THIS WEEK IN SECURITIES LITIGATION (December 4, 2009)
Market reform was a key topic on Capital Hill this week, as the House Financial Services Committee reported out and sent to the floor a major piece of market form legislation. During the week, House committees also heard additional testimony on the necessity for comprehensive regulation of the derivatives markets. The SEC Inspector General filed his semi-annual report, listing nine open investigations regarding the Division of Enforcement.
SEC Enforcement is reportedly conducting an insider trading investigation into the hedge fund industry. It is unclear if the inquiry is an off shoot of the on-going Galleon investigation discussed here. https://www.secactions.com/?p=1660 Cases brought by the division this week continued to focus on fraudulent investment funds.
In the seemingly never-ending criminal cases spinning out of Broadcom’s option backdating woes, the court in the criminal case of former CFO Ruehle took the unusual step of immunizing a witness at the request of the defense. At the same time, prosecutors announced that they will retry former Broadcom CEO Reyes.
Financial reform: The House Financial Services Committee will send H.R. 4173 to the floor next week. The bill includes nine major pieces of legislation approved by the committee to address the financial crisis. It includes: consumer protections, creating the new Consumer Financial Protection Agency; a new Financial Stability Council, an inter agency oversight council focused on the “too big to fail” issue; provisions addressing executive compensation by giving shareholders a “say on pay;” creating investor protection by enhancing the SEC’s authority to regulate the markets; providing for the regulation of derivatives by requiring standardized swap transactions to be cleared and traded on an exchange or electronic platform; provisions regarding mortgage reform and anti-predatory lending; providing for the reform of credit rating agencies; regulation of hedge funds; and requiring the office of insurance to monitor the insurance industry.
H.R. 2873 passed the House this week. The bill proposes to amend the securities laws to give the SEC nationwide service of process in court actions initiated by the agency.
Derivatives: CFTC Chairman Gary Gensler testified this week before the House Committee on Energy and Commerce. In part, his testimony focused on what the Chairman called “much-needed regulatory reform of the OTC derivatives marketplace.” According to Mr. Gensler, the value of derivates traded in the U.S. is nearly 20 times the size of the nation’s economy. This means that on average for a $50 tank of gas would have about $1,000 in derivatives behind it. The Chairman focused on two key points, improving transparency and lowering risk. To add transparency, Mr. Gensler advocated moving all standardized OTC derivative transactions onto regulated exchanges and requiring reporting for all others in addition to data reporting for all transactions and stringent record keeping requirements. To lower risk, Mr. Gensler told the Committee that standard transactions should be required to clear through “robustly” regulated central counterparties. If there are exemptions, they should be narrow and limited. He also advocated adequate capital and margin requirements and stringent business conduct standards.
Former CFTC Chairperson Brooklsey Born also testified about the risks of OTC derivatives. Ms. Born cautioned the Joint Economic Committee, as she has others over the years, about the risks of leaving what she called the “dark market” unregulated. In her testimony Ms. Born made three key points. First, there should be no statutory exceptions from the rule that all standardized and standardizable contracts should be traded on an exchange rather than over the counter. Second, only truly customized contracts should be permitted to be traded off an exchange. For those contracts however, at least one party should be required to certify that the contract is a hedge. This eliminates speculative customized contracts. Finally, any continuing over the counter market must be subjected to a robust federal regulatory regime.
SEC Inspector General: The SEC OIG issued its semiannual report to Congress. After reviewing previously announced and complete inquiries for the period April 1, 2009 through September 30, 2009, the report identifies nine pending investigations regarding the Enforcement Division. These include inquiries into: 1) the circumstances surrounding an enforcement action regarding a prominent financial institution and if there were conflicts of interest; 2) a claim that former SEC attorney took confidential investigative materials when he left and provided them to a company for which he went to work as a lobbyist and whether a settlement with the company was adequate in view of the available evidence of fraud; 3) whether Enforcement failed to properly investigate a corporation where there were substantial shareholder losses; 4) a claim of improper conduct by Enforcement attorneys during an investigation; 5) whether an SEC attorney continued with an investigation despite a conflict; 6) whether Enforcement attorneys in a regional office repeatedly and in violation of policy disclosed non-public information about investigations; 7) an investor complaint about a failure to investigate market manipulation; 8) whether Enforcement attorneys had access to evidence demonstrating insider trading prior to closing an investigation; and 9) whether Enforcement opened and investigation into a public company in retaliation for its complaints about naked short selling.
SEC enforcement actions
Financial fraud: SEC v. Canopy Financial, Inc., Case No. 09 cv 7429 (N.D. Ill.) is a financial fraud case brought against a private company and its co-founder as discussed here. https://www.secactions.com/?p=1738 In July and August 2009 the defendants raised $75 million in a private placement from hedge funds and other investors using a false audit opinion and other fraudulent materials. A portion of those proceeds were misappropriated. The SEC obtained an asset freeze. The case is in litigation.
Transfer agents: SEC v. Lund, Case No. 2:09-CV-1050 (D. Utah Nov. 30, 2009) named as defendants Whitney Lund, Sr. and Standard Transfer & Trust. The complaint alleges that the defendants abused their role as a gatekeeper by distributing restricted shares of Mosaic Nutraceuticals Corp. without the proper legends. This was done so Mr. Lund could profit from shares in the company he owned or controlled. The distribution yielded $700,000 in illicit profits. As part of the scheme, Mr. Lund falsified transfer agent records and obtained a false legal opinion to make the distribution appear legitimate. Mr. Lund also gave false testimony during the SEC’s investigation, according to the complaint. The complaint alleges, among other things, violations of the antifraud and registration provisions of the securities laws. The case is in litigation. See also Litig. Rel. 21317 (Dec. 1, 2009).
Investment fund fraud: SEC v. HomePals, LLC, Case No. 09-CV-81524 (S.D. Fla. Filed Oct. 16, 2009). This action against Abner Alabre and others alleged that the defendant ran a Ponzi scheme which targeted Haitian-Americans in South Florida. The complaint claims that about $14.3 million had been raised from investors beginning in April 2008 and continuing through the end of that year by selling unsecured notes which guaranteed a 100% return every 90 days. This week, Mr. Alabre consented to the entry of a permanent injunction prohibiting future violations of the registration provisions of the Securities Act and the antifraud provisions of that Act as well as the Exchange Act. The amount of disgorgement and any penalty will be determined by the court. See also Litig. Rel. 21316 (Dec. 1, 2009).
Financial fraud: SEC v. Fradella, Case No. 3:09-cv-02269 (N.D. Tex. Nov. 30, 2009) names as defendants Home Solutions of America, Inc. and several of its executives. The complaint alleges that between 2005 and 2006 following Hurricane Katrina the company issued false press releases and made false filings with the Commission boasting multimillion dollar contracts and robust financial results. The stock price soared but later fell. The CEO and others engaged in two other schemes to inflate the results of the company. In one expenses were improperly deferred. In the other more than $9 million of fake revenue based on undisclosed related party transactions was booked. The company was delisted from the NASDAQ National Market in January 2008. The Commission also brought an action for failure to file periodic reports. The complaint alleges violations of the registration, antifraud and books and records provisions of the securities laws. The case is in litigation. See also Litig. Rel. 21314 (Nov. 30, 2009).
U.S. v. Ruehle, discussed here, is the criminal case against the former Broadcom Corp. CFO arising out of the option backdating practices at the company. This week Judge Cormac Carney took the rare step of granting judicial immunity to a witness. Specifically, company co-founder Henry Samueli will be immunized by the court and compelled to testify in response to a defense motion.
U.S. v. Reyes, discussed here, is the criminal case against the former Brocade CEO whose conviction was reversed by the Ninth Circuit. The government announced that they will retry Mr. Reyes.
U.S. v. Rothstein, Case No. 0:09-cr-60331 (S.D. Fla. Filed Dec. 1, 2009) charges Fort Lauderdale attorney Scott Rothstein, with operating a billion dollar Ponzi scheme. Specifically, the information claims that, from 2005 through November 2009, Mr. Rothstein engaged in a pattern of racketeering activity through his law firm which is alleged to be a criminal enterprise. The firm was used by Mr. Rothstein and other alleged co-conspirators to fraudulently induce investors to loan money to non-existent borrowers based on promissory notes and requests for short term bridge loans for business financing and to invest funds based upon anticipated pay-outs from claimed confidential civil settlements. As part of the scheme, the defendant and his law firm allegedly filed a law suit on behalf of plaintiffs, settled it in favor of the defendants under terms which obligated the plaintiffs to pay $500,000 and then created a false court order and judgment showing that plaintiffs won $23 million. The clients were told that the defendants had transferred the funds off shore and to recover them they had to post bonds. This sham transaction generated $53 million.
U.S. v. Lawton, Case No. 0:09-cr-00319 (D. Minn. Filed Oct. 30, 2009) defendant John Lawton, the operator of hedge fund Crossroad’s Paramount Partners pleaded guilty to mail fraud and making a false statement. Mr. Lawton acknowledged overstating the assets of the fund to conceal losses and creating false monthly statements showing a positive performance for investors.
Trend of cases: Recent reports detail the fact that the number of private securities damage suits filed to date had declined. If the trend continues this year may be the lowest for filings in years. A report by Sheri Qualters at Law.com paints a potentially different picture. The report suggests that in fact plaintiffs are being named in securities fraud suits months and years after the events, in contrast to prior practice where suits were filed much more quickly. Some lawyers interviewed for the November 30, 2009 article reported they were working through a “backlog of targets.”
A perusal through press releases at locations such as the Business Wire reveals a number of announcements from plaintiffs firms detailing investigations of corporate activity. All of this suggests that, while the number of class action filings is at this point down, it may not stay that way in the future.
Plumbers and Pipefitters Local v. Zimmer Holdings, Inc., Case No. 1:08-cv-01041 (S.D. Ind. Filed Aug. 5, 2008) is a securities class action against the company and two of its officers. The complaint claims that the defendants withheld information about production issues at one plant and difficulties with a hip replacement product. The court dismissed the complaint concluding that it failed to adequately plead scienter. Plaintiffs relied on information from a dozen confidential witnesses.
Morrison v. National Australia Bank Ltd., Case No. 08-1191 is the Second Circuit’s “foreign-cubed” decision discussed here. The Supreme Court agreed to hear the case earlier this week. The case centers on the claimed manipulation of financial data in the U.S. subsidiary of an Australian bank. The bank’s shares are traded in Australia and its ADRs are listed in the U.S. The suit is on behalf of the Australian shareholders. The Second Circuit affirmed the dismissal of the complaint for lack of jurisdiction. The Solicitor General recommended that the Court not hear the case.
Merck & Co. v. Reynolds, Case No. 08-905, was argued this week as discussed here. The case focuses on what triggers the commencement of the two year limitation period of 28 U.S.C. § 1658(b)(1) and whether the concept of inquiry notice applies.