The SEC has again been ordered to justify the terms of a high profile and important settlement. The query comes in its latest high profile market crisis case, SEC v. Citigroup Global Markets Inc., Case No. 11 Civ. 7387 (S.D.N.Y. Filed Oct. 19, 2011). The court directed that the parties appear on November 9, 2011 to answer questions about the proposed settlement including:

Why the Court should impose a judgment in a case which “alleges a serious securities fraud” but the defendant neither admits nor denies the wrong doing?
What was the total loss here?
How was the penalty calculated and why is it about one fifth of that assessed in the Goldman Sachs case?
How were the factors identified in the SEC’s statement on financial penalties applied here?
Since an injunction is part of the settlement, how does the SEC monitor compliance and how many contempt proceedings against large financial entities have been brought arising from consent decrees in the past decade?
Why is the penalty to be paid in large part by Citigroup and its shareholders rather than culpable offenders and if those offenders could not be identified why not?
What “control weaknesses” lead to the acts alleged in the complaint and how do the proposed remedial undertakings which are part of the settlement ensure they will not happen again?
How can a securities fraud of this nature and magnitude be the result of simple negligence?
This is not the first time of course that a Court and particularly Judge Rakoff, who is presiding over this case, has posed these or similar questions. Judge Rakoff raised similar concerns regarding the SEC’s action against Bank of America that arose from its acquisition of Merrill Lynch. After difficult hearings, an opinion which charged that the Commission’s investigation was essentially a sham and significant amendments to the terms of the proposed settlement, the Court ultimately, albeit reluctantly, deferred to the Commission and signed the settlement. Whether the Court will again require changes to the settlement or if it will ultimately defer to the Commission and execute a consent decree remains to be seen.

Once way to consider the issues raised by Judge Rakoff is to compare Citigroup to the Commission’s actions against Goldman Sachs and J.P. Morgan and Goldman Sachs. SEC v. Goldman Sachs, Case No. 322 (S.D.N.Y.); SEC v. J.P. Morgan Securities LLC, Civil Action No. 11-04206 (S.D.N.Y.). While there are differences between the three cases the key elements in each are similar:

Each is based on undisclosed conflicts;
Each centers on transactions involving a specially constructed entity built at least partially of collateralized debt obligations or CDOs tied to the housing market;
In each the investors who were sold notes tied to the constructed entity – ABACUS for Goldman, Squared CD) 2007-1 for J. P. Morgan and Class V Funding III for Citigroup – were lead to believe that the collateral was selected by the manager who had a good reputation in the industry;
None of the investors in ABACUS, Squared or Class V were told that in fact the defendant participated, and in Goldman and J.P. Morgan hedge fund clients of the bank, in that process;
None of the investors knew that those involved in the collateral selection other than the manager had adverse interests to theirs: Paulson hired Goldman to create an entity it could short; J.P. Morgan shifted millions in paper loses from its books into the entity and hedge fund Magnetar Capital was short; and Citigroup loaded the entity with collateral left over from other deals and then shorted that specific collateral.
The settlements are also based common elements. In each case there is an injunction prohibiting future violations. In each there is a monetary component. In Goldaman and Citigroup an employee of the firm involved in the matter was charged. In J. P. Morgan no firm employee was named as a defendant although an employee of the manager was named as a Respondent in a related administrative proceeding. No senior executive of any of the three firms was named as a defendant.

There are however significant differences in the settlements. Goldman was charged with fraud and consented to the entry of an injunction based on antifraud Section 17(a) of the Securities Act. Both Goldman and the Commission took rare steps: Goldman made an admission in the settlement papers of an error and not properly disclosing the facts. The Commission dropped its Exchange Act Section 10(b) claim as part of the deal before any discovery, motion or court ruling. Goldman did agreed to pay the largest civil penalty ever paid by an investment bank, $550 million. The firm did not pay disgorgement and retained the fees paid by Paulson for the construction of the entity. Remedial steps are also being implemented.

J.P. Morgan in contrast was only charged with negligence. The firm paid $18.6 million in disgorgement and a $133 million penalty, far less than Goldman. The firm also agreed to implement certain remedial steps.

Citigroup, like J.P. Morgan, was only charged with negligence. The firm did agree to disgorge its trading profits of $160 million but, like Goldman, not its fees. The firm will pay the lowest civil penalty in this group of cases at $95 million and agreed to implement certain remedial steps.

The significant difference in the terms of the settlements despite the similar nature of the cases is sure to spark a series of questions by Judge Rakoff at the November 9 hearing. Likewise, the disparity between Goldman’s fraud charge and admission contrasts sharply with the negligence based charges and settlements involving J.P. Morgan and Citigroup. The huge disparity in civil penalties is also sure to be a key subject of discussion.

In the end however the focal point may well be the overall approach of the SEC in these cases and others where the courts have raised questions about the settlements of the agecny. Each complaint paints a picture of a deliberate, intentional fraud which only matches the charges and settlement in Goldman. The mismatch between the Commission’s allegations in J.P. Morgan and Citigroup raises significant questions about the quality of evidence underlying the claims, the exercise of charging discretion and the settlement process. It is perhaps for this reason order provides that “Given the S.E.C.’s statutory mandate to ensure transparency in the financial marketplace, is there an overriding public interest in determining whether the S.E.C.’s charges are true?”

Note: I want to thank all the readers who helped elect this blog to the top twenty five business blog. This is a great honor and I really appreciate it. The list is below along with a link to vote for the best business blog here.
Tom

The SEC has again been ordered to justify the terms of a high profile and important settlement. The query comes in its latest high profile market crisis case, SEC v. Citigroup Global Markets Inc., Case No. 11 Civ. 7387 (S.D.N.Y. Filed Oct. 19, 2011). The court directed that the parties appear on November 9, 2011 to answer questions about the proposed settlement including:

Why the Court should impose a judgment in a case which “alleges a serious securities fraud” but the defendant neither admits nor denies the wrong doing?
What was the total loss here?
How was the penalty calculated and why is it about one fifth of that assessed in the Goldman Sachs case?
How were the factors identified in the SEC’s statement on financial penalties applied here?
Since an injunction is part of the settlement, how does the SEC monitor compliance and how many contempt proceedings against large financial entities have been brought arising from consent decrees in the past decade?
Why is the penalty to be paid in large part by Citigroup and its shareholders rather than culpable offenders and if those offenders could not be identified why not?
What “control weaknesses” lead to the acts alleged in the complaint and how do the proposed remedial undertakings which are part of the settlement ensure they will not happen again?
How can a securities fraud of this nature and magnitude be the result of simple negligence?
This is not the first time of course that a Court and particularly Judge Rakoff, who is presiding over this case, has posed these or similar questions. Judge Rakoff raised similar concerns regarding the SEC’s action against Bank of America that arose from its acquisition of Merrill Lynch. After difficult hearings, an opinion which charged that the Commission’s investigation was essentially a sham and significant amendments to the terms of the proposed settlement, the Court ultimately, albeit reluctantly, deferred to the Commission and signed the settlement. Whether the Court will again require changes to the settlement or if it will ultimately defer to the Commission and execute a consent decree remains to be seen.

Once way to consider the issues raised by Judge Rakoff is to compare Citigroup to the Commission’s actions against Goldman Sachs and J.P. Morgan and Goldman Sachs. SEC v. Goldman Sachs, Case No. 322 (S.D.N.Y.); SEC v. J.P. Morgan Securities LLC, Civil Action No. 11-04206 (S.D.N.Y.). While there are differences between the three cases the key elements in each are similar:

Each is based on undisclosed conflicts;
Each centers on transactions involving a specially constructed entity built at least partially of collateralized debt obligations or CDOs tied to the housing market;
In each the investors who were sold notes tied to the constructed entity – ABACUS for Goldman, Squared CD) 2007-1 for J. P. Morgan and Class V Funding III for Citigroup – were lead to believe that the collateral was selected by the manager who had a good reputation in the industry;
None of the investors in ABACUS, Squared or Class V were told that in fact the defendant participated, and in Goldman and J.P. Morgan hedge fund clients of the bank, in that process;
None of the investors knew that those involved in the collateral selection other than the manager had adverse interests to theirs: Paulson hired Goldman to create an entity it could short; J.P. Morgan shifted millions in paper loses from its books into the entity and hedge fund Magnetar Capital was short; and Citigroup loaded the entity with collateral left over from other deals and then shorted that specific collateral.
The settlements are also based common elements. In each case there is an injunction prohibiting future violations. In each there is a monetary component. In Goldaman and Citigroup an employee of the firm involved in the matter was charged. In J. P. Morgan no firm employee was named as a defendant although an employee of the manager was named as a Respondent in a related administrative proceeding. No senior executive of any of the three firms was named as a defendant.

There are however significant differences in the settlements. Goldman was charged with fraud and consented to the entry of an injunction based on antifraud Section 17(a) of the Securities Act. Both Goldman and the Commission took rare steps: Goldman made an admission in the settlement papers of an error and not properly disclosing the facts. The Commission dropped its Exchange Act Section 10(b) claim as part of the deal before any discovery, motion or court ruling. Goldman did agreed to pay the largest civil penalty ever paid by an investment bank, $550 million. The firm did not pay disgorgement and retained the fees paid by Paulson for the construction of the entity. Remedial steps are also being implemented.

J.P. Morgan in contrast was only charged with negligence. The firm paid $18.6 million in disgorgement and a $133 million penalty, far less than Goldman. The firm also agreed to implement certain remedial steps.

Citigroup, like J.P. Morgan, was only charged with negligence. The firm did agree to disgorge its trading profits of $160 million but, like Goldman, not its fees. The firm will pay the lowest civil penalty in this group of cases at $95 million and agreed to implement certain remedial steps.

The significant difference in the terms of the settlements despite the similar nature of the cases is sure to spark a series of questions by Judge Rakoff at the November 9 hearing. Likewise, the disparity between Goldman’s fraud charge and admission contrasts sharply with the negligence based charges and settlements involving J.P. Morgan and Citigroup. The huge disparity in civil penalties is also sure to be a key subject of discussion.

In the end however the focal point may well be the overall approach of the SEC in these cases and others where the courts have raised questions about the settlements of the agecny. Each complaint paints a picture of a deliberate, intentional fraud which only matches the charges and settlement in Goldman. The mismatch between the Commission’s allegations in J.P. Morgan and Citigroup raises significant questions about the quality of evidence underlying the claims, the exercise of charging discretion and the settlement process. It is perhaps for this reason order provides that “Given the S.E.C.’s statutory mandate to ensure transparency in the financial marketplace, is there an overriding public interest in determining whether the S.E.C.’s charges are true?”

Note: I want to thank all the readers who helped elect this blog to the top twenty five business blog. This is a great honor and I really appreciate it. The list is below along with a link to vote for the best business blog here.
Tom

The D.C. Circuit rejected challenges to a disgorgement order which used a zero basis for stock rather than a market quote for the share price and which imposed joint and several liability for the full amount on a defendant who claimed to have transferred a portion of the funds to others. SEC v. Whittemore, No. 10-5321 (D.C. Cir. Oct. 28, 2011).

The underlying enforcement action was brought against Peter Cahill and another group identified as the Whittemore defendants. The complaint centered on an alleged pump and dump scheme involving a thinly traded penny stock quoted in the Pink Sheets. Mr. Cahill and other defendants consented to the entry of permanent injunctions but reserved the resolution of questions regarding disgorgement to the court. The district court entered an order which concluded that Mr. Cahill was liable for disgorgement in an amount based on valuing the stock from the scheme at zero, effectively finding that the entire sale price was the proper measure of the remedy. The court also concluded that Mr. Cahill could be held responsible for the entire amount of the disgorgement despite his claim that he had transferred a portion of the proceeds to others and that he is jointly and severally liable with the other defendants.

The Circuit Court affirmed. First, the Court concluded that using a zero basis for the value of the stock was appropriate. Separating legal from the illegal profits exactly may at times be virtually impossible the court held. Thus the SEC is only required to make a reasonable approximation of profits causally connected to the violation. Here the agency argued that the stock should have a zero basis while the Appellant claimed that the proper value is $0.32 per share. The value offered by Mr. Cahill however was from one market quote in an otherwise illiquid market. In fact the evidence demonstrates that the stock was rarely quoted. In addition, there is no evidence that Mr. Cahill could have sold the block of stock he obtained in the scheme. Under these circumstances it was appropriate for the SEC to use a zero basis to meet its initial burden. At that point the burden shifted to Mr. Cahill to demonstrate the value of the shares prior to the fraud. Since he failed to offer any evidence on this point, the district court’s calculation was appropriate.

Second, the district court correctly concluded that Mr. Cahill was liable for the entire amount of the disgorgement. A disgorgement order, the court held, pertains to “’a sum equal to the amount wrongfully obtained, rather than a requirement to replevy a specific asset’ and ‘establishes a personal liability, which the defendant must satisfy regardless [of] whether he retains the selfsame proceeds of his wrongdoing,’” quoting SEC v. Banner Fund International, 211 F. 3d 602 (D.C. Cir. 2000). Thus a person who controls the distribution of funds such as Mr. Cahill is responsible for those he retains and those he distributes.

Finally, the Court found it appropriate under the circumstances here to hold Mr. Cahill jointly and severally liable with the other defendants. Mr. Cahill argued that to impose such liability the court had to find that two or more individuals or entities collaborate and have a close relationship in engaging in the illegal conduct. While these tests are appropriate the Court noted, they should be stated in the disjunctive. Accordingly, once the Commission established the close collaboration between Mr. Cahill and the Whittemore defendants in the scheme, the burned shifted to Appellant to establish that apportionment was appropriate. Since Mr. Cahill wrongfully obtained the proceeds from the sale of the stock and controlled the distribution, if any, it was appropriate for the district court to impose joint and several liability.

Program: The ABA National Institute On Securities Fraud is being held on November 3-4, 2011 in New Orleans. This is one of the premier securities law programs each year. For more information please click here.

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Three recent auction rate securities cases provide an interesting glimpse into the events which lead to the market crisis and the difficulties of litigating claims relating to it. Each centers in 2007 and 2008 as the market for these securities began to show cracks and eventually crashed. Each is concerned with what investors were told about the market, its risks and the viability of the market that Wall Street created to turn long term investments into short term apparently liquid ones.

The market: Long term instruments become short term, liquid investments

Auction rate securities consisted primarily of long term bonds issued by municipalities and student loan entities and preferred stock issued by close end funds. They had variable interest rates or dividend yields which were periodically reset through auctions. Most of the bonds had maturity terms which ran for as long as 30 years. The student loans were backed by a government guarantee. The securities offered issuers an alternative variable rate financing vehicle and investors a highly liquid investment through the auctions. The yield to the investor and the cost of financing for the issuer was determined by the interest or clearing rate established through the periodic auctions. The clearing rate was the lowest bid sufficient to cover all of the securities in the auction.

The issuer typically selected a broker dealer to serve as the underwriter of the securities. Other brokers were designated as co-brokers. The lead broker typically placed bids in the auction for their own account but not the co-brokers. Investors could only submit bids through the selected broker dealers. The issuer paid an annual fee for the broker dealer to manage the auction process.

Those auctions began in the mid-1980s and prior to 2007 never failed. In 2007 they began to fail. By mid-February 2008 there were wide spread failures. Underwriters withdrew from the market. In the end customers were left holding billions of dollars in illiquid auction rate securities. While the underlying bonds would mature in a period of years, the investors had purchased the securities for their favorable rate of return and liquidity which ended with the collapse of the auctions.

Case 1: Raymond James

Broker dealer Raymond James settled claims related to ARS with the SEC. In the Matter of Raymond James & Associates, Inc., Adm. Proc. File No. 3-14445 (June 29, 2011). According to the findings of fact in the Order for Proceedings, the firm acted as an underwriter of single issuer municipal auction rate securities known as MARS. It managed the auction and submitted bids to prevent them from failing, to maintain an orderly market, or to set a clearing rate. The firm also acted as agents on a solicited and unsolicited basis for their customers by submitting order to purchase and sell other ARS products. The firm did not submit bids in these auctions.

Prior to the middle of February 2008 firm representatives sold ARS to customers. In some instances those representatives misrepresented the risks of the securities calling them “the same as cash” or “highly liquid” or using similar descriptions. Post sale trade confirmations sent to these customers disclosed the risks of the auctions noting that they could fail and that the firm was not obligated to ensure their success.

The disclosures were inadequate according to the SEC: “Respondents did not provide customers with adequate and complete disclosures regarding the complexity of the auction process including failing to adequately disclose to customers that Respondent . . .managed the auctions of the MARS and . . . routinely bid in MARS auctions to prevent a failed auction, maintain an orderly market, or set a particular clearing rate.” This violated Section 17(a)(2) of the Securities Act according to the Commission. The firm settled these charges by agreeing to implement certain undertakings which include the repurchase of certain ARS and to the entry of a cease and desist order.

Case 2: Merrill Lynch & Co.

This is a class action on behalf of all ASR investors who purchased securities for which Merrill Lynch served as the sole auction dealer, lead auction dealer, co-lead auction dealer or joint lead auction dealer between March 25, 2003 and February 13, 2008. The complaint alleges market manipulation in violation of Exchange Act Section 10(b) and Rule 10(b)-5. Colin Wilson v. Merrill Lynch & Co. No 10-1528 (2nd Cir.)

The allegations here are similar to those in Raymond James but more explicit. According to the complaint Merrill engaged in a scheme to manipulate the market by creating the appearance that the securities were traded at arm’s length when in fact the available supply well exceeded the demand for the securities. Merrill had a policy of routinely placing support bids in every auction through which it acquired ARS for its own account to mask a lack of demand and prevent auction failure. The complaint also claims that Merrill executives knew that the ARS market was unsustainable by the fall of 2007 and that it was only through the conduct of Merrill and other auction dealers in artificially supporting the auction and acting as buyers of last resort, that the market for Merrill ARS was able to exist during the class period. In essence the market was an illusion according to the complaint.

The firm provided investors with written warnings regarding the risks of the ARS market. Those materials discussed the possibility of auction failure. They also noted that Merrill may bid in the auctions, that it may routinely place bids and that those bids are likely to affect the clearing rate. The warnings also state that Merrill might place bids to keep the auctions from failing.

The district court dismissed the complaint for failing to state a claim upon which relief can be granted. That court concluded in part that the warnings furnished to investors negated a claim of fraud. Plaintiffs appealed. The case has been briefed and argued before the Second Circuit.

Recently the Court requested the SEC to provide its views on certain issues including the adequacy of the warnings. The Commission told the Court of Appeals that Merrill’s warnings are inadequate. In some instances disclosure can prevent a “false signal from being sent to the market, thereby undermining a claim of manipulation . . . “ the SEC stated in a letter to the Court. The letter goes on to note that courts have “long recognized .. . that disclosure of a potential risk is insufficient when, in fact, the risk is much greater and it a known certainty. . . Here, by stating that, in the absence of its bidding, there ‘may not always’ be enough bidders to prevent auction failure, and that therefore auction failure was ‘possible’ if Merrill failed to bid . . [the]disclosures imply that some auctions have sufficient independent demand to prevent failure.” In view of the allegations in the complaint that the firm knew there was no such demand, Merrill concealed this material fact from investors. The warnings were thus inadequate.

A decision from the court should be issued later this year.

Case 3: Morgan Keegan

The SEC litigated an enforcement action against the firm centered on claims similar to those in the Raymond James and Merrill Lynch cases. SEC v. Morgan Keegan & Co., Inc., Civil Action No. 1:09-cv-1965 (N.D. Ga. Opinion and Order dated June 28, 2011). AS in Merrill Lynch, the court here found the warnings adequate. Morgan Keegan prevailed on a motion for summary judgment in this action.

The Commission claimed in its complaint that as the auction rate securities market was collapsing the firm continued to sell the securities to customers based on misrepresentations. Between 2002 and February 27, 2008 Morgan Keegan placed bids for its own account in a majority of the auctions for which the firm served as the lead broker deale,r according to the complaint. A majority of those auctions would have failed but for those bids. After an auction failed on February 12, 2008 which was underwritten by others “Morgan Keegan declined to place bids in most of the auctions for which it served as lead broker dealer and in which the bids of other market participants were insufficient to satisfy all the sell orders.” As a result Morgan Keegan customers were left holding about $1.2 billion of illiquid ARS.

At summary judgment the issues focused not on the adequacy of the disclosures or on proof of the SEC’s claims that essentially the ARS market in which Morgan Keegan customers traded was artificial, but on the Commission’s evidence regarding misrepresentations made to four investors and the disclosures available. The four investors were told that ARS are “as good as cash,” or the product is “cash equivalents to CDs and money market” or similar statements. The firm however furnished or made available five written disclosures which detailed the risks of ARS including the prospect of market failure. Those disclosures also told investors that the firm submited bids in the auctions. The warnings did not state that most of the auctions where the firm was the lead would have failed but for the participation of Morgan Keegan.

On this record the court granted summary judgment in favor of Morgan Keegan. The SEC claimed that the oral misrepresentations were sufficient to support its claims under Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c). In making this argument the Commission argued that the firm did not do enough to ensure that customers read the written materials or to adequately distribute them. The court rejected this argument noting that Morgan Keegan does not have a duty to give each customer a copy of the disclosures and ensure that they are read as contended by the SEC. In any event the confirmations notified the customer that the transaction could be rescinded which is sufficient the court found.

There is no reference in the court’s opinion to the claims made in the SEC’s complaint regarding the liquidity of the market. There is no indication that the Commission offered evidence to support the claims. Likewise, there is no reference to the Commission’s claim that the disclosures of the firm were inadequate for failing to tell customers that without the participation of Morgan Keegan the auctions would likely fail. Again there is no reference to the submission of any evidence on this point by the SEC.

The Supreme Court continues to grant certiorari in securities cases. This week the High Court agreed to hear a case involving the application of the statute of limitations in Exchange Act Section 16(b) case.

The Commission had mixed results in court this week, losing an action centered on the sale of auction rate securities while prevailing in a financial fraud case in the court of appeals. New statistics regarding the enforcement program suggest that while it is filing cases at about the same rate as last year the mix may be changing with the number of FCPA cases increasing while insider trading cases are decreasing.

More blue collar tactics may be on the way. The Commission filed four stock manipulation cases based on a sting operation this week. The agency also settled an auction rate securities case and filed a financial fraud action.

In criminal cases the former chairman of Taylor Bean was given a long prison term. Another of the Galleon related defendants was also sentenced to prison.

The Commission

Whistleblowers: The Commission delegated authority to the Director of the Division of Enforcement to disclose information that could reasonably be expected to reveal he identity of a whistleblower to those authorized to receive such disclosures under Dodd-Frank without a loss of confidentiality. Release No. 34-64778.

Security-based swaps: The SEC issued proposed rules that would impose certain business conduct standards on security-based swap dealers and major security-based swap participants when the parties engage in security-based swap transactions (here).

Congressional inquiry: Representative Edward Markey, in a letter to SEC Chairman Mary Schapiro dated June 27, 2011, inquired about a rule change by the SEC in 2008 that essentially liberalized how natural gas companies reported reserves. The letter, referencing a New York Times article of June 27, 2011, notes that in 2008 natural gas company stocks were “declining due to the financial meltdown, recession fears, and falling gas prices, but . .. they began to rebound after a rule change by the Commission allowed the[sic] much greater latitude on how they reported their natural gas reserves.” The letter goes on to inquire about the nature and impact of the rule change.

SEC settlement trends: SEC enforcement statistics for the first half of this fiscal year may reflect changing trends. The number of cases the Commission settled during the period puts it on track to slightly exceed the number from last year, according to a report released by NERA Economic Consulting (here). To date the SEC has settled with 344 defendants. If this trend continues 688 cases will be settled this year, up slightly compared to the 681 for the prior year. Perhaps the most significant statistics are those regarding FCPA and insider trading cases. In the first half of the year the SEC settled 26 FCPA cases. If this trend continues it will be the largest number of post SOX FCPA settlements. The median settlement value also increased, up 40% relative to the post-SOX average. Settlements in insider trading cases however declined significantly. In the first half of the year the Commission settled 25 insider trading cases which projects to 50 for the year. This would be the lowest post-SOX year if the trend continues. In contrast the median settlement value for cases with individuals is $203,000. If this trend continues it would be the largest since 2002.

Supreme Court

The Court granted certiorari in Credit Suisse Securities LLC v. Simmonds, No. 1261. The issue the Court agreed to hear is whether the two year statute of limitations which applies to Section 16(b) claims under the Exchange Act can be tolled and, if so, the impact on that tolling if actual notice of the facts giving rise to the claim is received.

SEC enforcement – litigated cases

Auction rate securities: SEC v. Morgan Keegan & Co., Inc., Civil Action No. 1:09-cv-1965 (N.D. Ga. Opinion and Order dated June 28, 2011). Morgan Keegan prevailed on a motion for summary judgment in this action. The Commission brought the case claiming that as the auction rate securities market was collapsing the firm continued to sell the securities based on misrepresentations. Specifically, the SEC presented evidence from four investors that statements were made to them such as ARS are “as good as cash,” or the product is “cash equivalents to CDs and money market” or similar statements. In contrast Morgan Keegan pointed to five written disclosures either furnished or made available to investors which detailed the risks of ARS including the prospect of market failure.

On this record the court granted summary judgment in favor of Morgan Keegan. First, the SEC claimed that the oral misrepresentations were sufficient to support its claims under Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c). In making this argument the Commission claimed the firm did not do enough to ensure that customers read the written materials or to adequately distribute them. The court rejected this argument noting that Morgan Keegan does not have a duty to give each customer a copy of the disclosures and ensure that they are read as contended by the SEC. In any event the confirmations notified the customer that the transaction could be rescinded which is sufficient.

Second, statements from four investors are insufficient to conclude that the entire firm is liable in an enforcement action. While oral misrepresentations that conflict with written disclosures may, in certain circumstances, be a basis for liability but here the evidence is simply insufficient the court concluded. This is particularly true in view of the multiple disclosure documents available to customers.

Insider trading: In the Matter of Rajat K. Gupta, Adm. Proc. File No. 3-14279 is the proceeding against former Goldman Sachs director Rajat Gupta. The action had been scheduled for trial on July 18, 2011. The court granted a motion of the parties requesting a stay of the proceeding for six months. The judge did not set a new trial date in the order.

Unprofessional conduct: In the Matter of Dohan + Company CPA, Adm. Proc. File No. 3-13997 is a proceeding based on Rule 102(e) of the Commission’s Rules of Practice which names, among others, Erez Bahar, CA, a licensed Chartered Accountant in Canada with the firm of Davidson & company LLP. He served as the manager on the audits of International Commercial Television, Inc. That company is a defendant in a settled Commission enforcement action which alleged that in 2007 and the first two quarters of 2008 the revenue of the company was improperly inflated because it booked the proceeds from sales in violation of GAAP. In this proceeding Mr. Bahar was charged with improper professional conduct for failing to adequately supervise the audits. After a hearing, ALJ Carol Fox Foelak issued an Initial Decision which concluded that the Respondent had violated Rule 102(e). Specifically, the decision concludes that Mr. Bahar failed to properly plan the engagement, to consider the possibility of fraud, to conduct a walk through, to obtain certain evidential matter regarding the sales transactions and ignored repeated red flags in reviewing the work papers. Accordingly he is denied the privilege of appearing and practicing before the Commission for a period of two years.

SEC enforcement – filings and settlements

Manipulation: SEC v. Gibson, Civil Action No. 0:11-cv-61458 (S.D.Fla. Filed June 30, 2011); SEC v. Newton, Civil Action No. 0:11-cv-61455 (S.D.Fla. Filed June 30, 2011); SEC v. Klein, Civil Action No. 0:11-cv-61457 (S.D.Fla. Filed June 30, 2011); SEC v. Schroepfer, Civil Action No. 0:11-cv-61454 (S.D.Fla. Filed June 30, 2011) are four actions which charge three CEOs and their companies along with two penny stock promoters with manipulating various stocks. One scheme centered on paying bribes and kickbacks to a corrupt pension fund manager while in another payments were made to a stock broker. The payments were made to have the stock traded in a manner which is manipulative. In fact the payments were made to under cover FBI agents. The complaint allege violations of Securities Act Sections 17(a) and Exchange Act Section 10(b). The cases are in litigation.

Inadequate controls: In the Matter of Labarge, Inc., Adm. Proc. File No. 3-14447 (June 30, 2011) is a proceeding which names as a Respondent a manufacturer of electronic components for use in military, aviation and other industrial equipment. According to the Order, in 2006 and 2007 the company had inadequate internal controls regarding its use of estimates of completion costs for certain long term production contracts. The estimates were used to determine cost of sales and net earnings. As a result of the inadequate controls the company had inaccurate books and records in violation of Exchange Act Sections 13(a), 13(b)(2)(B) and 13(b)(2)(B). The company resolved the matter by consenting to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay a civil penalty of $200,000.

ARS: In the Matter of Raymond James & Associates, Inc., Adm. Proc. File No. 3-14445 (June 29, 2011). The Order for Proceedings alleges that the firm failed to properly disclose the risks associated with auction rate securities to some of its customers. Although following the sale customers were warned about the consequences of auction failure, some financial advisers told investors the securities were safe and liquid. The firm resolved the matter by agreeing to implement certain procedures including a program under which specified ARS would be repurchased. It also agreed to the entry of a cease and desist order based on Securities Act Section 17(a)(2). A penalty was not imposed at this time but the Division has the right to petition the Commission to reopen this matter if Respondent fails to fully implement its undertakings.

Rule 105, Reg M: In the Matter of Level Global Investors, L.P., Adm. Proc. File No. 3-14443 (June 28, 2011) is an action against the firm which is an investment adviser for two hedge funds. The action alleges two violations of Rule 105 of Regulation M. The Rule prohibits short selling of equity securities during a restricted period prior to a public offering and then repurchasing those securities in the offering. Respondent violated this Rule in April 2009 in connection with short sales in a public offering by Goldman Sachs. As a result it made profits of $298,415. In May 2009 the firm also violated the Rule with respect to transactions in the shares of Regions Financial Corporation from which it made a profit of $2,381,100. To resolve the matter the firm consented to the entry of a cease and desist order based on Rule 105 of Regulation M. The firm also agreed to pay disgorgement of $2,679,515 along with prejudgment interest. In resolving the case the Commission took into consideration the remedial efforts of the firm and its cooperation.

Rule 105, Reg M: In the Matter of Brookside Capital, LLC, Adm. Proc. File No. 3226 (June 28, 2011) is an action against a registered investment adviser for a violation of the Rule in connection with the offering of shares in Lincoln National Corporation Company. As a result of the violation the firm made profits of $1,658,660. The matter was resolved with Respondent consenting to the entry of a cease and desist order based on Rule 105 Reg M. It also agreed to pay disgorgement of $1,658,660 along with prejudgment interest and a civil penalty of $375,000. The settlement takes into account the remedial efforts of the firm and its cooperation.

Financial fraud: SEC v. Jensen, Civil Action No. CV 11-05316 (C.D. Cal. Filed June 27, 2011) names as defendants the founder of Basin Water, Inc. and its Chairman and CEO, Peter Jensen and the Chief Financial officer Thomas Tekulve. In the first quarter of 2006 the two defendants began fraudulently inflating the revenue of the company by booking contingent sales, recording sales in the wrong quarter and similar techniques. As a result Basin’s revenues were overstated by 13% in 2006 and 74% in 2007 according to the complaint. Just prior to the announcement of a restatement in February 2009, Mr. Jensen sold about 1.6 million shares of stock yielding over $9 million in insider trading profits while donating another 290,000 shares to charity to obtain a tax deduction. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(5) and 20(a). The complaint also alleges that the defendants failed to comply with Section 304(a) of SOX. The case is in litigation.

Sale of unregistered shares: SEC v. Verdiramo, Civil Action No. 10-CIV-1888 (S.D.N.Y.) is an action alleging the sale of unregistered securities and insider trading. The complaint names Richard Verdiramo, Vincent Verdiramo, Edward Meyer and Victoria Chen as defendants. This week Mr. Meyer settled with the SEC. As to him the compliant claimed that after acquiring shares of RECOV Energy Corporation when he and Ms. Chen entered into a contract to purchase a controlling interest in the company he sold them. At the time the shares were unregistered. The insider trading claim is based on allegations that while working as a consultant for a private company that entered into merger discussions with RECOV, he traded in the shares of the company while the discussions were non-public. To settle the case Mr. Meyer consented to the entry of a permanent injunction prohibiting future violations of the antifraud and registration provisions. In addition, he agreed to pay disgorgement of $62,050 and a civil penalty of $62,000. Under the order he will also be barred from participating in any penny stock offering or serving as an officer or director of a public company.

Advanced fee scheme: SEC v. Elite Resources, Civil Action No. 1:10-cv-3522 (N.D. Ga.) is an action against the company, various related entities and its principals Diane Gruber and Kadar Josey. The complaint alleged that the defendants raised about $2.85 million from at least nine investors. Investors were told that they could draw on bank guarantees worth millions of dollars without having to repay the funds. Investor funds were to be held in escrow until the bank guarantees were issued. According to the complaint there were no guarantees and the funds were not held in escrow. The defendants resolved the case by consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The injunctions against the individual defendants also preclude future violations of Exchange Act Section 15(a). The defendants were ordered to pay disgorgement, prejudgment interest and a civil penalty in amounts to be determined at a later date.

Criminal cases

Insider trading: U.S. v. Goffer, 10-cr-0056 (S.D.N.Y.) is one of the Galleon insider trading cases which names as defendants Zvi Goffer and Arthur Cutilo, among others. Mr. Cutillo was an associate at the law firm of Ropes & Gray in New York. In 2007 and 2008 he, along with another firm attorney, furnished inside information to Mr. Goffer who then tipped others. The information concerned the merger deals that the firm was working on for three clients. Previously, Mr. Cutilo pleaded guilty to one count of conspiracy and one count of securities fraud. This week he was sentenced to 30 months in prison, ordered forfeit $378,608 and, following his prison term, two years of supervised release.

Fraud: U.S. v. Farkas, 10-cr-00200 (E.D.Va.) is a fraud action against the former Chairman of Taylor Bean, Lee Farkas. Following a jury trial Mr. Farkas was found guilty on all fourteen counts in the indictment which included conspiracy, wire and securities fraud and bank fraud. The charges centered on his role in the collapse of Taylor Bean, at one time was the largest privately held mortgage company in the U.S., and his role in the demise of Colonial Bank, at one time one of the 25 largest banks in the country. Mr. Farkas was sentenced to 30 years in prison and order to forfeit about $38.5 million.

FINRA

Compliance: FINRA Chairman and CEO Richard Ketchum Addressed the IRI Government, Legal and Regulatory Conference on June 28, 2011. In his remarks Mr. Ketchum discussed changes to the examination program, the variable annuity data pilot program, issues relating to the possible move to a fiduciary standard and future guidance on issues relating to social media (here).

Court of appeals

Financial fraud: SEC v. Todd, No. 07-56098 (9^th Cir. June 23, 2011). The Circuit Court reversed the ruling of the district court setting aside a jury verdict which found that former Gateway Computers CFO John Todd and controller Robert Manza violated the antifraud provisions with respect to certain financial transactions and made misrepresentations to the auditors. The Court also overturned a grant of summary judgment in favor of the former CEO of the company, Jeffrey Weitzen on Section 10(b) and 20(a) claims.

The complaint centers on claims that in 2000 the three defendants participated in a “gap filling” scheme to bridge what was potentially over a $100 million shortfall in revenue for one quarter to make street expectations. It also claims that Mr. Weitzen made false and misleading statements by stating in an earnings call and release that Gateway had an “accelerated earnings” trend. In fact the company met expectations by booking over $100 million as revenue from three transactions: (1) A sale-lease back of fixed assets which the disclosed accounting policies stated could not be booked as revenue; (2) An incomplete sale of computers to VenServ which all agreed should not have been booked; and (3) Revenue from a change in contact terms with AOL which accelerated the payment of certain fees.

The court reversed the district court’s post trial ruling overturning the jury verdict. The court concluded that there was sufficient evidence to support the jury verdict. It also reversed the grant of summary judgment entered in favor of the former CEO, finding that there were disputes of fact which precluded summary judgment. The jury verdicts were thus reinstated as to two executives while the case as to the former CEO was remanded for further proceedings.

Last week Morgan Keegan & Co. settled an administrative proceeding centered on the market crisis which claimed that the NAV calculations for certain investment funds made as the markets catapulted downward were false. In contrast, this week the firm prevailed on summary judgment in another market crisis cases with the SEC. This action centered on claims that investors were not given adequate warnings about the risks of auction rate securities as the market unraveled. SEC v. Morgan Keegan & Co., Inc., Civil Action No. 1:09-cv-1965 (N.D. Ga. Opinion and Order dated June 28, 2011).

In Morgan Keegan the Commission brought an action claiming that as the auction rate securities market collapsed the firm continued selling ARS products. Between January 2 and March 19, 2008, the firm sold approximately $647 million of ARS to about 1,145 customers. In making these sales, according to the SEC, the firm misrepresented the risks. The Commission presented testimony from four customers who stated that representatives at the firm told them: ARS are “as good as cash;” ARS are “as good as money;” or the product is “cash equivalents to CDs and money markets;” or they are “just as good as” an investment in a CD insured by the “FDIC;” they are ‘completely liquid except for “a possible 35-day hold;” and ARS presented “zero concerns [and]zero risks;” or they involved “absolutely no risk.”

To bolster its case the SEC pointed to a February 9, 2008 e-mail from the head of Morgan Keegan’s retail ARS desk expressing his concerns about the market. In part it states that ARS auction failures have the “potential to kill consumer confidence and could cause a panic to sell based on fear of losing liquidity. . . [if this happens I fear] a lot of brokers have misrepresented [the] product . . . I know a lot of brokers do not understand the product fully and do not know what a failed auction means. . . “ By the time of this e-mail auctions which rarely failed before 2007, began to fail at increasing rates. By February 12, 2008 there were approximately 100 failures in which Morgan Keegan played some participating role. By that time most ARS underwriters other than Morgan Keegan stopped supporting auction success by placing bids for their own accounts. Subsequently, more auctions failed.

Morgan Keegan had five written disclosures either furnished or made available to investors. First, there was a twenty-four page description of its ARS practices and procedure referred to as the ARS Manual. The Manual tracked the best practices set forth by the Securities Industry Financial Markets Association. It warned customers about the risks including the prospect of auction failure.

Second, the firm issued an annual newsletter to customers in January 2007 and January 2008. It referred investors in ARS to the web site and noted that a written description of the practices and procedures regarding the securities was available. Third, investors received a trade confirmation after each transaction gave the customer ten days to rescind the transaction. Finally, an ARS Brochure reiterated the risks.

On this record the court granted summary judgment in favor of Morgan Keegan. First the SEC claimed that the oral misrepresentations were sufficient to support its claims under Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c). In making this argument the Commission claimed the firm did not do enough to ensure that customers read the written materials or to adequately distribute them.

The court rejected this argument noting that Morgan Keegan does not have a duty to give each customer a copy of the disclosures and ensure that they are read as contended by the SEC. The firm had available multiple documents with more than adequate warnings. In any event the confirmations notified the customer that the transaction could be rescinded. This “reverse-sale” provision has been found sufficient by the Second Circuit and ensures that unauthorized trading disputes do not devolve into “swearing contests” between the broker and customer, citing Modern Settings, Inc. v. Prudential-Bache, Inc., 936 F. 2d 640 (2^nd Cir. 1991).

Second, statements from four investors are insufficient to conclude that the entire firm is liable in an enforcement action. The court concluded that “oral misrepresentations that conflict with written disclosures may, in certain circumstances, form the basis of a Rule 10b-5 action.” This depends on a number of factors including the sophistication of the investor and the nature of the oral representation to determine if reliance on it was justified.

Here however the SEC argues that misrepresentations to four investors by four brokers “is sufficient to create an issue of fact whether all Morgan Keegan brokers made misrepresentations to their ARS customers.” (emphasis original). This proof is simply insufficient the court concluded. The e-mail from the head of the ARS desk is no help here since it expresses only on the fear of the writer. While individual investors may pursue individual remedies, such evidence is insufficient to support an SEC enforcement action against the firm.

Finally, the court agreed with Morgan Keegan that its failure to give investors more strident warnings sooner than it did does not constitute securities fraud. The failure to predict the market is not fraud the court held. Accordingly, summary judgment was granted in favor of Morgan Keegan.

A financial fraud complaint centered on claims that two senior executives of Basin Water, Inc. falsely inflated company revenue beginning before it was publically traded and continuing through the end of 2007 was filed by the SEC. Named as defendants are the founder of the company and its Chairman and CEO, Peter Jensen and the Chief Financial officer Thomas Tekulve. SEC v. Jensen, Civil Action No. CV 11-05316 (C.D. Cal. Filed June 27, 2011).

Basin Water, Inc. designs, manufactures and services groundwater treatment systems. Mr. Jensen founded the company in 1999. It became a public company in May 2006 when its stock was registered for trading with the Commission. In the first quarter of 2006 the two defendants began fraudulently inflating the revenue of the company. Specifically, the two officers caused the company to book revenue contrary to the requirements of GAAP. In this regard the company recorded as revenue:

• Sales that were contingent on the customer’s acceptance of the treatment system;

• The resale of a system to the ultimate customer;

• Sales that did not occur in the quarter;

• Sales where the company never delivered the treatment system;

• Sales where collectability was not reasonably assured and for which the company did not receive payment; and

• Sales to a special purpose entity the defendants created and which involved round trip sham transactions.

As a result Basin’s revenues were overstated by 13% in 2006 and 74% in 2007 according to the complaint.

On August 11, 2008 the company announced it was restating its financial results. The restatement was issued in February 2009.

Prior to the announcement Mr. Jensen sold 1,660,943 shares of company stock realizing profits of $9,173,075. He also donated 290,000 shares of stock for which he took tax deductions of $763,345. These transactions took place while he was in possession of material non-public information about the financial condition of the company.

The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(5) and 20(a). The complaint also alleges that the defendants failed to comply with Section 304(a) of SOX. The case is in litigation.

SEC enforcement statistics for the first half of this fiscal year may reflect changing trends. The number of cases the Commission settled during the period puts it on track to slightly exceed the number from last year, according to a report released by NERA Economic Consulting (here). To date the SEC has settled with 344 defendants. If this trend continues 688 cases will be settled this year, up slightly compared to the 681 for the prior year.

While a the Commission obtained a number of large monetary judgments in the first six months, only one would make the list of the ten largest post SOX judgments. Those range from the $800 million paid by AIG in 2006 to the $300 million paid by Time Warner in 2005. Heading the list for the first six months of the year is a $310 million judgment against Messrs. Brost and Sorenson in a Ponzi scheme case. That judgment was entered by default however. The second largest is from the misappropriation case against U.S. Pension Trust Company the Commission won after trial.

Several of the other largest judgments obtained last year stem cases that parallel those of DOJ and, in some instances, other regulators. Number 3 on the list, the judgment against Jacob Alexander ($54 million) from an option backdating case, is tied to a DOJ forfeiture action while the one against Joseph Nacchio ($45 million) in an insider trading case, which is number 5, followed his criminal conviction. Two of the others in the top ten, numbers 5 and 10 respectively, come from the FCPA cases against Alcatel-Lucent ($45 million) and Pride International ($24 million), both of which parallel DOJ actions. Likewise, number 7, Banc of America Securities ($36 million) in a bid rigging case, stems from an overall settlement with DOJ and state regulators.

The composition of the Commission’s cases and the related financial judgments appear to be shifting based on the first half statistics. During that period the number of settlements with business organizations increased 43% to 114. If this pace continues the agency would settle 228 cases with corporations. In 2010 the SEC settled with 160 companies. In contrast settlements with individuals decreased by 12% in the first half of the year to 230 for an annual rate of 460. That compares with 521 for fiscal 2010. This may reflect the fact that individuals are more likely to proceed to trial.

The financial component in these cases suggests a different trend. The amount of the average corporate settlement declined to $6.0 million compared to $18.5 million the prior year. The median corporate settlement however increased to $1.4 million compared to $0.8 million a year earlier.

For individuals the trend differs. The median amount was $310,000 while the average was $4.48 million. Both values are larger than in any post SOX year. These values may however have been skewed by the inclusion of the default judgment from the Ponzi scheme case.

Perhaps the most significant statistics are those regarding FCPA and insider trading cases. In the first half of the year the SEC settled 26 FCPA cases. If this trend continues it will be the largest number of post SOX FCPA settlements. The median settlement value also increased, up 40% relative to the post-SOX average. This is consistent with the increased emphasis in this area and the continually spiraling amounts paid in settlement.

Settlements in insider trading cases however declined significantly. In the first half of the year the Commission settled 25 insider trading cases which projects to 50 for the year. This would be the lowest post-SOX year if the trend continues. In contrast the median settlement value for cases with individuals is $203,000. If this trend continues it would be the largest since 2002. Overall the trend in these case appears contrary to the increased emphasis on insider trading. At the same time it may reflect the difficulty of the cases being brought and the willingness of defendants to challenge the Commission in such cases.

The SEC prevailed in then Ninth Circuit in its long running action against three former executives of Gateway, a computer manufacturer. SEC v. Todd, No. 07-56098 (9^th Cir. June 23, 2011). The Circuit Court reversed the ruling of the district court setting aside a jury verdict which found that defendants John Todd and Robert Manza violated the antifraud provisions with respect to certain financial transactions and made misrepresentations to the auditors. The court rejected a claim by Messrs. Todd and Manza that the district court should have set aside a jury verdict finding that they had aided and abetted certain filing violations by their former employer, Gateway. The Court also overturned a grant of summary judgment in favor of defendant Jeffrey Weitzen on Section 10(b) and 20(a) claims.

The complaint centers on a claimed financial fraud and misstatements which trace to 2000. According to the SEC, former CEO Jeffrey Weitzen, former CFO John Todd and former controller Robert Manza participated in a scheme in which they misrepresented the financial condition of the company in the third quarter of 2000 to meet analyst expectations. At the time the computer market was weakening. At one point in the quarter the company had a gap of over $100 million between revenue and street projections. Nevertheless, Gateway reported earnings which met analyst expectations and Defendant Witzen reported in an earnings call and the related release that Gateway had “accelerated year-over-year revenue growth.”

The company met expectations by booking over $100 million as revenue from three transactions. The first was a sale-lease back of fixed assets to Lockheed Martin. The transaction recorded $47.2 million. While the parties agreed that the transaction was unusual, they disputed whether under GAAP it was properly recorded as revenue.

The second involved $21 million from an incomplete sale of computers to VenServ. It was recorded as revenue. The parties agree that the transaction was improperly booked because it was incomplete. The third involved a change in contact terms with AOL regarding the payment of certain fees to Gateway. The modified agreement permitted Gateway to recognize those fees earlier giving it a revenue boost of $72 million.

Initially, the Court considered the SEC’s challenge to the district court’s ruling setting aside the jury verdict against Messrs. Todd and Manza. On the Lockheed transaction each side presented expert testimony that the transaction had been recorded in accord with GAAP. A dispute of fact is normally within the province of the jury the Court noted. Here however there is more. Regardless of its treatment under GAAP, Gateway’s internal polices which had been disclosed specified that a sale of fixed assets is not booked as revenue. Furthermore, while the defendants’ claim that the transaction was disclosed to the auditors is correct, in fact PWC did not learn about it until after the close of the period and the publication of the financial statements. Ultimately Gateway restated the transaction. Based on the delayed disclosure to PWC there is evidence to support the jury’s verdict that the two defendants acted with scienter the Court found.

Similarly, the Court concluded that there is sufficient evidence to support the jury’s findings as to the VenServ transaction. A violation of GAAP as all agree occurred with respect to this transaction is not sufficient to establish scienter and a Section 10(b) claim. Here however the evidence demonstrated that the two defendants acted recklessly by improperly recording the revenue while knowing the transaction terms and that the deal was not complete.

The Court also found that there was sufficient evidence to support the findings of the jury that Messrs. Todd and Manza made false statements to the auditors although it rejected the SEC’s claims about the applicable standard. Rule 13b2-2 prohibits an officer or director from making a materially false or misleading statement to an accountant. To be liable one must “knowingly” make the false statement, meaning the person must be aware of the falsification and that it was not the result of accident, mistake or ignorance. While acknowledging that the Rule does not impose strict liability the SEC argued that the standard is “closer to negligence or reasonableness.” The Court rejected this argument in favor of the knowing standard. Here since there is sufficient evidence to establish scienter for the Section 10(b) violations, the Court concluded that the evidence supported the jury’s verdict of liability.

Finally, the Court overturned the district court’s grant of summary judgment in favor of former CEO Weitzen on the Section 10(b) claim, concluding that there were genuine issues of material fact in dispute. Here the question focused on whether the statement of Mr. Weitzen about the earnings was false. Generally, such an issue is a mixed question of law and fact. In this instance the Court concluded that a rational fact finder could determine that Mr. Weitzen misled investors by publically describing Gateway’s growth as “accelerated” without disclosing the unusual nature of the Lockheed and AOL transactions. Indeed, there is evidence in the record which demonstrates that Mr. Weitzen participated in a “gap filling” program when the company realized it might miss analyst expectations. The evidence also demonstrates that the former CEO understood the significance of the transactions and that the revenue gap would not be closed without them.

The Court also concluded that there were genuine issues of material fact with respect to the Commission’s Section 20(a) claim against Mr. Weitzen which precluded summary judgment. Under this Section the defendant can be liable if there is a violation of the Act and if he directly or indirectly controls any person liable for it. There is no liability however if the controlling person acted in good faith and did not directly or indirectly induce the violation. The critical question here is control. The fact that Mr. Weitzen is the CEO does not create a presumption that he is a controlling person. In the context of this case actual authority over the preparation and presentation of the financial statements is sufficient. In this case there is a dispute of fact regarding the control of Mr. Weitzen which precluded granting summary judgment in his favor. Accordingly, the Section 10(b) and 20(a) claims against Mr. Weitzen were sent back to the trial court. The jury verdicts against Messrs. Todd and Manza were reinstated.