Friday, September 24, 2010


The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act” or “Dodd-Frank Act”) was enacted by Congress on July 21, 2010. The purported purpose of the Act is to promote financial stability by improving accountability and transparency within the financial industry and to protect consumers from abusive financial services practices. To help reach this goal, the Act contains powerful incentives for whistleblowers to come forward with information to the SEC.

Specifically, Section 922 of the Act, entitled “Whistleblower Protection,” defines a “whistleblower” as “any individual who provides…information relating to a violation of the securities laws to the [SEC].” The Act broadly mandates that in any judicial, administrative or related action, the SEC shall pay an award to any whistleblower who “voluntarily provided original information to the [SEC] that led to the successful enforcement of the covered judicial, administrative or related action” in an amount equal to between 10% and 30% of what has been collected if the monetary sanctions imposed upon the wrongful party exceed $1,000,000.00. “Original information” is defined as information that is derived from the independent knowledge or analysis of the whistleblower and that is not known to the SEC from any other source. The total amount of the award is within the discretion of the SEC based upon a number of criteria set forth in Section 922; but the whistleblower is entitled to no less than 10% of the amount collected.

Moreover, for those whistleblowers who do come forward with information, Section 922 makes clear that “[n]o employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of” the whistleblower’s submission of information to the SEC. And if a whistleblower feels that he or she has been discharged or discriminated against, Section 922 provides for a private cause of action against the employer which includes reinstatement, two times the back pay, attorneys’ fees and costs.

Section 922’s powerful provisions will likely result in a substantial increase the SEC’s enforcement capabilities by providing it with a greater means to access inside information. Indeed, insiders within the financial industry will inevitably come forward with information that they likely would not have come forward with in the past. To add to whistleblowers’ incentives, Section 922 explicitly provides that “[a]ny whistleblower who makes a claim for an award…may be represented by counsel.” With this provision in place, in the two months since the enactment of the Dodd-Frank Act, law firms around the country have already begun establishing “Section 922 practices” aimed at assisting individuals in providing information to the SEC.

For more information on the 2,300+ page Dodd-Frank Act, or to make sure your company is in compliance with its sweeping provisions, please feel free to contact one of our knowledgeable and experienced attorneys.

A complete copy of the Dodd-Frank Act can be found here.

Wednesday, September 22, 2010

FINRA Files Proposed Rule Change to Amend the Codes of Arbitration Procedure to Permit Arbitrators to Make Mid-case Referrals

On September 17, 2010, the SEC published a notice to solicit comments on a proposed rule change originally submitted by FINRA on July 12, 2010. Rule 12104(b) of the Code of Arbitration Procedure for Customer Disputes and Rule 13104(b) of the Code of Arbitration Procedure for Industry Disputes currently allow for referrals to FINRA for disciplinary investigation any matter that has come to the arbitrator's attention only at the conclusion of an arbitration. The proposed rule change would allow an arbitrator to refer to FINRA any matter or conduct that has come to the arbitrator’s attention during the prehearing, discovery, or hearing phase of a case, which the arbitrator has reason to believe poses a serious, ongoing, imminent threat to investors that requires immediate action. The proposed rule would state further that arbitrators should not make mid-case referrals based solely on allegations in the statement of claim, counterclaim, cross claim, or third-party claim.

FINRA's purported basis for the rule change is that, in light of recent well-publicized securities frauds that resulted in harm to investors, FINRA has reviewed its rule on arbitrator referrals and determined that it should be amended to permit arbitrators to make referrals during an arbitration proceeding. FINRA believes that restricting arbitrators from making referrals until the conclusion of an arbitration may hamper FINRA’s efforts to uncover fraud as early as possible. Therefore, FINRA proposes to amend Rules 12104 and 13104 of the Codes to permit referrals to the Director during the prehearing, discovery, or hearing phase of an arbitration proceeding.

A complete copy of the notice can be found here.

Monday, September 13, 2010

Ninth Circuit Court of Appeals Rejects Private Cause of Action Under Section 13(a) of the Investment Company Act

On August 12, 2010, the Ninth Circuit Court of Appeals issued a decision in which it found that there is no private cause of action to enforce the provisions of Section 13(a) of the Investment Company Act of 1940 ("ICA"), 15 U.S.C. Section 80a-13a. Section 13(a)(3) prohibits an investment company from deviating from its investment policies recited in its registration statement unless authorized by the vote of a majority of its outstanding voting securities.


The court of appeals began its analysis of the case before it by noting that Congress enacted the ICA in 1940 to provide comprehensive regulation of investment companies and the mutual fund industry. The ICA was the counterpart in the area of mutual fund regulation to the Securities Act of 1933 and the Securities Exchange Act of 1934, which were designed to regulate corporate securities. Section 8 of the ICA states that once an investment company registers with the SEC, it must file a registration statement that contains a recital of certain types of investment policies adopted by the company, including the company’s policy with respect to concentration of investments in a particular industry or group of industries; any policy that is only changeable through a shareholder vote; and any policy the company deems “fundamental.” 15 U.S.C. § 80a-8(b).

To ensure compliance with the requirements of the ICA, the court noted that Congress gave the SEC broad authority to police violations of the ICA. Only one section of the ICA as originally enacted authorized anyone other than the SEC to sue for violations of the Act. Section 30(f) of the 1940 Act incorporated a remedy under the 1934 Act. The Supreme Court has said that by incorporating the provisions of § 16(b) of the Securities Exchange Act of 1934 into § 30(f) of the ICA, Congress expressly authorized private suits for damages against closed-end investment company insiders who make short-swing profits. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 20 & n.10 (1979). Later, the 1970 amendments to the ICA included a change to Section 36 of the ICA, which authorized the security holders of a registered investment company to bring a derivative suit against the company's investment advisor and its affiliates for breach of the advisor's fiduciary duty. 15 U.S.C. Section 80a-35(b).

In 2007, Congress imposed economic sanctions on two Sudanese government officials and thirty-one Sudanese companiesas a result of their involvement with the genocide in Darfur. These sanctions barred the companies from doing business within the US financial system or with US companies. To facilitate the efforts of state and local governments and private asset fund managers to divest from companies involved in business sectors in Sudan, Congress enacted the Sudan Accountability and Divestment Act ("SADA") in 2007. As a part of SADA, Congress added subsection (c) to Section 13 of the ICA. Subsection (c) expressly barred any kind of civil, criminal, or administrative action against an investment company to challenge the company's divestment from the securities of companies conducting the affected business operations in Sudan.


The litigation involved in the case before the Ninth Circuit involved claims by investors that a large investment trust operating a series of mutual funds unlawfully deviated from the investment policies set forth in its registration statement, to the detriment of the fund's shareholders and in violation of Section 13(a) of the ICA. The plaintiff brought a claim against the defendant alleging that defendant violated Section 13(a) when it allegedly deviated from the defendant fund's fundamental investment policies. The plaintiff alleged that the deviations exposed the fund and its shareholders to tens of millions of dollars in losses stemming from a sustained decline in the value of non-agency mortgage-backed securities.

The defendant moved to dismiss for failure to state a claim under ICA Section 13(a), asserting that there is no private right of action to enforce that section's terms. The district court denied this motion, declining to adopt the Second Circuit's reasoning in Olmsted. Pruco Life Ins. Co. of New Jersey, 283 F.3d 429 (2d. Cir. 2002), because Olmsted predated the 2007 amendment of Section 13 by SADA. Relying on the language of subsection (c) added to Section 13 by the SADA, the district court held that Congress recognized a private right to enforce Section 13(a) when it enacted Section 13(c) - i.e., there was no basis for Congress to bar actions based on Sudanese divestments if the statute did not authorize other private causes of action.


The court of appeals noted that a statute must explicitly or implicitly contain a private right of action. In the case before it, the parties agreed that Section 13(a) did not expressly create a right of action. Therefore, if Section 13(a) implicitly contained a private right of action, it had to be determined from the statute's language, structure, context, and legislative history. In. re Digimarc Corp. Derivative Litig., 549 F.3d 1223, 1229 (9th Cir. 2008).

The court of appeals first found that Section 13(a)'s language contains no "rights creating language." Alexandar v. Sandoval, 532 U.S. 275, 290 (2001). Instead, Section 13(a) merely contains the types of actions an investment company can take without first obtaining shareholder approval.

The court next found that the structure of the ICA did not suggest any congressional intent to allow private enforcement of Section 13(a). The Court noted that in both Bellikoff v. Eaton Vance Corp., 481 F.3d 110 (2nd Cir. 2007) and Olmsted v. Pruco Life Ins. Co. of New Jersey, 283 F.3d 429 (2nd Cir. 2002), the Second Circuit focused on the fact that the ICA authorizes SEC enforcement and that there is a private right of action for certain breaches of fiduciary duties of investment advisors in Section 36(b). The Ninth Circuit noted additionally that in Lewis, 444 U.S. at 20 & n.10, the Supreme Court found that Section 30(f) provides for a private right of action for short-swing profits made by insiders of closed-end investment companies. The court agreed with the Second Circuit that this leads to the conclusion that Congress did not intend to imply a private right of action in the ICA to enforce Section 13(a).

The court further found that the legislative history of amendments to the ICA did not evince a clear congressional intent to allow private lawsuits to enforce the statute's provisions. The court first noted that the 1970 amendments dealt with the need for shareholder votes to change investment policy. The court found that the language and legislative history reflected that purpose and that purpose only.

The court found that the 2007 amendment by the SADA, which added Section 13(c), while a stronger argument, was unpersuasive. Section 13(a) is a bar to actions any person or goverment agency might file to challenge divestment from Sudanese investments. The court of appeals noted that the district court focused on the fact that Section 13(c) referred to actions that a "person" could file. The court of appeals found that this would have some validity if the bar applied only to causes of action to enforce the other provisions of Section 13. But it extends to any civil, criminal, or administrative action brought under any state or federal law. Thus, Congress included the term "person" to describe the entities restricted from bringing the types of actions barred by Section 13(c). The court further noted that the legislative history revealed that a primary purpose of the SADA was to permit public and private asset managers to adopt Sudanese divestment measures without fear of legal reprisals.


Based on its analysis, the Ninth Circuit Court of Appeals concluded that the neither the language of Section 13(a), the structure of the ICA, nor the statute's legislative history, including the addition of Section 13(c) by the SADA, reflected any congressional intent to create, or recognize a previously established, private right of action to enforce Section 13(a). Therefore, the court of appeals reversed the order of the district court and remanded the matter with instructions to grant the defendant's motion to dismiss the plaintiff's federal ICA claims.

A complete copy of the Ninth Circuit's opinion can be found here.

Monday, September 6, 2010

Is Broker/Trader liable for what Broker-Dealer approves?

There is an interesting albeit short article in this month's edition of Corporate Counsel regarding Goldman Sachs and its very own "Fabulous Fab". As you may recall, Goldman settled with the SEC recently for $550 million (without admitting wrongdoing) for its role in allegedly selling a mortgage backed securities vehicle to its customers that Goldman allowed a hedge fund to both assemble and bet against. Goldman's trader Fabrice Tourre became infamous for not only reducing to writing his callous appreciation for the irony of Goldman's position, but also for dubbing himself "Fabulous Fab." Now wonder pride is one of the 7 deadly sins. But I digress. General Counsel notes that one of the defenses Fabulous is asserting in response to the SEC's claims against him is that the product and procedures at issue had been vetted and approved by Goldman's compliance and legal departments. General Counsel oddly characterizes this as a "novel defense." I'm not sure it is novel or without merit. Indeed, it reminds me of a case I worked on where I represented the former brokers of a large regional broker dealer that was sued by a state regulator for its role in the traditional sale, but unexpected liquidity demise, of Auction Rate Securities. The regulator sued the broker-dealer and its trading desk employees for failing to train and disseminating inaccurate information regarding the risks and characteristics to its sales force/registered representatives. But it also simultaneously sued the allegedly untrained and inadequately informed representatives that sold the product to investors (why chose a coherent theory of liability unless you have to?). Of course, as predicted, the regulator dismissed the suit against the individual brokers--one months away from dieing from cancer--once the broker-dealer coughed up millions of dollars. So while Fab's arrogance may provide some insight in to a culture on Wall Street that needs to evolve for the better, his affirmative defenses aren't so novel, and may just have some merit. It is one thing when a broker disregards compliance and legal and engages in negligent or self-serving conduct, but it seems to be an entirely different story when he or she is merely selling a product that has structural deficits literally designed by his employer and principle, including legal and compliance experts. Stay tuned.