THIS WEEK IN SECURITIES LITIGATION (Aug. 6, 2010)
While the ink is drying on Dodd-Frank, Congress began considering repealing at least one section which appears to have given the Commission the authority to withhold a significant amount of material from FOIA requests and perhaps other demands for documents. SEC enforcement settled one of its significant market crisis cases, while bringing others centered on financial fraud, insider trading and the FCPA. At the same time, DOJ continued to target individuals in FCPA cases for which the length of sentences continue to increase.
Dodd-Frank: H.R. 5970 was introduced this week to amend Section 9291 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Generally, that Section of the Act protects from disclosure any internal compliance or audit records obtained by the Commission under the Section. Some commentators claim the provision will permit the Commission to withhold a broad array of materials from FOIA requests. The new bill, titled the SEC Transparency Act of 2010, would repeal the provision.
SEC enforcement actions
Financial fraud: In the Matter of Navistar International Corp., Adm. File No. 3-13994 (March 5, 2010) is a settled financial fraud action against the company, Daniel Ustian, its chairman and CEO, Robert Lannert, vice chairman and CFO, Thomas Akers, Jr., Director of Purchasing, James McIntosh, V.P. of Finance for the Engineering Division, James Stanaway, Director of Finance for the Engineering Division, Ernest Stinsa, replacement for Mr. Stanaway and Michael Schultz, Plant Controller. The company is a manufacturer of trucks and engines. From 2001 through 2005, the company overstated its pre-tax income by about $137 million dollars. This resulted in a restatement in 2007. Approximately $58 million of the overstatement resulted from the fraudulent handling of rebates at the Wisconsin foundry. The remaining $79 million was caused by improper accounting for certain warranty reserves and deferred expenses. The Order states that the improper accounting did not result from a scheme, but rather from poor internal controls.
To resolve the proceeding, Messrs. Lannert and Ustian each undertook to repay their incentive compensation in accord with the SOX clawback provision. This amounted to $1,049,503 for Mr. Lannert and $1,320,000 for Mr. Ustian. In addition, Mr. Lannert consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Mr. Ustian consented to the entry of a similar order, except it does not include Exchange Act Section 13(b)(2)(B). Mr. Lannert agreed to the entry of a C&D based on the same sections as Mr. Ustian while Mr. McIntosh consented to the entry of an order based on the same sections as Mr. Lannert. Messrs. Akers and Schultz agreed to the entry of orders based on Securities Act Sections 17(a) and Exchange Act Sections (10(b) and 13(b)(2)(A). Mr. Stinsa agreed to the entry of an order based on Section 13(b)(2)(A).
The settlement included two civil actions. In SEC v. McIntosh, Civil Action No. 10-cv-4903 (N.D. Ill. Filed Aug. 4, 2010) penalties were ordered by consent as to Mr. Akers ($100,000), Mr. McIntosh ($150,000), Mr. Stanaway ($50,000) and Mr. Stinsa ($25,000). A penalty was not imposed on Mr. Schultz. The second action is SEC v. Schwetschenau, Civil Action No. 10-cv-4904 (N.D. Ill. Filed Aug. 4, 2010) which is against the former controller of the company. In this case, the former controller consented to the entry of an order which imposed a civil penalty of $37,500. See also Litig. Rel. 21616 (Aug. 5, 2010). In a related administrative proceeding, he agreed to the entry of a cease and desist order based on Exchange Act Sections 13(a) and 13(b)(2)(B) and to an order which prohibits him from appearing and practicing before the Commission as an accountant with a right to reapply after one year. In the Matter of Mark T. Schwetschenau, Adm. File No. 3-13995 (Aug. 5, 2010).
False tender offer: SEC v. Al-Raya Investment Co., Civil Action No. 1:09-CV-6533 (S.D.N.Y. July 23, 2009) is an action against the late Kuwaiti financial advisor Hazem Al-Braikan and Al-Raya Investment Company. After filing an amended complaint which dismissed one defendant and substituted another party as a relief defendant, the action settled. The case is based on the SEC’s claim, discussed here, that Mr. Al-Braikan created a swirl of false rumors asserting that a tender offer was being made by an Arabian Peninsula Group for Harman International. Those rumors drove up the share price which permitted the defendants to sell the interests they had amassed. Previously, they had used the same technique to profit from a falsely fueled price rise in the shares of Textron Inc. Mr. Al-Raya and others made profits of $6.2 million from the hoaxes. To settle, Mr. Al-Braikan’s estate consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and agreed to disgorge $1,685,727.93 plus $894,093.22 which is the trading profits of another. His employer also agreed to the entry of a fraud injunction, to disgorge $1,209,707.49 and to pay a penalty of $300,000. Relief defendant KAMCO agreed to disgorge $2,439,199.87. Overall, the Commission obtained disgorgement of over $6.2 million. The settlements conclude this action. See also Litig. Rel. 21613A (Aug. 5, 2010).
Boiler room: SEC v. Porche, Civil Action No. SACV 10-01165 (C.D. Cal. Filed Aug. 4, 2010) names as defendants Joseph Porche, Larry Crowder, Konrad Kafarski, Carlton Williams and Dale Engelhardt. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), 15(a) and 15(b)(6)(B)(i). According to the complaint, Kingston Resources, Inc., under the direction of Messrs. Porche and Crowder, was operated as a boiler room. Investors were told that commissions would be limited to 10% when in fact they were 25% and that 80% of their investment would be used to conduct a green energy business. In fact, much of the money was diverted to Messrs. Porche and Crowder. Messrs. Crowder and Engelhardt were previously enjoined by the SEC. The case is in litigation. See also Litig. Rel. 21614 (Aug. 4, 2010).
Insider trading: SEC v. Flanagan, Civil Action No. 10-CV 4885 (N.D. Ill. Filed Aug. 4, 2010). Thomas P. Flanagan, a CPA and former Vice Chairman of Deloitte in Chicago, and his son Patrick, settled insider trading charges with the Commission as discussed here. Thomas Flanagan, according to the SEC, traded on inside information he obtained through his position at Deloitte on nine separate occasions between 2005 and 2008 in the securities of five different companies. Overall he made 71 purchases, most of which involved audit clients who made filings with the Commission. He also tipped his son who traded. Thomas Flanagan had trading profits of over $430,000 while his son had profits of about $57,000.
In the settlements, each defendant consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b) and 14(e). Thomas Flanagan also agreed to pay disgorgement and prejudgment interest of $557,158 and a penalty of $493,884. Patrick Flanagan agreed to pay disgorgement and prejudgment interest of $65,614 and a penalty of $57,656.
A separate Rule 102(e) administrative proceeding named Thomas Flanagan as a Respondent. The Order is based on the fact that by holding shares in audit clients, the firm was not independent. Thus its audit reports, which represented that the firm was in fact independent and which were filed with the Commission, were false. To resolve the administrative proceeding, Thomas Flanagan consented to the entry of an order denying him the privilege of appearing or practicing before the Commission as an accountant. In the Matter of Thomas P. Flanagan, C.P.A., Adm. Proc. File No. 3-13993 (Filed Aug. 5, 2010).
Market crisis/disclosure: SEC v. Morrice, Case No. CV 09-01426 (C.D. Cal. Filed Dec. 12, 2009). The Commission settled this action against three officers of the former number three sub-prime lender, New Century. The claims against Brad Morrice, former CEO and co-founder, Patti Dodge, former CFO and David Kenneally, former controller, as discussed here, centered a disclosure fraud. The complaint alleges that defendants Morris and Dodge failed to tell investors about the true status of the loan portfolio. As the liquidity crisis unfolded during the second and third quarters of 2006, accounting manipulations began. Reserves were drained which bolstered revenue, but left the company in difficult straights when the demand for loan repurchased increased beyond what could be funded. At the same time, the share price was inflated.
To settle Mr. Morrice consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(b)(5) as well as from aiding and abetting violations of Section 13(a). He also agreed to disgorge $464,364 plus prejudgments interest, to pay a civil penalty of $250,000 and to a five year officer-director bar. Ms. Dodge consented to a similar injunction and agreed to disgorge $379,808 plus prejudgment interest, to pay a civil penalty of $100,000 and to the entry of a five year officer-director bar. Mr. Kenneally consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b), 13(b)(5) and from aiding and abetting violations of Section 13(a). He also agreed to disgorge $126,676 along with prejudgment interest and to the entry of a five year officer- director bar.
Misappropriation: SEC v. Froning, Civil Action No. 3:10-cv-1503 (N.D. Tex. Aug. 2, 2010) is an action against registered representative Gregory Todd Froning. According to the complaint, over a four year period beginning in 2005, Mr. Froning solicited fifteen individuals to acquire certain rights in a defunct financial planning company he owned. Investors were falsely told that the funds would be used to expand the business when in fact the $800,000 raised was diverted to his personal use. Mr. Froning partially settled the case by consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The court will determine the amount of any disgorgement and civil penalty. Mr. Froning also consented to the entry of an order in an administrative proceeding which will bar him from association with any broker, dealer or investment adviser. See also Litig. Rel. 21610 (Aug/ 2, 2010).
SEC v. Summers, Civil Action No. 4:10-cv-02286 (S.D. Tex. Filed Aug. 5, 2010) names as a defendant Joe Summers, the former country manager for Venezuela for Pride International. From 2003 through 2005 Mr. Summers, according to the complaint, authorized the payment of $384,000 to third parties with the understanding the money was going to state officials to help obtain three oil drilling contracts. Mr. Summers settled the action by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 30A and 13(b)(5). He also agreed to pay a civil penalty of $25,000. See also Litig. Rel. 21617 (Aug. 5, 2010).
SEC v. Turner, Civil Action No. 1:10-cv-01309 (D.D.C. Filed Aug. 5, 2010) is a settled FCPA action against two former Innospec, Inc., executives, David Turner and Ousama Naaman. Mr. Turner was the business director, while Mr. Naaman was the agent for the company in Iraq. According to the SEC’s complaint, beginning in 2000 and continuing through 2008 $6.3 million in bribes were paid and another $2.8 million were promised to Iraqi ministers and officials and Indonesian officials to secure contracts worth $176 million. Beginning in 2001 and continuing for the next eight years, the company paid bribes to Iraqi officials to sell the chemical Tetra Ethyl Lean (“TEL”) in the country. The payments began under the U.N. Oil For Food Program and continued after it ended. The payments were set at 10% of the contract value. In addition, from 2000 through 2005 the company paid bribes in Indonesia equal to about $2.8 million to sell the same product. At one point Mr. Turner directed the payment of a bribe to ensure that a field test for the product of a competitor would fail. He also lied to the auditors when they began questioning certain entries related to the payments.
To settle the case each defendant consented to the entry of a permanent injunction prohibiting future violations of Sections 30A, 13(b)(5) and from aiding and abetting violations of 30A, 13(b)(2)(A) and 13(b)(2)(B). Mr. Turner also agreed to disgorge $40,000 along with prejudgment interest. No penalty was assessed against him because of his cooperation. Mr. Naaman agreed to disgorge over $810,000 and to pay prejudgment interest along with a penalty of $438,000 which will be satisfied by payment of a criminal fine in a related criminal action previously brought by the Department of Justice and discussed here. See also Litig. Rel. 21615 (Aug. 5, 2010).
U.S. v. Elkin, Case No. 4:10 CR 00015 (W.D. Va. Filed Aug 3, 2010) names as a defendant Bobby Jay Elkin Jr. Mr. Elkin is a former executive of tobacco company Dimon Inc., now called Alliance Once International. He pleaded guilty to a one count information alleging conspiracy to violate the FCPA. In entering the plea, he admitted making cash payments to officials of the Kyrgyz tobacco authority to obtain export licenses and gain access to the government owned tobacco processing facilities. About $2.6 million in payments were made between 1996 and 2004. The payments were based on the number of kilograms of Kyrgyz tobacco Mr. Elkin’s employer purchased and processed for export. Other bribes were paid to secure the ability to purchase tobacco from growers in the municipalities while still others were paid to the Kyrgyz Tax Inspection Police so that business could continue. The date for sentencing has not been set. Mr. Elkin previously settled with the SEC as discussed here.
U.S. v. Diaz, Case No. 09-20345 (S.D. Fla. April 22, 2009) is a case against Juan Diaz. He previously pleaded guilty to conspiracy to make corrupt payments to foreign government officials. The purpose was to secure business for three telecommunications enterprises from the Republic of Haiti’s state owned telecommunications company as discussed here. Mr. Diaz is alleged to have paid or concealed over $1 million in bribes to former Haitian government officials while serving as an intermediary for the three entities. For his role in the scheme, Mr. Diaz was sentenced to 57 months in prison and ordered to serve three years release following completion of the prison term. He was also ordered to pay $73,824 in restitution and to forfeit $1,028,851.
Program: The Vanishing Line Between Civil And Criminal Securities Fraud: Sunday August 8, 2010, 10:30 a.m. at the ABA Annual Convention, San Francisco, California. Co-chairs: Thomas O. Gorman and Frank C. Razzano. Panelists include: Hon. Cormac Carney, U.S. Dist. Court (C.D. CA), Greg Anders, Deputy Asst. AG, Criminal Division, DOJ; Michael Dicke, Associate Director – Enforcement, SEC, San Francisco; Ellen Podgar, Professor of Law, Stetson Univ. and Cheryl Evans, Special Counsel, National Chamber Law Reform Project.