This Week In Securities Litigation (Week ending March 7, 2014)

The Supreme Court was the focus of securities litigation this week. Oral argument was presented in the long running Halliburton case where the Petitioners are seeking to rewrite the rules for bringing securities fraud class actions cases by either overruling Basic and its fraud-on-the-market presumption or substantially modifying it. The High Court also handed down its ruling in Lawson, broadly construing the protections afforded whistleblowers under the Sarbanes-Oxley Act and agreed to hear next term a case on the pleading requirements for a Securities Act Section 11 claim.

The SEC continued to prevail in the Circuit Courts. In a ruling by the Tenth Circuit, the Commission’s position that partnership interests could be securities despite their form and a claim that the interests were not securities was sustained by the Court.

The Commission also brought a financial fraud action against five former attorneys, executives and financial professionals from collapsed law giant Dewey & LeBoeuf LLP centered on a fraudulent 2010 $150 million bond offering. A parallel criminal case was filed in the New York Supreme Court against four former Dewey officials. The SEC also prevailed on summary judgment in a case centered on a fraudulent investment scheme while filing an action to halt an on-going pyramid scheme soliciting investors through social media and a proceeding based on Rule 105 short selling violations that yielded the largest amount paid to date to settle such a proceeding.


Remarks: Commissioner Michael S. Piwowar addressed the AIMA Global Policy & Regulatory Forum, New York City (March 6, 2014). He outlined his approach to international regulatory issues (here).

Remarks: Commissioner Daniel M. Gallagher addressed the Institute of International Bankers 25th Annual Washington Conference, Washington, D.C. (March 3, 12014). The Commissioner’s remarks focused on capital requirements and their possible effects in the securities markets (here).


Testimony: Acting Chairman Mark P. Wetjen testified before the House Appropriations Subcommittee on Agriculture, Rural Development, Food and Drug Administration, and Related Agencies (March 6, 2014). The testimony focused on the budget for the fiscal year (here).

Supreme Court

Fraud-on-the-market theory:Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317(Argument March 5, 2014). The Court heard argument this week on issues that are critical to securities fraud class actions. The issues under consideration are whether 1) Basic Inc. v. Levinson, 485 U.S. 224 (1988), which adopted the fraud-on-the-market theory in securities class actions, should be overruled or 2) the approach should be modified so that evidence of price impact is permitted at the certification hearing. At argument the parties emphasized the key themes from their briefs while the Justices posed questions that at times sounded more like position statements. Petitioners argued that Basic should be overruled, contending that the fraud-on-the-market presumption is outmoded in view of recent scholarship and that it is out-of-step with the Court’s current jurisprudence on Rule 23. Respondents defended Basic, arguing that its presumption is not economics but a substantive provision of federal securities law and that the decision is also consistent with the approach of the Court in its recent class certification cases. Much of the questioning from the Court focused on what Justice Kennedy called a “midpoint” approach under which event studies would be used at certification regarding price impact. The arguments are summarized here.

Whistleblowers: In Lawson v. FMR LLC, No. 12-3 (Decided March 4, 2014) the Court held that the whistleblower provisions of the Sarbanes-Oxley Act of 2002, Section 1514A apply to employees of entities in a mutual fund cluster who are working for a non-public entity that is affiliated with the public company fund which has no employees. Accordingly, the provision “shelters employees of private contractors and subcontractors, just as it shelters employees of the public company served by the subcontractors and subcontractors.”

Section 11 liability: Omnicare, Inc. v. The Laborers District Council Construction Industry Pension Fund, No. 13-435 (March 3, 2014). The Court agreed to resolve a split in the circuits regarding the pleading requirements for a Securities Act Section 11 claim. Specifically, the Court will determine if to allege such a claim a plaintiff may “plead that a statement of opinion was ‘untrue’ merely by alleging that the opinion itself was objectively wrong, as the Sixth Circuit has concluded, or must the plaintiff also allege that the statement was subjectively false—requiring allegations that the speaker’s actual opinion was different from the one expressed—as the Second, Third, and Ninth Circuits have held?” The case will be heard next term.

SEC Enforcement – Litigated Actions

Investment fund fraud: SEC v. StratoComm Corporation, Civil Action No. 1:11-CV-1188 (N.D. N.Y.) is a previously filed action against the firm, CEO Roger Shearer and IR director Craig Danzig. The complaint alleges that the defendants falsely portrayed the company as a manufacturer and seller of telecommunications systems in underdeveloped countries. Investors were sold over $4 million in stock. In reality the company had no operations or revenue. Much of the money raised was used by Mr. Shearer for his own purposes. The Court granted the Commission’s motion for summary judgment, determining that the company had violated Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The Court also concluded that Mr. Shearer violated Securities Act Sections 5(a) and 5(c) and aided and abetted violations of Exchange Act Section 10(b) and found him liable as a control person of the company. Finally, the Court concluded that Mr. Danzig also violated the registration provisions along with Securities Act Section 17(a), Exchange Act Section 15(a) and that he aided and abetted the Section 10(b) violations by the company. Remedies will be considered at a later date. See Lit. Rel. No. 1:11-cv-1188 (March 5, 2014).

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 1 administrative proceeding (excluding follow-on and Section 12(j) proceedings).

Financial fraud: SEC v. Davis (S.D.N.Y. Filed March 6, 2014) is an action against five executives and finance professionals formerly with the collapsed law firm of Dewey & LeBoeuf LLP. The defendants are: Attorney Steven Davis, chairman of the firm; attorney Stephen DiCarmine, executive director; Joel Sanders, CFO; Frank Canellas, finance director; and Thomas Mullikin who held several accounting positions. The complaint alleges that in connection with a $150 million private bond offering in 2010 the firm and the defendants engaged in financial fraud, furnishing purchasers a PPM with false financial information. In fact, the financial fraud traced back to 2008 when the firm began falsifying its books. Bond purchasers were also furnished with quarterly financial information which was false. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See also People of the State of New York v. Davis (Sup. Ct. N.Y. Filed March 6, 2014)(parallel 106 count indictment against Messrs. Davis, DiCarmine, Sanders and Warren based on the accounting fraud at the law firm).

Short selling: In the Matter of Worldwide Capital, Inc., Adm. Proc. File No. 3-15772 (March 5, 2014) is a proceeding which names as Respondents the firm and Jeffrey Lynn. The Order alleges that from the end of October 2007 through February 2012 the firm sold shares short during the time period prohibited by Rule 105, Regulation M on 60 occasions and then purchased shares of the same firm in the follow-on offering. Respondents had trading profits of $4,212,797. To resolve the proceeding Respondents consented to the entry of a cease and desist order based on Rule 105, Regulation M. They also agreed to disgorge their trading profits along with prejudgment interest and pay a civil monetary penalty of $2,514,571. The total of the three payments – about $7.2 million – is the largest monetary sanction for a Rule 105 short selling violation ever imposed, according to the Commission press release. See Release 2014-43 (March 5, 2014).

Pyramid scheme: SEC v. Fleet Mutual Wealth Ltd,Civil Action No. CV 14-01409 (C.D. Cal. Filed Feb. 25, 2014) is an action against Fleet, a Hong Kong company, and MWF Financial Limited, a Cyprus company. Through the social media, defendants offered interests in a fund that was supposedly engaged in innovative high-frequency trading that yielded guaranteed returns of 2% to 3% per week. About 150 U.S. investors were solicited yielding about $300,000 for the defendants. In fact, virtually everything about the claimed investment program and the companies was false from its claimed Hong Kong headquarters and New York data-center to the list of executives on the website, according to the complaint. That complaint alleges violations of Exchange Act Section 10(b), each subsection of Securities Act Section 17(a) and Securities Act Sections 5(a) and (5)(c). The Commission obtained and Order deactivating the website and freezing the assets. The case is in litigation.

Circuit courts

SEC v. Shields, No. 12-1438 (10th Cir. Decided Feb. 24, 2014) is an action in which the Commission won the reversal of an order dismissing its complaint. The defendants are Jeffory Shields, GeoDynamics, Inc.. and several other business entities affiliated with Mr. Shields. They are alleged to have raised over $5 million selling interests in four purported oil and gas exploration and drilling joint ventures to sixty investors in twenty eight states. The interests were marketed through cold calls. Investors were promised annual returns that ranged from 256% to 548%. The investors solicited had little or no experience in the oil and gas business but were told about the unique qualifications of GeoDynamics as an experienced oil and gas driller and operator. Investors who expressed an interest in the program were furnished with documents which represented that they would acquire a partnership interest in a specific project, that they would have the typical rights of a partner and that their money would be in an account segregated from other offerings and dedicated to developing the oil and gas properties. The documents specifically stated that in the view of the defendants the partnership interests were not securities.

The SEC claimed that despite the terms of the contracts, investor funds were in fact comingled. Investors had no access to the books and records and much of the money raised was used by the defendants for their own purposes, according to the Commission. In fact, only a little over $600,000 of the investor funds went to oil and gas development. The complaint alleged fraud.

The District Court granted defendants’ Motion to Dismiss under Federal Rule 12(b)(6), concluding that the limited partnership interests were not securities. In reaching that conclusion the Court relied primarily on the offering documents. The Circuit Court reversed.

Here the critical question is not the form of the instrument but its substance. In determining if an instrument is an investment contract, and thus subject to the federal securities laws, the classic test is whether the scheme “involved an investment of money in a common enterprise with profits to come solely from the efforts of others.” (internal citations omitted). In applying this test the Tenth Circuit has adopted a “strong presumption that an interest in a general partnership is not a security . . . because the partners-the investors-are ordinarily granted significant control over the enterprise.”

In this case, however, the SEC has overcome that presumption.

First, the documents demonstrate that that investors had little control. While the joint venture agreements granted the investors certain rights, in fact investors were still required to rely on GeoDynamics. The turnkey contracts were the key to the success of enterprise and profits “because they were the only way these oil and gas investments could generate money.” Second, the investors were selected because they had little experience in the area. They were thus dependent on the defendants. Finally, the investors received all of their information from the defendants and were encouraged to rely on their touted expertise. Collectively these factors are sufficient to overcome the presumption. Accordingly, the order dismissing the action is reversed and remanded to the District Court for further proceedings

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