According to several news sources, the Securities and Exchange Commission plans to expand its New York office by about 8 percent this year as the financial regulator focuses more heavily on regulating hedge funds and brokerages.

The SEC stated that it plans to hire 18 people on the enforcement side, where it currently employs about 150 people in New York, and add 15 people to its examinations staff, which currently numbers about 210 in New York. Read more

A federal bankruptcy judge in Manhattan on March 1, 2010, agreed with the trustee trying to recoup money for victims of Bernard Madoff’s multibillion dollar Ponzi Scheme.

U.S. Bankruptcy Judge Burton Lifland ruled that trustee Irving Picard is correct in denying claims from investors who profited from Madoff’s scheme.

Picard argued that only the “net losers” — those who deposited more into their account than they took out — should be reimbursed, while “net winners” — those who made money on the fraud — should not recover anything.      The recent ruling is a defeat for Madoff investors who withdrew more from their Madoff accounts than they put in.

Lifland wrote in his ruling, “while the court recognizes that the outcome of this dispute will inevitably be unpalatable to one party or another, notions of fairness and the need for practicality also support” Picard’s method of determining claims.

Lifland also said “the plain meaning and legislative history” of the law allowed Picard to deduct withdrawals from cash deposits in determining who gets what.    “Because securities positions are in fact nonexistent, the trustee cannot discharge claims upon the false premise that customers’ securities positions are what the account statements purport them to be,” the judge ruled.

Picard’s methodology was backed by Madoff’s less fortunate victims, the so-called net losers, who stood to receive much less if the net-winners were included in the pool, as well as the Securities and Exchange Commission.

According to several sources, companies with a listing in Japan will have to disclose more information about their corporate governance practices and how much they pay directors under plans released by the country’s Financial Services Agency (FSA).

The new disclosures rules are aimed at giving investors more of the information they need to hold companies to account. Currently, Japanese companies are allowed to withhold information that is taken for granted in the United States.

Companies will have to reveal the names of any directors earning more than Y100 million ($1 million) and give a breakdown showing salary, bonus, stock options, and pension payments. The same applies to “statutory auditors,” who are the Japanese equivalent of non-executive or supervisory directors.

Companies will also have to disclose the roles of their independent directors, whether they have any financial or accounting expertise, and the details of their relationship with the company’s internal audit function.

The FSA also wants to make companies report more about the outcome of resolutions put to their annual shareholder meetings. Currently, Japanese companies only have to report if a resolution was passed or not. In the future, they will have to reveal the number of votes cast for or against and the number of votes withheld.

The FSA stated that more detailed voting disclosures, “will give a clearer picture of the decisions made by shareholders, which will entail a better functioning of the market pressure over the management.”

The proposals are subject to consultation until March 15 and will take effect on March 31.

According to various sources, Manhattan federal court Judge Jed Rakoff, said on Friday that he would consider postponing the case against Rajaratnam and New Castle Partners founder Danielle Chiesi until after the related criminal trial, which begins in October 25^th, 2010.

Rakoff had previously described the August 2^nd, 2010 start date of his trial as “firm and fixed.”   However, he did not did not indicate at a court hearing when he would rule to set the new date for civil trial.   U.S. prosecutors, lawyers for the SEC and defendants are all in favor of the criminal trial going ahead first.

Usually, when there are parallel cases brought by criminal prosecutors and the SEC, the criminal case takes precedence.   However, Rakoff quickly set a civil trial date and denied initial requests to wait for resolution of the criminal matter.

U.S. prosecutors have described the case of Galleon Group founder Raj Rajaratnam as the biggest-ever U.S. hedge fund insider-trading scandal.   More than 20 traders, lawyers, executives and firms have been charged in a probe that stretched from Wall Street to Silicon Valley.

Rajaratnam is accused of making as much as $49 million in illegal profits between 2003 and 2009 on tips he received from business associates and friends on forthcoming mergers and acquisitions.

The cases are USA v Raj Rajaratnam et al, U.S. District Court for the Southern District of New York, No. 09-01184 and SEC v Galleon Management et al, No. 09-08811

According to various news sources, the Securities Exchange and Commission will consider new short sale restrictions at an open meeting next week.

The SEC is expected to meet on Wednesday, February 24^th2010, to vote on rules that would restrict short selling in a company’s stock if that stock fell by more than a certain percentage, such as 10 percent.

Lawmakers and bank executives blamed short selling for contributing to the downfall of Lehman Brothers and Bear Stearns.   As the result, the SEC proposed a number of measures last year to restrict short selling, where investors bet the stock’s price will fall.   The SEC proposed restrictions that would apply across equity markets as well as curbs that would only apply if a stock fell precipitously.

One proposal was to bring back a version of the uptick rule — a curb that was first adopted after the 1929 market crash.   The SEC abolished the uptick rule in 2007 after concluding that it was no longer effective in modern markets.

According to sources familiar with the SEC plan, the agency is expected to consider a “circuit breaker” measure that would trigger a so-called passive bid test.   A passive bid test would only allow short selling above the national best bid.    Any new rule needs the approval of the majority of the five SEC commissioners.   The two Republican commissioners are not expected to vote in favor of the short sale restrictions.

The Financial Industry Regulatory Authority (FINRA) released Regulatory Notice 10-06, which serves as a guidance to members regarding the use of social networking websites such as Facebook, Twitter, LinkedIn and Facebook, in addition to blogs, to communicate with the public.     

The goal is to urge firms to develop customized policies and procedures for blogging and social networking, and to ensure that investors are protected from false or misleading claims posted on any social networking sites.    Further, FINRA’s guidance clarifies the responsibilities of firms to supervise the use of social networking sites to ensure that recommendations are suitable and their customers are not misled.   The guidance also addresses recordkeeping and other responsibilities of firms.

Some of the recommendations provided by FINRA include:

• Retain records of communications related to the business made through social media sites;
• NASD Rule 2310 may be triggered if a firm recommends a security through a social media site, depending on the facts and circumstances surrounding the recommendation;
• Firms should consider prohibiting all interactive electronic communications that recommend a specific investment product and any link to such a recommendation, unless a registered principal has previously approved it;
• Firms may also want to maintain a database of previously approved communications;
• Static blog postings are considered advertisements under NASD Rule 2210;
• If the blog includes real-time interactive communications it is considered to be an electronic forum that does not require prior principal approval, but must be supervised;
• Firms must supervise communications on social networking sites under NASD Rule 3010 in a manner that ensures compliance with FINRA’s communication rules; FINRA’s Regulatory Notice 07-59 provides further guidance on supervisory procedures;
• Generally, FINRA does not treat posts by customers or other third parties as the firm’s communication with the public subject to NASD Rule 2210.  However, third-party posts are attributable to the firm if the firm has involved itself in preparing the content or the firm explicitly or implicitly endorses or approved the content.

FINRA says that each firm must develop its own policies and procedures, designed to ensure that the firm and its personnel are complying with all applicable regulatory requirements when using social networking sites.

Some technology providers are developing systems intended to enable firms to retain records of communications made through social networking sites.   In its release, FINRA said it “does not endorse any particular technology to keep such records, nor are we certain that adequate technology currently exists.”

President Barack Obama is seeking a 12% budget increase for the Securities and Exchange Commission. 

The request to Congress includes nearly $1.3 billion for the SEC in the budget year starting October 1, 2010.    This proposal would allow for 390 hires, which would increase total staff to 4,190 from the current 3,800 at the traditionally low-profile agency, which was heavily criticized in the aftermath of the Madoff’s Ponzi scheme.   This proposal would also include $419 million for more than 100 new enforcement staff to work on the agency’s growing cases on fraud and market manipulation.

With the hires, the SEC estimates it could start 75 additional inquiries, conduct 314 additional formal investigations, file charges in 70 additional civil or administrative cases and conduct 50 additional exams of investment advisors, 25 additional mutual fund exams and 75 examinations of newly registered fund advisors. 

Of the roughly $1.3 billion requested for the SEC, $24 million is tied to the enactment by Congress of a sweeping overhaul of financial regulation. The overhaul would give the SEC new oversight of hedge funds and derivatives, the complex instruments widely blamed for hastening the crisis in the fall of 2008.

The SEC derives its funding from fees that companies pay to register new stock – an estimated $1.7 billion in the 2011 budget year – but the agency is subject to the congressional budget process in the same way as other federal departments.

The 12 percent budget increase for the SEC is significant because the administration’s record $3.83 trillion budget proposes spending cuts in some programs outside of defense and homeland security in order to keep overall non-defense spending frozen for three years. 

It was the first budget proposed for the agency under SEC Chairman Mary Schapiro, who led the agency through its most expansive restructuring in at least 30 years.   “If enacted, the president’s request will do a great deal to help the SEC keep pace with the continuing growth of the markets and provide necessary resources to support important regulatory initiatives in 2011”  Schapiro noted.

The Securities and Exchange Commission made substantial changes in liquidity and disclosure requirements of money-market funds.   The new rules require money-market mutual funds hold some assets that could be easily converted to cash and to disclose new information on fund values.   The goal is to strengthen protection for investors in money-market funds, which hold about $3.2 trillion in assets.

Money-market funds are open ended mutual funds that invest in short term debt securities, holding themselves out as safe and easily accessible investments that offer returns above conventional savings accounts.   Money market funds seek to limit exposure to losses due to credit, market and liquidity risks.   They generally invest in the safest types of debt such as Treasury bonds, while so-called prime money-market funds seek slightly higher yields but accept marginal risk by venturing into short-term corporate bonds.

In September 2008, the Primary Reserve Fund undermined safety of the trillions held in the money funds by “breaking of the buck.”   Within few days, the value of the Reserve Primary Fund’s assets fell to 97 cents per investor dollar — below the dollar-for-dollar level needed for full repayment.   Investors pulled out around $300 billion from prime money funds, representing 14 percent of the assets in those funds.    The SEC’s current decision came in response to this event that exposed investors to enormous losses.

The SEC new rules make substantial changes in liquidity and disclosure requirements.    The new liquidity rules require all money market funds to hold at least 10 percent of their assets in cash, Treasury bonds or other instruments could be sold for cash within a day.   Currently, there are no such liquidity requirements and the change would make it easier for investors to redeem their money from the funds in case of increased demand.   At least 30 percent of funds’ assets will have to be convertible to cash within a week.   In addition, the maximum average maturity of bonds in which money funds can invest will be shortened to 60 days from the current 90 days. Read more

President Barack Obama’s plan to limit the size of banks and prohibit them from investing in hedge funds and private equity funds is a new way to reduce risk-taking and prevent a repeat of the credit crisis.  

Under new rules bank holding companies would be barred from owning, investing in or sponsoring hedge funds and private equity funds.   They would also be prohibited from proprietary trading which has been a huge source of profits for Wall Street firms in recent years.    The new rules would also further curtail consolidation in the financial services sector, putting stricter limits on a firm’s market share of liabilities.

The new proposed plan to restrict the activities of commercial banks could have a significant impact on private equity and the hedge fund industry.   While banks have cut back on their own private equity businesses in recent years, some remain very active.    According to JPMorgan Chase & Co. analysts, this plan will cost Goldman Sachs Group Inc., Morgan Stanley, Credit Suisse Group AG, UBS AG and Deutsche Bank AG about $13 billion in revenue next year.   Of the five banks analyzed, Obama’s proposals will impact Goldman Sachs the most, resulting in an estimated $4.67 billion drop in earnings in 2011.   UBS stands to lose the least, Credit Suisse Group AG with revenue declining an estimated $1.92 billion. Read more

This has been a very busy week at the Securities and Exchange Commission.    Major happenings from this week include:    

First, the SEC Commissioner Mary Schapiro testified before the Financial Crisis Inquiry Commission on her views about the causes of the recent financial crisis.   In summary, Schapiro said the crisis resulted from “many interconnected and mutually reinforcing causes.”   These causes include the rise of mortgage securitization, the resulting weaker underwriting standards and excessive reliance on credit ratings by investors.    In addition, Schapiro noted that a general belief that markets were self-correcting and an underestimation of the risk resulted in weaker regulatory standards in some areas.   Schapiro also discussed other contributing causes, such as, the creation of complex financial products that weren’t fully understood, incentives in compensation arrangements that encouraged significant risk, insufficient risk management by companies involved in marketing and purchasing complex financial products.   Nonetheless, Schapiro admitted that the SEC has not performed up to expectations recently and she mapped out the agency’s recent efforts to revitalize itself. Read more

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