Answers to Frequently Asked Investor Questions Regarding the Bear Stearns Companies, Inc.
On March 18, the staff of the Securities and Exchange Commission issued the following answers to frequently asked questions from investors regarding The Bear Stearns Companies, Inc. (Bear Stearns).
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What protects customer funds and securities at broker-dealers?
Bear Stearns' corporate structure includes several broker-dealers registered with the SEC. As a result, notwithstanding the loss in market value in Bear Stearns' stock, and independent of the transaction announced on March 17, many protections remain in place for customers of Bear Stearns' broker-dealers.
Under SEC rules, registered broker-dealers must maintain net capital to provide financial resources so that if the firm fails, customers will get their cash and securities back. Customer claims for their funds and securities are preferred over other claims on the broker-dealer. As a second level of protection, the Securities Investor Protection Corporation (SIPC) guarantees remaining customer securities claims up to $500,000.
In addition to the protection provided by the net capital rule and SIPC, registered broker-dealers must segregate customer funds and fully paid securities from the brokers' own proprietary funds and securities. Thus, customer money and the firm's money are kept separate, protecting customers from trading losses of the firm.
Was Bear Stearns in compliance with applicable capital and liquidity requirements?
According to Bear Stearns' reports to the SEC, Bear Stearns' broker-dealers were in compliance with the SEC's capital and customer protection rules. The SEC also supervises the Bear Stearns parent company, whose capital also exceeded relevant regulatory standards, and whose liquidity position had been relatively stable, ranging between $15 and $20 billion in the weeks preceding March 11. As of the morning of Tuesday, March 11, the parent company had over $17 billion in cash and unencumbered liquid assets.
What is the difference between capital and liquidity pools?
It is important to realize capital is not synonymous with liquidity. A firm can be highly capitalized, that is, can have more assets than liabilities, but can have liquidity problems if the assets cannot quickly be sold for cash or alternative sources of liquidity, including credit, obtained to meet other demands. While the ability of a securities firm to withstand market, credit, and other types of stress events is linked to the amount of capital the firm possesses, the firm also needs sufficient liquid assets, such as cash and U.S. Treasury securities, to meet its financial obligations as they arise.
Accordingly, large securities firms must maintain a minimum level of liquidity in the holding company. This liquidity is intended to address pressing needs for funds across the firm. This liquidity consists of cash and highly liquid securities for the parent company to use without restriction.
Why was Bear Stearns' loss of credit so critical to its ongoing viability?
In accordance with customary industry practice, Bear Stearns relied day-to-day on its ability to obtain short-term financing through borrowing on a secured basis. Although Bear Stearns continued to have high quality collateral to provide as security for borrowings, as concerns grew late in the week, market counterparties became less willing to enter into collateralized funding arrangements with Bear Stearns.
Late Monday, March 10, rumors spread about liquidity problems at Bear Stearns, which eroded investor confidence in the firm. Bear Stearns' counterparties became concerned, and a crisis of confidence occurred late in the week. In particular, counterparties to Bear Stearns were unwilling to make secured funding available to Bear Stearns on customary terms.
This unwillingness to fund on a secured basis placed stress on the liquidity of the firm. On Tuesday, March 11, the holding company liquidity pool declined from $18.1 billion to $11.5 billion. On Wednesday, March 12, Bear Stearns' liquidity pool actually increased by $900 million to a total of $12.4 billion. On Thursday, March 13, however, Bear Stearns' liquidity pool fell sharply, and continued to fall on Friday.
Did the SEC staff play any role in the Bear Stearns/JPMorgan transaction?
During discussions of the possible transaction, SEC officials were in close contact with officials of the Board of Governors of the Federal Reserve System and the Department of the Treasury as well as representatives of JPMorgan Chase & Co. (JPMorgan) and Bear Stearns. To assist in advancing a possible transaction, the SEC staff was able to provide several letters clarifying the staff's position on certain matters connected with the merger.
The Division of Trading and Markets wrote a letter addressing the timing of JPMorgan's filing of a Form BD with the SEC. Form BD is required to be filed "promptly" after a registered broker-dealer is acquired by another firm. The staff's letter states that it would be acceptable if JPMorgan filed a completed Form BD a reasonable period after the merger closes.
The Division of Investment Management wrote two letters concerning issues under the Investment Company Act and Investment Advisers Act arising out of the change in control of investment advisers affiliated with Bear Stearns. One letter addresses approvals by the mutual funds advised by the Bear Stearns advisers of new advisory contracts between the funds and the advisers. The other letter provides temporary, conditional relief from restrictions on principal transactions between the Bear Stearns advisers and clients of investment advisers affiliated with JP Morgan and transactions between the JP Morgan advisers and clients of the Bear Stearns advisers.
The Division of Enforcement wrote a letter concerning investigations and potential future inquiries into conduct and statements by Bear Stearns before the public announcement of the transaction with JPMorgan. The staff declined to provide assurances about possible future enforcement actions. The letter states that reaching conclusions about those inquiries would be premature. In the letter, the Division confirmed that, consistent with prior statements and guidance by the SEC, the staff would favorably take into account the circumstances of the JPMorgan acquisition of Bear Stearns when considering whether to recommend enforcement action against JPMorgan arising out of statements made by Bear Stearns in the 60 days before the public announcement of the merger.
The Division of Corporation Finance wrote a letter addressing sales by client accounts managed by JPMorgan and Bear Stearns of the other firm's securities, in view of the control relationship created by the merger agreement. The letter states that these sales may occur temporarily without registration under the Securities Act or compliance with Securities Act Rule 144 in certain limited circumstances.
Does the SEC bring enforcement actions in circumstances like these?
The Division of Enforcement investigates possible violations of the securities laws as appropriate. Among the things the Division looks for are potential indications of insider trading or manipulation of markets through the dissemination of false or misleading information to investors by companies or other market participants. The SEC brings enforcement actions when it concludes the securities laws have been violated.
These answers to frequently asked questions were prepared by the SEC's Office of Investor Education and Advocacy, Division of Enforcement, Division of Trading and Markets, Division of Investment Management, Division of Corporation Finance, and Office of the General Counsel. (Press Rel. 2008-46)
Stock Promoter Receives 10-Year Sentence for Orchestrating Spam-Fueled Pump-and-Dumps of Unregistered Offerings
The Commission today announced that on March 14, Michael Saquella, a.k.a. Michael Paloma, was sentenced to serve ten years in federal prison consisting of 60 months for conspiracy to commit securities fraud and 60 months for conspiracy to commit electronic mail fraud. Paloma was also ordered to pay restitution to the victims of his crime in the amount $7,806,303.58.
On Aug. 20, 2007, Paloma pleaded guilty to one count of conspiracy to commit securities fraud and one count of electronic mail fraud. The criminal case was prosecuted by the U.S. Attorney's Office for the Eastern District of Virginia.
In a related case, on Sept. 17, 2007, the Commission filed a complaint in U.S. District Court for the Eastern District of Virginia, alleging that, over the past four years, Paloma repeatedly passed himself off to principals of private, cash-strapped companies as a legitimate financier, persuading company principals to issue to Paloma-affiliated entities large controlling blocks of stock, which were then resold in unlawful public offerings.
According to the Commission's complaint, Paloma surreptitiously gained control of the company's shares by convincing management to issue large blocks of stock to one or more entities he controlled. These issuances, purportedly made under federal registration exemptions to "accredited investors," were part of a plan to circumvent the registration requirements of the federal securities laws. In furtherance of this plan, Paloma obtained bogus opinions of counsel that permitted transfer agents to issue share certificates to his entities free of legends restricting resale. In fact, the entities Paloma controlled were not bona fide accredited investors, but merely conduits through which he and Kaplan effected unregistered public distributions of stock.
The Commission further alleged that, once his entities acquired the "free-trading" shares, Paloma then coordinated manipulative public trading -- carried out in part by Kaplan -- which artificially inflated the value of each issuer's stock. With the appearance of an active trading market established, Paloma coordinated the dissemination of millions of false and/or misleading blast fax and spam e-mails touting the companies' shares. Ultimately, Paloma and Kaplan dumped stock of the microcap issuers into the public market at the artificially inflated prices, realizing profits of some $2,155,000 and $677,000, respectively.
After Paloma and Kaplan liquidated their holdings of each company's stock, they ceased trading in the stock and the market for the shares collapsed. The Commission alleged that Paloma and Kaplan carried out versions of this scheme using the shares of Courtside Products, Inc., Latin Heat Entertainment, Inc., Xtreme Technologies, Inc., PokerBook Gaming Corp., Commanche Properties, Inc., TKO Holdings Ltd. and Motion DNA Corp.
In the Commission's action, Paloma consented to the entry of a final judgment (1) permanently enjoining him from violating Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; (2) imposing a penny stock bar against him; and (3) directing that he disgorge $2,155,034 in unlawful profits, plus prejudgment interest of $364,265. Kaplan has consented to the entry of a final judgment (1) permanently enjoining him from violating Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; (2) imposing a penny stock bar against him; and (3) directing that he disgorge $677,632 in unlawful profits, plus prejudgment interest of $121,127. [SEC v. Michael Saquella, a.k.a. Michael Paloma, and Lawrence Kaplan, Civil Action No. 1:07CV895 (BRP) (E.D. Va.)] (LR-20502)
INVESTMENT COMPANY ACT RELEASES
Triangle Capital Corporation
An order has been issued on an application filed by Triangle Capital Corporation (Triangle) under Section 6(c) of the Investment Company Act for an exemption from Sections 23(a), 23(b) and 63 of the Act, and under Sections 57(a)(4) and 57(i) of the Act and Rule 17d-1 under the Act authorizing certain joint transactions otherwise prohibited by Section 57(a)(4) of the Act. The order permits Triangle to issue shares of its restricted common stock as part of the compensation packages for certain of its employees and directors, and certain employees of its wholly-owned consolidated subsidiaries. (Rel. IC-28196 - March 18)
Proposed Rule Changes
NYSE Arca, through its wholly owned subsidiary, NYSE Arca Equities, Inc., filed a proposed rule change (SR-NYSEArca-2008-20) and Amendment No. 1 thereto to adopt listing rules relating to Fixed Income Index-Linked Securities, Futures-Linked Securities, and Multifactor Index-Linked Securities. Publication is expected in the Federal Register during the week of March 17. (Rel. 34-57505)
The Depository Trust Company filed an amended proposed rule change (SR-DTC-2007-10) that would implement a new issue information dissemination service for municipal securities. Publication is expected in the Federal Register during the week of March 24. (Rel. 34-57513)
Approval of Proposed Rule Change
A proposed rule change (SR-CHX-2007-09), filed by the Chicago Stock Exchange to amend the Exchange's institutional broker rules to add provisions relating to the handling of stop and stop-limit orders has been approved pursuant to Section 19(b)(2) of the Securities Exchange Act of 1934. Publication is expected in the Federal Register during the week of March 24. (Rel. 34-57509)
Immediate Effectiveness of Proposed Rule Changes
A proposed rule change, as modified by Amendment No. 1 thereto, filed by the Chicago Board Options Exchange relating to customer-to-customer immediate crosses (SR-CBOE-2008-19) has become effective under Section 19(b)(3)(A) of the Securities Exchange Act of 1934. Publication is expected in the Federal Register during the week of March 24. (Rel. 34-57512)
A proposed rule change filed by the Philadelphia Stock Exchange to add the SIG Energy MLP Index™ to Rules 1101A and 1104A (SR-Phlx-2008-21) has become immediately effective under Section 19(b)(3)(A) of the Securities Exchange Act of 1934. Publication is expected in the Federal Register during the week of March 24. (Rel. 34-57515)
Amendment to Proposed Rule Change and Accelerated Approval of Proposed Rule Change
The Commission issued notice of filing of Amendment No. 2 to a proposed rule change (SR-Amex-2008-02) and granted accelerated approval to such proposed rule change, as modified by Amendment Nos. 1 and 2 thereto, submitted pursuant to Rule 19b-4 under the Securities Exchange Act of 1934 by the American Stock Exchange relating to rules permitting the listing and trading of Managed Fund Shares, fees applicable to such Managed Fund Shares, and the listing and trading of shares of the Bear Stearns Current Yield Fund. Publication is expected in the Federal Register during the week of March 24. (Rel. 34-57514)
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