THE STATE OF SEC ENFORCMENT

Ponzi schemes, insider trading and discussions about the vitality of the enforcement program are the staples of SEC enforcement these days.

First, the Ponzi scheme. SEC v. Capital Mountain Holding Corp., Civ. Action No. 3:09-CV-02222-F (N.D. Tex. Filed Nov. 23 2009) names as defendants Capital Mountain Holding Corporation, its president Derek Nelson and two other entities controlled by Mr. Nelson. According to the SEC, over an eighteen month period beginning in June 2008, the defendants raised over $25 million from unsuspecting investors. The funds were raised by Capital Mountain and the two related entities selling promissory notes through a website and Canadian based investment club. Investors were told their money would be put in distressed properties which would be rehabbed and then sold. The notes promised significant interest payments to investors.

The representations by Mr. Nelson, Capital Mountain and the other entities were, according to the SEC, false. In fact, much of the money was used to make Ponzi payments to investors, purchase luxury items for Mr. Nelson as well as his personal expenses and the overhead for the controlled entities. The scheme collapsed in the summer of 2009. The SEC’s complaint alleges violations of Securities Act Sections 5 and 17(a), and Exchange Act Section 10(b).

At present, the action is partially resolved. The defendants have consented to the entry of permanent injunctions prohibiting future violations of the sections cited in the complaint. In addition, they have agreed to the entry of a freeze order and the appointment of a receiver. The Relief Defendants, alleged to have received portions of the investor funds, have also consented to the freeze order. See also, Litig. Rel. 21311 (Nov. 23, 2009). This is one of a stream of similar cases brought in recent months by the SEC.

Second, insider trading. SEC v. Hashemi, Civil Action No. 09-CV-6650 (S.D.N.Y. Filed July 27, 2009) names as a defendant Khaled Al Hashemi, a citizen and resident of Abu Dhabi, UAE. As discussed here, the complaint is based on trading in advance of a merger announcement made on February 23, 2009 involving Nova Chemicals. The complaint centers on the substantial trading of Mr. Hashemi prior to the deal announcement. The claim that he possessed inside information is made on information and belief. The allegation that he was either tipped or misappropriated that information is made on information and belief. That information and belief appears to be largely the significant trading by the defendant coupled with the sale of his other holdings to effectuate the trades in Nova shares.

The case was settled with the entry of a consent decree on November 18, 2009 as discussed here. That settlement contained the usual terms: consent to the entry of a permanent injunction and disgorgement of the over $450,000 in trading profits and prejudgment interest and the payment of a penalty equal to the trading profits. The decree was entered by the Court on November 18, 2009.

The day after the entry of the decree, something unusual happened. The Court, on its own motion, vacated the settlement. No papers had been filed by either side. No hearing was held. The order states in part that “the Court has reconsidered its endorsement of the proposed final judgment and has determined that more information relating to the settlement and the facts underlying his case are necessary to determine whether a final judgment on consent is appropriate … .” A pretrial conference is scheduled for December 1, 2009. Whether this is another Bank of America or there is some other reason for the Court’s action is unclear at present.

Third, perceptions about and the vitality of SEC enforcement. In remarks to the ABA Business Law Section last week David Becker, SEC General Counsel and Senior Policy Director, discussed, among other things, the cloud under which the SEC currently operates and the fact that public perception about the Commission only partially reflects reality. In truth, Mr. Becker noted, the SEC has always been an aggressive and effective regulator, “sometimes more so, sometimes less.” As an example, he cited the recent insider trading actions involving the founder of Galleon and others stating “[t]hese are a wonderful example of the new SEC. But they are a fine exemplar of the old SEC as well.” These are certainly noteworthy cases. But they are built on wire taps obtained by the U.S. Attorney’s Office, not the SEC.

WHERE ARE THE MARKET CRISIS CASES?

The SEC continued its almost endless stream of investment fraud cases on Friday, filing an action against Shidaal Express, Inc. and its principal, Mohamud Abdi Ahmed. SEC v. Shidaal Express, Inc., Case No. 09 cv 2610 (S.D. Cal. Filed Nov. 19, 2009). As in many of these cases, the complaint alleges a fraud in which investors were fleeced of millions of dollars. According to the SEC, Mr. Ahmed raised over $3 million from 40 investors for his alleged stock trading business. His sales pitch was targeted to members of the Somali immigrant community in San Diego, Seattle and elsewhere. Many of those belonged to a mosque in San Diego. Investors were promised exorbitant returns of 5% per month or 60% per year. They were assured that the investment was safe. Several investors put in their life savings. As so often happens in these cases there were returns at first, but ultimately the money was not invested as promised, the returns were not paid and portions were misappropriated. The SEC is litigating this case which unfortunately reflects an all too common story replayed over and over in the dozens of investment and Ponzi scheme cases the agency has brought in recent months. See also Litig. Rel. 21310 (Nov. 20, 2009).

While Ponzi and other investment scheme cases were once thought hard to find post-Madoff, that difficulty seems to have diminished. Whether that is because of a new focus resulting from Madoff, the market crisis or other factors is unclear. At the same time, this new stream of cases raises another question. What happened to the “market crisis” investigations. SEC officials have touted for months the dozens of market crisis related investigations underway. The speech of Commissioner Walter last March, for example, detailed dozens of inquiries in progress as discussed here. Those inquiries cover a range of subjects from subprime lenders, investment banks, large financial institutions, market rumors and manipulation to hedge funds.

SEC Enforcement Director Robert Khuzami, in conjunction with the announcement of the revamped Financial Fraud Task Force last week, highlighted the Division’s accomplishments in this area. In his remarks, available here, the director cited cases involving an Atlanta homebuilder and mortgage lender, the insider trading action involving credit default swaps, and the matter involving risky collateralized mortgage obligations to senior citizens. Mr. Khuzami also listed a number of statistics illustrating that the amount of disgorgement orders is up, penalties have increased and the number of asset freeze orders rose. Indeed, the Commission even has a press release on its website recounting its post-Madoff actions.

None of this answers the real question however: Where are the market crisis cases? Much of the market crisis focused on mortgage backed securities, credit default swaps, derivatives, credit rating agencies and the demise or near collapse of major institutions. Despite months of talk about all the investigations, few cases have been brought.

Mr. Khuzami is clearly correct in stating that SEC brought an insider trading case based on CDS. The agency also filed a case against the Countrywide officials and reportedly is gearing up to litigate its action against the Bear Stearns hedge fund managers, despite the recent loss in the criminal case, discussed here.

One CDS case, one action involving countrywide, and a handful of other smaller cases on the fringe of the market crisis does not reach the core of what happened over recent weeks and months as the market spun out of control. Likewise, while the stream of Ponzi scheme cases will hopefully help root out these fraud, they are not at the center of the market crisis.

To be sure, there has been a lot of discussion about the lack of regulation over derivatives, hedge funds and other key areas. The Administration, the SEC. the CFTC and others all have discussed proposals for more regulation. In these discussions there are usually references to the limited authority in these areas of the SEC and other agencies.

Yet, it is clear that the SEC has all the antifraud authority it needs to police the securities markets. Over the years the agency has always been able to use that authority to halt whatever new and creative fraud reared its ugly head to fleece investors and pollute the markets. When the SEC’s authority is combined with that of DOJ, the CFTC and others through the existing Financial Fraud Task Force – the new supercharged version adds little other than an executive order – it is beyond dispute that there is plenty of statutory authority to halt fraud.

The real question is when it will be used. While investigations take time the fact is to date the Commission has made little use of its antifraud authority in the areas that are the focus of the market crisis inquiries. It’s time for the SEC to stop rearranging the deck chairs, reeling off stats and issuing press releases about its accomplishments. Its time to clean up the causes of the market crisis and turn the dozens of investigations into effective enforcement actions. While new authority from Congress is fine, it’s time to effectively use existing authority. Perhaps then the once revered enforcer will again become the top cop of Wall Street.