The following is an excerpt from the Department of Justice web site:
"WASHINGTON — UBS AG has entered into an agreement with the Department of Justice to resolve anticompetitive activity in the municipal bond investments market and has agreed to pay a total of $160 million in restitution, penalties and disgorgement to federal and state agencies, the Department of Justice announced today.
As part of its agreement with the department, UBS admits, acknowledges and accepts responsibility for illegal, anticompetitive conduct by its former employees. According to the non-prosecution agreement, from 2001 through 2006, certain former UBS employees at its municipal reinvestment and derivatives desk and related desks, entered into unlawful agreements to manipulate the bidding process and rig bids on municipal investment contracts. These contracts were used to invest the proceeds of, or manage the risks associated with, bond issuances by municipalities and other non-profit entities.
"UBS and its former executives engaged in illegal conduct that corrupted the competitive process and harmed municipalities, and ultimately taxpayers, nationwide," said Assistant Attorney General Christine Varney. "Today's agreements with UBS ensure that restitution is paid to the victims of the anticompetitive conduct, that UBS pays penalties and disgorges its ill-gotten gains. The Antitrust Division will continue to use every tool at our disposal to root out illegal activity in financial markets that disrupts the competitive process."
Under the terms of the agreement, UBS agrees to pay restitution to victims of the anticompetitive conduct and to cooperate fully with the Justice Department's Antitrust Division in its ongoing investigation into anticompetitive conduct in the municipal bond derivatives industry. To date, the ongoing investigation has resulted in criminal charges against 18 former executives of various financial services companies and one corporation. Four of these charged executives are former UBS employees: Mark Zaino, Peter Ghavami, Gary Heinz and Michael Welty. Nine of the 18 executives charged have pleaded guilty, including Mark Zaino.
The Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS) and 25 state attorneys general also entered into agreements with UBS requiring the payment of penalties, disgorgement of profits from the illegal conduct and payment of full restitution to the victims harmed by the manipulation and bid rigging by UBS employees.
As a result of UBS's admission of conduct; its cooperation with the Department of Justice and the SEC, the IRS and the state attorneys general; its monetary and non-monetary commitments to the SEC, IRS and state attorneys general; and its remedial efforts to address the anticompetitive conduct, the department agreed not to prosecute UBS for the manipulation and bid rigging of municipal investment contracts, provided that UBS satisfies its ongoing obligations under the agreement.
In December 2010, Bank of America agreed to pay a total of $137.3 million in restitution to federal and state agencies for its participation in anticompetitive conduct in the municipal bond derivatives market.
The department's ongoing investigation into the municipal bonds industry is being conducted by the Antitrust Division, the FBI and the IRS Criminal Investigation. The department is coordinating its investigation with the SEC, the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Bank of New York.
The Antitrust Division, SEC, IRS, FBI, state attorneys general, OCC and Federal Reserve Bank are members of the Financial Fraud Enforcement Task Force. President Obama established the interagency task force to wage an aggressive, coordinated and proactive effort to investigate and prosecute financial crimes. The task force includes representatives from a broad range of federal agencies, regulatory authorities, inspectors general and state and local law enforcement who, working together, bring to bear a powerful array of criminal and civil enforcement resources. The task force is working to improve efforts across the federal executive branch, and with state and local partners, to investigate and prosecute significant financial crimes, ensure just and effective punishment for those who perpetrate financial crimes, combat discrimination in the lending and financial markets, and recover proceeds for victims of financial crimes. For more information about the task force, visit www.stopfraud.gov."
This is a photo of the National Register of Historic Places listing with reference number 7000063
Thursday, May 5, 2011
SEC PROPOSES DEFINITIONS REGARDING SWAPS
The need for clarity is important if our financial system is to survive. It is the role of government to make such rules that everyone involved can understand. During the past several years definitions of all types of new securities were blurred by those who were either ignorant or more probably, trying to confuse both governmental oversight agencies and the general public. Terms like “Swap” and "insurance" were often mixed or mismatched. The following excerpt is from the SEC web site and it is intended to clarify definitions regarding swaps:
“ Washington, D.C., April 27, 2011 — The Securities and Exchange Commission today voted unanimously to propose rules further defining the terms “swap,” “security-based swap,” and “security-based swap agreement.”
The Commission also proposed rules regarding “mixed swaps” and books and records for “security-based swap agreements.”
The rules were proposed jointly with the Commodity Futures Trading Commission (CFTC) and stem from the Dodd-Frank Wall Street Reform and Consumer Protection Act.
“The proposed definitions balance several policy and legal issues in a way I believe is practical, takes into account the specific nature of derivatives contracts, and is consistent with existing securities regulations,” said SEC Chairman Mary L. Schapiro. “The proposal seeks to provide guidance in rules and interpretations by using clear and objective criteria that should clarify whether a particular instrument is a swap regulated by the CFTC, a security-based swap regulated by the SEC, or a mixed swap regulated by both agencies.”
Public comments on the rule proposal should be received within 60 days after it is published in the Federal Register.
The SEC still has several more rules it must propose under Title VII of the Dodd-Frank Act and continues to welcome comments on those rulemakings that have already been proposed. When all of those rulemaking proposals have been completed, the SEC will consider what additional opportunity for public comment would be appropriate for its Dodd-Frank Act Title VII rules.
# # #
FACT SHEET
Proposals to Further Define Terms in Title VII of the Dodd-Frank Act
Background
The Dodd-Frank Act established a comprehensive framework for regulating the over-the-counter swaps markets. In particular, the Act provides that the SEC will regulate “security-based swaps,” the CFTC will regulate other “swaps,” and the CFTC and the SEC will jointly regulate “mixed swaps.”
Title VII of the Dodd-Frank Act requires that both the SEC and CFTC, in consultation with the Board of Governors of the Federal Reserve System, shall jointly further define the terms “swap,” “security-based swap,” and “security-based swap agreement.” Title VII further provides that the SEC and CFTC shall jointly establish such regulations regarding “mixed swaps” as may be necessary to carry out the purposes of swap and security-based swap regulation under Title VII.
In addition, Title VII requires the SEC and CFTC to jointly adopt rules governing the way in which books and records must be kept for security-based swap agreements. These rules would apply to those entities registered as swap data repositories under the Commodity Exchange Act or registered as swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants.
The Proposal
The joint proposal of the SEC and the CFTC would add rules under the Securities Exchange Act of 1934 and provide interpretive guidance regarding which products would – and would not – be considered a “swap” or a “security-based swap” (referred to collectively in the proposing release as “Title VII instruments”).
Products That Are Not “Swaps” or “Security-Based Swaps”
Insurance: Under the proposed rule and interpretive guidance, insurance products would not be considered swaps or security-based swaps. To be considered insurance, the rules would require that both the product as well as the person or entity providing the product must meet certain criteria. The interpretive guidance would provide that certain types of products must be provided by a person or entity that meets certain criteria in order to be considered insurance.
Among other things, the beneficiary of the insurance product must have an insurable interest and thereby bear the risk of loss with respect to that interest continuously throughout the duration of the agreement, contract, or transaction.
Additionally:
The loss must occur and be proved.
Any payment or indemnification for loss must be limited to the value of the insurable interest.
The agreement, contract or transaction must not be traded, separately from the insured interest, on an organized market or over-the-counter.
With respect to financial guaranty insurance only, in the event of a payment default or insolvency of the obligor, any acceleration of payments under the policy must be at the sole discretion of the insurer.
A person or entity providing the insurance product must be one of the following:
An insurance company whose primary and predominant business activity is insuring or reinsuring risks underwritten by insurance companies, subject to supervision by a state or federal insurance commissioner.
The United States or any of its agencies or instrumentalities.
In the case of reinsurance, a person located outside the United States providing the agreement, contract or transaction to an insurance company eligible under the proposed rules, provided that:
Such person is not otherwise prohibited by law from offering the agreement, contract, or transaction to such an insurance company.
The product to be reinsured meets the requirements under the proposed rules to be an insurance product.
The total amount reimbursable by all reinsurers for such insurance product cannot exceed the claims or losses paid by the cedant.
In some cases, under the proposed interpretive guidance, certain types of products that may not meet the proposed criteria would still be considered insurance, and not swaps or security-based swaps, if those products are offered by a regulated insurance company. These products include surety bonds, life insurance, health insurance, long-term care insurance, title insurance, property and casualty insurance, and annuity products the income on which is subject to tax treatment under Section 72 of the Internal Revenue Code.
Security forwards: The SEC proposed interpretive guidance clarifying that security forwards fall outside the definitions of swap and security-based swap. This includes the treatment of mortgage backed securities that are eligible to be sold in the “to-be-announced” or “TBA” market.
Consumer and Commercial Transactions: The SEC also proposed interpretive guidance describing the way in which certain consumer and commercial transactions fall outside the definitions of swap and security-based swap.
Consumer Transactions
Under the proposed interpretive guidance, certain agreements, contracts or transactions entered into by consumers primarily for personal, family or household purposes should not be considered swaps or security-based swaps.
They include agreements, contracts or transactions:
To acquire or lease real or personal property, to obtain a mortgage, to provide personal services, or to sell or assign rights owned by such consumer (such as intellectual property rights).
That provide for an interest rate cap or lock on a consumer loan or mortgage, where the benefit of the rate cap or lock is realized by the consumer only if the loan or mortgage is made thereto.
They also include consumer loans or mortgages with variable rates of interest, including such loans with provisions for the rates to change upon certain events related to the consumer, such as a higher rate of interest following a default.
Commercial Transactions
Under the proposed interpretive guidance, commercial agreements, contracts, or transactions that involve customary business or commercial arrangements (whether or not involving a for-profit entity) would not be considered swaps or security-based swaps.
They include:
Employment contracts and retirement benefit arrangements.
Sales, servicing, or distribution arrangements.
Agreements, contracts, or transactions for the purpose of effecting a business combination transaction.
The purchase, sale, lease, or transfer of real property, intellectual property, equipment, or inventory.
Warehouse lending arrangements in connection with building an inventory of assets in anticipation of a securitization of such assets (such as in a securitization of mortgages, student loans, or receivables).
Mortgage or mortgage purchase commitments, or sales of installment loan agreements or contracts or receivables.
Fixed or variable interest rate commercial loans entered into by non-banks.
Commercial agreements, contracts, and transactions (including, but not limited to, leases, service contracts, and employment agreements) containing escalation clauses linked to an underlying commodity such as an interest rate or consumer price index.
The consumer and commercial transactions listed in the proposed guidance are not an exhaustive list of transactions that should not be considered swaps or security-based swaps. The proposed guidance provides for certain factors the Commissions will consider in determining whether consumer and commercial transactions that are not listed are swaps or security-based swaps.
Transactions That Are “Swaps” or Security-Based Swaps”
The SEC proposed a rule and interpretive guidance that the following transactions fall within the definition of swap or security-based swap: foreign exchange forwards, foreign exchange swaps, foreign currency options (other than foreign currency options traded on a national securities exchange), non-deliverable forward contracts involving foreign exchange, currency and cross-currency swaps, forward rate agreements, contracts for differences, and certain combinations and permutations of (or options on) swaps and security-based swaps.
In its proposed interpretive guidance, the SEC would clarify whether particular agreements, contracts or transactions are swaps, security-based swaps, or mixed swaps. Among other things, the proposed guidance would provide that such a determination is to be made at the inception of the Title VII instrument and that such a characterization would remain throughout the life of the instrument unless the instrument is amended or modified.
Interest Rates, Other Monetary Rates and Yields: Under the proposed interpretive guidance, Title VII instruments on interest rates and other monetary rates would be swaps. And, Title VII instruments on “yields” – where “yield” is a proxy for the price or value of a debt security, loan, or narrow-based security index – would be security-based swaps, except in the case of certain exempted securities.
Meanwhile, Title VII instruments on rates or yields of U.S. Treasuries and certain other exempted securities (other than municipal securities) would be swaps and not security-based swaps.
Total Return Swaps: Under the proposed interpretive guidance, a Total Return Swap, or TRS, on a single security, loan, or narrow-based security index generally would be a security-based swap. Where counterparties embed interest-rate optionality or a non-securities component into the TRS (e.g., the price of oil, a currency hedge), it would be a mixed swap.
Title VII Instruments Based on Futures: Under the proposed interpretive guidance, Title VII instruments on futures (other than futures on foreign government debt securities) would generally be swaps and Title VII instruments on security futures would generally be security-based swaps.
Swaps and Security-Based Swaps Based on Security Indexes
The SEC proposed rules and interpretive guidance regarding the applicability of the “narrow-based security index” definition to certain products, including proposed rules regarding the definition of “narrow-based security index” and “issuers of securities in a narrow-based security index” for index credit default swaps (index CDS).
The SEC also proposed rules and interpretive guidance regarding the definition of a security index and the evaluation of Title VII instruments based on security indexes that migrate from broad-based to narrow-based and vice versa.
The SEC proposed rules and interpretive guidance regarding the term “narrow-based security index” in the security-based swap definition, including:
The existing criteria for determining whether a security index is a narrow-based security index and the applicability of past guidance of the SEC and CFTC regarding those criteria to Title VII instruments.
New criteria for determining whether an index CDS where the underlying reference is a group or index of entities or obligations of entities is based on an index that is a narrow-based security index.
The meaning of the term “index.”
A rule governing the tolerance period for Title VII instruments on security indexes traded on designated contract markets (DCMs), swap execution facilities (SEFs), foreign boards of trade (FBOTs), security-based SEFs, or national securities exchanges (NSEs), where the security index temporarily moves from broad-based to narrow-based or from narrow-based to broad-based.
A rule governing the grace period for Title VII instruments on security indexes traded on DCMs, SEFs, FBOTs, security-based SEFs, or NSEs, where the security index moves from broad-based to narrow-based or from narrow-based to broad-based and the move is not temporary.
If a broad-based index CDS requires mandatory physical settlement, it would be a mixed swap.
If a broad-based index CDS requires cash settlement or auction settlement, it would be a swap, and would not be considered a security-based swap or a mixed swap solely because the determination of the cash price to be paid is established through a security or loan auction.
Mixed Swaps
The SEC proposed interpretive guidance regarding the scope of the mixed swap category, which both the SEC and CFTC believe to be narrow.
The SEC also proposed rules and interpretive guidance that mixed swaps would remain subject to the entirety of the SEC and CFTC regulatory regimes, but that for bilateral uncleared mixed swaps entered into by at least one dually-regulated swap and security-based swap dealer or major swap and security-based swap participant, certain regulatory requirements would apply.
In addition, the SEC proposed a rule establishing a process, for all other mixed swaps, by which persons may request modified regulatory treatment by joint order of the SEC and CFTC.
Security-Based Swap Agreements
The SEC proposed interpretative guidance regarding certain products that are security-based swap agreements (SBSA). It also proposed a rule requiring market participants to maintain the same books and records for security-based swap agreements as they would under the CFTC’s proposed books and records requirements for swaps.
Interpretation of the Characterization of a Product
The SEC proposed a rule establishing a process that would allow market participants or either the SEC or CFTC to request a determination from the SEC and CFTC of whether a product is a swap, security-based swap, or both (i.e., a mixed swap).”
“ Washington, D.C., April 27, 2011 — The Securities and Exchange Commission today voted unanimously to propose rules further defining the terms “swap,” “security-based swap,” and “security-based swap agreement.”
The Commission also proposed rules regarding “mixed swaps” and books and records for “security-based swap agreements.”
The rules were proposed jointly with the Commodity Futures Trading Commission (CFTC) and stem from the Dodd-Frank Wall Street Reform and Consumer Protection Act.
“The proposed definitions balance several policy and legal issues in a way I believe is practical, takes into account the specific nature of derivatives contracts, and is consistent with existing securities regulations,” said SEC Chairman Mary L. Schapiro. “The proposal seeks to provide guidance in rules and interpretations by using clear and objective criteria that should clarify whether a particular instrument is a swap regulated by the CFTC, a security-based swap regulated by the SEC, or a mixed swap regulated by both agencies.”
Public comments on the rule proposal should be received within 60 days after it is published in the Federal Register.
The SEC still has several more rules it must propose under Title VII of the Dodd-Frank Act and continues to welcome comments on those rulemakings that have already been proposed. When all of those rulemaking proposals have been completed, the SEC will consider what additional opportunity for public comment would be appropriate for its Dodd-Frank Act Title VII rules.
# # #
FACT SHEET
Proposals to Further Define Terms in Title VII of the Dodd-Frank Act
Background
The Dodd-Frank Act established a comprehensive framework for regulating the over-the-counter swaps markets. In particular, the Act provides that the SEC will regulate “security-based swaps,” the CFTC will regulate other “swaps,” and the CFTC and the SEC will jointly regulate “mixed swaps.”
Title VII of the Dodd-Frank Act requires that both the SEC and CFTC, in consultation with the Board of Governors of the Federal Reserve System, shall jointly further define the terms “swap,” “security-based swap,” and “security-based swap agreement.” Title VII further provides that the SEC and CFTC shall jointly establish such regulations regarding “mixed swaps” as may be necessary to carry out the purposes of swap and security-based swap regulation under Title VII.
In addition, Title VII requires the SEC and CFTC to jointly adopt rules governing the way in which books and records must be kept for security-based swap agreements. These rules would apply to those entities registered as swap data repositories under the Commodity Exchange Act or registered as swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants.
The Proposal
The joint proposal of the SEC and the CFTC would add rules under the Securities Exchange Act of 1934 and provide interpretive guidance regarding which products would – and would not – be considered a “swap” or a “security-based swap” (referred to collectively in the proposing release as “Title VII instruments”).
Products That Are Not “Swaps” or “Security-Based Swaps”
Insurance: Under the proposed rule and interpretive guidance, insurance products would not be considered swaps or security-based swaps. To be considered insurance, the rules would require that both the product as well as the person or entity providing the product must meet certain criteria. The interpretive guidance would provide that certain types of products must be provided by a person or entity that meets certain criteria in order to be considered insurance.
Among other things, the beneficiary of the insurance product must have an insurable interest and thereby bear the risk of loss with respect to that interest continuously throughout the duration of the agreement, contract, or transaction.
Additionally:
The loss must occur and be proved.
Any payment or indemnification for loss must be limited to the value of the insurable interest.
The agreement, contract or transaction must not be traded, separately from the insured interest, on an organized market or over-the-counter.
With respect to financial guaranty insurance only, in the event of a payment default or insolvency of the obligor, any acceleration of payments under the policy must be at the sole discretion of the insurer.
A person or entity providing the insurance product must be one of the following:
An insurance company whose primary and predominant business activity is insuring or reinsuring risks underwritten by insurance companies, subject to supervision by a state or federal insurance commissioner.
The United States or any of its agencies or instrumentalities.
In the case of reinsurance, a person located outside the United States providing the agreement, contract or transaction to an insurance company eligible under the proposed rules, provided that:
Such person is not otherwise prohibited by law from offering the agreement, contract, or transaction to such an insurance company.
The product to be reinsured meets the requirements under the proposed rules to be an insurance product.
The total amount reimbursable by all reinsurers for such insurance product cannot exceed the claims or losses paid by the cedant.
In some cases, under the proposed interpretive guidance, certain types of products that may not meet the proposed criteria would still be considered insurance, and not swaps or security-based swaps, if those products are offered by a regulated insurance company. These products include surety bonds, life insurance, health insurance, long-term care insurance, title insurance, property and casualty insurance, and annuity products the income on which is subject to tax treatment under Section 72 of the Internal Revenue Code.
Security forwards: The SEC proposed interpretive guidance clarifying that security forwards fall outside the definitions of swap and security-based swap. This includes the treatment of mortgage backed securities that are eligible to be sold in the “to-be-announced” or “TBA” market.
Consumer and Commercial Transactions: The SEC also proposed interpretive guidance describing the way in which certain consumer and commercial transactions fall outside the definitions of swap and security-based swap.
Consumer Transactions
Under the proposed interpretive guidance, certain agreements, contracts or transactions entered into by consumers primarily for personal, family or household purposes should not be considered swaps or security-based swaps.
They include agreements, contracts or transactions:
To acquire or lease real or personal property, to obtain a mortgage, to provide personal services, or to sell or assign rights owned by such consumer (such as intellectual property rights).
That provide for an interest rate cap or lock on a consumer loan or mortgage, where the benefit of the rate cap or lock is realized by the consumer only if the loan or mortgage is made thereto.
They also include consumer loans or mortgages with variable rates of interest, including such loans with provisions for the rates to change upon certain events related to the consumer, such as a higher rate of interest following a default.
Commercial Transactions
Under the proposed interpretive guidance, commercial agreements, contracts, or transactions that involve customary business or commercial arrangements (whether or not involving a for-profit entity) would not be considered swaps or security-based swaps.
They include:
Employment contracts and retirement benefit arrangements.
Sales, servicing, or distribution arrangements.
Agreements, contracts, or transactions for the purpose of effecting a business combination transaction.
The purchase, sale, lease, or transfer of real property, intellectual property, equipment, or inventory.
Warehouse lending arrangements in connection with building an inventory of assets in anticipation of a securitization of such assets (such as in a securitization of mortgages, student loans, or receivables).
Mortgage or mortgage purchase commitments, or sales of installment loan agreements or contracts or receivables.
Fixed or variable interest rate commercial loans entered into by non-banks.
Commercial agreements, contracts, and transactions (including, but not limited to, leases, service contracts, and employment agreements) containing escalation clauses linked to an underlying commodity such as an interest rate or consumer price index.
The consumer and commercial transactions listed in the proposed guidance are not an exhaustive list of transactions that should not be considered swaps or security-based swaps. The proposed guidance provides for certain factors the Commissions will consider in determining whether consumer and commercial transactions that are not listed are swaps or security-based swaps.
Transactions That Are “Swaps” or Security-Based Swaps”
The SEC proposed a rule and interpretive guidance that the following transactions fall within the definition of swap or security-based swap: foreign exchange forwards, foreign exchange swaps, foreign currency options (other than foreign currency options traded on a national securities exchange), non-deliverable forward contracts involving foreign exchange, currency and cross-currency swaps, forward rate agreements, contracts for differences, and certain combinations and permutations of (or options on) swaps and security-based swaps.
In its proposed interpretive guidance, the SEC would clarify whether particular agreements, contracts or transactions are swaps, security-based swaps, or mixed swaps. Among other things, the proposed guidance would provide that such a determination is to be made at the inception of the Title VII instrument and that such a characterization would remain throughout the life of the instrument unless the instrument is amended or modified.
Interest Rates, Other Monetary Rates and Yields: Under the proposed interpretive guidance, Title VII instruments on interest rates and other monetary rates would be swaps. And, Title VII instruments on “yields” – where “yield” is a proxy for the price or value of a debt security, loan, or narrow-based security index – would be security-based swaps, except in the case of certain exempted securities.
Meanwhile, Title VII instruments on rates or yields of U.S. Treasuries and certain other exempted securities (other than municipal securities) would be swaps and not security-based swaps.
Total Return Swaps: Under the proposed interpretive guidance, a Total Return Swap, or TRS, on a single security, loan, or narrow-based security index generally would be a security-based swap. Where counterparties embed interest-rate optionality or a non-securities component into the TRS (e.g., the price of oil, a currency hedge), it would be a mixed swap.
Title VII Instruments Based on Futures: Under the proposed interpretive guidance, Title VII instruments on futures (other than futures on foreign government debt securities) would generally be swaps and Title VII instruments on security futures would generally be security-based swaps.
Swaps and Security-Based Swaps Based on Security Indexes
The SEC proposed rules and interpretive guidance regarding the applicability of the “narrow-based security index” definition to certain products, including proposed rules regarding the definition of “narrow-based security index” and “issuers of securities in a narrow-based security index” for index credit default swaps (index CDS).
The SEC also proposed rules and interpretive guidance regarding the definition of a security index and the evaluation of Title VII instruments based on security indexes that migrate from broad-based to narrow-based and vice versa.
The SEC proposed rules and interpretive guidance regarding the term “narrow-based security index” in the security-based swap definition, including:
The existing criteria for determining whether a security index is a narrow-based security index and the applicability of past guidance of the SEC and CFTC regarding those criteria to Title VII instruments.
New criteria for determining whether an index CDS where the underlying reference is a group or index of entities or obligations of entities is based on an index that is a narrow-based security index.
The meaning of the term “index.”
A rule governing the tolerance period for Title VII instruments on security indexes traded on designated contract markets (DCMs), swap execution facilities (SEFs), foreign boards of trade (FBOTs), security-based SEFs, or national securities exchanges (NSEs), where the security index temporarily moves from broad-based to narrow-based or from narrow-based to broad-based.
A rule governing the grace period for Title VII instruments on security indexes traded on DCMs, SEFs, FBOTs, security-based SEFs, or NSEs, where the security index moves from broad-based to narrow-based or from narrow-based to broad-based and the move is not temporary.
If a broad-based index CDS requires mandatory physical settlement, it would be a mixed swap.
If a broad-based index CDS requires cash settlement or auction settlement, it would be a swap, and would not be considered a security-based swap or a mixed swap solely because the determination of the cash price to be paid is established through a security or loan auction.
Mixed Swaps
The SEC proposed interpretive guidance regarding the scope of the mixed swap category, which both the SEC and CFTC believe to be narrow.
The SEC also proposed rules and interpretive guidance that mixed swaps would remain subject to the entirety of the SEC and CFTC regulatory regimes, but that for bilateral uncleared mixed swaps entered into by at least one dually-regulated swap and security-based swap dealer or major swap and security-based swap participant, certain regulatory requirements would apply.
In addition, the SEC proposed a rule establishing a process, for all other mixed swaps, by which persons may request modified regulatory treatment by joint order of the SEC and CFTC.
Security-Based Swap Agreements
The SEC proposed interpretative guidance regarding certain products that are security-based swap agreements (SBSA). It also proposed a rule requiring market participants to maintain the same books and records for security-based swap agreements as they would under the CFTC’s proposed books and records requirements for swaps.
Interpretation of the Characterization of a Product
The SEC proposed a rule establishing a process that would allow market participants or either the SEC or CFTC to request a determination from the SEC and CFTC of whether a product is a swap, security-based swap, or both (i.e., a mixed swap).”
Wednesday, May 4, 2011
SEC CHARGES UBS FINANCIAL SERVICES INC. WITH FRAUD
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.
“ 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.
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.
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