THIS WEEK IN SECURITIES LITIGATION (November 13, 2009)
The first major market crisis cases to go to trial resulted in acquittals this week, dealing the government a serious setback. Two former Bear Stearns hedge fund managers were found not guilty of securities fraud charges by a jury in a matter of hours, rejecting government claims that the cases were about simple lies. Now, prosecutors will have to reevaluate on-going investigations.
Insider trading continued to dominate SEC and DOJ enforcement efforts as well as those around the globe with prosecutors in Estonia bringing their first ever insider trading case. While not the blockbuster cases of the last few weeks, it should be clear to all on Wall Street that the war on insider trading continues.
On the hill, Senator Dodd published yet another lengthy bill to rewrite the financial regulatory landscape. Although far from passage and competing with other proposed legislation, the draft is already causing angst in many quarters such as those of the banking regulators who would be reorganized and streamlined and brokers who would become investment advisers.
The Senate Committee on Banking, Housing, and Urban Affairs unveiled a draft bill titled Restoring American Financial Stability Act of 2009, summarized here. It offers yet another blueprint for reform of the financial markets. The thousand plus page bill proposes to redraw the regulatory landscape, creating new agencies while consolidating others and enhancing the authority of the SEC.
New agencies and offices include the Agency for Financial Stability charged with monitoring and addressing systemic risks from large, complex companies and products that pose risk across firms; the Financial Institutions Regulatory Administration which consolidates the bank regulators; the Office of National Insurance within the Treasury Department to monitor the industry and prepare a study on ways to modernize insurance regulation; and the Office of Credit Rating Agencies at the SEC.
The draft also contains a number of provisions which deal with a range of topics including: corporate governance provisions on say on pay, the independence of compensation committees and the claw back of executive compensation if it is based on inaccurate financial statements. Others would require hedge funds of a specified size to register with the SEC, harmonize fiduciary standards for professionals giving investment advice, addresses the regulation of OTC derivatives, require those selling mortgage backed securities to retain a portion of the investment and revamp oversight in the municipal securities markets.
SEC enforcement actions
Fraudulent trading: In the Matter of S4 Capital, LLC, Adm. Proc. File No. 3-13683 (Filed Nov. 12, 2009) names as respondents S4 Capital, a registered investment adviser and Sharath Sury, the majority owner of the adviser. The Order alleges that Respondent Sury caused an unregistered hedge fund managed by S4 to engage in high risk trading contrary to the investment strategy which created huge losses and without disclosing it. Mr. Sury is also alleged to have misled investors about the trading and the profitability of the investments. The Order alleges violations of Securities Act Section 17(a) and Advisers Act Sections 206(1) & (2). The case is in litigation.
Financial fraud/option backdating: SEC v. SafeNet, Inc., Civil Action No. 09-2117 (D.D.C. Filed Nov. 12, 2009) is an action against the company, its CEO Anthony Caputo, its former CFO Kenneth Mueller and three former accountants, Clinton Greenman, John Wilroy and Gregory Pasko. The complaint alleges illegal option backdating and earnings management. It is also the first enforcement action based in part on Regulation G, which governs the use of non-GAAP financial measures The complaint alleges that Messrs. Mueller and Caputo were involved in both schemes, while the other individual defendants were only involved in the earnings management scheme.
Each of the defendants settled with the Commission. The company consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions along with Regulation G, as well as the proxy solicitation provisions and agreed to pay a penalty of $1 million. Mr. Mueller consented to the entry of an injunction on essentially the same terms as the company and also agreed to pay about $78,000 in disgorgement, plus prejudgment interest and a civil penalty of $75,000. Mr. Caputo consented to the entry of a permanent injunction prohibiting future violations of Sections 17(a)(2)&(3), along with the reporting and proxy provisions and Regulation G. In addition he agreed to pay disgorgement of about $1.6 million plus prejudgment interest (which is satisfied by a prior settlement with the company) and agreed to pay a penalty of $250,000.
Messrs. Greenman, Wilroy and Pasko each consented to the entry of a permanent injunction prohibiting future violations of Sections 17(a)(2)&(3) and from aiding and abetting violations of the reporting and books and records and internal controls provisions. Mr. Greenman agreed to disgorge $45,000, along with prejudgment interest which was waived (along with any penalty) based on his financial condition. Messrs. Wilroy and Pasko agreed to pay penalties of, respectively, $25,000 and $15,000. In addition, Messrs. Mueller, Greenman and Pasko each consented to the entry of administrative orders suspending them from appearing and practicing before the SEC with a right to reapply as to Mr. Mueller after five years, as to Messrs. Greenman and Wilroy after two years and as to Mr. Pasko after one year. See also Litig. Rel. 21290 (Nov. 12, 2009).
Previously, the Commission filed a settled action against Carole Argo, former president and CFO and COO of the company based on option backdating claims. SEC v. Argo, Civil Case No. 07-1397 (D.D.C. Filed Sept. 29, 2008); See also Litig. Rel. 20752 (Sept. 29, 2008).
Failure to supervise: In the matter of Merriman Curhan Ford & Co., Adm. Proc. File No. 3-1368` (Nov. 10, 2009) is a settled proceeding against the Merriman firm, a broker dealer, its founder and CEO, Jon Merriman, and its General Counsel and Chief Compliance Officer, Christopher Aguilar. The Order alleges a failure to supervise with respect to Scott Cacchione, a registered representative at the firm. This involved two schemes. The first involved Mr. Cacchione providing account statements of firm customers to his friend William Del Biaggio III, who used the to fraudulently pledge securities from customer accounts to obtain $45 million. The second involved unauthorized trading in customer accounts. To resolve the case, the firm offered a series of undertaking including the revision of its procedures and the retention of an independent consultant. Based on the consent of the respondents, the Commission entered a cease and desist order as to future violations of Exchange Act Section 15(b)(7) and the related rules thereunder. In addition, the firm is required to pay a civil penalty of $100,000, while Mr. Merriman will pay a penalty of $75,000 and be suspended from acting in a supervisory capacity for twelve months. Mr. Aguilar will pay a penalty of $40,000 and be suspended from acting in a supervisory capacity for a period of twelve months.
Insider trading: SEC v. Tedder, Case No. 3:08-CV-1013 (N.D. Tex. Filed Jun. 17, 2008) is an insider trading case against two former employees of Aviall, Inc., Robert Tedder and Brian Carr, and two alleged tippees of Mr. Tedder, his father Joseph and business associate Philip Gunn, and one claimed tippee of Philip, his brother Gregory Gunn. The case is based on the takeover of Aviall by Boeing as discussed here. Based on a series of events they observed at work, the SEC claimed Messrs. Tedder and Carr learned about the proposed deal before the public announcement. Mr. Tedder tipped his friend and business associate Philip Gunn and his father. Philip Gunn in turn tipped his brother, Gregory, a registered representative. All of the defendants traded and made substantial profits. According to the complaint, Gregory Gunn liquidated all of his securities holdings the day Mr. Tedder tipped him and then purchased a substantial number of shares and options in Aviall. Just before trial, all of the defendants agreed to settle, except Gregory Gunn. Following a three day trial the jury deliberated less than one hour before finding against Gregory Gunn and in favor of the Commission.
Insider trading: SEC v. Stephanou, Case No. 09 CV 325 (S.D.N.Y. Filed Feb. 5, 2009), discussed here, is an insider trading case against a former Managing Director of UBS in London and six individuals he is alleged to have tipped. See also Litig. Rel. 20884 (Feb. 5, 2009). The SEC settled with Mr. Stephanou and co-defendant George Paparrizos on November 6, 2009. In that settlement, each defendant consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Securities Act and the Exchange Act. Mr. Stephanou also agreed to pay disgorgement of over $460,000 along with prejudgment interest and to the entry of an order in a related administrative proceeding barring him from associating with any broker or dealer. Mr. Paparrizos agreed to pay disgorgement of over $24,000 along with prejudgment interest and a civil penalty equal to the amount of the disgorgement. See also Litig. Rel. 21285 (Nov. 6, 2009). The related criminal cases are discussed below.
Fraud: In U.S. v. Cioffi, Case No. 1:08-cr-00415 (E.D.N.Y. Filed June 18, 2008), the jury returned a not guilty verdict on all counts as to former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin. The case, billed as the first major market crisis action to proceed to trial, charged Messrs. Cioffi and Tannin with one count of conspiracy to commit securities and wire fraud, one count of securities fraud with respect to each of the two hedge funds involved, insider trading as to Mr. Cioffi, and four counts of wire fraud. These charges centered on what the government claimed was a fraud in which the two defendants realized the funds they managed were in grave financial condition and at risk of collapse but concealed this from investors and lenders. The verdict, discussed here, was a significant loss for the government. The parallel civil case filed by the SEC is still pending. SEC v. Cioffi, Case No. 08-2457 (E.D.N.Y. Filed June 19, 2008).
Fraud: U.S. v. Levy, Case No. 1:09-mj-02473 (S.D.N.Y. Filed Nov. 9, 2009) charges Ezra Levy, former chief trader and CFO of a New York City based hedge fund with the theft of over $1 million from the fund. In one transaction, Mr. Levy arranged for interest on an investment of the fund to be paid to his account. In another series of transactions he had the fund purchase securities from his personal trading account at inflated prices. This case is pending. See also SEC v. Levy, Case No. 09-CV-9340 (S.D.N.Y. Filed Nov. 10, 2009).
Fraud: U.S. v. Miller, Case No. 1:09 cr-01077 (S.D.N.Y. Filed Nov. 9, 2009) defendant Robert Miller, a former member of the SEC staff, pleaded guilty to one count of conspiracy and one count of securities fraud. According to the information, Mr. Miller participated in fraudulent schemes with attorney Marc Dreier. In those schemes Mr. Greier was attempting to sell fraudulent promissory notes to hedge funds. In one deal, which failed Mr. Miller agreed to impersonate a representative of a Canadian pension fund which supposedly had guaranteed a note issued by a fund in Iceland. In another, he agreed to impersonate a representative of the Icelandic hedge fund. As part of the plea Mr. Miller agreed to forfeit the $100,000 he was paid by Mr. Dreier.
Insider trading: U.S. v. Koulouroudis, Case No. 1:09-mj-00287 (S.D.N.Y. Filed April 30, 2009). Defendant, Michael Koulouroudis, an accomplice of former UBS Director of Mergers and Acquisitions Nicos Stephanou, pleaded guilty to one count of conspiracy to commit securities fraud and one count of securities fraud on Tuesday. The charges were based on an insider trading scheme which centered on information obtained by Mr. Stephanou through his employment at UBS in London as discussed here. The date for sentencing has not been set. The SEC also bought a case in which Mr. Koulouroudis is a defendant as discussed above.
Insider trading: U.S. v. Contorinis, Case No. 1:09-cr-01083 (S.D.N.Y. Filed Nov. 5, 2009) charges Joseph Contorinis, former money manager for Jefferies Paragon Fund, with insider trading based on tips from Nicos Stephanou (see above). According to the indictment, the defendant traded in the securities of Albertson’s prior to a takeover. The case is pending.
U.S. v. Tillery, Case No. 08-cr-0022 (S.D. Tex. Filed Jan. 17, 2008) charges Paul G. Novak, former consultant to Willbros International, Inc., with FCPA violations. The defendant pleaded guilty to engaging in a conspiracy to pay more than $6 million in bribes to government officials from Nigeria and a Nigerian political party. Mr. Novak served as an intermediary for the company in the scheme. The payments were made to assist Willbros in obtaining and retaining the Eastern Gas Gathering System Project, valued at about $387 million. The funds for the payments were obtained from West Africa Inc., a subsidiary of Willbros, with whom there were “consultancy agreements” which were used to facilitate the payments. Previously actions were brought against the company and others as discussed here.
U.S. v. Kozeny, Case No. 1:05-cr-00518 (S.D.N.Y. Filed May 12, 2005), discussed here, defendant Frederic A. Bourke, co-founder of handbag maker Dooney & Bourke, was ordered to serve one year and a day in prison. He was also ordered to pay a $1 million fine and serve three years of supervised release following the prison. Mr. Bourke was found guilty earlier this year of FCPA violations in which he participated in a scheme to bribe government officials in Azerbaijan to ensure that they would privatize the State Oil Company in a rigged auction. This would permit a consortium of which the defendant was a member to win the auction and profit.
The war on insider trading extends around the globe. Last week prosecutors in Estonia brought their first insider trading case. Dmitri Vassiljev, a former analyst at SEB Enskilda AS was charged with trading on inside information in the shares and options of Baltic telecommunications firms AS Eesti Telekom and TEO LT. Mr. Vassiljev reportedly had access to nonpublic information on TeliaSonera AB’s offer to buy out minority shareholders in the two companies. According to prosecutors, the defendant made about $142,700 (1.5 million krooni) in illegal trading profits.