Securities Law Prof Blog

Occupy the SEC Sues Agencies to Compel Implementation of Volcker Rule

Members of Occupy the SEC, an unincorporated association that advocates for regulatory reforms in the banking and financial system, have filed suit against Ben Bernanke and other financial regulators in federal district court (E.D.N.Y.), seeking declaratory, injunctive and mandamus relief to compel defendants to issue a joint Final Rulemaking under 12 U.S.C. 1851 or Dodd-Frank 619 (the "Volcker Rule").  Plaintiffs assert that almost three years have passed since the enactment of Dodd-Frank and defendants have yet to finalize regulations implementing the Volcker Rule.  They allege that although some banks have pared down their proprietary trading activities, other banks have not done so, thereby putting at risk money that is held by bank depositors like the plaintiffs.  They assert this violates the mandatory provision that specifies that defendants "shall" adopt rules implementing the provisions of  Dodd-Frank 619 within nine months after completing a study by the FSOC relating to the Volcker Rule, which study was completed in January 2011.  Plaintiffs further assert they have exhausted their administrative remedies, since Occupy the SEC previously issued a 325 page comment letter petitioning the agencies to avoid "any delay in [the Rule's] full and aggressive implementation."  The complaint also alleges that SEC Commissioner Gallagher recently stated publicly that he believed the agencies would be better off prioritizing other matters.  Taylor v. Bernanke, Case 1:13-cv-01013-ARR-JMA Filed 02/26/13

The complaint is available at

http://www.occupythesec.org/files/OSECVolckerComplaint.pdf

 (Thanks to Jennifer Taub for alerting me to this)

China-Based Company and Former CFO Settle SEC Accounting Charges

The SEC and Keyuan Petrochemical, a China-based petrochemical company, and its former chief financial officer settled charges of accounting and disclosure violations, with defendants agreeing to pay more than $1 million.  According to the SEC, Keyuan Petrochemicals, which was formed through a reverse merger in April 2010, systematically failed to disclose to investors numerous related party transactions involving its CEO, controlling shareholders, and entities controlled by management or their family members. Keyuan also operated a secret off-balance sheet cash account to pay for cash bonuses to senior officers, travel and entertainment expenses and an apartment rental for the CEO, and cash and non-cash gifts to Chinese government officials.

The SEC further alleges that Keyuan’s then-CFO Aichun Li, who lives in North Carolina, played a role in the company’s failure to disclose the related party transactions. Li was hired to ensure the company’s compliance with U.S. accounting and financial reporting regulations, and she received information and encountered red flags that should have indicated that the company was not properly identifying or disclosing related party transactions. Despite such knowledge, Li signed Keyuan’s registration statements and quarterly reports that failed to disclose material related party transactions.

Keyuan agreed to pay a $1 million penalty and Li agreed to pay a $25,000 penalty to settle the SEC’s charges. They consented to the entry of a judgment permanently enjoining them from violations of the respective provisions of the Securities Act and Exchange Act. Li also agreed to be suspended from appearing or practicing as an accountant before the Commission with the right to apply for reinstatement after two years. The proposed settlement, in which Keyuan and Li neither admit nor deny the charges, is subject to court approval.

UCLA Search for Executive Director -- Lowell Milken Institute

UCLA School of Law has posted a position for Executive Director of its Lowell Milken Institute for Business Law & Policy.  This is a full-time, academic, non-tenure track position.  Attached is the complete job posting. (Download Job posting_Executive Director of the Lowell Milken Institute for Business Law Policy rev 2-27-13)

Supreme Court Decides Amgen and Gabelli

The U.S. Supreme Court announced two decisions today involving federal securities law issues. 

In Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, the Court held that proof of materiality is not a prerequisite to certification of securities fraud class actions.  While I will have more to say about this opinion later, it is a significant victory for the plaintiffs' securities bar. (Download Amgen opinion)

According to the court, the "pivotal inquiry ...  is whether proof of materiality is needed to ensure that the questions of law or fact common to the class will 'predominate over any questions affecting only individual members' as the litigation progresses."  The Court answered its question "no" for two reasons: First, because materiality is judged according to an objective standard, it can be proved through evidence common to the class. Second, a failure of proof on the common question of materiality would not result in individual questions predominating. Instead, it would end the case, for materiality is an essential element of a securities fraud claim. The Court rejected defendants' calls to require proof of materiality on policy grounds, noting that Congress had determined not to undo the "fraud-on-the-market" theory that allowed for federal securities fraud class actions.  Justice Ginsburg wrote the opinion; three Justices (Scalia, Thomas and Kennedy) dissented. 

The SEC, however, suffered a defeat in Gabelli v. SEC, in which the Court unanimously held that the five year statute of limitations applicable to government actions seeking civil penalties begins to run when the fraud occurs and not when it is discovered.  The Court found this was the natural reading of the statutory language.  In addition, there were sound policy reasons not to read into the statute a discovery rule exception.  In particular, such an extension "would leave defendants exposed to Government enforcement actions not only for five years after their misdeeds, but for an additional uncertain period into the future." ( Download Gabelli)

FINRA Enforcement Will Appeal Charles Schwab Victory

As readers of this blog know, last week a FINRA hearing officer refused to enforce FINRA's rules prohibiting broker-dealers from including class action waivers in their customers' agreements, in a big win for Charles Schwab.  FINRA Enforcement announced today it will appeal the decision to FINRA's National Adjudicatory Council.

Trustee for Medical Capital Notes Settles Investors' Claims for $114 Million

Medical Capital aggressively marketed its promissory notes in "private placements" to thousands of unsophisticated investors from 2003-2007, in what was almost certainly a Ponzi scheme.  Medical Cap collapsed in 2009 after the SEC charged it with fraud, and investors have brought numerous lawsuits and arbitration proceedings against brokers and other intermediaries.  Yesterday the Bank of New York Mellon Corp., a trustee for Medical Cap notes, agreed to pay $114 million to investors.  Investors claimed that Med Cap executives used the account as their personal piggy bank and the bank received substantial fees for its services.  A lawsuit against another trustee, Wells Fargo, continues.

Investment News, Bank of NY Mellon to pay $114M in private-placement settlement

Judge Enjoins Vote of Apple Shareholders on Certificate Amendments

I have previously discussed David Einhorn's lawsuit against Apple, charging that the company violated federal proxy rules because its proposal to amend the company's certificate of incorporation violated the SEC's unbundling rule.  The proposal, if adopted, would amend the certificate of incorporation in several ways.  Einhorn objected to one of them, an amendment eliminating the board's power to issue blalnk check preferred stock without shareholder approval, but said he wanted to vote in favor of the others (amendment to implement majority voting for directors, amendment setting a par value for the stock).  Today a federal district judge agreed with Einhorn and issued an injunction against the shareholder vote, scheduled for February 27. 

WSJ, Judge Grants David Einhorn's Bid To Block Apple Proxy Vote

SEC Settles Backdating Charges With Two Former Mercury Execs

The SEC has pursued civil fraud claims arising from backdated stock options against Mercury Interactive LLC and various executives, including its General Counsel, since 2007.  Today it announced a settlement with two executives, Amnon Landan, the former Chairman and Chief Executive Officer, and Douglas Smith, a former Chief Financial Officer, but not with the GC.  In its suit the SEC charged Landan, Smith, and two other former senior Mercury officers with perpetrating a fraudulent and deceptive scheme from 1997 to 2005 to award themselves and other Mercury employees undisclosed, secret compensation by backdating stock option grants and failing to record hundreds of millions of dollars of compensation expense. The Commission's complaint also alleges that during this period Landan and certain other executives backdated stock option exercises and made fraudulent disclosures concerning Mercury's "backlog" of sales revenues to manage its reported earnings.

Landan consented to the entry of a permanent injunction and agreed to be barred from serving as an officer or director of any public company for five years. Landan will pay $1,252,822 in disgorgement and prejudgment interest, representing the "in-the-money" benefit from his exercise of backdated option grants, and a $1,000,000 civil penalty. Pursuant to Section 304 of the Sarbanes-Oxley Act, Landan will also reimburse Mercury, or the parent company that acquired it after the alleged misconduct (Hewlett-Packard Company), $5,064,678 for cash bonuses and profits from the sale of Mercury stock that he received in 2003. Under the terms of the settlement, Landan's Section 304 reimbursement shall be deemed partially satisfied by his prior return to Mercury of $2,817,500 in vested options.

Smith also consented to a permanent injunction.  He will disgorge $451,200, representing the "in-the-money" benefit from his exercise of backdated option grants, and pay a $100,000 civil penalty. Pursuant to Section 304 of the Sarbanes-Oxley Act, Smith will also reimburse Mercury or its parent company $2,814,687 for profits received from the sale of Mercury stock in 2003 and a cash bonus received for 2003. Under the terms of the settlement, all of Smith's disgorgement and all but $250,000 of his Section 304 reimbursement shall be deemed satisfied by his prior repayment to Mercury of $451,200 and his foregoing of his right to exercise vested options with a value of $2,113,487.

 

FINRA Hearing Panel Finds that Federal Arbitration Act Preempts FINRA Arbitration Rule

Charles Schwab amended its customer agreement to prohibit customers from bringing class actions in court.  FINRA brought a disciplinary proceeding charging that the provision violated FINRA's rules that prohibit any provisions in customer agreements that purport to take away customers' rights to bring class actions in court. FINRA announced the outcome of the FINRA hearing panel today: 

The panel concluded that the amended language used in Schwab's customer agreements to prohibit participation in judicial class actions does violate FINRA rules, but that FINRA may not enforce those rules because they are in conflict with the Federal Arbitration Act (FAA).

In the third cause of action, the panel found that Schwab violated FINRA rules by attempting to limit the powers of FINRA arbitrators to consolidate individual claims in arbitration. The panel further concluded that the FAA does not bar enforcement of FINRA's rules regarding the powers of arbitrators, because the FAA does not dictate how an arbitration forum should be governed and operated, or prohibit the consolidation of individual claims. The panel ordered Schwab to take corrective action, including removing violative language, and imposed a fine of $500,000. 

Schwab previously announced that it was removing the language that prohibited consolidation of claims.

 Unless the hearing panel's decision is appealed to FINRA's National Adjudicatory Council (NAC) or is called for review by the NAC, the hearing panel's decision becomes final after 45 days. 

I certainly hope that the NAC reviews the matter, because I believe that the hearing panel's conclusion that the FAA preempts the FINRA rule is wrong.  For my (and co-author Jill Gross's) analysis of the issues presented in this matter, see Investor Protection Meets the Federal Arbitration Act, 1 Stanford J. Complex Litig. 1 (2012), available on SSRN .

 

SEC Says Heiniz Trader was Goldman Private Wealth Client

It has been widely reported that the SEC has undertaken an investigation into suspicious trading in H.J. Heinz options in advance of the announcement that Berkshire Hathaway would acquire the company.  Last week the SEC obtained a freeze order over assets in a trading account.  In a court filing the SEC stated that the unknnown trader is a "private wealth client" of Goldman Sachs.  Goldman informed the SEC that it did not have direct access to information about the owner of the account, which is based in Zurich.

WSJ, Heinz Trader Tied To SEC Probe Was Goldman ‘Private Wealth Client’.

FINRA Fines ING Affiliates $1.2 Million for Email Retention and Review Violations

FINRA has fined five affiliates of ING $1.2 million for failing to retain or review millions of emails for periods ranging from two months to more than six years.  FINRA also ordered the firms to conduct a comprehensive review of their systems for the capture, retention and review of email, and to subsequently certify that they have established procedures reasonably designed to address and correct the violations.

FINRA found that the firms failed to properly configure hundreds of employee email accounts to ensure that the emails sent to and from those accounts were retained and reviewed at various times between 2004 and 2012. In addition, four of the firms failed to set up systems to retain certain types of emails, such as emails using alternative email addresses, emails sent to distribution lists, emails received as blind carbon copies, encrypted emails and "cloud" email (emails sent through third-party systems). As a result of these failures, emails sent to and from hundreds of employees and associated persons were not retained; and because the emails were not retained, they were not subject to supervisory review.

In addition, four of the firms failed to review millions of emails that the firms' email review software had flagged for supervisory review. At various times between January 2005 and May 2011, nearly six million emails flagged for review went unreviewed by supervisory principals because the email review software was not properly configured.

Court Will Hear Oral Argument in Einhorn-Apple Proxy Dispute Tomorrow

An interesting, albeit technical, issue under the federal proxy rules will be argued tomorrow in federal district court in Manhattan.  David Einhorn and his hedge fund, Greenlight Capital, seek a preliminary injunction to enjoin Apple from counting the votes cast by proxy on an Apple Proposal to amend its certificate of incorporation at its February 27 shareholder meeting.  According to plaintiffs, the Apple Proposal #2 violates SEC Rule 14a-4(a)(3) and (b)(1), the "anti-bundling rule," which requires that the proxy "shall identify clearly and impartially each separate matter intended to be acted upon.... "

The Proposal in question would amend the certificate of incorporation in (at least) three ways:

(i) eliminate certain language relating to the term of office of directors in order to facilitate the adoption of majority voting for the election of directors, (ii) eliminate “blank check” preferred stock, (iii) establish a par value for the Company’s common stock of $0.00001 per share and (iv) make other conforming changes... 

According to plaintiffs, this is really three separate proposals, and they want to vote against only the amendment eliminating preferred stock.  They argue that forcing them to vote up or down on the entire package of amendments is precisely the kind of decision that the SEC unbundling rule is designed to protect them from having to make.  This argument does have the advantage of simplicity.  In a close case, why not unbundle the proposals to give the shareholders the maximum amount of choice?

Apple, however, counters that the motion for preliminary injunction should be denied since plaintiffs are not likely to succeed on the merits: the proposal is a single proposal to amend the certificate of incorporation and does not bundle material matters (i.e., these are technical amendments).  Apple asserts that the proposal does not put the plaintiffs to an unfair choice since all the amendments are pro-shareholder and supported by corporate governance advocates like CALPERS (whose application to file an amicus brief was denied by the court as unnecessary).  Apple also asserts that many corporations have asked their shareholders to vote on single proposals to amend the certificate in several different respects, without objection by the SEC or shareholders.  Finally, Apple argues that the motion for a preliminary injunction should be denied because, in any event, the plaintiffs have not made a clear showing that they would suffer immediate and irreparable harm if the shareholder vote goes forward; if the Proposal is adopted by the shareholders and a court ultimately finds that it violated SEC rules, the Proposal could easily be undone (in contrast to a vote on a merger, which would be infeasible to unwind). 

According to Apple, Einhorn and Greenlight are using this litigation to pressure Apple into acceding to their demand for the creation of a high-yield preferred stock to unlock shareholder value.  Apple is certainly right about the plaintiffs' motivation.  Nevertheless, the question for the court is whether the voting decisions of Apple shareholders are likely to be distorted by the Proposal, which forces them to make a unitary decision, up or down, about several amendments to the certificate of incorporation on different matters. To this securities professor at least, it raises a nice question about what "each separate matter" means.  

Cain & Davidoff on 2012 Takeover Litigation

Takeover Litigation in 2012, by Matthew D. Cain, University of Notre Dame - Department of Finance, and Steven M. Davidoff, Ohio State University (OSU) - Michael E. Moritz College of Law; Ohio State University (OSU) - Department of Finance, was recently posted on SSRN.  Here is the abstract:

Takeover litigation continues to be a much discussed issue in Delaware and among the corporate bar. This report provides preliminary statistics for takeover litigation in 2012. Based on preliminary statistics, takeover litigation continued to be brought at a high rate in 2012. 92% of all transactions experienced litigation. Similar to last year, half of all transactions experienced multi-jurisdictional litigation with the average transaction attracting 5 lawsuits. Median attorneys’ fees for settlements inched slightly higher to $595 thousand per settlement while the average attorneys’ fee declined substantially reflecting a fewer number of large settlements in 2012. Further information and numbers are contained in the report.

McDonnell on Financial Regulatory Cycles

Dampening Financial Regulatory Cycles, by Brett McDonnell, University of Minnesota Law School, was recently posted on SSRN.  Here is the abstract:

Financial regulation should be countercyclical, strengthening during speculative booms to contain excessive leverage and loosening following crises so as to not limit credit extension in hard times. And yet, financial regulation in fact tends to be procyclical, strengthening following crises and loosening during booms. This paper considers competing descriptive and normative analyses of that procyclical tendency. All of the models and arguments considered are rooted in a public choice perspective on financial regulation, i.e. rational choice ideas drawn from economics and applied to politics, but with that perspective modified to take account of behavioralist biases in rationality, particularly the availability bias. That bias helps explain the procyclical tendency in financial regulation, as both the public and regulators ignore the threat of financial crises during boom times and become very focused on that threat when crises actually occur. The normal dominance of concentrated interest groups temporarily shifts as public attention turns to financial regulation following a crisis.

The models considered here, though differ greatly in their normative conclusions, with some mainly criticizing the deregulation which occurs during booms, others mainly criticizing the regulation which occurs following crises, and yet others critical of the timing of both. The models differ in how they understand the balance of interest groups outside of crises and how likely that balance is to lead to outcomes that reflect the public interest, in how well they think the crisis-related public attention can be channeled to reflect the public interest, and in how they analyze the underlying vulnerability of financial institutions and markets and the intellectual difficulty of regulation. After analyzing these differing models, the paper considers historical evidence to try to choose among them, and then considers various administrative mechanisms which might help dampen the procyclical tendencies of financial regulation. Some of the procedures considered include bicameralism and the committee system in Congress, notice-and-comment rulemaking, hard look judicial review, independent agencies, sunset clauses, mandated agency studies, regulatory “contrarians,” and automatic triggers for various rules

Litov et al. on Lawyer-Directors in Public Corporations

Lawyers and Fools: Lawyer-Directors in Public Corporations, by Lubomir P. Litov, University of Arizona - Department of Finance; University of Pennsylvania - Wharton Financial Institutions Center; Simone M. Sepe, University of Arizona - James E. Rogers College of Law; and Charles K. Whitehead, Cornell Law School, was recently posted on SSRN.  Here is the abstract:

The accepted wisdom — that a lawyer who becomes a corporate director has a fool for a client — is outdated. The benefits of lawyer-directors in today’s world significantly outweigh the costs. Beyond monitoring, they help manage litigation and regulation, as well as structure compensation to align CEO and shareholder interests. The results have been an average 9.5 percent increase in firm value and an almost doubling in the percentage of public companies with lawyer-directors.

This Article is the first to analyze the rise of lawyer-directors. It makes a variety of other empirical contributions, each of which is statistically significant and large in magnitude. First, it explains why the number of lawyer-directors has increased. Among other reasons, businesses subject to greater litigation and regulation, and firms with significant intangible assets (such as patents) value a lawyer-director’s expertise. Second, this Article describes the impact of lawyer-directors on corporate monitoring. Among other results, it shows that lawyer-directors are more likely to favor a board structure and takeover defenses that reduce shareholder value — balanced, however, by the benefits of lawyer-directors, such as the valuable advice they can provide. Finally, this Article analyzes the significant reduction in risk-taking and the increase in firm value that results from having a lawyer on the board.

Our findings fly in the face of requirements that focus on director independence. Our results show that board composition — and the training, skills, and experience that directors bring to managing a business — can be as or more valuable to the firm and its shareholders.

SEC Freezes Assets in Swiss Account in Heinz Insider Trading Investigation

It was reported this morning that the SEC had opened an investigation into possible insider trading in connection with the acquisition by Berkshire Hathaway of H.J. Heinz Co., and here's the official announcement from the SEC:

The Securities and Exchange Commission today obtained an emergency court order to freeze assets in a Zurich, Switzerland-based trading account that was used to reap more than $1.7 million from trading in advance of yesterday’s public announcement about the acquisition of H.J. Heinz Company.

*    *    *

In a complaint filed in federal court in Manhattan, the SEC alleges that prior to any public awareness that Berkshire Hathaway and 3G Capital had agreed to acquire H.J. Heinz Company in a deal valued at $28 billion, unknown traders took risky bets that Heinz’s stock price would increase. The traders purchased call options the very day before the public announcement. After the announcement, Heinz’s stock rose nearly 20 percent and trading volume increased more than 1,700 percent from the prior day, placing these traders in a position to profit substantially.

The SEC alleges that the unknown traders were in possession of material nonpublic information about the impending acquisition when they purchased out-of-the-money Heinz call options the day before the announcement. The timing and size of the trades were highly suspicious because the account through which the traders purchased the options had no history of trading Heinz securities in the last six months. Overall trading activity in Heinz call options several days before the announcement had been minimal.

The emergency court order obtained by the SEC freezes the traders’ assets and prohibits them from destroying any evidence.

SEC Obtains Default Judgment Against "America's Prophet"

The SEC announced today that a Manhattan federal district court entered default judgments against Sean David Morton (Morton), whom the SEC describes as "a nationally-recognized psychic who bills himself as 'America's Prophet'," and his wife, relief defendant Melissa Morton, and corporate shell entities co-owned by the Mortons (including the Prophecy Research Institute).  The SEC charged Morton with engaging in a multi-million offering fraud. According to the Commission's complaint, Morton fraudulently raised more than $5 million from more than 100 investors for his investment group, which he called the Delphi Associates Investment Group (Delphi Investment Group).

According to the Commission's complaint, Morton used his monthly newsletter, his website, his appearances on a nationally syndicated radio show called Coast to Coast AM, and appearances at public events, to promote his alleged psychic expertise in predicting the securities markets, and to solicit investors for the Delphi Investment Group. During these solicitations, Morton made numerous materially false representations. For example, Morton falsely told potential investors that he has called all the highs and lows of the stock market, on their exact dates, over a fourteen year period. In private one-on-one correspondence with potential investors, Morton was even more aggressive in his solicitation. For example, Morton wrote to a potential investor urging he invest more money in the Delphi Investment Group "RIGHT NOW…[Because] [o]nce the DOLLAR starts to DROP, which will happen soon, we are set to make a FORTUNE!"

Bizarrely, according to the SEC, the defendants never properly answered the allegations in the complaint. Instead, the Mortons filed dozens of papers with the Court claiming, for instance, that the Commission is a private entity that has no jurisdiction over them, and that the staff attorneys working on the case do not exist.

Merck Settles Securities Fraud Class Actions Over Cholesterol Drug Study

Merck agreed to pay $688 million to settle securities fraud class actions claiming that it misled investors by delaying the release of an unfavorable study over the efficacy of its cholesterol drug Vytorin.  Plaintiffs alleged that Merck and Schering-Plough knew of the study for nearly two years, but did not release it until 2008.  After it was made public, the stock prices of both companies dropped, as did the sales of the drug.

A jury trial was scheduled to begin in March.  In the settlement Merck does not admit to any wrongdoing.  Its press release states that:

“This agreement avoids the uncertainties of a jury trial and will resolve all of the remaining litigation in connection with the ENHANCE study,” said Bruce N. Kuhlik, executive vice president and general counsel of Merck. “We believe it is in the best interests of the company and its shareholders to put this matter behind us, and to continue our focus on scientific innovations that improve health worldwide.”

The size of the settlement is impressive because, unlike many securities fraud class actions, there were no parallel government actions.

NYTimes,  Merck Settles Investor Suits Over Cholesterol Drug

Former Stanford Execs Get 20-Year Sentences for Role in Ponzi Scheme

Two former executives of Stanford Financial Group were sentenced today for their roles in Allen Stanford's Ponzi scheme.  The former chief accounting officer, Gilbert Lopez, and former controller, Mark Kuhrt, each received sentences of 20 years in prison.  A jury convicted them on numerous fraud counts last November.

NYTimes, Ex-Stanford Executives Get 20 Years Over Roles in $7 Billion Fraud

SEC's Walter Says Staff Plans to Seek Information from Public on Retail Financial Advice Providers

We have not heard much lately from the SEC about a "uniform fiduciary duty" for broker-dealers and investment advisers.  Today, at a Senate Banking Committee hearing on "Wall Street Reform: Oversight of Financial Stability and Consumer and Investor Protections,"  SEC Chairman Elisse B. Walter stated (in her written testimony)  that since the publication of the IA/BD Study by the SEC staff, in January 2011:

the staff, including the Commission’s economists, continues to review current information and available data about the marketplace for personalized investment advice and the potential impact of the study’s recommendations. While we have extensive experience in the regulation of broker-dealers and investment advisers, we believe the public can provide further data and other information to assist us in determining whether or not to adopt a uniform fiduciary standard of conduct or otherwise use the authority provided under Section 913 of the Dodd-Frank Act. To this end, the staff is drafting a public request for information to obtain data specific to the provision of retail financial advice and the regulatory alternatives. The request aims to seek information from commenters – including retail investors, as well as industry participants – that will be helpful to us as we continue to analyze the various components of the market for retail financial advice.

The written testimony also summarizes other steps taken by the agency to implement Dodd-Frank.