In a long-awaited opinion issued on August 15 in Parkcentral v. Porsche, the Second Circuit limited the extraterritorial reach of the U.S. securities laws, affirming the dismissal of securities claims brought by parties to swap agreements that were entered into in the United States but were based on the price of foreign securities. Although the Parkcentral opinion offers an important interpretation of the Supreme Court’s 2010 opinion in Morrison v. National Australia Bank, the Second Circuit declined to set forth a bright-line rule for determining when a securities fraud claim based on domestic transactions in foreign securities is sufficiently “domestic” to be subject to U.S. securities laws, thereby leaving the door open to future litigants to confront this issue in securities cases involving foreign elements.
In Morrison, the Supreme Court found that Section 10(b) of the Exchange Act does not apply extraterritorially based on a lack of congressional intent to overcome the strong presumption against the extraterritorial application of domestic laws. In so holding, the Court rejected a long line of Second Circuit cases that allowed the application of Section 10(b) to claims involving foreign securities so long as the claims involved either significant conduct in the U.S. or some effect on U.S. markets or investors. The Supreme Court reasoned that the Second Circuit’s so-called “conduct test” and “effects test” improperly extended the geographic reach of the U.S. securities laws beyond Congress’s intent, and would interfere with foreign countries’ own securities regulations. Instead, the Court adopted a new “clear test,” holding that Section 10(b) applies only to claims based on: (1) “transactions in securities listed on domestic exchanges” or (2) “domestic transactions in other securities.”
“Dark pools of liquidity” have recently become the focus of increased regulatory scrutiny, including a number of high-profile enforcement actions related to these alternative trading systems. This increased scrutiny follows on the heels of Michael Lewis’s popular book, “Flash Boys,” which introduced the public at large to dark pools through its allegations that high frequency trading firms use dark pools to game the system to the detriment of common investors. But what exactly are dark pools and do they have any redeeming qualities? This post provides a primer on the benefits and disadvantages of dark pools and why they matter.
In general, “dark pools of liquidity” are private alternative forums for trading securities that are typically used by large institutional investors and operate outside of traditional “lit” exchanges like NASDAQ and the NYSE. The key characteristic of dark pools is that, unlike “lit” exchanges, the identity and amount of individual trades are not revealed. The pools typically do not publicly display quotes or provide prices at which orders will be executed. Dark pools, and trading in dark pools, have proliferated in recent years due in part to the fragmentation of financial trading venues coupled with advancements in technology, including online trading. There are currently over 40 dark pools operating in the United States. Around half of these are owned by large broker-dealers and are operated for the benefit of their clients and for their own proprietary traders. According to the SEC, the percentage of total trading volume executed in dark venues has increased from approximately 25% in 2009 to approximately 35% today.
As discussed in a previous December 3, 2013 post, the U.S. Supreme Court has agreed to hear Halliburton’s pitch to overrule or modify the decades old fraud-on-the-market presumption established inBasic Inc. v. Levinson, 485 U.S. 224, 243-50 (1988). This theory effectively allows shareholders to bring class action suits under Section 10 of the 1934 Act by presuming that plaintiffs, in purchasing stock in an efficient market, relied on alleged material misstatements made by defendants because such public statements were reflected in the company’s stock prices.
Urging the reversal of Basic, Halliburton filed its opening brief on December 30, 2013, in Halliburton Co. v. Erica P. John Fund, No. 13-317. Halliburton makes several arguments in its brief in support of overturning Basic, including many familiar legal arguments relating to statutory interpretation, congressional intent and public policy objectives. Perhaps most interesting, however, is the brief’s focus on the academic literature regarding the economic assumptions underlying Basic that may not be as familiar to practitioners. Specifically, Halliburton argues that academics have discredited and rejected Basic’s key premise that the market price of shares traded on well-developed markets reflects all publicly available information. In particular, Halliburton argues that: Read More
“Life settlements” are financial transactions in which the original owner of a life insurance policy sells it to a third party for an up front, lump sum payment. The amount paid for the policy is less than the death benefit on the policy, yet greater than the amount the policyholder would otherwise receive from an insurance company if the policyholder were to surrender the policy for its cash value. For the life settlement investor that buys the policy, the anticipated return is the difference between the death benefit and the purchase price plus the amount paid in premiums to keep the policy in force until the death benefit is payable.
Some commentators have deemed life settlements as essentially a “bet” on the life of the insured. The longer the insured lives, the lower the rate of return on the investment. Critics of life settlements are quick to point out that investors have a financial interest in the early demise of the insured person. The life settlement industry has been subject to extensive litigation for several years.
An important and as yet unsettled question is whether life settlements are “securities” as defined under federal and state securities law. This basic question has important ramifications for how life settlement contracts will be treated by courts and regulators. Read More
Many state securities laws, known as blue sky laws, are patterned after Section 12(a)(2) of the Securities Act of 1933. The interpretation of these state blue sky laws, however, may diverge significantly from the interpretation of analogous federal securities statutes. The recent Washington Court of Appeals opinion in FutureSelect Portfolio Management, Inc. et al. v. Tremont Group Holdings, Inc. et al., No. 68130-3-1 (Wn. Ct. App. Aug. 12, 2013), highlights one such divergence in which the scope of potential primary liability for secondary actors under the Washington State Securities Act extends beyond the scope of the federal law on which it was based.
In FutureSelect, a group of Washington state investors (“FutureSelect”) lost millions of dollars after purchasing interests in the Rye Funds, a “feeder fund” that invested in Bernie Madoff’s Ponzi scheme. The investors sued Tremont Group Holdings, Inc., the general partner in the Rye Funds and its affiliates, as well as the audit firm Ernst & Young LLP. The plaintiffs’ claims against EY were based primarily on the allegation that EY misrepresented that it had conducted its audit of the Rye Funds’ financial statements in conformity with generally accepted auditing standards when issuing its unqualified audit opinion on these financial statements. The trial court dismissed the plaintiffs’ claims against EY for failure to state a claim, but the Washington State Court of Appeals reversed that decision on appeal. Read More
A Texas federal judge denied defendants ArthoCare CEO Michael A. Baker and CFO Michael T. Gluk’s motion to dismiss the SEC’s claim against them under Sarbanes-Oxley (“SOX”) Section 304’s clawback provision. Section 304 requires CEOs and CFOs to reimburse their company for any bonus or similar compensations, or any profits realized from the sale of company stock, for the 12-month period following a financial report, if the company is required to prepare an accounting restatement due to material noncompliance committed as a result of misconduct.
Baker and Gluk, who were not alleged to have participated in the misconduct that led to ArthoCare’s restatement, challenged Section 304 as unconstitutional, arguing that the SEC could not require them to repay bonus compensation and profits from stock sales for merely holding CEO and CFO positions during the time of the alleged misconduct. In particular, they argued that Section 304 is vague and is unconstitutional because it does not require a reasonable relationship between the triggering conduct and the penalty as is required by the Due Process Clause.
Judge Sam Sparks of the Western District of Texas rejected the Officer-Defendants’ constitutional arguments. Judge Sparks first held that Section 304 was not vague because it clearly referred to misconduct on behalf of the issuer of the allegedly false financial statement. Judge Sparks noted that Defendants “should have been monitoring the various internal controls to guard against such misconduct; they signed the SEC filings in question, and represented they in fact were actively guarding against noncompliance. As such, they shouldered the risk of Section 304 reimbursement when noncompliance nevertheless occurred.” Read More
In its recently-released Report on the Municipal Securities Market, the Securities and Exchange Commission asked Congress to increase the SEC’s authority to regulate the municipal securities market, which it described as “decentralized . . . illiquid and opaque.” While the SEC has brought a handful of enforcement actions against issuers of municipal securities based on allegedly-misleading offering materials, most recently against the state of New Jersey in 2010 and the city of San Diego in 2006, it has done so rarely because municipal securities are exempted from most of the provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. Read More
Recently, Sean McKessy, chief of the United States Securities and Exchange Commission (“SEC”) Office of the Whistleblower, reported on the increase in whistleblower tips that have come rolling into his newly created department. The SEC began monitoring these tips eight months ago when the final provisions of the Dodd-Frank Act enacted the whistleblower provisions in Section 21F of the Securities Exchange Act. Section 21F of the Exchange Act directs the SEC to make monetary awards to whistleblowers that voluntarily provide original information that leads to successful enforcement action resulting in the imposition of monetary sanctions exceeding $1,000,000. Qualifying whistleblowers can reap between 10 percent and 30 percent of the monetary sanctions. Read More
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