by T. GormanPosted on Posted in Insider Trading, SECActions

A key part of the SEC’s statutory mandate is to prevent a repetition of the violation after halting it. Accordingly, an important component of many settled enforcement actions is the remedial steps taken to ensure against a repetition of the wrongful conduct. Frequently however, the remedial steps instituted are only briefly mentioned, if at all. Disclosure of these steps would not only help reassure investors and the markets, but offer guidance to others.

SEC v. Cole, Civil Action No. 3:09-CV-2107 (N.D. Ohio Filed Sept. 11, 2009) and In the Matter of Dana Holding Corporation, Adm. Proc. File No. 3-13614 (Sept. 11, 2009), two related settled financial fraud cases, are good examples of the failure by the SEC to provide any real disclosure regarding the remedial steps taken by an issuer to prevent a repetition of the wrongful conduct in the future. Both cases center on a financial fraud and the inadequate internal controls at the predecessor of Dana Holdings (Dana Corporation) from 2004 through mid-2005. The civil injunctive action names as defendants Bernard Cole, William Hennessy, Douglas Hodge and Robert Steimle, all former senior executives of Dana’s Heavy Vehicle Technologies and Systems Groups, one of two main business units of the company, in a fraud and books and records action. The administrative proceeding names the company as a respondent in a books and records action.

Both actions are based on efforts to improve the operating results in the Commercial Vehicle Systems subdivision of Dana’s Heavy Vehicle business unit. At the time, Dana Corporation manufactured and supplied automotive parts and systems to vehicle manufactures worldwide. On March 3, 2006, the company filed for protection under Chapter 11 of the Bankruptcy Code. In February 2008, the company emerged from Chapter 11 as a holding company and had its shares listed on the NYSE from which it had previously been delisted.

The complaint and Order for proceedings allege that the financial statements of the company were misstated in part as a result of a scheme carried out by the individual defendants to inflate income. Key elements of the scheme included:

1) The recognition of income in transactions where assets were never transferred or the risk of ownership never passed. Specifically, in a contract with a parts supplier, the company recognized revenue, despite the fact that the agreement stipulated that Dana would retain the parts and risk of loss pending completion of the sale. On another transaction, the company recognized $5 million on the sale and lease back of a facility, despite the fact that GAAP requires that the income be amortized. The company also recognized revenue on transactions where it could not deliver the products.

2) The recognition of revenue for price increases on parts sales without agreement from the customers. In fact, the company accrued revenue for price increases while its employees were still negotiating them.

3) Improperly deferring recognition of certain surcharges. Specifically, the company used a variety of techniques, including rejecting valid invoices, to defer payment of steel surcharges.

4) Making a series of improper accounting entries that lacked proper support. In 2004 and 2005, the company improperly increased EBIT by $3.9 million by issuing improper debit memos to suppliers without their agreement which reduced outstanding payables.

In addition, from 2004 through the first two quarters of 2005, the books and records of the company contained errors amounting to $56.4 million. In part, these were related to the LIFO inventory reserve of the company.

The audit committee of the company discovered the accounting fraud in September 2005 and disclosed it the following month. In December 2005, the company restated its financial statements.

In a December 30, 2005 Form 10-K/A, the company admitted to five material weaknesses in the design and operation of its internal controls which include: 1) a failure to maintain an effective control environment; 2) having a financial and accounting organization that was not adequate to the needs of the company; 3) failing to maintain effective controls over the completeness and accuracy of certain revenue and expense accruals; 4) failing to maintain effective controls over reconciliations of certain accounts; and 5) failing to maintain effective control over the valuation of certain inventory and related costs of goods sold.

To resolve the civil injunctive action, the individual defendants each consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions of the Exchange Act. Messrs. Hennessy, Hodge and Steimle also consented to the entry of an injunction prohibiting violations of Section 17(a) of the Securities Act. The final judgments also impose a $65,000 civil penalty and a five year officer/director bar against Messrs. Cole and Hodge and a $45,000 civil penalty against Messrs. Hennessy and Steimle. Mr. Hodge also agreed to pay over $71,000 in disgorgement, along with prejudgment interest, while Mr. Hennessy agreed to pay over $44,000 in disgorgement along with prejudgment interest and Mr. Steimle agreed to pay over $21,000 in disgorgement and prejudgment interest. See also Litig. Rel. 21207 (Sept. 11, 2009).

To resolve the administrative proceeding, the company agreed to the entry of an order directing it to cease and desist from committing or causing any violations of the reporting provisions and the related rules. The Commission considered the remedial acts taken by the Respondent and its cooperation, according to the Order.

At the center of the violations detailed in the Commission’s papers is the poor financial controls and environment of the company. What steps the company took to improve its financial report processes, strengthen its internal controls and ensure that it has the proper reporting environment is not disclosed by the Commission. Accordingly, neither investors nor the market can determine how effective those steps may be.

Disclosure of the remedial steps taken by the Company would help reassure investors and the markets that the difficulties which resulted in the wrongful conduct will not be repeated. Disclosure could also offer valuable guidance to others. Unfortunately, the lack of disclosure here is typical of Commission settlements, a stark anomaly for an agency whose mission is primarily disclosure. Perhaps in the future as the Commission retools its enforcement program it will consider enhancing the disclosures made concerning the steps taken by issuers to prevent a repetition.

by T. GormanPosted on Posted in SECActions

The dispute over the accuracy of the SEC’s case alleging that Bank of America deceived its shareholders when acquiring Merrill Lynch continued and broadened this week. The New York AG sent a letter to the bank claiming that its privilege assertions were blocking the state’s investigation which is at the charging stage. The bank disputed the claim.

In another brief filed in the SEC’s case, Bank of America continued to maintain that shareholders were not deceived. The SEC also filed another brief claiming again that its complaint against the bank is accurate and that the court should accept the settlement. The complete version of the SEC IG’s report on the failed Madoff investigations was released.

SEC enforcement filed cases based on insider trading, financial fraud and investment fund fraud. Criminal charges were brought accusing three former NASD registered representatives of running a boiler room. DOJ obtained another guilty plea to FCPA charges.

SEC enforcement

Bank of America: The New York AG sent a letter dated September 8, 2009 about the acquisition of Merrill Lynch by the bank — the deal at the center of the SEC’s case discussed here — to outside counsel for the bank. Mr. Cuomo’s office has also been investigating the merger and what was told to shareholders, according to the letter. In part, the inquiry has been blocked by claims of reliance on the advice of counsel while privilege was asserted. The letter notes that under these circumstances the bank’s assertions are not correct and should be reconsidered. A response from Bank of America claims that the AG has repeatedly refused to meet and discuss the case, that it has cooperated and that all of its actions were proper. The bank denies relying on an advice of counsel defense.

This week the SEC and Bank of America filed additional briefs in the Commission’s case. The SEC argued that the facts in its complaint clearly established a violation of the proxy rules. The Commission also stated that during its investigation the witnesses uniformly testified that the proxy materials and the decisions relating to disclosure were delegated to outside counsel. The bank, according to the Commission, asserted privilege and controlling Second Circuit case law holds that during an investigation privilege is not waived under the circumstances here, in contrast to a court proceeding where asserting reliance on the advice of counsel results in a waiver. Accordingly, investigators could not determine which individuals may have been responsible for the disclosure questions. The Commission urged the court to accept the settlement.

Bank of America maintained that it did no violate the proxy rules and that its actions were proper. The argument is predicated largely on the fact that materials outside the proxy materials referenced the fact that bonuses would be paid and that the text of the proxy materials did not state bonuses would not be paid. Rather, the proxy materials only stated that bank approval was required and referred to schedules not attached. In any event, the missing schedule only contained a “cap” for the bonuses of $5.8 billion, it did not state the actual amount of $3.6 billion that was paid. Disclosing the cap would be misleading according to the bank.

Finally, Bank of America argued that a 2005 Commission Section 21(a) report which cautioned against not attaching schedules which are part of a merger agreement to proxy materials should not be followed. The Commission argued that the report, commented on by all of the bank’s outside lawyers at seminars, clearly gave notice that the schedule listing the bonuses should have been included in the proxy materials.

Madoff: The SEC IG’s full report on the Madoff debacle details over hundreds of pages the now well know story: the SEC had repeated chances beginning as early as 1992 to discover and halt the Madoff fraud and failed. The detail offered by the full report makes it clear that the Madoff failures are not attributable to any one person. Rather, the failures stem from a variety of actions and inactions such as supervisors who signed-off on closing investigations where the basic investigative work had not been done; frontline investigators who failed to obtain and analyze the basic documents; in some instances the inexperience of investigators or a lack of resources; and sometimes supervisors who incorrectly directed an inquiry. The repeated gaffes, perhaps premised on a misguided supposition that a long standing and well know Wall Street player such as Mr. Madoff is honest, started at the top and flowed through the entire structure. The Chairman’s comments focus on the future, promising that the lessons of the Madoff debacle will be learned as enforcement is rejuvenated.

SEC enforcement actions

Insider trading: SEC v. Soisson, Civil Action No. 09-CV-1669 (N.D. Tex. Filed Sept. 8, 2009) names Jeff Soisson and his wife Karen Walker as defendants. Ms. Walker was employed at JDA Software Group, Inc. as the director of communications. In November 2008, she learned that the company was not going to proceed with its previously announced merger with i2Technologies. Ms. Walker informed her husband, who then sold all of their shares of i2Technologies prior to the announcement of the collapse of the deal. When that announcement was made, the share price fell from over $14 to just over $10. The couple avoided a loss of over $163,000. Both defendants settled by consenting to the entry of permanent injunctions prohibiting future violations of Section 10(b) and orders directing them to disgorge their trading profits along with prejudgment interest. The couple was also ordered to pay a civil penalty equal to the trading profits. See also Litig. Rel. 21201 (Sept. 9, 2009).

Financial fraud: SEC v. Huff, Civil Action No. 09-61419 (S.D. Fla. Filed Sept. 8, 2008) alleges that the former CFO of GlobTel Communications Corp., Timothy Huff, participated in a scheme to inflate the revenue of the company over a two year period. The scheme used hundreds of false invoices to make it appear that three subsidiaries of the company bought and sold telecom “minutes” with other wholesale telecom companies. In reality there were no transactions. As a result, the financial statements were false and misleading. Mr. Huff is alleged to have received about $4.9 million in compensation during the period as well as stock options he exercised with a value of about $1.5 million. The complaint alleges violations of the antifraud and reporting provisions of the securities laws. See also Litig. Rel. 21202 (Sept. 9, 2009); See also SEC v. GlobeTelCommunications Corp., Case No. 08-CV60647 (S.D. Fla. Filed May 1, 2008); SEC v. Monterosso, Case No. Nov. 21, 2007 (S.D. Fla. Filed Nov. 26, 2007).

Investment fund fraud: SEC v. Barry, Civil Action No. 09-CV-3860 (E.D.N.Y. Filed Sept. 8, 2009). The SEC’s complaint claims that for a period of over thirty years defendant Philip Barry and his controlled entities “conned hundreds of investors into investing over $40 million.” Mr. Barry told investors he would use a proven trading strategy to protect their principal and generate a guaranteed return rate of 12.55% per year. Investors were also told that they would be protected by SIPC. In fact defendant Barry had not traded in securities in years. Rather, he diverted the funds to his own use while fabricating periodic statements sent to investors. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2) and (4). See also Litig. Rel. No. 21199 (Sept. 8, 2009). The U.S. Attorney’s Office filed a parallel criminal action, U.S. v. Barry, Case No. 9-0876 (E.D.N.Y. Filed Sept. 8, 2009). See also http://www.usdoj.gov/usao/nye/pr/2009/2009sep08.html.

Investment fund fraud: SEC v. Hanson, Civil Action No. 3:09-CV-00336 (W.D.N.C. Filed Sept. 3, 2009). This case names as defendants Sidney Hanson, his wife and their controlled entities. Over a three year period Mr. and Mrs. Hanson, through a sales force of 45 “consultants,” sold about $32.5 million of what they called “private loan agreements” to an estimated 500 investors according to the SEC. Those investors were told that the agreements would yield profits ranging from 8% to 30% from safe investments. In fact, some of the funds were put in very risky investments while others were used to pay the Hansons and their sales force. The defendants consented to the entry of a permanent injunction and certain ancillary relief. Monetary relief will be determined later. See also Litig. Rel. 21198 (Sept. 8, 2009).

Criminal cases

Boiler room: Defendants Alan Labiner, Khurram Tanwir and Amed Awan were charged with conspiracy to commit securities, mail and wire fraud for operating a boiler room in Brooklyn and embezzling investor funds. The criminal complaint claims that from 2004 to 2009 the defendants raised more than $6 million from at least 50 investors by selling fraudulent securities in four different investment schemes. In each scheme, the defendants trained and supervised cold-callers who contacted and then lied to prospective investors. The defendants were all at one time registered representatives licensed by NASD. The investor funds were diverted to the personal use of the defendants. See also http://www.usdoj.gov/usao/nye/pr/2009/2009sep10b.html.

FCPA

U.S. v. Smith, Case No. 8:07-cr-00069 (C.D. Cal. Filed April 25, 2007). Defendant Leo W. Smith, pleaded guilty to a two count superseding information charging conspiracy to violate the FCPA on September 3, 2009. Mr. Smith is a former director of sales and marketing for PCI, a private company based at the time in Santa Ana California that manufactured air separation units and other equipment for defense department throughout the world. Under the plea agreement Mr. Smith admitted that he acted with the president of the company to create a sham marketing agreement with UK-Mod officials to facilitate the payment of over $70,000 in bribes to obtain contracts. See also http://www.usdoj.gov/opa/pr/2009/September/09-crm-928.html. The former president of the company, Martin Self pleaded guilty to a two count information.

Seminar

On September 24, 2009 at noon there will be a webcast sponsored by West Legal Ed tilted “The Uncertainties Surrounding Honest Services Mail Fraud: The Supreme Court and U.S. v. Black.”

http://westlegaledcenter.com/program_guide/course_detail.jsf?courseId=20367387