This Week In Securities Litigation (May, 22, 2009)

A new scandal added to the woes of the SEC this week with the release of a redacted version of an Inspector General report which sparked a criminal investigation into whether two enforcement attorneys engaged in insider trading. Subsequently, press reports suggested that the SEC may be stripped of much of its authority under forthcoming administration proposals. A challenge to the constitutionality of the PCAOB got new life this week when the Supreme Court agreed to hear an appeal from the DC Circuit which had rejected the claim.

SEC enforcement focused on option backdating, financial fraud and more investment fund fraud cases. Two more individuals pleaded guilty to criminal violations of the FCPA, while a former E&Y partner was convicted on insider trading charges.


A new report, discussed here, from the SEC’s Inspector General, released in redacted form by Senator Charles Grassley, states that over the last two years two attorneys in the Division of Enforcement have engaged in suspicious trading. The matter has been referred to the U.S. Attorney’s Office for the District of Columbia who, along with the FBI, is conducting a criminal investigation. The IG’s report also concludes that the division has virtually no insider trading controls.

The Supreme Court

PCAOB: The Court agreed to hear a challenge to the constitutionality of the Public Company Accounting Oversight Board created as part of the Sarbanes Oxley Act. Free Enterprise Fund and Beckstead and Watts, LLP v. Public Company Accounting Oversight Board and U.S.A., Case No. 08-861 (S. Ct. Filed Jan. 8, 2009). The case presents two constitutional questions as discussed here. First, whether the SOX sections creating the Board violate the Constitution’s separation of powers. Second, whether those sections are contrary to the Appointments Clause. The district court granted summary judgment in favor of defendants. The court of appeals affirmed in a 2-1 decision and later declined to rehear the case or consider it en banc in a 5-4 ruling.

If Petitioners prevail, it could be the end of the PCAOB and the comprehensive regulation of public company auditors Congress crafted in the wake of the corporate scandals which dominated the headlines early in this decade. The case will be heard next fall.

Pleading standards: The Court reaffirmed and clarified its conclusion that Federal Civil Rule 8(a) requires a complaint to set forth sufficient facts to establish that plaintiff has a plausible claim. The “plausibility” standard was previously announced by the Court in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007). In reaffirming Twombly, the court rejected a decision by the Second Circuit which concluded that only a “flexible plausibility standard” was required. Under that standard, “a pleader could amplify a claim with some factual allegations in those contexts where such amplification is needed to render the claim plausible.” The court also noted that under Rule 9(b), which requires that fraud be pleaded with “particularity” but state of mind “generally,” there must still be sufficient facts to make a plausible claim regarding state of mind. Ashcroft v. Iqbal, Case No. 07-1015 (S. Ct. Decided May 18, 2009).

SEC enforcement

Option backdating: SEC v. Monster Worldwide, Inc., Civil Action No. 09 CV 4641 (S.D.N.Y. May 18, 2009) is the latest in a series of actions regarding option backdating at Monster Worldwide, Inc. discussed here. As in the earlier cases, the complaint alleges that options were backdated at the company resulting in a restatement of the historical financial statements for the periods from 1997 through 2005. The cumulative pre-tax amount of the restatement was $339.5 million to record additional non-cash charges for option related compensation expenses.

The company resolved the case by consenting to the entry of a permanent injunction prohibiting future violations of the antifraud, reporting and proxy provisions of the federal securities laws. The company also agreed to pay a civil penalty of $2.5 million. The SEC took into consideration the cooperation of the company.

Option backdating: SEC v. Ray, Civil Action No. CV 09-3430 (C.D. Cal. Filed May 15, 2009) is a settled option backdating case against Gary Ray, the former vice president of human resources at KB Home, Inc. The complaint is based on the option backdating scheme at the company which is discussed here. Mr. Ray received backdated options for 380,000 shares and made more than $480,000 from exercising those options. He settled the case by consenting to the entry of a permanent injunction prohibiting future violations of the antifraud, books and records and proxy provisions of the securities laws. In addition, he agreed to pay over $540,000 in disgorgement and interest and a civil penalty of $50,000. Mr. Ray also agreed to be barred from serving as an officer or director of a public company for five years.

Financial fraud: SEC v. Apogee Technology, Inc., Civil Action No. 09 cv 10286 (D. Mass. May 19, 2009) is a settled financial fraud case against the company, its former COO, David Meyers and controller, Annette Jaynes as discussed here. The complaint centers on a scheme to inflate the revenues of the company in 2003 and 2004 by improperly recognizing income in violation of GAAP using a variety of techniques. The improper techniques used included improperly recognizing revenue: a) on transactions with a right of return; b) where the shipment did not go out until the next quarter; and c) where the terms of the agreement were not certain. As a result, quarterly revenues were overstated by as much as 45% in one quarter.

To resolve the case each defendant consented to the entry of a permanent injunction prohibiting future violations of the antifraud and books and records provisions. Mr. Myers also agreed to pay disgorgement of $9,356 plus prejudgment interest representing his gains on the sale of company stock during the period. Payment however, was waived based on his financial condition. Mr. Myers also consented to be barred from serving as an officer or director of a public company for five years. Ms. Jaynes agreed to the entry of an order requiring the payment of a civil penalty of $30,000.

Financial fraud: SEC v. WellCare Health Plans, Inc., Civil Action No. 8:09 cv 00910 (M.D. Fla. Filed May 18, 2009), discussed here. Here, the complaint alleges that over a four-year period from 2003 through 2007 the company engaged in a fraudulent scheme which inflated its reported profits by $40 million by retaining funds it was contractually required to reimburse to agencies of the state of Florida. The allegations in the complaint centered on two Florida state programs under which the company received funds or premiums that were to be expended on certain health care programs. By failing to spend the funds or return them as required, the company overstated its income. In 2007, the company restated its financial statements for FY 2004 through 2006.

To resolve the case, the company consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions and the payment of a $10 million civil penalty by the company. The Commission acknowledged the cooperation of the company

Investment fund cases: The SEC continued to file investment fund cases this week:

SEC v. Wealth Management LLC, Civil Action No. 1:09-cv-506 (E.D. Wis. Filed May 21, 2009) is an action against James Putman, the founder and majority owner of investment adviser Wealth Management, its CEO, the Chief Investment Officer and related entities. Wealth Management does financial planning for families and individuals. It has approximately $102 million in client assets invested in various pools. Over a two year period, Mr. Putman and the CEO took $1.24 million in undisclosed payments from certain investments made by the pools. In addition, the complaint claims that the defendants made misrepresentations regarding the stability and safety of the two largest pools. The complaint is based on claimed violations of the antifraud provisions and a breach of fiduciary duty. The Commission obtained an emergency freeze order. The case is in litigation.

• In SEC v. Sun Group, Civil Action No. SACV 09-399 (C.D. Cal. Amended complaint filed May 19, 2009), the Commission amended its complaint, adding as defendants Bich Quyen Nguyen, Johnny Johnson and two entities they control — Sun Group and Sun Investment Savings and Loan. The initial defendants are Empire Capital Asset Management and Sun Empire along with Delilah Proctor and Shauntel McCoy. According to the amended complaint, the new defendants raised more than $9 million from investors, promising guaranteed returns on high-yield instruments. The marketing pitch focused on individuals who were unemployed or recently bankrupt, promising them returns of over 19% with guarantees. Sun Investment Savings and Loan is not in fact a savings and loan, according to the complaint. The SEC obtained a freeze order as to the new defendants. Previously the Commission had obtained a preliminary injunction. The case is in litigation.

SEC v. Driver, Case No. CV 09-3410 (C.D. Cal. Filed May 14, 2009) alleges a Ponzi scheme conducted by defendant Gordon Driver and his company, Axcess Automation, LLC. According to the SEC, Mr. Driver rose over $14.1 million from investors by promising them weekly returns of 1 to 5% resulting from trading in futures using a proprietary software program he developed. In fact only a small fraction of the money was used to trade futures. The bulk of the investor cash was used to pay other investors, while over $1 million was spent on Mr. Driver’s personal expenses. The SEC obtained a temporary freeze order. The CFTC has also filed an action. The case is in litigation.


Juan Diaz and Antonio Perez each pleaded guilty to a one count information based on FCPA violations in connection with securing services from the Telecommunications D’Haiti as discussed here. Mr. Diaz admitted paying over $1 million in bribes to Haitian officials on behalf of three Florida based telecommunications to secure business advantages. Mr. Perez, formerly the controller of a company which paid over $674,000 in bribes to Haitian officials, admitted facilitating the payment of over $36,000 in bribes. The payments were channeled through a company owned by Mr. Diaz. Both men are awaiting sentencing. U.S. v. Diaz, Case No. 09-20345 (S.D. Fla. Filed April 22, 2009).

Criminal cases

Insider trading: In U.S. v. Gansman, Case No. 108-cr-00471 (S.D.N.Y. Filed May 27, 2008), former E&Y partner James Gansman was found guilty by a jury following a two week trial on six counts of securities fraud related to insider trading. Mr. Gansman, an attorney in charge of the human resource consulting services E&Y provided merger clients, regularly furnished inside information to Donna Murdoch. Ms. Murdoch in tern traded based on the information, yielding about $300,000 in profits. Ms. Murdoch previously pled guilty.

Financial fraud: U.S. v. Sulfridge, Case No. 3:09-cr-00119 (N.D. Tex. Filed May 6, 2009), the former vice president of corporate finance for Image Entry, Inc., Michael Sulfridge, pled guilty to a two count information charging conspiracy to commit wire and securities fraud and tax evasion. The charges stem from the acquisition of Entry by Sourcecorp, Inc. Under the terms of the agreement $33 million was paid at closing. An additional $11 would be paid if Entry hit certain earnings targets over three years. An additional amount of up to $25 million would be paid keyed to the amount by which Image exceeded the specified earnings targets. Mr. Sulfridge fraudulently increased the earnings of Image to obtain the additional payments and then failed to report on his tax returns about $592,393 in bonus compensation he received based on the inflated revenues. Sentencing has not been scheduled.