This Week In Securities Litigation (March 14 to 20, 2008): The SEC And Turmoil In The Markets

Last week, continued turmoil in the markets and the sale of Bear Stearns dominated events. At the same time, there were significant court actions such as the reversal of the conviction of former Quest CEO Joseph Nacchio and the sentencing of former Brocade employee Stephanie Jensen. In addition, the SEC brought another FCPA case and more insider trading cases.

The market crisis

On Thursday March 20th, SEC Chairman Cox provided the Basel Committee on Banking Supervision Working Group with an update on the recent market turmoil. The Chairman wrote the letter because the Working Group was revisiting the Committee’s standards in view of recent events.

The Chairman’s letter makes two key points. First, the sale of Bear Stearns at a bargain basement price to JP Morgan Chase resulted from a lack of confidence, not capital: “Specifically, even at the time of its sale on Sunday, Bear Stearns’ capital, and its broker-dealers’ capital, exceeded supervisory standards. Counterparty withdrawals and credit denials, resulting in a loss of liquidity – not inadequate capital – caused Bear’s demise.” The Chairman went on to argue that net capital rules, which are designed to preserve investors’ funds and securities in times of market stress, served their purpose here.

Second, the SEC has incorporated the Basel standards into the supervision of large broker dealers. Under SEC rules a broker-dealer’s holding company and its affiliates which are known as consolidated supervised entities or CSEs, can elect to be subject to group-wide SEC supervision. The holding company computes its group-wide capital in accord with the Basel standards as Bear did here.

Two days earlier, on March 18th, the Division of Market Regulation issued a release entitled “Answers to Frequently Asked Investor Questions Regarding The Bear Stearns Companies, Inc.” That release states in part: “According to Bear Stearns; reports to the SEC, Bear Stearns’ broker-dealers were in compliance with the SEC’s capital and customer protection rules. The SEC also supervises the Bear Stearns parent company, whose capital also exceeded relevant regulatory standards, and whose liquidity position had been relatively stable, ranging from between $15 and $20 billion in the weeks preceding March 11. As of the morning of Tuesday, March 11, the parent company had over $17 billion in cash and unencumbered liquid assets.”

Nevertheless, by March 19, 2008, the Wall Street Journal was reporting that the SEC’s Division of Enforcement had sent a letter to JP Morgan Chase indicating that it was conducting an inquiry which apparently in part concerned statements by Bear Stearns before its acquisition. At the time of this letter Bear Stearns was already the subject of civil and criminal probes surrounding the earlier collapse of its hedge fund.

At least part of the SEC’s investigation surrounding the circumstances of Bear’s sale may on possible insider trading. Days before the sale there was a surge in put options. Shortly before the sale a number of options traders reportedly were betting that the firm’s stock would drop by about 57% in value. One question is whether those traders had material information about the investment banking firm that was not public – particularly in view of the pre-sale statements of Bear reaffirming the market that it was financially solid as reflected in its disclosure documents. See, e.g., Kara Scannell, WSJ On-Line, print/SBJ20597050222250293.html

Other events

• The insider trading conviction of former Quest CEO Chairman Joseph Nacchio was reversed by the Tenth Circuit Court of Appeals. U.S. v. Joseph Nacchio, Case No. 07-1311 (10th Cir. March 17, 2008). The case was remanded to the district court for retrial after the appeals court concluded that the trial judge erroneously excluded a key expert witness offered by the defense at the behest of the government. U.S. Attorney Troy Eid announced “The good news is the Circuit Court said our trial team presented sufficient evidence to convict Mr. Nacchio of insider trading.” Apparently Mr. Eid is not familiar with the notion that the government wins when justice is served, not by simply securing convictions of those it accuses of a crime. See generally Berger v. U.S., 55 S.Ct. 629 (1935) (prosecutors have a duty to be fair).

• On March 20, 2008 the SEC filed a settled FCPA books and records case against AB Volvo. The case is another in a series of actions based on the United Nations Oil for Food Program (previously discussed here). SEC v. AB Volvo, Civil Action No. 08 CV 00473 (D.D.C.). The SEC’s Litigation Release is here.

• On March 19, 2008 former Brocade HR chief Stephanie Jensen was sentenced to four months in prison and ordered to pay a $1.25 million fine for her role in a stock options backdating scheme. Ms. Jensen had been convicted in December of conspiracy and falsifying corporate records at Brocade.

• On March 13, 2008 the SEC filed an insider trading case against a former employee of Diebold. The action is based on trading ahead of a disappointing earnings announcement. It is in litigation. SEC v. Cole, Case No. Civ. 08-265 C (W.D. Okla.). The SEC’s litigation release is here.

• On March 13, 2008 the Commission filed an insider trading case against the former Vice Chairman of ISE Holdings and his business partners based on trading ahead of a merger announcement. The action is in litigation. SEC v. Marshall, Civil Action No. 08-CV-2527 (S.D.N.Y.). The SEC’s litigation release is here.