by T. GormanPosted on Posted in SECActions

This week, SEC Chairman Christopher Cox resigned while the confirmation of his potential successor, Mary Schapiro, is still pending in the senate. New statistics released by NYSE Regulation demonstrate that insider trading is on the increase.

The SEC also filed a settled insider trading case this week. In addition, the Commission filed two settled financial fraud cases and resolved financial fraud claims with an individual defendant in an action filed last year.

The SEC

Chairman Christopher Cox stepped down this week after being at the helm of the agency since June 2005. Mr. Cox leaves an agency in crisis and at a crossroads. As Mr. Cox departs, many are calling for the merger of the SEC with other agencies. Congressional hearings also loom into alleged failures of the enforcement division. At the same time, many note that Mr. Cox made significant process in the push for greater global regulatory cooperation and the internationalization of accounting standards, as well as with the disclosure of executive compensation.

The successor for Mr. Cox, FINRA head Mary Schapiro, has yet to be confirmed by the Senate. During testimony, Ms. Schapiro has expressed interest in the regulation of hedge funds and reviewing the current schedule for adopting international accounting standards. Ms. Schapiro has also vowed to reinvigorate the enforcement division.

Insider trading

Insider trading in its classic form is up significantly, according to New York Stock Exchange Regulation, which monitors trading and listing compliance for NYSE Euronext’s U.S. operations. It referred 146 cases of suspected insider trading to the SEC in 2008, an increase of five cases over 2007. There was a significant drop in the number of cases involving hedge funds, however. In 2007 about 72% of the cases involved hedge funds. In 2008, the number dropped to about half. On the other hand, the classic type of insider trading – by insiders or those they tip – seems to be on the rise. Trends in trading show a marked spike at the end of the day in the last few minutes of trading and at midday when there tended to be large trading swings during 2008.

A new paper on insider trading suggests that there is a leakage of insider trading information within brokerages by market makers, a practice called piggybacking. The authors of the paper, two Wharton finance professors, suggest that this may be a new area for additional regulation. Christopher C. Geczy and Jinghua Yan, “Who are the Beneficiaries When Insiders Trade? An Examination of Piggybacking in the Brokerage Industry” (January 2009). The paper is published in Knowledge@Wharton.

SEC enforcement

SEC v. Cooksey, Civil Action No. 1:09-CV-044 (W.D. Tex. Filed Jan. 22, 2009) is a settled insider trading action against Aaron Cooksey, the manager of qualified plans at Freescale Semiconductor, Inc. According to the complaint, from November 2007 to early February 2008, Freescale negotiated to acquire SigmaTel, Inc. Mr. Cooksey learned about the transaction during those negotiations and traded in the shares of SigmaTel.

To resolve the transaction, Mr. Cooksey consented to the entry of a permanent injunction. He also agreed to pay disgorgement of about $23,000, prejudgment interest and a penalty equal to the amount of the disgorgement.

SEC v. General Motors Corporation, Civil Action No. 1:09-CV-00119 (D.D.C. Filed Jan. 22, 2009). The complaint alleged books, records and internal control violations beginning in 2000. Specifically, the SEC’s complaint alleged that in its 2002 Form 10-K GM made material misstatements regarding its pension discount rate selection and expected return on pension assets. The company also failed to disclose material information about the timing of its projected cash contributions to its pension plans to avoid variable rate premiums, as well as the impact the projected contributions might have on its liquidity and capital resources. The complaint also alleged that GM misstated its financial statements in 2000 by improperly accounting for a $97 million transaction involving the sale and repurchase of precious metals inventory. Likewise, GM is alleged to have improperly recognized a $100 million signing bonus in its 2001 Form 10-K and improperly accounted for two types of derivates in its 2004 Form 10-K.

The company settled the case by consenting to a books, records and internal controls injunction.

SEC v. McEnroe, Civil Action No. CV-09-0249 (E.D.N.Y. Filed Jan. 22, 2009); In the Matter of McEnroe, Adm. Proc. File No. 3-13348 (Jan. 22, 2009); In the Matter of Cablevision Systems Corporation, Adm. Proc. File No. 3-13347 (Jan. 22, 2009). The Commission filed three actions — two administrative proceedings and one civil action — relating to an alleged financial fraud at Cablevision Systems Corporation. The individual defendants are Catherine McEnroe, former president of AMC Networks, a Cablevision subsidiary; Noreen O’Loughlin, EVP and General Manager of AMC Networks, and Martin R. von Ruden, Senior VP and General Manager of Women’s Entertainment at AMC Networks.

The complaint and orders for proceedings alleged that from at least 1999 through mid-2003, Cablevision recognized certain costs as current expenses when in fact the costs should not have been recognized in those periods. This practice was called “prepays.” To facilitate the use of this practice, employees prepared and submitted inaccurate and misleading invoices and other supporting documents.

To resolve the cases, each individual defendant consented to the entry of a cease and desist order based on alleged violations of the internal controls and books and records provisions. In the civil case, defendants McEnroe, O’Loughlin and von Ruden consented to the entry of orders requiring them to pay civil penalties of, respectively, $30,000, $15,000 and $15,000.

In a related administrative proceeding the company consented to the entry of a cease and desist order based alleged violations of the internal controls and books and records provisions.

SEC v. Urs Kamber, Civil Action No. 1:07-CV-01967 (D.D.C. Filed May 30, 2008). This action was initially filed against three employees of Centerpulse, Ltd. based on an alleged financial fraud. Urs Kamber, the former CFO, settled with the Commission at filing. Stephan Husi, the former Head of Corporate Planning and Controlling for the company settled on January 21, 2009.

The complaint alleged that Mr. Husi, and others, fraudulently inflated the company’s income for the third quarter of 2002 by improperly deferring recognition of $25 million in expense and by approving a $3.6 improper reserve adjustment. In addition, the complaint alleged that the income for the fourth quarter of 2002 was improperly inflated by failing to increase a reserve to cover at least $18 million in liabilities, improperly using anticipated refund credits to offset other expenses and refusing to take certain write downs.

Mr. Husi resolved the case by consenting to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting and internal controls provisions of the securities laws. In addition, he agreed to pay disgorgement of about $14,000, prejudgment interest and a $30,000 civil penalty. Mr. Husi also consented to be the entry of an order suspending him from practice before the Commission for 5 years in a related administrative proceeding. Mr. Husi is a Swiss Certified Expert for Accounting and Controlling.

by T. GormanPosted on Posted in SECActions

A group of insurance companies has filed a petition challenging the SEC’s recently enacted Rule 151A regarding indexed annuities. At issue is whether the SEC overstepped its authority in enacting a rule which permits the Commission to assert jurisdiction over certain index annuity contracts or whether those contracts are exempt from the provisions of the Securities Act. American Equity Investment Life Ins. Co. v. SEC, (D.D.C. Filed Jan. 16, 2009).

Section 3(a)(8) of the Securities Act provides an exemption from its provisions for certain annuity contracts. Specifically, the Section provides an exemption for “[a]ny insurance or endowment policy or annuity contract or optional annuity contract, issued by a corporation subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State or Territory of the United States or the District of Columbia.” Previously, the Commission promulgated Rule 151, which provided a safe harbor for certain annuity contracts that are not deemed subject to the federal securities laws and which can rely on Section 3(a)(8). That safe harbor essentially applies to guaranteed investment contracts issued by a state regulated insurance company where “the insurer assumes the investment risk” in a manner described by the rule.

New Rule 151A deals with indexed annuity contracts. This product is a “contract issued by a life insurance company that generally provides for accumulation of the purchaser’s payments, followed by the payment of the accumulated value to the purchaser,” according to the Commission’s Release on the rule. Prior to the pay out under the contract, the insurer credits the purchaser with a return that is based on changes in a securities index such as the Dow Jones Industrial Average.

The Rule provides essentially that the contract is not exempt within the meaning of Section 3(a)(8) if the “amounts payable by the issuer under the contract are more likely than not to exceed the amounts guaranteed under the contract.” The SEC adopted, this test based primarily on investment risk. According to the SEC, at the time Section 3(a)(8) was adopted, the annuities that were typically offered and were thus exempt involved no investment risk to the purchaser. Thus, the protections of the securities laws were not necessary for the purchaser.

In contrast, under Rule 151A where “the amounts payable by an insurer under an indexed annuity contract are more likely than not to exceed the amounts guaranteed under the contract, the purchaser assumes substantially different risks and benefits. Notably, at the time that such a contract is purchased, the risk for the unknown, unspecified, and fluctuating securities-like portion of the return is primarily assumed by the purchaser,” according to the SEC’s Release. Under these circumstances, the purchaser can benefit from the protections of the securities laws.

Commissioner Tory Paredes apparently disagreed with the SEC’s position on Rule 151A, dissenting from its adoption. Essentially, Commissioner Paredes argued that Rule 151A exceeded the Commission’s jurisdiction. First, Commissioner Paredes claimed that in adopting the Rule the Commission did not properly characterize investment risk as the concept applies to Section 3(a)(8). In this regard, Rule 151A denies an exemption to an indexed annuity when it is “more likely than not” that the performance of the linked securities index amounts payable to the purchaser of the contract will exceed the amounts the insurer guarantees. This approach ignores the central insurance component of the product, according to Commissioner Paredes.

Second, Commissioner Paredes noted that the position taken by the SEC is inconsistent with its prior position on this issue. In an amicus brief, the Commission argued that a Section 3(a)(8) exemption applies when the “insurance company, regulated by the sate, assumes a ‘sufficient’ share of investment risk and there is a corresponding decrease in the risk to the purchaser.” This position differs from the SEC’s current position.

The petition challenging the rule is pending.