The Week In Review (November 2–8, 2007): Internationalization and Insider Trading

European Office for the SEC

Two key focal points of the SEC converged last week: the internationalization of the markets and insider trading. Chairman Cox has taken a number initiatives on the international front, such as moving forward with the use of international accounting standards. This week the Financial Times reports that the SEC is considering a European office that would focus on diplomatic efforts. The office would represent the Commission’s point of view at overseas regulatory gatherings.

Opening such an office would be consistent with the increasingly international scope of the SEC’s cases, as well as its impact. Many of the large insider trading cases brought earlier this year involve trading through foreign accounts or from other countries. Those cases have, for example, involved trading in Pakistan, Hong Kong and the U.K. Frequently, they are brought with aid from foreign regulators.

At the same time, according to the FT, the SEC has a growing impact on European business. According to one survey of European companies, the SEC was listed as the worst possible option when regulatory entanglements were considered. A significant percentage of companies reporting that an SEC enforcement action can be very damaging. The findings of this survey were amplified by those from another which reported that 23% of the European companies surveyed had been contacted by the SEC in the last twelve months. The SEC Looks Abroad, Nov. 8, 2007, FT.com.

Another Insider Trading Case

The SEC also continued to bring insider trading cases at home. On November 2, 2007, the Commission filed an insider trading case against a former scientist of Invitrogen Corporation. According to the complaint, Harry Yim obtained non-public information about the company’s poor financial results at a company meeting. Prior to the public announcement of that information, Mr. Yim sold shares thereby avoiding about $79,000 in losses. The case is currently in litigation. SEC v. Yim, Case No. 07 CV 2065 (S.D. Ca.). The Commission’s Litigation Release can be seen here.

Helsinki Judge Rules For Defendants

Prosecutors lost a significant criminal securities case last week, when a judge in Helsinki concluded that sixteen former managers of internet service provider Jippii (now Saunalahti) were not guilty of insider trading and stock market manipulation charges. The judge also ordered the government to reimburse the defendants’ court costs of EUR 1.5 million, a sum which is primarily attorneys’ fees.

The government had charged CEO Harri Hohannesdahl and Board Chairman Ilpo Kuokkanen, two board members and twelve others in the case. On the insider trading charges, the court concluded that Mr. Johannesdahl did not have insider information linked with the cancellation of a share issue by the company. As to the stock manipulation charges, the court concluded that the defendants did not give out false or misleading information deliberately or out of aggravated neglect. The prosecution, which had demanded prison sentences, vowed to appeal. There is news coverage on that case here.

Tighter Insider Trading Rules In Taiwan

Insider trading was also a focal point in Taiwan last week. The Cabinet there approved a set of revisions to the Securities Transaction Law which tightened rules against insider trading. If the changes are ratified by the Legislative Yuam at the current session, it will be put into practice on January 1, 2009. There is further news coverage on the Chinapots.com website here.

Hedge Funds Told To Tighten Procedures

Finally, the Managed Funds Association, the main U.S. lobbying group for the hedge fund industry, called for tighter internal rules for valuing securities and preventing insider trading. This report comes at a time when market regulators around the world are focusing on insider trading and the SEC is bringing an increasing number of cases in the area and against hedge funds.

The Continuing Impact of Dura Pharmaceuticals v. Broudo

As part of an occasional series leading up to the arguments before the Supreme Court in Stoneridge in the first week of October, we examined the impact of the Court’s decision in Dura, decided two years ago. That case held, as previously discussed here, that a securities law plaintiff must allege and prove more to establish a claim under Section 10(b) claim than mere price inflation. In addition, plaintiff must prove loss causation – the link between the claimed fraud and injury. Overall, Dura is making it more difficult to plead and prove a securities fraud case.

Dura is having an impact in other areas not discussed in the earlier series. Class certification is one such area. In Oscar Private Equity Inves. v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007), the Fifth Circuit vacated and remanded a district court class certification decision, concluding that “loss causation must be established at the class certification stage by a preponderance of all admissible evidence.”

The case is a class action against telecom company Allegiance. The complaint alleged that the company had fraudulently misrepresented it line-installation count in violation of Section 10(b). When the final quarterly results were announced for 2001, the company had to restate the line-installation count. Earnings were also reported below street expectations. Plaintiffs’ suit followed the drop in the share price.

The District Court certified the class following a hearing at which it concluded that class certification should not be a mini-trial on the merits. The Fifth Circuit held otherwise. The circuit court concluded that full consideration to the requirements of Federal Civil Rule 23 was required even if they overlap into the merits. This included consideration of whether loss causation had been established, thus extending the reach of Dura into critical the class certification area. See also In re Organogenesis Securities Litig., Case No. 04-10027-JLT (D. Mass. March 15, 2007) (considering expert affidavit arguing no Dura causation in denying class certification).

The Dura decision is also having an impact on non-securities, common law fraud cases. For example, in Glaser v. Enzo Biochem, Inc., 464 F.3d 474 (4th Cir. 2006), plaintiff investors brought a common law fraud action against Enzo Biochem and several of its officers. The complaint alleged that plaintiffs purchased their shares at an inflated price that resulted from a conspiracy by defendants to conceal the fact that clinical trials for a key drug had not progressed well so that they could sell their shares at an inflated price.

The Fourth Circuit affirmed the dismissal of the complaint based, in part, on Dura, despite the fact that the case was based on a common law fraud claim, not the federal securities laws. Although plaintiffs repeatedly claimed that they purchased shares at an inflated price, they failed to link the price inflation to the claimed economic injury. But see Merrill Lynch & Co. V. Allegheny Energy, Inc., 2007 WL 2458411 (2d Cir. Aug. 31, 2007) (declining to apply Dura to a common law fraud claim, citing New York law re proximate cause). Overall, courts are continuing to extend the reach of Dura.