Mr. Obama’s Letter to Santa For His New SEC Chairwoman

The children are all finishing their letters to Santa Claus, hoping that on Christmas morning they will find those special toys they have wanted for so long in their stockings and under the tree. President-elect Barack Obama is also writing to Santa this week in the hope of delivering on his promise of change to the country. One of his letters is for his nominee as SEC Chairwoman, Mary Schapiro. The President-elect asked Santa to put three things in the Chairwoman’s stocking, but they are big items:

Tone at the top: He wants the SEC to once again be the top cop of Wall Street. That begins at the top – the White House and the SEC Chairwoman’s office. The tone at the top must tell all that the SEC is back and on patrol, walking the beat, not just of Wall Street, but in the board room and across the country. If there is wrong-doing, those responsible will caught and brought to justice. If market professionals are violating the rules, they will be stopped. If corporate America is fudging the account principles, they will be discovered. If insiders are abusing their trust, they, along with all who are violating the rules, will be found in a timely fashion and promptly brought to justice. This message must come from the top and be clear, unequivocal and fairly delivered, not just on the first day, but every day.

Scrutiny at the bottom: Those in the trenches have to get the message from the top and apply it. Intake is key and effectively conducting the initial, informal inquiry is critical. When investor complaints come in, they have to be carefully reviewed. When information is obtained from the SRO’s, it has to be reviewed and carefully analyzed. When there are media reports raising questions about matters, they must be evaluated and followed up. At the same time, initial informal investigations, which the staff has the authority to open and close without asking the Commission, must be carefully conducted, the facts and data analyzed and rapidly pursued to make sure that the proper conclusion is reached. Intake and the initial investigations are critical to effective enforcement.

Economy in the middle: It is essential that the mid-level supervisory staff take a hands-on approach and use their expertise to make sure that the staff doing intake and conducting the initial investigations is searching out all potential leads, that the evidence is being carefully analyzed and at the pertinent legal issues are being fully evaluated. Mid-level staff must avoid the temptation to get caught up in reviewing memoranda which summarize information, rather than taking a hard look at actual pieces of key evidence. They must resist falling into a routine of running from meeting to meeting, leaving the actual collection and analysis of evidence – that is, the real investigation – to the most inexperienced staff members. It is thus essential that the staff operations be refocused to a more hands on approach. This will ensure that tone from the top and the scrutiny at the bottom come together to create effective enforcement.

If Santa fills Ms. Schapiro’s stocking with tone at the top, scrutiny at the bottom and economy in the middle, the President-elect will bring the change he promised to the Securities and Exchange Commission.

This Week In Securities Litigation (December 19, 2008)

This week, Mary Schapiro was nominated to be the new SEC Chairwoman in the wake of admissions by current SEC Chairman Cox that the agency failed to properly investigate the Madoff matter over the years. At the same time, the SEC filed an insider trading cases naming securities professionals while settling another long running insider trading case involving a former S&P analyst. The settlement followed guilty pleas in a parallel criminal case.

The Department of Justice, along with the SEC and German regulators, announced a record setting $1.6 billion resolution in an FCPA case against Siemens A.G. In another criminal case, a former official of KA Homes agreed to plead guilty to conspiring to obstruct an SEC investigation by preparing a false investigative report which was furnished to directors to prepare SEC filings.

NERA projects that the number of securities class actions this year will increase over last year, although the mean settlement value of these cases diminished modestly. Amkor settled their option backdating case for over $11 million while it had a derivative case regarding Autodesk was dismissed for failure to make a demand.

Finally, the Fourth Circuit followed the path of five other circuits in recent decisions, concluding that plaintiffs had failed to plead a strong inference of scienter under the Supreme Court’s Tellabs equipoise standard.

New SEC Chairwoman:: Mary Schapiro will be nominated by President-elect Barack Obama to be the new SEC chairwoman. Ms. Schapiro, who will be the first permanent chairwoman of the SEC, is currently the head of FINRA. Previously, she has served as the Chairwoman of the CFTC and as an SEC Commissioner.

Ms. Schapiro, if confirmed by the Senate, will take over as head of the SEC at a critical time in its history. In the wake of the market crisis, Congress is considering reorganization of the financial regulators, as well as the need for additional regulation over the largely unregulated derivatives market and perhaps hedge funds. Ms. Schapiro’s background should prove valuable in evaluating these issues. At the same time, her comments at the time of the announcement suggesting a focus on enforcement clearly reflect the need for the SEC to revitalize that program.

The announcement of Mr. Obama’s choice follows the stunning admission by current SEC Chairman Cox that the agency failed to properly investigate leads that may have unraveled the Madoff scandal years earlier. While Mr. Cox’s admission was, in many ways, refreshing, it fell far short of the Harry Truman standard of “the buck stops here.” Mr. Cox said the buck stops with SEC staff. Yet, there is little doubt that effective enforcement begins with leadership at the top. While the SEC was once a premier enforcement agency, the Madoff debacle is simply the latest and perhaps most dramatic failing of the enforcement program. Ms. Schapiro seems to understand that revitalizing the enforcement begins with leadership at the top, that is, the Chairman’s office.

SEC enforcement: In SEC v. Devlin, Case No. 08-CV-11001 (S.D.N.Y. Filed Dec. 18, 2008), the Commission brought an insider trading case against securities and legal professionals as well as their friends and clients. Named as defendants were two former Lehman Brothers registered representatives, Mathew Devlin and Frederick Bowers, an associate at an international law firm, Eric Holzer and others.

Mr. Devlin, called the “golden goose” by the group, is charged with tipping the others who in turn tipped friends about transactions involving a series of companies prior to the public announcements. He obtained the inside information by misappropriating it from his wife, an executive at a public relations firm. The U.S. Attorney’s Office for the Southern District of New York has filed criminal charges against some of the defendants in the SEC complaint. The SEC’s case is in litigation.

The SEC also a settled a long running insider trading case this week against a former senior analyst at Standard & Poor’s. SEC v. Marano, Civil Action No. 04 CV 5828 (S.D.N.Y. Filed July 27, 2004). The complaint alleged that Rick Marano, then an S&P analyst, tipped his brother, William Marano and Carl Loizzi, a friend and former business partner of his brother, about two potential acquisitions. The first was in 2000 and involved the potential acquisition of ReliaStar Financial by ING Group. The second focused on the potential acquisition of American General Corp. by AIG in April 2001.

To settle the case, each defendant consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions. In addition, Rick Marano and Mr. Loizzi agreed to orders requiring the payment of disgorgement. The judgments waived part of the disgorgement and did not seek a penalty based on the financial condition of the defendants.

The SEC settlements followed the entry of guilty pleas to inside trading charges by the three defendants in a parallel criminal case. There Rick Marano was sentenced to 15 months in prison and a fine of $5,000, William Marno was sentenced to 24 months of probation and a $1,000 fine while Mr. Loizzi was sentenced to 36 months of probation and a fine of $3,000.

FCPA: Siemens AG resolved FCPA charges with the Department of Justice, the Munich Public Prosecutor’s Office and the SEC with multiple guilty pleas and the payment of $1.6 billion in fines, penalties and disgorgement of profits, including $800 million to U.S. authorities. This is the largest monetary sanction ever imposed in an FCPA case, according to DOJ. U.S. v. Siemens Aktiengesellschaft, Case No. 08-367 (D.D.C. Filed Dec. 15, 2008); see also SEC v. Siemens Aktiengesellschaft, Case No. 1:08-cv-02167 (D.D.C. Filed Dec. 15, 2008). The case is discussed here.

Under the terms of the plea agreement, Siemens AG pled guilty to one count of failure to maintain internal controls and one count of books and records violations. At the same time, one Siemens’ subsidiary pled guilty to one count of conspiracy to violate the books and records provisions of the FCPA, while another pled guilty to one count of conspiracy to violate the anti-bribery and books and records provisions.

The charges are based on violations in Latin America and the middle east. In part, the middle east charges stem from transactions under the U.N. Oil for Food Program, while others were based on alleged corrupt payments made in Bangladesh to secure business regarding a mobile telephone project. The Latin America charges involved multiple corrupt payments in Argentina and Venezuela to secure business.

The company also settled charges with the Munich Public Prosecutor’s Office and the SEC.

Criminal cases: In U.S. v. Ray, Case No. 2:08-cr-01443 (C.D. Ca. Filed Dec. 15, 2008) Gary Ray, former head of Human Resources at KB Home, agreed to plead guilty to conspiracy to obstruct justice in connection with an internal investigation into stock option backdating at KB Home. Mr. Ray is pleading guilty to a charge that he and the then-CEO of the company agreed that they would cause the general counsel of the company to prepare and submit a false and misleading report on the option granting practice of the company to the audit committee and others who relied on that report to make disclosure decisions with respect to required SEC filings.

Private actions: NERA Economic Consulting, which compiles statistics on private securities actions, reports that filings for securities class actions are projected to reach 267 by the end of the year. This represents a 37% increase over 2007. The number of cases are on pace to be a 10 year high according to NERA (excluding atypical cases such as the IPO securities litigation and similar matters). At the same time however, the median settlement value has declined slightly from about $9.4 million in 2007 to approximately $7.5 million in 2008.

In Weiss v. Amkor Technology, Inc., Case No. 2:07-cv-00278 (D. Az. Filed Feb. 7, 2007), the parties reach a settlement in a securities class action based on allegations of option backdating. The court previously dismissed the complaint for failure to comply with the pleading requirements of the PSLRA. The parties agreed to settle for $11.25 million, most of which will be covered by insurance, while an appeal of the dismissal order is pending before the Ninth Circuit. The SEC is also investigating Amkor’s option backdating practices.

In In re Autodesk, Inc, Civil Action No. 3:06-cv-07185 (N.D. Ca. Filed Nov. 20, 2006) the court dismissed a derivative suit for failure to make a demand. The complaint, based on option backdating claims, followed an internal investigation which concluded that while options had been improperly granted there is no evidence that any officer or director granted any options to him or herself. As to the demand futility, the question was whether a majority of the board’s members were involved in the backdating or face substantial liability, the court noted. Plaintiffs failed to allege any facts to support such a claim.

Circuit Courts: In Cozzarelli v. Inspire Pharmaceuticals, Inc., Case No. 07-1851 (4th Cir. Dec. 12, 2008), discussed here, followed the lead of other circuits in recent weeks by affirming the dismissal of a securities complaint based on and its “strong inference” of scienter test.

The complaint claimed fraud based on statements made by executives of Inspire Pharmaceuticals about a new product and its FDA trial which eventually failed. The announcement of the failure was followed by a 44.5% drop in the share price.

In affirming the dismissal, the Circuit Court concluded that the complaint failed to plead scienter as required by Tellabs. Plaintiff’s claims were based in part on passages incorporated in the complaint which had been selectively taken from reports in the complaint. After reviewing each passage in the context of the entire report over the objection of the plaintiffs, the court concluded that, when read in context, the inference of innocent conduct undertaken for legitimate business reasons predominated. Accordingly, the complaint failed to plead a strong inference of scienter under Tellabs.