Securities Law Prof Blog

SEC Will Decide Whether Janus Applies to Enforcement Actions under 33 Act

The SEC has decided to review an administrative enforcement proceeding that raises the important issue of whether the Janus definition of "maker" applies to fraud claims brought by the SEC under the Securities Act.(Download Flannery.33-9307[1])

An administrative law judge previously dismissed administrative proceedings against John P. Flannery, formerly Fixed Income Chief Investment Officer for the Americas at State Street Global Advisors (a division of State Street Bank and Trust Company ("State Street")), and James D. Hopkins, formerly Vice President and head of North American Product Engineering of State Street (collectively, "Respondents").  In reaching her determination, the law judge concluded, in a case of first impression in administrative proceedings, that the construction of the words "to make" in Rule 10b-5 in Janus Capital Group, Inc. v. First Derivative Traders also applied to fraud claims brought by the Division.  The ALJ further concluded that Fund investors were sophisticated institutional investors and she considered that factor when evaluating the materiality element of the Division's allegations of fraud.

The Commission's order states:

The proceeding raises important legal and policy issues by presenting us with a case of first impression regarding the applicability of the Supreme Court's holding in Janus to claims other than those brought pursuant to Exchange Act Rule 10b-5(b). The proceeding also raises the issue of whether investor sophistication is relevant to an analysis of liability under the antifraud provisions of the federal securities laws in a Commission enforcement proceeding.

SEC Releases Organizational Reform Report Required by Dodd Frank 967

The SEC posted on its website the Report on the Implementation of SEC Organizational Reform Recommendations As Required by Section 967 of the Dodd–Frank Wall Street Reform and Consumer Protection Act. (Download Secorgreformreport-2012-df967[1])

The Report explains that it

is provided pursuant to the requirements of section 967(c) of the Dodd-Frank Act. Section 967(c) requires periodic reports on the “implementation of the regulatory and administrative recommendations contained in” a consultant’s report required by section 967(b) of the Dodd-Frank Act. The Commission has expressed no view as to whether or how any recommendation contained in that consultant’s report should be implemented.
Moreover, no Commissioner other than the Chairman has had any substantive involvement in the “Mission Advancement Program” (MAP) or the activities of the SEC staff and contractors outlined in this report. The Commission has not endorsed any assessment, determination, method, analysis, finding, or conclusion contained herein. The Commission was not consulted on the decision to hire the consultant advising as to the MAP project or the cost and scope thereof.
The MAP is the responsibility of the SEC’s Chief Operating Officer, who reports directly to the Chairman. The Commission has not made any determination that this report is accurate or complete. The Commission’s vote to provide this report to the Congress does not imply any concurrence in or endorsement of any aspect of this report or the activities it describes.

Former Bristol Myers CFO Settles SEC's "Channel-Stuffing" Charges

On March 27, 2012, a federal district court in New Jersey entered final judgments against Frederick S. Schiff, former CFO of Bristol-Myers Squibb Co. (Bristol Myers) and Richard J. Lane, former President of the Worldwide Medicines Group for Bristol Myers.   According to the Commission’s complaint, for the period January 1, 2000 through December 31, 2001, Schiff and Lane deceived the investing public about the true performance, profitability and growth trends of Bristol Myers and at their direction, Bristol Myers engaged in a “channel-stuffing” scheme. The complaint alleged that Bristol Myers used financial incentives to induce wholesalers to buy its pharmaceutical products in excess of prescription demand in order to artificially inflate its results, which in turn was necessary in order to meet Bristol Myers’ internal earnings targets and the consensus earnings estimates of Wall Street securities analysts.

Schiff and Lane consented to the entry of the final judgments without admitting or denying the allegations of the Commission’s complaint. Schiff is required to pay disgorgement plus prejudgment interest totaling $130,992, and is  barred from serving as an officer or director of a public company for one year. Lane is required to pay disgorgement plus prejudgment interest totaling $36,750, and is barred from serving as an officer or director of a public company for one year.

Happy 75 to Rule 10b-5!

The SEC Historical Society will be featuring the 75th anniversary of Rule 10b-5 on its website in April.

Read the minutes of the Commission meeting adopting 10b-5. For a behind the scenes view, read Mayer Newfield’s February 8, 1996 letter to Milton Freeman; both were present at the Commission meeting.

To learn more about the use and impact of 10b-5, visit the 10b-5 section in the “Fair To All People: The SEC and the Regulation of Insider Trading” Gallery; access the Insider Trading section in “The Bright Image: The SEC, 1961-1973” Gallery, or listen to the May 22, 2007 Fireside Chat on Insider Trading.

SEC Historical Society Presents Webcast on Ponzi Schemes

The SEC Historical Society has an interesting live audio program on Ponzi Schemes coming up.  For more information, visit its website.

Ponzi Scheme Puzzles

Wednesday, April 11th, 2:00 – 3:00 pm ET.

Moderator
Eric Roiter
Boston University School of Law and Boston College School of Law
Trustee-Elect, SEC Historical Society

Presenters
Tamar Frankel, Boston University School of Law
Donald Langevoort, Georgetown University Law Center
Francis Morrissey, Morrissey Wilson & Zafiropoulos LLP

 

Supreme Court Fails to Resolve Whether Equitable Tolling Extends 16(b) Liability for Short-Swing Profits

The U.S. Supreme Court recently addressed the issue of the two-year statute of limitations under section 16(b) of the Securities Exchange Act, although it decided little in the opinion except that the Ninth Circuit was wrong.  Credit Suisse Securities (USA) LLC v. Simmonds (No. 10-1261 Mar. 26, 2012).  The Ninth Circuit had ruled below that the limitations period is tolled until the insider files the section 16(a) disclosure statement "regardless of whether the plaintiff knew or should have known of the conduct at issue."

The Supreme Court, however, held that even assuming that the two-year period can be extended (an issue on which the Court was equally divided), the Ninth Circuit erred in determining that it is tolled until a section 16(a) statement is filed.  The Ninth Circuit's ruling was not supported by the text of section 16(b) -- from "the date such profit was realized" -- or the principle of equitable tolling for fraudulent concealment.  The Court remanded for the lower courts to consider in the first instance how usual equitable tolling rules apply in this case.

Judge Rakoff Rejects Gupta's Motion to Exclude Wiretaps From Insider Trading Prosecution

In U.S. v. Gupta, the government's insider trading case against former P&G director (and friend of Raj Rajaratnam) Rajat Gupta, Judge Jed Rakoff made a number of rulings on March 27.  The most significant is that he denied the defendant's motion to suppress wiretaps and the evidence derived from them at his criminal trial.  Judge Rakoff noted that Rajaratnam had made a similar motion in his criminal trial which Judge Holwell had denied.  While Judge Holwell's opinion has no preclusive effect on Gupta, nevertheless, Judge Rakoff found it persuasive, particularly since it was the same wiretaps at issue and Gupta made the same arguments as Rajaratnam.  First, Gupta argued that insider trading is not an offense as to which wiretapping is authorized under the statute.  But the wiretap also had the "bona fide" purpose of investigating wire fraud, an offense for which the statute does permit wiretapping, and so long as the government acted in good faith with respect to the crimes it is investigating and learning of in connection with the wiretap, the government is free to use the evidence obtained in an authorized wiretap in the prosecution of other crimes.  Second, Gupta argued that Judge Holwell failed to appreciate the seriousness of the government's failure to inform the judge who issued the initial wiretap of the parallel SEC investigation.  Like Judge Holwell, Judge Rakoff found the error harmless:  "the simple truth is that ... insider trading cannot often be detected, let alone successfully prosecuted, without the aid of wiretaps."

Judge Rakoff also ruled that the SEC had to turn over its notes on interviews with witnesses testimony to the DOJ, for their review and transmittal of any exculpatory material to the defense.  The judge rejected DOJ's argument that the SEC and DOJ investigations were separate and thus the SEC's notes were not covered by the DOJ's Brady obligations.

JOBS Act Goes to President

Yesterday the House approved the Senate version of H.R. 3606, the so-called JOBS Act, and so the bill goes to the President for signing.   The Senate version made changes to the crowdfunding provision, but otherwise it remains the same terrible piece of legislation that amounts to a significant weakening of investor protections.  My previous blog is here.  (Download JOBS Act)

Senator Bachus allowed that the crowdfunding provision "gave us more concern than anything else" and that "we'll see how this goes."  I predict the next time Congress looks at crowdfunding will be too late, after many small investors have been defrauded by slick promoters.

SEC & Medical Device Company Settle FCPA Charges

The SEC and Biomet Inc. settled charges that the medical device company violated the Foreign Corrupt Practices Act (FCPA) when its subsidiaries and agents bribed public doctors in Argentina, Brazil, and China for nearly a decade to win business.  Biomet, which primarily sells products used by orthopedic surgeons, agreed to pay more than $22 million to settle the SEC’s charges as well as parallel criminal charges announced by the U.S. Department of Justice today. The charges arise from the SEC and DOJ’s ongoing global investigation into medical device companies bribing publicly-employed physicians.

The SEC alleges that Biomet and its four subsidiaries paid bribes from 2000 to August 2008, and employees and managers at all levels of the parent company and the subsidiaries were involved along with the distributors who sold Biomet’s products. Biomet’s compliance and internal audit functions failed to stop the payments to doctors even after learning about the illegal practices.

Biomet consented to the entry of a court order requiring payment of $4,432,998 in disgorgement and $1,142,733 in prejudgment interest. Biomet also is ordered to retain an independent compliance consultant for 18 months to review its FCPA compliance program.  Biomet agreed to pay a $17.28 million fine to settle the criminal charges.

Rapp on the SOX Whistleblower Provision

Mutiny by the Bounties? The Attempt to Reform Wall Street by the New Whistleblower Provisions of the Dodd-Frank Act, by Geoffrey Christopher Rapp, University of Toledo - College of Law, was recently posted on SSRN.  Here is the SSRN:

The 2010 Dodd-Frank Act authorizes the Securities and Exchange Commission (SEC) to pay bounties to whistleblowers. This provision answers a call made by a number of legal scholars. The whistleblower protections of the 2002 Sarbanes-Oxley Act (SOX) had proven ineffective in stimulating insiders to report corporate and financial fraud. Unfortunately, time may reveal that Dodd-Frank, like SOX before it, was a missed opportunity. The new bounty program is limited to cases in which the SEC obtains $1 million in enforcement sanctions, an overly restrictive condition in an era when the SEC shows a continued preference for non-monetary penalties like cease-and-desist orders and obey-the-law junctions and an increasing preference for “therapeutic” sanctions. More fundamentally, however, the new whistleblower law fails to create true qui tam structures akin to those in the Federal False Claims Act. Whistleblowers under the new law lack the essential ability to direct litigation independent of federal authorities. This Article proposes an Informer’s Act model as a corrective measure to help Dodd-Frank fulfill its potential.

Becker et alia on Firm Value and Shareholder Proxy Access

Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge, by Bo Becker, Harvard Business School; National Bureau of Economic Research (NBER); Daniel Bergstresser, Harvard Business School;  and Guhan Subramanian, Harvard Business School, was recently posted on SSRN.  Here is the abstract:

We use the Business Roundtable’s challenge to the SEC’s 2010 proxy access rule as a natural experiment to measure the value of shareholder proxy access. We find that firms that would have been most vulnerable to proxy access, as measured by institutional ownership and activist institutional ownership in particular, lost value on October 4, 2010, when the SEC unexpectedly announced that it would delay implementation of the Rule in response to the Business Roundtable challenge. We also examine intra-day returns and find that the value loss occurred just after the SEC’s announcement on October 4. We find similar results on July 22, 2011, when the D.C. Circuit ruled in favor of the Business Roundtable. These findings are consistent with the view that financial markets placed a positive value on shareholder access, as implemented in the SEC’s 2010 Rule.

Padfield on Corporate Theory in Citizens United

The Silent Role of Corporate Theory in the Supreme Court’s Campaign Finance Cases, by Stefan J. Padfield, University of Akron School of Law, was recently posted on SSRN.  Here is the abstract:

In Citizens United v. Federal Election Commission, a 5-4 majority of the Supreme Court held that corporate political speech could not be regulated on the basis of corporate status alone. In support of that conclusion, the majority characterized corporations as mere “associations of citizens.” The dissent, meanwhile, viewed corporations as state-created entities that “differ from natural persons in fundamental ways” and “have been effectively delegated responsibility for ensuring society’s economic welfare." I have argued previously that these two competing conceptions of the corporation implicate corporate theory, with the majority adopting an aggregate/contractarian view, and the dissent an artificial entity/concession view. Even if one understands Citizens United to be primarily about listeners’ rights, this stark contrast of competing theories of the corporation is difficult to ignore. At the very least, what the majority and dissent thought about corporate speakers was relevant to the question of whether the campaign finance restrictions challenged in Citizens United should fall within that narrow class of speech restrictions justified on the basis of the speaker’s identity due to “an interest in allowing governmental entities to perform their functions.” Somewhat surprisingly, however, the majority was silent, and the dissent expressly disavowed, any role for corporate theory. I have previously offered some explanations for this apparent inconsistency, and concluded that an active “silent corporate theory debate” was indeed integral to the outcome of Citizens United - despite protestations to the contrary. In this project, I examine the key Supreme Court cases leading up to Citizens United to see whether a similar silent corporate theory debate is evident in those cases. I find that there is indeed such an on-going debate, and proceed to argue that in future cases involving the rights of corporations the justices should make their views regarding the proper theory of the corporation express. This will allow for a more meaningful discussion of the merits of those decisions, and impose an additional layer of intellectual accountability on the jurists.

Karmel on IOSCO's Response to Financial Crisis

Iosco's Response to the Financial Crisis, by Roberta S. Karmel, Brooklyn Law School, was recently posted on SSRN.  Here is the abstract:

Like other international financial bodies, the International Organization of Securities Commissions (IOSCO) has responded to the financial crisis of 2008. IOSCO thus revised its Objectives and Principles and added eight new Principles, including two that specifically focused on systemic risk. IOSCO’s ongoing efforts to support these new Principles are parallel to efforts by other financial regulators to deal with systemic risk. Yet, IOSCO’s efforts focus on somewhat different issues in the capital markets than the issues of interest to bank regulators.

This article will outline IOSCO’s Objectives and Principles and explain how they were revised in response to the financial crisis of 2008. The article also will discuss certain key initiatives where a lack of harmonization would be detrimental to effective regulation, in the regulation of hedge funds, credit rating agencies, short selling, and technological innovations, including direct electronic access, dark pools, and high frequency trading. These topics have been selected because they are not within the traditional purview of bank regulators and they are securities regulatory concerns related to systemic risk in the capital markets.

An important issue is whether IOSCO can successfully raise standards in these controversial areas in the face of political pressure from market players and competition between capital market centers. This article concludes that IOSCO harmonization efforts tend to be at a level of generality that may be an insufficient prod to regulatory reform. When national interests are at stake, securities regulators follow those interests rather than IOSCO directives. Since IOSCO has no enforcement mechanisms aside from peer pressure, and its members are so numerous and varied, it is unrealistic to expect rigorous and detailed harmonization of new standards of conduct or regulation. Nevertheless, IOSCO can play a useful role in highlighting critical emerging areas where securities regulation is in need of reform and it has done so with regard to a number of systemic risk issues in the trading markets.

Foster & Ward on Going Concern Evaluations after SOX

Are Auditors' Going-Concern Evaluations More Useful after SOX?, by Benjamin P. Foster, University of Louisville - College of Business and Public Administration, and Terry J. Ward, Middle Tennessee State University, was recently posted on SSRN.  Here is the abstract:

Bankruptcy risk is a crucial factor in auditors’ decisions whether or not to modify their audit opinion based on the going-concern assumption. SOX required more extensive audit procedures than those required before its passage. More extensive audit procedures should result in more meaningful audit reports. This study examines whether the auditors’ going-concern opinion provides more useful incremental information after SOX than before SOX in distinguishing between distressed companies that become bankrupt in the next year and those that do not. We find that an audit opinion variable adds more useful information to bankruptcy prediction models after SOX than before SOX. Our findings provide evidence that financial statement users have derived benefits from the costly procedures required under SOX.

Templin on Chinese Reverse Mergers

Chinese Reverse Mergers, Accounting Regimes, and the Rule of Law in China, by Benjamin A. Templin, Thomas Jefferson School of Law, was recently posted on SSRN.  Here is the abstract:

 In 2010, federal regulators and politicians became increasingly concerned over the accounting practices of Chinese companies that trade on U.S. stock exchanges. In particular, the Securities and Exchange Commission (“SEC”) targeted companies that went public through a process called the reverse merger. The instances of fraud became so widespread, regulators and commentators coined the term Chinese Reverse Merger (“CRM”) in order to describe a sector where investors assume the risk of accounting irregularities. Although CRMs must comply with international accounting standards, a weak rule of law in China has resulted in poor implementation and enforcement of its accounting regime. U.S. regulators are hindered in policing accountants since the auditing occurs in China, where they have no jurisdiction. This article explores two related questions: (1) the degree to which China’s weak rule of law as to its accounting regime can be explained by its political economy, and (2) whether U.S. regulatory actions and market responses might help drive change in the quality and enforcement of accounting laws in China?

Given the evidence from the CRM scandal, it is clear that China's institutionalized corruption and weak rule of law can be traced to the development of its political economy. Five factors that contributed to the CRM accounting fraud scandal include: (1) Chinese insularity, (2) poor implementation of accounting standards by Chinese regulators, (3) shortages in skilled accountants/auditors and a lack of quality in the accounting profession, (4) lack of enforcement of accounting standards because of a weak regulator and a weak judiciary, and (5) lack of jurisdiction by U.S. enforcement officials.

Given the rapid pace of economic growth in China, there may be little incentive in the near term for China to strengthen the rule of law as to its accounting regime. Although some economists contend that a developing country may experience growth in the absence of a strong rule of law, such growth is not likely to be sustainable. The market, naturally, acts as an informal adjudicator. When investors drive down the price of CRMs by selling the stock, they send a message that China authorities have to more strictly enforce accounting standards inorder to avoid a risk premium. Additionally, U.S. lawmakers and regulators should consider passing even stricter laws and regulations than already taken in order to better regulate countries that have a systemic problem in financial reporting. Stricter requirements will advance the goal of U.S. securities laws to protect investors and would also create incentives for Chinese regulators to start enforcing their own laws in order to provide easier access for Chinese firms to U.S. capital markets.

Problems at BATS

The IPO of BATS Global Markets did not get off to a good start today.  BATS operates two electronic exchanges in the U.S. which account for about 11-12% of all U.S. equity trading.  Selling sharerholders are offering about 6.3 million shares, which were priced Thursday at $16 per share.  The Wall St. Journal's lead story today reports on an SEC investigation into whether high-frequency traders use connections with computerized exchanges to gain an unfair advantage and specifically names BATS.  WSJ, SEC Probes Rapid Trading.  Then the IPO was halted on Friday morning after Nasdaq reported "erroneous trades" in BATS stock, and BATS itself reported problems with trading errors in Apple stock.  WSJ, BATS IPO Halted After Erroneous Trades

NASAA Calls JOBS Act "an Investor Protection Disaster Waiting to Happen"

NASAA's view on the JOBS Act: 

NASAA: The JOBS Act an Investor Protection Disaster Waiting to Happen
Legislation Remains Fundamentally Flawed Product of Rush to Legislate

Senate Passes JOBS Act

The Senate passed the JOBS Act yesterday by a vote of 73-26.  Because there are some differences from the House Bill, the versions must be reconciled.  This legislation appears to be on a fast track, so this may occur next week, and President Obama is expected to sign it.

Its supporters say the bill will create jobs, although I have not seen any factually-based support for this assertion.  The bill weakens significant investor protections, as many have pointed out in the past few weeks, including Professor John Coffee (Columbia Law), Professor Harvey Goldschmid (Columbia Law and former SEC Commissioner), Professor Simon Johnson (MIT) and SEC Chair Mary Schapiro.

There are three provisions that I find especially troubling.  First, the legislation creates a category of "emerging growth companies," defined as companies with less than $ 1 Billion of annual gross revenues.  Experts estimate this accounts for 90% of publicly traded companies.  Emerging growth companies are exempt from many important financial disclosure and accounting requirements, including the SOX 404(b) requirement that an independent auditor assess internal controls.

Second, the restrictions on research reports and securities analysts' communications are eliminated with respect to these emerging growth companies.  You'll remember that analysts' cheerleading for IPOs was one of the scandals of the dot.com bubble and bust.

Third, the act authorizes "crowdfunding," which, according to Professor Coffee, essentially legalizes boiler room operations.  It permits unregulated offerings of securities up to $1 million to small investors.  The House version limits each investor's participation to $10,000 or 10% of annual income (whichever is less); the Senate version is the greater of $2,000 or 5% of income or net worth if either figure is less than $100,000.  Apparently the philosophy is that if the amount is small enough, unsophisticated investors can be defrauded.

This is dreadful legislation.  Congress has no memory of past frauds, and both Republicans and Democrats alike want to jump on the deregulatory bandwagon under the banner of job creation.

Senate Approves House Version of STOCK Act

The Senate voted (96-3) for legislation that bans insider trading by members of Congress and their staff by establishing that they owe a duty of trust and confidence to Congress, the federal government and U.S. citizens.  The Senate accepted the version approved by the House (417-2) and thus does not include certain additional provisions that were contained in the original Senate version, including regulation of the "political intelligence" community.  The bill requires disclosure of purchases and sales within 45 days of the transaction.  NYTimes, Insider Trading Ban for Lawmakers Clears Congress

The Senate also passed the JOBS legislation which must still be reconciled with the House version.  I will write more about this in a later post.

U Cincinnati Presents Symposium on Dodd-Frank March 30

The 25th Annual Corporate Law Symposium at the University of Cincinnati College of Law will be held on March 30.  The topic is Implementing the Dodd-Frank Wall St. Reform and Consumer Protection Act, and the panelists represent a variety of viewpoints from the academic, policy-making and legal communities.  If you are in the Cincinnati area, we would love to see you!  It will also be webcast.

(Download CLSProgramFINAL)