Securities Compliance Sentinel - Analysis of Cutting Edge Securities Industry Issues

Regulators seem to believe that lawyers and their law firms act like ostriches when it comes to their clients and Ponzi schemes.  For example, a law firm paid $25 million to settle malpractice claims over legal services rendered to certain hedge funds and related entities controlled by a Ponzi Scheme artist, Arthur Nadel.  See SEC v. Nadel, M.D. Fla., 09-00087, 8/28/12, and http://en.wikipedia.org/wiki/Arthur_Nadel. 

Although the law firm continues to maintain its innocence, it settled with the Court appointed receiver over allegations that it failed to detect red flags from the fraudster’s activities during their representation of him between 2002 and 2009.  See Scoop Real Estate LP v. Holland & Knight LLP, Fla. 12th Cir. Ct., 2009-CA-014877, 2009, and  http://www.nadelreceivership.com/docs/Press_Release_HK-Settlement.pdf.  In his pleadings, the receiver argued that, if the firm acted sooner, things would have been different.  For its part, the law firm merely said that it wanted to end the litigation. 

In short, the lesson that lawyers and law firms must learn is that they have to implement systems to detect such potential frauds, or these law suits will undoubtedly become a terrible "cost of doing business."

Incredibly over the last several years, both the DOJ and SEC have been relentless in their aggressive enforcement of the Foreign Corrupt Practices Act.  As part of this pursuit, the FCPA's facilitation payment exception might not be as viable as it once was, thereby, defending these actions has gotten that much more complicated.

Many are suggesting that this exception is no longer a complete defense because there is no objective standard as to  what qualifies as a facilitating payment or a routine government action.  The FCPA does not apply to such things as payments facilitating or performance easing relating to routine government actions, including, among other things, the issuing of licenses,  permits, or processing paperwork.  In particular, the SEC does not even consider the facilitation payment exception an affirmative defense. The SEC focuses on what you are paying for, not the verbiage.  Further, larger payments make it less likely for anyone to believe it is a facilitating payment, however, not all licenses are the same, some may be more expensive than others.  Essentially, confusion reigns.

Nonetheless, companies must have appropriate internal controls to police these types of payments.  One aspect of internal controls must be adequate record keeping, ensuring that transactions are properly recorded.  As such, companies must be prepared to respond when these inquiries arise.

That may be the only real defense the company may have.

Companies that acquire or invest in offshore entities or in entities that conduct business overseas may inherit FCPA risks.

Clearly, the DOJ and the SEC are viewing these transactions and the resulting combinations with a jaundiced eye.  These regulators, most likely, will begin investigations, and, possibly, commence actions.  In fact, there have been recent FCPA actions that would fall under this category.

Consequently, acquirers must identify potential FCPA problems during the due diligence process so as to avoid these predicaments.  If identified, the acquiring company may be able to restructure the transaction to avoid assuming that liability.  Possibly, the parties may also submit an FCPA "opinion procedure request" to the DOJ seeking ways to mitigate the potential liability.

Essentially, it is critical that the due diligence process uncover these problems, and the parties address them before the closing.

Over the course of many years, I have been questioned by American BDs as to their responsibilities for sales to people outside the United States.  My response has always been that they are required to obtain an opinion from counsel in those jurisdictions before proceeding.  Most likely, those foreign jurisdictions may have registration requirements before conducting business in their countries. 

Now, the shoe is on the other foot.  We are now seeing non-US issuers selling certain fund interests into the United States.  Those persons, who are selling those securities into the United States, may require SEC registration as well as the requirement to implement compliance program before moving forward.  Further, certain states, such as California, will have various requirements requiring each of these sellers to follow, some of them may not appear at first blush, like California's lobbyist rules.  If the selling issuer does not comply with these items, it opens itself up to potential liability.   

Thus, we strongly recommend that non-US issuers contact American counsel before selling product into the United States.

This blog entry about hedge fund insurance coverage almost sounds like a car insurance commercial.  Sadly, both are critical in today's modern society.

Given the current regulatory environment, volatile market conditions, and the public perception of the industry, hedge funds face enormous risk in doing business.  Hedge funds should carry both D&O and E&O Liability Insurance to protect directors, officers, managers and the fund itself from liability.

The hedge fund should have coverage for governmental investigations.  Additionally, the hedge fund also needs coverage for when it or its affiliates are alleged to have committed fraud.  However, the hedge fund must be cautious in this particular area because insurance companies, generally, try to avoid such coverage and will construe just about anything as an admission of wrongdoing or responsibility.  Finally, the hedge fund has to ensure that its insurance coverage will pay for defense costs since said costs are usually the most expensive part of the process.

In short, hedge funds cannot just assume that insurance coverage will be there.  Periodic audits and check-ups are required before anything arises.  Like most insurance coverage, you never want to have to use it, but that is why it is there so make sure it will work.

Accountants beware - prison lurks.

Recently, a certified public accountant and auditor was sentenced to 54 months in prison for his role in a nearly half-billion dollar investment scam that impacted over 3,500 investors.  In the sentencing, the court indicated accountants and auditors are gatekeepers of our financial system, and must protect that system and those who are relying upon it for their well-being.  The court then went on to imposing a sentence of nearly 5 years in prison.

Accountants and CPAs need to be aware of these issues, and must be assertive with their clients to ensure their own security and the well-being of the investing public.

I previously wrote about how the Food and Drug Administration and Department of Justice used the responsible corporate officer doctrine to charge former Purdue Pharma executives and in-house counsel with criminal liability and career-ending debarment for “off-label” drug marketing, even though the charged parties did not personally participate in the conduct or even know about it.  Recent court activity may significantly reduce such exposure for similarly-situated individuals, with ripple effects spreading through many legal sectors, including shareholder suits.

In a game-changing decision released on December 3, 2012, the Second Circuit Court of Appeals reversed the conviction of Alfred Caronia, a pharmaceutical sales representative who had been convicted of conspiring to introduce a misbranded drug into interstate commerce.  The evidence at trial included recordings of Mr. Caronia’s statements to doctors that Xyrem, a drug that the FDA approved for narcolepsy, could also be used to treat various other conditions for which the FDA had not approved the drug.

Mr. Caronia argued that the prosecution violated his First Amendment right to free speech.  The Second Circuit agreed, and in reversing his conviction narrowly read the scope of the Food, Drug, and Cosmetic Act “as not criminalizing the simple promotion of a drug’s off-label use because such a construction would raise First Amendment concerns.”  Mr. Caronia’s conviction relied on off-label promotion, and was therefore invalid.

Depending on one’s perspective, pharmaceutical representatives promoting off-label uses for their products are either modern snake oil salesmen or critical conduits of information to medical treatment providers regarding cutting-edge therapies.  

Setting this debate aside, the Caronia decision could upend the current FDA regulatory and enforcement regime regarding off-label marketing, with wide-ranging effects.  In addition to the government’s revitalization of the responsible corporate officer doctrine, recent years have witnessed:  (1) the government attempt to prosecute in-house counsel for obstructing an off-label marketing investigation; (2) the government require, in settlement of misbranding charges, corporate integrity agreements that prohibit compensation of the sales force based on sales goals; and (3) scores of whistleblower lawsuits, False Claims Act actions, and the follow-on class-action shareholder lawsuits involving off-label marketing.

This could all change if the Supreme Court affirms the Second Circuit or if other appellate courts agree that prosecutions for “off label” marketing violate free speech rights.

We have repeatedly blogged about government investigations.  Moreover, regardless of the election results, government investigations will continue.  Further, these governement investigations take on a life of their own and almost always encompass several different areas.

Today, we wanted to digress somewhat from our usual securities topicS and let you in on what some of our colleagues at Fox Rothschild do when it comes to other enforcement or investigative areas.  One area that has received a great deal of press relates to the work of the United States Customs and Boarder Protection service and Immigration and Customs Enforcement as well as the FBI.  These agencies have been hard at work raiding a variety of businesses and entities.

Although such work does not necessarily imply that one would see a great deal of activity relating to the securities industry, securities firms, including investment banks, may find theiir work with high technology, defense companies and other manufacturing interests callled into question.  Moreover, this does not even consider the potential employment aspects to these investigations.  Nonetheless, securities industry firms will, most likely, see some of these issues in the future.

Recently, our partner, Patrick Egan, and other colleagues, gave a wonderful presentatino on these topics.  We are attaching the slide presentation for your review (and please contact Patrick if you have any questions).  Export Material.  We look forward to discussing these matters in the future and strongly urge you to take a look at what our colleges have done in this particular area.

One of the major issues an investor, who happens to be a victim of a ponzi scheme faces, is what is the proper measure of recovery, if any recovery is available.  One school of thought is that the victim should receive the value of the investment as they believed it to be at the time the fraud is uncovered; this method frequently based upon information contained in fraudulent account statements.  The other school of thought is net equity; or, the value of the investment, minus money the investor received in return from the scheme over time.  This method is derived from the books and records of the scheme.

On its face, the first method would allow victims to profit from a fraud.  Yes, they are victims, but should they profit.  Most commentators, the Madoff Trustee and the SEC all think that the answer to that question is no.  Now, the United States Supreme Court may have input on the viability of that position. 

There is currently an appeal pending, but not yet accepted, to the Supreme Court to challenge the Second Circuit Court of Appeals’ ruling that upheld the Trustee’s net equity method to calculate what a ponzi scheme victim should be allowed to recover.  The SEC has recently filed brief with the Court asking it not to take the appeal, but to leave the Second Circuit’s opinion stand. 

Although this issue will remain uncertain until the Supreme Court takes some action, either accepting or denying the appeal, the long-term answer should be one based upon the equities.  Victims need an avenue to recover, but they should not profit from a fraud, just like the fraudster should not have profited from the victims.  Net equity return would appear to be the fairest methodology to all concerned.  Now it is up to the Supreme Court to decide.

Recently, the SEC announced that it would take steps to bar felons and bad actors from any Regulation D offering. 

This rule was mandated by the Dodd-Frank Act, and the SEC issued the proposal last May 2011.  This new rule may be in place before the end of this year, but there is no certainty on timing at this point.  This new rule is part of an overall effort by the SEC to attempt to remove bad actors from early stage offerings since these offerings usually involve raising capital for small companies.

Late last week, one of my colleagues sent me an e-mail where he copied 8 other people, half of them I could not identify if my life depended upon it.  I then heard about the person who had a Twitter account with over 17,000 follwers, and was now being sued by his former employer over ownership of the account-- really, does anyone think the person knows 17,000 people?  Firms and persons working in financial services industries generate trillions of e-mails every year, encompassing the mundane to the critical. 

These firms and their employees also seem to be involved in numerous civil, regulatory and criminal investigations and litigations.  Much of the vast amount of money in legal fees paid to defend these firms and their employees (sums that sometimes greatly exceed the GDP of several developing countries) often relate to e-mail review and production.  General counsels and firm management looking for ways to save money on these bills should, initially, read my article that was published in the New Jersey Law Journal, outlining the "CC" problem and ways of clamping down on this terrible plague afflicting our society, http://www.foxrothschild.com/newspubs/newspubsArticle.aspx?id=4294970187.

Once read, please do your part in stopping this madness because the dollar you save maybe your own!!

Please join us for this program on Thursday, January 5, 2012. 

C:\Documents and Settings\ebadway\Local Settings\Temporary Internet Files\OLK8F\cle_GovernmentAndInternalInvestigations.html

Thought you might be interested in a recent podcast I did concerning my securities law practice.  http://web.me.com/cordpar/Client_Development_Tips/Law_Consulting_Coaching_Podcast/Entries/2011/10/28_Developing_a_Securities%2C_White_Collar_and_Complex_Litigation_Practice.html

At the recent American Bar Association gathering, the SEC’s and the Department of Justice’s recent activities regarding insider trading were heavily discussed. 

During this conference, defense attorneys on the panel suggested that both regulators were pushing insider trading law to its limits.  Many believed at the conference that the SEC should now consider defining insider trading. 

As many know, the SEC has, for many years, refused to define insider trading, feeling that such a definition would engender ways to avoid enforcement.  However, commentators at this conference seem to suggest the time had come given the SEC and DOJ’s increased use of a variety of insider trading theories as well as its impact on hedge funds and raising capital.  For example, with the recent Galleon case and SEC v. Dorozkho, a computer hacking and insider trading case, many believe that these cases are expanding the bounds of insider trading, and is only the beginning of the SEC’s and DOJ’s continued exploitation in this particular area.

In sum, the SEC and DOJ have made it clear that they will continue to effect these enforcement actions both on the civil and criminal side, and that the industry needs to consider alternatives other than a legislatively defined insider trading approach.

In an interesting speech, SEC Chairman Mary Shapiro stated that she believes securities violations are often the result of peer pressure and not individual greed. 

Chairman Shapiro was referring to the recent guilty verdicts in the Galleon insider trading matter, as well as numerous other insider trading convictions.  Chairman Shapiro seemed to suggest that individuals are engaging in insider trading to “return a favor,” or enhance their reputations in their businesses.  Further, she claims that the penultimate approach to performance is a motivating factor for many, and the old adage that “everybody was doing it” is a driving force.

Although Chairman Shapiro seems to sincerely believe her words, this may be an overly simplistic approach to insider trading.  Many individuals, who have been convicted, earned large sums of money, and it is unlikely that they were solely motivated to increase their reputational standing or that they were returning favors to friends.  At the very least -- or to be as generous as possible to Chairman Shapiro -- peer pressure may play some part, but the overwhelming evidence seems to suggest that the pursuit of money plays a much larger role in insider trading.

The government intends to continue to pursue civil and criminal legal action against insider trading and other financial wrongdoing according to SDNY U.S. Attorney Preet Bharara.  Mr. Bharara made these comments in a speech where he was unabashedly forceful in arguing that the government will not take a back seat to investigating insider trading and financial fraud. 

Mr. Bharara made it very clear that, in his opinion, insider trader is rampant in the United States capital markets, and that his office would continue to investigate this particular area.  He highlighted recent successes in the Galleon matter, as well as other cases.  Further, he also indicated that cyber crime was receiving as much government attention as the insider trading investigations, and he believed that those cases were developing because various federal agencies, including the FBI, CIA and the Secret Service, were involved.

The DOJ and, in particular, the SDNY U.S. Attorney’s Office will continue to aggressively investigate and prosecute these financial fraud matters.  However, one begins to wonder if their successes will meet the same fate as those of a former SDNY U.S. Attorney by the name of Rudy Guiliani where his high profile insider trading cases ended up overturned by the appellate courts.