Securities Law Prof Blog

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

Friday, April 20, 2012

SEC Plans to Charge Ratings Firm with Lying in SEC Filing

Egan-Jones Ratings Co. says that the SEC will file an administrative action against the rating firm soon.  The charges stem from the firm's 2008 application to the SEC to rate bonds and asset-backed securities; the firm allegedly lied about how many securities it rated and for how long.  Penalties could include cancelling the firm's ability to issue officially recognized ratings for those classes of securities.  Egan-Jones denies all charges.

Egan-Jones is one of nine credit-rating firms approved by the SEC.

WSJ, Ratings Firm Is in SEC Sights

April 20, 2012 in News Stories, SEC Action | Permalink | Comments (0) | TrackBack (0)

Thursday, April 19, 2012

Fed Confirms Two-Year Period to Conform Activities to Volcker Rule

The Fed issued a statement today clarifying the conformance period for the Volcker Rule:

The Federal Reserve Board on Thursday announced its approval of a statement clarifying that an entity covered by section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the so-called Volcker Rule, has the full two-year period provided by the statute to fully conform its activities and investments, unless the Board extends the conformance period.

Section 619 generally requires banking entities to conform their activities and investments to the prohibitions and restrictions included in the statute on proprietary trading activities and on hedge fund and private equity fund activities and investments.

Section 619 required the Board to adopt rules governing the conformance periods for activities and investments restricted by that section, which the Board did on February 9, 2011. Subsequently, the Board received a number of requests for clarification of the manner in which this conformance period would apply and how the prohibitions will be enforced. The Board is issuing this statement to address this question.

The Board’s conformance rule provides entities covered by section 619 of the Dodd-Frank Act a period of two years after the statutory effective date, which would be until July 21, 2014, to fully conform their activities and investments to the requirements of section 619 of the Dodd-Frank Act and any implementing rules adopted in final under that section, unless that period is extended by the Board.

The Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodity Futures Trading Commission (the agencies) plan to administer their oversight of banking entities under their respective jurisdictions in accordance with the Board’s conformance rule and the attached statement. The agencies have invited public comment on a proposal to implement the Volcker rule, but have not adopted a final rule.

April 19, 2012 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges OX Trading & optionsXpress with Registration Violations

The SEC charged OX Trading LLC, a Chicago-based securities dealer affiliated with online brokerage firm optionsXpress, with violating the registration provisions of the securities laws when it continued trading operations after delisting from the Chicago Board Options Exchange (CBOE) and deregistering with the SEC, apparently to avoid an audit.  In administrative proceedings against OX Trading LLC, optionsXpress, and their former CFO Thomas E. Stern, the SEC alleged that OX Trading operated as an unregistered dealer from October 2009 to November 2010 and illegally transacted in securities while not a member of a national securities association or national exchange from March 2009 to November 2010.

Earlier this week, the SEC charged optionsXpress and Stern for their roles in a naked short selling scheme.

OX Trading, which originally registered with the SEC in 2008, was created to provide price improvement on orders from optionsXpress customers and to profit from those trades. According to the SEC’s order, a CBOE examiner conveyed to Stern in early 2009 that OX Trading was required to have an annual audit based on its CBOE membership status. Despite CBOE’s request, Stern refused to pay for an audit and subsequently terminated OX Trading’s CBOE membership on March 2, 2009. Nonetheless, OX Trading continued to conduct the same trading through a customer portfolio margin account at optionsXpress.

According to the SEC’s order, OX Trading and optionsXpress became wholly-owned subsidiaries of The Charles Schwab Corporation in September 2011.

April 19, 2012 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Wednesday, April 18, 2012

SEC Adopts Rule Defining Swaps-Related Terms for Regulating Derivatives

The SEC unanimously adopted a new rule to define a series of terms related to the over-the-counter swaps market.  The rules, written jointly with the Commodity Futures Trading Commission (CFTC), implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that established a comprehensive framework for regulating derivatives.

The SEC has posted on its website a fact sheet on the new definitions.  The rule will become effective 60 days after the date of publication in the Federal Register.

April 18, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Looks to Hire More Economists

SEC Chair Mary Schapiro described recent SEC efforts to improve its economic analysis in rulemaking, In her testimony before a House congressional committee on April 17.  She referred to recent guidance prepared by the SEC's Risk, Strategy, and Financial Innovation Division and its Office of General Counsel (which, although news reports say it was distributed at the hearing, is not posted on the SEC's website) and provided to other Divisions and Offices to improve the process.  The guidance has also been provided to the Commissioners for their input.

In her testimony Ms. Schapiro discusses the difficulties of quantifying potential economic effects, often because of lack of suitable data and the difficulties of predicting how market participants will respond to a proposed regulation.

She also discussed a recent GAO report that "appeared to conclude" that the SEC had adopted a bright-line policy not to consider the economic effects of statutorily-mandated portions of Dodd-Frank rules.  While disputing that the SEC had such a policy, she noted that the new guidance states that divisions should consider the overall economic impacts, including both those attributable to Congressional mandates and those that result from an exercise of the agency's discretion.

She goes on to discuss the specific steps that are included in the new guidance.  In particular, she emphasized the strengthened role that economists will play in rulemakings and that the agency expects to hire at least 20 additional economists in the near future.

April 18, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC's Corp Fin Provides Guidance on JOBS Act's "Emerging Growth Companies"

Staff from the SEC's Division of Corporation Finance posted on its website Jumpstart Our Business Startups Act Frequently Asked Questions: Generally Applicable Questions on Title I of the JOBS Act (April 16, 2012).

April 18, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Final Call for Papers: National Business Law Scholars Conference


National Business Law Scholars Conference  
June 27-28, 2012
University of Cincinnati College of Law
The deadline has been extended for the National Business Law Scholars Conference (NBLSC), formerly known as the Midwest Corporate Legal Scholars Conference.  The planners of the event have received an enthusiastic response from over three dozen academics from across the nation who plan to attend.

The event will be held on Wednesday, June 27th and Thursday, June 28th at University of Cincinnati College of Law in Cincinnati, Ohio.  We welcome all on-topic submissions and will attempt to provide the opportunity for everyone to actively participate. 

The conference will feature a panel discussion: "Good, Bad or Stupid: The STOCK and JOBS Acts." Panelists (to date) include Steven Davidoff (Ohio State), Joan Heminway (Tennessee), and Donna Nagy (Indiana-Bloomington).

To submit a presentation, email Professor Eric C. Chaffee at [email protected] with an abstract or paper by May 25, 2012.  Please title the email “NBLSC Submission – {Name}”.  If you would like to attend, but not present, email Professor Chaffee with an email entitled “NBLSC Attendance”.  Please specify in your email whether you are willing to serve as a commentator or moderator.  A conference schedule will be circulated in early June.

Conference Organizers:

Barbara Black
Eric C. Chaffee
Steven M. Davidoff

April 18, 2012 in Professional Announcements | Permalink | Comments (1) | TrackBack (0)

Tuesday, April 17, 2012

Schapiro Testifies on Economic Analysis in SEC Rulemaking

Testimony Concerning Economic Analysis in SEC Rulemaking
by SEC Chairman Mary L. Schapiro, Before the Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs Oversight and Government Reform Committee, U.S. House of Representatives (April 17, 2012)

April 17, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Takes Up Joint CFTC Rules on Swap Dealers Tomorrow

The SEC is holding an open meeting on April 18, 2012.  The subject matter of the Open Meeting will be:

The Commission will consider whether to adopt joint rules with the Commodity Futures Trading Commission relating to the definitions of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant,” and “Eligible Contract Participant.”


April 17, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Proposes Expungement Procedures for Unnamed Brokers

FINRA is requesting comment on proposed new rules that would permit brokers who are the “subject of” allegations of sales practice violations made in arbitration claims, but who are not named as parties to the arbitration, to seek expungement relief by initiating  In re expungement proceedings at the conclusion of the underlying customer-initiated arbitration case. These allegations must be reported in the same way that customer complaints are reported—to the Central Registration Depository (CRD®) system on Forms U4 or U5. Currently, the Code of Arbitration Procedure for Customer Disputes (Customer Code) and the Code of Arbitration Procedure for Industry Disputes (Industry Code) (together, Codes) do not provide unnamed persons with express procedures to seek expungement of these types of allegations. 

According to FINRA, the proposed In re expungement rules and accompanying forms provide unnamed persons with a remedy to seek redress concerning allegations that could impact their livelihoods, yet maintain the protections of FINRA’s expungement rules to ensure the integrity of the CRD records, on which the investing public relies.

The Comment Period expires May 12, 2012.


April 17, 2012 in Other Regulatory Action, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Citigroup Shareholders Vote No on Executive Pay

At the Citigroup annual meeting, shareholders disapproved of the company's plan to pay $15 million in compensation to CEO Vikram Pandit.  The nonbinding shareholder vote, required by Dodd-Frank, is the first time shareholders at a large financial institution voted against a board's compensation plan.  NYTimes, Citigroup Shareholders Reject Executive Pay Plan

April 17, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, April 16, 2012

SEC Posts FAQ on Title I of JOBS Act

The SEC posted on its website Jumpstart Our Business Startups Act: Frequently Asked Questions
Generally Applicable Questions on Title I of the JOBS Act

The SEC explains that:

In these Frequently Asked Questions, the Division of Corporation Finance is providing guidance on the implementation and application of the JOBS Act, based on our current understanding of the JOBS Act and in light of our existing rules, regulations and procedures. These FAQs are not rules, regulations or statements of the Commission. Further, the Commission has neither approved nor disapproved these FAQs.

These FAQs address questions of general applicability under Title I of the JOBS Act. Title I provides scaled disclosure provisions for emerging growth companies, including, among other things, two years of audited financial statements in the Securities Act registration statement for an initial public offering of common equity securities, the smaller reporting company version of Item 402 of Regulation S-K, and no requirement for Sarbanes-Oxley Act Section 404(b) auditor attestations of internal control over financial reporting. Title I also enables emerging growth companies to use test-the-waters communications with QIBs and institutional accredited investors and liberalizes the use of research reports on emerging growth companies.

April 16, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges optionsXpress with Abusive Naked Short Selling Scheme

The SEC charged optionsXpress, an online brokerage and clearing agency specializing in options and futures, as well as four officers and a customer, with an abusive naked short selling scheme.  According to the SEC, optionsXpress failed to satisfy its close-out obligations under Regulation SHO by repeatedly engaging in a series of sham “reset” transactions designed to give the illusion that the firm had purchased securities of like kind and quantity. The firm and customer Jonathan I. Feldman engaged in these sham reset transactions in a number of securities, resulting in continuous failures to deliver.

Regulation SHO requires the delivery of equity securities to a registered clearing agency when delivery is due, generally three days after the trade date (T+3). If no delivery is made by that time, the firm must purchase or borrow the securities to close out the failure-to-deliver position by no later than the beginning of regular trading hours on the next day (T+4).

The former chief financial officer at optionsXpress – Thomas E. Stern – was also named in the SEC’s administrative proceeding against the firm and Feldman, while three other optionsXpress officials – head of trading and customer service Peter J. Bottini and compliance officers Phillip J. Hoeh and Kevin E. Strine – were named in a separate administrative proceeding and settled the charges against them for their roles in the scheme.

According to the SEC’s order, the misconduct occurred from at least October 2008 to March 2010. In September 2011, optionsXpress became a wholly-owned subsidiary of The Charles Schwab Corporation.

April 16, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Sunday, April 15, 2012

Is Crowdfunding the New Lottery?

Marc Wilson, a former Kansas securities regulator, has written a column in which he is cautiously optimistic about the crowdfunding exemption, but warns that

Like the lottery, both investors and entrepreneurs must ask themselves if they are playing, or getting played by, the crowd.

April 15, 2012 in News Stories | Permalink | Comments (2) | TrackBack (0)

Lubben on Resolution of Large Financial Firms

Resolution, Orderly and Otherwise: B of A in OLA, by Stephen J. Lubben, Seton Hall University - School of Law, was recently posted on SSRN.  Here is the abstract:

What precisely does it mean to “resolve” financial distress in a complex financial institution? What are the goals – liquidation, reorganization, or simple contagion avoidance? And, more precisely, how might such a resolution look under realistic conditions? This paper begins to examine these issues through a practical exercise: by examining the legal and financial structure of a specific, actual financial institution (Bank of America). What this analysis reveals is that no matter how complex Lehman was, the remaining “too big to fail” financial institutions are infinitely more complex. The exercise reveals some serious doubts about the ability of Dodd-Frank to perform in its most idealized way, it also shows how the Bankruptcy Code, at least as currently drafted, would be equally unsuited to the task. Moreover, this paper explain why adapting the code to the resolution of large financial institutions would involve something far more substantial than a few “tweaks,” as is often suggested. Ultimately it would involve adopting something that takes many features from both OLA and Chapter 11, while applying the name bankruptcy to the resulting beast.

April 15, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Alces & Galle, on the Efficiency of Inside Debt

Is Inside Debt Efficient? Theory and New Evidence from CEO Pensions and Deferred Compensation, by Kelli A. Alces, Florida State University College of Law, and Brian D. Galle, Boston College Law School, was recently posted on SSRN.  Here is the abstract:

The average publicly-traded firm pays its CEO millions of dollars in deferred compensation and defined-benefit pension commitments. Scholars debate whether firms use these payments to efficiently align managerial interests with those of creditors, or whether instead they represent “hidden” forms of rent extraction. Yet others recommend these forms of debt-like incentive compensation, sometimes called “inside debt,” as a way of controlling risk-taking in systemically important financial institutions.

We argue instead that inside debt is unlikely to be efficient in either setting. Inside debt is costlier and more complex than other tools for managing risk, such as covenants or simply cutting back on option pay, and gives managers opportunities to hedge their equity positions without revealing that fact to investors. Drawing on the behavioral literature, we also show that increasing pay complexity is likely to reduce the efficacy of all forms of manager incentives.

To test these hypotheses, we conduct a series of panel regressions utilizing matched CEO and firm data covering over 1300 firms during the period 2007 to 2009. Under most specifications, we find little evidence that current borrowing needs correspond with executive pay structures. We do find, however, significant relations between the use of pensions and markers of managerial power, markers of board risk aversion, and lagged firm debt levels.

April 15, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Squire on Collective Settlements of Shareholder Suits

How Collective Settlements Camouflage the Costs of Shareholder Lawsuits, by Richard Squire, Fordham Law School, was recently posted on SSRN.  Here is the abstract:

Settlements of shareholder lawsuits suffer from a collective action problem. Public corporations insure against liability by buying tiered coverage from multiple liability insurers, with each insurer covering a different slice of the potential damages in shareholder lawsuits. Current law, however, requires that any lawsuit settlement be a single resolution that collectively binds the defendant and all of its insurers. This combination of segmented coverage and collective settlements produces a conflict of interests: some insurers are better off if a case goes to trial, while other insurers — and the corporation’s managers — are better off if it settles pre-trial for the expected damages. To overcome this obstacle to settlement, courts often require an insurer to pay its full policy amount when the plaintiff makes a settlement demand that exceeds that amount and another insurer (or the corporation) is willing to pay the rest. This “duty to contribute,” encourages plaintiff overcompensation at the insurer’s expense, leading to overpriced liability insurance, lawsuits of doubtful merit, and insurer underspecialization. These costs would be avoided if settlements were de-collectivized, with the corporate defendant and each insurer able to settle separately with the plaintiff. Yet corporate managers probably prefer the status quo. By overcoming insurer resistance to pre-trial settlement, collectivized settlements shield reported corporate earnings — and the managers' incentive-based pay — from the impact of large settlement payments in shareholder lawsuits.

April 15, 2012 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Friday, April 13, 2012

GAO Finds Continuing Significant Internal Controls Deficiencies at SEC

The GAO released another report on the SEC entitled Improvements Needed in SEC's Internal Controls and Accounting Procedures (GAO-12-424R, Apr 13, 2012).  Here is what it found:

In our audit of SEC’s fiscal years 2011 and 2010 financial statements, we identified four significant deficiencies in internal control as of September 30, 2011. These significant internal control deficiencies represent continuing deficiencies concerning controls over (1) information systems, (2) financial reporting and accounting processes, (3) budgetary resources, and (4) registrant deposits and filing fees. These significant control deficiencies may adversely affect the accuracy and completeness of information used and reported by SEC’s management. We are making a total of 10 new recommendations to address these continuing significant internal control deficiencies.

We also identified other internal control issues that although not considered material weaknesses or significant control deficiencies, nonetheless warrant SEC management’s attention. These issues concern SEC’s controls over:

•payroll monitoring,
•implementation of post-judgment interest accounting procedures,
•accounting for disgorgement and penalty transactions, and
•the government purchase card program.
We are making a total of 9 new recommendations related to these other internal control deficiencies.

We are also providing summary information on the status of SEC’s actions to address the recommendations from our prior audits as of the conclusion of our fiscal year 2011 audit. By the end of our fiscal year 2011 audit, we found that SEC took action to fully address 38 of the 66 recommendations from our prior audits, subsequent to our March 29, 2011, management report.

Lastly, we found that SEC took action to address and resolve all four weaknesses in information systems controls that we identified in public and “Limited Official Use Only” reports issued in 2008 through 2009 that were reported as open at the time of our March 29, 2011, management report.


April 13, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Thursday, April 12, 2012

SEC Charges "Social Capitalist" with Running Ponzi Scheme

The SEC charged Ephren W. Taylor II, a self-described “Social Capitalist,” with running a Ponzi scheme that targeted socially-conscious investors in church congregations.  The SEC also charged City Capital Corporation and its former chief operating officer, Wendy Connor, who along with Taylor received hundreds of thousands of dollars from investors in salary and commissions.

According to the SEC’s complaint filed in federal court in Atlanta, Taylor strenuously cultivated an image of a highly successful and socially conscious entrepreneur. He marketed himself as “The Social Capitalist” and touted that he was the youngest black CEO of a public company and the son of a Christian minister who understands the importance of giving back. He authored three books and appeared on national television programs, and promoted his investment opportunities through live presentations, Internet advertisements, and radio ads. For instance, Taylor conducted a multi-city “Building Wealth Tour” during which he spoke to church congregations including Atlanta’s New Birth Church and at various wealth management seminars.

According to the SEC, Taylor made numerous false statements to lure investors into two investment programs being offered through City Capital Corporation, where he was the CEO. Instead of investor money going to charitable causes and economically disadvantaged businesses as promised, Taylor secretly diverted hundreds of thousands of dollars to publishing and promoting his books, hiring consultants to refine his public image, and funding his wife’s singing career.

The SEC alleges that more than $11 million that Taylor and City Capital raised from hundreds of investors nationwide from 2008 to 2010 was used to operate the Ponzi scheme. Investor money was misused to pay other investors, finance Taylor’s personal expenses, and fund City Capital’s payroll, rent, and other costs. City Capital’s business ventures were consistently unprofitable, and no meaningful amounts of investor money were ever sent to charities.

The SEC’s complaint seeks disgorgement, financial penalties and permanent injunctive relief against City Capital, Taylor, and Connor as well as officer and director bars against Taylor and Connor.

April 12, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Another Congressional Hearing on the SEC

The House Committee on Oversight and Government Reform has announced an April 17 hearing on "The SEC's Aversion to Cost-Benefit Analysis."  The website does not identify who will be testifying at the hearing.

April 12, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)