ANOTHER CASE FROM THE FINANCIAL FRAUD ENFORCEMENT TASK FORCE

Christopher F. Finazzo, former Executive Vice President and Chief Merchandising Officer of Aeropostale, Inc., and Douglas Dey, owner of South Bay Apparel, Inc., were charged in a twenty-eight count indictment. The charges center on a claimed kickback scheme. The indictment contains counts of conspiracy, wire and mail fraud and money laundering as to both men and, in addition, charges Mr. Finazzo with making false statements to the SEC. U.S. v. Finazzo, Case No. 10 cr 00457 (E.D.N.Y. Filed, June 11, 2010). The indictment follows investigations by the U.S. Attorneys Office for the Eastern District of New York and the SEC and was brought in coordination with the President’s Financial Fraud Enforcement Task Force.

Aeropostale is third largest teen clothing company. South Bay Apparel sold clothing to Aeropostale. From August 1996 through November 2006, Aeropostale paid over $350 million to South Bay. In connection with those transactions, Mr. Dey agreed to pay about 50% of his firm’s profits to defendant Finazzo. Approximately $14 million of those profits were paid to a company controlled by Mr. Finazzo, C&D Retail Consultants, Inc. The balance was invested in joint ventures with Mr. Finazzo, according to the indictment.

The defendants concealed their transactions from Aeropostale and its employees as part of their fraudulent scheme. Mr. Finazzo is also alleged to have falsely stated in numerous company questionnaires that he was not engaged in any related party transactions. That resulted in the company falsely reporting in filings made with the SEC that it did not engage in related party transactions.

In a November 2006 filing, Aeropostale disclosed that it fired Mr. Finazzo after it discovered he had concealed personal ownership interests in entities affiliated with South Bay. Those interests violated the company’s code of business ethics and Mr. Finazzo’s employment agreement, according to the filing.

Subsequently, the SEC issued a formal order of investigation focused on the events surrounding the termination. Mr. Finazzo then sued the SEC claiming that it breached his attorney-client privilege by obtaining an e-mail he sent to his attorney discussing the undisclosed relationships. The e-mail had been discovered by Aeropostale. The suit against the Commission was subsequently dismissed.

The criminal charges are in litigation.

SUPREME COURT TO CONSIDER SECURITIES FRAUD PLEADING QUESTION

The Supreme Court granted certiorari on Monday in a securities fraud class action, agreeing to hear a question regarding pleading standards. The question presented is: “Whether a plaintiff can state a claim under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5 based on a pharmaceutical company’s nondisclosure of adverse event reports even though the reports are not alleged to be statistically significant?” Matrixx Initiatives v. Siracusano, No. 09-1158 (S.Ct. Cert. granted June 14, 2010).

The case is based on a decision by of the Ninth Circuit Court of Appeals in Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167 (9th Cir. 2009), discussed here. The complaint claimed that Matrixx made false statements about its key product Zicam, a nasal spray. In 2003, the company issued statements regarding the success of the product and at one point revised guidance upward due to its success. The company had, however, received some information from researches and individuals that the nasal spray caused a loss of smell. Products liability suits had also been filed against the company asserting this claim.

Matrixx, however, maintained in press releases that none of the clinical trials supported any claim that the drug caused a loss of smell. The company denied press reports discussing complaints about a loss of smell. A report that the FDA was investigating this claim was followed by a drop in the share price despite statements by the company that it was not aware of any such investigation.

A shareholder suit alleging securities fraud based on claims that the denials of the company were false and misleading was dismissed by the district court. In its ruling, the court held that adverse product reports regarding a loss of smell need not be disclosed because they were not material. Specifically, the court held that a pharmaceutical company need not disclose every adverse report that it receives. Rather, those reports need only be disclosed when they are statistically significant. This conclusion was based on In re Carter-Wallace, Inc. Sec. Litig. , 220 F.3d 36 (2nd Cir. 2000). The First and Third Circuits follow a similar rule.

The Ninth Circuit reversed. Citing Basic v. Levinson, 485 U.S. 224 (1988) the court rejected the statistically significant test employed by the district court and the Second Circuit. Materiality, the court held, is a question generally reserved for the fact finder. Here, the question is whether the allegations are properly pleaded under the PSLRA and state a plausible cause of action under Bell Atlantic Corp. v. Twombly, 550 U.S. 554 (2007). After reviewing the claims in the complaint regarding the adverse product reports about Zicam, the circuit court concluded that the complaint met the pleading requirements. Accordingly, the decision of the district court was reversed. The Supreme Court will hear this case next term.