Congress continued to consider financial market reform this week with additional testimony from SEC Chairman Schapiro and others. SEC enforcement filed a settled administrative proceeding based on claimed violations of Regulation FD, an insider trading action, and a settled case charging a bank with aiding and abetting the fraudulent conduct of its business partner. FINRA sanctioned three securities firms for their conduct during an IPO, while claiming they did not cooperate with its inquiry. Finally, the Sixth Circuit affirmed the dismissal of a class action based on SLUSA, while the auditors and a bank won dismissal from another securities class litigation.

Market reform

SEC Chairman Schapiro testified before the House Committee on Agriculture this week regarding market reform. In her testimony, the Chairman called for the strengthening of the Treasury proposal for market reform regarding OTC derivatives. The Chairman emphasized five points: 1) minimizing regulatory arbitrage by regulating swaps in the same manner as their underlying reference; 2) strengthening existing antifraud authority; 3) clarifying the definition of security based swaps to include not only single name and narrow based index CDS, but also broad based index CDS and similar products; 4) revising the qualification standards for participation in the OTC derivatives markets; and 5) strengthening consumer protections by having an insolvency framework and a revision of the exclusion in the regulatory scheme for OTC derivative products that are identified as banking products for foreign banks and their subsidiaries that are not subject to U.S. regulation.

SEC enforcement actions

Reg. FD: In the Matter of Christopher A. Black, Adm. Proc. File No. 3-13625 (Sept. 24, 2009) and SEC v. Black, Case No. 09-cv-0128 (S.D. Ind. Sept. 24, 2009) is an administrative proceeding and a civil action against the former senior vice president and CFO of American Commercial Lines, Inc., (ACL) a marine transportation and manufacturing company. According to the Order and complaint, the company issued a press release on Monday, June 11, 2007 revising down its annual earnings guidance for 2007. The release also gave guidance for the second quarter of 2007, noting that earnings would be about the same as the first quarter. Mr. Black and the CEO of the company then traveled to a series of meetings with analysts. At the conclusion, Mr. Black began preparing an e-mail to those they met with, summarizing the meetings. On Friday, June 16, while he was drafting the e-mail, Mr. Black received a new earnings forecast which projected second quarter earnings at half of the first quarter.

The next day Mr. Black worked on the e-mail from home and then sent the revised second quarter earnings guidance along with an analysis to eight sell-side analysts who covered the company. No one else received the e-mail. When the CEO learned about the e-mail, he had the company file a Form 8-K. Before that filing was made at the end of Monday, the share price had dropped about 9.7%. The Order charges Mr. Black with causing a violation of Exchange Act Section 13(a) and Regulation FD.

To resolve the administrative proceeding Mr. Black consented to a cease and desist order. To settle the civil action Mr. Black consented to the entry of a final judgment requiring him to pay a $25,000 penalty. In Litigtion Release regarding the civil action the Commission took the unusual step of discussing the reasons it chose not to bring an action against ACL. There the SEC citing several factors: 1) ACL cultivated an environment of compliance by providing training regarding the requirements of Regulation FD and by adopting policies that implemented controls to prevent violations; 2) Black alone was responsible for the violation and he acted outside the control systems; 3) once the illegal disclosure was discovered by ACL, it promptly and publicly disclosed the information by filing a Form 8-K with the Commission the same day; 4) ACL self-reported the conduct to the staff the day after it was discovered and provided extraordinary cooperation; and 5) the company took remedial measures to address the improper conduct, including the adoption of additional controls to prevent such conduct in the future. See Litig. Rel. 21222 (Sept. 24, 2009). This welcome step should provide important guidance for other issuers.

Insider trading: SEC v. Saleh, Case No. 3:09-cv-01778 (N.D. Tex. Filed Sept. 23, 2009) is an insider trading case arising out of the acquisition of Perot Systems by Dell, Inc., announced September 21, 2009, discussed here. Reza Saleh, an employee of an affiliate of Perot Systems, is named as a defendant. Shortly after negotiations on the deal commenced in early September, Mr. Saleh had a discussion with a director in which he indicated knowledge a pending acquisition involving an affiliate of Perot Systems. During the deal negotiations Mr. Saleh purchased over 9,300 options in violation of company policy which required he pre-clear securities transactions. After the announcement of the deal, Mr. Saleh had over $8.6 million in profits on the options. He also told two company employees after the SEC inquiry began that he traded on inside information. The case is in litigation.

Aiding & Abetting: SEC v. Regions Bank, Civil Action No. 09-CV-22821 (S.D. Fla. Filed Sept. 21, 2009); In the Matter of Regions Bank, Adm. Proc. File No. 3-13618 (Filed Sept. 21, 2009). The civil injunctive action alleged that the bank aided and abetted violations of Exchange Act Section 15(a)(1) while the administrative proceeding claimed it was a cause of violations of Sections 17(a)(2) &(3) of the Securities Act by its business partner, U.S. Pension Trust Company and U.S. College Trust Corp (collectively USPT) as discussed here.

Regions Bank, which provides banking services in sixteen states, entered into a business partnership with USPT which sold mutual funds from well-known U.S fund companies through several retirement and college investment plans primarily to investors in Latin America. In soliciting investors, USPT did not disclose until March 2006 that it took up to 85% of their annual contributions and as much as 18% of investors’ lump-sum contributions as fees. According to the SEC, the bank, which assisted in soliciting investors and helped collect the fees, held about $80 million in mutual fund assets for about 11,000 investors under the arrangement. Regions knew, or should have known, that the extremely high commissions charged by USPT were not disclosed to investors. To settle the action, Regions Bank consented to the entry of a cease and desist order in the administrative proceeding. In the civil injunctive action, the bank agreed to pay a civil penalty of $1 million which will be paid into a Fair Fund for the benefit of investors. See also Litig. Rel. 21215 (Sept. 21, 2009).


Citigroup Global Markets, UBS Securities and Deutsche Bank Securities were fined and ordered to make restitution to certain IPO customers by FINRA in connection with the Vonage, LLC IPO. The three firms failed to adequately supervise communications with their customers in the offering according to FINRA. Each firm failed to establish adequate systems and procedures to supervise the outsourcing of communications with customers during the offering. Although each firm had written procedures for both direct share programs and for outsourcing, they were not followed. Thus, when an error occurred by an employee of the outside company resulting in certain customers being erroneously told they did not receive IPO allocations, the firms could not promptly take corrective action. The customers did not learn about the allocation in their account until several days later. By that time, the share price had dropped from the IPO price. Nonetheless, the firms charged the customers the full IPO price.

FINRA concluded that none of the firms knew what information had been communicated to the customers. During the investigation, the firms could not provide FINRA with the same access to the work of the outside company that it would have had if the firms did the work themselves and also hindered the investigation. The matter was resolved with Citigroup being fined $175,000 and ordered to pay a minimum of $285,000 to 284 potentially eligible customers; UBS was fined $150,000 and ordered to pay a maximum of $118,000 to 126 potentially eligible customers; and Deutsche Bank was fined $100,000 and ordered to pay a maximum of $52,000 to 59 potentially eligible customers.

Private actions

In pari delicto: In In re Parmalat Sec. Litig., Master Docket 04 BD 1653 (S.D.N.Y), the court granted summary judgment in favor of auditor Grant Thornton and Bank of America. The case centers on the collapse of Parmalat S.p.A. Suits were filed by the court appointed trustee and a wholly owned subsidiary of Parmalat.

Parmalat began as a small dairy distributor in Italy and grew into an international business. When it developed cash flow difficulties the company and Grant Thornton crafted schemes involving misleading transactions and off-shore entities that gave the appearance of financial well being to ensure that the company could continue to raise capital. Financial statements prepared by the company and approved by the auditors concealed those schemes. Billions of euros raised from the debt and equity markets kept the company afloat.

A key part of Parmalat’s financing was the huge loans made through a subsidiary. Defendant Bank of America became involved in these schemes, helping to raise about $800 million for the company. Despite these efforts, by late 2003 Parmalat could not pay bonds as they came due. In December 2003 the company filed for bankruptcy.

Both the Trustee and the financing subsidiary brought claims against, among others, Grant Thornton. The subsidiary also asserted claims against Bank of America. The defendants moved for summary judgment which was granted based on the defense of in pari delicto as discussed here.

Materiality: Landmen Partners, Inc. v. The Blackstone Group, Case No. 08-CV-3601 (S.D.N.Y.) is a class action based on Securities Act Sections 11 and 12(a) arising out of the IPO of Blackstone Group. The complaint alleges that the registration statement misrepresented and failed to disclose that certain portfolio companies of Blackstone were not performing well. Specifically, the complaint claims that the registration statement failed to disclose that one portfolio company in the business of insuring bonds issued by others was moving into a riskier business, that a high tech portfolio company lost a significant contact and the deteriorating conditions in the real estate market.

The court dismissed the complaint, concluding that the claims were not material. The first two claims involved investments that were a small fraction of the assets under management, less that 4% in both instances, thus below the 5% rule of thumb in SAB 99. The market conditions were not material because this was just general economic information. Even if viewed from a qualitative prospective, the information was not material the court ruled.

Court of appeals

SLUSA: In Segal v. Fifth Third Bank, N.A., No. 08-3576 (6th Cir. Decided Sept. 17, 2009) the court affirmed the dismissal of a class action complaint which alleged state law breach of fiduciary duty claims. Dismissal was based on SLUSA as discussed here. Plaintiff Daniel Segal, the beneficiary of trust accounts administered by the defendant bank, brought a class action which claimed breaches of fiduciary and contractual duties to a class of investors. The complaint claimed that the bank improperly invested class member funds. The Sixth Circuit rejected plaintiffs’ argument that because the complaint did not allege a misrepresentation or omission, but only garden variety state law claims, the case should not be dismissed under SLUSA.