2009 was a year to forget for the Securities and Exchange Commission, Wall Street, the White House, law firms-everywhere, really. However, 2009 was truly the gift that kept on giving for those of us who write about SEC enforcement and securities litigation. Here is my look back at 2009, which I have learned I must preface with this important warning:  Mom-the column below includes some efforts at satire. These efforts are marked in italics.

Okay, moving on! Let’s start in January, which began, as it has for the last three years, with members of Congress Louise M. Slaughter and Brian Baird sponsoring the “Stop Trading on Congressional Knowledge Act.”  The STOCK Act, which again failed to become law, would prohibit Congress and their staffers from engaging in insider trading based on nonpublic information obtained through their official positions.  The other 433 members of Congress once again dismissed the bill as “crazy talk” and ordered Slaughter and Baird back into hibernation until January 2010.

B. Ramalinga Raju, chairman and CEO of Satyam Computer Services, resigned after confessing to falsifying the company’s financial records in a $1 billion fraud.  He said the fraud was “like riding a tiger, not knowing how to get off without being eaten.” Raju promptly received a curious call from golfer Tiger Woods’ lawyers, who said Tiger wanted to know “what exactly you meant by that and whether $5 million would be enough for you to not say that again.”

In February, lawyer Marc Dreier, whose outrageous $700 million fraud was spared from being the securities fraud story of the year only because of the simultaneously unfolding Madoff scandal, asked the court to allow him to remain free on bail, but on “house arrest” with armed guards pending his trial. This prompted Judge Jed Rakoff to ask the 2009 Judicial Question of the Year to Dreier’s lawyers: “Are these armed guards authorized to shoot him?” After careful consideration and discussion with Dreier (who presumably said, “Hell no!”), Dreier’s lawyers said the guards could not, repeat NOT, shoot their client. Judge Rakoff granted the request anyway, and ordered Dreier to be held in Dreier’s $10 million Manhattan penthouse apartment until trial. In March, CFTC Commissioner Bart Chilton warned the public of “rampant Ponzimonium.”  The Topps Company jumped on board, announcing that it was issuing a series of trading cards featuring the “world’s biggest hoaxes, hoodwinks and bamboozles” such as Bernard Madoff, Charles Ponzi, and Enron.  From his penthouse, Dreier issued a statement that he was “finished taking a backseat to Madoff” and that he demanded a trading card, too.

The SEC charged Madoff’s auditor with securities fraud for falsely representing and “pretending” that they had conducted legitimate audits, when in fact the auditors had not. The auditors wrote a one-line reply brief to the SEC that read: “Really?? Pretending to do one’s job? Are you sure you want to go there?”

Asked in an interview whether she was tough enough to shake things up at the agency, new SEC Chair Schapiro responded that she had been “called the Muammar Qaddafi of regulation.”  From his palace in Libya, Colonel Qaddafi stated that he was “flattered but that Schapiro has a lot to prove first.”

In April, the L.A. Times, The New York Times and the UK’s Telegraph all ran stories announcing that the SEC had joined Twitter as a part of Schapiro’s effort to revitalize the SEC and make it more transparent.  The articles did not mention that that the SEC had already been actively using Twitter since July 2008, leading someone using the Twitter username @maryqaddafi to tweet that “it would be super if my Twitter followers could just keep that bit of information on the down low.”

Robert Khuzami, the new Director of the SEC’s Enforcement Division, addressed the Enforcement staff on his first day to outline his four major themes: being “strategic, swift, smart and successful.”  Madoff whistleblower Harry Markopolos immediately held a press conference claiming that Khuzami’s “single-minded pursuit of goals beginning with the letter ‘S’ was impeding the agency’s mission.”

The SEC’s Inspector General released a report stating that two attorneys at the SEC, including one in the Enforcement Division, were under “active” criminal investigation by the FBI for trading stocks based on inside information learned on the job.  The SEC promptly took action to bolster its internal processes to prevent against such trading, but also warned that it would “file an equally ironic case against anyone caught laughing at this development.”

In June, counsel for Bernard Madoff suggested to the court that a 12-year sentence would be appropriate for their client. After a brief awkward pause followed by uproarious laughter, the court sentenced Madoff to 150 years in prison.  Sholam Weiss, presently serving a record 845-year sentence after being convicted of racketeering, wire fraud and money laundering in the collapse of National Heritage Life Insurance, was heard to say “Wait-I’m serving 695 more years than Madoff?!”

June also brought a new type of collectible: Financial Crisis “Most Wanted” Playing Cards, featuring Madoff, R. Allen Stanford, and others such as Dick Fuld and Angelo Mozilo. In his penthouse, Dreier screamed, “No Dreier card again? Are you kidding me?  Did Madoff or Stanford walk into an office building and impersonate an actual lawyer from the Ontario Teachers’ Pension Plan? I don’t think so!!”

In July, prosecutors in the R. Allen Stanford case gave us the 2009 Thankless Job of the Year: someone, they said, would soon be tasked with the roughly two month long task of “re-assembling the contents of three bags of shredded documents” that were sought as evidence in the case.  12,000 associates laid off from major law firms in 2009 immediately applied for the position.

The trial began of William Jefferson, a nine term Congressman from Louisiana charged with soliciting bribes and violating the Foreign Corrupt Practices Act. This led to the first published photos of Jefferson’s now-famous “cash in the freezer,” i.e., $90,000 wrapped in aluminum foil in Jefferson’s freezer tucked inside containers of Pillsbury Pie Crust and Boca Burgers. From his new home in the Butner Correctional Facility in North Carolina, Madoff texted Dreier with a “rolling eyes” emoticon to say that “everyone knows you use the Red Baron Frozen Pizza box to hide sums of cash over $75,000.”

In August, a theatrical play called “Enron” opened in Chichester, England. The Guardian’s review stated that it was “an exhilarating mix of political satire, modern morality and multimedia spectacle.”  The play was so successful that by September, Columbia Pictures had entered into a “high six-figure deal” to acquire the screen rights and adapt the play into a feature length film. 43 telephone calls to Columbia Pictures from “B. Ebbers,” an inmate in a Louisiana federal prison pitching “WorldCom, the Musical,” went unreturned.

In October, Stanley Chais, a money manager who was sued by the SEC after feeding hundreds of millions of dollars to Madoff, argued that the SEC’s claims against him were barred because the SEC’s many inspections of Madoff’s firm without taking any action “provided credibility to Madoff.”  The SEC responded that this was the nicest thing anyone had said about them all year.

In November, the SEC began running an ad for a “Supervisory General Attorney” in the Enforcement Division, which included a prominent headline blaring “SEC RANKED THIRD BEST FEDERAL WORKPLACE FOR 2007!” (capital letters, bold face and exclamation point in original). SEC Inspector General H. David Kotz stated that he was opening a 12-month investigation into how the ranking was determined, and would be offering best practices for future rankings.

Also in November, the U.S. Marshals Service collected every watch, golf ball, sand wedge, cuff link, earring, duck decoy, wooden milk stool, baseball jacket, and baseball mitt ever owned by the Madoffs and sold them off at auction. The person who paid $14,500 for a blue satin New York Mets baseball jacket with “MADOFF” stitched across the back called the item a “great value” that could be paired “fabulously” with the Dennis Kozlowski button-fly jeans he’d bought at auction in 2007.

Finally, just under the wire in December, the SEC charged a former vice president of Pride International, Inc. who was responsible for FCPA compliance with … wait for it… violations of the FCPA. “We warned you in April not to laugh at SEC enforcement lawyers being investigated for insider trading,” the SEC said.

On Monday, Judge Jed Rakoff issued his order rejecting the proposed $33 million settlement of the SEC case against Bank of America.  The order raises numerous issues for the SEC such as whether it must now amend its case to include individual defendants, and whether it will now take the case to trial, but to me the more interesting aspect of the order goes well beyond the case itself.

Judge Rakoff focused heavily on the fact that the proposed $33 million settlement was with BofA itself, not the allegedly culpable executives.  That means it will be paid by the company, i.e., the existing shareholders.  As he put it,

the management of Bank of America - having allegedly hidden from the Bank’s shareholders that as much as $5.8 billion of their money would be given as bonuses to the executives of Merrill who had run that company nearly into bankruptcy - would now settle the legal consequences of their lying by paying the S.E.C. $33 million more of their shareholders’ money.

This, Judge Rakoff declared, was effectively a “proposal to have the victims of the violation pay an additional penalty for their own victimization.”  He went on to state that forcing the shareholders who were the victims of the Bank’s alleged misconduct to now pay the penalty for that misconduct was “not fair, first and foremost, because it does not comport with the most elementary notions of justice and morality.”

There is an undeniable logic to the Court’s view of corporate penalties, but the fact is that this is the way the securities litigation settlement process typically works right now, both in SEC cases and in private securities class actions.  In SEC cases, the SEC imposes a fine upon the company for its alleged misdeeds, which is then paid by the company’s current shareholders.  Under the Fair Funds provision of Sarbanes-Oxley, the penalty is then paid out to the victims — the company’s shareholders during the period that the fraud allegedly occurred.  In securities class actions, the company itself similarly settles the private case against it, and the company’s current shareholders pay (usually via the company’s D&O insurance policy) the defrauded shareholders from the class period.

For years, there has been a debate as to whether this practice of having current shareholders pay former shareholders in these settlements makes sense.  Although Judge Rakoff did not address this point, there is often a significant overlap in these two groups, so shareholders will actually be paying themselves.

In its filings with Judge Rakoff, the SEC acknowledged that corporate penalties such as the one proposed against BofA will be “indirectly borne by [the] shareholders,” but it argued that this is justified because “[a] corporate penalty … sends a strong signal to shareholders that unsatisfactory corporate conduct has occurred and allows shareholders to better assess the quality and performance of management.”  Judge Rakoff, however, ruled that

the notion that Bank of America shareholders, having been lied to blatantly in connection with the multi-billion-dollar purchase of a huge, nearly-bankrupt company, need to lose another $33 million of their money in order to “better assess the quality and performance of management” is absurd.

The SDNY is the home of more securities litigation than any other court, and Judge Rakoff is known to be among the most influential judges on that court in the securities area.  If Judge Rakoff finds the current settlement structure for SEC and securities class actions to be “absurd” and “not fair,” then big changes could be on the horizon.

I recently discovered a new website called “myCorporateResource.com.” MCR combs the websites of the top 100 American law firms to find new Client Alerts, which it estimates number approximately 10,000 per year. MCR says that it then “aggregates, reviews, sorts and summarizes this content -for free- to give you a really useful corporate resource.”

Predictably, I honed in on the SEC enforcement, securities litigation, and white collar memos, and found that many were very timely and useful. Nick Montgomery, the editor of MCR, very kindly responded to my request that MCR provide RSS feeds of its “Securities Litigation” and “White Collar Defense & SEC Enforcement” categories of memos, and I will begin featuring feeds of these memos on Securities Docket shortly (you can see them below now).

MCR sorts law firm memos in roughly 80 different ways, including industry, professional role (Board members, C-level executives, accountants, …), area of law, and geography (China, India, UK, …), and has a special sections dedicated to Corporate Governance, the SEC, and the Credit Crisis.

Below are the feeds from my two favorite categories: “Securities Litigation” and “White Collar Defense & SEC Enforcement.”

I’m pretty much flabbergasted to learn that (a) someone saw fit to write a play about the Enron scandal, and (b) it is getting rave reviews!

Via Enforcement Action’s London bureau (actually, via the Twitter feed of Werner Kranenburg, of London), I learned today that “Enron” the play opened last month in Chichester and starts a run in London in September.  The Guardian called Enron “an exhilarating mix of political satire, modern morality and multimedia spectacle.”

A new type of defendant emerged in the Madoff fallout this week as customers of Fiserv Investment Support Services, a former unit of Fiserv Inc. (FISV), filed a class action lawsuit on Thursday against Fiserv trying to recoup their lost money. The case has reportedly been filed in federal court in Denver by Jacob Zamansky of Zamansky & Associates on behalf of 800 investors who are hoping to recover up to $1 billion.

The lawsuit alleges that although Fiserv and its Fiserv Investment Support Services unit “were the designated ‘custodians’ for their pension and IRA accounts, that designation was pure fiction.”  In fact, the complaint alleges,  Fiserv Investment Support Services improperly turned actual custody of their pension and IRA accounts over to Madoff, without their knowledge. The plaintiffs allege that “from beginning to end, Madoff’s firm held and controlled the actual custody of their pension and IRA accounts, and their underlying cash,” not Fiserv. It was not until the day Madoff was arrested in December 2008 that plaintiffs learned that custody of their accounts had been handed over to Madoff’s firm, the complaint alleges.

The complaint also reportedly names TD Ameritrade Holdings Inc., as well, in a curious allegation related to its 2007 acquisition of about 300,000 retirement and custodial accounts from Fiserv.   Plaintiffs allege that TD Ameritrade excluded any business involving customer accounts with Madoff Securities when it acquired these 300,000 accounts from Fiserv in 2007, and claim that “[t]his exclusion is highly suspicious because it appears that [TD] obtained actual knowledge of Mr. Madoff’s fraud through the due diligence process, which caused these assets to be excluded.” It is unclear from the reports what cause of action, specifically, is alleged against TD Ameritrade for this “suspicious” exclusion.

On February 24, 2009, Stuart Grant of Grant & Eisenhofer P.A. and Michael Young of Willkie Farr & Gallagher LLP discussed the subject of the potential liability of professionals in the financial crisis with Enforcement Action’s Bruce Carton.  The discussion was part of a webcast in which Grant and Young collaborated on a presentation on this topic and answered questions from the audience.

Grant and Young began by explaining that we are now in the “third phase” of securities litigation in the U.S.  The first phase was from the 1970s to 1995, and was marked by the growth of such litigation in areas including who could bring a case, the number of cases filed, and the dollar amounts of settlements.

The second phase, from 1995-2006, was ushered in by the enactment of the watershed Private Securities Litigation Reform Act (PSLRA), but the growth from the first phase continued in almost every respect.  The PSLRA did bring change, however, because it effectively clamped down on “fraud by hindsight” cases.  A new phenomenon began in this period, as well: cases based on restatements and acting irregularities.

Young said the third phase, which began in 2006 and continues to the present, has seen a decline in the number of restatements and related litigation.  This phase is marked by two key trends: (1) a restrictive view of the law governing securities class action by the U.S. Supreme Court and the federal appellate courts; and (2) the evolution of Generally Accepted Accounting Principles to be more helpful to plaintiffs.

Grant agreed that it was challenging to identify even a single recent appellate court decision in the securities litigation area that has been favorable to plaintiffs, and listed the 4^th, 5^th, 8^th and 11^th circuits as being particularly difficult circuits for plaintiffs to bring cases in.  He added, however, that federal district courts were good about closely examining cases to see if there is something of substance in the plaintiffs’ allegations.  If there is something to the case, Grant said, the district courts will often deny a defendant’s motion to dismiss and let the case proceed.

On the topic of liability for accountants in the subprime crisis, Grant wondered if accountants had dodged a bullet simply because of timing. He observed that while the subprime crisis hit in the summer of 2008, most fiscal years did not end until December 2008, so perhaps the auditors had simply been the beneficiary of good timing.

In terms of international liability for accountants, Grant discussed recent developments involving the international offices of large firms such as Deloitte and PwC that audited Parmalat and Satyam, respectively.  Grant stated that accounting firms sell themselves as international organizations with seamless service until things go wrong.  Then, he said, they change their tune to claim that their organization is merely a “loose affiliation” of dozens of independent accounting firms worldwide.  In Parmalat, for example, Deloitte kicked the “bad apple” firm out of its organization, but the court still denied a motion for summary judgment against the Deloitte parent company.  Grant stated that the situation now unfolding with PwC in India appears to be a similar fact pattern.

Young emphasized the significant exposure that Big 4 accounting firms are now facing.  He believes that they may have some exposure as a defendant in as much as 25% of all securities litigation commenced.  After the demise of Arthur Andersen, he said, this exposure gives rise to questions of sustainability.

Grant and Young agreed that the law, most notably the recent Stonebridge case, now heavily favors investment banks in securities class actions.  Accordingly, very few Section 10(b) cases are now filed against investment banks.  Grant said that lawsuits against investment banks are now almost exclusively filed against them for their roles as underwriters, under Section 11 of the Securities Act of 1933.  Stoneridge provides similar protection for lawyers in securities class actions.

Asked whether he believed there might be other “Madoffs” lurking undetected, and whether any of the billions of dollars lost in the Madoff scheme may be insurable, Grant stated that it is in bad markets like the one we are in now that you see who is “swimming without a bathing suit.”  In such a market, investors often seek the return of their money, which causes Ponzi schemes to unravel.  Grant stated that he did not believe there was such a thing as “Ponzi scheme insurance,” but that feeder funds and funds of funds may become “de facto insurers” as it was their sole job to do due diligence on where their invested money was going.

Young added that he expects to see more rigorous SEC scrutiny in response to the barrage of recent criticism of the SEC for missing the Madoff scheme.  He also stated that in his view, accountants should not be liable for losses suffered by their feeder funds clients.  Feeder fund auditors, he said, should be able to accept and rely upon documentation provided by third parties such as Madoff if it appears to be legitimate.  If they cannot, he asked, how else can they perform the audit?

Finally, Grant said that his institutional clients are asking themselves three key questions before bringing cases against professionals in the current environment.  First, do they have the time and resources to devote to a lawsuit as opposed to trying to better manage and preserve their investment portfolios?  Second, will the prospective defendants even be in existence to potentially collect from in 2 or 3 years?  And third, will the current market downturn provide an effective defense for defendants on the issue of loss causation?  If a potential defendant is down 85%, and its peers are down 80%, institutional investors must ask themselves if it is it worth the effort to pursue damages that may be limited to the differential of 5%.

To watch an archived version of the webcast, please visit:
http://www.securitiesdocket.com/webcasts/

One month ago, US District Judge Lewis Kaplan sent a shock wave through the auditing world by ruling that a securities class action could proceed against Deloitte & Touche Tohmatsu and Deloitte & Touche LLP for the actions of Deloitte & Touche SpA, which served as Parmalat’s auditor in Italy. The two Deloitte entities argued that they did not have control over Deloitte Italy, but Judge Kaplan held that this issue was one that would have to be decided at trial.

On Wednesday of this week, Judge Kaplan once again ruled against an auditing firm in the Parmalat case, denying the motions for summary judgment of Grant Thornton International (GTI) and Grant Thornton LLP (GT US).  Similar to the case against Deloitte, plaintiffs’ claims against GTI and GT US rested on the premise that those defendants were vicariously liable for the alleged fraud of GT Italy, one of Parmalat’s former auditors.  Looking closely at the facts concerning GTI and GT US’ control over GT Italy, however, Judge Kaplan found that

The beauty of the Bayeaux tapestry or the genius of a Bach concerto cannot be appreciated by looking only at individual stitches on the fabric or by listening only to the B flats. Just so here. The question whether GT US controlled GTI cannot or, at least, need not be resolved by looking at each individual piece of evidence.

In the last analysis, the question before the Court is whether the evidence as a whole is sufficient to permit - not compel - a rational jury to conclude that GT US controlled GTI. Considering all of the evidence as a whole, the Court holds that it is. That is not to say that the points advanced by GT US lack force. It is to say only that it is beyond the Court’s proper function to resolve the conflicting inferences and conclusions that may be drawn from evidence that, in the Court’s view, quite plainly cuts in different directions.

Accordingly, Judge Kaplan denied the defendants’ motions for summary judgment.

Read the Court’s opinion (via American Lawyer)

On Tuesday, February 24, 2009, at 2:00 pm EST, Enforcement Action’s Bruce Carton will moderate a webcast entitled, “Liability of Professionals in the Financial Crisis” featuring two of the top lawyers in the securities litigation field. Stuart Grant of Grant & Eisenhofer P.A. and Michael Young of Willkie Farr & Gallagher LLP will addresses critical questions now arising as to the potential liability of professionals such as auditors, investment banks, rating agencies, lawyers, and others that are now in the crosshairs of investors seeking to recover massive losses in the midst of the financial crisis.

Please join Stuart Grant and Michael Young as they address these issues as well as your questions in a free, one-hour webcast. Moderated by Enforcement Action’s Bruce Carton and sponsored by Securities Docket. To attend this webcast, please sign up below:

On October 6, the U.S. Treasury Department’s Advisory Committee on the Auditing Profession issued its Final Report.  The report was the product of 12 months of work by the Committee, which was headed up by former SEC chairman Arthur Levitt and former SEC Chief Accountant Donald Nicolaisen, and consisted of no fewer than 21 members.

Among many other things, the 200+ page report examined in great detail the “possible impact of the current U.S. liability system on audit effectiveness and the continued sustainability of the public company auditing profession.”  The Committee, however, was “unable to reach a consensus as to whether limits on auditor liability would be beneficial or harmful to the capital markets and to investors or, for that matter, whether such limits are necessary to sustain the auditing profession,” and therefore presented no recommendation on this issue.

The Committee did present many interesting pieces of information that it gathered in considering this issue.  These include:

• The six largest auditing firms that each audit more than 300 U.S. public companies and together audit over 99% of the total U.S. public company market capitalization were asked by the Committee to supply a wide range of information regarding historical and pending litigation.
• These six auditing firms disclosed that they are currently defendants in ninety private actions related to audits of both public and private companies (either shareholder class actions or actions brought by companies or bankruptcy trustees) with damage claims against the auditors in each case in excess of $100 million.
• Forty-one of these ninety cases seek damages in excess of $500 million, twenty-seven cases seek  damages in excess of $1 billion, and seven cases seek damages over $10 billion. Of the forty-one claims in excess of $500 million, nineteen were lodged by private companies or bankruptcy trustees and allege claims of over $30 billion in the aggregate.
• Over a twelve-year period, since the enactment of the Private Securities Litigation Reform Act of 1995, the six largest auditing firms have paid out $5.66 billion to resolve 362 cases related to public company audits, private company audits, and all other non-audit services, with 65% of the total ($3.68 billion) related to public company audits.
• Information provided by the six largest auditing firms indicates that the weighted average of “litigation and practice-protection costs” was 6.6 percent of these firms’ revenues and 15.1% of these firms’ audit-related revenues for the most recent fiscal year.
• Over the 1996-2007 time period, median settlements by auditing firms in shareholder class actions (a subset of litigation against auditing firms) were 4.8% of the total estimated damages.

After reviewing the record summarized above, the Committee did not agree as to whether the litigation threats faced by the auditing profession are sufficient to justify substantial change to the current liability regime, or what change would even be most appropriate to limit liability risk.  Some Committee members believed that the “catastrophic litigation risk faced by the auditors of public companies is an unacceptably severe hazard to auditing firms, to investors, and to the stability of the U.S. capital markets, requiring actions to reduce the hazard.”  Others, however, simply did not believe the case had been made that the risk of litigation is catastrophic and they opposed significant change to the liability regime for auditing firms.

Given the lack of consensus among its members, the Committee made no recommendation on this issue in its report, and concluded by stating:

This Committee’s charge is primarily to identify matters impacting - positively and negatively - audit quality and the sustainability and competitiveness of the auditing profession. While the Committee’s charge does not include venturing into the general area of litigation policy, some Committee members feel that if, and when, such change is considered, it should go forward in a context broader than just consideration of the impact on the auditing firms. Litigation is clearly of significant concern to the auditing firms but is also of concern to investors and other market participants. And, changes in the litigation environment impacting auditors may potentially affect other market participants. The Committee believes it is important that the litigation system be fair and rational in serving the needs of both auditing firms and the public interest. However, as noted above, Committee members could not agree whether or not the existing litigation system satisfies those objectives.

Read the Final Report of the U.S. Treasury Department’s Advisory Committee on the Auditing Profession