Wednesday, January 26, 2005
The SEC announced that it filed and settled complaints against Goldman Sachs and Morgan Stanley relating to the allocation of shares in Initial Public Offerings (IPO) to clients of the firms by requiring those receiving shares to place orders to purchase additional shares, thereby raising the price of the stock. Each firm agreed to pay a civil penalty of $40 million. The Litigation Release regarding Morgan Stanley states:
In its complaint, the Commission alleges that Morgan Stanley violated Rule 101 of Regulation M under the Securities Exchange Act of 1934 by attempting to induce certain customers who received allocations of IPOs to place purchase orders for additional shares in the aftermarket. The complaint further alleges that Morgan Stanley did induce certain customers to place such orders during the new issues' first few trading days.
The allegations against Goldman Sachs are substantially similar (Litigation Release here). The Commission action does not involve a fraud allegation, and with the cooling of the IPO market there is much less demand for the shares of newly-public companies. (ph)
The U.S Attorney's Office for the Western District of Missouri (Kansas City) announced the indictment of Richard and Daniel Martino, the controlling shareholders Cass Country Telephone Co., a rural communications provider that is eligible to receive subsidies from the federal government for providing service (it's the Universal Service Fee on your telephone bill). The eleven-count indictment (here) charges conspiracy, mail and wire fraud related to inflated billings. A press release by the USAO states:
Count One of the federal indictment alleges that the Martinos participated in a conspiracy from January 1998 to July 2004 to defraud the Universal Service Administrative Company (USAC), which disperses federal subsidies to rural telephone companies, and the National Exchange Carriers Association (NECA), which handles tariff filings and revenue distribution among carriers. The Martinos, along with Kenneth M. Matzdorff, 48, of Belton, Mo., allegedly inflated expenses of the Cass County Telephone Comany, LP (known as CassTel) in order to qualify for $8.9 million in unwarranted subsidies and disbursements.
Tuesday, January 25, 2005
According to an AP story, opening statements in the trial of Bernie Ebbers had the prosecution and defense presenting very different sides to events. The government presented a scenario that "Bernard Ebbers told 'lie after lie after lie' about the crumbling state of WorldCom Inc. in an obsessive drive to meet Wall Street expectations and keep its stock price high." The defense, however, according to the AP story presented Ebbers "as a self-made corporate hero who never had an inkling of the massive fraud carried out by others on his watch." Reid Weingarten, Ebbers' lead trial counsel, made the point that "[t]here are zillions of documents in this case and there ain't one smoking gun." The article notes that the case may come down to "the testimony of Sullivan, who pleaded guilty to fraud in 2002 and agreed to testify against his former boss."
Cooperating witnesses are common in federal criminal trials and are not exclusive to white collar crime cases. For example, one finds cooperating witnesses at the heart of many drug prosecutions. Whether the accused had the intent to commit the crime is very often the focal point in a white collar crime case. This case will have the jury determining the knowledge of the accused and the evaluation may perhaps hinge on the credibility of a witness.
The government and defense made their opening arguments in the trial of former HealthSouth CEO Richard Scrushy. A report from the Atlanta Journal-Constitution (Jan. 25) provides the following summary of the arguments by U.S. Attorney Alice Martin and Jim Parkman:
"They pumped up the profits, and he hid it from the public," said Martin. She described Scrushy as "a very hands-on leader" who personally selected top aides and tried to sway their statements to federal agents once an investigation began."The evidence will show that Richard Scrushy as chief executive officer gave phony numbers to the public," Martin said.
The defense conceded that a fraud occurred, but Scrushy lawyer Jim Parkman blamed it on a group of overly ambitious, tightly knit executives who called themselves "the family" — a group, he said, that hid the misstatements from Scrushy."This was no ordinary family. This was a family that operated as a unit on their own," said Parkman.
In a deep, folksy drawl that contrasted with Martin's more businesslike approach, Parkman portrayed the Alabama-born Scrushy as an everyman CEO from humble beginnings who did his best yet failed to detect fraud that also eluded graduates of top Ivy League schools."How could it get by Richard Scrushy? You know how? This group controlled the numbers," Parkman said. In an early attack on a key government witness, Parkman described former chief financial officer Williams Owens as "the godfather" of the conspirators, casting doubt on the man who prosecutors say helped cement their case by secretly recording discussions with Scrushy.
An earlier post (here) discussed Parkman's "country lawyer" approach to the trial -- no doubt against the array of city-slickers. This is the rare prosecution in which the United States Attorney will try the government's case, and Martin is putting the reputation of her office on the line in the prosecution. (ph)
The SEC issued a Litigation Release (Jan. 25) discussing the settlement of a civil injunctive action for insider trading by Jun Singo Liang, a Chinese citizen who does not reside in the United States. Liang is a senior vice president and general manager of the Wireless Business Department for NetEase.Com, a Beijing-based company with an office in California whose shares are traded as American Depository Receipts on NASDAQ. The complaint alleges that prior to a public announcement that Liang's division, NetEase's largest, had suffered a significant revenue shortfall, he "sold more than 47,000 shares of NetEase stock * * *, realizing over $3 million in sales proceeds. After NetEase announced the revenue shortfall, the stock price plummeted by 23%. By trading ahead of this news, Liang avoided more than $700,000 in losses." Liang agreed to pay disgorgement and prejudgment interest totaling $731,169, a civil penalty of $355,129, and a five-year director-and-officer bar.
The Commission's Release notes that Liang's penalty is lower than the usual one-times trading profit sought from defendants because he voluntarily disclosed his trading to the company and the SEC. The civil action shows once again the scope of the SEC's jurisdiction to reach trading by those outside the United States when the securities are traded on an American market. (ph)
The jury has been picked in the trial of Richard Scrushy in Birmingham, Ala., and opening statements will begin today. An article in the Birmingham News (Jan. 25) describes the jury: "A jury made up mostly of blacks and men was selected Monday to decide the case of HealthSouth Corp. founder Richard Scrushy, who faces charges in the company's accounting scandal. Though the identities of the jurors are not public, at least 10 of the 18 chosen are black and at least 10 are male. On Monday, both sides seemed pleased with the jury selection process that began Jan. 5 and said they are prepared to move forward with the trial that could last up to four months." The jury selection process is nearly complete in the Bernie Ebbers trial in New York City, according to a Wall Street Journal story (Jan. 25), and seven more jurors have been selected in the retrial of former Tyco CEO Dennis Kozlowski, bringing the total to eleven.
It will be a surprise is any of the trials are done by mid-April -- barring a mistrial or grant of an acquittal -- and one (or more) could stretch into the summer. The Ebbers trial seems to be the least-complicated, to the extent that the paper-trail appears to be less extensive than in the other two cases. The testimony of Scott Sullivan, WorldCom's former CFO and the person with the closest business relationship with Ebbers, likely will take quite a while, possibly two to three weeks. Given how long these trials will take, make sure to curb your enthusiasm and don't get too worked up over the exciting accounting issues that will be aired to the juries. (ph)
Anthony Elgindy and former FBI Agent Jeffrey Royer were convicted (Jan. 24) in the U.S. District Court for the Eastern District of New York (Brooklyn) of racketeering and securities fraud after a trial that started in early November. Elgindy specialized in analyzing companies that he would recommend be sold "short" by investors, and the government accused Royer of leaking information to Elgindy about pending investigations of companies that could be used to short the shares or, in two instances, to extort the company to keep the information from being disclosed. According to an article in the Wall Street Journal (Jan. 24):
Mr. Elgindy was downcast as he entered the courtroom, appearing nervous, with his eyes closed or focused on his lap. The jury found Mr. Elgindy guilty of 11 counts against him, including five counts of securities fraud, a count of racketeering conspiracy, a count of securities fraud conspiracy, a count of extortion, a count of extortion conspiracy, and two counts of wire fraud.
As the jury read the verdict, there were gasps and cries from the crowd and defense table, leading Judge Raymond Dearie to halt the proceedings so Mr. Elgindy could be taken from the courtroom.
Mr. Royer was found guilty of nine of 14 counts against him, including four counts of securities fraud, a count of securities fraud conspiracy, a count of racketeering conspiracy, a count of obstruction of justice conspiracy, a count of obstruction of justice and a count of witness tampering.
Royer testified (earlier post here) that he leaked the information to Elgindy to cultivate a source of information about corporate wrongdoing, a defense rejected by the jury. The jury also rejected the defendants' venue defense (ealier post here). (ph)
Travelzoo Inc., an internet company that promotes travel bargains for other company's on its website, filed a Form 8-K (here) with the SEC disclosing that the Commission has requested information from the company regarding trades by CEO Ralph Bartel, who owns 80% of the company's outstanding shares. The stock has been the subject of significant short selling, and the shares dropped over 20% on Travelzoo's disclosure of the informal inquiry by the SEC. The Form 8-K states:
Travelzoo Inc. has provided information to the Securities and Exchange Commission in connection with an inquiry into trading in its shares. The inquiry follows a period of extreme volatility in the company's stock price on the NASDAQ Stock Market during 2004, which has also been a cause of concern to the company.
In response to this inquiry, Travelzoo Inc. has provided information concerning any transactions in the company's shares by its officers, directors and employees, including Ralph Bartel, the company's CEO. The results of the company's review showed that, during the period in question, when the price of the company's shares increased dramatically, neither Mr. Bartel nor any other directors or senior officers of the company purchased any shares, except for one exercise of a stock option. The inquiry also asked for additional information from Mr. Bartel. Mr. Bartel has confirmed that, since his last sale of 50,000 shares in May 2004, at $19.96 per share, he has neither purchased nor sold any of his shares, except for a previously reported sale of 30,000 shares in November 2004, which Mr. Bartel was required to sell under a stock warrant issued in 2003, which allowed the holder to purchase those shares from Mr. Bartel at $3.90 per share.
The company has provided all information which has been requested to date in this inquiry. The company has no reason to believe that the inquiry relates in any way to the financial reporting or operations of the company.
The impetus for the SEC's inquiry may well be the short sellers who are betting on a decline in Travelzoo's stock price. The last sentence is small comfort to the public shareholders when the SEC probes market manipulation.(ph)
Monday, January 24, 2005
The SEC filed a civil injunctive action on Jan. 24 accusing Penthouse International, Inc. (now PHSL Worldwide, Inc.), Charles Samel, a former officer of the company, and Jason Galanis, shareholder in the company, of accounting and Sarbanes-Oxley certification violations. In addition, the Commission filed and settled a separate cease-and-desist proceeding against Penthouse founder and former CEO Bob Guccione related to the Sarbanes-Oxley violations. The SEC Litigation Release states that "Penthouse improperly included as revenue on the financial statements for that quarter $1 million received as an up-front payment in connection with a five-year website management agreement" and that "Samel and Galanis prepared and filed the false Form 10-Q, and they did so knowing or recklessly disregarding that Guccione had not seen or approved it, that Penthouse's auditor had not performed its required review of the Form 10-Q, and that it would be improper to include the $1 million payment as revenue for the quarter ended March 31, 2003." The Commission is seeking inter alia director-and-officer bars against Samel and Galanis. The SEC complaint (here) does not have any pictures or forum items.(ph)
ImClone Systems Inc. announced on Jan. 24 (company release here) that it has reached a settlement in the consolidated securities class action and shareholder derivative suit regarding the company's disclosure of information about negative FDA action on a drug application. The timing and completeness of the disclosure was at the heart of the insider trading case against former CEO Sam Waksal, who entered a guilty plea related to his stock transactions the resulted in a seven-year prison term and a recent settlement of the SEC civil action in which he agreed to pay a $3 million civil penalty in addition to disgorgement and prejudgment interest (post here).
According to the ImClone release, the company will make a cash payment of $75 million to a settlement fund, of which $8.75 million will come from insurers. ImClone's release states, "The claims against all defendants would be dismissed with prejudice but the Company would retain the right to continue to pursue certain claims against its former chief executive officer, Samuel D. Waksal." The latter point is important because Waksal still has substantial assets, and the company will pursue its claims against him for breaching his fiduciary to the the company as an officer and director. Waksal's woes are not yet over. (ph).
An article in the Birmingham News (Jan. 23) gives a profile of Jim Parkman, who will be among the trial counsel representing Richard Scrushy in his securities fraud trial that has opening arguments scheduled to begin today (Jan. 24). Parker has taken the local "country lawyer" approach, as described in the article:
For Parkman, this is his promotion to the big-time, after more than 20 years of workaday litigating in his hometown of Dothan, a biography he is fond of repeating in court. "I'm just a country lawyer from Dothan, and I don't have all sorts of fancy notebooks," he told panelists at jury selection two weeks ago, waving a lonely piece of yellow paper, seconds after government attorney Richard Smith had yielded the floor, carting off bulky binders that he consulted every few minutes while questioning jurors. Later in the week, Smith attempted to poach on Parkman's territory, telling a new group of potential jurors, "I'm just a country lawyer from Talladega, Alabama." Parkman didn't let it stand, even though Smith is from Talladega. Next time he had the floor, Parkman told the jury that Smith and other government lawyers regularly work on major cases in Washington, Chicago and other business and legal capitals. "I'm only from Dothan," he told the potential jurors. "You aren't going to hold that against me, are you?"
Parkman is an unknown quantity, and certainly is not a high-profile white collar defense lawyer, unlike his predecessor, Abbe Lowell. It is an interesting strategy, consistent with Scrushy's approach that emphasizes his local roots, humble beginnings, and lack of sophistication, especially with regard to all that accounting "stuff." (ph)
An article in the Denver Business Journal (Jan. 21) discusses bankruptcy court proceedings against the relatives of Will Hoover, whose eponymous company was a ponzi scheme that resulted in investor losses of over $15 million. Hoover was sentenced to a 100-year prison term, and the trustees in bankruptcy for the company have made the following claims against Hoover's family members to recover funds transferred to them by Hoover:
- Katie Galpin, Hoover's sister living in Wimberley, Texas, received $224,622 from Hoover or his company within four years of the personal and business bankruptcy filings, of which $40,583 was made within one year of the filings.
- Michael Hoover, Hoover's brother living in Charlotte, N.C., received $33,050 within four years of the filings and $10,050 within one year of the filings.
- Kim Wyatt (formerly Kim Hoover), Hoover's daughter living in Orange, Calif., received $185,658 within four years of the filings and $119,215 within one year of them.
- Mark Hoover, Hoover's son living in Laguna Hills, Calif., received $84,218 within four years of the filings and $22,679 within one year of them.
There is a separate lawsuit seeking repayment of $8,000 from the photographer who took the pictures at Kim Wyatt's wedding that were paid for by Hoover. (ph)
An article in the Wall Street Journal (Jan. 21) discussing the retrial of former Tyco International Ltd. executives Dennis Kozlowski (CEO) and Mark Schwartz (CFO) points out that Koslowski's daughter, Sandy, has joined the defense team as a voluntary associate. She is a recent graduate of the Columbia Law School. The article notes: "Austin V. Campriello, one of Mr. Kozlowski's lawyers, told the judge that they had previously approached prosecutors about allowing them to use some of Mr. Kozlowski's frozen assets to pay her for work on the case. Prosecutors at the time said that was an 'absolute nonstarter,' Mr. Campriello told the judge." The first trial was quite contentious, even by criminal standards, and the relationship between the defense lawyers and prosecutors apparently remains frosty.
The article also discusses the background of the four jurors selected: "In the fourth day of jury selection, a building superintendent who hopes to one day become an English teacher, a psychiatric nurse who sings opera, a New York City employee whose brother has served jail time on robbery charges and an elementary school cafeteria worker were chosen as the first panelists in the retrial. Two have previously served on juries in criminal cases." The first trial ended when a holdout juror who allegedly gave an "OK" sign to the defendants received a threatening letter after being publicly identified. Given the slow pace of jury selection in the second go-round, estimates of a four-month trial may be on the low side. (ph)
The extent to which the SEC polices the securities markets regarding insider trading is shown by a recent Commission settlement of a civil injunctive action in which the defendant agreed to disgorge $1,969 of illegal trading profits, $338 in prejudgment interest, and a $1,969 civil penalty (a total of $4,276 for those scoring at home). The SEC Litigation Release states that Mark J. Lauzon engaged
in insider trading in the securities of Musicland Stores Corporation ("Musicland") before Musicland's December 7, 2000 announcement that it would be acquired by another company by tender offer. The Commission's complaint alleges that Alfred S. Teo, Sr. ("Teo"), a major Musicland shareholder, learned about the proposed tender offer for Musicland, and then tipped Lauzon and others with this information. According to the Commission's complaint, approximately two hours after Teo tipped Lauzon on November 9, 2000, Lauzon purchased 500 shares of Musicland stock, which he sold on December 11, 2000, and received $1,969 in illicit profits.
A pretty modest amount for an insider trading case, although it is part of a larger complaint by the SEC alleging that Teo's tipping resulted in total profits of over $1.8 million by a number of tippees (see earlier Litigation Release here). The message here appears to be that no one should think that they can fly beneath the SEC radar. (ph)
Bloomberg.com reports (here) that the New York and Miami branches of the Banco de Chile are being investigated for possible money laundering violations. Earlier posts (here and here) discussed the federal investigation of Riggs National Bank in Washington DC for money laundering problems involving foreign leaders, including former Chilean dictator Augusto Pinochet. The report states:
Banco de Chile's New York branch, which caters to foreign customers, is under investigation for compliance with anti-money laundering laws, according to a filing with the U.S. Securities and Exchange Commission. The Office of the Comptroller of the Currency is looking into the New York branch of Chile's second-largest bank, while the Federal Reserve Bank of Atlanta is examining certain accounts at the Miami operation, according to today's filing.
Sunday, January 23, 2005
The latest in the government's scrutiny into healthcare appears to be occurring at Medquist. According to a Washington Post story, "MedQuist Gets Subpoena in Massachusetts," "[t]he U.S. Attorney's Office for Massachusetts has subpoenaed records from medical information services company MedQuist Inc. seeking documents related to its dealings with both governmental and non-governmental customers." The article notes that "MedQuist also said it continues to cooperate with the Securities and Exchange Commission's ongoing investigation in the matter."
Agency Investigations add a component to white collar cases that one does not find in a typical street crime investigation. What was originally an agency investigation by the SEC, now is a subpoena request by DOJ. One has to wonder if the SEC has referred this matter to the DOJ for investigation or whether this is an independent investigation?
Saturday, January 22, 2005
As usual, Doug Berman on Sentencing Law & Policy takes the barest thoughts of others and builds on them to discuss important ramifications from Booker, and his post "Increased Sentences post-Booker" deals with the issue of judges increasing sentences beyond the Guidelines range and possible due process/ex post facto concerns. The post here earlier discussed U.S. District Judge Crane in the S.D. Texas (McAllen Div.) when he sentenced three defendants convicted of public corruption offenses to longer terms of imprisonment in reliance on the advisory nature of the Guidelines. Doug poses the following additional issues for consideration in light of the increased sentences:
. . . [while] the due process question is contestable, I must wonder out loud if individual prosecutors have an obligation to make an independent judgment (and not wait for a defense objection) about whether the law allows an increase in a post-Booker sentence based on pre-Booker conduct. Relatedly, in the name of consistency, I wonder if Main Justice should issue some sort of directive about this matter to its offices. Otherwise I could imaging varying legal and policy judgments from different US Attorneys Offices about whether to try to reopen and seek longer sentences in past-sentenced cases.
I think the issue Doug raises is particularly important in white collar crime cases because the pressure for an upward sentence (we can't really call them departures any more, can we?) will be greater in the area of public corruption and corporate/business crime (e.g. accounting, securities, bank, & insurance fraud) than in other prosecutions. The drug and weapons crimes already have significant sentences, and with the criminal history categories (and "armed career criminal" sentences) it is usually not difficult to give a long term of imprisonment to repeat offenders. White collar offenders are more likely to come in lower if the amount at issue is not significant, they're rarely higher than Catetory I on the grid, and there are no mandatory minimums to deal with in these cases.
Judge Crane in McAllen, TX, specifically mentioned the effect on the public trust as meriting the increased sentences for the three defendants called back before him. Cases involving those who owe a fiduciary obligation (especially lawyers!) may draw requests from prosecutors for increased sentences beyond those in the Guidelines because of the breach of trust and need to send a message to professionals. Will the U.S. Attorney's Offices adopt a consistent policy that permits (or opposes) sentences outside the now-advisory Guidelines range? The government should not be allowed to "have its cake and eat it too" by arguing against lower sentences as violative of the remedial portion of Booker or as unreasonable on appeal, and then ask judges to give greater sentences because the harm is not comprehended by the Guidelines.
Regarding Main Justice guidance, this is certainly an area that cries out for consistency, but the rather heavy-hand approach of Main Justice over the past few years in the area of charging, plea bargaining, and appeals of downward departures has caused the local USAOs to resist the rules coming from DC. There is nothing particularly new about the tension between Main Justice and the field offices, but any attempt to draft a rigid policy on sentencing will not be viewed positively in all offices. The change from John Ashcroft, who seemed to a the leading proponent of centralized control, to Alberto Gonzales may lead to a more flexible approach. Booker guidance will likely be the first chance Gonzales (and his team) has to send a message to the U.S. Attorney's Offices about how he will approach issues of cooperation between local offices and DC. The sentencing issue will also be a test of whether DoJ wants to use policy pronouncements or will turn to Congress to legislate a solution to restore of measure of prosecutorial control over sentencing. (ph)
An article in the Wall Street Journal (Jan. 21) discusses the settlement of an SEC action by Jonathan Orlick, the former general counsel for Gemstar-TV Guide International Inc., for his participation in an accounting fraud. In settling the action, Orlick agreed to a bar from serving as a director or officer of a public company for ten years, a $150,000 civil penalty, and to return $150,000 to investors as part of a bonus he received. According to the article:
The SEC has been cracking down on corporate lawyers, who the agency views as "gatekeepers" crucial to deterring fraud. In more than two years, the agency said it has charged lawyers in more than 30 enforcement cases. The SEC's main argument is that lawyers should be helping companies follow the rules instead of providing a way around securities laws. In Mr. Orlick's case, the SEC said that the former general counsel knew, but failed to disclose, that Gemstar was improperly recognizing and reporting material amounts of licensing revenue from two companies. The SEC also said that Mr. Orlick repeatedly signed false management letters used by Gemstar's auditors regarding the status of negotiations with one of the companies.
The Commission has made lawyers a prime target of its enforcement actions in the past year, particularly in-house counsel who do not take steps to prevent accounting fraud and material misstatements. (ph)
Barry Minkow's company, ZZZZ Best, made him the face of fraud in the early 1990s along with Mike Milken and Charles Keating. A media darling for founding a purported multi-million dollar janitorial company that was little more than a facade to fleece investors, Minkow served almost eight years in an FCI in Lompoc, CA, where another notorious white collar criminal, Ivan Boesky, served almost two years for insider trading (in the minimum security part). Minkow's new book, "Cleaning Up: One Man's Journey Through the Seductive World of Corporate Crime," is available in bookstores on Jan. 21. As part of his promotion tour, Minkow gave an interview reported here by the UPI that includes this assessment of the FBI and white collar crime:
Perpetrators don't fear the FBI like they should or like they used to because of the preoccupation with terrorism. Having said that, I'm working with the bureau on a couple of cases right now and they do take white-collar crime seriously. But the perception is that they are overburdened and undermanned for white-collar crime. It's a material concern. And I would say in addition to that -- and you would expect me to say this -- that I think economic conditions are not the only thing that causes people to perpetrate fraud but in this case it's certainly a big deal.
Minkow also has the following take on another well-known person sentenced to prison: "Martha (Stewart) should not be in prison. Martha's victim impact is about $60,000, and she's doing time. Ridiculous! She would be much more valuable on the speaking circuit, telling people not to do what she did . . . So people need to know that no matter how badly you failed, you can come back from failure."
Is Minkow's book self-serving? Sure. But he is also a very smart person, and if you get a chance to listen to him as he plugs the book, he is very entertaining. Will he be able to avoid the lure of investment scams forever? Time will tell. (ph)
Friday, January 21, 2005
Many fraud cases arise from situations where oversight is lacking. What proves to be the most unfortunate are those cases where the individual handling the company oversight is the person committing the fraud.
The Atlanta Journal Constitution reports on a case that may prove to fit within this category. The "vice-president in charge of compliance" "for Applied Financial Group Inc., an Atlanta firm that dispenses investment advice" was charged today in a "295-count federal indictment." According to the article the amount of the defrauding is "more than $5 million."
Addendum (ph) - In addition to the filing of a criminal case, the SEC also filed a civil action. See SEC Litigation Release. "The complaint alleges that from early 2000 through early 2004, Ms. Longo misappropriated at least $5.4 million from the accounts of four profit-sharing plans that were advisory clients of Applied Financial Group."