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This is the seventh in a series of articles
that will be published periodically analyzing the direction of SEC enforcement.
The SEC has been conducting dozens of investigations
related to the market crisis since it began to unfold. While significant cases
have been brought, they have been few in number. For discussion purposes they
can be divided into four groups: 1) Major Wall Street players; 2) Lenders; 3)
New Jersey; and 4) others. The results here, like those in court , are mixed.
The actions against Wall Street players Goldman Sachs, Citigroup and Bank of
America are among the most significant and high profile enforcement cases
brought by the Commission relating to the market crisis. Each has been
resolved, although not without controversy.
Perhaps the most significant case brought last year - and
certainly one of the most high profile - is SEC v. Goldman Sachs, Case
No. 3229 (S.D.N.Y. Filed April 16, 2010). The case centered squarely on events
involved in the market crisis. The factual allegations concerned an entity
called ABACUS, constructed at the request of Goldman client Paulson & Co.
The client asked that an investment vehicle be constructed which would permit
it to bet that the sub-prime real estate market would crash. Goldman had other
clients who held the opposite view.
In 2007 ABACUS was constructed using collateralized debt
obligations tied to the sub-prime residential real estate market. According to
the SEC, Paulson influenced the selection of the securities used to construct
the entity. The lowest grade securities consistent with maintaining a favorable
rating were chosen.
The offering materials furnished to potential investors
contained information on the construction of ABACUS, its investments and risks.
Those materials did not mention Paulson. Nor did they inform investors that the
role of ACA as portfolio selection agent had been undermined if not completely
Paulson shorted the fund. IKB, a large German bank took
long positions. When the market crashed Paulson made substantial sums while IKB
suffered huge losses.
The SEC filed suit against the investment bank and one of
its employees. Subsequently, Goldman settled, consenting to the entry of an
injunction prohibiting future violations of Securities Act Section 17(a). The
claim based on Exchange Act Section 10(b) was dropped. The bank also agreed to
pay a $535 million civil penalty, the largest ever obtained against a Wall
Street bank. In the settlement materials Goldman made an unusual
acknowledgement, stating that it made a mistake in not disclosing the role of
In what is perhaps a sign of the times, the suit was born
and settled in controversy. Media reports note that the Commissioners voted 3-2
to institute the action. There were allegations that the filing of the suit was
timed to assist the Administration win passage of financial reform legislation
and that there were press leaks about the case. The SEC IG investigated the
filing and settlement of the case. No wrongful conduct was found.
A second significant market crisis case brought last year
is SEC v. Citigroup, Inc., Civil Action No. 1:10-CV-01277 (D.D.C. July
29, 2010). The complaint, based on claimed violations of Securities Act Section
17(a)(2) and Exchange Act Section 13(a), alleged that beginning in July 2007 and
continuing through the fall of that year, the bank misrepresented its exposure
to the sub-prime market. Investors were told that Citigroup's exposure was $13
billion. In fact it was $56 billion. The bank failed to tell investors about
two groups of sub-prime investments valued at $43 million despite the fact that
two senior bank officials were repeatedly furnished with information about
Citigroup resolved the action
by consenting to the entry of a permanent injunction prohibiting future
violations of the statutory sections cited in the complaint. The bank also
agreed to pay disgorgement and a civil penalty totaling $75 million.
Administrative proceedings were brought against the two
officers involved, Arthur Tildesley, Jr., the current head of Global Cross
Marketing and Gary Crittenden, the former CFO. In the Matter of Gary L.
Crittenden, Adm. Proc. File No. 3-13985 (Filed July 29, 2010). Each
Respondent consented to the entry of an order directing them to cease and
desist from causing any further or future violations of Exchange Act Section
13(a). Mr. Crittenden also undertook to pay $100,000 while Mr. Tildesley paid
Again the case was engulfed in controversy. Judge Huvelle
delayed signing the settlement pending a hearing. Eventually the court deferred
to the judgment of the SEC after making it clear that the monetary penalty was
not a deterrent. The court also required the SEC to certify that the bank
instituted certain remedial procedures intended to preclude a future reoccurrence.
Recently, the SEC IG opened an investigation into this settlement at the behest
of a Senator. The inquiry focuses on whether a conflict of interest or perhaps
undue influence impacted the settlement because of the circumstances under
which it is alleged to have been negotiated.
The SEC also had difficulty winning court approval of its
enforcement action against Bank of America. SEC v. Bank of America, Civil
Action No. 09 cv 6829 (S.D.N.Y. Filed Aug. 3, 2009). The case arose out of its
acquisition of brokerage giant Merrill Lynch. The complaint centered on a claim
that the proxy materials furnished to shareholders to approve the acquisition
were false and misleading because they suggested that Merrill personnel would
not be paid bonuses absent further approval. In fact prior to the proxy
solicitation the boards of both companies had authorized the payment of bonuses
of up to $5.8 billion. That information was contained on a schedule to the
merger agreement which was omitted from the proxy materials.
The Commission initially agreed to resolve its complaint
with a consent decree based on Exchange Act Section 14(a). The court however
declined to enter the settlement. In a series of orders the court was highly
critical of the settlement terms, the amount of the penalty, the fact that
individuals were not named as defendants and the underlying SEC investigation.
After increasing the penalty from the initially proposed $33 million to $150
and an agreement by the bank to institute certain remedial procedures, the
court reluctantly entered the settlement.
In contrast a suit brought by the New York Attorney
General based on essentially the same factual allegations but grounded on state
law named not just the bank but its two senior officers. State of New York
v. Bank of America (S.Ct. N.Y. Filed Feb. 4, 2010). That case is currently
Two significant market crisis cases that settled last
year are SEC v. Mozilo, Case No. CV 09-03994 (C.D.Cal. Filed June 4,
2009) and SEC v. Morrice, Civil Action No. CV 09-01426 (C.D. Cal. Filed
Dec. 7, 2009). The former is against the officers of the number one sub-prime
lender, Countrywide Financial, while the latter names as defendants the senior
officers of New Century Financial, the number three sub-prime lender. Each case
essentially centered on fraud claims based on the failure of the defendants to
disclose the true financial condition of the company as the sub-prime lending
market tumbled down. Mozilo also contained claims that Angelo Mozilo, the company
chairman, engaged in insider trading as his company spiraled to a crash while
Morrice includes additional financial fraud claims.
On the eve of trial the Commission secured what the
headlines claim are significant settlements to resolve Mozilo. Each defendant
consented to the entry of an injunction and to pay disgorgement, prejudgment
interest and a civil penalty. Mr. Mozilo and former COO David Sambol agreed to
injunctions based on the antifraud and reporting provisions while former CFO
Eric Sieracki consented to the entry of an order based on Securities Act
Sections 17(a)(2) and (3). In addition to consenting to the entry of a
permanent officer and director bar, Mr. Mozilo agreed to pay a total of $67.5
million, including $45 million in disgorgement and interest and a penalty of
$22.5 million. Mr. Sambol, who agreed to the entry of a three year
officer/director bar, will pay disgorgement and interest of $5 million and a
civil penalty of $520,000. In his settlement Mr. Sieracki agreed to pay a
penalty of $130,000 and to the entry of a Rule 102(e) order barring him from
practicing before the Commission as an accountant for one year.
The Commission also fully resolved Morrice. There
Brad Morrice, the former CEO and co-founder, Patti Dodge, the former CFO and
David Kenneally, the former controller settled with the SEC. Mr. Morrice and
Ms. Dodge each consented to the entry of an injunction prohibiting future
violations of Securities Act Actions 17(a) and Exchange Act Sections 10(b) and
13(b)(5) as well as from aiding and abetting violations of Section 13(a). Mr.
Kenneally agreed to the entry of a similar injunction although it did not
include Section 17(a). Each defendant agreed to the entry of an
officer/director bar with a right to re-apply after five years. In addition,
Mr. Morrice will pay disgorgement $464, 364 along with prejudgment interest and
a penalty of $250,000. Ms. Dodge will pay disgorgement of $379,808 along with
prejudgment interest and a penalty of $100,000 while Mr. Kenneally will pay
disgorgement of $126,676 along with prejudgment interest. See also SEC v.
State Street Bank and Trust Co., Case No. 1:10-CV-10172 (D. Mass. Filed
Feb. 4, 2010); In the Matter of State Street Bank and Trust Co., Adm. Proc.
File No. 3-13776 (Filed Feb. 4, 2010)(settled actions relating to misleading
statements made to investors in a bond fund as the market unraveled).
More recently the Commission filed two actions arising
out of the collapse of lender IndyMac. As in earlier lender cases, the
complaints center on a failure to disclose the declining financial fortunes of
the bank as the market crisis unfolded. SEC v. Perry, Case No. CV
11-01309 (C.D. Cal. Filed Feb. 11, 2011); SEC v. Abernathy, Civil Action
No. CV 11-01308 (C.D. Cal. Filed Feb. 11, 2011).
Perry, which names as defendants
the former CEO and CFO, focuses on the impact of events on the capital of the
bank, its efforts to bolster it through stock sales and the failure to update
filings and offering documents which contained a mixture of statements which were
dated and vague, boiler plate statements about the use of funds. None of this
accurately and specifically disclosed the declining regulatory capital position
of the bank or that the stock sale proceeds were intended to bolster it.
Abernathy, which also names a
former CFO as a defendant, stems from the same basic allegations. The action
centers more however on the negligent failure of another former CFO to ensure
that updated information about difficulties with the consumer loan origination
documents were included in current filings rather than boiler plate. Investors
were thus not told about seriously flawed loan documents which portended
problems with the loans.
Perry, which includes allegations
of scienter based fraud, is in litigation. Abernathy settled with a
consent to a permanent injunction prohibiting future violations of Securities
Act Sections 17(a)(2) and (3), the payment of disgorgement and prejudgment
interest and a civil penalty. In addition, Mr. Abernathy agreed to the entry of
an order barring him from practicing before the Commission as an accountant
with a right to reapply in two year.
Another significant market crisis case brought last year
is In the Matter of State of New Jersey, Adm. Proc. File No. 3-14009
(Aug. 18, 2010). The Order claimed that the state violated Securities Act
Sections 17(a)(2) and (3) in connection with the sale of municipal bonds from
August 2001 through April 2007. Essentially the State is alleged to have made
it appear as a result of certain legislative action that two large pension
funds discussed in the offering materials were funded when in fact they were
not. When the state became aware of the underfunding it failed to take any
steps to correct the situation. Furthermore, until 2007 and 2008 when disclosure
counsel was retained, the state did not have any written policies and
procedures regarding the review or updating of bond offering documents. By the
time the proceeding was filed policies had been adopted and a committee created
to oversee the entire disclosure process.
The case against New Jersey was resolved with the entry
of a cease and desist order. The proceeding has particular significance in view
of the effects of the market crisis and con-going financial difficulties of
many states and municipalities.
Two other market crisis cases brought last year which are
in litigation are SEC v. ICP Asset Management LLC, Civil Action No.
10-cv-4791 (S.D.N.Y. Filed June 21, 2010) and SEC v. Farkas, Civil
Action No. 1:10 cv 667 (E.D. Va. Filed June 16, 2010). The former is an action
against a registered investment adviser and its related entities. The complaint
centers on transactions involving four multi-billion dollar collateralized debt
obligations in which ICP Asset Management and the other defendants are alleged
to have repeatedly defrauded certain clients in certain transactions.
The latter is a fraud action against Lee Farkas, the
former chairman of mortgage lender Taylor, Bean & Whitaker. Prior to its
collapse, Taylor Bean was the largest non-depository mortgage lender in the
country. When the lender began having liquidity problems as early as 2002,
Mr.Farkas is alleged to have shuffled funds among various accounts and engaged
in other fraudulent conduct including using sham transactions to conceal the
true nature of the company. Parallel criminal charges have been filed. U.S.
v. Farkas (E.D. Va. Filed June 16, 2010).
Overall, it is clear that the Commission has brought
significant market crisis cases. Filing enforcement actions against Wall Street
giants such as Goldman Sachs, Citigroup and Bank of America
is significant. Obtaining meaningful settlements in those cases despite the
difficulties is a significant achievement. Likewise, filing and settling a
proceeding against the state of New Jersey while obtaining large dollar
settlements from the Countrywide executives suggests that the enforcement
program is regaining its vitality.
At the same time the cases raise significant questions.
The SEC has by all accounts expended significant amounts of time and resources
on its market crisis cases. Yet only a relative handful of cases have been
Even more troubling is the fact that frequently there
appears to be some disconnect between the allegations in the complaint and the
terms of the settlement. This caused the Commission difficulties in cases such
a Bank of America and Citigroup. In the former the court
repeatedly questioned the reason for not prosecuting any individuals as was
done in the case brought by the New York AG. The allegations in the
Commission's complaint suggested that such action might be appropriate. A
similar issue was presented in the Citigroup case where the Commission
plead what appeared to be intentional or at least reckless conduct involving a
number of senior executives which is not reflected by the actual charges or the
settlements. Indeed, when these settlements are read together with the most
recent IndyMac complaints, it appear that at least in settlement Securities Act
Sections 17(a)(2) and (3) are becoming a kind of failure to supervise for
Equally troubling is the fact that in both Bank of
America and Citigroup the court seemed to be the moving force
ensuring that adequate procedures were put in place to prevent a future
replication of the misconduct. Yet such procedures have long been a staple of
Mozilo also raises significant
questions despite the headlines generated by the settlement. While the sum Mr.
Mozilo agreed to pay is large in dollar amount, the complaint claims he sold
stock worth $260 million and had insider trading gains of $139 million which is
far more than what was paid. Likewise, while Mr. Sambol is paying $5 million in
disgorgement and interest the complaint alleges he obtained $40 million. And,
there is no explanation for dropping all intentional fraud claims against Mr.
Sieracki in view of the repeated claims of intentional wrong doing in the
In sum, while significant cases have been brought, and
noteworthy settlements obtained, frequently there appears to be a disconnect
between the claims and their resolution. That disconnect has at times created
difficulties with obtaining court approval of a proposed settlement as well it
should. That same disconnect may also be the reason for the mixed results the
Commission has obtained in court.
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.
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