No “Loos” Causation From Mere Announcement Of Internal Investigation

Securities fraud actions are often filed on the heels of an announcement of an internal or SEC investigation.  A recent Ninth Circuit decision, Loos v. Immersion Corp., may make it easier for company executives to sleep at night following such an announcement.  The Ninth Circuit has joined a growing number of circuits holding that the announcement of an internal investigation, standing alone, is insufficient to show loss causation at the pleading stage. Read More

Can You Hear the Whistle Blowing?: SEC Punishes Company that Did Not Address Fraud Allegations by Whistleblower

The U.S. Securities and Exchange Commission recently announced the latest whistleblower bounty awarded under the Dodd-Frank Act, which authorizes rewards for original information about violations of securities laws.  Whistleblowers can receive 10 percent to 30 percent of the money collected in an SEC enforcement action where the monetary sanctions imposed exceed $1 million.

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Judge Rakoff’s “Sour Grapes”: SEC v. Citigroup Settlement Approved

On August 5, 2014, U.S. District Judge Jed Rakoff reluctantly approved a$285 million settlement in the SEC’s enforcement action against Citigroup.  In SEC v. Citigroup, the SEC alleged that after Citigroup realized in early 2007 that the market for mortgage-backed securities was beginning to weaken, it created a billion-dollar fund to sell some of these assets to investors without disclosing either that Citigroup had exercised significant influence in selecting the assets to include in the fund and had itself retained a $500 million short position in the assets it had helped select.

Judge Rakoff initially declined to approve the proposed consent judgment because he said it lacked “sufficient evidence to enable it to assess whether the agreement was fair, adequate, reasonable, and in the public’s interest.”  He was forced to reconsider that position when the Second Circuit ruled, on appeal, that the “primary focus of the [district court’s] inquiry . . . should be on ensuring the consent decree is procedurally proper, . . . taking care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.” Read More

SEC Can’t Pass On Pot Stock Puffery

Corporations facing federal securities suits can sometimes avoid liability by claiming that their forward-looking statements were so vague or indefinite that they could not have affected the company’s stock price and are therefore not material.  Such statements are not actionable because courts consider them “puffing,” famously described by Judge Learned Hand nearly 100 years ago as “talk which no sensible man takes seriously.”  Though we cannot know today what Judge Hand would think of the civil complaint recently filed by the SEC against several marijuana-company stock promoters, it’s safe to say that this isn’t the kind of ‘puffing’ he had in mind.

The defendants in the SEC civil action are all stock promoters, most of whom operate websites where they promote stocks, including microcap or so-called “penny” stocks.  The SEC alleges that the defendants promoted shares in microcap companies related to the marijuana industry. For example, one of the companies, Hemp Inc., claims to be involved with medical marijuana.  According to the SEC, three of the defendants bought and sold more than 40 million shares in Hemp Inc. in order to give the appearance that there was an active market in the company’s stock.  In reality, the transactions allegedly consisted of wash trades and matched orders.  A wash trade occurs when a security is traded between accounts, but with no actual change in beneficial ownership, while a matched order entails coordinating buy and sell orders to create the appearance of trading activity.  As the defendants were allegedly generating trading activity, they were also allegedly promoting the stock on the Internet, touting “a REAL Possible Gain of OVER 2900%” in Hemp Inc. stock.  Wow, that is high.

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On a Roll: The SEC Continues to Deliver on its Promise to Seek Admissions of Wrongdoing

The SEC announced last week that it has obtained yet another admission of wrongdoing in connection with an agreement to settle an SEC enforcement action.  This time, Peter A. Jenson, the former COO of Harbinger Capital Partners LLC, admitted that he aided and abetted Harbinger’s CEO, Philip Falcone, in obtaining a fraudulent loan from Harbinger.  Jenson agreed to a $200,000 penalty along with a two-year suspension from practicing as an accountant on behalf of any SEC-regulated entity.  The settlement awaits court approval.

The Jenson settlement is the latest in a series of settlements in which the SEC has obtained admissions of wrongdoing since announcing changes to its “no admit/no deny” settlement policy in June 2013. Other examples include the March 2014 Lions Gate settlement, the February 2014 Scottrade settlement, and the August 2013 Falcone/Harbinger settlement that settled charges related to those Jenson settled last week.    Read More

SEC Gives Itself the Home Court Advantage in an Accounting Fraud / Internal Controls Action Against a Corporate CEO

An otherwise mundane SEC announcement on July 30, 2014 of an enforcement action charging a public company CEO and CFO with accounting fraud and internal controls violations is significant because the SEC is proceeding against the non-settling individual (the CEO) in an administrative proceeding rather than in federal court.  While not unprecedented, it has been, to date, exceedingly rare for the Commission to proceed against an unregulated entity or person administratively rather than in federal court.  This decision reflects the Commission’s and Enforcement Division’s recently, but frequently, stated intent to bring more administrative proceedings that previously would have been brought in federal court, now that the Commission has expanded remedies under Dodd-Frank Act.  The decision also raises significant due process issues.

The action itself charges Marc Sherman and Edward Cummings, CEO and former CFO, respectively, of QSGI Inc., a Florida-based computer equipment company, with violation of the antifraud and other provisions of the Securities Exchange Act of 1934 and the Sarbanes-Oxley Act of 2002.  According to the Commission’s press release, Sherman and Cummings claimed they had disclosed all significant deficiencies in internal controls over financial reporting to the company’s independent auditors, but in fact did not disclose or direct anyone else to disclose ongoing inventory and accounts receivable issues or improper acceleration of recognition and the resulting falsification of QSGI’s books and records.  The Commission also alleges that the executives signed SEC filings and Sarbanes-Oxley certifications that were rendered false and misleading due to the above issues.  Cummings entered into an administrative settlement with the SEC, agreeing to a cease and desist order, a $23,000 civil penalty, a 5-year officer and director bar, and a 5-year bar on appearing or practicing before the Commission as an accountant.  Sherman did not settle, and will instead litigate against the Division of Enforcement in an administrative proceeding. Read More

Swimming in the Deep End: A Primer on Dark Pools

“Dark pools of liquidity” have recently become the focus of increased regulatory scrutiny, including a number of high-profile enforcement actions related to these alternative trading systems.   This increased scrutiny follows on the heels of Michael Lewis’s popular book, “Flash Boys,” which introduced the public at large to dark pools through its allegations that high frequency trading firms use dark pools to game the system to the detriment of common investors.   But what exactly are dark pools and do they have any redeeming qualities?  This post provides a primer on the benefits and disadvantages of dark pools and why they matter.

In general, “dark pools of liquidity” are private alternative forums for trading securities that are typically used by large institutional investors and operate outside of traditional “lit” exchanges like NASDAQ and the NYSE.  The key characteristic of dark pools is that, unlike “lit” exchanges, the identity and amount of individual trades are not revealed.  The pools typically do not publicly display quotes or provide prices at which orders will be executed.   Dark pools, and trading in dark pools, have proliferated in recent years due in part to the fragmentation of financial trading venues coupled with advancements in technology, including online trading.  There are currently over 40 dark pools operating in the United States.  Around half of these are owned by large broker-dealers and are operated for the benefit of their clients and for their own proprietary traders.  According to the SEC, the percentage of total trading volume executed in dark venues has increased from approximately 25% in 2009 to approximately 35% today.

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Patience is a Virtue: District Court Suggests that the SEC “Wait and See” Before Seeking Certain No-Admit, No-Deny Settlements

On June 18, 2014, Judge Victor Marrero of the U.S. District Court for the Southern District of New York approved the SEC’s no-admit, no-deny consent decrees in its insider trading case against CR Intrinsic Investors, LLC and affiliated entities.  In approving the decrees, however, the court called on the SEC to take a “wait and see” approach in cases involving parallel criminal actions arising out of the same transactions alleged in its complaint.

The decision follows the much-anticipated opinion in SEC v. Citigroup Global Markets (“Citigroup IV”), in which the Second Circuit vacated Judge Rakoff’s order refusing to approve a no-admit, no-deny consent decree between the SEC and Citigroup.  The Second Circuit found that district courts are required to enter proposed SEC consent decrees if the decrees are “fair and reasonable,” and if the public interest is not disserved.  A court must focus on whether the consent decree is procedurally proper, and cannot find that a proposed decree disserves the public based on its disagreement with the SEC’s use of discretionary no-admit, no-deny settlements.

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SEC Charges Hedge Fund Adviser with Whistleblower Retaliation under Dodd-Frank

On June 16, 2014, the SEC issued its first-ever charge of whistleblower retaliation under section 922 of the Dodd-Frank Act, charging a hedge fund advisor and its owner with “engaging in prohibited principal transactions and then retaliating against the employee who reported the trading activity to the SEC.” Read More

Flash Rules: Is A Wall Street Reform on the Horizon or is the SEC Merely Reacting to the Latest Media Headline?

Michael Lewis’ new book Flash Boys: A Wall Street Revolt has caused a commotion on Wall Street, on Capitol Hill, and with law enforcement agencies. The SEC is the latest government agency to examine and propose new rules on alternative exchanges and high-frequency trading. The SEC’s latest proposals and enforcement actions raise questions about the agency’s plans to effectively regulate and enforce these activities and its ability to do so.

In Flash Boys, Michael Lewis—author of Liar’s Poker, Moneyball, The Blind Side, and The Big Short—follows a “small group of Wall Street investors” who he says “have figured out that the U.S. stock market has been rigged for the benefit of insiders and that, post-financial crisis, the markets have become not more free but less, and more controlled by the Big Wall Street banks.” High frequency trading is a type of trading using sophisticated technological tools and computer algorithms to rapidly trade securities in fractions of a second to profit from the slightest market blips. High frequency trading is done over traditional exchanges. In contrast, dark pools are alternative electronic trading systems conducted outside traditional exchanges that institutional investors use, sometimes to hide their trading intentions or to move the market with large orders.

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