by T. GormanPosted on Posted in SECActions

The SEC filed two settled insider trading cases against two professionals who traded in the same take over stock. The defendants had no relationship. One was on the East Coast. The other was on the West Coast. Both settled on essentially the same terms with the Commission. One however was told about the deal in the course of his employment. The other assumed a deal would be forthcoming based on the information available to him. SEC v. Williams, Civil Action No. 12-1126 (E.D. Pa. Filed March 5, 2012); SEC v. Duncan, Civil Action No. CV 12-1785 (C.D. Ca. Filed March 5, 2012)

Each case is based on the acquisition of aerospace and defense industries manufacturer Hi-Shear Technology Corporation by Chemring Group PLC. The deal was announced on September 16, 2009. The defendant in the first case is John M. Williams, an employee of Deloitte Tax LLP since 1997. He was a tax manager resident in their Philadelphia, Pennsylvania office. In the second the defendant is William F. Duncan, the President of Duncan Insurance Service, Inc., dba The Olson Duncan Agency, a California insurance brokerage firm. Mr. Duncan and his agency had a long term relationship with Hi-Shear. The agency had provided property and casualty brokerage services to Hi-Shear for 8-10 years. The firm also wrote D&O insurance for the company.

Defendant Williams was told about the deal as part of his work at Deloitte. As the a tax manager for firm, Mr. Williams began assisting with Chemring’s proposed acquisition of Hi-Shear, code named “Project Harriet,” in late July. On August 31 he circulated a memorandum containing his tax analysis for the acquisition of Harriet. At about the same time he was told that the target was Hi-Shear. Subsequently, on September 9, 2009 he received an e-mail chain about the deal which again identified Hi-Shear.

From September 10 to 14 Mr. Williams purchased 850 shares of Hi-Shear stock. He did not report the transactions to Deloitte as required. Following the deal announcement he liquidated his holding, realizing profits of $6,803.18.

Mr. Duncan deduced that a transaction would be forthcoming from the information available to him through his work with the company. In late 2008 Hi-Shear conducted a review of its D&O insurance and concluded that additional coverage was required. Olson Duncan presented the company with a proposal to expand its coverage in late January 2009 pursuant to a request by Hi-Shear. Toward the end of the next month Hi-Shear gave Mr. Duncan an attorney-client privileged memorandum which analyzed its D&O coverage and specifically questioned if it was adequate in the event of a strategic transaction and, in one section, if control of the company was sold.

Five months later Mr. Duncan received an e-mail from the company asking about a 6-year “tail” for its existing D&O policy. Such a policy is “specific coverage to extend a D&O policy when a company is acquired or sold,” according to the complaint. Mr. Duncan furnished an estimate the day after he received the e-mail but noted that the underwriters would not give a specific quote until they were furnished with an actual agreement.

Mr. Duncan began purchasing Hi-Sear stock the day he furnished the company with the quote on the tail. By September 9 he had acquired 10,000 shares at a cost of over $102,000. Following the September 16 announcement he liquidated his holdings, realizing a profit of $85,525.

Each defendant settled on essentially the same terms, consenting to the entry of a permanent injunction, without admitting or denying the allegations in the complaint, which prohibits future violations of Exchange Act Section 10(b). Each defendant agreed to pay disgorgement along with prejudgment interest and a penalty equal to their trading profits. Mr. Williams also agreed to the entry of an administrative order which suspends him from appearing or practicing before the Commission as an accountant for five years.

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by T. GormanPosted on Posted in SECActions

Since the Supreme Court rewrote the rules regarding the extraterritorial reach of Exchange Act Section 10(b) in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869, the circuit and district courts have struggled with its application. In Morrison the High Court created a bright line test, holding that Exchange Act Section 10(b) does not provide a cause of action for securities fraud unless the purchase or sale of securities on which the claim is based either: 1) took place on a U.S. securities exchange or 2) occurred in the United States. Stated differently, the anti-fraud Section of choice in both SEC enforcement actions and private securities fraud cases does not have extraterritorial effect. In reaching its conclusion the Supreme Court rejected decades of case law developed initially by the Second Circuit, and adopted to varying degrees by other circuits, which utilized a jurisdictional test predicated on a conduct and effects standard. The decision is discussed here.

The Second Circuit recently applied the second prong of Morrison in Absolute Activist v. Ficeto, Docket No. 11-0221-cv (2nd Cir. Decided March 1, 2012). The case centered on a claim for damages based on Exchange Act Section 10(b) brought by nine Cayman Island hedge funds managed by Absolute Capital Management Holdings Ltd. (ACM). The defendants were Florian Homm, CIO of ACM, Sean Ewing, Chairman/Chief Executive Officer, Ullrich Angersbach, Head of IR and Marketing and Colin and Craig Heatherington, ACM employees who were principals of defendant CICV Global Capital Ltd. (CIC).

Plaintiffs claimed that over approximately three years Defendants Homm, Ficeto, Hunter and Colin Heatherington caused the nine Funds to purchase U.S. Penny Stocks directly from the issuers in PIPE transactions. Following the purchases various of the defendants are alleged to have engaged in a “pump and dump” type scheme involving the penny stock securities acquired by the Funds. In the end the defendants reaped huge profits while the Funds suffered losses of about $195,916,212.

The district court dismissed the complaint with prejudice. Based on Morrision, that court concluded sua sponte that although no defendant had invoked the decision, under the Supreme Court’s ruling it lacked subject matter jurisdiction. The Second Circuit reversed and remanded with leave to replead.

Morrison rejected the Second Circuit’s “conduct and effects,” developed in cases such as SEC v. Berger, 322 F. 3d 187, 192-93 (2nd Cir. 2003) to assess questions regarding the extraterritorial reach of Section 10(b) the Circuit Court noted. Under Morrison the question is whether the securities transaction took place on a U.S. exchange or in this country. This case involves only the second prong of the Morrison test according to the Funds – no claim is made that the first part prong of the decision is applicable despite a ruling in a related SEC enforcement action based on that prong. See, SEC v. Ficeto, No. 11 Civ. 1637, 2011 U.S. Dist. LEXIS 150141, at*31 (C.D.Ca Dec. 20, 2011)(action against defendants Ficeto, Homm, Colin Heatherington and Hunter in which SEC successfully argued that the first prong of Morrision applied since the securities were purchased and sold in the over-the-counter markets).

Morrision did not define the test for determining when the purchases and sale of a security is a domestic transaction. Accordingly, the Circuit Court began its analysis by considering the statutory definitions of purchase and sale. Those definitions include any contract to buy, purchase, or otherwise acquire a security. They thus suggest that the act of purchasing or selling securities is based on entering into a binding contract. Viewed in this context, the key question is when the parties first became bound to effectuate the transaction. To plead a claim under this test the plaintiff must “allege facts leading to the plausible inference that the parties incurred irrevocable liability within the United States: that is, that the purchaser incurred irrevocable liability within the United States to take and pay for a security, or that the seller incurred irrevocable liability within the United States to deliver a security,” citing SEC v. Goldman Sachs & Co., 790 F. Supp. 2d 147, 159 (S.D.N.Y. 2011).

In reaching its conclusion the Court rejected four alternatives argued by the parties. First, the location of the broker-dealer is not dispositive. While this may be a relevant consideration, it does not demonstrate where the contract was executed. Second, the fact that the securities were issued by U.S. companies and that the shares are registered with the SEC does not necessarily establish that the transactions were domestic within the meaning of Morrision. Likewise, the identity of the buyer or seller is not necessarily determinative of where the transaction took place. Finally, while Morrison did replace the conduct test with a transactional approach as argued by one defendant, the critical question is whether “the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States.”

In this case the mere allegation that the transactions took place within the U.S. is not sufficient. Rather, plaintiffs must plead “factual allegations suggesting that the Funds became irrevocably bound within the United States or that title was transferred within the United States, including, but not limited to, facts concerning the formation of the contracts, the placement of purchase orders, the passing of money . . . “

Since Morrision was decided after the complaint considered here was filed, plaintiffs will be given an opportunity to replead their complaint.

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