October 25, 2013

UBS in Web of Puerto Rico Bond Funds Suffering Massive Losses

Puerto Rico bond funds have been suffering massive losses recently and regulators have already taken action. According to the SEC, UBS Financial Services of Puerto Rico Inc. (“UBS”) misled thousands of its retail investors in 23 of its closed-end mutual funds. While UBS has already spent more than $26 million to settle the SEC’s charges, investors are now starting to pursue their own actions against the institution to recover potentially millions in losses.

Starting in 2008, UBS began soliciting investors in its Puerto Rico bond funds by promoting the funds’ market performance and high premiums to net asset value as the result of supply and demand in a competitive and liquid secondary market. However, UBS knew about a significant “supply and demand imbalance” and internally discussed the “weak secondary market.” UBS misled investors, failing to disclose that it controlled the secondary market. In 2009, UBS withdrew its market support and sold its inventory to unsuspecting customers. At the same time, it failed to disclose that it was drastically reducing its inventory, and undercut customer orders so that UBS’s inventory could be liquidated first.

Investors may have a host of claims against UBS including fraudulent misrepresentations and omissions, unsuitable investment advice, and failure to supervise.

December 9, 2011

Bloomberg Update on $383M Client Case v. Citigroup

Below is a piece by Bloomberg on our firm's $383 million claim against Citigroup. There's more on this case on the firm's website at http://www.riklawfirm.com/


Citigroup’s Mathur Said to Depart With Hybrid Traders as Pandit Cuts Jobs
By Donal Griffin - Dec 9, 2011

Citigroup Inc. (C), the third-biggest U.S. bank, is shrinking a team of traders who deal in “hybrid” products as Chief Executive Officer Vikram Pandit cuts Wall Street jobs, two people familiar with the matter said.

Samir Mathur, former head of hybrid trading, is leaving the New York-based firm and is in talks to join a hedge fund, according to one of the people, who asked to remain anonymous because the move hasn’t been announced. Other members of the desk who reported to him, including Yontcho Valtchev, Vivek Kapoor, Eric Kim, Sean Corrigan and Allison Niiya, also are leaving, the person said.

Mathur is among ex-members of the desk who are at the center of a dispute with Ghazi Abbar, a former customer from Jeddah, Saudi Arabia. Abbar claims he lost $383 million of his family’s fortune when Citigroup sold him products that later soured, even though the bank internally questioned his ability to properly manage some of them. Pandit, 54, is shrinking the desk as he cuts 4,500 jobs amid a revenue slump.

“It makes sense for Citigroup to reduce the size of its sales trading activities, particularly in developed markets,” Richard Staite, an analyst at Atlantic Equities LLP, wrote in a Dec. 7 note to clients. “We believe a shift away from trading toward lower-risk consumer and corporate banking may lead to a higher valuation multiple.”

Mathur follows Erwin Parviz, the former London-based head of hybrid structuring who left Citigroup in June, according to U.K. Financial Services Authority records.

Investment Banking

Planned layoffs will include about 900 from the division that contains trading and investment banking, a person familiar with the matter said last month.

Danielle Romero-Apsilos, a Citigroup spokeswoman, declined to comment. Members of the hybrid team didn’t respond to phone messages, said they couldn’t comment or couldn’t be located for comment. Citigroup, with 267,000 employees worldwide as of Sept. 30, is the third-biggest U.S. bank by assets behind JPMorgan Chase & Co. and Bank of America Corp.

Mathur’s team traded hybrid derivatives, financial instruments that derive their values from different underlying assets. Buyers seek to profit from the performance of assets, such as a stake in a hedge fund, without directly owning them. The desk often sold products to large investment firms including Man Group Plc (EMG) and Tudor Investment Corp., people familiar with the matter said last month.
Taxpayer Bailout

Mathur helped to create one of Abbar’s transactions, according to an arbitration claim Abbar has filed with the Financial Industry Regulatory Authority. The bank denies the allegations and has sued Abbar to block the arbitration.

Mathur has worked as a trader for Citigroup since 1998, according to Finra records. He rose to become head of hybrid trading before the bank almost collapsed in 2008 and received a $45 billion taxpayer bailout.

Colleagues of Mathur’s also are Wall Street veterans, Finra records show. Valtchev had worked for Citigroup since 2005 after stints with Deutsche Bank AG and Barclays Plc (BARC), while Kapoor joined in 2007 after working at UBS AG, Credit Suisse Group AG (CSGN) and Standard & Poor’s. Niiya had worked for Citigroup since 2000, according to the records. While most are traders, Kim is an analyst.

December 1, 2011

American Lawyer Piece on Firm's Citigroup Case

Below is an American Lawyer piece which explains our clients' pending $383 million FINRA arbitration against Citigroup. It goes on to talk about how there are more and more large and complex cases at FINRA. It's true. As partner John Rich points out at the end of the article, our firm is involved in other multi-million dollar matters at FINRA. In fact, we handled the Bayou v. Goldman FINRA arbitration case which generated a $20.6 million award, and is mentioned in the article. We think FINRA arbitration will continue to attract sophisticated legal disputes because it is more efficient and timely than court litigation.


Too Big for Their Britches?

Nate Raymond

The American Lawyer

12-01-2011

Just a few years ago, the Abbar family of Saudi Arabia could point to at least $383 million in investments managed by Citigroup Inc. Patriarch Abdullah Abbar and his son Ghazi had built the family fortune through an array of food import, travel, oil transport, and investment businesses. And beginning in 2006, they entrusted the bulk of their wealth to Citi.

Today the relationship has soured, and the money is almost gone. Both sides have lawyered up—the Abbars hired John Rich of Rich, Intelisano & Katz, and Citi retained Scott Edelman of Milbank, Tweed, Hadley & McCloy—and the legal battle is heating up. In August the Abbars filed a securities arbitration claim with the Financial Industry Regulatory Authority ­(FINRA), the U.S. securities industry's self-regulator. But while defendants often prefer the privacy arbitration affords, Citigroup wants to move the case into the courtroom.

The Abbar complaint is one of roughly 200 pending FINRA cases with at least $10 million at stake. The number of cases and the size of potential awards increased significantly after the stock market collapse in 2008. Before then, most FINRA cases involved small investors who were suing their brokers. But after the crash, richer investors flooded ­FINRA with claims that they were duped by large institutions. "The claims coming in now are substantially larger than what we had a few years ago," says Linda Fienberg, president of FINRA's dispute resolution unit.

The financial institutions, faced with hefty awards that are near impossible to overturn, have taken notice. Lawsuits by banks challenging the arbitrations are increasingly common, often contending that sophisticated investors are trying to twist FINRA's original definition of a brokerage customer to include their claims.

Established in 2007, FINRA is the result of a merger of two sets of self-regulatory organizations, the New York Stock Exchange's enforcement arm and the National Association of Securities Dealers. Cases number in the thousands annually, and currently 7,000 claims are pending, Fienberg says.

For most parties in FINRA cases, arbitration offers a quick and private venue to deal with securities claims. But the arbitration landscape changed when financial service firms began teetering. "There were some very large losses during that period," says Jonathan Harris, a commercial litigation partner at New York's Harris, Cutler & Houghteling.

Harris is counsel to Woodside, California, investment management firm Aurum STS Aggressive Trading LLC. During the fall of 2008, Harris and his cocounsel at Steptoe & Johnson contend that Société Générale breached agreements on warrants the bank issued to Aurum in 2003 and 2004, and unilaterally imposed new terms. Aurum filed an arbitration claim in June 2009 against SocGen, and in October a three-arbitrator panel awarded the company $61 million—the second-largest award this year. SocGen has said that it disagrees with the decision, but its lawyers at Latham & Watkins have not sought to vacate it.

Big awards like Aurum's have become more common in the wake of the subprime meltdown. Six of the ten largest securities arbitration awards were handed down during the last two years, according to Securities Arbitration Commentator Inc. In February 2009 FINRA awarded $406.6 million to ­STMicroelectronics N.V. in a fight with Credit Suisse Group AG, followed by a $80.8 million award to Kajeet Inc. against UBS AG in August 2010, and a $54.1 million payout to Colorado patent litigator Gerald Hosier and others in April 2011 over a squabble with Citigroup.

The largest award of 2011 involved options trading firm Rosen Capital Management LLC, which lost $90 million in fall 2008. Rosen's lawyers at Quinn Emanuel Urquhart & Sullivan blamed its prime broker Merrill Lynch & Co., Inc., which had placed ill-fated margin calls amid a crisis that had just weeks earlier thrown it into a government-brokered $50 billion sale to Bank of America Corporation. In July a three-arbitrator panel awarded Rosen $63.7 million. Merrill's lawyers at Wilmer Cutler Pickering Hale and Dorr moved in August to vacate the award.

Courts, though, rarely overturn arbitration awards. The Goldman Sachs Group, Inc. and its lawyers at Schulte Roth & Zabel unsuccessfully fought to vacate a $20.6 million FINRA award that resulted from the bank's alleged failure to detect fraud at the bankrupt hedge fund Bayou Group LLC. In November 2010 Manhattan federal district court judge Jed Rakoff denied Goldman's petition, saying that "having voluntarily chosen to avail itself of this wondrous alternative to the rule of reason, [Goldman] must suffer the consequences."

Banks are fighting over who is permitted to bring claims to ­FINRA. UBS's lawyers at Debevoise & Plimpton, with the backing of the Securities Industry and Financial Markets Association, argued that West Virginia University Hospitals, Inc., as an issuer, could not force the bank, as an underwriter, to arbitrate claims of more than $329 million in auction-rate securities. But in September the U.S. Court of Appeals for the Second Circuit rejected that narrow reading of who FINRA defines as a "customer."

In the Abbar case, Citigroup has similarly filed a lawsuit in Manhattan federal district court seeking to enjoin the arbitration. Milbank's Edelman, Citi's lawyer, declined to comment. But Citi in a statement says the Abbars were not clients of the U.S.–based broker-dealer Citigroup Global Markets Inc., so "their claims should not be subject to FINRA arbitration."

In the meantime, FINRA is adjusting to the bigger cases. In early 2012 it plans to implement a pilot program designed for cases with more than $5 million at stake, Fienberg says. The program, which will be tested in the Northeast and on the West Coast, will formalize the ways that FINRA ­allows parties to modify arbitration procedures. For example, parties could pick arbitrators who do not normally handle FINRA cases, such as former judges. Parties could agree to take depositions, which FINRA generally does not allow. And both parties would be able to pay arbitrators more than the $200 honorarium FINRA typically pays per hearing, a relief to some lawyers who worry about how the low pay might affect the complex cases.

And the Abbars' lawyer? Rich promises more cases from himself as well. "We have other multimillion-dollar cases in the works," he says. "This is not going to be an anomaly."
E-mail: nraymond@alm.com

Top Five Securities Arbitration Awards
Sanchez et al. v. Enrique Perusquia $429.5M
STMicroelectronics N.V. v. Credit Suisse Securities (USA) LLC 406.6M
Kajeet Inc. v. UBS Financial Services Inc. 80.8M
212 Investment Corp. et al. v. Myron Kaplan 74.8M
Rosen Capital Partners LPv. Merrill Lynch Professional Clearing Corp. 63.7M
Source: Securities Arbitration Commentator Inc.

November 30, 2011

Bloomberg Piece on $383M Client Case v. Citigroup

Below is Bloomberg piece about our client's $383 million FINRA arbitration claim against Citigroup Global Markets, Inc. related to hedge funds, private equity, and derivatives.

Bloomberg

Citigroup Saudi Deal Haunts Pandit
By Donal Griffin - Nov 30, 2011

Saudi businessman Ghazi Abbar, who claims in an affidavit he lost $383 million of his family’s fortune on investments with Citigroup Inc., was sold one of the transactions even though the bank questioned his ability to properly manage them, according to an internal memo.

The memo, an exhibit in arbitration proceedings with the Financial Industry Regulatory Authority, warned that Abbar didn’t have the risk-management capability of the large hedge funds that were typical clients of the bank’s “hybrid” desk, which in 2006 was trying to persuade him to move his family’s money into complex derivative securities.

Soured deals struck with wealthy clients are haunting Citigroup Chief Executive Officer Vikram Pandit. Finra awarded $54 million in April to customers of the New York-based bank’s municipal-bond hedge funds, and in February, Brazilian investor Bernardo Valentini sued the bank, claiming he lost more than $24 million on derivatives Citigroup told him had “no risk of loss.”

“The case is a setback in Pandit’s vision of delivering financial services with a higher sense of responsibility to customers,” said David Knutson, a credit analyst with Legal & General Investment Management in Chicago. “As each issue bubbles up, analysts or providers of capital to the firm have to say, ‘OK, what other tape bombs are lying in the dusty lines of Citi’s balance sheet?’”
Citigroup’s Lawsuit

Citigroup denies Abbar’s allegations, saying in a lawsuit that he was a sophisticated investor who knew the risks when he turned over control of his hedge-fund investments to the bank in exchange for derivatives that mimicked their performance. The bank has sued its former client in federal court in Manhattan to block the arbitration, arguing Finra has no jurisdiction because the deals were handled outside the U.S.

Danielle Romero-Apsilos, a Citigroup spokeswoman, declined to comment further.

According to the Finra claim, Citigroup had never before sold the investment idea to individual investors like Abbar, 56, whose family made its fortune in Saudi Arabia importing food and building businesses linked to tourism, aviation, cold storage, ship bunkering and oil. The hybrid team, which also arranged loans when clients wanted to leverage their bets, made about $200 million for the New York-based bank in 2007, people familiar with matter said.

Based in Jeddah, a port city on the Red Sea about 50 miles from Mecca, the Abbars were among the largest merchants in Saudi Arabia, with annual revenue of about $500 million, according to the internal memo. Family members had served in senior positions under the kingdom’s late rulers, kings Faisal and Saud, according to the memo.
Pandit Meeting

Citigroup executives lined up to court Abbar, who oversaw the family’s investments, according to the Finra complaint. Pandit, 54, met with Abbar after joining Citigroup in 2007 as part of the company’s effort to maintain a relationship with the family. So did Chief Operating Officer John Havens, former wealth management boss Sallie Krawcheck and current global markets head Francisco “Paco” Ybarra, according to the complaint.

Abbar moved about $350 million of his family’s wealth to Citigroup from Deutsche Bank AG (DBK) in 2006, and Citigroup rewarded the banker who persuaded Abbar to make the shift, Mohanned “Ned” Noor, with a trip to Hawaii, according to the claim. Abbar was introduced to the hybrid desk, which was growing under Pandit’s predecessor, Charles “Chuck” Prince. Prince was trying to boost revenue by taking more trading risk.
Burns, Mathur

The hybrid group was run by Richard Burns, a London-based Citigroup veteran, according to two people familiar with the group who asked not to be named because they aren’t authorized to speak about the matter. Burns oversaw structuring and trading of hybrid derivatives, securities whose values are tied to different kinds of underlying assets. Samir Mathur was head of hybrid trading for the group.

Abbar wanted a “simple loan structure” to finance some of the family’s hedge-fund investments, he claims. Over meals in restaurants in London and New York, the hybrid team persuaded Abbar to instead transfer control of some of those assets to Citigroup, according to one of the people familiar with the matter. The desk then created the hybrid derivative that would mimic the performance of those funds.

Abbar claims he invested $383 million in the product and a separate private-equity financing deal, which included funds he injected after his initial transfer from Deutsche Bank. Both transactions collapsed after markets plunged in late 2008.
Tiger Management

Abbar had more experience with hedge funds than most. He began investing his family’s fortune after he graduated with a master’s degree in business administration from Harvard University in 1978. He built close relationships with hedge-fund managers such as Julian Robertson of Tiger Management LLC and joined the board of one of the Tiger funds in 1997, according to Fraser Seitel, a spokesman for Tiger Management. Abbar said he also had relationships with Stephen Cohen, founder of SAC Capital Partners LP, billionaire Paul Tudor Jones and Louis Moore Bacon.

Still, as an individual, he was an unusual client for the desk, which typically dealt with large hedge funds and so-called fund of funds firms that make bets on other investment funds. Customers included Man Group Plc (EMG), the world’s biggest hedge fund; Tudor Investment Corp., Tudor Jones’s hedge fund; and Saudi Arabian financial-services firm Saad Group, according to the people familiar with the matter. Abbar didn’t have those firms’ resources, the bank said in the memo.
Operates ‘Alone’

“The Client is not like the typical fund of funds client the desk is used to dealing with,” according to the memo. “The Client does not maintain the extensive risk, due diligence and operational infrastructure that exists at most of the larger fund of funds. While Ghazi is experienced with alternative investments, he operates more or less alone with advice from his friends and industry contacts.”

Abbar’s lack of risk management concerned some Citigroup executives before he bought the product, according to one person familiar with the deal. Members of the hybrid desk concluded that his financial experience gave him the ability to manage the risks, and the bank approved the deal.

“Ghazi has the ability to understand the risks and rewards of the transactions,” Citigroup wrote in the internal memo.

After the deal went through, members of the hybrid team were encouraged to sell similar products to other wealthy individuals, according to the person, who didn’t want to be named because the matter is private.
Hedge Funds

Abbar’s hedge-fund investment collapsed in 2008 as Lehman Brothers Holdings Inc. failed and funds around the world plunged. The Eurekahedge Hedge Fund Index dropped almost 12 percent in the second half of the year, Bloomberg data show. Many investors who used derivatives to multiply their bets were wiped out, according to Satyajit Das, author of “Extreme Money: Masters of the Universe and the Cult of Risk” (FT Press, 2011).

The leverage used to increase derivatives bets “is like playing Russian roulette with six bullets in the chamber,” said Das, who isn’t familiar with Abbar’s case.

The failed investments erased the “considerable family wealth” the Abbars had placed with the bank and damaged relationships within the family, according to the claim. Citigroup now stands to gain $70 million as it sells off the hedge-fund assets at the center of the product, Abbar alleges.
‘Nuclear’ Products

“A lot of these highly leveraged, highly structured products, I analogize them to nuclear power,” said John Lovi, an attorney with Steptoe & Johnson LLP who handles cases involving derivatives and isn’t involved in the Abbar case. “There’s no doubt that it’s complicated and you better have your best and brightest on it and be watching it closely because when it goes bad, it goes really bad.”

The collapse of the deal came as Citigroup itself was posting record losses caused by the financial crisis and its investments in collateralized debt obligations, another form of derivative. The bank lost a total of $29.3 billion in 2008 and 2009 and took a $45 billion taxpayer bailout. Senior executives allowed their hunt for more revenue to eclipse proper risk management, according to a 2008 Federal Reserve Bank of New York inspection report.

Pandit, who took the top job in December 2007, disbanded part of the hybrid team in 2008 and began to wind down the structuring side of the business, the people said. He has since begun an effort to convince investors that the bank’s culture has changed to one of “responsible finance.”
New Team

“We have a new management team, a new governance structure,” Pandit said in a video on the bank’s website, called new.citi.com. “We’re completely focused around the client. Each and every one of our businesses is structured and always thinks about what is it that my clients need and how do I make sure I deliver all of Citi to each and every one of my clients.”

Citigroup advanced $1.44, or 5.7 percent, to $26.68 at 10:46 a.m. in New York trading. The shares slid 47 percent this year through yesterday, compared with a 32 percent drop in the 24-company KBW Bank Index. (BKX)

Abbar is seeking $383 million. The largest award ever granted by Finra was $406.6 million for STMicroelectronics NV against Credit Suisse Group AG (CS) in 2009, according to Finra records.

Citigroup was on the wrong side of the largest award for individual investors in April, when Finra ruled in favor of a group of wealthy, Aspen, Colorado-based customers’ $54 million claim, the records show. The clients said Citigroup misled them about the level of risk tied to investments in the bank’s municipal-bond hedge funds.
‘Guaranteed’ Investment

In a suit brought in Manhattan federal court, Brazilian client Bernardo Valentini claims he lost more than $24 million on derivatives the bank told him were “guaranteed.” He was convinced of the merits of the deal by two Citigroup private bankers, who visited his office in Curitiba and said they “wanted to get to know him,” he said in the court filings. Citigroup denied the allegations.

Banks that sell complex derivatives to wealthy customers often face complaints when the deals don’t work out as planned, said Das, the banker turned author.

“Clients are always good winners,” Das said. “The moment they lose money, they suffer a 100-point drop in IQ.”
Food Imports

Today, Abbar runs the largest of the family’s businesses, Abbar Cold Stores, which imports frozen foods, fresh fruits and cheeses into Saudi Arabia, according to John Rich, an attorney in New York with Rich, Intelisano & Katz LLP, which represents the family.

Some of the executives mentioned in the case have since left Citigroup, including Ned Noor, the Geneva-based private banker who persuaded Abbar to move his money to the bank in the first place. He declined to comment on Abbar’s claims.

Richard Burns and Samir Mathur continue to work in derivatives for Citigroup. They also declined to comment.

The Abbar case is Citigroup Global Markets Inc. v. Abbar, 11-CV-6993; the Valentini case is Valentini et al v. Citigroup Inc. (C) et al, 11-CV-01355. Both cases are in U.S. District Court, Southern District of New York (Manhattan).

November 23, 2011

Private Shares Market - Little Disclosure

Last week, we wrote about private shares fraud and how we think there may be significant litigation and/or arbitration in the future in this space. Today's NY Times has a very good Dealbook piece (below) by the "Deal Professor" about the lack of disclosure in the private shares markets of SharesPost and SecondMarket. The most important sentence: "The lack of information combined with this illiquidity contributes to the volatility and mispricing of shares." That's spot on. We're talking about large investments in unregistered shares within an unregulated market. Major exposure to potential fraud. Major.


November 22, 2011, 4:37 pm
Private Markets Offer Valuable Service but Little Disclosure
By STEVEN M. DAVIDOFF
Harry Campbell

Information is the lifeblood of capital markets. In the movie “Wall Street,” Gordon Gekko demanded confidential information from a young would-be Master of the Universe, Bud Fox, played by Charlie Sheen. The value of stocks is based on information, which is why securities laws are intended to ensure that all investors have at least minimum amounts of information.

Private, closed markets like SharesPost and SecondMarket aid in the cause of market transparency, providing platforms to trade shares of companies that have yet to go public. At the same time, the limited amount of information available to investors in these markets raises some questions. Regulators, which have been looking at these markets, may be right to be concerned.

Both SharesPost and SecondMarket, to be sure, are aimed at sophisticated investors, who can buy shares in up-and-coming companies, mainly Internet start-ups, before their initial public offerings. The two markets have cut their teeth on connecting buyers and sellers in hot pre-I.P.O. tech companies like Facebook and Groupon.

Yet gaining entry to both markets is simple. Before trading or being allowed full access to the market’s platforms, a user must first register and attest to being an accredited investor under the securities laws. This generally means that the user must have an individual income greater than $200,000 a year or a net worth of more than a million dollars. Lying on the Internet is easy, though, as anyone who has ever been on a dating site knows.

Both SharesPost and SecondMarket review the potential buyer’s declaration to ensure that these standards are met, including requiring government identification, but neither appears to ask for tax returns or require independent verification of a person’s salary and net worth. After being certified, an investor can bid to buy shares of these companies.

The problem is that potential buyers sometimes have little information on which to base their purchase. Public companies are required to make copious disclosures to the Securities and Exchange Commission, including audited financials that are reviewed by the S.E.C. The agency recently prompted Groupon and Zynga to revise their accounting disclosures before their I.P.O.’s.

SecondMarket changed its business model in 2010 to require companies to provide two years of audited financials and other information to potential bidders. The exception is Facebook, the most actively traded stock on SecondMarket. For Facebook, there is no information requirement. Shareholders fly blind, relying on anything they can glean from almost anywhere but the companies themselves.

SharesPost does not appear to provide the information that SecondMarket requires. SharesPost strives to fill this gap by arranging to have privately prepared research reports posted on its site. But without full information, the research providers cannot do any better than buyers in accurately pricing stocks. The result is volatility.

Facebook’s value on SharesPost has fluctuated wildly. In January, Facebook shares traded at a price that gave it an implied market value of more than $141 billion . Less than one month later, Facebook shares traded at an implied value of about $71 billion. Four days later it was at about $87 billion. Since that time, Facebook shares have traded in a range that values the company at $73 billion to $87 billion.

This summer, Groupon was reportedly trading on the private markets at an implied market valuation of about $20 billion. Groupon is now trading at a value of about $13 billion.

The problem is not just overvaluation. In January, Bloomberg News reported that shares of LinkedIn were trading on the private markets at $30 apiece, valuing the Internet company at $2.51 billion. LinkedIn is now public and trading at a market valuation of about $6.7 billion.

SharesPost appears to provide more market information than SecondMarket. It posts all of the prices of its trades and has enlisted research providers to assist investors.

One of the largest research providers on SharesPost traditionally was Global Silicon Valley Partners.

Brad Flynt, a law student at the University of Georgia School of Law, has written an unpublished paper questioning the independence of Global Silicon Valley Partners.

The research provider is affiliated with the Global Silicon Valley Corporation, a publicly traded company that is active in purchasing shares on the private markets. G.S.V.C. is headed by Michael Moe, who is also a director of SharesPost.

Last spring, Global Silicon Valley Partners published a research note that estimated Facebook shares at $22.24 to $22.57 apiece, valuing Facebook at $52.3 billion to $53.1 billion. About this time G.S.V.C. purchased 225,000 shares of Facebook at $29.28, valuing Facebook at roughly $68 billion.

This raises conflict-of-interest issues because Global Silicon Valley Partners set a low valuation target at the same time its affiliates, Mr. Moe and G.S.V.C., were buying shares at a higher one.

In an interview, Mr. Moe said that Global Silicon Valley Partners was now defunct and that, though this was not disclosed in the research reports, Global Silicon Valley Partner’s research was always independently prepared by Candlestick Advisers, a consulting and advisory firm based in India.

Mr. Moe said that there was no economic relationship between Candlestick and G.S.V.C. but rather a personal one between himself and Candlestick’s owners. According to Mr. Moe, Candlestick is compensated by SharesPost for its research reports but neither he nor G.S.V.C. received money from Candlestick. SharesPost declined to comment on the relationship between Mr. Moe, G.S.V.C. and its research providers, instead referring me back to Mr. Moe. Candlestick Advisers did not reply to a request for comment.

It all raises questions about what exactly shareholders know and how they know it on these markets.

SharesPost appears to be trying to do the right thing by putting more information out there. Given the lack of information on the companies itself, however, this is a roll of the dice. And there needs to be more disclosure about these research providers that would explain their motivations and compensation.

This is also an illiquid market. Except for trades in Facebook, shares of other private companies appear to be infrequently bought and sold. Twitter and Zynga do not appear to be available for purchase on SecondMarket. The last trade in Zynga on SharesPost was on Sept. 9. Twitter appears to have traded only once this year on SharesPost. The lack of information combined with this illiquidity contributes to the volatility and mispricing of shares.

The S.E.C. thus faces a quandary. These private markets offer an increasingly desirable service by providing an outlet to sell shares in companies that do not want to subject themselves to the increased regulation and scrutiny that comes with being public.

But it is too often all or nothing in terms of information. Congress is considering a number of bills intended to make trading in these markets easier, and the S.E.C. is also reviewing its rules governing private markets. Congress may also want to consider enacting requirements for companies with shares actively trading on these markets to disclose sufficient information to allow informed trading. SecondMarket has already taken a step in the right direction but could do more and provide data on purchases and sales.

Investors will otherwise remain in the dark, gambling without information.

Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.

November 18, 2011

Private Shares Fraud - Just the Beginning?

Private shares fraud? We've been talking about it internally for months. Unregulated space where investors buy and sell private shares often of pre-IPO companies such as Groupon and Facebook. We think the potential fraud claims will occur in the pricing of the private shares. The seller, perhaps a company insider, plays around with valuations. But the Dealbook story posted below of John Mattera is an old school fraud. He allegedly stole people's money by promising to sell them his personal private shares in high flying pre-IPO companies. Here's the problem for his "investors": may be no one to collect from. Mattera likely going to jail. His fund is finished. Good luck trying to sue and collect from the unregistered Long Island firm and/or its principals and the escrow service. What a shame. Private share investors need to be careful out there. Even in the more legitimate secondary private share markets run by larger firms. Due diligence is king.


DealBook - A Financial News Service of The New York Times
November 17, 2011, 4:32 pm
Manager Who Claimed to Own Facebook Shares Charged With Fraud
By KEVIN ROOSE
John A. Mattera was arrested in Florida on Thursday.

It may be the new, new thing in fraud.

John A. Mattera, 50, a Florida-based investment manager, was arrested Thursday on charges of running an $11 million, two-year fraud that falsely promised investors access to coveted shares of Groupon, Facebook and other private companies.

Mr. Mattera, the head of the Praetorian Global Fund, claimed to own more than a million shares each of Facebook and Groupon, according to a complaint filed in Federal District Court in Manhattan. He represented to investors that those holdings, bought on the private markets, would surge in value after the companies went public, the complaint said. Prosecutors allege the fund didn’t have such investments.

Instead, Mr. Mattera used millions of dollars of investor money to finance his lavish lifestyle, the complaint alleges. Among Mr. Mattera’s expenses: more than $245,000 for home furnishings and interior design services, more than $11,000 for tailored clothing and more than $17,000 for “boat-related expenses.”

Prosecutors have charged Mr. Mattera with one count of conspiracy to commit securities fraud and wire fraud, one count of securities fraud, one count of wire fraud and one count of money laundering. The Securities and Exchange Commission is also taking civil action against Mr. Mattera.

“As alleged, John Mattera duped investors into believing they had bought rights to shares of coveted stock in Facebook and other highly visible and attractive companies which had not yet gone public,” Preet S. Bharara, the United States attorney in Manhattan, said in a statement. “With today’s charges, his charade is exposed and he will be held to account for his alleged crimes.”

Carl F. Schoeppl, Mr. Mattera’s lawyer in the criminal case, declined to comment.

The charges against Mr. Mattera come as investors clamor for shares of newly public Internet companies, a frenzy that echoes the early days of the last dot-com boom in the 1990s. Getting into a company early can be lucrative. Groupon, the daily deals site, jumped more than 30 percent on its first day of trading.

To attract clients, Mr. Mattera allegedly enlisted the help of Joseph Almazon, an unregistered broker with Spartan Capital Partners on Long Island, who solicited investments for Mr. Mattera’s Praetorian funds using LinkedIn advertisements that offered customers “the opportunity to buy pre-I.P.O. shares” in Facebook, Groupon, Twitter, Zynga and other companies. Mr. Almazon promised that “unlike most of the other investment banking firms, we let you sell your shares right at the open” — referring to the first day the company goes public, according to the civil action.

After investors signed up, their money was transferred to an escrow service headed by John R. Arnold. Mr. Arnold, in turn, passed the money along to himself and to Mr. Mattera, as well as to accounts registered to Mr. Mattera’s mother and wife, the complaint said.

Mr. Mattera is no stranger to the law. In 2009, he was accused by the Securities and Exchange Commission of evading registration requirements by backdating certain promissory notes. He paid a penalty of $140,000 and was barred from trading penny stocks, shares of smaller public companies that are worth less than $1 apiece.

Three of the current criminal charges against Mr. Mattera, who was arrested at his home in Fort Lauderdale, Fla., on Thursday, carry a maximum sentence of 20 years in prison each. He faces a maximum sentence of five years on the conspiracy charge.

Mr. Mattera and his associates “exploited investors’ desire to get an inside track on a wave of hyped future I.P.O.s,” George S. Canellos, the S.E.C.’s New York regional director, said in a statement. “Even as investors believed their funds were sitting safely in escrow accounts, Mattera plundered those accounts to bankroll a lifestyle of private jets, luxury cars, and fine art.”

October 17, 2011

Bloomberg: Goldman Sachs Asks Court to Throw Out $20.5 Million Bayou Creditors’ Award

Below is a Bloomberg article about our firm's $20.6 million FINRA arbitration award against Goldman Sachs related to Bayou. It's the largest arbitration award ever rendered against Goldman. The award was confirmed by Judge Rakoff and Goldman filed it's brief to the Second Circuit.

Goldman Sachs Asks Court to Throw Out $20.5 Million Bayou Creditors’ Award
By Bob Van Voris - Oct 15, 2011

Goldman Sachs Group Inc. (GS) filed an appeal seeking to dismiss a $20.5 million arbitration award to creditors of the failed hedge fund firm Bayou Group LLC.

Goldman Sachs asked the U.S. Court of Appeals in Manhattan to overrule a decision by the Financial Industry Regulatory Authority, the independent regulatory group for the securities industry. A federal district judge declined in November 2010 to reverse the Finra award.

The creditors sued Goldman Sachs Execution and Clearing LP in 2008 for its role as the prime broker and clearing broker for Bayou’s hedge funds. They said the Goldman Sachs unit aided a $400 million fraud at Stamford, Connecticut-based Bayou, which filed for bankruptcy in May 2006. Bayou co-founder Samuel Israel pleaded guilty to directing the scheme and is serving a 22-year prison term.

In the November ruling, U.S. District Judge Jed Rakoff in Manhattan said Goldman Sachs failed to show that the arbitration panel had “manifestly disregarded the law” in granting the award.

Goldman Sachs, based in New York, argued in its appeal brief that the Finra panel was wrong in determining that deposits into Bayou’s accounts and internal bookkeeping entries qualified as fraudulent transfers.

John Rich, a lawyer for the Bayou creditors, didn’t immediately return a voice-mail message seeking comment yesterday on the Goldman Sachs filing.
Fellow Inmate

Israel is incarcerated at the same federal prison complex in Butner, North Carolina, as Bernard Madoff, who is serving a 150-year sentence for orchestrating the biggest Ponzi scheme in history.

In addition to a 20-year term for the fraud, Israel’s term was extended by two years after he attempted to make it appear that he had committed suicide by jumping off a bridge on the day he was to report to prison.

The case is Goldman Sachs Execution & Clearing LP v. Official Unsecured Creditors’ Committee of Bayou Group LLC, 10- cv-05622, U.S. District Court, Southern District of New York (Manhattan).

October 14, 2011

WSJ: Goldman Continues to Fight $20.5 Million Award in Pivotal Case

Below is a WSJ article about our firm's $20.6 million FINRA arbitration award against Goldman Sachs related to the Bayou hedge fund fraud. It is the largest arbitration award ever rendered against Goldman. The award was confirmed by Judge Rakoff of the SDNY in November 2010 and Goldman filed it's brief to the Second Circuit this week.

Goldman Continues to Fight $20.5 Million Award in Pivotal Case
By LIZ MOYER

NEW YORK—Goldman Sachs Group Inc. is continuing to fight a $20.5 million arbitration award that, while relatively small from the big bank's perspective, has broader implications for Wall Street.

The award stems from Goldman's role as a clearing broker for a failed hedge fund. Goldman filed an appeal Thursday in the U.S. Court of Appeals in the Second Circuit, arguing as it did last fall in district court that the Financial Industry Regulatory Authority arbitration panel that awarded the sum ignored the law.

On the opposite side are the creditors of Bayou Group LLC, which accused Goldman Sachs Execution & Clearing LP of ignoring signs of fraud at the hedge fund run by Samuel Israel III before it imploded in 2005.

A Finra panel awarded the Bayou creditors $20.5 million in June 2010. Goldman sued to vacate the arbitration award in July 2010, but Federal Judge Jed Rakoff confirmed the award in November.

Ross Intelisano, a lawyer for the Bayou creditors at Rich, Intelisano & Katz, said investors are "frustrated" by the delay in receiving their money. "We're looking forward to the Second Circuit reconfirming the arbitration award," he said.

The disputed case comes as regulators are eager to lay blame after the financial crisis exposed rampant cases of Ponzi schemes and other frauds. The $20.5 million award, if it is upheld, could raise the standards of care required by banks that clear trades for hedge funds, lawyers said.

The Securities Industry and Financial Markets Association, an industry group representing Wall Street sided with Goldman in district court last year and plans to file a brief in support of Goldman in the appeal, a spokesman said.

In May, Goldman said the Commodity Futures Trading Commission had "orally advised" it that it faced civil fraud charges over its role clearing trades for an unnamed client. Goldman said it was cooperating.

In that probe, the potential charges concern whether Goldman knew or should have known the client was using customer accounts in transactions with Goldman rather than the client's own accounts.

In the Bayou case, the creditors argued that the hedge fund's depositing of money into its account at Goldman, and then its shuffling around of that money among accounts, constituted transfers to Goldman that could be recovered by investors.

The creditors also accused Goldman of ignoring several warning signs, including suspicious money transfers. About $13.9 million of the award concerns money Bayou moved among its accounts.

Bayou was founded in 1996 and exposed as a $400 million fraud in 2005. Goldman was a prime broker and clearing firm for Bayou from 1999 to 2005. Mr. Israel, who went on the lam briefly, is currently serving a 22-year prison sentence.

Dan Carlson, a San Diego lawyer who represents investors in Finra arbitrations, said the financial crisis has "opened eyes that clearing firms and brokerages need to be doing more due diligence."

Wall Street firms have argued that extra due diligence will slow down business and increase costs. "In imposing liability on Goldman, the arbitrators disregarded the long-recognized principle that a clearing firm cannot be liable for merely processing transactions received from an authorized source," Sifma wrote in its friend of the court brief siding with Goldman in district court last fall.

"If clearing firms were required to analyze trading in introduced accounts," Sifma added, "the speed and efficiency demanded in the contemporary securities markets would not be possible."

October 11, 2011

On Wall Street Article About Firm's $383mm FINRA Claim

Below is an On Wall Street piece about our firm's representation of a Saudi investor in a $383 million FINRA arbitration against Citigroup Global Markets, Inc.


Citigroup Aims to Stop Arbitration From Proceeding
By Lorie Konish, On Wall Street
October 7, 2011

A new lawsuit filed by Citigroup Global Markets Inc. this week against a set of Saudi family investors with a $383 million claim against the firm will determine whether that case can proceed to arbitration.

Citigroup’s suit, dated Oct. 5, is aimed at putting a stop to the arbitration case filed with the Financial Industry Regulatory Authority in August by Abdullah Abbar and Ghazi Abbar, father and son Saudi nationals.

Citigroup claims that the Abbars were not clients of the U.S.-based broker-dealer Citigroup Global Markets Inc., which was named in the arbitration suit the pair filed with the Financial Industry Regulatory Authority in August. Instead, the private equity and hedge fund investments cited in the arbitration—investments the Abbars took part in during the years 2006 and 2007—came from Citigroup entities in the Cayman Islands, Switzerland and United Kingdom, the firm said.

Those entities are not subject to FINRA rules because they are located outside of the United States.

"We are confident this matter will be appropriately resolved when it is reviewed by legal authorities in the jurisdictions that the parties agreed to when they executed their trades,” Citigroup Spokeswoman Natalie Marin stated via email on Wednesday. “Because Citigroup Global Market Inc. was not a party to the trades in question and because the claimants were not customers of Citigroup Global Markets Inc., their claims should not be subject to FINRA arbitration."

But the Abbars, who are represented by New York-based law firm Rich & Intelisano LLP, disagree. The next step will probably be an oral argument over whether there should be a temporary restraining order stopping the arbitration, Ross B. Intelisano, a partner with the law firm, said.

“If we win in arguing to the Southern district that the arbitration should go forward, then the arbitration will go forward or Citigroup may appeal up to the Second Circuit,” Intelisano said. “If we win that, then we’ll have an arbitration.”

Intelisano plans to fight Citigroup’s claims based on the fact that the New York entity and its employees were the ones that sold the Abbars the investments. “We’re arguing that they’re attempting to evade their regulatory responsibility as a registered brokerage firm to arbitrate these disputes if the customer chooses to do so,” Intelisano said.

Clients who bring cases to FINRA also have the option of resolving disputes through mediation.

Another recent case, including UBS AG versus a West Virginia hospital, also called into question the definition of a customer and if a case can proceed to arbitration, Intelisano said. That case was ultimately sent to arbitration.

If the Abbars’ arbitration proceeds, the case will address their initial claims that misconduct by Citigroup Global Markets and its employees “virtually wiped out” the Abbars fortune that totaled about $350 million as of 2005, their August claim said.

The Abbars’ fortune came mostly from food products importing, as well as other businesses including oil investments and travel and tourism. Most of those assets were invested in hedge funds, with other investments in real estate trusts, private bond issues, private equity, public equities and bonds, real estate trusts and venture capital.

The family was wooed to work with Citigroup after a financial advisor they were working with at Deutsche Bank joined that firm. By luring the Abbars to Citigroup, that banker became a top private banker at the firm and the Abbars became one of the firm’s top ten international clients, according to the Abbars’ arbitration filing.

The investments cited in the arbitration dispute include two leveraged option transactions that had a leveraged exposure to multiple hedge funds, as well as another private equity transaction involving a unit trust and related loan.

"The crux of our case is that Citigroup sold a very, very complex product to a wealthy family that was really not appropriate for a non-institutional client," Intelisano said. "Citigroup had previously only sold these complex structures to funds of funds and hedge funds prior to selling it to our clients."

After banks and brokerage firms began selling complex derivative products to individuals and families in addition to the institutions they were originally targeted for around 2006 and 2007, more cases like this could crop up, according to Intelisano.

"I think you will see other cases filed involving retail investors who were improperly sold inappropriate institutional products by banks worldwide,” Intelisano said.

October 11, 2011

Bloomberg: Citi Moves to Stay Customer's $383mm FINRA Claim

Below is a story about CGMI's attempt to stay a $383 million FINRA arbitration filed by our firm related to inappropriate behavior with respect to derivatives, hedge funds, and private equity transactions.

Oct. 6 (Bloomberg) -- A Citigroup Inc. unit sued two Saudi investors seeking to block Financial Industry Regulatory Authority arbitration of their $383 million claim that the bank “wiped out” their family’s wealth.

Abdullah and Ghazi Abbar, a father and son from Jeddah who put family money into hedge funds, have no customer agreements or accounts with Citigroup Global Markets Inc., a New York-based broker dealer that they blame for mismanaging their family’s life savings, according to a complaint the Citigroup unit filed yesterday in federal court in Manhattan.

The Citigroup entities that handled two leveraged option transactions and a private-equity loan for the Abbars are based in the U.K., Switzerland and the Cayman Islands and aren’t subject to arbitration by Finra, a Washington-based brokerage regulator, according to the complaint.

“We are confident this matter will be appropriately resolved when it is reviewed by legal authorities in the jurisdictions that the parties agreed to when they executed their trades,” Natalie Marin, a spokeswoman for New York-based Citigroup, said in an e-mail.

John Rich, an attorney for the Abbars, didn’t immediately return a voice-mail message left after regular business hours seeking comment on the lawsuit.

The Abbars, whose money comes from food products importing, travel and tourism, oil investments and other businesses, were courted by top bank officers, including Chief Executive Officer Vikram Pandit and former global wealth management chief Sallie Krawcheck, to maintain or expand business with the New York- based company, they said in their Finra claim.

‘Gross Misconduct’

“Due to a pattern of gross misconduct by CGMI and its employees and affiliates, from late 2005 to present, the considerable family wealth which the Abbars entrusted to Citigroup has been virtually wiped out,” the Abbars said in the claim they filed with Finra on Aug. 17.

The Abbars said their family was lured to Citigroup in 2006 after their Deutsche Bank AG banker moved to Citi Private Bank Geneva. The Abbars put $343 million of their hedge fund investment assets into a leveraged option swap transaction to which Citigroup’s London affiliate was a last-minute counterparty, a move designed to shield the bank from U.S. regulatory and legal obligations, according to the claim.

Voting Shares

As part of the hedge-fund financing transaction, Citigroup Global Markets had all the voting shares of the entities that held the family’s investments. The bank failed to monitor the investments, which became over-leveraged and totally collapsed in late 2008 when the full force of the financial crisis hit, the Abbars alleged.

“Citigroup took over management of the remaining positions in the hedge fund portfolio and put in place a program for redeeming the entire portfolio,” they said in the Finra claim. “Citigroup will unjustly benefit in the amount of approximately $70 million from redemption of such investments after repayment of the loan and interest.”

The Abbars also set up a credit facility with Citigroup under Cayman law providing for loans of as much as $110 million and were persuaded to use the facility to invest in bank-related private-equity investments. The Citigroup entities involved in the day to day management of the credit deal “were ultimately responsible” to Finra-registered personnel in New York, they said in the claim. They said the credit structure eventually collapsed because of borrowings related to the Citigroup investments.

The Abbars seek damages of $147 million in connection with a credit facility that was set up to pay for capital calls in the family’s private-equity investments. They are also seeking $198 million tied to the hedge fund transaction and recovery of $38 million they injected into the Citigroup deals, according to their claim.

The case is Citigroup Global Markets v. Abbar, 11-6993, U.S. District Court, Southern District of New York (Manhattan).

--With assistance from Donal Griffin and Bob Van Voris in New York. Editors: Peter Blumberg, Andrew Dunn

July 13, 2011

OTC Derivatives Fraud - CFTC, SEC Differ on New Derivatives Rules

OTC Derivatives fraud aspect to an interesting Futures Magazine piece

CFTC, SEC Differ on New Derivatives Rules

6/26/2011

On June 14, 2011, the Commodity Futures Trading Commission (“CFTC”) issued a notice of proposed order and request for comment1 (the “Proposed CFTC Order”) with respect to the effective dates of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)2 relating to the regulation of the swaps markets. On June 16, 2011, the Securities and Exchange Commission (“SEC” and, with the CFTC, the “Agencies”) released an order3 (the “SEC Order” and, with the Proposed CFTC Order, the “Orders”) granting temporary exemptions and other temporary relief, and providing information on compliance dates, applicable to the regulation of the security-based swaps markets. The deadline for commenting on the Proposed CFTC order is July 1, 2011, and the deadline for commenting on the SEC order is July 6, 2011.

Dodd-Frank was enacted on July 21, 2010. Through enactment of Title VII of Dodd-Frank, Congress sought to create a comprehensive regulatory regime applicable to the over-the-counter derivatives markets. These markets have to date been largely unregulated. Title VII of Dodd-Frank adds extensive new provisions relating to OTC derivatives to the Commodity Exchange Act (“CEA”), the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”), while eliminating provisions of those statutes that were added by the Commodity Futures Modernization Act (“CFMA”) to provide legal certainty with respect to OTC derivatives through various “safe harbors.” Dodd-Frank generally eliminates those safe harbors.

The amendments to the CEA, Securities Act and Exchange Act made by Title VII of Dodd-Frank, including the elimination of certain safe harbors for OTC derivatives, are generally effective on July 16, 2011 or not less than 60 days after a rulemaking is finalized, to the extent that a provision of Title VII “requires a rulemaking.” Because the Agencies have, to date, finalized very few regulations implementing Title VII, there has been a great deal of uncertainty and concern about what will happen to the legal foundations for the OTC derivatives markets on and after July 16. The Agencies issued their respective Orders in an attempt to make July 16 a “non-event” for these markets. However, the Orders take entirely different approaches to providing regulatory relief and raise complex issues that market participants should discuss with counsel.

The Proposed CFTC Order

Title VII of Dodd-Frank grants the CFTC authority to regulate the “swaps” markets and certain participants in these markets. Absent relief, certain provisions of Dodd-Frank applicable to swaps are scheduled to automatically go into effect on July 16, 2011. Among these provisions are substantive requirements applicable to market participants, as well as the elimination of the existing safe harbors from the applicability of other laws for many forms of OTC derivative transaction.

The Proposed CFTC Order would grant temporary relief from the July 16 statutory effective date in two parts — first, the CFTC is proposing to temporarily exempt persons or entities with respect to CEA provisions added or amended by Title VII of Dodd-Frank if those provisions reference any term that is subject to “further definition” under Title VII, and second, the CFTC is proposing to grant temporary relief from the elimination of the CEA safe harbors for certain agreements, contracts or transactions in certain types of commodities.

The Proposed CFTC Order groups Title VII provisions affecting the CEA into four categories: (1) provisions that expressly require a rulemaking, (2) provisions that are, on their face, self-effectuating but that reference terms subject to further rulemaking, (3) self-effectuating provisions that do not reference terms subject to further rulemaking, but that repeal provisions of the CEA and (4) self-effectuating provisions for which the CFTC is not proposing to provide any relief under the Proposed CFTC Order. Provisions in Category 1 are beyond the scope of the Proposed CFTC Order because such provisions are, by their own terms, not effective until a minimum of 60 days after CFTC-mandated rulemaking is completed. Category 4 provisions do not reference terms subject to further rulemaking and do not repeal current provisions of the CEA.

Absent further CFTC action, the Proposed CFTC Order will expire on December 31, 2011.4

Category 1: Self-Effectuating Provisions that are Expressly Subject to Rulemaking

Certain provisions of the CEA added or amended by Title VII are expressly subject to CFTC rulemaking and will have no effect on July 16 unless the CFTC has put in place final rules by that date.5 Such provisions are outside the scope of the Proposed CFTC Order. Included among the Category 1 provisions are those defined terms in the CEA that are themselves subject to being “further defined,” as listed below. Note, however, that the expanded definitions of “futures commission merchant” and “introducing broker” are not on the Category 1 list. However, to the extent that these definitions reference terms subject to further definition, the definitions may fall within Category 2. Category 1 provisions will become effective on such dates as are determined by the CFTC in the exercise of its broad discretion under Title VII to determine the timing of implementation provisions of Title VII.

Category 2: Self-Effectuating Provisions that Reference Terms Subject to “Further Definition”

Many provisions of the CEA added or amended by Title VII do not themselves expressly require further CFTC rulemaking in order to become effective on July 16. Certain of these provisions, however, rely upon or reference terms that are expressly required by Dodd-Frank to be “further defined.”

The terms subject to further definition are:

“swap”;
“security-based swap”;
“swap dealer”;
“security-based swap dealer”;
“major swap participant”;
“major security-based swap participant”;
“eligible contract participant”; and
“security-based swap agreement.”

The Agencies have issued proposed rules to further define each of the terms listed above.6 However, those proposed rules will not be in effect by the July 16 statutory effective date. As these terms are central to the implementation of the regulatory framework established by Title VII, allowing self-effectuating provisions referencing these terms to go into effect without final definitions in place could lead to large-scale disruption of the swaps markets. The CFTC is therefore proposing to exempt persons and entities from virtually all Category 2 provisions of the CEA with respect to “those requirements or portions of such provisions that specifically relate to [the terms listed above].”7

For example, the new definitions of “commodity pool operator” (“CPO”) and “commodity trading advisor (“CTA”) require registration (subject to applicable exemptions) due to activities relating to “swaps” (e.g., currency swaps, interest rate swaps or broad-based stock index swaps), even if such persons do not engage in traditional exchange-traded futures activities. But because the term “swap” is subject to further definitional rulemaking, the CFTC is proposing exemptive relief to delay the effective date of the new CPO and CTA definitions pursuant to the CFTC’s general exemptive authority. Pursuant to the Proposed CFTC Order, persons who would be required to register as CPOs or CTAs based solely on their “swaps” activities will benefit from the proposed exemption and, if the exemption is finalized, will not need to become registered by July 16 as would otherwise be required under Dodd-Frank. However, the exemption will be temporary, so potential CPOs and CTAs should start familiarizing themselves with the registration process (and potentially applicable exemptions) and beginning the process of registering if necessary.

In addition, the Proposed CFTC Order would not affect the applicability of any provision of the CEA to transactions with retail customers in foreign currency. Note, however, that the addition of a “look-though” to the commodity pool prong of the definition of an “eligible contract participant” is listed by the CFTC as a Category 1 amendment, and therefore not effective on July 16, which would prevent commodity pools in which non-eligible contract participants are invested from becoming retail customers with respect to OTC foreign currency transactions.

The Proposed CFTC Order would not limit the CFTC’s anti-fraud or anti-manipulation authority (including new authorities created by Dodd-Frank with respect to swaps), nor would it affect the applicability of any provision of the CEA to futures contracts or options on futures contracts. This temporary exemptive relief would expire upon the earlier of (a) the date on which the CFTC issues final rules further defining the applicable term and (b) December 31, 2011.

Category 3: Self-Effectuating Provisions that Repeal CEA Provisions

The CEA includes provisions that exempt or exclude, to varying degrees, certain transactions from CFTC oversight. Among these provisions are “safe harbors” for off-exchange transactions in excluded commodities (including currencies, interest rates and exchange rates), exempt commodities (including energy and metal commodities), and other underlying interests. Dodd-Frank will eliminate virtually all of these safe harbors, effective July 16, 2011.

In 1993, years before the statutory safe harbors were added to the CEA, the CFTC adopted its Part 35 regulations, which provide a broad-based exemption from the CEA for “swap agreements,” irrespective of the nature of the underlying commodity. Although the enactment of the CFMA in 2000 rendered Part 35 moot with respect to many transactions, OTC transactions in agricultural commodities (for which no statutory safe harbor exists) have been conducted under Part 35 since 2000 and the CFTC has never repealed Part 35. In addition, in 1989, the CFTC issued its "Swaps Policy Statement" which set forth the criteria necessary for the CFTC to conclude that a "swap" is not an unlawful off-exchange futures contract. That document will take an increased relevance once the statutory safe harbors for OTC derivatives are eliminated from the CEA.

In the Proposed CFTC Order, the CFTC notes that, notwithstanding the elimination of the CEA statutory safe harbors for many OTC derivatives, parties may continue to rely on Part 35 to the extent they fully meet the requirements thereof. The CFTC is also proposing to extend Part 35 to parties and transactions that did not previously meet certain requirements of Part 35, provided that the relevant transaction (and the persons offering or entering into the transaction) would fall within the CEA statutory safe harbors, as in effect prior to July 16, 2011. Once again, this proposal would not in any way limit the CFTC anti-fraud or anti-manipulation authority with respect to the transactions in question. Under the Proposed CFTC Order, this temporary exemptive relief would expire on the earlier of (a) December 31, 2011 or (b) the repeal or replacement of Part 35 of the CFTC’s regulations. The CFTC is also proposing similar treatment for “commodity options” pursuant to Part 32 of the CFTC’s regulations.

Category 4: Provisions of Title VII that will go into Effect on July 16

Provisions of the CEA added or amended by Title VII that are not expressly subject to CFTC rulemaking and that do not rely on or reference any of the terms required to be “further defined” will become effective on July 16, 2011.8

Section 737 of Dodd-Frank requires the CFTC to establish speculative position limits for swaps that are economically equivalent to futures contracts traded on designated contract markets. This section became effective on the enactment date of Dodd-Frank on July 21, 2010. The Proposed CFTC Order advises that the exemptions proposed by the CFTC do not affect the effective date of section 737 position limits provisions (which already occurred in 2010). However, although the statutory provision is already effective, to the extent section 737 references "swaps," a term subject to further definition by the Agencies, it is reasonable to anticipate that final position limits rules in respect of economically equivalent swaps will not be implemented until the further definition of the term "swap" is finalized.

The SEC Order

Title VII of Dodd-Frank grants the SEC authority to regulate the “security-based swaps” markets and certain participants in these markets. Absent relief, certain provisions of Dodd-Frank applicable to the security-based swaps markets automatically go into effect on July 16, 2011. Among these provisions are substantive requirements applicable to market participants, as well as amendments to prior law that would cause security-based swaps to fall within the definition of a “security” for purposes of the Securities Act and Exchange Act. The impact of security-based swaps being treated as “securities” will be far-reaching and will require considerable time to evaluate. The SEC Order grants open-ended exemptive relief from the July 16 statutory deadline with respect to many (though not all) Securities Act and Exchange Act provisions added or amended by Title VII of Dodd-Frank relating to security-based swaps. This relief, while temporary, will not expire on a specific date that is independent of further SEC rulemaking. The SEC Order does not address the fact that security-based swaps will become securities effective July 16. The SEC has indicated that it will address that issue separately.9

As noted above, the CFTC took a broad and general approach to its proposed exemptive relief, leaving the applicability of that relief to specific CEA provisions open to further analysis and interpretation. The SEC, on the other hand, elected to address each Title VII requirement applicable to security-based swaps on a provision-by-provision basis, categorizing each such provision in one of three groups: (a) provisions for which compliance will (absent relief) be required as of July 16, 2011, (b) provisions for which compliance will be required upon registration, publication of final rules, or other SEC action, and (c) provisions that authorize or direct the SEC to take certain actions. The SEC Order then, where so determined by the SEC, affords relief from the July 16 effective date.

Provisions in the second group either apply only to certain registered persons for which the relevant registration processes have not yet been established or expressly require an SEC rulemaking. Neither type of provision will become effective automatically on July 16 and therefore no exemptive relief is being provided with respect to such provisions. Provisions in the third group similarly impose no obligation on market participants on July 16, except to the extent that the SEC has already taken the relevant action. Provisions in the first group, however, would impose compliance obligations on market participants as of July 16 absent SEC exemptive relief. The SEC is providing exemptive relief with respect to the majority of these provisions.

Although the SEC Order is open to comment through July 6, the order itself will be effective upon publication in the Federal Register, which should occur within several days of its initial release. There is no expiration date attached to the SEC Order.

Conclusion

Although the Agencies have signaled their intention that July 16 be a “non-event” for the OTC derivatives markets, and have attempted to craft their respective Orders accordingly, the Agencies’ approaches to implementing relief from the July 16 effective date with respect to the provisions of Title VII of Dodd-Frank differ substantially. In addition, certain substantive provisions of Dodd-Frank impacting the OTC derivatives markets will nevertheless go into effect, either partly or entirely, on July 16 notwithstanding the Orders. Each market participant should carefully review the Orders and discuss with counsel the impact of the Orders on its own business in light of its particular circumstances.

On June 14, 2011, the Commodity Futures Trading Commission (“CFTC”) issued a notice of proposed order and request for comment1 (the “Proposed CFTC Order”) with respect to the effective dates of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)2 relating to the regulation of the swaps markets. On June 16, 2011, the Securities and Exchange Commission (“SEC” and, with the CFTC, the “Agencies”) released an order3 (the “SEC Order” and, with the Proposed CFTC Order, the “Orders”) granting temporary exemptions and other temporary relief, and providing information on compliance dates, applicable to the regulation of the security-based swaps markets. The deadline for commenting on the Proposed CFTC order is July 1, 2011, and the deadline for commenting on the SEC order is July 6, 2011.

Dodd-Frank was enacted on July 21, 2010. Through enactment of Title VII of Dodd-Frank, Congress sought to create a comprehensive regulatory regime applicable to the over-the-counter derivatives markets. These markets have to date been largely unregulated. Title VII of Dodd-Frank adds extensive new provisions relating to OTC derivatives to the Commodity Exchange Act (“CEA”), the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”), while eliminating provisions of those statutes that were added by the Commodity Futures Modernization Act (“CFMA”) to provide legal certainty with respect to OTC derivatives through various “safe harbors.” Dodd-Frank generally eliminates those safe harbors.

The amendments to the CEA, Securities Act and Exchange Act made by Title VII of Dodd-Frank, including the elimination of certain safe harbors for OTC derivatives, are generally effective on July 16, 2011 or not less than 60 days after a rulemaking is finalized, to the extent that a provision of Title VII “requires a rulemaking.” Because the Agencies have, to date, finalized very few regulations implementing Title VII, there has been a great deal of uncertainty and concern about what will happen to the legal foundations for the OTC derivatives markets on and after July 16. The Agencies issued their respective Orders in an attempt to make July 16 a “non-event” for these markets. However, the Orders take entirely different approaches to providing regulatory relief and raise complex issues that market participants should discuss with counsel.

The Proposed CFTC Order

Title VII of Dodd-Frank grants the CFTC authority to regulate the “swaps” markets and certain participants in these markets. Absent relief, certain provisions of Dodd-Frank applicable to swaps are scheduled to automatically go into effect on July 16, 2011. Among these provisions are substantive requirements applicable to market participants, as well as the elimination of the existing safe harbors from the applicability of other laws for many forms of OTC derivative transaction.

The Proposed CFTC Order would grant temporary relief from the July 16 statutory effective date in two parts — first, the CFTC is proposing to temporarily exempt persons or entities with respect to CEA provisions added or amended by Title VII of Dodd-Frank if those provisions reference any term that is subject to “further definition” under Title VII, and second, the CFTC is proposing to grant temporary relief from the elimination of the CEA safe harbors for certain agreements, contracts or transactions in certain types of commodities.

The Proposed CFTC Order groups Title VII provisions affecting the CEA into four categories: (1) provisions that expressly require a rulemaking, (2) provisions that are, on their face, self-effectuating but that reference terms subject to further rulemaking, (3) self-effectuating provisions that do not reference terms subject to further rulemaking, but that repeal provisions of the CEA and (4) self-effectuating provisions for which the CFTC is not proposing to provide any relief under the Proposed CFTC Order. Provisions in Category 1 are beyond the scope of the Proposed CFTC Order because such provisions are, by their own terms, not effective until a minimum of 60 days after CFTC-mandated rulemaking is completed. Category 4 provisions do not reference terms subject to further rulemaking and do not repeal current provisions of the CEA.

Absent further CFTC action, the Proposed CFTC Order will expire on December 31, 2011.4

Category 1: Self-Effectuating Provisions that are Expressly Subject to Rulemaking

Certain provisions of the CEA added or amended by Title VII are expressly subject to CFTC rulemaking and will have no effect on July 16 unless the CFTC has put in place final rules by that date.5 Such provisions are outside the scope of the Proposed CFTC Order. Included among the Category 1 provisions are those defined terms in the CEA that are themselves subject to being “further defined,” as listed below. Note, however, that the expanded definitions of “futures commission merchant” and “introducing broker” are not on the Category 1 list. However, to the extent that these definitions reference terms subject to further definition, the definitions may fall within Category 2. Category 1 provisions will become effective on such dates as are determined by the CFTC in the exercise of its broad discretion under Title VII to determine the timing of implementation provisions of Title VII.

Category 2: Self-Effectuating Provisions that Reference Terms Subject to “Further Definition”

Many provisions of the CEA added or amended by Title VII do not themselves expressly require further CFTC rulemaking in order to become effective on July 16. Certain of these provisions, however, rely upon or reference terms that are expressly required by Dodd-Frank to be “further defined.”

The terms subject to further definition are:

“swap”;
“security-based swap”;
“swap dealer”;
“security-based swap dealer”;
“major swap participant”;
“major security-based swap participant”;
“eligible contract participant”; and
“security-based swap agreement.”

The Agencies have issued proposed rules to further define each of the terms listed above.6 However, those proposed rules will not be in effect by the July 16 statutory effective date. As these terms are central to the implementation of the regulatory framework established by Title VII, allowing self-effectuating provisions referencing these terms to go into effect without final definitions in place could lead to large-scale disruption of the swaps markets. The CFTC is therefore proposing to exempt persons and entities from virtually all Category 2 provisions of the CEA with respect to “those requirements or portions of such provisions that specifically relate to [the terms listed above].”7

For example, the new definitions of “commodity pool operator” (“CPO”) and “commodity trading advisor (“CTA”) require registration (subject to applicable exemptions) due to activities relating to “swaps” (e.g., currency swaps, interest rate swaps or broad-based stock index swaps), even if such persons do not engage in traditional exchange-traded futures activities. But because the term “swap” is subject to further definitional rulemaking, the CFTC is proposing exemptive relief to delay the effective date of the new CPO and CTA definitions pursuant to the CFTC’s general exemptive authority. Pursuant to the Proposed CFTC Order, persons who would be required to register as CPOs or CTAs based solely on their “swaps” activities will benefit from the proposed exemption and, if the exemption is finalized, will not need to become registered by July 16 as would otherwise be required under Dodd-Frank. However, the exemption will be temporary, so potential CPOs and CTAs should start familiarizing themselves with the registration process (and potentially applicable exemptions) and beginning the process of registering if necessary.

In addition, the Proposed CFTC Order would not affect the applicability of any provision of the CEA to transactions with retail customers in foreign currency. Note, however, that the addition of a “look-though” to the commodity pool prong of the definition of an “eligible contract participant” is listed by the CFTC as a Category 1 amendment, and therefore not effective on July 16, which would prevent commodity pools in which non-eligible contract participants are invested from becoming retail customers with respect to OTC foreign currency transactions.

The Proposed CFTC Order would not limit the CFTC’s anti-fraud or anti-manipulation authority (including new authorities created by Dodd-Frank with respect to swaps), nor would it affect the applicability of any provision of the CEA to futures contracts or options on futures contracts. This temporary exemptive relief would expire upon the earlier of (a) the date on which the CFTC issues final rules further defining the applicable term and (b) December 31, 2011.

Category 3: Self-Effectuating Provisions that Repeal CEA Provisions

The CEA includes provisions that exempt or exclude, to varying degrees, certain transactions from CFTC oversight. Among these provisions are “safe harbors” for off-exchange transactions in excluded commodities (including currencies, interest rates and exchange rates), exempt commodities (including energy and metal commodities), and other underlying interests. Dodd-Frank will eliminate virtually all of these safe harbors, effective July 16, 2011.

In 1993, years before the statutory safe harbors were added to the CEA, the CFTC adopted its Part 35 regulations, which provide a broad-based exemption from the CEA for “swap agreements,” irrespective of the nature of the underlying commodity. Although the enactment of the CFMA in 2000 rendered Part 35 moot with respect to many transactions, OTC transactions in agricultural commodities (for which no statutory safe harbor exists) have been conducted under Part 35 since 2000 and the CFTC has never repealed Part 35. In addition, in 1989, the CFTC issued its "Swaps Policy Statement" which set forth the criteria necessary for the CFTC to conclude that a "swap" is not an unlawful off-exchange futures contract. That document will take an increased relevance once the statutory safe harbors for OTC derivatives are eliminated from the CEA.

In the Proposed CFTC Order, the CFTC notes that, notwithstanding the elimination of the CEA statutory safe harbors for many OTC derivatives, parties may continue to rely on Part 35 to the extent they fully meet the requirements thereof. The CFTC is also proposing to extend Part 35 to parties and transactions that did not previously meet certain requirements of Part 35, provided that the relevant transaction (and the persons offering or entering into the transaction) would fall within the CEA statutory safe harbors, as in effect prior to July 16, 2011. Once again, this proposal would not in any way limit the CFTC anti-fraud or anti-manipulation authority with respect to the transactions in question. Under the Proposed CFTC Order, this temporary exemptive relief would expire on the earlier of (a) December 31, 2011 or (b) the repeal or replacement of Part 35 of the CFTC’s regulations. The CFTC is also proposing similar treatment for “commodity options” pursuant to Part 32 of the CFTC’s regulations.

Category 4: Provisions of Title VII that will go into Effect on July 16

Provisions of the CEA added or amended by Title VII that are not expressly subject to CFTC rulemaking and that do not rely on or reference any of the terms required to be “further defined” will become effective on July 16, 2011.8

Section 737 of Dodd-Frank requires the CFTC to establish speculative position limits for swaps that are economically equivalent to futures contracts traded on designated contract markets. This section became effective on the enactment date of Dodd-Frank on July 21, 2010. The Proposed CFTC Order advises that the exemptions proposed by the CFTC do not affect the effective date of section 737 position limits provisions (which already occurred in 2010). However, although the statutory provision is already effective, to the extent section 737 references "swaps," a term subject to further definition by the Agencies, it is reasonable to anticipate that final position limits rules in respect of economically equivalent swaps will not be implemented until the further definition of the term "swap" is finalized.

The SEC Order

Title VII of Dodd-Frank grants the SEC authority to regulate the “security-based swaps” markets and certain participants in these markets. Absent relief, certain provisions of Dodd-Frank applicable to the security-based swaps markets automatically go into effect on July 16, 2011. Among these provisions are substantive requirements applicable to market participants, as well as amendments to prior law that would cause security-based swaps to fall within the definition of a “security” for purposes of the Securities Act and Exchange Act. The impact of security-based swaps being treated as “securities” will be far-reaching and will require considerable time to evaluate. The SEC Order grants open-ended exemptive relief from the July 16 statutory deadline with respect to many (though not all) Securities Act and Exchange Act provisions added or amended by Title VII of Dodd-Frank relating to security-based swaps. This relief, while temporary, will not expire on a specific date that is independent of further SEC rulemaking. The SEC Order does not address the fact that security-based swaps will become securities effective July 16. The SEC has indicated that it will address that issue separately.9

As noted above, the CFTC took a broad and general approach to its proposed exemptive relief, leaving the applicability of that relief to specific CEA provisions open to further analysis and interpretation. The SEC, on the other hand, elected to address each Title VII requirement applicable to security-based swaps on a provision-by-provision basis, categorizing each such provision in one of three groups: (a) provisions for which compliance will (absent relief) be required as of July 16, 2011, (b) provisions for which compliance will be required upon registration, publication of final rules, or other SEC action, and (c) provisions that authorize or direct the SEC to take certain actions. The SEC Order then, where so determined by the SEC, affords relief from the July 16 effective date.

Provisions in the second group either apply only to certain registered persons for which the relevant registration processes have not yet been established or expressly require an SEC rulemaking. Neither type of provision will become effective automatically on July 16 and therefore no exemptive relief is being provided with respect to such provisions. Provisions in the third group similarly impose no obligation on market participants on July 16, except to the extent that the SEC has already taken the relevant action. Provisions in the first group, however, would impose compliance obligations on market participants as of July 16 absent SEC exemptive relief. The SEC is providing exemptive relief with respect to the majority of these provisions.

Although the SEC Order is open to comment through July 6, the order itself will be effective upon publication in the Federal Register, which should occur within several days of its initial release. There is no expiration date attached to the SEC Order.

Conclusion

Although the Agencies have signaled their intention that July 16 be a “non-event” for the OTC derivatives markets, and have attempted to craft their respective Orders accordingly, the Agencies’ approaches to implementing relief from the July 16 effective date with respect to the provisions of Title VII of Dodd-Frank differ substantially. In addition, certain substantive provisions of Dodd-Frank impacting the OTC derivatives markets will nevertheless go into effect, either partly or entirely, on July 16 notwithstanding the Orders. Each market participant should carefully review the Orders and discuss with counsel the impact of the Orders on its own business in light of its particular circumstances.

July 13, 2011

Securities Fraud Tweets

Recent Securities Fraud tweets by Ross Intelisano:

FT: Investigators listened in on almost 100 clients of Primary Global. Buyer (and Seller) Beware. http://t.co/GRNEcNs · reply · retweet · favorite

MBIA Drops Merrill Fraud Case.Hard to tell if ML settled with dollars or MBIA forced to just withdraw.Bad news if latter http://t.co/kwPT9t8 2 hours ago · reply · retweet · favorite

Lattman on SEC Examining Fletcher Fund. Bayou started same way. Huge red flags of potential fraud. Freeze those assets.http://nyti.ms/ppK3aF 2 hours ago · reply · retweet · favorite

Schneiderman questioning BofA settlement. Begs question why GS and others would settle at 5 cents. Seems odd. http://nyti.ms/mXtASx 2 hours ago · reply · retweet · favorite

Feds charge 3 CEOs with penny-stock fraud. What is this 1998? Can't believe still happens. via @forbes cptl.st/jsjEs

Deutsche fires big trader after "substantial trading anomalies" in huge CDS portfolio. Expect more of these reut.rs/ixeY1J via @reuters