THIS WEEK IN SECURITIES LITIGATION (March 25, 2011)
The Galleon insider trading trial continues this week in New York. In another New York court room the Commission struggled to have a partial settlement approved by the court. While the agency secured the necessary approval it was not without a cost: The court reserved the right to reconsider the propriety of entering consent decrees based on the Commission’s long standing practice of not admitting or denying the facts in the complaint.
SEC enforcement this week focused on its staples. Insider trading cases, investment fund cases and two FCPA cases were brought. Chairman Schapiro, speaking at a SIFMA conference outlined a new approach for OCIE while Enforcement Director Robert Khuzami highlighted the achievements of his division over the last year.
OCIE: In remarks at SIFMA’s Compliance and Legal Society Annual Seminar on March 23, 2011, Chairman Schapiro discussed in part a revised approach for the Office of Compliance, Inspections and Examinations. Now the office will focus in part on “engaging with the corporate governance structure of registrants, around enterprise risk and internal controls.” Without a commitment to good governance and risk management undertaken as a comprehensive approach to enterprise risk management, silos can form the Chairman noted. In that instance the interdependence between risk categories can be overlooked. Accordingly OCIE will now be asking questions about how the business units are ensuring that they are taking and managing risk effectively. Others questions will focus on key risk management, support and compliance functions and how senior managers ensure effective oversight of the enterprise. Others will center on the effectiveness of internal audit and how it independently operates to assure management and the board that systems and controls are properly functioning.
Enforcement: Speaking at the same SIFMA Conference, Enforcement Director Robert Khuzami highlighted recent enforcement efforts. After reviewing the now complete reorganization of the division, Mr. Khuzami cited a series of statistics suggesting what he called a high level of accomplishment for the division. In fiscal 2010 the division filed 681 cases, more than in any of the previous five years. During the same period orders for $2.85 billion in disgorgement and penalties were secured which represents a 17% increase over fiscal 2009 and a 176% increase over fiscal 2008. Finally, the Director cited a series of statistics illustrating the increased speed and efficiency of the division. To bolster the statistics Mr. Khuzami pointed to a series of cases including: Countrywide Financial, Citigroup, Morgan Keegan, Goldman Sachs, Pinnacle Capital Markets and the actions against TD Ameritrade and Charles Schwab. He also cited the recently filed insider trading administrative proceeding against Rajat Gupta, noting that it is the Divisions first under its new Dodd-Frank authority to obtain penalties in such actions against persons not associated with a regulated entity.
SEC settlements: SEC v. Vitesse Semiconductor Corporation, Civil Action No, 10 Civ. 9239 (S.D.N.Y. Filed Dec. 10, 2010) is a financial fraud case in which the Commission reached settlements with three defendants. After requiring the parties to file briefs justifying the proposed terms, Judge Rakoff reluctantly entered the settlements. In doing so he reserved the right to evaluate the long standing Commission practice of settling without admitting or denying the allegations in the complaint.
Matrixx Initiatives, Inc., v. Siracusano, Case No. 09-1156 (March 22, 2011). In a unanimous ruling the Court rejected Petitioner’s contention that there should be a bright line statistical test for materiality in a securities fraud suit. The Court adhered to the position it had taken in Basic Inc. v. Levinson, 485 U.S. 224 (1989). The case centered on claims about the cold nasal spray Zicam. Plaintiffs claimed that company statements touting the success of the remedy were false because there were reports from medical researchers and individuals demonstrating that there were adverse effects. Following the announcement of FDA involvement the share price dropped and suit was filed. The district court adopted a position followed by the second and other circuits that when adverse drug reports are statistically not significant they are not material. The ninth circuit reversed. The Supreme Court affirmed holding that “the materiality of adverse event reports cannot be reduced to a bright-line rule. Although in many cases reasonable investors would not consider reports of adverse events to be material information, respondents have alleged facts plausibly suggesting that reasonable investors would have viewed these particular reports as material.” Slip at 1-2.
Insider trading: SEC v. Duffell, Civil Action No. CV-11-1404 (N.D. Cal. March 24, 2011) is an action against Mark Duffell, a consultant for private investment firm Accel-KKR. According to the complaint, Mr. Duffell, on behalf of AKKR, approached SumTotal Systems about a take over. Two days later, while in possession of confidential information about that proposed transaction, he began purchasing shares of SumTotal. The deal was publically announced on March 2, 2009. Mr. Duffell made a profit of $162, 500. To resolve the case Mr. Duffell consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). In addition, he agreed to pay disgorgement of $162,500, prejudgment interest and a penalty equal to the amount of his trading profits.
Investment fund fraud: SEC v. Mike Watson Capital, LLC, 2;11-CV-00275 (D. Utah Filed march 24, 2011) is an action against the named entity along with Michael Watson and Joshua Escobedo. The complaint alleges that the defendants obtained over $27.5 million from October 2004 through February 2009 from 120 investors based on fraudulent representations. Investors were told that their funds would be invested and generate returns from real estate investments. They were also told that the investment fund was backed by substantial equity and had significant cash flow. In reality the properties never generated sufficient income to cover investment interest or redemptions which were thus paid from new investor funds. The defendants settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), and, as to the individuals, 15(a). The company and defendant Watson also agreed to be jointly and severally liable for disgorgement of $16,383,037.83 along with prejudgment interest and a civil penalty of $130,000. Disgorgement and a penalty were waived as to defendant Watson based on his financial condition.
Insider trading: SEC v. Wiener, Action No. 1:11cv292 (E.D. Va. March 23, 2011) is an action alleging violations of Exchange Act Section 10(b) by Daniel Wiener. The defendant was employed at BAE Systems, Inc On December 21, 2007 an announcement was made that BAE would acquire MTC Technologies, Inc. Although Mr. Wiener was not a member of the deal team he had regular contact with employees involved in the acquisition. Prior to the public announcement he participated in a staff meeting in which the transaction was discussed using code names. During that meeting Mr. Wiener discussed the products of the target in a manner which demonstrated that he knew the identity of the company. Thirty minutes after the meeting ended he purchased a block of MTC stock in his personal brokerage account. Subsequently, he purchased additional shares in his wife’s account. Following the public announcement of the deal he liquidated his holdings, realizing a profit of $67,686.99. The case is in litigation.
Churning: SEC v. Konaxis, Case No. 1:11-CV-10489 (D. Mass. Filed March 23, 2011) is an action against registered representative James Konaxis, formerly of Sentinel Securities, Inc. According to the Commission’s complaint, Mr. Konaxis excessively traded the account of a client. Initially the account was valued at $3.7 million. After two years its value had diminished to about $1.6 million while the defendant earned approximately $550,000 in commissions. The client is a widow from September 11. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Konaxis consented to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint and to a penny stock bar. He has also agreed to have the court resolve issues regarding disgorgement, prejudgment interest and the imposition of a penalty. In an administrative proceeding which will be instituted Mr. Konaxis has agreed to the entry of an order which will bar him from the securities industry.
Self-dealing: In the Matter of Roman Lyniuk, Adm. Proc. File No 3-14364 (Filed March 23, 2011) is an action against Roman Lyniuk who is a registered representative. He is the founder of Atlantis Capital Management, L.P., a small hedge fund which he operated beginning in late 1996. Until approximately 2004 investors in the fund were largely family and friends. Most of the capital was lost through trading. Subsequently, Respondent was successful in securing investments from outside investors. According to the Order, Mr. Lyniuk then engaged in self-dealing transactions, taking at least $400,000 in undisclosed compensation, including rebates from brokerage transactions, and a $40,000 referral fee in connection with one investment. In August and September 2006 the fund suffered significant losses which caused investors to seek the redemption of their interests. Rather than honoring the requests, Respondent misappropriated most of the remaining money to begin a new fund. Investors eventually received about 10% of their initial investment. From mid-2007 through December 2010 Respondent continued to promote a new fund. The Order, which alleges violations of Exchange Act Section 10(b) and Advisers Act Section 206(1) and (2), also states that Respondent attempted to fabricate exculpatory evidence during the investigation by the staff. The case is proceeding to hearing.
Investment fund fraud: SEC v. JSW Financial Inc., Case No. CV-11-1356 (N.D. Cal. Filed March 22, 2011) is an action against the company and five of its officers for defrauding investors in two real estate funds. From 2002 through 2008 the company and its predecessor created two real estate investment funds. Investors were told their money would be used to make loans secured by residential real estate. Contrary to those representations, the firm’s officers used most of the money to make unsecured loans to entities that they controlled which had increasing losses. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2) and (4). The case is in litigation.
Investment fund fraud: SEC v. Spyglass Equity Systems, Inc., Civil Action No. 11-2371 (C.D. Cal. March 21, 2011) is an action against Spyglass, Richard Carter, Preston Sjoblom, Tyson Elliott, Flatiron Capital Partners, LLC, Flatiron systems, LLC and David Howard. The complaint alleges that the defendants cold-called primarily elderly investor and, using false representations about the success of their trading system, raising about $2.15 million from nearly 200 investors. Contrary to the representations made to investors, less than half of the money raised was actually pooled and traded. About $1 million was lost trading. Another $500,000 was used for unauthorized business and personal expenses. By December 2008 the operation was out of money and steps were taken to conceal what had happened. Investors were told that trading halted to permit an audit. The complaint alleges violations of Securities Act Sections 5 and 17(a), Exchange Act Sections 10(b) and 15(a), Investment Company Act Section 7(a) and Advisers Act Sections 206(1), (2) and (4). The case is in litigation.
Insider trading: SEC v. Deskovick, Civ. 11-1522 (D.N.J. Filed March 17, 2011) is an action alleging violations of Exchange Act Section 10(b) by Kim Ann Deskovich and Brian S. Haig. The case centers on the acquisition of First Morris Bank and Trust by Provident Financial Services, Inc. which was announced on October 16, 2006. Defendant Deskovich was a director of the bank prior to the take over. Prior to the transaction announcement the bank made efforts to be acquired. As those efforts moved forward Ms. Deskovick was updated. Those updates continued through the merger negotiations. During that time period Ms. Deskovick tipped her friend and kept her updated. Her friend in turn tipped Brian Haig, telling him the source of the information. Mr. Haig also tipped a friend. Following the deal announcement Mr. Haig and his friend had profits from the 14% share price increase of 68,277. The action was settled with each defendant consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). Mr. Haig was also ordered to disgorge the total trading profits of he and his friend made along with prejudgment interest. Ms. Deskovick was ordered to pay a penalty of $64,277 and is barred from serving as an officer or director for five years. Mr. Haig was ordered to pay a penalty of $34,138.
Offering fraud: SEC v. St. Anseim Exploration Co., Civil Action No 11-CV-00668 (D. Colo. Filed March 18, 2011) is an action alleging fraud in violation of Securities Act Section 17(a) and Exchange Act Section (10) by the company and Michael Zaikroff, Anna Wells and Mark Palmer. According to the complaint the company had few assets. To keep it in operation the individual defendants sold promissory notes to about 200 investors raising about $62 million. The sales were based on false allegations that the company was profitable and able to pay investors from recurring revenue that came from oil and gas production and periodic sales of packages of assets. Eventually the defendants were making Ponzi like payments to some investors. The case is in litigation.
U.S. v. Aleynikov is an action against former Goldman Sachs high speed computer programmer Sergey Aleynikov. On December 10, 2010 Mr. Aleynikov was found guilty by a jury of stealing the proprietary high speed computer code used by Goldman. Mr. Aleynikov was employed by the firm from May 2007 through June 2009. During that period Goldman continued to develop a high speed trading program the firm initially acquired in 1999. When the defendant resigned from the firm in April 2009 he had secured a position with a start up firm on the basis that he would bring the system with him. This week the court sentenced Mr. Aleynikov to 97 months in prison.
In the Matter of Ball Corporation, Adm. Proc. File No. 3-14305 (March 24, 2011) alleges that the company violated the books and records and internal control provisions of the FCPA. Ball Corporation acquired Formametal, S.A. in March 2006. From July 2006 through October 2007Formametal paid bribes to employees of the Argentine government to secure the importation of prohibited used machinery and the exportation of raw materials at reduced tariffs. Those bribes totaled $106,749. Much of this activity happened prior to the acquisition of Formametal by Ball. However after the acquisition Ball official failed to take steps to prevent a reoccurrence of the wrongful conduct and in fact it did. The company resolved the case by consenting to the entry of a cease and desist order based on Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). The company also agreed to pay a penalty of $300,000. The penalty was limited in view of the cooperation of the company. The Commission acknowledged the remedial acts and voluntary disclosure of this matter.
SEC v. IBM, Case No. 1:11-cv-00563 (D.D.C. Filed March 18, 2011). The complaint centers on actions in Korea and China. In Korea the violations are based on the alleged improper payments by either IBM-Korea, a wholly owned subsidiary, or LG-IBM, a joint venture IBM controlled. The complaint states that from 1998 through 2002 these two subsidiaries made improper payments to South Korean government officials who worked for sixteen government entities. IBM-Korea is alleged to have made payments over the four year period totaling $135,558 while LG-IBM’s payments totaled $71,599. The conduct alleged in China differs. There the SEC complaint states that from 2004 through 2009 IBM-China employees created slush funds at local travel agencies in China. Those funds were used to pay for overseas and other travel expenses incurred by government officials. The complaint goes on to specify that in at least 114 instances the internal controls of the company failed to detect improper payments. While the company had FCPA compliance procedures, its internal controls were inadequate.
To resolve the case IBM consented to the entry of a permanent injunction prohibiting future violations of the books and records and internal control provisions of the FCPA, Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). The company also agreed to pay disgorgement of $5.3 million along with prejudgment interest and a $2 million civil penalty.
In settled proceedings the regulator imposed a $440,000 fine on Southwest Securities, Inc. and expelled Cutler Securities and barred it President Glenn Cutler. The action centered on the failure of Southwest to have adequate procedures as to its clearing operations and Cutler’s failure to comply with Regulation SHO. On the second day of clearing for Cutler, Southwest permitted the firm to establish a new 17.8 million share long position in a security and a 20,3 million short position. Cutler defaulted leaving an unsecured debt balance of $6.3 million. Cutler had a history of violating Regulation SHO.