Friday, February 11, 2011
The SEC charged three former senior executives at IndyMac Bancorp with securities fraud for misleading investors about the mortgage lender’s deteriorating financial condition. According to the SEC, former CEO Michael W. Perry and former CFOs A. Scott Keys and S. Blair Abernathy participated in the filing of false and misleading disclosures about the financial stability of IndyMac and its main subsidiary, IndyMac Bank F.S.B. The three executives regularly received internal reports about IndyMac’s deteriorating capital and liquidity positions in 2007 and 2008, but failed to ensure adequate disclosure of that information to investors as IndyMac sold millions of dollars in new stock.
IndyMac Bank was a federally-chartered thrift institution regulated by the Office of Thrift Supervision (OTS) and headquartered in Pasadena, Calif. The OTS closed the bank on July 11, 2008, and placed it under Federal Deposit Insurance Corporation (FDIC) receivership. IndyMac filed for bankruptcy protection later that month.
Vacatur of a securities arbitration award is rare, but a California state court threw out a $11.6 million award ($10 million punitive damages) that actor Larry Hagman (J.R. in Dallas) obtained against Citigroup. The judge ruled that the chairman of the arbitration panel should have disclosed that he and his wife brought a similar claim involving losses in their retirement account against a different respondent. WSJ, Court Ruling Favors Citi Against Larry Hagman
Dodd-Frank requires the SEC to adopt provisions that will award whistleblowers payments for reporting federal securities violations to the agency. In November the SEC proposed implementing rules. For a survey of reactions from the business community, see CFONews, Whistle-blower Debate Heats Up
Thursday, February 10, 2011
New Jersey's Bureau of Securities and UBS have signed a final Consent Order that requires UBS to repurchase auction-rate securities (ARS) from New Jersey clients to settle allegations that the firm’s securities dealers sold ARS without disclosing known risks of the ARS market. Under the terms of the settlement, UBS Securities LLC and UBS Financial Services, Inc. have agreed to offer the repurchase of $1.5 billion in ARS sold to retail investors in New Jersey. This is the eighth such settlement that the Bureau has reached with firms that sold ARS to New Jersey investors. More than $2.5 billion of these assets have been repurchased by the firms, under terms of the settlements.
The order also requires UBS to pay $3,790,487 in civil penalties to New Jersey. This amount represents the state’s pro-rata share of a settlement negotiated by a multi-state task force of state regulators formed by the North American Securities Administrators Association (NASAA).
The investigation into UBS’ role in the sale of these securities is part of a larger state-led effort to address problems in connection with ARS investments. Early in 2008, state offices began receiving complaints from investors throughout the country. As a result, 12 states, including New Jersey, formed a task force to investigate whether certain Wall Street firms had systematically misled investors when placing them in auction rate securities.
The SEC charged Tyson Foods Inc. with violating the Foreign Corrupt Practices Act (FCPA) by making illicit payments to two Mexican government veterinarians responsible for certifying its Mexican subsidiary’s chicken products for export sales. Tyson Foods agreed to pay more than $5 million to settle the SEC’s charges and resolve related criminal proceedings announced today by the Department of Justice.
According to the SEC, Tyson de Mexico initially concealed the improper payments by putting the veterinarians’ wives on its payroll while they performed no services for the company. The wives were later removed from the payroll and payments were then reflected in invoices submitted to Tyson de Mexico by one of the veterinarians for “services.” Tyson de Mexico paid the veterinarians a total of $100,311. It was not until two years after Tyson Foods officials first learned about the subsidiary’s illicit payments that its counsel instructed Tyson de Mexico to cease making the payments.
According to the SEC’s complaint filed in federal court in the District of Columbia, the scheme occurred during fiscal years 2004 to 2006. In order to export products, meat-processing facilities in Mexico must obtain certification through an inspection program administered by Mexico’s federal government and supervised by an office in the Mexican Department of Agriculture. Tyson de Mexico participated in the program in order to export goods to Japan and other countries. The two veterinarians involved were responsible for certifying Tyson de Mexico’s chicken products for export and served as official Mexican government veterinarians at Tyson de Mexico’s facilities.
The SEC alleges that in connection with these improper payments, Tyson Foods failed to keep accurate books and records and failed to implement a system of effective internal controls to prevent the salary payments to phantom employees and the payment of illicit invoices. The improper payments were improperly recorded as legitimate expenses in Tyson de Mexico’s books and records and included in Tyson de Mexico’s reported financial results for fiscal years 2004, 2005 and 2006. Tyson de Mexico’s financial results were, in turn, a component of Tyson Foods’ consolidated financial statements filed with the SEC for those years.
The Department of Justice charged Tyson Foods with conspiring to violate the FCPA and violating the FCPA. DOJ and Tyson Foods agreed to resolve the charges by entering into a deferred prosecution agreement. Tyson Foods has agreed to pay a $4 million criminal penalty.
Wednesday, February 9, 2011
The SEC voted unanimously to propose amendments to its rules that would remove credit ratings as one of the conditions for companies seeking to use short-form registration when registering securities for public sale. This marks the first in a series of upcoming SEC proposals in accordance with Dodd-Frank to remove references to credit ratings contained within existing Commission rules and replace them with alternative criteria.
The SEC’s proposal focuses on the use of credit ratings as a condition of so-called “short-form” eligibility. Companies that are “short-form eligible” also are allowed to register securities “on the shelf.” Shelf registration provides companies considerable flexibility in deciding when to access the public securities markets. The SEC’s proposed rule amendments would remove the NRSRO investment grade ratings condition included in SEC forms S-3 and F-3 for offerings of non-convertible securities, such as debt securities. Instead of ratings, the new short-form test for shelf-offering eligibility of companies would be tied to the amount of debt and other non-convertible securities they have sold in the past three years
Public comments on the SEC’s proposal should be submitted by March 28, 2011.
NYSE Euronext and Deutsche Borse (operator of the Frankfurt Stock Exchange) are in talks for a merger. The combined company would have headquarters in both cities, their chairmen would share power, and there would be equal seats on the executive committee, but Deutsche Borse shareholders would own 60% of the combined company. These two exchanges have previously held merger talks.
In another example of the interconnectedness of markets, the London Stock Exchange and TMX Group (parent of the Toronto Stock Exchange) announced a merger.
Tuesday, February 8, 2011
The SEC today charged Curtis Peterson and Eric Maher, two California residents, for operating a fraudulent, high-yield, “prime bank” investment scheme that defrauded investors out of more than $3 million. The SEC also charged Ronald White, a California-based attorney, for aiding in the scheme.
Prime bank schemes lure investors with false promises of enormous profits and an exclusive opportunity to participate in an international investing program. The SEC alleges that Peterson and Maher solicited investors nationwide in late 2009. Promising exorbitant returns of as much as 1000 percent per month, Peterson and Maher falsely told investors that their investments would be pooled to purchase international bank instruments that would then be “leased” to “top 25” international banks willing to pay substantial fees for the right to place the instruments on their balance sheets for a brief period of time.
According to the SEC’s complaint, Peterson and Maher were aided and abetted by White, who controlled the trust account into which investors were instructed to wire their monies. White then converted those funds into cashier’s checks payable to Peterson, thus allowing Peterson to dissipate investor funds for undisclosed purposes.
The SEC alleges that about 20 percent of investor funds were wired to a bank in Hungary, but none of that money was ever used to purchase any international bank instruments. Peterson used the remaining 80 percent of investor funds to pay his personal expenses and to pay third parties with no legitimate claim to the investor funds.
The seeks permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest thereon, and financial penalties, against each of them.
The DOJ and SEC brought new charges in their expanding investigations into insider-trading between experts' networks and hedge funds. DOJ unsealed charges today against three former hedge fund portfolio managers and a hedge fund technology analyst. Two of the former managers, Donald Langueuil and Noah Freeman, previously worked at the hedge fund SAC Capital Advisors, which has not been charged with wrongdoing. The third former manager, Samir Barai, was founder of Barai Capital Management. Charges were also unsealed against Jason Pflaum, a technology analyst. WSJ, U.S. Targets Hedge Funds in Latest Wave of Insider Charges.
In addition, the SEC filed charges against the same defendants, alleging that they received illegal tips from expert network consultants and then caused their hedge funds to trade on the inside information. The scheme netted more than $30 million from trades based on material, nonpublic information about such companies as AMD, Seagate Technology, Western Digital, Fairchild Semiconductor, and Marvell. The SEC’s amended complaint alleges:
- Samir Barai of New York, N.Y., the founder and portfolio manager of Barai Capital Management, obtained inside information about several technology firms from company insiders, and then traded on the inside information on behalf of Barai Capital.
- Jason Pflaum of New York, N.Y., a former technology analyst at Barai Capital Management, obtained inside information about technology companies and shared it with Barai. After Pflaum shared the confidential information with him, Barai used it to illegally trade on behalf of Barai Capital.
- Noah Freeman of Boston, Mass., a former managing director at a Boston-based hedge fund, obtained inside information regarding Marvell and shared it with Donald Longueuil of New York, N.Y., a former managing director at a Connecticut-based hedge fund. Longueuil caused his hedge fund to trade on the inside information. Freeman also obtained inside information about another technology company and caused his hedge fund to trade on the nonpublic information.
Rick Ketchum, Chairman and CEO, FINRA, spoke today at the CCOutreach BD National Seminar on product concerns:
Private Placements & Private Self Offerings
First, we're looking at retail sales of private placement interests, including those issued by broker-dealers and control affiliates. Our examinations and investigations have identified significant failures in firms' compliance with suitability, supervision and advertising rules, as well as potential instances of fraud and participation in illegal distributions of unregistered securities. A number of these investigations have led to enforcement actions.
Last year, we reminded firms of their obligations to conduct reasonable investigations into "Reg D" offerings. And we highlighted a number of specific practices relating to these offerings that firms should consider. But the bottom line is that the responsibility and the commitment to know what you're selling—whether it is from a legal or reputational standpoint—is more important than ever. Recently, we have also proposed changes and are requesting comment on an expansion of the provisions of our private placements rule, to provide investors with additional protection from fraud and abuse.
Second, we want to ensure that firms meet their sales practice and due diligence obligations when selling municipal securities. Municipal securities dealers must understand what they're selling in order to meet their disclosure, suitability and pricing obligations—and their obligation to deal fairly with customers under MSRB rules and federal securities laws. Firms must also review their procedures for compliance with MSRB Rule G-32, which requires the delivery of an official statement, or a notice of its availability on the MSRB's EMMA system, to any customer purchasing a municipal security during the primary offering disclosure period.
In any transaction in a municipal security, a dealer must obtain, analyze and disclose to customers all known material facts about the transaction, as well as material facts that are reasonably accessible to the market through established industry sources.
Third, we are looking at firms that sell structured products and certain riskier asset-backed securities to retail investors. Recent enforcement cases highlight the importance of training brokers on products sold and reasonable supervision to ensure suitable recommendations. Brokers must understand the risks and costs associated with the products recommended and disclose them to customers. For instance, collateralized mortgage obligations present a variety of risks, including credit and default risk, interest-rate risk, prepayment risk and extension risk. CMOs are structured into different tranches, each with their own set of rules by which interest and principal get distributed. So it is important for brokers to understand the features of the tranche they are selling and the rules governing its income stream as these affect the product's risk.
Monday, February 7, 2011
The House Financial Services Committee, under the leadership of Representative Bachus, has announced its agenda:
During the 112th Congress, the Committee will be at the forefront of an effort to end the bailout of Fannie Mae and Freddie Mac. Committee Republicans were the first to introduce a plan for Fannie Mae and Freddie Mac in July 2009. Additionally, Republicans have introduced 7 bills to protect taxpayers by ending the bailout of Fannie and Freddie. ...
Another priority of Chairman Spencer Bachus is bringing a real end to ‘too big to fail.’ The Dodd-Frank Act wrote ‘too big to fail’ into law, placing taxpayers at risk for future bailouts. The Committee will examine the taxpayer exposure of the bailout authority created under this law.
The House Financial Services Committee has jurisdiction over all issues pertaining to the economy, the banking system, housing, insurance, and securities and exchanges. Additionally, the Committee also has jurisdiction over monetary policy, international finance, international monetary organizations, and efforts to combat terrorist financing.
The Committee oversees the Nation’s economy through its oversight of the Federal Reserve Board and individual reserve banks, the Treasury, the production and distribution of currency, and the Nation’s capital markets.
Agencies under oversight by the Committee include: the Federal Reserve, Treasury, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, the National Credit Union Administration, the Office of the Comptroller of the Currency, the Department of Housing and Urban Development, the Federal Housing Finance Agency, and the Export-Import Bank.
The Committee's website also headlines a message on "Collateral Damage: The Real Impact Of The Democrats’ Bailout Bill":
In July 2010, the Democrats rushed through a massive 2300 page bill that failed to address the real causes of the financial crisis. For example, a key reform missing in the Act was an exit strategy from Fannie Mae and Freddie Mac. Instead, the Democrats used the crisis to pursue their long-term goals of a government managed economy.
In an attempt to meet an arbitrary deadline tied to an upcoming G-20 meeting, the Democrats engaged in a headlong rush to complete a conference committee established to reconcile competing House and Senate regulatory reform bills in a mere two weeks. Even before the bill was signed into law, the Democrats acknowledged there would need to be a “technical corrections” package to address drafting errors and unintended consequences.
Within days of the bill becoming law, their predictions were borne out, as the consequences of a poorly drafted bill began to become evident. The credit rating agency liability provisions nearly shut down the bond market. This forced the Securities and Exchange Commission to step in and issue temporary guidance.
Additionally, provisions that were added to the bill without public discussion about came to light. For example, the Securities and Exchange Commission was given broad exemption from the Freedom of Information Act. This led to a correction bill removing this exemption.
The 2300 page bill mandated approximately 240 rulemakings, and the Committee will have an enormous task in overseeing the implementation of the new law to make sure that the same regulators who helped cause the crisis and have been given enormous authority to write the new rules don't make a hash of things this time around.
It goes on to list a number of examples of what it describes as "the unintended consequences thus far from passing the Dodd-Frank Act."
Sunday, February 6, 2011
On Saturday NASDAQ confirmed that its computer systems had been hacked:
Through our normal security monitoring systems we detected suspicious files on the U.S. servers unrelated to our trading systems and determined that our web facing application Directors Desk was potentially affected. We immediately conducted an investigation, which included outside forensic firms and U.S. federal law enforcement. The files were immediately removed and at this point there is no evidence that any Directors Desk customer information was accessed or acquired by hackers. Our trading platform architecture operates independently from our web-facing services like Directors Desk and at no point was any of NASDAQ OMX’s operated or serviced trading platforms compromised.
Subsequently, the U.S. Department of Justice requested that we refrain from providing notice to our customers until, at the earliest, February 14, 2011, in order to facilitate the continuing investigation. NASDAQ OMX was honoring the U.S. Government’s request to delay notification, but when a story ran in the media on Saturday, February, 5, 2011, regarding a hacking incident at NASDAQ OMX, we immediately decided, in consultation with the authorities, that we must inform our customers.
We continue to evaluate and enhance our advanced security controls to respond to the ever increasing global cyber threat and continue to devote extensive resources to further secure our systems. Cyber attacks against corporations and government occur constantly. NASDAQ OMX remains vigilant against such attacks. We have been working in cooperation with the Government’s ongoing investigations and have received their technical advice for which we are appreciative.
The Wall St. Journal first broke the story. Exchanges and traders said that they will continue normal business at the exchange.WSJ, Nasdaq Trade to Continue as Normal
Insider Trading, Congressional Officials, and Duties of Entrustment, by Donna M. Nagy, Indiana University Maurer School of Law, was recently posted on SSRN. Here is the abstract:
A recent hullabaloo in the media put a spotlight on insider trading and Capitol Hill hypocrisy. Both topics have long fascinated the general public and the combination of the two proved irresistible. An October 11, 2010 front page article in the Wall Street Journal ignited the controversy, and by the end of that week, newspapers and the internet were filled with claims that insider trading by members of Congress and their legislative staff is "totally legal" because congressional officials are "immune" from federal insider trading laws. Enactment of the proposed "Stop Trading on Congressional Knowledge Act," dubbed by its sponsors the "STOCK Act," was heralded as the only effective way to render congressional insider trading unlawful.
This article refutes the conventional wisdom and argues that insider trading on the basis of nonpublic congressional knowledge is already illegal under Rule 10b-5 of the Securities Exchange Act, a general anti-fraud provision which prohibits deceptive conduct "in connection with" the purchase or sale of securities. The article further contends that the proposed STOCK Act, if enacted, would actually narrow the scope of the law that would otherwise apply to members of Congress and legislative staffers in the absence of a new prohibition. The principal arguments were first presented at a conference honoring the publication of Boston University Professor Tamar Frankel’s new book on Fiduciary Law. Building on the work of Professor Frankel and others, the article maintains that congressional officials owe fiduciary-like duties of trust and confidence to a host of parties including the citizen-investors whom they serve, as well as the federal government, other members of Congress, and government officials outside of Congress who rely on their loyalty and integrity. The article concludes that members of Congress and legislative staffers breach duties of entrustment, and thereby engage in fraud and deception, if they trade securities on the basis of material nonpublic information obtained through congressional service. For a variety of prudential reasons, however, the article suggests that education, rather than prosecution, may be the SEC’s most effective enforcement tool.
On the Role and Regulation of Proxy Advisors, by Paul Rose, Ohio State University Moritz College of Law, was recently posted on SSRN. Here is the abstract:
The role of proxy advisors has increasing relevance because the Securities and Exchange Commission has recently undertaken a review of the mechanisms of proxy voting - less gracefully but perhaps aptly described as “proxy plumbing” - and the role of proxy advisors in that process. This short essay discusses the role of proxy advisors and their regulation. In particular, the essay addresses why institutional investors purchase corporate governance ratings and advice despite the fact that the advice appears to be of poor quality. The essay then discusses potential regulation of proxy advisors by the Securities & Exchange Commission.
Don't Panic! Defending Cowardly Interventions During and after a Financial Crisis, by Brett McDonnell, University of Minnesota Law School, was recently posted on SSRN. Here is the abstract:
How should we regulate the U.S. financial system after the financial crisis, when we face the task with a radically inadequate understanding of what went wrong and what effect proposed regulations will likely have? This paper explores three quite different approaches to regulating in the face of severe uncertainty: the libertarianism of Friedrich Hayek, the conservatism of Michael Oakeshott, and the liberalism of John Maynard Keynes. Each thought deeply about the problem of how uncertainty affects human affairs, but each came to quite different conclusions about how to address such uncertainty. The paper outlines the core, immensely useful insights of each. It then outlines the even more useful and persuasive critiques that each launches at the other two. From this collision of viewpoints, the paper outlines a hybrid general approach to regulating the financial system which it (rather tongue-in-cheek) labels “cowardly interventions.” This approach accepts the basic insight of Keynes that unregulated financial markets will be deeply unstable, causing periodic destructive depressions. Thus, fairly strong regulation of finance is needed. But following the insights of Hayek and Oakeshott, I argue that new regulations should be cowardly. We should as much as possible heed the wisdom embedded in markets and existing institutions. We should identify as best we can the biggest problems that current markets pose, and address those problems with new rules that are measured, limited, market-friendly, and subject to evaluation and pruning.
This framework supports a three-part response to the crisis. First, the New Deal structure for regulating banks should be extended to the shadow banking system which was at the heart of the crisis. (What is “shadow banking”? Read the paper.) In that structure, the government acts as a lender of last resort to forestall panics, while using resolution authority and prudential regulation to replicate much of the discipline of an unregulated market. Second, more specific limited rules should address glaring problems in the mortgage securitization chain. Third, regulatory agencies should be prodded to constantly re-evaluate existing regulation in light of new circumstances. Using this framework, the paper gives a guarded defense of the Dodd-Frank Act. All three elements of a proper response are there in the Act. However, there are major concerns. Most importantly, the Act does not do enough to address the largely unregulated shadow banking system. The Act should also have begun the process of eliminating Fannie Mae and Freddie Mac. Even legislation without these weaknesses would not end financial crises forever. However, if the many regulations to implement Dodd-Frank are mostly well done, they may postpone the next big crisis for a decade or two, and they may make the next crisis shorter and less severe when it does happen. Dodd-Frank is imperfect even by the standards of a philosophy which emphasizes inevitable imperfection, but on balance it does pretty well under the circumstances.