In what may signal a new enforcement priority, the SEC filed another Regulation FD case this week. SEC v. Presstek, Inc., Civil Action No. 10-1058 (E.D.N.Y. Filed March 9, 2010). Last year the Commission brought its first Reg FD case in a considerable period of time, In the Matter of Christopher A. Black discussed here. There the SEC did not bring an action against the company, only the individual who made the disclosures.

Presstek is an action against the company, a Connecticut based manufacturer, and the former chairman of its audit committee, Edward Marino. According to the complaint Mr. Marino received an e-mail from the company controller on September 10, 2006. The e-mail stated that performance in both North America and Europe for August was weak and had a negative impact on margin and operating income relative to plan. No announcement of financial performance was planned before early October.

On September 28, 2010, Mr. Marino received a telephone call from Michael Barone, a managing partner of Sidus, a registered investment adviser. The funds managed by the adviser owned almost half a million shares of Pesstek. During the telephone call Mr. Marino told the adviser that the summer had not been as vibrant as expected in North America and Europe according to notes of the conversation prepared by Mr. Barone and quoted in the complaint. The notes go on to record Mr. Marino as saying, in substance, that “’overall a mixed picture’” for the company emerged for the quarter.

Mr. Barone began selling Presstek shares immediately, sending an e-mail during the call. By the end of the day had liquidated most of its holdings. The share price closed down about 19%.

The next day Presstek issued a preliminary announcement. It reported that quarterly financial performance was below prior estimates.

The Commission’s complaint alleges violations of Exchange Act Section 13(a) and Regulation FD. The company settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. As part of the settlement the company agreed to pay a $400,000 civil penalty. In an unusual step the Commission, in its complaint, acknowledged the cooperation of the company citing its remedial measures. Those included revising its corporate communications policies and governance principles, replacing its management team, appointing new independent board members and creating a whistleblower’s hotline.

Mr. Marino is litigating the case. See also Lit. Rel. No. 21443 (March 9, 2010).

A third settled administrative proceeding arising out of the churning of two Florida municipal accounts at First Allied Securities, Inc. was filed last week. This case was brought against the firm for failing to properly supervise the account executive. In the Matter of First Allied Securities, Inc., Adm. Pro. File No. 3-13808 (March 5, 2010). The earlier cases were filed against, respectively, the registered representative Harold Jaschke and his supervisor as discussed here.

Each case centers on trading conducted by Mr. Jaschke in the accounts of the City of Kissimmee, Florida and the Tohopekaliga Water Authority of Florida. Each municipality had ordinances which directed that it only make conservative investments designed to safeguard the principal. Mr. Jaschke developed an investment strategy based on trading STRIPS, a particular type of long term zero coupon Treasury Bond. While the bonds themselves are conservative investments, when traded they can be highly volatile and are sensitive to even small interest rate movements.

Over a three year period beginning in 2005, Mr. Jaschke made numerous unauthorized trades which were contrary to the policies of the two clients and which were not suitable. For Kissimee, he placed a total of 478 trades for $2.8 billion of STRIPS. This resulted in a profit of $4.3 million and commissions of $6.1 million. For the Water Authority, Mr. Jaschke placed 563 trades for $3.1 billion in purchases yielding $5.5 million in profits and $8.1 million in commissions. During the trading Mr. Jaschke, who had discretionary authority over the accounts, but failed to fully inform his clients about his actions, incorrectly told the two municipalities that account statements depicting his risky trading were wrong. The firm retained 10% of all the commissions. Throughout, the two clients relied on Mr. Jaschke.

According to the Order for Proceedings, the failure to supervise by First Allied hinged on the following:

• Ignoring “exceptions reports.” These are automated reports generated by Bear Stearns, the firm’s clearing agent, indicating the possibility of churning. When a report is generated, First Allied typically sent a “negative response letter” presenting the issue to the customer, but not requiring a response. In September and December 2006, exceptions reports were issued. After the June report, the firm chose not to send a letter based on the representations of Mr. Jaschke. Six months after the December report, a positive response letter (requiring a response) which also discussed other trading activity involving risky repos was sent to each client. Mr. Jaschke persuaded the clients to sign and return the letters. Nobody at the brokerage firm contacted either client before January 2008. This follow-up system was not reasonable, according to the Order.

• Use of personal e-mail/lack of record retention. Mr. Jaschke repeatedly used his personal e-mail account for business. Supervisors at the firm were aware of this use of personal e-mail. During a broker deal examination by the Commission staff, Mr. Jaschke’s use of personal e-mail was pointed out to the firm. The staff was assured that Mr. Jaschke’s personal e-mail was properly saved. In fact, it was not. Although the firm had a policy regarding the use of personal e-mail, it failed to monitor it and failed to ensure that the e-mail was properly maintained.

The Order for Proceedings charged the brokerage firm with failing to reasonably supervise Mr. Jaschke and to detect and prevent his violations of the antifraud provisions of the Securities Act and the Exchange Act.

To resolve the action, the firm consented to the entry of a cease and desist order. It also agreed to pay disgorgement of $1,224,606, pre-judgment interest of $233,699 and a civil penalty of $500,000. In addition, the firm will retain an Independent Consultant to review its written supervisory policies, prepare a report with recommendations for improvements and changes which the firm will adopt.

In the opening scenes of the film The American President, Michael Douglas as President Andrew Shepard, rebuffs his chief of staff over a piece of draft legislation. The staff member wants to propose a much more aggressive piece of legislation than what the President is backing. President Shepard cautions that governing is about the art of the possible, or essentially taking what you can get, even if it is not that meaningful. By the end of the film, the President once again finds the basic principles which got him elected, scraps the watered down draft bill and begins a campaign for legislation that is meaningful and which the country needs, vowing to fight the battle door-to-door.

Currently, Congress is considering legislation on financial reform. In the wake of what is, without a doubt, the worst market crisis since the great depression, it is clear that reform is needed. Many proposals have been made. Many bills have been proposed. Nothing is final. Assuming legislation is passed – and that is not free from doubt – will it be like the draft bill that President Shepard initially proposed or the one he vowed to enact at the end of the film? Stated differently, will the final product reflect what is possible given the Capital Hill grist mill or what is required to avert another financial crisis?

The various proposals for financial reform have clearly evolved over time. Last June for example, the Administration offered its White Paper, discussed here, which was followed by proposed legislation. Crafted to address the kinds of market turmoil that created the chaos of the market crisis, it contained key elements regulating derivatives, hedge funds, standards for those who give investment advice and called for the creation of a consumer protection agency. Since then, the House has passed a bill which adopts some of the administration’s provisions, while the Senate has yet to get a bill out of committee.

What, if anything, will emerge from this process? The fight over one key provision in the various proposals may give some indication. The administration and the SEC have strongly backed a provision which would require the harmonization of standards governing those who give investment advice. The new standard would replace the current outmoded one under which registered investment advisers have a fiduciary duty to act in the best interests of their clients while brokers and others are only required to make suitable recommendation to their clients. The difference is significant. Being required to act in the best interests of your clients means that the client comes first. That is not the obligation of a broker, subject to a suitability standard which focuses only on the investment objectives of the client. Many industry groups, such as The Securities Industry and Financial Markets Association, agree that a uniform standard should be adopted, although there is disagreement as to how to achieve that result.

The current House bill contains one version of this provision. While the initial version of the Senate committee bill had such a provision, it reportedly is being scrapped in favor of having the SEC conduct a study on the question. Translation – this is not even the beginning of The American President. As the Washington Post reported Sunday in an article on the Dodd bill (page G-1) (available here, registration required), a study commissioned by the SEC in 2008 reviewed this question and found investors were confused. There should not be any confusion. Whether the investor is a first time market participant or a more experienced person, those giving the advice should put the interests of the investor first, end of story.

More importantly however, what does dropping this important provision from the Senate bill mean for other critical issues which must be addressed? What of the proposals regarding derivatives and hedge funds? There is little disagreement, for example, that the lack of disclosure regarding derivatives coupled with rampant abuses underlies the market crisis. CFTC Chairman Gary Gensler has lead the charge on this issue, supported by former CFTC Chairman Brooksley Born, who correctly warned at the end of the Clinton Administration against deregulating those markets as discussed here, and others.

If there is going to be meaningful reform, it is critical that the legislation address the key issues and not reflect the usual Capital Hill sausage mill. Unfortunately, it appears that what is about to emerge from the Senate is the early version of the bill from the film The American President. Perhaps at some point before the legislative process ends, principle will prevail, we will fact forward to the end of the film, and meaningful legislation which fully addresses the crisis will be passed.

This week, the Supreme Court heard the appeal of former Enron executive Jeffrey Skilling, while prosecutors in the Galleon case obtained another guilty plea. DOJ settled its long running FCPA investigation with BAE. SEC enforcement focused largely on what has become a new staple – investment fund fraud cases. Finally, a new study notes that the number of restatements declined last year.

Supreme Court

U.S. v. Skilling, No. 08-1394 (S.Ct.) is the appeal of former Enron executive Jeffrey Skilling who is serving a 24 year prison sentence. His appeal to the Supreme Court, which was heard this week, presents two issues as discussed here. The first concerns the denied motion for a change of venue and jury selection. This question hinges on Mr. Skilling’s claim that the collapse of Enron was an event of such magnitude and proportion in the Houston community where the company was headquartered that he could not receive a fair trial and, in any event, the extraordinarily short jury selection process was inadequate.

The second focuses on the constitutionality of 18 U.S.C. §1346, the honest services fraud section. Mr. Skilling argued that the statute was vague and would permit virtually any workplace lie to be turned into a federal felony. This is the third honest services fraud case the Court has heard this term. Earlier the Court heard argument in Black and Weyhrauch, both of which also raised issues regarding this statute as discussed here.

SEC enforcement actions

Investment fund fraud: SEC v. Morton, Civil Action No. 10-CV-1720 (S.D.N.Y. Filed Mar. 4, 2010) is an action based on alleged violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b) against Sean Morton, his wife Melissa, and their controlled entities. According to the complaint, Mr. Morton used his reputation as a nationally known psychic to convince investors to put their money in his entities which supposedly traded in foreign currencies. Investors were told Mr. Morton would use his psychic powers to guide their investments and that he had a solid track record of success. In fact, the representations were false and portions of the money were diverted to the personal use of the defendants. The case is in litigation. See also Litig. Rel. 21433 (Mar. 4, 2010).

Theft: SEC v. Wallace, Case No. 3:10-cv-440 (N.D. Tex. Filed Mar. 4, 2010) is an action against Rodney Wallace, former CEO of North American Technologies, Inc. It also names Joe Dorman and John Blank, respectively, the general counsel and former acting CFO and former controller. The complaint alleges that in 2008 Mr. Wallace stole over $538,000 from the company, primarily through fictitious purchases he claimed to have made for the company. To facilitate his scheme, he falsely certified the third quarter Form 10-Q and provided the auditors with false documents. He was charged with violations of the antifraud and reporting provisions. The other two defendants were charged with aiding and abetting violations of the internal controls and books and records provisions. Messrs. Dorman and Blank settled, consenting to the entry of permanent injunctions. Mr. Dorman also agreed to pay a $15,000 civil penalty. See also Litig. Rel. 21434 (Mar. 4, 2010). In a related administrative proceeding, the company consented to the revocation of its securities registration.

Investment fund fraud: SEC v. Mitchell, Porter & Williams, Inc., Case No. 10-CV-01567 (C.D. Cal. Filed Mar. 4, 2010) is a fraud case against Thomas Mitchell and his investment advisory firm, Mitchell Porter. It alleges that the defendants targeted retired bus drivers, convincing them to invest their retirement funds in promissory notes issued by entities operated by the investment advisory firm. About $14.7 million was solicited from 82 investors. In fact, the operation was a Ponzi scheme. The Commission obtained an emergency freeze order. See also Litig. Rel. 21432 (Mar. 4, 2010).

Investment fund fraud: SEC v. Dobens, Civil Action No. CA-10360 (D. Mass. Filed Mar. 4, 2010) alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b) by defendants Kathleen Dobens and Charles Dobens, husband and wife, their business associate Joseph Roche, and a number of controlled entities. The complaint claims that beginning in February 2009 the defendants raised about $3.5 million from 60 investors with false claims of a guaranteed return ranging from 9 to 12%. The funds were to be invested in multi-family housing assets. In fact, there was no real estate and the funds were diverted to other purposes. The complaint also alleges that the defendants engaged in other similar schemes earlier. The case is in litigation. See also Litig. Rel. 21437 (Mar. 4, 2010).

Investment fund fraud: SEC v. Cantens, Case No. 1:10-CV-20635 (S.D. Fla. Mar. 3, 2010) is an enforcement action alleging violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b) against Gaston Cantens and Teresita Cantens, the founders and co-owners of real estate developer Royal West Properties, Inc. The complaint alleges that the defendants raised $135 million in a Ponzi scheme targeting Cuban American investors. Since 1993, investors were solicited to purchase “no-risk” promissory notes which supposedly paid between 9 and 16% returns. The notes, sold to over 400 investors, supposedly were backed by recorded mortgages. Since at least 2002, there has been insufficient returns to pay investors. The complaint claims the defendants have misappropriated about $20 million. The case is in litigation. See also Litig. Rel. 21430 (Mar. 3, 2010).

Financial fraud: SEC v. Verint Systems Inc., Civil Action No. 10-CV-0930 (E.D.N.Y. Mar. 3, 2010) is an action against a former subsidiary of Comverse Technology, Inc., which conducted an IPO in 2002. Beginning prior to the IPO, and continuing after, the company used its reserves to manipulate its financial statements and meet its objectives. As a result, the financial information used in the offerings was false. The complaint alleges violations of Securities Act Sections 17(a) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The company settled the action by consenting to the entry of a permanent injunction based on the sections cited in the complaint. The settlement reflects the cooperation of the company. See also Litig. Rel. 21428 (Mar. 3, 2010). In a separate proceeding, the Commission issued an Order Instituting Administrative Proceedings Pursuant to Exchange Act Section 12(j) to determine whether the registrations for the classes of securities of the company should be revoked. In the Matter of Verint Systems Inc., Adm. Proc. File No. 3-13802 (March 3, 2010).

Investment fund fraud: SEC v. Haugen, Civil Action No. 1: 09-CV-0129 (N.D. Ga.) is a fraud action based on Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a) in which the court granted the SEC’s motion for summary judgment. The complaint against Ross Haugen alleged fraud in connection with the sale of shares under private placement memos in four different funds. According to the SEC, about $30 million was raised over a two year period beginning in 2006. Investors were told that their funds would be invested in “risk controlled” strategies. They were furnished with monthly statements showing returns of 4%. In fact, the money was in off shore trading platforms and the statements were false as were the representations in the PPMs furnished to investors. See also Litig. Rel. 21429 (Mar. 3, 2010).

Financial fraud: SEC v. American Equity Investment Life Holding Co., Case No. 4:10-cv-87 (S.D. Iowa Filed Mar. 3, 2010) is an action against the life insurance company, its founder and Chairman, David Noble, and CFO Wendy Waugaman. The complaint, which alleges violations of Exchange Act Section 14(a), centers on claimed failures to properly disclose certain benefits in the proxy obtained by Mr. Noble when he sold a finance company he owned to American Equity. According to the complaint, the 2006 proxy failed to disclose that in the acquisition Mr. Noble was relieved of personal guarantees he had executed for the company whose liabilities exceeded its assets at the time of the transaction. He also faced personal liability for its debts and just before the deal caused a $2.5 million distribution which constituted most of its assets. Accordingly, the disclosures in the 2006 proxy statement were false and misleading. The action was settled with each defendant consenting to the entry of a permanent injunction. In addition, Mr. Noble agreed to pay a penalty of $900,000 and Ms. Waugaman will pay a $130,000 penalty. The company also agreed to certain corporate governance undertakings. See also Litig. Rel. 21431 (Mar. 3, 2010).

Investment fund fraud: SEC v. May, Civil Action No. 3:10-cv-425 (N.D. Tex. Filed Mar. 2, 2010) is an action based on alleged violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b) against Alan May and his controlled entity, Prosper Oil and Gas, Inc. The complaint alleges that Mr. May raised over $6 million from investors through unregistered and fraudulent offerings in oil and gas royalties. Investors were solicited through a website and a number of publications. Investors were falsely told they would earn between 25 and 38% returns. The SEC obtained emergency relief from the court. The case is in litigation. See also Litig. Rel. 21436 (Mar. 4, 2010).

Criminal cases

U.S. v. Hariri, Case No. 1:09-mj-02436 (S.D.N.Y. Filed Nov. 4, 2009) is the insider trading case against Ali Hariri, formerly an executive at Atheros Communications, Inc. This is one of the Galleon cases. Mr. Hariri pleaded guilty to a two count information which charged him with conspiracy and securities fraud as discussed here. The information alleges that Mr. Hariri obtained information regarding Atheros’ future earnings announcement for the fiscal quarter and furnished it to an unidentified hedge fund operator. The hedge fund operator used this information to purchase over 500,000 shares of Atheros and profited from a 6% increase in the share price when the earnings were announced. Sentencing has not been scheduled.

FCPA

U.S. v. BAE Systems plc, Case No. 1:10-cr-035 (D.D.C. Filed March 1, 2010) is an FCPA case in which the company pleaded guilty to conspiring to defraud the U.S., to making false statements about its FCPA compliance program and to violating the Arms Export Control Act and International Traffic in Arms Regulations as discussed here.

The case centers on conduct from 2000 to 2002. According to the court papers, the company falsely represented to DOJ and other agencies that it would create and implement policies and procedures to ensure compliance with the FCPA and similar foreign laws implementing the Organization for Economic Cooperation and Development Anti-bribery Convention. In fact, these statements are false as evidenced by the fact that the company engaged in a series of wrongful actions such as making a number of substantial payments to shell companies and third party intermediaries that were not reviewed in accord with representations made to the U.S. government and by regularly retaining so-called “marketing advisors” to assist in selling defense items without scrutinizing the relationships and at times concealing them. The company also made corrupt payments to influence foreign officials and falsified applications for export licenses for military hardware. The company was sentenced to pay a $400 million criminal fine. It will also adopt a comprehensive FCPA compliance program.

New study on restatements

A new report prepared by Audit Analytics concludes that the number of restatements declined last year by about 27% compared to the prior year. In 2009 630 companies filed restatements compared to 674 in the prior year. For 30% of the companies filing restatements, there was no real change in reported income, while for 16% there was a positive impact. In each of the others income was reduced. The majority of the restatements were from smaller companies who do not need to conform to Section 404 of Sarbanes Oxley, according to the report.

The much discussed blue collar tactics in white collar cases are continuing to roll up guilty pleas for the Government in the Galleon insider trading case. Yesterday, Ali Hariri, formerly an executive at Atheros Communications, Inc., pleaded guilty to a two-count information which charged him with conspiracy and securities fraud. Previously, a criminal complaint had been filed against Mr. Hariri. U.S. v. Hariri, Case No. 1:09-mj-02436 (S.D.N.Y. Filed Nov. 4, 2009). While the Galleon cases are not the first white collar cases to employ so-called blue collar tactics, they may be the most prominent example of what appears to be an increasing trend.

A court ordered wire tap is at the center of the factual allegations in the information. In January 2009, according to court papers, Mr. Hariri obtained information regarding Atheros’ future earnings announcement for the fiscal quarter and furnished it to an unidentified hedge fund operator. Specifically, during one telephone call Mr. Hariri told the hedge fund operator the revenue numbers for the fiscal quarter ending December 2008 before their public release. The hedge fund operator used this information to purchase over 500,000 shares of Atheros.

Just days after the Atheros shares were purchased, the company announced its quarterly earnings. They exceeded the expectations of analysts. Following that announcement, the share price increased by 6%. The hedge fund operator sold the shares at a substantial profit, according to the information.

The case against Mr. Hariri was initially named in a criminal complaint, filed along with two others, U.S. v. Goffer, Case No. 09 Mag 2437 (S.D.N.Y. Filed Nov. 4, 2009) and U.S. v. Shah, Case No. 09 Mag 2306 (S.D.N.Y. Filed Nov. 4, 2009) discussed here. Subsequently, indictments were handed down against several of the defendants in those cases as discussed here.

The plea by Mr. Hariri is just the most recent for the Government in these cases. Guilty pleas have also been obtained from: Anil Kumar, a former senior partner and director at international consulting giant McKinsey & Co.; Rajiv Goel, a former director of strategic investments at Intel Capital, the investment arm of Intel Corporation; and Mark Kurland, a former senior executive at New Castle LLC, the fund where Raj Rajaratnam codefendant Danielle Chiesi was employed. In the wake of those guilty pleas, a superseding indictment was brought against Mr. Rajaratnam, the founder of Galleon, and Ms. Chiesi as discussed here. The new indictment adds detail about the insider trading allegations and significantly increased the amount of the forfeiture claims. That criminal case, along with the parallel SEC actions, is currently in litigation and moving toward trial. Perhaps the real question from these cases is how many more guilty pleas and thus Government witnesses the blue collar tactics will yield before the trial date.

It was round three for honest services fraud, Section 1346 of the criminal code, passed after the Supreme Court held that the mail fraud statute does not cover intangible honest services fraud in McNally v. U.S., 360 U.S. 350 (1987). The statute is frequently the weapon of choice when the Government wants to indict corporate executives in white collar cases. Previously, the High Court heard the appeals of Canadian newspaper magnet Conrad Black and Alaska legislator Bruce Weyhrauch, discussed here.

On Monday, the Court heard the appeal of former Enron CFO Jeffrey Skilling, which also challenges Section 1346. Unlike the earlier two cases however, Skilling squarely raises the question regarding whether the statute is unconstitutionally vague. Both Black and Weyhrauch had argued for limitations on the construction of the statute which eliminated the potential constitutional infirmity while precluding the Section from applying to them. Prevailing on this issue will not win the release of Mr. Skilling from prison where he is serving a 24 year sentence.

Mr. Skilling’s appeal raised two issues for consideration by the Court. One issue which could win him a new trial concerns a denied motion for a change of venue and jury selection. The second challenging the constitutionality of the honest services fraud statute. U.S. v. Skilling, No. 08-1394 (S.Ct.).

The change of venue question hinges on Mr. Skilling’s claim that the collapse of Enron was an event of such magnitude and proportion in the Huston community were the company was headquartered that he could not receive a fair trail. This differs from a situation where pretrial publicity inflamed potential jurors, although publicity contributed to the atmosphere here. Conceding that the High Court has never concluded that the refusal to change venue is reversible error except in a capital case, Mr. Skilling’s counsel focused on the epic proportions of Enron’s collapse and the scant amount of time permitted for jury selection by the district court – a mere five hours overall and about 4 ½ minutes per juror in questioning primarily by the court. This compares to eighteen days and one hour per juror in the Oklahoma City bomber case after a change of venue and six days in the Martha Stewart case.

The Government countered, arguing that jury selection was fair. Its argument focused on two points. First, an extensive questionnaire was used to help evaluate jurors. Second, although the time was short and questioning by counsel limited, the selection process was conducted by a very experienced trial judge who could look the jurors in the eye as he questioned them.

Some members of the Court expressed skepticism regarding the fairness of the selection process, particularly in view of the very short time and the truncated questioning. Justice Breyer repeatedly expressed what may well be the focus of the issue for the Court. On the one hand the Justice expressed real concern as to whether Mr. Skilling received a trial by a fair and impartial jury given the selection process. At the same time, Justice Breyer conceded little actual experience in the area and expressed extreme reluctance to become involved in conducting a trial, effectively second guess an experienced district court judge who looked each juror in the eye to evaluate them. Any rule rejecting the district court’s procedure could lead to real difficulties in terms its limitations and application. In the end, it appeared that Justice Breyer and others left the argument with the intent of conducting a detailed review of the transcript for the jury selection process.

Honest services fraud was clearly on the Court’s mind throughout the arguments. Chief Justice Roberts abruptly moved the argument to a discussion of the statute during the presentation by the Petitioner and the Respondent. Although less animated than during the Black and Weyhrauch arguments held in December 2009, it was clear that the Justices were focused on the constitutional this issue which the Solicitor General had not briefed in those cases.

Petitioner claimed that the statute was vague. Encapsulating his argument in a single sentence, at one point counsel for Mr. Skilling noted that under Section 1346 virtually any work place lie can turn into a federal felony. In making this argument, Petitioner tried to focus on the shifting positions of the Government, a point which became evident later when the Solicitor General acknowledged that, in this case, the district court used the Fifth Circuit pattern jury instruction which is broader than the theory being argued to the Supreme Court. He also conceded in response to Justice Scalia that the instruction is somewhat circular.

Despite the concession regarding the actual jury instruction used here, the Solicitor General maintained that the statute is not vague. Focusing on the facts of the case, the Government contended that in this particular case the honest services fraud was actually a subset of the securities fraud. Furthermore, the language of the statute is defined by the pre-McNally case law and, in essence, the language of the statute is a term of art referencing that case law. In any event, the language of the statute is clear enough at its core, the Government argued.

As in Black and Weyhrauch the Justices repeatedly expressed concern about the open-ended breadth of the statute. At one point, Justice Kennedy pointedly noted that the Court is not supposed to rewrite statutes. Justice Scalia echoed this theme later, noting that just because some types of conduct clearly fall within the statute does not change the fact that it is vague. While at one point, the Chief Justice suggested that Petitioner had conceded the vagueness argument, at another, he clearly rejected the Government’s claim that the statute somehow contained a term of art for the pre-McNally case law. Again, Justice Breyer may have summed up the comments of the Justices when, toward the conclusion of the arguments, he commented that it is not the obvious cases that concern him but those which are not.

The Court is expected to hand down a ruling in Skilling, as well as Black and Weyhrauch, before its recess at the end of June.

DOJ concluded its long-running FCPA investigation into BAE Systems plc. The company pled guilty to conspiring to defraud the U.S., to make false statements about its FCPA compliance program and to violate the Arms Export Control Act and International Traffic in Arms Regulations. U.S. v. BAE Systems plc, (D.D.C. Filed March 1, 2010).

The case, which has been under investigation for years in this country and the UK as discussed here, centers on conduct from 2000 to 2002. According to the court papers, the company falsely represented to DOJ and other agencies that it would create and implement policies and procedures to ensure compliance with the FCPA and similar foreign laws implementing the Organization for Economic Cooperation and Development Anti-bribery Convention. Instead the company:

• Knowingly and willfully failed to create mechanisms to ensure compliance resulting in a gain from the false statements to the U.S of $200 million;

• Made a series of substantial payments to shell companies and third party intermediaries that were not reviewed in accord with representations made to the U.S. government;

• Regularly retained “marketing advisors” to assist in selling defense items without scrutinizing the relationships and at times took steps to conceal these relationships, using off-shore entities and accounts;

• Through a British Virgin Islands entity, made more than $150 million in payments that were in probability used to influence foreign government decisions;

• After the UK Government and the Kingdom of Saudi Arabia entered into a formal understanding, began providing substantial benefits to a foreign public official of the Kingdom in a position to influence the sale of fighter jets;

• Made false and incomplete statements to the U.S. government in connection with the administration of certain regulatory functions;

• Knowingly and willfully failed to identify commissions paid to third parties in soliciting and promoting the sales of defense items in violation of Arms Export Control Act and International Traffic In Arms Regulations; and

• Filed false applications for export licenses for Gripen fighter jets to the Czech Republic and Hungary by failing to tell the export license applicant or the State Department of payments made to an intermediary with a high probability that they would be used to influence the tender process.

BAE, which does business in the U.S. through a Rockville, Maryland subsidiary not implicated in the violations, will pay a $400 million criminal fine and adopt a comprehensive FCPA compliance program.

Pleading standards in SEC enforcement actions are suppose to be uniform under the Federal Rules of Civil Procedure. Two rulings last week, however, highlight the different standards that apply in those actions when pleading the key element of scienter. In one, the SEC was only required to plead scienter generally. In the other, the court applied the same standard, but followed the pre-PSLRA Second Circuit case law by imposing a heightened two-part test, at least portions of which were written into the Reform Act by Congress. While the SEC met each standard, its complaint was dismissed in the first for other pleading violations. SEC v. Medical Capital Holdings, Inc., Case No. CV 00-818 (C.D. Cal. Filed July 20, 2009); SEC v. Reserve Management Company, Inc., Case No. 09 Civ. 4346 (S.D.N.Y. Filed May 5, 2009).

Medical Capital Holdings is an action against the company and its principals, alleging fraud in connection with the sale of notes issued by a special purpose entity controlled by the company. The SEC complaint claims that the defendants defrauded investors by misappropriating about $18.5 million of investor funds and by making misrepresentations in the offering materials.

In ruling on a motion to dismiss, the first amended complaint the court rejected claims that the SEC failed to adequately plead fraud with particularity. To the contrary, the court concluded that the Commission had specifically identified false statements in the offering materials. In reaching this conclusion, the court rejected a defense argument that the SEC should be required to identify specific individuals who were defrauded.

In ruling on the adequacy of the allegations regarding scienter, the court rejected a claim by the defendants that the Private Securities Litigation Reform Act requires the SEC to meet a heightened pleading standard. That statute on its face does not apply to the SEC. Rather, quoting Federal Civil Rule 9(b) regarding the pleading of fraud, the court held that the Commission need only plead “[m]alice, intent, knowledge, and other conditions of a persons mind . . . generally.” The SEC met this standard, but failed to adequately plead with particularity how the materials containing the false statements were used in the offering. Accordingly, the complaint was dismissed with leave to amend.

Reserve Management is the Commission’s enforcement action stemming from the collapse of The Reserve Primary Fund, the first fund to “break the buck,” as discussed here. In ruling on the adequacy of the SEC’s complaint, the court agreed that the PSLRA does not apply by its plain terms, rejecting a defense argument. Accordingly, it is beyond dispute that the more relaxed pleading standard of Federal Civil Rule 9(b) need only be met.

The Second Circuit, however, has long held that a securities law plaintiff alleging fraud must plead facts which give rise to a strong inference of fraudulent intent the court noted, citing Novak v. Kasaks, 216 F.3d 300 (2nd Cir. 2000). While the Second Circuit has yet to decide how, if at all, Tellabs, Inc., v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) may apply, it is clear under Novak that plaintiff must plead facts demonstrating a strong inference by either alleging facts that show the defendants had both motive and opportunity to commit fraud, or by pleading facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness. In Reserve Management, the court found that the SEC had met the pleading standard. Accordingly, the motion to dismiss was denied.

While in the end each court agreed that the PSLRA standard does not apply to SEC enforcement actions and that Civil Rule 9(b) governs, the tests used are significantly different. The pleading “generally” standard of the Rule used in Medical Capital Holdings meant just that – a general allegation is sufficient. In contrast, in Reserve Management the same pleading “generally” standard means a strong inference of scienter as demonstrated by a two part test. Ironically, the Second Circuit uses that same two-part test to evaluate compliance with the heightened scienter pleading requirements of the PSLRA which both courts concluded do not apply here.

This week, the on-going saga of the SEC’s litigation against Bank of America drew closer to resolution with tentative court approval of a proposed settlement. The Commission voted 3-2 to adopt the alternative uptick rule. SEC enforcement brought another case based on the Madoff fraud, an insider trading action and more investment fund fraud cases. DOJ obtained a guilty plea in another Ponzi scheme and an FCPA case.

Market crisis

The Commission adopted the new alternative uptick rule this week over the strong dissent of Commissioner Paredes as discussed here. In essence, the rule would go into effect when a “circuit breaker” is tripped. That happens if the price of a security declines by 10% or more from the close of the previous day. In that instance, the “alternate uptick rule” goes into effect for the balance of the day and the next. The rule applies generally to all securities traded on a national securities exchange, as well as those in the over-the-counter markets. It also requires traders to establish and maintain certain procedures designed to aid implementation and enforcement of the rule.

SEC v. Bank of America

Judge Jed Rakoff tentatively approved the latest proposed settlement of the Commission’s two cases against the bank, subject only to submission of the final papers modified pursuant to suggestions by the Court. The underlying cases claim that the bank improperly failed to disclose to shareholders voting on the acquisition of Merrill Lynch by the bank billions of dollars in approved bonuses for executives of the broker and unprecedented fourth quarter losses of Merrill which undermined the value of the deal as discussed here.

Although the parties won approval of the new settlement, discussed here, the Court made it clear that approval was given reluctantly. Throughout its opinion, the court repeatedly returned to two points. One concerned the culture of Bank of America, which it described as being based on a presumption of non-disclosure. While the corporate governance provisions of the settlement will help correct this, they apparently did not go far enough for the Court.

The second point focused on the penalty. While the penalty is modest for both cases, according to Judge Rakoff, the critical problem is that it is really inflicted on the shareholders. If it is to have any significant deterring impact, it must be imposed on the individuals responsible. Since neither the fine, nor the remedial measures are directed at the specific individuals involved, the impact is likely to be “very modest” and results in “half-baked justice . . .,” according to the Court. In the end, however, the Court deferred to the parties, noting its limited role in approving settlements. Accordingly, the settlement will be approved when modified papers are submitted which adopt additions proposed by the Court to strengthen the governance provisions.

SEC enforcement actions

Insider trading: SEC v. Foley, Civil Action No. 1:00-cv-00300 (D.D.C. Filed Feb. 25, 2010) is an insider trading case brought against John Foley, Aaron Grassian, Timothy Vernier and Bradley Hale. According to the SEC, Mr. Foley, who worked as an employee benefits specialist at Deloitte, obtained material non-public information regarding three firm clients which was passed to Messrs. Grassian and Vernier. Each traded at a profit. Mr. Grassian later returned the favor by providing material non-public information to Mr. Foley about a take-over. Mr. Grassian learned about the pending deal from Mr. Hale, who was employed at one of the companies. Mr. Hale did not trade. To settle the case, each defendant consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions. Each of the three defendants who traded also agreed to disgorge their profits which collectively exceeded $210,000 and pay prejudgment interest. Mr. Foley did not pay a penalty and Mr. Vernier paid a reduced penalty based on their financial condition. Mr. Grassian agreed to pay a penalty equal to his trading profits. See also Litig. Rel 21425 (Feb. 25, 2010).

In a related administrative proceeding, Tara Eisler, who permitted Mr. Foley to repeatedly use her brokerage account to trade in the securities of firm clients consented to the entry of a cease and desist order that she not engage in future violations of Exchange Act Section 10(b). In the Matter of Tara L. Eisler, Adm. Proc. File No. 3-13792 (Filed Feb. 25, 2010).

Cover-up/fraud: SEC v. Bonventre, Case No. 10 CV 1579 (S.D.N.Y. Filed Feb. 25, 2010) is an action against the former director of operations of Bernard Madoff Investment Securities. The complaint alleges violations of the antifraud provisions of the Securities Act, the Exchange Act and the Advisers Act and aiding and abetting violations of Exchange Act Sections 15(c) and 17(a). Mr. Bonventre, who worked for the Madoff firm for thirty years, is charges with helping conceal the fraud by falsifying the books and records of the broker dealer by not properly accounting for the investor funds. To conceal the fact that the firm was operating at a significant loss, over $750 million in investor funds were used to bolster the finances of the firm. According to the SEC’s complaint, Mr. Bonventre made about $1.9 million as part of the scheme. See also Litig. Rel. 21424 (Feb. 25, 2010). The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal charges, discussed below.

Investment fund frauds: SEC v. Loomis, Case No. 2:10-cv-00458 (E.D. Cal. Filed Feb. 23, 2010) is an action against Lawrence Loomis and his father-in-law John Hagener. According to the SEC, the two men, and their controlled entities, misappropriated about $10 million raised from about 100 investors. The money was raised at “Loomis Wealth Solutions” seminars in 2007 and 2008. Investors were told that their funds would be loaned to home buyers and secured by real estate. A 12% return was supposedly guaranteed by a third party. In fact, the funds were misappropriated. The fraud complaint is in litigation. See also Litig. Rel. 21422 (Feb. 23, 2010).

Investment fund frauds: SEC v Pacific Asian Atlantic Foundation, Case No. CV 10-1214 (C.D. Cal. Filed Feb. 18, 2010) is an action against Samuel M. Natt and his controlled entity Pacific Asian Atlantic Foundation. The foundation is supposedly a non-profit humanitarian organization based in California. Mr. Natt, over a three year period beginning in 2009, created billions of dollars in bonds supposedly issued by the company. The bonds were bolstered by false financials. The scheme was to deposit the bonds with brokers and then use them as the basis for loans. Despite repeated efforts Mr. Natt failed to actually implement the scheme as discussed here. The case was settled when Mr. Natt and his company consented to the entry of permanent injunctions prohibiting future violations of Sections 17(a)(1) &(3) of the Securities Act. Mr. Natt also agreed to pay a penalty of $50,000. See also Litig. Rel. 21417 (Feb. 19, 2010).

Criminal cases

U.S. v. Bonventre, Case No. 10 Mag 385 (S.D.N.Y. Filed Feb. 25, 2010) charges Daniel Bonventre, formerly the director of operations for Bernard Madoff Investment Securities, with conspiracy and securities fraud. According to the criminal complaint, Mr. Bonventre, who was arrested yesterday, helped Mr. Madoff conceal the largest Ponzi scheme in history. The SEC filed a parallel civil case which is discussed above.

U.S. v. Nadel, 1:09-cr-0433 (S.D.N.Y.) is a Ponzi scheme case in which promoter Arthur Nadel pleaded guilty to fifteen fraud counts. According to the indictment, Mr. Nadel ran a classic Ponzi scheme through which he raised over $350 million from about 370 investors over a ten year period beginning in 1999. During the operation of the scheme, Mr. Nadel told potential investors that his fund yielded between 11% and 55% per year when in fact it had negative results. As part of the plea, Mr. Nadel will forfeit $162 million. Sentencing has not been scheduled.

FCPA

U.S. v. Fourcand, 10 cr 20062 (S.D. Fla. Filed Feb. 1, 2010) is an FCPA case based on a one count information alleging money laundering which named Jean Fourcand as a defendant. Mr. Fourcand, who pleaded guilty to the information, is alleged to have been involved in a scheme to bribe an official of the Republic of Haiti’s state owned national telecommunications company. Specifically, Mr. Fourcand admitted he received funds between November 2001 and August 2002 from U.S. telecommunications companies used to make improper payments to the foreign officials. Mr. Fourcand agreed to forfeit $18,500 in connection with the plea.

Alcatel-Lucent SA has, reportedly reached a tentative agreement with the Department of Justice and the SEC to resolve FCPA charges. The charges stem from bribes paid in Costa Rica, Taiwan and Kenya, according to a company filing. Under the agreement, Alcatel-Lucent SA will enter into a deferred prosecution agreement with the Department and pay a fine of $137.4 million, of which $92 million is a criminal fine and $45.4 is a civil penalty paid in connection with the SEC settlement. Three subsidiaries, Alcatel-Lucent France, Alcatel-Lucent Trade and Alcatel Centroamerica will plead guilty to violating the anti-bribery provisions of the FCPA.

State cases

The NY AG continues to resolve actions stemming from the crash of the auction rate securities market. This week the AG settled with Oppenheimer. Under the terms of the agreement, the firm will repurchase ARS from individuals, charities, non-profits and other small investors. It will later attempt to buy back other frozen ARS when resources become available. This settlement reflects the same basic pattern as others in this market.

The subject of short selling tends to create controversy. Since at least the abolition in 2007 of the 1930s era uptick rule which was designed to curb abusive short selling, the debate has continued over the merits of short selling. The SEC’s temporary restrictions on the practice as the market crisis unfolded in 2008 for example, provoked strong opinions on both sides of the debate. Since then, the Commission has taken a number of steps regarding short selling.

The tradition of controversy continued this week at the Commission’s open meeting which resulted in the adoption of the “alternative uptick” rule by a 3-2 vote. The Chairman and other members of the SEC such as Commissioners Walter and Aguilar favored adoption of the rule. Commissioners Paredes and Casey on the other hand did not. Each side claimed that investor confidence supported their position. Neither side could definitively prove its point. The new rule, however, is in effect.

The new alternative uptick rule is well summarized in the open meeting remarks of Chairman Schapiro. Briefly, the rule would go into effect when a “circuit breaker” is tripped. That happens where the price of a security declines by 10% or more from the close of the previous day. In that instance, the “alternate uptick rule” goes into effect for the balance of the day and the next. The rule applies generally to all securities traded on a national securities exchange, as well as those in the over-the-counter markets. It also requires traders to establish and maintain certain procedures designed to aid implementation and enforcement of the rule.

Chairman Schapiro endorsed the rule as a product of the market crisis. While short selling clearly has benefits, it also can be destabilizing to the markets, she noted. The new rule will prevent manipulation and, when the circuit breaker is tripped, put long traders at the head of the line according to Ms. Schapiro. Commissioner Aguilar echoed Ms. Schapiro’s support for the rule while prodding Congress to move forward with market reform and fill the gaping hole in current regulation regarding swaps.

Commissioner Walter found the decision most difficult, but ultimately supported the rule as a measured response. After noting that she has been intensely lobbied by both sides of the short selling debate, Ms. Walter went on to state that while short selling can be very beneficial to the markets, it can also have detrimental effects. The numerous studies of those effects are, at best, “mixed” according to the Commissioner. Accordingly, she would not favor short sale restrictions on a market wide basis. Since the rule being adopted is measured and only applies in certain limited circumstances – when the circuit breaker is tripped – Ms. Walter favored adoption.

In contrast, Commissioner Tory Paredes offered a lengthy dissent from the adoption of the rule. In essence, Commissioner Paredes argued that there is no evidence that adopting the rule would bolster investor confidence in the markets, which is one of the main rationales offered in support of the rule. Rather, the Commission is being inconsistent at best with the adoption of this rule according to Mr. Paredes. On the one hand, it has lengthy studies which supported dropping the initial version of the uptick rule. Now, however, it is adopting a modified version of that rule despite the fact that little has changed since the old rule was disregarded. The market crisis, according to Commissioner Paredes, did not change this fact.

In sum, Commissioner Paredes argued: 1) short selling is essential to proper market functioning and price discovery; 2) there are already sufficient restrictions in place; 3) the prior empirical research which supported dropping the old uptick rule is still valid; and 4) the adoption of the rule will be costly in terms of its implementation and its potentially negative impact on proper functioning markets, price discovery and investor confidence.

By the end of the Commission’s open meeting two points were clear: First, the rule was adopted. Second, both sides claim that investor confidence is critical to their position, despite what Commissioner Walter called the “mixed” results of the studies. In the end, there is little doubt that the controversy regarding the impact of short selling will continue.