by T. GormanPosted on Posted in SECActions

This week, the SEC enforcement division secured a default judgment in an insider trading case, while the U.S. Attorney’s Office for the Southern District of New York obtained a guilty plea in a case based on obstructing another SEC insider trading case. The Circuit Courts handed down three significant decisions regarding “foreign cubed,” PSLRA pleading requirements and constitutional standing requirements in a securities fraud action. Finally, Paul Flynn, a former managing director of CIBC, ended his years-long ordeal which began with eventually to-be-dismissed New York criminal charges based on market timing claims, continued through a related SEC administrative case dismissed after trial and which concluded this week when he won a settlement of $125 million in a suit against his former employer arising out of all this.

SEC enforcement

The SEC secured a default judgment in an insider trading case brought against a resident of Rome, Italy, permitting the Commission to recover over $2.6 million in claimed illegal insider trading profits. SEC v. De Colli, Case No. 08-CIV-4520 (S.D.N.Y. May 15, 2008). The complaint, discussed here, alleged that Cristian De Colli, a machinery engineer, purchased shares and call options of DRS Technologies, Inc. prior to public disclosure of its merger talks with Finmeccanica S.p.A. in the Wall Street Journal. Following the announcement, the positions were liquidated, netting profits of over $2.1 million on an initial investment of about $422,000.

Based on Mr. De Colli’s failure to respond to the complaint, the court entered a default judgment. The final judgment directed Mr. De Colli’s broker to liquidate his account and remit the proceeds to the Court. This payment is in partial satisfaction of his obligations under the judgment, which includes a requirement to pay over $2.1 million in disgorgement, over $19,000 in prejudgment interest and a civil penalty of about $2.1 million.

Criminal cases

A former director and founding member of the Chicago Board of Options Exchange, director of the American Stock Exchange, chairman and founding member of the AMEX Commodities Exchange and managing director of New York City broker dealer Broadband Capital Management LLC, Elliot Smith, pled guilty to obstructing an SEC insider trading investigation. U.S. v. Smith, Case No. 1:08-cr-01185 (S.D.N.Y. Filed Dec. 2, 2008).

Mr. Smith’s plea is based on allegations that during an SEC investigation into whether he engaged in insider trading in two stocks he submitted false documents, gave false testimony and procured false testimony by his administrative assistant. According to the court papers, in two instances Mr. Smith submitted falsified memos to the SEC which were intended to demonstrate that prior to his trades he had researched the stocks as the basis for his trades when in fact he had not. In one instance, he solicited his assistant to testify that she had found one of the memos in the firm files while conducting a search. In fact, according to the information, in both instances Mr. Smith fabricated the memos and traded while in possession of material non-public information. Mr. Smith is due to be sentenced in March 2009.

Private actions

Former CIBC director Paul Flynn settled his action against the Canadian Imperial Bank of Commerce. CIBC paid Mr. Flynn $125 million to resolve the case.

The suit by Mr. Flynn, a former managing director of equity investments in New York for CIBC, grew out of market timing charges brought against him by the State of New York and the SEC while he was employed by the bank. Then NY Attorney General Eliot Spitzer brought state criminal fraud charges against Mr. Flynn (and had him arrested) for allegedly contributing to an illegal market timing scheme. Later the charges were dropped.

Subsequently however, Mr. Flynn had to defend an SEC administrative proceeding brought against him, discussed here, based on substantially similar claims. Following a hearing, on the merits those claims were dismissed.

Court of Appeals

Foreign cubed: In The City of Edinburgh Council v. Vodafone, Case No. 07-Civ. 9921 (S.D.N.Y), the court dismissed a securities fraud action for lack of subject matter jurisdiction, following the recent decision in Morrison v. National Australia Bank, Ltd., 2008 WL 4660742 (2nd Cir. Oct. 23, 2008), discussed here.

City of Edinburgh, discussed in detail here, was brought against telecommunications giant Vodafone and four members of its management and board. The amended complaint, along with the materials submitted in response to the motion to dismiss, claimed that the Vodafone, whose shares are traded on European exchanges but files reports with the SEC and has ADR’s listed in New York, fraudulently inflated its results and future business prospects.

In rejecting plaintiff’s claim that the “conduct” test, which focuses on the situs of the fraud (in contrast to the effects test which is concerned with its impact) justified U.S. jurisdiction, the court concluded that “it appears that a United Kingdom company, overseen by executives and directors operating abroad, with common shares traded in London and Frankfurt exchanges, devised and implemented a scheme to artificially inflate the Company’s share price, allegedly to the damage of a United Kingdom plaintiffs. Vodafone’s conduct in the United States was incidental, and was limited to a pair of presentations by defendant Arun Sarin in New York … .”

While filing reports with the SEC may, in some instances, support subject matter jurisdiction since plaintiff relied on the conduct test, the question is the location of the fraud. Here, that is primarily in Europe and thus does not support subject matter jurisdiction.

PSLRA pleading requirements: The Ninth Circuit ruled on three significant PSLRA pleading issues in affirming the dismissal of a securities fraud suit. The claims centered on assertions that representations in a merger agreement asserting that the books and records of the company were in compliance with applicable requirements. In fact, there were FCPA violations. The three issues are use of the collective pleading doctrine, the impact of SOX certifications in pleading scienter and the use of allegations from DOJ/SEC settlement documents in the underlying FCPA cases. Glazer Capital Management, LP v. Sergio Magistri, No. CV -04-02181 (9th Cir. Nov. 26, 2008). The case is discussed in detail here.

After concluding that plaintiffs had adequately pled falsity as required by the PSLRA, the Court turned to the question of scienter. First, the court considered whether plaintiff is required to plead scienter as to the individual defendant or could rely on a “collective scienter” theory. Finding that the circuits are split on this question, the Court concluded that while in limited circumstances the collective approach may be utilized, here it rejected its application.

Second, in considering the interplay between the SOX certification requirements and the PSLRA pleading requirements, the Court concluded that there is nothing to indicate that the certification requirements were intended to alter the pleading requirements. Accordingly, the SOX certification is only probative of scienter if the person executing it was “severely reckless” in certifying the accuracy of the financial statements. This is not the case here.

Finally, the court rejected a claim that the settlement agreements with DOJ and the SEC are sufficient to create a strong inference of scienter. While in the agreements the company took responsibility for the violations, the general statements and largely legal conclusions in the settlement documents were insufficient to meet the particularity requirements of the PSLRA. Accordingly, the district court properly dismissed the complaint.

Constitutional standing: In W.R. Huff Asset Management Co., LLC v. Deloitte & Touche, LLP, Case No. 06-1664-cv (2nd Cir. Decided Dec. 3, 2008) the Court affirmed the decision of the district court to dismiss a securities fraud suit for lack of constitutional standing. Plaintiff, an investment advisor with discretionary authority to make investment decisions for its clients and a power of attorney from those clients to bring the suit, filed an action on behalf of purchasers of Adelphia Communications Corporation debt securities. The defendants were firms it alleged participated in the preparation of inaccurate and misleading disclosures in Adelphia’s financial statements.

Here, the key decision is the Supreme Court’s recent decision in Sprint Communications Co. L.P. v. APCC Servs., Inc., 128 S. Ct. 2531 (2008). Article III standing consists of three irreducible elements, according to the Court: (1) injury-in-fact; (2) causation; and (3) redressability. In view of these principles, merely holding a power of attorney is not sufficient since plaintiff does not have ownership or title to the claims. The court rejected plaintiff’s claim for a prudential exception to the injury-in-fact rule based on its authority to make investment decisions on behalf of its clients. This is not the kind of relationship which justifies constitutional standing, according to the court.

by T. GormanPosted on Posted in SECActions

In The City of Edinburgh Council v. Vodafone, Case No. 07-Civ. 9921 (S.D.N.Y), the court dismissed a securities fraud action for lack of subject matter jurisdiction. In its ruling, the court followed and applied the teachings of the Second Circuit’s first “foreign-cubed” decision, Morrison v. National Australia Bank, Ltd., 2008 WL 4660742 (2nd Cir. Oct. 23, 2008), discussed here.

City of Edinburgh was brought against telecommunications giant Vodafone and four members of its management and board. The amended complaint claimed that the company, which is registered for trading on European exchanges, has ADR’s listed in New York and files reports with the SEC, issued financial statements that falsely inflated the results and future business prospects of the company. This occurred to cover up the fact that it failed to timely account for certain write-downs from a failed acquisition. The misstatements focused primarily on the operations of the company abroad. Two presentations about the company were made to investors in New York.

The court granted defendants’ motion to dismiss for lack of jurisdiction after plaintiff declined an invitation to supplement its papers. Generally, in resolving a subject matter jurisdictional challenge, a two-part test may be considered. First is the conduct test. That test looks to whether the wrongful conduct occurred in the United States. Here, the question is whether substantial acts in furtherance of the fraud happened in the U.S.

Second is the effects test. This test focuses on whether the conduct had substantial effects in the U.S. or on its citizens.

Here, like Morrison, plaintiffs based their claim of jurisdiction solely on the conduct test, not the effects test. The complaints, as well as supplemental materials submitted by plaintiffs, were notable for their lack of factual detail. While the complaint alleged generally that jurisdiction is proper in the U.S., it failed to state that the fraudulent conduct occurred in the U.S. In fact, the complaint did not allege any situs of the fraud or specify where any of the misstatements were made. The complaint also failed to identify the nationality of the officers or even of the plaintiff.

In view of the lack of specific factual allegations tying the claimed fraud to the U.S., the court concluded that here “it appears that a United Kingdom company, overseen by executives and directors operating abroad, with common shares traded in London and Frankfurt exchanges, devised and implemented a scheme to artificially inflate the Company’s share price, allegedly to the damage of a United Kingdom plaintiffs. Vodafone’s conduct in the United States was incidental, and was limited to a pair of presentations by defendant Arun Sarin in New York … .”

While misleading financial statements prepared abroad and filed here with the SEC may support subject mater jurisdiction, it failed to do so in this case according to the court. As in Morrison, plaintiff here did not rely on the effects test. In relying exclusively on the conduct test to support jurisdiction, the question is “the location of the underlying acts of fraud and their nexus to the United States. Based on the record before [the court], it appears that any activity in the U.S. was secondary, and that, as with Morrison … the responsibility for ensuring the accuracy of public statements lies abroad.” Accordingly, the court concluded that defendants’ conduct in the U.S. was merely preparatory to any claimed acts of securities fraud. Those acts were not sufficient to establish jurisdiction.

Thanks to Lawyer Links which sent me this and other decisions commented on in this space.