Insider Trading Gets Political: Trading on Political Intelligence

Some things are better left unsaid. Especially, it seems, when they involve political intelligence shared by a congressional aide with a lobbyist linked to a political intelligence firm serving Wall Street traders.

The sharing of political-insider scoop has recently caused Congress to be subpoenaed for an insider trading investigation that will likely test recent legislation enacted to curb trading on non-public political information. The SEC subpoenaed Rep. David Camp (R., Mich.) for records, and the Justice Department subpoenaed Camp’s aide Brian Sutter, staff director of the House Ways and Means Committee’s healthcare subpanel, to testify before a federal grand jury. Read More

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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Sheer Yoga Pants and Over-Stretched Allegations: Court Refuses to Stretch Allegations of Corporate Mismanagement into Federal Securities Fraud

A lack of sweaty models trying on yoga pants may be problematic, but does it give rise to securities fraud? Not in the Southern District of New York. In In re lululemon Securities Litigation, decided on April 18, 2014, Judge Katherine B. Forrest dismissed in its entirety a class action complaint against lululemon based on sheer yoga pants alleging violations of Section 10(b) and Section 20(a) of the Exchange Act and SEC Rule 10b-5. As summarized by the court, lead plaintiff alleged, “if only lululemon had someone try on its black luon yoga pants before they shipped, it would have realized they were sheer; similarly, if lulumeon had only had someone exercise in certain athletic wear (enough to produce sweat), it would have realized that the colors bled.” Based on these purported shortcomings, plaintiff alleged that statements touting the high quality of the company’s products were materially false and misleading. The court, however, disagreed: “This narrative requires the Court to stretch allegations of, at most, corporate mismanagement into actionable federal securities fraud. This is not the law.” Read More

Honey, You Did What? SEC Charges Yet Another Spouse with Insider Trading

On March 31, 2014, the Securities and Exchange Commission brought insider trading charges against Ching Hwa Chen, the husband of a corporate insider, alleging that he misappropriated financial information from his wife and then shorted her employer’s stock, netting $138,000 in ill gotten gains.  SEC v. Chen, No. 5:14-cv-01467 (N.D. Cal).  The SEC’s allegations (taken from its complaint) are as follows:  Chen’s wife was the Senior Tax Director of Informatica, a data integration company.  In late June 2012, Informatica learned it would miss its revenue guidance for the first time in 31 consecutive quarters.  That miss caused the defendant’s wife to work more than usual as the company scrambled to close its books and prepare for a potential pre-release of its quarterly revenues.  Over the next several days, the defendant overheard his wife’s phone calls addressing the revenue miss, including on a four-hour drive to Reno, Nevada where his wife fielded calls from the passenger seat as he drove.  Early the next week, convinced that Informatica’s stock would lose value, Chen bet heavily against the company, shorting its stock, buying put options, and selling call options.  In early July, after announcing the miss, Informatica’s stock price fell 27% from $43 to $31.  Chen closed out all of his positions that same day. Read More

A Ponzi of A Different Color

High profile schemes perpetrated by Bernie Madoff, Allen Stanford, Nevin Shapiro, and others have brought, or at least reinforced, a general understanding of the term “Ponzi scheme” into the public lexicon.  But what, legally, is a Ponzi scheme?  In SEC v. Management Solutions, Inc., 2013 WL 4501088 (D. Utah Aug. 22, 2013), Judge Bruce Jenkins endeavored to answer that question and, in the process, authored an encyclopedic account of the term and key court opinions, from seven federal circuits, that have construed it.

Management Solutions was an SEC enforcement action against a father-and-son team that had allegedly raised over $200 million through a “classic Ponzi scheme.”  According to the SEC’s complaint, investors in the scheme were sold “membership interests” in an apartment-flipping business and were guaranteed a return of five to eight percent.  In reality, the funds were allegedly deposited into a general account and were used to pay a variety of expenses, including returns to other investors.  Each of the defendants in the SEC case settled without admitting or denying the allegations.

A hearing was held in 2013 to determine whether, as argued by the court-appointed receiver, the scheme was properly classified as a “Ponzi scheme” and, if so, at what point that designation became applicable.  The receiver sought such a finding in order to obtain the so-called “Ponzi presumption,” which is sufficient to establish actual intent to defraud.  Read More

Time is Money: Second Circuit Vacates SEC’s $38 Million Fine Against Hedge Fund Pentagon Capital Management

On August 8, 2013, the Second Circuit vacated the SEC’s $38 million fine against hedge fund Pentagon Capital Management PLC, holding that the Supreme Court’s decision in Gabelli v. SEC required the case to be remanded for recalculation of the civil penalty. This case is one of several SEC enforcement actions affected by the Gabelli ruling since the Court issued its decision less than six months ago. The Second Circuit’s decision highlights the limiting effect Gabelli will have on civil remedies available to the SEC for securities law violations that occurred more than five years before the agency initiated its enforcement action.

In Gabelli, the Court held that the five-year statute of limitations for filing civil enforcement actions seeking penalties for fraud begins to run from the date of the alleged violation, not when the SEC discovers, or reasonably should have discovered, the violation. Citing Gabelli, the Second Circuit in SEC v. Pentagram Capital Management PLC found that any profits Pentagon earned more than five years before the SEC filed its suit could not be included in the penalty. The parties agreed that remand on the issue was required.

The SEC alleged that Pentagon and its owner, Lewis Chester, committed securities fraud under Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 by engaging in late trading of mutual funds. Late trading involves placing and executing orders as if they occurred at or before the time the mutual fund price was determined. Such trading allows the purchaser to profit from information released after the mutual fund price is fixed each day, but before it can be adjusted the following day. The SEC alleged that Pentagon engaged in late trading through its broker dealer, Trautman Wasserman & Co., from February 2001 through September 2003. Read More

“Order up!” FIRREA update

Judge Carter issued his final order on July 16, 2013, following our blog post.  The final order is substantively the same as the tentative order, and denies S&P’s motion to dismiss the case for the same reasons previously set forth.  Judge Carter added a note rejecting Defendants’ argument at the hearing on July 8, 2013 that no reasonable investor or issuer bank could have relied on S&P’s claims of independence and objectivity, because this would beg the question of whether S&P truly believed that S&P’s rating service added zero material value as a predictor of creditworthiness.  Judge Carter’s finding that an issuer bank could be a victim that was misled by S&P’s fraudulent ratings of its own mortgage-backed security products is an interesting development, and one that may open new doors to mortgage-backed securities litigation under FIRREA.

Where There’s Smoke, There’s FIRREA (Part Two)

We first blogged about the obscure Financial Institutions Reform Recovery Enforcement Act (“FIRREA”) on May 14. As we explained, this statute provides a generous ten-year statute of limitations and a low burden of proof. Just as we predicted, the FIRREA story is beginning to heat up.

The most recent FIRREA litigation involves claims brought under this statute against ratings agency giant Standard & Poor’s. The DOJ sued S&P for $5 billion, accusing it of knowingly issuing ratings that didn’t accurately reflect mortgage-backed securities’ credit risk. S&P’s practices of issuing credit ratings to banks that paid for those services led to an inherent conflict of interest. To reassure banks and investors that its ratings were accurate, S&P issued a “Code of Conduct,” containing promises that it had established policies and procedures to address these conflicts of interest. The DOJ alleged that the “Code of Conduct” statements were false and material to investors.

On July 8, Judge David O. Carter of the Central District of California tentatively denied S&P’s motion to dismiss the case. In his tentative order, Judge Carter explained why S&P’s three arguments for dismissal were unpersuasive. First, he found that the allegedly fraudulent statements regarding the credibility of S&P’s ratings were not “mere puffery” because they were filled with “shalls” and “must nots” that went beyond mere aspirational language. Read More

Where There’s Smoke, There’s FIRREA

Few can ignite a legal firestorm like U.S. District Judge Jed Rakoff of the Southern District of New York. Last week, in a mortgage fraud suit against Bank of America and Countrywide, Judge Rakoff refused to dismiss a novel claim for civil penalties under the obscure Financial Institutions Reform Recovery Enforcement Act (“FIRREA”). The ruling will surely encourage civil prosecutors to make wider use of FIRREA, which provides a generous ten-year statute of limitations and low burden of proof, in pursuing financial fraud cases.

FIRREA was enacted in response to the Savings and Loan debacle of the 1980s, as well as the fraud scandals that emerged during that era. The statute includes a clause imposing a civil penalty for mail and wire fraud and other violations “affecting a federally insured financial institution.” Until recently the civil penalty provision has been ignored by prosecutors, leaving courts without occasion to decide what exactly the statute means by “affecting” a financial institution. Read More

Supreme Court Hears Argument in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds

Securities class action lawyers are looking to the U.S. Supreme Court this term to clear up an issue that has been at the center of several prominent securities class actions, specifically, what is the standard for class certification where the class members’ reliance on defendants’ alleged misstatements is presumed under the fraud-on-the-market theory of reliance. Last term, in a class action ruling in an employment case, Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 1541 (2011), the Court signaled that class certification may require “a preliminary inquiry into the merits of a suit,” singling out elements of the fraud-on-the-market theory as an example.

On November 5, the Supreme Court heard argument in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, a securities fraud putative shareholder class action presenting the question of how far a court should consider a merits issue when deciding whether to certify a class. The appeal in Amgen is from a Ninth Circuit decision that affirmed the district court’s order certifying a plaintiff class of purchasers of Amgen stock. Defendants opposed class certification on the ground that the rebuttable presumption of reliance under the fraud-on-the-market theory requires not only that the market for Amgen stock was efficient, but that the alleged misstatements were material. Defendants offered evidence that the alleged misstatements in the case were immaterial. Therefore, according to defendants, reliance could not be presumed, and the proposed plaintiff class could not be certified because common issues did not predominate. The Supreme Court took the case in order to determine whether the district court was correct to disregard defendants’ evidence of immateriality on the ground that materiality is an issue appropriately considered at trial or at summary judgment rather than at the class certification stage. Read More