Federal Securities Law Blog

Judge Selna To Deny Two Motions in FCPA Case Which Had Attacked DOJ's Relationship With Company That Cooperated During Investigation

William McGrath — Wed, 16 May 2012 14:14:18 -0500

In connection with a May 14, 2012 hearing, Judge James Selna has prepared Tentative Minute Orders which deny two motions in the Carson FCPA cases. In a Motion to Suppress and a Motion to Dismiss, the defendants raised issues regarding DOJ's relationship with Control Components, Inc. ("CCI"), the employer of defendants, who cooperated with the investigation and provided certain information. In addition to our discussion below, Professor Mike Koehler of The FCPA Professor Blog takes a careful look at the case (which includes copies of the tentative rulings, here and here).

On July 31, 2009, DOJ announced that Control Components, Inc. ("CCI"), a California company that designs and manufactures valves, had pled guilty to a three-count criminal information for its involvement in a lengthy scheme to secure contracts in approximately 36 countries by paying bribes to employees of various companies. That plea marked the culmination of an internal investigation by CCI and the company's cooperation with DOJ. The cooperation led to the indictment of six former executives of CCI in the Carson case, alleging that the group conspired to violate the FCPA in order to secure contracts which yielded approximately $46.5 million in profits.

As discussed here, on March 5, 2012, several of the defendants in the Carson case filed a Motion to Dismiss and a Motion to Suppress in the case.

• In the Motion to Suppress, defendants argued that because CCI had collaborated with DOJ during the investigation, it was, in effect, a Government agent or a state actor who improperly compelled statements from the defendants during an internal investigation, violating their Fifth Amendment rights. As a result, defendants argued that the statements should be suppressed.

• In the Motion to Dismiss, defendants argued that "the impact of the cumulative impediments – unique investigation tactics preventing Defendants access" to certain evidence deprived them of their Due Process and Sixth Amendment rights, ("including the right to present a complete defense") and that "dismissal is the only appropriate remedy" for such severe prejudice.

As discussed here, the Government filed its Opposition to the Motion to Suppress on April 2, 2012, arguing, among other things, that the statements should not be suppressed because the employer's "actions were not the result of any pressure or influence from the government sufficient to convert the Company’s lawyers to state actors." On April 6, 2012, the Government filed its Opposition to the Motion to Dismiss, arguing that the motion was meritless because, among other things, the Government "has gone beyond its discovery obligations" to make sure that defendants receive the appropriate documentation that had been in the possession of CCI."

An interesting development occurred while the motions were pending: two of the four defendants who had filed the Motion to Dismiss and the Motion to Suppress – Stuart and Hong ("Rose") Carson – pled guilty to one count of violating the FCPA on April 16, 2012. However, the remaining movants, Paul Cosgrove and David Edmonds, continue to pursue the motions. As discussed here, the two remaining defendants Reply Briefs on April 30, 2012.

The Motion to Suppress. With respect to the Motion to Suppress, Judge Selna rejected the defendants' theory that CCI had become a "state actor." After reviewing the correspondence between Steptoe & Johnson, counsel to CCI and its parent corporation (IMI plc), and DOJ prior to the interviews of Messrs. Cosgrove and Edmonds, Judge Selna found that "there is no basis to conclude on the basis of events that transpired prior to the interviews or in the aftermath that the Steptoe lawyers were acting as agents of the Government." Instead, the Court determined that there was nothing "more than a unilateral determination on the part of CCI and its parent to cooperate with the Government." Judge Selna acknowledged that "it was in CCI’s interest and a legitimate activity to investigate potential criminal conduct in its business operations." The Court also noted that the Government was not involved with the Defendants' interviews, and corporate counsel's acts were not "so intertwined with the Government" that the interviews could be viewed as Government conduct, specifically pointing out that "[t]he record is clear that CCI through its parent IMI had made a decision to conduct an internal investigation before Steptoe contacted the Government."

Judge Selna also reviewed the issue of whether the defendants were coerced to give statements during the investigation, and if so, did the Government bring about the coercion? He pointed out that: (1) none of the defendants said they were threatened with termination; (2) while the company instructed defendants to cooperate, there were no threats in those instructions; (3) there was no evidence that the Government "precipitated or encouraged any threats of sanctions for failing to cooperate;" and (4) the company had already made a decision to suspend the defendants. The Court concluded that "the Defendants’ Fifth Amendment right were not violated during the conduct of the Steptoe interviews" and denied the Motion to Suppress.

The Motion to Dismiss. Judge Selna also denied the Motion to Dismiss, stating that many of the arguments raised in the motion had "been previously presented and rejected." For example, a theory based on the claim that Steptoe and CCI were, in effect, Government agents was already denied in the Motion to Suppress discussed above. The Court also rejected the argument that the Government had interfered with defense access to witnesses, pointing out that while "the Government has a responsibility not to interfere with witness access, … the Government is not the guarantor of such access." According to Judge Selna, defendants failed to prove the Government interfered with access to those witnesses or that their testimony was going to be "material and favorable" to the defense. The Court also rejected arguments regarding the production of documents, the ability of defendants to secure foreign documents by Letters Rogatory, or the production of documents under Brady v. Maryland, 373 U.S. 83 (1963). Finally, the Court ruled that "[t]ere has been no systemic or systematic denial of access to evidence enabling the Defendants to present a complete defense."

The theories in these two motions raised interesting issues which could have impacted future cases where a company cooperated and individual employees did not and faced the Government alone. In this case, the Government concluded that, with respect to the issues raised by defendants, the Government, CCI and its counsel did not act inappropriately. It will be interesting to see how the companies, the Government and the Courts behave the next time a case involving similar circumstances occurs.

In the mean time, Messrs. Cosgrove and Edmonds are scheduled to be tried beginning on June 26, 2012.

SEC Adopts Instructions for Submitting Draft Registration Statements for Confidential/Non-public Review

Robert J. Tannous — Tue, 15 May 2012 13:00:37 -0500

On May 11, 2012, the Securities and Exchange Commission ("SEC") issued Instructions for Emerging Growth Companies ("EGC") to submit confidential draft registration statements or foreign private issuer non-public draft registration statements to the SEC. Until those submissions can be made on EDGAR, EGC's must submit draft registration statements to the SEC in a text searchable PDF format via a secure e-mail system. The SEC will also use the secure e-mail system to send comment letters to EGCs and EGCs must use this system to submit their correspondence regarding their draft submissions to the SEC. Prior to submitting such filings, EGCs must register an account.

Federal Securities Law Blog's Monthly Review (May 15, 2012 Edition)

William McGrath — Tue, 15 May 2012 11:14:44 -0500

Today, the Federal Securities Law Blog takes a look back at the last 30 days in the federal securities world in a regular feature which appears on approximately the 15th of each month. The last month saw our Blog turn five years old, but more importantly, the SEC continued to provide guidance relating to the Jumpstart Our Business Startups Act ("JOBS Act"), and there were a host of issues in insider trading cases and cases involving companies in China. These and other matters from the last month are discussed in greater detail after the jump.

The JOBS Act.

As discussed last month, on April 5, 2012, President Obama signed into law the JOBS Act. On April 16, 2012, the SEC Division of Corporation Finance issued additional Frequently Asked Questions to provide guidance on the implementation and application of the Act, addressing questions of general applicability under Title I of the JOBS Act (as discussed here). Title I provides scaled disclosure provisions for emerging growth companies and allows emerging growth companies to use test-the-waters communications with Qualified Institutional Buyers and institutional accredited investors. CorpFin supplemented that guidance on May 3, 2012 (as discussed here). The FAQs clarify how an issuer can qualify as an emerging growth company, applicable dates for qualification and registration, and various reporting and disclosure requirements.

Information on EDGAR.

As discussed here, the Commission announced that beginning on April 19, 2012, the SEC staff will begin to republish Commission orders pursuant to Exchange Act Section 12(j) revoking a company’s Exchange Act registration and Commission stop orders pursuant to § 8 of the 1933 Act on EDGAR. Although these orders are currently posted on the SEC’s website as administrative orders, they have not been posted on EDGAR. The SEC staff will begin with the most recently issued orders and go backwards through 2004. New orders will be published on EDGAR when issued going forward.

Commission Improvements in Economic Analysis in Rulemaking.

On Tuesday, April 17, 2012, SEC Chairman Mary Schapiro testified before the House Subcommittee on TARP, Financial Services and Bailouts about the steps the SEC has taken and is taking to strengthen our economic analyses in the rulemaking process. Chairman Schapiro acknowledged that "economic analysis is a critical element of the SEC’s rulemaking obligation," and that "the unprecedented rulemaking burden generated by passage of the Dodd-Frank Act has tested the resources and analytical capabilities of the agency." However, she explained, the Commission has "learned a great deal and our rulemaking processes have continued to evolve." As discussed here, she told the Subcommittee that the SEC's "new guidance reflects many of the current best practices, which the agency will refine in the future as necessary to ensure high quality economic analysis in its rulemaking."

Insider Trading Issues.

News in the last thirty days provided some excellent insight into the SEC's efforts to combat insider trading. Devin Leonard's fine profile in BusinessWeek of Sanjay Wadhwa, a deputy chief of the SEC's market abuse group, in took a close look at the insider trading investigation of Raj Rajaratnam (and the many leads that investigation has yielded) and was instructive in highlighting how the SEC overcomes disadvantages and what it has done to improve its investigative efforts in recent years. The article, discussed here, focused on the investigation into the Galleon Group and early key discoveries such as the remarkably similar trading by Mr. Rajaratnam and others and his instant messages with Roomy Khan (a witness who ultimately cooperated with prosecutors). As the article points out, the Galleon investigation has led to 56 arrests and 48 convictions, including the conviction of Mr. Rajaratnam, his subsequent sentencing to 11 years in prison and the SEC's civil judgment against him for over $92 million. For those who follow matters investigated and litigated by the SEC, the BusinessWeek article provides a rare insight into how the SEC performs those tasks and what changes have occurred in their methodology in recent times.

The investigation which ensnared Mr. Rajaratnam continues and the Commission received a positive result on a procedural issues in its litigation against him and Rajat Gupta. Judge Jed Rakoff denied a motion to compel by the two defendants, who were seeking an order that the SEC produce documents concerning settlement negotiations between the Commission and cooperating witnesses. As discussed here, Judge Rakoff rejected the defendants' argument that the information from the negotiations could be used to prove bias, stating that "[t]he best evidence of bias in a cooperator's testimony comes from the actual agreement he struck with the SEC, not from his lawyer's attempt to get him a good deal."

Another positive story arising from insider trading investigations was the May 3, 2012 announcement from DOJ that it "has returned approximately $44 million to victims of [the] securities fraud scheme" involving of Joseph Nacchio, the former CEO of Qwest Communications International Inc. Following a trial, a jury convicted Mr. Nacchio of 19 counts of insider trading on April 19, 2007 based on events which took place between 1999 and 2002. As discussed here, the long process of litigation in the District Court and the Appellate Court meant that those who invested in Qwest waited ten years to see any recovery (even though Mr. Nacchio paid the forfeiture amount in 2007). However, ultimately $44 million in forfeited funds is "being returned to 112,210 victims who incurred losses on Qwest securities purchased during the fraud scheme." The distribution of funds to victims was authorized and overseen by the Department of Justice’s Victim Asset Recovery Program in the Criminal Division’s Asset Forfeiture and Money Laundering Section.

The SEC also achieved success in a pair of cases discussed here involving families that engaged in insider trading. In both cases, the insider and the tippees settled with the Commission, paying far more than the profit they earned. In one case, the SEC filed a case against Mohammed Mark Amin, a Hollywood movie producer ("the producer or executive producer for more than 75 Hollywood movies including Frida, Eve’s Bayou, and four movies in the Leprechaun series," according to the Commission) and his brother, cousin, and three other friends and business partners for insider trading in the shares of DuPont Fabros Technology Inc., a company in which Mr. Amin served on the board of directors. Those who traded earned approximately $618,000, but the six defendants settled by paying nearly $2 million. The same week, the Commission filed a case against Angela Milliard, a former paralegal at Semitool Inc., a semiconductor company in Montana, and her father for trading on inside information about the 2009 acquisition of the company. The daughter and father (who earned $67,000) agreed to settle the SEC's case by paying more than $175,000.

Whistleblower Unmasked.

An April 25, 2012 article by Scott Patterson and Jenny Strasburg in the Wall Street Journal revealed that, during an investigation of Pipeline Trading Systems LLC, an SEC attorney showed a witness a notebook which included handwritten notes from a whistleblower, and the witness recognized the handwriting and was able to tell his employers who the whistleblower was. As discussed here, the Whistleblower spoke to the Journal and agreed to be identified (and provided some insight on how he was treated both before and after he blew the whistle on Pipeline's activities). The Journal also published a letter from a letter from George S. Canellos, the Director of the SEC's New York regional office, which stated that the SEC did not expose the whistleblower and stated that the agency's use of notebooks with his handwriting was not "inadvertent" and not a "gaffe."

Chinese Entities.

The last thirty days saw developments in several cases involving Chinese companies, including a case filed yesterday against China Natural Gas, Inc. and its former CEO Qinan Ji for having the corporation make loans to Mr. Ji's family and failing to disclose the transactions.

In another case against a Chinese company discussed here, on April 23, 2012, the SEC filed a case against SinoTech Energy Limited, an oil field services company, with intentionally misleading investors about the value of its assets and its use of $120 million in IPO proceeds. The SEC also charged CEO Guoqiang Xin and former CFO Boxun Zhang for their involvement in the fraud. The Complaint, filed in federal court in Louisiana, alleges that the company's IPO registration statement misled investors about the acquisition and value of a key asset lateral hydraulic drilling units ("LHD Units") that are central to its business. In addition, the SEC charged Qingzeng Liu, SinoTech’s chairman and controlling shareholder, with misappropriating at least $40 million of SinoTech’s cash between June, 2011 and August 2011. The SEC’s complaint seeks permanent injunctive relief against all defendants, and disgorgement of ill-gotten gains by SinoTech and Mr. Liu, as well as civil penalties against the three individuals. The Commission also director-and-officer bars against each of the individual defendants.

As discussed here, on April 25, 2012, DOJ announced that Garth Peterson, a former managing director for Morgan Stanley’s real estate business in China, pled guilty in federal court in Brooklyn, New York for participating in a conspiracy to evade the internal accounting controls which the company was required to maintain under the FCPA. The SEC also announced that it brought and settled a case against Mr. Peterson. However, in announcing the case against Mr. Peterson, DOJ stated that it was not bringing any enforcement action against Morgan Stanley related to this conduct (noting that "Morgan Stanley constructed and maintained a system of internal controls, which provided reasonable assurances that its employees were not bribing government officials").

On May 9, 2012, the SEC announced that it has filed an Administrative Proceeding against Deloitte Touche Tohmatsu CPA Ltd. ("D&T Shanghai") for its refusal to provide the agency with audit work papers in connection with the Commission's investigation of the firm's client for alleged fraud. The Administrative Proceeding was filed while the Commission is in the midst of a subpoena enforcement action against the same accounting firm, that is scheduled to be heard in federal court in early June. The new matter is latest proceeding in the dispute over whether the SEC can compel the Chinese accounting firm to respond to its subpoena – the penalty which D&T Shanghai could face for its failure to comply is censure or being denied the ability to appear before the Commission.

Class Action Settlement.

In the In re: Lehman Bros. Sec. and ERISA Litig., Judge Lewis Kaplan issued a May 3, 2012 Memorandum and Order directing certain defendants (five officers, who had already allowed a retired Judge specially retained to assist in the parties' discussions to review information regarding their assets), to provide that same financial information to the Court for an in camera review. As discussed here, Judge Kaplan will review that information in order to make a determination regarding the fairness a $90 million settlement (which was to be paid by insurance coverage) between class action plaintiffs and the directors and officers.

SEC Ups The Ante in Subpoena Dispute With Deloitte Touche Shanghai By Filing An Administrative Proceeding Against the Chinese Accounting Firm Threatening Its Ability to Appear Before the Commission

William McGrath — Thu, 10 May 2012 12:47:54 -0500

On May 9, 2012, the SEC announced that it has filed an Administrative Proceeding against Deloitte Touche Tohmatsu CPA Ltd. ("D&T Shanghai") for its refusal to provide the agency with audit work papers in connection with the Commission's investigation of the accounting firm's client for alleged accounting fraud. The Administrative Proceeding was filed while the Commission is in the midst of a subpoena enforcement action against the same accounting firm, that is scheduled to be heard in federal court in early June. The new matter is latest proceeding in the dispute over whether the SEC can compel the Chinese accounting firm to respond to its subpoena – the penalty which D&T Shanghai could face for its failure to comply is censure or being denied the ability to appear before the Commission.

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.

As part of its investigation of Longtop, the SEC subpoenaed documents from D&T Shanghai, and the discussions regarding that subpoena boiled over into litigation.

• On May 27, 2011, the SEC served its subpoena on D&T Shanghai's former U.S. counsel (who had represented that he had authority to accept service). The accounting firm 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 a Motion for an Order to Show Cause in Federal Court in D.C., arguing, among other things, that the "vague assertions of possible conflicts with a foreign law" did not justify D&T Shanghai's non-compliance with the subpoena.

• On October 7, 2011, Magistrate Judge Deborah 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 on Service Abroad of Judicial and Extrajudicial Documents or some other internationally agreed-upon method]."

• On October 13, 2010, the SEC responded 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 discussed here, Magistrate Judge Robinson granted the SEC's motion for a order to show cause, ruling that "service of the application is not a prerequisite to the issuance of the proposed show cause order." She directed D&T Shanghai to file responsive papers addressing why it should not be ordered to respond to the Commission's subpoena.

• As discussed here, in January 2012, D&T Shanghai filed: (1) a motion seeking clarification of the Magistrate Judge's Order, raising a question of whether the Order was intended to require the SEC to serve D&T Shanghai under the terms of the Hague Convention, or whether the Order was intended to allow service on D&T Shanghai's counsel by e-mail; and (2) a Motion seeking to establish a revised briefing schedule.

• As discussed here, on February 1, 2012, Magistrate Judge Deborah Robinson issued a Minute Order which reiterated that the SEC can serve its Order to Show Cause on counsel for D&T Shanghai by e-mail.

D&T Shanghai, which is registered with the Public Company Accounting Oversight Board ("PCAOB"), filed its Brief in Response to the Order to Show Cause on April 11, 2012, arguing, among other things, that the China Securities Regulatory Commission ("CSRC") has prohibited D&T Shanghai from producing the work papers directly to the SEC (insisting that the SEC must work through the CSRC to obtain access to them). D&T Shanghai further argued that Chinese regulators "would be authorized to dissolve the firm entirely and to seek prison sentences up to life in prison for any [D&T Shanghai] partners and employees who participated in the violation," which represented an undue burden. D&T Shanghai also argued that the securities laws under which the SEC served the subpoena do not allow the Commission to obtain the documents located abroad. The accounting firm also argued that the Commission should be required to serve the subpoena under the Hague Convention (D&T Shanghai also moved to quash the subpoena for the same reason). The SEC will be filing a Reply Brief on May 23, 2012 and the matter is scheduled to be heard by Magistrate Judge Robinson on June 8, 2012.

The Administrative Proceeding filed yesterday begins the process which could result in the punishment of D&T Shanghai for its failure to respond to the subpoena. The SEC claimed that D&T Shanghai violated the Sarbanes-Oxley Act and the Securities Exchange Act of 1934 by failing to provide the SEC with the audit work papers, claiming, among other things that "Section 106(b) of Sarbanes-Oxley directs a foreign public accounting firm that issues an audit report, performs audit work or interim review' to 'produce the audit work papers of the foreign public accounting firm and all other documents of the firm related to such audit work' to the Commission upon request." The Commission further stated:

it is appropriate that this proceeding be brought … to determine whether D&T Shanghai should be censured or denied the privilege of appearance and practice before the Commission for having willfully violated Section 106 of Sarbanes-Oxley.

D&T Shanghai is required to respond to the SEC's Order commencing the Administrative Proceeding within twenty days.

Judge in Lehman Class Action Orders Officer Defendants to Provide (In Camera) Information Regarding Their Net Worth As Part of Settlement Process

William McGrath — Wed, 09 May 2012 14:48:03 -0500

When asked to approve a $90 million settlement (which was to be paid by insurance coverage) between class action plaintiffs and the directors and officers in the In re: Lehman Bros. Sec. and ERISA Litig., Judge Lewis Kaplan issued a May 3, 2012 Memorandum and Order directing certain defendants (five officers), who had already allowed a retired Judge (specially retained to assist in the parties' discussions) to review information regarding their assets, to provide that same financial information to the Court for an in camera review. Judge Kaplan will review that information in order to make a determination regarding the fairness of the settlement.

The Court summarized the history of the settlement discussions (and impact of the litigation on insurance coverage):

• the insurance coverage for the individual defendants was originally $250 million;

• by late 2010, due to costs of defending that suit, the coverage was down to $180 million;

• the parties met with a mediator (retired Judge Daniel H. Weinstein) and during those sessions defense counsel stated that: (a) the directors and officers would not contribute anything toward a settlement beyond what was covered by the insurance; and (b) the specifics of the individual defendants' financial information would not be disclosed to Lead Plaintiffs or their counsel;

• lead plaintiffs and their counsel were concerned about an objection from the public if the directors and officers "[got] off the hook without paying any money," and wanted to prevent such an objection;

• the parties engaged a former Judge (John S. Martin, Jr.) to evaluate whether the individuals had liquid assets (excluding primary residences and pensions) in excess of $100 million;

• Judge Martin had five officer defendants respond to confidential questionnaires containing that information;

• Judge Martin concluded that the assets were substantially less than $100 million.

In December 2011, Plaintiffs' Lead Counsel submitted a proposed settlement with the directors and officers for $90 million. As Judge Kaplan described the latter settlement:

The entire $90 million, it is proposed, would come from insurance previously purchased by Lehman. The former directors and officers, despite the fact that each of them, if the settlement were approved, would pay nothing, yet would be released from all claims that were or might have been asserted against them in this action.

In reviewing a class action settlement for fairness, the Court is required to consider a number of factors, including the ability of the defendants to withstand a greater judgment and the reasonableness of the settlement in light of the risks of litigation.

At an April 12, 2012 fairness hearing, Judge Kaplan expressed the concern that it did not have "sufficient information regarding the ability of the directors and officers to satisfy a judgment in that case in the event the plaintiffs did not settle with them and ultimately prevailed." Counsel for Lead Plaintiff argued that the settlement was an "excellent" result and provided the Court with additional information (including a Declaration from Judge Weinstein regarding the mediation and the record from the proceedings before Judge Martin – but not the financial information disclosed by the officer defendants).

Judge Kaplan concluded that, if it were time consuming, difficult or costly to gather the information regarding the financial condition of the individual officers, he might not require it. However, in this case, the information regarding the officer defendants already had been gathered and submitted to Judge Martin (Judge Kaplan concluded that the likelihood of recovery against the officer defendants was higher than the possibility of recovery against the director defendants). He recognized that the officer defendants may not want to share information with Lead Plaintiffs or their counsel, but found there was no sound reason why the information that already had been provided to Judge Martin should not also be provided to the Court in camera. He directed them to submit the information by May 10, 2012.

Professor Barbara Black's Securities Law Prof Blog has an interesting discussion of the case here.

All in the Family: A Pair of Insider Trading Cases

William McGrath — Tue, 08 May 2012 14:00:20 -0500

The SEC filed and settled two cases this week in which insiders tipped family members about events at publicly traded companies. In both cases, the insider and the tippees settled with the Commission, paying far more than any profit earned.

• On Tuesday, May 8, 2012, the SEC filed a case against Mohammed Mark Amin, a Hollywood movie producer, and his brother, cousin, and three other friends and business partners for insider trading in the shares of DuPont Fabros Technology Inc., a company in which Mr. Amin served on the board of directors. Those who traded earned approximately $618,000, but the six defendants settled by paying nearly $2 million.

• On Monday, May 7, 2012, the Commission filed a case against Angela Milliard, a former paralegal at Semitool Inc., a semiconductor company in Montana, and her father for trading on inside information about the 2009 acquisition of the company. The daughter and father (who earned $67,000) agreed to settle the SEC's case by paying more than $175,000.

The Hollywood Executive. The SEC described Mr. Amin as "a motion picture executive," who was "the producer or executive producer for more than 75 Hollywood movies including Frida, Eve’s Bayou, and four movies in the Leprechaun series." The SEC claims that, prior to a company board meeting, Mr. Amin learned about three new leases that DuPont Fabros was negotiating and three loans it was obtaining to develop new facilities. Mr. Amin learned this information when he received materials for a special board meeting to approve the three new loans.

Mr. Amin tipped his brother, his cousin, and a long-time friend and business manager. Those three traded on the basis of the inside information, and his brother tipped two friends and business associates. The group made more than $618,000 in insider trading profits when the company's share price rose 36 % after an earnings release disclosed the development of these new facilities.

The six defendants agreed to settle the SEC’s charges by collectively paying almost $2 million (consisting of disgorgement of $618,497, prejudgment interest of $78,000, and penalties totaling $1,236,994). They also agreed to the entry of a final judgment permanently enjoining them from violating Section 10(b) of the Exchange Act and Rule 10b-5. Mr. Amin agreed to a 10-year bar from serving as an officer or director of a public company.

The Montana Paralegal. In 2009, Ms. Milliard learned that Semitool and Applied Materials Inc., a Silicon Valley company, had entered into advanced merger negotiations, which would result in a the tender offer for nearly 30 % more than Semitool’s price at the time. The Commission alleged that she wired money to her boyfriend’s brokerage account and used it to purchase Semitool shares. She also provided her father Kenneth Milliard with information about the negotiations. He then purchased shares and tipped his sons, who also acquired shares. After Applied's acquisition of Semitool was announced, the Milliards sold their shares, earning profits of more than $67,000.

The daughter and father agreed to settle with the Commission by paying more than $175,000. Ms. Milliard will disgorge her profits of $20,355, and pay prejudgment interest of $1,614 and a penalty of $54,022. Her father will disgorge both his and his sons’ profits of $47,805, and pay prejudgment interest of $3,765 and a penalty of $47,805.

SEC Guidance for JOBS Act

Jack J. Gravelle — Fri, 04 May 2012 13:55:51 -0500

Over the past month the SEC has provided guidance regarding the Jumpstart Our Business Startups Act of 2012, or JOBS Act, which became law on April 5, 2012. The most recent guidance is in the form of Frequently Asked Questions on Title I, available May 3, 2012, as a supplement to prior FAQs on Title I issued April 16, 2012. Title I of the JOBS Act provides scaled disclosure provisions for emerging growth companies, including, among other things, (i) two years of audited financial statements in the registration statement for an initial public offering of common equity securities, (ii) the smaller reporting company version of Item 402 of Regulation S-K, and (iii) no requirement for Sarbanes-Oxley Act Section 404(b) auditor attestations of internal control over financial reporting. Title I also enables emerging growth companies to use test-the-waters communications with Qualified Institutional Buyers and institutional accredited investors, and liberalizes the use of research reports on emerging growth companies. The FAQs clarify how an issuer can qualify as an emerging growth company, applicable dates for qualification and registration, and various reporting and disclosure requirements.

On April 11, 2012, the SEC issued FAQs to provide guidance regarding Title V and Title VI of the JOBS Act. These titles provide for an increase in the number of holders of record that triggers periodic reporting requirements with the SEC under the Exchange Act. The FAQs provide information regarding how issuers can terminate a not yet effective registration process, or alternatively deregister an effective registration, if the issuer no longer meets the registration requirements as a result of the increase in the threshold of shareholders of record. The FAQs further clarify that an issuer may exclude from the holders of record calculation persons who received securities pursuant to an employee compensation plan in transactions exempted from registration requirements, even though the Commission has not yet revised the definition of “held of record” as required by the new law.

Also on April 11, 2012, the SEC requested public comments before proposing any rulemaking under the JOBS Act.

Finally, on April 10, 2012, the SEC issued FAQs to provide guidance regarding the confidential submission of registration statements for review pursuant to new Securities Act Section 6(e). Section 6(e) provides that an emerging growth company may confidentially submit to the Commission a draft registration statement for confidential, non-public review prior to public filing. The FAQs clarify which registration statements are eligible for submission, among other specific requirements.

DOJ Returns $44 Million From Former CEO Joseph Nacchio To Investors of Qwest

William McGrath — Fri, 04 May 2012 12:45:37 -0500

Prosecutors and the SEC work quite vigorously to recover ill-gotten gains from those who have committed securities fraud, with the ultimate goal of compensating investors. A conviction in a criminal case or judgment in civil case brought by the SEC may result in a large number, like the $53.8 million forfeiture judgment in the criminal case and the $92 million civil judgment against Raj Rajaratnam (discussed here), but that is only the first step. A May 3, 2012 Press Release from DOJ provides some insight into this process (and how long it may take) – following a 2007 conviction of Joseph Nacchio, the former CEO of Qwest Communications International Inc., based on events which took place between 1999 and 2002, DOJ announced that it "has returned approximately $44 million to victims of [that] securities fraud scheme."

DOJ prosecuted Mr. Nacchio for acts between 1999 and 2002 when he announced unrealistic revenue projections for Qwest and subsequently caused Qwest to issue false and misleading statements to the public about the company’s financial condition. When those irregularities were discovered, Qwest stock, which had traded as high as $60 per share, fell to approximately $1 per share.

Following a spring 2007 trial, a jury convicted Mr. Nacchio of 19 counts of insider trading on April 19, 2007. Chief Judge Edward W. Nottingham originally sentenced him to 72 months in prison, fined him $19 million, and ordered him to forfeit $52,007,545.47. Mr. Nacchio tendered the forfeiture amount to the custodian of seized property. The $19 million fine was deposited into the registry of the Court in an interest bearing account in August 2007, and was ultimately paid to a fund for victims of crime.

Mr. Nacchio appealed and on March 17, 2008, a three-Judge panel reversed his conviction. However, on February 25, 2009, the Tenth Circuit Court of Appeals issued a new opinion en banc, confirming Mr. Nacchio's conviction, but vacating the sentence and remanding the case to the District Court for further proceedings. U.S. v. Nacchio, 573 F.3d 1062 (10th Cir. 2009).

Following the Tenth Circuit's decision, Mr. Nacchio and the Government stipulated to a new forfeiture amount of $44,632,464.38 on January 12, 2010. Then, on June 24, 2010, Mr. Nacchio was resentenced, this time by Judge Marcia S. Krieger, who sentenced him to 70 months in prison and left the fine of $19 million in place. Mr. Nacchio appealed that decision, but agreed to dismiss the appeal in February 2011.

DOJ announced on Thursday that the $44 million in forfeited funds "are being returned to 112,210 victims who incurred losses on Qwest securities purchased during the fraud scheme." The distribution of funds to victims was authorized and overseen by the Department of Justice’s Victim Asset Recovery Program in the Criminal Division’s Asset Forfeiture and Money Laundering Section. Gilardi & Co. LLC, a class action claims Administrator was appointed as Administrator.

Claimants established their eligibility by participating in the private securities class action, In re Qwest Communications International Inc. Sec. Litig., No. 01-cv-1451 (D. Colo.) and/or the US Securities and Exchange Commission Fair Fund, SEC v. Qwest Communications International Inc., No. 04-D-2179 (D. Colo.). The private securities class comprised "all persons or entities that purchased or otherwise acquired [Qwest shares] from May 24, 1999, through July 28, 2002." The eligibility requirements for participation in the distribution were the same as the eligibility requirements for participation in the securities class action. On September 28, 2011 Gilardi & Co. LLC, the appointed Administrator, notified claimants of their eligibility status.

Assistant Attorney General Lanny Breuer stated "we are fulfilling a central objective of the Criminal Division’s Victim Asset Recovery Program and returning those funds to the victims of Mr. Nacchio’s crime."

Those who invested in Qwest will have waited ten years to see this recovery – and, in this case, the defendant, Mr. Nacchio paid the forfeiture amount in 2007. In many cases, the defendant does not willingly pay may a forfeiture award and DOJ is forced to search for and secure assets, which would have made DOJ's job more difficult and taken longer than the years in Mr. Nacchio's case.

Judge Rakoff Issues Opinion in Civil Gupta Case Explaining Why He Will Not Compel the SEC to Produce Documents Relating to Settlement Negotiations

William McGrath — Wed, 02 May 2012 15:32:37 -0500

In a Memorandum Order entered on May 1, 2012, Judge Jed Rakoff formally denied a motion to compel by Rajat Gupta and Raj Rajaratnam, who were seeking an order that the SEC produce documents concerning settlement negotiations between the Commission and cooperating witnesses. In an April 11, 2012 telephone conference, Judge Rakoff tentatively ruled in the Commission's favor, but allowed the parties to submit letter briefs on the issue. In the Memorandum Order, Judge Rakoff confirmed his tentative ruling, rejecting the defendants' argument that the information from the negotiations could be used to prove bias, stating that "[t]he best evidence of bias in a cooperator's testimony comes from the actual agreement he struck with the SEC, not from his lawyer's attempt to get him a good deal."

In the past fourteen months, the litigation between Mr. Gupta, the former Managing Director of McKinsey & Company and board member at Goldman Sachs and Procter & Gamble, and the Commission has been remarkably active. From the outset, when the SEC brought an Administrative Proceeding against him alleging that he engaged in an insider trading scheme by providing nonpublic material information to Mr. Rajaratnam of Galleon Management, Mr. Gupta has argued that he should be able to take discovery to defend himself in Court. Mr. Gupta and the SEC agreed to the dismissal of the Administrative Proceeding and a related case in August, 2011 (as discussed here). By October 2011, both the SEC and the U.S. Attorney's Office for the Southern District of New York filed charges against Mr. Gupta (with the Commission also naming Mr. Rajaratnam, as well) (described here).

As they had planned, the attorneys for Mr. Gupta have raised discovery issues. During the factual investigation that preceded the two cases, Assistant U.S. Attorneys from the Southern District of New York and an attorney from the SEC conducted joint interviews of 44 witnesses. Mr. Gupta's attorneys filed motions in both the civil and criminal cases to seek materials regarding those interviews. On March 26, 2012, Judge Rakoff issued an Opinion and Order in the two cases (discussed here), granting in part a Motion to Compel and ordering the SEC to turn over to the U.S. Attorney's Office materials relating to the 44 witnesses and ordered the prosecutors to review those memoranda and promptly turn over to the defense any material under Brady v. Maryland, 373 U.S. 83 (1963) (material exculpatory evidence to the defense – including evidence that could allow the defense to impeach the credibility of a prosecution witness). With respect to the motion in the civil case, Judge Rakoff found that Mr. Gupta could not meet the burden of showing a "substantial need" for the SEC documents sufficient to overcome the attorney work product doctrine (except for the Brady material in the SEC's notes and memoranda).

In the most recent discovery dispute, Messrs. Gupta and Rajaratnam requested the Commission to produce documents concerning settlement negotiations between the SEC and cooperating witnesses, including tax returns or other financial statements provided by the cooperators to the SEC during negotiations. They argued that the documents were relevant to probing the bias of the cooperators expected to testify against them. The SEC objected, pointing out that the final settlement agreements themselves would satisfy defendants' interest in materials relating to bias.

Judge Rakoff held that Messrs. Gupta and Rajaratnam failed to demonstrate "that the settlement negotiations are relevant to proving bias." Instead, the Court held, "what is relevant are the actual cooperation agreements themselves. The otherwise protected negotiations that led to the agreements have very limited, if any, additional probative value." Judge Rakoff that the SEC did not have any Wells submissions or statements from the cooperating witnesses. In any event, the Judge noted:

Attorneys stake out adversarial positions in negotiations and engage in "puffing and posturing" in their attempt to obtain the best deal. But these posturings have only indirect and attenuated relevance, at best, to anything bearing on proof of their clients' bias.

Judge Rakoff also pointed out that the probative value of negotiations "is substantially outweighed by the policy concern in protecting against unnecessary intrusions into the settlement bargaining table."

Judge Rakoff also rejected defendants' request for financial information from the cooperators, because he did not see how it was relevant to bias. "the cource of any bias in a cooperator's testimony would be the 'break' the cooperator received from the the SEC in exchange for the cooperator's testimony, something that is readily apparent from comparing the complaint to the final agreement."

Defendants in the Carson FCPA Case File Reply Briefs Attacking Government's Interaction With The Employer During the Latter's Internal Investigation and the Government's Conduct During Discovery

William McGrath — Tue, 01 May 2012 15:42:59 -0500

On Monday, April 30, 2012, two of the remaining defendants in the Carson FCPA case submitted Reply Briefs in support of motions that raise significant issues about the impact on the employees when a corporation conducts an internal investigation and ultimately cooperates with the Government. The briefs argued that: (1) certain statements should be suppressed because the Government offered no evidence from the participants in discussions between the corporation's counsel and DOJ prior to interviews of employees during an internal investigation (thereby failing to rebut defendants' arguments that their Fifth Amendment rights were violated); and (2) the Government's tactics during discovery violated defendants' rights by denying them the opportunity to present a complete defense. The arguments on these issues are set to be heard on May 14, 2012.

On July 31, 2009, DOJ announced that Control Components, Inc. ("CCI"), a California company that designs and manufactures valves, had pled guilty to a three-count criminal information for its involvement "in a decade-long scheme to secure contracts in approximately 36 countries by paying bribes to officials and employees of various foreign state-owned companies as well as foreign and domestic private companies." That plea marked the culmination of an internal investigation by CCI and the company's cooperation with DOJ. The cooperation led to other CCI executives being indicted even before CCI pled guilty. For example, on April 8, 2009, prosecutors indicted six former executives of CCI, alleging that the group conspired to pay bribes to officials of foreign state-owned companies in order to secure contracts which yielded approximately $46.5 million in profits.

As discussed here, on March 5, 2012, the defendants in that case filed a Motion to Dismiss and a Motion to Suppress regarding DOJ's relationship with CCI. In the Motion to Suppress, defendants argued that because CCI had collaborated with DOJ during the investigation, CCI and its counsel "were de facto public actors" and acted as "an agent of the government during the interviews." Defendants further argued that "CCI compelled the Defendants' statements under a classic 'penalty situation' – CCI required them to answer all questions regardless of their Fifth Amendment right against self-incrimination or be fired." This conduct, defendants claimed, "violated their Fifth Amendment rights and the statements must be suppressed."

In the Motion to Dismiss, the defendants argued that they had been prejudiced by the Government's investigative tactics (including its relationship with CCI, who, according to defendants, "worked hand-in-hand with DOJ to investigate the matters at issue in this case), including: (1) tactics precluding defendants access to millions of pages of normally-discoverable evidence; (2) the lack of a meaningful review under Brady (including the fact that CCI would not turn over material to DOJ); (3) CCI’s loss of crucial documents underlying many of the counts and transactions; and (4) CCI's instructions to its employees not to speak with the defense. The defendants argued that that combination of tactics "deprived [them] of their Due Process and Sixth Amendment rights, including the right to present a complete defense." According to the motion, the "only appropriate remedy" for such severe prejudice is dismissal.

As discussed here, the Government filed its Opposition to the Motion to Suppress on April 2, 2012, arguing the statements should not be suppressed because the employer's "actions were not the result of any pressure or influence from the government sufficient to convert the Company’s lawyers to state actors," and because defendants could not "show that their statements were involuntary." On April 6, 2012, the Government filed its Opposition to the Motion to Dismiss, arguing that the motion to dismiss was meritless because, among other things, the Government "has gone beyond its discovery obligations in ensuring that defendants receive Brady/Giglio material in the possession of CCI."

In an interesting development on April 16, 2012, two of the four defendants who had filed the Motion to Dismiss and the Motion to Suppress – Stuart and Hong ("Rose") Carson – pled guilty to one count of violating the FCPA. However, the remaining movants, Paul Cosgrove and David Edmonds, continue to pursue the motions.

In filing the Reply Brief in support of the Motion to Suppress, Messrs. Cosgrove and Edmonds highlighted the fact that the Government had not offered any evidence from any witness who participated in the discussions between CCI (or their counsel) and DOJ during the key time frame. As a result, defendants argue, it is uncontroverted that CCI's counsel was a state actor when its attorneys interviewed defendants, those defendants had a reasonable fear that that they could lose their jobs if they did not answer, and that counsel did not warn them of their rights under the Fifth Amendment. As a result, the statements should be suppressed, according to defendants.

In their Reply Brief regarding the Motion to Dismiss, defendants argue that the "real issue" is whether the Government's tactics, whether undertaken in good faith or bad faith, deny defendants the opportunity to present a complete defense. The defendants also point to the Government's Brady obligations, asserting that the government significantly reduced the requests defendants made for Brady items when it (the Government) forwarded those requests to CCI, essentially exercising "unfettered discretion to unilaterally redact requests and deprive Defendants of a comprehensive Brady review."

Both motions are scheduled to be heard on May 14, 2012 and have the potential to provide insight and guidance regarding the interaction between counsel for the corporation and the employees in future investigations.

The case is presently scheduled to go to trial on June 5, 2012.

Happy Fifth Anniversary!

Robert J. Tannous — Fri, 27 Apr 2012 09:07:24 -0500

Today marks the fifth anniversary for our Federal Securities Law Blog. We look forward to providing many more years of content on federal securities laws, news, and developments. Many thanks to all who contributed to the success of our Blog.

Former Morgan Stanley Executive Pleads Guilty to Conspiring to Evade Internal Accounting Controls Under the FCPA in China, While Morgan Stanley Avoids Prosecution Due to Internal Controls

William McGrath — Thu, 26 Apr 2012 10:36:08 -0500

On Wednesday, April 25, 2012, DOJ announced that Garth Peterson, a former managing director for Morgan Stanley’s real estate business in China, pled guilty in federal court in Brooklyn, New York for participating in a conspiracy to evade the internal accounting controls which the company was required to maintain under the FCPA. Because Morgan Stanley had a system of internal controls designed to assure that its employees were not bribing government officials, the Government did not prosecute the company. The SEC also announced that it brought and settled a case against Mr. Peterson.

The Government alleged that Morgan Stanley ensured accountability for its assets by maintaining a system of internal controls. That system was also designed to prevent employees from offering, promising or paying anything of value to foreign government officials by prohibiting bribery and addressing corruption risks associated with the giving of gifts, business entertainment, travel, lodging, meals, charitable contributions and employment. In order to keep up with regulatory developments and specific risks, the policies were updated regularly. Morgan Stanley also provided frequent training for its employees on these issues (including over 54 training programs between 2002 and 2008 for personnel based in Asia). Mr. Peterson was trained on the FCPA seven times and received reminders regarding the policy 35 times.

Despite the wealth of training, the Government contends that Mr. Peterson conspired with others to transfer a multi-million dollar ownership interest in a Shanghai building to himself and a Chinese public official. Specifically, Mr. Peterson encouraged Morgan Stanley to sell an interest in the building at a discount to Shanghai Yongye Enterprise (Group) Co. Ltd., a state owned and controlled entity. Mr. Peterson knew the interest would then be conveyed to a shell company, which he controlled along with a Chinese public official and a Canadian attorney. The Government contends that the conspirators realized an immediate profit of more than $2.5 million (and covered up their conduct by continuing to falsely represent that Yongye owned the shell company.

Mr. Peterson pled guilty to one count of conspiring to evade Morgan Stanley's internal controls. Assistant Attorney General Lanny Breuer stated that "Mr. Peterson admitted today that he actively sought to evade Morgan Stanley’s internal controls in an effort to enrich himself and a Chinese government official," adding that, "[a]s a managing director for Morgan Stanley, he had an obligation to adhere to the company’s internal controls; instead, he lied and cheated his way to personal profit. Because of his corrupt conduct, he now faces the prospect of prison time." He is scheduled to be sentenced on July 17, 2012 and faces a maximum sentence of five years in prison.

In announcing the case against Mr. Peterson, DOJ stated that it was not bringing any enforcement action against Morgan Stanley related to this conduct (noting that "Morgan Stanley constructed and maintained a system of internal controls, which provided reasonable assurances that its employees were not bribing government officials").

The civil charges brought by the SEC make similar allegations regarding the sale of the Shanghai building and also alleges that Mr. Peterson arranged to have at least $1.8 million paid to himself and the Chinese official as finder's fees which were owed to third parties. Mr. Peterson consented to the entry of an injunction against future violations, permanent industry bars and an order requiring him to disgorge over $250,000 and to relinquish the interest (valued at $3.4 million) in the property.

Wall Street Journal Article Details How SEC Inadvertently Revealed The Identity of A Whistleblower During An Investigation UPDATED On April 27, 2012

William McGrath — Wed, 25 Apr 2012 12:50:10 -0500

An article by Scott Patterson and Jenny Strasburg in the Wall Street Journal today revealed that, during an investigation of Pipeline Trading Systems LLC, an SEC attorney showed a witness a notebook which included handwritten notes from a whistleblower, and the witness recognized the handwriting and was able to tell his employers who the whistleblower was. The Whistleblower agreed to speak to the Journal and be identified, and detailed how he was treated both before and after he blew the whistle on Pipeline's activities. UPDATE: As discussed below, the SEC denies inadvertently disclosing the whistleblower's identity.

According to papers filed in a settled Administrative Proceeding filed in October 2011, Pipeline operated an alternative trading system ("ATS"), a private stock-trading platform commonly referred to as a "dark pool." Pipeline represented that its trading system anonymously matched customers’ interests in trading large amounts of stock. What Pipeline did not disclose to its customers was "that the overwhelming majority of the shares traded on its ATS were bought or sold by a wholly owned subsidiary of Pipeline." In settling the matter, Pipeline did not admit or deny the SEC's findings, but agreed to pay a $1 million penalty. The company's founder and chief executive officer, Fred Federspiel, and its chairman and former CEO, Alfred Berkeley, also settled (without admitting or denying the claims) by paying $100,000 each.

In May 2011, the SEC adopted final rules to implement Section 922 of the Dodd-Frank Act regarding securities whistleblower incentives and protection. One of the significant highlights of the final rules is that the Commission has sought to struck a compromise between the importance of the corporation's compliance programs on the one hand, and the incentive for the whistleblower to report anonymously and directly to the SEC (and by-pass the corporation) on the other hand. One school of thought was that if employee whistleblowers simply presented information to the Commission, without reporting to the corporation, it would have an impact on compliance programs by depriving companies of one of the key sources of information necessary to identify and resolve potential issues. On the other hand, allowing whistleblowers to go directly to the SEC, as Commissioner Elisse Walter explained would encourage those sources "who fear for their jobs, their livelihood and their families’ welfare."

According to the Journal, the SEC's practice "has been to avoid unnecessarily revealing an informant's identity. The agency asserted that it followed its policy, but "officials said there is always a risk a whistleblower's identity might be disclosed during an investigation." The Commission acknowledged that the notebook with the handwriting was shown to a witness during the investigation. That witness, the head of Pipeline's trading affiliate, Milstream Strategy Group, said that he recognized the handwriting and discussed the matter with others at Pipeline, identifying the whistleblower.

The Journal article identified that whistleblower as Peter Earle, a former employee, (who sat near Gordon Henderson, the head of Milstream who was shown the notebook and able to identify his handwriting). He agreed to be publicly identified and told the Journal he was "disappointed" that his identity was revealed. According to the Journal, Mr. Earle "raised concerns internally about Milstream's trading activities" and "made other internal complaints about trading." He was fired in April, 2009, for allegedly poor performance (which Mr. Earle called "ridiculous"). He then contacted the SEC shortly after his dismissal. Mr. Earle said "Pipeline's efforts at all junctures have been to malign me. That's one of the reasons I went to the SEC in the first place." Mr. Earle further told the Journal that current and former Pipeline employees remain angry at him

UPDATE: On April 25, 2012, the Journal published a letter from George S. Canellos, the Director of the SEC's New York regional office in which he stated that the SEC did not expose Mr. Earle as a whistleblower and stated that the agency's use of notebooks with his handwriting was not "inadvertent" and not a "gaffe.

SEC Files Case Against Chinese Company For Misrepresentations Regarding the Use of Its IPO Proceeds

William McGrath — Tue, 24 Apr 2012 10:45:01 -0500

On Monday, April 23, 2012, the SEC announced that it had filed a case against SinoTech Energy Limited, an oil field services company based in China, with intentionally misleading investors about the value of its assets and its use of $120 million in IPO proceeds. The SEC also charged CEO Guoqiang Xin and former CFO Boxun Zhang for their involvement in the fraud. The Complaint, filed in federal court in Louisiana, alleges that the company's IPO registration statement misled investors about the acquisition and value of a key asset lateral hydraulic drilling units ("LHD Units") that are central to its business. In addition, the SEC charged Qingzeng Liu, SinoTech’s chairman and controlling shareholder, with misappropriating at least $40 million of SinoTech’s cash between June, 2011 and August 2011.

According to the Commission, SinoTech filed an IPO registration statement with the Commission in November, 2010. It described itself as a fast-growing, non-state owned provider of enhanced oil recovery ("EOR") services to major oil companies in China, whose success derived from the use of lateral hydraulic drilling techniques. Its IPO included the sale of nearly 20 million American Depository Shares ("ADS") at a price of $8.50 per share, from which SinoTech raised more than $120 million. The Commission alleged that "SinoTech’s IPO registration statement represented, among other things, that the company would use funds raised in the IPO for two purposes: $51 million to repay a credit line used to purchase LHD Units, and $69 million to purchase additional LHD Units."

The Commission claimed that SinoTech did not use the IPO proceeds as represented, but instead obtained all of its LHD Units from a sole supplier located in Lake Charles, Louisiana. SinoTech contracted to purchase 15 LHD Units (for approximately $18.9 million), but only paid $16 million and only received 11 LHD Units. Moreover, after the IPO, "SinoTech overstated the value of its equipment in numerous filings and press releases."

The Commission also alleged that Mr. Liu, the Chairman of SinoTech, conducted in unauthorized transactions resulting in the withdrawal of approximately $40 million from SinoTech’s bank account (and subsequently confessed to making the withdrawal). The company did record the withdrawal in its books and records and retained Mr. Liu as Chairman despite his confession. The company attempted to hide the theft and rebut an Internet report alleging fraud in August 2011 by issuing a press release that contained false information regarding the company's balance in its bank accounts.

The SEC’s complaint seeks permanent injunctive relief against all defendants, and disgorgement of ill-gotten gains by SinoTech and Mr. Liu, as well as civil penalties against the three individuals. The Commission also director-and-officer bars against each of the individual defendants. All three individuals are residents of China, which may complicate the Commission's efforts to serve them.

BusinessWeek Article Provides Detailed Look Into The Inner Workings of the SEC's Investigation of Raj Rajaratnam

William McGrath — Mon, 23 Apr 2012 13:50:49 -0500

An April 19, 2012 article by Devin Leonard of BusinessWeek profiles Sanjay Wadhwa, currently a deputy chief of the SEC's market abuse group. The article takes a close look at the insider trading investigation of Raj Rajaratnam (and the many leads that investigation has yielded). Although many bloggers point out situations where the SEC or prosecutors are criticized (this blog included, in entries such as here and here), the BusinessWeek article, entitled "The SEC: Outmanned, Outgunned and On a Roll," is instructive in highlighting how the SEC overcomes disadvantages and what it has done to improve its investigative efforts in recent years.

The article focuses on the investigation into the Galleon Group (including a May 2007 subpoena which yielded 4 million pages of documents, hundreds of thousands e-mails and 50,000 instant messages). Those documents yielded key discoveries such as the remarkably similar trading by Mr. Rajaratnam and his younger brother Rengan (which led the SEC to examine Mr. Rajaratnam more closely), and instant messages between Mr. Rajaratnam and Roomy Khan (a witness who ultimately cooperated with prosecutors). As the article points out, the Galleon investigation has led to 56 arrests and 48 convictions, including the conviction of Mr. Rajaratnam, his subsequent sentencing to 11 years in prison and the SEC's civil judgment against him for over $92 million.

The article emphasizes a number of the bureaucratic challenges SEC staff members like Mr. Wadhwa faced, as well as detailing how things have changed in recent years (particularly with the appointments of Mary Schapiro and Robert Khuzami). For example, the article describes the "unfathomable bureaucratic iceberg" which existed previously, that, for example, required multiple levels of review to have a subpoena issued. However, now an attorney within the Division of Enforcement can act immediately to get a subpoena issued, without going through layers of review.

The article also emphasizes the SEC's interaction with criminal prosecutors and the different powers they each have. For example, the criminal prosecution of Mr. Rajaratnam featured evidence from wiretaps, but the SEC is not permitted to use them. Mr. Wadhwa questioned that policy, saying: "… the U.S. Fish and Wildlife Service has access to wiretaps and the SEC doesn't? And somehow you expect us to oversee Wall Street?"

Ultimately, the Commission moves slowly at times, can be an advantage, according to the article: "As an investigatory method, this translates into the staff collecting as much information as possible – phone records, trading records, lists of people at public companies who possessed confidential information – and sequestering themselves until they figure out if they have anything."

For those who follow matters investigated and litigated by the SEC, the BusinessWeek article provides a rare insight into how the SEC performs those tasks and what changes have occurred in their methodology in recent times.

SEC to Republish Exchange Act Registration Revocations and Stop Orders on EDGAR

Jeremy D. Siegfried — Fri, 20 Apr 2012 15:32:19 -0500

The SEC announced that beginning on April 19, 2012, the SEC staff will begin to republish via EDGAR Commission orders pursuant to Exchange Act Section 12(j) revoking a company’s Exchange Act registration and Commission stop orders pursuant to Securities Act Section 8.

Although these orders are currently posted on the SEC’s website as administrative orders, they have not been posted on EDGAR. The SEC staff will begin with the most recently issued orders and go backwards through 2004. New orders will be published on EDGAR when issued going forward.

COLUMBUS/1625994v.3

Publishing on EDGAR will allow a viewer to see the order in the context of all of a company’s public flings. In addition, the SEC will note in search results if a company’s Exchange Act registration has been revoked.

SEC Chairman Schapiro Testifies Before A Congressional Committee About Improvements in Economic Analysis in Commission Rulemakings

William McGrath — Wed, 18 Apr 2012 16:05:19 -0500

On Tuesday, April 17, 2012, Mary Schapiro, the Chairman of the SEC, appeared before the House Subcommittee on TARP, Financial Services and Bailouts to testify about the steps the SEC has taken and is taking to strengthen our economic analyses in the rulemaking process. Chairman Schapiro acknowledged that "economic analysis is a critical element of the SEC’s rulemaking obligation," and that "the unprecedented rulemaking burden generated by passage of the Dodd-Frank Act has tested the resources and analytical capabilities of the agency." However, she explained, the Commission has "learned a great deal and our rulemaking processes have continued to evolve." She told the Subcommittee that the SEC's "new guidance reflects many of the current best practices, which the agency will refine in the future as necessary to ensure high quality economic analysis in its rulemaking."

Chairman Schapiro explained how the SEC's "rulemaking process is governed by a number of legal requirements, including those under the federal securities laws, the Administrative Procedure Act ('APA'), the Paperwork Reduction Act of 1980 ('PRA'), the Small Business Regulatory Enforcement Fairness Act of 1996, and the Regulatory Flexibility Act." She also explained how the Commission must determine whether a rule is in the public interest, whether it would protect investors, and whether it will promote efficiency, competition, and capital formation. The SEC must also consider the impact any rule would have on competition. She explained that while the Commission is not required to conduct a formal cost-benefit analysis, it has done so as a matter of good practice.

According to Chairman Schapiro, GAO and the SEC's Office of Inspector General have reviewed the SEC’s cost-benefit analysis in rulemaking and found that the Commission engages in a "systematic approach" to cost-benefit analysis in rulemaking. GAO also provided "useful direction for improvement." She also cited issues raised by Congress about certain aspects, as well as recent court decisions. An example of the latter was the decision in the Business Roundtable case, when the D.C. Circuit vacated Exchange Act Rule 14a-11, finding that "the Commission acted arbitrarily and capriciously for having failed once again … adequately to assess the economic effects of a new rule," as discussed here. Shortly after that decision, the SEC announced that it would not appeal the matter, pledging to "learn from the Court's objections," as described here.

Chairman Schapiro explained that the Commission and its staff have learned valuable lessons in implementing the rules required under the Dodd-Frank Act thus far. Those lessons have included:

• involving the Division of Risk, Strategy, and Financial Innovation ("RSFI") earlier in the rulemaking process, so that the RSFI economists can provide economic analysis of different policy options before a proposed course is chosen and throughout the course of the development of the rule;

• assuring that rule releases clearly identify the justification for the proposed rule, such as a market failure or a statutory mandate;

• considering the overall economic impacts of the rule, including those attributable to Congressional mandates and those resulting from the Commission’s exercise of discretion;

• quantifying the costs and benefits when possible; and

• conducting a more integrated analysis of economic issues (including efficiency, competition, and capital formation) in the Commission’s rule releases.

She also described how economists "must play a central role in rulemaking," and pledged "close collaboration" with RSFI to integrate economic analysis during the process. She explained Commission efforts to provide additional resources to RSFI by, among other things, adding at least 20 more economists in the coming months.

She explained how the SEC's efforts "should result in the public, Commission, and staff being better informed about rules' likely economic consequences and in more clear and comprehensive economic analyses," and pledged "further improvements … in the weeks and months ahead."

SEC Issues Additional JOBS Act FAQs: Generally Applicable Questions on Title I of the JOBS Act

Robert J. Tannous — Mon, 16 Apr 2012 12:44:15 -0500

On April 16, 2012, the SEC Division of Corporation Finance issued additional Frequently Asked Questions to provide guidance on the implementation and application of the Jumpstart Our Business Startups Act (the "JOBS Act"), based on its current understanding of the JOBS Act and in light of its existing rules, regulations and procedures. These FAQs address questions of general applicability under Title I of the JOBS Act. Title I provides scaled disclosure provisions for emerging growth companies, including, among other things, two years of audited financial statements in the Securities Act of 1933 registration statement for an initial public offering of common equity securities, the smaller reporting company version of Item 402 of Regulation S-K, and no requirement for Sarbanes-Oxley Act Section 404(b) auditor attestations of internal control over financial reporting. Title I also enables emerging growth companies to use test-the-waters communications with Qualified Institutional Buyers or "QIBs" and institutional accredited investors and liberalizes the use of research reports on emerging growth companies.

Federal Securities Law Blog's Monthly Review (April 15, 2012 Edition)

William McGrath — Fri, 13 Apr 2012 13:49:31 -0500

Today, the Federal Securities Law Blog takes a look back at the last 30 days in the federal securities world in a regular feature which appears on approximately the 15th of each month. Although our prior monthly reviews have examined litigation issues, we will be expanding our review to cover other issues. The biggest news this month has been the April 5, 2012 passage of the Jumpstart Our Business Startups Act ("JOBS Act"). The JOBS Act and other matters from the last month are discussed in greater detail after the jump.

The JOBS Act.

As discussed here, President Obama signed into law JOBS Act on April 5, 2012. The Act implements measures relating to the IPO process and reporting requirements for a new category of issuer known as the "emerging growth company" ("EGC"). The Act defines an EGC as a company with annual gross revenues of less than $1 billion during its most recent fiscal year. The Act amends applicable federal securities laws to exempt EGCs from various requirements and restrictions including the requirement to publicly file an IPO registration statement (an EGC may confidentially submit its registration statement and any amendments to the SEC). The exemption under Regulation A is discussed more closely here. The Act also provide relief to EGCs with respect to disclosure requirements, including exemption from the "say on pay" provisions of the Dodd-Frank Act and the auditor attestation of internal controls required by Section 404(b) of the Sarbanes-Oxley Act of 2002.

Shortly after passage, on two occasions (discussed here and here), the SEC's Division of Corporate Finance issued Frequently Asked Questions to provide guidance on the implementation and application of the JOBS Act in light of the SEC's existing rules, regulations and procedures. The topics covered by these FAQs include questions relating to the confidential submission of registration statements for review pursuant to new Securities Act Section 6(e) and the requirements for Exchange Act registration and deregistration (which is also examined in greater detail here).

One of the most discussed issues under the JOBS Act is a new way to raise money known as "crowdfunding." As discussed here and here, the Act creates a new securities registration exemption that issuers could rely on to sell up to $1 million worth of securities to non-accredited investors as long as no individual investor invests more than: (a) $2,000 or 5% of the investor’s annual income in any 12-month period (for investors with annual income or net worth less than $100,000); or (b) 10% of the investor’s annual income or net worth up to $100,000 in any 12-month period (for investors with annual income or net worth in excess of $100,000). These "crowdfunders" would not count toward the 500 shareholders of record threshold that triggers Exchange Act registration under Section 12(g). Furthermore, for those issuers that want to continue to sell to accredited investors, the JOBS Act would require the SEC to amend Regulation D to permit general solicitation and advertising in Rule 506 offerings sold only to accredited investors (which is also discussed here).

The STOCK Act.

The JOBS Act was not the only securities-related litigation passed this month. As discussed here, on April 4, 2012 President Obama signed into law the Stop Trading on Congressional Knowledge Act of 2012 ("the STOCK Act"). The Act bans insider trading by members of Congress and their staff as well as various other executive branch and judicial branch employees. The STOCK Act also amends the Ethics in Government Act of 1978 to require a government-wide shift to electronic reporting and on-line availability of pubic financial disclosure information. In addition, members of Congress and covered governmental employees must report certain investment transactions within 45 days after a trade. Members of the public will be able to search this electronic database. The Act also limits members of Congress and other high level governmental officials so that they only may participate in IPOs that are available to the general public at large. In addition, the STOCK Act also requires the GAO and CRS to produce a report on the role of political intelligence firms in the financial markets.

Investor Advisory Committee.

While Congress was enacting new laws, the SEC fulfilled one of its obligations under an existing law (Section 911 of the Dodd-Frank Act) by announcing on April 9, 2012 the formation of the new Investor Advisory Committee. The new Committee (discussed here), which replaced a prior Investor Advisory Committee, was formed to "advise the Commission on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, and on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace." The 21 members will "represent a wide variety of interests, including senior citizens and other individual investors, mutual funds, pension funds, and state securities regulators" and will begin working "in the near future."

SEC Cooperation Standards.

In a Litigation Release posted on March 19, 2012 (and discussed here), the SEC provided "guidance regarding the circumstances under which individuals may receive credit as part of the SEC’s Cooperation Initiative." The announcement focused on the acts of a un-named (and un-charged) senior executive at AXA Rosenberg, an institutional money manager that specialized in quantitative investment strategies, who cooperated with the SEC, leading to charges regarding a material error in a computer code that was used to manage client assets. The Commission focused on the four considerations identified in the January 2010 Policy Statement Concerning Cooperation by Individuals in its Investigations and Related Enforcement Actions. Specifically, the Commission considered the assistance provided by the cooperating individual; the importance of the underlying matter; the societal interest in ensuring that the cooperating individual is held accountable; and the appropriateness of cooperation credit. After considering these factors, the SEC elected not to take enforcement action against the senior executive, but noted that its evaluation "was dependent upon the unique facts and circumstances of this case," and pointed out that it did not "create or recognize any legally enforceable rights for any person."

In a second case, the SEC announced on March 27, 2012 that it has sued John Cinderey, a former executive vice president at United Commercial Bank for aiding and abetting securities law violations relating to falsifying books and records and misleading the bank's auditors. As discussed here, the Commission settled with Mr. Cinderey, who agreed to be permanently enjoined from violating provisions of the federal securities laws. The settlement reflected the credit given to Mr. Cinderey "for his substantial assistance in the investigation," along with his agreement to cooperate to assist in an ongoing related enforcement action.

The SEC and Discovery/Investigative Issues.

As described here, on March 26, 2012, Judge Jed Rakoff issued an Opinion and Order in the two related cases against Rajat Gupta, granting in part a Motion to Compel and ordering the SEC to turn over to the U.S. Attorney's Office materials relating to 44 witnesses (who were interviewed by the SEC and prosecutors jointly during the investigations of Mr. Gupta). He further ordered the prosecutors to review those memoranda and promptly turn over to the defense any material under Brady v. Maryland, 373 U.S. 83 (1963) (material exculpatory evidence to the defense – including evidence that could allow the defense to impeach the credibility of a prosecution witness). In what has become a familiar pattern for him, Judge Rakoff questioned the policy of the SEC and DOJ – this time it was the policy to not produce such material involving joint investigations. Judge Rakoff stated: "That separate government agencies having overlapping jurisdiction will cooperate in the factual investigation of the same alleged misconduct makes perfect sense but that they can then disclaim such cooperation to avoid their respective discovery obligations makes no sense at all." He further ruled that "where the Government and another agency decide to investigate the facts of a case together – such as in these 44 witness interviews – the Government has an obligation to review the documents" under Brady. The ruling identifies another possible method (albeit a limited one) for a party seeking discovery from the SEC's investigative file.

In matter related to an investigation, the SEC filed a subpoena enforcement action in federal court in California against Wells Fargo & Company on Friday, March 23, 2012. The Commission is investigating Wells Fargo’s sale of nearly $60 billion in residential mortgage-backed securities ("RMBS") to investors. The proceeding is unusual in that, while the Commission was still attempting to obtain information from Wells Fargo which it sought in investigative subpoenas, it sent Wells Fargo a "Wells Notice," stating that the Commission staff was "considering recommending" an enforcement action against the bank. When the SEC continued to press Wells Fargo for responses to the subpoenas, the company responded that it no longer thought a response was necessary while the Wells Process was ongoing. As a result, the Commission filed the subpoena enforcement action (discussed here), arguing that the issuance of a Wells Notice did not forgive Wells Fargo from responding to the subpoenas.

FCPA Matters.

On Tuesday, March 27, 2012, the Government filed a motion in the FCPA Sting Case to dismiss the charges against Jonathan M. Spiller, Haim Geri, and Daniel Alvirez, the three defendants who had previously pled guilty to conspiracy charges in the case and were awaiting sentencing, as discussed here. In doing so, the Government cited the two earlier mistrials in the case, as well as the acquittal of three defendants, and other rulings. This unusual event occurred after the Court had dismissed the same conspiracy charge against other defendants in the case and the Government dropped all other charges against the other defendants. As a result, the Sting Case, which was announced in January 2010 and charged twenty-two defendants with conspiring to violate the FCPA, violating the FCPA and conspiring to launder money, based on dealings with an informant and an undercover FBI agent posing as the Minister of Defense of Gabon in what Assistant Attorney General Lanny A. Breuer called a "turning point" in FCPA prosecutions, will end with zero convictions.

In a Brief filed on April 2, 2012 and discussed here, the Government argued that the statements by defendants in a criminal FCPA case that were given to their employer during an internal investigation should not be suppressed because the employer's "actions were not the result of any pressure or influence from the government sufficient to convert the Company’s lawyers to state actors," and because defendants could not "show that their statements were involuntary." The Government was addressing a Motion to Suppress filed on March 5, 2012 in the Carson case in which defendants argued that because Control Components, Inc. ("CCI") had collaborated with DOJ during the investigation, it was a Government agent whom improperly compelled statements from the defendants during an internal investigation in violation of their Fifth Amendment rights. The Court has scheduled a hearing on the Motion for May 14, 2012.

Action Involving a Private Company's Shares.

On March 14, 2012, the SEC announced that it had filed a complaint in federal court in San Francisco and an Administrative Proceeding relating to private investment funds which were established to acquire the shares of Facebook and other Silicon Valley firms which were privately-held. The Commission's charges included allegations that investors were misled and the funds and their managers pocketed undisclosed fees and commissions. According to the Commission, the fund managers raised more than $70 million from investors. The Commission also brought an Administrative Proceeding against an online service that matched buyers and sellers of pre-IPO stock, charging the entity with engaging in securities transactions without registering as a broker-dealer. The cases, discussed here, appear to be the first of their kind relating to the purchase of shares in the pre-IPO market.

Clawback Case.

On Monday, April 2, 2012, the SEC announced that it has filed suit in federal court in Austin, Texas against the former CEO and the former CFO of ArthroCare Corporation to recover bonus compensation and stock sale profits they received during an accounting fraud at the company. As the SEC pointed out in their press release, the two men "are not charged with personal misconduct, but they are still required under Section 304 of the Sarbanes-Oxley Act to reimburse ArthroCare for bonuses and stock profits that they received after the company filed fraudulent financial statements during 2006, 2007, and the first quarter of 2008." The case, discussed here, reflects one of the powerful weapons the Commission has at its disposal. The Director of Enforcement, Robert Khuzami, said "[c]lawback of incentive compensation and stock sale profits as authorized under the Sarbanes-Oxley Act is yet another reason for CEOs and CFOs to be vigilant in preventing misconduct and requiring that companies comply with financial reporting obligations."

Supreme Court Decision Rejects Argument Regarding Tolling of § 16(b) Claims.

On March 26, 2012, the U.S. Supreme Court ruled that the two-year time limit for bringing an action under § 16(b) of the Securities Exchange Act of 1934 is not tolled until after the filing of a § 16(a) disclosure statement. The case involves the right of an issuer (or, in this case, a shareholder bringing a derivative suit) to recover short swing profits obtained by a beneficial owner, director, or officer by reason of his relationship to the issuer under Exchange Act 16(b). Under §16(b), a corporation (or shareholder) may bring an action against corporate insiders who realize profits from the purchase and sale of the corporation’s securities within any 6-month period. The Act provides that such suits must be brought within "two years after the date such profit was realized." The Ninth Circuit ruled that the statute is tolled until there has been adequate disclosure of the trade (when the defendant files a Section 16(a) disclosure statement). As described here, the Supreme Court rejected that analysis, stating that Congress could have easily addressed that concern by having the statute of limitations began running after the filing of a § 16(a) statement, but did not do so.

JOBS Act Securities Law Alert

Jack J. Gravelle — Thu, 12 Apr 2012 13:01:06 -0500

For a summary of how the JOBS Act facilitates raising capital for a variety of businesses, please see this Porter Wright Securities Law Alert.