Monday, April 30, 2012
On April 27 the SEC posted new rules and interpretive guidance under the Commodity Exchange Act (“CEA”), and the Securities Exchange Act of 1934 (“Exchange Act”), to further define the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” and “eligible contract participant.”(Download 34-66868) The final rules are effective 60 days after publication in the Federal Register.
On April 25 the SEC announced a settlement in a $32 million insider trading case filed by the agency last year against a corporate attorney and a Wall Street trader. The SEC alleged that the insider trading occurred in advance of at least 11 merger and acquisition announcements involving clients of the law firm where the attorney — Matthew H. Kluger — worked. He and the trader — Garrett D. Bauer — were linked through a mutual friend now identified as Kenneth T. Robinson, who acted as a middleman to facilitate the illegal tips and trades. Kluger and Bauer used public telephones and prepaid disposable mobile phones to communicate with Robinson in an effort to avoid detection. Robinson, now also charged, cooperated in the SEC’s investigation.
Bauer, Kluger, and Robinson each agreed to give up their ill-gotten gains plus interest in order to settle the SEC’s charges. Those amounts under the terms of their consent agreements are approximately $31.6 million for Bauer, $516,000 for Kluger, and $845,000 for Robinson.
In parallel criminal actions brought by the U.S. Attorney’s Office for the District of New Jersey, Bauer, Kluger, and Robinson have all pled guilty and are scheduled to be sentenced on June 4, 2012.
Acknowledging the facts to which they have admitted as part of their guilty pleas, Bauer, Robinson, and Kluger consented to final judgments in the SEC’s civil actions that are subject to court approval. In the proposed final judgments, Bauer would be ordered to disgorge $30,812,796 plus prejudgment interest of $859,135; Kluger would be ordered to disgorge $502,500 plus prejudgment interest of $14,010; and Robinson would be ordered to disgorge $829,129 plus prejudgment interest of $16,106. They also would be permanently enjoined from future violations of Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and Rules 10b-5 and 14e-3 thereunder. Each of the orders of disgorgement will be deemed partially satisfied and offset on a dollar-for-dollar basis by assets seized at the direction of the U.S. Attorney’s Office for the District of New Jersey based upon orders of forfeiture.
Bauer also has agreed to settle a related SEC administrative proceeding by consenting to the entry of an order that would bar him from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any offering of a penny stock. Kluger agreed to settle a related administrative proceeding by consenting to the entry of an order which would permanently suspend him from appearing or practicing before the SEC as an attorney pursuant to Commission Rule of Practice 102(e).
The terms of the proposed settlement with Robinson reflect credit given to him by the SEC for his substantial assistance and cooperation in the investigation.
On April 25 the SEC charged Garth R. Peterson, a former executive at Morgan Stanley, with violating the Foreign Corrupt Practices Act (FCPA) as well as securities laws for investment advisers by secretly acquiring millions of dollars worth of real estate investments for himself and an influential Chinese official who in turn steered business to Morgan Stanley’s funds.
According to the SEC, Peterson, who was a managing director in Morgan Stanley’s real estate investment and fund advisory business, had a personal friendship and secret business relationship with the former Chairman of Yongye Enterprise (Group) Co. – a Chinese state-owned entity with influence over the success of Morgan Stanley’s real estate business in Shanghai. Peterson secretly arranged to have at least $1.8 million paid to himself and the Chinese official that he disguised as finder’s fees that Morgan Stanley’s funds owed to third parties. Peterson also secretly arranged for him, the Chinese official, and an attorney to acquire a valuable Shanghai real estate interest from a Morgan Stanley fund. Peterson was acquiring an interest from the fund but negotiated both sides of the transaction. In exchange for offers and payments from Peterson, the Chinese official helped Peterson and Morgan Stanley obtain business while personally benefitting from some of these same investments. Peterson’s deception, self-dealing, and misappropriation breached the fiduciary duties he owed to Morgan Stanley’s funds as their representative.
Peterson agreed to a settlement of the SEC’s charges in which he will be permanently barred from the securities industry, pay more than $250,000 in disgorgement, and relinquish his interest in the valuable Shanghai real estate (currently valued at approximately $3.4 million) that he secretly acquired through his misconduct. The U.S. Department of Justice has filed a related criminal case against Peterson.
According to the SEC’s complaint filed in U.S. District Court for the Eastern District of New York, Peterson’s violations occurred from at least 2004 to 2007. His principal responsibility at Morgan Stanley was to evaluate, negotiate, acquire, manage and sell real estate investments on behalf of Morgan Stanley’s advisers and funds. He was terminated in 2008 due to his FCPA misconduct.
On April 25, Representative Bachus introduced legislation to provide for the registration and oversight of national investment adviser associations, the Investment Adviser Oversight Act of 2012. (Download Investment Adviser Oversight Act of 2012) . Initial reactions to the legislation are predicatably divided.
Here is the statement from FINRA:
The bipartisan bill, Investment Adviser Oversight Act of 2012, introduced today is an important and thoughtful effort to address a serious gap in investor protection. The bill recognizes the need for regular exams of investment advisers, while rightly focusing on retail accounts.
As FINRA has said, the current level of IA exams is unacceptable, and SROs can help fill this untenable gap in the protection of investment advisory clients.
Here is a statement from NASAA:
The regulation of investment advisers long has been the shared responsibility of state and federal securities regulators. Chairman Bachus believes a self-regulatory organization for investment advisers is necessary because the federal government has not provided proper oversight over larger advisers, but his bill also would require state-registered advisers to become members of his new SRO. The creation of an SRO for state-regulated investment advisers is a misguided solution to a problem that does not exist.
There has never been any evidence to suggest that states have failed in their mission of regulating smaller investment advisers. Nonetheless, this bill dictates how each state should regulate smaller advisers and requires state-regulated advisers to join a national SRO. The Bachus bill is an astonishing attack on our system of federalism with no demonstrated justification.
While there have been marginal improvements from the draft Chairman Bachus released last September in the areas of conflicts of interest and information sharing, the nationalization of small and mid-sized investment adviser regulation would be a mistake that neither benefits investors nor promotes small business interests. Shifting their regulation to a central office would subject these small businesses to redundant regulation and add unnecessary costs to support this new bureaucracy. State securities regulators are best positioned to be the primary regulatory for small and mid-sized investment advisers.
I will be reporting more on this proposed legislation as it progresses. Stay tuned!
A FINRA hearing officer expelled Pinnacle Partners Financial, Corp., a broker-dealer based in San Antonio, TX, and barred its President, Brian Alfaro, for fraudulent sales of oil and gas private placements and unregistered securities. In addition, Brian Alfaro was found to have used customer funds for personal and business expenses. As restitution, Pinnacle and Alfaro are ordered to offer rescission to investors who were sold fraudulent offerings and refund all sales commissions to those customers who do not request rescission. The hearing officer issued a default decision because Alfaro failed to attend the hearing.
The hearing officer found that from August 2008 to March 2011, Alfaro and Pinnacle operated a boiler room in which approximately 10 brokers placed thousands of cold calls on a weekly basis to solicit investments in oil and gas drilling joint ventures Alfaro owned or controlled. Alfaro and Pinnacle raised over $10 million from more than 100 investors, and that Alfaro diverted some of the customer funds for unrelated business and personal expenses.
In April 2011, FINRA had suspended indefinitely Pinnacle and Alfaro for failure to comply with a FINRA Temporary Cease and Desist Order prohibiting their fraudulent misrepresentations.
Tuesday, April 24, 2012
The SEC announced charges against Egan-Jones Ratings Company (EJR) and its owner and president Sean Egan for material misrepresentations and omissions in the company’s July 2008 application to register as a Nationally Recognized Statistical Rating Organization (NRSRO) for issuers of asset-backed securities (ABS) and government securities. EJR and Egan also are charged with material misrepresentations in other submissions furnished to the SEC and violations of record-keeping and conflict-of-interest provisions governing NRSROs. EJR announced a few days ago that the SEC was going to institute these charges and denied all allegations.
The Commission issued an order instituting proceedings in which the SEC’s Division of Enforcement alleges that EJR submitted an application to register as an NRSRO for issuers of asset-backed and government securities in July 2008. EJR had previously registered with the SEC in 2007 as an NRSRO for financial institutions, insurance companies, and corporate issuers. SEC Enforcement alleges that in its 2008 application, EJR falsely stated that as of the date of the application it had 150 outstanding ABS issuer ratings and 50 outstanding government issuer ratings. EJR further falsely stated in its 2008 application that it had been issuing credit ratings in the ABS and government categories as a credit rating agency on a continuous basis since 1995. In fact, at the time of its July 2008 application, EJR had not issued any ABS or government issuer ratings and therefore did not meet the requirements for registration as an NRSRO in these categories. EJR continued to make material misrepresentations regarding its experience rating asset-backed and government securities in subsequent annual certifications furnished to the SEC.
The SEC’s Division of Enforcement also alleges that EJR made other misstatements and omissions in submissions to the SEC by providing inaccurate certifications from clients, failing to disclose that two employees had signed a code of ethics different than the one EJR disclosed, and inaccurately stating that EJR did not know if subscribers were long or short a particular security.
The SEC charged H&R Block subsidiary Option One Mortgage Corporation with misleading investors in several offerings of subprime residential mortgage-backed securities (RMBS) by failing to disclose that its financial condition was significantly deteriorating. Option One, which is now known as Sand Canyon Corporation, agreed to pay $28.2 million to settle the SEC’s charges.
The SEC alleges that Option One promised investors in more than $4 billion worth of RMBS offerings that it sponsored in early 2007 that it would repurchase or replace mortgages that breached representations and warranties. But Option One did not tell investors about its deteriorating financial condition and that it could not meet its repurchase obligations on its own.
According to the SEC, Option One was one of the nation’s largest subprime mortgage lenders with originations of $40 billion in its 2006 fiscal year. Option One was generally profitable prior to its 2007 fiscal year. However, when the subprime mortgage market started to decline in the summer of 2006, Option One experienced a decline in revenues and significant losses, and faced hundreds of millions of dollars in margin calls from its creditors. At the time Option One offered and sold the RMBS, it needed H&R Block, through a subsidiary, to provide it with financing under a line of credit in order to meet its margin calls and repurchase obligations. But Block was under no obligation to provide that funding. Option One did not disclose this information to investors. The SEC further alleges that Block never guaranteed Option One’s loan repurchase obligations and that Option One’s mounting losses threatened Block’s credit rating at a time when Block was negotiating a sale of Option One.
Richard Ketchum, FINRA CEO, testified today before the Senate Banking Committee on the collapse of MF Global and FINRA's role in overseeing the firm. Robert Cook, the SEC's Director of Trading and Markets also testified.
Monday, April 23, 2012
The SEC charged SinoTech Energy Limited, a China-based oil field services company, and two senior officers in a scheme to intentionally mislead investors about the value of its assets and its use of $120 million in IPO proceeds. The SEC additionally charged the company’s chairman of the board involved in a separate $40 million theft from the company.
The SEC alleges that SinoTech Energy Limited grossly overstated the value of its primary operating assets in financial statements, specifically the lateral hydraulic drilling (LHD) units that are central to its business. The company’s IPO registration statement in November 2010 promised investors it would spend $120 million raised in the IPO to acquire LHD units, but the company’s purchase contracts and other documents otherwise show it acquired far fewer LHD units, lied about the number it acquired, and grossly overstated the value of the units. SinoTech CEO Guoqiang Xin and former CFO Boxun Zhang were responsible for the fraud.
Meanwhile, the company’s chairman Qinzeng Liu is accused of secretly siphoning at least $40 million from a SinoTech bank account in the summer of 2011. He then stood silently by as SinoTech – attempting to counter negative Internet reports that the company was potentially fraudulent – falsely assured investors that the company had that money and more in the bank. Liu later admitted his theft to SinoTech’s auditor and board of directors, but he retained his position and investors were not informed of the incident.
The SEC’s complaint seeks permanent injunctive relief and financial penalties against all defendants as well as disgorgement of ill-gotten gains by SinoTech and Liu. The SEC also requests bars against each of the individual defendants from serving as officers or directors of U.S. public companies.
The SEC charged Federico R. Buenrostro, the former CEO of the California Public Employees' Retirement System (CalPERS), and his close personal friend, Alfred J.R. Villalobos, with scheming to defraud an investment firm into paying $20 million in fees to the friend's placement agent firms.
The SEC alleges that Buenrostro and Villalobos fabricated documents given to New York-based private equity firm Apollo Global Management. Those documents gave Apollo the false impression that CalPERS had reviewed and signed placement agent fee disclosure letters in accordance with its established procedures. In fact, Buenrostro and Villalobos intentionally bypassed those procedures to induce Apollo to pay placement agent fees to Villalobos's firms. The false letters bearing a fake CalPERS logo and Buenrostro's signature were provided to Apollo, which then went ahead with the payments.
According to the SEC's complaint, Apollo began requiring signed investor disclosure letters in 2007 from investors such as CalPERS before it would pay fees to a placement agent that assisted in raising funds. When ARVCO requested an investor disclosure letter from CalPERS's Investment Office to provide Apollo, it was informed that CalPERS's Legal Office had advised it not to sign a disclosure letter. ARVCO never again contacted CalPERS's Investment Office for an investor disclosure letter. Instead, according to the SEC, in January 2008, Villalobos instead fabricated a letter using a phony CalPERS logo. At Villalobos's request, Buenrostro then signed what appeared to be a CalPERS disclosure letter. Upon receipt of the fake disclosure letter for Apollo Fund VII, Apollo paid ARVCO about $3.5 million in placement agent fees. The SEC alleges that Villalobos and Buenrostro created false CalPERS disclosure letters for at least four more Apollo funds under similarly suspicious circumstances.
The SEC seeks an order requiring Buenrostro, Villalobos, and ARVCO to disgorge any ill-gotten gains, pay financial penalties, and be permanently enjoined from violating the antifraud provisions of the federal securities laws.
'Hallowed By History, But Not By Reason': Judge Rakoff's Critique of the Securities and Exchange Commission's Consent Judgment Practice, by Michael C. Macchiarola, City University of New York, was recently posted on SSRN. Here is the abstract:
Over the past several years, in a trilogy of opinions, Judge Jed S. Rakoff of the United States District Court of the Southern District of New York has established himself as a minor cult hero for daring to question the wisdom of the long-running consent judgment practice of the Securities and Exchange Commission (“Commission”). At its core, each opinion addresses issues of affinity for settlement, judicial deference to the judgments of administrative agencies and the general theory of damages in cases of corporate malfeasance. Much attention has been focused on the high-profile nature, appealing facts or colorful judicial language of each of the controversies. Yet, the value of the judge’s opinions is found elsewhere – in the basic questions he dares to confront regarding the proper role of the courts in validating and enforcing the special kind of settlement known as the consent judgment. The judge’s agitation reveals a practice “hallowed by history, but not by reason” and sheds light on a curious corner too long unexamined and unquestioned out of deference, convenience, apathy or some combination thereof. As Judge Rakoff notes, “in any case . . . that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth.”
This Article examines each of the three relevant opinions in an effort to articulate Judge Rakoff’s critique within a framework that remains faithful to the deference that should be accorded administrative agencies and respectful of the proper judicial function. The Article explores the history of the consent judgment practice at the Commission and examines the motivations and developments that have made it all too convenient for the Commission and defendants to routinely favor settlement. The Article also suggests a more active role for courts is both necessary and responsible in cases where the Commission seeks judicial enforcement powers to assist in the monitoring of wrongdoers post-settlement. Finally, the Article explores the anticipated results of this issue’s new found attention and theorizes as to the likely effects on the Commission’s ongoing practice of gaining settlements.
Sunday, April 22, 2012
There is a not-to-be-missed article on the front page of the Sunday New York Times alleging that Wal-Mart's Mexican subsidiary bribed its way to success in Mexico (currently, one in five Wal-Mart stores is in Mexico) and that top management shut down an internal investigation after the Mexican lawyer in charge of obtaining construction permits provided corporate headquarters with details about the bribe payments. According to the Times, the allegations and Wal-Mart's investigation had never been publicly disclosed.
A Behavioral Framework for Securities Risk, by Tom C.W. Lin, University of Florida - Fredric G. Levin College of Law, was recently posted on SSRN. Here is the abstract:
This article provides the first critical analysis and redesign of the existing securities risk disclosure framework given new insights from the emerging, interdisciplinary field of behavioral economics. Disclosure is the principle at the heart of federal securities regulation. Beneath that core principle of disclosure is the basic assumption that the reasonable investor is the idealized über-rational person of neoclassical economic theory. Therefore, once armed with the requisite information investors presumably can protect themselves through rational choice. Descriptively, however, real investors are not like their rational, neoclassical kin. This article examines this incongruence between the idealized rational investor and the imperfect actual investor, explores the consequences of this incongruence on risk assessment in investments, and highlights several shortcomings of risk disclosures as a result of it. Then, to address these shortcomings, this article argues for a better capture of the advantages of disclosure-based risk regulations, and proposes a new behavioral framework for securities risk disclosure built on relative likelihood and relative impact of dynamic risks. In doing so, this article challenges the conventional wisdom that securities risk management should be done primarily through increased government oversight and enforcement, and promotes the underappreciated utility of disclosure as a powerful, complementary risk management tool in the modern financial regulatory landscape. In advocacy of this contention, this article closes with a discussion of key implications of the proposed framework, namely how it could improve disclosure drafting, simplify transparency, increase financial literacy, lower information costs, and enhance financial arbitrage.
A Framework for Analyzing Financial Market Transformation, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN. Here is the abstract:
To open an international conference on “Rethinking Financial Markets,” this address seeks to frame that inquiry from the perspectives of scholars in the fields of law, economics, finance, and accounting. In attempting to identify what it is about financial markets that is worth rethinking, the address focuses on market changes that increase decentralization, fragmentation, globalization, disintermediation, and funding mismatches. The address also argues that the scholarly perspectives are inherently interrelated: although scholars in each field proceed from their own toolkits, they all aim for the common normative goal of optimizing financial markets to enable capital formation.
The History and Evolution of Intra-Corporate Forum Selection Clauses: An Empirical Analysis, by Joseph Grundfest, Stanford University Law School, was recently posted on SSRN. Here is the abstract:
Forum selection provisions are commonly found in the material contracts of publicly traded corporations. But they are exceedingly rare in the organic documents of the same publicly traded entities. Why?
This article documents that, as of June 30, 2011, only 133, or 1.49 percent, of publicly traded entities had forum selection provisions in their charters or bylaws. The vast majority of these provisions, 117 (88.0 percent), were adopted after Delaware Chancery’s March 15, 2010, decision in Revlon observing that corporations could avoid forum disputes by adopting forum selection provisions in corporate charters. Of the forum selection provisions adopted by corporations, 58.6 percent appear in corporate charters and 41.4 percent appear in bylaws adopted without prior shareholder consent. More than 91 percent of these provisions follow the form introduced by Netsuite in conjunction with its 2006 IPO, and approximately 16.06 percent of all IPOs declared effective since Revlon are of corporations whose charters contain forum selection provisions. Corporations headquartered in California are over-represented in the population of corporations that have adopted these provisions.
The historic scarcity of forum selection provisions in the organic documents of publicly traded entities is consistent with the observation that, prior to the early part of this century, intra-corporate litigation was almost always brought in the state of incorporation. In such an environment, the selection of a state of incorporation acted as a de facto forum selection clause, and these clauses could reasonably have been viewed as surplusage. But as plaintiff counsel began to litigate intra-corporate claims with vastly greater frequency in courts away from the state of incorporation, a demand emerged for a contractual provision that could restore the pre-existing jurisdictional equilibrium in which each state’s courts specialized in the interpretation of that state’s corporate law. Viewed from this perspective, the intra-corporate forum selection clause is not an innovation that seeks to disrupt traditional litigation processes: it is, instead, better viewed as an effort to restore an equilibrium that had prevailed for decades and that reflected the natural expectation of corporations and shareholders alike that courts would “stay in their lane” as they specialized in the interpretation of their own state’s corporation laws.
Regulation FD: An Alternative Approach to Addressing Information Asymmetry, by Jill E. Fisch, University of Pennsylvania Law School - Institute for Law and Economics, was recently posted on SSRN. Here is the abstract:
This chapter traces the development of the SEC’s use of Regulation Fair Disclosure (FD) to address information asymmetry in the securities markets. The chapter describes the SEC’s developing enforcement policy and notes, in particular, the SEC’s efforts, through its selection and settlement of Regulation FD cases, to provide guidance to corporations and corporate officials about areas of key concern. The chapter concludes by highlighting current areas of particular importance, including disclosure of information through private meetings and the implications of technological innovations such as the internet and social media. The chapter is forthcoming in Research Handbook on Insider Trading (Stephen Bainbridge, editor).
The SEC posted on its website CF Disclosure Guidance: Topic No. 5
Staff Observations Regarding Disclosures of Smaller Financial Institutions, which summarizes a number of the Division of Corporation Finance's observations on Management’s Discussion and Analysis and accounting policy disclosures of smaller financial institutions.
The SEC charged Gabriel and Marco Bitran, a Boston-based father-son duo of hedge fund managers and their firms, with securities fraud for misleading investors about their investment strategy and past performance. The SEC’s investigation found that the Bitrans raised millions of dollars for their hedge funds through GMB Capital Management LLC and GMB Capital Partners LLC by falsely telling investors they had a lengthy track record of success based on actual trades using real money. In truth, the Bitrans knew the track record was based on back-tested hypothetical simulations. The Bitrans also misled investors in certain hedge funds to believe they used quantitative optimal pricing models devised by Gabriel Bitran to invest in exchange-traded funds (ETFs) and other liquid securities. Instead, they merely invested the money almost entirely in other hedge funds. GMB Capital Management later provided false documents to SEC staff examining the firm’s claims in marketing materials of a successful track record.
The Bitrans agreed to be barred from the securities industry and pay a total of $4.8 million to settle the SEC’s charges.
Sometimes there are scams that are so outlandish that one can only shake one's head in dispair over the investors' gullibility. Here is one of those:
The SEC charged twin brothers from the U.K. with defrauding approximately 75,000 investors through an Internet-based pump-and-dump scheme in which they touted a fake “stock picking robot” that purportedly identified penny stocks set to double in price. Instead, the brothers were merely touting stocks they were being paid separately to promote.
According to the SEC, Alexander John Hunter and Thomas Edward Hunter were just 16 years old when they set their fraud in motion beginning in 2007. They disseminated e-mail newsletters through a pair of websites they created to tout stocks selected by the robot – which they described as a highly sophisticated computer trading program that was the product of extensive research and development. The Hunters received at least $1.2 million from investors primarily in the U.S. who paid $47 apiece for annual newsletter subscriptions. Some investors paid an additional fee for the “home version” of the robot software.
In reality, the SEC alleges that the Hunters used a third website to offer their services as stock promoters, claiming that they could “rocket” a stock’s price and increase its volume by sending out newsletters. The Hunters were consequently paid at least $1.865 million in fees from known or suspected stock promoters, and they did not disclose to their newsletter followers the conflicting relationship between their two businesses.
The SEC’s complaint charges the Hunters with violating the anti-fraud provisions of the U.S. securities laws and seeks permanent injunctions, disgorgement of all ill-gotten gains with prejudgment interest, and financial penalties.