Securities Law Prof Blog

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

A Member of the Law Professor Blogs Network

Tuesday, April 24, 2012

SEC Alleges that Egan-Jones Ratings Lied in SEC Application

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.

April 24, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC & H&R Block Subsidiary Agree to Settle Subprime Fraud Charges

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.

April 24, 2012 in SEC Action | Permalink | Comments (1) | TrackBack (0)

FINRA's Ketchum Testifies on Collapse of MF Global

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.

April 24, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, April 23, 2012

SEC Charges Chinese Company with Lying About IPO & Charges Chairman with Theft

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.

April 23, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former CalPERS CEO with Fraud

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.

April 23, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Macchiarola on Judge Rakoff's Critique of SEC Consent Judgment Practice

'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.

April 23, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Sunday, April 22, 2012

Wal-Mart Bribed Its Way to Success in Mexico: NY Times

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.

NYTimes, Vast Mexico Bribery Case Hushed Up by Wal-Mart
After Top-Level Struggle

April 22, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

Lin on Securities Risk Disclosure

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.

April 22, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Schwarcz on Analyzing Financial Market Transformation

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.

April 22, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Grundfest on Intra-Corporate Forum Selection Clauses

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.

April 22, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Fisch on Reg FD

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).

April 22, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

SEC Staff's Observations on Disclosures of Smaller Financial Institutions

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.

April 22, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC and Father/ Son Hedge Fund Managers Settle Fraud Charges

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.

April 22, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Brothers with Stock-Picking Robot Scam

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.

April 22, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Congress Has More Questions for SEC Chair

The  House Committee on Financial Services has scheduled yet another oversight hearing on the SEC for Wednesday, April 25, 2012.  SEC Chair Mary Schapiro is the only scheduled witness. 

April 22, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)