Securities class actions often follow close on the heels of major announcements by public companies. These class actions have been portrayed as a shareholder's weapon against corporate wrongdoing, but too often that weapon inflicts harm on the very shareholders it is intended to protect.
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The Securities and Exchange Commission settled with Credit Suisse for providing financial services to U.S. clients without having registered with the SEC. The Swiss firm's efforts at winning American business were successful enough to generate more than 8,000 U.S. client accounts with more than $5 billion in assets. The firm took inadequate steps to ensure that it was in compliance with U.S. law and, even after deciding to stop offering cross-border advice, the firm took several years to close U.S. accounts. The settlement includes an admission of wrongdoing and a $196 million payment consisting of disgorgement of the firms' fees, plus interest and a $50 million penalty.
That kind of money suggests that clients were really harmed, but the complaint does not reveal any investor harm. Indeed, the delay in shutting the cross-border program down appears to have stemmed in part from reluctance of clients to part with their advisers. Contrast the Credit Suisse settlement with a settlement last year with a registered adviser that the SEC alleges stole more than $3 million from a police and firefighter pension fund to buy shopping malls. The settlement consisted only of requiring the adviser to repay the money it had allegedly stolen. A sophisticated global firm like Credit Suisse has the wherewithal to understand and comply with registration requirements, but the SEC's disproportionately large settlement in a case without discernible investor harm will dissuade other foreign firms from registering to serve U.S. investors. Such a result is not good for investors, who ought to be able to seek advice overseas.
Advocacy group, Better Markets, filed suit in federal district court today to challenge the settlement between JPMorgan and the Department of Justice last November related to JPMorgan's crisis-era sales of residential mortgage-backed securities. The complaint alleges that the DOJ violated the law when it entered into a settlement that was shielded from judicial review and the details of which remain a mystery. As Better Markets paints it, the deal was negotiated by a politically connected bank with a department officials scrambling to show themselves tough on too big to fail institutions. The complaint suggests that the large settlement numbers served as a smoke screen to conceal DOJ's gentle slap on JPMorgan's brutish wrist. Better Markets, itself a confidant of regulators, likely overstates DOJ's deference in this matter, but correctly points out the settlement's troubling lack of transparency. When it was announced, I objected that the settlement's large dollar figures were not accompanied by any clear explanation of the violations being punished.
Mark Cuban has not forgotten the agency he defeated in court. He has embarked on a plan to post Securities and Exchange Commission trial transcripts on his blog. SEC lawyers make mistakes just as everyone else does, so this project will undoubtedly bring some embarrassing moments to light and laughter. The first episode of candid courtroom commenced on a more serious note. Federal district court judge William S. Duffey, Jr. chides the SEC for "looking at a case late and finding an issue and evidence that they want to admit and trying to find a rationalization for it." As the judge explains, the SEC's objective should be for "a just result and not just for a result." The judge may have put his finger on the hardest part of an SEC enforcement attorney's job. There is an understandable thrill in making a wrongdoer pay for violating the law. Carrying out investigative and trial responsibilities in order simply to achieve a just result is much less satisfying. Justice may demand that a case get dropped or that a particular tactic for securing victory be avoided. The SEC and other government agencies must do their part by rewarding good lawyering even if it does not result in a checkmark in the government's win column.
On January 29th, the Court of Appeals for the Second Circuit dealt Hank Greenberg another blow in his challenge of the federal government's crisis-era AIG rescue. Greenberg's company, Starr International, a large AIG shareholder, alleged that the Federal Reserve Bank of New York had violated state fiduciary duty law at multiple points in the government's prolonged rescue effort. Starr objected to the government's initial intervention in September 2008, but the challenge focused on later events not barred by the statute of limitations. Starr alleged that the government, without regard for AIG's best interests, had used the company to funnel bailouts to other financial companies. The court affirmed the lower court's verdict and held that Delaware fiduciary duty law could not stand in the way of the actions that the Federal Reserve Bank of New York took to fulfill its public duty to stabilize the financial system. The district court hinted that there might be some remedy under federal law if Starr could show, for example, that the Federal Reserve Bank of New York, "having attained control of AIG in the course of an emergency rescue, then forced AIG to purchase a photocopying machine from a bank in Utah for $1 billion, solely to subsidize the Utah bank in the interested of the banking system." Even absent a billion dollar copier, the Federal Reserve is not completely off the hook; another case is proceeding at the Court of Federal Claims.
During a conference hosted yesterday by two Dodd-Frank regulatory agencies, one of the panels focused on central counterparties (CCPs), the institutions that Dodd-Frank promises will help to avert the next financial crisis. But will they? The answer to that question remains very uncertain, and the panelists (all proponents of central clearing) highlighted some of the risks that we should be thinking about.
Yesterday's congressional spending deal did not contain all the money for which the Securities and Exchange Commission and Commodity Futures Trading Commission had asked. The SEC will get $29 million more than its fiscal 2013 level, and the CFTC will have approximately $10 million more to spend. Proponents of larger budgets for the financial regulators seem to see a directly proportional relationship between the amount of money each agency has at its disposal and the health of our capital markets. Based on the commissions' records, one wonders. The CFTC has employed much of its budget in recent years to remake the derivatives markets in a haphazard way that could impair their ability to serve the Main Street companies, farmers, and others that rely on them. The SEC has poured resources into writing (and defending against legal challenges) rules such as the proxy access rule, which would have paved the way for backroom deals with special constituencies at the expense of other shareholders, and the conflict minerals rule, which the SEC crafted to be even more onerous than the statute requires it to be. Both agencies already have large budgets that reflect the important roles they play in our capital markets, but congressional reluctance to send more money their way is not surprising given the way they might spend it.
Earlier this month, the Bureau of Consumer Financial Protection and the Department of Justice brought an $80 million discriminatory lending action against Ally Financial. Ally, a major recipient of TARP bailout money, allegedly charged different rates based on the race or national origin of borrowers. The loans at issue do not include information about the race or national origin of the borrowers, but "the CFPB and the DOJ assigned race and national origin probabilities to the applicants" based on a geography-based and name-based methodology. In other words, the government's discriminatory lending action is rooted in its assumptions about whether or not borrowers were minorities. Illegal discrimination in lending is just as unacceptable as it is in other contexts, but punishing lenders based on government guesses about whether discrimination occurred is not the solution.
Judge Jed Rakoff uses a piece in the New York Review of Books to consider why government officials, who have talked a lot about fraud being at the root of the financial crisis, have not prosecuted the individuals that allegedly perpetrated the fraud. In doing so, he raises some bigger concerns about how government bureaucracies make decisions about whom to pursue and how.
The long-in-the-making Volcker Rule was finalized this week. Under the rule, banks and affiliated entities, will not be permitted to engage in proprietary trading and their relationships with hedge funds and private equity funds will be limited. The rule--a five-agency, nearly thousand-page effort--is a reflection of the difficulty of distinguishing prohibited from permissible activity. Volcker compliance programs will be large and complex, and frequent unintentional missteps across Volcker's hazy lines are likely. Consequently, the rule promises to be a plentiful supplier of cases for regulators and a great source of enforcement risk to the companies subject to it.
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