Following the elections, Capital Hill is preparing for a significant shift. The SEC and the CFTC, however, continue to move forward with the implementation of Dodd-Frank. This week, the Commission proposed rules for comment on the whistleblower provisions of the Act, which promise to be very significant for the enforcement program, as well as on security-based swaps.
This week, SEC Enforcement and the U.S. Attorney’s Office for the Southern District of New York brought a significant insider trading case against a French physician. It alleges the doctor tipped several hedge funds he advises on medical related stocks by furnishing them with inside information on clinical drug trials. As the week drew to a close, the Enforcement Division again teamed up with DOJ this time to file a series of FCPA actions targeting the oil services and freight forwarding business. Interestingly, earlier in the week PWC issued a report on its annual survey of corporate directors. According to almost 25% of the directors, their companies do not have any FCPA compliance procedures. Over 50% of the directors stated that their FCPA procedures do not cover agents.
Whistleblower program: Under Section 922 of Dodd-Frank, the SEC is authorized to pay rewards to certain individuals who provide the agency with original information that leads to a successful enforcement action. This week, the Commission issued proposed rules under the Section for comment. The rules provide generally that the information must be voluntarily produced and be original. Provisions in the rules are designed to encourage employees to first report the information to the company.
Security-based swaps: While the CFTC has primary jurisdiction over all swaps, the SEC has long had authority over security-based swaps. Under Title VII of Dodd-Frank, the Commission is required to adopt rules reasonably designed to prevent fraud, manipulation and deception in connection with transactions in security based swaps. Following this directive, the Commission proposed Rule 9j-1 which in an anti-fraud rule relating not just to the purchase and sale, but to misconduct in connection with ongoing payments and deliveries under a security based swap.
Market access: The Commission adopted a new rule governing market access. In many instances, high frequency traders are provided with market access by a broker dealer. In some arrangements, called unfiltered or naked access, the customer can place an order without passing through the broker’s system. In other instances, the trade passes through the broker’s system. In view of the potential for errors or malicious acts, the new rule prohibits naked access. It also requires that the broker put in place risk management controls and supervisory procedures to help prevent erroneous orders and ensure proper compliance.
PWC released the results of its annual survey of corporate directors on a range of topics from risk management to executive compensation and FCPA compliance (here). Key findings include:
- Almost 75% of the directors stated that compliance and regulatory issues are already a major focus and do not require more time.
- The top five items identified as “red flags” in signaling a director to step up his/her board involvement are: (1) a restatement of the financial statements; (2) charges or investigations; (3) management missing strategic performance goals; (4) an adverse 404 opinion; and (5) multiple whistle-blower incidents.
- Almost 25% of the companies involved in the survey do not have an FCPA compliance program.
- Significantly less than half of companies in the survey have an FCPA program which covers employees and agents while almost 20% have a program limited to employees.
False statements: SEC v. Reys, Civil Action No. 09-cv-1262 (W.D. Wash. Filed Sept. 8, 2009) is an action against the former CEO of CellCyte Genetics Corp., a company engaged in stem cell research. The complaint alleged that false statements were made to investors claiming that the company’s cutting edge stem cell technology had proven successful and was going to commence human trials. According to the complaint, there was no reasonable basis for the claims. Mr. Reys is also alleged to have improperly concealed his past and the fact that the company engaged in a spam campaign. CellCyte, according to the Commission, engaged in an illegal stock distribution and partnered with a Canadian stock promoter that conducted a spam, email, fax and newsletter campaign. That campaign used false information to inflate the price of the stock from $4 to $7.50. It later collapsed to ten cents. This week, Mr. Reys settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b) and 13(a). He also agreed to pay a civil penalty of $50,000 and to the entry of an order barring him from serving as an officer or director of a public company for five years. See also Litig. Rel. 21723 (Nov. 3, 2010). The action against the company and another officer was resolved at the time the complaint was filed.
Madoff feeder funds: SEC v. Cohmad Securities Corp., Civil Action No. 09-CV-5680 (S.D.N.Y. Filed June 22, 2009) is an action against Robert Jaffe, Maurice Cohn, Marcia Cohn and Cohmad Securities Corp. The amended complaint claims that the defendants made material misrepresentations and omissions by referring hundreds of investors to Mr. Madoff and his firm without disclosing that their were serious questions about its operations (here). The court initially dismissed portions of the Commission’s complaint. This week the three defendants consented to the entry of permanent injunctions which have been entered by the Court. Mr. Jaffee consented to the entry of an injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b) and from aiding and abetting violations of Sections 15(b)(7) and 17(a) of the Exchange Act as well as Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act. Maurice Cohn and Marcia Cohn consented to the entry of injunctions prohibiting violations of Securities Act Section 17(a)(2) and from aiding and abetting violations of Exchange Act Sections 15(b)(1) and 17(a) and Advisers Act Section 206(4). Cohmad consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a)(2), Exchange Act Sections 15(b)(1) and 17(a) and Advisers Act Section 206(4). Issues regarding disgorgement, prejudgment interest and penalties will be decided at a later date. See also Litig. Rel. 21722 (Nov. 3, 2010).
Insider trading: SEC v. Benhamou, Civil Action No. 10-CV-8266 (S.D.N.Y. Filed Nov. 2, 2010) and U.S. v. Benhamou (S.D.N.Y. Filed Nov. 1, 2010) are, respectively, civil and criminal, insider trading cases against French national Dr. Yves Benhamou (here). Dr. Benhamou, a medical doctor residing in France, specializes in hepatitis and other diseases of the liver. He is a clinical investigative physician for Human Genome Science or HGSI and was involved the clinical trials for Albuferon, a new drug to treat liver disease Hepatitis C. He is also a consultant to several hedge funds which invested in medical stocks. HGSI believed that its new drug had tremendous potential. As advanced clinical trials progressed, certain adverse effects were experienced. Over a period of several months as the company assessed those effects, and prior to any public disclosure of them, Dr. Benhamou repeatedly updated the manager of the hedge funds. The funds repeatedly traded. Ultimately, the funds sold their entire stake in HGSI. A subsequent press release about the adverse effects caused the share price to drop significantly. The funds avoided a $30 million loss. After the announcement the funds repurchased part of their stake. The SEC’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The criminal complaint contains one count of conspiracy to commit securities fraud and one count of securities fraud. Both cases are in litigation.
Free riding: SEC v. Mohammed, Civ. No. 10-CV-5058 (E.D.N.Y. Filed Nov. 2, 2010) is an action charging Noor Mohammed with violations of Securities Act Section 17(a) and Exchange Act Section 10(b) centered on a “free riding scheme.” According to the complaint, Mr. Mohammed opened at least eight brokerage accounts using the identities of several Bangladeshi immigrants. The account opening documents contained false information. They were funded with checks totaling over $1 million. Before the checks cleared and bounced, the defendant is alleged to have purchased hundreds of short term options. When the trades resulted in losses, the accounts were abandoned. On one occasion, the account made a profit which the defendant secured. The case is in litigation. See also Litig. Rel. 21720 (Nov. 2, 2010). On November 4, 2010 Mr. Mohammed pleaded guilty to a one count information charging him with securities fraud. The information is based on the same scheme detailed in the Commission’s complaint. U.S. v. Mohammed (E.D.N.Y. Nov. 4, 2010).
Offering fraud: SEC v. Brewer, Case 10-cv-09832 (N.D. Ill. Filed Oct. 29, 2010) is an action against financial services holding company Brewer Investment Group, LLC (“BIG”), its two principals, CEO Steve Brewer and COO Adam Erickson, and BIG’s related entities (here). The complaint claims that a fraudulent sale of unregistered securities issued by an Isle of Man entity – FPA Limited – was made by the defendants. Over a period of several months, 74 investors purchased $5.6 million of these notes. The PPM used to sell the notes was materially misleading and false according to the complaint. The proceeds were diverted to BIG in an effort to prop up the company (here). The complaint alleges violations of Securities Act Sections 5 and 17(a), Exchange Act Sections 10(b). The case is in litigation.
Bank stock fraud: SEC v. Sterling, Case No. 10-Civ-8206 (S.D.N.Y. Filed Oct. 29, 2010) is an action against James Sterling alleging violations of Exchange Act Section 10(b). The complaint claims that Mr. Sterling conducted a fraudulent scheme in connection with 51 public offerings of bank shares from January 2003 until October 2008. Under the applicable regulations, when banks convert from mutual to stock ownership, depositors receive priority rights to purchase shares before other interested investors. The rights are not transferable. Mr. Sterling opened accounts at banks in his name and that of his daughter. When the banks converted, he obtained shares through the accounts in his daughter’s name by signing her name to the applicable documents. This harmed other shareholders who were deprived of shares because the offerings were oversubscribed. Mr. Sterling resolved the action by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to pay disgorgement and prejudgment interest of $2,084,494 and a civil penalty of $150,000. See also Litig. Rel. 21714 (Oct. 29, 2010).
Investment fund fraud: U.S. v. Cosmo (E.D.N.Y.) is a criminal action in which Nicholas Cosmo, the former president and owner of Agape World, Inc., is alleged to have raised over $195 million from 3,000 investors with claims that their funds would be invested in commercial business entities that accept credit cards. The investments were supposed to pay a high rate of return. In fact, Mr. Cosmo operated a Ponzi scheme. He pleaded guilty to mail and wire fraud charges. As part of the plea Mr. Cosmo agreed to forfeit his right in assets seized by the government and to the entry of a restitution order of no less than $195 million to be paid to his victims. The date for sentencing has not been set.
Court of Appeals
Collateral order doctrine: U.S. v. Krane, No. 10-30247 (9th Cir. Oct. 29, 2010) is a decision by the Ninth Circuit concluding that Mohawk Industries, Inc. v. Carpenter, 130 S.Ct. 599 (2009), which held that the collateral order doctrine could not be used to appeal an order to produce privileged materials, does not foreclose the use of the Perlman exception (here). In Krane, an appeal was taken by intervenor Quellos Group LLC from an order directing its former counsel, Skadden Arps, to produce certain privileged materials prior to a criminal tax shelter trial against two former Quellos executives.
The Ninth Circuit concluded that it properly had jurisdiction. Under Section 1291 of Title 28, appeals may only be taken from final judgments, the Court began. Typically, an order compelling compliance with a subpoena can only be appealed from a resulting contempt citation. Although Skadden had not been held in contempt, Perlman v. U.S., 247 U.S. 7 (1918) authorizes an appeal of an order requiring the production of privileged materials from a third party. This is because the third party does not have a sufficient interest in the proceeding and most likely would produce the documents rather than challenge the order by submitting to a contempt citation. This does not conflict with Mohawk Industries.
Honest services fraud: U.S. v. Black, Case Nos. 07-4080, 08-1030, 08-1106 (7th Cir. Decided Oct. 29, 2010) is the remand of Canadian news mogul Conrad Black’s case from the Supreme Court following that Court’s decision in U.S. v. Skilling, 130 S.Ct. 2896 (2010). http://www.secactions.com/?p=2341 Mr. Black, and two others, had been convicted by a jury of three counts of mail and wire fraud in violation of 18 U.S.C. §§ 1341 and 1342. Mr. Black was also convicted of obstruction of justice and sentenced to serve a total of 78 months in prison. The two co-defendants, also executives at Hollinger International, were given sentences of 24 months and 17 months. The wire and mail fraud counts had been presented to the jury on alternate theories of a fraudulent appropriation of money to which Hollinger was entitled (“pecuniary fraud”) and a scheme to deprive the company of its intangible right of honest services, 18 U.S.C. § 1346.
Skilling limited the honest services fraud to bribery and kickbacks, theories not presented to the jury. Since the theory on which the jury based its verdict cannot be determined, the convictions can only stand if it is not open to reasonable doubt that the jury would have convicted the defendants of pecuniary fraud. After reviewing the evidence as to one alleged fraud, the Court concluded that the verdict had to be reversed. On the other fraud claim however, the Circuit Court held that there was sufficient evidence. In remanding the case for resentencing the Court suggested that the government consider dismissing the one count, rather than having a retrial. Then “[t]he judge could consider at the resentencing hearing the evidence that had been presented at the original trial . . . [on the dismissed count] in determining what sentences to impose . . .”
Oil Services/Freight forwarding settlements: The Department of Justice and the SEC settled FCPA with several oil services and freight forwarding companies. The charges are based on the bribery of customs officials. The companies involved are: Panalpina, Inc.; Pride International, Inc.; Tidewater, Inc; Transocean, Inc.; GlobalSantaFe Corp.; Nobel Corporation; and Royal Dutch Shell plc.Generally, the settlements with DOJ are predicated on three year deferred prosecution agreements. One company resolved the investigation by entering into a deferred prosecution agreement based on its cooperation. To settle with the SEC, each company consented to the entry of a permanent injunction in a civil action except Shell which agreed to the entry of a cease and desist order in an administrative proceeding. The settlements with DOJ include the payment of $156,565,000 in criminal penalties. Each filed criminal case is in the Southern District of Texas. The settlements with the SEC include payments of about $80 million which includes disgorgement, prejudgment interest and penalties. Only two settlements contain a civil penalty. The total settlement payments are approximately $236.5 million.
The following summarizes the actions by DOJ and the SEC:
Panalpina World Transport Ltd: The company is a global freight forwarding and logistics services firm based in Basel, Switzerland. Its U.S. subsidiary is Panalpina, Inc. A criminal information was filed charging Panalpina World Transport with conspiracy to violate, and violations of, the FCPA books and records provisions. The action was resolved by entering into a deferred prosecution agreement. An information charging the U.S. subsidiary with conspiracy to violate the books and records provisions and aiding and abetting certain customers in violating those provisions of the FCPA was also filed. Panalpina, Inc. agreed to plead guilty to the information. The company admitted to engaging in a scheme to pay bribes to numerous foreign officials on behalf of many of its oil and gas industry customers. The scheme took place between 2002 and 2007 and involved the payment of at least $27 million to foreign officials in seven countries. This was done to circumvent local rules regarding the import of goods and materials. The agreements call for the payment of $70.56 million in criminal penalties. See also SEC v. Panalpina, Inc., Civil Action No. 4:10-4334 (S.D. Tex. Nov. 4, 2010) (charging violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B); settled with a consent decree and the payment of $11,329,369 in disgorgement); Litig. Rel. 21727 (Nov. 4, 2010).
Shell Nigeria Exploration and Production Co. Ltd. (“SNEPCO”): SNEPCO is a subsidiary of Royal Dutch Shell plc. A criminal information was filed against the company alleging that it conspired to violate the anti-bribery and books and records provisions of the FCPA and aided and abetted violations of the books and records provisions. The charges are based on claims that the company paid about $2 million to its subcontractors knowing that some or all of the money would be used to pay bribes to Nigerian customs officials by Panalpina to import material into Nigeria. The action was resolved by entering into a deferred prosecution agreement which requires the payment of a $30 million criminal penalty. See also In the Matter of Royal Dutch Shell plc, and Shell International Exploration and Production Inc., Adm. Proc. File No. 3-14107 (Nov. 4, 2010) (alleging violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B); settled with a consent to a cease and desist order and the payment of $18,149,459 in disgorgement and prejudgment interest).
Transocean Inc.: The company is the Caymans Island subsidiary of Transocean Ltd., a global provider of offshore oil drilling services and equipment. It is based in Vernier, Switzerland. A criminal information was filed naming the subsidiary. It alleges conspiracy to violate the anti-bribery and books and records provisions of the FCPA and violations of the anti-bribery provisions along with aiding and abetting the violation of the books and records provisions of the Act. The charges are based on the payment of $90,000 by the company’s freight forwarding agents to Nigerian customs officials to circumvent import rules and regulations. The action was resolved by entering into a deferred prosecution agreement which requires the payment of a $13.44 million criminal penalty. See also SEC v. Transocean Inc., Civil Action No. 1:10-CV-01891 (D.D.C. Filed Nov. 4, 2010) (charging violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B); settled with a consent decree and the payment of $7,265,080 in disgorgement and prejudgment interest); Litig. Rel. 21725 (Nov. 4, 2010).
Tidewater Marine International Inc.: The company is the Cayman Island subsidiary of Tidewater Inc, a global operator of offshore services and supply vessels for energy exploration. The company maintains its headquarters in New Orleans. A criminal information charges the company with conspiring to violate the anti-bribery and books and records provisions of the FCPA and with violating those provisions. It is based on allegations that the company paid $160,000 in bribes between August 2001 and November 2005 through employees and agents to tax inspectors in Azerbaijan to secure favorable tax assessments. The company is also alleged to have paid about $1.6 million in bribes through Pahalpina to Nigerian customs officials. The action was resolved by entering into a deferred prosecution agreement which requires the payment of a $7.35 million criminal penalty. See also SEC v. Tidewater Inc., Civil Action No. 2:10-CV-04180 (E.D. La. Filed Nov. 4, 2010) (charging violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B); settled with a consent decree and the payment of $8,104,362 in disgorgement and prejudgment interest and a penalty of $217,000 which was not increased because of the criminal penalties); Litig. Rel. 21729 (Nov. 4, 2010).
Pride International: The company is based in Huston. It has a French subsidiary, Pride Forasol S.A.S. Pride International was charged in a criminal information with conspiring to, and violations of, the anti-bribery and books and records provisions of the FCPA. The French subsidiary was also named as a defendant in a criminal information which charges conspiracy to violate, and violations of, the anti-bribery provisions and aiding and abetting the violations of the books and records provisions. The charges are based on claims that the company paid $800,000 in bribes directly and indirectly to government officials in Venezuela, India and Mexico to extend drilling contracts, secure a favorable administrative decision relating to a customs dispute and to avoid payment of customs duties. Pride Forasol agreed to plead guilty to the charges. Pride International entered into a deferred prosecution agreement. The agreements require the payment of a criminal penalty of $32.625 million. DOJ acknowledged that during the investigation Pride provided “information and substantially assisted in the investigation of Panalpina.” See also, SEC v. Pride International, Civil Action No. 4:10-cv-4335 (S.D. Tex. Filed Nov. 4, 2010) (charging violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B); settled with a consent decree and the payment of $23,529,718 in disgorgement and prejudgment interest); Litig. Rel. 21726 (Nov. 4, 2010). The SEC previously charged Pride employees Bobby Benton and Joe Summers for their role in the scheme (here).
Noble Corporation: The company is based in Switzerland. It entered into a non-prosecution agreement. The underlying conduct is based on allegations that Nobel paid about $74,000 to a Nigerian freight forwarding agent that was passed on as bribes to Nigerian customs officials. The company falsely recorded the bribe as a legitimate business expense. As part of the non-prosecution agreement the company will pay a $2.59 criminal fine. DOJ noted: “The non-prosecution agreement recognizes Noble’s early voluntary disclosure, through self-investigation of the underlying conduct, full cooperation with the department and extensive remedial measures . . . As a result of these factors, among others, the department agreed not to prosecute Noble or its subsidiaries for the bribe payments, provided that Noble satisfies its ongoing obligations under the agreement.” See also SEC v. Noble Corporation, Case No. 4:10-cv-4336 (S.D. Tex. Filed Nov. 4, 2010) (charging violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B); settled with a consent decree and the payment of $5,576,998 in disgorgement and prejudgment interest); Litig. Rel. 21728 (Nov. 4, 2010).
GlobalSantaFe Corp.: The company named in an SEC complaint but was not charged by DOJ. The SEC complaint alleges violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B). The Commission claims that from January 2002 through July 2007 the company made illegal payments to officials of the Nigerian Customs Service through companies acting as customs brokers. In December 2008, the company merged with a subsidiary of Transocean Inc., which is now known as Transocean Ltd. To settle the action, the company consented to the entry of a permanent injunction prohibiting future violations of the Exchange Act Sections cited in the complaint. It also agreed to pay disgorgement of $3,758,165 and a civil penalty of $2.1 million. SEC v. GlobalSantaFe Corp., Civil Action No. 1:10-CV-01890 (RMC) (D.D.C.); Litig. Rel. 21724 (Nov. 4, 2010).
The City of Hialeah Employees’ Retirement System v. Toll Brothers, Inc., Civ. Action No. 07-1513 (E.D. Pa.). is a class action brought against builder Toll Brothers tied to the subprime market. The complaint claimed that from December 9, 2004 through November 8, 2005 defendants made misrepresentations relating to the company’s ability to open new selling communities sufficient to support its financial projections and to continue its historically strong earnings. On October 28, 2010, the parties agreed to settle for $25 million. A more detailed discussion of the case can be found in Kevin LaCroix’s well written The D&O Diary, http://www.dandodiary.com/.
The FSA is continuing its aggressive insider dealing investigation. This week, the UK regulator executed search warrants at two addresses, one in London and one in Germany as part of the on-going inquiry. The FSA coordinated with the police and prosecution authority in Hessen, Germany on the execution of the warrants. Press reports note that two people were arrested as a result of the raids.