Securities Law Prof Blog

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

Saturday, May 5, 2012

Armour et alia on Delaware Corporate Litigation

Delaware Corporate Litigation and the Fragmentation of the Plaintiffs’ Bar, by John Armour, University of Oxford - Faculty of Law; University of Oxford - Said Business School; European Corporate Governance Institute (ECGI); Bernard S. Black, Northwestern University - School of Law; Northwestern University - Kellogg School of Management; European Corporate Governance Institute (ECGI); and Brian R. Cheffins,
University of Cambridge - Faculty of Law; European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:

Since 2000 a growing proportion of lawsuits against directors of public companies incorporated in Delaware have been filed outside Delaware. There has also been a large increase in the likelihood of litigation challenging for M&A transactions involving Delaware targets, and the likelihood that suits involving the same transaction will be filed both in Delaware and elsewhere. In this Article we explore one potential cause for these trends -- intensified competition between plaintiffs’ law firms. We trace the development of the plaintiffs’ bar from the 1970s to the present and identify three changes that plausibly contributed to the out-of-Delaware trend and a higher litigation rate: 1) stronger competition among plaintiffs’ lawyers specializing in securities litigation also affected the corporate law side of the plaintiffs’ bar, 2) changes in how the Delaware courts selected lead counsel encouraged non-Delaware filing by firms who were unlikely to win lead counsel status in Delaware, 3) potential obstacles associated with launching a suit in a jurisdiction other than Delaware become less of a concern to the plaintiffs’ bar.

May 5, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Wilmarth on Narrow Banking

Narrow Banking: An Overdue Reform that Could Solve the Too-Big-To-Fail Problem and Align U.S. And U.K. Regulation of Financial Conglomerates, by Arthur E. Wilmarth Jr., George Washington University Law School, was recently posted on SSRN.  Here is the abstract:

This article is based on testimony presented on December 7, 2011, before the Subcommittee on Financial Institutions and Consumer Protection of the Senate Committee on Banking, Housing, and Urban Affairs. The article provides an update and extension of my previous work showing that: (1) the U.S., U.K. and other developed nations provided enormous subsidies for “too-big-to-fail” (“TBTF”) financial institutions during the financial crisis, thereby creating dangerous distortions in our financial markets and economies; (2) large financial conglomerates follow a hazardous business model that is riddled with conflicts of interest and prone to speculative risk-taking; (3) the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) creates helpful new tools for regulating systemically important financial institutions (“SIFIs”) and dealing with their potential failure, but Dodd-Frank does not completely close the door to government bailouts of creditors of SIFIs; (4) Dodd-Frank relies on the same regulatory techniques – including capital-based regulation and prudential supervision – that failed to prevent the banking and thrift crises of the 1980s and the current financial crisis; and (5) Dodd-Frank also depends on many of the same federal agencies that failed to stop excessive risk-taking by financial institutions during the credit boom that preceded both crises.

In view of Dodd-Frank’s shortcomings, the article reiterates my proposals for more extensive structural reforms and activity limitations that would (i) prevent SIFIs from using federal safety net subsidies to support their capital markets activities, and (ii) make it easier for regulators to separate banks from their nonbank affiliates when financial conglomerates fail. Congress should mandate a pre-funded Orderly Liquidation Fund (“OLF”) and should require all bank and nonbank SIFIs to pay risk-based assessments to the OLF to provide for the future costs of resolving failed SIFIs. Congress should also mandate a “narrow bank” structure for financial conglomerates that would (a) protect the Deposit Insurance Fund from the risks created by nonbank affiliates of SIFI-owned banks, and (b) prevent narrow banks from transferring their FDIC-insured, low-cost funding advantages to their nonbank affiliates. My recommended reforms are similar to the “ring-fencing” proposal issued by the U.K. Independent Commission on Banking and endorsed by the Cameron coalition government. The narrow bank concept provides a promising way for the U.S. and the U.K. to adopt a common approach for regulating financial conglomerates. If the U.S. and the U.K. adopted consistent regimes for controlling the risks posed by SIFIs, they would place great pressure on other developed nations to follow suit.

May 5, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Friday, May 4, 2012

FINRA's Simplified Arbitration Cap Raised to $50,000

The SEC approved a proposed rule change filed by FINRA to amend FINRA’s Customer and Industry Codes of Arbitration Procedure to raise the limit for simplified arbitration from $25,000 to $50,000. (Download 34-66913[1])

FINRA currently offers streamlined arbitration procedures for claimants seeking damages of $25,000 or less. Under FINRA’s simplified arbitration rules, one chair-qualified arbitrator decides the claim and issues an award based on the written submissions of the parties, unless the customer requests a hearing (if it is a customer case), or the claimant requests a hearing (if it is an industry case). FINRA also expedites discovery in these cases.

The rule change raises the dollar limit for damages sought in order to offer simplified arbitration to claimants seeking damages of $50,000 or less. The rule change also states that if the amount of a claim is more than $50,000, but not more than $100,000, exclusive of interest and expenses, the panel would consist of one arbitrator unless the parties agree in writing to three arbitrators.

FINRA represented that the $25,000 threshold captured twenty-one percent of all cases filed with FINRA’s arbitration forum in 1998, but currently captures only ten percent of FINRA’s caseload. FINRA stated that, based on 2011 statistics, raising the threshold to $50,000 would increase the percentage of claims administered under simplified
arbitration to seventeen percent of the claims filed with the forum.

May 4, 2012 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

SEC Reopens Comment Period on Broker-Dealer Net Capital Rules

The SEC announced that it is re-opening the public comment period for proposed amendments to its net capital, customer protection, books and records, and notification rules for broker-dealers. (Download 34-66910[1]). The proposed rule amendments are designed to update the financial responsibility rules for broker-dealers and make certain technical amendments. The Commission issued the proposed amendments on March 9, 2007, and the public comment period on the proposal closed on June 18, 2007.

The SEC announcement says that:

Given economic events, regulatory developments, and passage of time since then, as well as the continuing public interest in this area, the Commission believes that it would be appropriate to seek additional public comment on the proposed rule amendments.

May 4, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Thursday, May 3, 2012

ProPublica: Why is SEC Picking on Egan-Jones?

Jesse Eisinger (ProPublica) goes after the SEC for bringing an enforcement action against the upstart ratings firm Egan-Jones allegedly for including inaccurate information in its SEC filing.  He makes some good points.  First, it isn't the most compelling case of financial wrongdoing.  Second, it gives the appearance that the SEC is going after a longstanding critic of the Big Three ratings firms.  They make their money from the issuers of the securities they rate.  Egan-Jones, in contrast, gets paid by the users of his ratings.  Whether you agree with Eisinger or not, it's well worth reading.  ProPublica, SEC Keeps Ratings Game Rigged

May 3, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

Eleventh Circuit Reverses Summary Judgment for Morgan Keegan in ARS Action

In SEC v. Morgan Keegan & Co., Inc. (11th Cir. May 2, 2012), the appeals court reversed a summary judgment in favor of Morgan Keegan involving its sales of auction rate securities (ARS) between Jan. 2 and March 19, 2008. (Download SECv.MorganKeegan)  The SEC alleged that MK's brokers and marketing materials misrepresented ARS as cash alternatives and omitted to disclose that ARS carried liquidity risk.  MK based its summary judgment motion on the SEC's failure to meet the materiality requirement and argued that the SEC's evidence of oral misrepresentations made by four brokers to individual investors should not be included in the "total mix" of information available to the hypothetical reasonable investor.  According to MK, the SEC must demonstrate that MK misled the public as a whole and not just a few individual investors.

The problem for Morgan Keegan is the SEC enjoys the authority to seek
relief for any violation of the securities laws, no matter how small or

The court found no support for MK's argument that some minimum number of investors must be misled before finding its brokers' misrepresentations material in an SEC enforcement action.

MK also argued that its written disclosures rendered individual brokers' oral misrepresentations immaterial as a matter of law.   The court, however, was not persuaded that MK's manner of distributing its written disclosures was adequate for purposes of granting summary judgment to the firm.  The only written disclosures given directly to ARS purchasers during this time period were the trade confirmations, which did not provide any warning about liquidity risk and only referred the customers to the firm's website for "information regarding auction procedures," without providing a direct link to the ARS web page. 

The court emphasized that its holding was narrow and limited to materiality.

May 3, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Tuesday, May 1, 2012

SEC Charges Mother, Daughter & Attorney in Penny Stock Fraud

The SEC charged a mother and daughter along with their attorney in a scheme to unlawfully acquire and sell billions of shares of penny stock in unregistered transactions.  According to the SEC, Christel S. Scucci and her mother Karen S. Beach, who live in Florida, used alter ego companies (Protégé Enterprises LLC and Capital Edge Enterprises LLC) to make more than $1.5 million from selling approximately 3.3 billion shares of purportedly unrestricted stock that they acquired in so-called debt conversion "wrap around" transactions. They were able to sell most of this stock only because Florida-based attorney Cameron H. Linton issued baseless legal opinions for them stating that the stock could be issued without a warning on the stock certificate limiting the transfer or sale of the security. The opinion letters concluded that their resale was exempt from the registration requirements of the federal securities laws.

According to the SEC’s complaint filed in federal court in Orlando, Fla., this scheme involving the illegal use of wrap around agreements lasted from January 2010 to October 2011. Under the wrap around agreements, affiliates or others purportedly owed money by certain microcap issuers for more than one year assigned from the issuers to Protégé or Capital Edge the right to collect the debts. The wrap around agreements also purported to amend the initial debt agreements thereby allowing Protégé and Capital Edge to convert the money owed to them by the issuers into shares of the issuers’ common stock at a deep discount (usually 50 percent) to the prevailing market price. Protégé and Capital Edge almost always elected to receive stock from the issuers shortly after execution of the wrap around agreements. None of the transactions was registered with the SEC.

The SEC’s complaint alleges that Protégé, Capital Edge, Scucci and Beach violated Section 5 of the Securities Act. The complaint further alleges that Linton violated, or aided and abetted the violation of, Section 5 of the Securities Act. The SEC seeks disgorgement, penalties, injunctions, and penny stock bars against the defendants.

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

SEC & UBS Puerto Rico Settle Fraud Charges Involving Proprietary Closed-End Funds

The SEC charged UBS Financial Services Inc. of Puerto Rico and two executives with making misleading statements to investors, concealing a liquidity crisis, and masking its control of the secondary market for 23 proprietary closed-end mutual funds.  UBS Puerto Rico agreed to settle the SEC’s charges by paying $26.6 million that will be placed into a fund for harmed investors.

According to the SEC’s order instituting settled administrative proceedings against UBS Puerto Rico, the firm knew about a significant “supply and demand imbalance” and discussed the “weak secondary market” internally. However, UBS Puerto Rico misled investors and failed to disclose that it controlled the secondary market, where investors sought to sell their shares in the funds. UBS Puerto Rico significantly increased its inventory holdings in the closed-end funds in order to prop up market prices, bolster liquidity, and promote the appearance of a stable market. However, UBS Puerto Rico later withdrew its market price and liquidity support in order to sell 75 percent of its closed-end fund inventory to unsuspecting investors.

The SEC instituted contested administrative proceedings against UBS Puerto Rico’s vice chairman and former CEO Miguel A. Ferrer and its head of capital markets Carlos J. Ortiz.

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

FINRA Fines Four Firms for Sales of Leveraged and Inverse ETFs

FINRA announced that it sanctioned Citigroup Global Markets, Inc; Morgan Stanley & Co., LLC; UBS Financial Services; and Wells Fargo Advisors, LLC a total of more than $9.1 million for selling leveraged and inverse exchange-traded funds (ETFs) without reasonable supervision and for not having a reasonable basis for recommending the securities. The firms were fined more than $7.3 million and are required to pay a total of $1.8 million in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases.

FINRA sanctioned the following firms:

Wells Fargo – $2.1 million fine and $641,489 in restitution
Citigroup – $2 million fine and $146,431 in restitution
Morgan Stanley – $1.75 million fine and $604,584 in restitution
UBS – $1.5 million fine and $431,488 in restitution

FINRA found that from January 2008 through June 2009, the firms did not have adequate supervisory systems in place to monitor the sale of leveraged and inverse ETFs, and failed to conduct adequate due diligence regarding the risks and features of the ETFs. As a result, the firms did not have a reasonable basis to recommend the ETFs to their retail customers. The firms' registered representatives also made unsuitable recommendations of leveraged and inverse ETFs to some customers with conservative investment objectives and/or risk profiles. Each of the four firms sold billions of dollars of these ETFs to customers, some of whom held them for extended periods when the markets were volatile.

ETFs are typically registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs seek to deliver the opposite of the performance of the index or benchmark they track, profiting from short positions in derivatives in a falling market.

Leveraged and inverse ETFs have certain risks not found in traditional ETFs, such as the risks associated with a daily reset, leverage and compounding. Accordingly, investors were subjected to the risk that the performance of their investments in leveraged and inverse ETFs could differ significantly from the performance of the underlying index or benchmark when held for longer periods of time, particularly in the volatile markets that existed during January 2008 through June 2009. Despite the risks associated with holding leveraged and inverse ETFs for longer periods in volatile markets, certain customers of these firms held leveraged and inverse ETFs for extended time periods during January 2008 through June 2009.

In settling these matters, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.



May 1, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, April 30, 2012

SEC Posts New Definitions and Rules Regarding Swaps

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[1])  The final rules are effective 60 days after publication in the Federal Register.

April 30, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC & Corporate Attorney Settle Insider Trading Charges

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.

April 30, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC & Former Morgan Stanley Exec Settle FCPA Charges

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.

April 30, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Will There Be Investment Adviser Oversight Legislation in 2012?

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!

April 30, 2012 in News Stories, Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Expels Pinnacle Partners Financial Corp. and Bars President

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.

April 30, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)