THIS WEEK IN SECURITIES LITIGATION (June 11, 2010)
Dell, Inc. filed a 10-KA late on Thursday reporting that it has revised the financial results previously reported to record a $100 million liability for a potential settlement of an SEC investigation. While the filing did not provide the terms of any settlement, Bloomberg reports that CEO Michael Dell is in settlement negotiations over allegations relating to the company’s relationship with Intel Corp. The settlement will be based on negligence fraud charges and would not bar Mr. Dell from being a director of a public company, according to the report. The SEC has not announced any settlement with Dell.
On Capital Hill, Congress is poised to reconcile the bills passed by the House and Senate which would overhaul the financial system and prevent another market crisis. In advance of those efforts, CFTC Chairman Gary Gensler continues to speak out in favor of strong new regulations to govern the derivatives market.
SEC enforcement prevailed this week on a motion to dismiss in its first litigated Section 304 claw back case. The Commission also brought a financial fraud case, settled with two more defendants in its Lucent financial fraud action which has been in litigation for the last six years and brought two additional investment fund fraud cases. Criminal cases were brought based on misstatements by an official of a biotech company and against persons claimed to be running a boiler room operation. And, a shareholder derivative suit was filed tied to alleged violations of the FCPA.
CFTC Chairman Gary Gensler, in remarks made this week, highlighted key provisions of the House and Senate bills on derivatives which he says should be in the final legislation. Key features of both bills require: robust recordkeeping and reporting requirements; on-exchange transactions and bilateral transactions that regulators could police; and all standardized products would be traded on regulated exchanges or similar vehicles. These provisions would bring transparency and narrow the pricing spreads, thereby reducing risk for the system. In addition, the final legislation should include a provision from the current Senate bill requiring the real time reporting of transactions.
Since centralized clearing is also a critical part of any regulatory reform in these markets, any exclusions should be limited the Chairman noted. The Senate bill requires that standard derivatives of financial entities be brought to clearing houses in contrast with the house bill which has a liberal exemption for entities using derivatives to hedge commercial, balance sheet or operational risk. Finally, clearinghouses must be effectively regulated to avoid conflicts, be open to both dealers and non-dealers and have open access, taking on trades from any regulated exchange or swap execution facility.
SEC enforcement actions
Investment fund fraud: SEC v. Merendon Mining (Nevada) Inc., Case No. 2:10-cv-00955 (W.D. Wash. Filed June 10, 2010) is an action alleging violations of the antifraud, registration and broker registration provisions of the securities laws by Milowe Allen Brost, Gary Sorenson, Larry Adair, Ward Capstick, Bradley Regier, Martin Werner and their controlled entities. According to the SEC, the defendants obtained funds from over 3,000 investors in the U.S. and Canada to invest in gold mining. The defendants claimed to be an independent financial educational firm which discovered investment opportunities in gold mining that would give investors returns ranging from 18 to 36%. In fact, the funds were put in shell companies and run through a series of transactions. Part of the money was used to pay “interest” to investors while the defendants diverted other portions to themselves. The case is in litigation. See also Litig. Rel. 21552 (June 10, 2010).
Disclosure fraud: In the Matter of Sam Douglas, Adm. Proc. File No. 3-13934 (June 10, 2010) is a proceeding against Sam Douglas, chairman and CEO of Equus Total Return, Inc., a business development company, and Anthony Moore, co-founder and CEO of Moore, Clayton & Co., Inc., an international private equity investment and advisory firm. The firm’s investment adviser was ECMC. The allegations in the Order center on a change in investment adviser made in 2005 and undisclosed payments to certain employees which were in effect retention bonuses. Those payments were mischaracterized in quarterly and annual filings with the Commission as well as a proxy statement. The proceeding, which alleges violations of Exchange Act Sections 10(b), 13(b)(5) and 14(a), is in litigation. See also In the Matter of Harry O. Nicodemus IV, Adm. Proc. File No. 3-13933 (June 10, 2010) (settled proceeding against accountant who consented to the entry of a cease and desist order based on the fact that he prepared a spread sheet used in the preparation of the false filings).
Claw back: SEC v. Jenkins, Case No. CV-09-1510 (D. Az. Jul. 23, 2010) is the action against Maynard L. Jenkins, the former CEO and chairman of the board of CSK Auto Corporation. The complaint, discussed here, seeks to recover certain incentive compensation paid to Mr. Jenkins during the time a financial fraud was in progress at the company. In seeking repayment, the SEC acknowledged that Mr. Jenkins was not involved in the fraudulent conduct. Defendant Jenkins moved to dismiss. The court rejected Mr. Jenkins’ claims that Section 304 should not be read to impose liability without fault as alleged in the complaint. The court’s ruling is predicated largely on the language of the Section, although it is bolstered with a review of the legislative history.
Financial fraud: SEC v. Lucent Technologies, Inc., Case No. 04-2315 (D.N.Y. Filed May 17, 2004) is an action in which the Commission named the company and a number of its executives. The complaint charges financial fraud, alleging violations of the antifraud and reporting provisions. Those claims are based primarily on the improper recognition of revenue from transactions subject to certain side arrangements as discussed here. This week the Commission settled with defendants Jay Carter, the former president of Lucent’s AT&T Customer Business Unit, and Alice Dorn, the former Vice President of Indirect Sales for North America. Mr. Carter consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 13(b)(5) and to the payment of a $25,000 civil penalty. Ms. Dorn consented to the entry of a permanent injunction prohibiting her from aiding and abetting violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) and from violating, or aiding and abetting, violations of Exchange Act Section 13(b)(5). She also agreed to pay a civil penalty of $40,000. The settlements followed a ruling from the court rejecting SEC claims of primary liability.
Books and records: In the Matter of China Yuchai International Ltd., Adm. Proc. File No. 3-13925 (June 7, 2010) is a settled administrative proceeding brought against China Yuchai, a Bermuda company headquartered in Singapore. The Order centers on an erroneous adjusting journal entry which resulted from inadequate financial controls at a controlled subsidiary, Guangxi Yuchai. The error was made in late 2005 when management at the subsidiary tried to evaluate if new accounting software had overstated certain accounts. In analyzing this question, a manual count of certain warehouse receiving documents was made. After an adjusting entry was done and the parent filed its annual report China Yuchai learned the entry was at least partially erroneous. The audit committee then conducted an internal investigation and appropriate corrections were made, including to the internal controls. To resolve this action, the company consented to the entry of a cease and desist order from committing or causing any violations and any future violations of Sections 13(a), 12(b)(2)(A) and 13(b)(2)(B).
Financial fraud: SEC v. Mortensen, Case No. 3 :10-CV-1142 (N.D. TX. June 9, 2010) is an action against William Mortensen, the former CFO of Advanced Materials Group, Inc. and his subordinate Feng Zheng. The case focuses on claims that Mr. Mortensen directed defendant Zheng to record false sales for two of AMG’s largest customers, thereby inflating the revenue of the company. That false revenue was used to obtain greater borrowings from AMG’s bank line of credit which defendant Mortensen misappropriated along with other company funds to pay personal expenses. The complaint alleges violations of the antifraud and reporting provisions of the Exchange Act. Mr. Zheng settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint and agreeing to pay a civil penalty of $25,000. The case is in litigation as to Mr. Mortensen. See also Litig. Rel. 21550 (June 9, 2010).
Investment fund fraud: SEC v. Petrogas Overseas Trading, Case No. 4-10 CV-395-A (N.D. Tex. Filed June 7, 2010) is an action against Petrogas Overseas Trading, LP and its owner Samuel LeMaire. According to the Commission, Mr. LeMaire claimed he was a minister raising money to help needy children in Nigeria. Investors were solicited to fund his foundation. They were also told they would make money from profits earned by the sale of Nigerian oil. Returns ranging from 200 to 1,000% were promised. The defendants raised about $2.3 million over the last three years. The money was diverted to the personal use of Mr. LeMaire. The complaint alleges violations of the antifraud provisions of the federal securities laws. The case is in litigation. See also Litig. Rel. 21549 (June 8, 2010).
Boiler room scheme: U.S. v. Kimmel, Case No. 1:10-cr-00476 (S.D.N.Y. Filed June 9, 2010) is an action which charges Steven Kimmel, CEO of Realcast Corp. and a former SEC employee, and twelve others, with running a boiler room which defrauded investors of more than $12 million. According to the indictment, defendant Anthony Cuarino oversaw a boiler room operated under the name of Powercom and Empire Energy. Investors were urged to purchase shares in Realcast and BBC Gaming based on false representations which included claims of a 40% return. The indictment, which is only partially unsealed, charges securities, wire and mail fraud and conspiracy.
False statements: U.S. v. Dragon (S.D. Cal. Filed June 2, 2010) is an action charging Elizabeth Dragon, former senior vice president for research and development at Sequenom, Inc., a biotechnology company, with conspiracy to commit securities fraud. Dr. Dragon pleaded guilty to the charge, admitting that between 2008 and 2009, she made disseminated false and misleading information about a Down syndrome screening test developed by the company. The SEC filed a parallel case which on the same date, discussed here.
Mohamed Kassamali v. Robert Parker, Jr., (Harris Co. Tex. Filed June 10, 2010) is a derivative action filed against the directors of Parker Drilling Co., seeking to recover for injuries caused to the company as a result of payments made in Kazakhstan and Nigeria in violation of the FCPA. The complaint claims that these payments, currently being investigated by DOJ and the SEC, demonstrate that the company failed to maintain a proper system of internal controls which resulted in the injuries to it.