by T. GormanPosted on Posted in SECActions

Yesterday the SEC brought another in what has become a series of cases based on claims that a company helped another falsify its financial statements.  This time the SEC brought an cease and desist action against Motorola, Inc. for entering into a “price support” agreement with Adelphia Communications Corporation.  http://sec.gov/litigation/admin/2007/34-55725.pdf  According to the Order for Proceedings, the purpose of the arrangement was to help Adelphia artificially inflate its Earnings Before Interest, Taxes, Depreciation and Amortization by reducing operating costs.  According to the SEC the agreement involves a round-trip of cash between Motorola and Adelphia.  

In bringing the action the SEC alleged that Motorola should have realized that the agreement lacked any economic substance.  The Order for Proceedings claimed that Motorola should have seen a series of red flags, which included that fact that this was the first time a vendor had ever requested a price increase.  Motorola agreed to the entry of a C&D, and to the payment a total of $25 million in disgorgement and prejudgment interest. The action against Motorola is the latest in a series of such cases.  For example, last year the SEC brought a civil injunctive actions against: 

Scientific-America claiming that it entered into a price support agreement with Adelphia to help inflate the latter’s earnings by $43 million.  The case settled with the entry of a consent injunction and the payment of $20 million in disgorgement.  SEC v. Scientific-Atlanta, (S.D.N.Y. June 22, 2006).  http://www.sec.gov/litigation/litreleases/20096/lr19735.htm. 

Ronald Ferguson and four other former senior executives of General Re for aiding and abetting AIG in improperly inflating its loss reserves by almost $500 million.  The case is pending as are parallel criminal charges. SEC v. Ronald Ferguson, et al., (S.D.N.Y. Feb. 2, 2006), http://www.sec.gov/litigation/litreleases/2007/lr19975.htm. 

Gary Bell and twelve other employees and agents of vendors to U.S. Food Services, a subsidiary of Royal Ahold, for executing false audit confirmation.   Several defendants agreed to settle for consent decrees and fines, while others are litigating with the SEC.  SEC v. Gary Bell, et al., (D.D.C. Jan 18, 2007), http://www.sec.gov/litigation/litreleases/2007/lr19975.htm

All of this suggests that issuers should carefully monitor agreements and other arrangements entered into with other companies.  In conducting that due diligence it is important to follow up.  One of the “red flags” missed by Motorola is the fact that it requested a letter of assurance from Adelphia stating that the arrangement complied with all applicable laws and regulations, but the company never received one and failed to follow up on the request.

by T. GormanPosted on Posted in SECActions

The SEC acted swiftly yesterday in the wake of news stories reporting unusual trading activity in the securities of Dow Jones in advance of the May 1, 2007 announcement by News Corp of its $60 per share take over bid.  (see blog post 5/4/07)  Immediately after the announcement of that bid, the shares of Dow Jones increased in value by about 58%, from about $37 to over $57 per share.  In advance of the announcement there was heavy trading in Dow Jones’ options.  According to a report in the New York Times on Tuesday, Dow Jones officials knew about the impending bid prior to May 1 but chose not to announce what is clearly one of the leading business stories of the year.  Eric Dash and Andrew Ross Sorkin, “Scrutiny Seen of Trading in Dow Jones,” NYT, May 9, 2007.  That same article suggested that many people knew about the proposed bid prior to its announcement in addition to the usual cadre of business executives, lawyers, accountants, bankers and other professionals involved with the deal. 

According to the SEC, two individuals who had advance knowledge of the deal are Kan Ling Wong and Charlotte Ka On Wong Leung, a husband and wife residing in Hong Kong.  http://sec.gov/litigation/litreleases/2007/lr20106.htm  The SEC’s complaint claims that the couple is the part owner of a Merrill Lynch account in Hong Kong that purchased 415,000 shares of Dow Jones stock in the two weeks prior to the announcement.  The cost of the shares was just over $15 million, paid for in part from funds in the account and with money wired to the Merrill Lynch account by the wife’s father, other funds the couple wired in from a their JP Morgan account in Brussels, Belgium and margin loans.  Three days after the announcement when the couple directed that the shares be sold, their value had increased by over  $8 million.  The court imposed a temporary freeze over the defendants’ assets and directed them to show cause why their assets should not remain frozen until the conclusion of the litigation. 

The SEC moved extraordinarily quickly in this case.  In the days to come there will no doubt be more developments in this case.  Those developments may explain why this case lacks some of the hallmarks of typical insider trading cases.  For example, the trades were in stock, not options where must larger profits can be realized for a much small investment – particularly here, where there was significant activity in Dow Jones options.  There may also be an explanation for the lack of deception in this case, such as the frequently used technique of using multiple accounts to conceal the size of the trades and keep them off the radar screen of brokerage house compliance departments and other market monitors.  Although the defendants apparently had multiple accounts – the complaint references accounts at Merrill Lynch and JPMorgan – all shares were purchased in one account. 

Further developments may also reveal what we do not know about this case.  What we do not know is who else has an interest in the frozen Merrill Lynch account, although presumably the SEC knows from the account opening records.  What we cannot know yet is what information the defendants had about the potential New Corp deal – the complaint simply uses the stylized legalese “material non-public information.”  Also, what we are not yet privy to is how the defendants supposedly received inside information – the complaint simply says that they had inside information.  The SEC offers no basis for its claim defendants had such information, other than its “belief.”  The initial crux of any insider trading case is, however, whether or not defendants have information that is material and non-public.