THIS WEEK IN SECURITIES LITIGATION (October 9, 2009)
The new Supreme Court term opened this week with a slate of important business cases. SEC enforcement continued its aggressive posture in insider trading cases, appealing one high profile loss and filing a settled case. The industry-wide inquiry into fraudulent transactions in the stock lending business continued with another indictment, while the ninth circuit reversed the dismissal of a high profile criminal option backdating case.
The new Supreme Court term
There are several business cases on the Court’s docket which may have a significant impact as discussed here. These include:
Merck & Co. v. Reynolds, Case No. 08-905, which raises the question of when the statute of limitations begins in securities fraud damage suits. Specifically, the Court will consider the question of “inquiry notice” and when shareholders are on notice of a possible claim such that the limitation period begins in a securities damage action.
Jones v. Harris Associates, L.P, No. 08-586 presents a question regarding the standard investors must meet under Section 36(b) of the Investment Company Act to challenge the fees of an investment advisor. Ultimately at issue in the case is whether the fees of investment advisors can effectively be challenged.
Free Enterprise Fund v. Public Company Accounting Oversight Board, Case No. 08-861 presents the question of whether the PCAOB violates separation of powers principles and the appointment power since it is overseen by the SEC rather than the President.
Weyhrauch v. U.S., Case No. 08-1196 and U.S. v. Black, Case No. 08-876 raise a question regarding the scope of “honest services” fraud under 18 U.S.C. § 1346. Specifically, the cases present the question of what limiting principles,if any, define the prohibited conduct under a statute. Alternatively, the statute may be unconstitutionally vague.
SEC enforcement actions
Inside trading: The SEC appealed from the decision dismissing its insider trading case against Mark Cuban. SEC v. Cuban, No. 08-2050 (N.D. Tex. July 17, 2009). Previously the Commission rejected an opportunity to amend its complaint. In dismissing the complaint against Mr. Cuban, the court rejected his position that insider trading had to be predicated on a breach of fiduciary duty. Rather, the court held that the violation could be predicated on a breach of an express obligation not to use the information to trade as discussed here. The court concluded however, that the factual record was insufficient to establish the required type of agreement.
Insider trading: SEC v. Xie, Case No. 3:09-CV-02210 (S.D. Cal. Oct. 7, 2009) is a settled insider trading case brought against Feng Xie, a project manager at Document Sciences Corporation. Mr. Xie traded in the shares of his company shortly prior to the announcement that it would be acquired by EMC Corp. prior to the public announcement of the deal on December 27, 2009. According to the complaint, Mr. Xie attended meetings with EMC concerning what he was told was a plan to further extend the pre-existing partnership between the two companies. That story however was a cover. Nevertheless Mr. Xie began purchasing shares of Document Sciences. Eventually he acquired a stake of over 10,000 shares. During the time he was acquiring the shares Mr. Xie asked his supervisor what would happen if he traded in the shares of the company. He was told not to do it. To settle the case, the defendant consented to the entry of a permanent injunction prohibiting future violations of Section 10(b) and agreed to pay disgorgement of over $62,000, prejudgment interest and a penalty equal to the disgorgement. See also Litig. Rel. 21240 (Oct. 7, 2009).
Financial fraud: SEC v. Milne, Case No. 3:08-CV-00505 (D. Conn.) is a financial fraud case against, among others, John Milne, former Vice Chairman, President and CFO of United Rentals, Inc. The Commission’s complaint alleges that Mr. Milne engaged in a series of fraudulent transactions to bolster the earnings of the company as discussed here. Mr. Milne agreed to settle the case by consenting to a permanent injunction prohibiting future violations of the antifraud and books and records provisions of the Exchange Act. He also agreed to pay disgorgement of $6.25 million and agreed to the entry of an officer and director bar. Mr. Milne also agreed to plead guilty to one count of conspiracy to falsify books and records in a parallel criminal case. This is one of a series of actions the Commission brought based on the fraud allegations here. See also Litig. Rel. 21239 (Oct. 7, 2009); SEC v. Nolan, Civil Action No. 07-CV-1833 (D. Conn), Litig. Rel. 20396 (Dec. 12, 2009); SEC v. Apuzzo, 07-CV-1910 (D. Conn.), Litig. Rel. 20418 (Dec. 31, 2007); SEC v. United Rentals, Civil Action No. 3:08-cv-1354 (D. Conn. Filed Sept. 8, 2008), Litig. Rel. 20706 (Sept. 8, 2008); SEC v. Terex Corp., Civil Action No. 3:09-civ-1281 (D. Conn. Filed Aug. 12, 2009), Litig. Rel. 21177 (Aug. 12, 2009).
U.S. v. Garcia, No. 1:09 (E.D.N.Y. Sept. 30, 2009) is the latest indictment in an on-going investigation of fraudulent fees, sham transactions and kickbacks in the stock loan business as discussed here. Defendant Ronald Garcia did business as Independent Investor Services, Inc., a stock loan finder.
The multi-count indictment grows out of an industry wide investigation of the stock loan business. The securities and wire fraud charges in the indictment center on what are alleged to be fraudulent loan fees and kickbacks. Specifically, Mr. Garcia is alleged to have received finders’ fees in connection with stock loan transactions involving Schonfeld Securities and Van Der Moolen Specialists despite the fact that no services were performed. To obtain the fees Mr. Garcia is alleged to have paid kickbacks to a trader at Van Der Moolen who in turn paid a trader at Schonfeld.
U.S. v. Ruehle, No. 09-50161 (9th Cir. Decided Sept. 30, 2009). Mr. Ruehle was indicted on criminal charges stemming from the option backdating woes of his former company, Broadcom. Initially, when backdating questions arose in May 2006, the audit committee retained its long-time outside counsel Irell and Manella to conduct an internal investigation. Early on, it was determined that the results of the inquiry would be shared with the firm’s outside auditors, E&Y, and that the company would cooperate with any government inquiries and self-report if necessary. The firm also represented Mr. Ruehle and others in a derivative suit and a class action based on option backdating claims.
During the course of the internal investigation, Mr. Ruehle met with the investigating attorneys. Later when criminal charges were brought against him based on similar claims Mr. Ruehle’s motion to suppress his statements which were turned over to the government was granted. The district court concluded the investigating attorneys breached the attorney client privilege.
The Ninth Circuit reversed as discussed here. In reaching its conclusion, the court left undisturbed the district court’s finding that the investigating attorneys failed to give an Upjohn warning, although in fact there was a disputed oral testimony on the point but no written record of warnings. The district court made a critical legal error, the Ninth Circuit held, by applying state rather than federal law regarding privilege. Under federal law Mr. Ruehle was obligated to establish the privileged nature of the communications. This he failed to do. The statements made by Mr. Ruehle were intended along with the other material to be disclosed to the outside auditors as the former CFO well knew. In any event, suppression is not the correct remedy for a breach of ethics.
Rick Ketchum, Chairman & CEO, FINRA testified before the House Committee on Financial Services this week. During his testimony, which reviewed current FINRA investor protection programs, Mr. Ketchum focused on the need to harmonize the regulation of broker dealers and investment advisers to enhance investor protections. Previously, Treasury proposals also referenced this point.