The Law Planet Blog

The U.S. Securities and Exchange Commission (SEC) is taking proactive measures to increase investor protection through strengthening regulatory requirements. This rule new change is expected to significantly increase the governing structure of money market funds, thus adding substantial protection to investors. The newly adopted rules will become effective 60 days after their publication in the Federal Register.

A full-scale review of the regulatory regime of money market funds by the SEC was precipitated by large-scale factors, including the ongoing financial crisis. The SEC’s review was also triggered by the Reserve Primary Fund’s so-called “breaking the buck” weakness, which causes a money market fund’s net asset value to fall below $1.00 per share. When this happens, investors lose money.

According to the SEC, the new rules are designed to increase the resilience of money market funds to stresses (such as economic pressure), and lessen the risks of runs on the funds. The agency hopes to achieve these ends by tightening the maturity and credit standards of quality as well as implementing new requirements for liquidity.

According to SEC Chairman Mary L. Schapiro,

"These new rules will have substantial benefits for investors and are an important first step in our efforts to strengthen the money market regime. These rules will help reduce risks associated with money market funds, so that investor assets are better protected and money market funds can better withstand market crises.”

The SEC expects the new rules to decrease the risks associated with money market funds by:

• Improving liquidity
• Placing limits on lower quality securities
• Shortening maturity limits
• Using “Know Your Investor” procedures
• Performing periodic stress tests
• Using Nationally Recognized Statistical Rating Organizations (NRSROs)
• Strengthening repurchase agreements

For more information about this reform and other important investor information, visit the SEC’s Web site at: http://www.sec.gov

David Brooks, a founder and ex-chief executive officer of DHB Industries (DHB), a contracting company for the U.S. military and other agencies, is accused of looting the company of $185 million. According to a federal prosecutor, Mr. Brooks allegedly used the looted money to fund “lavish” personal expenditures.

Along with Sandra Hatfield, DHB’s former chief operating officer, Mr. Brooks is accused of securities fraud, insider trading, manipulating financial records, and a bevy of additional charges. Brooks and Hatfield reportedly used deceitful techniques to increase the company’s reported earnings and profits substantially.

According to federal prosecutors, Brooks and Hatfield reportedly inflated the value of DHB’s stock by lying about the inventory of supposedly shipped combat vests to the U.S. military. As a result, the duo defrauded the company for a combined $190,000 million, reportedly $185 million for Brooks, and $5 million for Hatfield. Both have pleaded not guilty to the charges
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“This is a case about the naked greed of two people, Sandra Hatfield and David Brooks, and the lies and the fraud that they used to satisfy that greed,” Richard Lunger, Assistant U.S. Attorney told jurors in his opening statement. “In the end they lied in order to push up the price of the company’s stock, then [they] sold their stock for $190 million.”

In July 2006, shares of DHB stock were removed from American Stock Exchange listings. Although still headquartered in Pompano Beach, Florida, DHB has since been renamed Point Blank Solutions, Inc. According to the company’s Web site, Point Blank is an industry leader in ballistic technologies, including its Point Blank Body Armor and other protective apparel, for the military and other authorities.

For more information about the case, click on the following Bloomberg Business Week article on the DHB Fraud of Ex-CEO

To learn more about this and other financial fraud cases, visit the U.S. Securities and Exchange Commission’s Web site www.SEC.GOV

The case is U.S. v. David Brooks, 06-CR-550, U.S. District Court, Eastern District of New York (Central Islip).

The Department of Justice and the US Attorney for the Southern District of New York announced that seven Wall Street professionals and attorneys were indicted on Friday for insider trading at hedge funds and stock trading firms. The defendants included Zvi Goffer, Arthur Cutillo, Jason Goldfarb, Craig Drimal, Emanuel Goffer, Michael Kimelman and David Plate. The recent indictment includes conspiracy to commit securities fraud and three additional counts of securities fraud.

According to published reports, the defendants allegedly operated an insider trading network, where one member obtained information to pass along to others and traded on nonpublic information, about public company acquisitions and mergers. The conspirators tried to hide their scheme by using prepaid phones to pass along information.

It is believed that, the insider trader scheme earned the co-conspirators approximately, $11 million for themselves and their firms. The defendants will have a day of reckoning before United States District Judge Richard J Sullivan, on February 2, 2010, at their scheduled arraignment.

The Federal Bureau of Investigation and the Securities exchange commission are to be greatly praised with their role in helping to uncover this fraud, According to United States Attorney Preet Bharara. Assistant United States Attorneys Andrew Fish, Reed M. Brodsky and Marc Litt are in charge of prosecuting the case.

It is important to note that the defendants face a maximum of 170 years in prison collectively as a group. Was the risk of this jail time worth the reward? If you ask a few famous fraudsters, Bernie Madoff and Scott Rothstein, the answer is a resounding NO.

Click here to read more from the Department of Justice on the detailed counts, charges and penalties

Happy New Year! Today marks the first day of 2010. It marks the beginning of a fresh new start.

Please enjoy a few important highlights from the Securities and Exchange Commission:

The SEC has approved stronger safeguards to Protect Clients’ Assets Controlled by Investment Advisers
The new rules provide safeguards where there is a heightened potential for fraud or theft of client assets. The SEC’s new amended custody rule promotes independent custody and requires the use of independent public accountants as third-party monitors.

According to SEC Chairman Mary L. Schapiro, “The Madoff Ponzi scheme and other frauds have caused investors to question whether their assets are safe when they entrust them to an investment adviser. These new rules will apply additional safeguards where the safeguards are needed most — that is, where the risk of fraud is heightened by the degree of control the adviser has over the client’s assets.”

SEC Charges Houston-Based Broker With Defrauding Florida Municipalities
The Securities and Exchange Commission charged a Houston-based broker with engaging in unauthorized and unsuitable trading on behalf of two Florida municipalities, putting them at risk of losing millions of dollars while he personally made over 14 million in commissions.

$418 Million Fair Fund Distribution to Harmed Investors in Invesco Mutual Funds

The Fair Fund distribution stems from a prior SEC enforcement action against IFG. This distribution also includes money from two other Fair Funds related to separate unlawful marketing timing enforcement actions that affected Invesco investors.

Investment Adviser charged by SEC in Fraudulent Scheme Utilizing Football Stars
The Securities and Exchange Commission filed securities fraud charges against Kurt B. Barton and Triton Financial LLC,
for operating a multi-million dollar scam that used former professional football players to promote its offerings

According to a recent report issued by the Office of the Inspector General (OIG), the Securities and Exchange Commission’s (SEC) enforcement division needs to improve its processes and procedures for investigating and managing the fight against securities fraud. The main example cited in the report was the most current and most blatant example of the SEC’s failure to properly investigate securities fraud complaints - Bernard Madoff’s multi-billion-dollar Ponzi scheme. The report issued by the OIG stated that complaints about Mr. Madoff’s possible involvement in securities fraud were received by the SEC as long ago as 1999. Even though complaints of alleged fraud were made to the SEC in regard to Mr. Madoff, SEC staff failed to recommend that the SEC take action on these complaints.

The purpose of the OIG’s report was to determine the SEC enforcement department’s shortcomings and to identify those areas in which the department needs to make improvements to better fight securites fraud. The goal of the report was to bolster SEC enforcement measures in an effort to prevent another securities fraud case with such far-reaching implications and consequences as the Madoff case. It is the SEC’s job to protect investors from securities fraud. When the department fails to properly carry out its job duties the ramifications can spell disaster for investors.

The following systemic problems within the SEC’s enforcement department were identified in the OIG’s report: staff’s failure to thoroughly review complaints; due diligence was not exercised regarding complaints; inexperienced staff conducted unsupervised investigations; complaints were not sufficiently reviewed; staff failed to seek assistance from other departments and divisions; staff did not verify information with independent third-party representatives; administrative tasks were not completed in a timely manner. According to the OIG report, additional areas in which staff felt changes needed to be made and information clarified included: case handling procedure, program priorities, and working relationships.

The report issued by the OIG offered 21 recommendations to the department in order to create a more effective program. These recommendations focused on management control, establishment of formal guidelines, and a review of existing policy and procedures. The Director of Enforcement at the SEC stated that these measures would be implemented.

To read more on the this of OIG Recommendations view the following: Office of Inspector General (OIG) Audit on SEC - Program Improvements Needed within the SEC's Enforcement Division, Housingwire.com

Unfortunately, yesterday was not a great day for the SEC and the Bank of America legal team. Their $33 million agreed upon settlement regarding the BofA taking over Merrill Lynch was rejected by Southern District of New York Judge Jed S. Rakoff

Judge Rakoff entered strong words towards the SEC and Bank of America settelement in his 12-page order, in Securities and Exchange Commission v. Bank of America Corp., 09 Civ. 6829. The judge stated the following: "Overall, indeed, the parties' submissions, when carefully read, leave the distinct impression that the proposed Consent Judgment was a contrivance designed to provide the SEC with the façade of enforcement and the management of the Bank with a quick resolution of an embarrassing inquiry -- all at the expense of the sole alleged victims, the shareholders."

He continues to further scold the SEC with additional statements:

"When a federal agency such as the SEC seeks to prospectively invoke the Court's own contempt power by having the court impose injunctive prohibitions against the defendant, the resolution has aspects of a judicial decree and the Court is therefore obligated to review the proposal a little more closely, to ascertain whether it is within the bounds of fairness, reasonableness, and adequacy -- and, in some certain circumstances, whether it serves the public interest."

Judge Rakoff deems the settlement "neither fair, nor reasonable, nor adequate."

Click here to read more on the SEC and BofA settlement from the New York Law Journal.

As prior readers of The Law Planet Blog know, I have a strong dislike for Equity Index Annuities. I think they are lousy products and, to the extent they are sold, should be sold by someone who has proven at least a modicum of securities knowledge. Insurance salesman, without a Series 6 or 7 license, have not proven this knowledge. Yet they were allowed to sell complicated, market-based products.

I cheered last year when the SEC announced Rule 151A which would bring these products under their purview. It would also require licensing of salespeople and registration with a broker-dealer. All of these are good things. The Insurance and Annuity industry did not agree with me. It was nothing personal, I’m sure.

The industry took their case to court, in the case American Equity Investment Life Insurance Company v. Securities and Exchange Commission (July 21, 2009-6) on Petitions to argue that the Rule should not be enforced. The industry won, and lost.

There should be no joy in Mudville here. The District of Columbia Court of Appeals has told the SEC what it did wrong and what it needs to do right. On the other hand, the Court told the insurance industry that these products can be regulated as securities. For me, that’s the important part.

The court wrote “In this case, the SEC has adopted an interpretation that is based in reason. By their nature, FIAs ‘appeal to the purchaser not on the usual insurance basis of stability and security but on the prospect of ‘growth’ through sound investment management.’” This is what I’ve been saying all along. This is a market-based product. It is a security. It should be sold by qualified securities salespeople. Now it’s up to the SEC to make the requisite findings regarding its rulemaking and give it another try.

Stay tuned…

The Public Investors Arbitration Bar Association has proposed a rule directly to the SEC that would effectively eliminate the “industry” arbitrator from the arbitration panel. The paranoia exhibited by this organization, without any true empirical basis, knows no bounds.

As a lawyer who represents both industry and investor clients, I have a unique position to assess this proposal (although I am not alone in representing both types of parties.) PIABA remains critical of the presence of a person experienced in the industry on an arbitration panel. Personally, having experienced arbitrations where the industry panelist was marginally affiliated and the public arbitrators knew next to nothing about securities, I suggest that we should all be afraid of PIABA’s proposal.

PIABA continually refers to the industry panelist as an advocate for the industry. There is no basis for this. The organization cites flawed research that states that claimants in arbitration win less than they “should.” But how does PIABA know that these cases would have fared better either in court or with an all-public arbitration panel? It doesn’t. I have stated before and I will say it again, that cases that go to hearing tend to be self-selecting. Those cases which can’t settle because the Claimant wants too much or the Respondent won’t pay enough are the ones that go to hearing. Therefore, these are the more difficult, or bad, cases depending on one’s point of view.

I have been involved in a number of cases where it was obvious that the industry panelist did not agree with the Respondent’s position. There is no evidence that the industry panelist serves as a patsy for the brokerage firms. Just because a flawed analysis finds that the “win rate” is down, does not mean that the system is bad. In arbitration, each case stands on its own. Two cases cannot be compared as every person’s situation is different.

PIABA has come up with some good ideas in the past. This is not one of them.

Rule Change Petition presented to the SEC from the Public Investors Arbitration Bar Association

The top Accounting Officer at Beazer Homes USA, Michael Rand, has been charged with fraud and misleading company auditors by the Securities and Exchange Commission.

An SEC complaint filed in federal court, alleges that Michael T. Rand, Accounting Officer for Beazer Homes, deceived investors by fraudulently recorded improper accounting reserves during 2000 and 2005. This little creative accounting decreased Beazer's reported net income considerably.

According to Robert Khuzami, Director of the SEC's Division of Enforcement:

"Michael Rand orchestrated an old-fashioned 'cookie jar' earnings management scheme where he hid from view over $60 million in so-called reserves. Then when Beazer's business declined, he fraudulently reversed those secret reserves and appeased financial analysts, enticed new investors, and most importantly earned himself an undeserved lucrative bonus."

The SEC complaint against the Beazer Chief Accounting Officer, Michael Rand explicitly gives details on how he masterminded this Accounting scheme and profited personally. He personally sold stocks valued at $3 million and earned $1.7 million in bonuses. Was it worth it, to lose everything and risk going to jail? I guess only Mr. Rand can answer this question. I am certain that the Beazer investors are not happy about being duped by these false earnings statements. Time will tell if there were others involved in this scheme.

I have mentioned in the past that my distaste for Equity Indexed Annuities runs deep. I wondered aloud how a market-based product could be sold by someone with a securities registration. I would like to think that the SEC cares what I think, but I would be wrong. However, SEC Rule 151a went into effect in December and the Index Annuity folks are hopping mad.

They have a website, SEC151a.com, to plead their case. But what struck me most when reading their materials is the first page, which encourages its members to not get registered with either a Series 6 or Series 7. The authors of this site are discouraging people from the additional oversight that having a supervising broker/dealer would bring. Of course, that would likely mean another layer of overrides and reduction in income.

In my view, it would also lead to fewer inappropriate EIA sales. When I last blogged on this topic, I received an email from an annuity marketer taking me to task for blasting this "wonderful" product. It was all I could do to prevent myself from laughing (actually I did laugh). It's real simple in my mind. If you're selling something that relies on the stock market's performance to determine the performance of the underlying investment, you should be registered to sell securities.

Start sharpening your pencils, folks, and please bubble inside the circle only.

That's the view from The Law Planet, Jupiter, Florida.

Here's the deal. Equity Index Annuities look and smell like a security but for reasons that escape me they are regulated as fixed insurance. I have written about this before. An insurance agent, with no securities training, could sell a product whose performance is dependent upon the movements of the stock market. And that's the good part.

The bad part is that most buyers don't understand what they're buying and their agents are making it less than clear as to what they're selling. I have handled some of these cases. I have a sense of what's going on.

And while an equity index annuity touts its "value," the fact is that the value is usually paid out over a fixed term. It is not a surrender or liquidation value. In a recent article in Investment News, the general counsel of an EIA issuer actually used the same BS line that insurance salesman use when they don't understand the product. She said a variable annuity would have decreased in value over the last year while an EIA would still be worth the same amount.

Unless her company's EIAs are different than the others I've seen, that's a load of crap! It shows that the lack of understanding of this product goes to the highest level. If the client actually wants the full amount available in the EIA, he/she loses a big chunk to penalties and fees. I repeat, this is a roach motel for your money. Stay away. This is why the securities regulators are stepping in. Someone with some market savvy needs to examine this garbage.

That's the view from The Law Planet - Jupiter, Florida.