Securities Law Prof Blog

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

Saturday, January 29, 2011

Schwarcz on Ex Ante Versus Ex Post Approaches to Financial Regulation

Keynote & Chapman Dialogue Address: Ex Ante Versus Ex Post Approaches to Financial Regulation, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN.  Here is the abstract:

Ideal financial regulation would work ex ante, to prevent financial failures. Once a failure occurs, there may already be economic damage, and it may be difficult to stop the failure from spreading and becoming systemic. The reality, though, is that preventing financial failures should be only one role for regulators. Even an optimal prophylactic regulatory regime cannot anticipate and prevent every failure. This paper, which formed my Chapman Dialogue Address at Chapman University School of Law and the keynote speech at Chapman Law Review’s 2011 Symposium on the Future of Financial Regulation, attempts to contrast fundamental differences between ex ante and ex post financial regulation. It also illustrates how ex post approaches can, and arguably should, supplement ex ante approaches as part of a comprehensive financial regulatory framework.

January 29, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Klock on Private Enforcement Against Aiders & Abettors

Improving the Culture of Ethical Behavior in the Financial Sector: Time to Expressly Provide for Private Enforcement Against Aiders and Abettors of Securities Fraud, by Mark Klock, George Washington School of Business, was recently posted on SSRN.  Here is the abstract:

Financial markets do not function well when fraud is pervasive. It has been well documented that financial fraud has increased following changes in securities law that occurred in the 1990’s. Also around September of 2009, the investigations into the SEC examinations of Bernard Madoff Investment Securities, LLC were completed and released to the public. The simple facts reveal an alarming level of incompetence and lack of financial literacy on the part of the guardians of the integrity of our financial markets. I suggest two important tools for addressing these problems. One is to supplement enforcement of anti-fraud rules with more private attorney generals by expressly creating a private right of action for aiding and abetting violations of securities laws. This will foster a stronger culture of integrity and ethical conduct in the auditing profession. An additional tool is to increase financial literacy in our law schools which supply the regulators of our markets.

January 29, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Omarova on Financial Self-Regulation

Wall Street as Community of Fate: Toward Financial Industry Self-Regulation, by Saule T. Omarova, University of North Carolina at Chapel Hill School of Law, was recently posted on SSRN.  Here is the abstract:

In the wake of the worst financial crisis since the Great Depression, policy-makers around the world are searching for ways to manage systemic risk in the global financial market. This article argues that one key, and currently entirely overlooked, potential mechanism for controlling and minimizing systemic financial risk is industry-wide self-regulation. However, it advocates a fundamentally new self-regulatory regime in the financial sector, which would focus explicitly on the issue of systemic risk prevention and impose responsibility to protect the broader public from financial crises directly on the financial services industry. This article further argues that the financial services industry currently lacks meaningful incentives to develop this new type of more public-minded and socially responsible self-regulation. It examines the experience with self-regulation in other sectors – in particular, the nuclear power and chemical manufacturing industries – and analyzes how the key factors that made the emergence of such self-regulatory regimes possible in those industries might play out in the context of the financial sector. Finally, this article argues that it may be possible to alter the existing incentive structure through thoughtful regulatory design and proposes some steps that may be taken in that direction.

January 29, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Davidoff et alia on Fiduciary Duties in Investment Banking

Computerization and the ABACUS: Reputation, Trust, and Fiduciary Duties in Investment Banking, by Steven M. Davidoff, University of Connecticut School of Law; Alan D. Morrison, University of Oxford - Said Business School; University of Oxford - Merton College; and William J. Wilhelm Jr., University of Oxford - Said Business School, was recently posted on SSRN.  Here is the abstract:

 On April 16, 2010 the Securities and Exchange Commission (SEC) filed a civil complaint against Goldman Sachs in the U.S. District Court for the Southern District of New York. The complaint alleged that Goldman violated the anti-fraud provisions of the federal securities laws, in connection with a 2007 synthetic collateralized debt obligation (CDO) transaction, ABACUS 2007-AC1 SPV (ABACUS). Goldman agreed a $500 million settlement with the SEC on July 15, 2010. We analyze the ABACUS transaction and the SEC's complaint against Goldman Sachs in the context of recent technological changes within the investment banking market. Investment banking was historically a relationship-based business, sustained by reputationally intermediated tacit contracts. Recent advances in information technology and financial economics have codified many formerly tacit elements of investment banking. As a result, some investment banking deals are now transacted at arm's length, and rely more upon formal contracts; we argue that, for this type of deal, there is a stronger case for legal rules regulating the investment bank-counterparty relationship. However, some deals continue to be arbitrated by tacit rules and norms and, for these deals, legal rules are less appropriate, because it is very hard for a third party to ascertain tacit understandings made in the context of a long-lived relationship. An attempt to introduce legal rules into reputationally intermediated relationships may even impair the counterparties' ability to arrive at informal arrangements, and so to trade. The supervision of deals like ABACUS should therefore reflect the extent to which they are transactional or relational; we argue that in neither case is there justification for the application of legal rules or the gap-filling standard of fiduciary duties.

January 29, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Rodrigues on Separation of Ownership from Ownership

Corporate Governance in an Age of Separation of Ownership from Ownership, by Usha Rodrigues, University of Georgia Law School, was recently posted on SSRN.  Here is the abstract:

The shareholder empowerment provisions enacted as part of the recent bailout legislation are internally incoherent because they fail to address the short-termist realities of shareholder ownership today. Ownership has separated from ownership in modern corporate America: individual investors now largely hold stock through mutual funds, pension funds, and hedge funds. The incentives of these short-term financial intermediaries only imperfectly reflect the interests of their long-term holders - an imbalance only exacerbated by the bailout’s corporate governance legislation. The bailout’s focus on shareholder empowerment tactics - such as proxy access, say-on-pay, and increased disclosure - makes little sense if shareholders are only in it for the short term. This Article uses the bailout provisions to illustrate the point that shareholder empowerment inadequately addresses systemic problems. The Article explores the recent regulation of target-date retirement funds as a further example of regulators’ persistent neglect of the separation of ownership from ownership. The Article concludes with some reflections on the difficult question of how to encourage long-lived firms when individual players, including even long-horizoned investors, may be looking for a quick payoff.

January 29, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bartov et alia on Market Consequences of Late SEC Filings

Capital Market Consequences of Filing Late 10-Qs and 10-Ks, by Eli Bartov, New York University; Mark L. DeFond, University of Southern California - Leventhal School of Accounting; and Yaniv Konchitchki,
University of Southern California - Leventhal School of Accounting and Marshall School of Business, was recently posted on SSRN.  Here is the abstract:

We find that the market reacts negatively to announcements that firms will file late 10-Qs or 10-Ks, and that the reaction is more negative for late 10-Qs than late 10-Ks. We also find that the larger reaction to late 10-Q announcements is due to firms that report accounting reasons as the cause of the delay. In addition, we find that the market anticipates which late 10-Q filers will subsequently fail to file within the SEC’s allowed grace period, but only when accounting reasons explain the delay. Finally, we find that abnormal returns continue to decline during the months following the late filing announcement, except when accounting reasons explain the delay. Our study contributes to the literature by finding that late filings have important capital market consequences and that late 10-Q filings have distinct valuation implications compared with late 10-K filings. Importantly, we also show that accounting information included in Form NT plays a critical role in how market participants interpret the valuation implications of late filings.

January 29, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Kedia & Rajgopal on SEC's Enforcement Preferences

Do the SEC’s Enforcement Preferences Affect Corporate Misconduct?, by Simi Kedia, Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics, and Shivaram Rajgopal, Emory University - Goizueta Business School, was recently posted on SSRN.  Here is the abstract:

 Recent frauds have questioned the efficacy of the SEC’s enforcement program. We hypothesize that differences in firms’ information sets about SEC enforcement and constraints facing the SEC affect firms’ proclivity to adopt aggressive accounting practices. We find that firms located closer to the SEC and in areas with greater past SEC enforcement activity, both proxies for firms’ information about SEC enforcement, are less likely to restate their financial statements. Consistent with the resource-constrained SEC view, the SEC is more likely to investigate firms located closer to its offices. Our results suggest that regulation is most effective when it is local.

January 29, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Friday, January 28, 2011

SEC Charges Connecticut Investment Adviser with Stealing Millions From Investors

The SEC today obtained a court order freezing the assets of a Stamford, Conn.-based investment adviser and its principal, Francisco Illarramendi, charging that they misappropriated at least $53 million in investor funds and used the money for self-dealing transactions.  The SEC alleges that Illarramendi defrauded investors in the several hedge funds he managed by improperly transferring their money into bank accounts that he personally controlled. He then invested the money for his own benefit or for the benefit of the entities that he controlled, rather than for the benefit of the hedge fund investors.

According to the SEC's complaint filed in U.S. District Court for the District of Connecticut on January 14, Illarramendi is the majority owner of the Michael Kenwood Group LLC — a holding company for, among other entities, investment adviser Michael Kenwood Capital Management LLC. Through this adviser entity, Illarramendi manages several hedge funds, including one that contains up to $540 million in assets. The SEC’s complaint alleges that Illarramendi took at least $53 million in investor money out of this hedge fund without the knowledge or consent of the hedge fund’s investors

The SEC sought an asset freeze and other emergency relief because it alleged that Illarramendi was imminently planning to make additional investments using investor funds without the knowledge or consent of the investors. 

January 28, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Attorney Altered Documents in SEC's Examination of Client

The SEC today instituted administrative proceedings against a California-based attorney for engaging in improper professional conduct during an SEC examination.  The SEC’s Office of the General Counsel alleges that David M. Tamman — in the course of an SEC examination of his client NewPoint Securities LLC in April and May 2009 — altered private placement memoranda (PPMs) purportedly used in the offer and sale of securities issued by NewPoint Financial Services. The original PPMs purportedly provided to investors stated that the funds raised in the offerings would be used primarily for real estate related investments. In fact, the vast majority of money raised in the offerings was misappropriated by NewPoint’s principal John Farahi.

The SEC’s Office of the General Counsel alleges that Tamman — a member of the California Bar and a partner at a large international law firm — added language to the PPMs to make it appear that it was disclosed to investors that much of the money raised by NewPoint would be loaned to Farahi. The PPMs were then produced to the SEC’s examination and enforcement staff. According to the Office of the General Counsel, Tamman knew that the language he added to the documents was not included in the PPMs actually provided to investors.

Through his conduct, the SEC’s Office of the General Counsel alleges that Tamman engaged in unethical and improper professional conduct in violation of Rule 102(e) of the SEC’s Rules of Practice. An administrative hearing will be scheduled.

January 28, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former Galleon Trader with Insider Trading

The SEC today announced insider trading charges against Michael Cardillo, a former trader at the hedge fund investment adviser Galleon Management, LP, for trading ahead of September 2007 announced acquisition of 3Com Corp., and November 2007 announced acquisition of Axcan Pharma Inc.

The SEC’s complaint, filed in federal court in Manhattan, alleges that Arthur J. Cutillo and Brien P. Santarlas, former attorneys with the international law firm Ropes & Grey LLP, misappropriated from their law firm material, nonpublic information concerning the acquisitions of 3Com and Axcan. The SEC alleges that they tipped this inside information, through another attorney, to Zvi Goffer, a former proprietary trader at the broker-dealer Schottenfeld Group, LLC, in exchange for kickbacks. The SEC further alleges that Goffer tipped information about these acquisitions to Craig Drimal, a trader who worked out of the offices of Galleon, who then tipped the inside information to Cardillo. According to the complaint, Cardillo then traded in the securities of 3Com and Axcan on behalf of a Galleon hedge fund, resulting in more than $730,000 in illicit profits.

In a related criminal case filed by the U.S. Attorney’s Office for the Southern District of New York, Cardillo has pled guilty to criminal charges in connection with this insider trading scheme.

January 28, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former Galleon Portfolio Manager with Insider Trading

On January 26, 2011, the SEC filed a civil injunctive action in the United States District Court for the Southern District of New York alleging that Adam Smith — a former portfolio manager of the Galleon Emerging Technology funds (f/k/a the Galleon Communications funds) engaged in insider trading in the securities of ATI Technologies, Inc. The SEC alleges that Smith caused the Galleon funds he advised to purchase shares of ATI based on material non-public information concerning Advanced Micro Devices Inc.’s $5.4 billion takeover of ATI in July, 2006. The trading generated over $1.3 million in illicit profits.

According to the SEC’s complaint, Smith obtained material non-public information concerning the AMD/ATI transaction from an investment banking source that Smith had known for years. This source, according to the SEC, provided Smith with the tip in order to win favors from Galleon such as securing investment banking work from, or obtaining future employment with, Galleon. The complaint filed today relates to a pending enforcement action, SEC v. Galleon Management, LP, et al., 09-CV-8811 (S.D.N.Y.) (JSR).

The SEC has now charged 28 defendants in its Galleon-related enforcement actions which have alleged widespread and repeated insider trading at numerous hedge funds including Galleon — a multi-billion dollar New York hedge fund complex founded and controlled by Raj Rajaratnam — and by other professional traders and corporate insiders in the securities of 14 companies generating illicit profits totaling over $70 million.

January 28, 2011 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Thursday, January 27, 2011

Financial Crisis Inquiry Commission Releases Report

The Financial Crisis Inquiry Commission delivered the results of its investigation into the causes of the financial and economic crisis. The Commission concluded that the crisis was avoidable and was caused by:

 Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the
tide of toxic mortgages;
 Dramatic breakdowns in corporate governance including too many financial firms acting
recklessly and taking on too much risk;
 An explosive mix of excessive borrowing and risk by households and Wall Street that put the
financial system on a collision course with crisis;
 Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system
they oversaw;
 And systemic breaches in accountability and ethics at all levels.

The Commission’s report also offers conclusions about specific components of the financial system that
contributed significantly to the financial meltdown. Here the Commission concluded that: collapsing
mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis, over-the-counter derivatives contributed significantly to this crisis, and the failures of credit rating agencies were essential cogs in the wheel of financial destruction.

The Commission also examined the role of government sponsored enterprises (GSEs), with Fannie Mae
serving as the case study. The Commission found that the GSEs contributed to the crisis but were not a
primary cause. They had a deeply flawed business model and suffered from many of the same failures of
corporate governance and risk management seen in other financial firms but ultimately followed rather
than led Wall Street and other lenders in purchasing subprime and other risky mortgages.

The Reports's Conclusions and Dissents are posted on its website.

January 27, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC & CFTC Propose Rules on Reporting by Advisers to Private Funds

The SEC has posted on its website Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, joint proposed rules with the Commodity Futures Trading Commission.

January 27, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, January 26, 2011

SEC Adopts Final Rules on Say on Pay and Golden Parachutes

Here is a link to the final rules on Say on Pay and Golden Parachutes that the SEC, by a 3-2 vote, approved yesterday.

January 26, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Releases Staff Study on Improved Investor Access to Information about Brokers and Advisers

The SEC released its third staff study this week required by Dodd-Frank, the Study and Recommendations on Improved Investor Access to Registration Information About Investment Advisers and Broker-Dealers.  Section 919B directs the SEC to complete a study, including recommendations, of ways to improve the access of investors to registration information about registered and previously registered investment advisers, associated persons of investment advisers, brokers and dealers and their associated persons, and to identify additional information that should be made publicly available. The Act specifies that the study include an analysis of the advantages and disadvantages of further centralizing access to registration information, and identify data pertinent to investors and the method and format for displaying and publishing the data to enhance the information’s accessibility and utility to investors. Unlike the "fiduciary duty" study for investment advisers and broker-dealers, Dodd-Frank requires the SEC to implement any recommendations within eighteen months after completion of the study.

The study contains an overview of the registration information the Staff believes is important to investors, as well as a brief introduction to the primary sources of publicly available registration information. It first discusses broker-dealer registration and disclosure, then discusses investment adviser registration and disclosure, and finally compares the nature of information available in BrokerCheck and IAPD.

The study proposes several recommendations:

 For the near-term, i.e., within the eighteen-month implementation period, the Staff makes the following recommendations: (1) unify search returns for BrokerCheck and IAPD to help investors more easily obtain the data they need to make informed decisions regarding financial services providers; (2) add a search by ZIP code or other indicator of location to BrokerCheck and IAPD to increase the utility of the existing databases; and (3) enhance BrokerCheck and IAPD by adding educational content to make the data currently available more useful to investors.

The Staff also recommends that, subsequent to the eighteen-month implementation period, Commission staff and FINRA continue to analyze, including through investor testing, the
feasibility and advisability of expanding BrokerCheck to include information currently available in CRD, as well as the method and format of publishing that information; and that Commission staff continue to evaluate expanding IAPD content and the method and format of publishing that content, including through investor testing.

January 26, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, January 25, 2011

Crisis was "Avoidable" Disaster, Inquiry Commission Concludes

The Financial Crisis Inquiry Commission will release its report on the causes of the financial and economic crisis on January 27, 2011.  The Commission reviewed millions of pages of documents, interviewed more than 700 witnesses, and held 19 days of public hearings in New York, Washington, D.C., and communities across the country that were hit hard by the crisis.

The New York Times reports that it examined the conclusions of the report, which finds that the crisis was an "avoidable" disaster, with plenty of blame to go around -- the failure of government regulation (under both Democratic and Republican administrations), corporate mismanagement, and reckless risk-taking by Wall St.  None of the federal regulators escapes its scorn.

Of the ten Commissioner members, only the six Democrats endorse the report.  There are two dissents by Republican commissioners.

See NYTimes, Financial Meltdown Was ‘Avoidable,’ Inquiry Concludes

January 25, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Treasury Announces Auction for Warrants of Citigroup Stock

The U.S. Department of the Treasury announced yesterday that it commenced a secondary public offering of 255,033,142 warrants to purchase the common stock of Citigroup Inc. (the “Company”) (the “A Warrants”) and a secondary public offering of 210,084,034 warrants to purchase the common stock of the Company (the “B Warrants”). The offerings are expected to price through a modified Dutch auction. Deutsche Bank Securities Inc. is the sole book-running manager and Cabrera Capital Markets, LLC and Loop Capital Markets LLC are the co-managers for the offerings.
Deutsche Bank Securities Inc., in its capacity as auction agent, has specified that the auctions will commence at 8:00 a.m., Eastern Time, on January 25, 2011, and will close at 6:30 p.m., Eastern Time, on that same day (the “submission deadline”). During the auction period, potential bidders for the A Warrants will be able to place bids at any price (in increments of $0.01) at or above the minimum bid price of $0.60 per warrant, and potential bidders for the B Warrants will be able to place bids at any price (in increments of $0.01) at or above the minimum bid price of $0.15 per warrant.

January 25, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Adopts Final Rules on Say-on-Pay

The SEC today adopted rules concerning shareholder approval of executive compensation and "golden parachute" compensation arrangements as required under the Dodd-Frank Act.  The SEC's new rules specify that say-on-pay votes must occur at least once every three years beginning with the first annual shareholders' meeting taking place on or after Jan. 21, 2011. Companies also are required to hold a "frequency" vote at least once every six years in order to allow shareholders to decide how often they would like to be presented with the say-on-pay vote.

Under the SEC's new rules, companies also are required to provide additional disclosure regarding "golden parachute" compensation arrangements with certain executive officers in connection with merger transactions.

The Commission also adopted a temporary exemption for smaller reporting companies (public float of less than $75 million). These smaller companies are not required to conduct say-on-pay and frequency votes until annual meetings occurring on or after Jan. 21, 2013.

January 25, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Settles with Merrill Over Misusing Customer Order Information for Proprietary Trading

The SEC today charged Merrill Lynch, Pierce, Fenner & Smith Incorporated with misusing customer order information to place proprietary trades for the firm and for charging customers undisclosed trading fees.  To settle the SEC's charges, Merrill has agreed to pay a $10 million penalty and consent to a cease-and-desist order.  The SEC stated that, In determining to accept Merrill's offer, it considered certain remedial actions undertaken by Merrill after it was acquired by Bank of America.

The SEC's order found that Merrill operated a proprietary trading desk between 2003 and 2005 that was known as the Equity Strategy Desk (ESD), which traded securities solely for the firm's own benefit and had no role in executing customer orders. The ESD was located on Merrill's main equity trading floor in New York City, where traders on Merrill's market making desk received and executed customer orders. While Merrill represented to customers that their order information would be maintained on a strict need-to-know basis, the firm's ESD traders obtained information about institutional customer orders from traders on the market making desk. They then used it to place trades on Merrill's behalf after executing the customers' trades. In doing so, Merrill misused this information and acted contrary to its representations to customers.

The SEC's order also found that, between 2002 and 2007, Merrill had agreements with certain institutional and high net worth customers that Merrill would only charge a commission equivalent for executing riskless principal trades. However, in some instances, Merrill also charged customers undisclosed mark-ups and mark-downs by filling customer orders at prices less favorable to the customer than the prices at which Merrill purchased or sold the securities in the market.


January 25, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Proposes Private Fund Systemic Risk Reporting Rule

The SEC today proposed a rule to require advisers to hedge funds and other private funds to report information for use by the Financial Stability Oversight Council (FSOC) in monitoring risk to the U.S. financial system.  The proposal creates a new reporting form (Form PF) to be filed periodically by SEC-registered investment advisers who manage one or more private funds. Information reported on Form PF would remain confidential.  The proposed rule would implement Sections 404 and 406 of the Dodd-Frank Act.

Under the proposal, larger private fund advisers managing hedge funds, "liquidity funds" (i.e., unregistered money market funds), and private equity funds would be subject to heightened reporting requirements. Large private fund advisers would include any adviser with $1 billion or more in hedge fund, liquidity fund, or private equity fund assets under management. All other private fund advisers would be regarded as smaller private fund advisers and would not be subject to the heightened reporting requirements.  According to the SEC, this heightened reporting threshold would apply to only about 200 U.S.-based hedge fund advisers, which manage more than 80 percent of the assets under management.

January 25, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)