THIS WEEK IN SECURITIES LITIGATION (July 23, 2010)
The Dodd-Frank bill, now signed into law, contains a number of provisions enhancing SEC Enforcement. SEC Chairman Mary Schapiro estimates that the Commission will be required to hire an additional 800 people to implement the Act. The CFTC, however, is moving quickly to implement its new authority, publishing a list of rule making initiatives regarding derivatives.
SEC enforcement filed a settled action against computer giant Dell Inc, its founders and several officers. The company agreed to pay a large fine, consented to a fraud and books and records injunction and remedial procedures. Mr. Dell and others agreed to a Securities Act Section 17(a)(2)&(3) negligence based injunctions and other relief. Criminal prosecutors continued bringing investment fund fraud cases, while the FSA resolved a father and son insider trading action.
SEC enforcement: The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law, has a number of provisions which enhance the authority of SEC Enforcement as discussed here. They include provisions: (1) enhancing the antifraud provisions under Exchange Act Sections 9, 10(1) and 15; (2) on extraterritorial jurisdiction, effectively overruling the Supreme Court’s decision in Morrison and extending the jurisdiction in this area of the government and SEC; (3) extending aiding and abetting authority for the SEC under the Securities Act, the Investment Company Act and the Investment Advisers Act; (4) clarifying the SEC’s authority over formerly associated persons of regulated entities; (5) imposing joint and several liability on control persons in SEC actions; (6) authorizing the nationwide service of subpoenas in SEC district court enforcement actions; (7) authorizing the SEC to impose collateral bars; and (8) expanding the SEC’s authority to impose penalties to all cease and desist proceedings. The Act also imposes certain time limits on investigations and inspections.
CFTC rule making: The CFTC published a list of its rule making relating to over-the-counter derivatives under Dodd-Frank. The list includes: (1) the comprehensive regulation of swaps dealers and major swap participants; (2) clearing; (3) trading; (4) particular products; (5) enforcement; (6) position limits; and (7) other titles.
SEC enforcement action
Financial fraud: SEC v Dell Inc., Civil Action No. 1:10-cv-01245 (D.D.C. Filed July 22, 2010) is a settled action alleging violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a), 12(b)(2)(A) and (B). The defendants are Chairman and CEO Michael Dell, former CEO Kevin Rollins, former CFO James Schneider, former Assistant Controller Leslie Jackson and former regional Vice President of Finance Nicholas Dunning. The complaint alleges that Intel Corporation made exclusivity payments to Dell so that the company would not use CPUs manufactured by its rival Advance Micro Devices, Inc. The payments grew from 10% of operating income in fiscal 2003 to 38% in fiscal 2006 to 76 % in the first quarter of fiscal 2007. When Dell announced in the second quarter of fiscal 2007 that it would begin using ADM CPUs, Intel sharply cut the payments resulting in the equivalent of a 75% decline in Dell’s operating income. The defendants never disclosed that the company was able to meet its earnings targets as a result of the Intel payments. At a second quarter 2007 earnings call, investors were not told that the sharp drop in operating results was caused by Intel’s action. Rather, the drop was attributed to other causes. The company also maintained a cookie jar reserve from the third quarter of fiscal 2003 through the first quarter of fiscal 2005.
To settle the action the company consented to the entry of a permanent injunction prohibiting each of the sections cited in the complaint, agreed to enhance its Disclosure Review Committee and disclosure processes and to retain an independent consultant to make recommendations. The company also agreed to pay a $100 million civil penalty.
Messrs. Dell and Rollins consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) & (3) and aiding and abetting violations of Exchange Act Sections 13(a). Each executive agreed to pay a civil penalty of $4 million. Mr. Schneider consented to the entry of an injunction prohibiting future violations of Securities Act Section 17(a)(2) &(3), Exchange Act Section 13(b)(5) and aiding and abetting violations of 13(a) and 13(b)(2)(A) & (B). He also agreed to pay disgorgement of $83,096 along with prejudgment interest. Messrs. Dunning and Jackson consented to the entry of permanent injunctions prohibiting future violations of Exchange Act Section 13(b)(5) and from aiding and abetting violations of Sections 13(a) and 13(b)(2)(A)&(B). Mr. Dunning also agreed to pay a civil penalty of $50,000. Messrs. Schneider, Dunning and Jackson also consented to the entry of an order under Rule 102(e) suspending each from appearing or practicing as an accountant before the Commission with a right to reapply after five years for Mr. Schneider and three years for Messrs. Dunning and Jackson. See also Litig. Rel. 21599 (July 22, 2010).
Kickbacks: SEC v. Langford, Case No. CV-08-0761 (N.D. Ala. Filed April 30, 2008) is the first enforcement action involving security based swap agreement, discussed here. It centers on a kickback scheme involving Larry Langford, the mayor of Birmingham, Alabama, William Blount, the co-owner and chairman of Blount Parris, a municipal securities broker and Albert LaPierre, a lobbyist and former executive director of the Alabama Democratic Party. Mr. Blount, his brokerage firm, and Mr. LaPierre settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 15B(c)(1) and certain rules of the Municipal Securities Rulemaking Board. The SEC’s claims for disgorgement and civil penalties were dismissed. See also Litig. Rel. 21595 (July 20, 2010). Previously, the defendants in the Commission’s case were indicted on criminal charges based on the same scheme as discussed here. Mr. Blount also consented in a related administrative proceeding to the entry of an order barring him from associating with any broker, dealer or municipal securities dealer. In the Matter of William B. Blount, Adm. Proc. File No. 3-13974 (July 22, 2010).
Investment fund fraud: U.S. v. Brown (S.D.N.Y. Unsealed July 22, 2010) is a criminal complaint charging securities fraud, wire fraud and money laundering against CPA Laurence Brown. According to the court papers, beginning in 2008 Mr. Brown, a principal in an accounting firm, raised about $2 million from investors who were solicited to purchase shares in Infinity Reserves-Tennessee, Inc. The funds were to be used to upgrade a natural gas pipeline in Tennessee. In fact, the shares were fictitious and most of the money was diverted to the defendant’s personal use. The Commission filed a parallel proceeding against Mr. Brown and his partner Ronald Mangini, SEC v. Brown, Civil Action No. 10-CV-5564 (S.D.N.Y. Filed July 22, 2010). Both cases are in litigation.
SunTrust Investment Services, Inc., and two of its brokers, David Bredenburg and another broker, from 2004 through November 2006 engaged in a pattern of unsuitable short term UIT, CEF and mutual fund transactions in the accounts of seventeen customers, most of whom were elderly and/or disabled. In addition, FINRA concluded that the two brokers recommended to ten of those customers unsuitable purchases and sales of securities on margin. The firm settled the action by agreeing to pay $1.44 million. About $900,000 of that amount is a fine while nearly $224,000 constitutes disgorgement. The remaining $540,000 is restitution to the customers. Mr. Bredenburg was permanently barred from the industry in a prior proceeding. The supervisor of the two brokers, Donald Mattran, was suspended for six months from acting in any principal capacity and fined $10,000.
Court of appeals
Fiduciary duties: U.S. v. Lay, No. 08-3893 (6th Cir. July 14, 2010) is, as discussed here, an appeal by an investment adviser from his conviction on violations of the Advisers Act and other charges. Defendant Mark Lay is an investment adviser. His client is Ohio Bureau of Workers’ Compensation. Mr. Lay’s company, Capital Management, Inc. started managing the Bureau’s investment in a long-term bond fund, the Long Fund. Subsequently, in 1998 Mr. Lay started a hedge fund, the Active Duration Fund. The Bureau moved $100 million of its investment from the Long Fund to the Active Duration Fund. The agreement set a non-binding 150% leveraging guidelines which Mr. Lay exceeded. As losses grew at the hedge fund the Bureau transferred additional funds to it but the losses continued and most of the investment was lost. The losses resulted in large part from excessive leverage far beyond the guidelines. The jury was instructed on the elements of Adviser Section 80b-6-(1) or 80b-2(2) or 80b-6(4). The court also instructed the jury that it could find as a matter of fact that Mr. Lay had a fiduciary duty to the Bureau with regards to its investment in the hedge fund. The jury returned verdicts of guilty which the Sixth Circuit affirmed. Mr. Lay did not dispute the fact that he had an investment adviser-client relationship with respect to the Long Fund. He did dispute this claim with regard to the hedge fund, arguing that the fund and not the Bureau was the client. The court rejected this claim.
Jeremy Burley, the Managing Director of BMS Minerals, a Ugandan company, and his father Jeffery Burley, were fined by the FSA for engaging in market abuse or insider trading in June 2009. According to the FSA Jeremy Burley learned around June 11, 2009 that Tower Resources, a company for which BMS Minerals furnished equipment, was unlikely to find oil in the first well it was drilling and that exploration regarding a second was unlikely to proceed. Before the public announcement of these events Jeremy Burley passed the information to his father and another with instructions to his father to sell his holdings in the company. The father followed the instructions and avoided a loss of over $30,000. The FSA fined Jeremy Burley over $200,000 and his father over $50,000. The fine as to Jeremy Burley reflected his lack of cooperation.