Securities Law Prof Blog

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

Sunday, November 30, 2008

Steinbach on Trading on Stolen Information

Mere Thieves, by Robert Steinbuch, University of Arkansas at Little Rock, was recently posted on SSRN.  Here is the abstract:

Today, criminals are capable of covertly stealing financial secrets from multinational corporations. Securities jurisprudence, however, has focused largely on the activities of insiders who secretly trade on information that they legally garner through their positions of trust, and has not addressed the culpability of "mere thieves" who trade on confidential financial information gained through illegal means. As such, a void in securities law exists regarding how to address the theft and use of confidential financial information by strangers under the Securities and Exchange Commission's (SEC) Rule 10b-5. This article sets forth a jurisprudential analysis under which mere thieves who trade on stolen confidential information are liable for insider trading.

November 30, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Davidoff & Zaring on Government's Response to Financial Crisis

Big Deal: The Government's Response to the Financial Crisis, by Steven M. Davidoff, University of Connecticut School of Law; Ohio State University - Michael E. Moritz College of Law, and David T. Zaring, University of Pennsylvania - Legal Studies Department, was recently posted on SSRN.   Here is the abstract:

How should we understand the federal government's response to the financial crisis? The government's team, largely staffed by investment bankers, pushed the limits of its statutory authority to authorize an ad hoc series of deals designed to mitigate that crisis. It then decided to seek comprehensive legislation that, as it turned out, paved the way for more deals. The result has not been particularly coherent, but it has married transactional practice to administrative law. In fact, we think that regulation by deal provides an organizing principle, albeit a loose one, to the government's response to the financial crisis. Dealmakers use contract to avoid some legal constraints, and often prefer to focus on arms-length negotiation, rather than regulatory authorization, as the source of legitimacy for their actions, though the law does provide a structure to their deals. They also do not always take the long view or place value on consistency, instead preferring to complete the latest deal at hand and move to the next transaction. In this paper, we offer a first look at the history of the financial crisis from the fall of Bear Stearns up to, and including, the initial implementation of the Economic Emergency Stability Act of 2008. We analyze in depth each deal the government concluded, and how it justified those deals within the constraints of the law, using its authority to sometimes stretch but never truly break that law. We consider what the government's response so far means for transactional and administrative law scholarship, as well as some of the broader implications of crisis governance by deal.

November 30, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Michaels on Securities Litigation after Worldcom

An Empirical Study of Securities Litigation after WorldCom, by David I. Michaels, Delaware Court of Chancery; UCLA School of Law, was recently posted on SSRN.  Here is the abstract:

In this article I present the first empirical study analyzing whether and to what extent In re WorldCom, Inc. Securities Litigation impacted class action litigation brought under Section 11 of the Securities Act of 1933, one of the securities laws' principal liability provisions. The study tests the hypothesis of an article I previously published in which I argued that WorldCom would encourage plaintiffs to increasingly utilize Section 11 as a means to obtain settlement awards in securities class action cases. WorldCom, I argued, made it virtually impossible for outside directors to successfully assert Section 11's "due diligence" defense-an affirmative defense for parties involved in securities offerings who have completed the requisite investigation of the information disseminated to investors in connection with public offerings of securities-even though historically outside directors were held to a low standard. At the same time, outside directors' liability under Rule 10b-5, the securities laws' most broadly sweeping liability provision, has historically been negligible. Therefore, I concluded that plaintiffs would likely assert more Section 11 class actions relative to Rule 10b-5 actions. I described why this result is sub-optimal and proposed an effective solution. In this article, I test that hypothesis by utilizing empirical methodology, and conclude that there has been a statistically significant rise in post-WorldCom Section 11 class action flings relative to Rule 10b-5 class action filings. This supports the conclusion that the SEC should reexamine the Section 11 standard for outside directors.

November 30, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 26, 2008

Former Diebold Sales Rep Settles Inside Trading Charges

On November 19, 2008, the United States District Court for the Western District of Oklahoma entered final judgment against Robert G. Cole in SEC v. Cole, Civ 08-265 C (W.D. Okla.), an insider trading case the Commission filed on March 13, 2008. The Commission’s complaint alleged that Cole, a former sales representative for Diebold, Inc., made over $500,000 in illegal profits by using material, nonpublic information to trade Diebold securities. Diebold is an Ohio-based public company that manufactures and sells automated teller machines, bank security systems, and electronic voting machines.

The Commission’s complaint alleged that on September 15, 2005, shortly after learning from his sales manager that revenues and orders in Diebold’s North American regional bank business were significantly below target, Cole began purchasing hundreds of soon-to-expire Diebold put options contracts, at a total cost of $70,110, anticipating that Diebold would lower its earnings forecast and the price of Diebold stock would fall. As alleged in the complaint, on September 21, 2005 — one day after Cole completed purchasing these Diebold put option contracts — Diebold announced that it was lowering its earnings forecasts, primarily because of a revenue shortfall in the company’s North American regional bank business. After this public announcement, Diebold’s stock price dropped sharply, closing at $37.27 per share, which was a 16% drop from the previous day’s closing price of $44.13. As the complaint alleged, Cole immediately sold the Diebold put option contracts for $579,190, realizing illicit profits of $509,080 (a 700% return).

The Commission alleged that Cole violated Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. Without admitting or denying the allegations in the complaint, Cole consented to the entry of a final judgment that permanently enjoins him from future violations of these provisions, and orders him to disgorge his illicit profits of $509,080, which will be deemed satisfied by a forfeiture order entered in a related criminal case. In that case, U.S. v. Robert Cole, No. 5:08-CR-327 (N.D. Ohio), Cole pled guilty to a felony charge of securities fraud, and was sentenced to a prison term of 1 year and 1 day, two years of supervised release, forfeiture of $509,080, and a $180,000 fine.

November 26, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 25, 2008

IOSCO Technical Committee Studies Regulatory Reform

The International Organization of Securities Commissions (IOSCO) Technical Committee launched three task forces to support G-20 aims following a meeting by teleconference today. The Technical Committee Task Forces will consider the following issues:

Short Selling — the Task Force will work to eliminate gaps in various regulatory approaches to naked short selling, including delivery requirements and disclosure of short positions. In this connection, the Task Force will also examine how to minimize adverse impacts on legitimate securities lending, hedging and other types of transactions that are critical to capital formation and to reducing market volatility. The Task Force will be chaired by the Securities and Futures Commission of Hong Kong;
Unregulated Financial Markets and Products — given the impact unregulated financial markets and products have had on global capital markets, the Task Force will examine ways to introduce greater transparency and oversight to unregulated market segments, such as OTC markets for derivatives and other structured financial products. The Task Force will be co-chaired by the Australian Securities and Investments Commission and the Autorité de Marché Financiers of France; and
Unregulated Financial Entities — the Task Force will examine issues surrounding unregulated entities such as hedge funds, including the development of recommended regulatory approaches to mitigate risks associated with their trading and traditional opacity. The Task Force will be chaired by the CONSOB of Italy and the Financial Services Authority of the United Kingdom.

The Task Forces will present their reports at the next Technical Committee meeting in February 2009 and to the next G-20 summit in spring 2009.


November 25, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

AIG Announces Restrictions on Executive Compensation

In response to New York AG Cuomo's inquiry last week, AIG announced voluntary restrictions on executive compensation that include a $1 salary for its Chief Executive Officer; no 2008 annual bonuses and no salary increases through 2009 for AIG's top-seven-officer Leadership Group; and no salary increases through 2009 for the 50 next-highest executives, in addition to other bonus, severance and retention award restrictions.  In a letter to Mr. Cuomo, CEO Edwary Liddy noted the importance of "fair and reasonable incentives" to retain staff.  He also stated that no taxpayer dollars would be used for annual bonuses or future cash performance awards for the top 60 members of management.

November 25, 2008 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, November 24, 2008

Prosper Marketplace Settles Charges It Offered Unregistered Securities

The SEC settled administrative proceedings against Prosper Marketplace, Inc. (Prosper). The SEC Order finds that Prosper violated the registration provisions of the Securities Act of 1933 during the period January 1, 2006 through October 14, 2008, by engaging in the unregistered offering of securities via Prosper's online lending platform. Prosper offers loans in a double-blind, auction-like process wherein multiple lenders bid to fund loans to borrowers. Since the inception of its platform in January 2006, Prosper has initiated approximately $174 million in loans.

The loans are non-recourse in nature and in amounts between $1,000 and $25,000. Lenders and borrowers register on the website and create Prosper identities. Potential lenders bid on funding all or portions of loans for specified interest rates, which are typically higher than rates available from financial institutions. Individual lenders do not actually lend money directly to the borrower; rather, the borrower receives a loan from a bank with which Prosper has contracted. The interests in a given loan are then sold and assigned through Prosper to the lenders, with each lender receiving an individual non-recourse promissory note in the amount of the lender's bid. Prosper collects an origination fee from each borrower of one to three percent of loan proceeds and collects servicing fees from each lender of one percent of loan payments. Prosper administers the collection of loan payments from the borrower and the distribution of such payments to the lenders. Prosper also initiates collection of past due loans from borrowers, assigns delinquent loan accounts to collection agencies and sells defaulted loans to debt purchasers. Lenders and borrowers are prohibited from transacting directly and from learning each others' true identities.

Based on the above, the Order orders Prosper to cease and desist from committing or causing any violations and any future violations of Sections 5(a) and (c) of the Securities Act of 1933. Prosper consented to the issuance of the Order without admitting or denying any of the findings in the Order.

November 24, 2008 in SEC Action | Permalink | Comments (2) | TrackBack (0)

Sunday, November 23, 2008

Massachusetts Securities Division Charges Oppenheimer in ARS Downstream Sales and Inside Trading

The Massachusetts Securities Division brought an administrative complaint charging Oppenheimer & Co. and several of its executives with violations of the Massachusetts securities law in connection with its "downstream" sales of auction rate securities (ARS).  The complaint alleges that Oppenheimer significantly misrepresented the nature of the ARS and the overall stability and health of the ARS market when marketing the product to its customers.  In addition, key Oppenheimer executives sold their own ARS when they learned the market was in danger of imploding, without disclosing this information to investors.  Specifically, the complaint alleges that CEO Albert Oppenheimer sold $1.77 million of his personal holdings in January and February 2008, and Greg White, Managing Director of ARS Dept., sold $400,000 of his own and his wife's business ARS holdings in the same time period.   

November 23, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Jones on Regulatory Redundancy

Legitimacy and Corporate Law: The Case for Regulatory Redundancy, by Renee M. Jones, Boston College - Law School, was recently posted on SSRN.  Here is the abstract:

This article provides a democratic assessment of the corporate law making structure in the United States. It draws upon the basic democratic principle that those affected by legal rules should have a voice in determining the substance of those rules. Although other commentators have noted certain undemocratic aspects of corporate law, this Article is the first to present a comprehensive assessment of the corporate regulatory structure from the perspective of democracy. It departs from prior accounts by looking past the states' role to consider the ways that federal regulation shores up the legitimacy of the overarching structure.

This focus on the federal role provides some comfort on a democratic account, but also counsels caution with respect to continuing efforts to limit the scope of the federal role within the corporate governance structure. At the federal level, Congress has chosen to regulate corporate matters by setting broad policy objectives and delegating administrative tasks to the Securities and Exchange Commission ("SEC"). The democratic legitimacy of the corporate regulatory regime thus requires proper respect for the discretion that Congress has vested in the agency.

The Article therefore urges skepticism toward efforts to constrain the SEC's regulatory role through judicial challenges to its rulemaking authority. It argues that the SEC's ability to respond deftly to market crises and scandals has been unnecessarily hampered by a tradition of aggressive judicial review of agency rulemaking. While rooted in concerns for preserving democratic accountability for agencies, this tradition has undermined the very values it seeks to protect. Because the procedures for SEC rulemaking comport well with democratic values, the agency deserves more deference than courts have been willing to allow.

The analysis has implications for current proposals to reform regulation of the national financial markets. Recent calls to weaken the SEC's role in financial regulation should give pause to those concerned with the democratic integrity of our regulatory processes. It is the SEC's political independence that strengthens its ability to navigate the rough terrain of regulating the powerful industries within its jurisdiction. Bolstering rather than diminishing the agency's independence should therefore be a central element of any proposal to improve our financial regulatory system.

November 23, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Haslem on Disclosure to Mutual Fund Directors

What Independent Directors Should "Request" of Mutual Fund Advisers, by John A. Haslem, University of Maryland - Robert H. Smith School of Business, was recently posted on SSRN.  Here is the abstract:

The expenses, costs, and practices of mutual fund
advisers are not disclosed with normative transparency to
independent directors and shareholders. Such complete
disclosure is absolutely essential if independent directors are to
be vigorous and effective monitors of fund advisers.
To this end, directors should "request" advisers to provide
them with normative disclosure, especially with respect to fund
costs and expenses.

This disclosure requires a new "total expense ratio" that includes the many "hidden" costs and expenses. This comprehensive disclosure has four major components, each with specified categories and subcategories,and discussion: (1) management fees, (2) distribution fees, (3) "other" fund expenses, and (4) transaction costs.

However, there are several major impediments to
independent directors requesting normative transparency of
disclosure. Independent directors are not adequately
empowered under the 40Act, and they have been generally
ineffective in preventing use of numerous (often improper)
adviser practices designed to increase their profits. In fact, for
various reasons, directors often take positions sympathetic to
the profit motives of fund advisers.

November 23, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Schwarcz on Securitization

The Future of Securitization, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN.  Here is the abstract:

This essay examines the future viability of securitization in light of its causal involvement in the subprime-mortgage financial crisis. Securitization has many positive attributes. It efficiently allocates risk with capital, it enables companies to access capital markets directly (in most cases at lower cost than the cost of issuing direct debt), and it avoids middleman inefficiencies. When the securitized assets are loans, securitization helps to transform the loans into cash from which banks and other lenders can make new loans. These positives might be outweighed, however, by four negatives of securitization revealed by the subprime crisis: subprime mortgages were a flawed asset type that should not have been securitized; the originate-and-distribute model of securitization can create moral hazard; securitization can create servicing conflicts; and securitization can foster overreliance on mathematical models. This essay examines these negatives and the extent to which they can be remedied in the future.

November 23, 2008 in Law Review Articles | Permalink | Comments (1) | TrackBack (0)

Macey, O'Hara & Rosenberg on Subprime Mortgage Brokers

Helping Law Catch Up to Markets: Applying Broker-Dealer Law to Subprime Mortgages, by Jonathan R. Macey, Yale Law School; Maureen O'Hara, Cornell University - Samuel Curtis Johnson Graduate School of Management; Gabriel D. Rosenberg, Yale University - Law School, was recently posted on SSRN.  Here is the abstract:

Much of the blame for the current financial crisis is attributable to problems in the subprime mortgage market. In this Article we argue that changes in the nature of the mortgage contract make it both legally plausible and normatively desirable that subprime mortgages brokers be treated as securities broker-dealers for the purposes of the Securities Act of 1933 and the Securities and Exchange Act of 1934. Modern subprime mortgages are, in large part, investments that contain imbedded options and are not subject to any alternative comprehensive regulatory regime. Thus, they should qualify as "notes" under the Securities Act definition and the Supreme Court's Reves test, and expose their brokers to Rule 10b-5 oversight. In the alternative, we argue that the emergence of securitization as the primary process by which mortgages are financed provides a second, independent analytical basis for our theory that subprime mortgages financings should be subject to securities law: Mortgage financings qualify for the protections of rules such as SEC Rule 10b-5 because they occur "in connection with the purchase or sale of a security," the mortgage-backed security that is created and funded on the basis of the cash flows from the mortgagors' payments on their subprime mortgages.

Were the SEC to take control of subprime mortgages brokers, rules that forbid the sale of financial instruments to any person unless investing in those instruments is appropriate (suitable) to the investment needs and risk tolerance of that investor would come into play, oversight that would have avoided or greatly mitigated the current crisis. In describing what suitability would do for the mortgage market, we make a novel distinction between "product" and "transaction form" suitability in our analysis of the suitability rules. We argue that transaction form suitability is the appropriate legal theory to use when pursuing people who have unscrupulously sold subprime mortgages to unsophisticated investors. In closing, we discuss reasons why we believe the SEC has not tried to exert this authority to date.

November 23, 2008 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Friday, November 21, 2008

SEC Bars Adviser's Former Managing Director for Conversion, Fraud

The SEC imposed sanctions on Brendan E. Murray, formerly a managing director of registered investment advisor Cornerstone Equity Advisers, Inc. (Cornerstone) and secretary to Cornerstone's advisory clients the Cornerstone Funds, Inc. (Funds), for willfully aiding and abetting, and being a cause of, Cornerstone's violations of antifraud provisions of the Investment Advisers Act of 1940. Cornerstone, a fiduciary to the Funds, misappropriated client funds by knowingly inflating and falsifying vendor invoices, directing the payments of the inflated amounts to an intermediary, and instructing the intermediary to pay the vendors lesser amounts (or nothing) while keeping the overage. The Commission found that Murray participated in the scheme by creating, submitting, and authorizing payment of the inflated invoices. The Commission also found that Murray, who as secretary owed a fiduciary duty to the Funds, converted corporate funds by knowingly submitting inflated invoices for reimbursement. The Commission concluded that it is in the public interest to bar Murray from associating with any investment adviser or investment company, to impose a cease-and-desist order, to impose a civil money penalty in the amount of $60,000, and to order disgorgement in the amount of $21,157 plus prejudgment interest.

November 21, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Thursday, November 20, 2008

SEC Director Sirri Testifies on Credit Default Swaps

Erik Sirri, Director, Division of Trading and Markets, SEC, testified on Credit Default Swaps before the House Committee on Agriculture on November 20, 2008.

November 20, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Convenes Meeting of International Regulators

SEC Chairman Christopher Cox announced that he will convene a meeting of the International Organization of Securities Commissions (IOSCO) Technical Committee on Monday, November 24 by teleconference to discuss urgent regulatory issues in the ongoing credit crisis.  The Technical Committee meeting will consider:

Short Selling — Consider the effectiveness of recent regulatory responses in reducing manipulative short selling without stifling legitimate short selling activity, and explore possible coordination on rules relating to naked short sales, in particular with regard to position reporting and delivery and pre-borrowing requirements
Under-Regulated or Unregulated Products — Develop disclosure principles to promote transparency in OTC markets for derivatives and other financial instruments which will contribute to enhanced investor protection and mitigating systemic risk.

The meeting also will focus on:

Credit Rating Agencies — Assess members' progress in adopting rules based on IOSCO's revised Code of Conduct, and accelerate work on developing a common examination module.
International Accounting Standards — Ensure that the process of developing international accounting standards continues to take account of the interests of investors.

November 20, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, November 19, 2008

SEC Charges Day-Traders with Manipulative Short-Selling Scheme

The SEC filed charges against two day-traders, Robert Todd Beardsley and George Lindenberg, who allegedly perpetrated a manipulative short selling scheme through brokerage accounts at a now defunct broker-dealer, Redwood Trading LLC ("Redwood"). As alleged in the complaint, Beardsley and Lindenberg engaged in their manipulative short selling scheme by repeatedly selling short securities in violation of the then-existing short sale rule, commonly referred to as the "uptick rule," with the intent to artificially depress the price of shares that they had sold short in order to enable them to cover their short positions at favorable prices. In a related civil injunctive action, the SEC alleges that Dennis McNell, the former Chief Executive Officer and Chief Operations Officer of Redwood, aided and abetted the illegal short selling scheme. The complaint also alleges that McNell engaged in an unrelated fraudulent scheme to hide substantial trading losses that he had incurred in a Redwood proprietary account.  The SEC has settled the charges against Lindenberg and McNell, pending court approval.

November 19, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Announces Panelists for Mark-to-Market Accounting Roundtable

The SEC announced the expected panelists for its November 21 roundtable concerning mark-to-market accounting.  The roundtable will have one panel discussion focused on the usefulness of mark-to-market accounting to investors:

The sufficiency of information and the ability to improve the reliability regarding the valuation of assets recognized at fair value that do not currently trade in an active market
Challenges encountered and best practice used by preparers of financial statements related to estimating fair value during the current market conditions
Whether there are aspects of the current fair value measurement accounting standards that are not sufficiently clear, and if so, what are the areas that could be improved and how
Whether there needs to be more education related to fair value measurements
Challenges that auditors have faced and best practice employed in providing assurance regarding fair value accounting
Ways to increase transparency and consistency in the application of impairment models for investments not held for trading purposes

Scheduled panelists include:

James Gilleran, former Director, Office of Thrift Supervision
Jay Hanson, McGladrey & Pullen, LLP
Richard Jones, Dechert LLP
Wayne Landsman, University of North Carolina
David Larsen, Duff and Phelps LLC
Dane Mott, JP Morgan Chase
Donald Nicolaisen, former Chief Accountant of the SEC
Samuel Ranzilla, KPMG LLP
David Runkle, Trilogy Global Advisors
Kevin Spataro, The Allstate Corporation
Mark Thresher, Nationwide Financial
Bob Traficanti, Citigroup

In addition, the following individuals are scheduled to participate in the panel discussion as observers:

Daniel Goelzer, Public Company Accounting Oversight Board
Charles Holm, Federal Reserve Board
Kristen Jaconi, U.S. Department of the Treasury
Thomas Jones, International Accounting Standards Board
Thomas Linsmeier, Financial Accounting Standards Board

November 19, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

NASAA Announces Regulatory Reform Roundtable Next Month

The NASAA released five core principles to help guide the ongoing policy debate over the changes necessary to strengthen the nation’s financial services regulatory structure.  NASAA also announced that it will host a Regulatory Reform Roundtable next month in Washington, D.C. to discuss the Core Principles and present specific recommendations for future reforms.

The five core principles of regulatory reform are:

Preserve the system of state/federal collaboration while streamlining where possible.
Close regulatory gaps by subjecting all financial products and markets to regulation.
Strengthen standards of conduct, and use “principles” to complement rules, not replace them. 
Improve oversight through better risk assessment and interagency communication.
Toughen enforcement and shore up private remedies.

November 19, 2008 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Adopts Rules to Improve Mutual Fund Disclosure

The SEC voted unanimously to improve mutual fund disclosure by requiring that funds provide investors with a concise summary — in plain English — of the key information they need to make informed investment decisions. The new summary prospectus will appear at the front of a fund’s prospectus.  The Commission also approved amendments to encourage funds to make greater use of the Internet so investors can receive more detailed information in a way that best suits their needs.

Mutual funds are supposed to be the best investment vehicle for retail investors to obtain diversification, yet past SEC efforts to improve the quality of mutual fund disclosure have been unsuccessful.  As Andrew J. Donohue, Director of the SEC’s Division of Investment Management, acknowledged: “Many investors often find current fund prospectuses to be lengthy, legalistic and confusing.

Specifically, the SEC adopted the following improvements to mutual fund disclosure:

Summary Information at the Front of the Prospectus
Every mutual fund must include key information at the front of its statutory prospectus about the fund’s investment objectives and strategies, risks, and costs. The summary will also include brief information regarding investment advisers and portfolio managers, purchase and sale procedures, tax consequences, and financial intermediary compensation. Funds will be required to provide the summary information in plain English and in a standardized order.

New Prospectus Delivery Option for Mutual Fund Securities
The Commission adopted a new rule that permits sending a summary prospectus to satisfy prospectus delivery requirements provided that the mutual fund’s summary prospectus, statutory prospectus, and other specified information are available online. The summary prospectus must have the same information in the same order as the summary at the front of the statutory prospectus.

In addition:

The online materials must be in a user-friendly format that permits investors and other users to move back and forth between the summary prospectus and the statutory prospectus. This will allow investors and others to efficiently access particular information that is of interest to them.
Investors have to be able to download and retain an electronic version of the information.
The statutory prospectus and other information must be provided in paper or by e-mail upon request so investors can choose the format in which they receive more detailed information.

The full text of the Commission’s new disclosure requirements will be posted to the SEC Web site as soon as possible.

November 19, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, November 18, 2008

SEC Charges Fraud in Commodity Derivatives Trading at Bank of Montreal

The SEC filed charges in the United States District Court for the Southern District of New York alleging that four individuals engaged in a fraudulent scheme to overvalue the commodity derivatives trading portfolio at Bank of Montreal ("BMO") and thereby inflate BMO's publicly reported financial results. The defendants include a former senior derivatives trader at BMO and the top two senior executive officers of Optionable, Inc. ("Optionable"), a publicly traded commodities brokerage firm.

The defendants named in the Commission's complaint are:

David Lee ("Lee") was a natural gas options trader employed by BMO Capital Markets Corp., a wholly-owned subsidiary of BMO and a registered broker-dealer, until he resigned on May 15, 2007. From 2001 through 2004, Lee was a Vice President of BMO's Commodity Derivatives Group, the unit through which BMO traded commodity derivatives. In 2005, he was promoted to Managing Director of that group.

Kevin P. Cassidy ("Cassidy") was one of Optionable's founders and served as Vice Chairman of Optionable's board of directors until he resigned on May 12, 2007. Except for the period from March 2004 to October 2005, he was also Optionable's CEO throughout the relevant period.

Edward O'Connor ("O'Connor") was one of Optionable's founders and since 2001, he has served as President and a director of Optionable. From March 2004 through October 2005, he was also Optionable's CEO and Treasurer.

Scott Connor ("Connor") was employed by Optionable as a commodities broker until May 2007.

The Commission's complaint specifically alleges as follows:

Lee fraudulently overvalued BMO's portfolio of natural gas options by deliberately "mismarking" trading positions for which market prices were unavailable. Lee recorded inflated values that were then purportedly validated by Optionable, which held itself out to BMO and the public as a legitimate provider of independent derivatives valuation services. In fact, Cassidy, O'Connor and Connor schemed with Lee to have Optionable simply rubber-stamp whatever inflated values Lee recorded. After the scheme was discovered, BMO restated its financial results by reducing net income for the first quarter of its 2007 fiscal year by approximately $237 million Canadian dollars ($204 million USD), which reflects a 68% overstatement of BMO's net income for that quarter.

BMO was Optionable's largest customer, and BMO trades accounted for as much as 60% of Optionable's commodity brokerage business. Lee's trading accounted for virtually all of BMO's business with Optionable. As a result, Optionable's management, led by Cassidy, was willing to do whatever it took to keep Lee satisfied. When market prices were unavailable, BMO's risk management personnel sought to verify the accuracy of BMO's commodity derivatives traders' valuations of their positions, or their "marks," by obtaining supposedly independent valuations, or "quotes," for those positions from one or more third parties. During the relevant period, Optionable was the primary source of the third-party quotes that BMO used to validate Lee's marks. Lee provided his marks directly to Cassidy, O'Connor or Connor, who then simply forwarded Lee's marks, virtually unchanged, to BMO's risk management department as if they were Optionable's independent quotes. At first, Lee used this "u-turn" scheme to boost his trading profits and incentive compensation, but in 2006, the market turned against Lee and he used the scheme to hide substantial trading losses. In May 2007, BMO concluded that due to the Optionable scheme and other positions that Lee had also mismarked, Lee's trading book was overvalued by an aggregate total of $680 million (CAD) since the beginning of BMO's fiscal year ended October 31, 2006.

Cassidy and O'Connor also defrauded Optionable's public shareholders by concealing Optionable's role in the scheme. Optionable's periodic reports touted the synergistic benefits of the derivatives valuation services that Optionable purportedly provided to multiple brokerage clients, but those reports, which Cassidy and O'Connor signed, never disclosed that BMO was the principal client for whom those "services" were performed and that the "valuation services" provided to BMO were a sham designed to defraud BMO. In addition, Cassidy and O'Connor defrauded the New York Mercantile Exchange ("NYMEX") by selling over $10 million of their own Optionable stock to NYMEX in April 2007. Both Cassidy and O'Connor represented to NYMEX that Optionable's periodic reports were materially accurate, but they never disclosed anything about their scheme with Lee to defraud the shareholders of BMO, Optionable's largest customer. On May 9, 2007, one day after BMO announced that it had placed Lee on leave and suspended its business relationship with Optionable, Optionable issued an announcement stating that the suspension would have an adverse effect on Optionable's business. Optionable's stock price fell almost 40% that day, from $4.64 to $2.81 per share, and dropped to below 50 cents per share one week later after Cassidy's prior criminal record was disclosed in press reports.

The United States Attorney's Office for the Southern District of New York ("USAO"), the New York County District Attorney's Office ("NYCDA"), and the United States Commodity Futures Trading Commission ("CFTC") also filed parallel criminal and regulatory charges today arising from the same conduct that is alleged in the Commission's complaint. Lee pled guilty to parallel criminal charges filed by the USAO and the NYCDA. In connection with his guilty plea, Lee agreed to pay a total of $4.41 million in forfeiture.

Lee has agreed to settle the SEC charges by consenting, without admitting or denying the SEC's allegations, to the entry of a permanent injunction against future violations of various provisions of the federal securities laws. The Commission's claims for disgorgement and civil penalties against Lee, and all of its claims against the other three defendants, remain pending.

November 18, 2008 in SEC Action | Permalink | Comments (0) | TrackBack (0)