This Week In Securities Litigation (June 20, 2008)

This week, another option backdating derivative case settled with payments made personally by two senior executives. The SEC filed a complaint alleging securities fraud against two former Bear Stearns hedge fund executives based on the collapse of two hedge funds last summer. At the same time, the U.S. Attorney’s Office for the Eastern District of New York reportedly has issued arrest warrants for the same two executives based on sealed indictments.

Finally, the SEC is continuing its war on insider trading. The agency brought an insider trading case against five individuals which, unlike many of its cases, did not settle simultaneous with filing. The Commission also has reportedly opened a number of new insider trading investigations.

Option backdating

The derivative suit against Zoran Corporation, centered on option backdating claims, appears to have settled based in part on personal payments to the company by two senior executives. This is the second time the parties have tried to settle this derivative case. Pfeiffer v. Zoran Corp., Civil Action No. 3:06-cv-05503 (N.D.Ca.).

The first proposed settlement was rejected as inadequate by the court. The first proposed settlement was based on three key elements: 1) certain backdated options were canceled; 2) the company agreed to specific corporate governance chances, some of which had been instituted during the term of the litigation; and 3) plaintiffs’ counsel would receive $1.2 million in fees and expenses.

The revised settlement has been tentatively approved by the district court. Under the new proposal the company would receive $3.4 million, certain options would be canceled or re-priced and lead counsel for the plaintiffs agreed to limit fee requests to no more than $1 million plus actual expenses.

A key provision of the settlement involves out of pocket payments by two senior executives. CEO Levy Gerzberg agreed to pay $296,250 to the company, while CFO Karl Schmeider agreed to pay $98,750. These amounts reflect the value received by each executive from exercising backdated options. Both executives agreed to re-price options with a total value of $256,920 and cancel others valued at $482,310. The other cash amounts paid to the company were from insurance.

Securities fraud

On Thursday, the SEC filed civil fraud charges against two former Bear Stearns hedge funds executives. The action is based on the collapse last summer of two Bear Stearns hedge funds. SEC v. Croffi, Civil Action No. 08-2457 (E.D.N.Y. June 19, 2008).

According to the SEC’s complaint, the two executives, Ralph Croffi and Matthew Tannin, misled fund investors repeatedly about the financial condition of the two hedge funds in an effort to stave off redemptions. Specifically, the complaint alleges that as the financial condition of the funds deteriorated, the defendants misrepresented its financial condition and the level of redemptions. In addition, the defendants misrepresented in periodic reports the level of investment of the funds in sub-prime mortgage backed securities. Those reports represented that exposure to sub-prime loans was only about 6-8% when in fact it was about 60%.

Defendant Croffi also misrepresented his investment activities regarding the funds, claiming he continued to buy shares, when in fact he did not. In addition, by the end of March 2007 Mr. Tannin had redeemed about $2 million worth of shares of the funds.

The Commission thanked the U.S. Attorney’s office and the FBI for assistance. In an unusual step, the Release stated that the matter was investigated by Enforcement’s sub-prime task force which is “aggressively” investigating that market.

The U.S. attorney’s office for the Eastern District of New York has issued arrest warrants for Messrs. Croffi and Tannin based on similar charges in indictments which have not yet been unsealed. The two men were arrested late Thursday.

Insider trading

The SEC filed an insider trading case against five individuals this week. SEC v. Tedder, Civil Action No. 3-08-CV-1013-G (N.D. Tex. June 17, 2008). The complaint is based on trading in advance of a business combination, the acquisition of Aviall, Inc. by The Boeing Company. It names Robert Tedder and Brian Carr, two company employees as defendants. It also names two alleged tippees of Mr. Tedder, his father Joseph, and business associate Philip Gunn, and a claimed tippee of Mr. Gunn, his brother Gregory as defendants.

The Commission’s complaint centers on a claims that defendants Tedder and Carr learned inside information about the merger talks because of an extension of the company trading blackout, an e-mail inadvertently directed to over 160 employees by the CEO which discussed the merger, observations that the general counsel was continually in meetings, a plant tour by Boeing executives and rumors. The SEC alleges that these events constitute material non-public information as discussed in more detail here. The case is in litigation.

Finally, there are reports that the SEC has recently opened a number of new insider trading investigations. These include inquiries into trading around the Microsoft bid for Yahoo. The Commission is also reportedly investigation trading in the securities of Lehman Brothers Holding, H&R Block, Boeing, NYMEX Holdings, Zoltek, Clear Channel Communications, National City Corp., Safeco Corp., Thornbury Mortgage and Nationwide Financial Services.

Just Another Insider Trading Case Or One Worth Watching?

The SEC filed another insider trading case on Tuesday, part of its continuing war on insider trading. SEC v. Tedder, Civil Action No. 3-08-CV-1013-G (N.D. Tex. June 17, 2008). The complaint is based on trading in advance of a business combination, the acquisition of Aviall, Inc. by The Boeing Company. It names Robert Tedder and Brian Carr, two company employees as defendants. It also names two alleged tippees of Mr. Tedder (his father Joseph, and a business associate Philip Gunn), as well as a claimed tippee of Mr. Gunn (his brother Gregory) as defendants. In many respects, the claims differ little from those in other SEC insider trading complaints.

Tedder is in fact different from many other cases. First, none of the defendants settled. Few defendants litigate with the Commission. Corporate defendants frequently make a “business decision,” concluding that it is better to settle at any cost rather than litigate. Individuals frequently cannot afford the burden and expense of enforcement litigation. Thus, most SEC cases settle simultaneous with filing. None of the five defendants in this case settled, however.

Second, the case is based in part on an internal investigation conducted by Aviall. According to the complaint, the Philadelphia Stock Exchange alerted the company to suspicious trading in its options shortly after the merger announcement. The complaint does not detail findings of the inquiry. Nor does it state whether during the investigation statements were taken from Messrs. Tedder and Carr that were later turned over in some form (usually notes) to the SEC. Internal investigation witness interview notes are frequently a key part of cooperating with the Commission, particularly since it can give the SEC information it might not otherwise obtain – the witness may agree to be interviewed by the company, but not the Commission. Here, the complaint says only that the company terminated Mr. Tedder and Mr. Carr at the conclusion of the inquiry.

Finally, the complaint goes to some lengths to detail the basis for the SEC’s claims that defendants Tedder and Carr had material inside information about the merger. Many complaints allege that the insider obtained the information because he or she was working on the deal. Others claim that the information was misappropriated. Here, neither former employee was a member of the merger team. Neither misappropriated the information. Rather, the complaint details a series of events as the basis for having inside information: 1) an extended trading blackout at the company; 2) an executive tour at Aviall by Boeing executives; 3) becoming aware of repeated closed door meetings involving in-house counsel; 4) an e-mail inadvertently sent by Aviall’s CEO to 122 employees across the company concerning a conference call involving the directors, outside counsel and the financial advisor regarding due diligence; and 5) rumors.

Putting together bits and pieces of public information lawfully obtained does not of course constitute trading on inside information. In this case however, the complaint alleges that the key points cited in the complaint were material and non-public information. The defendants however appear to have a different view, which is perhaps the reason this case, unlike most, is in litigation. This case may be worth watching.