By Jan Larsen with Dr. Elaine Buckberg and Dr. Baruch Lev*

Overview

The Securities and Exchange Commission (SEC) settled with 205 defendants in its first quarter of fiscal year 2010, compared to 181 in the previous quarter and 123 in the first fiscal quarter of 2009.1,2 The increase in the number of settlements is particularly notable given that the first quarter is not typically one of the more active times for SEC settlements. Indeed, since the 2002 passage of the Sarbanes Oxley Act ("SOX"), the first quarter of the year has, on average, seen the fewest number of settlements, while the fourth quarter has seen the most.3 Furthermore, since SOX, the only other fiscal year in which the number of settlements in the first quarter exceeded that in the prior quarter was 2007.

Although large in number, settlements in the first fiscal quarter were generally modest in amount. Both the average and median settlement were lower than for fiscal year 2009 as a whole. The average settlement for companies whose settlement included a monetary payment was $4.7 million, compared to $10.8 million over the course of the SEC's fiscal year 2009 (FY09). The median company settlement in the fiscal first quarter was $0.4 million, compared to $1 million in FY09.

Settlement Activity

The 10 largest settlements of the first fiscal quarter of 2010 are detailed in Exhibit 1.

The largest settlement in the quarter was the $43.7 million settlement with Value Line, Inc. Value Line was accused of misappropriating assets from mutual funds that it advised. Specifically, the SEC alleged that Value Line obtained discounted trade commissions from certain brokerage firms, but failed to pass these negotiated discounts through to the funds, instead retaining the difference between the full and discounted commission. The SEC further alleged that Value Line traders were instructed to direct a fixed percentage of trades, of as much as 70%, to the brokers offering these discounts, rather than selecting brokers based solely on their ability to provide best execution. In addition, the SEC alleged that Value Line made misleading disclosures to fund shareholders about the commission arrangements.

The second-largest settlement was the $25.0 million settlement4 with JP Morgan Securities Inc. for alleged undisclosed payments made to friends and political allies of Jefferson County, Alabama officials, for the purpose of obtaining business with the municipality. The SEC alleges that more than $8.2 million of undisclosed payments were made, and that in exchange JP Morgan was selected as an underwriter for bonds with total face value of $3 billion and was selected as the counterparty on interest rate swaps with total notional amounts of $2 billion. According to the SEC, the recipients of the payments were mostly local broker-dealers who were unable to take on the business themselves under Alabama law. Some of the payments were allegedly incorporated into the swap rates that JP Morgan charged Jefferson County. In addition to the $25 million payment to the SEC, JP Morgan agreed to pay $50 million to Jefferson County as part of its settlement.

The third-largest settlement was the $25.0 million settlement with ICAP Securities USA LLC, which came in only $1 under the JP Morgan settlement. The ICAP case concerned alleged deceptive practices on its US Treasury bond and mortgage-backed securities trading desks. The US Treasury bond desk was accused of displaying fictitious "flash" trades, causing ICAP's customers to believe fictitious trades were actual traded levels and that ICAP was brokering more trades than was actually the case. In addition, the mortgage-backed securities desk was accused of engaging in undisclosed proprietary trading, contrary to its representations that it served as a "riskless principal" between customer trades.

Trends In Settlement Values

Monetary payments were a component of 41% of company settlements and 58% of individual settlements in the first fiscal quarter. The proportion of company settlements that included a monetary payment was the third-lowest in any quarter since the passage of SOX and well below the 56% rate for 4Q02 through 4Q09 (Exhibit 2). For individuals, however, the proportion of settlements that included a payment was consistent with recent levels.

Among companies whose settlements included a monetary payment, both the average and median settlement amount for the quarter declined compared to FY09 (Exhibit 3). In fact, the median company settlement of $0.4 million was the fourth lowest of any quarter since the passage of SOX, and the $4.7 million average was the fifth lowest average over the same period.

For individuals whose settlements included a monetary payment, the median settlement amount was approximately $120,000. By way of comparison, since FY03, the annual median settlement with individuals has ranged from $100,000 to $133,000. The average settlement with individuals was $730,000 in the quarter, compared to a range of annual average individual settlements of $1.0 million to $3.7 million since FY03.5

Conclusion

The increase in the number of settlements in the first fiscal quarter of 2010 may signal increased enforcement and a higher rate of settlements going forward. The increase is composed of relatively low-value settlements and includes a relatively high proportion of company settlements without any monetary payment. This may indicate that the SEC is pursuing all infractions of the securities laws, or it may represent a one-time "clearing out" of relatively minor cases.

We will continue monitoring these trends in this series of reports. For additional information, please visit www.securitieslitigationtrends.com.

Footnotes

* Mr. Larsen is a Consultant at NERA; Dr. Buckberg is a Senior Vice President at NERA; and Dr. Lev is the Director of the Vincent C. Ross Institute of Accounting Research and the Philip Bardes Professor of Accounting and Finance at New York University Stern School of Business, and a Special Consultant to NERA. The authors thank Ashley Hartman and Eric Schmitt for excellent research assistance and Pat Conroy for valuable comments and suggestions.

1. There are certain types of settlements that do not meet the criteria for inclusion in our analysis. These include settlements relating to failure to file periodic financial statements with the SEC, administrative proceedings barring accountants because of felony convictions, and administrative proceedings barring brokers, dealers, and accountants for practicing while unregistered.

2. The SEC's fiscal year ends on September 30. We therefore assume that the first fiscal quarter runs from October 1 to December 31.

3. The difference in the average number of first and fourth quarter settlements, however, is not statistically significant.

4. The settlement consisted of $25 million in civil penalties and disgorgement of $1. The disgorgement amount triggered the Fair Funds provision of SOX, which allows the SEC to distribute the entire settlement amount to parties it finds were harmed by the alleged fraud.

5. Average individual settlement statistics in this paragraph are rounded to the nearest thousand.

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