Securities Law Prof Blog

NASAA Proposes Model Rule on Investment Adviser Solicitors

NASAA’s Investment Adviser Regulatory Policy and Review Project Group is soliciting comments from the public on a proposed model rule regarding solicitors for investment advisers.  The Proposed Rule keeps intact the increased investor protection standards presently required by the states, while clarifying the conditions under which investment advisers, investment adviser representatives, and solicitors must operate. Additionally, the Proposed Rule provides an optional template for Administrators wishing to exempt solicitors performing limited activities from registration under specified conditions. The Proposed Rule is being provided under the Uniform Securities Act of 1956 and under the Uniform Securities Act of 2002. 

The comment period begins on Tuesday, July 28, 2009, and will remain open for 20 days.  All comments should be submitted on or before Monday, August 17, 2009.

SEC Charges Integral Systems Failed to Disclose Criminal Background of Officer

The SEC filed two actions (judicial and administrative) charging that Integral Systems, Inc. (Integral Systems or the Company), a corporation based in Columbia, Maryland that manufactures satellite ground systems, fraudulently concealed for over seven years the identity and involvement of a convicted securities fraud felon in the Company's top management. The civil action named three former officers, and the administrative action was against the corporation.  The company settled the administrative action.

The SEC alleged that from 1999 through August 2006 the company failed to disclose GaryPrince's role at the Company and his legal background in its filings. The complaint states that Prince pleaded guilty to criminal charges of conspiracy to commit securities fraud and bank fraud at another company in 1995. In related Commission actions, he was enjoined from violating the antifraud and other provisions of the federal securities laws and was barred from appearing or practicing before the Commission as an accountant. Prince had been CFO of Integral Systems for several years until he resigned shortly before his criminal conviction. When Prince was rehired in 1998 after serving his criminal sentence, he was given executive officer responsibilities in the Company's accounting, financial reporting, and policy making functions, but was never disclosed as an officer of the Company.

Helmerich & Payne Settles FCPA Charges with SEC

On July 30, the SEC settled administrative charges with Helmerich & Payne, Inc. (H&P), finding that from 2003 through 2008 H&P's books, records, and accounts did not properly reflect the improper payments made by H&P through two of its wholly-owned subsidiaries, Helmerich & Payne (Argentina) Drilling Company (H&P Argentina) and Helmerich & Payne de Venezuela, C.A. (H&P Venezuela) to customs officials. As a result, H&P violated Exchange Act Section 13(b)(2)(A). H&P also failed to devise or maintain sufficient internal controls to ensure that H&P Argentina and H&P Venezuela complied with the FCPA and to ensure that the payments those subsidiaries made to foreign officials were accurately reflected on its books and records. As a result, H&P violated Exchange Act Section 13(b)(2)(B).  The SEC ordered H&P to cease-and-desist from committing or causing any violations and any future violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B) and to pay disgorgement of $320,604 and prejudgment interest of $55,077.22. H&P consented to the issuance of the Order without admitting or denying any of the findings in the Order. In the Matter of Helmerich & Payne, Inc. Rel. 34-60400; AAE Rel. 3026; File No. 3-13565)

New York AG Releases Report on Bank Bonuses

New York Attorney General Cuomo released a report on bank bonuses, NO RHYME OR REASON: The Heads I Win, Tails You Lose I Bank Bonus Culture.

SEC's Investor Advisory Committee Raises Issues

The SEC's Investor Advisory Committee , after its first meeting, raised the following questions:  

Fiduciary duty: Should all financial intermediaries who provide investment advice to their customers be subject to the same fiduciary duties, and how should those duties be defined? Many investors rely heavily on financial advisors for investment decisions, but may not understand the different standards that apply to brokers and investment advisers.

Proper disclosures: Does the information that investors currently receive — both before making an investment decision and afterwards — meet their needs, and if not, what changes are necessary to ensure that investors have the information that they need, when they need it?

Technology: Can technology be better used to improve the flow of information to and from investors?

Financial Literacy: Should there be a distinction between "investor information" and "investor education," and if so, what is that distinction? What is the role of "financial literacy," and how can the SEC promote early education of these issues?

Valuation: Do investors fully understand the role that underlying asset valuation plays in portfolio and fund valuation? For example, do investors in variable annuities understand that guaranteed minimum payouts do not necessarily hold if the underlying investments (mutual funds, etc.) decline by a certain amount? Do fixed income investors understand that high yield bond funds involve more risk than other fixed income investments, or that fixed income investments are typically much less liquid and, therefore more difficult to definitively value, than are equities?

Majority Voting: Should majority voting for directors be mandatory for all U.S. companies? Although most large U.S. companies have adopted a form of "majority voting," many other companies still enable directors to be elected based only on plurality support.

Director-Investor Communications: Are there more effective ways for investors and directors to communicate with one another and what steps can the Commission take to facilitate dialogue and help ensure that corporate manager interests are aligned with investor interests?

Proxy Voting: Do investors — both institutional and individual — have the information they need to make informed proxy voting decisions, and are these decisions effective in holding corporate directors accountable? Does the proxy voting process and system foster informed decision-making? Should there be more transparency to the market about investors' proxy decisions? What is the role of proxy advisory firms, and should they be subject to more oversight by the Commission?

Resources: Does the SEC have the resources it needs to effectively achieve its investor protection mission?

SEC's Inspector General Says Stanford Hindered Investigation

The Wall St. Journal reports that the SEC's Inspector General (which has issued recent reports sharply critical of the agency) found that the SEC had been actively investigating Allen Stanford since 2005, but its investigation was hindered by Stanford's and his attorney's lack of cooperation.  The investigation became more active after Madoff and after DOJ gave the SEC the go-ahead.  WSJ, Stanford Hampered SEC Probe.

Avery Dennison Settles FCPA Charges with SEC

The Securities and Exchange Commission today filed two settled enforcement proceedings against Avery Dennison Corporation (Avery), a Pasadena, California-based multinational corporation, alleging violations of the Foreign Corrupt Practices Act (FCPA) in connection with improper payments and promises of improper payments to foreign officials by Avery's Chinese subsidiary and several entities Avery acquired.

The SEC filed a civil action in the United States District Court for the Central District of California charging Avery with violations of the books and records and internal controls provisions of the FCPA and seeking a civil penalty. The SEC also issued an administrative order finding that Avery violated the same provisions of the FCPA. In the administrative proceeding, the SEC ordered Avery to cease and desist from such violations, and to disgorge $273,213, together with $45,257 in prejudgment interest. In the federal civil action, Avery agreed to the entry of a final judgment requiring it to pay a civil penalty in the amount of $200,000.

The SEC's complaint and administrative order charge that, from 2002 through 2005, the Reflectives Division of Avery (China) Co. Ltd. (Avery China) paid or authorized the payments of kickbacks, sightseeing trips, and gifts to Chinese government officials. The amount of illegal payments actually paid amounted to approximately $30,000. In one transaction, Avery China secured a sale to a state-owned end user by agreeing to pay a Chinese official a kickback of nearly $25,000 through a distributor. Avery China realized $273,213 in profit from this transaction, which it inaccurately booked as a sale to the distributor rather than to the end user. In addition, after Avery acquired a company in June 2007, employees of the acquired company continued their pre-acquisition practice of making illegal petty cash payments to customs or other officials in several foreign countries, resulting in illegal payments of approximately $51,000. Avery failed to accurately record these payments and gifts in the company's books and records, and failed to implement or maintain a system of internal accounting controls sufficient to detect and prevent such illegal payments or promises of illegal payments.

As a result of the conduct described above, the SEC charged that Avery violated Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934. Avery consented to the ordered relief without admitting or denying either the findings contained in the SEC's administrative order, or the allegations of the SEC's complaint.

SEC Removes Requirement of NYSE Surveillance Program to Track Floor Trading

On July 28, 2009, the SEC issued an Order that removes the requirement for NYSE operate an on-floor video and audio surveillance program to track floor trading activity at NYSE trading posts, operated as a pilot, pursuant to the April 12, 2005 Order.  The Order found that:

The Commission has determined that the Pilot Program has played a helpful role in supplementing the NYSE’s routine surveillance, examination, and enforcement programs. While the nature of the NYSE trading has changed significantly in recent years, floor-based trading remains an important component of the NYSE’s current market structure.

The Commission recognizes, however, that allowing the NYSE greater flexibility in its usage of the on-floor surveillance hardware installed pursuant to the Pilot Program and the resulting data would allow it to devote additional resources to regulatory issues that arise. As such, the Commission has determined to amend the Order and to no longer require the NYSE to operate the Pilot Program so that the NYSE may be afforded greater flexibility in determining the appropriate regulatory usage of its audio-visual surveillance technology and data to maximize the potential benefit to the NYSE’s surveillance, examination, and enforcement process.

In the Matter of the New York Stock Exchange LLC (f/k/a "The New York Stock Exchange, Inc.").

FINRA Fines Merrill & UBS for Unsuitable CEF Sales

FINRA announced today that it fined Merrill Lynch, Pierce, Fenner & Smith, Inc. $150,000 and UBS Financial Services, Inc. $100,000 for supervisory failures that led to unsuitable short-term sales of closed-end funds (CEF) purchased at the funds' initial public offerings.  FINRA also suspended five Merrill Lynch brokers each for 15 days and fined them $10,000 for making unsuitable CEF recommendations to customers. FINRA's investigation into the activities of former UBS brokers involved in the short-term sales of CEFs continues.

 CEFs are investment companies that sell a fixed number of shares in an initial public offering (IPO), subject to built-in sales charges. After the offering, the shares trade in the secondary market, typically at a discount from the initial offering price. The CEFs at issue had sales charges of 4.5 percent, as well as a "penalty bid period" of generally 30 to 90 days immediately following the IPO.  During this period, brokers would lose their sales commission if their clients sold the CEFs purchased at the offering. One regulatory concern related to CEFs is the potential for brokers to earn high fees at their customers' expense by soliciting their customers to purchase CEFs at the IPO and then later, after the expiration of the penalty bid period, recommend that customers sell the CEFs, often at a loss, using the proceeds to purchase yet another CEF at an initial offering.

 FINRA found that despite being aware that CEFs purchased at the IPO are more suitable for long-term investments - and that the sales charges applied to purchases at the IPO make short-term trading of these CEFs generally unsuitable - Merrill Lynch and UBS did not have adequate supervisory systems and procedures designed to detect and prevent unsuitable short-term trading of CEFs.  The firms also failed to provide supervisors with any guidance or warning about the potential abuses and disadvantages relating to short-term trading of CEFs purchased at the IPO. Without adequate guidance, branch managers were not on notice that there were potential problems with short-term sales of CEFs bought at the IPO.

 FINRA also found that the firms failed to provide guidance or training to its registered persons regarding the impact of the sales charges on the short-term sales of CEFs purchased at the IPO. As a result, certain UBS and Merrill brokers recommended CEF purchases at the IPO and subsequent short-term sales without having a sufficient understanding of the effects that the sales charges and other pricing considerations had on the clients' investments.

 In determining the appropriate sanctions against the firms, FINRA considered the firms' remediation efforts, which included payments to customers in excess of $3 million by Merrill Lynch and more than $2 million by UBS. Also, FINRA considered the firms' self-reviews and prompt remedial measures to correct systems and procedures to prevent future violations.

SEC Finalizes Short Sales Rule and Announces Other Initiatives

The SEC published amendments to Regulation SHO to make permanent amendments contained in Interim Final Temporary Rule 204T (“temporary Rule 204T”) of Regulation SHO, with some modifications to address commenters’ concerns. These amendments are intended to help further the goals of reducing fails to deliver and of addressing abusive “naked” short selling in all equity securities. These goals will be furthered by requiring that, subject to certain limited exceptions, if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency it must immediately purchase or borrow securities to close out the fail to deliver position by no later than the beginning of regular trading hours on the settlement day following the day the participant incurred the fail to deliver position. In addition, a participant that does not comply with this close-out requirement, and any broker-dealer from which it receives trades for clearance and settlement, will not be able to short sell the security either for itself or for the account of another, unless it has previously arranged to borrow or borrowed the security, until the fail to deliver position is closed out.

In addition, the SEC announced other actions to protect against abusive short sales and to make more short sale information publicly available.  These include working with several SROs to make short sale volume and transaction data available through the SRO Web sites. The SEC is also considering proposals on a short sale price test and circuit breaker restrictions.

Finally, the SEC intends to hold a public roundtable on September 30 to discuss securities lending, pre-borrowing, and possible additional short sale disclosures. The roundtable will consider, among other topics, the potential impact of a program requiring short sellers to pre-borrow their securities, possibly on a pilot basis, and adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities.

Treasury Sends Proposed Systemic Risk Legislation to Congress

On July 22 Treasury sent to Congress proposed Systemic Risk Legislation that would require strong, consolidated supervision and regulation for all financial firms. The legislation also provides a regulatory regime to monitor, mitigate, and respond to risks in the financial system. 

SEC Approves Exemptions for Central Counterparties for CDSs

The SEC approved conditional exemptions that will allow ICE Clear Europe Limited and Eurex Clearing AG to operate as central counterparties (CCPs) for clearing credit default swaps.  These conditional exemptions provide the SEC with regulatory oversight of the central counterparty, and should enhance the quality of the credit default swap market and the Commission's ability to protect investors.

On Dec. 24, 2008, the SEC approved temporary exemptions allowing LCH.Clearnet Ltd. to operate as a central counterparty for credit default swaps. On March 6, 2009 and March 13, 2009, respectively, the SEC approved similar temporary exemptions for ICE US Trust LLC and the Chicago Mercantile Exchange, Inc. The SEC is soliciting public comment on all aspects of these exemptions to assist in its consideration of any further action that may be needed in this area.

SEC Proposes "Pay to Play" Rules for Investment Advisers

The SEC voted unanimously to propose measures intended to curtail "pay to play" practices by investment advisers that seek to manage money for state and local governments. The measures are designed to prevent an adviser from making political contributions or hidden payments to influence their selection by government officials.  The proposals relate to money managed by state and local governments under important public programs, including public pension plans that pay retirement benefits to government employees, retirement plans in which teachers and other government employees can invest money for their retirement, and 529 plans that allow families to invest money for college.

The rule being proposed for public comment by the SEC includes prohibitions intended to capture not only direct political contributions by advisers, but other ways advisers may engage in pay to play arrangements.

FINRA Fines 5 Bank Broker-Dealers for Improper Variable Annuities Sales

FINRA announced today that it fined five bank broker-dealers a total of $1.65 million for deficient supervision and procedures related to variable annuity (VA), mutual fund or unit investment trust (UIT) transactions.  Brokers at each of the firms operated out of branches of affiliated banks, selling VAs, mutual funds or UITs to bank customers, who, in many instances, were elderly. The brokerage customers were referred by bank personnel, and sales of these financial products represented a significant portion of each firm’s business.

 The five firms that FINRA fined for deficient systems and procedures relating to VA, mutual fund or UIT sales, and the amount of their fines, are:

McDonald Investments (now KeyBanc Capital Markets, Inc.) - $425,000
IFMG Securities - $450,000
Wells Fargo Investments, LLC - $275,000
PNC Investments - $250,000
WM Financial Services, Inc. (now Chase Investment Services Corp.) - $250,000
 

FINRA Fines NEXT Financial Group for Supervisory Violations

FINRA) announced today that it fined NEXT Financial Group, Inc., headquartered in Houston, TX, $1 million for supervisory violations that primarily involved the failure to supervise its approximately 130 Office of Supervisory Jurisdiction (OSJ) branch managers, who typically supervise transactions and sales activity for individual brokers or branches within a particular region. OSJ branch managers' transactions and sales activities are then supposed to be supervised by another registered principal designated by the firm.  Between January 2005 and November 2006, the firm allowed its OSJ branch managers to self-supervise their own handling of customer accounts without adequate review. In November 2006, the firm adopted a Regional Manager supervisory system to provide principal review of the OSJ managers’ transactions. Through at least December 2007, however, this new system was also unreasonable because, among other reasons, it required three Regional Managers to review thousands of transactions each month with limited access to client suitability information.

The lack of reasonable policies and written procedures resulted in the firm’s failure to detect churning of customer accounts and excessive markups and markdowns on corporate bond trades.  

FINRA further found that the firm’s systems and procedures governing variable annuity exchanges were not reasonable. Variable annuity sales accounted for approximately 33 percent of the firm’s revenue during the relevant period. The firm’s written supervisory procedures, however, failed to provide adequate guidance concerning the criteria that should be considered in recommending variable annuity exchanges to its customers including, for example, a comparison between the features, costs and benefits of the old and new products. 

As part of the settlement, the firm must certify that it has implemented new systems and procedures reasonably designed to achieve compliance with the federal securities laws and FINRA Rules described above and in other areas identified in the settlement agreement.  In settling this matter, NEXT and Eyster neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

GAO Issues Report on Leverage at Financial Institutions

The GAO issued a report on Financial Crisis Highlights Need to Improve Oversight of Leverage at Financial Institutions and across System.  It explains that the purpose of the report is to study the role of leverage in the current financial crisis and federal oversight of leverage. GAO’s objectives were to review (1) how leveraging and deleveraging by financial institutions may have contributed to the crisis, (2) regulations adopted by federal financial regulators to limit leverage and how regulators oversee compliance with the regulations, and (3) any limitations the current crisis has revealed in regulatory approaches used to restrict leverage and regulatory proposals to address them. To meet these objectives, GAO built on its existing body of work, reviewed relevant laws and regulations and academic and other studies, and interviewed regulators and market participants.

What GAO Recommends

As Congress considers establishing a systemic risk regulator, it should consider the merits of assigning such a regulator with responsibility for overseeing systemwide leverage. As U.S. regulators continue to consider reforms to strengthen oversight of leverage, we recommend that they assess the extent to which reforms under Basel II, a new risk-based capital framework, will address risk evaluation and regulatory oversight concerns associated with advanced modeling approaches used for capital adequacy purposes. In their written comments, the regulators generally agreed with our conclusions and recommendation.

SEC Seeks Clawback from Former CEO of CSK Auto

The SEC asked the U.S. District Court for the District of Arizona to order the former chief executive officer of CSK Auto Corporation to reimburse the company and its shareholders more than $4 million that he received in bonuses and stock sale profits while CSK was committing accounting fraud.  The SEC's enforcement action charges Maynard L. Jenkins with violations of the Sarbanes-Oxley Act (SOX). It is the first action seeking reimbursement under the SOX "clawback" provision (Section 304) from an individual who is not alleged to have otherwise violated the securities laws. The SOX "clawback" provision deprives corporate executives of money that they earned while their companies were misleading investors.

According to the SEC's complaint, Jenkins made $2,091,020 in bonuses and $2,018,893 in company stock sales that should have been reimbursed to CSK pursuant to SOX Section 304.  While Jenkins served as CEO, CSK filed two such restatements related to its overstated vendor allowances.  The SEC's complaint does not allege that Jenkins engaged in the fraudulent conduct.

D.C. Circuit Remands SEC Fixed Indexed Annuity Rule for Further Consideration

The D.C. Circuit continues its practice of being tough on the SEC's compliance with the requirements for federal rulemaking .  Yesterday the Circuit remanded to the agency the SEC's controversial rule 151A that stated that fixed indexed annuities (FIAs) are not annuity contracts within the meaning of the Securities Act (and therefore are treated as securities under the securities laws and not regulated solely by state insurance laws).  American Equity Investment Life Ins. Co. v. SEC (D.C. Cir. 7/21/09)(Download D.C.OpiniononIndexAnnuities).  According to the Court (1) the SEC's interpretation of "annuity contract" is reasonable under Chevron, but (2) the SEC failed to consider properly the effect of the rule on efficiency, competition and capital formation under section 2(b) of the Act.  Therefore, the SEC must either complete an analysis sufficient to satisfy its obligations under section 2(b) or explain why that section does not govern this rulemaking.

On the SEC's interpretation of "annuity contract," the Court found that the statute is ambiguous on the scope of the phrase and that the prior Supreme Court decisions did not set forth a test that determined the treatment of FIAs.  Accordingly, under Chevron, the SEC's interpretation of the statute will be upheld if it is reasonable.  Because FIAs have characteristics that "involve considerations of investment not present in the conventional contract of insurance," a "variability in the potential return that results in a risk to the purchaser," the SEC's interpretation was reasonable.

As to the SEC's inadequate section 2(b) analysis, the Court first rejected the SEC's argument that the agency was not required to conduct a section 2(b) analysis, since the agency purported to conduct just such an analysis.  It then found that the agency's analysis of the effect of the rule on efficiency, competition and capital formation was arbitrary and capricious, because it did not provide a reasoned basis for its conclusion that the rule would increase competition.  The agency could not justify the rule on the ground that it would bring clarity to an uncertain area of law, since this reasoning would support any rule that the SEC adopted in a previously unregulated area.  The SEC must provide an analysis of why this specific rule would promote competition.  The SEC's analysis was also deficient because it did not make any finding on the existing level of competition under state regulation.  Its efficiency and capital formation analyses were similarly deficient because it failed to analyze the efficiency of the current state regulation.

Perry Corp. Settles SEC Charges for Failure to Disclose Stock Purchases

The SEC settled charges that New York-based investment adviser Perry Corp. violated securities laws by failing to report that it had purchased substantial stock in a public company in order to vote them in favor of a merger from which Perry stood to profit.  Perry agreed to pay a $150,000 penalty to settle the SEC's charges without admitting or denying the Commission's findings.

According to the SEC, the firm failed to disclose that it had acquired nearly 10 percent of the common stock of Mylan Laboratories, Inc. At the time, Mylan had announced a proposed acquisition of King Pharmaceuticals, Inc. that was subject to shareholder approval. Perry had entered into an investment strategy known as "merger arbitrage" and would profit from a Mylan-King merger. To increase the likelihood of the merger, Perry separately purchased the Mylan voting shares and entered into a series of "swap" transactions — hedging transactions through the use of derivative instruments — designed to avoid any financial exposure from its ownership of those shares. The securities laws require institutional investors like Perry to report the acquisition and ownership of more than 5 percent of the common stock of a public company.

SEC Brings ARS Action Against Morgan Keegan

The SEC announced that it filed a complaint in the U.S. District Court for the Northern District of Georgia against Morgan Keegan & Company, Inc. (“Morgan Keegan”), a Tennessee-based broker-dealer, for misleading investors regarding the liquidity risks associated with auction rate securities (“ARS”) that the firm underwrote, marketed, or sold. The Commission’s complaint alleges that Morgan Keegan misrepresented to customers that ARS were safe, highly liquid investments that were comparable to money-market funds. According to the complaint, in 2007 and early 2008, Morgan Keegan was aware that the ARS market was deteriorating. Specifically, the complaint alleges that investor concerns about the creditworthiness of ARS insurers, auction failures in certain segments of the ARS market, increased clearing rates for auctions managed by Morgan Keegan and other broker-dealers, and higher than normal ARS inventories at Morgan Keegan collectively indicated that the risk of auction failures had materially increased. The SEC alleges that Morgan Keegan sold approximately $925 million of ARS to its customers between November 1, 2007, and March 20, 2008, but failed to inform its customers about liquidity risks for ARS, even after the firm decided to stop supporting the ARS market in February 2008.

The complaint also seeks (i) permanent injunctions against Morgan Keegan for future violations; (ii) disgorgement of ill-gotten gains with prejudgment interest; (iii) imposition of civil penalties; and (iv) an order requiring Morgan Keegan to repurchase ARS sold to its customers.