SEC Is Dealt Some Setbacks By Enforcement Dismissals

The latest setback came on Aug. 20, when Judge Graham C. Mullen of the Western District of North Carolina became the fourth judge to toss a case. And there are roughly a dozen similar hedge fund cases pending.

Judge Mullen found nothing illegal in the short sales of stock in CompuDyne Corp., just prior to private investment in public equity (PIPE) transactions. Generally, traders know that public stock prices drop immediately after announcement of a PIPE transaction. SEC v. Mangan, 2008 WL 3925059 (W.D.N.C.). Judge Mullen also threw out insider trading claims in the case.

“In our case there were all kinds of ways to address the issue but you can’t make it fit into a Section 5 [sale of unregistered securities] violation,” said George Covington of the Charlotte, N.C., office of Atlanta-based King & Spalding, who represented Mangan. “It is not illegal under current law.”

In January, Judge Sidney H. Stein of New York’s Southern District, finding that the agency had not stated a “plausible claim,” took a similar action dismissing the Section 5 claim in SEC v. Lyon, 529 F. Supp. 2d 444 (2008) (NYLJ, Jan. 8, 2008).

“I don’t know if it is economic times or the legal climate, but every now and then you run into a client who is not willing to roll over and has the gumption and ability to defend himself,” said Mr. Covington.

Judicial Philosophy

One former longtime prosecutor suggested judicial philosophy may be having an effect.

“Since we have been living under eight years of Republican rule, the judiciary has changed significantly and there are far more conservative judges who are skeptical of government, particularly in the regulatory area,” said Jeffrey Bornstein, a white-collar defense attorney in K&L Gates’ San Francisco office.

“They are not willing to give the benefit of the doubt to agencies like the SEC. That has translated into a willingness by defense counsel to feel the times are such that it is appropriate to fight back,” said Mr. Bornstein, who spent 20 years as an assistant U.S. attorney prosecuting complex and white-collar cases.

Richard Marmaro of the Los Angeles and San Francisco offices of New York-based Skadden, Arps, Slate, Meagher & Flom attributed defense wins to increased SEC aggressiveness.

“What I have seen is the SEC, in the last several years, has gotten more aggressive, and defense lawyers are forced to litigate rather than settle,” he said.

Mr. Marmaro won summary judgment for Jeffrey Weitzen, former chief executive officer of Gateway Inc., in 2007, four years after the case was brought accusing Mr. Weitzen and two other officers of securities fraud and earnings manipulation.

Judge Roger Benitez of the Southern District of California ruled that the SEC had no credible evidence against Mr. Weitzen and, although he was CEO, he was not a “person in control.” The issue is currently on appeal to the U.S. Court of Appeals for the Ninth Circuit.

For some defense lawyers, today’s courtroom headaches for the SEC may start with charging decisions years earlier.

“It always seems to start with what was going on then,” said Robert Rose, head of white-collar defense in the San Diego office of Los Angeles-based Sheppard, Mullin, Richter & Hampton. He represented Gateway’s chief financial officer and, although a jury convicted Chief Financial Officer John Todd and controller Robert Manza, the judge overturned a jury’s securities fraud verdict last year and imposed a minor fine. It is also on appeal.

In 2001, there were plenty of SEC investigations of corporate restatements around the country as the Enron Corp. scandal unfolded.

“At the beginning I assumed [Gateway] was deemed to be a very significant case before much was known about it,” he said. “The case was oversold by the region to headquarters and they were not going to back off, even when it turned into something different,” Mr. Rose said.

Also in 2001, the SEC charged more than 10 defendants in New Hampshire with market manipulation and false statements involving Cabletron Systems Inc.

In March, Judge Steven J. McAuliffe of the District of New Hampshire threw out the case against former General Counsel Eric Jaeger, saying that the SEC failed to allege sufficient facts to show Mr. Jaeger’s conduct was the proximate cause of alleged false filings. SEC v. Patel, 2008 WL 781914.

None of the directors or senior officers was called to testify during the Gateway trial, Mr. Rose said, despite 50 depositions and millions of pages of documents. Mr. Rose noted that the SEC insisted on a jury trial, though its past practice has been to accept defense preferences, whether jury or judge trial.

“In the last few years the SEC has come to realize there is anger among the general population at companies, and certainly at well-paid executives, that can be exploited,” Mr. Rose said.

“It is like a class warfare and that obscures what the case is about,” he said.

Pamela MacLean is a staff reporter for The National Law Journal, an affiliate of the New York Law Journal. This article originally appeared in Monday’s Law Journal.