Securities Law Prof Blog

Issuance of Securities in US Capital Markets Reaches $5 Trillion in First Nine Months

According to the latest Research Quarterly issued by SIFMA, issuance of securities in the U.S. capital markets reached $5.06 trillion in the first nine months of 2007, a 7.7 percent increase over the same period last year.  Third quarter issuance volume was lower at $1.33 trillion compared to $1.92 billion in the second quarter of 2007 and $1.51 trillion in the third quarter of 2006.  Long-term municipal issuance continues at a record pace, boosted by refunding activity.  Corporate bond issuance remains ahead of last year and on a record pace despite a sharp drop in high-yield issuance in the third quarter.  Agency and mortgage-backed securities (MBS), asset-backed securities (ABS) and collateralized debt obligations (CDOs) fell in the quarter on housing sector weakness and subprime mortgage market deterioration.

Do the U.S. Markets Need an Overhaul? Point and Counter-Point

In response to Treasury Secretary Paulson's requests for comments on overhauling the U.S. capital markets:

NASAA responds: “Our existing regulatory structure, particularly as it pertains to the securities markets, needs no fundamental restructuring.”  It cautioned against a significant overhaul in an effort to enhance the competitiveness of U.S. capital markets.

“The millions of investors in this country – for the most part hardworking, middle class citizens, not Wall Street CEO’s – deserve a much better justification for a regulatory overhaul if their financial futures are to be placed at risk,” NASAA President and North Dakota Securities Commissioner Karen Tyler wrote in a comment letter to the U.S. Department of the Treasury regarding its Review of the Regulatory Structure Associated with Financial Institutions.

NASAA noted that recent calls for regulatory reform share a universal set of “improvements” designed to ease perceived industry burdens.  “Each reform package offers industry less bureaucracy, fewer constraints, and wide latitude in matters of conduct,” Tyler wrote. “We are troubled, however, by the lack of discussion about the effects of these reforms on the retail investor. We observe a lack of principle within “principled regulation” models that have nothing to say about investor protection.”

SIFMA, in turn, responds that the U.S. Regulatory Structure Needs Reform. “One of the great challenges facing the financial services industry is the need for regulatory reform in the U.S.,” said Marc Lackritz, SIFMA president and CEO.  “This process, initiated by Secretary Paulson, provides an excellent opportunity to reform an antiquated system and simultaneously move financial services regulation in the U.S. into the 21st century.  With a regulatory landscape plagued by duplication and conflicting standards, the need to improve regulation couldn’t be greater.  Doing nothing is not an option.”

“Our businesses and our markets are increasingly converging and driven by technology.  It’s time for regulation to catch up,” Lackritz added.  “The U.S. regulatory regime is in need of both substantive and structural reform.  We need reform to move to principles-based regulation, coupled with prudential supervision and liability reform, to ensure that regulation becomes flexible, encourages innovation and competition, protects against systemic risk, and protects investors.”

Whom do you think Treasury Secretary Paulson will pay more attention to?

NYSE Plans Overhaul of Specialist System

Duncan Niederauer, soon-to-be CEO of NYSE Euronext, plans an overhaul of the NYSE specialist system.  In recent years, the role of specialist firms in stabilizing the market has been questioned, and the firms' reputations were sullied by a regulatory settlement that charged pervasive interpositioning before customers' trades for the firms' personal profit.  Under the proposal, the specialists would become "designated market makers" and would still be the designated traders for each listed stock.  However, they would have fewer responsibilities and more opportunities for proprietary trading.  WSJ, Hi, 'Designated Market Makers'.

Hedge Fund Invests in E*Trade

One of the surprising big losers in the mortgage crisis is E*Trade, the discount brokerage whose savings and loan affiliate used its deposits to invest in mortgages.  Yesterday hedge fund Citidal Investment Group announced it would invest $2.55 billion in E*Trade, which, along with its current holdings, will bring its stock holdings to close to 20%.  Mitch Caplan, the E*Trade CEO who instituted the mortgage strategy, is out.  The Wall St. Journal today has a detailed account of the negotiations that led to Citidel's investment.  WSJ, Why Citadel Pounced On Wounded E*Trade.

SEC Publishes Prototype Summary Prospectus for Mutual Funds

The SEC published a prototype "summary prospectus" for mutual funds, and asked for public comment from investors. The proposed streamlined prospectus would let investors quickly learn key information about a mutual fund.  The Commission voted on November 15 to propose rule amendments that would enable investors to view a concise, plain English summary of key facts about a mutual fund.

During the comment period, the Commission is seeking investor input about what improvements would make the summary prospectus easier to read and understand, and what key information investors would like to see included. The Commission also is seeking comment on its proposal for mutual funds to provide investors the summary information while making the full prospectus available online or in paper copy upon request.

FINRA Sanctions Brokerage Firm for Facilitating Late Trading by Hedge Funds

FINRA announced today that it has sanctioned Rafferty Capital Markets, LLC, for facilitating improper market timing practices and for failing to have an adequate supervisory system to prevent deceptive market timing and late trading, among other violations.  FINRA ordered Rafferty Capital to refrain for 90 days from opening new mutual fund brokerage accounts for any new or existing customers. The firm was also fined $350,000 and ordered to pay $59,605 in restitution to two mutual fund families in connection with customer profits derived from improper market timing. In addition, Rafferty Capital was ordered to review its procedures and certify that it has established systems and procedures to prevent late trading and deceptive market timing, to retain electronic communications, and to record the times of receipt and entry of mutual fund orders.

FINRA found that from about January 2001 through August 2003, the firm assisted six hedge fund customers in circumventing market timing restrictions and escaping detection by opening and using multiple related customer accounts, as well as by using different broker branch codes for market timing, among other methods.  In concluding this settlement, Rafferty Capital neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

NatWest Three Plead Guilty to Enron Charges

Three British bankers pleaded guilty in Houston to Enron-related charges that they conspired with Andrew Fastow to enrich themselves at the expense of their employer, the National Westminster Bank of England.  They also agreed to repay the bank $7.5 million.  Their trial was scheduled to start in January.  The extradiction of "the NatWest Three" created controversy in Great Britain in 2006.  NYTimes, 3 Bankers Plead Guilty in Case Tied to Enron; WSJ, Three British Bankers Enter Guilty Plea in Enron Case.

Reaction to SEC's No-Acess Rule

Reaction to the SEC's 3-1 vote to allow management to exclude shareholder proposals relating to directors' nominations (including bylaw amendments relating to procedures) was swift, heated and predictable.  While business groups praised the decision, the most controversial to date in Chair Cox's tenure, investors groups, union officials and pension funds expressed disappointment with it.  Barney Frank, chair of the House Financial Services Committee, and Christopher Dodd, chair of the Senate Banking Committee, also said they were disappointed with Cox's decision to move forward, which the SEC Chair defended as necessary to provide certainty for the 2008 proxy season.  When the SEC announced two contradictory versions of the rule over the summer, Cox said he supported broader shareholder access to the proxy statement, but after Commissioner Campos's resignation, it became clear that the "no-access rule" would be the only version that could be adopted.  The SEC received 34,000 letters commenting on the proposals.

The American Federation of State, City, and Municipal Employees (the plaintiff in the 2d Circuit case that invalidated the previous version of the rule) has asked JP Morgan Chase and Bear Stearns to allow shareholders to vote for bylaw changes for electing directors and has said that if the companies refuse to include their proposal on the proxy statement it will sue in a challenge to the new rule.  WPost, SEC Votes to Limit Shareholder Rights; NYTimes, S.E.C. Bars Investors’ Directors; WSJ, Cox, in Denying Proxy Access, Puts His SEC Legacy on Line.

SEC Adopts Amendment to Rule 14a-8

The SEC voted to adopt an amendment to Rule 14a-8(i)(8) under the Securities Exchange Act of 1934 to codify what the SEC describes as its "longstanding interpretation" of that exclusion.  The rule will read as follows: "If the proposal relates to a nomination or an election for membership on the company's board of directors or analogous governing body or a procedure for such nomination or election." This language was not revised from the proposal.

In 2006 the Second Circuit refused to defer to the SEC's interpretation of the shareholder proposal rule as excluding procedures for nominations or elections, finding that the SEC's interpretations of the exclusion had been inconsistent.

Commissioner Annette Nazareth, in perhaps one of her last actions as a Commissioner, expressed her disappointment at what she called the "non-access release" and voted against it.  Speech by SEC Commissioner:Opening Statement — Proxy Non-Access by Commissioner Annette L. Nazareth.

SEC Adopts Shareholder Forum Amendments

The SEC voted to adopt amendments to the proxy rules to facilitate the use of electronic shareholder forums. The amendments are expected to open up new avenues for real-time communications among shareholders, and between shareholders and the companies they own.  The rule amendments are intended to remove the risk that discussion in an online forum might be viewed as a proxy solicitation.

In summary:

Any participant in an electronic shareholder forum will be able to rely on the new exemption so long as his or her communications occur more than 60 days prior to the date announced by the company for its annual or special meeting of shareholders, and the communicating party does not solicit proxy authority while relying on the exemption. A participant in an electronic shareholder forum will be eligible to solicit proxy authority after the date that the exemption is no longer available, provided that the solicitation is conducted in accordance with Regulation 14A.
 
Where the company announces a meeting of shareholders less than 60 days before the meeting date, the solicitation could not occur more than two days following the company's announcement.
In addition, the amendments provide that a shareholder, company, or third party acting on behalf of a shareholder or a company, that establishes, maintains or operates an electronic shareholder forum will not be liable under the federal securities laws for any statement or information provided by another person participating in the forum.

FINRA Fines Wachovia for Research Report Violations

FINRA announced today that it censured and fined Wachovia Capital Markets, LLC $300,000 for violations of FINRA's research analyst conflict of interest disclosure rules that were adopted after the conflicted analysts scandal.  FINRA found that from June 2004 to May 2006, Wachovia failed to include in 40 research reports a total of 56 disclosures concerning Wachovia's financial relationships with subject companies. In 20 of those reports, Wachovia failed to disclose that it managed or co-managed a public offering of securities issued by the subject company.  In other research reports, Wachovia failed to disclose that it received compensation from the subject company for investment banking services, that it owned an interest in the common stock of the company or that it was making a market in the securities of the company.

Additionally, FINRA found that from March 2004 to July 2007, in over 15,000 research reports, Wachovia included a disclaimer stating that the firm and its affiliates "may" own an interest in the securities of the subject company. This disclaimer is inconsistent with FINRA's requirement that firms affirmatively disclose whether they own one percent or more of the common equity stock of the subject company.

In settling this matter, Wachovia neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

Freddie Mac Seeks to Shore Up Reserves by Stock Sales, Dividend Cut

Seeking to recover from its $2 billion third quarter loss, Freddie Mac announced it would sell $6 billion in preferred stock and cut its dividend in half, in order to boost its reserves.  Freddie said it was selling preferred stock so as not to dilute the common.  WPost, Freddie to Cut Dividend, Sell Stock to Aid Reserves.

Sovereign Funds Seek Low Profile

The sovereign funds of the Middle East and Asia are working hard to reassure U.S. politicians and the public that they aren't a threat.  The Abu Dhabi fund emphasized that its $7.5  billion in Citigroup did not include board representation, and Citigroup officials alerted Senator Charles Schumer about the deal in advance.  The funds learned their political savvy the hard way from the Dubai Ports blowup, when politicians viewed the acquisition of U.S. ports by a Dubai-controlled firm as a threat to national security.  Meanwhile, investments by the sovereign funds in international business continue to grow.  WSJ, Sovereign-Wealth Funds Buy Small Stakes and Keep Quiet, Winning Over Some Skeptics.

Court Allows Fraud Charges to Proceed Against Some Former Executives of Putnam Fiduciary Trust

Mixed results for the SEC in an enforcement action against former executives of Putnam Fiduciary Trust Co, a transfer agent -- the U.S. District Court for  the  District  of  Massachusetts dismissed charges against three former executives, but allowed the case to proceed against three other former executives.  According to the SEC's complaint, the former PFTC executives engaged in a scheme beginning  in January 2001 by which the defendants defrauded a defined  contribution  plan client and group of Putnam mutual funds of approximately  $4  million. The SEC alleges that the defendants'  misconduct arose out of PFTC's one-day delay in investing certain  assets  of  a  defined  contribution client, Cardinal Health, Inc.,  in  January  2001.  The markets rose steeply on the missed day, causing  Cardinal  Health's  defined  contribution plan to miss out on nearly  $4 million of market gains. According to the complaint, rather than  inform  Cardinal  Health  of  the  one-day  delay and the missed trading gain, the defendants decided to improperly shift approximately $3 million of the costs of the delay to shareholders of certain Putnam mutual     funds  through  deception,  illegal  trade  reversals,  and accounting     machinations.  The  complaint  also  alleges  that  the defendants  improperly  allowed Cardinal Health's defined contribution plan  to  bear approximately $1 million of the loss without disclosing to Cardinal Heath that they had done so. The complaint further alleges that  certain  defendants  also  took  steps  to cover-up the wrongful conduct and, as a result, the conduct was not discovered until January 2004.   The SEC is seeking injunctive relief and monetary penalties.

SEC Obtains TRO Against Alleged Boiler Room Operation

The SEC obtained a TRO against Alex Rabinovich, Rabinovich & Associates, LP, an unregistered investment company and broker-dealer managed by Rabinovich, and Joseph Lovaglio, who, according to the allegations in the SEC complaint, are operating a classic boiler room operation in Brooklyn and offering limited partnership interests in Rabinovich & Associates and other securities to investors, including senior citizens and retirees. According to the complaint, the defendants have raised at least $550,000 from at least twenty-three investors, and have lost most of that money, even while providing investors with quarterly account statements that reflect large gains and "dividends" in every period. The defendants allegedly have also failed to disclose to investors that Rabinovich has been barred by the NASD from associating with any broker or dealer and that there is a pending action by the Financial Industry Regulatory Authority, Inc. ("FINRA") seeking to bar Lovaglio from associating with any broker or dealer.

SEC and FINRA Announce National CCOutreach Seminar

The SEC and FINRA announced the establishment of the CCOutreach program for broker-dealers on October 30. The program is intended to further promote strong compliance practices at broker-dealer firms for the protection of investors.  The organizations announced today that the inaugural event of the CCOutreach BD program will be a National Seminar at SEC headquarters in Washington, D.C. on March 7, 2008.  It will include panel discussions with SEC and FINRA staff and broker-dealer CCO representatives on the latest compliance developments and significant compliance issues relevant to the broker-dealer community.  The SEC website has posted a list of potential agenda items.

HSBC Bails Out its SIVs

HSBC, the UK bank, announced that it would shut down two bank-sponsored structured investment vehicles (SIVs) and take $45 billion in mortgage-backed securities onto its own balance sheet.  It becomes the first major bank to bail out its troubled SIVs.  A big concern has been that there will be a "fire sale" if SIV assets are dumped on the market.  A consortium of banks, including Citigroup, Bank of America, and JPMorgan Chase, seek to create a "superfund" with $100 billion to buy assets from SIVs to prevent this.  WSJ, HSBC Becomes First Bank To Bail Out Troubled SIVs.

Abu Dhabi Invests $7.5 Billion in Citigroup

Citigroup is receiving a $7.5 billion investment from the investment arm of the Abu Dhabi government (ADIA); in turn, ADIA will receive convertible stock paying 11% that are required to be converted into common stock over a period of time between March 2010 and September 2011.  ADIA will become Citigroup's largest shareholder, holding no more than 4.9%.  Investors have been worried about Citigroup's capital levels since its "tier 1" capital level fell below its 7.5% target in the third quarter.  WSJ, Abu Dhabi to Bolster Citigroup With $7.5 Billion Capital Infusion.

Supreme Court Hears Argument in ERISA Case

The Supreme Court held oral argument yesterday in a case that raises the issue of whether an employee can sue for losses in his 401(k) account if the administrator of the 401(k) plan mishandles the account.  In LaRue v. DeWolff, Boberg & Associates, the administrator failed to follow the employee's instructions to switch mutual funds, resulting in a loss to the account.  The Fourth Circuit rejected the employee's claim, finding that ERISA permits lawsuits only for improper management of the entire plan, not individual accounts.  Several justices appeared uncomfortable with that distinction.  The Department of Labor agreed with the employee's position.  NYTimes, Justices Consider a Loss in a 401(k) Plan; WSJ, High Court Hears 401(k) Case.

FINRA Solicits Comments on International Prime Brokerage Practices

FINRA recently interviewed representatives from many of the largest prime brokerage firms to determine how the international prime brokerage business is conducted. The interviews covered the various practices used by the prime brokers and how they differed from practices used in domestic prime brokerage.  International prime brokerage is defined as the practice whereby a foreign domiciled customer executes transactions through a member firm(the executing broker) that are settled and carried by another member (the international prime brokerage custodian) on behalf of its affiliated foreign broker-dealer (the foreign prime broker or FPB).

FINRA's review found inconsistencies between member firms with regard to legal documentation/agreements, settlement practices, books and records, and other areas important in defining the roles and obligations of the parties when a prime broker customer (who is generally foreign domiciled) purchases or sells U.S. securities with a foreign prime broker and a U.S. executing broker.  In an attempt to establish consistency among member firms, share best practices, and apply fair and consistent standards to all firms that are active in this business, FINRA is soliciting comments from member firms and other interested parties on its Proposed Guidance regarding the IPB practices described herein.  The Proposed Guidance extends the existing requirements set forth by the SEC in the 1994 No-Action letter to IPB transactions relating to: (1) account arrangement, (2) delivery instructions, (3) affirmation of trades, (4) books and records, (5) documentation, (6) confirmation of trades, (7) notification and (8) net capital.  Regulatory Notice 07-58.