Securities Law Prof Blog

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

Wednesday, October 3, 2012

Dark Pool Operator Settles SEC Charges for Failing to Protect Confidential Information

The SEC charged dark pool operator eBX LLC with failing to protect the confidential trading information of its subscribers and failing to disclose to all subscribers that it allowed an outside firm to use their confidential trading information. eBX agreed to pay an $800,000 penalty to settle the charges.

According to the SEC’s order instituting a settled administrative proceeding, eBX operates the alternative trading system LeveL ATS, which it calls a “dark pool” trading program. eBX inaccurately informed its subscribers that their flow of orders to buy or sell securities would be kept confidential and not shared outside of LeveL. eBX instead allowed an outside technology firm to use information about LeveL subscribers’ unexecuted orders for its own business purposes. The outside firm’s separate order routing business therefore received an information advantage over other LeveL subscribers because it was able to use its knowledge of their orders to make routing decisions for its own customers’ orders and increase its execution rate. eBX had insufficient safeguards and procedures to protect subscribers’ confidential trading information.

According to the SEC’s order, eBX and the outside firm it hired to run LeveL signed a subscription agreement in February 2008, after which the outside firm’s separate order routing business began to use certain LeveL subscribers’ confidential trading data. In November 2008, eBX signed a new agreement with the outside firm that allowed its order routing business to remember and use all LeveL subscribers’ unexecuted order information. As a result of the agreements, the outside firm’s order routing business began to fill far more of its orders than other LeveL users did. Its order router also knew how other eBX subscribers’ orders in LeveL were priced and could use that information to determine whether to route orders to LeveL or another venue based on where it knew it might get a better price for its own customers’ orders.

October 3, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Two Hedge Fund Managers with Fraud & Issues Warning to Investors

The SEC separately charged two hedge fund managers and their firms with lying to investors about how they were handling the money invested in their respective hedge funds. The charges are the latest in a series of actions taken by the SEC Enforcement Division and its Asset Management Unit against hedge fund-related misconduct in the markets.

In one case, the SEC alleges that San Francisco-based hedge fund manager Hausmann-Alain Banet and his firm Lion Capital Management stole more than a half-million dollars from a retired schoolteacher who thought she was investing her retirement savings in Banet’s hedge fund. In the other case, the SEC charged Chicago-based hedge fund managers Norman Goldstein and Laurie Gatherum and their firm GEI Financial Services with fraudulently siphoning at least $147,000 in excessive fees and capital withdrawals from a hedge fund they managed.

Since the beginning of 2010, the SEC has filed more than 100 cases involving hedge fund malfeasance such as misusing investor assets, lying about investment strategy or performance, charging excessive fees, or hiding conflicts of interest.

The SEC today issued an investor bulletin detailing some of those cases as examples of why investors must rigorously evaluate a hedge fund investment before making one.  The bulletin, prepared by the Office of Investor Education and Advocacy, recommends that investors understand a hedge fund’s investment strategy and its use of leverage and speculative techniques before making the investment. It also explains the need to evaluate a hedge fund manager’s potential conflicts of interest and take other steps to research those managing the fund.( Download Ib_hedgefunds[1])

October 3, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, October 2, 2012

Purchasers in Private Placements Are Not "Customers" of Managing Broker-Dealer:Eighth Circuit

There have been a number of recent cases addressing the issue of who is a "customer" for purposes of FINRA securities arbitration.  Typically, investors assert they are "customers" in order to pursue an arbitation against a securities firm, which the firm resists.  The applicable FINRA Rule 12200 allows a "customer" to bring arbitration proceedings against a FINRA member or an associated person if the dispute arises in connection with the business activities of the member or associated person.  A FINRA rule defines "customer" as "not includ[ing] a broker or dealer." 

In a recent case, Berthel Fisher & Co. v. Larmon (8th Cir. Oct. 1, 2012)( Download BerthelFisher.100112[1]), unhappy purchasers of securities issued in private placements sought to arbitrate claims against Berthel Fisher, which served as the managing broker-dealer for the offering.  As managing broker-dealer Berthel reviewed and suggested changes to at least two private placement memoranda.  It also was required, along with the selling brokers, to determine each investor's eligibility to participate in the offering and maintained customer files for this purpose.  The purchasers alleged that Berthel performed insufficient due diligence on the offering.  Although the investors had no contact with Berthel, they argued that they were "customers" because Berthel provided "investment or brokerage services" to them in three ways:  It was responsible for conducting due diligence on the offering, it was obligated to conduct a reasonable basis suitability analysis on the securities, and it maintained customer files on the investors.

The court, however, held that the investors were not "customers" of Berthel, because there was no "relationship" between the firm and the investors.  Assuming that the firm's services were "investment or brokerage," the  firm did not provide them to the customer either directly or through its associated persons.  Its contractual obligations were with the issuer and the selling brokers, not with the customers.

October 2, 2012 in Judicial Opinions, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Second Circuit Rejects Constitutional Challenge to Sec. 16(b) Suit

The Second Circuit recently rejected a 10% shareholder's constitutional challenge to a suit for disgorgement of short-swing trading profits under section 16(b) of the Securities Exchange Act.  The defendant argued that because the trading caused no injury to the corporation, there was no genuine case or controversy, and therefore the plaintiff, suing derivatively on behalf of the corporation, did not have standing.  Donoghue v. Bulldog Investors General Partnership (2d Cir. Oct. 1, 2012) (Download Donoghue.100112[2])

Although it was undisputed that the complaint adequately alleged a section 16(b) claim against the defendant and that the plaintiff, as a shareholder, was a person statutorily authorized to bring the claim, the defendant asserted that the court did not have jurisdiction to hear the claim because it presented no live case or controversy affording plaintiff standing to sue.  As the opinion states,

Bulldog argues that plaintiff cannot demonstrate any injury to the issuer from the alleged 16(b) violation because Invesco "was a non-party to the trades at issue, and no issue of 'corporate opportunity,' fiduciary duty, breach of contract or misappropriation is on the table."...Indeed, Bulldog insists that it is a "consummate 'outsider,'" lacking any "fiduciary, contractual or confidential relationship with Invesco."

In affirming the district court's judgment awarding short-swing profits, the Court rejected defendant's argument as without merit, because Congress, in enacting 16(b), established a rule of strict liability that effectively makes 10% beneficial owners fiduciaries to the extent of making their short-swing trading transactions "breaches of trust."  Thus, defendant could not argue that it owed no fiduciary duty to the issuer.  Moreover, since the statute conferred upon the issuer (and in appropriate circumstances, a shareholder of the issuer) an enforceable legal right to expect the defendant not to engage in any short-swing trading in its stock, the issuer is not a bounty hunter, but a person with a cognizable claim to compensation for the invasion of a legal right.


October 2, 2012 in Judicial Opinions | Permalink | Comments (1) | TrackBack (0)

New York AG Sues Over Bear's Role in Marketing Residential Mortgage-Backed Securities

Yesterday the New York State Attorney General brought a civil suit against Bear, Stearns & Co. (now J.P. Morgan Securities LLC) under the state's Martin Act arising out of Bear's role in connection with the creation and sale of residential mortgage-backed securities ("RMBS" to investors prior to the firm's 2008 collapse.  AG Eric Schneiderman is co-chair of the Residential Mortgage-Backed Securities Group formed by the DOJ in January 2012.  According to the complaint:

At the heart of Defendants' fraud was their failure to abide by their representations that they took a variety of steps to ensure the quality of the loans underlying their RMBS, including checking to confirm that those loans were originated in accordance with the applicable underwriting guidelines, i.e., the standards in place to ensure, among other things, that loans were extended to borrowers who demonstrated the willingness and ability to repay.

As a result, the complaint alleges, defendants' misconduct constituted "a systemic fraud on thousands of investors."  The complaint does not set forth with specificity the requested relief beyond an injunction, an accounting, disgorgement, restitution and damages.

The AG's allegations are similar to those made in a number of private lawsuits currently before the courts.

AG's complaint (Download 108632018-nyagvjpmc[1])

GMorgenson, NYTimes, JPMorgan Unit Is Sued Over Mortgage Securities Pools

AG's Press Release, A.G. Schneiderman Sues JPMorgan For Fraudulent Residential Mortgage-backed Securities Issued By Bear Stearns


October 2, 2012 in News Stories, Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, October 1, 2012

Former IndyMac CEO Settles SEC Charges

The SEC announced that on September 28, 2012, the United States District Court for the Central District of California entered a settled final judgment as to Michael W. Perry, the former Chief Executive Officer and Chairman of the Board of IndyMac Bancorp, Inc. IndyMac primarily made, purchased, and sold residential mortgage loans. In July 2008, IndyMac Bank was placed under Federal Deposit Insurance Corporation receivership and IndyMac filed for bankruptcy. The Commission’s complaint alleges that IndyMac and Perry, in connection with IndyMac’s first quarter 2008 Forms 10-Q and 8-K and related earnings call, all dated May 12, 2008, failed to disclose that IndyMac Bank had only been able to maintain its well-capitalized regulatory status by retroactively including in IndyMac’s first quarter capital balance an $18 million capital contribution from IndyMac to IndyMac Bank, even though it was made on May 9, 2008, over five weeks after the end of the first quarter.

Without admitting or denying the allegations in the complaint, Perry consented to the entry of the Final Judgment permanently enjoining him from future violations of Section 17(a)(3) of the Securities Act of 1933, and ordering him to pay a civil penalty in the amount of $80,000.

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

Sunday, September 30, 2012

Law Profs File Amicus Brief in Amgen in Support of Plaintiff

On November 5, 2012, the U.S. Supreme Court will hear oral argument in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds (No. 11-1085), in which plaintiff brought a Rule 10b-5 class action alleging material misstatements about the safety of two products used to treat anemia.  In this appeal from the 9th Circuit, the defendants assert that at the class certification stage plaintiff must  prove materiality and defendants must be allowed to present evidence rebutting the applicability of the fraud on the market theory.  The courts of appeals have split on this issue.

This week an amicus brief in support of plaintiff was filed by a group of law professors who teach civil procedure or securities regulation.  The brief agrees with the plaintiff that proof of materiality is neither required nor appropriate at the class certification stage, either to assure that common questions predominate under F.R.C.P. 23(b)(3) or to invoke the fraud on the market presumption under Basic.  The brief sets forth the history of Rule 23(b)(3) to show that the drafters had securities fraud class actions in mind.  It also sets forth the underlying principles of market manipulation that were familar to the drafters of section 10(b).  (Download No. 11-1085 bsac Civil Procedure and Securities Law Professors[1])

September 30, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Henning on Managerial Accountability

Making Sure 'The Buck Stops Here': Barring Executives for Corporate Violations, by Peter J. Henning, Wayne State University Law School, was recently posted on SSRN.  Here is the abstract:

There have been persistent complaints about managerial accountability since the advent of the financial crisis in 2008, especially the lack of criminal prosecutions of senior executives. In contrast, there is widespread criticism of “overcriminalization” and the use of criminal punishments to accomplish what are viewed as regulatory goals, such as corporate compliance. So while there is frustration at the lack of prosecutions, there are complaints that there are too many prosecutions. The criminal law is a poor means to engage in oversight of corporate governance, especially of senior managers who are largely insulated from day-to-day decision-making that often triggers violations. In this article, I offer a modest means to police management of public companies and large investment firms by enhancing the authority of the Securities and Exchange Commission to seek the removal of executives when the company has engage in persistent or serious misconduct, even if the individuals were not directly implicated in a violation. This authority already exists in a limited form in certain industries, and a wider application of it could be a way to address concerns about managerial accountability for corporate criminal conduct.

September 30, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Fisch on Price Distortion after Halliburton

The Trouble with Basic: Price Distortion after Halliburton, by Jill E. Fisch, University of Pennsylvania Law School - Institute for Law and Economics, was recently posted on SSRN.  Here is the abstract:

Many commentators credit the Supreme Court’s decision in Basic, Inc. v. Levinson, which allowed courts to presume reliance rather than requiring individualized proof, with spawning a vast industry of private securities fraud litigation. Today, the validity of Basic’s holding has come under attack as scholars have raised questions about the extent to which the capital markets are efficient. In truth, both these views are overstated. Basic’s adoption of the Fraud on the Market presumption reflected a retreat from prevailing lower court recognition that the application of a reliance requirement was inappropriate in the context of impersonal public market transactions. And, contrary to arguments currently being made to the Supreme Court in the Amgen case, FOTM does not require a strong degree of market efficiency – merely that market prices respond to information.

The Basic decision had another less widely recognized effect, however; it began shifting the nature of private securities fraud claims from transaction-based claims to market-based claims, a shift that was completed by the Court’s later decision in Dura. The consequence of this shift was to convert the nature of the plaintiff’s harm from a corruption of the investment decision to one of transacting at a distorted price.

The legal significance of price distortion was at the heart of the Halliburton decision. The lower court confused two temporally distinct concepts: ex ante price distortion, which is part of the reliance inquiry and ex post price distortion, which is a component of loss causation.

The Supreme Court limited its holding in Halliburton to identifying this confusion, leaving examination of the appropriate role of price distortion for future cases. In Amgen, the Court may be forced to tackle this question. This Article argues that Amgen highlights the incongruity of considering price distortion at the class certification stage and provides an opportunity for the Court to reconsider and reject Basic’s insistence on retaining a reliance requirement

September 30, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)