Ford on Financial Regulation

New Governance in the Teeth of Human Frailty: Lessons from Financial Regulation, by Cristie L. Ford, University of British Columbia Faculty of Law; Columbia Law School, was recently posted on SSRN.  Here is the abstract:

New Governance scholarship has made important theoretical and practical contributions to a broad range of regulatory arenas, including securities and financial markets regulation. In the wake of the global financial crisis, question about the scope of possibilities for this scholarship are more pressing than ever. Is new governance a full-blown alternative to existing legal structures, or is it a useful complement? Are there essential preconditions to making it work, or can a new governance strategy improve any decision making structure? If there are essential preconditions, what are they? Is new governance “modular” – that is, does it still confer benefits when applied partially or imperfectly, or does it fail to achieve good regulatory results unless all the elements are in place? This article starts from the conviction that new governance is a promising response to the fluidity and complexity of contemporary regulatory environments. It then draws on three essentially unhappy narratives from recent financial markets regulation (around securities law enforcement, capital adequacy, and the impact of securitization), in an attempt to identify lessons for new governance scholarship at the level of practical implementation. These are not narratives about the failure of new governance structures. However, central to each narrative are components, or incomplete versions of components, that are also central to new governance structures. The paper considers the significance of incrementalism, regulatory capacity, and destabilization and complexity for regulatory design. It closes with some preliminary recommendations for making new governance structures effective, even as implemented by flawed human actors.

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The Predictive Power of Form 4 Filings

The Efficient Capital Market Hypothesis, Chaos Theory, and the Insider Filing Requirements of the Securities and Exchange Act of 1934: The Predictive Power of Form 4 Filings, by Patrick J. Glen, Department of Justice, Civil Division, Office of Immigration Litigation, was recently posted on SSRN.  Here is the abstract:

This article is primarily an examination of whether the filing of form 4’s under the ‘34 Act has a particular effect on the movement of securities prices. The ultimate results are then analyzed under traditional market theories, which are introduced earlier in the paper. The main question presented is the worth of information for traders. If chaos theory is correct in the weight it gives to information, then the filing requirements become very important, as does any movement that could be associated with those requirements. The paper is an initial step in an area that has not been addressed to a large extent, and could serve as the departure point for more rigorous empirical study of the questions presented.

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The History Behind Securities Law

Why Securities Laws?

The development of federal securities law was spurred by the stock market crash of 1929, and the resulting Great Depression.  In the period leading up to the stock market crash, companies issued stock and enthusiastically promoted the value of their company to induce investors to purchase those securities.  Brokers in turn sold this stock to investors based on promises of large profits but with little disclosure of other relevant information about the company.  In many cases, the promises made by companies and brokers had little or no substantive basis, or were wholly fraudulent.  With thousands of investors buying up stock in hopes of huge profits, the market was in a state of speculative frenzy that only ended on October 29, 1929, when the market crashed as panicky investors sold off their investments en masse.

In reaction to this calamity, and at President Franklin Roosevelt’s instigation, Congress set out to enact laws that would prevent speculative frenzies.  After a series of hearings that brought to light the severity of the abuses leading to the crash, Congress enacted the Securities Act of 1933 (the “Securities Act”), and the Securities Exchange Act of 1934 (the “Exchange Act”). The key theme of the federal securities law is the need to give investors access to information about the securities they buy and the companies that issue securities.     Federal securities laws primarily accomplish this by putting the burden on companies to disclose information about themselves and the securities they issue.  The efficacy of these disclosure requirements is backed up by broad liability for fraud under the Securities Act and the Exchange Act for both issuers and sellers of securities.  It is clear that Congress intended to ensure that investors had access to balanced, non-fraudulent information.
An Overview of the Regulatory Framework

Congress’ power to enact the securities laws derives from the Interstate Commerce Clause; the securities market is a national one, so Congress has the constitutional power to regulate the securities markets.  The Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act) are federal laws that provide for private causes of actions under which investors may recover for fraud, as well as for certain violations of the registration and disclosure processes mandated by the federal securities laws.  In addition, the Exchange Act created the Securities and Exchange Commission (SEC), a federal agency that has the authority to promulgate rules pursuant to the federal securities acts and to enforce federal law and its own rules.  The SEC also regulates the securities business. Under the Exchange Act, the SEC has the authority to register, regulate and discipline broker-dealers, regulate the securities exchanges, and review actions of the securities exchanges’ self-regulatory organizations (SROs).

Well before Congress enacted the federal laws, most states also had their own securities laws, which today are known as blue sky laws.  Congress drafted the federal securities laws against the backdrop of pre-existing state regulation, and in interpreting the federal securities laws, courts often reach back into relevant state law to interpret certain definitions or concepts that Congress used when drafting federal law.  State law and federal law do not correspond perfectly.  Although there is some overlap, state law may provide for causes of action unavailable under federal law, while federal law may provide for causes of action unavailable in a particular state.  State laws can be very different from state to state, and from federal law; key differences are what kinds of products and transactions are covered by the laws, as well registration requirements for brokers, dealers, and companies who issue securities, and the breadth and causes of action available under anti-fraud provisions.  For example, New York’s securities law, the Martin Act, only permits the Attorney General to bring a suit for violations. Individual investors may bring private suits for common-law fraud law in order to recover.

Tags: Securities Law History
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The Securities Regulation Code

The Securities Regulation Code (SRC), which replaced the Revised Securities Act, may not have turned the Securities and Exchange Commission (SEC) into a more effective securities regulator. But it was a big blessing for the five members of the commission because it exempted the agency’s officials and rank-and-file from the Salary Standardization Law. The generous senators and congressmen allowed the commission to increase their salaries—the amounts of which our lawmakers may not know until now—if the adjustments made were in accordance with the provisions of the new securities law which they approved five years ago.

Perhaps, it is time for our legislators to take another look at the new securities law to determine if its provisions were enough deterrent against the unscrupulous practices of scam perpetrators who operate beyond their corporate franchises. Our senators and congressmen may also want to review the SRC provisions to see which should be amended to give the SEC more teeth in going after erring companies. Of course, there may be some omissions by the commission as securities regulators. But to find out their infractions, a performance audit of the entire commission should be undertaken to prevent the disasters that have hit the pre-need industry to spread to other registered corporations such as mutual funds and companies whose shares are listed and traded on the Philippine Stock Exchange.

As a matter of fact, if our lawmakers were to review the SRC, they would surely ask how lawyers arrived at contrasting interpretations of the provisions on the issuance of cease-and-desist orders (CDO) by the SEC. It is understandable for practicing lawyers to interpret the law in a way that would favor their clients, who, after all, pay them. The SEC, on the other hand, finds it more convenient to assume jurisdiction over corporate intramurals involving quarreling stockholders despite the purpose of the new law, which was to rid the agency of court powers over board battle and to transfer these to regular courts designated by the Supreme Court (SC). This is the SEC’s stance and will continue to be its stance until the SC shall have ruled with finality if SEC still has the power to hear and decide corporate cases under the Securities Regulation Code as passed by Congress and which took effect in June 2001. Remember the controversial CDO issued by the SEC commissioner Jesus Enrique G. Martinez, whose term is due to end soon, against the Lopezes in connection with the annual stockholders’ meeting of the Manila Electric Co. last year?

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SEC Charges North Carolina Resident, Biltmore Financial Group For Operating Multi-Million Dollar Ponzi Scheme

The Securities and Exchange Commission has charged North Carolina resident J.V. Huffman and his company, Biltmore Financial Group, Inc., with securities fraud for conducting a Ponzi scheme where more than $25 million was raised from investors and used primarily to fund Huffman’s lavish lifestyle. The SEC also obtained a court order freezing the assets of Huffman and Biltmore, and appointing a temporary receiver.
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Rules on Securities Misrepresentation

Section 10 of the Securities Exchange Act of 1934 states:

“It shall be unlawful for any person…(b) To use or employ, in connection with the purchase or sale of any security…any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe… .”

Sec. 15 of the Exchange Act states:

“No broker…shall… effect any transaction in, or induce or attempt to induce the purchase or sale of any security…by means of any manipulative, deceptive, or other fraudulent device or contrivance.”

For Chicago Securities Arbitration attorneys call 312-782-0844.

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SEC Approves Procedures For Wiping Individuals Records Clean

The SEC has approved the Financial Industry Regulatory Authority’s proposed procedures for arbitrators to follow when considering requests to wipe clean individuals’ records.

Under the new rules, arbitration panels must comply with four requirements before granting expungement of customer dispute information: for example, holding a recorded hearing or explaining the grounds on which expungement should be granted.

FINRA rejected many of the concerns on the grounds that they fell beyond the scope of the rule making and that the proposals were designed to make sure expungement was “an extraordinary remedy…granted only under appropriate circumstances,” officials said.

The SEC agreed that expungement should be granted rarely and that comments on Rule 2130, the process itself and whether arbitrators should be the ones to decide on expungement were beyond the scope of the proposal.
Source

NASAA officials did not return calls.

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SEC Proposed Rule Change SR-FINRA-2008-054 Expected This Week

Proposed Rule Change

A notice of filing of proposed rule change (SR-FINRA-2008-054) filed by the Financial Industry Regulatory Authority to adopt FINRA Rule 5280  in the Consolidated FINRA Rulebook had been filed with the SEC pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 and Rule 19b-4 thereunder.

Publication in the Federal Register is expected this week. It will be interesting.

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Margin Account Violations

In a margin account the broker lends the customer money to buy securities. The broker holds the securities as collateral for the loan.

Margin increases an investor’s risk. The greater the percentage of the account’s value that is a loan, the greater the risk.

The broker must disclose the interest rate and other terms and conditions of the loan. The broker must also disclose under what circumstances and when securities in the account will be sold to cover the loan. The broker must give a monthly accounting of all transactions in the account and all interest, advances and charges.

Regulation T of the Federal Reserve regulates margin. Only certain securities are eligible for margin purchases. The Regulation limits margin to 50% of the value of the securities purchased. For most securities it applies only to the time credit is extended (initial margin). It does not apply after that as the value of the security fluctuates (maintenance margin). The NASD and certain stock exchanges impose maintenance margin rules that limit the loan balance to 75% of the value of the security.

For a Chicago Securties Lawyer call 312-782-0844

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The Sarbanes-Oxley Act

The Sarbanes-Oxley Act of 2002  also known as the Public Company Accounting Reform and Investor Protection Act of 2002 and commonly called SOX or Sarbox; is a United States federal law enacted on July 30, 2002 in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom. These scandals, which cost investors billions of dollars when the share prices of the affected companies collapsed, shook public confidence in the nation’s securities markets. Named after sponsors Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH), the Act was approved by the House by a vote of 334-90 and by the Senate 99-0. President George W. Bush signed it into law, stating it included “the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt.”

The legislation establishes new or enhanced standards for all U.S. public company boards, management, and public accounting firms. It does not apply to privately held companies. The Act contains 11 titles, or sections, ranging from additional Corporate Board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the new law. Debate continues over the perceived benefits and costs of SOX. Supporters contend that the legislation was necessary and has played a useful role in restoring public confidence in the nation’s capital markets by, among other things, strengthening corporate accounting controls. Opponents of the bill claim that it has reduced America’s international competitive edge against foreign financial service providers, claiming that SOX has introduced an overly complex and regulatory environment into U.S. financial markets.

The Act establishes a new quasi-public agency, the Public Company Accounting Oversight Board, or PCAOB, which is charged with overseeing, regulating, inspecting, and disciplining accounting firms in their roles as auditors of public companies. The Act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure.
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To find a Securities Lawyer visit the Securities Lawyer Directory.

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