This Week In Securities Litigation (January 16, 2009)

In Senate confirmation hearings on Thursday, SEC Chairwoman nominee Mary Schapiro vowed to re-energize the Enforcement Division. Earlier in the week, the SEC resolved a long running insider trading case against a former corporate general counsel and filed another insider trading case in conjunction with the Justice Department against a former Blackstone Group employee.

In the high profile criminal case against Bernard Madoff this week, the government lost repeated efforts to jail Mr. Madoff pending the resolution of his case. At the same time, the Department of Justice sought to follow up on its Siemens FCPA case by initiating a forfeiture action to freeze funds in Singapore alleged to have been paid by the company as bribes.

Finally, a New York Court of Appeals affirmed the dismissal of an option backdating derivative suit brought against Bed Bath and Beyond which had been dismissed for failure to establish demand futility, while the Northern District of Illinois held that filing a final Form 10-K does not waive privilege as to earlier drafts. And, the Ninth Circuit harmonized its pre-Tellabs rulings on pleading a strong inference of scienter with the Supreme Court’s teachings in that case.

Schapiro confirmation hearings

The Senate held confirmation hearings on President-elect Barack Obama’s choice to become Chairwoman of the Securities and Exchange Commission this week, Mary L. Schapiro (discussed here). Ms. Schapiro, who has been called a regulator “with a light touch” by The Wall Street Journal, promised the committee to be a tough enforcer. During her testimony, Ms. Schapiro vowed to overhaul the enforcement program and reconsider procedures which she views as hindering the enforcement staff. Ms. Schapiro also said she supported requiring hedge funds to register and would reconsider the up-tick rule regarding short sales. She also indicated that she wants to reconsider the time table for adopting international accounting standards.

SEC enforcement

SEC v. Heron, Civil Action No. 07-cv-01542 (E.D. Pa. Filed April 18, 2007): The SEC settled an insider trading case against the former General Counsel of Amkor Technology, Inc. The Commission’s complaint alleged that Mr. Heron repeatedly traded in the shares of his company prior to announcements of its financial results as discussed here. To resolve the case, Mr. Heron consented to the entry of a permanent injunction, the payment of disgorgement of $75,000 and to an order barring him from serving as an officer or director. The settlement followed Mr. Heron’s conviction on criminal charges based on similar allegations. Mr. Heron is serving a fifteen-month jail sentence from that case.

Criminal cases

U.S. v. Madoff: Prosecutors in the Bernard Madoff case were rebuffed twice this week in their efforts to have Mr. Madoff’s bail revoked. First, the magistrate rejected the government’s claims that Mr. Madoff was a flight risk and that the conditions of release were not sufficient to protect the safety of the community. The claims were based on allegations that Mr. Madoff mailed packages to family members and friends containing jewelry and other property as “gifts.” The magistrate imposed additional restrictions over the personal property in Mr. Madoff’s apartment and rejected the government’s motion. In his ruling, the magistrate concluded that the government failed to establish either flight risk or that the conditions of bail were insufficient to protect the community. U.S. v. Madoff, No. 08 Mag. 2735 (S.D.N.Y. Ruling: Jan. 19, 2009). The district court rejected the government’s appeal of that ruling for the same reasons.

U.S. v. Chakrapani, Case No. 1:09-mj-00094 (S.D.N.Y. Filed Jan. 13, 2009): Ramesch Chakrapani, a managing director of the Blackstone Group’s London office, was charged with insider trading. According to court papers Mr. Chakrapani tipped an analyst about the proposed take over of Albertson’s supermarket chain by a group of retailers and private equity firms in 2006. The analyst then either tipped his parents or traded through their account. The scheme netted $3.6 million in trading profits. At the time, Mr. Chakrapani was a member of Blackstone’s mergers and acquisitions advisory group in New York where he worked on the deal. The SEC filed a parallel civil action, SEC v. Chakrapani, Case No. 109-cv-00325 (S.D.N.Y. Filed Jan. 13, 2009). Both cases are pending.

FCPA

U.S. v. All Assets, Case No. 1:09-cv-00021 (D.D.C. Filed Jan. 8, 2009): As a follow-up to the Siemens AG FCPA case, discussed here, the government filed this forfeiture action to confiscate nearly $3 million in bank accounts in Singapore. The amounts are alleged to have been paid to bribe ex-Bangladesh Premier Khaleda Zia’s younger son, Arafat Rahman Koko. The payments were from Siemens AG and China Harbor Engineering Company through financial institutions in the U.S and later deposited in accounts in Singapore. Siemens Bangladesh has admitted that from May 2001 to August 2006 it caused corrupt payment of at least $5.3 million to be made through business consultants to various Bangladeshi officials in connection with a mobile phone projects.

Private actions

Wandel v. Eisenberg, Case No. 603665/06 (NY Sup. Ct., App. Div. 1st Dept): The New York Court of Appeals affirmed the dismissal of a derivative complaint filed against Bed Bath & Beyond. The complaint alleged option backdating. The appeals court affirmed the dismissal for failure to adequately plead demand futility. Although the complaint alleged that demand would be futile, it failed to allege detailed facts supporting this claim according to the initial ruling. The appeals court affirmed, noting that only three of the board members named as defendants actually received backdated options.

Roth v. Aon Corporation, Case No. 04 C 6835 (N.D. Ill. Ruling Jan. 8, 2009): Here, the district court concluded that a draft of part of a Form 10-K transmitted to in-house counsel and several employees of the company during preparation remained privileged when the final Form 10-K was filed with the SEC.

Circuit courts

In Zucco Partners, LLC v. Digmarc Corporations, Case No. 06-35758 (9th Cir. Jan. 12, 2009), the court harmonized its earlier rulings on pleading scienter with Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007). The court also ruled on the adequacy of allegations from confidential witnesses offered to support an inference of scienter.

In its pre-Tellabs opinions, the court held that allegations regarding state of mind must demonstrate either intentional conduct or deliberate recklessness. Those allegations must them be considered individually – an approach the court called “segmented” – to determine if a PSLRA strong inference of scienter has been pled. This approach, the court concluded, is not consistent with the “holistic” approach of Tellabs. To comply with the Supreme Court’s ruling, the circuit court concluded that both its “segmented” approach and the Tellabs holistic test should be used. The court also ruled that statements from confidential witness can be used to establish scienter if they are pled with particularity, demonstrate personal knowledge and scienter. Here, the court affirmed the dismissal of the complaint for failure to meet this pleading standard as discussed here.

Filing A Form 10-K Does Not Waive Privilege As To Drafts

In Roth v. Aon Corporation, Case No. 04 C 6835 (N.D. Ill. Ruling Jan. 8, 2009), the district court concluded that a draft of part of a Form 10-K transmitted to in-house counsel and several employees of the company during preparation remained privileged when the final Form 10-K was filed with the SEC. The opinion is important for those who prepare disclosure documents. It is also significant to the work of in-house counsel since it can be difficult to draw the line between their privileged legal work and non-privileged business dealings.

The issue arose in a securities class action based on Aon’s claimed role in, and reliance on, contingent commission kickbacks and steering arrangements with insurers. Plaintiff’s sought the production of an e-mail which solicited thoughts and comments on an attached a memorandum which contained an expanded draft version of part of the company’s Form 10-K. The memo was from the CFO to the CEO and General Counsel. The e-mail was from the CFO to the Deputy General Counsel, the Controller and an employee in the controller’s division. The Deputy General Counsel stated that he received the e-mail and memo in connection with rendering legal advice about the draft From 10-K.

In denying plaintiff’s motion to compel production, the court began by noting that it is to be expected that legal counsel would be involved with drafting a Form 10-K: “Consultation as to the scope of the provisions of the Act, as to language, and as to how best to legally comply with SEC regulations, for instance, are precisely the type of day-to-day guidance for which a corporation would likely rely on counsel. … The Court finds that the communications contained in the Bolger [CFO] e-mail did reasonably seek legal advice.”

The court then turned to the question of whether the e-mail and draft remained privileged after the final version of the Form 10-K was filed with the SEC and became public. Here, the court concluded that the filing did not waive the privilege as to the e-mail and draft. On this point the court concluded that “most courts have found that even when a final product is disclosed to the public, the underlying privilege attached to drafts of the final product remains intact.”

Finally, the court held that circulating the papers to a number of corporate officials did not waive the privilege: “To disallow corporations the space to collectively discuss sensitive information with legal counsel would be to ignore the realities of large-scale corporate operations. For this reason, there is no doubt that the inclusion of these individuals in the e-mail correspondence did not destroy the attorney-client privilege.” Circulating the e-mail and memo to a number of employees does not necessarily result in a waiver of privilege. Rather, the question is whether consulting those employees was, as here, a necessary part of rendering legal advice by in-house counsel.