This Week In Securities Litigation (June 6, 2008)
Insider trading, options backdating and the Foreign Corrupt Practices Act continued to dominate securities litigation. In insider trading, this week yielded heavy criminal penalties, while an SEC options backdating case again suggests shifting prosecution standards, while raising the issue of spring loaded options. And, another FCPA prosecution should again caution issuers and their employees and agents to carefully review compliance efforts in this critical and high risk area.
Former Credit Suisse investment banker Hafiz Naseem, convicted of illegally tipping his friend and former boss at American Express in Pakistan, was sentenced to 10 years in prison and given a $7.5 million fine. The charges against Mr. Naseem claimed that he obtained confidential information on pending merger deals from his position at Credit Suisse and furnished it to his friend and former supervisor who made about $7.8 million by trading in advance of the transaction announcement. Mr. Naseem did not trade and argued during his trial that he did not receive any of the trading profits. U.S. v. Naseem, Case No. 1:07-mj-00706 (S.D.N.Y. May 2, 2007).
The case grew out of the SEC’s inquiry into the trading surrounding the takeover of TXU by a KKR-led group. Shortly after the announcement of that transaction, the SEC filed suit, claiming that unknown purchasers acquired 8,020 TXU call options from an unrealized profit of about $5.4 million. SEC v. One or More Unknown Purchasers of Call Options for the Common Stock of TXU Corp., Civil Action No. 1:07-cv-01208 (N.D. Ill. March 2, 2007). Subsequently, the Commission amended its complaint twice. The first amendment added a married couple as defendants, claiming that they purchased 700 call options. The second amendment added Mr. Naseem as a defendant, claiming that he tipped an investment banker in Pakistan who also purchased TXU options. The criminal case followed. The SEC’s action is pending.
The SEC filed two insider trading cases last week. In one, SEC v. Myers, Civil Action No. 08-CV-5109 (S.D.N.Y. June 4, 2008), the Commission filed a settled insider trading case against attorney Jeffrey Myers. According to the complaint, discussed here, Mr. Myers learned about a pending takeover bid from a board member and traded in the stock. To settle the action, Mr. Myers consented to the entry of a permanent injunction prohibiting future violations of Section 10(b) and Rule 10b-5 and an order requiring the payment of disgorgement, prejudgment interest and a civil penalty.
In the second, SEC v. Fontanetta, Civil Action No. 08-CV-5110 (S.D.N.Y. June 4, 2008), the Commission filed a partially settled action against Joseph Fonanetta, the CEO and a board member of a privately held company, and his alleged tippee, Burr McKeehan. According to the complaint, also discussed here, Mr. Fonanetta learned about a pending takeover transaction from a fellow board member and later tipped Mr. McKeehan, the father of a friend and co-worker. Mr. McKeehan settled with the Commission, consenting to the entry of a permanent injunction as well as an order requiring him to disgorge the trading profits along with prejudgment interest and pay a civil penalty equal to the trading profits. The action is pending as to Mr. Fonanetta.
Last Friday, May 30, 2008, the SEC filed another settled civil action and administrative proceeding based on option backdating. SEC v. Analog Devices, Inc., Civil Action No. 1:08-cc-00920 (D.D.C. May 30, 2008); In the matter of Analog Devices, Inc., Admin. Proc. File No. 3-13050 (May 30, 2008). The Commission’s complaint, as in other option backdating cases, alleges that the company issued backdated in-the-money options. Specifically, between 1998 and 2001, the company issued these options to its executives without properly recording the $30.7 million in compensation costs.
Two aspects of this action are significant. First, CEO Jerald Fishman, a named defendant, was only charged with negligence in violation of Section 17(a)(2)&(3) in the complaint which claimed that he directed the backdating plan. The company, in contrast, was charged with Section 10(b) fraud. This is only the second options backdating case to base charges on negligence. It may suggest that prosecution standards in these cases are changing.
The second aspect of interest is what the complaint did not charge – spring loaded options. Although the Commission alleged that the company issued options keyed to pending corporate events based on an opinion of counsel that such action did not violate the company’s insider trading policy, the complaint notes that the claims against the defendants were not based on this conduct. Whether this suggests that the Commission will not bring actions based on the controversial practice of issuing spring loaded or bullet dodging options or deferred here because of the legal opinion is not clear. Both the company and Mr. Fishman settled the actions, consenting to cease and desist orders in the administrative proceeding and agreeing to the entry of orders requiring the payment of civil penalties in the civil action.
Cablevision Systems Corp, announced that the company and 16 past and current executives, directors and an outside compensation consultant settled a series of options backdating lawsuits for $34.4 million. According to the settlement documents, the chairman of the company, Charles Dolan will contribute $1 million to the settlement. His son, chief executive James Dolan, will pay over $366,000 to the company to cover previously exercised options in addition to $1 million which will be contributed to the settlement. Compensation consultant Harvey Benenson agreed to forfeit all claims to a severance payment of $1.5 million from the company and will pay $2 million to Cablevision in addition to forfeiting a home, valued at $2 million. The former general counsel of the company agreed to return $2.55 million to the company and relinquish options valued at $4.5 million. Plaintiff’s counsel will receive about $7.1 million in legal fees and expenses.
Prosecutors continued their renewed emphasis on enforcement of The Foreign Corrupt Practices Act, bringing an action against AGA Medical Corporation of Plymouth, Minnesota. The one-count information alleges that the company paid bribes to Chinese officials through a distributor between 1997 and 2005. The bribes were intended to cause government owned hospitals and government employed physicians to purchase AGA products rather than those of competitors. In addition, the company sought to cause the Chinese Patent Office to approve its applications.
This action, which followed voluntary disclosure by the company based on an internal investigation, was resolved with a deferred prosecution agreement. Under agreement the criminal complaint will be dismissed in three years if the company abides by the agreement. The agreement calls for the payment of a $2 million penalty, the implementation of enhanced compliance procedures and the retention of an independent corporate monitor. U.S. v. AGA Medical Corp., Case No. 0:08-cr-00172 (D. Minn. June 3, 2008).