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Thomas O. Gorman,
Dorsey and Whitney LLP
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    SEC Charges Adviser, Others In Fee Splitting Scheme

    April 15, 2014

    A registered investment adviser and its principals were named as Respondents in a proceeding that centers on allegations of undisclosed revenue sharing arrangements, conflict of interest, violations of the custody rule and misrepresentations about due diligence claimed to have been undertaken regarding investments. In the Matter of Total Wealth Management, Inc., Adm. Proc. File No. 3-15842 (April 15, 2014) is a proceeding in which the Respondents are: The firm, a registered investment adviser; Jacob Cooper, its co-founder, sole owner and CEO; Nathan McNamee, its current president and CEO; and Douglas Shoemaker, its co-founder and former chief compliance officer.

    Total Wealth is the owner and managing member of Altus Management, the general partner to the Atlas Funds. Atlas Fund Capital was founded by Mr. Cooper in 2009 to permit Total Wealth clients to pool their funds to meet the mandatory minimum investment requirements for certain funds. Two years later Mr. Cooper established the Atlus Portfolio Series pooled investment funds. Mr. Cooper makes all of the investments and recommendations. The investments of Total Wealth and the Altus funds are similar.

    Total Wealth obtains new clients through paid weekly radio broadcasts, referrals, webinars, the website and other marketing activities. Prior to the formation of the Altus funds, Total Wealth clients could put their investment funds directly in the offerings recommended by the investment adviser. After the formation of the Altus funds, Total Wealth and Mr. Cooper began advising former clients to transfer their investments to the Altus Capital Fund. New Total Wealth clients were also offered the Altus Capital Fund.

    Total Wealth established revenue sharing arrangements prior to the formation of the Altus funds. Under those arrangements other funds paid Total Wealth a fee for the placement of its clients’ investments in those funds. The revenue from these arrangements was distributed among the Respondents through a series of entities. While disclosure forms suggested that such arrangements “may” exist, the disclosures were materially incomplete and did not fully inform investors of the facts. Respondents McNamee and Shoemaker, two investment adviser representatives, were aware of these arrangements and the related misrepresentations and failed to fully disclose them to the clients.

    Total Wealth also violated the custody rule. A proposed new auditor sent the adviser a draft engagement letter. It quoted, in part, statements from an SEC staff publication regarding the audits of pooled investment vehicles and the Custody Rule. Total Wealth elected not to retain the auditor. Rather, an unqualified accountant was hired to conduct the audit which is not in accord with the Rule. The firm selected also lacked independence since it was instructed to audit the financial statements for Altus Capital Fund after preparing them. Messrs. Cooper and McNamee are alleged to have aided and abetted the violation of the custody rule.

    Finally, Total Wealth and Mr. Cooper misled Altus investors about the due diligence that was supposedly conducted with regard to investments selected. Potential investors were told that “rigorous due diligence” was conducted to select the investments. In fact Total Wealth received promotional materials, subscription agreements and unverified performance information for the underlying funds. It failed to review or analyze the documents or obtain any third party analysis.

    The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). It also alleges violations of Advisers Act Sections 206(1), 206(2), 206(4) and 207. The proceeding will be set for hearing.

    Circuit Court Largely Rejects Challenges To SEC Conflict Mineral Rules

    April 14, 2014

    The SEC largely prevailed in the D.C. Circuit Court of Appeals in a suit changing the Rules promulgated by the agency under Dodd-Frank regarding conflict minerals. National Association of Manufacturers v. SEC, No.. 13-5252 (D.C. Cir. Decided April 14, 2014).

    Section 1502 of Dodd-Frank directed the SEC to develop and issue rules the use of “conflict minerals” from the Democratic Republic of the Congo or DRC and its neighboring countries. Conflict minerals are gold, tantalum, tin and tungsten which are extracted from what the Court called technologically primitive mining sites in the remote eastern Congo. Armed groups profit by extorting, and in some instances managing, the largely unregulated mining operations. The armed conflicts among the groups, which are characterized by extreme violence that is particularly sexual and gender-based, have been financed at least in part through the sale of the conflict minerals.

    Dodd-Frank requires companies to disclose annually to the SEC if the minerals in their products “originated or may have originated in Congo” to help ensure activities involving such minerals do not finance or benefit the armed groups. If so, then the company must file an additional report with the SEC with a description of the products manufactured using the minerals.

    As directed by Congress, the Commission developed rules which require covered issuers to conduct a “reasonable country of origin inquiry” regarding their conflict minerals. If, after the inquiry, the company determines that its conflict minerals did not originate in the covered countries, the issuer must disclose that conclusion to the SEC along with its predicate. If the issuer concludes that the conflict minerals did originate for a covered country – or if it cannot make that determination – a report must be prepared and filed with the Commission.

    The District Court rejected the claims of Appellants. The Circuit Court largely affirmed.

    Appellants presented a series of challenges to the Rules under the Administrative Procedure Act, or APA, and one claim under the First Amendment. Under the APA Appellants have the burden of establishing that the agency acted in an arbitrary or capricious manner or that its action constituted an abuse of discretion or was otherwise not in accord with the law. Here the Association has not met that burden.

    First, the Association claims that the SEC should have included a de minimis exception. The Commission acknowledged that it has the authority to create such an exception. It found, however, that such an exception would be contrary to the statute and its purpose. In reaching this conclusion the agency relied on the text of the statute, context and policy concerns, inferring that “Congress wanted the disclosure regime to work even for those small uses.” This is sufficient the Court concluded.

    Second, Appellant challenges the provision requiring that an issuer conduct due diligence if, after inquiry it has reason to believe that its conflict minerals “may have originated” in “covered countries.” This provision contravenes the statute which only requires that a report be submitted when the conflict minerals did originate in a covered country, according to Appellant.

    In rejecting this claim the Court noted that the “Association has conflated distinct issues.” The statute does state that a report has to be prepared if the minerals originated from certain countries. It does not specify under what circumstances due diligence must be performed prior to filing that report. When a statute is silent or ambiguous with respect to a specific issue the Commission can exercise reasonable discretion in construing the statute. Here it has done that.

    Third, the Court rejected the Association’s contention that the standard regarding due diligence was to low. The Commission adopted a low standard so that issuers who encountered warning signs regarding the origin of the minerals would make inquiry to learn the source. A simple good faith inquiry would permit an issuer to perhaps ignore a red flag. While the Commission’s rule here is expansive, it could have gone further.

    Fourth, the Association’s claim regarding “persons described” is also incorrect. The statute specifically states that it applies to “persons described” and references manufactures of a product in which conflict minerals “are necessary to the functionality or production” of the product. If those persons file a report the statute requires them to describe products they “manufacture” or “contract to be manufactured.”

    The Commission applied the final rule not only to issuers that manufacture their own product but also to those who contract to manufacture. The Association is correct that the “person described” section only speaks of manufactures and is silent about contracting to manufacture while another section uses that phrase. The silence in that one section, however, permits the Commission to use its delegated authority to determine the scope of the overall provision as it has done here. Its interpretation is reasonable.

    The Court also rejected the Association’s final two points in this area. The temporary phase in rules which give large issuers two years and smaller ones four years are not inconsistent or arbitrary. Likewise, the Court did not “see any problems with the Commission’s cost-side analysis” which was “extensive.” While it is correct that the SEC did not conduct any analysis to determine whether the purpose of the statute could be achieved and relied on Congress for this point, that approach is permissible. The Commission was in fact required to promulgate the disclosure rule.

    The Court did, however, sustained the Association’s First Amendment claim. Here the challenge is to the requirement in the final rules that an issuer describe its products as not “DRC conflict free” in the report and must post on its website. The requirement unconstitutionally compels speech, according to the Association. The Court agreed.

    The critical issue here is the standard of review. The Commission argued that rational basis review is appropriate because the disclosure is purely factual and non-ideological. That standard of review is an exception used in certain instances when the disclosure is uncontroversial such as where the governmental interest is tied to preventing deception of consumers. Under this standard the government must show to compel speech that there is 1) a substantial governmental interest at stake, 2) which is directly and materially advanced by the restriction and 3) that the restriction is narrowly tailored.

    This case does not meet the test. As the Court stated “it is far from clear that the description at issue – whether a product is ‘conflict free’- is factual and non-ideological. The label ‘conflict free’ is a metaphor that conveys moral responsibility for the Congo war. It requires an issuer to tell consumers that its products are ethically tainted . . . By compelling an issuer to confess blood on its hands, the statute interferes with that exercise of the freedom of speech under the First Amendment.” Accordingly, the decision of the district court was affirmed in part and reversed in part and remanded for further proceedings consistent with the Court’s opinion.

    Circuit Judge Spinivasan concurred in the Court’s opinion regarding the APA challenges. He did not join the opinion with respect to the First Amendment issue. The question of whether the relaxed standard for reviewing compelled commercial speech applies only if the disclosure requirement serves a governmental interest in preventing consumer fraud is currently pending before the en banc court in another case. Under those circumstances a decision on the question should have been held until the resolution of that case.

    The SEC’s Continuing Investigation Regarding Carter’s, Inc.

    April 13, 2014

    Carter’s Inc. is the SEC investigation that just keeps on producing cases. Recently former firm vice president Richard Posey settled insider trading charges with the Commission after pleading guilty to one count of conspiracy in a parallel criminal action. SEC v. Posey, Civil Action No. 1:14-CV-664 (N.D. Ga. Filed March 6, 2014). See Lit. Rel. No. 22970 (April 10, 2014). Overall the Commission has brought six actions related to its investigation of Carter’s Inc. and entered into one non-prosecution agreement.

    Mr. Posey was a vice president of operations relating to various brands sold by the firm. That position required him to attend periodic internal staff meetings in which the operations and finances of the firm were discussed. Over approximately a three year period beginning in January 2006, Mr. Posey repeatedly traded in the shares of his employer while in possession of material non-public information he obtained through his position with the firm. Those trades were placed in violation of firm policy and procedures. The trades were placed in advance of earnings announcements and quarterly financial results, typically in the account of his wife. As a result of those trades he was able to make profits or avoid losses of about $49,778.

    Beginning in April 2009, and continuing through October 2010, Mr. Posey repeatedly furnished material non-public information about the company to Eric Martin, a former vice president and director of investor relations for Carter’s. Mr. Martin in turn tipped others. As a result of those trades Mr. Martin had profits or avoided losses of about $427,000. Two of the people Mr. Martin tipped avoided losses of about $3 million.

    The Commission’s complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b).

    Mr. Posey settled with the Commission, consenting to the entry of an order enjoining him from future violations of the antifraud provisions. That Order also directs him to pay disgorgement and prejudgment interest totally $60,265 and bars him from serving as an officer or director. The amount of a civil penalty will be determined by the Court on motion of the Commission.

    Other actions stemming from the Commission’s investigation of Carter’s Inc. include:

    Ø The non-prosecution agreement with the Company tied to a financial fraud. This was the first use of a non-prosecution by the SEC, announced December 2010 and discussed here.

    Ø SEC v. Elles, Civil Action No. 1:10-cv-4118 (N.D. Ga. Filed December 20, 2010, an action against Joseph Elles, a former EVP of Carter’s, based on financial fraud charges as discussed here.

    Ø SEC v. Pacifico, Case No. 1:12-cv-03636 (N.D. Ga. Filed October 18, 2012), an action against Joseph Pacifico, the one time president of the firm, and Joseph Elles, then EVP of sales, based on financial fraud charges as discussed here.

    Ø SEC v. Johnson, Civil Action No. 1;12-CV-03709 (N.D. Ga. Filed October 24, 2012), an action against Michael Johnson, an employee of Kohl’s department store, charged in connection with the financial fraud at Carter’s as discussed here.

    Ø SEC v. Martin, Civil Action, No. 1:12-CV-02922 (N.D. Ga. Filed August 23, 2012), an action against Mr. Martin, a one time EVP of finance at the company who repeatedly traded while in passion of inside information as discussed here.

    Ø SEC v. Magalli, Civil Action No. 1:13-CV-03783 (N.D. Ga. Filed November 14, 2013), an action against Mark Magalli who was furnished inside information about the company by Eric Martin and traded in four instances as discussed here.

    Ø SEC v. Rosenberg, Civil Action No. 1:13-CV-3559 (N.D. Ga. Filed Ocotber 29, 2013), an action against Dennis Rosenberg, an equity analyst who was also tipped by Mr. Martin and traded while in possession of inside information in four instances as discussed here.

    This Week In Securities Litigation (Week ending April 11, 2014)

    April 10, 2014

    Former hedge fund giant SAC Capital was sentenced this week. This concluded one of the most prominent insider trading cases. Under the terms of the sentence SAC Capital will no longer accept public funds.

    The DOJ and the SEC filed settled FCPA actions involving Hewlett-Packard and three of its subsidiaries. One subsidiary pleaded guilty to a multi-count information, a second entered into a deferred prosecution agreement while a third entered into a non-prosecution agreement. The parent company settled books and records and internal control charges with the Commission. Overall $108 million was paid to resolve the charges.

    This week the SEC also filed actions involving financial fraud, investment fund fraud and false filings by a stock transfer agent firm and its principals. The Commission also brought a market manipulation case coupled with unregistered broker-dealer charges.

    SEC

    Remarks: Commissioner Kara Stein addressed the North American Securities Administrators Association 2014 Public Policy meeting (April 8, 2014). Her remarks covered the lifting of the general solicitation ban, the disclosure review and high speed trading (here).

    Remarks: Commissioner Luis Aguilar addressed the North American Securities Administrators Association Annual NASAA/SEC meeting (April 8, 2014). His remarks reviewed the role of the states in Regulation A and the JOBS Act (here).

    Whistleblowers: The Commission announced that the whistleblower who received the first award under the new program was paid an additional $150,000 since additional funds were recovered. That person has now been paid 30% of what was recovered for a total of $200,000.

    CFTC

    Remarks: Commissioner Scott D. O’Malia delivered the Keynote address titled “If It’s Worth Fixing, it’s Worth Fixing Right” (April 7, 2014). His remarks covered the need for the agency to have an adequate technology budget, end-user energy traders and futurization (here).

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the Commission filed, or announced the filing of, 3 civil injunctive actions, DPAs, NPAs or reports and 6 administrative proceeding (excluding follow-on and Section 12(j) proceedings).

    Investment fund fraud: In the Matter of Keiko Kawamura, Adm. Proc. File No. 3-15826 (April 8, 2014) is a proceeding alleging that Respondent engaged in two investment schemes. In the first, which took place from December 2011 through mid-2012, Ms. Kawamura raised about $200,000 from seven investors for a hedge fund she claimed to manage. While the funds were supposed to be invested, much of the money was misappropriated. The small portion invested was lost on option trades. The second was initiated through a website. There the Respondent provided monthly investment advice for a fee. She has garnered about $50,000 from 70 different subscribers. The Order alleges violations of Advisers Acct Sections 206(1), 206(2) and 206(4), Securities Act Section 17(a) and Exchange Act Section 10(b). The proceeding will be set for hearing.

    False filings: In the Matter of Empire Stock Transfer, Inc., Adm. Proc. File No. 3-15827 (April 8, 2014) is a proceeding which names as Respondents the transfer agent and its president, Patrick Mokros. The Order alleges that filings made by the firm were materially false in two respects. First, they failed to disclose that Mr. Markos, the sole owner of the firm, financed its purchase by borrowing the funds from Marcus Luns who also played a significant role at the firm. Second, the registration forms failed to disclose the role of Matthew Blevins, retained in January 2007 to run the day-to-day operations. The Order alleges violations of Exchange Act Sections 17(a)(3) and 17A(c)(2). To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. Respondents also agreed to pay, on a joint and several basis, a civil penalty of $50,000. In addition, the firm agreed to implement undertakings which include the retention of an independent consultant regarding its policies and procedures. The firm will adopt the recommendations of the consultant. See also In the Matter of Matthew J. Blevins, Adm. Proc. File No. 3-15820 (April 8, 2014)(proceeding against Mr. Blevins arising out of his role with Empire Stock Transfer discussed above; settled with the entry of a cease and desist order based on the same Exchange Act Sections as in Empire Stock and the payment of a $25,000 civil penalty).

    Financial fraud: SEC v. CVS Caremark Corp., Civil Action No. 14-177 (D.R.I. Filed April 8, 2014) and In the Matter of Laird Daniels, CPA, Adm. Proc. File No. 3-15825 (April 8, 2014) are financial fraud actions centered on the two business segments of the company, its drug stores and pharmacy benefits manager or PBM as discussed in more detail here. First, in the Fall 2009 CVS filed a Prospectus Supplement for a $1.5 billion senior note offering. The supplements failed to disclose that the PBM segment of the business would lose significant amounts of business from the State of New Jersey, several large PBM contracts and as a result of the Medicare Part D bidding process. Second, the company changed the accounting for the acquisition of the Longs Drug Store chain which materially altered its results. This issue is central to the proceeding in which Mr. Daniels was named as a Respondent. The firm initially had a valuation done on a “continued use” basis in accord with its contractual obligations and later reversed that position. The reversal reduced the reported valuation for Longs tangible assets by $212 million with a corresponding increase in good will, compared to the January 2009 draft report prepared by the valuation expert firm CVS retained. CVS also made a one-time catch-up adjustment, reversing $49 million of depreciation taken from October 2008 through the end of June 2009, and did not take an additional $19 million of depreciation that would have otherwise been taken on the Longs properties for the period. The one time depreciation reversal increased third quarter 2009 EPS by about 2.4 cents. Despite the continued use premise, the drug store company completely wrote off all the personal property for about 430 of the 525 Long stores. This was contrary to GAAP since the adjustments failed: To reflect the expected future use of the Longs property as of the acquisition date; the information the firm had as of that date; and the firm did not account for the use by CVS of the assets to generate revenue after the acquisition date. This materially altered quarterly results.

    Finally, statements made by the then CVS CFO during a November 5, 2009 earnings call were materially incorrect since they failed to state that the announced and favorable PBM retention rate – a key metric – was calculated using a different methodology and did not take into account the projected business loses. Investors also were not told that the announced EPS number was in part the result of a material change in accounting regarding the Longs acquisition. Both actions settled. CVS consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) and each subsection of Securities Act Section 17(a). The firm also agreed to pay a $20 million penalty. See Lit. Rel. No. 22968 (April 8, 2014). Mr. Daniels, who was alleged to have violated Securities Act Sections 17(a)(2) & (3), consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(B) and 13(b)(2)(B) and Section 17(a). He will pay a penalty of $75,000. Mr. Daniels will be denied the privilege of appearing or practicing before the Commission as an accountant with the right to reapply after one year.

    Investment fund fraud: SEC v. JCS Enterprises, Inc., Civil Action No. 14-civ-80468 (S.D. Fla. Filed April 7, 2014) is an action against JCS, T.B.T. Inc. and their respective principals Joseph Signore and Paul Schumack. The complaint alleges that since 2011 the defendants have raised nearly $40 million by inducing investors nationwide to purchase interests in ATM like machines which were supposed to be a Virtual Concierge, dispensing tickets to various events. Investors were told that they could earn returns ranging from 80% to 120% annually and up to 500% over the life of a three to four year investment contract. Sales would be through advertising. Investors were solicited through YouTube, e-mails and seminars. The claims were false. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). A freeze order was obtained on filing. A parallel criminal case has also been filed. See Lit. Rel. No. 22969 (April 8, 2014).

    Investment fund fraud: SEC v. Sample, Civil Action No. 3:14-cv-1218 (April 4, 2014) is an action alleging that Mr. Sample, using his firm Lobo Volatility Fund, LLC, raised about $1 million from five investors based on claims that he would invest their money and trade on their behalf. Instead he diverted a significant portion of the investor funds to his use and lost the balance trading. To try and cover his losses he provided investors with false documents. The Commission’s complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). Mr. Sample consented to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint and to an order prohibiting him from soliciting or accepting funds from others for any unregistered securities offering. The Commission requested that the Court order the payment of disgorgement, prejudgment interest and impose civil penalties. See Lit. Rel. No. 22967 (April 7, 2014).

    Failure to disclose: In the Matter of Larry C. Grossman, Adm. Proc. File No. 3-15617 (Nov. 20, 2013) is a previously filed proceeding naming as Respondents Larry Grossman and Gregory Adams. The two men were affiliated with registered investment adviser Sovereign International Asset Management, Inc. Mr. Grossman was the sole owner of Sovereign from the time of its formation in 2001 until October 2008 when he sold the firm and its affiliates to Mr. Adams. After the sale Mr. Grossman continued to be affiliated with the adviser until the firm was administratively dissolved in 2012. Sovereign had about $85 million in assets under management at its peak in 2008. Many of its investors were retirees. Shortly after forming Sovereign, Mr. Grossman met Nikolai Simon Battoo, the principal of BC Capital Group, S.A. and its affiliated companies and a defendant in another Commission action. In 2003 Mr. Grossman executed three referral agreements and one consulting contract on behalf of a Sovereign affiliate with funds and entities controlled or owned by Mr. Battoo. Under the three agreements referral fees were paid to Sovereign. The fourth called for the payment of fees directly to Mr. Grossman for consulting services. From August 2003 through October 2008 Mr. Grossman recommended to Sovereign clients that they invest almost exclusively in off-shore funds in the Battoo group without disclosing the full risks including the fact that they were cross-collateralized. Likewise, the fees paid were not properly disclosed. In 2008 when one of the Battoo funds suspended redemptions, Mr. Grossman failed to inform investors. Investors also were not told investors of other difficulties with the funds. Yet by 2010 Mr. Battoo refused to permit withdrawals from another fund. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 15(a) and Advisers Act Sections 206(1), 206(2), 206(3), 206(4) and 207. The proceeding will be set for hearing. Mr. Adams partially resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to be barred from the securities business. In addition, Mr. Adams agreed to pay disgorgement and a third tier civil penalty in amounts to be determined later.

    Manipulation/broker registration: In the Matter of Visionary Trading LLC, Adm. Proc. File No. 3-15823 (April 4, 2014) is a proceeding which names as Respondents the firm; its four owners, Joseph Dondero, Eugene Giaquinto, Lee Heiss and Jason Mdevin; and Lightspeed Trading LLC, a registered broker dealer, along with its COO, Andrew Actman. Mr. Dondero, one of the owners of Visionary, is alleged to have engaged in manipulative trading in violation of Exchange Act Sections 9(a)(2) and 10(b). In 2009 he employed a manipulative practice known as “layering” or “spoofing.” Utilizing this technique Mr. Dondero obtained profits of $984,398. Other charges stem from an arrangement involving Visionary Trading. Beginning in May 2008, and continuing through November 2011, the firm’s owners and others engaged in day trading from its offices in New Jersey. Lightspeed was the broker. In connection with that trading two registered representatives of the firm shared their transaction based compensation with Visionary and its owners. Over the period Lightspeed retained about $330,000 in commissions but paid out approximately $474,407. With regard to the fee splitting arrangement the Order alleges that: 1) Visionary and its owners violated Exchange Act Section 15(a)(1); 2) that Lightspeed and Mr. Giaquinto aided and abetted and caused Visionary’s and its owner’s violations of Section 15(a)(1); 3) that Lightspeed failed to reasonably supervise Mr. Giaquinto; and 4) that Mr.Actman failed to reasonably supervise Mr. Giaquinto.

    Each of the Respondents resolved the proceeding by consenting to the entry of a cease and desist order based on the Sections cited in the Order as to them. Lightspeed was also censured. In addition, Messrs. Giaquinto, Heiss and Medvin were barred from the securities business and from participating in any penny stock offering with a right to apply for reentry after two years. Mr. Dondero was also barred from the securities business and from participating in any penny stock offering. Mr. Actman was barred from association in a supervisory capacity in the securities business with a right to apply for reentry after one year. Lightspeed agreed to pay disgorgement of $330,000, prejudgment interest and a civil penalty of $100,000 plus agreed upon post-Order interest of $308.22. Respondents Giaquinto, Hess and Medvin will pay disgorgement of $118,601 plus prejudgment interest and a civil money penalty of $35,000 each. Respondent Dondero will pay disgorgement of $1,102,999.96, prejudgment interest and a civil penalty of $785,000. Mr. Actman will pay a civil money penalty of $10,000 plus agreed upon post-Order interest of $46.23.

    Criminal cases

    Insider trading: U.S. v. SAC Capital Advisors LP, No. 13-cr-00541 (S.D.N.Y.) is the insider trading action against the once giant hedge fund. Previously, the firms pleaded guilty to the five count information. The Court imposed a sentence that includes a criminal fine of $900 million, a five year term of probation for each company, a condition that the SAC Hedge Fund terminate its investment advisory business and an requirement that the defendants and any successor entities employ compliance procedures necessary to identify and prevent insider trading. The defendants are required to retain an independent compliance consultant who will review, revise and report to the Government on those compliance procedures. Previously, the SAC Capital Hedge Fund was directed to pay $1.184 billion financial penalty in addition to the $616 million paid to the SEC.

    Investment fund fraud: U.S. v. Colangelo (S.D.N.Y.) is an action against Stephen Colangelo. It alleged that he operated two investment fund frauds which resulted in $3.5 million in investor losses. In one he solicited funds for the Brickell Fund. Investors were told he would take a very small management fee and receive a percentage of the profits. In the other he solicited investments for a group of companies collectively called the Business Ventures. It was supposed to invest the funds in various businesses. In fact he misappropriated much of the money. Previously, he pleaded guilty to two counts of securities fraud and two counts of wire fraud. He was sentenced to serve 87 months in prison followed by three years of supervised release and pay restitution of $3.5 million.

    FCPA

    Hewlett-Packard: The Russian, Polish and Mexican subsidiaries of Hewlett-Packard Company resolved criminal FCPA charges with the Department of Justice while the parent corporation settled with the SEC. ZAO Hewlett-Packard A.O., or HP Russia, made payments through its agents to retain a multi-million dollar contract with the federal prosecutors office. The payments were channeled through shell companies. In Poland agents and employees of Hewlett-Packard Polska, Sp.Z.o.o., or HP Poland furnished cash and gifts to government officials to obtain contracts with the national police agency. In Mexico Hewlett-Packard Mexico S.D. R.L. de C.V., or HP Mexico made improper payments to a third party in connection with a sale of software to Pemex. Overall the firm earned about $29 million on the contacts.

    To resolve the action with the DOJ HP Russia agreed to plead guilty to a criminal information alleging conspiracy and violations of the FCPA bribery provisions. U.S. v. ZAO Hewlett-Packard A.O., Case No. CR 14 201 (N.D. Cal.). HP Poland resolved FCPA accounting violations by entering into a deferred prosecution agreement while HP Mexico, entered into a non-prosecution agreement. U.S. v. Hewlett-Packard Polska, SP.Zo.o., Case No. 14 202 (N.D. Cal.). In total the three entities agreed to pay $76,760,224 in criminal penalties and forfeiture.

    Hewlett-Packard Company, the parent of HP Russia, Poland and Mexico, resolved SEC FCPA books and records and internal control provision charges with the Commission. The firm consented to the entry of a cease and desist order based on Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). HP also agreed to pay disgorgement of $29 million and prejudgment interest. A portion of the firm’s disgorgement obligation will be satisfied by the payment of $2,527,750 in forfeiture as part of HP Mexico’s resolution with the DOJ. The parent company also agreed to report to the Commission staff periodically, but not less than once each year, for three years on the status of its remedial efforts and the implementation of compliance measures. In addition, the company will report any credible evidence not previously reported of questionable or corrupt payments or transfers of property interests. In sum, the three subsidiaries paid over $108 million to resolve the charges. In the Matter of Hewlett-Packard Company, Adm. Proc. File No. 3-15832 (April 9, 2014). The actions are discussed in detail here.

    Hong Kong

    Pilot program: The Securities and Futures Commission has approved in principle the development of a pilot program to establishing mutual stock market access between Mainland China and Hong Kong. The program will operate between the Shanghai Stock Exchange and the Stock Exchange of Hong Kong Ltd., China Securities Depository and Clearing Corporaton Ltd and Hong Kong Securities Clearing Company Limited. This will permit investors to trade eligible shares listed on each exchange. The Shanghai-Hong Kong Stock Connect, as the project is called, is an important step in the opening of the China capital Markets according to the SFC.

    Former hedge fund giant SAC Capital was sentenced this week. This concluded one of the most prominent insider trading cases. Under the terms of the sentence SAC Capital will no longer accept public funds.

    HP, Three Subsidiaries Pay $108 Million To Settle FCPA Charges

    April 09, 2014

    The Russian, Polish and Mexican subsidiaries of Hewlett-Packard Company resolved criminal FCPA charges with the Department of Justice while the parent corporation settled with the SEC. ZAO Hewlett-Packard A.O., or HP Russia, agreed to plead guilty to a criminal information alleging conspiracy and violations of the FCPA bribery provisions. U.S. v. ZAO Hewlett-Packard A.O., CR 14 201 (N.D. Cal.). Hewlett-Packard Polska, Sp.Z.o.o., or HP Poland, resolved FCPA accounting violations by entering into a deferred prosecution agreement (U.S. v. Hewlett-Packard Polska, SP.Zo.o., CR 14 202 (N.D. Cal.)) while Hewlett-Packard Mexico S.D. R.L. de C.V., or HP Mexico, entered into a non-prosecution agreement. In total the three entities agreed to pay $76,760,224 in criminal penalties and forfeiture.

    Hewlett-Packard Company, the parent of HP Russia, Poland and Mexico, resolved SEC FCPA books and records and internal control provision charges with the Commission. The firm consented to the entry of a cease and desist order based on Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). HP also agreed to pay disgorgement of $29 million and prejudgment interest. A portion of the firm’s disgorgement obligation will be satisfied by the payment of $2,527,750 in forfeiture as part of HP Mexico’s resolution with the DOJ. The parent company also agreed to report to the Commission staff periodically, but not less than once each year, for three years on the status of its remedial efforts and the implementation of compliance measures. In addition, the company will report any credible evidence not previously reported of questionable or corrupt payments or transfers of property interests. In sum, the three subsidiaries paid over $108 million to resolve the charges. In the Matter of Hewlett-Packard Company, Adm. Proc. File No. 3-15832 (April 9, 2014).

    HP is a global provider of personal computers, printers, software and related items. It operates through wholly owned or indirect subsidiaries. The firm’s operations are organized by geographic regions and sub-regions as well as business units. The foreign subsidiaries were subject to compliance policies and directives developed by HP and implemented at the local subsidiary level by the country or regional management. Although the firm had certain anti-corruption policies and controls they were inadequate.

    Russia: Beginning in 2000, and continuing through 2007, HP Russia promised to, and did, pay bribes through agents and consultants to Russian government officials in order to win the first phase of a contract with the Russian government. The project was to automate the computer and telecommunications infrastructure of the Office of the Prosecutor General of the Russian Federation. The total project was worth more than $100 million. The first phase was seen by HP Russia as the path to other business.

    To win the tender, HP Russia agreed to partner with a series of third party intermediaries with close ties to Russian officials overseeing the tender. In December 2000 a small U.S. company with ties to the Russian government officials approached HP Russia and warned that the deal was in jeopardy. The subsidiary agreed to pay the agent up to $1.2 million if the deal moved forward and to make it the principal subcontractor. In January 2001 HP Russia secured the contract.

    Following an initial failed attempt to finance the transaction through a U.S. export bank, a German bank agreed to finance the deal. When Russian officials considered issuing a new tender and reopening the bidding, HP Russia executives promised to pay the officials €2.8 million through a German agent. Approximately €8 million was passed through the German agent and various shell companies. One of those entities was associated with a senior Russian official.

    To facilitate the payments HP Russia maintained two sets of project records. One set identified the recipients of the improper payments. Another version of the same records was sanitized for management in the credit, finance and legal offices outside of HP Russia.

    HP Russia’s credit officer initially denied credit approval for the German agent. Questions were raised about the substantial fee. Additional documentation was requested when HP Russia employees claimed that the funds were for various work related to the project. Although a list of purposed subcontractors was furnished to secure approval, the material provided to the credit officer did not identify payment entities.

    During the project over €21 million passed through the German agent. The agent retained less than €200,000 of that amount. The balance was passed on. Portions of the money went for goods and services actually provided. A portion of the €8 million paid to the German agent went to shell companies that did not provide any services. Over €311,000 went to bank accounts associated with the Russian government official. Another €2.2 million was wired to the Latvian and Lithuanian accounts of other shell companies. It was used to purchase expensive jewelry, luxury automobiles, travel and for other items. The payments to the agent were falsely recorded in HP’s books and records. Earnings from the project were about $10.4 million.

    Poland: From about 2006 through 2010 HP Poland, through certain agents or employees, made improper payments to public officials to secure and maintain contracts with Komenda Glowna Policji or KGP , the Polish national police academy. Payments were made in the form of cash bribes, travel and entertainment and gifts to the KGP’s Director of Information and Communications Technology. The official was give bags filled with cash totaling hundreds of thousands of dollars, HP desktop and laptop computes, mobile devices and leisure trips to Las Vegas.

    Overall at least $600,000 in cash, gifts worth over $30,000 given in violation of company policy, and several thousand dollars in travel and entertainment benefits were paid by HP Poland. In return the Polish government awarded at least seven contracts for KPG-related information technology product and services with an overall value of $60 million. To conceal communications regarding the scheme executives used anonymous email accounts and prepaid mobile telephones.

    Mexico: In 2009 HP Mexico paid commissions to an entity with ties to Mexican public officials in connection with its bid to obtain lucrative government contracts. In mid-2008 the subsidiary began seeking business form Pemex, the Mexican state-owned petroleum company. The software and licensing contracts it sought were worth about $6 million. To secure the contracts HP Mexico retained a third-party consultant with close ties to senior executives of Pemex. It then agreed to pay a $1.41 million commission to the consultant. The consultant and commission were not approved in accord with HP procedures. Accordingly, the arrangement was funneled through a previously approved HP channel partner.

    Cooperation: The DOJ and the SEC acknowledged the cooperation of HP. It consisted of conducting what the DOJ termed a “robust” internal investigation; voluntarily making U.S. and foreign employees available for interviews; collecting, analyzing and organizing voluminous amounts of evidence; and taking extensive anti-corruption remedial efforts. Those efforts included appropriate disciplinary action against culpable employees and enhancing internal controls.

    SEC Files Settled Financial Fraud Actions

    April 08, 2014

    The SEC filed financial fraud actions against drug store giant CVS Caremark Corporation and its Retail Controller, Laird Daniels, CPA. CVS was charged with “intentional misconduct” based on alleged violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B and each subsection of Securities Act Section 17(a). Mr. Daniels, alleged to have “orchestrated” improper accounting adjustments, is alleged to have violated Securities Act Sections 17(a)(2) and(3) while aiding and abetting the books and records violations by the firm.

    Both actions settled. CVS consented to the entry of a permanent injunction prohibiting future violations of the Sections it is alleged to have violated but no ancillary relief. The firm also agreed to pay a $20 million penalty. SEC v. CVS Caremark Corp., Civil Action No. 14-177 (D.R.I. Filed April 8, 2014). See Lit. Rel. No. 22968 (April 8, 2014). Mr. Daniels, the only individual charged, consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(B) and 13(b)(2)(B) and Section 17(a). He was also denied the privilege of appearing or practicing before the Commission as an accountant with the right to reapply after one year. He will pay a penalty of $75,000. In the Matter of Laird Daniels, CPA, Adm. Proc. File No. 3-15825 (April 8, 2014).

    CVS has two business segments that are approximately equal in size. One segment is the retail business which operates about 7,600 drugstores. The second segment is Caremark. That segment operates a pharmacy benefits manager or PBM which the firm acquired in March 2007.

    The SEC’s claims center on key events in the fall of 2009 regarding each segment. First, CVS filed a Prospectus Supplement for a $1.5 billion senior note offering. The supplements failed to disclose material changes in its business. Those omitted facts also were not included in other filings, including the Form 10-Q for the second quarter. Specifically, in early August CVS learned that the state of New Jersey was not going to renew a PBM contract that would have been worth more than $930 million of revenue in 2010. Later that month the firm also learned that it lost several more large PBM contracts in 2010.

    In mid-August 2009 the firm received more bad news as a result of the benchmarks for the Medicare Part D bidding process for 2010. CVS learned that it did poorly in that process. Internal projections at the firm indicated that CVS stood to lose 580,000 covered lives and as much as $101 million of 2010 EBIT as a result.

    The second issue — the focus of the proceeding in which Mr. Daniels is named as a Respondent — centers on the accounting for acquisition of the Longs Drug Store chain. That acquisition was made in late October 2008. CVS retained an accounting firm to prepare a valuation of the Longs purchase. The firm prepared a draft report in January 2009 based on a “continued use” premise, meaning that the drug store chain would retain and continue to use the acquired property, plant and equipment except for certain stores identified that would be closed. That approach was required by the contract.

    Nevertheless, in a quarterly filing by CVS in November 2009, the firm reduced the reported valuation for Longs tangible assets by $212 million with a corresponding increase in good will, compared to the January 2009 draft report. CVS made a one-time catch-up adjustment, reversing $49 million of depreciation taken from October 2008 through the end of June 2009, and did not take an additional $19 million of depreciation that would have otherwise been taken on the Longs properties for the period. The one time depreciation reversal increased third quarter 2009 EPS by about 2.4 cents. Despite the continued use premise, the drug store company completely wrote off all the personal property for about 430 of the 525 Long stores.

    The adjustments did not comply with the applicable GAAP provisions regarding business combinations, according to the Commission. Those adjustments failed to reflect the expected future use of the Longs property as of the acquisition date and the information the firm had as of that date. They also did not account for the use by CVS of the assets to generate revenue after the acquisition date. For the quarter the failure to recognize those current period expenses overstated: operating profit by as much as 13.7%; income from continuing operations by as much as 12.5%; net income by as much as 12.5%; and EPA by as much as 17%. The November 5, 2009 Form 10-Q was materially false, according to the complaint, because, in part it failed to mention the one-time $49 million reversal of previously recorded depreciation expense which bolstered the EPS.

    Finally, statements made by the then CVS CFO during a November 5, 2009 earnings call were materially incorrect. During that call the CEO stated that while CVS had assumed the PBM segment’s EBIT would grow 2% to 4% in 2010 it now expected the segment to decline 10% to 12%. Despite the losses, however, the CEO went on to note that the PMB segment’s retention rate—a key industry metric — for 2010 was 92%, just above the 91% for the prior year. The retention rate, however, was calculated using a methodology that differed from previous years and omitted the estimated revenue loss from its lack of success in the Medicare Part D bidding process. The CFO also informed investors that EPS was “just above” company guidance without noting the 2.4 cent increase from the adjustment and claimed that retail operating expenses had decreased as a percentage of net revenue as a result of “good spending discipline” – also without mentioning the reversal of the depreciation expense and its impact.

    Fund Principal Partially Resolves Administrative Charges

    April 07, 2014

    A principal of an investment adviser partially settled a previously filed administrative proceeding which centers on claims that he and another Respondent improperly advised their clients to invest in off-shore funds without fully disclosing their affiliation with those funds or the fees they were paid. In the Matter of Larry C. Grossman, Adm. Proc. File No. 3-15617 (Nov. 20, 2013).

    Respondents Larry Grossman and Gregory Adams were affiliated with registered investment adviser Sovereign International Asset Management, Inc. Mr. Grossman was the sole owner of Sovereign from the time of its formation in 2001 until October 2008 when he sold the firm and its affiliates to Mr. Adams. After the sale Mr. Grossman continued to be affiliated with the adviser until the firm was administratively dissolved in 2012.

    Sovereign had about $85 million in assets under management at its peak in 2008. Many of its investors were retirees. Shortly after forming Sovereign, Mr. Grossman met Nikolai Simon Battoo, the principal of BC Capital Group, S.A. and its affiliated companies which operated off shore hedge funds. Mr. Battoo was named as a defendant in a Commission fraud action brought in 2012, SEC v. Battoo, Case No. 12CV125 (N.D. Ill.).

    In 2003 Mr. Grossman executed three referral agreements and one consulting contract on behalf of a Sovereign affiliate with funds and entities controlled or owned by Mr. Battoo. Under three agreements referral fees were paid to Sovereign. The fourth called for the payment of fees directly to Mr. Grossman for consulting services.

    From August 2003 through October 2008 Mr. Grossman recommended to Sovereign clients that they invest almost exclusively in off-shore funds in the Battoo group. In making these recommendations the full risks of the investment were not adequately disclosed. Some investors were told that the funds were very safe, contrary to their offering documents. None were told that all of the funds were cross collateralized.

    Messrs. Grossman and Adams also did not properly or fully disclosed to Sovereign’s investors the fees paid under the four agreements with the Battoo group. In some materials there was no disclosure of the fees. In others there were statements indicating that fees may be paid despite the fact that they were actually being paid. Investors were thus largely unaware of the conflict on which the investment recommendations were based.

    In late 2008 one of the Battoo funds notified a shareholder class that it was suspending redemptions. Before that action was taken, Mr. Grossman learned that the fund had not honored redemption requests for several months. Messrs. Gossman and Adams also learned that Mr. Battoo had stopped providing investors with audited financial statements as required in the offering materials. In addition, the two men understood that the asset verification reports which were available on request were being prepared by parties related to Mr. Battoo, not independent third parties. Mr. Adams never questioned the reason for the suspension, accepting the representation of Mr. Grossman that it was caused by an account transfer. Mr. Grossman continued to advise Sovereign’s clients to invest in, or retain their investments in, the Battoo funds.

    By 2010 Mr. Batto refused to permit withdrawals from another fund. The next year he claimed that was caused by losses incurred in the MF Global bankruptcy. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 15(a) and Advisers Act Sections 206(1), 206(2), 206(3), 206(4) and 207. The proceeding will be set for hearing.

    Mr. Adams partially resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to be barred from the securities business. In addition, Mr. Adams agreed to pay disgorgement and a third tier civil penalty in amounts to be determined later.

    SEC Settles Spoofing, Unregistered Broker Charges

    April 06, 2014

    High speed trading and its impact on the markets is the topic de jour. Author Michael Lewis claims the markets are “rigged,” a statement which no doubt will help sell his latest book centered on high speed trading. Now the trading technique, which has been a large part of the markets in recent years, is the focus of investigations. The FBI is conducting a criminal probe. The Attorney General says the practice is being investigated. New York Attorney General Eric Schneiderman is continuing his probe of insider trading 2.0 which apparently includes high speed trading.

    SEC Commissioners have mentioned the topic at various points but not acknowledged an investigation. The Commission did file a settled market manipulation case at the close of last week, tied to unregistered broker and failure to supervise charges. The manipulation was not high speed trading. Rather, it was a more traditional form of market manipulation known as “spoofing” or “layering.” In the Matter of Visionary Trading LLC, Adm. Proc. File No. 3-15823 (April 4, 2014).

    The Visionary Trading Order names as Respondents the firm; its four owners, Joseph Dondero, Eugene Giaquinto, Lee Heiss and Jason Mdevin; and Lightspeed Trading LLC, a registered broker dealer, along with its COO, Andrew Actman.

    Mr. Dondero, one of the owners of Visionary, is alleged to have engaged in manipulative trading in violation of Exchange Act Sections 9(a)(2) and 10(b). In 2009 he employed a practice known as “layering” or “spoofing.” The technique combines actual trades with non-bona fide orders –essentially false statements since the order is put in the market place with no intent to execute it – and the use of trades which are displayed and those which are not.

    In this action the Order alleges that Mr. Dondero would place buy or sell orders that he intended to have executed, then immediately entered numerous non-bona fide sell or buy orders to attract interest to the bona fide orders he wanted executed. The non-bona fide orders were designed to induce others to execute against the initial order. Once the bona fide order was executed the others were canceled.

    The orders were typically placed in layers and the technique repeated until executions were obtained at a favorable price. The trading technique, frequently conducted for securities with wide spreads in thin markets, would cause a price distortion or movement favorable to the trader. Once the trading ceased the market price would revert to its pre-layering competitive level. Utilizing this technique Mr. Dondero obtained profits of $984,398.

    Other charges, which are the focus of the proceeding, stem from an arrangement involving Visionary Trading. Beginning in May 2008, and continuing through November 2011, the firm’s owners and others engaged in day trading from its offices in New Jersey. Lightspeed was the broker. In connection with that trading two registered representatives of the firm shared their transaction based compensation with Visionary and its owners. Over the period Lightspeed retained about $330,000 in commissions but paid out about $474,407.

    In connection with the fee splitting arrangement the Order alleges that: 1) Visionary and its owners violated Exchange Act Section 15(a)(1); 2) that Lightspeed and Mr. Giaquinto aided and abetted and caused Visionary’s and its owner’s violations of Section 15(a)(1); 3) that Lightspeed failed to reasonably supervise Mr. Giaquinto; and 4) that Mr.Actman failed to reasonably supervise Mr. Giaquinto.

    Each of the Respondents resolved the proceeding by consenting to the entry of a cease and desist order based on the Sections cited in the Order as to them. Lightspeed was also censured. In addition, Messrs. Giaquinto, Heiss and Medvin were barred from the securities business and from participating in any penny stock offering with a right to apply for reentry after two years. Mr. Dondero was also barred from the securities business or from participating in any penny stock offering. Mr. Actman was barred from association in a supervisory capacity in the securities business with a right to apply for reentry after one year.

    Lightspeed agreed to pay disgorgement of $330,000, prejudgment interest and a civil penalty of $100,000 plus agreed upon post-Order interest of $308.22. Respondents Giaquinto, Hess and Medvin will pay disgorgement of $118,601 plus prejudgment interest and a civil money penalty of $35,000 each. Respondent Dondero will pay disgorgement of $1,102,999.96, prejudgment interest and a civil penalty of $785,000. Mr. Actman will pay a civil money penalty of $10,0000 plus agreed upon post-Order interest of $46.23.

    This Week In Securities Litigation (Week ending April 4, 2014)

    April 03, 2014

    High speed trading and insider trading were key topics this week. Author Michael Lewis released a new book on high speed trading and, in an interview claimed the markets are “rigged.” The Commission focused on insider trading. This week the agency filed three new insider trading actions while resolving others. The Commission also filed a new offering fraud action and another centered on a pyramid scheme.

    The DOJ unsealed an indictment which named six foreign nationals in an FCPA related bribery scheme. One of the defendants is a foreign official who solicited the bribes. The scheme focused on mineral production in India.

    SEC

    Proposed rules: The SEC reissued for comment proposed rules regarding the marketing materials used for target date retirement funds (here).

    Testimony: Chair Mary Jo White testified before the House Subcommittee on Financial Services and General Government (April 1, 2014). Her testimony reviewed recent rule making initiatives, expanded oversight of investment advisers, provided an overview of recent enforcement initiatives and referenced the use of technology and oversight of the markets (here).

    Remarks: Commissioner Luis Aguilar delivered remarks titled “Taking an Informed Approach to Issues Facing the Mutual Fund Industry´ (April 2, 2014). In his remarks the Commissioner discussed oversight of the industry, the FSOC and OFR and money market funds, the need for Commission expertise in regulating mutual funds and the growing cyber threat (here).

    Remarks: Chair Mary Jo White delivered remarks titled “All-Encompassing Enforcement: The Robust Use of Civil and Criminal Actions to Police the Markets.” Her remarks focused on the vigorous use of all enforcement tools, the benefits of a strong partnership with the DOJ and the FBI, the importance of “stand alone” SEC actions, insider trading, microcap fraud and financial reporting fraud (here).

    Remarks: Kenneth Higgins, Director, Division of Corporation Finance delivered the Keynote Address at the 2014 Angel Capital Association Summit, Washington, D.C. (March 28, 2014). His remarks included comments on the elimination of the general solicitation prohibition, reasonable steps to verify an accredited investor and Regulation A (here).

    CFTC

    Distributions: The agency announced that the MF Global Inc. Trustee will being making final distributions to customers to satisfy its obligation of full restitution for the $1.212 billion in loses sustained by customers when the firm failed in 2011.

    Securities Class Actions

    Settlement trends: Last year 67 securities class actions settled. That is the largest number since 2010 when 85 cases settled, according to a new report. Cornerstone Research. Securities Class Action Settlements, 2013 Review and Analysis. In 2012 57 securities class actions settled while in 2011 65 cases were resolved. The total settlement dollars evidenced similar trends. The 67 settlements recorded last year yielded $4,774 million compared to the prior year when the total value was $3,264 million and 2011 when the amount was $1, 411 million. The total settlement dollars last year was the largest since 2007 when it was $8,131 million.

    The most prevalent claim in the post reform act period has been one based on Exchange Rule 10b-5. Suits based only Securities Act Sections 11 and/or 12(a)(2) were the least prevalent. However, the highest median settlement value over the period was achieved when the claims were combined. The median settlement value for Rule 10b-5 cases was $6.8 million during the period compared to $3.4 million for Section 11 and/or 12(a)(2) cases. When the Exchange Act and Securities Act claims were combined the median settlement amount increased to $11.7 million.

    Finally, the number of settled securities class actions with a parallel SEC case continued to fall last year. In 2013 about 19% of those actions had a parallel case brought by the Commission. That compares to 21% the prior year and 23% in the post reform act era. Interestingly, the median settlement of cases with a parallel SEC action in the post reform act period is $12.9 million, more than twice the median settlement value for cases without a parallel SEC action. A more detailed discussion of the report is available here.

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the Commission filed, or announced the filing of, 5 civil injunctive, DPAs, NPAs or reports and 1 administrative proceeding (excluding follow-on and Section 12(j) proceedings).

    Insider trading: SEC v. Wagner, Civil Action No. 8:14-cv-01036(W.D. Md. Filed April 3, 2014) is an action against Walter Wagner and Alexander Osborn. It centers on the acquisition by Chicago Bridge & Iron Company, N.V. of The Shaw Group Inc., announced on the morning of July 30, 2012. Prior to that date John Femenia, a personal friend of Mr. Wanger, was employed in the investment banking division of Wells Fargo Securities, LLC. Through that position he learned about the transaction and gifted the information to his friend who had lost his job. Mr. Wagner shared the information with his friend, Alexander Osborn. Both traded in the securities of the Shaw Companies and, following the deal announcement, had profits of, respectively, $517,784 and $439,830. The Commission’s complaint alleges violations of Exchange Act Section 10(b). Mr. Wagner resolved the action, consenting to the entry of a permanent injunction based on the Section cited in the complaint. He also agreed to pay disgorgement and prejudgment interest. The Court will determine any financial penalty. A parallel criminal action against Mr. Wagner was announced by the U.S. Attorney’s Office for the Western District of North Carolina. See Lit. Rel. No. 22965 (April 3, 2014).

    Unregistered securities: In the Matter of Donald J. Anthony, Jr., Adm. Proc. File No. 3-15514 (April 3, 2014) is a previously filed proceeding against a number of individuals centered on a series of offerings through MS&Co. undertaken in violation of Securities Act Sections 5 and 17(a), discussed here. Richard Feldmann, one of the registered representatives named as a Respondent, resolved the charges this week. He consented to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to the entry of a bar from the securities business and from participating in nay penny stock offering. Mr. Feldmann will pay disgorgement of $299,000, prejudgment interest and a civil money penalty of $130,000.

    Insider trading: SEC v. Terpins, Civil Action No. 13-CIV-1080 (S.D.N.Y.) is a previously filed action arising out of the acquisition of H.J. Heinz (here). This week the Court entered final judgments against two brothers in Brazil, Rodrigo and Michel Terpins. The order enjoins them from future violations of Exchange Act Section 10(b) and directs the payment of disgorgement, on a joint and several basis with Alpine Swift Ltd., in the amount of $1,809,857. In addition, each brother was directed to pay a civil penalty of $1.5 million. See Lit. Rel. No. 22964 (April 3, 2014).

    Fee discounts: In the Matter of Transamerica Financial Advisors, Inc., Adm. Proc. File No. 3-15822 (April 3, 2014) is a proceeding against the registered investment adviser and broker dealer. In its Form ADV the firm represented that clients could obtain certain advisory fee discounts. The firm’s policies and procedures also stated that certain discounts were available. Despite those statements, and a warning from the inspection staff, the firm failed to make them available in certain instances and did not have procedures reasonably designed to ensure that they would be made available. The Order alleges that the firm willfully violated Sections 206(2), 206(4) and 207 of the Advisers Act. To resolve the proceeding the firm undertook certain remedial efforts including providing refunds and credits to 2,304 accounts of clients and former clients totaling $553,624.32, including interest. It will also retain an independent consultant who will compile a report and make recommendations which will be implemented. In addition, the firm consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. The firm will pay a civil money penalty in the amount of $553,624 and to comply with its undertakings.

    Insider trading: SEC v. Kinnucan, Civil Action No. 12-CV-1230 (S.D.N.Y.) is a previously filed action against John Kinnucan and his firm, Broadband Research Corporation that arises out of the expert network insider trading investigations discussed here. Previously, Mr. Kinnucan pleaded guilty to two counts of securities fraud and one count of conspiracy to commit securities fraud and was sentenced to prison. This week the Court granted the Commission’s motion for summary judgment against Mr. Kinnucan and his firm. The Court entered orders of permanent injunction against each defendant, prohibiting future violations of Exchange Act Section 10(b). It also directed the payment, on a joint and several basis, of disgorgement in the amount of $1,583,445.96 along with prejudgment interest and a civil penalty of $4,750,337.88. See Lit. Rel. No. 22963 (April 2, 2014).

    Kickbacks: SEC v. Molinari, Civil Action No. 13-cv-80807 (S.D. Fla.) is a previously filed action against several microcap companies and their CEOs centered on a broker kickback and manipulation scheme discussed here. The Court granted the Commission’s motion for judgment on the pleadings as to defendant Stephen Molinari who previously was convicted and sentenced to prison in the parallel criminal case. The Court entered an injunction based on Securities Act Section 17(a)(1) and Exchange Act Section 10(b) against Mr. Molinari and, in addition, officer and director and penny stock bars. Claims for monetary relief were dismissed in view of the criminal conviction. The Court also entered a final judgment by consent as to his company, Nationwide Pharmassist Corporation. The Court entered an injunction based on the same Sections as the order against Mr. Molinari. The firm was ordered to pay a civil penalty of $20,000. The Court dismissed the Commission’s claims for disgorgement and prejudgment interest. See Lit. Rel. No. 22959 (April 1, 2014).

    Unregistered broker: SEC v. Sheinwald, Civil Action No. 12-iv-5811 (S.D.N.Y.) is a previously filed action against Alan Sheinwald and his firm, Alliance Advisors. The complaint alleged that they acted as unregistered brokers in violation of Exchange Act Section 15(a) by receiving transaction based compensation in exchange for actively soliciting investors to participate in securities offerings as discussed here. On March 17, 2014 the Court entered permanent injunctions prohibiting future violations of the Section cited in the complaint as to each defendant and ordered them to pay disgorgement of $177,166, prejudgment interest and a civil penalty of $25,000. In a related administrative proceeding the two defendants consented to the entry of an order barring them from the securities business and from participating in any penny stock offering with the right to apply for reentry after two years. See Lit. Rel. No. 22961 (April 1, 2014).

    Insider trading: SEC v. Hawk, Case No. 5:14-CV-01466(N.D. Cal. Filed March 31, 2014) centers on the tender offer by Oracle Corporation for Acme Packet Inc., announced on February 5, 2013. Tyrone Hawk’s wife was a finance manager at Oracle.

    On January 14, 2013 Mr. Hawk’s wife learned that her firm may acquire Acme Packet. She began working on the due diligence and was aware of the scheduled announcement date. Mr. Hawk overheard some of his wife’s telephone calls regarding the transaction. He was also told by his wife while she was working on the due diligence that Oracle had imposed a securities trading blackout for three weeks because of a potential acquisition.

    On January 17 Mr. Hawk began purchasing shares of Acme Packet. Over the next two weeks he acquired a total of 28,000 shares valued at $669,000. Prior to the open of the market on February 4, 2013 Oracle and Acme Packet announced an all-cash offer of $29.25 per share for Acme’s outstanding stock. That represented a premium of about 22% over the then current trading price. The next day the share price for Acme rose 23% to $29.59. Mr. Hawk sold all of his shares, realizing profits of $151,490. The complaint alleged a violation of Exchange Act Section 10(b). To resolve the case Mr. Hawke consented to the entry of a permanent injunction prohibiting future violations of the Section cited in the complaint. In addition, he agreed to pay disgorgement of $151,480, prejudgment interest and a civil penalty equal to the amount of his disgorgement. See Lit. Rel. No. 22957 (March 31, 2014). This case is also discussed here.

    Insider trading: SEC v. Chen, Case No. 5:14-cv-01467 (N.D. Cal. Filed March 31, 2014). Defendant Ching HwaChen’s wife was employed by Informatica Corporation as its Senior Tax Director. She was informed on June 28, 2012 that the firm would not meet its previously disclosed revenue guidance. This would be the first time in 31 consecutive quarters that the company would not meet guidance. The firm also needed to finalize its quarterly results earlier that anticipated to determine if the earnings miss should be disclosed prior to the earnings call. During a long weekend vacation the next week Mrs. Chen took work related calls and worked. Mr. Chen heard the substance of the calls. He “gleaned from his wife’s business calls and behavior” that Informatica might miss its revenue numbers. Despite an earlier admonition by his wife to never trade shares of her firm, on July 2 and 3, 2012 Mr. Chen sold Informatica shares short, sold call options and bought put options in four family brokerage accounts he controlled. The firm disclosed that it would not meet its previously issued revenue guidance after the close of the market on July 5, 2012. The next day its share price tumbled over 27% from the prior day’s closing price. On July 6 Mr. Chen closed all of his positions, realizing profits of $138,068. The Commission’s complaint alleges a violation of Exchange Act Section 10(b). To resolve the action Mr. Chen consented to the entry of a permanent injunction prohibiting future violations of the Section cited in the complaint. In addition, he agreed to pay disgorgement of $138,068, prejudgment interest and a civil penalty equal to the amount of the disgorgement. See Lit. Rel. No. 22956 (March 31, 2014). This case is also discussed here.

    Kickback scheme: SEC v. Syndicated Food Services International, Inc., Civil Action No. 04-CV-1303 (E.D.N.Y) is a previously filed action against, among others, Adam Klein, William Keeler and Jeffrey Richardson, discussed here. Previously the Court entered permanent injunctions against each of the men base on Securities Act Section 17(a) and Exchange Act Section 10(b). The order as to Mr. Keeler also included Securities Act Section 13(a) and contained an officer director bar. The order as to Mr. Klein contained a penny stock bar. Last week final judgments were entered which directed Mr. Klein to pay disgorgement of $151,500 and a civil penalty of $5,500; Mr. Richardson to disgorge $274,000 and pay a $55,000 civil penalty; and Mr. Keeler to pay a $220,000 civil penalty. See Lit. Rel. No. 22956 (March 31, 2014).

    Offering fraud: SEC v. Halek, Civil Action No. 3:14-cv-01106 (N.D. Tx. Filed March 28, 2014) is an action against Jason Halek, Joshua Spivey, Patrick Booths and Steven Little centered on an offering fraud. Specifically, from September 2009 through mid-2010 the defendants sold more than $5.5 million in what were represented to be interests in various companies in the oil and gas business. In fact the companies were straw men used by Mr. Halek in an effort to avoid Commission scrutiny since he was named in another enforcement action. Rather the projects were owned by newly formed Halek Energy, owned by Messrs. Halek and Booths. Over 100 investors purchased shares in the fraudulent scheme. The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 15(a) and Securities Act Sections 5(a), 5(c) and 17(a). Defendants Booths, Spivey and Little resolved the action, consenting to the entry of injunctions based on the Sections cited in the complaint and to bars from the securities business and from participating in any penny stock offering in a related administrative proceeding. The Commission is seeking civil penalties and disgorgement with prejudgment interest against each defendant. See Lit. Rel. No. 22954 (March 28, 2014).

    Pyramid scheme: SEC v. World Capital Market Inc., Civil Action No. CV14-2334 (C.D.Ca. Filed March 27, 2014) is an action against Ming Xu or Phil Ming Xu, the Chairman of a number of the entity defendants, World Capital Market Inc., WCM777 Inc. and WMC777 Ltd, also known at WCM777 Enterprises, Inc. The complaint centers on a classic pyramid scheme that raised $65 million in a matter of months from thousands of investors. Specifically, the defendants began soliciting investors in March 2013 using the umbrella name WCM777. Investors were told that WCM777 was incubating a number of high tech companies which would generate profits from the sale of packages of cloud services to investors and that over 700 major companies were involved. Investors were told that they could participate at various levels, all of which would reap huge profits. In fact, the entire operation is a pyramid scheme, according to the Commission. WCM777 sells its products exclusively to investors. It has no apparent source of revenues other than investor funds. It does not actually offer or sell any of the cloud services it describes to investors. The claims regarding the partnerships with major firms were false. Much of the money was siphoned off for the personal use of the promoter and to a Hong Kong account. The Commission’s complaint alleges violations of Exchange Act Section 10(b) and Securities Act Sections 17(a), 5(a) and 5(c). It also asserts a claim for control person liability under Exchange Act Section 20(a). A request for an emergency freeze order by the SEC was granted. The case is pending. See Lit. Rel. No. 22953 (March 28, 2014). This case is discussed in detail here.

    FCPA

    The DOJ unsealed this week and indictment against six foreign nationals, including one foreign official, which had been returned last year. Those named as defendants are: Dmitry Firtash, a Ukrainian national; Andras Knopp, a Hungarian businessman; Suren Gevorgyan, a Ukraine national; Gjendra Lal, an Indian national and permanent U.S. resident; Periyasamy Sunderalingam of Sri Lanka; and K.V.P. Ramachandra Rao, a Member of Parliament in India who was an official of the state government of Andhra Pradesh and a close advisor to the deceased chief minister of the state of Andhra Pradesh.

    The case centers on $18.5 million in bribes allegedly paid to secure mining licenses in the Indian coastal state of Andhra Pradesh and involved 57 money transfers in furtherance of the conspiracy between late April 2006 and mid-July 2010. U.S. financial institutions were used to facilitate the transfers. The five count indictment charges each defendant with one count of racketeering conspiracy and money laundering conspiracy and two counts of interstate travel in aid of racketeering. Each defendant, except Mr. Rao, was charged with one count of conspiracy to violate the FCPA. A more detailed discussion of the cases is available here.

    Criminal cases

    Insider trading: U.S. v. Hixon, 1:14-mj-0341 (S.D.N.Y.) is an action against former investment banker Frank Hixon who was a senior managing director of Evercore Group LLC. Between April 2010 and January 2014 he used inside information obtained from his employment to trade in a number of securities in the account of the mother of his child as discussed here. This week Mr. Hixon pleaded guilty to a six count information which charges securities fraud and obstruction. The SEC filed a parallel case which is pending.

    Investment fraud: U.S. v. Zarkiewicz (S.D.N.Y.) is an action against Scot Zaarkiewicz, the co-founder and former CEO of SingleClick Systems Corp, a software company. From mid-2009 through June 2013 he raised about $6.3 million from 35 investors who purchased shares of the firm based on representations that it was very successful. In fact it had little revenue. Mr. Zarkiewicz previously pleaded guilty and this week was sentenced to serve 63 months in prison.

    PCAOB

    Agreement: The Board announced an agreement with the Supervisory Board of Public Accountants (RN) of Sweden related to the oversight of audit firms subject to the jurisdiction of each regulator. The agreement provides for cross-border cooperation and a framework for inspections and the sharing of confidential information.

    Australia

    Insider trading: Christopher Jordinson, the former CEO of UCL Resources Ltd, his nephew Joe Turner and Jonathan Breen were convicted of insider trading. Mr. Jordinson admitted communicating inside information to Mr. Turner in November 2013 regarding the takeover of his firm by Mawarid Mining LLC. Mr. Turner then tipped Mr. Breen who traded for Mr. Turner and another. Overall the trading yielded profits of $20,000. Messrs. Turner and Breen were ordered to be on good behavior for two years and to pay pecuniary penalty orders of $2,769 and $13,805.10 respectively. Mr. Jordinson was ordered to serve two years in prison. The sentence was suspended on condition that he enter into a two year good behavior bond.

    Hong Kong

    Breach of duty: The Securities and Futures Commission suspended representative Chan Chi for six months. The action was based on the fact that he operated a client’s futures account as if it were discretionary when it was not and failed to ensure that the assets were properly accounted for.

    U.K.

    Contempt: The SFO prevailed in the Supreme Court in an action centered on a contempt order against convicted boiler room operator Brian O’Brien. An order had been entered directing Mr. O’ Brien to repatriate all of his movable assets held outside the U.K. Mr. O’Brien failed to comply and returned to his home in Chicago. The court found him in contempt and sentenced him to prison. He was extradited from the U.S. and, after appealing the contempt order, lost the appeal.

    Manipulation: The Serious Frauds Office announced the institution of criminal proceedings against three former employees of ICAP Plc. in connection with the manipulation of the bench mark interest rate LIBOR between August 2006 and early September 2010. They are Danny Wilkinson, Darrell Read and Colin Goodman. To date nine individuals have been charged in the investigation.

    FCPA: A Focus On Individuals

    April 02, 2014

    FCPA enforcement officials have repeatedly emphasized that they intend to focus on individuals as an effective means of halting possible violations. A case unsealed yesterday underscores this point.

    The action, based on an indictment returned last year in the Northern District of Illinois but unsealed on April 2, 2014, names as defendants six foreign nationals including one foreign government official. Those named as defendants are:

    Ø Dmitry Firtash, a Ukrainian national;

    Ø Andras Knopp, a Hungarian businessman;

    Ø Suren Gevorgyan, a Ukraine national;

    Ø Gjendra Lal, an Indian national and permanent U.S. resident;

    Ø Periyasamy Sunderalingam of Sri Lanka; and

    Ø K.V.P. Ramachandra Rao, a Member of Parliament in India who was an official of the state government of Andhra Pradesh and a close advisor to the deceased chief minister of the state of Andhra Pradesh.

    The case centers on $18.5 million in bribes allegedly paid to secure mining licenses in the Indian coastal state of Andhra Pradesh. The mining project was expected to yield over $500 million annually from the sale of titanium products. Portions of those sales would be to Company A, based in Chicago, Illinois.

    Mr. Firtash controls Group DF, an international conglomerate of companies directly and indirectly owned by Group DF Limited, a British Virgin Islands firm. The group includes a series of companies from Austria, Hungary and Switzerland. In April 2006 a member of Group DF entered into a joint venture agreement with the state government of Andhra Pradesh. The purpose was to mine various minerals, including one which may be processed into various titanium-based products.

    The next year company A entered into an agreement with a member of Group DF to work toward a deal under which it would be supplied 5 million to 12 million pounds annually of titanium sponge from the Indian project. The project required licenses and approval from both the Andhra Pradesh state government and the central government of India. Mr. Rao is alleged to have solicited bribes for himself and others in return for the approval of the necessary licenses and approvals. He met and discussed the matter with Defendant Sunderalingam.

    Mr. Firtash met with Indian government officials, including the Chief Minister, to discuss the project and its purpose, according to the allegations. He ultimately authorized the payment of $18.5 million in bribes to both state and central government official in India to secure the necessary licenses and approvals. Mr. Firtash also directed subordinates to create documents to make it appear that the payments were for legitimate reasons.

    Mr. Knopp, who supervised the enterprise, also met with Indian officials and representatives of Company A. In addition, Mr. Gevorgyan met with Company A in Seattle. Overall 57 money transfers were made in furtherance of the conspiracy between late April 2006 and mid-July 2010. The defendants are alleged to have used U.S. financial institutions to facilitate the payment of the bribes.

    The five count indictment charges each defendant with one count of racketeering conspiracy and money laundering conspiracy and two counts of interstate travel in aid of racketeering. Each defendant, except Mr. Rao, was charged with one count of conspiracy to violate the FCPA. The indictment seeks the forfeiture from Mr. Firtash of his interests in Group DF Limited and its assets and over $10.59 million from all six defendants.