Settlement Activity

The SEC settled with 160 defendants in the second quarter of 2009, compared to 175 in the previous quarter and 174 in the second quarter of 2008. Through the first half of the year, the SEC has settled with 335 defendants, compared to 330 during the same period last year. Exhibit 1 details the 10 largest settlements of the second quarter.

Exhibit 1. Ten Largest SEC Settlements In The Second Quarter Of 2009

Two of the three largest settlements in the quarter related to mutual fund market timing allegations. American Skandia Investment Services, Inc., a subsidiary of Prudential Financial, Inc., reached a $68 million settlement, the largest of the second quarter. The SEC alleged that Skandia allowed market timing in mutual fund portfolios, thereby diluting the funds by at least $34 million.1 Headstart Advisers Ltd., a UK-based hedge fund advisor, settled market timing charges for $17 million, the third-largest settlement of the second quarter. The SEC alleged that Headstart opened multiple accounts at various US broker-dealers, and split the firm's mutual fund trades among these accounts to keep the size of its trades below threshold amounts that the mutual funds monitored for market timing. The SEC also alleged that Headstart engaged in late trading, the practice of placing orders for mutual fund shares after 4:00 pm at the previous day's price. According to the SEC, Headstart's advisory client, Headstart Funds Ltd., profited from such market timing and late trading in the amount of $198 million.2

Allegations against other defendants whose settlements were among the 10 largest include insider trading, public company misstatements, microcap fraud, and investment manager fraud. The SEC obtained an order for $62.6 million in disgorgement and pre-judgment interest in its federal case against Michael Lauer in the second quarter. Mr. Lauer, who managed the hedge fund Lancer Management Group, was found to have misrepresented the nature of the investments made on behalf of his clients as well as the realized returns. Due to the large size of the disgorgement and pre-judgment interest, we include it in the table although the civil penalty in this case is still to be determined. Evergreen Investment Management Company, LLC and its advisory client, Evergreen Investment Services, Inc., settled SEC charges for $40 million, the second-largest final settlement of the quarter. The SEC alleged that Evergreen overstated the net asset value of its funds from February 2007 to June 2008. It also alleged that Evergreen initially revealed the overstatement only to select parties.3

Trends In Settlement Values

Monetary payments were a component of 62% of company settlements and 57% of individual settlements. Among companies whose settlement included a monetary payment, the average settlement was $6.6 million, a decrease from the $12.8 million average in the first quarter. However, the average through the first half of 2009 was $10.1 million, an increase over the full-year average of $8.4 million in 2008. The median company settlement, i.e., the settlement with an equal number of values above and below it, was $1.6 million, a slight decrease from the $1.7 million median in the first quarter. If the 2009 median remains at $1.6 million through the remainder of the year, it will be the highest median value in any year since the passage of the Sarbanes-Oxley Act.

The average company settlement declined more sharply than the median largely because in the first quarter there were two company settlements of over $100 million: the $200 million UBS settlement and the $177 million Halliburton settlement.4 By contrast, in the second quarter, the largest settlement was $68 million. Large settlement values have a more pronounced effect on the average value than on the median.

The average settlement with individual defendants was $1.6 million in the second quarter, an increase from $0.7 million in the first quarter. The median settlement was $0.2 million for individuals in the second quarter, compared to $0.1 million in the first quarter.

Exhibit 2. Company Settlement Values Increased In The First Half Of 2009 Over The Prior Year

The SEC Reform Discussion Continues

In the second quarter, the SEC announced plans to ask Congress for expanded enforcement powers. For example, the agency intends to ask for legislation empowering it to seek penalties in cease-and-desist proceedings and also to seek penalties against aiders and abettors under the Investment Advisers Act.5 The agency also plans to ask for new legislation granting it nationwide subpoena power in federal court.6 While the SEC currently has nationwide subpoena power in its administrative proceedings, in federal court it can only subpoena witnesses who reside within 100 miles of the courthouse.7

In addition to these potential expansions of the SEC's enforcement powers, the Department of the Treasury's recent report, "Financial Regulatory Reform—A New Foundation," recommends a number of reforms that could expand the SEC's regulatory powers and the scope of its future enforcement actions. Despite early indications that the Administration would recommend the creation of a consolidated financial regulator, the Treasury report instead would keep both the SEC and CFTC independent, as it would with a number of other financial regulators. However, it adds three cross-cutting authorities that would have oversight over some of the same jurisdiction as that of the SEC. A new Financial Services Oversight Council would consist of the heads of eight financial regulatory agencies, including the Chairman of the SEC, would be tasked with identifying emerging risks, and would serve as a forum for disputes between regulators.8 The Federal Reserve would be given broader regulatory authority, including over all "large interconnected financial firms," many of which are also regulated by the SEC.9 A new Consumer Financial Protection Agency's authority would include retail securities products currently under SEC regulation.10

Recommended reforms directly affecting the SEC's powers include:

  • Increased regulation of hedge funds and private equity funds, including requiring their advisers to register with the SEC11
  • Stronger SEC regulation of credit rating agencies, including new requirements for public disclosure of potential conflicts of interest, further public disclosure of how published ratings are determined and what they are meant to assess, and private disclosure to the SEC of each rating agency's methodologies12
  • SEC authority to require that compensation committees of public companies are more independent13
  • Harmonization of SEC and CFTC regulation of securities and futures14

Finally, the report endorses Ms. Schapiro's previously-announced support for legislation allowing the SEC to compensate whistleblowers in any type of financial fraud case.15 Currently the agency only has the ability to compensate whistleblowers in insider trading cases.16

Looking Ahead

While it remains to be seen which of the Administration's recommendations will be enacted, clearly the securities regulatory environment is rapidly evolving. The new regulatory landscape will doubtlessly affect future SEC enforcement actions and their resolutions. We will continue to provide updates on these trends in our series of quarterly reports. For additional information, please visit www.securitieslitigationtrends.com.

Footnotes

1. Order Instituting Administrative Cease-And-Desist Proceedings, In the Matter of American Skandia Investment Services, Inc., April 17, 2009.

2. "Commission Settles with Najy N. Nasser, Headstart Advisers Limited and Headstart Fund Ltd. In Connection with Deceptive Market Timing and Late Trading Scheme," SEC Litigation Release, June 29, 2009.

3. Order Instituting Administrative Cease-And-Desist Proceedings, In the Matter of Evergreen Investment Management Company, LLC et. al, June 8, 2009.

4. Jan Larsen with Dr. Elaine Buckberg and Dr. Baruch Lev, "SEC Settlements Trends: 1Q09 Update," April 9, 2009.

5. Robert Khuzami, Testimony Concerning Strengthening the SEC's Vital Enforcement Responsibilities, May 7, 2009.

6. Id.

7. Stephen M. Cutler, Testimony Concerning The Securities Fraud Deterrence and Investor Restitution Act, H.R. 2179 Before the House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, Committee on Financial Services, June 5, 2003.

8. "Financial Regulatory Reform—A New Foundation," Department of the Treasury, June 17, 2009, p. 10.

9. Id., pp.10-11.

10. Id., pp.55-63.

11. Id., pp. 37-8. See also Robert Khuzami, Testimony Concerning Strengthening the SEC's Vital Enforcement Responsibilities, May 7, 2009.

12. "Financial Regulatory Reform—A New Foundation," Department of the Treasury, June 17, 2009, p. 46.

13. Id., pp. 29-30.

14. Id., pp.49-51.

15. Id., p. 72.

16. Mary Schapiro, Testimony Concerning Enhancing Investor Protection and Regulation of the Securities Markets, March 26, 2009.

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