Securities Law Prof Blog

Going Fishing -- Until August 3

Happy dog days of summer!

Feinberg Releases Final Report on Bankers' Bonuses

Kenneth Feinberg, in one of his final acts as the TARP Special Master on Executive Compensation, released a Congressionally-mandated review of 2008-2009 bonuses paid to investment banks and found that many of them were excessive.  He did not, however, determine that payments were contrary to the "public interest" requiring monetary reimbursement.  He also proposed that firms adopt a compensation policy that, in the future, would permit them to restructure bonus payments in certain circumstances.  The Special Master for Tarp Executive Compensation Concludes the Review of Prior Payments.

Sunrise Senior Living Settles Accountin Fraud Charges with SEC

The SEC settled charges against Sunrise Senior Living, Inc., a Virginia-based owner and manager of assisted living facilities whose stock is listed on the New York Stock Exchange, and former Sunrise officers, Larry E. Hulse and Kenneth J. Abod. The Commission's complaint alleged that Sunrise engaged in financial reporting fraud from 2003 through 2005, by making improper adjustments to its reserve for self-insured health and dental benefits and its accrual for corporate bonuses to meet public earnings forecasts. The complaint further alleged that Hulse, Sunrise's Chief Financial Officer during most of the relevant period, oversaw improper adjustments to the health and dental reserve and signed false SEC filings and Sarbanes-Oxley certifications. In addition, the complaint alleges that Hulse and Abod, Sunrise's former Treasurer during most of the relevant period, directed Sunrise employees to make improper adjustments to the bonus accrual account. Hulse and Abod are both certified public accountants.

Without admitting or denying the allegations in the complaint, Sunrise and Hulse each agreed to injunctions against federal securities laws.  Hulse also agreed to pay $164,993, comprised of $50,000 in civil penalties, disgorgement of $83,333, and prejudgment interest of $31,660.  Abod has agreed, without admitting or denying the allegations in the complaint, to pay a civil penalty of $25,000. The proposed settlements in the civil action are subject to Court approval.

The terms of the proposed settlement with Sunrise reflect credit given to Sunrise for its substantial assistance in the investigation.

SEC Pays $1 Million Award to Informants in Pequot Capital Insider Trading Case

The SEC today announced the award of $1 million to Glen Kaiser and Karen Kaiser of Southbury, Connecticut, who provided information and documents leading to the imposition and collection of civil penalties in SEC v. Pequot Capital Management, Inc., et al. This is the largest award paid by the SEC for information provided in connection with an insider trading case.

The SEC staff previously investigated alleged insider trading in Microsoft Corp. securities by hedge fund adviser Pequot Capital Management, Inc., its chief executive, Arthur J. Samberg, and David E. Zilkha, a Microsoft employee who accepted an employment offer at Pequot, but closed its investigation without action. In late 2008, Karen Kaiser, the ex-wife of Zilkha, and her husband, Glen Kaiser, discovered key evidence that ultimately led to the filing of a settled enforcement action against Defendants Pequot and Samberg alleging they engaged in insider trading. Among other documents and information the Kaisers provided the SEC was a key email communication between Zilkha and another Microsoft employee that was not turned over to the SEC in the first investigation. Without admitting or denying the allegations in the SEC's complaint, Pequot and Samberg consented to the entry of injunctions and orders requiring the payment of civil penalties totaling $10 million (as well as the payment of disgorgement and prejudgment interest totaling over $17 million and an investment advisory bar as to Samberg and censure as to Pequot).

The SEC approved the award earlier this week pursuant to Section 21A(e) of the Securities Exchange Act of 1934, which authorized the Commission, in its discretion, to grant an award of up to 10% of the penalties paid in a case to a person who provided information leading to the imposition of those penalties, but only in insider trading cases. That provision has since been repealed by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which added new Section 21F to the Securities Exchange Act, authorizing the Commission to award bounties to parties who provide information leading to recovery of monetary sanctions in a broader range of cases, not limited as before to civil penalties recovered in insider trading cases.

On the same day the Commission filed the settled complaint against Pequot and Samberg in the above matter, it also issued an order instituting administrative and cease-and-desist proceedings against Zilkha in connection with the conduct described above. That matter is pending before an SEC administrative law judge

SEC's Corp Finance Waives Reg AB's Requirement of Ratings Disclosure for 6 Months

The SEC's Division of Corporate Finance issued the following no-action position yesterday:

Items 1103(a)(9) and 1120 of Regulation AB require disclosure of whether an issuance or sale of any class of offered asset-backed securities is conditioned on the assignment of a rating by one or more rating agencies. If so conditioned, those items require disclosure about the minimum credit rating that must be assigned and the identity of each rating agency. Item 1120 also requires a description of any arrangements to have such ratings monitored while the asset-backed securities are outstanding.

Effective today, Section 939G of the Dodd-Frank Act provides that Rule 436(g) shall have no force or effect. As a result, disclosure of a rating in a registration statement requires inclusion of the consent by the rating agency to be named as an expert. We note that the NRSROs have indicated that they are not willing to provide their consent at this time. In order to facilitate a transition for asset-backed issuers, the Division will not recommend enforcement action to the Commission if an asset-backed issuer as defined in Item 1101 of Regulation AB omits the ratings disclosure required by Item 1103(a)(9) and 1120 of Regulation AB from a prospectus that is part of a registration statement relating to an offering of asset-backed securities.

This no-action position will expire with respect to any registered offerings of asset-backed securities commencing with an initial bona fide offer on or after January 24, 2011.

SEC, Dell and Michael Dell Settle Accounting Fraud Charges

The SEC, and Dell Inc.settled charges that Dell failed to disclose material information to investors and used fraudulent accounting to make it falsely appear that the company was consistently meeting Wall Street earnings targets and reducing its operating expenses.  In addition, the SEC charged Dell Chairman and CEO Michael Dell, former CEO Kevin Rollins, and former CFO James Schneider for their roles in the disclosure violations. The SEC charged Schneider, former regional Vice President of Finance Nicholas Dunning, and former Assistant Controller Leslie Jackson for their roles in the improper accounting.

Dell Inc. agreed to pay a $100 million penalty to settle the SEC’s charges. Michael Dell and Rollins each agreed to pay a $4 million penalty, and Schneider agreed to pay $3 million, to settle the SEC’s charges against them. Dunning and Jackson also agreed to settle the SEC’s charges.

The SEC alleges that Dell did not disclose to investors large exclusivity payments the company received from Intel Corporation to not use central processing units (CPUs) manufactured by Intel’s main rival. It was these payments rather than the company’s management and operations that allowed Dell to meet its earnings targets. After Intel cut these payments, Dell again misled investors by not disclosing the true reason behind the company’s decreased profitability.

The SEC’s complaint, filed in federal district court in Washington, D.C., alleges that Dell Inc., Michael Dell, Rollins, and Schneider misrepresented the basis for the company’s ability to consistently meet or exceed consensus analyst EPS estimates from fiscal year 2002 through fiscal year 2006. Without the Intel payments, Dell would have missed the EPS consensus in every quarter during this period. The SEC’s complaint further alleges that Dell’s most senior former accounting personnel including Schneider, Dunning, and Jackson engaged in improper accounting by maintaining a series of “cookie jar” reserves that it used to cover shortfalls in operating results from FY 2002 to FY 2005. Dell’s fraudulent accounting made it appear that it was consistently meeting Wall Street earnings targets and reducing its operating expenses through the company’s management and operations.

Without admitting or denying the SEC’s allegations, Dell Inc. consented to the entry of an order that permanently restrains and enjoins it from violation of Section 17(a) of the Securities Act of 1933 and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1, and 13a-13. Dell Inc. also agreed to enhance its Disclosure Review Committee and disclosure processes, including the retention of an independent consultant to recommend improvements to those processes and enhance training regarding the disclosure requirements of the federal securities laws.

Michael Dell and Rollins settled the SEC’s disclosure charges, without admitting or denying the SEC’s allegations, by each agreeing to pay the $4 million penalties and consenting to the entry of an order that permanently restrains and enjoins each of them from violating Sections 17(a)(2) and (3) of the Securities Act and from violating or aiding and abetting violations of other provisions of the federal securities laws.

Schneider consented to settle the disclosure and accounting fraud charges against him without admitting or denying the SEC’s allegations, and agreed to pay the $3 million penalty, disgorgement of $83,096, and prejudgment interest of $38,640. Dunning and Jackson consented to settle the SEC’s improper accounting charges without admitting or denying the SEC’s allegations. Dunning agreed to pay a penalty of $50,000. In their settlement offers, Schneider, Dunning and Jackson consented to the issuance of administrative orders pursuant to Rule 102(e) of the Commission’s Rules of Practice, suspending each of them from appearing or practicing before the SEC as an accountant with the right to apply for reinstatement after five years for Schneider and three years for Dunning and Jackson.

FINRA Fines Sun Trust for Unsuitable UIT, CEF and Mutual Fund Transactions

FINRA has ordered SunTrust Investment Services, Inc. of Atlanta, GA, to pay $1.44 million to resolve charges related to unsuitable unit investment trust (UIT), closed-end fund (CEF) and mutual fund transactions. Of that amount, $900,000 is a fine that includes nearly $224,000 in disgorgement of commissions earned on the unsuitable trades. The remaining $540,000 represents restitution to 17 customers who incurred losses.  As part of this settlement, SunTrust must also review all UIT purchases and provide remediation to all eligible customers who did not receive the maximum sales charge discount. 

FINRA found that SunTrust, through two brokers in the firm's Maryland Region, engaged in a pattern of unsuitable short-term UIT, CEF and mutual fund transactions in accounts of 17 customers, most of whom were elderly and/or disabled. The brokers also engaged in unsuitable margin transactions in the accounts of 10 of the 17 customers. In addition, FINRA found that SunTrust failed to ensure that eligible customers received the maximum sales charge discount on UIT purchases and lacked adequate systems and procedures for monitoring and supervising UIT, CEF and margin transactions.

FINRA previously sanctioned one of the individual brokers involved in this matter, David Bredenburg of Timonium, MD, permanently barring him from working in the securities industry. FINRA has filed a complaint against the second broker, charging him with numerous violations, including unsuitable recommendations, sales and use of margin; failure to provide maximum sales charge discounts on UIT transactions; and engaging in discretionary trading in customer accounts without written authorization. FINRA also suspended the two brokers' former supervisor, Donald Mattran of Bel Air, MD, for six months in any principal capacity and fined him $10,000.

 FINRA also found that SunTrust lacked adequate systems and procedures to monitor UIT and CEF transactions and margin accounts, and to ensure that customers purchasing UITs received applicable sales charge discounts.

In concluding these settlements, SunTrust, Bredenburg and Mattran neither admitted nor denied the charges, but consented to the entry of FINRA's findings. FINRA's charges against the second broker alleged to be involved are pending

SEC Staff Report Recommends Improved Regulation of Life Settlements

The SEC released a staff report recommending that life settlements be clearly defined as securities so that the investors in these transactions are protected under the federal securities laws.  A life settlement is a transaction in which an individual with a life insurance policy sells that policy to another person, who then assumes responsibility for paying the premiums. Typically, the seller no longer wants the policy or can no longer afford to pay the premiums. In exchange, the insured party typically receives a lump sum payment that exceeds the policy's cash surrender value, but is less than the expected payout in the event of death.  The D.C. Circuit held, in SEC v. Life Partners, Inc., 87 F.3d 536 (D.C. Cir. 1996), that life settlements were not securities under the federal securities laws principally because the intermediary's efforts were largely completed before the purchase; a number of states, however, have found them securities under state law.

The staff report by the SEC's Life Settlements Task Force notes that the market for life settlements has grown over the past decade, raising questions about its regulation and oversight.  In particular, the report notes that there is inconsistent regulation of participants in the life settlements market, including those who arrange for the buying and selling of policies and those who provide estimates of an insured's life expectancy. In addition, the report notes that investors in individual life settlement transactions, or pools of life settlements, would benefit from the application of baseline standards of conduct to market participants.

In the report, the staff outlines the Task Force's findings about the life settlements market and recommends ways to improve market practices and regulatory oversight. It recommends that the Commission should:

• Consider recommending to Congress that it amend the definition of security under the federal securities laws to include life settlements as securities.
• Instruct the staff to continue to monitor that legal standards of conduct are being met by brokers and providers.
• Instruct the staff to monitor for the development of a life settlement securitization market.
• Encourage Congress and state legislators to consider more significant and consistent regulation of life expectancy underwriters.

Ohio and New York Pension Plans Sue BP

Ohio and New York public pension plans have filed a complaint in federal court (W.D. La.) against BP PLC, alleging material misstatements in connection with its safety record.  The plans hope to be lead plaintiffs in a securities fraud class action.  WSJ, Pension Funds Hope to Lead BP Suit

SEC Proposes New Regulation of Mutual Fund Distribution Fees

Will the SEC finally take action to get rid of 12b-1 fees?  The SEC today voted unanimously to propose measures aimed to improve the regulation of mutual fund distribution fees and provide better disclosure for investors.  The marketing and selling costs involved with running a mutual fund are commonly referred to as a fund's distribution costs. To cover these costs, the companies that run mutual funds are permitted to charge fees known as 12b-1 fees. These fees are deducted from a mutual fund to compensate securities professionals for sales efforts and services provided to the fund's investors.

12b-1 fees were developed in the late 1970s when funds were losing investor assets faster than they were attracting new assets, and self-distributed funds were emerging in search of ways to pay for necessary marketing expenses. These fees amounted to an aggregate of just a few million dollars in 1980 when they were first permitted, but that total has ballooned as the use of 12b-1 fees has evolved. These fees amounted to $9.5 billion in 2009.

The SEC's proposal would:

• Protect investors by limiting fund sales charges.
• Improve transparency of fees for investors.
• Encourage retail price competition.
• Revise fund director oversight duties.

There will be a 90-day public comment period after the SEC's proposal is published in the Federal Register.  Stay tuned ....

SEC Adopts Improved Disclosure about Investment Advisers

The SEC today voted unanimously to adopt changes to the principal disclosure document that SEC-registered investment advisers must provide to their clients and prospective clients.  Form ADV, Part 2 — commonly referred to as the “brochure” — explains to the investor an investment adviser’s qualifications, investment strategies, and business practices.  The brochure in its current format requires advisers to respond to a series of multiple-choice and fill-in-the-blank questions organized in a “check-the-box” format that frequently does not correspond well to an adviser’s business.

The amendments adopted by the SEC will:

• Improve the format and update the requirements of the brochure.
• Expand the content to better include details most relevant to the clients of investment advisers.
• Require brochure “supplements” to be delivered to new and prospective clients to give resume-like information about the individuals at an investment advisory firm who will provide services to the clients.

• Ensure investors have easy access to the brochures as investment advisers are required to file them electronically for posting on the SEC’s website.

Many state-registered investment advisers also currently file Form ADV with their regulators. The Commission authorized the staff to delay publication of the revised Form ADV, Part 2 for five business days in order to work with the states to accommodate technical, state-specific changes to the items and instructions of the form. This process would enable publication of Form ADV, Part 2 as a uniform SEC-state form.

The amended rules and forms will be effective 60 days after publication in the Federal Register. Most investment advisers will begin distributing and publicly posting new brochures in the first quarter of 2011.

FINRA Fines Deutsche Bank Securities $7.5 Million for Negligent Misrepresentations about Subprime Securities

FINRA fined Deutsche Bank Securities Inc. $7.5 million for negligently misrepresenting delinquency data in connection with the issuance of subprime securities.  FINRA found that Deutsche Bank Securities negligently misrepresented and underreported the percentages of mortgages that were delinquent in the prospectus supplements of six subprime residential mortgage backed securities (MBS) issued in 2006. The firm also failed to correct errors by a third party vendor and servicers, which underreported the historical delinquency rates of the mortgages in connection with its offer and sale of 16 additional subprime MBS issued in 2007. Further, Deutsche Bank Securities failed to establish a system to supervise its reporting of required historical delinquency information.

 During 2006 and 2007, Deutsche Bank Securities underwrote subprime MBS and sold them to institutional investors. FINRA found that in the prospectus supplements of six subprime securitizations worth approximately $2.2 billion offered in March 2006, the firm described a method of calculating delinquencies that was in fact different from the method it actually used. As a result, delinquencies were underreported. For example, in one MBS deal, Deutsche Bank Securities reported that under its described method of calculation, 8.75 percent of the loans were between 30 - 59 days delinquent, corresponding to $14 million in delinquent loans. But the actual delinquency numbers computed under the method Deutsche Bank Securities disclosed were significantly higher, with 24.02 percent of the loans between 30 – 59 days delinquent, corresponding to $38.5 million in delinquent loans.

FINRA also found that Deutsche Bank Securities negligently underreported historical delinquency rates on a website the firm maintained that was referenced in prospectus materials in connection with the sale of 16 MBS.  In January 2007, Deutsche Bank Securities learned that the outside vendor it retained to populate its Regulation AB website was underreporting delinquencies as a result of errors made by the servicers responsible for tracking delinquencies. Deutsche Bank Securities was able to determine that these errors affected 16 securitizations and was able to provide corrected delinquency data for 13 of them to the vendor to use going forward. But the vendor failed to use the corrected data. The firm never ensured that the vendor posted the corrected static pool information and continued to refer investors to the inaccurate information about these 13 securitizations on the Regulation AB website. While Deutsche Bank Securities was not able to determine the extent to which delinquency rates were underreported in the remaining three affected securitizations, the firm continued to use this data without indicating on its Regulation AB website that the information was inaccurate.

In settling this matter, Deutsche Bank Securities neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

Madoff Trustee Sues Fairfield Greenwich Affiliates

The court-appointed Trustee for Bernard Madoff, charged with the responsibility of recovering assets for his creditors, sued more than two dozen affiliates of Fairfield Greenwich Group and its founding partners, alleging that they had "actual and constructive knowledge" of the fraud and "generally looked the other way."  The Trustee seeks more than $3.6 billion in damages.  Fairfield denied the allegations, said it was negotiating in good faith with the Trustee, and found the complaint "incomprehensible."  WSJ, Madoff Trustee Sues 25 Fairfield Greenwich Affiliates

President Signs Dodd-Frank

President Obama signed the Dodd-Frank financial reform legislation today.  For media coverage see

NYTimes, Obama Signs Legislation Overhauling Financial Rules

WPost, Obama signs sweeping financial overhaul into law

WSJ, Obama Signs Financial-Regulation Bill

Schapiro Testifies on SEC's Present Reforms and Future Challenges

SEC Chair Schapiro, in Testimony Concerning Oversight of the U.S. Securities and Exchange Commission: Evaluating Present Reforms and Future Challenges before the United States House of Representatives Committee on Financial Services Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises on July 20, 2010, sets forth a list of accomplishments for the SEC and outlines initiatives taken to improve the agency and regulation.  Given the numerous studies and rulemaking initiatives that the Dodd-Frank Act requires of the SEC, it is hard to see how it will have time to accomplish much else.  As to the impact of Dodd-Frank, Schapiro stated:

Implementation Challenges of Regulatory Reform Legislation

The coming period likely will be dominated by implementing the Dodd-Frank regulatory reform legislation. Dodd-Frank in my view closes a number of regulatory gaps, gives the SEC important tools to better protect investors (including, for example, nationwide service of process in civil actions, a clarification on the scienter standard for Exchange Act aiding and abetting actions, and authority to order penalties in cease-and-desist proceedings), and adds or expands several areas of responsibility, including over-the-counter derivatives, credit rating agencies and private funds.

The Act requires the SEC to promulgate a large number of new rules, create five new offices, and conduct multiple studies, many within one year. The importance and complexity of the rules coupled both with their timing and high volume and the rulewriting agenda currently pending will make the upcoming rulewriting process both logistically challenging and extremely labor intensive.

The Act also requires the Commission to hire an independent consultant to examine SEC internal operations, structure, funding, and the need for comprehensive reform. Agency staff already have begun the initial work necessary to move forward with a formal procurement on the study, and to free up the funds needed to pay for the study we also have submitted a formal reprogramming request to the House and Senate Appropriations Committees for consideration.

In addition, the Act also contains a provision granting the SEC broad authority to reward whistleblowers. SEC staff has begun meeting internally to discuss the rules required by the legislation. The goal will be to establish a robust whistleblower program that incentivizes persons to come forward with information we would not otherwise receive and enhances the effectiveness of our enforcement efforts.

SEC Approves FINRA Rule Allowing Witnesses to have Legal Representation

The SEC approved FINRA's proposed rule change to amend Rule 12602 of the Code of Arbitration Procedure for Customer Disputes  and Rule 13602 of the Code of Arbitration Procedure for Industry Disputes to provide that a non-party witness may be represented by an attorney at an arbitration hearing while the witness is testifying. FINRA explains that it had not perceived that arbitrators were denying witnesses the right, but thought it was appropriate to have a rule explicitly giving witnesses the right

FINRA Files Revised Discovery Guide with SEC

FINRA recently filed with the SEC its proposed new Discovery Guide which includes new Document
Production Lists.  This revision of the Discovery Guide has been a long time in the works and is the product of much discussion among FINRA and practitioners from both claimants' and respondents' sides.  The next step is for the SEC to publish the Guide for public comments.

FINRA Extends Pilot Program Allowing All-Public Arbitrator Panels for a Third Year

FINRA recently announced an extension of its voluntary pilot program of allowing investors in arbitrations with 3-person arbitration panels against participating firms to select all-Public Arbitrator panels.  Initially, the Pilot Program was designed to run for two sequential years. Year One began October 6, 2008, and ended October 5, 2009. Year Two began October 6, 2009, and ends October 5, 2010. Recently, participating firms agreed to extend the Pilot Program for an additional year at the same case levels, while FINRA goes through the evaluation and decision making process. Year Three begins October 6, 2010, and ends October 5, 2011.

Langevoort on Psychology of Financial Risk-Taking

Chasing the Greased Pig Down Wall Street: A Gatekeeper’s Guide to the Psychology, Culture and Ethics of Financial Risk-Taking, by Donald C. Langevoort, Georgetown University Law Center, was recently posted on SSRN.  Here is the abstract:

The current financial crisis has once again focused attention on lawyers, corporate directors and auditors as gatekeepers, who are expected to introduce some degree of cognitive independence to the task of risk assessment and risk management in public companies, including financial services firms. This essay examines the psychological and cultural forces that may distort risk perception and risk motivation in hyper-competitive firms, beyond the standard economic incentives associated with agency costs and moral hazards, warning gatekeepers against too easily assuming that all is well when insiders display high levels of intensity, focus and devotion to hard-to-achieve goals. In fact, these may be the source of perceptual problems. It includes a section entitled “Three Variations on a Theme by Chuck Prince,” based on his famous reference to Citigroup having to dance because the music was still playing. Building on this metaphor, we look at the emotional and physiological impulses to dance into a frenzy, the pressure to win the dance competition, and dancing as performance for a fickle audience. The essay concludes by connecting culture to moral rationalizations – Goldman Sachs doing “God’s work”– and the exercise of individual power in organizations, and urges caution about the psychological and cultural forces that affect gatekeepers, too.

Files on SEC Enforcement

SEC Enforcement: Does Forthright Disclosure and Cooperation Really Matter?, by Rebecca Files, University of Texas at Dallas, was recently posted on SSRN.  Here is the abstract:

This study examines the conditions under which the Securities and Exchange Commission (SEC) exercises enforcement leniency following a restatement. I explore whether cooperation with SEC staff and/or forthright disclosure of a restatement (e.g., disclosures reported in a timely and visible manner) reduce the likelihood of an SEC sanction or SEC monetary penalties. After controlling for restatement severity, I find that cooperation increases the likelihood of being sanctioned, perhaps because it improves the SEC’s ability to build a successful case against the firm. However, both cooperation and forthright disclosures are rewarded by the SEC through lower monetary penalties.