Securities Law Prof Blog

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

Thursday, July 5, 2012

Second Circuit Affirms $20.5 Million Arbitration Award Against Ponzi Scheme's Clearing Firm

The Second Circuit summarily affirmed a district court's confirmation of a $20.5 million arbitration award against Goldman Sachs Execution & Clearing L.P.  The claimants, the unsecured creditors committee of Bayou Group, LLC, asserted that the clearing firm had "red flags" to alert them that Bayou was in fact a Ponzi scheme.  Goldman Sachs unsuccessfully argued that the award was "in manifest disregard of the law."  The Second Circuit, noting that the manifest disregard standard is, by design, exceedingly difficult to satisfy, agreed with district court that Goldman had not satisfied it.  Goldman Sachs Execution & Clearing, L.P. v. Official Unsecured Creditors' Committee of Bayou Group LLC (2d Cir. July 3, 2012).

July 5, 2012 in Judicial Opinions, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Sixth Circuit: Lawyers Performing Ordinary Legal Work are not Statutory Sellers under Kentucky Statute

The Sixth Circuit recently held that an attorney who performs traditional legal services for a company offering its securities to the public cannot be held liable as an offeror or seller of the securities or as an agent of the seller who materially aids the sale of securities, under the Kentucky securities statute.  Bennett v. Durham (6th Cir. June 28, 2012).  (Download BennettvDurham)

Durham was an attorney who represented two oil and gas exploration companies in connection with their sales of securities, including drafting the documents for the deals.  He also made himself available to answer prospective investors' questions, all the while, according to plaintiffs, knowing that the documents contained material misstatements and that the securities were neither registered nor exempt from registration.  The court relied on Pinter v. Dahl, 486 U.S. 622 (1988) and determined that there was no reason to think that Kentucky courts would construe the words differently.  The court emphasized that plaintiffs did not allege any facts that would show that Durham performed any services other than "ordinary legal work securities lawyers do every day."  Plaintiffs "cite no case holding an attorney liable under the Uniform Securities Act merely for drafting documents, providing advice and answering client questions." 

July 5, 2012 in Judicial Opinions, State Securities Law | Permalink | Comments (0) | TrackBack (0)

Claims Court Allows Former Controlling Shareholder of AIG to Sue Government

Starr International Company, which was the controlling shareholder of AIG before the federal bailout, sued the U.S. government on a variety of theories.  Essentially it asserted that the government, rather than providing liquidity support offered to other financial institutions, exploited AIG's vulnerable financial situation by becoming the controlling lender and controlling shareholder in September 2008.  According to Starr, the government took control of AIG so that it could use the corporation and its assets to provide a "backdoor bailout" to other financial institutions and that the government took AIG's property without due process or just compensation.  On July 2, the U.S. Court of Federal Claims granted in part and denied in part the government's motion to dismiss the claims.  It also deferred the issue of whether Starr adequately pled a demand on AIG's board or the futility of such a demand.  The government is required to file an answer by July 16.  (Download StarrvsUS11212011[1]

July 5, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Court Rejects SEC's Broad Definition of Customers: Stanford Investors Out of Luck

As I previously blogged, on July 3 the federal district court (D.C.) denied the SEC's application for an order compelling SIPC to commence a liquidation proceeding to protect customers who purchased CDs issued by an Antiguan bank marketed by the Stanford Group Company, a now-defunct broker-dealer that was a member of SIPC.  I now have read the court's opinion which concludes that the SEC failed to meet its burden of proving that SIPC "has refus[ed] ... to commit its funds or otherwise to act for the protection of customers of any member of SIPC."  (Download SECvSIPC)

While expressing sympathy to the plight of the Stanford customers who purchased the CDs, the court noted its duty to apply the statute as written by Congress.  The key issue in the dispute is whether the persons who purchased the CDs were "customers" of SGC within the meaning of the statute.  The court reviews the law and finds it well-settled that "the critical aspect of the 'customer' definition is the entrustment of cash or securities to the broker-dealer for the purpose of trading securities."  To prove entrustment, the claimant must prove that the SIPC member actually possessed the claimant's funds or securities.  Pursuant to facts stipulated by the parties, the SEC cannot show that SGC ever physically possessed the investors' funds at the time that the investors made their purchases.  The investors wrote checks or wired funds to the bank for the purpose of buying the CDs; the funds were never deposited into a SGC account.  Under a literal meaning of the statute, the investors were not customers of SGC.  The court declined the SEC's invitation to adopt a broader construction of the statute, finding that it did not square with the agency's longstanding interpretation of SIPA and was contrary to the statutory language.

July 5, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Friday, June 22, 2012

Judge Approves "Chump Change" Settlement with Two Former Bear Fund Managers

Judge Frederic Block, Senior Judge on the federal district court in E.D.N.Y., recently approved, with reluctance, an SEC consent judgment with former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin for "chump change," because the SEC persuaded him that its power to recover losses for investors was limited.  SEC v. Cioffi (E.D.N.Y. 6/18/12)(Download Cioffi.061812[1])

Cioffi and Tannin were managers of two Bear Stearns hedge funds that collapsed in 2007.  The government brought criminal securities fraud changes against the men; a jury acquitted them in 2009.  The SEC persisted in its civil action and earlier this year presented a proposed consent decree for judicial approval.  It would require Cioffi to pay $800,000 and Tannin $250,000 as well as impose industry bars for three and two years, respectively. 

Noting that investors' losses amounted to approximately $1.6 billion, the judge initially questioned the adequacy of the settlement.  The SEC persuaded the court, however, that the agency had limited power to recoup investors' losses, since it was limited to seeking disgorgement of profits.  The judge also expressed concern over the obstacles Congress had placed on private litigation in the PSLRA.  The judge reluctantly approved the settlement and invited Congress to consider whether the government should do more to aid victims of securities fraud. 

June 22, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Wednesday, June 13, 2012

Supreme Court Grants Cert to Consider Materiality Issue at Class Certification Stage

On June 11 the U.S. Supreme Court granted certiorari in a Rule 10b-5 private action, Amgen v. Connecticut Retirement Plans (Docket No. 11-1085).  The Question Presented is:

1. Whether, in a misrepresentation case under SEC Rule lOb-5, the district
court must require proof of materiality before certifying a plaintiff class based on
the fraud-on-the-market theory.
2. Whether, in such a case, the district court must allow the defendant to
present evidence rebutting the applicability of the fraud-on-the-market theory
before certifying a plaintiff class based on that theory.

Justice Breyer took no part in this decision.

The lower court opinion, from the Ninth Circuit, is reported at 660 F.3d 1170 ( Download Amgen v. ConnRetPlan.9Cir)

June 13, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Wednesday, May 30, 2012

Eleventh Circuit Says Misrepresentations Affecting Choice of Broker are not Material

SEC v. Goble (11th Cir. May 29, 2012) addresses the issue of what constitutes "securities fraud" under rule 10b-5 in the context of a clearing firm's fudging its books and records to meet regulatory reserve requirements.  To my astonishment, the appellate court decided that the principal of a clearing firm did not commit securities fraud when he caused the firm to enter on its records a sham transaction purporting to be a $5 million money market purchase because, according to the court, "a misrepresentation that would only influence an individual's choice of broker-dealers cannot form the basis for 10(b) securities fraud liability." ( Download SECv.Goble ) 

First, the facts: Richard Goble controlled North America Clearing, Inc., a clearing broker for about forty small brokerage firms.  In 2007-2008 the firm had financial difficulties and struggled to maintain at the appropriate level the cash reserve account required by SEC regulations.  Finally, in May 2008, Goble directed the CFO  to record a sham transaction -- $5 million money market purchase -- to make it appear that firm could withdraw $3.4 million from the reserve account.  FINRA examiners, who were on site, quickly discovered the sham transaction; within a few days, it was clear that the firm could not meet the reserve requirements, and the firm was wound down.  An SEC enforcement action followed, charging that the firm violated the customer protection rule and books and records requirements.  It also charged Goble with violating Rule 10b-5 (in addition to aiding and abetting the firm's violations).  The district found against Goble on both counts, enjoined him from future violatons of the securities laws and permanently restrained him from seeking a securities license or engaging in the securities business.  The appeals court reversed the district court's judgment on the 10(b) count, upheld the judgment on the aiding and abetting count and remanded for reconsideration of the injunctive relief and the bar.

Second, the appellate court's analysis of the 10(b) claim:  The SEC based its 10(b) claim on Goble's causing the CFO to record the fake money market fund purchase in the firm's books.  The appellate court first rejected the district court's finding that this was a material misrepresentation.  It "easily dispatch[ed] the ... theory that the sham transaction would have been material to an investor's choice of broker-dealers," because the materiality test focuses on the importance of the fact on an investment decision -- which the court believes does not include an investor's choice of broker-dealer.  The court categorically states that "a misrepresentation that would only influence an individual's choice of broker-dealers cannot form the basis for a 10(b) securities fraud liability."  The appellate court also found that the misrepresentation was not made "in connection with the purchase or sale of securities," even though it assumed, without deciding, that the money market fund was a security.  (The district court had found that a money market fund was not a security, another curious assertion.)  Since the only "purchase" was a sham transaction, it was neither a "purchase" nor the type of behavior that 10(b) forbids.  Indeed, another categorical assertion by the court:  "Section 10(b) was not intended to protect investors from a broker-dealer's inaccurate records or an inadequate reserve fund."

As noted, the count against Goble for aiding and abetting the customer protection rule and books and records regulations was upheld, although the district court was directed to reconsider the remedy and determine if a bar is an appropriate remedy.  Nonetheless, it is discouraging to read that information that would affect an investor's choice of broker-dealer is not material because it does not relate to an investment decision.  I just hope that the reach of this opinion is confined to its particular facts and the sweeping assertions do not come back to bite investors who rely to their detriment on brokers' assertions of their competence, expertise and probity.


May 30, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Tuesday, May 29, 2012

Second Circuit Interprets Disclosure Obligations under Item 303 of Reg S-K

The Second Circuit has issued several opinions interpreting the disclosure obligations created by Item 303 of Regulation S-K, which requires registrants to "describe any known trends or uncertainties ... that the registrant reasonably expects will have a material ... unfavorable impact on ... revenues or income from continuing operations."  Panther Partners Inc. v. Ikanos Communications, Inc. (decided May 25, 2012)(Download PantherPartners.052512[2]) is the latest in this line of cases.  Plaintiff appealed a federal district court order that dismissed its third complaint alleging violations of Securities Act 11, 12(a)(2) and 15 in connection with a March 2006 secondary offering of Ikanos Communications stock.  In contrast to the district court, the appeals courts held that the complaint stated a claim because it plausibly alleged that defects in the company's semiconductor chips constituted a known trend or uncertainty that the company reasonably expected would have a material unfavorable impact on revenues.

As alleged in the complaint, in 2005 Ikanos sold chips to Sumitomo and NEC, its two largest customers and the source of 72% of its 2005 revenues.  They in turn incorporated the chips into products that were sold to NTT and installed in its network.  In early 2006 Ikanos learned that the chips were defective and were causing the network to fail, with the complaints increasing in the weeks preceding the March 2006 offering.  Indeed the board of directors met and discussed the problem, and company representatives regularly traveled to Japan to meet with Sumitomo and NEC to discuss the problem.  Ultimately, the company had to replace at its expense all of the units sold, resulting in substantial losses.  

Plaintiff alleged that the company did not adequately disclose in its Registration Statement the magnitude of the problem and instead provided a generic cautionary warning that "highly complex products ... frequently contain defects and bugs..."  The district court had previously dismissed the complaint twice and denied plaintiff's motion to file another amended complaint because it failed to allege "additional facts that Ikanos knew the defect rate was above average before filing the registration statement."  In vacating the district court's judgment, the appeals court held that it construed the proposed complaint too narrowly:

We believe that, viewed in the context of Item 303's disclosure obligations, the defect rate, in a vacuum, is not what is at issue.  Rather, it is the manner in which uncertainty surrounding that defect rate, generated by an increasing flow of highly negative information from key customers, might reasonably be expected to have a material impact on future revenues.

The appeals court emphasized two allegations in the amended complaint that it considered critical: (1) Sumitomo andNEC accounted for 72% of revenues and (2) Ikanos knew when it was receiving the complaints that it would be unable to determine which chip sets contained defective chips. From these facts, two reasonable and plausible inference could be drawn: Ikanos would have to replace and write off a large volume of chip sets and it had jeopardized its relationship with the two customers that accounted for the vast majority of its revenues.

In light of these allegations, the Registration Statement's generic cautionary language did not fulfill the company's duty to inform the investing public of the particular, factually-based uncertainties of which it was aware in the weeks before the offering.  The court had "little difficulty concluding that Panther has adequately alleged that the disclosures concerning a problem of this magnitude were inadequate and failed to comply with Item 303."


May 29, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, May 14, 2012

New York's Highest Court Rejects Compliance Officer's Wrongful Discharge Claim

The New York Court of Appeals recently held that a hedge fund's compliance officer, who was an at will employee, had no claim for wrongful discharge because he was allegedly discharged for confronting the CEO about his front-running transactions.  Sullivan v. Harnisch (Download Sullivan.050812[1]).  According to New York's highest court,  exceptions to the state's at-will doctrine are narrow; it specifically declined to extend Wieder v. Skala, 80 NY2d 628, which recognized a wrongful discharge claim in the context of an attorney who claimed he was dismissed because of his insistence that the law firm report professional misconduct committed by another attorney at the firm. 

A majority of the judges rejected the plaintiff's assertion that "compliance with securities laws was central to his relationship with [the hedge fund] in the same way that ethical behavior as a lawyer was central in Wieder to the plaintiff's employment at a law firm."  Noting that the plaintiff did not associate with other compliance officers in a firm where all were subject to self-regulation as members of a common profession and that plaintiff was not even a "full-time compliance officer," the court said that "it is simply not true that regulatory compliance ... 'was at the very core and, indeed, the only purpose' of [plaintiff's] employment."

Moreover, according to the court, "the existence of federal regulation furnishes no reason to make state common law more intrusive."  If Congress wants to create protection for compliance officers, it is free to do so.

May 14, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Court Dismisses Schwab's Challenge to FINRA Rule For Failure to Exhaust Administrative Remedies

Regular readers of this blog will recall that Charles Schwab and FINRA are involved in a dispute over the SRO's rules that prohibit broker-dealers from requiring customers to give up their rights to bring class actions in court.  Last fall Schwab amended its customers' agreements to include such a prohibition in reliance on AT&T Mobility v. Concepcion.  FINRA promptly brought a disciplinary proceeding against the firm, and Schwab, in turn, brought an action in federal district court seeking a declaratory judgment that FINRA could not enforce its rules, first, because the FINRA rules do not really prohibit class action waivers and, second, even if it does, the rules violate the FAA.

On May 11, the federal district court granted FINRA's motion to dismiss the complaint because the court lacks jurisdiction to hear the case.  The court held that Schwab failed to exhaust its administrative remedies and that the failure to exhaust administrative remedies is jurisdictional.  In addition, even if failure to exhaust is only an element of a claim, Schwab failed to show that it meets the requirements for an exception to the requirement of administrative exhaustion.

The 21-page opinion emphasizes that the issues involved in this case are squarely within the expertise of FINRA and the SEC and do not involve any constitutional claims (unlike the issues in SEC v. Gupta dealing with retroactive application of Dodd-Frank).

Charles Schwab & Co., Inc. v. FINRA (N.D. Cal. May 11, 2012) (Download Order Granting Def's MTD)

May 14, 2012 in Judicial Opinions, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Tuesday, May 8, 2012

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

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

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

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

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

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

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

Thursday, May 3, 2012

Eleventh Circuit Reverses Summary Judgment for Morgan Keegan in ARS Action

In SEC v. Morgan Keegan & Co., Inc. (11th Cir. May 2, 2012), the appeals court reversed a summary judgment in favor of Morgan Keegan involving its sales of auction rate securities (ARS) between Jan. 2 and March 19, 2008. (Download SECv.MorganKeegan)  The SEC alleged that MK's brokers and marketing materials misrepresented ARS as cash alternatives and omitted to disclose that ARS carried liquidity risk.  MK based its summary judgment motion on the SEC's failure to meet the materiality requirement and argued that the SEC's evidence of oral misrepresentations made by four brokers to individual investors should not be included in the "total mix" of information available to the hypothetical reasonable investor.  According to MK, the SEC must demonstrate that MK misled the public as a whole and not just a few individual investors.

The problem for Morgan Keegan is the SEC enjoys the authority to seek
relief for any violation of the securities laws, no matter how small or

The court found no support for MK's argument that some minimum number of investors must be misled before finding its brokers' misrepresentations material in an SEC enforcement action.

MK also argued that its written disclosures rendered individual brokers' oral misrepresentations immaterial as a matter of law.   The court, however, was not persuaded that MK's manner of distributing its written disclosures was adequate for purposes of granting summary judgment to the firm.  The only written disclosures given directly to ARS purchasers during this time period were the trade confirmations, which did not provide any warning about liquidity risk and only referred the customers to the firm's website for "information regarding auction procedures," without providing a direct link to the ARS web page. 

The court emphasized that its holding was narrow and limited to materiality.

May 3, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Wednesday, March 28, 2012

Supreme Court Fails to Resolve Whether Equitable Tolling Extends 16(b) Liability for Short-Swing Profits

The U.S. Supreme Court recently addressed the issue of the two-year statute of limitations under section 16(b) of the Securities Exchange Act, although it decided little in the opinion except that the Ninth Circuit was wrong.  Credit Suisse Securities (USA) LLC v. Simmonds (No. 10-1261 Mar. 26, 2012).  The Ninth Circuit had ruled below that the limitations period is tolled until the insider files the section 16(a) disclosure statement "regardless of whether the plaintiff knew or should have known of the conduct at issue."

The Supreme Court, however, held that even assuming that the two-year period can be extended (an issue on which the Court was equally divided), the Ninth Circuit erred in determining that it is tolled until a section 16(a) statement is filed.  The Ninth Circuit's ruling was not supported by the text of section 16(b) -- from "the date such profit was realized" -- or the principle of equitable tolling for fraudulent concealment.  The Court remanded for the lower courts to consider in the first instance how usual equitable tolling rules apply in this case.

March 28, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Thursday, March 22, 2012

Brokerage Firms Can Profit From Sending Confirmations: 7th Circuit

Customers' complaints that their brokerage firms overcharge for their services rarely fare well in the courts, and the Seventh Circuit's recent opinion in Appert v. Morgan Stanley (Mar. 8, 2012) is no exception.  Plaintiffs brought a class action complaining that Morgan Stanley's fee for sending confirmations (a "handling, postage and insurance" or HPI fee) bore no relationship to actual costs and was excessive.  In 2002, the HPI fee was $2.35 per transaction, later raised to $5.00 and then $5.25.  In 2002, postage and handling charges were about 43 cents.

So what, said the court in affirming the district court's dismissal.  The customer's agreement with the firm did not suggest that the HPI fee represented actual costs, and Morgan Stanley had no implied duty under applicable state law to charge a fee that was reasonably proportionate to actual costs where it notified customers in advance of the charges and they were free to decide whether to continue business with the firm.

March 22, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Tuesday, March 20, 2012

Fifth Circuit Finds SLUSA Does Not Preclude Stanford Investors' State Claims

The Fifth Circuit recently held that SLUSA did not preclude state law class actions seeking to recover damages for losses resulting from the Stanford ponzi scheme, because the purchase or sale of securities (or representations about the purchase or sale of securities) was "only tangentially related" to the ponzi scheme.  Roland v. Green (5th Cir. Mar. 19, 2012). (Download Roland.031912[1])

In that case Louisiana investors sued the SEI Investments Company (SEI), the Stanford Trust Company, the Trust's employees and the Trust's investment advisers alleging violations of Louisiana law.  According to the plaintiffs, the Antigua-based Stanford International Bank (SIB) sold CDs to the Trust, which served as the custodian for individual IRA purchases of the CDs.  The Trust, in turn, contracted with SEI to administer the Trust, making SEI responsible for reporting the value of the CDs.  Plaintiffs allege that misrepresentations by SEI induced them to use their IRA funds to purchase the CDs, including that the CDs were a safe investment because SIB was "competent and efficient," that independent auditors "verified" the value of SIB's assets, and that SIB's assets were invested in a "well-diversified portfolio of highly marketable securities."  The defendants sought removal to district court on the basis of SLUSA preclusion.  (Roland was consolidated with two similar class actions.)

The district court, in holding that SLUSA precluded the class actions, acknowledged that the SIB CDs were not themselves "covered securities" under the statute, but determined that this did not end the inquiry.  It found that the requisite connection existed because (1) the plaintiffs' purchases of the CDs were allegedly induced by the representation that SIB invested in a portfolio of "covered securities" and (2) at least one plaintiff's purchases of the CDs were allegedly funded by sales of covered securities.

Though the question of the scope of the "in connection with" requirement under SLUSA was one of first impression in the Fifth Circuit, the appeals court noted that six circuits have addressed the issue.  The Fifth Circuit initially found the decisions from the Second, Ninth and Eleventh Circuits most useful, because they attempted to give dimension to what is sufficiently connected/coincidental to a transaction in covered securities to trigger SLUSA preclusion.  However, because each of these Circuits stated the requisite connection in a slightly different formulation, the Fifth Circuit looked to cases where the facts were closer to the allegations in this case, i.e., where the alleged fraud was centered around the purchase or sale of an uncovered security like the CDs in this case.  Accordingly, the court turned its attention to the "feeder fund" cases arising from the Madoff ponzi scheme and described three different approaches used by the courts: (1) whether the financial product purchased was a covered security (the product approach), (2) what was the separation between the investment in the financial product and the subsequent transactions in covered securities (the separation approach), (3) what were the purposes of the investment (the purposes approach).

Next, the Fifth Circuit returned to the "policy consideration" that the U.S. Supreme Court relied on in Dabit in determining the scope of the in connection with requirement and found persuasive Congress's explicit concern about the distinction between national, covered securities and other, uncovered securities.  "That SLUSA would be applied only to transactions involving national securitiess appears to be Congress's intent."  It also recognizes that "state common law breach of fiduciary duty actions provide an important remedy not available under federal law."  The court also acknowledged the concern expressed by some members of Congress who filed an amicus brief: "The interpretation of SLUSA and the 'in connection with' requirement adopted by the District Court ... could potentially subsume any consumer claims involving the exchange of money or alleging fraud against a bank, without regard to the product that was being peddled."

Ultimately, the Fifth Circuit concluded that the standards articulated by the Second and Eleventh Circuits were too stringent and adopted the Ninth Circuit test -- a misrepresentation is "in connection with" the purchase or sale of securities if there is a relationship in which the fraud and the stock sale coincide or are more than tangentially related.

In applying the test, the Fifth Circuit agreed with the district court that the fact that the CDs were uncovered securities did not end the inquiry and that it must closely examine the schemes and purposes of the frauds alleged by the plaintiffs.  It disagreed with the district court, however, about the importance of the representation that SIB's assets were invested in marketable securities because that was only one of many representations made to induce plaintiffs to purchase the CDs.  Rather, the "heart, crux and gravamen" of the fraudulent scheme was the representation that the CDs were a "safe and secure" investment.  It also dismissed the significance placed by the district court on the fact that at least one plaintiff sold covered securities to finance the purchase of CDs, because the fraud did not depend upon the defendant convincing the victims to sell their covered securities.  Accordingly, in both instances, the representations were no more than "tangentially related" to the purchase or sale of covered securities.


March 20, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Second Circuit Appoints Attorney to Argue in Support of Judge Rakoff's Position in SEC v. Citigroup

The Second Circuit appointed John R. Wing, Esq., of Lankler Siffert & Wohl, as counsel "to argue in support of the district court's position" in the appeal of SEC v. Citigroup.  Mr. Wing was recommended by Jed Rakoff.  (Although deciding only procedural issues, the Second Circuit last week expressed no support for Judge Rakoff's view of the scope of judicial review of an SEC settlement.)

According to his firm's website, Mr. Wing, for more than 25 years, has been actively involved in criminal trial, pretrial and appellate work, representing clients charged with, or under investigation for, violations involving securities, tax, antitrust, labor, environmental, fraud, bribery, money laundering and RICO laws.  Mr. Wing is a Fellow of the American College of Trial Lawyers and past President and Director of the New York Council of Defense Lawyers.  Mr. Wing has published and lectured extensively on jury trial work and criminal law topics and has taught trial advocacy courses at a number of law schools.

March 20, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Thursday, March 15, 2012

Second Circuit Grants Stay in SEC v. Citigroup

The Second Circuit issued a per curiam opinion today in SEC v. Citigroup Global Markets.  Technically the court granted the SEC's and Citigroup's request for a stay of the district court proceedings, refused to expedite the appeal and directed appointment of counsel to represent the "other side" of this appeal (since both parties want to reverse the district court's order).  Untechnically, the SEC and Citigroup won, and Judge Rakoff lost.

The court's views on the merits are made clear in its discussion of why the parties have a strong likelihood of success on the merits.  The court noted a number of problems with Judge Rakoff's determination that a consent judgment without Citigroup's admission of liability is bad policy, including:

The district court prejudges that Citigroup had misled investors and assumes the SEC would prevail at trial;

In addition, (and most important) the district court did not appear to give deference to the SEC's judgment on wholly discretionary matters of policy.  The scope of the district court's authority to second-guess an agency's discretionary and policy-based decision to settle is "at best minimal."

The Second Circuit did take care to emphasize that its discussion of the merits was solely for the purpose of establishing that the parties have a "strong likelihood" of success on the merits and that the "other side" was not represented. 

We recognize that, because both parties to the litigation are united in seeking the stay and opposing the district court’s order, this panel has not had the benefit of adversarial briefing. In order to ensure that the panel which determines the merits receives briefing on both sides, counsel will be appointed to argue in support of the district court’s position.
The merits panel is, of course, free to resolve all issues without preclusive effect from this ruling. In addition to the fact that our ruling is made without benefit of briefing in support of the district court’s position, our ruling, to the extent it addresses the merits, finds only that the movant has shown a likelihood of success and does not address the ultimate question to be resolved by the merits panel – whether the district court’s order should in fact be overturned.

Neverthless, unless this panel is an outlier, the opinion is a good prediction of the merits determination.

SEC v. Citigroup Global Markets (2d Cir. Mar. 15, 2012)(Download SECvCitigroup.2dCir)


March 15, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Sunday, February 19, 2012

District Court Emphasizes Differences Between Late Trading and Market Timing in SEC Action

On Feb. 14, Judge Sweet (S.D.N.Y.) handed down a 128 page opinion finding that Pentagon Capital Management PLC (PCM) and Lewis Chester violated federal securities laws by orchestrating a scheme to defraud mutual funds through late trading. He rejected the SEC's contentions that the defendants also violated the securities laws through their market timing, because the SEC did not establish that at the time of the trades market timing rules were sufficiently clear to permit liability. He granted the SEC injunctive relief, as well as $38.4 million in disgorgement and $38.4 million as a civil penalty. The SEC Release contains a link to the opinion.

The opinion followed a bench trial that lasted 17 days and heard from 18 witnesses. The opinion provides a thorough recital of the facts and the applicable law. With respect to the market timing charges, the Judge notes that liability turns on the "often blurry line between outwitting another in the marketplace and defrauding him." In contrast to the uncertainty about market timing, SEC regulation and uniform industry practice required a hard 4 p.m. cutoff for placing trades, so that the line is "startlingly bright" -- late trading is per se frauduluent.

February 19, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Monday, February 13, 2012

District Court Will Decide Dispute between SEC and SIPC in Summary Proceeding

The federal district court for the D.C. Circuit moved a step closer to resolving the unprecedented dispute between the SEC and the Securities Investor Protection Corp. (SIPC) over whether the customers of the Stanford Group Company (SGC), the defunct broker-dealer that was part of Robert Allen Stanford's ponzi scheme, are entitled to the protection from SIPC.  SIPC takes the position that the SGC customers are not covered by the statute because SGC did not perform a custody function for the customers who purchased the CDs issued by the Stanford International Bank.  The SEC originally held this position, but changed its mind in mid-2011, when it delivered to SIPC an analysis that the SGC customers were in need of protection and that SIPC should seek to commence a liquidation proceeding under SIPA.  

On Feb. 9, the court held that the statute authorizes the SEC to bring a summary proceeding for a protective decree and that the full, formal procedures of the Federal Rules of Civil Procedure are not required.  The court asked the parties to brief fully what procedures should apply in the summary proceeding.  SEC v. SIPC (D.D.C. Cir. Feb. 9, 2012)

The district court did address the SEC's contention that its "preliminary determination that SGC has failed or in danger of failing to meet its obligations to customers is not subject to judicial review by this Court."  The court found the SEC's contention "untenable:" "the plain meaning [of the statute] makes the relief available to the SEC contingent upon an affirmative determination that SIPC has refused to commit funds or otherwise protect customers."

February 13, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Thursday, February 2, 2012

Second Circuit Again Rules that Class Action Waiver In American Express Merchants Agreements is Unenforceable

In a victory for consumer and investor advocates, the Second Circuit reaffirmed its decision in In re American Express Merchants' Litigation, 634 F.3d 187 (2d Cir. 2011) (Amex II) that the class action waiver provision contained in the contracts between American Express and merchants is unenforceable under the Federal Arbitration Act (FAA), because enforcement of the clause would as a practical matter preclude any action seeking to vindicate the statutory rights asserted by the plaintiffs.  The Second Circuit ruled that the U.S. Supreme Court's recent opinion in AT&T Mobility v. Concepcion did not alter its analysis.  In re American Express Merchants' Litigation (Amex III) (2d Cir. Feb. 1, 2012) Download AmericanExpress.020112[2]

The Second Circuit has now issued three opinons on this question, necessitated by recent Supreme Court pronouncements.  In Amex I, 554 F.3d 300 (2d Cir. 2009), the court considered the enforcement of a mandatory arbitration clause in a commercial contract that also contained a class action waiver and determined that it was unenforceable.  The court reasoned that the high costs of litigating an antitrust claim ruled out individual claims and meant that without a class action plaintiffs would have no remedy.  The Supreme Court granted Amex's petition for certiorari and vacated and remanded in light of its decision in Stolt-Nielsen S.A. v. AnimalFeeds Int'l Corp., 130 S. Ct. 1758 (2010), which held that parties could not be compelled to submit to class arbitration unless they agreed to it.  In Amex II, the Second Circuit found that Stolt-Nielsen did not affect its original analysis, since the court acknowledged that it could not, and thus were not, ordering the parties to participate in class arbitration.  After Amex II, the court placed a hold on its mandate in order for Amex to file a petition for certiorari.  While the mandate was on hold, the Supreme issued Concepcion, which held that the FAA preempted a California law barring enforcement of class action waivers in consumer contracts.  The Second Circuit then sua sponte considered rehearing in light of Concepcion, and parties submitted supplemental briefing on the question.

In Amex III, the Second Circuit, in response to Amex's argument that Concepcion applies a fortiorari and requires reversal, observes that

[I]t is tempting to give both Concepcion and Stolt-Nielsen such a facile reading, and find that the cases render class arbitration waivers per se enforceable. But a careful reading of the cases demonstrates that neither one addresses the issue presented here: whether a class-action arbitration waiver clause is enforceable even if the plaintiffs are able to demonstrate that the practical effect of enforcement would be to preclude their ability to vindicate their federal statutory rights.

*    *    *    *

Concepcion plainly offers a path for analyzing whether a state contract law is preempted by the FAA.  Here, however, our holding rests squarely on a "vindication of statutory rights analysis, which is part of the federal substantive law of arbitrability."

Accordingly, since Concepcion and Stolt-Nielsen do not answer the question, the Second Circuit looked for guidance in other Supreme Court decisions addressing the issue of vindicating federal statutory rights in arbitration.  The court begins its analysis with precedent acknowledging the importance of class actions in vindicating statutory rights and then proceeds to a discussion of arbitration, also recognized as an effective vehicle for vindicating statutory rights, so long as the litigant can effectively vindicate its statutory cause of action in arbitration (citing Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc.)  Most recently, in Green Tree Financial Corp.-Alabama v. Randolph, 531 U.S. 79 (2000), the Supreme Court acknowledged in dicta "that the existence of large arbitration costs could preclude a litigant ... from effectively vindicating her federal statutory rights in the arbitral forum."

Because neither Stolt-Nielsen nor Concepcion overrules Mitsubishi and neither even mentions Green Tree, the Second Circut, in Amex III, reaffirms its earlier analysis in Amex II:  because plaintiffs' expert evidence establishes as a matter of law that the cost of plaintiffs' individually arbitrating their disputes with Amex would be prohibitive, the effect of enforcing the class-action waiver is to ensure that the merchants could not challenge Amex's tying arrangements under the antitrust laws.  Accordingly, the clause is unenforceable under the FAA.  The court made clear that each class-action waiver must be considered on its own merits, based on its own record and "governed with a healthy regard for the fact that the FAA 'is a congressional declaration of a liberal federal policy favoring arbitration agreements ....'"

We can expect that Amex will again seek a petition for certiorari.  Stay tuned!  In the meantime, kudos to the Second Circuit for a well-reasoned and eloquent opinion on the importance of class actions in enforcing federal statutory rights.

February 2, 2012 in Judicial Opinions | Permalink | Comments (1) | TrackBack (0)