Whenever there are large sums of money involved financial companies will seem to always find a way to rig financial markets to the detriment of investors, tax payers and, customers. The case below is from the SEC web site. In this case the SEC alleges that UBS Financial Services Inc., committed fraud by bid-rigging in the municipal bond market:
“ Washington, D.C., May 4, 2011 — The Securities and Exchange Commission today charged UBS Financial Services Inc. (UBS) with fraudulently rigging at least 100 municipal bond reinvestment transactions in 36 states and generating millions of dollars in ill-gotten gains.
To settle the SEC’s charges, UBS has agreed to pay $47.2 million that will be returned to the affected municipalities. UBS and its affiliates also agreed to pay $113 million to settle parallel cases brought by other federal and state authorities.
When investors purchase municipal securities, the municipalities generally temporarily invest the proceeds of the sales in reinvestment products before the money is used for the intended purposes. Under relevant IRS regulations, the proceeds of tax-exempt municipal securities must generally be invested at fair market value. The most common way of establishing fair market value is through a competitive bidding process in which bidding agents search for the appropriate investment vehicle for a municipality.
The SEC alleges that during the 2000 to 2004 time period, UBS’s fraudulent practices and misrepresentations undermined the competitive bidding process and affected the prices that municipalities paid for the reinvestment products being bid on by the provider of the products. Its fraudulent conduct at the time also jeopardized the tax-exempt status of billions of dollars in municipal securities because the supposed competitive bidding process that establishes the fair market value of the investment was corrupted. The business unit involved in the misconduct closed in 2008 and its employees are no longer with the company.
According to the SEC’s complaint filed in U.S. District Court for the District of New Jersey, UBS played various roles in these tainted transactions. UBS illicitly won bids as a provider of reinvestment products, and also rigged bids for the benefit of other providers while acting as a bidding agent on behalf of municipalities. UBS at times additionally facilitated the payment of improper undisclosed amounts to other bidding agents. In each instance, UBS made fraudulent misrepresentations or omissions, thereby deceiving municipalities and their agents.
“Our complaint against UBS reads like a ‘how-to’ primer for bid-rigging and securities fraud,” said Elaine C. Greenberg, Chief of the SEC’s Municipal Securities and Public Pensions Unit. “They used secret arrangements and multiple roles to win business and defraud municipalities through the repeated use of illegal courtesy bids, last looks for favored bidders, and money to bidding agents disguised as swap payments.”
According to the SEC’s complaint, UBS as a bidding agent steered business through a variety of mechanisms to favored bidders acting as providers of reinvestment products. In some cases, UBS gave a favored provider information on competing bids in a practice known as “last looks.” In other instances, UBS deliberately obtained off-market ”courtesy” bids or arranged “set-ups” by obtaining purposefully non-competitive bids from others so that the favored provider would win the business. UBS also transmitted improper, undisclosed payments to favored bidding agents through interest rate swaps. In addition, UBS was favored to win bids with last looks and set-ups as a provider of reinvestment products.
In a related enforcement action, the SEC barred former UBS officer Mark Zaino from associating with any broker, dealer or investment adviser, based upon his guilty plea last year in a criminal case charging him with two counts of conspiracy and one count of wire fraud for engaging in misconduct in the competitive bidding process involving the investment of proceeds of tax-exempt municipal bonds. The Commission recognizes Zaino’s cooperation in the SEC’s investigation as well as investigations conducted by other law enforcement agencies.
Without admitting or denying the allegations in the SEC’s complaint, UBS has consented to the entry of a final judgment enjoining it from future violations of Section 15(c) of the Securities Exchange Act of 1934. UBS has agreed to pay a penalty of $32.5 million and disgorgement of $9,606,543 with prejudgment interest of $5,100,637. The settlement is subject to court approval.
This is the SEC’s second settlement with a major bank in an ongoing investigation into corruption in the municipal reinvestment industry. In December 2010, the SEC charged Banc of America Securities LLC (BAS) with securities fraud for similar conduct. In that matter, BAS agreed to pay more than $36 million in disgorgement and interest to settle the SEC’s charges, and paid an additional $101 million to other federal and state authorities for its misconduct.
The SEC thanks the Antitrust Division of the Department of Justice and the Federal Bureau of Investigation for their cooperation and assistance in this matter. The SEC is bringing this enforcement action in coordination with the Department of Justice, Internal Revenue Service and 25 State Attorneys General.
The SEC’s investigation is continuing.”
The SEC seems to be very aggressive in it’s prosecution of bad guys. However, perhaps instead of levying a relatively small fine against these large institutions the SEC should be allowed to confiscate all of the shareholder and bond holder equity in these businesses. Fines seem to be having no deterrent value so perhaps only the complete loss of equity will get share holders and bond holders in these financial institutions to pay attention to what executives are doing in the name of the owners and chief creditors.
This is a photo of the National Register of Historic Places listing with reference number 7000063
Wednesday, May 4, 2011
Friday, April 29, 2011
SEC VOTES TO REMOVE CREDIT RATING REFERENCES FOR CERTAIN ASSETS
Credit rating agencies caused a great deal of harm to the world economy because of their poor performance in rating the credit worthiness of various securities related to mortgages. Many times these credit rating agencies worked for the companies selling the securities. This might be like having a used car dealer use one of the mechanics they employ to inform customers as to the condition of cars the dealer is selling. In the end the customers of broker/dealers of mortgage backed securities lost a great deal of money because they relied on the ratings of the credit rating agencies. There was of course another element that directly caused the economy to seize up.
The element that placed much of the economy at immediate risk was the inability for broker-dealers to have liquidity because the true credit worthiness of the mortgage backed securities they held was far less than what the credit rating agencies had determined. Because the liquid assets required to be maintained by broker-dealers was determined in part by the value of mortgage related securities when the true value of the mortgage related securities was determined by market forces many institutions became illiquid. The following changes are designed to deal with this issue and others relatng to credit rating agencies. The details below are an excerpt from the SEC web site:
“ Washington, D.C., April 27, 2011 — The Securities and Exchange Commission today voted unanimously to propose amendments that would remove references to credit ratings in several rules under the Exchange Act.
These proposals represent the next step in a series of actions taken under the Dodd-Frank Wall Street Reform and Consumer Protection Act to remove references to credit ratings within agency rules and, where appropriate, replace them with alternative criteria.
Proposed Rule Release No. 34-64352
Under Dodd-Frank, federal agencies must review how their existing regulations rely on credit ratings as an assessment of creditworthiness. At the conclusion of this review, each agency is required to report to Congress on how the agency modified these references to replace them with alternative standards that the agency determined to be appropriate.
Public comments on the rule amendments should be received within 60 days after they are published in the Federal Register.
Credit rating agencies are organizations that rate the credit-worthiness of a company or a financial product, such as a debt security or money market instrument. These credit ratings are often considered by investors evaluating whether to purchase securities.
In passing the Dodd-Frank Act, Congress included a provision in Section 939A that requires every federal agency to review rules that use credit ratings as an assessment of credit-worthiness. At the conclusion of this review, each agency is required to report to Congress on how the agency modified these references and replaced them with alternative standards that the agency determined to be appropriate.
The SEC is one such agency that has adopted rules over the years that reference credit ratings in assessing the credit-worthiness of a security. Among other things, the SEC’s net capital rule requires broker-dealers to maintain certain amounts of liquid assets (net capital) in the event that the broker-dealer fails. In computing this “net capital” amount, existing rules rely on credit ratings to determine the value of certain securities that broker-dealers are holding.
In addition, in Section 939(e) of the Dodd-Frank Act, Congress required credit rating references to be removed from certain sections of the Exchange Act that define the terms “mortgage related security,” and “small business related security.” In place of the credit rating references, Congress added language stating that a mortgage related security and a small business related security instead will need to satisfy “standards of credit-worthiness as established by the Commission.” This replacement language will go into effect on July 21, 2012.
The Commission today proposed rules that would replace such references in certain existing rules and would request comment on how to implement Section 939(e) of the Act.
Earlier this year, the SEC proposed rules that would change existing rules related to money market funds that allowed such funds to only invest in securities that have received one of the two highest categories of short-term credit ratings. Additionally, the SEC proposed amendments to its rules that would remove credit ratings as one of the conditions for companies seeking to use short-form registration when registering securities for public sale.
The Proposals
Removing References to Credit Ratings in the SEC’s Net Capital Rule for Broker-Dealers
Current rule: Rule 15c3-1, the “net capital rule,” requires broker-dealers to maintain specified minimum levels of liquid assets, or net capital. The rule is designed to protect the customers of a broker-dealer from losses upon the broker-dealer’s failure. Among other things, the net capital rule requires that broker-dealers, when computing net capital, apply a lower net capital deduction (or “haircut”) to certain proprietary securities positions in commercial paper, nonconvertible debt, and preferred stock if the securities are rated in higher rating categories by at least two Nationally Recognized Statistical Rating Organizations (NRSROs). That is, broker-dealers do not have to deduct as much from their net capital with respect to these securities because these securities typically are more liquid and less volatile in price than securities that are rated in lower rating categories or are unrated.
Proposed rule: The SEC is proposing to remove from the net capital rule all references to credit ratings and substitute an alternative standard of creditworthiness. Under the proposal, a broker-dealer would be required to take a 15 percent haircut on its proprietary positions in commercial paper, nonconvertible debt, and preferred stock unless the broker-dealer has a process for determining creditworthiness that satisfies the criteria described below. However, as is the requirement in the current rule, if these types of securities do not trade in a ready market as defined in the rule, they would be subject to a 100 percent haircut – meaning that the broker-dealers cannot include the value of these securities in their net capital. The 15 percent haircut is derived from the catchall haircut amount that applies to securities not specifically identified in the net capital rule as having an asset-class specific haircut, provided the security is otherwise deemed to have a ready market. It is also the haircut applicable to most equity securities.
If a broker-dealer establishes, maintains, and enforces written policies and procedures for determining creditworthiness under the proposed amendments, the broker-dealer would be permitted to apply the lesser haircut requirement currently specified in the net capital rule for commercial paper (between zero and ½ of 1 percent), nonconvertible debt (between 2 and 9 percent), and preferred stock (10 percent) when the creditworthiness standard is satisfied. Under this proposal, in order to use these lower haircut percentages for commercial paper, nonconvertible debt, and preferred stock, a broker-dealer would be required to establish, maintain, and enforce written policies and procedures designed to assess the credit and liquidity risks applicable to a security, and based on this process, would have to determine that the investment has only a “minimal amount of credit risk.”
Under the proposed amendments, a broker-dealer could consider the following factors to the extent appropriate when assessing credit risk for purposes of the net capital rule: (1) credit spreads; (2) securities-related research; (3) internal or external credit risk assessments; (4) default statistics; (5) inclusion on an index; (6) priorities and enhancements; (7) price, yield and/or volume; and (8) asset class-specific factors. The range and type of specific factors considered would vary depending on the particular securities that are reviewed.
Each broker-dealer would be required to preserve, for a period of not less than three years, the written policies and procedures that the broker-dealer establishes, maintains, and enforces for assessing credit risk for commercial paper, nonconvertible debt, and preferred stock. Broker-dealers would be subject to this requirement in the SEC’s broker-dealer record retention rule, Exchange Act Rule 17a-4.
Removing References to Credit Ratings in the Definition of “Major Market Foreign Currency”
Current rule: Appendix A to Rule 15c3-1 allows broker-dealers to employ theoretical option pricing models in determining net capital requirements for listed options and related positions. Broker-dealers also may elect a strategy-based methodology. The purpose of Appendix A is to simplify the net capital treatment of options and accurately reflect the risk inherent in options and related positions. Under Appendix A, broker-dealers’ proprietary positions in “major market foreign currency” options receive more favorable treatment than options for all other currencies when using theoretical option pricing models to compute net capital deductions. The term “major market foreign currency” is defined to mean “the currency of a sovereign nation whose short term debt is rated in one of the two highest categories by at least two nationally recognized statistical rating organizations and for which there is a substantial inter-bank forward currency market.”
Proposed rule: With respect to the definition of the term “major market foreign currency,” the SEC is proposing to remove from that definition the phrase “whose short-term debt is rated in one of the two highest categories by at least two nationally recognized statistical rating organizations.” The change would modify the definition of that term to include foreign currencies only “for which there is a substantial inter-bank forward currency market.” The SEC is also proposing to eliminate the specific reference in the rule to the European Currency Unit (ECU), which is identified by the rule as the only major market foreign currency under Appendix A. Because of the establishment of the euro as the official currency of the euro-zone, a specific reference to the ECU is no longer needed. A specific reference to the euro also is not necessary, as it is a foreign currency with a substantial inter-bank forward currency market.
Removing References to Credit Ratings When Determining Net Capital Charges for Credit Risk
Current rule: A broker-dealer may apply to the SEC for authorization to use the alternative method for computing capital (the alternative net capital, or “ANC,” computation) contained in Appendix E to the net capital rule. Under Appendix E, firms that have been determined to have robust internal risk management practices may utilize the mathematical modeling methods they use to manage their own business risk, including value-at-risk (VaR) models and scenario analysis, to compute deductions from net capital for market and credit risks arising from OTC derivatives transactions. OTC derivatives dealers may also apply to the SEC to use VaR models to calculate capital charges for market risk and to take alternative charges for credit risk under Appendix F.
Proposed rule: Under Appendix E and Appendix F to the net capital rule, broker-dealers subject to the ANC computation and OTC derivatives dealers, respectively, are required to deduct from their net capital credit risk charges that take counterparty risk into consideration. This counterparty risk determination is currently based on either NRSRO ratings or a dealer’s internal counterparty credit rating. To comply with Section 939A of the Dodd-Frank Act, the SEC is proposing to remove references to NRSRO ratings from Appendices E and F to Rule 15c3-1 and to make conforming changes to Appendix G and the form that OTC derivatives dealers periodically file with the SEC, Form X-17A-5, Part IIB.
Removing References to Credit Ratings in Rule 15c3-3
Current rule: Rule 15c3-3 under the Exchange Act protects customer funds and securities held by broker-dealers. In general, Rule 15c3-3 has two parts.
The first part requires a broker-dealer to have possession or control of all fully paid and excess margin securities of its customers. In this regard, a broker-dealer must make a daily determination in order to comply with this aspect of the rule.
The second part covers customer funds and requires broker-dealers subject to the rule to make a periodic computation to determine how much money it is holding that is either customer money or money obtained from the use of customer securities (credits). From that figure, the broker-dealer subtracts the amount of money that it is owed by customers or by other broker-dealers relating to customer transactions (debits). If the credits exceed debits after this “reserve formula” computation, the broker-dealer must deposit the excess in a “Special Reserve Bank Account for the Exclusive Benefit of Customers” (a Reserve Account). If the debits exceed credits, no deposit is necessary. Funds deposited in a Reserve Account cannot be withdrawn until the broker-dealer completes another computation that shows that the broker-dealer has on deposit more funds than the reserve formula requires.
Exhibit A to Rule 15c3-3 contains the formula that a broker-dealer must use to determine its reserve requirement.
Under Note G to Exhibit A, a broker-dealer may include required customer margin for transactions in security futures products as a debit in its reserve formula computation if:
That margin is required.
That margin is on deposit at a clearing agency or derivatives clearing organization that either:
Maintains the highest investment-grade rating from an NRSRO.
Maintains security deposits from clearing members in connection with regulated options or futures transactions and assessment power over member firms that equal a combined total of at least $2 billion, at least $500 million of which must be in the form of security deposits.
Maintains at least $3 billion in margin deposits.
Obtains an exemption from the Commission.
Proposed rule: The SEC is proposing to remove the first criterion described above (the highest investment-grade rating from an NRSRO). The criteria are disjunctive and, therefore, a clearing agency or derivatives clearing organization needs to satisfy only one criterion to permit a broker-dealer to treat customer margin as a reserve formula debit. While one potential criterion would be removed, there is only one clearing agency for security futures products (namely, the Options Clearing Corporation) and that clearing agency would continue to qualify under each of the other applicable criteria. If a new registered clearing agency or derivatives clearing organization could not meet one of the remaining criteria, a broker-dealer may request an exemption for the clearing agency or organization under the rule.
Removing References to Credit Ratings in Rules 101 and 102 of Regulation M
Current rule: Regulation M is a set of anti-manipulation rules designed to preserve the integrity of the securities market by prohibiting activities that could artificially influence the market for an offered security. Rules 101 and 102 of Regulation M specifically prohibit certain persons, such as issuers and underwriters from directly or indirectly bidding for, purchasing, or attempting to induce another person to bid for or purchase a “covered security” for a specified period of time. In particular the rules currently include an exception for “investment grade nonconvertible and asset-backed securities.” These exceptions apply to nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities that are rated by at least one NRSRO in one of its generic rating categories that signifies investment grade.
Proposed rule: The SEC’s proposal would instead provide an exception for nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities from Rules 101 and 102 if they: (1) are liquid relative to the market for that asset class; (2) trade in relation to general market interest rates and yield spreads; and (3) are relatively fungible with securities of similar characteristics and interest rate yield spreads. The proposed standards are an attempt to identify the subset of trading characteristics of these securities that make them less prone to the type of manipulation that Regulation M seeks to prevent. Under the proposal, a person seeking to rely on the exception would make the determination that the security in question meets the proposed standards. The determination would be required to be made utilizing reasonable factors of evaluation and would be required to be subsequently verified by an independent third party.
Removing References to Credit Ratings in Rule 10b-10
Current rule: Rule 10b-10, the Commission’s customer confirmation rule, generally requires that broker-dealers effecting securities transactions on behalf of customers provide to their customers, at or before completion of the securities transaction, a written notification with certain basic transaction terms. Under Rule 10b-10(a)(8), broker-dealers must disclose to customers in debt security transactions if the debt security is unrated by an NRSRO.
Proposed rule: When paragraph (a)(8) of Rule 10b-10 was adopted in 1994, the SEC indicated that this additional disclosure was not intended to suggest that an unrated security was riskier than a rated security; rather, it was intended to prompt a dialogue between the customer and the broker-dealer in the event that the customer was not aware of the unrated status prior to the transaction. Although the disclosure required by Rule 10b-10(a)(8) may not necessarily come within the mandate of Section 939A, the SEC is proposing to delete this reference in light of the SEC’s prior proposals to do so and because it would be consistent with the broader efforts under the Dodd-Frank Act to reduce direct, and in this case, indirect, reliance on NRSRO ratings.
Requests for Comment on Section 939(e) of the Dodd-Frank Act
Section 939(e) of the Dodd-Frank Act deleted Exchange Act references to credit ratings by NRSROs in Exchange Act Section 3(a)(41), which defines the term “mortgage related security,” and in Exchange Act Section 3(a)(53), which defines the term “small business related security.” The credit rating references in Sections 3(a)(41) and 3(a)(53) effectively exclude from the respective definitions securities that otherwise meet the definitions but are not rated by at least one NRSRO in the top two credit rating categories in the case of mortgage related securities or in the top four credit rating categories in the case of small business related securities.
In place of the credit rating references, Congress added language stating that a mortgage related security and a small business related security will need to satisfy “standards of credit-worthiness as established by the Commission.” This replacement language will go into effect on July 21, 2012. Before that time, the Commission will need to establish a new standard of creditworthiness for each Exchange Act definition. To assist the Commission in considering how to implement Section 939(e) of the Dodd-Frank Act, the Commission is requesting comment on potential “standards of credit-worthiness” for purposes of Sections 3(a)(41) and 3(a)(53)”
The element that placed much of the economy at immediate risk was the inability for broker-dealers to have liquidity because the true credit worthiness of the mortgage backed securities they held was far less than what the credit rating agencies had determined. Because the liquid assets required to be maintained by broker-dealers was determined in part by the value of mortgage related securities when the true value of the mortgage related securities was determined by market forces many institutions became illiquid. The following changes are designed to deal with this issue and others relatng to credit rating agencies. The details below are an excerpt from the SEC web site:
“ Washington, D.C., April 27, 2011 — The Securities and Exchange Commission today voted unanimously to propose amendments that would remove references to credit ratings in several rules under the Exchange Act.
These proposals represent the next step in a series of actions taken under the Dodd-Frank Wall Street Reform and Consumer Protection Act to remove references to credit ratings within agency rules and, where appropriate, replace them with alternative criteria.
Proposed Rule Release No. 34-64352
Under Dodd-Frank, federal agencies must review how their existing regulations rely on credit ratings as an assessment of creditworthiness. At the conclusion of this review, each agency is required to report to Congress on how the agency modified these references to replace them with alternative standards that the agency determined to be appropriate.
Public comments on the rule amendments should be received within 60 days after they are published in the Federal Register.
Credit rating agencies are organizations that rate the credit-worthiness of a company or a financial product, such as a debt security or money market instrument. These credit ratings are often considered by investors evaluating whether to purchase securities.
In passing the Dodd-Frank Act, Congress included a provision in Section 939A that requires every federal agency to review rules that use credit ratings as an assessment of credit-worthiness. At the conclusion of this review, each agency is required to report to Congress on how the agency modified these references and replaced them with alternative standards that the agency determined to be appropriate.
The SEC is one such agency that has adopted rules over the years that reference credit ratings in assessing the credit-worthiness of a security. Among other things, the SEC’s net capital rule requires broker-dealers to maintain certain amounts of liquid assets (net capital) in the event that the broker-dealer fails. In computing this “net capital” amount, existing rules rely on credit ratings to determine the value of certain securities that broker-dealers are holding.
In addition, in Section 939(e) of the Dodd-Frank Act, Congress required credit rating references to be removed from certain sections of the Exchange Act that define the terms “mortgage related security,” and “small business related security.” In place of the credit rating references, Congress added language stating that a mortgage related security and a small business related security instead will need to satisfy “standards of credit-worthiness as established by the Commission.” This replacement language will go into effect on July 21, 2012.
The Commission today proposed rules that would replace such references in certain existing rules and would request comment on how to implement Section 939(e) of the Act.
Earlier this year, the SEC proposed rules that would change existing rules related to money market funds that allowed such funds to only invest in securities that have received one of the two highest categories of short-term credit ratings. Additionally, the SEC proposed amendments to its rules that would remove credit ratings as one of the conditions for companies seeking to use short-form registration when registering securities for public sale.
The Proposals
Removing References to Credit Ratings in the SEC’s Net Capital Rule for Broker-Dealers
Current rule: Rule 15c3-1, the “net capital rule,” requires broker-dealers to maintain specified minimum levels of liquid assets, or net capital. The rule is designed to protect the customers of a broker-dealer from losses upon the broker-dealer’s failure. Among other things, the net capital rule requires that broker-dealers, when computing net capital, apply a lower net capital deduction (or “haircut”) to certain proprietary securities positions in commercial paper, nonconvertible debt, and preferred stock if the securities are rated in higher rating categories by at least two Nationally Recognized Statistical Rating Organizations (NRSROs). That is, broker-dealers do not have to deduct as much from their net capital with respect to these securities because these securities typically are more liquid and less volatile in price than securities that are rated in lower rating categories or are unrated.
Proposed rule: The SEC is proposing to remove from the net capital rule all references to credit ratings and substitute an alternative standard of creditworthiness. Under the proposal, a broker-dealer would be required to take a 15 percent haircut on its proprietary positions in commercial paper, nonconvertible debt, and preferred stock unless the broker-dealer has a process for determining creditworthiness that satisfies the criteria described below. However, as is the requirement in the current rule, if these types of securities do not trade in a ready market as defined in the rule, they would be subject to a 100 percent haircut – meaning that the broker-dealers cannot include the value of these securities in their net capital. The 15 percent haircut is derived from the catchall haircut amount that applies to securities not specifically identified in the net capital rule as having an asset-class specific haircut, provided the security is otherwise deemed to have a ready market. It is also the haircut applicable to most equity securities.
If a broker-dealer establishes, maintains, and enforces written policies and procedures for determining creditworthiness under the proposed amendments, the broker-dealer would be permitted to apply the lesser haircut requirement currently specified in the net capital rule for commercial paper (between zero and ½ of 1 percent), nonconvertible debt (between 2 and 9 percent), and preferred stock (10 percent) when the creditworthiness standard is satisfied. Under this proposal, in order to use these lower haircut percentages for commercial paper, nonconvertible debt, and preferred stock, a broker-dealer would be required to establish, maintain, and enforce written policies and procedures designed to assess the credit and liquidity risks applicable to a security, and based on this process, would have to determine that the investment has only a “minimal amount of credit risk.”
Under the proposed amendments, a broker-dealer could consider the following factors to the extent appropriate when assessing credit risk for purposes of the net capital rule: (1) credit spreads; (2) securities-related research; (3) internal or external credit risk assessments; (4) default statistics; (5) inclusion on an index; (6) priorities and enhancements; (7) price, yield and/or volume; and (8) asset class-specific factors. The range and type of specific factors considered would vary depending on the particular securities that are reviewed.
Each broker-dealer would be required to preserve, for a period of not less than three years, the written policies and procedures that the broker-dealer establishes, maintains, and enforces for assessing credit risk for commercial paper, nonconvertible debt, and preferred stock. Broker-dealers would be subject to this requirement in the SEC’s broker-dealer record retention rule, Exchange Act Rule 17a-4.
Removing References to Credit Ratings in the Definition of “Major Market Foreign Currency”
Current rule: Appendix A to Rule 15c3-1 allows broker-dealers to employ theoretical option pricing models in determining net capital requirements for listed options and related positions. Broker-dealers also may elect a strategy-based methodology. The purpose of Appendix A is to simplify the net capital treatment of options and accurately reflect the risk inherent in options and related positions. Under Appendix A, broker-dealers’ proprietary positions in “major market foreign currency” options receive more favorable treatment than options for all other currencies when using theoretical option pricing models to compute net capital deductions. The term “major market foreign currency” is defined to mean “the currency of a sovereign nation whose short term debt is rated in one of the two highest categories by at least two nationally recognized statistical rating organizations and for which there is a substantial inter-bank forward currency market.”
Proposed rule: With respect to the definition of the term “major market foreign currency,” the SEC is proposing to remove from that definition the phrase “whose short-term debt is rated in one of the two highest categories by at least two nationally recognized statistical rating organizations.” The change would modify the definition of that term to include foreign currencies only “for which there is a substantial inter-bank forward currency market.” The SEC is also proposing to eliminate the specific reference in the rule to the European Currency Unit (ECU), which is identified by the rule as the only major market foreign currency under Appendix A. Because of the establishment of the euro as the official currency of the euro-zone, a specific reference to the ECU is no longer needed. A specific reference to the euro also is not necessary, as it is a foreign currency with a substantial inter-bank forward currency market.
Removing References to Credit Ratings When Determining Net Capital Charges for Credit Risk
Current rule: A broker-dealer may apply to the SEC for authorization to use the alternative method for computing capital (the alternative net capital, or “ANC,” computation) contained in Appendix E to the net capital rule. Under Appendix E, firms that have been determined to have robust internal risk management practices may utilize the mathematical modeling methods they use to manage their own business risk, including value-at-risk (VaR) models and scenario analysis, to compute deductions from net capital for market and credit risks arising from OTC derivatives transactions. OTC derivatives dealers may also apply to the SEC to use VaR models to calculate capital charges for market risk and to take alternative charges for credit risk under Appendix F.
Proposed rule: Under Appendix E and Appendix F to the net capital rule, broker-dealers subject to the ANC computation and OTC derivatives dealers, respectively, are required to deduct from their net capital credit risk charges that take counterparty risk into consideration. This counterparty risk determination is currently based on either NRSRO ratings or a dealer’s internal counterparty credit rating. To comply with Section 939A of the Dodd-Frank Act, the SEC is proposing to remove references to NRSRO ratings from Appendices E and F to Rule 15c3-1 and to make conforming changes to Appendix G and the form that OTC derivatives dealers periodically file with the SEC, Form X-17A-5, Part IIB.
Removing References to Credit Ratings in Rule 15c3-3
Current rule: Rule 15c3-3 under the Exchange Act protects customer funds and securities held by broker-dealers. In general, Rule 15c3-3 has two parts.
The first part requires a broker-dealer to have possession or control of all fully paid and excess margin securities of its customers. In this regard, a broker-dealer must make a daily determination in order to comply with this aspect of the rule.
The second part covers customer funds and requires broker-dealers subject to the rule to make a periodic computation to determine how much money it is holding that is either customer money or money obtained from the use of customer securities (credits). From that figure, the broker-dealer subtracts the amount of money that it is owed by customers or by other broker-dealers relating to customer transactions (debits). If the credits exceed debits after this “reserve formula” computation, the broker-dealer must deposit the excess in a “Special Reserve Bank Account for the Exclusive Benefit of Customers” (a Reserve Account). If the debits exceed credits, no deposit is necessary. Funds deposited in a Reserve Account cannot be withdrawn until the broker-dealer completes another computation that shows that the broker-dealer has on deposit more funds than the reserve formula requires.
Exhibit A to Rule 15c3-3 contains the formula that a broker-dealer must use to determine its reserve requirement.
Under Note G to Exhibit A, a broker-dealer may include required customer margin for transactions in security futures products as a debit in its reserve formula computation if:
That margin is required.
That margin is on deposit at a clearing agency or derivatives clearing organization that either:
Maintains the highest investment-grade rating from an NRSRO.
Maintains security deposits from clearing members in connection with regulated options or futures transactions and assessment power over member firms that equal a combined total of at least $2 billion, at least $500 million of which must be in the form of security deposits.
Maintains at least $3 billion in margin deposits.
Obtains an exemption from the Commission.
Proposed rule: The SEC is proposing to remove the first criterion described above (the highest investment-grade rating from an NRSRO). The criteria are disjunctive and, therefore, a clearing agency or derivatives clearing organization needs to satisfy only one criterion to permit a broker-dealer to treat customer margin as a reserve formula debit. While one potential criterion would be removed, there is only one clearing agency for security futures products (namely, the Options Clearing Corporation) and that clearing agency would continue to qualify under each of the other applicable criteria. If a new registered clearing agency or derivatives clearing organization could not meet one of the remaining criteria, a broker-dealer may request an exemption for the clearing agency or organization under the rule.
Removing References to Credit Ratings in Rules 101 and 102 of Regulation M
Current rule: Regulation M is a set of anti-manipulation rules designed to preserve the integrity of the securities market by prohibiting activities that could artificially influence the market for an offered security. Rules 101 and 102 of Regulation M specifically prohibit certain persons, such as issuers and underwriters from directly or indirectly bidding for, purchasing, or attempting to induce another person to bid for or purchase a “covered security” for a specified period of time. In particular the rules currently include an exception for “investment grade nonconvertible and asset-backed securities.” These exceptions apply to nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities that are rated by at least one NRSRO in one of its generic rating categories that signifies investment grade.
Proposed rule: The SEC’s proposal would instead provide an exception for nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities from Rules 101 and 102 if they: (1) are liquid relative to the market for that asset class; (2) trade in relation to general market interest rates and yield spreads; and (3) are relatively fungible with securities of similar characteristics and interest rate yield spreads. The proposed standards are an attempt to identify the subset of trading characteristics of these securities that make them less prone to the type of manipulation that Regulation M seeks to prevent. Under the proposal, a person seeking to rely on the exception would make the determination that the security in question meets the proposed standards. The determination would be required to be made utilizing reasonable factors of evaluation and would be required to be subsequently verified by an independent third party.
Removing References to Credit Ratings in Rule 10b-10
Current rule: Rule 10b-10, the Commission’s customer confirmation rule, generally requires that broker-dealers effecting securities transactions on behalf of customers provide to their customers, at or before completion of the securities transaction, a written notification with certain basic transaction terms. Under Rule 10b-10(a)(8), broker-dealers must disclose to customers in debt security transactions if the debt security is unrated by an NRSRO.
Proposed rule: When paragraph (a)(8) of Rule 10b-10 was adopted in 1994, the SEC indicated that this additional disclosure was not intended to suggest that an unrated security was riskier than a rated security; rather, it was intended to prompt a dialogue between the customer and the broker-dealer in the event that the customer was not aware of the unrated status prior to the transaction. Although the disclosure required by Rule 10b-10(a)(8) may not necessarily come within the mandate of Section 939A, the SEC is proposing to delete this reference in light of the SEC’s prior proposals to do so and because it would be consistent with the broader efforts under the Dodd-Frank Act to reduce direct, and in this case, indirect, reliance on NRSRO ratings.
Requests for Comment on Section 939(e) of the Dodd-Frank Act
Section 939(e) of the Dodd-Frank Act deleted Exchange Act references to credit ratings by NRSROs in Exchange Act Section 3(a)(41), which defines the term “mortgage related security,” and in Exchange Act Section 3(a)(53), which defines the term “small business related security.” The credit rating references in Sections 3(a)(41) and 3(a)(53) effectively exclude from the respective definitions securities that otherwise meet the definitions but are not rated by at least one NRSRO in the top two credit rating categories in the case of mortgage related securities or in the top four credit rating categories in the case of small business related securities.
In place of the credit rating references, Congress added language stating that a mortgage related security and a small business related security will need to satisfy “standards of credit-worthiness as established by the Commission.” This replacement language will go into effect on July 21, 2012. Before that time, the Commission will need to establish a new standard of creditworthiness for each Exchange Act definition. To assist the Commission in considering how to implement Section 939(e) of the Dodd-Frank Act, the Commission is requesting comment on potential “standards of credit-worthiness” for purposes of Sections 3(a)(41) and 3(a)(53)”
Sunday, April 24, 2011
SEC CHARGES HEDGE FUND MANAGERS WITH DEFRAUDING CLIENTS
The following case brought by the SEC against two hedge fund managers alleges a “scheme” to defraud clients. Pleas read the following excerpt from the SEC web site for details of this case:
“Washington, D.C., March 15, 2011 – The Securities and Exchange Commission today charged a hedge fund investment advisory firm and its two founders with orchestrating a multi-faceted scheme to defraud clients and failing to comply with fiduciary obligations.
The SEC alleges that Eugenio Verzili and Arturo Rodriguez through their firm Juno Mother Earth Asset Management LLC misappropriated client assets, inflated assets under management, and filed false information with the SEC. Juno, Verzili and Rodriguez looted approximately $1.8 million of assets from a hedge fund they manage, misusing it to pay Juno’s operating costs related to payroll, rent, travel, meals, and entertainment. They issued promissory notes to conceal a substantial portion of their misappropriation. Juno, Verzili and Rodriguez also misrepresented the amount of capital that some Juno partners had invested in one of its funds, claiming they had invested millions of dollars when they actually had invested nothing in the funds.
“Verzili, Rodriguez and their firm violated the most fundamental duties of an investment adviser by lying to their clients and misappropriating the money entrusted to their care,” said George S. Canellos, Director of the SEC’s New York Regional Office. “They compounded their wrongdoing by providing false information in filings with the SEC that are designed to ensure that registered investment advisers make full disclosure to investors.”
Bruce Karpati, Co-Chief of the Asset Management Unit in the SEC’s Division of Enforcement, said, “Hedge fund investors derive comfort from knowing the fund’s adviser has so-called ‘skin in the game’ by investing its own money side-by-side with investors and sharing the same risks and rewards. These managers deliberately distorted their skin in the game.”
According to the SEC’s complaint filed in the U.S. District Court for the Southern District of New York, Juno sold securities in client brokerage and commodity accounts and directed 41 separate transfers of cash to Juno’s bank account, claiming falsely that the transfers were reimbursements for expenses Juno had incurred on behalf of the client fund. Verzili and Rodriguez later fabricated and issued nine promissory notes to make it appear that the client fund had invested the money in Juno. But they concealed the so-called investment from the independent directors of the client fund.
The SEC’s complaint further alleges that Juno, Verzili and Rodriguez marketed investments in the Juno-advised fund and failed to disclose Juno’s precarious financial condition to investors. They also failed to disclose that Juno owed a client fund a minimum of $1.2 million, which represented the proceeds of the promissory notes. While offering and selling securities in the client fund, Juno repeatedly inflated and misrepresented the amount of assets that Juno managed and claimed at one point that Juno had as much as $200 million under management. Verzili also represented falsely to investors that Juno’s partners had up to $3 million of their own capital invested in a client fund. Juno’s partners had never actually invested any of their own money.
The SEC alleges that Juno filed false Forms ADV with the SEC in order to avoid deregistration with the Commission, claiming in those filings that Juno managed $40 million more than it actually did. Verzili and Rodriguez also caused Juno to provide a number of false filings to the SEC that failed to disclose that Juno had engaged in principal transactions with its client and had custody of client assets.
The SEC’s complaint charges Juno, Verzili and Rodriguez with violations of the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940, as well as additional regulatory-based violations of the Advisers Act. The SEC seeks permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest, and monetary penalties.”
In the above case the SEC alleges that the hedge fund managers lied. This is a relatively small case involving a few million dollars. Nevertheless, if most of the people in the business world lie then the society they work in will simply breakdown. Most people over time get tired of businessmen stealing from them and sooner or later will stop doing any business transactions at all. No society can exist if productive enterprise is replaced as the main philosophy of business with who can be the biggest thief?
“Washington, D.C., March 15, 2011 – The Securities and Exchange Commission today charged a hedge fund investment advisory firm and its two founders with orchestrating a multi-faceted scheme to defraud clients and failing to comply with fiduciary obligations.
The SEC alleges that Eugenio Verzili and Arturo Rodriguez through their firm Juno Mother Earth Asset Management LLC misappropriated client assets, inflated assets under management, and filed false information with the SEC. Juno, Verzili and Rodriguez looted approximately $1.8 million of assets from a hedge fund they manage, misusing it to pay Juno’s operating costs related to payroll, rent, travel, meals, and entertainment. They issued promissory notes to conceal a substantial portion of their misappropriation. Juno, Verzili and Rodriguez also misrepresented the amount of capital that some Juno partners had invested in one of its funds, claiming they had invested millions of dollars when they actually had invested nothing in the funds.
“Verzili, Rodriguez and their firm violated the most fundamental duties of an investment adviser by lying to their clients and misappropriating the money entrusted to their care,” said George S. Canellos, Director of the SEC’s New York Regional Office. “They compounded their wrongdoing by providing false information in filings with the SEC that are designed to ensure that registered investment advisers make full disclosure to investors.”
Bruce Karpati, Co-Chief of the Asset Management Unit in the SEC’s Division of Enforcement, said, “Hedge fund investors derive comfort from knowing the fund’s adviser has so-called ‘skin in the game’ by investing its own money side-by-side with investors and sharing the same risks and rewards. These managers deliberately distorted their skin in the game.”
According to the SEC’s complaint filed in the U.S. District Court for the Southern District of New York, Juno sold securities in client brokerage and commodity accounts and directed 41 separate transfers of cash to Juno’s bank account, claiming falsely that the transfers were reimbursements for expenses Juno had incurred on behalf of the client fund. Verzili and Rodriguez later fabricated and issued nine promissory notes to make it appear that the client fund had invested the money in Juno. But they concealed the so-called investment from the independent directors of the client fund.
The SEC’s complaint further alleges that Juno, Verzili and Rodriguez marketed investments in the Juno-advised fund and failed to disclose Juno’s precarious financial condition to investors. They also failed to disclose that Juno owed a client fund a minimum of $1.2 million, which represented the proceeds of the promissory notes. While offering and selling securities in the client fund, Juno repeatedly inflated and misrepresented the amount of assets that Juno managed and claimed at one point that Juno had as much as $200 million under management. Verzili also represented falsely to investors that Juno’s partners had up to $3 million of their own capital invested in a client fund. Juno’s partners had never actually invested any of their own money.
The SEC alleges that Juno filed false Forms ADV with the SEC in order to avoid deregistration with the Commission, claiming in those filings that Juno managed $40 million more than it actually did. Verzili and Rodriguez also caused Juno to provide a number of false filings to the SEC that failed to disclose that Juno had engaged in principal transactions with its client and had custody of client assets.
The SEC’s complaint charges Juno, Verzili and Rodriguez with violations of the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940, as well as additional regulatory-based violations of the Advisers Act. The SEC seeks permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest, and monetary penalties.”
In the above case the SEC alleges that the hedge fund managers lied. This is a relatively small case involving a few million dollars. Nevertheless, if most of the people in the business world lie then the society they work in will simply breakdown. Most people over time get tired of businessmen stealing from them and sooner or later will stop doing any business transactions at all. No society can exist if productive enterprise is replaced as the main philosophy of business with who can be the biggest thief?
Thursday, April 21, 2011
SEC ALLEGES SUBPRIME AUTO LENDER WITH FRAUD
The Securities and Exchange Commission has found fraud in the sub prime housing market and this next case involves alleged fraud in the sub prime auto loan industry. The following case is an excerpt from the SEC web site:
“ Washington, D.C., April 14, 2011 — The Securities and Exchange Commission today charged Massachusetts-based sub prime auto loan provider Inofin Inc. and three company executives with misleading investors about their lending activities and diverting millions of dollars in investor funds for their personal benefit. The SEC also charged two sales agents with illegally offering to sell company securities without being registered with the SEC as broker-dealers.
The SEC alleges that Inofin executives Michael Cuomo of Plymouth, Mass., Kevin Mann of Marshfield, Mass., and Melissa George of Duxbury, Mass., illegally raised at least $110 million from hundreds of investors in 25 states and the District of Columbia through the sale of unregistered notes. Investors in the notes were told that Inofin would use the money for the sole purpose of funding subprime auto loans. As part of the pitch, Inofin and its executives told investors that they could expect to receive returns of 9 to 15 percent because Inofin loaned investor money to its subprime borrowers at an average rate of 20 percent. But unbeknownst to investors, starting in 2004 approximately one-third of investor money raised was instead used by Cuomo and Mann to open four used car dealerships and begin multiple real estate property developments for their own benefit.
Inofin is not registered with the SEC to offer securities to investors.
“Whether selling stock or notes, public and private companies alike must play it straight with investors or be held accountable for their misconduct,” said David Bergers, Director of the SEC’s Boston Regional Office. “Inofin and some top executives violated investors’ trust by misusing their funds to bankroll their personal business ventures.”
According to the SEC’s complaint filed in federal court in Boston, Inofin and the executives materially misrepresented Inofin’s financial performance beginning as early as 2006 and continuing to 2011. Inofin had a negative net worth and a progressively deteriorating financial condition caused not only by the failure of Inofin’s undisclosed business activities, but also by management’s decisions in 2007, 2008, and 2009 to sell some of its auto loan portfolio at a substantial discount to solve ever-increasing cash shortages that Inofin concealed from investors. Inofin and its principal officers continued to offer and sell Inofin securities while knowingly or recklessly misrepresenting to investors that Inofin was a profitable business and sound investment.
The SEC further alleges that beginning in 2006 and continuing to April 2010, Inofin’s executives defrauded investors while maintaining Inofin’s license to do business as a motor vehicle sales finance company by preparing and submitting materially false financial statements to its licensing authority, the Massachusetts Division of Banks. The SEC’s complaint charges Cuomo, Mann, and George with violating the antifraud and registration provisions of the federal securities laws, and seeks civil injunctions, the return of ill-gotten gains plus prejudgment interest, and financial penalties.
The SEC’s charges against the two sales agents — David Affeldt and Thomas K. (Kevin) Keough — allege that they promoted the offering and sale of Inofin’s unregistered securities. They were unjustly enriched with more than $500,000 in referral fees between 2004 and 2009. Affeldt and Keough are charged with selling the unregistered Inofin securities and failing to register with the SEC as a broker-dealer, and the SEC seeks civil injunctions, the return of ill-gotten gains plus prejudgment interest, and financial penalties. Keough’s wife Nancy Keough is named in the complaint as a relief defendant for the purposes of recovering proceeds she received as a result of the violations.
The SEC appreciates the assistance of the Secretary of the Commonwealth of Massachusetts William F. Galvin, who today filed charges against Inofin, Cuomo, Mann, George, Affeldt, Kevin Keough, and Nancy Keough based on the same conduct. The SEC also appreciates the assistance of the Massachusetts Division of Banks, which previously took action requiring Inofin to surrender its license to operate as a subprime auto lender in Massachusetts.”
Although it is difficult to find many sub prime mortgage loans being offered today it there are still sub prime auto loans being promoted. Of course repossessing an automobile is much less time consuming than repossessing a house: that is if the automobile can be located and the delinquent purchaser is literally not gunning for a fight.
The Securities and Exchange Commission has found fraud in the sub prime housing market and this next case involves alleged fraud in the sub prime auto loan industry. The following case is an excerpt from the SEC web site:
“ Washington, D.C., April 14, 2011 — The Securities and Exchange Commission today charged Massachusetts-based sub prime auto loan provider Inofin Inc. and three company executives with misleading investors about their lending activities and diverting millions of dollars in investor funds for their personal benefit. The SEC also charged two sales agents with illegally offering to sell company securities without being registered with the SEC as broker-dealers.
The SEC alleges that Inofin executives Michael Cuomo of Plymouth, Mass., Kevin Mann of Marshfield, Mass., and Melissa George of Duxbury, Mass., illegally raised at least $110 million from hundreds of investors in 25 states and the District of Columbia through the sale of unregistered notes. Investors in the notes were told that Inofin would use the money for the sole purpose of funding subprime auto loans. As part of the pitch, Inofin and its executives told investors that they could expect to receive returns of 9 to 15 percent because Inofin loaned investor money to its subprime borrowers at an average rate of 20 percent. But unbeknownst to investors, starting in 2004 approximately one-third of investor money raised was instead used by Cuomo and Mann to open four used car dealerships and begin multiple real estate property developments for their own benefit.
Inofin is not registered with the SEC to offer securities to investors.
“Whether selling stock or notes, public and private companies alike must play it straight with investors or be held accountable for their misconduct,” said David Bergers, Director of the SEC’s Boston Regional Office. “Inofin and some top executives violated investors’ trust by misusing their funds to bankroll their personal business ventures.”
According to the SEC’s complaint filed in federal court in Boston, Inofin and the executives materially misrepresented Inofin’s financial performance beginning as early as 2006 and continuing to 2011. Inofin had a negative net worth and a progressively deteriorating financial condition caused not only by the failure of Inofin’s undisclosed business activities, but also by management’s decisions in 2007, 2008, and 2009 to sell some of its auto loan portfolio at a substantial discount to solve ever-increasing cash shortages that Inofin concealed from investors. Inofin and its principal officers continued to offer and sell Inofin securities while knowingly or recklessly misrepresenting to investors that Inofin was a profitable business and sound investment.
The SEC further alleges that beginning in 2006 and continuing to April 2010, Inofin’s executives defrauded investors while maintaining Inofin’s license to do business as a motor vehicle sales finance company by preparing and submitting materially false financial statements to its licensing authority, the Massachusetts Division of Banks. The SEC’s complaint charges Cuomo, Mann, and George with violating the antifraud and registration provisions of the federal securities laws, and seeks civil injunctions, the return of ill-gotten gains plus prejudgment interest, and financial penalties.
The SEC’s charges against the two sales agents — David Affeldt and Thomas K. (Kevin) Keough — allege that they promoted the offering and sale of Inofin’s unregistered securities. They were unjustly enriched with more than $500,000 in referral fees between 2004 and 2009. Affeldt and Keough are charged with selling the unregistered Inofin securities and failing to register with the SEC as a broker-dealer, and the SEC seeks civil injunctions, the return of ill-gotten gains plus prejudgment interest, and financial penalties. Keough’s wife Nancy Keough is named in the complaint as a relief defendant for the purposes of recovering proceeds she received as a result of the violations.
The SEC appreciates the assistance of the Secretary of the Commonwealth of Massachusetts William F. Galvin, who today filed charges against Inofin, Cuomo, Mann, George, Affeldt, Kevin Keough, and Nancy Keough based on the same conduct. The SEC also appreciates the assistance of the Massachusetts Division of Banks, which previously took action requiring Inofin to surrender its license to operate as a subprime auto lender in Massachusetts.”
Although it is difficult to find many sub prime mortgage loans being offered today it there are still sub prime auto loans being promoted. Of course repossessing an automobile is much less time consuming than repossessing a house: that is if the automobile can be located and the delinquent purchaser is literally not gunning for a fight.
Monday, April 18, 2011
FDIC: DODD-FRANK COULD HELP A LEHMAN BROTHERS RESOLUTION
The following excerpt comes from the FDIC web site and discusses how the Dodd-Frank Act could have theoretically made the Lehman Brothers Holdings Inc. more orderly and less of a fiasco:
“FDIC Report Examines How an Orderly Resolution of Lehman Brothers Could Have Been Structured Under the Dodd-Frank Act
The FDIC on Monday released a report examining how the FDIC could have structured an orderly resolution of Lehman Brothers Holdings Inc. under the orderly liquidation authority of Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act had that law been in effect in advance of Lehman's failure.
The report concludes that the powers provided to the FDIC under the Dodd-Frank Act to act decisively to preserve asset value and structure a transaction to sell Lehman's valuable operations to interested buyers -- which are drawn from those long used by the FDIC in resolving failing banks -- could have promoted systemic stability while recovering substantially more for creditors than the bankruptcy proceedings -- and at no cost to taxpayers. The report estimates that given the substantial, though declining, equity and subordinated debt of Lehman in September 2008 and the power for the FDIC to implement a prompt structured sale while providing short-term liquidity to continue value-adding operations, general unsecured creditors could have recovered 97 cents on every $1 of claims, compared to the estimated 21 cents on claims estimated in the most recent bankruptcy plan of reorganization. While there remains no doubt that the orderly liquidation of Lehman would have been incredibly complex and difficult, report concludes that it would have been vastly superior for creditors and systemic stability in all respects to the bankruptcy process as it was applied.
FDIC Chairman Sheila C. Bair said, "This new report is an important step in ensuring that the public and market participants understand how the FDIC's new resolution authority for large systemic firms works. The powers to implement a FDIC liquidation of a systemic financial company during a future crisis give us the tools to end Too Big to Fail and eliminate future bailouts. Much work remains to be done, and we look forward to working with key stakeholders to ensure that this process is effective in achieving its goals. The Lehman failure provides an excellent model to contrast the tools available to the FDIC to effectuate an orderly resolution of a large financial institution against the process used in bankruptcy which, unlike our process, is not specifically designed to deal with the failure of a financial entity. I commend the professional staff for completing this comprehensive and rigorous analysis. It will add tremendous value to the public understanding of the FDIC's resolution process under Dodd-Frank."
Lehman's bankruptcy filing on September 15, 2008, was a signal event of the financial crisis. The disorderly and costly nature of the bankruptcy -- the largest financial bankruptcy in U.S. history -- contributed to the massive financial disruption of late 2008. The lengthy bankruptcy proceeding has allocated resources elsewhere that could have otherwise been used to pay creditors. Through February 2011, more than $1.2 billion in fees have been charged by attorneys and other professionals principally for administration of the debtor's estate.
The FDIC report concludes that Title II of the Dodd-Frank Act could have been used to resolve Lehman by effectuating a rapid, orderly and transparent sale of the company's assets. This sale would have been completed through a competitive bidding process and likely would have incorporated either loss-sharing to encourage higher bids or a form of good firm-bad firm structure in which some troubled assets would be left in the receivership for later disposition. Both approaches would have achieved a seamless transfer and continuity of valuable operations under the powers provided in the Dodd-Frank Act to the benefit of market stability and improved recoveries for creditors. As required by the Dodd-Frank Act, there would be no exposure to taxpayers for losses from Lehman's failure.
The powers provided under the Dodd-Frank Act are critical to these results. Among the critical powers highlighted in the report are the following:
Advance resolution planning: The resolution plans, or living wills, mandated under Title I of the Dodd-Frank Act would have required Lehman to analyze and take action to improve its resolvability and would have permitted the FDIC, working with its fellow regulators, to collect and analyze information for resolution planning purposes in advance of Lehman's impending failure.
Domestic and International Pre-planning: The Lehman resolution plan would have helped the FDIC and other domestic regulators better understand Lehman's business and how it could be resolved. This would have laid the groundwork for continuing development of improved Lehman-specific cross-border planning with foreign regulators to reduce impediments to crisis coordination.
Source of Liquidity: A vital element in preserving continuity of systemically important operations is the availability of funding for those operations. The FDIC could have provided liquidity necessary to fund Lehman's critical operations to promote stability and preserve valuable assets and operations pending the consummation of a sale. These funds are to be repaid from the receivership estate with the shareholders and creditors bearing any loss. By law, taxpayers will not bear any risk of loss.
Speed of Execution: The FDIC would conduct due diligence, identify potential acquirer and troubled assets, determine a transaction structure and conduct sealed bidding -- all before Lehman ever failed and was put into receivership under Title II. A suitable acquirer would be ready to complete the acquisition at the time of Lehman's failure. A critical element in quickly completing a transaction is the power, provided by the Dodd-Frank Act, to require contract parties to continue to perform under contracts with the failed financial company so long as the receiver continues to perform. This is particularly critical to avoid the lost value, as exemplified in the Lehman bankruptcy, when counterparties immediately terminate and net financial contracts and liquidate valuable collateral.
Flexible transactions: The FDIC's bidding structure would provide potential acquirers with the flexibility to bid on troubled assets (e.g., questionable real estate loans) or leave them behind in the receivership. Similarly, creditors could receive advance dividends (i.e., partial payment on their claims) to help move money back out into the market and further promote financial stability. Advance dividends would not be provided if they would expose the receivership to loss.
These powers would enable the FDIC to act to preserve the financial stability of the United States and to maximize value for creditors by preserving franchise value and by rapidly moving proceeds into creditors' hands.
The very availability of a comprehensive resolution system, which sets forth in advance the rules under which the government will act following the appointment of a receiver, could have helped to prevent a 'run on the bank' and the resulting financial instability.
The report was prepared using publically available information about the events leading up to and following the filing of the Lehman bankruptcy petition. The report was prepared by FDIC staff from the Division of Insurance and Research, Office of Complex Financial Institutions, and the Legal Division.
# # #
Congress created the Federal Deposit Insurance Corporation in 1933 to restore public confidence in the nation's banking system. The FDIC insures deposits at the nation's 7,760 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations.”
Under Dodd-Frank the FDIC may have more powers to deal with failing institutions but, without a DOJ (Department of Justice) that is dedicated to find and prosecute fraudsters, the underlying problems will come back to haunt the financial future of us all.
“FDIC Report Examines How an Orderly Resolution of Lehman Brothers Could Have Been Structured Under the Dodd-Frank Act
The FDIC on Monday released a report examining how the FDIC could have structured an orderly resolution of Lehman Brothers Holdings Inc. under the orderly liquidation authority of Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act had that law been in effect in advance of Lehman's failure.
The report concludes that the powers provided to the FDIC under the Dodd-Frank Act to act decisively to preserve asset value and structure a transaction to sell Lehman's valuable operations to interested buyers -- which are drawn from those long used by the FDIC in resolving failing banks -- could have promoted systemic stability while recovering substantially more for creditors than the bankruptcy proceedings -- and at no cost to taxpayers. The report estimates that given the substantial, though declining, equity and subordinated debt of Lehman in September 2008 and the power for the FDIC to implement a prompt structured sale while providing short-term liquidity to continue value-adding operations, general unsecured creditors could have recovered 97 cents on every $1 of claims, compared to the estimated 21 cents on claims estimated in the most recent bankruptcy plan of reorganization. While there remains no doubt that the orderly liquidation of Lehman would have been incredibly complex and difficult, report concludes that it would have been vastly superior for creditors and systemic stability in all respects to the bankruptcy process as it was applied.
FDIC Chairman Sheila C. Bair said, "This new report is an important step in ensuring that the public and market participants understand how the FDIC's new resolution authority for large systemic firms works. The powers to implement a FDIC liquidation of a systemic financial company during a future crisis give us the tools to end Too Big to Fail and eliminate future bailouts. Much work remains to be done, and we look forward to working with key stakeholders to ensure that this process is effective in achieving its goals. The Lehman failure provides an excellent model to contrast the tools available to the FDIC to effectuate an orderly resolution of a large financial institution against the process used in bankruptcy which, unlike our process, is not specifically designed to deal with the failure of a financial entity. I commend the professional staff for completing this comprehensive and rigorous analysis. It will add tremendous value to the public understanding of the FDIC's resolution process under Dodd-Frank."
Lehman's bankruptcy filing on September 15, 2008, was a signal event of the financial crisis. The disorderly and costly nature of the bankruptcy -- the largest financial bankruptcy in U.S. history -- contributed to the massive financial disruption of late 2008. The lengthy bankruptcy proceeding has allocated resources elsewhere that could have otherwise been used to pay creditors. Through February 2011, more than $1.2 billion in fees have been charged by attorneys and other professionals principally for administration of the debtor's estate.
The FDIC report concludes that Title II of the Dodd-Frank Act could have been used to resolve Lehman by effectuating a rapid, orderly and transparent sale of the company's assets. This sale would have been completed through a competitive bidding process and likely would have incorporated either loss-sharing to encourage higher bids or a form of good firm-bad firm structure in which some troubled assets would be left in the receivership for later disposition. Both approaches would have achieved a seamless transfer and continuity of valuable operations under the powers provided in the Dodd-Frank Act to the benefit of market stability and improved recoveries for creditors. As required by the Dodd-Frank Act, there would be no exposure to taxpayers for losses from Lehman's failure.
The powers provided under the Dodd-Frank Act are critical to these results. Among the critical powers highlighted in the report are the following:
Advance resolution planning: The resolution plans, or living wills, mandated under Title I of the Dodd-Frank Act would have required Lehman to analyze and take action to improve its resolvability and would have permitted the FDIC, working with its fellow regulators, to collect and analyze information for resolution planning purposes in advance of Lehman's impending failure.
Domestic and International Pre-planning: The Lehman resolution plan would have helped the FDIC and other domestic regulators better understand Lehman's business and how it could be resolved. This would have laid the groundwork for continuing development of improved Lehman-specific cross-border planning with foreign regulators to reduce impediments to crisis coordination.
Source of Liquidity: A vital element in preserving continuity of systemically important operations is the availability of funding for those operations. The FDIC could have provided liquidity necessary to fund Lehman's critical operations to promote stability and preserve valuable assets and operations pending the consummation of a sale. These funds are to be repaid from the receivership estate with the shareholders and creditors bearing any loss. By law, taxpayers will not bear any risk of loss.
Speed of Execution: The FDIC would conduct due diligence, identify potential acquirer and troubled assets, determine a transaction structure and conduct sealed bidding -- all before Lehman ever failed and was put into receivership under Title II. A suitable acquirer would be ready to complete the acquisition at the time of Lehman's failure. A critical element in quickly completing a transaction is the power, provided by the Dodd-Frank Act, to require contract parties to continue to perform under contracts with the failed financial company so long as the receiver continues to perform. This is particularly critical to avoid the lost value, as exemplified in the Lehman bankruptcy, when counterparties immediately terminate and net financial contracts and liquidate valuable collateral.
Flexible transactions: The FDIC's bidding structure would provide potential acquirers with the flexibility to bid on troubled assets (e.g., questionable real estate loans) or leave them behind in the receivership. Similarly, creditors could receive advance dividends (i.e., partial payment on their claims) to help move money back out into the market and further promote financial stability. Advance dividends would not be provided if they would expose the receivership to loss.
These powers would enable the FDIC to act to preserve the financial stability of the United States and to maximize value for creditors by preserving franchise value and by rapidly moving proceeds into creditors' hands.
The very availability of a comprehensive resolution system, which sets forth in advance the rules under which the government will act following the appointment of a receiver, could have helped to prevent a 'run on the bank' and the resulting financial instability.
The report was prepared using publically available information about the events leading up to and following the filing of the Lehman bankruptcy petition. The report was prepared by FDIC staff from the Division of Insurance and Research, Office of Complex Financial Institutions, and the Legal Division.
# # #
Congress created the Federal Deposit Insurance Corporation in 1933 to restore public confidence in the nation's banking system. The FDIC insures deposits at the nation's 7,760 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations.”
Under Dodd-Frank the FDIC may have more powers to deal with failing institutions but, without a DOJ (Department of Justice) that is dedicated to find and prosecute fraudsters, the underlying problems will come back to haunt the financial future of us all.
Sunday, April 17, 2011
SEC ALLEGES MORTGAGE SECURITIES FRAUD AND TARP SCAM
Many of the worldwide economic woes over the last decade are as a result of fantastical frauds perpetrated by many bankers and securities dealers in the United States. If the SEC is correct in its allegations, the following might be a prime example of just exactly what went on at many U.S. financial institutions over the past 10 years or more. Take a look at the following excerpt from the SEC web site for an understanding of this particular case.
“Washington, D.C., Feb. 24, 2011 — The Securities and Exchange Commission today charged the former treasurer of the one-time largest non-depository mortgage lender in the country with aiding and abetting a $1.5 billion securities fraud scheme and an attempt to scam the U.S. Treasury's Troubled Asset Relief Program (TARP).
The SEC alleges that Desiree E. Brown, the former treasurer of Taylor, Bean & Whitaker Mortgage Corp. (TBW), helped enable the sale of more than $1.5 billion in fictitious and impaired mortgage loans and securities from TBW to Colonial Bank, and caused them to be falsely reported to the investing public as high-quality, liquid assets. Brown also helped cause Colonial Bank to misrepresent that it had satisfied a prerequisite necessary to qualify for TARP funds.
The SEC previously charged former TBW chairman and majority owner Lee B. Farkas in June 2010. Farkas also was arrested in June by criminal authorities. In a related action today, Brown pleaded guilty to criminal charges filed by the Department of Justice in the Eastern District of Virginia.
"Brown willingly participated with Farkas in a $1.5 billion fraud on Colonial Bank and its investors," said Lorin L. Reisner, Deputy Director of the SEC's Division of Enforcement. "Brown also aided efforts by Farkas to mislead Colonial Bank and its regulators regarding the bank's application for TARP funds."
According to the SEC's complaint filed in U.S. District Court for the Eastern District of Virginia, Brown and Farkas perpetrated the fraudulent scheme from March 2002 to August 2009, when Colonial Bank was seized by regulators and Colonial BancGroup and TBW both filed for bankruptcy. TBW was the largest customer of Colonial Bank's Mortgage Warehouse Lending Division (MWLD). Because TBW generally did not have sufficient capital to internally fund the mortgage loans it originated, it relied on financing arrangements primarily through Colonial Bank's MWLD to fund such mortgage loans.
The SEC alleges that when TBW began to experience liquidity problems and overdrew its then-limited warehouse line of credit with Colonial Bank by approximately $15 million each day, Brown and Farkas and an officer of Colonial Bank concealed the overdraws through a pattern of "kiting" in which certain debits were not entered until after credits due for the following day were entered. In order to conceal this initial fraudulent conduct, Brown, Farkas and the Colonial Bank officer created and submitted fictitious loan information to Colonial Bank and created fictitious mortgage-backed securities assembled from the fraudulent loans. By the end of 2007, the scheme consisted of approximately $500 million in fake residential mortgage loans and approximately $1 billion in severely impaired residential mortgage loans and securities. These fictitious and impaired loans were misrepresented as high-quality assets on Colonial BancGroup's financial statements.
The SEC alleges that in addition to causing Colonial BancGroup to misrepresent its assets, Brown assisted Farkas in causing BancGroup to misstate publicly that it had obtained commitments for a $300 million capital infusion that would qualify Colonial Bank for TARP funding. In fact, Farkas and Brown never secured financing or sufficient investors to fund the capital infusion. When BancGroup issued a press release announcing it had obtained preliminary approval to receive $550 million in TARP funds, its stock price jumped 54 percent - its largest one-day price increase since 1983. When BancGroup and TBW later mutually announced the termination of their stock purchase agreement and signaled the end of Colonial Bank's pursuit of TARP funds, BancGroup's stock declined 20 percent.
The SEC's complaint charges Brown with violations of the antifraud, reporting, books and records and internal controls provisions of the federal securities laws. Without admitting or denying the SEC's allegations, Brown consented to the entry of a judgment permanently enjoining her from violation of Rule 13b2-1 of the Securities Exchange Act of 1934 and from aiding and abetting violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-11 and 13a-13 thereunder. The proposed preliminary settlement, under which the SEC's requests for financial penalties against Brown would remain pending, is subject to court approval.
The SEC acknowledges the assistance of the Fraud Section of the U.S. Department of Justice's Criminal Division, the Federal Bureau of Investigation, the Office of the Special Inspector General for the TARP, the Federal Deposit Insurance Corporation's Office of the Inspector General, the Office of the Inspector General for the U.S. Department of Housing and Urban Development, and the U.S. Attorney's Office for the Eastern District of Virginia, Civil Division. The SEC brought its enforcement action in coordination with these other members of the Financial Fraud Enforcement Task Force.
The SEC's investigation is continuing.”
The SEC may be able to get a small amount of money back from Wall Street Fraudsters. However, it is still unclear just how pervasive the fraud has been in the United States. The only thing that is known is that the financial consequences to Americans and others have been devastating in many cases.
“Washington, D.C., Feb. 24, 2011 — The Securities and Exchange Commission today charged the former treasurer of the one-time largest non-depository mortgage lender in the country with aiding and abetting a $1.5 billion securities fraud scheme and an attempt to scam the U.S. Treasury's Troubled Asset Relief Program (TARP).
The SEC alleges that Desiree E. Brown, the former treasurer of Taylor, Bean & Whitaker Mortgage Corp. (TBW), helped enable the sale of more than $1.5 billion in fictitious and impaired mortgage loans and securities from TBW to Colonial Bank, and caused them to be falsely reported to the investing public as high-quality, liquid assets. Brown also helped cause Colonial Bank to misrepresent that it had satisfied a prerequisite necessary to qualify for TARP funds.
The SEC previously charged former TBW chairman and majority owner Lee B. Farkas in June 2010. Farkas also was arrested in June by criminal authorities. In a related action today, Brown pleaded guilty to criminal charges filed by the Department of Justice in the Eastern District of Virginia.
"Brown willingly participated with Farkas in a $1.5 billion fraud on Colonial Bank and its investors," said Lorin L. Reisner, Deputy Director of the SEC's Division of Enforcement. "Brown also aided efforts by Farkas to mislead Colonial Bank and its regulators regarding the bank's application for TARP funds."
According to the SEC's complaint filed in U.S. District Court for the Eastern District of Virginia, Brown and Farkas perpetrated the fraudulent scheme from March 2002 to August 2009, when Colonial Bank was seized by regulators and Colonial BancGroup and TBW both filed for bankruptcy. TBW was the largest customer of Colonial Bank's Mortgage Warehouse Lending Division (MWLD). Because TBW generally did not have sufficient capital to internally fund the mortgage loans it originated, it relied on financing arrangements primarily through Colonial Bank's MWLD to fund such mortgage loans.
The SEC alleges that when TBW began to experience liquidity problems and overdrew its then-limited warehouse line of credit with Colonial Bank by approximately $15 million each day, Brown and Farkas and an officer of Colonial Bank concealed the overdraws through a pattern of "kiting" in which certain debits were not entered until after credits due for the following day were entered. In order to conceal this initial fraudulent conduct, Brown, Farkas and the Colonial Bank officer created and submitted fictitious loan information to Colonial Bank and created fictitious mortgage-backed securities assembled from the fraudulent loans. By the end of 2007, the scheme consisted of approximately $500 million in fake residential mortgage loans and approximately $1 billion in severely impaired residential mortgage loans and securities. These fictitious and impaired loans were misrepresented as high-quality assets on Colonial BancGroup's financial statements.
The SEC alleges that in addition to causing Colonial BancGroup to misrepresent its assets, Brown assisted Farkas in causing BancGroup to misstate publicly that it had obtained commitments for a $300 million capital infusion that would qualify Colonial Bank for TARP funding. In fact, Farkas and Brown never secured financing or sufficient investors to fund the capital infusion. When BancGroup issued a press release announcing it had obtained preliminary approval to receive $550 million in TARP funds, its stock price jumped 54 percent - its largest one-day price increase since 1983. When BancGroup and TBW later mutually announced the termination of their stock purchase agreement and signaled the end of Colonial Bank's pursuit of TARP funds, BancGroup's stock declined 20 percent.
The SEC's complaint charges Brown with violations of the antifraud, reporting, books and records and internal controls provisions of the federal securities laws. Without admitting or denying the SEC's allegations, Brown consented to the entry of a judgment permanently enjoining her from violation of Rule 13b2-1 of the Securities Exchange Act of 1934 and from aiding and abetting violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-11 and 13a-13 thereunder. The proposed preliminary settlement, under which the SEC's requests for financial penalties against Brown would remain pending, is subject to court approval.
The SEC acknowledges the assistance of the Fraud Section of the U.S. Department of Justice's Criminal Division, the Federal Bureau of Investigation, the Office of the Special Inspector General for the TARP, the Federal Deposit Insurance Corporation's Office of the Inspector General, the Office of the Inspector General for the U.S. Department of Housing and Urban Development, and the U.S. Attorney's Office for the Eastern District of Virginia, Civil Division. The SEC brought its enforcement action in coordination with these other members of the Financial Fraud Enforcement Task Force.
The SEC's investigation is continuing.”
The SEC may be able to get a small amount of money back from Wall Street Fraudsters. However, it is still unclear just how pervasive the fraud has been in the United States. The only thing that is known is that the financial consequences to Americans and others have been devastating in many cases.
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