Reform efforts continued this week with the introduction of a bill in the House of Representatives focused on the risk posed by large companies. The Galleon cases continued to move forward with the return of indictments against seven more individuals. SEC enforcement focused on insider trading and short selling actions. FCPA enforcement received a set back in a major case, however, from a ruling in the Bahamas.

In the circuit courts, the PSLRA scienter pleading requirements continued to have a significant impact. In private actions, another derivative suit based on option backdating claims settled.

Reform efforts

H.R. 4516, titled The Financial Services Industry Stability Act of 2010, was introduced in the House of Representatives on January 26, 2010. In general, the Act charges the head of each Federal department or agency, in consultation with the Chairman of the Federal Reserve, to “take such steps as may be necessary to ensure that no financial company is able to pose a systemic risk to the health of the United States economy by becoming to large to fail.” A report on this matter is to be filed annually with Congress.

SEC enforcement actions

Offering fraud: SEC v. Tsukuda-America Inc., Case No. 3:10-CV-00136-M (N.D. Tex. Filed Jan. 28, 2010) is an action against the company and its principal John Petros alleging fraud in connection with a $600,000 offering. According to the complaint, the registration statement contained: a forged audit report; a false identification of the transfer agent; a bogus legal opinion and geologist report; and sham consents from an attorney and geologist who did not exist. The complaint alleges violations of Securities Act Section 17(a). A related administrative proceeding based on Securities Act Section 8(d) was previously filed. In the Matter of Registration Statement of Tsukuda-America Inc., Adm. Proc. File No. 3-13761 (Jan. 26, 2010).

Short selling: In the Matter of Palmyra Capital Advisors LLC, Adm. Proc. File No. 3-13783 (Jan. 26, 2010). Palmyra Capital Advisors is an LA-based hedge fund manager that advises three limited partnerships. The three funds, according to the SEC, sold short 50,000 shares of Capital One in mid-September 2008. About one week later, Capital One announced the pricing for a secondary offering at about $6 per share under the price at which the three funds had sold short. The three funds subsequently received 50,000 shares in the offering yielding a profit of $225,000 in violation of Regulation M as discussed here.

To settle the action, Palmyra consented to the entry of a censure. The firm also agreed to pay disgorgement of $225,000, prejudgment interest and a civil penalty of $105,000. In settling this matter, the SEC considered the prompt remedial actions of the Respondent and its cooperation.

Short selling: In the Matter of AGB Partners LLC, Adm. Proc. File No. 3-13764 (Jan. 26, 2010). Investment adviser AGB Partners advised two private funds. One account belonged to AGB Partners. A second belonged to Del Rey Management. Respondents violated Regulation M in two transactions, according to the Order. In one deal AGB Partners sold short 173,632 shares of Boots and Coots in April 2007. Shortly thereafter, 35,000 shares acquired in a secondary offering by Del Rey were used to cover part of the short position. This transaction yielded a profit of $16,450.

In a second transaction, BCG priced its secondary offering at $8 per share in June 2008. Del Rey purchased 200,000 shares in the offering. The prior month AGB Partners sold short 16,200 shares of BGC Partners at an average price of $8.45 per share. By participating in the secondary offering, a virtually risk free profit of $14,704 was made. Both transactions violated Regulation M, according to the Order. To settle the action, Respondents consented to the entry of a censure. In addition, they agreed to disgorge trading profits of about $38,000 along with prejudgment interest and to pay a civil penalty of $20,000.

Insider trading: SEC v. Nothern, Civil Act No. 05-CV-10983 (D. Mass. Filed May 12, 2005). Steven Nothern, a former executive at Massachusetts Financial Services, is the last defendant to resolve a long running insider trading case as discussed here. According to the SEC, Mr. Nothern was provided with material non-public information from an agent who attended the Treasury Department’s quarterly refunding press conferences. At an October 31, 2003 conference, Treasury announced that it would suspend issuance of the 30 year bond later that morning. The news was embargoed until 10:00 a.m. Mr. Nothern obtained this information from the agent who attended the conference. Mr. Nothern and the two traders to whom he provided the inside information traded for three MFS funds. When the news was made public the price of the bonds soared. The three funds made profits of $3.1 million.

To settle the action, Mr. Nothern consented to the entry of a permanent injunction prohibiting future violations of Section 10(b) of the Exchange Act and Rule 10b-5. Mr. Nothern also agreed to pay a civil penalty of $460,000. The settlement followed a jury trial that concluded in June 2009 in favor of the Commission. The agent and another market professional who traded after being tipped both pleaded guilty to criminal charges. Mr. Nothern was not charged criminally.

Insider trading: SEC v. Fogel, Case No. 1:10-CV-10097 (D. Mass. Jan. 22, 2010). This is a settled insider trading case against Avi Fogel, the former Vice President of strategic initiatives at EMC Corporation as discussed here. It centers on the acquisition of Document Sciences Corporation, or DOCX, a global provider of customer communications management solutions by EMC. The public announcement of the deal was made prior to the opening of the markets on December 27, 2007. Although Mr. Fogel was part of the team which worked on the acquisition, shortly prior to the public announcement, he purchased 30,000 shares of DOCX stock in two transactions. Following the announcement, the share prices increased from just over $8 to over $14 for a 76% increase.

To settle the case, Mr. Fogel consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions. He also agreed to disgorge $191,393, pay prejudgment interest of $14,639.62 and to pay a penalty of $191,363. See also Litig. Rel. 21392 (Jan. 22 2010).


U.S. v. Kozeny, Case No. 1:05-cr-00518 (S.D.N.Y.) is an FCPA case in which Frederic Bourke, co-founder of handbag maker Dooney & Bourke, was convicted last year and sentenced to a year and a day in prison as discussed here. The case is based on a scheme to bribe government officials in Azerbaijan to ensure that they would privatize the State Oil Company in a rigged auction. This would permit a consortium in which he was a member to profit. Defendant Viktor Kozeny has been at large. This week, a court in the Bahamas rejected a U.S. request to extradite Mr. Kozeny who has resided in the Bahamas since 1995. The ruling was based on the requirement that for extradition the charges must be an offense under the laws of both countries.

Criminal cases

Galleon insider trading cases: This week seven more individuals were indicted in this on-going insider trading investigation discussed here. The seven defendants are among the fourteen charged earlier. They are: Zvi Goffer, formerly a Galleon employee and trader at Schottenfeld Group; Arthur Cutillo of Ropes & Gray; Jason Goldfarb, an attorney; Craig Drimal, a trader who worked at Galleon; Emanuel Goffer; Michael Kimelman of Incremental Capital; and David Plate of the same firm. U.S. v. Goffer, Case No. 1:10-cr-0056 (S.D.N.Y. Filed Jan. 21, 2010).

Circuit courts

Edward J. Goodman Life Income Trust v. Jabil Circuit, Inc., No. 09-10954 (11th Cir Decided Jan. 19, 2010) affirmed the dismissal of a securities class action for failure to plead scienter as discussed here. Plaintiffs alleged in their complaint against the technology company and certain of its officers that the defendants had fraudulently backdated stock option grants, causing earnings to be overstated by $54.3 million. This caused a restatement. A company inquiry concluded that there was no evidence of high level employees issuing themselves backdated options. The applicable accounting principles however had been misapplied.

In affirming dismissal, the circuit court concluded that scienter had not been adequately pleaded under Tellabs, Inc. v. Makor Issues & Rights, 551 U.S. 308 (2007) (discussed here). The standard for scienter in the eleventh circuit is “severe recklessness.” Although the plaintiffs did not plead particularized facts that any individual officer knew about the option practices, they claimed that the restatement is a virtual admission of liability, particularly in view of its magnitude. Plaintiff sought to bolster this claim by arguing that a significant percentage net income was misstated each year. The court rejected these claims. Backdating options is not, in and of itself, improper the court noted. The critical question is whether the accounting is done correctly. Here, there are no facts to demonstrate that any individual defendant knew the accounting standards had been violated. Likewise, plaintiffs’ claims regarding the percentage of net income are unavailing because net income is a variable metric. Finally, plaintiff’s contention that the amount of the misstatement was so large that it must have been a red flag does not demonstrate a strong inference of scienter.

Private actions

In re Black Box Corporation Derivative Litig., Case No. 2:06-cv-01531 (W.D. Pa. Filed Nov. 16, 2006) is a shareholders derivative suit based on option backdating claims. The complaint notes that in the 2007 Black Box restated 12 years of quarterly and annual financial reports because it had mispriced $71 million of options. The parties have agreed to settle the case with a payment of $6 million plus $1.6 million in attorney fees. Previously, the former CFO of the company settled an enforcement action based on option backdating claims with the SEC.


A new report by NERA on Trends in Canadian Securities Class Actions notes that for 2009 the number of filings remained above historical averages. In 2009, the number of suits filed declined to eight from ten the prior year but remained above the historical average. This type of suit is just developing in Canada. Settlement values in 2009 declined compared to 2008.


Trends in SEC Enforcement 2010, a web cast by Thomas O. Gorman, Tuesday, February 2, 2010 from 12:00 p.m. to 1:00 p.m. Sponsored by West Legal Ed and Celesq Legal Ed.