The SEC filed two cases yesterday stemming from an alleged financial fraud at Tvia, Inc., a Silicon Valley semiconductor company. One was against Benjamin Silva, III, the former Vice President of World Wide Sales at the company. SEV v. Silva, Case No. 09-5395 (N.D. Cal. Filed Nov. 17, 2009). This case is in litigation. The second named as a defendant Diane Bjorkstrom, former CFO of the company. SEC v. Bjorkstrom, Case No. 09-5394 (N.D. Cal. Filed Nov. 17, 2009). This case settled.

The action against Mr. Silva alleged that he 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. That revenue should not have been reported because the sales had side agreements in which the customer was promised extended payment terms. Those agreements also obligated Tvia to find a buyer for any product the customer was unable to sell.

Second, Mr. Silva had the company misapply about $300,000 in payments from new customers. Those payments were used to pay down the past due accounts of existing customers. Mr. Silva was seeking to avoid the reversal of previously recognized revenue by misleading the auditors.

As a result, Tvia materially overstated revenue for the second and third quarters of fiscal 2006 and for fiscal year end 2006. In addition, revenue was materially overstated for the first quarter of fiscal 2007.

Mr. Silva’s misconduct permitted him to meet his revenue goals, according to the SEC. He also was awarded stock options to acquire 70,000 shares of Tvia stock. Before the misconduct was discovered, those options were exercised and the stock was sold. Mr. Silva netted over $300,000.

The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). In addition, it asserts false statements to the auditors and aiding and abetting violations of the books and records and internal controls provisions.

The action against Ms. Bjorkstrom alleges that she participated in the misconduct at the company in two ways. First, she caused the company to improperly recognize $325,000 in revenue on a sale on the last day of the fiscal year. Recognition was improper because the customer had not agreed to accept delivery for several weeks.

Second, Ms. Bjorkstrom failed to “stand up” to efforts by Mr. Silva when he manipulated the accounting records to deceive the outside auditors, according to the complaint. In at least two instances Mr. Bjorkstrom did not “challenge Silva’s dubious explanations” when he asked her and others to apply funds from one customer to the past due payments of another customer. These acts contributed to the overstatement of revenue for the fiscal year end 2006 financial statements and the first quarter of the next year.

The Commission’s 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 with the Commission, Ms. Bjorkstrom consented to the entry of a permanent injunction prohibiting future violations of the sections alleged in the complaint. She 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. See also Litig. Rel. 21302 (Nov. 17, 2009).

In the stream of Ponzi scheme and other investment fund fraud cases that have been brought by DOJ, the SEC, the CFTC and private litigants, there is frequently a mad scramble for the money. The SEC and CFTC typically seek a freeze order. Frequently, a receiver will be appointed to marshal the assets and pursue claims for the defrauded investors. Private litigation often follows.

Almost lost in the tangle of claims is the investor who wants his or her money back. Sometimes, that means their account balance as shown on statements that they received from the fund. Typically, those statements depict principal along with its appreciation from whatever trading scheme the fraudster claimed to be implementing. Sometimes that means just the principal. All too frequently, it is whatever they can get.

In the maze of claims, those who should be on the same side sometimes end up on opposite sides. Such is the case in Janvey v. Adams, Case No. 09-10761 and Janvey v. Letsos, Case No. 09 – 10765, both decided by the Fifth Circuit Court of Appeals on November 13, 2009. The cases arise out of the alleged Ponzi scheme operated by the Stanford companies, reputedly a network of some 130 entities in 14 countries controlled by R. Allen Stanford. In the SEC’s enforcement action, SEC v. Stanford Int’l Bank, Ltd., Case No. 3-09-0298 (N.D. Tex. Filed Feb. 17, 2009), discussed here, the agency obtained a freeze order over funds belonging to the Stanford parties. The district court also appointed Ralph S. Janvey as Receiver with significant authority. The court granted a preliminary injunction prohibiting any disbursement of funds or securities.

Subsequently, the Receiver named as “relief defendants” several hundred investors who had invested in, and received proceeds from, Stanford CDs. These of course are the victims of the fraud. Some of these investors received principal payments while others were paid interest. The SEC argued that the Receiver was asserting “clawback” claims which were inequitable because they were brought against innocent investors. The district court agreed and denied a request to freeze the return of principal payments from the CDs, but permitted one as to the interest.

The Fifth Circuit affirmed as to the principal payments but reversed as to the interest. A relief defendant – actually a “nominal defendant” – is not accused of any wrong doing, the court explained. A person is only added as a relief defendant to facilitate collection. Accordingly, a federal court may order equitable relief against such a defendant only where “that person (1) has received ill-gotten funds, and (2) does not have a legitimate claim to those funds.” Where the party has a legitimate ownership interest in the property however, the person is not properly joined as a relief defendant.

In this case, the Receiver satisfied the first prong of the test. The payments to investor defendants came from funds that had been ill-gotten by the Stanford interests. The Receiver however, failed to establish the second prong of the test. Here, there is no question that the investors had investments in the CDs. That ownership interest precludes the person from being a proper relief defendant. Accordingly, the district court lacked authority to freeze the investor defendants’ assets. The SEC supported the investors in the assertion of this position.

The court’s decision in Janvey constitutes an important reaffirmation and clarification of the basic theory of relief defendants. With many investors, receivers and government agencies are pursing limited pools of funds left in the wake of collapsed Ponzi schemes and investment funds, the decision offers clear guidance on the basic principles which apply to adding persons as relief defendants.