Securities Law Prof Blog

SEC Investigates Harrisburg PA Muni-Bond Disclosures

The SEC is investigating whether Harrisburg PA officials provided investors with enough information about the financial condition of the city.  According to a spokesperson for the city, the inquiry began last November.  The SEC has recently stepped up its role in the municipal bond market.  It settled a case against New Jersey and is also investigating Illinois.  WSJ, SEC Probes Harrisburg's Muni Disclosures

Hedge Funds Seek Guidance on Expert Networks

Managed Funds Association, a Washington lobbying group, said it has requested guidelines from the SEC on the use of "expert networks."  Some of its members have expressed concern about the lack of clarity surrounding their use.  WSJ, Hedge Funds Seek Clarity on 'Expert Networks'

SEC Charges Three New York Investment Firms with Misusing Clients' Funds

On January 20, 2011, the SEC charged three affiliated New York-based investment firms and four former senior officers with fraud, misuse of client assets, and other securities laws violations involving their $66 million advisory business.  According to the SEC, the operation's investment adviser William Landberg and president Kevin Kramer - through the firms West End Financial Advisors LLC (WEFA), West End Capital Management LLC (WECM), and Sentinel Investment Management Corporation - misled investors into believing that their money was in stable, safe investments designed to provide steady streams of income. However, in reality West End faced deepening financial problems stemming from Landberg's failed investment strategies. When starved for cash to meet obligations of the West End funds or for his personal needs, Landberg misused investor assets, fraudulently obtained more than $8.5 million from a bank, and used millions of dollars from an interest reserve account for unauthorized purposes.  The SEC also charged West End's chief financial officer Steven Gould and controller Janis Barsuk for their roles in the scheme.

According to the SEC's complaint filed in U.S. District Court for the Southern District of New York, the misconduct occurred from at least January 2008 to May 2009. The Commission seeks permanent injunctive relief against each defendant and disgorgement of ill-gotten gains with prejudgment interest against defendants and relief defendants.

SEC and Maxwell Technologies Settle FCPA Charges

The SEC and energy-related products manufacturer Maxwell Technologies Inc. settled charges that Maxwell violated the Foreign Corrupt Practices Act (FCPA) by repeatedly paying bribes to government officials in China to obtain business from several Chinese state-owned entities.  The SEC alleged that a Maxwell subsidiary paid more than $2.5 million in bribes to Chinese officials through a third-party sales agent from 2002 to May 2009. As a result, the subsidiary was awarded contracts that generated more than $15 million in revenues and $5.6 million in profits for Maxwell. These sales and profits helped Maxwell offset losses that it incurred to develop new products now expected to become Maxwell's future source of revenue growth.

Maxwell — a Delaware corporation headquartered in San Diego — has agreed to pay more than $6.3 million to settle the SEC's charges. In a related criminal proceeding, Maxwell has reached a settlement with the U.S. Department of Justice and agreed to pay an $8 million penalty.

The SEC's complaint alleges that the illicit payments were made with the knowledge and tacit approval of certain former Maxwell officials. For example, former management at Maxwell knew of the bribery scheme in late 2002 when an employee indicated in an e-mail that a payment made in connection with a sale in China appeared to be "a kick-back, pay-off, bribe, whatever you want to call it, . . . . in violation of US trade laws." A U.S.-based Maxwell executive replied that "this is a well know[n] issue" and he warned "[n]o more e-mails please."

The SEC alleges that Maxwell failed to devise and maintain an effective system of internal controls and improperly recorded the bribes on its books. The illicit sales and profits from the bribery scheme helped Maxwell offset losses that it incurred to develop its new products. Maxwell made corrections in its Form 10-Q filing for the quarter ended March 31, 2009.

SEC Releases Money Market Fund Portfolio and "Shadow NAV" Information to the Public

The SEC announced that investors can now access detailed information that money market funds file with the Commission — including information about a fund's investments and the market-based price of its portfolio known as its "shadow NAV" (net asset value) or mark-to-market valuation.  The information is available on the SEC's website and will be updated monthly.

As part of its overhaul of money market fund regulation, the Commission last year adopted a rule requiring money market funds to file information about their holdings and portfolio valuations.  Funds began filing the information on the SEC's new Form N-MFP in December. Under the rule, the SEC will release the information with a 60-day delay. The rule also requires money market funds to post more current but less detailed portfolio information on their own websites within five business days after the end of the month.

See also Staff Responses to Questions about Information Filed on Form N-MFP

Schwarcz on Ex Ante Versus Ex Post Approaches to Financial Regulation

Keynote & Chapman Dialogue Address: Ex Ante Versus Ex Post Approaches to Financial Regulation, by Steven L. Schwarcz, Duke University - School of Law, was recently posted on SSRN.  Here is the abstract:

Ideal financial regulation would work ex ante, to prevent financial failures. Once a failure occurs, there may already be economic damage, and it may be difficult to stop the failure from spreading and becoming systemic. The reality, though, is that preventing financial failures should be only one role for regulators. Even an optimal prophylactic regulatory regime cannot anticipate and prevent every failure. This paper, which formed my Chapman Dialogue Address at Chapman University School of Law and the keynote speech at Chapman Law Review’s 2011 Symposium on the Future of Financial Regulation, attempts to contrast fundamental differences between ex ante and ex post financial regulation. It also illustrates how ex post approaches can, and arguably should, supplement ex ante approaches as part of a comprehensive financial regulatory framework.
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Klock on Private Enforcement Against Aiders & Abettors

Improving the Culture of Ethical Behavior in the Financial Sector: Time to Expressly Provide for Private Enforcement Against Aiders and Abettors of Securities Fraud, by Mark Klock, George Washington School of Business, was recently posted on SSRN.  Here is the abstract:

Financial markets do not function well when fraud is pervasive. It has been well documented that financial fraud has increased following changes in securities law that occurred in the 1990’s. Also around September of 2009, the investigations into the SEC examinations of Bernard Madoff Investment Securities, LLC were completed and released to the public. The simple facts reveal an alarming level of incompetence and lack of financial literacy on the part of the guardians of the integrity of our financial markets. I suggest two important tools for addressing these problems. One is to supplement enforcement of anti-fraud rules with more private attorney generals by expressly creating a private right of action for aiding and abetting violations of securities laws. This will foster a stronger culture of integrity and ethical conduct in the auditing profession. An additional tool is to increase financial literacy in our law schools which supply the regulators of our markets.

Omarova on Financial Self-Regulation

Wall Street as Community of Fate: Toward Financial Industry Self-Regulation, by Saule T. Omarova, University of North Carolina at Chapel Hill School of Law, was recently posted on SSRN.  Here is the abstract:

In the wake of the worst financial crisis since the Great Depression, policy-makers around the world are searching for ways to manage systemic risk in the global financial market. This article argues that one key, and currently entirely overlooked, potential mechanism for controlling and minimizing systemic financial risk is industry-wide self-regulation. However, it advocates a fundamentally new self-regulatory regime in the financial sector, which would focus explicitly on the issue of systemic risk prevention and impose responsibility to protect the broader public from financial crises directly on the financial services industry. This article further argues that the financial services industry currently lacks meaningful incentives to develop this new type of more public-minded and socially responsible self-regulation. It examines the experience with self-regulation in other sectors – in particular, the nuclear power and chemical manufacturing industries – and analyzes how the key factors that made the emergence of such self-regulatory regimes possible in those industries might play out in the context of the financial sector. Finally, this article argues that it may be possible to alter the existing incentive structure through thoughtful regulatory design and proposes some steps that may be taken in that direction.

Davidoff et alia on Fiduciary Duties in Investment Banking

Computerization and the ABACUS: Reputation, Trust, and Fiduciary Duties in Investment Banking, by Steven M. Davidoff, University of Connecticut School of Law; Alan D. Morrison, University of Oxford - Said Business School; University of Oxford - Merton College; and William J. Wilhelm Jr., University of Oxford - Said Business School, was recently posted on SSRN.  Here is the abstract:

 On April 16, 2010 the Securities and Exchange Commission (SEC) filed a civil complaint against Goldman Sachs in the U.S. District Court for the Southern District of New York. The complaint alleged that Goldman violated the anti-fraud provisions of the federal securities laws, in connection with a 2007 synthetic collateralized debt obligation (CDO) transaction, ABACUS 2007-AC1 SPV (ABACUS). Goldman agreed a $500 million settlement with the SEC on July 15, 2010. We analyze the ABACUS transaction and the SEC's complaint against Goldman Sachs in the context of recent technological changes within the investment banking market. Investment banking was historically a relationship-based business, sustained by reputationally intermediated tacit contracts. Recent advances in information technology and financial economics have codified many formerly tacit elements of investment banking. As a result, some investment banking deals are now transacted at arm's length, and rely more upon formal contracts; we argue that, for this type of deal, there is a stronger case for legal rules regulating the investment bank-counterparty relationship. However, some deals continue to be arbitrated by tacit rules and norms and, for these deals, legal rules are less appropriate, because it is very hard for a third party to ascertain tacit understandings made in the context of a long-lived relationship. An attempt to introduce legal rules into reputationally intermediated relationships may even impair the counterparties' ability to arrive at informal arrangements, and so to trade. The supervision of deals like ABACUS should therefore reflect the extent to which they are transactional or relational; we argue that in neither case is there justification for the application of legal rules or the gap-filling standard of fiduciary duties.

Rodrigues on Separation of Ownership from Ownership

Corporate Governance in an Age of Separation of Ownership from Ownership, by Usha Rodrigues, University of Georgia Law School, was recently posted on SSRN.  Here is the abstract:

The shareholder empowerment provisions enacted as part of the recent bailout legislation are internally incoherent because they fail to address the short-termist realities of shareholder ownership today. Ownership has separated from ownership in modern corporate America: individual investors now largely hold stock through mutual funds, pension funds, and hedge funds. The incentives of these short-term financial intermediaries only imperfectly reflect the interests of their long-term holders - an imbalance only exacerbated by the bailout’s corporate governance legislation. The bailout’s focus on shareholder empowerment tactics - such as proxy access, say-on-pay, and increased disclosure - makes little sense if shareholders are only in it for the short term. This Article uses the bailout provisions to illustrate the point that shareholder empowerment inadequately addresses systemic problems. The Article explores the recent regulation of target-date retirement funds as a further example of regulators’ persistent neglect of the separation of ownership from ownership. The Article concludes with some reflections on the difficult question of how to encourage long-lived firms when individual players, including even long-horizoned investors, may be looking for a quick payoff.

Bartov et alia on Market Consequences of Late SEC Filings

Capital Market Consequences of Filing Late 10-Qs and 10-Ks, by Eli Bartov, New York University; Mark L. DeFond, University of Southern California - Leventhal School of Accounting; and Yaniv Konchitchki,
University of Southern California - Leventhal School of Accounting and Marshall School of Business, was recently posted on SSRN.  Here is the abstract:

We find that the market reacts negatively to announcements that firms will file late 10-Qs or 10-Ks, and that the reaction is more negative for late 10-Qs than late 10-Ks. We also find that the larger reaction to late 10-Q announcements is due to firms that report accounting reasons as the cause of the delay. In addition, we find that the market anticipates which late 10-Q filers will subsequently fail to file within the SEC’s allowed grace period, but only when accounting reasons explain the delay. Finally, we find that abnormal returns continue to decline during the months following the late filing announcement, except when accounting reasons explain the delay. Our study contributes to the literature by finding that late filings have important capital market consequences and that late 10-Q filings have distinct valuation implications compared with late 10-K filings. Importantly, we also show that accounting information included in Form NT plays a critical role in how market participants interpret the valuation implications of late filings.

Kedia & Rajgopal on SEC's Enforcement Preferences

Do the SEC’s Enforcement Preferences Affect Corporate Misconduct?, by Simi Kedia, Rutgers University, Newark, School of Business-Newark, Department of Finance & Economics, and Shivaram Rajgopal, Emory University - Goizueta Business School, was recently posted on SSRN.  Here is the abstract:

 Recent frauds have questioned the efficacy of the SEC’s enforcement program. We hypothesize that differences in firms’ information sets about SEC enforcement and constraints facing the SEC affect firms’ proclivity to adopt aggressive accounting practices. We find that firms located closer to the SEC and in areas with greater past SEC enforcement activity, both proxies for firms’ information about SEC enforcement, are less likely to restate their financial statements. Consistent with the resource-constrained SEC view, the SEC is more likely to investigate firms located closer to its offices. Our results suggest that regulation is most effective when it is local.

SEC Charges Connecticut Investment Adviser with Stealing Millions From Investors

The SEC today obtained a court order freezing the assets of a Stamford, Conn.-based investment adviser and its principal, Francisco Illarramendi, charging that they misappropriated at least $53 million in investor funds and used the money for self-dealing transactions.  The SEC alleges that Illarramendi defrauded investors in the several hedge funds he managed by improperly transferring their money into bank accounts that he personally controlled. He then invested the money for his own benefit or for the benefit of the entities that he controlled, rather than for the benefit of the hedge fund investors.

According to the SEC's complaint filed in U.S. District Court for the District of Connecticut on January 14, Illarramendi is the majority owner of the Michael Kenwood Group LLC — a holding company for, among other entities, investment adviser Michael Kenwood Capital Management LLC. Through this adviser entity, Illarramendi manages several hedge funds, including one that contains up to $540 million in assets. The SEC’s complaint alleges that Illarramendi took at least $53 million in investor money out of this hedge fund without the knowledge or consent of the hedge fund’s investors

The SEC sought an asset freeze and other emergency relief because it alleged that Illarramendi was imminently planning to make additional investments using investor funds without the knowledge or consent of the investors. 

SEC Charges Attorney Altered Documents in SEC's Examination of Client

The SEC today instituted administrative proceedings against a California-based attorney for engaging in improper professional conduct during an SEC examination.  The SEC’s Office of the General Counsel alleges that David M. Tamman — in the course of an SEC examination of his client NewPoint Securities LLC in April and May 2009 — altered private placement memoranda (PPMs) purportedly used in the offer and sale of securities issued by NewPoint Financial Services. The original PPMs purportedly provided to investors stated that the funds raised in the offerings would be used primarily for real estate related investments. In fact, the vast majority of money raised in the offerings was misappropriated by NewPoint’s principal John Farahi.

The SEC’s Office of the General Counsel alleges that Tamman — a member of the California Bar and a partner at a large international law firm — added language to the PPMs to make it appear that it was disclosed to investors that much of the money raised by NewPoint would be loaned to Farahi. The PPMs were then produced to the SEC’s examination and enforcement staff. According to the Office of the General Counsel, Tamman knew that the language he added to the documents was not included in the PPMs actually provided to investors.

Through his conduct, the SEC’s Office of the General Counsel alleges that Tamman engaged in unethical and improper professional conduct in violation of Rule 102(e) of the SEC’s Rules of Practice. An administrative hearing will be scheduled.

SEC Charges Former Galleon Trader with Insider Trading

The SEC today announced insider trading charges against Michael Cardillo, a former trader at the hedge fund investment adviser Galleon Management, LP, for trading ahead of September 2007 announced acquisition of 3Com Corp., and November 2007 announced acquisition of Axcan Pharma Inc.

The SEC’s complaint, filed in federal court in Manhattan, alleges that Arthur J. Cutillo and Brien P. Santarlas, former attorneys with the international law firm Ropes & Grey LLP, misappropriated from their law firm material, nonpublic information concerning the acquisitions of 3Com and Axcan. The SEC alleges that they tipped this inside information, through another attorney, to Zvi Goffer, a former proprietary trader at the broker-dealer Schottenfeld Group, LLC, in exchange for kickbacks. The SEC further alleges that Goffer tipped information about these acquisitions to Craig Drimal, a trader who worked out of the offices of Galleon, who then tipped the inside information to Cardillo. According to the complaint, Cardillo then traded in the securities of 3Com and Axcan on behalf of a Galleon hedge fund, resulting in more than $730,000 in illicit profits.

In a related criminal case filed by the U.S. Attorney’s Office for the Southern District of New York, Cardillo has pled guilty to criminal charges in connection with this insider trading scheme.

SEC Charges Former Galleon Portfolio Manager with Insider Trading

On January 26, 2011, the SEC filed a civil injunctive action in the United States District Court for the Southern District of New York alleging that Adam Smith — a former portfolio manager of the Galleon Emerging Technology funds (f/k/a the Galleon Communications funds) engaged in insider trading in the securities of ATI Technologies, Inc. The SEC alleges that Smith caused the Galleon funds he advised to purchase shares of ATI based on material non-public information concerning Advanced Micro Devices Inc.’s $5.4 billion takeover of ATI in July, 2006. The trading generated over $1.3 million in illicit profits.

According to the SEC’s complaint, Smith obtained material non-public information concerning the AMD/ATI transaction from an investment banking source that Smith had known for years. This source, according to the SEC, provided Smith with the tip in order to win favors from Galleon such as securing investment banking work from, or obtaining future employment with, Galleon. The complaint filed today relates to a pending enforcement action, SEC v. Galleon Management, LP, et al., 09-CV-8811 (S.D.N.Y.) (JSR).

The SEC has now charged 28 defendants in its Galleon-related enforcement actions which have alleged widespread and repeated insider trading at numerous hedge funds including Galleon — a multi-billion dollar New York hedge fund complex founded and controlled by Raj Rajaratnam — and by other professional traders and corporate insiders in the securities of 14 companies generating illicit profits totaling over $70 million.

Financial Crisis Inquiry Commission Releases Report

The Financial Crisis Inquiry Commission delivered the results of its investigation into the causes of the financial and economic crisis. The Commission concluded that the crisis was avoidable and was caused by:

 Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the
tide of toxic mortgages;
 Dramatic breakdowns in corporate governance including too many financial firms acting
recklessly and taking on too much risk;
 An explosive mix of excessive borrowing and risk by households and Wall Street that put the
financial system on a collision course with crisis;
 Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system
they oversaw;
 And systemic breaches in accountability and ethics at all levels.

The Commission’s report also offers conclusions about specific components of the financial system that
contributed significantly to the financial meltdown. Here the Commission concluded that: collapsing
mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis, over-the-counter derivatives contributed significantly to this crisis, and the failures of credit rating agencies were essential cogs in the wheel of financial destruction.

The Commission also examined the role of government sponsored enterprises (GSEs), with Fannie Mae
serving as the case study. The Commission found that the GSEs contributed to the crisis but were not a
primary cause. They had a deeply flawed business model and suffered from many of the same failures of
corporate governance and risk management seen in other financial firms but ultimately followed rather
than led Wall Street and other lenders in purchasing subprime and other risky mortgages.

The Reports's Conclusions and Dissents are posted on its website.

SEC & CFTC Propose Rules on Reporting by Advisers to Private Funds

The SEC has posted on its website Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, joint proposed rules with the Commodity Futures Trading Commission.

SEC Adopts Final Rules on Say on Pay and Golden Parachutes

Here is a link to the final rules on Say on Pay and Golden Parachutes that the SEC, by a 3-2 vote, approved yesterday.

SEC Releases Staff Study on Improved Investor Access to Information about Brokers and Advisers

The SEC released its third staff study this week required by Dodd-Frank, the Study and Recommendations on Improved Investor Access to Registration Information About Investment Advisers and Broker-Dealers.  Section 919B directs the SEC to complete a study, including recommendations, of ways to improve the access of investors to registration information about registered and previously registered investment advisers, associated persons of investment advisers, brokers and dealers and their associated persons, and to identify additional information that should be made publicly available. The Act specifies that the study include an analysis of the advantages and disadvantages of further centralizing access to registration information, and identify data pertinent to investors and the method and format for displaying and publishing the data to enhance the information’s accessibility and utility to investors. Unlike the "fiduciary duty" study for investment advisers and broker-dealers, Dodd-Frank requires the SEC to implement any recommendations within eighteen months after completion of the study.

The study contains an overview of the registration information the Staff believes is important to investors, as well as a brief introduction to the primary sources of publicly available registration information. It first discusses broker-dealer registration and disclosure, then discusses investment adviser registration and disclosure, and finally compares the nature of information available in BrokerCheck and IAPD.

The study proposes several recommendations:

 For the near-term, i.e., within the eighteen-month implementation period, the Staff makes the following recommendations: (1) unify search returns for BrokerCheck and IAPD to help investors more easily obtain the data they need to make informed decisions regarding financial services providers; (2) add a search by ZIP code or other indicator of location to BrokerCheck and IAPD to increase the utility of the existing databases; and (3) enhance BrokerCheck and IAPD by adding educational content to make the data currently available more useful to investors.

The Staff also recommends that, subsequent to the eighteen-month implementation period, Commission staff and FINRA continue to analyze, including through investor testing, the
feasibility and advisability of expanding BrokerCheck to include information currently available in CRD, as well as the method and format of publishing that information; and that Commission staff continue to evaluate expanding IAPD content and the method and format of publishing that content, including through investor testing.