Securities Law Prof Blog

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

Friday, September 14, 2012

NYSE Settles SEC Charges for Improper Distribution of Market Data

The SEC brought charges against the New York Stock Exchange for compliance failures that gave certain customers an improper head start on trading information.  NYSE and its parent company NYSE Euronext agreed to a $5 million penalty and undertakings to settle the SEC's charges. It marks the first-ever SEC financial penalty against an exchange.

SEC Regulation NMS (National Market System) prohibits the practice of improperly sending market data to proprietary customers before sending that data to be included in consolidated feeds which broadly distribute trade and quote data to the public. According to the SEC's order against NYSE, the exchange violated this rule over an extended period of time beginning in 2008 by sending data through two of its proprietary feeds before sending data to the consolidated feeds. NYSE's inadequate compliance efforts failed to monitor the speed of its proprietary feeds compared to its data transmission to the consolidated feeds.

The two NYSE proprietary data feeds at issue were Open Book Ultra — which sends real-time data about NYSE's entire order book — and PDP Quotes, which contains NYSE's quote for each security. The transmission disparities had several causes. An internal NYSE system architecture gave one of the data feeds a faster path to customers than the path used to send data to the consolidated feed. Also there was a software issue in the internal NYSE system that sent data to the consolidated feed. The disparities in data release times ranged from single-digit milliseconds to multiple seconds.

The SEC's order finds that NYSE's compliance department was not involved in important technology decisions, including the design, implementation, and operation of NYSE's market data systems. By not involving the compliance department at critical junctures, NYSE missed opportunities to avoid compliance failures. NYSE also failed to retain computer files that contained information about its transmission of market data, including the times that NYSE sent data to be included in the consolidated feed. These computer files related to NYSE's compliance with Rule 603(a), and NYSE's failure to retain them complicated its ability to determine when it experienced delays sending data and calculate the length of delays when they occurred.

NYSE and NYSE Euronext agreed to a settlement without admitting or denying the Commission's findings. The order censures NYSE, imposes a $5 million penalty, and requires both NYSE and NYSE Euronext to cease and desist from committing or causing these violations. NYSE and NYSE Euronext are required to retain an independent consultant to conduct a comprehensive review of their market data delivery systems to ensure that they comply with Rule 603(a).

September 14, 2012 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Thursday, September 13, 2012

GAO Issues Report on Customer Outcomes in Madoff Liquidation

The GAO today issued a report on Customer Outcomes in the Madoff Liquidation Proceeding (GAO-12-991).  Here is what it found:

GAO's analysis of Madoff account data shows that more than three-fourths of the firm's customers were individuals and families (individuals). The remaining accounts were held by institutions, such as pension funds and charities. A higher proportion of accounts held by an individual (60 percent) were "net winners" based on their net equity position--meaning they had withdrawn more from their accounts than they had deposited--compared to accounts held by institutions (50 percent). Correspondingly, 40 percent of institutional accounts were "net losers" that had deposited more into their accounts than they had withdrawn, compared to 29 percent of individuals' accounts that were net losers. However, individual and institutional accounts had similar deposit and withdrawal activity from 1981 through 2008, including increased withdrawals immediately before the firm's failure in December 2008.

GAO's analysis shows that the Trustee's decisions to accept or reject claims were similar for individual and institutional account holders. Of the more than 16,000 claims, about 66 percent were denied because the customers were not direct account holders of the Madoff firm, but instead had invested in funds or other vehicles that held accounts directly with the firm. For the remaining claimants who were directly invested, the Trustee generally used the customers' net investment positions--that is, whether they were net winners or net losers-- to determine claims. In examining claims decisions by customer type, GAO found the Trustee denied claims filed by individuals and institutions determined to be net winners in similar proportions. Similarly, most claims filed by individuals or institutions determined to be net losers were allowed.

The Trustee has been pursuing litigation to recover, or "claw back," assets from net winner customers and others that can be used to reimburse customers that did not withdraw all of their principal investments. For those customers that withdrew fictitious profits--net winners--the Trustee has been pursuing more than 1,000 lawsuits to recover funds, as allowed under federal bankruptcy law and state law. In about 60 suits, the Trustee has sought more than fictitious profits, to include principal or other funds received, arguing the parties knew or should have known of the fraud. Thus far, the Trustee said he has recovered about $9.1 billion of the $17.3 billion in principal investments lost by customers who filed claims, including $8.4 billion from settlement agreements.

Because the Madoff fraud affects customers' taxable income, it also affects tax collections by the Department of the Treasury. Under Internal Revenue Service (IRS) rules, Madoff customers can deduct lost principal and fictitious profits on which they paid taxes while holding their accounts. However, IRS does not maintain statistics on specific frauds or their impacts on tax collections, and the tax impact may be reduced because some taxpayers may not be able to fully use this tax relief, such as those that lack other income that can be offset by these deductions. Tax experts expressed concerns about the lack of clarity over how payments stemming from fraud-related avoidance actions filed by the Trustee will be treated for tax purposes. In response to a recommendation in a draft report that IRS provide guidance to help limit taxpayer errors resulting in over- or underpayment of taxes, the agency issued such guidance on September 5, 2012, in the form of "frequently asked questions" posted to its website.


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

Tuesday, September 11, 2012

Treasury Announces an Expected Overall Positive Return of $182 Billion on AIG Bailout

On Sept. 10 U.S. Treasury announced that it planned to sell approximately 553.8 million shares of AIG common shares at $32.50 in an underwritten public offering, for expected proceeds of $18 billion.  Today it issued another release on the forthcoming offering, announcing that it expects to receive an additional $2.7 billion from the offering because the underwriters exercised their over-allotment option, bringing the total anticipated proceeds to $20.7 billion.

After the offering, Treasury's common stock ownership in AIG would decrease from approximately 53.4% to 15.9%.  According to the release:

The overall commitment that Treasury and the Federal Reserve made to stabilize AIG during the financial crisis totaled approximately $182.3 billion. Through repayments of principal and reductions/cancellations in commitments ($178.8 billion), as well as additional income from interest, fees, and other gains ($18.6 billion), Treasury and the Federal Reserve have now recovered a combined total of $197.4 billion (giving effect to the offering) – representing a positive return of $15.1 billion to date compared to the original combined $182.3 billion commitment. Future sales of Treasury's remaining AIG common stock holdings will provide an additional return to taxpayers.

 NYTimes Dealbook's Andrew Ross Sorkin features an interview with Neil Barofsky, former TARP special inspector general, who continues to assert that Treasury will suffer significant losses from the bailout.  NYTimes, Plot Twist in the A.I.G. Bailout: It Actually Worked

September 11, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

St. John's Law Hosts Symposium on Regulation of Financial Advice

St. John's School of Law is hosting a symposium on Revolution in the Regulation of Financial Advice: The U.S., the U.K. and Australia on October 12, 2012:

Recently, Australia and the U.K. have been carrying out radical reforms in compensation practices for investment advice to retail customers. These reforms contrast sharply with the normal U.S. practices of transparency and increased disclosure requirements. The Symposium will feature panelists from the U.S., Australia and the U.K. exploring recent developments in the regulatory regimes of those countries. Specifically, panelists will discuss the future of investment adviser regulation after Dodd-Frank in the U.S., the Future of Financial Advice in Australia and the Retail Distribution Review in the U.K. The Symposium will also examine the benefits of different regulatory plans ranging from mandatory disclosure to more substantive regulation preventing conflicts of interest.

For additional information, and to register for the symposium, see the law school's website.

September 11, 2012 in Professional Announcements | Permalink | Comments (0) | TrackBack (0)

Monday, September 10, 2012

Treasury Plans to Reduce AIG Ownership Below Majority

The U.S. Treasury hopes to reduce its ownership interest in AIG (once 92%, now about 53%) to less than majority ownership.  It announced that it has launched an underwritten public offering of $18.0 billion of its AIG common stock.  AIG has indicated that it intends to purchase up to $5.0 billion of the common stock sold by Treasury in this offering at the initial public offering price. Treasury will also grant to the underwriters in the offering a 30-day option to purchase up to an additional $2.7 billion in common stock from Treasury to cover over-allotments, if any.

Citigroup, Deutsche Bank Securities Inc., Goldman, Sachs & Co., and J.P. Morgan Securities LLC have been retained as joint global coordinators. Merrill Lynch, Pierce, Fenner & Smith Incorporated, Barclays Capital Inc., Morgan Stanley & Co. LLC, RBC Capital Markets, LLC, UBS Securities LLC, Wells Fargo Securities, LLC, Credit Suisse Securities (USA) LLC and Macquarie Capital (USA) Inc. have been retained as joint bookrunners for the offering.

September 10, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

FINRA Proposes Amending Procedures for Calling Witnesses or Producing Documents from FINRA Members

The SEC posted on its website a proposed rule change filed by FINRA to amend the Customer and Industry Codes of Arbitration Procedure (collectively “Codes”), to provide that when specified industry parties seek the appearance of witnesses or the production of documents from FINRA members (and individuals associated with the members) that are not parties to the arbitration, FINRA arbitrators shall issue orders for the appearance of witnesses or the production of documents, instead of issuing subpoenas. The proposed rule change would add procedures for non-parties to object to subpoenas and arbitrator orders of production (“arbitrator orders”). It would also standardize procedures under the Codes relating to service of motions for subpoenas and arbitrator orders, service of issued subpoenas and arbitrator orders, and time frames for responding to subpoenas and arbitrator orders, making them operationally consistent.
Rel. 34-67803 (Download 34-67803[1])

September 10, 2012 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

SEC Charges JP Turner with Compliance Failures Involving Churning

The SEC charged three former brokers at JP Turner & Co., an Atlanta-based brokerage firm, with  “churning” the accounts of customers with conservative investment objectives.  The SEC also charged the head supervisor, Michael Bresner, as well as the firm’s president William Mello and the firm itself for compliance failures. JP Turner and Mello agreed to settle the SEC’s charges, while an administrative proceeding will continue against the three brokers and the supervisor.

According to the SEC’s order instituting administrative proceedings against the three brokers and the supervisor,  the brokers collectively churned the accounts of seven customers with conservative investment objectives and low or moderate risk tolerances. The churning occurred between January 2008 and December 2009. Bresner, an executive vice president and the head of supervision at JP Turner, is charged with failing to reasonably supervise two of the brokers, who generated such high commissions for some of their churned customers that it triggered a requirement in the firm’s procedures requiring that Bresner personally review the underlying trading activity.

In settling the SEC’s charges without admitting or denying the findings, JP Turner agreed to hire an independent consultant to review the firm’s supervisory procedures in order to prevent future violations. The SEC’s order censures JP Turner and requires payment of $200,000 in disgorgement (JP Turner’s approximate share of the commissions and fees generated by the fraudulent churning) plus $16,051 in prejudgment interest and a $200,000 penalty. The order suspends Mello from association in a supervisory capacity with a broker, dealer, or investment adviser for a period of five months and requires him to pay a $45,000 penalty.

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

Sunday, September 9, 2012

SEC Posts Study on Standardizing Credit Ratings

Section 939(h)(1) of the Dodd-Frank Act provides that the SEC shall undertake a study on the feasibility and desirability of:

• standardizing credit rating terminology, so that all credit rating agencies issue credit ratings using identical terms;
• standardizing the market stress conditions under which ratings are evaluated;
• requiring a quantitative correspondence between credit ratings and a range of default probabilities and loss expectations under standardized conditions of economic stress; and
• standardizing credit rating terminology across asset classes, so that named ratings correspond to a standard range of default probabilities and expected losses independent of asset class and issuing entity.

The SEC released its staff report on September 7.  In it, the staff reports its findings and recommends:

that the Commission not take any further action at this time with respect to: (1) standardizing credit rating terminology, so that all credit rating agencies issue credit ratings using identical terms; (2) standardizing the market stress conditions under which ratings are evaluated; (3) requiring a quantitative correspondence between credit ratings and a range of default probabilities and loss expectations under standardized conditions of economic stress; and (4) standardizing credit rating terminology across asset classes, so that named ratings correspond to a standard range of default probabilities and expected losses independent of asset class and issuing entity. In addition, given the difficulties commenters identified with respect to implementing the standardization that is the subject of the study, the staff believes it would be more efficient to focus on the rulemaking initiatives mandated under the Dodd-Frank Act, which, among other things, are designed to promote transparency with respect to the performance of credit ratings and the methodologies used to determine credit ratings.

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

SEC Charges Asset Manager with Exaggerating Value of Assets and Concealing Loss

The SEC announced an emergency enforcement action against Nikolai Battoo, an asset manager who has boasted remarkable investment success throughout the global financial crisis while allegedly exaggerating the value of the assets he manages and concealing major losses from investors.

According to the SEC, Battoo claims to manage $1.5 billion on behalf of investors around the world, including at least $100 million for U.S.-based investors. But contrary to Battoo’s proclaimed track record of exceptional risk-adjusted returns for his investors, he actually suffered major losses in 2008 due to his investments in the Bernard Madoff Ponzi scheme and a failed derivative investment program. Rather than admit the losses to investors, Battoo has been overstating the value of his investments in a variety of ways. By boasting benchmark-beating returns, he has continued to attract new investors. However, during the past several months, investors have requested redemptions on their investments with Battoo. Instead of paying them, Battoo has provided a series of excuses ranging from the MF Global collapse to others placing a hold on investors’ money due to government investigations.

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

SEC Settles Fraud Charges Against ICP Asset Management

The SEC and New York-based investment advisory firm ICP Asset Management and its founder and president Thomas C. Priore have agreed to settle the agency’s charges that they defrauded several collateralized debt obligations (CDOs) they managed.  ICP, Priore, and related entities have agreed to a final judgment ordering them to pay more than $23 million to settle the case the SEC filed against them in June 2010. The SEC alleged they engaged in fraudulent practices and misrepresentations that caused the CDOs to overpay for securities and lose millions of dollars. Priore and the ICP companies also improperly obtained fees and undisclosed profits at the expense of the CDOs and their investors.

The court approved the settlement terms on September 6. The final judgment orders Priore to pay disgorgement of $797,337, prejudgment interest of $215,045, and a penalty of $487,618. ICP and its holding company Institutional Credit Partners LLC are ordered, on a joint and several basis, to pay disgorgement of $13,916,005 and prejudgment interest of $3,709,028. ICP also is ordered to pay a penalty of $650,000. An affiliated broker-dealer ICP Securities LLC is ordered to pay disgorgement of $1,637,581, prejudgment interest of $301,893, and a penalty of $1,939,474. Priore also agreed to settle an administrative proceeding against him and be barred from association with any broker, dealer, investment adviser, municipal securities dealer, or transfer agent, and from participating in any offering of a penny stock. He has a right to reapply for association or participation after a period of five years.

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

Couture on Falsity-Scienter Inference

The Falsity-Scienter Inference, by Wendy Gerwick Couture, University of Idaho College of Law, was recently posted on SSRN.  Here is the abstract:

This essay argues that, under certain circumstances in securities fraud cases, a statement’s well-pleaded falsity gives rise to a strong inference that the speaker acted with scienter. In particular, this essay contends that the well-pleaded falsity of a statement is sufficient to create a strong inference of scienter when (1) the truth is necessarily within the speaker’s core knowledge; and (2) the statement is sufficiently false to have necessarily caught the speaker’s attention. This falsity-scienter inference potentially applies in a variety of securities fraud contexts, including falsified CEO résumés, objectively unreasonable analyst opinions, and cooked books. In addition, the falsity-scienter inference supports adoption of the controversial “core operations inference” and provides guidance on the proper scope of this narrower inference.

September 9, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Diamond on the Facebook IPO

Facebook's Failed IPO and the Era of Insider Capitalism, by Stephen F. Diamond, Santa Clara University - School of Law, was recently posted on SSRN.  Here is the abstract:

The initial public offering (IPO) of Facebook is the most important failed IPO in the history of the American capital markets. Explanations for the failure largely focus on the widely publicized problems at Nasdaq, the exchange venue where the offering took place, and the role of the investment banks that helped lead the IPO. This paper argues that the problems were likely caused by a confluence of two other important factors: the pressures of what I define as “fictitious capital” and the internal culture of the company itself created by Mark Zuckerberg, the founder and dominant shareholder of the company, aided and abetted by early investors such as the libertarian Peter Thiel. These factors suggest the emergence of a new period in capitalism that I call “insider capitalism” where key investors ally with founding entrepreneurs to exploit informational advantages to appropriate value. The paper thus suggests that there is a deeper structural and ideological problem extant in modern capitalism.

September 9, 2012 in Law Review Articles | Permalink | Comments (1) | TrackBack (0)

Bhattacharya & O'Brien on Market Efficiency

Arbitrage Risk and Market Efficiency – Applications to Securities Class Actions, by Rajeev R. Bhattacharya, Berkeley Research Group, and Stephen Jerome O'Brien was recently posted on SSRN.  Here is the abstract:

Measuring the efficiency of the market for a stock is important for a number of reasons. For example, it determines the necessity for an investor to acquire expensive additional information about a firm, and it is a critical factor in class certification in a securities class action. We provide a general methodology to measure the market efficiency percentile for a stock for any relevant period. We apply this methodology to calculate arbitrage risk for each U.S. exchange-listed common stock for every calendar year from 1988 to 2010. We find that market efficiency is significantly affected by turnover (negatively), the number of market makers for Nasdaq stocks (negatively), and serial correlation in the market model of the stock (positively). These findings seem inconsistent with “conventional wisdom,” but we show that our findings are consistent with economic logic. The relations between market efficiency and market capitalization (positive), bid-ask spread (negative), institutional ownership (positive), and explanatory power of the relevant market model (positive) are consistent with conventional wisdom. The impact on market efficiency of the number of securities analysts following a stock and the public float ratio of a stock are of ambiguous significance.

September 9, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)