This Week In Securities Litigation (May 9, 2008 edition)

This week familiar themes continued: Option backdating, the FCPA and insider trading. The SEC continued to work through its inventory of option backdating cases, moving toward a conclusion of this scandal. The DOJ and the SEC resolved three FCPA cases against individuals, a key focus in this area. At the same time, an announcement was made that letters rogatory were about to be served from an Indian proceeding for information about a settled SEC FCPA case. Finally, reports suggest that the SEC and the Ontario Securities Commission are conducting a significant insider trading case involving 11 different Canadian takeover deals in which a major U.S. law firm may be involved, while U.K. watchdog FSA released a report on insider trading in London markets.

Option backdating

The SEC filed another settled option backdating case this week. Marvell Technology Group, Ltd. and its co-founder Weili Dai, were named as defendants in an SEC civil injunctive complaint which charged violations of the antifraud and books and records provisions of the federal securities laws.

According to the SEC’s complaint, Marvell engaged in a scheme to grant lucrative in-the-money options to employees by backdating the grants. From 2000 to 2006 the company overstated its income by $362 million by not properly recording the option expense. Defendant Dai acted as the company’s stock option committee. In that capacity, she regularly reviewed lists of Marvell’s historical stock prices to pick the lowest date. To make it appear that the company granted the options on the date selected, Ms. Dai signed falsified minutes which attested to meetings of the Committee on an earlier date when the option grant date was supposedly selected.

To resolve the case, the company and Ms. Dai consented to the entry of permanent injunctions prohibiting future violations of the antifraud and books and records provisions of the securities laws. In addition, the company consented to the entry of an order requiring the payment of a $10 million penalty while Mr. Dai agreed to pay a penalty of $500,000. Defendant Weili Dai also agreed to an order barring her from service as an officer or director for five years. SEC v. Marvell Technology, Case No. CV 08-2366 (N.D. Cal. May 8, 2008). The Commission’s Litigation Release is here.

FCPA

This week, the SEC and DOJ continued their focus on individuals in FCPA cases by concluding actions against three ITXC Corporation executives. ITXC is an international telecommunications carrier based in New Jersey which sought to do business in Africa. The defendants, Steven Ott, Roger Michael Young and Yaw Osei Amoako, were respectively the vice president of global sales, managing director of the Middle East and Africa and regional director for sales in Africa.

The complaints in these actions alleged that the three defendants negotiated and/or approved bribes of over $267,000 paid to foreign officials in Nigeria, Rwanda and Senegal to obtain contracts necessary for ITXC to transmit telephone calls to individuals and businesses in those countries. Those agreements earned the company about $11.5 million in net profits. The SEC cases were settled by consenting to statutory injunctions prohibiting future violations of the FCPA bribery and books and records provisions. Mr. Amoako, who was alleged to have received $150,000 through embezzlement and a kickback, was ordered to pay over $188,000 in disgorgement and prejudgment interest. SEC v. Ott, Civil Action No. 06-4195 (D.N.J. Sept. 6, 2006); SEC v. Amoako, Civil Action No. 05-4284 (D.N.J. Sept. 1, 2005).

To resolve these matters with the DOJ, each defendant pled guilty to conspiring to violate the FCPA and the Travel Act. Mr. Amoako was sentenced to 18 months in prison. Messrs. Ott and Young are awaiting sentencing. U.S. v. Ott, No. 07-608 (D.N.J. July 25, 2007); U.S. v. Young, No. 07-609 (D.N.J. Sept. 25, 2007); U.S. v. Amoako, No. 05-1122 (D.N.J. June 28, 2006).

Last week, the Central Bureau of Investigations in New Delhi disclosed that it is about to issue a letter rogatory to U.S. authorities to question Dow Chemicals regarding bribes that were allegedly paid by a subsidiary of the company to Indian officials. The bribes were supposedly paid to register banned pesticides in the Indian market. The request is part of a case which was filed six months ago against CBI officials and a retired official from the Ministry of Agriculture following an SEC FCPA action.

Previously, the SEC filed a settled civil action and related administrative proceeding against the Dow Chemical Company alleging violations of the FCPA. In that case the complaint alleged that Dow subsidiary, DE-Nocil Crop Protection Ltd., based in Mumbai, India, made approximately $39,700 in improper payments to an official in India’s Central Insecticides Board to expedite the registration of three product. The complaint claimed that from 1996 to 2001 the same subsidiary made $87,000 in improper payments to state officials in order to distribute and sell its product. Finally, the complaint detailed improper gifts, travel, entertainment and other items. The civil action was settled with the payment of a $325,000 civil penalty. A consent to a cease and desist order was entered in a related administrative proceeding. SEC v. The Dow Chemical Company, Civil Action No. 07CV00336 (D.D.C. Feb. 13, 2007) discussed in the Litigation Release here.

Insider trading

The SEC and Ontario securities officials are reportedly conducting a major insider trading investigation involving 11 Canadian takeovers over the past two years. According to an affidavit filed in Ontario Superior Court, the Ontario Securities Commission is investigating a Toronto business consultant, his sister and his brother-in-law who allegedly made over $1.1 million trading in take over stocks.

Also involved in the investigation is a U.S. law firm. While the court papers do not identify the law firm, the transactions which are the focus of the inquiry are listed. A review of those deals by a Canadian news organization determined that the only firm involved in each deal is Dorsey & Whitney.

Earlier this week, the Financial Services Board in the U.K. released a study which disclosed that nearly one-third of takeover deals may have been preceded by insider trading in the London markets. The FSA has reportedly more than doubled its team of prosecutors and is promising to crack down on insider trading and bring a steady stream of cases.

Part XII: SEC Enforcement Trends And Priorities, 2008

Hedge funds have been a key enforcement priority since at least the time of the decision of the D.C. Circuit in Goldstein v. SEC, 451 F.3d 871 (D.C. Cir. 2006). There, the court vacated the SEC’s rule requiring hedge fund advisors to register. The SEC chose not to appeal.

Subsequently, Chairman Cox told Congress that “[h]edge funds are not, should not be, and will not be unregulated.” Testimony Concerning the Regulation of Hedge Funds (July 25, 2006).

Later that year, the SEC passed Rule 206(4)-8, an antifraud rule focused on hedge funds. The agency also began a series of cases against the funds involving private investment in public equity (“PIPE”) offerings – regulation through enforcement action.

As with most SEC enforcement actions, the hedge fund/PIPE cases typically settle. Three are in litigation, however.

The complaints in these case focus on a similar core of factual and legal allegations, although the precise facts in each case vary. Typically, the hedge fund participated in one or more PIPE offerings and traded in the shares of the issuer shortly before and/or after the announcement of the private placement component of the offering. In each case, around the time of the private placement component of the transaction, the hedge fund shorted the shares of the issuer and later, after the resale registration statement became effective, covered with the shares from the transaction. The covering shares were not registered at the time of the short sale, but were registered at the time of the covering transaction. Typically, the SEC complaint alleges the sale of unregistered securities in violation of Section 5 based on the short sale and insider trading in violation of Section 10(b).

Examples of hedge fund/PIPE which have settled include:

• SEC v. Spiegel, Civil Action No. 1:07CV00008 (D.D.C. Jan. 4, 2007), a settled civil injunctive action involving short selling in connection with a PIPE.

• SEC v. Friedman, Billings, Ramsey & Co., Civil Action No 06-cv-02160 (D.D.C. Dec. 20, 2006), a settled civil injunctive action alleging insider trading, selling of unregistered securities and failure to supervise in connection with CompuDyne Corporation’s sale of a PIPE. The action was brought against investment banker Friedman, Billings, as well as its founder and Co-Chairman and its Director of Compliance.

Other cases have litigated. For example:

• SEC v. Lyon, Civil Action No. 06-CV 14338 (S.D.N.Y. Dec. 12, 2006). Here, the SEC alleged that the managing partner and chief investment officer of a group of funds engaged in an unlawful trading scheme with respect to 36 PIPE offerings by engaging in insider trading and the sale of unregistered securities. The court dismissed the Section 5 and related fraud claims in an opinion which was sharply critical of the SEC. Indeed, as to the SEC’s arguments on the Section 5 claims the opinion notes: “The Court finds this characterization of a short sale [by the SEC] inaccurate and not reflective of what occurs in the market.” Later, the court concluded that the SEC’s position was based on an “inherent logical implausibility.” The insider trading claims are in litigation.

• SEC v. Mangan, Civil Action No. 3:06-CV-531 (W.D.N.C. Dec. 28, 2006) is similar. Like Lyon, the complaint contained insider trading and Section 5 claims related to a PIPE. The court dismissed the Section 5 claims in an opinion which criticized the SEC. The SEC’s Section 5 clam was, in the Court’s view, nothing more than hindsight. The insider trading claim is in litigation, although the court expressed concern as to the viability of the claim.

• SEC v. Berlacher, Civil Action No. 07-cv-3800 (E.D. Pa. Sept. 13, 2007). The complaint here is similar to Lyon and Mangan, alleging insider trading and Section 5 violations related to a PIPE. Again, the court dismissed the Section 5 claim. The insider trading claim is in litigation. See also SEC v. Colonial Investment Management LLC, Civil Action No. 07-Civ-8849 (S.D.N.Y. Oct. 15, 2007) (similar allegations to other cases except the short sale violations are based on Rule 105 which prohibits short sales within 5 days of an offering; the case is pending).

Next: Backdated options