The passage of the most sweeping financial reform legislation since the 1930s and the settlement of the SEC’s most high profile enforcement action in years highlighted last week. The Dodd-Frank Wall Street Reform and Consumer Protection Act was sent to the President for signature, which is expected this week. The Act addresses “too big to fail,” derivatives and hedge fund regulation, while establishing new consumer protections.

The resolution of the Goldman Sachs enforcement action was a win for the SEC and a good outcome for the bank, neither of whom could afford to lose in the most high stakes case brought by the Commission in years. For the Commission, it is critical that Goldman Sachs represent the beginning of a new, effective enforcement program and not just one case. For the bank, it is out of the spotlight and back to business and rebuilding its reputation.

Market reform

The Dodd-Frank Wall Street Reform and Consumer Protection Act passed in the Senate and is being sent to the President for signing this week. The bill is being hailed as the most significant regulatory overhaul since the great depression. The 2,000 page piece of legislation is designed to address the roots of the financial crisis. The bill gives the SEC new authority, while requiring the agency to write rules and conduct studies in a variety of areas. Under the bill, the SEC will gain additional authority over derivatives and hedge funds. There are 95 provisions in Dodd-Frank concerning SEC rule making, while seventeen other sections require the preparation of reports, many of which are discussed here.

Implementation of the Act: Anticipating the passage of Dodd-Frank, Chairman Schapiro highlighted some of the areas of focus for the Commission under the Act in remarks last week. These include: 1) Derivatives: Working with the CFTC the Commission will be writing rules that address capital and margin requirements, mandatory clearing, the operation of execution facilities and data repositories and reporting and recordkeeping obligations; 2) Standards of care for broker dealers: The Act calls for a study on this point and gives the SEC authority to promulgate rules that would impose a harmonized fiduciary standard on broker-dealers and investment advisers who provide personalized investment advice to retail or other customers; 3) Hedge funds: The Commission will adopt rules governing record keeping and reporting requirements; 4) Enforcement: There are several key provisions to strengthen the program including the authority to issue subpoenas nationwide in civil actions and clarifying the agency’s aiding and abetting authority; and 5) Corporate disclosure: A number of provisions require that rules be written on corporate disclosure including executive compensation.

SEC enforcement actions

Disclosure: SEC v. Goldman Sachs, Civil Action No. 3229 (S.D.N.Y. Filed April 16, 2010) is the Commission’s landmark enforcement action against the Wall Street icon and one of its employees, Fabrice Tourre. The SEC’s claims, discussed here, are based on conflicts of interest and a failure to disclose critical information about the origins and formation of a synthetic collateralized debt obligation tied to the sub-prime residential real estate market. The CDO was structured at the request of Goldman client Paulson & Co. so it could short the sub-prime market. The marketing materials did not disclose this fact or the influence of Paulson in constructing the CDO. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b) and sought in injunction, disgorgement, prejudgment interest and a penalty. In the settlement, discussed here, the bank agreed to pay a record $550 million, made an unusual admission of having faulty marketing materials, consent to the entry of a fraud injunction based on Securities Act Section 17(a) and agreed to a series of procedures designed to prevent a reoccurrence of the wrongful conduct. The Section 10(b) claim was dropped. It does not end the litigation which will continue as to Fabrice Tourre.

Option backdating: SEC v. Trident Microsystems, Inc., Civil Action No. 1:10-CV-01202 (D.D.C. Filed July 16, 2010) alleges that defendants Trident Microsystems, Inc., a Santa Clara based provider of integrated circuits, and its founder and former CEO Frank Lin, and former Chief Accounting Officer, Peter Jen backdated options from 1993 through 2006. The grants were used to provide compensation to executives and other employees. The SEC claims that Mr. Lin and others he directed used hindsight to select option grant dates so that they would be in-the-money. At times, grants were parked with certain employees and later allocated to newly hired employees. As a result, Trident materially overstated its pre-tax income or understated its pre-tax loses by as much as 113%. The grants caused the company in August 2007 to restate $37 million of compensation expenses. The complaint also alleges that false proxy statements and Form 4s were filed as a result of the scheme.

The company settled by consenting to the entry of an order prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections (10)(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a). Messrs. Lin and Jen also consented to the entry of a permanent injunction prohibiting future violations of the same sections as the company and, in addition, Exchange Act Section 16(a). In addition, Mr. Lin agreed to disgorge the in-the-money benefits he received from his grants which totaled $817,509, to pay a penalty of $350,000 and to an order barring him for five years from serving as an officer or director of any issuer. In addition to the injunction, Mr. Jen agreed to disgorge the in-the-money component of his options which totaled $359,819, to pay a penalty of $50,000 and to be barred from serving as an officer or director of a public company for five years.

Discovery: In the Matter of Morgan Asset Management, Inc., Admin. Proc. File No. 3-13847 is an action which centers on claimed misconduct by the directors of Morgan Keegan & Company’s Funds as discussed here. Last week, on the motion of the Respondents, the ALJ entered an order essentially walling off the staff litigating the case from those who were conducting a parallel investigation as discussed here. ALJ Kelly found that after this proceeding was instituted the enforcement staff obtained a second formal order which clearly overlapped the administrative proceeding despite the efforts of the staff to make it appear otherwise. To preclude the staff from improperly using investigative subpoenas to supplement the evidence available in the proceeding, an order was entered which precludes the enforcement staff working on the case and using the material from the investigation.

Prohibited contributions: In the Matter of John F. Kendrick, Adm. Proc. File No. 3-13830 (July 14, 2010) is a settled action against John Kendrick, a senior vice president of public finance for New England Southwest Securities. From 2003 through 2008, Mr. Kendrick, according to the Order, contributed $1,625 to Timothy Cahill, the treasurer of the Commonwealth of Massachusetts. The treasurer is responsible for the hiring of brokers for municipal securities business by the state. The contributions here were made through several different sources but exceeded the $250 de minimis amount permitted. Under Rule G-37 each contribution above the $250 level triggered a two year ban on municipal securities business with the issuers. During that period Southwest, with the knowledge of Mr. Kendrick, participated as co-manager for 19 negotiated underwritings by the Issuers totaling approximately $14 billion. To settle this action, Mr. Kendrick consented to the entry of and order directing that he cease and desist from committing or causing any violations and any future violations of Sections 15B(c)(1) of the Exchange Act, MSRB Rule G-37(b) and MSRB Rule G-37(c). He also agreed to pay a $10,000 civil penalty.

Touting: SEC v. InvestSource, Inc., Case No. SACV 10-01041 (C.D. Cal. Filed July 9, 2010) is an action against investor relations firm InvestSource and its principal, Songkram Sahachaiser, alleging violations of Securities Act Sections 17(a) and 17(b) and Exchange Act Section 10(b). The complaint claims that from January 2008, and continuing through early 2009, InvestSource sent a Daily Digest to those listed in its e-mail base which profiled various clients and recommended the stock. Frequently the firm was paid in shares which were sold while the e-mails were being distributed. That fact was not disclosed and a “disclaimer” on its website was false and misleading according to the SEC since it only noted that the firm “may” be compensated when in fact it was always compensated. The disclaimer also falsely stated that shares received for services were immediately sold when in fact they were not. The case is in litigation.

Criminal cases

Insider trading: U.S. v. Plate (S.D.N.Y. July 16, 2010), is another of the Galleon insider trading cases. Here David Plate, a proprietary trader at The Schottenfeld Group LLC, pleaded guilty to one count of conspiracy and one count of securities fraud. Mr. Plate admitted to trading on what he believed to be inside information in the shares of 3Com and Axcan. In fact the information came from Zvi Goffer who had obtained it from Ropes & Gray attorneys Arthur Cutillo and Brian Santarlas through an intermediary. The law firm was providing legal advice to the companies prior to the public announcement of the deals.

Court of appeals

U.S. v. Graf, Case No. 07-50100 (Decided July 7, 2010) resolved an important question regarding the application of the attorney client relationship. There defendant, James Graf, was indicted for his involvement in the fraudulent operation of Employers Mutual LLC, a purported provider of health care benefits to 20,000 plan members. In reality, the company was a fraud and plan members had no benefits or coverage. At trial, the government sought to introduce the testimony of three attorneys who had provided legal advice to the company. Although the trustee for the company waived privilege, Mr. Graf objected claiming that he was a joint holder of any attorney client privilege with the company. The district court rejected the claim and Mr. Graff was convicted on all counts.

The Ninth Circuit affirmed the ruling and adopted the test used by the Third Circuit in In re Bevill, Bresler & Schulman Asset Mgt. Corp., 805 F.2d 120 (3rd. Cir. 1986). This test is also used by other circuits. In that case, the court held that any privilege as to a corporate officer’s role within the company belongs to the corporation. To evaluate whether an individual officer has a personal privilege with corporate counsel the Bevill court employed a five factor test: (1) the person must demonstrate that he or she approached counsel to seek legal advice; (2) the individual must demonstrate that it was made clear to counsel that they were seeking legal advice in their individual capacity; (3) they must demonstrate that the attorney communicated with them in their individual capacity, recognizing that a conflict might arise; (4) the conversations with the attorney must be confidential; and (5) the substance of the conversations with counsel must not have concerned matters about the company or the general affairs of the corporation. Under this test, it is clear Mr. Graff did not have an attorney client relationship with corporate counsel.


The Financial Industry Regulatory Authority issued a warning to investors regarding Ponzi schemes called high-yield investment programs which are being marketed through social network media. The promoters of HYIPs are using social media including YouTube, Twitter and Facebook to lure investors and create the illusion of social consensus that the investments are legitimate. The schemes offer yields of 20, 30 and 100%. Some suggest that the investors “ride the Ponzi” by getting in and out before the scheme collapses.


Proposed new confirmation standard: On July 13, 2010 the Board approved for comment a proposed audit standard titled Confirmation. It is intended to strengthen the current requirements regarding confirmation. The proposed standard is based on a concept release issued earlier this year and the comments received.

Work of other auditors: On July 12, 2010 the Board issued Staff Audit Practice Alert No. 6. The alert focuses on requirements for the use of, and reliance on, the work of other auditors when issuing a report. The alert stems from the Board’s observation that a number of registered public accounting firms in the U.S. have been issuing audit reports on financial statements filed by issuers that have most of their operations outside the country.