As Congress considered comprehensive legislation to regulate OTC derivates in the house, the SEC added management capability to the enforcement division, considered regulation for dark pools and issued a report on harmonization with the CFTC.

Enforcement, in conjunction with the USAO in the Southern District of New York brought what is clearly the most significant insider trading case in years, naming Raj Rajaratnam, the managing member of Galleon Management, LLC, and five other individuals as defendants. This is the largest case insider trading case against a hedge fund. It is also the first to be based in part on wire taps. SEC Enforcement also brought cases based on short selling, investment fund fraud and manipulation.

Finally, two circuit court cases affirmed the dismissal of securities class actions. Each was based in part on a failure to adequately plead loss causation.

Market reform

Enforcement: Adam Storch was named to the newly created position of Managing Executive of the Division of Enforcement. His task will focus on managing the work flow and internal management systems of the division. In conjunction with Lorin Reisner, Deputy Director of the Division, Mr. Storch will supervise the Office of Market Intelligence, improving the collection, analysis and referral of the tips, complaints and referrals received by the Commission. Mr. Storch was formerly the vice president in the business intelligence group at Goldman Sachs & Co.

Dark pools: Senator Charles Schumer sent SEC Chairman Schapiro a letter urging comprehensive reform regarding so-called dark pools, in advance of the Commission’s public meeting on this topic. The letter urged reform in several key areas including: 1) establishing consolidated market surveillance; 2) requiring broker dealers to obtain SEC approval prior to operating Alternative Trading Systems or amending their operations; 3) requiring ATSs to have procedures for reviewing system capacity, security and contingency planning; 4) having daily and standardized reporting; 5) adopting a lower percentage threshold for order display; and 6) treating actionable indications of interest as firm quotes under Regulation NMS.

The Commission conducted an open meeting to address a staff memorandum that is designed to toughen the limits on the amount of anonymous trading carried out on stock platforms. At the conclusion of the meeting the Commission voted to issue proposals for pre- and post trades.

Pre-trade the proposals would: 1) ensure that actionable IOIs are treated like quotations and are subject to the same disclosure rules as quotations; and 2) would lower the ATS trading volume threshold for displaying best priced orders. Each proposal excludes certain narrowly targeted IOIs related to large orders. Post-trade, the proposal will amend existing rules to require real time disclosure of the identity of dark pools and other ATSs on the public reports of the executed trades. This proposal also excludes all large trades of $200,000 or more.

Harmonization report: The SEC and the CFTC released A Joint Report of the SEC and CFTC on Harmonization of Regulation on Friday, October 16, 2009, discussed here. The report was prepared pursuant to the Treasury White Papers released last June, and discussed here. One section focuses on enforcement, discussing and comparing the authority of each agency in the areas of manipulation, insider trading and remedies. The report makes five recommendations with respect to enforcement matters relating to 1) whistleblowers, 2) restitution, 3) disruptive trading practices, 4) insider trading and 5) aiding and abetting.

SEC enforcement actions

Wells notice: The Charles Schwab Corporation filed a Report on Form 8-K announcing that it had received a Wells notice from the staff of the SEC on October 14, 2009. According to the notice, the staff intends to recommend the filing of enforcement actions against Schwab Investment, Charles Schwab Investment Management, Charles Schwab & Co., Inc. and the president of the funds. According to the filing, the charges relate to possible violations of the securities laws with respect to the two funds. Previously class actions have been filed with respect to the funds.

Manipulation: SEC v. Lambros D. Ballas, Case No. C-09-05036 (N.D. Cal. Filed Oct. 22, 2009) is an action against a registered broker alleging stock manipulation in violation of Section 10(b). According to the complaint, Mr. Ballas repeatedly issued false press releases about a company and then went on message boards to tout the stock, giving readers a link to what was supposed to be an official press release. For example, for one biotech company, he issued a false press release claiming the FDA had approved a drug which had been under development. He then went to a message board for the company and posted a link to what was claimed to be an official press release, but in fact was his false press release. The price of the stock shot up 50%. Mr. Ballas is alleged to have repeated this same technique with other stocks. The case is in litigation. See also Litig. Rel. 21259 (Oct. 22, 2009).

Investment fund fraud: SEC v. Slowey, Case No. 09 Civ. 4547 (E.D.N.Y. Filed Oct. 22, 2009) is an action against Charles Slowey, Jr., and his controlled entities, and Edward Puttick, Gregory Oldham and Glenn Harris, each of whom worked for broker dealer defendant Advanced Planning Securities, and Oldham Harris, Inc., a retirement planning company. This action, which alleges violations of Section 5 of the Securities Act, and Section 10b of the Exchange Act, claims that approximately 90 investors purchased about $12 million worth of unregistered securities in four unregistered, inter-related real estate investment funds known as the Endeavor Funds. Typically, the investors were solicited to free lunch or dinner seminars. The investors targeted were typically unsophisticated and had limited means. The unregistered securities were sold through a series of misrepresentations. Much of the money from the sale of the shares in these funds, which were controlled by defendant Slowey, was funneled off in large fees and commissions to several of the defendants. The Commission is seeking emergency relief in the form of a freeze order. The case is in litigation. See also Litig. Rel. 21258 (Oct. 22, 2009).

Short selling: In the Matter of First New York Securities LLC, Adm. Proc. File No. 3-13656 (Filed Oct. 20, 2009). Here, the firm is alleged to have violated the Rule 105 of Regulation M in two instances, once in September 2005 and a second time in January 2007. Overall, the firm made profits of just under $40,000. The Rule prohibits short selling within certain time limits of a registered cash offering as discussed here. First New York settled, consenting to the entry of a cease and desist order from committing or causing any violations and future violations of Rule 105 of Regulation M. It also agreed to pay disgorgement of just over $39,000, prejudgment interest of about $9,400 and a civil penalty of $20,000.

Short selling: In the Matter of Perceptive Advisors LLC, Adm. Proc. File No. 3-13657 (Filed Oct. 20, 2009) is a proceeding, also discussed here, in which the firm is alleged to have violated Rule 105 of Regulation M in five instances during 2005, yielding profits of about $245,000. The firm agreed to pay disgorgement of about $245,000, prejudgment interest of about $68,800 and a civil penalty of $125,000.

Insider trading: U.S. v. Rajaratnam, Case No. 09 mg 2306 (S.D.N.Y. Filed Oct. 16, 2009) and U.S. v. Chiesi. Case No. 09 mj 2307 (S.D.N.Y. Filed Oct. 16, 2009). The SEC filed civil insider trading charges, SEC v. Galleon Management, LP, Civil Action No. 09-CV-8811 (S.D.N.Y. Oct. 16, 2009). These are the largest insider trading cases involving a hedge fund as discussed here.

The actions name six individuals as defendants, Raj Rajaratnam, the managing member of Galleon Management, LLC a large, private hedge fund; Danielle Chiesi, an employee of New Castle Funds, LLC, formerly the equity hedge fund group of Bear Stearns Asset Management; Mark Kurland, a senior executive of New Castle; Rajiv Goel, a director in strategic investments at Intel Capital, the investment arm of Intel Corporation; Anil Kumar, a director at McKinsey & Co., Inc., a global management consulting firm; and Robert Moffat, senior vice president and group executive at IBM. The SEC complaint also names Galleon and New Castle as defendants.

The overlapping insider trading schemes, which have gone on since as early as 2006, are claimed to have yielded about $20 million in illegal trading profits and involved trading in the shares of Polycom, Hilton Hotels, Google, Clearwire, Akamai, Advanced Micro Devices and People Support, Intel and Sun. In part the inside information was obtained from some of the defendants. In other instances, it is alleged to have been obtained from an unidentified source who is cooperation with the government and apparently set-up some of the taped conversations.

Investment schemes: SEC v. HomePals Investment Club, Civil Action No. 09-81524 (S.D.N.Y. Filed Oct. 16, 2009) is a fraud action against Ronnie Bass, Jr., Alber Alabre and Brian Taglieri and their controlled entities. The complaint alleges that between April 2009 and December of that year the defendants raised over $14.3 million for their investment fund. Investors were promised a return of 100% every 90 days based on a proprietary and highly successful stock option and commodities trading scheme. In fact the fund traded little, generating significant losses and the fund was in fact a Ponzi scheme. A parallel criminal action was filed at the same time. The case is in litigation. See also Litig. Rel. 21251 (Oct. 16, 2009).

Criminal cases

U.S. v. Clamens, 09 Crim 1001 (S.D.N.Y. Filed Oct. 20, 2009) names Guillermo Clamens, chairman of FTC Capital Markets, a brokerage firm, as a defendant. The indictment alleges that from April 2008 through November 2008 Mr. Clamens allegedly ran a fraudulent investment fund. Specifically, during that time period Mr. Clamens solicited funds from institutional investors, telling them their money would be placed in safe investments. In fact, it was put, in part, in high risk investments and, in part, were misappropriated. For a time, investors were sent fraudulent account statements. The scheme unraveled when the defendant could not comply with withdrawal requests. The indictment charges the defendant with conspiracy to commit securities and wire fraud, securities fraud and wire fraud. Previously, the SEC brought a similar action against Mr. Clamens and his firm. SEC v. FTC Capital Markets, Inc., Case No. 09 CV 4755 (S.D.N.Y. Filed May 20, 2009).

U.S. v. Weitzman, No. 1:09 mj 01375 (S.D.N.Y. Filed Oct. 19, 2009) was brought against investment adviser Matthew Weitzman, formerly a principal of AFW Asset Management, Inc. Mr. Weitzman pleaded guilty to one count of investment adviser fraud, two counts of securities fraud and five counts of wire fraud. The complaint alleged that Mr. Weitzman, a co-founder of AFW, had more than $190 million in assets under management at the end of 2008. Between 2002 and 2009, he fraudulently obtained more than $7 million of investor funds which he converted to his own use. The funds were obtained using forged documents furnished to the brokerage firm which held customer securities. The documents made it appear that the customers had authorized the transfer of securities to Mr. Weitzman when in fact they had not.

Private actions

In re Ditech Networks, Inc., Derivative Litigation, Case No. 5:06-cv-05157 (N.D.CA. Filed Aug. 23, 2006) is a derivative action against certain officers and directors of Ditch Networks, Inc. The complaint is based on option backdating claims. This week the parties entered into a tentative settlement. Under the terms of the settlement, the company will adopt certain corporate governance improvements. Plaintiff’s counsel will also be paid $1.05 million.

Circuit courts

McAdams v. McCord, Case No. 09-1303 (Filed Oct. 20, 2009) is a securities fraud suit brought by three investors and their related entities against UCAP, Inc., several of its executives and outside the outside auditors, Moore Stephens Frost, PLC., discussed here. Plaintiffs claimed that the company, its executives and the auditors made misrepresentations which caused the share price they paid to be inflated. Suit was brought after the announcement of a restatement for three accounting periods. The district court dismissed the second amended complaint for failing to plead fraud with particularity.

The Eighth Circuit affirmed, but on different grounds. First, the court noted that the auditors could only be responsible for their alleged misstatements which were their audit opinions plaintiffs claimed were false. Second, the court focused on the question of causation. Here, the investors failed to plead facts about the value of their shares the time of purchase and before or after the restatement was announced. Without these facts, the complaint fails to demonstrate that the investor’s losses were caused by the auditor’s misstatements. In addition, a disclosure prior to the restatement announcement noted that the main operating subsidiary was in danger of losing its only line of credit and that the company sold a controlling interest in the entity to avoid its bankruptcy. The court then concluded that the lack of specificity about the value of investments defeated the plausibility of the claim that the auditors caused their losses.

Indiana State District Council of Laborers v. Omnicare, Inc., Case No. 07-6379 (6th Cir. Filed Oct. 21, 2009) is a securities class action against Omnicare, a large provider of pharmaceutical care for the elderly and certain of its officers. The complaint alleged that the defendants made materially false and misleading statements regarding its Medicare Part D preparedness, a contract dispute with United Health Group, violations of GAAP and the legality of its drug recycling and substitution programs. The district court dismissed the action for, among other things, failing to properly plead loss causation, for a lack of standing as to one claim and based on a finding that some of the alleged false statements were “soft” statements for which disclosure was not required.

The Sixth Circuit affirmed. First, with regard to the contract dispute the court found that plaintiffs failed to allege the reason it should have been disclosed earlier. In any event, plaintiff’s claim that a statement by the company of optimism about its future prospects is not actionable. This kind of rosy, vague statement is so lacking in specificity or so clearly the opinion of the speaker that it is not actionable. Second, plaintiff’s claims about Medicare Part D fail to explain how they are tied to any drop in the stock price and thus the complaint fails to adequately plead loss causation. Third, the allegations of GAAP violations suffer from the same infirmities. Specifically, plaintiffs fail to show how they relate to any impact on the stock price or that they were ever recognized or revealed to the market. Finally, general statements that the company complies with the law and has a policy of compliance are generally not actionable absent specific allegations that the defendants knew the statements were untruthful. Here, while there are general allegations to that effect, there are no specific facts supporting those claims. Accordingly, this claim, like the others must be dismissed.


Credit Suisse International has settled an insider trading case which has been on-going for three years with the Securities Commission of Brazil. The firm agreed to pay R$19.2m. This is the second largest payment of this type in a Commission proceeding.

The case is centered on the period between October 2005 and January 2006 when Embraer, a Brazilian aircraft manufacturer, was preparing a capital restructuring that resulted in its shares being listed on the Novo Mercado, a listing segment on the Sao Paul Stock Exchange with high corporate governance standards. Credit Suisse had been retained to analyze the proposed restructuring by the firm’s controlling shareholder. Shortly after being hired Credit Suisse began buying Embraer’s shares.