The grand jury subpoenas to companies with suspiciously-timed stock option grants to their senior executives seem to be coming fast and furious, and from two different districts separated only by the East River. The U.S. Attorney’s Office for the Eastern District of New York launched the first subpoena, to Comverse Technology, and then went quiet while the Southern District of New York unleashed a set of subpoenas on May 17 to companies such as Vitesse Semiconduct and UnitedHealth. Now comes word that additional companies have received grand jury subpoenas from one or the other district: KLA-Tencor (apparently SDNY); Brooks Automation (EDNY); F5 Networks (EDNY); Juniper Networks (EDNY) (see Wall Street Journal story here). Are the two districts competing over the investigation of companies that have options-timing issues, or is it a matter of dividing a potentially very large field so that one office is not overwhelmed by the truckloads of documents that should be arriving shortly from each corporation that has promised full cooperation? (ph)
Category: Securities
-
Add three more companies to the list of those that have received grand jury subpoenas from the Southern District of New York probing the pricing of stock options granted to senior executives, including the veracity of documents for the awards. The subpoenas, all delivered on Wednesday, May 17, were received by Affiliated Computer Services, Inc. (8-K here), Caremark Rx, Inc. (press release here), and SafeNet, Inc. (press release here). Each company also disclosed receiving an inquiry from the SEC as part of its informal investigation — which will go formal sometime soon, I expect — and each states that it will cooperate in the investigation. UnitedHealth and Vitesse Semiconductor also received subpoenas on that day (see post here), and no doubt there will be more companies disclosing the receipt of grand jury subpoenas, with the disclosures likely to come late Friday afternoon after the markets close. It is not clear whether the SEC requests for information were received at the same time as the grand jury subpoenas, but the Commission and the Southern District of New York have a long history of close cooperation so these investigations most likely are being coordinated. A Wall Street Journal story (here) discusses the expanding investigation. (ph)
-
The U.S. Attorney’s Office for the Southern District of New York has issued grand jury subpoenas to Unitedhealth Group and Vitesse Semiconductor concerning the timing of options grants to senior executives and allegations that documents were backdated to allow the options to be issued at a lower price to enhance their value. Unitedhealth announced the subpoena in a press release (here), and a Wall Street Journal story (here) discusses the subpoenas. A grand jury in the Eastern District of New York has already subpoenaed Comverse Technology related to options timing issues at that company (see earlier post here), and it’s not clear at this point whether the U.S. Attorney’s Offices will be conducting a coordinated investigation. The SEC has already begun an informal investigation of a number of companies related to their options grants, and that investigation is likely to become a formal one, if it hasn’t already happened, followed by the issuance of subpoenas. Companies will be facing parallel investigations, along with the usual host of shareholder lawsuits.
Vitesse Semiconductor also announced that it had terminated its CEO, CFO, and executive vice president, who had earlier been placed on leave, and the company faces a delisting of its stock by NASDAQ because it has not been able to file its quarterly report. More ominously for the former executives and the company is the disclosure that the internal investigation has raised questions about revenue recognition, and that its financial statements should not be relied on. This raises an interesting question whether the options grants were linked to possible accounting violations designed to make the company look better and thereby enhance the value of the options, something that the grand jury will likely review. An AP story (here) discusses the termination of the Vitesse Semiconductor officers. The various investigations are likely to expand rather quickly over the next few weeks. (ph)
-
My mother always said that it wasn’t what I did that got me in trouble, it was the fact that I lied about it. That was not entirely true, of course, but the lie can certainly turn a bad situation worse. That is especially applicable when the lie involves an SEC insider trading investigation and the initial story is that the information was overheard from two guys talking in a bar, a tale sure to pique the Enforcement Division’s interest. Stephen Messina will plead guilty to violating Sec. 1001(criminal information here) for making a false statement during an SEC investigation of his purchase of call options in Electronic Boutiques right before the announcement of an acquisition of the company by Game Stop that triggered a 34% increase in the stock price, giving him a profit of over $300,000. It turns out that the information came from Messina’s friend Robert Downs, an attorney at the time at Philadelphia law firm Klehr Harrison, which worked on the deal, although Downs was not involved in the representation.
Messina and Downs settled an SEC civil insider trading action, with Messina disgorging his profits, plus paying a 50% penalty, while Downs paid a penalty equal to Messina’s profits (Litigation Release here). Down, who is no longer with the law firm, was not involved in the criminal prosecution, and it will be interesting to see if the Pennsylvania state bar pursues any disciplinary action against him if the SEC allegations are correct. As a general matter, disclosing client-related information to a third party to trade on it would violate the confidentiality rules and the fiduciary obligation of lawyers that prohibits use of client information for personal benefit, even if the client does not suffer any direct harm. A Philadelphia Inquirer story (here) discusses the case. (ph)
-
Morgan Stanley & Co. has had more than its fair share of problems producing e-mails in civil litigation and to the SEC. The company settled an SEC civil complaint (here) alleging that from 2001 to 2005 it failed to supply e-mails in Commission investigations into IPO distributions and conflicts involving research analysts. According to the SEC Litigation Release (here):
The Commission alleges in its complaint that Morgan Stanley did not diligently search for back-up tapes containing responsive e-mails until 2005. Morgan Stanley also failed to produce responsive e-mails because it over-wrote back-up tapes. The complaint further alleges that Morgan Stanley made numerous misstatements regarding the status and completeness of its productions; the unavailability of certain documents; and its efforts to preserve requested e-mail. The Commission charged Morgan Stanley with violating the provisions of the federal securities laws requiring Morgan Stanley, a regulated broker-dealer, to timely produce its records and documents to the Commission.
$5 million of the penalty will be paid to the New York Stock Exchange and NASD, which were also involved in the investigations. The $15 million pales in comparison to the $1.6 billion judgment won by Ronald Perlman in litigation over Morgan Stanley’s role in the acquisition of Coleman Cos. by its client Sunbeam that was driven in part by the trial court’s finding that the firm made intentional misstatements regarding the production of e-mail evidence. That award included $850 million in punitive damages, and the judgment is on appeal.
While the dollar amount in the SEC case is not that significant, at least for a firm like Morgan Stanley, the long-term effect on its reputation with the regulators who oversee the firm may be more significant. In the near-term, at least, the SEC and NASD are less likely to trust the firm on document production issues, and I think the agencies will inspect Morgan Stanley’s responsiveness with a more critical eye. The firm’s "one free bite" is gone, and any failure to produce information, especially e-mails, will result in a much more severe punishment and possibly even a criminal investigation. Private litigants are sure to keep a copy of the Commission’s complaint close at hand, too. The case is yet another example of the importance of managing e-mail when the government comes knocking with one of those pesky little subpoenas. (ph)
-
An earlier post (here) discussed an insider trading case in New York in which the live-in boyfriend looked at the deal documents his girlfriend brought home from her office and bought shares in the client-company involved in an extraordinary transaction. A slightly different situation arose in an SEC civil insider trading case filed in San Francisco involving Marnie Sharpe, who got the news from a "close friend" and almost immediately tipped her father about it. As described in the SEC complaint (here), Sharpe received the information from an executive at biotech company Renovis, Inc., and "Sharpe and the executive, both divorced, met socially and exchanged email, phone calls and text messages." The executive and Sharpe had dinner at which he said the company expected to receive the results of a clinical trial on its most advanced drug on May 2. Shortly after the executive received information on May 2 that the results were positive, Sharpe called the executive and asked about the test results. After initially resisting her requests for information, he told her that the results were positive and warned her not to disclose the information. The executive then called her back to reiterate the confidentiality of the information and, when she asked if she or her family could trade, the executive said "of course not."
At this point, Sharpe’s relationship with the executive probably hit the skids because she immediately called her father, who liquidated mutual funds in his brokerage account to raise cash, and Sharpe wire transferred $10,000 to her father’s account. The father even asked the broker whether a company could trace who was buying its stock. On May 3, 2005, the father purchased over 7,000 Renovis shares, apparently not knowing that the best way to trade on such inside information is to purchase out-of-the-money call options on the company’s shares. On May 4, Renovis announced the positive clinical test results, and the stock nearly doubled, generating a $42,000 profit. Sharpe and her father settled the SEC case by disgorging the profits and each paying a one-time penalty of $42,000.
The SEC’s theory that Sharpe breached her fiduciary duty in tipping her father was the pattern of sharing confidential information in the relationship with the executive. As described in the complaint, "During their friendship, Sharpe and the Renovis executive had a history, pattern or practice of sharing confidential work and personal information. They each expected the other to keep such exchanges confidential and, until May 2005, did so. Because of their close personal relationship and history of sharing confidences, the Renovis executive trusted Sharpe and expected her to keep information about his work confidential." This is not the type of classic fiduciary relationship that is the basis for an insider trading case under Chiarella or O’Hagan, but it is consistent with the SEC’s definition of the "Duty of Trust or Confidence in Misappropriation Insider Trading Cases" in Rule 10b-5-2(b)(2). Whether that definition, which goes further than most judicial decisions have in describing the contours of the type of duty that can trigger insider trading liability, would hold up to a judicial challenge is an open question. While this case might have presented a good vehicle to address the scope of the fiduciary duty arising from a personal relationship, the San Jose Mercury News quotes the attorney for Sharpe and her father (here) as stating "[i]t is unfortunate that it is so expensive for people to defend themselves against government charges like these." The cost of settling was probably less than litigating the case, especially if it went up on appeal. But then, if you can’t trust your girlfriend, who can you trust these days. (ph)
-
The SEC filed civil insider trading charges against hedge fund manager Nelson Obus, Peter Black, an analyst at the hedge fund firm, and Thomas Strickland, who formerly worked at GE Capital. The inside information concerned the acquisition in 2001 of SunSource, Inc. by Allied Capital Corp. in a deal financed by GE Capital. According to the SEC complaint (here), Black and Strickland are close friends, and on May 24, 2001, Strickland allegedly told Black about the upcoming transaction, who in turn told Obus, who then called SunSource’s CEO to discuss the transaction. According to the complaint, "Obus told the CEO that a ‘little birdie’ at Capital had told him that SunSource management was planning to sell the company to a financial buyer." The complaint goes on to note that "Black was present when Obus spoke with Sunsource’s CEO. When Black heard what Obus told the CEO, he jumped out of his chair and began waving his arms because he was concerned that his friend Strickland would get into trouble. When Obus finished his conversation with Sunsource’s CEO, Black told Obus of his concern, and Obus responded that, if GE Capital fired Strickland, Obus would offer Strickland a job or find him a job elsewhere on Wall Street."
To this point, the SEC case describes a fairly mundane insider trading case. The issue in the case will be whether the defendants traded on the inside information, because they did not purchase any shares until June 8, when Obus bought 287,000 shares and apportioned them to three hedge funds his firm manages. When the deal was announced on June 19, SunSource’s stock increased by over 90%, and the funds had a profit of over $1.3 million. The tricky part of the case is the following allegation in the complaint: "Following Strickland’s May 24,2001, conversation with Black, Strickland continued to work on, and thus receive nonpublic information about, the progress of the proposed transaction between SunSource and Allied. On June 4,2001, Black called Strickland, and they had a four-minute conversation. That conversation provided Black with the opportunity to receive an update on the progress of the transaction and to update Obus." The italicized language does not say that Strickland actually provided additional information to Black and Obus, only that it could have happened. While the complaint has many details about the interactions of the defendants, like the arm waving, it is curiously vague on whether Strickland provided additional information to Black and Obus that can show the transaction was based on material nonpublic information.
Obus and his firm, Wynnefield Capital, have vigorously denied the SEC’s allegation. A press release (here) issued in response to the Commission complaint states:
We will detail our factual and legal case in our court filings, but you should know that the allegations are baseless and unsupported by the documentary or testimonial evidence. Our attorneys have advised us that the lawsuit lacks merit. We intend to contest this vigorously in the courts. Specifically, the facts are these:
- We acted ethically and legally;
- We followed and researched the stock for more than 10 years – and repeatedly invested in it for more than five years;
- We did not engage in insider trading;
- Our actions were consistent with our long-standing strategy to build positions in small-cap value investments;
- Our actions were consistent with the protection and enhancement of value for the company’s shareholders; and
- Our actions were intended to provide continued excellent results for our funds’ investors.
The press release notes that the trading took place nearly five years ago, and they cooperated in the investigation. Obus claims that he and his firm thought the matter had been been dropped, an assumption that should never be made with a government agency.
It is a fair question why the case took so long to come to fruition. None of the three defendants settled the matter, so it does not appear that the Enforcement Division would have received information from a cooperating witness at a late date to propelled the case forward. It may be that, due to staff turnover or other extraneous factors, the investigation became inactive for a period of time and only recently got restarted. Regardless of the reason for the delay, the defendants show no inclination to settle at this point, and given the pace of civil litigation, the trial may not begin until seven or eight years have elapsed since the trading. (ph)
-
Saudi financier Adnan Khashoggi and Ramy El-Batrawi, former CEO of telemarketing firm GenesisIntermedia, Inc. (GENI), were charged with securities fraud by the SEC in a civil complaint (here) filed in U.S. District Court in Los Angeles. Khashoggi is best-known as the arms dealer in the Iran-Contra scandal in the 1980s, and he and El-Batrawi were controlling shareholders of GENI before its collapse in 2001. They are accused of manipulating the stock price and misappropriating over $130 million in transactions that led to the collapse of several brokerage firms, resulting in the largest bailout in the history of SIPC. According to the SEC’s Litigation Release (here):
According to the complaint, Ramy El-Batrawi, GENI’s Chief Executive Officer at the time, and Adnan Khashoggi, with the assistance of Richard J. Evangelista, Wayne Breedon, and Kenneth P. D’Angelo (a stock loan broker previously charged by the SEC and criminal authorities), developed a manipulation scheme by which they could profit from lending GENI shares (rather than selling them). The complaint alleges that El-Batrawi and Khashoggi, through an offshore entity called Ultimate Holdings, loaned approximately 15 million shares of GENI stock to Evangelista’s employer at the time, Native Nations Securities, a New Jersey broker-dealer, and more than a dozen other broker-dealers in exchange for cash based upon the market value of the shares.
According to the complaint, Ultimate Holdings loaned stock through Native Nations (and other broker-dealers) to Breedon’s employer at the time, Deutsche Bank Securities Limited in Canada, and received the current market value of the stock in cash. As GENI’s stock price fluctuated, the loaned stock was marked-to-market by the broker-dealers. Ultimate Holdings received additional cash when GENI’s price increased, and was obligated to return cash when the stock price dropped. By lending the shares in this manner, El-Batrawi and Khashoggi raised approximately $130 million without giving up control of the stock or depressing the market price for the stock.
The manipulation caused GENI’s stock price to increase approximately 1,400%, from a low of $1.67 per share (split adjusted) on September 1, 1999 to a high of $25 per share on June 29, 2001. After the scheme collapsed in September 2001, GENI’s stock price plunged to pennies per share. El-Batrawi and Ultimate Holdings then defaulted on their obligations to repay the approximately $130 million they had obtained from the stock loans, which caused several of the broker-dealers in the stock loan chain to go bankrupt.
(ph)
-
The SEC issued a policy statement (here) setting forth its procedures for issuing a subpoena to the media during a formal investigation. The issue came to the forefront in February when the Commission issued subpoenas to three columnists who publish on-line for information about contacts with short sellers of Overstock.com shares. An allegation commonly made against those who specialize in selling short a company’s stock — a bet that the stock will decline — is that they spread false information through the media and internet to drive down the market price of the shares. The Enforcement Division sought information from the journalists about columns they wrote that contained negative information about Overstock.com, but the subpoenas were withdrawn shortly thereafter due to the storm of criticism regarding interference with the media.
SEC Chairman Christopher Cox issued the new policy, which imposes of number of intermediate steps before the Enforcement Division staff can issue a subpoena to members of the media. First, the SEC must try to obtain the information informally, and contacts should be done through counsel for the journalist rather than by a direct contact. The benefit of this approach is that issues of whether the journalist even has relevant information, and whether a claim of privilege might be raised, can be decided before any further steps are taken. The policy also stresses that other avenues for obtaining the information should be exhausted, and any information sought should be important and not peripheral:
If negotiations are not successful in achieving a resolution that accommodates the Commission’s interest in the information and the media’s interests without issuing a subpoena, the staff investigating the matter should then consider whether to seek the issuance of a subpoena for the information. The following principles should guide the determination of whether a subpoena to a member of the news media should be issued:
(1) There should be reasonable grounds to believe that the information sought is essential to successful completion of the investigation. The subpoena should not be used to obtain peripheral or nonessential information.
(2) The staff should have exhausted all reasonable alternative means of obtaining the information from non-media sources. Whether all reasonable efforts have been made to obtain the information from alternative sources will depend on the particular circumstances of the investigation, including whether there is an immediate need to preserve assets or protect investors from an ongoing fraud.
Only after working through other possibilities can a request for a subpoena be made, and the decision whether to issue the subpoena will be made by the Director of Enforcement in consultation with the General Counsel. If the decision is made to issue the subpoena, the Chairman must be notified, and the terms of the subpoena negotiated with counsel for the media outlet in advance so that it can be as narrow as possible. Moreover, the policy states that "[i]n the absence of special circumstances, subpoenas to members of the news media should be limited to the verification of published information and to surrounding circumstances relating to the accuracy of published information."
All in all, the Commission’s policy will make it very difficult for the Enforcement Division staff to issue subpoenas because of the many layers of review. The policy stresses a cooperative process, in which counsel for the subpoena recipient will work with the staff to shape the information request, rather than an "issue first, ask questions later" approach to obtaining information through the SEC’s compulsory powers. (ph)
-
Federal prosecutors and the SEC filed new criminal and civil insider trading charges in a case that grew out of suspicious trading in shares of Reebok in August 2005 right before the announcement of a friendly takeover by Adidas. A short time later, charges were filed against David Pajcin, who worked at Goldman Sachs and is the nephew of a woman in Croatia who was the name on the account that traded Reebok stock and call options. Pajcin was also charged with insider trading based on reviewing advance copies of Business Week, an old insider trading ploy that seems to crop up every few years. Pajcin has cooperated with the authorities, and a wide-scale insider trading operation has come to light that generated profits of over $6 million. The two lead players are Pajcin and Eugene Plotkin, who worked with Pajcin at Goldman and was most recently in the firm’s Fixed Income Research division — and I suspect he was terminated from that position as soon as the news hit the wire. The scheme had two prongs, with information coming from a junior analyst at Merrill Lynch about deals in that firm’s shotpand another pipeline into the printing plant for Business Week. The SEC’s litigation release (here) summarizes the two aspects of the insider trading operation:
The Merill Lynch Scheme:
The Complaint alleges that Plotkin and Pajcin infiltrated the investment banking unit of Merrill Lynch, repeatedly learning of mergers and acquisitions transactions before they became public. In exchange for a share of the illegal profits, Stanislav Shpigelman (“Shpigelman”), an analyst at Merrill Lynch, leaked confidential information to defendants Plotkin and Pajcin concerning at least six mergers or acquisitions that Merrill Lynch was working on, prior to the time the deals became public, including deals between (i) The Proctor & Gamble Company and The Gillette Company; (ii) Novartis AG and Eon Labs, Inc.; (iii) Duke Energy and Cinergy Corp.; (iv) Quest Diagnostics, Inc. and LabOne, Inc.; (v) Celgene Corp. and a company considering acquiring Celgene; and (vi) Reebok and Adidas. Plotkin and Pajcin traded on the insider information and passed the insider information on to individuals in the United States and Europe (“Traders”) who traded on it. Plotkin and Pajcin had an agreement with the Traders, pursuant to which they were to receive a percentage of the illicit profits made by the Traders. The Merrill Lynch Scheme yielded over $6.4 million in illicit trading profits.
The Business Week Scheme:
The Complaint further alleges that Plotkin and Pajcin also infiltrated one of the printing plants utilized by Business Week, repeatedly obtaining advance copies of the market-moving IWS [Inside Wall Street] column in Business Week. Plotkin and Pajcin recruited two individuals — first, Nickolaus Shuster (“Shuster”), and later Juan C. Renteria, Jr. (“Renteria”) — to obtain employment at Quad/Graphics, Inc., one of four printing plants that print Business Week magazine, for the sole purpose of stealing copies of upcoming editions of the magazine, and calling Plotkin or Pajcin to read them key portions of IWS — a widely-read column in the magazine that generally moves the price of the securities of companies mentioned in it – prior to the time the column became available to the public. The Complaint alleges that Shuster and Renteria provided Plotkin or Pajcin with insider information concerning at least twenty companies that were featured in the IWS column. Plotkin and Pajcin then either traded on the IWS insider information or passed the information to some or all of the Traders, who traded on the insider information. The Business Week Scheme yielded over $345,000 in illicit trading profits. here) discusses the charges. (ph)
All of the main players are in their 20s, with Pajcin the oldest at 29, although this is much more than a youthful indiscretion. Plotkin and Shpigelman were arrested in New York on the criminal charges. If the charges are proven, their careers on Wall Street were over before lunch was served. A Reuters story (here) discusses the charges, and the criminal complaint is available (here) on Findlaw. (ph)
MattBray.net 