Securities Law Prof Blog

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

Friday, March 22, 2013

Gender Parity as an Investment Strategy

There have been conflicting claims about whether the presence of women on corporate boards and in senior management improve the corporate bottom line.  Morgan Stanley is betting that it does; it is starting a "parity portfolio" that will invest in companies that have female representation on boards and cites research that "companies with significant female representation on boards and in senior leadership have stronger financials (return to shareholders, return on assets, return on equity, profit margins) than those that lack gender diversity in leadership."   According to a NY Times Dealbook column, this means companies with at least three women on their boards.  It strikes me that the portfolio won't be investing in a lot of companies!  

March 22, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)

Taub on the London Whale

Jennifer Taub (Vermont Law School) recently posted an insightful blog on the Senate Committee hearing on the JP Morgan Chase London Whale trading loss and the disturbing truths about the post-financial crisis state of risk management controls, too-big-to-fail and regulatory constraints.  Check it out here.

March 22, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

FINRA Proposes to Amend Rule Regarding Public Release of Disciplinary Complaints

FINRA has filed with the SEC a proposed rule change amending FINRA Rule 8313 (Release of Disciplinary Complaints, Decisions and Other Information) to make more information about disciplinary proceedings available to the public.  The SEC has put the proposal out for public comment. (Download 34-69178[1])

The proposed rule change generally would establish general standards for the release of disciplinary information to the public that would provide greater information about FINRA's disciplinary actions.  It would also clarify the scope of information subject to Rule 8313.

Rule 8313(a) currently provides that in response to a request FINRA shall release any identified disciplinary complaint or decision to the requesting party.  Absent a specific request for an identified complaint or decision, the rule provides publicity thresholds for the release of information to the public.  Thus, disciplinary information currently available in the FINRA Disciplinary Actions online database is limited by Rule 8313's publicity thresholds.  The proposed amendment would eliminate the publicity thresholds and in their place adopt general standards for the public release of the information and increase access to information about disciplinary actions.  Specifically, proposed Rule 8313(a)(1) would provide that FINRA shall release to the public a copy of, and at FINRA's discretion information with respect to, any disciplinary complaint or disciplinary decision issued by FINRA.  Subject to limited exceptions, FINRA would release the information in unredacted form. (Download 34-69178-ex5[1])

March 22, 2013 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Civil and Criminal Charges Brought Against Rengan Rajaratnam for Insider Trading

On Thursday the SEC charged Rajarengan “Rengan” Rajaratnam for his role in the massive insider trading scheme for which his older brother Raj Rajaratnam has been convicted.  According to the SEC, from 2006 to 2008, Rengan Rajaratnam repeatedly received inside information from his brother and reaped more than $3 million in illicit gains for himself and hedge funds that he managed at Galleon and Sedna Capital Management, a hedge fund advisory firm that he co-founded. In addition to illegally trading on inside tips, the SEC alleges that Rengan Rajaratnam was an active participant in his brother’s scheme to cultivate highly placed sources and extract confidential information for an unfair advantage over other traders.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Rengan Rajaratnam.

The SEC has now charged 33 defendants in its Galleon-related enforcement actions. The insider trading occurred in the securities of more than 15 companies for illicit gains totaling more than $96 million.

March 22, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, March 19, 2013

Former Oregon Gubernatorial Candidate Charged with Investor Fraud Involving Pre-IPO Shares of Facebook

This is a weird story:  Both the U.S. Attorney and the SEC have brought charges against Craig Berkman, a former Oregon gubernatorial candidate, alleging that he defrauded investors seeking to acquire highly coveted pre-IPO shares of Facebook and other social media companies.  According to the authorities, Berkman touted to investors that he had special access to scarce sources of pre-IPO stock in Facebook, LinkedIn, Groupon, and Zynga. Instead of purchasing shares on investors’ behalf as promised, Berkman misused their investments to make Ponzi-like payments to earlier investors, fund personal expenses, and pay off claims against him in a bankruptcy case.

The SEC also charged John B. Kern of Charleston, S.C., for his participation in the fraud as legal counsel to some of Berkman’s companies. When investors in Berkman’s phony Facebook fund began questioning what happened to their money after Facebook’s IPO occurred, Kern falsely assured them that their money was used to purchase pre-IPO Facebook stock being held for them by unnamed counterparties.

According to the SEC’s order instituting administrative proceedings, Berkman raised at least $13.2 million from 120 investors by selling membership interests in limited liability companies that he controlled and misappropriated virtually all investor funds that he raised.

The SEC’s order details a recidivist history for Berkman. The Oregon Division of Finance and Securities issued a cease-and-desist order and $50,000 fine against Berkman in 2001 for offering and selling convertible promissory notes without a brokerage license to Oregon residents. In June 2008, an Oregon jury found Berkman liable in a private action for breach of fiduciary duty, conversion of investor funds, and misrepresentation to investors arising from Berkman’s involvement with a series of purported venture capital funds known as Synectic Ventures. The court entered a $28 million judgment against Berkman. In March 2009, Synectic filed an involuntary Chapter 7 bankruptcy petition against Berkman in Florida for his unpaid debts arising from the 2008 court judgment. The parties to the bankruptcy proceeding reached a settlement with Berkman.

March 19, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

NASAA Cites Lack of Civil Recovery Options as Weakening Investor Confidence

The lack of civil recovery options for harmed investors is weakening the confidence of investors in financial products and markets, Heath Abshure, the president of the North American Securities Administrators Association (NASAA) said in a keynote speech delivered today at the Securities Industry and Financial Markets Association (SIFMA) Compliance and Legal Society Annual Meeting in Scottsdale, Arizona.

The virtual elimination of litigation as a dispute resolution option through mandatory arbitration clauses, coupled with increasing procedural and evidentiary burdens, will have profound effects on investors and their confidence in investment products and markets. Most troubling is that these remedies are decreasing just as the era of crowdfunding and general solicitation in Regulation D, Rule 506 offerings is about to launch.  This presents particular risks to small investors.


March 19, 2013 in State Securities Law | Permalink | Comments (0) | TrackBack (0)

FINRA and Charles Schwab's Class Action Waiver

Jill Gross and I critique the FINRA hearing panel's recent decision in a disciplinary proceeding against Charles Schwab, holding that FINRA's arbitration rule prohibiting class action waivers was unenforceable, at the CLS Blue Sky Blog.  Do Broker-Dealers Have a Green Light to Force Investors to Waive Class Actions in Court?

March 19, 2013 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Citigroup Settles Securities Class Action for $730 Million

Citigroup Inc. has agreed, subject to court approval, to settle a class action lawsuit brought on behalf of investors who purchased Citigroup debt and preferred stock in four dozen offerings during the period May 11, 2006, through November 28, 2008. Under the terms of the proposed settlement, Citi would pay a total of $730 million.  According to the WSJ, this is the second-largest settlement of investor litigation related to the financial crisis.

Plaintiffs alleged that Citigroup misled them about Citigroup's possible exposure to losses backed by home loans, understated its loss reserves and misrepresented the credit quality of some assets.

 Citigroup states that it denies the allegations and is entering into this settlement "solely to eliminate the uncertainties, burden and expense of further protracted litigation." The company released the following statement:

"This settlement is another significant step toward resolving our exposure to claims arising from the financial crisis, and we look forward to putting this matter behind us. Citi is a fundamentally different company today than at the beginning of the financial crisis. We have overhauled risk management and reduced risk exposures, while shedding assets and businesses that are not core to our strategy. We are completely focused on our clients and generating consistent, high-quality earnings."


March 19, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, March 18, 2013

FINRA's Arbitration Records Exempt from FOIA Disclosure: D.C. District Court

The D.C. district court recently rebuffed the efforts of an association of attorneys who represent public investors in securities arbitrations to obtain records related to the SEC's oversight of the FINRA arbitration forum under the Freedom of Information Act.  Public Investors Arbitration Bar Association v. SEC (No. 11-2285(BAH), Mar. 14, 2013).  Plaintiff sought records related to the arbitrator selection process of FINRA.  The court agreed with the SEC that the records were exempt under FOIA Exemption 8, which exempts from disclosure any matters "contained in or related to examination, operating, or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation or supervision of financial institutions." (Download PIABA.SEC)

The dispute centered on whether the records sought by plaintiff are "related to examination, operating, or condition reports prepared by, on behalf of, or for the use of" the SEC.  The court based its decision on the "plain meaning" of the exemption, as well the legislative purpose behind the exemption, which is to safeguard the relationship between the financial institution and its supervising agency, to ensure the institution's continuing cooperation.

The court also addressed an issue that the parties did not address: the definition of "financial institution" and its application to FINRA.  The plaintiff conceded that FINRA was a "financial institution" for purposes of Exemption 8, based on a 2010 amendment to the Securities Exchange Act.  The Court first reviewed the short history of in Dodd-Frank section 9291, which provided that the SEC shall not be compelled to disclose records obtained for regulatory and oversight activities.  Only a few months after its enactment, Congress repealed section 9291 because of its concern that it allowed the SEC to keep secret virtually any information it obtained through its examination authority.  However, at the same time it repealed section 9291, Congress amended the Securities Exchange Act to clarify that "any entity the SEC regulates under the Securities Exchange Act will be considered a financial institution for the purpose of FOIA Exemption 8."  The court expressed its puzzlement: "Congress appears to have given back with the FOIA what it simultaneously intended to take away by repealing Section 9291."  The Court also expressed skepticism that a self-regulatory organization like FINRA would qualify as a "financial institution" as that term is normally understood.  Nevertheless, it concluded that plaintiff's arguments about an overly broad exemption must be made to Congress, given the broad language.

March 18, 2013 in Judicial Opinions, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Second Circuit: Clearing Broker Owes No Disclosure Duty to Customers of Introducing Broker

A recent Second Circuit opinion, Levitt v. J.P. Morgan Securities (No. 10-4596-cv, Mar. 15, 2013), brought back memories of a notorious broker-dealer fraud.(Download Levitt 03152013[1])  Sterling Foster & Co. was a broker-dealer that engaged in numerous market manipulation schemes.  The allegations in this class action suit involve SF's activities as an underwriter for an IPO in the mid-1990s (!), in which it entered into secret agreements with the insiders to "pump-and-dump" the stock. The plaintiffs in this class action are former SF customers who purchased the securities in the IPO.  Since SF is no longer around, they seek to hold the clearing broker, Bear Stearns, liable alleging that it participated in the fraud.  The district court granted class certification on the Rule 10b-5 claim.  While acknowleding that it is "well-established" that a clearing broker owes no duty of disclosure to the clients of the introducing broker, the district court made an exception because "a preponderance of the evidence shows that Bear Stearns participated in Sterling Foster's scheme in such a way as to trigger a duty to disclose."

On appeal, however, the Second Circuit reversed.  In reviewing the precedent, the appellate court affirmed previous rulings that where a clearing broker provided normal clearing services, it would not be liable for the introducing broker's misconduct.  It also acknowledged a limited category of cases in which district courts have permitted claims to proceed against a clearing broker, in instances where the clearing broker "assumed direct control of the introducing firm's operations and its manipulative scheme."  However, the Second Circuit found that the district court misapplied this approach: the plaintiffs allege, at most, that Bear Stearns, "knowing of the fraud, joined in, permitted and facilitated said fraud and market manipulation;"  plaintiffs do not allege that Bear instigated or directed the manipulative scheme.  The Second Circuit held that this did not allege sufficient participation to create a duty of disclosure on the part of the clearing broker -- assuming that such a duty of disclosure existed in the first place.  Because there was no duty to disclose, plaintiffs could not avail themselves of the presumption of reliance under Affiliated Ute.  Accordingly, plaintiffs could not satisfy the predominance requirement of Rule 23(b)(3).

March 18, 2013 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Sunday, March 17, 2013

Former Mercury GC Settles Options Backdating Charges

Some of the SEC's cases involving options backdating have lingered on for years.  One of them, involving the former General Counsel at Mercury Interactive, has finally come to an end.  Susan Skaer consented to the entry of a permanent injunction and will pay $628,037 in disgorgement and prejudgment interest, representing the "in-the-money" benefit from her exercise of backdated option grants, and a $225,000 civil penalty. The settlement is subject to the approval of the United States District Court for the Northern District of California.

On May 31, 2007, the Commission charged three other former senior Mercury officers and Skaer with perpetrating a scheme from 1997 to 2005 to award Mercury executives and other employees undisclosed, secret compensation by backdating stock option grants and failing to record hundreds of millions of dollars of compensation expense. The Commission's Complaint also alleged other misconduct by Skaer related to the award of stock options to Mercury executives and employees.

The settlement with Skaer, if approved, will conclude the litigation.

March 17, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

UCincinnati Symposium on Enforcement Practices in the Post-Financial Crisis Era

On March 15 the Corporate Law Center at the University of Cincinnati College of Law presented the 26th Annual Corporate Law Symposium, which focused on Addressing the Challenges of Protecting the Public: Enforcement Practices and Policies in the Post-Financial Crisis Era.  The webcast with be posted on the CLC website in a few days; meanwhile, here's the list of the speakers and the titles of the papers they presented.  The papers will be published in a forthcoming issue of the University of Cincinnati Law Review.

Panel I: Securities Enforcement: the SEC and FINRA
Moderator:  Verity Winship
 ■Douglas Branson, SEC Enforcement: A New Era for Broker-Dealer Regulation
 ■Jennifer Johnson, Sinking in the Sea Change?  FINRA and the Regulation of Non-Public Offerings
 ■Renee Jones, Utilizing the Director Bar to Enforce Corporate Accountability
 ■Geoffrey Rapp, An Analysis of the SEC’s New Office of Market Intelligence

Distinguished Guest Speaker: David M. Becker; Cleary, Gottlieb

Mr. Becker discussed the challenges facing the SEC from the vantage point of his many years of experience both in private practice and in senior policy positions at the SEC.
Panel II: Policy Implications in Public Enforcement
Moderator:  Amanda M. Rose
 ■Samuel Buell,  Liability and Admissions of Wrongdoing in Public Enforcement of Law (posted on SSRN)
 ■J.W. Verret, Overcriminalization and its Consequences
 ■Adam Zimmerman, Executive Branch Compensation Settlements      

State Securities Regulation Roundtable
A panel discusses cutting-edge issues that especially concern state securities regulators.    

 Moderator: Jennifer Johnson  
 ■Joseph Brady, General Counsel, North American Securities Administrators Association
 ■Chris Naylor, Indiana Securities Commissioner
 ■Andrea L. Seidt, Commissioner, Ohio Dept. of Commerce, Division of Securities


March 17, 2013 in Law Review Articles, Professional Announcements | Permalink | Comments (0) | TrackBack (0)

Rose & Walker on Cost Benefit Analysis in Financial Regulation

The Importance of Cost-Benefit Analysis in Financial Regulation, by Paul Rose, Ohio State University (OSU) - Michael E. Moritz College of Law, and Christopher J. Walker, Ohio State University (OSU) - Michael E. Moritz College of Law, was recently posted on SSRN.  This is a Report for U.S. Chamber of Commerce & Law and Capital Markets @ Ohio State, 2013.  Here is the abstract:

This report reviews the role, history, and application of cost-benefit analysis in rulemaking by financial services regulators.

For more than three decades — under both Democratic and Republican administrations — cost-benefit analysis has been a fundamental tool of effective regulation. There has been strong bipartisan support for ensuring regulators maximize the benefits of proposed regulations while implementing them in the most cost-effective manner possible. In short, it is both the right thing to do and the required thing to do.

Through the use of cost-benefit analysis in financial services regulation, regulators can determine if their proposals will actually work to solve the problem they are seeking to address. Basing regulations on the best available data is not a legal “hurdle” for regulators to overcome as they draft rules, as some have described it, but rather a fundamental building block to ensure regulations work as intended.

Not only do history and policy justify the use of cost-benefit analysis in financial regulation, but the law requires its use. In a trio of decisions culminating in its much-publicized 2011 decision in Business Roundtable and U.S. Chamber of Commerce v. SEC, the D.C. Circuit has interpreted the statutes governing the Securities and Exchange Commission (SEC) to require the agency to consider the costs and benefits of a proposed regulation. Thus, the SEC’s failure to adequately conduct cost-benefit analysis, the D.C. Circuit has held, violates the Administrative Procedure Act. These judicial decisions have supporters as well as critics. However, the SEC’s response is telling: the SEC did not seek further judicial review, but instead issued a guidance memorandum in March 2012 that embraced virtually all of the instructions the D.C. Circuit had provided in its decisions. It remains to be seen whether the SEC will put its new guidance memorandum into practice.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) only elevates the importance of cost-benefit analysis in financial regulation. By requiring nearly 400 rulemakings spread across more than 20 regulatory agencies, implementing Dodd-Frank is an unprecedented challenge for both regulators and regulated entities. The scale and scope of regulations have made it even more important, despite the short deadlines, for regulators to ensure they adequately consider the effectiveness and consequences of their proposals.

Accordingly, we recommend that all financial services regulators should follow similar protocols found in the SEC guidance memorandum and apply rigorous cost-benefit analysis to improve rulemaking and put in place more effective regulations. These steps also promote good government and improve democratic accountability.

There is widespread agreement that ineffective and outdated financial regulation contributed to the financial crisis. As regulators seek to address that, they must take every reasonable step to ensure that their proposals work. This starts with grounding all proposals in an economic analysis to better achieve the desired benefits and better understand the possible consequences and costs that may result from their actions.

March 17, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Buell on the White Collar Offender

Is the White Collar Offender Privileged?, by Samuel W. Buell , Duke University School of Law, was recently posted on SSRN.  Here is the abstract:

For at least a decade, and especially since the banking catastrophe, much public commentary has asserted or implied that the American criminal justice system unjustly privileges individuals who commit crimes in corporations and financial markets. This Article demonstrates that this claim is not so, at least not in the ways commonly believed. Law and practice controlling sentencing, evidence, and criminal procedure cannot persuasively be described as privileging the white collar offender. Substantive criminal law makes charges easier to bring and harder to defend against in white collar cases. Enforcement institutions, and the political economy in which they exist, include features that both shelter corporate offenders and heighten their exposure. Corporate actors enjoy a large advantage in legal defense resources relative to others. That advantage, however, does not pay off as measurably as one might expect. Both in general and as applied to recent events in the banking sector, the claim of privilege can be sustained only by showing that basic American arrangements of criminal law and policing have been misguided. A fully developed argument would fault the justice system for failing to treat illegal behavior within firms as requiring omnipresent policing, looser definitions of criminality, the harshest of punishments, and rethinking of rights to counsel. Those who believe corporate offenders are privileged might have a cause. But they should confront the magnitude of their claims. And they should be aware of complications that follow from overreliance on punishment to deal with intractable problems of regulatory control.

March 17, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)