This Week In Securities Litigation (October 3, 2008)
This week the market crisis continued. The Senate passed legislation to try and cure the crisis. The SEC called for additional regulatory authority and extended its emergency orders regarding short selling. Yet, the Commission’s inspector general issued a report which highly critical of the SEC’s performance in the demise of Bear Stearns.
This week, KLA-Tencor concluded a settlement of a class action based on backdated options. A potentially far-reaching decision was issued in the Southern District of New York dismissing a class action for failure to plead scienter in a case based on fraud claims tied to high risk investments. The SEC also filed three additional insider trading cases in its war on insider trading, along with two settled financial fraud cases.
The market crisis
The Commission extended its emergency short selling rules which were due to expire on October 2. The new expiration date is October 17, 2008. In a statement which noted that short selling can have a positive and negative impact on the market, the SEC extended its: temporary ban on short selling in financial companies, a temporary requirement that institutional money managers report their short sales of certain securities, its hard close rule for naked shorts and its other temporary rules which were previously discussed here.
The Commission received a letter from Congressman Edward Markey, one of the sponsors of The Market Reform Act of 1990, requesting an explanation for the repeal last year of the so-called “collar rule” by the New York Stock Exchange. The letter raises questions about the current market volatility and poses a series of questions about the SEC’s use of its authority in this regard under the 1990 Act.
The rule cited by Congressman Markey is NYSE Rule 80A – the collar rule. It restricted certain program trading when there is an up or down movement of 2% from the previous day close. The Congressman wants the SEC to explain the reason it permitted the rule to be revoked and answer a series of related questions including if “the SEC examined whether such trading strategies or practices may afford aggressive trading firms an opportunity to profit from manipulative acts or practices such as intermarket frontrunning or self-frontrunning, or use aggressive trading strategies which prey on the existing fragility of our markets?” Letter of Congressman Edward J. Markey to The Hon. Christopher Cox, Sept. 30, 2008.
Congressman Markey’s letter comes in a week when Chairman Cox acknowledged that the Consolidated Supervised Entities program created to fill in a regulatory gap that left investment bank holding companies unregulated had failed as discussed here.
At the time of that announcement, the SEC Inspector General issued a report which was highly critical of the Commission’s supervision of Bear Stearns as discussed here. In part, that report suggested that, had the Commission properly reviewed Bear Stearns’ most recent filings, the flurry of rumors which contributed to the collapse of that firm may have been avoided. This claim, of course, raises questions about theories that the giant investment bank was the victim of a bear raid which the emergency short sale rules are intended to prevent.
Nevertheless, Chairman Cox has requested that Congress give the Commission additional authority over investment company holding companies and credit default swaps as discussed here. Congress has not considered that request. The SEC may, however, get additional authority over fair value accounting if the emergency rescue plan to be taken up by the House of Representatives on Friday is enacted as discussed here. Some groups are concerned over the sections of that bill which would permit the SEC to apply FAS 157 on a case-by-case basis.
KLA-Tencor Corp. finalized the settlement of its option backdating class action. The court approved a settlement which included about $65 million for the class and $10 million in legal fees. Garber v. KLA-Tencor Corp., Case No. 3:06-cv-04065 (N.D. Ca. Filed June 29, 2006). Previously, the company settled an option backdating case with the SEC discussed here. SEC v KLA-Tencor Corp., Case No. C 07 3799 (N.D. Ca. July 25, 2007). A case against the former CEO of the company, Kenneth Schroeder, is pending. SEC v. Schroeder, Case No. C 07 3798 (N.D. Ca. July 25, 2007). A criminal investigation was closed.
Scienter – high risk investments
In a case which may be a forerunner to others as the market crisis continues, the court, in In re: American Express Co. Sec. Litig., 02 cv 5533 (S.D. N.Y. Sept. 26, 2008), dismissed a class action securities suit for failure to plead a strong inference of scienter as required by the Supreme Court’s recent decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007). The allegations in the case centered on claims that defendants knew, or were reckless in not knowing, facts demonstrating that the public statements of the company regarding its high yield investments were false as discussed here.
The SEC filed three insider trading cases this week including:
SEC v. Queri, Case No. 2:08-cv-01361 (W.D. Penn. Oct. 1, 2008) is a partially settled insider trading action brought against sixteen defendants. The action focuses on trading in advance of the June 21, 2004 announcement that Dick’s Sporting Goods would acquire Galyan’s Trading Company, Inc. in a tender offer. Following that announcement, Galyan’s stock price increased over 50%. Five of the defendants settled this action which involves multiple tippees as discussed here.
SEC v. Abed, Case No. C-0804548 (N.D. Ca. Sept. 30, 2008) is a settled insider trading action against the President and CEO of Genesis Microchip, Inc., Ellas Antoun, and his friend Samir Abed. This case centers on the acquisition of Genesis, a manufacturer of flat panel TVs, by STMicroelectronics, Geneva Switzerland. Following the execution of a letter of intent, Mr. Antoun purchasing shares of Genesis. He also told his long time friend, Mr. Abed, about the deal in confidence. Nevertheless, Mr. Abed also purchased shares. Following the announcement of the deal the shares of Genesis increased about 57%. Both defendants consented to permanent injunctions and orders requiring the payment of disgorgement, prejudgment interest and penalties as also discussed here.
SEC v. Leone, Civil Action No. 3-08-cv-1686 (N.D. Tex. Sept. 30, 2008) is a settled insider trading case against defendants Randolph Leone and Randall Wall. It is based on the acquisition of Watsco, Inc. by ACR Group. Each defendant is alleged to have acquired inside information about the deal from a different source. Mr. Leone, according to the complaint, overheard a telephone conversation between his wife and her sister, the wife of ACR’s general counsel, about the deal and traded. Mr. Wall learned about the deal from his supervisor who had learned about it in confidence from a Watsco senior vice president. After he learned about the deal Mr. Wall purchased shares of ACR on which he made a profit after the deal announcement of about $6,200. Both defendants consented to the entry of injunctions and orders requiring the payment of disgorgement, prejudgment interest and penalties as discussed here.
The SEC filed two settled financial fraud case this week.
SEC v. The Penn Traffic Company, Civil Action No. 08 Civ. 01035 (N.D. N.Y. Sept. 30, 2008). There, the Commission alleged two fraudulent schemes. Under one, the company prematurely recognized promotional allowances. Under a second, the company used fraudulent entries and/or adjustment to help a subsidiary meet earnings goals. The case was settled with a consent to a permanent injunction and the agreement of the company to certain undertakings as discussed here.
SEC v. Wevodau, 08-Civ-8348 (S.D.N.Y. Filed Sept. 30, 2008) is the latest in a series of actions related to BISYS Group, Inc. Mr. Wevodau, the former vice president of finance for the Insurance and Education Services group at that company participated in a scheme by which BSYS Group overstated its income by about $180 million, largely as a result of fraud in the insurance group. The case was resolved with a consent injunction and an order requiring the payment of disgorgement, prejudgment interest and a penalty totaling $225,000 as also discussed here.