The SEC’s Inspector General is front and center this week as the summary from his report on the Madoff investigations was released following the issuance of a report on rating agencies. The summary from the Madoff report details repeated failures from 1992 on, as the Commission missed repeated opportunities to discover the giant Ponzi scheme. The report on rating agencies, which contains almost two dozen recommendations, repeatedly takes issue with the manner in which the Division of Trading and Markets administered the registration process and chides the Commission for not moving forward with rule-making in this important area.

SEC enforcement brought cases based on option backdating, financial fraud and insider trading, as well as another FCPA action. DOJ unsealed criminal charges based on another Ponzi scheme and FINRA settled three more ARS cases. In private litigation, Broadcom tentatively resolved a derivative suit based on its option backdating woes.

SEC enforcement

Madoff: The executive summary of the SEC Inspector General’s Report on the failed Madoff investigations was released by the Commission along with comments by Chairman Schapiro. The detailed summary traces the unsuccessful investigative efforts of the SEC enforcement staff from 1992 through the present, pointing frequently to the fact that the staff was inexperienced and failed to follow-up on investigative leads. The detailed summary cites instance after instance in which SEC investigators had the opportunity to discover the Madoff Ponzi scheme, but failed, largely by not taking the proper investigative steps or focusing on the wrong issue. The Chairman’s comments emphasize the future, focusing on the many steps taken to improve enforcement.

Rating agencies: Another report from the SEC Inspector General concerns the failure of the Commission to move forward with new regulations regarding rating agencies. Those agencies have repeatedly been cited as a cause of the current market turmoil. The IG’s report is also critical of the administration of the current rules by the Division of Trading and Markets. Overall the report contains five specific findings, including one which recommends that all significant issues regarding a rating agency application be resolved prior to approval and not left for consideration during a subsequent inspection as has been done in the past and another that the effectiveness of the examination process be improved. Another finding raises several policy issues for consideration by the Commission. The report also contains 23 recommendations. Chairman Schapiro responded by noting that the Commission is in fact considering many of the proposals in the report.

First half stats: NERA released a report compiling SEC enforcement statistics for the first half of the year. According to the report to date the SEC has settled 335 cases compared to 330 in the same period last year. In the second quarter of this year the SEC settled 160 cases, which is down from the 174 in same quarter in 2008. It is also down from the 175 cases settled in the first quarter of 2009. The median penalty was $1.7 million in the first quarter of 2009. In the second quarter, it dropped to $1.6 million. Both of these numbers exceed the median for 2008 of $1.3 million. Likewise, the average penalty for the first half of 2009 is $10.1 million which is up from the 2008 amount of $8.4 million. Overall however the trend for 2009 is a decline from the beginning of the year.

SEC enforcement actions

Options backdating: SEC v. The Hain Celestial Group, Inc., Case No. CV 09-3826 (E.D.N.Y. Filed Sept. 3, 2009) is a settled option backdating case. According to the SEC, the company backdated stock option grants from 1998 – 2002. As a result, millions of dollars in expense were not properly recorded. The company discovered the practices after being contacted by the SEC in 2007. At that time the independent directors retained outside counsel who conducted an internal investigation. As a result of that investigation, 48 grants were re-measured involving $13.2 million in compensation expense. Previously, the company had conducted a limited internal investigation in-house as a result of which it announced that no wrongful conduct was discovered.

To settle the matter the company consented to the entry of a permanent injunction prohibiting future violations of the antifraud, proxy and reporting provisions of the securities laws. The settlement was based in part on the cooperation of the company. See also Litig. Rel. 21195 (Sept. 3, 2009).

Financial fraud: SEC v. Mowen, Civil Action No. 2:09CV0786 (D. Utah Filed Sept. 2, 2009) is an action which alleges that Thomas Fry and others raised about $41 million through the sale of unregistered high-yield promissory notes from 150 investors and funneled part of those funds to Jeffery Mowen. Mr. Mowen is a securities law recidivist and convicted felon who was operating a Ponzi scheme. The funds were raised from January 2007 through July 2008. The complaint alleges violations of the anti-fraud and registration provisions of the securities laws. The case is in litigation. See also Litig. Rel. No. 21196 ( Sept. 3, 2009).

Financial fraud: SEC v. VeriFone Holdings, Inc., Case No. CV 09-4046 (N.D. Cal. Filed Sept. 1, 2009) named as defendants the company and Paul Periolat, a former supply chain controller. According to the complaint, Mr. Periolat made adjustments to internal actual results for three quarters in 2007 to ensure that the company would make guidance. In each instance, he created entries claiming accounting errors, which he failed to verify and which were then manually entered into the system. Ultimately, income was overstated by almost 130% resulting in a restatement.

To settle the case the company consented to a permanent injunction prohibiting future violations of the reporting and internal controls provisions of the federal securities laws. Mr. Periolat consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3) as well as reporting and internal control provisions. He also agreed to pay a $25,000 civil penalty. See also Litig. Rel. 21194 (Sept. 1, 2009).

Insider trading: SEC v. Gangavarapu, Civil Action No. CV 09-231 (E.D. Tenn. Filed Aug. 31, 2009) is a settled insider trading case against Sarath Gangavarapu. The complaint alleges that Mr. Gangavarapu misappropriated material non-public information from his sister, who was married to an executive officer of Covansys Corporation. That company was acquired by CSC in a transaction announced on April 25, 2007.

According to the complaint, prior to the announcement, Mr. Gangavarapu spoke repeatedly on the phone with his sister. During those conversations she told her brother that her husband was working very hard and had taken a trip overseas. On the evening of April 24, Mr. Gangavarapu learned from his sister that she was relieved because the next day her husband’s difficult work schedule would come to an end. During the month of April, Mr. Gangavarapu purchased almost $450,000 worth of Covansys stock. On April 25, he purchased another 37,000 shares at a cost of over $980,000. After the public announcement Mr. Gangavarapu sold his shares for a profit of over $361,000.

To settle the case, the defendant consented to the entry of a permanent injunction and agreed to pay disgorgement in the amount of his trading profits along with prejudgment interest and a penalty equal to the amount of the trading profits. See also Litig. Rel. 21192 (Aug. 31, 2009).

Investment fraud: SEC v. Souza, Civil Action No. 2:09-cv-02421 (E.D. Cal. Filed Aug. 28, 2009) is an action against David Souza and his controlled companies. The complaint alleges that Mr. Souza conducted a fraudulent investment scheme, raising more than $1 million over a nine month period from about 28 church members. The investors were told that Mr. Souza had phenomenal skill in investing. In fact none of the money was invested – defendant was operating a Ponzi scheme. The case is in litigation. See also Litig. Rel. 21191 (Aug. 31, 2009).

Criminal cases

U.S. v. Katz, Case No. 0:09-cr-00243-1 (D. Minn. Filed Aug. 20, 2009) is a case in which a criminal information charging securities fraud was unsealed on August 31, 2009. Harold Katz , named as a defendant, is the second executive connected with Lancelot Management LLC to be charged. The case is related to SEC v. Petters, Case No. 09 SC 1750 (D. Minn. Filed July 10, 2009). There, the Commission claimed that Gregory Bell and Lancelot invested more than $2 billion with Mr. Petters while taking millions in fraudulent fees from investors. According to the SEC, Mr. Petters was operating a huge Ponzi scheme based on the sale of notes related to consumer electronics. In that case, which is in litigation, the court granted a temporary freeze order. See also Litig. Rel. 21124 (July 10, 2009).


SEC v. Meza, Civil Action No. 1:09-cv-01688 (D.D.C. Filed Aug. 28, 2009) is discussed here. Defendant Oscar Meza is a former Director of Asia-Pacific Sales for Faro Technologies, a software development and manufacturing company. Mr. Meza was responsible for the Asia-Pacific sales force.

In 2003 a new Country Manager was retained who wanted to do business the “Chinese way,” that is, by paying kickbacks and giving other things of value. The request was reviewed by Faro officers who secured a legal opinion if such payments were permissible under local law. Mr. Mesa and others were advised that such payments likely violated China’s anti-bribery laws.

Subsequently, Mr. Meza authorized the Country Manager to pay what they called referral fees to employees of Chinese state-owned companies in order to secure business. Mr. Meza also took steps to cover up the payments made in 2004 and 2005.

Mr. Meza agreed to settle with the SEC by consenting to the entry of a permanent injunction prohibiting future violations of the bribery and books and records and internal control provisions. He also agreed to pay $26,707 in disgorgement and prejudgment interest and a $30,000 civil penalty. See also Litig. Rel. 21190 (Aug. 28, 2009).

Previously, the company resolved DOJ and SEC investigations based on these matters. The criminal inquiry concluded with a non-prosecution agreement and the company agreeing to pay a penalty of $1.1 million. The SEC investigation was resolved by consenting to the entry of a cease and desist order in an administrative proceeding and agreeing to pay disgorgement.


ARS: FINRA settled three additional auction rate securities cases. The settlements were with Northwestern Mutual Investment Services, LLC, City Securities Corporation and Fifth Third Securities, Inc. The settlements follow the pattern of earlier ARS cases, calling for the firms to repurchase the securities sold essentially to retail customers, charities and small businesses. In addition, each firm agreed to pay a fine. Northwester paid $200,000, City Services $250,000 and Fifth Third $150,000.

Private actions

In re Broadcom Corp. Derivative Litig., No. 2:06-cv-03252 (C.D. Cal.) is a derivative suit based on option backdating claims at Broadcom. The complaint alleged that from 1997 to 2007 the individual defendants profited from backdating options while the company filed false financial statements with the SEC. Broadcom eventually restated its earnings as a result of the practices. This week, the parties entered into a tentative settlement of the claims except those dealing with the former CFO of the company William Ruehle, co-founder and former CEO Henry Nicholas and Henry Samueli. Messrs. Ruehle and Nicholas are facing criminal charges. Under the terms of the proposed settlement $118 million would be paid in settlement from the D&O coverage along with $11.5 million in attorney fees.

FCPA Seminar

On September 10, 2009 from 12:00 to 1:30 p.m. the ABA will sponsor the Second Annual seminar on the FCPA. The program features a discussion of current enforcement trends by senior DOJ and SEC officials and provides guidance on compliance by expert in-house counsel. For more information please click on the link below.