THIS WEEK IN SECURITIES LITIGATION (June 18, 2010)
This week Congress moved forward with the financial reform bill, but did not complete its work. The Supreme Court continued to consider cases involving the constitutionality of the honest services fraud statute and the PCAOB, as well as one involving the application of Exchange Act Section 10(b) to suits brought by foreign shareholders over a largely foreign fraud. The High Court also agreed to a materiality question in a securities class action case.
The FSA, the U.K.’s top market regulator, issued its annual report and was then informed it would be dismantled over the next two years. SEC enforcement resolved an insider trading case and more investment fund fraud actions. Criminal prosecutors, along with the SEC, brought an action centered on phony mortgages and an effort to defraud the TARP program.
Enforcement/deterrence: The FSA, the top market regulator in the U.K. filed its annual report which in part reviews its recently initiated program focusing on the use of criminal prosecutions and large fines to deter market abuse. The regulator plans to continue with the program. Statistics in the report, however, undercut any claim that the new initiative is effective as discussed here.
FSA: The FSA will be abolished over the next two years and its authority and power divided. In part, its powers will go to the Bank of England. Much of the regulator’s authority, however, will go to a new Consumer Protection and Markets Authority, which will be charged with regulating the conduct of every bank and policing the markets. The action follows criticism of the FSA stemming from its performance in regard to the market crisis.
Materiality: Matrixx Initiatives, Inc. v. Siracusano, No. 09-1158 (S.Ct. cert. granted June 14, 2010). The Court agreed to hear a securities class action brought against Matrixx Initiatives, Inc., the manufacturer of Zicam a nasal spray, its key product. The question the Court agreed to review, discussed here, is “whether a plaintiff can state a claim under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5 based on a pharmaceutical company’s nondisclosure of adverse event reports even though the reports are not alleged to be statistically significant?” The district court, following Second Circuit precedent, dismissed the case which alleged fraud based on the non-disclosure of adverse event reports regarding Zicam because they were not statistically significant. The Ninth Circuit reversed, holding that materiality is a question for the fact finder. The court went on to hold that as long as the fraud claims were adequately pleaded, as here, the action could move forward.
SEC enforcement actions
Insider trading: SEC v. Leyva, Civil Action No. 09 CV 1565 (S.D. Cal.) is an action against the former Director of Strategic Marketing Analysis for Qualcomm Incorporated, Andres Leyva. According to the complaint, discussed here, when Nokia surprised Qualcomm with a substantial offer to settle a critical litigation on the eve of trial, the lead company negotiator phoned Mr. Leyva and discussed the terms. Two hours later Mr. Leyva purchased 80 Qualcomm call options at $0.39 each with a strike price of $50. After the market closed the settlement was announced. The next day, Qualcomm’s stock increased 17% in price to $52.43. Mr. Leyva sold his options for a profit of $34,739.98. To settle the case Mr. Leyva consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to disgorge his trading profits and to pay prejudgment interest and a civil penalty equal to the amount of the disgorgement and prejudgment interest. See also Litig. Rel. 21559 (June 17, 2010).
Investment fund fraud: SEC v. Wegener, Case No. 1:10-CV-566 (W.D. Mich. Filed June 14, 2010) is an action alleging violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 15(a) and Advisers Act Section 206 against Martin Wegener and two companies he controlled. According to the complaint, Mr. Wegener acted as an unregistered broker and investment adviser in raising about $6.5 million from twenty investors over a period of three years beginning in 2007. Defendant Wegener claimed he would invest the funds through his controlled company and furnished them with statements listing investments in a variety of securities. In reality, the defendant diverted the funds to his own use. To resolve the case, the defendants consented to the entry of a permanent injunction of the sections cited in the complaint. Disgorgement, prejudgment interest and the amount of any penalty will be determined by the court. See also Litig. Rel. 21560 (June 17, 2010).
Fraudulent bonds: SEC v. United American Ventures, LLC, Civil Action No. 1:10-cv-00568 (D.N.M. Filed June 14, 2010) is an action against United American, Philip Thomas, Eric Hollowell, Matthew Dies, Integra Investment Group and Anthony Oliva in connection with a fraudulent scheme involving the offer and sale of so-called convertible bonds. The Commission claims that, over a two year period beginning in 2006 defendants, Thomas and Hollowell, along with Mr. Dies, raised about $10 million selling bonds in UAV to about 100 individuals. The investors were told that the company had a solid track record of profits from medical related investments and that they would receive a 25% return. The defendants resolved the action by consenting to the entry of a permanent injunction prohibiting future violations of Sections 5 and 17(a) of the Securities Act and Section 10(b) of the Exchange Act. Messrs. Thomas Hollowell, Dies, and Olivia also consented to the entry of permanent injunctions prohibiting future violations of Exchange Act Section 15(a)(1). Disgorgement, prejudgment interest and civil penalties will be determined by the court. See also Litig. Rel. 21556 (June 14, 2010).
Financial fraud: SEC v. Collins, Case No. 07 cv 11343 (S.D.N.Y. Filed Dec. 18, 2007) is a fraud action against former Mayer Brown partner Joseph Collins based on his participation in the fraud at Refco, Inc. as discussed here. Mr. Collins is alleged to have lead a team of attorneys which aided and abetted the financial fraud at the company in which at the end of each quarter hundreds of millions of dollars was moved off the books of Refco and on to those of an affiliate controlled by its chairman. After the close of the accounting period, the debt was moved back. Mr. Collins was previously convicted of securities and wire fraud and sentenced to seven years in prison in a related criminal case. This week Mr. Collins settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Exchange Act. See also Litig. Rel. 21555 (June 14, 2010).
Investment fund fraud: SEC v. Chimay Capital Management Inc., Case No. 10 CIV 4582 (S.D.N.Y. Filed June 11, 2010) is an action against Chimay Capital and its chairman, Guy Albert de Chimay. According to the complaint, from 2008 through 2009, Mr. Chimay marketed the fund as the U.S. investment arm of the Chimay royal family of Belgium. Over $6 million was raised from investors based on claims that the funds would be pooled with those of the royal family to make short term loans. Investors were to receive a 12% return. In fact, none of the money was invested in the short term loans. Rather, much of it was misappropriated and used to pay personal expenses such as Mr. Chimay’s legal bills from his divorce and for a home in the Hamptons. The complaint alleges violations of the antifraud provisions of the federal securities laws. The SEC obtained an emergency freeze order at the time the complaint was filed. The case is in litigation. See also Litig. Rel. 21554 (June 11, 2010).
Mortgage fraud: U.S. v. Farkas, (E.D. Va. Filed June 16, 2010); SEC v. Farkas, Civil Action No. 1:10cv667 (E.D. Va. Filed June 16 2010). Both cases charge Lee Farkas, former chairman of mortgage lender Taylor, Bean & Whitaker, with fraud. Specifically, the sixteen count indictment charges Mr. Farkas with conspiracy, bank fraud and securities fraud based on a $1.9 billion scheme which is alleged to have contributed to the failure of his company and Colonial Bank. The court papers all allege Mr. Farkas tried to defraud the Troubled Asset Relief Program. The SEC’s complaint alleges violations of the antifraud and reporting provisions of the federal securities laws as discussed here.
The court papers claim that Mr. Farkas had Taylor Bean sell the bank essentially fake mortgages which the financial institution carried on its financial statements which were filed with the SEC. The transaction was part of an effort to conceal the huge liquidity problems Taylor Bean as well as its overdrafts at the bank. Taylor Bean also carried millions of dollars in impaired value loans on its books. In addition, Mr. Farkas is alleged to have defrauded those who purchased commercial paper from a Taylor Bean affiliate. That paper was required to be backed by cash and securities. Mr. Farkas diverted much of that collateral to his own use however. When the affiliate could not redeem the commercial paper, the purchasers were left with billions of dollars of worthless commercial paper. Finally the suits claim that Mr. Farkas attempted to defraud the TARP program in connection with an application for funds filed by the bank. Both cases are in litigation.
Kickbacks: U.S. v. Finazzo, Case No. 10 cr 00457 (E.D.N.Y. Filed, June 11, 2010) is a case against Christopher F. Finazzo, former Executive Vice President and Chief Merchandising Officer of Aeropostale, Inc., and Douglas Dey, owner of South Bay Apparel, Inc., discussed here. The twenty-eight count indictment centers on a claimed kickback scheme in which Mr. Dey paid Mr. Finazzo a portion of the profits his company made from selling merchandise to Aeropostale. The indictment contains counts of conspiracy, wire and mail fraud and money laundering as to both men and, in addition, charges Mr. Finazzo with making false statements to the SEC. The case is in litigation.
Investment fund fraud: U.S. v. Hodgson (S.D.N.Y. Filed June 16, 2010) a an action which charges Antoinette Hodgson with conspiracy to commit wire fraud and wire fraud in connection with the operation of a Ponzi scheme. Specifically, the court papers claim that Ms. Hodgson, over a period of three years beginning in 2006, raised about $45 million from investors with false claims that the funds were being invested in a real estate venture and that they would reap large profits. In fact, much of the investor money was used to repay other investors, while part of it was diverted to the personal use of the defendant. Only a small fraction of the money was used to invest in real estate.