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Senators Unveil Bill to Increase SEC Civil Penalties; House Members Propose Competing Bills to Enhance the SEC's Investment Adviser Oversight
On July 23, Senators Reed (D-RI) and Grassley (R-IA) unveiled legislation to increase statutory limits on SEC civil monetary penalties to $1 million per violation for individuals, and $10 million per violation for entities. The bill, S. 3416, would also allow for the size of penalties to be linked to the scope of harm and associated investor losses, and provide substantially higher penalties for repeat offenders. The legislation follows a letter SEC Chairman Shapiro sent to Senators Reed and Crapo (R-ID) in November 2011, seeking reforms to the SEC’s authority to impose civil penalties.
On July 24, Representatives Waters (D-CA), Frank (D-MA), and Capuano (D-MA) announced new legislation, H.R. 6204, that would provide the SEC with the authority to impose user fees on investment advisers for the purpose of funding an increase in the number and frequency of SEC examinations. This bill follows an earlier bill from Reps. Bachus (R-AL) and McCarthy (D-NY), H.R. 4624, which also seeks to improve oversight of investment advisers, but through the establishment of self-regulatory organizations overseen by the SEC that investment advisers with retail customers would be required to join.
Federal Court Allows Shareholder Suit Alleging Concealment of Mortgage-Related Risks to Proceed
On July 11, the U.S. District Court for the Southern District of New York declined to dismiss the majority of the claims brought by a putative class alleging that a national bank, certain of its current and former officers and directors, multiple underwriters, and the bank’s third-party accounting auditor, deliberately concealed the bank’s reliance on an electronic registry system and its exposure to MBS loan repurchase claims. Pa. Pub. Sch. Employee’s Ret. Sys. v. Bank of Am. Corp. No. 11-733, 2012 WL 2847732 (S.D.N.Y. Jul. 11, 2012). In this case, a state retirement system alleges on behalf of similarly situated shareholders that the bank misrepresented that it had “good title” to loans even though multiple courts had blocked the bank’s attempts to foreclosure based on the bank’s use of an electronic registry system. The court, in declining to dismiss these claims, held that the use of the registry system “clouded” the bank’s ownership of many loans, thereby causing the bank to publish misleading shareholder information. The court also declined to dismiss allegations that the defendants misstated or omitted the bank’s exposure to repurchase claims. Further, claims that the bank misled investors about its internal controls also survived. Several other claims, including certain claims against the directors and officers were dismissed without prejudice, while other certain other claims against the defendants were dismissed with prejudice.
SEC Announces Additional Senior Appointments
On July 5, the SEC announced Norm Champ as the new Director of the SEC’s Division of Investment Management. Mr. Champ has been serving as Deputy Director of the SEC’s Office of Compliance Inspections and Examinations. Prior to joining the SEC in 2010, Mr. Champ was general counsel and a partner at investment management firm Chilton Investment Company. On July 9, the SEC announced that beginning August 6, 2012, Paula Drake will serve as Associate Director, Chief Counsel and Chief Compliance and Ethics Officer. Ms. Drake joins the SEC from Oechsle International Advisors, LLC, where she served as General Counsel and Chief Operating Officer.
CFTC, SEC Approve Final Rules To Define "Swap"; CFTC Exempts Small Banks From Clearing Requirements
This week the CFTC and the SEC approved jointly written rules and guidance to further define “swap”, “security-based swap,” and other related terms for use in regulating over-the-counter (OTC) derivatives. The Dodd-Frank Act defines these terms but also requires both the SEC and CFTC to jointly define the terms further and jointly establish regulations regarding “mixed swaps” as may be necessary to carry out the purposes of swap and security-based swap regulation under the Act. The SEC and CFTC final rules and guidance identify specific products and services that do and do not fall within the further-defined terms. The approved rules will take effect 60 days after being published in the Federal Register. The approval of the definitions also triggers the period for swap dealers to comply with other Dodd-Frank Act rules put in place to regulate the OTC derivatives markets. The CFTC also approved a final rule that implements an exemption to the clearing requirement for non-financial entities and financial institutions with total assets of $10 billion or less that hedge or mitigate business risk through swaps.
New York Federal Court Certifies Class in MBS Litigation
On June 29, the U.S. District Court for the Southern District of New York granted the plaintiffs motion to certify a class in a putative class action concerning the sale of mortgage backed securities (MBS) by an investment bank. Tsereteli v. Residential Asset Securitization Trust 2006-A8, No. 08 Civ. 10637, 2012 WL 2532172 (S.D.N.Y. June 29, 2012). In Tsereteli, the plaintiffs alleged that the sale of the MBS violated the Securities Act of 1933, because the offering documents falsely represented that the underlying mortgage loans were originated in accordance with the lenders underwriting standards. According to the plaintiffs, the lender had in fact abandoned its underwriting standards and routinely made loans to borrowers who were unable to meet their repayment obligations. The bank, among other things, argued that Rule 23s predominance requirement was not met because certain sophisticated investors were aware of the alleged misstatements when they purchased the securities. The court, however, found that [g]eneral investment sophistication of certain class members does not show that any of the class members knew anything at all about [the lenders] alleged deviation from its underwriting guidelines.
New York State Appeals Court Upholds Decision Dismissing Buyback Lawsuit
On June 28, the Appellate Division of the Supreme Court of New York, First Department unanimously confirmed the New York Supreme Courts dismissal of a mortgage-buyback lawsuit brought by investors against a bank, holding that the investors action was barred by the no-action clause in the Pooling and Servicing Agreements (PSAs). Walnut Place LLC v. Countrywide Home Loans, Inc., No. 8046, 650497/11, 2012 slip op. 0521 (N.Y. App. Div. June 28, 2012). The Appellate Division found that the no-action clausea clause limiting the right to suewas not ambiguous and only allowed investors to sue under an event of default provision which was not applicable under the set of facts before the court. The case was brought by several entities collectively known as Walnut Place LLC, who had invested more than $1 billion in securities backed by the banks mortgages. The investors claimed that the bank made false representations about the characteristics and credit quality of loans underlying the securities in the PSAs.
SEC and FDIC Announce Senior Appointments
On July 3, the SEC announced that Ken C. Joseph will lead the Investment Adviser/Investment Company Examination Program for the New York Regional Office. Mr. Joseph previously served for 16 years as a Staff Attorney, Branch Chief, and Assistant Director in the SEC’s Division of Enforcement in Washington, DC and New York.
On July 2, the FDIC announced that Doreen R. Eberley will oversee all examination activities of the FDIC’s regional and field supervisory operations as Senior Deputy Director for Supervisory Examinations in the Division of Risk Management Supervision. Ms. Eberley currently serves as New York Regional Director and has been with the FDIC for 25 years. The FDIC also announced that Andrew Gray will serve as Deputy to the Chairman for Communications and Eric Spitler will serve as Director of the Office of Legislative Affairs.
California Appeals Court Holds Brokerage Agreement Sufficiently Incorporated Arbitration Provision
On June 21, the California Second District Court of Appeal held that a defendant brokerage firm had established an agreement to arbitrate, where the brokerage account application signed by the plaintiffs incorporated by reference certain arbitration provisions of a separate client agreement. Rodriguez v. Citigroup Global Markets, Inc., No. B230310, 2012 WL 2354637 (Cal. Ct. App. June 21, 2012). The appeals court observed that the plaintiffs had signed an account application that explicitly stated that any signatories had also agreed to all terms of a separate client agreement. Another paragraph of the same application, located directly above the signature lines, included an express acknowledgement that the client agreement included an arbitration provision. The court rejected several arguments proffered by the plaintiffs, including that (i) the references to the arbitration provision were unreadable, (ii) the plaintiffs had never received the client agreement containing the arbitration provision, (iii) the client agreement itself was not signed, and (iv) the client agreement was confusing.
Federal District Court Allows Interlocutory Appeal of Challenge to FHFA MBS Suit
On June 19, the U.S. District Court for the Southern District of New York granted defendants motion to certify an interlocutory appeal from a portion of the courts earlier denial of their motion to dismiss as untimely the FHFAs claims under the 1933 Securities Act. Fed. Hous. Fin. Agency v. UBS Americas, Inc., No. 11-5201, 2012 WL 2324486 (S.D.N.Y. June 19, 2012). On May 4, 2012, the court denied, in large part, the defendants motion to dismiss the FHFAs claims alleging that billions of dollars of MBS purchased by Fannie Mae and Freddie Mac were based on offering documents that contained materially false statements and omissions. The suit was selected to proceed first among the 18 such suits brought by the FHFA. In this most recent decision, the court reasoned that resolution of issues relating to the timeliness of the claims will remove a cloud of legal uncertainty that hangs over the other 17 actions in this suite of cases by clarifying the impact of the Housing and Economic Recovery Act of 2008 on the statute of limitations in the Securities Act of 1933 and, as a consequence, defining the scope of discovery.
State AGs Granted Right to Intervene in Private MBS Action
On June 6, a New York state court ordered that the attorneys general for the states of Delaware and New York (state AGs) could intervene in a case challenging an $8.5 billion settlement related to allegations that the originator and servicer of certain mortgage backed securities breached obligations owed to the trusts. In re Application of The Bank of New York Mellon, No. 651786/11, slip op. (NY Sup. Ct. Jun 6, 2012). The trustee is seeking state confirmation that it had authority to enter into the settlement agreement and in so doing did not violate its duties under the trust agreements and state law. A group of institutional investors moved to challenge the settlement, and in a decision earlier this year the Second Circuit reversed a federal district court and held that the case fell within the securities exception to both original and appellate jurisdiction under the Class Action Fairness Act of 2005 and should proceed in state court. The federal district court also had granted a motion to intervene filed by the state AGs, holding that they could appropriately intervene to represent the interests of absent investors. The court reasoned that the state AGs had "parens patriae standing" to preserve an "honest marketplace." On remand in state court, the state AGs renewed their motions to intervene. In granting intervention, the state court rejected arguments made by the trustee and the institutional investors that the state AGs lack parens patriae standing, and that the state AGs are not seeking any injunctive relief to protect any quasi-sovereign interests. Instead, the court followed the prior federal court decision and held that the state AGs identified legitimate quasi-sovereign interests sufficient to provide standing to intervene.