Securities Law Prof Blog

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

Friday, November 30, 2012

Goldman Loses Effort to Enjoin FINRA Arbitration over Auction Rate Securities Issued by Reno

In Goldman Sachs & Co. v. City of Reno (D. Nv. Nov. 26, 2012)( Download GSvReno) the investment banker sought to preliminarily enjoin a FINRA arbitration brought against it by the City of Reno, in connection with the city's issuance of auction rate securities.  Goldman acted as underwriter and also as broker-dealer in the offerings.  Neither the underwriting nor the broker-dealer agreement contained an arbitration clause, and the broker-dealer agreement contained a forum selection clause that all proceedings would be brought in the federal district court in Nevada.  Goldman argued, therefore, that FINRA arbitration could not be maintained.  The court refused to issue a preliminary injunction, finding that the City was a "customer" of Goldman because of the broker-dealer agreement and therefore could bring an arbitration under FINRA Rule 12200, requiring arbitration if requested by a customer.

The court's analysis largely adopts the analysis of the Second Circuit in UBS Financial Services, Inc. v. W. Va. Univ. Hosps., Inc., 660 F.3d 643 (2d Cir. 2011).  The forum selection clause, it held, was not a waiver of arbitration, but only controlled the forum of a court action apart from, or in review of, arbitration.  It recognized that the investment banker may have an argument that the alleged wrongdoing in this case was not directly related to its broker-dealer functions, but this was an issue of arbitrability that Goldman, as a FINRA member, agreed to arbitrate.

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

Judge Posner Discusses Methods of Allocating Recovered Assets in Ponzi Schemes

A recent 7th Circuit opinion authored by Judge Posner, SEC v. Huber (No. 12-1285, Nov. 29, 2012)Download SECvHuber.112912[1], explores two alternative methods for allocating recovered assets to investors in a Ponzi scheme, the net loss method generally used in bankruptcy and the rising tide method which the SEC-appointed receiver used in this case.  Judge Posner explains the differences clearly and concisely (using graphs!).

Assume three investors lose money in a Ponzi scheme.  Each invested $150,000.  A withdrew $60,000 before the scheme collapsed; B withdrew $30,000; C made no withdrawals, for total losses of $360,000.  Assume receiver has $60,000 to distribute.  Under the net loss method, each investor would receive one-sixth of his losses:  A gets $15,000; B gets $20,000; C gets $25,000.  As a result, A recovered a total of $75,000; B recovered a total of $50,000; and C recovered $25,000.

In contrast, under the rising tide method,  withdrawals are considered part of the distribution received by an investor and so are subtracted from the amount of receivership assets to which he would be entitled if there had been no withdrawals.  In this example, then, for the "tide" to raise B and C as close to A as possible, B has to recover $15,000 in receiver assets, and C has to recover the remaining $45,000, so that the division among the three investors is 60-45-45 under this method.  (See the charts for a more complete explanation.)  Rising tide appears to be the method most commonly used in receiverships.

Judge Posner goes on to discuss whether rising tide discourages or encourages withdrawals from Ponzi scheme and finds that the public policy in bringing about the swift collapse of Ponzi schemes does not support one method over the other.  He notes that the net loss approach may be attractive when under rising tide a large number of investors would receive nothing, but finds that is not the case before him.  He also notes possible inconsistencies between approaches in receiverships and bankruptcy proceedings, before concluding that the investors had not shown that the district court abused its discretion in approving the reciever's use of rising tide.   

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

Thursday, November 29, 2012

SEC Charges Two Brokers with Insider Trading Ahead of IBM's Acquisition of SPSS

The SEC charged two retail brokers who formerly worked at a Connecticut-based broker-dealer with insider trading on nonpublic information ahead of IBM Corporation’s acquisition of SPSS Inc. According to the SEC's complaint, Thomas C. Conradt learned confidential details about the merger from his roommate, a research analyst who got the information from an attorney working on the transaction who discussed it in confidence. Conradt purchased SPSS securities and subsequently tipped his friend and fellow broker David J. Weishaus, who also traded. The insider trading yielded more than $1 million in illicit profits. The SEC’s investigation uncovered instant messages between Conradt and Weishaus where they openly discussed their illegal activity. The SEC’s investigation is continuing.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Conradt and Weishaus, who live in Denver and Baltimore respectively.

The SEC alleges that the research analyst’s attorney friend sought moral support, reassurance, and advice when he privately told the research analyst about his new assignment at work on the SPSS acquisition by IBM. In describing the magnitude of the assignment, the lawyer disclosed material, nonpublic information about the proposed transaction, including the anticipated transaction price and the identities of the acquiring and target companies. The associate expected the research analyst to maintain this information in confidence and refrain from trading on this information or disclosing it to others.

The SEC is seeking disgorgement of ill-gotten gains with prejudgment interest and financial penalties, and a permanent injunction against the brokers.

November 29, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 28, 2012

SEC Charges Former Delta Petroleum CEO with Tipping Friend

The SEC charged Roger Parker, the former CEO of Delta Petroleum Corporation, with being at the center of an insider trading scheme that the SEC began prosecuting last month.  According to the SEC’s complaint, the insider trading occurred in advance of Delta Petroleum's public announcement that private investment firm Tracinda had agreed to purchase a 35 percent stake in the company, which shot its stock value up by nearly 20 percent. The SEC initially charged insurance executive Michael Van Gilder for his illegal trading in the case, and is now additionally charging his source: Delta’s then-CEO Roger Parker.

The SEC’s amended complaint alleges that Parker illegally tipped his close friend Van Gilder and at least one other friend with confidential information about Tracinda’s impending investment and about Delta’s quarterly earnings. The insider trading in this case generated more than $890,000 in illicit profits.


November 28, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Fund Executives with Overvaluing Assets During Financial Crisis

The SEC charged three top executives at KCAP Financial Inc., a publicly-traded fund being regulated as a business development company (BDC), with overstating the fund’s assets during the financial crisis. The fund’s asset portfolio consisted primarily of corporate debt securities and investments in collateralized loan obligations (CLOs).  This is the SEC’s first enforcement action against a public company that failed to properly fair value its assets according to the applicable financial accounting standard — FAS 157 — which became effective for KCAP in the first quarter of 2008. The three executives agreed to pay financial penalties to settle the SEC’s charges.

According to the SEC, KCAP Financial Inc. did not account for certain market-based activity in determining the fair value of its debt securities and certain CLOs. KCAP also failed to disclose that the fund had valued its two largest CLO investments at cost. KCAP’s chief executive officer Dayl W. Pearson and chief investment officer R. Jonathan Corless had primary responsibility for calculating the fair value of KCAP’s debt securities, while KCAP’s former chief financial officer Michael I. Wirth had primary responsibility for calculating the fair value of KCAP’s CLOs. Wirth, a certified public accountant, prepared the disclosures about KCAP’s methodologies to fair value its CLOs, and Pearson reviewed those disclosures. KCAP did not record and report the fair value of its assets in accordance with Generally Accepted Accounting Principles (GAAP) and in particular FAS 157, which requires assets to be fair valued based on an “exit price” that reflects the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

November 28, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Charges President of TWS Financial with Affinity Fraud Directed at Polish Community

FINRA has filed a complaint against Roman Sledziejowski, President and owner of Brooklyn, NY-based brokerage firm TWS Financial, LLC, charging him with defrauding three customers of more than $4 million through a scheme, carried on primarily outside the securities firm, involving converting client funds to his personal use while providing falsified account statements to his customers. Sledziejowski, a Polish-born investment manager, and his firm TWS Financial, catered to the Polish investment community in Brooklyn, and all of his victims were natives of Poland. On November 9, 2012, TWS Financial filed an application to withdraw its broker-dealer registration.

In its complaint, FINRA alleges that between June 2009 and August 2012, as part of his scheme, Sledziejowski instructed the customers to wire funds from their bank accounts or brokerage accounts to Innovest Holdings LLC, a company wholly owned and controlled by Sledziejowski, separate from the broker-dealer, which, in turn, owned TWS, for various purported investment purposes, including acquiring a Polish bank and buying stock in a vodka company. In other instances, Sledziejowski wired funds directly from the customers' TWS brokerage accounts to Innovest Holdings without their knowledge or consent. In order to mask his misconduct, Sledziejowski provided customers with falsified account statements or "account snapshots," which were fictional accounts of their holdings in their TWS brokerage accounts or the values of those accounts. Additionally, when some of his customers raised questions about the value of their brokerage accounts or sought to withdraw funds from their accounts, Sledziejowski wired funds from Innovest's bank accounts back to their bank or brokerage accounts. To date, more than $3 million of the customers' funds remain unaccounted for. Sledziejowski also refused to comply with FINRA's request to appear for testimony to answer questions related to the misconduct in question.

November 28, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 27, 2012

Four India-Based Firms Settle SEC Charges They Were Unregistered Broker-Dealers

The SEC settled charges with four financial services firms based in India that they provided brokerage services to institutional investors in the United States without being registered with the SEC as required under the federal securities laws. The four firms – Ambit Capital Private Limited, Edelweiss Financial Services Limited, JM Financial Institutional Securities Private Limited, and Motilal Oswal Securities Limited – agreed to pay more than $1.8 million combined to settle the SEC’s charges.

According to the SEC’s orders against the firms, they engaged with U.S. investors in some of the following ways despite being unregistered broker-dealers:

Sponsored conferences in the U.S.
Had employees travel regularly to the U.S. to meet with investors.
Traded securities of India-based issuers on behalf of U.S. investors
Participated in securities offerings from India-based issuers to U.S. investors.

In their respective settlements, the firms agreed to be censured while neither admitting nor denying the SEC’s charges. Ambit agreed to pay disgorgement and prejudgment interest totaling $30,910. Edelweiss agreed to pay $568,347. JM Financial agreed to pay $443,545. Motilal agreed to pay $821,594.

November 27, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, November 26, 2012

Brummer on Transatlantic Credit Rating Agency Regulation

The New Politics of Transatlantic Credit Rating Agency Regulation, by Chris Brummer, Georgetown University Law Center, was recently posted on SSRN.  Here is the abstract:

In the years immediately leading up to the global financial crisis, and shortly thereafter, scholars envisaged a possible “convergence” of rules relating to the cross-border regulation of credit rating agencies (CRAs). This paper argues, however, that any full harmonization of approaches will, be difficult due to varying political and economic realities motivating CRA regulation on both sides of the Atlantic. To demonstrate, this article traces the regulation of CRAs from the early 1900s in the United States through today’s European debt crisis. It shows that Europe’s incentives to regulate CRAs have started to diverge from the United States as its economy has shifted from bank to capital market finance, as globalization internationalized the consequences of what was weak CRA governance in the United States, and as CRA ratings of sovereign debt have come to more directly impact EU officials’ ability to manage responses to the crisis. In the wake of these developments, European regulators are poised to adopt measures that may move beyond not only U.S. approaches, but also the consensus expressed in G-20 declarations and the IOSCO Code of Conduct.

November 26, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Omarova on Financial Conglomerates

The Merchants of Wall Street: Banking, Commerce, and Commodities, by Saule T. Omarova, University of North Carolina at Chapel Hill School of Law, was recently posted on SSRN.  Here is the abstract:

This article examines the principal legal, policy, and theoretical implications of a transformative – but so far unrecognized – change in the banking industry: the emergence, over the last decade, of U.S. financial conglomerates as leading global merchants in physical commodities, including crude and refined oil products, natural gas, coal, base metals, and wholesale electricity. Historically, one of the core principles of U.S. bank regulation has been the separation of banking from commerce. Several statutes – including the National Bank Act of 1863, the Bank Holding Company Act of 1956, the Gramm-Leach-Bliley Act of 1999, and even the Dodd-Frank Act of 2010 – affirm this foundational principle, which generally prohibits banks and bank holding companies from conducting commercial (i.e., non-financial) activities. Notwithstanding these statutory restrictions, however, large U.S. bank holding companies – notably, Morgan Stanley, Goldman Sachs, and JPMorgan – have since the early 2000s been moving aggressively into the purely commercial businesses of mining, processing, transporting, storing, and trading a wide range of vitally important physical commodities. And, equally surprisingly, it is virtually impossible under the current system of public disclosure and regulatory reporting to understand the true nature and scope of these institutions’ commodity activities.

This article puts together the first comprehensive account to date of what appears to be publicly knowable about the nature and scope of U.S. banking organizations’ physical commodities activities and analyzes the existing legal and regulatory framework for conducting such activities. Based on this analysis, the article advances several claims.

As a matter of legal doctrine, the article argues that the quiet transformation of U.S. bank holding companies into global commodity merchants effectively nullifies the foundational principle of separation of banking from commerce. It further argues that the currently existing statutory framework does not provide a sufficiently robust structure for the regulation and supervision of banking organizations’ extensive commercial operations in global commodity and energy markets.

As a normative matter, the article argues that banking organizations’ physical commodities activities raise potentially serious public policy concerns. These activities threaten to undermine the fundamental policy objectives that underlie the principle of separating banking from commerce: ensuring the safety and soundness of the U.S. banking system, maintaining a fair and efficient flow of credit in the economy, protecting market integrity, and preventing excessive concentration of economic power. In addition, banking organizations’ expansion into physical commodities implicates a distinct set of policy concerns relating to potential new sources and transmission channels of systemic risk, the integrity and efficacy of the regulatory process, and the governability of financial markets and institutions.

Finally, the article argues that these developments in banks’ activities raise fundamental theoretical and conceptual questions about the very nature and social functions of financial intermediation. A factually-grounded examination of large financial institutions’ physical commodity activities lays a necessary conceptual foundation for potentially reconfiguring the entire system of financial services regulation.

November 26, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Attorney Liable for Aiding Securities Fraud by Drafting False Opinion Letter

A federal district court (S.D.N.Y.)recently granted the SEC partial summary judgment against attorney Virginia K. Sourlis for aiding and abetting securities fraud by issuing a false legal opinion that certain of her co-defendants used to obtain illegally more than six million shares of unrestricted stock of Greenstone Holdings, Inc.  Securities and Exchange Commission v. Greenstone Holdings, Inc. et al.

According to the SEC's summary judgment motion, in early 2006, Sourlis intentionally authored a materially false and misleading legal opinion, which Greenstone used to illegally issue over six million shares of stock in unregistered transactions. Among other things, Sourlis falsely described promissory notes, note holders, and communications with those holders, none of which actually existed. The SEC asserted that, contrary to Sourlis' fraudulent opinion letter, the stock issuance did not qualify for an exemption from registration under the federal securities laws.

The Court held Sourlis liable for aiding and abetting securities fraud under Section 10(b) of the Securities Exchange Act of 1934 but denied the SEC summary judgment against Sourlis for primary liability under Section 10(b). The Court also reserved decision on the SEC's non-fraud claim that Sourlis violated Section 5 of the Securities Act of 1933.

November 26, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Schapiro Steps Down; Walter is new SEC Chair

SEC Chairman Mary Schapiro announced that she will leave the Commission on Dec. 12, concluding her nearly four-year tenure.  The SEC release notes that she is one of the longest serving SEC chairman, having served longer than 24 of the previous 28.  The release also include a list of SEC accomplishments under her tenure.  The White House has already named current SEC Commissioner Elisse B. Walter as the new Chair.  Several other names had been floated, but Ms. Walter gets the top job.  Her appointment does not require Senate confirmation, since she is a sitting Commissioner.

Here is Ms. Walter's bio from the SEC website:

Elisse B. Walter was appointed by President George W. Bush to the U.S. Securities and Exchange Commission and was sworn in on July 9, 2008. Under designation by President Barack Obama, she served as Acting Chairman during January 2009.

Prior to her appointment as an SEC Commissioner, Ms. Walter served as Senior Executive Vice President, Regulatory Policy & Programs, for FINRA. She held the same position at NASD before its 2007 consolidation with NYSE Member Regulation.

Ms. Walter coordinated policy issues across FINRA and oversaw a number of departments including Investment Company Regulation, Member Education and Training, Investor Education and Emerging Regulatory Issues. She also served on the Board of Directors of the FINRA Investor Education Foundation.

Prior to joining NASD, Ms. Walter served as the General Counsel of the Commodity Futures Trading Commission. Before joining the CFTC in 1994, Ms. Walter was the Deputy Director of the Division of Corporation Finance of the Securities and Exchange Commission. She served on the SEC's staff beginning in 1977, both in that Division and in the Office of the General Counsel. Before joining the SEC, Ms. Walter was an attorney with a private law firm.

Ms. Walter is a member of the Academy of Women Achievers of the YWCA of the City of New York and the inaugural class of the ABA's DirectWomen Institute. She also has received, among other honors, the Presidential Rank Award (Distinguished), the SEC Chairman's Award for Excellence, the SEC's Distinguished Service Award, and the Federal Bar Association's Philip Loomis and Manuel F. Cohen Younger Lawyer Awards.

She graduated from Yale University with a B.A., cum laude, in mathematics and received her J.D. degree, cum laude, from Harvard Law School. Ms. Walter is married to Ronald Alan Stern, and they have two sons, Jonathan and Evan.

Press accounts frequently describe Schapiro's four years as "bruising"  (e.g. NYTimes, Schapiro, Head of S.E.C., Announces Departure ).  She was charged with the task of restoring the agency's reputation after the Madoff scandal, restoring investor confidence in the securities markets after the financial crisis, and implementing reforms called for in the Dodd-Frank Act.  She is credited with re-invigorating the Enforcement Division, among other accomplishments.  However, she was frequently called to testify at Congressional oversight hearings that questioned the agency's competence on various issues, and an important SEC rule on proxy access was thrown out by the D.C. Circuit for insufficient analysis of the costs of the rule.  Most recently, the Commission was unable to reach consensus on additional regulation of money market funds. 



November 26, 2012 in News Stories, SEC Action | Permalink | Comments (0) | TrackBack (0)