This is the seventh in a series of articles that will be published periodically analyzing the direction of SEC enforcement.

The SEC has been conducting dozens of investigations related to the market crisis since it began to unfold. While significant cases have been brought, they have been few in number. For discussion purposes they can be divided into four groups: 1) Major Wall Street players; 2) Lenders; 3) New Jersey; and 4) others. The results here, like those in court , are mixed.

Major players

The actions against Wall Street players Goldman Sachs, Citigroup and Bank of America are among the most significant and high profile enforcement cases brought by the Commission relating to the market crisis. Each has been resolved, although not without controversy.

Perhaps the most significant case brought last year – and certainly one of the most high profile – is SEC v. Goldman Sachs, Case No. 3229 (S.D.N.Y. Filed April 16, 2010). The case centered squarely on events involved in the market crisis. The factual allegations concerned an entity called ABACUS, constructed at the request of Goldman client Paulson & Co. The client asked that an investment vehicle be constructed which would permit it to bet that the sub-prime real estate market would crash. Goldman had other clients who held the opposite view.

In 2007 ABACUS was constructed using collateralized debt obligations tied to the sub-prime residential real estate market. According to the SEC, Paulson influenced the selection of the securities used to construct the entity. The lowest grade securities consistent with maintaining a favorable rating were chosen.

The offering materials furnished to potential investors contained information on the construction of ABACUS, its investments and risks. Those materials did not mention Paulson. Nor did they inform investors that the role of ACA as portfolio selection agent had been undermined if not completely compromised.

Paulson shorted the fund. IKB, a large German bank took long positions. When the market crashed Paulson made substantial sums while IKB suffered huge losses.

The SEC filed suit against the investment bank and one of its employees. Subsequently, Goldman settled, consenting to the entry of an injunction prohibiting future violations of Securities Act Section 17(a). The claim based on Exchange Act Section 10(b) was dropped. The bank also agreed to pay a $535 million civil penalty, the largest ever obtained against a Wall Street bank. In the settlement materials Goldman made an unusual acknowledgement, stating that it made a mistake in not disclosing the role of Paulson.

In what is perhaps a sign of the times, the suit was born and settled in controversy. Media reports note that the Commissioners voted 3-2 to institute the action. There were allegations that the filing of the suit was timed to assist the Administration win passage of financial reform legislation and that there were press leaks about the case. The SEC IG investigated the filing and settlement of the case. No wrongful conduct was found.

A second significant market crisis case brought last year is SEC v. Citigroup, Inc., Civil Action No. 1:10-CV-01277 (D.D.C. July 29, 2010). The complaint, based on claimed violations of Securities Act Section 17(a)(2) and Exchange Act Section 13(a), alleged that beginning in July 2007 and continuing through the fall of that year, the bank misrepresented its exposure to the sub-prime market. Investors were told that Citigroup’s exposure was $13 billion. In fact it was $56 billion. The bank failed to tell investors about two groups of sub-prime investments valued at $43 million despite the fact that two senior bank officials were repeatedly furnished with information about these investments.

Citigroup resolved the action by consenting to the entry of a permanent injunction prohibiting future violations of the statutory sections cited in the complaint. The bank also agreed to pay disgorgement and a civil penalty totaling $75 million.

Administrative proceedings were brought against the two officers involved, Arthur Tildesley, Jr., the current head of Global Cross Marketing and Gary Crittenden, the former CFO. In the Matter of Gary L. Crittenden, Adm. Proc. File No. 3-13985 (Filed July 29, 2010). Each Respondent consented to the entry of an order directing them to cease and desist from causing any further or future violations of Exchange Act Section 13(a). Mr. Crittenden also undertook to pay $100,000 while Mr. Tildesley paid $80,000.

Again the case was engulfed in controversy. Judge Huvelle delayed signing the settlement pending a hearing. Eventually the court deferred to the judgment of the SEC after making it clear that the monetary penalty was not a deterrent. The court also required the SEC to certify that the bank instituted certain remedial procedures intended to preclude a future reoccurrence. Recently, the SEC IG opened an investigation into this settlement at the behest of a Senator. The inquiry focuses on whether a conflict of interest or perhaps undue influence impacted the settlement because of the circumstances under which it is alleged to have been negotiated.

The SEC also had difficulty winning court approval of its enforcement action against Bank of America. SEC v. Bank of America, Civil Action No. 09 cv 6829 (S.D.N.Y. Filed Aug. 3, 2009). The case arose out of its acquisition of brokerage giant Merrill Lynch. The complaint centered on a claim that the proxy materials furnished to shareholders to approve the acquisition were false and misleading because they suggested that Merrill personnel would not be paid bonuses absent further approval. In fact prior to the proxy solicitation the boards of both companies had authorized the payment of bonuses of up to $5.8 billion. That information was contained on a schedule to the merger agreement which was omitted from the proxy materials.

The Commission initially agreed to resolve its complaint with a consent decree based on Exchange Act Section 14(a). The court however declined to enter the settlement. In a series of orders the court was highly critical of the settlement terms, the amount of the penalty, the fact that individuals were not named as defendants and the underlying SEC investigation. After increasing the penalty from the initially proposed $33 million to $150 and an agreement by the bank to institute certain remedial procedures, the court reluctantly entered the settlement.

In contrast a suit brought by the New York Attorney General based on essentially the same factual allegations but grounded on state law named not just the bank but its two senior officers. State of New York v. Bank of America (S.Ct. N.Y. Filed Feb. 4, 2010). That case is currently being litigated.


Two significant market crisis cases that settled last year are SEC v. Mozilo, Case No. CV 09-03994 (C.D.Cal. Filed June 4, 2009) and SEC v. Morrice, Civil Action No. CV 09-01426 (C.D. Cal. Filed Dec. 7, 2009). The former is against the officers of the number one sub-prime lender, Countrywide Financial, while the latter names as defendants the senior officers of New Century Financial, the number three sub-prime lender. Each case essentially centered on fraud claims based on the failure of the defendants to disclose the true financial condition of the company as the sub-prime lending market tumbled down. Mozilo also contained claims that Angelo Mozilo, the company chairman, engaged in insider trading as his company spiraled to a crash while Morrice includes additional financial fraud claims.

On the eve of trial the Commission secured what the headlines claim are significant settlements to resolve Mozilo. Each defendant consented to the entry of an injunction and to pay disgorgement, prejudgment interest and a civil penalty. Mr. Mozilo and former COO David Sambol agreed to injunctions based on the antifraud and reporting provisions while former CFO Eric Sieracki consented to the entry of an order based on Securities Act Sections 17(a)(2) and (3). In addition to consenting to the entry of a permanent officer and director bar, Mr. Mozilo agreed to pay a total of $67.5 million, including $45 million in disgorgement and interest and a penalty of $22.5 million. Mr. Sambol, who agreed to the entry of a three year officer/director bar, will pay disgorgement and interest of $5 million and a civil penalty of $520,000. In his settlement Mr. Sieracki agreed to pay a penalty of $130,000 and to the entry of a Rule 102(e) order barring him from practicing before the Commission as an accountant for one year.

The Commission also fully resolved Morrice. There Brad Morrice, the former CEO and co-founder, Patti Dodge, the former CFO and David Kenneally, the former controller settled with the SEC. Mr. Morrice and Ms. Dodge each consented to the entry of an injunction prohibiting future violations of Securities Act Actions 17(a) and Exchange Act Sections 10(b) and 13(b)(5) as well as from aiding and abetting violations of Section 13(a). Mr. Kenneally agreed to the entry of a similar injunction although it did not include Section 17(a). Each defendant agreed to the entry of an officer/director bar with a right to re-apply after five years. In addition, Mr. Morrice will pay disgorgement $464, 364 along with prejudgment interest and a penalty of $250,000. Ms. Dodge will pay disgorgement of $379,808 along with prejudgment interest and a penalty of $100,000 while Mr. Kenneally will pay disgorgement of $126,676 along with prejudgment interest. See also SEC v. State Street Bank and Trust Co., Case No. 1:10-CV-10172 (D. Mass. Filed Feb. 4, 2010); In the Matter of State Street Bank and Trust Co., Adm. Proc. File No. 3-13776 (Filed Feb. 4, 2010)(settled actions relating to misleading statements made to investors in a bond fund as the market unraveled).

More recently the Commission filed two actions arising out of the collapse of lender IndyMac. As in earlier lender cases, the complaints center on a failure to disclose the declining financial fortunes of the bank as the market crisis unfolded. SEC v. Perry, Case No. CV 11-01309 (C.D. Cal. Filed Feb. 11, 2011); SEC v. Abernathy, Civil Action No. CV 11-01308 (C.D. Cal. Filed Feb. 11, 2011).

Perry, which names as defendants the former CEO and CFO, focuses on the impact of events on the capital of the bank, its efforts to bolster it through stock sales and the failure to update filings and offering documents which contained a mixture of statements which were dated and vague, boiler plate statements about the use of funds. None of this accurately and specifically disclosed the declining regulatory capital position of the bank or that the stock sale proceeds were intended to bolster it.

Abernathy, which also names a former CFO as a defendant, stems from the same basic allegations. The action centers more however on the negligent failure of another former CFO to ensure that updated information about difficulties with the consumer loan origination documents were included in current filings rather than boiler plate. Investors were thus not told about seriously flawed loan documents which portended problems with the loans.

Perry, which includes allegations of scienter based fraud, is in litigation. Abernathy settled with a consent to a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3), the payment of disgorgement and prejudgment interest and a civil penalty. In addition, Mr. Abernathy agreed to the entry of an order barring him from practicing before the Commission as an accountant with a right to reapply in two year.

New Jersey

Another significant market crisis case brought last year is In the Matter of State of New Jersey, Adm. Proc. File No. 3-14009 (Aug. 18, 2010). The Order claimed that the state violated Securities Act Sections 17(a)(2) and (3) in connection with the sale of municipal bonds from August 2001 through April 2007. Essentially the State is alleged to have made it appear as a result of certain legislative action that two large pension funds discussed in the offering materials were funded when in fact they were not. When the state became aware of the underfunding it failed to take any steps to correct the situation. Furthermore, until 2007 and 2008 when disclosure counsel was retained, the state did not have any written policies and procedures regarding the review or updating of bond offering documents. By the time the proceeding was filed policies had been adopted and a committee created to oversee the entire disclosure process.

The case against New Jersey was resolved with the entry of a cease and desist order. The proceeding has particular significance in view of the effects of the market crisis and con-going financial difficulties of many states and municipalities.

Other cases

Two other market crisis cases brought last year which are in litigation are SEC v. ICP Asset Management LLC, Civil Action No. 10-cv-4791 (S.D.N.Y. Filed June 21, 2010) and SEC v. Farkas, Civil Action No. 1:10 cv 667 (E.D. Va. Filed June 16, 2010). The former is an action against a registered investment adviser and its related entities. The complaint centers on transactions involving four multi-billion dollar collateralized debt obligations in which ICP Asset Management and the other defendants are alleged to have repeatedly defrauded certain clients in certain transactions.

The latter is a fraud action against Lee Farkas, the former chairman of mortgage lender Taylor, Bean & Whitaker. Prior to its collapse, Taylor Bean was the largest non-depository mortgage lender in the country. When the lender began having liquidity problems as early as 2002, Mr.Farkas is alleged to have shuffled funds among various accounts and engaged in other fraudulent conduct including using sham transactions to conceal the true nature of the company. Parallel criminal charges have been filed. U.S. v. Farkas (E.D. Va. Filed June 16, 2010).

Overall, it is clear that the Commission has brought significant market crisis cases. Filing enforcement actions against Wall Street giants such as Goldman Sachs, Citigroup and Bank of America is significant. Obtaining meaningful settlements in those cases despite the difficulties is a significant achievement. Likewise, filing and settling a proceeding against the state of New Jersey while obtaining large dollar settlements from the Countrywide executives suggests that the enforcement program is regaining its vitality.

At the same time the cases raise significant questions. The SEC has by all accounts expended significant amounts of time and resources on its market crisis cases. Yet only a relative handful of cases have been brought.

Even more troubling is the fact that frequently there appears to be some disconnect between the allegations in the complaint and the terms of the settlement. This caused the Commission difficulties in cases such a Bank of America and Citigroup. In the former the court repeatedly questioned the reason for not prosecuting any individuals as was done in the case brought by the New York AG. The allegations in the Commission’s complaint suggested that such action might be appropriate. A similar issue was presented in the Citigroup case where the Commission plead what appeared to be intentional or at least reckless conduct involving a number of senior executives which is not reflected by the actual charges or the settlements. Indeed, when these settlements are read together with the most recent IndyMac complaints, it appear that at least in settlement Securities Act Sections 17(a)(2) and (3) are becoming a kind of failure to supervise for corporate directors.

Equally troubling is the fact that in both Bank of America and Citigroup the court seemed to be the moving force ensuring that adequate procedures were put in place to prevent a future replication of the misconduct. Yet such procedures have long been a staple of SEC enforcement.

Mozilo also raises significant questions despite the headlines generated by the settlement. While the sum Mr. Mozilo agreed to pay is large in dollar amount, the complaint claims he sold stock worth $260 million and had insider trading gains of $139 million which is far more than what was paid. Likewise, while Mr. Sambol is paying $5 million in disgorgement and interest the complaint alleges he obtained $40 million. And, there is no explanation for dropping all intentional fraud claims against Mr. Sieracki in view of the repeated claims of intentional wrong doing in the complaint.

In sum, while significant cases have been brought, and noteworthy settlements obtained, frequently there appears to be a disconnect between the claims and their resolution. That disconnect has at times created difficulties with obtaining court approval of a proposed settlement as well it should. That same disconnect may also be the reason for the mixed results the Commission has obtained in court.

Next: Insider trading