by T. GormanPosted on Posted in SECActions

The Commission prevailed on its appeal to the Eleventh Circuit Court of Appeals in an action against Morgan Keegan & Co. The case centers on claims that the firm defrauded its customers in connection with the purchase and sale of auction rate securities or ARS as the market crisis unfolded. SEC v. Morgan Keegan & Co., No. 11-13992 (11th Cir. May 2, 2012).

In the district court the Commission’s complaint alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c). As the ARS market was collapsing in early 2008, according to the Commission, Morgan Keegan continued selling the securities. Four of its customers stated that they were told things such as ARS are as good as cash and that the securities were completely liquid. Those allegations were bolstered by internal records suggesting that the firm knew the ARS market was unraveling as the sales continued.

The firm argued on a motion for summary judgment that it fully informed investors about the risks of the auction rate securities market in a series of disclosure materials. In support of this claim Morgan Keegan pointed to a twenty-four page ARS Manual, its annual newsletter to customers and a brochure which fully informed customers about the risks of the market. In addition, customer trade confirmations gave buyers the right to rescind any transaction for ten days.

The district court agreed with Morgan Keegan and granted summary judgment in its favor. Characterizing this action as a “’hybrid case where the SEC claims that Morgan Keegan misled the public through the oral statements made to four individuals,’” the court concluded that the SEC must do more to withstand summary judgment than point to a few isolated instances of alleged broker misconduct to obtain the relief it seeks in the face of Morgan Keegan’s disclosure documents.

The Eleventh Circuit reversed. The test for materiality has been well developed in a series of private damage cases, the Court noted, such as Matrixx Initiatives, Inc., v. Siracusano, 131 S.Ct. 1309 (2011) and Basic Inc. v. Levinson, 485 U.S. 224 (1988). The SEC and Morgan Keegan agreed that the test of materiality developed in these cases applies here.

In cases such as Matrixx and Basic the Supreme Court has repeatedly rejected the use of a bright line test for materiality as potentially over or under inclusive. Rather, the High Court has repeatedly opted for a standard utilizing the “total mix” of information important to an objective, reasonable investor test. Under this standard the representations made to the four clients of the firm cannot be disregarded in favor of the written materials relied on by the firm since it deprives them of context, the Court stated. It went on to note that “The problem for Morgan Keegan is the SEC enjoys the authority to seek relief for any violation fo the securities laws, no matter how small or inconsequential . . . The SEC thus may seek a civil penalty against any defendant who has made a single misstatement or omission, if material and made with scienter and in connection with the purchase or sale of securities. . . [thus] a rule excluding all individual broker-investor communications from the materiality inquiry is underinclusive . . .. “ (emphasis original). Since the brokers were acting within the scope of their authority the SEC may establish a violation as to each.

Finally, the Court rejected the conclusion of the district court that the written disclosures of the securities firm were sufficient as a matter of law to warrant summary judgment. Conceding that written disclosures may in some instances be sufficient to render an individual broker’s misrepresentations immaterial, the Court concluded that here the “manner of distribution of its written disclosures . . . was insufficient to warrant summary judgment.” While it is clear that the written disclosures were given to some customers in some years, there is no evidence that in late 2007 and early 2008 the firm directly gave customers written disclosures before purchasing ARS. In fact the only documents they received were the written trade confirmations which say nothing about the liquidity risk of auction rate securities. Accordingly, the Court reversed the grant of summary judgment and remanded the case for trial.

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by T. GormanPosted on Posted in SECActions

The Commission instituted proceedings against UBS Puerto Rico and two of its former senior executives alleging that misrepresentations were made in connection with the sale of shares in non-exchange traded closed end funds about the pricing and the market. The action involving UBS Puerto Rico or UBS PR settled. In the Matter of UBS Financial Services Inc. of Puerto Rico, Adm. Proc. File No. 3-14863 (Filed May 1, 2012). The proceeding against Respondents Miguel A. Ferrer, former CEO of UBS PR, and Carlos J. Ortiz, former Managing Director of Capital Markets of the subsidiary, did not. In the Matter of Miguel A. Ferrer, Adm. Proc. File No. 3-14862 (Filed May 1, 2012).

Since 1995 UBS PR, a subsidiary of UBS Financial Services, Inc., has been the primary underwriter of fourteen separately organized closed-end companies’ shares. Those companies had a market capitalization of about $4 billion. The firm was also co-managed nine offerings of similar fund shares. Those had a market capitalization of about $1 billion. The shares in the funds are not listed on an exchange or quoted by any quotation service. They are only available to residents of Puerto Rico. The majority of the funds held Puerto Rico municipal bonds. The firm is the only secondary dealer for the funds it underwrote. It is the dominant dealer for the others.

Fund share prices were effectively set by the UBS PR head trader. The firm priced the fund shares to maintain a high premium to net asset value or NAV throughout 2008 and early 2009. Nevertheless, customers were told that the prices were set through supply and demand. Those prices were also listed on the client account statements as “market values.” In fact that statement was false, according to the Order.

The reinvestment program for the funds was an important sales tool. Under this program investors could elect to receive dividend reinvestment shares at net asset value or NAV. Those shares could immediately be resold to UBS PR at the then existing market price which could earn a premium of up to 45% because of the manner in which the firm priced the fund shares.

By the spring of 2009 the parent firm concluded that the inventory of fund shares held by UBS PR was too large. The subsidiary was directed to reduce the inventory because it represented a potential risk to the firm. Subsequently, UBS PR regularly sold fund shares at prices which were below those reflected in pending customer sell order. The firm was undercutting customer orders, effectively preventing them from selling their shares.

From March to September 2009 UBS PR sold about 75% of its inventory to investors. Throughout the period the firm continued to misrepresent the manner in which it set secondary market prices and the liquidity of the market. The firm also did not disclose that it was withdrawing support from the market. By fall, when the inventory reduction was completed, market prices of certain funds declined by 10 – 15%. The Order as to the firm alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c).

The firm settled, consenting to the entry of a cease and desist order based on the Sections cited in the Order as well as to a censure. In addition, to complying with its undertakings, the firm agreed to pay disgorgement of $11.5 million along with prejudgment interest and a civil penalty of $14 million.

The Order as to the two executives, alleges violations of Securities Act Section 17(a)(1), (2) and (3) and Exchange Act Section 10(b). It also claims that Messrs. Ferrer and Oritz substantially assisted UBS PR’s principal violations and willfully aided and abetted those violations. That action is proceeding to hearing.

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