Category Archives: Securities Regulation

The Law of Non-Existent Markets

Written by: Todd Stevens

International borders are increasingly blending together in the corporate world, so it would seem natural that this would also be the case in corporate law. However, this is frequently far from reality, as securities regulations across the world often reveal themselves to be a patchwork quilt of individual legal systems struggling to interact. Such was the picture painted by Michael Mann, former first director for the Office of International Affairs at the SEC and current partner in the Washington, D.C. office of Richards Kibbe & Orbe, who spoke on the global regulation of financial markets at Chicago-Kent this past Thursday.

“One of the interesting things about international securities markets is that there is no such thing,” Mann said, introducing his presentation. “(The markets) are run by domestic bodies administering domestic laws.”

Having framed the international securities world in this light, Mann went on to emphasize the importance of individual relationships in international securities law. As securities markets differ from country to country, businesses are forced to work with different legal structures in each individual market. Thus, it is incredibly important to remember one’s position in any international business arrangement. An expert in the United States market is not necessarily an expert in the Chinese market, and being successful in the field of securities requires strong, mutually beneficial relationships with legal partners across the globe.

Mann went on to set up an outlook for the future. In the wake of the Supreme Court’s Morrison v. National Australia Bank decision, it is much harder to gain jurisdiction in the United States, even when presented with a company that has significant US contacts. This situation makes it all the more important for firms and their legal departments to focus on how they develop their own internal rules, making sure that they are prepared to deal with foreign legal systems as needed.
More importantly, attorneys working in securities markets need to communicate with utmost clarity the issues confronting clients who want to operate internationally so they can shield themselves against potentially hazardous foreign regulations.

“We need to make sure there’s an understanding in our customer of the rules of the marketplace,” Mann said.

On a grander scale, Mann said that the Morrison decision may offer an opportunity to take a new look at the international securities arena and retool it into something friendlier and more efficient, citing past compromises on insider trading law made by the United States and Switzerland as a possible example.
Similar concessions worldwide would be necessary to create an improved setting. As Mann stated, “If the marketplace is ever going to become internationalized, we need to redraw the jurisdictional boundaries… so that people can protect themselves as they so desire.


Compliance Career Chat Today!!!!!!!!

Compliance Career Chat

Kevin Saunders ‘09

Legal & Compliance Examiner in the Large Institution Division

The Federal Reserve Bank of Chicago

The Institute on Compliance invites all students to a series of informal discussions with alumni about careers incompliance. The first compliance chat will feature Kevin Saunders ’09. He will provide an overview of his career path, the type of work that he does, and suggestions that he has for obtaining positions in compliance. Students are encouraged to ask questions. 

 Thursday, September 6, 2012

Noon-1:00 p.m.

Room C40

Lunch will be provided.

Financial Regulators and Advancing Technology: The Social Media Paradox

Under Rule 206(4) of the Investment Advisors Act of 1940 (“the Act”), the SEC states that a Registered Investment Advisor (“RIA”) is prohibited from engaging “in any act, practice, or course of business which is fraudulent, deceptive, or manipulative. The Commission shall, for the purposes of this paragraph (4) by rules and regulations define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.” Registered Investment Advisors consist of individuals or firms that are in the business of giving advice about securities, and thus must be registered with the Securities and Exchange Commission or a state’s securities agency. Rule 206(4) was designed to protect the public from deceptive advertising tactics by investment advisors across the nation. Sounds simple enough, right?

If only that were so…

The imprecision of this rule has created confusion and uncertainty for RIAs for decades following its enactment. Fortunately for RIAs, the SEC released “SEC No-Action Letter, Clover Capital Management, Inc.” in 1983, which outlines certain circumstances the Commission deems to be prohibited under Rule 206(4). The Clover no-action letter prohibits certain activities including, but not limited to:

  • Failing to disclose the effect of material market or economic conditions on the results portrayed (e.g., an advertisement stating that the accounts of the adviser’s clients appreciated in the value 25% without disclosing that the market generally appreciated 40% during the same period);
  • Including models or actual results in an advertisement that do not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid;
  • Failing to disclose whether and to what extent the results portrayed reflect the reinvestment of dividends and other earnings;
  • Using advertisements that include testimonials or that refer to past specific recommendations unless certain information is provided

While Clover created greater confidence for RIAs at the time of its release, it has failed to evolve with advancing technology and changes in advertising practices. For instance, the surge in social media has convoluted RIA efforts to comply with SEC regulations considerably. According to the seventh annual Investment Management Compliance Testing Survey, released in July of 2012, social media use among RIAs increased over the past year, with 80% of RIAs stating they have adopted formal written policies concerning social networking, up from 64% in 2011 and 43% in 2010.

For instance, many firms have adopted social media policies and procedures stipulating who is permitted to use social networking for business purposes. All of those posts should be pre-approved by the firm’s chief compliance officer or a designee. This process helps to avoid situations in which a member of the firm distributes inconsistent or noncompliant information using social media.

However, how should RIAs with several thousand employees monitor the use of each employee’s personal social media profiles? If a sales representative of an RIA endorses a specific portfolio on his personal Facebook page, what ramifications could the RIA face? If client testimonials are subject to SEC regulations, what effect does that have on client postings on an investment advisor’s Linkedin profile? For instance, recent cases have indicated that “Liking a Page” on Facebook is allowed and encouraged since it is not considered a type of testimonial, but “Liking a Status Update” is an “endorsement” of another user’s post and is a violation of SEC standards.

To address these ambiguities, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) released a National Examination Risk Alert in January of 2012 entitled “Investment Adviser Use of Social Media.” The alert recommends various precautionary measures RIAs can implement in order to better prevent potential social media violations by their employees. However, the list is by no means exhaustive and explicitly states that adhering to all suggested procedures will not create a “safe harbor” for an RIA in the event of a violation.

As technological advancements continue to transform marketing strategies across the financial industry, RIAs must work diligently to devise compliance and corporate governance procedures which help overcome the uncertainty surrounding the outdated, ambiguous regulations set forth by both the SEC and FINRA.

Eight Wasn’t Enough

Victims of Bernie Madoff’s ponzi scheme which may have resulted in losses up to $13 billion  have good reason for looking for scape goats. Madoff himself is in jail and will no doubt die while incarcerated before his 2139 release date.  Although there must be some justice in that, is is not financial justice which the victims right deserve.  Some victims have used the legal system to go after Madoff’s wife, Ruth, while others have gone after his family members .  The latest justice seeking group of victims are choosing another scapegoat, namely the SEC. Continue reading

Shareholders Recovering Damages From… Shareholders?

Michael Orey over at BusinessWeek wrote a commentary about a problem with shareholder class action suits against their corporation, particularly concerning a case against Bank of America alleging failure to disclose bonuses set to be paid to Merrill Lynch employees. His concern centers on the fact that the former shareholders of BOA (they have since sold their securities after seeing its value drop due to the alleged misconduct) are seeking to recover directly from the corporation – in effect forcing existing shareholders to cover any resulting damages. The main problem is that the shareholders who did not sell their shares after the drop in value will now have to also bear the costs of paying to settle this lawsuit – even though the true wrongdoers are the officers of the corporation who allowed the alleged misconduct. Further, because the true wrongdoers are not being punished, the result of the lawsuit will not deter similar future conduct. The system seems to be clearly flawed and needs a change.

Short Selling Under Attack Again?

The SEC seems to be moving ahead with plans to place restrictions on short selling. Short selling occurs when Party A borrows a share of a stock from Party B for a fee and sells the borrowed stock to Party C. At some date in the future, Party A must buy a share of the borrowed stock on the market and give it to Party B. If the price of the stock went down between the time of the sale to Party C and the time of Party A’s purchase of the stock on the market, Party A makes a profit.

Some people believe that short selling is bad for the market because short sellers only profit when stock prices go down, and, thus, they have an incentive to spread false rumors about the companies whose stock they short to drive down the stock’s price. Also, in times of high market volatility, increased short selling in a stock could cause a sell-off panic. To combat these problems, the Commission is seeking comment on a proposed circuit-breaker rule and two proposed versions of the uptick rule. A circuit breaker rule would freeze short selling of a specific stock if its price falls a certain amount in a single trading session and the uptick rule would only allow a short sale after a stock’s price has moved up at least one tick.

Although short sellers face much opposition, the SEC is sure to receive many comments against these proposals because many commentors believe that short selling is essential for price discovery. For an in-depth discussion of the proposals, see Jim Hamilton’s and Floyd Norris’s blogs.

Revamping the Regulations

Treasury Secretary Timothy Geithner finally opened the can of worms last week, proposing a far-reaching plan to reform the financial system. He said the system had failed “in fundamental ways” and would require comprehensive overhaul. “Not modest repairs at the margin,” he told Congress, “but new rules of the game.” Geithner’s audience, the House Financial Services Committee, for once seemed to be satisfied with his presentation, which included regulating hedge funds and giving the government the power to seize and dismantle companies deemed a threat to the economy.

The key measures of Geithner’s proposal include:

  • Creating a new “sytemic risk regulator” that would have the authority to scrutinize and second-guess the operations of bank holding companies like JPMorgan Chase, insurance conglomerate American International Group and other institutions that are too big to fail.
  • Establishing a mechanism to seize and dismantle large institutions whose collapse or bankruptcy might threaten the nation’s financial stability.
  • Passing tougher requirements for the amount of money and assets that financial institutions need to have on hand so they can withstand economic troubles.
  • Requiring hedge funds, private-equity firms and other private investment funds to register with the Securities and Exchange Commission and tell it about their risk-management practices.
  • Setting up a new, comprehensive framework of regulation of derivatives, including a central clearinghouse for trades in that market.
  • Developing stronger requirements for money market funds so increased withdrawals won’t threaten the broader financial system.

Many of these proposals should generate a big welcoming, addressing dangers that clearly could have been addressed with simple regulatory reform. In the months ahead, Geithner said he will unveil more detailed proposals.

Nonetheless, a New York Times editorial posted today talk about the big underlying issues that Congress and the administration need to keep in mind. For instance:

  1. Is too big too fail actually exist? Such firms, like A.I.G., have proved dangerous mainly because of their involvement in a web of often conflicting financial practice and products. Geithner has called for a single regulator to police the most powerful institutions and presumably intervene in order to seize and restructure if failure seemed imminent. But, at what point should a firm ever even come close to become “too big” — i.e. too diverse, too interconnected — too fail?
  2. What are we trying to fix, anyway? Does anyone understand, with specificity, what brought on the financial meltdown? Can anyone actually sort out how much of the crisis is due to regulatory failure, how much to recklessness and greed, or how much to fraud and manipulation? Without the answers, the reform effort will be at best, hit or miss.
  3. Who is to carry out the reforms? For the last 30 years, there has been a serious political movement against regulation and for deregulation. In the last 10 years alone, opponents of financial regulation (e.g. Alan Greenspan) have been especially succesful in dismantling our financial regulatory scheme– letting the market forces run free. As a result, the very agencies that were formed to protect our interests struck out — big time. So if there is going to actually be meaningful regulatory reform, the rules will only be the first step.