This Week In Securities Litigation (May 1, 2009)
Rejuvenation, reform and new initiatives continue to be key themes at the SEC this week. Chairman Schapiro and Commissioner Aguilar discussed the revitalization of enforcement, key rule making initiatives that will be rolled out in coming weeks, and possible legislative reforms in speeches this week, as discussed here.
SEC enforcement continued to focus on insider trading, bringing another case against a Wall Street professional and a number of tippees who traded in advance of corporate deals and filing a settled case against an attorney who used client information to trade. The Commission also brought a market crisis based financial fraud case, three more investment fund fraud actions and amended its complaint in the on-going New York kickback scandal.
In private actions, the court dismissed most of the defendants in an option backdating derivative suit arising out of backdating practices at Take-Two Interactive. Criminal actions were brought against three individuals the SEC previously accused of running Ponzi schemes.
Regulatory reform
Speeches this week by SEC Chairman Mary Schapiro and Commissioner Louis Aguilar outline reforms at the Commission as well as future rule making projects. Ms. Schapiro, in her remarks emphasized a new approach for the division of enforcement and new rule making projects. The new approach focuses on new tone at the top keyed to speed, coordination with other regulators and efficiency. As part of this effort enforcement is considering unidentified “structural” changes that would make better use of its scarce resources. The Wall Street Journal reported on April 29, 2009 that the Enforcement Division may create groups with expertise in specific areas.
Ms. Schapiro also outlined key areas for future rule making. One priority is rating agencies. A second involves corporate governance in proposed rules that will be unveiled in May. A third focuses on proposed rules to be issued in June governing credit quality, maturity and liquidity provisions for money market funds. The final area focuses on strengthening the controls over investment advisers who have custody of investor assets. These proposals will include “consideration of ‘surprise’ examinations by a certified public accountant,” according to the Chairman.
Commissioner Aguilar discussed specific improvements for enforcement as well as possible legislative reforms. He made four specific suggestions to improve enforcement: 1) delegating authority to the Director of Enforcement and Heads of the Regional Offices to open routine, non-controversial formal investigations; 2) improving the collection processes to facilitate returns to investors; 3) implementing a risk-based data analysis system; and 4) revising the corporate penalty guidelines to focus on deterring misconduct.
Finally, in discussing legislative reform, Commissioner Aguilar focused on two key points. The first is to close the regulatory loopholes. This includes hedge funds and swaps which he termed “policy mistakes.” The second turns on the question of regulating systemic risk where “the focus needs to be on ensuring the continuation of systemically important market functions, and on investor protections.” This means identifying systemically important market functions and ensuring that they are backed up properly so that if there is a failure by one entity another can step forward. Accordingly, risk regulation would focus on overarching risk to the financial system. Under this view, the SEC will continue to function as a primary regulator, according to Commissioner Aguilar.
SEC Enforcement
Insider trading: SEC v. Kara, Civil Action No. CV-09-1880 (N.D. Cal. Filed April 30, 2009) is an insider trading case brought against a Wall Street investment banker and five others (and two related actions). The defendants are: Maher Kara, former director in Citigroup Global Markets’ investment banking division in New York; his brother Michael Kara, a self-employed environmental clean up consultant; Emile Jilwan, Michael Kara’s friend; Zahi Haddad, the uncle of Maher and Michael. Kara; Bassam Salman, brother of Michael Kara’s wife; and Karim Bayyouk, Mr. Salman’s brother-in-law.
The SEC’s complaint alleges that Maher Kara repeatedly tipped his brother Michael about pending deals involving Citigroup clients. Michael Kara, in turn, traded in the shares and options of those companies and passed the information onto a network of family and friends. The scheme took place over a period of at least three year from April 2004 to April 2007. The trading in the shares of Biostie, Inc. and Andrx Corporation, detailed in the complaint along with diagrams of the tipping, occurred in 2006 and 2007. Earlier there were illegal tips regarding three companies identified only as Company A, Company B and Company C.
Michael Kara is alleged to have made more than $1.5 million in illegal trading profits. Those he tipped made more than $4.5 million. The case, which charges each defendant with violations of Section 10b and 14(e), is in litigation.
Two related cases settled. Nasser Mardini is alleged to have traded based on one illegal tip from Michael Kara. Joseph Azar, according to the complaint against him, traded on two tips from Mr. Kara.. Each agreed to settle with the SEC, consenting to the entry of permanent injunctions and agreeing to disgorge their trading profits and pay a civil penalty. SEC v. Mardini, Case No. CV 09 1882 (N.D. CA. Filed April 30, 2009); SEC v. Azar, Case No. CV 09 1881 (N.D. CA. Filed April 30, 2009).
SEC v. Browne, Civil Action No. 4:09-CV-248 (N.D. Ok. Filed April 28, 2009) is a settled insider trading action brought against Tulsa, Oklahoma attorney Matthew J. Browne. According to the SEC, Mr. Browne learned while providing legal services to a lender for SemGroup Energy Partners LP, then listed on Nasdaq, that the parent of the company had liquidity problems. Three days after selling his shares, the company announced that it had liquidity problems and was considering bankruptcy. Mr. Browne avoided a loss of about $81,000 according to the Commission. To resolve the case, Mr. Browne consented to the entry of a permanent injunction and agreed to disgorge his trading profits and pay a civil penalty equal to those profits. He also agreed to a suspension of his right to appear and practice before the Commission for five years.
Financial fraud: SEC v. Strauss, Civil Action No. 09 CIV 4150 (S.D.N.Y. Filed April 28, 2009) is a market crisis based financial fraud case as discussed here. The defendants are Michael Strauss, formerly the chairman, CEO and president of American Home Mortgage Investment Corp., Stephen Hozie, former EVP and CFO; and Robert Bernstein, former EVP and controller of the company.
Since its IPO in 1999, American Home Mortgage reported profits every quarter following its IPO in 1999. Growth came in part by originating mortgages without verifying the income of the borrowers. Deteriorating market conditions in the first quarter of 2007 resulted in an increasingly large portfolio of loans for sale at the company. As losses mounted for the first quarter of 2007 the need for additions to the loan loss reserve were analyzed. Defendants Strauss and Hozie then under funded the reserve, turning a loss into a profit. Those results were reported in a false quarterly filing, as discussed here. Additional steps were taken to conceal the fraud.
Subsequently, the false filing was used in connection with the sale of company stock to Citigroup. Defendants Hozie and Bernstein also misled the outside auditors. The three defendants are also alleged to have falsified the books and records of the company and to have circumvented the internal controls.
Mr. Strauss settled with the SEC at the time the complaint was filed. He consented to the entry of a permanent injunction prohibiting future violations of the antifraud, reporting, record-keeping and internal controls provision of the securities laws. He also agreed to pay $2.2 million in disgorgement and prejudgment interest and a $250,000 penalty and to be barred from serving as an officer or director for five years. The remaining two defendants are litigating the case with the Commission. .
Investment fund frauds: In SEC v. Private Equity Management Group LLC, Civil Action No. CV 09-2901 (C.D. Cal. Filed April 27, 2009), the Commission filed a fraud complaint and obtained a temporary asset frees against financier Danny Pang and his two companies, Private Equity Management Group, Inc. and Private Equity Management Group LLC (PEM Group). PEM Group claimed it invested in life insurance policies of senior citizens and timeshare real estate. The returns for investors were supposed to be paid from the proceeds on these investments. The principal and interest were, according to defendants, guaranteed by a claimed $108 million of insurance. In fact, the amount of insurance was $31 million, although Mr. Pang is alleged to have altered the policy to make it appear to be $108 million when showing it to investors. Investor returns were paid from cash obtained from other investors. Mr. Pang also falsified his resume as part of his sales pitch. The case, which alleges violations of the antifraud provisions, is in litigation.
In SEC v. Ponta Negra Fund I, Civil Action No. 1:09-CV-00324 (W.D. Tex. Filed April 27, 2009), the Commission filed a complaint against a group of hedge funds and Francesco Rusciano. Mr. Rusciano, according to the complaint, was selling interests in the hedge fund using forged documents and by misrepresenting its assets. Specifically, the complaint claims that in two instances Mr. Rusciano altered brokerage records to solicit investors claiming that the fund had assets of over $42.9 million when in fact it had about $2.9 million.
Mr. Rusciano also misrepresented the fund’s monthly and yearly results, according to the SEC. He claimed that it had made a profit for every month throughout 2007 and 2008 when in fact it lost money in 10 of 24 months. For 2007, the fund actually lost money, contrary to his representations and made a small profit for 2008. From September 2007 to the present, Mr. Rusciano raised about $31 million from 15 investors. The complaint alleges violations of the antifraud provisions. The court granted the SEC’s request for an emergency freeze order. The case is in litigation.
In SEC v. Ruderman, Civil Action No. CV 09-02974 (C.D. Cal. Filed April 29, 2009), the Commission brought a fraud action against Bradley L. Ruderman and two of his hedge funds. According to the complaint, Mr. Ruderman made false representation to investors through which he raised at least $38 million from twenty individuals. Those false representations included claims: 1) that Larry Ellison, CEO of Oracle Corp, and Lowell Milken, chairman of the Milken Family Foundation, were investors; 2) that the fund had positive returns ranging from 15% to 60% per year when in fact it was losing money; and 3) that it had at least $800 million in assets, when in fact it had less than $650,000 in assets. The court granted the SEC’s request for an emergency freeze order and set the case for a hearing to consider a request for a preliminary injunction and the appointment of a receiver.
Kickbacks: SEC v. Morris, Case No. 09 CV 2518 S.D.N.Y. Filed March 19, 2009) is a political corruption case centered on an alleged kickback scheme involving New York state pension funds, and discussed here. The SEC amended its complaint naming as defendants Aldus Equity Partners, L.P. and one of its principals, Saul Meyer.
According to the amended complaint, Aldus was serving as the outside consultant to New York State Common Retirement Fund. Aldus then agreed with defendant Morris to kickback 35% of its management fee to a shell company he ran to secure the Fund’s emerging fund portfolio business. The New York Attorney General filed a parallel criminal complaint against Mr. Meyer. The People of the State of New York v. Meyer, (NY City Criminal Court, Filed April 30, 2009), available here.
Private actions
In In Re: Take-Two Interactive Software, Inc. Derivative Litigation, Case No. 1:06-cv-05279 (S.D.N.Y. Filed July 17, 2006), the court dismissed option backdating claims in a consolidated derivative suit against 19 defendants. The complaint names 23 defendants and is based on claims that options were improperly backdated between 1997 and 2006. A special litigation committee moved to dismiss the claims, arguing that there was no evidence based on their investigation to support claims against the 19 defendants. The court agreed and dismissed the claims against the 19 individuals. The company previously settled with the SEC as discussed here. SEC v. Take-Two Interactive Software, Inc., Civil Action No. 09 CIV 3113 (S.D.N.Y. Filed April 1, 2009). See also Litigation Release No. 20982 (April 1, 2009).
Criminal cases
Three criminal cases were brought against individuals previously charged by the SEC with operating Ponzi schemes:
• In U.S. v. Nicholson, Case No. 1:09-mj-00507 (S.D.N.Y. Filed April 23, 2009), an indictment alleging securities fraud was returned against James Nicholson, the operator of Westgate Capital Management. The SEC, as discussed here, previously charged Mr. Nicholson with operating a fraudulent investment fund with a “virtual office” and false financial statements.
• In U.S. v. Cosmo, 09-CR-255 (E.D.N.Y. Filed April 2, 2009), an indictment was returned against Nicholas Cosmo alleging that he operated a Ponzi scheme. The SEC previously filed suit against Mr. Cosmo, alleging that his fund, Agape World, Inc., was used to defraud investors.
• In U.S. v. Nadel, Case No. 09-mj-00169 (S.D.N.Y. Filed April 29, 2009) an indictment was returned against Arthur Nadel alleging securities, mail and wire fraud in connection with a fraudulent investment fund and Ponzi scheme. The SEC previously filed an action against Mr. Nadel as discussed here.