Securities Law Prof Blog

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

Friday, November 9, 2012

SEC Denies Motion to Stay Effective Date of Rule 13q-1 and amendments to Form SD

The SEC denied a motion submitted by the American Petroleum Institute, the U.S. Chamber of Commerce, and others, to stay the effective date of Exchange Act Rule 13q-1 and related amendments to Form SD.  (Rel. 34-68197, Nov. 8, 2012)

Section 13(q) directs the Commission to “issue final rules that require each resource extraction issuer to include in an annual report of the resource extraction issuer information relating to any payment made by the resource extraction issuer, a subsidiary of the resource extraction issuer, or an entity under the control of the resource extraction issuer to a foreign government or the Federal Government for the purpose of the commercial development of oil, natural gas, or minerals[.]” The Commission adopted Rule 13q-1 and amended new Form SD to implement the Section 13(q) disclosure requirements. A resource extraction issuer must comply with the new rules and form for fiscal years ending after September 30, 2013, and each annual report will be due no later than 150 days after the end of the issuer’s most recent fiscal year. Accordingly, the first reports under Rule 13q-1 would not be due until February 28, 2014 at the earliest.

The Petroleum Institute, and others, have filed a petition for review in the D.C. courts challenging the rule and related amendments to Form SD.  On Nov. 1, the D.C. court of appeals directed expedited briefing and argument.  Because of this, the SEC found that movants failed to carry their burden to demonstrate imminent, irreparable harm.

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

SEC Charges Bogus Credit Union with Offering Fraud

The SEC filed a civil injunctive action against Stanley B. McDuffie, a resident of Denver, Colorado, and his entity, Jilapuhn, Inc., d/b/a Her Majesty's Credit Union (HMCU), in connection with a fraudulent and unregistered offering through which McDuffie and HMCU sold more than $532,000 in alleged certificates of deposits (CDs) to investors.  In its complaint, the Commission alleges that from 2008 to 2012, McDuffie and HMCU lured investors to purchase the CDs through the HMCU website and a branch office in the U.S. Virgin Islands. McDuffie and HMCU held out HMCU as a secure, legitimate, regulated credit union, promised to pay above-market interest rates, and assured investors that their deposits were insured by Lloyd's of London or the U.S. Virgin Islands' government. In reality, HMCU was an unregulated, illegitimate credit union that never held share insurance covering investor deposits, and McDuffie and HMCU misappropriated investors' funds.

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

SEC Charges Executives and Auditor of Electronic Game Company will Fraud

The SEC today charged three executives of Electronic Game Card Inc. (EGMI) with repeatedly lying to investors about the operations and financial condition of the company that purported to sell credit card-size electronic games. The SEC also charged the company’s independent auditor with facilitating the scheme.

The SEC alleges that chief executive officer Lee Cole and chief financial officer Linden Boyne orchestrated a scheme in which EGMI enticed investors by claiming to have millions of dollars in annual revenue, hold millions of dollars in investments, and own an off-shore bank account worth more than $10 million. In reality, many of the company’s purported contracts were phony, the purported investments were merely in entities affiliated with Cole or Boyne, and the bank account did not exist. As a result of EGMI’s false claims, the company’s outstanding common stock was once valued as high as $150 million. EGMI is now bankrupt and its stock is worthless.

The SEC also charged the company’s outside auditor — certified public accountant Timothy Quintanilla — with repeatedly issuing clean audit opinions about EGMI based on reckless and deficient audit work. Also charged is Kevin Donovan, who later replaced Cole as CEO and ignored many red flags about the accuracy of the company’s public statements and the integrity of Cole and Boyne. He provided false information during conference calls with analysts and investors.

The SEC’s complaint seeks, among other things, a final judgment ordering Cole, Boyne, Donovan, and Quintanilla to pay financial penalties and permanently enjoining them from future violations of the securities laws; enjoining Cole, Boyne, and Donovan from serving as officers and directors of public companies and from participating in penny stock offerings; and ordering Cole, Boyne, and Quintanilla to disgorge their ill-gotten gains with prejudgment interest.

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

Thursday, November 8, 2012

SEC Charges Louisiana Investment Adviser with Hiding Losses from RMBS

The SEC charged Walter A. Morales, a hedge fund manager in Baton Rouge, La., with defrauding investors by hiding millions of dollars in losses suffered during the financial crisis from investments tied to residential mortgage-backed securities (RMBS). The SEC alleges that Morales and his firm Commonwealth Advisors Inc. caused the hedge funds they managed to buy the lowest and riskiest tranches of a collateralized debt obligation (CDO) called Collybus. They sold mortgage-backed securities into the CDO at prices they had obtained four months earlier while knowing that the RMBS market had declined precipitously in the meantime. As the CDO investments continued to perform poorly, Morales instructed Commonwealth employees to conduct a series of manipulative trades between the hedge funds they advised (called cross-trades) in order to conceal a $32 million loss experienced by one of the funds in its Collybus investment. Morales and Commonwealth lied to investors about the amount and value of mortgage-backed assets held in the hedge funds, and they created phony internal documents to justify their false valuations.

According to the SEC’s complaint filed in U.S. District Court for the Middle District of Louisiana, Commonwealth’s hedge fund clients included pension funds and individual investors.

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

FINRA Expels Hudson Valley Capital Management & Bars CEO for Defrauding Clearing Firm and Customers

FINRA has expelled NY-based Hudson Valley Capital Management and barred Chief Executive Officer, Mark Gillis, from the securities industry for defrauding its clearing firm and customers by using their funds and securities to cover losses caused by Gillis' manipulative day trading.

FINRA found that in 2012, Hudson Valley, acting through Gillis, used the firm's Average Price Account to improperly day trade millions of dollars of stock. Gillis then manipulated the share prices of these stocks and withdrew the proceeds of his day trading through accounts he controlled. When Gillis' fraudulent trading caused significant losses in the firm's account, he covered those losses by making unauthorized trades involving customer accounts. Gillis purchased thousands of shares of securities in the open market in the firm's account and allocated these shares to customers at markups between 177 percent and 280 percent. Gillis also converted a customer's funds to pay for an unauthorized stock purchase and caused another customer to sustain a loss of approximately $400,000. When confronted about unauthorized trades that occurred in their accounts, Gillis lied to two customers about the transactions to hide his misconduct, and lied to FINRA staff during sworn testimony.

Gillis' scheme caused a net capital deficiency for Hudson Valley in excess of $350,000.


November 8, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 7, 2012

SEC Announces Agenda for Small Business Capital Formation Forum

The SEC announced the agenda and panelists for the November 15 Government-Business Forum on Small Business Capital Formation.  The Forum will focus on JOBS Act implementation, as well as small business capital formation issues not addressed by the JOBS Act. In the afternoon, breakout groups will develop recommendations on a variety of issues related to small business capital formation.

November 7, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 6, 2012

Chamber to Geithner: Don't Mess with Money Market Funds

The U.S. Chamber of Commerce, in a letter to Treasury Secretary Timothy Geithner, expressed its concern about Treasury's request that the Financial Stability Oversight Council (FSOC) use its authority, under Dodd-Frank 120, to recommend changes to the SEC's regulation of money market funds.  Such action would, it warns, "create uncertainty, weaken financial regulation, harm investors, and damage the capital formation process needed for businesses to grow and create jobs."

The Chamber faults the SEC for "failing to do any of the necessary work to study the impact of prior money market mutual fund reforms and identify any additional needed changes."   The Chamber requests that Treasury withdraw its request and instead encourage the SEC to consider a different approach.  The Chamber understands that the SEC is moving forward with a study of the impact of the 2010 reforms.   Only after completion of that study and any proposed course of action by the SEC should the Council consider using its authority under Dodd-Frank 120.

Download Chamber letter to Geithner[1]

November 6, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Issues Guidance on Disputes Between Investors and Non-Member IAs

FINRA Dispute Resolution recently announced that it would make its arbitration forum available to non-member investment advisers and has posted on its website Guidance on Disputes between Investors and Investment Advisers who are not FINRA-regulated firms.  FINRA will accept disputes between investors and non-member IAs on a "voluntary, case-by-case basis" if the parties meet the following conditions:

  • The IA and investor submit a post-dispute agreement to arbitrate.
  • The IA or other parties agree to pay all arbitration surcharge fees.
  • The investor files a special written submission agreement to submit the dispute to FINRA Dispute Resolution that is:
    Signed by all parties to the arbitration (including all investor parties and all IA parties).
    Signed after the events occurred that gave rise to the underlying dispute.

The special submission agreement requires the parties to acknowledge that:

  • FINRA cannot enforce awards entered against non-member IAs and/or their employees (because FINRA is not a Self-Regulatory Organization for IAs).
  • Prevailing parties may enforce awards entered against non-member IAs and/or their employees in a court of competent jurisdiction pursuant to applicable state or federal law.
  • FINRA may bar the IA from the forum in future cases if an IA fails to pay any award, settlement agreement, or FINRA fees.
  • FINRA and its arbitrators and mediators will be held harmless from liability arising in connection with the resolution of the parties’ dispute.
  • Disputes involving IAs will be administered in accordance with the SEC approved FINRA Codes of Arbitration Procedure.
  • The final award will be made publicly available.

FINRA will also accept industry disputes between non-member IAs and their employees on a voluntary, case-by-case basis if the parties meet the above conditions.  FINRA will offer mediation services for any IA disputes on a voluntary basis.



November 6, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, November 5, 2012

Supreme Court Hears Argument on Proving Materiality in FOTM Class Action

The Supreme Court heard oral argument today in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, in which the parties debate whether in a securities fraud class action courts must require proof of materiality before certifying a class based on the fraud-on-the-market (FOTM) theory and the related question of whether defendants must be allowed to present evidence rebutting the applicability of the FOTM theory at the class certification stage.

Seth Waxman, arguing on behalf of the petitioners/defendants, argued that each of the four predicates to the FOTM theory is common:  market efficiency, public nature of statement, transactions in the stock during the period of market distortion, and materiality.  Therefore, they should be treated similarly; each must be established at the class certification stage and again at trial.  He drew a distinction between a judicial determination of materiality at the class certification stage and at a subsequent summary judgment stage, which elicited some questioning and requests for clarification from the Justices.  He then addressed the purpose of Fed. R. Civ. Pro. 23, which he asserted was for the court to determine whether all of the preconditions for “forcing everyone into a class action” are present before certification. 

David C. Frederick, arguing on behalf of respondent/plaintiff, started his argument with Basic and asserted that the Court indicated that materiality did not have to be proved at the class certification stage.  With respect to Rule 23(b)(3), because materiality always generates a common answer for all class members, it is the quintessential common issue that does not cause the class to be noncohesive for purposes of deciding predominance.  He emphasized that in a FOTM case, the only theory of reliance that is being advanced is indirect reliance on the integrity of the market; efficiency and publicity serve gate-keeping functions at the class certification stage, while materiality does not.  This led to questioning about the distinctions he was making.  Mr. Frederick also argued that Congress already addressed the concerns about securities fraud class actions in the PSLRA.

Melissa Arbus Sherry argued on behalf of the United States, as amicus curiae supporting the respondent.  She focused on Rule 23 and the predominance requirement and also argued that materiality was different from efficiency and publicity, which again drew questioning from the Justices.  She also argued Congressional intent.

It is difficult to “read” the Justices’ reactions to the counsel’s arguments from the written transcript.   Nevertheless, nearly all the Justices questioned why materiality should be treated differently from the other predicates to FOTM.  In addition, at least two Justices appeared to be thinking about policy implications.  Justice Scalia suggested that perhaps the FOTM theory should be overruled as based on bad theory, and Justice Kennedy noted that post-Basic economic scholarship has shown that the efficient market theory is “really an overgeneralization.”

Download Transcript.11-1085[1]

November 5, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

FINRA Files Cease & Desist Order Against WR Rice Financial Alleging Fraudulent Sales of Limited Partnership Interests

FINRA filed a Temporary Cease-and-Desist Order (TCDO) today to halt further fraudulent sales activities by Michigan-based WR Rice Financial Services and its owner Joel I. Wilson, as well as the conversion of investors' funds or assets. FINRA also issued a complaint against WR Rice and Wilson charging fraud in the sales of limited partnership interests in entities affiliated with the Diversified Group and American Realty Funds Corporation, companies in which Wilson has ownership interest and control. FINRA is filing the TCDO based on the belief that ongoing customer harm and depletion of customer assets would likely continue before a formal disciplinary proceeding against WR Rice and Wilson could be completed.

In its complaint, FINRA alleges that WR Rice, Wilson and other registered representatives at the firm sold more than $4.5 million in limited partnership interests to approximately 100 investors from predominantly low-to-moderate-income households, while misrepresenting or omitting material facts. FINRA charges that Wilson and WR Rice raised funds promising that the proceeds would be invested in land contracts on residential real estate in Michigan, paying an interest rate of 9.9 percent, when in fact, investors' funds were used to make unsecured loans to companies Wilson owned or controlled. In addition, FINRA alleges that WR Rice and Wilson failed to disclose to investors that Wilson extended the improper loans due to an inability to pay them as they became due.


November 5, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Sunday, November 4, 2012

Davidoff & Hill on Limits of Disclosure

Limits of Disclosure, by Steven M. Davidoff, Ohio State University (OSU) - Michael E. Moritz College of Law; Ohio State University (OSU) - Department of Finance, and Claire A. Hill, University of Minnesota, Twin Cities - School of Law, was recently posted on SSRN.  Here is the abstract:

Disclosure has its limits. One big focus of attention, criticism, and proposals for reform in the aftermath of the 2008 financial crisis has been securities disclosure. But most of the criticisms of disclosure relate to retail investors. The securities at issue in the crisis were mostly sold to sophisticated institutions. Whatever retail investors’ shortcomings may be, we would expect sophisticated investors to make well-informed investment decisions. But many sophisticated investors appear to have made investment decisions without making much use of the disclosure. We discuss another example where disclosure did not work as intended: executive compensation. The theory behind more expansive executive compensation disclosures was that shareholders might react to the disclosures with outrage and action, and companies, anticipating shareholder reaction, would curtail their compensation pre-emptively. But it was apparently not the reality and instead compensation spiraled higher.

The two examples, taken together, serve to elucidate our broader point: underlying the rationale for disclosure are common sense views about how people make decisions — views that turn out to be importantly incomplete. This does not argue for making considerably less use of disclosure. But it does sound some cautionary notes. The strong allure of the disclosure solution is unfortunate, although perhaps unavoidable. The admittedly nebulous bottom line is this: disclosure is too often a convenient path for policymakers and many others looking to take action and hold onto comforting beliefs in the face of a bad outcome. Disclosure’s limits reveal yet again the need for a nuanced view of human nature that can better inform policy decisions.

November 4, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Johnson on Regulatory Arbitrage & Global OTC Derivative Regulation

Regulatory Arbitrage, Extraterritorial Jurisdiction and Dodd-Frank: The Implications of US Global OTC Derivative Regulation, by Christian A. Johnson, University of Utah College of Law, was recently posted on SSRN.  Here is the abstract:

A review of the Dodd–Frank rulemaking projects suggests that the U.S. has entered into a “race to the top” of over-the-counter derivative regulation. Many of the Dodd-Frank statutes and proposed rules go well beyond the relatively modest objectives agreed to by the G20 countries in 2009. These efforts in the U.S. create a legal environment ripe for regulatory arbitrage and the isolation of U.S. OTC derivative markets. Isolation results from participants simply abandoning U.S. markets because of overly aggressive U.S. regulation. Regulatory arbitrage occurs as both U.S. and non-U.S. persons attempt to structure their trading activities to avoid the extraterritorial reach of Dodd-Frank. This paper will discuss the regulatory arbitrage implications triggered by the Dodd-Frank reforms and concerns surrounding the extraterritorial powers given to the CFTC to enforce these mandates.

November 4, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Dent on Legalizing Insider Trading

Why Legalized Insider Trading Would Be a Disaster, by George W. Dent Jr., Case Western Reserve University School of Law, was recently posted on SSRN.  Here is the abstract:

Although insider trading is illegal and widely condemned, a stubborn minority still defends it as an efficient method of compensating executives and spurring innovation. However, their arguments depend on a crucial assumption that the scope of insider trading is constrained by the wealth of individual insiders. Accordingly, the abnormal profits realized by inside traders at the expense of outsiders are rarely or never so large as to cause outsiders to flee the affected stock. Similarly, the potential gains from insider trading are rarely if ever big enough to corrupt the managers’ conduct of the business. Thus insider trading generates benefits for stockholders that exceed their immediate losses from insider trading.

The theme of this note is that if insider trading were allowed, it would not be constrained by insiders’ wealth because insiders could obtain enough outside financing to fully exploit their informational advantage. In so doing they would inevitably muscle out public investors. Stock markets would drastically shrink if not disappear. The prospect of huge trading profits would tempt managers to alter many decisions and even to take steps damaging to the firm in ways that would be virtually impossible for corporate monitors to detect. The resulting damage to public shareholders would far exceed any benefits from insider trading. Individual companies cannot police insider trading. Accordingly, the case for legalizing insider trading is insupportable.

November 4, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)