Financial Services Litigation & Investigation Monitor : Financial Services Lawyer & Attorney : Perkins Coie Law Firm : Government Investigations, Class Actions

The Wall Street Journal has reported that on Monday evening, U.S. District Judge Jed S. Rakoff of the Southern District of New York denied the SEC’s motion to expand charges against Bank of America in connection with the company’s 2009 merger with Merrill Lynch. A previously filed SEC suit accused the bank of concealing plans to pay billions of dollars in bonuses to employees at Merrill Lynch before shareholders were asked to approve a merger of the two firms.  Most recently, the SEC moved to amend that complaint to include allegations that Bank of America also failed to disclose “extraordinary financial losses at Merrill Lynch prior to a shareholder vote to approve a merger between the two companies.” The SEC's proposed second amended complaint alleged that Bank of America negligently failed to disclose those losses before the shareholder vote, violating its fiduciary duty to its investors and making its previous disclosures materially false and misleading.

Judge Rakoff had previously rejected a $33 million settlement between the SEC and Bank of America last fall because it failed to hold accountable any of the executives or lawyers who were allegedly responsible for omissions in documents submitted to shareholders ahead of a vote that approved the acquisition. However, the SEC still declined to charge individuals in its proposed second amended complaint, stating that the “executives are not alleged to have deliberately concealed information from counsel or otherwise acted with scienter or intent to mislead.  Nor is any counsel alleged to have acted with scienter or intent to mislead.”

In a letter addressing the SEC’s proposed second amended complaint, Bank of America’s counsel stated that “the new theories the SEC seeks to advance in this case are baseless.”  The WSJK has now reported that on Monday evening, Judge Rakoff ruled that the S.E.C. cannot amend its complaint against Bank of America a second time, but can instead file a new complaint.

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On December 9, 2009, the Director of the SEC’s Division of Enforcement, Robert Khuzami, testified before Senate Judiciary Committee at a hearing entitled “Mortgage Fraud, Securities Fraud and the Financial Meltdown: Prosecuting Those Responsible.” Khuzami’s testimony detailed five primary areas in which the SEC is focusing its enforcement efforts.

First, the SEC is investigating and pursuing enforcement cases based on unlawful conduct related to the financial crisis.  Second, the SEC is enhancing its working relationship with other law enforcement authorities, including the DOJ.  Third, the SEC is implementing several reorganization initiatives, including the creation of specialized units within the Division of Enforcement that are aimed at attacking both the causes of the recent financial crisis, as well as current and future market practices that are a potential cause for concern for the SEC.  Fourth, the SEC’s staff is proposing various legislative reforms, including nationwide service of process, a whistleblower program and enhanced access to grand jury material.  Last, the SEC is seeking additional resources for both the Enforcement Division and throughout the SEC.

A transcript of Khuzami’s testimony is available here.

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Last month, the SEC approved a proposed rule change filed by the New York Stock Exchange which amends certain of the Exchange’s disclosure requirements for listed companies, including publicly traded financial services corporations. The changes take effect January 1, 2010, so the new disclosures will be required in proxy statements for annual meetings to be held after December 31, 2009. Below is a general overview of the new disclosure requirements. 

·        303A.02(a):  NYSE's independence disclosure will no longer require a listed company to disclose the board's categorical standards for independence. However, a listed company may still disclose these standards as a means of supporting its claim that a director is independent.

·        303A.02(b)(v):  A listed company may choose where to make its charitable contribution disclosure: on its website or in its annual proxy statement. If the former, the company must so disclose this fact in the proxy/Form 10-K and provide its website address.

·        303A.09 / 303A.10:  A listed company will no longer need to disclose that its nominating/corporate governance, compensation and audit committee charters, corporate governance guidelines and code of business conduct and ethics are available in print upon request. The company need only disclose that the above are available on the company's website and provide the website address.

·        303A.10:  A company must disclose any waivers of the code of business conduct and ethics for executive officers or directors within four days (rather than the "promptly," which had been inconsistently defined).

·        303A.12(a):  A listed company will not be required to disclose in the company's annual report to shareholders or Form 10-K that: the previous year's CEO certification was submitted to NYSE (and disclose any qualifications to that certification;  the company filed as an exhibit to its most recently filed Form 10-K, the Sarbanes-Oxley Act Section 302 certification.

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Two reports issued by the SEC's independent inspector general recommends sweeping changes to the agency's investigation and enforcement programs following failures to detect fraudulent activity, including Bernard Madoff's ponzi scheme, according to a New York Times report. 

The two reports issued by SEC inspector general H. David Kotz recommend a total of 58 changes in the way the agency evaluates tips, trains investigators and documents examinations.  The set of recommended changes include incorporation of basic investigative techniques, such as recording witness interviews and using a database for tips and complaints.  The SEC should also "require tips and complaints to be reviewed by at least two individuals experienced in the subject matter prior to deciding not to take further action,"  the report recommends.  (Read the Inspector General's Report)

The S.E.C. has accepted the recommendations, according the the New York Times article. 

The proposed changes follow the IG's publication of its investigative report regarding  the SEC’s failure to detect the Madoff ponzi scheme.  That investigation found that the SEC had failed to properly examine  Madoff’s firm and had not adequately followed up on whistleblower tips from as far back as 1992 that could have lead to discovery of the estimated $65 billion fraud scheme.

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After an 18 month investigation, federal prosecutors are preparing to impanel a grand jury in Brooklyn, N.Y., to consider an indictment of former American International Group Inc. executive Joseph Cassano, according to the Wall Street Journal.    WSJ reported that, according to sources familiar with the matter, the Justice Department and the SEC have been investigating whether Cassano, who ran AIG's Financial Products unit, committed securities fraud by allegedly misleading investors about the value of mortgage-related contracts, and by failing to disclose material facts regarding such contracts to AIG's outside auditor.

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The Wall Street Journal reports that FairfieldGreenwich Group, one of the largest funds to invest in Barnard Madoff's Ponzi scheme, has agreed to pay  Massachusetts $8 million to settle civil fraud charges filed by the state's chief securities regulator.  The April 2009 complaint alleged that FairfieldGreenwich invested its clients' money with Madoff, but neglected to conduct its promised due diligence.   According to the settlement, FairfieldGreenwich will pay a $500,000 fine to Massachusetts, with the remaining settlement funds used for restitution for Massachusetts investors who lost money in the Madoff scheme.  Following the filing of the complaint in April, the hedge fund initially denied the allegations, claiming that "[t]he complaint here was rushed into existence and is so filled with errors and factual distortions as to completely misstate the conduct of the companies that make up the Fairfield Greenwich Group."

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On Wednesday, July 1st, the SEC filed a civil suit against the former chief accounting officer of Beazer Homes USA, Inc. The complaint alleges that from 2000 to 2007, Michael Rand manipulated Beazer’s reported quarterly and annual income in order to meet EPS projections and analyst expectations, as well as to maximize bonuses for company officers and senior staff. The complaint also alleges that Rand took affirmative steps to conceal the fraud from Beazer’s auditors.

The SEC first alleges that during the housing boom from 2000 to 2005, Rand caused Beazer to under report its net income by a total of $63 million through the recording of improper operating expenses which created false accounting reserves and liabilities in Beazer’s books and records. Next, during 2006 and 2007, when the housing market began to slow, Rand is alleged to have caused the improper reserves to be reversed, thereby inflating Beazer’s income by approximately $47 million. The SEC also alleges that during 2006 and 2007, Beazer improperly recognized revenue from the sale and leaseback of model homes, when in fact no revenue should have been recognized from such transactions.

In May 2008, Beazer restated its financial statements to reflect adjustments for fiscal years 1998 through 2006, and the first half of fiscal year 2007. The SEC is seeking a permanent injunction against future violations, disgorgement if ill-gotten gains, civil penalties and a D&O ban against Rand.

Also on July 1st, Beazer Homes USA, Inc. reached a settlement with the U.S. DOJ to pay up to $53 million to resolve allegations that the company violated the False Claims Act.  Specifically, the government alleged that when the mortgage division of Beazer Homes made FHA insured loans, it 1) required purchasers to pay "interest discount points" at closing, but then kept the cash and failed to reduce interest rates; 2) provided cash "gifts" to home purchasers through certain charities, so purchasers could provide down payments, with assurances the "gifts" would not have to be repaid, and then increased home purchase prices to offset the amount of the gifts; 3) obscured which of its branches made defaulting mortgage loans to avoid FHA detection of excessive default rates, and; 4) ignored "stated income" requirements in making loans to unqualified purchasers.
 

To resolve these allegations, Beazer agreed to pay the United States $5 million, plus contingent payments of up to $48 million dollars to be shared with Beazer homeowners impacted by the above allegations.  Please refer to the Department of Justice press release regarding the Beazer Homes settlement for additional details.

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The SEC and Financial Industry Regulatory Authority (FINRA) filed separate lawsuits alleging that 16 brokers from the now defunct Brookstreet Securities Crop. fraudulently mislead investors that derivatives based on mortgage-backed securities were safe and conservative investments.  In its complaint, the SEC alleges that 10 Brookstreet brokers failed to inform customers about the risks associated with investing in collateralized mortgage obligations.  The brokers portrayed collateralized mortgage obligations as secure investments to more than 750 customers, which ultimately cost those investors more than $36 million in losses, but earned the brokers $18 million in commission and salaries, according to SEC allegations.  The SEC is seeking civil penalties and repayment of ill-gotten gains.

FINRA filed a companion complaint against six other former Brookstreet brokers.  According to a FINRA press release,  from June 2004 through May 2007, the brokers sold collateralized mortgage obligations to customers when the brokers themselves lacked a basic understanding of these complex and illiquid securities.

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Following a Securities and Exchange Commission Office of Inspector General investigation which "revealed suspicious activity, appearances of improprieties, and evidence of possible trading on nonpublic information, and/or potential insider trading on the part of SEC Enforcement attorneys," the SEC has imposed new internal rules governing securities transactions for all SEC employees.

Under the new SEC rules, staff will be prohibited from trading in the securities of companies under SEC investigation, regardless of whether the employee has personal knowledge of the investigation.   Employees will also be required to preclear all securities transactions with supervisory staff prior to trading and certify that they do not possess non-public information about the company being traded.  Finally, all SEC staff must authorize their brokers to provide the Commission with copies of trade confirmation statements, so that ethics officials can monitor compliance with the new rules.

Whether the SEC has adequate infrastructure to monitor staff trading, in addition to its preexisting oversight duties, remains to be seen.  While the Commission currently lacks surveillance systems to monitor staff trading, the new rules call for an agency-wide computer system that will assist officials in preclearing and tracking all employee trades.  Chairman Schapiro has also directed the consolidation of compliance and reporting responsibilities within the SEC's Ethics Office, and has authorized the hiring of a new chief compliance officer.

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The Securities Exchange Commission has proposed new rules to increase the oversight of investment advisors who retain custody of client assets. The proposed measures come in the wake of what many have termed as a lack of SEC regulation and enforcement that enabled ponzi schemes and other investment fraud to thrive in recent years.

The SEC’s newly proposed regulations include yearly “surprise” audits performed by independent public accountants in order to verify the sanctity of client assets under an investment advisor’s custody. Advisers would be required to disclose the identity of the independent public accountant that performs its surprise audit in public SEC filings, and amend these filings to reflect changes in accountants.  In addition, when an adviser or an affiliate directly holds client assets, a custody control review would have to be conducted by a PCAOB-registered and inspected accountant.

The proposed amendments would further require all other custodians holding client assets to directly deliver custodial statements directly to the clients, rather than through investment advisers.  These additional safeguards are meant to deter advisers from preparing false account statements, and increase the likelihood that clients discover any discrepancies between the custodial statements and statements from their investment advisors.

The public comment period on these proposed rule amendments will be open for 60 days after their publication in the Federal Register. The full text of the proposed rule amendments have yet to be published.

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The Los Angeles Times reported on May 14, 2009 that SEC investigators had recommended the filing of civil fraud charges against former Countrywide chief executive Angelo Mozillo.  According to the article written by E. Scott Reckard and William Heisel, persons familiar with the matter report that SEC staff are seeking approval to file fraud charges that include insider trading and failing to disclose to shareholders the company's risks associated with its sub-prime mortgage business.  The article states that Mozillo's attorneys were provided with a "Wells" letter weeks ago, and the matter is now before the SEC's five commissioners to approve or reject the investigator's recommendation. 
 .
 

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On April 6th, SEC Chairwoman Schapiro told the Counsel of Institutional Investors that the Commission was looking into “many potential reforms” for market professionals and intermediaries, including brokers, advisors and credit rating agencies. Among the Commission’s early ideas, Schapiro added, were annual unannounced audit requirements for market professionals who directly hold client assets, in order to "confirm the safekeeping of those assets.”

The Wall Street Journal has now reported that the SEC plans to propose these audit rules, and other reforms for market professionals, possibly as soon as mid-May. Citing an SEC official “familiar with the matter,” the Wall Street Journal reports that the new rules, designed to safeguard customer assets, are tentatively scheduled to be proposed on May 14th.

The Wall Street Journal article is available here [log-in required]. A transcript of Chairwoman Schapiro’s address to the Counsel of Institutional Investors is available on the SEC’s website.

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On April 16th, SEC Chairwoman Mary Schapiro appeared on PBS’s Nightly Business Report for her first television interview since taking office. During her interview, Chairwoman Schapiro discussed initiatives for the SEC’s “aggressive enforcement program,” including new regulations for credit rating agencies, possibly as soon as this summer. According to Chairwoman Schapiro, these rules will be designed to “align interests of credit rating agencies with the users of the ratings (investors) – as opposed to the issuers of the securities.”

Chairwoman Schapiro also indicated that within the next month, the Commission will be considering rules to enable “responsible proxy access” for “longer term shareholders,” in order to increase Board-member accountability.

Other topics addressed during the interview include increased enforcement actions against ponzi schemes, the Commission’s utilization of investor fraud tips, and the SEC’s role in boosting investor confidence.

Click here to view the extended version of Chairwoman Schapiro’s interview.

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