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    This Week In Securities Litigation (December 19, 2014)

    December 18, 2014

    The Commission brought two FCPA cases this week, one of which was in conjunction with the DOJ. Both centered on the payments for gifts and travel in China.

    In addition, the SEC filed three manipulation cases, an action centered on a boiler room, three offering fraud actions, a proceeding centered on a failed audit and an investment fund fraud action.

    SEC

    Rules: The Commission issued a temporary rule regarding principal trades with certain advisory clients. Release No. IA-3984 (Dec. 18, 2014). The rule provides an alternative means for registered investment advisers to meet the requirements of Section 206(3) when they act in a principal capacity in transactions with certain advisory clients.

    Rules: As mandated by the JOBS Act, the Commission issued proposed rules relating to the thresholds for registration, termination of registration and the suspension of reporting under Exchange Act Section 12(b)(here).

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the SEC filed 6 civil injunctive actions and 6 administrative proceedings, excluding 12j and tag-along-actions.

    Boiler room: SEC v. Premier Links, Inc., (E.D.N.Y. Filed Dec. 18, 2014) is an action which names as defendants the company, Dwayne Malloy, President of Premier, Chris Damon, a sales representative, and Theirry Regan, also a sales representative. The complaint alleges that from December 2005 through August 2012 Premier operated as an unregistered broker-dealer. The defendants cold-called prospective investors, pressuring them to purchase unregistered shares of start-up companies, often with representations that the firm would soon conduct an IPO. About $9 million was raised from investors. Investors were not told that only a small fraction of that sum was invested in the shares while the balance was siphoned off by the defendants. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending. A parallel criminal action was brought by the U.S. Attorney’s Office for the Eastern District of New York.

    Insider trading: SEC v. Hahn-Balyor, Civil Action No. 3:14-cv-07631 (D.N.J.) is a previously filed action against Robert Hahn-Balyor who was tipped by his cousin, the Chairman of Home Diagnostics about the firm’s impending acquisition and then traded. The Court entered a final judgment against Mr. Hahn-Balyor, enjoining him from future violations of Exchange Act Sections 10(b) and 14(e) and ordering him to pay a civil penalty of $66,100. See Lit. Rel. No. 23161 (Dec. 18, 2014).

    Related party transactions: In the Matter of Baker Tilly Hong Kong Limited, Adm. Proc. File No. 3-16324 (Dec. 17, 2014) is a proceeding which names as Respondents the audit firm and two of its members, Andrew Ross and Kwok Laiha Helena. The proceeding centers on the audit and unqualified audit opinion the firm issued on the 2009 financial statements of China North East Petroleum Holdings Ltd., a company whose operations are exclusively in the PRC. That entity and others are the subject of a Commission enforcement action. During the engagement the firm encountered 176 related party transactions totaling over $59 million. There were red flags indicating high risk and possible fraud. Nevertheless, Respondents failed to plan the engagement as appropriate for these transactions. Although the financial statements only contained a single line regarding the transactions showing a net balance of the transactions, the firm issued an unqualified audit opinion. The Order alleges violations of Exchange Act Section 10A(a)(2). Respondents settled, consenting to the entry of a cease and desist order based on the Section cited in the Order. The firm also agreed to a censure. Respondents Ross and Kwok are denied the privilege of appearing and practicing before the Commission as accountants with a right to request reinstatement after three years. They also agreed to pay, respectively, penalties of $20,0000 and $10,000. The firm agreed to implement a number of undertakings.

    Offering fraud: In the Matter of Michael Crow, Adm. Proc. File No. 3-16318 (Dec. 16, 2014); In the Matter of Angel E. Lana, CPA, Adm. Proc. File No. 3-16319 (Dec. 16, 2014). The first proceeding names as Respondents: Michael Crow, a principal of Respondent Aurum Mining, LLC, co-owner of Respondent The Corsair Group, part of the management of PanAm Terra, Inc. and who has been barred from the securities business and filed for bankruptcy; and Alexander S. Clug, a principal of Aurum, co-owner of Corsair and CEO of PanAm. Respondent Lana was the CFO of Aurum Mining. The actions center on the sale of interests in a gold mines that Aurum Mining claimed to own and operate in Brazil and Peru. About $3.9 million was raised from investors who were told the Brazilian mine had substantial reserves in gold. The investors were never paid. In addition, Messrs. Crow and Clug established PanAm as a public company and raised additional funds from investors for claimed farmland investment opportunities in South America. No farm land was purchased and substantial portions of the money was diverted to the personal used of the two men. The Crow Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The proceeding will be set for hearing. The Lana Order alleges violations of Securities Act Section 17(a). He resolved the matter, consenting to the entry of a cease and desist order based on the Section cited. In addition, he is denied the privilege of appearing and practicing before the Commission as an account but may apply for reinstatement after five years. He also agreed to pay a civil penalty of $50,000.

    Manipulation: In the Matter of Paul J. Pollack, Adm. Proc. File No. 3-16316 (Dec. 16, 2014). Mr. Pollack and his controlled entity, Montgomery Street Research LLC, are Respondents in an action centered on alleged violations of Exchange Act Sections 10(b) and 15(a). In March 2010 Montgomery entered into a three year Letter Agreement with Company A which focused on raising money in the capital markets. From November through April 2011 Respondents helped effect transactions for the company in its common stock. As a result of efforts by Respondents, nine investors purchased $445,000 of the company’s common stock. This represented about 74% of the total offering. Later in 2011 Respondents again solicited prospective investors for the firm, this time to acquire shares of preferred stock. About $5.2 million was raised in the offering. Approximately 40% came from the efforts of Respondents. At the conclusion of this offering it was agreed that Respondents would be paid 5% of the value of the preferred stock. Mr. Pollack also controlled about 665,000 shares of the firm’s common stock through the Letter Agreement. From December 2010 through October 2012 he had exclusive trading authority over ten online brokerage accounts at five brokers. During the period he effected a series of wash sales which put upward pressure on the share price. The transactions resulted in net trading proceeds of about $369,686.23. The proceeding will be set for hearing.

    Manipulation: SEC v. Blackburn, Civil Action No. 4:14-cv-00812 (E.D. Tex. Filed December 15, 2014). This action centers around a scheme created by convicted felon and Ronald Blackburn, Treaty Energy Corporation and its executives – Andrew Reid, CEO, Bruce Gwyn, co-CEO, Michael Mulshine, corporate secretary and Lee Schlesinger, CIO, each named as a defendant. Samuel Whitley, outside securities counsel is also named as a defendant. The company was formed in December 2008 by Mr. Blackburn who implemented a the reverse-merger of a private oil and gas company and a dormant public shell. Its shares, 86% of which were controlled by Mr. Blackburn, were quoted on the OTC Bulletin Board. While the other defendants were appointed to various positions at the company, Mr. Blackburn controlled the firm behind the scenes – a fact not disclosed in its Commission filings. In April 2010, through a joint venture agreement, Treaty obtained the drilling rights in Belize. In January 2012 a press release announcing that Treat stuck Oil. The press release claimed the well had an estimated 5 to 6 million barrels of recoverable oil. The stock price shot up by 79.3% in one day. The announcement was false, according to the complaint. The price did not return to pre-announcement levels for a months. Between 2009 and 2013 Mr. Blackburn and others sold shares of the company in an unregistered public offering and using a Form S-8 to distribute shares to ineligible persons. About $3.6 million was raised from 90 investors. By June 2013 Treaty depleted all of its authorized shares. Subsequently, the firm began offering investors oil and gas working interests in a well located in West Texas. Nineteen investors paid about $565,000 for interests based on false representations about the production of the well and the use of the proceeds which were largely misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b), 13(a) and 16(a). The case is in litigation. See Lit. Rel. No. 23158 (Dec. 15 2014).

    Revenue recognition: In the Matter of Canadian Solar, Inc., Adm. Proc. File No. 3-16315 (Dec. 15, 2014) is a proceeding which names as Respondents the company, a manufacturer of solar powered products, and Yan Zhuang, its senior vice president and chief commercial officer. The operations of the company are based in the PRC. Following its IPO in 2006, the firm expanded its operations in the U.S. In 2007 its revenue from U.S. operations was still only about $2.6 million or less than 1% of reported annual revenue. Subsequently, the firm entered into a distributorship with a California company and opened sales offices in that state. By the end of 2008 its U.S. revenue increased to $32.3 million. In 2009 the firm reported strong sales growth in Asia and America. The growth was fueled in large part, however, from the improper recognition of revenue by, at times, recognizing revenue when collectability was questionable and where discussions were underway about financing. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the proceeding the company consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(b)(2)(A) and 13(b)(2)(B). It also agreed to pay a penalty of $500,000. Mr. Zhuang consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(5). He also agreed to pay a penalty of $50,000.

    Offering fraud: SEC v. Fleet, Civil Action No. 6-14-06695 (S.D.N.Y. Filed Dec. 12, 2014) is an action against David Fleet, the sole shareholder of Cornerstone Homes, Inc. That firm was engaged in the business of selling and renting distressed single family homes to low income customers. From 1997 to 2010 the firm raised about $16.75 million from unregistered notes sold to about 300 investors. Most of those funds were raised between January 2006 and March 2010. Beginning in 2006 the firm failed to tell investors that its business model had changed and that it was using bank financing. Cornerstone also did not tell investors that the balance sheet was burdened with senior secure notes. By 2009 the model was unsustainable. Beginning in July the firm invested $6 million in the stock market, frequently trading options. This resulted in millions of dollars in losses. By April 2010 the firm told investors in a newsletter that it was seeking an out of court restructuring. Eventually Fleet tried to do a fast track bankruptcy. That effort was halted by the U.S. Trustee. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is pending.

    Investment fund fraud: SEC v. Bennett (S.D.N.Y. Filed Dec. 12, 2014) is an action against attorney Charles Bennett. Beginning in 2008, and continuing until 2014, Mr. Bennett solicited clients, family members and friends to invest in what he described as a pool of funds that invested in joint venture opportunities with a certain family owned investment fund based in Wyoming. He claimed to have a long-standing relationship with the fund. It invested in European real estate, mortgage backed securities and CDS which yielded very favorable returns. Prominent individuals invested in the fund. Using this approach Mr. Bennett raised about $5 million. The story about the fund was true – except for his claim that he had a relationship with it. The funds were misappropriated. Investors were given false documents and Ponzi type payments were made until the venture collapsed. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is pending.

    Manipulation: SEC v. Furth, Civil Action No. 14 Civ. 7254 (E.D.N.Y. Filed Dec. 12, 2014) is an action which names as a defendant Douglas Firth. The complaint alleges that in 2010 Mr. Furth manipulated the shares of SearchPath HCS, Inc. In connection with his scheme, which used matched orders, he solicited an individual who claimed to represent a group of registered representatives with trading discretion who could participate in return for a kickback. Mr. Furth entered into the arrangement and furnished the individual with trading instructions. The complaint alleges violations of Securities Act Section 17(a)(1), and Exchange Act Sections 9(a)(1) and 10(b). The case is pending. See Lit. Rel. No. 23157 (Dec. 15, 2014).

    FCPA

    SEC v. Avon Products, Inc., Civil Action No. 14 cv 9956 (S.D.N.Y. Filed December 17, 2014). Avon Products is a global manufacturer and marketer of beauty products. The company sells product primarily through direct marketing by over 6 million active independent sales representatives. The firm is active in over 100 countries. In the PRC subsidiary Avon Products China began operations in 1989. In 1998 when China banned all direct selling the company had to alter its typical business model. By 2001, however, China agreed to permit direct selling as part of its admission to the WTO. Avon wanted to influence that process and obtain the first license. Employees in the corporate affairs department furnished government officials with gifts, entertainment and travel to influence the laws and the companies to be selected. In April 2005 Avon China was the first to receive test approval to conduct direct selling in certain areas of China.

    In April 2005 Avon’s global internal audit flagged gifts to government officials and inadequacies in related recordkeeping as an area of concern. Although a report was prepared and a major law firm consulted, no action was taken. In December 2005 China’s new direct selling regulations became effective. In March 2006 Avon obtained the first direct sale license. In April the company provided over $100,000 in cash or items of value to government officials. At the same time the company implemented a “zero penalty” policy under which cash and items of value were given to government officials and media to reduce or eliminate potential fines and avoid negative news articles.

    In May 2008 a terminated Avon China executive wrote to the CEO of the company alleging improper payment to Chinese government officials over several years. Eventually the letter was forwarded to the audit committee which launched an internal investigation and self-reported to the SEC and the DOJ.

    Overall, Avon China provided about $8 million in cash and items of value to government officials between 2004 and 2008. Those included payments for meals and entertainment, tickets to events, travel and to avoid fines. The Commission’s complaint alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter with the SEC the company consented to the entry of a permanent injunction based on the Sections cited in the complaint. In addition, the firm agreed to pay disgorgement of $52,850,000 and prejudgment interest. See Lit. Rel. No. 23159 (Dec. 17, 2014). The Commission considered the cooperation and remedial efforts of the company in the settlement.

    To resolve the action with the DOJ the parent company entered into a deferred prosecution agreement after admitting responsibility. Avon China pleaded guilty to an information charging conspiracy to violate the accounting provisions of the FCPA. The Avon entities will also pay criminal penalties totaling $67,648,000. In total the firm agreed to pay $135,013,013 to resolve the actions.

    In the Matter of Bruker Corporation, Adm. Proc. File No. 3-16314 (December 15, 2014). Bruker Corporation manages its China operations through the Shanghai and Beijing representative offices of the Asia-based subsidiaries of four divisions. From 2005 through 2008 the Bruker China offices paid about $119,710 to fund 17 trips for Chinese government officials. For the most part the trips were not related to any legitimate business. The trips were recorded as business expenses. The firm had about $1,131,740 in profits from contracts obtained from the state owned enterprises whose officials participated in the trips. From 2008 through 2011 the China offices also paid $111,228 to Chinese government officials through 12 Collaboration Agreements. The agreements were executed with a Chinese official who, in certain instances, was paid directly. Generally, those agreements provided that the state owned enterprise was to provide research on Bruker products or use them in their demonstration labs. In fact no work was provided. The firm had profits of about $583,112 from contracts obtained from the state owned enterprises. Throughout the period the firm had inadequate internal controls and FCPA compliance procedures, according to the Order. Bruker discovered the improper payments in 2011. The firm promptly initiated an investigation, self-reported to the SEC and the DOJ and provided what the Commission called “extensive, through and real-time cooperation.” The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter the company consented to the entry of a cease and desist order base on the Sections cited in the Order. In addition, the firm will pay disgorgement of $1,714,852, prejudgment interest and a civil penalty of $375,000.

    FINRA

    AML procedures: The regulator fined Wells Fargo Advisors and Wells Fargo Advisors Financial Network $1.5 million for AML failures. As part of an AML program the broker is required to establish and maintain a written Customer Identification Program which allows them to verify the identity of the customer. The software used by the firms had a flaw. When new accounts were processed the system sometimes assigned a previously used identifier to the account. When this occurred the system did not conduct the required verification. This error persisted for nine years.

    Fair pricing: The regulator fined Merrill Lynch $1.9 million for fair pricing and supervisory violations in connection with more than 700 transactions in certain distressed securities. The firm will also pay $540,000 in restitution to customers. FINRA found that the firm purchased the securities at deep discounts from retail customers and then resold the securities to other broker dealers within the prevailing market prices.

    PCAOB

    Revenue recognition: In the Matter of Akiyo Yoshida, CPA, PCAOB Release No. 105-2014-024 (Dec. 17, 2014). Respondent was a partner of Grant Thornton Taiyo ASG, LLC (Japan) and was the partner-in-charge of auditing Baldwin-Japan, Ltd, the Japanese subsidiary of Baldwin Technology Company, Inc., a U.S. public company at the time. During the engagement Respondent failed to evaluate numerous red flags regarding the possible improper acceleration of revenue. For example, there was a 40% error rate in the results of year end sales cutoff testing and the firm recorded all material sales for the last month on the last day. Respondent was also not sufficiently knowledgeable in the relevant professional accounting and auditing standards. Subsequently, Baldwin announced a restatement resulting from the premature recognition of revenue for equipment sales. The Order censures Respondent, suspends him from association with a registered public accounting firm for one year, limits his activities for one addition year and requires that he complete certain professional education courses.

    Australia

    Failure to register: The Australian Securities and Investment Commission found that from July 2010 to August 2013 Interactive Brokers LLC, an online U.S. brokerage firm, did not hold an Australian financial services license which authorized the provision of margin loans. In resolving the matter the firm admitted to contravening the Corporations Act, agreed to refund about $1.5 million and commissions and will pay $100,000 to the Financial Rights Legal Center for consumer education and retain PWC to monitor the refunds.

    Avon Settles FCPA Charges with the DOJ and SEC

    December 17, 2014

    Travel, entertainment and gifts continue to be a central focus of FCPA enforcement. Earlier this month, and last month, the Commission filed settled FCPA actions centered on these items. Now the SEC and the DOJ have settled with Avon Products, Inc. in a case which again centers on these same items. SEC v. Avon Products, Inc., Civil Action No. 14 cv 9956 (S.D.N.Y. Filed December 17, 2014).

    Avon Products is a global manufacturer and marketer of beauty products. The company sells product primarily through direct marketing by over 6 million active independent sales representatives. The firm is active in over 100 countries.

    In the PRC company subsidiary Avon Products China began operations in 1989. In 1999 the firm hired an executive to bring Avon to the attention of relevant organizations and develop business. The executive became a vice president in the corporate affairs department of the China subsidiary.

    In 1998 when China banned all direct selling the company had to alter its typical business model. By 2001, however, China agreed to permit direct selling as part of its admission to the WTO. Avon wanted to influence that process and obtain the first license. Employees in the corporate affairs department furnished government officials with gifts, entertainment and travel to influence the laws and the companies to be selected. In 2003 the company was told informally that when China opened its markets to direct selling Avon China would be the first to receive a test license.

    The next year Avon China retained the services of a third-party consulting company to manage public relations related affairs with the government and others. The contract did not contractually bind the consulting company to comply with the FCPA. In April 2005 Avon China was the first to receive test approval to conduct direct selling in certain areas of China.

    In April 2005 Avon’s global internal audit flagged gifts to government officials and inadequacies in related recordkeeping as an area of concern. Eventually a report was prepared noting that it was common for Avon China to offer gifts and meals to various government officials and that a majority of the government related activities at the subsidiary were not adequately documented. The legal department took over the inquiry. After additional field work, and consulting a major law firm, the legal and government affairs department told the law firm the company had “moved on.”

    In December 2005 China’s new direct selling regulations became effective. For the company to obtain a license it was required to satisfy a number of conditions including “a good business reputation” requirement. At the same time the General Counsel decided to reform certain practices at Avon China. A policy was initiated which required the creation of a log listing government officials and entertainment and gifts. The reforms also required contracts to contain certain representations and warranties. The reforms did not require a description of the business purpose of any meeting with government officials. None of the measures were implemented.

    In March 2006 Avon obtained the first direct sale license. In April the company provided over $100,000 in cash or items of value to government officials. At the same time the company implemented a “zero penalty” policy under which cash and items of value were given to government officials and media to reduce or eliminate potential fines and avoid negative news articles.

    In May 2008 a terminated Avon China executive wrote to the CEO of the company alleging improper payment to Chinese government officials over several years. Eventually the letter was forwarded to the audit committee which launched an internal investigation and self-reported to the SEC and the DOJ.

    Overall, Avon China provided about $8 million in cash and items of value to government officials between 2004 and 2008. Those included payments for meals and entertainment, tickets to events, travel, and to avoid fines. The Commission’s complaint alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).

    To resolve the matter with the SEC the company consented to the entry of a permanent injunction based on the Sections cited in the complaint. In addition, the firm agreed to pay disgorgement of $52,850,000 and prejudgment interest. See Lit. Rel. No. 23159 (Dec. 17, 2014). The Commission considered the cooperation and remedial efforts of the company in the settlement.

    To resolve the action with the DOJ the parent company entered into a deferred prosecution agreement after admitting responsibility. Avon China pleaded guilty to an information charging conspiracy to violate the accounting provisions of the FCPA. The Avon entities will also pay criminal penalties totaling $67,648,000. In total the firm agreed to pay $135,013,013 to resolve the actions.

    SEC Continues To Focus On Microcap Fraud

    December 16, 2014

    The Commission continues to focus on microcap fraud actions with two new manipulation cases involving penny stocks. In one a former registered representative acted as an unregistered broker and then engaged in a series of wash sales. In the Matter of Paul J. Pollack, Adm. Proc File No. 3-16316 (December 16, 2014). In the other an oil and gas company and five executives manipulated the share price of the company. SEC v. Blackburn, Civil Action No. 4:14-cv-00812 (E.D. Tex. Filed December 15, 2014).

    Mr. Pollack and his controlled entity, Montgomery Street Research LLC, are Respondents in an action centered on alleged violations of Exchange Act Sections 10(b) and 15(a). While Mr. Pollack was a registered representative, he has never been registered with the Commission as a broker. Montgomery claims to provide equity research and consulting services.

    In March 2010 Montgomery entered into a three year Letter Agreement with Company A to provide general advice on growth strategies and “position within the public capital markets.” The focus of the undertaking was to raise money in the capital markets and introduce potential investors to the company. From November through April 2011 Respondents helped effect transactions for the company in its common stock. As a result of efforts by Respondents, nine investors purchased $445,000 of the company’s common stock. This represented about 74% of the total offering.

    Later in 2011 Respondents again solicited prospective investors for the firm, this time to acquire shares of preferred stock. About $5.2 million was raised in the offering. Approximately 40% came from the efforts of Respondents. At the conclusion of this offering it was agreed that Respondents would be paid 5% of the value of the preferred stock.

    Mr. Pollack also controlled about 665,000 shares of the firm’s common stock through the Letter Agreement. From December 2010 through October 2012 he had exclusive trading authority over ten online brokerage accounts at five brokers. During the period he used the accounts to purchase about 5.3 million shares of the company while selling about 5.6 million. These transactions yielded over $800,000 in net proceeds. Over a period of 300 trading days Mr. Pollack conducted 4,341 transactions. On some days accounts under his control accounted for over 90% of the reported trading volume.

    During the period July 2011 through June 2012 eight of the accounts controlled by Mr. Pollack engaged in wash trading. The creation of this false activity created upward pressure on the share price. None of the 100 wash trades by various controlled entities resulted in a change of beneficial ownership. The transactions resulted in net trading proceeds of about $369,686.23. The proceeding will be set for hearing.

    Blackburn centers around a scheme created by convicted felon Ronald Blackburn, Treaty Energy Corporation and its executives – Andrew Reid, CEO, Bruce Gwyn, co-CEO, Michael Mulshine, corporate secretary and Lee Schlesinger, CIO, each named as a defendant. Samuel Whitley, outside securities counsel is also named as a defendant.

    The company was formed in December 2008 through a reverse-merger of a private oil and gas company and a dormant public shell by Mr. Blackburn. Its shares, 86% of which were controlled by Mr. Blackburn, were quoted on the OTC Bulletin Board. While the other defendants were appointed to various positions at the company, Mr. Blackburn controlled the firm behind the scenes – a fact not disclosed in its Commission filings.

    In April 2010, through a joint venture agreement, Treaty obtained the drilling rights in Belize . Press releases were issued touting the merits of the program in July 2011. Later that year the company hired a stock promoter to post misleading information on message boards. The hype regarding the drilling program culminated in January 2012 with a press release announcing that Treat stuck Oil. The press release claimed the well had an estimated 5 to 6 million barrels of recoverable oil. The stock price shot up by 79.3% in one day. The announcement was false, according to the complaint. The same day the release was issued, a government agency in Belize published a release refuting the claim of the company. Nevertheless, Mr. Blackburn and the company officers continued to tout the claimed oil strike. A second release by the company again touting the strike halted the share price decline. The price did not return to pre-announcement levels for a months.

    Between 2009 and 2013 Mr. Blackburn and others sold shares of the company in an unregistered public offering and using a Form S-8 to distribute shares to ineligible persons. About $3.6 million was raised from 90 investors.

    By June 2013 Treaty depleted all of its authorized shares. Subsequently, the firm began offering investors oil and gas working interests in a well located in West Texas. Investors were told that the well had an initial production rate of 62 barrels per day with a life span of 20 years and that the investment was low risk. In reality the well produced far less. Nevertheless, 19 investors paid about $565,000 for interests. While the investors were told the funds would be invested in current oil and gas filed development much of the money was misappropriated.

    The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b), 13(a) and 16(a). The case is in litigation. See Lit. Rel. No. 23158 (December 15 2014).

    SEC Files Settled FCPA Action Centered On Improper Travel

    December 15, 2014

    A “world tour” was at the center of FCPA violations by two employees of FLIR Systems, Inc., In the Matter of Stephen Timms, Adm. Proc. File No. 3-16281 (Nov. 17, 2014). Travel was also the focus of the Commission’s latest FCPA case, In the Matter of Bruker Corporation, Adm. Proc. File No. 3-16314 (December 15, 2014).

    Bruker Corporation, based in Billerica, Massachusetts, manufactures and markets analytical tools and life science and materials research systems. The firm manages its China operations through the Shanghai and Beijing representative offices of the Asia-based subsidiaries of four divisions.

    From 2005 through 2008 the Bruker China offices paid about $119,710 to fund 17 trips for Chinese government officials. For the most part the trips were not related to any legitimate business. The trips were recorded as business expenses. The firm had about $1,131,740 in profits from contracts obtained from the state owned enterprises whose officials participated in the rips. Examples of the trips include:

    • In 2006, as part of a sales contract with a state owned enterprise, the China offices paid for training expenses for a Chinese government official who executed the sales contracts for the SOEs. The so-called training expenses included payment for sightseeing, tour tickets, shopping and other leisure activities in Frankfurt and Paris.
    • In 2007 the China offices paid for three Chinese government officials to visit Sweden for a conference. The payments also covered several days of sightseeing in Sweden, Finland and Norway.
    • In 2009 the China offices paid for two Chinese government officials to travel to New York where the firm does not have any offices and Los Angeles where the firm does have facilities but the expenses included sightseeing activities. During the year the China offices also paid for three Chinese government officials to visit destinations in Europe for sightseeing.
    • In 2010 the China offices paid for three Chinese officials to visit Frankfurt, Heidlberg, Stutgart, Munich, Salzburg, Liz, Graz and Vienna.
    • In 2011 those offices paid for officials from seven state owned enterprises to go on sightseeing visits to destinations which included Austria, France, Switzerland, Italy and the Czech Republic.

    From 2008 through 2011 the China offices also paid $111,228 to Chinese government officials through 12 Collaboration Agreements. The agreements were executed with a Chinese official who, in certain instances, was paid directly. Generally those agreements provided that the state owned enterprise was to provide research on Bruker products or use them in their demonstration labs. In fact no work was provided. The firm had profits of about $583,112 from contracts obtained from the state owned enterprises.

    Throughout the period the firm had inadequate internal controls and FCPA compliance procedures, according to the Order. The firm failed to monitor and supervise its senior executives, did not have an independent compliance staff or an internal audit function that had authority to intervene into management decisions and take appropriate action. When the company distributed its training presentations, code of conduct and FCPA policy it failed to translate the documents into the local language.

    Bruker discovered the improper payments in 2011. The firm promptly initiated an investigation, self-reported to the SEC and the DOJ and initiated a broad review of the China operations. Bruker also initiated remedial actions which included terminating senior staff at each China office, revising its compliance program and updating and enhancing its financial accounting controls. Throughout the process the firm provided what the Commission called “extensive, through and real-time cooperation.”

    The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).

    To resolve the matter the company consented to the entry of a cease and desist order base on the Sections cited in the Order. In addition, the firm will pay disgorgement of $1,714,852, prejudgment interest and a civil penalty of $375,000.

    Suit to Enjoin SEC Forum Selection Dismissed

    December 14, 2014

    Many have expressed concern regarding the increasing use of administrative proceedings by the SEC. Those concerns range from the fairness of the forum to the impact of its lack of discovery on complex cases to the right to a jury trial and the development of the law. At the same time the decision regarding forum selection is vested in the discretion of the SEC under the statutes. The difficulty of challenging that authority is illustrated by the Court’s decision in Chau v. SEC, Case No. 14-cv-1903 (S.D.N.Y. Opinion issued Dec. 11, 2014).

    Chau centers claims regarding securities law violations brought by the SEC in an Order Instituting Proceedings which names as Respondents Wing Chau and Harding Advisory LLC. The Order alleges that the Respondents – plaintiffs in this action – violated the securities laws in connection with the sale of interests in a CDO called Octans I CDO Ltd. during the market crisis. Specifically, the Order alleged that the collateral was to be selected by Respondents when in fact they failed to disclose that a hedge fund, whose interests were not aligned with those of Octans I and its investors, had substantial influence over the selection. In the administrative proceeding Respondents moved for an adjournment for time to prepare, to have the Federal Rules apply to the proceeding and that the documents be produced in a manner more to their liking. Each motion was denied as was a request for interlocutory review before the SEC. The hearing in that case has concluded. The initial decision has not been issued.

    This action was initiated while the initial proceedings were taking place before the ALJ. The complaint alleges violations of the due process and equal protection clauses of the Constitution. The former keyed on the procedural differences between an SEC administrative proceeding and a district court action. Plaintiffs claimed that the time limits imposed on those proceedings would not permit adequate preparation in view of the fact that 22 million documents were dumped on them by the Division. This concern was amplified by the lack of discovery and pleading standards.

    The equal protection claim centered on an argument that three other cases brought by the Commission based on very similar facts were brought in district court. In a footnote in a motion plaintiffs appeared to tie that claim to the right to a jury trial since in the other three similar cases the defendants had the right to a trial before a jury.

    In considering a motion for a preliminary injunction by the plaintiffs and a motion to dismiss by the SEC, the Court, in an opinion authored by Judge Lewis Kaplan, concluded that it lacked subject matter jurisdiction. Two key decisions guided the Court’s conclusion. The first is Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994). There the Supreme Court considered a pre-enforcement suit seeking injunctive relief that would preclude the application of certain regulations to the company arising out of a dispute regarding the representative of Thunder Basis’ employees. The district court granted the injunction but was reversed by the Tenth Circuit. The Supreme Court affirmed, concluding that the requested injunction would be inimical to the structure and purpose of the Mine Act. The Court stated that three factors should be considered to determine whether a statutory review scheme divests the district courts of jurisdiction as to pre-enforcement challenges to an administrative action: 1) whether a finding of preclusion could foreclose all meaningful judicial review; 2) if the suit is wholly collateral to a statute’s review provisions; and 3) whether the claims are outside the expertise of the agency.

    The second is Free Enterprise Fund v. PCAOB, 561 U.S. 477 (2010). There plaintiffs challenged the structure of the PCAOB, arguing that it violated principles of separation of powers. Following Thunder Basin the Court concluded that a pre-enforcement constitutional challenge to the existence of the Board was permissible. If the challenge was not permitted it would foreclose judicial review. Likewise, the claim was “wholly collateral” to any SEC adjudication since the suit challenged the very existence of the PCAOB. Finally, the Court found that the SEC had no special expertise to consider the challenge.

    Application of these decisions results in the dismissal of plaintiffs’ claims in this case, according to the Court. First, in considering the due process claims the Court focused on the difference between a facial challenge to the scheme which argues that it is unconstitutional in all instances and one in which the question is if the application of the scheme results in the claimed infirmity. Courts are more likely to sustain pre-enforcement claims regarding the former as in Free Enterprise Fund rather than the latter. Indeed, the application of the Thunder Basin factors dictates against jurisdiction when a pre-enforcement constitutional claim relates to factual issues that are the subject of a pending administrative adjudication, according to the Court.

    This is precisely the case here. First, an SEC adjudication would not foreclose all meaningful judicial review of the due process claim. To the contrary plaintiffs in this case developed a record in the hearing before the ALJ and can raise their issues on appeal first to the SEC and if necessary to a circuit court. Second, the due process arguments are not wholly collateral to the SEC proceeding. In fact, they are actually central to its day-to-day conduct. Finally, plaintiffs have not articulated any “convincing reason why the SEC lacks the competence to consider . . .” the issues raised.

    The Court also rejected the equal protection claims raised by plaintiffs. At the outset plaintiffs do not claim to be part of a protected class. Likewise, the decision in Gupta v. SEC, 796 F. Supp. 2d 503 (S.D.NY. 2011), where the court concluded it had jurisdiction, is distinguishable. There the SEC brought actions in the district court against 28 persons and entities associated with Mr. Rajaratnam but an administrative proceeding against Mr. Gupta. Following Thunder Basin the court found that judicial review of the constitutional claim would be effectively foreclosed because of the lack of discovery, that the request for an injunction was wholly collateral because the claim would survive even if Mr. Gupta were found guilty and finally that the equal protection claim was not peculiarly within the expertise of the SEC. Gupta is distinguishable, according to Judge Kaplan, because he was one member of a class treated differently while here plaintiffs only point to three similar cases. And, in any event “this Court does not find Gupta’s application of the Thunder Basin factors persuasive in these circumstances.” To the contrary, applying those factors here compels dismissal. First, judicial review will not be precluded since plaintiffs have been litigating it. Second, it is not wholly collateral to the SEC proceeding. Where as here the claimed injury is the burden of going through the agency proceeding the party must await judicial review in accord with the statutory scheme. Finally, the claim is not outside the expertise of the SEC.

    This Week In Securities Litigation (December 12, 2014)

    December 11, 2014

    The Second Circuit took center stage this week, handing down a decision which reversed the insider trading convictions of two remote tippees. The decision circumscribes tippee liability by defining the elements of a claim and resurrecting the personal benefit test crafted by the Supreme Court in Dirks as a protection for analysts.

    SEC enforcement brought another insider trading case as an administrative proceeding, number seven since September. In addition, the agency brought actions which include violations of the auditor independence rules, a claim of failure to properly supervise market access by a Wall Street bank, accounting violations by a regional bank and violations of the broker registration provisions.

    Finally, the OECD published a report which provides an analysis of over 400 FCPA cases, giving insight into trends in this area.

    SEC

    Remarks: Chair Mary Jo White delivered remarks at the NYT DealBook Opportunities for Tomorrow Conference titled Enhancing Risk Monitoring and Regulatory Safeguards for the Asset Management Industry, New York, New York (Dec. 11, 2014). Her comments focused on improving the information used to assess risk; ensuring that registered funds enhance their controls; and steps to ensure firms have a plan to transition client assets if necessary (here).

    Remarks: Norm Champ, Director, Division of Investment Management, addressed the ICI 2014 Securities Law Developments Conference, Washington, D.C. (Dec. 10, 2014). The Director commented on the Division’s efforts to better monitor risk, the increasing use of technology and specialized expertise by the Division, efforts to provide transparency into their work, innovative new products and promoting a culture of compliance (here).

    CFTC

    Testimony: Chairman Timothy Massad testified before the Senate Committee on Agriculture, Nutrition and Forestry. His remarks review the work of the agency over the last six months on implementing Dodd-Frank, cross boarder issues, enforcement and the budget (here).

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the SEC filed 0 civil injunctive actions and 16 administrative proceedings, excluding 12j and tag-along-actions.

    Conflicts/misappropriation: SEC v. Crafton, Civil Action No. 3:14-cv-02916 (S.D. Cal. Filed Dec. 10, 2014) is an action against Bill Crafton, the owner of Martin Kelly Capital Management. Through that entity Mr. Crafton delivered investment and wealth administration services to current and former major league athletes. In doing so he failed to disclose that he received over $1.5 million in undisclosed compensation and brokerage commissions from the principals of certain funds and businesses in exchange for the recommendations. In addition, he arranged through forged wire transfer authorizations for two clients to purchase a third client’s $700,000 position in a fund. Mr. Crafton knew at the time he arranged the transaction that the fund was subject to an SEC freeze order based on a fraud claim. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 15(a) and Advisers Act Sections 206(1), 206(2) and 206(3). Mr. Crafton resolved this issues, agreeing to the entry of a permanent injunction based on the Sections cited in the complaint and to the entry of an order requiring that he pay $1,505,952 in disgorgement plus prejudgment interest which it is anticipated he will pay in a related criminal case. He also agreed to the entry of an order barring him from the securities business and from participating in any penny stock offering. See Lit. Rel. No. 23155 (Dec. 11, 2014).

    Misrepresentations: In the Matter of Reliance Financial Advisors, LLC, Adm. Proc. File No. 3-16311 (Dec. 10, 2014); In the Matter of Scott M. Stephan, Adm. Proc. File No. 3-16312 (Dec. 10, 1014). Reliance names as Respondents the registered adviser and its two co-founders, Timothy Dembski and Walter Grenda, Jr. Scott Stephan, the Respondent in the second proceeding was hired by his long time friend Timothy Dembski to work at Reliance in 2007. In 2010 Messrs. Dembski and Grenda helped Scott Stephan start a hedge fund. The idea was to trade using an algorthim that would frequently be changed. Despite having little experience and the high risk nature of the venture, the co-founders of Reliance recommend that their clients invest in the new fund. Both men knew, or were reckless in not knowing, that the PPM they furnished clients greatly exaggerated Mr. Stephan’s experience. Some clients were lead to believe that institutional investors would invest in the new fund. Clients of Mr. Dembski invested about $4 million while those of Mr. Grenda put in about $8 million. The fund was not successful. A number of clients withdrew. Before it closed Mr. Grenda borrowed $175,000 from two clients based on a misrepresentation that the money would help grow the business. The Order in Reliance alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2) and 206(4). The Reliance proceeding will be set for hearing. Mr. Stephan partially settled the proceeding in which he is named as a Respondent, consenting to the entry of a cease and desist order based on violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206(4). He also agreed to be barred from the securities business and from participating in any penny stock offering. A hearing will be set latter to consider monetary sanctions.

    Market access: In the Matter of Morgan Stanley & Co., LLC, Adm. Proc. File No. 3-16310 (Dec. 10, 2010) is a proceeding against the broker dealer for violations of the market access rule. Specifically, on October 25, 2012 the firm increased the monetary limit for market access for Rochdale Securities from $200 million to $500 million and then to $750 million for a trader who planned to purchase $1 billion of Apple stock. The plan, which was a fraud, was to order 1,625 shares and, if the price increased, take the profits and if it decreased claim the order was an error. When the price went down Rochdale was left with a huge loss which pushed the firm below its net capital. Morgan Stanley increased the market access limits without making any investigation or inquiry. The Order alleges violations of Exchange Act Section 15(c)(3). Morgan Stanley consented to the entry of a cease and desist order based on the Section cited in the Order and to a censure. The firm will also pay a penalty of $4 million.

    Insider trading: SEC v. Holley, Civil Action No. 3:11-cv-00205 (D.N.J.) is a previously filed action against George Holley, the former Chairman of Home Diagnostics, Inc. The complaint alleged that in 2010 Mr. Holley tipped six of his friends, relatives and employees about the impending acquisition of the company. Previously he pleaded guilty in a parallel criminal case and was sentenced to serve three years of probation and fined $250,000. This week the Court entered a final judgment which permanently enjoins Mr. Holley from future violations of Exchange Act Sections 10(b) and 14(e) and bars him from serving as an officer or director. The order also directs him to pay $66,100 in disgorgement, prejudgment interest and a civil penalty of $312,440. See Lit. Rel. No. 23153 (Dec. 9, 2014).

    Independence: In the Matter of BKD, LLC, Adm. Proc. File No. 3-16299 (Dec. 8, 2014) is one of eight proceedings which charge auditors of broker-dealers with independence violations. BKD is an accounting and auditing firm registered with the PCAOB. During the fiscal years 2010 through 2012 BKD served as the independent public accountant for 21 broker-dealer audit clients. For at least “one audit performed for nine of its broker-dealer audit clients . . . BKD prepared the financial statements and/or notes to the financial statements that were filed with the Commission . . .” according to the Order. The example in the Order involved Broker-Dealer A. There, for fiscal 2011, the audit firm created the financial statements of the client. Those statements were filed with the Commission with an opinion from the firm stating the audit was in accord with GAAS. In fact it was not because the independence rules preclude an auditor from preparing the financial statements that are the subject of the audit. The audit firm also caused its client to violate Exchange Act Section 17(a) because it knew, or should have known, that its conduct contributed violations of Exchange Act Section 17(a) and Rule 17a-5. In resolving the action BKD, entered into a series of undertakings. The firm also consented to the entry of a cease and desist order based on Exchange Act Section 17(a) and Rule 17a-5 and a censure. BKD will pay a penalty of $15,000.

    Registration violations: In the Matter of BTC Trading, Corp., Adm. Proc. File No. 3-16307 (Dec. 8, 2014) is a proceeding which names as Respondents BTC Trading and Ethan Burnside, a computer programmer. BTC Trading operated LTC Global Virtual Stock Exchange and BTC Virtual Stock Exchange. The two exchanges operated as unregistered, online, virtual currency-denominates securities exchanges and broker dealers from August 2012 through October 2013. Each had a website and solicited persons to open accounts. Account holders could buy and sell securities of businesses listed on the website using virtual currencies Bitcoin and Litecoin. The websites also offered shares in unregistered transactions in exchange for bitcoins and litecoins in LTC-Global and LTC Mining, another virtual currency enterprise founder by Mr. Burnside. During the period about 2,655 users opened accounts and about 60,496 trades were made through LTC. About 7,050 users opened accounts at BTC and approximately 3,66,490 trades were made. The Order alleges violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Sections 5 and 15(a). The Respondents settled the action. Mr. Burnside consented to the entry of a cease and desist order based on Securities Act Sections 5(a) and 5(c) and to the entry of an order barring him from the securities business with the right to reapply after 2 years. He will also pay disgorgement of $55,000, prejudgment interest and a penalty of $10,000. BTC Trading consented to the entry of a cease and desist order based on Exchange Act Sections 5 and 15(a). In resolving the action the Commission considered the cooperation and remedial efforts of the Respondents.

    Improper accounting: In the Matter of Hampton Roads Bankshares, Inc., Adm. Proc. File No. 3-16296 (Dec. 5, 2014); In the Matter of Neal A. Petrovich, CPA, Adm. Proc. File No. 3-16297 (Dec. 5, 20154). Hampton Roads is a bank holding company for Bank of Hampton Roads and Shore Bank, its primary subsidiaries. Mr. Petrovich was the Executive Vice President and CFO of Hampton Roads until his resignation, effective June 4, 2010. Prior to 2008 Hampton Roads did not record significant deferred tax assets. In 2008 as its loan portfolio deteriorated and loan losses increased, the firm recorded a deferred tax assets of $32.6 million. As the firm’s losses increased, the deferred tax asset grew. By the first quarter of 2010 it was $70.32 million. The vast majority of the assets recorded in 2009 and the first quarter of 2010 related to the firms loan losses. The only valuation allowance record by the company during the period was for $1 million related to capital losses realized. While the firm performed an analysis that projected a return to profitability shortly so the deferred tax assets could be used and a valuation reserve would not be needed, operating results and other data suggested otherwise. On August 13, 2010 Hampton Roads issued an amended Form 10K/A for 2009 and an amended Form 10Q/A for the first quarter of 2010, restating the financial statements for those periods. The restated financial statements reflected a valuation allowance against the entire deferred tax asset. The valuation allowance question also impacted the firm’s capitalization level. Prior to the restatement the financial institution reported that it was “adequately capitalized” as of December 31, 2009 and “undercapitalized” as of March 31, 2010. Following the restatement Hampton Roads reported that it was “undercapitalized” as of December 31, 2009 and “significantly undercapitalized” as of March 31, 2009. These changes are material to investors. The Order alleges that the projections relied on by Hampton Roads were not reasonable in view of the totality of the evidence. Each proceeding alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding the bank consented to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay a penalty of $200,000. Mr. Petrovich resolved the proceeding which names him as a Respondent. He undertook to pay a penalty of $25,000 and consented to the entry of a cease and desist order based on the same Sections as Hampton Roads.

    Municipal bonds: SEC v. City of Harvey, Civil Action No. 1:14-cv-4744 (N.D. Ill.) is a previously filed action against the City and its comptroller, Joseph Letke. The action alleged that the city had engaged in a scheme over several years to improperly divert the proceeds from prior bond offerings. The action was filed during another offering. The City settled the action, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). An independent consultant and an independent audit firm will be retained to enhance transparency into the financial condition of the City for future bond investors. The action continues as to Mr. Letke. See Lit. Rel. No. 23149 (Dec. 5, 2014).

    Insider trading: In the Matter of Robert A. Hemm, Adm. Proc. File No. 3-16298 (Dec. 5, 2014). This case centered on a tender offer for SFN Group, Inc. by Randstad Holding nv, announced on July 20, 2011. SFN was a strategic workforce solutions provider which offered temporary and permanent staffing solutions. Randstad is a Dutch multinational human resource consulting firm. On July 12, 2011 a relative of Mr. Hemm’s began working on the tender offer for one of the involved parties. Prior to the announcement of the tender offer Mr. Hemm spoke with the relative several times. Some of those telephone calls took place on July 20, 2011. During the afternoon of July 20, 2011 Mr. Hem purchased 5,000 shares of SFN stock at an average price of $9.23 per share in his and his wife’s brokerage accounts. After the market closed on July 20, 2014 the tender offer was announced. The next trading day SFN’s stock price close up 51%. On August 8, 2011 Mr. Hemm sold his shares for $21,763. The Order alleges violations of Exchange Act Sections 10(b) and 14(e). Mr. Hemm settled the action, consenting to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to disgorge his trading profits, pay prejudgment interest and a penalty equal to the amount of the trading profits.

    Unregistered broker: In the Matter of David Mura, Adm. Proc. File No. 3-15045 (Dec. 5, 2014). The Order alleges that Mr. Mura acted as an unregistered broker-dealer in connection with the solicitation of investors in certain promissory notes issued by a number of limited liability companies. At the time he was a registered representative at a broker-dealer. He also directed Edward Tackaberry, an employee of the limited liability entities and who worked under his supervision, during the solicitations. Through the efforts of Mr. Tackaberry and an individual identified as Investor I, several individuals eventually invested in the promissory notes. Specifically, 17 investors invested about $850,000 in the notes between July 2007 and September 2009. Mr. Mura played an active role in a number of the solicitations. The Order alleges violations of Exchange Act Section 15(a). The proceeding will be set for hearing.

    Criminal cases

    Investment fund fraud: U.S. v. Tomazin (S.D.N.Y.) is an action alleging one count of securities fraud and one count of commodities fraud against Ryan Tomazin. The action centers around trading in R2 Capita which began in 2008. Subsequently, the fund created a commodity pool with $2.2 million. In 2010 it initiated trading on behalf of that pool and quickly lost most of its assets. Mr. Tomazin then solicited an investor who put in $1 million on the representation that the fees would be limited to half of the trading profits. Again the fund experienced significant losses. Trading stopped by June 2011. Nevertheless, Mr. Tomazin sent false statements to the investor showing trading profits. Mr. Thomazin and others associated with the fund caused $850,000 to be withdrawn from bank accounts associated with the pool for their benefit. The CFTC filed a separate action in U.S. District Court in Colorado against Mr. Tomazin.

    Investment fund fraud: U.S. v. OHara, No. 1:10-cr-00228 (S.D.N.Y.) is an action in which Daniel Bonventre, the former Director of Operations for Bernard L. Madoff Investment Securities LLC, was sentenced to 10 years in prison stemming from his role in the Madoff Ponzi scheme. Mr. Boneventre worked for the firm for 40 years, serving as its Director of Operations since 1978. As part of his role of maintaining and supervising the production of the principal internal accounting documents for the firm, he directed that falsified entries be made in the books which concealed in part the scope of the fraud. Since the general ledger was false filings made with the SEC were also false.

    FCPA

    Report: The OECD issued a report on international bribery. The report analyzed the results in over 400 cases worldwide. Those cases involved companies and individuals from 41 signatory countries. Bribes were promised, offered or given most frequently to employees of state-owned enterprises, followed by customs officers, health officials and defense officials. In 57% of the cases bribes were paid to obtain public procurement contracts. Another 12% of the cases involved payments for clearance of customs procedures while 6% related to taxes. About 41% of the cases involved management level employees while only 12% of the actions involved CEOs. Intermediaries were involved in three out of four bribery cases. Overall the length of time to resolve cases is increasing. In 1999 the average case took two years to resolve. Currently the typical case takes just over seven years.

    Court of appeals

    Insider trading: U.S. v. Newman, Nos. 13-1837-cr, 13-1917 (2nd Cir. Decided December 10, 2014). Defendants Todd Newman and Anthony Chaisson were portfolio managers at, respectively, Diamondback Capital Management, LLC and Level Global Investors, L.P. Both were convicted of insider trading in the shares of Dell and NVIDIA following a six week trial. Both were remote tippees. With regard to the trading in Dell, the inside information went down a chain: Company employee Rob Ray transmitted the earnings information to analyst Sandy Goyal, who in turn tipped Diamondback analyst Jesse Tortora who then told Mr. Newman and Global Level analyst Sam Adondukis who told Mr. Chaissom. Each portfolio manager traded.

    The inside information regarding NVIDIA traveled a similar, lengthy path to the two portfolio managers. It began with company insider Hyung Lim who passed the information to Danny Kuno who furnished it to Messrs. Tortora and Adondukis who transmitted it to, respectively, Mr. Newman and Mr. Chaisson. Each portfolio manager traded in NVIDA shares.

    The Second Circuit reversed, concluding that the jury instructions were inadequate and that the evidence on tippee liability was insufficient. The Court began its analysis by reviewing the basic tenants of the classical and misappropriation theories of insider trading. The elements of tipping liability are the same regardless of the theory utilized, the Court noted. Under Dirks the test for determining if there has been a breach of fiduciary duty is “’whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty . . .’” the Court stated, quoting Dirks v. S.E.C., 463 U.S. 646 (1983). The tippee’s liability stems directly from that of the insider. Since the disclosure of inside information alone is not a breach, “without establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the Government cannot meet its burden of showing that the tippee knew of a breach.”

    Based on these principles, the elements of tippee liability are: “(1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade. ..” Since the jury instructions did not incorporate these elements they were incorrect.

    Finally, in reviewing the sufficiency of the evidence, the Court gave definition to the personal benefit test. That test is broadly defined to include pecuniary gain and also reputational benefit that will translate into future earnings and the benefit one, would obtain from making a gift of confidential information to a relative or friend. While the test is broad it does not include, as the Government argued, “the mere fact of a friendship, particularly of a casual or social nature.” A personal benefit can be inferred from a personal relationship but “such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature. In other words . . . this requires evidence of a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the latter.” (internal quotes omitted). Here the evidence is not sufficient to meet this test.

    FINRA

    Conflicts: The regulator fined 10 firms a total of $43.5 million for allowing equity research analysts to solicit investment banking business for a proposed IPO for Toys “R” Us. Specifically, Toys “R” Us was contemplating and IPO. In connection with that proposal it invited 10 firms and their analysts to make presentations to determine if the coverage would be in sync with the plan. Each firm either implicitly or explicitly offered favorable research coverage in return for a role in the IPO. Ultimately the firm did not conduct the offering. Those fined were: Barclays Capital Inc., $5 million; Citigroup Global Markets Inc., $5 million; Goldman Sachs & Co. $5 million; JP Morgan Securities LLC, $5 million; Deutsche Bank Securities Inc., $4 million; Merrill Lynch Pierce, Fenner & Smith Inc. , $4 million; Morgan Stanley & Co. LLC, $4 million; Wells Fargo Securities, LLC, $4 million; Needham & Company LLC, $2.5 million.

    Australia

    Compliance: The Australian Securities and Investment Commission accepted an undertaking to not participate in the securities business for one year from former Professional Investment Services Pty Ltd. representative Seamus O’Brien. The ASIC found that he did not have a reasonable basis for investment advice, did not provide reasonable replacement product advise to clients and failed to keep certain records and comply with the Statement of Advice requirements. If he elects to reenter the business it must be under strict supervision.

    Hong Kong

    Undisclosed account: The Securities and Futures Commission banned Lee Wai Keung, a representative at Glory Sky Global Markets Ltd., for 12 months from the securities business. From October 2007 through June 2013 he traded through a secret account in the name of his sister-in-law. The SFC considers the conduct plainly dishonest.

    IPO subscriptions: The SFC suspended the license of Dick Ma Tore Fok, the former responsible officer of ICBC International Securities Limited for eight months for failures related to the IPO for Powerlong Real Estate Holdings Limited in 2009. ICBC served as one of the joint lead managers for the listing. While the firm referred several people for subscriptions, the appropriate due diligence on potential subscribers was not conducted. Mr. Ma also failed to perform ongoing scrutiny to ensure that the subscriptions were consistent with his knowledge of the purchaser’s financial condition.

    UK

    Investment fraud: Gary West, James Whale and John Stone, formerly senior executives of Sustainable AgroEnergy plc or its parent, Sustainable Growth Group were convicted of using false representations in connection with the selling and promotion of SAE investment products based on “green biofuel” largely to self-invested pensions. Mr. West was sentenced to serve 13 years in prison, Mr. Whale 9 years and Mr. Stone 6 years. Messrs. West and Whale were also disqualified from being a director for 15 years while Mr. Stone was disqualified for 10 years.

    The Second Circuit Defines Tippee Liability and The Personal Benefit Test

    December 10, 2014

    Todd Newman and Anthony Chiassons, remote tippees, three to four steps removed from the source of the inside information about pending earnings announcements for Dell, Inc. and NVIDIA, were convicted of insider trading. In reviewing their convictions for insider trading, the Second Circuit stated: “ We note that the Government has not cited, nor have we found, a single case in which tippees as remote as Newman and Chiasson have been held criminally liable for insider trading.” U.S. v. Newman, Nos. 13-1837-cr, 13-1917 (2nd Cir. Decided December 10, 2014). The Second Circuit drew a clear line regarding the requirements for tipper liability. Perhaps more noteworthy, the Court revived the all but dormant – some might say virtually eliminated — “personal benefit” test crafted for the protection of analysts by the Supreme Court in Dirks v. S.E.C., 463 U.S. 646 (1983). The convictions were reversed.

    Todd Newman and Anthony Chaisson were portfolio managers at, respectively, Diamondback Capital Management, LLC and Level Global Investors, L.P. Both were convicted of insider trading in the shares of Dell and NVIDIA following a six week trial. Both were remote tippees. With regard to the trading in Dell, the inside information went down a chain: Company employee Rob Ray transmitted the earnings information to analyst Sandy Goyal, who in turn tipped Diamondback analyst Jesse Tortora who then told Mr. Newman and Global Level analyst Sam Adondukis who told Mr. Chaissom. Each portfolio manager traded.

    The inside information regarding NVIDIA traveled a similar, lengthy path to the two portfolio managers. It began with company insider Hyung Lim who passed the information to Danny Kuno who furnished it to Messrs. Tortora and Adondukis who transmitted it to, respectively, Mr. Newman and Mr. Chaisson. Each portfolio manager traded in NVIDA shares.

    At the close of the evidence each defendant made Rule 29 motions for acquittal, arguing that tippee liability derives from that of the tipper. Since here there was no evidence that the corporate insiders obtained a personal benefit the charges should be dismissed. The District Court reserved judgment and sent the case to the jury for consideration based on its instructions. The defendants argued that the jury charge on tippee liability should include the element of knowledge of a personal benefit received by the insider. The Court gave the jury an alternate instruction which stated in part that the Government had to prove that the insider “intentionally breached that duty of trust and confidence by disclosing material nonpublic information for their own benefit.” The instructions also stated that the defendant had to “know that it [the inside information] was originally disclosed by the insider in violation of a duty of confidentiality.”

    The Second Circuit concluded that the jury instructions were inadequate and that the evidence on tippee liability was insufficient. Accordingly, the convictions were reversed and the charges dismissed with prejudice.

    The Court began its analysis by reviewing the basic tenants of the classical and misappropriation theories of insider trading. The elements of tipping liability are the same regardless of the theory utilized, the Court noted. Under Dirks the test for determining if there has been a breach of fiduciary duty is “’whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty . . .’” the Court stated, quoting Dirks. The tippee’s liability stems directly from that of the insider. Since the disclosure of inside information alone is not a breach, “without establishing that the tippee knows of the personal benefit received by the insider in exchange for the disclosure, the Government cannot meet its burden of showing that the tippee knew of a breach.”

    In reaching its conclusion the Court held that “nothing in the law requires a symmetry of information in the nation’s securities markets.” That notion was repudiated years ago in Chiarella v. U.S., 445 U.S. 222 (1980). While efficient capital markets depend on the protection of property rights in information, they also “require that persons who acquire and act on information about companies be able to profit from the information they generate.” It is for this reason that both Chiarella and Dirks held that insider trading liability is based on breaches of fiduciary duty, not on “informational asymmetries.”

    Based on these principles, the elements of tippee liability are: “(1) the corporate insider was entrusted with a fiduciary duty; (2) the corporate insider breached his duty by (a) disclosing confidential information to a tippee (b) in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit; and (4) the tippee still used that information to trade. ..” Since the jury instructions did not incorporate these elements they were incorrect.

    Finally, in reviewing the sufficiency of the evidence, the Court gave definition to the personal benefit test. That test is broadly defined to include pecuniary gain and also reputational benefit that will translate into future earnings and the benefit one, would obtain from making a gift of confidential information to a relative or friend. While the test is broad it does not include, as the Government argued, “the mere fact of a friendship, particularly of a casual or social nature.” A personal benefit can be inferred from a personal relationship but “such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature. In other words . . . this requires evidence of a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the latter.” (internal quotes omitted). Here the evidence is not sufficient to meet this test.

    Forum Selection For SEC Cases – District Court or Administrative Proceeding?

    December 09, 2014

    In late September the SEC filed a settled insider trading case against an associate of an unregistered investment adviser. In the Matter of Richard O’Leary, Adm. Proc. File No. 3-16166 (September 25, 2014). The next week the agency filed another settled insider trading case as an administrative proceeding. This time the action was against a Wells Fargo analyst and trader. In the Matter of George T. Bolan, Jr., Adm. Proc. File No. 3-16178 (September 29, 2014). The next day two more settled insider trading cases were filed as administrative proceedings. Those actions were against, respectively, a hedge fund analyst and his tippee. In the Matter of Filip Szymik, Adm. Proc. File No. 3-16183 (September 30, 2014); In the Matter of Jordan Peixoto, Adm. Proc. File No. 3-16184 (Sept. 30, 2014).

    In early November of this year the Commission again filed a settled insider trading case as an administrative proceeding. This action was against the CEO of Intellicheck Mobilisa, Inc. In the Matter of Steven Durrelle Williams, Civil Action No. 3-146246 (November 3, 2014). A few days later the administrative forum was again selected for filing a settled administrative proceeding based on insider trading charges. In the Matter of Michael S. Geist, Adm. Proc. File No. 3-16269 (Nov. 12, 2014).

    The seventh case in this series was file at the end of last week. In the Matter of Robert A. Hemm, Adm. Proc. File No. 3-16298 (Dec. 5, 2014). This case centered on a tender offer for SFN Group, Inc.. by Randstad Holding nv, announced on July 20, 2011. SFN was a strategic workforce solutions provider which offered temporary and permanent staffing solutions. Randstad is a Dutch multinational human resource consulting firm.

    On July 12, 2011 a relative of Mr. Hemm’s began working on the tender offer for one of the involved parties. Prior to the announcement of the tender offer Mr. Hemm spoke with the relative several times. Some of those telephone calls took place on July 20, 2011.

    During the afternoon of July 20, 2011 Mr. Hem purchased 5,000 shares of SFN stock at an average price of $9,23 per share in his and his wife’s brokerage accounts. By that date substantial steps had been taken in furtherance of the offer. Those included the execution of confidentiality agreements, the retention of attorneys and investment bankers and extensive due diligence by Randstad.

    After the market closed on July 20, 2014 the tender offer was announced. The next trading day SFN’s stock price close up 51%. On August 8, 2011 Mr. Hemm sold his shares for $21,763. The Order alleges violations of Exchange Act Sections 10(b) and 14e.

    Mr. Hemm settled the action, consenting to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to disgorge his trading profits, pay prejudgment interest and a penalty equal to the amount of the trading profits.

    Prior to the filing of these seven cases the SEC rarely brought insider trading actions as administrative proceedings. While it is true that the Dodd-Frank Act added remedies to the Commission’s arsenal that were not previously available, that statute was signed into law in 2010. The filing of these seven settled insider trading cases traces to September of 2014, for years after the enactment of Dodd-Frank.

    SEC Enforcement Director Andrew Ceresney discussed the use of administrative proceedings in a recent speech. Remarks to the American Bar Association’s Business Law Section Fall Meeting, Washington, D.C. (Nov. 21, 2014). In his remarks the Director discussed some of the benefits of administrative proceedings, noting in part that a prompt decision is typically obtained, there is a specialized fact-finder and that the Law Judge can give “each piece of evidence the weight that they deem appropriate” because the Federal Rules of Evidence do not apply. He also remarked on some concerns about the proceedings noting that the Supreme Court has rejected claims that there is a right to a jury trial for government claims based on statutes such as the securities laws, that the discovery provisions are adequate and that the use of this forum will not hinder the development of the law but rather will further “the balanced and informed development of the federal securities laws . . .”

    On the question of forum selection the Director stated that “For settled matters, we often, but not always, choose to file in an administrative forum, largely because of efficiency. The filing quickly ends the matter on a settled basis, among parties that have agreed to a settlement, and there is no need to have implementation of the parties’ agreement subject to the competing demands of busy district court dockets . . .” For litigated cases “we evaluate each case to determine the appropriate forum based on the facts and circumstances.”

    Under this approach the seven insider trading cases filed as administrative proceedings since September would not represent a new trend or a move toward bringing these actions as administrative proceedings rather than the traditional civil injunctive action. At the same time the filing of so many insider trading cases as administrative proceedings in a brief period does represent a significant departure from prior practice. That is particularly notable for an agency which frequently looks for consistency. No doubt, the Director is correct that selecting the administrative forum quickly ends the matter – there is no district court to seek the assistance of or to ask questions and delay the entry of the settlement.

    A key point in the Director’s remarks is the statement that the agency decides on a case by case basis which forum to select for contested actions. In weighing those options the SEC will clearly consider the factors cited by the Director about the administrative forum – speed, discovery but no depositions and the inapplicability of the Federal Rules of Evidence. Those factors can be significant for an agency which typically conducts a lengthy investigation to marshal the facts prior to filing an action. Whether those factors will increasingly tip the scales in favor of the administrative forum has yet to be seen. The agency does however have a history of moving into new areas slowly, with a string of settled cases.

    SEC Charges Eight Audit Firms Charged With Independence Violations

    December 08, 2014

    The broker windows approach of filing groups of actions together which center on common theme is expanding to auditor independence. The Commission grouped proceedings naming as Respondents eight audit firms. Each Order alleges violations of the independence rules. In each instance the audit firm conducted audits for a number of broker-dealers clients. In each action the Order alleges that in one or more instances the firm assisted in preparing the financial statements which were the subject of the audit. In each instance the audit firm settled, agreeing to implement certain procedures and to the entry of a cease and desist order, a censure and a directive to pay a penalty.

    Typical of these actions is the one which names as a Respondent BKD, LLP. In the Matter of BKD, LLC, Adm. Proc. File No. 3-16299 (Dec. 8, 2014). BKD is an accounting and auditing firm registered with the PCAOB. It has 245 partners and approximately 1,200 additional professional staff in 34 offices located in 15 states. The firm is based in Missouri.

    During the fiscal years 2010 through 2012 BKD served as the independent public accountant for 21 broker-dealer audit clients. For at least “one audit performed for nine of its broker-dealer audit clients . . . BKD prepared the financial statements and/or notes to the financial statements that were filed with the Commission . . .” according to the Order.

    The example in the Order involved Broker-Dealer A. For that client for the fiscal year ending 2011 BKD audited the annual financial statements. During the audit the firm was given financial documents generated by the Broker-Dealer, including a trial balance and FOCUS reports. The firm used these documents and other financial information to create a set of financial statements for filing with the Commission. BKD gave the financial statements it generated to the client for approval.

    In February 2012 Broker-Dealer A filed Form X-17A-5 Part III for 2011 with the Commission. It contained an audit report signed by BKD. That report represented that the audit had been in accord with GAAS.

    Exchange Act Section 17(e)(1)(A) requires that every registered broker or dealer annually file a balance sheet and income statement with the Commission that has been certified by an independent public accounting firm. The auditor has to be independent under the Commission’s Rules. The audit has to be conducted in accord with GAAS. Rule 2-01(c)(4) of Regulation S-X provides that accountants are not independent if, during the engagement, the accountant provides prohibited non-audit services to an audit client. Those services include preparing the audit client’s accounting records, the financial statements or originating source data underlying the financial statements.

    Here BKD violated Exchange Act Rule 17a-5(i) by representing in its audit reports that it had performed the engagements in accord with GAAS because its independence had been impaired by preparing the financial statements. The audit firm also caused its client to violate Exchange Act Section 17(a) because it knew, or should have known, that its conduct contributed violations of Exchange Act Section 17(a) and Rule 17a-5. Under Rule 102(e) the Commission can censure a person who engages in improper professional conduct within the meaning of the Rule. In this case BKD engaged in highly unreasonable conduct that resulted in violations of the applicable professional standards since it knew, or should have know, that heightened scrutiny was required which is always warranted when independence questions are presented.

    In resolving the action BKD entered into a series of undertakings. Those include establishing written policies and procedures or revising existing procedures regarding independence requirements; establishing a policy regarding training; providing a copy of the Order to all personnel and broker-dealer audit clients; adopting procedures to provide reasonable assurances that prohibited bookkeeping services are not provided to broker-dealer clients; and certifying to the staff that it has complied with all of the undertakings.

    The firm also consented to the entry of a cease and desist order based on Exchange Act Section 17(a) and Rule 17a-5 and a censure. BKD will pay a penalty of $15,000.

    Bank, CFO Settle Accounting Charges with SEC

    December 07, 2014

    The SEC filed settled accounting actions with a financial institution and its CFO, keyed to a restatement. The accounting issue focused on deferred tax assets and the failure to have the related reserve. In the Matter of Hampton Roads Bankshares, Inc., Adm. Proc. File No. 3-16296 (Dec. 5, 2014); In the Matter of Neal A. Petrovich, CPA, Adm. Proc. File No. 3-16297 (Dec. 5, 20154).

    Hampton Roads is a bank holding company for Bank of Hampton Roads and Shore Bank, its primary subsidiaries. Mr. Petrovich was the Executive Vice President and CFO of Hampton Roads until his resignation, effective June 4, 2010.

    Prior to 2008 Hampton Roads did not record significant deferred tax assets. In 2008 as its loan portfolio deteriorated and loan losses increased, the firm recorded a deferred tax assets of $32.6 million. These assets reflects the right to offset a future tax expense or obligation with a future tax benefit or refund. They arise from timing differences that occur between reporting the effect of taxes accrued for under U.S. GAAP and calculating the tax impact under the enacted tax law. When recording such assets the firm must determine if it is more likely than not that the deferred tax asset will be realized in a future period. Where it may not all be utilized, a valuation allowance that is sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized must be established.

    In May 2009 Bank of Hampton Roads merged with Gateway Bank. The acquisition increased the assets of the Hampton Roads from about $1 billion to $3.1 billion. During that year the company disclosed that its problem loans had increased significantly, This was due in large part to the loans obtained in the merger. As the firm’s losses increased, the deferred tax asset grew. By the first quarter of 2010 it was $70.32 million. The vast majority of the assets recorded in 2009 and the first quarter of 2010 related to the firms loan losses. The only valuation allowance record by the company during the period was for $1 million related to capital losses realized.

    In assessing if a valuation allowance should be taken, the critical question was if the credit could be used which was a function of future financial performance. In a March 2010 analysis, made with the assistance of an outside accounting expert, the firm determined that its losses were not expected to continue. Accordingly, no valuation allowance related to the loans was taken. Two months later the firm updated its analysis. Again the analysis projected profits in 2011. This same approach continued through June and July.

    Actual results differed significantly from the projections relied on by the bank. Those results are also consistent with other internal documents which projected continued loan losses. The company actually reported loan loss provisions of $54.6 million, $83.7 million and $27.9 million for the second, third and fourth quarters of 2010.

    On August 13, 2010 Hampton Roads issued an amended Form 10K/A for 2009 and an amended Form 10Q/A for the first quarter of 2010, restating the financial statements for those periods. The restated financial statements reflected a valuation allowance against the entire deferred tax asset.

    The valuation allowance question also impacted the firm’s capitalization level. Prior to restatement the financial institution reported that it was “adequately capitalized” as of December 31, 2009 and “undercapitalized” as of March 31, 2010. Following the restatement Hampton Roads reported that it was “undercapitalized” as of December 31, 2009 and “significantly undercapitalized” as of March 31, 2009. These changes are material to investors.

    The Order alleges that the projections relied on by Hampton Roads were not reasonable in view of the totality of the evidence. Each proceeding alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding the bank consented to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay a penalty of $200,000.

    Mr. Petrovich also resolved the proceeding which names him as a Respondent. He undertook to pay a penalty of $25,000 and consented to the entry of a cease and desist order based on the same Sections as Hampton Roads.