Securities Law Prof Blog

Exchanges & FINRA Propose Expanding Circuit Breakers to Stocks in Russell 100 and ETFs

The SEC will publish for public comment proposals by the national securities exchanges and FINRA to expand a recently adopted circuit breaker program to include all stocks in the Russell 1000 Index and certain exchange-traded funds. A list of the securities included in the Russell 1000 Index is available on the Russell website. The exchange-traded funds included in the proposal will be available on the SEC's website along with the proposed rule changes under Exhibit 3 to each filing.

SEC Adopts New Pay to Play" Restrictions for Investment Advisers

The SEC today voted to approve new rules to significantly curtail "pay to play" practices by investment advisers.  Pay to play is the practice of making campaign contributions and related payments to elected officials in order to influence the awarding of lucrative contracts for the management of public pension plan assets and similar government investment accounts. The rule adopted by the SEC today includes prohibitions intended to capture not only direct political contributions by investment advisers, but also other ways that advisers may engage in pay to play arrangements.

The new SEC rule has three key elements:

• It prohibits an investment adviser from providing advisory services for compensation — either directly or through a pooled investment vehicle — for two years, if the adviser or certain of its executives or employees make a political contribution to an elected official who is in a position to influence the selection of the adviser.

• It prohibits an advisory firm and certain executives and employees from soliciting or coordinating campaign contributions from others — a practice referred to as "bundling" — for an elected official who is in a position to influence the selection of the adviser. It also prohibits solicitation and coordination of payments to political parties in the state or locality where the adviser is seeking business.

• It prohibits an adviser from paying a third party, such as a solicitor or placement agent, to solicit a government client on behalf of the investment adviser, unless that third party is an SEC-registered investment adviser or broker-dealer subject to similar pay to play restrictions.

The new rule becomes effective 60 days after its publication in the Federal Register.

No Financial Reform Before July 4

Harry Reid says the Senate won't vote on the bill until after the week-long July 4 recess.  Stay tuned for further changes.WSJ, Senate Delay on Financial Bill Gives Critics an Opening

SEC Settles Wrongful Termination Claim with Former Enforcement Attorney

The SEC and Gary Aguirre, a former attorney in the Enforcement Division, settled wrongful termination charges, with the SEC agreeing to pay $755,000.  Aguirre alleged that he was fired because he sought to interview John Mack (soon-to-be named CEO at Morgan Stanley) in connection with an insider trading investigation involving the hedge fund Pequot Capital Management.  WSJ, SEC Settles Firing Claim For $755,000

Democrats Looking for 60 Votes for Financial Reform

Senator Scott Brown has withdrawn his support for the financial reform legislaion because of its new tax on banks.  Democratic leaders are meeting to figure out some other way to pay for the legislation -- perhaps through TARP funds.  Washington Post, Democrats regroup over financial reform after Sen. Brown pulls support

SEC Considers "Pay to Play" Practices Tomorrow

SEC's Open Meeting Agenda for June 30, 2010
.

Item 1: Political Contributions by Certain Investment Advisers
Office:  Division of Investment Management

The Commission will consider whether to adopt a new rule and related rule amendments under the Investment Advisers Act of 1940 to address "pay to play" practices by investment advisers. The new rule is designed to prohibit advisers from seeking to influence the award of advisory contracts by public entities by making or soliciting political contributions to or for those officials who are in a position to influence the awards.

SEC Charges California Investment Adviser with Fraud and Fiduciary Duty for Unsuitable Recommendations

On June 28, 2010, the SEC filed a civil action in the United States District Court for the Central District of California charging Life Wealth Management, Inc. and its owner Jeffery S. Preston with fraud and breach of fiduciary duty for placing clients in unsuitable investments and misrepresenting and failing to disclose the risks of these investments.  The SEC alleges that Life Wealth and Preston invested $6.9 million of client funds in unsecured promissory notes issued by Atherton-Newport Investments, LLC, a real estate company that buys and renovates distressed properties and is headquartered in Irvine, Calif. Beginning in or about October 2005, Preston recommended the notes to Life Wealth clients even though the notes were not suitable to the clients' risk tolerances. Preston also characterized the notes as a "solid" and "strong" investment without disclosing the risks inherent in an unsecured loan. Atherton-Newport defaulted on all of the outstanding notes in September 2007, which amounted to almost total losses for Life Wealth clients.

The SEC is seeking permanent injunctions barring future violations of the federal securities laws, disgorgement of the defendants' ill-gotten gains with prejudgment interest, and monetary penalties.

SEC Charges Canadian Couple with Touting Penny Stocks Through Social Networking Sites

The SEC announced today that it obtained an emergency asset freeze against a Canadian couple who fraudulently touted penny stocks through their website, Facebook and Twitter. The SEC alleges that since at least April 2009, Carol McKeown and Daniel F. Ryan, a couple residing in Montreal, Canada, have touted U.S. microcap companies. According to the SEC's complaint, McKeown and Ryan received millions of shares of touted companies through their two corporations, defendants Downshire Capital Inc., and Meadow Vista Financial Corp., as compensation for their touting. McKeown and Ryan sold the shares on the open market while PennyStockChaser simultaneously predicted massive price increases for the issuers, a practice known as "scalping."

The SEC's complaint, filed in the U.S. District Court for the Southern District of Florida, also alleges McKeown, Ryan and one of their corporations failed to disclose the full amount of the compensation they received for touting stocks on PennyStockChaser. The SEC alleges that McKeown, Ryan and their corporations have realized at least $2.4 million in sales proceeds from their scalping scheme.

 

SEC Settles FCPA Charges Against Telecommunications Company Doing Business in China

The SEC filed a settled federal court action against San Jose, California-based telecommunications company Veraz Networks, Inc., alleging that Veraz violated the books and records and internal controls provisions of the FCPA. The alleged violations stemmed from improper payments made by Veraz to foreign officials in China and Vietnam after the company went public in 2007.

The SEC alleges that Veraz engaged a consultant in China who in 2007 and 2008 gave gifts and offered improper payment together valued at approximately $40,000 to officials at a government controlled telecommunications company in China in an attempt to win business for Veraz. A Veraz supervisor who approved the gifts described them in an internal Veraz email as the "gift scheme." Similarly in 2007 and 2008, the SEC alleges that a Veraz employee made improper payments to the CEO of a government controlled telecommunications company in Vietnam to win business for Veraz.

Veraz, without admitting or denying the allegations in the Commission's complaint, consented to the entry of a final judgment permanently enjoining Veraz from future violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and ordering Veraz to pay a penalty of $300,000.

FINRA Bars Former Deutsche Bank Broker for Stock Manipulation

A FINRA hearing panel has permanently barred a former Deutsche Bank broker from the securities industry for manipulating the price of Monogram Biosciences (MGRM) stock in an effort to enrich a hedge fund client, himself and his family.  The panel found that Edward S. Brokaw, who worked in the Greenwich, CT branch office of Deutsche Bank Securities, engaged in a pattern of trading designed deliberately to drive the value of MGRM stock down and, in turn, drive up the value of contingent value rights (CVRs) on that stock. Included in the evidence against Brokaw were tape recordings of his phone calls to his firm's trading desk to place sell orders.

The MGRM CVRs were created and issued in December 2004, in connection with the merger of two firms to form MGRM. The CVRs were to be valued during a 15-day pricing period scheduled for 18 months after the merger – beginning on May 19, 2006, and ending on June 9, 2006.  The value of the CVRs was to be determined by the volume weighted average price (VWAP) of MGRM shares trading during that 15-day period. At the end of the pricing period, CVR holders were to receive a payment from MGRM, most or all of which would be in cash. If the final VWAP was at or above $2.90, the CVRs would be worthless. But if the final VWAP was below $2.90, CVR holders would receive a penny-for-penny payment for the amount below $2.90, down to $2.02. The maximum of $.88 per CVR would be paid if the final MGRM VWAP was at or below $2.02.

Brokaw's hedge fund client held approximately 18.5 million CVRs – nearly 30 percent of the 64.8 million MGRM CVRs outstanding. For every penny the final VWAP dropped below $2.90, the value of the hedge fund's CVRs increased by $185,000. If the maximum payout of $.88 per CVR were achieved, the hedge fund would receive approximately $16 million. Brokaw and his family owned 217,000 of the CVRs, with a potential maximum payout of $188,000.

The hearing panel decision notes that the hedge fund owned 3 million shares of MGRM and told Brokaw that it wanted to sell off all of those shares during the pricing period. Prior to market open on the first day of the pricing period, the hedge fund placed an order with Brokaw to sell 50,000 MGRM shares close to the open and another 50,000 shares close to the close. In a tape-recorded phone call that morning, Brokaw told a Deutsche Bank sales trader, "Take 50,000 MGRM at the market. Sell it down. Sell it as low as you want. Sell it hard, 50,000." According to the panel decision, the sales lasted little more than a minute – and MGRM shares dropped from $2.06 to $1.94.

The panel decision quotes another phone call from Brokaw to the sales trader that afternoon, in which he explained the pricing of the CVRs and the strategy behind the hedge fund's instructions to sell close to the market's open and close, saying, "Just so you know what the target price is … So yeah, understand the game that's being played for the next 15 days."  The hedge fund's orders and Brokaw's aggressive placement of those sell orders continued for three trading days. But when Deutsche Bank's compliance personnel reviewed those orders, the firm decided it would no longer execute MGRM sales for the hedge fund's account. Deutsche Bank first suspended, then terminated Brokaw based on his MGRM sales orders for the hedge fund.

The hearing panel concluded that "the objective of the selling strategy was to drive down the price of MGRM shares rather than to obtain the best price … (Brokaw) placed the orders to artificially depress the price of MGRM to impact the pricing of the CVRs." The panel noted that for every penny MGRM stock dropped, the hedge fund lost $29,000 in value on its shares but gained more than $180,000 in value on its CVRs.  The panel also found that Brokaw violated Deutsche Bank's policy requiring the individual accepting a client order to create an order ticket "immediately upon receipt of an order." Instead, Brokaw's sales assistant completed one "booking ticket" each day, each showing a single 100,000-share order to sell, each with a false notation that the order was given by the client directly to the trading desk rather than to Brokaw – thus circumventing automatic branch office compliance review of the orders.

Supreme Court Grants Certiorari in Securities Fraud Class Action Involving Market-Timing Statements in Fund Prospectuses

The Supreme Court accepted certiorari in a securities fraud class action based on alleged misstatements in mutual fund prospectuses that market-timing was not permitted.  In Janus Capital Group v. First Derivative Traders, 566 F.3d 111 (4th Cir. 2007), First Derivative appealed the dismissal of its putative class action complaint, which it filed, individually and on behalf of certain shareholders of Janus Capital Group Inc. (JCG), against JCG and Janus Capital Management LLC (JCM), the investment advisor to the Janus mutual funds. The complaint alleged that JCG and JCM were responsible for certain misleading statements appearing in prospectuses for a number of the individual Janus funds during the class period. These statements represented that the funds' managers did not permit, and took active measures to prevent, “market timing” of the funds. First Derivative alleged that class members (plaintiffs) bought JCG shares at inflated prices and thereafter lost money when market timing practices authorized by JCG and JCM became known to the public.  The district court had concluded that plaintiffs had failed to sufficiently plead certain elements of a § 10(b) securities fraud action against either JCG or JCM and also dismissed plaintiffs' claim of control person liability against JCG under § 20(a).  The Fourth Circuit, however, held that plaintiffs' § 10(b) primary liability claim against JCM and plaintiffs' § 20(a) control person liability claim against JCG were sufficiently pled to overcome defendants' motion to dismiss. It reversed the district court's order granting defendants' motion to dismiss and remanded the case for further proceedings. 

The Fourth Circuit stated that:

Here, the allegedly misleading statements about market timing appearing in the Janus funds prospectuses are unquestionably public. The real question is whether these statements were sufficiently attributable to JCG and JCM. While the prospectuses did not explicitly name JCG and JCM as the drafters, plaintiffs nevertheless allege in their complaint that JCG and JCM may be held responsible for the statements in the prospectuses because “as a practical matter [JCM] runs” the Janus funds, defendants disseminated the prospectuses on a joint Janus website and, consequently, the public would attribute the misstatements in the prospectuses to defendants.

* * *

The courts of appeal have diverged over the degree of attribution required to plead reliance.

* * *
Consequently, for the public attribution element of the reliance inquiry, we hold that a plaintiff seeking to rely on the fraud-on-the-market presumption must ultimately prove that interested investors (and therefore the market at large) would attribute the allegedly misleading statement to the defendant. ...At the complaint stage a plaintiff can plead fraud-on-the-market reliance by alleging facts from which a court could plausibly infer that interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributed to the defendant. ...

Direct attribution of a public statement, while undoubtedly sufficient to establish fraud-on-the-market reliance, is an inexact proxy for determining whether investors will attribute a publicly available statement to a particular person or entity. We conclude that the attribution determination is properly made on a case-by-case basis by considering whether interested investors would attribute to the defendant a substantial role in preparing or approving the allegedly misleading statement....

We conclude, at the Rule 12(b)(6) stage, that given the publicly disclosed responsibilities of JCM, interested investors would infer that JCM played a role in preparing or approving the content of the Janus fund prospectuses, particularly the content pertaining to the funds' policies affecting the purchase or sale of shares. It was publicly known that JCM furnished advice and recommendations concerning the Janus funds' investment decisions and even made NAV determinations, which in part enabled market timing. In light of the publicly available material, interested investors would have inferred that if JCM had not itself written the policies in the Janus fund prospectuses regarding market timing, it must at least have approved these statements. This circumstance is sufficient to support the adequacy of plaintiff's pleading of fraud-on-the-market reliance as to JCM...

* * *

The Question Presented in the petition for certiorari is as follows:

There is no aiding-and-abetting liability in private actions brought under Section 10
(b) of the Securities Exchange Act of 1934. Central Bank of Denver, N.A. v. First
Interstate Bank of Denver, N.A., 511 U.S. 164 (1994). Thus, a service provider who
provides assistance to a company that makes a public misstatement cannot be held
liable in a private securities-fraud action. Stoneridge Inv. Partners, LLC v. Scientific-
Atlanta, Inc., 128 S. Ct. 761 (2008). In the decision below, however, the Fourth
Circuit held that an investment adviser who allegedly "helped draft the misleading
prospectuses" of a different company, ''by participating in the writing and
dissemination of [those] prospectuses," can be held liable in a private action "even if
the statement on its face is not directly attributed to the [adviser]." App., infra, 17a-
18a, 24a (emphases added). The questions presented are:

1. Whether the Fourth Circuit erred in concluding-in direct conflict with decisions of
the Fifth, Sixth, and Eighth Circuits-that a service provider can be held primarily
liable in a private securities fraud action for "help[ing]" or "participating in" another
company's misstatements.

2. Whether the Fourth Circuit erred in concluding-in direct conflict with decisions of
the Second, Tenth, and Eleventh Circuits-that a service provider can be held
primarily liable in a private securities-fraud action for statements that were not
directly and contemporaneously attributed to the service provider.

Supreme Court Remands Scrushy's Conviction in Light of Skilling

The Supreme Court vacated the conviction of Richard Scrushy, former Chairman of HealthSouth Corp., for bribery and conspiracy and remanded to the appellate court for further consideration in light of its Skilling opinion that narrowed the scope of the honest services fraud statute.  Scrushy, along with former Alabama Governor Don Siegelman, was convicted in 2006 based on allegations that Scrushy gave $500,000 in contributions to a state lottery campaign in exchange for a seat on the state health-care board.  It is not clear, however, that the remand will result in any change in the disposition, since, unlikely Skilling's case, the convictions here were based on bribery and kickbacks, which the Supreme Court held to be the core criminal conduct under the statute.

SEC Asks Few Questions About Russian IPOs

Interesting reading in the Wall St. Journal:  it reports that in the past two years the SEC's Corporation Finance Division has cleared registration statements for IPOs by nine start-up shell corporations from Russia or Ukraine, in most cases without asking a single question.  WSJ, The SEC's Russian Roulette

Financial Reform: So Near and Yet So Far?

See Washington Post, Byrd's absence could be problematic for financial regulation bill

Technip Settles FCPA Charges with SEC and DOJ

The SEC announced a settlement with Technip for multiple violations of the Foreign Corrupt Practices Act (FCPA). The SEC alleged that Technip, a global engineering, construction and services company based in Paris, France, was part of a four-company joint venture that bribed Nigerian government officials over a 10-year period in order to win construction contracts in Nigeria worth more than $6 billion. The SEC also charged that Technip engaged in books and records and internal controls violations related to the bribery.

Technip will pay $98 million to settle the SEC’s charges and deprive the company of its ill-gotten gains. The firm will pay an additional $240 million penalty in separate criminal proceedings announced today by the U.S. Department of Justice. Previously, one of Technip’s joint venture partners, KBR, Inc., and its former parent Halliburton Co., settled to similar charges. Together with Technip’s payment, the combined sanctions of $917 million represent the largest combined settlements ever paid to date to the U.S. resulting from an FCPA violation. Technip’s American Depository Shares traded on the New York Stock Exchange from August 2001 to November 2007.

The SEC alleges that between at least 1995 and 2004, senior executives at Technip and other members of TSKJ, a four-company joint venture that includes KBR, Inc., devised and implemented a scheme to bribe Nigerian government officials to obtain multi-billion dollar contracts to build liquefied natural gas (LNG) production facilities. According to the SEC’s complaint, from the inception of the joint venture, Technip and the other joint venture partners paid bribes to assist in obtaining the LNG contracts. The joint venture partners formed a “cultural committee,” comprised of senior sales executives at each company, to consider how to carry out the bribery scheme. To conceal the illicit payments, the joint venture entered into sham contracts with a shell company controlled by a U.K. solicitor and a Japanese trading company as conduits for the bribes. Total payments to the two agents exceeded $180 million.

In the related criminal proceeding announced today, the U.S. Department of Justice filed a criminal action against Technip, charging one count of conspiring to violate the FCPA and one count of violating the anti-bribery provisions of the FCPA. Technip has entered into a deferred prosecution agreement with the DOJ and agreed to pay a criminal penalty of $240 million.

Investment Adviser Public Disclosure Expands to Include information on Investment Adviser Representatives

NASAA today announced the launch of an enhancement to the Investment Adviser Public Disclosure (IAPD) website that will allow investors to electronically access information about individuals who work for money management, financial planning and other investment advisory firms. This enhancement will provide information on investment adviser representatives – the individuals who work for these firms and provide investment advice to clients.  Investors will be able to access information on more than 220,000 individual investment professionals, including background information such as customer complaints, criminal or regulatory disclosures, professional qualifications, and employment history. Previously, IAPD provided instant access only to registration documents filed by registered investment advisory firms.

The information provided on IAPD for both investment advisory firms and individuals comes from documents filed electronically with state securities administrators or the Securities and Exchange Commission. The registration documents provide information about each adviser’s business, advisory services and fees and also disclose any disciplinary problems an adviser or its employees may have had during the last 10 years.

Supreme Court Strikes Down Removal Restrictions on PCAOB Members, Leaves Rest of Sarbox Intact

The Supreme Court handed down its much-anticipated decision in Free Enterprise Fund v. Public Company Accounting Oversight Board (Download PCAOB Opinion) today and held (5-4) that the dual for-cause limitations on the removal of the Board members contravene the Constitution's separation of powers.  However, it also held that the unconstitutional tenure provisions are severable from the remainder of the statute.  The Board's existence does not violate the separation of powers; the fix to the unconstitutional removal restrictions is to make the Board members removable by the SEC at will. In addition, the Court found that the Board's appointment is consistent with the Appointments Clause.

Chief Justice Roberts wrote the majority opinion, joined by Justices Scalia, Kennedy, Thomas and Alito.  Justice Breyer dissented, joined by Stevens, Ginsberg, and Sotomayor.

Some had forecast that because of the lack of a severability clause in Sarbanes Oxley, the Court might strike down the entire statute.  However, the court found nothing in the text or historical context that makes it evident that Congress would have preferred no Board at all to a Board whose members are removable at will. 

FINRA Arbitration Panel Tells Goldman to Pay $20.6 Million to Bayou Group Creditors

A FINRA arbitration panel ordered Goldman Sachs Group to pay $20.6 million (the largest arbitration award against a securities firm) to unsecured creditors of Bayou Group LLC.  The claimants alleged  Goldman, who acted as clearing broker for Bayou, ignored signs of fraud.  The fund's CEO, Samual Israel III, is in prison for fraud.  It is extremely rare to impose liability on a clearing broker for the fraud committed by a broker or an issuer.  As is customary, the arbitration panel did not give reasons.  WSJ, Goldman Told to Pay Bayou Fund Creditors.

SEC Loses Major Insider Trading Case Involving Swaps

After a three-week trial, a judge in S.D.N.Y. dismissed the SEC's insider trading case against Deutsche Bank salesman John-Paul Rorech and Renato Negrin, a manager of the Millenium hedge fund.  The SEC alleged that the defendants shared confidential information about a debt restructuring and then traded swaps, but the judge said the SEC offered no evidence to support its allegations.  This case was the SEC's first to allege insider-trading in connection with swaps.  The court found that the SEC did have jurisdiction over insider trading in swaps.  WSJ, Judge Dismisses Charges in Major 'Swaps' Case.

SEC Settles Mismanagement Charges Against Former Portfolio Manager of ICP Asset Management

On June 25, 2010, the SEC settled charges that Aamer Abdullah, formerly a portfolio manager at the New York-based investment advisory firm, ICP Asset Management, LLC, mismanaged several multi-billion-dollar collateralized debt obligations (CDOs), including knowingly causing CDOs under ICP's management to purchase securities at above-market prices.

Abdullah agreed to be barred from association with any broker, dealer, or investment adviser, without admitting or denying the allegations of the Commission's complaint. Under the terms of the partial judgment, which is subject to the approval of the Court, any monetary relief against Abdullah will be determined at a later date by the Court upon motion by the Commission.