This Week In Securities Litigation (February 13, 2009)

New policies and a new enforcement director are the talk of the SEC this week. SEC Chairman Mary Schapiro reversed the pre-clearance penalty policy of former Chairman Cox, while speeding the process for the staff to obtain formal orders. The Enforcement Division will soon also have a new director in the wake of Linda Thomsen’s resignation. Ms. Schapiro is beginning to make good on her promise to energize the enforcement division. According to NERA, it’s none too soon. Their new report chronicles a declining number of settlements for SEC enforcement, even as the FBI told Congress that it is overwhelmed with corporate and financial fraud cases.

The Commission obtained two partial settlements this week. One was in an insider trading case filed last year, and the other was in the Bernard Madoff action. In addition, the SEC, in conjunction with the Department of Justice, settled another record setting FCPA case. At the same time, the first circuit gave definition to the scope of aiding and abetting in a Commission enforcement action.

In private litigation, Broadcom co-founder Henry Nicholas won dismissal in a class action based on allegations of financial fraud keyed to illegal option backdating at his company. And, the part owner of the Nashville Predators hockey team pled guilty to one count of criminal securities fraud.


New policies: The new SEC Chairman promised when she took over to reinvigorate enforcement. That process began with the announcement last Friday by Ms. Schapiro of two key policy changes. First, the corporate penalty policies instituted by Chairman Cox were reversed. Under the policy instated by Mr. Cox, the staff was required to present a corporate case to the Commission for an assessment of whether a penalty would appropriate, and if so, in what range, before discussing settlement. Second, Ms. Schapiro announced streamlined procedures for obtaining a formal order of investigation. Both changes should help speed enforcement’s work. See Speech by SEC Chairman Marry L. Schapiro, Address to Practicing Law Institute’s “SEC Speaks in 2009” Program, Feb. 6, 2009.

Director resigns: On Monday, the Director of the Division of Enforcement, Linda Thomsen resigned. Ms. Thomsen stepped down in the wake of increasing criticism over the performance of the enforcement division. That criticism may have peaked earlier this month when Ms. Thomsen and other senior staff members refused to testify before a congressional oversight committee inquiring into the Commission’s failed efforts to uncover the Madoff Ponzi scheme as discussed here.

Declining settlements: NERA Economic Consulting reports that the number of settlements by the SEC for 2008 declined to the second lowest yearly level since the passage of the Sarbanes Oxley Act in 2002. For the month of December 2008, the report states that the number of settlements declined to 123 compared to the quarterly pace of 185 earlier in the year. The value of the fourth quarter settlements however increased. The report was prepared by Jan Larsen and Dr. Baruch Lev and is available here.

Corporate fraud cases: FBI Deputy Director John Pistole told the Senate Judiciary Committee that the “increasing mortgage, corporate fraud, and financial institution failure case inventory is straining the FBI’s limited White Collar Crime resources.” Mr. Pistole went on to note that the FBI currently has 530 open corporate fraud investigation, including 38 directly related to the current financial crisis. These cases involve financial statement manipulation, accounting fraud and insider trading.

The FBI participates in the Corporate/Securities Fraud Working Group, a national interagency coordinating body established by DOJ to provide a forum for exchanging information and reviewing trends, according to Mr. Pistole. In addition, since April 2007 the FBI headquarters personnel have met with representatives of the SEC once each month to coordinate their respective corporate fraud inventories focused on the current financial crisis and share information. The testimony was at a hearing entitled “The need for increased fraud enforcement in the wake of the economic downturn.”

SEC enforcement

Insider trading: The SEC settled with four additional defendants in its insider trading case based trading in advance of the acquisition of Galyan’s Trading Company by Dick’s Sporting Goods, Inc. in June 2004. SEC v. Queri, Case No. 2:08-cv-01361 (W.D. Pa. Filed Oct. 1, 2008). The complaint alleged that Dicks’ former Senior Vice President of Real Estate, Joseph Queri, Jr., set off a chain of illegal trading. Specifically, Mr. Queri is alleged to have tipped his father Joseph and his friend Gary Gosson. Mr. Gosson in turn tipped Joseph Federico, Philip Simao and Mark Costello. Joseph Queri, Sr. then tipped Gino Ferraro, who tipped his son-in-law Franko Marretti.

Messrs. Federico, Simao, Costello and Marretti, agreed to settle by consenting to the entry of permanent injunctions prohibiting future violations of Section 10(b) and 14(e) and the related rules. In addition, each defendant agreed to disgorge their trading profits and pay prejudgment interest. Each defendant also agreed to pay a civil penalty equal to their trading profits except Mr. Marretti, who consented to a penalty of over $54,000, apparently based on his approximately $9,500 in trading profits and those of a colleague he is alleged to have tipped. Four of the original sixteen defendants settled at the time the case was filed. The other defendants are litigating with the Commission.

Madoff: The SEC has entered into a partial settlement of its enforcement action against Bernard Madoff. Under the terms of the proposed agreement, Mr. Madoff consented to the entry of a permanent injunction prohibiting future violations of the federal securities laws and to a continuation of the asset freeze order previously entered. The questions of disgorgement, prejudgment interest and or a civil penalty remain unresolved at this point. SEC v. Madoff, Civil Action No. 08 CV 10791 (S.D.N.Y. Filed Dec. 11, 2008).


The Department of Justice and the SEC set another FCPA record this week with an FCPA settlement KBR, a subsidiary of Halliburton. This record is for the largest combined settlement paid by U.S. companies in a FCPA. U.S. v. Kellogg Brown & Root LLC, 4:09-cr-00071 (S.D. Tex, Filed Feb. 6, 2009); SEC v. Halliburton Company, Case No. 4:09-CV-399 (S.D. Tex. Filed Feb. 11, 2009).

Here, KBR pled guilty to conspiring with its joint venture partners and others to violate the FCPA. The company admitted to paying bribes to Nigerian government officials in connection with the award of four contracts between 1995 and 2004 valued at over $6 billion. The company paid over $182 million in bribes to two agents for to bribe Nigerian government officials. As part of the plea agreement KBR agreed to pay a fine of $402 million and to retain a monitor for three years.

The SEC’s complaint is based on essentially the same allegations. There, the defendants settled by agreeing to pay disgorgement of $177 million.

The SEC filed a second settled FCPA case last week. SEC v. ITT Corp., Civil Action No. 1:09-cv-00272 (D.D.C. Filed Feb. 11, 2009). In this case, the Commission claimed that the Chinese subsidiary of ITT made about $200,000 in illegal payments to Chinese state-owned entities in connection with the sale of water pumps for a large infrastructure project in China. As a result, the company obtained about $4 million in sales yielding $1 million in profits.

To settle the action, ITT consented to the entry of a permanent injunction prohibiting future violations of the FCPA books and records provisions. The company also agreed to pay disgorgement of over $1 million along with prejudgment interest and a civil penalty of $250,000. The SEC took into consideration the fact that ITT self-reported, cooperated with its investigation and instituted remedial measures.

The circuit courts

The First Circuit Court of Appeals gave definition to the parameters of aiding and abetting liability in an SEC enforcement action in SEC v. Papa, Case No 08-1172 (1st Cir. Decided Feb. 6, 2009).

The Commission’s complaint names as defendants six former employees of Putnam Fiduciary Trust Company who were alleged to have engaged in a scheme to cover up a $4 million error in the account of pension client Cardinal Health, Inc. The district court, dismissed the complaint as to three defendants who were alleged to have attended meetings about the cover up, but whose only actions were to sign false internal conformations over one year after the error and fraudulent cover-up. Those confirmations essentially denied the accounting machinations used to cover the error.

The first circuit affirmed. The test of aiding and abetting is whether the defendants rendered substantial assistance to the wrong committed. First, the court concluded that the execution of the audit letters did not render substantial assistance to the fraud since they were executed long after the fraud was committed. Second even if executing the false documents constituted a breach of duty as the SEC argued, the Court concluded that it did not support a finding of aiding and abetting. Adoption of such a theory would turn this into a continuing and never ending fraud.

Private actions

In Bakshi v. Samueli, Case No. 2:06-cv-05036 (C.D. CA), Broadcom Corp. co-founder Henry T. Nicholas III obtained an order dismissing him from the suit. The class action complaint brought by the New Mexico State Investment Counsel, alleged that the company engaged in illegal option backdating as a result of which the financial statements of the company were false. Although the case is moving forward, the court entered an order of dismissal as to Mr. Nicholas, concluding that the plaintiffs had failed to allege any actionable conduct by him during the five year statue of limitations period. Mr. Nicholas still faces related criminal charges.

Criminal cases

In U.S v. Del Biaggio, Case No. 3:08-cr-00874 (Filed Dec. 4, 2008), defendant William Del Biaggio, a venture capitalist and part owner of the Nashville Predators hockey team, pled guilty to one count of securities fraud. Mr. Del Biaggio admitted to falsifying documents to obtain $100 million in loans and misusing $19.9 million in investor funds from investment funds he operates. The SEC has a parallel civil case.