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Archive for March, 2016

Seadrill Ltd. Class Actions Combine Their Stock and Options Claims

A Manhattan federal judge on Tuesday consolidated three fraud class action suits claiming Bermuda-based Seadrill Ltd. misled investors with vows to preserve its chunky dividend payments, adding to the original stock-purchasing plaintiffs a new universe of claimants who bought options in the offshore drilling giant.

U.S. District Judge Lorna G. Schofield’s move set up a potential squabble over which plaintiff would lead.

Plaintiffs including Issek Fuchs sued in December, on behalf of stock purchasers who saw Seadrill’s share value drop after the company announced in November that it would suspend dividends. Stock-purchase plaintiff Ron Heron followed with a suit in January. Then in March, plaintiff Sheldon Glow sued on behalf of stock and options investors.

Judge Schofield said Tuesday that “there is a basis to consolidate.” She called for a new round of notice to potential class members to clarify that options claims were in play. She also called for briefing on how to select a lead plaintiff or whether to potentially select two leads — one for buyers of Seadrill’s U.S.-traded equity and another for options traders.

Seadrill’s counsel said Tuesday it would respond after consolidation was complete.

The company “shocked the market” on Nov. 26, when it disclosed that it would be suspending its annual $4-per-share dividend, causing the price of its American depository receipts to plunge that day from $20.71 to $15.19.

That big miss came after Seadrill’s summer 2014 statements that the company was “in the best possible financial situation” and enjoyed “significant flexibility to support the dividend,” the plaintiffs claim.

On raising its quarterly dividend from $0.98 to $1 per share in May 2014, Seadrill had called the move “sustainable in the coming years,” the suits say.

But Seadrill management knew its statements were materially false and misleading, the plaintiffs allege.

Wedbush Securities Inc. fined $675,000 For Supervisory Violations

The Financial Industry Regulatory Authority (FINRA) and The Nasdaq Stock Market LLC (Nasdaq) announced today that they jointly censured and fined Wedbush Securities Inc. $675,000 for supervisory violations in connection with its handling of a client’s redemption activity and trading of leveraged exchange-traded funds (ETFs) that led to chronic fails to deliver in several ETFs for over two years.

Wedbush served as the clearing firm for its broker-dealer customer, Scout Trading, LLC, and acted as an Authorized Participant of various ETFs. This enabled Wedbush to submit redemption/creation orders on Scout Trading’s behalf and on behalf of its other clients. From January 2010 to March 2012, Scout Trading routinely submitted “naked” redemption orders in ETFs to Wedbush, meaning Scout Trading was insufficiently long in the ETF shares comprising the redemption orders. During the review period, Scout Trading submitted at least 255 naked redemption orders through Wedbush in 11 ETFs, totaling over 295 million shares. This naked redemption activity, along with short selling of the ETFs on the secondary market by Scout Trading, resulted in substantial, repeated fails to deliver by Wedbush. Scout Trading submitted creation orders, used to create new shares of the ETFs, through Wedbush to close out the fails to deliver; however, Scout Trading, shortly thereafter, submitted further naked redemption orders, or engaged in additional secondary market selling activity in the ETFs, through or with the assistance of Wedbush, that led to fails to deliver redeveloping at Wedbush. This pattern of naked redemption orders followed by creation orders resulted in persistent and sustained fails to deliver at Wedbush, and was profitable but impermissible.

Wedbush repeatedly effectuated Scout Trading’s ETF orders without first ascertaining whether Scout Trading owned, or had full legal and beneficial right to tender for redemption, the requisite number of ETF shares associated with its orders, contrary to its obligations as an Authorized Participant, and without taking sufficient follow-up actions concerning Scout Trading’s systemic and cyclical fails to deliver. As such, Wedbush failed to observe high standards of commercial honor and just and equitable principles of trade, and failed to meet its supervisory obligations to ensure that its activities as an Authorized Participant, including its processing of ETF orders, complied with applicable securities laws and regulations.

Thomas Gira, FINRA Executive Vice President and Head of Market Regulation, said, “Timely delivery of securities is a critical component of sales activity in the markets, particularly in ETFs that rely on the creation and redemption process. Naked trading strategies that result in a pattern of systemic and recurring fails flout such principle and do not comply with Regulation SHO. Authorized Participants and their broker-dealer clients need to have adequate supervisory procedures and controls in place to ensure that they are properly redeeming and creating shares of ETFs.”

John Zecca, Senior Vice President of Market Regulation for Nasdaq’s U.S. Markets, continued, “Authorized Participants, as gatekeepers and conduits to the primary ETF markets, play vital roles in ensuring they carry out their obligations consistent with applicable securities laws and do not become a vehicle for misconduct. We will continue to monitor firms for adherence to Regulation SHO and adequate supervisory systems to ensure such compliance.”

In concluding this settlement, Wedbush neither admitted nor denied the charges, but consented to the entry of FINRA’s findings. Scout Trading, which was a member of Nasdaq but not FINRA, was the subject of a separate Nasdaq disciplinary proceeding on April 7, 2015, in which it consented, without admitting or denying the charges, to the entry of findings by Nasdaq that Scout Trading violated Rule 204 of Regulation SHO and Nasdaq’s requirements that pertain to supervision and just and equitable principles of trade. That settlement resulted in a censure and $3 million fine against Scout Trading, a former Nasdaq member.

Linn Energy Bankruptcy May Be Unavoidable, Investor Losses Loom

Linn Energy LLC warned Tuesday that a chapter 11 bankruptcy filing may be “unavoidable” for the oil and gas producer.

The company said it has hired financial and legal advisers “to address our liquidity and capital structure, including strategic and refinancing alternatives through a private restructuring,” but added that bankruptcy may be its only option.

The warning in the company’s financial statement came alongside an announcement that it would skip $60 million in interest payments on bonds maturing in 2021 and 2022 and would enter a 30-day grace period. If the interest isn’t paid within the grace period, Linn could trigger a default.

Asset Allocation Losses – Striking the Right Balance

An prudent investment strategy starts with an asset allocation suitable for the portfolio’s objective.

The allocation should be built upon reasonable expectations for risk and returns, and should use diversified investments to avoid exposure to unnecessary risks.

Both asset allocation and diversification are rooted in the idea of balance. Because all investments involve risk, investors must manage the balance between risk and potential reward through the choice of portfolio holdings.

When building a portfolio to meet a specific objective, it is critical to select a combination of assets that offers the best chance for meeting that objective, subject to the investor’s constraints.1 Assuming that the investor uses broadly diversified holdings, the mixture of those assets will determine both the returns and the variability of returns for the aggregate portfolio.

This has been well documented in theory and in practice. For example, in a paper confirming the seminal 1986 study by Brinson, Hood, and Beebower, Wallick et al. (2012) showed that the asset allocation decision was responsible for 88% of a diversified portfolio’s return patterns over time:

Investment outcomes are largely determined by the long-term mixture of assets in a portfolio.

Asset allocation chart

Note: Calculations are based on monthly returns for 518 U.S. balanced funds from January 1962 through December 2011. For details of the methodology, see the Vanguard research paper The Global Case for Strategic Asset Allocation (Wallick et al., 2012).

Many investors use asset allocation as a way to diversify their investments among asset categories. By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can protect against significant losses. Historically, the returns of the three major asset categories have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you’ll reduce the risk that you’ll lose money and your portfolio’s overall investment returns will have a smoother ride. If one asset category’s investment return falls, you’ll be in a position to counteract your losses in that asset category with better investment returns in another asset category.

Kenneth Bolton and Sandlapper Complaints

Kenneth Bolton, a current broker-dealer at Sandlapper Securities in Greenville, South Carolina. According to his Financial Industry Regulatory Authority (FINRA) BrokerCheck, Bolton allegedly breached fiduciary duty, misrepresented and omitted material facts, recommended unsuitable investments, and executed unauthorized trades, among other transgressions. Bolton was registered with the following firms: American Eagle Securities, First Investors Corporation, E.F. Hutton & Co., Oppenheimer & Co., Shearson Lehman Hutton, Smith Barney, Reich & Co., Fahnestock & Co., First Montauk Securities and National Securities Corp. He is currently registered with Sandlapper in Greenville, South Carolina and has been since December 2011. He has 10 customer disputes against him.

SEC Charges Rhode Island Agency and Wells Fargo With Fraud in 38 Studios Bond Offering

The Securities and Exchange Commission today charged a Rhode Island agency and its bond underwriter Wells Fargo Securities with defrauding investors in a municipal bond offering to finance startup video game company 38 Studios.

The Rhode Island Economic Development Corporation (RIEDC, now called the Rhode Island Commerce Corporation) issued $75 million in bonds for the 38 Studios project as part of a state government program intended to spur economic development and increase employment opportunities by loaning bond proceeds to private companies.

According to the SEC’s complaint filed in federal district court in Providence:

  • The RIEDC loaned $50 million in bond proceeds to 38 Studios.  Remaining proceeds were used to pay related bond offering expenses and establish a reserve fund and a capitalized interest fund.
  • The loan and, in turn, bond investors would be repaid from revenues generated by video games that 38 Studios planned to develop.
  • The bond offering document produced by the RIEDC and Wells Fargo failed to disclose to investors that 38 Studios had conveyed it needed at least $75 million in funding to produce a particular video game.
  • Therefore, investors weren’t fully informed when deciding to purchase the bonds that 38 Studios faced a funding shortfall even with the loan proceeds and could not develop the video game without additional sources of financing.
  • When 38 Studios was later unable to obtain additional financing, the video game didn’t materialize and the company defaulted on the loan.

“Municipal issuers and underwriters must provide investors with a clear-eyed view of the risks involved in an economic development project being financed through bond offerings,” said Andrew Ceresney, Director of the SEC Enforcement Division. “We allege that the RIEDC and Wells Fargo knew that 38 Studios needed an additional $25 million to fund the project yet failed to pass that material information along to bond investors, who were denied a complete financial picture.”

The SEC also charged Wells Fargo’s lead banker on the deal, Peter M. Cannava, and two then-RIEDC executives Keith W. Stokes and James Michael Saul with aiding and abetting the fraud.  Stokes and Saul agreed to settle the charges without admitting or denying the allegations and must each pay a $25,000 penalty.  They are prohibited from participating in any future municipal securities offerings.  The SEC’s litigation continues against Cannava, Wells Fargo, and RIEDC.

The SEC’s complaint further alleges that Wells Fargo and Cannava misled investors in an additional way in bond offering materials:

  • Wells Fargo disclosed its bond offering compensation as a share of the placement agent fee plus a $50,000 payment from 38 Studios.  No other fees or compensation to Wells Fargo were disclosed, and the bond placement agreement stated that no other money was anticipated.
  • Investors weren’t informed that Wells Fargo had a side deal with 38 Studios that enabled the firm to receive nearly double the amount of compensation disclosed in offering documents.
  • This additional compensation, totaling $400,000 and paid from bond proceeds, created a conflict of interest that Wells Fargo should have disclosed to bond investors.
  • Cannava was responsible for Wells Fargo’s failure to disclose its additional fees.

“An underwriter’s ‘skin in the game’ is material information to investors,” said LeeAnn Ghazil Gaunt, Chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit.  “We allege that Wells Fargo failed to fully disclose its own economic interest in this bond transaction.”

The SEC’s complaint charges the RIEDC and Wells Fargo with violations of Sections 17(a)(2) and (a)(3) of the Securities Act of 1933, and charges Stokes, Saul, and Cannava with aiding and abetting those violations.  Wells Fargo also is charged with violations of Section 15B(c)(1) of the Securities Exchange Act of 1934 and Rules G-17 and G-32 of the Municipal Securities Rulemaking Board (MSRB).  Cannava is charged with aiding and abetting those violations.

In a separate administrative proceeding, the RIEDC’s financial advisor for the bond offering – First Southwest Company LLC – agreed to settle charges that it violated MSRB rules by failing to document in writing the scope of the services the firm was providing in the bond offering until seven months after the financial advisory relationship began.  Without admitting or denying the findings, First Southwest agreed to pay disgorgement of $120,000, prejudgment interest of $22,400, and a penalty of $50,000.

Wave of US oil bond defaults to come

Energy XXI Ltd. and SandRidge Energy Inc., oil and gas drillers with a combined $7.6 billion of debt, didn’t pay interest on their bonds last week. They have until the middle of next month to either pay the interest, work out a deal with their creditors or face a default that could tip them into bankruptcy.

If the two companies fail in March, it would be the biggest cluster of oil and gas defaults in a month since energy prices plunged in early 2015.
The U.S. shale boom was fueled by junk debt. Companies spent more on drilling than they earned selling oil and gas, plugging the difference with other peoples’ money. Drillers piled up a staggering $237 billion of borrowings at the end of September, according to data compiled on the 61 companies in the Bloomberg Intelligence index of North American independent oil and gas producers. U.S. crude production soared to its highest in more than three decades.

Oil prices have now fallen more than 70 percent from a 2014 peak, and banks and bondholders are fighting for scraps. Bond prices reflect investors’ fears. U.S. high-yield energy debt lost 24 percent last year, the biggest fall since 2008, according to Bank of America Merrill Lynch U.S. High Yield Indexes. Investors are now demanding a yield of 19.3 percent to hold U.S. junk-rated energy bonds, after borrowing costs for these companies exceeded 20 percent for the first time ever this month, according to data compiled by Bank of America Merrill Lynch.

 Both Energy XXI and SandRidge could still reach an agreement with creditors that will give them time to turn their businesses around. SandRidge said last week that it missed a $21.7 million interest payment. The company owes $4.2 billion, including a fully-drawn $500 million credit line. Energy XXI, which owes $3.4 billion, said in a filing last week that it missed an $8.8 million interest payment.

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