Financial reform efforts continued on Capital Hill this week with testimony about the so-called Volker Rule which some call “Glass Steagall lite.” SEC Chairman Mary Schapiro met with her counter parts at the FSA in London to discuss coordination on topics such as rating agencies and hedge funds.

The SEC and Bank of America are trying again to settle their dispute centered on the Bank’s acquisition of Merrill Lynch, while the NY AG brought a civil fraud action against the bank and two of its officers, also centered on the Merrill acquisition. Other SEC enforcement actions centered on disclosure questions, insider trading and an offering fraud. The U.S. Attorney’s Office in New York unsealed another insider trading case in which the defendant pleaded guilty and is cooperating in the Galleon investigation. FINRA resolved two actions regarding a failure to have adequate anti-money laundering procedures. Finally, one of the very few securities class actions to proceed to trial resulted in a jury verdict for the plaintiffs.

Reform efforts

The Volker Rule: Paul Volker, former Chairman of the Federal Reserve and current Chairman of the President’s Economic Recovery Advisory Board, testified before the Senate Banking Committee this week on the so-called “Volker Rule.” Mr. Volker’s approach is designed to preclude banks from engaging in speculative activities centered on proprietary trading. While the precise terms of the plan have not been defined, many have called it “Glass Steagall lite.”

SEC – FSA Dialogue: The SEC and FSA held the fifth meeting in their on-going strategic dialogue this week. SEC Chairman Mary Schapiro met with U.S Financial Services Authority Chairman Adair Turner and Chief Executive Hector Sants in London. The discussions focused on cooperation between the staff members of the two agencies in areas which include oversight of credit rating agencies, hedge fund advisers and the clearing of OTC derivatives.

Bank of America

The SEC and Bank of America have reached a tentative settlement of the Commission’s cases arising out of the acquisition of Merrill Lynch by the Bank. SEC v. Bank of America Corporation, Case Nos. 09 -5829 & 10-0215 (S.D.N.Y.). See also Litig. Rel. 21407 (Feb. 4, 2010). According to the SEC’s complaint, the Bank misled shareholders in the proxy materials submitted in connection with seeking approval of the acquisition by omitting a key schedule noting that billions of dollars in bonuses had been approved for Merrill employees. The court previously rejected a proposed settlement in which the Bank would have consented to a permanent injunction which prohibited future violations of Section 14(a) of the Exchange Act and would have required the payment of a $33 million fine as discussed here.

Under the terms of the new proposed settlement, Bank of America will consent to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 14(a). The firm has also agreed to pay a civil penalty of $150 million which will be distributed to shareholders through fair funds. In addition, the bank also agreed to institute for a three year period a number of corporate governance provisions. Those include: an audit of internal disclosure controls; having the CEO and CFO execute certifications as to all annual and merger proxy statements; having the Audit Committee retain special counsel with expertise in disclosure issues; using a super independence standard for compensation committee members; maintaining a super independent compensation consultant; giving shareholders a say on pay; and implementing and maintaining incentive compensation principles that will be posed on its website.

An unusual feature of the proposed settlement is a Statement of Facts prepared by the staff. The Bank acknowledged that there is an evidentiary basis for the detailed factual recitations in the statement regarding the acquisition of Merrill Lynch. The statement is based on the discovery record in the case. The SEC has also filed a second complaint, discussed here, based on claims relating to the failure of the bank to update shareholders on the deteriorating financial condition of Merrill Lynch. That action is pending.

The New York AG filed an action against Bank of America and two of its former officers, Kenneth Lewis, former Chairman and CEO, and Joseph Price, former CFO. The People of the State of New York v. Bank of America, (S.Ct. of N.Y. Filed Feb. 4, 2010). The complaint centers on the acquisition of Merrill Lynch by the bank. The factual allegations focus largely on the failure of the Bank to update shareholders about the rapidly deteriorating financial condition of the broker prior to the shareholder vote on the deal, alleged misrepresentations about the deal made to the U.S. Government to obtain financial assistance and the false proxy materials used to solicit shareholder votes for the deal. The complaint seeks injunctive relief, disgorgement, penalties and attorneys fees.

SEC enforcement actions

Disclosure: SEC v. State Street Bank and Trust Co., Case No. 1:10-CV-10172 (D. Mass. Filed Feb. 4, 2010); In the Matter of State Street Bank and Trust Co. , Adm. Proc. File No. 3-13776 (Filed Feb. 4, 2010) are actions against the Bank relating to its sale of shares in the Limited Duration Bond Fund. According to the SEC, State Street sold shares in this fund as an “enhanced cash” investment strategy that was an alternative to a money market fund for some investors. In fact, the fund was invested almost entirely in sub-prime residential mortgages.

The Bank also sent investors a series of misleading communications about the Fund as the market unraveled. To resolve the case, the Bank consented to the entry of a judgment in the court action which orders it to pay a civil penalty of $50 million, disgorgement of about $7.3 million and about $1 million in prejudgment interest, all of which will be paid into a fair fund along. In addition State Street agreed to pay an additional $225 million to compensate investors. See also Litig. Rel 21408 (Feb. 4, 2010). Previously, the bank paid $340 million to some harmed investors in private actions. State Street also agreed to retain an Independent Compliance Consultant to conduct a comprehensive review of its disclosure and compliance procedures. In the administrative proceeding, the Bank agreed to an order requiring it to cease and desist from future violations of Securities Act Sections 17(a)(2) & (3).

Insider trading: SEC v. Levinberg, Case No. 10-CV-777 (S.D.N.Y. Filed Feb. 2, 2010) centers on the acquisition of Scopus Video Networks, Ltd. by Harmonic Inc. in December 2008. For several months prior to the acquisition, Scopus attempted to interest Gilat Satellite Networks in acquiring it. In an initial meeting with the defendant, an officer of Gilat, Scopus furnished confidential information about the company as a take over target. Those discussions failed. However, defendant purchased shares of Scopus prior to the take over announcement. Those shares were sold after the announcement at a profit of $187,996.48. To resolve this action, Mr. Levinberg consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Exchange Act. He also agreed to disgorge his trading profits, pay prejudgment interest and a penalty equal to those profits. See also Litig. Rel. 21405 (Feb. 3, 2010).

Insider trading: SEC v. Macdonald, Case No. 3:10cv151 (D. Conn. Filed Feb 2, 2010) is a pillow talk case in which defendant Bruce Macdonald is alleged to have misappropriated inside information from his wife, traded for his account and that of a friend and tipped others as discussed here. Mr. Macdonald’s wife is the corporate secretary and vice president of human resources of Memry Corporation which had put itself up for sale. Throughout a process which led to the acquisition of the company in 2008, she was involved at each key step. As the process unfolded, Mrs. Macdonald updated her husband.

Without informing his wife, Mr. Macdonald purchased shares of the company in his business account and in the account of a long time friend for whom he regularly traded, Bruce Bohlander, a relief defendant. He also tipped three friends, including Defendant Robert Maresca. Mr. Maresca subsequently purchased 9,000 shares of stock. As a result of the trading, Mr. Macdonald had ill-gotten gains of $890 in his account and $25,508 in Mr. Bohlander’s account. Mr. Maresca had gains of $12,335, while the two unidentified traders made $7,307.50.

To resolve the case Messrs. Macdonald and Maresca consented to the entry of permanent injunctions prohibiting future violations of the antifraud provisions of the Exchange Act. Each man also agreed to the entry of an order requiring him to disgorge the trading profits along with prejudgment interest and to pay a penalty equal to the trading profits. Mr. Bohlander consented to the entry of a final judgment requiring him to disgorge the trading profits and pay judgment interest. See also Litig. Rel. 21404 (Feb. 2, 2010).

Aiding and abetting: SEC v. Cohmad Securities Corporation, Case No. 1:09-cv-05680 (S.D.N.Y. Filed June 22, 2009) is a complaint against broker dealer Cohmad Securities and its chairman Maurice Cohn, chief operating officer Marcia Cohn and registered representative Robert Jaffee. It alleges that the defendants aided and abetted Bernard Madoff’s Ponzi scheme by raising more than $1 billion from investors. This week, the court dismissed the complaint with leave to replead. The court concluded that the complaint failed to adequately plead facts demonstrating that the defendants would have been on notice of the Madoff fraud.

Offering fraud: SEC v. Winning Kids, Inc., Case NO. 10-CV-80186 (S.D. Fla. Filed Jan. 29, 2010) is an action against the company, its founder and CEO Christian Hainsworth and three former sales agents. The complaint claims that the defendants raised about $2 million from investors, supposedly for the development and marketing of books for children. According to the complaint, investors were sold unregistered securities and falsely told that the company was established and expanding nationwide. They were also provided with baseless financial projects depicting significant growth. In fact, the company had almost no revenue from the sale of books or any other product. The company and defendant Hainsworth have consented to the entry of a final judgment that enjoins them from future violations of the registration and antifraud provisions. It also orders them to pay disgorgement, prejudgment interest and civil penalties in amounts to be determined by the court. See also Litig. Rel. 21400 (Feb. 2, 2010).

Criminal cases

Insider trading: U.S. v. Slaine, Case No. 1:10-cv-00754 (S.D.N.Y. Unsealed Feb. 2, 2010) and SEC v. Slaine, Civil Action No. 10 CV 754 (S.D.N.Y. Filed Feb. 10, 2010). Defendant David Slaine was charged with, and pleaded guilty to, participating in an insider trading scheme based on material nonpublic information from former UBS analyst Mitchel Guttenberg, discussed here. Mr. Slaine pleaded guilty to conspiracy and securities fraud charges in December 2009, but the indictment remained sealed this week. Mr. Slaine is alleged to have received information about UBS investment recommendations prior to their release to the public indirectly from Mr. Guttenberg between 2001 and 2006. The information came through Erik Franklin, an analyst for Chelsey Capital. Mr. Slaine, in turn, traded for his employer’s account, Chelsey Capital, and his personal account.

Overall, Mr. Slaine made over $3 million in profits for Chelsey as a result of the information he obtained from Mr. Guttenberg through Erik Franklin. In his personal account during 2002, he made over 20 trades yielding more than $500,000 in profits from the UBS information. In the criminal case, a date for sentencing has not been set. The SEC case has not been resolved. Previously the SEC settled insider trading charges with Chelsey Capital and Mr. Franklin in connection with the resolution of the Guttenberg case as discussed here. See also Litig. Rel. 21403 (Feb. 2, 2010).

Mr. Slaine also worked at Galleon at one time (discussed here). Reportedly he is assisting prosecutors in that investigation.


Two firms were fined for failing to have adequate anti-money laundering programs. Penson Financial Services, a Dallas based securities clearing firm, failed from October 1, 2003 through May 31, 2009 to adequately establish and implement its anti-money laundering program. In fact, even after the firm installed a sophisticated automated system in December 2007, it failed to conduct timely inquiries of suspicious activity. The firm consented to pay a fine of $450,000.

Pinnacle Capital Markets, which operates an online business providing primarily foreign customers with direct access to the U.S. securities markets, was fined $300,000 for similar violations.

Circuit courts

In The New York City Employees Retirement System v. Jobs, Case No. 5:06-CV-05208 (9th Cir. Decided Jan. 28, 2009), the court held that dilution alone is insufficient to establish loss causation as discussed here. The class action complaint against Apple, Inc. and fourteen of its directors and officers, alleged violations of Exchange Act Sections 14(a) and 20(a) for a misleading 2005 proxy solicitation. Based on option backdating claims, plaintiffs claimed that from 1996 through 2005 Apple shareholders unwittingly approved the issuance of 205 million shares based on a series of false statements. This resulted in a 20% dilution. The complaint sought rescission of the votes, compensatory damages for the share dilution, an accounting and attorney’s fees and costs.

The district court dismissed the Section 14(a) claims without leave to amend. The Ninth Circuit affirmed the dismissal, but remanded to permit plaintiffs to amend. To establish a claim under Section 14(a) the court held, a securities law plaintiff must plead loss causation. Here, the only claim is that stock ownership was diluted by 20%. Economic loss does not necessarily accompany dilution however, according to the court. Accordingly, a claim of dilution, standing alone, is not sufficient to plead loss causation.

Private actions

In Re Vivendi Universal SA Sec. Litig., Case No. 02-cv-5571 (S.D.N.Y.) is one of the few securities class actions to be tried to verdict before a jury. In this case, the jury returned a verdict against the company, concluding that it had made 57 false statements which improperly inflated its share price. The complaint claimed that, from 1996 through 2002, the company went on a multi-billion dollar acquisition spree, transforming itself from a French water company into the world’s largest music company. The misstatements were made over a two year period beginning in 2000 to mask the true financial condition of the company. The amount of damages has not been determined.