by T. GormanPosted on Posted in SECActions

The Commission filed a settled insider trading action against a husband who is alleged to have misappropriated inside information about a merger from his wife and then traded, reaping illegal profits of over $29,000. SEC v. Balchan, Civil Action No. 4:13-cv-298 (S.D. Tx. Filed Feb. 6, 2013).

The action centers on the acquisition of National Semiconductor Corporation by Texas Instruments, announced after the close of the market on April 4, 2011. Defendant James Balchan, an IT specialist, is married to a partner in a law firm. One of her partners, called Partner A in the complaint, was a close friend of the general counsel of National Semiconductor. In honor of his friend the general counsel, the Partner A organized a “wine and dine” weekend. Mr. Balchan and his wife were invited.

Prior to the event Partner A called his friend the general counsel. During the call the general counsel told him that he was working on the merger of his firm, National
Semiconductor. He sought advice regarding certain regulatory requirements. By the end of the conversation the General Counsel noted that because of the pending merger he would have to cancel the social event.

Subsequently, Partner A advised Mrs. Balchan that the event would be canceled because of the pending acquisition. Mr. Balchan then learned about the deal from his wife. The information was shared in confidence, according to the complaint.

The next morning Mr. Balchan purchased 2,000 shares of National Semiconductor. Several days later he purchased another 1,000 shares.

Following the deal announcement by Texas Instruments the share price increased from about $14 to $26.06. This represented a premium to market of about 76%. Mr. Balchan had profits of $29,052.39. The Commission’s one count complaint alleges a violation of Exchange Act Section 10(b).

Mr. Balchan resolved the case, consenting to the entry of a permanent injunction based on the Section cited in the complaint. He also agreed to pay disgorgement of $29,052.39 along with prejudgment interest and a penalty equal to the amount of the disgorgement.

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by T. GormanPosted on Posted in SECActions

The Department of Justice brought what is perhaps the most significant market crisis case to date, named as defendants rating agency Standard & Poor’s Financial Services LLC and its parent McGraw-Hill Companies, Inc. The case focuses on ratings given to traunches of residential mortgage backed securities or RMBS and collateralized debt obligations or CDS. It centers on a period beginning in 2004 and continuing through the unraveling of the U.S. economy as the securities S&P once rated AAA turned to junk. U.S. v. McGraw-Hill Companies, Inc., Case No. CV 13-00779 (C.D. Cal. Filed Feb. 4, 2013).

The action is predicated not on the securities laws but rather the Financial Institutions Reform, Recover, and Enforcement Act of 1989 or FIRREA, an S&L crisis era statute designed to protect federally insured institutions. Alleging wire fraud, mail fraud and financial institution fraud, the suit seeks to vindicate the interests of a number of federally insured institutions ranging from Citibank and Bank of America to the Easter Financial Florida Credit Union, which purchased the RMBS and CDOs based on the lofty ratings given the securities by S&P, one of the nation’s premier rating agencies.

The complaint is long, complex and covers a series of securities rated by S&P over the three year period in contrast to other market crisis cases which often focused on a single transaction. At times it quotes e-mails and unidentified witnesses regarding the S&P ratings process. Yet it is in fact straight forward.

The complaint alleges an on-going scheme to defraud purchasers of the securities by S&P involving a series of transactions over years. In this regard it contrasts with other market crisis cases which often focused on a single transaction. The scheme involved repeated representations that its credit ratings of RMBS and CDO traunches were objective, independent, uninfluenced by any conflicts that might compromise S&P’s analytic judgment . . . “ In making this assertion the firm knew that its prominent reputation and ratings were critical to the sale of the securities. It knew that the ratings assigned by the firm were relied on by the financial institutions and others who purchased the securities. It knew that the assertions were false, the DOJ claims.

The motive for the scheme was equally straight forward: it acted in the interests of the securities sellers who retained the firm and to maintain and grow its market share and profits, the complaint claims. This is evidenced by the fact that:

· Weakened standards: Beginning in September 2004 and continuing through the period the firm “limited, adjusted, and delayed updates to the ratings criteria and analytical models . . . “ used in formulating its ratings which had the effect of weakening the standards heading into the market crisis.

· Revised criteria to minimize downgrades: In 2006 analysts in RMBS at the firm began noticing rising delinquencies in the mortgages underlying non-prime RMBS that S&P had rated. To deal with the problem new criteria were developed to test their assumptions after which those assumptions with lead to the desired results – fewer downgrades – were selected.

· Ignored increasing risk: Beginning in March 2007 the firm disregarded “the true extent of the credit risks associated with those non-prime RMBS tranches in issuing and/or confirming ratings for CDOs with exposure to those non-prime RMBS tranches . . . “ knowing that the ratings did not reflect the actual credit risk of the securities.

· Disregarded announced policies: As the markets continued to deteriorate during the summer of 2007 the firm disregarded policies it announced to reassure the public that the ratings accounted for market conditions. In selected instances S&P worked with issuers on an issue by issue basis to achieve the desired rating.

The complaint demands civil money penalties in an unspecified amount and other relief. Reports indicate that the DOJ demanded a $1billion penalty and admissions of liability to settle. A number of states may join the DOJ in its suit. The SEC, according to reports, previously issued a Wells Notice to the firm but no action has been taken.

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