Financial Services Litigation & Investigation Monitor : Financial Services Lawyer & Attorney : Perkins Coie Law Firm : Government Investigations, Class Actions

On Wednesday, February 17th, the Financial Industry Regulatory Authority (FINRA) announced that it will seek authority from the SEC to significantly expand the amount of information available to the public on current and former securities brokers through its online BrokerCheck service.

The proposed BrokerCheck expansion would enable the public to access more data on customer complaints; extend the time that the public may view the full record of a broker who has left the industry from two years to 10 years; and make certain information about former brokers available permanently, such as criminal convictions and certain civil and arbitration judgments.

Commenting on FINRA’s proposals to make more information about former brokers available to the public for longer periods of time, FINRA Chairman and CEO Rick Ketchum stated that such changes “will provide valuable information about persons who have left the securities industry, often not of their own accord, but who can still cause great harm to the investing public. Recent regulatory and criminal proceedings in the financial services sector reveal that former brokers have been engaging in fraud and other misconduct long after establishing themselves in other segments of the financial services industry.”

Specifically, FINRA's proposed expansion of BrokerCheck would:

Disclose all historic complaints, including customer complaints, arbitrations or certain litigation dating back to 1999 for individual brokers who are currently registered or whose registrations were terminated within the preceding two years.  If the SEC approves all of FINRA’s proposals, the reporting of historic complaints could apply to brokers whose registrations were terminated within the preceding 10 years.

Expand the disclosure period for former brokers from two years to ten years.  The current two-year period coincides with the period in which an individual remains subject to FINRA's jurisdiction.  The new proposal calls for making a former broker's record public for 10 years.

Increase the amount of information that is permanently available on former brokers.  Last year, BrokerCheck made information about final regulatory actions (i.e., bars, suspensions, fines, etc.) against former brokers permanently available to the public.  The new proposal would add more information to that list, including criminal convictions or pleas of guilty or nolo contendere; civil injunctions or findings of involvement in a violation of any investment-related statute or regulation; and arbitration awards or civil judgments based on the individual's involvement in an alleged sales practice violation.

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The Wall Street Journal has reported that on Monday evening, U.S. District Judge Jed S. Rakoff of the Southern District of New York denied the SEC’s motion to expand charges against Bank of America in connection with the company’s 2009 merger with Merrill Lynch. A previously filed SEC suit accused the bank of concealing plans to pay billions of dollars in bonuses to employees at Merrill Lynch before shareholders were asked to approve a merger of the two firms.  Most recently, the SEC moved to amend that complaint to include allegations that Bank of America also failed to disclose “extraordinary financial losses at Merrill Lynch prior to a shareholder vote to approve a merger between the two companies.” The SEC's proposed second amended complaint alleged that Bank of America negligently failed to disclose those losses before the shareholder vote, violating its fiduciary duty to its investors and making its previous disclosures materially false and misleading.

Judge Rakoff had previously rejected a $33 million settlement between the SEC and Bank of America last fall because it failed to hold accountable any of the executives or lawyers who were allegedly responsible for omissions in documents submitted to shareholders ahead of a vote that approved the acquisition. However, the SEC still declined to charge individuals in its proposed second amended complaint, stating that the “executives are not alleged to have deliberately concealed information from counsel or otherwise acted with scienter or intent to mislead.  Nor is any counsel alleged to have acted with scienter or intent to mislead.”

In a letter addressing the SEC’s proposed second amended complaint, Bank of America’s counsel stated that “the new theories the SEC seeks to advance in this case are baseless.”  The WSJK has now reported that on Monday evening, Judge Rakoff ruled that the S.E.C. cannot amend its complaint against Bank of America a second time, but can instead file a new complaint.

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Last month, the SEC approved a proposed rule change filed by the New York Stock Exchange which amends certain of the Exchange’s disclosure requirements for listed companies, including publicly traded financial services corporations. The changes take effect January 1, 2010, so the new disclosures will be required in proxy statements for annual meetings to be held after December 31, 2009. Below is a general overview of the new disclosure requirements. 

·        303A.02(a):  NYSE's independence disclosure will no longer require a listed company to disclose the board's categorical standards for independence. However, a listed company may still disclose these standards as a means of supporting its claim that a director is independent.

·        303A.02(b)(v):  A listed company may choose where to make its charitable contribution disclosure: on its website or in its annual proxy statement. If the former, the company must so disclose this fact in the proxy/Form 10-K and provide its website address.

·        303A.09 / 303A.10:  A listed company will no longer need to disclose that its nominating/corporate governance, compensation and audit committee charters, corporate governance guidelines and code of business conduct and ethics are available in print upon request. The company need only disclose that the above are available on the company's website and provide the website address.

·        303A.10:  A company must disclose any waivers of the code of business conduct and ethics for executive officers or directors within four days (rather than the "promptly," which had been inconsistently defined).

·        303A.12(a):  A listed company will not be required to disclose in the company's annual report to shareholders or Form 10-K that: the previous year's CEO certification was submitted to NYSE (and disclose any qualifications to that certification;  the company filed as an exhibit to its most recently filed Form 10-K, the Sarbanes-Oxley Act Section 302 certification.

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After an 18 month investigation, federal prosecutors are preparing to impanel a grand jury in Brooklyn, N.Y., to consider an indictment of former American International Group Inc. executive Joseph Cassano, according to the Wall Street Journal.    WSJ reported that, according to sources familiar with the matter, the Justice Department and the SEC have been investigating whether Cassano, who ran AIG's Financial Products unit, committed securities fraud by allegedly misleading investors about the value of mortgage-related contracts, and by failing to disclose material facts regarding such contracts to AIG's outside auditor.

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At yesterday’s hearing on BofA’s proposed $33 million settlement of an SEC civil suit, Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York continued to withhold his consent for the settlement, stating that he needs more time and information before deciding whether to approve the settlement. Judge Rakoff requested further filings by August 24th, and told the parties he would not be able to approve the settlement prior to September 9th.

The SEC’s complaint, initially filed on August 3rd, states that BofA made “materially false and misleading statements in the joint proxy statement that it filed with Merrill Lynch & Co., Inc. (“Merrill”) in connection with Bank of America’s $50 billion acquisition of Merrill on January 1, 2009.” Specifically, the SEC alleges that BofA authorized Merrill to pay up to $5.8 billion in bonuses, despite telling investors in proxy documents that Merrill had agreed not to award year-end performance bonuses or incentive pay before the merger closed. Merrill would ultimately pay $3.6 billion in bonuses, according to the SEC.

One issue on which Judge Rakoff focused his questioning was who at BofA was responsible for not disclosing that Merrill could award $5.8 billion in incentives and bonuses to employees. At one point the Judge asked David Rosenfeld, the associate regional director of the SEC’s New York office, “[w]as it some sort of ghost? Who were these people? Mr. Thain and Mr. Lewis would seem to be responsible, yes?” John Thain was the CEO at Merrill during negotiations of the sale to BofA, and Kenneth Lewis is BofA’s CEO. Rosenfeld responded, in part, that the SEC “can’t infer” misconduct from an accelerated bonus schedule.

Judge Rakoff also requested additional information on how the settlement figure of $33 million was arrived upon by the parties. “Don’t I need to know what the truth is to make a determination?” the Judge questioned. If BofA indeed broke the law by not disclosing the bonus payments in proxy materials, Judge Rakoff asked, “is there not something strangely askew in a fine of $33 million?” when compared to the billions that were paid in bonuses? Rosenfeld, on behalf of the SEC, responded that the settlement figure was “fair and reasonable” based upon prior cases.

Judge Rakoff concluded that he wants more information to determine whether the settlement amount is appropriate and whether an evidentiary hearing might be necessary, commenting that he “would be less than candid” if he didn’t “express [his] continued misgivings about the settlement at this stage.

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This afternoon at 4 p.m. EST, Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York will hold a hearing at which the SEC and Bank of America (BofA) will have to justify a proposed $33 million settlement to resolve an SEC civil suit stemming from BofA’s takeover of Merrill Lynch earlier this year.

The SEC’s complaint, initially filed on August 3rd, states that BofA made “materially false and misleading statements in the joint proxy statement that it filed with Merrill Lynch & Co., Inc. (“Merrill”) in connection with Bank of America’s $50 billion acquisition of Merrill on January 1, 2009.” Specifically, the SEC alleges that BofA authorized Merrill to pay up to $5.8 billion in bonuses, despite telling investors in proxy documents that Merrill had agreed not to award year-end performance bonuses or incentive pay before the merger closed. Merrill would ultimately pay $3.6 billion in bonuses, according to the SEC.  Two weeks after the merger was complete, losses at Merrill prompted BofA to accept $20 billion of TARP funds, on top of its earlier $25 billion.

In conjunction with the August 3rd complaint, the parties submitted a proposed Consent Judgment by which BofA, without admitting or denying the allegations, agreed to pay a penalty of $33 million. However, Judge Rakoff took issue with the proposed settlement in an August 6, 2009 Order, stating that “[d]espite the public importance of this case, the proposed Consent Judgment would leave uncertain the truth of very serious allegations made in the Complaint. Further, the proposed Consent Judgment in no way specifies the basis for the $33 million figure or whether any of this money is derived directly or indirectly from the $20 billion in public funds previously advanced to Bank of America as part of its ‘bail out’.”

Today’s hearing is expected to focus on whether the $33 million settlement is in the public’s interest.  The underlying context is that shareholders and the public might get the short end of the deal twice in a row – first when they were “defrauded” by the BofA proxy statements, and then again if BofA uses TARP money to pay the fine for that fraud.

Ultimately, the settlement is expected to win Judge Rakoff’s approval if the SEC and BofA can convince him that the public’s interest is not being harmed.  In 2003, Judge Rakoff blocked a $500 million SEC settlement with WorldCom Inc. over the accounting fraud that led to the phone company's bankruptcy.  Judge Rakoff later approved a $750 million settlement of the case.

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The SEC and Financial Industry Regulatory Authority (FINRA) filed separate lawsuits alleging that 16 brokers from the now defunct Brookstreet Securities Crop. fraudulently mislead investors that derivatives based on mortgage-backed securities were safe and conservative investments.  In its complaint, the SEC alleges that 10 Brookstreet brokers failed to inform customers about the risks associated with investing in collateralized mortgage obligations.  The brokers portrayed collateralized mortgage obligations as secure investments to more than 750 customers, which ultimately cost those investors more than $36 million in losses, but earned the brokers $18 million in commission and salaries, according to SEC allegations.  The SEC is seeking civil penalties and repayment of ill-gotten gains.

FINRA filed a companion complaint against six other former Brookstreet brokers.  According to a FINRA press release,  from June 2004 through May 2007, the brokers sold collateralized mortgage obligations to customers when the brokers themselves lacked a basic understanding of these complex and illiquid securities.

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The Securities Exchange Commission has proposed new rules to increase the oversight of investment advisors who retain custody of client assets. The proposed measures come in the wake of what many have termed as a lack of SEC regulation and enforcement that enabled ponzi schemes and other investment fraud to thrive in recent years.

The SEC’s newly proposed regulations include yearly “surprise” audits performed by independent public accountants in order to verify the sanctity of client assets under an investment advisor’s custody. Advisers would be required to disclose the identity of the independent public accountant that performs its surprise audit in public SEC filings, and amend these filings to reflect changes in accountants.  In addition, when an adviser or an affiliate directly holds client assets, a custody control review would have to be conducted by a PCAOB-registered and inspected accountant.

The proposed amendments would further require all other custodians holding client assets to directly deliver custodial statements directly to the clients, rather than through investment advisers.  These additional safeguards are meant to deter advisers from preparing false account statements, and increase the likelihood that clients discover any discrepancies between the custodial statements and statements from their investment advisors.

The public comment period on these proposed rule amendments will be open for 60 days after their publication in the Federal Register. The full text of the proposed rule amendments have yet to be published.

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The Los Angeles Times reported on May 14, 2009 that SEC investigators had recommended the filing of civil fraud charges against former Countrywide chief executive Angelo Mozillo.  According to the article written by E. Scott Reckard and William Heisel, persons familiar with the matter report that SEC staff are seeking approval to file fraud charges that include insider trading and failing to disclose to shareholders the company's risks associated with its sub-prime mortgage business.  The article states that Mozillo's attorneys were provided with a "Wells" letter weeks ago, and the matter is now before the SEC's five commissioners to approve or reject the investigator's recommendation. 
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