Securities Industry Commentator by Bill Singer, Esq.

October 17, 2017

The Securities and Exchange Commission filed a Complaint in the United States District Court for the Southern District of New York naming as Defendants: Rio Tinto PLC, Rio Tinto Limited, Thomas Albanese, and Guy Robert Elliott. The mining company, its former CEO Albanese and former CFO Elliott were charged with failing to follow accounting standards and company policies to accurately value and record its assets.  As stated in the SEC's Press Release:

According to the SEC's complaint, in 2011, Rio Tinto acquired coal assets in Mozambique shortly after disclosing huge losses associated with its previous large-scale acquisition of Alcan.  Both acquisitions took place under Albanese's leadership.  The second acquisition was also unsuccessful as it was based on the incorrect assumption that Rio Tinto could inexpensively mine, transport, and sell large quantities of high-quality coal, chiefly using barges for shipping.  The SEC's complaint alleges that the project suffered setbacks almost immediately, as Rio Tinto, Albanese, and Elliott learned that there was less coal and of lower quality than expected, and that Mozambique had rejected its barge application. The complaint alleges that the drop in quantity and quality of coal, coupled with the lack of infrastructure to transport it, significantly eroded the value of the acquisition.

The complaint alleges that after already impairing Alcan twice, Rio Tinto, Albanese, and Elliott knew that publicly disclosing its second failure and rapidly declining value would call into question their ability to pursue the core of Rio Tinto's business model to identify and develop long-term, low-cost, and highly-profitable mining assets.  Instead, they concealed the adverse developments, allowing Rio Tinto to release misleading financial statements days before a series of U.S. debt offerings.  Rio Tinto raised $5.5 billion from U.S. investors, approximately $3 billion of which was raised after May 2012, when executives at Rio Tinto Coal Mozambique had already told Albanese and Elliott that the subsidiary was likely worth negative $680 million.  The complaint alleges Albanese then repeated and reinforced the false positive outlook for the project in public statements.

The alleged fraud continued until January 2013, when an executive in Rio Tinto's Technology & Innovation Group discovered that the coal assets were being carried at an inflated value on Rio Tinto's financial statements.  After an internal review allegedly triggered by the executive's report to Rio Tinto's Chairman, Rio Tinto announced that Albanese had resigned and the company reduced the value of the coal assets by more than $3 billion, or more than 80 percent.  After a second reduction, Rio Tinto sold the Mozambique subsidiary for $50 million, billions of dollars below the acquisition price.

Among FINRA's more lucrative fine-generating violations is FINRA Rule 3280: Private Securities Transactions of an Associated Person, or, in industry jargon, the FINRA PST Rule. Contrary to what some might believe, I fully appreciate the motivation for this rule and support some form of restriction on a registered representative's outside securities transactions. The problem for me is not the justification for a PST Rule but the fact that FINRA's version isn't particularly well written. Frankly, that definition isn't much of a definition but, at best, an example of circuitous logic.

During my 35 years on Wall Street in compliance, regulation, and as a lawyer in private practice, I have had many discussions with registered representatives about PST violations. Okay, sure, many of those folks simply didn't give a crap about the prohibition and figured that no one would find out -- and, of course, that gambit didn't play out particularly well. On the other hand, I have spoken to many -- far too many folks -- who simply misunderstood what constituted a "securities transaction" or a "private securities transaction."

If you re-read FINRA Rule 3280(e), you should immediately spot some sources of confusion; for example, just what is "outside" an associated person's "regular" course or scope of employment? And while you're pondering that bit of statutory vagueness, just what is the difference between the "course" and the "scope" of employment? If there is no meaningful difference between those two ideas, then why include both in a rule? Using different terms such as "course" and "scope" to suggest different ideas without a statutory definition of either is a perfect example of how poorly drafted rules confuse those who are expected to follow them. Yes, we should expect that those regulated by FINRA have commonsense but that does not give the self-regulator license to draft its rules with vague terms and amorphous concepts and then file disciplinary charges based upon the false premise that everyone reading the rulebook draws the same inference and reaches the same understanding. When your audience is left dazed and confused after reading a rule, you haven't done a great job of drafting!