Friday, December 16, 2011
The SEC charged Daniel Ruettiger and 12 other participants in a scheme to deceive investors into buying stock in his sports drink company. Apparently Ruettiger was the inspiration for the 1993 motion picture "Rudy."
According to the SEC, Ruettiger founded Rudy Nutrition, which produced and sold modest amounts of a sports drink called “Rudy” with the tagline “Dream Big! Never Quit!” However, the company primarily served as a vehicle for a pump-and-dump scheme that occurred in 2008 and generated more than $11 million in illicit profits.
The SEC alleges that investors were provided false and misleading statements about the company in press releases, SEC filings, and promotional materials. For example, a promotional mailer to potential investors falsely claimed that in “a major southwest test, Rudy outsold Gatorade 2 to 1!” A promotional e-mail falsely boasted that in “several blind taste tests, Rudy outperformed Gatorade and Powerade by 2:1.” Meanwhile, the scheme’s promoters engaged in manipulative trading to artificially inflate the price of Rudy Nutrition stock while selling unregistered shares to investors. The SEC suspended trading and later revoked registration of the stock in late 2008. Rudy Nutrition is no longer in business.
Ruettiger and 10 of the scheme’s other participants have agreed to settle the SEC’s charges without admitting or denying the allegations. The settlements, which are subject to court approval, impose penny stock bars and officer-and-director bars as appropriate. Ruettiger agreed to pay $382,866 in settling the charges, and other participants consented to final judgments also ordering disgorgement, prejudgment interest, and financial penalties.
The SEC charged six former top executives of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) with securities fraud, alleging they knew and approved of misleading statements claiming the companies had minimal holdings of higher-risk mortgage loans, including subprime loans. Fannie Mae and Freddie Mac each entered into a Non-Prosecution Agreement with the Commission in which each company agreed to accept responsibility for its conduct and not dispute, contest, or contradict the contents of an agreed-upon Statement of Facts without admitting nor denying liability. Each also agreed to cooperate with the Commission's litigation against the former executives.
The SEC stated that, in entering into these Agreements, it took into account "the unique circumstances presented by the companies' current status, including the financial support provided to the companies by the U.S. Treasury, the role of the Federal Housing Finance Agency as conservator of each company, and the costs that may be imposed on U.S. taxpayers."
In addition, three former Fannie Mae executives - former Chief Executive Officer Daniel H. Mudd, former Chief Risk Officer Enrico Dallavecchia, and former Executive Vice President of Fannie Mae's Single Family Mortgage business, Thomas A. Lund - were named in the SEC's complaint filed in U.S. District Court for the Southern District of New York.
The SEC also charged three former Freddie Mac executives — former Chairman of the Board and CEO Richard F. Syron, former Executive Vice President and Chief Business Officer Patricia L. Cook, and former Executive Vice President for the Single Family Guarantee business Donald J. Bisenius — in a separate complaint filed in the same court.
The SEC is seeking financial penalties, disgorgement of ill-gotten gains with interest, permanent injunctive relief and officer and director bars against Mudd, Dallavecchia, Lund, Syron, Cook, and Bisenius.
The Non-Prosecution Agreements and Complaints are available on the SEC website.
FINRA fined Wells Fargo Investments, LLC, $2 million for unsuitable sales of reverse convertible securities through one broker to 21 customers, and for failing to provide sales charge discounts on Unit Investment Trust (UIT) transactions to eligible customers. As part of the settlement, the firm is required to pay restitution to customers who did not receive UIT sales charge discounts and to provide restitution to certain customers found to have unsuitable reverse convertible transactions.
FINRA also filed a complaint against Alfred Chi Chen, the former Wells Fargo registered representative who recommended and sold the unsuitable reverse convertibles, and made unauthorized trades in several customer accounts, including accounts of deceased customers.
FINRA found that Chen recommended hundreds of unsuitable reverse convertible investments to 21 clients, most of whom were elderly and/or had limited investment experience and low risk tolerance. As of June 2008, Chen had 172 accounts that held reverse convertibles, with 148 of those accounts having concentrations greater than 50 percent of their total account holdings, and 46 having concentrations greater than 90 percent. Fifteen of the 21 customers were over 80 years old. The reverse convertible transactions exposed these customers to risk inconsistent with their investment profiles, and resulted in overly concentrated reverse convertible positions in their accounts.
FINRA also found that Wells Fargo failed to provide certain eligible customers with breakpoint and rollover and exchange discounts in their sales of UITs because the firm had insufficient systems and procedures to monitor for unsuitable reverse convertible sales and to ensure that UIT customers received discounts for which they were entitled.
In concluding these settlements, Wells Fargo neither admitted nor denied the charges, but consented to the entry of FINRA's findings
The SEC issued a release (33-92284Download 33-9284) containing a list of rules to be reviewed under the Regulatory Flexibility Act and invited public comment on them. Included on the list are rules relating to Selective Disclosure and Insider Trading, specifically 17 CFR 243.100-103 (Reg FD) and 17 CFR 240.10b5-1 and 10b5-2.
As I discussed in a blog earlier this week, the SEC filed an application in D.C. federal district court to compel SIPC to institute liquidation proceedings for Stanford Group Company, a broker-dealer registered with the Commission and a SIPC-member brokerage firm.
The SEC has now posted its application and memorandum of legal authorities on its website.
The SEC continues its post-Madoff crackdown on Ponzi schemes (which nevertheless continue to proliferate). Yesterday the agency charged Wendell A. Jacobson and his son Allen R. Jacobson with selling purported investments in their real estate business in Utah that turned out to be nothing more than a wide-scale $220 million Ponzi scheme.
According to the SEC, the Jacobsons offered investors the opportunity to invest in limited liability companies (LLCs) in order to share ownership of large apartment communities in eight states. The Jacobsons solicited investors personally and through word of mouth, and appeared to be using their memberships in the Church of Jesus Christ of Latter-Day Saints to make connections and win over the trust of prospective investors.
The SEC alleges that the Jacobsons represent that they buy apartment complexes with low occupancy rates at significantly discounted prices. They then renovate them and improve their management, and aim to resell them within five years. Investors are said to share in the profits derived from rental income at the apartment complexes as well as the eventual sales. But in reality, the LLCs are suffering significant losses and the Jacobsons are merely pooling the money raised from investors into large bank accounts from which they are siphoning money to pay family expenses and the operating expenses of their various companies. They also are paying earlier investors with funds received from new investors in classic Ponzi scheme fashion.
After filing its complaint today in federal court in Salt Lake City, the SEC obtained an emergency court order freezing the assets of the Jacobsons and their companies.
The rumors have been out there for days, and yesterday the SEC's Enforcement Division filed a notice of appeal of Judge Rakoff's rejection of the Citigroup settlement. An issue that I have not seen addressed is whether a judicial rejection of a proposed settlement is an appealable final order. My colleague Professor Michael Solimine refers me to Digital Equipment Corp. v. Desktop Direct, Inc., 511 U.S. 863 (1994), interpreting the “final order” language of 28 U.S.C. sec. 1291. I welcome the thoughts of other civil procedure scholars.
Here is an excerpt of Mr. Khuzami's statement about why the SEC decided to appeal:
We believe the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits. For this reason, today we filed papers seeking review of the decision in the U.S. Court of Appeals for the Second Circuit.
We believe the court was incorrect in requiring an admission of facts — or a trial — as a condition of approving a proposed consent judgment, particularly where the agency provided the court with information laying out the reasoned basis for its conclusions. Indeed, in the case against Citigroup, the SEC filed suit after a thorough investigation, the findings of which were described in extensive detail in a 21-page complaint.
The court’s new standard is at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country. In fact, courts have routinely approved settlements in which a defendant does not admit or even expressly denies liability, exactly because of the benefits that settlements provide.
In cases such as this, a settlement puts money back in the pockets of harmed investors without years of courtroom delay and without the twin risks of losing at trial or winning but recovering less than the settlement amount - risks that always exist no matter how strong the evidence is in a particular case. Based on a careful balancing of these risks and benefits, settling on favorable terms even without an admission serves investors, including investors victimized by other frauds. That is due to the fact that other frauds might never be investigated or be investigated more slowly because limited agency resources are tied up in litigating a case that could have been resolved.
In contrast, the new standard adopted by the court could in practical terms press the SEC to trial in many more instances, likely resulting in fewer cases overall and less money being returned to investors.
Tuesday, December 13, 2011
The SEC charged seven former senior executives of Siemens AG ("Siemens") and its regional company in Argentina with violations of the anti-bribery, books and records, and internal controls provisions of the Foreign Corrupt Practices Act in connection with a decade-long scheme to bribe senior government officials in Argentina, including two Presidents and Cabinet Ministers in two Presidential administrations.
According to the SEC complaint, the seven individuals, all foreign nationals, paid scores of millions of dollars in bribes for Siemens to obtain and retain a $1 billion contract to produce national identity cards for Argentine citizens. The SEC alleges that over $100 million in bribes were paid. The defendants charged in the scheme are Uriel Sharef, Ulrich Bock, Carlos Sergi, Stephan Signer, Herbert Steffen, Andres Truppel, and Bernd Regendantz. The most senior of these, Uriel Sharef, is a former Siemens Managing Board member.
The SEC previously charged Siemens in December 2008 with FCPA violations in Argentina and numerous other countries around the world. Siemens paid over $1.6 billion to resolve the charges with the Commission, the U.S. Department of Justice, and the Office of the Prosecutor General in Munich, Germany.
The SEC's complaint seeks permanent injunctive relief, disgorgement and civil penalties from the defendants.
One defendant has agreed to settle the charges. Bernd Regendantz will pay a civil penalty of $40,000, deemed satisfied by Regendantz' payment of a €30,000 administrative fine ordered by the Public Prosecutor General in Munich, Germany.
On December 12, the SEC sued SIPC (for the first time!), asserting that SIPC is not fulfilling its responsibilities to customers of Stanford Financial Group (SFG) because it has refused to recognize that they are entitled to the protections of SIPA. SIPC has asserted that SIPA does not apply to SFG customers because they purchased CDs from a bank and did not lose cash or securities in a brokerage account.
The SEC and SIPC have been disputing the coverage of SIPA since SFG was exposed as a Ponzi scheme. After the SEC sent SIPC a letter on June 15, 2011, stating its position and requesting that SIPC take the necessary steps to institute a SIPA liquidation proceeding, SIPC announced that it would consider the SEC's request and make an announcement in mid-September. This announcement was delayed, and the SEC has now taken matters into its own hands by filing this lawsuit.
SIPC said today that it will defend itself against the lawsuit:
"We have great sympathy for the victims of this extraordinary Ponzi scheme that inflicted heartbreaking losses on thousands of people across the world," said Orlan M. Johnson, Chairman of the Securities Investor Protection Corporation. "But, SIPC must adhere to the requirements established by Congress. After careful and exacting analysis, we believe the SEC's theory in this case conflicts with the Securities Investor Protection Act, the law that created SIPC and has guided it for the last 40 years."
"SIPC is not the equivalent of the FDIC for investment fraud," said Stephen P. Harbeck, President of the Securities Investor Protection Corporation. "Congress considered whether to guarantee investment losses and rejected that sort of protection as unrealistic and inappropriate."
"Given the diametrically opposed positions of the SEC and SIPC, this matter is going to have to be resolved in the courts," Mr. Harbeck said. "The courts have a process in place for examining both the facts and the law to test the SEC's position."
Monday, December 12, 2011
The SEC charged Geoffrey J. Eiten and his company National Financial Communications Corp. (“NFC”) for making material misrepresentations and omissions in a penny stock publication they issued. The SEC alleges that Eiten and NFC publish a penny stock promotion piece called the “OTC Special Situations Reports” that promotes penny stocks on behalf of clients in order to increase the price per share and/or volume of trading in the market for the securities of penny stock companies. The complaint alleges that Eiten and NFC have made misrepresentations in these reports about the penny stock companies they are promoting. According to the complaint, Eiten and NFC were hired to issue the reports and used false information provided by their clients, without checking the accuracy of the information.
In its complaint, the Commission seeks permanent injunctions, disgorgement plus prejudgment interest, civil penalties, and penny stock bars pursuant to Section 21(d)(6) of the Exchange Act against the defendants.
The SEC today charged a "shell packaging firm" and several others allegedly involved in a penny stock scheme to issue purportedly unrestricted shares in the public markets. According to the SEC, Joseph Meuse and his firm Belmont Partners LLC – which is in the business of identifying and selling public shell companies for use in reverse mergers – fabricated and backdated documents used to convince a transfer agent and an attorney writing an opinion letter to issue free-trading shares of Alternative Green Technologies Inc. (AGTI). The SEC also charged AGTI and its CEO Mitchell Segal as well as Segal’s business partner Howard Borg and stock promoters David Ryan, Vikram Khanna, and Panascope Capital Inc. for their roles in the scheme that resulted in unknowing investors purchasing fraudulently issued AGTI shares without the protections afforded by the securities laws.
The SEC’s complaint charges all defendants with violating Section 5 of the Securities Act of 1933, and AGTI and Segal with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(a) and (c) thereunder. Segal, Meuse and Belmont Partners are charged with aiding and abetting the fraud by AGTI. The SEC’s complaint seeks permanent injunctions and disgorgement against all defendants; a financial penalty against AGTI, Segal, Belmont Partners, Meuse, and Ryan; and officer and director and penny stock bars against Segal and Meuse. The SEC’s complaint also names several relief defendants for the purposes of recovering proceeds they received from the illicit stock sales.
Borg, Khanna and Panascope Capital have consented to the entry of a final judgment enjoining them from further violations of Section 5 of the Securities Act without admitting or denying the allegations in the SEC’s complaint. Khanna and Panascope Capital agreed to pay $81,477.10 to settle the charges, and Borg agreed to pay $35,264.05 and surrender to the transfer agent for cancellation more than four million shares of AGTI stock that were illegally issued. The settlements are subject to court approval.
The SEC today charged a subsidiary of pharmaceutical company GlaxoSmithKline and the subsidiary’s former chairman and CEO with defrauding employees and other shareholders in the company’s stock plan by buying back their stock at severely undervalued prices. According to the SEC's complaint, Stiefel Laboratories Inc., which was a family-owned business located in Coral Gables, Fla., prior to being purchased by GlaxoSmithKline two years ago, used low valuations for stock buybacks from November 2006 to April 2009. Stiefel Labs omitted key information that would have alerted employees that their stock was actually worth much more. Instead, the information was confined to then-CEO Charles Stiefel and certain members of his family as well as some senior management. At the time, Stiefel Labs was the world’s largest private manufacturer of dermatology products.
The SEC’s complaint seeks permanent injunctive relief, financial penalties, and the disgorgement of ill-gotten gains with prejudgment interest against both defendants, and an officer and director bar against Charles Stiefel.
At its December Board of Governors meeting, FINRA discussed several rulemaking items involving arbitration. Specifically:
Expungement for Persons Not Named as Parties in Arbitration Claims
The Board authorized staff to issue a Regulatory Notice requesting comment on a rule proposal to amend the Codes of Arbitration Procedure for Customer and Industry Disputes to adopt new rules that would permit persons who are the "subject of" allegations of sales practice violations made in arbitration claims, but who are not named as parties to the arbitration, to seek expungement relief by initiating In re expungement proceedings. The proposed In re proceeding would eliminate the practice of naming public customers or brokerage firms as respondents in claims seeking expungement. However, unnamed persons would retain the ability to have their firm or former firm seek expungement in the underlying customer arbitration.
The proposal also clarifies that if an associated person is named as a respondent in a customer-initiated arbitration proceeding, that person may seek expungement of customer dispute information only during that customer case, and not later under the In re expungement rule.
Under the proposal, FINRA would create two new documents to facilitate the process: a Notice of Intent to File an In re Expungement Claim, and a Submission Agreement for In re Expungement Claims. An unnamed person must file a Notice of Intent to alert FINRA that the person is considering filing a claim for expungement relief. If an unnamed person determines to seek expungement relief, the person must file a Submission Agreement, which would confer jurisdiction on FINRA to arbitrate these types of cases.
Subpoenas and Orders of Production in Arbitrations
The Board authorized staff to file with the SEC proposed amendments to the Customer and Industry Codes of Arbitration Procedure (Rules 12512, 12513, 13512 and 13513) to standardize FINRA practices relating to arbitrator orders or subpoenas to non-party brokerage firms. The amendments provide that a brokerage firm party requesting the appearance of a witness or production of documents, either by subpoena or arbitrator order, would pay the reasonable costs of the appearance and/or production. In addition, the amendments would codify FINRA's current practice of allowing the non-party to raise objections to subpoenas or orders issued by arbitrators.
Threshold for Simplified Arbitration
The Board authorized staff to file with the SEC proposed amendments to Rules 12800 and 13800 of the Customer and Industry Codes of Arbitration Procedure, respectively, to raise the threshold for simplified arbitration from $25,000 to $50,000. Under simplified arbitration procedures, claims may be decided on the written submissions of the parties, and no hearing takes place.
The Board authorized staff to file with the SEC a proposed amendment to Rule 14107 of the Code of Mediation Procedure, to provide the Director of Mediation with discretion to determine whether parties to a FINRA mediation may select a mediator who is not on FINRA's mediator roster. Currently, the Mediation Code permits parties to select a mediator either from a FINRA-supplied list or from a list or other source of the parties' choosing.
Sunday, December 11, 2011
Using Hostages to Improve the Quality of Financial Disclosure, by Jennifer W. Kuan, Stanford Institute for Economic Policy Research (SIEPR), and Stephen F. Diamond, Santa Clara University - School of Law, was recently posted on SSRN. Here is the abstract:
In a well-functioning stock market, issuing firms publicly disclose all relevant information to investors and prices approximate the true value of those firms. This disclosure generates liquidity as investors large and small engage in trading. While it is tempting to take this “good equilibrium” for granted, the current banking crisis suggests a “bad equilibrium” in which disclosure is suspect so banks stop lending to each other and small investors flee the market.
In this paper, we argue that a good equilibrium was in place when the New York Stock Exchange (NYSE) operated as a non-profit organization. We argue that far from being an outdated and elitist holdover, the mutual form allowed underwriters, who dominated NYSE membership, to extract hostages from managers of firms listed on the NYSE. That is, managers were expected to invest personal funds in shares of other listed firms, including new issuers (“IPOs”).
Since the hostage arrangement was tied to the non-profit form of the NYSE, we predict a decline in information quality after the NYSE became a for-profit firm in March 2006. By comparing the bid-ask spread before and after demutualization, we show that information quality did indeed decline. This finding holds after controlling for market-level variation measured by the bid-ask spread of the NASDAQ National Market. We believe our results can help shed light on the current banking crisis, which originated in areas of the financial system that lack a hostage structure.
Potentially Perverse Effects of Corporate Civil Liability, by Samuel W. Buell, Duke University School of Law, was recently posted on SSRN. Here is the abstract:
Inadequate civil regulatory liability can be an incentive for public enforcers to pursue criminal cases against firms. This incentive is undesirable in a scheme with overlapping forms of liability that is meant to treat most cases of wrongdoing civilly and to reserve the criminal remedy for the few most serious institutional delicts. This effect appears to exist in the current scheme of liability for securities law violations, and may be present in other regulatory structures as well. In this chapter for a volume on "Prosecutors in the Boardroom," I argue that enhancements of the SEC's enforcement processes likely would reduce the frequency of DOJ criminal enforcement against firms, an objective shared by many. Among other enforcement features, I address problems with the practice of accepting "neither admit nor deny" settlements in enforcement actions, a subject that has drawn greater attention since this chapter was published.
The Dodd-Frank Act and Housing Finance, by Adam J. Levitin, Georgetown University Law Center; Andrey D. Pavlov, Simon Fraser University (SFU) - Finance Area; and Susan M. Wachter, University of Pennsylvania - The Wharton School - Real Estate Department; was recently posted on SSRN. Here is the abstract:
Private risk capital has virtually disappeared from the U.S. housing finance market since the market’s collapse in 2008. This Article argues that private risk capital is unlikely to return on any scale until the informational problems in housing finance are resolved so that investors can accurately gauge and price the risks they assume.
The Dodd-Frank Act represents a first step in reforming the U.S. housing finance. It takes a multi-layered approach, regulating both loan origination and securitization. Dodd-Frank’s reforms, however, fail to adequately address the opacity of credit risk information in mortgage markets and thus are insufficient for the restoration of private risk capital.
The Article argues that Dodd-Frank reforms like “skin-in-the-game” credit risk retention fail to solve the informational problems in the housing finance market, as they merely replace one informational opacity with another. Instead, the Article argues, it is necessary to institute structural changes in the housing finance market, particularly the standardization of mortgage securitization, that force the production of information necessary for accurate risk-pricing.
In-House Counsel’s Role in the Structuring of Mortgage-Backed Securities, by Shaun Barnes, Duke University - School of Law; Kathleen G. Cully, Kathleen G. Cully PLLC; and Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN. Here is the abstract:
We briefly introduce the financial crisis and the role played by mortgage-backed securities. Then we describe the controversy at issue: whether, in order to own and enforce the mortgage loans backing those securities, a special-purpose vehicle “purchasing” mortgage loans must take physical delivery of the notes and security instruments in the precise manner specified by the sale agreement. Focusing on this controversy, we analyze (i) the extent, if any, that the controversy has merit; (ii) whether in-house counsel should have anticipated the controversy; and (iii) what, if anything, in-house counsel could have done to avert or, after it arose, to mitigate the controversy. Finally, we examine how the foregoing analysis can help to inform the broader issue of how in-house counsel should address complex legal transactions.
Remedies for Foreign Investors Under U.S. Federal Securities Law, by Hannah L. Buxbaum, Indiana University School of Law-Bloomington, was recently posted on SSRN. Here is the abstract:
In its 2010 decision in Morrison v. National Australia Bank, the Supreme Court held that the general anti-fraud provision of U.S. securities law applies only to (a) transactions in securities listed on domestic exchanges and (b) domestic transactions in other securities. That decision forecloses the use of the “foreign-cubed” class action, and in general precludes the vast majority of claims that might otherwise have been brought in U.S. court by foreign investors. This article assesses the post-Morrison landscape, addressing the question of remedies in U.S. courts for investors defrauded in foreign transactions. It begins by reviewing the current case law, analyzing the approaches that courts have used in applying Morrison and highlighting certain weaknesses in the transaction-based test adopted in that case. It then investigates two potential paths for foreign investors: litigation brought in U.S. federal courts under foreign, rather than domestic, securities law; and participation in FAIR fund distributions ordered by the Securities and Exchange Commission.
The SEC and Zvi Goffer recently settled insider trading charges in SEC v. Galleon Management, LP. The SEC charged Goffer, who was a registered representative and a proprietary trader at the broker-dealer Schottenfeld Group, LLC during the relevant time period, with using inside information to trade ahead of impending acquisitions.
To settle the SEC’s charges, Goffer consented to the entry of a judgment that: (i) permanently enjoins him from violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; and (ii) orders him to pay disgorgement of $265,709.33, plus prejudgment interest of $59,564.56, for a total of $325,273.89. In a related SEC administrative proceeding, Goffer consented to the entry of an SEC order permanently barring him from association with any broker or dealer, investment adviser, municipal securities dealer or transfer agent, and barring him from participating in any offering of a penny stock. Goffer previously was found guilty of securities fraud and conspiracy to commit securities fraud in a related criminal case, United States v. Zvi Goffer, 10-CR-0056 (S.D.N.Y.), and was sentenced to a ten-year prison term and ordered to pay criminal forfeiture of $10,022,931.
The SEC also announced today the entry of a consent judgment against Goffer in a separate case alleging insider trading in other securities. See SEC v. Cutillo et al., No. 09-CV-9208 (S.D.N.Y.) (RJS).