Investor Lawyers Blog

Paper Offers Defenses Against Proxy Access Challenges

Published on: September 24, 2010 | by Shepherd Smith Edwards & Kantas, LLP

Assistant Professor J.W. Verret of George Mason University’s School of Law has issued a research paper that suggests a number of unique strategies that boards can use to defend against proxy access challenges. The paper is called “Defending Against Shareholder Proxy Access: Delaware’s Future Reviewing Company Defenses in the Era of Dodd-Frank.”

It was just this August that a divided US Securities and Exchange Commission approved rule changes that put in place an access regime that lets shareholders include their director nominees in proxy materials as long as they meet eligibility requirements. In his paper, Verret notes that even with the new regime, Delaware law still allows for the “limiting or expanding of the reach of proxy access.” He says that corporate boards that want to defend themselves against such challenges should refer to corporate governance arrangements with a “secondary effect on the shareholder franchise and the shareholder nomination process” as seen by the “SEC’s proxy access rule.”

Verret has said that the federal mandate for proxy access will negatively affect retail shareholders in the long run. His defense tactic recommendations include:

• Defenses related to board characteristics
• Defenses that up insurgents’ costs
• Structured shareholder-voting related defenses

Verret’s paper argues that rule amendments by the SEC likely cannot preempt all state laws, which the boards can then use. He believes that federal pre-emption is not a high risk to the defenses that he is suggesting.

Related Web Resources:

Defending Against Shareholder Proxy Access: Delaware’s Future Reviewing Company Defenses in the Era of Dodd-Frank, Social Science Research Network

Plan by FINRA and CHX to Re-Allocate Regulatory Tasks Approved by SEC

Published on: September 23, 2010 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has approved the Financial Industry Regulatory Authority and Chicago Stock Exchange Inc. proposed agreement to re-allocate certain regulatory duties that deal with firms that belong to the two self-regulatory organizations.

Under the plan, FINRA is to assume specific enforcement and examination functions for common members when the applicable CHX rules and FINRA rules involved are “substantially similar.” Also, with respect to certain federal securities laws and rules and regulations and as specified by the agreement, FINRA is to take regulatory responsibility for common members.

The SEC says the plan will cut down “unnecessary regulatory duplication” when common members are involved. While FINRA will take charge of certain responsibilities that the two SROs would otherwise have both performed, CHX will remain in charge of examination, surveillance, investigation, and enforcement when it comes to trading practices and activities in its marketplace. The latest agreement supercedes the one from 1977. It has no impact on CHX’s operations or its market oversight functions.

However, according to Securities Fraud Attorney William Shepherd, “Considering the abysmal job that these self-regulatory organizations (SRO’S) have done in regulating, for example, the lack of regulation of the Madoff securities firm, perhaps a little duplication would be perfectly acceptable!”

Related Web Resources:
SEC Approves Plan by FINRA, CHX To Re-Allocate Certain Regulatory Duties, BNA Securities Law Daily, September 13, 2010
FINRA

Chicago Stock Exchange

SEC
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Illegal High Frequency Trading: Trillium Brokerage Services LLC and 11 individuals agree to settle FINRA Charges for $2.27M

Published on: September 22, 2010 | by Shepherd Smith Edwards & Kantas, LLP

The Financial Industry Regulatory Authority says that it is fining and censuring Trillium Brokerages LLC and 11 individuals $2.27 million for their involvement in an illegal high frequency trading strategy and supervisory failures. It is the first enforcement action to target this type of improper trading behavior.

FINRA claims that through the traders, Trillium entered a number of layered, non-bona fide market moving orders in more than 46,000 instances to purposely make it appear that there was substantial selling and buying in NASDAQ and NYSE Arca stocks. Because of the high frequency trading, others in the industry submitted orders to execute against those that the Trillium traders had placed. However, after the Trillium traders submitted their orders they would immediately cancel them.

FINRA Market Regulation Executive Vice President Thomas Gira says that Trillium purposely and “improperly baited unsuspecting market participants” into making trades at illegitimate prices and to the advantage of Trillium’s traders. Gira says that FINRA will continue to “aggressively pursue disciplinary action” against those involve in illegal high frequency trading activity that undermines legitimate trades, abusive momentum ignition strategies, and other illegal conduct.

Regarding the FINRA fines, the New York-based broker-dealer has agreed to pay $1 million for using a trading technique involving the placement of a number of nonauthentic orders to make it falsely appear as if there was market activity for specific NASDAQ and NYSE Arca stocks. Trillium also must disgorge $173,000 in illegal profits.

Nine Trillium traders, the brokerage company’s chief compliance officer, and its trading director have agreed to pay a total of $805,500. They have been told to disgorge $292,000. The individuals are temporarily suspended from the securities industry or as principals.

The SEC also is looking into high frequency trading- and “quote stuffing,” which involves the placement and then immediate cancellation of bulk stock orders. The SEC wants to see whether such practices have allowed for improper or fraudulent conduct.

Related Web Resources:
FINRA Investigating Whether Broker-Dealers Providing Adequate Risk Controls to High-Frequency Traders, Institutionalinvestorsecuritiesblog.com, September 19, 2010

FINRA Sanctions Trillium Brokerage Services, LLC, Director of Trading, Chief Compliance Officer, and Nine Traders $2.26 Million for Illicit Equities Trading Strategy, FINRA, September 13, 2010

Trillium Fined by Finra for Illegal Trading Strategy, BusinessWeek, September 13, 2010

Broker-Dealer Can Be Held Liable as Control Person if Ponzi Scammer is a Registered Representative, Says Eight Circuit

Published on: September 21, 2010 | by Shepherd Smith Edwards & Kantas, LLP

According to the U.S. Court of Appeals for the Eighth Circuit, under federal securities law a broker-dealer can be liable as a control person if one of its registered representatives is involved in a Ponzi scam even if the scheme was channeled through a separate entity. The court issued its ruling in Lustgraaf v. Behrens last month. In making his decision, Judge Michael J. Melloy reinstated the investors’ control person claims against Sunset Financial Services Inc. and didn’t join the other circuits in making culpable participation by a defendant a requirement in a control-person liability action.

Melloy said that even though the Ponzi scheme didn’t take place through Sunset, the broker-dealer is the one that gave scammer Bryan S. Behrens access to the markets. Melloy says that Sunset had the duty to monitor Behrens’ activities. It was in 2008 that the Securities and Exchange Commission obtained a temporary restraining order against Behrens and National Investments Incorporated. The SEC accused Behrens of raising more than $6 million from some 20 investors through promissory notes. He and National Investments, which he controls, also are accused of falsely claiming that the high percentage of interest payable on the notes would come from the lending of investors’ funds to other people at a high interest rate when actually the assets belonging to newer investors were used to pay off current clients.

A number of the investors sued Behrens, Kansas City Life Insurance Company, and its wholly owned subsidiary Sunset. They argued that the defendants should be held liable for Behrens actions on claims of apparent authority, state and federal control-person liability, and respondeat superior.

In reversing the previous ruling, the court rejected the broker-dealer’s claim that under the 1934 Securities Exchange Act Section 20 no control person liability could come from Behren’s use of National, which is an entity unrelated to Sunset. The court, however, did affirm that the control person claims against Kansas City Life were lacking.

Related Web Resources:
LUSTGRAAF v. Behrens, Court of Appeals, 8th Circuit 2010

1934 Securities Exchange Act Section 20, SEC.gov, (PDF)
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FINRA Investigating Whether Broker-Dealers Providing Adequate Risk Controls to High-Frequency Traders

Published on: September 19, 2010 | by Shepherd Smith Edwards & Kantas, LLP

A Financial Industry Regulatory Authority says the SRO is investigating whether broker-dealers failed to put adequate risk-management controls in place for high-frequency traders with access to an exchange or alternative trading system. The probe comes following the flash crash last May that involved the stock markets dropping almost 1,000 points in a matter of minutes before rebounding just as quickly. While lawmakers said that high-frequency trading was to blame, the Commodity Futures Trading Commission and Securities and Exchange Commission disagree.

FINRA says that Chief Executive Officer Richard Ketchum’s concern is whether brokers had full comprehension of how the traders were using algorithms and whether the latter understood the possible consequences during times of serious volatility. Ketchum vowed that if serious cases of brokers failing to “even try to exercise their obligations to run checks on the firms” prior to giving them access are uncovered, then enforcement actions will be taken.

Meantime, the Securities and Exchange Commission is considering a pending rule proposal on unfiltered or naked access arrangements that would allow high-frequency traders to completely bypass risk management controls set up by broker-dealers.

High-Frequency Trading
High-frequency trading depends on computer algorithms (rather than human action) to execute transactions at super fast speed. High-frequency traders are usually institutional investors, such as pension funds or mutual funds. Through broker-dealers, these traders are able to gain direct electronic access to an exchange or ATS. According to recent data, high-frequency trading now makes up over 70% of market volume.

Related Web Resources:
High Frequency Trading and the Roiling Markets, Newsweek, June 1, 2010

High-frequency traders in the cross hairs after stock market’s wild day, LA TImes, May 6, 2010

FINRA

Securities Fraud Lawsuit Against Calamos Investments Filed on Behalf of Calamos Convertible Opportunities and Income Fund Shareholders

Published on: September 17, 2010 | by Shepherd Smith Edwards & Kantas, LLP

Calamos Asset Management, Inc., the Calamos Convertible Opportunities and Income Fund (NYSE: CHI), Calamos Advisors LLC, current trustees, and one former Fund trustee are now the defendants of a putative class action securities complaint purportedly submitted on behalf of a class of common fund shareholders. The securities fraud lawsuit is alleging breach of fiduciary duty, the aiding and abetting of that breach, and unjust enrichment related to the redemption of auction rate preferred securities (ARPS) after the ARS market collapsed in 2008.

In the securities fraud lawsuit filed by Christopher Brown, Calamos Holdings LLC founder John Calamos Sr. is accused of allowing the investment firm and its management team to benefit from investors’ losses. Brown’s complaint is a refiling of a lawsuit filed in federal court last July. That complaint was withdrawn earlier this month and the claims resubmitted in state court.

Brown contends that Calamos and others were aware they were breaching their fiduciary duty when they let fund advisers benefit while investors sustained financial losses in the “multiple millions of dollars.” Brown wants all losses restored.

He claims that even as the ARS market failed, a burden was not placed on the Calamos Convertible Opportunities and Income Fund, which held auction market preferred shares. However, in June and August, Calamos managers allegedly redeemed some of the funds’ holdings, which were replaced with debt financing that was “less favorable.” Brown says that because this advanced the interests of the managers, the funds’ investment advisors and affiliates but not the interests of common shareholders, it was a breach of fiduciary duty.

Brown is seeking class-action status for any investors in the fund since March 19, 2008. He wants a judge to prevent Calamos trustees from earning fees from the fund or acting as advisers.

Related Web Resources:
Calamos Investments Statement on ARPS Lawsuit for Convertible Opportunities and Income Fund, Centredaily.com, September 15, 2010
Calamos founder sued by investor who claims bad fund management, Chicago Business, September 14, 2010 Continue Reading ›

Former DHB Industries CEO and COO Found Guilty of Nearly $200M Securities Fraud Scam

Published on: September 16, 2010 | by Shepherd Smith Edwards & Kantas, LLP

After two months of deliberation, a jury has found Ex-DHB Industries CEO David Brooks and Ex-DHB Industries COO Sandra Hatfield guilty of committing securities fraud, insider trading, and obstruction of justice. The two defendants allegedly made close to $200 million as a result of their scam. The jury also found Brooks guilty of lying to auditors.

Prosecutors claimed that Brooks and Hatfield manipulated financial records to increase company earnings and profit margins. This resulted in the inflation of stock prices. The defendants are also accused of committing insider trading from when they sold over $72 million of their DHB stock in November 2004 and then another (approximately) $118 million of their shares the following month. The sales occurred as DHB’s stock price went up to over $20/share. Hatfield made over $5 million while Brooks realized over $180 million from the scheme.

Also, Hatfield and Brooks allegedly took part in a scheme to cover up the related party status of Tactical Armor Products, which Brooks’ wife was supposed to be running separate from DHB. In fact, Brooks wholly controlled TAP. According to the Federal of Bureau of Investigation’s New York Division Web site, profits from related party transactions were used to pay for over $16 million in Brooks’ personal expenses. He reportedly doctored internal DHB documents and created fraudulent multi-million dollar transactions to cover up the scheme and fool investors and auditors. Personal expenditures included plastic surgery for his wife, luxury vehicles, pills for his 100 racing horses, his family’s use of the company jet, and other charges.

The two defendants are each facing up to 25 years in prison.

Standard and Poor’s Ratings Lawsuit to Go Forward, Says Judge

Published on: September 16, 2010 | by Shepherd Smith Edwards & Kantas, LLP

A superior court judge has turned down Standard & Poor’s motion to dismiss Connecticut Attorney General Richard Blumenthal’s lawsuit against it. Blumenthal, who filed companion complaints against Moody’s Corp, and Fitch Inc., is accusing the credit rating agency of issuing artificially low ratings to municipalities. He claims that this ended up costing taxpayers millions of dollars in unnecessary bond insurance and high interest rates.

S & P’s parent company McGraw-Hills Cos. had moved to dismiss for improper venue by claiming that a mandatory exclusive forum provision in the S&P Terms and Conditions barred the case from being filed in Connecticut. McGraw-Hills argued that the internal laws of the State of New York are supposed to govern the agreement and that the courts there are to serve as the exclusive forums for any disputes stemming from the agreement.

Superior Court Judge Robert Shapiro, however, denied the motion to dismiss. He said that under the Connecticut Unfair Trade Practices Act, the state has a number of sovereign powers and that one of them lets the commission of consumer protection request that the state’s attorney general enforce CUTPA in state superior court.

Blumenthal called Shapiro’s decision a victory, while saying that credit rating agencies will likely continue to avoid being held accountable for misconduct. Meantime, a spokesperson for S & P told BNA last month that the lawsuit against the credit ratings agency has no factual merit.

The ratings lawsuits against Moody’s, S & P, and Fitch will now go forward in state court.

Related Web Resources:
Ratings case against S&P to proceed, MarketWatch, August 21, 2010

Richard Blumenthal, CT AG, Sues Moody’s, S&P, Says They Knowingly Falsified Debt Ratings, Huffington Post, March 10, 2010

Whistleblower Sues Moody’s Investors Service for Defamation

Published on: September 15, 2010 | by Shepherd Smith Edwards & Kantas, LLP

Ilya Eric Kolchinsky, a former Moody’s Investors Service executive, is suing the credit ratings agency for defamation. This is one of the first lawsuits involving a Wall Street company and an ex-employer that blew the whistle on it. Kolchinsky is seeking $15 million in damages in addition to legal fees.

Kolchinsky claims that Moody’s tried to ruin his reputation after he publicly talked about problems with its ratings model. Kolchinsky, who supervised the ratings that were given to subprime mortgage collateralized debt obligations (many of these did not live up to their triple-A ratings), testified before Congressional panels about his concerns. He addressed the potential conflicts that can arise as a result of the issuer-pay ratings model, which lets banks and borrowers that sell debt securities pay for ratings. He alleged securities fraud and claimed that the ratings agency placed profits ahead of doing their job. He also claimed that Moody’s lacked the resources to enforce its rules.

Kolchinsky contends that Moody’s began attacking him through the media and that the statements that the credit ratings firm issued have caused him to become “blacklisted by the private sector financial industry.” Moody’s suspended him last year. In his civil suit, Kolchinsky notes that he was attacked by the credit ratings agency even though it went on to adopt some of his recommendations.

The recently passed financial reform bill provides greater protections for whistleblowers while offering financial rewards for those brave enough to tell regulators about their concerns. However, it is unclear whether Kolchinsky’s complaint will benefit from the new law because his case involves alleged actions that occurred prior to the bill’s passing.

Related Web Resources:
Former Moody’s Executive Files Suit, New York Times, September 13, 2010
Exec who blew whistle on Moody’s ratings sues for defamation, Central Valley Business TImes, September 14, 2010
Wall Street Whistleblowers May Be Eligible to Collect 10 – 30% of Money that the Government Recovers, Stockbroker Fraud Blog, July 29, 2010 Continue Reading ›

Allegations Against Goldman Sachs in $56M Securities Fraud Lawsuit Meet Morrison Standard, Says Australian Hedge Fund

Published on: September 14, 2010 | by Shepherd Smith Edwards & Kantas, LLP

Basis Yield Alpha Fund says that its $56 million securities fraud lawsuit against Goldman Sachs Group Inc. should go to trial. The Australian hedge fund contends that its securities complaint, which accuses the investment bank of inflating certain collateralized debt obligations’ value, meet the standard recently articulated by the US Supreme Court in Morrison v. National Australia Bank. Goldman, however, contends that the transactions and securities under dispute do not meet the Morrison standard.

In the Supreme Court’s ruling, The judges limited Section 10(b) of the 1934 Securities Exchange Act’s extraterritorial reach by determining that the law was applicable only to transactions involving securities that took place in the United States or were listed on US exchanges. Following the decision, a district court ordered Goldman and Basis to use Morrison for determining whether there is grounds to drop the case. Goldman submitted its motion to dismiss and noted that the securities in the CDOs were not included on any US exchange list and that the underlying agreements were subject to English law and executed in Australia.

Meantime, Basis is arguing that its case is a “quintessential” securities fraud case involving a US sales transaction. The Australian hedge fund, which invested $42 million in “Timberwolf,” an AAA-rated tranche, and $36 million in an AA-rated tranche of CDOs, maintains that the CDO assembled mortgage-backed securities in Timberwolf came from the subprime real estate market in the US and was a New York sales transaction from beginning to end. The hedge fund was forced into insolvency when after investing in Timberwolf the CDOs value dropped dramatically and the fund sustained over $50 million in losses.

Basis contends that Goldman’s effort to make the transaction an Australian one that is not subject to federal securities laws has no legal or factual basis. It argues that adopting Goldman’s theory would nullify US securities law whenever a US seller committed securities fraud when effecting the sale of a security to a foreign buyer.

Related Web Resources:
Basis Yield Alpha Fund v Goldman Sachs Complaint, Scribd

Timberwolf Lawsuit: Goldman Sachs Sued By Australian Hedge Fund Over ‘Sh–ty Deal, Huffington Post, June 9, 2009

Read the Supreme Court Ruling (PDF)