The war on insider trading by the Manhattan U.S. Attorney was propelled forward this week with the conviction of Galleon hedge fund founder Raji Rajaratnam on all fourteen counts. At the same time another defendant in the expert network investigation pleaded guilty. DOJ also prevailed in an FCPA jury trial.

SEC enforcement filed another investment fraud case and a settled financial fraud action. The division lost an effort to retroactively apply a Dodd-Frank collateral bar provision.

Market Reform

Monitoring risk: SEC Chairman Mary Schapiro testified on May 12, 2011 before the Senate Committee on Banking, Housing and Urban Affairs on monitoring systemic risk and promoting financial stability. In her testimony the Chairman addressed a number of topics including: steps the SEC is taking to examine strengthening market structure; its response to the flash crash; rule making under Dodd-Frank regarding derivatives and private fund adviser registration and reporting; the Financial Stability Oversight Council; new authority regarding Financial Market Utilities; and systemic risk assessment (here).

Capital formation: SEC Chairman Mary Schapiro also testified before the House Committee on Oversight and Government Reform regarding the future of capital formation. In her testimony the chairman addressed issues concerning registered offerings, private placements, capital formation for smaller companies, IPOs and reporting. The Chairman also stated that a review is underway of restrictions on communications in IPOs, whether the general solicitation ban should be revisited, the number of shareholders that trigger public reporting and regulatory questions posed by new capital raising strategies (here).

SEC Enforcement

Investment fraud: SEC v. Gracy, Civil Action No. CV 11-2282 (S.D.N.Y. May 11, 2011) is an action against George Garcy and Angelo Cuomo alleging violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). From 2003 through early 2009 the defendants raised about $8 million from at least 200 investors through the fraudulent sale of unregistered securities of E-Z Media, Inc. Defendants employed a series of misrepresentations about the company to sell the securities and then misappropriated substantial sums. The action is pending. Parallel criminal charges were unsealed on May 11 in the Eastern District of New York.

Financial fraud/insider trading: SEC v. Michael Baker Corp., Civil Action No. 4:11-cv-1791 (S.D. Tx. Filed May 11, 2011) is a settled action against the company, John Scullin, a former Manager of Project Accounting, and Dennis Higgins, a former operations manager for the company. Beginning in the fourth quarter of 2006, and continuing through the first three quarters of 2007, Mr. Scullin made a series of manual journal entries that were unsupported and inflated the pre-tax income of the company by amounts which ranged from 13% to 100%. This was facilitated by materially deficient internal controls. When Mr. Higgins learned about the material misstatements and before the public announcement he sold all of his shares in the company.

The company settled, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Mr. Scullin resolved the case by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b) and 13(b)(5) and from aiding and abetting violations of the books and records and internal control provisions. He also agreed to pay a civil penalty of $35,000. Mr. Higgins resolved the charges against him by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and agreeing to pay disgorgement of $16,929.75 along with prejudgment interest and a civil penalty in the same amount.

In a related administrative proceeding Michael Higgins, the former CFO of the company and Mr. Scullin’s supervisor, consented to the entry of a cease and desist order precluding him from causing violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). In the Matter of Michael Higgins, CPA, Adm. Proc. File No. 3-14379 (May 11, 2011).

Retroactivity: In the Matter of John W. Lawton, Adm. Proc. File No. No. 3-14162 (April 29, 2011). This action was brought under Section 203(f) of the Advisors Act. Respondent previously managed a multi-million hedge fund through an investment adviser, Crossroads Capital Management, LLC. As a result of his misconduct over fifty investors lost somewhere between $2.5 million and $7 million. Mr. Lawton pleaded guilty to one count of mail fraud and one count of false statements in a criminal case and consented to the entry of a permanent injunction in and SEC enforcement actions. Based on this record a request for summary disposition was granted. The critical question in the case was the application of Section 925 of Dodd-Frank which amended Advisors Act Section 203(f) to provide for a collateral bar. Judge Murray rejected a request for a collateral bar since statutes are presumed not to be retroactive. To the extent Section 925 provided for new penalties, they could not be applied to past conduct under the ruling.

Criminal cases

Insider trading: U.S. v. Rajaratnam, Case No. 1:09-cr-0118 (S.D.N.Y.). Defendant Raji Rajaratnam was found guilty on all fourteen counts of conspiracy and insider trading. Mr. Rajaratnam is the founder of the Galleon funds. The charges are based on overlapping insider trading schemes in which the defendant received inside information from a variety of sources as discussed here.

Insider trading: U.S. v Shimoon, 10-mj-2823 (S.D.N.Y.) is one of the expert network cases. This week defendant Manosha Karunatilaka pleaded guilty to one count of conspiracy to participating in an insider trading scheme. It involved expert networking firm Primary Global Research. The defendant is a former account manager at Taiwan Semiconductor Manufacturing Co. From 2008 through 2010 he participated in a conspiracy to furnish inside information to clients of the expert network firm. This included information about his company. Sentencing is scheduled for September 15, 2011.


U.S. v. Noriega, Case No. 2:10-cr-01031 (C.D. CA.). Lindsey Manufacturing and its owner and President, Keith Lindsey, vice president and CFO Steve Lee were convicted on FCPA charges following a jury trial. Angela Aguilar was convicted of money laundering. Ms. Aguilar is a Mexican national, married to Enrique Aguilar of Grupo International which served as an agent for Lindsey to secure business from a state owned enterprise. Mr. Aguilar is a fugitive.

The charges stem from bribes paid to employees of Comision Federal de Electricidad or CFE, a state owned enterprise in Mexico, by Lindsey through Grupo. Beginning in 2002, and continuing over the next seven years, Lindsey secured business from CFE. Over the period the company was paid more than $19 million by the utility. To secure the business Lindsey paid a 30% commission to Grupo with the understanding that all or part of it would go to CFE officials. To cover the cost of the commission Lindsey raised its prices to CFE thereby passing on the cost to the electric company. The commissions were paid under false invoices. Over the years Messrs. Lindsey and Lee wired about $5.9 million to Grupo. Ms. Aguilar authorized the payment of Grupo funds to CFE officials. The company and Messrs. Lindsey and Lee were each convicted on one count of conspiracy and five counts of FCPA violations. Ms. Aguilar was convicted on one count of conspiracy to commit money laundering. Sentencing is scheduled for the company and defendants Lindsey and Lee on September 16, 2011. Ms. Aguilar is scheduled to be sentenced on August 12, 2011.