THIS WEEK IN SECURITIES LITIGATION (April 15 , 2011)
The market crisis, the FCPA and insider trading were again the key focus this week. On Capitol Hill the Senate Permanent Committee on Investigations issued a lengthy, detailed report regarding the causes of the market crisis. This report builds on earlier efforts but contains substantial new evidence. Just prior to the release of the report the Chairman of the SEC and the CFTC were testifying about the implementation of regulations being enacted under the Dodd- Frank Act which is suppose to prevent the reoccurrence of the kind of events detailed in the new report.
Securities enforcement litigation centered on the FCPA and insider trading. DOJ and the SEC added another member to group of ten largest FCPA settlements this week. At the same time the Manhattan U.S. attorney and the SEC brought two more high profile insider trading cases while in District Court in New Jersey a key player in a years long insider trading scheme pleaded guilty to criminal charges.
Market reform
Market report: The U.S. Senate Permanent Subcommittee on Investigations issued its report on the market crisis, Wall Street and The Financial Crisis: Anatomy of a Financial Collapse (here). The report, which is based on hundreds of new document, discusses the findings of the committee after a two year probe regarding the causes of the market crisis. According to the report those include high risk lending by institutions such as Washington Mutual, failures by regulators like the Office of Thrift Supervision and credit rating agencies and conflict riddled deals by large players on Wall Street.
Swaps market place: CFTC Chairman Gary Gensler testified before the Senate Committee on Banking-Housing and Urban Affairs on April 12, 2011. In his testimony Chairman Gensler reviewed current efforts to implement Title VIII of Dodd-Frank regarding enhanced oversight of clearinghouses and, specifically, about the implementation of provisions in the Act regarding the swaps market place (here). SEC Chairman Mary Schapiro testified at the same hearing regarding the new derivatives regulatory framework (here).
Basic principles: SEC Chairman Mary Schapiro, in Remarks before the Society of American Business Editors and Writers on April 8, 2011, discussed the question of basic principles which underlie and guide financial regulation. The Chairman also provided a brief review of recent significant efforts by the agency to improve its overall effectiveness (here).
SEC Enforcement
Financial fraud: SEC v. Higgins, Civil Action No. 3:11-cv-763 (N.D. Tx. Filed April 14, 2011) is a settled action against Rebecca Higgins, a former vice president of marketing at Zale Corporation. According to the complaint, during the period 2004 through 2009 Ms. Higgins caused the company to incorrectly record certain television advertising costs as prepaid advertising when in fact they should have been expenses. Accordingly, the reported expenses for those accounts were materially misstated. Ms. Higgins resolved the case by consenting to the entry of a permanent injunction prohibiting her from aiding and abetting violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). She also agreed to pay a $25,000 civil penalty.
Fraudulent note sales: SEC v. Inofin, Inc., No. 1:11-CV-10633 (D. Mass. Filed April 14, 2011) is an action which names as defendant Inofin, a subprime auto loan provider, three of its executives, Michael Cuomo, Kevin Mann and Melissa George, and two salesmen, David Affeldt and Nancy Keough. The complaint claims that the company and the three executives raised at least $110 million from the sale of unregistered notes beginning as early as 2004 from investors in twenty – five states. The sales were based on promises of 9 to 15% returns based on the fact that the money would be loaned to subprime borrowers who are charged 20%. In fact about one third of the money was diverted to other projects of two of the executives. By 2006 the company was also misrepresenting its financial condition as business deteriorated. The two salesmen are charged with selling unregistered securities. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). Massachusetts filed a parallel action against the defendants who are based in Boston.
Market manipulation: SEC v. East Delta Resources Corp., Civil No. CV10-0310 (E.D.N.Y.) is an action in which the SEC won a summary judgment ruling against defendants and brothers David and Mayer Amsel. The complaint claims that the two brothers manipulated the shares of East Delta. In granting summary judgment the court also entered permanent injunctions prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b) and imposed a penny stock bar against both brothers and, in addition an injunction based on Exchange Act Section 13(a) against David Amsel. The court has not ruled on the Securities Act Section 5 claim or the Commission’s request for an officer and director bar against David Amsel, or questions regarding disgorgement and civil penalties.
In the Matter of Gualario & Co., Adm. Proc. File No. 3-14340 (April 8, 2011) is a proceeding which names as Respondents Gualario & Co., a registered investment adviser from 1998 through 2009, and Ronald Gualario, the founder, President and CEO of the firm. The Order centers on four key allegations: First, Respondents are alleged to have induced an advisory client of limited means to invest $100,000 of her retirement funds in a promissory note that was suppose to be with Mr. Gualario’s cousin but was in fact for his benefit. Mr. Gualarion had a $50,000 debt with the cousin that the funds repaid after which the note and the remaining funds were transferred to Gualario & Co. Second, in 2006 Respondents raised $1.17 million from the sale of notes to advisory clients. The funds were to start a hedge fund and for working capital. Instead a significant portion of the funds were used in risk options trading in the firm’s proprietary account. Later the firm defaulted on its notes. Third, Respondents launched another hedge fund, raising $7.1 million from five advisory clients based on representations that the funds would be conservatively traded. Again the funds were used and most of them were lost in risky option trading. Finally, Respondents sold limited partnership interest and received transaction based fees without being a broker dealer. The Order alleges violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 15(a)(1) and Advisers Act Sections 206(1) and (2). The case is in litigation.
Investment fund fraud: SEC v. Fox, Case No. 11-CV-211 (Filed April 8, 2011) is a financial fraud action against Brian Fox, Chairman, CEO and CFO of Power River Petroleum International, Inc. Beginning in 2004 and continuing through 2008 Mr. Fox is alleged to have raised over $43 million by conveying working interests in the oil and gas company to investors who were guaranteed an annual return of 9%. In addition, the investment was to be returned. Mr. Fox and the company booked the proceeds from the transactions as revenue when in fact they were loans. He also booked oil and gas properties as assets which did not belong to the company. The result was significantly inflated revenues and assets. While the company paid the promised returns at first, eventually the obligations from continuing sales outstripped the revenues from the assets the company did own. At that point Ponzi like payments were made to prior investors with funds from new investors. Eventually the company collapsed into bankruptcy and liquidation. The Commission’s complaint alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The case is in litigation.
Criminal cases
Insider trading: U.S. v. Skowron (S.D.N.Y. Unsealed April 13, 2011) and SEC v. Skowron, Civil Action No. 10-cv-8266 (S.D.N.Y. Nov. 2, 2010) are, respectively, civil and criminal actions against a former hedge fund manager. The cases center on the allegation that Mr. Skowron obtained inside information from Dr. Yves M. Benhamou, a medical researcher at Human Genome Science Inc., about clinical trials at that company. Dr. Behamou was previously charged with criminal insider trading. He was also the initial defendant in the SEC’s case which now has been amended to include Mr. Skowron. Dr. Behamou has pleaded guilty to conspiracy to commit securities fraud, securities fraud and conspiracy to obstruct justice.
Dr. Behamou began consulting with Mr. Skowron through an expert network. By early 2007 the two men developed a personal relationship according to the court papers. Mr. Skowron gave the Doctor cash payments and paid some of his personal expenses. During drug trials in early 2008 Dr. Benhamou furnished Mr. Skowron with inside information about them which, when later announced, resulted in a significant drop in the share price of Human Genome. Prior to that announcement Mr. Skowron sold the fund’s entire position in Human Genome, avoiding a loss of about $30 million. Later the trader asked his friend to lie to investigators which he did. In the criminal case Mr. Skowron is charges with one count of conspiracy to commit securities fraud, one count of securities fraud and one count of conspiracy to obstruct justice. The SEC’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b).
Insider trading: U.S. v. Robinson (D.N.J.) is a criminal insider trading case against Kenneth Robinson, previously identified as “CC-1” in U.S. v. Bauer, and the companion case brought by the SEC against a former law firm associate and professional trader (here). Mr. Roberson pleaded guilty to a three count information charging one count of conspiracy to commit securities fraud and two counts of securities fraud. The date for sentencing has not been set.
FCPA
U.S. v. Depuy, Inc., (D.D.C. Filed April 8, 2011); SEC v. Johnson & Johnson, Civil Action No. 1:11-cv-00686 (D.D.C. Filed April 8, 2011). The cases are based on payments by Johnson &Johnson subsidiaries to publically employed health care providers in Greece, Poland and Romania. Kickbacks were paid on behalf of company subsidiaries to the former government of Iraq under the U.N. Oil for Food Program. They began the year before J&J purchased the company in 1998 and continued until 2006. During that period the company earned $24,258,072 in profits on sales obtained through bribery. In Poland employees of MD&D Poland, a J&J subsidiary, bribed publicly employed doctors and hospital administrators to obtain business. From 2000 through 2006 the company earned $4,348,000 in profit from sales made through bribery. In Romania J&J subsidiary J&Jd.o.o. paid bribes through local distributors to obtain business. Over a seven year period beginning in 2000 this scheme yielded the company $3,515,500 in profits from the bribery. Finally, Johnson & Johnson participated in the U.N. program through two subsidiaries, Cilag AG International and Janssen Pharmaceutica N.V. During the program the subsidiaries sold pharmaceuticals to an arm of the Iraqi Ministry of Health known as Kimadia and paid kickbacks of $857,387 which were not properly recorded in the books and records of the company.
To settle with DOJ the company entered into a deferred prosecution agreement with respect to its subsidiary Depuy Inc. That company was charged in a two count information alleging conspiracy and violations of the FCPA. In addition, J&J agreed to pay a criminal fine of $21.4 million. To settle with the SEC the company consented to the entry of a permanent injunction prohibiting future violations of the anti-bribery and book and records and internal control provisions of the FCPA. J&J also agreed to pay $38,227,826 in disgorgement and $10,438,490 in prejudgment interest. The resolution with DOJ reflects the extraordinary cooperation and self-reporting of the company as well as the fact that it will also have to pay a criminal fine in the U.K.
FINRA
Undisclosed fees: Jefferies & Company, Inc. agreed to pay a $1.5 million fine for failing to disclose additional commissions it earned on the sale of auction rate securities in discretionary accounts. Two Jefferies brokers involved in the transactions were also fined $20,000 each in addition to being suspended for five business days. According to the regulator, from August 1, 2007 to March 31, 2008, the firm did not disclosure to corporate customers over whose accounts it had discretion that it obtained additional commissions on the ARS selected. Jefferies was also directed to repay $425,000 in fees and commissions earned from the sale of ARS to this group of customers.
Inadequate procedures/supervision: Santander Securities of Puerto Rico was fined $2 million and directed to review its trading and procedures with regard to the sale of certain structured products. The regulator found that from September 2007 through September 2008 the brokers selling structured products and reverse convertibles had inadequate guidance and training with regard to these securities. The firm had inadequate supervisory policies. As a result these securities were sold to persons for whom they were not suitable. Significant customer losses resulted. The broker has reimbursed more than $7 million to its customers.
Suitability/procedures: UBS Financial Services agreed to pay a fine of $2.5 million and to pay restitution of $8.25 million to certain customers in connection with the sale of Principal-Protection Notes of Lehman Brothers Holdings. The notes were sold from March to June 2008 as the credit crisis was unfolding and prior to the bankruptcy of Lehman. Customers were not adequately warned of the credit risk in purchasing the Lehman issued notes and of the issuer credit risk. Some registered representatives failed to understand the risks and therefore misinformed investors.