by T. GormanPosted on Posted in SECActions

SEC enforcement cases, along with the number of insider trading cases, and perhaps criminal sentences for insider trading, all seem to be increasing.  According to a Bloomberg report (available here), the number of SEC enforcement cases rose last year for the first time in four years.  In the last fiscal year, SEC enforcement cases rose by about 10%.  That is contrary to the trend in recent years, when the number of cases declined each year by about 5%.  While the significance of an increase or decrease in the number of cases may not in and of itself be significant – SEC enforcement officials have said this in the past as the numbers went down – it should be considered with other trends. 

A second news report concerns actions against general counsels.  According to the National Law Journal (see here), for the first nine months of 2007, a record number of 10 General Counsels were charged with or pled to civil or criminal fraud charges.  Many of those cases are part of the stock-options backdating scandal.  This trend seems to be consistent with SEC pronouncements that they will focus on the “gatekeepers.”  At the same time, it suggests that there may be much less tolerance for the actions of in-house counsel and perhaps even outside counsel.   The SEC is also continuing to focus on insider trading cases.  The SEC closed out the government fiscal year last week by filing more insider trading cases.

In SEC v. McKay, the Commission settled insider trading action filed against the husband of a Triangle Pharmaceutical Co. executive who allegedly misappropriated inside information from his wife.  This case is discussed in a prior post here.    

In SEC v. Chavarria, the Commission brought a partially settled insider trading action brought against three Dell, Inc. accountants accused of trading in advance of earnings announcements.  This case is also discussed here.    

In addition, the SEC filed another “friends and family” insider trading case (see earlier post discussing these types of cases here) case on Thursday.  SEC v. Calder, Civil Action No. 07-01786 (D.D.C. Filed October 4, 2007).  In this settled action, the SEC’s complaint alleged that the defendant traded on misappropriated inside information about a possible acquisition of Commercial Federal Corporation.  Mr. Calder is alleged to have misappropriated the information from his brother, who in turn obtained the information from his wife.  The wife is the executive assistant to the Chairman and Chief Executive Officer of Commercial Federal.  Both the wife and the brother communicated the information on the understanding that it would be kept confidential.  Defendant traded while in possession of the material non-public information and, in addition, tipped a friend.  Defendant consented to the entry of a statutory injunction and an order requiring him to pay disgorgement in an amount equal to his trading profits and those of his friend, a penalty in an equal amount and prejudgment interest.  The Commission discusses this case further in its Litigation Release here.    

The SEC’s war on insider trading seems to be having an impact.  According to a study by Professor Darren T. Roulstone, University of Chicago Graduate School of Business, and Professor Joseph D. Piotroski, Stanford University on how corporate insiders limit their trading, there is a reluctance on the part of executives to trade on extreme news events.  This trend is particularly telling as to bad news.  In sum, the study concludes that there is a marked reluctance to trade on such information.  The study is reported here. 

Finally, those who have ignored the clear warning from the trend of SEC civil insider trading cases should consider a recent decision by the First Circuit Court of Appeals.  Earlier this week, that court reversed the sentence given to a hedge fund manager convicted of insider trading as being too lenient.  The District Court had imposed a sentence of 36 months of probation after defendant Michael Tom pled guilty to making about $750,000 in insider trading profits.  The government appealed, seeking a harsher sentence.  The appeals court concluded that “the sentence is unreasonable and that it did not give adequate consideration to the seriousness of the offense, the need for general deterrence for white collar crimes, and the need for some imprisonment …,” and remanded the case for re-sentencing,  U.S. v. Tom, No. 07-1074 (1st Cir. October 1, 2007) (a copy is here).   The message from all of this is clear.  SEC enforcement actions are increasing.  This trend is particularly evident in the insider trading area both on the civil and criminal side.  Company counsel and their advisors would do well to consider this trend as they review compliance programs and executive Rule 10b5-1 one plans – and perhaps their own activities given the emphasis on gatekeepers. 

by T. GormanPosted on Posted in SECActions

A key question following Dura Pharmaceuticals, Inc., v. Broude, 544 U.S. 356 (2005) is whether the truth has been revealed. But how much truth? Must all be revealed or just some? This question was considered in In re Retek Sec. Litig., 2005 WL 3059566 (D. Minn. Oct. 21, 2005). There, the complaint alleged four deals as part of a financial fraud. When a press release was issued disclosing one deal, the price dropped. On a motion to dismiss, defendants argued that the disclosure was not sufficient. At the pleading stage, however, the court found the complaint adequate, holding: “While the thread of causation may be long and somewhat tortured, at this state … Plaintiffs have alleged enough … [there is] a corrective disclosure followed by a drop in the stock price … .”

In contrast, where the complaint alleged two separate schemes, the court held that the truth had to be disclosed as to each scheme – if the truth was only told about one scheme, only that part of the complaint could survive: “In essence, lead plaintiff’s position is that a corrective disclosure about any questionable conduct that impacts a company’s financial statements is sufficient … [this] would create a boundless rule, rendering meaningless the loss causation requirement … .” In re St. Paul Travelers Sec. Litig. II, 2007 WL 1589524 (D. Minn. June 1, 2007); accord Marsden v. Select Medical Corp., 2007 WL 1725204 (E.D. Pa. June 12, 2007).

Following Dura, another key question concerns who reveals the truth – the company or a third person. This question was addressed in In re Winstar Comm., 2006 WL 473885 (S.D.N.Y. Feb. 27, 2006). There, the complaint claimed financial fraud, misrepresentations about a relation with a vendor and the financial condition of the company. An analyst’s report based on public information revealed the truth about these issues and the stock price dropped. The court held that loss causation had been pled: “The key to this [materialization] is the veracity of the information, not the source.” The fact that the report is from public information “does not mean that a reasonable investor could have drawn those same conclusions.”

If, however, the stock price drops because of general economic news or cause other that the revelation of the truth, Dura has not been met. For example, in In re Acterna Corp., Sec. Litig., 378 F. Supp. 2d 561 (D. Md. 2005), the court found that a price drop of 94% during the class period was not sufficient to plead loss causation: “Not only do plaintiffs not allege that the rapid decline in Acterna’s share price was caused in some way by Defendant’s alleged misrepresentations or omissions, their complaint suggests otherwise, alleging that prior to the class period, the global communications industry experienced a severe economic slow down that continued throughout the class period … .” See also In re Tellium, Inc. Sec. Lit, 2005 WL 1677467 (D. N.J. June 30, 2005).

At the same time, plaintiff is not required to rule out all other causes. Rather, if the revelation is a substantial cause, it is sufficient. In In re Daou Systems, Inc. Sec. Litig., 411 F.3d 1006 (9th Cir. 2005), plaintiffs’ complaint alleged a financial fraud. According to the complaint, by the third quarter the financial condition of the company was deteriorating and when the results for that quarter were announced the stock price dropped. Analysts suggested that the company was cooking the books. The court found that plaintiff need not prove that the alleged cause is the only reason for the stock price drop to satisfy Dura: “To establish loss causation plaintiff must demonstrate a causal link between the fraud and the injury suffered. Plaintiff is not required to show that the misrepresentation was the sole cause. Rather, plaintiff must only demonstrate that it is ‘one substantial cause’ for the decline in value of the shares. The fact that there are other contributing causes will not bar the recovery.” See also In re Geopharma Inc. Sec. Litig., 2005 WL 2431518 (S.D. N.Y. Sept. 30, 2005).

Collectively, these cases and the other cases discussed in this series illustrate the significant impact of Dura in the two years since it was decided. Like the recent decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007), the approach used by the Supreme Court in these cases has generally tightened pleading standards and made bringing a private securities fraud case more difficult. These themes will undoubtedly come into play next week when the Court hears arguments in Stoneridge Inv. Partners, LLC. v. Scientific-Atlanta, Inc. and Motorola, Inc., No. 06-43, which addresses the potential scope of liability under Section 10(b). The concluding segment of this series will examine the impact of these themes on Stoneridge.

Next: The Conclusion – Stoneridge before the Supreme Court