This Week In Securities Litigation (December 12, 2008)

This week, the Department of Justice brought another case alleging FCPA violations, again emphasizing its focus on the area. The Department also had more high profile criminal securities cases, including one charging the former Chairman of the NASDAQ Stock Market with securities fraud.

The SEC finalized two of its settlements in the auction rate securities markets, memorializing the terms initially outlined in the preliminary settlements the New York Attorney General and the Commission negotiated earlier this year. The Commission also filed a settled financial fraud case against two Swiss entities and a partially settled administrative proceeding against ten former Fidelity employees for taking gifts from brokers.

Finally, in a civil action, Bank of America was found liable in a case brought by a group of companies based on a fraudulent securities transaction. Following a six-week trial the jury returned a verdict of $141 million for the plaintiffs


In U.S. v. Hioki, Case No. 4:08-cr-00795 (S.D. Tex. Filed Dec. 8, 2008), Misao Hioki, the former general manager of a rubber products manufacture, pled guilty to conspiring to engage in bid rigging and conspiring to violate the FCPA. Mr. Hioki was sentenced to two year in prison and an $80,000 criminal fine.

The case is one of a series brought by the Justice Department’s antitrust division based on bid rigging claims in the flexible rubber hose market. Those hoses are used to transfer oil between tankers and storage facilities. In this investigation, Mr. Hioki was charged with FCPA violations.

The FCPA claim is based on allegations that Mr. Hioki and his co-conspirators negotiated with employees of government-owned businesses to secure business for the company and its subsidiaries. In this regard, he approved the making of corrupt payments to foreign officials through local sales agents to secure business. In addition, he took steps to conceal those payments. The countries involved were Argentina, Brazil, Ecuador, Mexico and Venezuela.

Criminal securities cases

There were four high profile criminal securities cases this week, two involving attorneys and one a city mayor. First, Bernard L. Madoff, founder of Bernard L. Madoff Investment Securities LLC, a broker dealer based in New York City, and a former Chairman of the NASDAQ Stock Market, was arrested on Thursday and charged with one count of securities fraud.

According to the criminal complaint, the Bernard L. Madoff Investments, founded in 1960, is a leading international market maker with more than $700 million in capital. Mr. Madoff conducts a separate proprietary trading and market making business which has between 11 and 25 clients and had a total of about $17.1 billion in assets under management. On December 10, 2008, Mr. Madoff informed a senior employee that that this business was a fraud and that he was “finished” – that is the business was essentially “a giant Ponzi scheme.” The losses from the fraud, according to Mr. Madoff, were about $50 billion.

Mr. Madoff is scheduled to appear in court on Friday on these charges. The SEC filed a parallel civil action in the Southern District of New York yesterday.

Second, a criminal complaint was filed against New York attorney Marc S. Dreier. In a most unusual case, Mr. Dreier is charged with conducting a multi-million dollar fraud scheme in which he sold bogus promissory notes alleged to have been issued by a former client. Mr. Dreier solicited hedge funds using fraudulent documents, audit opinions and even staging a fake telephone call to a claimed official of the issuer who in fact was a confederate.

The scheme unraveled when one fund solicited by Mr. Dreier checked with the audit partner who supposedly signed an audit report and learned that the opinion was false. Criminal charges are pending in the Southern District of New York. The SEC also filed a parallel civil action. SEC v. Dreier, Case No. 08 Civ. 10617 (S.D.N.Y. Filed Dec. 8, 2008). Both cases are discussed here.

In another case involving an attorney, a superseding indictment was filed against Joseph P. Collins. U.S. v. Collins, Case No. 1:07-cr-01170 (S.D.N.Y. Filed Dec. 18, 2007). Mr. Collins is the former major law firm partner who served as the outside counsel to collapsed market giant Refco. The new papers add bank fraud charges to those previously filed which include conspiracy, securities fraud and wire fraud. All of the charges are based on the alleged role of Mr. Collins in concealing the millions of dollars of debt incurred by Refco prior to its collapse as discussed here.

Finally, the Mayor of Birmingham, Alabama, Larry Langford, and two of his claimed confederates were named in a 101-count criminal indictment. The charges are based on a claimed kickback scheme in which the mayor directed county securities business to a brokerage of one of his confederates in exchange for kickbacks. U.S. v. Langford, Case No. 2:08-CR-00245 (N.D. Ala. Filed Dec. 1, 2008). The SEC previously brought a suit based on essentially the same conduct. SEC v. Langford, Civil Action No. cv-08-0761-S (N.D. Ala. April 30, 2008). Both cases are also discussed here.

Auction rate securities

The SEC finalized settlements with Citigroup Global Markets, Inc. and UBS Securities LLC regarding auction rate securities. SEC v. Citigroup Global Markets, Inc., Case No. 08 CIV 10753 (S.D.N.Y. Filed Dec. 11, 2008); SEC v. UBS Securities LLC, Case No. 08 Civ 10754 (S.D.N.Y. Filed Dec. 11, 2008). See also Press Release of NY AG Andrew Cuomo, (attaching materials from state proceedings).

The two complaints are based on similar allegations. Generally, each alleges that the defendant misled its ARS customers regarding the risks associated with auction rate securities that each underwrote, marketed and sold. Specifically, the complaints allege that customers were told “ARS were safe, highly liquid investments comparable to money market instruments.”

As the market deteriorated neither defendant informed their customers of the risks. Rather, each continued with its sales programs although deteriorating market conditions undermined the financial ability of Citigroup and UBS to continue participating in the market. Finally, in mid-February 2008, each decided not to continue supporting the ARS market. At that point, the market collapsed. Customers who purchased what they were told were highly liquid securities were left with illiquid portfolios of ARS.

The terms of the settlements track those announced in the earlier tentative deals announced by the SEC and New York AG Andrew Cuomo as discussed here. Under the terms of each agreement, what are essentially retail customers will be made whole by having their securities repurchased. Those customers also have the option to pursue claims for consequential damages in a FINRA arbitration. For large investors and institutional clients, the settlements provide only that each firm will use its best efforts to provide liquidity to the crashed ARS market.

As part of the settlements each firm consented to the entry of an injunction prohibiting future violations of Exchange Act Section 15 (c). No fines were imposed.

In late November, the Washington State Department of Financial Institutions filed charges against Wells Fargo & Co. based on its role in the ARS market. Washington State claimed that Wells Fargo misled customers in the sale of more than $175 million of auction rate securities. The state securities division is seeking the return of funds to Washington state customers.

Wells Fargo disputes the charges. The bank claims that it did not actively market or promote ARS to its brokers or clients. In addition, Wells Fargo claims that its role in the ARS market was fundamentally different from that of others who have entered into settlements with the SEC and other states. The claims are pending.

SEC enforcement actions

The Commission filed a settled civil case and two settled administrative proceedings based on claims of financial fraud involving two Swiss companies. SEC v. Zurich Financial Services, 08 Civ. 10760 (S.D.N.Y. Filed Dec. 11, 2008); In the Matter of Zurich Financial Services, File No. 3-13306 (Filed Dec. 11, 2008); In the Matter of SCOR Holdings (Switzerland) Ltd., formerly known as Converium Holding AG, File No. 3-13307 (Filed Dec. 11, 2008).

Zurich is a Swiss based reinsurance company. Its shares are traded on the SWX Swiss Exchange and its ADRs are traded on the Over-the-Counter Bulletin Board and the Pink Sheets. Converium was organized under the laws of Switzerland by Zurich in 2001. Initially, it operated as a subsidiary. In March 2001 Zurich spun off Converium and following an IPO it was no longer affiliated with Zurich. Its shares and ADRs were registered with the SEC for trading. Later the company was acquired by SCOR SE, a French reinsurer.

According to the Commission’s papers, beginning in 1999 and prior to the IPO, Zurich developed three reinsurance transactions which ended with falsified financial statements for Converium that were used in its IPO. These transactions were crafted to make it appear to transfer risk to third-party reinsurers, when in fact no actual risk was insured outside the Zurich group of companies. As a result of these transactions, the financial statements used in the IPO for Converium, which were filed with the SEC, were false and materially misleading. Specifically, Converium understated its pre-tax loss by about 57% or $100 million in 2000 and by 1% or about $3 million in 2001.

To settle these actions both Zurich and Converium consented to the entry of cease and desist orders in the administrative proceedings. In the civil action, Zurich agreed to pay a $25 million civil penalty. The Commission acknowledged the cooperation of each company.

The Commission also filed a partially settled administrative proceeding against ten employees of Fidelity Management & Research Company and its investment advisor subsidiary FMR Co., Inc. In the Matter of Scott E. DeSano, File No. 3-12978 (Filed Dec. 11, 2008). Essentially, the Order for Proceedings alleges that each individual defendant received significant gifts in the form of travel, tickets to various events and other similar items from brokers in violation of Section 17(e)(1) of the Investment Company Act.

To resolve the proceeding, each settling defendant consented to the entry of a cease and desist order. In addition, Scott DeSano, a senior vice president in charge of global equity trading, was barred from associating with any investment advisor and essentially barred from the business with a right to reapply after one year. He was also ordered to pay disgorgement of $106,000 plus prejudgment interest and a penalty of $125,000. Timothy Burnieika, David Donovan, Edward Driscoll, Christopher Horan, and Steven Pascucci, were each censured and ordered to pay disgorgement, prejudgment interest and a $30,000 fine. Each was an equity trader.

Three defendants did not settle. They are Thomas Bruderman, Robert Burns, and Jeffrey Harris. All three were equity traders.

Private actions

In AIG Global Corp. v. Banc of America, Case No. 1:01-cv-11448 (S.D.N.Y. Filed Dec. 13, 2001) Bank of America was found liable in a securities fraud suit following a six-week jury trial.

The complaint alleged that Bank of America engaged in securities fraud in connection with the sale of the securities of Heilig-Meyers. Plaintiffs purchased more than $300 million in asset backed securities which lost much of their value when Heilig-Meyer filed for bankruptcy in 2002. Plaintiffs, who included AIG, Allstate, Societe Generale, Travelers, Bank Leumi, Bayerische Landesbank and the International Finance Corporation, claimed that the defendant failed to disclose the fact that Heilig-Meyers kept two sets of accounting books and distorted the loss and delinquency statistics supporting the consumer payments backing the securities. The jury returned a verdict for $141 million against Bank of America.