Securities Law Prof Blog

California Court Says Brokers Can Invoke Equitable Powers to Expunge CRD Records

A California appellate court recently held that a registered representative could invoke the court's equitable and inherent powers to do justice and pursue an action to expunge his public securities brokerage records from FINRA's central registration depository database (CRD).  FINRA had maintained that there were no grounds for expungement apart from the very narrow criteria set forth in FINRA Rule 2080(b), which were not applicable here.  Lickiss v. FINRA (Cal. 1st Appel. Dist. Aug. 23, 2012) (Download Lickiss.082312[1])

The broker, Edwin Lickiss, sought expungement of 17 customer complaints and a regulatory action filed between 1991-1996 because those records were old and because 13 of the 17 customer complaints related to sales of one specific stock, whose failure was outside his control.  Asserting that he had a clean record since then, he sought expungement because he suffers professional and financial hardship because current and potential clients use the internet to obtain his BrokerCheck history.

The appellate court found that the trial court erred by relying exclusively on FINRA Rule 2080 as the grounds for expungment, since the broker had invoked the equitable powers of the court.  "The choice of a very narrow, rigid legal rule to assess the legal sufficiency of Lickiss's petition -- a choice that closed off all avenues to the court's conscience in formulating a decree and disregarded basic principles of equity -- was nothing short of an end run around equity."

As a result of this decision, commentators predict that more brokers will seek expungement of CRD records, in an effort to rewrite history and clean up their records.

Court Rules that Delaware Chancellors Serving as Arbitrators is Unconstitutional

A federal district court ruled that a Delaware law that allows the Chancellors to conduct arbitrations in business disputes is unconstitutional.  The judge ruled that since the proceeding "is essentially a civil trial," the public has a right of access to the proceedings.  In arbitration the parties "still submit their dispute to a sitting judge acting pursuant to state authority, paid by the state, and using state personnel and facilities."  There have been six cases arbitrated under the law, but there is no public record of five of them.  The arbitrations, which cost a minimum of $12,000, were expected to be an additional source of revenue for the state.

The Chancellors named as defendants said that they would appeal the ruling, which put the United States at a competitive disadvantage in providing businesses with efficient methods for resolving business disputes.

NYTimes, Judge Rules Against Arbitration by a Delaware Court

WSJ, Delaware Arbitration Procedure Overturned

SEC Releases Staff Financial Literacy Report

The SEC posted on its website a SEC Staff Study Regarding Financial Literacy Among Investors, which was mandated by Dodd-Frank section 917.( Download 917-financial-literacy-study-part1[1])  As described in the SEC's press release, 

the study draws on numerous sources, including online survey research, focus group research, public comments to the SEC, and a Library of Congress review of studies of financial literacy among U.S. retail investors.

The study identifies investor perceptions and preferences regarding a variety of investment disclosures. The study shows that investors prefer to receive investment disclosures before investing, rather than after, as occurs with many investment products purchased today. The study identifies information that investors find useful and relevant in helping them make informed investment decisions. This includes information about fees, investment objectives, performance, strategy, and risks of an investment product, as well as the professional background, disciplinary history, and conflicts of interest of a financial professional. Investors also favor investment disclosures presented in a visual format, using bullets, charts, and graphs.

As a strategy to improve financial literacy, OIEA and other FLEC participants will work jointly and collaboratively to develop programs:
o Targeting specific groups including young investors, lump sum payout recipients, investment trustees, the military, underserved populations, and the elderly;
o Promoting the importance of checking the background of investment professionals;
o Promoting Investor.gov as the primary federal government resource for investing information; and
o Promoting awareness of the fees and costs of investing.

 

SEC Charges Florida Brokers with Fraudulent Markup Scheme

The SEC charged two former brokers in Miami with fraud for overcharging customers approximately $36 million by using hidden markup fees on structured notes transactions.  According to the SEC, Fabrizio Neves, assisted by Jose Luna, conducted the scheme while working at LatAm Investments LLC, a defunct broker-dealer. The pair defrauded two Brazilian public pension funds and a Colombian institutional investor that purchased from LatAm the structured notes issued by major commercial banks.

To conceal the excessive markups that Neves charged customers, Neves directed Luna to alter the banks' structured note term sheets in half of the transactions by either whiting out or electronically cutting and pasting the markup amounts over the actual price and trade information, and then sending the forged documents to customers. Neves and Luna further concealed the egregious markups in most transactions by first purchasing the notes into accounts in the name of nominee entities they controlled in the British Virgin Islands.

The SEC also instituted an administrative proceeding against LatAm's former president Angelica Aguilera, who was the direct supervisor over Neves and Luna. The SEC's Enforcement Division alleges that Aguilera failed reasonably to supervise Neves and Luna.

Luna has agreed to the entry of a judgment ordering him to pay disgorgement of $923,704.85, prejudgment interest of $241,643.51, and a penalty amount to be determined.

SEC Proposes Rules to Eliminate Prohibition Against General Solicitation

The SEC proposed rules to eliminate the prohibition against general solicitation and general advertising in certain securities offerings. Under the proposed rules, which are mandated by the Jumpstart Our Business Startups Act, companies would be permitted to use general solicitation and general advertising to offer securities under Rule 506 of Regulation D of the Securities Act and Rule 144A of the Securities Act. (Download 33-9354[1])

The Commission will seek public comment on the proposed rules for 30 days. Shortly thereafter, the Commission will review the comments and determine whether to adopt the proposed rules.

Citigroup Agrees to Settle Securities Fraud Class Action for $590 Million

Citigroup and plaintiffs have agreed to settle for $590 million a securities fraud class action lawsuit that alleged that officers and directors "concealed the company's failure to write down impaired securities containing subprime debt" when it became apparent that the collapse in the mortgage market would require writedowns.  Citigroup issued a statement, saying it "will be pleased to put this matter behind us."  The settlement is subject to the approval of Judge Stein (S.D.N.Y.)  NYTimes, Citigroup in $590 Million Settlement of Subprime Lawsuit

Gallagher & Paredes Speak Out on Money Market Fund Reform

Unfortunately, it appears that proposals for reforming money market funds have generated not only constructive debate but considerable dissension among the SEC Commissioners.  Commissioners Gallagher and Paredes issued a joint statement yesterday, stating they were "dismayed at SEC Chairman Schapiro's August 22 statement (SEC Commissioner Aguilar had previously issued a statement, for which Commissioners Gallagher and Paredes expressed their respect for his views):

...the Chairman’s statement creates the misimpression that three Commissioners — a majority of the Commission — are not concerned with, or are somehow dismissive of, the goal of strengthening money market funds. This is wholly inaccurate.

The truth is that we have carefully considered many alternatives, including the Chairman’s preferred alternatives of a “floating NAV” and a capital buffer coupled with a holdback restriction, and we are convinced that the Commission can do better. ...

Our decision not to support the Chairman’s proposal, based on the data and analysis currently available to us, has also been informed by our concern that neither of the Chairman’s restructuring alternatives would in fact achieve the goal of stemming a run on money market funds, particularly during a period of widespread financial crisis such as the nation experienced in 2008. ...

Commisioners Gallagher and Paredes go on to suggest several reforms for further consideration:

(i) empower money market fund boards to impose “gates” on redemptions; (ii) mandate enhanced disclosure about the risks of investing in money market funds; and (iii) conduct a searching inquiry into, and a critical analysis of, the issues raised by the questions we pose below.

It remains to be seen whether the Commission has the will to deal with this contentious issue further or whether, like other controversial and difficult reforms (see uniform fiduciary duty, proxy access) it is relegated to the back burner. 

 

 

 

SEC Rethinking Quiet Period Rules

The Wall St. Journal reports that the SEC is reviewing whether to ease the restrictions on pre-IPO communications imposed on issuers and others.   This is in response to complaints that retail investors were kept in the dark about developments at Facebook prior to its IPO.  WSJ, Regulators Rethink Pre-IPO Chatter.  The WSJ also published Mary Schapiro's letter to Rep. Darrell Issa on this subject (Download Secipoletter0826[1]).

SEC's Final Rules on Resource Extraction Issuers and Conflict Minerals

The SEC has posted on its website the releases involving Disclosure of Payments by Resource Extraction Issuers (Rel. 34-67717Download 34-67717[1]) and Conflict Minerals (Rel. 34-67716Download 34-67716[1]), which were approved last week.

SEC Announces Sept. 14 Roundtable on Technology and Trading

The SEC announced it will host a one day roundtable entitled “Technology and Trading: Promoting Stability in Today’s Markets” on Sept. 14, 2012 to discuss ways to promote stability in markets that rely on highly automated systems. The roundtable will focus on the relationship between the operational stability and integrity of our securities market and the ways in which market participants design, implement, and manage complex and inter-connected trading technologies.  The roundtable discussion will be available via webcast on the Commission’s Web site.

The SEC will also accept comments on issues addressed at the roundtable until Oct. 5, 2012.

Why Did SEC Commissioner Aguilar Oppose Money Market Fund Reform?

Today's New York Times features a story on SEC Commissioner Luis Aguilar's decision to oppose SEC Chairman Schapiro's proposal to reform money market funds.  His was the swing vote on the 5-member Commission.  According to Aguilar, he objected to the approach taken by Schapiro and cited the need for additional information.  The Times reports that Aguilar has met frequently with industry representatives this year.  Aguilar also worked for the industry as an attorney from 1994-2002.  NYTimes, A Regulator’s Key Role in Failed Mutual Fund Reform

Dombalagian on Alternative Implementation of the Volcker Rule

The Expressive Synergies of the Volcker Rule, by Onnig H. Dombalagian, Tulane Law School, was recently posted on SSRN.  Here is the abstract:

In this manuscript, I propose an alternative implementation of the Volcker Rule, Section 619 of the Dodd-Frank Wall Street Reform and Customer Protection Act of 2010. The Volcker Rule restricts the proprietary trading of U.S. banks and their affiliates to certain “client-oriented” activities, such as market making. Under my proposal, federal financial regulators would implement the Rule’s “market-making-related activities” exemption to realize synergies with Dodd-Frank’s initiatives in the area of swaps regulation and the regulation of over-the-counter markets. The manuscript draws upon the academic literature regarding expressive law, the history of federal banking legislation, and the text of the Dodd-Frank Act to argue that federal financial regulators have the discretion to implement the Rule’s mandate in a manner that transcends the twin concerns of safety and soundness and mitigation of conflicts of interest. I further argue that such an implementation may well be essential to the vitality of the Volcker Rule, in light of the parsimonious implementation currently proposed by the federal financial regulators and the political forces aligned in favor of the Rule’s repeal.

Thompson & Langevoort on Public-Private Boundaries in Capital-Raising

Redrawing the Public-Private Boundaries in Entrepreneurial Capital-Raising, by Robert B. Thompson, Georgetown University Law Center, and Donald C. Langevoort, Georgetown University Law Center, was recently posted on SSRN.  Here is the abstract:

The JOBS Act is the most far-reaching legislative reform in what it means to be a public company or to make a public offering in the almost 80 years of American securities regulation. More generally, though, it exposes the shaky foundation of existing theory that guides how we have thought about dividing public from private obligations in this area of the law. And for the ’33 Act, which regulates the capital-raising portion of securities regulation, the changes spotlight a lingering identity crisis: Given the ever-expanding presence of ’34 Act regulation over the last half-century, why is there any place left for the additional regulation traditionally found in the ’33 Act?

To better understand these issues we look at the evolution of two somewhat out of the way securities transactions — reverse mergers and PIPEs — located in the transition space as companies move between the ’33 and ’34 Acts. What we see are innovative hybrid forms of capital-raising (a ’33 Act function), although clothed in a transactional setting that takes advantage of the less intense regulation of the ’34 Act. We compare these transactions against the core functions visible in securities regulation: mandatory disclosure, SEC review, restrictions on sales pressure, and liability aimed to force due diligence. When one or more of these is compromised or abandoned we ask why and if we are comfortable with what compensates for the loss? More specifically, we identify the particular concern that motivates additional regulation drawn from the ’33 Act for issuer or affiliates sales: will there be a “dump” of a large quantity of stock that will require special selling efforts, with the potential for abuse that entails? We note that these fundamental questions do not always get asked when creative lawyers and their clients claim open spaces created by technological change and aggressive marketplace innovation. Here they assume favorable regulatory treatment, of which the SEC only becomes fully aware after the practice has already been established and when it is very hard to undo the occupation.

This same structure animates our analysis of the changes made by the JOBS Act to the exemptions available under the ’33 Act. For the two new exemptions added (crowdfunding and Reg. A+) we see a balance between the efforts to promote due diligence that will protect investors and the scaled back requirements for disclosure, review and liability — perhaps so much that those exemptions will get very little use, at least by serious issuers. However, for the third major change of the Act, the removal of the general solicitation ban for offerings under Rule 506, the legislation flew in the face of the fundamentals — permitting what is likely to be intense selling efforts on the Internet and elsewhere with no due diligence or liability constraints.

Having identified special sales effort as what justifies ’33 Act regulation, we ask whether this concern might better be addressed with a more technology-driven, forward-looking rethinking of how we regulate sales practices in the securities industry that would be outside of the ’33 Act context to which we are accustomed. Our conclusion here is positive, with a condition so unlikely as to perhaps destroy its value — that sufficient regulatory resources exist for such a repositioning.

Campbell on Reg A and JOBS Act

Regulation A and the Jobs Act: A Failure to Resuscitate, by Rutheford B. Campbell Jr., University of Kentucky - College of Law, was recently posted on SSRN.  Here is the abstract:

Regulation A offers small businesses an exemption from the registration requirements of the Securities Act of 1933. The exemption is generally consistent with the obligation of the Securities and Exchange Commission to fashion exemptions that balance investor protection and capital formation. From the perspective of small businesses, the exemption may appear to provide an efficient access to external capital.

Regulation A, however, has fallen into nearly complete disuse. The millions of small businesses in this country, all of which at some point need external capital to survive and grow, simply do not use Regulation A.

Two reasons account for small businesses’ non-use of Regulation A. First, the disclosure and filing requirements for Regulation A are somewhat out of balance, unnecessarily increasing the relative offering costs. Second, and much more important, is the impact of the registration provisions of state securities laws. The added burden – and expense – of meeting the state registration requirements simply price Regulation A out of the marketplace for exemptions.

Congress recently passed the Jumpstart Our Business Startups Act (the JOBS Act). Title IV of the JOBS Act delegates to the Commission broad authority to enact new regulations that cure the problems that made Regulation A unusable.

Unfortunately, it is unlikely that the Commission will step up to its responsibility to enact regulations that provide small businesses with efficient access to external capital. Historically, the Commission has shown an unwillingness to expand by regulation the preemption of state authority over the registration of securities. Without preemption, the new regulatory regime under Title IV of the JOBS Act will be useless to small businesses in search of external capital.

Such an outcome would amount to an abdication of the Commission’s responsibilities to enact regulations that balance investor protection and capital formation.

Barry et alia on Derivatives Markets & Social Welfare

On Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership, by Jordan M. Barry, University of San Diego School of Law; John William Hatfield, Stanford Graduate School of Business; and Scott Duke Kominers, University of Chicago - Becker Friedman Institute for Research in Economics, was recently posted on SSRN.  Here is the abstract:

The prevailing view among many economists is that derivatives markets simply enable financial markets to incorporate information better and faster. Under this view, increasing the size of derivatives markets only increases the efficiency of financial markets.

We present formal economic analysis that contradicts this view. Derivatives allow investors to hold economic interests in a corporation without owning voting rights, or vice versa. This leads to both empty voters — investors whose voting rights in a corporation exceed their economic interests — and hidden owners — investors whose economic interests exceed their voting rights. We show how, when financial markets are opaque, empty voting and hidden ownership can render financial markets unpredictable, unstable, and inefficient. By contrast, we show that when financial markets are transparent, empty voting and hidden ownership have dramatically different effects. They cause financial markets to follow predictable patterns, encourage stable outcomes, and can improve efficiency. Our analysis lends insight into the operation of securities markets in general and derivatives markets in particular. It provides a new justification for a robust mandatory disclosure regime and facilitates analysis of proposed substantive securities regulations.

SEC Scraps Staff Proposal to Reform Money Market Funds

There will be no money market fund reform anytime soon, as SEC Chairman Schapiro released this statement yesterday:

Three Commissioners, constituting a majority of the Commission, have informed me that they will not support a staff proposal to reform the structure of money market funds. The proposed structural reforms were intended to reduce their susceptibility to runs, protect retail investors and lessen the need for future taxpayer bailouts.

SEC Will Take Up Money Market Funds, Solicitation Rule Next Week

Will the SEC propose next week to reform money market funds?  SEC Chairman Schapiro says changes are necessary to avoid the "break the buck" panic of the last financial crisis, but industry -- and at least two fellow Commissioners -- are opposed.  According to the Wall St. Journal, Commissioner Aguilar is the swing vote, and he's not talking.  WSJ, SEC to Confront the Money-Fund Dilemma

The SEC will also consider proposed rules that would implement the JOBS Act and allow solicitations under Reg D at its August 29 meeting. 

FAQs from SEC JOBS Act & Research Analysts & Underwriters

Jumpstart Our Business Startups Act: Frequently Asked Questions About Research Analysts and Underwriters, Division of Trading and Markets (August 22, 2012)

In these Frequently Asked Questions (“FAQs”), the Division of Trading and Markets (“staff”) is providing guidance on certain provisions of the Jumpstart Our Business Startups Act (“JOBS Act”) as they affect firms and their obligations with respect to securities analysts (“analysts”) and research reports. These FAQs are not rules, regulations or statements of the Commission. The Commission has neither approved nor disapproved these FAQs.

SEC Adopts Conflict Minerals & Resource Extraction Issuer Rules

The SEC approved today two disclosure rules that are required by Dodd-Frank: (1) the conflict minerals rule and (2) the resource extraction issuer rule.

(1) The conflict minerals rule requires companies to publicly disclose their use of conflict minerals that originated in the Democratic Republic of the Congo (DRC) or an adjoining country.  Dodd-Frank directed the Commission to issue rules requiring certain companies to disclose their use of conflict minerals that include tantalum, tin, gold, or tungsten if those minerals are “necessary to the functionality or production of a product” manufactured by those companies. Companies are required to provide this disclosure on a new form to be filed with the SEC called Form SD.  The SEC included a Fact Sheet in the release.  Chairman Schapiro's Opening Statement.  Paredes' Dissenting Statement.

(2) The SEC also adopted rules requiring resource extraction issuers to disclose certain payments made to the U.S. government or foreign governments.  Dodd-Frank directed the Commission to issue these rules requiring companies engaged in the development of oil, natural gas, or minerals to disclose the information annually by filing a new form with the SEC called Form SD.

FINRA Fines Rodman & Renshaw for Interactions between Research and Investment Banking

FINRA announced that it fined Rodman & Renshaw LLC $315,000 for supervisory and other violations related to the interaction between the firm's research and investment banking functions. Rodman's former CCO, William A. Iommi Sr., was fined $15,000, suspended from acting in a principal capacity for 90 days and must requalify as a general securities principal.

FINRA found that, because of deficiencies in the firm's supervisory system, there were at least two incidents where a research analyst participated in efforts to solicit investment banking business, and another incident where a research analyst attempted to arrange a payment from a public company. FINRA also sanctioned the two research analysts involved. 

Rodman, the New York-based broker-dealer subsidiary of Direct Markets Holdings Corp., provides investment banking services, including Private Investments in Public Entities (PIPEs) and registered direct offerings, to public and private companies. It also provides research, sales and trading services to institutional investors and therefore must have supervisory and compliance procedures to monitor potential conflicts of interest between research and investment banking, given concerns that research analysts could be pressured to tailor their coverage to the interests of a firm's current or prospective investment banking clients.