Securities Law Prof Blog

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

Saturday, March 26, 2011

Fairfax on the Inside Director

The Uneasy Case for the Inside Director, by Lisa M. Fairfax, George Washington University - Law School, was recently posted on SSRN.  Here is the abstract:

In the wake of recent scandals and the economic meltdown, there is nearly universal support for the notion that corporations must have independent directors. Conventional wisdom insists that independent directors can more effectively monitor the corporation and prevent or otherwise better detect wrongdoing. As the movement to increase director independence has gained traction, inside directors have become an endangered species, relegated to holding a minimal number of seats on the corporate board. This Article questions the popular trend away from inside directors by critiquing the rationales in favor of director independence, and assessing the potential advantages of inside directors. This Article argues that the value of independent directors has been overstated, while the value of inside directors has been under-appreciated and under-examined. This argument rests on three critical points. First, independent directors are constrained in their ability to perform their monitoring functions, and many of these constraints may be insurmountable – particularly as we increase independent directors’ responsibilities. Second, inside directors can make valuable, and often overlooked, contributions to board governance. Third, reliance on independent directors as a substitute for external regulation is inappropriate and potentially costly. To this end, this Article suggests that inside directors may serve an important signaling function, underscoring the need for enhanced regulation, while ensuring that corporate monitors are subject to appropriate liability and therefore have increased incentives to perform their responsibilities.

To be sure, the case for the inside director is not an easy one, particularly given that any benefits such directors bring to the board come with costs, including the potential for self-dealing and overreaching. However, before we render inside directors extinct, we first should determine whether their costs are outweighed by their benefits.

March 26, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Schwarcz on Assessing Dodd-Frank

Keynote Address – Identifying and Managing Systemic Risk: An Assessment of Our Progress, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN.  Here is the abstract:

 This short address attempts to provide a succinct overview, critiquing how well the Dodd-Frank Act identifies and manages systemic risk. Keynote address given at AGEP Advanced Policy Institute on Financial Services Regulation, George Mason University, March 10, 2011.

March 26, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Third Week of Rajaratnam's Trial: Testimony from Goldman CEO

During the third week of Raj Rajaratnam's trial, the star witness was clearly Goldman Sachs CEO Lloyd Blankfein, who testified on Wednesday.  The government called him to testify that Rajat Gupta, the former Goldman director, violated the company's confidentiality policy when Gupta gave RR information that he learned in his capacity as Goldman director.  Although Gupta is not a defendant in the criminal action (the SEC has brought a civil administrative proceeding against him), his alleged tipping to RR has played a prominent role; during the first days of the trial, the government played a tape of a conversation between the two men, in which Gupta tells RR about board discussions (including Warren Buffet's proposal to invest in Goldman during the financial crisis).  RR's defense attorney, on cross, asked Blankfein about the March 2010 Goldman press release on Gupta's stepping down from the board and whether Blankfein was aware of the government investigation into Gupta?  Blankfein said that he knew there were "some questions" about Gupta's behavior.  (The judge did not allow the defense to elicit much testimony about Goldman's role in the financial crisis.)

The other important witness this week was Rajiv Goel, a former intel executive and longtime friend of RR, who has pleaded guilty to illegally tipping RR.  The government played more tapes of phone conversations between Goel and RR and also presented an Intel executive as a witness to establish that Goel had access to confidential information and that Intel would have fired Goel if it knew he was sharing it with RR.  When Goel took the stand, he testified that he gave RR secret information about Intel because of friendship.  He also testified about the benefits he received from RR: hundreds of thousands of dollars, plus RR made profitable trades in Goel's stock trading account (using inside information, according to the government, which spent a lot of time on these trades).

The strategies of the opposing sides are playing out as predicted.  The government presents tape after tape in which RR is apparently soliciting and receiving inside information from the other party.  Two witnesses who have pleaded guilty to illegal tipping, Anil Kumar last week and Rajiv Goel this week, have testified at length about the confidential information that each of them says he passed on to RR.  Two witnesses (Goldman CEO, Intel exec) have testified about their companies' confidentiality policies. The defense, in turn, introduces research reports and news reports in order to show that the shared information was either already known in the marketplace or was immaterial.

March 26, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Friday, March 25, 2011

FINRA CEO Speaks on Self-Regulation of Investment Advisers

Richard Ketchum, FINRA CEO, spoke on March 22 at the SIFMA Compliance and Legal Division's Annual Seminar and addressed the issue of FINRA's becoming an SRO for investment advisers, a possibility that most investment advisers oppose.  In his prepared remarks, Ketchum stated:

Specifically, whenever the discussion moves to whether FINRA should be the SRO for investment advisers, the talking points for IAs in opposition are simple: FINRA is not qualified because it only regulates broker-dealers and therefore doesn't understand the differences between the two models—meaning the end result would be that IAs would be forced to live under a broker-dealer regime. Frankly, that's simply wrong.

First, let me agree that there are important differences between broker-dealers and investment advisers. Any entity that would be empowered to oversee IAs would need to recognize that and regulate accordingly—and FINRA most certainly would.

If FINRA became the SRO for some or all investment advisers, we would have no intention to force the full suite of specific broker-dealer requirements on investment advisers. That would not be appropriate or in the public interest. The regulatory concerns regarding investment advisers primarily relate to the lack of examination resources, which places advisory clients at unacceptable risk, which is why we have said, and will continue to say, that SROs—especially for stand-alone IAs—should be viewed as a positive development for investors. No matter how rigorous the regulatory requirements, an adviser's obligations may provide only hollow protection to investors absent rigorous examination and enforcement. That's a service FINRA is well-positioned to provide.

FINRA would implement regulatory oversight that is tailored to the particular characteristics of the investment adviser business. We would have authority to examine for, and enforce compliance with, the Investment Advisers Act and the SEC rules under that Act. We don't see the necessity for extensive SRO rulemaking and believe that the extent of that authority should be fully a matter for the SEC to determine. Of course, as it does with SROs now, the Commission would approve all rules. FINRA and its predecessor entities have operated under a similar regime for more than 70 years and would have no problem operating the same way in the IA space.

The other red herring related to FINRA serving as an IA SRO is that our governance structure would only reflect broker-dealer interests and not have IA representation. As we stated in our comment letter to the SEC—and as I have said many times—if FINRA becomes the SRO for investment advisers, our governance structure would appropriately reflect investment advisers. This would be carried out most effectively by setting up a separate affiliate that would have a board comprised of majority public representatives, but members of the investment adviser industry would be allocated the remaining seats.

The debate on how best to increase the oversight of investment advisers is one worth having, but the problem is too significant to let it wallow. As a proud "alumni" of the SEC, I would never suggest the Commission couldn't do the job if it had the resources. But the idle hope of that funding should not justify more delay. As Commissioner Walter said in her statement when the IA report was released, we must act now—investors deserve no less.

March 25, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Thursday, March 24, 2011

SEC Agenda: More Dodd-Frank Implementation

The SEC announced an Open Meeting on March 30, 2011.The subject matters of the Open Meeting will be:

Item 1: The Commission will consider whether to propose joint rules with other Agencies to implement Section 941(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to credit risk retention by securitizers of asset-backed securities.

Item 2: The Commission will consider whether to propose a new rule and rule amendments to implement Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires the Commission to direct the national securities exchanges and national securities associations to adopt certain listing standards with respect to compensation committees and compensation advisers. Section 952 also requires the Commission to adopt new disclosure rules concerning the use of compensation consultants and conflicts of interest.

March 24, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Will Ameriprise Bail Out Securities America?

Reuters reported earlier today that Ameriprise Financial doesn't want to bail out Securities America.  If so, its brokerage unit would likely go under because of the huge liability resulting from customers' claims (both in a class action and arbitrations) stemming from SA's sales in private placements of securities in Provident Royalties and Medical Capital Holdings.  Last week a federal district judge rejected a $21 million class action settlement of the class action.

But maybe Ameriprise is just posturing.  After the class action settlement was rejected, lawyers for investors, Ameriprise and SA started mediation.  If Ameriprise is willing to walk away, it certainly impacts the bottom line.  Investment News (which has provided excellent coverage of this drama) quotes an industry source this afternoon that who would be "shocked" if Ameriprise let SA collapse.

Stay tuned!


March 24, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Wednesday, March 23, 2011

Judge Rakoff Challenges SEC Practice of Settling Defendants "Neither Admitting nor Denying"

Judge Jed Rakoff continues to poke and prod the SEC about how the agency negotiates consent judgments.  In SEC v. Vitesse Semiconductor Corp.(Download SEC.VitesseSettlement), the Judge approved the settlement before him, but made it very clear that he has serious difficulties with the SEC's practice of accepting settlements in which the defendants neither admit nor deny the SEC's allegations and whether the practice meets the standards necessary for approval by the court.

The complaint alleged that for more than a decade Vitesse engaged in fraudulent revenue recognition practices and stock options backdatings, allegedly orchestrated by the four individual defendants, the CEO, the CFO, the Controller and the Manager of Finance.  In the Judge's words:

Simultaneous with filing the complaint ..., the SEC -- confident that the courts in this judicial district were no more than rubber stampes -- filed proposed Consent Judgments against Vitesse, Mody, and Kaplan without so much as a word of explanation as to why the Court should approve these Consent Judgments or how the Consent Judgments met the legal standards the Court is required to apply before granting such approval.

After receiving a written submission from the SEC and convening a hearing (at which the Judge did not grant the request to excuse the attendance of the attorneys representing the individual defendants), the Judge was satisfied that the financial terms, although modest,  and the injunctive terms of the proposed settlement met the standard of "fair, reasonable, adequate and in the public interest."

The Judge found much more troubling the requested judicial approval of settlements in which the defendants resolve the serious allegations of fraud brought against them "without admitting or denying the allegations of the Complaint."  Although acknowledging that this is a longstanding policy, the result is a

stew of confusion and hypocrisy unworthy of such a proud agency as the SEC.  The defendant is free to proclaim that he has never remotely admitted the terrible wrongs alleged by the SEC; but, by gosh, he had better be careful not to deny them either (though, as one would expect, his supporters feel no such compunction).  Only one thing is left certain: the public will never know whether the SEC's charges are true, at least not in a way that they can take as established by these proceedings.

Judge Rakoff ultimately decides that the issue is of less significance in this case because the two individual defendants have already admitted their guilt in parallel criminal proceedings and the corporate defendant effectively admitted the allegations by contributing $2.4 million of its stock to a class action settlement and paying a $3 million penalty in the Consent Judgment, leaving it with less than $1.5 million in net operating cash flow.  However, the Judge concludes by describing these as "unusual circumstances" and making clear that he is reserving for the future ""substantial questions of whether the Court can approve other settlements that involve the practice of 'neither admitting nor denying.'"


March 23, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Tuesday, March 22, 2011


The SEC charged Calif.-based JSW Financial Inc. and five officers for defrauding investors in two real estate funds, alleging that the firm used investor funds to prop up the officers’ own failing real estate development projects while concealing the loss of $17 million of investors’ money.  The SEC alleges that from 2002 to 2008, JSW and its predecessor, Jim Ward & Associates (JWA), created two real estate investment funds – Blue Chip Realty Fund and Shoreline Investment Fund – and told investors that their money would be used to make loans secured by residential real estate. In reality, according to the SEC, the firms’ officers used most of the money to make unsecured and undocumented loans to entities that the officers themselves controlled, which were suffering mounting losses and protracted delays on Silicon Valley real estate development projects. Meanwhile, as the enterprise collapsed, investors continued receiving monthly statements showing steady growth in the value of their portfolios.

The SEC’s complaint seeks injunctive relief and disgorgement of ill-gotten gains against JSW, Ward, Lee, Locker, Tipton and Lin, as well as monetary penalties against the five officers. The complaint also seeks disgorgement of ill-gotten gains and appointment of a receiver over Blue Chip and Shoreline as relief defendants.

March 22, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Spyglass Equity Systems Reps with Boiler Room Operations

The SEC charged three firms and four individuals involved in a boiler room scheme operating out of Los Angeles that defrauded investors who they persuaded to buy purportedly profitable trading systems.  According to the SEC, representatives of Spyglass Equity Systems Inc. cold-called investors and made false and misleading statements to help raise more than $2.15 million from nearly 200 investors nationwide for two related investment companies – Flatiron Capital Partners LLC (FCP) and Flatiron Systems LLC (FS). However, only a little more than half of that money was actually used for the advertised trading purposes, and much of the trading that did occur failed to use the purported trading systems. FCP and FS wound up losing about $1 million in investor funds. The managing member of the two firms – David E. Howard II – misused almost $500,000 of investor money for unauthorized business expenses as well as personal expenses including travel, entertainment, and gifts for his girlfriend.

Along with Howard, FCP and FS, Spyglass and its owners – Richard L. Carter, Preston L. Sjoblom and Tyson D. Elliott – also are charged with fraud in connection with the unregistered securities offerings.

The SEC seeks permanent injunctions, disgorgement plus prejudgment and post-judgment interest, and financial penalties.

March 22, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FiNRA Fines Southwest Securities and Expels its Correspondent Firm for Improper Short Sales

FINRA announced today that it fined Southwest Securities, Inc., of Dallas, $650,000 for deficiencies in due diligence, risk assessment and written supervisory procedures that permitted one of its correspondent firms, Cutler Securities, to lose over $6 million in one day through improper short sales. FINRA also required Southwest to designate a risk management officer to identify and manage the risks associated with its correspondent clearing services business. In addition, FINRA expelled Cutler Securities and barred its President, Glenn Cutler, for Cutler Securities' violative short selling.

On August 6, 2009, its second day of clearing through Southwest, Cutler Securities bought over 17.8 million shares of a stock while selling over 20.3 million shares of the same stock. Despite receiving alerts regarding this trading during the day, Southwest allowed Cutler to establish a 2.5 million share short position. Cutler Securities was unable to meet its obligation on the position, requiring Southwest to close the position, leaving it with an unsecured debit balance of approximately $6.3 million.

Among the deficiencies in Southwest's supervisory practices were failures to establish written due diligence policies, written criteria to determine the acceptability of potential correspondents, awareness of the proper procedure for terminating correspondent firms on an intra-day basis, appropriate trading alert parameters for many of its correspondent firms, and procedures recognizing that it had clearing and settlement responsibility for all correspondent firms that had the ability to execute trades away from Southwest.Cutler Securities also had significant regulatory and supervisory deficiencies relating to its short sales, including a history of failing to comply with Regulation SHO by obtaining locates and properly marking order tickets, and a failure to comply with SEC Emergency Orders.

In settling this matter, Southwest and Cutler neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

March 22, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Supreme Court Unanimously Rules No Bright-Line Rule of Statistical Significance in Matrixx

The U.S. Supreme Court unanimously decided, in Matrixx Initiatives, Inc. v. Siracusano (No. 09-1156) (Mar. 22, 2011)( Download Matrixx opinion) that plaintiffs can state a case for securities fraud under Rule 10b-5 based on a pharmaceutical company's failure to disclose reports of adverse events associated with a product even though the reports do not disclose a statistically significant number of adverse events.  Although this outcome was widely predicted, it is something of a surprise that no Justice even felt the need to write a concurring opinion.  Justice Sotomayor wrote the Court's opinion and emphasized that the Northway/Basic definition of materiality cannot be reduced to a bright-line test.  "As in Basic, Matrixx's categorical rule would 'artificially exclud[e]' information that 'would otherwise be considered significant to the trading decision of a reasonable investor.'...Matrixx's argument rests on the premise that statistical significance is the only reliable indication of causation.  This premise is flawed."  Although in many instances reasonable investors would not consider reports of adverse events to be material information, plaintiffs have alleged facts plausibly suggesting that reasonable investors would have viewed these particular reports a material.

In addition, plaintiffs have also alleged facts "giving rise to a strong inference" that Matrixx acted with scienter.  "Matrixx's proposed bright-line rule requiring an allegation of statistical significance to establish a strong inference of scienter is just as flawed as its approach to materiality."  The Supreme Court once again found it unnecessary to consider whether scienter includes reckless conduct.  

March 22, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, March 21, 2011

Oxley Works on Behalf of FINRA for Adviser SRO

Investment News reports that FINRA has hired Michael Oxley (of Sarbanes-Oxley) as a lobbyist to advocate its position for a SRO (presumably FINRA) for investment advisers.  Finra hires big gun to lobby for advisor biz SRO

March 21, 2011 in News Stories, Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Judge Refuses to Approve Securities America Settlement

Securities America (as readers of this blog know) faces class actions and arbitrations brought by customers who suffered losses from private placement sold by its brokers.  SA and plaintiffs' attorneys in one class action negotiated a $21 million settlement and previously obtained a temporary stay of arbitrations that SA said would otherwise deplete its assets.  SA said that unless the settlement was approved, it would be out of business.  On March 18, however, a federal district court judge refused to approve the settlement and refused to continue the stay of the arbitrations.  See Judge rejects Securities America class settlement.)  Observers have wondered whether SA's parent, Ameriprise Financial, would bail it out.  Reuters reported earlier today that Ameriprise refused to commit itself, but Investment News reports that it has announced it would be willing to contribute cash to its subsidiary.  Details were not provided. 

March 21, 2011 in News Stories, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)