Securities Law Prof Blog

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

Sunday, April 10, 2011

Johnson on Secondary Liability in State Court

Secondary Liability for Securities Fraud: Gatekeepers in State Court, by Jennifer J. Johnson, Lewis & Clark Law School, was recently posted on SSRN.  Here is the abstract:

This paper discusses gatekeeper liability under state securities laws for professionals and other secondary participants in securities transactions. The recent economic meltdown exposed numerous Ponzi schemes from Madoff to Medical Capital that were no longer able to masquerade as profitable enterprises. When promoters of fraudulent ventures are unable to provide restitution to their victims, plaintiffs seek out other sources of repayment including professionals and other secondary participants in the transactions that precipitated their losses. Although most scholars agree that professionals can perform an important role in deterring securities fraud, scholarly opinions vary widely on the appropriate liability regime, if any, that these gatekeepers should face.

While civil liability for secondary participants in securities fraud was once well accepted in the federal courts, in 1994 the Supreme Court invalidated such claims as beyond the purview of Section 10(b) of the 1934 Act and Rule 10b-5. In contrast, there is a robust tradition of aiding and abetting liability in most state blue sky statutes. Unlike the federal implied Rule10b-5 cause of action, state blue sky laws contain express secondary liability statutes that do not have strict scienter standards or rigorous pleading requirements. Indeed, some state statutes are negligence based and contain burden-shifting provisions that require non-seller defendants to establish that they were not negligent in failing to discover the seller’s fraud.

The paper traces the development of secondary liability under state securities laws and contrasts the state regimes with each other and their federal counterparts. It also reviews federal efforts to restrict states from adjudicating securities related claims. Relying on available empirical evidence, the Article ultimately concludes that Congress should reverse its propensity of the last decade to preempt state securities actions and should recognize the valuable contribution of such actions in addressing fraud, particularly fraud committed upon retail investors.

April 10, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Pan on Financial Regulation

Understanding Financial Regulation, by Eric J. Pan, Yeshiva University - Benjamin N. Cardozo School of Law, was recently posted on SSRN.  Here is the abstract:

This paper offers an account of financial regulation that is focused on the types of regulatory strategies employed by financial regulators. Noting the lack of prior academic work in this area, the paper presents a taxonomy of strategies, consisting of rulemaking, supervision, certification and enforcement, and argues that regulators actively choose between versions of strategies that require their direct input and immediate expenditure of regulatory resources (“public regulatory strategies”) and strategies that delegate the burden of regulation onto private actors (“private regulatory strategies”). This choice affects the nature and effectiveness of financial regulation, both in terms of the degree to which financial regulation relies on self-regulation, gatekeepers, private rights of action and other private strategies and the manner in which the interests of private parties involved in private strategies are aligned with those of the public. As the primary difference between public and private regulatory strategies is the immediate cost to the regulator, the paper further argues that the availability of resources is the primary determinant of the types of regulatory strategies selected by financial regulators.

The paper then explores two implications of the role of resource constraints on financial regulation. The first is an explanation for the oft-noted “sine curve of regulatory activity,” a cyclical pattern of lighter to heavier regulatory activity before and after a financial crisis or scandal. In the aftermath of any such financial crisis or scandal, regulators face intense pressure to demonstrate they are in control of the financial markets and, therefore, rely more on public strategies - strategies that give the regulator greater visibility and command. Eventually, however, resource constraints force regulators to seek more cost effective regulatory strategies, driving them to rely more on private strategies. The second is what happens when regulators cannot easily access private strategies, such as in the case of systemic risk regulation. Under resource constraints, regulators resort to “blunter” public strategies that are less costly but are not as fine-tuned, such as the Volcker Rule, or abandon traditional financial regulatory strategies in favor of extra-regulatory solutions, such as bank fees and size limitations on financial institutions.

April 10, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Miller on Post-Tellabs Securities Fraud Pleading

A Modest Proposal for Securities Fraud Pleading after Tellabs, by Geoffrey P. Miller, New York University (NYU) - School of Law, was recently posted on SSRN.  Here is the abstract:

This article criticizes the Tellabs standard for scienter pleading under federal securities law on the ground that it weeds out too many non‐frivolous cases. The article proposes a procedure designed to rectify the problem. Under the tentative dismissal approach, a dismissal under Tellabs would not end the litigation if the plaintiff filed an objection to the decision. Instead, the plaintiff would be required to pay the defendant’s attorneys’ fees incurred between the judge’s ruling on the motion to dismiss and the resolution of a motion for summary judgment.

Professor Miller presented his proposal at the Institute for Law & Economic Policy (ILEP) Conference on Access to Justice held on April 8.

April 10, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

SEC & CFTC Deliver Feasibility Study on Standardized Algorithmic Descriptions for Derivatives

On April 8 the SEC and the CFTC delivered to Congress a joint staff study on the “the feasibility of requiring the derivatives industry to adopt standardized computer-readable algorithmic descriptions which may be used to describe complex and standardized financial derivatives” (see Title VII, Sec. 719(b) of Dodd-Frank). Based on the public input, staff investigation and analysis, the joint study concludes that current technology is capable of representing derivatives using a common set of computer-readable descriptions. These descriptions are precise enough to use both for the calculation of net exposures and to serve as part or all of a binding legal contract.

The Commissions’ staff study also concludes that before mandating the use of standardized descriptions for all derivatives, the following are needed: a universal entity identifier and product or instrument identifiers, a further analysis of the costs and benefits of having all aspects of legal documents related to derivatives represented electronically, and a uniform way to represent financial terms not covered by existing definitions.

To that end, in the Commissions’ staff view, standardized computer-readable descriptions are feasible for at least a broad cross-section of derivatives. The joint study contemplates that other financial regulators and the U.S. Treasury’s Office of Financial Research, along with the Commissions’ staff, may engage in a series of public-private initiatives to foster collaboration between regulators and the derivatives industry, working towards representing a broader cross-section of derivatives in computer-readable form.

April 10, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Announces May 10 Roundtable on MM Funds & Systemic Risk

The SEC announced that it will host a roundtable discussion in May on money market funds and systemic risk. The roundtable will include participants from the Financial Stability Oversight Council (FSOC).  The roundtable will take place on May 10, 2011, and will provide a forum for various stakeholders in money market funds to exchange views on the potential effectiveness of certain options in mitigating systemic risks associated with money market funds. These will include, but are not limited to, options raised in the President’s Working Group report on possible money market fund reforms that was issued in October 2010.

Roundtable panelists are expected to include sponsors of money market funds, short-term debt issuers, investors, and the academic community. A list of participants will be published closer to the date of the roundtable.

Members of the public who wish to provide their views on the matters to be considered at the roundtable discussion may submit comments to the comment file for the President’s Working Group Report on Money Market Fund Reform.

April 10, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC & Comverse Technology Settles FCPA Charges

The SEC and Comverse Technology, Inc. settled charges alleging violations of the books and records and internal controls provisions of the Foreign Corrupt Practices Act (“FCPA”). Comverse has offered to pay a total of approximately $1.6 million in disgorgement and prejudgment interest to the SEC. In a related action, Comverse will pay a $1.2 million criminal fine to the U.S. Department of Justice.

The SEC’s complaint alleges that:

Between 2003 and 2006, Comverse Limited, an Israeli operating subsidiary of Comverse, made improper payments to obtain or retain business. In particular, Comverse Limited made improper payments of approximately $536,000 to individuals connected to OTE, a telecommunications provider based in Athens, Greece that is partially owned by the Greek Government. These payments resulted in contracts worth approximately $10 million in revenues and ill-gotten gain of approximately $1.2 million.

In order to facilitate and conceal the payments, Comverse Limited employed a third-party agent to establish an offshore entity in Cyprus which, in turn, funneled the improper payments to Comverse Limited’s customers. Comverse Limited employees made payments to the agent’s offshore entity and, after taking 15% off the top of these payments, the agent paid the remaining 85% in cash bribes, directly or indirectly, to Comverse Limited’s customers.

These payments were improperly recorded on Comverse’s books and records as “agent commissions,” and in addition, Comverse failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions at all levels of the organization were properly recorded. For example, neither Comverse nor Comverse Limited had a process, formal or otherwise, for conducting due diligence of sales agents or for the independent review of agent contracts outside the sales departments.

April 10, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former GunnAllen Officers Settle SEC Charges of Violating Privacy Rules on Confidential Customer Information

On April 7 the SEC charged three former brokerage executives of GunnAllen Financial Inc. for failing to protect confidential information about their customers.  According to the SEC, while GunnAllen was winding down its business operations last year, former president Frederick O. Kraus and former national sales manager David C. Levine violated customer privacy rules by improperly transferring customer records to another firm. The SEC also found that former chief compliance officer Mark A. Ellis failed to ensure that the firm’s policies and procedures were reasonably designed to safeguard confidential customer information.

Kraus, Levine, and Ellis each agreed to settle the SEC’s charges against them. This is the first time that the SEC has assessed financial penalties against individuals charged solely with violations of Regulation S-P, an SEC rule that requires financial firms to protect confidential customer information from unauthorized release to unaffiliated third parties.

Without admitting or denying the SEC’s findings, Kraus, Levine, and Ellis each consented to the entry of an SEC order that censures them and requires them to cease and desist from committing or causing any violations or future violations of the provisions charged. Kraus and Levine have been ordered to pay penalties of $20,000 each, and Ellis has been ordered to pay a $15,000 penalty.

April 10, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Johnson & Johnson Settles FCPA Charges for $48.6 Million

On April 7 the SEC  announced a settlement with Johnson and Johnson (“J&J”) to resolve SEC charges that the global pharmaceutical, consumer product, and medical device company violated the Foreign Corrupt Practices Act (FCPA) by bribing public doctors in several European countries and paying kickbacks to Iraq to illegally obtain business.  According to the SEC, since at least 1998, J&J’s subsidiaries paid bribes to public doctors in Greece who selected J&J surgical implants, paid bribes to public doctors and hospital administrators in Poland who awarded tenders to J&J, and paid bribes to public doctors in Romania to prescribe J&J pharmaceutical products. J&J also paid kickbacks to Iraq in order to obtain contracts under the United Nations Oil for Food Program (“Program”).

J&J has agreed to pay more than $48.6 million in disgorgement and prejudgment interest to settle the SEC’s charges and to pay a $21.4 million fine to the U.S. Department of Justice to settle criminal charges. A resolution of a related investigation by the United Kingdom Serious Fraud Office is anticipated.

The SEC's release states that J&J voluntarily disclosed some of the violations by its employees, and conducted a thorough internal investigation to determine the scope of the bribery and other violations, including proactive investigations in more than a dozen countries by both its internal auditors and outside counsel.

April 10, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Imposes Sanctions on Firms & Individuals for Sales of Private Placement Securities without Due Diligence

On April 7 FINRA announced it sanctioned two firms and seven individuals for selling interests in private placements without conducting a reasonable investigation. The companies ultimately failed, resulting in significant investor losses.

FINRA imposed sanctions against the following firms and individuals for failing to conduct a reasonable investigation of the sale of private placements offered by Medical Capital Holdings, Inc. (MedCap) and/or Provident Royalties, LLC.

  • Workman Securities Corp., of MN, was ordered to pay $700,000 in restitution to affected customers.
  • Robert Vollbrecht, Workman's former President, was barred in any principal capacity, and fined $10,000.
  • Timothy Cullum, former Chief Executive Officer, and Steven Burks, former President, of Cullum & Burks Securities, Inc., of Dallas, TX, a now-defunct firm, were each suspended in any principal capacity for six months and fined $10,000.
  • Jeffrey Lindsey and Bradley Wells, two former executives with Capital Financial Services, Inc., of ND, were each suspended for six months in any principal capacity and fined $10,000.
  • Jay Lynn Thacker, former Chief Compliance Officer for Meadowbrook Securities, LLC (fka Investlinc Securities, LLC), of MS, was suspended for six months in any principal capacity and fined $10,000.
  • David William Dube, former Owner, President, Chief Compliance Officer and Anti-Money Laundering (AML) Compliance Officer of (now-defunct) Peak Securities Corporation, of FL, was barred for failing to conduct adequate due diligence, as well as a failure as AML Compliance Officer to detect, investigate and report numerous suspicious transactions in 10 customer accounts where "red flags" existed.

In addition, FINRA fined Askar Corporation, of MN, $45,000 for its failure to conduct due diligence on a private placement from DBSI, Inc., another company that defaulted on its obligations. FINRA found that Askar only reviewed the offering documents and sales materials provided by DBSI before approving the product for sale, without independently verifying DBSI's representations in the offering documents.

FINRA found that broker-dealers who sold the MedCap, Provident and DBSI private placement offerings did not have reasonable grounds to believe that the private placements were suitable for any of their customers. They failed to engage in an adequate investigation of the private placements and failed to establish, maintain and enforce a supervisory system reasonably designed to achieve compliance with applicable securities laws and regulations.  

From 2001 through 2009, MedCap, a medical receivables financing company based in Anaheim, CA, raised approximately $2.2 billion from over 20,000 investors through nine MedCap private placement offerings of promissory notes. MedCap made interest and principal payments on its promissory notes until July 2008, when it began experiencing liquidity problems and stopped making payments on notes sold in two of its earlier offerings. Nevertheless, MedCap proceeded with its last offering, MedCap VI, which it offered through an August 2008 private placement memorandum.

In July 2009, the SEC obtained a preliminary injunction to stop all MedCap sales. The SEC alleged that MedCap and its executives defrauded investors in MedCap VI by misappropriating approximately $18.5 million of investor funds. The court appointed a receiver to gather and conduct an inventory of MedCap's remaining assets. The SEC action is pending.

From September 2006 through January 2009, Provident Asset Management, LLC marketed and sold preferred stock and limited partnership interests in a series of 23 private placements offered by an affiliated issuer, Provident Royalties. The Provident offerings were sold to customers through more than 50 retail broker-dealers nationwide and raised approximately $485 million from over 7,700 investors. Although a portion of the proceeds of Provident Royalties' offerings was used for the acquisition and development of oil and gas exploration and development activities, millions of dollars of investors' funds were transferred from the later offerings' bank accounts to the Provident operating account in the form of undisclosed and undocumented loans, and were used to pay dividends and returns of capital to investors in the earlier offerings, without informing investors of that fact.  On July 2, 2009, the SEC obtained a temporary restraining order and an emergency asset freeze and appointment of a receiver to take control of the entities, and marshal and preserve the assets for the benefit of the defrauded investors. All the named defendants subsequently agreed to the entry of a preliminary injunction, which remains in effect. In March 2010, FINRA expelled Provident Asset Management, LLC from membership for marketing a series of fraudulent private placements offered by its affiliate, Provident Royalties, LLC.

April 10, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)