THIS WEEK IN SECURITIES LITIGATION (July 17, 2009)
Treasury continued its march toward regulatory reform this week, sending proposed legislation to Capitol Hill regarding hedge funds and executive compensation. The Treasury Secretary also testified about the regulation of OTC derivatives while DOJ antitrust began a civil inquiry into informational disparities in the credit default swap market.
SEC enforcement, which Chairman Schapiro told Congress is being rejuvenated, brought cases focused on financial fraud, illegal short sales, insider trading, broker commissions and Ponzi schemes. Ponzi schemes were also the subject of two criminal cases, in which the defendants pleaded guilty. Finally, the jury returned a guilty verdict after a six-week trial in a criminal FCPA case.
Draft legislation: Treasury sent draft legislation to the hill on hedge funds titled the Private Fund Investment Advisers Registration Act of 2009. The proposed legislation would amend the Investment Advisers Act and require that all investment advisers with more than $30 million of assets under management register with the SEC. Once registered, the advisers would be required to provide confidential reports on the amount of assets under management, borrowings, off-balance sheet exposures, counterparty credit risk exposures, trading and investment positions and other information. The SEC would also be required to monitor compliance and conduct regular examinations. Position information would be shared with the Federal Reserve and the Financial Services Oversight Council contained in the Administration’s other legislative proposals. The legislation would also clarify the SEC’s rule making authority. Press Release, “Fact Sheet: Administration’s Regulatory Reform Agenda Moves Forward: Legislation for the Registration of Hedge Funds Delivered to Capitol Hill” (Jul. 15, 2009), available at http://www.ustreas.gov/press/releases/tg214.htm.
Treasury also sent up draft legislation regarding corporate compensation committees and “say-on-pay.” The former focuses on ensuring that the compensation committee is independent from management and has the authority to retain and compensate consultants and counsel to set compensation to protect investors. Press Release, “Administration’s Regulatory Reform Agenda Moves Forward: New Independence for Compensation Committees” (Jul. 15, 2009) available at http://www.treas.gov/press/releases/tg218.htm. The latter would require a non-binding annual shareholder vote on compensation for senior executives. This would be included in the annual proxy. A separate vote would be required on golden parachutes. Treasury modeled its say-on-pay proposal on the current system in Britain. Press Release, “Administration’s Regulatory Reform Agenda Moves Forward: Say-On-Pay” (Jul. 16, 2009) available at http://www.treas.gov/press/releases/tg219.htm.
Hedge fund regulation: Andrew J. Donohue, Director of the Division of Investment Management, testified before the Senate subcommittee on Securities, Insurance and Investment on July 15, 2009. In his testimony Mr. Donohue outlined the gaps in current regulation regarding private equity funds. He recommended comprehensive regulation for hedge funds, offering three basic approaches. First, the Private Funds Transparency Act of 2009 would address regulatory gaps by eliminating the Section 203(b)(3) de minimis exception from the Advisers Act. Investment adviser registration would be beneficial to investors in several ways including assuring accurate, reliable and complete information, the enforcement of fiduciary responsibilities, the prevention of market abuse and compliance programs. A second approach to fill in the regulatory gaps is to have the funds register under the Investment Company Act. A third option which could be used in conjunction with adviser registration is to give the SEC sufficient rule making authority to meet changing circumstances in the future. The testimony is available at http://www.sec.gov/news/testimony/2009/ts071509ajd.htm.
Proposed OTC derivative regulation: Treasury Secretary Timothy Geithner provided further details regarding the proposed new regulation in this area in testimony before the House Financial Services and Agriculture Committees as discussed here. With an overall goals of minimizing risk and providing stability to the financial system, the Secretary discussed seven key points regarding legislation for all OTC derivatives which will be sent to Capitol Hill shortly: 1) standardization for derivative contracts; 2) a broad definition of “Standardized” to cover as many contracts as possible; 3) capital and margin requirements; 4) transparency with the public having access to aggregate trading data; 5) antifraud authority for the SEC and CFTC; 6) regulation of sellers which would be comprehensive; and 7) international, such that other regulators around the world will institute similar regimens.
CDS: DOJ antitrust has issued civil investigative demands to certain participants in derivative. Markit Group Holdings, a data warehouse owned by several large banks and which provides information to hundreds of derivative market participants, was notified of the inquiry. DOJ is reportedly focusing on the use of informational disparities by some market participants with respect to credit default swaps.
Rejuvenating enforcement: SEC Chairman Mary Schapiro testified before the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises this week. In her testimony, the chairman reviewed the Commission’s efforts to reinvigorate the Enforcement Division. Those efforts include the termination of the pilot program regarding corporate penalties and the streamlining of the formal order process as well as the contemplated reorganization of the division which is still in the planning stage. Ms. Schapiro also highlighted the fact that the Division has more than 439 active investigations underway compared to 395 at this time last year. In addition, the Commission has issued at lest 224 formal orders compared to 93 at about the same time last year. Ms. Schapiro went on to highlight some of the enforcement cases as well as efforts being made to strengthen the examination and oversight functions. In her testimony the Chairman also discussed a number of rule making projects which are underway. Her testimony is available at
Working group on market reform: A group called the Investors’ Working Group issued a report on market reform this week endorsed by the Council of Institutional Investors. Former SEC Chairmen William Donaldson and Arthur Levitt, Jr. are co-chairs of the group. The report contains an extensive list of recommendations for strengthening federal regulation. Those include extending regulation to OTC derivatives and hedge funds. The report also recommends creating a new agency to regulate consumer financial products including mortgages, considering ways to encouraging alternatives to the predominant issuer-pays NRSRO business model, strengthening corporate governance and creating an independent governmental Systemic Risk Oversight Board. The report is entitled: “U.S. Financial Regulatory Reform: The Investors’ Perspective,” and is available at http://www.cfainstitute.org/centre/pdf/us_investors_working_group_report.pdf.
Financial fraud: SEC v. DeBlanc, Case No. 3012 (E.D. La. Jul. 15, 2009) is a financial fraud action against Matthew Hardey, Cyrus DeBlanc and Joe Penland, respectively, the former CFO of Newpark Resources, CFO of Soloco LLC a Newpark subsidiary and the president of Newpark vendor Quality Matt. The complaint alleges that in 2002 and 2003 Newpark recognized $4.2 million from sales to Quality Matt and another vendor. When neither vendor could pay for the goods, the defendants entered into a scheme in which two sham transactions were used to funnel money to the two vendors, allowing them to pay. As a result Newpark reported about $500,000 of net income rather than a significant loss. As part of the scheme Newpark’s auditors were also deceived. The complaint alleges violations of the antifraud and reporting provisions of the securities laws. The case is in litigation. See also Lit. Rel. No. 21137 (July 16, 2009).
Insider trading: Three insider trading cases were filed based on the acquisition of Safeco Corp. by Liberty Mutual as discussed here.
• SEC v. Hipp, Case No. C09-0987 (W.D. Wash. Filed July 15, 2009) is a settled action against Math Hipp, Jr. The complaint alleges that Mr. Hipp misappropriated inside information about the transaction from his wife, the executive assistant to Safeco’s EVP of insurance operations. Mr. Hipp sold Safeco call options which netted him a profit, after the announcement of the deal, of over $118,000. He settled, consenting to the entry of a permanent injunction and agreeing to disgorge his trading profits along with pre-judgment interest and pay a civil penalty equal to his trading profits. See also Lit. Rel. 21133 (July 15, 2009).
• SEC v. Perez, Civil Action No. 6:09-cv-1225 (M.D. Fla. Filed Jul. 15, 2009) named as defendants Anthony Perez, then an investment banker at Goldman Sachs, and his brother Ian Perez. Anthony, who worked on the Safeco side of the deal, told his brother that Safeco would be acquired. Ian Perez bought call options in Safeco and another company to cover his trading. Following the announcement of the deal the options netted him a profit of over $152,000. To settle the action, each defendant consented to the entry of a permanent injunction and an order holding them jointly and severally liable for the payment of disgorgement of the trading profits and pre-judgment interest. No penalty was imposed on Ian Perez based on his financial condition. Anthony Perez agreed to pay a financial penalty of $25,000 which was based on his financial condition. See also Lit. Rel. No. 21133 (July 15, 2009).
• SEC v. Binette, Case No. 09:CV-30107 (D. Mass. Filed Jul. 15, 2009) named as defendants Carl Binette and his uncle Peter Talbot, an assistant vice president at Hartford Investment Management Company. Mr. Talbot, according to the complaint, knew that Hartford was shopping for the acquisition of another insurance company and saw data about Safeco in the computer folder of a co-worked. He also noticed key company employees working long hours while refusing to discuss their work. He shared this information with his nephew and helped him open brokerage accounts using false information. Mr. Binette then traded Safeco options. Following the announcement of the transaction the options netted a profit of over $615,000. This case is in litigation. See also Lit. Rel. 21133 (July 15, 2009).
Insider trading: SEC v. Acord, Case No. 09-21977 (S.D. Fla. Filed July 15, 2009 names six defendants in an insider trading case based on the acquisition of Neff Corp. by Odyssey Partners as also discussed here.
The complaint has three groups of defendants. (1) Kevan Acord and Philip Growney learned about the deal while doing tax work on the transaction. Both traded. (2) Alberto Perez and his brother Jose are long time friends and business associates of Neff’s CEO and his two brothers. Through the use of an office at Neff headquarters the complaint claims Alberto Perez learned of the deal. The two brothers then acquired 83,000 shares through a joint account. The shares were sold after the deal announcement for a profit of $399,000. (3) The third group is Dr. Sebastian De La Maza and Thomas Borell. The Doctor learned about the deal through his daughter, the wife of Neff’s CEO. The Doctor made fourteen purchases of Neff securities which he sold following the deal announcement for $111,000. Finally, Mr. Borell is a long time friend of Jose Mas, a Neff director during the negotiations which led to the acquisition and a brother of Neff’s CEO. As a result of his close relationship with Jose Mas, Mr. Borell had access to inside information according to the Commission. Mr. Borell made repeated acquisitions of the stock which he sold after the announcement for a profit of over $974,000. See also Lit. Rel. 21132 (July 15, 2009).
Financial fraud: Two additional cases stemming from the significant financial fraud at Tyco International Ltd. moved toward a resolution were settled this week.
• In SEC v. Kozlowski, Civil Action No. 02-CV-7312 (S.D.N.Y. Filed Sept. 12, 2002), the SEC settled with former Chairman and Chief Executive Officer Dennis Kozlowski and former CFO Mark Swartz. The complaint alleged that from 1996 through 2002, Messrs. Kozlowski and Swartz failed to disclose hundreds of millions of dollars in executive indebtedness, executive compensation and related party transactions. The two men also granted themselves low interest and no interest loans they used for their personal benefit. The action was settled with permanent injunctions prohibiting future violations of the antifraud, reporting and proxy provisions. Both defendants agreed to the entry of officer director bars. In prior state court proceedings each defendant was convicted on criminal charges and sentenced to 8 1/3 to 25 years in prison. See also Lit. Rel. No. 21129 (July 14, 2009).
• SEC v. Power, Civil Action No. 06-CV-15343 (SD.N.Y. Filed Dec. 21, 2006) also stems from the Tyco fraud. In this case Richard Power, a former Tyco Vice President, is alleged to have devised a sham transaction to fraudulently inflate Tyco’s operating income in connection with its merger with ADT Limited. The scheme was used each time Tyco purchased a new security monitoring account from one of its dealers. Mr. Power also used other fraudulent merger accounting to inflate the revenue of the company, according to the complaint. He resolved the action by consenting to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions, paying $425,000 in disgorgement and a $100,000 civil penalty. In paying the disgorgement Mr. Power will receive a credit for $250,000 he is to pay the company as part of the settlement of a suit with Tyco. See also Lit. Rel. 21128 (July 14, 2009).
Illegal short sales: In SEC v. Colonial Investment Management LLC, Case No. 07 Civ. 8849 (S.D.N.Y. Filed Oct. 15, 2007), the court found the defendants liable after a bench trial. The defendants are Cary Brody and two entities he controlled. The court found, that the defendants engaged in illegal trading in violation of Rule 105 which concerns manipulative trading by short sellers prior to registered offerings, with regard to eighteen registered public offerings. The SEC claimed that the defendants violated the rule by purchasing shares in the offerings to cover short sales they made during the restricted period thereby making over $1.4 million in profits. The court entered a permanent injunction and imposed a fine of $450,000. See also Lit. Rel. 21123 (July 10, 2009).
Undisclosed commissions: In In the Matter of Ameriprise Financial Services, Inc., Adm. Proc. File No. 3-13544 (July 10, 2009), the brokerage firm settled an administrative proceeding which alleged that it only sold shares in two groups of REITS if it received what the firm called revenue sharing payment. Between 2000 and 2004, as discussed here, Ameriprise received undisclosed cash payments in the form of checks and wire transfers from Carey REITs of $9.7 million and from CNL REITs totaling $21.1 million. These payments were made pursuant to mislabeled invoices which made it appear that they were legitimate reimbursements for services provided by Ameriprise. Ameriprise also sold unregistered shares in one of the Carrey REITs.
The action, based alleged violated Sections 5(a) and 17(a)(2) & (3) of the Securities Act and Exchange Act Rule 10b-10, settled with Ameriprise consenting to the entry of a censure and a cease and desist order. The company also agreed to pay disgorgement of $8.65 million and a penalty in an equal amount.
Investment fund cases: The SEC brought two investment fund cases this week.
• SEC v. Healy, Case No. 1:09-CV-01330 (M.D. Pa. July 14, 2009) alleges that the defendant stole more than $15 million in investor funds. Those funds came largely from one individual who raised money from about 40 investors. The money was supposed to be invested in trading and earning excellent returns. In fact, the defendant used it for his personal benefit. The SEC obtained a freeze order. The case is in litigation. See also Lit. Rel. 21127 (July 14, 2009). The CFTC brought a similar action. See CFTC Release 5676-09 (July 14, 2009).
• SEC v. Petters, Civil Action No. 09 SC 1750 (D. Minn. July 10, 2009) alleged that Gregory Bell and Lancelot Management LLC invested more than $2 billion in hedge fund assets with Thomas Petters and pocketed millions in fraudulent fees at the expense of investors. The complaint also claims that Mr. Petters perpetrated a massive Ponzi scheme through the sale of notes related to consumer electronics. As the scheme began to unravel the defendants executed a series of sham transactions to conceal the fact that Mr. Petters owed more than $130 million in investor payments on the notes. The SEC obtained a freeze order that in part requires the repatriation of overseas assets. The case is in litigation. See also Lit. Rel. No. 21124 (July 10, 2009).
U.S. v. Ballard, Case No. 1:09-cr-00307 (N.D. Ga. Filed June 25, 2009) is an action against a Georgia lawyer, Steven Ballard, who used his practice as a business law attorney to bilk his friends and clients out of more than $2 million by running a Ponzi scheme. Mr. Ballard pled guilty to a one count information. Sentencing is scheduled for September 29, 2009.
U.S. v. Diehl, Case No. 8:08-cr-00080 (C.D. Cal. Filed April 2, 2008) is a fraudulent investment scheme case against former NFL player Reed Diehl. This week Mr. Diehl pled guilty to three counts of wire fraud and one count of money laundering for his participation in the scheme. According to the plea agreement, Mr. Diehl falsely claimed to be a banker who made loans. In this role, he fraudulently collected deposits from people who wanted financing for projects in Mexico. Sentencing is set for September 28, 2009.
U.S. v. Kozeny, Case No. 1:05-cr-00518 (S.D.N.Y. Filed May 12, 2005) is a criminal FCPA case in which Frederic Bourke, the co-founder of handbag maker Dooney & Bourke, was convicted following a six week jury trial. The case is based on claims that Mr. Bourke conspired with Czech expatriate Viktor Kozeny to bribe Azerbaijan’s former president and other leaders. The government claims centered on allegations that Mr. Bourke invested with Mr. Kozeny knowing that he gave Azeri leaders millions of dollars in cash and a secret two thirds interest in a venture formed to buy the state oil company, Socar. That oil company was never sold. Mr. Bourke, through an investment vehicle, put up $8 million in the deal. Mr. Kozeny is a fugitive.
CFTC v. Equity Financial Group, LLC, Case Nos. 08-1558, 08-1838 & 08-2495 (3rd Cir. July 13, 2009) is an appeal by the defendants in a CFTC enforcement action. The defendants are Equity Financial, its president Vincent Firth and Robert Shimer, its lawyer. The complaint alleged that the defendants solicited more than $15 million into Shasta Capital to trade future contracts. No futures were traded, however. Rather, Equity acted as a feeder fund for Tech Traders which, along with its operator, misappropriated much of the investor money. The district court concluded, among other things, that Equity was a commodity pool operator, that the two individual defendants were associated persons, that each defendant failed to properly register and that they had engaged in fraud. On appeal the key issue was whether in fact Equity was a commodity pool — the futures equivalent of a mutual fund — since it had never traded futures.
The court affirmed. Under Section 1a(5) of the Act defines a commodity pool as “any person engaged in a business that is of the nature of an investment trust . . . and who . . . solicits, accepts, or receives from others, funds . . . for the purpose of trading in any commodity for future delivery . . .” This definition focuses on the form of the business the court held, not whether it actually engaged in trading. In fact, there is no requirement within the definition of a commodity pool that there be trading. Rather, the section focuses on regulating activities involving the solicitation of funds as was done here.
In re Novell, Inc. Derivative Litig., Case No. 1:06-cv-11625 (D. Mass. Filed Sept. 12, 2006) is a derivative suit brought against the officers and board of Novell. The case is based on stock option backdating claims. Initially the complaint claimed that demand would be futile. Now however, the shareholders who instituted the suit have offered to turn the litigation over to the company. If the company does not proceed with the litigation then the shareholders will pursue their action.