Today, the Federal Securities Law Blog takes a look back at the last 30 days in the world of securities-related litigation in a regular feature which appears on approximately the 15th of each month. Recent issues which have appeared in the news include the SEC’s Inspector General’s examination of the SEC’s conduct, cases which have been brought that stem from the market crisis and the several significant criminal sentences in insider trading cases. These issues, and others, are discussed in greater detail after the jump.
The SEC’s Inspector General
Normally, the SEC closely investigates the conduct of individuals and corporations. The last 30 days have seen the issuance of several reports where the Commission is the one being investigated. As discussed here, on Tuesday, September 20, the Inspector General released a report concerning the involvement of David Becker, the former General Counsel and Senior Policy Director of the Commission, in matters relating to Bernie Madoff. The Inspector General "found that Becker participated personally and substantially in particular matters in which he had a personal financial interest by virtue of his inheritance of the proceeds of his mother’s estate’s Madoff account and that the matters on which he advised could have directly impacted his financial position." The Inspector General referred the results of the investigation to the Public Integrity Section of the Criminal Division of the United States Department of Justice. Shortly thereafter, Congress heard testimony from Inspector General David Kotz, SEC Chairman Mary Schapiro and Mr. Becker (as discussed here). Mr. Becker vigorously denied any wrongdoing and declared it was a "dreadful experience" personally, and feared it "also has been a dreadful experience for the public interest." Even prior to the report, former SEC Chairman Harvey Pitt provided testimony to Congress that (according to news coverage discussed here) "denounced the agency’s inspector general …, saying the internal watchdog appears bent on destroying reputations and staff morale and crippling the SEC’s effectiveness."
The Inspector General was less critical in a report released in late September, concluding that it "did not find sufficient evidence to substantiate any allegations of misconduct" by the SEC Division of Enforcement during its investigation of Mark Cuban (which is discussed here). That investigation was triggered by a complaint from Mr. Cuban, one of the few individuals with the financial ability to mount a very aggressive defense in cases brought by the SEC.
Market Crisis Cases
Despite the scrutiny of the Inspector General, the SEC still had time to bring two significant cases that stem from the market crisis of 2008. As discussed here, the SEC announced on Tuesday, September 27 that it had filed a settled administrative proceeding against RBC Capital Markets LLC, a broker-dealer, for misconduct relating to the sale of unsuitable investments (credit-linked notes that were tied to the performance of synthetic collateralized debt obligations or "CDOs") to five Wisconsin school districts.
On October 11, 2011, the SEC brought a case against Thomas Wu, the former CEO of United Commercial Bank, for misleading investors regarding the financial state of the bank during the 2008 financial crisis (discussed here). Mr. Wu, who the SEC described as a "rising star in the banking industry," allegedly directed subordinates to conceal information regarding the true value of the bank’s collateral and assets, understating the value by at least $65 million and causing as the United Commercial to be one of the ten largest bank failures during the recent financial crisis. Criminal charges were brought against two other individuals.
Shift in SEC Strategy
As described here, in an interview with the Wall Street Journal, Ken Lench, who heads the Commission’s structured and new products enforcement unit, signaled a shift in SEC tactics in upcoming cases by stating that the SEC may bring more negligence cases in situations where executives fail to meet the duty of care in providing fair and accurate information to investors, even if there is no intent to defraud by the executive.
As discussed here, the Wall Street Journal pointed out that the length sentences in insider trading cases have dramatically increased in the last few years. Two such defendants experienced that trend first-hand. Zvi Goffer (discussed here), who formerly worked at with the Schottenfeld Group LLC, part of Raj Rajaratnam’s Galleon Group, and was nicknamed "Octopussy" due to the number of connections he had, was sentenced to ten years in prison in September. This week, Mr. Rajaratnam earned what appears to be the longest sentence for insider trading when he was sentenced to eleven years in prison, which was less than the 19 to 24 year sentence sought by the Government (as described here).
The Head of the Whistleblower Office
Sean McKessey, the Chief of the Office of the Whistleblower at the SEC, spoke at a panel discussion regarding the Foreign Corrupt Practices Act this month. Mr. McKessey commented on the efforts of his office to date and responded to questions regarding a number of issues as discussed here. His comments (discussed in greater detail here) included a discussion of a hypothetical whistleblower who may be civilly liable for a violation, but may still collect an award, who Mr. McKessey likened to "Huggy Bear," the character from the "Starsky and Hutch" TV series who may not have always been "clean," but without whom the case could not be solved.
The Second Circuit Says FINRA Cannot Collect Fines in Court
As discussed here, on October 5, the U.S. Court of Appeals for the Second Circuit ruled that FINRA lacks the authority to bring court actions to collect disciplinary fines it has imposed. Fiero v. FINRA, No. 09-cv-1556, slip op. (2d Cir. Oct. 5, 2011). Significantly, the ruling appears to extend to all “self-regulatory organizations” ("SROs"). However, the Court hinted that, under Section 19(b) of the Exchange Act, an SRO can potentially address this issue by filing a proposed rule change with the SEC, who must publish notice of the proposed rule change and give interested individuals an opportunity to comment prior to either approving or disapproving the rule (something which FINRA failed to do in this situation).
Ohio Court Allows Say-on-Pay Case to Proceed
In a September 20, 2011 Opinion, Judge Timothy Black of the Southern District of Ohio ruled that a lawsuit brought against senior executives and directors of Cincinnati Bell, Inc. alleging a breach of fiduciary duty regarding compensation would be allowed to proceed. The lawsuit focuses on the "say-on-pay" provisions of the Dodd-Frank Act: specifically, attacking the Board’s decision to increase 2010 executive compensation in light of the nonbinding vote by 66% of the voting shareholders to reject that increase. Although the defendants argued that they are entitled to rely upon the business judgment rule in proceeding with the increase in compensation, the Court held that the issue of whether defendants properly exercised that judgment or, as plaintiff claimed, acted with deliberate intent to injure the company (or reckless disregard for the company) would be an issue based on the evidence (at trial or summary judgment) and not decided at the pleading stage (discussed here).