Securities Law Prof Blog

SEC Charges Former Terex CFO With Assisting United Rentals Fraud

The SEC filed a complaint against Joseph F. Apuzzo, former Chief Financial Officer ("CFO") of Terex Corporation, for aiding and abetting securities law violations of United Rentals, Inc. ("URI") and Michael J. Nolan ("Nolan"), a former CFO of URI. Apuzzo is the second CFO charged in connection with the alleged violations. On December 12, 2007, the Commission filed settled financial fraud charges against Nolan.

The SEC alleges that Apuzzo aided and abetted a fraudulent accounting scheme involving two sale-leaseback transactions, carried out between 2000 and 2002 by URI, Nolan and others. The transactions were structured to improve URI's 2000 and 2001 financial results by allowing URI to recognize revenue prematurely and to inflate the profit generated from the sales. The complaint alleges that Apuzzo signed agreements with URI that he knew, or was reckless in not knowing, were designed to hide URI's continuing risks and financial obligations relating to the sale-leaseback transactions and approved the issuance of inflated invoices that he knew, or was reckless in not knowing, URI, through Nolan and others, would use to inflate URI's gain on the transactions.  As a result, URI materially overstated its financial results in its Forms 10-K for fiscal years 2000 and 2001, as well as in other filings and public releases.

Grundfest Replies to Prentice

Is There an Express Section 10(b) Private Right of Action? A Response to Professor Prentice, by JOSEPH GRUNDFEST, Stanford University Law School, was recently posted on SSRN.  Here is the abstract:

In Scheme Liability: A Reply to Grundfest, Professor Robert A. Prentice asserts that the United States Supreme Court was simply and abysmally wrong in Central Bank v. First Interstate Bank. He also claims that the majority of lower courts have been dead wrong in interpreting Central Bank. He further states that the Section 10(b) private right of action is express and not implied, that Congress in 1934 intended to create that private right of action, and that the Securities and Exchange Commission also intended to create a private right when it adopted Rule 10b-5 in 1942. From these premises, Professor Prentice urges that Section 10(b) and Rule 10b-5 be interpreted to sustain a private right of action for scheme liability.

Professor Prentice's analysis rests on revisionist history. The record is clear that the private right of action under Section 10(b) is implied: it is not and has never been express. Congress in 1934 did not intend to create a private right of action under Section 10(b), much less one that would encompass scheme liability. Nor did the Commission intend to create a private right of action in 1942 when it adopted Rule 10b-5. Professor Prentice's conclusions based on these false premises fail of their own weight.

Professor Prentice's analysis is also strategically selective. He ignores 1934-era common law rejecting scheme liability. He nowhere discusses the Court's admonitions that implied rights be narrowly construed. He also fails to appreciate the implications of his historically revisionist analysis. If Professor Prentice is correct that the Section 10(b) private right is express, and intended by Congress and the Commission, then the entire corpus of federal securities law must be rewritten. Central Bank is then far from the only decision in which the Supreme Court is simply and abysmally wrong.

Davidoff on Black Market Capital

Black Market Capital, by STEVEN M. DAVIDOFF, Wayne State University Law School, was recently posted on SSRN.  Here is the abstract:

Hedge funds and private equity offer unique investing opportunities, including the possibility for diversified and excess returns. Yet, current federal securities regulation effectively prohibits the public offer and purchase in the United States of these hedge fund and private equity investments. Public investors, foreclosed from purchasing hedge funds and private equity, instead seek to replicate their benefits. This demand drives public investors to substitute less-suitable, publicly available investments which attempt to mimic the characteristics of hedge funds or private equity. This effect, which this Article terms black market capital, is an economic spur for a number of recent capital markets phenomena, including fund adviser IPOs, special purpose acquisition companies, business development companies and specialized exchange traded funds all of which largely attempt to replicate private equity or hedge fund returns and have been marketed to public investors on this basis. Black market capital has not only altered the structure of the U.S. capital market but has shifted capital flows to foreign markets and engendered the creation of U.S. private markets. This Article identifies and examines the ramifications of black market capital. It finds this effect to be an irrational by-product of current hedge fund and private equity regulation, one likely harmful to U.S. capital markets. These are external costs inherent in the current regulatory scheme which the SEC has not recognized. The SEC should consequently undertake a thorough cost-benefit analysis of its hedge fund and private equity regulation. Based on the available evidence, such an analysis is likely to conclude that the benefits of a regulatory scheme permitting the public offer of hedge funds and private equity funds not only exceed its costs but is superior to current regulation. Black market capital is also an example of the unintended effects of regulating under the precautionary principle and difficulty of regulating in an era of market proliferation.

Tennesee Court Orders Finish Line to Complete Genesco LBO

A Tennessee state court ordered The Finish Line to complete its $1.5 billion LBO of Genesco.  The Finish Line, in September, said it was calling off the deal because its adviser, UBS, raised concerns about Genesco's financial condition.  However, the issue of the solvency of the combined entity remains an issue in a New York law suit brought by UBS.  CFO.com, Court Orders Shoe Companies to Pair Up.

Delphi's Auditors Settle Accounting Charges

Deloitte & Touche agreed to pay $38 million to settle accounting fraud charges involving Delphi Corp., the auto parts manufacturer that is currently in Chapter 11.  Delphi was required to restate its financials from 1999-2005.  Previously the SEC brought charges against eight former employees.  CFO.com, Deloitte to Pay $38 Million in Delphi Case.

UnitedHealth Group's Settlement with Former CEO Questioned by Judge

Earlier this month, the parties announced a $420 million settlement between UnitedHealth Group and its ousted CEO William McGuire.  The agreement requires McGuire to forfeit stock options and retirement pay to settle civil and federal charges of stock option backdating.  However, the federal district court judge reviewing the proposed settlement has asked the Minnesota Supreme Court the extent to which, under Minnesota law, he can review the reasonableness of the settlement.  The judge noted that the lack of findings by the Special Litigation Committee made it difficult for him to determine that its exercise of business judgment was reasonable.  WSJ, UnitedHealth Ex-CEO's Pact Is Uncertain.

Berkshire Hathaway in the News

Warren Buffett's Berkshire Hathaway is in the news today. 

First, it is going into the municipal bond insurance business, providing another source of bond insurance for municipalities and competing with the large bond insurers whose triple-A ratings are at risk because of mortgage loans.  The Berkshire Hathaway Assurance Corp. expects to charge premium rates for its Berkshire Hathaway name.  WSJ, Buffett to Start A Bond Insurer For Cities, States.

Second, a judge ruled that Berkshire Hathaway  and its subsidiary General Reassurance must respond to subpoenas in the upcoming criminal trial of former General Re CEO Ronald Ferguson and other former General Re employees.  They are accused of helping AIG create sham reinsurance contracts to inflate AIG's reserves.  Ferguson claims that Buffett approved the transactions, which Buffett has denied.  NYTimes, General Re Subpoenas Supported.

SEC Files Fraud Charges Involving Website Offering

The SEC filed a civil action in U.S. District Court for the Southern District of Texas, charging Navigators International Management Co., Ltd. ("Navigators"), James R. Spurger and Benjamin W. Young, Jr. with securities fraud, conducting unregistered securities offerings and acting as unregistered broker-dealers.  Among the allegations -- in an ongoing offering, Navigators sells unregistered "ZCASH" electronic tokens on its website. Navigators promises exorbitant returns and rebates to be generated in an unspecified manner and timeframe when customers use ZCASH to purchase items on the Navigators' website.

Goldman Increases Estimates of Write-Offs at Other Firms

A Goldman Sachs analyst predicts that Citigroup will cut its dividend by 40% and will announce CDO-related write-offs in the fourth quarter of $18.7 billion.  Goldman Sachs also increased its estimates of fourth quarter CDO-related write-offs at other firms:  JPMorganChase, an estimated $3.4 billion (up from $1.7 billion) and Merrill Lynch, an estimated $11.5 billion (up from $6 billion).  And Goldman must be laughing all the way to the bank.  Bloomberg.com, Citigroup May Cut Dividend by 40%, Goldman Sachs Says (Update1).

Sallie Mae Plans $2.5 Billion Stock Offering

In an effort to rcover from the failed LBO and other troubles of its own making, Sallie Mae announced it would try to raise $2.5 billion by selling common and convertible preferred stock.  It needs money to pay off commitments to buy back its shares.  Known as equity forward contracts, they are bets that the company's stock will rise in price -- a bet that Sallie Mae has lost.  As a result, it needs about $2 billion to buy about 44 million of its shares from Citibank.  It also needs additional cash to improve its credit rating.  WPost, Sallie Mae Bids to Raise $2.5 Billion In Stock Sale; NYTimes, Sallie Mae to Sell Stock to Pay Off a Failed Bet ;WSJ, Sallie Mae Plans $2.5 Billion Stock Offering.

A CDO Called Norma Goes Too Far

The Wall St. Journal has a terrific front page story on a CDO called Norma -- a new breed of mortgage investment created by Merrill Lynch that illustrates how Wall St. "took a good idea too far" to generate big fees.  Unlike traditional CDOs, whose purpose was to diversify investors' risks, Norma increased risks by constructing portfolios of securities with the same risks, subprime mortgage loans.  In addition, banks took large pieces of these CDOs for themselves, further concentrating the risks.  Whose brainchild was Norma?  A Long Island penny stock dealer.  The article is complete with a graphic to show you how it works.  I hope this isn't the kind of article Rupert Murdoch plans to do away with.  WSJ, Wall Street Wizardry Amplified Credit Crisis.

FINRA Eliminates Requirement that Confirmation Include Securities Market on which Transaction was Effected

FINRA Amends NYSE Rule 409(f) (Statements of Accounts to Customers) to Eliminate the Requirement to Include the Name of the Securities Market on which a Transaction is Effected; Effective Date: January 1, 2008.  Dual Member firms will not be required to disclose the name of the securities market on which the transaction was effected on confirmations or reports as required under NYSE Rule 409(f). This change makes permanent the temporary relief that was granted in March 2007 and extended until January 1, 2008.  FINRA concluded that because of member firms' best execution and disclosure requirements, the usefulness of including on a confirmation the securities market on which a transaction was effected does not outweigh the operational difficulties of capturing the information after adoption of Regulation NMS.  FINRA Regulatory Notice 07-65.

Frankel & Fagan on Trust & Honesty in the Real World

Introduction to Trust and Honesty in the Real World: A Joint Course for Lawyers, Business People and Regulators, by TAMAR FRANKEL, Boston University School of Law, and MARK FAGAN was recently posted on SSRN.  Here is the abstract:

Open any newspaper and you are likely to find stories of financial scandals, frauds and questionable ethical behavior in the business and professional worlds. The latest and lasting scandals in corporate America touched the highest level of corporate management and professional firms raising the question of whether business leaders are being taught the value of trust and honesty. Yet the very fabric of our economic prosperity and social stability are woven with trust and honesty. Distrust and dishonesty are not new. However, we appear to be at a tipping point where we run the risk of a culture that accepts and justifies corporate abuse of trust and dishonesty. The consequences include higher costs, slower growth and less freedom.

The goal of these course materials is to help students and seasoned practitioners recognize the ease with which trust and honesty can be lost, understand the impact of the business environment and social culture on trust and honesty, and explore measures to reinforce and, if necessary, restore trust and honesty in the business world. These course materials are founded on Trust and Honesty, American's Business Culture at a Crossroad (Frankel, 2006). The centerpiece of each module in this book is a case study drawn from actual business experience. Assigned readings from Trust and Honesty provide context for each teaching module. The case study assessments and discussions are used to highlight and illustrate the issues in more specific and practical terms. They demonstrate the complexity and indeterminacy of the issues. Role plays are provided with each module to provide the students with opportunities to test their ideas, simulate real life situations, manage tradeoffs and build consensus with their peers.

2007 is the Year of Blank Check IPOs

"Blank check" IPOs accounted for nearly 25% of all US IPOs in 2007 -- a total of 66 and a total capital raised of $12 billion.  In contrast, in 2006, blank check IPOs raised $3.4 billion and accounted for 16% of new issues.  WSJ, 'Blank Checks' Generate New Interest.

Merrill Sells Up to $6.2 Billion in Stock

Merill Lynch is getting a much needed capital infusion by selling up to $6.2 billion in common stock at a discount price of $48 to two investors.  An investment company owned by Singapore (Temasek Holdings) is purchasing $4.4 billion, with an option to purchase an additional $600 million, which would give it a 9.9% interest.  The other investor ($1.2 billion) is money manager Davis Selected Advisors.  WSJ, Merrill Lynch Cuts Deals With Temasek, GE as Firm Seeks to Shore Up Capital.

Fifth Circuit Holds that Customer of Non-NASD Brokerage Firm Did Not Have to Arbitrate Claim

The Fifth Circuit, in Galey v. World Marketing Alliance, 2007 WL 4323610 (Dec. 12, 2007), agreed with a securities customer that he did not have to arbitrate his dispute before NASD pursuant to an arbitration clause in his customer agreement, since the brokerage firm had allowed its membership in NASD to lapse.  NASD Rule 10301 provides that a claim involving a member whose membership has been terminated is ineligible for arbitration.  The Fifth Circuit found that the Rule meant what it says and it was incorporated by reference into the customer's arbitration agreement.  Moreover, since the Rule was to protect the customer, it was not severable from the rest of the agreement.  As a result, the customer was free to bring his claim in court.

SEC Final Rule on Form S-3 Eligibility Published

The SEC published its final rule relating to Revisions to Eligibility Requirements for Primary Offerings on Forms S-3 and F-3.

Former Prudential Broker Indicted on Market-Timing Charges

The United States Attorney's Office in Boston, Massachusetts obtained an indictment against Justin F. Ficken of Boston, Massachusetts, related to Ficken's alleged deceptive market timing activity while working at Prudential Securities, Inc. Ficken was charged with one count of conspiracy to commit wire fraud and securities fraud, four counts of wire fraud, four counts of securities fraud, and one count of obstruction related to testimony he gave during the SEC's related investigation.  The SEC previously filed a civil enforcement action against Ficken and others, alleging that Ficken was part of a three-person group of registered representatives, known as the "Druffner Group," that defrauded mutual fund companies and the funds' shareholders by placing thousands of market timing trades worth more than $1 billion for five hedge fund customers from at least January 2001 through September 2003. According to the amended complaint, Ficken knew that the mutual fund companies monitored and attempted to restrict excessive trading in their mutual funds. The amended complaint alleged that, to evade those restrictions when placing market timing trades, Druffner Group members disguised their own identities by establishing multiple broker identification numbers and disguised their customers' identities by opening numerous customer accounts for what were, in reality, only a handful of customers.

On September 13, 2007, the U.S. District Court for the District of Massachusetts entered a final judgment against Ficken. Ficken has appealed that judgment, and that appeal is pending.

Lucent Settles FCPA Allegations

The SEC filed another action involving FCPA violations, this time a settled complaint against Lucent Technologies Inc. ("Lucent"). Lucent agreed, without admitting or denying the allegations in the complaint, to the entry of a permanent injunction and to pay $1.5 million in civil penalties.  The SEC alleges that, from at least 2000 to 2003, Lucent spent over $10,000,000 for approximately 1,000 Chinese foreign officials, who were employees of Chinese state-owned or state-controlled telecommunications enterprises, to travel to the United States and elsewhere. The Commission alleges that while the trips were ostensibly designed to allow the Chinese foreign officials to inspect Lucent's factories and to train the officials in using Lucent equipment, in fact, the officials spent little or no time visiting Lucent's facilities. Instead, they visited tourist destinations such as Hawaii, Las Vegas, the Grand Canyon, Niagara Falls, Disney World, Universal Studios, and New York City. As set forth in the complaint, the Chinese government enterprises for whom the officials worked were either entities to which Lucent was seeking to sell its equipment and services or existing Lucent customers.

SEC Extends Simplified Method for Valuing Stock Options

The SEC's Office of the Chief Accountant and Division of Corporation Finance today released a new Staff Accounting Bulletin (SAB) that is intended to assist public companies in valuing stock option grants to their employees for income statement purposes.  As a result of new SAB 110, eligible public companies may continue to use a simplified method set forth in SAB 107 for estimating the expense of stock options if their own historical experience isn't sufficient to provide a reasonable basis.  Without this action, otherwise eligible public companies would have lost the option to use the simplified method as of Dec. 31, 2007. The limited extension in SAB 110 will be of particular benefit to those public companies that lack historical exercise data, many of which are smaller companies.

Specifically, SAB 107 provided a simple rule for estimating the expected term of what it called a "plain vanilla" option : it would be just the average of the time to vesting and the full term of the option. Companies could use this simplified method until Dec. 31, 2007.  As the Dec. 31, 2007 deadline in SAB 107 quickly approaches, however, the detailed information about exercise behavior that the staff contemplated is still not readily available. As a result, the staff will continue to accept use of the simplified method on an interim basis, provided a company concludes that its own historical share option exercise experience doesn't provide a reasonable basis for estimating expected term. Once relevant detailed external information about exercise behavior becomes widely available for companies to make more refined estimates of expected term, the staff will no longer accept use of the simplified method.