The Week in Review (October 26 to November 1, 2007): Key SEC Enforcement Trends and A Significant Litigation Loss
This past week key cases brought by the SEC, highlight areas of focus over the past year and signal the direction of enforcement efforts to come: insider trading and the Foreign Corrupt Practices Act. At the same time a litigation loss may impact future PIPE and hedge fund cases, another area of emphasis for the enforcement division.
INSIDER TRADING – In SEC v. Cao, Civil Action No. CV 06-1269 (C.D. Cal. Filed October 29, 2007), the Commission is a settled insider trading case against the former vice president of Countrywide Financial Corp. The complaint alleges that Mr. Cao traded while in possession of negative financial information about subprime mortgage giant Countrywide Financial. The action was settled simultaneous with the filing of the complaint. The defendant consented to the entry of a statutory injunction prohibiting future violations of the antifraud provisions and to the entry of an order requiring the payment of disgorgement, prejudgment interest and a civil penalty equal to twice the amount of the disgorgement. Related press reports suggest that the SEC in investigating to determine whether others at Countrywide were abusing Rule 10b5-1 plans.
INSIDER TRADING – In SEC v. Durozhko, Civil Action No. 07-CV-9606 (S.D.N.Y. Filed October 29, 2007), the Commission alleges that the defendant traded while in possession of negative earnings announcement regarding IMS health. According to the complaint, Mr. Durozhko purchased 300 out of the money and 330 at the money put options on the common stock of IMS that would expire just three days later. On October 17, 2007, after the close of the market, IMS reported third quarter earnings that were 28% below the consensus analysts estimates. The next morning the stock price fell about 28%. The same day the defendant sold all of his IMS Health options, realizing a profit of over $287,000. Simultaneous with the filing of its complaint the SEC sought and obtained a freeze order over Mr. Dorozhko’s assets. The case is currently in litigation.
FCPA – In SEC v. Ingersoll-Rand Co., Ltd., Civil Action No. 107-CV-01955 (D.D.C. Filed October 31, 2007) the Commission filed a settled FCPA case. The SEC’s complaint alleged that defendant Ingersoll-Rand based on payments made to Iraq under the U.N. Oil for Food Program. Essentially, the complaint alleged that over a three-year period, four subsidiaries of the defendant entered into contracts in which over $950,000 in kickbacks were made. The company settled the action, consenting to a statutory injunction and the payment of disgorgement, pre-judgment interest and a civil penalty along with certain undertakings regarding its FCPA compliance program. The company also paid a fine under a deferred prosecution agreement executed with the Justice Department.
LITIGATION LOSS – PIPE CASE – SEC v. Mangan, Civil Action No 3:06-CV-531 (W.D.N.C. Filed December 28, 2006) is one of a series of cases brought by the SEC in recent months relating to short selling in connection with a PIPE offering. Frequently, these cases involve hedge funds, a key regulatory focus. In this case a registered representative from the investment banking firm of Friedman, Billings, Ramsey & Co. was alleged to have sold shares of CompuDyne Corp. short after learning of a PIPE offering but prior to the public announcement. The complaint alleged violations of Section 5 based on the theory that Mr. Mangan intended to cover the short sale with the PIPE shares and insider trading based on an allegation that he sold short prior to the public announcement of the deal. Previously, Friedman Billings had settled similar allegations based on the same PIPE offering. Mr. Mangan, however, filed a motion to dismiss which was granted in part. Count I of the complaint regarding the PIPE offering was dismissed while the Court expressed significant skepticism about the insider trading claim.
No doubt the SEC has a large inventory of cases in other areas such as option backdating and financial fraud. Yet, week after week there seems to be increasing numbers of insider trading cases and a growing inventory of FCPA cases. This trend, of course, counsels that issuers should carefully review their compliance programs in these areas as well as any executive Rule 10b5-1 plans.
At the same time the ruling in Mangan may suggest that the SEC will have to reconsider its PIPE cases. Until now, the SEC had been aggressively pursuing these cases. The court’s ruling however not only dismissed the Section 5 claim but was critical of the theory on which it was based. This may cause the SEC to reconsider its position on this issue.