by T. GormanPosted on Posted in SECActions

The Second Circuit Court of Appeals heard argument in SEC v. Citigroup Global Markets, Inc., No. 11-5227-cv, one of the most closely watched SEC enforcement actions. The Court’s decision has the potential to shape the future of SEC settlements in district court enforcement actions. Before the Court the SEC was joined by Citigroup in arguing for the reversal of the district court’s order refusing to enter their settlement while court appointed counsel defended the ruling of Judge Rakoff. A host of groups weighed in with amicus briefs.

Central to the resolution of the case is the role of the district court when presented with a proposed settlement in an SEC enforcement action which requests the entry of an order by the court for injunctive and other relief. The enforcement action here stems from Citigroup’s role in the creation and marketing of a largely synthetic collateralized debt obligation or CDO called Class V Funding III. The firm concluded that the residential real estate market would drop significantly. In late 2006 it decided to construct a CDO-squared – a CDO collateralized by tranches of other CDOs rather than instruments such as bonds – tied to the residential real estate market. The collateral would be largely CDO tranches left from earlier deals.

Credit Suisse Alternative Capital, Inc. or CSAC was retained as collateral manager. An experienced collateral manager was essential to selling the notes. Citigroup selected most of the collateral for Class V, although CSAC did select some, according to the complaint. The marketing material featured CSAC and its experience without disclosing Citibank’s role in selecting the collateral or that it had a $500 million short position against the Class V collateral it selected. Class V collapsed only months after the notes were sold, leaving investors with millions of dollars in losses. Citigroup made $34 million in fees for structuring the entity and $160 million in net profits on its positions.

The firm settled the action, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3). Citigroup also agreed to disgorge $160 million and pay $30 million in prejudgment interest and $95 million as a penalty for a total of $285 million which would be placed in a fair fund. The settlement requires Citigroup to take certain remedial action related to its review and approval of offerings of certain mortgage related securities.

U.S. District Court Judge Jed Rakoff refused to enter the proposed consent decree. Initially, the Court held hearings and requested that the parties answer a series of questions. Following the submission of those responses another hearing was held. Ultimately the Court refused to enter the proposed judgment, concluding: “. . . the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, the Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.” SEC v. Citigroup Global Markets Inc., Case No. 11 Civ. 7387 (S.D.N.Y.). The Court ordered the case be set for trial with the companion action against Brian Stoker, the mid-level Citigroup employee who oversaw the deal. The SEC appealed, filed a wit of mandamus and requested a stay of the order that it proceed to trial which was granted. Later the case against Mr. Stoker, based on essentially the same facts as the Citigroup action, was tried and the jury found against the SEC. SEC v. Stoker, Case No. 11 Civ. 7388 (S.D.N.Y. Filed Oct. 19, 2011); See also In the Matter of Credit Suisse Alternative Capital, Adm. Proc. File No. 3-14594 (Filed Oct. 19, 2011)(settled administrative proceeding against collateral manager and one of its employees).

The central issue before the Appeals Court is the role of the judiciary in agency settlements. In its brief the SEC argued that: “The district court did not defer to the Commission’s decision to resolve the matter though a consent judgment, which the Commission reached after years of investigation and lengthy negotiations with Citigroup. This decision reflected the Commission’s judgment that the settlement best served the public interest given the balance of various factors, such as litigation risk, resource allocation, and the relief contained in the judgment . . . “ In making this argument the SEC claims that the ruling of the district court conflicts with well established judicial precedent and that it interferes with executive power vested in the agency.

In this case the settlement was fair, reasonable and in the public interest, the SEC told the Court. This determination is based in part on the fact that the agency obtained 80% of the monetary relief available under the statute, includes a mandatory injunction to alter key business practices, minimizes the risks for the agency and conserves its resources.

Citigroup largely echoed the Commission’s views, arguing in favor of reversing the district court and requesting that and order issue directing that the settlement be entered. Calling the position of the District Court a “new rule,” the firm told the Second Circuit that a district court has “extremely circumscribed” authority when presented with an agency consent decree as in this case. Here the district court abused its authority because the proposed decree was negotiated at arms-length, was reasonable and adequate and served the public interest as determined by the SEC.

Counsel appointed to advocate the position of the district court rejected the contentions of the SEC and Citigroup arguing: “Confronted with puzzling anomalies in the case at hand, the district court properly held that it could not determine whether a problematic consent judgment invoking the court’s injunctive powers satisfied the well established standards of judicial review because the parties had not provided the court with the slightest factual or evidentiary basis upon which to exercise its independent judgment.”

Citing Judge Rakoff’s ruling in SEC v. Bank of America, the brief rejected the notion that the district court required an admission of liability in Citigroup. Rather, a statement of facts as in Bank of America would have been sufficient to provide the district court with a factual basis for the proposed decree. Here the SEC did not provide such a statement. Likewise, the defendant did not even make the kind of acknowledgement that Goldman Sachs did in SEC v. Goldman Sachs where the firm admitted errors.

Citing the same “adequate, reasonable and in the public interest” standard for entering a consent decree relied on by the SEC and Citigroup, the brief states that deference to the agency does not mean failing to inquire as to whether that standard for entering the injunction and other requested relief has been met. This is particularly true on the record in this case where there are substantial unanswered questions to be resolved such as: 1) the inconsistency between the facts in the complaint alleging an intentional fraud and its charging sections which are based only on negligence; 2) the discrepancy between the amount of the penalty here and the Goldman Sachs action which is based on similar conduct; and 3) the demand for broad injunction relief in the face of the SEC’s admission that the conduct terminated years ago and that it has failed to enforce other “obey the law” injunctions entered against Citigroup.

A group of law securities law professors seemed to have summed up the critical issues before the Court: “As scholars who study securities enforcement and the SEC, we have concerns about the SEC’s practices, exemplified in this case, of settling enforcement actions alleging serious fraud without any acknowledgement of facts, on the basis of pro forma “obey the law” injunctions, a commitment to undertake modest remedial measures, and insubstantial judicial penalties.”

A decision is expected later this year.

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by T. GormanPosted on Posted in SECActions

The Department of Justice filed one of the most significant market crisis cases this week against a major rating agency as a defendant. The case centers on years of false statements about ratings given to RMBS and CDOs, according to the complaint, as the market crisis evolved and the market for those securities collapsed. At the same time the SEC announced that last Spring the court granted summary judgment against it and in favor of a defendant in one of its major market crisis cases. No appeal will be taken.

The PCAOB announced two new cooperative agreements this week. The D.C. Circuit handed down a decision which defines the circumstances under which reports prepared under Commission consent decrees become official records subject to a common law right of access.

Market crisis

Market crisis: U.S. v. McGraw-Hill Companies, Inc., Case No. CV 13-00779 (C.D. Cal. Filed Feb. 4, 2013). The complaint is based on Financial Institutions Reform, Recover, and Enforcement Act of 1989 or FIRREA and alleges wire fraud, mail fraud and financial institution fraud. It seeks to vindicate the interests of a number of federally insured institutions who purchased RMBS and CDOs based on the ratings issued by S&P from 2004 through 2007. The complaint details an on-going scheme to defraud purchasers of the securities by S&P involving a series of transactions over years. The scheme centered on repeated false representations by S&P that its credit ratings of RMBS and CDO traunches were objective, independent, uninfluenced by any conflicts. Throughout the period the firm failed to appropriately adjust its criteria and models as the market unraveled, made changes to its standards which were designed to achieve a certain result rather than reflect the markets, ignored the increasing risks of the market crisis and, in some cases, disregarded its own policies. The complaint demands civil money penalties in an unspecified amount and other relief.

SEC Enforcement: Litigated cases

Market crisis: SEC v. Perry, Civil Action No. CV 11-1309 (C.D. Cal.) is an action which arose out of the collapse of IndyMac Bancorp, Inc. It named as defendants Michael Perry, the former CEO, and Scott Keys, the former CFO. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b) based on allegations that as the market crisis unraveled the two men knew about the deteriorating condition of the financial institution but misled investors about its true state in repeated filings and statements. Previously, Mr. Perry settled, consenting to the entry of an injunction based on Securities Act Section 17(a)(3) and agreeing to pay a penalty of $80,000. This week the Commission announced that on May 31, 2012 the court granted summary judgment in favor of Mr. Keys on all claims and that it had elected not to appeal. See also Lit. Rel. No. 22614 (Feb. 7, 2013).

SEC Enforcement: Filings and settlements

Weekly statistics: This week the Commission filed 2 civil injunctive actions and 1 administrative proceeding (excluding tag-along-actions and 12(j) actions).

Insider trading: SEC v. Balchan, Civil Action No. 4:13-cv-298 (S.D. Tx. Filed Feb. 6, 2013). The action centers on the acquisition of National Semiconductor Corporation by Texas Instruments, announced after the close of the market on April 4, 2011. Defendant James Balchan is married to a partner in a law firm. One of her partners, called Partner A in the complaint, was a close friend of the general counsel of National Semiconductor. In honor of his friend the general counsel, the Partner A organized a “wine and dine” weekend. Mr. Balchan and his wife were invited. Prior to the event Partner A called his friend the general counsel who told him the event had to be canceled after requesting advise regarding the merger. Subsequently, Partner A advised Mrs. Balchan that the event would be canceled because of the pending acquisition. She told her husband who then purchased 3,000 shares of National Semiconductor in to transactions. When the deal was announced the price spiked 76% giving him profits of $29,052.39. The Commission’s one count complaint alleges a violation of Exchange Act Section 10(b). Mr. Balchan resolved the case, consenting to the entry of a permanent injunction based on the Section cited in the complaint. He also agreed to pay disgorgement of $29,052.39 along with prejudgment interest and a penalty equal to the amount of the disgorgement.

Short selling: In the Matter of Ardsley Advisory Partners, File No. 3-15199 (Feb. 5, 2013) is an action against the investment adviser alleging violations of Rule 105 of Regulation M. The Order claims that the Respondent sold short during the restricted period preceding its purchase of securities in public offerings by Sunpower Corporation in April 2009, China Agritech, Inc. in April 2010 and Synutra International, Inc. in June 2010. Overall the firm had profits of $506,671.50. Prior to being contacted by the staff the adviser developed compliance procedures for Rule 105. To resolve the matter the Respondent consented to the entry of a cease and desist order based on Rule 105, agreed to disgorge its trading profits and pay prejudgment interest. The firm also agreed to pay a civil penalty of $253,335.

Investment fund fraud: SEC v. We the People, Inc. (S.D. Fla. Filed Feb. 4, 2013); SEC v. Olive (S.D. Fla. Filed Feb. 4, 2013); SEC v. Reeves (S.D. Fla. Filed Feb. 4, 2013). These three cases center on claims that Richard and Susan Olive essentially hijacked what was a legitimate, albeit essentially dormant, charity that had been devoted to promoting nuclear safety. In March 2008 Richard and Susan Olive were employed by We The People to assist with fund raising on a commission basis. The couple did not disclose their checkered regulatory history which included securities fraud actions and state and federal indictments. At We the People the couple embarked on a fund raising campaign which raised over $75 million from 400 investors in over 30 states over a four year period. Investors were offered the right to purchase a tax deductible gift annuity or a charitable gift annuity that was supposed to make charitable contributions over the life of the investor in most cases. The representations on which the annuities were sold were false and much of the money was siphoned off by the couple with the assistance of attorney William Reeves, named in a separate action. The complaint against the Olives and another company owned by Mrs. Olive, We’re Not Alone, LLC, alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is in litigation.

The company settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). We the People also agreed to pay disgorgement and consented to the appointment of a receiver who will marshal the over $60 million in remaining investor assets. Attorney Reeves also settled, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 5(a) and 5(c) as well as each subsection of Section 17(a). He also agreed to be suspended from practicing before the Commission for a period of five years. The court will determine at a later date what financial penalty, if any, should be imposed. Mr. Reeves entered into a cooperation agreement with the Commission, which is reflected in the terms of the settlement.

Criminal cases

Investment fund fraud: A criminal complaint was filed by the Manhattan U.S. Attorney’s Office naming as defendants Charles Huggins, Christopher Butchko and Anne Thomas. Beginning in 2009 and continuing through 2011 the three defendants are alleged to have raised about $2.5 million from investors through companies known as JYork Industries Inc. and Urogo Inc. Investors were falsely told that their funds would be used to develop gold and diamond mines in Sierra Leone and Liberia. In fact much of the money was diverted to the personal use of the defendants. The case is pending.

Insider trading: U.S. v. Motey (S.D.N.Y.) is the criminal insider trading action against Karl Motey of the Coda Group. From 2007 through early 2009 he is alleged to have provided inside information to a number of individuals, including Doug Whitman about Marvel Technologies. Mr. Motley testified at the trial of Mr. Whitman for the government. Previously he pleaded guilty. This week he was sentenced to time served in view of his cooperation.

PCAOB

The Board entered into cooperative agreements with the French High Council for Statutory Auditors and the Auditing Board of the Central Chamber of Commerce of Finland. The agreements call for cooperation, provides a framework for inspections and authorizes the exchange of confidential information. The Board now has agreements with six European Union members.

Circuit courts

Accessibility of reports: SEC v. American International Group, Case No. 12-5141 (Decided: Feb. 1, 2013). The Circuit Court held that a report prepared by a consultant retained under a consent decree, and which was part of the ancillary relief, was not a public record and accessible to the reporter plaintiff. The case arose out of the 2004 settlement of a Commission enforcement action against insurance giant AIG. The consent decree called for the entry of an injunction against future violations, the payment of disgorgement, establishment of a restitution fund and the creation of a committee to review future transactions. It also required the retention of an independent consultation who was charged with reviewing a number of AIG’s completed transactions and preparing pertinent reports documenting the findings and recommendations. Reporter Sue Reisinger requested access to the reports citing a common law right of access and the First Amendment. The district court granted Ms. Reisinger’s request. The D.C. Circuit reversed.

The critical issue was whether the reports are considered to be a judicial record. The public has a fundamental interest in viewing the work of public agencies, the Court noted. Accordingly, courts have long recognized a common law right to inspect and copy public records. Those are records created and kept for the purpose of memorializing official actions, decisions, statements or other matters of significance. Viewed in that context the critical question regarding judicial records is the role they play in the adjudicatory process. If the record is part of that process there is a right of access, although it is not unfettered. Rather, disclosure will ultimately hinge on balancing the government’s interest in secrecy and the public’s in disclosure. In this case the Court found it unnecessary to balance the rights involved in view of its conclusion that the reports sought are not judicial records. The reports in this case have nothing to do with the court’s decision to enter the consent decree or the relief ordered at the time and thus there is no right of access.

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