Securities Law Prof Blog

Siebecker on Trust & Transparency

Trust & Transparency: Promoting Efficient Corporate Disclosure Through Fiduciary-Based Discourse, by Michael R. Siebecker, University of Florida - Fredric G. Levin College of Law,  was recently posted on SSRN.  Here is the abstract:

Could embracing the philosophy of “encapsulated trust” as the basis for a fiduciary duty of disclosure improve the integrity and effectiveness of corporate communications? The question arises because a tragedy of transparency threatens the viability of the burgeoning corporate social responsibility (CSR) movement, where consumers and investors employ various social, environmental, or ethical screening criteria before purchasing a company‟s stock or products. In an efficient market, fully informed consumers and investors could reward companies that engage in CSR by purchasing their products or stock and, conversely, punish companies that fail to engage in desired practices by refusing to purchase their products or stock. Unfortunately, corporations are increasingly engaging in a sort of “strategic ambiguity” in their public communications-an ambiguity made possible by a variety of static yet inconsistent standards regarding the collection, auditing, and dissemination of information regarding CSR practices. Consumers and investors simply cannot trust the existing disclosure regime to provide reliable information necessary to monitor CSR compliance. That lack of trust will cause the market for CSR to collapse, as consumers and investors stop offering rewards for responsible business behavior.

The Article suggests solving that disclosure tragedy by using the philosophy of “encapsulated trust” to reshape the existing fiduciary duties governing officers and directors. In simple terms, encapsulated trust constitutes a rational expectation that others will take our interests into account when determining what course of action to pursue. Applied in the context of corporate disclosures on CSR, encapsulated trust would require officers and directors to demonstrate they took into account shareholder preferences regarding the timing, content, and form of corporate disclosures. In essence, the duty is a process-based standard that relies on continual discourse to improve the integrity of disclosure practices. In contrast to static statutory disclosure rules, an emphasis on improved discourse between the corporations and shareholders would promote greater efficiency in corporate communication by attending more accurately to evolving consumer and investor disclosure preferences. Moreover, the focus on greater discourse within the corporate setting would also lead to enhanced ethical practices by corporate actors and their counsel.

Reuveni on Extraterritoriality of the Securities Laws

Extraterritoriality as Standing: A Standing Theory of the Extraterritorial Application of the Securities Laws, by Erez Reuveni, United States Second Circuit Court of Appeals, was recently posted on SSRN.  Here is the abstract:

This Article contends that the current treatment of the extraterritorial scope of the 1934 Securities and Exchange Act as a question of subject matter jurisdiction is wrong. Although the Act is silent as to its extraterritorial application, for over forty years courts have analyzed the Act’s extraterritorial scope as a question of subject matter jurisdiction, relying on the so-called “conduct” and “effects” tests. Because courts apply these tests in an ad hoc, case-by-case manner, they are inherently unpredictable and unnecessarily complicated. This state of affairs has become particularly troublesome in recent years, as so-called “foreign-cubed” securities fraud lawsuits - lawsuits filed by foreign plaintiffs against foreign defendants, alleging fraud in connection with the sale or purchase of shares in foreign markets - have proliferated in federal courts. This Article argues that contrary to current practice, the extraterritorial reach of Section 10(b) and Rule 10b-5 of the 1934 Act is really a question of statutory standing. Under the analysis developed here, the appropriate question for courts to ask is not whether they have jurisdiction over foreign claims, but whether Congress intended for the statutory scheme to provide a remedy to foreign plaintiffs. As this Article shows, only foreign investors who purchase or sell stock in the United States have standing to invoke the securities laws. This approach resolves the problems inherent in jurisdictional analysis and provides a simple, easily understood bright-line rule whose predictive value and procedural benefits ensure an optimal enforcement regime where American interests are affected by foreign fraud.

Ferrarini & Miller on Takeover Regulation

A Simple Theory of Takeover Regulation in the United States and Europe, by Guido A. Ferrarini, University of Genoa - Law School; European Corporate Governance Institute (ECGI), and Geoffrey P. Miller, New York University - School of Law, was recently posted on SSRN.  Here is the abstract:

This paper presents a simple model of takeover regulation in a federal system. The theory has two parts. First, the model predicts that the rules applicable at more general political levels will be more favorable to takeover bids than will the rules applicable at local levels. The reason is that unlike bidders, who do not know ex ante where they will find targets, targets can concentrate their political activities knowing that the law of their jurisdiction will apply to any attempt to take them over. On the other hand, at more general political levels this advantage for target firms disappears, so the rules are expected to be less target-friendly. This is in fact the pattern we observe both in the United States and the European Union. Second, the model predicts that rules on takeovers will reflect the degree of concern that targets have about potential hostile bids. Where firms are well-protected against unfriendly takeovers – for example, in jurisdictions where companies are under family control – takeover regulation is likely to be less target-friendly than in jurisdictions where potential targets are more exposed to a hostile acquisition. This pattern is also observed in takeover regulation.

SEC's Inspector General Releases Exhibits to Madoff Report

The SEC's Inspector General released hundreds of exhibits supporting its highly critical report on the SEC's past investigations of Bernard L. Madoff, including a transcript of an interview with Madoff in which he expressed astonishment that the SEC staff did not uncover his Ponzi scheme.  NYTimes, In Transcripts, Madoff Called S.E.C. Exams ‘a Nightmare.’

Continued Fight over Regulation of Investment Advisers by FINRA

Investment advisers, state regulators and consumer advocates were critical of the adoption of an amendment to the Investor Protection Act that would give Finra power to oversee any adviser associated with a registered broker-dealer, including about 500 dually registered Finra members.
That amendment, which the House Financial Services Committee approved Wednesday by a voice vote, would give the SEC the authority to allow the Financial Industry Regulatory Authority Inc. to expand its oversight of brokers' registered investment advisers.  InvNews, Industry blasts move that would expand Finra's authority over advisers.

Geithner's Testimony Before House Financial Services Committee

TreasurySecretary Timothy F. Geithner's Written Testimony before House Financial Services Committee (October 29)

SEC Settles Insider Trading Charges against Former CyberKey Outside Counsel

The SEC settled insider trading charges against J. Bennett Grocock, the former outside counsel for CyberKey Solutions, Inc. ("CyberKey").  It alleged that Grocock made at least $170,000 by selling shares of the company's stock while in possession of material, nonpublic information about the company. Grocock also sold CyberKey shares before he possessed material, nonpublic information about the company, but none of the shares he sold were issued under a registration statement or with any legitimate exemption from registration.

According to the Commission's complaint, Grocock became aware in the summer and fall of 2006 that CyberKey was under investigation for possible securities violations by several different agencies, including the Commission, the then-National Association of Securities Dealers, and the Utah Division of Securities. Despite being aware of these investigations, any one of which would have had material consequences for the company if carried forward to its logical conclusion, Grocock continued to sell CyberKey shares and in fact accelerated his sales after learning of the Commission's investigation in mid-November 2006. Grocock generated $248,800 in total from his sales, which ended shortly after CyberKey's CEO was arrested and charged with civil and criminal securities fraud, among other things, in March 2007.

Grocock has consented, without admitting or denying the allegations in the complaint, to a permanent injunction against future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, as well as against future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933. On the basis of sworn financial statements and other documents and information furnished to the Commission, payment of disgorgement was waived and civil penalties were not imposed.

SEC Charges Former CFO of California Investment Firm with Insider Trading

The SEC today charged Chen Tang, the former chief financial officer of a San Francisco private investment firm, and six of his relatives and friends with insider trading, alleging that their scheme collectively reaped more than $8 million in illicit profits from unlawful trades in the securities of Tempur-pedic International, Inc. and Acxiom Corporation.  The SEC alleges that Tang learned non-public information as the CFO of a private equity fund and from illegal tips by his brother-in-law, who was the CFO of a venture capital fund. Tang and his trading partners, which included his brother and four friends, traded on the inside information through their personal brokerage and retirement accounts, the accounts of their spouses, children and relatives, and the accounts of several privately-offered investment funds that Tang and three of his friends managed.

The SEC has charged the seven defendants with violating the antifraud provisions of the federal securities laws. In its complaint, the Commission requests that the court permanently enjoin them from future violations of the federal securities laws, and order them to disgorge ill-gotten gains with prejudgment interest and pay financial penalties.

The SEC also named 15 relief defendants in its complaint for the purpose of seeking disgorgement of ill-gotten gains in their possession. These include family members and funds whose brokerage accounts were used by the defendants in the illegal trading. The relief defendants are not accused of any wrongdoing.

NASAA Calls for Expanding its Regulation of Investment Advisers

The following is a statement from North American Securities Administrators Association President and Texas Securities Commissioner Denise Voigt Crawford calling for Congress to increase the regulatory responsibility of state securities regulators over investment advisers:

“States have both the will and the ability to regulate. The state system of investment adviser regulation has worked well with the $25 million threshold since it was mandated in 1996.  The states have developed an effective regulatory structure and enhanced technology to oversee investment advisers. Increasing the threshold to $100 million would reduce the SEC’s examination burden and allow the agency to focus on larger firms and other market issues.

“Government never has enough resources to do everything, but it’s clear that states have done a much better job at deploying their limited resources. States are ready to accept this increased responsibility.”

FINRA and AMF Sign Agreement to Improve Cooperation in Financial Markets

FINRA and the Autorité des marchés financiers (AMF) signed on 19 October 2009 a memorandum of understanding (MoU) on information-sharing with a view to strengthening and improving cooperation in the surveillance and supervision of the markets under their jurisdictions.  The memorandum establishes a formal basis for cooperation among FINRA and the AMF in order to more effectively conduct their oversight of regulated markets and financial firms.

 The MoU has two main aims:  organize the transmission of information between authorities regarding market surveillance and investigations into market abuse and facilitate the sharing of information on trading by firms coming within the two authorities' respective jurisdictions.
 

Schapiro on Investor Confidence

Speech by SEC Chairman: "The Road to Investor Confidence" by Chairman Mary Schapiro, U.S. Securities and Exchange Commission, SIFMA Annual Conference, New York, New York, October 27, 2009

FINRA Fines Scottrade for Inadequate AML Program

FINRA announced that it fined Scottrade $600,000 for failing to establish and implement an adequate anti-money laundering (AML) program to detect and trigger reporting of suspicious transactions, as required by the Bank Secrecy Act and FINRA rules.  FINRA requires brokerage firms to establish and implement anti-money laundering policies, procedures and internal controls reasonably designed to detect and cause the reporting of any suspicious transactions that could be related to possible violations of laws or regulations - regardless of whether those transactions are associated with suspicious movement of funds into or out of accounts.

Specifically, FINRA found that between April 2003 and April 2008, Scottrade failed to establish and implement an adequate AML program tailored to its business model, which primarily consists of providing an on-line platform for customers trading in securities. In 2003, Scottrade handled about 49,000 customer trades per day, and its volume grew to about 150,000 daily trades in 2007. Among the risks inherent to Scottrade's brokerage model and the firm's substantial trading volume are an increased risk of identity theft, account intrusions and the use of customer accounts to launder money using securities or other financial instruments, or to violate securities laws.

FINRA has advised firms that in designing their AML program, they should consider factors such as their size, location, business activities, the types of accounts they maintain and the types of transactions in which their customers engage. FINRA also has instructed on-line firms such as Scottrade to consider conducting computerized surveillance of account activity to detect suspicious transactions.

 In concluding this settlement, Scottrade neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

SEC Adopts Revisions to EDGAR Filer Manual

The SEC adopted revisions to the Electronic Data Gathering, Analysis, and Retrieval System (EDGAR) Filer Manual to reflect updates to the EDGAR system made in EDGAR Release 9.17. The revisions were made primarily to enforce additional XBRL validation requirements to improve the quality of XBRL exhibits; to allow filers to electronically submit the withdrawal of application for exemptive or other relief from the Investment Companies Act as submission types APP WD and APP WD/A; and, to allow filers to add Subject Company related information for the submission types F-6, F-6/A, F-6EF, and F-6POS. The revisions to the Filer Manual reflect changes within Volume I entitled EDGAR Filer Manual, Volume I: “General Information,” Version 8 (September 2009) and Volume II entitled EDGAR Filer Manual, Volume II: “EDGAR Filing,” Version 13 (September 2009). The updated manual will be incorporated by reference into the Code of Federal Regulations.

SEC Settles Insider Trading Charges Against Former SemGroup Officer

The SEC settled charges that Don N. Spaugy, the former Vice President of Financial Services at SemGroup, LP ("SemGroup"), engaged in insider trading in the securities of then Nasdaq-listed SemGroup Energy Partners, LP ("SGLP"). At the time of Spaugy's trading, SemGroup was SGLP's parent company and its largest source of revenue.

According to the Commission's complaint, between late May 2008 and the morning of July 15, 2008, and in the course of his employment at SemGroup, Spaugy learned that SemGroup was in a liquidity crisis driven by massive margin calls from its wrong-way bets in the commodities and futures markets. In particular, the complaint alleges that, shortly before liquidating his SGLP holdings, Spaugy: (1) received, via email, 111 margin calls for SemGroup from six futures commission merchants totaling over $570 million; (2) knew that certain SemGroup customers and trading partners were reducing/terminating their trade and credit lines with the company; and (3) was notified by SemGroup's commercial bank that a primary corporate account was overdrawn by over $4 million.

The complaint further alleges that, after learning this material nonpublic information, on July 15 and 16, 2008, Spaugy liquidated 4,500 SGLP units, at an average price of $23.28 per unit. On July 17, after the close of trading, SGLP announced that SemGroup was "experiencing liquidity issues" and was considering bankruptcy. On July 18, SGLP's unit price closed at $8.30 per unit, 64.35% lower than Spaugy's average sale price. According to the complaint, by liquidating his SGLP holdings on July 15 and 16, Spaugy avoided losses of $67,424.

Spaugy has consented, without admitting or denying the allegations in the complaint, to a permanent injunction against future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and to pay disgorgement of the $67,424 loss he avoided by his illegal trading, plus prejudgment interest of $3,378.13, and a civil penalty of $67,424.

Laby on Reforming Regulation of Brokers and Advisers

Reforming the Regulation of Broker-Dealers and Investment Advisers, by Arthur B. Laby, Rutgers University School of Law - Camden, was recently posted on SSRN.  Here is the abstract:

A key component of financial regulatory reform is harmonizing the law governing broker-dealers and investment advisers. Historically brokers charged commissions and were regulated under the Securities Exchange Act of 1934. Advisers charged asset-based fees and were subject to the Investment Advisers Act of 1940, which contains a special exclusion for brokers. In recent years, brokers have changed their compensation structure and many now market themselves as advisers, raising questions about whether they should be treated as such. The Obama Administration’s 2009 White Paper on regulatory reform and draft legislation call for a fiduciary duty to be imposed on brokers that provide advice. In this article, I explore the debate over regulating brokers and advisers and suggest how to resolve it. I make four key claims. First, changes in brokers’ compensation and marketing methods vitiate application of the broker-dealer exclusion and should subject brokers to the Advisers Act. Second, changes in the nature of brokerage, spurred by changes in technology, make the broker-dealer exclusion unsustainable and Congress should repeal it. I then turn to the consequences of regulating brokers as advisers. The third claim is that imposing fiduciary duties on brokers is incompatible with their historical roles as dealers and underwriters. To resolve this tension, the article suggests a compromise that enhances brokers’ duties but does not hobble their ability to perform their traditional functions. Finally, regulating brokers as advisers would overburden the SEC and the article offers alternatives to alleviate the strain.

Subramanian et al. on the Constitutionality of Delaware's Antitakeover Statute

Is Delaware's Antitakeover Statute Unconstitutional? Evidence from 1988-2008, by Guhan Subramanian, Harvard Business School; Steven Herscovici, Analysis Group, Inc.; and Brian Barbetta, Analysis Group, Inc., was recently posted on SSRN.  Here is the abstract:

Delaware’s antitakeover statute, codified at Section 203 of the Delaware corporate code, is by far the most important antitakeover statute in the United States. When it was first enacted in 1988, three bidders challenged its constitutionality under the Commerce Clause and the Supremacy Clause of the U.S. Constitution. All three federal district court decisions upheld the constitutionality of Section 203 at the time, relying on empirical evidence indicating that Section 203 gave bidders a “meaningful opportunity for success,” but leaving open the possibility that future empirical evidence might change this constitutional conclusion. This Article presents the first systematic empirical evidence since 1988 on whether Section 203 gives bidders a meaningful opportunity for success. The question has become more important in recent years because Section 203’s substantive bite has increased, as Exelon’s recent hostile bid for NRG illustrates. Using a new sample of all hostile takeover bids against Delaware targets that were announced between 1988 and 2008 that were subject to Section 203 (n=60), we find that no hostile bidder in the past nineteen years has been able to avoid the restrictions imposed by Section 203 by going from less than 15% to more than 85% in its tender offer. At the very least, this finding indicates that the empirical proposition that the federal courts relied upon to uphold Section 203’s constitutionality is no longer valid. While it remains possible that courts would nevertheless uphold Section 203’s constitutionality on different grounds, the evidence would seem to suggest that the constitutionality of Section 203 is up for grabs. This Article offers specific changes to the Delaware statute that would preempt the constitutional challenge. If instead Section 203 were to fall on constitutional grounds, as Delaware’s prior antitakeover statute did in 1986, it would also have implications for similar antitakeover statutes in thirty-two other U.S. states, which along with Delaware collectively cover 92% of all U.S. corporations.

Dent on Optional Federal Incorporation

For Optional Federal Incorporation, by George W. Dent Jr., Case Western Reserve University - School of Law, was recently posted on SSRN.  Here is the abstract:

The American economy suffers from the domination of corporations by chief executive officers who exercise control for their own benefit, at considerable cost to shareholders and to efficiency. The costs of this defect are rising as capital flees the United States for a growing number of countries that treat investors better. America’s corporate governance problem began and persists because corporations are franchised by the states, and it is in the economic interest of the states (especially Delaware) to cater to CEOS because they control the choice of state of incorporation. To break this destructive arrangement I propose optional federal incorporation with the choice of jurisdiction to be made by shareholders alone. Shareholders are the only constituency whose goal is to maximize share value, and this goal coincides with society’s interest in economic efficiency. Shareholders also have the sophistication to decide major corporate questions wisely. The institution of optional federal incorporation and shareholder choice of jurisdiction of incorporation would trigger a true “race to the top,” a competition to offer the most efficient corporation law.

Fanto on Adequacy of Risk Management

Anticipating the Unthinkable: The Adequacy of Risk Management in Finance and Environmental Studies, by James A. Fanto, Brooklyn Law School, was recently posted on SSRN.  Here is the abstract:

The purpose of the Article is to consider the role of risk management in the current financial crisis. My argument is that risk management in systemically important financial institutions failed, which contributed to the recent collapse of the financial system. For a number of reasons that I explore, risk management did not fulfill its purpose, which was to prevent financial institutions from suffering the kinds of losses that they experienced in the crisis. This Article identifies these risk-management failings and offers remedies to them. At times, environmental risk management, which deals with extreme environmental risks such as global warming, inspires my discussion of financial risk management.

The Article proceeds as follows. Part I briefly identifies the financial crisis. Part II then discusses the practice of risk management in financial institutions and identifies its failings as revealed by the financial crisis. These failings include problems in risk management modeling, questions about the reliability of the models themselves, failures to supplement models with other risk management approaches, governance problems in financial firms regarding risk management, and imperfect regulatory oversight of risk management in these firms. Part III considers the lessons that can be drawn from the financial crisis and identifies improvements to risk management that would avoid a repetition of the crisis. This Part also highlights obstacles to risk management reforms, which include compensation practices in financial institutions and, more generally, human limitations in dealing with complexity. In addition, it provides a course of action for risk management in light of these obstacles.

SEC Announces Nov. 19 Small Business Forum

The SEC plans to host its 2009 Government-Business Forum on Small Business Capital Formation on Thursday, November 19, 2009, from 9:00 a.m. to 5:30 p.m., at its headquarters at 100 F Street, N.E., Washington, D.C. 20549. For the first time, those who are pre-registered will be able to participate in the Forum fully without traveling to Washington.

The SEC hosts an annual forum that focuses on the capital formation concerns of small business. A major purpose of the Forum is to provide a platform for small business to highlight perceived unnecessary impediments to the capital-raising process. Previous Forums have developed numerous recommendations seeking legislative and regulatory changes in the areas of securities and financial services regulation, taxation and state and federal assistance. Participants in the Forum typically have included small business executives, venture capitalists, government officials, trade association representatives, lawyers, accountants, academics and small business advocates. In recent years, the format of the Forum typically has emphasized small interactive breakout groups developing recommendations for governmental action.

SEC Charges Broker with Using Fake Press Releases to Manipulate Stock Prices

The SEC charged a New York securities broker with securities fraud for repeatedly creating and then distributing fake press releases to manipulate the stock prices of multiple publicly traded companies. The SEC alleges that Lambros Ballas, a registered representative of New York stock brokerage firm Global Arena Capital Corporation, purported to announce good news regarding the companies, including that Google was buying one of them at a substantial premium. Ballas then posed as an investor on Internet message boards, touting the announcements he had fabricated. In one instance, his scheme caused the stock price to increase by nearly 80 percent within a few hours of the issuance of his phony press release. The SEC is seeking an emergency court order to enjoin the broker from further fraudulent activity. 

According to the SEC’s complaint, filed in federal court in San Jose, Calif., and other court documents filed in the case:

Ballas issued a phony press release the evening of Sept. 29, 2009, announcing that Pennsylvania biotech company Discovery Laboratories had obtained approval from the U.S. Food and Drug Administration for a drug under development. Ballas then posted a message on a stock message board with a link to what he described as the company’s “official press release.” In his post, Ballas claimed to have called his “personal broker” who “says it’s been confirmed.” The next morning, Discovery Laboratories shares opened significantly higher.
 
The next day, Ballas issued another press release falsely claiming that IMAX Corporation had been acquired by Disney. Once again, he followed up by posting links to the phony release on a stock message board, telling other potential investors that he had bought 10,000 IMAX shares and that his broker “just called me to tell me at the crack of dawn.
 
Ballas continued his scheme on October 1, issuing a phony press release stating that California search engine company Local.com was being acquired by Microsoft. Ballas again followed up by posting messages and links to the Local.com release on stock message boards. In one posting he stated: “Local just bought out by Microsoft, at $12.50 per share including patent ownership.” In after-market trading, Local.com’s stock price rose nearly 80 percent.
 
Later that night, Local.com issued a corrective release saying that the Microsoft release had been false — there was no Microsoft acquisition. Undeterred, the next day Ballas issued another phony release, this time stating that it was Google, and not Microsoft, that was acquiring the company.
The SEC further alleges that shortly before he sent the hoax press release about Discovery Laboratories, Ballas’s brokerage clients purchased shares of the company and thus stood to profit by any price rise Ballas’s fake release created. Similarly, the complaint alleges that Ballas bought shares of Local.com stock just before he sent out the fake Local.com-Microsoft release so that he could capitalize on the fraudulent share price inflation he intended to trigger.

The SEC’s complaint charges Ballas with violations of the antifraud provisions of the federal securities laws. The SEC seeks injunctive relief, disgorgement of ill-gotten gains, and monetary penalties against Ballas.