THIS WEEK IN SECURITIES LITIGATION (July 9, 2010)
This week in securities litigation fraudulent trading and insider trading cases were a focus of SEC Enforcement. Both DOJ and the SEC continued to bring FCPA cases and the CFTC filed a Ponzi case. The Second Circuit Court of Appeals reversed securities fraud convictions because the court failed to properly instruct the jury on conscious avoidance.
SEC enforcement actions
Fraudulent trading: In the Matter of Ephraim Fields, Adm. Proc. File No. 3-13962 (July 8, 2010). This is a settled administrative proceeding against Ephraim Fields, the owner and manager of registered investment adviser Clarus Capital Management and the general partner of Clarus Capital, LLC, a hedge fund. Here, Hawk Corporation, a Cleveland, Ohio based supplier of products used in industrial, agricultural, performance and aerospace, sought to avoid compliance with SOX Section 404. That Section requires the company to evaluate and report on the design and effectiveness of its internal controls. Extensions to comply with Section 404 were issued for, among others, companies with worldwide market values of less than $75 million. For Hawk, the closing price of its shares on June 30, 2006 would determine if it had to comply.
On June 30, 2006, a company executive called Mr. Fields. Based on the call, he concluded that the company wanted to make sure its share value fell below the required dollar level. Accordingly, Mr. Fields had Clarus sell a total of 40,000 shares of Hawk stock in eight limit day orders the day of the call. Since the average daily trading volume is just over 11,000 shares per day, the trades were unusual. The trades were also priced to cap the share price at a level which ensured that Hawk would not have to comply with SOX Section 404. The Order alleges these trades violated the antifraud provisions of the federal securities laws. To resolve the case, Mr. Fields consented to the entry of a cease and desist order and a censure. He also agreed to pay a penalty of $50,000.
Insider trading: SEC v. Binette, Case No. 3:09 cv 30107 (D. Mass. Filed July 15, 2009) is an insider trading action against Carl Binette and Peter Talbot. According to the complaint, discussed here, Peter Talbot concluded from analyzing a number of pieces of non-public information he learned through his employment at The Hartford Financial Services Group, Inc. that the company was evaluating the potential acquisition of Safeco Corp. Mr. Talbot tipped his nephew, Carl Binette, who purchased out of the money Safeco options in April 2008. Later that month, Liberty Mutual Insurance Company announced it was acquiring Safeco. Mr. Binette sold the options for a profit of $615,833.06. Mr. Binette agreed to resolve the action by consenting to the entry of a permanent injunction prohibiting future violation of Exchange Act Section 10(b). The judgment provides that Mr. Binette will pay disgorgement and a penalty determined by the court on motion of the Commission.
Fraudulent trading: SEC v. Abdullah, Civil Action No. 10-4957 (S.D.N.Y. Filed July 6, 2010) is an action against Aamer Abdullah, the former head of ICP Asset Management LLC’s mortgage backed securities desk. This case is related to the action against ICP Asset Management, discussed here. The complaint here alleges that defendant Abdullah engaged in a series of transactions that defrauded ICP’s advisory clients. In some instances, trades were undertaken which favored one client over another. In other instances Mr. Abdullah and ICP President Thomas Priore are alleged to have executed cross trades among various CDOs, trading bonds at prices that vastly exceeded their market prices and which inflated the clients’ overall assets. The complaint alleges violations of the antifraud provisions and aiding and abetting. Mr. Abdullah consented to the entry of an injunction prohibiting violations of the antifraud provisions to resolve the action. Issues regarding any disgorgement and a penalty will be resolved by the court.
Offering fraud: SEC v. Wright, Civil Action No. 2:10-cv-00602 (D. Utah Filed July 2, 2010) is an action alleging violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a) against Travis Wright. The complaint alleges that Mr. Wright made false and misleading representations when raising about $145 million from 175 investors. The investors were sold promissory notes issued by Waterford Loan Fund, LLC. Those representations included claims that investor funds would only be used to make loans secured by commercial real estate, that the notes were secured by a deed of trust and that the company would never lend more than 50% of the value of the real estate in question. Waterford is in Chapter 11 and being liquidated. The Commission’s case is in litigation. See also Litig. Rel. 21586 (July 2, 2010).
Insider trading: SEC v. Santarias, Civil Action No. 09-CV-10100 (S.D.N.Y. Filed July 2, 2010) is a settled insider trading case against former Ropes & Gray attorney Brian Santarias. Mr. Santarias is alleged to have misappropriated material non-public information about two corporate acquisitions from his law firm. Mr. Santarias, along with Arthur Cutillo, is alleged to have tipped Zvi Goffer, a trader at Schottenfeld Group, LLC in exchange for kickbacks. To resolve the case Mr. Santarias consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and agreed to pay disgorgement of $32,500 and a penalty in the same amount. The disgorgement will be credited against any forfeiture order entered in the criminal case. Mr. Santarias has also agreed to be barred from practicing before the Commission as an attorney in a related administrative proceeding. In the Matter of Brian Santarlas, Esq., Adm. Proc. File No. 3-13958 (Filed July 7, 2010); See also Litig. Rel. 21587 (July 7, 2010). The action against Mr. Cutillo is discussed here while the case against Schottenfeld Group is discussed here.
U.S. v. Snamprogetti Netherlands B.V., Case No. H-10-460 (S.D. Tex. Filed July 7, 2010 is an FCPA action against the Dutch subsidiary of Snamprogetti S.p.A., an Italian company. The information, which contains one count of conspiracy and one count of aiding and abetting violations of the FCPA, is based a scheme which involved Kellogg Brown & Root and Technip S.A. According to the court documents in each of these cases, the defendants entered into a joint venture to secure contracts from Nigeria LNG Ltd. to build LNG facilities on Bonny Island, as discussed here. Bribes to Nigerian government officials were paid through two agents. To resolve this case, the company entered into a deferred prosecution agreement and agreed to pay a criminal fine of $240 million. In the parallel action brought by the Commission, SEC v. ENI, S.p.A., Case No 4:10-cv-02414 (S.D. Tex. Filed July 7, 2010), the parent and subsidiary agreed to settle by consenting to the entry of permanent injunctions prohibiting future violations of the anti-bribery, books, records and internal control provisions of the FCPA. In addition, the defendants agreed to pay a penalty of $125 million in addition to the one paid in the criminal case. See also Litig. Rel. 21588 (July 7, 2010).
U.S. v. Carson, Case No. 8:09-cr-00077 (C.D. CA. Filed April 8, 2009) is an FCPA case which names six former executives of Control Components as defendants, discussed here. One executive, Italian citizen Flavio Ricotti, the former vice president and head of sales for Europe, Africa and the Middle East of the company, was extradited from Germany to stand trial. Mr. Ricotti is charged with one count of conspiracy to violate the FCA and the Travel Act, one count of violating the FCPA and three counts of violating the Travel Act. He is alleged to have caused company employees and agents to make corrupt payments valued at $750,000 to officers and employees of state owned companies. He is also alleged to have caused an additional $380,000 in corrupt payments to be made to officers and employees of private companies. The payments were made in connection with projects in the UAE, Kazakhstan, India and Qatar. Previously the company and two other executives pleaded guilty.
Investment fund fraud: CFTC v. Milton, (S.D. Fla. Filed June 22, 2010) is an action initially filed under seal and later announced on July 6, 2010 against Phillip Milton, Gregory Center and William Center and their controlled entity Trade LLC. The complaint claims the defendants raised about $28 million from at least 900 investors. The funds were to invest in a commodity pool. Investors were told that the defendants were successful in trading commodity futures and that the pool had a profitable track record. Those representations were false. In addition, only a portion of the funds were placed in a pool while substantial amounts of the investor funds were misappropriated. Investors were paid principal and purported profits by using funds from new investors. The complaint alleges solicitation fraud and misappropriation of pool funds as well as a failure to register with the CFTC as commodity pool operators. An order entered at the time the complaint was filed froze the assets of the pool and directed that the books and records be preserved.
Court of Appeals
U.S. v. Kaiser, Case No. 07-2365-cr (2nd Cir. Decided July 1, 2010). The court reversed the securities fraud convictions of Mark Kaiser, a former executive of U.S. Food Services. The convictions were based on the financial fraud at the Royal Ahold subsidiary, discussed here. The scheme centered on the improper recognition of payments from vendors and the government’s claims that Mr. Kaiser deceived the auditors and tried to cover up the fraud. In reviewing the convictions, first the court rejected the defendant’s claim that the instruction on “willfulness,” a key intent element required by Exchange Act Section 32(a), was inadequate. Since the jury was told that it had to find Mr. Kaiser knew that his statements were “false and fraudulent” and were made “with intent to create a deception” the jury had to find he knew his acts were wrongful. Accordingly, the instruction was sufficient. However the instruction on “conscious avoidance” was incorrect since it lacked two key elements: “(1) that a jury may infer knowledge of the existence of a particular fact if the defendant is aware of a high probability of its existence, (2) unless the defendant actually believes that it does not exist.” Indeed, the instruction given may have permitted the jury to find conscious avoidance based on a negligence standard which is wrong. Accordingly, the conviction was reversed.