The 10 Leading SEC Enforcement Developments Of 2006 (Part I)

1. Stop Options Backdating
More than 100 companies were investigated by the Department of Justice and the SEC because of an article published in the Wall Street Journal in March 2006. The newspapers had asked a finance professor to give it a list of companies that made stock option grants that led to large stock market gains. The Journal studied several of the companies on the list and found that several of the option grant patterns found could not have happened without backdating. The article resulted in one of the largest securities investigations ever. The DOJ and the SEC only filed a few backdating cases, including cases against Comverse Technology, Inc. and Brocade Communication Systems, Inc.

2. Corporate Civil Penalties Guidance
The SEC put out a statement in January 2006 that reaffirmed its commitment to issuing civil penalties against corporations. It also formally named the factors it looks at when determining whether to impose these penalties. Factors included the absence or presence of a direct benefit to the corporation because of the violation and the extent to which the penalty will “recompense of further harm” the victims. The SEC also named seven additional factors it would look at when deciding whether to issue a civil penalty: the extent the corporation in question cooperates, deterrence, degree of complicity within the corporation, extent of injury to victims, difficulty of detection, level of intent, and lack of or presence of remedial steps.

3. Court Opinions Which Suggested Cooperation Limits Between Criminal Authorities and the SEC
In U.S. V. Stringer, the district court dismissed the criminal indictment that charged three FLIR Systems, Inc. executives with securities fraud and conspiracy. The court said that the Department of Justice and the SEC deprived the defendants of their rights by pursuing parallel criminal and civil investigations before filing the indictment. The court said that the SEC did not properly warn the defendants of the DOJ’s involvement with the SEC’s investigation-which deprived them of their Fifth Amendment rights and due process. The court also said that the prosecution used the SEC to conduct its criminal investigation. The court accused the government of taking part in “deceit and trickery.” An appeal in front of the Ninth Circuit is pending.

4. Improper Investment Adviser Fee Arrangements
The SEC escalated its investigation of mutual fund fee arrangements. In September of last year, it filed a settlement administrative proceeding against third-party service provider BISYS Fund Services, Inc., which conducts back-office services and recordkeeping for mutual fund advisers.

The SEC determined that BISYS aided and abetted 27 mutual fund advisers in their defrauding of investors by entering into undisclosed side agreements that allowed advisers to use investors’ mutual fund assets to fund marketing expenses. Part of the administration fee was returned to investment advisers so they would continue retaining BISYS. BISYS provided third parties or the funds’ advisors with more than $230 million from its administrative fees. Mutual funds’ shareholders and trustees were not informed of these side agreements.

BISYS did not admit or deny wrongdoing. It did, however, paid $21.4 million (10 million in civil penalties, $9.7 million in ill-gotten gains, and $1.7 million in prejudgment interests. The money was put in a distribution fund to benefit those harmed by the improper fee arrangements.

5. Sanctions On Counsel for Negligence Upheld
The DC Circuit Court upheld the SEC’s sanctions against the bond counsel who issued a “tax-exempt” opinion regarding issuing municipal bond without a proper investigation first. The DC Circuit said that an issuer could, in theory, issue tax-exempt bonds with an interest of 4% and earn 5% by investing the proceeds in treasury bonds, gaining an immediate profit without risk. By law, however, the federal government limits arbitrage by mandating that municipal bonds undergo certain tests or give up their tax-exempt status.

In the case ruled on by the DC court, a school board issued the bonds. An investment banker, Ira Weiss, told the board that it could borrow money for capital projects for a number of years and keep the profits if it issued municipal bonds. Weiss said that the plan was legal, issuing an unqualified opinion on the tax-exempt status of the bonds. He drafted a nonarbitrage certificate that the board signed, but the DC court says the representations did not justify the counsel’s reliance. Although an administrative law judge ruled in favor of Weiss, the SEC found him negligent and ordered him to cease and desist violating certain sections of the Securities Act. They also made him pay a disgorgement fee. Weiss, the promoter, had used the possibility of arbitrage to make a transaction sale and did not provide the board with full information concerning the taxable IRS risks.

If you are an investor who has sustained financial losses because of the inappropriate actions of a member of the securities industry, contact Shepherd Smith and Edwards right away. While the SEC can force securities industry members to pay fines, it is up to an experienced law firm to help you recover your losses. Shepherd Smith and Edwards has helped thousands of investors get their money back.

#6-10 can be found on this Web site during the week of April 23, 2007. The full, original article was originally published by the Bureau of National Affairs on April 9, 2007

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