Securities Mosaic® Blogwatch
March 7, 2012
Recent Cases Interpreting Intercreditor Rights
by Matthew Clark and Ken Hackman

Recently, several courts have published decisions interpreting the rights granted to mezzanine lenders under intercreditor agreements - I've recently co-authored this Dechert OnPoint detailing the cases. These decisions, in large part, follow the holding of the Stuytown decision (not great news for many subordinate lenders). Also, a recent decision from the United States Bankruptcy Court for the District of Massachusetts, which holds that the assignment of a junior mortgage lender's voting rights contained in an intercreditor agreement is unenforceable in a bankruptcy case, indicates there are some limits to how far bankruptcy courts will go to serve senior lenders (better news for subordinate lenders).

As we approach a time where an increasing number of mezzanine lenders may seek to enforce their rights, insight into how courts will interpret intercreditor agreements becomes increasingly important. For even more in-depth information and analysis about these recent cases, and their potential impact on senior and junior lenders, click here to read Dechert's OnPoint.

March 7, 2012
GAO Reports on How SIPC Selected Madoff Trustee
by Barbara Black

GAO released an Interim Report on the Madoff Liquidation Proceeding (GAO-12-14). According to the report, it conducted the investigation because:

With the collapse of Bernard L. Madoff Investment Securities, LLC - a broker-dealer and investment advisory firm with thousands of clients - Bernard Madoff admitted to reporting $57.2 billion in fictitious customer holdings. The Securities Investor Protection Corporation (SIPC), which oversees a fund providing up to $500,000 of protection to qualifying individual customers of failed securities firms, selected a trustee to liquidate the Madoff firm and recover assets for its investors. The method the Trustee is using to determine how much a customer filing a claim could be eligible to recover - an amount known as "net equity" - has been the subject of dispute and litigation. This report discusses (1) how the Trustee and trustee's counsel were selected, (2) why the method for valuing customer claims was chosen, (3) costs of the liquidation, and (4) disclosures the Trustee has made about its progress. GAO examined the Securities Investor Protection Act; court filings and decisions; and SIPC, Securities and Exchange Commission (SEC), and Trustee reports and records. GAO analyzed cost filings and interviewed SIPC, SEC, and SEC Inspector General officials, and the Trustee and his counsel.

GAO recommends that:

SEC should advise SIPC to (1) document its procedures for identifying candidates for trustee or trustee's counsel, and in so doing, to assess whether additional outreach efforts should be incorporated, and (2) document a process and criteria for appointment of a trustee and trustee's counsel. SEC and SIPC concurred with our recommendations.

March 7, 2012
Tax Reform Must Deal Fairly With Privately Held and Family Owned Co's, FEI Member Tells Congress

At a hearing held earlier today (March 7) by the House Ways and Means Committee on The Treatment of Closely Held Businesses in the Context of Tax Reform, FEI member Mark Smetana, CFO of Eby-Brown Company, testified that tax reform must deal fairly with privately held and family owned companies. (See FEI press release; Testimony of Mark Smetana.

As noted in the Hearing Advisory, this was the second hearing sponsored by the House Ways and Means Committee on the subject of tax, accounting and tax reform.

Smetana is the former Chairman of FEI's Committee on Private Company - Policy and one of the thought leaders behind the formation of FEI's Private Company Roundtable. FEI members interested in CPC-P or the Private Company Roundtable should contact Tyler Roberts in FEI's Government Affairs office.

Others testifying at the March 7 hearing included Dewey W. Martin on behalf of the National Federation of Independent Businesses, Stefan F. Tucker, Partner, Venable LLP, Jeffrey Kwall, Loyola Univ. School of Law, Tom Nichols, Meissner Tierney Fisher & Nichols S.C., and Martin A. Sullivan, Contributing Editor, Tax Analysts.

Earlier hearing focused on public companies
Read FEI's summary of the first (February 8) House Ways and Means Committee hearing on accounting, tax and tax reform. The February 8 hearing focused more on publicly-held companies whereas the March 7 hearing focused on private companies.

March 7, 2012
Citizens United and the Political Process
by J Robert Brown Jr.

While all eyes focused yesterday on the Republican primaries/caucuses taking place on Super Tuesday, some Democrats also caucused.

Caucuses were held, for example, in Colorado. For those in Denver, copies of the platform for the Democratic Party of Denver was distributed (a copy is here). One of the planks in the Platform provided: "We believe that corporations are not persons and should not be treated as persons under the law and support legislation to reverse the effects of the Citizens United case."

It has to be a relatively rare circumstance where a local party platform specifically references a Supreme Court opinion and takes issue with something as esoteric as the status of corporations. Nonetheless, it is evidence of the deep feelings stirred by the opinion and perhaps another indication that the issue will eventually generate a legislative change.

March 7, 2012
The SEC Issues Mixed Rulings on Proxy Access Proposals
by Ted Allen

In the first no-action rulings of the season on this topic, the Securities and Exchange Commission has granted a request by Textron to omit a proxy access resolution, while rejecting a petition from KSW Inc.

In a March 7 ruling, the staff of the SEC's Corporation Finance Division agreed with Textron's argument that retail investor Kenneth Steiner's access resolution improperly constitutes multiple proposals and thus could be excluded. The staff concluded that the proposal's sixth paragraph, which discussed events that would not amount to a "change in control," constituted a "separate and distinct" matter. Textron made various other arguments to omit Steiner's resolution, but the SEC staff did not address those points.

Steiner's non-binding proposal, which is based on language prepared by the U.S. Proxy Exchange, calls for a 1 percent ownership threshold for at least two years. Steiner's proposal also would allow access nominees from groups of 100 or more investors who each hold at least $2,000 in company stock for one year.

Bank of America and Goldman Sachs have sought to omit USPX-inspired access proposals on similar grounds, but it remains to be seen whether they will receive no-action relief from the SEC. Chiquita Brands, Sprint Nextel, MEMC Electronic Materials, and Dell have challenged USPX proposals on other grounds.

KSW, a small-cap firm based in Long Island City, N.Y., was seeking to exclude a binding access proposal filed by the Furlong Fund, which is seeking a 2 percent for one year standard. KSW, which adopted its own access bylaw with a 5 percent threshold, argued that it had substantially implemented the Furlong proposal. The SEC staff was not persuaded, noting the difference in ownership levels required to nominate board candidates to appear in the company's proxy materials.

March 8, 2012
SEC Prevails On Summary Judgment In Market Crisis Case
by Tom Gorman

The Commission prevailed on its motion for summary judgment in a market crisis case based on the sale of risky collateralized mortgage obligations or CMOs to unsuitable retail customers. Ultimately investors suffered significant losses from the purchases and the broker's firm collapsed as the market crisis unfolded. SEC v. Brookstreet Securities Corp., Case No. SA 8:09-cv-1411 (C.D. Cal.).

The action centered on the sale of high risk collateralized mortgage obligations by defendant Stanley Brooks and his firm, broker dealer/investment adviser Brookstreet Securities Corporation. Specifically, from 2004 through 2007 the two defendants promoted what was called the "CMO Program." As part of the program high risk and illiquid CMOs were sold to retail customers with conservative investment goals. Purchasers included retirees and retirement accounts. Eventually over 1,000 Brookstreet customers put about $300 million into the securities as part of the program.

As the market crisis unfolded in 2007 CMO prices plummeted. This precipitated margin calls for investors in the CMO Program. Many did not have sufficient equity in their accounts to cover the calls. To secure equity for the accounts and avoid falling under its required net capital level, Mr. Books directed the liquidation of CMO Program accounts. This resulted in part in the unauthorized liquidation of fully paid CMOs from cash only accounts of customers.

In the end many CMO Program customers suffered loses including of their savings, homes and ability to retire. Some customers ended up with negative account balances.

Despite his efforts Mr. Brooks failed to save his firm. Brookstreet failed to meet its net capital requirements by mid-2007 and ceased operations. The Commission's complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b).

The Court granted the Commission's motion for summary judgment as to each defendant. On March 1, 2012 the Court entered a judgment against the defendants, enjoining them from future violations of each of the Sections cited in the complaint. The order also requires Mr. Brooks to pay $110,713.31 in disgorgement and prejudgment interest and a civil penalty of $10,010,000, the maximum for each violation. A related action is pending in Florida against ten former Brookstreet registered representatives.

March 8, 2012
Is the FDIC Ramping Up Its Failed Bank Litigation?
by Kevin LaCroix

Though the current bank failure wave has been rolling for several years now and though there have been over 425 bank closures during that period, the much anticipated FDIC failed bank litigation has been slower to gain momentum - that is, perhaps, at least until now. Through the end of 2011, the FDIC had filed 18 lawsuits against former directors and officers of failed banks. But now with the latest FDIC lawsuits, described below, the FDIC has already filed seven so far in 2012, three of which just in the last nine business days. There is a definite sense that the pace of litigation activity is picking up.

The latest FDIC failed bank lawsuit was filed in the Northern District of Illinois and relates to the failed Broadway Bank of Chicago, Illinois. Broadway Bank failed on April 23, 2010. The FDIC's complaint, which can be found here, alleges that at the time of failure that bank had assets of 1.06 billion and that the bank's failure cost the insurance fund $391.4 million. According to news reports, the failed bank is the former family bank of a former Illinois state treasurer.

The FDIC's lawsuit, filed in its capacity as the failed bank's receiver, seeks to recover over $104 million in losses the bank allegedly suffered on commercial real estate loans. The complaint names nine individuals as defendants, seven director defendants and two officer defendants. The complaint asserts claims against the nine defendants for gross negligence; breach of the fiduciary duty of care; and negligence.

The complaint alleges that the defendants "recklessly implemented a strategy of rapidly growing Broadway's assets by approving high-risk loans without regard for appropriate underwriting and credit administration practices, the Bank's written loan policies, federal regulations and warnings from the Bank's regulators." With regard to the regulators' warnings, the complaint alleges that the Director Defendants approved "two of the worst Loss Loans" on June 24, 2008 after a meeting earlier the same day with the Bank's regulators in which the regulators "specifically warned the Director Defendants about the risks that these types of loans posed to the Bank." That same day regulators had discussed with the Director Defendants the need to "enter a Memorandum of Understanding" that would "impose restrictions on the Bank to stop this type of high risk lending."

One of the director defendants, James McMahon, who served on the bank's board from 2003 to December 22, 2008 issues a press release about the FDIC's complaint, in which McMahon notes that the bank had been founded "by an immigrant who left Greece in 1962 to find a better life in America," and had become a "vital force in the financial life of the community." The bank had been "unable to withstand the greatest market decline since the Great Depression and, along with over 400 other community banks" had been "forced to close their doors." With respect to the lawsuit, McMahon states "with the advantage of 20-20 hindsight, the FDIC now blames Broadway's former officers and directors for not anticipating the same unprecedented market forces that also surprised central bankers, national banks, economists, major Wall Street firms and the regulators themselves." McMahon concludes by noting that the allegations in the complaint are "utterly without merit and I expect to be fully vindicated by the Court."

With this lawsuit, the FDIC has now filed 25 lawsuits against the former directors and officers as part of the current wave of bank failures. The Broadway bank lawsuit is the fifth that the FDIC has filed so far in Illinois, the most of any state except Georgia, where the FDIC has filed six suits. There clearly are more cases in the pipeline, as the FDIC has stated on its website that, as of February 14, 2012, the agency has authorized suits in connection with 49 failed institutions against 427 individuals for D&O liability with damage claims of at least $7.8 billion.

Thus the 25 lawsuits filed so far represent only about half of the lawsuits that had been authorized as of the middle of February, and the 205 individuals named in those 25 lawsuits represent less than half of the individuals against whom lawsuits have been authorized. The number of authorizations undoubtedly will continue to climb in the months ahead, as will the number of lawsuits.

With this latest suit, the FDIC has now filed three new lawsuits in just the last nine business days. These three cases include the February 24, 2012 lawsuit filed in the Northern District of Georgia involving two former officers of the failed Community Bank and Trust of Cornelia, Georgia (about which refer here, scroll down) as well as the March 2, 2012 lawsuit filed in the Northern District of Georgia against 12 former directors and officer of the failed Freedom Bank of Commerce, Georgia (about which refer here, scroll down). There is a definite sense that the pace of the FDIC's litigation activity has picked up. Though this latest lawsuit was filed well in advance of the three-year statute of limitations, the two prior suits were much closer to the cut-off, and with the three-year deadline date looming for the failed bank class of 2009 - the largest year for failed banks - it seems likely there will be increasing numbers of suits ahead.

Very special thanks to John M. George, Jr. of the Katten & Temple law firm for sending me a copy of the Broadway bank complaint and for sending me James McMahon's press release. The Katten & Temple law firm represents Mr. McMahon.

Corruption Investigation Follow-On Civil Suits Reach Canada: The occurrence of follow-on civil actions being filed in the wake of corruption and bribery investigations is a phenomenon I have noted frequently on this blog. It now appears this type of follow on civil suit has now reached Canada.

As discussed here, the share price of SNC-Lavalin Group recently declined sharply after the company announced an internal investigation of the accounting for certain payments in connection with a company project in Libya. As reflected in their March 1, 2012 press release (here), plaintiffs' lawyers have now initiated a securities class action lawsuit in Quebec Superior Court against the Company and certain of its directors and officers.

The plaintiffs' complaint, which can be found here, alleges that the company violated its continuing disclosure obligation by misrepresenting the company's internal controls and accounting. Among other things the complaint alleges that an anonymous letter the company's senior management alleged that for years shell companies had been used to funnel money from SNC-Lavalin to members of Libya's Gadhafi family.

The phenomenon of follow on civil litigation has been a factor in the U.S. for years. As anticorruption efforts spread elsewhere, the likelihood is not only that more companies will face scrutiny from government officials, but they may also face civil litigation as well. At a minimum this case shows how Canada's litigation environment is continuing to evolve, and its litigation landscape is becoming both more extensive and more complex.

Special thanks for a loyal reader for alerting me to this case.

March 8, 2012
Citizens United and the SEC (Part 3)
by J Robert Brown Jr.

So what might happen if the SEC doesn't propose rules requiring disclosure of political contributions?

Efforts are afoot in Congress to provide a legislative solution. Congressman Van Hollen recently reintroduced the DISCLOSE 2012 Act. This is legislation that would impose a variety of disclosure requirements on corporations in connection with campaign contributions.

Most of the proposed legislation deals with mandatory reports to the Federal Election Commission. Tucked away inside, however, is a proposed amendment to the Federal Election Campaign Act that would add a mandatory disclosure requirement aimed at shareholders. While the provision also applies to non-profits and their donors, the title of the proposed section identifies its primary intent: "Shareholders' Right to Know."

The provision applies to a "covered organization which submits regular, periodic reports to its shareholders, members, or donors on its finances or activities". Because a covered organization includes a corporation, this language would presumably apply to any public company that distributes proxy materials to shareholders.

The language, however, could be much broader and apply to non-public companies that routinely distribute financial materials to shareholders. Companies may do so because of state law requirements (perhaps to conform with the duty of complete honesty), contractual obligations, and on a voluntary basis in order to keep shareholders informed.

The proposed legislation provides that the information distributed to shareholders must include "in a clear and conspicuous manner, the information included in the statements filed by the organization under section 324 with respect to the campaign-related disbursements made by the organization during the period covered by the report." The proposed requirement also mandates that companies maintaining a web site include a link to the disclosure at the FEC web site. The link must go up within 24 hours of posting at the FEC site and remain in place at least one year from the date of the relevant election.

The provision requires disclosure to shareholders. Yet the agency with more than 70 years of experience crafting shareholder disclosure- the SEC- is nowhere mentioned in the legislation. To the extent there is a need for implementing regulations, therefore, the task presumably falls to the FEC. An agency with no experience in shareholder disclosure owuld become primarily responsible for shareholder disclosure.

The approach also opens the door for conflicting regulation. Nothing in the legislation changes the SEC's general authority to regulate the content of a proxy statement. Thus, whatever disclosure the FEC imposes, the SEC could add to it. Moreover, even if the SEC did not impose additional requirements, the antifraud provisions would still be available for actions against companies in the event of incomplete disclosure. Thus, the SEC (and private parties) could bring actions against companies conforming to the FEC disclosure requirements where the disclosure was viewed as materially incomplete.

In short, companies confront the risk of disclosure regulation by a second agency not necessarily equipped for the task. They confront the risk of conflicting regulatory regimes. And the SEC confronts the possibility that the proxy disclosure requirements will need to be shared with another agency.

None of this sounds particularly appealing. Can this be headed off? Presumably if the SEC acts, there will either be less reason (or no reason) for legislation designed to regulate disclosure to shareholders. Moreover, the requirements will be ensconced in regulations rather than statutes, providing greater flexibility in crafting the standards. Finally, it will leave corporate disclosure where it belongs, with the SEC.

Of course, the concern over congressional intervention is only as serious as the likelihood the legislation will be adopted. It has 117 co-sponsors. Nevertheless, Congress is very divided these days and likely to remain without a consensus on this issue, at least through the November elections. But after that, all bets are off. Pressure for reform will likely continue to build. Moreover, serious abuse or scandal may cause Congress to act with unscheduled alacrity. Recall that Sarbanes Oxley was moribund until the collapse of Worldcom. Campaign finance disclosure could easily undergo a similar reincarnation.

The Commission needs to take control of this issue and not cede away such an important disclosure issue to another agency. For that to occur, the Commission will need to move forward with rulemaking in this area.

March 8, 2012
Delaware Joins States Changing Escheat Laws: A Sleeper
by Broc Romanek

Delaware Joins States Changing Escheat Laws: A Sleeper

With states hungry for money, many have changed their escheat laws to make it easier for them to grab dormant accounts. This has been widely covered in the mass media (egs. ABC's Good Morning America; NPR's All Things Considered; UK's Tonight Show with Sir Trevor McDonald).

In our "Q&A Forum," we recently got a question (#7007) stating: "It appears the State of Delaware is re-interpreting "period of dormancy." We have discussed the new interpretation with Delaware and according to the Delaware State Escheator, "period of dormancy means the full and continuous period of time during which an owner has ceased, failed or neglected to exercise dominion of control over property or to assert a right of ownership or possession or to make presentment and demand for payment and satisfaction or to do any other act in relation to or concerning such property." That is, the statue requires that accounts for which shareholders have not exercised dominion, control or any other act related to the account for three years be turned over to the State of Delaware. As a result of this reinterpretation, several thousand shareholder accounts not considered "lost" under rule 17Ad-17 have now been identified as eligible for escheatment if contact cannot be established with the holder. What is going on here?"

Since this is not my area of expertise, I turned to Bill Palmer- who knows this stuff cold- who answered:

Clearly the State of Delaware is attempting to cast the net out as broadly as possible with its new interpretation, but there are more than a few problems with it. The Unclaimed Property Law (UPL) statutes first purpose is to reunite lost and unknown owners with their unclaimed property, and the secondary purpose is to allow the states an opportunity to make use of the property while the primary purpose is accomplished. As a result, starting with the opening definitions, the statutes require that the individual shareholder or owner actually be "lost" and "unknown" to the financial institution or holder.

A review of the statutes will show that the definition includes the requirement that the shareholder is "lost/unknown" and that the specific dormancy period has run. There's an important conjunction in the definition with the word "and," so to the extent that the individual is part of a dividend reinvestment plan, an ESPP, a custodial trust, or any number of scenarios, then it is not reasonable to conclude that the individual is "lost" and "unknown" for purposes of escheating their stock or assets to the various states. Based on the short note below, there are potentially serious statutory and constitutional issues regarding Delaware's new interpretation of escheat.

Another problem is created by the State of Delaware's approach is in the area of corporate liability, because it places the holder and its transfer agent in a difficult position vis- -vis their common law and statutory duties to the shareholders or owners. The corporation is acts under common law, federal and state securities laws that require it to operate with the utmost care regarding the shareholder, and to convey material information to the shareholder. This is the dilemma created by Delaware's new definition, because "known" shareholders are about to have their stock transferred potentially without proper notice, where the investment will be sold and permanently destroyed so that the funds from the sale may be used by the state.

Mailed: January-February Issue of "The Corporate Counsel"

We mailed the January-February Issue of The Corporate Counsel and it includes pieces on:

- Mine Safety Disclosure Is Here-And The Forms They Are A-Changin'
- New Four-Month Deadline for Form 20-F
- Staff Weighs In on Say-on-Pay Wording on the Proxy Card/Voting Instruction Form
- Proxy Summaries
- Proxy Access Private Ordering (Barely) Up and Running
- NYSE About-Face on Shareholder-Friendly Governance Proposals
- The Staff's Waiver Position on Item 5.07 8-K/A Evolves
- Global Section 12(g) No-Action Relief for RSUs
- Trading in Securities of Pre-Public/Private Companies
- Loss Contingency Disclosures-Latest Input from the Staff
- The Staff Clarifies New Standards for Confidential IPO Filings for Foreign Private Issuers

Act Now: Get this issue for free when you try a 2012 No-Risk Trial today.

SEC Brings Increasingly Rare Financial Fraud Case

In his "Cady Bar the Door" blog, David Smyth of Brooks Pierce has been doing an excellent job and I've been learning a lot about SEC enforcement issues from reading his missives. Here's a recent one below:

A curious aspect of the SEC's enforcement program in recent years has been the lack of significant accounting fraud cases. The Enforcement Division has created a number of specialized units, including ones studying structured products and hedge funds, but dismantled its financial fraud task force in 2010, reasoning that accounting fraud was the specialty of the entire staff, and not just one group. Perhaps as a result of that, or maybe as a result of Sarbanes-Oxley or other reasons, accounting fraud cases just have not been brought in the numbers they were in years past.

But the SEC filed an interesting case last month in the Southern District of Florida, one that combines traditional accounting fraud with the problems underlying the most recent credit crisis. The Miami Regional Office sued BankAtlantic Bancorp and its CEO, Alan Levan, for making misrepresentations about the bank's loan portfolio and then using accounting tricks to conceal the misstatements. The case is not settled, so the facts that follow are unproven, and may not actually be true.

Disclosure Issues

In 2007, BankAtlantic had about $1.5 billion in its commercial residential real estate loan portfolio. The borrowers intended to develop large tracts of land for residential housing construction, and the portfolio included three types of loans: (1) Builder Land Bank loans, in which the borrowers' sole intent was to "flip" the raw land to a national builder at a later date. The bank usually required the borrower in one of these BLB loans to have option contracts in place in which the builder agreed to give a down payment and close on a minimum number of lots by a specific date; (2) Land Acquisition and Development (LAD) Loans, in which the borrower bought land and conducted "horizontal development" such as building utilities and roads; and (3) Land Acquisition, Development, and Construction (LADC) loans, which were the same as LAD loans, but also included financing for "vertical development," or houses, as well.

Signs of problems in BankAtlantic's commercial residential portfolio began to appear in early 2006. Builders were starting to walk away from their option contracts with BLB borrowers at other banks, and BankAtlantic started to scrutinize its own portfolio more closely. By the time BankAtlantic filed its first quarter 10-Q, the bank had granted extensions on eleven loans constituting a book value of $147 million, or 26% of the commercial residential portfolio. For most of these extensions sales had slowed or stopped, and borrowers were having to resort to entirely different development plans to salvage their projects. While these problems were affecting all three types of loans in the bank's commercial residential book, Levan didn't say as much publicly. In the bank's first quarter earnings call, Levan discussed the BLB segment and acknowledged that some problems were developing with the underlying projects. But when asked by an analyst whether the problems extended to the LAD and LADC loans, Levan said no, that those loans were "proceeding in the normal course" and the bank was experiencing no significant problems with them. The bank's 10-Q for that quarter discussed the commercial residential portfolio in board terms, but did not alert investors to the problems already existing at that time.

BankAtlantic's loans continued to be downgraded in the second quarter, and the value of the downgraded loans was nearly an even split between BLB and non-BLB loans. The second quarter earnings call continued the pattern from the first, as an analyst again asked if the bank was concerned about the non-BLB loans. Levan said again that the BLB side was the only one forecasting any problems. The 10-Q for that quarter also made no mention of any problems with the LAD and LADC loans, though those loans were having significant problems as well. BankAtlantic eventually released the extent of the bank's loan difficulties with an 8-K filed on October 26, 2007, that announced a $29 million loss due to the commercial residential loan portfolio. On the third quarter earnings call, Levan said the earnings release would have been very different if it had been done on September 30, 2007, suggesting that the problems were a surprise that came about after quarter-end.

Accounting Issues

This wasn't the end of BankAtlantic's problems, though. In the fourth quarter of 2007, the bank began efforts to sell many of its problem loans, and even engaged an investment bank, JMP Securities, in the effort. Unfortunately for the bank, the AICPA's Statement of Position 01-6 says that once a decision has been made to sell loans not previously classified as "held for sale," those loans should be transferred to the "held for sale" classification and carried on the books at the lower of cost or fair value. But that is not what BankAtlantic did. Instead, the bank changed its contract with JMP Securities to refer to the sales efforts as a "market test." At the end of 2007, the bank continued to record as held for investment the loans subject to the JMP engagement. The bank also represented to its auditor that "management had the intent and ability to hold loans classified as held-for-investment for the foreseeable future or until maturity or payoff." Meanwhile, JMP's efforts- to "sell" the loans or "test market" them or whatever- continued apace, and eventually some bids for the loans came in, all at 28-50% of book value.

BankAtlantic didn't like the bids enough to sell, but also did not like having the loans on the bank's books. So it made a deal to give an inactive subsidiary $100 million, which the subsidiary then gave back to the bank in exchange for the problem loans. For the bank, it was a perfect deal, in that it released the loans from BankAtlantic's books, and at the same time gave the bank an quick infusion of cash. JMP valued the loans for purposes of this transaction based on appraisals, and ignored the bids that came in at 28-50% of their book value. BankAtlantic continued to try to sell these loans, and even reached agreements to sell some of them, but never reclassified any of the loans as "held for sale."

The SEC has sued BankAtlantic for violations of Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Levan for aiding and abetting all of those violations. The Commission has also sued Levan for direct violations of Section 13(b)(5) of the Exchange Act.

Lessons from the Case

One thing we can learn from the matter is that accounting fraud is alive and well, and the SEC is still pursuing it. Also, publicly traded banks in particular should take note that the contents of their portfolios have to be characterized accurately, both in public statements to investors and with respect to accounting conventions established by the AICPA. If particular loans are being shopped to other buyers, you have to say as much, or you're out of compliance with GAAP, and are breaking the accounting rules. Finally, the public misstatements did not go on for a terribly long time. It was only two quarters before BankAtlantic owned up (sort of) to the problems on its books. But that was enough. The case is being litigated; it will be interesting to see what happens as it proceeds.

- Broc Romanek

March 8, 2012
Lawrence v. Bank of America: Allegations of Actual Knowledge of Ponzi Scheme Fall Short
by Susan Beblavi

In Lawrence v. Bank of America, D.C. Docket No. 8:09-cv-02162-VMC-TGW, 2012 LEXIS 777 (11th Cir. Jan. 11, 2012), putative class action plaintiffs alleged "(1) common law fraud; (2) conversion; and (3) breach of fiduciary duty" against Bank of America ("BOA"). These causes of action stemmed from allegations that BOA was aware of, and "substantially assisted in," a Ponzi scheme by one of its account holders. The Eleventh Circuit Court of Appeals affirmed the district court's holding to dismiss the initial complaint and denied the plaintiffs leave to amend their complaint.

Through his company, Diamond Ventures LLC, Beau Diamond ("Diamond") allegedly engaged in a Ponzi scheme and deposited millions of dollars from investors into an account at BOA. By upgrading the account to the Premier Banking Division which could "provide daily updates on major deposits and wire transfers," the plaintiffs alleged BOA should have been on alert that only $15,400,000 of the $37,600,000 deposited was invested in foreign exchange companies. Additionally, Diamond described his business to BOA as an "investment club," even though BOA prohibited such "clubs."

Under the federal securities laws, there is no cause of action for aiding and abetting violations of the antifraud provisions. See Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994). In order to survive a motion to dismiss for aiding and abetting under state law, a plaintiff must show "(1) an underlying violation on the part of the primary wrongdoer; (2) knowledge of the underlying violation by the alleged aider and abetter; and (3) the rendering of substantial assistance in committing the wrongdoing by the alleged aider and abettor."

The court held that the plaintiffs' allegations were too weak to infer that it was plausible the bank had "actual knowledge" of the scheme, in spite of the alleged "atypical" transactions. Even though BOA authorized numerous large transactions by Diamond, it was not required to "investigate" them under Florida law.

The plaintiffs attempted to strengthen the inference of actual knowledge by showing that a BOA representative advised another bank customer that Diamond's clients were "happy with their investment," and consequently, that customer transferred money to Diamond Ventures. The court found that this "amendment would have been futile" because the positive comments do not "necessarily establish [BOA's] participation in a Ponzi scheme."

The primary materials for this case may be found on the DU Corporate Governance website.

View today's posts

3/8/2012 posts

CrunchedCredit: Recent Cases Interpreting Intercreditor Rights
Securities Law Prof Blog: GAO Reports on How SIPC Selected Madoff Trustee
FEI Financial Reporting Blog: Tax Reform Must Deal Fairly With Privately Held and Family Owned Co's, FEI Member Tells Congress
Race to the Bottom: Citizens United and the Political Process
Insight: The SEC Issues Mixed Rulings on Proxy Access Proposals
SEC Actions Blog: SEC Prevails On Summary Judgment In Market Crisis Case
D & O Diary: Is the FDIC Ramping Up Its Failed Bank Litigation?
Race to the Bottom: Citizens United and the SEC (Part 3) Blog: Delaware Joins States Changing Escheat Laws: A Sleeper
Race to the Bottom: Lawrence v. Bank of America: Allegations of Actual Knowledge of Ponzi Scheme Fall Short

Blog posts are subject to copyrights held by the authors and are republished here with permission. Views expressed are those of the authors alone. Infringement Notification.