Securities Law Prof Blog

Is It Financial Reform's Time Finally?

Senators Gregg and Corker, two Republicans on the Senate Banking Committee (which voted Senator Dodd's version out of committee, on a partisan vote, without debate), say yes:

WPost, GOP's Gregg, Corker predict financial regulation bill will pass in 2010

SEC Charges New Mexico Realtor with $80 Million Ponzi Scheme

The SEC yesterday filed fraud charges against Douglas F. Vaughan, a prominent New Mexico realtor, and obtained an emergency court order to halt an alleged $80 million Ponzi scheme.  According to the complaint, Vaughan through his company — The Vaughan Company Realtors — issued promissory notes that he claimed would generate high fixed returns for investors. Vaughan also used another entity — Vaughan Capital LLC — to solicit investors for different types of real estate-related investments, such as buying residential properties at distressed prices. Vaughan relied entirely on new money raised from investors through both companies to fund Vaughan Company's ever-increasing obligations to note holders.

The U.S. District Court for the District of New Mexico granted the SEC's request for a temporary restraining order and asset freeze against Vaughan and his companies.

Daimler Agrees to Settle FCPA Charges

Daimler AG has agreed to pay $185 million to settle charges brought by the DOJ and SEC that the company paid bribes to secure overseas business.  In addition to paying the fines, the company will plead guilty to violating the FCPA.  WSJ, Daimler Agrees to Pay $185 Million to Settle U.S. Bribery Investigation

UK Arrests Six in Insider Trading Crackdown

The U.K. regulator, the Financial Service Authority, announced a major crackdown on insider trading, including the arrest of six individuals.  Although the FSA release did not name names, the Wall St. Journal does -- including an employee of the U.S. hedge fund Moore Capital Management.  WSJ, U.K. Arrests Deutsche Bank, Moore Capital Employees in Insider-Trading Probe

SEC Freezes Assets in Alleged Life Settlement Fraud

The SEC recently obtained a judicial order temporarily freezing assets and appointing a receiver to take control of the assets and operations of American Settlement Associates, LLC ("ASA") in an alleged $3.5 million life settlement fraud.  According to its complaint, Charles C. Jordan, Kelly T. Gipson, and ASA LLC, sold fractional ownership interests in a particular life settlement policy to a specific group of investors ("the Policy"), and then failed, without warning or disclosure, to use investors' money to cover the future premium payments on the Policy. Instead of reserving investor funds to pay future Policy premiums, Defendants commingled the funds and used them to pay Defendants' business and personal expenses and to support lavish lifestyles, including payments for jewelry, casinos and other travel and entertainment. The complaint alleges that Defendants enriched themselves with approximately $2.3 million of investor funds. As a result, the Policy lapsed on March 9, 2010. The Commission further alleges that Jordan and Gipson misled investors by falsely claiming that the investments were protected by a bonding company, but failed to disclose to investors significant risks associated with the purported bonding company, including the fact that it is located offshore and is not licensed to provide insurance in the U.S.

The complaint seeks preliminary and permanent injunctions, disgorgement together with prejudgment interest, and civil penalties. The Commission's complaint also seeks an asset freeze against the Defendants, and the appointment of a receiver to recover and conserve assets for the benefit of defrauded investors.

SEC Issues Statement on Modifications to 2003 Analysts Settlement

You will recall that I reported last week that the securities firms subject to the 2003 Analysts Settlement sought modifications to certain provisions of the settlement, which request the SEC did not oppose.  The Judge approved most of them, but rejected a modification that would have  permitted analysts and investment bankers to speak outside of the presence of a compliance person.  Here is the official SEC release on the modifications:

The Securities and Exchange Commission today announced that the Honorable William H. Pauley III issued an Order on March 15, 2010 approving modifications to the final judgments entered against the twelve firms covered by the Global Research Analyst Settlement.

The final judgments first entered in October 2003 contained an extensive Addendum with provisions mandating structural and other reforms that addressed potential conflicts of interest between equity research analysts and investment banking.

The Global Settlement provided that with respect to any provision that had not been expressly superseded by subsequent rulemaking within five years, it was the expectation of the parties that, "the SEC would agree to an amendment or modification of such term, subject to Court approval, unless the SEC believes such amendment or modification would not be in the public interest."

As set forth in an Aug. 3, 2009 letter to the Court made public in connection with the Court's decision, the Settling Firms "strongly believe[d]" that all existing operative provisions of the Addendum should be eliminated, but the Commission believed that it was in the public interest to retain a number of provisions in their current form or with certain modifications. The Settling Firms consequently did not seek elimination of all of the Addendum's operative provisions, but instead requested specific modifications. The SEC did not oppose the resulting request by the Settling Firms.

In particular, there was no request for modification of the following provisions and firewalls, all of which remain in place under the modified Addendum approved by Judge Pauley:

Investment banking input into the research budget is prohibited;
The physical separation of research analysts and investment banking is required;
Investment banking is prohibited from having input into company-specific coverage decisions;
Research oversight committees are required to ensure the integrity and independence of equity research;
Communications between investment banking personnel and research analysts regarding the merits of a proposed transaction or a potential candidate for a transaction are prohibited unless a chaperone from the firm's legal and compliance department is present;
Research analysts and investment bankers are prohibited from having any communications for the purpose of having research personnel identify specific potential investment banking transactions; and
Research analysts must be able to express their views to a commitment committee about a proposed transaction outside the presence of investment bankers working on the deal.
The SEC supported the continued retention of these provisions in the Addendum.

The Court approved removing a number of provisions from the Addendum because rules issued by the National Association of Securities Dealers Inc. and New York Stock Exchange addressed the same concerns and provided comparable protections. As a result, the Addendum no longer includes prohibitions against investment banking input into research analyst compensation and the bar against research analysts participating in efforts to solicit investment banking business, among other things.

As noted above, the modified Addendum as ordered by Judge Pauley and supported by the SEC maintained the requirement that a chaperone from legal or compliance be present when investment banking seeks the views of research analysts concerning a proposed transaction or a potential candidate for a transaction. One proposed modification would have allowed investment banking to seek the views of research analysts regarding market or industry trends, conditions, or developments without the requirement of a chaperone, subject to certain limitations including the implementation of controls and training as described in the November 30, 2009 letter to the Court from the Settling Firms. In his March 15, 2010 Order, Judge Pauley did not approve this proposed modification.

As a result of the Court's Order, the Settling Firms remain subject to a number of important restrictions that apply only to Global Settlement firms. Together with the rest of the industry, they also remain subject to all of the provisions of NASD Rule 2711, NYSE Rule 472, and the SEC's Regulation AC that address research analyst conflicts of interest.

TARP Special Master Issues Rulings on 2010 Executive Pay for 5 "Exceptional Assistance" Firms

The Special Master for TARP Executive Compensation, Kenneth R. Feinberg, issued his rulings on 2010 executive pay packages for the `Top 25' executives at the five remaining firms that received exceptional assistance from taxpayers: AIG, Chrysler, Chrysler Financial, GM, and GMAC.  Because Bank of America and Citigroup repaid their exceptional assistance, they are not subject to the Special Master's 2010 rulings.  The Special Master also released a letter requesting information on compensation paid to the `Top 25' executives at each firm that received TARP assistance before February 17, 2009 to obtain information needed for the `look back' review required by the Recovery Act.

Massachusetts Issues Subpoenas to Broker-Dealers Over Private Placements

Massachusetts securities regulator William Galvin yesterday issued subpoenas to six brokerage firms concerning sales of participations in private placements marketed by Medical Capital Holdings Inc. and Provident Royalties LLC, seeking information on due diligence efforts, suitability data and promotional materials.  The firms are QA3 Financial Corp., National Securities Corp., CapWest Securities, Independent Financial Group, Investors Capital Corp., and Centaurus Financial.  InvNews, Six broker-dealers subpoenaed over private placements.

Dodd Calls for DOJ Investigation of Lehman Brothers Accounting

Today Senate Banking Committee Chairman Chris Dodd (D-CT) sent a letter to Attorney General Eric Holder asking that he commission a task force to investigate activities at Lehman Brothers and other companies that may have engaged in similar accounting manipulation with a view to prosecution of those who broke of the law.

On a related topic:  The Guardian has a recent article on Erin Callan, the former Lehman Brothers CFO, the title of which says it all:  Lehman Brothers' golden girl, Erin Callan: through the glass ceiling – and off the glass cliff

Senate Banking Committee Votes Financial Reform Bill to Senate

Yesterday the Senate Banking Committee voted, on strict party lines, to send the committee's version of the financial reform package to the Senate for debate and vote.  The House approved its version last December.  NYTimes, Bank Panel Clears Bill on Overhaul.

Here is the Senate's version after yesterday's mark-up session.

Afsharipour on Reverse Termination Fees

Transforming the Allocation of Deal Risk Through Reverse Termination Fees, by Afra Afsharipour, University of California, Davis - School of Law, was recently posted on SSRN.  Here is the abstract:

Buyers and sellers in strategic acquisition transactions are fundamentally shifting the way they allocate deal risk through their use of reverse termination fees (RTFs). Once relatively obscure in strategic transactions, RTFs have emerged as one of the most significant provisions in agreements that govern multi-million and multi-billion dollar deals. Despite their recent surge in acquisition agreements, RTFs have yet to be examined in any systematic way. This Article presents the first empirical study of RTFs in strategic transactions, demonstrating that these provisions are on the rise. More significantly, this study reveals the changing and increasingly complex nature of RTF provisions and how parties are using them to transform the allocation of deal risk. By exploring the evolution of the use of RTF provisions, this study explicates differing models for structuring deal risk and yields greater insights into how parties use complex contractual provisions not only to shift the allocation of risk, but also to engage in contractual innovation.

Thomas & Wells on Executive Compensation

Executive Compensation in the Courts: Board Capture, Optimal Contracting and Officer Fiduciary Duties, by Randall S. Thomas, Vanderbilt University - School of Law, and Harwell Wells, Temple University Beasley School of Law, was recently posted on SSRN. Here is the abstract:

This Article proposes a new approach to monitoring executive compensation. While the public seems convinced that executives at public corporations are paid too much, scholars are sharply divided. Advocates of “Board Capture” theory believe officers so dominate their boards that they can negotiate their own employment agreements and set their own pay. “Optimal contracting” theorists doubt this, contending that, given legal and economic constraints, executive compensation agreements are likely to be pretty good and benefit shareholders. Disputes about which theory is correct have hampered efforts to reform executive compensation practices.

Recent developments in corporate law point to a way out of this theoretical impasse. Last year, in Gantler v. Stephens, Delaware’s Supreme Court resolved a major unanswered issue in corporation law when it held that a corporation’s officers owe the same fiduciary duty to the corporation and its shareholders as do its directors. Gantler opens the door for courts to scrutinize rigorously officers’ actions in negotiating their own compensation agreements. The Delaware Chancery Court has taken up this invitation by holding that corporate officers are bound by their duty of loyalty to negotiate employment contracts in an arm’s-length, adversarial manner. If the officers do not do so, but instead try to take advantage of the Board, they will open themselves up to shareholder lawsuits and give courts the opportunity to examine the compensation agreements and their negotiations. This will provide a new level of judicial scrutiny of executive compensation arrangements, and should go far to answer criticisms leveled by Board Capture theorists, who believe the present negotiating system is corrupt, while Optimal Contracting theorists will welcome judicial intervention that improves the present negotiating environment.

Interview with SEC Chair Schapiro

Charles Lane of the Washington Post has a video interview with SEC Chair Mary Schapiro, in which she discusses improvements at the agency in response to the Madoff scandal, the inadequacies of the SEC's Consolidated Supervised Entity (CSE) Program and the downfall of Lehman Brothers, and her expectations for regulatory reform.

More Bad Press for the SEC

The Wall St. Journal reported this morning on the SEC's approval of some easing of the restrictions on dealings between analysts and investment bankers at the major firms that are signatories to the 2003 Analysts' Settlement.  (Elimination of a significant restriction -- allowing communications between analysts and investment bankers outside the presence of a compliance officer -- was denied by the judge overseeing the settlement.)  The WSJ follows up on this and describes how the SEC failed to enact industry rules that would continue and broaden the applicability of some of the settlement's key provisions.  WSJ, SEC Didn't Expand Upon Stock-Abuse Settlement.

Innospec Settles FCPA Charges

The SEC settled charges that Innospec, Inc. (“Innospec”), a specialty chemical company incorporated in Delaware with principal offices in the United States and the United Kingdom, violated the anti-bribery, books and records, and internal controls provisions of the Foreign Corrupt Practices Act (“FCPA”).  Innospec has offered to pay $40.2 million as part of a global settlement with the Commission, the Department of Justice, Fraud Section (“DOJ”), the United Kingdom’s Serious Fraud Office (“SFO”), and the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”).  This case is the first corruption-related settlement coordinated between the Commission, DOJ, and the SFO.

The SEC’s complaint alleges that from 2000 to 2007, Innospec routinely paid bribes to sell Tetra Ethyl Lead (“TEL”), a fuel additive that boosts the octane value of gasoline, to state owned refineries and oil companies in Iraq and Indonesia.  Innospec also paid kickbacks to Iraq to obtain contracts under the United Nations Oil for Food Program (the “Program”). Innospec’s former management did nothing to stop the bribery, and in fact authorized and encouraged it.  In addition, Innospec’s internal controls failed to detect the illicit conduct, which continued for nearly a decade.  In all, Innospec made illicit payments of approximately $6,347,588 and promised an additional $2,870,377 in illicit payments to Iraqi ministries, Iraqi government officials, and Indonesian government officials in exchange for contracts worth approximately $176,717,341 in revenues and profits of $60,071,613.

In addition, from 2000 through 2003, Innospec obtained five Program contracts for the sale of TEL to the Iraqi Ministry of Oil and its component oil refineries (“MoO”) and paid kickbacks equaling 10% of the contract value on three of the contracts and offered kickbacks on the remaining two contracts.  Innospec increased its agent’s commission as a means to funnel the payments to Iraq.  Innospec artificially inflated its prices in the Program contracts and did not notify the UN of the kickback scheme.  When the Program ended shortly before Innospec paid the promised kickbacks on two of the contracts, Innospec kept the promised payments as part of its profit.

After the Program was terminated in late 2003, Innospec continued to use its agent in Iraq to pay bribes to Iraqi officials to secure additional TEL sales.  From at least 2004 through 2007, Innospec made payments totaling approximately $1,610,327 and promised an additional $884,480 to MoO officials so as to garner good will with Iraqi authorities, obtain additional orders under a Long Term Purchase Agreement that was executed in October 2004 (the “2004 LTPA”) and ensure the execution of a second LTPA in January 2008 (the “2008 LTPA”).  Innospec also paid lavish travel and entertainment expenses for MoO officials, including paying for a seven day honeymoon, supplying mobile phone cards and cameras, and paying thousands in cash for “pocket money” to officials.  Innospec also paid bribes to ensure the failure of a 2006 field test of MMT, a fuel product manufactured by a competitor of Innospec.  Finally, Innospec promised additional bribes of approximately $850,000 in connection with the 2008 LTPA, which was thwarted due to the U.S. governments’ investigation of the Iraq bribery.

Innospec also had several schemes to pay bribes to Indonesian government officials from at least 2000 through 2005 to win contracts with state owned oil and gas companies. 

Without admitting or denying the Commission’s allegations, Innospec has consented to the entry of a court order permanently enjoining it from future violations of Sections 30A, 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act; ordering it to pay $60,071,613 in disgorgement, provided that the Commission waive all but $11,200,000 of disgorgement and permitting payment in four installments based upon Innospec’s sworn Statement of Financial Condition; and ordering it to comply with certain undertakings regarding its FCPA compliance program, including an independent monitor for a period of three years.  Based on its financial condition, Innospec offered to pay a reduced criminal fine of $14.1 million to the DOJ and a criminal fine of $12.7 million to the SFO.  Innospec will pay $2.2 million to OFAC for unrelated conduct concerning allegations of violations of the Cuban Assets Control Regulations.

SEC Warns Firms on Muni Pay-to-Play Rules

The SEC today issued a report warning firms that municipal securities rules prohibiting pay-to-play apply to affiliated financial professionals, not just a firm's employees.  The pay-to-play rule, MSRB Rule G-37, generally prohibits firms from underwriting municipal bonds for an issuer for two years after a municipal finance professional (MFP) involved with that firm makes a campaign contribution to an elected official of that municipality.

In the Report of Investigation, the Commission makes clear that an executive who supervises the activities of a broker, dealer, or municipal securities dealer is not exempt from the MSRB's pay-to-play rule just because he or she may be outside the firm's corporate governance structure. As such, an executive may be deemed an MFP if he or she is not part of a broker-dealer, but oversees the broker-dealer from the vantage of the holding company.

When the Commission approved the rule in 1994, it indicated that banks and bank holding companies affiliated with brokers, dealers and municipal securities dealers were excluded from the rule. Since then, the Commission has not directly addressed whether directors, officers or employees of such banks and bank holding companies are MFPs if they supervise the public finance activities of brokers, dealers and municipal securities dealers or serve on executive committees that engage in such supervision.

The Commission's Report of Investigation stems from an Enforcement Division inquiry into whether JP Morgan Securities Inc. (JPMSI) violated the MSRB Rule. According to the Report, JPMSI underwrote municipal bonds issued by the state of California within two years after a then-Vice Chairman of JPMSI's parent bank holding company (JP Morgan Chase) gave a $1,000 contribution to a California elected official.

Under Section 21(a) of the Securities Exchange Act, the Commission may investigate violations of the federal securities laws and at its discretion "publish information concerning any such violations." JPMSI consented to the issuance of the Report without admitting or denying any of the statements or conclusions.

Provident Asset Management Expelled from FINRA for Marketing Fraudulent Private Placements

FINRA announced today that it has expelled Provident Asset Management, LLC, a Dallas-based broker-dealer, for marketing a series of fraudulent private placements offered by its affiliate, Provident Royalties, LLC, in a massive Ponzi scheme.  Provident Asset Management misrepresented to investors that the funds raised through the offerings would be used to purchase interests in the oil and gas business, including exploration activity and the acquisition of real estate, oil and gas leases and mineral rights. In fact, investors' funds were commingled and used by an affiliated issuer to make dividend and principal payments to other investors. In addition, the firm acted as the agent in an oil and gas private placement offering but failed to establish an escrow account for investors' funds during the contingency period of the offering.

The action announced today is the first produced by a FINRA initiative involving active examinations and investigations of broker-dealers involved in retail sales of private placement interests, as well as broker-dealers affiliated with private placement issuers. FINRA is looking at firms' compliance with suitability, supervision and advertising rules, as well as potential instances of fraud. The initiative was undertaken in response to an increase in investor complaints involving private placements and Securities and Exchange Commission actions halting sales of certain private placement offerings.

 FINRA found that from September 2006 through January 2009, Provident Asset Management marketed and sold preferred stock and limited partnership interests in a series of 23 private placements offered by Provident Royalties, LLC. Provident Asset Management's only business line was acting as the wholesaling broker-dealer for the Provident Royalties' offerings, which were sold to customers through more than 50 retail broker-dealers nationwide, raising over $480 million through approximately 7,700 individual investments made by thousands of investors.

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

Judge Rejects to Tear Down Firewall between Analysts and Investment Bankers

As the Wall St. Journal reported this morning, Judge Pauley, who is responsible for overseeing the 2003 Analysts' Settlement between major securities firms and the SEC that separated the investment banking from the research departments, rejected a modification that would have permitted:

Research personnel and Investment Banking personnel to communicater with each other, outside the presence of internal legal or compliance staff, regarding market or industry trends, conditions or developments, provided that such communications are consistent in nature with the types of communications that an analyst might have with investing customers.

The Judge said(Download Order1) such a proposed amendment (approved by the SEC) is "counterintuitive and would undermine the separation between research and investment banking."  The court did permit the other modifications proposed by the parties which the firms stated were appropriate to eliminate in light of existing SRO rules.

In its request(Download Requesttomodify2003Settlement) the firms state that they "strongly believe" that  all operative provisions of the settlement should be abrogated, and that the firms and the SEC agree that the remaining provisions will be reconsidered at the earlier of the Court's approval of these modifications or the effective date of new equity research analyst rules currently being considered by FINRA, with the expectation that if such rules address the remaining provisions, the SEC will agree to a further amendment or modification, unless the SEC believes the modification would not be in the public interest.

Schapiro Testifies and Says Lehman Oversight was Inadequate

SEC Chair Shapiro testified today before the House Appropriations Committee on what the agency would do with the $1.26 billion appropriated to it in next year's budget and also reported on her efforts to reinvigorate the agency.  In response to questioning, she conceded that the agency may have fallen short in its oversight of Lehman after the collapse of Bear Stearns and was not aware of its use of "Repo 105" that allowed the firm to conceal its failing financial condition.  (Do you think?)  WSJ, SEC Chairman Says Lehman Oversight Fell Short.

SEC Obtains Freeze on Russian Defendants' Assets in Online Intrusion Scheme

On Monday, March 15, 2010, the SEC obtained a freeze on the assets of Russian defendants allegedly responsible for a hi-tech market manipulation scheme. According to the SEC, BroCo Investments, Inc. and its president Valery Maltsev hijacked the online brokerage accounts of unwitting investors using stolen usernames and passwords and subsequently placed unauthorized trades through the compromised accounts to manipulate the markets of at least thirty-eight issuers between August 2009 and December 2009. In almost every instance, prior to intruding into these accounts, the Defendants acquired positions in their own account. Then, just minutes later, without the accountholders' knowledge, the Defendants, and/or individuals acting in concert with them, placed scores of unauthorized buy orders at above-market prices using the compromised accounts. After these unauthorized buy orders were placed, the Defendants sold the positions held in their own account at the artificially inflated prices. In other instances, the Defendants profited by covering short positions previously established in their account while placing unauthorized sell orders through the compromised accounts at substantially lower prices. This illicit account activity artificially affected the share price and trading volume for each of the thinly-traded issuers and enabled the Defendants to sell their holdings at a substantial profit, realizing at least $255,532 in ill-gotten gains.