Week in Review (December 14-20, 2007): A Major Government Report, A Scandal Continues and New Turns in the Brocade Cases

Last week, the SEC was chastised for inefficiencies which may be impeding its war on insider trading. At the same time, the Refco scandal continued to unfold, while the Brocade Communications option backdating cases of Gregory Reyes and Stephanie Jensen took unexpected twists.

The Government Accountability Office (“GAO”) issued a report which concludes that the SEC, long thought to be one of the most efficient agencies in government, is inefficient. The report focuses on the relationship between the SEC and Self Regulatory Organizations (SROs) which police the markets and frequently conduct the initial phase of inquiries on insider trading. The GAO report notes that the SEC fails to review SRO internal audit reports and that the agency lacks the computer capability to efficiently analyze data provided by the SROs from their insider trading and other inquiries. According to the report, which is discussed here, this lack of computer capacity leads to major inefficiencies. The lack of computer capabilities could impede the SEC’s war on insider trading, since many of its cases begin with referrals from SROs. Chairman Cox noted in a letter that the situation will be remedied in 2008.

The scandal over the demise of Refco continued to unfold with the indictment of Mayer Brown partner Joseph Collins on securities fraud charges. U.S. v. Collins, Case No. 1:0-cr-01170 (S.D.N.Y. Filed Dec. 18, 2007); SEC v. Collins, Case No. 07 CV 11343 (S.D.N.Y. Filed Dec. 18, 2007). Refco is the Wall Street derivatives player that collapsed into bankruptcy following the sale of a 53% stake to a group led by Thomas H. Lee Partners, L.P. and an IPO. According to the indictment, Mr. Collins was a key player in a scheme to defraud investors which focused primarily on a “round trip” loan transactions in which an entity controlled by the former CEO of Refco would loan millions of dollars to the company at the end of a quarter to conceal its true financial condition and then be repaid after the end of the quarter. The cases brought by the U.S. attorney’s office for the Southern District of New York and an action by the SEC are discussed here.

Finally, the sentencing of former Brocade Communications CEO Gregory Reyes was postponed until after prosecutors have an opportunity to review his affidavit, which was just unsealed and there is a hearing on the motion for a new trial filed by Mr. Reyes. Mr. Reyes was convicted earlier this year for orchestrating a scheme to defraud by backdating millions of dollars in option grants.

In the affidavit, Mr. Reyes states that former Brocade human resources director Stephanie Jensen did not participate in any scheme to defraud the company. In addition, Mr. Reyes states that Ms. Jensen did not have any authority to select option grant dates or prices. The affidavit was filed in support of a motion for a separate trial. Ms. Jensen was originally indicted with Mr. Reyes. In a separate trial Ms. Jensen was convicted on two counts relating to falsifying company records after prosecutors dropped most of the charges against her. She is scheduled to be sentenced on March 12, 2008.

Mr. Reyes will have a hearing on his motion for a new trial on January 9, 2008. The motion is based in part on the fact that Elizabeth Moore, who was a key government witness has recanted her testimony. Mr. Moore now states that she lied under oath to keep her job and as a result of pressure from prosecutors.