Securities Law Prof Blog

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

A Member of the Law Professor Blogs Network

Monday, November 21, 2011

Former AIG CEO Challenges Bailout as Unconstitutional Taking

Did the U.S. Government's bailout of AIG constitute an illegal taking under the 5th Amendment?  That is the argument that former AIG CEO "Hank" Greenberg (through Starr International Co., which he controls) is making in two lawsuits filed today. 

The complaint in Starr International Co. v. U.S. (Download StarrvsUS11212011[1]), filed in the U.S. Court of Federal Claims, alleges that, rather than provide AIG with liquidity support offered to comparable firms, the Government took steps in September 2008 that resulted in its taking control away from AIG shareholders and taking 80% of shareholder equity, without shareholder approval and without just compensation.

Starr International also filed a complaint (Download StarrvsNYFed11212011[1]) in federal district court in Manhattan against the New York Federal Reserve, alleging that as AIG's controlling shareholder and controlling lender, it breached duties owed to AIG and Starr International.

November 21, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Fordham's Securities Law Moot Court Seeks Judges

Fordham Law's Kaufman Securities Law Moot Court Competition is looking for a few good judges!  I am happy to post the following notice on its behalf:

Each spring, Fordham University School of Law hosts the Irving R. Kaufman Memorial Securities Law Moot Court Competition.  Held in honor of Chief Judge Kaufman, a Fordham Alumnus who served on the United States Court of Appeals for the Second Circuit, the Kaufman Competition has a rich tradition of bringing together complex securities law issues, talented student advocates, and top legal minds.    

 The year’s Kaufman Competition will take place on March 23, 2012 to March 25, 2012.

Our esteemed final round panel includes Judge Paul J. Kelly, Jr., of the Tenth Circuit; Chief Judge Alex Kozinski, of the Ninth Circuit; Judge Boyce F. Martin, Jr., of the Sixth Circuit; Judge Richard A. Posner, of the Seventh Circuit; Judge Jane Richards Roth, of the Third Circuit; and Commissioner Troy A. Paredes, of the United States Securities and Exchange Commission.

 We are currently soliciting practitioners and academics to judge oral argument rounds and grade competition briefs.  No securities law experience is required to participate and CLE credit is available.

Information about the Kaufman Competition and an online Judge Registration Form is available on our website.  Please contact Michael A. Kitson, Kaufman Editor, at KaufmanMC@law.fordham.edu or (212) 636-6882 with any questions.

 

November 21, 2011 in Professional Announcements | Permalink | Comments (0) | TrackBack (0)

Sunday, November 20, 2011

Chaffee & Rapp on Peer-to-Peer Lending

Regulating On-Line Peer-to-Peer Lending in the Aftermath of Dodd-Frank: In Search of an Evolving Regulatory Regime for an Evolving Industry, by Eric Chaffee, University of Dayton School of Law, and Geoffrey Christopher Rapp, University of Toledo - College of Law, was recently posted on SSRN.  Here is the abstract:

The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act called for a government study of the regulatory options for on-line Peer-to-Peer lending. On-line P2P sites, most notably for-profit sites Prosper.com and LendingClub.com, offer individual “investors” the chance to lend funds to individual “borrowers.” The sites promise lower interest rates for borrowers and high rates of return for investors. In addition to the media attention such sites have generated, they also raise significant regulatory concerns on both the state and federal level. The Government Accountability Office report produced in response to the Dodd-Frank Act failed to make a strong recommendation between two primary regulatory options – a multi-faceted regulatory approach in which different federal and state agencies would exercise authority over different aspects of on-line P2P lending, or a single-regulator approach, in which a single agency (most likely the new Consumer Financial Protection Bureau) would be given total regulatory control over on-line P2P lending. After discussing the origins of on-line P2P lending, its particular risks, and its place in the broader context of non-commercial lending, this paper argues in favor of a multi-agency regulatory approach for on-line P2P that mirrors the approach used to regulate traditional lending.

November 20, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Stratmann & Verret on Small Public Companies and Proxy Access

Does Shareholder Proxy Access Damage Share Value in Small Publicly Traded Companies?, by Thomas Stratmann, George Mason University - Buchanan Center Political Economy; CESifo (Center for Economic Studies and Ifo Institute for Economic Research), and J. W. Verret, George Mason University School of Law, was recently posted on SSRN.  Here is the abstract:

The field of corporate governance has long considered the costs of the separation of ownership from control in publicly traded corporations and the regulatory and market structures designed to limit those costs. The debate over the efficiency of regulations designed to limit agency costs has recently focused on the SEC’s new rule requiring companies to include shareholder nominees on the company financed proxy statement to facilitate insurgent challengers to incumbent board members in board elections. A recent vein of empirical literature has examined the stock price effects of events surrounding the new proxy access rule. We present a study that focuses on small companies who expected an exemption from the rule under the Dodd-Frank legislation that preceded the adoption of the SEC rule. We consider the effect of the August 25, 2010 announcement of the proxy access rule, comparing its effect on the value of firms that expected to be subject to the full rule against its effect on the value of small firms unexpectedly given only a temporary exemption from part of the rule (Rule 14a-11) and no exemption from part of the rule (Rule 14a-8). Supporters of proxy access have long argued that it will enhance shareholder value. Critics of proxy access have argued that it will empower investors with conflicted agendas that will destroy shareholder wealth. The unexpected application of the rule to small-cap companies on August 25 provides a natural experiment for this question and allows us to examine the differential effect of the rule on firms above and below the arbitrary SEC cutoff of $75 million dollars in market capitalization. We find that the unanticipated application of the proxy access rule to small firms, particularly when combined with the presence of investors with a 3% interest able to use the rule, resulted in negative abnormal returns. We present multiple methods to measure that effect and demonstrate losses for our sample of roughly 1,000 small companies of as much as $335 million.

November 20, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Packin on Living Wills

The Case Against the Dodd-Frank Act’s Living Wills: Contingency Planning Following the Financial Crisis, by Nizan Geslevich Packin, University of Pennsylvania, was recently posted on SSRN.  Here is the abstract:

The Dodd-Frank Act’s “living will” requirement mandates that systemically important financial institutions develop wide-ranging strategic analyses of their business affairs, and submit comprehensive contingency plans for reorganization or resolution of their operations to regulators. The goal is to mitigate risks to the financial stability of the US and encourage last-resort planning, which will allow for a rapid and efficient response in the event of an emergency. Beyond the general framework set forth in the Dodd-Frank Act, very little is known about living wills; no legal literature currently exists on what the concept entails, and regulators have not yet created any rules that detail how living wills will operate. Nevertheless, living wills are perceived to be a successful regulatory solution to the problems highlighted by the recent financial crisis. This article focuses on two issues: (i) the implementation and operation of living wills for systemically important financial institutions; and (ii) the problematic aspects of living wills, and how they can lead to the failure of even the most ideally planned living wills. The article concludes that living wills are merely a disclosure requirement with high expectations, but only limited power; accordingly, they should not be perceived as a comprehensive, satisfactory regulatory solution to the too-big-to-fail problem.

November 20, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Thursday, November 17, 2011

SEC Halts Scam Touting Access to Pre-IPO Shares of Facebook, Groupon

The SEC filed an emergency enforcement action to stop a fraudulent scheme targeting investors seeking coveted stock in Internet and technology companies like Facebook before they go public.  According to the SEC, Florida resident John A. Mattera and several other individuals carried out the scam using a newly-minted hedge fund named The Praetorian Global Fund. They falsely claimed that the fund and affiliated Praetorian entities owned shares worth tens of millions of dollars in privately-held companies that were expected to soon hold an initial public offering (IPO) including Facebook, Groupon, and others. Mattera solicited funds and told investors that an escrow service was receiving their funds.

In reality, according to the SEC’s complaint filed in federal court in Manhattan, Mattera and his cohorts never owned the promised pre-IPO shares in these companies. The purported escrow service, headed by John R. Arnold of Florida, merely transferred investor funds to personal accounts controlled by Mattera and Arnold. After Arnold took a cut of the money for himself, Mattera stole most of the remaining funds to afford his lavish personal expenses and pay others for their roles in the scheme.

The U.S. Attorney’s Office for the Southern District of New York, which conducted a parallel investigation of the matter, today filed criminal charges against Mattera, who was arrested earlier today.   Mattera has been a subject of a prior SEC enforcement action and several state criminal actions

November 17, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Legislation Introduced to Ban Insider Trading by Congressional Officials

Since the 60 Minutes segment aired on Sunday, there has been a quite a flap over alleged insider trading by Congressional officials and a healthy debate over the legality of the practice.  Professors Donna Nagy (it is already illegal) and Stephen Bainbridge (it is currently legal) have eloquently stated their positions in scholarly publications and other communications. My post earlier this week gives the citations to Professor Nagy's work, and Professor Bainbridge provides a link to his discussion in his comment to my blog.

Although legislation to ban the practice has previously been introduced, and quickly died, in Congress, there is now renewed interest.  Senator Scott Brown (R-Mass) introduced S. 1871, the Stop Trading on Congressional Knowledge (STOCK) Act, on Wednesday.  It would prohibit members or employees of Congress and Executive Branch employees from buying or selling stocks, bonds, or commodities futures based on nonpublic information they obtain because of their privileged status. The Act would also prohibit Members and employees from disclosing any non-public information about any pending or prospective legislative action obtained from a member or employee of Congress for investment purposes.  Members of Congress and employees would also be required to report the purchase, sale or exchange of any stock, bond, or commodities future transaction in excess of $1,000 within 90 days.

A different version of legislation has been introduced by some Democratic senators, including Senator Kirsten Gillibrand.  It would redefine insider trading to include knowledge gained from Congressional work and service, create rules and reporting requirements, and require “political intelligence consultants” to register as lobbyists. 

Since various Congressional committees regularly summon the SEC to the Hill to account for its activities, perhaps they could ask the SEC whether it has ever investigated stock trading by Congressional officials and why it has not pursued any enforcement actions against the practice?

November 17, 2011 | Permalink | Comments (0) | TrackBack (0)

Second Circuit Refuses to Reconsider Calculation of Madoff Damages

The Second Circuit denied the petition from some Madoff investors for an en banc rehearing of the panel's decision upholding the bankruptcy trustee's method of calculating damages that excludes recovery for net winners.  In re Bernard L. Madoff Investment Securities LLC (2d Cir. Nov. 8, 2011).

November 17, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

FINRA Plans Second Concept Proposal on Broker-Dealer's Disclosure Duties

FINRA CEO Richard G. Ketchum recently stated that FINRA may issue a concept proposal to articulate its position on the disclosure obligations of broker-dealers, in anticipation of the SEC’s release of a proposed uniform fiduciary duty standard for securities professionals (reported in BNA Corporate Law Daily 11/17/11).

 In October 2010 FINRA released for public comment a concept proposal that would require broker-dealers to provide certain disclosures about its products and services, conflicts of interest, and any limitations on its duties, to retail investors at the beginning of their relationship.  Since the comment period expired in December 2010, FINRA has not taken any action on the proposal.  About 55 comments were filed in response to the concept proposal.

In January 2011 the SEC released its report, required under section 913 of Dodd-Frank( Download 913studyfinal), on the effectiveness of existing legal and regulatory standards for broker-dealers and investment advisers.  Since then, although SEC Chair Schapiro has stated on several occasions that the SEC plans to propose a uniform fiduciary duty standard, it has not yet done so.  The SEC website’s timeline for implementing Dodd-Frank lists proposing rules based on the § 913  study by year-end. 

November 17, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 16, 2011

SEC Directors Testify before Senate Securities Subcommittee

Testimony on "Management and Structural Reforms at the SEC: A Progress Report," by Robert Khuzami, Director, Division of Enforcement; Meredith Cross, Director, Division of Corporation Finance; Robert Cook, Director, Division of Trading and Markets; Carlo di Florio, Director, Office of Compliance Inspections and Examinations; Eileen Rominger, Director, Division of Investment Management; Craig Lewis, Chief Economist and Director, Division of Risk, Strategy, and Financial Innovation;

Before the United States Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Securities, Insurance, and Investment (November 16, 2011)

November 16, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

GAO Reports on Deficiencies in SEC Internal Controls

The GAO posted on its website a report, Financial Audit: Securities and Exchange Commission's Financial Statements for Fiscal Years 2011 and 2010 (GAO-12-219 November 15, 2011).  Here is the summary:

Pursuant to the Accountability of Tax Dollars Act of 2002, the United States Securities and Exchange Commission (SEC) is required to prepare and submit to Congress and the Office of Management and Budget audited financial statements. Pursuant to the Securities Exchange Act of 1934, amended in 2010 by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), SEC is also required to submit audited financial statements for the Investor Protection Fund (IPF) to Congress. GAO, under its audit authority, audited SEC's and IPF's financial statements to determine whether (1) the financial statements are fairly presented, and (2) SEC maintained effective internal control over financial reporting. GAO also tested SEC's compliance with selected provisions of laws and regulations. In accordance with the 1934 act, as amended by the Dodd-Frank Act, GAO also reported on SEC's assessment of its internal control over financial reporting.

In GAO's opinion, SEC's fiscal years 2011 and 2010 financial statements are fairly presented in all material respects. Also in GAO's opinion, IPF's fiscal years 2011 and 2010 financial statements are fairly presented in all material respects. In addition, GAO concluded that although internal controls could be improved, SEC maintained, in all material respects, effective internal control over financial reporting for both the agency as a whole and IPF as of September 30, 2011. GAO's conclusion on the effectiveness of SEC's internal control over financial reporting is consistent with SEC's assessment of its internal control over financial reporting as of September 30, 2011. GAO found no reportable noncompliance for either SEC or IPF in fiscal year 2011 with the provisions of laws and regulations it tested. During fiscal year 2011, SEC made important progress in addressing previously reported material weaknesses in internal control over its information systems and over its financial reporting and accounting processes. Because of these improvements, GAO concluded that the deficiencies that comprised these weaknesses no longer constitute material weaknesses. However, GAO also concluded that, because of the remaining control deficiencies along with newly identified deficiencies in fiscal year 2011, SEC had significant deficiencies in its internal control in four areas: (1) information security, (2) financial reporting and accounting processes, (3) budgetary resources, and (4) registrant deposits and filing fees. These significant deficiencies pertain to SEC's financial reporting, but not that of IPF because of the nature of IPF's financial transactions during fiscal year 2011. While these significant deficiencies are not material weaknesses, they nonetheless warrant the attention of those charged with SEC's governance. SEC's ability to establish and maintain effective internal control over financial reporting remains at risk until it can reduce its reliance on compensating manual financial reporting and accounting processes. GAO will be separately reporting at a later date to SEC on additional details regarding these significant deficiencies along with recommendations for corrective action. GAO noted other matters involving SEC's internal control that were less significant than a material weakness or significant deficiency and will also be reporting separately to SEC management on these matters. GAO is not making recommendations in this report, but will be reporting separately on the control issues identified during its audit, along with recommendations for corrective actions. In commenting on a draft of this report, SEC stated that, as part of its strategy for addressing financial reporting control issues, SEC will complete migration of its core financial system to a federal government shared service provider in fiscal year 2012. SEC also plans to continue to remediate deficiencies in other areas.
 

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

Morgan Stanley Settles SEC Allegations that Adviser Charged Fees for Non-Existent Services

The SEC charged Morgan Stanley Investment Management (MSIM) with violating securities laws in a fee arrangement that repeatedly charged a fund and its investors for advisory services they weren’t actually receiving from a third party.  According to the SEC, MSIM — the primary investment adviser to The Malaysia Fund — represented to investors and the fund’s board of directors that it contracted a Malaysian-based sub-adviser to provide advice, research and assistance to MSIM for the benefit of the fund, which invests in equity securities of Malaysian companies. The sub-adviser did not provide these purported advisory services, yet the fund’s board annually renewed the contract based on MSIM’s representations for more than a decade at a total cost of $1.845 million to investors.

The SEC’s Asset Management Unit has an initiative inquiring into the investment advisory contract renewal process and fee arrangements in the fund industry.

“We want to take the advisory fee setting process out of the shadows by scrutinizing the role of investment advisers and fund board members in vetting fee arrangements with registered funds,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.

The SEC’s order finds that MSIM willfully violated Sections 15(c) and 34(b) of the Investment Company Act and Sections 206(2) and (4) of the Investment Advisers Act of 1940, and Rule 206(4)-7 thereunder. Without admitting or denying the SEC’s findings, MSIM agreed to a censure and to cease and desist from committing or causing any violations and any future violations of those provisions. MSIM agreed to repay the fund $1.845 million for the sub-adviser’s fees and pay a $1.5 million penalty. MSIM also agreed to implement policies and procedures specifically governing the Section 15(c) process and its oversight of service providers.

November 16, 2011 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Two Defendants in Expert Networks Insider Trading Case Settle SEC Charges

The SEC wrapped up enforcement actions against two of the defendants in an alleged "expert networks" insider trading scheme brought earlier this year.  The SEC announced that the federal district court in S.D.N.Y. recently entered Final Judgments on Consent as to Mark Anthony Longoria and as to Donald Longueuil in the SEC’s insider trading case, SEC v. Mark Anthony Longoria, et al., 11-CV-0753 (SDNY) (JSR).

The SEC filed its Complaint on February 3, 2011, charging two expert network employees and four consultants with insider trading for illegally tipping hedge funds and other investors. On February 8, 2011, the SEC filed an Amended Complaint, charging a New York-based hedge fund and four hedge fund portfolio managers and analysts who illegally traded on confidential information obtained from technology company employees moonlighting as expert network consultants. The scheme netted more than $30 million from trades based on material, nonpublic information about such companies as Advanced Micro Devices (“AMD”), Seagate Technology, Western Digital, Fairchild Semiconductor, and Marvell Technology Group Ltd. (“Marvell”). The charges were the first against traders in the SEC's ongoing investigation of insider trading involving expert networks.

The SEC alleged that Longoria, a Supply Chain Manager at AMD, was privy to confidential information about AMD’s internal sales figures and other confidential information and, from 2006 to 2010, Longoria regularly provided Primary Global Research LLC (“PGR”) and PGR clients with this inside information so it could be used to trade securities. Longoria received a total of $178,850 for talking to PGR and its clients.

The Final Judgment entered against Longoria orders him liable for disgorgement of ill-gotten gains of $178,850, together with prejudgment interest of $18,328.94, for a total of $197,178.94. Based on Longoria’s agreement to cooperate with the SEC, the Commission did not seek a civil penalty.

With respect to Longueuil, the SEC alleged that in May 2008, while Longueil was working as a managing director at Empire Capital Management LLC (“Empire Capital”), Longueuil received material nonpublic information regarding an earnings report about to be issued by Marvell. Longueuil caused Empire Capital to purchase more than 800,000 shares of Marvell stock. Days later, when Marvell announced better-than-expected quarterly results, Empire reaped a total of more than $2.5 million in profits.

The Final Judgment entered against Longueuil orders him to pay disgorgement in the amount of $250,000, plus prejudgment interest in the amount of $102,832.60, for a total of $352,832.60. Based on Longueuil’s agreement to cooperate with the SEC, the Commission did not seek a civil penalty. 

November 16, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former CSK Auto CEO Agrees to Clawback $2.8 Million to Settle SEC Charges

Under SOX 304, senior officers are required to reimburse their corporation for incentive-based compensation and stock sale profits if the corporation's financial statements are subsequently restated because of material noncompliance, as a result of misconduct, with financial reporting requirements.  This "clawback" is required even if the officers are not personally charged with wrong-doing.  The SEC recently announced that Maynard L. Jenkins, the former chief executive officer and chairman of CSK Auto Corporation, has agreed to return $2.8 million in bonus compensation and stock profits that he received while the company was committing accounting fraud.  The SEC filed court papers against Jenkins in July 2009 saying he violated the SOX “clawback” provision by failing to reimburse the company. It marked the agency’s first SOX clawback case against an individual who was not alleged to have otherwise violated the securities laws.

Jenkins has agreed to reimburse $2,796,467 to O’Reilly Automotive Inc., which has since acquired CSK Auto.

The SEC previously charged four former CSK Auto executives who perpetrated the accounting fraud, and separately charged the company for filing false financial statements for fiscal years 2002 to 2004. The company settled the charges, and the litigation against three of the former executives is continuing (CSK’s former chief operating officer has since died). The U.S. Department of Justice brought a criminal indictment against those same executives, who have pleaded guilty to various charges. CSK Auto recently entered into a non-prosecution agreement with the DOJ in which it agreed to pay a $20.9 million penalty.

November 16, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 15, 2011

Second Circuit Holds that Merrill's Website Disclosures Defeat ARS Manipulation Claim

In Wilson v. Merrill Lynch & Co. (No. 10-1528-cv, 2d Cir., Nov. 14, 2011)( Download WilsonvML), the Second Circuit  held that an ARS purchaser could not maintain his class action alleging that Merrill, acting as a dealer,  manipulated the ARS market because Merrill adequately disclosed its auction practices on its website.  The appellate court accordingly affirmed the district court’s dismissal of the action.

Central to the plaintiff’s manipulation was Merrill’s practice of “support bidding,” or using its own capital to place bids in order to prevent the failure of auctions for which it served as lead dealer.  Plaintiff alleged that the support bids masked the liquidity risks and created the false impression that the lack of auction failures reflected investor demand.  In resisting the manipulation claim, Merrill relied principally on its public disclosures of its ARS auction practices on its website, mandated by an 2006 SEC Order.

The court acknowledged that its precedents “contain little discussion of when disclosures are sufficient to negate a claim that a certain market practice is manipulative.“   Looking at analogous contexts, the court stated that although half-truths will support claims for securities fraud, there are limits on what securities markets participants are required to disclose.  The court found that Merrill’s disclosures revealed, “at the very least, the possibility that Merrill would place support bids in some auctions that it managed and that in the absence of these bids, some of these auctions might fail.”  Moreover, because the plaintiff’s complaint did not adequately allege that at the time of his purchase Merrill intended to place a bid “in every single auction, knew that each auction would fail if it did not place these bids and signaled to its ARS investors that these securities were genuinely liquid,” the court did not have to address whether a “hypothetical complaint” containing those allegations would state a market manipulation claim. 

In reaching its conclusion, the Second Circuit acknowledged that the SEC had filed a brief in support of the plaintiff.  Yet, “although we accept that brief’s articulation of the legal principles that govern the sufficiency of disclosures for purposes of a market manipulation claim, we cannot defer to the SEC’s conclusion that Merrill’s disclosures were inadequate.”

The Second Circuit's conclusion is consistent with its recent decision in Ashland Inc. v. Morgan Stanley & Co., 652 F.3d 333 (2d Cir. 2011).  In that decision claims by a SLARS purchaser that Morgan Stanley materially misrepresented the liquidity of that investment  failed because of website disclosures similar to Merrill’s.

November 15, 2011 | Permalink | Comments (0) | TrackBack (0)

FINRA Fines Chase for Unsuitable Sales of UITs and Floating-Rate Loan Funds

FINRA ordered Chase Investment Services Corporation to reimburse customers more than $1.9 million for losses incurred from recommending unsuitable sales of unit investment trusts (UITs) and floating rate loan funds. FINRA also fined Chase $1.7 million.  FINRA's investigation found that Chase brokers recommended the purchase of UITs and floating rate loan funds to unsophisticated customers with little or no investment experience and conservative risk tolerances, without having reasonable grounds to believe that those products were suitable for the customers. FINRA also found that Chase failed to implement supervisory procedures to reasonably supervise its sales of UITs and floating rate loan funds. 

FINRA found that Chase did not provide its brokers with sufficient training and guidance regarding the risks and suitability of UITs and floating-rate loan funds.  Chase brokers made almost 260 unsuitable recommendations to purchase these UITs to customers with little or no investment experience and a conservative risk tolerance. The customers suffered losses of approximately $1.4 million as a result of investing in these unsuitable transactions.

 FINRA's findings also include that WaMu Investments, Inc., which merged with Chase in July 2009, made recommendations to customers to purchase floating-rate loan funds that were not suitable for them, and that WaMu failed to provide adequate training and failed to reasonably supervise the sale of floating-rate loan funds to customers.

 

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

FINRA Finds Widespread Use of Senior Designations and Issues Additional Guidance

A pervasive regulatory problem is the use by securities professionals of certifications or designations that imply expertise in advising senior investors (senior designations).  Many of these senior designations are, in fact, little more than marketing gimmicks.  For this reason, FINRA has regularly reminded broker-dealer firms of their obligations to supervise their registered representatives' use of certifications that imply expertise in the area.  FINRA recently released survey results that point to the widespread use of senior designations among broker-dealers.  Specifically, 68% of firms that completed the survey indicated that they allow the use of senior designations.  Of the firms that permit the use of senior designations, 88% currently have registered persons who use senior designations.  Of these, 66% require approval and verify credentials, 23% require approval but do not verify credentials, and 11% do not require approval and do not verify credentials.

FINRA noted that in certain instances senior designations approved by firms or widely used by registered persons did not require rigorous qualification standards.  This is of concern to FINRA since "[i]nvestors are unlikely to differentiate between designations that represent an enhanced level of proficiency in dealing with financial matters relevant to senior investors versus a designation that is simply a marketing tool."

The  Regulatory Notice goes on to highlight sound practices currently used by some firms and to encourage firms to adopt procedures to strengthen their own supervisory procedures.

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

Monday, November 14, 2011

Yet Another Oversight Hearing on the SEC

The Senate's COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT will meet on November 16 in OPEN SESSION to conduct a hearing entitled “Management and Structural Reforms at the SEC: A Progress Report.” The witnesses will be: Mr. Robert S. Khuzami, Director, Division of Enforcement; Ms. Meredith Cross, Director, Division of Corporation Finance; Mr. Robert W. Cook, Director, Division of Trading and Markets; Ms. Eileen Rominger, Director, Division of Investment Management; Mr. Craig Lewis, Director, Division of Risk, Strategy and Financial Innovation; and Mr. Carlo V. di Florio, Director, Office of Compliance Inspections and Examination.

November 14, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Insider Trading by Congressional Officials is NOT "Perfectly Legal"

60 Minutes ran a piece last night on members of Congress who may have used confidential information obtained through their positions to make profitable stock trades.  Curiously, the correspondent asserted that the practice is “perfectly legal” and legislation is necessary to prohibit the conduct.

Yet this common wisdom -- that insider trading by Congressional insiders  may be unethical, but is legal -- is “a specious claim,” according to Professor Donna Nagy, who has  written a law review article, “Insider Trading, Congressional Officials, and Duties of Entrustment” (available on SSRN), as well as a shorter  Roll Call piece, “Enforce Laws to Fight Lawmaker Insider Trading."  Professor Nagy explains that this fundamental misunderstanding stems from two misconceptions:  “a lack of regard for the broad and sweeping duties of entrustment that attach to public office and an unduly restrictive view of the Supreme Court’s precedents….”  As she explains, “the (un)lawfulness of Congressional insider trading therefore turns on whether these officials owe duties of trust and confidence to others who would be deceived and defrauded by the self-serving use of nonpublic Congressional knowledge.”

Is there any debate about the answer to that question?  While legislation to clarify insider trading law generally may be useful , there is no “legal loophole” that permits insider trading by Congressional insiders.

November 14, 2011 | Permalink | Comments (4) | TrackBack (0)

Sunday, November 13, 2011

Crowdfunding Legislation : Answer to Entrepreneurs’ Prayers or Nightmare for Small Investors?

On November 9, 2012, the House of Representatives, by a 407-17 vote, passed The Entrepreneur Access to Capital bill (H.R. 2930), which, according to its sponsors, will allow small businesses to raise capital without burdensome regulation and thus promote job growth.  The Obama Administration supported House passage of H.R. 2930 because it will “make it easier for entrepreneurs to raise capital and create jobs.”  The legislation has been introduced in the Senate. 

H.R. 2930 creates a “crowdfunding” exemption from registration under the Securities Act of 1933 and allows the offering of securities up to $1 million annually ($2 million if the  issuer provides audited financial statements), so long as individual investments are limited to the lesser of $10,000 or ten percent of the investor’s annual income.   The securities may be sold with or without the services of an intermediary, who would not be deemed a broker under the securities laws solely by reason of participating in such a transaction.  It is expected that offerings will take place over the internet.

The crowfunding exemption does not require disclosure about the issuer and its business plans.  This is in contrast to existing exemptions that involve general solicitation of investors (apart from the intrastate exemption).  Instead, investors must be warned about:

• the speculative nature generally applicable to investments in startups, emerging businesses and small issuers, including risks in the secondary market related to illiquidity; and
• that they are subject to restrictions on resale.

Potential investors need not be sophisticated, but will have to answer questions demonstrating competency in:

• Recognition of the level of risk generally applicable to investments in startups, emerging businesses, and small issuers;
• Risk of illiquidity; and
• Other areas that the SEC may determine appropriate.

Intermediaries, or issuers if an intermediary is not used, are required to:

• Take reasonable measures to reduce the risk of fraud with respect to such transaction;
• State a target offering amount and withhold proceeds until the aggregate capital raised from investors is no less than 60 percent of the target offering amount; and
• Outsource cash-management functions to a qualified third-party custodian.

Intermediaries, or investors, cannot offer investment advice.

If an intermediary is used, it is required to carry out a background check on the issuer’s principals.

Securities sold pursuant to this new exemption cannot be resold for a one-year period from the date of purchase, except to the issuer or an accredited investor.

The legislation requires the SEC to issue implementing rules not later than 90 days after enactment and explicitly directs the SEC to carry out the cost-benefit analysis required under section 2(b) of the Securities Act.  The legislation also directs the agency to establish disqualification provisions for ineligible issuers and intermediaries substantially similar to those contained in regulations adopted pursuant to section 926 of the Dodd-Frank Act.

Holders of securities issued pursuant to this new exemption shall not be counted for purposes of determining the number of shareholder s of record under section 12(g)(5) of the Securities Exchange Act (500) that triggers the reporting requirements.

Finally, securities issued pursuant to this new exemption are “covered securities” under section 18(b)(4) of the Securities Act and therefore exempt from state regulation.

According to press reports, SEC Commissioner Elisse Walter supports a crowdfunding exemption within limits – “if it is too big, it will become a haven for fraud and it will backfire.”  Previously, in Congressional testimony, Meredith B. Cross, Director of the SEC’s Division of Corporation Finance, noted the SEC’s responsibilities both to facilitate capital formation and to protect investors and cited the agency’s experience under the small public offering exemption (Rule 504) and the investor protection concerns that led to significant revision of that Rule in 1999.  Further, Ms. Cross stated:

Although the business venture may have a well formulated plan and a committed entrepreneur, potential investors may have little information about the plan, its execution, or the entrepreneur behind the business. Investments in small businesses can be open to opportunism created by this information asymmetry. Sophisticated investors generally negotiate protections for themselves and may provide their funding over time to protect their investment, but due to the nature of crowdfunding ventures, crowdfunding investors may have limited investment experience, limited information upon which to make investment decisions, and almost no ability to negotiate for protections. While the small amount of any potential crowdfunding investment should generally limit the extent of any individual’s losses, these issues are among those that would need to be considered as a part of the cost-benefit analysis that the Commission would consider in connection with any future proposal.

Similarly, NASAA has urged Congress to balance the need for investor protection with the need to help small businesses raise capital.  In  Congressional testimony on behalf of NASAA, Arkansas Securities Commissioner Heath Abshure cited state regulators’ experience under SEC Rule 506 after Congress preempted states from reviewing private placement offerings:

Today, the exemption is being misused to steal millions of dollars from investors through false and misleading representations in offerings that provide the appearance of legitimacy without any meaningful scrutiny of regulators.

As Professor Thomas Hazen has argued in a forthcoming article(available on SSRN), “it is naïve to assume that limiting offerings to small amounts per investor will deter scammers from taking advantage of investors via crowdfunding.”  Moreover, $10,000 or ten per cent of the investors’ annual income is not a de minimus amount for small investors.   While the national economy needs incentives to promote job growth, it cannot be at the expense of investor protection.  I agree with Professor Joan Heminway and Sheldon Hoffman, who state in their forthcoming article (also available on SSRN) that “[w]e do not find it acceptable … that a regulatory exemption for crowdfunding leave those who invest a small dollar value in a venture to fend for themselves.”  

Accordingly, I agree with Professor Hazen’s conclusion that “there should be no special carve-out for crowdfunding efforts unless the exemption is conditioned on disclosures necessary to enable even unsophisticated investors to make an informed investment decision.”

(Thanks to Professor Margaret V. Sachs for calling my attention to H.R. 2930)


 

November 13, 2011 in News Stories, Other Regulatory Action | Permalink | Comments (1) | TrackBack (0)