Securities Law Prof Blog

Money Market Fund Reform on Agenda for SEC's June 5 Meeting

The SEC will consider money market fund reform again.  Its agenda for its June 5 meeting is:

•The Commission will consider a recommendation to propose amendments to certain rules under the Investment Company Act that govern the operation of money market funds and related amendments to Form PF under the Investment Advisers Act. 

 

Former Broker Charged with Obstructing Justice for Lying to SEC Investigators

The SEC announced that the subject of an enforcement inquiry in Florida has has been criminally charged with obstructing justice and lying to SEC investigators looking into his real estate securities offerings to investors.  

The U.S. Attorney’s Office for the Southern District of Florida has filed criminal charges against former broker Robert J. Vitale.  According to the criminal information filed in U.S. District Court for the Southern District of Florida, the SEC issued subpoenas to Vitale and his investment company Realty Acquisitions & Trust in order to identify investor funds and assets related to the securities offerings. The SEC investigators subpoenaed Vitale for all related bank records and took his sworn testimony.

The criminal information alleges that Vitale lied about the existence of two separate bank accounts that he did not disclose to the SEC. Vitale was charged by the SEC several years ago for participating in a pump-and-dump market manipulation scheme. Vitale later settled the charges in federal district court and was barred from the brokerage industry.

Financial Capability Survey Finds Many Americans Struggle with Finances

The FINRA Investor Education Foundation released the results of America's State-by-State Financial Capability Survey. The survey features a clickable map of the United States and allows the public, policymakers and researchers to delve into and compare the financial capabilities of Americans across all 50 states and the nation as a whole.  

The State-by-State Financial Capability Survey, which surveyed more than 25,000 respondents, was developed in consultation with the U.S. Department of the Treasury, other federal agencies and the President's Advisory Council on Financial Capability.  It found a significant disparity in financial capability across state lines and demographic groups.

The five measures of financial capability used to rank the states measure how well Americans are managing their day-to-day finances and saving for the future. The national averages among survey respondents for these key measures are below.

Fewer than half (41 percent) of Americans surveyed reported spending less than their income.
Over a quarter (26 percent) of Americans reported having unpaid medical bills.
More than half of Americans (56 percent) do not have rainy-day savings to cover three months of unanticipated financial emergencies.
Over a third of Americans (34 percent) reported paying only the minimum credit card payment during the past year.
On a test of five basic financial literacy questions, the national average was 2.88 correct answers.

 "This survey reveals that many Americans continue to struggle to make ends meet, plan ahead and make sound financial decisions—and that financial literacy levels remain low, especially among our youngest workers. No matter how you slice and dice it, this rich, new dataset underscores the need for us to continue to explore innovative ways to build financial capability among consumers," said FINRA Foundation Chairman Richard Ketchum.

 

 

SEC Charges French Oil & Gas Company with Bribing Iranian Official

The SEC charged France-based oil and gas company Total S.A. with violating the Foreign Corrupt Practices Act (FCPA) by paying $60 million in bribes to intermediaries of an Iranian government official who then exercised his influence to help the company obtain valuable contracts to develop significant oil and gas fields in Iran.  Total, whose securities are publicly traded on the New York Stock Exchange, agreed to pay more than $398 million to settle the SEC’s charges and a parallel criminal matter announced today by the U.S. Department of Justice.

The SEC alleges that Total made more than $150 million in profits through the bribery scheme. Total attempted to cover up the true nature of the illegal payments by entering into sham consulting agreements with intermediaries of the Iranian official and mischaracterizing the bribes in its books and records as legitimate “business development expenses” related to the consulting agreements. Total had inadequate systems to properly review the consulting agreements and lacked sufficient internal controls to comply with federal laws prohibiting bribery.

NASDAQ Pays $10 Million Fine to Settle Facebook Offering Violations

The SEC and NASDAQ settled charges relating to the initial public offering (IPO) and secondary market trading of Facebook shares, with NASDAQ agreeing to settle the SEC’s charges by paying a $10 million penalty – the largest ever against an exchange.

According to the SEC’s order instituting settled administrative proceedings, despite widespread anticipation that the Facebook IPO would be among the largest in history with huge numbers of investors participating, a design limitation in NASDAQ’s system to match IPO buy and sell orders caused disruptions to the Facebook IPO.

NASDAQ then made a series of ill-fated decisions that led to the rules violations.  According to the SEC’s order, several members of NASDAQ’s senior leadership team decided not to delay the start of secondary market trading in Facebook with the expectation that they had fixed the system limitation by removing a few lines of computer code. However, they did not understand the root cause of the problem. NASDAQ’s decision to initiate trading before fully understanding the problem caused violations of several rules, including NASDAQ’s fundamental rule governing the price/time priority for executing trade orders. The problem caused more than 30,000 Facebook orders to remain stuck in NASDAQ’s system for more than two hours when they should have been promptly executed or cancelled.

The SEC’s order also charges NASDAQ’s affiliated third party broker-dealer NASDAQ Execution Services (NES) with failing to maintain sufficient net capital reserves on the day of the Facebook IPO as a result of NASDAQ’s own Facebook trading through the unauthorized error account.

The SEC’s order finds that NASDAQ violated Section 19(g)(1) of the Securities Exchange Act of 1934 by not complying with several of its own rules, and that NES violated Section 15(c)(3) of the Exchange Act and Rule 15c3-1 thereunder by failing to maintain sufficient net capital reserves on May 18, 2012. NASDAQ and NES agreed to a settlement without admitting or denying the SEC’s findings. The order censures NASDAQ and NES, imposes a $10 million penalty on NASDAQ, and requires both NASDAQ and NES to cease and desist from committing or causing these violations and any future violations. The order also requires NASDAQ and NES to complete numerous undertakings.

Schwartz on Disclosing Corporate Disclosure Policies

Disclosing Corporate Disclosure Policies, by Victoria L. Schwartz, University of Chicago - Law School; Pepperdine University School of Law, was recently posted on SSRN.  Here is the abstract:

Between Steve Jobs’ diagnosis of pancreatic cancer in 2003 and his death in 2011, Apple struggled to respect the privacy of its CEO while disclosing relevant information to its shareholders. The existing rules that govern corporate disclosure were of little help. They offer no mechanism for taking into account privacy considerations; nor do they provide any clear guidance regarding whether, when, and under what circumstances a corporation must disclose personal information about its executives. Existing privacy laws also fail to comprehensively address this problem. This legal void has created widespread uncertainty for executives, corporations, and shareholders. Scholars have also struggled to identify solutions that appropriately account for both privacy and disclosure. Their attempts have been hindered by the difficulty of estimating the respective values of disclosure to investors and of privacy to executives, especially to the extent that the value of privacy varies widely across individuals and depends on the type of personal information.

This Article offers one solution for accounting for this privacy-disclosure problem. First, corporations and executives should contract for a disclosure policy that takes into consideration the individual executive’s privacy preferences. The corporation should then be required to disclose the contracted-for disclosure policy to its shareholders. The use of a contractual menu approach would allow for the possibility of executives’ heterogeneous privacy preferences, while minimizing transaction and other costs of traditional default rules. At the same time, disclosure of the policy allows shareholders to indirectly exert influence on the corporation’s negotiations. In addition, the creation and disclosure of the disclosure policy increases certainty for all the parties involved.

Heminway on SEC Reform

Desire, Conservatism, Underfunding, Congressional Meddling, and Study Fatigue: Ingredients for Ongoing Reform at the Securities and Exchange Commission?, by Joan MacLeod Heminway, University of Tennessee College of Law, was recently posted on SSRN.  Here is the abstract:

This article suggests the use of program evaluation -- a branch of social science research designed to assess organizations and their activities -- to analyze continued reform efforts at the Securities and Exchange Commission ("SEC") under Section 967 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 967 compelled the SEC to retain an independent consultant to evaluate and issue a report on its structure and operations and mandated that the SEC engage in post-study reporting to Congress over a two-year period on its implementation of resulting reforms. The article concludes that program evaluation techniques are useful in this context and identifies, based on program evaluation literature, both positive and negative aspects of the study and reporting required under Section 967.

Colesanti on Plain English

Demanding Substance or Form? The SEC's Plain English Handbook as a Basis for Securities Violations, by Scott Colesanti, Hofstra University - Maurice A. Deane School of Law, was recently posted on SSRN.  Here is the abstract:

 
In 1998, the United States Securities and Exchange Commission (“SEC” or “Commission”) released a style manual titled “The Plain English Handbook.” The culmination of a drive by its Chairman, Arthur Levitt, the Handbook drew upon the rules of grammar, best industry practice, and even the support of billionaire Warren Buffett in calling for a layman’s translation of corporate disclosure documents.

To varying degrees, commentators noted the significance of the Handbook. Initial textual studies provided mixed results. The press marveled at its novelty, but securities regulation experts were less sanguine, chiding Commission members for naming themselves “language czars of the universe.”

Meanwhile, the cause of corporate disclosure – a mission long defined by federal case law – continued its second phase as the SEC, the courts, and stock issuers sought to strike a balance between financial expertise and consumer satisfaction. From this effort came the separate but related causes of evaluating substantive content and delivering it in good faith. These causes eventually morphed, however, forcing jurists to locate further authority animating the remedial securities laws. Consequentially the Handbook, at times, tipped this balance of corporate disclosure.

Accordingly, this Article traces the gradual yet impressive growth in importance of a nearly 15-year old exhortation. To be sure, the authoritative value of a style manual is a topic of great moment. In the Fall of 2012, changes implemented by the controversial federal healthcare law required insurers to publish marketing materials in “plain language.” Further, the Commission itself is gradually expanding the Handbook’s application to additional mutual fund disclosures, proxy materials, and investment adviser communications. Those commenting on the rule's primacy will undoubtedly note the lessons of indirect agency rulemaking. Of more immediate consideration, this Article seeks to examine the subtle means by which a call for simplicity may have become grounds for violations of securities law, in the eyes of the government and others. Ultimately, the SEC’s continuing emphasis on simplicity begs the question of which shareholder communications are being read at all.

SEC Charges Dallas Trader with Front-Running

The SEC announced fraud charges and an asset freeze against Daniel Bergin, a senior equity trader at Cushing MLP Asset Management, a Dallas-based investment advisory firm, who allegedly profited by placing his own trades before executing large block trades for firm clients that had strong potential to increase the stock's price.

According to the SEC, Bergin secretly executed hundreds of trades through his wife's accounts in a practice known as front running. Bergin illicitly profited by at least $520,000 by routinely purchasing securities in his wife's accounts earlier the same day he placed much larger orders for the same securities on behalf of firm clients. Bergin concealed his lucrative trading by failing to disclose his wife's accounts to the firm and avoiding pre-clearance of his trades in those accounts. Bergin also attempted to hide his wife's accounts from SEC examiners.

According to the SEC's complaint, Bergin realized at least $1.7 million in profits in his wife's accounts from 2011 to 2012 as a result of his illegal same-day or front-running trades. More than $520,000 of the $1.7 million represents profits from approximately 132 occasions in which Bergin placed his initial trades in his wife's account ahead of clients' trades.

The SEC's complaint names Bergin's wife Jacqueline Zaun as a relief defendant for the purpose of recovering Bergin's illegal trading profits in her accounts.

Obama Nominates Piwowar and Stein to SEC

The White House announced that it is nominating two individuals to seats on the SEC:

Michael Sean Piwowar, of Virginia, to be a Member of the Securities and Exchange Commission for a term expiring June 5, 2018, vice Troy A. Paredes, term expiring.  Mr. Piwowar is the chief Republican economist for the Senate Banking Committee.

Kara Marlene Stein, of Maryland, to be a Member of the Securities and Exchange Commission for a term expiring June 5, 2017, vice Elisse Walter, term expired.  Ms. Stein is a legal counsel and senior policy adviser to Sen. Jack Reed (D-R.I.).

 

Former Goldman Banker Settles SEC "Pay-to-Play" Charges

Neil M.M. Morrison, a former VP in the investment banking division of Goldman, Sachs, settled SEC charges that he engaged in a "pay-to-play" scheme.  The SEC alleged that starting in July 2008 Morrison was employed by Goldman to solicit municipal underwriting business from the Massachusetts Treasurer's Office, among others.  During the period from November 2008 to October 2010, Morrison was also substantially engaged in the political campaigns of Timothy Cahill, then-Treasurer of Massachusetts, and worked on the campaign during Goldman Sach work hours and using Goldman Sachs resources.  The SEC found that Morrison's campaign activities constituted valuable undisclosed "in-kind" campaign contributions to Cahill attributable to Goldman Sachs.  At the same time he was working on the campaign, he actively solicited municipal securities business from the Treasurer's Office.

The SEC barred Morrison from the securities industry with the right to apply for reentry after five years and also imposed a $100,000 fine.  In re Neil M.M. Morrison, Sec. Exch. Act Rel. 69627 (May 23, 2013)

ISS Settles SEC Charges that Employee Sold Confidential Proxy Voting Results for Tickets

The SEC charged proxy adviser Institutional Shareholder Services (ISS) with failing to safeguard the confidential proxy voting information of clients participating in a number of significant proxy contests. ISS, which is registered with the SEC as an investment adviser, agreed to settle the charges by paying $300,000 and retaining an independent compliance consultant.

According to the SEC, an ISS employee provided a proxy solicitor with material, nonpublic information revealing how more than 100 ISS institutional shareholder advisory clients were voting their proxy ballots. In exchange for voting information, the proxy solicitor provided the ISS employee with meals, expensive tickets to concerts and sporting events, and an airline ticket. The breach was made possible in part because ISS lacked sufficient controls over employee access to confidential client vote information, as this employee gathered the data by logging into the ISS voting website from home or work and using his personal e-mail account to communicate details to the proxy solicitor. The employee no longer works at ISS.

According to the SEC's order instituting settled administrative proceedings, the breach occurred from approximately 2007 to 2012. ISS failed to establish or enforce written policies and procedures reasonably designed to prevent the misuse of material, nonpublic information by ISS employees. Specifically, ISS lacked sufficient controls over employee access to databases of confidential client vote information.

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Today's Wall St. Journal has an article, by Joann S. Lublin and Kirsten Grind, on For Proxy Advisers, Influence Wanes, reporting that the influence of ISS and Glass Lewis is waning, as the management of companies are increasingly reaching out to institutional investors for support on key votes and money managers are increasingly relying on their own research.  For example, both ISS and Glass Lewis recommended voting for the shareholder proposal to split the CEO and Chairman positions at JP Morgan Chase, yet it received only 32% of the vote.  The SEC settlement certainly creates additional reputational problems for ISS.

Five Broker-Dealers Settle with Massachusetts over Improper Sales of REITs

The Massachusetts Securities Division announced a settlement with five independent broker-dealers for improper sales of REITs that will return over $11 million to Massachusetts investors.  The firms are Ameriprise Financial Services, Commonwealth Financial Services, Lincoln Financial Advisors, Securities America, and Royal Alliance Associates.

South Miami Settles SEC Charges of Defrauding Bond Investors

The SEC charged the City of South Miami, Fla., with defrauding bond investors about the tax-exempt financing eligibility of a mixed-use retail and parking structure being built in its downtown commercial district.  According to its release:

An SEC investigation found that the city of 11,000 residents located in Miami-Dade County borrowed approximately $12 million in two pooled, conduit bond offerings through the Florida Municipal Loan Council (FMLC). South Miami's participation in those offerings enabled it to borrow funds at advantageous tax-exempt rates. The city represented that the project was eligible for tax-exempt financing in various documents for the second offering that were relied upon by bond counsel in rendering its tax opinion. However, South Miami failed to disclose that it had actually jeopardized the tax-exempt status of both bond offerings by impermissibly loaning proceeds from the first offering to a private developer and restructuring a lease agreement prior to the second offering.

South Miami agreed to settle the charges and retain an independent third-party consultant to oversee its policies, procedures, and internal controls for municipal bond disclosures.

FINRA Will Provide Surveillance Oversight of More than 90% of U.S. Equities Trading Volume

FINRA issued an announcement that Direct Edge®, the third largest stock exchange operator in the U.S., and FINRA have agreed that FINRA will provide market surveillance services on behalf of Direct Edge's two licensed stock exchanges.  Under this agreement, FINRA will have surveillance oversight of more than 90% of U.S. equities trading volume. Direct Edge expects the new arrangement will become operative in the fourth quarter of 2013. Currently, FINRA performs examination and disciplinary services on behalf of Direct Edge. With this agreement, all of Direct Edge's third-party regulatory services will be consolidated with FINRA.

Lew Reiterates Need for Money Market Fund Reform in Senate Testimony

Treasury Secretary Lew testified today before the Senate Banking Committee on the Financial Stability Oversight Council (FSOC) Annual Report to Congress.  His written testimony identified seven areas of risks to U.S. financial stability:

·         First, market participants and regulatory agencies should take steps to reduce vulnerabilities in wholesale funding markets that can lead to destabilizing fire sales. 
·         Second, significant reform in the housing finance system is still needed.
·         Third, government agencies, regulators, and businesses should take action to address operational risks from internal control and technology failures, natural disasters, and cyber-attacks, which can cause major disruptions to the financial system.
·         Fourth, as recent developments with the London Interbank Offered Rate (LIBOR) have demonstrated, reforms are needed to address the reliance on voluntary, self-regulated, and self-reported reference interest rates.
·         Fifth, financial institutions and market participants should be cognizant of interest rate risk, particularly given the historically low interest rate environment of the past few years. 
·         Sixth, long-term fiscal imbalances that have potential economic and financial market impacts should be addressed.
·         Finally, regulators need to continue to keep a close eye on potential threats to U.S. financial stability from adverse developments in the global economy.

With respect to the first risk, Wholesale Funding Markets, the Secretary's written testimony focused on the need for additional reforms related to money market mutual funds:

The Council remains concerned that vulnerabilities in wholesale funding markets could lead to destabilizing fire sales.  Specifically, run-risk vulnerabilities related to money market mutual funds (MMFs), which became apparent during the financial crisis, still remain, despite an initial set of reforms implemented in 2010.  In November 2012, the Council issued proposed recommendations for public comment to implement structural reforms of MMFs to reduce the likelihood of runs.  Council members should also examine whether similar reforms are warranted for other cash management vehicles. 

 The Secretary's testimony noted that:

The Council is also authorized to issue recommendations to a regulatory agency when financial activities and practices are creating risk for U.S. financial markets.  In November 2012, the Council issued for public comment proposed recommendations to the SEC with three alternatives for reform to address the structural vulnerabilities of MMFs.  The Council is currently considering the public comments on the proposed recommendations.  If the SEC moves forward with meaningful structural reforms of MMFs before the Council completes its process, the Council expects that it would not issue a final recommendation to the SEC.  However, if the SEC does not pursue additional reforms that are necessary to address MMFs’ structural vulnerabilities, the Council should use its authorities to take action in this area.

SEC's Walter: No Review of Mandatory Arbitration Before 2014

SEC Commissioner Elisse Walter personally thinks that the SEC should take a hard look at mandatory arbitration of investors disputes with their broker-dealers and financial advisers, but says that the SEC will not have time to undertake a review before 2014.  Reuters, SEC review of brokerages use of arbitration not seen in 2013.  The agency continues to be busy with Dodd Frank and JOBS Act reforms, as well as money market fund reform.

FINRA Fines LPL for Systemic Email Failures & Misstatements to FINRA

FINRA fined LPL Financial LLC (LPL) $7.5 million for 35 separate, significant email system failures, which prevented LPL from accessing hundreds of millions of emails and reviewing tens of millions of other emails. Additionally, LPL made material misstatements to FINRA during its investigation of the firm's email failures. LPL was also ordered to establish a $1.5 million fund to compensate brokerage customer claimants potentially affected by its failure to produce email.

FINRA found that:

As LPL rapidly grew its business, the firm failed to devote sufficient resources to update its email systems, which became increasingly complex and unwieldy for LPL to manage and monitor effectively. The firm was well aware of its email systems failures and the overwhelming complexity of its systems. Consequently, FINRA found that from 2007 to 2013, LPL's email review and retention systems failed at least 35 times, leaving the firm unable to meet its obligations to capture email, supervise its representatives and respond to regulatory requests. Because of LPL's numerous deficiencies in retaining and surveilling emails, it failed to produce all requested email to certain federal and state regulators, and FINRA, and also likely failed to produce all emails to certain private litigants and customers in arbitration proceedings, as required.

...

FINRA also found that

In addition, LPL made material misstatements to FINRA concerning its failure to supervise 28 million DBA emails. In a January 2012 letter to FINRA, LPL inaccurately stated that the issue had been discovered in June 2011 even though certain LPL personnel had information that would have uncovered the issue as early as 2008. Moreover, the letter stated that there weren't any "red flags" suggesting any issues with DBA email accounts when, in fact, there were numerous red flags related to the supervision of DBA emails that were known to many LPL employees.

In addition, LPL likely failed to provide emails to certain arbitration claimants and private litigants. LPL will notify eligible claimants by letter within 60 days from the date of the settlement and the firm will deposit $1.5 million into a fund to pay customer claimants for its potential discovery failures. Customer claimants who brought arbitrations or litigations against LPL as of Jan. 1, 2007, and which were closed by Dec. 17, 2012, will receive, upon request, emails that the firm failed to provide them. Claimants will also have a choice of whether to accept a standard payment of $3,000 from LPL or have a fund administrator determine the amount, if any, that the claimant should receive depending on the particular facts and circumstances of that individual case. Maximum payment in cases decided by the fund administrator cannot exceed $20,000. If the total payments to claimants exceed $1.5 million, LPL will pay the additional amount.

 

NASAA Releases Report on IA Switch

NASAA released a report on the regulatory transfer of more than 2100 investment advisers from federal to state oversight, IA Switch Report, The IA Switch: A Successful Collaboration to Enhance Investor Protection.  According to NASAA, the IA Switch "was one of the most significant achievements in the history of the North American Securities Administrators Association (NASAA)."  The Switch stemmed from Section 410 of the Dodd-Frank Act, which raised the assets under management threshold for state regulation of investment advisers from $25 million to $100 million.

The report documents the work that went into the successful completion of the Switch. It draws from a survey completed by state securities regulators on the effect of the Switch;  detailed interviews with NASAA members who were key players throughout the Switch;  and industry feedback.

 

SEC Charges Atlanta Resident with Fraud in Prime Bank Investment Scheme

The SEC recently filed an emergency action in federal court in Atlanta, charging Robert Fowler (Fowler) and his company, US Capital Funding Series II Trust 1 (US Capital), with violations of the federal securities laws for defrauding investors in a “prime bank” investment scheme.

The Commission's complaint alleges that, since at least August 2012, Fowler and US Capital have raised at least $350,000 from investors by falsely promising high profits for investing in standby letters of credit or bank guarantees that would purportedly grant the investors loans, the proceeds of which would be invested for a significant profit. Fowler and US Capital instead misappropriated investor funds for personal and business uses. Fowler was actively soliciting additional investors for his scheme, the complaint alleged.

According to the complaint, Fowler targeted foreign-born small business owners with little or no experience in finance or investing.