Investor Lawyers Blog

SEC Chairwoman Mary Schapiro to Leave Job

Published on: November 27, 2012 | by Shepherd Smith Edwards & Kantas, LLP

SEC Chairwoman Mary Schapiro announced this week that she plans to vacate the position on December 14. According to The New York Times, she leaves behind a stronger SEC that underwent an overhaul because of her focus on “detail and meticulous preparation.”

Schapiro became SEC chairwoman following the tenure of former SEC chairman Christopher Cox. Following her appointment in 2009, Schapiro, who is the first woman to serve as SEC head, revamped the agency’s management and obtained it more Congressional funding (an approximately 50% budget bump). She also has been credited with reviving the enforcement unit, speeding up the investigative process by eliminating a policy mandating that enforcement attorneys get the SEC’s permission before they can begin a probe, getting the enforcement division to combine over 70 tip lines into one, and selecting former federal prosecutor Robert Khuzami to head up the unit. Also, in just the last two years of her tenure, the SEC’s enforcement division has filed a record number of enforcement actions against firms and individuals, even winning a securities fraud case against Goldman Sachs (GS) that required the firm to pay a $550 million fine.

Commenting on Schapiro’s departure, Shepherd Smith Edwards Kantas founder and stockbroker fraud lawyer William Shepherd said: “Any credit given Ms. Schapiro can only be as a comparison to her deplorable predecessor. She has been an instrument of the investment community her entire career. Proof of this lies a single statistic: Her SEC filed actions against 129 people and firms tied to the financial crisis – yet no top banking official was ever named.”

Judge that Dismissed Regulators’ Claims Against Morgan Keegan to Rule on ARS Lawsuit Again After His Ruling Was Reversed on Appeal

Published on: November 27, 2012 | by Shepherd Smith Edwards & Kantas, LLP

Almost a year and a half after US District Judge William Duffey Jr. dismissed the SEC’s lawsuit accusing Morgan Keegan & Co. of misleading thousands of auction-rate securities investors about the risks involved with these investments, he must now rule on the same case again. This latest trial in federal court comes after the 11th U.S. Circuit Court of Appeals in Montgomery, Alabama dismissed Duffey’s decision on the grounds that he erred when he concluded that the verbal comments made by brokers to four clients were immaterial because of disclosures that were on the retail brokerage firm’s website. Morgan Keegan is a Raymond James Financial (RJF.N) unit.

In SEC v. Morgan Keegan & Company Inc., regulators are claiming that the brokerage firm told its clients that over $2B securities came with no risk, even as the ARS market was failing, and that the investments were short-term and liquid. The commission filed its ARS fraud lawsuit against the broker-dealer in 2009.

During opening statements at this latest trial, prosecutors again contended that the brokers did not tell the investors that their cash could become frozen indefinitely. Reports Bloomberg News, orange grower John Tilis, who is a witness in this case, said that he decided to invest $400K in ARS in 2007 because he thought they were a safe place to keep his money until he had to pay taxes in April the next year. Tilis claims that the firm’s broker had informed him that he would be easily able to get his funds when he needed them. Yet when Tilis attempted to do so, he said that all the broker would tell him is that the ARS couldn’t be sold. (Morgan Keegan later refunded his principal.)

The SEC is arguing that Morgan Keegan found out about a number of failed auctions in November of 2007. In March 2008, one month after even more auctions had begun failing, the brokerage company started mandating that customers that wanted to buy ARS sign statements noting that they were aware that it might be some time before the investments became liquid again.

Meanwhile, Morgan Keegan is maintaining that it did not fail to inform clients about the risks involved in auction-rate securities, which had a history of being very “safe and liquid.” The firm contends that not being able to predict the future is not the same as securities fraud (Duffey noted this same logic when he dismissed the SEC lawsuit last year), and that even prior to the SEC lawsuit, it bought back $2B in ARS from clients. Morgan Keegan says that those who took part in the buyback program did not lose any money.

Morgan Keegan Trial Judge to Decide SEC Case He Dismissed, Bloomberg, November 26, 2012

More Blog Posts:

Court Upholds Ex-NBA Star Horace Grant $1.46M FINRA Arbitration Award from Morgan Keegan & Co. Over Mortgage-Backed Bond Losses, Stockbroker fraud Blog, October 30, 2012

Morgan Keegan & Company Ordered by FINRA to Pay $555,400 in Texas Securities Case Involving Morgan Keegan Proprietary Funds, Stockbroker fraud Blog, September 6, 2011

Securities Fraud Roundup: FINRA Examiners See Rise in Brokers Engaging in Improper Activities, SEC Chairman Backs Stronger Enforcement of Civil Penalties Act, & About 800 Investor Fraud Scam Defendants Accounted for Since 2011

Published on: November 26, 2012 | by Shepherd Smith Edwards & Kantas, LLP

According to Financial Industry Regulatory Authority EVP Susan Axelrod, the SRO’s examiners are reporting an increase in how many brokers appear to be taking part in questionable actions outside their firms or improperly selling securities. Speaking at the Securities Industry and Financial Markets Association’s complex products forum, she pressed brokerage firms to make sure its compliance programs will sniff out such violations.

Axelrod also said that FINRA examiners are noticing issues with the firms’ complex product sales, including those involving reverse convertibles and non-traded real estate investment trusts. For example, several firms did not conduct reasonable due diligence before selling non-traded REITs or make sure they were suitable for the investors. As for the reverse convertibles, examiners reportedly discovered an overconcentration of products in certain investor portfolios primarily due to poor recommendations. Failure to detect such problems appeared to have played a factor in this happening. Other problems discovered included inadequate training regarding products, product misrepresentation via sales and advertising, and failure to notify investors well in advance that products’ per-share estimated values had been repriced at figures significantly lower than the offering price.

In other securities news, Securities and Exchange Commission Chairman Mary Schapiro wants Congress to grant the SEC the power to impose penalties that are more reflective of the losses sustained by investors. Right now, the agency can only pursue ill-gotten gains’ disgorgement and impose per-violation penalties. Schapiro said that the Stronger Enforcement of Civil Penalties Act of 2012, which was introduced by Senators Jack Reed and Charles Grassley, would give the Commission the authority it needs to make violators “think twice” about abusing investors’ funds while allowing the regulator to recover significantly more for victims. She expressed her views at the New England Securities Conference last month.

SEC Clawback Lawsuit Against Two Former Arthrocare Corp. Executives Over Fraud Scheme Can Proceed, Says District Court in Texas

Published on: November 24, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The U.S. District Court for the Western District of Texas says that the Securities and Exchange Commission’s clawback lawsuit against two Arthrocare Corp. (ARTC) executives who received bonuses and compensation following accounting irregularities made by two other company officials can move forward. The defendants, ex-CEO Michael A. Baker and ex-CFO Michael Gluck, have not been charged with misconduct, and the district court said they do not need to have done anything wrong to be sued under the Sarbanes-Oxley Act’s Section 304.

This Texas securities case is one of many resulting from an alleged revenue recognition scam at the medical device manufacturer that was executed by two of its senior executives. (Arthrocare has since restated its financials for 2006 through 2008’s first quarter.) The SEC had argued that even though Baker and Gluck weren’t the charged with wrongdoing, under SOX’s Section 304, they must pay ArthroCare back their stock profits and bonuses that they received during the period of the accounting fraud.

The two men had filed a dismissal motion contending that the statute cannot be interpreted to make CFOs and CEOs with no scienter elements liable. They also claimed that statute’s vagueness not only makes it void but also it has other constitutional deficiencies. Now, however, the district court has denied their motion, finding that no separate misconduct or scienter by the defendants was necessary.

The court said that without ambiguity, the statute’s words “are dispositive” and Section 304 is unambiguous in mandating that CFOs and CEOs pay back the issuer for compensation that qualifies within a year of a filing that the issuer must restate because of misconduct by it or its agents. The district court also rejected the constitutional challenges made by the defendants and disagreed that the statute is constitutionally vague because it doesn’t clarify whose misconduct compels reimbursement. Referring to the statutory language, the court said that the ‘misconduct’ at issue in this case is misconduct by the issuer, and, since issuers include business entities and corporations, their agents, acting within the scope and course of their jobs, are also included within the definition of issuer.

The district court also disagreed with the two men’s contention that Section 304 is unconstitutionally vague. It said that the requirements for CFOs and CEOs are “crystal clear” when read along with the rest of SOX. It also noted that Section 302 tells executives exactly what they have to do to avoid reimbursement liability under Section 304, which is to ensure that the issuer submits financial statements that are accurate.

SEC v. Baker (PDF)

Sarbanes-Oxley Act of 2002

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Texas Securities RoundUp: Provident Royalties CEO Pleads Guilty in $485M Ponzi Scam and District Court Upholds $100K Arbitration Award in Adviser Fee Dispute, Stockbroker Fraud Blog, November 10, 2012

Texas Securities Fraud: Investors Bilked in $68M Dallas Ponzi Scam Hope To Recover Some Funds Via Rare Guitar Auction, Stockbroker Fraud Blog, October 25, 2012

Govt. Not Prepared for Next Inevitable Financial Crisis, Says Ex-SEC Chair, Institutional Investor Securities Blog, July 30, 2012 Continue Reading ›

Securities Roundup: BP Settles for $525M SEC Lawsuit Over Deepwater Horizon Spill Disclosures, Ex-OIG Official Says He Was Fired for Exposing Misconduct, Ex-Merrill Lynch Advisor Accused of Defrauding Elderly Client, & Trader Pleads Guilty to $28M Fraud

Published on: November 22, 2012 | by Shepherd Smith Edwards & Kantas, LLP

BP Plc. has consented to settle for $525 million Securities and Exchange Commission allegations that it gave the agency and investors misleading information about the 2010 Deepwater Horizon oil spill. If approved, this would be the third biggest penalty in SEC history.

According to the Commission, during the crisis the oil giant issued fraudulent statements about how much oil was flowing on a daily basis from the Deepwater Horizon rig into the Gulf of Mexico, including underestimating this rate by up to 5,000 oil barrels a day even though it allegedly had internal data noting that possible flow rates could be up to 146,000 barrels daily. Even after a government task force later determined that 52,700 to 62,200 oil barrels were flowing out a day, BP allegedly never modified the omissions or misrepresentations it made in SEC filings.

In other SEC news, David Weber, one of its ex-Office of Inspector General officials, is suing the agency and Chairman Mary Schapiro for allegedly getting back at him for disclosing misconduct that had been taking place at the Commission. Weber contends that SEC staff spoke about him to the media in a “malicious and defamatory” manner and leaked his personal information because he not only disclosed that ex-SEC Inspector General H. David Kotz had engaged in misconduct that placed several OIG investigations at peril, but also he revealed that there were cyber security breaches at the agency.

UBS ‘Rogue Trader’ Convicted of Fraud that Caused $2.3B Loss

Published on: November 22, 2012 | by Shepherd Smith Edwards & Kantas, LLP

Kweku Adoboli, an ex-UBS (UBS) trader, has been convicted of fraud over bad deals he made at the Swiss Bank that resulted in $2.2 billion in losses. He has been sentenced to 7 years behind bars.

Adoboli, who had pled not guilty to the criminal charges, is accused of booking bogus hedges and storing profits in a secret account to hide the risks related to his trades and dealings involving exchange-traded funds, commodities, bonds, and complex financial products that track stocks. Not only did he go beyond his trading limits but also he did not cover his losses.

Meantime, the ex-UBS trader had argued in his defence that the trading losses happened not because of fraudulent or dishonest conduct on his part but because he and other traders were asked to accomplish too much without sufficient resources and in a very volatile market.

MassMutual Settles for $1.625M SEC Charges Over Failure to Disclose Allegations Related to Complex Investments’ “Cap”

Published on: November 20, 2012 | by Shepherd Smith Edwards & Kantas, LLP

In the wake of Securities and Exchange Commission charges accusing
Massachusetts Mutual Life Insurance Company of securities law violations, the insurance company has agreed to settle the allegations by paying a $1.625M penalty. The SEC contends that the insurer did not adequately disclose the potential negative impact of a “cap” it had placed on certain complex investments.

Per the Commission, MassMutual placed a cap feature that could potentially impact $2.5B of its variable annuities in specific optional riders that were offered to investors. However, sales materials and prospectuses did not properly explain that if they cap were reached, the GMIB (guaranteed minimum income benefit) value would cease to accrue interest. Instead, the disclosures appeared to infer that interest would keep growing after the GMIB value hit the cap while investors would still have the option for dollar-for-dollar withdrawals. Not only did several MassMutual sales representatives become confused by the disclosure content, but also clients were not properly apprised of how making withdrawals could hurt them financially were the cap to be reached about 10 years from now. MassMutual has since taken out the cap to make sure that no investors suffer financial harm.

Specifically, says the SEC order, between 2007 and 2009 the insurer offered investors GMIB 5 and 6 riders as an option on specific variable annuity instruments. The GMIB riders were presented as giving “Income Now” if withdrawals were made during the accumulation phase. “Income Later” could occur if investors opted to get annuity payments. (MassMutual’s sales material noted the guarantee in the riders, which state that even if a contract were to hit a 0 in value, an investor could still apply the GMIB value to a variable or fixed annuity.)

The riders came with a maximum GMIB value-a cap that would investors would not be able to hit until 2022. However, if the cap were reached by the GMIB value, every dollar taken out would lower the GMIB value by a pro-rata figure linked to the percentage drop on the contract value. After a number of these types of withdrawals-market conditions pending-the GMIB value and the contract value would go down and adversely impact how much a customer could apply to the future income stream and an annuity.

However, contends the SEC, several MassMutual sales agents did not fully comprehend all of this and they thought that if the GMIB value hit the cap, investors could still take withdrawals with the GMIB value staying at the cap. The sales force was also suffering from other misconceptions, such as wrongly believing that investors would be able to maximize benefits if they waited until the cap was reached by the GMIB value, take yearly withdrawals of 5 or 6 percent, and annuitize contracts to get an income stream linked to the maximum GMIB value. In fact, this type of investment strategy was actually more harmful than beneficial.

The Commission says that MassMutual should have identified the signs indicating that sales argents and others didn’t fully comprehend how post-cap withdrawals might impact the GMIB value and realized that its disclosures were not adequate enough. The insurer has agreed to settle without admitting to or denying the SEC’s findings.

Read the Administrative Proceeding (PDF)

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Securities Roundup: FINRA Tells Broker Dealer to Cease-a-Desist Its Allegedly Fraudulent Sales, SEC Supports Creation of Variable Annuities Summary Prospectus, & US Supreme Court Hears Amgen & Comcast Appeals to Shut Down Class Action Lawsuits, Stockbroker Fraud Blog, November 15, 2012

California Securities Lawsuit Claiming Negligent Misrepresentation Over Allegedly Flawed Bond Offering Documents May Proceed, Says District Court, Stockbroker Fraud Blog, November 13, 2012

US Chamber of Commerce Wants Treasury Secretary to Let SEC Finish Study About Money Market Mutual Funds Before Pressing for Action, Institutional Investor Securities Blog, November 15, 2012 Continue Reading ›

FDIC Sues Pricewaterhouse Coopers & Crowe Horwath for Over $1B Over Alleged Failure to Detect Large Fraud That Led to Colonial Bank’s Collapse

Published on: November 20, 2012 | by Shepherd Smith Edwards & Kantas, LLP

In a record first involving the Federal Deposit Insurance Company suing the auditors of a failed bank, the government agency has filed a lawsuit against Crowe Horwath LLP (CROHORP) and PricewaterhouseCoopers LLP for over $1 billion for their alleged failure to detect the securities fraud perpetuated by Taylor Bean & Whitaker Mortgage Corp. that led to the demise of Colonial Bank. Taylor Bean was one of the bank’s biggest clients. The two auditors are accused of gross negligence, professional malpractice, and breach of contract for not spotting the scam.

According to the FDIC’s complaint, two Colonial mortgage lending employees, Teresa Kelly and Catherine Kissick, let Taylor Bean officials divert money from the bank without it getting collateral in return. This resulted in Taylor Bean allegedly stealing nearly $1 billion from Colonial by promising it would provide the bank with mortgages that it had actually sold to other banks. The FDIC contends that not only did Kissick and Kelly know about Bean’s fraud but also they made it possible for the cash to be illegally diverted. The two of them would later plead guilty to aiding Taylor Bean’s fraud.

In 2009, Alabama banking regulators seized Colonial. The downfall of Colonial Bank is considered one of the biggest bank failures in our nation’s history and Is expected to cost the FDIC’s insurance fund about $5 billion.

Although auditing firms usually tend to benefit from pari delicto, a common-law doctrine that prevents one wrongdoer from suing another for money made from a joint wrongdoing (and since employees’ actions are usually imputed to the corporation, in this case Colonial typically would also be considered a wrongdoer), the FDIC’s securities case portrays the Colonial lending officials as rogue employees who were working against the bank’s interest—especially as Colonial was harmed by the fraud when it lent Taylor Bean hundreds of millions of dollars that had been secured by loans that didn’t exist or were worthless. If the FDIC succeeds in demonstrating that Kissick and Kelly were working for their own benefit, then in pari delicto may not provide Pricewaterhouse Coopers and Crowe Horwath with such protections.

Meantime, Pricewaterhouse Coopers’s legal team is contending that Colonial’s employees acted to protect Colonial from loss and that Taylor Bean had been paying the bank $20-30 million/month in interest. The defendants are also arguing that auditors shouldn’t have been expected to discover the fraud that was so well hidden that the FDIC and OCC didn’t uncover it either when they conducted targeted exams.

A Tale of Two Lawsuits — PricewaterhouseCoopers and Colonial Bank, Forbes, November 10, 2012

FDIC Sues Auditors Over Colonial Bank Collapse, Smart Money/Dow Jones, November 15, 2012

Federal Deposit Insurance Corporation

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FDIC Objects to Bank of America’s Proposed $8.5B Settlement Over Mortgage-Backed Securities, Stockbroker Fraud Blog, August 30, 2011

Texas Securities RoundUp: Provident Royalties CEO Pleads Guilty in $485M Ponzi Scam and District Court Upholds $100K Arbitration Award in Adviser Fee Dispute, Stockbroker Fraud Blog, November 10, 2012

Standard & Poor’s Misled Investors By Giving Synthetic Derivatives Its Highest Ratings, Rules Australian Federal Court, Institutional Investor Securities Blog, November 8, 2012

Institutional Investor Fraud Roundup: 3,001 Whistleblower Tips Sent to SEC in ’12, CFTC Contends with ‘Regulatory Cliff,’ and Private Placement Failures Prompt Insurers to More Closely Examine Alternative Investments

Published on: November 17, 2012 | by Shepherd Smith Edwards & Kantas, LLP

According to the SEC’s Whistleblower Office, during fiscal year 2012 it received 3,001 tips. The categories that received the most complaints involved the areas related to manipulation, offering fraud, and corporate disclosures and financials. Although complaints came from every state, the states with the most complaints were California, with 435 whistleblower tips, 246 from New York, while 202 tips came from Florida. Tips also were sent in from 49 countries.

During this past fiscal year, there were 143 notices of covered enforcement actions that resulted in sanctions of over $1 million—the minimum amount that needs to be collected for a whistleblower to obtain a reward. (A quality, original tip may entitle a whistleblower to 10-30% of what the government recovers). The SEC said that its Investor Protection Fund, which pays these rewards to qualifying whistleblowers, is fully funded and at the end of FY 2012 contained over $435 million. In August, the SEC paid its first whistleblower reward of $50,000 under the program.

In other securities regulator news, Scott O’Malia the CFTC commissioner announced that the agency will have to contend with a “regulatory cliff” next month when the temporary no-action relief stemming from new swaps rules expires. The regulator had put out 18 no-action letters and other guidance on October 12, providing a lot of swap market participants with a brief reprieve from rules that were scheduled to go into effect the next day. The relief for most expires on the last day of the year, and O’Malia wants the agency to take action to resolve this situation. He made his comments at the DC conference sponsored by George Mason University’s Mercatus Center.

Regulators Also At Fault in MF Global Debacle, Says House Report

Published on: November 16, 2012 | by Shepherd Smith Edwards & Kantas, LLP

According to a report from Republican oversight panel members of the House Financial Services Committee, as MF Global teetered on the brink of failure, regulators were confused about how to deal with the crisis. The findings come from a number of Congressional hearings with MF Global executive and other officials during a yearlong probe, including interviews with numerous ex-MF Global employees and over 240,000 documents. The Republicans released the report without the backing of House Democrats.

E-mails that went back and forth between the regulators in the hours leading up to the financial derivatives broker’s bankruptcy exhibited what the Republicans describe as a “disorganized and haphazard” approach to oversight, as well as communication issues.
Some of the Republicans behind this 100-page report believe that regulators gave former MF Global chief executive John S. Corzine a lot of leeway. Meantime, Democrats have said that the report is a way for Republicans to embarrass Obama administrative watchdogs.

Representative Randy Neugebauer, who is the oversight panel’s chairman and led the investigation, commented that it wasn’t that more regulation was necessary in the handling of the MF Global crisis but that the regulators needed to actually do their job and work together better. For example, per the report, after the Commodity Futures Trading Commission had instructed MF Global to transfer $220M to stop up a hole in customer accounts, which the firm agreed to do, the Securities and Exchange Commission and other regulators complained that the order was given without first consulting them. The report also cites other incidents of missed communications and frustration among the different agencies toward each other.

Some Republicans are suggesting that SEC and CFTC would better serve investors and customers if they streamlined themselves or merged into one agency. However, this is not the first time that lawmakers have tried to combine the two regulators. Such efforts in the past have always hit a wall of opposition.

The report on MF Global is the most significant attempt by the government to address errors made by the broker and the bulk of the blame continues to be pointed toward Corzine, who fought back against attempts to limit his authority over European trades, including the demands of auditor PriceWaterhouseCoopers (PWC) that MF Global account for sovereign debt holdings in a manner that would have lowered profitability. However, authorities continue to remain wary of filing criminal charges against MF Global’s top executives because they believe that loose controls and chaos and not criminal actions, are why over a billion dollars in customer money disappeared. (The report also names the Federal Reserve Bank of New York, contending that it should have been more careful when deciding to approve MF Global’s application to sell securities on the New York Fed’s behalf.)

House Report Faults MF Global Regulators, New York Times, November 15, 2012

Financial Services Subcommittee Report Finds Decisions by Corzine, Lack of Communication Between Regulators Led to MF Global Bankruptcy and Loss of Customer Funds, Financial Services, November 15, 2012
Read the Report (PDF)

More Blog Posts:
$1.2 Billion of MF Global Inc.’s Clients Money Still Missing, Stockbroker fraud Blog, December 10, 2011

MF Global Holdings Ltd. Files for Bankruptcy While Its Broker Faces Liquidation and Securities Lawsuit by SIPC, Institutional Investor Securities Blog, October 31, 2011
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