Securities Law Prof Blog

ARS Purchasers' Suit Against UBS Dismissed Because of SEC Settlement

The federal district court in the Southern District of New York dismissed an investors' action against UBS that charged the investment bank misled them about the safety and liquidity of ARS.  The judge said the investors could not continue their suit because UBS previously entered a $19.4 billion settlement with the SEC and state regulators and agreed to buy back the securities.  NYTimes, Investors’ Suit Against UBS Is Dismissed.

Wachovia and Citigroup Agree to Buy Back ARS from California Residents

Wachovia Securities and Citigroup Global Markets entered settlements with California to buy back $4.7 billion in ARS from California residents and companies.  California regulators say these are "the first two" investment banks to settle with the state and "it won't be the last" settlement.  Bizjournals, Citigroup, Wachovia reach 'significant' settlement with California.

Treasury Extends Money Market Fund Guarantees Until Sept. 18, 2009

The U.S. Treasury Department today announced an extension of its temporary Money Market Funds Guarantee Program through September 18, 2009, in order to support ongoing stability in financial markets.  The Program was scheduled to end on April 30, 2009. As a result of this extension, the temporary guarantee program will continue to provide coverage to shareholders up to the amount held in participating money market funds as of the close of business on September 19, 2008.  All money market funds that currently participate in the Program and meet the extension requirements under the Guarantee Agreements are eligible to continue to participate in the Program.  Funds that are not currently participating in the Program are not eligible to participate.

SEC Obtains Consent Judgment in Action Involving Sales of Restricted Securities

On March 30, 2009, the United States District Court for the Southern District of New York entered a partial consent judgment against defendant Pinchus Gold, of Brooklyn, New York, in an action filed in February by the SEC.  Without admitting or denying the allegations of the Commission's complaint, Gold consented to the entry of judgment that permanently enjoins him from further violation of the anti-fraud and registration provisions of the federal securities laws. The judgment further provides that Gold will disgorge his ill-gotten gains and prejudgment interest in an amount to be determined by the Court, and that Gold will be subject to a civil penalty in an amount to be determined by the Court.

The Commission's complaint alleges that Gold and others made material misrepresentations to the transfer agent for Forest Resources Management Corp. in order to obtain millions of restricted shares without the required restricted legend. A registration statement was never in effect for the shares issued to Gold and his nominees. Gold and his nominees then sold these unlegended shares on the open market, falsely holding them out to the investing public as free-trading shares, when in fact they were restricted stock. Gold received nearly $600,000 from the improper sale of these shares.

The litigation is continuing against the remaining defendants.

SEC Charges Tacoma Wash. Man with Affinity Fraud

The SEC charged John H. Min of Tacoma, Wash., and his company Dime Financial Group LLC with raising more than $6 million in a fraudulent investment scheme that targeted churches, church members and senior citizens. The SEC alleges that Min misled some investors into believing their money would support Third World charitable causes while in fact spending the funds on his own lavish lifestyle and on failed high-risk investments.  According to the SEC's complaint, Min associated himself with a tight-knit religious and philanthropic community in the Pacific Northwest, creating a not-for-profit entity to attract charitable investors who believed that their investments would support certain Third Word aid groups, such as a charity supporting Bolivian widows and orphans. Min lured other investors by telling them that his trading expertise allowed him to make annual returns as high as 800 percent, and by touting Dime as a safe, low-risk investment for retirees' savings. The SEC alleges that Min and Dime deceived more than 60 investors since 2005 into buying interests in Dime's purportedly prosperous investment program.

The SEC seeks permanent injunctions, civil monetary penalties, and disgorgement against both Min and Dime.

Separately, today the United States Attorney's Office for the Western District of Washington (USAO) unsealed an indictment charging Min with criminal violations based on the same misconduct.

GAO Update on TARP Program

The GAO issued an update on the TARP program, Troubled Asset Relief Program: March 2009 Status of Efforts to Address Transparency and Accountability Issues. GAO-09-504.  It contains a useful timeline of programs and selected actions under TARP from Jan 30, 2009 through March 23, 2009.

SEC Defers Consideration of Rule 12b-1 Reform

Andrew J. Donohue, the SEC's Director, Division of Investment Management, gave the Keynote Address at the Investment Company Institute, 2009 Mutual Funds and Investment Management Conference on March 23, 2009.  Among the topics covered was Rule 12b-1 reform, which the SEC has put on hold:

Just as you are adjusting to the new market realities, we also need to adjust and reconsider our regulatory priorities to ensure that limited resources are employed where they can provide the greatest impact and benefit to fund investors. While I know our Chairman is supportive of investor-oriented rule 12b-1 reform, I believe that it would be wise in the current market environment, for us to defer consideration of rule 12b-1 reform for this year. We should address a few fundamental matters that directly impact investor protection concerns. For example, we urgently need to reconcile the diverse regulatory regimes governing investment advisers and broker-dealers, and alleviate the uncertainty in the industry emanating from this unresolved matter.

FINRA Panel Awards Customer Over $30 Million in Damages from Merrill

On March 16, A FINRA arbitration panel awarded claimants $30.6 million in compensatory damages (the full amount of claimant's claim), plus 9% interest, against Advest, Inc. and Merrill Lynch, one of the largest awards in a customer dispute.  The claimant, the Trustees of the Masonic Hall and Asylum Fund, charged Advest and Merrill with negligence, breach of contract, misrepresentation and breach of fiduciary duty in connection with the purchase of interests in Sphinx Managed Futures Index Fund.  The award also ordered the claimant to assign to Merrill its interest of its claims in New York State courts against Price Waterhouse Coopers and in the liquidation proceeding of the Sphinx Fund to the extent of the monetary award recovered in the arbitration.

The arbitration was conducted in Albany, NY.

SEC Obtains Judgment in Ponzi Scheme Targeting Cambodian Immigrants

The SEC announced that on March 26, 2009, the United States District Court for the District of Massachusetts entered final judgments against five defendants in a civil action filed in November 2005 involving a fraudulent investment scheme targeting Cambodian immigrants. The Commission's action charged that defendants WMDS, Inc. ("WMDS"), OneUniverseOnLine, Inc. ("1UOL"), James Bunchan, Seng Tan and Christian Rochon falsely promised members of the Cambodian immigrant community guaranteed monthly returns on investments that purportedly would pass on to future generations. The complaint alleged that the defendants emphasized their shared Cambodian heritage with their victims, and that certain written solicitation documents drew a parallel between investing in WMDS and fulfilling the American dream. In fact, according to the complaint, the defendants were operating a fraudulent pyramid scheme that ceased making the promised monthly payments in mid-2005.

The final judgments entered by the Court against Bunchan, Tan, Rochon, WMDS and 1UOL came in response to a Commission motion for default judgments and (1) permanently enjoin the defendants from future violations of Sections 17(a) and 5(a) and 5(c) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; and (2) require the defendants, jointly and severally, to disgorge $26,261,133.16 in ill-gotten gains, such amount to be reduced by any amount forfeited or paid as part of a related criminal proceeding.

On November 28, 2007, Bunchan and Tan each were sentenced by the United States District Court for the District of Massachusetts in a related criminal action after being convicted of mail fraud, conspiracy and money laundering in connection with the fraudulent investment scheme. Bunchan was sentenced to 35 years in prison and Tan was sentenced to 20 years in prison. On August 7, 2008, Rochon was sentenced by the same court based on his June 4, 2007 guilty plea to mail fraud, conspiracy and money laundering in connection with the fraudulent investment scheme. Rochon was sentenced to 5 years probation, with the first year to be served in home confinement.

McCoy et alia on Securitization

Systemic Risk through Securitization: The Result of Deregulation and Regulatory Failure, Patricia A. McCoy, University of Connecticut - School of Law, Andrey D. Pavlov, University of Pennsylvania - Real Estate Department; Simon Fraser University - Finance Area, and Susan M. Wachter, University of Pennsylvania - Finance Department, was recently posted on SSRN.  Here is the abstract:

Without regulation, securitization allowed mortgage industry actors to gain fees and to put off risks. During the housing boom, the ability to pass off risk allowed lenders and securitizers to compete for market share by lowering their lending standards, which activated more borrowing. Lenders who did not join in the easing of lending standards were crowded out of the market. Artificially low risk premia caused the asset price of houses to go up, leading to an asset bubble and breeding fraud. The consequences of lax lending were thereby covered up.

The market might have corrected this problem if investors had been able to express their negative views by short selling mortgage-backed securities, thereby allowing fundamental market value to be achieved. However, the one instrument that could have been used to short sell mortgage-backed securities - the credit default swap -was also infected with underpricing due to lack of minimum capital requirements and regulation to facilitate transparent pricing. As a result, there was no opportunity for short selling in the private-label securitization market. The authors propose countercyclical regulation to prevent a race to the bottom at the height of the business cycle.

Three Defendants in Insider Trading Ring Settle Charges

On March 26, 2009, the United States District Court for the Southern District of New York entered final consent judgments against defendants Nickolaus Shuster, Juan C. Renteria, Jr. and Monika Vujovic, in an action filed in 2005 by the Commission, charging 17 defendants with collectively engaging in a insider trading scheme, which netted almost $7 million in illicit gains, through trading in at least 26 stocks.  The SEC alleged that Shuster and Renteria were hired by the two primary architects of the insider trading schemes, David Pajcin and Eugene Plotkin, to obtain jobs at Quad/Graphics, Inc., a printing plant for BusinessWeek magazine. Shuster and Renteria would call Pajcin and Plotkin, and read them key portions of the "Inside Wall Street" column — a widely-read column that generally moves the price of the securities of companies mentioned in it — prior to the time the column was made available to the public. As a result of the information provided, Pajcin and Plotkin traded in, and/or tipped others with material non-public information concerning at least 10 companies, resulting in collective ill-gotten gains of approximately $280,000. Pajcin and Plotkin paid Renteria approximately $5,000 and paid Shuster approximately $20,000 for the information. The Court entered orders permanently enjoining both Shuster and Renteria from further violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

As alleged by the SEC, Vujovic, who was dating Pajcin at the time, allowed Pajcin to open a brokerage account in her name at Ameritrade, Inc. and to engage in insider trading through that account in order to avoid detection. Pajcin executed trades from this account based on material non-public information he received stemming from BusinessWeek, as well as Merrill Lynch, collectively making over $314,000 in ill-gotten gains. The Court entered an order permanently enjoining Vujovic from further violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and further found Vujovic liable to pay disgorgement of $261,364.12, to be satisfied by payment of all funds in a brokerage account held in Vujovic's name at TD Ameritrade, Inc., which had been frozen since 2005 pursuant to a Court order.

GAO Reports on SEC Oversight of Clearing Agencies

The GAO released a report on Securities and Exchange Commission: Oversight of U.S. Equities Market Clearing Agencies.

Geithner Testifies on Regulatory Reform

Here is Treasury Secretary Tim Geithner's Written Testimony before the House Financial Services Committee Hearing today, and here is Framework for Regulatory Reform that Treasury also released.

FINRA's Ketchum and NASAA's Joseph Testify Before Senate Banking Committee

Richard G. Ketchum, Chairman and Chief Executive Officer, FINRA, testified today before the Senate Committee on Banking, Housing, and Urban Affairs, as did Fred J. Joseph, Colorado Securities Commissioner and President, NASAA.

Schapiro Testifies Before Financial Services on Enhancing Investor Protection

SEC Chairman Mary L. Schapiro testified today on Enhancing Investor Protection and Regulation of the Securities Markets before the United States Senate Committee on Banking, Housing and Urban Affairs.

SEC Obtains Emergency Freeze Against Millennium Bank Alleging Ponzi Scheme

Another day -- another Ponzi scheme:

The SEC obtained an emergency court order halting a $68 million Ponzi scheme involving the sale of fictitious high-yield certificates of deposit (CDs) by Caribbean-based Millennium Bank.  The SEC alleges that the scheme targeted U.S. investors and misled them into believing they were putting their money in supposedly safe and secure CDs that purportedly offered returns that were up to 321 percent higher than legitimate bank-issued CDs. The SEC's complaint alleges that William J. Wise of Raleigh, N.C., and Kristi M. Hoegel of Napa, Calif., orchestrated the scheme through Millennium Bank, its Geneva, Switzerland-based parent United Trust of Switzerland S.A., and U.S.-based affiliates UT of S, LLC and Millennium Financial Group. In addition to Wise and Kristi Hoegel and these entities, the SEC has charged Jacqueline S. Hoegel (who is the mother of Kristi Hoegel), Brijesh Chopra, and Philippe Angeloni for their roles in the scheme.

Judge Reed O'Connor, in the U.S. District Court for the Northern District of Texas, granted the SEC's request for an asset freeze and emergency relief for investors.

Additionally, the SEC's complaint names four individuals and four entities as relief defendants: Lynn P. Wise of Raleigh, N.C. (the wife of William J. Wise); Ryan D. Hoegel of Lincoln, Calif. (the brother of Kristi Hoegel); Daryl C. Hoegel of American Canyon, Calif. (the husband of Jacqueline Hoegel), Laurie H. Walton of Raleigh; and United T of S, LLC, Sterling I.S., LLC, Matrix Administration, LLC, and Jasmine Administration, LLC. All four entities are based in Las Vegas. The SEC's enforcement action seeks an order compelling them to return funds and assets traceable to the Millennium Bank fraud.

SEC's Inspector General Recommends Improved Procedures for Handling Complaints about Naked Short Selling

The SEC's Office of Inspector General recently released a report on Practices Related to Naked Short Selling Complaints and Referrals, in which it examines the SEC Enforcement Division's procedures relating to naked short selling.  The Report explains that Enforcement has received a great deal of complaints during the past several years from issuers and investors about “naked” short selling, which has become an issue of increasing concern to both issuers of securities and investors. Many complaints requested that Enforcement investigate specific instances of naked short selling. Other complaints concerned the perceived failure on the part of the Commission and others, including Enforcement, to address the harmful effects of naked short selling.  In addition, the the SEC’s Office of Inspector General (OIG) has also received numerous complaints, particularly since December 2007, alleging that Enforcement has failed to take sufficient action regarding naked short selling. Many of these complaints asserted that investors and companies lost billions of dollars because Enforcement has not taken sufficient action against naked short selling practices. These complaints further indicated a lack of confidence on the part of some members of the public in Enforcement’s ability to protect investors.

In light of these complaints and based on our audit plan, we conducted an audit to assess whether Enforcement:
1.
Established policies and guidelines that enabled Enforcement to respond appropriately to complaints and referrals, including those involving naked short selling; and
2.
Followed existing policies and procedures for responding to complaints and referrals, including those pertaining to naked short selling.

Our audit disclosed that despite the tremendous amount of attention the practice of naked short selling has generated in recent years, Enforcement has brought very few enforcement actions based on conduct involving abusive or manipulative naked short selling.

...during the period of our review we found that few naked short selling complaints were forwarded to Headquarters or Regional Office Enforcement staff for further investigation.

The Report concludes with a series of recommendations to improve Enforcement's procedures in handling complaints about naked short selling.

E&Y Settles HealthSouth Accounting Fraud Charges for $109 Million

Ernst & Young, HealthSouth's auditor from 1996-2002, agreed to pay $109 million to settle accounting fraud charges brought by HealthSouth investors.  UBS previously settled similar charges for $100 million.  Richard Scrushy, HealthSouth's CEO at the time, was acquitted of accounting fraud charges, although subsequently convicted on fraud and bribery charges.  CFO.com, E&Y Settles HealthSouth Case for $109M.

FINRA Fines Morgan Stanley for Improper Retirement Advice to Kodak and Xerox Employees

FINRA announced that it fined Morgan Stanley & Co. $3 million — and ordered it to pay more than $4.2 million in restitution to 90 Rochester, NY-area retirees — to resolve charges that its supervisory system failed to detect and prevent brokers from persuading Eastman Kodak Company and Xerox Corporation employees to take early retirement based upon unrealistic promises of consistently high investment returns and by espousing unsuitable investment strategies.  FINRA found that Morgan Stanley failed to reasonably supervise the activities of Michael J. Kazacos and David M. Isabella, two former registered representatives in its Rochester branch office. FINRA has permanently barred Kazacos from the securities industry for committing numerous violations of FINRA rules in connection with his solicitation and handling of IRA rollover/retirement accounts, such as making unrealistic predictions that customers would earn investment returns of 10 percent each year.

 In a formal disciplinary complaint filed today, FINRA charged Isabella with having engaged in similar misconduct. The matter will be adjudicated before a three-member FINRA Hearing Panel. FINRA also found that Ira S. Miller, the manager of Morgan Stanley's Rochester branch, failed to reasonably supervise both representatives. Miller was fined $50,000, suspended from acting in a principal capacity for one year and ordered to re-qualify as a principal before serving in such capacity in the future.

 FINRA found that as a result of the misconduct at least 184 customers suffered financial hardships, including market losses, a reduction in principal and the inability to sustain expected withdrawal rates. In many cases, the customer's initial investment was eroded by market declines and the customer's monthly withdrawals were not funded by income but were really distributions of principal. Some customers were forced to return to work at a greatly reduced income in order to meet their basic living expenses. FINRA has ordered Morgan Stanley to pay restitution to 90 former customers of Kazacos or Isabella who sustained losses. The firm has previously settled with 101 other customers of those brokers. 

As to Isabella, a former Xerox employee, FINRA charged that from 2000 through 2003, he solicited many of that company's retirees and potential retirees to invest with him at Morgan Stanley. Isabella allegedly represented to prospective customers that, if they invested their retirement money with him, they would earn approximately 10 percent returns or more each year and be able to satisfy their income needs by withdrawing a consistent amount of money each year without reducing their principal.

In addition to the violations above, FINRA charged Isabella with falsifying records concerning the financial situations and goals of his customers. FINRA also alleged that, in exchange for various gifts to certain Xerox employees, Isabella improperly obtained confidential employment records regarding, among other things, the retirement status of prospective customers employed by Xerox. He utilized this confidential information to attract new customers. FINRA further alleged that, in communicating with prospective customers, Isabella used a professional designation — Retirement Planning Specialist — that he did not actually possess. Finally, FINRA charged Isabella with providing false testimony during its investigation.

 FINRA found that Morgan Stanley failed to enforce a reasonable supervisory system to ensure that Kazacos and Isabella provided customers with appropriate risk disclosures concerning their retirement accounts. During the relevant time period, Kazacos and Isabella generated approximately $15.4 million in gross commissions. The firm knew or should have known that these representatives were actively marketing their early retirement programs to retirees and potential retirees. Nevertheless, the firm failed to take reasonable steps to ensure, among other things, that customers received proper risk disclosures and that Kazacos and Isabella did not promise or promote unrealistic investment returns. FINRA further found that Morgan Stanley also failed to ensure that the securities and accounts that those representatives recommended for the retirees, such as variable annuities and fee-based managed accounts, were properly reviewed for suitability and other concerns.

 FINRA also found that Miller failed to take appropriate action to reasonably supervise Kazacos and Isabella to prevent their unsuitable investment recommendations and failures to disclose risks to many customers.

 In settling these matters, Morgan Stanley, Kazacos and Miller neither admitted nor denied the findings, but consented to the entry of FINRA's findings.

 Under FINRA rules, a firm or individual named in a complaint, such as Isabella, can file a response and request a hearing before a FINRA disciplinary panel. Possible remedies include a fine, censure, suspension, or bar from the securities industry, disgorgement of gains associated with the violations, and payment of restitution. The issuance of a disciplinary complaint represents the initiation of a formal proceeding by FINRA in which findings as to the allegations in the complaint have not been made and does not represent a decision as to any of the allegations contained in the complaint.

SEC's Chief Accountant Testifies on Increased Credit Availability & Prudent Lending Standards

James L. Kroeker, the SEC's Acting Chief Accountant, testified today on Testimony Concerning Exploring the Balance Between Increased Credit Availability and Prudent Lending Standards before the House Committee on Financial Services.