(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

SEC Responds to Federal Judge on Wall Street Global Settlement

The SEC has responded to a federal judge (SD NY) who had raised a number of issues in connection with the approval of the recent Wall Street global settlement under which ten of the nation's top investment firms settled enforcement actions involving conflicts of interest between their research and investment banking divisions.

The total of all payments in the settlement is roughly $1.4 billion, with amounts divided among a federal fund distribution, investor education efforts, independent research, and the states. The distribution funds will be administered by an SEC-recommended, court-appointed distribution fund administrator, who will formulate a plan to distribute the funds in an equitable manner to customers who purchased the equity securities of companies referenced in the complaint against the firm through which the customer bought the securities. The fund administrator's plan of distribution will be subject to court approval.

Initially, the federal court, noting the broad indemnification provisions of the settlement, declined to approve any decree holding harmless administrators, agents or attorneys acting on their behalf from criminal liability. The SEC does not object to a decision not to indemnify or hold harmless any of the above persons from criminal liability.

Turning to the substance of the consent judgments, the court had noted that, while the judgments are called final, they defer the specifics to unnamed administrators and independent consultants. The SEC assured the court that the judgments are indeed final since they ended the litigation on the merits and left nothing for the court to do but execute them. The fact that the court will retain jurisdiction in order to oversee the implementation of the final judgments does not make them any less final.

Noting that the judgments contemplate future acceptance by the states, the court had queried what would happen if one or more states rejected the settlement. In addition, the court asked if there is a time frame for state acceptance.

According to the SEC, the rejection of the settlement by any state or any number of states would have no impact on finality, validity, or implementation. The SEC also related that Christine A. Bruenn, president of the North American Securities Administrators Association, told the agency that she is not aware of any state that intends to opt out of the global settlement. She also said that NASAA's goal is for all states to finalize the settlements within 90 days after entry of the final judgments.

The court also expressed concern that mutual fund investors and investors in derivatives might be excluded from claims against the distribution fund. But the SEC assured that a mutual fund would not be excluded simply because it is an institution, but will be eligible provided it purchased the equity securities in question through the defendant during the relevant period identified in the complaint against that defendant.

A shareholder of such a mutual fund would not be able to receive a direct payment from the distribution funds but might be able to receive a payment indirectly through the mutual fund if the court-approved distribution fund plan in question provides for payments to the mutual fund. In identifying eligible distribution fund recipients, the fund administrator may consider whether the person in question was a retail or institutional customer.

Similarly, since derivatives such as options and futures fall within the Exchange Act's definition of equity securities, derivatives investors are not specifically excluded from receiving payments from the distribution fund. The administrator, however, could determine that stock purchasers are more appropriate recipients of payments from the fund than are derivatives investors.

The research at issue in these actions concerned the fundamentals of the securities that were the subject of the research, explained the SEC, and options and futures traders often do not trade on the basis of fundamentals. Indeed, many of the defendant firms issued research specifically on options and other derivatives that was not the subject of the SEC's complaints.

Noting that the consent judgments require the federal payments to be designated as a penalty and disgorgement in equal proportions, the court asked if that allocation would be affected by the states' acceptance of the settlement. The SEC responded by first observing that the judgments do not require that the federal payments be designated as a penalty and disgorgement in equal proportions. Rather, said the Commission, they provide that the total amount of penalties and disgorgement paid to all regulators combined shall be equally divided between penalties and disgorgement.

How much of the federal payments are to be characterized as a penalty and how much as disgorgement will depend on how each state that accepts the settlement treats the payment made to it. In this regard, the SEC understands that each state will treat its respective payments according to its law and that the states' laws are not uniform.

Finally, responding to the court's desire for an explanation of the tax ramifications, the SEC emphasized that there will be no tax credit or deduction at any level for any penalty paid by any defendant pursuant to the global settlement. But the judgments do not contain any provisions stipulating the tax treatment of disgorgement, independent research, or investor education payments. The tax treatment of payments other than penalties will presumably be in accordance with the tax laws of the pertinent jurisdiction.