Holland & Hart Securities Blog

Parallel Insider Trading Charges Filed Against 13 Individuals

            Yesterday, the SEC charged 13 individuals with insider trading in stocks that were the subject of research by UBS Financial Services, and takeover deals in the works at Morgan Stanley. [1]  Collectively, the complaint alleges, the defendants made at least $15 million in illicit profits from these two insider trading schemes. The case primarily alleges that UBS executive Mitchel Guttenberg agreed to tip Bear Stearns Cos. hedge fund manager Erik Franklin.  According to the SEC, the fund, “Lyford Cay,” earned substantial profits, including earning $10,000 by selling “short” the shares of Allstate Corp. prior to a UBS downgrade of that insurer.   After leaving Bear Stearns, Franklin allegedly provided UBS tips to the portfolio manager of another hedge fund, Chelsey Capital, which realized $2 million in illicit profits through the scheme.  Further, one of Guttenberg’s friends, David Tavdy, earned $6 million in illicit profits for himself, a friend and a relative. 

            The SEC’s complaint secondarily alleged a scheme under which certain participants in the UBS scheme traded on stock tips provided by Randi Collotta, a former Morgan Stanley lawyer charged with monitoring compliance with securities rules.  Among others, Collata allegedly tipped a Florida broker who was a friend of Ms. Collotta’s husband. In turn, the broker also tipped Bear Stearns broker Robert Babcock regarding Adobe Systems’ proposed acquisition of Macromedia and other transactions.   

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[1] See litigation release available at http://www.sec.gov/litigation/litreleases/2007/lr20022.htm

The Illusory Nature of the SEC’s New Corporate Penalty Standards

    In the post-Enron era, civil penalties imposed against public companies by the Commission seemed arbitrary and consistent.  In January 2006, commentators applauded the SEC for issuing its Statement Concerning Financial Penalties (“Statement”).  Chairman Cox intended this document to provide guidance and transparency regarding the factors the Commission would consider in deciding whether to impose a civil penalty against a public company, and if so, the amount of such a penalty.  However,  the “major factors” set forth in the Statement - the benefit to shareholders resulting from the misconduct,  and the degree to which the penalty will unfairly harm injured shareholders – have posed conceptual problems.  As discussed below, an intellectually honest application of these factors would preclude all corporate penalties, since the first is rarely, if ever, satisfied, and the second always is present.  This article suggests that the Commission has chosen to interpret these two factors in a manner that renders them illusory and meaningless, and is instead giving great weight to the size of the company being sued, as well as remediation and cooperation, factors that are characterized by the Statement as “minor.”

Should Hedge Fund Advisers Deregister?

        In their euphoria over the D.C. Circuit’s recent ruling invalidating the SEC’s adviser registration rule, hedge fund advisers may be tempted to rush to deregister.   My analysis of applicable state law, however, demonstrates that this may be a mistake.  Advisers may be merely trading one set of regulations for another.  Therefore, any decision to deregister should be made carefully and with full consideration of the consequences.

COURT INVALIDATES SEC RULES REQUIRING REGISTRATION OF HEDGE FUND ADVISERS

         In a serious blow to the SEC, the U.S. Court of Appeals for the D.C. Circuit recently invalidated Advisers Act Rule 203(b)(3)-2, requiring most hedge fund advisers to register with the Commission.  Goldstein v. SEC, No. 04-1434 (June 23, 2006). This ruling calls into question the SEC’s ability to regulate the entire hedge fund industry. 

Effective Responses to Findings of Deficiency

             Despite the best efforts of broker-dealers and investment advisers to fully comply with all relevant rules, there are times when NASD or SEC examiners find deficiencies during an examination.  This is not surprising, given the increasing complexity of securities regulation and current harsh political climate.  The manner in which a firm responds to a notice of deficiencies is critical.  This article describes the regulatory decisionmaking process and effective responses to such a notice.

SEC Files its First Anti-Money Laundering Case

Yesterday, the SEC instituted settled administrative proceedings against Los Angeles-based broker-dealer Crowell Weedon & Co.  This case is the SEC’s first anti-money laundering (AML) enforcement action based on violations of the Patriot Act. [1] According to the SEC, the broker-dealer failed to document properly its actual procedures employed in its written customer identification program (CIP).  In verifying the identities of approximately 2,900 customers, Crowell, Weedon simply relied on its registered representatives' attestations that they had personal knowledge of the new customers, a practice not documented in the firm's written CIP.   The SEC alleged that in contrast, the firm’s CIP specified that it would verify the identity of each new customer using certain non-documentary and documentary procedures, such as a public database search and reviewing government-issued identification.

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[1] See press release available at http://www.sec.gov/news/press/2006/2006-78.htm.

SEC Investigates Stock Option Backdating

            The SEC is expanding its previously disclosed probe of stock-options backdating by numerous publicly held companies. According to a May 6, 2006 Wall Street Journal article, at least ten companies are involved in multiple investigations by the SEC and the U.S. Attorney’s Office for the Eastern District of New York.  Several of these companies have admitted that back-dating did in fact occur.

Liability of Investor Relations Firms Involved in Publicity Campaigns

             Like many of  you, I am the recipient of numerous unwanted “junk faxes” touting the stocks of publicly traded microcap companies.  On April 27, 2006, someone sent me a junk fax recommending the stock of Toronto-based Phinder Technologies, Inc. (“Phinder”), which was portrayed as having “very strong potential.”  At first blush, it seems unlikely that anyone would buy stock based on an anonymous junk fax.  However, the persistence of these publicity campaigns indicates that they have the desired effect of creating short-term investor interest. Apparently due to the junk faxes, about $50,000 of Phinder stock traded on April 27 alone.  This is an impressive feat, considering that the company has reported operating losses, and its audit opinion has a “going concern” qualification.  Besides providing a window into the OTC market, the Phinder publicity campaign illustrates the liability issues faced by investor relations firms that publicize stocks through the use of unsolicited faxes, e-mails and other aggressive means.   

Dismissal of Indictment Due to SEC’s Failure to Disclose Pending Criminal Investigation

      

          The SEC has a longstanding policy of refusing to disclose known parallel criminal investigations.   In U.S. v. Stringer, 408 F. Supp. 2d 1083 (D. Oregon 2006), a U.S. District Court dismissed the government’s securities fraud indictment against several former executives of FLIR Systems, Inc., due primarily to the conduct of SEC enforcement attorneys who followed this policy.  Stringer signals that at the beginning of any SEC testimony, defense lawyers should make a record of inquiring about related criminal matters.

Lawsuits Against Lawyers

          Two SEC enforcement cases filed in late 2005 illustrate the perils faced by securities attorneys who sell their corporate clients’ stock under questionable circumstances.  These cases can be best understood in the context of guidance provided by the SEC about when it will sue a company’s lawyers.