This Week In Securities Litigation (Week ending March 28, 2014)

by Dorsey & Whitney LLP

The New York Attorney General secured one of the most significant market crisis settlements to date this week. The former CEO of Bank of America agreed to a three year bar from serving as an officer or director of a public company. Collectively, the bank and the former CEO agreed to pay $25 million. The bank agreed, in addition, to certain ancillary relief. The fraud suit was based on the acquisition by the bank of Merrill Lynch at as the market crisis spun out of control. The NY AG also announced that he plans to file a motion for summary judgment shortly against the remaining defendant, the former CFO of the bank. The issue of holding senior executive of large Wall Street participants accountable for actions during the market crisis has long been a point of contention.

Five former Madoff employees were convicted this week on multiple counts. Following a lengthy trial, the jury rejected claims that the former employees did not know about the massive Ponzi scheme their employer operated for years.

The Commission prevailed this week on a summary judgment motion in an action based on a broker kickback scheme designed to manipulate the share price of a company’s stock. It also brought two proceedings based on false statements about the management team of a company, a stop order proceeding, an action based on delinquent filings and settled a case centered on false statements made about the firm’s FDA application.

Finally, the conviction of a former Goldman Sachs director who tipped the now imprisoned founder of the Galleon hedge funds was upheld by the Second Circuit. The Court again rejected challenges to the wire taps used to gather much of the evidence as well as other objections to the admission of the statements.


Remarks: Commissioner Daniel Gallagher addressed the 26th Annual Corporate Law Institute, Tulane University Law School, delivering remarks titled “Federal Preemption of State Corporate Governance,” New Orleans, LA (March 27, 2014). The Commissioner commented on the FSOIC, the federalization of corporate governance and the proxy process and reviewing corporate disclosure requirements (here).

Remarks: Chair Mary Jo White addressed the Australian Securities Investment Commission in remarks titled “Perspectives on Strengthening Enforcement” by videoconference (March 24, 2014). Her remarks focused on the need for international cooperation and having a credible deterrence in enforcement (here).

Remarks: Chair Mary Jo White addressed the Consumer Federation of America, 2014 Consumer Assembly with remarks titled “Protecting the Retail Investor” (March 21, 2014). Her remarks focused on investor protection through education, enforcement and rule making (here).

Money market reform: The Commission released the “Staff Analysis of Data and Academic Literature Related to Money Market Fund Reform” (here).


Remarks: Commissioner Scott O’Malia delivered the keynote address at The Future of Financial Standards –SWIFT, SWIFT’s Standards Forum, titled “Disruptive Data: Transforming Regulatory Oversight Through Technological Innovation,” London, England (March 25, 2014). Topics discussed included the CFTC’s data challenges, international data sharing and recent CFTC proposed rules (here).

SEC Enforcement – litigated cases

Kickbacks: SEC v. Grossman, Civil Action No. 08-cv-7893 (S.D.N.Y.) is a previously filed action against Bruce Grossman and Jonathan Curshen centered on allegations that the defendants engaged in a fraudulent broker bribery scheme intended to manipulate the share price of Industrial Biotechnology Corp. Previously Mr. Grossman pleaded guilty in a parallel criminal case and was sentenced to serve 36 months in prison and forfeit $97,500. U.S. v. Grossman, No. 09-cr 0136 (S.D.N.Y.). He also settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). He was directed to pay disgorgement of $76,000 which was deemed fully satisfied by his obligations in the criminal case.

On March 21, 2014 the Court granted the Commission’s motion for summary judgment against defendant Curshen and entered a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). The Court also held Mr. Curshen jointly and severally liable with Mr. Grossman for the payment of $76,000 in disgorgement along with prejudgment interest. He was directed to pay a civil penalty of $65,000 and an order barring him from participating in any penny stock offing was entered. See Lit. Rel. No. 22951 (March 26, 2014).

SEC Enforcement – Filed and Settled Actions

Statistics: This week the Commission filed, or announced the filing of, no civil injunctive, DPAs, NPAs or reports and 4 administrative proceedings (excluding follow-on and Section 12(j) proceedings).

False statements: In the Matter of L&L Energy, Inc., Adm. Proc. File No. 3-15815 (March 27, 2014) is a proceeding against the company, a Seattle based coal company with with its operations in China and Taiwan, and Dickson Lee, its founder, COB and CEO. Respondents represented in Commission filings that the firm had a professional management team when it fact it was Mr. Lee. Specifically, in fiscal 2008 the firm represented in its Form 10-K that Mr. Lee’s brother was the CEO when I fact he was not. In that same filing, the firm represented that a company employee was the Acting CFO when in fact that person had declined the job. Multiple filings made the next year repeated the same misrepresentation regarding the CFO. That false claim was also repeated in a successful effort to secure a listing on NASDAQ. The Order alleges violations of Exchange Act Sections 10(b) and 13(a) and Securities Act Section 17(a). The matter will be set for hearing. In the Matter of Shirley Kiang, Adm. Proc. File No. 3-15816 (March 27, 2014) is a related proceeding against the Chairwoman of the Audit Committee. When the employee who declined the Acting CFO position learned of the misrepresentation, that person informed Ms. Kiang who investigated and learned the truth. Mr. Lee requested that she remain silent and not inform the board. Subsequently, Ms. Kiang executed a SOX certification representing that any fraud, even if not material, had been disclosed. The Order alleged a violation of Exchange Act Section 13(a). Respondent resolved the proceeding, consenting to the entry of a cease and desist order based on the Section cited in the Order and agreed to refrain from signing any Commission public filings that contain any certification required under SOX. The U.S. Attorney for the Western District of Washington brought a parallel criminal action against Mr. Lee.

Stop order: In the Matter of the Registration Statement of Creative Vision Alliance Corporation, Adm. Proc. File No. 3-15812 (March 25, 2014) is a stop order proceeding as to the registration statement. The Order alleges that the statement does not contain the required audited financial statements or management discussion and analysis. A hearing on the issues is set for April 7, 2014.

Misrepresentations: SEC v. Imaging Diagnostic Systems, Inc., Civil Action No. 13-cv-62025 (S.D. Fla.) is a previously filed action against the medical technology company, its CEO, Linda Grable, and its CFO, Allan Schwartz. The complaint alleged that the defendants made material misstatements and omissions in the firm’s filings regarding the timing of an FDA application, failed to remit payroll taxes and that the individuals did not file beneficial ownership reports. This week the Court entered judgments by consent as to each defendant, prohibiting future violations of specific sections of the securities laws. As to the company and defendants Grable and Schwartz: Securities Act Section 17(a)(2) and Exchange Act Section 10(b); as to the company only, Exchange Act Section 13(a), 13(b)(2)(A) and 13(b)(2)(B); as to the company and defendant Grable, Exchange Act Section 14(a); and as to defendants Grable and Schwartz, Exchange Act Section 16(a) and from aiding and abetting the company’s violations of each Exchange Act Section cited in the order except 14(a). In addition, defendants Grable and Schwartz were directed to pay civil penalties of $150,000 each and are barred from serving as directors or officers of a public company or from participating in any penny stock offering. The Commission’s claim for a civil penalty against the company was dismissed. See Lit. Rel. No. 22950 (March 25, 2014).

Delinquent filings: In the Matter of The Phoenix Companies, Inc., Adm. Proc. File No. 3-15810 (March 21, 2014) is an action naming as Respondents the firm, is a holding company for three insurance subsidiaries, and PHL Variable Insurance Company, a wholly owned indirect subsidiary of Phoenix. On September 18, 2012 PHL, a non-accredited filer, announced that its financial statements could no longer be relied on. On November 8, 2012 Phoenix made a similar announcement. While Respondents have projected dates for filing the restated financial statements and other delinquent filings, they have failed to meet them. The Order concludes that Respondent Phoenix violated Exchange Act Section 13(a), listing a series of delinquent filings. Respondent PHL violated Exchange Act Section 15(d). To resolve the matter each Respondent has provided an undertaking with projected dates for filing the delinquent filings. Each firm also consented to the entry of a cease and desist order based on the Section it is alleged to have violated. Each firm will pay a civil money penalty of $375,000.

Court of Appeals

Insider trading: U.S. v. Gupta, Docket No. 12-4448 (2nd Cir. Decided March 25, 2014) is the appeal of former Goldman Sachs director Rajat Gupta following his conviction on conspiracy and insider trading charges. Mr. Gupta’s challenge to his conviction focused on the admissibility of certain wiretap evidence involving two key transactions. The first concerned trades of Goldman Sachs shares on September 23, 2008 prior to the announcement that Warren Buffett would make a substantial investment in the investment bank as the market crisis was unfolding. Immediately after a telephone board meeting in which Mr. Gupta learned about the deal, he called his longtime friend Raji Rajaratnam who then purchased 1.5 million Goldman shares just before the close. After the announcement Mr. Rajaratnam had a substantial profit. The next day he discussed the transaction with Galleon’s chief trader in a taped conversation, noting that he got information from a Goldman board member.

The second centered on the sale of Goldman shares on October 24, 2008. The day before that transaction Mr. Gupta participated in a Goldman Sachs conference call during which he learned that the firm would suffer a quarterly loss for the first time since going public. Immediately after hanging up from the call Mr. Gupta telephoned Mr. Rajaratnam. The next morning Mr. Rajaratnam sold 150,000 shares of Goldman Sachs stock beginning 1 minute after the open. Later that afternoon Mr. Rajaratnam spoke with David Lau, a Singapore based portfolio manager for Galleon International. During a taped telephone call Mr. Rajaratnam described the negative news he received “from somebody who’s on the Board of Goldman Sachs.” When Goldman announced the disappointing results the share price dropped. Mr. Mr. Rajaratnam avoided a loss of over $3.8 million.

The district court rejected Mr. Gupta’s claims that the taped evidence and the statements on the tapes was not admissible. The Second Circuit affirmed. First, the Court rejected arguments that the wiretap was contrary to law since the issue was resolved in the appeal of Mr. Rajaratnam. Second, the Court rejected claims that the conversations were inadmissible hearsay. The statements are admissible under Rule 801(d) which permits the introduction of such testimony if made by “the party’s coconspirator during and in furtherance of the conspiracy.” Here the statements were in furtherance of the conspiracy, according to the Court. Mr. Gupta’s claim that the statements to Mr. Horowiz are part of another conspiracy is incorrect in view of the language in the indictment noting that the conspiracy encompassed Messrs. Rajaratnam, Gupta and “other coconspirators at Galleon.” Similarly, the statement of Mr. Rajaratnam to Mr. Lau was admissible as being in furtherance of the conspiracy. While Mr. Lau was not a member of the conspiracy, there is no requirement that the statement be made to a member of it. Mr. Gupta’s claim that the statements to Mr. Lau are not admissible because he had to have more than a theoretical ability to actually place the trades, misses the mark. The goal here was to avoid losses which was accomplished by dumping the stock quickly for the U.S. Galleon entity. While Mr. Lau was the trader for Galleon International, an entity in which Mr. Gupta had a 15% ownership interest and which generally traded international stock “it was not precluded from investing in domestic securities . . . and, indeed, it had in the past owned stock in Goldman. . .” The conversation may have convinced him not to purchase shares at this time.

Finally, the statements were admissible under Rule 804(b)(3). That Rule provides for the admission of statements made against pecuniary or penal interest if the person is unavailable as a witness. Here the statements to Horowitz and Lau were both self-incriminating and thus admissible.


Supervision: LPL Financial LLC was fined $950,000 by the regulator for supervisory deficiencies related to the sales of alternative investment product. Those included non-traded real estate investment trusts, oil and gas partnerships, business development companies, hedge funds, managed futures and other illiquid pass-through investments. Many alternative investments have concentration limits for investors in their offering documents. Some states have such limits. Here from January 1, 2008 through July 1, 2012 the firm failed to adequately supervise the sales of alternative investments that violated these concentration limits. While it had at first a manual process to review these limits, and later an automated system, neither was adequate. LPL also did not adequately train its supervisory staff to analyze state suitability standards. In addition to the fine, the firm is also required to conduct a comprehensive review of its policies, systems, procedures and training and remedy the failures.

New York

New York v. Bank of America Corp., New York State Supreme Court, New York County, No. 450115/2010. Former Bank of America CEO Kenneth Lewis agreed to pay $10 million and to be barred from serving as an officer or director for three years to settle fraud charges brought by the New York Attorney General based on the firm’s acquisition of Merrill Lynch just prior to the bankruptcy of Lehman Brothers. The bank also settled, agreeing to pay $15 million toward the expenses of the Attorney General’s investigation and to certain ancillary relief. Previously, the bank resolved a shareholder suit based on similar facts, agreeing to pay $2.43 billion. Under New York law the AG cannot secure damages for shareholders who have settled a class action. The NYAG announced that he will file a motion for summary judgment shortly against remaining defendant, former CFO Joe Price.

The suit against Bank of America was once of the most significant arising out of the market crisis. Following the institution of a similar complaint by the Securities and Exchange Commission, the New York AG filed suit against the Bank and two senior officers alleging that investors were defrauded when the financial institution agreed to acquire the then financially troubled broker-dealer for $50 billion as Lehman Brothers was collapsing and the market crisis was spiraling out of control. The complaint claimed that investors were not told the true financial condition of Merrill which at the time was rapidly deteriorating. Indeed, by the time of the December 2008 shareholder vote, losses totaled over $15 billion. Investors also were not told that the bank agreed to the payment of over $3 billion in bonuses for Merrill employees despite the desperate financial condition of the firm. Bank of America continued to conceal the true financial condition of the broker even after the shareholder vote, according to the NYAG’s complaint. In seeking Federal financial assistance the bank claimed that there had been a “material adverse” change. The facts regarding the fraud did not emerge until mid- January 2009 when the losses lead to a $50 billion sell-off in the shares of the Bank. See also SEC v. Bank of America Corporation, Civil Action No. 09-5829 (S.D.N.Y.)(similar suit against bank only based on Exchange Act Section 14(a) settled for an injunction, ancillary relief and a $150 million fine).


Suitability: The Financial Conduct Authority fined Santander UK Plc £12,377, 800 for serious failings in connection with rendering investment advice. Specifically, the FCA determined that the bank: failed to make sure its advisers fully understood the personal circumstances of customers before making recommendations; failed to ensure that investing customers were given clear and not misleading information about products; for Premium Investments failed to carry out regular ongoing checks to ensure the investments continued to meet the needs of the customer; failed to make sure its executives were properly trained; and failed to properly monitor investment advice. Customers can contact the bank and receive appropriate compensation. The firm received a 30% discount on the fine for agreeing to settle early.

Remarks: Martin Wheatley, Chief Executive of the Financial Conduct Authority, addressed the Australian Securities and Investment Commission in remarks titled “Making competition king – the rise of behavioral economics at the FCA” (here).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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