Opinion

Alison Frankel

Accounting board drops call for beefed-up litigation risk disclosure

Alison Frankel
Jul 11, 2012 01:30 UTC

More than four years after the Financial Accounting Standards Board first proposed a stringent new standard for corporate disclosure of litigation loss contingencies, it voted Monday to drop the effort, citing increased scrutiny of litigation exposure by the Securities and Exchange Commission and the Public Company Accounting Oversight Board. The accounting rulemaker’s decision has to be considered a relief for public corporations, many of which have bitterly opposed the FASB’s litigation disclosure proposals as a gift to plaintiffs’ lawyers.

The controversy over exactly what corporations must say in their financial statements about potential litigation losses actually dates back to the 1970s, when accountants and defense lawyers compromised on a standard mandating the disclosure of a litigation contingency when there’s a “reasonable possibility” of a loss. The FASB – which is responsible for setting generally accepted accounting principles – eventually decided that there was too much wiggle room in the “reasonable possibility” standard. In 2008, the accounting board proposed new rules that called for corporations to disclose virtually all litigation exposure, including the company’s assessment of its maximum exposure. Defense lawyers, according to Eric Roth of Wachtell, Lipton, Rosen & Katz, read the proposal as a dangerous encroachment on privileged communications about litigation prospects. “You can’t adopt a rule that strips companies of attorney-client privilege,” Roth said. “That was seen as an attack on the adversary system.”

Michael Young of Willkie Farr & Gallagher, who has been talking to FASB board members about litigation contingency disclosure for years, said that if the 2008 proposal had been adopted, plaintiffs’ lawyers arguing for damages could simply have shown juries excerpts on maximum exposure from a defendant’s own financial statements. “To the FASB’s credit, it took the board about two minutes to understand the problem,” Young said.

In 2010 the FASB revised the proposal to eliminate the maximum-exposure requirement, but the raised bar for disclosure still prompted an outcry of opposition from corporations. Of the 339 comments the FASB received in response to the 2010 proposal, 289 opposed it. (And of the 46 commenters who supported the proposal, 19 were plaintiffs’ lawyers, according to the FASB.)

Meanwhile, as the accounting board considered responses to the 2010 proposal, the SEC’s corporate finance division began to crack the whip on compliance with the existing disclosure standard for litigation loss contingencies. As Reuters reported in February 2011, the financial crisis apparently prompted the agency to send hundreds of companies letters questioning litigation disclosures. Banks, in particular, were informed in a “Dear CFO” letter in October 2010 that they’d better disclose exposure to mortgage-related litigation; the SEC’s chief accountant warned securities lawyers in 2011 that they needed to “take a fresh look” at disclosure – “Carefully, carefully comply with the standard,” he said.

To silence critics, SEC should use Option One MBS case as template

Alison Frankel
May 3, 2012 22:12 UTC

If you haven’t already, read Jesse Eisinger’s piece for ProPublica and the New York Times on the Securities and Exchange Commission’s case against the upstart credit-rating agency Egan-Jones. The SEC sued Egan-Jones – which challenged the traditional business model for rating agencies by charging users, not issuers, to opine on the riskiness of securities – for exaggerating its bona fides in a 2008 filing. Eisinger questioned the wisdom of sending Egan-Jones “to the guillotine” while letting bigger players, with business models that are susceptible to corruption, off the hook for their patently ridiculous ratings of toxic mortgage-backed securities. “This is your S.E.C., folks,” Eisinger wrote. “It courageously assails tiny firms, and at the pace of a three-toed sloth. And when it goes after its prey, it’s because it has found a box unchecked, rather than any kind of deep, systemic rot.”

Inspired by the piece, I went back to take another look at the SEC’s Apr. 12 complaint against Option One, a relative small-timer in the mortgage-backed securities market. Could Eisinger’s criticism of the SEC’s credit-rating enforcement – that the agency is netting minnows while the sharks swim away – apply just as well to MBS issuers?

Well, yes. But I’m getting tired of asking why the SEC has been so slow to enforce accountability for banks that packaged and sold securities backed by subprime mortgages that didn’t meet even the lax underwriting standards they warranted. So instead, I’m choosing to regard the Option One case as a model for the kinds of actions the already much-maligned mortgage fraud task force keeps promising to bring. From my reading, there’s no reason other MBS defendants can’t be held liable for the same disclosure problems that Option One agreed to settle for $28.2 million.

Former SEC GC Becker gives $556k gift to Madoff investors

Alison Frankel
Feb 29, 2012 18:24 UTC

There’s a very good chance that former Securities and Exchange Commission general counsel David Becker owes absolutely nothing to the folks who lost money in Bernard Madoff’s Ponzi scheme. Nevertheless, on Monday, Becker and his two brothers agreed to turn over every penny of the proceeds they received from their mother’s long-ago Madoff investment account, a total of $556,017. Becker, a partner at Cleary Gottlieb Steen & Hamilton, didn’t return my call seeking comment. But he is doubtless hoping that the $556,017 settlement with Madoff bankruptcy trustee Irving Picard of Baker & Hostetler puts an end to the ugliest chapter in his career.

For a brief while last year, you’ll recall, Becker was the favorite whipping boy of Madoff victims and their congressional champions. Becker and his two brothers were what’s known as net winners in the Madoff pyramid. After their mother’s death in 2004 they transferred the approximately $2 million in her Madoff investment account to a Smith Barney probate account. By September 2006, the will was probated and the account was liquidated. But in December 2010, Picard sued Becker and his brothers, demanding the return of $1.5 million in allegedly fraudulent profits from their mother’s estate.

At the time, Becker was the SEC’s general counsel. And though he informed the agency’s ethics office of his inheritance (and SEC Chairman Mary Schapiro was aware of Becker’s Madoff proceeds), the GC was not asked to step out of SEC deliberations — and did not recuse himself from the debate — on the appropriate method for compensating investors. When word got out of Becker’s Madoff money, Schapiro took a beating in Congress.

Welcome to the MBS party, SEC — you’re only 3 years late!

Alison Frankel
Feb 10, 2012 15:16 UTC

If the Securities and Exchange Commission were an ordinary investor, it would already be too late in trying to sue the banks that issued (allegedly) deficient mortgage-backed securities.

The SEC is not, of course, an ordinary investor. On Wednesday night, the Wall Street Journal broke the news that the SEC plans to send Wells notices, otherwise known as target letters, to several banks that issued mortgage-backed notes and certificates. The Journal said the agency is looking at whether the banks misled investors about the quality of mortgage loan pools underlying securities issued in 2007 and 2008.

But here’s the thing: The first federal-court MBS class action, against Countrywide, was filed in 2007. By 2008, bond insurers and private investors were busily suing MBS issuers in state and federal courts in New York, starting the clock on the three-year statute of limitations for suits under the federal Securities Act of 1933 and the two-year time limit for fraud cases under the Exchange Act of 1934. Private investors who entertained thoughts of bringing federal claims for mortgage-backed notes issued in 2007 and 2008 would be tossed out of court quicker than you can say “time-barred.”

SEC settlement-language change is (at best) mere cosmetics

Alison Frankel
Jan 9, 2012 15:28 UTC

Late Friday the Securities and Exchange Commission confirmed in a statement what the New York Times first reported Friday morning: it has changed its policy on the boilerplate “neither admit nor deny” language in most SEC settlement agreements. But don’t get too excited. The change will affect only cases in which the defendant has admitted guilt or been convicted in a related criminal action. In settlements with those criminal defendants, the SEC will delete “inconsistent” concessions and instead “recite the fact and nature of the criminal conviction or criminal [admission] in the settlement documents.”

In other words, defendants whose guilt has already been established under the higher standard of criminal law can no longer evade responsibility for civil charges. Which leads, of course, to the question of why it took the SEC 40 years to change such a ridiculous policy.

In the weeks since U.S. Senior District Judge Jed Rakoff of Manhattan federal court rejected the agency’s proposed $285 million settlement with Citigroup for misleading investors about a synthetic CDO, the SEC has argued long and loud that the boilerplate Rakoff scorned is intrinsic to its ability to reach settlements with defendants worried about liability in follow-on civil suits by private plaintiffs lawyers. I get that. And as I’ve reported, just about every other federal agency with enforcement power has a similar practice of permitting defendants to settle without conceding they’ve done anything wrong. I have my doubts that deleting pro forma “neither admit nor deny” language from settlement agreements would result in a dramatic change in the value of follow-on private settlements, but perhaps I, like most federal judges, have become inured to boilerplate.

Previewing the defense in SEC cases v. Fannie and Freddie execs

Alison Frankel
Dec 19, 2011 21:17 UTC

For the last three years, since the housing bubble burst, the Securities and Exchange Commission has been investigating the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Association (Freddie Mac). Fannie and Freddie, after all, were the biggest players in the mortgage lending and securitization business, and there’s a lot of sentiment that they deserve a hefty share of blame for encouraging the financial industry’s voracious appetite for mortgage loans, no matter how deficiently underwritten. The problem for regulators hoping to hold Fannie and Freddie accountable, though, is that the previously quasi-private agencies went into public receivership conservatorship in 2008. Any SEC suit against Fannie and Freddie would essentially be one wing of the U.S. government seeking damages against another.

But the people who ran Fannie and Freddie in the run-up to the mortgage meltdown were another story. About nine months ago the SEC issued Wells notices to top Fannie and Freddie executives. I’ve heard there was virtually no give-and-take between regulators and defense lawyers for the executives after initial defense responses. So it was a disappointment but not a big surprise to the defendants when, on Friday, the SEC sued three former top officials from both Fannie and Freddie. (Here’s the SEC’s complaint against Richard Syron, Patricia Cook, and Donald Bisenius of Freddie Mac; and here’s the complaint against former Fannie Mae execs Daniel Mudd, Enrico Dallavecchia, and Thomas Lund.) The SEC complaints charge two defendants in each case with full-on securities fraud (the third official in each complaint faces aiding and abetting claims) for allegedly misleading investors about their agencies’ exposure to subprime mortgages. In the Freddie complaint, the SEC asserts that the agency claimed only $2 to $6 billion of its single-family guaranteed mortgages were considered subprime loans, when, in fact, $140 billion to $244 billion in loans fit that classification. Fannie allegedly reported $4.8 billion in exposure when its subprime lending exceeded $40 billion.

There are a few points to keep in mind about the Fannie and Freddie suits. First, the allegations all center on disclosures. There’s no accusation of accounting manipulation or more obvious fraudulent acts. Yet four of the defendants are accused of intentionally defrauding investors — partly because Fannie and Freddie were not registered entities during the entire period of alleged wrongdoing, which means the execs couldn’t be accused of negligence. That’s a high bar, in which the agency has to show the defense acted with fraudulent intent. Second, the former Fannie and Freddie executives — unlike the Citigroup executives who agreed to an administrative settlement in the bank’s 2010 subprime exposure agreement with the SEC — had no leverage because the SEC wasn’t also negotiating with their employer. There was little reason for financial regulators to reign in aggressive allegations, especially because there’s a strong public-relations incentive for the SEC to charge senior executives of agencies that ended up in such severe straits that they had to be placed in receivership, with taxpayers bearing the burden of management’s overly risky strategy.

Rakoff ripples: NY court says SEC boilerplate no defense

Alison Frankel
Dec 15, 2011 15:17 UTC

In 2006, Bear Stearns entered a $250 million settlement of Securities and Exchange Commission allegations that its traders engaged in illicit market timing for certain preferred customers. Like scores of SEC defendants concerned with liability in related civil litigation, Bear insisted on the language that’s become boilerplate in SEC settlements. So “without admitting or denying” the SEC’s findings, the bank agreed to disgorge $160 million and pay a $90 million penalty.

Bear and its successor, JPMorgan Chase, turned to Bear’s insurers to cover the disgorgement. (Penalties aren’t indemnified in Bear’s policy.) The insurance agreements said the bank was covered for damages awards and charges incurred by regulatory investigations, with one catch: The policies excluded claims “based upon or arising out of any deliberate, dishonest, fraudulent, or criminal act or omission,” if there were a final adjudication reflecting that wrongdoing.

No problem, right? The SEC settlement explicitly said that Bear didn’t admit deliberate or dishonest behavior when it agreed to the disgorgement. The insurers, represented by DLA Piper, Drinker Biddle & Reath and several other firms, balked at paying, but JPMorgan, with counsel from Proskauer Rose, sued to enforce the policies. In September 2010, New York State Supreme Court Justice Charles Ramos agreed that Bear hadn’t admitted anything. “An insured’s settlement or consent to entry of an order with the SEC, wherein it did not admit guilt, will not preclude if from disputing those findings in subsequent litigation with its insurers,” Ramos wrote in an order refusing to dismiss JPMorgan’s suit. “The [SEC settlement] does not contain an explicit finding that Bear Stearns directly obtained ill-gotten gains or profited by facilitating these trading practices.”

Chief judge: Rakoff assignment to Citi case was ‘totally random’

Alison Frankel
Nov 30, 2011 16:30 UTC

If there’s one federal jurist the Securities and Exchange Commission absolutely, positively did not want to see at the top of the docket in its $285 million settlement with Citigroup, it was Senior Judge Jed Rakoff of Manhattan federal court. Rakoff has been a festering sore for the agency since 2009, when he rejected a proposed $33 million settlement with Bank of America over failing to disclose bonus payments to Merrill Lynch executives in merger-related documents. In a March 2011 opinion in the Vitesse Semiconductor case, Rakoff took the agency to task for agreeing to settlements in which defendants neither admit nor deny wrongdoing. Then in July he claimed jurisdiction over the SEC’s case against former Goldman Sachs director Rajit Gupta, accusing the agency of forum shopping in filing an administrative action against Gupta. You can only imagine the teeth-gnashing at the SEC when Rakoff was assigned the Citi case. After the SEC tried to argue that Rakoff doesn’t have the power to consider the public interest in his evaluation of the proposed settlement, Monday’s rejection of the settlement was practically a foregone conclusion.

So you may be wondering — as I was — how it is that Rakoff ended up with the Citi case. The answer, according to his chambers and Chief Judge Loretta Preska of the Southern District, is that the assignment was purely random. Yes, there are 41 federal district judges in the district, so the odds of any of them overseeing multiple, unrelated cases filed by the same plaintiff are long. But according to Preska and Rakoff’s chambers, that’s what happened here.

The SEC filed the Citigroup case in federal court in Manhattan, rather than Washington, D.C. (where it filed a $75 million settlement with Citi in 2010) because the new Citi case includes SEC charges against Brian Stoker, a Citi Global Markets employee who allegedly structured and marketed the CDO that’s at the bottom of the case. Unlike the two Citi employees in the 2010 case, Stoker refused to settle with the agency. So in anticipation of litigation with him, the agency filed the entire Citi case in New York.

Rakoff to SEC: Oh yes, it is my job to consider public interest

Alison Frankel
Nov 29, 2011 00:34 UTC

In 2010, when the Securities and Exchange Commission brought a case against Citigroup for misleading investors about the bank’s exposure to subprime mortgages, the SEC filed the proposed $75 million settlement in Washington, D.C., federal court. Judge Ellen Huvelle gave the agency some gruff about the deal, in which two individual Citi defendants also settled SEC claims through an administrative action, but she eventually accepted the settlement without demanding any big changes.

The SEC and Citi must be looking back with regret at those halcyon days. For reasons the agency has not explained, when it filed a proposed $285 million settlement with Citi last month, it opted for the federal court not in D.C. but in Manhattan. There, the case — which involves claims that Citi defrauded investors in a mortgage-backed CDO — was randomly assigned to U.S. District Judge Jed Rakoff, who has recently been engaged in a highly-publicized campaign of insisting on corporate accountability in SEC settlements. The SEC proceeded to undermine its credibility in Rakoff’s court by arguing, as my colleague Erin Geiger Smith reported, that it’s not the judge’s role to consider the public interest in SEC settlements.

In a 15-page, eminently quotable exercise in rhetoric issued Monday, Rakoff pushed the agency into the grave it dug for itself, rejecting not only the proposed settlement but also the SEC’s assertion that he must heed its assessment of the public interest. “A court, while giving substantial deference to the views of an administrative body vested with authority over a particular area, must still exercise a modicum of independent judgment in determining whether the requested deployment of its injunctive powers will serve, or disserve, the public interest,” Rakoff wrote. “Anything less would not only violate the constitutional doctrine of separation of powers but would undermine the independence that is the indispensible attribute of the federal judiciary.”

Want inside look at SEC dealmaking? Read IG’s Khuzami report

Alison Frankel
Nov 21, 2011 22:48 UTC

On June 28, 2010, the Enforcement Director of the Securities and Exchange Commission, Robert Khuzami, spoke on the phone with Mark Pomerantz, a partner at Paul, Weiss, Rifkind, Wharton & Garrison. Pomerantz and Khuzami had worked together as assistant U.S. attorneys in Manhattan in the 1990s; according to Pomerantz, he was partly responsible for Khuzami’s promotion to chief of the office’s securities unit. But this wasn’t a social call. Pomerantz represented Citigroup, which had agreed to settle SEC allegations that it drastically underreported its subprime mortgage exposure. The deal was held up, however, by the agency’s insistence that Citi CFO Gary Crittenden face fraud claims for allegedly misleading investors.

Pomerantz told Khuzami, as he had many times before, that Citi would suffer collateral damage if Crittenden were accused of fraud. According to Khuzami, he just told Pomerantz to “talk to Crittenden.” But soon after the June 28 call, another Citi lawyer, Lawrence Pedowitz of Wachtell, Lipton, Rosen & Katz, told SEC Associate Enforcement Director Scott Friestad that Khuzami had agreed to back a non-fraud settlement with Crittenden.

In July 2010 the SEC announced its deal with Citi. As part of the settlement, Crittenden and another individual defendant, former Citi investor relations chief Arthur Tildesley, settled administrative actions that didn’t involve fraud allegations. Six months later, an anonymous (but obviously insider) source tipped U.S. Senator Chuck Grassley that Khuzami had forced the agency to drop fraud claims against the execs as a favor to his friends in the defense bar. The SEC’s inspector general, H. David Kotz, undertook an investigation of the complaint.

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