The securities fraud, mail/wire fraud, and conspiracy trial of former Cendant CEO Walter Forbes and former vice-chairman Kirk Shelton ended in a split verdict on Jan. 4: Shelton guilty on all 12 counts, and a hung jury on the charges against Forbes. According to a New York Times story (Jan. 5),the jury deliberated for 33 days after hearing testimony for seven months. The case involved complex accounting issues related to inflated revenues, proper accounting of expenses, etc. Even with the length of the trial, 33 days to deliberate seems like a very long time, and it was not doubt excruciating for all involved. No word yet from the U.S. Attorney’s Office in New Jersey whether it will seek to retry Forbes, but given his high position in the company, the company’s settlement of shareholder lawsuits for $2.85 billion–the largest payment ever from a fraud case–and the possibility that Shelton might cooperate with the government in a retrial, it is more likely that there will be a second trial absent a plea bargain. (ph)
Category: Securities
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A post here on Nov. 22 (Lawyer Reporting of Corporate Misconduct) discussed the role of two U.S. law firms that advised their client, TV Azteca, regarding the company’s disclosure obligations under the federal securities laws and, when the corporate client refused to make the disclosures, the lawyers resigned. The SEC has now charged TV Azteca, a Mexican corporation whose shares are traded on the New York Stock Exchange, and three current and former officers, Ricardo Salinas Pliego, Pedro Padilla Longoria, and Luis Echarte Fernandez, with violating Section 10(b) and Rule 10b-5 for its failure to disclose material information and for making false disclosures. The SEC’s Litigation Release states:
The SEC alleges in its Complaint that the defendants engaged in an elaborate scheme to conceal Salinas’s role in a series of transactions through which he personally profited by $109 million. The SEC complaint also alleges that Salinas and Padilla sold millions of dollars of TV Azteca stock while Salinas’s self-dealing remained undisclosed to the market place.
The SEC’s complaint further notes how the resignation of TV Azteca’s counsel (and subsequent publicity about it in a New York Times article) affected the company’s disclosure:
The Commission further alleged in its Complaint that after the resignation of TV Azteca’s U.S. legal counsel and a Dec. 24, 2003, New York Times article concerning the matter, Echarte sent an email to Salinas and Padilla, stating, "The damage is done and the situation that we didn’t want to explain openly is now in the hands of the public." Shortly thereafter, on Jan. 9, 2004, TV Azteca issued a press release confirming that Salinas indirectly owned half of Codisco.
Maybe the Sarbanes-Oxley Act isn’t so bad after all. (ph)
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One of our earliest posts (Nov. 2 here) discussed the beginning of the securities fraud and market manipulation trial of Anthony Elgindy and former FBI Agent Jeffrey Royer. Among other things, Royer is accused of feeding confidential information to Elgindy about companies being investigated by the FBI and SEC, which Elgindy used to short the stock of the companies and, allegedly, to extort money from others under the threat of publicizing the investigations, which would negatively affect their shares. An article in the New York Times (Jan. 4) discusses Royer’s cross-examination, in which he defended his disclosure of the information to Elgindy as a means of cultivating a source who could provide information about corporate fraud. The article states:
"I was interested in getting information back," said Mr. Royer, who was soft-spoken at first but grew more feisty as prosecutors continued with their cross-examination. He said he had no idea that Mr. Elgindy would use the information to sell stocks short, which involves borrowing shares in the hope that their price will fall.
Mr. Royer said that he thought that Mr. Elgindy’s network of contacts in the investment world could provide the F.B.I. with useful information, and that he showed Mr. Elgindy some confidential e-mail messages and other documents related to companies under investigation as a way of winning trust.
"By sharing information, I would allow law enforcement and regulatory authorities to shut down companies that scammed the general public. That is what I planned to do."
Other government witnesses, including FBI agents, have testified that Royer gained access to password-protected files and disclosed the information to Elgindy, and that Royer said he planned to work for Elgindy when he resigned from the FBI in 2001. It will be interesting to see if Royer’s explanation for his actions convinces the jury because he largely admits to disclosing secret information to Elgindy. It does not appear that Elgindy will testify. (ph)
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An AP article (Jan. 4) discusses a shareholder lawsuit accusing Krispy Kreme and its management of engaging in the age-old accounting practice known as channel stuffing, in which a company sends out large amounts of its wares at the end of the quarter to increase its revenue for that period. With Krispy Kreme as the defendant in the private lawsuit and already involved in an SEC investigation, one can only imagine the puns that will be baked-up for this story (ding!). (ph)
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UBS AG, a large multinational investment bank, disclosed yesterday (press release here) that it received a Wells Notice from the SEC that the Enforcement Division staff is planning to recommend the institution of a civil action against the company for securities fraud related to its investment banking work on behalf of HealthSouth Corporation. A Wells Notice invites a company or person to file a response with the Commission staff arguing why charges should not be filed, and it is often an invitation to negotiate a settlement.
UBS was the leading investment banker for HealthSouth, and participated as an underwriter in numerous stock and bond offerings for the company while its analysts were among thestock’s main cheerleaders. According to a Wall Street Journal article (Dec. 22), two UBS bankers, Benjamin Lorello and William McGahan, had a close relationship with Richard Scrushy, HealthSouth’s former CEO who is scheduled to go on trial early next year for securities fraud and violating the Sarbanes-Oxley Act’s CEO/CFO certification provision. The WSJ article notes:
The SEC has been looking into UBS’s work for HealthSouth for months, with a focus on whether any UBS bankers had knowledge of the accounting fraud or did transactions with HealthSouth that made the company’s books appear stronger than they actually were, according to people familiar with the probe. HealthSouth, one of the nation’s largest providers of rehabilitative and surgical health care, has been under the scrutiny of Justice Department and SEC investigators for two years.
At this point, there is no indication that any individuals at UBS have received Wells Notices, but there is a reasonable likelihood that the SEC will file charges against individuals at some point. (ph)
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Edward D. Jones & Co., a nationwide brokerage firm that caters largely to individual investors has agreed to settle SEC charges and pay a $75 million fine, according to a report in the Wall Street Journal (Dec. 20). The firm settled charges that it marketed mutual funds to its customers as among the "best" choices available to investors without disclosing that the funds paid the firm a fee to be included on the list–a fact that any reasonable investor would–or at least should–consider quite important in making a decision about what assets to purchase. The settlement is part of a continuing effort by the SEC to police conflicts of interest on Wall Street, and another example that sometimes the difference between a broker and a used car salesman can be quite small. (ph)
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With the re-election of President Bush and the fading memory of the collapse of Enron et al., it appears that the business lobby is increasing the pressure on the SEC and prosecutors to back off from the tough stance that had been taken in the past few years towards corporate crime and accounting/regulatory violations. Last week, Treasury Secretary John Snow indicated in an interview that he favored a more "balanced" approach toward enforcement of the Sarbanes-Oxley Act. A CNN report includes the following statement by Secretary Snow: "I think regulators, government officials, U.S. attorneys — all of us who have a role in administering the oversight system for corporate governance — have to be cognizant of the need for appropriate, measured balance here." An article in the Wall Street Journal (Dec. 20) indicates that business groups are opposed to William Donaldson continuing as Chairman of the SEC. The article notes, "The biggest gripes center on the SEC’s regulatory and enforcement approach. Businesses complain they are being forced to spend too much time and money trying to comply with a slew of new regulations, many of which are required under the 2002 Sarbanes-Oxley Act. They also have taken aim at other SEC initiatives, including plans to give shareholders more power to nominate directors, register hedge-fund advisers and require independent chairmen for mutual-fund boards."
Chairman Donaldson is hardly the scourge of Wall Street, and Secretary Snow of course asserts that the Sarbanes-Oxley Act is "absolutely essential" and requires "no major modifications." One wonders whether his teeth were clenched when he said that. It will be interesting to see whether the enforcement climate changes over the next couple years, or at least until the next major scandal erupts. (ph)
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Martin Marks, the former President and COO of Cutter & Buck Inc., a Seattle sportswear company, settled charges filed by the SEC that he inflated revenue at the end of the April 2000 quarter by shipping goods to three "distributors" who in fact could not pay for the items. According to the SEC Litigation Release (No. 2154, Dec. 17 and complaint):
Cutter negotiated deals with three purported distributors under which Cutter would ship them a total of $5.7 million in products. Cutter recognized revenue for the supposed sales, which constituted over 10% of the quarter’s revenue. In reality, the distributors had no obligation or ability to pay for any of the goods unless and until Cutter’s sales force found actual customers to purchase the products. The distributors essentially acted as warehouses, rendering revenue recognition for the shipments improper under generally accepted accounting principles (known as "GAAP"). Marks signed Cutter’s annual Commission filings falsely announcing revenue of $54.6 million for the fourth quarter and $152.5 million for the fiscal year; because these amounts included $5.7 million in bogus revenue on the distributor sales, they overstated Cutter’s true quarterly and annual revenue by 12% and 4%, respectively.
Marks agreed to pay $45,777 in disgorgement and prejudgment interest.
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Fidelity Investments announced that it has disciplined 16 stock traders for accepting gifts and entertainment from brokers seeking business from the large mutual fund company. Two traders, Thomas Bruderman and Robert Lewis Burns, have left the company, apparently because of their ties with Kevin Quinn, a broker with Jefferies & Co. who has been terminated by that firm (see Dec. 16 post) for improperly accounting for entertainment expenses. Bruderman and Burns appear to have been recipients of Quinn’s largesse, according to a story in the New York Times (Dec. 17). In a press release, Fidelity stated:
Fidelity Investments has been cooperating with the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers (NASD) in an investigation of policies and procedures regarding gifts, gratuities and business entertainment. During the course of our own investigation, we uncovered instances where there were violations of the company’s policies and procedures. This has caused us deep concern because we do not tolerate wrongful behavior. We take this matter very seriously. That said, our internal review has not revealed any instance where inappropriate and unauthorized behavior on the part of any individual has resulted in any financial loss to the Fidelity mutual funds or to any shareholder by adversely affecting the quality of executions received by the Fidelity funds on their trades.
Fidelity had largely dodged the after-hours trading controversy that rocked the mutual fund industry in 2003, and this issue may be just an isolated incident. However, the number of traders who violated the firm’s own policies indicates that this may well be an issue that will touch other mutual fund companies, hedge funds, and pension plans. The issue of gifts is certainly not limited to the investment business, and serious questions have been raised regarding entertainment and travel provided to doctors by the pharmaceutical companies. No telling yet whether this will this presages a wide crackdown on the industry. (ph)
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The government is delving rather energetically into the conduct of brokers who act for their own personal benefit to the detriment of their clients and the market. A criminal complaint filed against a former managing director of SG Cowen (Dec. 13) alleges that he engaged in insider trading about companies about to undertake PIPE transactions, which are Private Placement in Public Equity sales that usually cause a companies stock price to drop because of the dilutive effect of the transaction. According to a release from the U.S. Attorney’s Office for the Eastern District of New York, GUILLAUME POLLET, has been charged in a criminal complaint with one count of conspiracy to commit securities fraud related to short sales of three companies who were using Cowen for PIPE transactions. According to the complaint:
The complaint alleges that in furtherance of the scheme, POLLET, and others, obtained material non-public information concerning PIPE transactions that were being contemplated by Sorrento Networks, Inc., Aradigm Corp., and HealthExtras, Inc. (collectively, the "Subject PIPEs"), the securities of which were publicly-traded on the NASDAQ national market system. While SG Cowen operated as the placement agent for the Subject PIPES, POLLET obtained the material, non-public information concerning the Subject PIPEs from SG Cowen employees and from representatives of the Subject PIPE issuers. The information was disclosed to POLLET pursuant to confidentiality agreements to enable him to determine whether SG Cowen would participate as an investor in the Subject PIPEs. Notwithstanding the terms of the confidentiality agreements, POLLET caused SG Cowen to short sell the publicly-traded securities of the PIPE issuers before the Subject PIPEs were publicly announced, resulting in substantial decreases in PIPE issuers’ stock prices. POLLET then covered these short positions by either purchasing discounted stock through an investment in the Subject PIPEs, or purchasing the PIPE issuers’ publicly-traded securities at the deflated post-announcement market prices.
An article in the Wall Street Journal (Dec. 15) details a regulatory action by the New York Stock Exchange against a clerk for a floor broker who engaged in "front-running," which involves trading ahead of large orders to take advantage of the current price before the execution of the large order. Front-running has been an issue of continuing concern to the NYSE and the SEC, and was the subject of a large-scale undercover operation at the futures exchanges in Chicago in the 1980s that resulted in multiple convictions of brokers.
The temptation to take the "free money" available from the use (and misuse) of information is very strong, and one suspects that the number of cases is only a small fraction of transactions involving self-dealing and insider trading. A front page article in the Wall Street Journal (Dec. 15) discusses the problem of self-dealing in brokerage firms, with the following example:
When a mutual-fund company asked brokerage firm Knight Securities to get it 600,000 shares of a fiber-optic stock, traders at Knight quickly swung into action.
A half-dozen traders — figuring the big order would push up the price of the stock — quickly began buying some for accounts that benefited their firm and themselves, according to testimony in a National Association of Securities Dealers arbitration.
The buying may have affected the price the client ultimately had to pay for the stock, JDS Uniphase, according to people familiar with the trading records. They say the traders in some cases sold their newly bought stock to the client, Oppenheimer Funds. According to testimony, it was sold to the client at a markup, a move that may have taken money out the pockets of mutual-fund shareholders.
The NASD’s regulatory arm has examined Knight’s trading from the period in question, March 2001, and other periods. It and the Securities and Exchange Commission are expected to levy a penalty against Knight soon. Knight, which has since changed management, testified that the trades weren’t improper, didn’t disadvantage the client, and followed typical industry practice. Oppenheimer declined to comment.
The incident points to one of the hardest-to-eradicate conflicts of interest on Wall Street. Securities laws generally require brokerage firms to put the client first. But it’s an open secret that they or individual traders sometimes take advantage of their role as middleman to profit, at clients’ expense, from what they know about clients’ investing intentions.
Notably, New York Attorney General Eliot Spitzer has not gotten involved in this area . . . yet. (ph)
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