by T. GormanPosted on Posted in SECActions

Stoneridge is clearly a pro-business decision. While the Supreme Court did not render the blockbuster decision many anticipated by dramatically reinterpreting the contours of key anti-fraud Section 10(b), the Court clearly delimited the contours of private damage actions. Under the Court’s decision, third party vendors who contribute to an issuer’s fraud on its shareholders are simply too remote from the securities transaction to be liable – at least for damages. Those persons are, however, still potentially liable in SEC enforcement actions under Section 20(e) which gives the agency authority to bring suits for aiding and abetting.

Examination of Stoneridge in the context of recent amendments to the federal securities laws and another key decision by the Supreme Court suggests that the decision may have far broader implications than what might initially appear from reading the opinion. Traditionally, remedies available to plaintiffs under the federal securities laws are a supplement to those under state law. For example, Section 28 of the Securities Exchange Act of 1934 provides in part that “the rights and remedies provided by this title shall be in addition to any and all other rights and remedies that may exist at law or in equity … .” According, plaintiffs had the option of bringing an action for damages under either the federal securities laws or the applicable state laws.

Congress, of course, altered this balance with the passage of the Securities Litigation Uniform Standards Act (“SLUSA”) of 1998. Generally, under that Act class actions alleging Section 10(b) type fraud can only be brought in federal court – state court suits are pre-empted. See, e.g., Merrill Lynch Pierce Fenner & Smith v. Davit, 547 U.S. 271 (2006). The purpose of SLUSA was not to deny those with meritorious claims the right to bring suit but rather to ensure that class action plaintiffs do not evade the stringent pleading and procedural requirements of the Securities Litigation Reform Act of 1995 (“PSLRA”) intended to weed-out frivolous suits.

If, however, Stoneridge is read together with SLUSA, a significant question arises as to whether certain types of actions have been left without a remedy. Stated differently, does Stoneridge and SLUSA effectively immunize third parties from private securities fraud class action liability?

Under Stoneridge the conduct of the third party vendors is fraud within the meaning of Section 10(b) according to the Court. Indeed, as the Court points out, the vendors may be subject to suit by the SEC for aiding and abetting violations of the anti-fraud provisions. Accordingly under SLUSA a class action suit against those vendors could only be maintained in federal court. Under Stoneridge however, once that suit is filed or removed to federal court it must be dismissed. SLUSA and Stoneridge thus preclude plaintiffs who claim to have been injured by the actions of third party vendors from bringing a fraud suit in either federal or state court as a class action. Since the cost of securities actions is typically to great to permit individual cases, effectively this reading of SLUSA and Stoneridge immunizes third party vendors from suit. This result would be consistent with Dabit (concluding that “holder suits” are pre-empted by SLUSA despite the fact that the Court’s earlier decision in Blue Chip Stamps v. Manor Drug, 421 U.S. 723 (1975) would require dismissal once removed. Under this reading Stoneridge has far broader implications than might have initially appeared.

by T. GormanPosted on Posted in SECActions

This week the SEC continued to reduce its inventory of option backdating cases, filing one which raises questions about prosecution standards and notifying another company that it was closing the investigation. At the same time the SEC continued its war on insider trading and brought a self –dealing case against a corporate manger.

Options Backdating

SEC v. Tullos, Civil Action No. SACV 08-242 AG (C.D. Calif. Filed March 4, 2008) is the SEC’s latest stock option backdating case. There, the Commission brought an action against Nancy M. Tullos, the former vice president of human resources of Broadcom Corporation. According to the Commission’s complaint, Ms. Tullos participated in a scheme from 1998 to 2003 to backdate options at Broadcom. As part of the scheme grants were backdated to the low closing price for the company’s stock. Ms. Tullos communicated false grant dates within the company, provided spreadsheets of stock option allocations for the backdated grants to the finance and shareholder services departments knowing that they would use the information to prepare Broadcom’s books and records and periodic filings with the SEC and personally profited.

To settle the case, Ms. Tullos consented to the entry of a statutory injunction prohibiting future violations of Section 17(a)(3) of the Securities Act of 1933, as well as Section 13(b)(5) of the Securities Exchange Act of 1934 and the pertinent rules there under. In addition, Ms. Tullos consented to the entry of an order which required her to pay over $1.3 million in disgorgement and prejudgment interest to be offset by the value of her exercisable stock options which were cancelled and the payment of a $100,000 civil penalty.

This case, like the SEC’s case last year against former Maxim Integrated Products CEO and Chairman, John F. Gifford, raises questions about the prosecution standards used in option backdating cases. In contrast to many option backdating cases Tullos and Gifford are based on negligence, not intentional fraudulent conduct.

In contrast, on the same date Tullos was announced, semiconductor developer Circus Logis, Inc disclosed that the SEC had ended its investigation of the company regarding backdated stock options. Following notification of an informal inquiry by the SEC into its options issuances practices, Circus Logis undertook an internal investigation. Based on that inquiry the company concluded that the accounting measurement dates for some options granted between January 1, 1997 and December 31, 2005 differed from the recorded measurement dates. As a consequence the company restated its financial statements for the fiscal years from 1997 to 2001, adding about $32 million in compensation expenses. This resulted, according to the investigative findings of the company, because it had “limited controls” and it did not have a “definitive processes for stock option granting and approval,” all of which permitted the use of “hindsight” to select grant dates for options. Private actions have been filed against the company as a result of its disclosures.

Insider trading

In SEC v. Beahm, Civil Action No. 08 CV 02209 (S.D.N.Y. Filed March 5, 2008) the SEC again demonstrated that it is not the amount in question but the conduct. In this settled civil injunctive action the SEC alleged that Mr. Beahm, a consultant for Church and Dwight, Inc., traded in advance of the acquisition of Del Labs by Kelso & Co. and Church and Dwight. This trading yielded $2,928.84 in illegal profits. Mr. Beahm also tipped his friend James P. Crilly who traded. Mr. Crilly’s trading was more profitable, yielding $11,388 in illegal profits.

Both men agreed to settle with the SEC consenting to statutory injunctions prohibiting future violations of Section 10(b). In addition, Mr. Beahm consented to the entry of an order which requires him to disgorge his profits and the pre-judgment interest as well as those of Mr. Crilly (along with the prejudgment interest) and to the payment of a civil fine equal to his disgorgement payment. Mr. Crilly consented to the entry of an order also requiring him to disgorge his trading profits, prejudgment interest and to pay a civil fine equal to the amount of his disgorgement payment.

In SEC v. Manne, Civil Action No. 08-CV-1068 (E.D. Pa. Filed March 4, 2008) the Commission alleged that Stanley Manne traded on inside information in the securities of Valley Forge Scientific, Inc. Specifically, the SEC’s complaint alleges that Mr. Manne learned about the possibility of a merger between Valley Forge and Synergetics when the chief operating officer of Valley Forge asked his long time friend Stanley Manne to become a company director. In that conversation the chief operating officer “told Manne that Valley Forge was involved in discussions with several potential sale or merger partners, including Synergetics, and that, as a director, Manne would be involved in these matters. The Chief Operating Officer told Manne that this information was confidential and that he could not trade on the information, and Manne agreed” according to the complaint.

According to the complaint, Mr. Manne misappropriated the information given to him and executed 45 trades in Valley Forge common stock and purchasing a total of 105,680 shares. The complaint alleges that Mr. Mane traded in Valley Forge securities on the basis of material nonpublic information in breach of a duty of trust and confidence to the chief executive officer. Those trades made Mr. Manne $85,601 in alleged illegal trading profits, although he did not immediately sell his shares after the merger announcement according to the complaint. By breaching his pledge to his friend the SEC alleges Mr. Manne violated Section 10(b) and Rule 10b-5.

Mr. Manne settled the action by consenting to a statutory injunction prohibiting future violations of Section 10(b). In addition, he consented to an order requiring him to disgorge the trading profits plus prejudgment interest and to pay a penalty equal to the trading profits.

Executive self-dealing

SEC v. Jenson, Civil Action No. 08-0241 (C.D. Cal. Filed March 5, 2008) is a civil injunctive action brought against the former chief executive and financial officer of Merisel Inc. for self-dealing. The Commission’s complaint alleges that in two instances Mr. Jenson caused Merisel to sell assets to entities he controlled without disclosing his relationship to the buyer substantially below their actual value. Specifically, in one transaction Mr. Jenson is alleged to have caused the company to sell certain software licensing assets and real property to a company he controlled at over $2.6 million below value. In a second he caused a dormant company subsidiary to be sold to an entity he controlled for $1,000 despite the fact that the subsidiary sold held over $952,000 in assets. According to the complaint, Mr. Jenson misrepresented or failed to disclose the related party nature of these transactions in Merisel’s filings and earning press release. This case is in litigation.