Last week US SEC released a staff report recommending that life settlements be clearly defined as securities so that the investors in these transactions are protected under the federal securities laws.
A life settlement is a transaction in which an individual with a life insurance policy sells that policy to another person, who then assumes responsibility for paying the premiums. Typically, the seller no longer wants the policy or can no longer afford to pay the premiums. In exchange, the insured party typically receives a lump sum payment that exceeds the policy's cash surrender value, but is less than the expected payout in the event of death.
The staff report by SEC's Life Settlements Task Force, which SEC Chairman Mary Schapiro established in August 2009, notes that the market for life settlements has grown over the past decade, raising questions about its regulation and oversight.
In particular, the report notes that there is inconsistent regulation of participants in the life settlements market, including those who arrange for the buying and selling of policies and those who provide estimates of an insured's life expectancy. In addition, the report notes that investors in individual life settlement transactions, or pools of life settlements, would benefit from the application of baseline standards of conduct to market participants.
In the report, the staff outlines the Task Force's findings about the life settlements market and recommends ways to improve market practices and regulatory oversight. It recommends that the Commission should:
- Consider recommending to Congress that it amend the definition of security under the federal securities laws to include life settlements as securities.
- Instruct the staff to continue to monitor that legal standards of conduct are being met by brokers and providers.
- Instruct the staff to monitor for the development of a life settlement securitization market.
- Encourage Congress and state legislators to consider more significant and consistent regulation of life expectancy underwriters.
SEC also issued an investor bulletin regarding investments in life settlements, consistent with one of the recommendations of the Task Force.
Amending the federal securities laws to define life settlements as securities could have several benefits:
- The amendment would clarify the status of life settlements under the federal securities laws and provide for a more consistent treatment of life settlements under both federal and state securities laws.
- The amendment would bring intermediaries in the life settlement market within the regulatory framework of SEC and FINRA. This would subject them to regulatory requirements designed to protect investors from abusive practices and to promote business conduct that facilitates fair, orderly and efficient markets.
- The amendment would give SEC and FINRA clear authority to police the life settlements market, which could lead to early detection of abuses and help deter fraud.
Jack's comment: It appears that life settlement is not regarded as securities under SFO, but would they be treated as regulated investment agreement, or structured product in future?
Last week UK FSA has today outlined proposals to ensure all mortgages are carefully assessed to make sure borrowers can afford them.
Reflecting FSA's enhanced consumer protection strategy and intensive day-to-day supervision, the proposed changes aim to ensure all lenders get back to the basics of responsible lending and that problems are prevented before they can develop or get out of control.
Some of the key proposals include:
- Imposing affordability tests for all mortgages and making lenders ultimately responsible for assessing a consumer's ability to pay;
- Requiring verification of borrowers' income in every case to prevent over inflation of income and to prevent mortgage fraud;
- Extra protection for vulnerable customers with a credit-impaired history.
The tough new proposals, published in the consultation paper, form part of a major review by FSA into the UK mortgage market and are based on detailed analysis of past lending decisions, looking at the causes of arrears and repossessions since 2005.
FSA found that:
- 46% of households either had no money left, or had a shortfall after mortgage payments and living costs were deducted from their income;
- Almost half of new mortgages between 2007 and the first quarter of 2010 were provided without a customer having to verify their income;
- The share of interest-only mortgages has been increasing. At the peak of the market, over 30% of all mortgages were interest-only;
- Many consumers with no repayment vehicle count on future house price rises or uncertain life events to repay their mortgage and some have no plan at all;
- Borrowers with a credit-impaired history are particularly vulnerable.
Jack's comment: While FSA is enforceing responsible lending, it may have failed to ensure responsible borrowing.
A FINRA hearing panel has permanently barred a former Deutsche Bank broker from the securities industry for manipulating the price of Monogram Biosciences (MGRM) stock in an effort to enrich a hedge fund client, himself and his family.
The panel found that Edward S. Brokaw, who worked in the Greenwich, CT branch office of Deutsche Bank Securities, engaged in a pattern of trading designed deliberately to drive the value of MGRM stock down and, in turn, drive up the value of contingent value rights (CVRs) on that stock. Included in the evidence against Brokaw were tape recordings of his phone calls to his firm's trading desk to place sell orders.
The MGRM CVRs were created and issued in December 2004, in connection with the merger of two firms to form MGRM. The CVRs were to be valued during a 15-day pricing period scheduled for 18 months after the merger – beginning on May 19, 2006, and ending on June 9, 2006.
The value of the CVRs was to be determined by the volume weighted average price (VWAP) of MGRM shares trading during that 15-day period. At the end of the pricing period, CVR holders were to receive a payment from MGRM, most or all of which would be in cash. If the final VWAP was at or above $2.90, the CVRs would be worthless. But if the final VWAP was below $2.90, CVR holders would receive a penny-for-penny payment for the amount below $2.90, down to $2.02. The maximum of $.88 per CVR would be paid if the final MGRM VWAP was at or below $2.02.
Brokaw's hedge fund client held approximately 18.5 million CVRs – nearly 30% of the 64.8 million MGRM CVRs outstanding. For every penny the final VWAP dropped below $2.90, the value of the hedge fund's CVRs increased by $185,000. If the maximum payout of $.88 per CVR were achieved, the hedge fund would receive approximately $16 million. Brokaw and his family owned 217,000 of the CVRs, with a potential maximum payout of $188,000.
The hedge fund owned 3 million shares of MGRM and told Brokaw that it wanted to sell off all of those shares during the pricing period. Prior to market open on the first day of the pricing period, the hedge fund placed an order with Brokaw to sell 50,000 MGRM shares close to the open and another 50,000 shares close to the close. In a tape-recorded phone call that morning, Brokaw told a Deutsche Bank sales trader, "Take 50,000 MGRM at the market. Sell it down. Sell it as low as you want. Sell it hard, 50,000." According to the panel decision, the sales lasted little more than a minute – and MGRM shares dropped from $2.06 to $1.94.
The panel decision quotes another phone call from Brokaw to the sales trader that afternoon, in which he explained the pricing of the CVRs and the strategy behind the hedge fund's instructions to sell close to the market's open and close, saying, "Just so you know what the target price is … So yeah, understand the game that's being played for the next 15 days."
The hedge fund's orders and Brokaw's aggressive placement of those sell orders continued for three trading days. But when Deutsche Bank's compliance personnel reviewed those orders, the firm decided it would no longer execute MGRM sales for the hedge fund's account. Deutsche Bank first suspended, then terminated Brokaw based on his MGRM sales orders for the hedge fund.
The hearing panel concluded that "the objective of the selling strategy was to drive down the price of MGRM shares rather than to obtain the best price … (Brokaw) placed the orders to artificially depress the price of MGRM to impact the pricing of the CVRs." The panel noted that for every penny MGRM stock dropped, the hedge fund lost $29,000 in value on its shares but gained more than $180,000 in value on its CVRs.
The panel also found that Brokaw violated Deutsche Bank's policy requiring the individual accepting a client order to create an order ticket "immediately upon receipt of an order." Instead, Brokaw's sales assistant completed one "booking ticket" each day, each showing a single 100,000-share order to sell, each with a false notation that the order was given by the client directly to the trading desk rather than to Brokaw – thus circumventing automatic branch office compliance review of the orders.
Unless the hearing panel's decision is appealed, its ruling will resolve charges filed in a FINRA complaint against Brokaw filed in December 2008.
Jack's comment: Actually the design of CVR motivated this kind of "arbitrage" activities, but were incidentally regarded as "market manipulation".
US SEC has recently obtained an emergency asset freeze against a Canadian couple who fraudulently touted penny stocks through their website, Facebook and Twitter. It also charged two companies the couple control and obtained an asset freeze against them.
According to SEC's complaint, the defendants profited by selling penny stocks at or around the same time that they were touting them on www.pennystockchaser.com. The website invites investors to sign up for daily stock alerts through email, text messages, Facebook and Twitter.
Since at least April 2009, Carol McKeown and Daniel F. Ryan, a couple residing in Montreal, Canada, have touted U.S. microcap companies. They received millions of shares of touted companies through their two corporations, defendants Downshire Capital Inc., and Meadow Vista Financial Corp., as compensation for their touting. McKeown and Ryan sold the shares on the open market while PennyStockChaser simultaneously predicted massive price increases for the issuers, a practice known as "scalping."
McKeown and Ryan used all the modern methods to communicate with investors including the PennyStockChaser website, e-mail, text messages, Facebook, and Twitter yet failed to adequately communicate that their rosy predictions for touted stocks were accompanied by their sales of those very same stocks.
McKeown, Ryan together with their corporations failed to disclose the full amount of the compensation they received for touting stocks on PennyStockChaser, and they have realized at least $2.4 million in sales proceeds from their scalping scheme.
Jack's comment: If such scalping practice happened in Hong Kong, probably SFC would charged those scalpers for violating Section 300 of SFO - Offence involving fraudulent or deceptive devices, etc. in transactions in securities, futures contracts or leveraged foreign exchange trading.
SFC has recently resolved its compliance concerns with Julius Baer (Hong Kong) Ltd. Under the resolution, SFC reprimands and fines Julius Baer $3 million.
An SFC investigation revealed that Julius Baer, which is licensed to provide services only to professional investors, failed:
- to take adequate steps to identify clients as professional investors before treating them as such;
- to conduct an annual confirmation as to whether its clients continued to fulfil the professional investor requirements; and
- to maintain adequate written records of its investment advice given to clients.
In deciding the disciplinary sanction, the SFC took into account that:
the failures took place between October 2006 and July 2008 when they were detected;
- Julius Baer has a clean disciplinary record;
- Julius Baer co-operated in resolving these disciplinary proceedings;
- Julius Baer does not admit to the failures as identified by SFC; and
- Julius Baer will engage an independent reviewer to review its internal controls in relation to its compliance with the regulatory requirements for treating clients as professional investors and the provision of investment advice.
Jack's comment: The implication of this case seems alarming. It may indicate that certain non-eligible clients had been mis-classified as professional investors but recommended to purchase unauthorized investment products without reasonable care being taken by their relationship managers.
Last week SFC reprimanded Christfund Securities Ltd (CSL), Christfund Futures Ltd (CFL) (collectively referred to as Christfund) and their respective responsible officers, and fined them a total of $2.5 million over internal control deficiencies in handling Mainland clients' accounts.
CSL and CFL were fined $1,200,000 and $700,000 respectively while responsible officers Ng Kam Shing and Chow Yuen Tung were fined $300,000 each in relation to Christfund’s internal control deficiencies in handling Mainland clients’ accounts.
An SFC investigation covering the period from August 2007 to July 2008 found that a Shenzhen-based company, Hang Fung Investment Consultants (Shenzhen) Co Ltd (HF Shenzhen) -- an affiliate of Christfund -- provided marketing services for Christfund on the Mainland.
HF Shenzhen made available account opening forms for Mainland investors to open accounts with Christfund. In handling the account opening process for these Mainland individuals, SFC found that:
- Christfund had not performed sufficient know-your-client procedures with respect to Mainland clients;
- Christfund took insufficient steps to establish the full identities and addresses of each of these Mainland individuals, thereby failing to establish the accuracy of such information;
- Christfund allowed 22 and 44 such Mainland clients of CSL and CFL respectively to use the office address of HF Shenzhen as their correspondence address. Also, 51 such Mainland clients of CSL were permitted to use the address of one of Christfund’s clients as their correspondence address;
- Christfund allowed about 1,000 clients at CSL to authorise one individual amongst them to operate their accounts on their behalf;
- Christfund had taken insufficient steps to check the operation of two accounts of clients emanating from HF Shenzhen for a prolonged period of time, thereby allowing these accounts to be used to transfer funds to facilitate settlement of transactions in the Mainland clients' accounts at Christfund, although each transfer is supported by written transfer authorisation by the respective clients; and
- in allowing these matters to occur, Christfund had taken insufficient steps to address the potential regulatory issues arising from inadequate records and the safe custody of client assets, including cash.
In deciding the sanction, SFC took into account that:
- Christfund was acting in good faith and there is no evidence of any dishonesty on its part or its senior management in its business activities;
- Christfund has co-operated with the SFC by readily accepting responsibility for the above breaches;
- Christfund has agreed to engage an independent audit firm to review the relevant aspects of its internal controls system and account opening procedures. The audit firm will also verify that remedial steps had been taken since the deficiencies were identified;
- Christfund has also agreed that CSL shall: (i) cease operating those Mainland individuals’ client accounts apart from taking those clients’ sell order instructions and returning their securities and remaining balances to those clients; and (ii) cease opening accounts for any Mainland individuals referred by or through HF Shenzhen or any other persons or corporations on the Mainland, unless such practice is in compliance with applicable Mainland laws; and
- CFL, Ng and Chow have not previously been disciplined by the SFC.
Jack's comment: Obviously Christfund's consent to cease the Mainland business is made under the pressure of the watchdog. However, even Christfund's internal controls were inadequate, why should an indefinite "show-stopper" be imposed? Who is the judge to determine whether "such practice is in compliance with applicable Mainland laws"?
Last week US SEC approved the new stock-by-stock "circuit breaker" rules. The rules, which were proposed by the national securities exchanges and FINRA and published for public comment, come in response to the market disruption of May 6.
SEC anticipates that the exchanges and FINRA will begin implementing the newly-adopted rules as early as Friday, June 11.
Under the rules, trading in a stock would pause across U.S. equity markets for a five-minute period in the event that the stock experiences a 10% change in price over the preceding five minutes. The pause, which would apply to stocks in the S&P 500 Index, would give the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion. Initially, these new rules would be in effect on a pilot basis through December 10, 2010.
The markets will use the pilot period to make appropriate adjustments to the parameters or operation of the circuit breakers as warranted based on their experience, and to expand the scope to securities beyond the S&P 500 (including ETFs) as soon as practicable.
At Chairman Schapiro's request, the SEC staff also will:
- Consider ways to address the risks of market orders and their potential to contribute to sudden price moves.
- Consider steps to deter or prohibit the use by market makers of "stub" quotes, which are not intended to indicate actual trading interest.
- Study the impact of other trading protocols at the exchanges, including the use of trading pauses and self-help rules.
- Continue to work with the exchanges and FINRA to improve the process for breaking erroneous trades, by assuring speed and consistency across markets.
SEC staff is working with the markets to consider recalibrating market-wide circuit breakers currently on the books — none of which were triggered on May 6. These circuit breakers apply across all equity trading venues and the futures markets.
Jack's comment: When the market is getting more "emotional", the circuit breaker may be an effective way to let investors cool down, especially if the emotion is triggered by error or manipulative orders.
