May 28, 2015
The Impact of Newman on SEC Enforcement: Part I
This is the first segment of a five part series discussing the impact of the Second Circuit’s ruling in Newman on SEC insider trading cases
In seeking rehearing and an en banc hearing before the Second Circuit Court of Appeals the Manhattan U.S. Attorney’s Office told the Court that the panel decision in U.S. v. Newman, Case Nos. 13-1837, 13-1917 (2nd Cir. December 10, 2014), would undermine the ability of law enforcement to effectively police the securities markets for insider trading. Petition of the United States of America for Rehearing and Rehearing En Banc, filed January 23, 2015 (“Petition for Rehearing”) at 22. The SEC, in an amicus brief, concurred. Brief for the Securities and Exchange Commission as Amicus Curiae Supporting the Petition of the United States for Rehearing or Rehearing En Banc, filed January 29, 2015 (“SEC Brief”) at 11. The Court denied the request for rehearing. Newman is the law, at least in the Second Circuit.
Unless Newman is overturned by the Supreme Court, the decision will remain the law in the Second Circuit and perhaps others in view of the Court’s influence in securities law. The impact of Newman thus becomes a critical issue for SEC enforcement. To assess the potential impact of Newman on SEC enforcement four key points should be considered: 1) the decision; 2) its impact on existing criminal and civil cases; 3) its impact on SEC cases; and 4) analysis.
The Decision in Newman
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 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 using the “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 jury found both defendants guilty of insider trading.
The Second Circuit disagreed. The Court held 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, according to the Court. 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 had a fiduciary like 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. The Second Circuit subsequently denied a motion for rehearing by the U.S. Attorney.
May 27, 2015
Another SEC FCPA Action Tied to Hospitality
Hospitality and effective compliance procedures are often critical issues when dealing with government officials. Those two issues came into sharp focus in the SEC’s latest FCPA case. In the Matter of BHP Billiton Ltd., Adm. Proc. File No. 3-16546 (May 20, 2015).
BHP Billiton is a combination of two companies, BHP Billiton Ltd. of Melbourne, Australia and BHP Billiton Plc of London, England. Both are Respondents. The two firms operate as a single entity. Both have shares traded in the U.S. The firm is among the world’s leading producers of major commodities, including iron ore, coal, oil, gas and others. While the two firms operated together and have an advisory body called the Global Ethics Panel, there was no centralized compliance group within the firm’s legal department.
In December 2005 the firm became an official sponsor of the 2008 Beijing Olympic Games. This meant that it had the right to use the Olympic trademark and intellectual property and priority access to tickets, hospitality suites and accommodations during the games. One of the firm’s objectives in being a sponsor was to reinforce and develop relationships with key stakeholders in the product and investor markets where it wanted to have operations. Accordingly, select guests were invited to attend he games to implement with that objective. Hospitality packages were put together which included luxury hotel accommodations, meals, event tickets, sightseeing excursions and in some instances airfare. The value of the packages ran about $12,000 to $16,000.
In early 2007 BHPB employees prepared country-specific Olympic Leverage Plans which represented the firm’s business and Olympic-related objectives. In some instances the plans discussed inviting key shareholder, including government officials, to help relationship build. Eventually about 650 people were invited, including 176 government officials. Of those invited, 98 were official s represented state-owned enterprises that were BHPB customers or suppliers.
While the company assessed the risk of inviting government officials to the Olympics, the Order states that adequate precautions were not taken. Applications were developed that were prepared by business managers. Those applications included questions about existing business obligations and contracts and whether the hospitality would create an impression of an improper connection.
The controls were inconsistent. For example, in most instances there was little review although the website noted that requests would be approved by the Olympic Sponsorship Steering Committee and the Global Ethics Panel Sub-Committee. In fact there was no meaningful review of requests. In some cases applications were incomplete and/or contained incorrect information. There was no training regarding the application process.
As a result of the inadequate controls over the selection process, BHP invited a number of government officials who were directly involved with, or in a position of influence regarding pending negotiations. For example, in mid-2007 there was a hospitality application for the then to be named Burundi Minister of Mines and spouse. At the time the application for a hospitality package noted that the firm was not in negotiations with the Minister of Mines. Later, however, the company began to negotiate with the Minister regarding a dispute with a joint venture partner. There was no update process for the hospitality applications.
In another instance, at the time an invitation was extended to the Secretary of Department of Environment and Resources of the Philippines the firm did not have any matters involving the Secretary. Later, the Secretary took on a role in reviewing a dispute with another joint venture partner. BHPB later withdrew the invitation. Overall the firm’s procedures were inadequate to ensure that those invited were not in positions to influence firm business.
The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and13(b)(2)(B). In resolving the matter the Commission considered the cooperation and remedial efforts of the firm which included creating a compliance group within the legal department independent from the business units.
To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay a $25 million penalty.
May 19, 2015
Last week the Commission resolved a proceeding involving a life insurance company centered on the pricing of its variable annuity and variable life insurance products. Specifically, the Order alleged violations of Rule 22c-1 since the company apparently chose not to receive at its office mailed orders for certain products until after 4:00 p.m. pricing time. With no discussion of inadequate procedures, harm to investors, ill-gotten gains or new remedial steps, the action leaves more questions unresolved that answered. In the Matter of Nationwide Life Insurance Company, Adm. Proc. File No. 3-16537 (May 14, 2015).
Nationwide Life Insurance Company is a stock life insurance firm owned by Nationwide Financial Services, Inc.. That firm is an indirect subsidiary of Nationwide Mutual Insurance Company and Nationwide Mutual Fire Insurance Company.
This proceeding centers on subsequent purchase payments – not the initial payment – for two types of variable insurance products. One is a variable annuity product which provides for a cash value that can be paid to the owner and lifetime income payments to the annuitant. A second is a variable life insurance contract which provides for payment equal to the cash value of the policy and a death benefit that is a multiple of the cash value.
Nationwide was subject to the pricing requirements of Rule 22c-1 which generally requires that an investment company sell or repurchase any security based at the NAV next computed after the order. That NAV must be computed each day. Typically that is at 4:00 p.m.
Respondent was subject to the Rule at two levels. First, contracts were issued and/or serviced through 35 separate accounts registered with the SEC under the Investment Company Act. Second, the firm entered into participation agreements with various mutual funds which agreed to serve as investment options for Nationwide’s variable contracts.
The firm received orders related to its variable products through a variety of methods. Those include mail sent to the Post Office or its headquarters. The insurer had a number of PO Boxes at the Columbus, Ohio Post Office to segregate different types of mail. At the firm’s request the Post Office further divided the mail into two groups: PO Box mail directed to Nationwide Financial businesses, including its variable products, and mail directed to other business units.
Generally, the Post Office began sorting the mail early in the morning and completed the task by 10:00 a.m. each day. Curriers retrieved the mail at various times during the day. Those curriers were instructed not to retrieve and bring the regular mail regarding variable products to the firm until after 4:00 p.m. each day. Priority mail, which is dated, relating to these products was exempt from this procedure. When the variable contract orders were received by the firm they were stamped with a “post-4:00 p.m. time stamp. Those orders were then processed for price at using the next day’s pricing. This practice, which began in 1995 and continued through the Fall of 2011, violated Rule 22c-1, the Order states.
Nationwide resolved the proceeding, consenting to the entry of a cease and desist order based on the Rule cited in the Order. In addition, the firm agreed to ay a civil penalty of $8 million.
This appears to be the first proceeding which focuses on the manner in which variable products are priced by life insurance companies. It centers on procedures regarding the pricing of Nationwide’s variable products. Yet there is no charge that the firm had inadequate procedures, on a discussion of Rule 22c-1 on pricing. Indeed, there is no discussion of the firm’s procedures or order processing or how it handles the flood of orders received daily.
Likewise, there is no discussion of what steps the firm took to remedy what appears to be inadequate procedures. While the Order states the practice continued for over 15 years, beginning in the mid-1990s and continuing through most of 2011 when it presumably stopped – perhaps when the Commission’s investigation began—there is no indication of what steps were taken to ensure compliance in the future beyond a statement noting that the SEC considered the remedial acts of the company and its cooperation. Yet future compliance is a key focus of enforcement actions.
There also is no discussion of the impact, if any, on investors, another key enforcement focus. To be sure the Order states that customer orders received by ordinary mail were priced the next day, there is no allegation that this had any impact on the investors. The Order does not allege that Nationwide obtained ill-gotten gains – no disgorgement was ordered. It also does not allege that any investor was harmed by the practice – no restitution was ordered. Nor does it detail any facts regarding the reason the firm chose to price what was in probability the bulk of its orders for the variable products the next day. Since SEC enforcement actions are designed to halt violations, protect investors and prevent a reoccurrence of the wrongful conduct in the future, the Order here should have discussed these factors rather than just recount what some might view as a technical violation of a rule ending in an unexplained $8 million penalty.
May 18, 2015
SEC enforcement actions are supposed to halt violations, protect investors and the markets, act as a deterrent and prevent a future repetition of wrongful conduct. To facilitate those goals settlements typically incorporate common elements. For example, when settling a civil injunctive action in Federal court the agency generally requires that the defendant admit to the jurisdiction of the court, neither admit nor deny the factual allegations in the complaint and consent to the entry of a permanent injunction preventing future violations of the Sections of the statutes alleged to have been violated. In addition, the defendant will be ordered to pay disgorgement and prejudgment interest if there are ill-gotten gains and a civil penalty. There may be other provisions, depending on the case, such as an officer/director bar or a penny stock bar to protect investors in the future. The settlement papers also provide as a matter of policy that the defendant is precluded from denying the allegations of the complaint – settlements are a matter of principle, not a business decision.
The resolution of SEC administrative proceedings are similar. In many instances there are undertakings to institute certain procedural reforms with the assistance of a retained consultant to preclude a repetition of the conduct. The settling order will then contain many of the same elements as those in a civil injunctive action, substituting a cease and desist order for the injunction. In this age of “get tough” enforcement, the resolution of either the civil injunctive action or the administrative proceeding may be based not just on consent but admissions of fact extracted from the defendant or Respondent rather than on the more traditional basis of neither admit nor deny.
Then came the settlement in SEC v. Syron, Civil Action No. 11 Civ 9201 (S.D.N.Y.), centered on the conduct of GSE Freddie Mac and its officers during the market crisis. The settlement omitted every standard element of an SEC settlement without explanation.
The underlying case
The defendants in Syron are the former Chairman of the Board, Richard Syron; former Executive Vice President and Chief Business Officer, Patricia Cook; and former Executive Vice President for the Single Family Guarantee business, Donald Bisenius.
The case centered on claims that the company and the named defendants failed to disclose, and made misrepresentations regarding, the exposure of the firm to the subprime real estate market as the market crisis was unfolding.
The complaint focus on the period from March 2007 through May of 2008. In statements, speeches and filings with the SEC during that period, the complaint alleges that the named defendants misled investors. Investors were lead to believe that the company used a broad definition of subprime loans and that it was disclosing all of its Single-Family subprime loan exposure. Mr. Syron and Ms. Cook reinforce this view by publicly stating that the company has essentially no subprime exposure. Thus at December 31, 2006 Freddie Mac represented in Commission filings that its the exposure to the Single Family Guarantee business for subprime loans was between $2 billion and $6 billion or about 0.1% and 0.2% of its Single Family guarantee portfolio. In fact, as of December 31, 2006, its exposure in that market was about $141 billion or 10% of its portfolio. Those numbers are based on loans the Company internally referred to in various classifications such as “subprime,” “otherwise subprime” or subprime-like.” By June 30, 2008 that exposure grew to about $244 billion or 14% of the portfolio.
Mr. Syron had ultimate authority over the subprime discloses in Freddie Mac’s Information Statements and supplements and Commission filings during the period. Ms. Cook, according to the complaint, provided substantial assistance to Mr. Syron and Freddie Mac in making subprime disclosures by certifying the accuracy of the disclosures which related to her area of responsibility. Mr. Bisenius also certified the accuracy of the subprime disclosures in certain Information Statements and Supplements published during the period and in the Form 10-Q, thus substantially assisting Mr. Syron and the company in making the misleading disclosures.
The disclosures did not reflect the true exposure of the firm to the subprime market and were thus inaccurate and misleading. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a).
The case was resolved with an Order by the Court stating that it “retains jurisdiction to enforce the Stipulation . . .” The Stipulation referred to is the Stipulation and Agreement and Order, dated March 2015 and executed by the parties.
The Stipulation resolves the action as to each defendant. After reciting the history of the case, it states that “the parties agree, without conceding the strengths or weaknesses of their respective claims and defenses, that it is not in the interest of justice to continue to litigate this matter . . . the parties have accordingly agreed to resolve this Case without further litigation.” It then provides that the case is resolved and that the Stipulation and Agreement are in full force and effect for twelve months as to defendant Bisenius eighteen months for defendant Cook and twenty-four months for defendant Syron. During those periods each defendant will:
- Refrain from signing any SEC report based on Exchange Act Sections 13(a) or 15(d) or any certification required by SOX Sections 302 or 906;
- Cause the following amounts to be donated to the Freddie Mac Fair Fund under SOX Section 308(b): Mr. Syron: $250,000; Ms. Cook: $50,000; and Mr. Bisenius: $10,000; and
- Each defendant will cooperate fully and truthfully with the Commission as to any related proceeding.
This is the entirety of the agreement.
SEC enforcement actions are supposed to halt violations, protect investors and the markets, and prevent the wrongful conduct from being replicated in the future. In the age of “broken windows” and “get tough” enforcement, those settlements have become punitive in the view of many. Yet here not only did the SEC avoid being punitive it is at best questionable what was accomplished. There is no injunction prohibiting a repetition of wrongful conduct to protect investors and the markets. There is no disgorgement, no penalty, no procedures to prevent a repetition of the wrongful conduct in the future.
Also missing is any explanation – or even a hint of a suggestion – as to the reason the the SEC abandoned every standard settlement provision it routinely imposes on parties. No admissions; no “neither admit nor deny:” no permanent injunction or cease and desist order; no disgorgement; no penalty; no ancillary relief and no requirement that the defendants not deny the claims in the complaint. In place of these standard elements are brief limitations on the ability of the defendants to make filings with the Commission and execute SOX certification coupled with an obligation to “donate” certain amounts to a fair fund. There seems to be little purpose to these provisions.
This is not the stuff of SEC Enforcement settlements. The complaint alleges a significant, systematic fraud on the public and the markets – intentional misrepresentation during a time when investors and the markets were in critical need of the information. It claims the defendants lied to investors and the markets. Yet for no apparent reason the big bad watch dog surrendered his growl and teeth, rolled over and gave up.
If the case collapsed in discovery, which does happen, the proper remedy is dismissal, not a meaningless settlement. If this was supposed to be a face saving settlement, the SEC should think again – this is a face defacing settlement. While the company took responsibility for its conduct and agreed not to contest the statement of facts when entering into an agreement to resolve its liability, that does not explain the result here. The SEC owes the public and the markets it is supposed to protect an explanation.
May 17, 2015
The Commission resolved another financial fraud action stemming from the aftermath of the market crisis. This proceeding, initially brought in June 2014, named as a Respondent Thomas Neely, Jr., and E.V. P. of Regions Bank. In the Matter of Thomas A. Neely, Jr., Adm. Proc. File No 3-15945 (June 25, 2014).
Mr. Neely was in the risk management credit division. The Order alleged that in the first calendar quarter of 2009 the special asset department initiated procedures to place about $168 million of commercial loans into non-accrual status. Mr. Neely circumvented the banks controls and, without supporting documentation, took steps to keep the loans in accrual status. His actions, which evaded the bank’s controls, prevented Regions from appropriately measuring impairment in accordance with GAAP.
As a result, according to the Order, Regions failed to maintain a system of internal accounting controls sufficient to provide reasonable assurances that the loans were recorded as necessary to permit preparation of financial statements in conformity with GAAP. The bank also failed to keep books, records and accounts in reasonable detail, which accurately and fairly reflected the loans. Since those books, records and accounts were incorporated into Regions’ consolidated financial statements for the quarter ended March 31, 2009, the income before taxes for that quarter was overstated by $16 million and net income was overstated by $11 million. Earnings per share were overstated for the quarter by $0.02 per share. Those results were incorporated into filings made with the Commission. The Order alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) , 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5) and 20(b).
Mr. Neely resolved the charges after initially contesting them, consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, he agreed to the entry of an officer and director bar for a period of five years and will pay a civil penalty of $100,000.
Previously, the Commission settled with two other bank officers. In that proceeding the Order named as Respondents Jeffrey C. Kuehr, E.V.P of Regions’ Bank risk management credit division and Michael J. Willoughby, a senior EVO and Regions’ CCO. The Order alleged violations of the same Sections as the Order regarding Mr. Neely. Messrs. Kuehr and Willoughby each consented at the time the action was filed to the entry of a cease and desist order based on the Sections cited in the Order. Each man also agreed to the entry of an order barring them from serving as an officer or director of a public company for five years. In addition, each Respondent will pay a penalty of $70,000. In the Matter of Jeffrey C. Kuehr, Adm. Proc. File No. 3-15946 (June 25, 2014)
The bank entered into a deferred prosecution agreement, in recognition of its cooperation and extensive remedial undertakings. It will also payed a penalty of $26 million that will be offset provided it pays a $46 million penalty assessed by the Federal Reserve. The bank will pay a $5 million penalty to the Alabama Department of Banking.
May 14, 2015
The Commission filed and insider trading case in tandem with the Manhattan U.S. Attorney’s Office against a father and son based on repeated trades in advance of deal announcements even after FINERA initiated an investigation this week. The agency also filed a settled administrative proceeding against an insurance company based on the pricing of variable insurance contracts and a financial fraud case centered on an educational firm. In addition, the SEC brought actions based on: An advance fee scheme, misappropriation, an offering fraud and an investment fund fraud. Finally, another stop order proceeding was initiated.
Remarks: Marc Wyatt, Acting Director, Office of Compliance Inspections and Examinations, delivered remarks titled “Private Equity: A Look Back and a Glimpse Ahead,” New York, New York (May 13 2015). His remarks reviewed recent activities of the Office, its enhanced experience with private equity and influence beyond exams (here).
Remarks: Andrew Ceresney, Director, Division of Enforcement, delivered remarks titled “The SEC’s Cooperation Program: Reflections on Five Years of Experience,” at the University of Texas School of Law’s Government Enforcement Institute, Dallas, Texas (May 13, 2015). His remarks reviewed the cooperation program and benefits to individuals (here).
Remarks: Andrew Ceresney, Director, Division of Enforcement, delivered the Keynote Speech at the New York City Bar 4th Annual White Collar Institute, New York, New York (May 12 2015). His remarks provided an overview of the enforcement program, reviewed recent trial results and discussed admissions, remedies and the use of administrative proceedings (here).
Remarks: Commissioner J. Christopher Ciancario delivered the Keynote Address to the EnergyRisk Summit USA program, Huston, Tx. ( May 13, 2015). The Commissioner discussed position limits in the energy markets, potential liquidity challenges in some markets, bona fide hedging and guiding principles (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 6 civil injunctive cases and 2 administrative actions, excluding 12j and tag-along proceedings.
Pricing: In the Matter of Nationwide Life Insurance Company, Adm. Proc. File No. 3-16537 (May 14, 2015) is a proceeding centered on the pricing of orders and redemptions of variable insurance contracts and underlying mutual funds. The Order alleges that beginning in 1995, and continuing for the next sixteen years, Nationwide intentionally delayed picking up its first class mail for these orders from its PO Box until after 4:00 p.m. The orders were then processed and priced at the next day’s price. These repeated acts were willful violations of Investment Company Act Rule 22c-1. Nationwide resolved the proceeding, consenting to the entry of a cease and desist order based on Rule 22c-1. The firm also agreed to pay a civil penalty of $8 million. The Commission considered the prompt remedial efforts and cooperation of the company.
Insider trading: SEC v. Stewart, Civil Action No. 15 cv 03719 (S.D.N.Y. Filed May 14, 2015) is an action naming as defendants a father, Robert Stewart, and son, Sean Stewart. The son was employed at two different investment banks between 2010 and 2014. During that period he furnished material non-public information regarding pending deals that he obtained through his employment to his father who profitably traded. After the first transaction FINRA began an inquiry. Nevertheless, the trading continued. At one point R. Stewart began trading through the account of another with whom he shared profits. During the scheme the two men also talked in code at times in order to try and avoid detection. R. Stewart had over $1 million in trading profits. The SEC’s complaint alleges that the son gifted the information to his father and that the father became an insider with an obligation not to trade. A parallel criminal complaint alleges that there is a cooperating witness who recorded conversations with Robert Stewart. The SEC’s complaint alleges violations of Exchange Act Sections 10(b) and 14(e) . The Manhattan U.S. Attorney’s Office filed the parallel criminal case. Both cases are pending.
Insider trading: SEC v. Jorgenson, Civil Action No. 13-cv-02275 (W.D. Wash.) is a previously filed action against Brian Jorgenson, a former Senior Portfolio Manager in Microsoft’s corporate finance and investments division, and his friend Sean Stokke. After pleading guilty to parallel criminal charges both men admitted to unlawful conduct which is the basis for the Court entering final judgments as to each of permanent injunction prohibiting future violations of Exchange Act Section 10(b) and directing that they pay, on a joint and several basis, over $400,000 in disgorgement and prejudgment interest stemming from their illegal trading. See Lit. Rel. No. 23261 (May 14, 2015).
Advanced fee scheme: SEC v. North Star Finance LLC, Civil Action No. 23262 (D. Md. Filed May 14, 2014) names as defendants the firm, Thomas Ellis, Yasuo Oda, Thomas Vetter, Michael Martin, Sharon Salinis, Capital Source Funding LLC and Capital Source Lending LLC. The complaint alleges that the defendants have collected about $5 million from investors since 2013 through an advanced fee scheme. Specifically, the SEC alleged that North Star and the Capital Source entities promised investors that in return for an advance fee to be held safely in escrow they could monetize bank guarantees to generate millions of dollars. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b) and 15(a). See Lit. Rel. No. 23262 (May 14, 2015).
Misappropriation: SEC v. Ahmed, Civil Action No. 3:15-cv-00675 (D. Conn. Filed May 5, 2015). Defendant Iftikar Ahmed is an investment professional who was a partner at Oak Investment Partners, a multistage venture capital firm. It advises several funds, each of which invest investor funds in various entities. Those investors range from individuals to institutions and pension funds. As a general partner at Oak Investment Mr. Ahmed identified and recommended investment opportunities for the funds advised by the firm. Beginning in October 2013, and continuing through the end of 2014, Mr. Ahmed recommended that Oak Investment funds make significant investments in three companies where he benefited either by misappropriating part of the claimed price or from undisclosed conflicts: 1) In August 2014 Mr. Ahmed recommended an investment in a Chinese e-commerce company where he inflated the share price from $1.5 million to $3.5 million – the increase went to him; 2) He recommended the purchase of shares of an Asia based joint venture for $20 million that were actually offered for $2 million, pocketing the extra $18 million; and 3) he recommended the purchase of shares in another e-commerce company without disclosing that his firm owned a significant stake in the company at the time of the first purchase or that the second was actually from his firm. The complaint alleges violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1), 206(2), 206(3) and 206(4). The case is pending. See Lit. Rel. No. 23260 (May 13, 2015).
Financial fraud: SEC v. ITT Educational Services, Inc., Civil Action No. 15-cv-00758 (S.D. Ind. Filed May 12, 2015) names as defendants: ITT Educational, a higher education company with over 50,000 students, whose shares are trade on the NYSE; Kevin Modany as ITT’s CEO; and Daniel Fitzpatrick, the firm’s CFO. Most of ITT’s revenue is generated by tuition. Students generally pay that tuition with federal and state student loans. In 2009 ITT formed two private student loan programs known as PEAKS and CUSO. PEAKS was structured as a trust that sold securities to investors. The CUSO student loan program was funded by a group of credit unions organized by ITT. Both were designed to be held off the books. Together over $400 million in loans were made to ITT students. Guarantees were extended by ITT to mitigate the risk. By 2012 the loans in the programs had extremely high default rates. ITT’s guarantee obligations increased. The defendants took steps to conceal that and avoided consolidating PEAKS as required. They also concealed the poor loan performance from the auditors. The scheme unraveled in early 2014. The auditors began to discover previously undisclosed information about the programs. Eventually ITT was required to restate its financial statements to consolidate PEAKS for periods beginning in the first quarter of 2013 and to reclassify and disclose the timing for CUSO liabilities. In March 2014 ITT paid $40 million to settle claims by PEAKS program participants tied to the firm’s circumvention of the guarantees through the POBOB program. Overall ITT paid millions of dollars on the guarantees because of poor loan performance. The complaint alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2), 13(b)(5) and control person liability under 20(a) and Securities Act Section 17(a) and a failure to reimburse under SOX 304. The case is pending.
Insider trading: SEC v. McGee, Civil Action No 12-cv-1296 (E.D. Pa.) is a previously filed insider trading action. This week the Court entered by consent, judgment against Michael Zirinsky, enjoining him from future violations of Exchange Act Section 10(b). He was also required to pay disgorgement of $46,396, prejudgment interest and a penalty of $192,054. The action was based on the merger of Philadelphia Consolidated holding corp with Tokio Marine Holdings. See Lit. Rel. No. 23257 (May 11, 2015).
Stop order: In the Matter of the Registration Statement of First Xeris Corp., Adm. Proc. File No. 3-16530 (May 11, 2015) is a proceeding regarding the firm’s registration statement which is alleged to contain false and misleading statements by the one director/officer company. It will be set for hearing.
Offering fraud: SEC v. Novinger, Civil Action No. 4:15-cv-00358 (N.D. Tex. Filed May 11, 2015). The defendants are: Christopher Novinger, licensed by the Texas Department of Insurance; Brady Speers, also licensed by the Texas Department of Insurance; NFS Group, LLC, d/b/a Novers Financial which is the name Messrs. Novinger and Speers conduced business under prior to the firm’s formation in late 2012; Ican Investment Group, LLC, a firm formed by Mr. Novinger in the Fall of 2013; and Speers Financial Group, LLC formed by Mr. Speers, which then established Speers Financial to receive commissions on the sales of life settlement interests to investors. Messrs. Novinger and Speers hosted a weekly radio show called the “Retirement Experts Radio Show” in the Dallas/Fort Work area. They represented themselves under titles such as “licensed consultants.” From February 2012 through January 2014 Defendants Novinger, Speers and NFS Group, d/b/a Novers Financial, offered and sold life settlement interest. In soliciting investors the two men assured them that: 1) the interests were safe and guaranteed; 2) had annualized average returns of 7-11%; 3) were as safe as a CD; and 4) they were federally insured. Investors were not told that despite their claimed titles the two men had little experience in the area or that they had a checkered regulatory history with the Oklahoma Department of Securities, the Texas Attorney General, the FCC and the State of California based on wrongful securities activities. While investors were supposed to be accredited, in fact their finances were falsely inflated to make it appear they met the appropriate tests. Messrs. Novinger and Speers and Novers sold more than $4.3 million of life settlement interests to 26 investors. At least three were not accredited investors. These sales generated about $515,000 in commissions that were paid directly to Ican Investment and Speers Financial. 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.
Investment fund fraud: SEC v. ClearPath Wealth Management, LLC, Civil Action No. 15-cv-00191 (D.R.I. Filed May 7, 2015) is an action which names as defendants Patrick Churchville, the president and owner of ClearPath, and ClearPath Wealth Management, L.L.C., a state registered investment adviser. Beginning in December 2010 the defendants diverted deposits from new investors to pay prior investors, used proceeds from selling certain investments to pay other investors and misappropriated about $2.5 million in investor funds. These actions were concealed from investors and the auditors. 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). The case is pending. See Lit. Rel. No. 23255 (May 8, 2015).
Investment fund fraud: U.S. v. Huggins (S.D.N.Y.) is an action against Charles Huggins. He is alleged to have conducted a years long, $8 million investment fraud which victimized dozens of investors. Following a two week trial he was convicted. The Court imposed a ten year prison sentence followed by three years of supervised release. Previously, two co-defendants pleaded guilty. They are awaiting sentencing.
Investment fund fraud: U.S. v. Valente (N.D.N.Y.) is an action in which Scott Valente pleaded guilty to one count of securities fraud, one count of mail fraud and one count of obstructing and impeding the due administration of the I.R.S. The plea was based on his conduct from December 2010 through June 2014. During that period Mr. Valente, operating investment company ELIV Group LLC, raising over $10.5 million from over 100 investors. Investors were solicited with falsified investment returns for the firm. Mr. Valente also falsely represented that the firm was eligible to receive IRA funds.
False claims: The Australian Securities Investment Commission cancelled the license of Australian Financial Services, an FX dealer. The firm falsely promoted a number of websites as insurance compensation scheme, raising about $2.5 million. The website used the ASIC logo. The scheme does not exist in Australia. This investigation was part of a sweep of the FX industry.
Unlicensed activity: Hong Kong Game Theory Association Ltd. and Sze Ching Lok , its sole proprietor, were convicted after a ten day trial of advertising futures contracts without a license and rendering investment advice. They were acquitted of selling securities without a license. A sentence of one month in prison and a suspension for two years was imposed on Mr. Sze while the firm was fined $7,000.
May 13, 2015
The SEC charged another investment professional with fraud and self-dealing. SEC v. Ahmed, Civil Action No. 3:15-cv-00675 (D. Conn. Filed May 5, 2015). Defendant Iftikar Ahmed is an investment professional who was a partner at Oak Investment Partners, a multistage venture capital firm. It advises several funds, each of which invests investor funds in various entities. Those investors range from individuals to institutions and pension funds.
As a general partner at Oak Investment Mr. Ahmed identified and recommended investment opportunities for the funds advised by the firm. Part of his duties included specifically recommending the purchase of securities and advising on the price. He also managed investments he recommended.
Beginning in October 2013, and continuing through the end of 2014, Mr. Ahmed recommended that Oak Investment funds make significant investments in three companies:
Chinese e-commerce firm: In August 2014 Mr. Ahmed recommended an investment in a Chinese e-commerce company whose shares were held by an offshore firm. Although he knew, according to the complaint, that the shares were being offered at $1.5 million, he recommended that the fund pay a price which was $2 million more – that is, $3.5 million. To support the recommendation Mr. Ahmed made false representations regarding the finances of the firm. The fund purchased the shares for $3.5 million. Mr. Ahmed arranged for the purchase price to be wired to Iftikar Ali Ahmed Sole Prop, a claimed business with a BVI bank account where the seller was supposed to be located. In fact the firm’s bank account listed the address of Mr. Ahmed’s Connecticut residence. Later the $2 million was transferred to a personal bank account in the name of Mr. Ahmed and his wife.
Asia based joint venture: A second recommendation was made at the end of 2014. In this instance Mr. Ahmed arranged for an Oak Investment fund to purchase the shares of an Asia-based joint venture from its two partners. Although the offering price was $2 million, the fund was told by Mr. Ahmed that it was $20 million. Again he made false representations regarding the finances of the joint venture to support his claim. Mr. Ahmed then made arrangements for the payment to be wired in two installments, one of $2 million and a second of $18 million. The latter was to go to the BVI based partner and transferred to the partnership. Again the funds were wired to Iftikar Ali Ahmed Sole Prop. The funds were never transferred to the partnership. Mr. Ahmed had purported deal documents e-mailed to an Oak Investment employee showing the deal closed.
E-commerce firm: In late 2013 Mr. Ahmed made the first of two recommendations regarding the purchase by an Oak Investment fund of shares in an e-commerce company. At the time of the recommendations a substantial portion of those shares were owned by I-Cubed, a firm initially owned by Mr. Ahmed and later his wife. Initially, Mr. Ahmed recommended a $25 million purchase. He did not disclose his interest in the firm. Later he advised the fund to purchase additional shares of the e-commerce company directly from I-Cube. Although his firm purchased those shares in late 2012 for $2 million he advised the fund to pay $7.5 million. His interest in I-Cube was not disclosed.
The complaint alleges violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1), 206(2), 206(3) and 206(4). The case is pending. See Lit. Rel. No. 23260 (May 13, 2015).
May 12, 2015
Student loans, and the debt burdening many students at graduation, is an important political topic. It is not generally a subject for the Securities and Exchange Commission. Nevertheless, at the center of is most recent enforcement action is an educational institution that was forced to restate its financial statements as a result of delinquent pools of student loans it held off the books but which had been guaranteed. SEC v. ITT Educational Services, Inc., Civil Action No. 15-cv-00758 (S.D. Ind. Filed May 12, 2015).
Named as defendants are: ITT Educational, a higher education company with over 50,000 student whose shares are trade on the NYSE; Kevin Modany as ITT’s CEO; and Daniel Fitzpatrick, the firm’s CFO.
Most of ITT’s revenue is generated by tuition. Students generally pay that tuition with federal and state student loans. Historically students relied on traditional private education loans. In 2008 and 2009 ITT tried to secure a new source of private loans for its students but failed. The firm then used a temporary credit system for students that required loans.
In 2009 ITT formed two private student loan programs known as PEAKS and CUSO. PEAKS was structured as a trust that sold securities to investors. It used the funds to make over $300 million in loans to ITT students. The CUSO student loan program was funded by a group of credit unions organized by ITT. It made about $141 million in loans to ITT students. Guarantees were extended by ITT to mitigate the risk. If the students defaulted on their loans ITT could be liable for significant guarantee payments.
PEAKS and CUSCO were designed to enable ITT to avoid reporting on their finances. Both were variable interest entities or VIEs. Under GAAP a company must consolidate the financial results of a VIE if its directs the activities that most significantly impact the economic performance of the entity. For PEAKS and CUSCO that activity was loan underwriting and performance. ITT did not, however, consolidate the financial results of the two entities – ITT shareholders were not furnished with direct information about the two programs.
By 2012 the loans in the programs had extremely high default rates. ITT’s guarantee obligations increased. To conceal the poor performance of the two loan programs, and its impact on ITT, the firm and Messrs. Monday and Fitzpatrick used various devices. For example, they created the Payments on Behalf of Borrowers or POBOB program. Under this program the company made payments on behalf of student borrowers who failed to make timely payments. This had the effect of temporarily delaying defaults. Public filings did not mention this program. Rather, those filings made it appear that the student loans were performing well.
Another approach used to conceal the impact of the defaulting loans was “netting.” Under this approach the near term PEAKS guarantee payments ITT projected making were netted against potential future recoveries that were not projected to be realized for years. The disclosed amount was thus millions of dollars lower than the more than $100 million in near term payments ITT was projected to make. The PEAKS program was not consolidated into ITT’s financial statements despite having the kind of control that required such action.
For CUSO the defendants only made the minimum guarantee payments. This was a practice “akin to making minimum payments on a high interest credit card . . .” according to the complaint. Messrs. Modany and Fitzpatrick also concealed important information about the PEAKS and CUSO programs form the auditors. That included internal projections about future guarantee payments and other matters.
The scheme unraveled in early 2014. The auditors began to discover previously undisclosed information about the programs. Eventually ITT was required to restate its financial statements to consolidate PEAKS for periods beginning in the first quarter of 2013 and to reclassify and disclose the timing for CUSO liabilities. In March 2014 ITT paid $40 million to settle claims by PEAKS program participants tied to the firm’s circumvention of the guarantees through the POBOB program. Overall ITT paid millions of dollars on the guarantees because of poor loan performance.
The complaint alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2), 13(b)(5) and control person liability under 20(a) and Securities Act Section 17(a) and a failure to reimburse under SOX 304. The case is pending.
May 11, 2015
The SEC filed another offering fraud action, a staple of Enforcement. This action centers on two recidivist radio talk show hosts selling interest in life settlements based on enhancements of their investment credentials, omissions of their regulatory history and a series of misrepresentations. SEC v. Novinger, Civil Action No. 4:15-cv-00358 (N.D. Tex. Filed May 11, 2015).
The defendants names in the action are: Christopher Novinger, licensed by the Texas Department of Insurance; Brady Speers, also licensed by the Texas Department of Insurance; NFS Group, LLC, d/b/a Novers Financial which is the name Messrs. Novinger and Speers conduced business under prior to the firm’s formation in late 2012; Ican Investment Group, LLC, a firm formed by Mr. Novinger in the Fall of 2013; and Speers Financial Group, LLC formed by Mr. Speers, which then established Speers Financial to receive commissions on the sales of life settlement interests to investors.
Messrs. Novinger and Speers began working together in the late 1990s, selling various goods, services and investment interests. In early 2012 the two men were introduced to life settlements, fractionalized interest in the benefits payable under life insurance policies that are payable on the death of the insured. The interests are securities.
The two men hosted a weekly radio show called the “Retirement Experts Radio Show” in the Dallas/Fort Work area. Messrs. Novinger and Speers represented themselves as “licensed consultants,” or “licensed financial strategists.” They also employed slogans to describe themselves such as “The Low Risk, Safe Money Guys” or retirement experts or “the largest non-risk investment consulting firm in the Southwest.”
From February 2012 through January 2014 Defendants Novinger, Speers and NFS Group, d/b/a Novers Financial, offered and sold life settlement interest. In soliciting investors the two men assured them that: 1) the interests were safe and guaranteed; 2) had annualized average returns of 7-11%; 3) were as safe as a CD; and 4) they were federally insured.
Investors were not told that despite their claimed titles, Mr. Novinger and Mr. Speers had little expertise or training in the area. Also omitted was their regulatory history. In September 2013 the Oklahoma Department of Securities issued a cease-and-desist order against Messrs. Novinger and Speers and Novers for their fraudulent offer of unregistered life settlements in that state. Also not disclosed were the facts that the Texas Attorney General, the FCC and the State of California each took regulatory action against a prior company owned, managed and directed by Defendants Novinger and Speers which had participated in a fraudulent scheme to mass-market discount health plans.
Investors were told that they had to be “accredited.” That term is defined under Rule 501 of Regulation D which requires the investor’s net worth or income meet certain thresholds. To help investors meet those thresholds Messrs. Novinger and Speers used a “Net Worth Calculator” which improperly included the tabulation of 20 years worth of future social security, pension and other similar payments.
As a result Messrs. Novinger and Speers and Novers sold more than $4.3 million of life settlement interests to 26 investors. At least three were not accredited investors. These sales generated about $515,000 in commissions that were paid directly to Ican Investment and Speers Financial. 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.