The SEC has walked away from its fraud case against Edward Steffelin, a financial adviser who helped J.P. Morgan structure a CDO deal. On Friday, Judge Miriam Cedarbaum approved the SEC’s decision to dismiss the case with prejudice. The SEC had alleged that Steffelin knew that a hedge fund had helped select the assets for the CDO and then bet against the CDO and that Steffelin had failed to make sure that the hedge fund’s involvement was disclosed to investors. Steffelin was the first individual in a case arising out of the financial crisis who was charged by the SEC with only negligence under the securities laws, instead of intentional fraud.
Continue Reading SEC Dismisses Fraud Action Against CDO Manager With Prejudice

On Tuesday, Judge Gardephe rejected an attempt by Reserve Management Company (RMCI), the investment adviser to the Reserve Primary Fund – the money market fund that “broke the buck” four years ago after Lehman’s bankruptcy – to send its malpractice action against Wilkie Farr & Gallagher LLP back to state court. The Court concluded that the exercise of federal jurisdiction over the action was appropriate because of the “strong federal interest in the federal securities law issues raised in RMCI’s malpractice complaint.” As we reported previously, in defending the SEC’s securities fraud action against them, RMCI and two of its principals have claimed that they relied on Wilkie’s advice in communicating with the public on September 15 and 16, 2008 and considering a credit support agreement that would preserve the Primary Fund’s $1.00 NAV. RMCI’s malpractice action against Wilkie asserts that Wilkie provided incompetent advice to RMCI that led to it being sued by the SEC and private parties. It also alleges that Wilkie’s simultaneous representation of RMCI and the Reserve Primary Fund presented a conflict of interest that the firm never disclosed to RMCI and that has caused significant prejudice to RMCI. RMCI claims that Wilkie failed to advise RMCI properly about including an indemnification and advancement of attorney fees provision in the management agreement between RMCI and the Reserve Primary Fund.
Continue Reading Judge Gardephe Won’t Send Reserve Fund Malpractice Suit Back to State Court

Trial in the SEC’s securities fraud action against several entities and individuals who managed the Reserve Primary Fund – the money market fund that “broke the buck” four years ago after Lehman Brothers announced its bankruptcy – is slated to begin on October 1, 2012. Earlier this week, in anticipation of the looming trial date, Judge Paul Gardephe issued a series of evidentiary rulings. They were a mixed bag for the parties. On the one hand, Judge Gardephe rejected the SEC’s attempt to prevent the Reserve Fund defendants from pursuing an advice of counsel defense. On the other, he ruled that two of defendants’ expert witnesses could not testify at trial. These rulings could have a substantial effect on the trial or on any settlement negotiations between the parties.
Continue Reading Judge Gardephe Allows Reserve Fund Defendants to Proceed with Advice of Counsel Defense

Last Friday, Judge Crotty denied the attempt of three former Fannie Mae executives to dismiss the SEC’s charges that they mislead investors about the company’s exposure to subprime mortgages. Judge Crotty found that the SEC had adequately alleged that Fannie Mae’s “quantitative subprime disclosures were misleading” because “they failed to include all loans that fell within [Fannie Mae’s] subprime and Alt-A description.” In allowing the SEC’s civil fraud suit to proceed, Judge Crotty rejected the defendants’ argument that they were exempt from liability because the Securities Exchange Act of 1934 does not apply to employees of any “independent establishment of the United States,” and Fannie Mae, as a government-sponsored enterprise chartered by the federal government, qualifies as such an establishment. Although Judge Crotty held that Fannie Mae is a government instrumentality, he concluded that it is not an “independent establishment” within the meaning of the Act given that it is a publicly-traded corporation managed and controlled by a Board of Directors elected by its shareholders.
Continue Reading Judge Crotty Rejects Ex-Fannie Mae Executives’ Bid to Dismiss SEC Charges

Yesterday, the SEC asked Judge Barbara Jones to reinstate certain securities fraud claims against Goldman Sachs trader Fabrice Tourre relating to the sale of CDO notes to IKB, a German financing bank. Judge Jones dismissed these claims last June because the transaction was not a “domestic securities transaction” under the Supreme Court’s 2010 decision in Morrison v. National Australia Bank Limited, 130 S. Ct. 2869 (2010). It fell outside Section 10(b) of the Exchange Act. The SEC asserts in its motion that a recent Second Circuit case adopted a “broader” definition of “domestic securities transaction” than Judge Jones and that under that broader definition, the sale is a “domestic securities transaction” subject to U.S. law. According to the SEC, in Absolute Activist Master Fund Limited v. Ficeto, 672 F.3d 143 (2d Cir. 2012), the Second Circuit held that a transfer of title to securities within the United States is sufficient to satisfy the “domestic securities transaction” test. The SEC claims that the closing of the CDO transaction took place in New York and that title to the notes also transferred in New York. Based on the alleged transfer of title within the U.S., the SEC contends that it should be allowed to pursue its fraud claims against Tourre arising from the sale of the notes.
Continue Reading SEC Moves to Reinstate Fraud Claims Against Goldman Trader Fabrice Tourre

Last Wednesday, Judge Rakoff explained why, back in February, he denied ex-Citigroup executive Brian Stoker’s motion to dismiss the SEC’s enforcement action against him. As we previously blogged, the SEC has charged Stoker with securities fraud in connection with a CDO that he allegedly helped to create and market. The SEC contends that Stoker failed to disclose to investors that Citigroup influenced the selection of the CDO’s assets and then shorted those assets. Judge Rakoff’s decision is significant in two respects. First, it holds that to state a claim under Section 17(a)(2) of the Securities Act of 1933, the SEC is required to allege only that a defendant “obtained money or property for his employer while acting as its agent” or, alternatively, that the defendant “personally obtained money indirectly from the fraud.” While acknowledging that the case law is “surprisingly sparse, and inconclusive” on this point, Judge Rakoff rejected Stoker’s argument that Section 17(a)(2) requires that a defendant must have personally obtained money or property by means of the alleged misleading statements or omissions.
Continue Reading Judge Rakoff Explains Denial of Ex-Citigroup Executive’s Motion to Dismiss SEC Action

Yesterday, defendant Perry Gruss moved to certify for immediate appeal Judge Sweet’s recent ruling in SEC v. Gruss concerning the extraterritorial application of the Investment Advisers Act. In a case of first impression, Judge Sweet held that that the Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010), did not bar SEC enforcement of Section 206 of the IAA even where the alleged fraud involved a foreign investor subject to a foreign securities regulatory regime. Judge Sweet concluded: “To bar the SEC, the government agency tasked with the job of regulating investment advisers from initiating an action against a domestic adviser because his actions defrauded a foreign investor would defeat the purposes of the IAA.” Judge Sweet’s ruling was the first to consider the implications of Morrison for IAA Section 206 enforcement actions. In Morrison, the Supreme Court held that Section 10(b) of the Securities Exchange Act of 1934 did not apply extraterritorially. In seeking certification, Gruss stated that whether Section 206 has extraterritorial reach is “an issue of first impression of national importance” because Section 206 is “one of the key antifraud provisions in the federal securities laws” and is “routinely relied on by the SEC to protect investment funds.” The Second Circuit’s early resolution of the issue therefore could affect “numerous on-going non-public SEC investigations as well as cases pending in district courts across the country.”
Continue Reading SEC Defendant Seeks Certification of Judge Sweet Ruling that Investment Advisers Act Can Be Applied Extraterritorially

The SEC recently asked Judge Rakoff to compel Citigroup Global Markets, Inc. to produce attorney-client privileged communications concerning a CDO offering. It did so because, in defense to an SEC enforcement action, a banker asserted that he reasonably relied on Citigroup’s internal processes – including its attorneys – to handle the disclosure of information that the SEC claims was misleadingly omitted from the offering documents. In a letter filed Thursday, the parties told the court that they had resolved the issue, but the terms were not disclosed. The parties’ resolution of the motion leaves open an interesting issue. In the underlying case, the SEC charged a former Citigroup employee, Brian Stoker, with failing to disclose material facts in a CDO’s offering circular and pitch book. The SEC alleges that these omissions included Citigroup’s influence over the selection of assets for the CDO and its retention of a proprietary short position in the assets it helped to select. Stoker answered that he “reasonably relied on Citigroup’s institutional processes to ensure adequate review – both legal and managerial – and disclosure of material information, and he cannot be held liable for alleged failings of those processes.”
Continue Reading SEC Resolves Motion to Compel Attorney-Client Communications Where Defendant Has Asserted Reasonable Reliance Defense