Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, February 28, 2011

Sutherland Releases Annual Survey of FINRA Sanctions

Sutherland Asbill & Brennan LLP announced that it completed its annual Sutherland FINRA Sanction Study – a review of the disciplinary actions brought by the Financial Industry Regulatory Authority (FINRA) against broker-dealers and associated persons.  The Study found that in 2010 FINRA reported a significant increase in the number of cases despite a slight decrease in the total amount of fines.  Sutherland also identified the top enforcement issues for FINRA in 2010, as well as trends in enforcement cases.

February 28, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)


On February 24, 2011, the SEC charged Francis E. Wilde and Matrix Holdings LLC, an entity he controls, with orchestrating two fraudulent “high yield” or “prime bank” investment schemes that defrauded investors out of more than $11 million. Wilde is the CEO of Riptide Worldwide, Inc. (“Riptide”), a public company that is quoted on the OTC Market Group Inc.’s OTC Pink quotation service. The SEC alleges that Wilde started the fraudulent schemes when Riptide began experiencing financial difficulties. The SEC also charged Steven E. Woods, Mark A. Gelazela, and entities they control, for participating in the larger of the two schemes, and Bruce H. Haglund, a California-based attorney, for aiding in that scheme.

According to the SEC’s complaint, filed in the U.S. District Court for the Central District of California, the first scheme began in April 2008 when Wilde obtained a U.S. Treasury bond with a market value of nearly $5 million from an investor. He secured the investment by knowingly making false and misleading promises of outsized returns from what he claimed was a “private placement program.” Using a credit line obtained with the investor’s bond, Wilde promised to acquire a $100 million financial instrument and to pay the investor $12 million within 5 days as well as a prorated share of proceeds from the private placement program. Wilde also guaranteed the return of the bond if the $12 million payment was not made on time. Wilde (through Matrix) then used the bond to secure a line of credit that he drew down to pay personal expenses, to pay investors, creditors and debt holders of Riptide, and to make failed attempts to acquire fictitious prime bank instruments or to invest in high yield programs. Wilde’s bank closed the credit line after he attempted to deposit a fraudulent financial instrument into the account. After the bond serving as collateral for the credit line was sold, Wilde transferred about $2.1 million to another bank account and exhausted the rest of the investor’s funds. Wilde strung along the investor, continuing to misrepresent the status and whereabouts of the investment, the SEC alleges.

The SEC further claims that, beginning in October 2009, Wilde concocted another fraudulent scheme with Woods and Gelazela in the form of a “bank guarantee funding” program using the services of Haglund as escrow attorney. Between October 2009 and mid-March 2010, Woods and Gelazela signed contracts with 24 investors who sent over $6.3 million to Haglund’s trust account. Gelazela raised more than $5 million and Woods raised more than $1 million. The investment contracts stated that a “bank guarantee” with a denomination of at least $100 million would be leased “for the purpose of Private Placement Program enhancements” and fifteen percent of the credit line value would be paid weekly to the investor for a term of 40 weeks. Wilde, Gelazela and Woods later sought to pacify investors with additional misstatements as the scheme unraveled in 2010.

According to the SEC, Haglund knowingly and substantially aided and abetted the fraud perpetrated by Wilde, Woods and Gelazela. Haglund controlled the trust account into which investors were instructed to wire their funds. Haglund then wired those funds out of the account according to instructions from Wilde, thus allowing Wilde to utilize funds for undisclosed purposes. Wilde transferred millions of dollars to bank accounts controlled by Gelazela, Woods, Haglund, Wilde and Wilde’s wife. Haglund pocketed nearly $500,000 in “legal services” fees for making wire transfers, payments that were not disclosed to investors. Haglund also knowingly made, and Wilde knowingly authorized, Ponzi-like payments to old investors using new investor deposits.

The SEC seeks permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest thereon, financial penalties, and accountings, against each defendant, as well as officer and director bars against Wilde and Haglund.


February 28, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Won't Discipline Schwab for ARS Sales

On February 11, FINRA notified Charles Schwab that it has decided not to bring a disciplinary action against it related to sales of auction rate securities.  Schwab previously reported that in November 2009 FINRA issued a Wells notice in connection with the ARS.  A complaint filed by the New York AG around the same time is still pending against the firm.  InvNews, Finra backs down, won't discipline Schwab over ARS sales

February 28, 2011 in Other Regulatory Action | Permalink | Comments (1) | TrackBack (0)

SEC Charges Former Outside Directors at DHB Industries with Complicity in Accounting Fraud

The SEC today charged DHB Industries ((now known as Point Blank Solutions), a major supplier of body armor to the U.S. military and law enforcement agencies, with engaging in a massive accounting fraud. The agency separately charged three of the company’s former outside directors and audit committee members for their complicity in the scheme.

The SEC alleges that DHB engaged in pervasive accounting and disclosure fraud through its senior officers and misappropriated company assets to personally benefit the former CEO. The SEC further alleges that outside directors Jerome Krantz, Cary Chasin, and Gary Nadelman were willfully blind to numerous red flags signaling the accounting fraud, reporting violations, and misappropriation at DHB.  The SEC previously charged former DHB CEO David Brooks as well as two other former DHB senior officers for their roles in the fraud.

The SEC filed two separate complaints in U.S. District Court for the Southern District of Florida against DHB and the former outside directors. According to the SEC’s complaint against Krantz, Chasin, and Nadelman, their willful blindness to red flags allowed senior management to manipulate the company’s reported gross profit, net income, and other key figures in its earnings releases and public filings between 2003 and 2005. The company overstated inventory values, failed to include appropriate charges for obsolete inventory, and falsified journal entries. By ignoring red flags, the three outside directors also facilitated the misconduct by Brooks, who diverted at least $10 million out of the company through fraudulent transactions with a related entity that he controlled. Their willful blindness to red flags additionally facilitated DHB’s improper payment of millions of dollars in personal expenses for Brooks, including luxury cars, jewelry, art, real estate, extravagant vacations, and prostitution services. Despite being confronted with the red flags indicating fraud, Krantz, Chasin, and Nadelman approved or signed DHB’s false and misleading filings.

The SEC’s complaints against DHB, Krantz, Chasin, and Nadelman charge them with violating or aiding and abetting the antifraud, reporting, books and records, and other provisions of the federal securities laws. DHB has agreed to settle with the SEC and agreed to a permanent injunction from future violations. The proposed settlement took into account the remedial measures already taken by the company. The company is currently in bankruptcy and its settlement with the SEC is pending the approval of the bankruptcy court. The SEC seeks injunctive relief, disgorgement of ill-gotten gains, monetary penalties, and officer and director bars against Krantz, Chasin, and Nadelman.

The U.S. Attorney’s Office for the Eastern District of New York previously filed criminal charges against Brooks, Hatfield, and Schlegel based on the same misconduct. On Sept. 14, 2010, a jury convicted Brooks and Hatfield of, among other things, multiple counts of securities fraud, insider trading, and obstruction of justice, including obstructing the SEC’s investigation. Brooks and Hatfield are awaiting sentencing. Schlegel previously pled guilty to criminal charges pursuant to a plea agreement. The SEC’s civil actions against Brooks, Hatfield, and Schlegel are stayed pending the full resolution of the criminal actions.

February 28, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

42 Law Profs Support Extending Dodd-Frank's Extraterritorial Test to Private Claims

The SEC recently asked for comments on its study on extraterritorial private rights of action, required by Dodd-Frank.  As you may recall, the U.S. Supreme Court in Morrision v. NAB rejected the longstanding conduct-effects approach and instead held that “Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” In response to Morrison, Congress reinstated the conduct-effects test for government actions and directed the SEC to study whether private rights of action should similarly be restored.

A group of 42 law professors, spearheaded by Frank Partnoy (San Diego), filed comments.  As the letter states:

We differ in our views of private rights of action: some of us have significant doubts about the efficacy of securities class actions, while others believe shareholder litigation rights should be strengthened. Nevertheless, as a group we believe reform efforts should be applied consistently and logically to both domestic and affected foreign issuers, and we therefore support extending the test set forth in Section 929P of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to private plaintiffs.

With the prospect of a merger of Deutsche Boerse and NYSE Euronext, the extraterritoriality of the federal securities laws is a timely and pressing issue.  As the comment states:

Assuming that merger happens, there is the potential for most trades between U.S. buyers and sellers to occur offshore, likely in London. Even those of us who are deeply skeptical about extending U.S. securities law to its fullest reach agree that it would make little sense to apply the approach in Morrison to preclude application of the securities laws to those trades.

A number of comments have been filed, some of which support maintaining the distinction between private and government actions.

February 28, 2011 | Permalink | Comments (0) | TrackBack (0)

Sunday, February 27, 2011

Branson on Women on Boards

Women on Boards of Directors: A Global Snapshot, by Douglas M. Branson, University of Pittsburgh School of Law, was recently posted on SSRN.  Here is the abstract:

Since my books on the role of women appeared, in 2007 and in 2010, the participation by women in corporate governance has become a front page issue in many European nations, including Norway, Spain, and France, which have adopted quota laws, and in Belgium, the Netherlands and Italy, which may soon do the same. By contrast, Germany and the United Kingdom are staunchly opposed to any such incursions into their governance regimes. On the other side of the world, the issue of women in governance has moved from the back to the front burner in just the last year, as organizations in countries such as Australia have inaugurated new programs which have shown great success. By way of further contrast, progress on issue in the U.S. has been largely dormant from 2004, or earlier, with the exception of little-noted SEC disclosure regulations taking effect in 2010. This article reviews the comparative statistics and categorizes the types of programs being implemented around the world.

February 27, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Stout on Shareholder Primacy

New Thinking on ‘Shareholder Primacy’, by Lynn A. Stout, University of California, Los Angeles (UCLA) - School of Law, was recently posted on SSRN.  Here is the abstract:

By the beginning of the twenty-first century, many observers had come to believe that U.S. corporate law should, and does, embrace a “shareholder primacy” rule that requires corporate directors to maximize shareholder wealth. This Essay argues that such a view is mistaken.

As a positive matter, U.S. corporate law and practice does not require directors to maximize shareholder wealth but instead grants them a wide range of discretion, constrained only at the margin by market forces, to sacrifice shareholder wealth in order to benefit other constituencies. Although recent “reforms” designed to promote greater shareholder power have begun to limit this discretion, U.S. corporate governance remains director-centric.

As a normative matter, several lines of theory have emerged in modern corporate scholarship that independently suggest why director governance of public firms is desirable from shareholders’ own perspective. The Essay reviews five of these lines of theory and explores why each gives us reason to believe that shareholder primacy rules in public companies in fact disadvantage shareholders. It concludes that shareholder primacy thinking in its conventional form is on the brink of intellectual collapse, and will be replaced by more sophisticated and nuanced theories of corporate structure and purpose.

February 27, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Kaal & Painter on Morrison

The Aftermath of Morrison v. National Australia Bank and Elliott Associates v. Porsche, by Wulf A. Kaal, Mississippi College - School of Law, and Richard W. Painter, University of Minnesota Law School, was recently posted on SSRN.  Here is the abstract:

This article evaluates the ambiguities and shortcomings of the U.S. Supreme Court decision in Morrison with a particular emphasis on the implications of the recent Porsche decision in the Southern District of New York. We conclude that the ambiguities in Morrison and the implications of interpreting Morrison for persons and companies in European jurisdictions and elsewhere in the world make it necessary for the U.S. Congress to further clarify the extraterritorial reach of the implied right of action under the Securities Exchange Act of 1934. We also conclude that the U.S. Congress should clarify its intent in Section 929P(b) of the Dodd-Frank Act of 2010 to give extraterritorial enforcement authority to the U.S. Securities and Exchange Commission (SEC) and U.S. Department of Justice. An SEC study of private rights of action is also required by the Dodd-Frank Act, but regardless of the outcome of this study, Congress should decline to reinstate private rights of action in “foreign-cubed” cases. Restraining and clarifying the U.S. approach to extraterritoriality could help provide certainty to international securities markets and avoid a downturn in international economic cooperation.

February 27, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Hazen on Broker's Fiduciary Duties

Stock Broker Fiduciary Duties and the Impact of the Dodd-Frank Act, by Thomas Lee Hazen, University of North Carolina (UNC) at Chapel Hill - School of Law, was recently posted on SSRN.  Here is the abstract:

In recent years there has been concern about the sufficiency of broker-dealer regulation. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 mandates the SEC to review and evaluate existing regulation and to adopt such rules as may be necessary to enhance existing regulation. Existing SEC and FINRA rule-making addresses broker-dealer conduct, but by and large the regulation has been based on principles and standards rather than voluminous detailed rules specifying prohibited conduct. This article examines the extent to which additional regulation is warranted and whether to continue to rely on principles-based regulation, or whether there should be more explicit rules to heighten broker-dealer standards. The article concludes that although the existing framework for broker-dealer regulation is robust, it could be fine-tuned by possibly adding an express fiduciary duty requirement as well as more specific rule-based prohibitions.

February 27, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Dan-Cohen on Sanctioning Corporations

Sanctioning Corporations, by Meir Dan-Cohen, University of California, Berkeley - School of Law, was recently posted on SSRN.  Here is the abstract:

The question of corporate criminal liability should be split into (at least) two questions: (1) Should corporations be subject to criminal sanctions? (2) Should these sanctions be subject to the same substantive, procedural, and evidentiary constraints as those that apply in the case of individual defendants? I argue for a positive answer to the first question, and a negative answer to the second.

February 27, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Fisch on Federal Proxy Access

The Destructive Ambiguity of Federal Proxy Access, by Jill E. Fisch, University of Pennsylvania Law School - Institute for Law and Economics, was recently posted on SSRN.  Here is the abstract:

After almost seventy years of debate, on August 25, 2010, the SEC adopted a federal proxy access rule. This Article examines the new rule and concludes that, despite the prolonged rule-making effort, the new rule is ambiguous in its application and unlikely to increase shareholder input into the composition of corporate boards. More troubling is the SEC’s ambiguous justification for its rule which is neither grounded in state law nor premised on a normative vision of the appropriate role of shareholder nominations in corporate governance.

Although the federal proxy access rule drew an unprecedented number of comment letters and is now being challenged in court, its practical significance is likely to be minimal. The SEC’s ambiguous approach to proxy access is particularly problematic because its rules continue to burden issuer-specific innovations in nominating procedures. The SEC has admitted that its rules impede shareholder participation in the nominating process, but it has refused to remove existing regulatory burdens on such participation.

The core of the problem is that, as this Article will show, federal regulation is poorly suited for regulating corporate governance. Private ordering, within the framework of existing state regulation, offers a more flexible mechanism for maintaining equilibrium in the allocation of power between shareholder and managers. The article concludes by outlining the federal regulatory changes necessary to enable effective private ordering.

February 27, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bartram et alia on U.S. Stock Volatility

Why are U.S. Stocks More Volatile?, by Sohnke M. Bartram, Lancaster University; Gregory W. Brown , University of North Carolina (UNC) at Chapel Hill - Finance Area; and Rene M. Stulz, Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:

From 1991 to 2006, U.S. stocks are more volatile than stocks of similar foreign firms. A firm’s stock return volatility in a country can be higher than the stock return volatility of a similar firm in another country for reasons that contribute positively (good volatility) or negatively (bad volatility) to shareholder wealth and economic growth. We find that the volatility of U.S. firms is higher mostly because of good volatility. Specifically, firm stock volatility is higher in the U.S. because it increases with investor protection, stock market development, research intensity at the country level, and firm-level investment in R&D. These are all factors that are related to better growth opportunities for firms and better ability to take advantage of these opportunities. Though it is often argued that better disclosure is associated with greater volatility as more information is impounded in stock prices, we find instead that greater disclosure is associated with lower stock volatility.

February 27, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Thursday, February 24, 2011

SEC Alleges International Microcap Fraud

The SEC today charged two securities professionals, a hedge fund trader, and two firms involved in a scheme that manipulated several U.S. microcap stocks and generated more than $63 million in illicit proceeds through stock sales, commissions and sales credits.  According to the SEC, Florian Homm of Spain and Todd M. Ficeto of Malibu, Calif., conducted the scheme through their Beverly Hills, Calif.-based broker-dealer Hunter World Markets Inc. (HWM) with the assistance of Homm’s close associate Colin Heatherington, a trader who lives in Canada. They brought microcap companies public through reverse mergers and manipulated upwards the stock prices of these thinly-traded stocks before selling their shares at inflated prices to eight offshore hedge funds controlled by Homm. Their manipulation of the stock prices allowed Homm to materially overstate by at least $440 million the hedge funds’ performance and net asset values (NAVs) in a fraudulent practice known as “portfolio pumping.”

The SEC additionally brought administrative proceedings against HWM’s trader and chief compliance officer, who each agreed to settle the SEC’s charges against them.

According to the SEC’s complaint filed in the U.S. District Court for the Central District of California, Homm along with Ficeto and Heatherington conducted the scheme from September 2005 to September 2007. The SEC’s complaint charges Ficeto, Homm, Heatherington, HWM, and Hunter Advisors LLC with violating the antifraud provisions of the federal securities laws, and additionally charges HWM and Ficeto with violations of several broker-dealer recordkeeping provisions. The SEC seeks permanent injunctive relief, disgorgement of illicit profits with prejudgment interest, and financial penalties. The SEC also seeks an order permanently barring Ficeto from participating in any penny stock offering or from serving as an officer or director of a public company.

The SEC instituted separate but related administrative proceedings against Ahn and HWM’s former chief compliance officer Elizabeth Pagliarini, who each agreed to settle their cases without admitting or denying the SEC’s findings. Ahn agreed to pay a $40,000 penalty, comply with certain undertakings, and be barred from association with a broker and dealer for five years. Pagliarini agreed to a $20,000 penalty and one-year suspension as a supervisor with a broker or dealer.

February 24, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Will Consider Dodd-Frank Rules at March 2 Open Meeting

The SEC will hold an Open Meeting on March 2, 2011.  The subject matter will be:

Item 1: The Commission will consider whether to propose regulations with respect to incentive-based compensation practices at certain financial institutions in accordance with Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Item 2: The Commission will consider whether to propose rules for the operation and governance of clearing agencies in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and Section 17A of the Securities Exchange Act of 1934.

Item 3: The Commission will consider whether to reopen the comment period for Regulation MC, which was proposed pursuant to Section 765 of the Dodd-Frank Act to mitigate conflicts of interest at security-based swap clearing agencies, security-based swap execution facilities, and national security exchanges that post or make available for trading security-based swaps, in order to solicit further comment on Regulation MC and other more recent proposed rulemakings that concern conflicts of interest at security-based swap clearing agencies and security-based swap execution facilities.

Item 4: The Commission will consider whether to propose a new rule and rule and form amendments under the Securities Act of 1933 and the Investment Company Act of 1940, relating to references to credit ratings. These amendments are in accordance with Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

February 24, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former TBW Treasurer with Securities and TARP Fraud

The SEC today charged Desiree E. Brown, the former treasurer of Taylor, Bean & Whitaker Mortgage Corp. (TBW), the one-time largest non-depository mortgage lender in the country, with aiding and abetting a $1.5 billion securities fraud scheme and an attempt to scam the U.S. Treasury's Troubled Asset Relief Program (TARP).

The SEC alleges that Brown helped in selling more than $1.5 billion in fictitious and impaired mortgage loans and securities from TBW to Colonial Bank and caused them to be falsely reported to the investing public as high-quality, liquid assets. Brown also helped Colonial Bank to misrepresent that it had satisfied a prerequisite necessary to qualify for TARP funds.  In a related action today, Brown pleaded guilty to criminal charges filed by the Department of Justice in the Eastern District of Virginia.

The SEC previously charged former TBW chairman and majority owner Lee B. Farkas in June 2010. Farkas also was arrested in June by criminal authorities.

 According to the SEC's complaint filed in U.S. District Court for the Eastern District of Virginia, Brown and Farkas perpetrated the fraudulent scheme from March 2002 to August 2009, when Colonial Bank was seized by regulators and Colonial BancGroup and TBW both filed for bankruptcy. TBW was the largest customer of Colonial Bank's Mortgage Warehouse Lending Division (MWLD). Because TBW generally did not have sufficient capital to internally fund the mortgage loans it originated, it relied on financing arrangements primarily through Colonial Bank's MWLD to fund such mortgage loans.

The SEC alleges that when TBW began to experience liquidity problems and overdrew its then-limited warehouse line of credit with Colonial Bank by approximately $15 million each day, Brown and Farkas and an officer of Colonial Bank concealed the overdraws through a pattern of "kiting" in which certain debits were not entered until after credits due for the following day were entered. In order to conceal this initial fraudulent conduct, Brown, Farkas and the Colonial Bank officer created and submitted fictitious loan information to Colonial Bank and created fictitious mortgage-backed securities assembled from the fraudulent loans. By the end of 2007, the scheme consisted of approximately $500 million in fake residential mortgage loans and approximately $1 billion in severely impaired residential mortgage loans and securities. These fictitious and impaired loans were misrepresented as high-quality assets on Colonial BancGroup's financial statements.

The SEC alleges that in addition to causing Colonial BancGroup to misrepresent its assets, Brown assisted Farkas in causing BancGroup to misstate publicly that it had obtained commitments for a $300 million capital infusion that would qualify Colonial Bank for TARP funding. In fact, Farkas and Brown never secured financing or sufficient investors to fund the capital infusion. When BancGroup issued a press release announcing it had obtained preliminary approval to receive $550 million in TARP funds, its stock price jumped 54 percent - its largest one-day price increase since 1983. When BancGroup and TBW later mutually announced the termination of their stock purchase agreement and signaled the end of Colonial Bank's pursuit of TARP funds, BancGroup's stock declined 20 percent.

Brown consented to the entry of a judgment permanently enjoining her from violation of Rule 13b2-1 of the Securities Exchange Act of 1934 and from aiding and abetting violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-11 and 13a-13 thereunder. The proposed preliminary settlement, under which the SEC's requests for financial penalties against Brown would remain pending, is subject to court approval.

February 24, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, February 23, 2011

SEC Secures Emergency Relief in Alleged International Investment Fraud

The SEC filed an emergency action on February 18, 2011 against Secure Capital Funding Corporation, Bertram A. Hill, PP&M Trade Partners, and Kiavanni Pringle, to halt an alleged multi-million dollar international investment scheme that has defrauded investors in the United States and overseas. The Court issued a temporary restraining order freezing assets and ordering repatriation of investor funds.

The SEC alleged that in recent months defendants Secure Capital Funding Corporation, Bertram A. Hill, PP&M Trade Star Partners, and Kiavanni L. Pringle, defrauded investors of millions of dollars through the sale of fictitious Swiss “debentures.” According to the SEC’s complaint, defendants told investors that these securities were “risk-free” and would be used to establish highly leveraged margin accounts to trade other securities, and that investors would earn monthly returns of 10-100%. In reality, according to the SEC, these securities were fictitious and nearly $3 million of investor funds were quickly wired out of the country to accounts in Latvia and Jamaica.

February 23, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA NAR Rule Impermissibly Retroactive as Applied to Banned Broker

The Ninth Circuit held that a FINRA rule that prohibited non-attorneys who have been banned from the securities industry from representing parties in securities arbitrations was impermissibly retroactive as applied to Richard Sacks, who was banned from the securities industry in 1991.  Since then, according to Sacks, he has represented parties in over 1,300 securities arbitrations.  Sacks v. SEC (No. 07-74647 02/22/11)(Download SacksvSEC).

The Ninth Circuit emphasized the "deeply rooted" presumption against retroactivity in U.S. jurisprudence, based on concerns about fairness.  Relying on its precedent, Koch v. SEC, 177 F.3d 784 (9th Cir. 1999) (finding SEC rule banning participation in penny stock offerings impermissibly retroactive as applied to previously barred broker), it found that the FINRA rule imposed a "new and grave consequence" on Sacks' prior conduct.  The court did not explicitly address FINRA's interest in protecting investors and its forum, although it noted that the rule bars Sacks from participating in activity in which he had previously engaged.

February 23, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Second Circuit Expands SRO's Absolute Immunity from Private Damages Suits

The Second Circuit, in Standard Investment Chartered, Inc. v. NASD (No. 10-945-cv, 02/22/11)(Download StandardInvCharter), held that NASD and its officers had absolute immunity from a private damages suit alleging misstatements in its proxy solicitation of its members to amend its bylaws in connection with the consolidation of NASD and NYSE to form FINRA.  In so doing, the court, in its short per curiam opinion, reiterated that "there is no question" that an SRO and its officers are entitled to absolute immunity from private damages suits in connection with the discharge of their regulatory responsibilities.  While cautioning that the doctrine "is of a rare and exceptional character," the appellate court expanded the list of instances where an SRO has absolute liability to include amendment of its bylaws where the amendments are inextricable from the SRO's role as a regulator.  The court thought that it was significant that, under federal securities law, NASD could not alter its bylaws without SEC approval and that the SEC retained discretion to amend any SRO rule, thus demonstrating the extent to which an SRO's bylaws are interwined with the regulatory powers delegated to the SROs by the SEC.

February 23, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Sunday, February 20, 2011

Cunningham on Executive Compensation and Unconscionability

A New Legal Theory to Test Executive Pay: Contractual Unconscionability, by Lawrence A. Cunningham, George Washington University Law School, was recently posted on SSRN.  Here is the abstract:

Lucrative pay to corporate managers remains controversial yet continues to evade judicial scrutiny for legitimacy. Although many arrangements likely would pass the most rigorous scrutiny, it seems equally clear that some would not. Some agreements are not the product of arm’s-length bargaining, can rivet managers on short-term stock prices at the destruction of long-term business value, and can misalign manager-shareholder interests. Yet even such objectionable arrangements are immune from serious legal oversight. In theory, they are open to judicial review under corporate law, but shareholders challenging pay contracts face formidable procedural hurdles in derivative litigation and substantive obstacles from corporation law’s business judgment rule and the anemic doctrine of waste. A new legal theory would be useful to check board excesses in the population of clearly objectionable cases.

This Article explains why and how traditional contract law’s theory of unconscionability should be used to create a modicum of judicial scrutiny to strike obnoxious pay contracts and preserve legitimate ones. Under this proposal, pay contracts that are the product of managerial domination of the process and formed on terms massively favoring the executive will be stricken. This will follow direct shareholder lawsuits in state courts where the contract is made or performed and applying that state’s contract law. This new legal theory circumvents today’s dead-end route, where pay contracts are always upheld in derivative shareholder lawsuits applying corporate law that sets no meaningful limits on executive pay. This proposal creates new but modest pressure from sister states on Delaware to take greater responsibility for the effects its production of corporate law has nationally.

For those outraged by lopsided corporate executive compensation, this Article offers an appealing new legal theory of contractual unconscionability to police them. Those who see no or few problems with contemporary pay arrangements, or who are outraged by federal regulatory schemes like the Dodd-Frank Act, will welcome how this proposal is narrowly tailored using common law to address the most obnoxious cases.

February 20, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Conti-Brown on Elective Shareholder Liability for Systemically Important Institutions

Elective Shareholder Liability for Systemically Important Financial Institutions, by Peter Conti-Brown, Stanford University, Rock Center for Corporate Governance, was recently posted on SSRN.  Here is the abstract:

Despite the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and the initial proposal of Basel III, the debate regarding the regulation of systemically important financial institutions (SIFIs) continues unabated. Prominent among the present proposals is one led by prominent financial economists who argue in favor of 15% capital adequacy requirements for banks. So far, banks and their political supporters have resisted this proposal, claiming that it presents the banks with prohibitive and unnecessary costs. This Article proposes a mechanism, called elective shareholder liability, that provides the shareholders of the largest banks with a way to identify the costs of higher capital adequacy beyond simply the subsidies that come by way of the implicit governmental guarantees that the SIFIs presently enjoy. Elective shareholder liability gives SIFIs the option to subject themselves to the 15% capital adequacy, or, if not, grant a bailout exception to the SIFI’s present limited shareholder liability status. The latter is structured as an obligatory governmental cause of action for the recoupment of all bailout costs against the shareholders, assessed on a pro-rata basis. The cause of action would include an up-front stay on litigation to ensure that there are, in fact, taxpayer losses to be recouped, and to dampen government incentives for over-bailout, political manipulation, and crisis exacerbation. The cause of action would also give the government the authority to declare the shareholders’ use of the corporate form to evade liability null and void. After explaining the structure and benefits of elective shareholder liability, the Article addresses more than a dozen potential objections. Close inspection of these objections, however, reveals that the overall case for elective shareholder liability is strong as a matter of history, law, and economics.

February 20, 2011 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)