This Week In Securities Litigation (Week ending February 28, 2014)

The Supreme Court handed down a significant decision, construing SLUSA in the context of suits by investors defrauded investors in the Stanford Ponzi scheme. The Court concluded that the Act does not bar four state law class actions against two law firms and others.

The SEC prevailed again in the circuit courts, this time convincing the Second Circuit to affirm the decision of the district court on the proper measure of disgorgement. Specifically, the Court adopted the Commission position that a portfolio manager who traded in a managed fund on inside information, but did not trade personally, could be directed to disgorge the profits of the fund.

The Commission settled another action this week in which admissions were required. Swiss giant Credit Suisse admitted to violating the Federal securities laws in connection with soliciting brokerage business and giving investment advice in the U.S. from offices in the firm’s home country without complying with the broker registration requirements. The agency also filed another insider trading action against a market professional, a case against a hedge fund manager for misallocating expenses and an action against a broker for misappropriating client funds.


Remarks: Chair Mary Jo White addressed the SEC Speaks 2014 Conference, Washington, D.C. (Feb. 21, 2014). Her remarks reviewed rule making initiatives, enforcement and corporate finance and the JOBS Act (here).

Remarks: Commissioner Luis Aguilar addressed the SEC Speaks 2014 Conference with remarks tiled Addressing Known Risks To better Protect Investors, Washington, D.C. (Feb. 21, 2014)(here).

Remarks: Commissioner Kara Stein addressed the SEC Speaks Conference, Washington, D.C. (Feb. 21, 2014). Topics discussed included enforcement and individual accountability, executive compensation, money markets and Dodd-Frank (here).

Remarks: Commissioner Daniel Gallagher addressed the SEC Speaks 2014 Conference with remarks titled An Open Letter to the SEC Staff, Washington, D.C. (Sept. 21, 2014)(here).

Supreme Court

SLUSA: Chadbourne & Parke LLP v. Troice, No. 12-79 (S.Ct. Decided Feb. 26, 2014) is four state law class actions arising out of the Stanford Ponzi schemes. Investors purchase certificates of deposits issued by the Sanford bank which were supposedly backed by marketable securities. The funds were not invested as advertised but used to repay other investors and support the life-style of Allen Stanford and his cohorts. Mr. Stanford is now in prison, serving a sentence of 110 years and subject to a $6 billion forfeiture order. He is also subject to a $6 billion civil fine from a parallel SEC enforcement action. The plaintiff investors are attempting to recover their losses. The District Court concluded that SLUSA or the “Litigation Act” as it is called by the majority decision here – the Securities Litigation Uniform Standards Act of 1998 – requires dismissal of the actions. The Circuit Court reversed. In a 7-2 decision, the Supreme Court affirmed.

Justice Bryer, writing for the Court, began by noting that the Litigation Act provides that plaintiffs may not maintain a class action involving 50 or more members based on the statutes or common law of any state (with certain exceptions) that alleges misrepresentations or omissions of a material fact “in connection with the purchase or sale of a covered security,” that is, one traded on a national exchange (or issued by an investment company).

Here there were material misrepresentations. The issue for decision, Justice Bryer wrote, is how “broad is that scope” of the phrase in connection with? “Does it extend further than misrepresentations that are material to the purchase or sale of a covered security? In our view, the scope of this language does not extend further.” Stated differently, a “fraudulent misrepresentation or omission is not made ‘in connection with’ such a ‘purchase or sale of a covered security’ unless it is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a ‘covered security.’”

This interpretation of the Litigation Act is supported by five points. First, the focus of the Act is transactions in covered securities, not other instruments. Second, the natural reading of the statute “suggests a connection that matters” to the covered securities and “makes a significant difference to someone’s decision to purchase or to sell a covered security . . .” Third, the prior case law supports this reading of the Act. In this regard “every securities case in which this Court has found a fraud to be ‘in connection with’ a purchase or sale of a security has involved victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition.” (emphasis original). The dissent’s claims that this is a new reading of the requirement are wrong. Fourth, this reading is consistent with the Securities Act and the Exchange Act which “refer to persons engaged in securities transactions that lead to the taking or dissolving of ownership positions.” Finally, to interpret the Act more broadly would interfere with state efforts to provide remedies for victims of ordinary state-law frauds, a result Congress took care to avoid.

Here the Court concluded that “[a]t most, the complaints allege misrepresentations about the Bank’s ownership of covered securities – fraudulent assurances that the Bank owned, would own, or would use the victims’ money to buy for itself shares of covered securities. But the Bank is an entity that made the misrepresentations. The Bank is the fraudster, not the fraudster’s victim . . . And consequently, there is not the necessary ‘connection’ between the materiality of the misstatements and the statutorily required ‘purchases or sale of a covered security.’” Justice Thomas concurred in the result, penning a brief opinion.

Justice Kennedy, joined by Justice Alito, dissented. While everyone agrees that SLUSA does not reach transactions involving only the CDs, here there is more, according to the dissenters. Here the Act “must be given a ‘broad construction,’ because a ‘narrow reading of the statute would undercut the effectiveness’ of Congress’ reforms. . . Today’s decision does not heed that principle. The Court’s narrow reading of the statute will permit a proliferation of state-law class actions, forcing defendants to defend against multiple suits in various state for a.” This will be a serious burden to attorneys, accountants, brokers and investment bankers nationwide.

The Court’s construction of the Act is also inconsistent with prior decisions such as SEC v. Zandford, 536 U.S. 813 (2002)(victims were duped into believing defendant would invest their assets in stock market), Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006)(suit precluded where covered securities involved but plaintiffs had no cause of action because they lacked standing), and U.S. v. O’Hagan, 521 U.S. 642 (1997)(requiring only that material misrepresentations “’coincide[d] with” third-party securities transactions”)all of which directed that a broad reading of the requirement be given.

Canadian Securities Cases

A new report by NERA Economic Consulting shows that in 2013 there were 10 new securities actions filed in Canada. That is the same number filed in the prior year. While it is below the high of 15 brought in 2011 (NERA statistics go back to 1997), it exceeds the average of just over 8 cases filed per year over the last decade. Trends in Canadian Securities Class Actions: 2013 Update (here).

Nine of the ten actions brought last year were Bill 198 cases. Those are actions tie to secondary market civil liability based on provincial securities act provisions that have come into force since 2005. Nine of the Canadian domiciled companies against whom actions were filed last year were also subject to a U.S. securities class action. At the same time, four Canadian companies were subject to a U.S. securities suit but were not named in a Canadian filing.

SEC Enforcement – Filed and Settled Actions

Statistics: This week the Commission filed or announced the filing of 2 civil injunctive, DPAs, NPAs or reports and 2 administrative proceedings (excluding follow-on and Section 12(j) proceedings).

Investment fund fraud: SEC v. Custis, Civil Action No. 3:12-cv-01696 (D. Oregon) is a previously filed action against attorney Robert Custis. The action alleged that Mr. Curtis made false and misleading statements to investors in funds operated by Yusaf Jawed. Mr. Jawed, who operated a Ponzi scheme through Grifphon Asset Management, LLC and Pacific Northwest Holdings, LLC., was the subject of another Commission enforcement action. This week the Court entered a final judgment against Mr. Custis, enjoining him from future violations of Exchange Act Section 10(b) and Advisers Act Section 206(4). He also consented to the entry of an order in an administrative proceeding prohibiting him from appearing and practicing before the Commission as an attorney. See Lit. Rel. No. 22934 (Feb. 27, 2014).

Expense misallocation: In the Matter of Clean Energy Capital, LLC, Adm. Proc. File No. 3-15766 (Feb. 25, 2014) is a proceeding against the registered investment adviser and its co-founder, CEO and main portfolio manager, Scott Brittenham. From 2008 to the present, according to the Order, the Respondents misallocated over $2 million in expenses from managed funds and then had the adviser secretly loan operating cash to the funds at high rates. The adviser also violated the custody rule and had inadequate compliance procedures. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2), 206(3) and 206(4). The proceeding will be set for hearing.

Financial fraud: SEC v. China MediaExpress Holdings, Inc., Civil Action No. 1:13-cv-00927 (D.D.C.) is a previously filed action against the company and its Chairman and CEO, Zheng Cheng. It alleged that beginning in October 2009 the defendants engaged in a scheme to mislead and defraud investors by, among other things, overstating the cash balance of the company. This week the Court entered judgments by default against both defendants. A permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b) was entered against each defendant. In addition, Mr. Cheng is precluded from serving as an officer or director of any issuer and was directed to pay disgorgement and prejudgment interest in the amount of $17,718,359.07 along with a civil penalty of $1.5 million. See Lit. Rel. No. 22932 (Feb. 24, 2014).

Misappropriation: SEC v. O’Brien, Civil Action No. 13-CV-169 (S.D. Ohio Filed Feb. 21, 2014) is an action against former registered representative Kevin O’Brien. Beginning in 1998, and continuing through 2008, Mr. O’Brien, according to the court papers, misappropriated sums of money from the brokerage account of a client by writing checks, forwarding them to a P.O. Box, depositing them in a controlled account in the name of the client and then withdrawing the money for personal expenses. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). To resolve the case, Mr. O’Brien consented to the entry of a permanent injunction based on the Sections cited in the complaint. He also agreed to pay disgorgement of $298,917 and prejudgment interest. Payment, and a penalty, were waived based on financial condition. See Lit. Rel. No. 22931 (Feb. 24, 2014).

Financial fraud: SEC v. Sells, Civil Action No. 4:11-cv-04941 (N.D. Cal.) is a previously filed action against Christopher Sells and Timothy Murawski, respectively, the former V.P. of Commercial Operations and V.P. of Sales, for Hansen Medical. In 2008 and 2009 the two men caused the company to book improper sales as part of a scheme to falsify its financial results. To resolve the action each defendant consented to the entry of a permanent injunction based on Securities Act Sections 17(a)(1) and (3) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). In addition, Mr. Sells agreed to pay a civil penalty of $85,000 while Mr. Murawski will pay $35,000. See Lit. Rel. No. 3539 (Feb. 21, 2014).

Broker registration violations: In the Matter of Credit Suisse Group AG, File No. 3-15763 (Feb. 21, 2014). Beginning in 2002, and continuing until about 2008, Credit Suisse provided broker-dealer and investment advisory services to a group of U.S. clients from its offices in Switzerland, according to the Order. During that period the firm had as many as 8,500 client account that held securities and were beneficially owned by U.S. residents. The financial institution solicited some of these clients and furnished them with broker-dealer and advisory services. A number of firm employees serviced U.S. based clients from offices located in Switzerland. To service existing clients, and solicit others, employees traveled periodically to the U.S. During meetings in this country with clients, or potential clients, investment advice was furnished in certain instances. In some meetings securities transaction business was solicited. Credit Suisse recognized that there were risks of violating the federal securities laws as a result of its practices. To mitigate that risk, beginning in 2002 the bank enacted directives and policies which prohibited its representatives from engaging in improper conduct. The efforts were ineffective. In 2008 there was a highly publicized civil and criminal tax investigation of UBS tied to cross-boarder banking, broker-dealer and investment adviser services. Credit Suisse initiated a process to exit from U.S. cross-boarder securities business. By 2010 the bank had either transferred or terminated the vast majority of its relationships with U.S. clients. During the period the institution faced conflicting pressures from various employees regarding the decision to withdraw from the U.S. business and continued to collect fees and manage accounts.

The Order alleges willful violations of Exchange Act Section 15(a) and Advisers Act Section 203(a). To resolve the proceeding Credit Suisse admitted the facts in the Order and that it violated the federal securities laws but not the specific Sections cited in the Order. The firm also agreed to implement a series of procedures focused on ensuring a complete termination of the cross-border business described in the Order. A consultant will be retained to conduct an independent examination and prepare a report which will be made available to the staff. It will assess if the cross-border business described in the Order has fully terminated. The firm also consented to the entry of a censure and a cease and desist order based on the Sections cited in the Order. In addition, Credit Suisse will pay disgorgement of $82,170,990, prejudgment interest and a civil penalty of $50 million.

Insider trading: SEC v. Hixon, Civil Action No. A14CV0158 (W.D. Tx. Filed Feb. 20, 2014) and U.S. v. Hixon, Case No. 1:14-mj-0341 (S.D.N.Y. Filed Feb. 20, 2014) charge investment banker Frank Hixon, a Senior Managing Director at Evercore Group, LLC in 2010 and 2011, with insider trading. The charges center on trading in the shares of two firm clients – Westway Group, Inc. and Titanium Metals Corporation – and his own firm. In September 2011 Westway engaged Evercore as its advisor regarding the sale of two business units to its largest shareholder. Mr. Hixon served as Evercore’s lead on the engagement. As negotiations proceeded in 2011, Mr. Hixon, according to the court papers, traded in the account of Destiny Robinson, the mother of his son. Shares of Westway were purchased for her account. Text messages suggest the transactions, in part, were undertaken in connection with child support. The transactions were traced to Mr. Hixon through IP addresses. At one point during the extended negotiations, 140,000 shares were sold at a profit of about $260,000, according to the papers in the criminal case. The day after the 2012 merger announcement the shares held had an imputed profit of about $64,500, according to the SEC complaint.

Transactions in the shares of Titanium follow a similar pattern. There Mr. Hixon and his firm were retained regarding negotiations the company had undertaken to be acquired by Precisin Castparts. Again IP address track access to Ms. Robinon’s securities account, where Titanium shares were purchased, to Mr. Hixon’s locations. Shares were also purchased for his father’s securities account. Following the transaction announcement, the shares in Ms. Robinson’s account were sold, yielding a profit of $184,000. Those in the account of Mr. Hixon’s father were liquidated at a profit of $71,000. Finally, after learning at a January 14, 2013 firm meeting about the quarterly financial results, and shortly before their announcement, shares of the firm were purchased for Ms. Robinson’s account and that of Mr. Hixon’s father. The shares held by Ms. Robinson’s account were liquidated after the announcement at a profit of $56,000. Those held by the account of Mr. Hixon’s father were liquidated at a profit of $21,000.

Evercore received multiple inquiries from FINRA regarding suspicious trading. Those inquiries asked about trading for Frank P. Hixon, Duluth, Georgia and Destiny W. Robinson, Austin, Texas. Mr. Hixon denied knowing either person. Mr. Hixon also met with the FBI. He informed the agents that he had never traded in, or accessed, the account of Ms. Robinson. The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 14(e). The criminal complaint contains five counts of securities fraud, two counts of securities fraud in connection with a tender offer and one count of making a false statement. Both cases are pending.

Circuit courts

Disgorgement: SEC v. Contorinis, No. 12-1723-cv (2nd Cir. 2014) is an action against Joseph Contorinis, a Managing Director at Jeffries & Company, which centers on a question regarding disgorgement. In January 2006 Mr. Contorinis obtained inside information regarding the then pending acquisition talks for supermarket chain Albertson’s, Inc. from an investment banker working on the deal. He then executed trades in the securities of Albertson’s for the fund he co-managed, Jeffries Paragon Fund. He did not trade for his own account. Paragon Fund realized profits of $7,304,738 and avoided losses of $5,345,700 as a result of the transactions.

Following his conviction on criminal insider trading charges the SEC brought an action against Mr. Contorinis. The court granted summary judgment in favor of the Commission based on the conviction and ordered the payment of disgorgement based on the profits of the fund. On appeal the key question was whether an insider trader who has no trading profits, but placed trades for a fund which was unaware that he possessed inside information, can be directed to disgorge the profits of that fund. The Second Circuit affirmed the disgorgement decision in a 2-1 ruling.

Disgorgement is an equitable remedy the Court began, designed to ensure that wrongdoers do not profit from their illegal conduct. “By forcing wrongdoers to give back the fruits of their illegal conduct, disgorgement also has the effect of deterring subsequent fraud,” according to the Second Circuit (citations omitted). Since disgorgement does not have a punitive function or purpose, the “amount may not exceed the amount obtained through the wrongdoing.”

In this case Defendant Contorinis argued that he should only be required to disgorge what he “personally swallowed,” that is, the money he obtained. The SEC claimed that he should be required to return “not only those profits from the fraud that he has reserved for his own use, but also those that he bestowed on others.” The Court concluded that the SEC is correct based on a series of tipping cases. In those cases the Court held that a “tippee’s gains are attributable to the tipper, regardless whether benefit accrues to the tipper.” This is because a potential “tipper in possession of inside information who seeks to confer a benefit on a friend or to curry favor with someone who can confer reciprocal benefits in the future can do so either by trading on the information himself and passing the profit on to the intended beneficiary, or by passing the information to the beneficiary and thus allowing the tippee to realize the profit himself.” (emphasis original). This rule makes perfect sense the Court found. Thus the district court can in its discretion, but need not, require the payment of disgorgement under the circumstances here. In reaching its conclusion the Court acknowledged that other courts on related issues have reached different results.

Judge Denny Chin dissented, arguing that disgorgement is an “equitable remedy that requires a defendant to give up the amount by which he was unjustly enriched.” (emphasis original). The focus is equitable, not punitive. Requiring a defendant to give up more than he got exceeds the basic theory of the remedy. Furthermore, the tipper and tippee cases are inapposite, according to Judge Chin. In that situation the “tipper and tippee are concerted actors, jointly engaged in fraudulent activity – the tipper breaches a fiduciary duty by disclosing inside information; the tippee trades on that information, knowing of the breach and without disclosing that he knows; and the tipper obtains a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings.”

That is not the case here. Mr. Contorinis was not a tipper. The fund was not a tippee engaged in fraudulent conduct. To the contrary, the fund was an innocent party. Accordingly, the tipper-tippee cases are inapplicable. Rather, the basic equitable principles on which disgorgement is based should govern.

Criminal cases

Investment fund fraud: U.S. v. Barriger, Case No. 7:11-cr-00416 (S.D.N.Y.) is a previously filed action against the former president and principal shareholder of hedge fund Gafken & Barriger Fund LLC, Lloyd Barriger. Previously, Mr. Barriger pleaded guilty to conspiracy, securities fraud and mail fraud charges in connection with the operation of the fund. The charging papers alleged that from mid-2008 through early 2008 Mr. Barriger raised over $12 million from about 70 investors by deceiving them about the safety of the real estate fund and its performance. This week Mr. Barriger was sentenced to serve five and one half years in prison and ordered to forfeit $12 million. See also SEC v. Barriger, Civil Action No. 7:11-cv-03250 (S.D.N.Y.).

Investment fraud: U.S. v. Mills, Case No. 3:14-mj-70160 (N.D. Cal.) is an action charging Jonathan Mills with wire fraud. Mr. Mills is the founder and former CEO of tech company Motionloft, Inc. Shortly before he was due to be terminated by the board of directors, he solicited investors by falsely representing that the firm was about to be acquired by Cisco, Inc. One investor put up $210,000. The claims were false. The case is pending.


Supervisory failures: Berthel Fisher & Co. and its affiliate, Securities Management & Research, Inc., were fined $750,000 by the regulator in connection with supervisory deficiencies. Specifically, from January 2008 through the end of 2012, Berthel Fisher had inadequate supervisory systems and procedures for the sale of alternative investments such as REITs, managed futures, oil and gas programs, equipment leasing programs and business development companies. Similarly, for three years beginning April 2009, the firm did not have a reasonable basis for certain sales of leveraged and inverse ETFs. Berthel Fisher did not adequately research or review non-traditional EFTs before allowing its registered representatives to recommend them to customers. It also failed to provide adequate training on these instruments.

New York

Insider trading 2.0: Interim agreements were reached with several large New York banks and brokerages to halt the practice of taking analyst surveys. This practice was first challenged under the New York Martin Act last month in an action resolved with BlackRock. Now Merrill Lynch, UBS Securities LLC, Barclays Capital Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Goldman, Sachs & Co., J.P. Morgan Securities LLC, Morgan Stanley & Co. LLC, Deutsche Bank Securities, Inc., Jefferies LLC, Stifel, Nicolaus & Co., Inc., Stanford C. Bernstein & Co., Keefe Bruyette & Woods, Inc., Thomas Weisel Markets & Co. and Wolf Research have agreed to halt the practice.

European Securities and Markets Authority

Remarks: Executive Director Verena Ross delivered remarks titled Liquidity and new financial market regulation to the European Market Liquidity Conference, London (Feb. 26, 2014). His remarks focused on the implementation of new legislation from the European Parliament and Council and liquidity (here).

Hong Kong

Dark pools: The Securities and Futures Commission initiated a two month consultation regarding future regulation of alternative liquidity pools, typically known as dark pools. The SFC is considering a number of points including restricting access to institutional investors, enhancing the level of disclosure by users and maintaining system adequacy.


Annual reports: The Securities and Exchange Surveillance Commission issued its Annual Report 2012/2013. It reviews actions by the agency regarding market surveillance, inspections, investigations, international matters, criminal cases and policy proposals (here).


Misrepresentations: The Financial Conduct Authority banned Arnold Eber, the former CEO of CIB Partners Limited. From 2007 through 2009 SIB was the adviser to SLS Capital S.A., a Luxembourg based special purpose vehicle. During the time period the entity issued bonds underpinning investments sold to UK investors. Mr. Eber learned that without continuous cash injections there was a huge risk that the SLS portfolio would suffer from severe liquidity issues within a year. He also learned that SLS had sold off most of the asset portfolio that underpinned the bonds. Nevertheless, he issued a number of false and misleading documents about the strength of the SLS portfolio and did not disclose the financial problems of the portfolio.

Withheld client profits: The FCA fined Forex Capital Markets Ltd. and FXCM Securities Ltd. £4 million for permitting its U.S. affiliate to withdraw profits worth about £6 million that should have been paid to the UK clients. The firm took orders in one section and then executed the forex transactions in another. Beginning in 2006, and continuing until the end of 2010, the firm kept the profit from favorable market movement between the time the orders were placed and executed but allocated the losses to clients. It also failed to notify UK authorities that U.S. enforcement officials commenced an investigation in 2010 into the practice. Clients with losses were compensated.

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