On Capital Hill, discussions continue about the possible
revision or repeal of the Section 9291 of Dodd-Frank, the SEC FOIA exemption discussed here.
The SEC filed three related financial fraud actions this week, two of which are
in litigation. The agency and DOJ continued to bring FCPA actions, as FINRA
fined Morgan Stanley for not complying with its disclosure rules regarding
analyst conflicts. The circuit courts handed down decisions regarding forward looking
statements and loss causation, while shareholders entered into a tentative
settlement in a class action fraud case centered on the collapse of a major
sub-prime lender.
SEC enforcement actions
Financial fraud: SEC v. International
Commercial Television, Inc., Case No. 3:10-cv-05555 (W.D. Wash.
Filed Aug. 9, 2010). The complaint, discussed here, centers on three key allegations. First,
the company recognized revenue on sales of its primary product made through
Home Shopping Network prior to the time the product was actually sold and
before the expiration of the right of return. Under its arrangement with HSN,
product was drop shipped and kept in its warehouse. When that product was sold
HSN remitted the customer payments. ICT however recognized the revenue when the
product was shipped to HSN. Second, under the same arrangement the company
carried a receivable on its books from Home Shopping Network for product that
was never sold through the HSN because it was defective. Third, on direct
customer sales the ICT improperly recognized revenue from sales before the
right of return expired. As a result, the company had to restate its financial
statements for fiscal 2007 and the first two quarters of 2008. The company
settled the action, consenting to the entry of a permanent injunction
prohibiting future violations of Exchange Act Sections 13(a), 13(b)(2)(A) and
13(b)(2)(B).
A related action against Karlheinz Redekopp, the former
CFO of ICT, is based on alleged violations of Securities Act Section 17(a) and
Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5),
along with the pertinent rules. SEC v. Redekopp, Case No. 3:10-cv-05557
(W.D. Wash. Filed Aug. 9, 2010). This case is in litigation. In the Matter
of Dohan + Company CPAs, Adm. Proc. File No. 3-13997 (Aug. 9, 2010) is a
proceeding based on Rule 102(e) against the outside auditors of ICT, Dohan +
Company CPA and its founding partner Steve Dohan, the engagement partner Nancy
Brown and the manager of the audits Erez Bahar. This action is also in
litigation.
Criminal cases
Investment fund fraud: U.S. v. Huber,
Case No. 10-cr-1008 (C.D. Ill.) is a case in which William Huber pleaded guilty
to mail fraud, money laundering and engaging in prohibited monetary
transactions. This action follows an SEC case which alleged that Mr. Huber
obtained over $1.9 million from investors by making a series of false
representations regarding the trading by his fund, the account balances held by
investors and about his fees. In fact, he operated the fund as a Ponzi scheme.
The Commission's action is settled, as discussed here.
Sentencing is scheduled for December 10, 2010.
Obstruction: U.S. v. Ono,
Case No. 10-0371 (N.D. Cal. Aug. 9, 2010) is an action against Alvin Ono. The
indictment alleges that Mr. Ono intentionally destroyed files and data stored
on the hard drive of his computer in response to document requests by the SEC
in April and May 2008. At the time, the Commission was investigating possible
FCPA violations by Mr. Ono and his company.
FCPA
U.S. v. Mercator Corp.,
(S.D.N.Y. Filed Aug. 6, 2010) is an action in which the defendant merchant bank
pleaded guilty to one count of making corrupt payments in violation of the
FCPA. The bank acted as an adviser to the government of Kazakhstan in
connection with the sale of part of the oil and gas wealth of the country. It
was dependent on the good will of three senior government officials. Those
officials had the ability to influence whether Mercator obtained and retained
lucrative business and would be paid. To maintain its lucrative contacts, in
November 1999 Mercator purchased two snowmobiles and shipped them to Kazakhstan
for delivery to one of the officials.
In a related case, James Giffen, the Chairman of the
bank, pleaded guilty to failing to indicate on his tax return that he had a
Swiss bank account in 1997. U.S v. Giffen, 1:03-mj-06663 (S.D.N.Y. Filed
April 2, 2003). In 2007, a civil forfeiture action was brought against $84
million on deposit in Switzerland. The complaint claimed the funds were
traceable to unlawful payments to senior Kazakh officials in connection with
oil and gas transactions arranged by Mercator for Kazakhstan. Under a 2007
agreement involving the United States, Switzerland and Kazakhstan, the funds
were used by a non-government organization to benefit underprivileged Kazakh
children. The dates for sentencing have not been set. See also http://fcpablog.squarespace.com/ (speculating about the
predicate for the plea).
SEC v. Universal Corporation, Inc.,
Civil Action No. 01:10-cv-01318 (D.D.C. Filed Aug. 6, 2010); SEC v. Alliance
One International, Inc., Civil Action No. 01:10-cv-01319 (D.D.C. Filed Aug.
6, 2010). Each case centers on an agreement between Universal and Alliance One
to obtain business from the Thailand Tobacco Monopoly as discussed here.
Universal, in coordination with Alliance, paid about $800,000 million in bribes
to the Thailand Tobacco Monopoly to secure approximately $11.5 million in sales
contracts between 2000 and 2004. During the same period Dimon and Standard
(which later merged to form Alliance One) paid bribes to government officials
of the Thailand Tobacco Monopoly of $1.2 million to obtain about $18.3 million
in sales contracts. Each company failed to properly record the payments in its
books and records.
Each case is also to have engaged in additional FCPA
violations. Universal is alleged to have made a series of payments from 2004
through 2007 totaling about $165,000 to government officials in Mozambique. The
company also paid about $850,000 to high ranking officials of the Malawian
government between 2002 and 2003. Alliance One is alleged to have violated the
FCPA by making payments totaling more than $3 million to officials of the
Kyrgyzstan government to purchase Kyrgyz tobacco from 1996 through 2004. The
company is also alleged to have made improper payments to tax officials in
Greece to avoid certain tax difficulties and in Indonesia to obtain a tax
refund.
Each company agreed to settle with the SEC, consenting to
the entry of a permanent injunction prohibiting future violations of Exchange
Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B). Universal also agreed to pay
disgorgement of $4,581,276. 51 while Alliance One agreed to pay $10,000,000.00.
Each company will also retain an independent monitor.
Universal and Alliance One settled criminal charges with
DOJ by entering into a non-prosecution agreement. In addition, Universal agreed
to pay a $4.4 million criminal fine while Alliance One will pay a $9,450,000
fine. Each company will retain an independent monitor for three years.
The Commission previously filed a settled enforcement
action against four former employees of Dimon, Inc., discussed here.
FINRA
Morgan
Stanley resolved an inquiry focused on its failure to make the disclosures
required by FINRA rules regarding research analyst conflicts of interest. The
firm also violated the terms of its 2003 settlement with the SEC on analyst
conflicts. Morgan Stanley was censured and directed to pay a fine of $800,000.
The firm is also required to review a sample of its research reports and
certify compliance with the research analyst conflict of interest rules every
six months for the next two years.
Court of appeals
Forward looking statements: In re Aetna, Inc.
Sec. Litig., No. 09-2970 (3rd Cir. Aug. 11, 2010) is an
appeal from the dismissal of a securities class action complaint. Plaintiffs
alleged that Aetna and its officers made materially false statements in a
number of filings and releases which described their insurance pricing policy
as "disciplined," when in fact it was not. Following an earnings release and a
significant price drop, suit was filed. The district court dismissed the
complaint concluding that the statements were forward looking and therefore
protected by the statutory safe harbor of the PSLRA. The Third Circuit
affirmed. Generally, the safe harbor requires proof of actual knowledge of
falsity. Here, plaintiffs claimed that the statements were not forward looking.
The term "disciplined" in the context of the pricing policy referred to Aetna's
expectation of achieving premium yields in line with its medical cost trends.
This clearly is based on future trends and is thus a forward looking statement
the court concluded. In any event, when read in context, the statements were
mere vague puffery and not material. At the conclusion of its opinion, the
court chastised plaintiffs for failing to submit most of the transcripts of
conference calls which contained the statements. This hindered review of the
specific statements alleged to have been false.
Loss causation: Miller v. Thane
International, Inc., Case No. 09-55474 (9th Cir. Aug. 9, 2010)
is a case in which the court affirmed the dismissal of a class action for
failure to establish loss causation. The complaint centers on the merger of
Thane International with another company in a stock-for-stock deal valued at $7
per share. The prospectus stated that at the conclusion of the merger, the
shares would be listed for trading on the NASDAQ National Market. In fact, they
were listed on the OTC Bulletin Board. For nineteen days following the merger
the share price remained above $7. One day before a disappointing earnings release
the price fell to about $6. Following the earnings release the price continued
to drop. The court held that although the market was inefficient the share
prices could still be used to establish loss causation. Here, the record and
testimony establish that the misrepresentation about the listing emerged and
was absorbed into the price while the share price remained above the $7
exchange price. On this record, plaintiffs have failed to establish loss
causation.
Private actions
In re New Century,
Case No. CV 07-00931 (C.D. CA.) is a securities class action arising out of the
collapse of sub-prime lender New Century. The defendants include a group of the
former officers and directors of the company, its outside auditors KPMG LLP and
underwriters J.P. Morgan Securities, Inc., Deutsche Bank Securities, Inc. and
Morgan Stanley & Co. This week the court gave preliminary approval to a
$125 million settlement. The officers and directors will pay $65 million, KPMG
$44.75 million and the underwriters $15 million.
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.