The SEC In Court: A Win, A Loss and Stay Tuned

In Part I of our series on SEC Enforcement Trends (see post of February 23, 2007) we noted that some commentators have questioned the vitality of the enforcement program. Three recent cases reflect on this question:

First, in SEC v. Blue Bottle et al., Civil Action No. 07Civ.01-CV-1380 (CSH)(KNF)(S.D.N.Y.)(February 26, 2007) the SEC was successful in obtaining a temporary retraining order prohibiting future violations of the antifraud provisions of the federal securities laws as well as an order directing that certain funds be repatriated from overseas bank accounts in an insider trading case. Specifically, the SEC claims that Blue Bottle, a Hong Kong company and defendant Matthew Charles Stokes, a citizen of Guernsey, repeatedly traded in the securities of twelve different companies immediately prior to the publication of news releases about those entities. According to the complaint the defendants realized profits of over $2.7 million. The information about the twelve companies was obtained, according to the agency, through fraudulent means which included hacking into computer networks. The brokerage accounts used to execute the trades were opened with fake documents and false information.

Second, in SEC v. Thomas W. Jones et al., Civil Action No. 05Civ. 7044(RCC)(S.D.N.Y. February 26, 2007) the court entered summary judgment against the SEC and in favor of the defendants. The agency alleged defendants, employees of Citigroup Asset Management, a business unit of Citigroup that provides investment advisor and management services to Citigroup sponsored mutual funds, aided and abetted violations of Section 206 of the Investment Advisors Act. Specifically, the complaint alleged that defendants profited at the expense of mutual fund investors through a deal to hire a bank-affiliated fund transfer agent which had an undisclosed side deal. The SEC sought an injunction, penalties and disgorgement. The court began by dismissing the claim for penalties as time bared under 28 U.S.C. Section 2462 which provides for a five year statute of limitations in suits where a civil fine, penalty or forfeiture is sought. In reaching its conclusion the court rejected an SEC claim that the statute should be tolled because of fraud, finding that the agency failed to present any facts demonstrating that the claimed misrepresentations or omissions were unknowable. The court also concluded that the SEC’s request for injunctive relief was time barred because the there was no showing that the requested relief was necessary to prevent future harm beyond the claim of a past violation. Accordingly, the injunction was more in the nature of a penalty and thus subject to the five year statute of limitations which had run. Finally, while disgorgement is an equitable remedy not subject to the statute of limitations, the SEC failed to present evidence demonstrating the amount which should be ordered.

Finally, U.S. v. Reyes, Civil Action No. C06-04435 (CRB) (N.D. Cal July 19, 2006)(the Brocade stock option backdating case) is reportedly set for trial in June. While the allegations in the criminal case and the SEC’s complaint paint a picture of clear fraud, problems may be arising for the government. As reported earlier (post of February 20, 2007) parallel proceedings issues have been raised in the SEC’s civil case. While those have currently been resolved in favor of the SEC, the court cautioned the agency’s lawyers that if problems persist a remedy for the defendants would be fashioned. Now in the criminal case evidence is appearing which may call into question government claims. BusinesWeek Online reports in a story dated March 5, 2007 (but now available) that former CEO Reyes has vowed to fight the case. Documents which are coming out appear to undercut the very clear cut claims made by the government. Specifically, it appears that an operations manual specified that the options clerk pick the lowest stock price since the previous option grant when preparing new options paper work for Mr. Reyes to sign. Unlike other option backdating cases, apparently Mr. Reyers was not involved in the dating process. These facts may prove to be significant in a case which focuses on an intentional and concealed fraud. While the government started this case with a great deal of fanfare last year, press releases are one thing, proof in court, as the Jones case cited above suggests, is another.

Next: Part III of the Series on SEC Enforcement Trends