The SEC’s efforts to settle its case with Bank of America for alleged proxy violations continued to present difficulties for the Commission and the bank. SEC enforcement filed a settled insider trading case and an action based on an alleged Ponzi scheme. The former CFO of Stanford Financial Group pleaded guilty to criminal charges, while the D.C. Circuit handed down its first decision concluding that limited partnership units are securities. Finally, a new study by three Canadian professors concludes that the most significant red flag to financial fraud at a company is an oversized ego of the CEO.

SEC enforcement

Settlements: In SEC v. Bank of America, discussed here, the court ordered additional briefing after reviewing the latest round of papers filed by the SEC and the bank about the proposed settlement. The brief filed by the Commission this week repeatedly states that the proxy materials furnished to the shareholders omitted the information about the huge bonuses authorized for Merrill employees. Accordingly, those papers were incomplete and incorrect, according to the SEC. Suits were not brought against individuals, the Commission told the court, because the witnesses in the investigation claimed the lawyers made the decision to omit the key schedule listing the bonuses and the bank asserted privilege. Bank of America argued its proxy materials were correct, but it decided to settle and pay a $33 million fine to avoid a dispute with a regulator.

In a subsequent order, discussed here, the court directed additional briefing. The order directs the SEC to explain how the bank could rely on the advice of counsel without waiving the privilege. The bank was also directed to discuss that point and also to explain why it was proposing to pay $33 million of shareholder and perhaps taxpayer money to settle this case when it claims there was no wrong doing.

Insider trading: SEC v. Jewell, Civil Action No. 09-CV-7417 (S.D.N.Y. Filed Aug. 24, 2009) is a settled insider trading case discussed here. According to the complaint, an unnamed Director of First Indiana Corporation who knew the bank was looking for a merger partner got a telephone call late on a Friday morning telling him to attend a special board meeting that Sunday. That afternoon, the Director complained to a number of people about having to attend the board meeting, claiming it would ruin his plans. Included in the people to whom the Director grumbled were the three defendants, Nancy Jewell, an employee of a private company owned by the Director, Kristin Mays, his daughter and Matthew Murphy, III, a business partner. Previously, the Director had trusted the three with confidential information. This time however, the three defendants, according to the SEC, misappropriated the material non-public information and traded in the securities of the bank, an unusual event for each. Later the bank announced a merger. The three defendants sold their shares at a profit.

The three defendants settled with the SEC. Each consented to the entry of a permanent injunction prohibiting future violations of Section 10(b) and Rule 10b-5. Each defendant also agreed to disgorge their trading profits and to pay prejudgment interest and a civil penalty equal to the trading profits. See also Litig. Rel. 21183 (Aug. 24, 2009).

Insider trading: SEC v. Marshall, Case No. 1:08-cv-02527 (S.D.N.Y. Filed March 13, 2008) is an insider trading case based on the merger of International Securities Exchange Holdings, Inc. and Eurex Frankfurt AG. The initial complaint alleged that John Marshall, former vice chairman of ISE tipped his business partners, defendants Alan Tucker and Mark Larson. After dismissing all claims with prejudice against Mr. Larson, the Commission amended it complaint to add Thomas Genzale as a defendant.

Subsequently, the three defendants agreed to settle with the SEC, consenting to the entry of permanent injunctions. Mr. Marshall agreed to pay disgorgement of over $31,000 along with prejudgment interest and to an officer/director bar. Mr. Genzale agreed to pay over $826,000 in disgorgement along with prejudgment interest and to a penalty equal to the amount of the disgorgement. Mr. Tucker agreed to pay over $18,000 in prejudgment interest. See Litig. Rel. 21185 (Aug. 27, 2009). Previously, Messrs. Marshall and Tucker pleaded guilty to criminal charges. The U.S. Attorney’s Office dismissed charges against Mr. Larson last year.

Investment funds: SEC v. Titan Wealth Management, Case No. 4:09-cv-00418 (E.D. Tex. Filed Aug. 25, 2009) names as defendants Thomas Lester Irby II, Titan Wealth Management, LLC and Point West Partners, LLC. The complaint claims the defendants operated a Ponzi scheme beginning in 2007. The scheme raised over $3.1 million from over 30 investors with promises of short term returns ranging from 10% to 50%. The complaint seeks an emergency freeze order. The case is in litigation. See Litig. Rel 21184 (Aug. 24, 2009).

Auditing fraud: SEC v. Moore, Civil Action No. 2:09-cv-01637 (D. Nev. Filed Aug. 27, 2009) is a fraud action against Michael Moore and his CPA firm. The complaint alleges that the auditing firm issued audit reports on over 300 companies which were primarily shell or development stage entities and that the opinions which were false and misleading. In conducting the audits, the defendants, according to the complaint, failed to comply with the standards of the Public Company Accounting Oversight Board. In fact, the complaint alleges that frequently the work was done by untrained individuals who had no education or experience in accounting and auditing.

The action was settled with the defendants consenting to the entry of a permanent injunction prohibiting future violations of Sections 10(b), 10A(a)(1) and 10A(b)(1) and the related rules and an order requiring the payment of almost $180,000 in disgorgement with prejudgment interest and a penalty of $130,000. See Litig. Rel. 21189 (Aug. 27, 2009). The defendants also consented to the entry of a Rule 102(e) order suspending their right to appear or practice before the SEC as accountants.

Criminal cases

U.S. v. Davis, Case No. 4:09-cr-00335 (S.D. Tex. Filed June 18, 2009) is a criminal case against the former CFO of Stanford Financial Group, James Davis. Mr. Davis pleaded guilty on August 27, 2009 to a criminal information with counts of conspiracy to commit mail, wire and securities fraud, mail fraud and conspiracy to obstruct the SEC. At his plea Mr. Davis admitted defrauding investors who purchased about $7 billion in CDs administered by Stanford International Bank, that he and others misused much of those assets and that they misrepresented the true financial condition of the bank to regulators. He also admitted that about 80% of the claimed investment portfolio for the company was made up of illiquid investment, including at least $2 billion in personal loans from a coconspirator. Mr. Davis also agreed to a preliminary order of forfeiture of $1 billion.

U.S. v. Wong, Case No. 8:09-cr-00328 (D. Neb. Filed Aug. 19, 2009) is a securities fraud case against Mary Wong. The indictment alleges that she operated a Ponzi scheme. Part of the proceeds from the scheme flowed to a partnership involving Ms. Wong and two NFL players. The indictment contains one count of securities fraud and multiple counts of wire and mail fraud.

U.S. Ruderman, Case No. 09-1011 (C.D. Cal. Filed May 14, 2009) is a Ponzi scheme case which named as a defendant Bradley Ruderman. On August 24, Mr. Ruderman pleaded guilty to two counts of wire fraud and two counts of investment adviser fraud relating to schemes he ran from 2003 to 2009. Mr. Ruderman admitted taking over $44 million from investors, many of whom were family members, based on promises of returns which could reach 60%. The SEC has a parallel action pending, SEC v. Ruderman, Civil Action No. CV 09-02974 (C.D. Cal. Filed April 29, 2009). See also Litig. Rel. 21017 (April 29, 2009).

Circuit courts

Liberty Property Trust v. Republic Properties Corporation, Case No. 08-7095 (D.C. Cir. Decided Aug. 21, 2009) is the first decision by the DC Circuit to conclude that units of a limited partnership are a security under SEC v. W.J. Howey Co., 328 U.S. 293 (1946) as discussed here. The district court dismissed the case, concluding that the units were not a security because the individual defendants also controlled the plaintiff entities. In a 2-1 decision the circuit reversed.

The suit was brought by a REIT and its related partnership against a development corporation and its two founders who also created and were key to the management of the REIT. The units were issued by the plaintiff partnership in exchange for a development contract negotiated by the defendant corporation and the two individual defendants with the city of West Palm Beach, Florida. In connection with that contract the defendants retained the services of a West Palm commissioner who later pleaded guilty to public corruption charges. After the plea the plaintiff partnership canceled the development contract at the insistence of the city and brought suit alleging fraud in violation of Section 10(b) for failure to disclose the contract with the corrupt county commissioner. The partnership units used to pay for the development contract were held to be Howey investment contracts.

Avon Pension Fund v. GlaxoSmithKline Plc, Case No. 08-4363 (2nd Cir. Aug. 24, 2009) affirmed, in a summary order, the dismissal of a securities class action which alleged that the company and several of its officers failed to disclose the cardiovascular risks associated with the drug Avandia. The action was dismissed for failing to adequately plead scienter. When viewed in their totality, the allegations failed to allege a strong, cogent inference of scienter. First, the allegations of insider trading failed to demonstrate a motive to defraud. Second, plaintiffs’ circumstantial pleadings, even when viewed in the aggregate, do not demonstrate conscious misbehavior or recklessness the court concluded.

New academic studies

“Like Moths Attracted to Flames: Managerial Hubris and Financial Reporting Fraud,” by Michel Magnan, Denis Cormier and Pascale Lapointe-Antunes, three Canadian professors, studied financial fraud cases in an effort to identify risk factors. The study focused on what it called the usual red flags or incentives to commit fraud and concluded that they are not key. Rather, the three researches argue that the biggest risk factor for fraud is a CEO with a truly oversized ego. In most instances those executives were in the media and closely followed by analysts.