by T. GormanPosted on Posted in SECActions

The market crisis continued to dominate Capitol Hill and the news this week with SEC Chairman Cox testifying before a House subcommittee regarding the causes of the crisis. The New York Attorney General released a letter to AIG regarding his agreement with the company pending his inquiry into their role in the on-going crisis.

This week the SEC filed another settled insider trading case, settled a long running financial fraud action and filed another settled hedge fund-PIPE case, but with a glaring omission. The Commission also released a preview of a report to be issued next month containing enforcement statistics for last year. The statistics release this week demonstrate that during the last fiscal year the Enforcement Division brought the second largest number of cases while returning over $1 billion to investors through fair funds.

At the circuit court level, the second circuit issued two securities law opinions while the eighth handed down one decision. The second circuit cases focused on jurisdictional requirements in one instance and the standards for vacating a PSLRA/Rule 11 based opinion finding that the complaint there lacked a sufficient factual foundation as part of a settlement. The eighth circuit applied the Supreme Court’s Tellabs ruling in affirming the dismissal of a securities fraud complaint.

The market crisis

SEC Chairman Christopher Cox testified before the House Committee on Oversight and Government Regulation on Thursday. The Committee is holding hearings on the causes of the current market crisis. Reviewing the current crisis through the lens of hindsight, the Chairman reviewed several things he would do differently, such as urging Congress to repeal the swaps loophole in the 2000 Commodity Futures Modernization Act. He also would have sought stronger disclosure in the municipal securities market and to close earlier the loophole in Gramm-Leach-Bliley which left investment bank holding companies unregulated. Mr. Cox noted that “[w]e have learned that voluntary regulation does not work.” The Chairman went on to note that the enforcement staff has over 50 pending investigations related to subprime mortgages.

While Mr. Cox did not identify the areas of focus by the Enforcement Division, a senior staff member speaking at the ABA White Collar Crime town hall meeting identified several areas of concern. Those include insider trading, the securitization process, retail sales, disclosure by mortgage lenders and the financial statement treatment of loans by mortgage companies. The subprime task force, established in the Spring of 2007, is coordinating these investigations nationwide and with other federal and state regulators as well as the Department of Justice.

The testimony of Mr. Cox followed an op-ed piece he authored for the New York Times on October 18, 2008. In that piece Mr. Cox again called for additional regulation of credit default swaps.

The New York Attorney General, who is conducting and investigation along with the U.S. Attorney’s Office into the credit default swap market, released a letter he sent to the new Chairman of AIG regarding his probe into that company. According to the October 22, 2008 letter, the company has agreed to freeze payments under an employment package to its former CEO Martin Sullivan. In addition, the company confirmed that funds will not be distributed from its $600 million deferred compensation and bonus pools of the AIG’s Financial Products subsidiary. Mr. Cuomo noted that the taxpayer loans should be repaid before any distribution from this pool. According to the letter “The Financial Products subsidiary was largely responsible for AIG’s collapse, … .” This letter follows a joint statement by Mr. Cuomo and AIG issued last week regarding a meeting between the Attorney General and Edward Liddy.

SEC enforcement

SEC v Maas, Civil Action No. 2:08-cv-02947 (D. Az. Oct. 23, 2008) is a settled insider trading action. The defendant, Bret C. Maas of Glendale, Arizona, is the owner of Hayden Communications, Inc, an investor relations firm. In its complaint, the SEC claimed that Mr. Maas’ firm was retained by Manatron, Inc., a data processing firm, being acquired by Thoma Cressey Bravo, a private equity firm. After being retained, and prior to the public announcement of the deal, Mr. Maas purchased 20,000 shares of Manatron stock. Following the public announcement of the deal the share price of the stock rose 32%. Mr. Maas sold his shares, making a profit of $59,077. 31.

To settle the case Mr. Maas consented to the entry of a permanent injunction prohibiting future violations of Section 10(b) and Rule 10b-5 thereunder. In addition, he agreed to the entry of an order requiring that he disgorge his trading profits along with prejudgment interest and a civil penalty of $29,538. The Commission’s Release states that it considered the cooperation of Mr. Maas during the staff’s investigation.

The Commission also settled its four year old financial fraud case against Gary L. Lenz, former president of Peregrine Systems, Inc. SEC v. Gartiner, Civil Action No. 04 CV 2002 (S.D. Cal. Oct. 5, 2004). The SEC’s complaint alleged that senior officials at Peregrine, including in some instances Mr. Lenz, used relationships with third parties to enter into sham reseller agreements to inflate revenues and meet forecasts. In addition, in 2001 Mr. Lenz signed a letter to the outside auditors which falsely stated that the company’s financial statements had been prepared in accord with GAAP.

To settle the matter, Mr. Lenz consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions of the securities laws. In addition, he consented to the entry of an order requiring him to pay a $110,000 civil penalty and to be barred from serving as an officer or director of any public company.

Previously, Mr. Lenz pled guilty to one count of making false statements to the FBI. He was sentenced to three years probation, a $5,000 fine and 200 hours of community service. The initial SEC case was brought against six former senior officers of the company, a former outside auditor and two customers. The criminal case was brought against all nine defendants named in the SEC’s action. See Litigation Release No. 18919 (Oct. 6, 2004).

The Commission also filed another settled hedge fund-PIPE case this week, SEC v. Ladin, Civil Action No. 1:08-CV-01784 (D.D.C. Filed Oct. 20, 2008). Defendant Ladin, an analyst for a hedge fund reportedly tipped the fund about a PIPE, resulting in it selling short the securities of the issuer. The case was settled with a consent injunction prohibiting future violations of the antifraud provisions, the payment of disgorgement and prejudgment interest and a civil fine. The case is noteworthy because the SEC did not allege a Section 5 violation as in other similar cases. Whether this represents a new enforcement position in these cases is unclear as discussed here.

Finally, the SEC released selected enforcement statistics from its Performance and Accountability Report which will be released next month. Those statistics, discussed here, show that the enforcement division last year brought the second highest number of cases and obtained more than $1 billion for harmed investors through Fair Funds. Significant areas of emphasis for the division last year included insider trading, market manipulation and the FCPA.

Appellate decisions

The Second Circuit handed down a decision affirming the dismissal of a securities suit for lack of jurisdiction, the first “foreign-cubed” securities class action to be decided by the circuit. The case involved the manipulation of the internal books of the U.S. subsidiary of an Australia public company who’s ADRs are traded in New York. The key question the court states “boils down to what conduct comprise the heart of the alleged fraud.”

In this case, the court concluded that the key actions taken and not taken by the Australian parent were “significantly more central to the fraud and more directly responsible for the harm to investors than the manipulation of numbers in Florida.” Thus in a suit by foreign shareholders where the central conduct complained of was that of a foreign corporation and there was no harm to U.S. investors, the court concluded that it lacked jurisdiction. Morrison v. National Australia Bank Ltd., Case No. 07-0583-cv (Oct. 23, 2008).

Another Second Circuit decision this week declined to vacate a district court order imposing sanctions on the plaintiff in a securities action which was a condition of a settlement as discussed here. ATSI Communications, Inc. v. The Shaar Fund, Ltd., Case No. 08-1815 (2nd Cir. Oct. 20, 2008). In this case, the Second Circuit initially affirmed the dismissal of the third amended complaint brought by a plaintiff issuer against those who participated in a private placement of floorless preferred stock. The complaint alleged that short selling by defendants had caused the stock of the company to go into a death spiral. Concluding that the claim not plausible and that plaintiff failed to adequately plead scienter, the Circuit Court affirmed the dismissal of the action.

Subsequently all defendants except Knight Capital settled. Knight filed and prevailed in a motion for sanctions against plaintiff under the PSLRA and Rule 11. On appeal Knight and ATSI agreed to settle if the court would vacate the sanctions order. The Second Circuit refused, noting that plaintiff had failed to meet its burden to obtain the extraordinary relief sought and, in any event, the public interest favored leaving the order in place.

Finally, the Eighth Circuit handed down a decision applying the teachings of Tellabs, Inc., v. Makor Issues and Rights, Ltd., 127 S. Ct. 2499 (2007). It also discussed the question of pleading scienter through the use of allegations regarding core operations.

Here, the court affirmed the dismissal of a securities fraud suit based on claimed false statements regarding the earnings of the company. In analyzing the adequacy of the allegations regarding scienter the court used the Tellabs test in combination with its prior case law which used the “motive and opportunity” test. While the court declined to rule on the core operations issue, it found that in this case plaintiff failed to plead sufficient facts to prevail on the theory.

Web seminars

The Washington Legal Foundation will sponsor a program entitled “Who’s Going to Court, Who’s Going to Jail?: Civil and Criminal Law Enforcement in the Wake of Financial Crisis.” The live web seminar, a part of WLF’s continuing series, will be held on Tuesday, October 28, 2008 from 10:00 a.m. to 11:00 a.m. EST. For further information see http://www.wlf.org

by T. GormanPosted on Posted in SECActions

The SEC announced a portion of its fiscal year Enforcement statistics for last year showing that the Division brought the second highest number of cases ever. During the same period it returned more than $1 billion to harmed investors through Fair Funds. The press release is a preview of the Commission’s Performance and Accountability Report which will be issued next month. While the statistics suggest that the Enforcement program, which is key to the agency fulfilling its statutory mission, is vibrant and operating at a very high level, questions remain concerning its vitality.

Last year, the SEC brought 671 enforcement actions. In contrast, in 2007 there were 636 enforcement actions filed. 2007 was the first time in years the number increased. In 2006 the total had dropped by about 9% compared to the prior year.

Insider trading, market manipulation and FCPA cases were key areas of focus for the Division based on the preliminary statistics released yesterday. Compared to the prior year, the number of insider trading cases increased 25% while the number of market manipulation cases was up 45%. In addition, 15 FCPA cases were brought. While perhaps not a large number standing alone, over the last few years there should be little doubt that the FCPA is a key area of emphasis for both the SEC Enforcement Division and the Department of Justice. Indeed, since January 2006 the SEC has brought 38 FCPA enforcement actions which is more than in all prior years combined since the enactment of the Act in 1977.

Two groups of cases cited in the release may suggest the immediate future direction of the Enforcement program. One group is the 50 on-going investigations related to the subprime crisis. The other is the settlements in the auction rate securities market.

At first glance, the statistics released by the Commission are impressive – more cases, lots of money recovered, complex investigations and news making settlements. There are, however, questions. While the number of enforcement cases increased last year, many of those actions were defaults based on claims that an issuer failed to file its periodic reports. While these cases may be important, they obviously lack the substance of an insider trading case or a financial fraud action.

Likewise, the amount of money distributed under Fair Funds appears impressive. The release does not, however, mention the amount of disgorgement and fines obtained through enforcement actions. In 2007 that amount decreased by 50% compared to 2006. While such statistics are hardly dispositive of the health of the enforcement program, they did raise questions in Congress earlier this year. Chairman Cox was apparently so concerned about those questions that he responded by claiming record amounts at the date of his congressional testimony. Unfortunately his claim was “puffed” as discussed in the May 2, 2008 post.

Similarly, the number of subprime inquiries appears impressive. Mr. Sirri, Director of Trading and Markets, indicated in his recent testimony (discussed on Oct. 16, 2008), however, that the Division of Enforcement is encountering significant difficulties with these inquiries.

Finally, the ARS settlements also appear impressive. At the same time, those settlements appear to have been driven in large measure by the New York Attorney General and his counterparts in other states, not the SEC. The tentative settlements also raise significant questions about their merit. Typically, the settlements are structured so that consumers and other small investors are made whole. While that is an admirable result, small investors in probability only account for only a fraction of the traders in those markets. Institutional investors who conduct the bulk of trading in that market are largely left to fend for themselves. For those investors, the settlements give only the vague and undefined prospect that the settling institution will use its “best efforts” to provide liquidity in the already declared dead ARS market.

Overall, the statistics in the SEC release are interesting. Any analysis of the state and health of the Enforcement Division will have to await the final report, however. For now, the partial statistics released raise more questions about the state of Enforcement than they answer.