Securities Law Prof Blog

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

Friday, July 29, 2011

Financial Stability Oversight Council Issues Annual Report on Current State of U.S. Financial System

The Financial Stability Oversight Council released its 2011 Annual Report. Under the Dodd-Frank Act, the Council must report annually to Congress on a range of issues, including the activities of the Council; significant financial market and regulatory developments; and potential emerging threats to the financial stability of the United States. The report must also make recommendations for promoting market discipline; maintaining investor confidence; and enhancing the integrity, efficiency, competitiveness, and stability of U.S. financial markets.
In this first annual report, the Council describes the current state of the U.S. financial system and some of the major forces that will shape its development going forward. The report also includes recommendations for additional steps that should be taken to complement these efforts and further strengthen the financial system. Those recommendations include:
1)      Heightened risk management and supervisory attention
Construct robust capital, liquidity and resolution plans.
Bolster resilience to unexpected interest rate shifts.
Maintain discipline in credit underwriting standards.
Employ appropriate due diligence for emerging financial products.
Keep pace with competitive, technological, and regulatory market structure developments.

2)      Reforms to address structural vulnerabilities
Implement structural reforms to mitigate run risk in money market funds. 
Elimination of most intraday credit exposure and reform of collateral practices in the tri-party repo market to strengthen the market.
Improve the overall quality of mortgage servicing by establishing national mortgage servicing standards and servicer compensation reform.

3)      Continued progress on housing finance
To strengthen the housing finance system, the Council member agencies and the Department of Housing and Urban Development should set forth standards and guidelines for participants in the housing finance system, and other actions that strengthen mortgage underwriting.
To give further confidence to the market and provide long-term stability to the U.S. financial system, the Council believes Congress must pass responsible legislation to reform the housing finance system. The reform efforts should not further destabilize the fragile housing market.

July 29, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Arbitration Rule Would Broaden Arbitrators' Authority to Make Disciplinary Referrals

FINRA recently filed with the SEC a proposed rule change to amend Rule 12104 of the Code of Arbitration Procedure for Customer Disputes (“Customer Code”) and Rule 13104 of the Code of Arbitration Procedure for Industry Disputes (“Industry Code”) to broaden arbitrators’ authority to make referrals during an arbitration proceeding.  Currently, Rule 12104(b) of the Customer Code and Rule 13104(b) of the Industry Code state, in relevant part, that any arbitrator may refer to FINRA for disciplinary investigation any matter that has come to the arbitrator’s attention during and in connection with the arbitration only at the conclusion of an arbitration.  As FINRA explains, "in light of well publicized securities frauds that resulted in harm to investors, FINRA has reviewed the Customer and Industry Codes (together, Codes) and determined that its rules on arbitrator referrals should be amended to permit arbitrators to make referrals during an arbitration proceeding, rather than solely at the conclusion of a matter as is currently the case." 

July 29, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Re-Proposes Rules on Shelf-Eligibility Conditions for ABS

The SEC re-proposed for public comment proposed rules requiring greater accountability and enhanced quality around asset-backed securities (ABS) when issuers seek to use an expedited registration process known as shelf registration.  The SEC initially proposed rules in April 2010 to significantly revise the regulatory regime for ABS. Subsequent to that proposal, the Dodd-Frank Act was signed into law and addressed some of the same ABS concerns. In light of those Dodd-Frank Act provisions and comments received from the public, the SEC re-evaluated its initial proposals.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Adopts Rule Eliminating Use of Credit Ratings as Eligibility Criteria for S-3

The SEC unanimously adopted new rules to conform to Dodd-Frank's mandate to reduce reliance on credit ratings as eligibility criteria for companies seeking to use “short form” registration (S-3 and F-3) when registering securities for public sale.  Companies currently qualify to use these forms if they are registering an offering of non-convertible securities, such as debt securities, that have received an investment grade rating by at least one nationally recognized statistical rating organization (NRSRO).

The new rules eliminate the credit ratings criteria and replace it with four new tests, one of which must be satisfied for an issuer to use Form S-3 or Form F-3. In order to ease transition for companies, the rules include a temporary, three-year grandfather provision.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Adopts Rule Requiring Large Trader Reporting

The SEC unanimously adopted a new rule establishing large trader reporting requirements to enhance the agency’s ability to identify large market participants, collect information on their trading, and analyze their trading activity.  The new rule requires large traders to identify themselves to the SEC, which will then assign each trader a unique identification number. Large traders will provide this number to their broker-dealers, who will be required to maintain transaction records for each large trader and report that information to the SEC upon request.

The new rule has two primary components:

  • it requires large traders to register with the Commission through a new form, Form 13H.
  • it imposes recordkeeping, reporting, and limited monitoring requirements on certain registered broker-dealers through whom large traders execute their transactions.

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

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Staff Report Finds Lack of Supervision in Selling Structured Products to Retail Investors

The SEC released a staff report identifying common weaknesses seen in sales of structured securities products and describing measures by broker-dealers to better protect retail investors from fraud and abusive sales practices.  The report summarizes the results of a sweep examination of the retail structured securities products business of 11 broker-dealers, covering a cross-section of the industry.

Among other things, the staff observed that broker-dealers might have:

  • recommended unsuitable structured securities products to retail investors;
  • traded at prices disadvantageous to retail investors;
  • omitted material facts about structured securities products offered to retail investors;
  • engaged in questionable sales practices with customers.

The report notes that there appears to have been a lack of training requirements for supervisors and registered representatives that market structured products to their customers. The report contains recommendations for improved surveillance of sales practices and enhanced training for sales and supervisory personnel.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Diageo Settles FCPA Charges with SEC for $16 Million

The SEC recently charged London-based Diageo plc, one of the world’s largest producers of premium alcoholic beverages, with widespread violations of the Foreign Corrupt Practices Act (FCPA) stemming from more than six years of improper payments to government officials in India, Thailand, and South Korea.  The SEC found that Diageo paid more than $2.7 million to obtain lucrative sales and tax benefits relating to its Johnnie Walker and Windsor Scotch whiskeys, among other brands. Diageo agreed to pay more than $16 million to settle the SEC’s charges. The company also agreed to cease and desist from further violations of the FCPA’s books and records and internal controls provisions.

The SEC’s order found that Diageo violated Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934. Without admitting or denying the findings, Diageo agreed to cease and desist from further violations and pay $11,306,081 in disgorgement, prejudgment interest of $2,067,739, and a financial penalty of $3 million. Diageo cooperated with the SEC’s investigation and implemented certain remedial measures, including the termination of employees involved in the misconduct and significant enhancements to its FCPA compliance program.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Fines SunTrust $5 Million for ARS Practices

The FINRA recently announced that it fined SunTrust Robinson Humphrey, Inc. (SunTrust RH) and SunTrust Investment Services, Inc. (SunTrust IS) for violations related to the sale of auction rate securities (ARS). SunTrust RH, which underwrote the ARS, was fined $4.6 million for failing to adequately disclose the increased risk that auctions could fail, sharing material non-public information, using sales material that did not adequately disclose the risks associated with ARS, and having inadequate supervisory procedures and training concerning the sales and marketing of ARS. SunTrust IS was fined $400,000 for having deficient ARS sales material, procedures and training.

FINRA found that beginning in late summer 2007, SunTrust RH became aware of stresses in the ARS market that raised the risk that auctions might fail. At the same time, SunTrust RH was told by its parent, SunTrust Bank, to reduce its use of the bank's capital and began to examine whether it had the financial capability in the event of a major market disruption to support all ARS in which it acted as the sole or lead broker-dealer. As these stresses increased, the firm failed to adequately disclose the increased risk to its sales representatives while encouraging them to sell SunTrust RH-led ARS issues in order to reduce the firm's inventory. As a result, certain SunTrust RH sales representatives continued to sell these ARS as safe and liquid. In February 2008, SunTrust RH stopped supporting ARS auctions, knowing that those auctions would fail and the ARS would become illiquid.

 In addition, both SunTrust RH and SunTrust IS used advertising and marketing materials that were not fair and balanced, and did not provide a sound basis for evaluating all the facts about purchasing ARS. Specifically, the materials did not contain adequate disclosure of all the risks of ARS, including adequately disclosing the risk that ARS auctions could fail, rendering the investments illiquid for substantial periods of time. Both firms failed to maintain adequate supervisory procedures and training concerning their sales and marketing of ARS. 

This action concludes the agreements in principle with FINRA that were previously announced in Sept. 2008 and withdrawn in May 2009. SunTrust RH and SunTrust IS voluntarily repurchased approximately $381 million and $262 million of ARS, respectively, from their customers after FINRA began its investigation. In addition, as part of the settlements, the firms will participate in a special FINRA-administered arbitration program for eligible investors to resolve investor claims for consequential damages.



July 29, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

RBS Agrees to Fed Reserve Order to Improve Oversight of U.S. Operations

The Federal Reserve Board recently announced the issuance of a joint consent cease and desist order by and among The Royal Bank of Scotland Group plc, Edinburgh, Scotland (RBS Group), a registered bank holding company, and The Royal Bank of Scotland plc, Edinburgh, Scotland (RBS plc), a foreign bank, and its branches in New York and Connecticut.  In addition to the Federal Reserve Board, the order is being issued by the New York State Banking Department, the State of Connecticut Department of Banking, and the State of Illinois Department of Financial and Professional Regulation.

The order requires the RBS Group to improve its oversight of its U.S. operations and also requires RBS plc and RBS N.V. to improve risk-management practices and compliance with Bank Secrecy Act and anti-money laundering requirements at their U.S. branches.

July 29, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, July 26, 2011

Is There Proxy Access After Business Roundtable v. SEC?

On July 22, the D.C. Circuit, a court that has previously vacated SEC rules for inadequate cost-benefit analysis, issued its harshest criticism yet of the agency when it vacated the proxy access rule for failure to consider the rule's effect upon efficiency, competition and capital formation.  The opinion is only 10 pages long, and Judge Ginsburg devotes himself to heaping criticism and scorn on the agency's failure to consider adequately its economic effects.  Business Roundtable v. SEC (D.C. Cir. July 22, 2011). To paraphrase just a snippet of the opinion:  the agency "inconsistently and opportunistically" framed the costs and benefits; failed adequately to quantify certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself and failed to respond to substantial problems raised by commenters, etc.  You get the drift of the opinion.

What's next for proxy access?  The SEC has not previously sought an en banc hearing or certiorari in those instances where the D.C. Circuit vacated rules, so that option seems unlikely.  It could, as with the previous efforts (variable annuity contracts and investment company boards with majority of independent directors), simply give up.  Activist shareholder groups, however, fought hard for proxy access and are not likely to give up the fight.  The agency can go back to the drawing board and attempt to develop a record on cost-benefit analysis that will satisfy the D.C. Circuit, but that will be a difficult, time-consuming task, given the numerosity of the court's criticisms, which has made it clear that it will not give the agency any benefit of the doubt.  (Jay Brown has demonstrated that this is inconsistent with the APA's arbitrary and capricious standard.)  Alternatively, the SEC might consider adopting a weaker version to encourage, but not mandate, proxy access that might pass muster with the business community and the D.C. Circuit.

In any event, morale must be low today at the SEC, as this is yet another black mark on Mary Schapiro's administration.

July 26, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Thursday, July 21, 2011

SEC & CFTC Seek Comments on International Swap Regulation

Section 719(c) of the Dodd-Frank Act requires the CFTC and the SEC jointly to study and then report to Congress on swap regulation and clearinghouse regulation in the United States, Asia, and Europe and to identify areas of regulation that are similar and other areas of regulation that could be harmonized. The report also must identify major dealers, exchanges, clearinghouses, clearing members, and regulators in each geographic area and describe the major contracts (including trading volumes, clearing volumes, and notional values), methods for clearing swaps, and the systems used for setting margin in each geographic area. In connection with the study and report, the CFTC and SEC issued a request for information through public comment.

July 21, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Report on Risk Management Supervision of Designated Clearing Entities

The CFTC, the SEC, and the Board of Governors of the Federal Reserve System (the Board) released their report on Risk Management Supervision of Designated Clearing Entities under Section 813 of the Dodd-Frank Act.  Section 813 requires that the CFTC and the SEC coordinate with the Board to jointly develop risk management supervision programs for clearing entities that have been identified as systemically important by the Financial Stability Oversight Council (the Council).

Section 813 also requires the CFTC, the SEC, and the Board to make recommendations in four areas:
(1) improving consistency in the DCE oversight programs of the SEC and CFTC,

(2) promoting robust risk management by DCEs,

(3) promoting robust risk management oversight by regulators of DCEs, and

(4)improving regulators’ ability to monitor the potential effects of DCE risk management on the stability of the financial system of the United States.

July 21, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Releases Report on Reliance on Credit Ratings

The SEC released a staff Report on Review of Reliance on Credit Ratings As Required by Section 939A(c) of the Dodd-Frank Wall Street Reform  and Consumer Protection Act.  The report describes various proposed rules to amend rules and forms in response to the enactment of Section 939A.

July 21, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former Galleon Trader Cardillo Settles SEC Insider Trading Charges

On July 18, 2011, a judgment was entered against Michael Cardillo in SEC v. Michael Cardillo,  an insider trading case in which the SEC charged Cardillo, a trader at the hedge fund investment adviser Galleon Management, LP during the relevant time period, with using inside information to trade ahead of the September 2007 announced acquisition of 3Com Corp. and the November 2007 announced acquisition of Axcan Pharma Inc.

In its complaint, the SEC alleged that Arthur Cutillo and Brien Santarlas, two former attorneys with the international law firm of Ropes & Gray LLP, misappropriated from their law firm material, nonpublic information concerning the acquisitions of 3Com and Axcan, and tipped the inside information, through another attorney, to Zvi Goffer, a former proprietary trader at Schottenfeld Group LLC, in exchange for kickbacks. The SEC further alleged that Goffer tipped information about these acquisitions to Craig Drimal, a trader who worked out of the offices of Galleon, who tipped the information to Cardillo. As alleged in the complaint, Cardillo then traded in the securities of 3Com and Axcan on behalf of a Galleon hedge fund.

To settle the SEC’s charges, Cardillo agreed to pay disgorgement of $58,520 plus $9,523 in prejudgment interest, and a civil penalty of $29,260. In a related SEC administrative proceeding, Cardillo consented to the entry of an SEC order barring him from association with any investment adviser, broker, dealer, municipal securities dealer, or transfer agent. Cardillo previously pled guilty to charges of securities fraud and conspiracy to commit securities fraud in a related criminal case and is awaiting sentencing.

July 21, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Massachusetts Charges RBC Capital Markets with Improper Sales of Leveraged ETFs

The Massachusetts Securities Division recently filed a complaint against RBC Capital Markets charging it with dishonest sales of leveraged and inverse leveraged exchange traded funds.


July 21, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Senate Celebrates D-F's 1st Anniversary by Holding a Hearing

This is the first anniversary of Dodd-Frank, and so, of course, some Congressional committee had to hold a hearing about it; in this case, the Senate Committee on Banking, Housing and Urban Affairs.  Here is the list of announced testifiers:

           The Honorable Barney Frank (D-MA), Ranking Member, House Financial Services Committee
          The Honorable Neal S. Wolin, Deputy Secretary, U.S. Department of the Treasury
            The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal Reserve System
            The Honorable Mary Schapiro, Chairman, U.S. Securities and Exchange Commission
            The Honorable Gary Gensler, Chairman, Commodity Futures Trading Commission
            The Honorable Martin J. Gruenberg, Acting Chairman, Federal Deposit Insurance Corporation
            Mr. John Walsh, Acting Comptroller of the Currency, Office of the Comptroller of the Currency

Here is SEC Chair Schapiro's testimony: “Enhanced Oversight After the Financial Crisis: The Wall Street Reform Act at One Year,” 

Here is Federal Reserve Chairman Ben S. Bernanke's testimony 

Here is CFTC Chairman Gensler's testimony.

Here is the testimony of Deputy Secretary, Treasury, Wolin.

July 21, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC & CFTC Announce Roundtable on International Issues Relating to D-F Title VII

The staffs of the SEC and the CFTC will hold a joint public roundtable on August 1 to discuss international issues related to the implementation of Title VII of the Dodd-Frank Act. They released an agenda and stated that panelists will be announced at a later date.  They are also soliciting public comments.

Session I – Cross-Border Transactions

Application of requirements to foreign and domestic entities
Reporting requirements
Mandatory clearing and trading requirements 

Session II – Global Entities

Registration as a swap or security-based swap dealer or major swap or security-based swap participant.
Substantive requirements.
Regulation of transactions versus regulation of entities.
Effect of international regulatory differences on global entities.

Session III – Market Infrastructure

Registration of clearing agencies, trade data repositories, execution facilities and exchanges.
Substantive requirements.
Effect of international regulatory differences on market infrastructure.

July 21, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Rejects Enforcement's Proposed Settlement of Clawback Case

The Washington Post reports that the SEC Commissioners rejected a proposed settlement negotiated by its enforcement division that would have resolved an enforcement action brought against Maynard Jenkins, the former CEO of CSK Auto, in 2009 to claw back about $4 million received by Jenkins during the period when its financial statements misstated the company's profitability.  The enforcement action occasioned some publicity because it is the first time the SEC has sought to claw back compensation from an executive who is not personally accused of wrongdoing.  (SOX 304 requires executives to return to their company bonus-based compensation if the company subsequently has to restate its financials, without a finding of wrongdoing on the part of the CEO.)  The enforcement division reportedly recommended a settlement for less than half the amount originally demanded.  WPost, SEC rejects proposal by its enforcement staff to settle landmark ‘clawback’ suit

July 21, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

Wednesday, July 20, 2011

SEC Takes Up Dodd-Frank Rules at July 26 Meeting

The SEC announced its agenda for an Open Meeting on July 26, 2011:

Item 1: The Commission will consider whether to adopt Rule 13h-1 and Form 13H under Section 13(h) of the Securities Exchange Act, to establish a large trader reporting system to identify market participants that conduct a substantial amount of trading activity and collect information on their trading.

Item 2: The Commission will consider whether to adopt amendments to rules and forms under the Securities Act of 1933 and Schedule 14A under the Securities Exchange Act of 1934, to replace references to credit ratings with alternative criteria. These amendments are in light of Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Item 3: The Commission will consider whether to re-propose rules related to shelf-eligibility for asset-backed securities and request additional comment on an outstanding proposal to require asset-level information about pool assets.

Item 4: The Commission will consider whether to adopt rule and form amendments under the Securities Exchange Act of 1934 and the Investment Company Act of 1940 to require an institutional investment manager that is subject to Section 13(f) of the Securities Exchange Act to report annually how it voted proxies relating to executive compensation matters as required by Section 14A of the Securities Exchange Act, which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act.


July 20, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Former Pitney Bowes Exec Settles Insider Trading Charges

The SEC settled charges that Howard B. Wildstein, a former Pitney Bowes, Inc. executive, engaged in insider trading in the stock of MapInfo Corporation in advance of the March 15, 2007 public announcement that Pitney Bowes had entered into a definitive agreement to acquire MapInfo.

According to the SEC's complaint, in late February 2007, Wildstein learned that MapInfo was a potential target of Pitney Bowes and that executives of Pitney Bowes who were responsible for mergers and acquisitions had recently visited MapInfo. On March 1 and March 2, 2007, based on this material nonpublic information, Wildstein purchased 8,000 shares of MapInfo common stock. After the acquisition was publicly announced, Wildstein sold all 8,000 shares, realizing an unlawful profit of $51,177.

The settlement requires Wildstein to pay a total of $114,848 in disgorgement, prejudgment interest, and civil penalties. The settlement is subject to approval by the court.

July 20, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)