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XPP-PDF Support Utility A BNA, INC. SECURITIES! REGULATION & LAW REPORT Reproduced with permission from Securities Regula- tion & Law Report, 41 SRLR 360, 3/2/2009. Copyright ஽ 2009 by The Bureau of National Affairs, Inc. (800- 372-1033) http://www.bna.com ENFORCEMENT Top 10 SEC Enforcement Developments of 2008 1 BY MARC DORFMAN AND ELLEN WHEELER Madoff , as well as to the departure of the SEC’s Direc- tor of the Division of Enforcement, Linda Thomsen.2 his article highlights significant developments dur- The Madoff scandal and its fallout are the Number One ing 2008 in the enforcement program of the U.S. enforcement development of 2008. T Securities and Exchange Commission (‘‘SEC’’). Developments were selected because they may signal The SEC’s enforcement actions and investigations re- future trends or establish new legal standards. lating to auction rate securities and the subprime lend- Many commentators predicted that SEC enforcement ing market during 2008 were noteworthy, and include actions arising from the freezing of the auction rate se- the largest settlements in the history of the SEC on be- curities market or the subprime lending meltdown half of investors. While it is difficult to make any pre- would lead the list of important SEC enforcement devel- dictions in the current economic and regulatory cli- opments in 2008. Such cases have been overshadowed, mate, these proceedings provide some guidance as to however, by the unraveling of the $50 billion Ponzi the types of cases the SEC is likely to pursue in 2009. scheme allegedly perpetrated by Bernard Madoff and The SEC’s response to the freezing of the auction rate the intense scrutiny of the SEC that has followed. In- securities market is the Number Two enforcement de- deed, in the weeks following the initial Madoff disclo- velopment, while the SEC’s cases relating to the sures, the SEC has been subjected to a firestorm of criti- subprime market, including actions against mortgage cism by the media and Congress, leading to an an- brokers, is the Number Three enforcement develop- nouncement that the SEC’s Inspector General was ment, of 2008. investigating the SEC’s regulatory failures relating to The remaining Top Ten developments highlight other significant issues and trends in the SEC enforcement program: Marc Dorfman and Ellen Wheeler are mem- s bers of the Securities Enforcement & Liti- The Number Four enforcement development of gation Practice Group of Foley & Lard- 2008 is the emphasis that the SEC has placed on pursu- ner LLP. Adrian Jensen also contributed to the ing insider trading, including the highest number of in- preparation of this article. Foley & Lardner LLP represents parties who are the subject of 1 Press Release No. 2008-297 (available at http:// SEC enforcement inquiries and actions, www.sec.gov/news/press/2008/2008-297.htm). including in cases discussed in this article. 2 Press Release No. 2009-22 (available at http:// www.sec.gov/news/press/2009/2009-22.htm). COPYRIGHT ஽ 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 0037-0665 2 sider trading cases in the SEC’s history as well as the off Securities is the world’s largest Ponzi Scheme.’’5 first Section 21(a) report since 2005. The thrust of Mr. Markopolous’s analysis was that there s Number Five is the SEC’s continued focus on vio- simply were not enough options traded in any market to lations of the Foreign Corrupt Practices Act of 1977. support the trading strategy that Madoff was allegedly s Number Six is the Ninth Circuit’s reversal of a dis- pursuing according to the materials provided to Mad- trict court opinion challenging ‘‘stealth’’ parallel pro- off’s investors. While the SEC investigated Mr. Marko- ceedings. polous’s tips, the SEC’s enforcement staff closed the s case asserting that, while the staff had found minor dis- Number Seven is the SEC’s first market manipu- closure violations, ‘‘[t]he staff found no evidence of lation case based on rumor mongering. fraud’’ and that the violations they had found ‘‘were not s Number Eight is the First Circuit’s decision poten- so serious as to warrant an enforcement action.’’6 tially expanding the scope of primary liability for mis- The SEC has been widely criticized in the media for statements contained in prospectuses. not taking earlier action on complaints against Madoff s 7 Number Nine is the Second Circuit’s decision af- and BMIS. On December 16, 2008, then Chairman Cox firming dismissal of an indictment based on the govern- issued a statement acknowledging that ‘‘credible and ment’s interference with an employer’s advancement of specific allegations’’ regarding Madoff’s conduct going legal fees to individuals. back to at least 1999 were repeatedly brought to the s Number Ten is the Eleventh Circuit’s decision up- staff’s attention, but never recommended to the Com- holding penalties and disgorgement despite the defen- mission for action.8 He further stated that he was dant’s claimed inability to pay. ‘‘gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these al- legations or at any point to seek formal authority to pur- 1. The Fallout from the Madoff Scandal sue them.’’ Cox also noted that the failure to seek a for- mal order of investigation meant that the staff relied on On December 11, 2008, the SEC filed a complaint information voluntarily produced by Madoff and BMIS, with the U.S. District Court for the Southern District of rather than using subpoena power. Cox stated that he New York against Bernard L. Madoff (‘‘Madoff’’) and had directed the SEC’s inspector general to conduct an Bernard L. Madoff Investment Securities LLC 3 investigation into ‘‘the past allegations regarding Mr. (‘‘BMIS’’). The SEC alleged that Madoff had admitted Madoff and his firm and the reasons they were not to two senior employees of BMIS that the investment found credible....’’ advisory business was ‘‘basically, a giant Ponzi scheme’’ and estimated losses from this fraud to be ap- On January 5, 2009, SEC Inspector General H. David proximately $50 billion.4 Kotz testified before the U.S. House of Representatives Committee on Financial Services and reported that his Within days of the SEC’s filing of its complaint, the office had opened an investigation and that it intended Wall Street Journal reported that a competitor of Mad- to investigate the following specific issues: (1) the off had, for almost ten years, attempted to alert the SEC SEC’s response to complaints regarding Madoff; (2) al- to Madoff’s misconduct. Harry Markopolous, then chief legations of conflicts of interest regarding relationships investment officer at Rampart Investment Management between SEC staff and members of the Madoff family; Co., even submitted a paper to the SEC entitled ‘‘The (3) the conduct of examinations and/or inspections of World’s Largest Hedge Fund is a Fraud’’ in November BMIS and whether any red flags were overlooked; and 2005, in which he surmised that Madoff was either (4) the extent to which Madoff’s reputation, his mem- front-running his customers or, more likely, that ‘‘Mad- bership on SEC Advisory Committees, his participation on securities industry boards and panels, and his social 3 Complaint in SEC v. Bernard L. Madoff & Bernard L. and professional relationships with SEC officials may Madoff Inv. Sec. LLC, Case No. 08 CIV 10791 (available at have affected decisions regarding investigation and ex- http://www.sec.gov/litigation/complaints/2008/comp- aminations.9 Perhaps of more far-reaching conse- madoff121108.pdf). On that same day, the U.S. Attorney for quence, Inspector General Kotz also testified that his the Southern District of New York filed a criminal complaint office also ‘‘plans to consider analyzing’’ certain against Madoff based on the same allegations. See criminal broader issues, including: (1) the Division of Enforce- complaint in U.S. v. Bernard L. Madoff, Case No. 08 MAG 2735 (available at http://www.usdoj.gov/usao/nys/madoff/ ment’s complaint handling procedures; (2) the SEC’s criminalcomplaint.pdf). Office of Compliance, Inspection and Examination’s 4 SEC Complaint, at ¶ 23. 5 Available at http://online.wsj.com/documents/madoff_ SECdocs_20081217.pdf. 6 SEC Division of Enforcement Case Closing Recommenda- Note to Readers tion (available at http://online.wsj.com/public/resources/ documents/Madoff_SECRecommend_20081217.pdf). The editors of BNA’s Securities Regulation & 7 See Julie Creswell & Landon Thomas Jr., The Talented Law Report invite the submission for publica- Mr. Madoff, N.Y. Times, Jan. 24, 2009, at BU1 (‘‘Current and tion of articles of interest to practitioners. former S.E.C. regulators have come under fire, accused of fail- ing to adequately supervise Mr. Madoff and being too cozy Prospective authors should contact the Manag- with him.’’). ing Editor, BNA’s Securities Regulation & Law 8 Press Release 2008-297 (available at http://www.sec.gov/ Report, 1801 S. Bell St. Arlington, Va. 22202- news/press/2008/2008-297.htm). 4501; telephone (703) 341-3889; or e-mail to 9 H. David Kotz, Inspector General, SEC, Testimony Before [email protected]. the U.S. House of Representatives Committee on Financial Services (Jan. 5, 2009) (available at http://www.sec.gov/news/ testimony/2009/ts010509hdk.htm). 3-2-09 COPYRIGHT ஽ 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665 3 procedures, including whether there are gaps in the 2. The SEC’s Response to the Freezing of procedures relating to hedge funds that may lead to a the Auction Rate Securities Market failure to detect fraud; and (3) the relationship between different divisions and offices within the SEC and Auction Rate Securities (ARS) are securities with whether there is adequate communication and collabo- variable interest rates or dividend yields which are re- ration.
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