This Summary, which draws from a wide range of sources, endeavors to condense important investment management regulatory news of the preceding week into one, easily digestible source. This Summary is not intended as legal advice. Readers should not act upon information contained in this Summary without professional legal counsel. This Summary may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts.
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Second Circuit Upholds Insider Trading Conviction Involving Publicly Available Information
January 16, 2009 9:14 AM
On December 17, 2009, the U.S. Court of Appeals for the Second Circuit ruled that the fact that information may be available to the public will not prevent it from serving as the basis for an insider trading conviction.
The defendants in the case were two individuals: a member of an FBI white collar crime unit and an online publisher who operated Web sites for securities investors. It was alleged that the FBI agent would access government databases, review confidential law enforcement reports on firms under investigation, and share the information with the online publisher, who would in turn advise members of his subscription-based website to sell these firms’ securities short. Both defendants were convicted of racketeering conspiracy, securities fraud conspiracy, and securities fraud.
One of the theories underlying the convictions for securities fraud was that the defendants traded on the basis of material confidential information in violation of 15 U.S.C. §§78j(b) and 78ff. The defendants argued that much of the information gleaned from the law enforcement reports could be found publicly if one knew where to look, and thus the related trading was not trading on “nonpublic” confidential information. Nonetheless, the district court instructed the jury that the fact that information may be found publicly if one knows where to look does not make the information “public” for securities trading purposes unless it is readily available, broadly disseminated, or the like.
In an opinion by Judge Jed S. Rakoff, sitting by designation, the Second Circuit upheld the district court’s decision to import into securities law principles relating to the public availability of information that were developed in the context of the privacy exemption of the Freedom of Information Act. In U.S. Department of Justice v. Reporters Committee for Freedom of the Press, 489 U.S. 749 (1989), which involved the disclosure of criminal histories compiled by the FBI, the U.S. Supreme Court said: “The very fact that federal funds have been spent to prepare, index, and maintain these criminal-history files demonstrates that the individual items of information in the summaries would not otherwise be ‘freely available’ either to the officials who have access to the underlying files or to the general public.” Finding this logic “highly instructive,” the Second Circuit ruled that “[t]he law enforcement reports that [the FBI agent] misappropriated were not themselves public in any practical sense, even if some of the sources from which they were compiled could be accessed by the public.” Although the jury instruction given in this case “might not be universally appropriate,” the court decided that “in the factual context of this case it correctly stated the relevant principles the jury needed to apply.” The court also rejected the argument that the dissemination of the information to the online publisher’s subscribers meant that it ceased to be nonpublic information. The court explained that the disclosure to subscribers did not accomplish the required public dissemination under the law and, moreover, the online publisher did not refrain from trading on the information.
For more information, please see:
United States v. Royer, 2d Cir., No. 06-4081-cr, 12/17/08.
MSRB Calls for Federal Regulation of Muni Market
January 16, 2009 9:07 AM
In a January 9, 2009 release, the Municipal Securities Rulemaking Board urged lawmakers to extend regulatory oversight over the municipal securities market, in particular in light of the recent controversy involving New Mexico Governor Bill Richardson and alleged “pay to play” practices. The MSRB, a self-regulatory organization that regulates municipal securities dealers, noted in its release that it regulates only the broker-dealer community. As such, there are currently participants such as guaranteed investment contracts (“GIC”) brokers and various other financial advisors who are neither registered nor regulated. The MSRB proposed “placing financial advisors, GIC brokers and other unregulated market participants in the municipal market under federal regulation” so that all segments of the municipal marketplace can “meet the high standards a fair municipal market that protects investors requires.”
For more information, please see: http://www.msrb.org/msrb1/Press/Release/MSRBStatementonRegulationoftheMunicipalMarket.asp
European Commission to Propose Regulatory Framework for Derivative Contract Clearing, Revise Prospectus Directive
January 16, 2009 8:59 AM
The European Commission announced on January 9, 2009 that it will propose a regulatory framework in 2009 for counterparty clearing of over-the-counter credit derivative contracts after the failure of the industry to commit to ensuring that trades for European companies are done in the European Union. A Commission spokesman said that, as a result of the refusal of the credit derivative industry to commit to key demands outlined by Single Market Commissioner Charlie McCreevy in October 2008, plans for a regulatory framework have begun. The spokesman stated that the timeframe for the framework will become more clear in the coming months.
The Commission also announced that it was launching a process to revise its Prospectus Directive, which introduced a “single passport” for making securities available through public offer or trading, to remove unnecessary burdens.
For more information on the plans to revise the Prospectus Directive, please see: http://ec.europa.eu/internal_market/consultations/2009/prospectus_en.htm
Financial Services Authority Ends UK Ban on Short Selling, Extends Disclosure Regime
January 16, 2009 8:55 AM
On January 5, 2009, the Financial Services Authority announced that investors will be able to engage in short-selling in the United Kingdom, a practice banned since last September, after January 16, 2009, but that they will have to continue to disclose their positions during rights issues until June 30, 2009.
The FSA said that it decided not to extend the original January 16 expiration date for the ban on short selling because market conditions have become less extreme, policy measures have been taken to strengthen the position of the financial sector, and the risks posed by short selling for market abuse and creating disorderly markets have declined. It also noted that the ban “may have had some impact in terms of reducing liquidity and widening bid/offer spreads in the stocks.”
The FSA emphasized that it could re-introduce the ban at its discretion, and that further urgent action could be taken “without consultation.”
The FSA said it would extend the disclosure regime for significant net short positions until June 30, and proposed one change to the disclosure rules it introduced last June. Under current rules, a disclosure is required if a short position exceeds 0.25 percent of a relevant firm’s issued shared capital and further disclosures are necessary if there are any changes in the position. Under new proposals, further disclosures would only be required every 0.1 percent above the 0.25 percent threshold (for instance at 0.35 percent, 0.45 percent, 0.55 percent and so on).
For more information, please see:
Four CPOs Settle Untimely Reporting Allegations
January 16, 2009 8:51 AM
On January 8, 2009, four registered commodity pool operators settled CFTC allegations that they failed in a timely manner to distribute to investors and file with the National Futures Association (“NFA”) one or more of their respective pools’ annual reports. Under CFTC regulations, CPOs are required to file an annual report with the NFA and distribute it to each pool participant within a prescribed period after the close of the pool’s fiscal year. The CFTC said that each of the four CPOs operated one or more commodity pools, including pools that operated as funds-of-funds.
While some of the CPOs obtained extensions of the prescribed deadlines for various pools and reporting years, each allegedly failed to comply in a timely manner with its obligations, in violation of CFTC regulations.
For more information, please see:http://www.cftc.gov/stellent/groups/public/@lrenforcementactions/documents/legalpleading/enfubsfundorder010809.pdf, http://www.cftc.gov/stellent/groups/public/@lrenforcementactions/documents/legalpleading/enffortisorder010809.pdf, and http://www.cftc.gov/stellent/groups/public/@lrenforcementactions/documents/legalpleading/enfspringmtnorder010809.pdf.
SEC Approves FINRA Rule Change Designed to Eliminate Frivolous Motions to Dismiss in Arbitration Cases
January 16, 2009 8:41 AM
On January 8, 2009, the SEC approved a FINRA rule change designed to eliminate frivolous motions to dismiss with regard to the soaring number of arbitration cases.
FINRA stated in its release that under the new rule, a motion by a broker-dealer to dismiss before a claimant’s case is presented can only be granted on three grounds: the parties have settled their dispute in writing; there is a “factual impossibility,” meaning the party could not have been associated with the conduct at issue; or the dispute is untimely under the eligibility rule that requires parties to bring arbitration claims within six years of the events at issue.
FINRA further states that the new rule requires that the arbitrators conduct a hearing on motions to dismiss, and that a decision to grant the motion be unanimous. The arbitration panel also will be required to issue a written explanation of a decision to grant dismissal. Finally, parties will be prohibited from re-filing a denied motion to dismiss “unless specifically permitted by an order of the panel.”
For more information regarding this special procedure, please see:
FINRA Fines Online Brokerage Firm $1 Million for Inadequate Anti-Money Laundering Programs
January 16, 2009 8:39 AM
On January 2, 2009, FINRA announced that it has imposed a $1 million fine against brokerage and clearing affiliates of an online brokerage firm for failing to establish and implement anti-money laundering (“AML”) policies and procedures that could reasonably be expected to detect and cause the reporting of suspicious securities transactions. In particular, Susan L. Merrill, Chief of Enforcement at FINRA, noted that the firm’s “AML program lacked automated electronic systems specifically designed to detect potentially manipulative trading activity in customer accounts.”
FINRA found that between January 1, 2003 and May 31, 2007, the firm did not have an adequate AML program based upon its business model. Because the firm did not have separate and distinct monitoring procedures for suspicious trading activity in the absence of money movement, its AML policies and procedures could not reasonably be expected to detect and cause the reporting of suspicious securities transactions. The firm relied on analysts and other employees to manually monitor for and detect suspicious trading activity without providing them with sufficient automated tools. FINRA determined that this approach to suspicious activity detection was unreasonable given the firm’s business model. The firm neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.
For more information, please see:
FINRA Seeks Comments on Proposals to Expand Front-Running Prohibition
January 16, 2009 8:36 AM
In a December 2008 notice to members, FINRA requested comments on proposals to expand the scope of its ban against front-running. The proposals would expand the front-running ban beyond certain options and security futures to include other types of related financial instruments, and arise as part of FINRA’s ongoing preparation of a consolidated rulebook.
FINRA proposes to adopt IM-2110-3, its current rule against front-running, as FINRA Rule 5270, and to amend it in several ways to broaden its scope. Among other changes, FINRA proposes to extend the prohibitions in the rule to cover trading in an option, derivative, or other financial instruments that are materially related to, or otherwise act as substitutes for, an underlying security that is the subject of an imminent block transaction. FINRA proposes that the prohibitions be in place until the material nonpublic information becomes publicly available or obsolete.
In addition, FINRA proposes deleting the existing exceptions in the front-running policy and replacing them with supplementary material enumerating new, explicitly allowed transactions. It further proposes including with this new supplementary material the requirement that firms obtain customers’ “affirmative written consent” before engaging in hedging or other positioning activity that could affect the price of the underlying security.
FINRA asks for comments on whether its proposed definition of “related financial instruments” adequately encompasses those instruments that could be used to take advantage of prior knowledge of a block transaction. It also asks for comments on whether the specific exceptions to the front-running policy should be retained.
Comments are due by February 6, 2009.
For more information, please see:
Legislation to Reinstate Uptick Rule Introduced in House
January 16, 2009 8:31 AM
On January 8, 2009, Rep. Gary Ackerman (D-NY) reintroduced legislation (H.R. 302) to compel the SEC to reinstate its price test, or “uptick” rule, for traders to engage in short selling, citing the support of a brokerage executive.
In a release, Ackerman, a member of the House Financial Services Committee, said that since the SEC rescinded the rule in July 2007, the value of many stocks has “plummeted due to an onslaught of manipulative” short selling. The rule’s reinstatement “is essential to rein in these abuses and restore much-needed stability and confidence to our financial markets.”
Ackerman introduced a similar bill in July 2008 (H.R. 6517), but it stalled after referral to the committee. According to his release, Ackerman has now circulated a January 7, 2009 letter from the chief executive officer of a major brokerage firm to members of Congress to “secure support for the bill.” The letter to lawmakers stated: “The SEC should move on its own to restore the uptick rule, but if it won’t, this legislation will compel the agency to do so.”
For more information, please see: http://www.house.gov/apps/list/press/ny05_ackerman/PR_010809.html.
SEC Files Emergency Action to Halt Alleged Ponzi Scheme
January 16, 2009 8:26 AM
On January 7, 2009, the SEC announced that it filed an emergency action to halt an estimated $50 million Ponzi scheme. According to the SEC’s complaint, the Ponzi scheme has existed from at least February 1995 to the present, and has involved the obtaining of approximately $50 million from as many as 80 investors through the sale of securities in the form of limited partnership interests in a limited partnership in which the operator of the scheme was general partner. The SEC has obtained an order granting a preliminary injunction, freezing assets, compelling an accounting, and imposing other emergency relief. In addition to the emergency relief obtained, the SEC seeks disgorgement of the defendants’ ill-gotten gains plus prejudgment interest, civil penalties, and permanent injunctions barring future violations of the antifraud provisions of the federal securities laws.
For more information, please see:http://www.sec.gov/litigation/complaints/2009/comp20847.pdf