Questions about what many claim is the sparse number of market crisis cases continued to swirl on Capital Hill. A subpoena from the Manhattan DA to an icon of Wall Street bank only intensified the buzz. Yet on Capital Hill a House committee is considering a bill to postpone at least part of the regulations intended to prevent another market crisis.

In court insider trading continues to be the focus with another major trial moving to conclusion in Manhattan. Two guilty pleas were entered in the on-going expert network investigation.

The SEC won another insider trading trial while filing actions involving investment fund fraud and fraudulent trading. FINRA resolved cases with two firms regarding the marketing of subprime securitizations.

The court in the Alcatel-Lucent S.A. FCPA case rejected a novel and perhaps unprecedented effort by a foreign power company whose officials were bribed to intervene in the resolution of the action. The company claimed it is entitled to be treated by DOJ as a victim. The court disagreed.

Finally, the Sixth Circuit handed down a decision which may well rewrite how the Supreme Court’s Tellabs decision regarding pleading a strong inference of scienter is applied. In applying Tellabs the circuit court rejected its earlier two step approach which first considered each inference and then the collective in favor of a one step holistic analysis based on its reading of Matrixx Initiatives, a case generally known for its holding on materiality.

Market Reform

The Commission and FINRA issued a warning to retail investors regarding investments in structure notes with principal protection. This product combines a zero-coupon bond with an option or other derivative whose payoff is linked to an underlying asset. In an environment of low interest rates and returns this product offers the prospect of superior returns but also has risks as discussed here.

SEC enforcement

Investment fund fraud: SEC v. Rothenberg, Case No. 1:11-CV-1803 (N.D.Ga. Filed June 2, 2011) is an action against the attorney Michael Rothenberg and his controlled entity, Four Five LLC. Between February and March 2010 the defendants raised over $1.7 million from investors on the promise that the funds would be invested in a secret, risk free trading platform or facility that would generate returns of over 300% every two weeks. Investors were also told that most of the funds would remain in Mr. Rothenberg’s attorney trust account. In fact there was no trading platform. A portion of the funds wentto pay expenses for Mr. Rothenberg’s judicial campaign. Other portions of the money went to his personal expenses. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation.

Manipulation and fraud: In the Matter of Betty Getty, LLC, Adm. Proc. File No. 3-14404 (May 31, 2011) is a proceeding which names as Respondents Betty Getty, a registered investment adviser, Terry Deru, the Managing Member and Chief Compliance Officer of the firm, and Andrew Limpert, a former member and direct owner and control person of the firm. The Order alleges several violations. First, market manipulation of Nine Mile stock. By October 2008 Nine Mile had a market maker and trading symbol but was not publicly quoted by any major quotation system. Respondent Deru ordered trades for individual firm clients for whom there was discretionary authority and conducted manipulative trading. This raised the price to an artificial level. Second, Respondents made misrepresentations regarding the management and use of proceeds in connection with the private placement of shares for Axxess Funding Group LLC, an entity formed by Respondents Deru and Limpert and Damon Deru. In place of the experienced management promised by the PPM the company paid Respondent Deru’s son almost 10% of the money raised in the offerings for virtually no work. Mr. Deru also took $500,000 for his personal benefit. Third, Respondent Deru recommended to a firm client a $1 million investment in Vermillion Holdings which supposedly owned a gold mine in Mexico. In fact it did not. Third, Respondent Deru recommended to an elderly firm client that he purchase what was in fact Deru’s person restricted stock in a company created from a reverse merger. The client made the investment based on a false promise that it had a rate of return of 33% to 50%. He also recommended high risk speculative and illiquid investments to other elderly firm clients. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b) as well as violations of Advisers Act Sections 206(1) & (2) and 204(a). The proceeding is being set for hearing.

Fraudulent trading: In the Matter of Larry Feinblum, Adm. Proc. File No. 3-14407 (May 31, 2011) is a proceeding against a former executive director at Morgan Stanley & Co. arising out of his conduct and that of his direct report, Jennifer Kim. From October through December 2009, Respondent and Ms. Kim executed an arbitrage trading strategy that sought to profit from price discrepancies between U.S. and foreign markets. Since the trades exceed the internal position limits of the firm the traders concealed the risk by entering other trades to reduce it except that they were later cancelled. By trading in this manner Respondent substantially increased the risk for the firm and ultimately contributed to millions of dollars in losses. The Order alleges violations of Exchange Act Section 10(b). The matter was resolved with Respondent consenting to the entry of a cease and desist order from committing or causing any violations of Section 10(b). Respondent will also be barred from the securities business with a right to apply for reentry after two years. He will also pay a $150,000 civil penalty.

Overcharging advisory fees/procedures: In the Matter of Wunderlich Securities, Inc., Admin. Proc. File No 3-14403 (May 27, 2011) names as Respondents Wunderlich Securities, Inc, a broker dealer and state registered adviser, Tracy Wiswall, the COO of the firm, and Gary Wunderlich, the principal founder and CEO of the firm. The Order alleges that from 2007 through 2009 the firm overcharged advisory clients for commissions and other transaction fees. In addition, it failed to adopt and implement certain written procedures or to establish and maintain a written code of ethics. Ms. Wiswall is alleged to have been the cause of the firms violations relating to principal trades with advisory clients. Both individual defendants are alleged to have aided and abetted the firm’s violations relating to policies and procedures and a code of ethics. The Order alleges violations of Advisors Act Sections 204A, 206(2), (3) and (4) -7. The matter was resolved with each Respondent consenting to the entry cease and desist orders based on the Sections cited in the Order. The firm also agreed to implement a number of procedures including the retention of a consultant. In addition, the firm will pay disgorgement of $369,336.15 along with prejudgment interest and a penalty of $125,000. Mr. Wunderlich agreed to pay a penalty of $45,000 while Ms. Wiswall will pay $50,000.

Insider trading: SEC v. Teo, 04 Civ. 1815 (D. N.J. Filed April 22, 2004). A jury found Alfred S. Teo liable for insider trading and a trust for his children, the M.A.A.A. Trust, liable for disclosure violations. The case involved trading related to two take-over transactions and disclosure violations. The first centered on a tender offer for Musicland Stores Corporation. Mr. Teo was its largest shareholder. Prior to the announcement of a tender offer by Best Buy for Musicland he learned about the proposed transaction through several confidential communications with senior management. Before the deal announcement Mr. Teo began buying Musicland shares. Overall he purchased 45,000 shares. He also tipped several others. Musicland announced the transaction on December 7, 2000. The share price increased 30%. Mr. Teo sold his shares at a profit of $185,275.0. Eight others he tipped had profits of over $1.1 million, according to the complaint.

The MAAA trust also held a substantial number of shares of Musicland. The trust, along with Mr. Teo and another, filed a Schedule 13D which falsely disclosed their holdings. This permitted them to avoid triggering the Musicland poison pill. False reports were also filed in violation of Exchange Act Section 16(a). This stock was later sold at a profit of $22 million.

Mr. Teo also traded on inside information regarding the acquisition of C-Cube Microsystems, Inc., according to the complaint. He learned about C-Cube as a board member of Cirrus Logic, Inc., a company which considered acquiring it. The deal announcement was made on March 26, 2001. Prior to the announcement, and after the board meeting, Mr. Teo purchased 35,000 shares of C-Cube stock. He also tipped another who purchased. Following the announcement Mr. Teo sold his shares at a profit of $180,012 while his tippee had profits of $115, 155. The court will determine remedies at a later date.

Criminal cases

Insider trading: U.S. v. Jiau, No. 11-161 (S.D.N.Y.). Samir Barai, a portfolio manager at two different New York hedge funds, pleaded guilty to one count of conspiracy to commit securities fraud and wire fraud, one count of securities fraud, one count of wire fraud and one count of obstruction of justice. Son Ngoc Nguyen, a former senior financial analyst for Nvidia Corp., pleaded guilty pleaded guilty to one count of conspiracy to commit securities fraud and wire fraud. The charges against Mr. Barai involve two overlapping conspiracies. Between 2006 and 2010 he conspired to insider trade with Donald Longueuil, Noah Freeman, Jason Pflaum and Winifred Jiau. The inside information involved several public companies including NVIDIA and Marvel Technology Group, Ltd. Frequently the group obtained information through an expert network in addition to other sources. In May 2008 Mr. Barai obtained inside information from Ms. Jiau regarding Marvell’s financial results for the quarter ending on May 3, 2008. As a result of trading in the shares of Marvell he had profits of over $800,000. During the course of the scheme he destroyed records and other evidence relating to it. In a separate scheme, from 2007 through early 2009, Mr. Nguyen conspired with an employee in the finance department of Marvell and shared inside information with Ms. Jiau about the two companies. Ms. Jiau used the information to trade for her account and also sold it to the group which included Mr. Barai.


The Court has accepted the settlement between DOJ and Alcatel-Lucent S.A. in an FCPA case (here). In accepting the settlement the court rejected an effort by the state owned electric company in Costa Rica known as ICE to intervene and be treated as a victim, according to a report by Main Justice. The utility, which awarded contracts to Alcatell-Lucent as a result of the bribes involved in the DOJ case, claimed that the settlement should be rejected because DOJ refused to treat it as a victim of the violations (here).


Insufficient investigation re pricing: An action was initiated against David Lerner & Associates, Inc. regarding the offering and sale of shares in Apple REIT Ten, a non-traded $2 billion Real Estate Investment Trust. The firm has acted as sole operator for Apple REIT Ten since 1992. Since January 2011 it has served as sole underwriter for Apple REIT Ten, selling over $300 million of an open $2 billion offering. Since 2004 the closed Apple REITs have unreasonably valued their shares at a constant price of $11 regardless of market conditions. The complaint claims that DLA failed to sufficiently investigate the valuation and distribution irregularities of the closed Apple REIs prior to selling Apple REIT Ten. Rather than conduct the appropriate due diligence the firm simply accepted the valuations and continued to solicit clients without determining if the valuations were reasonable and if the Apple REITs were suitable.

Misrepresentations re historical performance of RMBS: Credit Suisse Securities and Merrill Lynch were fined, respectively, $4.5 million and $3 million relating to misrepresentations regarding the delinquency data and inadequate supervision in connection with the issuance of residential subprime mortgage securitizations or RMBS. Issuers of these securities are required to disclose historical performance information for past securitizations that contain mortgage loans similar to thoe in the RMBS. Those rates are material to in assessing value. In 2006 FINRA found that Credit Suisse misrepresented the historical delinquency rates for 21 subprime RMBS it underwrote and sold. Although the firm knew about the inaccuracies it failed to sufficiently investigate them. In a separate case the agency found that Merrill negligently misrepresented the historical delinquency rates for 61 subprime RMBS it underwrote or sold. However after it learned of the error the firm recalculated the data and posted it on its website.

Circuit courts

Pleading scienter: In Plumbers & Pifefitters National Pension Fund v. Dana Corporation, Case No. 09-4233 (6th Cir. Decided May 25, 2011) the Circuit Court concluded that in assessing whether scienter is properly pleaded only a holistic approach should be used and each individual allegation should not be evaluated. This altered the Court’s prior two step process which considered each allegation and used a holistic approach. The case is based on the demise of Dana Corporation. The complaint alleges that between April 2004 and October 2005 its CEO and CFO made a series of false statements about the company which later had a restatement and filed for bankruptcy protection. The district court dismissed the complaint for failing to plead a strong inference of scienter as required by Tellabs, Inc. v. Makor Issues & rights, Ltd., 551 U.S. 308, 324 (2007).

The Sixth Circuit reversed. In Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (2011) the Court applied its Tellabs test. Following this approach the Court rejected its prior two step approach to evaluating if a strong inference of scienter has bas been pleaded:

“Writing for the Court, Justice Sotomayor expertly addressed the allegations collectively, did so quickly, and, importantly, did not parse out the allegations for individual analysis . . this is the only proper approach following Tellabs’s mandate to review scienter pleadings based on the collective view of the facts, not the facts individually. . . Our former method of reviewing each allegation individually before reviewing them holistically risks losing the forest for the trees. Furthermore, after Tellabs, conducting an individual review of myriad allegations is an unnecessary inefficiency.” The application of this approach here established that plaintiff had adequately pleaded scienter.

Seminar: June 8, 2011, 12:00 — 1:30, Trends In DOJ and SEC Financial Fraud Cases, ABA Program, Live in Washington, D.C. and webcast nationally. Co-Chairs: Thomas Gorman and Frank Razzano. Panel: Lorin Reisner, Deputy Director, Division of Enforcement, SEC: Patrick Stokes, Deputy Chief, Fraud Section, Department of Justice; Stephen Gannon, Deputy General Counsel and V.P., Capital One. The program is live, and will be broadcast from, the Metropolitan Club of Washington, D.C. (dress code — jacket and tie for gentlemen, similar for ladies; cell phone use not permitted in the club; lunch served).

For further information please click here.

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