IT IS TIME FOR THE SEC TO FOLLOW ITS OWN ADVICE
www.secactions.com/June 13, 2011 Sometimes the hardest thing is to follow your own advice. Its also easier to give advice that to follow it. Could this be the dilemma of the SEC?
The Commission is a disclosure agency which tells issuers to furnish investors all of the material facts. During its investigations the SEC encourages cooperation, urging companies and witnesses to furnish all of the facts. The Commission holds it against those who do not follow this advice. If a witness invokes his or her constitutional right not to testify, the Commission draws an adverse inference. If a witness invokes privilege and withholds what the agency deems to be facts it wants, it may hold it against the witness or company. If the witness wants to withhold proprietary information even for legitimate business reasons, the SEC will demand that it be produced despite the fact that it has no real way to protect the information as Form 1662 well illustrates. If the witness does not turn over all of the facts the agency demands, the SEC will conclude that something is being covered up, hidden and worse.
When the tables are turned however the Commission seems to think a different set of rules apply. When Congress asks for information from the SEC, the agency seems to have no problem refusing to furnish the request. So it was last week when the Commission forwarded its response to Senator Grassley refusing to furnish the requested information.
Last month the Senator asked the SEC to furnish information regarding how it handled multiple referrals over the last decade from FINRA about suspicious trading by SAC Capital (here). Since several former SAC traders have been implicated in the on-going expert network insider trading inquiry and pleaded guilty there is a clear basis for congress to wonder what happened to those referrals.
The SEC refused. In a letter sent to the Senator dated June 9, 2011 the Commission explained that it does not discuss on-going law enforcement investigations. The letter then furnishes pages of detail about matters not covered by the information request. Understandably the Senator found the letter unresponsive. The Senator’s press release along with the SEC’s letter is available here.
There can be no doubt that the SEC’s letter is unresponsive. While its letter correctly notes that Commission law enforcement investigations are non-public, this is beside the point. The agency could have made some effort to provide some responsive information. For example, the Commission could have detailed how the requests were processed and given some assurance that there was appropriate follow up. The SEC could have offered to brief the Senator and his staff privately about any on-going investigative efforts. On the other hand if the SEC failed to conduct appropriate follow up it should have admitted the error.
The question now is, should the Commission’s own rules apply to it? Should the Senator and the public label the agency uncooperative and draw an adverse inference? Is it appropriate to assume that the SEC is just covering up a series of failures?
Even setting aside the notion of applying the SEC’s rules to it, there is good reason to assume that this is a cover up. It was not that long ago that every SEC staff division director stood before Congress and refused to give testimony about the Commission’s investigative efforts regarding Ponzi scheme king Bernard Madoff. In effect the agency invoked the Fifth Amendment (here). Now it is clear those refusals were made to cover up a series of failures. The SEC’s refusal here can be seen as nothing less.
The SEC claims it is working hard to restore its credibility. It claims it is working hard to be the investor’s advocate and the top cop of Wall Street and Main Street. More rules and lots of investigation statistics are not going to restore its credibility. If the SEC wants to bring a new ethics to the market place it starts with the Commission ending the double standard. A new ethics starts at the top with the Commission rebuilding its credibility. It starts with the SEC walking the walk. It starts with answering the questions truthfully and fully.
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THIS WEEK IN SECURITIES LITIGATION (June 10, 2011)
June 10, 2011 The Supreme Court handed its second ruling this Term which favors plaintiffs in securities class actions. What may well be the most important securities decision by the Court this term has yet to be decided.
SEC enforcement brought additional insider trading cases this week. The Commission also settled an insider trading case brought last December against unknown purchasers, filed an investment fund fraud action and a case halting an effort to take over a beer company.
Another defendant pleaded guilty in the expert network investigations. Likewise another former Madoff employee pleaded guilty and began cooperating with prosecutors. The SEC partially settled a parallel action with the employee.
Finally, the Second Circuit reversed a partial grant of summary judgment which had been granted in favor of the SEC, concluding that the district court had improperly imposed a penalty. The court held that the SEC could not obtain a penalty under Section 21(d)(3) based on guilty pleas to insider trading.
Supreme Court
In Erica P. Hon Fund, Inc. v. Halliburton Co., No. 09-1403 (Decided June 6, 2011) the Court, in a unanimous ruling, reversed a decision by the Fifth Circuit Court of Appeals which held that plaintiffs at the class certification stage had the burden of proving loss causation. The lower courts agreed that all the Rule 23 requirements had been met and the only unresolved question was loss causation. The Supreme Court thus focused only on Rule 23(b)(3) which requires that common questions of law or fact predominate over individual question for the class to be certified. The key issue here is reliance, an essential element of a Section 10(b) cause of action. Citing Basic Inc. v. Levinsion, 485 U.S. 224, 243 (1988), the Court went on to note that reliance assures there is a proper connection between the defendant’s misrepresentation and a plaintiff’s injury.
Basic permits the plaintiff to invoke a rebuttable presumption of reliance called the “fraud-on-the-market theory.” Under this theory the price of a security traded on an efficient market is presumed to reflect all of the publically available information, including any material misrepresentation. Investors who purchase securities in such a market are presumed to rely on its integrity.
The Court of Appeals confused loss causation and reliance. The Circuit Court held that to invoke the Basic presumption plaintiff is required to prove at the class certification stage that the decline in the price of the shares resulted because of a correction to the prior misleading statement and that the subsequent loss could not be explained by other factors revealed in the market at the time. This is loss causation as required by Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (3005) the High Court noted. Dura loss causation is distinct from Basic and the question of reliance. Reliance typically focuses on the facts regarding an investor’s decision to engage in a transaction. Loss causation requires the plaintiff to show that the misrepresentation affected the integrity of the price and caused the subsequent economic loss. Accordingly, loss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory.
The Commission
Hedge fund: Commissioner Tory A. Paredes delivered Remarks at the Symposium on “Hedge Fund Regulation and Current Developments” on June 8, 2011. In his remarks the Commissioner reviewed provisions in Dodd-Frank regarding hedge funds (here).
Investor warning: The Commission issued a Bulletin on Risks of Investing in Reverse Merger Companies (here).
SEC investigations: The Director of the Division of Enforcement, Robert Khuzami, spoke at a meeting of the Criminal Law Group of the UJA-Federation of New York (June 1, 2011). In his remarks Mr. Khuzami discussed the impact of abusive tactics employed by some defense counsel during SEC investigations (here).
SEC enforcement
False statements: SEC v. Copper King Mining Corp., Civil No. 2:11-cv-00526 (D. Utah, Filed June 9, 2011) is an action against the company, Alexander Lindale, LLC, Mark Dotson, Wilford Blum and Stephen Bennett. The company, along with its former President and CEO, defendant Dotson, posted false information about its mining capabilities, contracts and its prospects, according to the complaint. In addition, Alexander Lindale LLC and stock promoter Blum, with the knowledge of Mr. Dotson, issued false press releases about the company and sold unregistered shares. About $12,280,419 was raise from 2008 through 2010. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 159a). The case is in litigation.
Insider trading: SEC. OneleTrading & Finance Ltd., 10 Civ. 9159 (S.D.N.Y. Filed Dec. 8, 2010) is an insider trading case initially brought against unknown traders. The action centered on trading in advance of the December 2, 2010 announcement that PepsiCo, Inc. would acquire a 66% interest in Wimm-Bill-Dann Foods OJSC. The initial complaint alleged that unknown purchasers placed orders to buy 107,500 ADRs on November 29, 2010, another 132,000 on November 30 and an additional 160,000 on December 1. Following the deal announcement the traders had profits of about $2.7 million. This week the Commission amended its complaint and named Onele as a defendant. That firm traded through an account maintained at SG Private Banking (Suisse) SA in Geneva, Switzerland and placed orders for 400,000 of the ADRs in the three day time period. The company resolved the case by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). The company also agreed to pay disgorgement in the amount of $2,864,638 and a civil penalty in the same amount. The sums will be paid from the assets frozen at the time the Commission filed its initial action.
Fraudulent offering: In the Matter of MMR Investment Bankers, LLC, Adm. Proc. File No. 3-14163 (June 8, 2011) is a proceeding against the firm, a registered broker dealer, and William Martin, its president, Eugene Rankin, its vice president, John Hubert, a registered representative and Aaron Fimreite, also a registered representative. The Order alleges that from 2005 through 2008 Respondents offered and sold eleven best efforts, no minimum private placement debenture offerings for eight small start up companies that are all now in default. The interests were sold without disclosing that Messrs. Martin and Rankin had created Sunflower Management Group, LLC to manage the proceeds for which they obtained fees. They also did not disclose that Messrs. Rankin, Hubert and Fimreite had received shares in some of the offering companies under the Sunflower Management agreements. Debentures were also sold to customers that were not suitable. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c). The proceeding was resolved as to Respondent Fimreite who consented to the entry of a cease and desist order based on Exchange Act Sections 10(b) and 15(c) and Securities Act Section 17(a). Mr. Fimreite will also be barred from the securities business and from participating in any penny stock offerings. In addition he agreed to pay disgorgement of $2,644.78. The proceeding is continuing as to the other Respondents.
Unregistered offering: In the Matter of Michael Migliozzi II, Adm. Proc. File No 3-14415 (June 8, 2011) is a proceeding which names as Respondents Michael Migliozzi II, the managing partner of an advertising agency, and Brian William Flatow, the President of another advertising agency. The Respondents created the BuyaBeerCompany.com website and solicited pledges to acquire the Pabst Brewing Company. Since 2009 they have secured over $200 million in pledges. Investors were not asked to put up money at this time. After securing the pledges Respondents sought out an attorney to conduct an IPO and planned to secure a vehicle to make the acquisition. Investors were also solicited on Twitter and Facebook. The Order alleges violations of Securities Act Section 5. Respondents resolved the matter by consenting to the entry of an order directing that they cease and desist from violations of Section 5.
Improper professional conduct: In the Matter of Livingston & Haynes, P.C., Adm. Proc. File No. 3-14410 (June 6, 2011) is a proceeding based on alleged violations of Exchange Act Section 10A and Rule 102(e). The Respondents are the named audit firm which is registered with the PCAOB, Kevin Howley, the engagement partner on the LocatePlus’ audits and William Wood, the concurring partner on the engagement. The allegations center on the audits for 2005 and 2006 of LocatePlus’ which is a defendant along with its CEO and CFO in a Commission enforcement action which claims the defendants fabricated revenue for the company from a fictitious customer. Criminal charges have also been filed. The Order alleges that the Respondents failed to include any procedures to provide reasonable assurance of detecting illegal acts that would have a material effect on the financial statements. During the engagements Respondents became aware of multiple allegations of illegal acts at the company and red flags but failed to conduct the proper procedures and exercise due professional case. To resolve the action Respondents offered to undertake a series of procedures and agreed not to accept any new public company clients for one year after the date of the order or the implementation of the specified procedures. Each Respondent also consented to the entry of a cease and desist order from committing future violations of Section 10A. The firm was censured pursuant to Rule 102(e). It will also pay a money penalty of $130,000. Respondents Howley and Wood are denied the privilege of appearing and practicing before the Commission with a right to reapply after three years.
Insider trading; SEC v. One or More Unknown Purchasers of Securities of Telvent GIT S.A., Civil Action 11 Civ. 3794 9S.D.N.Y. Filed June 3, 2011) is an action which centers on the June 1, 2011 announcement that Schneider Electric S.A., a French company, would acquire Telvent, a company based in Madrid, Spain. Between April 29, 2011 and May 27, 2011 unknown purchasers bought 1,200 Telvent call options through an account at Pershing LLC. About two thirds of the options were purchased within two trading days of the announcement, representing in one instance about 52% of the daily volume for a series. Following the purchases the price of the call options increased significantly. In one instance it was up 480%. After the deal announcement the account had trading profits of about $475,000. The Commission filed its action two days later, obtaining an order freezing the assets and directing the account holders to identify themselves. Expedited discovery was also ordered.
Insider trading: SEC v. Goetz, Case No. 11 CV 1220 (S.D. Cal. June 3, 2011) is an insider trading case against Dean Goetz, an attorney who practices in Solana Beach, California. His practice focuses on personal injury litigation. His daughter is a corporate associate in the Los Angeles office of an international law firm. The case centers on the acquisition of Advanced Medical Optics, Inc. by Abbott Laboratories. The deal was announced on January 12, 2009. From mid-December 2008 through the end of the year the daughter stayed at her parent’s home. During that time she could not participate in the family holiday activities because of her work on the deal for firm client, Advanced Medical. She cut her visit short, telling her parents that she thought the deal she was working on would close soon. On January 8, 2009 Mr. Goetz purchased 500 shares of Advanced Medical through his on-line brokerage account while in possession of inside information he misappropriated from his daughter, according to the complaint. Following the deal announcement the share price increased about 143%. He liquidated his account on February 19, 2009 at a profit of $11, 418. Mr. Goetz settled the action, consenting to the entry of a permanent injunction prohibiting violations of Exchange Act Sections 10(b) and 14(e). He also agreed to disgorge his trading profits along with prejudgment interest and pay a penalty equal to the trading profits.
Investment fund fraud: SEC v. Abernathy, Case No. 1:11-cv-00580 (W.D. MI. Filed June 3, 2011). Beginning in late 2008 Defendants Ronald Abernathy, Arthur Weiss and their controlled entity, Sovereign International Group, LLC raised over $560,000 from investors who were sold unregistered securities. Defendants, who have a history of securities fraud, told investors that their money would be used to purchase investment grade securities that would later be sold at a profit. The promissory notes had a term of one year and a $500 one time set-up fee. Investors were promised an annual return of 15% or 60% of the net profits. The representations were false as the defendants essentially admitted, according to the complaint. During the staff’s investigation defendants produced spread sheets detailing the use of investor proceeds. Since December 2008 defendants had spent most of the investor money on themselves and the operations of their company. The complaint alleges violations of Securities Act Sections 17(a) and Exchange Act Section 10(b). The case is in litigation.
Sale unregistered securities: SEC v. Association For Betterment Through Education and Love, Inc., Civil Action No. 11-cv-3181 (D.N.J. Filed June 3, 2011) is an action against the company and its principal, Anthony DeGregorio, Sr. The defendants have raised about $1.3 million since 1989 through the sale of unregistered securities which purport to be CDs that pay an above market rate of return. The purpose of the company was to invest in securities, pay investors a guaranteed return and donate a portion to charity. At times the proceeds from a new offering of securities were used to pay promised interest payments to earlier investors. The complaint alleges violations of Securities Act Section 5. The case is in litigation.
Criminal cases
Expert network insider trading: U.S. v. Chu, 1:11-cr-00032 (S.D.N.Y.) is one of the actions stemming from the expert network insider trading investigation. Defendant Don Ching Trang was an employee of Primary Global. He served as a liaison between the firm and its clients, acting essentially as a conduit for inside information. He pleaded guilty to one count of conspiracy to commit securities fraud and one count of conspiracy to commit wire fraud. Sentencing is scheduled for September 7, 2011.
Madoff Ponzi scheme: U.S. v. Lipkin, 10-cr-278 (S.D.N.Y.) is an action against Madoff lieutenant Eric Lipkin who pleaded guilty to a six count superseding indictment charging him with conspiracy, falsifying books and records of a broker-dealer, falsifying books and records of an investment advisor, bank fraud and making false statements to facilitate a theft concerning ERISA. Mr. Lipkin has agreed to cooperate with the government. Mr. Lipkin, who worked for Bernard Madoff Securities from the mid-1980s to its collapse, falsified the books and records of the firm, creating fraudulent account statements and account values for the advisory clients. In connection with reviews by the SEC and an accounting firm he, along with others, created false books and records regarding the business. He also was responsible for managing the payroll and was aware that employment records listed people who did not in fact work at the firm. The SEC filed a parallel action. SEC v. Lipkin, Civil Action No. 11 CV 03826 (S.D.N.Y.). That action is partially settled. Defendant consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and from aiding and abetting violations of Sections 204, 206(1) and 206(2) of the Advisers Act. He also agreed to pay disgorgement and a fine in an amount to be determined at a later time by the court.
Circuit courts
Penalties: SEC v. Rosenthal, Docket Nos. 10-1204-cv; 10-1253 (con) (2nd Cir. Decided June 9, 2011) is an appeal by Defendants Amir and Ayal Rosenthal from an order granting partial summary judgment in favor of the SEC and ordering disgorgement and imposing a civil penalty. The motion for summary judgment was based on the guilty pleas of Amir, Ayal and Heyman Rosenthal to insider trading. They had traded on inside information based on two tips. The deals did not go through however and they did not make any profits or avoid any losses. Appellants argued that the court incorrectly imposed a penalty. The Second Circuit agreed and reversed that part of the order.
The SEC brought the action under Exchange Act Section 21(d)(3) which provides in part that “Whenever it shall appear to the Commission that any person has violated any provision of this chapter . . . other than by committing a violation subject to a penalty pursuant to section 78u-1 [Section 21A] of this title, the Commission may bring an action . . and the court shall have jurisdiction to impose . . a civil penalty . . .” The italicized passage was added by the Insider Trading and Securities Fraud enforcement Act of 1988. Section 21A authorizes the SEC to seek an order for a civil penalty for insider trading. The amount of that penalty depends on the profits made or the loss avoided and the surrounding facts and circumstances. Here since no penalty can be imposed under Section 21A because there were no trading profits or losses avoided. The SEC argued that in view of that fact it could obtain a penalty under Section 21(d)(3). The Court concluded that the italicized passage is ambiguous but after reviewing the legislative history rejected the SEC contention. Rather since defendants were “subject to” a penalty under Section 21A, Section 21(d)(3) does not apply.
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CREDIBILITY AND DEFENDING SEC INVESTIGATIONS
June 09, 2011 Defending a company or an individual in an SEC investigation is, like representing a client in court, more often than not about credibility. The approach and tactics must be credible. Counsel and the client must be credible. Good, well prepared and forceful advocacy should fortify credibility and ultimately the position of the client. Unscrupulous and improper tactics do not. Credibility can help win a point or a case. When credibility is compromised the case is lost whether it is in court or in an SEC investigation.
SEC Enforcement Director Robert Khuzami recently made this point in Remarks to Criminal Law Group of the UJA-Federation of New York (June 1, 2011)(here). This should be an obvious point to any experienced practitioner. Yet the Director’s remarks are replete with examples of tactics which are in inappropriate and compromise credibility.
Good advocacy facilitates the investigative process Mr. Khuzami noted. Inappropriate tactics do not. These include:
» Multiple representations: This can present difficulties where there is a significant potential for conflicts or actual conflicts exist. When representing those who may be culpable, the Commission’s recently adopted cooperation procedures can enhance the difficulties here.
» Lack of recollection: Witnesses who repeatedly claim a lack of recollection to even basic facts, repeatedly refuse to permit their recollection to be refreshed with documents or who have detailed memories of all matters except those where there may be culpability raise questions about their credibility and the manner in which they were prepared for testimony by counsel.
» Signaling: Repeatedly signaling or coaching the witness during testimony is inappropriate. This includes repeatedly having a witness recant or qualify testimony after a break.
» Problems with documents: Producing documents on the eve of testimony and withholding large groups of material under the guise of a privilege review and then producing that material toward the end of an investigation after key witnesses have testified can only serve to unnecessarily delay the investigation.
» Internal investigations: Improper investigative techniques such as interviewing multiple witnesses at once, aggressively promoting exculpatory evidence while ignoring obvious red flags, throwing lower level employees under the bus to protect senior executives and not acknowledging limitations on the scope of the inquiry compromises the investigation.
The staff has a number of tools to deal with these issues according to the Director. They range from pointing out the conflicts to referring possible obstruction and perjury to the Department of Justice.
Nobody can argue that representing clients where there are clear conflicts, playing games with a document production or ignoring red flags while conducting an internal investigation is inappropriate and compromises the client and counsel. Mr. Khuzami’s conclusion seems equally apparent: “Counsel serves as a kind of prism through which the staff invariably assesses certain evidence developed in the investigation, including that based on representations of counsel.” When the tactic used to defend the investigation are more than questionable and become inappropriate – and that does not mean hard fought advocacy – it can compromise credibility. At that point counsel has failed the client who is the ultimate loser.
