by T. GormanPosted on Posted in SECActions

There has been a lot of discussion as the market crisis continues to unfold about reorganizing the regulators in Washington. An action filed on Tuesday by the SEC suggests that at least sometimes the market regulators can in fact work together.

The case filed by SEC is based on a fraudulent scheme keyed to derivatives. It named as defendants David Lee, a former commodity option trader at a subsidiary of Bank of Montreal, and Kevin Cassidy, Edward O’Connor and Scott Connor, all former employees of Optionable, Inc., a commodity brokerage whose shares are traded on the OTC Bulletin Board. The SEC’s action was coordinated with the U.S. Attorney’s Office for the Southern District of New York, the Federal Reserve Board, the Commodity Futures Trading Commission and the Manhattan District Attorney’s Office. SEC v. Lee, Civil Action No. 08-CIV-9961 (S.D.N.Y. Nov. 18, 2008).

The Commission’s complaint, which outlines the claims in the various cases, is based on scheme which has three principle victims, the shareholders of the bank, the shareholders of the brokerage firm and the New York Mercantile Exchange. First the bank’s shareholders were defrauded by the four defendants in what the complaint calls a “u-turn” scheme. Here, the SEC claims that when Mr. Lee could not obtain market prices for trading positions in natural gas options, he inserted prices or marks which were verified by the Optionable defendants. At first Mr. Lee engaged in this scheme to inflate his trading results and compensation. Later, when the market turned against him, he used it to mask losses. The victims of this scheme are the shareholders of the Bank of Montreal.

As a result of the scheme, Bank of Montreal announced on May 17, 2007 that it was reducing its reported income by a total of $680 million Canadian dollars. That resulted in a $327 million Canadian dollar reduction in net income for the six months ended April 30, 2007. On May 29, 2007 the bank restated its financial results for the quarter ended January 31, 2007, reducing previously reported income by $237 million Canadian dollars. The SEC’s action is in litigation.

The shareholders of Optionable are also the victims. The periodic reports of this company were false. They claimed that “touted the synergistic benefits of the derivatives valuation services that Optionable purportedly provided to multiple brokerage clients …,” but failed to disclose that the primary client was Bank of Montreal and that the services provided to that client were fraudulent.

The third victim was New York Mercantile Exchange. According to the complaint, in April 2007, Optionable sold over $10 million of its shares to the exchange based on its periodic reports. Those reports were materially false. On May 9, 2007, one day after Bank of Montreal announced it had placed Mr. Lee and his supervisor on leave and suspended its relationship with Optionable, the share price of the brokerage firm fell almost 40% from $4.64 to $2.81 and dropped below fifty cents when Mr. Cassidy’s prior criminal record was disclosed in press reports.

The U.S. Attorney’s Office for the Southern District of New York announced the unsealing of a six count indictment against Mr. Cassidy at the same time the SEC filed its case. In doing, so the USAO noted that Mr. Lee had pled guilty to a four count criminal information on November 13, 2008. These charges were based on the same scheme outlined in the SEC complaint. Mr. Lee also pled guilty to violating New York State’s Banking Law. In a separate action, he consented to the issuance of a Consent Order of Prohibition, according to the Federal Reserve Board.

by T. GormanPosted on Posted in SECActions

The SEC filing another insider trading case based on a private investment in public equity offering or a “PIPE” offering. This high profile case named as a defendant Mark Cuban, owner of the Dallas Mavericks, HDNet, Landmark Theaters and a possible bidder for the Chicago Cubs baseball team. SEC v. Cuban, Civil Action No. 3-08-CV-2050 (N.D. TX Filed Nov. 17, 2008).

The claims in the complaint are based on a PIPE offering made by Mamma.com Inc., a NASDAQ traded company based in Montreal, Quebec. According to the Commission, in 2004, when the company was planning the offering, Mr. Cuban was its largest known shareholder. He was contacted by the company and offered the opportunity to participate in the upcoming offering. Before company officials made that offer however, Mr. Cuban was advised that the information he was about to be furnished was confidential. As a condition of receiving the information, Mr. Cuban agreed to maintain its confidentiality, according to the SEC.

According to the complaint, Mr. Cuban became very upset after learning about the PIPE offering because it would dilute his holdings. In additional conversations with the company about the PIPE, he learned more details about the offering and was furnished with materials about it. In each instance, Mr. Cuban expressed his opposition to the offering. He also acknowledged an obligation to keep the information confidential. In one conversation, according to the SEC, Mr. Cuban noted that he could not sell his shares until after the public announcement.

Following his last conversation with a company official about the proposed offering, Mr. Cuban called his broker and directed that his 600,000 share stake in the company be sold. Over a two-day period his shares were sold. The sales were completed the day before the announcement of the PIPE.

Following the public announcement of the offering, the share price of the company fell about 9.3%. That price continued to fall over the next week. According to the complaint, Mr. Cuban avoided losses in excess of $750,000 by selling before the announcement. The complaint alleges violations of Section 10(b) and 17(a).

This case differs from earlier PIPE cases that the SEC has litigated. In those cases
Involved Section 5 and insider trading claims based on short sale before the announcement of the offering. In each of the three litigated cases, the SEC’s Section 5 claim was dismissed on a motion to dismiss. In one, SEC v. Mangan, Civil Action No. 06-CV-531 (W.D.N.C. Dec. 28, 2006), the court also denied the SEC’s subsequent motion for summary judgment on the remaining insider trading claim, but granted the motion of defendant as discussed here. That order, entered on August 20, 2008, has not been appealed. In the other two litigated cases the insider trading claims are pending.

In contrast, the case against Mr. Cuban does not involve a Section 5 claim or short selling. Rather, it is pled as a standard insider trading case, trading on material non-public corporate information. Unlike most defendants in SEC insider trading actions however, Mr. Cuban is litigating the claims. Whether the SEC’s new approach will prove more successful than their earlier one remains to be seen.