Posts by: Editorial Board

SEC Suffers Defeat in Trial Against “Break the Buck” Executives

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A federal court jury in Manhattan returned verdicts on Monday, November 12, largely exonerating the two most senior Reserve Management Company executives in a Securities and Exchange Commission enforcement action accusing them of fraud.

The SEC alleged that Bruce R. Bent, the company’s CEO, and his son, Bruce R. Bent II, the company’s president, as well as their investment advisory firm Reserve Management Co. and Resrv Partners Inc., had defrauded investors and the fund’s trustees by falsely claiming they would support the fund financially when it faced a run by investors after Lehman Brothers’ bankruptcy (the fund held about $785 million in Lehman debt on the day it filed for bankruptcy). The bankruptcy announcement caused investors to flee the fund, leading the fund to “break the buck,” i.e., to have a net asset value (“NAV”) of less than $1 per share. The SEC alleged that, on the morning after Lehman announced its bankruptcy, the Bents falsely assured investors and the trustees that they would use money from their firm to support the $1 NAV.

Following a trial lasting approximately a month, the jury found the elder Bent not liable on all counts and the younger Bent not liable on six of seven counts. The only count on which Bent II was found liable was a negligence-based claim, not the more serious claims that he had “knowingly and recklessly” defrauded investors and the trustees. The jury found the Bents’ two entities liable for the more serious scienter-based fraud charges. The case will now proceed for United States District Judge Paul Gardephe to determine what relief and sanctions, if any, are warranted against the entities and against Bent II for the one negligence-based count on which the jury found him liable. READ MORE →

President Barack Obama’s Win Also a Win for the SEC and the CFTC

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The U.S. Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) can breathe a little easier after President Barak Obama’s re-election on Tuesday, November 6, 2012, according to legal scholars and attorneys.

Presidential Candidate Mitt Romney voiced his criticisms of the Dodd-Frank Act during the October 3, 2012, presidential debate, promising to repeal and replace Dodd-Frank. While the political climate in the United States Congress made repeal of Dodd-Frank unlikely, Romney’s administration may have eliminated or weakened provisions of the Act, appointed SEC and CFTC heads who were less interested in aggressive enforcement, and reduced both agencies’ funding.

Legal scholars and attorneys predict that President Obama’s re-election will allow the SEC and the CFTC to continue their aggressive enforcement campaigns of 2011. President Obama’s re-election is particularly important for the CFTC, which Dodd-Frank awarded new oversight powers. The Romney administration may have eliminated key provisions of the Act, returning the CFTC to the limited role it exercised under President George W. Bush. Under President Obama, the CFTC is likely to continue its expanded watchdog role and receive the funding necessary to do so. READ MORE →

Pick Your Poison: Regulators Find Overvalued Assets, Securities Fraud, and Insider Trading at Failed Thrift

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In a case involving all of the hallmarks of the housing and economic crisis, on September 25, 2012 the SEC announced that it had charged three Nebraska bank executives and the CEO’s son with violations of securities fraud and insider trading laws stemming from subprime lending, undercapitalization, and the ultimate demise of TierOne Bank.

TierOne Bank was a century-old thrift that had traditionally focused on loans to the agricultural and residential sectors in Midwestern states, but like many banks caught up in the housing boom, in 2004 TierOne expanded into riskier loans in then-exploding markets such as Nevada, Florida, and Arizona. All of these markets would collapse just a few years later, leaving banks like TierOne with significant losses on their books. As a result, in June 2008, the Office of Thrift Supervision gave TierOne a choice: maintain elevated core and risk-based capital ratios or face enforcement action—the top leaders at TierOne allegedly chose neither.

Rather than increase capital ratios or accept an OTS enforcement action, CEO Gilbert Lundstrom, COO James Laphen, and Chief Credit Officer Don Langford allegedly materially understated TierOne’s loan and OREO losses. Not to be confused with the cookie, “OREO” in the banking context refers to “other real estate owned”—in this case real estate that TierOne had repossessed. Though TierOne was left holding real estate from failed markets around the country, its executives allegedly ignored the fact that the value of these assets was based on stale and inadequately discounted appraisals, and consequently made misstatements in its 2008 10-K and a number of other filings. READ MORE →

The Tip Is In the Mail: Court Tries to Make Sense of Dodd-Frank’s Whistleblower and Retaliation Provisions and Asks Whether It’s Enough Just to Send a Letter

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In what may be one of the first Dodd-Frank retaliation claims to make it past a motion to dismiss, a federal court on September 25, 2012 issued a ruling attempting to harmonize the definition of “whistleblower” under the landmark statute with its protections against employer retaliation for engaging in whistleblower activities. Acting in accord with the SEC’s final rule on the statute as well as opinions from the few federal courts to have weighed in on the subject, the court sided with the alleged whistleblower.

For some eighteen years, Richard Kramer had served as the vice president of human resources and administration at Trans-Lux Corporation. In that role, he had a number of responsibilities related to Trans-Lux’s ERISA-governed pension plan. Concerned with what he saw as conflicts of interest and deficiencies in the pension plan committee’s composition and reporting, Kramer went to Trans-Lux’s leadership and later the board’s audit committee to sound the alarm. Kramer eventually sent a letter to the SEC the old-fashioned way—by regular mail—a choice that would later have significance in the case.

Within hours of Kramer reaching out to Trans-Lux’s audit committee with his concerns, Trans-Lux’s CEO and another Trans-Lux employee reprimanded Kramer, and went downhill from there: Kramer’s staff was reassigned, an investigation into him was launched by Trans-Lux’s in-house counsel, his responsibilities were diminished, and he was eventually terminated. Kramer later sued Trans-Lux, claiming among other things that the Company had retaliated against him in violation of Dodd-Frank. Trans-Lux moved to dismiss. READ MORE →

Supreme Court to Resolve Split on Timing for SEC Penalty Actions

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Today, the Supreme Court granted a petition for certiorari in Gabelli v. Securities and Exchange Commission (11-1274). In the appeal from a Second Circuit opinion, the Court will decide whether a governmental claim for penalties accrues on the date that the underlying violation occurs, or when the SEC discovers (or reasonably could have discovered) the violation, for purposes of the 5-year statute of limitations for governmental penalty actions embodied in 28 U.S.C. s. 2462. The precise question presented is:

“When Congress has not enacted a separate controlling provision, does the government’s claim first accrue for purposes of applying the five-year limitations period under 28 U.S.C. s. 2462 when the government can first bring the action for a penalty?”

The Second Circuit, in an opinion adopting the SEC’s position, held that the discovery rule applies to SEC enforcement actions rooted in fraud. Under that rubric, the SEC could bring an enforcement action within five years of learning about a fraud, which, in many cases, can be far more than five years after the underlying violation occurred. The Supreme Court’s decision to take the case follows closely on the heels of the Fifth Circuit’s August 7, 2012 decision in SEC v. Bartek, previously discussed here. In Bartek, the Fifth Circuit held that the statute of limitations for penalties in SEC enforcement actions began to run on the date of the underlying in violation, and that the discovery rule does not apply to 28 U.S.C. s. 2462. The Bartek decision therefore created a clear Circuit split that the Supreme Court is poised to resolve next term.

Can We Be Classmates?

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On September 6, the Second Circuit expanded class standing in a mortgage-backed securities class action suit for alleged misrepresentations in a shelf registration statement. NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., No. 11-2763 (2d Cir. Sept. 6, 2012). The plaintiff, an investment fund, sued Goldman Sachs & Co. (“Goldman”) and GS Mortgage Securities Corp. (“GS”) alleging violations of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 on behalf of a putative class of persons who acquired mortgage-backed certificates underwritten by Goldman and issued by GS. The plaintiff alleged that a single shelf registration statement connected with 17 separate offerings sold by 17 separate trusts contained false and misleading statements concerning underwriting guidelines, property appraisals, and risks and that these alleged misstatements were repeated in prospectus supplements.

The lower court had granted the defendants’ motion to dismiss, holding that the plaintiff—who had purchased securities from only two of the seventeen trusts—lacked standing to bring claims on behalf of purchasers of securities of the other fifteen trusts.

The Second Circuit disagreed that the plaintiff lacked class standing. Although the plaintiff had individual standing only as to the securities it purchased from the two trusts, the court held that the analysis for class standing is different. According to the court, to assert class standing, a plaintiff has to allege (1) that he personally suffered an injury due to the defendant’s illegal conduct and (2) that the defendant’s conduct implicates the “same set of concerns” as the conduct that caused injury to other members of the putative class. READ MORE →

Second Circuit Revives Securities Fraud Class Action, Finding Economic Loss Where Stock Price Rebounds Soon After Fraud Is Disclosed

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Imagine a plaintiff who buys stock in a company that subsequently discloses a misstatement in its financial statements that existed at the time plaintiff invested.  The stock price drops upon the initial disclosure, and then rebounds back above the purchase price. Can that plaintiff plead economic loss, as is required under Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005)? According to the Second Circuit, the answer is yes. READ MORE →

PCAOB Expands Lines of Communication Between Auditors and Audit Committees

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The Public Company Accounting Oversight Board (PCAOB)’s new accounting standard, Accounting Standard No. 16, seeks to bolster the relationship between audit committees and outside auditors, especially by encouraging ongoing, two-way tailored communications, as opposed to after-the-fact or boiler-plate notices. Auditing Standard No. 16, adopted August 15, 2012, was issued in light of requirements in Sarbanes-Oxley and the Dodd-Frank Act that relate to oversight and accounting, and replaces interim standards AU section 380 and AU section 310. The SEC is expected to approve the new rule, which could become effective as early as December of this year depending on the timing of SEC approval. READ MORE →

SEC Asks Congress For Increased Authority To Regulate Muni Bond Market

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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 →