Bloomberg’s Morning Report on Securities Regulation, Compliance

Aiming to stay a step ahead of “the next Madoff,” the Securities and Exchange Commission is set to hire University of Texas professor Henry Hu to oversee risk analysis and seek out market areas where abuses may emerge, Joshua Gallu, Jesse Westbrook and David Scheer report.

Hu, who has researched how complex securities and credit derivatives pose systemic risk, will lead SEC staff members who identify areas of potential abuse and analyze the costs and benefits of regulating them. Hu will report to Chairman Mary Schapiro.

Hu “is one of the leading scholars in law and financial markets,” said Darrell Duffie, a finance professor at Stanford University’s Graduate School of Business, who co-wrote a paper with Hu in 2008 on U.S. competitiveness in the global derivatives market. Hu is particularly focused on “disclosure of derivatives positions related to corporate governance issues,” he said.

In June, Hu told a Senate committee that innovation in derivatives markets threatens to leave regulators unaware of certain products and the risks they pose. He told lawmakers he has urged creation of a centralized clearinghouse to collect information on over-the-counter derivatives since 1993. The Obama administration has proposed that all standard derivative products be cleared through regulated clearinghouses and executed on a regulated exchange or trading platform.

Hu has also testified to Congress on the collapse of hedge fund Long-Term Capital Management LP in 1998, the regulatory implications of the New York Stock Exchange’s public listing in 2006 and the role of credit-default swaps in the financial crisis last year. In 2007, he spoke on an SEC panel about the rights of shareholders to choose corporate directors.

For more from Gallu, Westbrook and Scheer, click here.

Schapiro Seeks Swaps Data for Probes, Plans More CEO Clawbacks

For regulators to effectively police the swaps markets, it’s “critical” they get information that allows them “to construct an audit trail” to find “insider-trading, manipulation and other concerns that can reverberate through the entire marketplace,” U.S. Securities and Exchange Commission Chairman Mary Schapiro said in an interview for Bloomberg Television’s “Conversations with Judy Woodruff” airing tonight.

Schapiro said the SEC and the Commodity Futures Trading Commission can jointly bring soundness and stability to derivatives trading. “The SEC should absolutely have a role in policing these instruments, particularly where these instruments are economic substitutes for securities,” said Schapiro, adding that access to information “is really going to be critical.”

Schapiro and CFTC Chairman Gary Gensler have suggested a dual regulatory structure for derivatives. Primary responsibility for derivatives tied to securities, such as credit-default swaps, should go to the SEC, Schapiro told lawmakers on June 22. Other derivatives, including those related to interest rates and commodities, should be regulated by the CFTC, Gensler said then.

Though lawmakers decided in 2000 to exempt derivatives from government oversight, the financial industry now recognizes there is broad consensus in Washington to regulate the instruments, Gensler said yesterday in an interview.

Schapiro also said she can’t predict how often the SEC may invoke a seven-year-old law forcing executives to pay back bonuses if their company has to restate earnings as a result of misconduct. The agency’s five commissioners voted 3-2 to approve the law’s first use last month against an executive who wasn’t accused of wrongdoing, prompting some lawyers and academics to question how aggressively the SEC will apply the rule.

The law is intended to ensure top executives pay “careful attention to the financial statements and accounting issues,” Schapiro said, noting that each case depends on “individual facts and circumstances.”

She also said the SEC is concerned that firms may violate rules by privately offering trading tips to preferred clients. The Wall Street Journal reported Aug. 24 that Goldman Sachs Group Inc.’s research analysts give short-term tips to the New York-based bank’s own traders, and later to its major clients.

“There are lots of issues surrounding” such practices, and the SEC is looking “very closely” at them, she said, without referring specifically to Goldman Sachs. One concern is that a firm may privately share information with some clients that is inconsistent with its public research, she said.

President Barack Obama’s proposed regulatory overhaul would impose higher capital and margin requirements, move most derivatives to regulated exchanges and clearinghouses and impose supervision over all dealers. Such proposals go “quite far” toward improving oversight, Schapiro said in the interview.

For more, click here.

For ongoing AIG-type swap replication, click here.

Wall Street Betrayal Seen in $4.8 Billion Company Debt Losses

Eighteen months after investment banks quit supporting auction-rate securities that were once marketed as an equivalent to cash, companies from Dallas-based Texas Instruments Inc. to Israel’s Teva Pharmaceutical Industries Ltd. have more than doubled writedowns on the debt to $4.8 billion, Dunstan McNichol reports.

While U.S. state and federal regulators have announced settlements with 23 banks since December 2008, obliging them to repurchase a total of $61 billion in the bonds from individual investors, almost all new sales are failures. More than 400 companies stuck with $22 billion worth of the debt are selling at losses of as much as 40 cents on the dollar to get cash, according to SecondMarket Inc., a New York-based brokerage firm. Others have decided to wait decades until the securities mature.

“We’re not happy about this,” said James B. Flaws, chief financial officer of Corning Inc. The glass-fiber maker is one of two owners of Midland, Michigan-based Dow Corning Corp., a manufacturer of silicone products that holds $1.1 billion of the securities in a market once worth $330 billion.

Corning wrote down its share of the portfolio by $33 million and reclassified the assets as a long-term investment, according to a Securities and Exchange Commission filing for the quarter ended June 30. Its affiliate trusted the auction-rate market after functioning smoothly for more than two decades, Flaws said in a telephone interview.

“They invested in auction-rate securities based on the understanding that this was a lot like a money-market instrument, and there was a very liquid market for these,” he said. “There should be a market for this. We are appealing, pressuring, trying to get the banks to reopen the market.”

For more from McNichol, click here.

Treasury Document Called AIG Investment ‘Highly Speculative’

The U.S. Treasury said in a draft of a presentation that its $40 billion investment in the American International Group Inc. bailout was “highly speculative.”

A slide with the phrase was included in documents obtained in a Freedom of Information Act request by Judicial Watch, a group that advocates government transparency. The sentence was omitted from another version of the slide in a presentation describing the November revision to AIG’s rescue in which the insurer got $40 billion from the Treasury.

“The prospects of recovery of capital and a return on the equity investment to the taxpayer are highly speculative,” according to the first of the two Treasury slides.

For more from Hugh Son, click here.

AIG Rises After CEO Says He’ll Wait to Sell Units

American International Group Inc. rose after Chief Executive Officer Robert Benmosche told the Wall Street Journal he may wait as long as three years before selling two overseas life insurance units.

The stock climbed as much as 17 percent as of 10:08 a.m. in New York Stock Exchange composite trading. AIG has more than tripled since Benmosche was named CEO on Aug 3.

The insurer may be unable to repay the government’s $182.5 billion bailout if it sells American International Assurance Co. and American Life Insurance Co. at today’s market levels, Benmosche told the Wall Street Journal in an interview in Dubrovnik, Croatia. He plans to bolster the businesses before selling them off, the newspaper reported.

Benmosche will take six to 12 months to decide whether to sell New York-based AIG’s property and casualty unit and aircraft leasing operator International Lease Finance Corp., the newspaper said.

For link to New York Times story questioning stock boost, click here.

CFO Davis Says Stanford, Antiguan Regulator Took ‘Blood Oath’

James M. Davis, chief financial officer of Stanford Financial Group Co., pleaded guilty to helping R. Allen Stanford in a $7 billion Ponzi scheme and prosecutors said he will testify against his former colleagues.

Davis, 60, admitted three felony counts yesterday before U.S. District Judge David Hittner in Houston and agreed to forfeit $1 billion. Davis has been “cooperating like crazy” with authorities investigating the company, said his defense attorney, David Finn of Dallas. In his signed plea, he said Stanford enlisted Antiguan securities regulator Leroy King to take part in a “‘blood oath’ brotherhood ceremony,” after which Stanford gave King cash bribes so the regulator wouldn’t “kill the business,” the Wall Street Journal reported.

The Justice Department will request leniency in Davis’s sentencing if it deems his cooperation “sufficient,” Assistant U.S. Attorney Paul Pelletier told Hittner. Davis has met for hundreds of hours with federal investigators, helping them find hundreds of millions of dollars that he claimed Stanford stashed in European banks, Finn said.

Leniency has been hard to come by for cooperating witnesses lately. Bradley Birkenfeld, who blew the whistle on UBS AG’s offshore tax-dodge shelters for U.S. accountholders, received a 40-month sentence last week. Frank DiPascali, Bernard Madoff’s so-called CFO who has been cooperating since March, was denied bail when he was indicted two weeks ago.

Stanford, the company founder who is being held without bail, was to appear before Hittner yesterday for a hearing on his legal defense. Instead, he was taken to a medical center with what a court aide said was an elevated pulse rate.

For more on Davis, click here.

CEO Hubris Biggest Risk Factor for Financial Fraud, Study Says

The signature sign that financial fraud is occurring at a company is a chief executive officer with an oversized ego, three Canadian professors said in a study titled: “Like Moths Attracted to Flames: Managerial Hubris and Financial Reporting Fraud.”

Michel Magnan of Concordia University’s John Molson School of Business, Denis Cormier of the University of Quebec’s Accountancy Department and Pascale Lapointe-Antunes of Brock University’s business program identified fraud risk factors based on their analysis of frauds at publicly traded firms in Canada from 1995 to 2005.

For securities lawyer Thomas Gorman of Porter Wright in Washington, the takeaway from the study is that the usual red flags or incentives to commit fraud pale in comparison to the CEO’s outsize ego. More often than not, such CEOs “were in the media and closely followed by analysts,” Gorman says.

Ex-ISE Vice Chairman Marshall Settles SEC Insider-Trading Case

Former International Securities Exchange Holdings Vice Chairman John F. Marshall agreed to settle a U.S. regulatory lawsuit claiming he leaked information about the options exchange’s 2007 merger with Eurex to associates who reaped more than $1.8 million through insider trades.

Marshall, who was sentenced in December to 18 months in prison in a related criminal case, agreed to pay $35,500 to resolve the Securities and Exchange Commission’s lawsuit, the regulator said in a statement yesterday. He also consented to an order barring him from serving as an officer or director of a publicly traded company, the agency said.

Two traders who acted on the tips also agreed to settle the SEC’s claims, the agency said. They and Marshall didn’t admit or deny wrongdoing under the accords, which still require a judge’s approval, it said.

For more, click here.

Merrill Bad Blood Over Sontag Treatment in Krawcheck Hiring

When Daniel Sontag left Bank of America Corp., where he ran the Merrill Lynch wealth management unit, on Aug. 4, a day after the lender said it hired Sallie Krawcheck for the position, Danny Sarch, president of Leitner Sarch Consultants in White Plains, New York, said his exit would be a “big blow” to the firm where he’d spent the last 31 years.

“With all due respect to Ms. Krawcheck, she doesn’t have nearly the depth of experience in terms of nuts and bolts and retail,” Sarch said then.

Two weeks later, Merrill veterans are saying their boss was poorly treated by Bank of America executives who hired Krawcheck, Business Insider’s Clusterstock blogger John Carney reported, citing unnamed sources within the bank. Sontag didn’t confirm his account.

Sontag learned from bank President Brian Moynihan only moments before BofA’s Aug. 4 public announcement that Krawcheck was being brought in to run his division, Carney said. The ill will now stems from a feeling that the Sontag family deserved better, as he worked at Merrill for 31 years, his father was a Merrill trader and his son is one as well, Carney reported.

Sontag, who’d expanded his staff just two months earlier, may have expected to be consulted about potential new hires, Carney said.

Since he left, Sontag has only spoken positively about the bank. Others are criticizing the way he was treated. Carney said he was told by one source that Sontag doesn’t want to publicly criticize Bank of America.

Carney reported on Aug. 26 that Anne Finucane, Bank of America’s chief marketing officer, urged Chief Executive Officer Ken Lewis to hire Krawcheck.

Krawcheck, 44, and Sontag, 53, held a conference call with employees on Aug. 4 to announce his exit. Krawcheck, who stepped down in September as head of Smith Barney, spent much of her first day meeting Merrill employees, David Mildenberg reported.

Sontag oversaw 15,000 financial advisers. He joins more than three dozen senior Merrill executives who have departed since the company’s Jan. 1 acquisition by Bank of America.

For more from David Mildenberg, click here.

For Carney on Finucane’s role, click here.

For Carney on Sontag’s treatment, click here.

GE, AmEx, Nissan Lead TALF Sales, SEC Approves Broker Expansion

American Express Co., Bank of America Corp. and Nissan Motor Co. are lining up debt sales for the seventh round of a Federal Reserve program to jump-start credit markets.

Investors have until Sept. 3 to take out Fed loans to purchase the debt through the Term Asset-Backed Securities Loan Facility. Dow Jones reported yesterday that the Securities and Exchange Commission approved a request by the Fed to boost participation in the program by expanding the pool of brokers who will be allowed to extend credit to purchasers.

The SEC’s nod was disclosed in a letter last week, Dow Jones reported.

The Fed started TALF in March to revive the market for securities backed by consumer and small-business loans. Sales of securities backed by auto loans, credit cards and student loans plunged 42 percent last year to $135 billion as the recession sapped demand for the debt and choked off funding for lenders, according to data compiled by Bloomberg.

For more, click here.

FDIC’s ‘Problem Bank’ List Surges, Putting Fund at Risk

The U.S. added 111 lenders to its list of “problem banks,” a jump that suggests rising bank failures may force the Federal Deposit Insurance Corp. to deplete a reserve fund that shrank 40 percent this year.

A total of 416 banks with combined assets of $299.8 billion failed the FDIC’s grading system for asset quality, liquidity and earnings in the second quarter, the most since June 1994, the Washington-based FDIC said yesterday in a report. Regulators didn’t identify companies deemed “problem” lenders.

The U.S. has taken over 81 banks this year, including Guaranty Financial Group Inc. in Texas and Colonial BancGroup Inc. in Alabama, amid the worst financial crisis since the Great Depression. The surge forced regulators to charge banks an emergency fee to raise $5.6 billion for its insurance fund, which fell to $10.4 billion as of June 30 from $13 billion in the previous quarter, the agency said. The total was the lowest since the savings-and-loan crisis in 1993.

An $11.6 billion increase in loss provisions for bank failures caused the decline in the reserve fund, the FDIC said. If the fund is drained, the FDIC has the option of tapping a line of credit at the Treasury Department that Congress extended in May to $100 billion, with temporary borrowing authority of $500 billion through 2010.

The agency doesn’t expect to use the Treasury line, FDIC Chairman Sheila Bair said in a news conference releasing the data.

More than 150 publicly traded U.S. lenders own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival, according to data compiled by Bloomberg.

The biggest banks with nonperforming loans of at least 5 percent include Wisconsin’s Marshall & Ilsley Corp. and Georgia’s Synovus Financial Corp., according to Bloomberg data. Among those exceeding 10 percent, the biggest in the 50 U.S. states was Michigan’s Flagstar Bancorp. All said in second- quarter filings they’re “well-capitalized” by regulatory standards, which means they’re considered financially sound.

The agency this week approved new guidelines for private- equity firms that invest in failed banks to increase the pool of buyers beyond traditional lenders and reduce costs to the banking industry and taxpayers.

For more from Alison Vekshin, click here.

For new FDIC bank buyout rules, click here and here.

Regulators May Weigh ‘Phase-In’ of Higher Capital Requirements

U.S. regulators may consider giving banks a reprieve from capital requirements that could rise under an accounting rule forcing companies to add billions of dollars of assets and liabilities to their balance sheets next year, Bloomberg’s Ian Katz reports.

Courts

Singapore Central Bank Sues Pheim, Tan for Share Manipulation

Singapore’s central bank sued Pheim Asset Management Pte Chief Executive Officer Tan Chong Koay and the fund manager’s Malaysian unit for manipulating the shares of a water treatment company.

For more, click here.

SEC Fines Las Vegas Accounting Firm for Using Untrained Auditors

A Las Vegas-based accountant will pay more than $319,000 to resolve U.S. regulatory claims that he and his firm issued false audit reports for more than 300 companies, some of them prepared by high school graduates with little or no training as auditors.

The Securities and Exchange Commission announced the case against Michael J. Moore and Moore & Associates Chartered in a news release yesterday. Moore and the firm agreed to settle SEC and Public Company Accounting Oversight Board claims without admitting or denying wrongdoing, according to the SEC statement.

The suit, filed in Los Vegas federal court, charged Moore and his firm with issuing false reports that failed to comply with audit standards set by the Public Company Accounting Oversight Board in three areas: planning and supervision, exercising due care and obtaining sufficient evidence.

Moore and his firm were suspended form practicing before the SEC as accountants.

Sunwest Seeks Court Approval of Plan to Pay Creditors

Sunwest Management Inc., the U.S. retirement-home operator sued for fraud by the Securities and Exchange Commission, asked a federal judge to approve a plan for repaying creditors owed about $2 billion.

For more, click here.

Company News, SEC Filings, Interviews

Leverage Rising on Wall Street at Fastest Pace Since ‘07 Freeze

Banks are increasing lending to buyers of high-yield company loans and mortgage bonds at what may be the fastest pace since the credit-market debacle began in 2007.

For more, click here.

California Gains $1.5 Billion With JPMorgan Note Sale

California borrowed $1.5 billion from JPMorgan Chase & Co. at an annual interest rate of 3 percent, raising cash the most- populous U.S. state will use to help repay IOUs it used for routine bills, the Treasurer’s office said. The New York-based bank purchased securities that will be repaid after California next month sells as much as $10.5 billion of revenue anticipation notes, used to cover expenses until most of its tax revenue is received later in the budget year.

For more from William Selway, click here.

Trump Casinos Must Face Examiner’s Review of Donald Trump Deal

Donald Trump’s effort to regain control of Trump Entertainment Resorts Inc. will be investigated by a court- approved bankruptcy examiner, U.S. Bankruptcy Judge Judith Wizmur in Camden, New Jersey, ruled yesterday.

For more, click here.

Tribune Bondholders, Creditors Seek Probe of $8.3 Billion LBO

Bondholders of Tribune Co., owner of the Chicago Tribune and Los Angeles Times, asked a bankruptcy judge for permission to investigate billionaire Sam Zell’s $8.3 billion takeover of the media company.

“I’m surprised we haven’t seen more of these,” said Charles Tatelbaum, a bankruptcy lawyer at Adorno & Yoss in Fort Lauderdale, Florida, and former editor of the American Bankruptcy Institute Journal. “This is what happens when you have a leveraged buyout, and when it fails there is always a good possibility of a subsequent investigation and litigation.”

For more, click here.

Comings and Goings

UBP to Cut 10% of Workforce This Year as Client Assets Decline

Union Bancaire Privee, the Swiss hedge-fund investor whose clients lost about $700 million with Bernard Madoff, plans to cut 10 percent of its workforce this year after assets under management declined.

“UBP should reduce its staff by 10 percent over the course of the year, from a headcount of 1,372 at the end of December, through redundancies, early retirements and not filling vacant positions,” said Jerome Koechlin, spokesman for the Geneva- based firm.

For more, click here.

U.K. FSA Names Julian Adams as Its New Retail Firms Director

About 900 U.K. lenders and fund managers have a new regulatory director at the Financial Services Authority.

The FSA named Julian Adams as director of retail firms in a statement yesterday. Adams takes over from Sheila Nicoll, who becomes director of conduct policy. Adams’s group supervises 900 small lenders, building societies, medium-sized insurers and fund managers, the FSA said.

For more from Caroline Binham, click here.

International

Japan Considers Credit-Default Swap Clearinghouses, Nikkei Says

Japan’s Financial Services Agency may require credit default swaps be conducted through clearinghouses to improve transparency, Nikkei English News said, without saying where it got the information.

The derivatives, which have been blamed for setting off the global financial crisis, now are mostly settled by financial institutions. The Japanese agency wants to consolidate settlement at approved clearinghouses being considered by entities including the Tokyo Stock Exchange and Tokyo Financial Exchange.

FSA’s Turner Wades Into Political Debate With Tobin Tax Comment

The U.K. Financial Services Authority was dragged into a second political controversy in as many weeks after its chairman championed a global tax on financial transactions based on a 40- year-old theory.

FSA Chairman Adair Turner proposed a “Tobin Tax” on banking deals in a Prospect magazine interview. This would redistribute bank profits to the poor and to “public goods” like fighting climate change. The remarks grabbed the attention of lawmakers and bankers who say the regulator might have a short political future.

For more from Caroline Binham, click here.

To contact the reporter responsible for this report: Lisa Brennan in New York at lbrennan1@bloomberg.net.

To contact the editor responsible for this report: David E. Rovella at drovella@bloomberg.net.

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