Securities Law Prof Blog

Scottrade Settles SEC Charges On Best Execution

The SEC charged St. Louis-based broker-dealer Scottrade, Inc., for fraudulent misrepresentations it made to customers relating to the firm's execution of their Nasdaq pre-open orders, which are placed after the day's market close to be executed at the next market opening. According to the Commission's Order, Scottrade did not conduct a regular and rigorous review of the execution quality of its Nasdaq pre-open orders and falsely disclosed to customers that it would route orders based on factors including liquidity at market opening when in practice it did not do so.  Without admitting or denying the Commission's findings, Scottrade agreed to pay a $950,000 penalty to settle the SEC's charges.

In 2000, the Commission advised the public that some market makers trading Nasdaq securities offered investors an opportunity to avoid paying a liquidity premium at the market opening. A liquid market allows buying and selling with relative ease and, accordingly, allows market makers to offer opportunities for superior executions. The Commission stated that an example of this is "midpoint pricing" — one price that is offered to both buy and sell orders at the midpoint between the national best bid and offer (NBBO). Another example is a "single price" — one price that is offered to both buy and sell orders somewhere between the NBBO. The Commission further advised that broker-dealers should take these alternative pricing options into consideration when seeking to obtain best execution for their customers' Nasdaq pre-open orders.

According to the SEC's Order, Scottrade did not follow the Commission's advice, and from Jan. 1, 2001, to Dec. 31, 2004, misrepresented in customer account opening documents and statements that it would route its customers' orders based on factors that included "liquidity at market opening," which gave its customers the opportunity to receive executions "that may be superior to the national best bid offer (NBBO) in any one market center." Scottrade, however, had no written policies and procedures to assess liquidity at the market opening provided by market centers and, as a result, did not consider the availability of executions that may have been superior to the NBBO, such as single or midpoint pricing, for its Nasdaq pre-open orders.

NYSE Sells Real-Time Market Data to Google & CNBC

The New York Stock Exchange (NYSE) introduced NYSE Realtime Stock Prices, a new data product that enables Internet and media organizations to buy real-time, last-trade market data from the NYSE for a flat fee and provide it broadly and free of charge to the public.  Google and CNBC are the first organizations to make the product available to the public, effective today.  The Securities and Exchange Commission last week approved NYSE Realtime Stock Prices for a four-month pilot period.

NYSE Euronext Will Acquire 25% of Doha Securities Market

The State of Qatar and NYSE Euronext (NYSE Euronext: NYX) announced a strategic partnership expected to transform the Doha Securities Market (“DSM”) into a significant international player and provide NYSE Euronext with a valuable presence in the Middle East.  The closing of the transaction is expected to take place early during the fourth quarter of 2008.

Highlights include:

Strategic relationship between the State of Qatar and NYSE Euronext to build a new, internationally integrated cash and derivatives exchange in Doha;

Interests of both the State of Qatar and NYSE Euronext fully aligned through equity participation, technology integration and market structure harmonisation and committed to work together as partners to explore other opportunities in the Middle East;

NYSE Euronext to purchase a 25% stake in the DSM for US$250 million in cash, the largest investment ever made by NYSE Euronext in a foreign exchange;

NYSE Euronext to receive three of the eleven seats on DSM’s board of directors;

The State of Qatar to retain ownership of the remaining 75% of the DSM through the Qatar Investment Authority;

NYSE Euronext has been selected as the technology provider by the State of Qatar and the DSM for both the cash equities and derivatives markets;

NYSE Euronext to act as a partner managing the operation of the new exchange, including the appointment of the senior management team, and providing technology services.

THE STATE OF QATAR AND NYSE EURONEXT ANNOUNCE MAJOR STRATEGIC PARTNERSHIP;
NYSE EURONEXT TO ACQUIRE 25% OFTHE DOHA  SECURITIES MARKET FOR US$250 MILLION.

SEC's Director of Trading & Markets Division Testifies on Risk Managment at Investment Banks

Erik Sirri, Director, Division of Trading and Markets, SEC, testified on Oversight of Risk Management at Investment Banks before the Senate Subcommittee on Securities, Insurance, and Investment Committee on Banking, Housing, and Urban Affairs on June 19.  Here is his conclusion:

The CSE [Consolidated Supervised Entity] program adopted by the Commission has served to fill a gap left after the Gramm-Leach-Bliley Act broadly restructured the regulation of financial institutions. Although supervised on an elective basis by the Commission under the CSE program, and in compliance with capital standards at the holding company and regulated entity level, Bear Stearns ultimately was overwhelmed by the unprecedented demands for liquidity it faced in a crisis of confidence. As detailed above, the Commission has taken the lessons learned from the Bear Stearns events to improve the supervision of the remaining investment banks and to enhance existing relationships with other supervisors to address the issues that these and other financial institutions are experiencing in the current turbulent market conditions.

An imperative from the Bear Stearns crisis is addressing explicitly through legislation how and by whom large investment banks should be regulated and supervised, and specifically whether the Commission should be given an explicit mandate to perform this function at the holding company level, along with the authority to require compliance. Chairman Cox has called for such an explicit mandate, together with a dedicated funding stream for the CSE program. These steps are intended to ensure that the supervisory regime for investment banks is adequate in light of evolving market conditions and builds on a long history of Commission involvement in the supervision of securities firms.

Broadcom Co-Founder Expected to Plead Guilty in Backdating Probe

Broadcom's troubles over backdating continue.  The Wall St. Journal reports that Henry Samueli, co-founder of Broadcom Corp., agreed to plead guilty to making a false statement to the SEC in exchange for 5 years of probation and $12 million in penalties.  His plead agreement will state that during a SEC deposition last year, he falsely stated that he was not involved in granting of options to top executives in 2002.  WSJ, Broadcom Co-Founder Expected to Plead Guilty.

Chairman Cox Under Scrutiny

Was Chairman Cox too passive in formulating the SEC's role in the Bear Stearns crisis, losing public relations and political ground to the Federal Reserve Board, who, after all, had the money to bail out the investment bank?  The Wall St. Journal compares Cox's performance with that of previous SEC Chairmen and presents the view of both his detractors and supporters in this balanced article.  Ultimately, the issue of the SEC's role in regulating investment firms will be Congress's to decide, if and when it decides to focus on overhauling financia regulation.  Congressional hearings on the subject have been announced for this summer, but no one expects legislation before the election.  WSJ, SEC Chief Under Fire as Fed Seeks Bigger Wall Street Role.

SEC Schedules Roundtable on Fair Value Standards

The SEC announced that it will host a roundtable on July 9, 2008, to facilitate an open discussion of the benefits and potential challenges associated with existing fair value accounting and auditing standards.

The roundtable will be organized as two panels. The first panel will discuss fair value accounting issues from the perspective of larger financial institutions and the needs of their investors. The second panel will discuss the issues from the perspective of all public companies, including small public companies, and the needs of their investors.  The panel discussions will focus on:

the usefulness of fair value accounting to investors
potential market behavior effects from fair value accounting
practical experience and potential challenges in applying fair value accounting standards
aspects of the current standards, if any, that can be improved
experience with auditors providing assurance regarding fair value accounting

A final agenda including a list of participants and moderators will be announced at a future date. The Commission welcomes feedback regarding any of the topics to be addressed at the roundtable. The information that is submitted will become part of the public record of the roundtable.

Former Williams-Sonoma Manager Settles Insider Trading Charges

The SEC settled insider trading charges against Adrian P. Di Vita, a former manager at Williams-Sonoma, Inc. In its complaint, the SEC alleged that, by attending certain meetings with senior management and otherwise, Di Vita received material nonpublic information that enabled him to know that Williams-Sonoma would lower its earnings guidance for fiscal year 2006 and the third quarter of that year when the company issued a scheduled earnings press release on August 24, 2006. With that information, and prior to the issuance of the press release, Di Vita sold all 707 of his Williams-Sonoma Stock Fund units and additionally purchased 1,000 put option contracts on Williams-Sonoma stock. After Williams-Sonoma issued its August 24 press release, the company's stock price fell by more than eight percent, and Di Vita sold his put options. As a result of his trading in the stock fund units and the put options, Di Vita avoided losses and had profits totaling $67,690.

Without admitting or denying the allegations in the Commission's complaint, Di Vita has offered to settle the action. Di Vita has consented to the entry of a final judgment permanently enjoining him from future violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5; ordering him to pay $76,932.80 in disgorgement of ill-gotten gains and losses avoided plus prejudgment interest; and ordering him to pay a civil penalty of $67,690.

SEC Approves One-Year Extension for SOX 404(b) Compliance for Smaller Public Companies

The SEC announced that it has approved a one-year extension of the compliance date for smaller public companies to meet the Section 404(b) auditor attestation requirement of the Sarbanes-Oxley Act. The SEC also announced that it received Office of Management and Budget (OMB) approval yesterday to proceed with data collection for a study of the costs and benefits of Section 404 implementation, focusing on the consequences for smaller companies and the effects of the Section 404 auditor attestation requirements. The results of the study are expected to become available during the extension period.

With the extension, smaller companies will now be required to provide the attestation reports in their annual reports for fiscal years ending on or after Dec. 15, 2009. SEC Chairman Christopher Cox first proposed this one-year delay for small businesses during December 2007 testimony before the House Small Business Committee, and the Commission formally proposed this extension on Feb. 1, 2008.

The SEC staff's cost-benefit study, which was announced in February, is being led by the SEC's Office of Economic Analysis with assistance from the Office of the Chief Accountant and the Division of Corporation Finance. With OMB approval, and the key financial data for annual reports becoming available to companies this spring, the SEC staff will be moving forward with interviews and a web-based survey as part of its effort to collect real-world data from a broad array of companies and analyzing what drives costs, particularly for smaller companies, and where companies and investors derive the benefits from Section 404.  The SEC staff's cost-benefit study will help determine whether the new management guidance on evaluating the internal controls over financial reporting issued by the Commission in June 2007 and the Public Company Accounting Oversight Board's (PCAOB) Auditing Standard No. 5 approved by the Commission in July 2007 are having the intended effect of facilitating more cost-effective internal control evaluations and audits of smaller reporting companies. The study includes gathering new data from a broad array of companies about the costs and benefits of compliance with the Section 404 requirements. The study also pays special attention to those smaller companies that are complying for the first time with the requirements that are currently in effect.

The full text of the final amendments for the extension of the auditor attestation requirement for smaller companies will be posted to the SEC Web site as soon as possible. The amendments will take effect 60 days after the release is published in the Federal Register.

Paulson on Market Reform

Excerpt from Remarks by Secretary Henry M. Paulson, Jr. on Economy and Markets before Women in Housing and Finance, June 19, 2008:

When we published the Blueprint in March, I made clear I believed we were laying out a long-term vision that would take time to consider and implement. Since then, the Bear Stearns episode and market turmoil more generally have placed in stark relief the outdated nature of our financial regulatory system. We are working with the Fed and the SEC on the immediate issues raised by the Fed's provision of liquidity to the primary dealers. But we must dramatically expand our attention to the fundamental needs of our system, and move much more quickly to update our regulatory structure – always keeping in mind that there must be a balance between market discipline and market oversight.

I see three clear lessons from the experience of recent months:

First, we should quickly consider how to most appropriately give the Federal Reserve the authority to access necessary information from complex financial institutions and the authority to act to mitigate systemic risk in advance of a crisis.

Second, we need to take several critical steps to make sure that market discipline continues to play the vital role it needs to play to keep our financial system in balance, as we work to ensure the system's stability. To reduce the perception and the likelihood that a complex financial institution is too interconnected to fail, steps are needed to strengthen our practices and financial infrastructure in the OTC derivatives market and in the tri-party repo system, and to provide greater certainty around the mechanics of winding down a failed institution that is not a federally insured depository institution.

Third, we must re-examine the emergency authorities of the Federal Reserve, Treasury and other financial regulators to ensure they are adequate to the roles they are expected to play in today's modern and multi-faceted financial system.

SEC Charges Two Former Bear Fund Managers

The SEC charged two former Bear Stearns Asset Management (BSAM) portfolio managers for fraudulently misleading investors about the financial state of the firm's two largest hedge funds and their exposure to subprime mortgage-backed securities before the collapse of the funds in June 2007.  The SEC's complaint alleges that when the hedge funds took increasing hits to the value of their portfolios during the first five months of 2007 and faced escalating redemptions and margin calls, then-BSAM senior managing directors Ralph R. Cioffi and Matthew M. Tannin deceived their own investors and certain institutional counterparties about the funds' growing troubles until they collapsed and caused investor losses of approximately $1.8 billion.

According to the SEC's complaint, the Bear Stearns High-Grade Structured Credit Strategies Fund and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund collapsed after taking highly leveraged positions in structured securities based largely on subprime mortgage-backed securities. According to the complaint, Cioffi and Tannin misrepresented the funds' deteriorating condition and the level of investor redemption requests in order to bring in new money and keep existing investors and institutional counterparties from withdrawing money. The complaint alleges that, for example, Cioffi misrepresented the funds' April 2007 monthly performance by releasing insufficiently qualified estimates — based only on a subset of the funds' portfolios — that projected essentially flat returns. The complaint alleges that final returns released several weeks later revealed actual April losses of 5.09 percent for the High-Grade Structured Credit Strategies Fund and 18.97 percent for the High-Grade Structured Credit Strategies Enhanced Leverage Fund.

The SEC's complaint alleges that Cioffi and Tannin also misrepresented their funds' investment in subprime mortgage-backed securities. According to the complaint, monthly written performance summaries highlighted direct subprime exposure as typically about 6 to 8 percent of each fund's portfolio. As alleged in the complaint, however, after the funds had collapsed, the BSAM sales force was ultimately told that total subprime exposure — direct and indirect — was approximately 60 percent.

The SEC further alleges that Cioffi and Tannin continually exaggerated their own investments in the funds while using their personal stake as a selling point to investors. In its complaint, the Commission seeks permanent injunctive relief, disgorgement of all illegal profits plus prejudgment interest, and the imposition of civil monetary penalties.

Two Former Bear Fund Managers Are Indicted

As expected, federal prosecutors indicted Ralph Cioffi and Matthew Tannin, former managers of two bond portfolios in Bear Stearn's asset-management unit that collapsed last summer.  These are the first indictments arising from the subprime mortgage collapse and accuse the two of securities and wire fraud.  The SEC is expected to announce civil charges against the two as well.  The prosecutors charge that Cioffi and Tannin believed that the funds were in serious trouble as early as March 2007, but continued to misrepresent their financial condition to investors, hoping to avert their collapse.  In addition, they charge that Cioffi transferred $2 million of his own money out of one of the funds without telling investors.  WSJ, Bear Fund Managers Indicted.  The Wall St. Journal earlier reported that prosecutors will focus on an April 2007 email sent by Tannin to Cioffi in which he said he feared that the market for the bond securities was "toast."  Four days later they assured investors in a conference call that all was well.  Defendants are expected to counter that Tannin and Cioffi met and assured themselves that Tannin had overreacted.  WSJ, Prosecutors in Bear Case Focus In on Email.

Paulson and Cox on Regulation of Investment Banks

Treasury Secretary Henry Paulson is expected to call for greater oversight by the Federal Reserve over investment banks in a speech today, including explicit authority to intervene whenever an investment firm poses risks to the system.  WPost, Paulson To Urge New Fed Powers. The SEC's Chairman Cox, in an opinion piece in today's Wall St. Journal, sets forth the argument he has made recently in testimony and speeches about the differences in regulation of commercial and investment banks.  While the SEC has, through its voluntary Consolidated Supervised Entities Program, exercised oversight over the four (previously five, until Bear's collapse) major investment firms not regulated by the Fed, the SEC's focus is on capital and liquidity requirements to protect the customers of the broker-dealer from failure.  The net capital rules proved inadequate to prevent the "run on the bank" loss of confidence that caused Bear's demise.  He notes that the Fed's intervention through emergency borrowing raises the moral hazard issue that others have raised.  Finally, he calls for explicit statutory recognition of the SEC's CSE program.  WSJ, A Brave New World for Financial Regulation.  This is an important debate in which Congress needs to engage.  It seems clear that there is a need for new tools and a shared role between the Federal Reserve and the SEC.

SEC Charges Five in Inside Trading in Stock of Company Acquired by Boeing

The SEC filed a complaint against five individuals (Defendants) in the United States District Court for the Northern District of Texas alleging that they engaged in unlawful trading on the basis of material, nonpublic information in the securities of Aviall, Inc. (Aviall) before a May 1, 2006 merger announcement with The Boeing Company. According to the Commission's complaint, two Aviall employees became aware of material, nonpublic information concerning the impending acquisition of Aviall in the course of their employment at Aviall's Dallas headquarters and that they, in turn, tipped family members and a business associate. As a result of their trading in Aviall common stock and call options, the Defendants collectively reaped hundreds of thousands of dollars in profits

SEC Charges Two Former Sentinel Management Executives with Fraud

The SEC recently charged two former Sentinel Management Group, Inc. (Sentinel) executives, Eric A. Bloom (Bloom) and Charles K. Mosley (Mosley), for their roles in devising and carrying out a fraud that resulted in several hundred millions dollars in losses to Sentinel's clients. Prior to its August 2007 bankruptcy, Sentinel was a registered investment adviser that primarily managed short-term cash investment portfolios (Client Portfolios) for various types of advisory clients, including Futures Commission Merchants, hedge funds, financial institutions, pension funds, and individuals. In an amended complaint filed today in federal court in Chicago, the Commission added Bloom and Mosley as defendants in the action it instituted against Sentinel on August 20, 2007. Bloom was the President and Chief Executive Officer of Sentinel from approximately October 1988 until August 2007. He controlled the day-to-day operations at Sentinel. Mosley was Senior Vice President, head trader and portfolio manager of Sentinel from approximately October 2002 until August 2007. He was responsible for Sentinel's investing and trading activities. The Commission's amended complaint also added new causes of action against Sentinel, which is now under the control of a bankruptcy trustee, in connection with Sentinel's pre-bankruptcy conduct.

The Commission's amended complaint alleges that from approximately 2003 through August 2007, Sentinel, through the actions of Bloom and Mosley, exposed its clients to substantial risks by engaging in an undisclosed investment strategy that relied extensively on leverage and repurchase transactions. Additionally, the Commission's amended complaint alleges that Sentinel, Bloom, and Mosley misused Client Portfolio assets to finance risky leveraged trading for the benefit of Sentinel's house portfolio (House Portfolio), which was owned by Sentinel insiders, including Bloom and Mosley. The amended complaint also alleges that Mosley, with the knowledge and approval of Bloom, caused Sentinel to record huge returns -- annualized gains of 100% or more -- for its leveraged trading in the House Portfolio, partly through misuse of Client Portfolio assets. The Commission's amended complaint also alleges that as part of their fraud, Bloom and Mosley improperly used Client Portfolio assets to collateralize a bank line of credit to Sentinel, thus subjecting clients to the risk that the lender would assert a security interest in the assets and sell them if Sentinel could not meet its loan obligations.

The amended complaint seeks a permanent injunction against the Defendants and also seeks disgorgement, prejudgment interest, and civil penalties against Bloom and Mosley.

Senator Seeks Additional Regulation of Equity Swaps

Senator Charles Schumer (D-NY) called on the SEC to clarify the treatment of equity swaps in contests for corporate control.  A federal district court recently held, in CSX Corp. v. The Children's Investment Fund, that the fund did not properly disclose its holdings in equity swaps in its campaign to take control of the CSX board, but did not issue an injunction.  WSJ, Schumer Pressures SEC On Equity-Swap Rules.

SEC Obtains Emergency Asset Freeze in Securities Offering Case

The SEC obtained an order freezing assets and granting other emergency relief in a pending action in Dallas federal court involving what the Commission contends is a fraudulent offering of securities, known as Secured Debt Obligations ("SDOs"), by W Financial Group, LLC. ("W Financial"). The district court entered orders freezing the defendants' assets, requiring an accounting and repatriation of assets, and ordered defendants to preserve documents and submit to expedited discovery. The Court scheduled a preliminary injunction hearing for June 25, 2008, at which time the Court will consider the Commission's request to appoint a receiver to marshal and conserve assets for the benefit of defrauded investors.

The Commission's Complaint, filed on March 21, 2008, alleges that the defendants, directly and through sales agents, raised at least $17.9 million from at least 182 investors between September 2006 and February 2007. According to the Complaint, W Financial investors, primary senior citizens and retirees, were lured into purchasing SDOs through a series of misrepresentations and omissions that portrayed SDOs to be as safe as FDIC-backed certificates of deposit. The Complaint further alleges that the defendants misappropriated and misused the majority of W Financial investor funds, spending millions of dollars, for example, to purchase and operate high-risk business enterprises such as a retail electric power provider and a custom home-building company. In addition to the relief granted by the court, the Complaint seeks civil penalties and disgorgement of ill-gotten gains against each defendant.

Simultaneously with the filing of the Complaint, the Commission, with the consent of defendants, asked the Court to appoint a Special Master to oversee the liquidation by defendants of certain assets and to take custody of the proceeds from these sales.

CMS Energy Officer Settles SEC Charges

The SEC settled administrative charges against Tamela Pallas.  Its Order finds that Pallas participated in and approved of the decision to do round trip energy trades while she was (a) Senior Vice President of Reliant Energy Services, Inc., a subsidiary of Reliant Energy, Inc. (Reliant), that was a part of Reliant's Wholesale Group and as the Chief Operating Officer and later (b) Chief Executive Officer of CMS Marketing Services & Trading, a subsidiary of CMS Energy Corp. (CMS). The inclusion of those transactions caused Reliant's and CMS's financial statements to present materially misleading pictures of their actual business activity. Although Pallas neither participated in discussions or decisions regarding how to account for the transactions nor participated in drafting earnings releases or Commission filings at either Reliant or CMS, according to the SEC, Pallas should have known that the revenues and expenses associated with the round trip trades would be included in each company's financial statements, including filings made with the Commission. The Order finds that Pallas's conduct with respect to the round trip trades was negligent and, as such, was a cause of the filing of reports, including offering materials, which included revenues and expenses related to round trip trades. Respondent's negligent conduct was also therefore a cause of the related misstatement of the transactions in each company's books, records and accounts.

Tamela Pallas consented to the issuance of the Order without admitting or denying any of the findings contained in the Order.

Amex Approves Merger with NYSE Euronext

NYSE Euronext (NYX) and the American Stock Exchange® (Amex®) announced today that members of The Amex Membership Corporation (AMC) approved the adoption of the merger agreement between AMC and NYSE Euronext and certain of their subsidiaries. The Securities and Exchange Commission must still approve the rule changes related to the transaction before it becomes final.

Under the terms of the agreement, NYSE Euronext will pay $260 million in NYSE Euronext common stock for the Amex. In addition, Amex members will be entitled to receive additional shares of NYSE Euronext common stock calculated by reference to net proceeds, if any, from the expected sale of Amex's lower Manhattan  headquarters.

Milberg Firm Pays $75 Million to Settle Government Charges

The Milberg law firm agreed to pay $75 million to settle criminal charges that the firm made secret payments to lead plaintiffs in securities fraud class actions.  The firm acknowledged that seven former partners paid kickbacks in more than 165 lawsuits over a period of 25 years.  No current Milberg partner was named in the agreement.  As part of the settlement, the firm must follow a "best practices program" for two years and present referrals and co-counsel fees to an outside "compliance monitor."  NYTimes, Big Penalty Set for Law Firm, but Not a Trial; WSJ, Milberg Settles With Government.