The Week In Review (September 17-21, 2007): The SEC Continues to Focus on Favorite Targets While The GAO Targets the SEC

Hedge Funds — Last week, the SEC continued to focus on hedge funds and insider trading, while option backdating, another current enforcement favorite, apparently continued to spread.  As we described last week (see here), the agency brought another case involving PIPE offerings and hedge funds – an apparent growing trend since late last year.  The agency named hedge fund manager Robert Berlacher and Lancaster Hedge Funds as defendants in a civil injunctive action which alleges that the defendant made $1.7 million in ill-gotten gains from an illegal PIPE trading scheme.  SEC v. Berlacher, Civil Action No. 07-cv-3800 (E.D. Pa. September 13, 2007).  According to the complaint, which is reminiscent of several similar actions brought earlier, the defendants evaded the registration provisions of the securities act by selling short. The complaint is pending and the investigation is continuing.

In other hedge fund news, the SEC is also sending out a 27-page letter to hedge fund industry executives in connection with agency insider trading efforts.  The letter seeks information about fund manager, family members and public companies they are deal with.  Last year the SEC did a sweep of Wall Street, focused on hedge funds and their securities trading activities. 

Wall Street Professionals — The SEC also continued to focus on Wall Street professionals.  On Thursday, the agency brought two actions against a total of 38 defendants, several of whom were employed at major Wall Street firms.  The two cases charge the defendants with engaging in a multimillion dollar “stock loan” scam.  In a complaint filed against twenty-eight defendants (including thirteen current and former stock loan traders) in the Eastern District of New York, the SEC alleged that stock loan traders from firms such as Van der Moolen, Janney Montgomery, A.G. Edwards, Oppenheimer and Normua Securities engaged in schemes with 15 stock loan “finders” to skim profits on stock loan transactions.  This scheme netted the defendant over $8 million.  SEC v. Simone, Civil Action No. 07-3928 (E.D.N.Y. Filed September 20, 2007).  The SEC’s Litigation Release regarding Simone is here.  

A second complaint filed in the same district alleged that ten defendants engaged in a fraudulent scheme involving improper finder fees and illegal kickbacks in the stock loan industry.  The plan netted the defendants over $4 million.  The defendants include three current and former traders from Morgan Stanley.  SEC v. DeMizio, Civil Action No. 07-3927 (E.D.N.Y. Filed September 20, 2007).  Both cases are pending.  The Commission’s Litigation Release regarding DeMizio can be found here.    

These cases follow SEC enforcement actions filed earlier this year which charged Wall Street professionals employed at major houses with insider trading.  SEC v. Guttenberg, Case No. 1:07-cv-01774 (S.D.N.Y. Filed March 1, 2007) has been called the most significant insider trading case brought by the SEC since the late 1980’s.  It involved professionals from UBS, Jefferies, Morgan Stanley and other houses.  Another enforcement action named Barclays Bank as a defendant – SEC v. Barclays Bank, Civil Action No. 07-CV-04427 (S.D.N.Y. Filed May 30, 2007), while another also involved an employee of Morgan Stanley.  SEC v. Kan King Wong, Civ. Action No. 07CIV. 3628 (S.D.N.Y. Filed May 8, 2007).  Shortly after those cases were filed, a research associate from Goldman Sachs pled guilty to cone count of conspiracy and eight counts of insider trading in the “Merrill Lynch/Business Week” insider trading case.  U.S. v. Plotkin, No. 06 CR 389 (S.D.N.Y.).

The continued focus on Wall Street Professionals suggests that the lessons of the 1980’s when the likes of Ivan Boesky and Dennis Levine were there have been forgotten and that we are returning to an era like the one portrayed in “Den of Thieves,” an excellent book on the period by James B. Stewart.  Backdated Options — The number of scandals stemming from this current enforcement favorite is apparently continuing to expand.  A report in the Financial Post by Julius Melnitzer dated September 19, 2007 (available on-line herenotes that studies by two Ontario-based law firms conclude that option backdating or manipulation is wide spread among Canadian listed companies.  This report comes as the SEC struggles to sort through the reportedly 140 cases involving option backing that it has under investigation.   

Not only is option backdating the scandal that will not end – it keeps spreading.  Apparently UnitedHealth Group has had enough, however.  Earlier this week the company requested a Minnesota Appeals court to lock an inquiry into its option practices by the state attorney general.  The company is already the focus of an SEC inquiry and one by the U.S. Attorney’s office for the Southern District of New York.

The Investigator is Investigated — Finally, a report by the GAO reviews the activities of the SEC and specifies additions needed to improve its operations.  Much of the report deals with necessary management and systems improvements.  One key recommendation however concerns closing letters.  In this regard the report notes extended delays in issuing such letters. 

Immediate improvement in this area would be most welcome.  Delays in issuing closing letters can have a significant negative impact on a company or an individual.  When an investigation is closed, the SEC should promptly issue a closing letter to avoid these difficulties.

A related issue not mentioned in the report deals with Wells notices.  These notices are issued by the staff when it is considering making an enforcement recommendation.  In many instances, there is a much too long delay between the issuance of the notice and any action.  In some instances, no action is taken and no closing letter is issued.  What ever the result of the Wells process, those who received a notice are entitled to a prompt response, not slow torture by prolonged silence.