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Tuesday, November 06, 2007 5:21:44 PM
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THE RENEWED CAMPAIGN ON INSIDER TRADING: Part II: If This is A Return to the “Den of Thieves,” is the Answer Better Enforcement?
November 05, 2007
In a widely quoted comment, an SEC enforcement official recently noted that insider trading is “rampant.” Another SEC official stated earlier that there is an increase in insider trading among market professionals. Both of these comments are reflected in the ever increasing number of insider trading cases brought by the SEC. Indeed, the trend seems to be reminiscent of the days chronicled in James Stewart’s book, Den of Thieves, about the insider trading scandals of the 1980’s.
Perhaps the 1980’s have returned. Consider, for example, SEC v. Guttenberg, Case No. 1:07-cv-01774-PKC (S.D.N.Y. Filed March 1, 2007) and related cases (originally discussed here). There, the SEC brought insider trading cases against 14 defendants. The cases involved two basic insider trading schemes. One scheme is the UBS scheme which ran from 2001 to 2006 where UBS insider Guttenberg tipped two Wall Street traders regarding up coming UBS analysts’ recommendations. The two traders had downstream tippees at other firms and hedge funds.
The second scheme involved a Morgan Stanley attorney, her husband attorney and other professionals. There, according to the allegations, the Morgan Stanley attorney misappropriated M&A information and tipped others.
What is perhaps most significant about the cases is the defendants: a “who’s who” of Wall Street players: a UBS registered representative, a Morgan Stanley attorney, a Lyford Cay hedge fund manager, an Andover brokerage representative, a Chelsey Capital portfolio manager, a representative from Jefferies & Co. and others.
The criminal case, U.S. v. Jurman, Case No. 1:07-cr-00140-TPG (S.D.N.Y. Filed Feb. 26, 2007) (and related cases) contained many of the same Wall Street professionals as defendants.
A second significant case involving Wall Street professionals is SEC v. Barclays Bank, Civil Action No. 07-CV-04427 (S.D.N.Y. Filed May 30, 2007). There, a major Wall Street bank and its proprietary trader for distressed debt were named as defendants in an insider trading case. The complaint alleged illegal profits from trading in debt securities of bankrupt companies where the bank and its trader obtained the inside information from positions held on various creditors committees.
While the Barclays case raises significant questions about the use of so-called “Big Boy” letters, discussed here, what is perhaps more important is the fact that is was brought directly against a major Wall Street institution.
A third case brought this year named a fund manager as a defendant, SEC v. Frohna, Civil Action No. 07-C-0702 (E.D. Wis. Filed August 1, 2007). In this case, the fund manager is alleged to have received inside information from his brother, who was leading a major clinical study for a significant drug at XOMA. The fund, which held a large stake in XOMA, is alleged to have avoided a large loss based on information Mr. Frohna obtained from his brother about the study. While there are significant materiality questions raised by this case, which are discussed here, again what is perhaps more significant is the defendant: another Wall Street professional.
These cases and another involving two Wall Street professionals, SEC v. Smith, discussed here, follow last year’s block buster cases, SEC v. Anticevic, Case No 05 Civ. 6991 (S.D.N.Y. Filed August 5, 2006) and the related criminal case, U.S. V. Plotkin, Case No. 06 CR 380 (RLH) (S.D.N.Y.) (and related cases). These cases involved three overlapping insider trading schemes: one involving inside information obtained from on Merrill Lynch M&A deals; a second involving advance information on copies of Business Week; and a third involved inside information concerning a grand jury inquiry into Bristol Myers. Again, however, what is disturbing is the involvement of Wall Street professionals.
Collectively these cases raise significant questions regarding the reasons for the current wave of “rampant” insider trading. While many argue that the current generation of traders have forgotten the lessons of the past that explanation seems a bit to glib. No doubt the amount of money to be made is tempting. Perhaps this wave of rampant insider trading says something about compliance and enforcement. Prevention often begins with good compliance not only by Wall Street players, but also every company. At the same time, no compliance program is bullet proof. In the end, consistent, effective enforcement by the SEC is key to preventing “rampant” insider trading. While the SEC is clearly stepping up its efforts in this area and there is no doubt that investigation and proof of these cases is difficult, perhaps it is time to carefully reevaluate enforcement in this critical area.
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The Week in Review (October 26 to November 1, 2007): Key SEC Enforcement Trends and A Significant Litigation Loss
November 02, 2007
This past week key cases brought by the SEC, highlight areas of focus over the past year and signal the direction of enforcement efforts to come: insider trading and the Foreign Corrupt Practices Act. At the same time a litigation loss may impact future PIPE and hedge fund cases, another area of emphasis for the enforcement division.
INSIDER TRADING – In SEC v. Cao, Civil Action No. CV 06-1269 (C.D. Cal. Filed October 29, 2007), the Commission is a settled insider trading case against the former vice president of Countrywide Financial Corp. The complaint alleges that Mr. Cao traded while in possession of negative financial information about subprime mortgage giant Countrywide Financial. The action was settled simultaneous with the filing of the complaint. The defendant consented to the entry of a statutory injunction prohibiting future violations of the antifraud provisions and to the entry of an order requiring the payment of disgorgement, prejudgment interest and a civil penalty equal to twice the amount of the disgorgement. Related press reports suggest that the SEC in investigating to determine whether others at Countrywide were abusing Rule 10b5-1 plans.
INSIDER TRADING – In SEC v. Durozhko, Civil Action No. 07-CV-9606 (S.D.N.Y. Filed October 29, 2007), the Commission alleges that the defendant traded while in possession of negative earnings announcement regarding IMS health. According to the complaint, Mr. Durozhko purchased 300 out of the money and 330 at the money put options on the common stock of IMS that would expire just three days later. On October 17, 2007, after the close of the market, IMS reported third quarter earnings that were 28% below the consensus analysts estimates. The next morning the stock price fell about 28%. The same day the defendant sold all of his IMS Health options, realizing a profit of over $287,000. Simultaneous with the filing of its complaint the SEC sought and obtained a freeze order over Mr. Dorozhko’s assets. The case is currently in litigation.
FCPA – In SEC v. Ingersoll-Rand Co., Ltd., Civil Action No. 107-CV-01955 (D.D.C. Filed October 31, 2007) the Commission filed a settled FCPA case. The SEC’s complaint alleged that defendant Ingersoll-Rand based on payments made to Iraq under the U.N. Oil for Food Program. Essentially, the complaint alleged that over a three-year period, four subsidiaries of the defendant entered into contracts in which over $950,000 in kickbacks were made. The company settled the action, consenting to a statutory injunction and the payment of disgorgement, pre-judgment interest and a civil penalty along with certain undertakings regarding its FCPA compliance program. The company also paid a fine under a deferred prosecution agreement executed with the Justice Department.
LITIGATION LOSS – PIPE CASE – SEC v. Mangan, Civil Action No 3:06-CV-531 (W.D.N.C. Filed December 28, 2006) is one of a series of cases brought by the SEC in recent months relating to short selling in connection with a PIPE offering. Frequently, these cases involve hedge funds, a key regulatory focus. In this case a registered representative from the investment banking firm of Friedman, Billings, Ramsey & Co. was alleged to have sold shares of CompuDyne Corp. short after learning of a PIPE offering but prior to the public announcement. The complaint alleged violations of Section 5 based on the theory that Mr. Mangan intended to cover the short sale with the PIPE shares and insider trading based on an allegation that he sold short prior to the public announcement of the deal. Previously, Friedman Billings had settled similar allegations based on the same PIPE offering. Mr. Mangan, however, filed a motion to dismiss which was granted in part. Count I of the complaint regarding the PIPE offering was dismissed while the Court expressed significant skepticism about the insider trading claim.
No doubt the SEC has a large inventory of cases in other areas such as option backdating and financial fraud. Yet, week after week there seems to be increasing numbers of insider trading cases and a growing inventory of FCPA cases. This trend, of course, counsels that issuers should carefully review their compliance programs in these areas as well as any executive Rule 10b5-1 plans.
At the same time the ruling in Mangan may suggest that the SEC will have to reconsider its PIPE cases. Until now, the SEC had been aggressively pursuing these cases. The court’s ruling however not only dismissed the Section 5 claim but was critical of the theory on which it was based. This may cause the SEC to reconsider its position on this issue.
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Another FCPA Case: Clearly a Growing Trend
November 01, 2007
Yesterday, the SEC filed another enforcement action based on alleged violations of the Foreign Corrupt Practices Act (“FCPA”). This action was against Ingersoll-Rand Company, Ltd. and related to payments made to Iraq under the U.N. Oil for Food Program. In essence, the complaint alleges that over a three year period, four subsidiaries of the company entered into contracts in which over $950,00 in kickback payments were made. SEC v. Ingersoll-Rand Co., Civil Action No. 107-CV-01955 (D.D.C. Filed October 31, 2007).
The U.N. Oil for Food Program was designed to provide humanitarian relief for the Iraqi people facing severe hardship under international trade sanctions. Under the program, the Iraqi government can purchase humanitarian goods through a U.N. escrow account. According to the SEC’s complaint, the kickback paid by Ingersoll-Rand’s subsidiaries and third parties diverted funds from the account and into an Iraqi slush fund. The U.N., in turn, effectively paid for illicit payments because they were rolled into the price of contracts used in connection with the program, thereby improperly inflating the prices.
Ingersoll-Rand agreed to settle the action, consenting to the entry of a statutory injunction prohibiting future violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. The company also consented to the entry of an order directing it to pay disgorgement of approximately $1.7 million in profits, over $560,000 in pre-judgment interest and a civil penalty of $1,950,000. The company also agreed to comply with certain undertakings regarding its FCPA compliance program and to pay a $2.5 million fine under a deferred prosecution agreement with the Justice Department.
This case is the latest in a series of FCPA actions the SEC and DOJ has brought this year. Reportedly, there are a number of additional similar actions under investigation. Prosecutions in this area are clearly a growing trend and may be at the highest level in years. In view of this increasing trend, it is clear that issuers should carefully review their compliance programs in this area as well as monitor compliance. This is particularly true since the SEC’s release notes that the settlement here was based in part on the remedial actions of the company and its cooperation.
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Court Dismisses Claim Based on Short Sales In Connection With PIPE Offering And Criticizes SEC
October 29, 2007
On Friday, the SEC lost its first Section 5 claim relating to a PIPE offering when the court granted a defense motion to dismiss. In SEC v. Mangan, Civil Action No. 3: 06-CV-531 (W.D.N.C. Filed December 28, 2006), the SEC filed a complaint against former Friedman, Billings, Ramsey & Co., Inc. registered representative John F. Mangan, Jr., alleging the sale of unregistered securities and insider trading. Specifically, the SEC’s complaint alleged that Mr. Mangan sold CompuDyne Corporation shares short at the opening of the market at prices over $15 per share at a time when he knew that company would announce a PIPE offering later that morning. Subsequently, the complaint claimed Mr. Mangan continued to sell CompuDyne shares short. After the Commission approved the resale registration statement and the shares were issued at about $12 per share, Mr. Mangan closed his short position at a significant profit according to the SEC. The complaint alleged that by placing his initial short sale order prior to the opening of the market on the day the PIPE was announced, Mr. Mangan engaged in insider trading and that he violated the registration provisions by later covering his positions with shares from the offering because he effectively sold them prior to the effective date of the registration statement.
After a hearing on a motion to dismiss the court dismissed the Section 5 claim, but allowed the insider trading claim to stand. In dismissing the Section 5 claim the court noted: “And what we have here, it seems to me, is a post hoc ergo propter [sic] argument by the government that because the PIPE in fact was not registered and because the PIPE shares were later in fact used, he in effect sold the PIPE. Well, maybe, but I don’t think he [defendant] did anything illegal. In short, no sale of unregistered securities occurred as a matter of law.”
This same unregistered sale theory has been used repeatedly over the last year by the SEC. For example, at the time the action was brought against Mr. Mangan the SEC brought a similar action against Friedman Billings and its principal. Both defendants in that action settled (see the December 20, 2006 Litigation Release here), as did another hedge fund trader in SEC v. Spiegel (the Commission’s January 4, 2007 Release is here). However, the defendant in SEC v. Berlacher, filed in September (the Litigation release is here) elected to litigate. The ruling in Mr. Mangan’s case may have an impact on this case as well as other which may be under investigation.
Although the Court denied Mr. Mangan’s motion to dismiss the insider trading claim, it expressed some doubt about the claim. In ruling on this claim the court noted that “As to the insider trading, the issue is coalesced around whether the information concerning the PIPE was material. There’s no doubt that as of the time Mr. Mangan directed and called at 7:40 a.m. [on the morning of the announcement], the information was not public. He strenuously argues that the information could not have been material as a matter of law. The basic thrust of his argument is that the announcement of the PIPE was basically a nonevent so far as the price of the stock was concerned, at least for most of the day that the PIPE was announced. And intriguingly, even looking at the information from the SEC, although the stock dropped to $12.41 on the 15th, significantly prior to the closing of the PIPE it also went beck up well above that. So the stock price movement is interesting to say the least. The SEC argues otherwise and points to a sharp drop in price from closing to closing the day before [the announcement] compared to the day of the announcement. I find that pretty misleading. The major part of the price drop occurred from the 8 October closing to the 9 October opening. The price actually increased after the PIPE was announced on that day. … Relying on the standard [of materiality] quoted earlier, it seems clear to this court that the complaint as to the 10b-5 and insider trading states a claim. Concededly, it is a very close call. I found the defense argument rather compelling and persuasive … .”
The court’s ruling on both counts is significant. The Section 5 claim raised by the SEC in the context of a trading market raises clear questions as the court recognized, since the short position could be covered with open market purchases. There are also materiality issues concerning the insider trading claim based on facts presented at the hearing which demonstrated that the market price of the shares was essentially unchanged shortly after the announcement of the PIPE offering.
What is perhaps more important, however, are the comments by the court about the SEC’s case and presentation. Clearly the court had little regard for the basis of the Section 5 claim and the manner in which the case was presented. The court’s comment that the Section 5 claim is little more than hindsight raises significant issues about the claims the SEC is selecting to include in its enforcement actions. More disturbing, however, is the court’s statement that an argument presented by the Commission was misleading. Such conduct has no place in court, let alone in a presentation by a government prosecutor. Unfortunately, this is not the first time a court has made such a comment. We should not simply sit by and hope that it is the last, however. Rather, this case again argues for a careful review and revision of enforcement policies and procedures.
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The Week In Review (October 19-25, 2007): Insider Trading, Insider Trading, Insider Trading
October 26, 2007
There is more than a renewed emphasis on insider trading, if last week is any indicator. Insider trading is dominating the regulatory landscape, again suggesting that issuers and executives carefully review compliance procedures and trading programs and carefully consider the timing of securities transactions not made within the confines of a Rule 10b5-1 plan. Key events from last week support this thought.
DHB INDUSTRIES, INC. – The SEC and DOJ have brought insider trading charges against former top executives of this defense contractor. In SEC v. Brooks, Civil Action No. 07-61526 -CIV-Althonaga/Turnoff (S.D. Fla. Filed October 25, 2007), the Commission filed fraud charges against David H. Brooks, former DHB CEO and COB. The complaint alleges a pervasive accounting fraud between 2003 and 2005 and insider trading by Mr. Brooks. At the same time the SEC filed its complaint, the U.S. Attorney’s Office for the Eastern District of New York announced that it was filing criminal insider trading and securities fraud charges against Mr. Brooks, who was arrested in Florida on October 25. Previously, criminal securities charges had been brought against former DHB CFO Dawn Schlegel and former COO Sandra Hatfield. U.S. v. Hatfield, 06-CR-550 (E.D.N.Y.). A superseding indictment will be filed in that case including Mr. Brooks. The Commission’s Litigation release, which also summarizing the criminal action, can be viewed here.
SEC TEMPLATE – The SEC Office of Compliance and Exanimations announced that it is testing out a new template for its inspections which includes an insider trading component. Frequently, when the SEC conducts examinations, firms do not perform testing for potential insider trading problems. This new template will require the firms to focus on and assist the SEC staff in reviewing the issue.
This action follows a staff request in an August letter to hedge funds seeking selected information about persons who have access to inside information. The apparent purpose of this information request, which is raising privacy concerns among many, is to create some type of inside trader profile.
RULE 10b5-1 PLANS – The SEC enforcement staff has commented previously on the fact that it is reviewing Rule 10b5-1 plans to determine whether executives are using the plans in a manner which gives them some type of trading advantage in the markets – something that was not intended when the safe harbor was created. These comments come in the wake of an academic study suggesting that executives using the plans are achieving above market returns. That conclusion at least raises a question as to whether the plans are being properly used. No cases have been brought to date, although there have been media reports of SEC inquiries focused at least in part on the question such as those regarding the Countrywide investigation.
The word from the SEC staff, however, is “watch for something shortly” on this issue. This is the substance of a comment made by a senior enforcement staff official at the ABA National Institute on Securities Fraud which is concluding today in Washington, D.C.
FOREIGN MARKETS – The increasingly intensifying focus on insider trading is not just the U.S. Congress, SEC and DOJ. Rather, for months there have been reports of rampant insider trading around the globe. Last week was no exception. There were reports of insider trading investigations or actions not just in the U.S., but also Singapore, Belgium, France, South Africa and Canada. This continuous stream of reports is no doubt the cause of the increasing global and national efforts of the SEC and DOJ to detect and prosecute insider trading. In the weeks to come, expect to see this trend continue. Again, prudent issuers and executives should consider the clear warning.
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Time For a New Wells Commission
October 25, 2007
SEC Commissioner Paul Atkins recently called for the formation of a “new ‘Wells-like’ advisory committee to review the policies and procedures of our enforcement program. The Commission and the staff should welcome, not fear, such a review.” Remarks at the Eighth Annual A.A. Sommer, Jr. Corporate, Securities and Financial Law Lecture, October 9, 2007 (the full text of Commissioner Atkins’ comments can be viewed here).
The purpose of this Committee would be much the same as the original Wells Committee formed in 1972. According to then-Chairman Casey, that Committee was formed because it is “essential for the Commission to redouble its efforts to keep in touch with the best thinking on investor protection at the private bar, in the accounting profession, and in the financial community generally.”
Chairman Casey’s comments are as true today as they were when he made them thirty-five years ago – perhaps even more so. Today, the Division of Enforcement faces continued, difficult challenges. While the staff of that division has and continues to serve with distinction, working tirelessly to carry out its mission, a breath of fresh air and an induction of new ideas would serve to continue propelling it forward and continue its critical mission. This is particularly true now in the wake of various reports calling for reform and more. The recent GAO and Senate reports, for example, both point to a need for reform and improvement.
The recommendations of those reports are fortified by a review of cases brought by the Division. Despite many significant successes, some recent cases brought by the Division are years old – to the point of being stale. In other instances, courtroom losses such as the one in SEC v. PacketPort.com, Inc., Civil Action No. 3:05cv1747 (D. Conn. Filed November 16, 2005), discussed here last week, serve point to the obvious need for a new look and fresh ideas.
The mandate of this new Committee should be forward looking and not respective. Its charge should be to seek out the best ideas to assist the Division and the Commission as it moves forward to meet the increasing challenges of tomorrow, not to be critical of the past. In view of the critical and daunting mission of the Enforcement Division and its role in safeguarding the nation’s capital markets, we should demand no less. Hopefully, Commissioner Atkins’ call for new advisory committee on enforcement procedures will be quickly heeded.
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THE RENEWED CAMPAIGN ON INSIDER TRADING: Part I
October 23, 2007
This is the first part of an occasional series on the renewed emphasis on insider trading by the Securities and Exchange Commission and the Department of Justice.
While insider training has always been a staple of the enforcement program, the recent emphasis on detecting and prosecuting it today rivals the efforts of the 1980s. Then, the SEC and DOJ brought cases which captured the headlines in a manner similar to those grabbed by the recent corporate scandals such as Enron, Worldcom and others.
The renewed emphasis may stem in part from reports around the globe of rampant insider trading. Markets in the UK, China, Japan, South Korea, Australia and Canada for example, have all reported significant increases in insider trading. Last fall, Congress held hearings on insider trading. In a recent report inquiring into a whistle-blower claim from a former SEC staff member, a Senate committee directed that the agency focus more resources on insider trading.
All of this increased activity has spurred regulators to band together in an effort to eradicate the perceived increasing tide of illegal trading. The SEC is part of those world-wide efforts. At the same time, the agency has joined with domestic regulators as part of its efforts.
The SEC has new initiatives focused on detecting insider trading. For example, in September 2006, the Commission launched an unprecedented sweep of Wall Street focused on the trading activities of major Wall Street brokers and banks and hedge funds. Enforcement Chief Linda Thomsen has repeatedly cautioned executives trading through Rule 10b5-1 plans that their safe harbor may no longer be safe. This past August, the SEC circulated a letter to hedge funds requesting what many view as an unprecedented amount of information about employees and clients in a position to acquire inside information in an apparent effort to profile prospective violators.
Despite intensified efforts, detection remains difficult and proof may be daunting. Frequently, the evidence is circumstantial, implied from what may be viewed as “suspicious trading” because of its timing or size. At the same time, that suspicious trading is not proof of illegal activity and may be the result of shrewd market observation and analysis which actually contributes to market efficiency.
To examine the renewed emphasis on insider trading we will examine recent SEC and DOJ cases in seven areas:
1. Major Wall Street players;
2. Trading prior to corporate announcements;
3. Pillow talk cases;
4. Spouse v. spouse;
5. Family and friends;
6. Corporate executives; and
7. Attorneys.
After examining these areas, we will assess the new insider trading programs.
Next: Major Wall Street Players: A return to the “Den of Thieves?”
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The Week In Review (October 12-18, 2007): A Typical Week Ends With Lingering Questions About SEC Charging Policies
October 19, 2007
The week looked like many others. A settlement in a large options backdating class action suit; the filing of a settled financial fraud case by the SEC with a significant penalty despite cooperation; another case against a hedge fund; and a settled insider trading case. The end of the week was hardly typical however: a dropped two year old fraud action in favor of a settled Section 5 C&D which again raised significant questions about SEC charging policies.
First, the typical. Last Friday, Hewlett-Packard agreed to settle a two year old shareholder suit related to stock options backdating at Mercury Interactive, a business software company H.P. acquired. While the company confirmed the agreement it did not acknowledge press reports (here, registration required) that suit settled for $117.5 million.
The SEC announced the settlement of a financial fraud suit against Nortel Networks Corporation. According to the SEC’s complaint, in late 2000 and early 2001, the company altered its revenue recognition policies that did not conform to GAAP to accelerate revenue into 2000 to meet revenue targets. In addition, the company improperly established and maintained excessive reserves in 2002, according to the complaint. The company settled the case by consenting to a statutory injunction and an order requiring it to pay a civil penalty of $35 million. This settlement reflects what the SEC called “substantial remedial efforts and cooperation,” a comment which leads one to wonder about the value of cooperation. SEC v. Nortel Networks Corporation, Civil Action No. 07-CV-8851 (S.D.N.Y. October 15, 2007). The Commission’s Litigation Release is here.
In SEC v. Colonial Investment Management LLC, Civil Action No. 07-Civ. 8849 (S.D.N.Y. Filed October 15, 2007), the Commission brought another in a series of actions against hedge funds. Here, the SEC alleged that a hedge fund, its adviser and its managing director engaged in illegal trading in connection with eighteen public offerings. According to the complaint, defendants violated Rule 105 which prohibits short sales made five days before an offering from being covered with shares from the offering. The complaint alleges that defendants profited because the shares in the offerings sold at prices lower than those from the short sales. This case is in litigation. The Commission has brought several similar cases earlier this year against hedge funds, typically based on PIPE offerings (discussed previously here). The Commission’s Litigation Release in Colonial Investment is here.
The Commission also continued its campaign against insider trading, filing another settled case. SEC v. Lenzner, Civil Action No. 07-cv-01404 (W.D.P.A. Filed October 17, 2007). In this settled action the SEC alleged that NSD Bancorp director Charles Lenzner tipped Michael Pitterich about a merger between NSD and F.N.B. Corporation according to the complaint. Mr. Pitterich traded while in possession of material non-public information about the transaction prior to the announcement. Both defendants consented to the entry of statutory injunctions. Mr. Pitterich also agreed to the entry of an order requiring him to pay disgorgement, prejudgment interest and a penalty equal to the trading profits. Mr. Lenzner consented to the entry of an order requiring him to pay a penalty equal to the trading profits. The Lenzer case is discussed here.
Now, the not so typical. The week ended with the case which apparently should not have been brought – at least not as originally filed. The saga of PacketPort.com, Inc. began over two years ago with the filing of a fraud complaint by the SEC charging six individuals and four companies. Specifically, the complaint alleged a fraudulent pump and dump scheme claimed to have involved manipulative trading, false publicity, misrepresentations and a cover up. The statutory violations were alleged to include Section 10(b) (fraud), Section 17(a) (fraud), Section 5 (registration), Section 17(b) (touting) and a failure to file Schedule 13D, a failure to report beneficial ownership per Section 16(a), filing misleading issuer’s reports in violation of Section 13(a), failure to make and keep accurate books and record in violation of 13(b)(2)(A) and various aiding and abetting claims. SEC v. PacketPort.com, Inc., Civil Action No. 3:05cv1747 (D. Conn. Filed November 16, 2005). The original Litigation Release in that matter from 2005 is here.
After two years in litigation (and since the events at issue occurred in late 1999 and early 2000, a presumably lengthy pre-filing investigation), the SEC dismissed the civil action with prejudice. At the same time, a settled administrative proceeding was filed against PacketPort.com. Inc. and all but three of the original defendants against whom all claims were dropped. The remaining defendants agreed to settle the administrative proceeding by consenting to the entry of a C&D based on Section 5 violations and entry of orders requiring disgorgement. The Commission’s Litigation Release regarding the settlement is here.
In the settlement, not only did the SEC drop the civil injunctive action but, in addition, virtually all of its key claims. Gone were the claims of pump and dump. Gone were the fraud charges. Gone were the claims of touting. Gone were the false books claims. Gone were the allegations of failure to file required schedules and reports. Gone were all the key elements of the SEC’s original case.
Left, however, were lingering questions such as how with all of its vast investigative powers did the SEC get the facts so wrong? How with its vast expertise, did the SEC so grossly overcharge the claimed violations of law? Why did it take two years of litigation after the investigation for the SEC to finally figure out the actual facts and correct charges? And, perhaps more importantly, how many other times does this happen where the company or individuals simply capitulate to charges which are inappropriate or perhaps worse because of the burden and expense of fighting with the SEC or perhaps even worse, the DOJ?
The sad saga of PacketPort.com is not, unfortunately, the first instance of getting the charges wrong. It also will not be the last, unless the SEC carefully reviews and reforms its charging processes. In view of the impact of its allegations and the potential for wrongful charges and settlements, the SEC cannot start this reform process to soon.
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Return to The Den of Thieves?
October 17, 2007
The SEC and DOJ have been waging a renewed and reinvigorated battle on insider trading, bringing more high profile cases this year than perhaps since the late 1980s. Indeed, many have described the Guttenberg litigation (discussed here) as perhaps the most important since the days of the 1980s. Then, a group of Wall Street traders whose exploits are chronicled in James Stewart’s book, Den of Thieves became the targets of a well publicized-string of enforcement actions which landed many in jail.
The campaign being waged today appears no different than the one from the 1980s, focusing on a number of Wall Street professionals. Consider for example the following cases:
SEC v. Guttenberg, Case No. 1:07-cv-01774 (S.D.N.Y. Filed March 1, 2007), and the related criminal cases which involve UBS representatives, a Morgan Stanley attorney, a Lyford Cay hedge fund manager, and other Wall Street professionals;
SEC v, Barclays Bank, Civil Action No. 07-cv-04427 (S.D.N.Y. Filed May 30, 2007), brought against a major bank and one of its senior officers; and
SEC v. Joseph A. Frohua, Civil Action No. 07-C-0702 (E.D. Wis. Filed August 1, 2007), filed against a fund manager.
The common theme to these cases is insider trading allegations against Wall Street professionals – just like Den of Thieves. Some say these cases stem from the fact that the current generation of Wall Street traders is too young to remember the prior wave of prosecutions on Wall Street.
An interesting theory. But then consider the most recent case – SEC v. Gregg Ashley Smith, Civil Action No. 07-CV08394 (Filed September 27, 2007) which was brought against two securities professionals (previously discussed here). Defendant Ashley Smith, age 37, perhaps does not recall the prior round of cases. Codefendant and father of the first defendant, Elliot Joel Smith, at age 75 surely, however must remember those celebrated cases. If so, then what accounts for this apparent return to Mr. Stewart’s Den of Thieves? Perhaps it is simpler than lack of memory. Perhaps Gordon Gekko in the movie Wall Street got it right.
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The New Insider Trading Cases and Warnings to the Market: Effective Enforcement?
October 15, 2007
The SEC is clearly telling the markets that it will come down hard on insider trading. After years of huge financial fraud cases, where the subject of insider trading seemed to fade in the background, this last year has seen the filing of more insider trading cases than in any recent year. Some may argue that this trend is consistent with the fact that the SEC’s Enforcement Division filed more cases last year than in the prior year for the first time in several years.
Statistics about the number of enforcement cases filed, however, are not very meaningful, standing alone. Consider, for example, that last year SEC enforcement brought a number of delinquent filing cases in which it sought to have penny stock companies delisted. Now, this is not to say those cases are not significant, but they are hardly the stuff of huge financial fraud cases or insider trading cases or many of the other enforcement actions brought by the agency. The point is that to understand the significance of the number of cases filed, one has to look beyond the numbers and analyze the type and quality of cases that the division filed.
As to the insider trading cases, there should be little doubt that this is a current enforcement priority. In many instances, the SEC has been very aggressive in filing actions, bringing them within days of a significant event. For example, in the case the TXU options case, the complaint was filed within days of the public announcement of a KKR lead takeover of TXU. See SEC v. One or More Unknown Option Purchasers, Civil Action No. 1:07-cv-01208 (N.D. Ill. March 2, 2007) (public announcement February 26, 2007). Likewise, the case based on trading in advance of the News Corp. – Dow Jones announcement was filed within seven days of the takeover announcement. SEC v. Kan King Wong, Civil Action No. 07 Civ. 3628 (S.D.N.Y. Filed May 8, 2007).
The Enforcement Division deserves credit for the swift aggressive manner in which it has brought these and other large insider trading cases this year. This is particularly true in view of the fact that in many instances the Division has moved far to slowly and brought stale cases, which are clearly not effective enforcement.
The question with many of the new and high profile insider trading cases, however, is whether the SEC can prove them and prevail. The swiftly-filed cases were brought in large part without the benefit of an extensive investigation. In many instances, the cases appear to be based on little more than the basic trading data and information which the agency probably obtained from the brokers. While suspicious trading may suggest insider trading, as we have repeatedly noted (here), standing alone, such trading is not sufficient to prove insider trading. It does, however, counsel corporate insiders that they should take care to review their compliance programs to avoid perhaps getting caught up in what may be viewed as suspicious trading.
For the SEC, the key to their current campaign on insider trading will be to prevail on the swiftly-brought blockbuster cases they filed this year. Winning these cases will send a clear and effective enforcement message. Since many of these cases are in discovery, it will be some time before it can be determined whether this new round of cases is effective enforcement.
So too, with the repeated warnings of Enforcement Chief Linda Thomsen regarding Rule 10b5-1 plans. Last week, Ms. Thomsen reportedly again cautioned executives that the staff is reviewing reported abuses regarding these plans. No doubt these comments suggest that prudent corporate executives carefully review their trading plans.
Ms. Thomsen’s comments prompt other more significant questions about effective enforcement, however This is not the first time that Ms. Thomsen has cautioned executives about the safe harbor plans. Earlier this year, the Enforcement Chief warned executives that the staff was reviewing these plans following the publication of an academic study suggesting that executives might be abusing them. To date, there are no enforcement actions from the staff reviews.
Effective SEC enforcement promotes investor confidence and deep, liquid markets. Ineffective enforcement can be worse than no enforcement. Bringing cases quickly is fine and can be effective. Increasing numbers of enforcement cases is fine and may caution the markets. Warning the markets of perceived abuses is fine and can be caution the markets. The key, however, is the results. The SEC will have to prevail in these insider trading cases. The review of trading plans will have to produce results. We will have to wait to see the results from these efforts and whether they constitute effective enforcement.
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THE RENEWED CAMPAIGN ON INSIDER TRADING: Part II: If This is A Return to the “Den of Thieves,” is the Answer Better Enforcement?
November 05, 2007
In a widely quoted comment, an SEC enforcement official recently noted that insider trading is “rampant.” Another SEC official stated earlier that there is an increase in insider trading among market professionals. Both of these comments are reflected in the ever increasing number of insider trading cases brought by the SEC. Indeed, the trend seems to be reminiscent of the days chronicled in James Stewart’s book, Den of Thieves, about the insider trading scandals of the 1980’s.
Perhaps the 1980’s have returned. Consider, for example, SEC v. Guttenberg, Case No. 1:07-cv-01774-PKC (S.D.N.Y. Filed March 1, 2007) and related cases (originally discussed here). There, the SEC brought insider trading cases against 14 defendants. The cases involved two basic insider trading schemes. One scheme is the UBS scheme which ran from 2001 to 2006 where UBS insider Guttenberg tipped two Wall Street traders regarding up coming UBS analysts’ recommendations. The two traders had downstream tippees at other firms and hedge funds.
The second scheme involved a Morgan Stanley attorney, her husband attorney and other professionals. There, according to the allegations, the Morgan Stanley attorney misappropriated M&A information and tipped others.
What is perhaps most significant about the cases is the defendants: a “who’s who” of Wall Street players: a UBS registered representative, a Morgan Stanley attorney, a Lyford Cay hedge fund manager, an Andover brokerage representative, a Chelsey Capital portfolio manager, a representative from Jefferies & Co. and others.
The criminal case, U.S. v. Jurman, Case No. 1:07-cr-00140-TPG (S.D.N.Y. Filed Feb. 26, 2007) (and related cases) contained many of the same Wall Street professionals as defendants.
A second significant case involving Wall Street professionals is SEC v. Barclays Bank, Civil Action No. 07-CV-04427 (S.D.N.Y. Filed May 30, 2007). There, a major Wall Street bank and its proprietary trader for distressed debt were named as defendants in an insider trading case. The complaint alleged illegal profits from trading in debt securities of bankrupt companies where the bank and its trader obtained the inside information from positions held on various creditors committees.
While the Barclays case raises significant questions about the use of so-called “Big Boy” letters, discussed here, what is perhaps more important is the fact that is was brought directly against a major Wall Street institution.
A third case brought this year named a fund manager as a defendant, SEC v. Frohna, Civil Action No. 07-C-0702 (E.D. Wis. Filed August 1, 2007). In this case, the fund manager is alleged to have received inside information from his brother, who was leading a major clinical study for a significant drug at XOMA. The fund, which held a large stake in XOMA, is alleged to have avoided a large loss based on information Mr. Frohna obtained from his brother about the study. While there are significant materiality questions raised by this case, which are discussed here, again what is perhaps more significant is the defendant: another Wall Street professional.
These cases and another involving two Wall Street professionals, SEC v. Smith, discussed here, follow last year’s block buster cases, SEC v. Anticevic, Case No 05 Civ. 6991 (S.D.N.Y. Filed August 5, 2006) and the related criminal case, U.S. V. Plotkin, Case No. 06 CR 380 (RLH) (S.D.N.Y.) (and related cases). These cases involved three overlapping insider trading schemes: one involving inside information obtained from on Merrill Lynch M&A deals; a second involving advance information on copies of Business Week; and a third involved inside information concerning a grand jury inquiry into Bristol Myers. Again, however, what is disturbing is the involvement of Wall Street professionals.
Collectively these cases raise significant questions regarding the reasons for the current wave of “rampant” insider trading. While many argue that the current generation of traders have forgotten the lessons of the past that explanation seems a bit to glib. No doubt the amount of money to be made is tempting. Perhaps this wave of rampant insider trading says something about compliance and enforcement. Prevention often begins with good compliance not only by Wall Street players, but also every company. At the same time, no compliance program is bullet proof. In the end, consistent, effective enforcement by the SEC is key to preventing “rampant” insider trading. While the SEC is clearly stepping up its efforts in this area and there is no doubt that investigation and proof of these cases is difficult, perhaps it is time to carefully reevaluate enforcement in this critical area.
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The Week in Review (October 26 to November 1, 2007): Key SEC Enforcement Trends and A Significant Litigation Loss
November 02, 2007
This past week key cases brought by the SEC, highlight areas of focus over the past year and signal the direction of enforcement efforts to come: insider trading and the Foreign Corrupt Practices Act. At the same time a litigation loss may impact future PIPE and hedge fund cases, another area of emphasis for the enforcement division.
INSIDER TRADING – In SEC v. Cao, Civil Action No. CV 06-1269 (C.D. Cal. Filed October 29, 2007), the Commission is a settled insider trading case against the former vice president of Countrywide Financial Corp. The complaint alleges that Mr. Cao traded while in possession of negative financial information about subprime mortgage giant Countrywide Financial. The action was settled simultaneous with the filing of the complaint. The defendant consented to the entry of a statutory injunction prohibiting future violations of the antifraud provisions and to the entry of an order requiring the payment of disgorgement, prejudgment interest and a civil penalty equal to twice the amount of the disgorgement. Related press reports suggest that the SEC in investigating to determine whether others at Countrywide were abusing Rule 10b5-1 plans.
INSIDER TRADING – In SEC v. Durozhko, Civil Action No. 07-CV-9606 (S.D.N.Y. Filed October 29, 2007), the Commission alleges that the defendant traded while in possession of negative earnings announcement regarding IMS health. According to the complaint, Mr. Durozhko purchased 300 out of the money and 330 at the money put options on the common stock of IMS that would expire just three days later. On October 17, 2007, after the close of the market, IMS reported third quarter earnings that were 28% below the consensus analysts estimates. The next morning the stock price fell about 28%. The same day the defendant sold all of his IMS Health options, realizing a profit of over $287,000. Simultaneous with the filing of its complaint the SEC sought and obtained a freeze order over Mr. Dorozhko’s assets. The case is currently in litigation.
FCPA – In SEC v. Ingersoll-Rand Co., Ltd., Civil Action No. 107-CV-01955 (D.D.C. Filed October 31, 2007) the Commission filed a settled FCPA case. The SEC’s complaint alleged that defendant Ingersoll-Rand based on payments made to Iraq under the U.N. Oil for Food Program. Essentially, the complaint alleged that over a three-year period, four subsidiaries of the defendant entered into contracts in which over $950,000 in kickbacks were made. The company settled the action, consenting to a statutory injunction and the payment of disgorgement, pre-judgment interest and a civil penalty along with certain undertakings regarding its FCPA compliance program. The company also paid a fine under a deferred prosecution agreement executed with the Justice Department.
LITIGATION LOSS – PIPE CASE – SEC v. Mangan, Civil Action No 3:06-CV-531 (W.D.N.C. Filed December 28, 2006) is one of a series of cases brought by the SEC in recent months relating to short selling in connection with a PIPE offering. Frequently, these cases involve hedge funds, a key regulatory focus. In this case a registered representative from the investment banking firm of Friedman, Billings, Ramsey & Co. was alleged to have sold shares of CompuDyne Corp. short after learning of a PIPE offering but prior to the public announcement. The complaint alleged violations of Section 5 based on the theory that Mr. Mangan intended to cover the short sale with the PIPE shares and insider trading based on an allegation that he sold short prior to the public announcement of the deal. Previously, Friedman Billings had settled similar allegations based on the same PIPE offering. Mr. Mangan, however, filed a motion to dismiss which was granted in part. Count I of the complaint regarding the PIPE offering was dismissed while the Court expressed significant skepticism about the insider trading claim.
No doubt the SEC has a large inventory of cases in other areas such as option backdating and financial fraud. Yet, week after week there seems to be increasing numbers of insider trading cases and a growing inventory of FCPA cases. This trend, of course, counsels that issuers should carefully review their compliance programs in these areas as well as any executive Rule 10b5-1 plans.
At the same time the ruling in Mangan may suggest that the SEC will have to reconsider its PIPE cases. Until now, the SEC had been aggressively pursuing these cases. The court’s ruling however not only dismissed the Section 5 claim but was critical of the theory on which it was based. This may cause the SEC to reconsider its position on this issue.
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Another FCPA Case: Clearly a Growing Trend
November 01, 2007
Yesterday, the SEC filed another enforcement action based on alleged violations of the Foreign Corrupt Practices Act (“FCPA”). This action was against Ingersoll-Rand Company, Ltd. and related to payments made to Iraq under the U.N. Oil for Food Program. In essence, the complaint alleges that over a three year period, four subsidiaries of the company entered into contracts in which over $950,00 in kickback payments were made. SEC v. Ingersoll-Rand Co., Civil Action No. 107-CV-01955 (D.D.C. Filed October 31, 2007).
The U.N. Oil for Food Program was designed to provide humanitarian relief for the Iraqi people facing severe hardship under international trade sanctions. Under the program, the Iraqi government can purchase humanitarian goods through a U.N. escrow account. According to the SEC’s complaint, the kickback paid by Ingersoll-Rand’s subsidiaries and third parties diverted funds from the account and into an Iraqi slush fund. The U.N., in turn, effectively paid for illicit payments because they were rolled into the price of contracts used in connection with the program, thereby improperly inflating the prices.
Ingersoll-Rand agreed to settle the action, consenting to the entry of a statutory injunction prohibiting future violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. The company also consented to the entry of an order directing it to pay disgorgement of approximately $1.7 million in profits, over $560,000 in pre-judgment interest and a civil penalty of $1,950,000. The company also agreed to comply with certain undertakings regarding its FCPA compliance program and to pay a $2.5 million fine under a deferred prosecution agreement with the Justice Department.
This case is the latest in a series of FCPA actions the SEC and DOJ has brought this year. Reportedly, there are a number of additional similar actions under investigation. Prosecutions in this area are clearly a growing trend and may be at the highest level in years. In view of this increasing trend, it is clear that issuers should carefully review their compliance programs in this area as well as monitor compliance. This is particularly true since the SEC’s release notes that the settlement here was based in part on the remedial actions of the company and its cooperation.
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Court Dismisses Claim Based on Short Sales In Connection With PIPE Offering And Criticizes SEC
October 29, 2007
On Friday, the SEC lost its first Section 5 claim relating to a PIPE offering when the court granted a defense motion to dismiss. In SEC v. Mangan, Civil Action No. 3: 06-CV-531 (W.D.N.C. Filed December 28, 2006), the SEC filed a complaint against former Friedman, Billings, Ramsey & Co., Inc. registered representative John F. Mangan, Jr., alleging the sale of unregistered securities and insider trading. Specifically, the SEC’s complaint alleged that Mr. Mangan sold CompuDyne Corporation shares short at the opening of the market at prices over $15 per share at a time when he knew that company would announce a PIPE offering later that morning. Subsequently, the complaint claimed Mr. Mangan continued to sell CompuDyne shares short. After the Commission approved the resale registration statement and the shares were issued at about $12 per share, Mr. Mangan closed his short position at a significant profit according to the SEC. The complaint alleged that by placing his initial short sale order prior to the opening of the market on the day the PIPE was announced, Mr. Mangan engaged in insider trading and that he violated the registration provisions by later covering his positions with shares from the offering because he effectively sold them prior to the effective date of the registration statement.
After a hearing on a motion to dismiss the court dismissed the Section 5 claim, but allowed the insider trading claim to stand. In dismissing the Section 5 claim the court noted: “And what we have here, it seems to me, is a post hoc ergo propter [sic] argument by the government that because the PIPE in fact was not registered and because the PIPE shares were later in fact used, he in effect sold the PIPE. Well, maybe, but I don’t think he [defendant] did anything illegal. In short, no sale of unregistered securities occurred as a matter of law.”
This same unregistered sale theory has been used repeatedly over the last year by the SEC. For example, at the time the action was brought against Mr. Mangan the SEC brought a similar action against Friedman Billings and its principal. Both defendants in that action settled (see the December 20, 2006 Litigation Release here), as did another hedge fund trader in SEC v. Spiegel (the Commission’s January 4, 2007 Release is here). However, the defendant in SEC v. Berlacher, filed in September (the Litigation release is here) elected to litigate. The ruling in Mr. Mangan’s case may have an impact on this case as well as other which may be under investigation.
Although the Court denied Mr. Mangan’s motion to dismiss the insider trading claim, it expressed some doubt about the claim. In ruling on this claim the court noted that “As to the insider trading, the issue is coalesced around whether the information concerning the PIPE was material. There’s no doubt that as of the time Mr. Mangan directed and called at 7:40 a.m. [on the morning of the announcement], the information was not public. He strenuously argues that the information could not have been material as a matter of law. The basic thrust of his argument is that the announcement of the PIPE was basically a nonevent so far as the price of the stock was concerned, at least for most of the day that the PIPE was announced. And intriguingly, even looking at the information from the SEC, although the stock dropped to $12.41 on the 15th, significantly prior to the closing of the PIPE it also went beck up well above that. So the stock price movement is interesting to say the least. The SEC argues otherwise and points to a sharp drop in price from closing to closing the day before [the announcement] compared to the day of the announcement. I find that pretty misleading. The major part of the price drop occurred from the 8 October closing to the 9 October opening. The price actually increased after the PIPE was announced on that day. … Relying on the standard [of materiality] quoted earlier, it seems clear to this court that the complaint as to the 10b-5 and insider trading states a claim. Concededly, it is a very close call. I found the defense argument rather compelling and persuasive … .”
The court’s ruling on both counts is significant. The Section 5 claim raised by the SEC in the context of a trading market raises clear questions as the court recognized, since the short position could be covered with open market purchases. There are also materiality issues concerning the insider trading claim based on facts presented at the hearing which demonstrated that the market price of the shares was essentially unchanged shortly after the announcement of the PIPE offering.
What is perhaps more important, however, are the comments by the court about the SEC’s case and presentation. Clearly the court had little regard for the basis of the Section 5 claim and the manner in which the case was presented. The court’s comment that the Section 5 claim is little more than hindsight raises significant issues about the claims the SEC is selecting to include in its enforcement actions. More disturbing, however, is the court’s statement that an argument presented by the Commission was misleading. Such conduct has no place in court, let alone in a presentation by a government prosecutor. Unfortunately, this is not the first time a court has made such a comment. We should not simply sit by and hope that it is the last, however. Rather, this case again argues for a careful review and revision of enforcement policies and procedures.
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The Week In Review (October 19-25, 2007): Insider Trading, Insider Trading, Insider Trading
October 26, 2007
There is more than a renewed emphasis on insider trading, if last week is any indicator. Insider trading is dominating the regulatory landscape, again suggesting that issuers and executives carefully review compliance procedures and trading programs and carefully consider the timing of securities transactions not made within the confines of a Rule 10b5-1 plan. Key events from last week support this thought.
DHB INDUSTRIES, INC. – The SEC and DOJ have brought insider trading charges against former top executives of this defense contractor. In SEC v. Brooks, Civil Action No. 07-61526 -CIV-Althonaga/Turnoff (S.D. Fla. Filed October 25, 2007), the Commission filed fraud charges against David H. Brooks, former DHB CEO and COB. The complaint alleges a pervasive accounting fraud between 2003 and 2005 and insider trading by Mr. Brooks. At the same time the SEC filed its complaint, the U.S. Attorney’s Office for the Eastern District of New York announced that it was filing criminal insider trading and securities fraud charges against Mr. Brooks, who was arrested in Florida on October 25. Previously, criminal securities charges had been brought against former DHB CFO Dawn Schlegel and former COO Sandra Hatfield. U.S. v. Hatfield, 06-CR-550 (E.D.N.Y.). A superseding indictment will be filed in that case including Mr. Brooks. The Commission’s Litigation release, which also summarizing the criminal action, can be viewed here.
SEC TEMPLATE – The SEC Office of Compliance and Exanimations announced that it is testing out a new template for its inspections which includes an insider trading component. Frequently, when the SEC conducts examinations, firms do not perform testing for potential insider trading problems. This new template will require the firms to focus on and assist the SEC staff in reviewing the issue.
This action follows a staff request in an August letter to hedge funds seeking selected information about persons who have access to inside information. The apparent purpose of this information request, which is raising privacy concerns among many, is to create some type of inside trader profile.
RULE 10b5-1 PLANS – The SEC enforcement staff has commented previously on the fact that it is reviewing Rule 10b5-1 plans to determine whether executives are using the plans in a manner which gives them some type of trading advantage in the markets – something that was not intended when the safe harbor was created. These comments come in the wake of an academic study suggesting that executives using the plans are achieving above market returns. That conclusion at least raises a question as to whether the plans are being properly used. No cases have been brought to date, although there have been media reports of SEC inquiries focused at least in part on the question such as those regarding the Countrywide investigation.
The word from the SEC staff, however, is “watch for something shortly” on this issue. This is the substance of a comment made by a senior enforcement staff official at the ABA National Institute on Securities Fraud which is concluding today in Washington, D.C.
FOREIGN MARKETS – The increasingly intensifying focus on insider trading is not just the U.S. Congress, SEC and DOJ. Rather, for months there have been reports of rampant insider trading around the globe. Last week was no exception. There were reports of insider trading investigations or actions not just in the U.S., but also Singapore, Belgium, France, South Africa and Canada. This continuous stream of reports is no doubt the cause of the increasing global and national efforts of the SEC and DOJ to detect and prosecute insider trading. In the weeks to come, expect to see this trend continue. Again, prudent issuers and executives should consider the clear warning.
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Time For a New Wells Commission
October 25, 2007
SEC Commissioner Paul Atkins recently called for the formation of a “new ‘Wells-like’ advisory committee to review the policies and procedures of our enforcement program. The Commission and the staff should welcome, not fear, such a review.” Remarks at the Eighth Annual A.A. Sommer, Jr. Corporate, Securities and Financial Law Lecture, October 9, 2007 (the full text of Commissioner Atkins’ comments can be viewed here).
The purpose of this Committee would be much the same as the original Wells Committee formed in 1972. According to then-Chairman Casey, that Committee was formed because it is “essential for the Commission to redouble its efforts to keep in touch with the best thinking on investor protection at the private bar, in the accounting profession, and in the financial community generally.”
Chairman Casey’s comments are as true today as they were when he made them thirty-five years ago – perhaps even more so. Today, the Division of Enforcement faces continued, difficult challenges. While the staff of that division has and continues to serve with distinction, working tirelessly to carry out its mission, a breath of fresh air and an induction of new ideas would serve to continue propelling it forward and continue its critical mission. This is particularly true now in the wake of various reports calling for reform and more. The recent GAO and Senate reports, for example, both point to a need for reform and improvement.
The recommendations of those reports are fortified by a review of cases brought by the Division. Despite many significant successes, some recent cases brought by the Division are years old – to the point of being stale. In other instances, courtroom losses such as the one in SEC v. PacketPort.com, Inc., Civil Action No. 3:05cv1747 (D. Conn. Filed November 16, 2005), discussed here last week, serve point to the obvious need for a new look and fresh ideas.
The mandate of this new Committee should be forward looking and not respective. Its charge should be to seek out the best ideas to assist the Division and the Commission as it moves forward to meet the increasing challenges of tomorrow, not to be critical of the past. In view of the critical and daunting mission of the Enforcement Division and its role in safeguarding the nation’s capital markets, we should demand no less. Hopefully, Commissioner Atkins’ call for new advisory committee on enforcement procedures will be quickly heeded.
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THE RENEWED CAMPAIGN ON INSIDER TRADING: Part I
October 23, 2007
This is the first part of an occasional series on the renewed emphasis on insider trading by the Securities and Exchange Commission and the Department of Justice.
While insider training has always been a staple of the enforcement program, the recent emphasis on detecting and prosecuting it today rivals the efforts of the 1980s. Then, the SEC and DOJ brought cases which captured the headlines in a manner similar to those grabbed by the recent corporate scandals such as Enron, Worldcom and others.
The renewed emphasis may stem in part from reports around the globe of rampant insider trading. Markets in the UK, China, Japan, South Korea, Australia and Canada for example, have all reported significant increases in insider trading. Last fall, Congress held hearings on insider trading. In a recent report inquiring into a whistle-blower claim from a former SEC staff member, a Senate committee directed that the agency focus more resources on insider trading.
All of this increased activity has spurred regulators to band together in an effort to eradicate the perceived increasing tide of illegal trading. The SEC is part of those world-wide efforts. At the same time, the agency has joined with domestic regulators as part of its efforts.
The SEC has new initiatives focused on detecting insider trading. For example, in September 2006, the Commission launched an unprecedented sweep of Wall Street focused on the trading activities of major Wall Street brokers and banks and hedge funds. Enforcement Chief Linda Thomsen has repeatedly cautioned executives trading through Rule 10b5-1 plans that their safe harbor may no longer be safe. This past August, the SEC circulated a letter to hedge funds requesting what many view as an unprecedented amount of information about employees and clients in a position to acquire inside information in an apparent effort to profile prospective violators.
Despite intensified efforts, detection remains difficult and proof may be daunting. Frequently, the evidence is circumstantial, implied from what may be viewed as “suspicious trading” because of its timing or size. At the same time, that suspicious trading is not proof of illegal activity and may be the result of shrewd market observation and analysis which actually contributes to market efficiency.
To examine the renewed emphasis on insider trading we will examine recent SEC and DOJ cases in seven areas:
1. Major Wall Street players;
2. Trading prior to corporate announcements;
3. Pillow talk cases;
4. Spouse v. spouse;
5. Family and friends;
6. Corporate executives; and
7. Attorneys.
After examining these areas, we will assess the new insider trading programs.
Next: Major Wall Street Players: A return to the “Den of Thieves?”
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The Week In Review (October 12-18, 2007): A Typical Week Ends With Lingering Questions About SEC Charging Policies
October 19, 2007
The week looked like many others. A settlement in a large options backdating class action suit; the filing of a settled financial fraud case by the SEC with a significant penalty despite cooperation; another case against a hedge fund; and a settled insider trading case. The end of the week was hardly typical however: a dropped two year old fraud action in favor of a settled Section 5 C&D which again raised significant questions about SEC charging policies.
First, the typical. Last Friday, Hewlett-Packard agreed to settle a two year old shareholder suit related to stock options backdating at Mercury Interactive, a business software company H.P. acquired. While the company confirmed the agreement it did not acknowledge press reports (here, registration required) that suit settled for $117.5 million.
The SEC announced the settlement of a financial fraud suit against Nortel Networks Corporation. According to the SEC’s complaint, in late 2000 and early 2001, the company altered its revenue recognition policies that did not conform to GAAP to accelerate revenue into 2000 to meet revenue targets. In addition, the company improperly established and maintained excessive reserves in 2002, according to the complaint. The company settled the case by consenting to a statutory injunction and an order requiring it to pay a civil penalty of $35 million. This settlement reflects what the SEC called “substantial remedial efforts and cooperation,” a comment which leads one to wonder about the value of cooperation. SEC v. Nortel Networks Corporation, Civil Action No. 07-CV-8851 (S.D.N.Y. October 15, 2007). The Commission’s Litigation Release is here.
In SEC v. Colonial Investment Management LLC, Civil Action No. 07-Civ. 8849 (S.D.N.Y. Filed October 15, 2007), the Commission brought another in a series of actions against hedge funds. Here, the SEC alleged that a hedge fund, its adviser and its managing director engaged in illegal trading in connection with eighteen public offerings. According to the complaint, defendants violated Rule 105 which prohibits short sales made five days before an offering from being covered with shares from the offering. The complaint alleges that defendants profited because the shares in the offerings sold at prices lower than those from the short sales. This case is in litigation. The Commission has brought several similar cases earlier this year against hedge funds, typically based on PIPE offerings (discussed previously here). The Commission’s Litigation Release in Colonial Investment is here.
The Commission also continued its campaign against insider trading, filing another settled case. SEC v. Lenzner, Civil Action No. 07-cv-01404 (W.D.P.A. Filed October 17, 2007). In this settled action the SEC alleged that NSD Bancorp director Charles Lenzner tipped Michael Pitterich about a merger between NSD and F.N.B. Corporation according to the complaint. Mr. Pitterich traded while in possession of material non-public information about the transaction prior to the announcement. Both defendants consented to the entry of statutory injunctions. Mr. Pitterich also agreed to the entry of an order requiring him to pay disgorgement, prejudgment interest and a penalty equal to the trading profits. Mr. Lenzner consented to the entry of an order requiring him to pay a penalty equal to the trading profits. The Lenzer case is discussed here.
Now, the not so typical. The week ended with the case which apparently should not have been brought – at least not as originally filed. The saga of PacketPort.com, Inc. began over two years ago with the filing of a fraud complaint by the SEC charging six individuals and four companies. Specifically, the complaint alleged a fraudulent pump and dump scheme claimed to have involved manipulative trading, false publicity, misrepresentations and a cover up. The statutory violations were alleged to include Section 10(b) (fraud), Section 17(a) (fraud), Section 5 (registration), Section 17(b) (touting) and a failure to file Schedule 13D, a failure to report beneficial ownership per Section 16(a), filing misleading issuer’s reports in violation of Section 13(a), failure to make and keep accurate books and record in violation of 13(b)(2)(A) and various aiding and abetting claims. SEC v. PacketPort.com, Inc., Civil Action No. 3:05cv1747 (D. Conn. Filed November 16, 2005). The original Litigation Release in that matter from 2005 is here.
After two years in litigation (and since the events at issue occurred in late 1999 and early 2000, a presumably lengthy pre-filing investigation), the SEC dismissed the civil action with prejudice. At the same time, a settled administrative proceeding was filed against PacketPort.com. Inc. and all but three of the original defendants against whom all claims were dropped. The remaining defendants agreed to settle the administrative proceeding by consenting to the entry of a C&D based on Section 5 violations and entry of orders requiring disgorgement. The Commission’s Litigation Release regarding the settlement is here.
In the settlement, not only did the SEC drop the civil injunctive action but, in addition, virtually all of its key claims. Gone were the claims of pump and dump. Gone were the fraud charges. Gone were the claims of touting. Gone were the false books claims. Gone were the allegations of failure to file required schedules and reports. Gone were all the key elements of the SEC’s original case.
Left, however, were lingering questions such as how with all of its vast investigative powers did the SEC get the facts so wrong? How with its vast expertise, did the SEC so grossly overcharge the claimed violations of law? Why did it take two years of litigation after the investigation for the SEC to finally figure out the actual facts and correct charges? And, perhaps more importantly, how many other times does this happen where the company or individuals simply capitulate to charges which are inappropriate or perhaps worse because of the burden and expense of fighting with the SEC or perhaps even worse, the DOJ?
The sad saga of PacketPort.com is not, unfortunately, the first instance of getting the charges wrong. It also will not be the last, unless the SEC carefully reviews and reforms its charging processes. In view of the impact of its allegations and the potential for wrongful charges and settlements, the SEC cannot start this reform process to soon.
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Return to The Den of Thieves?
October 17, 2007
The SEC and DOJ have been waging a renewed and reinvigorated battle on insider trading, bringing more high profile cases this year than perhaps since the late 1980s. Indeed, many have described the Guttenberg litigation (discussed here) as perhaps the most important since the days of the 1980s. Then, a group of Wall Street traders whose exploits are chronicled in James Stewart’s book, Den of Thieves became the targets of a well publicized-string of enforcement actions which landed many in jail.
The campaign being waged today appears no different than the one from the 1980s, focusing on a number of Wall Street professionals. Consider for example the following cases:
SEC v. Guttenberg, Case No. 1:07-cv-01774 (S.D.N.Y. Filed March 1, 2007), and the related criminal cases which involve UBS representatives, a Morgan Stanley attorney, a Lyford Cay hedge fund manager, and other Wall Street professionals;
SEC v, Barclays Bank, Civil Action No. 07-cv-04427 (S.D.N.Y. Filed May 30, 2007), brought against a major bank and one of its senior officers; and
SEC v. Joseph A. Frohua, Civil Action No. 07-C-0702 (E.D. Wis. Filed August 1, 2007), filed against a fund manager.
The common theme to these cases is insider trading allegations against Wall Street professionals – just like Den of Thieves. Some say these cases stem from the fact that the current generation of Wall Street traders is too young to remember the prior wave of prosecutions on Wall Street.
An interesting theory. But then consider the most recent case – SEC v. Gregg Ashley Smith, Civil Action No. 07-CV08394 (Filed September 27, 2007) which was brought against two securities professionals (previously discussed here). Defendant Ashley Smith, age 37, perhaps does not recall the prior round of cases. Codefendant and father of the first defendant, Elliot Joel Smith, at age 75 surely, however must remember those celebrated cases. If so, then what accounts for this apparent return to Mr. Stewart’s Den of Thieves? Perhaps it is simpler than lack of memory. Perhaps Gordon Gekko in the movie Wall Street got it right.
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The New Insider Trading Cases and Warnings to the Market: Effective Enforcement?
October 15, 2007
The SEC is clearly telling the markets that it will come down hard on insider trading. After years of huge financial fraud cases, where the subject of insider trading seemed to fade in the background, this last year has seen the filing of more insider trading cases than in any recent year. Some may argue that this trend is consistent with the fact that the SEC’s Enforcement Division filed more cases last year than in the prior year for the first time in several years.
Statistics about the number of enforcement cases filed, however, are not very meaningful, standing alone. Consider, for example, that last year SEC enforcement brought a number of delinquent filing cases in which it sought to have penny stock companies delisted. Now, this is not to say those cases are not significant, but they are hardly the stuff of huge financial fraud cases or insider trading cases or many of the other enforcement actions brought by the agency. The point is that to understand the significance of the number of cases filed, one has to look beyond the numbers and analyze the type and quality of cases that the division filed.
As to the insider trading cases, there should be little doubt that this is a current enforcement priority. In many instances, the SEC has been very aggressive in filing actions, bringing them within days of a significant event. For example, in the case the TXU options case, the complaint was filed within days of the public announcement of a KKR lead takeover of TXU. See SEC v. One or More Unknown Option Purchasers, Civil Action No. 1:07-cv-01208 (N.D. Ill. March 2, 2007) (public announcement February 26, 2007). Likewise, the case based on trading in advance of the News Corp. – Dow Jones announcement was filed within seven days of the takeover announcement. SEC v. Kan King Wong, Civil Action No. 07 Civ. 3628 (S.D.N.Y. Filed May 8, 2007).
The Enforcement Division deserves credit for the swift aggressive manner in which it has brought these and other large insider trading cases this year. This is particularly true in view of the fact that in many instances the Division has moved far to slowly and brought stale cases, which are clearly not effective enforcement.
The question with many of the new and high profile insider trading cases, however, is whether the SEC can prove them and prevail. The swiftly-filed cases were brought in large part without the benefit of an extensive investigation. In many instances, the cases appear to be based on little more than the basic trading data and information which the agency probably obtained from the brokers. While suspicious trading may suggest insider trading, as we have repeatedly noted (here), standing alone, such trading is not sufficient to prove insider trading. It does, however, counsel corporate insiders that they should take care to review their compliance programs to avoid perhaps getting caught up in what may be viewed as suspicious trading.
For the SEC, the key to their current campaign on insider trading will be to prevail on the swiftly-brought blockbuster cases they filed this year. Winning these cases will send a clear and effective enforcement message. Since many of these cases are in discovery, it will be some time before it can be determined whether this new round of cases is effective enforcement.
So too, with the repeated warnings of Enforcement Chief Linda Thomsen regarding Rule 10b5-1 plans. Last week, Ms. Thomsen reportedly again cautioned executives that the staff is reviewing reported abuses regarding these plans. No doubt these comments suggest that prudent corporate executives carefully review their trading plans.
Ms. Thomsen’s comments prompt other more significant questions about effective enforcement, however This is not the first time that Ms. Thomsen has cautioned executives about the safe harbor plans. Earlier this year, the Enforcement Chief warned executives that the staff was reviewing these plans following the publication of an academic study suggesting that executives might be abusing them. To date, there are no enforcement actions from the staff reviews.
Effective SEC enforcement promotes investor confidence and deep, liquid markets. Ineffective enforcement can be worse than no enforcement. Bringing cases quickly is fine and can be effective. Increasing numbers of enforcement cases is fine and may caution the markets. Warning the markets of perceived abuses is fine and can be caution the markets. The key, however, is the results. The SEC will have to prevail in these insider trading cases. The review of trading plans will have to produce results. We will have to wait to see the results from these efforts and whether they constitute effective enforcement.
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