusetts Attorney General's office, which both announced related charges against State Street today.
According to the SEC's complaint filed in federal court in Boston and a related administrative order issued by the Commission, State Street established its Limited Duration Bond Fund in 2002 and marketed it as an "enhanced cash" investment strategy that was an alternative to a money market fund for certain types of investors.
By 2007, however, the fund was almost entirely invested in subprime residential mortgage-backed securities and derivatives that magnified its exposure to subprime securities. But State Street continued to describe the fund to prospective and current investors as having better sector diversification than a typical money market fund, and failed to disclose the extent of the fund's concentration in subprime investments.
According to the SEC's complaint and order, State Street sent investors a series of misleading communications beginning in July 2007 concerning the effect of the turmoil in the subprime market on the Limited Duration Bond Fund and other State Street funds that invested in it. At the same time, however, State Street provided particular investors with more complete information about the fund's subprime concentration and other problems with the fund. These other investors included clients of State Street's internal advisory groups, which provided advisory services to some investors in this fund and related funds.
The SEC alleges that, based on this more complete information, State Street's internal advisory groups subsequently decided to recommend that all of their clients including the pension plan of State Street's publicly-traded parent company (State Street Corporation) redeem their investments from the fund and the related funds. The SEC alleges that State Street sold the fund's most liquid holdings and used the cash it received from these sales to meet the redemption demands of better informed investors, leaving the fund and its remaining investors with largely illiquid holdings.
Under the terms of the settlement, State Street agreed to pay a $50 million penalty, more than $8.3 million in disgorgement and prejudgment interest, and more than $255 million in additional payments to compensate investors. Combined with nearly $350 million that State Street has already paid or agreed to pay some investors through settlements of private lawsuits, the total compensation to harmed State Street investors is approximately $663 million.
State Street also was ordered to cease and desist from any further violations of certain securities laws. The SEC's enforcement action took into account the company's remediation and its cooperation, including:
- Replacement of key senior personnel and portfolio managers.
- Conducting a review of its procedures and revised its risk controls.
- Entering into private settlements with harmed investors.
- Recent agreement — pursuant to a limited privilege waiver — to provide information it was not otherwise obligated to provide to enable the SEC to assess the potential liability of individuals with respect to certain investor communications.
In a previous post, I discussed the new litigation arising from the Bank of America-Merrill Lynch merger brought today by the New York AG. That suit targets the failure to disclose Merrill's recent losses toBofA shareholders prior to the vote. The SEC announced a settlement and today filed a motion seeking court approval of a proposed settlement of its two suits against BofA, under which the bank would pay $150 million and strengthen its corporate governance and disclosure practices to settle SEC charges that the company failed to properly disclose employee bonuses and financial losses at Merrill Lynch before shareholders approved the merger of the companies in December 2008.
You will recall that the SEC previously filed two sets of charges in the U.S. District Court for the Southern District of New York. In the first enforcement action on Aug. 3, 2009, the Commission charged Bank of America with failing to disclose, in proxy materials soliciting shareholder votes for approval of the merger, its prior agreement authorizing Merrill to pay year-end bonuses of up to $5.8 billion to its employees prior to the closing of the merger. The SEC and BofA previously sought to settle this case for $33 million, but Judge Rakoff rejected it. In the second enforcement action on Jan. 12, 2010, the Commission charged Bank of America with failing to disclose the extraordinary losses that Merrill sustained in October and November 2008.
Under the terms of the proposed settlement, which are again subject to approval by the Honorable Jed S. Rakoff, the $150 million penalty will be distributed to Bank of America shareholders harmed by the Bank’s alleged disclosure violations.
In addition, the proposed settlement requires Bank of America to implement and maintain seven remedial undertakings for a period of three years:
- Retain an independent auditor to perform an audit of the Bank’s internal disclosure controls, similar to an audit of financial reporting controls currently required by the federal securities laws.
- Have its Chief Executive and Chief Financial Officers certify that they have reviewed all annual and merger proxy statements.
- Retain disclosure counsel who will report to, and advise, the Board’s Audit Committee on the Bank’s disclosures, including current and periodic filings and proxy statements.
- Adopt a “super-independence” standard for all members of the Board’s Compensation Committee that prohibits them from accepting other compensation from the Bank.
- Maintain a consultant to the Compensation Committee that would also meet super-independence criteria.
- Provide shareholders with an annual non-binding “say on pay” with respect to executive compensation.
- Implement and maintain incentive compensation principles and procedures and prominently publish them on Bank of America’s Web site
The proposed settlement includes a Statement of Facts describing the details behind the allegations in the actions based on the discovery record.
New York AG Attorney General, who was joined by Special Inspector General for the Troubled Asset Relief Program Neil Barofsky, today announced a lawsuit against Bank of America, its former CEO Kenneth D. Lewis, and its former CFO Joseph L. Price for duping shareholders and the federal government in order to complete a merger with Merrill Lynch. According to the complaint, Bank of America’s management intentionally failed to disclose massive losses at Merrill so that shareholders would vote to approve the merger. Once the deal was approved, Bank of America’s management manipulated the federal government into saving the deal with billions in taxpayer funds by falsely claiming that they would back out of the deal without bailout funds.
Bank of America announced its plan to buy Merrill Lynch on September 15, 2008 and a shareholder vote to approve the transaction was scheduled for December 5, 2008. However, according to the complaint, by the day of the shareholder vote, Merrill had incurred disastrous actual losses of more than $16 billion. Bank of America’s top management, including CEO Lewis and CFO Price, knew about these massive losses and that additional losses were forthcoming. Despite the fact that this information would be important to shareholders, the bank’s management chose not to disclose this information so that shareholders would approve the merger.
After shareholders approved the deal, Lewis then misled federal regulators by telling them that the bank could not complete the merger without an extraordinary taxpayer bailout due to accelerated losses from Merrill. However, between the time that the shareholders had approved the deal and the time that Lewis sought a taxpayer bailout, Merrill’s actual losses had only increased by another $1.4 billion. The bank also threatened federal officials that they would terminate the merger agreement based on a material adverse change in Merrill’s financial condition, even though the bank knew that such an attempt would likely be futile.
As a result of their efforts, Bank of America received more than $20 billion in taxpayer aid.
Furthermore, the lawsuit alleges the following:
- Shortly before the shareholder vote, Price ignored a warning from the bank’s Corporate Treasurer, Jeffrey Brown, who told Price that, “I didn’t want to be talking [about Merrill’s losses] through a glass wall over a telephone.”
- The bank’s management failed to tell shareholders that it was allowing Merrill to pay $3.57 billion in bonuses. The amount, criteria, and timing of the bonus payments were omitted from the proxy. The bonuses were distributed in a manner that was completely inconsistent with Merrill’s prior practice, and in the worst year in Merrill’s history.
- The bank’s management did not tell the bank’s lawyers about the full extent of Merrill’s losses before the shareholder vote. For example, the bank’s former General Counsel, Timothy Mayopoulos, was intentionally mislead about the size and nature of Merrill’s losses. After the shareholder vote, when Mayopoulos learned of the actual losses, he attempted to confront Price but was summarily terminated.
- In the course of the Attorney General’s investigation, Lewis and other executives misled investigators about their conduct during and after the shareholder vote.
- In the process of acquiring Merrill Lynch, Bank of America’s management intentionally misled its shareholders, its Board of Directors, its lawyers, and United States taxpayers.
The lawsuit filed today in New York State Supreme Court seeks monetary relief and injunctions from Bank of America, Lewis, and Price.
Wednesday, February 3, 2010
Tuesday, February 2, 2010
Here we go again! Prepare for lots of Congressional righteous anger.
The SEC's Investor Advisory Committee will hold a public meeting on Monday, February 22, 2010. The public is invited to submit written statements to the Committee.
The agenda for the meeting includes: (i) consideration of a Committee recusal policy; (ii) report from the Education Subcommittee, including a presentation on the National Financial Capability Survey; (iii) report from the Investor as Purchaser Subcommittee, including a discussion of fiduciary duty and mandatory arbitration; (iv) report from the Investor as Owner Subcommittee, including recommendations for the Committee on Regulation FD and proxy voting transparency, as well as reports on a work plan for environmental, social, and governance disclosure and on financial reform legislation; and (v) discussion of next steps and closing comments.
Written statements should be received on or before February 16, 2010.
The SEC today announced insider trading charges against David R. Slaine, a former hedge fund portfolio manager at DSJ International Resources Ltd. (d/b/a “Chelsey Capital”). The SEC alleges that Slaine used inside information tipped by a former executive at UBS Securities LLC (“UBS”) to trade ahead of upcoming UBS analyst recommendations for Chelsey Capital and in his personal brokerage account. The complaint alleges that Slaine’s personal profits from this illicit scheme totaled more than $500,000.
The Commission previously filed insider trading charges against Chelsey Capital and other defendants in connection with this insider trading scheme. See SEC v. Guttenberg, et al., No. 07 CV 1774 (S.D.N.Y.) (PKC)/Lit. Rel. 20022. Chelsey Capital and these other defendants previously entered into settlements with the Commission, and final judgments have been entered against them. Without admitting or denying liability, Chelsey Capital consented to a final judgment that ordered permanent injunctive relief, disgorgement of $3,637,548, plus prejudgment interest of $1,626,344, and a $3,637,548 civil penalty.
As a result of conduct described in the complaint, the Commission alleges that Slaine violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The Commission’s complaint seeks permanent injunctive relief, disgorgement of Slaine’s personal illicit profits, plus prejudgment interest, and civil monetary penalties.
In a related criminal case, the U.S. Attorney’s Office for the Southern District of New York announced today that Slaine has pled guilty to criminal charges in connection with this insider trading scheme.
On February 1, 2010, the SEC sued Stephen Czarnik, a securities lawyer, for his role in multi-million dollar pump-and-dump stock schemes. According to the complaint, the actions of Czarnik allowed three stock promoters — Ryan Reynolds, Jason Wynn and Carlton Fleming — to purchase millions of shares of stock in three penny stock companies for pennies per share, hype the companies through promotional mailers and other advertising, and illicitly sell their shares to the public for millions of dollars in profits. The Commission alleges that because the shares were not registered, Reynolds, Wynn and Fleming were able to deprive the investing public of important information about the actual financial condition and business operations of the companies.
According to the SEC, Czarnik purportedly served as counsel to the companies — My Vintage Baby, Inc., Alchemy Creative, Inc., and Beverage Creations, Inc. — and issued legal opinion letters and other documents proclaiming improper registration exemptions under Rule 504 of Regulation D. In these documents, Czarnik falsely represented that Reynolds, Wynn and Fleming intended to hold, rather than illegally distribute, shares of My Vintage Baby, Inc., Alchemy Creative, Inc. and Beverage Creations, Inc. in the public market. The SEC alleges that Czarnik knew or was reckless in not knowing that Reynolds, Wynn and Fleming intended to distribute the stock because he received emails describing the distribution plan and saw other indications of their promotional and trading activities.
The SEC alleges that by the above-mentioned conduct, Czarnik served as a necessary and substantial participant in unregistered offerings of stock, and as such, violated the registration provisions of the Securities laws, Sections 5(a) and (c) of the Securities Act of 1933. The SEC also alleges that by his fraudulent statements in the opinion letters and other associated documents, Czarnik violated Section 17(a) of the Securities Act and Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 thereunder. The SEC is seeking against Czarnik a permanent injunction, a civil penalty, disgorgement of ill-gotten gains and a penny stock bar, among other relief.
The SEC settled charges against Winning Kids, Inc. and its founder and CEO, Christian Hainsworth for conducting a fraudulent offering scheme reaching approximately 200 investors nationwide. According to the complaint, the defendants raised approximately $2 million from investors, purportedly for the development and marketing of children's books. The SEC alleged that Winning Kids and Hainsworth defrauded investors by offering and selling unregistered securities through a series of private offerings, which they marketed primarily through radio advertisements. The SEC also charged sales agents Robert Comiskey, Edward Tamimi, and Victor Selenow for their role in the scheme.
According to the SEC's complaint, the defendants misrepresented to investors that the company was already established, expanding nationally, and starting an acceleration phase of extraordinary growth. In reality, Winning Kids generated almost no revenue from the sale of its books or any other products from 2004 through 2008. The complaint also alleges the defendants provided investors with baseless profit projections of 300 percent annual returns at a time when the company was not even actively attempting to commercially sell and distribute the books. The complaint further alleges the defendants failed to disclose that the sales agents were receiving commissions of up to 20 percent for the sale of Winning Kids' shares. Winning Kids and Hainsworth also failed to disclose that Hainsworth was using offering proceeds for personal expenses, according to the complaint.
Without admitting or denying the allegations in the complaint, Winning Kids and Hainsworth have consented to the entry of a final judgment that: (i) permanently enjoins them from committing or aiding and abetting future violations of the above provisions; and (ii) orders them to pay disgorgement of ill-gotten gains, prejudgment interest thereon, and civil penalties, in amounts to be determined by the court upon the Commission's motion.
Deputy Secretary of the Treasury Neal S. Wolin testified today before the Senate Committee on Banking, Housing, and Urban Affairs about the Administration's recent proposals to prohibit certain risky financial activities at banks and bank holding companies and to prevent excessive concentration in the financial sector.
FINRA fined two firms for inadequate anti-money laundering (AML) programs. Penson Financial Services, a Dallas-based securities clearing firm, settled charges and agreed to pay a fine of $450,000 for failing to establish and implement an adequate anti-money laundering (AML) program to detect and trigger reporting of suspicious transactions, as required by the Bank Secrecy Act and FINRA rules and other violations. In a similar matter, FINRA fined Pinnacle Capital Markets of Raleigh, NC, $300,000 for failing to implement AML procedures reasonably designed to detect and cause the reporting of suspicious activity as well as to verify the identity of customers.
A firm's AML procedures must address a number of areas, including monitoring transactions to detect and determine whether to report suspicious activity where appropriate. For example, when potentially suspicious activity that warrants further investigation is identified, including higher-risk penny stock deposits and liquidations or suspicious activity involving customers from high-risk foreign jurisdictions, a firm must initiate a review of that activity promptly and complete its review within a reasonable period of time. FINRA has advised firms that in designing their AML programs, they should consider factors such as their size, location, business activities, the types of accounts they maintain and the types of transactions in which their customers engage. FINRA also has instructed clearing firms to consider conducting computerized surveillance of account activity to detect suspicious transaction.
In concluding these settlements, Pinnacle and Penson neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
Monday, February 1, 2010
The SEC released its 2011 Budget Justification which provides further information about how the SEC plans to spend its funds if the increased funding set forth in the Administration's budget comes to pass. The Executive Summary states:
Between fiscal years (FY) 2005 and 2007, the SEC experienced three years of flat or declining budgets, losing 10 percent of its employees and severely hampering key areas such as the agency’s enforcement and examination programs. Even with the funding increases provided by Congress in the last two years, under the SEC’s current funding level, the agency’s workforce still falls about one percent—or 35 full-time-equivalents (FTE)—short of the FY 2005 level. And yet while the workforce at the SEC has shrunk, the job that the SEC has been asked to do has grown even larger. Since 2005, the number of investment advisers registered with and overseen by the SEC has grown by 32 percent, and the number of broker-dealer branch offices has grown by 67 percent.
The SEC oversees a total of more than 35,000 registrants, including over 10,000 public companies, 7,800 mutual funds, about 11,500 investment advisers, 5,400 broker-dealers, 600 transfer agents, 12 securities exchanges, 10 nationally recognized statistical rating organizations (NRSROs), and self-regulatory organizations (SROs) such as the Financial Industry Regulatory Authority, Municipal Securities Rulemaking Board, and Public Company Accounting Oversight Board. While other financial regulators have close to parity between the number of staff and the number of entities they regulate, in recent years SEC staffing and funding simply have not kept pace with industry growth.
In order to provide sufficient resources to restore the agency as a vigorous and effective regulator of the nation’s securities markets, and to implement the Administration’s proposal for financial reform, the President has requested $1.258 billion in FY 2011 for the SEC. This represents an increase of approximately $139 million over the SEC’s FY 2010 funding level of $1.119 billion, and authority for 4,720 total positions (or 4,190 FTE), an increase of 380 positions (associated with 119 FTE) over FY 2010. Within this amount, $24 million in FY 2011 is requested contingent upon the enactment of financial reform legislation, to begin implementation of the SEC’s new and enhanced authorities under the Administration’s financial reform proposal.
It is important to note that this proposed increase in SEC spending would be fully offset by increased SEC collections of fees on securities transactions and registrations. In FY 2011, pursuant to the requirements of the Investor and Capital Markets Fee Relief Act (P.L. 107-123), the SEC will set fees at levels sufficient to raise $1.7 billion in collections, an increase of $220 million over FY 2010.
The SEC identifies as its top priority reinvigorating its enforcement program, and its plans to fill 1478 positions, an increase of 70 positions over FY2010. It plans to fill 1033 positions in the Examinations program, an increase of 100 positions. The new Division of Risk, Strategies & Financial Innovation will be allocated 102 positions, an increase of 30 positions.
President Obama released the 2011 Budget today. According to published reports, it calls for a 11 to 13% increase (varies in reports) in the SEC's budget, to nearly $1.3 billion, and a 55% increase in the CFTC's budget, to $261 million. Some of the increases are contingent on Congress passing legislation expanding the agencies' authority. See: WPost, Obama 2011 budget request: SEC, CFTC
The SEC released the following statement:
The following is a statement from SEC Chairman Mary L. Schapiro regarding the President's FY 2011 budget request of $1.258 billion for the SEC, which represents a 12 percent increase over its FY 2010 budget:
"If enacted, the President's request will do a great deal to help us keep pace with the continuing growth of the markets and provide necessary resources to support important regulatory initiatives in 2011."