Securities Law Prof Blog

SEC Posts Actions During Credit Crisis

Is the SEC feeling defensive?  It has posted at its website a compendium of SEC Actions During Turmoil in Credit Markets.

SEC Charges Two Ex-Duane Reade Execs with Accounting Fraud

The SEC charged two former senior executives of Duane Reade with fraud for orchestrating multi-million dollar accounting schemes that caused the Duane Reade to inflate its reported earnings and overstate its net income. Duane Reade is the operator of the largest chain of drug stores in the New York Metropolitan area.  The SEC’s complaint, filed in federal court in Manhattan, alleges that the former Duane Reade executives entered into a series of fraudulent transactions designed to boost reported income and enable the company to meet quarterly and annual earnings guidance. According to the SEC’s complaint, the fraudulent transactions were designed by the company’s former CEO, Anthony J. Cuti, and primarily implemented by its former Real Estate Administrator and one-time CFO, William J. Tennant and caused Duane Reade to overstate its pre-tax income by a total of approximately $17.5 million.

Sjostrom on Equity Capital and Share Liquidity

Carving a New Path to Equity Capital and Share Liquidity, by William K. Sjostrom Jr., Northern Kentucky University - Salmon P. Chase College of Law, was recently posted on SSRN.  Here is the abstract:

The Article advocates regulatory reforms designed to carve a new path to equity capital and share liquidity for private companies. Specifically, the reforms would allow private companies to generally solicit sophisticated investors and would foster the development of a liquid "sophisticated-investors only" (SIO) market for private company shares. The reforms are grounded in the fundamental principle of U.S. securities laws that sophisticated investors can "fend for themselves" and therefore require considerably fewer legal safeguards. As a result, the reforms would enhance capital formation by reducing regulatory burdens without compromising investor protection. The Article details the reforms and explains how they can be implemented under existing federal securities laws. It then considers the possibilities for new SIO markets if the reforms are adopted and theorizes about how the resulting securities regulatory void for SIO companies would be filled.

SEC Charges Stock Promoters with Market Manipulation

The SEC brought two separate actions against stock promoters charging them with market manipulation.  What is interesting is that both cases involve sting operations with undercover FBI agents acting as the purported representatives of undisclosed wealthy investors.

In SEC v. Grossman, the SEC charged four stock promoters, Glenn Grossman, Lawrence Steven Cohen, David Schmidt and John Zanic (the "Defendants"), with engaging in a fraudulent broker bribery scheme designed to manipulate the market for the common stock of Guyana Gold, Corp. ("GYGC").  The complaint alleges that beginning in at least April 2008,  the Defendants engaged in an undisclosed kickback arrangement with an individual who claimed to represent a group of registered representatives with trading discretion over the accounts of wealthy customers. Unbeknownst to the Defendants, the individual actually was an undercover FBI agent. The Defendants promised to pay a 30% kickback to the agent and the registered representatives he purported to represent in exchange for the purchase of up to $3 million of GYGC stock through the customers' accounts.

The complaint further alleges that from May 1-5, 2008, Zanic instructed the agent to purchase approximately 115,000 shares of GYGC stock for a total of approximately $72,000 through matched trades using detailed instructions concerning the size, price and timing of the purchase orders. Thereafter, the Defendants paid bribes of almost $14,000 to the agent.

In SEC v. Jadidian, the Commission charged a stock promoter with engaging in a fraudulent broker bribery scheme designed to manipulate the market for the common stock of Tecton, Corp. ("TTNC").  The complaint alleges that beginning in at least April 2008, Jason Jadidian engaged in an undisclosed kickback arrangement with an individual who claimed to represent a group of registered representatives with trading discretion over the accounts of wealthy customers. Unbeknownst to Jadidian, the individual actually was an undercover FBI agent. Jadidian promised to pay a 30% kickback to the agent and the registered representatives he purported to represent in exchange for the purchase of TTNC stock through the customers' accounts.

The complaint further alleges that on May 1, 2008, Jadidian instructed the agent to purchase approximately 80,000 shares of TTNC stock for a total of approximately $18,600 through matched trades using detailed instructions concerning the size, price and timing of the purchase orders. Thereafter, Jadidian paid a $5,000 bribe to the agent.

Both complaints charge the defendants with violating the antifraud provisions.

Cox Speaks at Roundtable on Modernizing Disclosure

SEC Chairman Cox's Opening Remarks at SEC Roundtable on Modernizing the Securities and Exchange Commission’s Disclosure System on Oct. 8.

SEC Settles ARS Charges with Bank of America and RBC Capital Markets

The SEC, NASAA and New York Attorney General's Office announced two additional agreements in principle with respect to auction rate securities (ARS), one with Bank of America and the other with RBC Capital Markets.  Under its agreement Bank of America agrees to provide 5,500 individual investors, small businesses, and small charities the opportunity to sell back to Bank of America up to $4.7 billion in ARS they purchased before the ARS market collapsed in February 2008.  The SEC's agreement with RBC Capital Markets Corp. (RBC) would provide individual investors, small businesses, small nonprofits, charities and religious organizations the opportunity to sell back to RBC all of the ARS they purchased from RBC before the ARS market collapsed in February 2008. The terms of both settlement are subject to finalization, review, and approval by the Commission.

Former Senior UBS Lawyer Settles New York Charges of Selling ARS on Inside Information

New York Attorney General Andrew M. Cuomo announced a $6.5 million settlement with David Aufhauser, a top executive at UBS, regarding his insider trading of auction rate securities.  Today’s agreement will settle allegations that Aufhauser, former General Counsel of UBS AG and General Counsel of the Investment Bank at UBS AG, sold his personal holdings of auction rate securities after acquiring insider information about UBS’s collapsing auction rate securities market. Under the agreement secured by Cuomo, Aufhauser will pay $6.5 million to New York State. The payment includes his 2008 UBS discretionary incentive compensation of $6,000,000 plus an additional $500,000 as civil penalties.

Aufhauser further agreed that for two years following the settlement:

Aufhauser shall not be employed by or associated with a broker dealer, investment advisor, hedge fund or other participant in the securities industry;
Aufhauser shall not serve as a director or officer of any public company;
Aufhauser shall not practice law in the State of New York.

According to the AG, while traveling on the Amtrak Acela train from New York to Washington in the early evening hours of Friday, December 14, 2007, Aufhauser opened an e-mail sent earlier in the day by UBS’s Chief Risk Officer containing material, non-public information concerning UBS’s position and intentions in the auction rate securities market.    In the e-mail, the Chief Risk Officer outlined a series of grave problems with respect to UBS’s auction rate securities market. Aufhauser immediately forwarded it to two other UBS lawyers requesting that a meeting be arranged to discuss these issues.  A few minutes later, while still on the train, Aufhauser e-mailed his financial advisor directing his financial advisor to sell all of his auction rate securities.  Aufhauser instructed his financial adviser: “I want to get out of arcs [auction rate certificates].  Let’s talk on Monday.”

On Monday, December 17, 2007, Aufhauser reiterated his instruction to his broker to sell his auction rate securities, and his broker then sold Aufhauser’s $250,000 worth of auction rate securities on December 18 and 21, 2007.

Aufhauser’s trading and conduct violated Section 352-c of the General Business Law.  Aufhauser committed fraud in connection with a securities transaction by misappropriating confidential information for securities trading purposes in breach of a duty owned to the source of the information.

SEC Announces Agenda for Transparency Roundtable

The SEC announced the agenda for Wednesday’s roundtable on providing more transparency to investors that will include discussion of lessons from the current credit crisis. Among other issues, panelists will address better ways to explain complex financial instruments to investors and the marketplace, and will propose ways to provide investors with more transparent, useful, and timely access to high-quality information.

SEC Announces Steps in Mark to Market Accounting Study

The SEC announced additional details on the process and initial steps that the SEC has undertaken to conduct a study on "mark-to-market" accounting, as required by Sec. 133 of the Emergency Economic Stabilization Act of 2008, signed into law by President Bush last Friday.  The study is to be completed by Jan. 2, 2009, in consultation with the Secretary of the Treasury and the Board of Governors of the Federal Reserve System. Under the terms of the EESA, the study will focus on:

The effects of such accounting standards on a financial institution's balance sheet
The impacts of such accounting on bank failures in 2008
The impact of such standards on the quality of financial information available to investors
The process used by the Financial Accounting Standards Board in developing accounting standards
The advisability and feasibility of modifications to such standards
Alternative accounting standards to those provided in [Financial Accounting Standards Board] Statement Number 157

The SEC also announced that it is scheduling public roundtables to obtain input into the study from investors, accountants, standard setters, business leaders, and other interested parties.

SEC Charges Former Restoration Hardware Executive with Tipping Friends

The SEC charged a former vice president of national home furnishing retailer Restoration Hardware with insider trading for tipping three friends that the company was about to be acquired, enabling them to make more than $900,000 in unlawful profits when public announcement of the subsequent merger caused the stock price to soar.  The SEC alleges that Ciriaco "Eric" Rivor, who was Vice President of Treasury at Restoration Hardware, learned in mid-2007 that the company was about to be acquired by a private equity firm at a substantial premium. Rivor allegedly passed the confidential, non-public information to friends Emmanuel Axiaq. and Steven Lusardi and told Emmanuel Axiaq to pass the information to his father, Francis Axiaq.  The SEC's complaint alleges that Emmanuel Axiaq and Lusardi profited by $29,539 and $4,398, respectively, on their stock purchases, while Francis Axiaq had an illicit potential profit of nearly $900,000.

Rivor, Lusardi, and Emmanuel Axiaq, without admitting or denying the allegations in the SEC's complaint, have agreed to a permanent injunction from further violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Rivor, who did not personally trade on the information, has agreed to pay a $68,000 penalty. Lusardi has agreed to pay a total of $8,901, including disgorgement of his trading profits, prejudgment interest and a penalty equal to his trading profits. Emmanuel Axiaq has agreed to pay a total of $90,249, including $30,249 in disgorgement of his trading profits and prejudgment interest and a penalty of $60,000.

In a non-settled enforcement action, Francis Axiaq is charged with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The SEC is seeking a permanent injunction, disgorgement, financial penalties, and other relief.

SEC Charges Securities Firm with Illegal Short Sales

The SEC filed an injunctive action in the United States District Court for the Central District of California against Lion Gate Capital, Inc. (Lion Gate) and its principal, Kenneth Rickel alleging illegal short selling. According to the complaint, from January 2005 through September 2006, Lion Gate and Rickel allegedly used shares purchased in fourteen registered public offerings to cover short sales that occurred during the five business days before the pricing of those offerings (the restricted period). The Commission’s complaint alleges that this conduct violates Rule 105 of Regulation M under the Securities Exchange Act of 1934. The SEC alleges that in each instance, Lion Gate and Rickel engaged in transactions that created the appearance that the shares covering the restricted period short sales were purchased on the open market. According to the complaint, Lion Gate and Rickel realized profits of at least $207,291 from their illegal trading.

At the time of the conduct in the complaint, Rule 105 prohibited covering a short sale made during the restricted period with securities purchased in a registered offering.The Commission seeks permanent injunctions against each defendant, and disgorgement, prejudgment interest, and civil penalties against each defendant.

President's Working Group on Financial Markets Issues Statement

The President's Working Group on Financial Markets issued the following statement today:

Conditions in U.S. and global financial markets remain extremely strained.  The President's Working Group on Financial Markets (PWG) is working with market participants and regulators globally to address the current challenges and restore confidence and stability to financial markets around the world.

With the passage of the Emergency Economic Stabilization Act of 2008 (EESA), Congress has granted important new authorities to the Treasury, Federal Reserve, and the FDIC.  These new authorities will be employed in conjunction with existing authorities to restore market confidence by strengthening the balance sheets of financial intermediaries and improving overall market functioning.

The diversity of institutions and markets under stress, and the magnitude and complexity of the adjustment underway, requires that the tools available to policymakers, regulators and supervisors be used in forceful and coordinated ways across regulatory and supervisory agencies in the United States and throughout the world.  This will involve moving with substantial force on a number of fronts.  These broad initiatives are outlined below.   

Text of Emergency Economic Stabilization Act

For those who wish to read the complete text of the Emergency Economic Stabilization Act of 2008, here it is.

SEC's Enforcement Division Posts Enforcement Manual

The SEC's Enforcement Division posted its Enforcement Manual on the SEC website.  According to the Manual,

it is an electronic document designed to be a reference for the staff in the U.S. Securities and Exchange Commission’s (“SEC”) Division of Enforcement (“Division” or “Enforcement”) in the investigation of potential violations of the federal securities laws. It contains various general policies and procedures and is intended to provide guidance only to the staff of the Division.

SEC Files Amicus Brief in Transnational Fraud Case

The SEC filed an amicus brief, at the request of the Second Circuit, in Morrison v. National Australia Bank, Ltd. (No. 07-0583-cv)  to offer its views as to whether  the antifraud provisions of the U.S. securities laws apply to the alleged transnational fraud involving foreign purchasers who bought a foreign issuer’s securities on a foreign exchange, but where significant aspects of the fraudulent conduct occurred in the United States.  The SEC urged the court to expressly set forth the following standard to assess whether the antifraud provisions apply to transnational securities-fraud cases:

The antifraud provisions of the securities laws apply to transnational frauds that result exclusively or principally in overseas losses if the conduct in the United States is material to the fraud’s success and forms a substantial component of the fraudulent scheme.

SEC Charges Next Components & Hsu with Ponzi Scheme

The SEC filed a Complaint in the United States District Court for the Central District of California against Next Components, Ltd. and its principal, Norman Hsu alleging that the defendants operated a nationwide Ponzi scheme.  Norman Hsu is in federal custody awaiting trial on federal criminal charges of investment fraud and wire fraud.  According to the SEC’s complaint, Hsu presented himself as an international businessman with high-level contacts with overseas businesses, particularly in the Chinese apparel and technology industries. From January 2003 through September 2007, Hsu allegedly told investors that Next Components would pool their funds to finance bridge loans negotiated by Hsu that would generate investor returns of 14 to 24 percent every 70 to 130 days.  Insstead, according to the SEC, Hsu and Next Components used new investor funds to pay “returns” to pre-existing investors, and misappropriated the remainder of investor funds to pay sales agent commissions, finance Hsu’s luxury living and entertainment expenses, and reimburse investors for political donations solicited by Hsu.

The complaint alleges that Next Components and Hsu violated the antifraud and registration provisions of the federal securities laws. The Commission seeks permanent injunctions, disgorgement, prejudgment interest, and civil penalties against the defendants.

Short-Selling Ban Ends Oct. 8

The SEC announced that its Emergency Order that prohibits persons from selling short the securities of financial institutions will expire at 11:59 p.m. ET on Wednesday, October 8, 2008.

McAfee GC Acquitted of Fraud on Backdating Charges

The Wall St. Journal reports that a jury acquitted the former general counsel at McAfee Inc., Kent Roberts, of fraud in connection with illegal backdating of stock options in federal district court in San Francisco.  While the jury did not come to a decision on a charge of falsifying accounts, the judge recommended no further action.  WSJ, Ex-McAfee Executive Clear of Illegal Option Dating.

SEC Charges Five World Securities Brokers with Unsuitable Sales of Variable Universal Life Policies

The SEC filed a complaint against Kederio Ainsworth, Guillermo Haro, Jesus Gutierrez, Gabriel Paredes, and Angel Romo, five World Group Securities (WGS) registered representatives, including a branch office manager, charging them with fraudulently selling unsuitable securities, primarily variable universal life policies. Most customers who bought these securities lacked the cash or income to do so but were urged by the defendants to raise the money to pay for the purchases and subsequent monthly payments required for these products by refinancing their fixed-rate mortgages into subprime adjustable-rate negative amortization mortgages. Most customers had little formal education beyond high school, had little prior investment experience and several did not speak English fluently, if at all.  In making the sales, the defendants allegedly misrepresented the expected returns from the securities, the liquidity of securities, and the nature of the securities and the terms of the new mortgages while failing to disclose material facts about the products.

The Commission's complaint also alleges that the defendants falsified customer account forms and prepared order tickets that contained information they knew was inaccurate relating to the securities sales.

The Complaint seeks to enjoin the defendants from future violations of Section 17(a) of the Securities Act of 1933, and Sections 10(b) and 17(a) of the Securities Exchange Act of 1934 and Rules 10b-5 and 17a-3 thereunder; payment of disgorgement and prejudgment interest and the imposition of civil penalties.

SEC Charges 16 Individuals in Insider Trading in advance of Dick's Sporting Goods Merger Announcement

The SEC filed two complaints in the U.S. District Court for the Western District of Pennsylvania against a total of sixteen individuals for insider trading in advance of Dick's Sporting Goods Inc.'s June 21, 2004, announcement that it intended to acquire Galyan's Trading Company, Inc. via a tender offer. The complaints allege that Joseph J. Queri, Jr., Dicks' Senior Vice President of Real Estate, tipped his close friend, Gary Gosson, and his father, Joseph Queri, Sr., about the acquisition.  Gosson, in turn, tipped his friends defendants Gary L. Camp, Michael A. Santaro, Joseph A. Federico, Philip J. Simao, Mark J. Costello, and Alan J. Johnston, who all bought shares of Galyans stock. Johnston, in turn, tipped family members and friends, who also bought shares. Gosson gave Camp money to buy shares of Galyans stock through Camp's brokerage account. Santaro and Federico shared profits with Gosson.

Queri Sr. tipped his friends James L. Jerome, Kyle D. Kaczowski, Gino M. Ferraro, Felix A. Crisafulli, and Thomas M. Heller, who all bought shares of Galyans stock. Jerome, in turn, tipped defendant Brandt A. England, who also bought shares. Kaczowski tipped two friends who traded. Ferraro tipped his son-in-law, defendant Franko J. Marretti III, who traded and tipped a business colleague.

The day after the public announcement, Galyan's stock closed at $16.68, a 50.3% increase from the previous day's closing price of $11.10. The traders collectively profited over $620,000 after selling their Galyans stock.

Five of the defendants have agreed to settle with the SEC. Without admitting or denying the allegations in the complaint, Queri Sr., Santaro, Ferraro, Crisafulli and Heller consented to the entry of a Final Judgment, subject to the court's approval.