March 1, 2024

High & Low Finance: Not Crying for Argentina but Fearful of a Ruling

After a second offer — on the same terms — in 2010, all but 7 percent of the bonds have been exchanged. But some of the remaining ones were owned by hedge funds that went to court. Last week they won a decision from the United States Court of Appeals for the Second Circuit in New York that has caused considerable concern at institutions like the Treasury Department and the International Monetary Fund.

The decision essentially says that Argentina cannot pay any creditors if it does not pay all of them, and says banks — in the United States and perhaps around the world — could face contempt charges if they allow Argentina to make payments to only those lenders it wishes to pay.

“While we strongly disagree with Argentina’s actions in the international financial arena,” a senior Treasury official, who spoke on the condition of anonymity, said this week, “we have serious concerns that the Second Circuit’s decision will undermine the orderliness and predictability of sovereign debt restructuring and could roll back years of progress.”

The United States government, in a brief filed with the appeals court before it made its decision, urged that it not take the course it ultimately took, warning that the decision could damage the status of New York as a chief world financial center and cause “a detrimental effect on the systemic role of the U.S. dollar” by encouraging countries to denominate their debt in other currencies and put them outside the jurisdiction of United States courts.

The International Monetary Fund, in a paper issued earlier this year, warned that the decision could “risk undermining the sovereign debt restructuring process.”

Such fears were brushed aside in the appeals court decision.

“We do not believe the outcome of this case threatens to steer bond issuers away from the New York marketplace,” said the opinion, written by Judge Barrington D. Parker. “On the contrary, our decision affirms a proposition essential to the integrity of the capital markets: borrowers and lenders may, under New York law, negotiate mutually agreeable terms for their transactions, but they will be held to those terms. We believe that the interest — one widely shared in the financial community — in maintaining New York’s status as one of the foremost commercial centers is advanced by requiring debtors, including foreign debtors, to pay their debts.”

Most international bonds are issued under either New York law or English law. The I.M.F., in its paper, states that under English law bondholders have no rights to file suits. Only the bond’s trustee can do that, and the trustee can be compelled to act only if a large number of bondholders demand it. It was concern that countries would flock to English law that led to the United States government warning that New York’s status as a world financial center could be damaged.

In the past, as the I.M.F. paper noted, it has been easy to get an American court to render a judgment against a country that defaulted on its bonds, but “it has been far more difficult to find assets that can be used to satisfy the judgment.”

That is because a federal law severely limits the assets that bondholders can seek to attach. Diplomatic missions are off limits, as are many other assets. And it is obvious that the courts of the nation that defaulted are not going to help the unfortunate creditors. So having the judgment has in the past proved to be worth very little.

But the appeals court has turned that around, at least in the case of Argentina. It concluded that Argentina is required by the “pari passu” clause that, in one form or another, is standard in bond contracts, to treat all its bondholders alike. So if it pays the interest payments owed on its restructured bonds, it must also pay the money owed on the bonds whose holders refused to restructure. And because those bonds are in default, that means the entire amount of principal and interest is owed and must be paid.

The United States brief says that interpretation of “pari passu” is simply wrong. “The settled understanding of pari passu clauses is that selective repayment does not violate the clause, even if it is the result of sovereign policy,” the brief stated. “This view has been expressed not only by the United States, but by academics, governmental bodies, and market participants.” It noted that similar clauses had not been impediments to debt restructurings in the 1980s and 1990s.

That, in and of itself, would have little effect. Argentina could simply ignore the ruling and continue to make payments on the restructured bonds while ignoring the other ones.

Floyd Norris comments on finance and the economy at

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You’re the Boss: A Win for Small Businesses in a Bank Fraud Case

“Yeah, I feel good about winning,” said Mark Patterson, whose construction company was hit by hackers.Craig Dilger for The New York Times “Yeah, I feel good about winning,” said Mark Patterson, whose construction company was hit by hackers.

In June, we published an article advising small-business owners to guard against hackers who use malicious software, or malware, to raid business bank accounts. Computer security specialists say these crimes, called “corporate account takeovers,” have become increasingly common, and small businesses are especially easy prey because many lack firewalls and monitoring systems.

Worse, business owners often assume incorrectly that the protection they have on personal bank accounts applies to their business accounts as well. But historically that has not been the case. Provided banks can show adequate security procedures, they have no legal obligation to reimburse businesses for attacks, as federal regulations do not cover commercial accounts.

A recent court decision, however, creates a precedent to change that. In July, the United States Court of Appeals for the First Circuit in Boston ruled in favor of a construction company that had been hacked, declaring its bank responsible for the losses. Last month the two parties reached a settlement.

In May 2009, Mark Patterson’s company, Patco Construction in Sanford, Me., was robbed of $588,000 by cybercriminals using ZeuS Trojan, a form of malware. Over seven consecutive days, thieves executed automated clearinghouse batch transactions with Patco’s user name and password.

Mr. Patterson assumed incorrectly that his financial institution, Ocean Bank, a southern Maine community bank, would cover the unauthorized debits. When he learned otherwise, he tried to cut a deal.

“We thought there were enough red flags that the bank should have detected” fraudulent activity, Mr. Patterson said, “but we also knew the malware was on our systems.” Because the bank was able to recover about $240,000 by halting or clawing back money from transfers processed within 24 hours of discovering the fraud, Patco’s actual losses were about $350,000. So Mr. Patterson asked Ocean Bank to reimburse $250,000. When the bank refused, he called a lawyer.

Patco brought suit against People’s United Bank, a regional bank based in Bridgeport, Conn., which had acquired Ocean Bank. With both sides in agreement that money was stolen and about how it was stolen, the facts of the case were never in dispute. In August 2011, Maine’s Federal District Court ruled in favor of the bank, finding that People’s United’s security systems were “commercially reasonable,” meaning the bank had done everything possible to protect its customers from fraud.

But Patco appealed, arguing that because People’s United had configured its security systems improperly, the bank failed to prevent the crime. “In this case, the bank put settings in place that were counter to good security,” said Dan Mitchell, a partner in the Portland, Me., office of Bernstein Shur and a member of the law firm’s data security practice. Mr. Mitchell represented Patco in the case. “The way they operated it left holes in the system.”

Mr. Mitchell explained that thieves spirited away money from Patco’s account to places like California and Florida, where the company does not normally conduct business. The timing and values of payments were also inconsistent with regular orders.

While People’s United assigned a risk score from zero to 1,000 for every transaction, the bank did not monitor scores to halt the fraud. “Patco’s typical scores were zero to 214 max, but in this case the risk scores were in the high 700s,” Mr. Mitchell said. “So the bank had the ability to generate these scores but didn’t do anything with them.”

On this basis, Patco won the appeal, and in November People’s United agreed to pay back the full amount stolen from Patco, plus interest. Representatives of People’s United did not respond to requests for comment.

“The Patco case was the first to come from a court that high up,” Mr. Mitchell said. “This case is a guidepost now. My guess is that most of these cases get resolved, and this case will encourage that even more.” He believes the ruling will motivate banks not only to purchase adequate security systems but also to configure and maintain them properly.

Still, the impact of the Patco case may be muted, as financial institutions and their customers have become increasingly knowledgeable about computer security in the past three years. “If the status quo had been maintained, this decision would have put the fear of God into institutions,” said Sari Stern Greene, president of Sage Data Security in South Portland, Me., who testified as an expert witness in the case on behalf of Patco. “But in the interim, financial institutions have significantly enhanced their security controls and helped educate their customers.”

Ms. Greene also underscores that small businesses must erect their own firewalls and take precautions to prevent hacking. “Online banking security is really a partnership between the customer and the financial institution. When customers use online banking, they’re in essence creating their own personal branch,” she said. “Businesses invest in locks, alarms and motion sensors; they understand they need those controls in the physical world. And now they need them in the digital world too.”

As for Patco, the company no longer makes automated clearinghouse batch transactions. Mr. Patterson and his lawyer estimate People’s United spent more than $1 million in legal fees, while Patco spent hundreds of thousands of dollars to resolve the case.

“Yeah, I feel good about winning,” Mr. Patterson said. “But in the end, why does this stuff have to occur? Why didn’t the bank just settle?”

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DealBook: Appeals Court Revives Insider Trading Case Against Obus

Accused of insider trading in 2002, Nelson Obus refused to settle: That is the same as guilty to me.Chang W. Lee/The New York TimesAccused of insider trading in 2002, Nelson Obus refused to settle: “That is the same as guilty to me.”

A Federal Appeals Court has revived a decade-old insider-trading case brought against a New York hedge fund manager by the Securities and Exchange Commission.

Nelson Obus, the president of Wynnefield Capital, was charged by the S.E.C. with illegal trading in the stock of SunSource after receiving confidential information about the company. Also charged in the case were Peter Black, an analyst at Wynnefield, and Thomas B. Strickland, a former employee at General Electric who was the alleged source of the secret tip that SunSource was about to be acquired by another company.

Judge George B. Daniels, a federal trial court judge in Manhattan, had thrown out the case in late 2010. But on Thursday, a three-judge panel for the United States Court of Appeals for the Second Circuit reversed his decision.

“The S.E.C. established genuine issues of material fact with respect to its claims of insider trading,” wrote Judge John M. Walker Jr., a Federal Appeals Court judge.

Joel M. Cohen, a lawyer for Mr. Obus, said he and his client were disappointed by the ruling. “We will now prepare for trial and welcome the full airing of the facts, which will confirm the merits of our case,” he said.

Mark S. Cohen, a lawyer for Mr. Black, did not immediately respond to a request for comment.

“We are of course disappointed by this outcome, but we knew it was a possibility based on the complexity of the law in this area,” said Roland G. Riopelle, a lawyer for Mr. Strickland.

The case against Mr. Obus centered on Allied Capital’s 2001 acquisition of SunSource, a manufacturer of bolts, washers and lock nuts. Wynnefield Capital, Mr. Obus’s hedge fund, owned nearly 6 percent of the company. The S.E.C. said that Wynnefield made $1.3 in illegal profits trading on an inside tip about the deal.

Wynnefield’s source on the deal, regulators said, was Mr. Strickland, an associate at GE Capital, which was looking to finance Allied’s acquisition of SunSource. Mr. Strickland spoke with Mr. Black, his friend and an employee of Wynnefield, but they insisted that they did not discuss the potential merger.

The S.E.C. said that Mr. Obus bought SunSource stock while in possession of secret information about the Allied deal. Mr. Obus said he had no knowledge of any possible transaction. When Allied announced its purchase, SunSource’s stock nearly doubled.

Among the sticky legal issues in the case is whether Mr. Strickland violated a duty to his employer, General Electric, a necessary element of an insider trading lawsuit. Mr. Obus’s lawyers argue that Mr. Strickland did not violate his duty to G.E., and that G.E. had not entered into any confidentiality agreement with SunSource.

Judge Daniels, the trial court judge, dismissed the case, ruling that “neither Strickland nor his employer, GE Capital, was a corporate insider of SunSource.” He added that the S.E.C. had not “demonstrated the requisite degree of deceptive conduct on the part of any defendant.”

The Federal Court of Appeals disagreed, ruling that “the S.E.C. has established genuine questions of fact about whether Obus knew that Strickland had breached a duty to GE Capital and whether Obus traded in SunSource stock while in knowing possession of the material non-public information that SunSource was about to be acquired.”

On Thursday, Mr. Cohen, a lawyer for Mr. Obus, said that for more than 10 years his client has refused to settle this lawsuit as a matter of principle.

“The facts remain the same: the lawsuit is baseless; Obus and Wynnefield behaved properly; and this case never should have been brought,” he said.

Mr. Obus, whose fund managed about $280 million in assets, has called the case “a nightmare” and said he has racked up more than $6 million in legal bills.

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DealBook: Conviction Reversed in Refco Case

A federal appeals court reversed the conviction of a former outside lawyer to the collapsed brokerage firm Refco on Monday, ruling that the trial court judge in the case had improper discussions with a juror outside the presence of the defendant’s lawyers.

The defendant, Joseph Collins, was found guilty in July 2009 of assisting Refco’s senior executives with defrauding its shareholders of $2.4 billion. He was sentenced to seven years in prison, but has been free on bail pending the outcome of his appeal.

A three-judge panel for the United States Court Appeals for the Second Circuit overturned Mr. Collins’s conviction and ruled that he was entitled to a new trial.

“After this long fight, we are very gratified by the court of appeal’s decision,” said William Schwartz, a lawyer for Mr. Collins.

The spokeswoman for the United States attorney’s office in Manhattan declined to comment on whether it would retry the case.

A retrial of Mr. Collins could be complicated by the death of Santo Maggio. The former president of Refco’s capital markets unit, Mr. Maggio died last week at the age of 60. Scott Hershman, his former lawyer, confirmed his death.

Mr. Maggio, known as Sandy, was the government’s top cooperating witness in the Refco case. He testified in the trials of Mr. Collins and Tone N. Grant, a former senior Refco executive. He also wore a wire to help ensnare Phillip R. Bennett, Refco’s chief executive, who pleaded guilty to hiding about $430 million in bad debt from the company’s auditors and investors. Mr. Grant and Mr. Bennett are both in prison. In exchange for his cooperation, Mr. Maggio was not sentenced to jail time.

Though it was a pre-financial crisis scandal from the middle of last decade, the Refco case continues to linger.

Refcok, a New York brokerage firm, which facilitated trades in commodities and futures contracts, collapsed in October 2005 after disclosing Mr. Bennett’s fraud. Much of Refco’s assets were acquired in bankruptcy by the Man Group, which later spun out the business and renamed it MF Global. Late last year, MF Global filed for bankruptcy after failed bets on the debt of European countries and a series of credit downgrades.

The Refco case has also haunted Mr. Collins, a former corporate lawyer at Mayer Brown, a large Chicago-based firm. He was charged in 2007 with helping Refco’s executives manipulate its balance and hide losses from its investors. It was an unusual white-collar prosecution, as outside corporate lawyers are rarely indicted alongside their clients in accounting fraud cases. The outside lawyers at Enron, for example, did not face criminal charges.

A jury convicted Mr. Collins on 5 of the 14 counts of securities fraud against him. But during deliberations, the foreman sent the judge, Robert P. Patterson Jr., a note that one juror had tried to barter his vote and was refusing to deliberate. Another juror sent a note that the same juror had threatened to cut off his finger.

Judge Patterson interviewed the problematic juror outside the presence of Mr. Collins’s lawyers and emphasized the importance of resolving the case.

“This sequence of events deprived Mr. Collins of his right to be present at every stage of the trial,” wrote Judge Denny Chin in the appellate court opinion. The right to be present at every trial stage is rooted in the Constitution, including the Fifth Amendment “due process” clause.

“We cannot say with fair assurance that the judgment was not substantially swayed by the district court’s errors in this case,” Judge Chin said.

If the United States attorney’s office in Manhattan decides to retry Mr. Collins, the trial could be made more difficult by Mr. Maggio’s death. The government could try to have Mr. Maggio’s testimony from the first trial read into the record, say legal experts.

Mr. Maggio, who pleaded guilty to participating in the Refco fraud, testified for two days during Mr. Collins’s 2010 trial, walking the jury through what he said were the company’s complex accounting fraud scheme.

Federal prosecutors also asked Mr. Maggio about his new life since his Wall Street career. He said that he now lived in Naples, Fla., and ran a fishing charter business called Starting Over Charters. The name of the company was not, as many had suspected, a reference to his post-Refco life.

Instead, Mr. Maggio explained to the jury that Starting Over was what he had named his boat when he got divorced in 1982.

“My ex-wife also bought a boat and called it Free Again,” he added.

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Constellation Energy Coal Company Urges Stricter Pollution Rules

The company, Constellation Energy, says it is an issue of fairness. A little more than two years ago, it completed an $885 million installation that has vastly reduced emissions from two giant coal-burning units at its Brandon Shores plant here, within view of the city’s downtown office towers.

The goal was to comply with a Maryland law, but the company also anticipated that the federal Environmental Protection Agency would adopt similar limits. The agency followed through last year, completing a rule on sulfur and nitrogen emissions that was due to take effect on Sunday.

But last Friday, a three-judge panel of the United States Court of Appeals for the District of Columbia issued a stay of the regulations, ceding to challenges filed by several major coal-burning utilities, the State of Texas, the National Mining Association and the International Brotherhood of Electrical Workers. They argued that the deadline was draconian, among other objections.

The court said it hoped to hold a hearing on the case in April.

Having invested the $885 million — nearly as much as it cost to build the two generating units in 1984 and 1991 — Constellation argues that laggard plants should also have to comply with the emission limits or shut down. Otherwise, it argues, the utility will be operating at a big disadvantage: simply running the retrofitted plant requires 40 megawatts of electricity, enough to keep a small town humming.

“When we started making plans for this project, we did it with the expectation that there would be a federal regime, and we still have that expectation,” said Paul Allen, the company’s vice president for environmental compliance.

On a press tour of the plant on Thursday, engineers showed off the extensive new construction, including the replacement of twin 700-foot smokestacks with a new one that belches steam produced in the process of scrubbing out acid gases. The old stacks, still standing but capped, are now “hood ornaments,” said Heather Lentz, the general supervisor of operations.

“It’s a premier clean coal plant,” she said.

Depending on the demand for electricity, barges bring anywhere from two million to three million tons of coal up the Patapsco River each year for burning at Brandon Shores. With the new technology, the coal-burning produces 90 percent less nitrogen oxide, an ingredient of smog; 95 percent less sulfur, which causes acid rain; and vastly lower fractions of other pollutants.

The rule that was to come into effect on Jan. 1, known as the Cross State Air Pollution Rule, is intended to address the longstanding inability of some states to meet federal air pollution standards because of contaminants that blow in from other states, mostly from power plants.

Before they were cleaned up, Brandon Shores and five other coal-burning plants in Maryland were part of the problem: the state’s nurses association commissioned a study that found that in 2006, emissions from the plants caused 700 deaths per year nationwide, including 100 in Maryland.

Pointing out that it took only three years to install the scrubbing technology, completing construction in 2009, Constellation argues that other utilities could have been getting ready, too.

Its criticism of other utilities is part of “a very clear, longstanding split” between companies that made the leap and those that deferred the investment or even challenged the rules in court, said John Walke, a coal expert at the Natural Resources Defense Council. But the laggards, he said, should have seen it coming.

Constellation’s competitors see it differently, saying that they cannot build for rules that do not yet exist. American Electric Power, one of the utilities that sued to block the new rule, knows how long it probably takes to build a scrubber, said Pat Hemlepp, a spokesman, because it has already built 25 of them at plants it operates.

But for companies in traditionally regulated states like most of those where A.E.P. operates, the utility needs authorization from a public service commission to collect the cost from ratepayers, which takes about a year, in addition to time for engineering work and obtaining numerous permits, he said.

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Airfares With Less Fine Print

Beginning Jan. 24, the Transportation Department will enforce a rule requiring that any advertised price for air travel include all government taxes and fees. For the last 25 years, the department has allowed airlines and travel agencies to list government-imposed fees separately, resulting in a paragraph of fine print disclaimers about charges that can add 20 percent or more to a ticket’s price.

But with airlines now promoting fares on Web ads, Facebook and Twitter, and adopting a menu of fees for services that used to be part of the ticket price, the government decided it was time for a change so travelers have a clearer sense of the total price they must pay. (The price will not include baggage fees, though, because they are optional.)

“Requiring all mandatory charges to be included in a single advertised price will help consumers compare airfares and make it easier for them to determine the full cost of their trip,” Bill Mosley, a department spokesman, said by e-mail in response to questions about the rule.

The government and the airlines are being guarded in discussing the full-fare advertising policy, since Spirit Airlines, Allegiant and Southwest have asked the United States Court of Appeals for the District of Columbia to block the proposed change, arguing that it violates their commercial free speech rights.

Spirit has built its business around advertising $9 fares, then charging additional fees for checked and carry-on bags, advance seat assignments and now a “passenger usage fee” of up to $17 each way for tickets booked online.

Since that online booking fee is technically optional — travelers can instead drive to the airport and buy a ticket there — Spirit is not required to include it in advertised prices. The proliferation of these types of fees has prompted the government to impose a growing number of fines against airlines and travel agencies that violate existing rules.

This year, the Transportation Department has assessed 21 penalties for fare advertising violations, with total fines of more than $1 million; in 2001, there were 14 penalties and $379,000 in fines.

Since August, Spirit, LAN Airlines, South African Airways, Orbitz, Virgin Atlantic, Thai Airways, JetBlue and Air Canada have all been fined at least $50,000 each for advertising infractions.

Under current regulations, ticket sellers may list government taxes separately on an ad promoting a fare, but those mandatory fees must be clearly disclosed — hence the asterisk pointing to additional text or a Web page that itemizes these charges. One of Spirit’s violations was advertising a $9 fare on Twitter and forcing customers to click links to two more Web pages to find out the full cost, including taxes and fees.

The new advertising rule is one of a dozen passenger protections the Transportation Department proposed in 2010 and adopted last spring. It extended the deadline for some provisions to give the airlines more time to comply.

Spirit and Allegiant have also challenged new rules requiring airlines to allow passengers to cancel a ticket purchase without penalty within 24 hours of booking; include information about baggage fees on e-ticket confirmations; and notify passengers more promptly about flight cancellations and delays.

Misty Pinson, a Spirit spokeswoman, said the airline could not comment on its objections to the new rules because of its coming stock offering. But in its S-1 filing with the Securities and Exchange Commission, Spirit cited “burdensome consumer protection regulations” as a risk factor for its business model, saying, “We are evaluating the actions we will be required to take to implement these rules, and we believe it is unlikely that we will be able to meet the 2012 compliance deadline in every respect.”

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Supreme Court to Hear Two Human Rights Cases

The Supreme Court has offered only limited and tentative guidance on the general question of what sorts of human rights lawsuits may be brought in federal courts in the United States. The lower courts in both cases drew a clean line, saying that only individuals and not artificial entities like corporations are subject to being sued.

One of the cases was brought by 12 Nigerians, who said that oil companies affiliated with Royal Dutch Shell had aided and abetted the Nigerian government in torture and executions in the Ogoni region of the country in the early 1990s. The plaintiffs sued under the Alien Tort Statute, a 1789 law that allows federal district courts to hear “any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States.”

The meaning of that language is not obvious, and the law itself was largely ignored until the 1980s, when federal courts started to apply it in international human rights cases. A 2004 Supreme Court decision, Sosa v. Álvarez-Machain, left the door open to some claims under the law, as long as they involved violations of international norms with “definite content and acceptance among civilized nations.”

A footnote in that decision instructed lower courts to consider a related question, too: “whether international law extends the scope of liability for a violation of a given norm to the perpetrator being sued, if the defendant is a private actor such as a corporation or individual.”

With that prompting, a divided three-judge panel of the United States Court of Appeals for the Second Circuit, in New York, ruled that corporations were not subject to the law.

Judge José A. Cabranes, writing for the majority, said that international law jurisprudence since the Nuremberg trials after World War II allows human rights violations of international law to be “charged against states and against individual men and women but not against juridical persons such as corporations.”

In a concurrence, Judge Pierre N. Leval said that the case should have been dismissed on the narrower ground that the plaintiffs had not plausibly asserted that the oil companies had assisted the Nigerian government for the purpose of perpetrating human rights abuses, as opposed to obtaining protection for their operations.

But Judge Leval said the majority’s broad ruling did grave damage to the cause of international human rights, and had confused criminal and civil law. He wrote that international law took no position on whether civil liability may be imposed on corporations for violations of international law, leaving the question to individual nations. The Alien Tort Statute, he said, allows such liability.

The plaintiffs, in their brief urging the Supreme Court to hear the case, Kiobel v. Royal Dutch Petroleum, No. 10-1491, said the Second Circuit majority had accomplished a “radical overhaul” of the law in this area and created “blanket immunity for corporations engaged or complicit in universally condemned human rights violations.”

The second case accepted for review on Monday, Mohamad v. Rajoub, 11-88, concerns a similar issue. It was brought by the sons and widow of Azzam Rahim, an American citizen who was tortured and killed during a 1995 visit to the West Bank.

Mr. Rahim’s relatives sued the Palestinian Authority and the Palestine Liberation Organization under a 1991 federal law, the Torture Victim Protection Act. The law allows civil lawsuits against “an individual” who engages in torture or killings.

A unanimous three-judge panel of the United States Court of Appeals for District of Columbia Circuit ruled that the law by its terms “encompasses only natural persons and not corporations or other organizations.”

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Court Rules Against Finra on Enforcement Actions

A federal appeals court in Manhattan ruled on Wednesday that Finra, an important regulator of Wall Street for more than 70 years, does not have the right to take its members to court to enforce its disciplinary actions.

The surprise decision curbs the powers of Financial Industry Regulatory Authority, formerly the National Association of Securities Dealers, at a time when it has been under pressure to impose greater accountability on its licensed brokers and brokerage firms.

The ruling came after a 14-year fight waged by Fiero Brothers, a tiny penny-stock brokerage firm, and its owner, John J. Fiero. In December 2000, after legal disputes that lasted several years, Finra accused Mr. Fiero and his firm of violating federal fraud statutes — specifically, engaging in a manipulative activity known as naked short-selling. Besides expelling the firm, the regulator imposed a $1 million fine.

The firm was shuttered and its owner was barred from the market — but both refused to pay the fine and, ultimately, Finra wound up in federal court trying to collect the money.

But Finra had no right to do that, according to a three-judge panel of the United States Court of Appeals for the Second Circuit, which encompasses Wall Street.

In an opinion written by Judge Ralph K. Winter Jr., the panel unexpectedly overturned a lower court and ruled that neither the nation’s foundational securities laws, adopted in 1934, nor a “housekeeping” rule adopted by Finra in 1990 gave it the right to pursue its monetary sanctions in court.

“The principal issue is whether the Financial Industry Regulatory Authority Inc. has the authority to bring court actions to collect disciplinary fines,” Judge Winter wrote. “We hold that it does not and reverse.”

T. Grant Callery, Finra’s general counsel, said the organization would “continue to review the ruling and weigh our options.” But he insisted the decision would not affect the self-regulatory group’s “ability to enforce Finra rules and securities laws, to discipline firms or protect investors.”

But some securities law experts predicted that the ruling could have both practical and psychological effects.

“The decision neuters Finra,” said John C. Coffee Jr., a securities law professor at Columbia who has been a consultant both to regulatory agencies and to private defendants appearing before them. “It has been trying to show that it has teeth and could hold its members more accountable — now, those teeth have been surgically removed.”

Martin H. Kaplan, a lawyer for Mr. Fiero and his firm, agreed that the ruling “changes the regulatory landscape in a profound way.” He said the decision vindicated those who had complained for years that Finra was exceeding its statutory power and abusing the rule-making process.

“Not only did the court find that Finra/N.A.S.D. never had authority to enforce fines using the courts, but it also highlighted Finra/N.A.S.D.’s failure to follow rule-making procedures and its frustration of Congressional intent,” Mr. Kaplan said.

At a practical level, Finra still retains its most potent weapon: the power to suspend or expel misbehaving brokers from the financial industry, what the appeals court called a “draconian” power.

But Susan Merrill, a securities lawyer and a former head of enforcement at Finra, said the decision cast an adverse light on the process Finra used to adopt the 1990 rule and, potentially, other “housekeeping” rules.

The court said the 1990 rule should have been given a more formal review, with an opportunity for public comment, because it did not deal with mere housekeeping matters. Rather, the rule “affected the rights of barred and suspended members to stay out of the industry and not pay the fines imposed on them in prior disciplinary proceedings.”

Analyzing whether other Finra rules may be affected by the decision is something “people will be wrestling with in days to come,” Ms. Merrill said.

The court’s criticism will also sting a bit at the Securities and Exchange Commission. The commission oversees Finra’s rule-making, and the chairwoman and chief executive of Finra during much of the time it pursued the Fiero case in court was Mary L. Schapiro, the current head of the commission.

The Fiero case has been a colorful one since it began in the mid-1990s, and regulators blamed Mr. Fiero and other “naked shorts” for bringing down a small clearinghouse that served 41 other small brokerage firms. Clearinghouse failures are rare and potentially dangerous, since they can greatly magnify the consequences of a single firm’s failure.

Since banned brokers cannot return to the industry unless they pay any unpaid fines, it has been extremely rare for Finra to sue to recover unpaid penalties.

Until now, both Finra and its members assumed that it had the power to do so if necessary. If it does not, its misbehaving members need no longer fear that a stiff fine will follow them into Wall Street exile.

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Court Sides With Trustee Over Madoff Payouts

A federal appeals court has approved the method being used to calculate the losses incurred by the victims of Bernard L. Madoff’s global Ponzi scheme, saying the approach used by the trustee in the case is “legally sound in light of the circumstances of this case and the relevant statutory language.”

The ruling, by the United States Court of Appeals for the Second Circuit, is a significant victory for Irving H. Picard, the court-appointed trustee who is liquidating the Madoff firm in bankruptcy court in Manhattan. In the face of vocal opposition in the courts and among some in Congress, Mr. Picard had calculated victims’ losses under the “cash in, cash out” method, which relied on the difference between the cash invested and the cash withdrawn by investors, without giving any weight to the fictional profits shown on the victims’ account statements over the years.

The favorable ruling in the closely watched dispute probably will advance the day when claims for the eligible victims in the case can be paid from the $10 billion pool of assets already collected by Mr. Picard. Those payments had been held in abeyance by the legal dispute over Mr. Picard’s calculation method.

But the decision is a setback for the thousands of so-called “net winners” in the vast Madoff fraud, investors whose withdrawals from the Ponzi scheme over the years matched or exceeded the amount they originally invested.

Lawyers for those investors had urged the courts to throw out Mr. Picard’s method and order him to rely instead on the final account balances shown on the their statements in the weeks before the fraud collapsed with Mr. Madoff’s arrest on Dec. 11, 2008. Some members of Congress had supported their fight, proposing legislation that would take the dispute out of the courts by changing the laws governing Wall Street bankruptcies and Ponzi scheme loss calculations.

The ruling supports the trustee’s efforts to recover fictional profits that investors withdrew from the sceme before its collapse through so-called “clawback” lawsuits.

Amanda Remus, a spokeswoman for Mr. Picard, released a statement saying the decision “is an important step forward for customers with allowed claims. We have maintained all along that our definition of net equity — which is supported by longstanding precedents in bankruptcy and securities laws — is the fairest approach to the determination of claims, and we hope that the Court’s decision can be the final word on this issue.”

  One of the lawyers opposing Mr. Picard’s approach to calculating losses, Helen Davis Chaitman, predicted the appeals court ruling “will destroy investor confidence in the capital markets” because it does not require the Securities Investors Protection Corporation, the industry-supported organization that provides a limited safety net for customers of failed brokerage firms, to honor the Madoff investors’ final account statements.  

“The message to every American who invests in the stock market is clear: invest at your own risk and assume that S.I.P.C. insurance does not exist,” Ms. Chaitman said.

  An investor advocacy group initially formed by those opposing Mr. Picard’s loss calculation formula also criticized the ruling. Ron Stein, the president of the Network for Investor Action and Protection, said the ruling “is another blow to small investors who merely relied on the information their broker gave them.” Mr. Stein continued: “The court’s regrettable decision underscores the need for Congress to reinforce securities laws that were intended to protect the small investors harmed by this decision and the actions of the S.I.P.C. trustee.”

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Economix: A Lie That Was ‘Literally True’

Remember market timing?



Notions on high and low finance.

That was a financial scandal before Wall Street brought on the collapse of the economy. Some mutual funds allowed favored customers to trade mutual funds based on stale prices. In many cases, this involved funds that invest in foreign securities, where a lot of news may have happened after the stocks stopped trading in their home countries but before the 4 p.m. New York deadline. The effect is to transfer money from other investors in the fund to the market timers.

One example was the Gabelli Global Growth Fund, known as GGGF, run by Marc Gabelli, the son of Mario Gabelli, the founder of the Gabelli Funds. He told the fund’s board that the fund was diligently seeking to stop investors from market timing, and that was true, with one not-so-minor exception. He allowed a favored hedge fund to do it hundreds of times. That fund made money in the fund; other investors lost money. The hedge fund effectively paid off Gabelli by investing in a Gabelli hedge fund.

When market timing became an issue in 2003, the fund reassured investors that management was on the case, in a memo signed by Bruce Alpert, the chief operating officer of Gabelli Funds, that said market timers were really scalpers:

For more than two years, scalpers have been identified and restricted or banned from making further trades. Purchases from accounts with a history of frequent trades were rejected. . . . While these procedures were in place they did not completely eliminate all timers.

The Securities and Exchange Commission filed a civil suit against Mr. Gabelli and Mr. Alpert, only to have a federal judge, Deborah Batts, dismiss the suit. That judge concluded the letter was “literally true,” and thus not misleading. After all, some market traders were blocked, and the funds admitted that some succeeded.

On Monday the United States Court of Appeals for the Second Circuit reversed that decision, in a ruling by another district judge, Ned Rakoff, who was temporarily sitting on the appellate court:

“The law is well settled, however, that so-called “half truths” — literally true statements that create a materially misleading impression — will support claims for securities fraud.”

Judge Rakoff concluded that “a reasonable investor reading the Memorandum would conclude that the Adviser had attempted in good faith to reduce or eliminate GGGF market timing across the board, whereas, as Alpert well knew but failed to disclose, the Adviser had expressly agreed to let one major investor . . . engage in a very large amount of GGGF market timing.”

The case will thus be able to go to trial. But I find it amazing that this appeal was necessary. Given the facts as alleged by the S.E.C. (and the judge has to assume they are accurate in considering a dismissal motion), it is hard to imagine a less absurd conclusion than the one reached by Judge Batts.

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