Legislation was introduced in the Senate that would expand liability in private securities damage actions, while the SEC significantly revised its procedures to empower the Enforcement staff by delegating to the Director of the Division the authority to issue a formal order of investigation. The Director of Enforcement, in assessing his initial one hundred days on the staff, discussed structural changes to the Division and proposals under consideration to encourage cooperation from individuals and companies including the use of deferred prosecution agreements.

The SEC filed cases this week based on proxy fraud allegations stemming from the acquisition of Merrill Lynch by Bank of America, financial fraud claims in cases against GE and the former Chairman of AIG and the first actions based on naked short selling claims. FCPA enforcement continued to be a priority, with the SEC filing a settled action and DOJ obtaining guilty plea in one case while unsealing charges in another. Finally, a derivative suit based on option backdating claims was dismissed for failure to make a demand and lack of standing.

Regulatory reform

New legislation: Senator Specter introduced S. 1551 in the Senate to amend Section 20 of the Securities Exchange Act. The bill would add a provision extending aiding and abetting liability to private actions based on implied causes of action as discussed here. The proposed legislation would effectively overturn Central Bank of Denver v. First Interstate, 511 U.S. 164 (1994) (rejecting aiding and abetting) and Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 522 U.S. 148 (2008) (rejecting scheme liability).

SEC enforcement: The SEC amended its rules to delegate to the Director of the Division of Enforcement the authority to issue formal orders of investigation as also discussed here. The change is being made on a one year trial basis. According to the release (available here), the purpose is to facilitate the investigative process. This represents a significant change in the investigative process. Under the securities laws, the Commission has the authority to conduct investigations in aid of its duties. Previously, formal investigations with the authority to issue a subpoena to compel the production of documents and testimony could only conducted when directed by a Commission order. Now, the Director of Enforcement will have the authority to issue those orders.

Enforcement policies: Division Director Robert Khuzami assessed his first one hundred days on the staff in Remarks to the New York City Bar Association earlier this week. In his comments the Director reviewed structural changes to the Division including: the creation of five specialization units that will focus on asset management, market abuse, structured and new products, the FCPA and municipal securities and public pensions.

Internal processes of the Division are also being streamlined by eliminating the branch chief position to put more investors on the front line. At the same time the policy on tolling agreements is being revised to tighten the process. Now approval is required by the Division Director. An Office of Market Intelligence is also being created to collect and analyze the tips, complaints and referrals the SEC receives.

Finally, initiatives are also being considered to foster cooperation. These include preparing a Seaboard type release for individuals, expediting the immunity process and assessing ways to provide a witness with an oral assurance early in the case that charges will not be filed against the person. A proposal is also being prepared for submission to the Commission regarding the use of deferred prosecution agreements in appropriate instances for individuals and entities. This would be for what the Director termed “extraordinary cooperation.” The Speech is available at

SEC enforcement

SEC v. Greenberg, Civil Action No. 09 Civ 6939 (S.D.N.Y. Filed Aug. 6, 2009) is a settled enforcement action brought against former AIG Chairman and CEO Maurice Greenberg and former Vice Chairman and CFO Howard Smith. The complaint claims that Messrs. Greenberg and Smith were responsible for material misstatements regarding the financial condition of AIG, projecting it as an industry leader with consistently high earnings. In fact, the company faced financial challenges which were concealed by sham transactions, deals which hid losses, phony round-trip transactions designed to give the appearance of income and similar items. To settle the case, each defendant consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions of the securities laws. Mr. Greenberg also agreed to pay disgorgement of $7.5 million and a penalty in the same amount. Mr. Smith agreed to pay disgorgement of $750,000 and a penalty in the same amount. See Lit. Rel. 21170 (Aug. 6, 2009).

Financial fraud: SEC v. Gerhardus, Civil Action No. 1:04-CV-01741 (S.D.N.Y. Filed Aug. 5, 2009) is the latest settlement arising from the financial fraud at Royal Ahold discussed here. The defendant is Johannes Gerhardus Andreae, a former Executive Vice President and member of the executive board of the company. The underlying complaint alleges a wide ranging financial fraud. As to Mr. Andreae, it is based on an improperly consolidate joint ventures which resulted in incorrect financial reporting. To resolve the transaction, Mr. Andreae consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions of the securities laws. The defendant also agreed to the entry of an order barring him from serving as an officer or director of a public company. See also Lit. Rel. No. 21168 (Aug. 5, 2009).

Short selling: In the Matter of Hazan Capital Management, LLC, Adm. File No. 3-1570 (Filed Aug. 5, 2009) along with In the Matter of TJM Proprietary Trading (below) are the first naked short selling actions brought by the Commission. The Order for Proceedings in Hazan Capital claims that over an almost two year period beginning in January 2005 the Respondents violated Rule 203 of Reg. SHO. That rule in part has a “locate requirement” which specifies that non-market makers seeking to effect a short sale must borrow, arrange to borrow or have reasonable grounds to believe that a security can be borrowed prior to the short sale. The rule also has a “fail to deliver” provision which requires that for certain securities if a failure to deliver persists for thirteen consecutive settlement days the position must be immediately closed out.

In one series of transactions, the firm improperly relied on its market making exception to avoid compliance with the locate requirement. In those transactions, it was not engaged in market making. Rather, the firm was trading using a synthetic long position which involved pairing a put and call option while selling short the underlying security. In others transactions, the firm used paired stock and option positions to make it appear it had complied with the close out rule when in fact it had not.

To resolve the case the firm, a New York broker dealer, and its majority owner, Steven Hazan, consented to the entry of a cease and desist order, a censure against the firm and an order barring Mr. Hazan from associating with a broker or dealer with a right to reapply after five year. The Respondents also undertook jointly to pay a fine of $500,000 to NSE Amex, LLC and NYSE Arca, Inc., both under terms of agreements with those entities.

Short selling: In the Mater of TJM Proprietary Trading, LLC, Adm. File No. 3-13569 (Aug. 5, 2009) is another settled administrative proceeding based on the naked short selling rules. This action is against TJM Proprietary Trading, a CBOE market maker, and its principal, John Burke, and a trader, Michael Benson. The Order for Proceedings alleges that over a period of seven months beginning in January 2007, Respondents violated the locate requirement of Regulation SHO by using a synthetic long position while shorting the stock. To resolve the action, Respondents consented to the entry of a cease and desist order and a censure against the firm. Mr. Benson was suspended from association with any broker or dealer for three months while Mr. Burke was suspended from acting in a supervisory capacity for nine months.

SEC v. General Electric Co., Civil Action 3:09 cv 1235 (D. Conn. Aug. 4, 2009) is a settled accounting case based on four alleged improprieties as discussed here. Two related to the use of hedge accounting, one concerned the improper acceleration of revenue and one involved a change in accounting to an improper method to avoid a large charge to revenue. Three of the four errors had previously been acknowledged by the company and corrected. To resolve the case GE consented to the entry of a permanent injunction prohibiting future violations of Sections 17(a) of the Securities Act and Sections 10(b), 13(a) and 13(b)(2)(A)&(B) of the Exchange Act. The company also agreed to pay a $50 million civil penalty. With the filing of this action the Commission announced that it had concluded its investigation as to the company. See also Lit. Rel. 21166 (Aug. 4, 2009).

Proxy violations: SEC v. Bank of America Corporation, Case No. 09 CV 6829 (S.D.N.Y. Filed Aug. 3, 2009) is a settled action which alleges violations of Section 14(a) and Rule 14a-9 as discussed here. The Commission’s claims that Bank of America and Merrill Lynch concealed from shareholders voting on the acquisition of the broker by the bank an agreement under which Merrill executives would be paid huge bonuses. The bonuses were listed on an attachment to the merger agreement, the text of which suggested that Merrill was not authorized to pay bonuses. Although the merger agreement was attached to the proxies, the schedule was not.

To settle the action Bank of America consented to the entry of a permanent injunction prohibiting future violations of Section 14(a) and Rule 14a-9. The firm also agreed to pay a civil penalty of $33 million. See Lit. Rel. 21164 (Aug. 3, 2009).

Option backdating: SEC v. Selterman, Civil Action No 09-CV-6813 (S.D.N.Y. Filed Jul. 31, 2009) is a settled option backdating case against Kenneth Selterman, the former General Counsel of Take-Two Interactive Software, Inc., and Patti Tay, the former controller and chief accounting officer of the company. The complaint is based on an option backdating scheme at the company which is discussed here. To settle the case, both defendants consented to the entry of permanent injunctions prohibiting future violations of the antifraud and reporting provisions. Mr. Selterman also agreed to pay disgorgement of about $363,000 along with prejudgment interest. Both defendants agreed to pay a civil penalty of $125,000 and to the entry of an order under Rule 102(e) permanently suspending them from appearing or practicing before the SEC in their respective professions. See also Lit. Rel. 21163 (Aug. 3, 2009).


U.S. v. Naaman, Case No. 1:08-cr-00246 (D.D.C. Filed Aug. 7, 2008) named as a defendant Ousama Naaman, a citizen of the UAE. The indictment alleges violations of the FCPA in connection with the UN Oil for Food Program. The charges, unsealed on July 30, 2009 after the arrest of the defendant in Germany, claim that the Mr. Naaman negotiated contracts for a U.S chemical company and its subsidiary which were increased by 10% to cover a kickback. In exchange for the kickbacks Mr. Naaman received 2% of the contract value. The defendant is also alleged to have paid $150,000 in bribes on behalf of the U.S. company to the Iraqi Ministry of Oil to ensure that a competing product from another company failed a field test. See also Department of Justice Press Release, “Canadian National Charged with Foreign Bribery and Paying Kickbacks Under the Oil for Food Program” (Jul. 31, 2009) (available at

SEC v. Nature’s Sunshine Products, Inc., Case No. 09CV672 (D. Utah Filed Jul. 31, 2009) named as defendants the company and its CEO, Douglas Faggioli and CFO, Craig D. Huff. The complaint is based on payments made in 2000 and 2001 by the Brazilian subsidiary of the company to local regulators as discussed here. The payments were made to circumvent restrictions in Brazil which reclassified certain products as medicines. When the company was unable to register some of its products for import following the implementation of the new regulations it sought to get them into the country by providing cash payments to customs officials. The payments were not properly recorded in the books and records of the company.

To resolve the case, the three defendants consented to the entry of permanent injunctions prohibiting future violations of the antifraud, anti-bribery and books and records and internal control provisions of the federal securities laws. In addition, the company agreed to pay a civil penalty of $600,000 while Messrs Faggioli and Huff each agreed to pay a civil penalty of $25,000. See also Lit. Rel. No. 21162 (Jul. 31, 2009).

U.S. v. Control Components, Inc., Case No. 8:09-cr-00162 (C.D. Cal. Filed July 22, 2009). The company pleaded guilty to a three count information alleging violations of the FCPA and the Travel Act on July 31, 2009. The charges are based on a scheme which began in 2003 and continued through 2007 in which the company, a designer and manufacturer of service control valves, paid about $4.9 million in bribes in violation of the FCPA to officials at various foreign state-owned companies. During that period, the company also paid approximately $1.95 million in bribes in violation of the Travel Act to officers and employees of foreign and domestic privately-owned companies. The payments were made in a number of countries including China, Korea, Malaysia and the UAE.

Earlier this year two former executives of the company pleaded guilty to conspiracy charges based on this conduct and six other former executives of the company were indicted on FCPA charges. See also Department of Justice Press Release, “Control Components Inc. Pleads Guilty to Foreign Bribery Charges and Agrees to Pay $18.2 Million Criminal Fine” (Jul. 31, 2009) available at

An arbitration panel has expelled and permanently barred Legacy Trading Co., LLC and its CEO Mark Uselton from the securities industry. The panel concluded that the firm and its owner had engaged in violations of the short selling rules and well as the requirements for maintaining books and records. The panel also imposed a $1 million fine after concluding that the firm and its owner made almost $900,000 in profits from more than 2,000 transactions over a two year period which violated the short selling rules.

Private Actions

Option backdating: Dilorenzo v. North, Case No. 1:070-cv-00144 (D.D.C. Filed Jan. 18, 2007) is a derivative suit against eight officers and directors of Eplus Inc. base on option backdating claims. The complaint alleges that beginning in 1998 and continuing through March 2005 the company backdated certain option grants. The court dismissed the complaint for two reasons. First, it appears that plaintiff lacked standing since he became a shareholder in October 2003, six years after the first challenged grant. Plaintiff also failed to make a demand and, although demand futility was pleaded, insufficient there were insufficient facts to support the claim.