Securities Law Prof Blog

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

Friday, May 11, 2012

Schapiro on Money Market Fund Reform

SEC Chairman Mary Schapiro gave a speech at the Investment Company Institute's General Membership Meeting in which she reiterated her position that money market funds need additional regulation:  We saw what happened in 2008."  Her remarks (as reported in Investment News; the speech is not yet posted on the SEC website) suggested that she favors a floating NAV, but she says she wants to hear suggestions from the industry.  The reforms put in place in 2010 were positive but not sufficient:  "We can't sit by when we see systematic risks and not have a discussion about it."  Inv News, Schapiro sticks to her guns on money funds

Meanwhile, three SEC Commissioners (Paredes, Gallagher, and Aguilar) released a statement in opposition to an IOSCO report exploring further regulation of the money market fund industry and seeking comments:

We feel that it is important to state for the record that the Consultation Report does not reflect the views and input of a majority of the Commission. In fact, a majority of the Commission expressed its unequivocal view that the Commission’s representatives should oppose publication of the Consultation Report and that the Commission’s representatives should urge IOSCO to withdraw it for further consideration and revision. Accordingly, the Consultation Report cannot be considered to represent the views of the U.S. Securities and Exchange Commission.

(Statement concerning publication by IOSCO on April 27, 2012 of the “Consultation Report of the IOSCO Standing Committee 5 on Money Market Funds: Money Market Fund Systemic Risk Analysis and Reform Options.”)


May 11, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Thursday, May 10, 2012

SEC Charges Firm with Using Advisory Client to Rescue Hedge Fund Client

The SEC settled charges with Martin Currie, a Scotland-based fund management group, that it fraudulently used one of its U.S. fund clients to rescue another client, a China-focused hedge fund struggling in the midst of the global financial crisis.  Martin Currie agreed to pay a total of nearly $14 million to the SEC and the United Kingdom's Financial Services Authority (FSA) to settle the charges that it steered a U.S. publicly-traded fund called The China Fund Inc. into an investment to bolster the hedge fund. The hedge fund had acquired a significant and largely illiquid exposure to a single Chinese company. Martin Currie directly alleviated the hedge fund's liquidity problems by deciding to use the China Fund — to the detriment of the fund and its shareholders — in a bond transaction that reduced the hedge fund's exposure.

According to the SEC's order, the firm managed the China Fund side-by-side with the hedge fund through its SEC-registered investment adviser subsidiaries. These funds and other Martin Currie accounts made similar investments in Chinese companies under the direction of two senior portfolio managers based in Shanghai. One company was Jackin International, a printer-cartridge recycling company listed on the Hong Kong Stock Exchange.

According to the SEC's order, in June 2007, Martin Currie's lead portfolio manager in Shanghai caused the hedge fund to purchase $10 million of unlisted illiquid Jackin bonds that deviated from the fund's normal equities-trading strategy. Martin Currie improperly classified those bonds as cash in its risk-management system, and as a result the liquidity and credit risks associated with the hedge fund's exposure to Jackin weren't revealed until November 2008 after the hedge fund had purchased additional Jackin bonds. By that time, the hedge fund's total investment in Jackin had come close to breaching the fund's limit on portfolio exposure to a single issuer.

The SEC's order says that as the global financial crisis deepened, the hedge fund faced a significant increase in redemption requests by its investors, exacerbating the fund's liquidity problems. At the same time, Jackin was starved for capital to continue funding its operations and make debt payments to bondholders such as the hedge fund. In response to the hedge fund's overlapping problems, Martin Currie decided to use the China Fund to purchase $22.8 million in convertible bonds from a Jackin subsidiary. The subsidiary instantly lent $10 million of the proceeds to Jackin, which in turn redeemed $10 million in otherwise-illiquid bonds held by the troubled hedge fund. The bond transaction closed in April 2009.

According to the SEC's order, Martin Currie officials were aware that the China Fund's involvement presented a direct conflict of interest and may have been unlawful. In an attempt to cure that conflict, they sought and obtained approval from the China Fund's board of directors. However, they failed to disclose that proceeds of the fund's investment would be used to redeem bonds held by another client — the hedge fund. Martin Currie also failed to sufficiently consider whether the investment's rationale and pricing were in the China Fund's best interests.

The SEC's order noted that the China Fund's bond investment in the Jackin subsidiary turned out poorly. In April 2011, the China Fund sold the bonds for about 50 percent of their face value for a loss of $11.5 million.

The SEC's order found that Martin Currie engaged in separate improper conduct by failing to follow the China Fund's policies and procedures for fair valuing the convertible bonds at issue. Between April 2009 and October 2010, Martin Currie advised the China Fund's board to value the convertible bonds at cost ($22.8 million) while failing to disclose information that was relevant for the board to fair value the bonds.

May 10, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, May 9, 2012

SEC Charges Barred Broker with Manipulating Biopharm Stocks

David Blech was permanently barred from the securities industry in 2000 for fraud. But according to the SEC, that did not stop him from carrying out a complex market manipulation scheme in biopharmaceutical stocks. The SEC alleges that Blech established more than 50 brokerage accounts in the names of family members, friends, and even a private religious institution and used those accounts to buy and sell significant amounts of stock in two biopharmaceutical companies in order to create the artificial appearance of activity in their securities so he could maintain their market price and use it to his own financial advantage. Blech also solicited investments for biopharmaceutical companies – including the two companies whose stock he manipulated.  

According to the SEC’s complaint, Blech engaged in his scheme at various points in 2007 and 2008, specifically manipulating the stocks of Pluristem Therapeutics Inc. and Intellect Neurosciences Inc. Blech first opened dozens of nominee accounts at several broker-dealers in the names of his wife, uncle, and sister-in law as well as a longtime friend and a company he controlled, and a religious institution that is managed by Blech’s cousin. Blech then used the accounts to engage in deceptive activities and carry out matched trades in Pluristem’s and Intellect’s stocks. Blech’s activity in these thinly-traded securities artificially inflated the stock price of both companies and created the false impression of a liquid market for each company. Blech then used the artificially inflated stock price to sell off his holdings of Pluristem and Intellect through the nominee accounts, and as collateral for a line of credit he established in his wife’s name.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Blech.

The SEC’s complaint seeks a final judgment ordering Blech and his wife to disgorge their ill-gotten gains plus prejudgment interest, pay financial penalties, and be permanently enjoined from future violations of the provisions of the federal securities laws they violated. The complaint seeks orders requiring Blech to comply with a prior SEC order barring him from association with a broker or dealer, and prohibiting him from various other stock activities.

May 9, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Former Detroit Mayor in Influence Peddling Scheme

The SEC charged former Detroit mayor Kwame M. Kilpatrick, former city treasurer Jeffrey W. Beasley, and the investment adviser to the city’s public pension funds with a secret exchange of lavish gifts to peddle influence over the funds’ investment process.  According to the SEC, Kilpatrick and Beasley, who were trustees to the pension funds, solicited and received $125,000 worth of private jet travel and other perks paid for by MayfieldGentry Realty Advisors LLC, an investment adviser whose CEO Chauncey Mayfield was recommending to the trustees that the pension funds invest approximately $117 million in a real estate investment trust (REIT) controlled by the firm. Neither Kilpatrick and Beasley nor Mayfield and his firm informed the boards of trustees about these trips and the conflicts of interest they presented. The funds ultimately voted to approve the REIT investment, and MayfieldGentry received millions of dollars in management fees.

According to the SEC’s complaint, members of Kilpatrick’s administration began to exert pressure on Mayfield in early 2006 after he supported Kilpatrick’s opponent in his 2005 re-election and hired that candidate’s daughter at MayfieldGentry. Beasley met with Mayfield in February 2006 and told him he was “in the dog house” with Kilpatrick and offered to help him “clear the air.” Throughout 2007, Mayfield appeared before the boards of trustees for Detroit’s public pension funds recommending the REIT investment.  Meanwhile, the SEC alleges, MayfieldGentry began footing the bills for trips taken by Kilpatrick, Beasley and others that extended beyond business.

The SEC seeks disgorgement of ill-gotten gains, penalties, and permanent injunctions, including an injunction against Kilpatrick and Beasley to prohibit them from participating in any decisions involving investments in securities by public pensions.

May 9, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Deloitte & Touche-Shanghai for Refusal to Turn Over Audit Work Papers

The SEC announced an enforcement action against Shanghai-based Deloitte Touche Tohmatsu CPA Ltd. for its refusal to provide the agency with audit work papers related to a China-based company under investigation for potential accounting fraud against U.S. investors.  According to the SEC, the agency has been making extensive efforts for more than two years to obtain documents related to the firm’s work for the company, which issues U.S. securities registered with the SEC. The firm is charged with violating the Sarbanes-Oxley Act, which requires foreign public accounting firms to provide audit work papers concerning U.S. issuers to the SEC upon request. D&T Shanghai has nonetheless failed to provide the documents, citing Chinese law as the reason for its refusal.  SEC staff also has sought to obtain the relevant audit work papers through international sharing mechanisms, yet these efforts have been unsuccessful.

This is the first time the Commission has brought an enforcement action against a foreign audit firm for failing to comply with a Section 106 request.

May 9, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, May 8, 2012

Judge Requests Financial Information From Former Lehman Officers Before Ruling on Fairness of Proposed Settlement

Before deciding whether to approve a proposed $90 million settlement with the former directors and officers of Lehman Brothers (to be paid entirely from D&O insurance), Judge Lewis Kaplan requested additional financial information to assess the ability of the individual officer defendants to satisfy a judgment in the event the plaintiffs did not settle and ultimately prevailed.  In re Lehman Brothers Sec. & ERISA Litig. (S.D.N.Y. May 3, 2012).  The memorandum and order offers a concise description of the realties of class action settlements involving individual defendants.  (Download Lehman.050712[1])

As Judge Kaplan explains, the individual defendants began the litigation with $250 million in insurance coverage.  By the end of 2010, the remaining coverage was down to $180 million, and there were many actual and potential claims against the fund in addition to this litigation.  In settlement negotiations, the insurance carrier took the position it would only contribute to a settlement that resolved all claims against the individual defendants. The individual defendants insisted that they would not make any financial contributions to a settlement and would not disclose personal financial information to the lead plaintiffs or their counsel.   

Because lead counsel was conscious of the bad press coverage that would likely result if the individual defendants did not contribute financially to a settlement, it sought to break the impasse by engaging a former federal district court judge, Judge Martin, to determine whether the five officer defendants' combined liquid assets exceeded $100 million.  Despite the focus on liquid assets, Judge Martin required the defendants to complete net worth questionnaires that disclosed all their assets, including non-liquid assets such as secondary residences, retirement accounts, artwork, jewelry, etc.  He then answered precisely the question asked of him: he was satisfied that the liquid net worth of the officer defendants was substantially less than $100 million.

Judge Kaplan, however, determined that he did not have sufficient information to sign off on the proposed settlement.  Acknowledging that lead counsel are able and distinguished, the judge allowed that "their judgment may prove to be within the range of reasonableness despite the modest amount of the settlement when considered against these defendants' potential exposure."  But the very limited charge they gave to Judge Martin -- focusing on liquid net worth -- does not provide the court with sufficient information to determine the fairness of the proposed settlement, including "the ability of the defendants to withstand a greater judgment."

Accordingly, Judge Kaplan ordered that the defendants' personal financial information that had previously been provided to Judge Martin be turned over to the court for an in camera review.

May 8, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, May 7, 2012

Who Will Regulate Money Market Funds?

Will the SEC ever adopt tougher regulations for money market funds, in the face of intense industry resistance?  If not, will Treasury or the Fed seek other ways to regulate MM funds?  According to the Wall St. Journal, federal regulators are looking for a Plan B in the event the SEC does not act and considering whether the Financial Stability Oversight Council could take on the task.  WSJ, Regulators Seek Plan B on Money Funds

May 7, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)

GAO Reports on AIG's TARP Debt

GAO posted a further report on the government's bailout of AIG on its website: Government's Exposure to AIG Lessens as Equity Investments Are Sold (GAO-12-574, May 7, 2012).  Its summary states:

Since GAO’s last report in July 2011, more of the assistance provided by the Department of the Treasury (Treasury) and the Board of Governors of the Federal Reserve System (Federal Reserve) to benefit American International Group, Inc. (AIG) has been repaid. As of March 22, 2012, the remaining assistance to AIG was $46.3 billion, including unpaid dividends and accrued interest. This amount includes Treasury’s $35.9 billion investment in AIG common stock and a balance of $8.3 billion owed by Maiden Lane III to the Federal Reserve Bank of New York (FRBNY). This remaining assistance was down from $92.5 billion in March 2011 and $154.7 billion in December 2010. Several indicators show that as of March 2012, the government’s remaining outstanding assistance to AIG has continued to be reduced, mostly because of repayments on the FRBNY loan to Maiden Lane II; repayment of AIA Aurora, LLC, a special purpose vehicle; and sales of Treasury’s common stock in AIG. The government’s outstanding assistance to AIG is largely composed of Treasury’s common stock in AIG. Treasury’s sales of AIG stock in May 2011 and March 2012 have yielded total proceeds of $11.8 billion and reduced Treasury’s ownership to 70 percent of the company. Based on the $30.83 closing share price of AIG common stock on March 30, 2012, Treasury could recoup the total value of assistance extended to AIG and take in an additional $2.7 billion including dividends. The remaining assistance through Maiden Lane III will likely be repaid in full and net additional returns to the government. When all the assistance is considered, the amount the federal government ultimately takes in could exceed the total support extended to AIG by more than $15.1 billion. This analysis is primarily based on repayments and recoveries and market valuation of AIG’s stock and does not include estimates of subsidy costs associated with the assistance. The actual repayment of the remaining assistance continues to depend on AIG’s long-term health, the timing of Treasury’s sale and the share price of AIG stock, among other things. As Treasury arranges to sell its stock in AIG to exit the company, several indicators suggest that the most likely buyers will be institutions, many of whom already have considerable holdings in other insurance companies.

Several indicators show that in 2011, AIG had positive net income and its insurance operations were stable and profitable. AIG had a net income for 2011 of $18.5 billion, primarily attributable to an income tax benefit and divested businesses. AIG’s operating cash flows declined in 2011, which was mostly due to cash payments covering several years of accrued interest and fees on the FRBNY revolving credit facility and reduction in cash flows from the absence of a full year of operating cash flows of foreign life subsidiaries that were sold during the year. Also, payments on catastrophic loss claims and asbestos liabilities reduced operating cash flows. The indicator on AIG’s quarterly insurance operating performance shows that AIG was profitable in most quarters and that investment income contributed considerably to that profitability, including several quarters when insurance underwriting by itself was not profitable. The sustainability of any positive trends in AIG’s operations will depend on how well it manages its business in the current economic environment. GAO will continue to monitor these issues.

Treasury also recently announced that it agreed to sell about 164 million shares of AIG common stock at $30.50 in an underwritten public offering.  As part of the offering, AIG agreed to purchase about 65.5 million shares.



May 7, 2012 in News Stories | Permalink | Comments (0) | TrackBack (0)