As the week drew to a close reports surfaced of a rogue trader who had run up $2 billion in trading losses at UBS in London while the SEC reportedly is expanding its market crisis probe. At the same time Congress heard testimony from SEC Chairman Mary Schapiro regarding the Commission’s efforts to improve its performance and her concerns regarding two bills before the House Financial Services committee. These bills propose to reshape the organization of the agency and impose additional economic and cost analysis factors on SEC rule making.

Key cases this week centered on the FCPA and insider trading. In the former the DOJ announced a plea agreement by a large corporation by to conspiracy to bid rig and conspiracy to violate the FCPA. The Manhattan U.S. Attorney continued the war on insider trading, filing new charges which were echoed by the Commission. The SEC also continued to focus on investment fund fraud actions.

Finally, the FSA brought another action based on suitability claims. This is one of a series of actions charging suitability brought by the regulator.

The Commission

SEC reform: Chairman Mary Schapiro testified before the House Committee on Financial Services. Her remarks are titled: Testimony on “Fixing the Watchdog: Legislative Proposals to Improve and Enhance the Securities and Exchange Commission.” During a substantial part of her testimony, the Chairman recounted recent enforcement statistics, organizational changes, the findings of the Boston Consulting Group and the current analysis of the recommendations in that report being conducted by the staff. The Chairman also briefly commented on two bills before the Committee. The first, The SEC Modernization Act of 2011, is of concern, the Chairman noted, because it would impose a rigid structure on the Commission’s organization which would make it hard to keep pace with changing markets. The second, the SEC Regulatory Accountability Act, would require a more rigorous economic and cost-benefit analysis by the Commission in rule making. This proposal is of concern according to the Chairman because some of the factors were duplicative of existing requirements while others were unrelated to SEC rulemaking, unclear or contradicted the mission of the agency. The testimony is here.

Small business advisory committee: The Commission announced the formation of an advisory committee on small and emerging companies. The committee will advise on issues which include capital raising through private placements and public securities offerings, trading in the securities of small and emerging companies and public reporting requirements for these companies (here). In a separate statement Commissioner Aguilar noted that he only voted for the proposal on condition that an investor advisory committee be re-established at the same time (here).

SEC enforcement – filings and settlements

Fraudulent offering: SEC v. O’Reilly, Case No. 4:11-cv-592 (E.D. Tx. Filed Sept. 15, 2011) is an action against James O’Reilly, James McAluney and Martin Cutler. It alleges that from December 2007 until July 2009 the defendants raised about $16 million from 130 investors through fraudulent Rule 506 Regulation D offerings of membership interests in Shale Synergy, LLC, Shale Synergy II and Ranch Rock Properties, LLC. Investors were promised returns from 7.5% to 9% per quarter from investments in oil and gas interests to be acquired by the entities. About $13 million of the funds were diverted to an undisclosed partner of the defendants. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The case is in litigation.

Investment fund fraud: SEC v. Dunn, Case No. 4:11-CV-00577 (E.D. Tx. Filed Sept. 12, 2011) is an action against Jody Dunn who is alleged to have solicited investments over a three year period from those in the deaf community. The defendant is also deaf. Defendant Dunn raised over $3.45 million for Imperia Invest IBC without verifying that any of the money was ever invested. In fact much of the money raised by the defendant was diverted to personal use. Defendant Dunn continued to raise money for Imperia even after the SEC brought a fraud action against the company. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending.

Selected district court decisions

Primary liability: Hawaii Ironworkers Annuity Trust Fund v. Cole, Case No. 3:10CV371 (N.D.Oh. Decided Sept. 7, 20911) arose out of the bankruptcy of Dana Corporation following a restatement caused by a financial fraud. The four defendants were officers of the company who worked in the operating divisions. Dana’s former CEO and CFO and top management set a 6% profit margin for the company which was not based on forecasts or performance. The operating divisions were essentially required to prepare results showing the specified profit margin. The defendants did as instructed.

In considering the question of primary liability the court began by concluding that the Supreme Court’s decision in Janus applies to corporate insiders such as the defendants. The key question here is who is the ultimate authority as to the making of the statement. The four defendants here clearly were not. Rather, they acted in response to the mandatory directives of senior officers. Accordingly, the court reversed its earlier ruling as to Rule 10b-5(2) and dismissed the claim. However subsections (a) and (c) of Rule 10b-5 are concerned with deceptive conduct. Such conduct can be a basis for primary liability. While a plaintiff must establish reliance to sustain such a claim, attribution is not required. Here the defendants engaged in manipulative conduct according to the allegations of the pending complaint. Accordingly, the court declined to reconsider that portion of its earlier ruling which held that under subsections (a) and (c) of the rule the four defendants can be held primarily liable.

Criminal cases

Insider trading: U.S. v. Allen (S.D.N.Y. Filed Sept. 15, 2011) and SEC v. Allen, (S.D.N.Y. Filed Sept. 15, 2011) are actions against Scott Allan, a former consultant at a global human resources consulting firm, and John Bennett, an independent film producer. The charges in each case center around two take-over transactions. Mr. Allan’s firm was an adviser on each deal. The first concerned the April 2009 acquisition of Millennium Pharmaceuticals, Inc. by Takeda Pharmaceutical Company Limited. The second involved the September 2009 acquisition of Sepracor, Inc. by Dainippon Sumitomo Pharma Co., Ltd. According to the charging papers, from late February through early April 2008 Mr. Bennett purchased about 1,090 Millennium call options for $17,000. Following the announcement the share price rose about 50%. Mr. Bennett sold the call options for about $690,000.

Similarly, from late May through mid-July 2009 Mr. Bennett purchased about 1,700 Spracor call options after at a total cost of $227,000. Following the deal announcement the share price rose about 26% giving Mr. Bennett a profit of about $682,000. Mr. Bennett also tipped a co-worker who traded. Collectively the two traders had profits of about $2.6 million. Mr. Allan received about $100,000 in cash paid in multiple installments for the information.

The defendants took steps to avoid detection by meeting in person and using public phones. The authorities reportedly tracked them in part through subway passes and ATM withdrawals. Mr. Allen is also alleged to have lied to FBI agents who questioned him about his relationship with Mr. Bennett. In the criminal case each defendant is charges with one count of conspiracy to commit securities fraud and two counts of securities fraud. The SEC complaint alleges violations of Exchange Act Sections 10(b) and 14(e). Both cases are pending.

Financial fraud: The DOJ resolved a financial fraud action involving O’Reilly Automotive Inc. and CSK Auto Corporation by entering into a deferred prosecution agreement executed by each company. Under the terms of the agreement CSK Auto agreed to pay a criminal fine of $20.9 million. From 2001 through 2006 senior executives at the company conspired to manipulate its earnings, according to the court papers, by manipulating certain rebates. The executives also tried to hide their fraud resulting in about $52 million in uncollectable receivables being concealed. O’Reilly Automotive acquired CSK after the scheme was disclosed to the government. The settlement reflects the extensive cooperation and remedial efforts of CSK Auto. Each of the three executives involved pleaded guilty to criminal charges and is awaiting sentencing. An SEC enforcement action brought against those executives is also pending.


U.S. v. Bridgestone Corporation (S.D.Tx. Filed Sept. 15, 2011) is an antitrust and FCPA action brought against Bridgestone Corporation. The information contains one count of conspiring to bid rig and one count of conspiracy to violate the FCPA. According to the information, from 1999 through 2007 the company was part of a conspiracy to fix prices in the marine hose market. During that period the conspiracy set prices and divided markets. To sell the products to state owned enterprises in Latin America the company authorized agents to pay bribes. Typically the company paid the agent a commission on sale and added to it the amount to be transmitted to the foreign official. To resolve this case the company has agreed to plead guilty to the information and pay a $28 million criminal fine. The resolution reflects the extensive cooperation of the company which included conducting a world wide investigation, restructuring parts of its business and taking extensive remedial steps. Bridgestone is the fifth company to be charged in this bid rigging investigation. Nine individuals have also been convicted as part of the inquiry including Misao Hioki, a former general manager of Bridgestone’s international engineered products department who was sentenced to two years in prison.

U.S. v. Grandos: Jorge Granados, the former CEO and Chairman of Latin Node from 1999 to 2007 was sentenced to serve 42 months in prison after pleading guilty to one count of conspiracy to violate the FCPA and cooperating with the government. The charges stem from his role in a bribery scheme involving the Honduras telecommunication authority. Initially he was changed with one count of conspiracy, twelve counts of FCPA bribery violations, one count of money laundering conspiracy and five counts of money laundering. The DOJ had sought a sentence of five years.


Cooperation agreement: The Board entered into a cooperative agreement with the Financial Supervisory Authority of Norway. It concerns the oversight of audit work performed by public accounting firms that practice in the jurisdiction of each regulator. It also provides for the sharing of certain confidential information between the two regulators under the Dodd-Frank Act.

Court of appeals

SLUSA: Atkinson v. Morgan Asset Management, Inc., No. 09-6265 (6th Cir. Sept. 8, 2011) is a decision in which the Circuit Court affirmed the dismissal of a class action based on SLUSA. Plaintiffs filed suit in state court against the advisers, officers, directors, distributor, auditor, and affiliated trust company of three mutual funds issued by Morgan Keegan Select Fund, Inc. The complaints assert thirteen state law claims centered on allegation that in 2007 and 2008 the defendants took unjustified risks in allocating fund assets which were concealed from the shareholders. Defendants removed the state court action to federal court under SLUSA. Plaintiffs moved for remand. The district court concluded that SLUSA precludes the action and dismissed the action with prejudice.

SLUSA precludes plaintiffs from filing a class action in state court if four elements are met: 1) the case consists of more than fifty prospective members; 2) it asserts state law claims; 3) it involves a nationally listed security; and 4) the complaint alleges “an untrue statement or omission of a material fact in connection with the purchase or sale of” that security. Here plaintiffs claim that their suit is not precluded based on what is known as the Delaware carve-out. Under this section the action can go forward and is not precluded if it “involves . . .the purchase or sale of securities by the issuer or an affiliate of the issuer exclusively from or to holders of equity securities of the issuer.” In this case however plaintiffs are neither purchasers or sellers and thus do not qualify for the carve-out. In addition, plaintiffs’ contention that their claims are not grounded in fraud is belied by an examination of the substance of the complaint. The Court also rejected plaintiffs’ claim that they could modify the complaint to reduce the number of class members or eliminate the fraud claims.

Rule 10b5-2 instruction: U.S. v. Gansman, Docket No. 10-0731-cr (2nd Cir. Decided Sept. 9, 2011). James Gansman was an attorney employed by the Transactional Advisory Services Department of Ernst & Young, LLP. Through that position he had access to confidential, material non-public information about potential mergers and acquisitions. From 2005 through late 2007 Mr. Gansman repeatedly provided information about pending deals to Donna Merdoch with whom he was having an affair. Ms. Merdoch traded in shares of companies engaged in merger talks prior to the deal announcements.

On February 25, 2010 a jury returned a verdict convicting Mr. Gansman on six counts of securities fraud.

Here the Court held that Mr. Gansman was entitled to an instruction under Rule 10b5-2 which provides that “For purposes of this section, a ‘duty of trust or confidence’ exists in the following circumstances, among others . . . whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality . . .“ A defendant in Mr. Gansman’s position can invoke Rule 10b5-2 despite evidence that he knew Ms. Merdoch was trading on the information. In this case while the district court rejected the proposed instruction offered by Mr. Gansman the one given was sufficient. Accordingly, the conviction was affirmed.


Suitability: The regulator fined Rockingham Independent Ltd. ?35,000 and restricted the activities of directors Stephen Hunt and Jonathan Edwards and adviser Gary Forster for selling unsuitable investments. Specifically, the regulator found that the firm was selling or making available to elderly, near retirement age investors Unregulated Collective Investment Schemes without adequately understanding the investments and in violation of rules which restrict promoting these investments except to sophisticated investors and high net worth individuals. The firm also provided misleading descriptions of its pension draw product as low risk when in fact it is not. The FSA has emphasized suitability in a series of actions.

Program: ABA Seminar: Is the DOJ and SEC War On Insider Trading Rewriting the Rules? ABA program, live in New York City, webcast nationally. Friday September 23, 2011 from 12 – 1:30 p.m. at Dorsey & Whitney, 51 West 52 St. New York, New York 10019.
Co-Chairs: Thomas O. Gorman, Dorsey & Whitney LLP and Frank C. Razzano, Pepper Hamilton LLP.
Panelists: Christopher L. Garcia, Chief, Securities and Commodities fraud Task Force, Assistant U.S. Attorney, Southern District of New York; Daniel Hawke, Chief, Market Abuse Unit, Securities and Exchange Commission; Stuart Kaswell, Executive Vice President & Managing Director, General Counsel, Managed Funds Association; Tammy Eisenberg, Chief Compliance Officer, General Counsel and Senior Vice President, DIAM U.S.A., Inc.
For furhter information please click here.

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