This week SEC enforcement stayed with their staples, actions involving insider trading and investment fund fraud. DOJ’s cases involved insider trading and a Ponzi scheme. The circuit courts however, turned to other subjects, handing down decisions regarding D&O coverage for an SEC enforcement action and the availability of state law indemnification rights regarding a Commodity Exchange Act case. Finally, the U.S. and SEC filed an amicus brief in the Supreme Court urging that the Second Circuit’s foreign cubed decision not be reviewed.

SEC enforcement actions

Insider trading: SEC v. Grocock, Civil Action No. 09-cv-1833 (M.D. Fla. Filed Oct. 29, 2009) is a settled insider trading action which names as a defendant J. Bennett Grocock, former outside counsel for CyberKey Solutions, Inc. According to the complaint Mr. Grocock sold unregistered shares of CyberKey while knowing that it was under investigation by the SEC, then-NASD and the Utah Division of Securities. These investigations were material non-public information about the company, according to the SEC. The sales were halted when the CEO of the company was arrested on criminal securities charges. To settle the case, Mr. Grocock consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 5 and Exchange Act Section 10(b). Payment of disgorgement and a penalty was waived based on financial condition. See also Litig. Rel. 21267 (Oct. 29, 2009).

Offering fraud: SEC v. Amante Corporation, Case No. 09-CIV-61716 (S.D. Fla. Filed Oct. 29, 2009) is an action alleging that the defendants were selling unregistered shares through a boiler room operation. Investors were told that the company was about to conduct an IPO, a claim which is false. The SEC’s complaint alleged violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The Commission obtained an emergency freeze order. See also Litig. Rel. 21266 (Oct. 29, 2009).

Insider trading: SEC v. Grmovsek, Case No. 09-9029 (S.D.N.Y. Filed Oct. 27, 2009) is a settled insider trading action brought in conjunction with a criminal case and charges by the Ontario Securities Commission. Defendant Stanko Grmovsek is a Canadian citizen who is alleged to have reaped almost $10 million in illegal trading profits. According to the complaint, Mr. Grmovsek traded from 1994 to 1998 and then from 2004 to 2008 on inside information obtained from his former law school classmate, Gil Cornblum who is now deceased. The defendant traded through numerous Canadian accounts in shares in that country and in the U.S. Mr. Cornblum is alleged to have obtained the inside information from working at U.S. law firms. To resolve the case with the SEC, the defendant consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions. He also agreed to pay disgorgement of $8.5 million with all but $1.5 million of that amount being waived based on financial condition. See also Litig. Rel. 21263 (Oct. 27, 2009).

Investment fund fraud: SEC v. Kokesh, Case No. 6:09-cv-1021 (D.N.M. Oct. 27, 2009) is an action against Charles R. Kokesh claiming violations of Section 37, or alternatively 57 of the Investment Company Act and aiding and abetting violations of Sections 13(a) and 14(e) of the Exchange Act as well as Sections 205 206(1) and 206(2) of the Investment Company Act. The complaint claims that, over a twelve year period beginning in 1995 and continuing until mid-2007, the defendant used two controlled, registered investment adviser firms to misappropriate about $45 million, defrauding about 21,000 investors. The funds were taken through illegal distributions, performance fees and expense reimbursements. The case is in litigation. See also Litig. Rel. 21264 (Oct. 28, 2009).

Investment fund fraud: In SEC v. Boros, Case No. 08-cv-5004 (N.D. Ill. Filed Sept. 3, 2008), the court granted summary judgment against defendant Rick Boros. The SEC’s complaint claimed that Mr. Boros operated a fraudulent investment fund for over two years during which time he defrauded 17 investors out of at least $1.2 million. The complaint alleges that the funds were misappropriated. After the SEC filed its action, Mr. Boros moved to dismiss, claiming all the money would be returned. He then solicited an additional $1.1 million from other investors, telling them that the funds would be invested in a high yield private placement program. The court ordered the defendant to disgorge over $2.3 million plus prejudgment interest and to pay a civil penalty of $130,000 for each fraudulent scheme. Mr. Boros is in prison on unrelated charges. See also Litig. Rel. 21262 (Oct. 27 2009).

Investment fund fraud: In SEC v. Thompson Price Holding Inc., Case No. 07 Civ. 9525 (S.D.N.Y. Filed Oct. 25, 2007), the court granted summary judgment in favor of the SEC. The complaint alleges that defendants Damir Lukovic and Thompson Price Holdings solicited funds from investors by claiming they would be placed in IPO shares of several Australian companies. The claims were false. The court entered a permanent injunction against each defendant prohibiting future violations of the antifraud provisions. In addition, the defendants were ordered to disgorge approximately $154,510 along with prejudgment interest. The company also must pay a civil penalty of $120,000, while Mr. Lukovic is required to pay a penalty of $16,500. See also Litig. Rel. 21261 (Oct. 27, 2009).

Insider trading: SEC v. Spaugy, Civil Action No. 09-CV-687 (N.D. Okla. Filed Oct. 23, 2009) is a settled action against Don Spaugy, former Vice President of Financial Services for SemGroup, LP. Between late May and July 15, 2008, SemGroup suffered a severe liquidity crisis, as Mr. Spaugy well knew. The crisis stemmed largely from 111 margin calls on its commodity and future market positions. In addition, trading partners began to reduce their credit and trade lines with the company. By July 9, 2008 the company received an e-mail from its commercial bank stating that its account was overdrawn by over $4.1 million. The company was forced to transfer its NYMEX portfolio to an international bank, paying a fee of $143 million. Shortly before a public announcement about the liquidity crisis, which noted, in part, that various options were being considered including Chapter 11, Mr. Spaugy sold all of his units in the company, avoiding a significant loss.

To resolve the case, Mr. Spaugy consented to the entry of a permanent injunction prohibiting future violations of Section 10(b) and Rule 10b-5 thereunder. He also agreed to disgorge the over $67,000 he avoided in losses, plus prejudgment interest and to pay a civil penalty equal to the amount of the disgorgement and prejudgment interest. See also Litig. Rel. 21260 (Oct. 23 2009).

Criminal cases

In U.S. v. Grmovsek, Case No. 1:09-cr-01044 (S.D.N.Y. Filed Oct. 27, 2009), Mr. Grmovsek pleaded guilty to a one count of conspiring to commit securities fraud. The criminal information claimed that he traded on inside information obtained from an unidentified person who secured it from Dorsey & Whitney from 2006 through February 2008. As a result, the defendant had profits based on trading on nine deals of about $2 million. Mr. Grmovsek also pleaded guilty to insider trading charges in the Ontario Court of Justice in Toronto, Canada. He is also subject to regulatory orders of the Ontario Securities Commission.

U.S. v. McCready, Case No. 2:09-cr-01066 (C.D. Cal. Filed Oct. 14, 2009) charges defendant Michael McCready with running a $9 million Ponzi scheme. Mr. McCready, who pretended to manage both a hedge fund and other investment vehicles, pleaded guilty. A date for sentencing has not bee set.


FINRA announced that it has entered into a memorandum of understanding with the Autorite des marches financiers (AMF). The purpose of the agreement it to facilitate market surveillance and investigations as well as information sharing on trading by firms.

On October 26, 2009, FINRA announced that it had imposed a $600,000 fine against Scottrade. The broker failed to establish and implement an adequate anti-money laundering program to detect and trigger the reporting of suspicious transactions as required by the Bank Secrecy Act and FINRA rules.

Private actions

Barrie v. Intervoice-Brite, Inc., Case No. 3:01-CV-1071 (N.D. Tex. Filed June 5, 2001) is a securities class action which claims that defendant Intervoice, which marketed interactive voice response systems, concealed the true financial condition of the company following its merger with Brite for cash and stock. After the 1999 merger, the company claimed to have strong revenues until a June 6, 2000 press release revealed that it had been impacted by sales staff attrition. The release forecasted reduced revenues. When analysts reduced their projections the share price fell about 55%.

In an October 26, 2009 ruling, the court denied a request for class certification. The court concluded that failed to demonstrate loss causation as required by Dura Pharm., Inc., v. Broudo, 544 U.S. 336 (2005). In making its ruling, the court rejected the approach to loss causation used by an expert for the plaintiff because under it “a litigant must merely identify a disclosure followed by a large price drop, regardless of whether that disclosure has any factual nexus to the earlier representations that allegedly caused the price of that security to become falsely inflated.” This approach has been rejected by the Fifth Circuit, the court held.

Circuit courts

Siracusano v. Matrixx Initiatives, Inc., Case No. 06-15677 (9th Cir. Oct. 28, 2009) is a class action brought against the pharmaceutical company that sells the cold remedy Zicam. The complaint claims that the company failed to disclose material information about the remedy, specifically that it causes a condition called anosmia. That condition results in a loss of smell. The circuit court revered the dismissal of the complaint. In part, the court concluded that the complaint pleaded a strong inference of scienter as required by the Supreme Court’s Tellabs decision because, when read as a whole, it alleged that the company withheld reports about the adverse effects of the product which was responsible for much of its success. The inference of scienter from these facts is “cogent and at least as compelling” as any competing inference the court concluded.

Delay v. Rosenthal Collins Group, LLC, Case No. 08-4557 (6th Cir. Decided Oct. 27, 2009) is an action brought by Todd Delay, former employee of defendant, seeking indemnification for legal expenses incurred in connection with his successful defense of an action brought against him under the Commodities Exchange Act. The district court dismissed his state law claim finding it was preempted by federal law. The Sixth Circuit reversed. While there are analogous cases under the securities statutes concluding that state law indemnification claims are preempted, those actions deal with wrongdoers. That is not the case here. In addition the CEA says nothing about state law. Accordingly, the court concluded that Congress did not intend to displace state law indemnification rights, if any, of parties found not to have violated the CEA.

Rivelli v. Twin City Fire Ins. Co., Case No. 08-1480 (10th Cir. Decided Oct. 26, 2009) is an action brought by the directors and officers of Fischer Imaging Co against their D&O carrier. Plaintiffs are also defendants in an SEC enforcement action which alleges they falsified the books of the company beginning in 2000. The layer of D&O coverage under which plaintiffs were seeing the advancement of fees had a rider in which the company represented that nobody had knowledge of any circumstance which would give rise to a claim. Since the SEC complaint alleged that plaintiffs participated in cooking the books, the insurer denied coverage. The trial court ruled in favor of the insurer and the circuit court affirmed as discussed here.

The circuit court invoked the “Colorado complaint rule.” That rule specifies that an insurer’s duty to defend is determined solely by considering the policy and the complaint filed against the insured. Here, the policy clearly provides under a 2002 amendment that there is no coverage if the insured has knowledge of facts which could give rise to a claim. The SEC’s amended complaint specifies that the defendants in that action, the plaintiffs here, participated in the fraudulent acts which gave rise to the securities fraud claims on which the action was based. The acts, according to the SEC, began in 2000. Thus there is no coverage.

Supreme Court

Morrison v. National Australia Bank, Ltd., Case No. 08-1191 (S.Ct.) is an action where the Petitioner’s are seeking Supreme Court review of the Second Circuit’s foreign-cubed decision discussed here. Essentially, the case involved the manipulation of the internal books of the U.S. subsidiary of an Australian public company whose ADRs are traded in New York. The district court dismissed the action. The Second Circuit affirmed. In an amicus curiae brief the United States, joined by the SEC, urged that the writ be denied.

Essentially, the brief argues that while Petitioners adequately allege a substantive violation of Section 10(b) the link between the U.S. part of the scheme and their injury is too attenuated to support a private suit. In a final footnote, the Commission distinguished its position as amicus in the Second Circuit as being premised on the acceptance of existing precedent from that circuit. Under those cases, the question of the application of Section 10(b) to transnational frauds involves an issue of subject matter jurisdiction. The brief argues that this position is wrong, although the conclusion of the Second Circuit that the action should be dismissed is correct.