Securities Law Prof Blog

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

Thursday, December 8, 2011

Wachovia Pays $148 Million to State and Federal Regulators to Settle Fraud Allegations Involving Municipal Bond Derivatives

Wachovia Bank N.A. and Wells Fargo Bank, N.A., as its successor, entered into settlements totalling $148 million with 26 state regulators, the SEC and other federal regulators as part of an ongoing national investigation of alleged anticompetitive and fraudulent conduct in the municipal bond derivatives industry.

As part of the multistate settlement with 26 Attorneys General, Wachovia has agreed to pay $54.5 million in restitution to affected state agencies, municipalities, school districts and not-for-profit entities nationwide that entered into municipal bond derivative contracts with Wachovia between 1998 and 2004.  In addition, Wachovia agreed to pay a $1.25 million civil penalty and $3 million for fees and costs of the investigation to the settling states.

Wachovia also agreed to pay $46 million to the SEC that will be returned to affected municipalities or conduit borrowers. Wachovia also entered into agreements with the Justice Department, Office of the Comptroller of the Currency, and Internal Revenue Service. 

The settlements arise out of long-standing parallel investigations into widespread corruption in the municipal securities reinvestment industry in which 18 individuals have been criminally charged by the Justice Department’s Antitrust Division. In April 2008, the states began investigating allegations that certain large financial institutions, including national banks and insurance companies, and certain brokers and swap advisors, engaged in various schemes to rig bids and commit other deceptive, unfair and fraudulent conduct in the municipal bond derivatives market.

The investigation, which is still ongoing, revealed collusive and deceptive conduct involving individuals at Wachovia and other financial institutions, and certain brokers with whom they had working relationships. The wrongful conduct took the form of bid-rigging, submission of non-competitive courtesy bids and submission of fraudulent certifications of compliance to government agencies, among others.

According to the SEC, Wachovia engaged in fraudulent bidding of GICs, repos, and FPAs from at least 1997 to 2005. Wachovia’s fraudulent practices and misrepresentations not only undermined the competitive bidding process, but negatively affected the prices that municipalities paid for reinvestment products. Wachovia deprived certain municipalities from a conclusive presumption that the reinvestment instruments had been purchased at fair market value, and jeopardized the tax-exempt status of billions of dollars in municipal securities because the supposed competitive bidding process that establishes the fair market value of the investment was corrupted.

Wachovia is the fourth financial institution to settle with a multistate task force in the ongoing municipal bond derivatives investigation following Bank of America, UBS AG and JP Morgan.  To date, the state working group has obtained settlements worth almost $310 million.

December 8, 2011 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)

Corzine Apologizes, Doesn't Know Where Customers' Money Is

The House Committee on Agriculture held a hearing today on the MF Global bankruptcy, at which Jon Corzine was scheduled to testify.  Here is an excerpt from his written testimony about the missing cutomers' funds:

As the chief executive officer of MF Global, I ultimately had overall responsibility for
the firm. I did not, however, generally involve myself in the mechanics of the clearing and
settlement of trades, or in the movement of cash and collateral. Nor was I an expert on the
complicated rules and regulations governing the various different operating businesses that
comprised MF Global. I had little expertise or experience in those operational aspects of the

Again, I want to emphasize that, since my resignation from MF Global on November 3,
2011, I have not had access to the information that I would need to understand what happened. It
is extremely difficult for me to reconstruct the events that occurred during the chaotic days and
the last hours leading up to the bankruptcy filing.

I simply do not know where the money is, or why the accounts have not been reconciled
to date. I do not know which accounts are unreconciled or whether the unreconciled accounts
were or were not subject to the segregation rules. Moreover, there were an extraordinary number
of transactions during MF Global’s last few days, and I do not know, for example, whether there
were operational errors at MF Global or elsewhere, or whether banks and counterparties have
held onto funds that should rightfully have been returned to MF Global. I am sure that the
trustee in bankruptcy, the SIPC receiver, and the regulators are working to answer these
questions and to understand precisely what happened during the firm’s last days and hours.

As the chief executive officer of MF Global, I tried to exercise my best judgment on
behalf of MF Global’s customers, employees and shareholders. Once again, let me go back to
where I started: I sincerely apologize, both personally and on behalf of the company, to our
customers, our employees and our investors, who are bearing the brunt of the impact of the
firm’s bankruptcy.

The Wall St. Journal reports that Mr. Corzine was contrite and expressed both sorrow and a firm defense of his actions.  WSJ, 'Devastated' Corzine Defends Actions as MF Global Chief

December 8, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Wednesday, December 7, 2011

FINRA Proposes Rule to Invalidate PDAAs for Whistleblower Disputes

FINRA has filed with the SEC a proposed rule change (Release No. 34-65896; File No. SR-FINRA-2011-067) (December 6, 2011) to amend FINRA Rule 13201 of the Code of Arbitration Procedure
for Industry Disputes (“Industry Code”) to align the rule with statutes that invalidate predispute
arbitration agreements for whistleblower claims.

The Dodd-Frank Act amended the Sarbanes-Oxley Act of 2002 by adding a new paragraph (e) to 18 U.S.C. § 1514A4 to provide that:

(1) WAIVER OF RIGHTS AND REMEDIES – The rights and remedies provided for
in this section may not be waived by any agreement, policy form, or condition
of employment, including by a predispute arbitration agreement.
(2) PREDISPUTE ARBITRATION AGREEMENTS – No predispute arbitration
agreement shall be valid or enforceable, if the agreement requires arbitration
of a dispute arising under this section.

Prior to the Dodd-Frank Act, it was FINRA staff’s position that parties were required to arbitrate SOX whistleblower claims under the Industry Code.  The proposed rule change would amend FINRA Rule 13201 of the Industry Code to make clear that parties are not required to arbitrate SOX whistleblower claims, superseding the existing guidance to the contrary. While the main impetus for the proposed rule change is the need to update FINRA staff’s stated position on SOX whistleblower claims, FINRA proposes to make the rule text broad enough to cover any statutes that prohibit predispute arbitration agreements for whistleblower claims.


December 7, 2011 in Other Regulatory Action, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Does the SEC Need the Power to Impose Stiffer Fines?

President Obama, in a speech yesterday in Osawatomie, Kansas, called on Congress to increase the penalties for fraud, saying that:

Too often, we’ve seen Wall Street firms violating major anti-fraud laws because the penalties are too weak and there’s no price for being a repeat offender. No more. I’ll be calling for legislation that makes those penalties count so that firms don’t see punishment for breaking the law as just the price of doing business.

While the President did not specifically refer to securities fraud, he appears to be echoing the recent request SEC Chair Schapiro made in a letter to Representative Jack Reed, Chair of the House Subcommittee on Securities, Insurance and Investment. (I could not find the letter on the SEC website, but the Scribd site has a copy of what appears to be the letter.)  Ms. Schaprio wants changes to the law to "increase the statutory limits on civil monetary penalties, more closely link the size of monetary penalties to the scope of harm to investors and associated investor losses, and substantially raise the financial stakes for securities law recidivists."

While, as a general principle I'm all in favor of hitting securities law violators (especially Wall St. firms) with hefty fines, I remain skeptical that the SEC has been hindered in its enforcement efforts by reason of constraints of its power to impose penalties. The statute generally sets forth two alternative methods for calculating the maximum amount of penalties.  The first method permits a "per violation" calculation, the amount of which increases by tier according to the seriousness of the violation.  The second method permits imposition of a penalty equal to "the gross amount of pecuniary gain" to the defendant "as a result of the violation."   While the appellate courts that have reviewed penalties do not provide much guidance as to the amount of penalties, they confirm the discretionary nature of the remedy.   It is true that in the instances of secondary market fraud, the monetary gain to the defendant may be small (thus ruling out the second method of calculation); however, there is a considerable degree of interpretation about what constitutes a "violation," particularly in the typical financial fraud situation where many defendants have made numerous misstatements that allegedly violate a number of different statutory provisions.  

I worry that the SEC may be crying "wolf" on this occasion.

December 7, 2011 in News Stories, SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, December 6, 2011

Treasury's Wolin Testifies on Implementing Dodd-Frank

 Written Testimony of Deputy Secretary Neal S. Wolin before the Senate Committee on Banking, Housing, and Urban Affairs on “Continued Oversight of the Implementation of the Wall Street Reform Act” ( 12/6/2011)

December 6, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Schapiro Testifies on Implementing Dodd-Frank

Testimony on “Continued Oversight of the Implementation of the Wall Street Reform Act” by SEC Chairman Mary L. Schapiro, before the United States Senate Committee on Banking, Housing, and Urban Affairs (December 6, 2011)

December 6, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Eric Pan Appointed Associate Director in SEC's Office of International Affairs

The SEC today announced that Eric J. Pan (on leave from his academic appointment at Cardozo Law School) has been named Associate Director in the SEC’s Office of International Affairs, where he will oversee the development of international regulatory policy.

The Office of International Affairs advises the Commission on cross-border enforcement and regulatory matters, engages in regulatory dialogues with authorities outside the U.S., provides technical assistance, and is responsible for the Commission’s participation in multilateral standard setting bodies such as the Financial Stability Board and International Organization of Securities Commissions.

Mr. Pan has been an Academic Fellow in the Office of International Affairs since January 2011.

December 6, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Obtains Asset Freeze of Chinese Citizens Charged with Insider Trading

The SEC announced that it has frozen the assets of four Chinese citizens and a Chinese-based entity charged with insider trading in advance of a merger announcement by educational companies based in London and Beijing.  The SEC moved to obtain an emergency court order to freeze assets just two weeks after the suspicious trading by Sha Chen, Song Li, Lili Wang, and Zhi Yao, who have U.S.-based brokerage accounts. According to the SEC, they purchased American Depository Shares (ADS) of Beijing-based Global Education and Technology Group in the two weeks leading up to a November 21 public announcement of a planned merger with London-based Pearson plc. Some of their brokerage accounts were dormant until they bet heavily on Global Education shares, and some of the purchases made either equaled or exceeded the stated annual income of that trader. After the agreement was announced, they immediately began selling some of their Global Education shares. Their illicit gains totaled more than $2.7 million.

The SEC also charged All Know Holdings Ltd. and one or more unknown purchasers of Global Education stock in its complaint filed on December 5 in U.S. District Court for the Northern District of Illinois.

In addition to the emergency relief, the SEC seeks permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties. The emergency court order that the SEC obtained on December 5 on an ex parte basis freezes more than $2.7 million of defendants’ assets held in U.S. brokerage accounts and, among other things, grants expedited discovery and prohibits the defendants from destroying evidence.

December 6, 2011 in SEC Action | Permalink | Comments (1) | TrackBack (0)

SEC Charges D.C. Attorney with Prime Bank Scheme

The SEC today filed charges and obtained an emergency court order to halt a prime bank scheme in which the perpetrators allegedly stole investor funds to purchase luxury cars, take a trip to the Bahamas, and pay the bills of a Washington D.C. law firm.  According to the SEC, Frank L. Pavlico III and Washington D.C. attorney Brynee K. Baylor offered investors risk-free returns of up to 20 times the original investment within as few as 45 days through the purported “lease” and “trading” of foreign bank instruments in highly complex transactions involving unidentified parties and secretive “trading platforms.” However, the bank instruments and trading programs were entirely fictitious. Pavlico and Baylor provided investors with phony contracts and legal documents, digitally-created computer screen shots, and copies of fictitious foreign bank instruments as purported proof of the ongoing success of the transactions. Baylor and her law firm Baylor & Jackson P.L.L.C. acted as “counsel” for Pavlico’s company The Milan Group, vouching for Pavlico and acting as an escrow agent that in reality was merely receiving and diverting the majority of investor funds.

According to the SEC’s complaint filed on November 30 in federal court in Washington D.C. and unsealed by the court late yesterday, Pavlico and Baylor defrauded at least 13 investors out of more than $2 million since August 2010.

The Judge granted the SEC’s request for a temporary restraining order, asset freezes, and other emergency relief to prevent Pavlico, Milan, Baylor, and Baylor & Jackson from further engaging in the investment program. The SEC seeks permanent injunctive relief and financial penalties against Pavlico, Milan, Baylor, and Baylor & Jackson as well as disgorgement from them and the relief defendants of all ill-gotten gains.

Separately, the Federal Bureau of Investigation arrested Pavlico on Nov. 29, 2011, charging him with wire fraud.

December 6, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, December 5, 2011

Senate Schedules Hearing on Congressional Insider Trading

Last week the Senate Committee on Homeland Security and Governmental Affairs held a hearing on members of Congress and their staff trading on the basis of confidential information  (archive here).  Tomorrow, at 10 a.m., the House Committee on Financial Services will also hold a hearing on the same subject.  Among the witnesses are SEC Director of Enforcement, Robert Khuzami, and Professor Donna Nagy (Indiana), who also testified last week.

December 5, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Sunday, December 4, 2011

Feibelman on Living Wills

Living Wills and Pre-Commitment, by Adam Feibelman, Tulane University - Law School, was recently posted on SSRN.  Here is the abstract:

Among many other things, the Dodd-Frank Act of 2010 requires large bank holding companies and systemically important non-bank financial institutions to prepare plans for their resolution – living wills – in case they experience financial distress. Living wills have emerged as one of the few innovative aspects of recent financial regulatory reforms around the globe, and yet they have attracted relatively little attention and commentary compared to other reforms. Living wills have the potential to be a significant tool for financial regulators who aim to avoid systemic crises and taxpayer bailouts, but much depends on regulatory design and practice. With questions of design and practice in mind, this Essay emphasizes some basic similarities between living wills and proposals to allow parties to pre-commit with respect to bankruptcy. Like contracting about bankruptcy, living wills potentially involve firms making some form of commitment or strong prediction regarding their insolvency-state treatment. Considering the nascent living wills regime through the lens of this literature on bankruptcy law underscores some important potential consequences of regulatory design. Most notably, if living wills do purport to reflect some meaningful degree of commitment, and if the contents of the wills are disclosed to regulated firms’ counter-parties, these counter-parties are likely to adjust to the plans if they can. Thus, financial regulators should be mindful of the potential ex ante effects of living wills and they should aim clarify to market participants as much as possible how they intend to utilize the wills in the event of a firm’s financial distress.

December 4, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Zaring & Donelson on the Office of Thrift Supervision

Requiem for a Regulator: The Office of Thrift Supervision's Performance During the Financial Crisis, by David T. Zaring, University of Pennsylvania - Legal Studies Department, and Dain C. Donelson, University of Texas at Austin - McCombs School of Business, was recently posted on SSRN.  Here is the abstract:

 We evaluate evidence reflecting the stability of our multi-regulator, charter-competitive system of financial regulation during the financial crisis in this symposium essay. Specifically, we compare thrifts to banks, charter-switchers to other thrifts and banks, and bailout recipients to non-bailout recipients to discover if any of these institutions did poorly when compared to their peers during the financial crisis. First, we compare publicly traded thrifts to publicly traded banks during 2008--the critical year of the crisis--and find that thrifts fared only marginally worse than banks, if at all, during that year. This result modestly suggests that the multi-regulator regime, however illogical, did not concentrate instability in a particular industry subject to a weak regulator. Second, to evaluate the impact of competition for charters, we compare thrift and bank performance to those institutions that chose to switch regulators immediately before and during the financial crisis. We find no significant differences in returns among either institutions that converted their federal bank charters to federal thrift charters, or institutions that converted federal thrift charters to bank charters, although our samples of these institutions are small. Third, we examine the bailout propensity of these charter-switchers. Our results suggest that although institutions switching to thrift charters were big enough to receive bailout money from the government, they did not. Conversely, we find that institutions switching away from thrift charters received more bailout money than their size would suggest. Our final finding may suggest some (possibly misplaced) dissatisfaction with the performance of the federal thrift regulator among federal government officials, which may have contributed to the decision to eliminate it in the Dodd-Frank Financial Reform Act passed in the wake of the crisis.

December 4, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Ford & Hess on Corporate Monitorships

Corporate Monitorships and New Governance Regulation: In Theory, in Practice, and in Context, by Cristie L. Ford, University of British Columbia Faculty of Law, and David Hess, University of Michigan - Stephen M. Ross School of Business, was recently posted on SSRN.  Here is the abstract:

Over the last few years, it has become increasingly common for government agencies to resolve corporate criminal law and securities regulations violations through the use of settlement agreements that require corporations to improve their compliance programs and hire independent monitors to oversee the changes. Based on our interviews with corporate monitors, regulators, and others, we find that these monitorships are failing to meet their full potential in reforming corrupt corporate cultures. After reviewing potential reforms to improve monitorships from a new governance perspective, we discuss the limits of these reforms that are due to the sociological and institutional environment in which monitorships are embedded.

December 4, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Maynard on The Ethics of Taking Stock in Start-Ups

Ethics for Business Lawyers Representing Start-Up Companies, by Therese H. Maynard, Loyola Law School Los Angeles, was recently posted on SSRN.  Here is the abstract:

Starting in the 1990’s, it became an increasingly common practice for lawyers - particularly Silicon Valley lawyers - to take an equity investment in the business ventures of their new clients. While the practice lulled somewhat in the aftermath of the burst of the bubble, it is becoming relevant again as the market for stocks of high-tech companies has been gaining strength in the wake of the economic recovery from the recent Great Recession. This Essay explores the ethical issues as well as the general business considerations that arise in connection with the practice of taking stock in lieu of payment of legal fees in cash, which has long been the traditional billing practice for legal services. For reasons that are described in detail in this Essay, many academics and experienced venture capital lawyers believe that taking stock in a client presents significant potential to strengthen the lawyer’s relationship with the new business client. At the other end of the spectrum, there are others within the legal community (both academics and practicing lawyers) who just as strongly believe that these equity investment arrangements significantly undermine time-honored ideals that have long guided the legal profession in determining how corporate lawyers should go about fulfilling the ethical and fiduciary obligations that they owe to their business clients. This Essay describes the advantages and disadvantages of these equity fee arrangements in order to address the fundamental public policy concerns presented by the growing practice of taking stock in payment of legal fees - namely, whether this practice serves the client’s best interests, and separately, whether these arrangements also serve the best interests of the legal profession.

December 4, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)