by T. GormanPosted on Posted in SECActions

The Second Circuit Court of Appeals vacated a preliminary injunction secured by the SEC and the CFTC freezing the assets a spouse received in a divorce settlement from her former husband who ran a massive Ponzi scheme. The court held that the agencies are only entitled to obtain disgorgement of ill-gotten funds to the extent a relief defendant “lacks a legitimate claim to them.” CFTC v. Walsh, Nos. 09-3742, 09-3787 (2nd Cir. Decided Sept. 15, 2011).

Relief defendant Janet Schaberg (named in the action as Janet Walsh) was married to Stephen Walsh for two decades. By the time of their separation in 2004 Mr. Walsh had amassed a substantial fortune. Under the terms of the final 2006 divorce settlement Mr. Walsh paid his former spouse $12.5 million in biannual installments through 2020. She also obtained nearly $5 million held in several checking accounts during the marriage as well as their home in Port Washington, New York and other real estate.

In 2009 the SEC and the CFTC accused Mr. Walsh of operating a Ponzi scheme. He and his partner supposedly fleeced investors out of $554 million. Investor funds which were suppose to be put in a vehicle to trade in equity index arbitrage were in fact used for the personal expenses of Mr. Walsh. Both agencies filed enforcement actions and requested a preliminary injunction freezing assets including those held by Ms. Schaberg. The district court granted the motions of the SEC and CFTC.

Critical to a resolution of this case is the question of whether Ms. Schaberg has a legitimate claim to the assets. To resolve this issue the court certified two questions to the New York Court of Appeals for resolution, rejecting the contention of each agency that it is one of federal law. Question one focused on whether “marital property can include the proceeds of a fraud.” The second, which the New York court recast, is whether a spouse paid fair consideration if all or part of the marital estate consists of the proceeds of a fraud. The answer to the first question is yes while the response to the second is no. The response to the second question is qualified however. The court stated that a spouse cannot be viewed as having paid fair value for the assets received by relinquishing a claim to a bigger share of the fraudulently obtained assets where the marital estate is primarily or all the proceeds of a fraud. Fair consideration giving the spouse a legitimate claim to assets can be given the court held by relinquishing rights such as maintenance, inheritance and child custody.

In this case the preliminary injunction was predicated on the notion that Ms. Schaberg had no legitimate claim to the assets because the estate was largely if not wholly the fruits of the Ponzi scheme. However, under New York law it is clear from the ruling of the Court of Appeals that a “divorce decree may cleanse such a taint [from a Ponzi scheme] where the innocent spouse acts in good faith and gives fair consideration.”

In reaching its conclusion that the preliminary injunction had to be vacated the court rejected arguments by the SEC and CFTC that the ruling could be affirmed on the basis that under the facts here valid consideration was not paid. First, the Court of Appeals held that there could be fair consideration under New York law. Second, at least some part of the funds spent on the residence in Port Washington, appear to have come from untainted sources. Third, Ms. Schaberg relinquished rights to maintenance and inheritance which might not have been worth much at the time, but at some point they may have value. Finally, it is possible that fair value may have been given for at least some of the assets. Accordingly, the case had to be remanded to the district court for further proceedings.

Program: ABA Seminar: Is the DOJ and SEC War On Insider Trading Rewriting the Rules? ABA program, live in New York City, webcast nationally. Friday September 23, 2011 from 12 – 1:30 p.m. at Dorsey & Whitney, 51 West 52 St. New York, New York 10019.
Co-Chairs: Thomas O. Gorman, Dorsey & Whitney LLP and Frank C. Razzano, Pepper Hamilton LLP.
Panelists: Christopher L. Garcia, Chief, Securities and Commodities fraud Task Force, Assistant U.S. Attorney, Southern District of New York; Daniel Hawke, Chief, Market Abuse Unit, Securities and Exchange Commission; Stuart Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association; Tammy Eisenberg, Chief Compliance Officer, General Counsel and Senior Vice President, DIAM U.S.A., Inc.
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by T. GormanPosted on Posted in SECActions

Two legislative proposals which would reorganize the SEC and impact the manner in which regulations are enacted are pending before the House Financial Services Committee. These proposals were considered at a hearing last week entitled “Fixing the Watchdog: Legislative Proposals to Improve and Enhance the Securities and Exchange Commission.” The Commission’s repeated and continuing scandals along with decisions by the D.C. Circuit striking down its rules for failure to conduct the proper analysis undoubtedly contributed to these proposals.

The two bill are titled the SEC Modernization Act of 2011 and the SEC Regulatory Accountability Act. The Modernization Act proposes to legislatively mandate the internal organization of the SEC. In some respects the bill reiterates the current structure. In others, it reorganizes and alters the existing organization chart. For example, the bill would require that the Commission have the following divisions: Corporate Finance; Enforcement; Investment Management; and Trading and Markets. It also provides that the Commission can establish regional offices which would report to the director of each of the three divisions. The Act also directs that there be certain other Offices. Those include the Offices of: the Chairman; Risk Strategy and Financial Innovation; Compliance, Inspections and Examinations; the Chief Economist; Equal Employment; Investor Education; and Ethics.

The Modernization Act would require that certain functions be part of the Chairman’s office. Those include the Offices of the General Counsel, Secretary, Chief Accountant, External Affairs and Chief Officer. The bill also proposes to consolidate the functions of certain offices while creating an independent Ombudsman. The latter would report to the Chairman and have responsibilities which include acting as a liaison between the Commission and any affected person regarding any problem with the SEC from its regulatory activities.

The Regulatory Accountability Act focuses on reforming the Commission’s rule making processes. The bill would require that the Commission consider certain factors including the significance of the problem addressed and the costs and benefits as assessed by the Chief Economist on a qualitative and quantitative basis prior to issuing any regulation. The bill would also require the Commission to periodically review its regulations to determine if they are outmoded, ineffective or excessively burdensome.

The Committee heard testimony from several witnesses including the Chairman, the Chamber of Commerce and the American Enterprise Institute. Chairman Mary Schapiro commented briefly on the two bills, noting primarily her concerns about mandating a specific structure for the internal operations of the Commission and the fact that the new factors to be considered in rule-making are in some respects duplicative, contradictory and confusing (here).

In its comments, the Chamber, represented by former SEC Secretary Jonathan Katz, was critical of many aspects of the study prepared earlier by Boston Consulting Group under the Dodd-Frank Act. The Chamber also reiterating the findings of an earlier study it conducted regarding certain staff divisions while noting that a report on the Enforcement Division is being prepared.

In commenting on the proposed Modernization Act, Mr. Katz told the Committee that he supported the goal of “transformative change that is needed to restore the Commission as the world’s preeminent financial regulator. At the same time he called for the repeal of the Dodd-Frank provisions which require the creation of five new independent offices at the SEC. Rather that utilize this approach he called for Congress to “outline a series of principles and objectives for the Commission to achieve . . .”

Similarly, Mr. Katz noted that he supported the goals of the Accountability Act while discussing the inherent limitations of pre-enactment studies of the potential impact of any rule. Accordingly, he suggested that a three prong approach be used in rule making. This would require that when the SEC votes to adopt a rule it would: 1) Require the Division of Risk, Strategy and Financial innovation to submit a plan for collecting data on compliance with the rule and its costs; 2) Provide a plan for examining the data collected; and 3) Create a time table for presentation of the results of the study.

The testimony offered by the American Enterprise Institute through former Commissioner Paul Atkins generally agreed with the comments of the Chamber. Mr. Atkins cited what he called Reorganization Plan Number 10 of 1950 which increased the power of the chairman, creating clear authority over hiring and supervising the staff and its responsibilitie,s as a model for organization. This contrasts with Dodd-Frank which Mr. Atkins described as “a grab-bag of ideas that through micro-management has made management of the SEC more difficult.” In this context he noted that the draft Modernization Act contains a number of good points including giving economists a more prominent role. At the same time the draft bill “suffers in part from the same prescriptive tendencies of Dodd-Frank . . . I would thus encourage this Committee to address the specifics of Dodd-Frank and leave other organizational aspects at a general level and to the SEC chairman’s discretion.”

In commenting on the Regulatory Accountability Act the former Commissioner noted that the SEC has “for years failed to incorporate true economic analysis into its rulemaking process . . . “ He thus shares this goal of the draft bill.

Finally, Mr. Atkins told the Committee that the SEC and the CFTC should be merged: “Merging the SEC and CFTC and creating a new agency with seven Commissioners would save money and reduce bureaucracy, owing to the scheme’s fewer Commissioners and a reorganized staff.”

Program: ABA Seminar: Is the DOJ and SEC War On Insider Trading Rewriting the Rules? ABA program, live in New York City, webcast nationally. Friday September 23, 2011 from 12 – 1:30 p.m. at Dorsey & Whitney, 51 West 52 St. New York, New York 10019.
Co-Chairs: Thomas O. Gorman, Dorsey & Whitney LLP and Frank C. Razzano, Pepper Hamilton LLP.
Panelists: Christopher L. Garcia, Chief, Securities and Commodities fraud Task Force, Assistant U.S. Attorney, Southern District of New York; Daniel Hawke, Chief, Market Abuse Unit, Securities and Exchange Commission; Stuart Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association; Tammy Eisenberg, Chief Compliance Officer, General Counsel and Senior Vice President, DIAM U.S.A., Inc.
For furhter information please click here.

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