This Week In Securities Litigation (January 9, 2009)

This week, the Madoff scandal continued to dominate securities litigation news. Congressional hearings opened in the House of Representatives about the matter with testimony from the SEC’s Inspector General, who is conducting an internal inquiry regarding the Commission’s investigative efforts in this matter. The Senate, as a prelude to its hearings, sent the SEC a document request for all its Madoff related documents. In each of these inquiries, the SEC will undoubtedly have to explain why it did not discovery the claimed Madoff Ponzi scheme earlier.

The Commission filed two enforcement actions this week based on alleged Ponzi schemes. In addition, the Justice Department brought two criminal cases based on earlier SEC enforcement actions which named alleged Ponzi scheme operators as defendants. The Department also continued to focus on FCPA enforcement, bringing another case in which an individual pled guilty. Finally, Cornerstone Research reports that the number of securities class actions filed last year increased significantly.

The Madoff Scandal

The U.S. House of Representatives began hearings this week regarding the Madoff scandal with the testimony of SEC Inspector General H. David Kotz. SEC Chairman Cox had previously asked Mr. Kotz to conduct an internal investigation into what happened in earlier Commission investigations and inspections regarding Madoff. In his congressional testimony, Mr. Kotz promised a full and complete inquiry which will be significantly broader than the one requested by Chairman Cox. Mr. Kotz’s testimony is discussed in detail here.

The Senate is also planning hearings into the question of why the SEC failed to discover the Madoff Ponzi scheme earlier. In anticipation of those hearings, the Senate Banking Committee sent the SEC a request for the production of all documents relating to its inquiries and inspections of Mr. Madoff and his entities, as discussed here.

Both the House and Senate hearings are likely to focus on matters such as the case opening and closing forms from a 2006 SEC inquiry into Mr. Madoff’s activities, also discussed here. Those documents state that the SEC received allegations from a source deemed credible that Mr. Madoff was conducting a Ponzi scheme. The SEC documents also state that Mr. Madoff had violated the securities laws and that one of his largest hedge fund investors failed to adequately disclose to its shareholders that their funds were invested with Mr. Madoff. Nevertheless, the preliminary inquiry was closed.

The Madoff scandal is also spawning private litigation. Essentially, there are two groups of private suits as discussed in detail here. One is the typical securities damage suit against Mr. Madoff and his entities. The second, which may be the harbinger of the future, is by investors the so-called “feeder” funds (like the one discussed above in the SEC documents). The feeder funds placed investor money with Mr. Madoff for investment.

Finally, in the criminal case against Mr. Madoff, prosecutors requested that the Court revoke Mr. Madoff’s bail. The request was based on a claim that Mr. Madoff violated an asset freeze order by giving about $1 million in goods to relatives. Defense attorneys deny this claim, although they admitted Mr. Madoff did give some items to family members. Both sides have submitted briefs on the issue. A ruling is expected Friday.

SEC enforcement

The SEC brought two enforcement actions this week based on claimed Ponzi schemes it did discover:

SEC v. Forte, Case No. 2:09-cv-00063 (E.D. Pa. Filed Jan 7, 2009) (alleging a $50 million Ponzi scheme from 1995 to the present); and

SEC v. Gen-See Capital Corp., Civil Action No. 09 CV 0014 (W.D.N.Y. Filed Jan. 8, 2009) (alleging a Ponzi scheme which has raised millions of dollars).

In addition, the Department of Justice recently brought two criminal cases based on claimed Ponzi schemes where the Commission had brought actions earlier:

U.S. v. Steinger, Case No. 08-21158-CR (S.D. Fla. Filed Dec. 23, 2008) (alleging a $1.25 billion Ponzi scheme; the SEC previously filed an emergency action which halted the scheme in 2004 as noted here); and

U.S. v. James, Case No. 2:08-CR-20674 (E.D. Mich. Filed Dec. 23, 2008) (alleged Ponzi scheme based on an earlier SEC action, SEC v. James, Case No. 08-61516 Civ. (S.D. Fla. Filed Sept. 24, 2008).


The focus on FCPA enforcement continued with the entry of a guilty plea by Mario Covino, an Italian citizen residing in California who was employed by an Orange County, California based manufacturing company. U.S. v. Covino, Case No. 8:08-cr-00336 (C.D. Cal. Filed Dec. 17, 2008).

According to the information, Mr. Covino paid about $1 million in bribes between March 2003 and August 2007 to secure business. The bribes were paid to officials in Brazil, China, India, Korea, Malaysia and the UAE. Mr. Covino also admitted providing false information to internal auditors during an inquiry into the payments and to deleting e-mails. The company reportedly earned about $5 million in profits from the contracts secured through the corrupt payments.

Mr. Covino pled to a one count information charging conspiracy to make corrupt payments in violation of the FCPA. Sentencing is scheduled for July 20, 2009.

Private litigation

Last year, there was a 19% increase in the number of federal securities class action suits compared to the prior year, according to Cornerstone Research. Specifically, in 2008 there were 210 class action complaints filed compared to 176 in the prior year. About half of the cases filed were against companies in the financial services sector.