by T. GormanPosted on Posted in SECActions

The Financial Crisis Inquiry Commission heard testimony this week from Wall Street bankers, DOJ, the SEC and others about the market crisis. SEC Chairman Schapiro recounted developments at the agency over the past year, while summarizing her prior proposals on market reform. The head of DOJ’s criminal division outlined the focus of the new financial fraud task force. At a press conference, the Director of the SEC’s Enforcement Division announced his selections for the newly created new unit chief positions. A revised Enforcement Manuel was issued with a new chapter on cooperation standards.

In court, SEC enforcement lost an effort to amend its Bank of America complaint, but filed a new case with the proposed claims. In an unusual release, the Commission explained the reason no individuals were charged. In other cases, Enforcement continued to focus on insider trading and investment fraud cases.

Reform efforts

Financial fraud task force: Lanny Breuer, Assistant AG, Criminal Division, detailed the focus of the new Financial Fraud Task Force formed by executive order last November, discussed here. In his testimony, Mr. Breuer noted that the task force, which will function through working groups, will focus on what he described as the type of financial fraud that “affect us most significantly in this time of economic recovery” including: 1) mortgage fraud ranging from foreclosure rescue and loan modification fraud to systematic lending fraud; 2) securities fraud, including Ponzi schemes, misrepresentations to investors and corporate frauds along with insider trading; 3) Recovery Act and rescue fraud to ensure that the taxpayers’ investments are not siphoned away; and 4) discrimination to make sure that the financial markets work for all.

SEC Unit chiefs: Director Robert Khuzami named the unit chiefs for the five specialized units that are being created within the Enforcement Division. He also designated the head of the new Office of Market Intelligence, essentially an intake unit for tips received by the Division as discussed here. The units focus on asset management, market abuse, structured and new products, the FCPA and municipal securities and public pensions. The unit chiefs were drawn from the staff as was the head of the new Office of Market Intelligence. All of the appointments are of persons within the Division.

SEC cooperation standards: The Division also announced new initiatives to induce cooperation. Specifically, new Section 6.1.1 of the Enforcement Manual details standards for individuals to earn cooperation credit while reaffirming the Seaboard standards for corporations. The chapter also outlines principles for entering into deferred prosecution agreements and non-prosecution agreements for persons cooperating with the SEC. These agreements appear to be modeled at least in part on practices used by the Department of Justice and are discussed here.

SEC enforcement actions

Insider trading: SEC v. Macdonald, Case No. 09-CV-5352 (Jan. 12, 2010) is a partially settled insider trading action, discussed here, which was filed on June 10, 2009. The complaint claims that defendant Martin Gollan had been illegally tipped about certain business combinations. The information came from defendant Michael Goodman, who, according to the SEC, had obtained the information from his wife, an administrative assistant employed at Merrill Lynch Canada. Mr. Gollan agreed to settle the case by consenting to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the federal securities laws and agreeing to disgorge his trading profits of about $91,000 along with prejudgment interest. See also Litig. Rel. 21376 (Jan. 12, 2010).

Proxy fraud: SEC v. Bank of America, Case No. 09 Civ. 6829 (S.D.N.Y. Filed Aug. 3, 2009) is the Commission’s action against the bank based on its acquisition of Merrill Lynch, discussed here. This week, the court rejected the SEC’s request to amend its complaint and include additional claims which would also constitute violations of Section 14(a) and the pertinent rules thereunder. The court rejected the request, but noted the SEC could file the claims as a separate action.

The next day the Commission filed SEC v. Bank of America, Civil Action No. 10-0215 (S.D.N.Y. Filed Jan 12, 2010). In the new complaint, the SEC alleges that the bank should have disclose to shareholders the fact that Merrill Lynch had incurred a net loss of $4.5 billion in October 2008 and estimated billions of dollars of additional losses in November. This represented a fundamental change from the information which had previously been presented to shareholders. In its release regarding the proposed amended complaint, the SEC explained that it did not name any individuals in the complaint because the staff had concluded and informed it that charges against individuals would not be appropriate. The staff concluded that the individuals involved in the making the disclosure decisions had not acted with scienter or an intent to mislead. See also Litig. Rels. 21371 (Jan. 11. 2010) and 21377 (Jan. 12, 2010).

Investment advisers: SEC v. Moody, Case No. 8:10-CV-0053 (M.D. Fla. Filed Jan. 11, 2010) is an action against Neil Moody and his son Christopher Moody, who were both investment advisers to three funds. The action alleges that they misled investors by distributing offering materials, account statements and newsletters which misrepresented the actual performance of the funds. They also misled investors by telling them that they were faithfully managing the funds when in fact they had essentially abandoned their obligations while ignoring warning signs that should have alerted them to the underlying fraud. In truth, there was an arrangement with Arthur Nadel who ran the funds. The two defendants settled the action by consenting to permanent injunctions and agreeing to the entry of an order which bars them from associating with an investment adviser for five years. See also Litig. Rel. 21372 (Jan. 11, 2010).

Investment fund fraud: SEC v. NewPoint Financial Services, Inc., Case No CV 10 0124 (C.D. Cal. Filed Jan. 11, 2010) is an action against John Farahi, Gissou Farahi, Elaheh Amouel and their company. The complaint claims that since 2003 the defendants have engaged in an offering and investment fund fraud which raised as much as $20 million from over 100 investors, largely from the Los Angeles Iranian-American community. The investors were induced to purchase what the defendants claimed were debentures or interests that were safe and in some instances backed by the FDIC and/or the TARP program. In reality as much as $18 million was lost in risky trading. The defendants also diverted part of the money to personal use. The complaint alleges violations of Securities Act Section 5 and the antifraud provisions. The court has entered a temporary freeze order. See also Litig. Rel. 21369 (Jan. 11, 2010).

Insider trading: SEC v. Wagner, Case No. 1:10-cv-10031 (D. Mass. Filed Jan. 11, 2010) is a settled action against Brooke D. Wagner, former VP of Corporate Communications of Indevus Pharmaceuticals, Inc. According to the complaint, Mr. Wagner learned that the FDA had expressed concerns about side effects for a drug for which the company was seeking approval. Prior to the public announcement about the FDA in June 2008, the defendant sold his shares in the company and later sold additional shares short. The share price fell about 69% following the announcement. To settle the matter, Mr. Wagner consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the federal securities laws and agreed to pay disgorgement of about $64,000 along with prejudgment interest and a civil penalty equal to the amount of the disgorgement. See also Litig. Rel. 21370 (Jan. 11, 2010).

Investment adviser fraud: SEC v. Salutric, Civil Action No. 1:10-CV-00115 (N.D. Ill. Jan. 8, 2010) is an action against an investment adviser for misappropriating at least $1.8 million from 17 clients. The SEC claims in its complaint that Mr. Salutric misappropriated client funds by making unauthorized withdrawals from their accounts, forging client signatures on withdrawal requests submitted to the custodian. The funds were used to support the defendant’s other business activities and make payments to other clients. The complaint alleges violations of Exchange Act Section 10(b) and Section 206 of the Investment Advisers Act in addition to the pertinent rules under each Act. The case is in litigation. See also Litig. Rel. 21366 (Jan. 8, 2010).

Investment fund fraud: SEC v. Elkinson, Case No. 10-CA-10015 (D. Mass. Jan. 7, 2010) is an action against Richard Elkinson, who is alleged to have run a Ponzi scheme. According to the SEC, since 1997 Mr. Elkinson has sold notes to investors which claimed to pay between 9% and 13% interest. The notes were supposed to represent an interest in a business which brokered contracts on behalf of a Japanese firm that manufactured uniforms sold to large purchasers such as state and local governments. In fact, the scheme defrauded 130 investors out of approximately $28 million. The complaint alleges violations of Securities Act Section 5, Exchange Act Section 10(b) and the pertinent rules thereunder. The case is in litigation. See also Litig. Rel. 21364 (Jan. 8, 2010).

FCPA

In the Matter of NATCO Group Inc., Adm. Proc. File No. 3-13742 (Filed Jan. 11, 2010); SEC v. NATCO Group, Inc., Civil Action No. 4:10-CV-98 (S.D. Tex. Filed Jan. 11, 2010). These actions, discussed here, are against Houston based NATCO, and involve the its subsidiary, TEST Automation & Controls which has an office in Kazakhstan.

TEST won a contract in Kazakhstan. The subsidiary hired local Kazakh workers and expatriates. During an audit of TEST in 2007, Kazakh immigration prosecutors claimed that the expatriate workers did not have the proper documentation and threatened to impose fines and to either jail or deport the workers if the company did not pay the fines. TEST senior management furnished employees funds to reimburse two payments made to officials. The payments were not properly recorded. In addition, a TEST consultant who did not have the proper license, but had close ties to the Ministry of Labor, requested cash in two instances to facilitate obtaining visas. To secure the payments, the consultant provided TEST with bogus invoices totaling $80,000 for the funds. The invoices, which were necessary under local law to withdraw the money from the bank, were later submitted to TEST and reimbursed despite knowledge of the true purpose. These cases were settled, based on the cooperation of the company (which is no longer a registrant following a merger) with a consent by the company to a cease and desist order based on the FCPA books and records and internal control provisions and the payment of a $65,000 penalty.

by T. GormanPosted on Posted in SECActions

The SEC continued its efforts to rejuvenate the Enforcement program yesterday, taking two important steps yesterday. Once concerns the reorganization of the Division of Enforcement to increase its expertise and efficiency, while the other focuses on securing cooperation to facilitate investigations by adopting techniques used by the Department of Justice.

At a news conference on Tuesday, Enforcement Director Robert Khuzami named the unit chiefs for the five specialized units that are being created within the Enforcement Division, as well as the head of the new Office of Market Intelligence. Those units focus on asset management, market abuse, structured and new products, the FCPA and municipal securities and public pensions. The unit chiefs were drawn from the staff as was the head of the new Office of Market Intelligence, essentially an intake unit for tips received by the Division.

The specialty groups should help focus the expertise of the Division and thus speed investigations. Calling this step, along with the others being made, the “most significant reorganization” since the Division was established in 1972, as the press release states, may, perhaps, overstate the case. In fact, the creation of specialized units within Enforcement returns the Division to its past when it was considered one of the premier investigative units in government. Until the early 1980s, the Enforcement Division had units which specialized in various matters. A reorganization under then Chairman Shad eliminated those groups. Regardless, this return to the past should facilitate the work of the Division.

The new cooperation standards, added as a new chapter to the Enforcement Manual, should also aid the work of the division. The standards have two main features. One focuses for the first time on incentives for individuals to cooperate with the SEC. The other concerns the use of deferred and non-prosecution agreements for individuals and business organizations.

Section 6.1.1 of the Manual, which is also being published in CFR, details principles regarding cooperation by individuals. After noting that “there exists some tension between the objectives of holding individuals fully accountable for their misconduct and providing incentives for individuals to cooperate with law enforcement authorities,” the Manual outlines four basic considerations amplified by various sub-points that will be used in evaluating the question of cooperation credit for individuals. As under Seaboard, none of the factors are binding and the list is non-exclusive. The factors are:

1) Assistance provided by the individual: This point focuses on the value of the assistance to the investigation, the nature of the cooperation, whether others were encouraged to assist and any unique circumstances in which cooperation was provided.

2) Importance of the underlying matter: This factor is a function of the nature of the investigation and the danger to investors and others presented by the underlying violations.

3) Interest in holding the individual accountable: Here, the nature of the misconduct by the individual will be assessed, along with culpability, any efforts to remediate the harm caused and any sanctions imposed by other authorities.

4) Profile of the individual: This factor considers whether, and by how much, it is in the public interest to award cooperation credit based on the history of the person, the degree to which responsibility has been accepted and opportunities for future violations.

For business organizations Seaboard, discussed here, is still the standard and is incorporated into the Manual in Section 6.1.2.

The key new provision for both business organizations and individuals is the prospect for avoiding prosecution through the use of either a deferred prosecution or non-prosecution agreement. Both types of agreement are commonly used by the Department of Justice.

A deferred prosecution agreement, which must be approved by the Commission, is a written agreement which contains the following elements, according to the Manual: a) an agreement to cooperate; b) a long term tolling agreement which presumably would not be more than five years since that is typically the outside length of the agreement; c) an undertaking to comply with express prohibitions and/or undertakings during a period of deferred prosecution; and d) a promise “under certain circumstance, [to] agree either to admit or not to contest underlying facts that the Commission could assert to establish a violation of the federal securities laws.” This latter provision would not apply to individuals who are not: professionals, employees of a regulated entity, officers or directors of a public company or persons who are not recidivists. The agreement would also contain any prohibitions or undertakings deemed necessary to protect the investing public.

A non-prosecution agreement, which also must be approved by the Commission, is defined as a written agreement which provides that the SEC will not pursue an enforcement action against the person if that person cooperates and complies under certain circumstances with express undertaking. There is no reference in the discussion of non-prosecution agreements of making admissions of, or not contesting, the facts. Such an agreement may however require the payment of disgorgement and/or a penalty, a point not mentioned in the discussion of deferred prosecution agreements. The agreement may also contain any other prohibitions or undertakings deemed necessary to protect the investing public.

The prospect of entering into a deferred or non-prosecution agreement should help encourage cooperation and thus be beneficial to Enforcement. For individuals, the prospect that they may not be prosecuted should offer an inducement to cooperation. Business organization may also be induced to cooperate by the prospect of entering into a deferred or non-prosecution agreement, particularly if it avoids the filing of the typical SEC speaking complaint detailing pages of misconduct. Presumably if a non-prosecution agreement is reached this would be the case. The precise procedure under the Manual for a deferred prosecution agreement, however, is not specified.

It remains to be seen, however, whether in practice the prospect of cooperation credit for individuals and business organizations will have the desired impact. Under Seaboard, it is typically difficult for a person considering cooperation to evaluate its potential impact on any potential charging decision in view of the opaque process used to award cooperation credit. If no action is filed there is no press release. Even when the Commission credits cooperation, the typical Litigation Release rarely specifies the nature of the cooperation or its impact. Since the Manual does not specify that this practice will be altered, presumably it will continue to be difficult to assess the impact of cooperation.

The Manual does, however, suggest that deferred and non-prosecution agreements will only be used in limited circumstances. Any requirement that there be an admission of facts before entering into a deferred prosecution agreement may also cause many to have second thoughts about cooperation on this basis. This may be particularly true for business organizations facing parallel civil damage and derivative actions or for any person where there is the prospect of criminal liability. At the same time, the Manual makes it clear that non-prosecution agreements will only be used in very limited circumstances. Thus, the impact of these new provisions is difficult to assess.

Overall, however, the two announcements represent a good step in the direction of rejuvenating the enforcement program. The return to the use of specialty groups within the Division of Enforcement should have a beneficial impact on the program. Likewise the new cooperation provisions may well have a positive impact on the program.