Capital Hill continues to be the focus of attention as the Dodd-Frank Wall Street Reform and Consumer Protection Act was approved by the House. Senate consideration is not expected until after the Fourth of July holiday.

The Supreme Court struck down a portion of the Sarbanes Oxley statute regarding the PCAOB, but left the board largely in tact. The High Court also agreed this week to hear a case next term which should define primary liability in Exchange Act Section 10(b) cases. SEC Enforcement lost its first insider trading case based on CDSs, while continuing to file more investment fund fraud actions. The FCPA continues to be a key focus for the SEC and DOJ, with two new cases filed and a guilty plea in a previously brought criminal action. And, another private damage action based in part on options backdating and in part on claims that a video game had concealed porn scenes was tentatively settled.

Supreme Court

Primary liability: Janus Capital Group v. First Derivative Traders, No. 09-525 is a case the Court agreed to hear this week. The complaint alleges violations of Exchange Act Section 10(b) by Janus Capital and its related entities. Specifically, the complaint claims that Janus violated the antifraud provisions because the prospectuses for several of the Janus Funds give the misleading impression that Janus and its related entities would curb market timing when in fact there were secret arrangement which permitted it. The district court granted a motion to dismiss, finding that there was no allegation that Janus actually made or prepared the prospectuses, let alone the statements contained in them. The Fourth Circuit reversed, concluding that plaintiff had adequately pleaded primary liability. The question presented by the Petition is whether “a service provider can be held primarily liable in a private securities fraud action for “help[ing]” or “participating in” another company’s misstatements.”

Separation of powers: Free Enterprise Fund v. PCAOB, No. 08-861 (June 28, 2010), discussed here, challenged the constitutionality of the Public Company Accounting Oversight Board, created under the Sarbanes Oxley Act. Plaintiff petitioners claimed that the Act contravened separation of powers principles, as well as the presidential appointment power. The district court granted summary judgment in favor of the Board. The circuit court affirmed. The Supreme Court reversed in part, striking down a portion of the Act, and remanded for further proceedings. Under SOX, the PCAOB Commissioners are appointed by the SEC and can only be dismissed for cause. Likewise, the SEC Commissioners can only be dismissed for cause. The Constitution in Article II vests authority for the Executive branch with the President, who is obligated to see that the laws are faithfully executed. Under long standing decisions of the Court, the President has been understood to have the authority under the Constitution to hold executive officers accountable who are retained to assist. In those decisions, the Court held that it was appropriate when creating independent agencies run by principal officers to provide that the President cannot remove those officers except for good cause shown. Here however, the President is restricted in his ability to remove board members by the statutory arrangement. This violates separation of powers principles, the Court held. Accordingly, the Court struck down only those sections of the Act which infringed these principles, leaving the PCAOB board members serving at the pleasure of the SEC. The PCAOB otherwise remains in tact.

SEC enforcement actions

Investment fund fraud: SEC v. Stinson, Civil Action No. 10-cv-3130 (E.D. Pa. Filed June 29, 2010) is an action against Robert Stinson, Jr. and his related entities, which claims he operated a Ponzi scheme. According to the complaint, beginning in 2006, Mr. Stinson raised about $16 million from more than 140 investors. He claims that his fund invested in commercial mortgage loans and other similar instruments and paid returns of 10 – 16%. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The case is in litigation.

Suitability: SEC v. Life Wealth Management, Inc., Civil Action No. CV-10-4769 (C.D. CA. (Filed June 29, 2010) is an action against Life Wealth Management Inc, and its owner Jeffery S. Preston, which alleges violations of Exchange Act Section 10(b) and Advisers Act Section 206. The complaint claims that Mr. Preston recommended that his clients invest in notes of Atherton-Newport Investments, a real estate company that renovates distressed properties. The two defendants had invested $6.9 million of client funds in unsecured promissory notes issued by the company. Mr. Preston made the recommendations even though Life Wealth’s attorney cautioned him about the enormous risk of the investment. The complaint also alleges that Mr. Preston reassured investors that the investment was safe. Mr. Preston failed, however, to disclose to those clients that in fact he had doubts about the investment and redeemed his holdings before Atherton-Newport defaulted. The case is in litigation.

Investment fund fraud: SEC v. Spitzer, Civil Action No. 10 C 3758 (N.D. Ill. Filed June 28, 2010) is an action alleging fraud in violation of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206 by defendant Daniel Spitzer. According to the complaint, Mr. Spitzer raised over $105 million from about 400 investors beginning in 2004 with claims that he would invest primarily in foreign currency and that he never lost money. Historically, he had annual returns which in one year were over 180%, investors were told. In fact, only a small portion of the funds were invested in foreign currency. Substantial portions of the funds were put in investments that lost money, a small portion was put in money market funds and other portions were used to pay expenses. Some investors were repaid with portions of the investment funds. Investors were given false Schedule K-1s showing profits. The case is in litigation.

Investment fund fraud: SEC v. Zufelt, Civil Action No. 2:10-cv-00574 (D. Utah Filed June 23, 2010) is an action against Anthony Zufelt, Joseph Nelson, David Decker, Jr., Cache Decker and their related entities alleging violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). According to the SEC, the defendant raised at least $3.6 million form 36 investors between June 2005 and June 2007. Investors were promised returns of up to 220% with false claims that Mr. Zufelt ran a profitable credit card transaction processing business that was selling secure investments backed by so-called “merchant portfolio” of credit card accounts. In a separate scheme which began in 2005 and continues to the present, the complaint claims that Mr. Nelson solicited investors with fraudulent claims that he buys and sells merchant portfolios for a profit through his companies which are defendants. In this scheme, he raised at least $12 million from over 100 investors who were promised returns of up to 200% in a short time. In fact, the defendants were running Ponzi schemes. The Commission obtained an emergency freeze order here. The case is in litigation.

Insider trading: SEC v. Rorech, Civil Action No. 09 Civ. 4329 (S.D.N.Y. Decided June 25, 2010) is the Commission’s first insider trading case based on credit default swaps as discussed here. It focused on trading in the high yield bond market by defendant Renato Negrin, a portfolio manager for hedge fund Millennium Partners. Defendant Jon-Paul Rorech is a trader in the high yield bond sales group at Deutsche Bank. The Commission’s complaint focused on trades in CDSs related to a bond offering for VNU NV, a Dutch holding company on July 17 and 18, 2006. Specifically, it alleges that Mr. Rorech misappropriated material inside information that the bond offering would be restructured and furnished it to Mr. Negrin in two cell phone conversations shortly before the trades. The district court concluded that the Commission established that the CDSs here were in fact subject to Exchange Act Section 10(b). However, in a detailed series of findings, the Court found that the SEC had wholly failed to prove its case. Illegal tipping could not be inferred from the trades and surrounding circumstances where the record established that the decision to restructure the bond offering was not made until after the trades. The court dismissed the action.

Investment fund fraud: SEC v. Estate of Kenneth Wayne McLeod, Civil Action No. 10-22078 (S.D. Fla. Filed June 24, 2010) is an action alleging violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Adviser Act Section 206 against the estate of Kenneth McLeod, who died before the action was filed, and his controlled entities. Mr. McLeod, according to the complaint, for about two decades ran a Ponzi scheme called FEBG Bond Fund. That fund supposedly invested in government bonds. Mr. McLeod targeted government employees to invest in the fund. Over the years he raised money from about 260 investors. At the time of the case, he had raised $34 million from 139 current investors. In fact, the fund did not exist. It is a Ponzi scheme. The SEC obtained an emergency freeze order on filing the action. The case is in litigation.

Initial Decision

Sales practices/failure to supervise: In the Matter of Prime Capital Services, Inc., Adm. Proc. File No. 3-13532 (Filed June 25, 2010) is an action which named as Respondents Gilman Ciocia, Inc., a tax preparation business, its subsidiary Prime Capital Services, a registered broker dealer, Michael Ryan, the president of PCS, Rose Rudden, the COO of PCS, and registered representatives Eric Brown, Matthew Collins, Kevin Walsh and Mark Wells. The Order alleges violations of the antifraud provisions of the securities laws in connection with the sale of variable annuities. It also charges Mr. Ryan and Ms. Rudden with failing to reasonably supervise the registered representative defendants. In the Initial Decision, the ALJ concluded that the Division had established the charges. The variable annuities were sold largely to retired investors with little experience. Typically, the investors were not told the nature of the investment or about the fees associated with the purchase and the transactions were rushed. Generally, the investors were not furnished a prospectus. The ALJ concluded that the sales to the investors were not suitable. The ALJ also found hat there was a failure to reasonably supervise. Respondents Ryan and Rudden, located in New York, tried to supervise salesmen in Florida. While the firm had procedures in place they were largely not followed. In fact, the salesmen had little supervision, ignored procedures and falsified documents at times. Customer complaints were not adequately reviewed. Given the distance between the supervisors and the salesman, there should have been increased procedures. In fact there were none.


SEC v. Technip, Case No. 4:10-cv-02289 (S.D. Tex. Filed June 28, 2010), discussed here, is an action against a French company whose ADRs are traded in New York. According to the SEC, the company entered into a joint venture to secure contracts from Nigeria LNG, Ltd, a company formed by the Nigerian government to capture and sell natural gas associated with oil production in that country. From 1995 through 2004, the joint venture paid about $180 million in bribes to secure contracts worth more than $6 billion. The payments were not properly recorded in the books and records of the company. To resolve the case, the company consented to the entry of a permanent injunction, prohibiting future violations of the bribery, books, records and internal control provisions of the FCPA. It also agreed to disgorge $98 million in profits from the scheme and prejudgment interest. In the related criminal case, U.S. v. Technip S.A., Case No H-10-439 (S.D. Tex. Filed June 28, 2010), the company entered into a deferred prosecution agreement. As part of that agreement, the company agreed to pay a penalty of $240 million and to engage a corporate compliance monitor.

SEC v. Veraz Networks, Inc., Case No. CV-10-2849 (N.D. Cal. Filed June 29, 2010), also discussed here, alleges that the company made improper payments in China and Vietnam. In China, Veraz retained a consultant in late 2007 who provided about $4,500 worth of gifts to officials at a Telecommunications company to secure a business deal. In January 2008, another improper payment was offered to officials at the same company to secure a contract valued at $233,000. The improper payment was set at 15% of the value of the contract. In 2007 and 2008 the company also sold products to a telecommunications company controlled by the government of Vietnam and reimbursed its employees for questionable expenses related to the Telecommunications Company. The Commission alleged violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B) by the San Jose based telecommunications company.

To resolve the case, Veraz consented to the entry of a permanent injunction prohibiting future violations of each of the Exchange Act Sections cited in the complaint. The company also agreed to pay a penalty of $300,000.

U.S. v. Naaman (D.D.C. Aug. 7, 2008) is an FCPA case which names as a defendant Osama M. Naaman, a citizen of Canada and Lebanon. From 2001 to 2003 Mr. Naaman is alleged to have offered and paid 10% kickbacks to the then Iraqi government as part of the U.N. Oil for Food Program. The payments were in exchange for five contracts under the program for Innospec Inc. That U.S. company previously pleaded guilty to a twelve count indictment charging wire fraud and FCPA violations in connection with the payments. Mr. Naaman pleaded guilty to a two count superseding indictment which contains one count of conspiracy to commit wire fraud, violate the FCPA and falsify the books and records of a U.S. company and one count of violating the FCPA. In entering his plea, Mr. Naaman admitted that over a four year period beginning in 2004 he paid more than $3 million in bribes to officials of the Iraqi Ministry of Oil to secure more favorable exchange rates on the contracts. Sentencing has not been scheduled.


Edward Brokaw, an employee of Deutsche Bank Securities, has been barred from the brokerage business for manipulating the share price of Monogram Biosciences securities for the benefit of a hedge fund client and himself. The manipulation was undertaken to increase the price of contingent value rights which were issued in connection with the merger of the companies that created Monogram. The hedge fund client had a large stake in the CVRs which were to be priced by a formula over a 15 day period. By driving the price of the stock down, the value of the CVRs increased. In telephone calls that were recorded Mr. Brokaw explained the scheme.

Private actions

Option backdating; Take-Two Interactive Sec. Litig., No 1:06-cv-0803 (S.D.N.Y.) is a securities class action against the company based primarily on option backdating claims. An internal investigation discovered a pattern of backdating at the company and a failure to comply with term provisions. The suit also claimed that the company secretly hid porn scenes in its video game “Grand Theft Auto: San Andreas.” The court gave tentative approval to a $20.1 million settlement.