Securities Law Prof Blog

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

Thursday, May 19, 2011

J.P. Turner Not Liable to Investors in Provident Royalties Private Placement

According to Investment News, a federal district court judge in Atlanta dismissed investors' claims against the brokerage firm J.P. Turner involving its sales of interests in Provident Royalties LLC (which offered oil and gas deals and which has been the subject of numerous regulatory and investors' actions).  The article quotes the firm's attorney as stating that J.P. Turner is the only broker-dealer to have a class action against it dismissed.  I have not seen the opinion myself, but if the article accurately summarizes it, it is a blockbuster.  Judge Carnes finds that there is no Georgia authority to support investors' allegations that the firm had a duty to confirm the accuracy of the issuer's statements in the private placement memoranda because it was not an underwriter. 

Hello?  What about a "know your security" obligation?  What about a duty to have a reasonable basis when recommending a security to a customer? 

I have written extensively about the need for a federal cause of action that would allow investors to recover against brokers that provide negligent or incompetent investment advice -- to no avail.  This opinion sounds like the poster child in support of my position. 

See InvNews, Rare sighting: Indie B-D wins private placement case

May 19, 2011 in State Securities Law | Permalink | Comments (1) | TrackBack (0)

SEC Approves FINRA Rule Change on New Issue Allocations and Distributions

The SEC approved, on an accelerated basis, a FINRA proposed rule change to amend FINRA Rule 5131 (New Issue Allocations and Distributions) to simplify the spinning provision in that Rule and to delay the implementation date of paragraphs (b) and (d)(4) under that Rule. This proposal was published for comment in the Federal Register on April 29, 2011, and the SEC received no comments regarding the proposal.

May 19, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Obama Submits Nominations for SEC, but Other Positions Remain Unfilled

Pro'Publica/New York Times columnist Jesse Eisinger writes about the disturbing number of vacancies in key regulatory positions at a time when Dodd-Frank's difficult implementation issues are being --or should be-- addressed. At a Time of Needed Financial Overhaul, a Leadership Vacuum

In other news, President Obama nominated Luis Aguilar for a second term at the SEC and Daniel Gallagher as a new apppointment to replace Kathleen Casey.  Gallagher is a former SEC Market & Trading attorney currently a partner at Wilmer Cutler.  WPost, Obama plans to nominate Gallagher to be SEC commissioner

May 19, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Proposes New Rules on Credit Ratings

On May 18 the SEC voted unanimously to propose new rules intended to increase transparency and improve the integrity of credit ratings.  The proposed rules would implement certain provisions of the Dodd-Frank Act and enhance the SEC’s existing rules governing credit ratings and Nationally Recognized Statistical Rating Organizations (NRSROs).

Under the SEC’s proposal, NRSROs would be required to:

  • Report on internal controls.
  • Protect against conflicts of interest.
  • Establish professional standards for credit analysts.
  • Publicly provide – along with the publication of the credit rating – disclosure about the credit rating and the methodology used to determine it.
  • Enhance their public disclosures about the performance of their credit ratings.

The SEC’s proposal also requires disclosure concerning third-party due diligence reports for asset-backed securities.

Public comments are due 60 days after publication in the Federal Register.

May 19, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC & Tenaris Enter DPA over FCPA Allegations

On May 17 the SEC announced that for the first time it has entered into a Deferred Prosecution Agreement (DPA) with Tenaris S.A. The agreement with Tenaris involves allegations that the global manufacturer of steel pipe products violated the Foreign Corrupt Practices Act (FCPA) by bribing Uzbekistan government officials during a bidding process to supply pipelines for transporting oil and natural gas. The SEC alleges that Tenaris made almost $5 million in profits when it was subsequently awarded several contracts by the Uzbekistan government. Under the terms of the DPA, Tenaris must pay $5.4 million in disgorgement and prejudgment interest.

The SEC signaled last year that it would use DPAs to encourage individuals and companies to provide information about misconduct and assist with an SEC investigation. When Tenaris conducted a thorough, worldwide internal review of its operations and controls, it discovered FCPA violations by personnel in Uzbekistan and informed the SEC. In response to its findings, Tenaris reviewed its controls and compliance measures and significantly enhanced its anti-corruption policies and practices. Tenaris has agreed to cooperate further with the SEC, Justice Department, and any other law enforcement agency in connection with this case. Tenaris also agreed to pay a $3.5 million criminal penalty in a Non-Prosecution Agreement announced today by the Justice Department.

Tenaris is incorporated in Luxembourg and its American Depositary Receipts (TS) are listed on the New York Stock Exchange.

Under the terms of the DPA, the SEC will refrain from prosecuting the company in a civil action for its violations if Tenaris complies with certain undertakings. Among other things, Tenaris has agreed to enhance its policies, procedures, and controls to strengthen compliance with the FCPA and anti-corruption practices. Tenaris will implement due diligence requirements related to the retention and payment of agents, provide detailed training on the FCPA and other anti-corruption laws, require certification of compliance with anti-corruption policies, and notify the SEC of any complaints, charges, or convictions against Tenaris or its employees related to violations of any anti-bribery or securities laws. Tenaris has agreed to continue to fully cooperate with the SEC in its investigation.

May 19, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, May 16, 2011

House Financial Services Committee Approves Three Bills Affecting CFPB

On May 13 the House Financial Services Committee approved three bills affecting the Consumer Financial Protection Bureau (CFPB) that is a principal component of the Dodd-Frank Act. According to Chairman Spencer Bachus, “Everyone on this Committee supports robust consumer protection.  But there must be real oversight and accountability of every massive government bureaucracy, and that includes the CFPB.”

The bills approved by the Financial Services Committee are:

H.R. 1121 would establish a five-member, bipartisan commission to lead the CFPB.  The legislation was approved by a vote of 33-24.

H.R. 1315 would clarify that the Financial Stability Oversight Council must set aside any CFPB regulation that is inconsistent with the safe and sound operations of U.S. financial institutions.  In addition, the bill would change the vote required to set aside regulations from two-thirds of the FSOC’s voting members to a simple majority. The legislation was approved by a vote of 35-22.

H.R. 1667 would ensure that a Senate-confirmed Director of the CFPB is in place before  the transfer of regulatory authority to the new bureau takes place.  If the CFPB does not have a Senate-confirmed Director by July 21, the Bureau may continue to operate under the Treasury Secretary’s authority. The legislation was approved by a vote of 32-26.

May 16, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Proposes Changes to Rule on Investment Company Securities

FINRA recently filed a proposed rule change with the SEC FINRA to adopt NASD Rule 2830 (Investment Company Securities) as FINRA Rule 2341 (Investment Company Securities) with significant changes. NASD Rule 2830 regulates members’ activities in connection with the sale and distribution of securities of companies registered under the Investment Company Act of 1940 (“investment company securities”)and limits the sales charges members may receive, prohibits directed brokerage arrangements, limits the payment and receipt of cash and non-cash compensation, sets conditions on discounts to dealers, and addresses other issues such as members’ purchases and sales of investment company securities as principal.

Proposed FINRA Rule 2341 would revise the provisions of NASD Rule 2830 in four areas. First, Rule 2341 would require a member to make new disclosures to investors regarding its receipt of or its entering into an arrangement to receive, cash compensation. Second, Rule 2341 would make a minor change to the recordkeepingrequirements for non-cash compensation. Third, Rule 2341 would eliminate a condition regarding discounted sales of investment company securities to dealers. Fourth, Rule
2341 would codify past FINRA staff interpretations regarding the purchases and sales of
exchange-traded funds (“ETFs”).

May 16, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Launches Disciplinary Actions Online Database

The FINRA announced the launch of the FINRA Disciplinary Actions Online database, a web-based searchable system that makes its disciplinary actions accessible via its website.  Users can conduct a search for FINRA disciplinary actions that were issued during 2006 or later, and are eligible for publication pursuant to FINRA Rule 8313 (Release of Disciplinary Complaints, Decisions and Other Information). Results will also include opinions issued by the SEC and federal appellate courts that relate to FINRA disciplinary actions that have been appealed.  Users may search for actions by case number, document text, document type, action date (by date range), a combination of document text and action date, individual name and Central Registration Depository (CRD®) number, or firm name and CRD number.

BrokerCheck® reports will now link to disciplinary actions housed in the system, as it currently does for arbitration awards in the Arbitration Awards Online database. Beginning June 15th, FINRA Monthly Disciplinary Actions will also link each write-up to its corresponding action in the database.


May 16, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Watchdog Group Studies "Revolving Door" Policies at the SEC

A recurring and thorny issue is the "revolving door" policy (or lack thereof) of SEC employees who leave the agency and then begin to represent clients before the SEC.  This practice raises obvious issues of conflicts of interest -- most recently surfacing in connection with questions about the SEC's failure to investigate the Stanford ponzi scheme.  As many point out, however, the reality is that many of the SEC's "best and the brightest" come for the experience and training and accept the relatively low government salary because of the expectation that it will pay off with subsequent lucrative employment.  Hiring only SEC-"lifers" is not necessarily in the best interests of the agency.  What then is the best way to manage these conflicts of interests so they do not jeopardize the agency's mission of effective enforcement of the federal securities laws? 

As part of an effort to shed light on the revolving door at the SEC, and to examine whether the SEC has adequate policies and procedures in place to detect and mitigate conflicts of interest involving former SEC employees, The Project on Government Oversight (POGO) obtained five years' worth of statements filed by former SEC employees who appeared before the SEC seeking to represent outside clients within two years after leaving the agency. POGO has also made these post-employment statements publicly available in a searchable online database.

Among its findings, POGO reports that:

  • Between 2006 and 2010, 219 former SEC employees filed 789 post-employment statements indicating their intent to represent an outside client before the Commission.
  • Some former SEC employees filed statements within days of leaving the Commission, with one employee filing within 2 days of leaving.
  • Some former SEC employees filed numerous statements during this time period, with one former employee filing 20 statements.
  • There are 131 entities providing legal, accounting, consulting, and other services that were identified as new employers in the statements. Some entities recruited numerous SEC employees during the five-year period.
  • In the vast majority of statements, former SEC employees affirm that they did not participate personally or substantially in, or have official responsibility for, the matter on which they now expect to appear before the Commission.
  • POGO identified instances in which former SEC employees may have been required to file statements during the five-year period but did not.
  • Some former SEC employees disclosed that they consulted with ethics officers regarding the work they intended to do on behalf of their clients before the SEC, but in many other statements, it is unclear whether the former employees discussed their post-employment plans with an ethics officer.
  • Some statements indicate that the former employee did participate in or have responsibility for a related matter while they worked at the SEC, but that they discussed the matter with an ethics officer who advised them they could contact Commission staff on that issue on behalf of their new client.

May 16, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

NASDAQ & ICE Drop Bid for NYSE Because of Antitrust Obstacle

The NASDAQ OMX Group Inc. and IntercontinentalExchange Inc. abandoned their joint bid to acquire NYSE Euronext after the Department of Justice informed the companies that it would file an antitrust lawsuit to block the deal.   The department said that the acquisition would have substantially eliminated competition for corporate stock listing services, opening and closing stock auction services, off-exchange stock trade reporting services and real-time proprietary equity data products. 

According to Christine Varney, Assistant Attorney General in charge of the Department of Justice’s Antitrust Division,  “The acquisition would have removed incentives for competitive pricing, high quality of service, and innovation in the listing, trading and data services these exchange operators provide to the investing public and to new and established companies that need access to U.S. stock markets.”

In a release from NASDAQ OMX, its CEO Bob Greifeld said:

"We took the decision to withdraw our offer when it became clear that we would not be successful in securing regulatory approval for our proposal despite offering a variety of substantial remedies, including the sale of the NYSE SRO and related businesses. We saw a unique opportunity to create more value for stockholders and strengthen the U.S. as a center for capital formation amid an ongoing shift of these vital activities and jobs outside of our country.

"NASDAQ OMX has demonstrated an ability to outperform, whether the comparison is against all other equity exchanges today, or even against the largest derivatives exchanges. We have achieved outstanding earnings growth over the last few years and are confident that our global model features a healthy mix of product diversification and will continue to thrive based on our efficiency and ability to innovate."

May 16, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Sunday, May 15, 2011

Heminway on Fairness Opinions

A More Critical Use of Fairness Opinions as a Practical Approach to the Behavioral Economics of Mergers and Acquisitions, by Joan MacLeod Heminway, University of Tennessee College of Law, was recently posted on SSRN.  Here is the abstract:

This paper responds to Professor Donald C. Langevoort's essay entitled "The Behavioral Economics of Mergers and Acquisitions" (12 Transactions: Tenn. J. Bus. L. 65 (2011)). Together with Professor Langevoort's essay and another responsive work written from the standpoint of behavioral psychology – Eric Sundstrom's "Tall Steps, Slippery Slopes & Learning Curves in the Behavioral Economics of Mergers & Acquisitions" (12 Transactions: Tenn. J. Bus. L. 65 (2011)) – this paper preliminarily explores solutions to behavioral issues in the context of mergers and acquisitions.

Specifically, this paper contends that changes in the contents, construction, use, and assessment of fairness opinions may better enable fairness opinions to counteract the potential and actual biases of corporate management and shareholders in M&A decision-making. The paper begins by briefly reviewing the nature (attributes, benefits and detriments), regulation, and utilization of fairness opinions in the M&A transactional process, including the ways in which fairness opinions manifest, support, and attempt to counteract behavioral norms. Next, the paper suggests best practices in the construction and use of fairness opinions that take into account our knowledge of behavioral psychology as it relates to M&A transactions. The net effect of these best practices is to transform what may be unconscious behavioral norms into conscious biases that, once exposed, can be confronted and, as desired, mitigated.

May 15, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Hackney on Intellectual History of Corporate Finance Theory

The Enlightenment and Financial Crisis of 2008: An Intellectual History of Corporate Finance Theory, by James R. Hackney, Jr., Northeastern University - School of Law, was recently posted on SSRN.  Here is the abstract:

 This article examines the financial crisis of 2008 and connections to corporate finance theory. The financial products and deregulation that led to the crisis were informed by corporate finance theories. These theories include diversification, the capital asset pricing model, and options theory. The theories have a scientific basis but can get deployed (in the form of financial product presentation or policy justification) in ways that deviate from the scientific articulation. The article provides an intellectual history of mainstream corporate finance theory and argues that it, despite the consequences of its misuse, is a valuable scientific achievement and even arguments for its correction (most notably by behavioral finance theorists) do not detract from its value. The debate within corporate finance is used to illustrate the virtues of Enlightenment principles.

May 15, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Thor Industries and Former VP-Finance Settle SEC Charges Involving Fraudulent Accounting

The SEC filed a settled enforcement action charging Ohio-based producer of recreational vehicles Thor Industries, Inc. with issuer reporting, record-keeping, and internal control violations. Thor agreed to be permanently enjoined and to pay a $1 million civil penalty for violating a 1999 Commission cease-and-desist Order prohibiting violations of the books and records and internal controls provisions. The SEC also charged Mark C. Schwartzhoff, a former Vice President of Finance at Thor’s Dutchmen Manufacturing, Inc. subsidiary, with securities fraud and other violations. Schwartzhoff agreed to be permanently enjoined, to be permanently barred from serving as an officer or director of a public company, and to be permanently suspended from appearing or practicing before the Commission as an accountant. Schwartzhoff also agreed to pay disgorgement of $394,830, which shall be deemed satisfied by the entry of a restitution order against Schwartzhoff in a parallel criminal case.

The SEC’s complaint alleges that from approximately December 2002 to January 2007, while serving as the senior financial officer of Dutchmen, one of Thor’s principal operating subsidiaries, Schwartzhoff engaged in a fraudulent accounting scheme to understate Dutchmen’s cost of goods sold in order to avoid recognizing inventory costs that were not reflected in Dutchmen’s financial accounting system.

As alleged in the complaint, Schwartzhoff’s fraud overstated Dutchmen’s pre-tax income by nearly $27 million from fiscal year 2003 to the second quarter of fiscal 2007, and allowed him to obtain nearly $300,000 in ill-gotten bonuses. In June 2007, Thor filed restated financial statements for fiscal years 2004 to 2006, each of the quarters of fiscal 2005 and 2006, and the first quarter of fiscal 2007, reducing its pre-tax income by approximately $26 million in the aggregate.

These settlements are subject to the approval of the United States District Court for the District of Columbia. The settlement with Thor takes into account the company’s self-reporting and significant cooperation in the SEC’s investigation.

Separately, on May 12, 2011, the United States Attorney’s Office for the Northern District of Indiana filed a related criminal action against Schwartzhoff, and Schwartzhoff agreed to plead guilty to an Information charging him with one count of wire fraud and to pay restitution of approximately $1.9 million.

May 15, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Upholds NYSE Sanctions Involving Misleading Marketing to Worldcom Employees

The SEC recently sustained NYSE disciplinary action against Philip L. Spartis and Amy J. Elias, former registered representatives of Salomon Smith Barney, Inc., and sustained the censures NYSE imposed against Spartis and Elias for misleading marketing materials sent to employees of Worldcom.

During the period from 1998 to 2001, according to the Commission, Spartis and Elias provided assistance to their customers in the exercise of employee stock options granted to them by WorldCom. In so doing, Spartis and Elias distributed a document, titled the "Exercise & Hold vs Exercise & Sell Analysis," that encouraged customers to exercise their WorldCom stock options and hold the resulting stock for at least a year, rather than exercising their options and immediately selling the stock in the market. The document further assumed an ever-increasing appreciation in WorldCom's stock price, which was consistent with Smith Barney's then-telecommunications analyst Jack Grubman's projections, and encouraged customers, as part of the holding strategy, to use margin loans to fund the transactions. Subsequently, however, the predicted stock price increases "never materialized," producing heavy customer losses.

The Commission agreed with the NYSE that the document was materially misleading, under NYSE's public communications rule, by "'present[ing] an unduly optimistic picture of the potential gains' that would result under the . . . hold[ing] strategy and by failing to include any downside risk analysis." According to the Commission, it was particularly "troubled by the omission of information" in the document "regarding the potential adverse consequences of financing these transactions on margin," noting that "transactions effected on margin . . . entail substantial risks." In upholding NYSE's sanction, the Commission stated that Spartis's and Elias's distribution of the one-sided document to their customers "thwarted" "an important policy objective" of "provid[ing] full and fair disclosure" to investors.  

May 15, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA CEO and SEC Enforcement Director Testify before House Oversight Committee on Stanford Ponzi Scheme

The Subcommittee on Oversight and Investigations, Committee on Financial Services, U.S. House of Representatives, held on a hearing on May 13 on the Stanford ponzi scheme.  Robert Khuzami, Director, SEC Division of Enforcement and Carlo di Florio, Director, SEC Office of Compliance Inspections and Examinations, testified on “The Stanford Ponzi Scheme: Lessons for Protecting Investors from the Next Securities Fraud.”  Rick Ketchum, Chairman & CEO, FINRA,  also testified.

May 15, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Thursday, May 12, 2011

SEC Schedules May 18 Open Meeting on Credit Rating Agencies

The SEC's next Open Meeting is scheduled for May 18, 2011.  The subject matter of the Open Meeting will be:

The Commission will consider whether to propose new rules and amendments to existing rules to implement provisions of Subtitle C of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act that would apply to credit rating agencies registered with the Commission as nationally recognized statistical rating organizations, providers of third-party due diligence services for asset-backed securities, and issuers and underwriters of asset-backed securities.


May 12, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Senate Committee Holds Another Hearing on Dodd-Frank Implementation

Today the Senate Banking Committee held its fourth hearing with regulators on implementation of Dodd-Frank financial reform.  In particular, lawmakers expressed concern that regulators are not providing the public with enough information or an opportunity to comment on what firms will be deemed to pose a systemic risk.  WSJ, Regulators Defend Financial Revamp Efforts; WPost, Bernanke, fellow regulators update Congress on efforts to overhaul US financial rulebook

May 12, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC's Schapiro Testifies On Monitoring Systemic Risk

SEC Chairman Mary L. Schapiro testified on Monitoring Systemic Risk and Promoting Financial Stability before the United States Senate Committee on Banking, Housing and Urban Affairs on May 12, 2011.

May 12, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Roundtable: What To Do About Money Market Funds

The SEC held a roundtable discussion yesterday on what to do with money market funds, and, as expected, the regulators and the industry had different views about whether to maintain the stable $1 NAV.  Investment News provides a good summary.  FDIC Chair Sheila Blair and former Fed Chair Paul Volcker called for a floating NAV, while industry representatives testified that forcing MM funds to abandon the stable $1 NAV would destroy the funds' appeal to investors.  InvNews, Money fund 'fiction' a real threat to investors: FDIC's Bair

May 12, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

2d Circuit: Rating Agencies are not "Underwriters" or "Control Persons"

The Second Circuit, in In re Lehman Brothers Mortage-Backed Securities Litigation (May 11, 2011)(Download 2dCir.LehmanMortBackAssets) affirmed the district court's dismissal of three class action complaints brought by purchasers of mortgage pass-through certificates registered with the SEC that entitled them to distributions from the underlying pools of mortgages.  Most of the certificates received AAA ratings from one of the three major credit rating agencies named as defendants -- S&P, Moody's, and Fitch.  According to plaintiffs, the rating agencies exceeded their traditional roles by actively aiding in the structuring and securitization process and helped to determine the composition of the loan pools, the certificates' structures and the amount and kind of credit enhancement for particular tranches.  Plaintiffs argued that the rating agencies' activities made them "underwriters" for purposes of Securities Act section 11 liability or "control persons" under section 15.  The Second Circuit, however, was not persuaded. 

As to underwriter status, the Second Circuit held that:

To qualify as an “underwriter” under 15 U.S.C. § 77b(a)(11), a person must
have participated, directly or indirectly, in the purchase of securities with a view toward
distribution, or in the sale or offer of securities in connection with a distribution. Because
the Rating Agencies’ alleged structuring or creation of securities was insufficient to
demonstrate their involvement in the requisite distributional activities, plaintiffs’ § 11 claims
against these defendants were properly dismissed.

The court based its holding on statutory interpretation, legislative history and policy.

As to "control person" liability:

Because the Rating Agencies’ provision of advice and guidance regarding
transaction structures was insufficient to permit an inference that they had the power to direct
the management or policies of alleged primary violators of § 11, plaintiffs’ “control person”
claims against these defendants pursuant to 15 U.S.C. § 77o(a) were properly dismissed.

The court also found that the district court did not abuse its discretion in implicitly denying plaintiffs' cursory requests to amend their complaints.

May 12, 2011 | Permalink | Comments (0) | TrackBack (0)