S.E.C. v. Durgarian
| Decision Date | 06 March 2007 |
| Docket Number | Civil Action No. 05-12618-NMG. |
| Citation | 477 F.Supp.2d 342 |
| Parties | SECURITIES EXCHANGE COMMISSION, Plaintiff, v. Karnig H. DURGARIAN, Jr., Donald F. McCracken, Ronald B. Hogan, Virginia A. Papa, Kevin F. Crain, Sandra G. Childs, Defendants. |
| Court | U.S. District Court — District of Massachusetts |
Ian D. Roffman, Scott D. Pomfret, Securities and Exchange Commission, Boston, MA, for Plaintiff.
Frank A. Libby, Jr., Kelly, Libby & Hoopes, PC, Gary S. Matsko, David M. Cogliano, Davis, Malm & D'Agostine, P.C., Bruce A. Singal, Jamie L. Wacks, Donoghue, Barrett & Singal, PC, Kelley A. Jordan — Price, Michael J. Connolly, Hinckley, Allen and Snyder, LLP, Anthony Mirenda, Jennifer A. Cardello, Robert E. Toone, Jr., Foley Hoag LLP, Jason C. Moreau, John A. Sten, Greenberg Traurig LLP, Boston, MA, for Defendants.
This case involves a securities enforcement action brought against former officers and employees of Putnam Fiduciary Trust Company ("Putnam"), a subsidiary of Putnam Investments, which provides record-keeping and administrative services for mutual funds and retirement and defined contribution plans sponsored by various companies. The six defendants are: Karnig Durgarian, Jr. ("Durgarian"), formerly Putnam's Chief of Operations as well as Principal Executive Officer of several Putnam mutual funds, Donald McCracken ("McCracken"), former Head of Global Operation Services, Ronald B. Hogan ("Hogan"), former vice president in the new business implementation unit, Virginia A. Papa ("Papa"), former Director of the Defined Contribution Plan Servicing unit, Kevin Crain ("Crain"), former head of the plan administration unit and Sandra Childs ("Childs"), former head of both the compliance and new business implementation units. Currently pending before this Court are: 1) motions of all six defendants to dismiss all counts, 2) a motion of the SEC to amend its complaint if the Court grants, in whole or in part, the motions to dismiss and 3) a motion of Defendant Durgarian to strike two items referenced in the complaint.
The Complaint alleges that on January 2, 2001, Putnam failed to invest certain assets of the retirement and defined contribution plans of Cardinal Health, Inc. and Allegiance Health, Inc. (collectively, "the Combined Plan"), as requested. Putnam made the investment one day later, on January 3. As a result of the delay, the Combined Plan missed out on an estimated $4 million market appreciation that it would have earned if the funds had been invested on January 2. Despite the delay, an email from a representative of the Combined Plan to an unknown employee at Putnam indicated, that representatives of the Combined Plan were under the impression that the money had been invested on January 2 and had benefitted financially from the market appreciation.
The SEC filed a complaint against the defendants on December 30, 2005, alleging that the defendants violated various securities laws in an effort to conceal the fact that the Combined Plan's assets had not been invested on January 2. According to the facts alleged by the SEC, all of the defendants, as well as some other uncharged individuals, met numerous times to discuss the situation. At those meetings, defendant Durgarian stated that the one-day delay was not to be disclosed to the Combined Plan and that Putnam would not bear the cost of the shortfall. In order to make up the shortfall, Hogan revealed a plan he devised which would move money from other Putnam mutual funds to the Combined Plan through the use of "as of trades. By using those funds to make up the shortfall, the Combined Plan would not realize that it had not capitalized on the market appreciation. The Complaint alleges that all of the defendants agreed to the plan and Durgarian directed Hogan to execute the necessary trades.
An "as of trade is a backdated purchase or sale of a security that utilizes the net asset value ("NAV") from a prior day rather than the current day's NAV. The NAV is the price shareholders pay for mutual fund shares which is calculated by dividing the total value of the assets in a fund's portfolio by the fund's outstanding shares. An "as of trade is the purchase or sale of mutual fund shares at an NAV different than the present NAV and results in an artificial dilution (or increase) in the overall value of the fund.
Proper uses of "as of trading to correct trading errors are not themselves illegal. In order to protect mutual fund shareholders from being harmed by such "as of trades, Putnam had a "penny-per-share" policy which required that the party responsible for the error which necessitated the "as of trade to compensate for any harm if the value of the fund's per share NAV was reduced by at least one penny per share.
In this case, the SEC alleges that the harm caused by the "as of trades exceeded the penny-per-share policy and resulted in significant losses to Putnam's other mutual funds: $2.7M to the Research Fund, and a combined loss of $450,000 to the George Putnam Fund of Boston and three portfolios within the Asset Allocation Fund.
In order to conceal the costs of the "as of' trades to the unknowing shareholders of the mutual funds, the defendants allegedly agreed to further the fraudulent scheme by using various accounting adjustments to hide the incurred losses. Durgarian directed McCracken to find accounting adjustments that could be used to move money back into those mutual funds so that the net losses would drop below one penny-per-share and conceal the dilution caused by the "as of trades. According to the allegations, McCracken successfully directed his employees to identify accounting adjustments.
The Complaint alleges that the defendants also took further steps to conceal the fraudulent scheme. Following the execution of the "as of trades and accounting adjustments, Durgarian made several periodic certifications to the SEC that he had
disclosed to each registrant's auditors and the audit committee of each registrant's board of directors ... any fraud, whether or not material, that involves management or other employees who have a significant role in each registrant's internal controls.
Those certifications were filed with the SEC on numerous occasions in 2002 and 2003. Furthermore, in 2003, in response to an unrelated Putnam internal audit of the defined contribution plan servicing unit, defendants Childs, Crain and Papa made similar certifications to the auditors. The Complaint alleges that the four certifying defendants knew about the "as of trades and the accounting adjustments and that therefore, the certifications were false.
The alleged fraud first came to the attention of Putnam and the SEC in January, 2004 when defendant Crain left a message for an internal Putnam auditor which sparked an internal investigation. The investigation resulted in a correction to the price of the Research Fund, disclosure of the conduct to the Combined Plan investors, termination of the employment of defendants Durgarian, Papa and Hogan, and compensatory payments to the mutual funds, the Combined Plan and all affected shareholders.
The Complaint alleges three claims against all six defendants: 1) Violation of the Securities Exchange Act Section 10(b), 2) Violation of Securities Act Section 17(a) and 3) Aiding and Abetting Putnam's Uncharged Violations of the Securities Exchange Act Section 10(b). Moreover, the SEC alleges against defendant Durgarian, additional claims of violating the Investment Company Act Sections 34(b) and 37.
Each of the defendants has filed an individual motion to dismiss the charges against him or her. The defendants have filed a joint memorandum with respect to the three claims alleged against the group and, except for defendant Papa, have filed individual memoranda of law in support of their separate motions. Durgarian also filed a separate memorandum of law to address the two claims brought against him alone.
All of the defendants contend that the Complaint should be dismissed pursuant to Fed.R.Civ.P. 9(b), failure to state fraud claims with particularity, and Fed.R.Civ.P. 12(b)(6), failure to state a claim upon which relief can be granted.
Rule 9(b) of the Federal Rules of Civil Procedure requires that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." The instant enforcement action by the SEC involves claims of securities fraud, and thus, the heightened pleading requirements apply. The First Circuit Court of Appeals has interpreted the Rule 9(b) requirements to include "specification of the time, place, and content of an alleged false representation." Greebel v. FTP Software, Inc., 194 F.3d 185, 193 (1st Cir.1999)(quoting McGinty v. Beranger Volkswagen, Inc., 633 F.2d 226, 228 (1st Cir.1980)). In applying that standard to securities fraud actions, this circuit has been notably strict and rigorous. Greebel, 194 F.3d at 193.
Given the number of defendants and the several claims brought by the SEC, the Court will address the heightened pleading standard only with respect to those individual claims that fail to meet its requirements.
A court may not dismiss a complaint for failure to state a claim under Fed.R.Civ.P. 12(b)(6) "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Judge v. City of Lowell, 160 F.3d 67, 72 (1st Cir.1998)(quoting Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)). In considering the merits of a motion to dismiss, the court may look only to the facts alleged in the pleadings, documents attached as exhibits or incorporated by reference in the complaint and matters of which judicial notice can be taken. Nollet v. Justices of the Trial Court of Mass.,...
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