Securities Law Prof Blog

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

Wednesday, November 21, 2012

Attorneys Plead to Fraud Charges in Profiting from Variable Annuities On Lives of Terminally-Ill

Two Rhode Island lawyers, Joseph Caramadre and Raymond Radhakrishnan, pleaded guilty to fraud in federal district court, for selling variable annuities to help investors profit off the deaths of terminally ill people.  Authorities said that the men concealed from the terminally-ill individuals and their families that their identities would be used on annuities purchased by Caramadre and others.  They were also charged with lying to insurers and the broker-dealers that processed the annuity applications.

InvNews, 'Death put' lawyer pleads guilty to fraud charge

November 21, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

Cantor Settles CFTC Charges for Allowing Customer Funds to Become Under-Segregated

The CFTC and Cantor Fitzgerald & Co. settled charges for failing to maintain sufficient funds in its customer segregation account for a period of three days, for failing to provide the CFTC timely notice of its under-segregation, as required, and for related supervisory failures. The CFTC order imposes a $700,000 civil monetary penalty and a cease and desist order on Cantor, and requires Cantor to undertake certain improvements to its internal controls to prevent future under-segregation violations and notification failures.

Cantor, as a registered FCM, is required to segregate customer funds from its own funds and on a daily basis compute the amount of customer funds required to be segregated. The CFTC order finds that, on three consecutive days, January 24 to January 26, 2012 (the “relevant period”), Cantor failed to maintain adequate segregated customer funds due to an inadvertent transfer of $3 million from its customer segregated funds account, instead of from Cantor’s house account, as intended. According to the order, on each of the three days, Cantor made the daily required computation to determine the amount of customer funds it needed to be on deposit to meet its segregation requirements. However, Cantor failed to realize it was under-segregated until January 27, 2012, when the Cantor operations department employee primarily responsible for determining Cantor’s daily segregation requirements returned to work after being out unexpectedly. The Cantor operations department immediately corrected the segregation deficiency and the firm came back into compliance with its segregation requirements by transferring the $3 million back into the customer segregated funds account.

The order also finds that Cantor had related supervisory failures by not having an adequate system of internal controls and procedures to ensure that daily segregation calculations were reviewed and deficiencies noted, appropriately escalated, and addressed. Cantor also lacked sufficient procedures and training concerning the regulatory requirements relating to segregation of customer funds and failed to have adequate procedures and controls relating to the transfer of funds to and from customer segregated funds accounts.

November 21, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 20, 2012

Treasury Official Rumored to be in the Running for SEC Chairman

According to the Wall St. Journal, Mary John Miller, Treasury's undersecretary for domestic finance, is a top contender to replace Mary Schapiro as Chairman of the SEC.  Last year she was responsible for managing the government's debt and its relations with capital market officials.  Before joining Treasury, she worked for T. Rowe Price Group.

WSJ, Treasury Official Seen as Potential SEC Chairman

November 20, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

New York Sues Credit Suisse For Misrepresentations about Residential Mortgage-Backed Securities

The New York AG filed a Martin Act complaint against Credit Suisse Securities (USA) LLC and its affiliates for making fraudulent misrepresentations and omissions to promote the sale of residential mortgage­-backed securities (RMBS) to investors.

According to the complaint, Credit Suisse deceived investors as to the care with which they evaluated the quality of mortgage loans packaged into residential mortgage-backed securities prior to 2008. RMBS sponsored and underwritten by Credit Suisse in 2006 and 2007 have suffered losses of approximately $11.2 billion. Credit Suisse led its investors to believe that the quality of the loans in its mortgage-backed securities had been carefully evaluated and would be continuously monitored. In fact, it failed to adequately evaluate the loans, ignored defects that its limited review did uncover, and kept its investors in the dark about the inadequacy of its review procedures and defects in the loans. The loans in Credit Suisse’s mortgage-backed securities included many that had been made to borrowers who were unable to repay the loans, were very likely to default, and ultimately did default in large numbers.

This complaint is the most recent enforcement action by the Residential Mortgage-Backed Securities Working Group, a state-federal task force created by President Obama earlier this year to investigate those responsible for misconduct contributing to the financial crisis through the pooling and sale of residential mortgage-backed securities.

November 20, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Ex-SAC Capital Trader Charged in $276 Million Insider Trading Scheme

The SEC and the DOJ have filed complaints in parallel actions, charging Mathew Martoma, a former trader at CR Intrinsic, a division of SAC Capital, with insider trading in pharma stocks Elan and Wyeth.  According to the government, which says defendant made $276 million in combined profits and avoided losses, he obtained confidential information about a drug trial for an Alzheimer's drug from Sidney Gilman, a neurology professor and leading expert in Alzheimer's, through an expert network firm.  Dr. Gilman has entered into a nonprosecution agreement with the U.S. Attorney and has agreed to settle the SEC charges, and is cooperating with both investigations.

According to the SEC’s complaint, Martoma received a $9.3 million bonus at the end of 2008 – a significant portion of which was attributable to the illegal profits that the hedge funds managed by CR Intrinsic and the other investment advisory firm had generated in this scheme. Dr. Gilman, who was generally paid $1,000 per hour as a consultant for the expert network firm, received more than $100,000 for his consultations with Martoma and others at the hedge fund advisory firms. Dr. Gilman also received approximately $79,000 from Elan for his consultations concerning bapi in 2007 and 2008.

According to the Wall St. Journal story, the criminal complaint implicates Steven A. Cohen, the founder of SAC Capital Advisors, by referring to him as "Portfolio Manager A," who authorized many of the trades.

WSJ, Steven Cohen Implicated in Alleged Insider-Trading Scheme .

 Peter Lattman, NY Times, Ex-SAC Capital Trader Charged in $276 Million Insider Scheme

SEC, SEC Charges Hedge Fund Firm CR Intrinsic and Two Others in $276 Million Insider Trading Scheme Involving Alzheimer's Drug


November 20, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Adopts Rule Establishing Credit Quality Standard to Replace Credit Rating Reference in Investment Co. Act Exemption

The SEC adopted a new rule under the Investment Company Act to establish a standard of credit-worthiness in place of a statutory reference to credit ratings that the Dodd-Frank Act removes. The rule will establish the standard of credit quality that must be met by certain debt securities purchased by entities relying on the Investment Company Act exemption for business and industrial development companies.  The rule becomes effective 30 days after publication in the Federal Register.

(Download Ic-30268[1])

November 20, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, November 19, 2012

SEC Charges Ring of High School Buddies with Insider Trading in Health Care Stocks

The SEC today charged three health care company employees and four others in a insider trading ring of high school buddies," generating $1.7 million in illegal profits and kickbacks by trading in advance of 11 public announcements involving mergers, a drug approval application, and quarterly earnings of pharmaceutical companies and medical technology firms.

The SEC alleges that Celgene Corporation's director of financial reporting John Lazorchak, Sanofi S.A.'s director of accounting and reporting Mark S. Cupo, and Stryker Corporation's marketing employee Mark D. Foldy each illegally tipped confidential information about their companies for the purpose of insider trading. Typically the nonpublic information involved upcoming mergers or acquisitions, but Lazorchak also tipped confidential details about Celgene's quarterly earnings and the status of a Celgene application to expand the use of its drug Revlimid. According to the SEC, the trading was orchestrated so there was usually someone acting solely as a non-trading middleman who received the nonpublic information from the insider and tipped others. The insiders were later compensated for the inside information with cash payments made in installments to avoid any scrutiny of large cash withdrawals.

The SEC alleges that Cupo's friend Michael Castelli along with Lawrence Grum, who attended high school with Castelli, were the primary traders in the scheme. The other two traders charged are Lazorchak's high school friends Michael T. Pendolino and James N. Deprado. In a parallel criminal action, the U.S. Attorney's Office for the District of New Jersey today announced criminal charges against Lazorchak, Cupo, Foldy, Castelli, Grum, and Pendolino.

The SEC is seeking permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest, financial penalties, and officer and director bars for Lazorchak, Cupo, and Foldy.

November 19, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Refco's Former Outside Counsel Again Convicted of Deceiving Investors

Joseph Collins, former Mayer Brown partner and outside counsel for failed futures firm Refco, Inc., was convicted last week by a Manhattan jury for the second time of fraud.  His prior conviction had been tossed because of communications between a juror and the trial judge without the presence of Collins' attorney.  The jury convicted him on seven counts on charges he helped Refco executives defraud investors by hiding transactions that concealed losses.

Bloomberg, Refco Lawyer, A&O, Mayer Brown, Skadden: Business of Law

November 19, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

Sunday, November 18, 2012

Jeffries on Janus and Collective Scienter

The Implications of Janus on the Liability of Issuers in Jurisdictions Rejecting Collective Scienter, by N. Browning Jeffries, Atlanta's John Marshall Law School, was recently posted on SSRN.  Here is the abstract:

This article addresses the increasing limitations placed on both the Securities and Exchange Commission (“SEC”) and private litigants to pursue claims of fraud against wrongdoers under the federal securities laws, specifically for claims of misrepresentation under Section 10(b) of the Securities Exchange Act of 1934 and the SEC’s Rule 10b-5. The most recent and glaring example of this curtailment occurred in 2011 with the United States Supreme Court’s decision in Janus Capital Group, Inc. v. First Derivative Traders. For a defendant to be liable for a misrepresentation, Rule 10b-5(b) requires that the defendant be the “maker” of the false statement. The Janus decision significantly limits the universe of individuals who can be considered a “maker” of a misstatement for purposes of 10b-5 liability. After Janus, merely participating in the preparation or publication of a statement, even if that involvement is significant, is not sufficient to subject one to 10b-5 liability as a “maker.”

As lower courts have interpreted Janus, they have extended its holding to corporate insiders such as officers, directors, and employees of an issuer. Though lower courts have not found that Janus serves as an outright bar to bringing claims against corporate insiders, in order to satisfy the definition of “maker” set forth in Janus, it appears that the misrepresentation must have been publicly attributed to the insider for liability to attach. But the person to whom public statements are publicly attributed is not necessarily the same person who has scienter, a required element for establishing 10b-5 liability. As such, scenarios will frequently arise where a plaintiff is unable to establish liability of any insider because the individual with scienter is not considered the “maker” after Janus, and the only insider who may be viewed as the “maker” had no reason to know that the public statements attributed to him or her contained misrepresentations.

Even more troubling than the impact of Janus on the potential liability of culpable insiders, however, is the fact that, in many jurisdictions, Janus may thwart claims against even the issuer to which the misstatement is attributed. Although a plaintiff typically can establish the scienter of a corporation by imputing to the corporation the scienter of one or more culpable officers, directors, or employees, some jurisdictions require, for imputation purposes, that the individual with the requisite scienter also be the “maker” of the statement. Such jurisdictions have rejected the theory commonly referred to as “collective scienter,” which allows a court to impute to the corporation the scienter of some or all of the employees, even where none of the wrongdoers are necessarily the “maker” or where the wrongdoer has not yet been identified. As such, in jurisdictions rejecting collective scienter, courts may refuse to impute the sceinter of the individual to the corporation where the individual with scienter is not the person who made the misrepresentation. In the wake of Janus, which curtails the universe of potential “makers” of a statement, plaintiffs in such jurisdictions may not be able to identify any defendant with the requisite scienter – not even the issuer itself. Consequently, plaintiffs may have no defendant against whom they can pursue a 10b-5 claim, even in the face of blatant fraud. And since Janus has been extended beyond private suits to SEC enforcement actions as well, this significant limitation has an even greater impact.

This article explores the implications of Janus on the liability of primary actors – the issuer itself and its corporate insiders. The article analyzes the lower courts’ interpretations of Janus in the year since it was decided, and addresses the liability gaps the decision has created, particularly when viewed in connection with previously-existing precedent in jurisdictions rejecting collective scienter. The article argues that the limitations imposed by Janus do not accurately reflect the realities of the marketplace, where statements made available to the public are a product of diffuse responsibility of a team of individuals, rather than attributable to one and only one “maker.” After discussing policy considerations that weigh in favor of warranting a more expansive view of liability for fraudulent misrepresentations than that permitted by Janus, the article proposes some potential solutions to the liability gaps established by Janus, including a call for legislative action.

November 18, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Manns on Rating Agency Reform

Downgrading Rating Agency Reform, by Jeffrey Manns, George Washington University Law School, was recently posted on SSRN.  Here is the abstract:

The Dodd-Frank Act promised to usher in sweeping changes to overhaul the rating agency industry whose shortcomings helped to pave the way to the financial crisis. But two years after the Act’s passage, hopes have given way to disappointment. The most important challenges of how to enhance rating agency competition, accuracy, and accountability remain largely open questions. The Securities & Exchange Commission (SEC) has made progress in heightening rating agency oversight and addressing the most egregious abuses that fueled the financial crisis. But rating agency reforms have fallen far short of their potential due to the Act’s competing objectives to marginalize ratings, to expose rating agencies to greater sunlight and private liability exposure, and to treat rating agencies as a regulated industry. The most important part of the Act remains the most unresolved: the SEC’s mandate to design an alternative for the issuer-pays system that addresses the conflicts of interest created by debt issuers selecting their rating agency gatekeepers. Prospects for an independent commission to select rating agencies for structured finance products have foundered due to the challenges of crafting benchmarks for rating agency performance to use in selecting rating agencies and holding them accountable. The danger is that any standard chosen for rating agencies could fuel herding effects as rating agencies may shape their methodologies to game the system, rather than to enhance accurate and timely assessments of credit risk. Given the difficulties in resolving this issue, this Article suggests that policymakers should consider alternative ways to enhance competition such as by using regulatory incentives to break up the leading rating agencies, so that smaller rating agencies can more plausibly compete. Additionally, it suggests the potential for expanding the scope of private enforcement opportunities to leverage the self-interest of issuers to prosecute grossly negligent conduct by rating agencies. This approach would complement the SEC’s ongoing efforts to foster greater competition and accountability

November 18, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Birdthistle on Janus

The Supreme Court's Theory of the Fund, by William A. Birdthistle, Chicago-Kent College of Law, was recently posted on SSRN.  Here is the abstract:

Just as the firm has long served as the foundational molecule of the U.S. capitalist economy, theories of the firm have for more than a century dominated legal and economic discourse. Ever since Ronald Coase published The Nature of the Firm in 1937 and asked why firms should exist in an efficient market, classicists and neoclassicists have competed to develop theories — predominantly managerialist and contractual — that best explain the structure and behavior of business organizations.

The investment fund, by contrast, has languished at the margins of corporate theory, relegated as simply a minor, if somewhat curious, example of the firm. But as the flow of assets into funds has swollen dramatically in recent years, so too has the relevance of the question whether funds are, in fact, best considered a subspecies of the firm or instead ought to be evaluated as independent phenomena.

Part II of this Article discusses the shortcomings of the recent ruling in Janus Capital Group v. First Derivative Traders, taking particular exception with the remarkable formalism of the majority’s reasoning, which appears to ignore or misapprehend the actual operations of mutual funds. If operating companies follow the lead of investment funds and use Janus as a model for immunity against securities litigation, deterrence of financial fraud is likely to drop substantially. Part III considers the potentially deleterious implications of the Court’s fund jurisprudence and predicts that substantial mischief will flow from the decision should its lessons be taken advantage of in other sectors of the economy. Part IV considers the theoretical lens — the theory of the fund — that justices of the Supreme Court appear to use to examine investment funds, and it identifies mistaken assumptions and problems with that lens and its use in the pair of recent rulings in Janus and Jones v. Harris. This Article considers whether alternative theories of the firm might inform a more useful theory of the fund for both the judicial and legislative branches in the future.

November 18, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Perino on Institutional Fiduciaries as Lead Plaintiffs

Have Institutional Fiduciaries Improved Securities Class Actions? A Review of the Empirical Literature on the Pslra's Lead Plaintiff Provision, by Michael A. Perino, St. John's University School of Law, was recently posted on SSRN.  Here is the abstract:

In 1995, Congress substantially revamped the governance of securities class actions when it created the lead plaintiff provision as part of the Private Securities Litigation Reform Act. This paper reviews the empirical literature evaluating that provision. The story that emerges from these studies is of a largely successful statutory innovation that has markedly improved the conduct of these cases. There is little doubt that passage of the PSLRA spurred institutions to become more active in securities class actions. Overall, the results of that participation are positive. Existing studies demonstrate that cases with institutional lead plaintiffs settle for more and are subject to a lower rate of dismissal than cases with other kinds of lead plaintiffs, although some questions remain regarding whether these results are driven by institutional self-selection of higher quality cases. One study has shown that institutional participation is correlated with at least some improvements in corporate governance. Institutional lead plaintiffs have had their largest impact on attorneys’ fees. Not only is institutional participation correlated with lower fees and greater attorney effort, but there is evidence to suggest that institutions have created an economically significant positive externality — a reduction in fee awards even in cases without institutional plaintiffs. Institutional participation, however, has not been an unalloyed good. Other studies suggest that institutional investors are subject to their own agency costs, particularly in the form of pay-to-play arrangements with plaintiffs’ law firms. Those arrangements appear to eliminate some of the beneficial effects associated with institutional service as lead plaintiffs.

November 18, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)