Securities Law Prof Blog

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

Saturday, July 16, 2011

Kaufman & Wunderlich on Pleading Scienter in Securities Fraud Litigation

The Core Operations Inference in Private Securities Fraud Litigation, by Michael J. Kaufman, Loyola University Chicago School of Law, and John M. Wunderlich , was recently posted on SSRN.  Here is the abstract:

Adequately pleading scienter is a cornerstone to successful securities fraud litigation under Rule 10b-5. But pleading any state of mind is difficult. To meet this burden, litigants often rely on the core operations inference to adequately plead scienter. This inference presumes that a company’s senior management was aware of facts pertaining to the company's core operations, or at least should have been. Thus, when senior management makes misleading statements about these core operations, we can strongly infer that senior management acted with an intent to deceive, or we can infer that senior management acted recklessly in making public statements that pertain to the company’s core operations when management was not aware of all the facts. The inference is a powerful tool, and as this Article argues, is even more so in light of the implicit support the inference has from Supreme Court precedent.

July 16, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bebchuk & Jackson on Blockholder Disclosure

The Law and Economics of Blockholder Disclosure, by Lucian A. Bebchuk, Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI), and Robert J. Jackson Jr., Columbia Law School, was recently posted on SSRN.  Here is the abstract:

This paper, which is based on our recent submission to the Securities and Exchange Commission, provides a detailed analysis of the policy issues relevant for the Commission’s ongoing examination of changes to its rules under Section 13(d) of the Securities Exchange Act of 1934. These rules, which govern share accumulation and disclosure by blockholders, are the subject of a recent rulemaking petition submitted by Wachtell, Lipton, Rosen and Katz, which proposes that the rules be tightened.

We argue that the Commission should not view the proposed tightening as merely “technical” changes needed to modernize its Section 13(d) rules. In our view, the proposed changes should be examined in the larger context of the beneficial role that outside blockholders play in American corporate governance and the broad set of rules that apply to such blockholders. Our analysis proceeds in five steps

First, we describe the significant empirical evidence indicating that the accumulation and holding of outside blocks in public companies benefits shareholders by making incumbent directors and managers more accountable and thereby reducing agency costs and managerial slack.

Second, we explain that tightening the rules applicable to outside blockholders can be expected to reduce the returns to blockholders and thereby reduce the incidence and size of outside blocks - and, thus, blockholders’ investments in monitoring and engagement, which in turn may result in increased agency costs and managerial slack.

Third, we explain that there is currently no empirical evidence to support the Petition’s assertion that changes in trading technologies and practices have recently led to a significant increase in pre-disclosure accumulations of ownership stakes by outside blockholders.

Fourth, we explain that, since the passage of Section 13, changes in state law—including the introduction of poison pills with low-ownership triggers that impede outside blockholders that are not seeking control - have tilted the playing field against such blockholders.

Finally, we explain that a tightening of the rules cannot be justified on the grounds that such tightening is needed to protect investors from the possibility that outside blockholders will capture a control premium at other shareholders’ expense.

We conclude by recommending that the Commission to pursue a comprehensive examination of the rules governing outside blockholders and the empirical questions raised by our analysis. In the meantime, the Commission should not adopt new rules that tighten restrictions on outside blockholders. Existing research and available empirical evidence provide no basis for concluding that tightening the rules governing outside blockholders would satisfy the requirement that Commission rulemaking protect investors and promote efficiency, and indeed raise concerns that such tightening could harm investors and undermine efficiency.

July 16, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

SEC Charges Forex Operator with Running Ponzi Scheme

The SEC filed fraud charges against Jeffery A. Lowrance, the CEO of First Capital Savings & Loan Ltd., a purported foreign currency trading firm, alleging he scammed hundreds of investors with false promises of high, fixed-rate returns while secretly using their money to fund his start-up alternative newspaper.  Lowrance, who had fled to Peru and was arrested there earlier this year, was arraigned on criminal fraud charges.  In addition, the Commodity Futures Trading Commission filed fraud charges Thursday against Lowrance and First Capital.

The SEC alleges that Lowrance raised approximately $21 million from investors in at least 26 states, by promising huge profits from a specialized foreign currency trading program. First Capital actually conducted little foreign currency trading, lost money on the little trading that it conducted, and never engaged in any profitable business operations. Lowrance targeted certain investors by purporting to share their Christian values and their limited-government political views.

According to the SEC’s complaint, filed in federal district court in San Jose, California, Lowrance and First Capital promised investors a “predictable monthly income,” with monthly returns up to 7.15 percent through foreign currency trading. Lowrance’s scheme began to unravel in June 2008 and Lowrance and First Capital had lost all of the investors’ money by September 2008. Nevertheless, Lowrance solicited at least an additional $1 million from at least 36 investors between June 2008 and February 2009 by continuing to tout First Capital’s fictitious high returns, the SEC alleged.

The SEC’s lawsuit seeks court orders prohibiting the defendants from engaging in securities fraud and requiring them to disgorge their ill-gotten gains and pay financial penalties.

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

Stating the Obvious

James Stewart explains in a New York Times article how cutting the SEC budget has nothing to do with deficit reduction and everything to do with benefiting Wall St.  NYTimes, As a Watchdog Starves, Wall Street Is Tossed a Bone.

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

SEC Schedules Hearing in Alabama on Municipal Bonds

The SEC will hold a municipal securities market field hearing in Jefferson County, Ala., on July 29. Topics will include distressed communities, small issuers, disclosure, derivatives and pre-trade price transparency.  The event is the third in a series of hearings examining issues that affect investors in the municipal securities market. The first was held in San Francisco in September, 2010, followed by a hearing in December at the SEC’s headquarters in Washington, D.C.

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

Wednesday, July 13, 2011

GAO Issues Report on Regulating Proprietary Trading

The GAO issued a report on Proprietary Trading: Regulators Will Need More Comprehensive Information to Fully Monitor Compliance with New Restrictions When Implemented (GAO-11-529 July 13, 2011).  Here is the summary:

Proprietary trading and investments in hedge funds and private equity funds, like other trading and investment activities, provide banking entities with revenue but also create the potential for losses. Banking entities have conducted proprietary trading at stand-alone proprietary-trading desks but also have conducted such trading elsewhere within their firms. GAO determined that collecting information on activities other than at stand-alone proprietary trading desks was not feasible because the firms did not separately maintain records on such activities. As a result, GAO did not analyze data on broader proprietary trading activity but analyzed data on stand-alone proprietary-trading desks at the six largest U.S. bank holding companies from June 2006 through December 2010. Compared to these firms' overall revenues, their stand-alone proprietary trading generally produced small revenues in most quarters and some larger losses during the financial crisis. In 13 quarters during this period, stand-alone proprietary trading produced revenues of $15.6 billion--3.1 percent or less of the firms' combined quarterly revenues from all activities. But in five quarters during the financial crisis, these firms lost a combined $15.8 billion from stand-alone proprietary trading--resulting in an overall loss from such activities over the 4.5 year period of about $221 million. However, one of the six firms was responsible for both the largest quarterly revenue at any single firm of $1.2 billion and two of the largest single-firm quarterly losses of $8.7 billion and $1.9 billion. These firms' hedge and private equity fund investments also experienced small revenues in most quarters but somewhat larger losses during the crisis compared to total firm revenues. Losses from these firms' other activities, which include lending activities and other activities that could potentially be defined as proprietary trading, affected their overall net incomes more during this period than stand-alone proprietary trading and fund investments. Some market participants and observers were concerned that the act's restrictions could negatively affect U.S. financial institutions by reducing their income diversification and ability to compete with foreign institutions and reducing liquidity in asset markets. However, with little evidence existing on these effects, the likelihood of these potential outcomes was unclear, and others argued that removing the risks of these activities benefits banking entities and the U.S. financial system. Financial regulators have struggled in the past to effectively oversee bank holding companies. While the act's restrictions reduce the scope of activities regulators must monitor, implementing them poses challenges, including how to best ensure that firms do not take prohibited proprietary positions while conducting their permitted customer-trading activities. Regulators have yet to gather comprehensive information on the extent, revenues, and risk levels associated with activities that will potentially be covered, which would help them assess whether expected changes in firms' revenues and risk levels have occurred. Without such data, regulators will not know the full scope of such activities outside of stand-alone proprietary trading desks and may be less able to ensure that the firms have taken sufficient steps to curtail restricted activity. As part of implementing the new restrictions, regulators should collect and review more comprehensive information on the nature and volume of activities potentially covered by the act. Treasury and the financial regulators agreed to consider this as part of their rulemaking.

July 13, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Adopts Interim Rule to Permit Retail Forex Transactions by Brokers

Under section 742(c) of the Dodd-Frank Act, certain foreign exchange transactions with persons who are not “eligible contract participants” (commonly referred to as “retail forex transactions”) with a registered broker or dealer will be prohibited as of July 16, 2011, in the absence of the Commission adopting a rule to allow such transactions under terms and conditions prescribed by the Commission. The Commission is adopting interim final temporary Rule 15b12-1T to allow a registered broker-dealer to engage in a retail forex business until July 16, 2012, provided that the broker-dealer complies with the Securities Exchange Act of 1934, the rules and regulations thereunder, and the rules of the self-regulatory organization(s) of which the broker-dealer isa member, insofar as they are applicable to retail forex transactions.

July 13, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Armor Holdings Settles FCPA Charges with SEC & DOJ

The SEC settled charges that Armor Holdings, Inc. violated the Foreign Corrupt Practices Act by participating in a bribery scheme from 2001 through 2006 to obtain contracts to supply body armor for use in United Nations (U.N.) peacekeeping missions. The SEC also charged Armor Holdings, a Florida-based manufacturer of military and law enforcement safety equipment, with failing to properly account for more than $4 million in commissions from 2001 through 2007 in violation of the books and records and internal controls provisions of the federal securities laws.  Armor Holdings agreed to settle the SEC’s charges by paying nearly $5.7 million in disgorgement, prejudgment interest, and penalties. Armor Holdings also agreed to pay a $10.29 million fine to settle a parallel criminal investigation announced by the U.S. Department of Justice today.

The SEC’s complaint alleges that certain agents of Armor Holdings caused its U.K. subsidiary to wire at least 92 payments, totaling approximately $222,750 to a third-party intermediary, with the understanding that part of these payments would be offered to a U.N. official who could help steer business to Armor Holdings’ U.K. subsidiary. The complaint alleges that agents of Armor Holdings caused its U.K. subsidiary to enter into a sham consulting agreement with the intermediary for purportedly providing legitimate services in connection with the sale of goods to the U.N. The complaint alleges that, through this bribery scheme, Armor Holdings derived gross revenues of $7,121,237, and net profits of $1,552,306.

The SEC alleges that another Armor Holdings subsidiary disguised in its books and records commissions paid to intermediaries who brokered the sale of goods to foreign governments. Even after being warned by internal and external accountants that this practice violated U.S. Generally Accepted Accounting Principles, Armor Holdings’ subsidiary continued the improper accounting practice. As a result, approximately $4 million in commissions was not properly disclosed in the books and records of the company.

July 13, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Schapiro Testifies on SEC's Leasing Scandal

SEC Chairman Mary L. Schapiro recently testified on the most recent SEC scandal, the Lease of Constitution Center, before the U.S. House of Representatives Committee on Transportation and Infrastructure Subcommittee on Economic Development, Public Buildings, and Emergency Management.

July 13, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former Morgan Trader Sanctioned for Fictitious Swap Orders

The SEC recently settled charges against Jennifer Kim, a former trader at Morgan Stanley & Co. assigned to the swaps desk.  The SEC alleged that from October through December 2009 Kim and her supervisor entered at least 32 fictitious swap orders for the purpose of concealing from risk managers the extent of losses resulting from their proprietary trading.  The sanctions were a cease-and-desist order from committing violations of section 13(b)(5) and an industry bar, with the right to re-apply after 3 years.  What is interesting is that Commissioner Aguilar dissented because, in his view, the settlement should have included charges of violating the antifraud provisions.  In re Jennifer Kim; Aguilar dissent

July 13, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Hears Converse Appeal on Sanctions for Failure to File Reports

  The SEC will meet in Open Meeting on July 14, 2011 to hear oral argument in an appeal by Comverse Technology, Inc. from an initial decision of an administrative law judge.  On July 22, 2010, the law judge issued his decision finding that Comverse had violated Securities Exchange Act Section 13(a) and Exchange Act Rules 13a-1 and 13a-13 by failing to file quarterly and annual reports for any period after Oct. 31, 2005. The law judge revoked the registration of Comverse's common stock. Subsequent to the issuance of the law judge's decision, Comverse has filed certain annual and quarterly reports.

Comverse does not appeal the law judge's findings of violation but, rather, the law judge's determination to revoke its registration. Exchange Act Section 12(j) authorizes sanctions, including revocation, for reporting violations where it is “necessary or appropriate for the protection of investors.” Issues likely to be considered at oral argument include the extent to which, under the circumstances, sanctions are warranted.


July 13, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Proposes Revolving Door Restrictions on Former FINRA Officers

FINRA recently filed with the SEC a proposed rule change to amend (i) FINRA Rule 9141 (Appearance and Practice; Notice of Appearance) to prohibit a former officer of FINRA, for a period of one year after termination of employment with FINRA, from making an appearance before an adjudicator on behalf of any other person under the FINRA Rule 9000 Series; and (ii) FINRA Rule 9242 (Pre-hearing Submission) to prohibit a former officer of FINRA, for a period of one year after termination of employment with FINRA, from providing expert testimony on behalf of any other person under the FINRA Rule 9000 Series.  SR-FINRA-2011-032, Proposed Rule Change to Implement Revolving Door Restrictions on Former Officers of FINRA.

For industry reaction, see Inv. News, Critics slam Finra panel ban plan

July 13, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, July 12, 2011

GAO Calls for Strengthening SEC's Post-Employment Controls

The GAO recently released a report on SECURITIES AND EXCHANGE COMMISSION Existing Post-Employment Controls Could Be Further Strengthened.  Here is the summary:

Because SEC historically has not collected future employer information from separating employees on an agencywide basis, complete information on where former SEC officials obtained employment is not currently available. Based on available SEC attrition data, about 37 percent of the more than 2,000 employees who separated from SEC between October 2005 and September 2010 were in occupation categories that included examiners, accountants, economists, or attorneys--occupations particularly relevant to SEC examinations and investigations. GAO analyzed notice of appearance requests--which are required when former SEC employees wish to appear before SEC, within 2 years of their separation, for purposes of representing their firm or client--submitted between October 2005 and October 2010. Sixteen entities, consisting primarily of law and consulting firms, accounted for approximately 35 percent of the individuals filing these notices. GAO also selected a nongeneralizable sample of 150 former employees from occupation categories relevant to SEC's examination and investigative efforts and searched publicly available sources for information about their post-SEC employment. These individuals frequently obtained positions with financial, consulting, or law firms that represent firms regulated by SEC. According to SEC officials, representatives from law and financial firms, and academic researchers with whom GAO spoke, the potential benefits of employees moving between SEC and the private sector include bolstering SEC's ability to attract experts to help fulfill its mission and increasing understanding of SEC rules and regulations among industry participants. Academic researchers and citizen advocacy groups described potential challenges of such movements, such as the appearance of potential conflicts of interest when former SEC staff work for or represent regulated firms. SEC has a number of controls for managing post-employment and conflict-of-interest issues, and many of SEC's controls are similar to those of other agencies. For example, the SEC Ethics Office provides information to employees about ethics rules and regulations as well as agency-specific conflict-of-interest and post-employment restrictions. Also, some SEC divisions and offices take steps through staffing and work processes to manage potential conflicts of interest and have multiple levels of review and systems for documenting key decisions, such as closing SEC investigations. As previously recommended by GAO, SEC also recently began collecting future employer information from separating employees. This information can be used as part of SEC's mandatory exit interviews to advise departing staff about potential conflicts of interest they might encounter in their new positions related to their SEC experience. While SEC ethics officials routinely advise current and former employees on post-employment and conflict-of-interest issues, SEC has not consistently documented this advice. The agency's lack of documentation standards could limit SEC's and employees' ability to demonstrate that appropriate consultation occurred and could contribute to questions about the movement of employees between SEC and the private sector. GAO recommends that SEC establish standards for documentation of ethics advice on current and post-employment issues associated with the movement of employees between SEC and other employers. SEC generally agreed with GAO's recommendation and stated that it has begun drafting standards.

July 12, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, July 11, 2011

SEC & Janney Settle Charges Over Policies to Prevent Insider Trading

The SEC settled charges that Janney Montgomery Scott LLC failed to establish and enforce policies and procedures to prevent the misuse of material, nonpublic information, as required by law.  Janney, without admitting or denying the findings, agreed to be censured and to pay an $850,000 penalty to settle the SEC’s administrative proceeding. It also agreed to cease and desist from committing or causing any violations of Section 15(g) of the Securities Exchange Act of 1934, which seeks to prevent the misuse of material, nonpublic information.

According to the Commission’s order instituting proceedings, from at least January 2005 through July 2009, Janney’s policies and procedures for its Equity Capital Markets division, which encompassed its equity sales, trading, syndicate and research departments, were deficient in a number of ways. In some instances, Janney did not enforce its policies and procedures and in others, it failed to follow them as written, creating the risk that material, nonpublic information could be used for insider trading.

In addition to the censure, penalty and cease-and-desist order, Janney agreed to hire an independent compliance consultant to conduct a comprehensive review and make recommendations regarding its policies, practices and procedures relating to Section 15(g) of the Exchange Act, including the prevention of the misuse of material, nonpublic information. The independent consultant also will prepare written reports and certify in writing that Janney has established and continues to maintain policies, practices and procedures pursuant to Section 15(g) of the Exchange Act that are consistent with the findings of the Order.

July 11, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

GAO Releases Report on SRO for Private Fund Advisers

The GAO released the following report today:

Private Fund Advisers: Although a Self-Regulatory Organization Could Supplement SEC Oversight, It Would Present Challenges and Trade-offs
GAO-11-623 July 11, 2011

Here is the Summary In Process:

Regulators, industry representatives, investment advisers, and others told GAO that it was difficult to opine definitively on the feasibility of a private fund adviser SRO, given its unknown form, functions, and membership. Nonetheless, the general consensus was that forming a private fund adviser SRO could be done, as evidenced by the creation and existence of other SROs. At the same time, they said that the formation of a private fund adviser SRO would require legislation and would not be without challenges. SEC staff and securities law experts said that the federal securities laws currently do not allow for the registration of a private fund adviser SRO with SEC. In addition, regulators, industry representatives, and others told GAO that forming such an SRO could face challenges, including raising the necessary start-up capital and reaching agreements on its fee and governance structures. Some of the identified challenges are similar to those that existing securities SROs had to confront during their creation. Creating a private fund adviser SRO would involve advantages and disadvantages. SEC will assume responsibility for overseeing additional investment advisers to certain private funds on July 21, 2011. It plans to oversee these advisers primarily through its investment adviser examination program. However, SEC likely will not have sufficient capacity to effectively examine registered investment advisers with adequate frequency without additional resources, according to a recent SEC staff report. A private fund adviser SRO could supplement SEC's oversight of investment advisers and help address SEC's capacity challenges. However, such an SRO would oversee only a fraction of all registered investment advisers. Specifically, SEC would need to maintain the staff and resources necessary to examine the majority of investment advisers that do not advise private funds and to oversee the private fund adviser SRO, among other things. Furthermore, by fragmenting regulation between advisers that advise private funds and those that do not, a private fund adviser SRO could lead to regulatory gaps, duplication, and inconsistencies.

July 11, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Gupta's Case Against SEC Can Proceed, Judge Rakoff Rules

Judge Rakoff ruled today that former Goldman director Rajat Gupta can sue the SEC for bringing an administrative proceeding against him instead of suing him in federal district court, as the agency has done with other individuals allegedly involved in Raj Rajaratnam's insider trading ring.  Gupta asserts that he is being denied his right to a jury trial and other procedural protections available in court and seeks injunctive relief to move the case to federal court.

Judge Rakoff has previously faulted the SEC for lack of transparency in its settlement negotiations, and lannguage in the opinion (as quoted in the Wall St. Journal) suggests that is his concern here as well.  He noted that this is an "unusual" case of different treatment for one defendant, with no explanation from the SEC as to why it is treating Gupta differently, so that Gupta can proceed with a claim under the Equal Protection Clause of the Constitution.

WSJ, Ex-Goldman Director Can Pursue Case Against SEC

July 11, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Sunday, July 10, 2011

Choi et alia on Scandal Enforcement at SEC

Scandal Enforcement at the SEC: Salience and the Arc of the Option Backdating Investigations, by Stephen J. Choi, New York University (NYU) - School of Law; Adam C. Pritchard, University of Michigan Law School; and Anat Carmy Wiechman, New York University (NYU), was recently posted on SSRN.  Here is the abstract:

We study the impact of scandal-driven media scrutiny on the SEC’s allocation of enforcement resources. We focus on the SEC’s investigations of option backdating in the wake of numerous media articles on the practice of backdating. We find that as the level of media scrutiny of option backdating increased, the SEC shifted its mix of investigations significantly toward backdating investigations and away from investigations involving other accounting issues. We test the hypothesis that SEC pursued more marginal investigations into backdating as the media frenzy surrounding the practice persisted at the expense of pursuing more egregious accounting issues that did not involve backdating. Our event study of stock market reactions to the initial disclosure of backdating investigations shows that those reactions declined over our sample period. We also find that later backdating investigations are less likely to target individuals and less likely to accompanied by a parallel criminal investigation. Looking at the consequences of the SEC’s backdating investigations, later investigations were more likely to be terminated or produce no monetary penalties. We find that the magnitude of the option backdating accounting errors diminished over time relative to other accounting errors that attracted SEC investigations.

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

Fried & Shilon on Excess-Pay Clawbacks

Excess-Pay Clawbacks, by Jesse M. Fried, Harvard Law School, and Nitzan Shilon, Harvard Law School, was recently posted on SSRN.  Here is the abstract:

We explain why firms should have a policy requiring directors to recover “excess pay” – payouts to executives resulting from an error in compensation metrics (such as inflated earnings). We then analyze the clawback policies voluntarily adopted by S&P 500 firms as of 2010 and find that only a small fraction had such a policy. Our findings suggest that the Dodd-Frank Act, which requires firms to adopt a clawback policy for certain types of excess pay, will improve compensation arrangements at most firms. We also suggest how the types of excess pay not reached by Dodd-Frank should be addressed.   

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