THIS WEEK IN SECURITIES LITIGATION (July 30, 2010)
Market reform continued to be a key topic this week with the SEC soliciting comments on a number of provisions under Dodd-Frank even before the opening of the official comment period. SEC enforcement brought an insider trading case based on corporate officers and directors trading through off-shore trusts which is in litigation and filed a settled action against Citibank based on false statements made about its exposure to the sub-prime market. The Commission also filed a settled FCPA case, while a class action was brought against a company and its directors based on violations of the Act.
Dodd-Frank: The SEC published a request for comments regarding its study of the obligations of broker-dealers and investment advisers. The Commission is also seeking comments on a number of issues under the Act even before the official comment period begins. The Release lists provisions under Title II (liquidation authority), Title III (transfer of certain powers to the Comptroller), Title IV (regulation of hedge funds), Title VI (improvements to regulation of banks and savings associations holding companies), Title VII (Wall Street Transparency and Accountability), Title VIII (payment, clearing and settlement supervision), Title IX (investor protection and improvements to the regulation of securities) and Title XV (miscellaneous provisions).
Securities class actions: Both NERA Economic Consulting and Stanford Law School Securities Class Action Clearinghouse released reports tracking securities class actions. Both reports noted that for the first half of 2010 the number of cases filed declined. According to the Stanford report, the number of cases filed during that period declined by about 16% compared to the prior year. The number of filings has declined since 2008.
SEC-IG: The inspector general has expanded his probe into the Commission’s action against Goldman Sachs. The IG opened an investigation shortly after the complaint was filed, looking at claimed pre-filing press leaks and allegations that its filing was politically timed. Now, in response to more questions from Capitol Hill – this time claims the settlement was politically timed – the IG has expanded his inquiry as discussed here.
SEC enforcement actions
Insider trading/fraud: SEC v. Wyly, Case No. 10 CV 5760 (S.D.N.Y. Filed July 29, 2010) is an action against Sam Wyly, former Chairman of Michaels, Sterling Software and Scottish Re and former Executive Committee Vice Chairman of Sterling Software; Charles Wyly, former Vice Chairman of the same companies and a former director of Sterling Software; Michael French, their lawyer; and Louis Schaufele, their broker. The complaint centers on an insider trading scheme involving trading in the shares of the companies with which the two Wyly defendants were affiliated. Specifically, it claims that the Wyly defendants maintained an elaborate web of off-shore trusts which they used to hold significant blocks of stock in the companies and which were traded using inside information. Messrs. French and Schaufele are alleged to have facilitated this scheme which traded over $750 million of stock in the four companies with which the Wylys were affiliated. The complaint alleges that all four defendants violated, and that Messrs. French and Schaufelee aided and abetted violations of, Exchange Act Section 10(b). It also alleges that the two Wyly defendants and Mr. French violated Exchange Act Sections 13(d), 14(a) and 16(a). The two Wyly defendants are also charged with violations of Securities Act Section 5 and aiding and abetting violations of Exchange Act Sections 13(a) and 14(a). Mr. French is also charged with aiding and abetting violations of Exchange Act Sections 13(d), 14(a) and 16(a). The case is in litigation
False statements: SEC v. Citigroup Inc., Civil Action No. 1:10-CV-01277 (D.D.C. July 29, 2010) is a settled action which alleges violations of Securities Act Section 17(a)(2) and Exchange Act Section 13(a) by the bank. The complaint centers on allegations that beginning in July 2007 and continuing through the fall of that year, the bank misrepresented its exposure to the sub-prime market. Investors were told that Citigroup’s investment bank’s sub-prime exposure was $13 billion. In fact it was about $56 million – the bank failed to tell investors about two groups of sub-prime investments valued at $43 billion. The false disclosures were repeatedly made despite the fact that two senior bank officials named in a related Order for Proceedings, Gary Crittenden, its former CFO, and Arthur Tildesley, Jr., its current head of Global Cross Marketing, were repeatedly given information about the full extent of Citigroup’s sub-prime exposure. To resolve its case, Citibank consented to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint and agreed to pay disgorgement and a penalty totaling $75,000,0001. See Litig. Rel 21605 (July 29, 2010). To resolve In the Matter of Gary L. Crittenden, Adm. Proc. File No. 3-13985 (Filed July 29, 2010) Messrs. Crittenden and Tildesley consented to the entry of an order directing them to cease and desist from causing any further or future violations of Exchange Act Section 13(a). In addition, Mr. Crittenden undertook to pay $100,000 while Mr. Tildesley undertook to pay $80,000.
Financial fraud: SEC v. Fisher, Case No. 07-cv-4483 (N.D. Ill. Filed Aug. 9, 2007). The complaint alleges a financial fraud which caused the falsification of Nicor’s annual reports for 2000 and 2001 and eight quarterly reports as discussed here. According to the Commission, beginning in 1999 and continuing through 2002, Nicor failed to disclose “rigged reductions in gas inventory levels that enabled it to improperly manipulate its earnings . . .” This scheme increased Nicor’s revenues under a plan administered by the Illinois Commerce Commission. The defendants also understated the expenses of the company during the first quarter of 2001 by improperly bundling a weather-insurance contract with an agreement to supply gas to its insurance provider at below market prices. The losses from that agreement were charged to the customers of the company, contrary to the dictates of the ICC. The complaint also alleges a failure to make disclosures required by GAAP regarding the cash flow impact of certain inventory liquidations. To settle the action, Mr. Fisher consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3) and from aiding and abetting violations of Exchange Act Section 13(a). He also agreed to pay disgorgement and prejudgment interest in the amount of $825,000. The Commission dropped its claim based on Exchange Act Section 10(b), Securities Act Section 17(a)(1) and for a civil penalty. The litigation continues as to the other two defendants.
False statements: In the Matter of Spencer International Advisors, Inc., Adm. Proc. File No. 3-13980 (Filed July 27, 2010) is a proceeding against Spencer International, a registered investment adviser, and its president, Scott Spencer. The Order alleges that in 2006 Mr. Spencer induced 55 clients of Spencer International to purchase $5 million in promissory notes issued by a Florida limited liability company owned by a developer and guaranteed by Mr. Spencer and his wife. The offering materials contained false and misleading information about the developer and failed to disclose personal debt guarantees owed by the developer to other Spencer International clients. The notes defaulted as did the developer. To resolve the action, the Respondents agreed to the entry of an order directing that they cease and desist from current and future violations of Advisers Act Section 206. Mr. Spencer is also barred from associating with any investment adviser with a right to reapply after five years and agreed to pay a civil penalty of $75,000.
False statements: SEC v. Geotec, Inc., Case No. 09-80986 (S.D. Fla.) names as defendant the company, Bradley Ray, Stephen Chanslor, CPA and William Lueck in a complaint filed in 2007. That complaint alleged that the defendants made false statements about the acquisition of millions of tons of coal, improperly reported it as inventory and incorrectly recognized millions of dollars in revenue from the coal. The company also failed to have an independent accountant review its quarterly reports. To resolve the case the defendants consented to the entry of permanent injunctions. As to the company, it is based on Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B); as to Mr. Ray it is based on Exchange Act Sections 10(b) and 13(b)(5) and prohibits him from aiding and abetting violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) while imposing an officer director bar and ordering him to pay a penalty of $75,000; and as to Mr. Chanslor it is based on Exchange Act Sections 10(b) and 13(b)(5) and prohibits him from aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) while imposing an officer and director bar and a civil penalty of $25,000. Mr. Chanslor also agreed to the entry of an order in a related administrative proceeding which prohibits him from appearing or practicing before the Commission as an accountant with a right to reapply after three years. The Commission’s Release does not indicate the basis for the injunction against defendant Lueck. See Litig. Rel. 21604 (July 28, 2010).
Financial fraud: SEC v. Sunrise Senior Living, Inc., Civil Action No. 1:10-CV-01247 (D.D.C. Filed July 23, 2010). This accounting fraud action was brought against the company and two of its former senior officers, Larry Hulse, former CFO, and Kenneth Abode, former Treasurer. The Commission’s complaint alleges an earnings management scheme that began in the second half of 2003 and continued during 2005. The complaint centers on improper accounting in the corporate bonus accrual account and the health and dental reserve to make earnings forecasts as discussed here.
The company settled by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 13(a) and 13(b)(2)(A) and (B). Mr. Hulse consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 12(b)(2)(A) and (B) and 13(b)(5). He also agreed to pay disgorgement of $83,333 and prejudgment interest and a civil penalty of $50,000. In a related administrative proceeding, Mr. Hulse consented to the entry of an order under Rule 102(e) suspending him from appearing or practicing before the Commission as an accountant with a right to reapply after three years. Mr. Abode consented to pay a civil penalty of $25,000. In a related administrative proceeding he consented to the entry of a cease and desist order from causing any violations of Section 13(b)(5) of the Exchange Act and related rules and to the entry of an order denying him the privilege of appearing or practicing before the Commission as an accountant with a right to reapply after one year. The Commission acknowledged the cooperation of the company.
Investment fund fraud: U.S. v. Greenwood, 09 cr 722 (S.D.N.Y. Filed July 28, 2010) is a case against Paul Greenwood who, along with broker WG Trading Investors, LP, his partner Stephen Walsh and investment adviser Westridge Capital Management, Inc., and other controlled vehicles, is alleged to have raised about $800 to $900 million from investors. The money was to be invested in a stock index arbitrage strategy. Instead, Mr. Greenwood and his partner, Stephen Walsh, diverted the money to his own use. Mr. Greenwood pleaded guilty to a six count indictment which charges conspiracy, securities fraud, commodities fraud, money laundering and two counts of wire fraud. Mr. Greenwood is cooperating with prosecutors. In a related case, SEC v. WG Trading Investors, LP, 09-CV-1750 (S.D.N.Y. Filed July 29, 2010), Mr. Greenwood settled similar charges with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206. Disgorgement and the imposition of a civil penalty will be considered later. Mr. Greenwood also settled with the CFTC. CFTC v. Stephen Walsh, 09-CV-1749 (S.D.N.Y. July 29, 2010). In that settlement he consented to the entry of an order which prohibits him from trading commodity futures and options and from soliciting funds for such trading. He also agreed to pay disgorgement and a penalty in amounts to be determined later.
SEC v. General Electric Company, Case No. 1:10-CV-01258 (D.D.C. Filed July 27, 2010). The case names as defendants GE, Amersham plc (currently GE Healthcare) and Ionics, Inc (currently GE Ionics). The complaint centers on violations by two GE subsidiaries and two companies which GE acquired after the alleged violations. According to the complaint, discussed here, from 2000 to 2003 the two GE subsidiaries made about $2.04 million in kickback payments in the form of computer equipment, medical supplies and services to the Iraqi Health Ministry as part of the U.N. program. The kickbacks were made through agents in the form of “after sales service fees” on the sale of products to Iraq. Similarly, the two companies which later became GE subsidiaries paid about $1.55 million in cash kickback payments to Iraqi under the U.N. program. The payments were paid as kickbacks through agents in the form of “after sales service fees.” To settle the action, each of the three defendants consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). GE also agreed to disgorge $18,397,949 in wrongful profits, pay prejudgment interest and a civil penalty of $1 million. The settlement reflects the cooperation of the defendants.
Shareholder suit: York v. Cornwell, No. 651065/2010 (N.Y. St Sup. Ct) is a shareholder suit against the Avon Products Inc., its board and three former directors. The complaint centers on a claimed failure to prevent improper payments in China. In October 2008, the company announced an internal investigation which has continued to expand. It is focused on FCPA compliance. In April, the company suspended four executives as part of that investigation. The litigation is pending.