This Week In Securities Litigation (April 11, 2008 edition)

This week, the Ninth Circuit handed down a significant parallel proceedings ruling. At the same time the SEC brought another in a series of financial fraud cases, while the U.S Attorney in New York resolved the last of the criminal cases related to the Guttenberg insider trading cases brought last year. Home Depot also resolved securities class actions and derivative suits based on options backdating.

Parallel proceedings

The Government prevailed in a key parallel proceedings decision last week. On April 4 2008, the Ninth Circuit Court of Appeals vacated the decision of the District Court which had dismissed an indictment finding that the defendants’ constitutional rights had been violated by the conduct of the U.S. Attorney’s Office and the SEC in conducting investigations which had merged. U.S. v. Stringer, 408 F. Supp. 2d 1083 (D. Or. 2006), vacated and remanded, No. 06-30100 (9th Cir. April 4, 2008). The Circuit Court concluded that the conduct of government prosecutors and SEC attorneys was not improper where they did not make affirmative misrepresentations and, in response to questions about a possible criminal investigation, referred the defendants to the boilerplate warnings in Form 1662.

The court did not find it improper that: 1) the investigations of the USAO and SEC merged; 2) that the U.S. Attorney’s office hid behind the SEC during its investigation from the outset when they had determined the targets of the inquiry; 3) that prosecutors coached SEC staff attorneys on how to set up its targets for possible false statement charges; 4) that the SEC moved the testimony of the defendants from Los Angeles to Oregon at the request of members of the U.S. Attorney’s Office to establish venue in that jurisdiction for the criminal case; and 5) that the criminal prosecutors decided to keep their inquiry secret to make sure the defendants continued to cooperate with the SEC by testifying in its inquiry and then entering into a settlement. This case and its potential adverse impact on law enforcement investigations are discussed more fully here.

Financial fraud

Civil and criminal fraud charges were filed against the former vice chairman, president and chief financial officer of United Rentals, Inc., John Milne. According to the SEC’s complaint, Mr. Milne engaged in a fraudulent scheme from 2000 to 2002 in which he falsely inflated the profits of the company to meet earnings forecasts. As a result, the company filed false Form 10Ks and Qs. At the same time Mr. Milne is alleged to have sold about $38 million of company stock after the false filings were made. SEC v. Milne, Civil Action No. 3: 08-CV-505 (D. Conn. April 7, 2008). This case is discussed here.

Previously, criminal charges were brought against Mr. Milne. The indictment included charges of conspiracy, securities fraud and making false statements. U.S. v. Milne, 3:08-cr-00090 (D. Conn. Filed April 3, 2008).

The SEC brought two prior related actions. SEC v. Nolan, Civil Action No. 07-CV-1833 (D. Ct. Filed Dec. 12, 2007) is a settled enforcement action brought against Michael Nolan, the former CFO of United Rentals based on essentially the same conduct. Mr. Nolan consented to the entry of a statutory injunction prohibiting future violations of the antifraud and books and records provisions of the securities laws, an order imposing an officer director bar and an order suspending him from practicing before the Commission. Mr. Nolan also pled guilty to one count of making false filings with the SEC in the parallel criminal case.

In addition, the SEC filed an action against Joseph F., Apuzzo, the former CFO of Terex Corporation. SEC v. Apuzzo, Civil Action No. 07-CV-1910 (D. Ct. Filed Dec. 31 2007). The complaint in that case alleges that Mr. Apuzzo aided and abetted the fraud at United Rentals. This case is in litigation.

Insider trading

This week Samuel Childs, a former broker at Assent LLC, a securities broker-dealer, pled guilty. Mr. Childs was the last of the defendants in the criminal cases brought last year when investigators uncovered a large insider trading ring involving Wall Street professionals. The Guttenberg cases, which have been called the most significant since the late 1980s, are based on two overlapping schemes. One scheme was based on trading in advance of stock recommendations from UBS. As second involved trading on inside information obtained from Morgan Stanley about pending transactions. The SEC named fourteen individuals in its case. SEC v. Guttenberg, Case No. 107-cv-01774 (S.D.N.Y. Filed March 1 2007). That case is pending. Thirteen persons were named as defendants in the related criminal cases. U.S. V. Jurman, Case No. 1:07-cr-00140-TPG (S.D.N.Y. Filed Feb. 26, 2007). The plea by Mr. Childs resolves the last of the criminal cases. U.S. v. Childs, 1:07-cr-00142 (S.D.N.Y. Filed Feb. 26, 2007). These cases are discussed here.

Shareholder suits settled

Home Depot entered into a settlement of securities class actions and derivative suits brought against it based on claims of option backdating. Specifically, the complaints claimed that for nearly 20 years the board had backdated options granted to executives, fraudulently manipulated the company’s return to vendor program under which suppliers are billed for damaged or returned merchandise and gave disproportionate payments and benefits to the former chairman of the company.

The suits were settled with the payment of $14.5 million and the adoption of thirteen corporate governance changes. Those changes included requirements which ensure that two thirds of the board members are independent, that certain committees were only composed of independent directors and other governance changes.

Part I: SEC Enforcement Trends and Priorities, 2008

Last year the SEC Enforcement Division brought a record number of cases:

• 1776 investigations;
• 262 civil actions; and
• 394 administrative proceedings.

In these cases the Division obtained $520,000,000 in disgorgement and penalties.

The statistics suggest that the Division was also very successful. These statistics suggest a very successful program. They represent an increase of about 10% over the previous year. This reverses a trend over prior years where the number of cases handled by the division had been declining. The success of the program seems confirmed by the fact that about 92% of these cases either settled or ended in default.

There are signs, however, that the Enforcement program was not as successful as these statistics suggest. For example, the amount of disgorgement and penalties obtained in 2007 was down by 50% over the prior year. While that may result from the fact that there were no huge Enron or similar cases, the decrease has caused enough concern in Congress to spark an investigation.

Another disturbing sign is the results in some court cases. For example:

• SEC v. PacketPort.com, Inc., Civil Action No. 3:05 cv 1747 (D. Conn. Mar. 21 2007). This case was brought so late that the SEC could not seek a penalty because the statute of limitations had expired. Later, the case was dismissed for want of prosecution. The case ended when the defendants agreed to what can only be called a face-saving settlement for the SEC and in which defendants avoid further litigation by avoiding an SEC appeal.

• In each litigated PIPE/hedge fund case where the SEC claimed insider trading and the sale of unregistered securities, the court dismissed the Section 5, sale of unregistered securities claims. In two of the cases the courts criticized the legal theory on which the Section 5 claims were based. These cases will be discussed in detail in a later installment of this series.

• SEC v. Jones, No. 07 Civ 7044 (S.D. N.Y. Feb. 26, 2007). The court refused to award a penalty sought by the SEC because the statute of limitations had passed. The court also refused to issue the standard SEC injunction, finding that the case was so old that it would only be punitive and not equitable and was thus also time barred.

• SEC v. Todd, Civil Action 03 CV 2230 (S.D. Ca. May 30, 2007). Post trial defense motions were largely granted where the court concluded that the SEC misrepresented key evidence regarding whether the defendant had signed a claimed false filing. Despite an SEC representation that the defendant had singed the filing which the court had relied on in denying earlier defense motions, in fact the defendant not signed the filing and there was no evidence he had anything to do with it.

While every law enforcement agency loses cases, these are particularly disturbing. Bringing stale cases, relying on unsupported securities law theory and misrepresenting facts to the court is inexcusable for any litigant. This is particularly true for an agency charged with administering the federal securities laws and policing the nation’s securities markets. These cases suggest that Enforcement program is troubled.

Next: Enforcement policies