Securities Law Prof Blog

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

Friday, April 13, 2012

GAO Finds Continuing Significant Internal Controls Deficiencies at SEC

The GAO released another report on the SEC entitled Improvements Needed in SEC's Internal Controls and Accounting Procedures (GAO-12-424R, Apr 13, 2012).  Here is what it found:

In our audit of SEC’s fiscal years 2011 and 2010 financial statements, we identified four significant deficiencies in internal control as of September 30, 2011. These significant internal control deficiencies represent continuing deficiencies concerning controls over (1) information systems, (2) financial reporting and accounting processes, (3) budgetary resources, and (4) registrant deposits and filing fees. These significant control deficiencies may adversely affect the accuracy and completeness of information used and reported by SEC’s management. We are making a total of 10 new recommendations to address these continuing significant internal control deficiencies.

We also identified other internal control issues that although not considered material weaknesses or significant control deficiencies, nonetheless warrant SEC management’s attention. These issues concern SEC’s controls over:

•payroll monitoring,
•implementation of post-judgment interest accounting procedures,
•accounting for disgorgement and penalty transactions, and
•the government purchase card program.
We are making a total of 9 new recommendations related to these other internal control deficiencies.

We are also providing summary information on the status of SEC’s actions to address the recommendations from our prior audits as of the conclusion of our fiscal year 2011 audit. By the end of our fiscal year 2011 audit, we found that SEC took action to fully address 38 of the 66 recommendations from our prior audits, subsequent to our March 29, 2011, management report.

Lastly, we found that SEC took action to address and resolve all four weaknesses in information systems controls that we identified in public and “Limited Official Use Only” reports issued in 2008 through 2009 that were reported as open at the time of our March 29, 2011, management report.


April 13, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Thursday, April 12, 2012

SEC Charges "Social Capitalist" with Running Ponzi Scheme

The SEC charged Ephren W. Taylor II, a self-described “Social Capitalist,” with running a Ponzi scheme that targeted socially-conscious investors in church congregations.  The SEC also charged City Capital Corporation and its former chief operating officer, Wendy Connor, who along with Taylor received hundreds of thousands of dollars from investors in salary and commissions.

According to the SEC’s complaint filed in federal court in Atlanta, Taylor strenuously cultivated an image of a highly successful and socially conscious entrepreneur. He marketed himself as “The Social Capitalist” and touted that he was the youngest black CEO of a public company and the son of a Christian minister who understands the importance of giving back. He authored three books and appeared on national television programs, and promoted his investment opportunities through live presentations, Internet advertisements, and radio ads. For instance, Taylor conducted a multi-city “Building Wealth Tour” during which he spoke to church congregations including Atlanta’s New Birth Church and at various wealth management seminars.

According to the SEC, Taylor made numerous false statements to lure investors into two investment programs being offered through City Capital Corporation, where he was the CEO. Instead of investor money going to charitable causes and economically disadvantaged businesses as promised, Taylor secretly diverted hundreds of thousands of dollars to publishing and promoting his books, hiring consultants to refine his public image, and funding his wife’s singing career.

The SEC alleges that more than $11 million that Taylor and City Capital raised from hundreds of investors nationwide from 2008 to 2010 was used to operate the Ponzi scheme. Investor money was misused to pay other investors, finance Taylor’s personal expenses, and fund City Capital’s payroll, rent, and other costs. City Capital’s business ventures were consistently unprofitable, and no meaningful amounts of investor money were ever sent to charities.

The SEC’s complaint seeks disgorgement, financial penalties and permanent injunctive relief against City Capital, Taylor, and Connor as well as officer and director bars against Taylor and Connor.

April 12, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Another Congressional Hearing on the SEC

The House Committee on Oversight and Government Reform has announced an April 17 hearing on "The SEC's Aversion to Cost-Benefit Analysis."  The website does not identify who will be testifying at the hearing.

April 12, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

Goldman Fined and Censured for Failures Involving Research Huddles

FINRA and the SEC announced fines and a censure of Goldman Sachs for supervisory failures relating to research "huddles." Under the settlements Goldman will pay $11 million each to FINRA and the SEC.  According to the FINRA release:

In 2006, Goldman established a business process known as "trading huddles" to allow research analysts to meet on a weekly basis to share trading ideas with the firm's traders, who interfaced with clients, and, on occasion, equity salespersons. Analysts would also discuss specific securities during trading huddles while they were considering changing the published research rating or the conviction list status of the security. Clients were not restricted from participating directly in the trading huddles and had access to the huddle information through research analysts' calls to certain of the firm's high priority clients. These calls included discussions of the analysts' "most interesting and actionable ideas."

 Trading huddles created the significant risk that analysts would disclose material non-public information, including, among other things, previews of ratings changes or changes to conviction list status. Despite this risk, Goldman did not have adequate controls in place to monitor communications in trading huddles and by analysts after the huddles.

Goldman did not adequately review discussions in the trading huddles to determine whether an equity research analyst may have previewed an upcoming ratings change. For example, an analyst said of a particular company in a trading huddle in 2008 that "we expect companies with consumer and small business exposure to be under pressure in the current environment, including [the company]." The next day, the analyst sought and received approval to downgrade the company from "neutral" to "sell," and to add the stock to Goldman's conviction sell list. Goldman published an equity research report making these changes that same day.

Goldman also failed to establish an adequate system to monitor for possible trading in advance of research rating or conviction list changes in employee or proprietary trading, institutional customer, or market-making and client-facilitation accounts. Accordingly, Goldman failed to identify and adequately investigate increased trading in proprietary accounts in advance of the addition of securities to the firm's conviction list, certain transactions effected in an account in advance of changes in published research that warranted review based on their size or profitability and/or atypical trading for that account, and certain spikes in trading volume that immediately preceded the addition of stocks to the firm's conviction list.


April 12, 2012 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, April 11, 2012

SEC Releases Study on Cross-Border Scope of Private Rule 10b-5 Action

Congress, in response the Supreme Court's decision in Morrison, provided, in Section 929P(b)(2) of the Dodd-Frank Act, that federal district courts have jurisdiction over SEC and DOJ Rule 10b-5 actions if the fraud involves:
(1) conduct within the United States that constitutes a significant step in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or
(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.

With respect to private actions under Section 10(b), Section 929Y of the Dodd-Frank Act directed the Commission to solicit public comment and then conduct a study to consider the extension of the cross-border scope of private actions in a similar fashion, or in some narrower manner. Additionally, Section 929Y provided that the study shall consider and analyze the potential implications on international comity and the potential economic costs and benefits of extending the cross-border scope of private actions.

The SEC released today the staff's Study on the Cross-Border Scope of the Private Right of Action Under Section 10(b) of the Securities Exchange Act of 1934 as required by Section 929Y( Download 929y-study-cross-border-private-rights[1])  In the report the staff sets forth two options for consideration:

Options Regarding the Conduct and Effects Tests. Enactment of conduct and effects tests for Section 10(b) private actions similar to the test enacted for Commission and DOJ enforcement actions is one potential option. Consideration might also be given to alternative approaches focusing on narrowing the conduct test’s scope to ameliorate those concerns that have been voiced about the negative consequences of a broad conduct test. One such approach (which the Solicitor General and the Commission recommended in the Morrison litigation) would be to require the plaintiff to demonstrate that the plaintiff’s injury resulted directly from conduct within the United States. Among other things, requiring private plaintiffs to establish that their losses were a direct result of conduct in the United States could mitigate the risk of potential conflict with foreign nations’ laws by limiting the availability of a Section 10(b) private remedy to situations in which the domestic conduct is closely linked to the overseas injury. The Commission has not altered its view in support of this standard.
Another option is to enact conduct and effects tests only for U.S. resident investors. Such an approach could limit the potential conflict between U.S. and foreign law, while still potentially furthering two of the principal regulatory interests of the U.S. securities laws – i.e., protection of U.S. investors and U.S. markets.
Options to Supplement and Clarify the Transactional Test. In addition to possible enactment of some form of conduct and effects tests, the Study sets forth four options for consideration to supplement and clarify the transactional test. One option is to permit investors to pursue a Section 10(b) private action for the purchase or sale of any security that is of the same class of securities registered in the United States, irrespective of the actual location of the transaction. A second option, which is not exclusive of other options, is to authorize Section 10(b) private actions against securities intermediaries such as broker-dealers and investment advisers that engage in securities fraud while purchasing or selling securities overseas for U.S. investors or providing other services related to overseas securities transactions to U.S. investors. A third option is to permit investors to pursue a Section 10(b) private action if they can demonstrate that they were fraudulently induced while in the United States to engage in the transaction, irrespective of where the actual transaction takes place. A final option is to clarify that an off-exchange transaction takes place in the United States if either party made the offer to sell or purchase, or accepted the offer to sell or purchase, while in the United States.

Commissioner Luis Aguilar released a dissenting statement to express his "strong disappointment that the Study fails to satisfactorily answer the Congressional request, contains no specific recommendations, and does not portray a complete picture of the immense and irreparable investor harm that has resulted, and will continue to result, due to Morrison v. National Australia Bank, Ltd."  He concludes that "investors should have a private right of action under the antifraud provisions of the Exchange Act in transnational securities fraud cases, in accordance with the conduct and effects test. This would be consistent with the authority granted by Congress to the SEC and DOJ, as has been the case for 40 years prior to the Morrison decision."


April 11, 2012 | Permalink | Comments (0) | TrackBack (0)

SEC Charges AutoChina Int'l with Market Manipulation

The SEC charged AutoChina International Limited and 11 investors, including a senior executive and director at the China-based firm, with conducting a market manipulation scheme to create the false appearance of a liquid and active market for AutoChina’s stock.  According to the SEC’s complaint, AutoChina senior executive and director Hui Kai Yan, a former AutoChina manager, and others fraudulently traded AutoChina’s stock to boost its daily trading volume. Starting in October 2010, the defendants and others deposited more than $60 million into U.S.-based brokerage accounts and engaged in hundreds of fraudulent trades over the next three months through these accounts and accounts with a Hong Kong-based broker-dealer. The fraudulent trades included matched orders, where one account sold shares to another account at the same time and for the same price, and wash trades, which resulted in no change of beneficial ownership of the shares. AutoChina and the other defendants engaged in the scheme after lenders offered AutoChina unfavorable terms for a stock-backed loan due to low trading volume in its stock.

The SEC complaint alleges that in the three months before the defendants opened the U.S.-based brokerage accounts, the average daily trading volume of AutoChina’s stock was approximately 18,000 shares. From Nov. 1, 2010 to Jan. 31, 2011, the average daily trading volume increased to more than 139,000 shares. On some days, the defendants and related accounts’ trading accounted for as much as 70 percent of the trading of AutoChina’s stock.

According to the SEC’s complaint, several of the defendants are related to AutoChina’s Chairman and Chief Executive Officer, who at the time of the scheme owned more than 57 percent of the company. Three of the defendants are siblings of AutoChina’s Chairman and Chief Executive Officer and another is married to one of his siblings.

April 11, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Solicits Comments Prior to JOBS Act Rulemaking

The SEC announced it will begin accepting comments from the public as the agency sets out to make rules required under the recently-signed Jumpstart Our Business Startups (JOBS) Act.  Under a process first utilized with the Dodd Frank Wall Street Reform and Consumer Protection Act, the public will be able to comment before the agency even proposes its regulatory reform rules and amendments.

To facilitate public comment, the SEC is providing a series of links on its website organized by titles of the JOBS Act.

In addition, to ensure full transparency, the SEC will post information on its website about any JOBS Act meetings with interested parties. Staff will request that meeting participants provide an agenda of intended topics in advance, which will become part of the public record. Meeting participants will be encouraged to submit written comments to the public file so that all interested parties have the opportunity to review and consider the views expressed.

April 11, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, April 10, 2012

SEC Approves FINRA Rule Change on FLSA Collective Action Claims

The SEC approved a FINRA proposed rule change to make explicit FINRA's longstanding position that collective action claims brought under the Fair Labor Standards Act are class actions and therefore ineligible for arbitration in its forum.  The rule change was made necessary by a federal district court opinion that held to the contrary. (Download 34-66774[1])

April 10, 2012 in SEC Action, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

SEC Report Examines Significance of Reg D Offerings in Raising Capital

The SEC posted on its website a report, prepared by the Division of Risk, Strategy, and Financial Innovation, analyzing Reg D offerings since 2009, based on information contained in Form D filings.  (Download Sec_analysis-reg-d-offering[1]) Among its findings:

• In 2010, Reg D offerings surpassed debt offerings as the dominant offering method in terms of aggregate amount of capital raised in the U.S.: $905 billion.
• The amount of capital raised through Reg D offerings may be considerably larger than what is disclosed on Form D because there is no closing filing requirement.
• The median Reg D offering is modest in size: approximately $1 million.
• Consistent with the original intent of Regulation D to target the capital formation needs of small business, there have been a large number of smaller offerings: 37,000 unique offerings since 2009.
• There is a strong presence of foreign issuers in the Reg D offering market. Over the period 2009 to first quarter of 2011, they account for approximately 25% of capital raised.
• Among broader trends in capital raising, there has been a shift from public to private capital raising over the past three years, due to both a decline in public issuances and an increase in private issuances: public issuances fell by 11% from 2009 to 2010 while private issuances increased by 31% over the same period.
• Although capital raised in the U.S. by domestic issuers is almost twice that raised by foreign issuers, the capital raised by foreign issuers increased by 5% from 2009 to 2010, accounting for nearly the entire increase in total capital raised in the U.S. during the period. This is evidence that the current regulatory environment is not pushing capital formation offshore; rather, this evidence is more consistent with the U.S. competing favorably with foreign markets.


April 10, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Last Call: National Business Law Scholars Conference June 27-28

This is a reminder  of the April 15 deadline for submitting proposals for presentations at the June 27-28 National Business Law Scholars Conference at the University of Cincinnati College of Law.  Here is the Call for the Papers:

The National Business Law Scholars Conference (NBLSC), formerly known as the Midwest Corporate Legal Scholars Conference, will be held on Wednesday, June 27th and Thursday, June 28th at University of Cincinnati College of Law in Cincinnati, Ohio.  This is the third annual meeting of the NBLSC, which has been renamed this year to reflect its national scope and the widely varied interests of its participants.  We welcome all on-topic submissions and will attempt to provide the opportunity for everyone to actively participate.  We will also attempt to assign a commentator for each paper presented.  Junior scholars are especially encouraged participate, and we will hold a special “how-to” panel for prospective business law scholars discussing the job market and transitioning into the legal academy. 

To submit a presentation, email Professor Eric C. Chaffee at with an abstract or paper by April 15, 2012.  Please title the email “NBLSC Submission – {Name}”.  If you would like to attend, but not present, email Professor Chaffee with an email entitled “NBLSC Attendance”.  Please specify in your email whether you are willing to serve as a commentator or moderator.  A conference schedule will be circulated in early June.

Conference Organizers:

Barbara Black
Eric C. Chaffee
Steven M. Davidoff

April 10, 2012 | Permalink | Comments (0) | TrackBack (0)

Monday, April 9, 2012

TARP Pay Czar Makes 2012 Compensation Determinations for Execs at TARP Companies

On April 6, 2012, the Acting Special Master for TARP Executive Compensation, Patricia Geoghegan, released 2012 compensation determinations for the “top 25” executives at the three remaining companies that received exceptional Troubled Asset Relief Program (TARP) assistance—AIG, Ally Financial (formerly GMAC), and GM. 

1. Overall CEO Compensation Frozen at 2011 Levels:  The overall CEO compensation packages payable by AIG, Ally Financial and GM have not increased.  Although there has been some modification in the mix of stock salary and long-term restricted stock for the CEO group, the overall amount of CEO compensation is frozen at 2011 levels.

2. 2012 Pay Packages Follow the Framework Established in 2009-2011:  As in the prior determinations, most pay (83 percent overall in 2012), including target incentives, is in the form of stock, tying the ultimate value of the compensation to company performance.  Transferability of the stock remains subject to deferral over a period of three years, and hedging of the stock compensation remains prohibited.  Bonuses are subject to clawback.  Cash salary continues to be limited—in most cases to $500,000 or less. The $25,000 cap on perquisites continues to apply.

3. Companies Have Made Progress Repaying Taxpayer Investments: AIG has reduced its obligations to the U.S. government (including through cancellation of undrawn commitments) by more than 75 percent.  Treasury has also recovered nearly half of the TARP funds invested in GM and nearly one-third of the TARP funds invested in Ally Financial through repayments and other income. 

4. ‘Top 25’ Compensation Packages:  The group of 69 executives consists of the five senior executive officers and next 20 most highly compensated employees (based on 2011 compensation) at the three companies, minus six departures since January 1, 2012.  Of that total, 48 individuals were also in the 2011 “top 25,” and 21 are new members of the group.  Some individual compensation packages increased, some decreased, and some remained at 2011 levels.  Overall the cash compensation for these 69 individuals decreased 18 percent and their total direct compensation decreased 10 percent from 2011 levels.  For the individuals in the “top 25” in both 2011 and 2012, cash compensation increased 1 percent and total direct compensation decreased 2 percent.  For the individuals new to the “top 25” group for 2012, cash compensation decreased 47 percent as compared to the cash they received for 2011, and total direct compensation decreased 30 percent as compared to 2011.

April 9, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Appoints Jay Brown to Investor Advisory Committee

Congratulations to Jay Brown (Denver), who has been appointed to the SEC's new Investor Advisory Committee required by Dodd-Frank.  Other members of the 21-member committee are listed on the SEC's website.

April 9, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Sunday, April 8, 2012

Greenberger on Extraterritoriality of Dodd-Frank and Worldwide Bailouts

The Extraterritorial Application of the Dodd-Frank Act Protects U.S. Taxpayers from Worldwide Bailouts, by Michael Greenberger, University of Maryland Francis King Carey School of Law, was recently posted on SSRN.  Here is the abstract:

The significant extraterritorial scope of the Dodd-Frank Wall Street Reform and Consumer Protection Act promises to foster rigorous international standards for financial regulation that will restore transparency and stability to the global derivatives markets. At present, that market exceeds $700 trillion notional value or over ten times the world GDP. Despite opposition to the extraterritorial application of Dodd-Frank, strictly following the plain language of that statute would protect U.S. taxpayers from bailing out the world’s banks, which they did shortly after the subprime credit meltdown of 2008.

The unregulated nature of the global derivatives market exposes the world to continued systemic risk, especially in a time of worry about sovereign defaults and the defaults of banks that hold sovereign debt. Defaults of that nature are conceded by almost everyone as having the ability to trigger undercapitalized and non-transparent credit derivatives of the kind that were triggered in the 2008 subprime fiasco and that led to the U.S. taxpayer’s near-$13 trillion bailout of the financial industry. With worldwide economic stability at stake, tough regulatory protections for the derivatives markets are needed instantaneously.

This article argues that the extraterritorial scope of Dodd-Frank rules on capitalization, collateralization, and transparency will restore stability and integrity to the global derivatives market. To this end, the article is divided into five parts. First, the article shows how Dodd-Frank aims to regulate derivatives trading so as to avoid, inter alia, the kind of systemic risk that presented itself in the wake of the subprime mortgage meltdown. Second, it establishes that Congress, pursuant to its constitutional authority, intended U.S. financial reforms to apply across jurisdictions so long as the U.S. has a vested relationship to the derivative transaction. Third, the article discusses the current controversy caused by worldwide Too Big to Fail banks and the European Union surrounding the extraterritorial scope of Dodd-Frank-mandated reforms. Fourth, the article defends the cross-jurisdictional application of Dodd-Frank regulations when a derivatives trade threatens either a U.S. party or the U.S. economy: it demonstrates that Congress has the constitutional authority to direct the extraterritorial application of U.S. regulations and that such an application aligns with U.S. regulators’ standard enforcement practices. Fifth, the article establishes that the extraterritorial scope of Dodd-Frank regulation is necessary to protect U.S. taxpayers from the risks posed by the global derivatives market and that it will benefit U.S. banks by establishing a more stable derivatives market. For that matter, the broad application of Dodd-Frank standards will also protect foreign taxpayers from further bailouts of defaulting and systemically risky banking institutions.

April 8, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

SEC Freezes Assets of Chinese Traders in Zhongpin Stock

The SEC obtained a court-ordered freeze of the assets of six Chinese citizens and one British Virgin Islands entity charged with insider trading in Zhongpin Inc., a China-based pork processor whose shares trade in the U.S.  The SEC’s complaint, filed in U.S. District Court in Chicago on April 4, alleges the defendants reaped more than $9 million by trading in Zhongpin ahead of a March 27 announcement of a proposal to take the company private.  The complaint names as defendants one entity, Prestige Trade Investments Ltd., and six individuals, Siming Yang, Caiyin Fan, Shui Chong (Eric) Chang, Biao Cang, Jia Wu, and Ming Ni.  The SEC alleged that Yang formed Prestige in January and funded its U.S. brokerage account in March with $29 million transferred from a Hong Kong bank.

According to the SEC’s complaint, the seven defendants bought substantial quantities of common stock and call options in Zhongpin between March 14 and March 26. Zhongpin’s stock price jumped 21.8% on March 27 when the company publicly announced that its Chairman and CEO Xianfu Zhu had made a non-binding offer to acquire all of Zhongpin’s outstanding stock at $13.50 a share, a 46% premium over the previous day’s closing price.

The SEC alleges that the purchases of Zhongpin stock and options were inconsistent with the defendants’ financial situations and prior investment behavior.  Each of the defendants placed at least some of their trades from computer networks and hardware that other defendants also used to place trades. In addition to the emergency relief, the SEC is seeking permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties. The emergency court order that the SEC obtained on April 4 on an ex parte basis froze defendants’ assets held in U.S. brokerage accounts, grants expedited discovery and prohibits the defendants from destroying evidence.

April 8, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former Bank's Officers with Disguising Deteriorating Loan Portfolio

The SEC charged Franklin Bank Corp.’s former chief executives for their involvement in a fraudulent scheme designed to conceal the deterioration of the bank’s loan portfolio and inflate its reported earnings during the financial crisis.  The SEC alleges that former Franklin CEO Anthony J. Nocella and CFO J. Russell McCann used aggressive loan modification programs during the third and fourth quarters of 2007 to hide the true amount of Franklin’s non-performing loans and artificially boost its net income and earnings. The Houston-based bank holding company declared bankruptcy in 2008.

According to the SEC’s complaint filed in U.S. District Court for the Southern District of Texas late Thursday, as Franklin’s holdings of delinquent and non-performing loans rose significantly in the summer of 2007, Nocella and McCann instituted three loan modification schemes that caused Franklin to classify such loans as performing. By the end of September 2007, Nocella and McCann had used the loan modification programs to conceal more than $11 million in non-performing single family residential loans and $13.5 million in non-performing residential construction loans.

On May 2, 2008, in a Form 8-K report filed with the SEC, Franklin acknowledged that the accounting for the loan modifications should be revised and that investors should no longer rely upon Franklin’s Form 10-Q for the quarter ended September 30, 2007.

The SEC’s complaint seeks financial penalties, officer-and-director bars, and permanent injunctive relief against Nocella and McCann to enjoin them from future violations of the federal securities laws. The complaint also seeks repayment of bonuses received by Nocella and McCann under Section 304 of the Sarbanes Oxley Act of 2002, which allows for “clawbacks” of bonuses received by executives if the company later must restate its earnings.

April 8, 2012 in SEC Action | Permalink | Comments (1) | TrackBack (0)