On Thursday of last week, the SEC filed a insider trading lawsuit against a ring of seven individuals, including Matthew Devlin.  According to the SEC, for over four years Devlin secretly obtained, traded on, and shared with friends inside information from his unknowing wife, who had access to the information because she handled PR for companies entering into mergers and acquisitions.

The familial betrayal alleged by the SEC in the Devlin case is shocking, but hardly novel, unfortunately.  Indeed, there has been a long series of such cases through the years.  Here are my picks for the SEC’s Top 5 Familial Betrayal Cases, sorted by my all-new, color-coded “Familial Betrayal Advisory System.”

#5. SEC v. Melton (April 2007) — Betrayal Level: Low (”Someday We’ll Laugh About It”)

The SEC sued Gary Melton, the husband of an Amgen vice president, for insider trading in the stock of Abgenix, Inc. The SEC alleged that in early November 2005, Melton and his wife discussed the publicly announced favorable results of a clinical trial for an antibody jointly developed by Amgen and Abgenix. At the time, Melton commented to his wife that he might purchase some Abgenix stock, to which his wife said nothing.  A month later Melton’s wife learned through her employment at Amgen that Amgen was about to announce that it was acquiring Abgenix, and she specifically instructed Melton not to purchase Abgenix stock.

Despite his wife’s admonition, Melton promptly purchased 2,050 shares of Abgenix stock prior to the acquisition, and later liquidated his Abgenix stock for a profit of $15,252.

4.  SEC v. Rocklage (January 2005) — Betrayal Level: Guarded (”Counseling Required”)

The SEC sued Patricia Rocklage (the wife of the CEO of Cubist Pharmaceuticals), her brother, and others for insider trading in Cubist securities.  According to the SEC, on December 31, 2001, Rocklage’s husband informed her of the negative results of a clinical trial involving one of Cubist’s most important products, Cidecin.  However, unbeknownst to her husband, Ms. Rocklage had a “pre-existing understanding with her brother whereby she would give him a ‘wink and a nod’” if she ever became aware of any bad news about Cubist that might affect its stock price.  Ms. Rocklage told her husband that she intended to signal her brother to sell his Cubist stock, and her husband urged her not to do so.  The SEC alleged that “notwithstanding her husband’s entreaties, by no later than the morning of January 2, 2002, Ms. Rocklage provided ‘a wink and a nod’” to her brother, who promptly sold all of his 5,583 shares, avoiding a loss of nearly $100,000 when Cubist stock plummeted.

3.  SEC v. Edelman (January 2006) — Betrayal Level: Elevated (”Clothes Thrown Out Window”)

The SEC sued Lee Edelman for insider trading in the securities of Metron Technologies shortly before the August 2004 announcement that it was being acquired by Applied Materials. According to the SEC, Edelman learned about the acquisition negotiations while living with his girlfriend, an associate at a prominent New York law firm retained by Applied Materials. Edelman saw his attorney girlfriend working in their apartment, reviewing deal documents and discussing the transaction on the phone with colleagues, and used this information to secretly begin acquiring Metron shares.

The SEC alleged that several days later, Edelman’s girlfriend directly told him that she was working on an acquisition of Metron, but cautioned him that he could not use the information for any purpose. Edelman agreed not to misuse the information. Unbeknownst to his girlfriend and despite their agreement, Edelman continued acquiring Metron shares, ultimately making profits of $23,000. As a final kicker, it was later reported that a few weeks after he betrayed his girlfriend, Edelman broke up with her, to boot.

2.  SEC v. Stummer (April 2008) — Betrayal Level: High (”Restraining Order”)

The SEC brought an insider trading case against Michael Stummer for insider trading in the common stock of Ryan’s Restaurant Group. According to the SEC, on July 21, 2006, Stummer and his family arrived at the New York home of his brother-in-law for an annual weekend gathering. At this time, his brother-in-law served as director of a private equity firm advising a company on the acquisition of Ryan’s Restaurant Group. During the weekend visit, Stummer snuck into the brother-in-law’s bedroom office and secretly accessed his bedroom office computer. He then correctly guessed his brother-in-law’s password, gained access to the private equity firm’s computer network, and read several confidential and nonpublic emails relating to the Ryan transaction. The SEC alleges that Stummer used the information he obtained to buy 5,500 shares of Ryan’s over the next several days, ultimately realizing a profit of $22,351.17 after the acquisition was announced.

Stummer was subsequently featured in an article in Portfolio, which dubbed him the “Brother-in-Law from Hell” and asked:

What’s the worst thing your brother in law could possibly do at a big family gathering? Get drunk and hit on your spouse? Insult your mother? Break a family heirloom?

How about hack into your home computer, discover confidential information about a private equity deal you’re running, and trade on it illegally?

1.  SEC v. Devlin (December 2008) — Betrayal Level: Severe (”Hell Hath No Fury”)

As discussed above, the SEC sued Matthew Devlin last week for trading on and tipping his clients and friends with confidential, nonpublic information about 13 impending corporate transactions that allegedly led to $4.8 million in illegal profits. According to the SEC, Devlin obtained the information from his wife, a partner in the New York City office of an international public relations firm (Brunswick Group) that was working on the deals. The betrayal allegedly began just four months after the two got married in 2003, and went on for more than four years. Devlin’s wife, who just had a baby three weeks ago, reportedly had no idea that her husband was doing this and is “devastated beyond words.”

The SEC alleged that because the information from his wife was so valuable, Devlin and his friends, including co-defendant Jamil Bouchareb, dubbed Ms. Devlin the “Golden Goose.”  At one point, Devlin reportedly told Bouchareb, whose girlfriend Maria Checa was once a Playboy Playmate (and who is also named in the complaint as a relief defendant), “[your girlfriend] may be amazing at some things, but none of them are like the golden goose.”

Spurred by the recent insanity arrests events involving Marc Dreier and Bernard Madoff, I set out yesterday to create a Mount Rushmore of Securities Fraud in a post (click here) over at Securities Docket.  After much deliberation, I went with:

1. Marc Dreier
2. Bernard Madoff
3. David Pajcin and Eugene Plotkin; and
4. Lohmus Haavel & Viisemann (Lohmus) and two of its employees, Oliver Peek and Kristjan Lepik

You can read the post at Securities Docket for my reasoning, but I’m pretty comfortable with nos. 1, 2 and 3.  I think I can be persuaded to change #4, although the “Estonian Spider Hackers” from Lohmus are a personal favorite of mine.

Please weigh in below in the comments: Who do you think should be on the Mount Rushmore of Securities Fraud?

The SEC announced today (click here) that it has finalized settlements with Citigroup Global Markets, Inc. and UBS Securities LLC and UBS Financial Services, Inc. that will provide nearly $30 billion to tens of thousands of customers who invested in auction rate securities before the market for those securities froze in February. The SEC stated that the settlements “resolve the SEC’s charges that both firms misled investors regarding the liquidity risks associated with auction rate securities that they underwrote, marketed and sold.” In mid-February 2008, according to the complaints, Citi and UBS decided to stop supporting the ARS market, leaving tens of thousands of Citi and UBS customers holding tens of billions of dollars in illiquid ARS.

SEC Chairman Christopher Cox stated that “Today’s settlements are the largest in SEC history, and represent the largest return of customer money in the agency’s 75 years.”  The SEC said the settlements will restore approximately $7 billion in liquidity to Citi customers who invested in ARS, and $22.7 billion to UBS customers who invested in ARS.

Read that last part again: $22 billion! What does that even mean? Is UBS stroking a check or a series of checks in the amount of $22 billion? It turns out that the answer is no, and that UBS does not expect its cost to be even 5% of that amount.  In a press release from August 2008 (click here), when UBS first announced its settlement with the SEC and state regulators, UBS stated that:

The full cost of the proposed settlement, taking into account the projected redemption
patterns of clients, the difference between the purchase prices and the current market
value of client ARS holdings, and the regulatory fine related to the settlements, is
estimated to be in the range of USD 900 million on a pre-tax basis, to be booked in the
second quarter results. This includes reimbursements to all clients for losses incurred from sales of ARS holdings between Feb. 13 and Aug. 8, 2008.

This $900 million estimate includes $150 million in fines paid to state regulators, meaning that UBS estimates the total cost to it under the SEC settlement to be $750 million.

How does the number get from $22 billion to an expected total cost of $750 million?  I spoke today with UBS spokeperson Karina Byrne, who explained that the far lower expected cost is the result of several factors:

• Only a percentage of those eligible to participate and receive funds in the settlement from UBS will elect to do so.
• Nearly half of UBS payments need not be made until the middle of 2010, by which time the ARS market may have improved.
• Many of the ARS that UBS is offering to repurchase maintain a significant percentage of their market value, meaning that the net cost to UBS is only a fraction of par value.

The $750 million is a pre-tax number, as well, meaning that the total cost may be even less if it can be used as a tax deduction.  Ms. Byrne also explained that UBS will pay for the settlement via “a combination of standard financing solutions involving short and long term debt financing, as well as more specialized structured solutions.”

An SEC spokesperson confirmed to me that the SEC considers the amounts of today’s settlements to be the larger $22.7 billion (UBS) and $7 billion (Citigroup) figures in its press release.

A couple interesting things I heard this week from people who usually know what they’re talking about when it comes to the SEC:

• There were several articles today about the SEC’s “Restacking Project,” a reshuffling of offices for nearly all of the 1,900 SEC employees at its 3-year-old DC headquarter.  The reshuffling is apparently an effort to correct a problem with the the initial office plan, which mixed up staffers from the various Divisions on each floor rather than maintain the Divisions on their own floors.  The result of this original distribution of employees was that people in the same division had less communication with each other because they rarely saw each other, and had far more communication via email.

  Someone commented to me today that in a more traditional arrangement such as the old SEC building (pre-1995), where the Division of Enforcement employees and groups sat together, many of the intra-agency emails that were fodder for the Inspector General’s report in the Aguirre matter and the subject of scrutiny and criticism would never have existed.  Instead, employees would have just walked down the hall to discuss cases verbally.

• At a time when the SEC desperately needs a champion to represent it in Congress and in the transition effort, possibly to avoid being dispensed with altogether, some think it simply has no credible spokesperson right now.  The Chairman has been relentlessly criticized amd marginalized for his role, or lack thereof, in preventing and responding to the financial crisis, and the Director of Enforcement has been the subject of harsh criticism in the IG’s report in the Aguirre matter and also in a separate inquiry by Sen. Grassley related to questionable communications with JP Morgan about its possible acquisition of Bear Stearns.  Who is left to be the SEC’s champion?
• Leader in the clubhouse for next chairman of the SEC?  I’m hearing Harvey Goldschmid….

Mark Cuban has apparently devoted some time, like us, to reading the SEC IG’s Semiannual Report to Congress over this holiday weekend. And he has some thoughts about it that he is very happy to share on his “blog maverick” blog. He writes:

It never crossed my mind that it would be legal for employees of the SEC to trade stocks. Not that they shouldn’t have rights to own whatever they want in a trust. They should. Trading individual stocks and bonds. Wow.

There is a SEC policy in place regarding trading and what employees can and can’t do according to this report, but if you know about actions of one company, even if you don’t trade that company, doesn’t that provide you insight into an entire industry ?

But wait there is more. According to this report,

”we have determined that the Commission’s current system in place to report the ownership and trading of securities is insufficient to prevent and detect insider trading on the part of Commission employees or violations of the Commission’s rules.

The OIG investigation has found that the reports that employees are required to file when they buy, sell or own securities are not meaningfully reviewed or sufficiently checked for conflicts of interest. Moreover, there is currently no system in place for the Commission to detect if an employee who has traded or owns a security failed to properly report such transaction. “

Double wow.

He highlights some other bits of dirty laundry in the report, and concludes that it is “no wonder they released it on the Friday after Thanksgiving without any press release to let people know its available….”

Read Cuban’s post on “blog maverick”

Read the SEC IG’s Semiannual Report to Congress

As discussed in the prior post, “Legal Insider Trading?” (click here), I reached out to the SEC to get its take on the significance and implications of the assertion that corporate disclosures going out over the same PR wire service are being delivered at different times to investors. To briefly recap, a recent article by IR Web Report (click here) states that

leading PR wire services used for corporate disclosure do not deliver information simultaneously to all investors, and that “some investors, mostly professionals with access to expensive subscription services, are trading in extended hours on information they receive from companies up to several minutes ahead of most other investors who rely on public sources of information, such as company websites or popular investment websites like Yahoo! Finance.”

SEC spokesman John Nester declined to discuss the facts set forth in the IR Web Report specifically, but stated that

Regulation FD requires that when a company discloses material non-public information to one of the enumerated persons, it must simultaneously either file a Form 8-K or use an alternate means of public disclosure that is dissemination of the information through a method or methods of disclosure that is reasonably designed to provide broad non-exclusionary distribution of the information to the public.

Read into that what you want.  My sense, however, is that at the SEC does not consider the scenario laid out in the IR Web Report article to be a violation of Reg FD.

What do you think?  Please offer your opinion in the Comments section below.

For those of you who have been out of touch with the rest of the world for the past five hours, let me be the first to tell you that the SEC sued Dallas Mavericks’ owner/billionaire Mark Cuban today for insider trading.  Oh, and depending on the length of your recent isolation, you should probably also be aware that Barack Obama won the US presidential election.

Over at Securities Docket, today has been “all Mark Cuban, all the time.”  The easiest way to catch you up and for you to stay current on this is to visit the “Mark Cuban” tag link (click here), an ongoing thread of all of the Mark Cuban stories (five and counting today) on Securities Docket.  You can also check out the series of “Tweets” on this topic and others at Securities Docket’s Twitter feed (@SecuritiesD).

As widely reported last week, Brenda Murray, the Initiating Official tasked with reviewing and acting on the disciplinary recommendations of the SEC’s Inspector General in two high-profile matters, rejected the IG’s calls that discipline be imposed on several senior Enforcement officials. In separate reports dated November 7, 2008, Murray found that the IG’s Reports of Investigation did not support his conclusions in the Pequot/Aguirre matter or the W Holding Co./Bear Stearns matter, and that there was no basis in either case for following the IG’s recommendation as to disciplinary or performance-based action.

This flat-out rejection of the IG’s recommendations in both matters immediately drew a range of public responses. SEC Inspector General H. David Kotz, whose office conducted the investigations, issued a statement that his office was “surprised and disappointed by the administrative judge’s decisions…. We believe her findings were flawed and not supported by the evidence. We also have serious concerns about the process utilized in arriving at these decisions. We stand by our comprehensive and thorough reports 100 percent.” Mr. Kotz declined to elaborate on his statement above for this article.  U.S. Senator Charles Grassley, the ranking minority member of the Senate Finance Committee who helped initiate a re-investigation of the Aguirre matter, stated that “[i]t looks like the lawyers for the wrongdoers wrote the decisions.”

Privately, people at the SEC with knowledge of the matter go even further, stating that they are “stunned” by Murray’s decisions and the process that she used. An SEC official told me that Murray did not follow the standard procedure used by Initiating Officials in disciplinary matters, which is to examine only the record laid out in the IG’s report itself and decide based on that record whether disciplinary action is appropriate. If discipline is appropriate, the standard procedure is for the Initiating Official to draft a recommendation as to the type of discipline and then (and only then) seek comments and input from the subjects of the potential discipline.

To the contrary, for the two decisions she issued last week, Murray is said to have used a process that the SEC official with whom I spoke stated he had never seen in his many years of experience with a large number of cases. According to this official, Murray went outside the report, re-opened the record, and re-examined the facts by soliciting new statements from the subjects of the disciplinary recommendations. The official stated that it appeared that Murray made her decision that discipline was not appropriate based almost exclusively on the one-sided information she received from counsel for the various subjects. Notably, this information was not subject to any cross-examination or any follow-up by the IG’s office or other parties involved, and additionally was not provided under oath. The official stated that in his experience, such re-opening of the record is simply never done.

Seinfeld introduced us to the “low talker” (the woman whose almost inaudible voice led to Jerry wearing the puffy shirt (seen here) on the Today Show); the “high talker” (a man who talks with a really high-pitched voice); and even the “close talker” (seen here), the memorable character played by Judge Reinhold who invaded Jerry’s personal space.

Seinfeld seemed to exhaust the range of “talkers” but now, thanks to the SEC, we could have a new entrant: the “loud talker” supervisors at McKesson Corp. whose volume levels appear to have led to multiple insider trading cases.

The SEC filed not one but two insider trading cases today against employees of McKesson who are alleged to have separately “overheard” their supervisors discussing matters related to McKesson’s plans to acquire a company called D&K through a tender offer. Both employees allegedly then purchased shares of D&K prior to the announcement, and profited when the stock price shot from $8.50 to $14.30 per share after the deal was announced. Notably, it appears from the job descriptions of the supervisors included in the SEC’s two Litigation Releases (SEC v. Wilson; SEC v. Gallahair) that these were two different “loud talker” supervisors.

Its not clear to me what the lesson of these cases might be.  Use only low-talkers in supervisory roles, maybe?

After an investigation by the SEC Inspector General concerning allegations by Gary Aguirre that his supervisors in the Enforcement Division gave preferential treatment to the Chairman and CEO of Morgan Stanley in an investigation, the IG concluded in a report dated September 30, 2008 that senior Enforcement officials including Director Linda Thomsen should be disciplined. The IG investigation took eight months; involved the testimony or memoranda from 51 separate witnesses including five separate testimony sessions of Aguirre; involved the review of thousands if not hundreds of thousands of emails and documents; and ultimately resulted in a 191-page report.

In another IG investigation that resulted in a separate report also dated September 30, the IG concluded after an extensive investigation that SEC Regional Director David Nelson failed to vigorously enforce compliance with securities laws in connection with the W Holding Company, Inc. and Bear Stearns investigation.  The IG recommended that Nelson be subject to disciplinary and/or performance-based action.

On Friday of last week, SEC Administrative Law Judge Brenda Murray rejected any and all disciplinary action in either of the cases.  In the Bear Stearns case, Judge Murray wrote in a 9-page decision that “the IG’s Report of Investigation does not support his conclusions,” and that there was “no basis for following the IG’s recommendation as to disciplinary or performance-based action.”  Similarly in the separate Pequot/Aguirre matter, Murray found that the record did not support any disciplinary or performance-action against SEC Enforcement Director Linda Chatman Thomsen or Robert Hanson.

Kotz stated in an interview prior to the ALJ’s rejection of his recommendations that things had not gotten “icy” in the SEC building his office shares with the Enforcement Division despite his critical reports. This latest development essentially tossing out his disciplinary recommendations against his SEC colleagues may drop the temperature down a few more degrees, however.

Following the judge’s ruling, Kotz stated:

“We are surprised and disappointed by administrative judge’s decisions. We believe her findings were flawed and not supported by the evidence. We also have serious concerns about the process utilized in arriving at these decisions,” Kotz said in a statement. “We stand by our comprehensive and thorough reports 100 percent.”

Sen. Charles Grassley, R-Iowa, whose Senate committee requested the investigations, also expressed frustration:

“It looks like the lawyers for the wrongdoers wrote the decisions. It’s hard to believe that after everything that’s happened over the last two years, the Securities and Exchange Commission is refusing to hold anyone accountable for the misconduct exposed by two independent inquiries,” Grassley said in a statement.

Frankly, it’s all starting to remind me a bit of the cartoon below, with the IG being Sam the Sheepdog and the Enforcement Division being Ralph Wolf.  They head into the building together, grab some coffee and chat about the Redskins as they head to their offices.  Then they battle each other all day, every day, until the whistle blows and they carpool home together.