This Week In Securities Litigation (August 8, 2008)
This week, Cornerstone Research reported that the number of securities cases filed in the first half of this year increased. The SEC announced a significant tentative settlement in its auction rate securities investigation of Citigroup, while concluding its three-year litigation against Biopure Corporation for making misleading statements regarding FDA’s position on one of its key developing products. Other SEC settlements however, raised significant questions about the vitality of the enforcement program. And, Monster Worldwide entered into a tentative settlement agreement regarding a securities class action based on the payment of one of the largest settlement amounts in an option backdating case, plus a personal cash contribution by its former CEO.
Securities class action filings up
The number of securities class actions filed in the first half of 2008 increased significantly, driven in part by the current crisis in the financial markets, according to a new report by Cornerstone Research. Between January and June 2008, 110 new securities class actions were filed compared to the semiannual average of 63 filings between July 2005 and June 2007, as well as the annual average between January 1997 and December 2007. About half of those cases are based on the current market crisis.
The median loss for cases filed in the first half of 2008 increased to $243 million, more than twice the historical average. The finance sector had the most cases for the third straight six-month period with 63 cases, up from 30 in the second half of 2007 and 19 in the first half of 2007. The filings here were driven by the market crisis.
Auction rate securities
The SEC announced what it is calling a “preliminary settlement in principle” with Citigroup Global Markets, Inc. regarding auction rate securities. Under the proposed agreement, Citi would return all $7.5 billion invested by individual investors, small businesses and charities in auction rate securities that they purchased from the firm. The proposed settlement calls for Citi to liquidate at par all ARS from its retail customers no later than three months from the date of the tentative agreement. The firm will also make whole any losses sustained by customers who purchased auction rate securities before February 12, 2008.
The tentative agreement requires Citi to use its best efforts to liquidate by the end of 2009 all of the approximately $12 billion worth of ARS the firm sold to retirement plans and other institutional investors. Until Citi provides for the liquidation of the securities under the schedule in the agreement, the firm has agreed to provide no-cost loans to customers that will remain outstanding until the ARS are repurchased. The firm will also reimburse customers for any interest costs incurred under any prior loan programs it provided to these customers.
The ARS market collapse in mid-February 2008. Since that time a number of suits have been filed against participants in the auction rate securities markets. Those include: In re: Citigroup Auction Rate Securities Litigation, Civil Action No. 1:08-cv-03095 (S.D.N.Y. Filed March 26, 2008); Kraemer v. Deutsche Bank AG, Civil Action No. 1:08-cv-02788 (S.D.N.Y. Filed March 17, 2008); Milch v. The Goldman Sachs Croup, Inc., Civil Action No. 1:08-cv-03659 (S.D.N.Y. Filed April 16, 2008); Burton v. Merrill Lynch & Co., Civil Action No. 1:08-cv-03037 (S.D.N.Y. Filed March 25, 2008); and Miller v. Morgan Stanley & Co., Civil Action No. 1:08-cv-03012 (S.D.N.Y. Filed March 25, 2008).
Similar cases have been filed against Oppenheimer, Raymond James, SunTrust Bank, UBS AG, Wells Fargo, Bank of America, Calamos Global and Royal Bank of Canada.
The Commission concluded its litigation against Biopure Corporation and three of its executives, former CEO Thomas Moore, former Senior Vice President of Regulatory Affairs and Operations Howard Richman and former General Counsel Jane Kober. SEC v. Biopure Corp., Civil Action No. 05-11853 (D. Mass. Filed September 14, 2005).
On August 7, 2008, Mr. Richman entered into a settlement with the SEC under which he consented to the entry of a permanent injunction prohibiting future violations of the antifraud and books and records provisions of the securities laws. He also consented to the entry of an order barring him from serving as an officer and director of any public company and imposing a civil penalty of $150,000.
The 2005 complaint alleged that beginning in April 2003, the company received negative information from the FDA regarding possible FDA approval for one of its products. For the next eight months, company executives failed to disclose the negative information while issuing positive statements regarding FDA consideration of the product. Despite additional negative comments by the FDA about the product in August 2003, defendants continued to make positive statements to the marketplace. During that period, Biopure raised over $35 million from investors.
Previously, the other defendants entered into settlements with the Commission. Litigation Release No. 19825 (Sept. 12, 2006, settlement of Ms. Kober); Litigation Release No. 20010 (Feb. 21, 2007, settlement of Mr. Moore). A related action which has also been settled was brought against Carl Rausch, former Vice Chairman of the Board of Directors and Senior Technology Officer of the company. SEC v. Rausch, Civil Action No. 06-10642 (D. MA. Filed April 11, 2006).
The SEC filed two settled books and records case financial cases this week. SEC v. Prudential Financial, Inc., Civil action No. 08 Civ. 3916 (D.N.Y. Aug. 6, 2008) is a settled books and records case based on a scheme to falsify revenue. Specifically, the SEC’s complaint claims that a subsidiary of Prudential entered into round trip transactions with reinsurance giant General Re in which it first built up credits with that company and understated income and later drew those credits down and overstated revenue. The scheme began in 1997 and ended in 2002. The action was settled with a consent injunction.
SEC v. Hozhabri, Civil Action No. 08-CV 1359 (D.D.C. Filed Aug. 6, 2008) is another action settled with a books and records injunction. Here, Defendant Ali Hozhabri, a former project manager for ABB Network Management, fraudulently submitted $468,714 in cash and check disbursements requests to his employer between 2002 and 2004. Mr. Hozhabri has also pled guilty to wire fraud and is awaiting sentencing.
These cases raise significant questions about the SEC’s enforcement program which are discussed here.
The SEC filed two related, settled financial fraud cases this week. SEC v. Crowley, Civil Action No. 08-cv-1388 (S.D. Cal. Filed Aug 1, 2008); SEC v. Burdick, Civil Action No. 08-cv-1390 (S.D. Cal. Filed Aug. 1, 2008). The complaints are based on a financial fraud at SeraCare Life Sciences in 2005. Mr. Burdick, a former board member and interim CFO, is alleged to have improperly released reserves in two quarters, improperly inflating revenue by a material amount. Mr. Crowley, the former CEO of the company, failed to disclose in an earnings call and subsequently in a SOX certification that the day before the earnings call, a significant transaction terminated which caused a material drop in revenue. Both defendants settled with the SEC by consenting to injunctions based on Section 17(a)(2)&(3) of the Securities Act and the books and records provisions. Mr. Burdick also agreed to a suspension from practice under Rule 102(e). This case is discussed here.
Monster World Wide, Inc. announced this week that it has tentatively settled a securities class action filed against it based on option backdating. In re Monster Worldwide, Inc. Securities Litigation, Case No 1:07-cv-02237 (S.D.N.Y. Filed March 15, 2007). Under the terms of the proposed settlement, the lead plaintiff, Middlesex Pension System and the other shareholders will be paid $47.5 million. This is one of the largest option backdating settlements.
As part of the settlement, Andrew McKelvey, the former CEO of the company, will personally pay $550,000. Mr. McKelvey previously paid over $275,000 as part of a settlement of the suit filed against him with the Commission. SEC v. McKelvey, Civil Action No. 08-cv-05555 (S.D.N.Y. Filed Jan 23, 2008).
Accounting and auditing
In the Matter of Ernst & Young LLP, Adm. Proc. File No. 3-131155 (Aug. 5, 2008) is the Commission’s latest ruling on the issue of auditor independence. Here, E&Y and two of its partners were sanctioned because the firm entered into a business and marketing relationship with Mark Thompson, who was board member of three audit clients. The SEC rejected the firm’s contention that the relationship fell within an exception to the independence rules as discussed here.
The only real question in this case was not the availability of an exception to the independence rules, but the reason E&Y’s internal procedures did not examine this issue from the beginning rather than near its conclusion, a point not discussed in the settlement papers.
For interesting illustrated commentary on accounting and auditing issues visit: www.retheauditors.com
The 10b-5 Guide, A Survey of 2007 Securities Fraud Litigation, by Robert F. Carangelo, Paul F. Ferrillo and Caitlyn M. Campbell of Weil, Gotshal & Manges, LLP is a compendium of recent securities fraud securities fraud cases as well as a primer on the basics required for a claim, available from the firm at the firm’s web site here.