Tuesday, April 30, 2013
FINRA announced the appointment of a Chief Economist and Senior Vice President, who will report directly to FINRA CEO Richard Ketchum. Jonathan S. Sokobin is currently Acting Deputy Director, Research and Analysis in the Office of Financial Research at the U.S. Treasury Department. The appointment is further demonstration of the importance of cost-benefit analysis in financial regulation. According to the press release,
The Office of the Chief Economist will work closely with the Office of General Counsel and other departments in developing new rules and analyze the costs and benefits of existing and potential rulemakings. In order to facilitate that effort, the Office will be responsible for gathering and analyzing data on securities firms and markets.
Senator Al Franken (D-Minn) and other Congressional representatives have written to SEC Chair Mary Jo White, urging the agency to use its authority under Dodd-Frank to prevent mandatory arbitration clauses in brokerage contracts. Concerns over the use of the predispute arbitration agreements have increased in the wake of Charles Schwab's inclusion of a class action waiver (contrary to FINRA rules) in its brokerage agreement. A FINRA hearing panel recently held that FINRA could not enforce its rules prohibiting the class action waiver against Schwab because of U.S. Supreme Court's interpretation of FAA preemption in AT&T Mobility v. Concepcion. FINRA Enforcement has appealed the hearing panel's decision.
Here is the text of the letter:
Dear Chairman White,
We write to express our strong belief that the Securities and Exchange Commission (the “Commission”) should promptly exercise its authority under Section 921 of the Dodd-Frank Wall Street Reform and Consumer Protection Act to prohibit the use of mandatory arbitration provisions in customer service agreements.
The Dodd-Frank Act was enacted, among other reasons, to protect American consumers from abusive financial services practices. Section 921 reflects Congress’s concern over the increasingly widespread use of mandatory arbitration agreements in customer and client contracts, and grants the Commission authority to restrict or prohibit the use of these provisions. Ensuring a choice of forum, particularly for small investors, heightens fairness and ultimately enhances participation in our capital markets. To our disappointment, in the almost three years since the Dodd-Frank Act’s enactment, the Commission has largely disregarded this important mandate.
The time is ripe for the Commission to act under Section 921 to protect the investing public and prevent further abuse of forced arbitration contracts.
Recently, we were alarmed to see further attempts to erode investor rights when Charles Schwab, one of the country’s largest brokers, expanded the mandatory arbitration clauses in its customer agreements to include a mandatory class action waiver clause. In this instance, Schwab argued that, in response to the Supreme Court’s interpretation of the Federal Arbitration Act (FAA) in AT&T Mobility v. Concepcion, it could include a waiver of class action and class arbitration rights in its customer agreements. FINRA initiated a disciplinary action against Schwab for violation of FINRA rules barring class action waivers. In February, however, a FINRA hearing panel ruled that although Schwab’s actions did in fact violate FINRA rules, those rules could not be enforced under Concepcion.
While the Supreme Court in Concepcion did find that the FAA preempts state actions that would restrict the use of arbitration, the facts in the Schwab case are notably distinguishable—not least because FINRA is a membership organization seeking to enforce its own rules. However, the ambiguity created by the panel’s ruling underscores the urgency with which the Commission should adopt rules under Section 921.
Section 921 was included in the Dodd-Frank Act to address the threat to consumers posed by mandatory arbitration clauses in investment contracts. During Congress’s deliberation of this section, legislators heard concerns that investors forced into arbitration must face “high upfront costs; limited access to documents and other key information; limited knowledge upon which to base the choice of arbitrator; the absence of a requirement that arbitrators follow the law or issue written decisions; and extremely limited grounds for appeal.”
If arbitration offers investors an efficient forum to resolve disputes, as some argue, investors may choose that option—but they should be given the choice. It is equally important that investors not be precluded from bringing class actions because of contractual fine print imposed by a mandatory waiver class action clause.
Although evidence suggests that the use of mandatory arbitration agreements is widespread, we are concerned about the lack of transparency and reliable data regarding the prevalence of such agreements. We encourage the Commission to track how many brokerage firms are inserting mandatory arbitration agreements and class action waivers into consumer contracts, so that this questionable practice may be better monitored and addressed.
We are deeply concerned that the Commission’s failure to respond to the dangers posed by widespread forced arbitration will weaken existing investor protections. Given the uncertainty created by the recent FINRA decision, we urge the Commission to act quickly to exercise its authority under Section 921 to prevent this practice and protect investor rights.
We recognize that the Commission is balancing competing demands, and that it must prioritize its recent mandates by Congress. The exigent circumstances at hand, however, require that the Commission exercise its authority under Section 921 of the Dodd-Frank Act and prohibit the use of mandatory arbitration provisions.
 FINRA Department of Enforcement v. Charles Schwab & Company Inc. (CRD No. 5393) Disciplinary Proceeding No. 201102976021. February 21, 2013.
 Senate Committee on Banking, Housing, and Urban Affairs on S. 3217, S. Rep. No.111-176, at 110.
Monday, April 29, 2013
The SEC announced that Greenwich, Conn.-based hedge fund advisory firm Level Global Investors LP agreed to pay more than $21.5 million to settle charges that its co-founder, who also served as a portfolio manager, and its analyst engaged in repeated insider trading in the securities of Dell Inc. and Nvidia Corp.
In January 2012, the SEC filed insider trading charges against Level Global, the firm's co-founder Anthony Chiasson, a former analyst Spyridon "Sam" Adondakis, and six other defendants, including five investment professionals and the hedge fund advisory firm Diamondback Capital Management. The SEC alleged that Adondakis was a member of a group of closely associated hedge fund analysts who illegally obtained highly sensitive information regarding the financial performance of Dell and Nvidia before this information was made public. The illegally obtained information involved Dell and Nvidia's revenues and profit margins and sometimes indicated that the tech companies' quarterly results would differ significantly from the consensus expectations of Wall Street analysts.
According to the SEC, during 2008 and 2009, Adondakis passed the information on to Chiasson, who used it to execute trades on behalf of hedge funds managed by Level Global and reap millions of dollars in illegal profits. In 2011, following news reports of the government's investigation, Level Global, which had once managed as much as $4 billion, announced that it would close its business and begin returning money to its investors. It is presently in the process of winding down its business.
The settlement with Level Global, which is subject to court approval, requires the firm to disgorge $10,082,725 in fees that it reaped from the alleged insider-trading scheme, to pay prejudgment interest of $1,348,824, and to pay a penalty of $10,082,725. Level Global has also agreed to the entry of an order permanently enjoining the firm from future violations of Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5, and Section 17(a) of the Securities Act of 1933.
Level Global neither admits nor denies the SEC's allegations. Adondakis previously pleaded guilty to parallel criminal charges and agreed to a settlement with the SEC in which he admitted liability for insider trading. The SEC is continuing to pursue its insider trading claims against the firm's co-founder Chiasson, who was convicted in December 2012 of securities fraud in a parallel criminal proceeding.
Saturday, April 27, 2013
Cyberfinancing for Economic Justice, by Lisa T. Alexander, University of Wisconsin Law School, was recently posted on SSRN. Here is the abstract:
This article argues for the socially optimal regulation of online peer-to-peer (P2P) lending and crowdfunding to advance economic justice in the United States. Peer-to-peer lending websites, such as Prosper.com or Kiva.org, facilitate lending transactions between individuals online without the involvement of a traditional bank or microfinance institution. Crowdfunding websites, such as Kickstarter.com, enable individuals to obtain financing from large numbers of contributors at once through an open online request for funds. These web-based transactions, and the intermediary organizations that facilitate them, constitute emerging cyberfinancing markets. These markets connect many individuals at once, across class, race, ethnicity, nationality, space, and time in an interactive and dynamic way. During a time of significant economic distress in the United States, these markets also represent an unprecedented economic development opportunity for historically marginalized economic actors. Yet, no legal scholar has addressed the implications of these developments for economic justice in the United States. Drawing from the fields of law and geography, social networking theory, and comparative institutional analysis, this Article conceptualizes these new markets as "cyberspaces," similar to geographic spaces, whose laws, norms, and rules will partially determine who will benefit from the economic opportunities that arise in these spaces. The recently enacted Jumpstart Our Business Startups (JOBS) Act does not facilitate substantial distributive justice in crowdfunding markets. The U.S. Government Accountability Office (GAO), which produced a report in response to the 2010 Dodd-Frank Wall Street Reform Act's mandate that it study the P2P lending industry, has also failed to recommend a regulatory structure that will facilitate economic justice. This Article recommends that a range of federal regulators such as the U.S. Securities and Exchange Commission(SEC), the new Consumer Financial Protection Bureau (CFPB), and the U.S. Treasury Department (Treasury), should collaborate to implement a revised Community Reinvestment Act (CRA) that would promote economic justice in these markets
Mechanism Design in M&A Auctions, by Steven J. Brams, New York University (NYU) - Wilf Family Department of Politics, and Joshua Mitts, Yale Law School, was recently posted on SSRN. Here is the abstract:
The recent controversy over “Don’t Ask, Don’t Waive” standstills in M&A practice highlights the need to apply mechanism design to change-of-control transactions. In this Essay, we propose a novel two-stage auction procedure that induces honest bidding among participants while potentially yielding a higher sale price than an open ascending, a sealed-bid first price, or a Vickrey second-price auction. Our procedure balances deal certainty with value maximization through the Nobel Prize-winning principle of incentive compatibility, making participation in the M&A auction and honest disclosure of reservation prices in the parties’ interests rather than relying solely on heavy-handed ex-post enforcement. Moreover, the social benefits of our two-stage auction mechanism - greater transparency regarding the distribution of bids, avoidance of the winner’s curse, certainty in the M&A auction environment, and fairness to buyers and sellers - justify reduced judicial scrutiny of transactions utilizing the procedure under Revlon and Chancellor Strine’s recent dicta in Ancestry.com.
To Be or Not to Be (a Security): Funding For-Profit Social Enterprises, by Joan MacLeod Heminway, University of Tennessee College of Law, was recently posted on SSRN. Here is the abstract:
This article explores the federal securities law status of financial interests in for-profit social enterprise entities. When analyzed through the lens of the Securities Act of 1933 and the Securities Exchange Act of 1934, financial interests in social enterprise businesses raise both concerns and opportunities. Ultimately, the federal securities regulation status of interests in for-profit social enterprise ventures is important for choice-of-entity reasons (since the regulatory framework may impose different costs on interests in different structural business forms), for capital-structuring reasons within individual forms of entity, and for risk-management reasons at the entity level. In addition, an inquiry into the applicability of federal securities regulation to the funding of social enterprise serves as a catalyst for further thought on the optimal applicability of federal securities regulation to interests in business entities and projects.
Deferred Prosecutions and Corporate Governance: An Integrated Approach to Investigation and Reform, by Lawrence A. Cunningham, George Washington University Law School, was recently posted on SSRN. Here is the abstract:
When evaluating how to proceed against a corporate investigative target, law enforcement authorities often ignore the target’s governance arrangements, while subsequently negotiating or imposing governance requirements, especially in deferred prosecution agreements. Ignoring governance structures and processes amid investigation can be hazardous and implementing improvised reforms afterwards may have severe unintended consequences — particularly when prescribing standardized governance devices. Drawing, in part, on new lessons from three prominent cases — Arthur Andersen, AIG and Bristol-Myers Squibb — this Article criticizes prevailing discord and urges prosecutors to contemplate corporate governance at the outset and to articulate rationales for prescribed changes. Integrating the role of corporate governance into prosecutions would promote public confidence in prosecutorial decisions to broker firm-specific governance reforms currently lacking and increase their effectiveness. The Article, therefore, contributes a novel perspective on the controversial practice: though substantial commentary urges prosecutors to avoid intruding into corporate governance, this Article explains the importance of prosecutors investing in it.
On April 25, 2013, a federal court in New York found defendants Joshua Constantin and Windham Securities, Inc. jointly and severally liable for over $2.49 million and defendant Brian Solomon liable for over $249,000 in disgorgement, pre-judgment interest, and civil penalties. In addition, the court found relief defendants Constantin Resource Group, Inc. (CRG) and Domestic Applications Corp. (DAC) jointly and severally liable with Constantin and Windham for over $760,000 and $532,000, respectively, of disgorgement and pre-judgment interest.
The SEC's complaint alleged that Windham, Windham's owner and principal Constantin, and former Windham managing director Solomon fraudulently induced investors to provide more than $1.25 million to Windham for securities investments. The complaint alleged that defendants made false claims to the investors about the intended use of the investors' funds and about Windham's investment expertise and past returns. Instead of purchasing securities for the investors, the defendants misappropriated the investors' funds and then provided false assurances to the investors to cover up their fraud.
On April 2, 2013, the court issued an opinion granting the SEC's motion for summary judgment in its entirety. Based on the undisputed evidence, the court found that "[t]he litany of misrepresentations that Solomon and Constantin made to their clients is striking;" that Constantin "diverted [investors'] funds to his own purposes;" and that "both Solomon and Constantin provided clients with misleading documents to cover up the fraudulent nature of their investment scheme." On April 25, 2013, the court issued a supplemental order finding Windham, Constantin, Solomon, CRG, and DAC collectively liable for more than $2.74 million in disgorgement, pre-judgment interest, and civil penalties.
The SEC will hold an Open Meeting on Wednesday, May 1, 2013 at 10:00 a.m., in the Auditorium, Room L-002. The subject matters of the Open Meeting will be:
•Item 1: The Commission will consider whether to propose new rules and interpretive guidance for cross-border security-based swap activities and to re-propose Regulation SBSR and certain rules and forms relating to the registration of security-based swap dealers and major security-based swap participants.
•Item 2: The Commission will consider whether to reopen the comment periods and receive new information for certain rulemaking releases and the policy statement applicable to security-based swaps proposed pursuant to the Securities Exchange Act of 1934 and the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The University of Illinois College of Law and the University of Richmond School of Law invite submissions for the First Annual Workshop for Corporate & Securities Litigation. This workshop will be held on Friday, November 8, 2013, in Chicago, Illinois.
OVERVIEW: This annual workshop will bring together scholars focused on corporate and securities litigation to present their works-in-progress. Papers addressing any aspect of corporate and securities litigation or enforcement are eligible. Appropriate topics include, but are not limited to, securities litigation, fiduciary duty litigation, or comparative approaches to business litigation. We welcome scholars working in a variety of methodologies, including empirical analysis, law and economics, law and sociology, and traditional doctrinal analysis. Authors whose papers are selected will be invited to present their work at a workshop hosted by the University of Illinois College of Law in Chicago, Illinois, on Friday November 8, 2013. Local costs (lodging and workshop meals) will be covered. Participants are asked to pay for their own travel expenses. The workshop is designed to maximize discussion and feedback. All participants will have read the selected papers. The author will provide a brief introduction to the paper, but the majority of the individual sessions will be devoted to collective discussion of the paper involved.
SUBMISSION PROCEDURE: If you are interested in participating, please send an abstract of the paper you would like to present to Jessica Erickson at [email protected] not later than Friday, May 31, 2013. Please include your name, current position, and contact information in the e-mail accompanying the submission. Authors of accepted papers will be notified by Friday, June 28.
Friday, April 26, 2013
Perhaps the first JOBS Act scam? The SEC announced fraud charges against a Spokane Valley, Wash., company and its owner for misleading investors with claims to raise billions of investment capital under the Jumpstart Our Business Startups (JOBS) Act and invest it exclusively in American businesses.
The SEC alleges that Daniel F. Peterson and his company USA Real Estate Fund 1 promised investors that they could reap spectacular returns from an upcoming offering in a “secured” product backed by prominent financial firms. Peterson repeatedly told investors that the 2012 JOBS Act would enable him to raise billions of dollars by advertising the offering to the general public, and produce big profits for early investors. He also promised to invest the proceeds of the offering in exclusively American businesses, and help assist in Washington State’s economic recovery. The SEC alleges that Peterson used investors’ money for personal expenses, and is continuing to solicit investors and may be preparing to tout the offering through investor seminars and public advertising.
According to the SEC’s complaint filed in federal court in Spokane, Peterson sold common stock in USA Real Estate Fund from November 2010 to June 2012 to more than 20 investors in Washington and at least five other states.
(Thanks to Jennifer Taub for calling this to my attention.)
Thursday, April 25, 2013
Wednesday, April 24, 2013
The SEC charged Capital One Financial Corporation and two senior executives for understating millions of dollars in auto loan losses incurred during the months leading into the financial crisis. Capital One agreed to pay $3.5 million to settle the SEC’s charges. The two executives – former Chief Risk Officer Peter A. Schnall and former Divisional Credit Officer David A. LaGassa – also agreed to settle the charges against them.
An SEC investigation found that in financial reporting for the second and third quarters of 2007, Capital One failed to properly account for losses in its auto finance business when they became higher than originally forecasted. The profitability of its auto loan business was primarily derived from extending credit to subprime consumers. As credit markets began to deteriorate, Capital One’s internal loss forecasting tool found that the declining credit environment had a significant impact on its loan loss expense. However, Capital One failed to properly incorporate these internal assessments into its financial reporting, and thus understated its loan loss expense by approximately 18 percent in the second quarter and 9 percent in the third quarter.
Capital One’s material understatements of its loan loss expense and internal controls failures violated the reporting, books and records, and internal controls provisions of the federal securities laws, namely Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 12b-20 and 13a-13. Schnall and LaGassa caused Capital One’s violations of Section 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rule 13a-13 thereunder and violated Exchange Act Rule 13b2-1 by indirectly causing Capital One’s books and records violations.
Schnall agreed to pay an $85,000 penalty and LaGassa agreed to pay a $50,000 penalty to settle the SEC’s charges. Capital One and the two executives neither admitted nor denied the findings in consenting to the SEC’s order requiring them to cease and desist from committing or causing any violations of these federal securities laws.
Tuesday, April 23, 2013
Monday, April 22, 2013
On April 18 the Consumer Financial Protection Bureau released its report on Senior Designations for Financial Advisers. Congress directed that its Office for Older Americans study the issue of "senior designation" titles used by financial advisers and make recommendations. The Bureau
found that the use of senior designations is extremely confusing for consumers. There are more than 50 different senior designations currently used in today’s marketplace with senior designees recommending or selling a variety of products, such as securities, investment opportunities, financial products, and insurance products like annuities and long-term care insurance.
* * *
The recommendations in this report seek to reduce consumer confusion and protect consumers
by improving the: (1) dissemination of information and consumer education around senior
designations; (2) standards for the acquisition of senior designations; (3) standards for senior
designee conduct; and (4) enforcement related to the misuse of senior designations. The Bureau
believes that adoption of these recommendations will help older consumers avoid financial
advisers who would misuse their designations to sell inappropriate investment and financial
The SEC announced a non-prosecution agreement (NPA) with Ralph Lauren Corporation in which the company will disgorge more than $700,000 in illicit profits and interest obtained in connection with bribes paid by a subsidiary to government officials in Argentina from 2005 to 2009. The misconduct was uncovered in an internal review undertaken by the company and promptly reported to the SEC.
The SEC said it determined not to charge Ralph Lauren Corporation with violations of the Foreign Corrupt Practices Act (FCPA) due to the company's prompt reporting of the violations on its own initiative, the completeness of the information it provided, and its extensive, thorough, and real-time cooperation with the SEC's investigation.
The NPA is the first that the SEC has entered involving FCPA misconduct. NPAs are part of the SEC Enforcement Division's Cooperation Initiative, which rewards cooperation in SEC investigations. In parallel criminal proceedings, the Justice Department entered into an NPA with Ralph Lauren Corporation in which the company will pay an $882,000 penalty.
According to the NPA, Ralph Lauren Corporation's cooperation included:
Reporting preliminary findings of its internal investigation to the staff within two weeks of discovering the illegal payments and gifts.
Voluntarily and expeditiously producing documents.
Providing English language translations of documents to the staff.
Summarizing witness interviews that the company's investigators conducted overseas.
Making overseas witnesses available for staff interviews and bringing witnesses to the U.S.
According to the NPA, the bribes occurred during a period when Ralph Lauren Corporation lacked meaningful anti-corruption compliance and control mechanisms over its Argentine subsidiary. The misconduct came to light as a result of the company adopting measures to improve its worldwide internal controls and compliance efforts, including implementation of an FCPA compliance training program in Argentina. Ralph Lauren Corporation's Argentine subsidiary paid bribes to government and customs officials to improperly secure the importation of Ralph Lauren Corporation's products in Argentina. The purpose of the bribes, paid through its customs broker, was to obtain entry of Ralph Lauren Corporation's products into the country without necessary paperwork, avoid inspection of prohibited products, and avoid inspection by customs officials. The bribe payments and gifts to Argentine officials totaled $593,000 during a four-year period.
Under the NPA, Ralph Lauren Corporation agreed to pay $593,000 in disgorgement and $141,845.79 in prejudgment interest.
Mr. Canellos has been serving as Acting Director since January, and previously had been the division’s Deputy Director since June 2012.
Representative Maxine Waters (D-Cal.), along with Representative John Delaney (D-MD), again introduced legislation that would allow the SEC to charge user fees to fund examinations of investment advisers, the Investment Adviser Examination Improvement Act of 2013. Currently, the SEC examines only about eight per cent of registered investment advisers each year. Imposing user fees is a sensible solution, since the industry is opposed to the creation of an SRO for investment advisers and FINRA, which once appeared to want the job, now states it has no interest in becoming the SRO for investment advisers. The proposed legislation also has the backing of a number of organizations including NASAA, which issued a supporting statement. Nevertheless, the likelihood of action in the foreseeable future is remote.
The FINRA Board of Governors approved several proposed rule changes that will be submitted to the SEC for review and approval.
The Board approved a proposal to publicly disseminate 144A transactions in TRACE-eligible securities for those asset types currently subject to dissemination. FINRA is taking this step after reviewing the comments submitted in response to its September 2012 Regulatory Notice and in light of JOBS Act provisions. FINRA believes that making this information publicly available will help market participants determine the quality of their executions and help firms comply with their regulatory obligations.
FINRA also approved two proposed rule changes related to securities arbitration:
Arbitration Panel Composition
The Board authorized FINRA to file with the SEC proposed amendments to FINRA Rule 12403 to simplify the panel selection rules. Rather than requiring the customer to elect a panel selection method, parties in all customer cases with three arbitrators would have the same selection method. Under this method, all parties would see lists of 10 chair-qualified public arbitrators, 10 public arbitrators and 10 non-public arbitrators. The rules would permit four strikes on each of the public arbitrator lists. However, any party could select an all-public arbitration panel by striking all of the arbitrators on the non-public list. Alternatively, if the parties leave on the non-public list one or more of the same non-public arbitrators, the parties could have a majority public panel—that is two public and one non-public arbitrator.
Discovery Guide Used in Investor Arbitration Proceedings
The Board authorized FINRA to file with the SEC proposed amendments to the Discovery Guide used in customer arbitration proceedings to provide general guidance on e-discovery issues and product cases, and to clarify existing provisions relating to affirmations. Specifically, FINRA would amend the Discovery Guide introduction to:
1.include guidelines for arbitrators to consider when deciding disputes relating to the form of e-discovery;
2.add guidance on product cases to explain, among other matters, that these cases are different from other customer cases and that the Document Production Lists may not provide all of the documents parties usually request in a product case; and
3.clarify that a party may request an affirmation when an opposing party makes a partial production.