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This is a photo of the National Register of Historic Places listing with reference number 7000063

Sunday, February 27, 2011


The following is another case involving alleged bribery of foreign governments by an official working for a U. S. corporation. The charges are based upon the violation of the Foreign Corrupt Practices Act. For details please read the excerpt from the SEC web site:

The SEC “charged a former chief executive officer at Innospec, Inc., with violating the Foreign Corrupt Practices Act (FCPA) by approving bribes to government officials to obtain and retain business.
The SEC alleges that Paul W. Jennings learned of the company's longstanding practice of paying bribes to win orders for sales of tetraethyl lead (TEL) in mid- to late 2004 while serving as the CFO. After becoming CEO in 2005, Jennings and others in Innospec's management approved bribery payments to officials at the Iraqi Ministry of Oil (MoO) in order to sell the fuel additive to Iraq refineries. Innospec used its third-party agent in Iraq to funnel payments to Iraqi officials.

Jennings agreed to settle the SEC's charges against him. The SEC previously charged Innospec as well as its former TEL business director and its agent in Iraq with FCPA violations.
"This is the third enforcement action against an individual responsible for the widespread bribery that occurred at Innospec," said Cheryl J. Scarboro, Chief of the SEC's Foreign Corrupt Practices Act Unit. "We will vigorously hold accountable those individuals who approve such bribery and who sign false SOX certifications and other documents to cover up the wrongdoing."
According to the SEC's complaint filed in U.S. District Court for the District of Columbia, Jennings played a key role in Innospec's bribery activities in Iraq and Indonesia. Innospec, a manufacturer and distributor of fuel additives and other specialty chemicals, was charged last year for making illicit payments of approximately $6.3 million and promised an additional $2.8 million in illicit payments to Iraqi ministries and government officials as well as Indonesian government officials in exchange for contracts worth approximately $176 million.
The SEC alleges that Innospec made payments totaling more than $1.6 million and promised an additional $884,480 to MoO officials. For example, in an October 2005 e-mail copying Jennings, the agent said that Iraqi officials were demanding a 2 percent kickback and that "[w]e are sharing most of our profits with Iraqi officials. Otherwise, our business will stop and we will lose the market. We have to change our strategy and do more compensation to get the rewards." The kickback and later payments were paid by increasing the agent's commission, which Jennings approved. The SEC's complaint also alleges that Jennings was aware of the scheme to pay an official at the Trade Bank of Iraq in exchange for a favorable exchange rate on letters of credit. Another scheme involved a bribe to ensure the failure of a field test of a competitor product. A confidential MoO report for the field trial test was shared with Jennings. Bribes were offered to secure a 2008 Long Term Purchase Agreement that would have caused approximately $850,000 to be shared with Iraqi officials. The agreement, however, did not go forward due to the investigation and ultimate discovery by U.S. regulators of widespread bribery by Innospec.
According to the SEC's complaint, Innospec also paid bribes to Indonesian government officials from at least 2000 to 2005 in order to win contracts worth more than $48 million from state-owned oil and gas companies in Indonesia. Jennings became aware of and approved payments beginning in mid to late 2004. Various euphemisms to refer to the bribery were commonly used in e-mails and in discussions with Jennings and others at Innospec, including "the Indonesian Way," "the Lead Defense Fund," and "TEL optimization." Bribery discussions were held on a flight in the U.S. and even discussed at Jennings' performance review in 2005. In one bribery scheme with Pertamina, an Indonesian state owned oil and gas company, Innospec agreed, with approval by Jennings, to a "one off payment" of $300,000 to their Indonesian Agent with the understanding that it would be passed on to an Indonesian official.
The SEC's complaint also alleges that from 2004 to February 2009, Jennings signed annual certifications that were provided to auditors where he falsely stated that he had complied with Innospec's Code of Ethics incorporating the Company's FCPA policy. Jennings also signed annual and quarterly personal certifications pursuant to the Sarbanes-Oxley Act of 2002 in which he made false certifications concerning the company's books and records and internal controls.
Jennings has consented, without admitting or denying the SEC's allegations, to the entry of a final judgment that permanently enjoins him from violating Sections 30A and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 13a-14, 13b2-1 and 13b2-2 thereunder, and from aiding and abetting Innospec's violations of Exchange Act Sections 30A, 13(b)(2)(A) and13(b)(2)(B). Jennings will disgorge $116,092 plus prejudgment interest of $12,945, and pay a penalty of $100,000 that takes into consideration Jennings's cooperation in this matter.
The SEC appreciates the assistance of the U.S. Department of Justice's Fraud Section, the Federal Bureau of Investigation, and the U.K.'s SFO in this matter. The SEC's investigation is continuing.”

It is good to see that there was cooperation between agencies in the investigation of this case. There have been many cases of bribery which violated the Foreign Corrupt Practices Act. It might be to the advantage of The United States if the State Department would seek severe punitive actions against nations that allow officials to seek out bribes.

Wednesday, February 23, 2011


The following excerpt from the FDIC shows that overall big banks are doing well and smaller banks are recovering:

"The fourth quarter 2010 FDIC Quarterly Banking Profile (QBP) is now available on line. FDIC-insured institutions reported an aggregate profit of $21.7 billion in the fourth quarter of 2010, a $23.5 billion improvement from the $1.8 billion net loss the industry reported in the fourth quarter of 2009. This is the sixth consecutive quarter that earnings registered a year-over-year increase. Almost two-thirds of all institutions (62 percent) reported improvements in their quarterly net income from a year ago. The average return on assets (ROA) rose to 0.65 percent, from negative 0.06 percent a year ago. Although community banks' aggregate return on assets lags the ROA for larger institutions, as a group they are recovering, as most community banks reported higher earnings than a year ago."

Sunday, February 20, 2011


The Securities and Exchange Commission has a lot of territory to cover when it comes to uncovering insider trading frauds. The internationalization of securities trading has tempted many individuals to pass on insider information to friends and relatives living over seas. The hope of such fraudsters is to move their ill gotten profits along with themselves to a safe haven out side of the United States. In the following case the SEC alleges that a bio-tech manager arranged to have his relatives purchase stock options in the manager’s company after the manager became aware that there was a positive result for a cancer drug that his company was developing. The following excerpt came from the SEC website:

“Washington, D.C., Jan. 21, 2011 — The Securities and Exchange Commission today announced that it has obtained a court order freezing the bank and brokerage accounts controlled by an individual who made more than $800,000 in illegal profits by trading on inside information tipped to him by an employee of a Seattle-area biopharmaceutical firm.
In a complaint unsealed late Thursday by the U.S. District Court for the Western District of Washington, the SEC alleges that Zizhong (James) Fan, a manager at Seattle Genetics, told family member Zishen (Brandon) Fan about confidential positive trial results for the company's flagship cancer treatment. Zishen spent hundreds of thousands of dollars purchasing speculative stock options in the company as well as common stock, which skyrocketed in value when the news became public in late September 2010.

According to the SEC's complaint, the SEC staff contacted both Zizhong and Zishen last Thursday, January 13. Almost immediately after being contacted, Zishen attempted to wire several hundred thousand dollars to a bank in China while Zizhong informed his employer that he was leaving unexpectedly for China. The SEC thereafter filed an emergency enforcement action. On Wednesday, January 19, Judge Marsha J. Pechman of the Western District of Washington issued an order freezing brokerage and bank accounts containing the Seattle Genetics trading proceeds.

Marc Fagel, Director of the SEC's San Francisco Regional Office, explained, "While our investigation is at an early stage, when we have evidence of insider trading and the individuals involved respond to our investigation by trying to funnel their illicit profits offshore, we are prepared to take quick action to preserve those assets for recovery by the authorities."

The SEC's complaint alleges that Zizhong Fan, who lives in Bothell, Wash., was employed during 2010 as the manager of clinical programming at Seattle Genetics. He was involved in clinical trials for a development-stage product to be used in the treatment of Hodgkin's lymphoma. As Zizhong Fan began learning information about the success of those trials, Zishen Fan, who lives in Chino Hills, Calif., began amassing large quantities of risky stock options that would allow him to profit from a rise in the company's stock price.
The SEC's complaint alleges that on Sept. 24, 2010 — the day that Zizhong attended a series of meetings to finalize the results for presentation to the company's senior executives — Zishen made his largest options purchase to date (over 50 percent of the options trades in the entire market), while also buying $150,000 in stock. The next business day — September 27 — Seattle Genetics reported the positive results to the public, and its stock price rose nearly 18 percent. According to the SEC, Zishen ultimately realized net trading profits of more than $803,000.
The SEC's complaint charges Zizhong Fan and Zishen Fan with violating the antifraud provisions of the federal securities laws. The complaint seeks permanent injunctive relief, disgorgement of illicit profits with prejudgment interest, and monetary penalties. The SEC also named another family member Junhua Fan, who resides in the People's Republic of China, as a relief defendant in the case. His brokerage account was used by Zishen to make many of the illegal trades, according to the SEC's complaint.
The SEC's investigation was conducted by Jennifer J. Lee and Jina L. Choi of the San Francisco Regional Office. The case will be litigated by Robert L. Mitchell. The SEC would like to thank the Chicago Board Options Exchange for its assistance in this matter. The SEC also acknowledges the cooperation of Seattle Genetics.”

Insider trading is done all the time however; there is some debate about what information should constitute an actionable crime and what information may be justifiably obtained. If a business executive knows some secret information that he and his family try to profit from at the publics expense then clearly that could be considered a crime. But, what about a case where the businesses executive passes on the same information but does not profit in any way from its distribution? What if a low level accountant casually passes on insider information to an acquaintance about a large purchase the government just made from his company? Even a shipping clerk or truck driver might be privy to insider information regarding large purchases. The line between obtaining insider information from company personnel and doing research by talking to company personnel should make any investor feel uncomfortable.

Thursday, February 17, 2011


The following testimony of Sheila Bair, Chaiman of the FDIC was downloaded from the FDIC web site:

Statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation on Implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act to the Committee on Banking, Housing, and Urban Affairs, U.S. Senate; 538 Dirksen Senate Office Building
February 17, 2011

Chairman Johnson, Ranking Member Shelby and members of the Committee, thank you for the opportunity to testify today on the Federal Deposit Insurance Corporation's (FDIC) progress in implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
The recent financial crisis exposed grave shortcomings in our framework for regulating the financial system. Insufficient capital at many financial institutions, misaligned incentives in securitization markets and the rise of a largely unregulated shadow banking system bred excess and instability in our financial system that led directly to the crisis of September 2008. When the crisis hit, regulatory options for responding to distress in large, non-bank financial companies left policymakers with a no-win dilemma: either prop up failing institutions with expensive bailouts or allow destabilizing liquidations through the normal bankruptcy process. The bankruptcy of Lehman Brothers Holdings Inc. (Lehman) in September 2008 triggered a liquidity crisis at AIG and other institutions that froze our system of intercompany finance and made the 2007-09 recession the most severe since the 1930s.

The landmark Dodd-Frank Act enacted last year created a comprehensive new regulatory and resolution regime that is designed to protect the American people from the severe economic consequences of financial instability. The Dodd-Frank Act gave regulators tools to limit risk in individual financial institutions and transactions, enhance the supervision of large non-bank financial companies, and facilitate the orderly closing and liquidation of large banking organizations and non-bank financial companies in the event of failure. Recognizing the urgent need for reform and the importance of a deliberative process, the Act directed the FDIC and the other regulatory agencies to promulgate implementing regulations under a notice and comment process and to do so within specified timeframes. The FDIC is required or authorized to implement some 44 regulations, including 18 independent and 26 joint rulemakings. The Dodd-Frank Act also grants the FDIC new or enhanced enforcement authorities, new reporting requirements, and responsibility for numerous other actions.

We are now in the process of implementing the provisions of the Dodd-Frank Act as expeditiously and transparently as possible. The lessons of history – recent and distant – remind us that financial markets cannot function for long in an efficient and stable manner without strong, clear regulatory guidelines. We know all too well that the market structures in place prior to the crisis led to misaligned incentives, a lack of transparency, insufficient capital, and excessive risk taking. As a result, the U.S. and global economies suffered a grievous blow. Millions of Americans lost their jobs, their homes, or both, even as almost all of our largest financial institutions received assistance from the government that enabled them to survive and recover. Memories of such events tend to be short once a crisis has passed, but we as regulators must never forget the enormous economic costs of the inadequate regulatory framework that allowed the crisis to occur in the first place. At the same time, our approach must also account for the potential high cost of needless or ill-conceived regulation – particularly to those in the vital community banking sector whose lending to creditworthy borrowers is necessary for a sustained economic recovery.

My testimony will review the FDIC's efforts to date to implement the provisions of Dodd-Frank and highlight what we see as issues of particular importance.

Implementing the Resolution Authority and Ending Too Big To Fail

A significant number of the FDIC's rulemakings stem from the Dodd-Frank Act's mandate to end "Too Big to Fail." This includes our Orderly Liquidation Authority under Title II of the Act, our joint rulemaking with the Board of Governors of the Federal Reserve System (FRB) on requirements for resolution plans (or living wills) that will apply to systemically important financial institutions (SIFIs), and the development of criteria for determining which firms will be designated as SIFIs by the Financial Stability Oversight Council (FSOC).

Orderly Liquidation Authority

The Lehman bankruptcy in September 2008 demonstrated the confusion and chaos that can result when a large, highly complex financial institution collapses into bankruptcy. The Lehman bankruptcy had an immediate and negative effect on U.S. financial stability and has proven to be a disorderly, time-consuming, and expensive process. Unfortunately, bankruptcy cannot always provide the basis for an orderly resolution of a SIFI or preserve financial stability. To overcome these problems, the Dodd-Frank Act provides for an Orderly Liquidation Authority with the ability to: plan for a resolution and liquidation, provide liquidity to maintain key assets and operations, and conduct an open bidding process to sell a SIFI and its assets and operations to the private sector as quickly as possible.

While Title I of the Dodd-Frank Act significantly enhances regulators' ability to conduct advance resolution planning for SIFIs, Title II vests the FDIC with legal resolution authorities similar to those that it already applies to insured depository institutions (IDIs).

If the FDIC is appointed as receiver, it is required to carry out an orderly liquidation of the financial company. Title II also requires that creditors and shareholders "bear the losses of the financial company" and instructs the FDIC to liquidate a failing SIFI in a manner that maximizes the value of the company's assets, minimizes losses, mitigates risk, and minimizes moral hazard. Under this authority, common and preferred stockholders, debt holders and other unsecured creditors will know that they will bear the losses of any institution placed into receivership, and management will know that it could be replaced.

The new requirements will ensure that the largest financial companies can be wound down in an orderly fashion without taxpayer cost. Under Title II of the Dodd-Frank Act, there are no more bailouts. In implementing the Act's requirements, our explicit goal is that all market players should share this firm expectation and that financial institution credit ratings should, over time, fully reflect this fact. By developing a credible process for resolving a troubled SIFI, market discipline will be reinforced and moral hazard reduced.

From the FDIC's more than 75 years of bank resolution experience, we have found that clear legal authority and transparent rules on creditor priority are important elements of an orderly resolution regime. To that end, the FDIC issued an interim final rule implementing certain provisions of our Orderly Liquidation Authority on January 25, 2011. In the interim rule, the FDIC posed questions to solicit public comment on such issues as reducing moral hazard and increasing market discipline. We also asked for comment on guidelines that would create increased certainty in establishing fair market value of various types of collateral for secured claims. The rule makes clear that similarly situated creditors would never be treated in a disparate manner except to preserve essential operations or to maximize the value of the receivership as a whole. Importantly, this discretion will not be used to favor creditors based on their size or interconnectedness. In other words, there is no avenue for a backdoor bailout.

Comments on the interim rule and the accompanying questions will help us further refine the rule and bring more certainty to the industry as it navigates the recalibrated regulatory environment. This summer we expect to finalize other rules under our Title II authority that will govern the finer details of how the FDIC will wind down failed financial companies in receivership.

Resolution Plans

Even with the mechanism of the Orderly Liquidation Authority in place, ending "Too Big to Fail" requires that regulators obtain critical information and shape the structure and behavior of SIFIs before a crisis occurs. This is why the Dodd-Frank Act mandated in Title I that the FDIC and the FRB jointly establish requirements for these firms to maintain credible, actionable resolution plans that will facilitate their orderly resolution if they should fail. Without access to critical information contained in credible resolution plans, the FDIC's ability to implement an effective and orderly liquidation process could be significantly impaired.

As noted in my September testimony, the court-appointed trustee overseeing the liquidation of Lehman Brothers Inc. found that the lack of a disaster plan "contributed to the chaos" of the Lehman bankruptcy and the liquidation of its U.S. broker-dealer. Recognizing this, the Dodd-Frank Act created critical authorities designed to give the FDIC, the FRB, and the FSOC information from the largest potentially systemic financial companies that will allow for extensive advance planning both by regulators and by the companies themselves.

The Dodd-Frank Act requires the FDIC and the FRB jointly to issue regulations within 18 months of enactment to implement new resolution planning and reporting requirements that apply to bank holding companies with total assets of $50 billion or more and non-bank financial companies designated for FRB supervision by the FSOC.

Importantly, the statute requires both periodic reporting of detailed information by these financial companies and the development and submission of resolution plans that allow "for rapid and orderly resolution in the event of material financial distress or failure." The resolution plan requirement in the Dodd-Frank Act appropriately places the responsibility on financial companies to develop their own resolution plans in coordination with the FDIC and the FRB.

The Dodd-Frank Act lays out steps that must be taken with regard to the resolution plans. First, the FRB and the FDIC must review each company's plan to determine whether it is both credible and useful for facilitating an orderly resolution under the Bankruptcy Code. Making these determinations will necessarily involve the agencies having access to the company and relevant information. This new resolution plan regulation will require financial companies to look critically at the often highly complex and interconnected corporate structures that have emerged within the financial sector.

If a plan is found to be deficient, the company will be asked to submit a revised plan to correct any identified deficiencies. The revised plan could include changes in business operations and corporate structure to facilitate implementation of the plan. If the company fails to resubmit a plan that corrects the identified deficiencies, the Dodd-Frank Act authorizes the FRB and the FDIC jointly to impose more stringent capital, leverage or liquidity requirements. In addition, the agencies may impose restrictions on growth, activities, or operations of the company or any subsidiary. In certain cases, divestiture of portions of the financial company may be required. Just last month, Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program, recognized that this regulatory authority, including the ability to require divestiture, provides an avenue to convincing the marketplace that SIFIs will not receive government assistance in a future crisis.1 The FDIC is working with the FRB to develop requirements for these resolution plans. It is essential that we complete this joint rule as soon as possible.

SIFI Designation

The Dodd-Frank Act created the FSOC to plug important gaps between existing regulatory jurisdictions where financial risks grew in the years leading up to the recent crisis. An important responsibility of the FSOC is to develop criteria for designating SIFIs that will be subject to enhanced FRB supervision and the requirement to maintain resolution plans. To protect the U.S. financial system, it is essential that we have the means to identify which firms in fact qualify as SIFIs so we do not find ourselves with a troubled firm that is placed into a Title II liquidation without having a resolution plan in place.

Since enactment of the Dodd-Frank Act, experienced and capable staff from each of the member agencies have been collaborating in implementing the FSOC's responsibilities, including establishing the criteria for identifying SIFIs. The Dodd-Frank Act specifies a number of factors that can be considered when designating a non-bank financial company for enhanced supervision, including: leverage; off-balance-sheet exposures; and the nature, scope, size, scale, concentration, interconnectedness and mix of activities. The FSOC will develop a combination of qualitative and quantitative measures of potential risks posed by an individual nonbank institution to U.S. financial stability.

The nonbank financial sector encompasses a multitude of financial activities and business models, and potential systemic risks vary significantly across the sector. A staff committee working under the FSOC has segmented the nonbank sector into four broad categories: 1) the hedge fund, private equity firm, and asset management industries; 2) the insurance industry; 3) specialty lenders; and 4) broker-dealers and futures commission merchants. The Council has begun developing measures of potential risks posed by these firms. Once these measures are agreed upon, the FSOC may need to request data or information that is not currently collected or otherwise available in public filings.

Recognizing the need for accurate, clear, and high quality information, Congress granted the FSOC the authority to gather and review financial data and reports from nonbank financial companies and bank holding companies, and if appropriate, request that the FRB conduct an exam of the company for purposes of making a systemic designation. By collecting more information in advance of designation, the FSOC can be much more judicious in determining which firms it designates as SIFIs. This will minimize both the threat of an unexpected systemic failure and the number of firms that will be subject to additional regulatory requirements under Title I.

Last October, the FSOC issued an Advance Notice of Proposed Rulemaking regarding the criteria that should inform the FSOC's designation of nonbank financial companies. The FSOC received approximately 50 comments from industry trade associations, individual firms, and individuals. On January 26, the FSOC issued a Notice of Proposed Rulemaking, with a 30-day comment period, describing the criteria that will inform – and the processes and procedures established under the Dodd-Frank Act – the FSOC's designation of nonbank financial companies. The FDIC would welcome comments particularly on whether the rule can offer more specificity on criteria for SIFI designation. The FSOC is committed to adopting a final rule on this issue later this year, with the first designations to occur shortly thereafter.

Strengthening and Reforming the Deposit Insurance Fund

Prior to 2006, statutory restrictions prevented the FDIC from building up the Deposit Insurance Fund (DIF) balance when conditions were favorable in order to withstand losses under adverse conditions without sharply increasing premiums. The FDIC was also largely unable to charge premiums according to risk. In fact, it was unable to charge most institutions any premium as long as the DIF balance exceeded $1.25 per $100 of insured deposits. Congress enacted reforms in 2006 that permitted the FDIC to charge all banks a risk-based premium and provided additional, but limited, flexibility to the FDIC to manage the size of the DIF. The FDIC changed its risk-based pricing rules to take advantage of the new law, but the onset of the recent crisis prevented the FDIC from increasing the DIF balance. In this crisis, as in the previous one, the balance of the DIF became negative, hitting a low of negative $20.9 billion in December 2009. The DIF balance has improved in each subsequent quarter, and stood at negative $8.0 billion as of last September. Through a special assessment and the prepayment of premiums, the FDIC took the necessary steps to ensure that it did not have to rely on taxpayer funds during the crisis to protect insured depositors.

In the Dodd-Frank Act, Congress revised the statutory authorities governing the FDIC's management of the DIF. The FDIC now has the ability to achieve goals for deposit insurance fund management that it has sought to achieve for decades but has lacked the tools to accomplish. The FDIC has increased flexibility to manage the DIF to maintain a positive fund balance even during a banking crisis while maintaining steady and predictable assessment rates throughout economic and credit cycles.

Specifically, the Dodd-Frank Act raised the minimum level for the Designated Reserve Ratio (DRR) from 1.15 percent to 1.35 percent and removed the requirement that the FDIC pay dividends of one-half of any amount in the DIF above a reserve ratio of 1.35 percent. The legislation allows the FDIC Board to suspend or limit dividends when the reserve ratio exceeds 1.50 percent.

FDIC analysis has shown that the dividend rule and the reserve ratio target are among the most important factors in maximizing the probability that the DIF will remain positive during a crisis, when losses are high, and in preventing sharp upswings in assessment rates, particularly during a crisis. This analysis has also shown that at a minimum the DIF reserve ratio (the ratio of the DIF balance to estimated insured deposits) should be about 2 percent in advance of a banking crisis in order to avoid high deposit insurance assessment rates when banking institutions are strained and least able to pay.

Consequently, the FDIC Board completed two rulemakings, one in December 2010, and one earlier this month, that together form the basis for a long-term strategy for DIF management and achievement of the statutorily required 1.35 percent DIF reserve ratio by September 30, 2020. The FDIC Board adopted assessment rates that will take effect on April 1, 2011. The Board also adopted lower rates that will take effect when the DIF reserve ratio reaches 1.15 percent, which we expect will approximate the long-term moderate, steady assessment rate that would have been needed to maintain a positive fund balance throughout past crises. The DRR was set at 2 percent, consistent with our analysis of a long-term strategy for the DIF, and dividends were suspended indefinitely. In lieu of dividends, the rules set forth progressively lower assessment rate schedules when the reserve ratio exceeds 2 percent and 2.5 percent.

These actions increase the probability that the fund reserve ratio will reach a level sufficient to withstand a future crisis, while maintaining moderate, steady, and predictable assessment rates. Indeed, banking industry participants at an FDIC Roundtable on deposit insurance last year emphasized the importance of stable, predictable assessments in their planning and budget processes. Moreover, actions taken by the FDIC's current Board of Directors as a result of the Dodd-Frank Act should make it easier for future Boards to resist inevitable calls to reduce assessment rates or pay larger dividends at the expense of prudent fund management and counter-cyclical assessment rates.

The Dodd-Frank Act also requires the FDIC to redefine the base used for deposit insurance assessments as average consolidated total assets minus average tangible equity. Earlier this month, the FDIC Board issued a final rule implementing this requirement. The rule establishes measures for average consolidated total assets and average tangible equity that draw on data currently reported by institutions in their Consolidated Report of Condition and Income or Thrift Financial Report. In this way, the FDIC has implemented rules that minimize the number of new reporting requirements needed to calculate deposit insurance assessments. As provided by the Dodd-Frank Act, the FDIC's rule adjusted the assessment base for banker's banks and custodial banks.

Using the lessons learned from the most recent crisis, our rule changed the large bank pricing system to better differentiate for risk and better take into account losses from large institution failures that the FDIC may incur. This new system goes a long way toward reducing the pro-cyclicality of the risk-based assessment system by calculating assessment payments using more forward-looking measures. The system also removes reliance on long-term debt issuer ratings consistent with the Dodd-Frank Act.

The FDIC projects that the change to a new, expanded assessment base will not materially change the overall amount of assessment revenue that the FDIC would have collected prior to adoption of these rules. However, the change in the assessment base, in general, will result in shifting more of the overall assessment burden away from community banks and toward the largest institutions, which rely less on domestic deposits for their funding than do smaller institutions, as Congress intended.

Under the new assessment base and large bank pricing system, the share of the assessment base held by institutions with assets greater than $10 billion will increase from 70 percent to 78 percent, and their share of overall dollar assessments will increase commensurately from 70 percent to 79 percent. However, because of the combined effect of the change in the assessment base and increased risk differentiation among large banks in the new large bank pricing system, many large institutions will experience significant changes in their overall assessments. The combined effect of changes in this final rule will result in 59 large institutions paying lower dollar assessments and 51 large institutions paying higher dollar assessments (based upon September 30, 2010 data). In the aggregate, small institutions will pay 30 percent less, due primarily to the change in the assessment base, thus fewer than 100 of the 7,600 plus small institutions will pay higher assessments.

Strengthening Capital Requirements

One of the most important mandates of the Dodd Frank Act is Section 171—the Collins Amendment—which we believe will do more to strengthen the capital of the U.S. banking industry than any other section of the Act.

Under Section 171 the capital requirements that apply to thousands of community banks will serve as a floor for the capital requirements of our largest banks, bank holding companies and nonbanks supervised by the FRB. This is important because in the years before the crisis, U.S. regulators were embarking down a path that would allow the largest banks to use their own internal models to set, in effect, their own risk-based capital requirements, commonly referred to as the "Basel II Advanced Approach."

The premise of the Advanced Approach was that the largest banks, because of their sophisticated internal-risk models and superior diversification, simply did not need as much capital in relative terms as smaller banks. The crisis demonstrated the fallacy of this thinking as the models produced results that proved to be grossly optimistic.

Policymakers from the Basel Committee to the U.S. Congress have determined that this must not happen again. Large banks need the capital strength to stand on their own. The Collins Amendment assures that whatever advances in risk modeling may come to pass, they will not be used to allow the largest banks to operate with less capital than our nation's Main Street banks.

The federal banking agencies currently have out for comment a Notice of Proposed Rulemaking to implement Section 171 by replacing the transitional floor provisions of the Advanced Approach with a permanent floor equal to the capital requirements computed under the agencies' general risk-based capital requirements. The proposed rule would also amend the general risk-based capital rules in way designed to give additional flexibility to the FRB in crafting capital requirements for designated nonbank SIFIs.

The Collins Amendment, moreover, does more than this. While providing significant grandfathering and exemptions for smaller banking organizations, the amendment also mandates that the holding company structure for larger organizations not be used to weaken consolidated capital below levels permitted for insured banks. That aspect of the Collins Amendment, which ensures that bank holding companies will serve as a source of strength for their insured banks, will be addressed in a subsequent rulemaking.

The Dodd-Frank Act also required regulators to eliminate reliance on credit ratings in our regulations. As you know, our regulatory capital rules and Basel II currently rely extensively on credit ratings. Last year, the banking agencies issued an Advance Notice of Proposed Rulemaking seeking industry comment on how we might design an alternative standard of credit worthiness. Unfortunately, the comments we received, for the most part, lacked substantive suggestions on how to approach this question. While we have removed any reliance on credit ratings in our assessment regulation, developing an alternative standard of creditworthiness for regulatory capital purposes is proving more challenging. The use of credit ratings for regulatory capital covers a much wider range of exposures; we cannot rely on non-public information, and the alternative standard should be usable by banks of all sizes. We are actively exploring a number of alternatives for dealing with this problem.

Separately and parallel to the Dodd-Frank Act rulemakings, the banking agencies are also developing rules to implement Basel III proposals for raising the quality and quantity of regulatory capital and setting new liquidity standards. The agencies issued a Notice of Proposed Rulemaking in January that proposes to implement the Basel Committee's 2009 revisions to the Market Risk Rule. We expect to issue a Notice of Proposed Rulemaking that will seek comment on our plans to implement Basel III later this year.

Reforming Asset-backed Securitization

The housing bust and the financial crisis arose from a historic breakdown in U.S. mortgage markets. While emergency policies enacted at the height of the crisis have helped to stabilize the financial system and plant the seeds for recovery, mortgage markets remain deeply mired in credit distress and private securitization markets remain largely frozen. Moreover, serious weaknesses identified with mortgage servicing and foreclosure are now introducing further uncertainty into an already fragile market.

It is clear that the mortgage underwriting practices that led to the crisis, which frequently included loans with low or no documentation in addition to other risk factors such as impaired credit histories or high loan-to-value ratios, must be significantly strengthened. To this point, this has largely been accomplished through the heightened risk aversion of lenders, who have significantly tightened standards, and investors, who have largely shunned private securitization deals. Going forward, however, risk aversion will inevitably decline and there will be a need to ensure that lending standards do not revert to the risky practices that led to the last crisis.

In the case of portfolio lenders, underwriting policies are subject to scrutiny by federal and state regulators. While regulators apply standards of safe and sound lending, they typically do not take the form of pre-specified guidelines for the structure or underwriting of the loans. For these portfolio lenders, the full retention of credit risk by the originating institution tends to act as a check on the incentive to take risks. Provided that the institution is otherwise well capitalized, well run, and well regulated, the owners and managers of the institution will bear most of the consequences for risky lending practices. By contrast, the crisis has illustrated how the mortgage securitization process is somewhat more vulnerable to the misalignment of incentives for originators and securities issuers to limit risk taking, because so much of the credit risk is passed along to investors who may not exercise due diligence over loan quality.

The excessive risk-taking inherent in the originate-to-distribute model of lending and securitization was specifically addressed in the Dodd-Frank Act by two related provisions. One provision, under Section 941 of the Act, mandates that the FSOC agencies write rules that require the securitizers (and, in certain circumstances, originators) of asset-backed securities to retain not less than 5 percent of the credit risk of those securities. The purpose of this provision is to encourage more careful lending behavior by preventing securitizers from avoiding the consequences of their risk-taking. Section 941 also mandates that the agencies define standards for Qualifying Residential Mortgages (QRMs) that will be exempt from risk retention when they are securitized. An interagency committee is working to define both the mechanism for risk retention and standards for QRMs.

Defining an effective risk retention mechanism and QRM requirements are somewhat complex tasks that have required extensive deliberation among the agencies. Because securitization structures and the compensation of securitizers can take many alternate forms, it is important that the rule be structured in a way that will minimize the ability of issuers to circumvent its intent. While we continue to work to move these rules forward without delay, we are also determined to get them right the first time. The confidence of the marketplace in these rules may well determine the extent to which private securitization will return in the wake of the crisis.

Long-term confidence in the securitization process cannot be restored unless the misalignment of servicing incentives that contributed to the present crisis is also addressed through these rules. There is ample research showing that servicing practices are critically important to mortgage performance and risk.2 Regulators must use both their existing authorities and the new authorities granted under the Dodd-Frank Act to establish standards for future securitizations to help assure that, as the private securitization market returns, incentives for loss mitigation and value maximization in mortgage servicing are appropriately aligned.

The FDIC took a significant step in this regard when updating our rules for safe harbor protection with regard to the treatment of securitized assets in failed bank receiverships. Our final rule, approved in September, established standards for loan level disclosure, loan documentation, compensation and oversight of servicers. It includes incentives to assure that loans are made and managed in a way that achieves sustainable lending and maximizes value for all investors. There is already evidence of market acceptance of these guidelines in the $1.2 billion securitization issue by Ally Bank earlier this month, which fully conformed to the FDIC safe harbor rules for risk retention.

In short, the desired effect of the risk retention and QRM rules will be to give both loan underwriting and administration and loan servicing much larger roles in credit risk management. Lenders and regulators need to embrace the lessons learned from this crisis and establish a prudential framework for extending credit and servicing loans on a sounder basis. Servicing provisions that should be part of the QRM rule include disclosure of ownership interests in second-liens by servicers of a first mortgage and appropriate compensation incentives.

Better alignment of economic incentives in the securitization process will not only address key safety-and-soundness and investor concerns, but will also provide a stronger foundation for the new Consumer Financial Protection Bureau (CFPB) as it works to improve consumer protections for troubled borrowers in all products and by all servicers.

Additional Implementation Activities

While we have focused on the important ongoing reforms where the Dodd-Frank Act assigned a significant role to the FDIC, we have been pleased to work closely with the other regulators on several other critical aspects of the Act's implementation.

Earlier this month, the FDIC Board approved a draft interagency rule to implement Section 956 of the Dodd-Frank Act, which sets forth rules and procedures governing the awarding of incentive compensation in covered financial institutions. Implementing this section will help address a key safety-and-soundness issue that contributed to the recent financial crisis – namely, that poorly designed compensation structures and poor corporate governance can misalign incentives and induce excessive risk taking within financial organizations. The proposed rule is proportionate to the size and complexity of individual banks and does not apply to banks with less than $1 billion in assets. For the largest firms, those with over $50 billion in assets, the proposal requires deferral of a significant portion of the incentive compensation of identified executive officers for at least three years and board-level identification and approval of the incentive compensation of employees who can expose the firm to material loss.

Another important reform under the Dodd-Frank Act is the Volcker Rule, which prohibits proprietary trading and acquisition of an interest in hedge or private equity funds by IDIs. The FSOC issued its required study of proprietary trading in January of this year, and joint rules implementing the prohibition on such trading are due by October of this year. The federal banking agencies will be working together, with the FSOC coordinating, to issue a final rule by the statutory deadline.

In addition to these rulemakings, the FDIC has a number of other implementation responsibilities, including new reporting requirements and mandated studies. Among the latter is a study to evaluate the definitions of core and brokered deposits. As part of this study, we are hosting a roundtable discussion next month to gather valuable input from bankers, deposit brokers, and other market participants.

Preparation for Additional Responsibilities

The FDIC Board of Directors has recently undertaken a number of organizational changes to ensure the effective implementation of our responsibilities pursuant to the Dodd-Frank Act.

As I previously described in my September testimony before this Committee, the FDIC has made organizational changes in order to enhance our ability to carry out the Dodd-Frank Act responsibilities, as well as our core responsibilities for risk management supervision of insured depository institutions and consumer protection. The new Office of Complex Financial Institutions (OCFI) will be responsible for orderly liquidation authority, resolution plans, and monitoring risks in the SIFIs. The Division of Depositor and Consumer Protection will focus on the FDIC's many responsibilities for depositor and consumer protection.

In response to the Committee's request for an update about the transfer of employees to the new CFPB, I can report that we continue to work with the Treasury Department and the other banking agencies on the transfer process of employees to ensure a smooth transition. The number of FDIC employees detailed to the CFPB will necessarily be limited since the FDIC retains the compliance examination and enforcement responsibilities for most FDIC-regulated institutions with $10 billion or less in assets. Nonetheless, there are currently seven FDIC employees being detailed to the Treasury Department and the CFPB to work on a wide range of examination and legal issues that will confront the CFPB at its inception. There are also several more employees who have expressed interest in assisting the CFPB and are being evaluated by the Treasury Department. Recognizing that FDIC employees have developed expertise, skills, and experience in a number of areas of benefit to the CFPB, our expectation has been that a number of employees would actively seek an opportunity to assist the CFPB in its earliest stages, or on a more permanent basis.

Finally, consistent with the requirements of Section 342, the FDIC in January established a new Office of Minority and Women Inclusion (OMWI). Transferring the existing responsibilities and employees of the FDIC's former Office of Diversity and Economic Opportunity into the new OMWI has allowed for a smooth transition and no disruption in the FDIC's ongoing diversity and outreach efforts. Our plans for the OMWI include the addition of a new Senior Deputy Director and other staff as needed to ensure that the new responsibilities under Section 342 are carried out, as well as an OMWI Steering Committee which will promote coordination and awareness of OMWI responsibilities across the FDIC and ensure that they are managed in the most effective manner.

Regulatory Effectiveness

The FDIC recognizes that while the changes required by the Dodd-Frank Act are necessary to establish clear rules that will ensure a stable financial system, these changes must be implemented in a targeted manner to avoid unnecessary regulatory burden. We are working on a number of fronts to achieve that necessary balance. An example is the recent rule to change the deposit insurance assessment system, which relied as much as possible on the current regulatory reporting structure. Although some additional reporting will be required for some institutions, most institutions should see their reporting burden unchanged or slightly reduced as some items that were previously required will no longer be reported.

At the January 20 meeting of the FDIC's Advisory Committee on Community Banking, we engaged the members – mostly bankers themselves – in a full and frank discussion of other ways to ease the regulatory burden on small institutions. Among the ideas discussed at that meeting were:

Conduct a community bank impact analysis with respect to implementation of regulations under the Dodd-Frank Act,
Identify which questionnaires and reports can be streamlined through automation,
Review ways to reduce the total amount of reporting required of banks,
Impose a moratorium on changes to reporting obligations until some level of regulatory burden reduction has been achieved,
Develop an approach to bank reporting requirements that is meaningful and focuses on where the risks are increasing, and
Ensure that community banks are aware that senior FDIC officials are available and interested in receiving their feedback regarding our regulatory and supervisory process.
The FDIC is particularly interested in finding ways to eliminate unnecessary regulatory burden on community banks, whose balance sheets are much less complicated than those of the larger banks. Our goal is to facilitate more effective and targeted regulatory compliance. To this end, we have established as a corporate performance goal for the first quarter of 2011 to modify the content of our Financial Institution Letters (FILs) -- the vehicle used to alert banks to any regulatory changes or guidance -- so that every FIL issued will include a section making clear the applicability to smaller institutions (under $1 billion). In addition, by June 30 we plan to complete a review of all of our recurring questionnaires and information requests to the industry and to develop recommendations to improve the efficiency and ease of use and a plan to implement these changes.

The FDIC has challenged its staff to find additional ways of translating some of these ideas into action. This includes launching an intensive review of existing reporting requirements to identify areas for streamlining. We have also initiated a process whereby, as part of every risk management examination, we will solicit the views of the institution on aspects of the regulatory and supervisory process that may be adversely affecting credit availability.

Above all, it is important to emphasize to small and mid-sized financial institutions that the Dodd-Frank reforms are not intended to impede their ability to compete in the marketplace. On the contrary, we expect that these reforms will do much to restore competitive balance to the marketplace by restoring market discipline and appropriate regulatory oversight to systemically important financial companies, many of which received direct government assistance in the recent crisis.


In implementing the Dodd-Frank Act, it is important that we continue to move forward with dispatch to remove unnecessary regulatory uncertainties faced by the market and the industry. In passing the Act, the Congress clearly recognized the need for a sounder regulatory framework within which banks and other financial companies could operate under rules that would constrain the excessive risk taking that caused such catastrophic losses to our financial system and our economy during the financial crisis.

In the wake of the passage of the Act, it is essential that this implementation process move forward both promptly and deliberately, in a manner that resolves uncertainty as to what the new framework will be and that promotes long-term confidence in the transparency and stability of our financial system. Throughout this process, regulators must maintain a clear view of the costs of regulation – particularly to the vital community banking sector – while also never forgetting the enormous economic costs of the inadequate regulatory framework that allowed the crisis to occur in the first place. We have a clear obligation to members of the public who have suffered the greatest losses as a result of the crisis to prevent such an episode from ever recurring again.

Thank you for the opportunity to testify.

Sunday, February 13, 2011


Fraud is a common crime in the world of finance. The excerpt from the SEC website below covers a case where a company allegedly had officers that misled investors, misused funds and obtained fraudulent loans to cover the misuse of funds:

“Washington, D.C., Jan. 20, 2011 — The Securities and Exchange Commission today charged three affiliated New York-based investment firms and four former senior officers with fraud, misuse of client assets, and other securities laws violations involving their $66 million advisory business.

The SEC alleges that the operation’s investment adviser William Landberg and president Kevin Kramer — through the firms West End Financial Advisors LLC (WEFA), West End Capital Management LLC (WECM), and Sentinel Investment Management Corporation — misled investors into believing that their money was in stable, safe investments designed to provide steady streams of income. However, in reality West End faced deepening financial problems stemming from Landberg’s failed investment strategies. When starved for cash to meet obligations of the West End funds or for his personal needs, Landberg misused investor assets, fraudulently obtained more than $8.5 million from a bank, and used millions of dollars from an interest reserve account for unauthorized purposes.
The SEC also charged West End’s chief financial officer Steven Gould and controller Janis Barsuk for their roles in the scheme.
“The investment advisers here grossly abused the trust of their clients,” said George S. Canellos, Director of the SEC’s New York Regional Office. “They misappropriated and commingled their clients’ assets and sustained the illusion of a viable and successful business through a range of false representations.”
David Rosenfeld, Associate Director of the SEC’s New York Regional Office, added, “West End raised millions from investors by touting false positive returns while concealing fraudulent bank loans, cash flow problems, and the misappropriation of investor assets.”
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, the misconduct occurred from at least January 2008 to May 2009. The SEC alleges that Landberg used substantial amounts of fraudulently-obtained bank loans to make distributions to certain West End fund investors, thereby sustaining the illusion that West End’s investments were performing well. During the same period, Landberg also misappropriated at least $1.5 million for himself and his family. Landberg’s wife Louise Crandall and their family partnership are named as relief defendants in the SEC’s complaint.
The SEC further alleges that Gould and Barsuk knew, or were reckless in not knowing, that Landberg was defrauding a bank that provided loans to a West End fund by misusing funds in a related interest reserve account. Both officers nevertheless participated in the fraud by facilitating Landberg’s misappropriations from that account. The SEC alleges that Gould conceived and used improper accounting methods to conceal aspects of the fraud, and he issued account statements to investors showing false investment returns. Barsuk facilitated Landberg’s uses of investor money to cover his personal obligations. Similarly, Kramer knew, or was reckless in not knowing, that West End faced severe financial problems and had difficulty obtaining sufficient financing to sustain its investment strategy. Nevertheless, Kramer failed to disclose those material facts to investors as he continued to market the funds to new and existing investors through April 2009.
The SEC charged Landberg, Kramer, Gould, WEFA, WECM, and Sentinel with violations of the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. In addition, Landberg, WEFA, WECM, and Sentinel are charged with violating the antifraud provisions of the Investment Advisers Act of 1940. Kramer, Gould, and Barsuk are charged with aiding and abetting violations of the Advisers Act. Barsuk is also charged with aiding and abetting violations of the antifraud provisions of the Exchange Act. The SEC seeks to enjoin each defendant from future violations of the securities laws as well as monetary relief, the imposition of an independent monitor, and certain other sanctions.
The SEC acknowledges the assistance of the U.S. Attorney for the Southern District of New York, the Federal Bureau of Investigation, and the U.S. Commodity Futures Trading Commission.”

It should become clear that a lot of people who run financial organizations may not have their clients best interest at heart. It is not just corruption that makes organizations and individuals unfit in carrying out fiduciary obligations to their clients but, many times incompetence not fraud is the real problem.

Thursday, February 10, 2011


Many people are still afraid of investing in the equities markets. It seems that many people believe that the securities market is really just a big fraud with certain traders with inside information making millions of dollars off the sinking investment accounts of hard working Americans. The following case alleges a grand conspiracy to trade on inside information which was not available to the general public:

“ Washington, D.C., Feb. 8, 2011 — The Securities and Exchange Commission today charged a New York-based hedge fund and four hedge fund portfolio managers and analysts who illegally traded on confidential information obtained from technology company employees moonlighting as expert network consultants. The scheme netted more than $30 million from trades based on material, nonpublic information about such companies as AMD, Seagate Technology, Western Digital, Fairchild Semiconductor, and Marvell

The charges are the first against traders in the SEC’s ongoing investigation of insider trading involving expert networks. The SEC filed its initial charges in the case last week against technology company employees who illegally tipped hedge funds and other investors with material nonpublic information about their companies in return for hundreds of thousands of dollars in sham consulting fees.
In its amended complaint filed today in federal court in Manhattan, the SEC alleges that four hedge fund portfolio managers and analysts received illegal tips from the expert network consultants and then caused their hedge funds to trade on the inside information.
“It is illegal for company insiders who moonlight as consultants to sell confidential information about their companies to traders, and it is equally illegal to buy that corruptly obtained information and trade on it,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “Instead of competing on a level playing field with other investors, these hedge fund managers sought to illegally trade today on what others would not learn until tomorrow.”
The SEC’s ongoing investigation is focusing on the activities of expert networks that purportedly provide professional investment research to their clients. While it is legal to obtain expert advice and analysis through expert networking arrangements, it is illegal to trade on material nonpublic information obtained in violation of a duty to keep that information confidential.
The technology company insiders who tipped the confidential information were expert network consultants to the firm Primary Global Research LLC (PGR).
The SEC’s amended complaint alleges:
Samir Barai of New York, N.Y., the founder and portfolio manager of Barai Capital Management, obtained inside information about several technology firms from company insiders, and then traded on the inside information on behalf of Barai Capital.
Jason Pflaum of New York, N.Y., a former technology analyst at Barai Capital Management, obtained inside information about technology companies and shared it with Barai. After Pflaum shared the confidential information with him, Barai used it to illegally trade on behalf of Barai Capital.
Noah Freeman of Boston, Mass., a former managing director at a Boston-based hedge fund, obtained inside information regarding Marvell and shared it with Donald Longueuil of New York, N.Y., a former managing director at a Connecticut-based hedge fund. Longueuil caused his hedge fund to trade on the inside information. Freeman also obtained inside information about another technology company and caused his hedge fund to trade on the nonpublic information.
The SEC’s amended complaint charges each of the defendants with violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and additionally charges Barai, Pflaum, Freeman and Longueuil with aiding and abetting others’ violations of Section 10(b) and Rule 10b-5 thereunder. The complaint also charges Barai, Pflaum and Barai Capital with violations of Section 17(a) of the Securities Act of 1933. The complaint seeks a final judgment permanently enjoining the defendants from future violations of the above provisions of the federal securities laws, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and ordering them to pay financial penalties.”

Divining what is going to happen in the future is a key to financial success. If you were to invest in a company that makes horse shoes because you believe horses will replace automobiles in the near future then you might be making a bad investment. On the other hand, if you invest in a technology company because you know of a big contract that company was about to receive then you might just be making a good investment. Of course if you invest in the aforementioned company when only corporate officials knew about the contract then you will make lots of money with virtually no risk.

Sunday, February 6, 2011


Many times businesses will pay key employees who leave the business consulting fees for help in solving difficult problems. In the following case the SEC alleges that these fees were paid as perks and were not properly disclosed to investors. Please read the following excerpt from the SEC web site for more details:

"Washington, D.C., Jan. 12, 2011 — The Securities and Exchange Commission today charged a Kansas-based company that manages government websites and four current or former company executives with failing to disclose to investors more than $1.18 million in perks paid to the former CEO over a six-year period.

The SEC alleges that NIC Inc.'s public filings failed to disclose that the company footed the bill for wide-ranging perks enjoyed by former CEO Jeffrey Fraser, his girlfriend, and his family — including vacations, computers, and day-to-day personal living expenses. NIC failed to disclose that it paid thousands of dollars per month for Fraser to live in a Wyoming ski lodge and commute by private aircraft to his office at NIC's Kansas headquarters. Meanwhile, NIC and its executives falsely represented to investors that Fraser worked virtually for free from 2002 to 2005, and then continued to materially understate the perks that Fraser received in 2006 and 2007. NIC's related party disclosures for 2002 through 2005 also were misleading.

NIC, Fraser, current CEO Harry Herington and former CFO Eric Bur agreed to pay a combined $2.8 million to settle the SEC's charges against them without admitting or denying the allegations. The SEC's litigation continues against NIC's current CFO Stephen Kovzan.

Additional Materials
SEC Complaint vs. NIC, Fraser, Herington, and Bur
SEC Complaint vs. Kovzan
Litigation Release No. 21809

Public disclosure of executive perks helps investors evaluate whether corporate assets are being used wisely or squandered," said Antonia Chion, Associate Director of the SEC's Division of Enforcement. "NIC and its executives did not comply with their disclosure obligations and the company's internal controls by paying Fraser's personal expenses while telling shareholders that Fraser was working for little or no compensation."

Among the alleged undisclosed perks for Fraser outlined in the SEC's complaints filed in federal court in the District of Kansas:

More than $4,000 per month to live in a ski lodge in Wyoming.
Costs for Fraser to commute by private aircraft from his home in Wyoming to his office at NIC's Kansas headquarters.
Monthly cash payments for purported rent for a Kansas house owned by an entity Fraser set up and controlled.
Vacations for Fraser, his girlfriend and his family.
Fraser's flight training, hunting, skiing, spa and health club expenses.
Computers and electronics for Fraser and his family.
A leased Lexus SUV.
Other day-to-day living expenses for Fraser such as groceries, liquor, tobacco, nutritional supplements, and clothing.
The SEC's complaints allege that Fraser, who did not have a personal credit card, routinely charged living expenses on NIC credit cards and submitted expense vouchers falsely claiming personal items were business-related in order to have NIC pay for these personal expenses. Fraser also sought reimbursement for certain expenses he had not incurred.

The SEC alleges that Kovzan, who was then the company's Chief Accounting Officer, authorized NIC's payment of Fraser's personal expenses, circumventing NIC's internal controls and policies that required the CEO to document the business purpose for his expenses. Kovzan knew, or was reckless in not knowing, that Fraser's expenses were falsely characterized as business expenses in NIC's books and records. Kovzan prepared, reviewed or signed NIC's proxy statements, annual reports and registration statements that materially underreported Fraser's compensation, and Kovzan made false representations to NIC's independent auditors.

The SEC alleges that Bur permitted NIC to pay the expenses that Fraser submitted on his expense vouchers even though he was informed that Fraser was not submitting the required documentation. A finance department employee raised concerns to Bur that some of Fraser's expenses were not business-related. Bur was aware of the SEC's rules requiring the disclosure of executive perks, yet he reviewed, signed or certified NIC's public filings that failed to disclose Fraser's perks.

The SEC alleges that Herington, who was then NIC's Chief Operating Officer, was informed of problems with Fraser's expense reporting and failed to adequately address them. Herington received information showing that NIC was paying for some of Fraser's personal expenses, yet he reviewed or signed NIC's public filings that failed to disclose Fraser's perks.

According to the SEC's complaints, NIC failed to correct Fraser's expense reporting problems even after the finance department employee warned in 2006 of the risk of possible income tax fraud charges, a whistleblower complained to NIC and the company learned of the SEC's investigation of this matter in mid-2007. The majority of Fraser's perks were not repaid or disclosed, and NIC continued to make misleading public filings. NIC failed to disclose to investors in public filings that an internal review concluded Fraser had intentionally misclassified his expenses.

NIC agreed to settle the SEC's charges by paying a $500,000 penalty and hiring an independent consultant to recommend, if appropriate, improvements to policies, procedures, controls, and training relating to payment of expenses, handling of whistleblower complaints, and related party transactions. NIC consented to a final judgment enjoining it from violating Sections 17(a)(2) and (3) of the Securities Act of 1933; Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a) of the Securities Exchange Act of 1934, and Exchange Act Rules 12b-20, 13a-1, 13a-11, 14a-3, and 14a-9.

Fraser agreed to pay $1,184,246 in disgorgement, $358,844 in prejudgment interest, and a $500,000 penalty, and consented to an order barring him from serving as an officer or director of a public company. Fraser consented to a final judgment enjoining him from violating Section 17(a) of the Securities Act, Sections 10(b), 13(b)(5), and 14(a) of the Exchange Act, and Exchange Act Rules 10b-5, 13a-14, 13b2-1, 13b2-2, 14a-3, and 14a-9, and from aiding and abetting NIC's violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Exchange Act Rules 12b-20 and 13a-1.

Herington agreed to pay a $200,000 penalty and consented to a final judgment enjoining him from violating Sections 17(a)(2) and (3) of the Securities Act and Section 13(b)(5) of the Exchange Act, and aiding and abetting NIC's violations of Sections 13(a) and 14(a) of the Exchange Act, and Exchange Act Rules 12b-20, 13a-1, 14a-3, and 14a-9.

Bur agreed to pay a $75,000 penalty and consented to a final judgment enjoining him from violating Exchange Act Rules 13a-14 and 13b2-1, and aiding and abetting NIC's violations of Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a), and Exchange Act Rules 12b-20, 13a-1, 14a-3, and 14a-9. In addition, Bur agreed to resolve an anticipated administrative proceeding by consenting to an SEC order prohibiting him from appearing or practicing before the SEC as an accountant with a right to reapply after one year.

Kovzan is charged with violating Section 17(a) of the Securities Act, Section 10(b) and 13(b)(5) of the Exchange Act and Exchange Act Rules 10b-5, 13b2-1, and 13b2-2; and aiding and abetting NIC's violations of Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), and 14(a) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1, 14a-3, and 14a-9. The SEC's complaint seeks a permanent injunction, disgorgement, penalties, prejudgment interest, and an officer-and-director bar against Kovzan, against whom the SEC's charges are still pending."

The above case is one in which the SEC really got tough on alleged inaccurate disclosures. Trying to pay people off the books is common in business although usually the IRS and not the SEC end up investigating these matters.


Many employees moonlight in order to make more money for themselves and their families. However, the SEC takes a dim view of people who moonlight as informational gatherers for certain securities trading operations while working for the companies they are gathering information on. The following SEC web site excerpt explains charges brought against such consultants:

“Washington, D.C., Feb. 3, 2011 — The Securities and Exchange Commission today charged six expert network consultants and employees with insider trading for illegally tipping hedge funds and other investors to generate nearly $6 million in illicit gains. The charges stem from the SEC's ongoing investigation into the activities of expert networks that purport to provide professional investment research to their clients.
While it's legal to obtain expert advice and analysis through expert networking arrangements, it's illegal to trade on material nonpublic information obtained in violation of a duty to keep that information confidential.

The SEC alleges that four technology company employees, while moonlighting as consultants or "experts" to Primary Global Research LLC (PGR) without the knowledge of their employers, abused their access to inside information about such technology companies as AMD, Apple, Dell, Flextronics, and Marvell. The consultants received hundreds of thousands of dollars in purported consulting fees from PGR for sharing the inside information with PGR employees and clients. The SEC charges two PGR employees for facilitating the transfer of inside information from PGR consultants to PGR clients.

"Company executives and other insiders moonlighting as consultants to hedge funds cannot blatantly peddle their company's confidential information for personal gain," said Robert Khuzami, Director of the SEC's Division of Enforcement. "These PGR consultants and employees schemed to facilitate widespread and repeated insider trading by several hedge funds and other investment professionals."
The SEC's complaint filed in federal court in Manhattan alleges that PGR consultants Mark Anthony Longoria, Daniel L. DeVore, Winifred Jiau and Walter Shimoon obtained material, non-public confidential information about quarterly earnings and performance data and shared that information with hedge funds and other clients of PGR who traded on the inside information. PGR employees Bob Nguyen and James Fleishman acted as conduits by receiving inside information from PGR consultants and passing that information directly to PGR clients.
The SEC alleges that:
Longoria, a manager in AMD's desktop global operations group, had access to sales figures for AMD's various operational units. He also obtained from a colleague AMD's financial results, including "top line" quarterly revenue and profit margin information prior to their public announcement. Longoria shared this inside information with multiple PGR clients who, in turn, traded in AMD securities. From January 2008 to March 2010, Longoria received more than $130,000 for talking to PGR and its clients.
DeVore, a Global Supply Manager at Dell, was privy to confidential information about Dell's internal sales forecasts as well as information about the pricing and volume of Dell's purchases from its suppliers. DeVore regularly provided PGR and PGR clients with this inside information so it could be used to trade securities. From 2008 to 2010, DeVore received approximately $145,000 for talking to PGR and its clients.
Shimoon, a Vice President of Business Development for Components in the Americas at Flextronics, was privy to confidential information concerning Flextronics and its customers including Apple, Omnivision, and Research in Motion. Shimoon provided this inside information to PGR and PGR clients so it could be used to trade securities. From September 2008 to June 2010, Shimoon received approximately $13,600 for talking to PGR and its clients.
Jiau was a "private" PGR expert, meaning that PGR made her available only to a small number of PGR clients. Jiau, who had contacts at Marvell and other technology companies, regularly provided certain PGR clients with inside information regarding Marvell and other technology companies. Jiau provided company-specific financial results that companies had not yet announced publicly. From September 2006 to December 2008, Jiau received more than $200,000 for her consultations with select PGR clients.
Nguyen and Fleishman received, directly or indirectly, specific inside information from PGR consultants and passed this inside information on, directly or indirectly, to PGR clients.

The SEC's complaint charges each of the defendants with violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and, additionally, charges Fleishman, Nguyen and Jiau with aiding and abetting others' violations of Section 10(b) of the Exchange Act and SEC Rule 10b-5. The complaint also charges Longoria and DeVore with violations of Section 17(a) of the Securities Act of 1933. The complaint seeks a final judgment permanently enjoining the defendants from future violations of the above provisions of the federal securities laws, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and ordering them to pay financial penalties. The complaint also seeks to permanently prohibit Longoria, Shimoon and DeVore from acting as an officer or director of any registered public company.”

Thursday, February 3, 2011


The following excerpt fro the SEC website discusses some of the proposed rules for security based swaps. It is a complicated document which has proposals to regulate some extremely complicated securities transactions.

"Washington, D.C., Feb. 2, 2011 — The Securities and Exchange Commission today voted unanimously to propose rules defining security-based swap execution facilities (SEFs) and establishing their registration requirements, as well as their duties and core principles.

The Dodd-Frank Wall Street Reform and Consumer Protection Act authorized the SEC to implement a regulatory framework for security-based swaps, which currently trade exclusively in the over-the-counter markets with little transparency or oversight.

The Dodd-Frank Act sought to move the trading of security-based swaps onto regulated trading markets, and therefore created security-based SEFs as a new category of market intended to provide more transparency and reduce systemic risk.

"Our objective here is to provide a framework that allows the security-based swap market to continue to develop in a more transparent, efficient, and competitive manner," said SEC Chairman Mary L. Schapiro. "This is an important and complex undertaking that adds a significant new component to the regulatory framework for over-the-counter derivatives."

The Commission's proposed rules:

Interpret the definition of "security-based SEFs" as set forth in Dodd-Frank.
Set out the registration requirements for security-based SEFs.
Implement the 14 core principles for security-based SEFs that the legislation outlined.
Establish the process for security-based SEFs to file rule changes and new products with the SEC.
Exempt security-based SEFs from the definition of "exchange" and from most regulation as a broker.
Public comments on the rule proposal should be received by the Commission by April 4, 2011.

Security-Based Swap Execution Facilities
Division of Authority
The Dodd-Frank Act established a comprehensive framework for regulating the over-the-counter swaps markets. In the process, it divided regulatory authority over swaps between the SEC and the Commodity Futures Trading Commission (CFTC).

Among other things, Title VII of the Act authorizes the Commission to regulate "security-based" swaps and directs it to engage in rulemaking to shape the regulatory framework for such products.

Security-Based Swaps and Derivatives
A derivative is a financial instrument or contract whose value is 'derived' from an underlying asset, such as a commodity, bond or equity security. The instruments provide a mechanism for the transfer of market risk or credit risk between two counterparties. Derivatives are incredibly flexible products that can be engineered to achieve almost any financial purpose.

For instance, a derivative can be used by two parties who have a differing view on whether a particular financial asset price will go up or down or whether an event will happen in the future. With derivatives, market participants can track or replicate the economics of holding or shorting an underlying asset, such as a security, thereby enabling participants to gain a desired market or credit exposure without actually holding the underlying asset.

A swap is a type of derivative contract that is traded in the over-the-counter market. One type of swap is a "security-based swap", over which the SEC has authority. Such swaps are broadly defined as swaps based on (1) a single security, (2) a loan, (3) a narrow-based group or index of securities or (4) events relating to a single issuer or issuers of securities in a narrow-based security index.

As an example, in a credit default swap transaction, the party who is seeking to hedge against a loss from a particular credit event, say the default of a bond, is referred to as the credit protection buyer. The credit protection buyer will receive a payment to compensate for its loss in the event that the default occurs. A credit protection seller is the counter-party.

The current market for security-based swaps, which trade over-the-counter, is opaque, with swap dealers acting as liquidity providers, and institutional investors and investment managers acting as liquidity takers. Compared to the exchange-traded markets, there is little pre-trade transparency (the ability to see trading interest prior to a trade being executed) or post-trade transparency (the ability to see transaction information after a trade is executed).

Security-Based Swap Execution Facilities
To ensure greater transparency in the security-based swaps market and reduce systemic risk, the Dodd-Frank Act sought to move the trading of security-based swaps onto regulated trading markets.

As such, Dodd-Frank requires security-based swap transactions that are required to be cleared through a clearing agency to be executed on an exchange or on a new trading system called a security-based swap execution facility. The Dodd-Frank Act, however, states that the transaction need not be executed on a security-based SEF or exchange if no security-based SEF or exchange makes the security-based swap "available to trade."

This newly created entity is defined under the Dodd-Frank Act in relevant part as "a trading system or platform in which multiple participants have the ability to execute or trade security-based swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce. . . ."

The Core Principles
The Dodd-Frank Act further requires security-based SEFs to be registered with the Commission and specifies that such a registered security-based SEF, among other things, must comply with 14 core principles.

The core principles would require these security-based SEFs to:

Comply with the core principles and any requirement the Commission may impose.

Establish and enforce rules governing, among other things, the terms and conditions of security-based swaps traded on their markets; any limitation on access to the facility; trading, trade processing and participation; and the operation of the facility.

Permit trading only in security-based swaps that are not readily susceptible to manipulation.

Establish rules for entering, executing and processing trades and to monitor trading to prevent manipulation, price distortion, and disruptions through surveillance, including real-time trade monitoring and trade reconstructions.

Have systems to capture information necessary to carry out its regulatory responsibilities and share the collected information with the Commission upon request.

Have rules and procedures to ensure the financial integrity of security-based swaps entered on or through the facility, including the clearance and settlement of security-based swaps.

Have rules allowing it to exercise emergency authority, in consultation with the Commission, including the authority to suspend or curtail trading or liquidate or transfer open positions in any security-based swap.

Make public post-trade information (including price, trading volume, and other trading data) in a timely manner to the extent prescribed by the Commission.

Maintain records of activity relating to the facility's business, including a complete audit, for a period of five years and to report such information to the Commission, upon request.

Not take any action that imposes any material anticompetitive burden on trading or clearing.

Have rules designed to minimize and resolve conflicts of interest.

Have sufficient financial, operational, and managerial resources to conduct its operations and fulfill its regulatory responsibilities.

Establish a risk analysis and oversight program to identify and minimize sources of operational risk and to establish emergency procedures, backup facilities, and a disaster recovery plan, and to maintain such efforts, including through periodic tests of such resources.

Have a chief compliance officer that performs certain duties relating to the oversight and compliance monitoring of the security-based SEF and that submits annual compliance and financial reports to the Commission.

The Proposal
The Commission proposed a series of rules related to security-based SEFs.

Attributes of a Security-Based SEF
The Commission proposed an interpretation of the definition of a security-based SEF. Under its proposed interpretation, a security-based SEF would be a system or platform that allows more than one participant to interact with the trading interest of more than one other participant on the system or platform.

Various types of trading platforms potentially could meet the proposed interpretation. For example, a limit order book system (i.e., a system or platform that allows a participant to submit executable bids and offers for display to all other participants) could meet the proposed interpretation.

Also, the proposed interpretation would accommodate a "request for quote" system that provides a participant with the ability to send a single request for a quote to all participants providing liquidity on that system, or to choose to send the request to fewer than all such participants.

The security-based SEF would not be able to limit the number of liquidity providing participants from whom a quote-requesting participant could request a quote on the SEF. However, the security-based SEF would be able to let the quote-requesting participant choose to send its request for a quote to less than all the liquidity-providing participants.

The security-based SEF also would have to provide a functionality that allows any participant the ability to make and display executable bids and offers accessible to all other participants on the security-based SEF, if the participant chooses to do so. Also, the security-based SEF would have to create and disseminate composite indicative quotes for all swaps that trade on the security-based SEF to all participants.

The Requirements for Registering SEFs
Under the proposed rules, security-based SEFs would be required to register with the Commission by filing a form, Form SB SEF. The SEF also would be required to update its filing when the information becomes inaccurate and file an amended form annually.

The proposed rules also would require that a security-based SEF:

File with the Commission proposed changes to its rules as well as the security-based swaps that it intends to trade.

Have rules to ensure compliance with the core principles outlined in the Dodd-Frank Act.

Have rules regarding access to, and the financial integrity of transactions on, the security-based SEF.

Put in place rules governing the procedures for trading on the security-based SEF.

Ensure the integrity of security-based SEF systems by having policies and procedures reasonably designed to ensure that its systems have adequate levels of capacity, resiliency, and security.

Make and keep certain books and records.

Have adequate resources to operate as a security-based SEF.

In addition, the proposal would exempt a security-based SEF from the definition of exchange and from most regulations as a broker.

Previous Related Rulemaking
This proposal coincides with rules the SEC proposed in December that would set out the way in which clearing agencies provide information to the SEC about security-based swaps that the clearing agencies plan to accept for clearing. This information is designed to aid the SEC in determining whether such security-based swaps should be required to be cleared.

In addition, under the Dodd-Frank Act, the SEC has engaged in several additional rulemakings related to the derivatives market:

Defining Security-Based Swap Terms: Proposed jointly with the Commodity Futures Trading Commission new rules that would further define a series of terms related to the security-based swaps market, including "swap dealer," "security-based swap dealer," "major swap participant," "major security-based swap participant" and "eligible contract participant."

Security-Based Swap Reporting: Proposed new rules entailing how security-based swap transactions should be reported and publicly disseminated.

Security-Based Swap Repositories: Proposed rules regarding the registration and regulation of security-based swap data repositories.

Security-Based Swap Fraud: Proposed a new rule to help prevent fraud, manipulation, and deception in connection with the offer, purchase or sale of any security-based swap as well as in connection with ongoing payments and deliveries under a security-based swap.

Security-Based Swap Conflicts: Proposed rules intended to mitigate conflicts of interest for security-based swap clearing agencies, security-based swap execution facilities, and national securities exchanges that post security-based swaps or make them available for trading.

Reporting of Pre-Enactment Security-Based Swaps: Adopted an interim rule requiring certain swaps dealers and other parties to report any security-based swaps entered into prior to the July 21 passage of the Dodd-Frank Act. This rule applies only to such swaps whose terms had not expired as of July 21.

Confirmation of Transactions: Proposed a rule governing the way in which certain security-based swap transactions are acknowledged and verified by the parties who enter into them.

What's Next
The proposal seeks public comment by April 4, 2011, on a broad range of issues relating to the proposed interpretation, exemptions, rules and form relating to security-based SEFs, including the costs and benefits associated with the proposal. After careful review of comments, the Commission will consider whether to adopt the proposal or modify it."

Hopefully, Security Based Swaps will become less of a vehicle for gamblers and more of a vehicle to help manage risk. Of course it would be nice if you could go long the stock market and make money holding a stock for decades like our grandfathers.
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