THIS WEEK IN SECURITIES LITIGATION (March 18, 2011)

SEC Chairman Mary Schapiro continued to press congress for adequate funding which would permit the Commission to carry out its statutory duties and avoid furloughs. At the same time the agency continues to suffer through its latest scandal. This one relates to the investments by the family of the Commission’s former general counsel with Ponzi king Bernard Madoff.

SEC enforcement this week focused on two of its staples, insider trading and investment fund fraud actions. In addition, two more defendants pleaded guilty to criminal charges stemming from the demise of Taylor Bean. Finally, both FINRA and the PCAOB both issued warnings to investors. FINRA cautioned against scams involving the sale of pre-IPO shares in social networking companies like Facebook. At the same time the accounting board expressed concern about Chinese companies that went public through reverse mergers.

SEC Enforcement

Insider trading: SEC v. Carroll Case No. 3;11-CV-00165 (W.D. KY. Filed March 17, 2011) is an action involving family and friends who are alleged to have traded while in possession of inside information about a pending take over. The complaint centers on the acquisition of Steel Technologies, Inc. by Mitsui & Co. which was announced on February 28, 2007. Following the announcement the share price rose 60%. Defendants Patrick Carroll, William Carroll, David Stitt and David Calcutt all held a position of vice president of sales at Steel Technologies. Each reported to the company president and COO Michael Carroll. Each vp is alleged to have had inside information regarding the acquisition as did Michael Carroll who is not a defendant. Each vice president is alleged to have traded while in possession of the information. Four individuals named as defendants are alleged to be tippees. The are: James Carroll (son of Patrick); John Monroe who is a friend of defendant Stitt; Stephen Somers who is a friend of defendant and tippee John Monroe; and Christopher Calcutt, the brother of defendant David Calcutt. Overall the four vice presidents purchased about $339,000 of stock in those accounts. The tippees also traded and, collectively the defendants had profits of about $320,000. The complaint alleges violations of Exchange Act Section 10(b). The case is in litigation.

Looting: SEC v. Durham, Civil Action no. 1:11-CV-0370 (S.D. Ind. Filed March 15, 2011) is an action against Timothy Durham, former CEO of Fair Finance Co., James Cochran, former Chairman of the Board of Fair, and Rick Snow, former CFO of Fair. According to the complaint, Fair was an Ohio based consumer finance company. Following the acquisition of Fair in 2002 defendants altered its historical operating methods by steadily loaning Fair’s funds to other failing businesses they controlled. By 2009 the defendants had booked over $200 million of these related party loans. Those loans constituted about 90% of Fair’s supposed investments.

From 2005 through late 2009 defendants raised about $230 million from about 5,200 investors by selling investment certificates from Fair. Defendants made false representations in connection with the sales not disclosing that Fiar’s investments were in largely to insolvent entities that could not repay. The majority of the related parities did not even pay the interest on the so-called loans. Eventually the defendants began making Ponzi like payments to investors to repay notes due. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). It is in litigation. Parallel criminal charges were also filed against the defendants. U.S. v. Durham, Case No. 1:11-cr-0042 (S.D. Ind. March 15, 2011).

Diversion of fund assets: SEC v. Juno Mother Earth Asset management, LLC (S.D.N.Y. filed March 15, 2011) is an action against Juno Mother Earth Asset Management, LLL, a registered investment adviser, Eugenio Verzili, its chief compliance officer, and Arturo Rodrigues, its portfolio manager and later chief investment officer. Beginning in late 2006 Juno offered investors securities in Resources Fund which it managed, eventually raising about $16 million. Throughout that year and the next the investment adviser raised about $16 million. Juno however was chronically short of cash. Accordingly, in 2007 and 2008 defendants Verzili and Rodriguez made 41 withdrawals from the commodity and brokerage accounts of Resources Fund totaling $1.8 million. Portions of the funds were used to pay Juno operating expenses, contrary to representations in the PPM, while others were diverted to the personal use of the individual defendants. By the middle of 2008 substantially all of the investors in Resources Fund sought redemption. Juno ceased offering Resources Fund securities. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2), (4), 203A and 207. The case is in litigation.

Insider trading: SEC v. Hollier, Civil Action No. 6:09-cv-00928 (W.D. La.) is a previously filed insider trading case against Robert Hollier and Wayne Dupuis. The Commission claimed in its complaint that Mr. Hollier obtained inside information regarding the merger of Warrior Energy Services Corporation and Superior Energy Services, Inc. The transaction was announced on September 25, 2006. While on a hunting trip prior to the announcement, Mr. Hollier told Mr. Dupuis about the then pending deal according to the Commission. Following their return Mr. Dupuis purchased 5,000 shares of Warrior for $85,000. After the announcement he sold those shares at a profit of about $41,800 when the share price rose almost 70%. This week the case settled. Each defendant consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). The court ordered the two defendants to jointly and severally pay disgorgement in the amount of the trading profits along with prejudgment interest. Mr. Dupuis was all directed to pay a civil penalty in the amount of the trading profits.

Disclosure: In the Matter of JSK Associates, Inc., Adm. Proc. File No. 3-14296 (March 14, 2011) is a proceeding naming as Respondents: JSK, a registered investment adviser; Jerome Keenan, the President and Chief Compliance Officer of JSK and the Vice President and Chief Compliance Officer of International Equity Services, Inc, a broker dealer; and Dos Santos, an officer of JSK and IES. The Order alleges that JSK failed to inform investors that IES was obtaining compensation from the JSK accounts at the broker dealer. Investors were told that IES might receive clearing and processing and other types of fees from the accounts but this was inadequate. JSK also failed to inform investors that through IES it engaged in hundreds of fixed income transactions involving mark-ups and mark-downs with advisory clients on a principal basis. Finally, the firm failed to have adequate written policies and procedures reasonably designed to prevent violations of the Advisers Act. The Order alleges violations by Respondents of Advisers Act Sections 206(2), 206(3), 204, 204A, 206(4) and 207. The matter was resolved with consents to the entry of cease and desist orders as to each Respondent. In addition, Respondents Keenan and Dos Santos each agreed to pay a civil penalty of $10,000. Respondents also agreed to pay disgorgement of $60,350 along with prejudgment interest. The Order acknowledges the prompt remedial efforts and cooperation of Respondents.

Criminal cases

Fraud: U.S. v. Bowman (E.D.Va.) is an action against Raymond Bowman, the former president of Taylor, Bean & Whitaker. Mr. Bowman pleaded guilty to charges of conspiring to commit bank, wire and securities fraud and of lying to federal agents about his role in the fraudulent scheme that caused the demise Taylor Bean and Colonial bank. Taylor Bean was the largest non-depository mortgage lender in the country while its lender, Colonial BancGroup, Inc., was one of the fifty largest banks in the U.S. The fraudulent scheme began with concealing from the bank the fact that Taylor Bean, which had liquidity problems as early as 2002, was operating essentially on overdrafts by shuffling funds among accounts and concealing its true financial condition from the bank. Subsequently, Taylor Bean raised cash by selling a package of fraudulent mortgages to Colonial that were carried on the books of the bank. Finally, the one time mortgage lender created a special purpose entity to obtain funds by selling asset backed loans. By August 2009 the entity had a collateral deficit of about $1.5 billion. Yet Taylor Bean caused Colonial and the Federal Home Loan Mortgage Corporation to believe that each had an undivided interest in thousands of loans worth hundreds of millions of dollars. This was false Mr. Bowman admitted in his plea. Eventually Taylor Bean collapsed. Colonial was seized by banking regulators. The date for sentencing has not been set.

Fraud: U.S. v. Kelly (E.D. Va.) is another criminal action based on the collapse of Taylor Bean. The defendant is Teresa Kelly, a former supervisor in Colonial bank’s Mortgage Warehouse Lending Division. Ms. Kelly pleaded guilty to conspiring to commit bank, wire and securities fraud based on her role in the scheme outlined above. The SEC also filed a parallel civil case. The date for sentencing has not been set.

FCPA

U.S. v. Tesler, H-09-098 (S.D.Tx.). British solicitor Jeffrey Tesler pleaded guilty to one count of conspiracy to violate the FCPA and one count of violating the FCPA. The indictment, which contains eleven counts, centers on FCPA violations in connection with the TSKJ consortium and the EPC contracts to build liquefied natural gas facilities on Bonny Island, Nigeria. In his plea agreement Mr. Tesler admitted that he served as an agent of the TSKJ consortium, formed to secure $6 billion in contracts relating to the Bonny Island project. The members of the consortium were KBR, Technip S.A., Snamprogetti Netherlands BV and a Japanese engineering and construction company.

To facilitate obtaining the contracts, according to the plea agreement, Messrs. Tesler, through a company he controlled, funneled millions of dollars in bribes to Nigerian government officials. As part of the plea arrangement Mr. Tesler agreed to forfeit $148,964,568.67 which may be the largest FCPA forfeiture order against an individual. He is now cooperating with the government. Sentencing is set for June 22, 1011. KBR, Technip and Snamprogetti previously resolved FCPA charges.

FINRA

FINRA issued a warning to investors regarding the sale of pre-IPO shares in social media entities such as Facebook. While most sales of such shares are legitimate the regulator cautioned that there are scams involving the sale of shares in social media companies. The release notes that the SEC recently settled an action involving a scam in which investors paid several million dollars for shares of Google, Facebook and other well known sites.

PCAOB

The Board issued its first “Research Note” regarding Chinese reverse mergers. The Note states that some U.S registered accounting firms may not be conducting audits of companies with operations outside of the U.S. in accord with PCAOB standards. The Board is currently prevented from conducting inspections of U.S. related audit work of PCAOB registered firms in the PRC. There has however been a significant number of reverse mergers involving companies in that country. From January 2007 through the end of March 2010 there were 159 reverse merges involving Chinese companies. This compares to 56 IPOs for companies from that region. Following the reverse merger two thirds of the companies had a market capitalization below $75 million according to a PCAOB study. In contrast, over three quarters of those companies which had conducted an IPO had a market capitalization above $75 million. Similarly, as of March 31, 2010 the total market capitalization of all the Chinese companies involved with a reverse merger was less than half that of the companies that conducted an IPO. PCAOB registered accounting firms based in the U.S. audited 74% of the Chinese firms involved in a reverse merger.

SEC ENFORCEMENT TRENDS 2011: INSIDER TRADING (cont)

This is part eight (continued) of a series of articles that will be published periodically analyzing the direction of SEC enforcement.

SEC insider trading cases for 2010 can, for purposes of discussion, be divided into three group: 1) Market and other professionals; 2) corporate executives; and friends and family.

Market and other professionals

Last year the Commission brought several insider trading cases which involved market and other professions who had access to inside information. Cases involving market professionals frequently center on insider trading rings. For example, last year the SEC settled with David Slane, formerly a hedge fund portfolio manager with Chelsey Capital. SEC v. Slane, Civil Action No. 10-CV-752 (S.D.N.Y.). Previously Mr. Slane had pleaded guilty to criminal charges. Lit. Rel. No. 21 652 (Sept. 16, 2010). The case stems from the long running Guttenberg prosecutions which were based in part on trading in advance of UBS analyst publications. See, e.g., SEC v. Guttenberg, No. 07 cv 1774 (S.D.N.Y.).

SEC v. Poteroba, (S.D.N.Y.) Filed March 25, 2010 and U.S. v. Poteroba (S.D.N.Y. Filed March 25, 2010) are similar. In these cases the defendants are Igor Poteroba, a managing director at UBS Securities in their Healthcare Group, and Alexander Koval, previously employed at Citigroup Asset management, and Alexander Vorobiev. Each defendant is a Russian National.

The criminal and civil cases are based on essentially the same scheme. The criminal information, alleging one count of conspiracy and three counts of securities fraud, alleges that Mr. Poteroba tipped defendant Koval about six different companies over a four year period beginning in 2005. The trading generated about $870,000 in illegal profits. The SEC complaint, alleging violations of Exchange Act Sections 10(b) and 14(e), centers on the same conduct but adds five additional deals. Both cases are in litigation.

In other cases the market professionals are alleged to have traded for their own account. SEC v. Garcia, Civil Action No. 10 C 5268 (N.D. Ill filed Aug. 20, 2010) is an example of this type of case. The defendants are Juan Jose Fernandez Garcia, the head of European equity derivatives at Banco Santander, S.A. and Luis martin Caro Sanchez. Both are residents of Madrid, Spain. The case centers on the unsolicited bid for Potash Corporation of Saskatchewan by BHP Billiton Plc announced on August 17, 2010. The announcement of the deal was followed by a share price increase of 27%. Banco Santandar was an adviser to Potrash.

Prior to the bid Mr. Garcia purchased 282 Potash call options for $13,669. After the announcement they were sold at a profit of $576,033. Mr. Sanchez purchased 331 call options in Potash in mid-August at a cost of $496,953.33. The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). The case is in litigation. See also In the Matter of David W. Baldt, Adm. Proc. File No. 3-13887 (Filed May 11, 2010)(portfolio manager for bond funds learned of large redemptions and is alleged to have suggested to family members that they liquidate their holdings); SEC v. Marquardt, Civil Action No. 10-10073 (D. Mass. Jan. 20, 2010)(settled action against fund administrative officer who learned that certain actions would result in a reduction of NAV after which he and his family redeemed their holdings).

Market professionals were not the only individuals to use their professional position to access inside information, SEC v. Flanagan, Civil Action No. 10-CV-4885 (N.D. Ill. Filed Aug. 4, 2010) is an action against Thomas P. Flanagan, former Vice Chairman of Deloitt, resident in its Chicago office and his son Patrick, the COO of a private company. According to the complaint, between 2005 and 2009 Mr. Flanagan traded on inside information nine times, making 71 trades through multiple accounts. The information concerned audit clients of the firm. Overall Mr. Flanagan made profits of about $430,000. The complaint also claims that Mr. Flanagan in some instances tipped his son who traded, making profits of about $57,000.

The action was resolve with each defendant consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act sections 10(b) and 14(e). Each defendant also agreed to disgorge their trading profits and pay prejudgment interest along with a civil penalty equal to the trading profits. In addition, Mr. Flanagan consented to the entry of an order denying him the right to appear and practice before the Commission as an account in a separate administrative proceeding. Lit. Rel. 21612 (Aug. 4, 2010). See also SEC v Gansman, Civil Action No. 089-CV – 4918 (S.D.N.Y. Filed May 18, 2008)(settled insider trading case against attorney James Gansman who was employed in the transaction advisory group of Ernst & Young an is alleged to have repeatedly tipped his friend and former stock broker Donna Murdoch); SEC v. Foley, Civil Action No. 1:00-CV-00300 (D.D.C. Filed Feb. 25, 2010)(settled case in which Mr. Foley obtained inside information from his employment at Deloitte and tipped two others).

Corporate executives

A number of SEC insider trading cases involve corporate executives. As with the cases against professionals, in some instances the executives traded for their own account. In some instances they passed the information on to others.

SEC v. Horn, Civil Action No 1:10-CV-00955 (N.D. Ill. Feb. 16, 2010) is a case where the executive traded for his own account. Defendant Gerald Horn was the medical director for one of the facilities of LCA Visions, Inc. According to the complaint, from December 2005 through August 2006, the defendant made six separate trades while in possession of inside information. The information came from reviewing internal reports about the number of eye surgeries done. From this data Mr. Horn estimated revenue. By trading in LCA options the defendant made profits of $869,629. The case is in litigation. Lit. Rel. No. 2114 (Feb. 16, 2010).

Another case in which the executive traded for his own account is SEC v. Wagner, Case No. 1:10-cv-10031 (D. Mass. Filed Jan. 11, 2010). The defendant, Brooke D. Wagner, is the former VP of Corporate communications of Indevus Pharmaceuticals, Inc. According to the SEC Mr. Wagner learned that the FDA had expressed concerns about the side effects of a drug for which the company was seeking approval. Prior to the public announcement about the FDA letter, the defendant sold his shares and later sold short. The share price fell about 69% following the announcement. To settle the case Mr. Wagner consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the federal securities laws. He also agreed to pay disgorgement of about $64,000 along with prejudgment interest and a civil penalty equal to the amount of the disgorgement. Lit. rel. No. 21370 (Jan. 11, 2010); See also SEC v. Lyva, Civil Action No. 09 CV 1565 (S.D. Cal.)(settled action against the former director of strategic marketing analysis for Qualcomm who traded in call options before the announcement that the company had obtained a significant litigation settlement); SEC v. Navarro, Civil Action No. 4:10-CV-189 (N.D. Okla. Filed march 31, 2010)(settled action against a crude oil purchasing manager who liquidated his holdings after learning of unannounced cash flow difficulties); SEC v. Fogel, Case No. 1:10-CV-10097 (D. Mass. Jan. 22, 2010)(settled case against former vice president who traded prior to an acquisition by his company).

In some cases the executive passed the information on to others. For example, in SEC v. Self, Civil Action No. 10-cv-430 (E.D. Pa. Filed Sept. 1, 2010) James Self, executive director at Merck & Co., tipped his friend, Stephen Goldfield, an unemployed former hedge fund manager according to the complaint. Prior to the acquisition in April 2007 of AstraZeneca by Medimmune, Inc., Mr. Self and others were solicited by investment bankers representing Medimune about a possible acquisition. Mr. Self was on the team which reviewed the material non-public information about the deal.

By March 2007 Mr. Self furnished his friend with information on the subject. Mr. Goldfield purchased Medimmune options and, following the deal announcement, made profits of $13.9 million. The case settled with each defendant consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act section 10(b). Mr. Self also agreed to pay a civil penalty of $50,000 based on his financial condition. Mr. Goldfield agreed to disgorge the trading profits along with prejudgment interest. All but $600,000 of that amount was waived based on his financial condition. Lit. Rel. No. 21638 (Sept. 1, 2010); see also SEC v. Berrettini, Civil Action No. 10-CV-01614 (N.D. Ill. Mar. 31, 2010)(action against former director of real estate for Philips Electronics who tipped his friend about a take over by his company).

Family and friends

The Commission also brought several insider trading cases in 2010 involving family and friends. In some instances the family and/or friends traded together. In others, one family member misappropriated inside information from the other to trade.

SEC v. McClellan, Case No. CV 10 5412 (N.D. Cal. Filed Nov. 30, 2010) is an action against two couples who are alleged to have formed an international insider trading ring. Arnold McCelland and his wife Annabel reside in San Francisco. Mrs. McCelland’s sister and her husband, James and Miranda Sanders, reside in London. According to the complaint, Arnold McCelland, is a mergers and acquisition tax partner at Deloitte. He misappropriated inside information on six deals over a two year period beginning in 2006. Both couples used the information to trade. In addition, Mr. Sanders, in some instances, furnished the information to customers at the brokerage where he worked. The FSA in London has filed charges against the Sanders in the U.K. as well as customers of the brokerage. Mrs. McCelland has also been indicted on obstruction of justice charges in connection with the SEC investigation. The cases are in litigation. See also SEC v. Cohen, Case No. 10 CV 2514 (S.D. Cal. Filed Dec. 8, 2010)(insider trading ring involving two brothers, a fraternity brother and an uncle where the source of the information is alleged to have been the employment of one brother); SEC v. Temple, Case No. 10-cv-1058 (D. Del. Filed Dec. 7, 2010)(action involving two brothers-in-law where one is alleged to have misappropriated the inside information from the law firm where he worked).

In some instances one spouse misappropriated the information from another. In SEC v. Mcdonald, Case No. 3:10cv151 (D. Conn. Filed Feb. 2, 2010) defendant Bruce Macdonald’s wife is a corporate secretary and vice president of human resources of Mamry Corporation. The company put itself up for sale. Mrs. Macdonald, who was involved in the process, periodically discussed it with her husband who later purchased shares and tipped friends. Overall Mr. Macdonald had gains in one account of $890 and $25,509 in another. His friends had profits of about $20,000.

To resole the case Mr. Macdonald, and the friend he tipped, consented to the entry of permanent injunctions prohibiting future violations of the antifraud provisions of the Exchange Act. Each man also agreed to the entry of an order requiring him to disgorge the trading profits along with prejudgment interest and to pay a penalty equal to the trading profits. Lit. rel. No. 21404 (Feb. 2, 2010).

Reg FD

Finally, last year there was a renewed interest in Reg FD. One group of cases involved Office Depot, Inc. and its CEO, Stephen Odland and former CFO, Patricia McKay. SEC v. Office Depot, Inc, Civil Acton No 9:10-cv-81239 (S.D. Fla. Filed Oct. 21, 2010); In the Matter of Stephen Odland, Adm. Proc. File No. 3-14095 (Filed Oct 21, 2010); In the Matter of Patricia McKay, Adm. Proc. File No. 3-14096 ( Filed Oct. 21, 2010). The cases center on a series of talking points used by the director of investor relations in would not make guidance. The CEO and CFO worked out a series of talking points for the IR director to deliver in a meeting. Those talking points did not reference material non-public information. Rather, they focused on publicly available information regarding the difficulty of making guidance.

Following the talk, a number of analysts lowered guidance. The company settled the Reg FD charge as part of an overall global settlement of other filing violations. The two individuals also settled. Each consented to the entry of a cease and desist order based on Exchange Act Action 13(a) and Reg FD. Each also undertook to pay a civil penalty of $50,000. See also SEC v. Presstek, Inc. Civil Action No 10-1058 (E.D.NY. Filed March 9, 2010)(settled action against manufacturer and its former audit committee chairman who, after learning of performance difficulties in some segments discussed the matter with an investment adviser).

Next: The FCPA