Bloomberg News

SEC Nominees, FDIC Capital Rule, Broker-Dealers: Compliance

June 15, 2011

(Adds shareholder limit bill in Compliance Policy.)

June 15 (Bloomberg) -- If the U.S. Senate confirms him for a spot on the Securities and Exchange Commission, Daniel M. Gallagher will take a pay cut of more than $1 million a year.

Gallagher, a securities lawyer and former SEC deputy division director, earned about $1.2 million a year advising SEC-regulated firms at Wilmer Cutler Pickering Hale & Dorr LLP, his financial disclosures show. He is one of two SEC nominees who appeared at a confirmation hearing yesterday before the Senate Banking Committee. If confirmed, his salary will be $155,500, according to the U.S. Office of Personnel Management.

Gallagher, 39, would replace fellow Republican Kathleen Casey, whose five-year term expired last week. President Barack Obama also nominated incumbent Commissioner Luis Aguilar, 57, a Democrat, for a second term. Casey is permitted to keep serving on the five-member commission until replaced, as Aguilar has done since his term ended more than a year ago.

“This is a time of great importance for the SEC,” Gallagher said at the hearing. “Investors will only commit capital if they have faith in the fairness of our markets, and the SEC is charged with instilling and maintaining this confidence.”

The Banking Committee yesterday also considered the nominations of Anthony Frank D’Agostino and Gregory Karawan to be directors of the Securities Investor Protection Corp.

The committee likely will vote on the nominations in the next few weeks, said Senator Tim Johnson, the South Dakota Democrat who chairs the committee.

A Republican member of the Banking Committee, however, said in a statement yesterday that he plans to block the nominations of both Gallagher and Aguilar. David Vitter of Louisiana said he is concerned that the SEC, which has been meeting to consider whether to help investors in R. Allen Stanford’s alleged Ponzi scheme through the SIPC, will have to re-start discussions if new commissioners are introduced.

The Senate confirmation process has drawn criticism this year from others frustrated with procedural roadblocks, including Treasury Secretary Timothy F. Geithner. He said at last week’s International Monetary Conference that political abuses of the confirmation process are “undermining the core elements of reform,” with Dodd-Frank opponents blocking appointments of financial regulators.

The day of Geithner’s June 6 speech, Nobel laureate Peter Diamond withdrew as Obama’s nominee to the Federal Reserve’s board of governors, citing 14 months of Republican opposition.

For more, click here.

Compliance Policy

FDIC Approves Final Rule Setting Capital Floor for Banks

The Federal Deposit Insurance Corp. board yesterday approved a final rule barring the nation’s largest lenders from reducing their capital levels below baselines set for smaller banks as part of a joint rulemaking under the Dodd-Frank Act.

FDIC board members approved the measure at a meeting in Washington yesterday. The joint-agency rule with the Federal Reserve and the Office of the Comptroller of the Currency will also hold large financial holding companies to the same capital requirements as their subsidiaries that take insured deposits.

The measure, included in the regulatory overhaul at the request of U.S. Senator Susan Collins of Maine, prevents lenders from lowering capital holdings using formulas in the Basel II international banking accords. Without such a floor, banks and their holding companies would have been allowed to reduce capital levels over time.

The “rule implements the Collins amendment, which in my view is the single most important provision of the Dodd-Frank Act for strengthening the capital of the U.S. banking system and leveling the competitive playing field,” FDIC Chairman Sheila Bair said in a statement.

The rule by itself won’t require lenders to hold additional capital, since all U.S. banking companies are already computing capital requirements using the rules that would serve as the floor, Bair said. It does, however, ensure that “when the crisis is forgotten and models again tell us that risks and needed capital are minimal, that large banks will not be allowed to operate with less capital than Main Street banks,” she said.

The rule will take effect 30 days after it is published in the Federal Register.

Systemic Firms May Be Told to Simplify, FDIC Official Says

Systemically important financial institutions in the U.S. may have to simplify their business if they can’t provide viable plans for unwinding themselves in a crisis, a senior Federal Deposit Insurance Corp. official said.

“Ultimately, a SIFI could be required to restructure its operations if it cannot demonstrate it is resolvable in an orderly manner under the Bankruptcy Code,” Michael Krimminger, the FDIC’s chief counsel, told a House Financial Services subcommittee yesterday at a hearing in Washington.

The Dodd-Frank Act requires firms deemed systemically important to file plans with the FDIC and the Federal Reserve, laying out how they could be resolved if they should collapse. Lawmakers gave the FDIC authority to resolve complex firms aiming to prevent a repeat of the market tumult that followed the September 2008 bankruptcy of Lehman Brothers Holdings Inc.

Companies with at least $50 billion in assets will be required to provide information on debt, funding, capital and cash flows. Firms that fail to file workable resolution plans could be subject to increased capital, leverage or liquidity requirements, and restrictions on growth or operations.

Krimminger, testifying at a Financial Institutions subcommittee hearing on whether the new rules put an end to the notion that some firms are “too big to fail,” said the FDIC anticipates that companies will “pursue the resolution planning process in a way to meet statutory requirements.”

Republican lawmakers, who almost unanimously opposed Dodd- Frank last year, said yesterday the new FDIC powers create another mechanism for taxpayer bailouts of firms that have only grown larger in the wake of the subprime mortgage crisis.

“The truth of the matter is, in times of crises, regulators have always and will always err on the side of more intervention and more bailouts,” said Representative Ed Royce, a California Republican. The agency’s new authority “does little more than facilitate this process.”

Representative Barney Frank, a Massachusetts Democrat who was the co-sponsor of the financial regulation law, said that Republicans were the only public officials keeping the option of bailouts open with their statements. He also disagreed with the idea advanced by Republicans that a designation of systemic importance would serve as a business enhancement for the largest firms. Non-bank financial firms have lobbied regulators to avoid the designation, according to meeting summaries posted on the Fed and FDIC websites.

CFTC Proposes Six-Month Delay of Swap Rules Slated for July

Rules scheduled to take effect in mid-July for the $601 trillion swaps market would be delayed until as late as the end of the year under a proposal by the U.S. Commodity Futures Trading Commission.

The agency’s commissioners voted 5-0 yesterday to propose “temporary relief” from some requirements set to be in place on July 16, a year from the enactment of the Dodd-Frank Act. The delay would give the CFTC more time to write dozens of rules aimed at reducing risk and boosting transparency after largely unregulated trades helped fuel the 2008 credit crisis.

“Some might ask: why six months? Six months will provide the commission with the opportunity to re-examine the status of final rulemaking in light of the changed regulatory landscape at the time,” Gary Gensler, CFTC chairman, said at the meeting in Washington. The proposal is open to 14 days of public comment before it is finalized.

Under the proposal, Dodd-Frank provisions scheduled to take effect July 16 and that refer to agency rules that haven’t been finalized would be delayed until those rules are adopted, though not later than Dec. 31. The agency’s commissioners also could decide to push the deadline into 2012 if they find that more time is needed, according to the CFTC.

The CFTC scheduled its next meeting for July 7.

For more, click here.

Bill Would Double Shareholder Limit for Closely Held Firms

Eight U.S. lawmakers backed a bill that would allow closely held firms including Facebook Inc. and Twitter Inc. to have as many as 1,000 shareholders before the companies needed to file public financial statements.

The legislation, introduced yesterday by Representative David Schweikert of Arizona, would also exclude employees and accredited investors from the rules, which currently set the ceiling at 500 investors.

“The underlying premise is that there is lots of capital sitting on the sidelines and for some reason it’s not flowing into the market,” Schweikert, a Republican on the Financial Services Committee, said in a telephone interview. “The current rules just seem to be out of date.”

The legislation is the latest attempt by lawmakers to revise the regulations that governed closely held firms since 1964. Representative Darrell Issa, a California Republican and chairman of the Oversight and Government Reform Committee, has called on Securities and Exchange Commission Chairman Mary Schapiro to loosen the rules.

Closely held companies with fewer than 500 shareholders aren’t required to disclose financial data, so investors often don’t know key figures such as revenue, profit, cash flow and debt obligations.

Schapiro, in responses to Issa in a letter and in testimony, said the SEC is in the midst of studying whether the growth of closely held companies is being hindered by limits on the numbers of shareholders they can have.

For more, click here.

Compliance Action

Broker-Dealer Audits Targeted in New U.S. Inspection Program

The biggest U.S. broker-dealers will have to pay more than $1 million a year to finance inspections of the firms that audit them under a regulatory program prompted by revelations related to Bernard Madoff’s Ponzi scheme.

The Public Company Accounting Oversight Board voted 5-0 yesterday to establish a temporary system for monitoring auditors of broker-dealers that will give the Washington-based watchdog time to determine what a permanent system should look like.

“If we find violations of law, we won’t wait to act on them,” Chairman James R. Doty said in remarks before the vote. “We will use our disciplinary authority in any appropriate cases of auditor misconduct.”

The PCAOB’s new program requires U.S. broker-dealers to fund the estimated $14.4 million inspections program, which could amount to more than $1 million for the largest firms. The board said 640 brokerages will be charged this year, with fees assessed in proportion to a firm’s net capital. The fee structure was also passed by the board with a 5-0 vote.

Companies such as Goldman Sachs Group Inc. and Morgan Stanley can expect the new fees to be assessed on their broker- dealers, separately from fees already assessed on parent companies for the PCAOB’s existing public-company audit inspections.

Lawmakers included expanded oversight of broker-dealers in the Dodd-Frank Act last year after it was revealed that Madoff conducted his multibillion-dollar fraud while his brokerage was being audited by a small firm operating out of a 13-by-18-foot storefront. The regulatory overhaul eliminated a system in which auditors had to register with the PCAOB but weren’t overseen by the panel.

A group of U.S. House members who are also accountants urged the PCAOB in a Feb. 14 letter to focus the program on brokers who have custody of client assets, not those who don’t.

For more, click here.

Citigroup Asked for More Data-Breach Details by Connecticut

Connecticut Attorney General George Jepsen asked Citigroup Inc. to provide more information on how a recent data breach occurred and what is being done to protect affected customers from fraud.

Citigroup said this month that the account information of about 1 percent of its Citi-branded North America credit cards was viewed through unauthorized access to accounts online.

Jepsen said in a statement yesterday that he wrote to New York-based Citigroup’s Chief Executive Officer Vikram Pandit and its general counsel, Michael Helfer. He requested the additional information by June 22.

Sean Kevelighan, a Citigroup spokesman, said he couldn’t comment directly on Jepsen’s request.

“Citi immediately rectified the data breach upon discovery, while also placing internal fraud alerts and monitoring on all accounts at risk,” Kevelighan said in an e- mail. “Simultaneously, we began analysis to determine the precise accounts and type of information accessed.”

Citigroup also notified law enforcement and government officials, Kevelighan said. On June 3, within three weeks, the bank began to notify clients by letter, most of which included re-issued credit cards, he said.

“None of the data breached was sufficient to perpetrate fraud,” Kevelighan said.

U.K. Trader Told to Pay $1.6 Million for Manipulating Shares

A self-employed trader was fined 700,000 pounds ($1.15 million) and ordered to pay more than 300,000 pounds in restitution for manipulating the price of shares traded on the London Stock Exchange.

Barnett Michael Alexander, a former private-client stockbroker, made multiple small buy and sell orders in an effort to manipulate the price of contracts-for-differences and spread bets, generating a profit of 629,130 pounds over 16 months. The Financial Services Authority banned him from working in the finance industry for five years.

“Alexander’s behavior was deliberate and repeated over a significant period of time,” said Tracey McDermott, the acting director of enforcement at the FSA. “He sought to conceal his trading and made substantial profits at the expense of the firms which allowed him to trade with them.”

The FSA increased its enforcement of market abuse over the past year to help deter the crime, it said June 13 in its annual report. Market abuse is a crime where the price of a financial instrument is distorted.

Alexander, 47, said he “never thought for a second” that he’d done anything illegal.

“This whole thing is a bit of a nightmare,” Alexander said in an interview. “I found a loophole in one of the spread betting companies and I set about exploiting that.”

Courts

New York ‘Boiler Room’ Salesman Pleads Guilty During Trial

A New York man pleaded guilty to his role in the Gryphon Holdings Inc. “boiler room” scheme, the last of 18 defendants to do so, the day after his trial began.

Baldwin Anderson, 57, a former salesman for Gryphon, pleaded guilty yesterday before U.S. District Judge Jack Weinstein in Brooklyn, New York, and was taken into custody. Anderson and Gryphon misled investors into paying for phony stock tips and investment advice, defrauding them of $20 million, prosecutors charged.

“From April 2007 until April 2010 I participated in the scheme to defraud Gryphon clients,” Anderson told the judge.

Kenneth Marsh, 44, who ran Gryphon, was the last defendant before Anderson to plead guilty, on April 14. He’s scheduled to be sentenced July 12. Gryphon told victims its office was on Wall Street or even in the New York Stock Exchange when it was in a strip mall in the New York borough of Staten Island, according to Anderson’s indictment. Anderson told Weinstein he was paid $1.1 million while working at Gryphon.

“He took a long, hard look at the situation and decided this was the right thing to do,” Michael Padden, Anderson’s lawyer, said after the hearing.

Anderson, a Jamaican citizen who lived on Staten Island, pleaded guilty to one count of wire fraud and securities fraud conspiracy. Federal guidelines call for a prison sentence of up to 21 years and 10 months, Assistant U.S. Attorney Roger Burlingame said at the hearing.

Weinstein set sentencing for July 29.

The criminal case is U.S. v. Marsh, 10-cr-00480, and the SEC case is SEC v. Gryphon Holdings Inc., 10-cv-01742, U.S. District Court, Eastern District of New York (Brooklyn).

BGC Begins U.K. Trial Against Tullett Over Broker Defection

BGC Partners Inc., a New York brokerage that matches trades between banks, told a U.K. judge that competitor Tullett Prebon Plc wrongfully encouraged a “disaffected” broker to defect.

Peter Rees, hired in 2007 to manage BGC’s Swiss Franc desk, was persuaded to move to Tullett half-way through his four-year contract, lawyers for the U.S. inter-dealer company said yesterday at the start of a 10-day trial in London. Rees said he quit after BGC blamed him for failing to secure business from UBS AG and cut his salary by more than half.

“This industry is about contracts,” BGC’s lawyer, Jonathan Cohen, said. “The life-blood of this industry is the brokers -- that’s why they take home so much” of the revenue they generate.

The trial comes a year after London-based Tullett won another U.K. lawsuit accusing BGC of using tens of millions of pounds of inducements to poach 10 of its traders -- a ruling that was upheld on appeal and prompted BGC to reach a private financial settlement in April. In the U.S., Tullett in August sued BGC in New York state court over claims it plotted to hire away 77 staffers.

BGC claims that as the previous trial unfolded in London, Tullett was already in the process of offering Rees a job in the U.K., where he wanted to relocate. BGC is seeking damages from lost business and repayment of a 250,000-pound ($410,000), interest-free loan to Rees.

“Tullett identified Rees as a disaffected broker who was vulnerable to a recruitment approach,” BGC said in court papers outlining its case. Rees quit in 2009 after his salary of 228,000 pounds was reduced to about 105,000 pounds due to poor performance, according to the filing.

Tullett claims Rees’s desk couldn’t have performed well without UBS’s business, and that BGC’s internal head-hunter had promised him the brokerage would secure a “direct line” between his trading desk and the Zurich-based bank.

While BGC was “rightly concerned” about Rees’s low revenue without UBS, it breached his contract by failing to take the head-hunter’s guarantee into account when it reduced his salary, Tullett claims.

The reduction should have been “slightly less Draconian,” said Mohinderpal Sethi, Tullett’s lawyer. “It’s an exaggeration to say the desk could succeed without UBS. BGC seeks to downplay the importance of the line because of the promise it had made.”

Rajaratnam’s Arrest Led Hedge Fund Analyst to Destroy Data

A former analyst at hedge fund Barai Capital Management LP yesterday testified that after the arrest of Galleon Group LLC co-founder Raj Rajaratnam he destroyed files of inside information his firm received from so-called expert networkers.

The testimony of the former analyst, Jason Pflaum, came yesterday in federal court in Manhattan during the trial of Winifred Jiau, 43, the ex-Primary Global Research LLC consultant who is charged with passing tips about Nvidia Corp. and Marvell Technology Group Ltd. to hedge fund managers, including Pflaum’s former boss, Samir Barai.

Under questioning by Jiau’s lawyer, Joanna Hendon, Pflaum, 38, said at least eight people provided Barai with nonpublic information about technology companies, including Mark Anthony Longoria, a former employee of Advanced Micro Devices Inc. Pflaum said he destroyed the files related to these tipsters. Pflaum testified he didn’t delete files related to Jiau.

“What caused you to delete the files?” Hendon asked.

“The context was the Galleon case,” Pflaum said. “There was some discussion internally post-Galleon. There was more sensitivity to over-the-line business. More of a concern internally of who we could be talking to that was over the line,” he said.

Pflaum testified he decided to cooperate secretly with the U.S. after agents with the Federal Bureau of Investigation approached him in October 2010. He continued to work for Barai until he pleaded guilty in January.

Jiau is the first of the expert networkers, who provide industry information to financial company clients, to go to trial on federal charges of securities fraud and conspiracy. She faces as long as 25 years if convicted.

The case is U.S. v. Jiau, 11-cr-00161, U.S. District Court, Southern District of New York (Manhattan).

--With assistance from Silla Brush, Joshua Gallu, Jesse Hamilton, Meera Louis and Phil Mattingly in Washington; Karen Freifeld, Donal Griffin, Patricia Hurtado and Thom Weidlich in New York; and Lindsay Fortado and Erik Larson in London. Editor: Stephen Farr

To contact the reporter on this story: Ellen Rosen in New York at erosen14@bloomberg.net

To contact the editor responsible for this report: Michael Hytha at mhytha@bloomberg.net.


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