This month, a Federal Judge in Massachusetts entered a final judgment of dismissal as to three of six named defendants in the SEC’s two year old action against the former Putnam Fiduciary Trust Company executives. The SEC’s complaint, filed in 2005, alleged violations of the Sections 10(b) and 17(a), among others, based on an claimed scheme to defraud regarding Putnam defined contribution plan client, Cardinal Health, Inc. Specifically, the complaint alleged that the defendants’ misconduct arose out of a one-day delay in investing certain assets of Cardinal, which caused the company’s plan to miss out on about $4 million of market gains. Following the error, the defendants chose not to inform Cardinal. Rather, they took steps to cover up the action by improperly shifting approximately $3 million of costs to the shareholder of other Putnam mutual funds and through various accounting machinations. In the end, according to the complaint, Cardinal’s plan bore approximately $1 million in losses. SEC v. Durgarian, Civil Action No. 05-12618 (D. Mass. Filed Dec. 30, 2005).

In detailing the scheme and the participation of the defendants, the complaint repeatedly detailed the actions of defendants Karnig Durgarian, then Chief of Operations, Donald McCracken, former Head of Global Operations Services, and Ronald Hogan, then vice president in the new business implementation unit. In contrast, defendants Virginia Papa, then Director of Defined Contribution Plan Servicing, Kevin Crain, former head of the plan administration unit and Sandra Childs, previously responsible for overall compliance, are generally described as attending various meetings where the error and cover up were discussed and in which “all” agreed with the adopted course of action. These three defendants did however certify, in connection with audits of the internal controls, that they were unaware of any “uncorrected errors, frauds or illegal acts … .”

In reviewing motions to dismiss by each of the defendants, the court first held that the SEC must comply with the dictates of Rule 9(b), requiring that fraud be pled with particularity, as well as the standard pleading rules. As to Defendants Durgarian, McCracken and Hogan, the court had little trouble finding that the SEC met the requisite pleading standards in view of the detailed allegations regarding the conduct of each.

In contrast, however, the court found the allegations as to defendants Crain, Papa and Ghilds wholly insufficient: “The Court finds that, beyond their attendance at the January, 2001 meeting, the Complaint identifies no explicit acts, taken by defendants Crain, Papa and Childs … in furtherance of the fraudulent scheme. While the Complaint contends generally that all of the defendants listened, discussed and then agreed upon the fraudulent scheme, there are no explicit details outlining specific actions taken by these defendants.” Citing Central Bank of Denver v. First Interstate, 511 U.S. 164 (1994), the court went on to hold that the SEC must “make an explicit allegation of a manipulative act committed by the defendant in furtherance of the scheme … .” In this regard “generalized allegations” as the defendants termed them are insufficient, the court concluded.

The court also rejected the SEC’s argument that the certifications executed by defendants Crain, Papa and Childs were sufficient to establish liability, even at the pleading stage: “The Court agrees with the contention of these defendants that the alleged false certifications bearing their signatures are too attenuated to link them to the fraudulent scheme. The SEC provides no allegation linking the signatures to the fraud other than its general assertion that the defendants attended the meeting.”

Finally, the court rejected the SEC’s claim that Crain, Papa and Childs could be held liable under an aiding and abetting theory. Again, the court pointed to the fact that the SEC had failed to detail specific participation by each of the defendants. Throughout its opinion, the court repeatedly rejected the SEC’s attempt to lump these three defendants together and hold them liable based on generalized allegations. Rather, the court made it clear that to plead a securities fraud complaint, the SEC must allege specific allegations as to each defendant detailing that person’s participation in the scheme to defraud.

The Commission’s November 27, 2007 Litigation Release discussing, among other things, the dismissal of these three defendants, may be found here.

Print Friendly, PDF & Email

Insider trading cases have been brought against corporate executives by the SEC and DOJ alleging misuse of corporate information in a variety of contexts. Frequently, the cases are based on trading ahead of earnings or product announcements. In other instances the trading was related to a proposed corporate take over. These cases include:

SEC v. Kopsky, Civil Action No. 4:07-CV-0379 (E.D. Mo. Filed Feb. 26, 2007). Here, defendant Ronald Davis, former Engineered Systems President, is alleged to have tipped his friend and broker Matthew Kopsky regarding future earnings announcements. According to the complaint, Mr. Kopsky was tipped in each of the first three quarters of 2003 about the results. In the third quarter, Mr. Kopsky purchased call options for the first time and invested over 90% of an IRA. When the company announced earnings that greatly exceeded expectations, the options yielded a 132% profit. Mr. Kopsky is also alleged to have traded for his accounts and friends. This case, in which Mr. Kopsky is alleged to have made over $276,000 in profits while his clients made over $169, 000, is in litigation.

SEC v. Cao, Case No. 2:06-cv-1269 DSF-RC (C.D. Ca.) involved three executives at Countrywide Financial. The defendants in this settled action learned that the third quarter earnings for 2004 would be seven cents below projections. Prior to the announcement, each defendant purchased options and sold Countrywide shares short. To resolve the action, each defendant consented to a statutory injunction and an order requiring the payment of disgorgement, a penalty equal to the amount of the disgorgement and the payment of prejudgment interest. In the related criminal case, U.S. v. Cao, 2:07-cr-598 (FMC) (C.D. Ca. Filed June 26, 2007), each defendant pled guilty to one count of securities fraud. The defendants are awaiting sentencing.

SEC v. Shah, Civil Action No. 2:07CV1075 (D.N.J. Filed March 8, 2007). Defendant Shah was the vice president of quality control assurance and regulatory affairs of Able Labs. On eight occasions he is alleged to have traded using employee options while in possession of material non-public information. In each instance, according to the complaint, the defendant was aware of problems with products that had been concealed from the FDA. Eventually Able Lab discovered the faulty testing practices that cause the difficulties and disclosed them. The share price dropped 75%. Mr. Shah avoided over $900,000 in losses by trading prior to the disclosures. The SEC’s cases was settled with a consent to a statutory injunction and an order requiring the payment of disgorgement, prejudgment interest and a penalty in an amount to be determined by the court. The defendant consented to the entry of an order baring him from being an officer or director of a public company for five years. Criminal charges were also filed. U.S. v. Shah, Case No. 2:07-cr-00198 (D.N.J. Filed March 8, 2007). There, defendant Shah pled guilty to one count of conspiracy to commit securities fraud and to the distribution of misbranded and adulterated drugs. He is awaiting sentencing. Five colleagues also pled guilty to one count of conspiracy to distribute misbranded and adulterated drug products and are also awaiting sentencing.

SEC v. Fontana, Case No. 01:07CV0195 (D.D.C. Filed June 19, 2007). Here, the complaint claims that the defendant corporate director learned from the Chairman of Sadia that the company would bid for Perdigao S.A. Subsequently, the defendant bought 18,000 ADRs. After the tender offer was announced, the board decided to revoke it. Prior to the announcement of that decision, Mr. Fontana sold his shares reaping a profit of over $139,000. To settle the action, the defendant consented to the entry of a statutory injunction and an order requiring him to pay disgorgement, prejudgment interest, a penalty equal to the disgorgement and a five year officer/director bar. Two related cases are SEC v. Murat, Case No. 1:07CV00381 (D.D.C. Filed Feb. 22, 2007) (defendant is former CFO of Sadia); and SEC v. Azevedo, Case No. 1:07CV00380 (D.D.C. Feb. 22, 2007) (defendant is an employee of Banco ABN). Both cases settled with the entry of statutory injunctions and orders requiring the payment of disgorgement, prejudgment interest and a penalty.

SEC v. Ericksen, Civil Action No. 3-07-CV-0254-N (N.D. Tex. Filed Feb. 6, 2007). This case was brought against the former Chairman of the Audit Committee of Magnum Hunter Resources. The complaint claims that the defendant, as a member of the board and audit committee, engaged in a search for a merger partner and negotiations with that potential partner. Defendant purchased call options, which were exercised shortly before the announcement. This case, which charges insider trading and filing late and incorrect trading reports, is in litigation.

Next: Attorneys

Print Friendly, PDF & Email