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    This Week In Securities Litigation (Week ending October 23, 2014)

    October 23, 2014

    Rengan Rajaratnam settled his insider trading case with the SEC this week, consenting to the entry of a permanent injunction and agreeing to pay disgorgement, prejudgment interest, a civil penalty and to be barred from the industry with a right to reapply after five years. The settlement follows Mr. Rajaratnam’s victory in the criminal insider trading action brought against him.

    SEC enforcement this week brought two new administrative proceedings. Once centered on an offering fraud while the other focused on a breach of duty.

    SEC

    Rulemaking: The SEC, along with the Board of Governors of the Federal Reserve, the Department of Housing and Urban Development, the FDIC, FHFA and the Office of the Comptroller announced the adoption of rules implementing risk retention requirements regarding securitizations under the Dodd-Frank Act (here).

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the SEC filed 0 civil injunctive action and 2 administrative proceedings, excluding 12j and tag-along-actions.

    Insider trading: SEC v. Rajaratnam, Civil Action No. 13 cv 1894 (S.D.N.Y.) is a previously filed action against Rengan Rajaratnam, the brother of Galleon hedge fund founder, Raji Rajaratnam. The action centered on insider trading claims involving 15 companies and nearly $100 million in illicit trading gains. The action was resolved this week when Mr. Rajaratnam consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). In addition, he agreed to pay disgorgement of $372,264.42, prejudgment interest and a penalty equal to the amount of the disgorgement. He also agreed to be barred from the securities business with a right to apply for reentry after five years. Previously, Mr. Rajaratnam prevailed in the criminal insider trading case brought against him, handing the Manhattan U.S. Attorney’s Office its only insider trading loss in this group of cases.

    Financial fraud: SEC v. Subaye, Inc., Civil Action No. 13 Civ. 3114 (S.D.N.Y.) is a previously filed action against the company and James Crane who served as its CFO. The complaint alleged that the company, which claimed to be a PRC based cloud computing enterprise, was in fact little more than a shell. Mr. Crane, a former auditor barred by the PCAOB, signed a series of false filings made with the Commission. This week the Court entered a permanent injunction by consent prohibiting future violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and Section 105 of the Sarbanes Oxley Act. In addition, the order bars Mr. Crane from serving as an officer or director of a public company for ten years and requires him to pay a penalty of $150,000. See Lit. Rel. No. 23116 (October 21, 2014).

    Offering fraud: In the Matter of Anthony Coronti, Adm. Proc. File No. 3-161203 (October 17, 29014). Respondent Coronti controls, Bidtoask LLC, also named as a Respondent in the proceeding. He claims to be the chairman and CEO of Corsac Inc., an investment adviser to a fund. From 2008 through 2011 Mr. Coronati offered investors units in a fund which supposedly invested in U. S. equity securities. Eleven investors purchased units. There was no fund, according to the Order. When the money ran out, Mr. Coronati moved on. In another iteration of the scheme, Mr. Coronati offered investors shares in a fund at a price of $5 per share. This time investors were told that the funds would be invested a fund that would conduct an IPO in the third quarter of 2012. Again, when the investor funds were drained, Mr. Coronati move on. In early 2012 Mr. Coronati began soliciting investors to purchase shares in a fund that held pre-IPO Facebook shares. This investment was offered through Bidtoask. Approximately $1.75 million was raised from 44 investors. This time the investment was made and the proceeds were distributed to investors, minus sums misappropriated by Mr. Coronti.

    Finally, for about one year, beginning in mid-2013, Respondents offered investments in two privately-owned technology companies. One was going to conduct an IPO investors were told. Rather than invest the funds as represented however, Respondents misappropriated the money. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). Respondents resolved the proceeding, each consenting to the entry of a cease and desist order based on the Sections cited in the Order. Mr. Cononati was also barred from the securities business and will pay disgorgement of $292,646.36, prejudgment interest and a civil penalty of $100,000. A fair fund will be created for investors.

    Misappropriation: SEC v. Wright, Civil Action No. 1:14-cv-01896 (M.D. Pa.) is a previously filed action against registered representative Dennis Wright. The complaint alleged that Mr. Wright induced 28 customers to redeem securities held in their accounts that were then reinvested in what was supposed to be accounts with a higher yield. Instead of reinvesting the money, Mr. Wright misappropriated it. Now the Court has entered a final judgment by consent, prohibiting Mr. Wright from engaging in future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). In addition, he was ordered to pay disgorgement of $1,533,416.33 and prejudgment interest which will be deemed satisfied by the entry of an order of restitution in a parallel criminal case. See Lit. Rel. No. 23115 (October 17, 2014).

    Breach of duty: In the Matter of Clean Energy Capital, LLC, Adm. Proc. File No. 3-15766 (October 17, 2014) is a proceeding which names the previously registered adviser and its co-founder, Scott Brittenham, as Respondents. The Order alleges violations of Securities Act Section 17(a)(2) and Advisers Act Sections 206(2) and 207. CEC marketed 19 separate private equity funds to investors using Ethanol Capital Partners, L.P. Each fund was marketed as a separate series, labeled by a letter such as Fund A. Respondent also marketed the Tennessee Ethanol Partners, L.P. Collectively the 20 CEP Funds raised $64 million from hundreds of investors. The Order alleges a series of violations including the misallocation of expenses which included Mr. Bittenham’s salary, creating an undisclosed conflict; unauthorized borrowings and undisclosed principal transactions; misstatements in connection with a sale to one investors; the improper comingling of cash belonging to the Funds and improper compliance procedures. The Respondents resolved the action and entered into a series of undertakings. Those included the retention of an independent consultant whose recommendations will be adopted. In addition, each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order, to a censure and to pay disgorgement of $1,918,157.00 along with prejudgment interest. Respondents will also pay a penalty of $225,000. Portions of the disgorgement will be returned to certain Funds.

    Criminal cases

    Investment fund fraud: U.S. v. Elmas, No. 1:14-cr-00358 (E.D. Va.). Ismail Elmas , a FINRA registered investment adviser, at one time was employed as an investment adviser with Apple Financial Services, an affiliate of Apple Federal Credit Union. He defrauded 10 investors out of $1 million. The scheme centered on soliciting largely senior citizens and widows for investments. Mr. Elmas owned a bank account in the name of I.E. Financial Solutions. Over a two year period beginning in 2012, he raised over $1 million from investors. In some instances Mr. Elmas induced investors to deposit their funds with I. E. Financial without telling them that it was actually his bank account. In other instances the bank account was described as an investment vehicle such as a certificate of deposit or a real estate investment trust. Other clients just transferred their funds to I.E. Financial. Regardless of the mechanism used, Mr. Elmas misappropriate the funds. Overall 10 investors were defrauded. He pleaded guilty to one count of wire fraud.

    Mr. Elmas is scheduled to be sentenced on January 16, 2015.

    Hong Kong

    Improper conduct: The Securities and Futures Commission suspended Ho Siu Po, a registered representative of DBS Vickers Ltd., for seven months. The suspension is based on his disregard of firm policies which included operating accounts on a discretionary basis and accepting cash from a client, both of which are prohibited.

    MOU: The SFC entered into a memorandum of understanding with the China Securities Regulatory Commission. It calls for cooperation regarding enforcement, the sharing of information and data, establishes a process for joint investigations and ensures that enforcement actions in both jurisdictions operate to protect the investing public.

    Adviser, Co-founder, Settle SEC Breach of Duty Proceeding

    October 22, 2014

    The Commission filed settled administrative proceedings against an investment adviser and its co-founder based on a claimed breach of fiduciary duty. The Order alleged violations based on negligence, citing Securities Act Section 17(a)(2) and Advisers Act Section 206(2) and, in addition, Advisers Act Section 207. In the Matter of Clean Energy Capital, LLC, Adm. Proc. File No. 3-15766 (October 17, 2014).

    Clean Energy Capital, or CEC, was a registered investment adviser until 2012 when the firm determined it was no longer eligible to register with the Commission because of the amount of assets under management. Respondent Scott Brittenham is the co-founder of the adviser and holds an 89% ownership interest but only has a 50% voting interest. He managed the business.

    CEC marketed 19 separate private equity funds to investors using Ethanol Capital Partners, L.P. Each fund was marketed as a separate series, labeled by a letter such as Fund A. Respondent also marketed the Tennessee Ethanol Partners, L.P. Collectively the 20 CEP Funds raised $64 million from hundreds of investors.

    The Order alleges a series of violations:

    Expenses: Beginning in 2008, and continuing to the present, Respondents misallocated certain CEC expenses to the ECP Funds. Specifically, the ECP Funds, each of which is a separate entity, paid CEC a management fee and a portion of the dividends received by the Funds from portfolio companies and portions of the proceeds from sales of portfolio company stock.

    The expenses were divided into three groups: 1) CEC only expenses; 2) ECP Fund only expenses; and 3) expenses split between CEC and the Funds. For the split expenses, typically 70% were allocated to the Funds, divided equally among them. Part of those expenses included Mr. Bittenham’s $1.1 million in compensation from 2008 to 2011 and his bonus.

    Neither the PPMs nor the LPAs for eight of the funds disclosed the payment of the split expenses. Likewise, CEC’s Forms ADV filed in July 2011 and March 2012 did not disclose those expenses. In addition, the allocation of Mr. Brittenham’s compensation to the funds constituted an undisclosed conflict of interest. Mr. Brittenham benefitted from these transactions since he received distributions from CEC’s profits.

    Conflicts/principal transactions: Beginning in September 2012, and continuing for the next four years, CEC issued loans to 17 of the Funds which had insufficient cash reserves to pay the expenses after closing. The LPAs for 14 of the Funds did not permit borrowing money to pay expenses. Promissory notes were issued for the loans and the assets of the funds pledged. Mr. Brittenham unilaterally, and without notice to the investors, amended the documents. The loans represented a conflict of interest. The pledges represented principal transactions between CED and the Funds which require written notice and consent that was not obtained.

    Distributions: Beginning in 2011 CEC and Mr. Brittenham altered the manner in which CED calculated distributions. The new methodology was to the detriment of the Funds. The new methodology also adversely affected the dividends received by investors in Series A, B and C. The changes were not adequately disclosed.

    Misstatements: During the offering for Series R in 2009, misrepresentations were made to an investor regarding the investment of Mr. Brittenham and the co-founder in the offering. Specifically, the investor was told that each invested $100,000. In reliance on that representation the investor put $250,000 into the fund.

    Custodian: From August 2010 through September 2013 CEC kept the Funds’ cash assets in a single master bank account that was comingled, failing to segregate the client assets. In addition, CEC did not have a qualified custodian for original stock certificates it held that were owned by the Funds.

    Compliances: The compliance procedures for CEC incorrectly described the private offering exception of the custody rule. Specifically, the procedures failed to specify that audited financial statements needed to be prepared and distributed – and they were not.

    Prior violations: The PPMs for three series of offerings for the Funds failed to disclose the co-founder’s prior disciplinary settlement with the Commission. That 2012 settlement was based on violations of the antifraud provisions of the Securities Act, the Exchange Act and the Advisers Act and included a cease and desist order and a civil penalty.

    The Respondents resolved the action and entered into a series of undertakings. Those included the retention of an independent consultant whose recommendations will be adopted. In addition, each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order, to a censure and to pay disgorgement of $1,918,157.00 along with prejudgment interest. Respondents will also pay a penalty of $225,000. Portions of the disgorgement will be returned to certain Funds.

    Investment Adviser Pleads Guilty to Wire Fraud Charge

    October 21, 2014

    Investment adviser Ismail Elmas pleaded guilty this week to an information charging one count of wire fraud. U.S. v. Elmas, No. 1:14-cr-00358 (E.D. Va.). This action is the latest is a series cases centered on investment frauds in which the adviser or promoter solicits funds from unsuspecting investors and then misappropriates their money.

    Mr. Elmas at one time was employed as an investment adviser with Apple Financial Services, an affiliate of Apple Federal Credit Union. He was registered with FINRA as an investment adviser.

    The scheme centered on soliciting largely senior citizens and widows for investments. Mr. Elmas owned a bank account in the name of I.E. Financial Solutions. Over a two year beginning in 2012, he raised over $1 million from investors. In some instances Mr. Elmas induced investors to deposit their funds with I. E. Financial without telling them that it was actually his bank account. In other instances the bank account was described as an investment vehicle such as a certificate of deposit or a real estate investment trust. Other clients just transferred their funds to I.E. Financial. Regardless of the mechanism used, Mr. Elmas misappropriate the funds. Overall 10 investors were defrauded.

    Mr. Elmas is scheduled to be sentenced on January 16, 2015.

    SEC Commissioner Piwowar On Enforcement Policy

    October 20, 2014

    Commissioner Michael Piwowar, the only economist currently on the Commission, outlined his views regarding enforcement policy in remarks delivered at the Securities Enforcement Forum 2014 last week (here).

    That policy begins with the due process clause of the Fifth Amendment, the Commissioner stated. The clause “starts with fundamental notions of fairness. Persons should be on notice as to what acts, or failures to act, constitute violations of the law and our regulations.” Persons should also be on notice as to potential sanctions and liabilities.

    Building on this theme, Commissioner Piwowar discussed the purpose of enforcement. The “ultimate goal” is not “regulatory compliance.” Rather, the point is to have healthy capital markets, to protect investors and facilitate capital formation.

    The complexity of that task is reflected in the multiple sources of law and its complexity. Those include rules and regulations, case law, briefs, administrative orders and opinions and views stated by the staff in no-action letters, compliance alerts and similar items. In outlining this issue the Commissioner made it clear that he is opposed to making new law through enforcement measures as an alternative to rule making. While rule making under the Administrative Procedure Act may take time, Commissioner Piwowar stated that he has “significant concerns when Commission orders – especially in settled administrative actions – create new interpretations of the laws or regulations or impose new regulatory requirements.” This is a failure of due process he noted.

    Critical to effective enforcement is the policy which drives it. The Commissioner expressed concern that in these complex times “a ‘broken windows’ approach to enforcement may not achieve the desired result. If every rule is a priority, then no rule is a priority. If you create an environment in which regulatory compliance is the most important objective for market participants, then we will have lost sight of the underlying purpose for having regulation in the first place.” As an alternative, the Commissioner pointed to OCIE, where the staff works with a variety of groups to determine priorities. This process increases efficiency and effectiveness for the program. Enforcement will be most effective, he noted, if its efforts are tied to the Commission’s policy provisions. To implement this effectively the senior staff has to provide leadership and appropriate guidance to the Division.

    Measuring the effectiveness of enforcement presents another key issue. Simply counting the number of cases or reviewing the number of dollars imposed as sanctions is not the answer and may be counter-productive. At the same time the Commissioner raised what he called “another fundamental component of due process” regarding who is held responsible for violations. For example, when a corporation settles and no individuals are named in the action “I often wonder whether the entity is settling because the individuals have actually committed violations or whether the entity is settling simply to resolve the investigation, regardless of the merits,” the Commissioner noted.

    Commissioner Piwowar then turned to the question of corporate penalties. The initial statement in 2006 was adopted to provide clarity and consistency. The real question about that statement is what role it plays. “In recent months, I have become concerned by the increasing number of staff recommendations that have not been accompanies by analysis of the principal factors described in the 2006 penalty statement,” the Commissioner noted. If the Commission is not following its announced policy, it raises a significant due process question.

    The Commissioner’s concern about the predicate for corporate penalties has intensified in the wake of Dodd-Frank which authorized the imposition of penalties in administrative proceedings on any person, not just regulated entities. Increased use of the administrative forum makes it more important that a clear analytical framework exist for determining corporate penalties. Accordingly, the Commissioner stated that he would “welcome a discussion about our analytical framework for corporate penalties” and, if appropriate, a new policy could be articulated through a public notice and comment process.

    SEC Brings Another Offering Fraud Case

    October 19, 2014

    The Commission filed another in what appears to be an unending series of offering fraud actions. Unlike many of its prior cases, this action centers on a Respondent who kept shifting his scheme to continually raise more money at the expense of innocent investors. In the Matter of Anthony Coronti, Adm. Proc. File No. 3-161203 (October 17, 29014).

    Respondent Coronti controls, Bidtoask LLC, also named as a Respondent in the proceeding. He claims to be the chairman and CEO of Corsac Inc., an investment adviser to a fund. Corsac Group Ltd, sometimes called, Corsac Fund, is also controlled by Mr. Coronti.

    From 2008 through 2011 Mr. Coronati offered investors units in Corsac Fund. In the first iteration of this offering, investors were told the fund invested in U. S. equity securities. The fund was looking for a 30% return with minimal risk.

    Eleven investors purchased units. There was no fund, according to the Order. When the money ran out, Mr. Coronati moved on.

    In another iteration of the scheme, Mr. Coronati offered investors shares in Corsac at a price of $5 per share. This time investors were told that the funds would be invested in a fund that would hold an IPO in the third quarter of 2012. Investors were assured the IPO price would be higher than what they paid. When the investor funds were drained, Mr. Coronati move on.

    In early 2012 Mr. Coronati began soliciting investors to purchase shares in a fund that held pre-IPO Facebook shares. This investment was offered through Bidtoask. Approximately $1.75 million was raised from 44 investors.

    While Mr. Coronati misappropriated portions of the money, in fact investor funds were used to acquire interests in a fund that actually owned pre-IPO Facebook shares. After the IPO, the funds were distributed to the investors, but portions were again misappropriated by Mr. Coronati.

    Finally, for about one year beginning in mid-2013, Respondents offered investments in two privately-owned technology companies. One was going to conduct an IPO investors were told. Rather than invest the funds as represented however, Respondents misappropriated the money.

    As the schemes unraveled Mr. Coronati attempted to placate investors by using portions of their money to pay others. False account statements were also distributed.

    The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). Respondents resolved the proceeding, each consenting to the entry of a cease and desist order based on the Sections cited in the Order. Mr. Cononati was also barred from the securities business and will pay disgorgement of $292,646.36, prejudgment interest and a civil penalty of $100,000. A fair fund will be created for investors.

    This Week In Securities Litigation (Week ending October 17, 2014)

    October 16, 2014

    The Commission prevailed in three litigated decisions. The agency secured a favorable jury verdict in an action centered on an offering fraud. In two other cases — one based on misrepresentations regarding the only company product and a second alleging an investment fund fraud – the SEC prevailed on summary judgment motions.

    The SEC also brought its first action centered on high-speed trading, alleging that a firm marked the close repeatedly over a six month period. In addition, actions were brought based on the failure of a broker to produce documents during an investigation, for aiding and abetting violations of the broker registration requirements and for insider trading and investment fund fraud.

    SEC

    Remarks: Commissioner Michael S. Piwowar delivered remarks at the Securities Enforcement Forum 2014, Washington, D.C. (October 14, 2014). His remarks centered on the need for due process and fairness, questioned if broken windows is an effective approach to enforcement and suggested that the 2006 statement on corporate penalties might be revisited (here).

    Statistics: The Commission issued a release titled: FY 2014 Enforcement Actions Span Securities Industry and Include First-Ever Cases. The Release tabulates the number of cases brought during the last fiscal year and highlights selected cases in a number of areas (here).

    CFTC

    Remarks: Chairman Timothy G. Massad addressed the Managed Funds Association (October 16, 2014). His remarks focused on ensuring that the new Dodd-Frank rules do not impose undue burdens and cross-border harmonization (here).

    SEC Enforcement – Litigated Actions

    Offering fraud: SEC v. iShopNoMarkup.com, Inc., Civil Action No. 04-CV-4057 (E.D.N.Y.) is an action against the company and its co-founder and former Chairman, Anthony Knight, and others. The complaint alleged that from 1999 to 2000 the defendants sold nearly 6.75 million shares of stock to over 350 investors, raising about $2.3 million. There was no registration statement in effect and material misrepresentations were made to investors. On October 14, 2014 a jury returned a verdict in favor of the Commission and against Mr. Knight, concluding that he violated Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). Remedies will be determined at a later date. Mr. Knight was the sole remaining defendant in the action. See Lit. Rel. No. 23112 (Oct. 15, 2014).

    Misrepresentations: SEC v. Ferrone, Civil Action No. 1:11-cv-05223 (N.D. Ill.) is an action against Douglas McClain Sr., Douglas McClain Jr., Immounosyn Corporation, Argyll Biotechnologies. LLC, Stephen Ferrone and James T. Micell. The complaint claims that from 2006 through 2010 misrepresentations were made about the sole product of the company, a drug known as SF-1019. Specifically, investors were told that the company planned to commence the regulatory approval process for human clinical trials but were not told that the FDA had twice issued clinical holds on the applications which prevented the trials from moving forward. The Court granted the SEC’s motion for summary judgment as to Mr. McClain Sr., concluding that he failed to deliver Immunosyn shares to investors and made misrepresentations to them about the FDA approval process. The motion was also granted as to both McClain defendants for insider trading since each sold firm shares without disclosing the correct FDA status of the drug in violation of Exchange Act Section 10(b) and Securities Act Section 17(a). Remedies will be determined at a later date. See Lit. Rel. No. 23114 (Oct. 15 2014).

    Investment fund fraud: SEC v. Funinaga, Civil Action No. 2:13-CV-1658 (D. Nev. Order entered Oct. 3, 2014) is an action which names as defendants Edwin Yoshihiro Funinaga and MRI International, Inc. The complaint alleged an investment fund fraud which began in 1998, and continued through 2013. Over $800 million was raised from investors. Those investors were largely in Japan. Investors were told that the firm purchased medical accounts receivables at a discount. Full value would be realized from the insurance companies. Investors were assured that their funds were safe because of certain procedures. In fact the defendants were operating a Ponzi scheme, according to the complaint. Mr. Funinaga invoked his Fifth Amendment rights in the action.

    In considering a series of motions, the Court initially rejected defendants’ claim that it lacked subject matter jurisdiction based on the application of 28 U.S.C. Section 2462, the five year statute of limitations. The Court concluded that the statute of limitations does not apply to disgorgement claims based on controlling Ninth Circuit precedent. Second, the Court rejected a claim that the action should be dismissed under Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010) which held that a cause of action under Exchange Act Section 10(b) does not have extraterritorial application. While the SEC claimed that Morrison has been overruled for government enforcement actions by Dodd-Frank, the Court did not reach that issue. Rather, the Court concluded that the securities transactions involved here closed, and title was transferred, in Nevada. That is sufficient under Morrison the Court found.

    Finally, the Court concluded that there was sufficient evidence to grant summary judgment in favor of the SEC. The evidence demonstrates that the defendants made material misrepresentations regarding the investments. Mr. Funinaga had sole control over the investment fund and used the cash for his personal benefit. His control over the scheme, use of the funds, misrepresentations regarding the safety of the funds, when coupled with his assertion of the Fifth Amendment, were sufficient to establish the key elements of a claim. Accordingly, summary judgment was entered in favor of the Commission. See Lit. Rel. No. 23111 (October 10, 2014).

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the SEC filed 2 civil injunctive action and 4 administrative proceeding, excluding 12j and tag-along-actions.

    Marking the close: In the Matter of Athena Capital Research, LLC, Adm. Proc. File No. 3-16199 (October 16, 2014) is a proceeding against the high speed trading firm, alleging marking the close, a form of market manipulation scheme. The scheme centers on trading during the NASDAQ closing auction and imbalances. Each day at about 4 p.m. NASDAQ ran a closing auction known as the closing cross. During the auction as many buyers and sellers are matched as possible. At times there are imbalances and notices are furnished to traders who can enter specific types of orders. Respondent implemented a series of high speed strategies, taking positions during the process and then overwhelming the market fractions of a second before the close, at times trading as much as 70% of the market during at the moment, to push the price in a direction favorable to its positions. The complex strategy was implemented daily over a six month period beginning in June 2009. The Order alleges violations of Exchange Act Section 10(b). The proceeding was resolved with Respondent consenting to the entry of a cease and desist order based on the cited Section and to a censure. The firm will also pay a $1million penalty.

    Producing records: In the Matter of Judy K. Wolf, Adm. Proc. File No. 3-016195 (October 15, 2014). Ms. Wolf was a compliance consultant for Wells Fargo Advisors prior to her termination in June 2013. In 2009 she drafted the firm’s policies and procedures governing how “look back” reviews would be conducted. On September 2, 2010, the day the acquisition of Burger King was announced, Ms. Wolf began a look back review of the trading surrounding the deal. She concluded that: 1) Wells Fargo account executive Prado and his customers represented the top four positions in Burger King securities firm-wide; 2) Mr. Prado and his customers purchased Burger King stock within 10 days of the announcement; 3) Mr. Prado and his customers each had profits that exceeded the $5,000 threshold specified in the look back review procedures; 4) Mr. Prado and Burger King were located in Miami; and 5) Mr. Prado, his customers and the acquiring company were all Brazilian. News articles about the event were not printed and included in the file despite a provision in the procedures requiring this step. The review was closed and therefore not forwarded to her supervisor. In July 2012 the Commission requested as part of its on-going investigation, and after charging Mr. Prado with insider trading, that Wells Fargo produce its compliance files relating to Mr. Prado. Although the production was eventually certified as complete, it did not include Ms. Wolf’s file. When a second request was made in January 2013, her file was included in the production. Ms. Wolf’s log stated “09/02/10 opened 24% higher@$23.35 vs. previous close of $18.86. Rumors of acquisition by a private equity group had been circulating for several weeks prior to the announcement. The stock price was up 15% on 9/1/12 [sic], the day prior to the announcement.” Ms. Wolf provided contradictory testimony during the investigation. Initially, she denied altering the document. Later she admitted it. The Order alleges violations of Exchange Act Section 17(a) and the related rules. The proceeding will be set for hearing.

    Unregistered broker: In the Matter of Edward L. Maggiacomo, Jr., Adm. Proc. File No. 3-16197 (October 15, 2014); In the Matter of Edward J. Hanrahan, Adm. Proc. File No. 3-16197 (October 15, 2014). The Respondent in each of these proceedings is a registered representative of a broker-dealer. Each proceeding centers on the fraudulent scheme of Joseph Camarmadre who defrauded insurance companies by recruiting individuals who were terminally ill to purchase variable annuities. The annuities, in effect, were short term investments that practically guaranteed an immediate return of the investment. To assist Mr. Camarmadre, who is under indictment as a result of the scheme, recruited Messrs. Maggiacomo and Hanrahan to facilitate the scheme and act as the brokers. Each Respondent is charged with aiding and abetting violations of Exchange Act Section 15(a). In addition, Mr. Maggiacomo is charged with violations of Exchange Act Section 10(b) for submitting false forms to his broker in connection with the annuity scheme. Each Respondent settled, consenting to the entry of a cease and desist order based on the Section or Sections cited in the respective Order. Each is also barred from the securities business and from participating in any penny stock offering with a right to reapply after five years. Mr. Maggiacomo will also pay disgorgement of $216,752.21 and prejudgment interest which will be offset by payments made in related actions. Mr. Hanrahan will pay disgorgement of $83,349.76 along with prejudgment interest but the amount will be offset by the $200,000 he has already paid to settle related claims.

    Insider trading: SEC v. Zwerko, Civil Action No. CV 8181 (S.D.N.Y. Filed Oct. 10, 2014) is an action against Zachary Zwerko, formerly a senior financial analyst at a major pharmaceutical company identified only as Pharma Co. His job responsibilities included conducting analysis in support of business combination and divestiture opportunities, giving him access to a shared hard drive where all deal information was stored. Mr. Zwerko’s longtime friend is Trader. Trader traded in advance of the June 9, 2014 pre-market announcement that Pharma Co. had agreed to acquire Idenix Pharmaceuticals, Inc. While Mr. Zwerko did not work on that deal, he learn about it by accessing the hard drive and through an e-mail chain sent to him by his supervisor. He contacted Trader after learning the identity of Idenix which had been coded in deal documents. Trader began purchasing Idenix shares. Over time Mr. Zwerko continued to access information and contact Trader. Following the deal announcement Trader sold his shares, reaping profits of about $579,000. In 2012 Mr. Zwerko is also alleged to have tipped his friend Trader in advance of the April 23, 2012 pre-market open announcement that Ardea Biosciences, Inc. had agreed to be acquired by AstraZeneca PLC. In the months prior to the deal announcement, Aredea engaged in a series of confidential discussions with several companies, including Pharma Co., regarding possible acquisitions. Mr. Zwerko worked on the proposed deal. Although Pharma did not acquire Areda, the firm participated in the negotiations until at least a week prior to the announcement. During the negotiations Mr. Zwerko and Trader spoke on the phone, sometimes shortly after a meeting about the deal. Ultimately he purchased 9,800 shares through three brokerage accounts. Following the deal announcement he had trading profits of over $105,000. The Commission’s complaint alleges violations of Exchange Act Section 10(b). A parallel criminal case brought by the Manhattan U.S. Attorney’s Office filed criminal charges. Both cases are pending.

    Investment fund fraud: SEC v. The Estate of Vincent James Saviano, Civil Action No. 14-cv-13902 (Oct. 9, 2014) is an action against the estate and Palmetto Investments LLC, operated by Mr. Saviano prior to his death. Defendants claimed to be operating a pooled investment vehicle that conducted “extreme day trading.” Investors were told it was highly profitable and received investment advice from an SEC registered adviser. In fact Mr. Saviano lost most of the $2 million of investor funds raised and misappropriated portions. The complaint alleges violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1), 206(2) and 206(4). It was brought to preserve assets for investors. A receiver has been appointed. See Lit. Rel. No. 23109 (Oct. 10, 2014).

    Manipulation: SEC v. 8000, Inc., Civil Action No. 12-cv-7261 (S.D.N.Y.) is a previously filed action against the company, Thomas Kelly, the CEO of 8000, Jonathan Bryant and Carl Duncan. The complaint alleges that in 2009 and 2010 the defendants manipulated the shares of the company and sold unregistered securities using false legal opinions. This week the Court entered a final judgment against Mr. Kelly, enjoining him from future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The order bars him from serving an officer or director and directs that he pay disgorgement of $415, 592 and prejudgment interest. See Lit. Rel. No. 23110 (Oct. 10, 2014).

    Criminal cases

    Investment fund fraud: U.S. v. Huggins, Case No. 1:13-mj-00301 (S.D.N.Y.) is an action in which Charles Huggins was found guilty of one count of conspiracy and one count of wire fraud following a two week jury trial. From 2008 through 2011 Mr. Huggins and others raised millions of dollars from investors through JYork Industries Inc. and Urogo Inc. Investors were told that their funds would be used to mine gold and diamonds from Sierra Leone and Liberia. Investors were also promised a high rate of return. In fact much of the money was misappropriated.

    Australia

    Insider trading: Hui Xiao, the firmer managing director of Hanlong Mining Investment Pty Ltd, appeared in court on 104 counts of insider trading. The charges stem from two schemes. In the first, from July 1-8, 2011, while in possession of inside information relating to a proposed takeover by Hanlong Mining of Bannerman Resources Ltd, Mr. Xiao procured his wife and two companies to acquire Bannerman contracts for a difference and shares. In the second, which took place from July 13-15, 2011, while in possession of inside information relating to a proposed takeover by Hanlong Mining of Sundance Resources Ltd, Mr. Xiao had his wife and two entities acquire Sundance contracts for a difference.

    Hong Kong

    Misappropriation: The Securities and Futures Commission banned Roger John and Hamish Cruden, both former directors and responsible officers of Salisbury Securities Ltd, from the securities business for life. The order is based on findings that the two misappropriated securities and sale proceeds belonging to clients in order to settle the instructions of another client and their own obligations. In addition, they failed to maintain the required level of capital and made false and misleading statements to the SFC.

    Wells Fargo Compliance Officer Charged With Altering Document

    October 15, 2014

    The acquisition of Burger King by 3G Capital Partners is the matter that just keeps on giving – at least for SEC enforcement. Initially, the Commission brought an action against Wells Fargo broker Waldyr Da Silva Prado Neto, who misappropriated inside information about the transaction from a client, tipped others who traded and traded for his own account. SEC v. Prado, Civil Action No. 12-CIV-7094 (S.D.N.Y. Sept. 20, 2012); see also U.S. v. Prado, Case No. 13-mg-2201 (S.D.N.Y. Sept. 13, 2013). Then the Commission brought an action against Wells Fargo for failing to establish and enforce procedures to prevent the misuse of material, non-public information. In the Matter of Wells Fargo Advisors, LLC., Adm. Proc. File No. 3-16153 (Sept. 22, 2014). Now the Commission has instituted an administrative proceeding against a former Wells Fargo compliance officer for altering a record produced to the staff in connection with its investigation of the broker. In the Matter of Judy K. Wolf, Adm. Proc. File No. 3-016195 (October 15, 2014).

    Ms. Wolf was a compliance consultant for Wells Fargo Advisors prior to her termination in June 2013. In 2009 she drafted the firm’s policies and procedures governing how “look back” reviews would be conducted. Ms. Wolf was the sole compliance officer conducting these reviews. Most of her reviews closed with “no findings.” A log of those inquiries was maintained, although it did not specify the reason for terminating the inquiry.

    On September 2, 2010, the day the Burger King deal was announced, Ms. Wolf began a look back review of the trading surrounding the deal. She concluded that: 1) Mr. Prado and his customers represented the top four positions in Burger King securities firm-wide; 2) Mr. Prado and his customers purchased Burger King stock within 10 days of the announcement; 3) Mr. Prado and his customers each had profits that exceeded the $5,0000 threshold specified in the look back review procedures; 4) Mr. Prado and Burger King were located in Miami; and 5) Mr. Prado, his customers and the acquiring company were all Brazilian. News articles about the event were not printed and included in the file despite a provision in the procedures requiring this step. The review was closed and therefore not forwarded to the branch manager. Supervisors at Wells Fargo did not learn about the review until two years later when the SEC filed its insider trading action against Mr. Prado.

    In July 2012 the Commission requested as part of its on-going investigation, that Wells Fargo produce its compliance files relating to Mr. Prado. Although the production was eventually certified as complete, it did not include Ms. Wolf’s file. When a second request was made in January 2013, that file was included in the production. Ms. Wolf’s log stated “09/02/10 opened 24% higher@$23.35 vs. previous close of $18.86. Rumors of acquisition by a private equity group had been circulating for several weeks prior to the announcement. The stock price was up 15% on 9/1/12 [sic], the day prior to the announcement.”

    Ms. Wolf provided contradictory testimony during the investigation. Initially, she testified that the file had not been altered. She claimed that the date of 9/1/12 in the sentence quoted above was a typo. In addition, Ms. Wolf stated that the news articles were a primary reason for closing the file. Later Wells Fargo produced documents indicating that the Burger King log entry had been altered on December 28, 2012. A prior version of the log was produced that did not contain the sentence quoted above along with the metadata.

    Following her termination from Wells Fargo the Commission took Ms. Wolf’s testimony a second time. During the testimony she admitted altering the log.

    The Order alleges violations of Exchange Act Section 17(a) and the related rules. The proceeding will be set for hearing.

    The Second Time Around Analyst Is Charged With Insider Trading

    October 14, 2014

    The second time around proved to be the undoing of a senior financial analyst at a pharmaceutical company identified only as Pharma Co. Two years ago he supposedly furnished material non-public information about a proposed take-over to his longtime friend, identified as Trader. Trader traded and profited. No action was brought. In 2014 the analyst supposedly furnished the same friend inside information on another transaction. This time the SEC and the Manhattan U.S. Attorney filed civil and criminal charges against the analyst. SEC v. Zwerko, Civil Action No. CV 8181 (S.D.N.Y. Filed Oct. 10, 2014).

    Zachary Zwerko was a senior financial analyst at Pharma Co. His job responsibilities included conducting analysis in support of business combination and divestiture opportunities. Accordingly, he had access to a shared drive that contained confidential project folders regarding potential transactions.

    Mr. Zwerko’s longtime friend is Trader who was a 2008 classmate at business school. Since that time the two have maintained a social relationship.

    Trader traded in advance of the June 9, 2014 pre-market announcement that Pharma Co. had agreed to acquire Idenix Pharmaceuticals, Inc. whose shares were listed on the NASDAQ stock market. The transaction traces to April 2014 when the two firms entered into confidential, non-public discussions regarding a potential business combination. By mid-May confidentiality and standstill agreements were executed.

    Mr. Zwerko did not work on the Idenix transactions. By May 5, 2014, however, he began accessing confidential information about the deal. Those documents referenced the deal by a code name. On May 20 Mr. Zwerko’s supervisor sent him and others and email chain that referenced the deal, noting that a few days earlier a non-binding offer had been made. The lead email referenced the discount rates used for financial modelling and cited Idenix. The chain discussed the acquisition, using the code name.

    Minutes after receiving the e-mail, Mr. Zwerko accessed Yahoo Finance for Idenix from his work computer. Later that day he reviewed headlines about the company. That evening he accessed folders relating to the deal at the office.

    On the same day he received the e-mail from his supervisor, Mr. Zwerko sent a text to Trader. Later that evening, the two friends spoke on the phone. Two minutes after the call ended Trader placed an order for 1,000 shares of Idenix. Although it was not executed, starting the next day Trader purchased shares, investing over $219,000.

    Mr. Zwerko continued to access confidential material about the deal at work and contact Trader:

    • On May 21, 2014 the analyst accessed a confidential file at work that contained a revised offer and noted the proposed deal would go to the board on May 27;
    • On June 3, Mr. Zwerko accessed another confidential file on the deal;
    • On June 3, a few hours after accessing the file, Mr. Zwerko called Trader; and
    • On June 4, 5 and 6 Trader purchased additional shares.

    Following the deal announcement Trader sold his shares, reaping profits of about $579,000.

    In 2012 Mr. Zwerko is alleged to have tipped his friend Trader in advance of the April 23, 2012 pre-market open announcement that Ardea Biosciences, Inc. had agreed to be acquired by AstraZeneca PLC. In the months prior to the deal announcement, Aredea engaged in a series of confidential discussions with several companies, including Pharma Co., regarding possible acquisitions. Mr. Zwerko worked on the proposed deal. Although Pharma did not acquire Areda, the firm participated in the negotiations until at least a week prior to the announcement.

    During the negotiations Mr. Zwerko and Trader spoke on the phone. For example, on February 27, 2012, there was an internal meeting at Pharma regarding a non-binding offer to Ardea. Hours after the meeting Mr. Zwerko called Trader’s cell phone. The next day Trader began purchasing Ardea securities. Ultimately he purchased 9,800 shares through three brokerage accounts. Following the deal announcement he had trading profits of over $105,000.

    The Commission’s complaint alleges violations of Exchange Act Section 10(b). The criminal case alleges one count of conspiracy to commit securities fraud. Both cases are pending.

    SEC Charges E*Trade Subs: When Is the Due Diligence Sufficient?

    October 13, 2014

    Having the correct compliance procedures in place can often be critical. The SEC and the DOJ have repeatedly emphasized this in FCPA cases. Conducting due diligence can be equally critical. For gatekeepers such as lawyers, accountants and brokers, conducting appropriate due diligence can mean the difference between preventing a violation and becoming entangled in it. That was the result for two E*Trade subsidiaries who sold millions of shares of microcap stocks that were not registered despite representations to the contrary from their clients. In the Matter of E*Trade Securities, LLC, Adm. Proc. File No. 3-16192 (October 9, 2014).

    From March 2007 through April 2011 the two E*Trade subsidiaries named at Respondents at various times facilitated the sale of millions of unregistered microcap shares for three Customers, according to the Order. Customer A opened an account with E*Trade in early 2007; Customer B opened an account later that year; and Customer C opened an account in March 2010. The Customers are institutional clients.

    During the period the three Customers routinely acquired large quantities of newly issued penny stocks in private offerings. The Customers represented to E*Trade that the stocks were acquired in PIPE offerings. The size of the deposits varied from several thousand shares to a billion. The shares were issued by 247 companies. Generally the shares were resold within a short period. There were no registration statements on file with the Commission for the shares.

    Respondents did not ask Customers A and B to identify the specific exemption from registration relied on. Likewise, the two Customers were not asked for documentation regarding any exemption. Rather, the two subsidiaries made the following inquiries:

    • What was the intended trading activity;
    • Customer A was asked for written representations that the shares were freely tradable;
    • Customer A furnished written representations that it would comply with the applicable law;
    • Respondents visited the offices of both customers several times to determine that they were reputable;
    • Beginning in March 2009 Respondents reviewed pending deposits to determine if they had financial risk; and
    • In November 2009 the trading history of both Customers was reviewed.

    From March 2010 through April 2011 “Enhanced Due Diligence” was conducted regarding share deposits for Customers A and C. Under this process written representations were obtained from the Customer and issuer that the shares were freely tradable. Opinions from attorneys were also obtained that were based largely on representations from the reseller and issuer. Respondents also researched the attorneys.

    These procedures were inadequate, according to the Order. While Securities Act Section 4(a)(4) exempts from registration brokers’ transactions, it is unavailable when the broker knows, or has reasonable grounds to know, that the shares are not exempt. To rely on the exemption a reasonable inquiry must be conducted. The scope of that inquiry depends on the surrounding facts and circumstances.

    Here Customers A, B and C were continually faced with a series of red flags which should have raised a question as to whether they were engaged in an illegal distribution: 1) each acquired substantial amounts of newly issued penny stocks; 2) those shares were acquired from little known, non-reporting issuers; 3) they were acquired through private unregistered transactions; 4) the shares were immediately resold; and 5) the funds were wired out. Nevertheless, Respondents failed to conduct the kind of searching inquiry that was required under the circumstances. Accordingly, Respondents willfully violated Securities Act Sections 5(a) and 5(c).

    To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited and to a censure. On a joint and several basis Respondents will pay disgorgement of $1,402,850, prejudgment interest and a penalty of $1 million.

    SEC Wins Summary Judgment Ruling In Ponzi Scheme Case

    October 12, 2014

    The Commission prevailed in an investment fund scheme action, obtaining a favorable summary judgment ruling. In reaching its conclusion the Court rejected claims that the action was time barred and that the cause of action was outside the scope of Exchange Act Section 10(b). SEC v. Funinaga, Civil Action No. 2:13-CV-1658 (D. Nev. Order entered Oct. 3, 2014).

    The SEC named as defendants Edwin Yoshihiro Funinaga and MRI International, Inc. The complaint alleged an investment fund fraud which began in 1998, and continued through 2013, in which over $800 million of investor funds were raised. Those investors were largely in Japan.

    Investors were told that the firm purchased medical accounts receivables at a discount. Full value would be realized from the insurance companies. Investors were assured that their funds were safe because of the “role of state governments” which provided guarantees through the deposit system. Investor funds were supposedly kept in “special lock box accounts” managed by an escrow agent.

    In fact the defendants were operating a Ponzi scheme, according to the complaint. Investors were repaid with funds raised from other investors. The supposed escrow agent claimed the funds were transferred to Mr. Funinaga. In a statement to the Japanese Financial Services Agency, Mr. Funinaga admitted that investor funds were used to repay other investors. Other portions of the investor funds were diverted to the personal use of Mr. Funinaga who invoked his Fifth Amendment rights in the action.

    In considering a series of motions the Court initially rejected defendants’ claim that it lacked subject matter jurisdiction based on the application of 28 U.S.C. Section 2462, the five year statute of limitations. The SEC opposed this motion, claiming that the cause of action continued until 2013 and, in any event, the statute does not apply to equitable remedies. Following SEC v. Ring, 991 F. 2d 1486 (9th Cir. 1993) the Court concluded that the statute of limitations does not apply to disgorgement claims. While other jurisdictions have applied Section 2462 to all forms of relief, Ring is controlling here.

    Second, the Court rejected a claim that the action should be dismissed under Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010) which held that a cause of action under Exchange Act Section 10(b) does not have any extraterritorial application. While the SEC claimed that Morrison had been overruled for government enforcement actions by Dodd-Frank, the Court did not reach that issue. The Court noted that other jurisdictions have found a “lack of clarity” on this point, citing. SEC v. Chi. Convention Ctr., LLC, 961 F. Supp. 2d 905, 916-17 (N.D. Ill. 2013). Rather, the Court concluded that the securities transactions involved here closed and title was transferred in Nevada. That is sufficient under Morrison the Court found.

    Finally, the Court concluded that there was sufficient evidence to grand summary judgment in favor of the SEC. Here the evidence demonstrates that the defendants made material misrepresentations regarding the investments. Mr. Funinaga had sole control over the investment fund and used the cash for his personal benefit. His control over the scheme, use of the funds, misrepresentations regarding the safety of the funds, when coupled with his assertion of the Fifth Amendment are sufficient to establish the key elements of a claim. Defendants’ attempt to refute the evidence of the SEC by claiming that the Court does not have jurisdiction is not sufficient. Accordingly, summary judgment was entered in favor of the Commission. See Lit. Rel. No. 23111 (October 10, 2014).