The fallout from the Milberg Weiss indictment continues to spread as other firms seek to lure away its partners and a remnant formed by former name partner William Lerach is accused of being linked to the misconduct. An article in The Recorder (here) states that a San Francisco law firm is soliciting a number of Milberg Weiss partners to join it and, not surprisingly, bring along the securities class actions for which they are lead counsel. The Lerach Coughlin firm, which broke off from Milberg Weiss in 2004, is the object of a motion to exclude its proposed lead plaintiff in a securities class action because of the firm’s potential involvement in the government’s continuing investigation related to payments to representative plaintiffs before Milberg Weiss split up. The motion (here courtesy of the Securities Litigation Watch) states that appointment of Lerach Coughlin’s proposed plaintiff would be "troubling, to say the least," and the competing lawyers are kind enough to attach a copy of the Milberg Weiss indictment — as if it were unknown to the court. The lawyers offer their plaintiff to serve as the lead plaintiff and themselves as suitable counsel, showing that the competition remains fierce in the securities class action world. The indictment is barely a month old, and hardly a week goes by without a challenge to Milberg Weiss’ (and now Lerach Coughlin’s) representation in a case or partners announcing they are leaving the firm. The momentum is unlikely to slow down in the near future, and could pick up if cooperating witnesses (or a defendant) are able to link former firm leaders Melvyn Weiss or William Lerach to the alleged improper payments. (ph)
Category: Securities
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The Tenth Circuit joined every other federal circuit aside from the Eighth Circuit in rejecting the "selective waiver" approach to the attorney-client privilege and work product protection, which means that documents provided to the government cannot be withheld on either a privilege or work product claim. The decision arises from the private securities fraud claims filed against Qwest Communications after the Department of Justice and the SEC began investigating the company when it disclosed in 2002 that there were substantial accounting problems. As part of that investigation, Qwest voluntarily turned over to the government more than 220,000 pages that were subject to privilege and work product claims. Qwest settled an SEC civil enforcement action in November 2004 by paying a $250 million penalty. In the consolidated securities class action, the plaintiffs demanded production of the documents turned over to the government, which the district court ordered.
In a mandamus action to the Tenth Circuit, In re Qwest Communications International Inc. Securities Litigation (here), Qwest argued that the court should adopt the selective waiver analysis from the Eighth Circuit decision in Diversified Industries v. Meredith, 572 F.2d 596 (8th Cir. 1977) (en banc), that would permit it to assert the attorney-client privilege and work product protection because it only intended to waive the privilege with regard to the government agencies and not private parties. The court noted that every other circuit has rejected that position with regard to waiver of the attorney-client privilege, and, aside from attorney opinion work product, the same result applied to general work product claims, including the Eighth Circuit. The court rejected the argument that a failure to recognize selective waiver in the current "culture of waiver" would result in less cooperation by corporations with law enforcement investigations, stating:
[H]aving considered the purposes behind the attorney-client privilege and the work-product doctrine as well as the reasoned opinions of the other circuits, we conclude the record in this case is not sufficient to justify adoption of a selective waiver doctrine as an exception to the general rules of waiver upon disclosure of protected material. Qwest advocates a rule that would preserve the protection of materials disclosed to federal agencies under agreements which purport to maintain the attorney-client privilege and work-product protection but do little to limit further disclosure by the government. The record does not establish a need for a rule of selective waiver to assure cooperation with law enforcement, to further the purposes of the attorney-client privilege or work-product doctrine, or to avoid unfairness to the disclosing party. Rather than a mere exception to the general rules of waiver, one could argue that Qwest seeks the substantial equivalent of an entirely new privilege, i.e., a government-investigation privilege. Regardless of characterization, however, the rule Qwest advocates would be a leap, not a natural, incremental next step in the common law development of privileges and protections. On this record, "[w]e are unwilling to embark the judiciary on a long and difficult journey to such an uncertain destination." Branzburg v. Hayes, 408 U.S. 665, 703 (1972).
The Tenth Circuit noted that adoption of a selective waiver provision is better left to Congress and the rulemaking committee of the Judicial Conference, which has proposed a new Evidence Rule 502(c) (here) on this issue, which if adopted will provide:
In a federal or state proceeding, a disclosure of a communication or information covered by the attorney-client privilege or work product protection — when made to a federal public office or agency in the exercise of its regulatory, investigative, or enforcement authority — does not operate as a waiver of the privilege or protection in favor of non-governmental persons or entities. The effect of disclosure to a state or local government agency, with respect to non-governmental persons or entities, is governed by applicable state law. Nothing in this rule limits or expands the authority of a government agency to disclose communications or information to other government agencies or as otherwise authorized or required by law.
Without selective waiver in this case, counsel for the plaintiffs now get to wade through a mountain of documents that Qwest will have to produce. (ph)
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We looked at the sad story of Anthony Elgindy here, but the story became even sadder yesterday with his sentencing. According to the Wall Street Jrl here, Elgindy received a sentence of 11 years. He was convicted in January of 2005 of the crimes of racketeering, conspiracy and securities fraud. The 11 year sentence he received also includes a forfeiture of 1.5 million.
(esp)
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As identified in a St. Louis Post-Dispatch article and discussed in an earlier post (here), suspicious trading in Maverick Tube call options right before the company announced it agreed to be taken over at a 30%+ premium has triggered an SEC civil action for insider trading (complaint here). The purchaser is Tenaris S.A., a company headquartered in Luxembourg and controlled by a parent company in Argentina. And, not surprisingly, the trading comes from Argentina, with two sets of purchasers identified by the SEC as trading in Maverick Tube call options and stock during the relevant period. According to the SEC complaint, the two sets of defendants are the Cavalleros of Buenos Aires and the Millers, who list a permanent address of Buenos Aires and apparently reside in Uruguay.
The complaint does not set forth any connection between the various defendants (there are five individuals) and Tenaris, going with the geographic connection and the timing to assert "on information and belief" that they were in possession of material nonpublic information in breach of a duty of trust and confidence. The timing evidence certainly is striking, with each group purchasing large numbers of June 06 out-of-the-money call options less than ten days before they would expire worthless — a very risky bet, or a sure thing if you know the deal is about to be announced. The defendants also purchased Maverick Tube common stock, transactions that were much less lucrative. On the call option trades, the Cavalleros had a profit of over $850,000 on a $55,000 investment, while the Millers’ profits were over $220,000 on an investment of a little less than $20,000. If you annualize those investment gains, they make Warren Buffett look like a minor leaguer.
Typical of insider trading cases involving overseas defendants, the Commission obtained a Temporary Restraining Order and Asset Freeze (order here) to prevent the money from leaving the United States while the Enforcement Division continues its investigation. Each group of defendants traded through the overseas offices of U.S.-based brokerage firms (Merrill Lynch and Wachovia), so the funds were on deposit in this country after the execution of the sale orders at the time the SEC filed suit. The case will now move forward on an expedited discovery basis in which the Commission will try to identify the source of the material nonpublic information, if any. I would expect Tenaris to cooperate in the investigation because it hardly does the company any good to have the SEC angry at it while it tries to complete the purchase of a U.S. corporation whose shares are publicly traded.
As part of the SEC’s discovery, the various defendants will be noticed for depositions in the United States, at which they can try to explain why their trading did not involve material nonpublic information. If they were to show up, however, they would likely risk an immediate arrest and criminal insider trading charges. The SEC case is being conducted out of its Chicago office, which means the U.S. Attorney’s Office for the Northern District of Illinois likely would be involved on the criminal side, and somehow I expect U.S. Attorney Patrick Fitzgerald’s securities/commodities group will be quite aggressive if given the chance. A default judgment in the SEC civil action is a real possibility, leaving over $1 million on the table. (ph)
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The release of transcripts of depositions of former New York Stock Exchange CEO Richard Grasso show that during his examination by the SEC in 2005 he asserted the Fifth Amendment over 150 times. The deposition concerned whether he pressured the floor broker for American International Group’s stock to keep the share price up to assist the company in a pending transaction. The deposition is part of an investigation by the SEC of former AIG CEO Maurice Greenberg for possible securities law violations related to the company’s accounting and manipulation of its stock. A second Grasso deposition, this one given in connection with the lawsuit filed by New York Attorney General Eliot Spitzer related to compensation while he was CEO of the NYSE, does not show him asserting the Fifth Amendment in response to questions. The deposition in the New York state case against him came more recently, in April 2006, at a point in time when it does not appear that the federal government will be pursuing criminal charges against Greenberg, and the SEC has not yet filed a civil enforcement action against him. Spitzer has filed a securities fraud action against Greenberg, who has vowed to fight any charges related to his time as CEO of AIG.
Why did Grasso have to assert the Fifth Amendment repeatedly in the SEC deposition? While it certainly looks striking, and suspicious, to assert the privilege against self-incrimination so many times, the number of responses is more a function of the requirement that the SEC ask every possible question on which Grasso will assert the Fifth Amendment if it wants to ask the court (or jury) to draw an adverse inference from the assertion. Unlike a criminal case, in which a defendant cannot be forced to testify nor can the prosecutor comment on the defendant’s decision not to testify, in civil litigation an assertion of the Fifth Amendment can be evidence considered by the trier of fact in deciding whether the person engaged in the alleged misconduct. By asking all relevant questions, and forcing Grasso to assert the Fifth Amendment, the SEC is creating a building block should it decide to sue Grasso. In criminal investigations, the assertion of the privilege cannot be used at all, so if a witness indicates that he or she will refuse to answer questions on that ground prosecutors will not call the person before the grand jury, unless there is a plan to grant the witness immunity and require the testimony.
There is no great harm to Grasso in asserting the privilege, aside from the embarrassment of having done so, because if he were to be sued by the SEC he could testify during discovery or at the trial and his earlier assertion of the Fifth Amendment most likely would not be admissible against him. At the time of the SEC deposition in 2005, it was certainly the prudent thing to do. Until it is clear where the government is headed in its investigation, an assertion of the Fifth Amendment keeps a person from incriminating himself or creating a record that could be the basis for a perjury or obstruction charge. Now that things have settled down regarding AIG and Greenberg, Grasso can answer questions like he did in the New York case without the same fear of negative consequences. In that sense, then, the story about Grasso asserting the Fifth Amendment over 150 times turns out not to be much of a story at all. An AP article (here) discusses the two depositions. (ph)
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The U.S. Attorney’s Office for the Southern District of New York may now be in the lead in issuing grand jury subpoenas to companies for documents related to the timing of stock options granted to senior executive. RSA Security Inc. issued a press release (here) on June 13 stating that the company "announced that it has received a document subpoena from the U.S. Attorney for the Southern District of New York requesting records from 1996 to the present relating to the Company’s granting of stock options. The Company plans to cooperate fully with the office of the United States Attorney in connection with this subpoena." On June 12, Monster Worldwide Inc., parent company of Monster.Com, issued a press release (here) that "the company has been served with a subpoena from the United States Attorney for the Southern District of New York relating to stock option grants. Monster Worldwide intends to cooperate fully in this matter." Strikingly similar language, but then there is no way for counsel to spin the receipt of a grand jury subpoena other than to promise cooperation, something companies are virtually required to do these days if they hope to avoid indictment should the investigation come to that point.
A Wall Street Journal scorecard (here) tracking the various government and internal investigations of stock option timing now lists twenty companies that have received grand jury subpoenas, from U.S. Attorney’s Offices in New York, Brooklyn, San Francisco, and Boston. The question is whether anything will come of these various inquiries — aside from the tidal wave of attorney’s fees, of course. A key step to watch for is a plea agreement and SEC settlement with a corporate officer involved in backdating documents, which will indicate the types of violations prosecutors and the SEC are looking at in the cases. (ph)
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If you don’t share the basketball with your teammates, you are likely to lose the game. When you share insider information with them, however, you may well come to the attention of the SEC and be sued for insider trading. Such is the fate of Matthew Roszak, Douglas Jozwiak, Darrin Edgecombe, and two others when Roszak learned from a director of Blue Rhino that the company was in the process of being acquired by Ferrellgas Partners. Roszak worked with the director closely, including serving as the CFO of a company controlled by the director. The director first told Roszak in December 2003 that he would be doing significant work on a deal involving Blue Rhino, and on January 9, 2004, after spending two days together, Roszak made his first purchase of Blue Rhino shares and tried to figure out how to buy call options on the stock — a much more cost-effective way of trading on inside information.
If the trading had stopped there, Roszak might have stayed underneath the radar because he had once before bought Blue Rhino shares. Inside information is like a wad of cash in one’s pocket, however, and pretty soon it burns a hole and has to be let out. On January 29, the director told Roszak that he would be in daily Blue Rhino board meetings, a clear signal that the deal was close to completion. That evening, Roszak called basketball teammates Jozwiak, his brother-in-law, and Edgecombe, his friend for 15 years, apparently to tell them about the deal. The SEC complaint (here) details a number of telephone calls between the three men, the type of circumstantial evidence on which these types of cases are often built. Roszak also called two relatives, who are not identified in the complaint, that evening. The next morning, the Blue Rhino spigot was turned on as the tippees began buying up shares at a rapid clip. Jozwiak bought $56,000 worth of stock the next morning, his largest trade since opening the account, and Edgecombe bought almost $300,000 the moment the market opened the next morning — nothing like trying to be subtle about using your inside information.
Edgecombe tipped two other friends, Trifon Beladakis and Mark Michel, who also started buying Blue Rhino. The complaint details the calls on January 29 down to the minute as the information burned up the telephone wires in Illinois, where all the defendants reside. To compound matters by making it more likely that the securities exchanges and the SEC would notice the trading, Michel, a registered rep at Wachovia Securities, also bought $1.2 million worth of Blue Rhino for relatives and clients in addition to his own purchases. When the companies announced the deal on February 9, Blue Rhino jumped almost 20%, and the defendants reaped the following profits: Roszak $23,230; Edgecombe $65,017; Jozwiak $14,136; Beladakis $29,783. Michel made almost $32,000 for himself, $92,381 for relatives, and almost $202,000 for clients. Not bad for less than two weeks worth of investing. I vaguely recall an adage about hogs getting slaughtered.
According to the SEC Litigation Release (here), four of the five defendants settled on the following terms: "Roszak, Edgecombe and Beladakis have agreed to pay disgorgement, plus prejudgment interest thereon, and civil penalties totaling $240,740, $114,805 and $62,353, respectively. To settle charges against him, Jozwiak agreed to pay a civil penalty in the amount of $14,136." Michel did not settle the case, and likely faces some pretty unhappy Wachovia Securities clients (and if he hasn’t been fired yet, he probably will be very soon) who do not want to have to return their ill-gotten Blue Rhino bonanza. (ph)
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Former technology investment banker Frank Quattrone ended 2005 as a convicted felon waiting for the Second Circuit to rule on the appeal of his conviction on three counts of obstruction of justice and witness tampering; he had also been barred by the NASD from the securities industry. Things have gotten better since then. First, the appellate court reversed the convictions due to faulty jury instructions. Then, the SEC overturned the NASD’s lifetime ban on Quattrone that was based on his assertion of the Fifth Amendment when required to testify before a hearing panel investigating his role in distributing shares in "hot" initial public offerings (IPO). The Commission determined that a ban based solely on asserting the self-incrimination privilege was improper when Quattrone raised colorable claims whether that was constitutionally permissible. Now, the NASD has dropped its regulatory complaint regarding the IPO distributions completely, according to an AP story (here).
The SEC and grand jury investigations of the distribution of IPO shares triggered the underlying obstruction charges, but no criminal or SEC action was ever taken regarding that conduct. With the NASD complaint now gone, it would seem that there is a good argument that the obstruction charges should not be retried. The basis for those charges was always open to significant question as a potential securities fraud. Quattrone used shares in IPOs brought to market by his firm, Credit Suisse First Boston (CSFB), to reward CEOs and executives at other firms with whom CSFB did business or hoped to do business in the future. As the options-timing investigations that have emerged in the past month show, corporate executives are not shy about lining their pockets. The issue in Quattrone’s case, however, is whether there was anything fraudulent in what he did, as opposed to what the executives did in taking a personal reward for picking the corporation’s investment bank. In effect, Quattrone was the ice cream man handing out treats, while it was the executives who spent someone else’s money who got the cones. It’s not clear what is wrong with selling your services to a willing, if personally greedy, buyer.
Quattrone’s criminal case has been assigned to a new district judge, and he has retained new lawyers. Along the same lines, the government has new attorneys on the case. Will it all go away? (ph)
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There are now four U.S. Attorney’s Offices looking into the timing of stock options granted to senior executives with the issuance of a grand jury subpoena from the District of Massachusetts to Sycamore Networks, Inc., a Chelmsford, Mass., company. According to an 8-K filed on May 30 (here):
In addition to the previously reported investigation by the Securities and Exchange Commission (the “SEC”) of the practices of Sycamore Networks, Inc. (the “Company”) related to certain stock option grants, the Company is also cooperating with the U.S. Attorney’s Office for the District of Massachusetts (“U.S. Attorney’s Office”) in its investigation of the Company’s stock option practices. On May 26, 2006, the U.S. Attorney’s Office issued a grand jury subpoena to the Company requesting that the Company produce documents relating to stock option grants. The Company is cooperating, and will continue to cooperate, with the SEC and the U.S. Attorney’s Office in their investigations.
The U.S. Attorney’s Offices for the Southern and Eastern Districts of New York, i.e. Manhattan and Brooklyn, have taken the lead by subpoenaing over a dozen companies between them, while the U.S. Attorney’s Office for the Northern District of California issued a subpoena to Altera Corp. related to its options grant practices (see press release here). It remains unclear whether there is a coordinated investigation by the U.S. Attorney’s Offices, although the companies subpoenaed in Massachusetts and California are within the districts, while the New York investigations are nationwide. The SEC is also conducting investigations of the companies that have received grand jury subpoenas, so there is likely at least some coordination through that agency, although there are important limitations on how closely the civil and criminal investigators can work together. Of particular concern, after two district court decisions in the past year dismissing criminal charges, will be how the SEC deals with witnesses who may also be the targets of grand jury investigations.
The Wall Street Journal has a very helpful chart (here) detailing the companies that so far have disclosed governmental and internal investigations of possible options-timing issues. The investigations have already resulted in the dismissal of a few senior executives related to the probes, including the firing of the general counsel at McAfee discussed in an earlier post (here). With the U.S. Attorneys in New York, Boston, and San Francisco conducting investigations, can the offices in Chicago and Los Angeles be too far behind? Moreover, look for the SEC investigations, most of which have been identified as "informal" to this point, to move into the "formal" category in the near future, which will trigger a wave of civil subpoenas. (ph)
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Along with the criminal indictment on false statement, perjury, obstruction, and conspiracy charges filed on June 4, 2003, Martha Stewart and Peter Bacanovic were sued the same day by the SEC for insider trading (complaint here) arising from her sales of ImClone Systems, Inc. stock on December 27, 2001. The Commission alleged that Stewart sold her shares (and avoided approximately $45,000 in losses) based on information about stock sales by ImClone’s CEO, Dr. Sam Waksal, that was passed on to her by Bacanovic, her broker at Merrill Lynch. The complaint does not allege that Waksal — who is serving a 7-year prison term after pleading guilty to insider trading and tax charges — tipped either Stewart or Bacanovic about problems ImClone was having in obtaining FDA approval for its main drug, Erbitux. Instead, the SEC alleges that Bacanovic violated his fiduciary duty to Merrill Lynch by tipping Stewart about customer information: "As of December 27, 2001, the Waksals’ efforts and instructions to sell their ImClone stock were not public and Merrill Lynch policies specifically required employees to keep information about those transactions confidential. Indeed, Merrill Lynch had in place at least four policies that prohibited employees, such as Bacanovic and [his assistant Douglas] Faneuil, from disclosing client transactions to others or effecting trades on information about client securities transactions." The alleged insider trading is a step removed from the confidential information, and concerns market information rather than corporate information, raising questions of materiality and causation. Federal prosecutors did not charge Stewart and Bacanovic with securities fraud, most likely because it would have been too difficult to establish guilt beyond a reasonable doubt. The SEC suit operates under the more relaxed civil standard of preponderance of the evidence, although the case is certainly not an easy one.
The parties agreed to stay the civil case until the criminal case was over, and now that Stewart will not pursue any further appeals from the affirmance of her conviction by the Second Circuit in January 2006, the SEC suit can move forward. An AP story (here) states that Stewart and Bacanovic must now file an answer to the complaint. The civil case involves a fairly trivial amount of money for someone of Stewart’s wealth, and could probably be settled for not much more than $200,000 with interest and a triple penalty, at the most. The problem in settling the case most likely is a possible director and officer bar that could be imposed on Stewart if there is a finding that she engaged in a violation of the antifraud provisions of the federal securities laws. The complaint seeks the following relief: "Order[] that Stewart be barred from acting as a director of, and limiting her activities as an officer of, any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act, 15 U.S.C. § 781, or that is required to file reports pursuant to Section 15(d) of the Exchange Act, 15 U.S.C. § 78o(d) . . . ." A D&O bar would prevent Stewart from exercising control of Martha Stewart Omnimedia Inc. as a senior executive, barring a move to take it private so that it would not be subject to the registration and reporting provisions of the Securities Exchange Act of 1934. If the Commission is insisting on a bar, that may be too high a price to pay, especially in a case that Stewart stands a reasonable chance of winning, although at the cost of another round of negative publicity. Then again, having appeared on a version of The Apprentice, there may be no such thing as too much bad publicity. (ph)
UPDATE: An AP story (here) states that Martha Stewart filed an answer to the SEC complaint asserting that she acted in "good faith," which is a defense to a fraud charge under Section10(b) and Rule 10b-5, the legal basis for the insider trading prohibition. At this point, discovery will move forward, which means deposition notices are likely to go out to Stewart and Peter Bacanovic, her co-defendant and former broker. Unlike the criminal case, in which neither testified, as civil defendants the opposing party has the right to compel them to testify. While either can assert the Fifth Amendment privilege at the deposition, that can be used as evidence to infer that the person had the requisite intent to violate the antifraud provisions. Settlement is certainly not precluded at this point, and as discovery proceeds the sides may move closer to resolving the issues. (ph)
MattBray.net 