by T. GormanPosted on Posted in SECActions

This week there were several criminal and civil securities actions of note:

Criminal 

Options backdating: U. S. v. Reyes (N.D. Cal.).  The trial of former Brocade CEO Greg Reyes continued, with closing arguments being made on Thursday.  The jury is expected to begin deliberations on Friday.  This is the first options backdating case – criminal or civil – to go to trial.  The criminal charges, as well as the SEC’s parallel civil complaint are based on allegations involving intentional fraud centered on falsified documents and a cover-up.  At mid-trial, the Court reserved ruling on defense Rule 29 motions for acquittal for a number of days, leading to speculation that the case might be dismissed.  While the Court may still consider those motions, the case seems poised to go to the jury shortly.  The result in this case should help define the future course of possible criminal and civil prosecutions which could involve the dozens of companies still under investigation, as well as directors, officers and others who may have been involved.  

Options backdating:  U.S. v. Argo (S.D.N.Y.).  The former president and COO of SafeNet was indicted on securities fraud charges in connection with the alleged backdating of millions of dollars in stock options grants.  According to the indictment, the defendant routinely backdated options grants to coincide with points in time when SafeNet’s stock price was low between 2000 and 2006.

Civil 

Corporate penalties/financial fraud:  SEC v. ConAgra Foods, Inc., Case no. 07cv01557-MSK-MEH (D. Col., filed July 25, 2007).  ConAgra agreed to pay $45 million in penalties and to the entry of a statutory injunction prohibiting future violations of the antifraud and reporting provisions of the federal securities laws.  The complaint alleged improper and, in some instances, fraudulent accounting practices from 1999 through 2005.  Those practices involved the misuse of reserves to manipulate reported earnings, premature revenue recognition, and numerous tax errors, which resulted in misstated reported income.  See www.sec.gov/litigation/litreleases/2007/lr20206.htm.

Corporate penalties/financial fraud:  SEC v. Cardinal Health, Inc., Case No 07CV6709 (S.D.N.Y., filed July 26, 2007).  Cardinal Health agreed to pay a $35 million civil penalty and consented to the entry of a statutory injunction prohibiting future violations of the antifraud and reporting provisions of the federal securities laws to settle an SEC enforcement action.  The complaint in the case alleged that Cardinal engaged in a variety of improper practices to manage its reported revenue and earnings over a period of four years.  The improper practices included misclassifying revenue, selectively accelerating payment of vendor invoices without disclosure to prematurely record millions in cash discount income, improperly adjusting reserve accounts and improperly classifying expected litigation settlement proceeds to increase operating earnings.  See www.sec.gov/litigation/litreleases/2007/lr20121.htm.

Foreign Corrupt Practices Act:  SEC v. Delta & Pine Land Company, Civil Action No. 1:06-CV-1260 (E.D. Va., filed July 25, 2007).  An civil injunctive action and an administrative proceeding was filed and settled against Delta & Pine Land Co. and its former subsidiary, Turk Deltapine, for violations of the FCPA.  The administrative proceeding (filed July 26, 2007) charged violations of the books and records, internal controls and anti-bribery provisions of the FCPA.  Each case centered on claims that from 2001 to 2006 Turk Deltapine made payments of about $43,000 to officials of the Turkish Ministry of Agricultural and Rural Affairs to obtain government reports and certificates necessary to operate its business in Turkey.  In the administrative proceeding, respondents agreed to the entry of a cease-and-desist order and the appointment of an independent consultant to make recommendations regarding FCPA compliance provisions.  In the Court action, defendants agreed to the entry of an order requiring them to pay a penalty of $300,000.  See www.sec.gov/litigation/litreleases/2007/lr20214.htm. 

Options backdating:  SEC v. KLA-Tencor Corp., Case No. C07 3798 HRL (N.D. Cal.. filed July 25, 2007); and SEC v. Schroeder, Case No. C07 3798 JW (N.D. Cal., filed July 25, 2007).  The SEC filed complaints against KLA-Tencor and its former CEO Kenneth Schroeder, based on claims of option backdating.  According to the SEC allegations, KLA concealed over $200 million in stock option compensations by providing employees with potentially in-the-money options.  The company consented to the entry of a statutory injunction prohibiting future violations of the reporting provisions of the federal securities laws.  The complaint is pending against Mr. Schroeder. See www.sec.gov/litigation/litreleases/2007/lr20207.htm. 

Option backdating:  SEC v Therrien, Civil Action No. 07 CA 11364 RCL (D. Mass., filed July 24, 2007).  The SEC filed a complaint alleging violations of the antifraud and books and records provisions of the federal securities laws against Robert Therrien, former President and CEO of Brooks Automation, Inc., a software company.  According to the complaint Mr. Therrin engaged in an option backdating scheme between 1999 and 2005 in which documents were falsified, resulting in and overstatement of income on the financial statements of at least $54 million.  The company has restated its financial statements as a result of these actions.  www.sec.gv/litigation/litreleases/2007/lr20210.htm.

Insider trading:  SEC v. Suman, No. 07-CV 6625 (S.D.N.Y.)  The SEC charged former MDS Inc. employee Shane Bashir Suman with stealing confidential information about his company’s impending tender offer for the shares of Molecular Devices.  Mr. Suman and his wife then traded based on the information.  According to the complaint, the couple purchased 12,000 shares and 900 options in Molecular (which were financed with a margin loan) prior to the announcement.  Following the announcement of the tender offer, Molecular’s share price increased almost $24, making defendants’ trades worth more than $1 million.  See www.sec.gov.litigation.litreleases.2997lr29293.htm.

by T. GormanPosted on Posted in SECActions

Since Stoneridge Inv. Partners, LLC. v. Scientific-Atlanta, Inc. and Motorola, Inc., No. 06-43 will determine the parameters of a securities fraud cause of action in damage cases, it may be the most significant securities law decision in years for all of those who deal with public companies. The key question the Court will decide is just how far antifraud Section 10(b) goes – does it cover, for example, only those directly responsible for a fraud, those who were also key participants or perhaps others who knew about it and without whose participation it could not go have occurred?  Stated differently, does the Section only cover the company and its insiders or can others be liable such as outside auditors, lawyers and even vendors?  

At least three key factors will impact the Supreme Court’s decision.  First, Stoneridge is rooted in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, 511 U.S. 164 (1994) and a long line of Court decisions on which that case is based such as Santa Fe Industries v. Green, 430 U.S. 462 (1977), Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) and Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975).  In each of those cases, as the Court did this last term in Tellabs (which will be discussed in the next segment of this series), the Court hewed closely to the literal text of the statute.  Indeed, the Central Bank opinion is little more that a reading of the statute to determine that the phrase “aiding and abetting” does not appear in the text.  In view of this approach, it is little wonder that the Central Bank Court called terms its conclusion “unremarkable.”  

Those cases however, stand for more than just simple text reading.  An underlying current is the concern for what is frequently called the “vexatious” nature of securities litigation and the lack of certainty which can be caused by those cases for business leaders in directing the activities of their companies. It is this quest for certainty which translated into the so-called bright line test after Central Bank.  No doubt these themes will emerge in Stoneridge.  

These themes will also be apparent in the way the facts of the case are viewed.  The Eighth Circuit, for example, viewed the transaction in which plaintiffs sought to hold the third-party vendor defendants liable in Stoneridge as a legitimate business transaction despite the fact that the complaint alleged that at a minimum it had a sham component (the inflated cost for the TV set top boxes) which was used by the company as a key part of its fraudulent scheme.  In re Charter Commc’n, Inc., Sec. Litig., 443 F.3d 987 (8th Cir. 2006).  If the Supreme Court views the transactions in Stoneridge in a manner similar to the Eighth Circuit, the application of the Central Bank themes should leave little doubt about the outcome. 

In contrast, if the Court decides to hear the Enron case (Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372 (5th Cir. 2007); Pet. For Cert. filed, 75 U.S.L.W. 3557 (March 5, 2007) (No. 06-13)), the view of the transactions may be different.  In that case, petitioners have argued that the third party-bank defendants engaged in sham transactions with Enron and knew that the company had been cooking the books for years.  Such a view of the facts could cause the Court to draw a line similar to the one adopted by Judge Kaplan in In re Parmalat Sec. Litig., 376 F. Supp 2d 472 (S.D.N.Y. 2005), essentially putting legitimate business transactions misused by a company to commit fraud outside Section 10(b), but those which are complete shams inside the scope of the antifraud provision.  

A final point of consideration is the composition of the Court.  In Stoneridge, Chief Justice Roberts and Justice Breyer have recused themselves.  This leaves three Justices from the Central Bank majority (Justices Kennedy, Scalia and Thomas) and three from the dissent (Justices Stevens, Souter and Ginsburg).  Under these circumstances Justice Alito will be the swing vote.  In Tellabs, Inc.  v.  Makor Issues & Rights, Ltd., No. 06-484, 2007 WL 1773208 (June 21, 2007), Justice Alito concurred with the majority but argued for a test of “strong inference” of scienter which was the most conservative on the Court.  This suggests a narrow decision. 

In contrast, if the Court hears Credit Suisse, it appears that, for now, all of the Justices will participate in the decision.  This changes the composition of the Court and may alter the outcome. 

As Stoneridge is argued and moves to decision next term, no doubt many groups will be watching closely.  The stakes in this case are very high.  The Court’s decision will in many ways define the future course of securities damage cases in a manner that no court decision in years has done.  At the same time the case will have a significant impact on the business community and all those who interact with public companies.  

This series is reviewing three key case and their impact on securities fraud damage actions – Stoneridge, Tellabs and Dura Pharmaceuticals v. Broudo, 544 U.S. 336 (2005).  This concludes the segment on Stoneridge.  Next, Tellabs.