Securities Law Prof Blog

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

Friday, February 19, 2010

Pacific Asian Atlantic Foundation Settles SEC Fraud Charges over Worthless Bonds

The SEC settled fraud charges against Pacific Asian Atlantic Foundation, a purported international humanitarian organization, and its president and chief executive officer for fraudulently offering billions in worthless bonds to several U.S broker-dealers.  The SEC's complaint, filed in the United States District Court for the Central District of California, charges Samuel M. Natt  and Pacific Asian Atlantic Foundation ("PAAF"), with offering billions in fraudulent PAAF bonds from late 2006 through 2009. The complaint alleges that the defendants created the false impression that the bonds were genuine debt securities by drafting and disseminating fraudulent offering memoranda that misrepresented, among other things, PAAF's assets and financial condition, its ability and intent to pay the principal and interest on the bonds, the riskiness of the offering, and PAAF's intended use of the bond proceeds. The complaint further alleges that Natt and PAAF attempted to legitimize the bonds by obtaining corporate bond identification numbers from the CUSIP Service Bureau based upon PAAF's misleading offering memoranda. According to the complaint, the defendants took these actions to ensure that registered broker-dealers and other financial institutions would accept the worthless bonds and deposit them into accounts held by PAAF.

Natt and PAAF have agreed to settle this case without admitting or denying the allegations in the complaint. Natt and PAAF consented to a permanent injunction from further violations of Sections 17(a)(1) and 17(a)(3) of the Securities Act of 1933. In addition to the permanent injunction, Natt consented to pay a $50,000 civil penalty.

February 19, 2010 in SEC Action | Permalink | Comments (1) | TrackBack (0)

SEC Charges Greenstone Holdings, CEO and Attorneys with Illegal Stock Distribution

On February 18, 2010, the SEC filed a civil action in the United States District Court for the Southern District of New York charging issuer Greenstone Holdings, Inc., the company's Chief Executive Officer, Hisao Sal Miwa, the company's outside counsel, John B. Frohling, attorney Thomas F. Pierson, and four stock promoters, Daniel D. Starczewski, Joe V. Overcash, Jr., Frank J. Morelli, III, and James S. Painter, III with engaging in an illegal, and in some cases fraudulent, scheme to sell hundreds of millions of Greenstone shares to the public. At the same time, Greenstone and Miwa fraudulently "pumped" the market for Greenstone stock by issuing a series of false and misleading press releases and hiring third-party stock promoters to circulate many of these statements on the internet and via email. On June 18, 2008, as part of its Anti-Spam Initiative, the SEC suspended trading in Greenstone's securities.

The complaint also names as relief defendants thirteen companies controlled by the defendants and through which the defendants directed their illegal public sales of Greenstone's stock.

The SEC's complaint alleges that all defendants violated Sections 5 of the Securities Act of 1933 (the "Securities Act") and that Greenstone, Miwa, Starczewski, Overcash, Pierson, and Frohling violated Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder. The SEC's complaint also charges, alternatively, that Miwa, Starczewski, Overcash, Pierson, and Frohling aided and abetted Greenstone's violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The SEC seeks injunctive relief and financial penalties from the defendants, disgorgement from Greenstone, Pierson, Starczewski, Morelli, Overcash, and Painter, penny stock bars for Miwa, Starczewski, Overcash, Pierson, Frohling, Painter, and Morelli, and an officer-and-director bar against Miwa.

February 19, 2010 in SEC Action | Permalink | Comments (1) | TrackBack (0)

SEC Announces Agenda for Feb. 24 Open Meeting

SEC Open Meeting - February 24, 2010

The subject matter of the Open Meeting will be:

Item 1: The Commission will consider whether to adopt amendments to Rules 201 and 200(g) of Regulation SHO relating to short sale restrictions.

Item 2: The Commission will consider whether to publish a statement regarding its continued support for a single-set of high-quality globally accepted accounting standards and its ongoing consideration of incorporating International Financial Reporting Standards into the financial reporting system for U.S. issuers.

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

Judge Rakoff Mulls Over Deposition Testimony in Deciding Whether to Approve SEC-BofA Settlement

The New York Attorney General's Office turned over to Judge Rakoff copies of five depositions, including that of former (and fired) Bank of America GC Timothy Mayopoulos, as the judge requested.  Judge Rakoff is trying to figure out why the factual allegations of the New York AG and the SEC differ.  He is expected to announce on Monday whether he will approve the SEC-BofA settlement.  If not, trial of one of the SEC's actions will begin March 1.  WSJ, Cuomo Turns Over BofA Testimony.

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

Thursday, February 18, 2010

FINRA Proposes Rule Change Addressing Attorney Representation of Non-Party Witnesses

FINRA filed with the SEC a proposed rule change that would explicitly permit non-party witnesses to be represented by attorneys in arbitration proceedings.  The release explains that in customer disputes against the brokerage firm the registered representative who dealt with the customer will frequently be a witness.  Currently, whether the witness is able to be accompanied by an attorney is within the discretion of the arbitration panel.  While the release states that Finra is not aware of arbitrators' denying a witness's request to have his attorney present, it believed that fairness requires that the rules explicitly permit this. 

SECURITIES AND EXCHANGE COMMISSION (Release No. 34-61517; File No. SR-FINRA-2010-006)
February 16, 2010 Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Proposed Rule Change to Amend the Codes of Arbitration Procedure to Provide for Attorney Representation of Non-party Witnesses in Arbitration

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

Former UBS Executive Settles ARS Insider Trading Charges with New York

The New York AG continues its aggressive enforcement in the auction rate securities (ARS) market, announcing today settlement of insider trading charges against David Shulman, formerly a top executive at UBS.  According to the AG, Shulman sold his personal holdings of auction rate securities based on insider information about UBS’s collapsing auction rate securities market.  Shulman must pay $2.75 million to New York State and must serve a suspension from employment by, or association with, a broker or dealer.  Shulman was formerly the Global Head of the Municipal Securities Group of UBS AG and the Head of Fixed Income for the Americas of UBS Securities LLC.  From August 2006 to August 2008, Shulman was UBS’s highest-ranking executive with day-to-day responsibility for UBS’s auction rate securities program. 

According to the AG, between December 11 and December 13 of 2007, Shulman learned that UBS’s auction rate securities program was in distress and that there was concern that upcoming auctions in student loan auction rate securities could fail.  At that time, Shulman owned $1.45 million in student loan auction rate securities, which were scheduled to be sold in late December and early January.  On December 13, 2007, Shulman instructed his broker to immediately sell his holdings in student loan auction rate securities, before the upcoming auctions could occur.  Later that day, Shulman’s student loan auction rate securities were sold, inter-auction, directly to the UBS Short Term Trading desk, which was under his supervision.  Shulman’s broker mentioned Shulman by name when he called the desk to place the trades.  This was the first and only time Shulman sold auction rate securities inter-auction.

The settlement resolves charges that Shulman violated New York’s Martin Act.  Today’s action marks the second settlement with a UBS senior executive over insider trading in the Attorney General’s auction rate securities investigation

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

Wednesday, February 17, 2010

Judge Rakoff Seeks More Information on BofA GC's Firing

Why was former Bank of America GC Timothy Mayopoulos fired five days after the BofA shareholders approved the merger with Merrill Lynch?  In its complaint the New York AG suggests that the firing resulted from Mayopoulos' advice that Merrll's growing losses should be disclosed.  Judge Rakoff asked the SEC about this in the recent hearing on the agency's proposed settlement with BofA.  In a filing today, the SEC stated that Mayopoulos was fired to make room for Brian Moynihan, who later became CEO of BofA, and not because of his job performance or legal advice.  Judge Rakoff has asked the New York AG to provide him with its deposition testimony, so that he can better evaluate the premises for the SEC's proposed settlement.

Stay turned for the next installment in the drama.  The trial on the SEC's complaint relating to the Merrill bonuses is still scheduled to begin on March 1.

WSJ, SEC: Ex-BofA General Counsel Not Fired Over Advice

February 17, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Should Brokers be Subject to a Fiduciary Duty?

Anyone with an interest in the ongoing debate over the regulation of broker-dealers and investment advisers (the "harmonization" of regulation or "should brokers be held to a fiduciary duty standard" debate) should read the article in yesterday's New York Times, TARA SIEGEL BERNARD Struggling Over a Rule for Brokers.  Really excellent presentation of the issues.

February 17, 2010 in News Stories | Permalink | Comments (0) | TrackBack (0)

Two Investment Firms Sign on to New York's Public Pension Fund Reform Code of Conduct

Two more investment firms have agreed to adopt New York Attorney General Cuomo’s Public Pension Fund Reform Code of Conduct, which eliminates placement agents and campaign contributions from the public pension fund system nationwide. Ares Management LLC (“Ares”) and Freeman Spogli & Co. (“Freeman Spogli”) bring to eleven the number of firms that have adopted the Code.

Today’s announcement arises out of Cuomo’s two-year ongoing investigation involving the New York State Common Retirement Fund (the “CRF”), last valued at $126 billion. The investigation focuses in part on the use of placement agents and other intermediaries who are paid for marketing investments to public pension funds. The investigation found that the use of intermediaries in the public pension funds unnecessarily exposes the pension system to risks of improper influence. Last year, the Attorney General introduced his Code of Conduct, which, among other things, eliminates placement agents and intermediaries from the public pension fund system.

In addition to the placement agent ban, the Code bars investment firms from doing business with a public pension fund for two years after the firm makes a campaign contribution to an elected or appointed official who can influence the fund's investment decisions. Investment firms must also disclose any conflicts of interest to public pension fund officials or law enforcement authorities, to increase transparency and avoid abuse of the fund for personal gain.

Both Ares and Freeman Spogli obtained investments from the CRF under then-Comptroller Alan Hevesi. Each firm separately retained Wetherly Capital Group LLC (“Wetherly”) as a placement agent. Subsequently, Wetherly agreed to split its fees with Henry “Hank” Morris who was then Hevesi’s paid political adviser. Ares and Freeman Spogli were not informed of Wetherly’s arrangement with Morris.


February 17, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Proposes to Expand Publicly Available Information about Brokers

FINRA is seeking authority to significantly expand the amount of information available to the public on current and former securities brokers through its free online BrokerCheck service.  The proposed expansion – which FINRA will submit to the SEC in the near future – would increase the number of customer complaints reported publicly; extend the public disclosure period for the full record of a broker who leaves the industry from two years to 10 years; and, make certain information about former brokers available permanently, such as criminal convictions and certain civil and arbitration judgments.

 Specifically, FINRA's proposed expansion of BrokerCheck would:

  • Disclose all "historic" complaints against a broker dating back to 1999, when electronic filing of broker information began. Generally, historic complaints are customer complaints, arbitrations or litigations more than two years old that have not been adjudicated or have been settled for an amount less than the reporting requirement (currently $15,000). They are currently reported on BrokerCheck when the broker has three or more currently disclosable regulatory actions, customer complaints, arbitrations, litigations or historic complaints. The new proposal would disclose all historic complaints dating back to 1999 for individual brokers who are currently registered or whose registrations were terminated within the preceding two years. If the SEC approves the entire package of BrokerCheck expansion proposals, the reporting of historic complaints would apply to brokers whose registrations were terminated within the preceding 10 years.
  • Expand the disclosure period for former brokers. Currently, a broker's record is publicly available for two years after he or she leaves the securities industry. That two-year period coincides with the period in which an individual remains subject to FINRA's jurisdiction and within which an individual can return to the industry without having to take requalifying exams. The new proposal calls for making a former broker's record public for 10 years, so investors can access information about individuals who may work in other sectors of the financial services industry or who have attained other positions of trust.
  • Further expand the amount of information that is permanently available on former brokers. Last year, BrokerCheck started making information about final regulatory actions (i.e., bars, suspensions, fines, etc.) against former brokers permanently available to the public. The new proposal would make additional information permanently available – including criminal convictions or pleas of guilty or nolo contendere; civil injunctions or findings of involvement in a violation of any investment-related statute or regulation; and arbitration awards or civil judgments based on the individual's involvement in an alleged sales practice violation.

February 17, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, February 16, 2010

SEC Charges Doctor with Insider Trading in LCA Visions Stock

The SEC filed on February 11, 2010 securities fraud charges against Gerald D. Horn ("Horn") for his alleed illegal insider trading in the securities of LCA Visions, Inc. ("LCA") that resulted in total illicit gains of approximately $1.4 million.  LCA is a public company headquartered in Cincinnati, Ohio that provides laser surgery vision correction services in 31 states. Horn, a doctor of ophthalmology, is both an employee of LCA and the owner of the Illinois professional corporation that operates LCA facilities in the Chicago area.

The SEC's complaint, filed in the U.S. District Court for the Northern District of Illinois, alleges that, between December 2005 and August 2006, Horn traded on the basis of material, non-public information when he made six separate purchases of LCA call and put options, resulting in illicit gains of approximately $869,629. Horn also traded on the basis of material, non-public information when he decided to exercise LCA stock option grants and sell the stock, resulting in a loss avoided of approximately $533,603.

According to the SEC complaint, Horn traded on the basis of information contained in LCA's internal Eyes by Laser Reports, which provided non-public information regarding LCA's total number of laser eye surgeries performed and revenue generated from these procedures. These reports also allowed him to successfully predict whether LCA's earnings would miss or beat LCA's previous earnings guidance previously provided to the public.

The complaint also alleges that, during sworn testimony before the SEC, Horn provided numerous false explanations for his timely trading in LCA securities.

The SEC seeks a permanent injunction against Horn prohibiting him from future violations of the federal securities laws. The SEC also seeks an order requiring Horn to pay disgorgement of his ill-gotten gains plus prejudgment interest, and a civil penalty.

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

Four Individuals Enjoined for Distribution of Unregistered Securities

The SEC announced today that the United States District Court for the District of Arizona granted the Commission's motion for summary judgment and entered final judgments, on February 8, 2010, against the four remaining defendants in a civil injunctive action filed by the Commission in August 2008. The Commission's complaint alleged that the defendants engaged in an unregistered distribution of the securities of Alliance Transcription Services, Inc. (formerly Strategy X, Inc.) from April 2005 through September 2006 and that Alliance and its officers participated in a scheme to manipulate the price and trading volume of its stock.The final judgments permanently enjoin Raymond C. Dabney, Richard A. Dabney, Charles J. Smith, and Philip M. Young from violations of the securities registration provisions of the federal securities laws, and also enjoin Richard Dabney from violations of the antifraud provisions. The four defendants were ordered to pay more than $1.4 million in disgorgement, interest, and civil penalties.

Final judgments against all of the other defendants in this action were entered previously by the court.

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

SEC's Investor Advisory Committee Announces Agenda for Feb. 22 Meeting

The Securities and Exchange Commission Investor Advisory Committee will hold an Open Meeting on Monday, February 22.

The agenda for the meeting includes a report from the Education Subcommittee, including a presentation on the National Financial Capability Survey, a report from the Investor as Purchaser Subcommittee, including a discussion of fiduciary duty and mandatory arbitration, a 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 discussion of next steps and closing comments.

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

University of Buffalo Researcher Accused of Hiring Actors to Testify on his Behalf in Misconduct Hearing

The following has nothing to do with securities fraud -- it's just weird.  Also, Dr. Nancy Zimpher, Chancellor of the State University of New York system, who is credited for cooperating in the investigation, is the former President of my University of Cincinnati:

According to allegations made by New York Attorney General Cuomo, a former University at Buffalo researcher hired professional actors to portray real people who were familiar with his projects to testify on his behalf during a formal misconduct hearing. The researcher, who was exonerated of the misconduct because of the false testimonies, then attempted to seek $4 million from the state for monetary damages.

In September 2004, William Fals-Stewart was accused of scientific misconduct for allegedly fabricating data in federally funded studies he was undertaking as an employee at the University at Buffalo and Research Institute on Addictions. According to court papers, the allegations were based upon discrepancies between the number of volunteers he reported to the National Institute for Drug Addiction relating to grants for which Fals-Stewart was the Principal Investigator, and the actual number of volunteers who participated in his studies.

According to the felony complaint, during a subsequent formal investigation launched by the University, three witnesses testified by telephone because Fals-Stewart claimed they were out of town. In reality, they were actors who thought they were taking part in a mock-trial. Fals-Stewart paid the actors to testify. He also provided them with scripts to use during the proceedings that were riddled with inaccuracies regarding his research. Fals-Stewart told the three actors, who he had hired before for legitimate training videos, that they would be performing in a mock trial training exercise. They were not aware that they were testifying at a real administrative hearing, nor did they know they were impersonating real people. Because of these false testimonies, Fals-Stewart was exonerated at the administrative hearing.

Claiming that the misconduct allegations tarnished his reputation, Fals-Stewart sued the University, seeking $4 million from the state in damages. The Office of the Attorney General, in its role of defending the University and the state in the court action, conducted a thorough investigation of the claims against the University. It was during this investigation that Cuomo’s office discovered the alleged fraud, forced Fals-Stewart to withdraw his lawsuit and initiated a criminal investigation.

Fals-Stewart was arrested today and charged in Buffalo City Court with Attempted Grand Larceny in the First Degree (class C felony); three counts of Perjury in the First Degree (class D felony); three counts of Identity Theft in the First Degree (class D felony); two counts of Offering a False Instrument for Filing in the First Degree (class E felony); and three counts of Falsifying Business Records in the First Degree (class E felony). The maximum permissible sentence for a class C felony is 15 years in prison.

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

Senator Proposes Amendment Calling for SEC Study of Broker-Adviser Issue

Senator Tim Johnson (D-SD) is circulating a change to the Senate financial reform legislation (remember that?) so that brokers offering advice to their customers would not have to register as investment advisers or owe fiduciary duties to their customers.  Instead, his proposal would authorize the SEC to do yet another study of the issue (remember the RAND report?).  Expect the investment advisory community to slap this down hard.  InvNews, Johnson amendment would let brokers off the fiduciary hook

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

FINRA Settles Enforcement Action Against H&R Block Financial Advisors for Sales of RCNs

FINRA announced its first enforcement action involving the sales of reverse convertible notes (RCNs) — fining H&R Block Financial Advisors, Inc., (n/k/a Ameriprise Advisor Services, Inc.) $200,000 for failing to establish adequate supervisory systems and procedures for supervising sales of RCNs to retail customers. FINRA also fined and suspended H&R Block broker Andrew MacGill for making unsuitable sales of RCNs to a retired couple. The firm was ordered to pay $75,000 in restitution to the couple for losses they incurred.

 At the same time, FINRA released an Investor Alert, Reverse Convertibles - Complex Investment Vehicles, to educate retail investors about how these products work, what risks they involve and what factors to consider before investing in an RCN. FINRA also issued Regulatory Notice 10-09, reminding firms of their sales practice obligations when recommending or selling RCNs to retail investors.

 An RCN is a structured product that typically consists of a high-yield, short-term note of an issuer and effectively a put option that is linked to the performance of an unrelated, or "linked," asset - usually a single common stock, but sometimes a basket of stocks, an index or some other asset. As a general rule, upon maturity of an RCN, the investor will receive either his full principal investment or a predetermined number of shares of the linked equity (which may be worth less than the principal investment), depending on the performance of the linked equity. Generally speaking, the higher the coupon rate, the higher the expected volatility of the linked equity and the greater the likelihood of the investment resulting in payment of shares. Reverse convertibles not only come with the risks that fixed income products ordinarily carry, such as issuer default and inflation risk, but with additional risks of the underlying asset, which can depreciate or even become worthless. The initial investment for most RCNs is $1,000 per unit and most RCNs have maturity dates ranging from three months to one year.

 In the enforcement matter, FINRA found that during the period from January 2004 through December 2007, H&R Block engaged in sales of RCNs without having a system or procedures in place to effectively monitor customer accounts for potential over-concentrations in RCNs. As a result, the firm failed to detect and respond to indications of potential over-concentration in RCNs in numerous customer accounts.

 FINRA found that H&R Block utilized an automated surveillance system to facilitate its suitability review of securities transactions and to monitor customer accounts for potentially unsuitable positions and activity. The system would flag for review any transaction or account meeting certain parameters established by the firm relating to, for example, account turnover and concentration levels in a particular security or class of security. The firm's system, however, was not configured or designed to monitor RCN transactions or RCN positions in customer accounts and the firm did not establish an effective alternative means to do so. As a result, H&R Block failed to detect and respond to indications of potentially unsuitable RCN concentration levels in numerous customer accounts. Additionally, the firm failed to provide sufficient guidance to its supervising managers on how to assess suitability in connection with their brokers' recommendation of RCNs.

 FINRA found that the retired couple receiving restitution had, on MacGill's recommendation, invested nearly 40 percent of their total liquid net worth in nine RCNs. This exposed the customers to a risk of loss that was inconsistent with their investment objectives and risk tolerance and which ultimately resulted in substantial loss. FINRA suspended MacGill from associating with any FINRA regulated firm in any capacity for a period of 15 days, fined him $10,000, and ordered him to disgorge $2,023 in commissions that he earned from his sales of RCNs to the couple.

 In concluding this settlement, H&R Block and MacGill neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

February 16, 2010 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Sunday, February 14, 2010

Weber on Capital Adequacy Regulation

New Governance, Financial Regulation, and Challenges to Legitimacy: The Example of the Internal Models Approach to Capital Adequacy Regulation, by Robert F. Weber, Loyola University New Orleans - School of Law, was recently posted on SSRN.  Here is the abstract:

In the aftermath of the subprime credit crisis, recent academic and policy debate about the regulation and supervision of financial institutions has rightly focused on potential solutions to the manifold conflicts of interest and regulatory lacunae that exist in our current system. While most of these proposals concern the situs and scope of regulation, this Article contends that theoretical scrutiny of the methodologies and tools by which financial institutions are regulated - especially the modes of interaction between financial firms, their regulators, and other non-state stakeholders - are relatively under-scrutinized in financial regulation legal scholarship. This Article examines one financial regulatory reform - the recent trend of incorporating proprietary internal risk models in capital adequacy regulatory systems, most prominently the “Basel II” regime - and explains why it should be considered a so-called “new governance” technique aiming to bridge information asymmetries resulting from increasing complexity of regulated financial institutions. Despite its manifold advantages as a tool of governance in a highly complex and dynamic regulated field, this “internal models approach” to capital adequacy regulation falls into traps familiar to new governance reforms that render it susceptible to literal and softer forms of agency capture, and which threaten to compromise its democratic legitimacy and effectiveness.

My hope is that this Article, by analyzing a financial regulatory technology as a response to complexity from a new governance perspective, will prompt a deeper appreciation for new governance theory within financial regulation scholarship. New governance theory offers notable insights into the regulation of social systems dominated by complexity and dynamism, as with the contemporary financial system. By analyzing the complex financial system according to a new governance framework, scholars and policymakers will likely be able to (i) improve their diagnosis of sources of regulatory dysfunction, including in connection with the recent subprime credit crisis, (ii) propose reforms that will better conduce to the public goals of financial regulation, and (iii) deepen their understanding of the normative challenges to democratic legitimacy that are implicated when regulators seek to govern complexity through increased involvement of non-state actors in the regulatory process.

February 14, 2010 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)