Bloomberg News

Brokerage IRAs, Trader Monitor, SunTrust Settles: Compliance

July 27, 2011

(Updates with foreclosure probes in Compliance Action, Lehman and Sky Capital in Courts, and Date in Comings and Goings.)

July 27 (Bloomberg) -- Brokerage firms may drop millions of individual retirement account holders if a proposed U.S. Labor Department rule takes effect, a lobbying group said yesterday.

The Labor Department wants to expand the scope of fiduciary responsibility to protect those saving for retirement from conflicts of interest, such as recommending investments with higher fees. The rule would require investment professionals who advise employers and workers with retirement savings plans such as 401(k)s or IRAs to act in the best interest of their clients.

The change may cause financial firms to offer fewer investment options in retirement accounts and shift to a fee- based model used by investment advisers, which may increase costs, Kenneth Bentsen, executive vice president for public policy and advocacy at the Securities Industry and Financial Markets Association, said at a Washington hearing before the House Subcommittee on Health, Employment, Labor and Pensions.

Assistant Secretary of Labor Phyllis Borzi said at the hearing that the broker concern “is perhaps due to a misunderstanding.” Exemptions already exist in Labor Department rules that would allow brokers to continue to provide securities, mutual funds and annuities to IRA owners, Borzi said.

Employers generally are held responsible for making sure their retirement plans operate in the best interest of employees. The proposed Labor Department regulation would apply a fiduciary standard to firms that advise plan sponsors and investors about investments even if they don’t give that advice regularly.

The Labor Department rule also may apply to advice given to savers when they are leaving a job and trying to decide whether to roll their money into IRAs.

For more, click here.

Compliance Policy

SEC Adopts System to Seek Abuses Among Biggest Traders

The U.S. Securities and Exchange Commission is establishing a system for monitoring the behavior of high-frequency trading firms and hedge funds under new reporting standards for the most-active market participants.

SEC commissioners voted 5-0 yesterday to adopt a tracking system for firms that buy and sell at least 2 million shares a day. The system, initially proposed three weeks before the May 2010 crash that temporarily erased $862 billion in U.S. share value, aims to use technology to help guard against market abuse and manipulation.

For more, click here.

SEC Replaces Credit Ratings as Short-Form Eligibility Standard

The U.S. Securities and Exchange Commission voted to cut credit ratings from eligibility requirements yesterday for firms seeking fast-track approval for securities offerings.

SEC commissioners voted 5-0 at a meeting in Washington yesterday to replace credit ratings as a gauge of creditworthiness with standards including whether a firm has issued $1 billion of non-convertible securities over the prior three years.

Banks Try Clout in Congress to Fight Financial Patent Owners

Software maker Trading Technologies International Inc. is among companies that say the validity of patents they spent years establishing may be threatened by legislation nearing final approval in Congress.

Patents covering financial business methods, such as those held by Trading Technologies for ways to connect to electronic exchanges, would face an additional layer of government review under the bill, which would mark the biggest overhaul of the U.S. patent system in at least 50 years.

Banks and insurers contend the added scrutiny is needed to weed out patents of questionable validity that are being used to extract multimillion-dollar damage awards through lawsuits. Owners of business-method patents say financial-services companies are using their clout in Washington to avoid paying for using someone else’s inventions.

The proposal would help banks, retailers, airlines and hotels defend lawsuits by companies known as non-practicing entities, or NPEs, that use patents to generate royalties rather than make products, Peter Freeman, vice president of the Financial Services Roundtable, a Washington-based trade group, said in an interview.

Business-method patents, which protect techniques including ways to run an organization or sort financial data, have been around as long as the patent system itself, with the first issued in 1799 for a way of detecting counterfeit notes.

Banks have obtained business-method patents, such as one issued to Goldman Sachs Group Inc. for “automatic online sales risk management,” or one received by Bank of America for a “bank card fraud protection system.” Bank of America said it had no comment, and Goldman Sachs didn’t respond to requests for comment on the legislation.

The disputed provision would apply only to patents related to data-processing for financial products or services that are in litigation.

For more, click here.

Compliance Action

SunTrust Agrees to Pay $5 Million in Auction-Rate Settlement

SunTrust Banks, Inc., the 10th biggest U.S. bank by assets, agreed to pay $5 million to resolve regulatory claims that it misled investors about the risks of auction-rate securities before the market froze three years ago.

Two of SunTrust’s brokerage units marketed the securities as “safe and liquid” even though the firm knew as early as 2007 that stresses in the market raised the risk that auctions might fail, the Financial Industry Regulatory Authority said in a statement yesterday. Prior to the collapse, SunTrust failed to disclose the increased risks to its sales representatives, while encouraging them to sell the products to reduce the firm’s own inventory, Finra said.

The Atlanta-based bank has repurchased about $643 million of the securities from investors, Finra said.

Auction-rate securities are typically municipal bonds, corporate bonds and preferred stocks whose rates of return are reset periodically through auctions. Lawsuits by state regulators and the Securities and Exchange Commission have led to the return of at least $60 billion to individual investors. According to the Municipal Securities Rulemaking Board, about $55 billion of the debt remains outstanding.

For more, click here.

FTC Said to Ready Oil Company Subpoenas in Gas Price Probe

The U.S. Federal Trade Commission is preparing to issue subpoenas to oil companies and refiners as it probes rising gasoline prices, a person familiar with the matter said.

The FTC called oil companies and refiners in the past three to four weeks to alert them to stand by for the subpoenas, said the person, who declined to be identified because the calls were confidential.

President Barack Obama announced in April an interagency task force to investigate potential fraud in oil markets as a possible cause for the run-up in fuel costs. Five Democratic senators sent a letter to FTC Chairman Jon Leibowitz on May 17 asking the agency to look into gasoline-price increases, saying reports at the time indicated U.S. refiners were restricting production to boost prices.

The FTC will “take action whenever we find wrongdoing,” Leibowitz said at the time. FTC spokesman Mitch Katz declined to comment yesterday because the investigation isn’t public.

The FTC’s Bureau of Economics regularly scrutinizes price movements in about 20 wholesale regions and almost 400 retail points across the country, according to the agency’s website.

Foreclosure-Deal Releases Draw State Resistance Amid Probes

Three states conducting their own probes of residential mortgage practices are resisting broad liability releases sought by banks to settle a nationwide foreclosure investigation.

The banks, in settlement talks with state and federal officials, are seeking releases that would protect them from future legal liabilities. Massachusetts Attorney General Martha Coakley said July 25 she won’t endorse a deal that includes certain releases. New York and Delaware have raised similar concerns over terms of a possible deal.

All three states are conducting investigations tied to mortgage operations of banks. Delaware and Massachusetts officials say a settlement shouldn’t release banks from some claims, including those related to bundling mortgages into securities, while the inquiries continue.

State and federal officials are negotiating a settlement with the five largest mortgage servicers over their servicing and foreclosure practices. Attorneys general from all 50 states began investigating the practices last year.

Delaware is also investigating the Mortgage Electronic Registration Systems Inc., or MERS, according to a person familiar with the matter. MERS is a national mortgage database used by banks.

For more, click here.

Courts

Bundesbank, Lehman Battle Over $4.2 Billion CDO Default

Lehman Brothers Holdings Inc. asked a U.K. judge to block Germany’s central bank from seizing control of a 2.9 billion- euro ($4.2 billion) securitization vehicle set up weeks before Lehman’s collapse.

Lehman in July 2008 packaged a group of loans and sold 2.1 billion euros of senior notes in the security to the Bundesbank.

The central bank’s lawyers told a London court yesterday that the securitization, known as Excalibur Funding No. 1, had been in technical default since January. Lawyers for Lehman, which holds 722 million euros of junior debt in Excalibur, argued it has enough cash to meet obligations.

Under the terms of the 2008 securitization deal, if Excalibur defaults, the Bundesbank as senior noteholder could force it to sell assets and return cash to investors. New York- based Lehman filed for bankruptcy in September 2008 with assets of $639 billion, sparking a global contraction in the credit markets and a flurry of litigation around the world.

Kimberly Macleod, a spokeswoman for Lehman Holdings, declined to comment on the case. A Bundesbank spokesman said the bank wouldn’t comment on pending court decisions.

A decision is expected next week.

Separately, a Lehman Brothers unit lost a case at the U.K.’s highest court over whether it should be paid before bondholders in two swap agreements.

The Supreme Court dismissed a ruling from 2009 that Lehman’s claim to collateral shouldn’t take precedence over noteholders. The court said the underlying contract in the case should be upheld unless there was an intention to evade insolvency laws.

The case in Europe is LB RE Financing No.3 Ltd. v. Excalibur Funding No.1 Plc, 11-01164, U.K. High Court of Justice (Chancery Division).

The U.S. case is Lehman Brothers Holdings Inc. v. BNY Corporate Trustee Services Ltd., 09-01242, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

For more, click here.

Sky Capital Founder Mandell Convicted in $140 Million Fraud

Sky Capital Holdings Ltd. founder Ross Mandell was convicted of operating what the U.S. said was an eight-year scheme that defrauded investors out of $140 million.

Mandell, 54, of Boca Raton, Florida, was found guilty yesterday by a federal jury in New York of all four counts he was charged with -- conspiracy, securities fraud, wire fraud and mail fraud -- after a trial in federal court in Manhattan.

Adam Harrington, 41, of Miami, a former broker at Sky Capital who was tried with Mandell, was convicted of the same four counts. The jury began its deliberations July 22.

Prosecutors said the evidence showed the defendants used the funds for tens of thousands of dollars of personal luxury expenditures.

Mandell, Harrington and others at Sky Capital also used the money to pay themselves excessive commissions and pay off other victims who had lost money through prior purported investment opportunities, prosecutors argued during the trial.

U.S. District Judge Paul Crotty declined to set a sentencing date or revoke bail for Mandell and Harrington. The judge said he wouldn’t rule on prosecutors’ request to jail both men before sentencing because they pose a flight risk. He gave defense lawyers until Aug. 5 to file legal papers before issuing a ruling.

“It’s unjust,” Harrington said about the verdict as he sat outside the courtroom. “We will appeal.”

Mandell’s lawyer, Jeffrey Hoffman, said after the verdict that “there are very significant issues for appeal,” citing a U.S. Supreme Court ruling last year in Morrison v. National Australia Bank that U.S. securities laws don’t protect foreign investors who buy stocks on overseas exchanges in a civil case. The charges against Mandell and Harrington included manipulating shares.

Four other men were arrested and charged in the case and have pleaded guilty. Two of them, Robert Grabowski and Michael Passaro, both former Sky Capital brokers, agreed to cooperate with the U.S. and testified against Mandell and Harrington.

The criminal case is U.S. v. Mandell, 09-cr-00662, U.S. District Court, Southern District of New York (Manhattan).

For more, click here.

Interviews/Speeches

Balestrino Says U.S. Rating Downgrade Is ‘On the Table’

Joseph Balestrino, a fixed-income market strategist at Federated Investors Inc., talked about the outlook for the U.S. credit rating and Treasury market amid continued negotiations over raising the government’s debt ceiling and reducing the federal deficit.

Balestrino spoke on Bloomberg Television’s “InBusiness with Margaret Brennan.” Ian Bremmer, president of Eurasia Group Ltd., also spoke.

Comings and Goings

FDIC, OCC Nominees Face Dodd-Frank Queries From Senate Panel

President Barack Obama’s nominees to head agencies overseeing the biggest U.S. banks were quizzed over plans for implementing new regulations at a Senate hearing that provided a contrast to Washington’s debt-ceiling battle.

Martin J. Gruenberg and Thomas Curry, who helped guide the Federal Deposit Insurance Corp. through the 2008 credit crisis, testified at a Senate Banking Committee hearing on Gruenberg’s nomination to be FDIC chairman and Curry’s selection as comptroller of the currency.

Gruenberg, a longtime Senate staffer who is serving as acting FDIC chairman, and Curry, who was nominated as an FDIC board member by President George W. Bush in 2004, haven’t inspired the partisan rancor that led Senate Republicans to block or threaten Obama nominees for the Federal Reserve and the Consumer Financial Protection Bureau.

Curry, 54, who would oversee national banks if appointed, was asked about his position on capital rules for banks.

“The actual language in Dodd-Frank is a matter of some controversy,” Curry told the panel. “The principle is clear that federal law supersedes state law. It is incumbent on the OCC to maintain its independence as a bank regulatory agency.”

Gruenberg, 58, who has been FDIC vice chairman since 2005, would inherit the broader authority that Sheila Bair fought to gain for the agency before she stepped down this month. The new duties expand on the agency’s traditional role insuring deposits up to $250,000 at about 7,500 banks and overseeing safety and soundness at nearly 5,000 small and mid-sized lenders.

“The FDIC will also continue to play a leading role in expanding access to insured financial institutions to all Americans as a means for economic opportunity,” Gruenberg said in his remarks.

Date to Run Consumer Bureau as Warren Returns to Harvard

Raj Date, a former banker, will replace Elizabeth Warren as adviser to the Treasury secretary for the Consumer Financial Protection Bureau on Aug. 1, the Treasury Department said yesterday.

Date, the associate director of the bureau for research, markets and regulations, will run the day-to-day operations of the new agency, which officially began work on July 21, Treasury said yesterday in a statement.

Since her appointment on Sept. 17, Warren has been setting up the bureau as an adviser to Treasury Secretary Timothy F. Geithner and assistant to President Barack Obama. She has been on leave from Harvard Law School, and will return there, Treasury said.

Obama nominated Richard Cordray, the former Ohio attorney general, to be the first director of the agency, on July 18. Under the Dodd-Frank Act, the bureau’s director must be confirmed by the Senate.

When a director is in place, the agency officially becomes an independent bureau within the Federal Reserve. Until then, it doesn’t have the new powers created by Dodd-Frank, such as the ability to supervise non-bank financial firms.

--With assistance from Phil Milford in Wilmington, Delaware; Carter Dougherty, Susan Decker, Sara Forden, Jesse Hamilton, Meera Louis and Joshua Gallu in Washington; Kit Chellel in London; and Patricia Hurtado, Chris Dolmetsch, David McLaughlin and Margaret Collins in New York. Editor: Fred Strasser

To contact the reporter on this story: Carla Main in New Jersey at cmain2@bloomberg.net.

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


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