The Supreme Court continues to grant certiorari in securities cases. This week the High Court agreed to hear a case involving the application of the statute of limitations in Exchange Act Section 16(b) case.

The Commission had mixed results in court this week, losing an action centered on the sale of auction rate securities while prevailing in a financial fraud case in the court of appeals. New statistics regarding the enforcement program suggest that while it is filing cases at about the same rate as last year the mix may be changing with the number of FCPA cases increasing while insider trading cases are decreasing.

More blue collar tactics may be on the way. The Commission filed four stock manipulation cases based on a sting operation this week. The agency also settled an auction rate securities case and filed a financial fraud action.

In criminal cases the former chairman of Taylor Bean was given a long prison term. Another of the Galleon related defendants was also sentenced to prison.

The Commission

Whistleblowers: The Commission delegated authority to the Director of the Division of Enforcement to disclose information that could reasonably be expected to reveal he identity of a whistleblower to those authorized to receive such disclosures under Dodd-Frank without a loss of confidentiality. Release No. 34-64778.

Security-based swaps: The SEC issued proposed rules that would impose certain business conduct standards on security-based swap dealers and major security-based swap participants when the parties engage in security-based swap transactions (here).

Congressional inquiry: Representative Edward Markey, in a letter to SEC Chairman Mary Schapiro dated June 27, 2011, inquired about a rule change by the SEC in 2008 that essentially liberalized how natural gas companies reported reserves. The letter, referencing a New York Times article of June 27, 2011, notes that in 2008 natural gas company stocks were “declining due to the financial meltdown, recession fears, and falling gas prices, but . .. they began to rebound after a rule change by the Commission allowed the[sic] much greater latitude on how they reported their natural gas reserves.” The letter goes on to inquire about the nature and impact of the rule change.

SEC settlement trends: SEC enforcement statistics for the first half of this fiscal year may reflect changing trends. The number of cases the Commission settled during the period puts it on track to slightly exceed the number from last year, according to a report released by NERA Economic Consulting (here). To date the SEC has settled with 344 defendants. If this trend continues 688 cases will be settled this year, up slightly compared to the 681 for the prior year. Perhaps the most significant statistics are those regarding FCPA and insider trading cases. In the first half of the year the SEC settled 26 FCPA cases. If this trend continues it will be the largest number of post SOX FCPA settlements. The median settlement value also increased, up 40% relative to the post-SOX average. Settlements in insider trading cases however declined significantly. In the first half of the year the Commission settled 25 insider trading cases which projects to 50 for the year. This would be the lowest post-SOX year if the trend continues. In contrast the median settlement value for cases with individuals is $203,000. If this trend continues it would be the largest since 2002.

Supreme Court

The Court granted certiorari in Credit Suisse Securities LLC v. Simmonds, No. 1261. The issue the Court agreed to hear is whether the two year statute of limitations which applies to Section 16(b) claims under the Exchange Act can be tolled and, if so, the impact on that tolling if actual notice of the facts giving rise to the claim is received.

SEC enforcement – litigated cases

Auction rate securities: SEC v. Morgan Keegan & Co., Inc., Civil Action No. 1:09-cv-1965 (N.D. Ga. Opinion and Order dated June 28, 2011). Morgan Keegan prevailed on a motion for summary judgment in this action. The Commission brought the case claiming that as the auction rate securities market was collapsing the firm continued to sell the securities based on misrepresentations. Specifically, the SEC presented evidence from four investors that statements were made to them such as ARS are “as good as cash,” or the product is “cash equivalents to CDs and money market” or similar statements. In contrast Morgan Keegan pointed to five written disclosures either furnished or made available to investors which detailed the risks of ARS including the prospect of market failure.

On this record the court granted summary judgment in favor of Morgan Keegan. First, the SEC claimed that the oral misrepresentations were sufficient to support its claims under Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c). In making this argument the Commission claimed the firm did not do enough to ensure that customers read the written materials or to adequately distribute them. The court rejected this argument noting that Morgan Keegan does not have a duty to give each customer a copy of the disclosures and ensure that they are read as contended by the SEC. In any event the confirmations notified the customer that the transaction could be rescinded which is sufficient.

Second, statements from four investors are insufficient to conclude that the entire firm is liable in an enforcement action. While oral misrepresentations that conflict with written disclosures may, in certain circumstances, be a basis for liability but here the evidence is simply insufficient the court concluded. This is particularly true in view of the multiple disclosure documents available to customers.

Insider trading: In the Matter of Rajat K. Gupta, Adm. Proc. File No. 3-14279 is the proceeding against former Goldman Sachs director Rajat Gupta. The action had been scheduled for trial on July 18, 2011. The court granted a motion of the parties requesting a stay of the proceeding for six months. The judge did not set a new trial date in the order.

Unprofessional conduct: In the Matter of Dohan + Company CPA, Adm. Proc. File No. 3-13997 is a proceeding based on Rule 102(e) of the Commission’s Rules of Practice which names, among others, Erez Bahar, CA, a licensed Chartered Accountant in Canada with the firm of Davidson & company LLP. He served as the manager on the audits of International Commercial Television, Inc. That company is a defendant in a settled Commission enforcement action which alleged that in 2007 and the first two quarters of 2008 the revenue of the company was improperly inflated because it booked the proceeds from sales in violation of GAAP. In this proceeding Mr. Bahar was charged with improper professional conduct for failing to adequately supervise the audits. After a hearing, ALJ Carol Fox Foelak issued an Initial Decision which concluded that the Respondent had violated Rule 102(e). Specifically, the decision concludes that Mr. Bahar failed to properly plan the engagement, to consider the possibility of fraud, to conduct a walk through, to obtain certain evidential matter regarding the sales transactions and ignored repeated red flags in reviewing the work papers. Accordingly he is denied the privilege of appearing and practicing before the Commission for a period of two years.

SEC enforcement – filings and settlements

Manipulation: SEC v. Gibson, Civil Action No. 0:11-cv-61458 (S.D.Fla. Filed June 30, 2011); SEC v. Newton, Civil Action No. 0:11-cv-61455 (S.D.Fla. Filed June 30, 2011); SEC v. Klein, Civil Action No. 0:11-cv-61457 (S.D.Fla. Filed June 30, 2011); SEC v. Schroepfer, Civil Action No. 0:11-cv-61454 (S.D.Fla. Filed June 30, 2011) are four actions which charge three CEOs and their companies along with two penny stock promoters with manipulating various stocks. One scheme centered on paying bribes and kickbacks to a corrupt pension fund manager while in another payments were made to a stock broker. The payments were made to have the stock traded in a manner which is manipulative. In fact the payments were made to under cover FBI agents. The complaint allege violations of Securities Act Sections 17(a) and Exchange Act Section 10(b). The cases are in litigation.

Inadequate controls: In the Matter of Labarge, Inc., Adm. Proc. File No. 3-14447 (June 30, 2011) is a proceeding which names as a Respondent a manufacturer of electronic components for use in military, aviation and other industrial equipment. According to the Order, in 2006 and 2007 the company had inadequate internal controls regarding its use of estimates of completion costs for certain long term production contracts. The estimates were used to determine cost of sales and net earnings. As a result of the inadequate controls the company had inaccurate books and records in violation of Exchange Act Sections 13(a), 13(b)(2)(B) and 13(b)(2)(B). The company resolved the matter by consenting to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay a civil penalty of $200,000.

ARS: In the Matter of Raymond James & Associates, Inc., Adm. Proc. File No. 3-14445 (June 29, 2011). The Order for Proceedings alleges that the firm failed to properly disclose the risks associated with auction rate securities to some of its customers. Although following the sale customers were warned about the consequences of auction failure, some financial advisers told investors the securities were safe and liquid. The firm resolved the matter by agreeing to implement certain procedures including a program under which specified ARS would be repurchased. It also agreed to the entry of a cease and desist order based on Securities Act Section 17(a)(2). A penalty was not imposed at this time but the Division has the right to petition the Commission to reopen this matter if Respondent fails to fully implement its undertakings.

Rule 105, Reg M: In the Matter of Level Global Investors, L.P., Adm. Proc. File No. 3-14443 (June 28, 2011) is an action against the firm which is an investment adviser for two hedge funds. The action alleges two violations of Rule 105 of Regulation M. The Rule prohibits short selling of equity securities during a restricted period prior to a public offering and then repurchasing those securities in the offering. Respondent violated this Rule in April 2009 in connection with short sales in a public offering by Goldman Sachs. As a result it made profits of $298,415. In May 2009 the firm also violated the Rule with respect to transactions in the shares of Regions Financial Corporation from which it made a profit of $2,381,100. To resolve the matter the firm consented to the entry of a cease and desist order based on Rule 105 of Regulation M. The firm also agreed to pay disgorgement of $2,679,515 along with prejudgment interest. In resolving the case the Commission took into consideration the remedial efforts of the firm and its cooperation.

Rule 105, Reg M: In the Matter of Brookside Capital, LLC, Adm. Proc. File No. 3226 (June 28, 2011) is an action against a registered investment adviser for a violation of the Rule in connection with the offering of shares in Lincoln National Corporation Company. As a result of the violation the firm made profits of $1,658,660. The matter was resolved with Respondent consenting to the entry of a cease and desist order based on Rule 105 Reg M. It also agreed to pay disgorgement of $1,658,660 along with prejudgment interest and a civil penalty of $375,000. The settlement takes into account the remedial efforts of the firm and its cooperation.

Financial fraud: SEC v. Jensen, Civil Action No. CV 11-05316 (C.D. Cal. Filed June 27, 2011) names as defendants the founder of Basin Water, Inc. and its Chairman and CEO, Peter Jensen and the Chief Financial officer Thomas Tekulve. In the first quarter of 2006 the two defendants began fraudulently inflating the revenue of the company by booking contingent sales, recording sales in the wrong quarter and similar techniques. As a result Basin’s revenues were overstated by 13% in 2006 and 74% in 2007 according to the complaint. Just prior to the announcement of a restatement in February 2009, Mr. Jensen sold about 1.6 million shares of stock yielding over $9 million in insider trading profits while donating another 290,000 shares to charity to obtain a tax deduction. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(5) and 20(a). The complaint also alleges that the defendants failed to comply with Section 304(a) of SOX. The case is in litigation.

Sale of unregistered shares: SEC v. Verdiramo, Civil Action No. 10-CIV-1888 (S.D.N.Y.) is an action alleging the sale of unregistered securities and insider trading. The complaint names Richard Verdiramo, Vincent Verdiramo, Edward Meyer and Victoria Chen as defendants. This week Mr. Meyer settled with the SEC. As to him the compliant claimed that after acquiring shares of RECOV Energy Corporation when he and Ms. Chen entered into a contract to purchase a controlling interest in the company he sold them. At the time the shares were unregistered. The insider trading claim is based on allegations that while working as a consultant for a private company that entered into merger discussions with RECOV, he traded in the shares of the company while the discussions were non-public. To settle the case Mr. Meyer consented to the entry of a permanent injunction prohibiting future violations of the antifraud and registration provisions. In addition, he agreed to pay disgorgement of $62,050 and a civil penalty of $62,000. Under the order he will also be barred from participating in any penny stock offering or serving as an officer or director of a public company.

Advanced fee scheme: SEC v. Elite Resources, Civil Action No. 1:10-cv-3522 (N.D. Ga.) is an action against the company, various related entities and its principals Diane Gruber and Kadar Josey. The complaint alleged that the defendants raised about $2.85 million from at least nine investors. Investors were told that they could draw on bank guarantees worth millions of dollars without having to repay the funds. Investor funds were to be held in escrow until the bank guarantees were issued. According to the complaint there were no guarantees and the funds were not held in escrow. The defendants resolved the case by consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The injunctions against the individual defendants also preclude future violations of Exchange Act Section 15(a). The defendants were ordered to pay disgorgement, prejudgment interest and a civil penalty in amounts to be determined at a later date.

Criminal cases

Insider trading: U.S. v. Goffer, 10-cr-0056 (S.D.N.Y.) is one of the Galleon insider trading cases which names as defendants Zvi Goffer and Arthur Cutilo, among others. Mr. Cutillo was an associate at the law firm of Ropes & Gray in New York. In 2007 and 2008 he, along with another firm attorney, furnished inside information to Mr. Goffer who then tipped others. The information concerned the merger deals that the firm was working on for three clients. Previously, Mr. Cutilo pleaded guilty to one count of conspiracy and one count of securities fraud. This week he was sentenced to 30 months in prison, ordered forfeit $378,608 and, following his prison term, two years of supervised release.

Fraud: U.S. v. Farkas, 10-cr-00200 (E.D.Va.) is a fraud action against the former Chairman of Taylor Bean, Lee Farkas. Following a jury trial Mr. Farkas was found guilty on all fourteen counts in the indictment which included conspiracy, wire and securities fraud and bank fraud. The charges centered on his role in the collapse of Taylor Bean, at one time was the largest privately held mortgage company in the U.S., and his role in the demise of Colonial Bank, at one time one of the 25 largest banks in the country. Mr. Farkas was sentenced to 30 years in prison and order to forfeit about $38.5 million.


Compliance: FINRA Chairman and CEO Richard Ketchum Addressed the IRI Government, Legal and Regulatory Conference on June 28, 2011. In his remarks Mr. Ketchum discussed changes to the examination program, the variable annuity data pilot program, issues relating to the possible move to a fiduciary standard and future guidance on issues relating to social media (here).

Court of appeals

Financial fraud: SEC v. Todd, No. 07-56098 (9th Cir. June 23, 2011). The Circuit Court reversed the ruling of the district court setting aside a jury verdict which found that former Gateway Computers CFO John Todd and controller Robert Manza violated the antifraud provisions with respect to certain financial transactions and made misrepresentations to the auditors. The Court also overturned a grant of summary judgment in favor of the former CEO of the company, Jeffrey Weitzen on Section 10(b) and 20(a) claims.

The complaint centers on claims that in 2000 the three defendants participated in a “gap filling” scheme to bridge what was potentially over a $100 million shortfall in revenue for one quarter to make street expectations. It also claims that Mr. Weitzen made false and misleading statements by stating in an earnings call and release that Gateway had an “accelerated earnings” trend. In fact the company met expectations by booking over $100 million as revenue from three transactions: (1) A sale-lease back of fixed assets which the disclosed accounting policies stated could not be booked as revenue; (2) An incomplete sale of computers to VenServ which all agreed should not have been booked; and (3) Revenue from a change in contact terms with AOL which accelerated the payment of certain fees.

The court reversed the district court’s post trial ruling overturning the jury verdict. The court concluded that there was sufficient evidence to support the jury verdict. It also reversed the grant of summary judgment entered in favor of the former CEO, finding that there were disputes of fact which precluded summary judgment. The jury verdicts were thus reinstated as to two executives while the case as to the former CEO was remanded for further proceedings.

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