by T. GormanPosted on Posted in SECActions

The Senate Committee on the Judiciary heard testimony yesterday on what might be called the current state of rejuvenating SEC Enforcement. Witnesses included Division Director Robert Khuzami, Fort Worth Regional Office Director Rose Romero and SEC Inspector General H. David Kotz.

Mr. Khuzami highlighted the reorganization efforts he initiated after assuming the position of Division Director, noting that those efforts are now complete. Tying his appearance back to his December 2009 testimony titled “Mortgage Fraud, Securities Fraud and the Financial Meltdown; Prosecuting Those Responsible,” Mr. Khuzami told the Committee ‘we have achieved significant results’ but “much more work [remains] to be done.”

According to the Director, significant results were achieved in fiscal year 2010 while undertaking and completing the largest reorganization in the history of the Division. This includes filing 634 enforcement actions; obtaining disgorgement orders totaling $1.53 billion; securing orders requiring the payment of $968 million in penalties; obtaining 45 emergency temporary restraining orders and 56 asset freeze orders; and distributing nearly $2 billion to injured investors from 42 separate Fair Funds. While these statistics are impressive, it is noteworthy that no bench marks from prior years were offered for comparison.

SEC Enforcement has also brought a number of significant cases the Director told the Committee. These include the actions against: Goldman Sachs & Co. which is settled (here); ICP Asset Management LLC which is in litigation (here); Lee B. Farkas, the former chairman of Taylor, Bean & Whitaker (here) which is in litigation; Citigroup which is tentatively settled although the Court has, to date, declined to accept the agreement (here); LACE Financial Corp, a credit rating agency, which is in litigation (here); Morgan Keegan & Co. which is currently in trial (here); State Street Bank, which is settled (here); and the Moody’s Investor Services Section 21(a) report declining to bring an enforcement action because of jurisdictional concerns (here). The Director did not comment on the fact that the Division appears to be litigating more cases while facing increased scrutiny from district court judges regarding the terms of its settlements.

The Director also gave the Committee a good overview of the management reorganization implemented to streamline the Division and make it more efficient. At the same time, it is clear that the remarks understate the work which remains to be done. This is particularly true with respect to the market crisis investigations (here) which were the subject of the Director’s December 2009 testimony.

Ms. Romero largely reiterated the Director’s comments. She began by telling the Committee of her regret that “the SEC failed to act more quickly to limit the investor losses suffered by [Robert Allen] Stanford’s victims” (here). Ms. Romero went on to recount for the Committee the significant actions the Commission has taken since filing its case against Mr. Stanford and his entities in 2009. This discussion included steps taken to improve the inspection and enforcement processes in the Fort Worth office. She also told the Committee that “several former Stanford executives” recently received Wells notices and that the investigation is continuing, clearly indicating that more enforcement actions will be brought.

Finally, Mr. Kotz summarized his report on the inspection and investigative efforts taken several years prior to the filing of the action against Mr. Stanford and his entities. This mixture of fact, hindsight and supposition is in a report prepared by the IG’s Office which was available at the end of March 2010. He concluded by reiterating the recommendations for new procedures from the report most, if not all of which, have been implemented.

Overall the testimony presented a picture of a program in transition. Significant management and organizational changes have been initiated and completed. The program is moving forward beyond the past. While the change is significant and the results are positive, SEC Enforcement might well keep in mind a famous line written in 1922 by American poet Robert Frost in “Stopping by Woods on a Snowy Evening:” “But I have promises to keep, And miles to go before I sleep.”

by T. GormanPosted on Posted in SECActions

The SEC won a significant victory in the Fifth Circuit Court of Appeals. The court reversed the Commission’s high profile loss (here) in its insider trading case against entrepreneur and Dallas Mavericks owner Mark Cuban. SEC v. Cuban, No. 09-10996 (5th Cir. Sept. 21, 2010). The real question, however, is whether the agency has the facts to win at trial.

The facts to the Cuban case are straightforward. In March 2004, Mr. Cuban acquired a 6.3% stake or 600,000 shares of Mamma.com. Later that spring, the company prepared to raise capital through a PIPE offering. In June, Mamma.com invited Mr. Cuban to participate. The CEO of the company called Mr. Cuban. The conversation began with the CEO stating that the information he wanted to discuss had to be kept confidential. Mr. Cuban agreed and was told about the PIPE offering. After becoming upset, Mr. Cuban noted he did not like PIPE offerings because they are dilutive. He ended the call stating “Well, now I’m screwed. I can’t sell.”

Subsequently, the CEO sent Mr. Cuban an e-mail telling him how to obtain more information about the offering. Mr. Cuban called the banker conducting the deal in accord with the CEO’s e-mail. He was supplied with additional, confidential details about the offering. In response to questions, the banker told Mr. Cuban that the PIPE would be priced at a discount to market and there were other incentives for investors. One minute after the phone call ended Mr. Cuban sold his stake, avoiding a $700,000 loss.

The critical question on the defense motion to dismiss in the district court was whether there was a relationship of trust and confidence and a duty not to trade. The district court read the complaint as stating that there was an agreement to keep the information confidential, but no understanding that Mr. Cuban would not trade. Thus, selling his shares did not constitute a breach of duty according to the district court.

The circuit court disagreed with this reading. Stressing that all reasonable inferences must at this stage of the case be drawn in favor of the SEC, the court concluded that the “allegations [in the complaint], taken in their entirety, provide more than a plausible basis to find that the understanding between the CEO and Cuban was that he was not to trade . . .” It is plausible the court found that “each of the parties understood, if only implicitly” that Mr. Cuban could not trade.

The inferences drawn by the court in favor of the SEC are predicated on what the opinion describes as a “factually sparse record.” If there were more facts, the outcome might be different. For example, the court noted that “it would require additional facts that have not been put before us for us to conclude that the parties could not plausibly have reached” an agreement that Mr. Cuban could not trade. The parties also dispute Mamma.com’s motive in providing Mr. Cuban information, the court stated. The effect of resolving this dispute is unclear. The court also declined to consider the SEC’s argument based on Rule 10b-5-2(b)(1) which provides for a duty of trust and confidence. A footnote in the opinion notes that the validity of the rule was not considered.

Whether the SEC can develop more facts in discovery to bolster its sparse position remains to be seen. The district court offered the Commission the opportunity to amend its complaint prior to dismissal. It did not, at least suggesting that whatever facts had been obtained during the underlying investigation were in the complaint. Likewise, the Commission does not appear to have the benefit of evidence that might suggest guilt, such as efforts to cover-up or lie. To the contrary, Mr. Cuban informed the SEC about his trades and made other public statements concerning them.

There is no doubt that the SEC will have to develop more facts to replace the favorable procedural inferences it used to move past the motion to dismiss stage of this case. Whether that factual support can be developed so the agency can prevail at trial remains to be seen.