Securities Law Prof Blog

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

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Friday, June 14, 2013

Former Regions Morgan Keegan Funds Directors Settle Charges They Failed Pricing Responsibilities

The SEC announced a settlement in an enforcement proceeding against eight former directors of five Regions Morgan Keegan open- and closed-end funds that were heavily invested in securities backed by subprime mortgages. The SEC alleged that the directors failed to satisfy their pricing responsibilities under the federal securities laws.

Specifically, the directors delegated their fair valuation responsibility to a valuation committee without providing adequate substantive guidance on how fair valuation determinations should be made. The directors then made no meaningful effort to learn how fair values were being determined. They received only limited information about the factors involved with the funds' fair value determinations, and obtained almost no information explaining why particular fair values were assigned to portfolio securities. The limited information provided to the directors was particularly problematic because fair valued securities comprised a significant percentage of the funds' net asset values (NAVs) - in most cases above 60 percent.

The settled order finds that the valuation committee to whom the directors delegated the fair valuation responsibilities did not utilize reasonable procedures and often allowed the portfolio manager to arbitrarily set values. As a result, the settled order finds that the funds overstated the value of their securities as the housing market was on the brink of financial crisis in 2007. The SEC and other regulators previously charged Morgan Keegan and others, and the firms later agreed to pay $200 million to settle charges related to that conduct.

The open and closed end funds involved were the RMK High Income Fund, RMK Multi-Sector High Income Fund, RMK Strategic Income Fund, RMK Advantage Income Fund, and Morgan Keegan Select Fund.

The settled order finds that the directors caused the funds' violations of Rule 38a-1 under the Investment Company Act of 1940, which requires funds to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws. The directors are also ordered to cease and desist from committing or causing any violations and any future violations of that rule. The directors consented to the entry of the settled order without admitting or denying any of the findings, except as to jurisdiction.

June 14, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Revlon Settles SEC Charges It Misled Shareholders in Going Private Transaction

The SEC charged Revlon with misleading shareholders during a "going private transaction."  An SEC investigation found that during a voluntary exchange offer to satisfy a significant debt to its controlling shareholder, Revlon engaged in "ring fencing" that deprived its independent board members from knowing critical information: the transaction's consideration had been deemed inadequate by a third party who evaluated whether current and former employees invested in Revlon common stock through the company's 401(k) plan could exchange their shares.  Revlon agreed to settle the SEC's charges and pay an $850,000 penalty.

According to the SEC's order instituting settled administrative proceedings, controlling shareholder MacAndrews and Forbes (M&F) asked Revlon in 2009 to offer minority shareholders the option to exchange their common stock shares on a one-for-one basis for preferred shares with certain financial characteristics. The exchanged shares would then be provided to M&F to pay down Revlon's debt. The trustee administering Revlon's 401(k) plan decided that 401(k) members could tender their shares only if a third-party financial adviser made an "adequate consideration determination," which involved assessing whether the value of the preferred stock 401(k) members would receive was at least equal to the fair market value of the exchanged common stock shares. The third-party financial adviser ultimately found that the consideration offered in the transaction was inadequate for tendering 401(k) shareholders.

The SEC's order finds that Revlon, In an attempt to avoid a potential disclosure obligation, engaged in what one employee termed as "ring fencing" to avoid receiving the adequate consideration determination from the third-party adviser:

•Revlon amended the trust agreement it had with the trustee to ensure that the trustee would not share the adequate consideration determination with Revlon.
•Revlon ensured that it was not a party to any engagement letter concerning the adequate consideration determination.
•Revlon directed the trustee to inform Revlon of its decision whether to allow 401(k) members to tender their shares without any reference to the adequate consideration determination.
•In a notice sent to the 401(k) members and publicly filed as an exhibit to the exchange offer documents, Revlon removed the explicit term "adequate consideration" and replaced it with citations to ERISA statutes.

The SEC's order finds that Revlon violated Section 13(e) of the Securities Exchange Act of 1934 and Rule 13e-3(b)(1)(iii), which prohibits issuers and their affiliates in going private transactions from directly or indirectly engaging in any act, practice, or course of business that operates or would operate as a fraud or deceit.

June 14, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Cunningham Tells the AIG Story at NBLSC

The Fourth Annual National Business Law Scholars Conference was held June 12-13 at The Ohio State University Moritz College of Law.  Organized by Steven Davidoff (OSU), Eric Chaffee (Toledo) and Barbara Black (Cincinnati), the NBLSC is a forum that provides a forum for scholars to present papers on corporate, securities, bankruptcy and related topics.  OVer 40 professors participated in this year's program.

Lawrence  Cunningham (George Washington) was the keynote speaker, speakinng about The AIG Story, a book co-authored with Maurice (Hank) Greenberg, the longtime AIG CEO whose employment was terminated because of pressure from Eliot Spitzer and Arthur Levitt to impose corporate governance reforms.  Cunningham argues that "flavor of the day" corporate governance practices led to deterioration of internal controls, employee alienation, and chaos at AIG.  Cunningham is careful to acknowledge correlation does not establish causation, but he notes that the government report on the AIG collapse attributed the collapse of AIG at least in part to weak internal controls after Greenberg's departure.

Cunningham's book is well worth reading.  Chapter 18 of the book, on the government bailout of AIG, is available on SSRN.

Next year's Conference will be moving to one of the Coasts, east or west not yet decided.  Stay tuned for details!

June 14, 2013 in Professional Announcements | Permalink | Comments (0) | TrackBack (0)

Tuesday, June 11, 2013

CFPB Seeks Comments on Survey on Arbitration Clauses in Consumer Financial Contracts

The Consumer Financial Products Bureau is proposing to conduct a nationwide telephone survey of 1,000 credit card holders as part of its Dodd-Frank-mandated study about predispute arbitration clauses in consumer financial contracts.  The proposed survey will explore consumer awareness of dispute resolution terms in credit card agreements.  It is asking for comments (by August 6, 2013) on its proposed survey questionnaire and the initial plan for gathering data.

June 11, 2013 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Surveys to Update Series 4, 9 and 10 Exams

FINRA is conducting job analysis surveys to inform updates to the Series 4, 9 and 10 qualification examinations. Through these surveys, FINRA intends to gather information from currently registered individuals regarding their roles, responsibilities and job functions, and to use the information to update the related qualification examinations. FINRA encourages survey recipients to participate to help ensure that qualification examination content accurately measures competence in a particular area.

June 11, 2013 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA's Revised Definition of Public Arbitrator Effective July 1

FINRA announced that the SEC approved amendments to the definition of public arbitrator in the Customer and Industry Codes of Arbitration Procedure.  The amended definition excludes persons associated with a mutual fund or hedge fund from serving as public arbitrators and requires individuals to wait for two years after ending certain affiliations before FINRA may permit them to serve as public arbitrators.

The effective date of the amended rule is July 1, 2013.

June 11, 2013 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

SEC's Office of Inspector General Makes Recommendations to Strengthen Economic Analysis of Rulemaking

The SEC's Office of Inspector General recently issued a report, Use of the Current Guidance on Economic Analysis in SEC Rulemakings, Report No. 518, detailing the results of its evaluation of the SEC's use of the current guidance on economic analysis in its rulemakings.  The final report contains six recommendations that, if fully implemented, should strengthen the SEC's economic analysis process and requests, within 45 days, a written corrective action plan that addresses the recommendations.  The report is available at the SEC Office of Inspector General's website.

The Report finds that the SEC rules in its sample followed "the spirit and intent" of the Current Guidance; all of the rules specified the justification for the rule, considered alternatives, and integrated the economic analysis into the rulemaking process.  However, some rules could have better clarified and specified the baselines in the economic analysis section.  In addition, only one of the twelve rules included a quantification of benefits of the regulatory action.  The report also finds that FINRA, other SROs, and PCAOB are not required to follow the SEC's Current Guidance in their rulemakings.

The report contains six recommendations to improve the SEC’s application of the requirements in the Current Guidance. One is that, in consultation with the rulemaking divisions and offices, RSFI develop a general outline for economic analysis sections in rule releases. The report also recommends that RSFI consider whether to create a management control, such as a guide, to achieve greater consistency in presentation of economic analyses.

June 11, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

CBOE Pays $6 Million to Settle SEC Charges of Regulatory Failures

The SEC charged the Chicago Board Options Exchange (CBOE) and an affiliate for various systemic breakdowns in their regulatory and compliance functions as a self-regulatory organization, including a failure to enforce or even fully comprehend rules to prevent abusive short selling.  CBOE agreed to pay a $6 million penalty and implement major remedial measures to settle the SEC's charges.

The financial penalty is the first assessed against an exchange for violations related to its regulatory oversight. Previous financial penalties against exchanges involved misconduct on the business side of their operations.

According to the SEC's order instituting settled administrative proceedings, CBOE demonstrated an overall inability to enforce Reg. SHO with an ineffective surveillance program that failed to detect wrongdoing despite numerous red flags that its members were engaged in abusive short selling. CBOE also fell short in its regulatory and compliance responsibilities in several other areas during a four-year period.  According to the SEC's order, CBOE moved its surveillance and monitoring of Reg. SHO compliance from one department to another in 2008, and the transfer of responsibilities adversely affected its Reg. SHO enforcement program. After that transfer, CBOE did not take action against any firm for violations of Reg. SHO as a result of its surveillance or complaints from third parties.

According to the SEC, CBOE failed to adequately enforce Reg. SHO because its staff lacked a fundamental understanding of the rule. CBOE investigators responsible for Reg. SHO surveillance never received any formal training and did not have a basic understanding of a failure to deliver.

The SEC's order also found that not only did CBOE fail to adequately detect violations and investigate and discipline one of its members, but it also took misguided and unprecedented steps to assist that same member firm when it became the subject of an SEC investigation in December 2009. CBOE failed to provide information to SEC staff when requested, and went so far as to assist the member firm by providing information for its Wells submission to the SEC. The CBOE actually edited the firm's draft submission, and some of the information and edits provided by CBOE were inaccurate and misleading. The SEC brought its enforcement action against the firm in April 2012, and an administrative law judge recently rendered an initial decision in that case.

According to the SEC's order, CBOE had a number of other regulatory and compliance failures at various times between 2008 and 2012. CBOE failed to adequately enforce its firm quote and priority rules for certain orders and trades on its exchange as well as rules requiring the registration of persons associated with its proprietary trading members. CBOE also provided unauthorized "customer accommodation" payments to some members and not others without applicable rules in place, resulting in unfair discrimination. And CBOE and affiliate C2 Options Exchange failed to file proposed rule changes with the SEC when certain trading functions on their exchanges were implemented.

CBOE and C2 agreed to settle the charges without admitting or denying the SEC's findings. CBOE agreed to pay $6 million, accept a censure and cease-and-desist order, and implement significant undertakings. C2 also agreed to a censure and cease-and-desist order and significant undertakings.

June 11, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, June 10, 2013

U.S. Supreme Court: Arbitrator's Decision Allowing Class Arbitration Survives Limited Judicial Review under FAA

The Supreme Court today unanimously held that a court has no power to vacate an arbitrator's interpretation of an arbitration agreement permitting class arbitration under section 10(a)(4) of the Federal Arbitration Act, so long as (1) the parties agreed that the arbitrator should decide whether their contract authorized class arbitration and (2) the arbitrator based on his decision on an interpretation of the arbitration agreement.  Oxford Health Plans LLC v. Sutter (U.S. June 10, 2013).

The Court thus reaffirmed the narrow grounds for vacating an arbitrator's decision under section 10(a)(4) for exceeding his powers.  The Court, in essence, found that Oxford got what it bargained for -- it "chose arbitration and it must now live with that choice."  The Court distinguished its earlier decision in Stolt-Nielsen S.A. v. AnimalFeeds Int'l Corp., 559 U.S. 662, because there the parties had stipulated that they had not agreed to class arbitration and thus the arbitrator could not order class arbitration based on the parties' consent.  The court also noted that the Court would have faced a different issue if Oxford had argued that the availability of class arbitration was a question of arbitrability, an issue that Stolt-Nielsen had left open.  The Court emphasized that nothing in the opinion should be taken to reflect any agreement with the arbitrator's interpretation of the contract.

Justices Alito, with Justice Thomas concurring, wrote a brief concurrence to note that it was unclear whether absent class members would be bound by the arbitrator's ultimate resolution, since they had not consented to the arbitrator's interpretation of the contract. Justice Alito thus makes clear that his view that the availability of class arbitration should not be decided by the arbitrator, absent the stipulation of the parties in the case before the Court.

Oxford Health Plans is an affirmation of the very narrow grounds for judicial review of an arbitrator's decision.  While the class arbitration in this case can go forward, it is unlikely to lead to very many class arbitrations, as corporate defendants increasingly are including explicit class action waivers in their arbitration agreements. 

June 10, 2013 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

SEC Alleges that Detroit Adviser Stole Money from Police & Firefighters' Pension Fund

The SEC and Chauncey C. Mayfield, the founder, president, and CEO of MayfieldGentry Realty Advisors, a Detroit-based investment adviser, agreed to settle charges that Mayfield stole nearly $3.1 million from the pension fund that the firm manages for the city's police officers and firefighters so he could buy two strip malls in California. The SEC charged four other top officials at the firm for helping him try to cover up the theft.  Mayfield and his firm agreed to settle the charges by paying back the stolen amount.  They neither admit nor deny the allegations in the settlement, which is subject to court approval. In a parallel criminal matter, Mayfield is awaiting sentencing in connection with his guilty plea for participation in the pay-to-play scheme.

June 10, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)