THIS WEEK IN SECURITIES LITIGATION (Week ending February 10, 2012)

Government authorities announced a $26 billion settlement with five of the largest banks arising out of the market crisis and its impact on home owners. In announcing the deal, the Attorney General noted that the resolution would not impact other market crisis litigation including criminal and civil charges that might be brought.

In other litigation, the PCAOB announced that it resolved a proceeding against E&Y and four of its partners by, in part, imposing a record setting fine as well as a censure on the audit firm. The SEC filed another insider trading case and an action centered on an offering fraud.

Finally, the “new era” of FCPA enforcement had mixed results this week. The DOJ and the SEC filed another settled action arising out of one of their industry wide inquiries. The Department however informed the Court in the SHOT-Show or African Sting cases that it was reconsidering its position after the latest trial ended with two acquittals and a hung jury as to the other defendants.

Litigation trends abroad

Securities litigation in Canada, the U.K. and Australia generally is on the rise, according to recent reports by NERA Economic Consulting.

Canada: The filing of securities class actions in Canada increased significantly in 2011 to fifteen new cases compared to ten in 2010 and nine in 2009. The largest number of cases filed in 2011 were so-called Bill 198 actions which relate to the adoption of a continuous disclosure system in late 2005. In addition, in 2011 five Canadian domiciled companies were named as defendants in six securities class action filings in the U.S., an increase from the three cases filed each year in 2009 and 2010. Since Bill 198 was instituted 46% of the U.S. class actions filed against Canadian domiciled companies have had a parallel action filed in Canada.

United Kingdom: For fiscal 2010/2011 fines were at record levels. Total fines for that period were ₤98.6 million compared to ₤33.3 million for the prior fiscal year. Of the total fines imposed in fiscal 2010/2011 however, ₤64 million were in four cases. For individuals during that period, the number of fines imposed was more than ten times the average over the six years prior to fiscal 2008/2009.

Japan: Enforcement actions by the Securities and Exchange Surveillance Commission centered on claimed misstatements which reached a record high of 12 in 2010, up from nine in the prior year. In private litigation the number of judgments increased to a record 56 cases in 2010, up from 14 in 2009. The 56 civil and criminal judgment cases in 2010 more than doubled the average of 25 per year from 1998 through 2009. The number of judgments centered on alleged misstatements, however, decrease to seven in 2010 in contrast to fourteen in the prior year.

Australia: In 2009 six actions were filed compared to five in 2008 and three each year in 2006 and 2007. A key to the increase in the number of cases is the manner of funding. The emergence of commercial litigation funding has altered the incentives for, and ability of, investors to participate.

SEC Enforcement: Filings and settlements

Insider trading: SEC v. Bankosky, Civil Action No. 12 CIV 1012 (S.D.N.Y. Filed Feb. 9, 2012) is an action against Brent Bankosky, formerly a Director in Takeda Pharmaceuticals International, Inc.’s business development group. Through his position with the company Mr. Bankosky obtained material, non-public information regarding two pending deal and then traded. One was announced on March 31, 2008 and involved a strategic alliance with Cell Genesys, Inc. The second centered on the April 10, 2008 announcement that his employer had agreed to acquire Millenium Pharmaceuticals, Inc. through a cash tender offer. After acquiring the information regarding each transaction, Mr. Bankosky purchased out of the money call options in the securities of, respectively, Cell Genesys and Millennium. Overall he made profits of over $63,000 on an initial investment of $37,500. He also traded on inside information obtained from his employer in two other instances regarding proposed deals but was not successful. The complaint alleges violations of Exchange Act Section 10(b) and 14(e). Mr. Bankosky agreed to pay about $136,000 as part of a settlement of the case. The court will determine on motion by the Commission whether to impose an officer and director bar. The settlement is subject to court approval.

Offering fraud: SEC v. Dachman, Case No. 1:12-cv-00821 (N.D. Ill. Filed Feb. 6, 2012) names as defendants Kenneth Dachman, Scott Wold and his company Stone Lion Management. Between July 2008 and June 2010 Mr. Dachman raised almost $3.6 million from investors in 13 states and 12 foreign countries for his controlled companies. The funds were suppose to be for outpatient diagnostic sleep studies. From December 2008 through April 2010 Mr. Dachman raised an additional $567,399 on behalf of another controlled entity. Investors were solicited using materials which were false and misleading, including misrepresentations regarding the financial condition of the company and Mr. Dachman’s background. Defendants Wolf and Stone Lion assisted in marketing the shares for a 6% commission despite the fact that they were never registered. According to the complaint, Mr. Dachman diverted at least $1,875,739 or over 45% of the total, to his own use. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a)(1).

Mr. Wolf and Stone Lion settled, consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Sections 5(a) and (5)(c) and Exchange Act Section 15(a)(1). Mr. Wolf also agreed to pay disgorgement of $335,216 along with prejudgment interest and a penalty of $20,000. Mr. Wolf will be barred from participating in any penny stock offering for one year. Mr. Dachman did not settle.


SHOT-Show/Africa sting cases: The DOJ informed the Court that it is evaluating the future of these cases which stem from the largest FCPA sting operation in history. The decision followed the second in what has been scheduled to be a series of trials. In the most recent case two defendants were found not guilty and the jury hung as to three others. Prior to submitting the case to the jury the Court dismissed the conspiracy count as to each defendant. That ended the prosecution for one defendant who was only charged in that count. The first trial ended in a hung jury. Prior to submitting that case to the jury the Court dismissed a substantive FCPA count as to two defendants and the money laundering charge as to each defendant. U.S. v. Goncalves, No. 09-cr-335 (D.D.C.)(and related cases).

Smith & Nephew: The DOJ and the SEC settled FCPA investigations with Smith & Nephew, a medical device company. See, e.g., SEC v. Smith & Nephew Plc, Civil Action No. 1;1-CV-00187 (D.D.C. Feb. 6, 2012). Smith & Nephew plc is a U.K. based company whose ADRs are traded in New York. One of its wholly owned subsidiaries is Smith & Nephew, Inc., based in Memphis, Tenn. From 1998 through 2008 Smith & Nephew, through two of its subsidiaries, authorized the payment of bribes to Greek health care providers to secure business. In the first part of the scheme the two subsidiaries sold their devices to a Greek Distributor at full price. Discounts due the distributors, and totaling over $19 million, were then funneled off to shell entities controlled by the distributor. Portions of the funds were used to pay bribes.

To resolve the criminal inquiry the U.S. subsidiary entered into a deferred prosecution agreement under which a $16.8 million criminal fine will be paid and a monitor appointed for eighteen months. The DOJ acknowledge the cooperation of the company. To settle with the SEC, the parent company consented, without admitting or denying the allegations in the complaint, to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 30A, 13(b)(2)(A) & 13(b)(2)(B) and agreed to retain an independent consultant and to pay disgorgement of $4,028,000 along with prejudgment interest.

Criminal cases

Investment fund fraud: U.S. v. Pettibone (E.D.Va.) is an action in which Richard Pettibone pleaded guilty to operating a Ponzi scheme. From 2002 through 2006 he operated Benten Investors which he claimed was an investment company in the real estate and private lending business. During its operation Mr. Pettibone raised at least $2 million from investors based on misrepresentations about the operations of the company and a claimed guaranteed return. In fact much of the money was diverted to his personal use. As the scheme collapsed Mr. Pettibone wired over $500,000 to Costa Rica to which he fled. Eventually he was captured and held in jail for eleven months prior to extradition. Following his plea he was sentenced to an additional 36 months in prison based on his recommendation as well as that of the government.


Reserves: In the Matter of Ernst & Young LLP, PCAOB Release No. 105-2012-001 (February 8, 2012) is a proceeding against the firm and four of its partners Jeffrey Anderson, Robert Thibault, Ronald Butler and Thomas Christie. The Order centers on the audits for the fiscal years ended December 31, 2005, 2006 and 2007 of Medicis Pharmaceutical Corporation based in Scottsdale, Arizona. In the audits for those years the Board concluded that the firm failed to properly evaluate the sales returns reserve which is a material part of the financial statements. The company essentially utilized replacement cost rather than sales price thereby materially understating the reserves. Although E&Y personnel conducted a 2006 AQR and questioned Medicis’ reliance on the exchange exception, Messrs. Anderson, Thibault and Butler altered their rationale as to the method the company used, adopting an inappropriate analogy to warranty accounting. In 2006 and 2007 Messrs. Anderson, Butler and Christie also failed to appropriately test, or ensure the performance of adequate procedures to test, key assumptions for management’s new estimation methodology for units-in-channel for the year end reserve. Rather, they placed undue reliance on the estimations of management.

On November 10, 2008 Medicis filed with the SEC restated financial statements for the years ended December 31, 2007 and 2006, the six months ended December 31, 2005 and the fiscal year ended June 30, 2005. In those statements the return reserve increased $94.6 million or 585% as of December 31, 2005, $52.1 million or 148% as of December 31, 2006 and $58.9 million or 600% as of December 31, 2007.

In resolving the proceeding, which the Board made public, E&Y was fined a record $2 million and censured. In addition, the following sanctions were imposed on the partners: Mr. Anderson, who served as the lead partner on the 2005 and 2007 engagements and participated in the audit quality review and consultation, was barred from associating with a PCAOB registered firm with a right to petition for removal of the bar after two years and fined $50,000; Mr. Thibault, who served as the independent review partner for the 2005 and 2006 audits and participated in the consultation in a National Office role as a member of the firm’s Professional Practice Group, was barred with a right to petition for removal after one year and fined $25,000; Mr. Butler, who was the second partner on the 2005 audit, led the 2006 engagement and concurred with the consultation conclusion, was fined $25,000; and Mr. Christie, who was the second partner on the 2007 audit, was censured.

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