This Week In Securities Litigation (June 19, 2009)
The Treasury department unveiled its financial market reform proposals this week in a lengthy “white paper.” The proposals would significantly enhance the authority of the SEC while creating mechanisms to facilitate the coordination of financial regulators. It would also significantly enhance the authority of the Federal Reserve and merge banking regulators. The proposal also calls for the creation of a new consumer regulatory agency.
In the courts, the SEC brought settled option backdating and financial fraud cases against Comverse Technologies, its subsidiary Ulticom, Inc. and the sub’s former CFO, a fraud action against two former Quest executives for looting their company, and cases against several registered representatives for churning the accounts of their clients.
In private litigation, a long running securities fraud suit against Oracle and its chairman Larry Ellison appears to have concluded with a court ruling that plaintiffs failed to establish fraud. A prior dismissal order was reversed on appeal. And, in the U.K., the FSA continued bringing criminal insider trading cases, this time naming two former partners of U.S. law firms with insider trading.
Market reform
Treasury white paper: The Department of the Treasury issued its “white paper” this week, outlining sweeping regulatory reform proposals which touch many key financial sectors as discussed here. If implemented, the proposals would enhance the authority of the SEC.
Under the proposals, a Financial Services Oversight Council would be created to ensure proper coordination among financial regulators. The Council would include the Chairman of the key financial regulators including the SEC Chairman. It is part of the plan to avoid the “too big too fail” problem by ensuring that overall risk to the financial system is monitored in addition to activities in specific sectors of the economy.
The proposals also call for enhancing the SEC’s regulatory authority in key areas. The Commission would be given authority over hedge fund advisors and derivatives. Hedge fund advisors would be required to register with the SEC and subject to reporting requirements. The SEC and the CFTC would be given authority over OTC derivatives within their respective jurisdictions. The plan would promote the standardization of derivatives and impose robust margin and reporting requirements. Standardized derivates would be traded on exchanges and there would be record keeping requirements. The Commission would also be given authority to require reporting by issuers of asset backed securities.
The Treasury proposal also calls for the SEC to be given expanded authority to promote transparency in investor disclosures and new tools to increase fairness for investors. This would include the creation of a fiduciary duty for broker-dealers offering investment advice and harmonization of regulations governing investment advisers and broker-dealers.
The SEC would continue with certain current initiatives. These include plans to strengthen the regulatory framework for money market funds, the addition of transparency and standardization of the securitization markets and increasing regulations of credit rating agencies. The SEC and FINRA would also expand the Trade Reporting and Compliance Engine to include asset-backed securities.
The SEC and the CFTC are to work together to harmonize regulation under their respective statutes. To facilitate this goal the two agencies would be required to prepare a report to Congress by September 30, 2009 detailing all existing conflicts in the statutes and regulations for similar types of financial instruments and proposing appropriate amendments to the statutes. In addition, the two agencies would be required to harmonize their differing approaches to regulation.
New legislation: S. 1276, titled the “Private Fund Transparency Act of 2009,” was introduced by Senator Reed this week to require investment advisers of hedge funds to register with the SEC. The draft legislation would require hedge fund advisors with more than $30 million in assets to register and be subject to reporting requirements. The proposal appears to presage the Treasury white paper which calls for giving the SEC similar authority.
SEC enforcement
Option backdating/financial fraud: SEC v. Ulticom, Inc., Civil Action No. 09-CV-02589 (E.D.N.Y. Filed June 18, 2009); SEC v. Roberts, Civil Action No. 09-CV-02590 (E.D.N.Y. Filed June 18, 2009) are settled option backdating and financial fraud cases brought against Ulticom, a subsidiary of Comverse Technology, and its former CFO, Lisa Roberts. The company was a wholly owned subsidiary of Comverse until 2000 when it conducted an IPO. Subsequently, it remained a controlled subsidiary of Comverse.
The Commission’s complaint alleges two schemes. The first took place between 2000 and 2004. During that period, eight different stock option grants were backdated without taking the proper accounting charges. The second, which took place between 1996 and the IPO in April 2004, involved improper accounting practices keyed to building inappropriate reserves to meet the company’s analysts’ expectations. As a result of these practices, the filings the company made with the Commission were incorrect.
To resolve the actions, both defendants consented to the entry of permanent injunctions prohibiting future violations of the antifraud, books and records and proxy provisions. In addition Ms. Roberts agreed to pay a $25,000 civil penalty, to an officer and director bar and to a Rule 102(e) order prohibiting her from practicing before the Commission as an accountant with a right to reapply after five years. See also Lit. Release No. 21091 (June 18, 2009).
Option backdating/financial fraud: SEC v. Comverse Technologies, Inc., Civil Action No. 09-CV-02588 (E.D.N.Y. Filed June 18, 2009) is a settled option backdating and financial fraud case similar to Ulticom and Roberts. As in those cases, the action involves two schemes. The first involved option backdating from 1991 through 2001. During that period the company backdated 26 grants without taking the appropriate accounting charges. The second involved the use of fraudulent accounting techniques including the improper use of reserves from 2000 through 2003. During that period, the company also made materially false disclosures about its operating margins and sales backlog. As a result, for a decade beginning in 1995, the company filed false and misleading periodic reports with the Commission.
To resolve the case, the company consented to the entry of a permanent injunction prohibiting future violations of the antifraud, books and records and proxy provisions of the securities laws. See also Lit. Rel. 21090. Previously the Commission brought an action based on similar allegations against the former CEO of the company, Jacob Kobi Alexander who is currently fighting extradition. There are also outstanding criminal charges against Mr. Alexander as discussed here. See Lit. Release No. 2472 (August 9, 2006). The SEC also filed settled actions involving David Kreinberg, the former CEO, and William Sorin, the former general counsel. Those cases are discussed in, respectively, Lit. Release No. 19878 (Oct. 24, 2006) and Lit. Release No. 19964 (Jan. 10, 2007).
Financial fraud: SEC v. Cash, Civil Action No. 5:09-CV-639 (W.D. Okla. Filed June 17, 2009) names as defendants former the CEO and Chairman of Quest Resources Corporation, Jerry Cash, and Quest’s former CFO, David Grose. The complaint charges the two men with misappropriating millions of dollars from the company. Specifically, over a three year period beginning in 2005, the two defendants embezzled $10 million from the company by transferring funds from Quest-related entities and transferring it to companies Mr. Cash owned and controlled. According to the complaint, Mr. Grose exploited week internal controls at the company to siphon over $1.8 million while taking about $850,000 in undisclosed kickbacks from a supplier. He also facilitated the improper actions of Mr. Cash. The scheme collapse in 2008 when other executives began questioning the transfers. The complaint alleges violations of the antifraud, reporting provisions in addition to counts claiming false SOX certifications, prohibited loans and lying to the auditors. The action is in litigation.
Ponzi schemes: In the Matter of Bernard L. Madoff, Adm. Proc. File No. 3-13520 (June 16, 2009) is a settled administrative proceeding the Commission filed against reputed Ponzi scheme king Bernard Madoff discussed here. In the action, Mr. Madoff consented to the entry of an order under Section 15(b)(6) of the Exchange Act and Section 203(f) of the Advisers Act, barring him from association with any broker, dealer, or investment adviser. The Commission’s civil injunctive action against Mr. Madoff is still pending. SEC v. Madoff, Civil Action No. 08-10791 (S.D.N.Y.). There, Mr. Madoff has consented to the entry of a permanent injunction. The question of relief has not been resolved. Mr. Madoff is scheduled to be sentenced on Monday in the parallel criminal action.
Insider trading: SEC v. Guttenberg, Civil Action No. 07 CV 1774 (S.D.N.Y.). Mr. Guttenberg, a former UBS employee, consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Securities Act and the Exchange Act. He also agreed to the entry of an order requiring him to pay disgorgement of $15,810,000. In a related administrative proceeding, Mr. Gutenberg agreed to the entry of an order barring him from the securities business. The Guttenberg case, also discussed here, has been called one of the most significant insider trading cases brought by the SEC since the Wall Street scandals of the 1980s. The case was brought against fourteen individuals, most of whom were Wall Street professionals. It focused on two insider trading rings. Mr. Guttenberg was at the center of one ring which furnished inside information to others regarding up coming recommendations of his employer. See Lit. Release No. 21086 (June 16, 2009); See also U.S. v. Guttenberg, Case No. 1:07-CR-141 (S.D.N.Y.) (parallel criminal case in which Mr. Guttenberg pled guilty).
Churning: In SEC v. Aura Financial Services, Inc., Case No. 09-21592 (S.D. Fla. Filed June 11, 2009), the Commission filed an action against an Alabama company and six individuals who served as registered representatives. According to the SEC, from about October 2005 through April 2009 defendants induced customers to open brokerage accounts at Aura Financial. The registered representatives then churned the accounts, took excessive mark-ups and executed unauthorized trades repeatedly, yielding over $1 million in commissions. During 2008, fifteen customers who were victims of the alleged fraud had losses of over $3.5 million in their accounts. The SEC’s complaint, which charges violations of Sections 17(a) and 10(b), is in litigation. See also Lit. Release No. 21081.
Investment fraud: In SEC v. ZNext Mining Corporation, Inc., Civil Action No. CV 09-2611 (N.D. Cal. Filed June 12, 2009), the Commission’s action alleges fraud in violation of Section 10(b) and the sale of unregistered securities in violation of Section 5 by defendants ZNext Mining and its principal, Elvira Gamboa. According to the SEC, over a four year period Ms. Gamboa promoted the sale of stock in ZNext by distributing false and misleading press releases suggesting that the shell company owned and operated a gold mine in the Philippines. Overall she made at least $1 million from the sale of the shares according to the SEC. This case is in litigation. See also Lit. Release No. 21084.
Ponzi scheme: SEC v. Hernandez, Civil Action No. 09-cv-3587 (N.D. Ill. Filed June 15, 2009) is an action against David Hernandez, doing business as NextStep Financial Services. The defendants are alleged to have been conducting a Ponzi scheme. Mr. Hernandez, a convicted felon, has raised over $11 million from investors in twelve states since February 2008 by guaranteeing returns of 10% to 16% per month with no risk, according to the SEC. The complaint claims that Mr. Hernandez sold what he called guaranteed investment contracts in person and through his website. The contracts were supposedly covered by insurance. The court granted the SEC’s request for an emergency freeze order. The complaint, which alleges violations of Section 10(b) as well as Securities Action Section 5, is in litigation.
Private actions
Nursing Home Pension Fund v. Oracle, Case No. 01-988 (N.D. Cal.), is a financial fraud and insider trading suit brought against software maker Oracle and its CEO, Larry Ellison. The long running suit was dismissed this week. The court concluded that plaintiffs failed to establish deception. The complaint centered on a 21% drop in share price in March 2001 following an announcement that the company failed to meet earnings expectations. Previously, the case was dismissed by the district court in a decision that was later reversed on appeal. Mr. Ellison donated $100 million to charities and paid $22 million to resolve a separate insider trading suit in 2005. That settlement followed the dismissal of a similar suit in Delaware against Mr. Ellison.
In In re Vivendi Universal, S.A. Securities Litigation, Civil Action No. 02 Civ. 5571 (S.D.N.Y.), a securities class action, the court was asked to reconsider an order requiring E&Y (U.S.) to produce 35 cartons of work papers compiled while auditing Vivendi subsidiaries in the U.S. at the request of two French auditors as discussed here. Previously, two courts in France ruled that the papers were confidential and could not be produced. E&Y (U.S.) lost a bid to withhold the materials in the class action in the U.S. It has asked the court to reconsider its production order, claiming that principles of collateral estoppel should preclude production.
United Kingdom
Partners in the London offices of two U.S. law firms were charged with insider trading by the U.K. financial regulator according to a report on Bloomberg. Andrew Rimmington, a former corporate partner at Dorsey & Whitney, and Michael Gerard McFall, a former corporate partner at McDermott Will, were charged by the FSA with insider dealing. The case centers on the takeover of Neutec Pharma Ltd. by Novartis AG in 2006. According to the report, Peter King, former financial director of Neutec, who was also charged, tipped Mr. McFall who in turn passed the inside information to Mr. Rimmington. Mr. McFall purchased 4,000 shares while Mr. Rimmington bought 7,000 shares prior to the announcement of the deal. The share price for Neutec rose 84% following the announcement.