Securities Law Prof Blog

More Questions on the SEC-BofA Settlement

Zachary Goldfarb of the Washington Post consistently provides insightful coverage into the SEC.  Check out his article today on the SEC's dilemma in persuading Judge Rakoff to accept the Bank of America settlement over the Merrill bonuses, in the face of the judge's criticism about not going after individual defendants.  He raises a number of unresolved issues about the settlement process.  WPost, SEC's About-Face on Bank of America Raises Eyebrows.

(And now I'm going on vacation.)

Going Fishing

I'll be out of town and without a pc for a few days.  Check back here on Sept. 2, and I'll be doing some catch-up.

SEC Suspends Las Vegas CPA for Auditing Deficiences

The SEC charged a Las Vegas-based CPA and his public accounting firm with securities fraud for issuing false audit reports that failed to comply with Public Company Accounting Oversight Board ("PCAOB") Standards and were often the product of high school graduates hired with little or no education or experience in accounting or auditing. The Commission's lawsuit, filed in federal district court in Las Vegas, Nevada, names Michael J. Moore ("Moore"), CPA, and Moore & Associates Chartered ("M&A"), and they have agreed to settle the charges without admitting or denying the allegations.

According to the SEC's complaint, Moore and M&A issued audit reports for more than 300 clients who consist of primarily shell or developmental stage companies with public stock quoted on the OTCBB or the Pink Sheets. The SEC alleges that Moore and M&A violated numerous auditing standards, including a failure to hire employees with adequate technical training and proficiency. The SEC further alleges that Moore and M&A did not adequately plan and supervise the audits, failed to exercise due professional care, and did not obtain sufficient competent evidence. Despite the audit failures, M&A issued and Moore signed audit reports falsely stating that the audits were conducted in accordance with PCAOB Standards.

To settle the Commission's charges, Moore and M&A consented to the entry of a final judgment permanently enjoining them from future violations of the securities and ordering them to disgorge ill-gotten gains of $179,750 plus prejudgment interest of $10,151.59. Moore separately agreed to pay a $130,000 penalty. Moore and M&A also consented to the entry of an administrative order that makes findings and suspends them from appearing or practicing before the Commission as an accountant pursuant to Rule 102(e)(3) of the Commission's Rules of Practice.

Three Defendants Settle SEC Charges Involving Insider Trading in ISE Merger

The SEC announced that it filed an amended complaint in its pending insider trading case originally filed on March 13, 2008, against John F. Marshall, the former Vice Chairman of International Securities Exchange Holdings, Inc. ("ISE"), Alan L. Tucker and Mark R. Larson. The original complaint alleged that Marshall tipped his business partners, Tucker and Larson, concerning ISE's merger talks with Eurex Frankfurt AG ("Eurex"), a German company, and that both men traded on the information ahead of the April 30, 2007 announcement of Eurex's $2.8 billion cash merger agreement with ISE, for illegal profits totaling approximately $1.1 million and $31,000, respectively. This amended complaint adds a new defendant, Thomas Genzale, and charges him with having also traded in ISE securities in advance of the April 30, 2007 acquisition announcement based on tips from defendant Marshall, resulting, in Genzale's case, in profits of approximately $826,000. Genzale, Marshall, and Tucker have all agreed to settle the Commission's charges set forth in the Complaint without admitting or denying those allegations.

Recently, on the Commission's motion, the Court dismissed the Commission's charges against defendant Larson with prejudice. In place of the original complaint's allegation that Marshall tipped Larson, the First Amended Complaint alleges that Marshall recommended the purchase of ISE securities to a business partner, who, in turn, purchased 1,700 shares of ISE, resulting in profits of approximately $31,000.

Genzale has consented to pay $826,118.84 in disgorgement, $105,977.61 in prejudgment interest, and an $826,118.74 penalty. Marshall has consented to pay $31,452.73 in disgorgement (the alleged amount of the trading profits of the business partner to whom he recommended ISE), and $4,034.88 in prejudgment interest-and has also consented to be permanently barred from serving as an officer or director of a publicly-traded company. Finally, Tucker has consented to pay $18,342.06 in prejudgment interest.

Assessing Bernanke's First Term

There has been much talk the last few days about the reappointment of Ben Bernanke to head the Federal Reserve, an action that went from unlikely to quite certain in a short period of time.  Today's Wall St. Journal offers a thoughtful assessment of Bernanke's evolution during his first term.  The title sums it up:

After Slow Start, Fed Chief Found His Groove

Judge Asks for More Explanation for SEC-BofA Settlement

Judge Rakoff still isn't satisfied with the explanations given to him by the SEC and the Bank of America about the settlement involving the disclosure (or lack thereof) of Merrill bonuses in the BofA proxy statement.  He instructed the SEC to provide more explanation about why it didn't follow SEC policy and seek penalties from individual defendants.  He also didn't accept the agency's explanation that its hands were tied because the corporation asserted reliance on advice of counsel as a defense and would not waive the attorney client privilege and give the SEC the documents.  How could the corporation base a defense on attorneys' advice without disclosing the advice?  The judge asked for further submissions due Sept. 9.  WSJ, SEC Ordered to Explain Handling of BofA Case.

The standard for judicial review for negotiated settlements, in case you're wondering, is that the judge should give deference to the agency and approve the settlement so long as it is reasonable and in the public interest.

SEC Settles Insider Trading Charges Involving First Indiana Corp. Stock

The SEC today settled charges against Nancy Jewell, Kristin Mays, and Matthew B. Murphy, III, alleging that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder by buying First Indiana Corporation (First Indiana) common stock on the basis of material nonpublic information ahead of a public announcement that First Indiana had entered into a merger agreement.

The Commission's complaint alleges that on July 6, 2007, a member of First Indiana's Board of Directors received a phone call advising him of a special Board meeting scheduled for Sunday, July 8, 2007. The Director had a longstanding relationship and a history of sharing confidences with each of the defendants. The complaint further alleges that the Director complained to each of the defendants that he was upset that a special First Indiana Board meeting was taking place on Sunday and ruining his scheduled plans for that day. The complaint alleges that the defendants then each misappropriated that information from the Director by purchasing First Indiana common stock that same day on the basis of the information. Before the start of trading on July 9, 2007, First Indiana announced that it had agreed to be acquired by Marshall & Ilsley Corporation at a price per share that represented a 42% premium over the Friday, July 6, closing price for First Indiana common stock.

Pursuant to the proposed settlements, Jewell would pay disgorgement of $8,888, with prejudgment interest of $943.56, and a civil penalty of $8,888; Mays would pay $7,960, with prejudgment interest of $845.03, and civil penalty of $7,960; and Murphy would pay $9,078, with prejudgment interest of $963.72, and a civil penalty of $9,078. The proposed settlements are subject to the approval of the District Court.

NASAA Identifies Top 10 Investor Traps

NASAA recently published its Top 10 Investor Traps.  They are:

Entertainment Investments.  

Gold Bullion and Currency Scams.

Leveraged Exchange-Traded Funds (ETFs).

Life Settlements.

Natural Resource Investments.

Ponzi Schemes.

Private Placement Offerings. 

Real Estate Investment Schemes.

Short-term Commercial Promissory Notes.

Speculative Inventions and New Products.

New Blog on FCPA

Readers of this Blog know that the SEC has recently been enforcing the Foreign Corrupt Practices Act (FCPA) with renewed energy.  Mike Koehler (Butler University) has a new blog, FCPA Professor, that is devoted to FCPA issues; check it out!

Bullard on Recursivity in Securities Laws

Professor Mercer Bullard (Mississippi) recently published  a  commentary on recursivity in the securities laws as illustrated by Bank of America’s recent SEC settlement.

Velasco on Fiduciary Duties in Corporate Law

How Many Fiduciary Duties Are There in Corporate Law?, by Julian Velasco, University of Notre Dame, was recently posted on SSRN.  Here is the abstract:

Historically, there were two main fiduciary duties in corporate law, care and loyalty, and only the duty of loyalty was likely to lead to liability. In the 1980s and 1990s, the Delaware Supreme Court breathed life into the duty of care, created a number of intermediate standards of review, elevated the duty of good faith to equal standing with care and loyalty, and announced a unified test for review of breaches of fiduciary duty. The law, which once seemed so straightforward, suddenly became elaborate and complex. In 2006, in the case of Stone v. Ritter, the Delaware Supreme Court rejected the triadic formulation and declared that good faith was a component of the duty of loyalty. In this and other respects, Delaware seems to be returning to a bifurcated understanding of the law of fiduciary duties. I believe that this is a mistake. The law is inherently complex and much too important to be oversimplified.

The current academic debate on the issue focuses on whether there should be two duties or three. In this article, I argue that the question is misleading and irrelevant, but that if it must be asked, the best answer is that there are five duties - one for each paradigm of enforcement. In defending this claim, I explain the true nature of fiduciary duties and provide a robust framework for the discussion, implementation, and development of the law.

Will Proxy Access Be Here Soon?

Yesterday I attended a Directors' Roundtable program here in Cincinnati sponsored by the law firm KMK and others.  The program was excellent, with panels discussing developments in securities regulation, risk management and D&O insurance.  What I found particularly interesting were comments by one speaker, Martin Dunn, a D.C. attorney and former SEC staff member, on the SEC's Proxy Access Proposal.  The comment period has just ended (and why, Dunn wonders, does the comment period end in the middle of August, when no one is in D.C.?), and he was surprised that only about 150 comments were filed, running 2 to 1 in favor of the proposal.  He senses that the consensus view is that it is "a done deal." 

Has the controversy over proxy access really died down?  Given the prolonged history of proxy access proposals at the SEC, it's like a fantasy to imagine one in place.  Let's wait and see.

SEC & CFTC Announce Public Meetings on Harmonization of Market Regulation

The SEC and the CFTC announced that the two regulatory agencies will hold joint meetings to seek input from the public on harmonization of market regulation. President Barack Obama in June called on the two regulators to recommend changes to statutes and regulations that would eliminate differences with respect to similar types of financial instruments.  The first meeting, on Sept. 2, 2009, will be held at the CFTC. The second meeting, on Sept. 3, 2009, will be held at the SEC.  The deadline for public comments is set for Sept. 14.

Financial Firms Pay Big Bucks to Lobby Congress

Investment News reports on the big bucks paid by financial firms in the second quarter on lobbying Congress.  SIFMA paid $1.25 million, the Investment Company Institute paid $1.23 million, and the American Council of Life Insurers paid $2 million.  InvNews, Groups opened wallets to influence financial reforms in second quarter.

Mutual funds also spent large sums.  InvNews, Fidelity, Vanguard, others spent big bucks on 2Q lobbying.

FPA Asks SEC to Clarify FINRA's Authority over Financial Planning Activities of Broker Dealer

On August 17 the Financial Planning Association (FPA) wrote to the SEC questioning the authority of FINRA to bring an enforcement action against a dual registrant (Ameritas) relating to its marketing of misleading financial plans.  According to FPA, financial planning  is investment advisory activity subject to the Investment Advisers Act and over which FINRA has denied authority to regulate.  Thus, FPA asks two questions:

1. On what basis of statutory authority, and to what extent, does the SEC permit FINRA to take enforcement action for misleading or fraudulent financial planning activities of brokerage firms separate from the IAA; and
2. Where financial planning activity is clearly under the jurisdiction of the IAA, does the SEC have a policy in place for FINRA to refer cases?

FPA also notes that in congressional hearings on the Madoff scandal, FINRA testified that it had no authority over Madoff's investment advisory business: "We do not believe FINRA can have it both ways, claiming on the one hand that it had no authority over a highly publicized regulatory failure, Madoff, and on the other, clear and unambiguous oversight over the development and marketing of financial plans by an Ameritas broker."

FPA raises good questions that again illustrate the importance of devoting serious attention to the appropriate regulation of all financial professionals.  Let's hope it does not play out as just another turf war. 

SEC Charges Two with Defrauding Brokers to Manipulate Penny Stocks

On July 21, 2009 the SEC filed an emergency enforcement action against Eric Todd Seiden to halt an ongoing scheme in which Seiden fraudulently induced at least fifteen broker-dealers to buy over $1.8 million worth of thinly traded stock. On August 14, 2009, the Commission amended its complaint and added Kamal Abdallah as a second defendant.

The Commission's amended complaint, filed in the Eastern District of New York, alleges that on numerous occasions, Seiden, a former securities professional, telephoned broker-dealers, falsely identified himself as a customer or customer representative, and placed large orders to purchase a thinly traded stock for the customer's account. In many instances, Seiden's false representation caused the broker-dealers to execute the orders, which resulted in purchases totaling more than $1.8 million.

The amended complaint also alleges that Abdallah conspired with Seiden to manipulate the prices of penny stocks. Abdallah, the former CEO of Universal Property Development & Acquisition Corp. ("UPDV"), paid Seiden to create artificial demand for UPDV stock and inflate its stock price. Seiden and Abdallah worked in concert to manipulate the market price of UPDV stock, enabling Abdallah to dump his UPDV stock in the public market at an inflated price.

The Complaint charges Seiden with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Abdallah with violating Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

On July 21, 2009, the Court issued a temporary restraining order. On July 30, 2009, the Court issued a preliminary injunction which, among other things, prohibits Seiden from further violations of the federal securities laws. The Commission seeks a final judgment enjoining Seiden and Abdallah from committing future violations of the foregoing federal securities laws and ordering them to disgorge ill-gotten gains plus prejudgment interest thereon and assessing civil penalties. The Commission also seeks a final judgment prohibiting Seiden and Abdallah from participating in any offering of penny stock and barring Abdallah from serving as an officer or director of a public company.

FINRA and SEC Issue Alert on Leveraged and Inverse ETFs

FINRA and the SEC have issued an Investor Alert called Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors warning retail investors of the risks associated with investing in these highly complex financial products. This Investor Alert follows a recent FINRA Regulatory Notice reminding securities firms and brokers of their sales practice obligations relating to leveraged and inverse exchange-traded funds (ETFs).

 Traditional ETFs are designed to track an index, such as the S&P 500, or the price of an individual asset. Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark (such as commodities or currencies) they track. Inverse ETFs (also called "short" funds) seek to deliver the opposite of the performance of the index or benchmark they track and are often marketed as a way for investors to profit from, or at least hedge their exposure to, downward moving markets. Both leveraged and inverse ETFs pursue a range of investment strategies through the use of swaps, futures contracts and other derivative instruments.

 Most leveraged and inverse ETFs "reset" daily. This means that they are designed to achieve their stated objectives on a daily basis. Their performance over longer periods of time — over weeks, months or years — can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets. For example, between December 1, 2008, and April 30, 2009, a leveraged ETF seeking to deliver three times the daily return of the Russell 1000 Financial Services Index fell 53 percent, while the underlying index actually gained approximately 8 percent. A leveraged inverse ETF seeking to deliver three times the inverse of the Russell 1000 Financial Services Index's daily return declined by 90 percent over the same period.

 The SEC and FINRA are advising investors to consider leveraged and inverse ETFs only if they are confident the product can help meet their investment objectives and they are knowledgeable about and comfortable with the risks associated with these specialized ETFs.  

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FINRA Expels Maximum Financial Investment Group for Forex Violations

FINRA announced that it has expelled Maximum Financial Investment Group, Inc. of Southfield, MI, for violations arising out of its retail foreign currency (forex) business, as well as for repeated violations of FINRA registration and related rules.  FINRA also permanently barred Maximum's Chief Executive Officer and Chief Compliance Officer, Christopher T. Paganes, from ever serving in any principal capacity at a securities firm and suspended him from associating with a securities firm in any capacity for nine months. No fine was imposed because Paganes evidenced an inability to pay.

 FINRA found that in September 2007, Maximum entered into an agreement with a non-registered entity — Boston Trading & Research (BTR) — to engage in a retail forex trading business. Maximum agreed to act as a counterparty to the forex transactions. Beginning in January 2008, and continuing through May 2008, more than $15 million in customer funds to be used for retail forex transactions were deposited in Maximum's bank accounts. The receipt of these funds created a liability for Maximum, which it failed to record on its own books and records. This failure led to the firm having insufficient minimum net capital, in violation of federal securities laws and FINRA rules. The firm also failed to calculate the amount it had to deposit on behalf of the forex customers in a reserve bank account to safeguard the funds. In addition, FINRA found that Maximum failed to establish systems and procedures to monitor for money laundering while engaging in the forex transactions.

 FINRA also found that on three occasions, Maximum failed to timely file an application for approval of a material change in its business.  

In settling this matter, the firm and Paganes neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

SEC Proposes Alternative Uptick Rule

The SEC announced that it is seeking public comment on an alternative approach to short selling price test restrictions that may be more effective and easier to implement than previously proposed price test restrictions currently under consideration.  The alternative uptick rule would allow short selling only at an increment above the national best bid. As a result, the Commission has determined to reopen the comment period for 30 days in order to receive input specifically on this alternative.

In April, the Commission proposed two approaches to restricting short selling. One approach would apply on a market-wide and permanent basis, and would implement short sale restrictions based on either the last sale price or the national best bid. The other approach, considered a "circuit-breaker," would apply only to a particular security during severe declines in the price of that security. Once triggered, the circuit breaker would impose a short sale halt or short sale restriction based on either the last sale price or the national best bid.

Unlike proposals in April, the alternative uptick rule would not require monitoring of the sequence of bids (that is, whether the current national best bid is above or below the previous national best bid), and as a result the alternative uptick rule would be easier to monitor. It also may be possible to implement this approach more quickly and with less cost than the prior proposals.

The initial comment period for the April proposals ended on June 19, 2009. The comment period will now be extended for 30 days from the date of publication of an associated notice in the Federal Register. The Commission particularly seeks comments on the alternative uptick rule as a permanent market-wide approach, as well as whether the alternative uptick rule should be combined with a circuit breaker approach.

New York AG Sues Schwab over ARS

Attorney General Andrew M. Cuomo today filed a lawsuit against Charles Schwab & Co. (“Schwab”) charging the discount brokerage firm for falsely representing auction rate securities as liquid, short-term investments without discussing the risks. According to the Attorney General, Schwab brokers repeatedly and persistently misrepresented the liquidity risks in auction rate securities, comparing them to money market funds or certificates of deposit, selling auction rates as suitable for cash management purposes, or otherwise telling customers they would always be able to retrieve their cash.

The Attorney General referred to audio recordings obtained during the investigation that allegedly confirm that Schwab brokers repeatedly misled investors about the risks of investing in auction rate securities. One Schwab broker “guaranteed” that his customer would be able to “get out of [his auction rate security] on the auction date.” Another assured a customer that she just needed to “call me … and then the next month I’ll stop the auction and all the cash [invested in auction rate securities] will come back to your account.” Another Schwab broker described preferred auction rate securities as a “short-term institutional holding instrument” that was particularly suitable for managing the customer’s cash balances:

If you need to have that access to them at any time, that’s a good place for those to be. You know if you think you might need to get into that money, that’s probably as good a place if not better than anywhere to leave them.

Another broker represented that the hardest part of investing in an auction rate security “is getting into it. That would be the tough part. I mean, getting out is something as easy as just selling it.”

According to the Attorney General, while Schwab publicly touted its “extensive fixed-income research,” “expertise” and “seasoned bond traders, who have an average of 15 years of industry experience,” Schwab’s persistent fraud was possible because Schwab failed to train or otherwise ensure that its brokers had even a basic understanding of auction rate securities. Brokers interviewed during the investigation all confirmed that they received no formal training from Schwab relating to auction rate securities. As a result, many Schwab brokers misunderstood or knew little about the auction rate securities they were selling to Schwab’s customers. While Schwab sold customers on its fixed income “expertise,” one broker stated: “I don’t know what measuring scale you would want to use to assess my knowledge about auction rate securities … but on whatever measuring scale my knowledge was pretty low.” The lack of training and understanding at Schwab proved devastating to Schwab’s customers. When one broker was asked if his customers adequately understood the risks of auction rate securities, the broker replied: “No. . . . They probably didn’t know that here is a product you might not be able to sell. It wasn’t conveyed by myself or the financial consultant because we didn’t know either.” Just one week before the auction rate securities market collapsed, during a call with another broker-dealer, one Schwab broker still did not understand the risks that were about to haunt Schwab’s customers, asking “how could an auction fail?”

Today’s action seeks, among other things, to compel Schwab to buy-back auction rate securities from the Schwab investors still holding illiquid securities, penalties, costs, disgorgement, restitution, and other equitable relief.

Here is the complaint.