by T. GormanPosted on Posted in SECActions

The SEC and the U.S. Attorney’s Office, New Jersey, brought civil and criminal insider trading charges against, respectively, six and seven individuals based on a five year insider trading ring that garnered over $1.4 million in illegal profits. Three of the individuals are executives at pharmaceutical companies. Several been friends since high school. Overall there were ten tippees At the center of the trading was four take-over transaction and six earnings releases which spawned trading tracing to 2007 and continuing through mid-2012. Elaborate steps were taken to conceal the trading. Those steps failed. SEC v. Lazorchak, Case No. 2:12-cv-07164 (D.N.J. Filed Nov. 19, 2012).

The Commission’s complaint named as defendants: John Lazorchak, Director of Financial Reporting at pharmaceutical company Celgene Corporation; Mark Cupo, Director of Accounting at Sanofi-Aventis Corporation, another pharmaceutical company and a former co-worker of Mr. Lazorchak; Mark Foldy, employed in the marketing department at a third pharmaceutical company, Styker Corporation; Michael Castelli, a friend of defendant Cupo; Lawrence Grum, who holds a brokers license and attended high school with defendant Castelli; Michael Pendolino; and James Deprado who is not named as a defendant in the criminal case. Defendants Larzorchak, Pendolino, Foldy and Deprado attended the same high school.

The ring is alleged to have traded on inside information in advance of four corporate take-over announcements:

  • Celgene’s acquisition of Pharmion corporation, announced on November 19, 2007;
  • Sanofi’s acquisition of Chattem, Inc., announced on December 21, 2009;
  • Celgene’s of Abraxix BioSciences, Inc., announced on June 30, 2010; and
  • Stryker’s acquisition of Orthaveta, Inc., announced on May 16, 2011.

Insider trading also is alleged to have occurred prior to the announcement by Celgene that it was withdrawing an application from the European Medicines Agency’s Committee on June 21, 2012 and earnings announcements for the quarters ended: September 30, 2009; March 31, 2010; June 30, 2010; September 30, 2010; June 30, 2011; and March 31, 2012.

The basic scheme involved an arrangement devised by Messrs. Castelli and Grum. It called for Mr. Lazorchak, through defendant Cupo, to furnish them inside information obtained from his position at Celgene. Mr. Cupo served only as a middleman. Defendants Castelli and Grum placed the trades, often in options. Mr. Cupo would be compensation for his role.

The idea behind the scheme was to separate the source of the information from the securities transactions to conceal the activity. Other steps were also taken to avoid detection. The members of the scheme typically interacted with Mr. Cupo in person. The traders also purchased Celgene securities at times when then did not have inside information. In some cases they sold portions of their holdings in advance of the corporate announcement. The traders also created contemporaneous research files and e-mails regarding the transactions to justify the trades.

Over time the scheme expanded. Mr. Lazorchak illegally tipped Messrs. Pendolino and Foldy and was in turn compensated by them. Messrs. Pendolino also tipped others as the number of tippees multiplied.

At the outset of the scheme FINRA identified the trading of Messrs. Foldy and Pendolino following the acquisition of Pharmion by Celgene. The regulator circulated a questionnaire to executives at Celgene asking that they specify if they knew anyone on a list of names which included Messrs. Foldy and Pendolino. Mr. Lazorchak falsely reported that he did not know either man. He later informed both men along with defendant Cupo about the FINRA questionnaire and his actions. Mr. Cupo reassured the group that their plan would evade detection, a step he took repeatedly according to the SEC.

The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 14(e) and Securities Act Section 17(a). Each defendant in the criminal case is charged with multiple counts including conspiracy and securities fraud. The defendants voluntarily surrendered in the criminal action. Both cases are pending.

Hurricane Sandy: As we prepare to give thanks with family and friends this Thanksgiving please remember the victims of Sandy with a donation to the Red Cross (here).

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by T. GormanPosted on Posted in SECActions

The SEC filed two settled actions at the end of last week tied to the residential mortgaged backed securities market. SEC v. J.P. Morgan Securities LLC (S.D.N.Y. Filed Nov. 16, 2012); In the Matter of Credit Suisse Securities (USA) LLC, Adm. Proc. File No. 3-15098 (Nov. 16, 2012). Despite continued clamor from Congress and the public the actions are only against the institutions. No individuals are named as a party in either proceeding.

These actions may reflect an evolving view by investigators that the events which generated the market crisis are not the product of a single individual or even a group of individuals. The Department of Justice has brought few criminal cases tied to the market crisis despite public pressure demanding prosecutions and long prison sentences. The SEC has brought a number of market crisis cases which include prosecutions against individuals. Yet those earlier actions may not represent current thinking.

On Friday, the same day it filed J.P. Morgan and Credit Suisse, the Commission secured the dismissal with prejudice of its market crisis action against Edward Steffelin, a Managing Director at GSCP (NJ) L.P. SEC v. Steffelin, Civil Action No. 11-04206 (S.D.N.Y. filed June 21, 2011). That action was filed in conjunction with another market crisis case against J.P. Morgan Securities, SEC v. J.P. Morgan Securities LLC, Civil Action no. 11-04204 (S.D.N.Y. filed June 21, 2012). Both actions centered on the sale of interest in a largely synthetic collateralized debt obligation known as Squared CDO 2007-1. The Commission’s complaint alleged misstatements in connection with the marketing of interests in the entity tied to the role of hedge fund Magnetar Capital LLC. Mr. Steffelin’s firm served as the portfolio managed on the deal. Although the factual allegations in the complaint appeared to detail an intentional fraud, the charges were negligence based fraud under Securities Act Sections 17(a)(2) & (3). J.P. Morgan settled. Mr. Steffelin did not.

The papers dismissing the proceedings with prejudice against Mr. Steffelin do not disclose any reason for the dismissal. The action follows, however, two losses against individuals by the Commission in market crisis cases. One is the case against Brian Stoker, the Citigroup employee who was responsible for what the SEC claimed were misleading marketing materials used to sell interests in another CDO Squared. SEC v. Stoker, 11 Civ. 7388 (S.D.N.Y. Filed Oct. 19, 2011). There, based on a complaint which appeared to allege intentional contact but charged negligence, a New York jury last August found in favor of Mr. Stoker and against the SEC. In rendering its verdict the jury took the unusual step of issuing a note to the SEC urging the agency to continue its investigations. The Commission’s settlement with Citigroup is pending before the Second Circuit following the refusal of the district court to enter a proposed consent decree.

The SEC also lost the primary charges against the individuals as well as the entities in its action arising out of the demise of Primary Reserve Fund, one of the oldest money funds in the country and the first to “break the buck.” Following contentious discovery and a hotly contested trial, the jury rejected Commission claims that the individual defendants intentionally mislead investors and the markets as they scrambled to save the dying entity following the collapse of Lehman Brothers whose bonds were a large fund holding. The jury did, however, find in favor of the SEC on negligence based claims, hardly surprising under the chaotic circumstances surrounding the collapse of the fund. SEC v. Reserve Management Co., Case No. 1:09-cv-4346 (S.D.N.Y. Filed May 5, 2009).

While the papers dismissing Steffelin do not reference Stoker or Reserve Management Co., the dismissal by the Commission reflects a thoughtful and exemplary process of continually evaluating the merits of its cases and the enforcement program. Continual self-reflection and re-evaluation in view of the verdicts in Stoker and Reserve Management Company reflects the highest prosecutorial, ethical standards.

All of this also points to what may be the critical lesson of the market crisis. Larger monetary penalties and longer prison sentences, while popular and good press, may not be the key to preventing a reoccurrence. If the findings of intensive investigations by the SEC, DOJ and others are correct, the events which caused the crisis are not the work of one individual or even a group. Rather, those events stem from institutional failures. Under those circumstances the key to preventing a reoccurrence is not fines and prison but cultural reform. While bills in Congress seek more authority for larger fines and prison terms, the message from all of the government investigations is that those remedies will not work. Increasing the dollar fine for institutions which can easily pay mult-billion dollar quarterly losses will simply mean the shareholders pay more for the daily business operations of the institution. Likewise, adding a few years to the current top sentence of 20 years for securities fraud is unlikely to increase deterrence. This is particularly true if government investigators are correct – the problem is institutional.

If preventing a reoccurrence of the market crisis is the goal, then the lesson from all the investigations and prosecutions is that reform of those who which created the crisis is required. While that may come in part from legislation like Dodd-Frank, new statutes and rules alone cannot change the culture of institutions which permitted, encouraged and perhaps even rewarded the kind of actions uncovered by government investigators.

Preventing a reoccurrence begins with the SEC focusing its settlement efforts on the creation and institution of procedures and policies driven from the top of the organization which will foster and reward ethical conduct and prudent management rather than the type of conduct uncovered in the market crisis actions. The SEC and the DOJ are already doing this in the FCPA area. The SEC can use its recently created cooperation tools to bring this same focus to settling market crisis and other similar cases. In the end while focusing on these types of procedures may not generate the same kind of headlines as huge penalties, it will bring a new ethics to the market place which is the Congressional mandate of the SEC.

Hurricane Sandy: As we prepare to give thanks this week please remember the victims of Sandy’s destruction with a donation to the Red Cross, here.

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