THIS WEEK IN SECURITIES LITIGATION (Week ending January 27, 2012)
The President announced a new financial fraud task force focused on the root causes of the financial crisis in his State of the Union Address to Congress. The new task force is composed of DOJ and state prosecutors. It is charged with investigating the securitization process which many believe is at the center of the market crisis. While it is clear that the new task force differs from the one announced by the President in 2009, whether the group will simply reinvestigate areas which have been analyzed by the DOJ and SEC with a view toward bringing criminal actions, or will focus on other issues is unclear.
A new report on SEC enforcement settlements notes that the number of cases resolved in fiscal 2011 is about the same as in fiscal 2010 while the mean settlement value for cases against corporations and individuals increased. A comparable report on securities class actions reports a modest increase in the number of cases brought last year.
Finally, SEC enforcement this week focused on insider trading, financial fraud and account intrusion as well as failure to supervise. The Second Circuit handed down a decision interpreting Exchange Act Section 16(b).
Securities litigation trends
SEC enforcement: The Commission settled virtually the same number of cases in fiscal 2011 as in fiscal 2010, respectively 682 and 680, according to a recent report published by NERA. The median settlement value for companies in fiscal 2011 increased to $1.47 million from $800,000. For individuals the median value in fiscal 2011 was $175,000 which is a post-SOX high. The largest settlement reported by NERA for fiscal 2011 is a $330 million default judgment against Ponzi scheme operators Milowe Allen Brost and Gary Allen Sorenson. (Financial values reported by NERA combine disgorgement, prejudgment interest and civil penalties).
The case distribution for fiscal 2011 is similar to that of fiscal 2010. In fiscal 2011 the three largest groups of actions against corporations were: 1) financial services misrepresentations and misappropriation (89 cases); 2) Illegal securities offerings/market manipulation/microcap fraud (43); and 3) Ponzi schemes (27). This is similar to fiscal 2010. For individuals the three top categories were: 1) financial services misrepresentations and misappropriation (195); 2) illegal securities offerings/market manipulation/microcap fraud (143); and 3) insider trading (63). Again the results are similar to fiscal 2010.
Finally, in fiscal 2011 the SEC brought 63 insider trading cases compared to 70 in the prior year. The $92.8 million settlement with Raj Rajaratnam is the largest insider trading settlement ever reached by the Commission.
Class actions: The number of securities class actions filed in 2011 increased to 188 compared to 176 filings the prior year, according to a recent report from Cornerstone Research. That number is still below the average of 194 cases filed from 1997 through 2010. One large group of case is the 33 actions representing 17.6% of all securities class actions which are related to Chinese issuers listed on U.S. exchanges through reverse mergers. As the year progressed however, the number of these filings appeared to decline. A second large group of case were the 43 actions related to M & A activity. This appears to build on a trend which began in 2010.
Other key points indentified in the survey include:
- Stage of litigation: The survey analyzed the progress of securities class actions through the discovery process by taking a sample of cases from 1997 through 2011. Based on this sample 75% of the cases reached the motion to dismiss stage while only 8% reached a ruling on summary judgment.
- FCPA related cases: The survey also tracked the number of class actions related to FCPA investigations being conducted by the DOJ and the SEC. Since 1998 there have been 25 such actions filed. In 2011 the second largest number of these cases were filed. In 2005 the largest number of FCPA related cases were brought.
- Industry: In 2011 the largest number of cases was brought against companies in the telecommunications services industry. Over the years companies in the healthcare business have typically been a key target. Last year a number of securities class actions were brought against smaller health care companies.
- Whistleblowers: The new SEC whistleblower program received 334 tips. Most related to claims of market manipulation, corporate disclosures, financial statements and offering fraud. The data is only for seven weeks however.
SEC Enforcement: Filings and settlements
Insider trading: In the Matter of Spencer D. Mindlin, Adm. Proc. File No 3-14557 (Jan. 26, 2012) is an action instituted on September 21, 2011 against Spencer Mindlin, formerly an employee at Goldman, Sachs & Co. and his father, Alfred Mindlin for trading based on inside information obtained from Goldmanâ€™s Exchange Traded Funds Desk (here). Respondents agreed to settle the matter by consenting to the entry of a cease and desist order based on Exchange Act Section 10(b). Spencer Mindlin also agreed to the entry of an order barring him from the securities business and from participating in any penny stock offering. Respondents are jointly and severally liable for disgorgement of $57,481 along with prejudgment interest. Spencer Mindlin will also be required to pay a civil penalty of $25,000 (an affidavit on file demonstrates the cannot pay more than this amount).
Account intrusion: SEC v. Nagaicevs, Case No. CV-12-0413 (N.D. Cal. Filed Jan. 26, 2012) is an action against Igors Nagaicevs, a resident of Latvia. The complaint alleges that he conducted a widespread online account intrusion scheme. Mr. Nagaiceves is alleged to have broken into online brokerage accounts of customers at U.S. brokers and manipulated the stock prices of over 100 NYSE and Nasdaq securities by conducting unauthorized transactions in the hacked accounts. This occurred in about 150 instances over a period of 14 months. The defendant is alleged to have made more than $850,000 in illegal profits. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Related administrative proceedings were brought against four electronic trading firms and individuals who are alleged to have given Mr. Nagaicevs online access to trade directly in the U.S. markets through an account held in the firmâ€™s name without first registering as a broker. Respondents Mercury Capital, Lisa Hyatt and Richard Rizzo settled the proceedings by consenting to an order finding that they committed or aided and abetted and caused broker registration violations. Ms. Hyatt and Mr. Rizzo each also agreed to pay a $35,000 penalty. See, In the Matter of Alchemy Ventures, Inc., Adm. Proc. File No. 3-14720 (Jan. 26, 2012)(naming as Respondents are Alchemy Ventures, Inc., KM Capital Management, LLC, Zanshin Enterprises, LLC, Mark Rogers, Steven Hotovec, Joshua Klein, Yisroel Wachs, Frank McDonald and Douglas Frederick; this case will proceed to hearing); In the Matter of Mercury Capital and Lisa Hyatt, Adm. Proc. File No. 3-14719 (Jan. 26, 2012)(settled as noted above); In the Matter of Richard v. Rizzo, Adm. Proc. File No. 3-14718 (Jan. 26, 2012)(settled as noted above).
Insider trading: SEC v. Shafer, Civ. Action No. 1:12-CV-00062 (S.D. Ohio Filed Jan. 24, 2012) and SEC v. Ward, Civ. Action No. 1:12-CV-00061 (S.D. Ohio Filed Jan. 24, 2012) center on the acquisition of Oak Hill Financial, Inc. by WesBanco, Inc., announced on July 20, 2007. Shafer names as defendants Dale Schafer, interim CFO of Oak Hill, his cousin, Jason Gonski and the cousinâ€™s friend, Joseph Mroz. On May 14, 2007 the President of Oak Hill advised Mr. Schafer that the company was in merger negotiations with WesBanco. Subsequently, Mr. Shafer told Mr. Gonski who traded. After Mr. Gonssku told his friend this fact, Mr. Shafer continued to update him on the merger. Mr. Shafer also told his friend, defendant Mroz, about the pending deal. Both traded. Mr. Gonski had profits of about $43,000 while Mr. Mroz had over $7,400.
The defendants in Ward are Robert Ward, a loan officer at Oak Hill, Benjamin Lewis, his childhood friend, Jamie Lewis, sister of Benjamin and Stanley Lewis, father of Benjamin and Jamie. Mr. Ward learned about the pending deal from an Executive Vice President of the bank. Shortly thereafter Mr. Ward told his friend Benjamin Lewis about the deal. The information was then passed to other Lewis family members. Each traded. All of the defendants settled with the Commission. Each defendant in each case consented to the entry of a permanent injunction, without admitting or denying the allegations in the complaint, prohibiting future violations of Exchange Act Section 10(b). In addition, each agreed to pay as follows: Mr. Shafer: A civil penalty of $33,484.08 in addition to consenting to being barred from serving as an officer or a director for five years and to an order suspending him from appearing or practicing before the Commission as an accountant with a right to reapply after five years; Mr. Gonski: Disgorgement and prejudgment interest of $59,565.24 and a civil penalty of $50,686.38. Mr. Shafer is jointly and severally liable for $38,957.81 of the disgorgement while Mr. Mroz is jointly and severally liable for $8,766.74 of it; Mr. Mroz: In addition to the amount noted above, a civil penalty of $7,459.95; Mr. Ward: Is jointly and severally liable for the disgorgement and prejudgment interest for which the Lewis defendants are liable but that amount, along with any penalty, has been waived based on his financial condition; Benjamin Lewis: Disgorgement and prejudgment interest of $50,209.77 along with a penalty of $44,574.55; Stanley Lewis: Disgorgement and prejudgment interest totaling $54,715.77 along with a civil penalty of $48,842.66; and Jamie Lewis: Disgorgement and prejudgment interest totaling $17,564.70 along with a civil penalty of $14,995.58.
Financial fraud: SEC v. Familant, Civil Action No. 1:12-CV-00119 (D.C. Filed Jan. 25, 2012) is an action against Len Familant, then a senior vice president of InPhonic, Inc., and Paul Greene, president of Americas Premier Corporation. The complaint alleges that the two men engaged in a financial fraud from late 2005 through early 2007 to conceal the true financial condition of InPhonic. The defendants caused the two companies to engage in a series of fraudulent round-trip transactions to artificially inflate the financial results. Mr. Familant settled with the Commission, consenting to the entry of a permanent injunction, without admitting or denying the allegations in the complaint, which precludes future violations of Exchange Act Section 10(b) and from aiding and abetting InPhonicâ€™s violations of Sections 13(a) and 13(b)(2)(A). He also agreed to pay a $50,000 civil penalty and to be barred from serving as an officer and director of a public company. Mr. Greene is charged with violating, and aiding and abetting InPhonicâ€™s and Mr. Familantâ€™s violations of, the sections cited in Mr. Familantâ€™s injunction. The action is pending as to him.
Insider trading: U.S. v. Newman, 12 mag 0124 (S.D.N.Y. Filed Jan. 18, 2012) and SEC v. Addondakis, 12-cv-0409 (S.D.N.Y. Filed Jan. 18, 2012) are the Dell insider trading cases. Diamondback Capital, LLC was named in the Commissionâ€™s action. Two employees of the firm were involved, according to the court papers. The DOJ and the SEC settled insider trading charges with Diamondback. The firm entered into a non-prosecution agreement with the U.S. Attorneyâ€™s Office and agreed to forfeit $6 million based on the profits it obtained/losses avoided. The firm also provided the U.S. Attorneyâ€™s Office with a detailed Statement of Facts relating to the alleged wrongful conduct of two of its employees named as defendants and represented, based on an investigation by outside counsel, that the misconduct under investigation does not extend beyond that described in the Statement of Facts and was not known by the co-founders of the firm. To settle with the Commission Diamondback consented to the entry of a permanent injunction which precludes future violations of the antifraud provisions of the federal securities laws and agreed to disgorge its trading profits and to pay a civil penalty of $3 million. The settlement papers do not specify that the firm neither â€œadmits nor deniesâ€ the allegations in the complaint.
Failure to supervise: In the Matter of AXA Advisors, LLC., Adm. Proc. File No. 3-14708 (Jan. 20, 2012) is an action against a registered broker dealer and investment adviser for failure to supervise. From December 2005 through December 2008 the firm failed to properly supervise Leo Buggy. During that period Mr. Buggy fraudulently induced customers to redeem securities held at the firm based on false representations that the funds would be reinvested. In fact he misappropriated the client funds. In a related criminal action Mr. Buggy pleaded guilty to criminal charges and was sentenced to 46 months in prison. To settle the action the firm agreed to implement a series of undertakings including the retention of an independent compliance consultant. The firm also agreed to the entry of a censure and to pay a fine of $100,000. In accepting the settlement, the Commission acknowledged the cooperation of the firm and the fact that it reached out to each of the clients assigned to Mr. Buggy and no additional substantive concerns were identified.
Court of appeals
Short swing profits: Huppe v. WPCS International, Inc., No. 08-4463 (2nd Cir. Decided Jan. 20, 2012) is derivative suit on behalf of WPCS International, Inc. against two funds under Section 16(b) of the Exchange Act. The two funds sold company shares from December 2005 through the end of January 2006. Following the restatement of its financial statements in March 2006, the share price of WPCS securities dropped, ending company plans for a secondary offering to finance an acquisition. The company approached the funds about acquiring shares in a PIPE. In April 2006 the funds, in conjunction with other affiliated investment vehicles, purchased 876,951 shares of WPCS at $7.00 per share. That price represented a discount of approximately 7% from the market price. The transaction was approved by the WPCS board of directors which used the capital infusion from the PIPE to make the acquisition. The share price for WPCS began to improve. Nevertheless, WPCS shareholder Maureen Huppe brought a derivative action in the name of the company against the funds based on Section 16(b). The district court ruled in her favor and the Second Circuit affirmed. The Court rejected contentions by the funds that since the transaction was initiated by the company and approved by the board it should be viewed as an exception to Section 16(b). Here the sales and purchases not only fall within Section 16(b) but also present the kind of potential congress sought to bar when drafting the Section the Court concluded. Accordingly, it is precluded by Section 16(b).
Merrill Lynch was fined $1 million for failing to arbitrate disputes with its employees. FINRA rules require that disputes between firms and associated persons be arbitrated if they arise out of the business activities of the firm or associated persons. Here, after its acquisition by Bank of America, Merrill Lynch entered into bonus arrangements structured as promissory notes with certain high produces to retain their services. The notes however were structured in a manner which was intended to circumvent FINRA rules and preclude arbitration. In fact they required litigation in the New York courts which severely restrict counter claims. Merrill filed over 90 actions in the New York courts based on the notes against individuals who left the firm.
The Board again proposed its auditing standard on communications with audit committees. Previously, it had proposed a standard to improve communications with audit committees in December 2010. Recently, Congress gave the Board authority over the audits of broker dealers. The re-proposed standard will cover those audits.
Insider trading: The regulator imposed a fine of â‚¤7.2 million on Greenlight Capital, Inc. and its owner, David Einhorn for insider dealing. According to the FSA, Mr. Einhorn was party to a telephone call on June 9, 2009 in which it was disclosed to him by a corporate broker acting for Punch Taverns Plc that the company was in an advanced stage of negotiating a significant equity fundraising. Immediately after the call Mr. Einhorn directed that his fund liquidate its Punch position which constituted about 13.3% of the outstanding shares. Over a four day period the firm reduced its position to 8.89%. On June 15, 2009 the Punch announced its fundraising. Its share price, fell 29.9%. In resolving the matter the FSA concluded that Mr. Einhornâ€™s trading was not deliberate because he did not believe the what he learned constituted inside information. Although the regulator accepted this statement, it concluded that this was not a reasonable belief for a market professional. The fine of â‚¤3,638,000 paid by Mr. Einhorn included the disgorgement of â‚¤638,000. The fine paid by Greenlight of â‚¤3,650,795 included disgorgement of â‚¤650,795.