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.

THIS WEEK IN SECURITIES LITIGATION (November 20, 2009)

The Financial Fraud Task Force replaced the 2002 Corporate Fraud Task Force this week. The new group, created by executive order, is composed of a broad array of federal departments and regulatory agencies. Like its predecessor, it is charged with rooting out and prosecuting financial fraud.

The SEC continued to focus on insider trading, offering fraud and Ponzi schemes. The agency also brought an action against two former Madoff computer programmers which tracks criminal charges filed in the Southern District of New York.

FCPA enforcement continued to be a key DOJ enforcement priority, with another guilty plea. At the same time the Department cautioned big pharma, in a speech by an assistant AG, that is will be carefully scrutinized in view of the extensive involvement of foreign governments in healthcare systems and the potential for corrupt payments.

Market reform

The President issued an executive order this week establishing the Interagency Financial Fraud Task Force. The Order was announced by AG Eric Holder, treasury Secretary Tim Geithner, HUD Secretary Shaun Donovan and SEC Chairwoman Mary Schapiro. The task force, which brings together a broad range of federal agencies and state and local partners, is charged with investigating and prosecuting significant financial crimes. It replaces the Corporate Fraud Task Force, established in 2002. It is composed of senior officials from 23 departments and agencies including DOJ, Treasury, Commerce, Labor, HUD, Education, Homeland Security, the SEC, the CFTC, the FTC, the FDIC, the Fed and others. The group also includes the relevant Offices of Inspectors General and additional executive branch agencies, offices and departments designated by the President or the Attorney General. The first meeting will be called in the next thirty days.

SEC enforcement actions

Insider trading: SEC v. Hashemi, Case No. 09-CV-6650 (S.D.N.Y. July 27, 2009 ) is an insider trading case brought against Khaled Al Hashemi, a citizen and resident of Abu Dhabi, UAE, discussed here. Mr. Hashemi, alleged to have traded in advance of the announcement that Nova Chemicals would merge with International Petroleum Investment Co., settled with the Commission. In addition to consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b), the defendant agreed to pay disgorgement of about $450,000, prejudgment interest and a penalty of just over $400,000. See also Litig. Rel. 21307 (Nov. 19, 2009).

Insider trading: SEC v. Axiaq, Case No. C-08-CV-4637 (N.D. Cal. Filed Oct. 7, 2008) is an insider trading case based on the acquisition in 2007 of Restoration Hardware, Inc. by a private equity firm. The SEC claimed that company vice president Ciriaco Rivor learned about the deal and tipped his friend Emmanuel Axiaq who was told to pass the information to his father, Francis Axiaq. Francis Axiaq had potential trading profits after the announcement of the transaction of over $880,000, but later sold the stock, realizing profits of about $400,000. This week, he consented to the entry of a permanent injunction. Mr. Axiaq also agreed to the entry of an order requiring him to pay disgorgement of over $880,000, prejudgment interest and a civil penalty of $250,000. See also Litig. Rel 21303 (Nov. 18, 2009). The other defendants previously settled.

Financial fraud/unregistered securities: SEC v. Big Apple Consulting USA, Case No 6:09-cv-1963 (M.D. Fla. Filed Nov 18, 2009), discussed here, is an action against a public relations firm and its principals and CyberKey Solutions, Inc. and its principals. The complaint alleges that Big Apple and its principals participated in a scheme through which millions of unregistered shares of CyberKey stock were sold to the public over an almost two-year period, beginning in 2005. The sales were predicated on the false claim that CyberKey had obtained a $25 million purchase order from the U.S. Department of Homeland Security. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See also SEC v. Grocock, Civil Action No. 09-cv-1833 (M.D. Fla. Filed Oct. 29, 2009).

Financial fraud: SEV v. Silva, Case No. 09-5395 (N.D. CA. Filed Nov. 17, 2009), discussed here, names as a defendant Benjamin Silva, III, VP of world sales for Silicon Valley semiconductor company Tvia, Inc. The complaint claims that Mr. Silva caused the company to falsify its financial books and records in two ways. First, over a period of almost two years, beginning in September 2005, he caused the company to improperly report millions of dollars in revenue on sales where there were undisclosed side agreements precluding recognition. Second, he had the company misapply about $300,000 in payments from new customers to past due accounts avoid the reversal of those transactions by the auditors. As a result, Tvia materially overstated revenue for the second and third quarters of fiscal 2006, for fiscal year end 2006 and for the first quarter of fiscal 2007. The complaint alleges violations of the antifraud provisions. The case is in litigation.

Ponzi scheme: SEC v. Mantria Corporation, Case No. 09-CV-02676 (D. Colo. Filed Nov. 16, 2009) named as defendants the company, its principals, Speed of Wealth, LLC and its principals. According to the complaint, the defendant raised about $30 million from more than 300 investors with claims that the money would be invested in “green” initiatives such as supposed “carbon negative” housing. Investors were also promised returns which ranged from 17% to “hundreds of percent.” The claims were false. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See also Litig. Rel. 21301 (Nov. 17, 2009).

Financial fraud: SEC v. Bjorkstrom, Case No. 09-5394 (N.D. Cal. Filed Nov. 17, 2009), also discussed here, is the companion case to Silva. The action is against Diane Bjorkstrom, former CFO of the company. The complaint alleges she participated in the misconduct at the company in two ways. First, by causing $325,000 in revenue to be improperly recognized. Second, by failing to “stand up” to efforts by Mr. Silva when he manipulated the accounting records and misapplied customer payments to deceive the outside auditors. The complaint alleged violations of Securities Act, Sections 17(a)(2)&(3) and aiding and abetting violations of the books and records and internal control provisions. It also claims that she signed false CFO certifications.

To settle Ms. Bjorkstrom consented to the entry of a permanent injunction. The defendant also agreed to pay a civil penalty of $20,000 and to the entry of an order barring her from appearing or practicing before the Commission as an account for two years.

False financial statements: SEC v. Bancinsurance Corp., Case No. 1:09-CV-02155 (D.D.C. Filed Nov. 16, 2009) is an action against an Ohio insurance company and its CEO, John Sokol. The complaint claims that the Form 10-K filed with the SEC for fiscal 2003 was false and misleading because it failed to properly account for more than $2 million of reinsurance claims. Mr. Sokol also filed to ensure that the CFO and auditors were aware of this fact. The defendants settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of Section 10(b) as well as the books and records provisions. See also Litig. Rel. 21300 (Nov. 16, 2009).

Offering fraud: SEC v. Kaleta, Civil Action No. 4:09-cv-3674 (S.D. Tex. Filed Nov. 13, 2009) names as defendants Albert Kaleta and his company Kaleta Capital Management. The complaint alleges that the defendants raised about $10 million from 50 investors through a fraudulent offering of promissory note securities. Investors were told that their funds would be invested in credit worthy businesses. In fact, a significant portion of the proceeds were placed in affiliate companies with no prospect of repayment. The complaint alleges violations of Sections 17(a), 10(b) and Adviser Act Section 206. The defendant consented to the entry of a permanent injunction and the appointment of a receiver. See also Litig. Rel. 21293 (Nov. 13, 2009).

Criminal cases

U.S. v. O’Hara, Case No. 1:09-mj-02484 (S.D.N.Y. Filed Nov. 12, 2009) names as defendants computer programmers Jerome O’Hara and George Perez, who worked for Bernard Madoff and helped him cover up his scheme. The two are alleged to have facilitated the Ponzi scheme by creating and maintaining false trading records, DTC records and other phantom books and documents to cover up the scheme. See also, SEC v. O’Hara, Civil Action No. 09 CV 9425 (S.D.N.Y. Filed Nov. 13, 2009). See also Litig. Rel. 21292 (Nov. 13, 2009).

FCPA

U.S v. Jumet, Case No. 09-cr-0397 (E.D. Va. Filed Nov. 13, 2009). Charles Jumet pleaded guilty to a two-count information based on participating in a conspiracy to bribe Panamanian officials in connection with obtaining business under a maritime contract. Beginning in December 1997 and continuing through July 2003, as discussed here, Mr. Jumet made a series of corrupt payments to officials in Panama to obtain a no-bid 20-year concession to perform the work along a waterway. Payments were made through Panama company Ports Engineering, which is affiliated with Overman Associates, an engineering firm based in Virginia Beach, Va. Mr. Jumet is cooperating with the on-going DOJ investigation. His sentencing is scheduled for February 12, 2010.

Speech by Asst. AG Lanny Breuer: In his remarks to the Tenth Annual Pharmaceutical Regulatory and Compliance Congress, Mr. Breuer stated that the Department is focusing FCPA compliance in the pharmaceutical industry. This is based on the depth of government involvement in foreign health care systems and the significant risk that corrupt payments will infect the process.

Circuit courts

Janvey v. Adams, Case No. 09-10761 and Janvey v. Letsos, Case No. 09-10765, discussed here, consider the question of whether a receiver for the Stanford companies can file claw back claims against investors who held CDs. The court held that a person can only be named as a relief defendant if two conditions are met: (1) the person has received ill-gotten funds; and (2) that person does not have a legitimate claim to those funds. Here, the relief defendants were paid from ill-gotten gains, but they had a legitimate claim on the money invested in the CDs.

FINRA

MetLife and three of its affiliates were fined $1.2 million this week for failing to establish an adequate supervisory system for the review of broker’s email with the public. The failures permitted brokers to engage in undisclosed outside business activities and private securities transactions without detection by the firm. This resulted in significant losses for firm customers. While the firm and its affiliates had a policy in place, it relied on brokers to monitor the email traffic and report it to supervisors. Brokers were also able to delete email from their assigned computers, rendering spot-checks unreliable.

Private actions

Fiala v. Metropolitan Life Ins. Co., Case No. 9:00 cv 02258 (E.D.N.Y) is a securities class action based on claims that the company misled policy holders when it became a public company in 2000. In April 2000, the company completed its demutualization from an insurer owned by policyholders to a stock insurance company. There were alleged misrepresentations and omissions in connection with this process. To resolve the long running suit the company agreed to pay $50 million.

Plichta v. Sunpower Corp., Case No. 3:09-cv005473 (N.D.CA. Nov. 18, 2009) is a class action which claims that the company issued false financial statements in its quarterly reports in 2008 and 2009 and in its annual report for 2008. The false statements are alleged to relate to unsubstantiated accounting entries regarding the cost of goods sold to the company subsidiary in the Philippines and to the SOX certifications made regarding internal controls.