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Hearings on Financial Crisis Begin

A bipartisan panel created by Congress charged with examining the causes of the nation's financial crisis, the Financial Crisis Inquiry Commission, started its public hearings into the financial crisis. Today, top executives from the major banks were testifying. During a heated exchange between the Commission’s Chairman, the former California State Treasurer Phil Angelides and Goldman Sachs’s CEO Lloyd Blankfein accused the biggest banks as acting like used-care salesmen knowingly selling lemons to consumers.

Click here to find out more information about the Commission and its hearings.

Key Pieces of Legislation to Empower Investors

On October 1, 2009, Congressman Paul E. Kanjorski, Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises released discussion drafts of three pieces of legislation aimed at reforming needed areas in the U.S. financial services industry. The draft bills are the Investor Protection Act, the Private Fund Investment Advisers Registration Act, and the Federal Insurance Office Act.

According to Congressman Kanjorski’s press release, the Investor Protection Act will strengthen the SEC’s enforcement powers to “better protect investors, and efficiently and effectively regulate our securities markets.” The Private Fund Investment Advisers Registration Act will require private advisers to register in order for regulators to “better understand exactly how those entities operate and whether their actions pose a threat to the financial system as a whole.” The Federal Insurance Office Act will create a federal insurance office “will provide policymakers with access to the information and resources needed to respond to crises, mitigate systemic risks, and help ensure a well functioning financial system.”

From the Pages of The Pomerantz Monitor: Senator Specter Introduces Two Bills That Could Prove Very Important to Plaintiffs

As Susan Weiswasser reports in the current issue of The Pomerantz Monitor, two pieces of legislation recently introduced in the United States Senate, both sponsored by Arlen Specter of Pennsylvania, could, if passed, prove very important to plaintiffs. Both would effectively overrule Supreme Court decisions that made surviving motions to dismiss or getting relief for the acts of secondary actors in securities cases more difficult.

The Anti-Twombly Act. The first bill deals with the way plaintiffs have to present claims in their complaints to survive a motion to dismiss. Rule 8 of the Federal Rules of Civil Procedure requires, among other things, that a plaintiff make “a short and plain statement of the claim showing that the pleader is entitled to relief.” The standard for deciding whether a complaint satisfied Rule 8 was established in the 1957 Supreme Court case Conley v. Gibson. The Court held that the Federal Rules “do not require a claimant to set out in detail the facts upon which he bases his claim.” It stands to reason that plaintiffs very often will not have detailed facts available until after they have filed suit and obtained discovery from the defendants. The language the Conley Court used to describe this standard — that dismissal is improper “unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief” — would be quoted by courts reviewing motions to dismiss for the next 50 years.

Then, in 2007, the Court decided Bell Atlantic v. Twombly, and created a new standard — often referred to as the “plausibility standard” — which requires that, to survive a motion to dismiss, a plaintiff must provide “enough facts to state a claim to relief that is plausible on its face." Ashcroft v. Iqbal, decided earlier this year, reinforced Twombly’s message noting that “[t]he plausibility standard is not akin to a ‘probability requirement,’ but it asks for more than a sheer possibility that a defendant has acted unlawfully.” Since Twombly was decided, it is reported that motions to dismiss have been filed with much greater frequency.

Senator Specter’s bill would restore the pleading standard set forth in Conley v. Gibson. In his comments introducing the bill, Specter, a lawyer, made the point that “[n]ot until a plaintiff has had access to relevant information in the defendant’s possession during the discovery process . . . can the plaintiff normally offer evidence to support the complaint’s allegations.” Since the Federal Rules do not allow federal courts to pass on the merits of a case until plaintiffs have submitted evidence, either on summary judgment or at trial, Specter expressed the inappropriateness of requiring plaintiffs to do more than provide defendants with notice.

The Anti-Stoneridge Act. Second on Specter’s agenda is a bill that will restore securities fraud liability for aiders and abettors. While Congress had not specifically created a private right to sue aiders and abettors under the securities laws, until 1994 courts had allowed suits against accountants, lawyers, business associates and the like who assist primary violators in carrying out schemes to defraud investors.

In Central Bank of Denver v. First Interstate Bank of Denver, the Supreme Court dealt a serious blow to investors,  holding that no private right of action for aiding and abetting could be had under the securities laws. Thus investors lost the ability to pursue wrongdoers who often played an indispensable role in perpetrating a fraud in spite of not being primary violators. Analyzing Congress’s intent as expressed in the text of the statute, the Court ruled that a cause of action against one who had not committed the manipulative or deceptive act could not be inferred. The majority discounted arguments that the availability of such a claim functioned as a deterrent to those who might provide behind-the-scenes assistance to actual violators of section 10(b).

Less than a year later, Congress introduced the Private Securities Litigation Reform Act (PSLRA). The SEC, which had filed a friend-of-the-court brief in Central Bank in support of maintaining the aiding and abetting cause of action, pressed Congress to overturn the Central Bank decision in the new law. Congress refused, delegating the right to bring an action for aiding and abetting to the SEC alone. The bill passed over President Clinton’s veto.

Recently, the Court had another look at who could be sued for securities fraud. In Stoneridge Investment Partners v. Scientific-Atlanta, where the Pomerantz firm represented plaintiffs, the Court considered whether the Central Bank decision barred a suit against a party who engaged in deceptive conduct but made no public statements about that conduct. The Court ruled that deceptive acts could create primary liability under the securities laws, as long as investors relied on those deceptive acts. Because the deceptions in Stoneridge were directed at the auditors, rather than the public, the Court held that investors could not have relied on them and thus could not prevail.

Senator Specter’s bill would recreate the private right of action for aiding and abetting, so that “any person that knowingly or recklessly provides substantial assistance” to a primary violator could be held liable for securities fraud. Specter is likely to have support for this bill beyond investors and the plaintiffs’ bar. As Specter pointed out in his introduction of the bill, Judge Gerald Lynch of the federal court in Manhattan recently wrote in an opinion that Congress’s choice to deny investors a private right of action against aiders and abettors:

“may be ripe for legislative reexamination. While the impulse to protect professionals and other marginal actors who may too easily be drawn into securities litigation may well be sound, a bright line between principals and accomplices may not be appropriate. There are accomplices and there are accomplices: after all, in the criminal context when the Godfather orders a hit, he is only an accomplice to murder – one who ‘counsels, commands, induces or procures’ but he is nonetheless liable as a principal for the commission of the crime. Likewise, some civil accomplices are deeply and indispensably implicated in wrongful conduct.”

Everything You Always Wanted to Know About Securities Litigation

The Council of Institutional Investors has published a primer on securities litigation, which we think our readers will find interesting and educational.  Everything You Always Wanted to Know About Securities Litigation... But Were Afraid to Ask is available in PDF format by clicking here:

Download Everything You Always Wanted to Know About Securities Litigation

Obama Preaches Reform on the Anniversary of Lehman’s Collapse

On Monday, September 14, the one-year anniversary of the collapse of Lehman Brothers, a crowd assembled at Wall Street’s Federal Hall – steps away from the New York Stock Exchange – to hear President Obama speak on the necessity of comprehensive regulatory reform. Urging his audience to “embrace serious financial reform, not fight it” while prodding bankers to check their “reckless behavior,” the President received a cool, if polite, response.

Alex Koppelman of Salon.com wrote: “Executives from places like Bank of America, Goldman Sachs, Deutsche Bank Americas, American Express, Credit Suisse and Morgan Stanley can't exactly be expected to do the wave when the president says "there are some in the financial industry" who are ignoring "the lessons of ... the crisis from which we're still recovering" and says he's proposing "the most ambitious overhaul of the financial regulatory system since the Great Depression."”

Although the President took pains to reassure the crowd that he is not anti-capitalist, it will be a major challenge to enforce more aggressive government oversight over finance. In June, Mr. Obama proposed giving the Federal Reserve more power, creating a new agency for consumer protection, toughening oversight of exotic financial products and making it easier for the government to close down out-of-control mega-financial firms. Wall Street, however,  is already battling to prevent any meaningful regulation. Significantly, not one CEO from a top U.S. bank attended President Obama’s speech, and Republicans have strongly criticized it.

According to the Wall Street Journal, House Financial Services Committee Chairman Barney Frank (D., Mass.) vowed to work towards pushing legislation through Congress despite the resistance of banks and conservative lawmakers. And Senate Banking Committee Chairman Christopher Dodd (D., Conn.), spoke of the importance of moving forward soon. “Memories fade very quickly,” he said.

From the Pages of The Pomerantz Monitor: Squabble Over BofA/Merrill Merger Has Major Ramifications

In the July/August issue of The Pomerantz Monitor, the editors report on the latest rumblings over Bank of America’s merger with Merrill Lynch.

Did they or didn’t they? Did Ben Bernake and Hank Paulson threaten to fire the entire Bank of America (“BofA”) board, including the CEO, last December unless they completed the merger with Merrill Lynch? It depends on whom you ask. 

Months ago Ken Lewis, BofA CEO, testified in a civil suit that he considered withdrawing from the merger when he learned last December that Merrill had suffered losses of $15 billion in the fourth quarter. He discussed this possibility with Bernanke, Chairman of the Federal Reserve, and Paulson, then the Treasury Secretary, and they both threatened to oust him and the board if they pulled the plug on the deal, instructing Lewis and the board not to disclose Merrill’s catastrophic losses to shareholders before the deal closed. The Fed promised it would lend Merrill $20 billion to help cover the losses. Lewis repeated this testimony before Congress in early June.

But on June 25 Bernanke told a totally different version of this story, which is that “I did not tell Bank of America’s management that the Federal Reserve would take action against the board or management” if they decided to back out of the deal, nor did he tell anyone else to make such representations. Bernanke also said no one at the Fed ever urged Bank of America to keep quiet about Merrill Lynch’s financial problems.

Merrill’s $15 billion fourth quarter loss was not disclosed until January, two weeks after the deal had closed. The result was a shareholder outcry and, of course, massive class action litigation. As if to underscore this last point, a couple of weeks after Bernanke testified, the State Teachers Retirement System of Ohio, the Ohio Public Employees Retirement System, the Teachers Retirement System of Texas, Stichting Pensioenfonds Zorg en Welzijn and Fjarde AP-Fonden were appointed lead plaintiffs in the securities class action targeting Lewis and BofA.

There is good reason to be skeptical of both versions of this story. Lewis, for his part, might have exaggerated the government’s threats in an attempt to justify his own questionable decision to go ahead with the merger while keeping his mouth shut. Although Lewis subsequently lost his position as BofA chairman, he still clinging to his CEO post.

On the other hand, we might also be skeptical of Bernanke’s testimony because he seemed to believe that unless the merger went through, Merrill would collapse and cause another Lehman-like shock to the financial system. He therefore had reason to pressure Lewis, if necessary, to make the merger happen; and internal Fed emails confirm that this was his intention. Even if he did not make explicit threats, he may have made his intentions more than clear in other ways.

Beyond that, Bernanke is no doubt worrying that his alleged bullying of BofA may put Congress in fear of what he might attempt with the vastly expanded powers the Fed is slated to be granted under the Obama Administration’s new regulatory proposals.

The Pomerantz Firm Hosts 12th Annual Abraham L. Pomerantz Lecture at Brooklyn Law School

Each year, the Pomerantz firm hosts the Pomerantz Lecture at Brooklyn Law School, which honors the life and work of Abraham L. Pomerantz, a 1924 graduate of Brooklyn Law School and the founding partner of the Pomerantz firm.  The lecture series focuses on topics of corporate securities law and related issues of professional responsibility.  This year’s lecture, held on March 31, explored the topic of Due Diligence:  Failures and Remedies with featured guest speaker Bernard S. Black.  An esteemed scholar, Professor Black is the Hayden W. Head Regents Chair for Faculty Excellence at the University of Texas School of Law, and Professor of Finance at the University of Texas, McCombs School of Business.

Professor Black’s lecture focused on how the participation of investment bankers, auditors, securities lawyers, and sometimes rating agencies and other professionals is central to both public and private securities offerings.  Professor Black addressed why due diligence failures are common and why reputational concerns may provide suboptimal due diligence incentives.  He also suggested a number of legal standards for minimum due diligence.  Professor John C. Coffee, Professor of Law at Columbia Law School, and Pomerantz senior partner Marc I. Gross provided commentary on the lecture.

The Madoff Saga Continues as Pomerantz Files the First Derivative Suit Against an Auditor

Britain’s Times Online has taken a keen interest in the Madoff scandal as numerous members of English society have emerged on lists of Madoff clients.  Members of Parliament have now joined ranks with the likes of the New York Mets, prominent banks, and various celebrities – not to mention all of the charitable organizations that were wiped out by Madoff’s $50 billion Ponzi scheme.  This is truly a scandal that has gone global.

The names emerged in court documents as the Pomerantz firm filed the first Madoff-related derivative class action complaint against an auditor of one of the hedge funds that steered investor capital Madoff’s way.  The suit was brought by the Tomchin Family Charitable Trust, a $7 million California charity, which was invested in Tremont Group Holdings’ Rye Select Broad Market XL Fund.  The suit alleges that the fund’s auditor, KPMG, missed numerous red flags that should have alerted the auditor to Madoff’s scheme.  From financial returns that were too good to be true, to the fact that Madoff’s multi-billion dollar operation was utilizing bookkeepers headquartered in an upstate strip mall, KPMG truly missed the elephant in the room.  Read more about our client’s suit against KPMG here.

The End of Mark-To-Market

In light of the current financial crisis, the passage of the Emergency Economic Stabilization Act of 2008 will create a real possibility that the SEC will suspend mark-to-market accounting or “fair value” accounting. However, the Center for Audit Quality (“CAQ”), Council of Institutional Investors and the CFA Institute, representing the country’s public company auditors, institution investors and chartered financial analysts have strongly come out to oppose any suspension and calling it “unnecessary and counterproductive.”

In a letter to Congress and top federal officials, the CAQ argued that suspending mark-to-market accounting is not in the best interest of investors because the end result would be less transparency and decrease investor confidence in capital markets. In short, “suspending mark-to-market accounting would throw financial reporting back to a time of less comparability, less consistency and less transparency.” Moreover, in arguing against a suspension, Cynthia M. Fornelli, CAQ’s Executive Director said in the letter:

The principles of mark-to-market accounting are rooted in the fundamental value of transparency and are central to informed market decision and efficient allocation of capital. In our view, investor confidence would be undermined by efforts designed to mask the actual value of financial assets at a given point.

The CAQ correctly notes that mark-to-market accounting did not create the current financial crisis, but instead brought the seriousness of the crisis to light and into the eyes of the public. A suspension of it “would not help solve our economic difficulties.”

New Rule: Comments Not Required, Effective Immediately

On September 17, 2008, the SEC announced new rules effective immediately, to protect investors against “naked” short selling abuses. According to the SEC press release, the new rules require:

that short sellers and their broker-dealers deliver securities by the close of business on the settlement date (three days after the sale transaction date, or T+3) and imposing penalties for failure to do so.

If a short sale violates this close-out requirement, then any broker-dealer acting on the short seller's behalf will be prohibited from further short sales in the same security unless the shares are not only located but also pre-borrowed. The prohibition on the broker-dealer's activity applies not only to short sales for the particular naked short seller, but to all short sales for any customer.

Even though the new rules are effective immediately, the SEC is seeking comments for a period of 30 days. As correctly noted in a fellow blog, the SEC sudden action looks like a panic without “justifications for avoiding the requirements of the Administrative Procedures Act” which “requires agencies to propose rules, provide an opportunity for comment, and wait at least 30 days before they become effective.” Moreover, the SEC did not invoke the APA’s “good cause” exception to immediately adopt these rules.