Securities Law Prof Blog

GAO Issues Report on Foreign Investment

The GAO issued a report (GAO-08-320) on Laws and Policies Regulating Foreign Investment in 10 Countries, conducted at the request of the Honorable Richard Shelby, Ranking Member, Committee on Banking, Housing, and Urban Affairs, U.S. Senate and updating a 1996 study.  The Report found:

As is the case in the United States, the countries we reviewed have enacted laws and instituted policies regulating foreign investment, often to address national security concerns. However, each of the 10 countries has its own concept of national security that influences which particular investments may be restricted. As a result of the differing concepts, restrictions range from requiring approval of investments in a narrowly defined defense sector to broad restrictions on the basis of economic security and cultural policy. In addition, some countries have recently made changes to their laws and policies to more explicitly identify national security as an area of concern, in some cases as the result of controversial investments. Several countries have also introduced lists of strategic sectors in which foreign investment requires government review and approval.
While there are many unique characteristics of the systems employed by the 10 countries to regulate foreign investment, in many ways the systems are similar to each other, and to the U.S. process under Exon-Florio. Eight countries use a formal review process—usually conducted by a government economic body with input from government security bodies—to review a transaction. Generally, national security is a primary factor or one of several factors considered in evaluating transactions. While the concepts of national security vary from country to country, all countries share concerns about a core set of issues. These include, for example, the defense industrial base, and more recently, investment in the energy sector and investment by state-owned enterprises and sovereign wealth funds. Most countries have established time frames for the review and can place conditions on transactions prior to approval. For example, a country may place national citizenship requirements on company board members.
However, unlike the voluntary notification under Exon-Florio, most countries’ reviews are mandatory if the investment reaches certain dollar thresholdsor if the buyer will obtain a controlling or blocking share in the acquired company. Further, unlike the United States, five countries allow decisions to be appealed through administrative means or in court.
Two countries do not have a formal review process. The Netherlands restricts entry into certain sectors such as public utilities, and the UAE restricts the extent of ownership allowed in all sectors without a review. In addition to the formal mechanisms, there are unofficial factors that may influence investment in each of the 10 countries. For example, in some countries an informal government preapproval for sensitive transactions may be needed.

In commenting on a draft of this report, the Department of the Treasury emphasized the United States’ commitment to an open investment policy.

SEC Announces Distribution of Xerox Fair Fund

The SEC announced that checks totaling nearly $50 million were mailed to investors harmed by the financial fraud at Xerox Corporation between 1997 and 2000. The distribution totals $45,867,740, representing the penalties and disgorgement, plus interest, paid by five Xerox managers and Xerox's auditors. Checks were mailed to 80,964 investors, with an average distribution amount of $566.  The SEC, which has been criticized for delays in distributing funds, noted in its press release that the distribution occurred within seven months of the federal district court's approval of the establishment of the Fair Fund in July 2007.

The Xerox Fair Fund resulted from SEC actions brought in 2002 and 2003 against Xerox Corporation, five of its officers, Xerox's independent audit firm (KPMG, LLP) and five KPMG accountants who held senior positions on the Xerox engagement. Among them, the defendants paid more than $46 million to settle SEC charges that they caused Xerox to make materially false and misleading statements in SEC filings. (Ten million dollars of the total amount was paid by Xerox to the U.S. Treasury before the Fair Fund provisions were enacted.)

SIFMA Files Comments on Mutual Fund Reform

SIFMA today filed a comment letter in support of most aspects of the SEC's  proposed disclosure and new prospectus delivery option for mutual funds.  The SEC reforms would require preparation and delivery of a summary prospectus written in plain English to replace the current mutual fund prospectus which the SEC itself recognizes does a poor job of providing information to prospective mutual fund investors.  The summary prospectus would contain seven categories of information most important to investors, including investment objectives, costs, strategies and risks, among others.

SIFMA, however, in a joint letter with the Investment Company Institute, did raise objections to the SEC’s proposal that a summary prospectus include quarterly updates of performance and portfolio holdings. They assert that requiring quarterly updates would reduce the industry’s incentive to utilize the summary document, due to the significant administrative and operational burdens it would create.   

MF Global Loses $141.5 Million in Unauthorized Trades

MF Global, the commodities brokerage firm, accused one of its traders, Evan Dooley, of making unauthorized trades on early on Wednesday that resulted in a $141.5 million loss for the firm. Dooley bought as many as 15,000 wheat futures (about 10% of the market) a month.  The firm had deactivated its electronic controls, intended to prevent unauthorized trades, for Dooley because the controls slowed down transactions.  NYTimes, Trader Accused of Betting Money He Didn’t Have; WSJ, Safety Net Breaks Again.

Freddie Mae Reports Loss, Forms SLC

Freddie Mac reported a $2.5 billion loss in the fourth quarter of 2007 and a $3.1 billion loss for fiscal year 2007.  In addition, it announced that the board formed a special litigation committee in response to two demand letters from shareholders alleging corporate mismanagement.  A company spokesperson said formation of the SLC was a "pro forma action" on the part of the company.  WashPost, Freddie Mac Reports $2.5 Billion Loss.

Cox Announces Expansion of SEC Office of Risk Assessment

Chair Cox recently announced an expansion of the SEC's Office of Risk Assessment, which was created in 2004 and which is responsible for helping SEC Divisions and Offices develop new ways to anticipate emerging issues and address potential problems in the securities markets.  In announcing a new Director, Chair Cox said that the Office of Risk Assessment will see a doubling of its professional staff to provide resources and analytical support to the Divisions of Enforcement, Trading and Markets, Investment Management, and Corporation Finance, as well as the Office of the Chief Accountant and the Office of Compliance Inspections and Examinations.

Bally Total Fitness Settles Financial Fraud Charges

The SEC settled financial fraud charges against Bally Total Fitness Holding Corporation, a nationwide commercial operator of fitness centers that recently emerged from bankruptcy proceedings under new, private ownership. The Commission alleges that from at least 1997 through 2003, Bally's financial statements were affected by more than two dozen accounting improprieties, which caused Bally to overstate its originally reported year-end 2001 stockholders' equity by nearly $1.8 billion, or more than 340%. The Commission's complaint further alleges that Bally understated its originally reported 2002 net loss by $92.4 million, or 9341%, and understated its originally reported 2003 net loss by $90.8 million, or 845%.

According to the Commission's complaint, Bally fraudulently accounted for three types of revenue it received from its members: initiation fees, prepaid dues, and reactivation fees; additionally, Bally fraudulently accounted for its membership acquisition costs. These frauds account for $1.2 billion of the $1.8 billion overstatement of Bally's originally reported year-end 2001 stockholders' equity. In addition, Bally's accounting for more than 20 other revenue or expense items failed to conform to Generally Accepted Accounting Principles. These failures account for the remaining $600 million of the $1.8 billion overstatement of Bally's originally reported year-end 2001 stockholders' equity.

Without admitting or denying the Commission's allegations, Bally has consented to the entry of a court order enjoining it from violating these provisions. In determining to accept Bally's settlement offer, the Commission considered Bally's cooperation with the Commission staff in the investigation leading to this action and prompt commencement of remedial action.

SEC Open Meeting Agenda for March 4

The Agenda for the SEC's Open Meeting on Tuesday, March 4, 2008, at 10:00 a.m., includes the following items:

The Commission will consider whether to propose two new rules under the Investment Company Act concerning exchange-traded funds (ETFs). Proposed Rule 6c-11 would provide exemptions from restrictions of the Act, to permit ETFs to operate without the need to obtain individual exemptive orders from the Commission. The Commission also will consider related disclosure amendments, and rule revisions concerning fund of funds restrictions of that Act.
 
The Commission will consider whether to propose a rule directed at misrepresentations in connection with a seller's ability or intent to deliver securities by settlement date.
 

FINRA Settles Mutual Fund Sales Violations Against Five Securities Firms

FINRA settled cases against five firms for mutual fund sales and supervisory violations - including improper sales of Class B and Class C mutual fund shares and failure to have supervisory systems designed to provide all eligible investors with the opportunity to purchase Class A mutual fund shares at net asset value (NAV) through NAV transfer programs.

For the share class sales violations, FINRA imposed an $800,000 fine against Prudential Securities and a $750,000 fine against UBS Financial Services, Inc. for improper sales of Class B and Class C mutual fund shares. A $100,000 fine was imposed against Pruco Securities for improper sales of Class B shares. In resolving the Class B and Class C share matters, these firms also agreed to remediation plans that will address over 27,000 fund transactions in the accounts of 5,300 households.

To resolve the NAV violations, Merrill Lynch, Prudential Securities, UBS and Wells Fargo agreed to remediation plans for eligible customers who qualified for, but did not receive, the benefit of NAV transfer programs. It is estimated that total remediation to customers will exceed $25 million.

In addition, FINRA fined Prudential Securities, UBS, and Merrill Lynch $250,000 each for failure to have reasonable supervisory systems and procedures to identify and provide opportunities for investors to obtain sales charge waivers through NAV transfer programs. From 2001 through 2004, many mutual fund families offered NAV transfer programs that eliminated front-end mutual fund sales charges for certain customers. Customers who redeemed fund shares for which they had paid a sales charge were permitted to use the proceeds to purchase Class A shares of a new mutual fund at NAV - that is, without paying another sales charge. FINRA found that, as a result of inadequate supervisory systems at Merrill Lynch, Wells Fargo and UBS from 2002 through 2004, and at Prudential Securities from 2002 to 2003, certain customers eligible for the NAV programs incurred front-end sales loads that they should not have paid, or purchased other share classes that unnecessarily subjected them to higher fees and the potential of contingent deferred sales charges.

Although FINRA found that Wells Fargo Investments failed to have reasonable supervisory systems and procedures relating to NAV transfer programs, FINRA did not impose a fine because of the firm's proactive remedial actions taken upon its discovery of - and before FINRA's inquiry into - the violative conduct. When Wells Fargo discovered it had failed to provide certain eligible customers with NAV pricing, the firm initiated a review of its mutual fund sales and acted promptly and in good faith to repay customers and correct its system and procedures. As part of this process, Wells Fargo paid more than $612,000 in restitution to investors in Class A shares.

Each firm settled these matters without admitting or denying the allegations, but consented to the entry of FINRA's findings.

A Profile of Abu Dhabi's SWF

Abu Dhabi has about 9% of the world's oil and 0.02% of its population.  This means it has a lot of money to invest.  The Abu Dhabi Investment Authority (ADIA), the world's largest SWF, has about $650-700 billion in assets, about 15 times larger than the Magellan Fund.  About 65% of its assets ($450 billion) are invested in equities.  The New York Times profiles the publicity-shy ADIA, who controls it and its investment strategy.  NYTimes, Cash-Rich, Publicity-Shy, Abu Dhabi Fund Draws Scrutiny.

SEC Charges Three with Scam Targeting Military Families

The SEC charged three promoters who targeted military families in a multi-million dollar investment scheme that forced victims into personal bankruptcy and their homes into foreclosure. The scam also targeted other affinity groups, including the Southern California Filipino community and fellow church members.  The SEC's complaint names James B. Duncan and two others — Hendrix M. Montecastro and Maurice E. McLeod — who solicited investors in Southern California, Arizona, and elsewhere using sham investment seminars and "referral partners" including a member of the Air Force who solicited his fellow servicemen. The complaint alleges they gained control over investors' finances by offering them securities in the form of real estate investment contracts, and purporting that the money investors earned would help make mortgage payments on investment homes purchased on their behalf. Instead of investing client funds as promised, they operated a Ponzi-like scheme by using money from new investors to make mortgage payments on previously purchased investment homes. When the scheme unraveled, it cost more than 75 investors an estimated $10 million.

The SEC's complaint, filed in U.S. District Court in Riverside, Calif., alleges that between October 2004 and June 2006, the three defendants operated through Murrieta, Calif.-based Pacific Wealth Management, LLC (PWM) and Stonewood Consulting, Inc., to defraud investors from several affinity groups. The complaint alleges that Duncan, Montecastro, and McLeod falsely promised investors that their funds would be invested in real estate and various other investments that would subsidize their investment homes. The SEC's complaint further alleges that Duncan, a recidivist, raised $1.2 million in a separate offering of preferred membership units in Total Return Fund, LLC, to approximately 20 investors. The complaint alleges that the proceeds raised in both offerings were commingled and used to run a Ponzi-like scheme that fell apart and left investors with homes in foreclosure and forced some investors to declare bankruptcy.

The SEC's complaint charges the defendants with violating the antifraud and registration provisions of the federal securities laws, and seeks permanent injunctions, disgorgement of ill-gotten gains, and civil penalties. The complaint also names Christopher J. Oetting, Anthony M. Contreras and Biocybernaut Institute, Inc., as relief defendants, alleging that they received ill-gotten gains from the defendants' fraudulent conduct.

"Say on Pay" on Many Corporations' Proxy Statements This Spring

"Say on pay" resolutions are on proxy statements of almost 100 companies this year, including Citigroup, Walmart, and Apple.  Last year resolutons to adopt an advisory vote on executive compensation attracted, on average, about 40% support from shareholders.  Corporate management, however, resist adopting advisory votes, and since the resolutions are nonbinding, they don't have to.  Management say shareholders have other opportunities (such as?) to express their concerns.  WSJ, 'Say on Pay' Gets a Push, But Will Boards Listen?

IBM Announces $15 Billion Stock Buyback Plan

IBM authorized a $15 billion stock repurchase plan, its second in less than a year.  IBM said the funds will come from operations.  It could increase IBM's earnings by as much as 5 cents.  In the past 5 years IBM has spent $46.2 billion on repurchasing its shares, equal to about 30% of its current market capitalization.  S&P said that 423 companies in the S&P 500 made share buybacks in the 18 month period ended June 30, 2007, but only one-fourth of them outperformed the S&P 500 through Sept. 30.  WSJ, IBM Plots Another Share Buyback; NYTimes, I.B.M. Plans $15 Billion Share Buyback.

Cox Testifies on Plain English

SEC Chairman Christopher Cox, spoke on one of his favorite topics, Plain Language — The Benefits to Small Business, before the Subcommittee on Contracting and Technology, Committee on Small Business,
U.S. House of Representatives, on February 26, 2008.   He announced that the SEC will soon conduct a baseline survey of America's investors to find out whether they find proxy statements, 10-Ks, and other SEC-required disclosure documents to be useful.  The survey will also gather ideas on what would make these documents more useful.   He stated that "over time, we hope to see a significant decline in the percentage of investors who routinely put SEC documents in the trash."

Two Deloitte Accountants Settle Charges Involving Delphi Audits

The SEC settled two administrative proceedings and found that Nicholas Difazio and Duane Higgins, Deloitte & Touche LLP (D&T) engagement partners on the 2000 and 2001 audits of the financial statements of Delphi Corporation, engaged in improper professional conduct on those audits.  In its first Order, the Commission found that Difazio, the lead engagement partner, engaged in improper professional conduct in auditing: (1) Delphi's improper accrual of an estimated warranty expense by its former parent as a direct charge to equity in the second quarter of 2000, rather than as an expense of the period in accordance with GAAP; (2) Delphi's improper classification of most of a $237 million payment settling the former parent's warranty claims to pension and other post-employment benefit "true-up," causing the amount to be accounted for as prepaid pension cost in the third quarter of 2000 in contravention of GAAP; and (3) Delphi's failure to account for the fourth quarter 2000 sale of certain batteries and generator cores, coincident with a side agreement to repurchase that inventory, as a financing transaction, as required by GAAP.

In a separate Order, the Commission found that Higgins, the audit engagement partner, engaged in improper professional conduct with respect to issue (3) above, as well as in connection with Delphi's failure to account for the simultaneous execution of agreements to sell and repurchase precious metals in the fourth quarter of 2000 as a financing transaction, as required by GAAP.

In each Order, the Commission found that Difazio and Higgins, among other things, failed to obtain sufficient competent evidential matter to afford a reasonable basis for the opinion rendered by D&T, to exercise due professional care in the planning and performance of the Delphi audit, and in performing the audit to identify material departures from GAAP in the financial statements.

The Commission's Orders denied Difazio the privilege of appearing or practicing before the Commission, pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice, with a right to reapply after three years, and denied Higgins the privilege of appearing or practicing before the Commission, pursuant to Rule 102(e)(1)(ii), with a right to reapply after two years.  Both Difazio and Higgins consented, respectively, to the issuance of the Orders without admitting or denying the findings of the Orders.

SEC Brings Pump & Dump Charges

The SEC filed a complaint in the U.S. District Court for the District of Arizona against Mario A. Pino, alleging that Pino usurped the "corporate identity" of Bancorp International Group, Inc. (BCIT), a public shell, by fabricating, issuing, and trading fraudulently issued shares of the company. The complaint also alleges that Pino issued false press releases between May 2 and July 13, 2005, and issued millions of shares of fraudulent BCIT stock to himself and others. The complaint alleges Pino sold 175,005,000 shares, earning profits of $269,033, in unregistered, non-exempt transactions into the resulting inflated market. The Commission seeks a permanent injunction against Pino, disgorgement, including pre- and post-judgment interest, third-tier civil penalties, an officer and director bar, and a penny stock bar.

In a related matter, the SEC settled administrative proceedings with Pamela J. Thompson. The Order finds that, in April and May 2005, Thompson prepared false BCIT documents, including counterfeit stock certificates, while knowing she did not have the proper authority. During June and July 2005, Thompson received and sold two million shares of fraudulent BCIT stock, earning profits of $7,632. Thompson also acted as the transfer agent of BCIT between April and August 2005 even though she never registered as a transfer agent with the Commission. The Commission ordered that Thompson cease and desist from further securities laws violations; be barred from association with any transfer agent, with the right to reapply for association after three (3) years; and pay disgorgement of $7,632 and prejudgment interest of $830.82. The Commission is not imposing a penalty against Thompson based on her inability to pay. Finally, the Commission ordered Thompson to comply with her undertaking to cooperate with the Commission. Thompson consented to the issuance of the Order without admitting or denying any of the findings in the Order.

Five Convictions in AIG Reserves Trial

Five insurance executives -- one from AIG, 4 from General Re -- were convicted for their participation in sham reinsurance deals to bolster AIG's loss reserves.  Former CEO Maurice Greenberg, who resigned in 2005 because of the scandal but remains a large shareholder, was an unindicted co-conspirator, and prosecutors said they plan to "work up the ladder."  Gen Re is owned by Warren Buffett's Berkshire Hathaway, whose name the defense invoked in the trial, but who did not testify.  WSJ, Jury Convicts Five of Fraud In Gen Re, AIG Case; NYTimes, Guilty Verdict for 5 in A.I.G. Case.

SWFs Urged not to Become Political

The U.S. Treasury Dept. met with two of the largest SWFs -- the Abu Dhabi Investment Authority ($900 billion in assets) and the Government Investment Corp. of Singapore ($300 billion in assets) -- as part of discussions to encourage SWFs to adopt "best practices" that would increase their transparency.  In addition, it is hoped that the SWFs will not use their investments for political advantage.  At a time when U.S. businesses need their investments, these measures are designed to ward off tougher measures from Congress.  Overall, SWFs have $3 trillion in assets.  WSJ, U.S. Pushes Sovereign Funds
To Open to Outside Scrutiny.

FINRA-AARP Partnership is Criticized

Some securities firms are critical of FINRA's partnership with AARP to promote automatic 401(k) enrollment ("Retirement Made Simpler") because they view AARP's for-profit financial services unit as a competitor.  It sells a variety of financialproducts, including mutual funds that are offered to 401(k) accounts.  FINRA says Retirement Made Simpler offers information to employers and is not targeted at investors.  InvNews, Brokers pan Finra-AARP tie.

Proposed Legislation Imposing Costs on Securities Plaintiff's Lawyer Introduced

Representative Jeb Hensarling (R-Tex.) recently introduced the "Securities Litigation Attorney Accountability and Transparency Act" (H.R. 5463) that would require a court, in any private securities litigation that awarded a final judgment against a plaintiff, to determine: whether the plaintiff's position "was not substantially justified," whether imposing fees and expenses on the plaintiff's attorney would be just, and whether the cost of such fees and expenses to the defendant is "substantially burdensome or unjust."  If the court makes these three determinations, then the court shall award the defendant reasonable fees and expenses and impose the fees and expenses on plaintiff's attorney.  The defendant would have the burden of persuasion on the determination of whether the position of the plaintiff was substantially justified.  The proposed legislation also would require sworn certifications by the plaintiff and plaintiff's attorney that would identify payments or promised payments by the attorney to the plaintiff, the nature and terms of any legal representation provided by the attorney other than the private securities litigation, any contributions made by the attorney to any elected official with authority to retain counsel for the plaintiff, and any other conflicts of interest.  The bill would also direct a study and review of fee awards to lead counsel in securities class actions over the past five years to determine the effective average hourly rate for lead counsel.