On Capital Hill, a bill was introduced in the Senate to expand the definition of Honest Services fraud in the wake of the Supreme Court’s ruling in Skilling and legislation was sent to the President for signature repealing Dodd-Frank Section 9291, an FOIA exemption long sought by the Commission. SEC Enforcement brought three insider trading cases, a market crisis action against employees of a bank and finally won approval of its settlement with Citigroup. The SEC and DOJ continued to emphasize FCPA enforcement, filing settled actions against ABB. In private actions Apple, resolved shareholder suits based on option backdating claims.

Capital Hill and regulatory reform

Honest services fraud: The Senate Judiciary Committee heard testimony regarding proposed legislation to amend the honest services fraud statute in the wake of the Supreme Court’s decision last term in Skilling v. U.S., 130 S. Ct. 2896 (2010) (here). There, the Court limited Section 1346 to bribes and kickbacks as defined in earlier case law and rejected the government’s suggestion that it includes undisclosed conflicts of interest.

In testimony, Assistant Attorney General Lanny Breuer urged the Senate Committee to move forward with a legislative fix which would permit the government to bring honest services fraud claims against public officials based on undisclosed conflicts of interest. While Mr. Breuer noted that a legislative fix to reach conduct in the private sector is also necessary, he stated that the Department is not prepared at this time to advance a specific proposal. Other witnesses agreed that in the wake of Skilling, legislation is necessary, but urged caution and careful drafting to avoid the vagueness difficulties of the past (here).

S. 3854 was also introduced this week. This bill would expand the definition of scheme or artifice to defraud in the mail and wire fraud statutes. Under the proposed legislation the phrase would include “a scheme or artifice by a public official to engage in undisclosed self-dealing . . . [and] a scheme or artifice by officers and directors to engage in undisclosed private self-dealing . . .” Essentially, the draft legislation seeks to extend Honest Services Fraud to encompass self-dealing, an argument the Supreme Court specifically rejected in its Skilling v. U.S..

Disclosure: Legislation repealing Dodd-Frank Section 9291 has passed both the House and the Senate. It is being forwarded to the President’s desk for signature. Section 9291, long sought by the SEC, would have provided a broad FOIA exemption for proprietary materials gathered during inspections as discussed here.

Proxy rules: The U.S. Chamber of Commerce and the Business Roundtable filed suit against the SEC to block the new proxy rules. Those rules were adopted August 25 by a 3-2 vote of the Commission. Business Roundtable v. U.S. Securities and Exchange Commission (D.C. Cir. Filed Sept. 29, 2010).

SEC enforcement actions

Insider trading: SEC v. Steffes, Case No. 1:10-cv-06266 (N.D. Ill. Filed Sept. 30, 2010) names as defendants Rex Steffes, Cliff Steffes, Rex R. Steffes, Bret W. Steffes, Robert J. Steffes and W. Gary Griffiths. In the complaint, the SEC alleged that Gary Griffiths and Cliff Steffes obtained inside information about the upcoming acquisition of Florida East Coast Industries Inc., which owned the freight railway where they were employed. The two men then tipped Rex C. Steffes, Cliff’s father and Gary Griffiths’ brother-in-law. Other family members were also tipped. Collectively, the traders purchase over $1.6 million in stock and option prior to the May 8, 2007 acquisition date. More than $1 million in illicit profits were made following the public announcement of the deal. The complaint alleges violations of Exchange Act Section 10(b). Robert J. Steffes settled the action, consenting to the entry of a permanent injunction prohibiting future violations of Section 10(b). The order also requires him to disgorge $104,981 in trading profits, pay prejudgment interest and a civil penalty equal to the trading profits. The case is in litigation as to the other defendants. See also Litig. Rel. 21678 (Sept. 30, 2010).

False statements: In the Matter of John P. Flannery, Adm. Proc. File No. 3-14081 (Sept. 30, 2010) is an action against former State Street Bank employees John Flannery and James Hopkins. The Order alleges that the Respondents marketed State Street’s Limited Duration Bond Fund as an “enhanced cash” investment strategy that was an alternative to money market funds. By 2007, however, the fund was largely invested in sub-prime residential mortgaged backed securities and derivatives but the marketing continued. In July 2007, many investors were unaware of this exposure. In late July, a series of shareholder communications regarding the impact of the turmoil in the sub-prime market on the fund failed to disclose its concentration in that market. Investors were misled. Respondent played an instrumental role in drafting these communications according to the Order. Other communications sent to select shareholders accurately described the situation. One of the internal advisory groups which reported directly to Mr. Flannery decided to redeem or recommend redemption from the fund. At the direction of Mr. Flannery and the bank’s investment committee, the most liquid assets in the fund were sold and the cash used to meet the redemption demands of the better informed customers. The Order alleges violations of Securities Act Sections 17(a)(1), (2) and(3) The action is in litigation. The bank previously settled (here).

Insider trading: SEC v. Hansen, Civil Action No. 10-CV-5050 (E.D. Pa. Filed Sept. 27, 2010) is an insider trading action against Richard Hansen, a registered representative and former chairman of a regional investment bank and his long time friend Stuart Kobrovsky. According to the complaint, Mr. Hansen obtained inside information from business associate Donna Murdoch who, in turn, obtained it from James Gansman, then an EY partner in their Transaction Advisory Services Department. The information concerned several upcoming acquisitions, as described in the action against Mr. Gansman (here). As a result, Messrs. Hansen and Kobrovsky made trading profits of abut $215,000. Mr. Kobrovsky settled the action, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to disgorge trading profits of $160,000 along with prejudgment interest. A civil penalty was not imposed based on his financial condition. The case against Mr. Hansen is pending along with the parallel criminal case, U.S. v. Hansen, 10 Crim. 875 (S.D.N.Y.).

Financial fraud: SEC v. Forman, Civil Action No. 07-1151 (D. Mass.) is an action against Steven Forman, formerly the controller of Speechworks International, Inc. It alleges that he and others engaged in a scheme which improperly inflated the revenue and financial condition of the company. Specifically, the SEC claimed that Mr. Forman participated in the improper recognition of $2 million of royalty repayments as revenue. To resolve the action, Mr. Forman consented to the entry of a permanent injunction prohibiting future violations of the books and records and internal control provisions of the Exchange Act. He also agreed to pay a civil penalty of $20,000. The fraud charges, based on claimed violations of Securities Act Section 17(a) and Exchange Act Section 10(b), were dropped without explanation in the settlement.

Financial fraud: SEC v. Huff, Civil Action No. 08-06315 (S.D. Fla.) is an action in which the Commission prevailed against defendant W. Anthony Huff following a seven-day bench trial. The claims were based on Exchange Act Sections 10(b) and 20(a) and Securities Act Section 17(a). The court concluded that Mr. Huff engaged in a scheme to overstate the financial results of Certified Services, Inc., then of Fort Lauderdale. From the third quarter of 2002 through the third quarter of 2004 Mr. Huff and others recorded $47 million in bogus letters of credit on Certified’s books and records. The public filings for the company also failed to disclose Mr. Huff’s criminal background and control. Through the scheme, Mr. Huff was able to fraudulently obtain over $10 million for himself and his family. In addition to entering an injunction prohibiting future violations, the court imposed an officer and director bar and ordered the payment of more than $10 million in disgorgement along with prejudgment interest and a civil penalty of $600,000.

Undisclosed conflicts: In the Matter of Valentine Capital Asset Management, Inc, Adm. Proc. File No. 3-14072 (Sept. 29, 2010) is a settled administrative proceeding against registered investment adviser Valentine Capital and its founder John Valentine. The Order claims that after having made about $3 million in fees from his clients who invested in Series A limited partnership units Respondents recommended that they switch to Series B. According to the Order, there is little difference between Series A and Series B. In making the recommendations, Respondents did not tell clients that switching would cause them to pay significant additional fees. The Order alleges a breach of fiduciary duty in violation of Advisers Act Section 206(2). To resolve the matter, the Respondents each consented to the entry of a cease and desist order from further violations of Section 206(2). Both were censured. In addition, Valentine Capital agreed to disgorge $394,710.82 in commissions along with prejudgment interest. Mr. Valentine also agreed to pay a civil penalty of $70,000. As part of the settlement Respondents undertook to post the summary portion of the Order on the Fund’s website and distribute it to clients.

Cherry picking scheme: In the Matter of Ark Asset Management Co., Inc., Adm. Proc. File No. 3-13174 (Sept. 29, 2010) is a settled proceeding against a registered investment adviser that is in involuntary bankruptcy under Chapter 7. According to the Order, Respondent fraudulently allocated trades by “cherry-picking,” that is favoring proprietary accounts over client account. As a result Ark realized over $19 million in ill-gotten gains. The firm also made false statements in its form ADV and failed to comply with the books and records provisions. To resolve the matter Respondent undertook to ensure that all assets are liquidated for the benefit of its creditors and consented to the entry of an order requiring compliance with that undertaking. The order also requires the payment of $750,000 in disgorgement, an amount limited because of the firm’s financial circumstances.

Insider trading: SEC v. Jobe, Civil Action No. 4:10-cv-711 (N.D. Tex. Filed Sept. 24, 2010) is an action against Michael Jobe and Richard Vlasich. The complaint claims that in December 2009 Mr. Jobe learned from an XTO Energy, Inc. employee that the company would be acquired by Exxon. Mr. Jobe told Mr. Vlasich about the pending deal. Both purchased XTO securities prior to December 14, 2009 when the deal was announced. Mr. Jobe earned profits of $107,220 while Mr. Vlasich made $466,295.90. To settle the action, each defendant consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). Each also agreed to disgorge his trading profits and pay prejudgment interest. Mr. Jobe paid a $100,000 civil penalty. The Commission did not seek a penalty against Mr. Vlasich because he agreed to cooperate in the Commission’s investigation and in any related enforcement action. See also Litig. Rel. 21665 (Sept. 24, 2010).

Settlement: SEC v. Citigroup, Civil Action No. 10-cv-127 (D.D.C. Filed July 29, 2010) is an action in which the Commission claimed the bank made false statements regarding its exposure to the sub-prime market as discussed here. Initially, the Court declined to accept the settlement which called for the entry of an injunction, the payment of a $75 million fine and the adoption of certain procedures by the bank. After additional briefing and directing the Commission to certify the implementation of the proposed procedures (here), the Court accepted the settlement. Two related administrative proceedings, one against a current and another against a former bank officer, each alleged to have been involved in the underlying conduct, were previously settled.


U.S. v. ABB Inc., No. H-10-664 (S.D. Tex. Filed Sept. 29, 2010); U.S. v. ABB Ltd. –Jordan, No. H-10-665 (S.D. Tex. Filed Sept. 29, 2010); and SEC v. ABB Ltd, Civil Action No. 1:10-CV-01648 (D.D.C. Filed Sept. 29, 2010) are three FCPA actions which have been resolved. ABB is a Swiss based provider of power and automation products and services around the world. According to the court papers the company, through various subsidiaries, engaged in two schemes. First, from 1999 through 2004 a business unit of the U.S. subsidiary bribed officials in Mexico to obtain and retain business with two government owned electric utilities. As a result of the scheme the business unit was awarded contracts that generated over $90 million in revenues and $13 million in profits. The second involved the U.N. Oil for Food Program on the humanitarian side. Through six different subsidiaries ABB obtained contracts by making kickback payments to Iraqi officials. The kickbacks were funneled through ABB’s Jordanian subsidiary. They were recorded on the books and records as legitimate payments for after sales services, consultation costs and commissions.

With DOJ, ABB entered into a deferred prosecution agreement, consenting to the filing of a criminal information charging its Jordanian subsidiary, ABB Ltd. – Jordan. That information alleges one count of conspiracy to commit wire fraud and violate the books and records provisions of the FCPA. The company agreed to pay a criminal penalty of $1.9 million. In addition, ABB’s U.S. subsidiary pleaded guilty to a criminal information charging one count of violating the anti-bribery provisions of the FCPA and one count of conspiracy to violate the FCPA. The company will pay a criminal fine of $17.1 million. To resolve the SEC case the company consented to the entry of a permanent injunction prohibiting future violations of the anti-bribery and books and records and internal control provisions of the FCPA. In addition, the company agreed to pay disgorgement of $22,804,262 along with prejudgment interest and a civil penalty of $16,510,000. See also Litig. Rel. 21673 (Sept. 29, 2010).

Court of appeals

Insider trading: SEC v. Rajaratnam, Case No. 10-462-cv (2nd Cir. Sept. 29, 2010) is an appeal relating to the Galleon insider trading cases (here). Here, the defendants, Raj Rajaratnam and Danielle Chiesi appealed a discovery order in which Judge Rakoff directed them to turn over to the SEC evidence obtained from wiretaps. The defendants had obtained that information in the parallel criminal insider trading case. Specifically, the court directed the defendants to furnish the SEC with evidence regarding 18,150 communications involving 550 separate individuals which was intercepted from ten separate telephones over a sixteen month period. The district court declined to certify the appeal. Initially, the court held that it did not have jurisdiction over the matter as a final order. However, the matter could be reviewed on a writ of mandamus.

On the merits, the court held that the materials need not be turned over to the SEC at the moment. First the questions raised by the defendants motion to suppress needed to be resolved. If that motion of defendants is not granted then in the civil case the SEC has a valid claim to the materials which must be evaluated in view of the privacy interests of defendants and after determining which recordings may be relevant to the civil case.

Private actions

Option backdating: In re: Apple Inc. Sec. Litig., No. 5:06-cv-05208 (N.D. Cal.) is a shareholder action against Apple Inc. based on claims of illegal option backdating. The suit settled this week with the company paying $14 million to the shareholders. Apple also agreed to donate $2.5 million to 12 university corporate governance programs and amend its governance policies.

Program: Fifth Annual Securities Fraud National Institute, October 7-8, 2010 in New Orleans. For further information on this excellent program please click here: