This week familiar themes continued: Option backdating, the FCPA and insider trading. The SEC continued to work through its inventory of option backdating cases, moving toward a conclusion of this scandal. The DOJ and the SEC resolved three FCPA cases against individuals, a key focus in this area. At the same time, an announcement was made that letters rogatory were about to be served from an Indian proceeding for information about a settled SEC FCPA case. Finally, reports suggest that the SEC and the Ontario Securities Commission are conducting a significant insider trading case involving 11 different Canadian takeover deals in which a major U.S. law firm may be involved, while U.K. watchdog FSA released a report on insider trading in London markets.

Option backdating

The SEC filed another settled option backdating case this week. Marvell Technology Group, Ltd. and its co-founder Weili Dai, were named as defendants in an SEC civil injunctive complaint which charged violations of the antifraud and books and records provisions of the federal securities laws.

According to the SEC’s complaint, Marvell engaged in a scheme to grant lucrative in-the-money options to employees by backdating the grants. From 2000 to 2006 the company overstated its income by $362 million by not properly recording the option expense. Defendant Dai acted as the company’s stock option committee. In that capacity, she regularly reviewed lists of Marvell’s historical stock prices to pick the lowest date. To make it appear that the company granted the options on the date selected, Ms. Dai signed falsified minutes which attested to meetings of the Committee on an earlier date when the option grant date was supposedly selected.

To resolve the case, the company and Ms. Dai consented to the entry of permanent injunctions prohibiting future violations of the antifraud and books and records provisions of the securities laws. In addition, the company consented to the entry of an order requiring the payment of a $10 million penalty while Mr. Dai agreed to pay a penalty of $500,000. Defendant Weili Dai also agreed to an order barring her from service as an officer or director for five years. SEC v. Marvell Technology, Case No. CV 08-2366 (N.D. Cal. May 8, 2008). The Commission’s Litigation Release is here.

FCPA

This week, the SEC and DOJ continued their focus on individuals in FCPA cases by concluding actions against three ITXC Corporation executives. ITXC is an international telecommunications carrier based in New Jersey which sought to do business in Africa. The defendants, Steven Ott, Roger Michael Young and Yaw Osei Amoako, were respectively the vice president of global sales, managing director of the Middle East and Africa and regional director for sales in Africa.

The complaints in these actions alleged that the three defendants negotiated and/or approved bribes of over $267,000 paid to foreign officials in Nigeria, Rwanda and Senegal to obtain contracts necessary for ITXC to transmit telephone calls to individuals and businesses in those countries. Those agreements earned the company about $11.5 million in net profits. The SEC cases were settled by consenting to statutory injunctions prohibiting future violations of the FCPA bribery and books and records provisions. Mr. Amoako, who was alleged to have received $150,000 through embezzlement and a kickback, was ordered to pay over $188,000 in disgorgement and prejudgment interest. SEC v. Ott, Civil Action No. 06-4195 (D.N.J. Sept. 6, 2006); SEC v. Amoako, Civil Action No. 05-4284 (D.N.J. Sept. 1, 2005).

To resolve these matters with the DOJ, each defendant pled guilty to conspiring to violate the FCPA and the Travel Act. Mr. Amoako was sentenced to 18 months in prison. Messrs. Ott and Young are awaiting sentencing. U.S. v. Ott, No. 07-608 (D.N.J. July 25, 2007); U.S. v. Young, No. 07-609 (D.N.J. Sept. 25, 2007); U.S. v. Amoako, No. 05-1122 (D.N.J. June 28, 2006).

Last week, the Central Bureau of Investigations in New Delhi disclosed that it is about to issue a letter rogatory to U.S. authorities to question Dow Chemicals regarding bribes that were allegedly paid by a subsidiary of the company to Indian officials. The bribes were supposedly paid to register banned pesticides in the Indian market. The request is part of a case which was filed six months ago against CBI officials and a retired official from the Ministry of Agriculture following an SEC FCPA action.

Previously, the SEC filed a settled civil action and related administrative proceeding against the Dow Chemical Company alleging violations of the FCPA. In that case the complaint alleged that Dow subsidiary, DE-Nocil Crop Protection Ltd., based in Mumbai, India, made approximately $39,700 in improper payments to an official in India’s Central Insecticides Board to expedite the registration of three product. The complaint claimed that from 1996 to 2001 the same subsidiary made $87,000 in improper payments to state officials in order to distribute and sell its product. Finally, the complaint detailed improper gifts, travel, entertainment and other items. The civil action was settled with the payment of a $325,000 civil penalty. A consent to a cease and desist order was entered in a related administrative proceeding. SEC v. The Dow Chemical Company, Civil Action No. 07CV00336 (D.D.C. Feb. 13, 2007) discussed in the Litigation Release here.

Insider trading

The SEC and Ontario securities officials are reportedly conducting a major insider trading investigation involving 11 Canadian takeovers over the past two years. According to an affidavit filed in Ontario Superior Court, the Ontario Securities Commission is investigating a Toronto business consultant, his sister and his brother-in-law who allegedly made over $1.1 million trading in take over stocks.

Also involved in the investigation is a U.S. law firm. While the court papers do not identify the law firm, the transactions which are the focus of the inquiry are listed. A review of those deals by a Canadian news organization determined that the only firm involved in each deal is Dorsey & Whitney.

Earlier this week, the Financial Services Board in the U.K. released a study which disclosed that nearly one-third of takeover deals may have been preceded by insider trading in the London markets. The FSA has reportedly more than doubled its team of prosecutors and is promising to crack down on insider trading and bring a steady stream of cases.

Hedge funds have been a key enforcement priority since at least the time of the decision of the D.C. Circuit in Goldstein v. SEC, 451 F.3d 871 (D.C. Cir. 2006). There, the court vacated the SEC’s rule requiring hedge fund advisors to register. The SEC chose not to appeal.

Subsequently, Chairman Cox told Congress that “[h]edge funds are not, should not be, and will not be unregulated.” Testimony Concerning the Regulation of Hedge Funds (July 25, 2006).

Later that year, the SEC passed Rule 206(4)-8, an antifraud rule focused on hedge funds. The agency also began a series of cases against the funds involving private investment in public equity (“PIPE”) offerings – regulation through enforcement action.

As with most SEC enforcement actions, the hedge fund/PIPE cases typically settle. Three are in litigation, however.

The complaints in these case focus on a similar core of factual and legal allegations, although the precise facts in each case vary. Typically, the hedge fund participated in one or more PIPE offerings and traded in the shares of the issuer shortly before and/or after the announcement of the private placement component of the offering. In each case, around the time of the private placement component of the transaction, the hedge fund shorted the shares of the issuer and later, after the resale registration statement became effective, covered with the shares from the transaction. The covering shares were not registered at the time of the short sale, but were registered at the time of the covering transaction. Typically, the SEC complaint alleges the sale of unregistered securities in violation of Section 5 based on the short sale and insider trading in violation of Section 10(b).

Examples of hedge fund/PIPE which have settled include:

• SEC v. Spiegel, Civil Action No. 1:07CV00008 (D.D.C. Jan. 4, 2007), a settled civil injunctive action involving short selling in connection with a PIPE.

• SEC v. Friedman, Billings, Ramsey & Co., Civil Action No 06-cv-02160 (D.D.C. Dec. 20, 2006), a settled civil injunctive action alleging insider trading, selling of unregistered securities and failure to supervise in connection with CompuDyne Corporation’s sale of a PIPE. The action was brought against investment banker Friedman, Billings, as well as its founder and Co-Chairman and its Director of Compliance.

Other cases have litigated. For example:

• SEC v. Lyon, Civil Action No. 06-CV 14338 (S.D.N.Y. Dec. 12, 2006). Here, the SEC alleged that the managing partner and chief investment officer of a group of funds engaged in an unlawful trading scheme with respect to 36 PIPE offerings by engaging in insider trading and the sale of unregistered securities. The court dismissed the Section 5 and related fraud claims in an opinion which was sharply critical of the SEC. Indeed, as to the SEC’s arguments on the Section 5 claims the opinion notes: “The Court finds this characterization of a short sale [by the SEC] inaccurate and not reflective of what occurs in the market.” Later, the court concluded that the SEC’s position was based on an “inherent logical implausibility.” The insider trading claims are in litigation.

• SEC v. Mangan, Civil Action No. 3:06-CV-531 (W.D.N.C. Dec. 28, 2006) is similar. Like Lyon, the complaint contained insider trading and Section 5 claims related to a PIPE. The court dismissed the Section 5 claims in an opinion which criticized the SEC. The SEC’s Section 5 clam was, in the Court’s view, nothing more than hindsight. The insider trading claim is in litigation, although the court expressed concern as to the viability of the claim.

• SEC v. Berlacher, Civil Action No. 07-cv-3800 (E.D. Pa. Sept. 13, 2007). The complaint here is similar to Lyon and Mangan, alleging insider trading and Section 5 violations related to a PIPE. Again, the court dismissed the Section 5 claim. The insider trading claim is in litigation. See also SEC v. Colonial Investment Management LLC, Civil Action No. 07-Civ-8849 (S.D.N.Y. Oct. 15, 2007) (similar allegations to other cases except the short sale violations are based on Rule 105 which prohibits short sales within 5 days of an offering; the case is pending).

Next: Backdated options

The SEC and DOJ concluded three FCPA cases it had previously filed against three former executives of ITXC Corporation. These cases are consistent with the focus on individuals in FCPA cases by the SEC and DOJ.

ITXC is a publicly held international telecommunications carrier based in Princeton, New Jersey that sought to do business in Africa. The defendants are Steven Ott, former Vice President of Global Sales; Roger Michael Young, former Managing Director of the Middle East and Africa; and Yaw Osei Amoako, the former Regional Director for Sales in Africa.

According to the complaints, the three defendants are alleged to have negotiated and/or approved bribes that the company paid to foreign officials in Nigeria, Rwanda and Senegal. The bribes were alleged to have been paid to obtain contracts necessary for ITXC to transmit telephone calls to individuals and businesses in those countries. From August 2001 to May 2004 over $267,000 in bribes were paid. During the same period, the company made approximately $11.5 million in net profits from the contracts.

To settle the cases Messrs. Ott, Young and Amoako each consented to the entry of an injunction prohibiting future violations of the FCPA bribery and books and records provisions. In addition, Mr. Amoako, who was alleged to have received $150,000 through embezzlement and a kickback in connection with the bribery scheme, was ordered to pay over $188,000 in disgorgement and prejudgment interest. The SEC is continuing its investigation. SEC v. Ott, Civil Action No. 06-4195 (D.N.J. Sept. 6, 2006); SEC v. Amoako, Civil Action No. 05-4284 (D.N.J. Sept. 1, 2005). The SEC’s Litigation Release regarding the settlement is here.

To resolve these matters with DOJ, each defendant pled guilty to conspiring to violate the FCPA and the Travel Act. Mr. Amoako was sentenced to 18 months in prison. Messrs. Ott and Young are awaiting sentencing. U.S. v. Ott, No. 07-608 (D.N.J. July 25, 2007); U.S. v. Young, No. 07-609 (D.N.J. Sept. 25, 2007); U.S. v. Amoako, No. 05-1122 (D.N.J. June 28, 2006).

Financial fraud is a traditional SEC enforcement area. Last year was no exception. The Commission brought cases focused on earnings management, revenue recognition and the misuse of reserves. One recent study of SEC financial fraud cases suggested that post-SOX the SEC has focused on larger companies. Prior to SOX, the Commission had been criticized on occasion for keying its enforcement efforts to smaller issuers. Whether the new focus on larger companies is a new trend or an aberration resulting from the recent scandals such as Enron, Global Crossing, Tyco and others remains to be seen.

Many of the corporate fraud cases focus on years-old conduct, raising questions such as those seen in SEC v. Jones, No. 07 Civ. 7044, slip op. (S.D.N.Y. Feb. 26, 2007), concerning whether the typically requested injunction is actually the equitable relief intended by Congress. Others raise questions regarding cooperation credit under Seaboard and the SEC’s policy on corporate penalties as well as Chairman Cox’s new procedures for deciding on corporate penalties. The settlements in BISYS Group, Nortel Networks, Federal Home Loan Mortgage and Cardinal Health raise illustrate these issues.

SEC v. The BISYS Group, Inc., Case No. 07-Civ-4010 (S.D.N.Y. May 23, 2007) is a settled civil injunctive action which illustrates the application of cooperation credit. Here, the Commission’s complaint alleged a variety of improper accounting techniques engaged in by senior management over a period of years to meet Wall Street expectations. For fiscal years 2001-2003, the financial results were overstated by about $180 million. Based on two restatements, pretax income was overstated 69%, 58% and 43% for fiscal years 2001-2003.

The settlement in BISYS Group reflects cooperation credit, according to the SEC. The company consented to a statutory injunction prohibiting future violations of the books and records provisions and to an order requirement the payment of $25 million in disgorgement and prejudgment interest. The fact that the settlement does not include an antifraud injunction despite allegations of a pervasive fraud or a penalty, presumably is the result of cooperation credit.

Another settlement which involved cooperation credit is SEC v. Nortel Networks, Corp., Civil Action No. 07-CV-8851 (S.D.N.Y. Oct. 15, 2007). There, the SEC’s complaint alleged that the company improperly accelerated the recognition of revenue to meet targets from 2000 to 2001. The company adopted revenue recognition policies that were not in conformity with U.S. GAAP. These actions, according to the complaint, permitted the company to inflate its fourth quarter and fiscal year 2000 revenues by about $1.4 billion. In addition, in 2002 the company improperly established and maintained reserves.

The settlement here differs from BISYS Group. Here, it includes a statutory injunction prohibiting future violations of both the antifraud and books and records provisions. In addition, the company agreed to the entry of an order requiring the payment of a civil penalty of $35 million and requiring it to report to the staff periodically on progress in resolving a material weakness in its revenue recognition procedures. Thus, despite cooperation, an antifraud injunction was required and a substantially larger fine despite the similarity of the actions.

Two other cases raise questions about the application of the Commission’s policy on corporate penalties and the new procedures for determining them instituted by Chairman Cox. SEC v. Federal Home Loan Mortgage Corp., Civil Action No 07-CV-1728 (D.D.C. Sept 27, 2007) is a financial fraud case where the Commission alleged that the company improperly smoothed earnings trends by misreporting income from 2000 to 2002. In those years, as a result of pressure from senior management and a culture which prized smooth steady earnings rather than compliance, net income was misreported by 30.5%, 23.9% and 42.9%.

To settle the action the company consented to the entry of a statutory injunction prohibiting future violations of the antifraud provisions. In addition, the company agreed to pay a penalty of $50 million.

SEC v. Cardinal Health, Inc., Case No. 07CV6709 (S.D.N.Y. July 26, 2007) is a similar financial fraud case. There, the Commission’s complaint alleged that Cardinal used a variety of practices to manage reported earnings from 2000 to 2004. The improper practices included misclassifying revenue, selectively accelerating payment of vendor invoices, improperly adjusting reserve accounts and improperly classifying expected litigation settlement proceeds to increase operating earnings.

To resolve the case, Cardinal consented to the entry of a statutory injunction prohibiting future violations of the antifraud and reporting provisions and to pay a $35 million penalty. Despite the apparent similarities in the cases and the fact that Cardinal had a parallel criminal action, that company paid a substantially smaller fine than Federal Home Loan.

Next: Hedge funds

The SEC and DOJ have taken an expansive view of the FCPA as part of their renewed emphasis on enforcement. Their approach here echoes that taken to the insider trading cases. Two key limitations illustrate this approach.

The first is the limitation on the antibribery provision that the payment must be to obtain or retain business. This provision was incorporated in the Act in 1978 and has remained unchanged through the 1988 amendments. It was intended to reflect the fact that not all payments to foreign officials violated the Act, but only those to obtain business or retain business. The legislative history at the time the FCPA was first passed suggests that payments regarding taxes were not within this provision, although the legislative reports from the 1988 amendments suggest to the contrary despite not changing the statutory language.

Nevertheless, both DOJ and the SEC are expanding the obtain/retain business provision to include matters relating to taxes. In two decision in U.S. v. Kay, the court of appeals has expansively read this key limitation to include payments about taxes. The first decision focused only on the adequacy of the language of the indictment while the second followed the remand and trial of the case. U.S. v. Kay, 359 F.3d 738 (5th Cir. 2004) (Kay I); U.S. v. Kay, 2007 WL 3099140 (5th Cir. Oct. 24, 2007) (Kay II). In these decisions, the court concluded that in certain instances payments regarding taxes may fall within the obtain/retain business limitation. In Kay II, the court held that since the defendants testified that payments to officials to reduce certain taxes were necessary because everyone was doing it, then those payments must in fact be necessary to obtain or retain business. As such, they are within the prohibitions of the antibribery sections.

The SEC has recently taken a similar position in a settled administrative proceeding. In the Matter of Bristow Group, Admin. Proc. File No. 3-12833, SEC Release 5633 (Sept. 26, 2007).

The second limitation concerns the payment of promotional expenses. 15 U.S.C. § 78dd-2(c)(2) permits the payment of a “reasonable and bona fide expenditure, such as travel and lodging expenses …” and the payment of expenses for “the promotion, demonstration, or explanation of products or services.”

Last year, the SEC brought two key cases involving this section. Perhaps the most significant is SEC v. Lucent Technologies, Inc., Civil Action No. 07-092301 (D.D.C. Dec. 21, 2007). In this settled civil injunctive action, the SEC’s complaint alleged that over a three year period the company paid over $10 million of about 1,000 Chinese foreign officials to travel to the U.S. According to the complaint 315 of those trips had disproportionate amounts of sightseeing, entertainment and leisure. The trips had been booked to a “factor inspection account.” The SEC also claimed that Lucent had inadequate FCPA training.

To resolve the case, Lucent consented to the entry of an injunction prohibiting future violations of the books and records provisions of the FCPA. In addition, the company agreed to pay a $1.5 million civil penalty.

To settle with DOJ, Lucent entered into a non-prosecution agreement that required the payment of a $1 million fine.

The SEC brought a similar action against Dow Chemical Company. That settled action was based on the payment of $37,000 in gifts, travel, entertainment and other items. SEC v. The Dow Chemical Co, Civil Action No. 07-00336 (D.D.C. Feb. 13, 2007).

The Department of Justice also published two rulings regarding travel and entertainment which define limitations in this area consistent with these cases. FCPA Op. Proc. Rel 2007-01; Rel 2007-02.

Next: Financial fraud

This week in securities litigation familiar themes continued to be the key topic: the health of the SEC’s enforcement program, insider trading and option backdating.

The health of SEC enforcement

The debate over the future of the SEC’s enforcement program, as well as its current health, and a past transgression continued this week. First, the debate over the adequacy of the SEC’s budget and a proposal for regulatory reform continued. Previously, SEC Chairman Cox had largely embraced the administration’s proposed fiscal 2009 budget for the agency as discussed here. In an editorial in the New York Times published on April 29, 2008, former SEC Chairmen William Donaldson, Arthur Levitt Jr. and David Ruder offer the constructive and sensible suggestion that before there are any regulatory reforms such as those proposed by Treasury Secretary Paulson to, in part, merge the SEC and CFTC, there should be a complete study by the Commission of the situation. Following a careful assessment of what happened, the three former Chairman argue that “any reforms undertaken … should not undermine the SEC’s central roles as an investor’s advocate and a law enforcement agency.” They go on to note that, in part, the “the problem with the SEC today is that it lacks the money, manpower and tools it needs to do its job. The Commission’s 2009 enforcement budget does not keep pace with inflation, although it does provide significant increases in the risk-assessment function” as also previously discussed here.

Second, Chairman’s Cox’s claim that the SEC enforcement program is healthy as evidenced in part by the record results obtained so far this year was severely criticized in an article that appeared in Financial Week on April 28, 2008. Responding to the Chairman’s claim, the article states: “FUZZY MATH? SEC chairman Christopher Cox wrote [in an April 1, 2008 letter to Senator Dodd discussed here] that former United Health CEO William McGuire paid the ‘largest financial sanction ever asserted against an individual.’ Fresh from his assertions last month that Bear Stearns was well capitalized, Christopher Cox has told another whopper.” As noted here, virtually all of the money in the settlement with Dr. McGuire is attributable to the class and derivative actions which were settled together with the SEC’s case.

Finally, the SEC lost another round over its botched Pequot investigation. Previously it had been criticized in a Congressional report for mishandling the inquiry as discussed here. Last week, the agency was ordered to turn over the transcripts of interviews with Pequot founder Arthur Samberg, along with trading records and other documents pursuant to a FOIA request made by former staff member and whistleblower Gary Aguirre. Aguirre v. SEC, Civil Action No. 1:06-cv-01260 (D.D.C. July 14, 2006). It seems like it is more than time for the Commission to resolve this sad affair, make any necessary reforms and move on – the medicine it usually requires of those ensnared in its enforcement net.

Insider trading

Insider trading continues to be an enforcement priority as previously reported here. This week one high profile criminal case continued, while the SEC brought another family trading case.

• In U.S. v. Nacchio, No. 07-1311 (10th Cir. Aug. 2, 2007) the government requested rehearing en banc following the panel decision reversing the former Quest Communication CEO’s convictions on insider trading (here). In their brief, prosecutors disputed the panel conclusion that the district court’s exclusion of expert testimony offered by the defense required a reversal of the convictions and a retrial. The excluded testimony from Professor Daniel Fischel would have informed the jury that the inside information Mr. Nacchio had was not significant enough to require disclosure.

• In SEC v. Norton, Civil Action No. 2:08-CV-541 (D.Nev. April 29, 2008) the Commission filed a settled civil injunctive action which named a father and corporate director and his son as defendants in an insider trading case based on trading ahead of a merger as discussed here.

Option backdating

The option backdating scandal continued to move slowly forward as the SEC and government prosecutors plow slowly through their inventories of cases.

• The former CFO of Pixar Animation Studios, now owned by Walt Disney, and a current Google director, was given a Wells notice, indicating that the SEC staff is considering recommending an enforcement action against her based on allegations tied to option backdating. Both the SEC and criminal prosecutors have been investigating questions of option backdating at Pixar.

• The SEC brought a civil injunctive action against the former COO and former controller of Monster Worldwide, Inc. based on claims related to the backdating of options. SEC v. Treacy, Civil Action No. 08 CV 4052 (S.D.N.Y. April 30, 2008). This case is in litigation. At the same time the SEC is continuing its investigation.

First swap case

This week the SEC filed its first enforcement action involving security-based swap agreements – a derivative which in this case involved an agreement to exchange periodic interest rate payments on an amount of debt. The case also involves the sale of municipal bonds. The action focuses on kickbacks paid by a municipal bond dealer to a public official through an intermediary to obtain the bond and swap business as discussed here. SEC v. Langford, Civil Action No. cv-08-B-0761-S (N.D. Ala. April 30, 2008).

SEC v. Langford, Civil Action No. cv-08-B-0761-S (N.D. Ala. April 30, 2008) is the Commissions first enforcement action involving security-based swap agreements – a derivative which in this case involved an agreement to exchange periodic interest rate payments on an amount of debt. It is also involves the sale of municipal bonds as in In the Matter of City of San Diego, Release No. 8751, Admin. Proceeding File No. 3-12478 (Nov. 14, 2006), previously discussed here.

The complaint in Langford is a based on a kickback scheme involving four persons: Larry Langford, the current mayor of Birmingham, Alabama; William Blount, the co-owner and chairman of Blount Parris, a municipal securities broker-dealer registered with the SEC, which is also a defendant; and Albert LaPierre, a lobbyist registered with the State of Alabama and a former executive director of the Alabama Democratic Party. The complaint is based on fees and payments made in connection with five County and offerings and four security-based swap agreements in 2003 and 2004.

Messrs. Langford, Blount and LaPierre have a years-long personal relationship. Prior to June 2002 when Mr. Langford was elected County Commissioner, Blount Parrish had not had any County municipal bond work in years. Following the election Mr. Blount began making payments and conferring benefits on Mr. Langford through defendant LaPierre. Those payments exceed $156,000 over a two year period.

Once Mr. Langford became Chairman of the County Commission, Blount Parrish participated in every Jefferson County municipal bond offering and security-based swap agreement transaction over a two-year period. This included five municipal bond offerings in which Blount Parrish participated as lead or co-underwriter or as a remarketing agent and four security-based swap transactions. The bond firm earned over $6.7 million in fees. In these transactions, the payments between Messrs. Langford and Blount were not disclosed to the County, according to the complaint.

The complaint, which alleges violations of the anti-fraud provisions as well as Exchange Act Section 15B and rules of the Municipal Securities Rulemaking Board, seeks permanent injunctions, disgorgement, prejudgment interest and penalties. The case is in litigation. The SEC’s investigation is also continuing.

The SEC’s campaign against insider trading continued this week, extending trends from last year. Two cases filed this week based on trading in advance of take-over announcements involved, respectively, a father and son and a corporate director and an attorney in private practice.

Another family trading together. In SEC v. Norton, Civil Action No. 2:08-CV-541 (D. Nev. April 29, 2008), the Commission filed a settled insider trading case against a father and a son. The SEC’s complaint focuses on trading in advance of the take-over announcement of Valley Bancorp by Community Bancorp. Community Bancorp director Charles R. Norton learned that the bank was about to acquire Valley Bancorp at a board meeting. Subsequently, Chad Norton, the son of Charles Norton, purchased 7,000 shares of Valley Bancorp stock prior to the announcement of the take-over. After the announcement the shares were sold yielding a profit of $35,064.71.

To settle the action, the father and son consented to the entry of permanent injunctions prohibiting future violations of the anti-fraud provisions. Chad Norton also agreed to the entry of an order directing that the trading profits be disgorged and requiring the payment of prejudgment interest and a civil penalty equal to the trading profits. Charles Norton also consented to the entry of an order requiring that he pay a penalty equal to the trading profits and a five year officer/director bar. This is the latest in a series of family insider trading cases. Last year, the SEC brought a number of actions frequently referred to as “pillow talk” cases which involved allegations of insider trading by spouses and in some instances family members that were insider trading rings as discussed here.

Another director and attorney. In SEC v. Boshell, Civil Action No. 08-CV-2392 (N.D. Ill. April 28, 2008) the Commission filed a settled insider trading case against a corporate director and outside counsel. This case is also based on trading in advance of the public announcement of a takeover, in this instance the acquisition of Laserscope by American Medical Systems Holding, Inc.

According to the complaint, defendant Edward Boshell, a director of American Medical Systems, learned during a board meeting that the company would acquire Laserscope. Defendant Donald Pochopien was a shareholder of a Chicago law firm that served as counsel to American Medical in the due diligence review of the potential Laserscope acquisition. Prior to the public announcement of the acquisition, both defendants traded in the securities of Laserscope. Mr. Boshell made profits of over $85,000 while Mr. Pochopien is alleged to have made profits of over $134,000.

To settle this action, both defendants consented to the entry of statutory injunctions prohibiting future violations of the antifraud provisions and orders requiring the payment of disgorgement, prejudgment interest and civil penalties equal to the amount of the disgorgement. This case, like the Norton case, continues a trend from last year when a number of insider trading cases were brought against corporate directors and attorneys as also discussed here.

Recent enforcement cases in this area have focused on industry-wide investigations, individuals and those deriving from pre-merger due diligence. Perhaps the most significant industry-wide actions are based on the U.N. Oil for Food Program (“OFFP”). A report on that program from a group chaired by former Fed Chairman Paul Volker concluded that 2,253 companies had paid over $1.8 billion in illicit income to the Iraqi government. About two dozen companies have disclosed inquiries. The SEC and DOJ have a number of open, on-going investigations in this area.

The SEC and DOJ filed a number of settled cases related to OFFP. Typically, the actions have focused on either the oil side or the humanitarian side of the program. Cases involving the former are usually based on “surcharges” added to contracts. For example, in the El Paso Corp. case the SEC claimed that, beginning in 2001, the company paid about $2.1 million in surcharges to Iraq’s State Oil Marketing Organization. Those surcharges were booked as “cost of goods sold.”

To settle with the SEC, El Paso agreed to the entry of an injunction, prohibiting future violations of the books and records provisions of the FCPA, and the payment of disgorgement and a fine. SEC v. El Paso Corp., Civil Action No. 07-00899 (S.D.N.Y. Feb. 7, 2007). To settle with DOJ, the company entered into a non-prosecution agreement requiring the forfeiture of about $5.8 million, which was transferred to the Development Fund Of Iraq sanctioned by a U.N. resolution. The SEC disgorgement order was deemed satisfied by paying the forfeiture order in the DOJ case. As in several other cases, the Office of Foreign Asset Control also participated in the resolution of the case.

On the humanitarian side, kickbacks are often paid as “after sales service fees.” The Textron, Inc. case is typical of these actions. There, the SEC alleged that two French subs paid over $650,000 in kickbacks on humanitarian aid contracts. Those kickbacks, added to the contracts as after sales service fees, were booked as “commissions” and “consulting fees.”

To resolve the action with the SEC, Textron consented to the entry of an injunction prohibiting future violations of the books and records provisions of the FCPA, the payment of disgorgement and prejudgment interest, a civil penalty to compliance with undertakings regarding future FCPA compliance. SEC v. Textron, Inc., Civil Action No. 07-01505 (D.D.C. Aug 23, 2007). To settle with DOJ, the company entered into a non-prosecution agreement under which it agreed to pay a $1.5 million fine.

Both the SEC and DOJ have announced that they are focusing on actions against individuals in the FCPA area, in contrast to the more traditional approach keyed to business organizations. Recently, the SEC and DOJ have brought a number of cases against corporate executives, examples of which include an action against:

• A former executive of Schnitzer Steel based on claimed bribes and gifts given to managers of government owned steel mills, SEC v. Wooh, No. 07-975 (D. Or. June 29, 2007); U.S. v. Wooh, No. 07-244 (D. Or. June 26, 2007);

• Three executives of ITXC Corp, alleged to have paid bribes to foreign telecommunications officials in Nigeria, Rwanda and Senegal, SEC v. Ott, Civil Action No. 06-4195 (D.N.Y. Sept. 6, 2006); SEC v. Amoako, Civil Action No. 05-4284 (D.N.Y. Sept. 2005); U.S. v. Young, No. 07-609 (D.N.J. Sept. 25, 2007); U.S. v. Ott, No. 07-608 (D.N.U. July 25, 2007); U.S. v. Amoako, No. 05-1122 (D.N.J. June 28, 2006); and

• A former government affairs director of Asia for Monsanto alleged to have paid a bribe to a senior Indonesian Ministry of Environment to try and repeal a consent decree, SEC v. Martin, No. 07-0434 (D.D.C. March 26, 2007).

A number of FCPA cases also arose out of pre-merger due diligence. SEC v. Delta & Pine Land Co., No. 07-01352 (D.D.C. July 25, 2007) is a settled FCPA action which arose from self-reporting by Monsanto following pre-merger due diligence. The case involved a parent and sub alleged to have made about $43,000 in payment to Turkish officials to obtain reports and certifications.

Next: The SEC and DOJ expand the reach of the FCPA

Like insider trading, the FCPA is a traditional enforcement area which has become a recent priority of the SEC and the Department of Justice. Last year, there were 38 FCPA cases compared to 15 the prior year. At the end of 2007, there were reportedly more than 100 open FCPA investigations, as well as a docket of significant cases heading toward trial.

The FCPA, 15 U.S.C. §§ 78dd-1 et seq., is rooted in the Watergate scandal and the SEC’s “volunteer program” of the 1970’s. Under that program, hundreds of companies self-reported after conducting internal investigations focused on “questionable foreign payments” and the failure to properly record those payments in the books and records of the company. Since the statutes were passed in 1978, and amended in 1988, this has been a traditional enforcement area.

The statutes have two key sections. First, and perhaps best known, is the anti-bribery provisions. Generally, these sections prohibit payments to foreign officials to obtain or retain business. The “obtain or retain business” provision was intended to be a key limitation on this section, denoting the determination of congress that not every payment to a foreign official was prohibited.

Second, is the books and records and internal control provisions which are perhaps less well known than the anti-bribery provisions, but more expansive. Unlike the ant-bribery provisions, these sections do not apply only to certain payments to foreign officials. Rather, they apply generally to all of the books and records and internal controls of all issuers. Since they substitute a standard of “reasonable detail” for the usual “materiality” standard applied under the federal securities laws, they can have a far reaching impact.

Enforcement of the sections is generally shared between the SEC and DOJ. Generally, the SEC is responsible for civil enforcement as to all issuers. In those actions, the SEC can utilize all of its traditional enforcement weapons – civil injunctive actions, including seeking equitable relief such as disgorgement and requesting penalties. The agency can also bring administrative proceedings.

DOJ is generally responsible for criminal prosecutions of the anti-bribery provisions as well as the books and records and internal control provisions. The Department also has limited civil enforcement authority over “domestic concerns,” which are generally non-SEC reporting U.S. companies.

Many SEC investigations in this area have a parallel DOJ criminal investigation. The SEC’s policies on parallel proceedings, discussed in an earlier post here, are thus of particular importance in this area.

Next: SEC and DOJ FCPA enforcement – an expansive view