Federal Securities Law Blog

SEC v. Koss Corporation: The Commission Responds to Judge Randa's Questions Regarding the Whether the Proposed Settlement is Fair, Reasonable and Adequate

William McGrath — Wed, 25 Jan 2012 14:03:09 -0500

On Tuesday, January 24, 2012, the SEC filed a Memorandum which defended the proposed settlement with Koss Corporation ("Koss") and its CEO. The Commission's Memorandum was filed after a Wisconsin federal judge, Rudolph Randa, issued a letter order on December 20, 2011, directing the Commission to "provide a written factual predicate for why it believes the Court should find that the proposed final judgments are fair, reasonable, adequate, and in the public interest," citing Judge Rakoff's November 28, 2011 order in SEC v. Citigroup Global Markets, Inc. (discussed here). The issues in the Koss Corporation litigation do not include the "neither-admit-nor-deny" policy at the hear of Citigroup Global Markets, but focus on specific language in the proposed Judgments. The SEC's Memorandum defends the provisions, while arguing that the language (which is similar to that used in other judgments) should not be changed.

On October 24, 2011, the SEC announced that it had brought an action against and settled charges against Koss and its CEO and former CFO, Michael J. Koss. The Commission alleged that the company's former Principal Accounting Officer, Secretary, and Vice-President of Finance Sujata Sachdeva and former Senior Accountant Julie Mulvaney engaged in a wide-ranging accounting fraud to cover up Ms. Sachdeva’s embezzlement of over $30 million from Koss. The SEC alleged, in part, that the two were able hide the substantial embezzlements in Koss’s financial records in part because Koss and Mr. Koss failed to adequately maintain internal controls to assure the accuracy and reliability of financial reporting. The SEC's Complaint charged Koss and Mr. Koss with preparing materially inaccurate financial statements, book and records, and lacking adequate internal controls.

In settling, Koss and Mr. Koss consented to the entry of an injunctive order without admitting or denying the allegations in the Commission’s complaint. The proposed settlement would enjoin the company and Mr. Koss from future violations and order Mr. Koss to reimburse Koss $242,419 in cash and 160,000 of options pursuant to Section 304 of the Sarbanes-Oxley Act (Mr. Koss had previously voluntarily reimbursed $208,895 in bonuses to Koss). The SEC submitted a motion, along with Consents signed both by Koss and Mr. Koss, along with proposed judgments (again, one for Koss and one for Mr. Koss).

On December 20, 2011, Judge Rudolph Randa issued the letter directing the SEC to explain why the proposed settlements were "fair, reasonable, adequate, and in the public interest." Judge Randa raised certain specific issues.

• Judge Randa was concerned with the adequacy of two parts of the injunctive relief in the proposed final judgments to prevent future violations of the federal securities laws, and for enforcement of their terms through the Court’s contempt powers or otherwise. He noted that the Court has an independent duty to assure that injunctions comply with the directive of Fed. R. Civ. P. 65(d) (which requires specificity). However, Judge Randa was concerned that if enforcement became necessary, the terms in the proposed judgment were too vague, which would make enforcement difficult for the Court.

• Judge Randa was also concerned that the language of the Judgments incorporated the terms of the Consents entered into by Koss and Mr. Koss. Judge Randa noted that "the consent documents may be interpreted as containing injunctive relief, those injunctions are also vague and could pose enforcement issues in the future," and said that "additional injunctive relief must be expressly stated in the final judgments."

• Judge Randa requested that the Commission address the adequacy of the SEC’s proposed final judgment provision regarding disgorgement by Mr. Koss (whose family owns 70% of Koss), pointing out that he could not assess the fairness of the provision without any factual predicate for how those disgorgement terms were determined.

• Finally, Judge Randa was concerned that the proposed judgments are not final judgments because they do not expressly state dispose of the claims against the parties (such as dismissing the claims without prejudice, while including a provision for retaining jurisdiction over the enforcement of the settlement).

The SEC's Memorandum, filed on January 24, 2012, addressed each of these questions. As an initial matter, the SEC argued that "the Court must only find that the judgments are fair, adequate and reasonable," and claimed that the Court should not, as Judge Rakoff suggested, add "a requirement that a reviewing court also find such judgments to be in the public interest." Nonetheless, the SEC argued that the proposed settlement in Koss Corporation was in the public interest.

• In responding to the Court's inquiries regarding whether the provisions of the two proposed Judgments contained sufficient detail as required under the rules, the SEC pointed out that "the proposed consent judgments are similar in form and substance to consent judgments in Commission enforcement actions entered by district courts in similar cases in this Circuit and elsewhere." The Commission asserted that "the books and records and internal controls provisions that are the subject of the injunctions against Koss and [Mr. Koss], as written, are well-tailored to prescribe what an issuer such as Koss must do to comply." The SEC argued that the Judgment does not include additional details raised by the Court because the defendants had already taken remedial action to address those issues.

• With respect to the question of whether incorporating the terms of the Consents into the Judgments rendered them vague, the Commission argued that "the consents are tailored to achieve important public policy objectives," but said that, if the Court found it necessary, it would submit revised proposed judgments that contained the language from the consents.

• With respect to the Court's request that the SEC address the adequacy of the proposed final judgment provision regarding disgorgement by Mr. Koss, the Commission argued that it was not seeking disgorgement, but instead are seeking reimbursement under Sarbanes-Oxley Section 304(a) and laid out how the amount was calculated. The Commission also argued that it considered seeking reimbursement for additional years, but, after weighing the risk of litigating those years (Koss's financial statements were not restated), elected to not do so.

• With respect to the concern as to whether the judgments were final, the Commission argued that "so long as the language of the judgment makes clear that the district court is finished with the case, there is no requirement that a judgment contain language specifically disposing of the claims against the parties – e.g., dismissing the complaint or awarding judgment in favor in favor of one party or another – in order for the judgment to be rendered final." The Commission argued that the proposed Judgments against Koss and Mr. Koss satisfied that standard.

Although Judge Randa's questions in Koss Corporation cited Judge Rakoff's order, the issues are different. For example, the SEC's policy of settling on a neither-admit-nor-deny basis does not appear to be at issue. In Citigroup Global Markets, the SEC is so concerned with the precedent set by Judge Rakoff's ruling on that issue that it has appealed the case, obtained a temporary stay in the Court of Appeals and taken steps which caused Judge Rakoff to accuse the Commission of filing "materially misleading" papers. The SEC's Memorandum in Koss Corporation seems low-key in comparison to the answers the SEC provided to the Judge's questions in Citigroup Global Markets.

Still, Judge Randa is the latest Judge to question how the SEC does things, focusing on the language of the Judgment – language which is similar (if not identical) to the language which it has used for years. The SEC could satisfy Judge Randa by amending the language, but seems reluctant to do so (other than adding language from the consents, which is also similar, if not identical, to language used in other consents).

The question Judge Randa must consider is whether the language is, as stated by Judge Rakoff, "hallowed by history, but not by reason." In other words, should the Commission continue using the same language because that is the way it decided it should be written and it is the language the SEC has always used (which does promote consistency in the SEC's cases) or should the Judge in each case that signs the Final Judgment have some input into its terms?

Corporate Defendant in "Perfect Hedge" Case Settles Insider Trading Charges With SEC and Enters Into a Non-Prosecution Agreement With U.S. Attorney

William McGrath — Tue, 24 Jan 2012 11:37:35 -0500

On Monday, January 23, 2012, the SEC announced that Diamondback Capital Management LLC ("Diamondback"), the Stamford, Connecticut-based hedge fund named as a defendant in the SEC's insider trading case last week (as discussed here), has agreed to settle charges with the Commission. Diamondback will pay more than $9 million as part of the settlement, which must be approved by Judge Paul G. Gardephe, a federal judge in New York. Diamondback has also entered a non-prosecution agreement with the U.S. Attorney’s Office for the Southern District of New York.

Diamondback and two of its employees (analyst Jesse Tortora and portfolio manager Todd Newman), along with five other men and a second hedge fund, were named in the SEC's January 18, 2012 lawsuit. According to the charges, Mr. Tortora provided nonpublic material information about Dell Inc.'s quarterly earnings to Mr. Newman, who traded on the information on behalf of the Diamondback hedge funds he controlled. The two also combined to act on information regarding Nvidia Corporation and engage in additional trading in Diamondback's account. At the time the case was filed, SEC Director of Enforcement Robert Khuzami called the defendants "sophisticated players who built a corrupt network to systematically and methodically obtain and exploit illegal inside information again and again at the expense of law-abiding investors and the integrity of the markets." The seven individuals named in the SEC's lawsuit were also criminally charged (Mr. Tortora and two others have pled guilty). By using the information regarding Dell, the participants netted more than $60 million in illegal profits, which the U.S. Attorney called the "largest insider trading scheme involving single stock charged to date."

With respect to the SEC, Diamondback will pay more than $6 million of allegedly ill-gotten gains in disgorgement and will also pay a $3 million civil penalty. Under the proposed settlement, Diamondback consented to being permanently enjoined from future violations. George S. Canellos, Director of the SEC’s New York Regional Office said that "the proposed settlement appropriately sanctions the misconduct while giving due credit to Diamondback for its substantial assistance in the government’s investigation and the pending actions against former employees and their co-defendants."

In entering into the non-prosecution agreement with the U.S. Attorney's Office, Diamondback cooperated by providing a detailed Statement of Facts setting forth the wrongful conduct of its two employees. The company was also given credit for the $6 million in disgorgement paid to the SEC. The U.S. Attorney’s Office identified several additional factors which led to the non-prosecution agreement:

• Diamondback’s prompt and voluntary cooperation upon becoming aware of the Government’s investigation;

• Diamondback’s voluntary implementation of remedial measures;

• Diamondback’s willingness to continue to cooperate with U.S. Attorney's Office and the FBI; and

• Diamondback’s representation, based on an investigation by external counsel, that the there was no additional misconduct beyond what it had disclosed to prosecutors, and that the conduct was not known by the firm’s co-founders.

The non-prosecution agreement applies only to Diamondback and not to any of the individuals. It also requires that the firm continue to provide full and truthful cooperation, including the voluntary provision of information and documents.

Federal Magistrate Judge in Oregon Recommends Dismissing "Say-on-Pay" Lawsuit Against Umpqua Board

William McGrath — Fri, 20 Jan 2012 12:12:57 -0500

On January 11, 2012, Magistrate Judge John Acosta recommended the dismissal of the derivative lawsuit against the Board of Directors of Umpqua Holdings Corporation ("Umpqua") for breach of fiduciary duty. The lawsuit was filed after the shareholders, in an advisory vote, rejected the Board-approved executive compensation program. The Magistrate Judge found that the plaintiffs failed to make a presuit demand as required for a derivative suit and were not excused from doing so under the arguments they raised regarding the Board members' exercise of the business judgment rule or their lack of independence or disinterest. As Broc Romanek of theCorporateCounsel.Net Blog pointed out, "[t]his is the first federal court decision to dismiss such an action." Magistrate Judge Acosta has referred his Findings and Recommendations to District Judge Michael W. Mosman for review and final determination.

According to Umpqua's Proxy Statement, the company received "capital investment from the U.S. Treasury in 2008." As a part of that investment, Umpqua agreed to certain compensation limitations for 2009 and 2010. The Proxy Statement further stated that once the limitations were lifted in 2010, the company's compensation committee decided to "normalize" compensation of its executives. Umpqua commissioned an executive compensation study and a benchmarking study to provide guidance regarding executive base salaries and established performance categories based on both financial and non-financial metrics which were to be used in determining incentive pay. The Board unanimously approved the compensation package on February 25, 2011.

Plaintiffs alleged that the 2010 executive compensation program increased the compensation for each executive officer by approximately 60% and up to 160%, although the 2010 return to shareholders was a negative 7.7%. On April 22, 2011, the shareholders, in an advisory vote mandated under the Dodd-Frank Act, voted against the compensation plan by a 62% to 35% margin. Shareholders Plumbers Local No. 137 Pension Fund and Laborers’ Local #231 Pension Fund filed their action against the Umpqua Board on May 25, 2011.

On June 27, 2011, the defendants moved to dismiss, arguing, among other things that plaintiffs failed to allege facts raising certain reasonable doubts that would excuse a presuit demand. Defendants' two-pronged argument was that: (1) plaintiffs failed to adequately allege that the Board majority was independent and disinterested; and (2) the Board's decision was the product of a valid business judgment.

Plaintiffs (who were represented by the same counsel who were initially successful in defeating a motion to dismiss in the Cincinnati Bell litigation discussed here) opposed the motion, arguing that: (1) a presuit demand was not required because the Board was not disinterested; and (2) the breach of the fiduciary duty by the Board stripped it of his ability to rely on the business judgment rule (also excusing the presuit demand).

Focusing on the Board's interest and independence, Magistrate Judge Acosta said "the court determines only whether the board’s alleged interest in the compensation decision would have precluded it, in response to a demand, from conducting an objective and unbiased assessment of a shareholder challenge to the appropriateness of that decision." Defendants argued that only one Board member, the CEO, was impacted by the compensation plan (meaning the majority was disinterested), while plaintiffs argued that demand may be excused where, as here, that board member is in a leadership position or otherwise wields significant influence. Plaintiffs also argued that the remaining directors were not disinterested because they face a substantial likelihood of liability in this derivative action.

The Court quickly rejected the "likelihood-of-liability-from-the-lawsuit" argument, pointing out that it "would permit every derivative action plaintiff to argue that demand is futile and need not be made because no board would be able to act objectively in evaluating a presuit demand," and that "[s]uch a result would effectively erase the demand requirement and negate its purpose." With respect to the claimed influence wielded by the CEO, Magistrate Judge Acosta noted that plaintiffs failed "to provide particularized factual allegations" to support that argument.

Turning to the exercise of business judgment, Magistrate Judge Acosta stated that "the plaintiffs must plead particularized facts sufficient to raise (1) a reason to doubt that the action was taken honestly and in good faith or (2) a reason to doubt that the board was adequately informed in making the decision" (internal quotations and citations omitted). The Court agreed with defendants that compensation determinations are typically within the business judgment of the board and concluded that the allegations regarding the board’s decision failed to overcome the presumption that the board exercised business judgment. For example, the Court noted, the Board did not directly defy or violate any Umpqua bylaw, any shareholder agreement, or any legally mandated disclosure or reporting requirement, but, instead relied on a policy. Magistrate Judge Acosta also found that plaintiffs’ conclusory allegations that the approved level of compensation was inconsistent with general corporate performance was not sufficient to create a reasonable doubt that the Board took this action honestly and in good faith or that it was adequately informed in making the decision.

Magistrate Judge Acosta recommended that because plaintiffs failed to make a presuit demand and did not allege facts that would excuse it from such a demand, the lawsuit should be dismissed. His recommendation is to dismiss the suit without prejudice, which would allow plaintiffs an opportunity to amend the complaint. Plaintiffs are required to file any objections to the Findings and Recommendations by January 25, 2012 which will be considered by District Judge Mosman.

"Perfect Hedge" - Criminal and Civil Insider Trading Charges Brought Against Seven Investment Professionals

William McGrath — Wed, 18 Jan 2012 17:40:44 -0500

Today, federal prosecutors and the SEC named seven fund managers and analysts as defendants in an insider trading scheme based on nonpublic information about Dell’s quarterly earnings and similar inside information regarding Nvidia Corporation. The U.S. Attorney called the trading in Dell shares the "largest insider trading scheme involving single stock charged to date." Three of the individuals pled guilty and are cooperating with the Government. The SEC's lawsuit also named two Connecticut-based hedge fund firms as defendants.

The criminal case, which according to media reports stemmed from a four-year FBI investigation into an industry dubbed "Perfect Hedge," resulted in charges against the seven individuals, who worked at three different hedge funds and two other investment firms, for engaging in a scheme to provide material, non-public information about Dell and Nvidia. By using the information regarding Dell, the three hedge funds netted more than $60 million in illegal profits. The SEC, which is conducting its own ongoing investigation into the trading activities of hedge funds noted that, in addition to the trades of Dell shares, the insider trading gains regarding Nvidia exceeded $15 million.

The seven defendants who exchanged information regarding Dell are:

• investment analyst Sandeep ""Sandy" Goyal, who obtained Dell quarterly earnings information and other performance data from an insider at Dell before earnings announcements in 2008;

• analyst Jesse Tortora of Diamondback Capital Management LLC ("Diamondback"), who was tipped by Mr. Goyal and, in turn, tipped several others, leading to insider trades;

• Diamondback portfolio manager Todd Newman, who was tipped by Mr. Tortora and traded on the information on behalf of the Diamondback hedge funds he controlled;

• Spyridon "Sam" Adondakis, an analyst at Level Global Investors LP ("Level Global"), who was tipped by Mr. Tortora;

• Anthony Chiasson, a manager at Global Level, who was tipped by Mr. Adondakis and used the inside information to trade on behalf of Level Global hedge funds;

• Jon Horvath, a technology research analyst at another hedge fund, who was also tipped by Mr. Tortora and caused insider trades at his firm; and

• Danny Kuo, a vice-president and fund manager at an investment adviser who also was tipped by Mr. Tortora and caused his firm to execute profitable insider trades in Dell securities.

The charges allege that Mr. Kuo obtained inside information about Nvidia’s calculation of its revenues, gross profit margins, and other financial metrics in advance of the company’s earnings announcement for the first quarter of 2010, and caused his firm to trade on that information. Mr. Kuo tipped Messrs. Tortora and Adondakis, who then tipped Mr. Newman and Mr. Chiasson, respectively (which resulted in further insider trades at Diamondback and Global Level).

In the criminal case, Messrs. Goyal, Tortora and Adondakis have pled guilty to their roles in the insider trading scheme and are cooperating with the Government’s investigation. The charges against the remaining for individuals are still pending. U.S. Attorney Preet Bharara said: "The charges unsealed today allege a corrupt circle of friends who formed a criminal club whose purpose was profit and whose members regularly bartered lucrative inside information so their respective funds could illegally profit. … We have demonstrated through our prosecutions that insider trading is rampant and has its own social network, a network we intend to dismantle. We will be unrelenting in our pursuit of those who think they are above the law." Mr. Bharara's vow has been backed up by the cases – the lengths of insider trading sentences have increased greatly in recent years, as discussed here.

The SEC's case named all seven men as defendants, along with Diamondback and Global Level. SEC Director of Enforcement Robert Khuzami called the defendants "sophisticated players who built a corrupt network to systematically and methodically obtain and exploit illegal inside information again and again at the expense of law-abiding investors and the integrity of the markets." The SEC has touted its successes in insider trading cases, such as the $92.8 million civil penalty against the central defendant in the last large insider trading ring, Raj Rajaratnam (previously discussed here).

Judge Dismisses FCPA Charges Against John O'Shea

William McGrath — Tue, 17 Jan 2012 09:52:07 -0500

On Monday, January 16, 2012, Judge Lynn Hughes granted defendant John O'Shea's motion for acquittal in the FCPA case, dismissing the FCPA charges case against him. According to a Press Release from defense counsel, Judge Lynn Hughes "found that the Government’s chief witness, … could not tie Mr. O’Shea to the alleged crimes. The judge found that O’Shea’s conduct, including efforts to renew an ABB-Esimex contract, was reasonably explained by lawful motives." The decision by Judge Hughes marks the second loss in less than two months for the Government in cases related to the Comisión Federal de Electricidad ("CFE") – Judge A, Howard Matz had previously vacated the guilty verdict in the Lindsey Manufacturing case, as discussed here. UPDATED (on January 19, 2012): While Judge Hughes' Order dismisses the 12 FCPA counts, the Judge has scheduled a status conference for the remaining counts (conspiracy, money laundering and creating a false document) for January 20, 2012.

Mr. O'Shea was indicted in November 2009 on one count of conspiring to violate the FCPA, twelve counts of violating the FCPA, four counts of money laundering and one count of creating a false document to obstruct the Government's investigation. Specifically, the Indictment alleges that Mr. O'Shea, while serving as the General Manager for Sugar Land, the Texas business unit of ABB, Inc., a U.S. subsidiary of Swiss corporation ABB, Ltd., arranged and authorized payments through a Mexican sales agent, Esimex, to multiple officials at the CFE, an electric utility company owned by the government of Mexico, in exchange for contracts to provide products and services to CFE.

In March 2011, Mr. O'Shea moved to dismiss the Indictment, arguing that, because the CFE was a state-owned company, its employees did not fall under the definition of a "foreign official." As discussed here, in a Management Order entered on January 3, 2012, Judge Hughes denied Mr. O'Shea's Motion to Dismiss in a single sentence, without explanation.

The trial began on January 11, 2012. During the Government's Case-in-Chief, the prosecutors, did not call as a witness Fernando Basurto, Sr. (the President of Esimex, a Mexican sales agent, whom had been granted immunity), but called his son as witness instead. According to the defense team, Judge Hughes "expressed concern that the Government had granted immunity" Mr. Basurto, Sr., "allowing him to disclose selective information to the Government, while refusing to grant immunity to an important defense witness even six to seven years after the facts at issue."

Defense counsel Joel Androphy of Berg & Androphy said it was unfair to deflect "blame for bribery in corruption-ridden countries unto unknowing business executives," and hoped that Mr. O'Shea's acquiital "will encourage others wrongfully accused under the FCPA to fight the charges against them."

Federal Securities Law Blog's Monthly Litigation Review (January 15, 2011 Edition)

William McGrath — Fri, 13 Jan 2012 11:54:30 -0500

Today, the Federal Securities Law Blog takes a look back at the last 30 days in the world of securities-related litigation in a regular feature which appears on approximately the 15th of each month. In the last month, events in the Citigroup matter continued to dominate the news, but there were some interesting developments in FCPA cases, insider trading cases and discovery issues. These cases and other matters from the last month are discussed in greater detail after the jump.

The SEC's Appeal in the Citigroup Global Markets Appeal

It is remarkable to think that it has been less than three months since the SEC announced its $285 million settlement with Citigroup Global Markets, Inc. under the usual neither-admit-nor-deny standard. On November 28, 2011, Judge Jed Rakoff rejected the proposed settlement and was particularly critical of the policy of accepting settlements without an admission of liability. The last thirty days have seen a great deal of activity, building up to a hearing before the Second Circuit's Motion panel on January 17 2012.

On December 15, 2011, the SEC appealed Judge Rakoff's Opinion and Order rejecting the proposed settlement. In a statement, the Director of the Division of Enforcement, Robert Khuzami said that Judge Rakoff "committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits."

On December 16, 2011, the SEC filed a Motion in front of Judge Rakoff, asking him to stay to proceedings while the SEC's appeal is pending before the Second Circuit. On December 20, 2011, Citigroup filed a memorandum joining in the SEC's Motion.

In the week between Christmas and New Year's Day, the case really heated up, as discussed here. Before noon on December 27, 2011, the SEC filed an emergency motion for a stay before the Second Circuit, arguing that "[i]f Citigroup files its answer, denying some or all of the allegations in the Complaint, or if Citigroup moves to dismiss, challenging the Complaint's legal sufficiency, it will disrupt a central negotiated provision of the proposed consent judgment pursuant to which Citigroup agreed not to deny the allegations in the Complaint."

At approximately 4:20 pm that afternoon, the Second Circuit ruled that the emergency motion will be submitted to the Second Circuit's motions panel on January 17, 2012 and that, "[i]n the interim, proceedings in the District Court are stayed until a ruling by the motions panel."

At approximately 4:21 pm, Judge Rakoff, who was "totally unaware" of the events in the Second Circuit, issued his own order, denying the motion for a stay, finding, among other things, that neither the SEC, nor Citigroup Global Markets had a statutory basis for their appeals.

On December 29, 2011, Judge Rakoff issued a supplemental order stating that the SEC's statement to the Court of Appeals regarding the ramifications of Citigroup either filing an answer or a motion to dismiss was "materially misleading."

On the same day that Judge Rakoff issued his Supplemental Order, the SEC filed a Petition for a Writ of Mandamus with the Second Circuit, arguing that Judge Rakoff has overstepped his bounds and requesting that the Second Circuit order him "to enter [the] proposed consent judgment" between Citigroup and the Commission.

On December 30, 2011, the SEC filed a supplemental brief in the original appeal, responding to both of Judge Rakoff's orders that week. The Commission also explained that it "filed a petition for a writ of mandamus in the event that this Court disagrees about appealability under Section 1292(a)(1), in which case this Court may exercise jurisdiction under 28 U.S.C. 1651."

On January 3, 2011, the Second Circuit issued an Order consolidating the two appeals (the one by the SEC and the one by Citigroup), along with the proceedings involving the petition for a writ of mandamus.

On January 12, 2012, Business Roundtable requested leave to file an Amicus Brief in the appeal, arguing that the Second Circuit should reject the "potentially dangerous, approach to reviewing settlement agreements" in Judge Rakoff's decision.

The issues raised by Judge Rakoff's decision began to have an impact elsewhere, too. In SEC v. Koss Corporation, No. 2:11-cv-00991 (E.D. Wis.), a federal judge in Wisconsin cited Judge Rakoff's Opinion and Order as a basis to request that the SEC "provide a written factual predicate for why the agency believes the court should find that proposed final judgments in an enforcement action alleging that a company prepared materially inaccurate financial statements and lacked adequate financial controls are fair, reasonable, adequate, and in the public interest."

News regarding the "neither-admit-nor-deny" standard was not limited to the Courtroom. On December 16, 2011, the House Committee on Financial Services announced that it "will hold a hearing next year to examine the practice by the Securities and Exchange Commission of settling cases with defendants that neither admit nor deny complaints made by the SEC." The exact schedule for the Congressional Committee hearing has not been established, yet.

Finally, according to media reports discussed here, the SEC decided last week that it will no longer allow defendants who plead guilty in criminal proceedings to settle parallel civil charges with the Commission by neither admitting or denying the allegations. The policy shift applies only in those cases where there has been an admission of guilt or if the company or an individual enters an agreement with a deferred prosecution agreement or a non-prosecution agreement, not in cases where there has been no plea or if there is only civil proceedings.

The FCPA Cases – Trials Proceed as the Government Wins Some Issues, But Loses Some

By the end of the last thirty days, two high profile FCPA cases were underway – one just beginning, the other entering its fourth month. In the older case, the FCPA Sting case, Judge Richard Leon dismissed Count 1 (on the grounds that there was not sufficient evidence to that the six defendants participated in the overarching conspiracy to violate the FCPA) as to all six defendants in Trial Group No. 2. In addition, Judge Leon dismissed the Government's case against defendant Stephen Giordanella in its entirety. The December 22, 2011 rulings are considerable setback for the Government in its first-of-a-kind sting operation in an FCPA case.

The trial resumed on January 3, 2012 with the remaining five defendants having their opportunity to put on their defense. Those defendants moved for a mistrial, arguing that they were prejudiced by the admission of evidence regarding the now-dismissed conspiracy count. Judge Leon denied the Motion on January 9, 2012, and the trial continues.

The newer case, pending in Texas against John O'Shea, saw Judge Lynn Hughes deny his Motion to Dismiss the Indictment, which had been pending since March 2011 and argued that the Indictment failed to alleged that he bribed a "foreign official" because it only alleged that he bribed employees of a state-owned entity. Judge Hughes' January 3, 2012 decision marked the fifth time the argument has been rejected. The trial against Mr. O'Shea commenced on January 11, 2012.

Insider Trading Cases

Two interesting insider trading cases were in the news in the last month. One case, discussed here, was unique in that it was brought against a company and its former CEO for defrauding shareholders by buying back stock at severely undervalued stock prices – at a time when the company was privately held, a reminder that the SEC regulates securities – not just those publicly traded over an exchange.

The second case, brought against the former CEO of company and his friend, seemed to be a straightforward case of the CEO tipping his friend about an acquisition of the company. The case became notable, as also discussed here, when a report in the Atlanta Business Chronicle quoted defense counsel as saying that the CEO took and passed a polygraph test and, more remarkably, was then asked by the SEC to take a second polygraph test (but was sued instead).

Discovery and Investigative Issues

In an Opinion and Order entered on January 4, 2012 and a separate Order entered on January 5, 2012, Magistrate Judge Deborah Robinson granted the SEC's motion for a order to show cause, requiring Deloitte Touche Tohmatsu CPA Ltd. ("D&T Shanghai") to file a brief by mid-January 2102 and appear before the Court in early February to explain why it should not be required to respond to the SEC's subpoena on it. The ruling is largely procedural, but it does set in a motion a round of briefing and a hearing to address whether the SEC can compel the Chinese accounting firm to respond to its subpoena. D&T Shanghai is required to file responsive papers by January 20, 2012, addressing why it should not be ordered to respond to the Commission's subpoena. The SEC will file its reply brief by January 27, 2012 and Judge Robinson will hear the motion on February 1, 2012.

The long-standing discovery disputes between Mark Cuban and the SEC continued, as discussed here. Mr. Cuban has a pending motion requesting the SEC's files from the Investigation (and/or a privilege log), arguing that it would be relevant to (1) the credibility of the witnesses (and their possible bias in favor of the SEC) and (2) Mr. Cuban’s scienter with respect to his sale of the stock at issue. The SEC filed a motion which asked the Court to order Mr. Cuban to produce a privilege log of his documents. On December 13, 2011, Mr. Cuban responded to the Commission's Motion to Compel by arguing that: (1) he had already produced a log for the years 2004 to 2006; and (2) the Commission was asking for a log of documents for the 2007 to 2011 time-frame, long after the events in dispute took place (i.e., during the SEC's investigation) without explaining why. The SEC then filed its another motion on December 16, 2011, asking that Mr. Cuban be ordered to appear for his deposition at some point in December or January (as opposed to the day before the February 17, 2012 discovery cut-off, which was the only date Mr. Cuban had proposed). The Court has not yet ruled on the document issues, but did rule on December 30, 2011 that Mr. Cuban "shall appear for his deposition on a date between February 1 and 16, 2012 that is mutually agreeable to the parties," and that if the SEC needed to take certain depositions after Mr. Cuban's testimony, it could seek relief to do so.

U.S. Chamber of Commerce Wants to "Transform" the SEC

As discussed here, on December 14, 2011, the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness issued a 135-page report entitled "U.S. Securities and Exchange Commission: A Roadmap for Transformational Reform," expanding on its 2009 report and saying that "extraordinary steps are needed to achieve change." The Report, which was authored by Jonathan Katz (who was Secretary of the SEC for twenty years), contains 28 separate recommendations on how to reform the Commission as a whole, and specifically addresses the Division of Enforcement.

The Chamber made a group of 15 recommendations intended to address the Commission's leadership structure. Those recommendations included: "Congress should increase the number of Commissioners from five to seven and specify that at least one Commissioner must be an accountant, one an economist, and one an attorney."

The Chamber also examined the SEC's Enforcement Division. The Chamber stated that recent structural reforms in the SEC's Enforcement Division "are largely positive and should, over time, improve the effectiveness of SEC enforcement," but noted that it "is too soon to conclude that they are already successful." The Chamber had its own recommendations, which included increasing the number of specialty units and the staffing of those units, as well as adding a specialty unit for complex accounting frauds or misstatements. The Chamber also recommended that the Commission update the Seaboard principles on voluntary cooperation and criticized the SEC for "issuing press releases that evaluate its performance based on the total number of cases and the amount of money ordered to be paid," as opposed to the actual amounts paid.

Business Roundtable Files an Amicus Brief in the Citigroup Litigation, Asking the Second Circuit To Reverse Judge Rakoff

William McGrath — Fri, 13 Jan 2012 11:09:40 -0500

On Thursday, January 12, 2012, Business Roundtable ("BRT"), the association of chief executive officers of leading U.S. companies, requested leave to file an Amicus Brief in the SEC v. Citigroup Global Markets, Inc. appeal, requesting that the Second Circuit reject the "potentially dangerous, approach to reviewing settlement agreements" in Judge Jed Rakoff's November 28, 2011 decision in the lower court.

Judge Rakoff's decision to reject the proposed settlement with Citigroup Global Markets criticized the policy of accepting settlements without an admission of liability. Both the SEC and Citigroup Global Markets appealed the decision, which the SEC filing an emergency motion to stay the lower court proceedings (which resulted in a temporary stay until that motion can be heard by the Second Circuit's Motions Panel on January 17, 2012). This week, Citigroup filed a brief in support of the Motion to Stay as well.

In submitting their proposed amicus brief (available here), Business Roundtable argued that "the district court’s rejection of the parties’ consent decree could potentially affect most of the BRT’s members, as virtually every large company faces enforcement actions by federal regulators. Such companies have a significant interest in resolving enforcement actions through consent decrees, and in many cases would be unwilling or unable to settle them if required to admit or deny each of the agency’s allegations."

Business Roundtable argued that, from the corporate defendant's viewpoint, the "ability to resolve enforcement actions without admitting misconduct is important to defending claims in related litigation, obtaining insurance coverage, prudently managing its defense costs, the ability to attract and retain qualified directors and officers, access to the capital markets, and other ongoing business decisions … ." According to Business Roundtable, Judge Rakoff's decision "could harm all parties involved and increase the burdens on the already overburdened federal judiciary," and should be overturned.

SEC Investor Alert: Social Media and Investing - Avoiding Fraud

Robert J. Tannous — Thu, 12 Jan 2012 16:27:51 -0500

The SEC’s Office of Investor Education and Advocacy has issued an Investor Alert to help investors be better aware of fraudulent investment schemes that may involve social media. While social media can benefit investors, it also presents opportunities for criminal activity and fraud. Social media provides fraudsters an easy, low-cost way to create a site, account, email, direct message, or web page that looks and feels legitimate – giving criminals a better chance to convince you to send them your money. Once the fraud is perpetrated, it is difficult to track down the true account holders because of the anonymity that social media allows to criminals. As a result, investors need to use caution when using social media when considering an investment. The key to avoiding investment fraud on the Internet is to be an educated investor. The SEC has provided five tips to help investors avoid investment fraud on the Internet:

Be Wary of Unsolicited Offers to Invest - An unsolicited sales pitch may be part of a fraudulent investment scheme. If you receive an unsolicited message from someone you don’t know containing a “can’t miss” investment, your best move is to pass up the “opportunity” and report it to the SEC Complaint Center.

Look out for Common “Red Flags” - It sounds too good to be true; the promise of “guaranteed” returns; pressure to buy RIGHT NOW.

Look out for “Affinity Fraud” - Never make an investment based solely on the recommendation of a member of an organization or group to which you belong, especially if the pitch is made online. Even if you do know the person making the investment offer, be sure to check out everything – no matter how trustworthy the person seems who brings the investment opportunity to your attention.

Be Thoughtful About Privacy and Security Settings - Understand that unless you guard personal information, it may be available not only for your friends, but for anyone with access to the Internet – including fraudsters.

Ask Questions and Check Out Everything - Investigate the investment thoroughly and check the truth of every statement you are told about the investment.

Two Interesting Insider Trading Cases Against Former CEOs - One Involving Shares of a Privately Held Company, the Other Involving a Polygraph Test

William McGrath — Thu, 12 Jan 2012 13:59:17 -0500

Two unique insider trading cases have received a bit of attention recently. One case, brought on December 12, 2011 against a company and its former CEO, alleged that they defrauded shareholders by buying back stock at severely undervalued stock prices – at a time when the company was privately held. The second, brought on January 9, 2012 against the former CEO of company and his friend, alleged that the former tipped the latter about the upcoming acquisition of his company and resulted in a report in the Atlanta Business Chronicle that the CEO took and passed a polygraph test and was then asked by the SEC to take a second polygraph test.

December 2012 Case Against Privately-Held Company and Former CEO. The December action was filed in federal court in Florida against Stiefel Laboratories Inc.(which is now a fully-owned subsidiary of GlaxoSmithKline PLC, but at the time of the events in issue was the world’s largest private manufacturer of dermatology products) and its former chairman and CEO, Charles Stiefel. According to the Commission, the company bought back stock from its own shareholders on three occasions based on low and misleading stock valuations:

• between November 2006 and April 2007, the company purchased more than 750 shares from shareholders at $13,012 a share, even though Mr. Stiefel knew that five private equity firms had submitted offers to buy preferred stock in November 2006 based on equity valuations of Stiefel Labs that were more than 50% to 200% higher than the valuation used for the buybacks;

• between late July 2007 and June 2008, the company purchased more than 350 shares from shareholders under the Company’s employee stock plan at $14,517 a share and more than 1,050 shares from shareholders outside the Plan at an even lower stock price even though Mr. Stiefel knew, not only about the private equity valuations from November 2006, but that another private equity firm had bought preferred stock based on an valuation that was more than 300% higher than the valuation for the buybacks; and

• between December 3, 2008 and April 1, 2009, the company purchased more than 800 shares from shareholders at $16,469 a share, even though Mr. Stiefel knew that equity valuation was low and misleading, because he was negotiating the sale of the Company (resulting in the announcement in April 2009 of the company's acquisition by Glaxo).

The Commission alleged that the shareholders lost more than $110 million by selling their stock back to Stiefel Labs based on the low and misleading valuations. The company was charged with violating Exchange Act Section 10(b) and Rule 10b-5, while Mr. Stiefel was charged with aiding and abetting those violations.

Both Kevin LaCroix's D&O Diary Blog and David Smyth's Cady Bar the Door Blog have excellent discussions regarding the case, both noting that the case presents a cautionary tale. As Mr. Smyth points out, "[t]he SEC regulates securities, not just publicly traded companies."

January 2012 Case Involving Polygraph Test. The second case, brought against Earl Arrowood and Parker H. "Pete" Petit in federal court in Georgia, seems fairly straightforward. The Commission alleges that Mr. Arrowood received material non-public information about the potential sale of Matria Healthcare, Inc. ("Matria") (formerly a NASDAQ-listed company) from his friend Mr. Petit, who was, at the time, the Chairman and CEO of Matria.

The unique twist in this case is detailed in the article in the Atlanta Business Chronicle, which states:

Aaron Danzig, Petit’s attorney with Arnall Golden Gregory, said Petit has passed a polygraph test about the allegations.

"We gave the SEC results of the expert’s polygraph test as specific evidence that Mr. Petit was truthful in stating he did not provide inside information, and that the SEC’s claims are groundless," said [Mr. Danzig].

Danzig said the SEC asked Petit to submit to a second polygraph test that it would conduct. Petit agreed on the condition the SEC decline any enforcement action after he passed the second test. The SEC then sued Petit.

Bruce Carton's Compliance Week Enforcement Action Blog examines the case and, in particular, Mr. Danzig's assertion:

I am not surprised that from time-to-time, potential SEC defendants might offer to sit for polygraph tests. I just had no idea that the SEC ever took people up on such offers or actually conducted/supervised such tests. Can any SEC enforcement alumni or current SEC employees shed any light on this? Is taking an SEC-administered polygraph test actually on the menu of options for potential SEC defendants?

The SEC did not comment on the polygraph issue in its Litigation Release.

The FCPA Sting Case - Judge Leon Denies Motion For Mistrial, In Effect Ruling That Evidence Admitted Under the Now-Dismissed Conspiracy Count Did Not Cause Sufficient Prejudice to Merit a Mistrial

William McGrath — Tue, 10 Jan 2012 15:45:52 -0500

On Monday, January 9, 2012, Judge Richard Leon, who had already dismissed the central conspiracy count against six defendants in the FCPA Sting Case, was faced with an interesting question: if the conspiracy count was dismissed for insufficient evidence, should the trial continue when much of the evidence the Government has offered was based on the acts and statements of coconspirators who were not present at the trial? The Motion for a Mistrial filed by the defendants presently at trial argued that they were prejudiced by the evidence regarding the now-dismissed conspiracy count. Judge Leon denied the Motion, ruling that the trial will continue.

Under the rules of evidence, hearsay statements are excluded – what a witness who is not at trial said outside the courtroom is not admissible. However, the rules also provide that "a statement by a coconspirator of a party during the course of the conspiracy and in furtherance of the conspiracy," is not hearsay, and is therefore admissible. In the FCPA Sting Case, the 22 defendants have been charged in a single conspiracy, but were being tried in four separate groups. As in all conspiracy cases, the Government offered evidence regarding the acts and statements of individual conspirators against all conspirators.

As discussed here, on December 22, 2011, Judge Richard Leon granted the Rule 29 Motions for Judgment of Acquittal in the FCPA Sting Case and dismissed Count 1 (on the grounds that there was not sufficient evidence to that the six defendants in Trial Group No. 2 participated in the overarching conspiracy to violate the FCPA. At the same time, Judge Leon dismissed the Government's case against one of the six defendants in its entirety.

On January 2, 2012, the remaining five defendants moved for a mistrial, arguing, among other things, that they were prejudiced because they were improperly joined in the discovery count and the "admission in the government’s case-in-chief of hearsay statements of alleged co-conspirators and other testimony and exhibits that would not have been admissible at individual trials." The defendants argued that they were further prejudiced by the prosecutor’s opening statement, which charged the defendants with "collective wrongdoing" together with sixteen other defendants not on trial, including some whom have pled guilty. The defendants also argued that the prejudice "is so great that it cannot be cured by striking testimony and exhibits, or through curative instructions to the jury." As an alternative, the defendants argued that the Court was required to strike the testimony and other evidence regarding statements and acts of coconspirators and instruct the jury not to consider those issues.

The Government responded on January 4, 2012, arguing that "a mistrial is a severe remedy that is neither required nor warranted under the circumstances, especially given the less drastic alternatives available, such as an appropriate jury instruction." The Government also argued that "the defendants cannot show prejudice warranting severance, especially given that the Court can cure the risk of any such prejudice by a appropriate jury instruction." The Government asserted that under the relevant case law, it was not required to "charge the defendant with conspiracy in order to admit hearsay statements into evidence under the co-conspirator exception," and offered a variety of legal theories under which the statements of co-conspirators were admissible. The Government concluded that the Court, "should properly instruct the jury to consider the evidence against each defendant individually," as it did in the first of the trials in this matter (which resulted in a hung jury, as discussed here). On January 8, 2012, the Government submitted proposed supplemental jury instructions, including ones to address "Liability On The Grounds Of An Uncharged Conspiracy" and "Statements and Acts of Co-Defendants in a Common Venture."

On January 9, 2012, Judge Leon, without an Opinion, denied the Motion for a Mistrial. It remains to be seen how he will instruct the jury on these issues, as the defendants were to continue with their case-in-chief today.

SEC Adopts Disclosure Guidance on European Sovereign Debt Exposures

Robert J. Tannous — Mon, 09 Jan 2012 16:05:30 -0500

On Friday, January 6, 2012, the SEC Division of Corporation Finance issued Disclosure Guidance: Topic No. 4 (European Sovereign Debt Exposures) regarding disclosure relating to registrants' exposures to risk of debt to certain European countries. As a result of the uncertainties with European sovereign debt holdings, the SEC reviewed disclosures of direct and indirect exposures from these holdings made by financial institutions that are SEC registrants. The SEC's review noted that the disclosures of the exposure by registrants has been inconsistent in both substance and presentation. The SEC believes that this inconsistency may lead to disclosures that lack transparency and comparability for investors.

In reviewing the disclosures, the SEC issued comments requesting enhanced disclosure relating to the European sovereign debt exposures. The comments asked registrants to disclose for each country:

Gross sovereign, financial institutions, and non-financial corporations’ exposure, separately by country;
Quantified disclosure explaining how gross exposures are hedged; and
A discussion of the circumstances under which losses may not be covered by purchased credit protection.

As a result, the SEC is providing guidance that registrants provide additional disclosure in their Management's Discussion and Analysis ("MD&A") regarding their European sovereign debt exposures. The disclosure guidance asks registrants to determine which countries are covered focusing on those experiencing significant economic, fiscal, and/or political strains, and asks registrants to disclose the basis used for identifying the countries included in their disclosure. The disclosure guidance provides that disclosures should be provided separately by country, segregated between sovereign and non-sovereign exposures, and by financial statement category, to arrive at gross funded exposure, as appropriate. The disclosure guidance also provides that registrants should also consider separately providing disclosure of the gross unfunded commitments made, and information regarding hedges in order to present an amount of net funded exposure. The disclosure guidance provides an outline of disclosure topics for registrants to consider when analyzing their European sovereign debt exposures.

SEC Changes Settlement Policy Impacting the "Neither-Admit-Nor-Deny" Standard in Cases With Parallel Criminal Proceedings

William McGrath — Mon, 09 Jan 2012 12:00:59 -0500

According to media reports, the SEC decided last week that it will no longer allow defendants who plead guilty in criminal proceedings to settle parallel civil charges with the Commission by neither admitting or denying the allegations. At the present, the policy shift applies only in those cases where there has been an admission of guilt, not in cases where there has been no plea or if there is only civil proceedings.

Prior to the SEC's change, a defendant who pled guilty to criminal charges was able to settle with the SEC by neither admitting nor denying the same allegations. Frequently (though not always) if there were parallel criminal proceedings, prosecutors would seek to stay any civil proceedings with the SEC. Once the criminal case was resolved, the SEC case would proceed. Those convicted in criminal cases who did not settle with the Commission would usually face a motion for summary judgment under the legal theory of collateral estoppel because the same factual had already been resolved in the criminal case. Those defendants who pled guilty or were convicted after trial who elected to settle with the SEC had the option of doing so under the Commission's standard "neither-admit-nor-deny" basis.

The SEC's policy change eliminates that option in cases where the defendant has pled guilty in the criminal case. An article on Reuters.com by Aruna Viswanatha and Sarah N. Lynch quoted the SEC's Director of Enforcement Robert Khuzami as stating that it seemed "unnecessary" for the SEC to include its traditional "neither admit nor deny" approach if a defendant was convicted of the same conduct. An article by Joe Palazzolo of the Wall Street Journal further quoted Mr. Khuzami "[t]he new policy does not require admissions or adjudications of fact beyond those already made in criminal cases, but eliminates language that may be construed as inconsistent with admissions or findings that have already been made in the criminal cases." According to Edward Wyatt's article in the New York Times, "[t]he new policy will also apply to cases where a company or an individual enters an agreement with criminal authorities to defer prosecution or to not be prosecuted as part of a settlement."

The SEC's "neither-admit-nor-deny" policy has been under increased scrutiny recently – Judge Jed Rakoff, in denying a motion to approve a settlement in the Citigroup Global Markets litigation, criticized the SEC's long-standing policy as "hallowed by history, but not by reason" and expressed concern that it deprived the Court "of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact." The Citigroup case does not involve a criminal parallel proceeding and would not be impacted by the SEC's change in policy.

The Commission, who has appealed Judge Rakoff's ruling (and sought a writ of mandamus against him), maintains that policy change has been in the works for months prior to the Citigroup case. The Wall Street Journal article reported that the SEC stated that "the changes were made last week, after discussions that began this spring between senior enforcement staff and the commissioners."

Judge Denies Motion to Dismiss Based on Definition of Foreign Official in O'Shea FCPA Case

William McGrath — Fri, 06 Jan 2012 12:38:24 -0500

On January 3, 2012, Judge Lynn Hughes denied defendant John O'Shea's Motion to Dismiss the Indictment against him. Mr. O'Shea's Motion, which was filed in March 2011, argued that the Indictment failed to alleged that he bribed a "foreign official" because it only alleged that he bribed employees of a state-owned entity. Judge Hughes' decision marked the fifth time the argument has been rejected. The case against Mr. O'Shea is now set to go to trial on January 11, 2012.

Mr. O'Shea was indicted in November 2009 on one count of conspiring to violate the FCPA, twelve counts of violating the FCPA, four counts of money laundering and one count of creating a false document to obstruct the Government's investigation. Specifically, the Indictment alleges that Mr. O'Shea, while serving as the General Manager for Sugar Land, the Texas business unit of a U.S. subsidiary of a Swiss corporation, arranged and authorized payments to multiple officials at Comisión Federal de Electricidad ("CFE"), an electric utility company owned by the government of Mexico, in exchange for contracts to provide products and services to CFE.

In March 2011, Mr. O'Shea moved to dismiss the Indictment, arguing that, because the CFE was a state-owned company, its employees did not fall under the definition of a "foreign official." The FCPA defines a foreign official to include "any officer or employee of a foreign government or any department, agency, or instrumentality thereof …." 15 U.S.C. § 78dd-2(h)(2)(A). Mr. O'Shea argued, among other things, that CFE was neither a department, nor an agency, and that the legislative history revealed that Congress could have stated that the definition of "instrumentality" included state-owned companies (and had actually considered that language in a prior bill), but did not do so.

In a Management Order entered on January 3, 2012, Judge Hughes denied Mr. O'Shea's Motion to Dismiss in a single sentence, without explanation. However, in the same order, the Court also stated that it would take judicial notice of several facts relating to CFE (which may have impacted his decision on the Motion to Dismiss): (1) CFE is a monopoly; (2) the Mexican Ministry of Energy, Mines, and State-Owned Industries sets requirements for the CFE; and (3) the President of Mexico appoints the CFE's Director and its governing board. The Government had requested that the Court take judicial notice of several additional facts, which the Court elected not to do.

The argument regarding employees of state-owned entities has been raised in a number of cases recently. Indeed, Mr. O'Shea's Motion was filed within weeks of two similar motions in other cases. The argument was raised in another high-profile FCPA case tried in 2011.

One of the motions was filed by three of the defendants in the Lindsey Manufacturing case, in which the charges were also based on alleged bribes paid to CFE officials. As discussed here, Judge A. Howard Matz rejected the arguments raised by defendants in that case, ruling that under its ordinary meaning, CFE was an "instrumentality" of Mexico and therefore, its employees were "foreign officials." Judge Matz also found that "the legislative history [of the FCPA did] not clearly support either side’s contentions." Although the defendants were convicted by the jury, that conviction was subsequently vacated for prosecutorial misconduct (as discussed here).

Another case, U.S. v. Carson, Case No. 09-077 (C.D. Cal.), involves alleged payments to multiple companies. As discussed here, in May 2011, Judge James Selna in California denied defendants' motion to dismiss, holding that "the question of whether state-owned companies qualify as instrumentalities under the FCPA is a question of fact." The Court concluded that issue could not be segregated from the evidence to be presented at trial and that there were several factors (none of which were dispositive) that must be considered. The parties have submitted proposed jury instructions on the issue (some of which are discussed here) and the case is scheduled to be tried in June 2012.

In U.S. v. Esquenazi, Case No. 09-cr-21010 (S.D. Fla. Filed Dec. 4, 2009), the prosecution for FCPA violations involving bribes paid to Telecommunications D’Haiti S.A.M. ("Haiti Teleco"), a state-owned telecommunications company in Haiti, defendant Joel Esquenazi raised the issue of whether payments to a employees of state-owned companies constituted a violation of the FCPA. As discussed here, the Court denied the motion to dismiss: "[t]he plain language of this statute and the plain meaning of this term show that as the facts are alleged in the indictment Haiti Teleco could be an instrumentality of the Haitian government." Mr. Esquenazi and a co-defendant, Carlos Rodriguez, were convicted in August 2011 and Mr. Esquenazi was sentenced to fifteen years in prison (as discussed here). According to Professor Mike Koehler's Blog, the FCPA Professor, one of the issues raised by Mr. Rodriguez (who received a seven-year sentence) challenges the jury instructions given at trial on the "foreign official" issue.

D.C. Magistrate Judge Orders Shanghai Accounting Firm To Show Cause Why It Should Not Respond to SEC Subpoena

William McGrath — Thu, 05 Jan 2012 14:49:51 -0500

In May 2011, the SEC commenced an investigation into Longtop Financial Technologies Limited ("Longtop"), a Cayman Islands corporation whose ADRs are traded on the New York Stock Exchange. Longtop's principal offices are located in China, where D&T Shanghai served as its auditors until the accounting firm resigned in May 2011 after, according to the SEC, "discovering numerous financial improprieties" at Longtop.

On May 27, 2011, the SEC served its subpoena on D&T Shanghai's former U.S. counsel, who, according to the Commission, represented that he had authority to accept service on behalf of the firm. The subpoena sought documents related to D&T Shanghai's business and in particular, its activities as Longtop's auditor for the period from January 1, 2007 to the date of the subpoena. The accounting firm, which is registered with the Public Company Accounting Oversight Board ("PCAOB"), acknowledged that it possessed "vast amounts of responsive documents," but refused to produce them to the Commission.

On July 8, 2011, new counsel for D&T Shanghai wrote to the SEC and explained that the firm was refusing to comply with the subpoena because, among other things: (1) it could not be compelled to produce documents that predated the July 21, 2010 passage of the Dodd-Frank Act; and (2) the production of any documents may subject the firm to sanctions under Chinese law.

On September 8, 2011, the SEC filed its Motion for an Order the Show Cause (supporting brief here). The SEC subsequently highlighted this subpoena enforcement action in its November 2010 report on enforcement statistics for the fiscal year ending on September 30, 2010 (previously discussed here). In the Motion, the SEC addressed the issues raised by D&T Shanghai, arguing that the firm misunderstood the basis for the subpoena – the SEC has long held the authority to issue such subpoenas. The SEC further argued that the "vague assertions of possible conflicts with a foreign law" did not justify D&T Shanghai's non-compliance with the subpoena.

Following a hearing though, Magistrate Judge Robinson focused on a different issue, namely, the issue of whether she could issue such an Order if D&T Shanghai had not yet been served and appeared before her. Typically, service on an entity located aboard is accomplished under an internationally agreed-upon method, such as the Hague Convention on Service Abroad of Judicial and Extrajudicial Documents. So, on October 7, 2011, Magistrate Judge Robinson issued a Minute Order requiring the SEC to submit a brief "to address (1) the authority for the proposition that the court can require Respondent to appear to show cause where Respondent has not been served and has not appeared, and (2) the authority for the request that service be permitted pursuant to Rule 4(f)(3) of the Federal Rules of Civil Procedure [service by other means] rather than Rule 4(f)(1) [service under the Hague Convention or some other internationally agreed-upon method]."

The SEC responded on October 13, 2011 by arguing that the Court could issue the order to show cause on an ex parte basis, pointing out that D&T Shanghai will have "the full protections provided by due process, and will have an opportunity to be heard on the merits of this case." The SEC also argued that it should not be required to "exhaust all possible means of serving a foreign person, including service through the Hague Convention," but should be permitted to serve its papers on D&T Shanghai's U.S. counsel.

In a January 4, 2012 Opinion and Order, Magistrate Judge Robinson ruled that "service of the application is not a prerequisite to the issuance of the proposed show cause order." She noted that the D.C. Circuit "has repeatedly approved the issuance of a show cause order in a miscellaneous action brought by an agency, commission or corporation of the United States in the absence of prior service of the application upon the respondent." The Court also found that D&T Shanghai would not be prejudiced by the procedure – its counsel had already had numerous conversations with the SEC, received copies of the pleadings and actually attended the status conference (observing from the courtroom gallery).

In the January 5, 2012 Order to Show Cause, the Court directed D&T Shanghai to file responsive papers by January 20, 2012, addressing why it should not be ordered to respond to the Commission's subpoena. The SEC will file its reply brief by January 27, 2012 and Judge Robinson will hear the motion on February 1, 2012.

Judge Rakoff Issues a New Order Criticizing the SEC in the Citigroup Litigation as SEC Files A Petition for Writ of Mandamus and Submits Additional Briefing to the Second Circuit

William McGrath — Tue, 03 Jan 2012 13:32:26 -0500

The participants in the Citigroup litigation did not take much of a break during the holidays. As discussed here, on December 27, 2011, Judge Rakoff denied the SEC's request to stay the litigation. As it turns out, the Commission did not even wait for that order – it appears that the SEC's Motion for an Emergency Stay was filed with the Second Circuit before Judge Rakoff denied the similar motion in the District Court. That resulted in the Second Circuit's Order for a temporary stay (also discussed here). On December 29, 2011, Judge Rakoff issued a Supplemental Order, stating that the SEC made a "materially misleading" statement to the Court of Appeals and accused the Commission of misleading him during the process in the District Court. On December 29, 2011, the SEC filed a petition for a Writ of Mandamus and on December 30, 2011, the SEC filed a Supplemental Brief with the Second Circuit, responding to Judge Rakoff's statements by asserting that it [the Commission] was acting "in good faith."

The history of the fast-moving saga of SEC v. Citigroup Global Markets, Inc. was discussed in some detail in our Top 10 piece last Friday. In short, on October 19, 2011, the SEC and Citigroup Global Markets agreed to a settlement under the usual neither-admit-nor-deny standard in which the defendant agreed to pay $285 million. On November 28, 2011, Judge Rakoff rejected the proposed settlement with Citigroup in a sharply-worded Order, which was particularly critical of the policy of accepting settlements without an admission of liability. On December 15, 2011, the SEC appealed the matter to the Second Circuit (as did Citigroup) and the following day filed a Motion with Judge Rakoff, asking him to stay the litigation pending the appeal.

But that is when the procedural activities of the parties got even more interesting. The SEC's Motion before Judge Rakoff required Citigroup to respond by December 30, 2011. Judge Rakoff asked Citigroup to submit a brief with its position sooner – and Citigroup did so, filing its papers (agreeing with the requested stay) on December 20, 2011. Judge Rakoff then "spent the intervening Christmas Holiday considering the parties' position and drafting an opinion," planning to issue it by the first business day after Christmas (December 27).

However, before noon on December 27, 2011, the SEC filed an emergency motion for a stay before the Second Circuit. The Commission traced the history of the proceedings for the Second Circuit (including its then pending motion to stay before Judge Rakoff and stated:

Because the district court has "failed to afford the relief requested," the Commission moves this Court for a stay on the same grounds that it asserted in the district court. Fed. R. App. P. 8(a)(2)(A)(ii). The Commission seeks a stay on an emergency basis because the January 3 deadline for Citigroup to answer creates an exigency that threatens the Commission with additional irreparable harm.

The SEC also argued that "[i]f Citigroup files its answer, denying some or all of the allegations in the Complaint, or if Citigroup moves to dismiss, challenging the Complaint's legal sufficiency, it will disrupt a central negotiated provision of the proposed consent judgment pursuant to which Citigroup agreed not to deny the allegations in the Complaint."

At approximately 3:30 pm on December 27, 2011, the attorneys for the SEC and Citigroup telephoned Judge Rakoff so that Citigroup could request leave to exceed the page-limitation when it filed its motion to dismiss the Complaint (which was due on January 3, 2012). As Judge Rakoff noted "[at]t no point in that conversation did the parties reveal that the SEC had moved a few hours earlier for an emergency stay." Judge Rakoff granted the request regarding the page-limitation.

Later that afternoon, at approximately 4:20 pm, the Second Circuit ruled that the emergency motion before it will be submitted to the Second Circuit's motions panel on January 17, 2012 and that, "[i]n the interim, proceedings in the District Court are stayed until a ruling by the motions panel."

One can imagine that Judge Rakoff was not pleased by these events before the Second Circuit. On Thursday, December 29, 2011, he took the extraordinary step of issuing a Supplemental Order "to make the Court of Appeals aware of this background and to attempt to prevent similar recurrences." He directed the parties to fax to him any filings before the Court of Appeals immediately after they have been filed.

In his Supplemental Order, Judge Rakoff stated that the SEC's statement to the Court of Appeals regarding the ramifications of Citigroup either filing an answer or a motion to dismiss was "materially misleading" for four reasons:

• a motion to dismiss (unlike an answer) does not constitute an admission or denial, it is a legal challenge to the face of the compliant;

• the SEC was aware that Citigroup planned to move to dismiss (based on the December 27 telephone conference with the Court discussed above) or could have asked Citigroup;

• when seeking a stay before Judge Rakoff, the SEC had not argued that January 3 was a material date; and

• the SEC failed to advise the Court of Appeals that the Supreme Court had previously ruled that "the denial of the fruits of a settlement does not, without more, provide a basis for an interlocutory appeal, let alone a stay," citing Digital Equip. Corp. v. Desktop Direct, Inc., 511 U.S. 863, 884 (1994).

On the same day that Judge Rakoff issued his Supplemental Order, the SEC filed a Petition for a Writ of Mandamus with the Second Circuit, a drastic remedy invoked in extraordinary circumstances, arguing that Judge Rakoff has overstepped his bounds and requesting that the Second Circuit order him "to enter [the] proposed consent judgment" between Citigroup and the Commission. As it explained in a brief on December 30, 2011 (discussed below), the SEC "filed a petition for a writ of mandamus in the event that this Court disagrees about appealability under Section 1292(a)(1), in which case this Court may exercise jurisdiction under 28 U.S.C. 1651."

On December 30, 2011, the SEC filed a supplemental brief in the original appeal, "respond[ing] to the district court’s December 27, 2011 order denying the stay motion … and the district court’s supplemental order of December 29, 2011." The SEC argued that the Second Circuit does have jurisdiction under Carson v. American Brands, 450 U.S. 79 (1981), and that the "denial of a consent decree including injunctive relief is immediately appealable under Section 1292(a)(1)." The Commission further argued that the Digital Equip. decision cited by Judge Rakoff was "irrelevant to the jurisdictional bases asserted by the Commission," because it "did not involve injunctive relief, it did not involve an appeal arising under Section 1292(a)(1), it did not involve a consent judgment proposed by a federal agency, and it did not involve a mandamus petition." The SEC also argued that it did not mislead either the Second Circuit or Judge Rakoff, but that it acted "in good faith."

On Tuesday, January 3, 2011, the Second Circuit issued an Order consolidating the two appeals (the one by the SEC and the one by Citigroup), along with the proceedings involving the petition for a writ of mandamus.

The SEC will undoubtedly want this issue resolved quickly. As Jim Hamilton pointed out in his World of Securities Regulation blog, Judge Rudolph Randa cited Judge Rakoff's Opinion and Order as a basis to request that the SEC "provide a written factual predicate for why the agency believes the court should find that proposed final judgments in an enforcement action alleging that a company prepared materially inaccurate financial statements and lacked adequate financial controls are fair, reasonable, adequate, and in the public interest" in SEC v. Koss Corporation, No. 2:11-cv-00991 (E.D. Wis.).

The Top 10 Most Intriguing Federal Securities Litigation Stories in 2011 (Part 2 of 2)

William McGrath — Fri, 30 Dec 2011 10:27:54 -0500

Today, the Federal Securities Litigation Blog continues its with its larger-than-usual blog entry examining the Top 10 securities litigation stories that were the most intriguing in 2011. As mentioned yesterday, like any sort of Top 10 list, not everyone will agree. Other bloggers will have their own lists with different stories. But on a personal basis, these stories that fascinated me – like a good book, I look forward to the next "chapter" in these stories in 2012.

Here's a quick headline look at the Top 5:

5. The SEC's Inspector General Reports on the Conduct of the Commission Staff.

4. Insider Trading at Galleon Management: Record-Setting Results.

3. The New Whistleblower Rules: Do I Tell Management Before I Tell The SEC?

2. The Lindsey Manufacturing Saga: The Verdict DOJ was "Fiercely Committed" to Obtaining is Vacated.

1. The Citigroup Case: Judge Rakoff's Decision and the Potential Impact on How SEC Cases Proceed.

These five stories are discussed in greater detail after the jump.

The stories selected as numbers 6 through 10 are available here.

As they used to say on Casey Kasem's American Top 40, "the Countdown now continues with Number Five …"

5. The SEC's Inspector General Reports on the Conduct of the Commission Staff.

If you listen to Congressional testimony of people like former SEC Chairman Harvey Pitt, you would have to conclude that SEC Inspector General David Kotz is the most unpopular employee walking the halls at the SEC. Mr. Pitt denounced the Inspector General, saying that he "seemingly operates on the assumption that he can effectively terrorize innocent employees under the guise of upholding the law." Why does Mr. Kotz trigger such a vitriolic response? The Inspector General issued a series of reports this fall that examined the way the Commission handled certain issues, finding certain errors and suggesting reforms.

In one of the most talked about reports, released on September 20, 2011 and discussed here, the Inspector General found that David Becker, the former General Counsel and Senior Policy Director of the Commission, "participated personally and substantially in particular matters in which he had a personal financial interest by virtue of his inheritance of the proceeds of his mother's estate's Madoff account and that the matters on which he advised could have directly impacted his financial position." According to the Inspector General:

• upon the death of Mr. Becker's mother in 2004, an account at Bernard L. Madoff Investment Securities LLC was transferred to her estate and liquidated for approximately $2 million and the Trustee administering the Madoff liquidation filed a clawback suit against Mr. Becker and his brothers (who were the executors and beneficiaries of the estate) in February 2011, alleging that approximately $1.5 million of the $2 million constituted "fictitious profits" and should be returned to the fund of customer property for distribution to other Madoff customers;

• while Mr. Becker was at the SEC, he was aware that the Trustee might commence such a lawsuit, but "played a significant and leading role in the determination of what recommendation the staff would make to the Commission regarding the position the SEC would advocate as to the determination of a customer's net equity," which would be used to determine the amount of funds that the Trustee would seek to clawback in the Liquidation;

• seven SEC officials including Chairman Mary Schapiro and now General Counsel Mark Cahn were informed of the existence of this account, yet "none of these individuals recognized a conflict or took any action to suggest that [Mr.] Becker consider recusing himself from the Madoff Liquidation;" and

• Mr. Becker "provided comments on a proposed amendment to [the Securities Investor Protection Act of 1970] that would have severely curtailed the Trustee's power to bring clawback suits against individuals like him in the Madoff Liquidation."

As discussed here, Congress held a hearing to look into the matter, hearing testimony from Inspector General Kotz, Mr. Becker and SEC Chairman Mary Schapiro. Mr. Becker emphasized that he sought and followed the advice of the SEC Ethics office (a fact acknowledged by the Inspector General's Report) and "was advised that [he] had no conflict of interest in providing legal advice to the SEC about the interpretation of the legal standard in the Securities Investment Protection Act … that governed the net equity claims of holders of [Madoff] securities accounts."

The Inspector General referred the results of the investigation to the Public Integrity Section of the Criminal Division of the United States Department of Justice, who, as discussed here, elected not to prosecute Mr. Becker.

Other issues which the Inspector General considered this fall included:

• the SEC's policy of destroying documents gathered in pre-investigation inquiries known as Matters Under Inquiry ("MUI") (as mentioned in No. 7 of our Top 10 list yesterday and also further discussed here) (the Inspector General found that in some cases, documents that should have been preserved were destroyed); and

• the SEC's investigation of Mark Cuban, which resulted in a finding that there was not "sufficient evidence to substantiate any allegations of misconduct" by the Division of Enforcement (as discussed here).

Perhaps one of the more intriguing elements of the Inspector General's work in 2011 was that, in some circumstances, the individuals responding to his inquiries responded in such a way that one suspects defendants in SEC investigations might respond. For example, Mr. Becker acknowledged that he was "aware of the possibility" that the Trustee might sue him and his brothers, but said he "was confident that the Trustee would never find it necessary to sue me. If it turned out that there were indeed fictitious profits in my mother’s account, all the Trustee had to do was notify me and explain his calculations, and I would return any excess funds in my possession." One wonders how the Commission would respond if an individual under investigation made a similar statement. As for Mr. Becker, the Trustee did find it necessary to sue him and the parties were still in litigation as of November 2011.

4. Insider Trading at Galleon Management: Record-Setting Results.

When Raj Rajaratnam and others involved in the Galleon Management LLC circle were arrested and charged in October 2009, many pointed out that the authorities' use of wire taps as a new development in these types of cases. Well, that development yielded results in 2011 as a parade of guilty pleas and guilty verdicts commenced. Mr. Rajaratnam, the central figure in the cases, was sentenced to 11 years in October 2011 in prison, the longest to date for anyone involved in the group.

As discussed here, on May 11, 2011, a federal Jury in New York convicted Mr. Rajaratnam of five counts of conspiracy to commit securities fraud and nine counts of securities fraud, stemming from what prosecutors called "his involvement in the largest hedge fund insider trading scheme in history." Prosecutors argued that Mr. Rajaratnam received non-public, material insider information through overlapping conspiracies from insiders and others at hedge funds, public companies, and investor relations firms, and then executed trades in the stock of public companies, including Goldman Sachs, Clearwire, Akamai, AMD, Intel, Polycom, and PeopleSupport. The evidence in the eight-week trial included numerous recordings of wiretapped phone calls between Mr. Rajaratnam and co-conspirators (many of whom pled guilty). Mr. Rajaratnam claimed that he pieced together information from a variety of sources to reach a decision on investing.

On June 13, 2011, one of his co-conspirators, Zvi Goffer and two other Wall Street professionals, were found guilty on Monday of conspiracy and securities fraud charges (as discussed here). Prosecutors argued that Mr. Goffer, his brother, Emanuel, and a third defendant, Michael Kimelman, conspired with attorneys Arthur Cutillo and Brien Santarlas, (formerly of the Ropes & Gray law firm) and others. Specifically, Mr. Goffer, nicknamed "Octopussy" due to the number of connections he had, and others paid the attorneys for inside information regarding mergers and acquisitions of public companies represented by the law firm.

On September 21, 2011, Mr. Goffer was sentenced to ten years in prison. With respect to Mr. Goffer, U.S. Attorney Preet Bharara said that his "sentence is a fitting conclusion to yet another sordid chapter in the illegal insider trading conspiracies that have become so alarmingly pervasive."

On October 13, 2011, Mr. Rajaratnam received his 11-year sentence. The sentence, despite its length, fell short of what was sought by the prosecution, who had argued that Mr. Rajaratnam should be given a sentence "within the applicable Guidelines range of 235 to 293 months" (in other words between approximately 19 to 24 years). Mr. Rajaratnam argued that such a sentence was "grotesquely severe," and pointed out that the average sentence imposed in 2010 for violent crimes were far less – the average sentence for manslaughter was 73 months, for example. Media coverage of the sentencing hearing revealed that Judge Holwell said Mr. Rajaratnam’s ill health (advanced diabetes and the likely need for a kidney transplant) justified some leniency in sentencing. Less than a month later, Judge Jed Rakoff entered a $92 million civil judgment against Mr. Rajaratnnam in the SEC's civil case against him. Mr. Rajaratnam was also named as a defendant in the SEC's suit against Rajat Gupta, bringing new insider trading charges against him (as discussed here).

The lengthy sentences in the criminal cases are not a surprise to those who have considered the issue – but remain an ominous warning sign. In October, 2011, as discussed here, a Wall Street Journal article presented data showing an increase in the length of sentences in insider trading cases over the last eighteen years. The article reviewed the data from sentences in 108 insider trading cases from the Eastern District and Southern District of New York since 1993. From 1993 to 2000, no defendant received a sentence of longer than two years in prison, a trend which ended in 2000 when a six-year sentence was given. From 2000 to 2006, the sentences remained brief (less than three and one-half years, with one exception). But from 2006 to the present, the Journal identified nine defendants who were sentenced five years or more in prison. Moreover, in 2011 alone, 14 defendants were sentenced to jail terms in the Eastern and Southern Districts.

3. The New Whistleblower Rules: Do I Tell Management Before I Tell The SEC?

As discussed here, on May 25, 2011, the SEC adopted final rules to implement Section 922 of the Dodd-Frank Act regarding securities whistleblower incentives and protection. The mostly hotly debated issue at that point was whether whistleblowers should be required to raise their issues with their corporate employer before reporting to the SEC or whether they could report directly (by-passing the corporation). In the final rules, the Commission elected to not require whistleblowers to report to their employer first, but created a number of incentives for them to do so.

According to Chairman Mary Schapiro, the Commission's final rules "[struck] the correct balance – a balance between encouraging whistleblowers to pursue the route of internal compliance when appropriate – while providing them the option of heading directly to the SEC." She highlighted three elements of the final rules which address this issue:

• expanding the length of time by which a whistleblower must report to the SEC (after reporting to the corporation internally) from 90 to 120 days;

• providing that, when determining the amount of the award, the Commission will consider how much a whistleblower has participated in or interfered with the internal compliance process; and

• giving credit to a whistleblower who reports to the corporation internally when the company passes the information along to the Commission, even if the whistleblower does not.

The Commission established an Office of the Whistleblower, headed by Sean McKessy, to work with whistleblowers, handle their tips and complaint, and help the Commission determine the awards for each whistleblower. That Office announced the launch of its new website (discussed here), which "include[d] information on eligibility requirements, directions on how to submit a tip or complaint, instructions on how to apply for an award, and answers to frequently asked questions."

The new website yielded 334 whistleblower tips between August 12 and September 30, 2011. As discussed here, the Office of the Whistleblower's Annual Report revealed that the most common complaint categories were market manipulation (16.2%), corporate disclosures and financial statements (15.3%), and offering fraud (15.6%). The Report also provided information regarding the geographic origins of the tips, with California having over 30, New York having over 20 and Florida and Texas both having over 15 (with no other state having more than 10). There were 32 tips from overseas, including 10 from China and 9 from the United Kingdom.

As the 2012 continues, we learn more about the impact of the new rules and the Office's work.

2. The Lindsey Manufacturing Saga: The Verdict DOJ was "Fiercely Committed" to Obtaining is Vacated.

On May 10, 2011, when a federal jury convicted Lindsey Manufacturing Company (a privately-held company), its President Keith Lindsey, its Vice President Steve Lee and an intermediary, Angela Aguilar, in an FCPA case, Assistant Attorney General Lenny Breuer, called the verdicts "an important milestone," and said "we are fiercely committed to bringing to justice all the players in these bribery schemes." In a little over six months, the words "fiercely committed" took on a whole new meaning and the case unraveled when Judge A. Howard Matz found that the Government conducted a "… notably over-zealous investigation … that was so flawed that the Government’s lawyers tried to prevent inquiry into it." The Court held that "the multiple acts of misconduct … undoubtedly affected the verdicts and thus substantially prejudiced" the Defendants, necessitating the remarkable decision – made with what the Court called "deep regret" – to vacate the convictions and dismiss the Superseding Indictment.

The May 2011 conviction (discussed here) was based on payments to employees of the Comisión Federal de Electricidad ("CFE"), an electric utility company owned by the government of Mexico, which were made in exchange for the CFE to award contracts to Lindsey Manufacturing. After hearing evidence for five weeks, the jury took one day to find the company, President Lindsey and Vice President Lee guilty on all counts (one count of conspiracy to violate the FCPA and five counts of actually violating the Act). Ms. Aguilar, the intermediary, was found guilty of a single count of conspiracy to commit money laundering.

As discussed here, in the immediate aftermath of the verdict, Jan Handzlik of Greenberg Trauig, counsel to Lindsey Manufacturing and Mr. Lindsey, vowed to continue fighting the charges, including "pursu[ing] our motion to dismiss the indictment on grounds of prosecutorial misconduct." That motion (filed on May 9 – before the verdict) accused the Government of presenting the Grand Jury with "knowingly false and misleading representations on critical matters" and omitting the "disclosure of material facts" during the testimony of an FBI Special Agent. The defendants further accused the Government of covering up this testimony by refusing to produce the complete Grand Jury transcript of the agent's testimony until ordered by the Court in the middle of the trial. The Government filed its Opposition on June 6, 2011.

As discussed here, at a June 27, 2011 hearing, Judge Matz learned that certain grand jury transcripts which he previously ordered to be disclosed had not been turned over to the defendants. The Court then ordered the Government to turn over the missing transcripts by 9:00 a.m. the following morning and ordered further briefing. On July 25, 2011, the defendants filed a supplemental brief (discussed here), stating that the Government's "investigation and prosecution of this case were permeated with instances of purposeful, prejudicial government misconduct. The government’s misconduct was patent and pervasive, designed to win the case, not do justice." The Government filed a responsive brief on September 5, 2011. The Court also issued an order vacating the scheduled sentencing hearing for the company and Messrs. Lindsey and Lee, which had been set for September 16, 2011.

On December 1, 2011, Judge A. Howard Matz entered an order granting the motion to dismiss. The Court's decision was based, in part, on: the untruthful testimony of an FBI agent to the grand jury; the provision of false information in applications for search and seizure warrants; the improper review of e-mail communications between a defendant and her lawyer; the failure to comply with discovery obligations and other court rulings; and misrepresentations to the Court. The Court noted that there were other examples of wrongful conduct that may not have directly prejudiced Lindsey Manufacturing and Messrs. Lindsey and Lee, but reflected "just how far the Government was willing to go" in the case. The Court found that these acts "substantially prejudiced" the defendants, and that it was appropriate to dismiss the Superseding Indictment and vacate the convictions as both a deterrent and to release the defendants "from further anguish and uncertainty." The Government immediately appealed Judge Matz's ruling.

Judge Matz described the parties as having engaged in "almost non-stop, often acrimonious motion practice" prior to the trial. He also described the individuals as having been " put through a severe ordeal." He described the "immense" financial costs and "the emotional drubbing" to the individuals, and that the very survival of the "small, once highly-respected enterprise [Lindsey Manufacturing] has been placed in jeopardy."

Few expect the events of this case to be repeated, but the case is a stark reminder of how aggressively these issues will be fought by the government and defendants alike, and the impact of those actions.

Finally, the most intriguing matter in securities litigation in 2011 was:

1. The Citigroup Case: Judge Rakoff's Decision and the Potential Impact on How SEC Cases Proceed.

For decades, when the SEC has settled a matter against a defendant, it has allowed the defendant to do so without admitting or denying any wrongdoing. So, in October 2011, when the Commission settled a case with Citigroup Global Markets, Inc., it did so under its usual practice – Citigroup Global Markets was not required to admit or deny the allegations in the Complaint. While the Commission viewed the matter one way, Judge Jed Rakoff viewed it another and refused to approve the settlement. Now, the Second Circuit will have an opportunity to review the matter and a Congressional Committee has decided to hold hearings on the issue.

In short, the Citigroup case began a chain of events, which may (or may not) result in a significant change in the way the SEC handles its settlements. Looking back a mere ten and a half weeks ago …

On October 19, 2011, the SEC and Citigroup Global Markets agreed to a settlement under the usual neither-admit-nor-deny standard in which the defendant agreed to pay $285 million (consisting of $160 million in disgorgement, $30 million in prejudgment interest and a $95 million civil penalty).

When the parties requested that Judge Rakoff approve the settlement, he asked them to answer a series of questions about it (including "[w]hy should the Court impose a judgment in a case in which the SEC alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?"), in an effort to "ascertain whether the proposed judgment is fair, reasonable, adequate, and in the public interest."

The SEC responded on November 7, 2011 by saying that the use of such consent judgments "has been long endorsed by the Supreme Court" and "criticism of consent decrees for not including … an admission is 'unjustified.'" The SEC traced the history of its policy, emphasizing the desire to "preclude denials both in the consent decree itself and elsewhere." The Commission argued that, based on the fact that Citigroup does not deny the allegations in the Complaint, the "approach has clearly succeeded in clearly conveying that the conduct alleged did in fact occur." The SEC also argued that the Court was not entitled to consider some of the questions it had raised.

On November 28, 2011, Judge Rakoff issued a blistering ruling in which he rejected the proposed settlement with Citigroup as "neither fair, nor reasonable, nor adequate, nor in the public interest." He also accused the SEC of searching for "a quick headline," stated that they had argued the wrong legal standard, and criticized the long-standing policy of accepting settlements without an admission of liability as "hallowed by history, but not by reason." He also said that the Commission's request that the Court assert its authority without knowing the facts was "worse than mindless, it [was] inherently dangerous."

The SEC fired back with its own statement that afternoon, asserting that Judge Rakoff "ignore[d] decades of established practice throughout federal agencies and decisions of the federal courts," but on the same day wrote to Congress to seek stricter penalties (which was another issue raised by Judge Rakoff).

On December 15, 2011, the SEC appealed the matter to the Second Circuit and the following day moved to stay the litigation before Judge Rakoff, arguing, among other things, that Judge Rakoff's Opinion and Order ran afoul of "the strong deference afforded to federal agencies presenting proposed consent judgments for approval."

On December 27, 2011, Judge Rakoff denied the Motion to Stay. The SEC then filed an emergency motion with the Second Circuit seeking a stay. On December 28, 2011, the Second Circuit ruled that the SEC's emergency motion would be submitted to that Court's motions panel on January 17, 2012," and that "[i]n the interim, proceedings in the District Court are stayed until a ruling by the motions panel."

Meanwhile, on December 16, 2011, the House Committee on Financial Services announced that it would hold hearings on the neither-admit-nor-deny practice. Congressman Spencer Bachus, the Chairman of the Committee, said "[t]he SEC’s practice of using 'no-contest settlements' has raised concerns about accountability and transparency."

To summarize, the Commission argued that its decision to settle under its usual practice should be approved under "the well-established and oft-approved practice of federal agencies entering into consent judgments providing for injunctive relief in which defendants do not admit to the allegations in the complaint."

Judge Rakoff ruled that he did not care if the cases had been settled that way for years, it did not make it right (which sounds like a variation of what my father called the "if-all-your-friends-jumped-off-a-bridge-would-you-do-it-too?" argument). Judge Rakoff ruled that "when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt, the court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance."

Both arguments have their merits. Sit down and sort out the possibilities and it is very likely that your head will start to ache. The Second Circuit could agree with the SEC and reverse Judge Rakoff and return everything back to the way it was. But, if the appellate court Circuit does not do so. The Second Circuit could agree with Judge Rakoff and say, don't ask for an injunction without getting an admission. The parties in the dozens of SEC cases that are settled each year would face a slew of new questions …

• What will defendants do? Will they tell the Commission: "I cannot settle with you and admit wrongdoing because every plaintiff's class action lawyer from Philadelphia to San Diego will be waiting outside the Courthouse with a summons for me"? On the other hand, can they afford to go to trial with the SEC?

• What then will Commission do? If the Court won't accept a settlement without an admission and defendants cannot afford to make such an admission, will the SEC be forced to litigate many more cases? Chairman Mary Schapiro has already told Congress that under existing budget constraints, the Commission is stretched awfully thin. Alternatively, will the SEC begin using Administrative Proceedings to resolve matters and avoid the federal court system and the Judge Rakoffs of the world?

• Will Congress weigh in and address the issue? It seems unlikely, but the very prospect of the SEC defending the practice and others attacking it in a Capitol Hill hearing room will only heat up the debate further.

It is possible that in the next twelve months, Judge Rakoff's ruling could be a distant footnote and settlements with the SEC could continue as usual. On the other hand, it could result in a significant shift in the way the SEC, defendants and the Courts look at settlements going forward. That alone made the case, the ruling and its aftermath, the story to watch as the calendar page turns.

**********

As 2011 comes to a close and the new year beckons, on behalf of Porter Wright and the Federal Securities Law Blog, we want to wish all of you who read our blog a happy, healthy and prosperous 2012.

The Top 10 Most Intriguing Federal Securities Litigation Stories in 2011 (Part 1 of 2)

William McGrath — Thu, 29 Dec 2011 13:27:32 -0500

Today and tomorrow, the Federal Securities Litigation Blog will take a break from discussing the most recent events and, with a larger-than-usual entry, examine the Top 10 securities litigation stories that were the most intriguing in 2011. Undoubtedly, others will be preparing similar lists and this is not intended to be a definitive or complete version. Instead, these are the stories that piqued my interest. Half of the list will be discussed today and the other half tomorrow.

Here's a quick headline look at the bottom half of the Top 10:

10. The D.C. Circuit Vacates SEC Exchange Rule 14a-11 Regarding Shareholders' Rights to Include Board Nominee on Proxy Materials.

9. The Jenkins Litigation: Settlement Negotiations in Clawback Case Collapse, But Are Ultimately Resolved.

8. The SEC's Director of the Division of Enforcement Now Has Authority To Issue Witness Immunity Orders.

7. Where is That File? The SEC Addresses Issues Related to the Destruction of Documents and Discovery Issues Relating to their Notes.

6. The FCPA Sting Case: One Hung Jury, One On-Going Trial, A Conspiracy Count Dismissed and More to Come.

These five stories are discussed in greater detail after the jump.

Here is the List, in the form of a countdown, starting, of course, at Number Ten …

10. The D.C. Circuit Vacates SEC Exchange Rule 14a-11 Regarding Shareholders' Rights to Include Board Nominee on Proxy Materials.

Exchange Act Rule 14a-11 (finalized in 2010, as discussed here) allowed 3% (or larger) shareholders to use the company proxy statement to nominate directors. The Rule was challenged by Business Roundtable and the U.S. Chamber of Commerce, who filed a petition with the D.C. Circuit, arguing that it was promulgated in violation of the Administrative Procedures Act ("APA") because, among other things, "the Commission failed adequately to consider the rule’s effect upon efficiency, competition, and capital formation," as required under provisions of the Exchange Act and the Investment Company Act of 1940.

As discussed here, on July 22, 2011, the D.C. Circuit Court of Appeals issued an Opinion vacating the Rule. The Court found that "the Commission acted arbitrarily and capriciously for having failed once again … adequately to assess the economic effects of a new rule." Specifically, the Court found that the SEC "inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters."

One of the intriguing aspects of this story was the fact that SEC did not appeal. Like many individuals and agencies in Washington (and elsewhere for that matter), the SEC does not like being told by the Courts that cannot do something. Moreover, the agency is willing to appeal matters to a higher court when necessary (as seen in the Citigroup case to be discussed elsewhere in this list). However, in this matter, the SEC announced on September 6 that it was not seeking rehearing of the decision, as discussed here. Chairman Mary Schapiro stated that she "remain[ed] committed to finding a way to make it easier for shareholders to nominate candidates to corporate boards," but also noted that "I want to be sure that we carefully consider and learn from the Court's objections as we determine the best path forward."

In a world where litigants seem to exhaust all appeals before stopping, it was, to this blogger, a remarkable response.

9. The Jenkins Litigation: Settlement Negotiations in Clawback Case Collapse, But Are Ultimately Resolved.

Another remarkable turn of events occurred when the SEC's Division of Enforcement Staff agreed to resolve a case with Maynard Jenkins, the former CEO of CSK Auto Corporation, only to have the five SEC Commissioners reject the settlement. Although the case was ultimately settled, the path the parties took to reach that resolution was unusual.

In July 2009, the SEC filed suit against Mr. Jenkins, asking that he be ordered under Section 304 of the Sarbanes-Oxley Act to reimburse the company and its shareholders the more than $4 million that he received in bonuses and stock sale profits while CSK Auto was committing accounting fraud (although the complaint did not allege that Mr. Jenkins engaged in the conduct resulting in the fraudulent accounting). SEC v. Jenkins, No. 09-cv-01510 (D. Ariz. filed Jul. 22, 2009). At the time the Complaint was filed, the SEC announced: "[i]t is the first action seeking reimbursement under Section 304 from an individual who is not alleged to have otherwise violated the securities laws."

As discussed here, on March 24, 2011, the parties advised the Court that "Mr. Jenkins and the Staff of the Securities and Exchange Commission have reached a tentative settlement agreement to resolve this matter," noting that "such tentative settlement agreement is subject to approval by the Securities and Exchange Commissioners." According to the Washington Post, "the proposed settlement was for less than half the amount the SEC originally sought." However, in July 2011, the Commissioners rejected the proposal. According to a source "close to the matter," the combination of two contrasting views resulted in the lack of support for the settlement. In the view of some Commissioners, the amount of the settlement was too low. However, a second view was that the case should not have been brought at all.

Rather than litigate, on November 15, 2011, the SEC announced that it had reached a new settlement with Mr. Jenkins, as discussed here. The Commission did not settle for the entire amount (over $4 million) which was demanded in the Complaint. Instead, the Commission agreed to accept approximately $2.8 million of bonus compensation and stock profits that Mr. Jenkins received while the company was committing accounting fraud. While there is likely a reason for accepting the lower amount, it was not disclosed. The settlement was approved by the Court the following day.

The story was odd enough when the Commission's rejection of the staff's proposed settlement became public, but it became even more unique when the Commission accepted a settlement for quite a bit less than the amount demanded.

8. The SEC's Director of the Division of Enforcement Now Has Authority To Issue Witness Immunity Orders.

Prior to this summer, when a witness in an SEC Investigation exercised his or her right not to testify under the Fifth Amendment (and given the increase in the number of cases with parallel criminal investigations, the issue is occurring more and more), the Enforcement Staff would typically advise the witness that they did not have the authority to compel his or her testimony by granting him or her immunity from prosecution. That was slightly amended in January 2010, when the Enforcement Director was granted authority to submit witness immunity requests to the Department of Justice, in connection with judicial proceedings, to compel testimony or the production of other information.

However, as discussed here, on June 13, 2011, the SEC announced that it was amending its rules to delegate authority to the Director of the Division of Enforcement to issue witness immunity orders to compel individuals to give testimony or provide other information in either investigations or related enforcement proceedings. This rule went into effect on June 17, 2011 for an 18-month period.

The Director of the Division of Enforcement, Robert Khuzami, was formerly was with the U.S. Attorney's Office in the Southern District of New York. He has already taken steps to organize his investigative teams along the lines of a prosecutor's office. Granting him this immunity authority seems to continue that trend.

Because the Commission's investigations are non-public, it is difficult to know whether Mr. Khuzami has exercised that option during an SEC investigation, yet. When the end of the 18-month period approaches in December 2012, we may learn more as the Commission evaluates whether it wants to extend the delegation of that authority.

7. Where is That File? The SEC Addresses Issues Related to the Destruction of Documents and Discovery Issues Relating to their Notes.

There were two sets of stories in 2011 regarding the SEC and its documents. One stemmed from a line of inquiries (from Congress and from the Commission's Inspector General) about whether the Commission was destroying some of its files. The second arose in litigation in two different matters (one a FOIA request, the other an SEC civil action).

With respect to inquiries, in a letter dated August 17, 2011, Senator Chuck Grassley of the Senate's Judiciary Committee asked SEC Chairman Mary Schapiro whether the Commission has destroyed files relating to some of its more high-profile and controversial matters, such as its investigations of Bernie Madoff, Goldman Sachs, Bank of America, Lehman Brothers and others. Senator Grassley's inquiry (discussed here) was based on the allegations in a letter from Darcy Flynn, a thirteen-year veteran of the staff. According to a September 7 report in the Wall Street Journal discussed here, Mr. Flynn, through counsel, advised the SEC that documents were still being destroyed and "that 'we may need to seek injunctive relief' in federal court if the SEC doesn’t freeze its document-destruction policy." As a result, according to the Wall Street Journal's report, "SEC General Counsel Mark Cahn issued a memo to Division of Enforcement staff telling them to stop existing record-destruction procedures for closed cases, until further notice."

In a second inquiry, the SEC's Inspector General investigated the policy, resulting in the November 1, 2011 release of a Report, discussed here. Specifically, the Inspector General examined the SEC's policy of destroying documents gathered in pre-investigation inquiries known as Matters Under Inquiry ("MUI"), as well as statements made by the Commission to the National Archives and Records Administration ("NARA") regarding that policy. The Inspector General found that the SEC had a policy in place for nearly 30 years which called for the destruction of such documents and that the documents that should have been preserved were destroyed. The Inspector General also found that, when asked about NARA about the destruction of documents, the SEC did not disclose the existence of the policy and stated it did not know if such documents had been destroyed. Although his office did not conduct an exhaustive audit, the Inspector General was "not aware of a particular investigation that was hampered by the destruction of records for a MUI." The Inspector General made a series of recommendations for the SEC to address these issues.

While all of this was taking place, the SEC found time to resolve a case against FINRA for altering its documents. As discussed here, on October 27, 2011, the SEC entered a Cease-and-Desist Order against FINRA, which, according to the SEC's Press Release, included a finding that "certain documents requested by the SEC’s Chicago Regional Office during an inspection were altered just hours before FINRA’s Kansas City District Office provided them." FINRA consented to hire an independent consultant and undertake other remedial measures.

The production of SEC documents was litigated as well. In one example, a dispute arose when the lawyers for Walter Forbes, the former CEO of Cendant Corporation who was facing criminal charges for securities fraud, sent Freedom of Information Act ("FOIA") requests to the SEC seeking all of the notes taken by the SEC staff members during the Commission's investigation of two individuals who were subsequently Government witnesses in a criminal prosecution of Mr. Forbes. The SEC refused to disclose the notes and the attorneys sued the SEC to compel production. The District Court refused to order the production of the documents and the D.C. Circuit, in a December 9, 2011 Opinion discussed here, affirmed a lower court's decision.

A second matter being litigated, which is on-going, is the SEC's insider trading case against Mark Cuban (who sold shares of Mamma.com shortly before the announcement of a PIPE offering). While a whole slew of issues have been raised by the parties in that case, one of the most interesting issues is whether Mr. Cuban is entitled to the production of notes of the SEC staff members taken during the investigation. As discussed here, Mr. Cuban has argued that the notes are discoverable because they would be relevant to: (1) the credibility of the Mamma.com witnesses (and their possible bias in favor of the SEC); (2) Mr. Cuban’s scienter with respect to his sale of Mamma.com stock; and (3) whether the statements made by witnesses may have changed over time. His motion is still pending.

If 2011 is any indication, there will be some focus on SEC records and notes, as defendants hope to obtain them.

6. The FCPA Sting Case: One Hung Jury, One On-Going Trial, A Conspiracy Count Dismissed and More to Come.

One of the FCPA cases being followed closely this year has been the "FCPA Sting" or "Shot Show" case in the District of Columbia. The first trial, involving 4 of the 22 defendants, resulted in a mistrial in July. The second trial resulted in the dismissal of the DOJ's central conspiracy charge and acquittal of one defendant, but is still on-going as to five other defendants. It was, according to the Department of Justice, the first sting operation in an FCPA case.

The case began in December 2009 when the Government filed 16 sealed indictments in (which were unsealed in January 2010), charging 22 defendants with conspiring to violate the FCPA, violating the FCPA and conspiring to launder money. The Government alleged that the defendants met an informant who claimed to be an agent for the Minister of Defense of Gabon and arranged an introduction. The Government further alleged that the defendants met with and agreed to bribe the Minister, with the payments disguised as sales commissions. However, the "Minister" was, in reality, an undercover FBI agent. In April 2010, the Government filed a superseding indictment in U.S. v. Goncalves, No. 09-cr-00335 (D.D.C.), naming all 22 defendants in a single case. Three of the defendants pled guilty to conspiracy charges in March and April 2011.

The case has been divided into four groups for the purposes of trial. On May 16, 2011, the trial commenced against the first four defendants (Trial Group No. 1). The testimony included that of the informant, Richard Bistrong, who had pled guilty to conspiring to violate the FCPA himself. The Jury began deliberating on June 27, 2011. As discussed here, on July 7, 2011, D.C. Federal Judge Richard Leon declared a mistrial in a criminal case against four defendants who were accused of conspiracy and FCPA violations when the jury was unable to reach an unanimous verdict on all charges.

As discussed here, on August 4, 2011, the Court set a new schedule for the four groups of defendants (with each trial expected to last eight weeks). The next trial, involving six defendants (known as Trial Group No. 2) began on September 26, 2011. It has already gone well beyond the eight-week estimate, with the Government not finishing its case-in-chief until December 19.

As discussed here, on December 22, 2011, Judge Leon dismissed Count 1 (conspiracy to violate the FCPA) as to all six defendants in Trial Group No. 2 and dismissed the Government's case in its entirety against one defendant, Stephen Giordanella. The trial will resume on January 3, 2012 with the remaining five defendants having their opportunity to put on their defense.

The next group (consisting of five defendants) was scheduled to be on December 12, 2011, a date that has already been postponed. The four defendants from the original case which resulted in the July mistrial and the remaining four defendants will be tried at some point in 2012.

Bringing a case against 22 defendants is ambitious. Using a sting operation to gather than evidence made it even more so. Thus far, there have been three guilty pleas, but there has also been one hung jury, and a second trial that has taken 12 weeks for the Government to put on its evidence, which resulted in the acquittal of one defendant already and the central conspiracy charge being dismissed. The developments in this case in 2012 will undoubtedly be interesting as well.

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On Friday, the Top 10 list continues …

Second Circuit Grants Temporary Stay in Citigroup Case

William McGrath — Thu, 29 Dec 2011 12:47:24 -0500

On Wednesday, December 28, 2011, the Second Circuit Court of Appeals stayed the SEC's case against Citigroup Global Markets, Inc. (which is before Judge Rakoff in New York). The appellate court received an emergency motion for a stay after Judge Rakoff denied the request made at the District Court level. That emergency motion is to be submitted to the Second Circuit's motions panel on January 17, 2012. The appellate court ruled that "[i]n the interim, proceedings in the District Court are stayed until a ruling by the motions panel."

As previously discussed here, in a November 28, 2011 Opinion and Order, Judge Rakoff rejected the SEC's proposed settlement with Citigroup for $285 million as "neither fair, nor reasonable, nor adequate, nor in the public interest." On December 15, 2011, the SEC appealed the Opinion and Order (discussed here). On Friday, December 16, 2011, the SEC filed a Motion in front of Judge Rakoff, asking him to stay to proceedings while the SEC's appeal is pending before the Second Circuit (discussed here).

On December 27, 2011, Judge Rakoff denied the Motion for a Stay, referring to the SEC's "purported appeal." Judge Rakoff found that neither the SEC, nor Citigroup Global Markets (who has also appealed) has a statutory basis for their appeals. The parties had cited 28 U.S.C. § 1292(a)(1), which, according to Judge Rakoff, "allows an interlocutory appeal from the rejection of a proposed consent decree only where injunctive relief is 'at the very core of the disapproved settlement.'" The Court acknowledged that the proposed Consent Judgment's injunctive provisions "were relevant and material to the scope and nature of the Court's evaluation," but found that "the Court's denial of injunctive relief is not the basis on which the parties premise their instant appeals." Instead, Judge Rakoff stated that "the alleged 'legal error' that the SEC, joined by Citigroup, seeks to correct by their appeals is this Court's insistence that it be provided with proven or acknowledged facts in order to evaluate whether the proposed Consent Judgment, in any of its aspects, is fair, reasonable, adequate, and in the public interest."

Because Judge Rakoff has established a tight discovery schedule, with deadlines in early January, the SEC sought an emergency stay before the Second Circuit. The Appellate Court granted a temporary stay, but without discussing the merits. Instead, the Second Circuit stated in its order that the emergency motion for a stay will be submitted to the Court's Motion Panel on January 17, 2012 and that the case before Judge Rakoff was stayed until that motions panel had ruled.

The FCPA Sting Case - Judge Leon Dismisses The Central Conspiracy Count As To Six Defendants in Trial Group No. 2

William McGrath — Tue, 27 Dec 2011 13:15:59 -0500

On Thursday, December 22, 2011, Judge Richard Leon ruled on the Rule 29 Motions for Judgment of Acquittal in the FCPA Sting Case by dismissing Count 1 (on the grounds that there was not sufficient evidence to that the six defendants participated in the overarching conspiracy to violate the FCPA) as to all six defendants in Trial Group No. 2. In addition, Judge Leon dismissed the Government's case against defendant Stephen Giordanella in its entirety. The trial will resume on January 3, 2012 with the remaining five defendants having their opportunity to put on their defense. The rulings are considerable setback for the Government in what the Department of Justice called the first sting operation in an FCPA case.

In December 2009, the Government filed 16 indictments charging 22 defendants with conspiring to violate the FCPA, violating the FCPA and conspiring to launder money stemming from an agreement to bribe the Minister of Defense of Gabon (who was, in reality, an undercover FBI agent. In April 2010, the Government filed a Superseding Indictment naming all 22 defendants in a single case. 3 of the 19 defendants pled guilty to conspiracy charges in March and April 2011. The case was divided into four groups for the purposes of trial. As discussed here, on July 7, 2011, D.C. Federal Judge Richard Leon declared a mistrial in Trial Group No. 1 when the jury was unable to reach an unanimous verdict on all charges.

The case against Trial Group No. 2 commenced on September 26, 2011, and, the Government did not finish its case-in-chief until December 19. After hearing argument on the Rule 29 Motions for Acquittal during last week, Judge Leon ruled on December 22, 2001.

• The Judge dismissed Count 1 of the Superseding Indictment (which charged all defendants with conspiring to violate the FCPA) as to the six defendants in Trial Group No. 2. According to Professor Mike Koehler of the FCPA Professor Blog, Judge Leon stated:

[V]iewing the evidence in the light most favorable to the Government, the Court does not believe the Government has produced sufficient evidence to enable a rational trier of fact to conclude beyond a reasonable doubt that each of these six defendants participated in the overarching conspiracy charged in the superseding indictment in this case.

• The Judge dismissed the charges against Mr. Giordanella, who was only charged in Count 1. Originally, he also had been charged conspiracy to commit money laundering, but the Government had dismissed that charge against in September 2011, shortly before trial began.

• The Judge also dismissed two of the substantive FCPA counts as to two defendants, but denied the remaining Rule 29 motions and the trial against the five remaining defendants in Trial Group No. 2 will proceed on January 3, 2012.

As discussed by Mike Scarcella of the Blog of the Legal Times, the ruling came only a week after Judge Leon "criticized prosecutors for mishandling evidence" and "voided a portion of the testimony from a key witness."

Net Worth Standard for Accredited Investors

Jack J. Gravelle — Thu, 22 Dec 2011 12:32:10 -0500

Yesterday the SEC released its final rule regarding the exclusion of the value of a person’s primary residence when determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million. The accredited investor standards are used to determine certain exemptions from Securities Act registration for private offerings. Prior to Dodd-Frank, investors could include their primary residence in calculating a minimum net worth of more than $1,000,000. Section 413(a) of the Dodd-Frank Act changed the requirement to exclude the value of the primary residence, for which the SEC has now finalized rules.

But, expect more changes to the accredited investor concept. Section 415 of the Dodd-Frank Act requires the Comptroller General of the United States to conduct a “Study and Report on Accredited Investors” examining “the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds.” The study is due by July 2013, and the SEC will likely use the study for future rule making.