Securities Law Prof Blog

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

Sunday, May 19, 2013

Bullard on the 401(k) Plan Large Menu Defense

The Social Costs of Choice, Free Market Ideology and the Empirical Consequences of the 401(k) Plan Large Menu Defense, by Mercer Bullard, University of Mississippi - School of Law, was recently posted on SSRN.  Here is the abstract:

Regulatory reforms have recently improved 401(k) plan participation rates, but recent decisions by certain courts threaten to reverse that trend. These courts have substituted their free market ideology for fiduciary duties under ERISA in dismissing claims against plan sponsors on the ground that the menu offered was so large as to abrogate the sponsors’ ERISA duties. Under the “large menu defense,” courts have held that, even assuming a failure to exercise due care in selecting plan options, the employer can nonetheless claim the protection of the employee-control safe harbor under ERISA because, when the plan’s menu is sufficiently large, the plan participant is deemed to have exercised legal control over the relevant investment decision. The courts’ interpretation of the control safe harbor contradicts the plain meaning of the statute. Far worse, the courts’ free market assumption that large menus will increase participants’ wealth is empirically false. Research has shown that large 401(k) menus result in lower participation rates, overly conservative allocations, inferior investment options and other adverse effects that, collectively, cost workers billions of dollars every year.

May 19, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Friday, May 17, 2013

Schwab Eliminate Class Action Waiver in Customers' Agreements -- At Least For Now

As regular readers of this Blog know, Charles Schwab includes in its brokerage agreements with its customer a provision that purports to prohibit customers from bringing class actions against the firm.  This class action waiver violates FINRA rules, but recently a FINRA hearing officer ruled that FINRA could not enforce its rule because of the Federal Arbitration Act, as interpreted by the Supreme Court in AT&T Mobility v. Concepcion.  That decision is currently on appeal before the FINRA appellate body.  Yesterday, Charles Schwab issued a statement that it was modifying its account agreements to eliminate the class action waiver until the issue is resolved:

Effective immediately, Schwab is modifying its account agreements to eliminate the existing class action lawsuit waiver for disputes related to events occurring on or after May 15, 2013 and for the foreseeable future.

While the company believes that dispute resolution is best handled via FINRA arbitration, we have chosen to voluntarily remove the waiver going forward until the issue is resolved by the appropriate regulatory and/or court decisions.  Given that the process will likely take considerable time to resolve, and may leave clients with a degree of uncertainty about their dispute resolution options in the meantime, we have elected to remove that uncertainty until the legal and regulatory process is completed.

To help ensure that small investors have access to pursue any claims they consider appropriate within the arbitration forum available to them, we will continue our existing policy of paying for the arbitration fees of any investor electing to pursue an arbitration claim under $25,000 against Schwab.


May 17, 2013 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Thursday, May 16, 2013

SEC Chair White Testifies on Oversight of the SEC before House Committee

SEC Chair White testified today on Oversight of the SEC before the U.S. House of Representatives Committee on Financial Services.

May 16, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges Chicago Investment Advisers with Cherry-Picking Trades

The SEC charged Charles J. Dushek and his son Charles S. Dushek and their Chicago-area investment advisory firm with defrauding clients through a cherry-picking scheme that garnered them nearly $2 million in illicit profits, which they spent on luxury homes, vehicles, and vacations.  According to the SEC, the Dusheks placed millions of dollars in securities trades without designating in advance whether they were trading personal funds or client funds. They delayed allocating the trades so they could cherry pick winning trades for their personal accounts and dump losing trades on the accounts of unwitting clients at Capital Management Associates (CMA). CMA misrepresented the firm’s proprietary trading activities to clients, many of whom were senior citizens.

According to the SEC’s complaint filed in federal court in Chicago, the scheme lasted from 2008 to 2012. During that period, the Dusheks made more than 13,500 purchases of securities totaling more than $350 million. The Dusheks typically waited to allocate the trades for at least one trading day – and often several days – by which time they knew whether the trades were profitable. The Dusheks ultimately kept most of the winning trades and assigned most of the losses to clients. At the time of the trading, they did not keep any written record of whether they were trading client funds or personal funds.

The SEC’s complaint charges the Dusheks and CMA with fraud and seeks final judgments that would require them to return ill-gotten gains with interest and pay financial penalties.

May 16, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Maryland Court Upholds Arbitration Bylaw in Publicly Traded REIT

Last month Steven Davidoff (the New York Times' Deal Professor) wrote a column on the hostile takeover bid for CommonWealth REIT by two hedge funds:  What’s at Stake in the Fight Over a REIT (Apr. 18, 2013).  He highlighted the fact that CommonWealth has a bylaw provision that requires arbitration of any shareholders' disputes.   Apparently when the REIT filed its registration statement for its public offering with the SEC, the agency, consistent with its longstanding position that such arbitration provisions in public corporations violate the antiwaiver provisions in federal securities laws, required the REIT to delete the provision.  But not to be thwarted, after the offering, the CommonWealth board amended the bylaws and reinstated the arbitration clause.  As Davidoff nicely frames the issue:

"If the Maryland court upholds CommonWealth's arbitration provision, more companies like Commonwealth can simply adopt these bylaws.  They can then take aggressive positions to resist a takeover, and the results will be sent to the black hole of an arbitration conducted in secret and with no timeline for an outcome."

At least as of now, CommonWealth is victorious.  On May 8, 2013, the Circuit Court for Baltimore City held that the arbitration bylaw is enforceable.  In a case of first impression for the Maryland courts, the court emphasized that arbitration is strongly favored as a matter of public policy and applied contract law principles to determine that there was both mutual assent and consideration to make the arbitration bylaw enforceable as a contract term.  Although the court's language is broad and states that constructive knowledge is sufficient, the court also found that the plaintiffs -- who, the court noted, were "two very sophisticated parties" -- had actual knowledge of the arbitration bylaw and assented to it by their stock purchases. The court also rejected plaintiffs' arguments that defendants' unilateral power to amend the bylaws made the agreement unfairly one-sided, citing case law that courts should not look beyond the "four corners" of the arbitration agreement in determining whether it is valid and enforceable.  "Because the Trustees' power to amend or revoke the Arbitration Bylaws springs from legitimate, legal sources, outside the "four corners" of the Arbitration Agreement -- namely, the company's Declaration of Trust and Maryland REIT law -- Plaintiffs' argument must fail."

So, to quote Professor Davidoff again, we now have our first ruling on this critical issue, "with real consequences for the takeover market."  I suspect that an appeal is under serious consideration.

Corvex Management LP v. CommonWealth REIT (Baltimore City Circuit Court 5/8/13)

May 16, 2013 in Judicial Opinions, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

GAO Releases Testimony on Elder Fraud

The GAO released recent testimony on Federal Government Has Taken Some Steps but Could Do More to Combat Elder Financial Exploitation (GAO-13-626T, May 16, 2013).  Here is what the GAO found:

Older adults are being financially exploited by strangers who inundate them with mail, telephone, or Internet scams; unscrupulous financial services professionals; and untrustworthy in-home caregivers. Local law enforcement authorities in the four states GAO visited indicated that investigating and prosecuting the growing number of cases involving interstate and international mass marketing fraud--such as "grandparent scams," which persuade victims to wire money to bail "grandchildren" out of jail or pay their expenses--is particularly difficult. In addition, older adults, like other consumers, may lack the information needed to make sound decisions when choosing a financial services provider. As a result, they can unknowingly risk financial exploitation by those who use questionable tactics to market unsuitable or illegal financial products. Local officials also noted that it is difficult to prevent exploitation by in-home caregivers, such as home health or personal care aides, individuals older adults must rely on.

The GAO goes on to identify ways that federal agencies could support state and local efforts to combat elder fraud.

May 16, 2013 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, May 15, 2013

Executives of China-Based Company Settle SEC Charges of Using Offering Proceeds to Buy House

The SEC charged China-based RINO International Corporation’s chief executive officer Dejun “David” Zou and chairman of the board Jianping “Amy” Qiu with engaging in a scheme to overstate the company’s revenues and divert proceeds from a securities offering for their personal use.

The SEC alleges that Zou and Qiu (who are husband and wife) diverted $3.5 million in company money to purchase a luxury home in Orange County, Calif., without disclosing it to investors. Conflicting information was provided to RINO’s outside auditor when questions were raised about the expenditure. Zou and Qiu also used offering proceeds to pay for automobiles as well as designer clothing and accessories without recording them as personal expenses or otherwise disclosing them in RINO’s public filings.

The SEC issued a trading suspension in 2011 against RINO, which is a holding company for subsidiaries that manufacture, install, and service equipment for the Chinese steel industry. The company became a China-based U.S. issuer through a reverse merger in 2007. The trading suspension was based on questions raised about RINO’s public filings — signed and certified by Zou and Qiu — overstating company revenues by including false sales contracts.

Zou and Qiu agreed to settle the SEC’s charges by paying penalties and consenting to decade-long bars from serving as officers or directors of any company publicly traded in the U.S.

May 15, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Sen. Warren Asks Fed, DOJ & SEC for Analysis on Settling without Admission of Guilt

Senator Elizabeth Warren (D-Mass.) posed this question to Ben Bernanke, Eric Holder and Mary Jo White in a May 14 letter: 

Have you conducted any internal research or analysis on trade-offs to the public between settling an enforcement action without admission of guilt and going forward with litigation as necessary to obtain such admission and, if so, can you provide that analysis to my office?

She previously asked the same question to Thomas J. Curry, Comptroller of OCC, at a hearing.  The OCC subsequently stated it did not have any such internal research or analysis.

In her letter Senator Warren stated that "I believe strongly that if a regulator reveals itself to be unwilling to take large financial institutions all the way to trial -- either because it is too timid or because it lacks resources -- the regulator has a lot less leverage in settlement negotiations and will be forced to settle on terms that are much more favorable to the wrongdoer."

Download Warren.LtrtoRegulatorsre2-14-13hrg[1]

May 15, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)

Tuesday, May 14, 2013

Senator Franken Introduces Arbitration Fairness Act

Once again an Arbitration Fairness Act (S. 878) has been introduced into Congress to prohibit mandatory arbitration clauses in disputes involving antitrust claims, civil rights claims, consumer claims (including services related to securities and other investments), and employment claims.  While similar measures introduced in recent years have gone nowhere, some Congressional representatives, including Senator Franken, who introduced this bill, have been energized by the Supreme Court's endorsement of class waivers in consumer arbitration contracts in Concepcion and the recent inclusion of a class action waiver by Charles Schwab in its brokerage agreements (which was upheld by a FINRA hearing panel and is now on appeal to FINRA's appellate body).

Download S.878

May 14, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)

Saturday, May 11, 2013

Klausner et alia on D&O Insurance in Securities Class Actions

How Protective is D&O Insurance in Securities Class Actions? — An Update, by Michael Klausner, Stanford Law School; Jason Hegland, Stanford Law School; and Matthew Goforth, Stanford Law School, was recently posted on SSRN.  Here is the abstract:

Nearly all securities class actions that are not dismissed settle. Very few are tried to judgment. Who pays into settlements — the corporation, its directors and officers, or its D&O carrier? Companies buy D&O insurance in order to protect themselves and their directors and officers from liability. But D&O policies have exclusions, limits, retentions, and other terms that might result in the carrier paying less than the full amount of a settlement. So, as an empirical matter, who pays when a company settles? We provide some basic statistics on that question, which reveal that in fact D&O insurance is quite protective. Focusing on individual officers’ contributions to settlements, we find that these are quite rare, even in cases in which the SEC has imposed a serious penalty on the same individuals for the same misconduct.

May 11, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Branson on Proposals for Corporate Governance Reform

Proposals for Corporate Governance Reform: Six Decades of Ineptitude and Counting, by Douglas M. Branson, University of Pittsburgh School of Law, was recently posted on SSRN.  Here is the abstract:

This article is a retrospective of corporate governance reforms various academics have authored over the last 60 years or so, by the author of the first U.S. legal treatise on the subject of corporate governance (Douglas M. Branson, Corporate Governance (1993)). The first finding is as to periodicity: even casual inspection reveals that the reformer group which controls the "reform" agenda has authored a new and different reform proposal every five years, with clock-like regularity. The second finding flows from the first, namely, that not one of these proposals has made so much as a dent in the problems that are perceived to exist. The third inquiry is to ask why this is so? Possible answers include the top down nature of scholarship and reform proposals in corporate governance; the closed nature of the group controlling the agenda, confined as it is to 8-10 academics at elite institutions; the lack of any attempt rethink or redefine the challenges which governance may or may not face; and the continued adhesion to the problem as the separation of ownership from control as Adolph Berle and Gardiner Means perceived it more than 80 years ago.

May 11, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Friday, May 10, 2013

Nominations Open for Tamar Frankel Fiduciary Prize

The Institute For The Fiduciary Standard, a non-profit organization based in Washington, D.C., has created a prize—to be known as the Tamar Frankel Fiduciary Prize—which will be awarded annually to a person who has made a “significant contribution to the preservation and advancement of fiduciary principles in public life.”  The award is named after Professor Tamar Frankel, an expert on fiduciary duties and investment management and a longtime Professor at Boston University Law School.

The chairman of the Nominating Committee is Professor John C. Coffee, Jr. of Columbia University Law School.  Nominations are invited from the public, but the deadline is May 23rd.  Additional information is available at the CLS Blue Sky Blog.

May 10, 2013 in Professional Announcements | Permalink | Comments (0) | TrackBack (0)

SEC Considers a NAV for Institutional Prime Funds

There has been much anticipation about what, if anything, Chairman White will do about money market funds, a notable failure of the previous Chairman Schapiro.  Several in the media are reporting that the  Commissioners are considering a staff proposal that would require institutional prime funds, the riskiest money market mutual funds, to adopt a floating share price, but not other money market funds.  Inv News, SEC floats small step in money market fund reform

May 10, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Council of Institutional Investors Urges SEC to Curb Abuses of 10b5-1 Trading Plans

The Council of Institutional Investors has written its second letter to the SEC calling for re-examination of Rule 10b5-1 trading plans, which allow corporate insiders to trade in their company's stock pursuant to advance plans, and issuance of guidance or further rulemaking to prevent abuses.  CII notes that "Since the issuance of our letter, evidence continues to mount that many companies and company insiders have adopted practices that are inconsistent with the spirit, if not the letter of Rule 10b5-1" and cites articles in the Wall St. Journal.

The WSJ also featured the CII's letter in today's issue:  SEC Is Pressed to Revamp Executive Trading Plans

May 10, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)

Thursday, May 9, 2013

NASAA Files Amicus Brief in Schwab Class Action Waiver Appeal

Several amicus briefs have been filed in the appeal of FINRA's disciplinary proceeding against Charles Schwab for including in its customer agreement a class action waiver, contrary to FINRA rules.  A FINRA hearing panel ruled that the FINRA rules were unenforceable because they were preempted by the Federal Arbitration Act; the case is now on appeal before FINRA's NAC.  While the docket in the appeal is confidential, NASAA posted its amicus brief on its website.  Professor Jill Gross and I also filed an amicus brief (Download Amicus Brief Final) that is a distillation of our recent law review article, Investor Protection Meets the Federal Arbitration Act, 1 Stanford J. Complex Litigation 1 and also available at

May 9, 2013 in Other Regulatory Action, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

SEC & FINRA Issue Alert on Pension or Settlement Income Streams

The SEC and FINRA issued an investor alert, Pension or Settlement Income Streams – What You Need to Know Before Buying or Selling Them.  The investor alert informs investors about the risks involved when selling their rights to an income stream or investing in someone else’s income stream.  The alert urges investors considering an investment in pension or settlement income streams to proceed with caution.

The alert explains that

Anyone receiving a monthly pension or regular distributions from a settlement following a personal injury lawsuit may be targeted by salespeople offering an immediate lump sum in exchange for the rights to some or all of the payments the person would otherwise receive in future.  Typically, recipients of a pension or structured settlement will sign over the rights to some or all of their monthly payments to a factoring company in return for a lump-sum amount, which will almost always be significantly lower than the present value of that future income stream.

The investor alert contains a checklist of questions to consider before selling away an income stream.

May 9, 2013 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)

Falcone Agrees to Two-Year Bar as Associated Person of Investment Adviser

Philip A. Falcone, the CEO of Harbinger Group and Harbinger Capital, and the SEC's Enforcement Division have reached an agreement in principle to settle two SEC enforcement actions, according to a 10-Q filed by Harbinger Group.  Under the terms of the settlement, Falcone will be barred for a period of two years from acting as an associated person of any broker, dealer, or investment adviser.  After two years, Falcone may seek the SEC's consent to have the ban lifted. The settlement does not prevent Falcone from owning or controlling Harbinger Group or from serving as an officer or director of the company.  Harbinger agreed to pay $18 million and to be overseen by a monitor to ensure compliance with the agreement.  Neither Falcone nor Harbinger admitted or denied the allegations of fraud.

The SEC charged that Falcone put his own interests, including maintaining a "lavish lifestyle," above those of his investors.

WSJ, Falcone Reaches Deal With SEC

May 9, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, May 8, 2013

FINRA Fines 3 Firms for Failing to Establish AML Programs

FINRA announced that it has fined three firms a total of $900,000 for failing to establish and implement adequate anti-money laundering (AML) programs and other supervisory systems to detect suspicious transactions. FINRA also fined and suspended four executives involved.

FINRA imposed the following sanctions:

  • Atlas One Financial Group, LLC – Miami, Florida – fined $350,000; Napoleon Arturo Aponte, former Chief Compliance Officer and AML Compliance Officer, fined $25,000 joint and severally with the firm, and suspended for three months in a principal capacity
  • Firstrade Securities, Inc. – Flushing, New York – fined $300,000
  • World Trade Financial Corporation (WTF) – San Diego, CA – fined $250,000; President and Owner Rodney Michel fined $35,000 and suspended in all capacities except as a financial operations principal for four months; Chief Compliance Officer Frank Brickell fined $40,000 and suspended from association in all capacities for nine months; trade desk supervisor and minority owner Jason Adams fined $5,000 and suspended for three months in a principal capacity


May 8, 2013 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, May 7, 2013

SEC Charges Traders with Paying Kickbacks to Venezuelan Official

The SEC charged four individuals with ties to Direct Access Partners (DAP), a New York City brokerage firm, in a scheme involving millions of dollars in illicit bribes paid to a high-ranking Venezuelan finance official to secure the bond trading business of a state-owned Venezuelan bank.  According to the SEC's complaint, the global markets group at DAP executed fixed income trades for customers in foreign sovereign debt. DAP Global generated more than $66 million in revenue for DAP from transaction fees on riskless principal trade executions in Venezuelan sovereign or state-sponsored bonds for Banco de Desarrollo Económico y Social de Venezuela (BANDES). A portion of this revenue was illicitly paid to BANDES Vice President of Finance, María de los Ángeles González de Hernandez, who authorized the fraudulent trades.

The SEC's complaint charges the following individuals for the roles in the kickback scheme:

•Tomas Alberto Clarke Bethancourt, who lives in Miami and is an executive vice president at DAP. Known as "Tomas Clarke," he was responsible for executing the fraudulent trades and maintaining spreadsheets tracking the illicit markups and markdowns on those trades.
•Iuri Rodolfo Bethancourt, who lives in Panama and received more than $20 million in fraudulent proceeds from DAP via his Panamanian shell company, which then paid Gonzalez a portion of this amount.
•Jose Alejandro Hurtado, who lives in Miami and served as the intermediary between DAP and Gonzalez. Hurtado was paid more than $6 million in kickbacks disguised as salary payments from DAP, and he remitted some of that money to Gonzalez.
•Haydee Leticia Pabon, who is Hurtado's wife and received approximately $8 million in markups or markdowns on BANDES trades that were funneled to her from DAP in the form of sham finders' fees.

In a parallel action, the U.S. Attorney's Office for the Southern District of New York announced criminal charges against Gonzalez as well as Clarke and Hurtado.


May 7, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, May 6, 2013

Treasury Announces Plan to Sell Remaining GM Shares

The U.S. Department of the Treasury announced the next step in its plan to sell its approximately 241.7 million remaining shares of General Motors (GM) common stock with the initiation of a second pre-defined written trading plan.  Treasury’s sale of its GM common stock is part of its continuing efforts to wind down the Troubled Asset Relief Program (TARP). 
In December 2012, GM repurchased 200 million shares of GM common stock from Treasury.  At that time, Treasury also announced that it intended to sell its remaining 300 million shares into the market in an orderly fashion and fully exit its GM investment within the next 12-15 months, subject to market conditions.

May 6, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)