Securities Law Blog

For the first time, the U.S. Department of Labor (DOL) has established disclosure obligation regulation for advisers and brokers who manage 401(k) plans. The proposed rulemaking began in December 2007 to help plan sponsors and fiduciaries better understand how (and how much) service providers are compensated.

The disclosure obligation is designed to ensure that Employee Retirement Income Security Act (ERISA) plan fiduciaries are provided the information they need to make better decisions when selecting and monitoring service providers for their plans.

The rules define service providers that must comply with the disclosure requirements, as being fiduciaries, investment advisers and record keepers or brokers who make investment alternatives to a plan.

According to the DOL, the regulation will apply to defined contribution and defined pension plans and focuses on the disclosure of the direct and indirect compensation certain service providers receive. Plan service providers that expect to receive at least $1,000 in compensation in connection with their services will be expected to provide a detailed account of the fees they are charging to manage the retirement plans.

Such services will include “certain fiduciary or registered investment advisory services; recordkeeping or brokerage services to a participant-directed individual account plan in connection with the investment options made available under the plan; or certain other services for which indirect compensation is received.”

Information must also be disclosed about plan investments and investment options.

According to the DOL, “the new rules are aimed at assisting plan sponsors in assessing the reasonableness of contracts or arrangements, including the reasonableness of service providers’ compensation and potential conflicts of interest.”

The new rules are scheduled to go into effect in July 2011.

Goldman, Sachs & Co. will pay $550 million to settle the charges raised in the April 16, 2010 complaint filed by the Securities and Exchange Commission (SEC). The settlement also requires the Wall Street firm to review its business practices related to complex mortgage securities, and the way it educates its employees in that part of its business. The role of Goldman’s internal legal counsel, compliance personnel, and outside counsel is also expected to expand to include the review of written marketing materials for mortgage securities offerings.

According to the SEC complaint, “Goldman misstated and omitted key facts regarding a synthetic collaterized debt obligation (CDO) it marketed that hinged on the performance of subprime mortgage-backed securities.” The CDO, known as ABACUS 2007-AC1, was created by Goldman in 2007 as a vehicle for the bank and some of its clients to bet against the housing market.

Goldman allegedly told investors that the bonds were chosen by independent manger, ACA Management LLC. Instead, the SEC claims that Goldman failed to disclose to investors that hedge fund manager John Paulson of Paulson & Co. Inc. was allowed to select mortgage bonds that he believed were most likely to lose value. Investors lost more than $1 billion in the deal, while Paulson netted an estimated $3.7 billion by betting on the housing bubble to burst, according to the complaint.

In the settlement papers, Goldman stated that “the marketing materials for the ABACUS 2007-AC1 transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was ‘selected by’ ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson’s economic interests were adverse to CDO investors.
Goldman regrets that the marketing materials did not contain that disclosure.”

Of the $550 million to be paid by Goldman, $250 would be returned to harmed investors through a Fair Fund distribution and $300 million would be paid to the U.S. Treasury.

The settlement does not include charges against Goldman employee Fabrice P. Tourre, who played a key role in marketing the security to potential investors, according to the SEC.

The Financial Industry Regulatory Authority (FINRA) has announced that it will be making significant changes to its free, online BrokerCheck service before the end of 2010. FINRA will be casting a wider net to expand the information made available to the public about current and former securities brokers.

The expansion will increase the number of customer complaints reported publicly and extend the public disclosure period for the full record of a broker who leaves the industry within the ten preceding years. Complaints dating back to 1999, when electronic filing of broker information began, will be available. These complaints will include customer complaints, regulatory actions, arbitrations and litigations.

Currently, a broker’s record is publicly available for two years after he or she leaves the securities industry. The expanded BrokerCheck will make a former broker’s record public for ten years, enabling investors to access information about individuals who may work in other sectors of the financial services industry.

Investors will benefit from the additional information when deciding whether to begin or continue their business with a particular broker or firm, said FINRA Chairman and CEO Rick Ketchum. “Just as important, it will provide valuable information about persons who have left the securities industry, often not of their own accord, who have established themselves in other segments of the financial services industry and can still cause great harm to the investing public.”

Last year, BrokerCheck started making information about regulatory action such as bars, suspensions and fines, against former brokers permanently available to the public. The more comprehensive version will include additional information reported to FINRA since 1999. The additional information will include reportable criminal convictions or pleas of guilty or nolo contendere, civil injunctions or findings of involvement in a violation of any investment-related statute or regulation, and arbitration awards or civil judgments based on the individual’s involvement in alleged sales practice violations.

Current and former brokers will be able to submit a written notice of dispute to FINRA with all supporting documentation, if they believe the information to be inaccurate or out of date. A notation signifying the broker is disputing the information will be posted to the broker’s BrokerCheck report, and removed following an investigation.

The first wave of changes will come in late August, when all historic complaints will be added to current and former broker’s reports. By the end of the year, full records for any broker registered within the last 10 years will be public, and all permanent information will be added to the appropriate broker reports.

What do sandwiches in a can, greeting card sentiments on rose petals, and a film about the Pinewood Derby all have in common? They were all ideas allegedly invested in by Utah money manager Travis L. Wright with $145 million of investor money.

The Securities and Exchange Commission (SEC) filed a lawsuit against Wright on July 1, 2010 in federal court in Salt Lake City, Utah. The SEC claimed that between 2001 and 2009 Wright misused $139 million of the $145 million raised from over 175 investors by selling notes issued by his Waterford Loan Fund LLC.

Wright allegedly told investors that their money would be used for loans secured by commercial real estate and promised returns of up to 24%.

Instead Wright purportedly used the money to invest in Candwich development of canned sandwiches to be sold in vending machines. The concept has been patented by the president of Mark One Foods, Mark Kirkland, who reported that Wright promised full financial backing for Candwich production.

Wright’s other business investments allegedly included an investment company he owned with his brother to distribute a film about the Pinewood Derby, companies that sell watches online, and rose petals that carry printed greeting card sentiments. The SEC also claims that some of the money raised went towards loans to friends and a lavish lifestyle for Wright and his family.

Investors confronted Wright after they stopped receiving interest payments.

The SEC is seeking to recover ill-gotten gains, impose civil fines and a ban on Wright selling securities.

Three former State Street Corp. executives are being sued by the securities giant for allegedly breaching terms of their employment contracts and attempting to steal business from their previous employer.

In a lawsuit filed on June 23, 2010 in Superior Court for the Commonwealth of Massachusetts in Boston, State Street alleged that its former securities finance chief, Craig V. Starble, has been luring State Street employees and soliciting its customers to build his own firm, Premier Global Securities Lending.

According to the lawsuit, Starble was employed at State Street until March 2009, at which point he resigned to start his own firm. In early 2010 Starble purportedly approached State Street with the idea of turning the securities lending operation into a separate business under his supervision. State Street, however, rejected the idea as being bad for the company and its shareholders.

Two other executives named in the suit are former senior director and head of global trading, Paul F. Lynch, and Peter A. Economou, who was running securities finance at State Street after Starble resigned.

According to State Street, Economou’s involvement in Starble’s firm is a violation of his amended employment agreement. In the agreement Economou pledged that if he left the company, he would not hire any State Street employees within 18 months of his departure. State Street claims that Economou is breaking the nonsolicitation agreement by having someone else act on his behalf.

State Street alleges that the executives named in the suit are unfairly competing with their former employer “by using its confidential information and trading on its customer good will, potentially resulting in loss of significant business to this direct competitor.”

On June 15, 2010, eight executives in the securities lending division all resigned to join Starble at Premier Global Securities Lending.

State Street has filed an emergency motion for expedited discovery, to secure documents and depositions it says could prevent further damage to the company. They are seeking unspecified damages and funds to cover the cost of attorney fees.