This is the fourth of six parts in a series examining future trends in securities enforcement

Ponzi schemes and investment fund fraud cases were at one time thought difficult to detect. Post-Madoff, the schemes seem to have percolated to the surface. Now, the SEC brings these cases which such regularity that they might be viewed as a staple of enforcement.

A few of these schemes are noteworthy because of the epic proportions. The massive fraud of Ponzi scheme king Bernard Madoff (here), currently serving what is essentially a life sentence in prison, and the alleged scheme of Robert Allen Stanford, presently awaiting trial (here) fall in this category.

Fortunately, the overwhelming majority of these cases are not of such magnitude. Most of these cases have common elements. Typically the defendants in these cases include the individuals who are the promoters, an entity which is the fund and perhaps related entities which serve and an investment adviser or provide alternative investment opportunities. Generally, investors are solicited to invest their money in some type of proprietary trading scheme. The claims range from simple representations of uncommon expertise in trading to proprietary systems to various exotic schemes. All offer the prospect of safety and returns which are way to good to be true such as steady returns day in and day out regardless of market conditions (Madoff’s pitch) or more fantastic returns on a weekly, monthly or yearly basis that cannot be achieved elsewhere. The investors, of course, lose while the promoters misappropriate their money.

Typically, the SEC moves quickly after discovering the scheme to file its complaint and obtain an asset freeze. That action is frequently followed by the appointment of a receiver to marshal the assets. Over time, the Commission has become very aggressive in brining these cases. Many are followed by criminal charges. In some instances, the Commission coordinates with the CFTC. See, e.g. SEC v. Rockwell Energy of Texas, Civil Action No. 4:09-cv-080 (S.D. Tex. Filed Dec. 23, 2009) (here); SEC v. Shidaal Express, Inc., Case No. 09 cv 2610 (S.D. Cal. Filed Nov. 19, 2009)(here); SEC v. Nicholson, Case No. 09-cv-1748 (Filed Feb. 25, 2009) (here).

In some matters the Commission may be moving to swiftly, spurred perhaps by the ghost of Madoff. For example in SEC v. Sunwest Management, Inc., Case No. CV 06056 (D. Ore. Filed March 2, 2009) an action was brought against a large operator of retirement facilities. Sunwest had operations in 34 states. The complaint, discussed here, alleges that investors were defrauded in a securities offering. As the market crisis deepened and the company began to unravel, it was operated like a Ponzi scheme, according to the SEC. An asset freeze was obtained and a preliminary injunction entered.

Whether Sunwest was in fact operating like a Ponzi scheme, and the validity of the preliminary injunction, is an open question however. In an appeal prosecuted by a group of secured creditors who contested the injunction, the Ninth Circuit reversed the order because the district court did not make any findings as required by Federal Civil Rule 52 beyond a statement of “good cause shown.” Whether the court can make the necessary findings remains to be seen. SEC v. ING USA, Case No. 09-35250 (9th Cir. Dec. 29, 2009).

In contrast to Ponzi scheme cases, actions based on financial fraud have long been a staple of SEC enforcement. Last year was no exception. Three high profile financial fraud cases are illustrative. One is SEC v. General Motors, Civil Action No. 1:09-CV-00119 (Filed Jan. 22, 2009) (here). The claims in the complaint center on events between 2000 through 2004. In that time period, the SEC claims: 1) the company made material misstatements about its pension discount rate selection and expected return on pension assets; 2) failed to disclose information about its projected cash contributions plans to avoid variable rate premiums and the impact on its liquidity; and 3) improperly accounted for a $97 million transaction involving the sale and repurchase of precious metals inventory. The company also improperly recognized $100 million.

The action, brought only against the company, was settled when the company consented to the entry of a permanent injunction prohibiting future violations of the books, records and internal controls provisions. The Commission did not require the company to adopt any remedial procedures.

Another high profile financial fraud action against a large company is SEC v. General Electric, Civil Action No. 1:09 cv 1235 (D. Conn. Aug. 4, 2009) (here). In this case the complaint focuses on the time period 2002-2003 when the company is alleged to have used improper accounting to boost its revenue and earnings. Two of the errors related to hedge accounting. A third involved the improper recognition of revenue in a deal involving the sham sale of locomotives which rivals the Enron – Merrill Lynch barge deal and a fourth involved improper changes in accounting principles to avoid a significant charge.

The case was settled when the company consented to the entry of a permanent injunction prohibiting future violations of the antifraud and certain books, records and internal control provisions of the securities laws. The company also agreed to pay a civil penalty of $50 million. No individuals were prosecuted. The SEC did not require the company to adopt any remedial measures.

A third high profile case which did involve the prosecution of individuals is SEC v. Greenberg, Civil Action No. 09 Civ. 6939 (S.D.N.Y. Filed Aug. 6, 2009). This action against the former Chairman and CEO of AIG and one other former officer centers on transactions alleged to have occurred over a five year period beginning in 2000. The complaint alleges that the two former officers falsely projected the company as an industry leader with consistently high earnings. In fact, the company faced significant financial challenges, concealed losses, engaged in sham transactions and entered into fraudulent round-trip transactions.

To settle this case Mr. Greenberg and the other defendant consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions. Mr. Greenberg also agreed to pay disgorgement of about $7.5 and a civil penalty in the same amount.

Finally, despite the deliberate pace at which financial fraud cases are investigated and its significant investigative powers, in some instances the SEC has difficulties pleading sufficient facts in its complaint. SEC v. Fraser, Case No. CV 09-00443 (D. Ariz. Filed March 6, 2009) is a financial fraud action brought against former executives of CSK Auto Corporation which is now in bankruptcy (here). The case centers on the time period 2002 to 2004. During that period the defendants are alleged to have overstated revenue, failing to write off allowances obtained from vendors which were worthless. Pre-tax income was overstated by 47% in 2002 and 65% in 2004. The SEC’s initial complaint was dismissed for failing to adequately plead fraud. Its second complaint was dismissed for the same reason. The third complaint is pending.

Another area of emphasis is the Foreign Corrupt Practices Act. Following the blockbuster and record setting settlement with Siemens A.G. (here) last year – which followed record setting settlements from the year before – the SEC continues to focus on this area. Indeed, one of the five new groups being formed as part of the rejuvenation of Enforcement will focus on the FCPA.

While the FCPA is a key area of emphasis for the SEC, in many instances the charge is being led by the Department of Justice. The Department reportedly has well over 100 open FCPA cases under investigation. Many involve public companies and parallel SEC investigations. At the same time the Department has brought a number of actions against private companies. Many focus on individuals.

Once significant SEC action brought last year by the Commission is SEC v. Nature’s Sunshine Products, Inc., Case No. 09 CV 672 (D. Utah Filed July 31, 2009) (here). There, the Commission brought an action against the company and its CEO and CFO. The complaint claims that in 2000 and 2001 the company made improper payments through its Brazilian subsidiary to local regulators in an effort to circumvent certain import restrictions. The case was resolved with each defendant consenting to the entry of a permanent injunction prohibiting future violations of the antifraud, anti-bribery and books and records and internal control provisions. The company agreed to pay a $600,000 civil penalty while each of the individuals paid a $20,000 penalty.

This case, which appears to be typical of many FCPA cases in many respects, has two unusual features. First, it is based in part on the antifraud provisions in addition to the typical FCPA sections. Second, it imposed liability on the officers using the control person provisions of Exchange Act Section 20(a). This may suggest a new trend in this area.

Next: Cases involving regulated entities and other significant actions

Seminar sponsored by the ABA Criminal Justice Section: January 13, 2010, Enforcement Trends in Securities & Commodities Actions 2010, in person in Washington, D.C. at 600 14th St. and webcast nationally.

Speakers: Laura Josephs, Assistant Director SEC, Division of Enforcement; Adam Safwat, Deputy, Fraud Section, Department of Justice; Steve Obie, Director, Division of Enforcement, CFTC; and Cheryl Evans, Special Counsel U.S. Chamber Initiatives For Legal Reform.