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    THE ORIGINS OF THE FCPA: LESSONS FOR EFFECTIVE COMPLIANCE AND ENFORCEMENT — PART THREE

    September 15, 2014

    This is the third part of an occasional series. The first part is available here, while the second is here. The entire paper will be published by Securities Regulation Law Journal early next year. .

    The foreign payments cases held the organization and the individuals involved accountable while improving corporate governance for the benefit of the shareholders in the future. A series of cases followed the initial filings. Examples include:

    · SEC v. Gulf Oil Corporation, Civil Action No. 75-00563 (Filed March 11, 1975) in which the complaint alleged that the company disbursed over $10 million to various subsidiaries, including the Bahamas Exploration Company, through false book entries in therecords of the company. About $5.4 million was converted to cash and returned to the United States to make domestic political contributions or to disburse overseas.

    · SEC v. Lockheed Aircraft Corporation, Civil Action No. 76-0611 (D.D.C. Filed April 13, 1976) in which the complaint alleged that the company paid at least $25 million in corporate funds to foreign government officials, including officials in Japan and Italy. In addition, over $200 million was paid to various consultants and agents without adequate records or controls to ensure that the payments were used for the purpose indicated in the records and that the services were received. The complaint also alleged that the company maintained a secret cash fund of at least $750,000 which was used in part to make payments to foreign government officials.

    · SEC v. Foremost-McKesson, Inc., Civil Action No. 76-1257 (D.D.C. Filed July 7, 1976) in which the complaint alleged that the firm made payments of $6 million in cash and merchandise to retailers and wholesalers to induce the purchase of wine and spirits distributed by the company. It also alleged that at least $213,000 was paid to various government officials to impact government policy and that the books and records were falsified.

    · SEC v. General Tire & Rubber Co., Civil Action No. 76-0799 (D.D.C. Filed May 10, 1976) in which the Commission alleged that under the direction of the president of the company funds were diverted for political purposes by purporting to increase bonuses and salaries. Slush funds were created, including one with the knowledge and approval of senior management of the international division, which totaled $3.9 million. It was used to pay foreign government officials. Another fund maintained by a foreign subsidiary was used in conjunction with five major tire companies to finance efforts to secure a price increase from a foreign government. See also SEC Report at 7.

    The Commission’s illicit payment actions were brought against some of the most prominent corporations in the U.S. They included: Minnesota Mining & Manufacturing Co. (1975); Phillips Petroleum Co. (1975); Northrop Corporation (1975); Gulf Oil Corporation (1975); United Brands Company (1975); Ashland Oil, Inc. (1975); General Refractories Co. (1975); Braniff Airways, Inc. (1976); Waste Management, Inc. (1976); Lockheed Aircraft Corporation (1976); General Tire & Rubber Company (1976); Firestone Tire & Rubber Company (1976); and Foremost-McKesson (1976). Herlihy & Levine at 578 n. 185 (collecting cases); see also SEC Report at 3.

    Many of the cases brought named senior corporate officials as defendants in addition to the company. The following are examples of actions brought against the firm where one or more senior executives were named as defendants:

    · American Shipbuilding Company — George M. Steinbrenner, III, CEO;

    · Minnesota Mining & Manufacturing — Harry Heltzer, CEO; Irwin Hansen, Director and former vice president; Bert Cross, former Chairman of the board;

    · Phillips Petroleum — William Keeler, former Chairman of the Board of Directors and CEO; John Houchin, former president and chairman of the board; William Martin, Chairman of the Board and CEO; Carstens Slack, vice president;

    · Gulf Oil Corporation – Claude Wilde, Jr. former vice president; and

    · Northrop Corporation — Thomas Jones, President and CEO; James Allen Director and former vice president.

    The naming of the executives was consistent with the overall approach of these cases. Each action centered on the notion that corporate officials were the stewards of shareholder funds. In that capacity they had an obligation to account to the shareholders whose money they utilized, and tell them how their funds were used. See generallySporkin at 274.

    The remedies in these cases were driven by Director Sporkin’s vision of what the cases were about: I “always tried to look at how to create something for the overall good; to create something with a purpose. The purpose was if we could get all companies to have honest books and records and what not that would be a good purpose,” the Director later noted. Transcript at 17. Thus the consent decrees typically included an injunction based on the Sections of the securities laws cited in the complaint. The injunction was implemented and given meaning through a series of court ordered undertakings which were carefully crafted to ensure that shareholders were informed how their funds were being utilized to strengthen corporate governance. Typically a special board committee would be created, chaired by independent director since many firms did not have an audit committee. A report would be prepared under the direction of the committee with the assistance of outside counsel and the auditors. That report would be filed with the SEC and distributed to the board of directors. It would contain recommendations for improving corporate governance systems. Those recommendations would be implemented by the company as ordered by the court. Summaries of these reports are available in Appendix B to the SEC Report.

    The reports generated in these actions served as models for other companies and the future. One of the most comprehensive was that of Gulf Oil.

    · The report was prepared by a special committee headed by John J. McCoy, Esq.

    · The nearly 300 page report was supported by six appendices;

    · It analyzed more than $12 million of corporate funds for payments to government officials in the U.S. and overseas;

    · The report detailed the responsibility of corporate management for years of misusing funds;

    · It contained recommendations to avoid the reoccurrence of the improper conduct; and

    · Following the completion of the report the independent directors on the Gulf board replaced senior management.

    The reports prepared in other cases were similar. The specific recommendations were tailored in those reports to the facts and circumstances at the company. They included revisions to corporate policies and procedures, requirements that restitution be made by those involved and directives that employees be discharged. Summaries of these reports are available in Appendix B to the SEC Report. In each instance the focus was on using the equitable powers of the court – the SEC did not have the authority to impose fines and did not seek disgorgement – to “make sure things went well” according to Director Sporkin. Transcript at 6.

    The approach to remedies centered on halting violations and preventing a reoccurrence of wrongful conduct. A central point was the impact on long-term corporate practice and governance. In this regard what two SEC officials stated at the time regarding the Gulf report applies equally to the significance of the program: “Long after the present furor in reaction to overseas corporate payments has passed, the Gulf report will survive as an invaluable resource tool providing a revealing portrayal of the operations of a major company, the evolution of ethical practices in business, and as a model for remedial action in the future.” Herlihy & Levine at 584.

    THE ORIGINS OF THE FCPA: LESSONS FOR EFFECTIVE COMPLIANCE AND ENFORCEMENT: PART TWO

    September 14, 2014

    This is the second part of an occasional series. The first part is available here.

    The entire paper will be published by Securities Regulation Law Journal early next year.

    The illicit or foreign payments cases

    The preliminary inquiry was followed by formal SEC investigations early in 1974. The resulting cases would become known as the “illicit or foreign payments” cases. The focus of the investigations was on corporate accountability and governance, not the propriety of making the payments. Report of the S.E.C. on Questionable and Illegal Corporate Payments and Practices, submitted to the Committee on Banking, House and Urban Affairs, U.S. Senate (May 1976) (“SEC Report”).If shareholder funds entrusted to corporate officials were being used to make political contributions, pay bribes and take other, similar actions, there should be disclosure. Shareholders are entitled to know how their money is being used, the manner in which their company is operating and the type of stewards who work for them. As Director Sporkin stated: ”Our concept was to get the information to the shareholders and let the shareholders make decisions on what they wanted to do.” Transcript at 14. That theme was echoed in the SEC Report to Congress on its enforcement efforts in 1976: “Disclosure of these matters reflects the deeply held belief that the managers of corporations are stewards acting on behalf of the shareholders, who are entitled to honest use of, and accounting for, the funds entrusted to the corporation and to procedures necessary to assure accountability and disclosure of the manner in which management performs its stewardship.” SEC Report at 20.

    The investigations focused on several prominent corporations. A variety of conduct was uncovered.

    · In a number of instances facilitation payments were found, that is, those made to obtain the performance by foreign officials of their duties;

    · In others, excess sales commissions and kickbacks were uncovered;

    · Off the book transactions were discovered;

    · Falsified corporate records were discovered along with secret slush funds used for a variety of purposes;

    · The corporate records did not reflect accurately how shareholder funds were used – they concealed the transactions, the source of the funds and the fact that their application was for illegal purposes.

    See, e.g., Statement of SEC Chairman Roderick M. Hills Before the Subcommittee on Consumer Protection and Finance, House Committee on Interstate and Foreign Commerce at 2 (Sept. 21, 1976);Mike Koehler, The Story of the Foreign Corrupt Practices Act, 73 Ohio St. L. J. 929, 935 (2012) (“Koehler”).

    Collectively, these practices “cast doubt on the integrity and reliability of the corporate books and records which are the very foundation of the disclosure system established by the federal securities laws.” SEC Report at 3.

    In January 1974 the SEC considered the issuance of what would become Securities Act Release No. 5466 (March 8, 1974) and a recommendation from Director Sporkin and the Division of Enforcement to file the first enforcement action stemming from the illicit payment investigations. The Commission carefully deliberated a series of issues before authorizing the Release and the enforcement action. SEC Commissioner John Evans recounted those deliberations: “Before making the decision to file the complaint [in SEC v. American Shipbuilding], and before voting to accept the settlement, various members of the Commission expressed concern, and there was considerable discussion that this application of the securities laws and enforcement approach would lead to undesirable results. Although there was some speculation at the time, we could not have known, of course, that our program would result in the disclosure of illegal or questionable payments by many corporations to recipients throughout the world. We could not have known that investigations by independent company committees would bring about the replacement of top management officials of some major corporations. We could not have known that some corporations had made payments which, if disclosed, would result in political crises in foreign countries.” SEC Commissioner John Evans, Remarks at Northwest State-Federal-Provincial Securities Conference at 5 (May 13, 1076), (“Evans”), available at http://www.sec.gov/news/speech/1976/051376evans.pdf. Director Sporkin and the Commission did not think that additional legislative authority was necessary to support the proposed enforcement action. The securities laws provided a firm foundation in their view. Sporkin at 274.

    Materiality was a key question carefully evaluated by the five Commissioners and the Enforcement Division. That concept was generally defined at the time in objective terms, considering, information which a reasonable investor might find useful. See e.g., Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970). Two years later the Supreme Court further developed that standard in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976). A key point in the materiality discussions, as Commissioner Evans recounted, was the fact that most of the illegal or questionable payment cases involved false and fictitious entries on the corporate books and records and the filing of false and misleading reports with the Commission. These two points “were weighed heavily in our decisions [to bring the actions] . . . Any diversion of funds outside the corporate system, or any deception with respect to corporate books and records, cannot be permitted without undermining the purposes of the securities laws,” the Commissioner noted. Evans at 9.

    Later in its Report to Congress the Commission reiterated its view on materiality: “[Q]uestionable or illegal payments that are significant in amount or that, although not significant in amount, relate to a significant amount of business, are material and required to be disclosed . . . [if the payments are] unknown to the board of directors, [it] could be grounds for disclosure regardless of the size of the payment itself or its impact on dependent business because the fact that corporate officials have been willing to make repeated illegal payments without board knowledge and without proper accounting raises questions regarding improper exercise of corporate authority and may also be a circumstance relevant to the ‘quality of management’ that should be disclosed to the shareholders. . . [in addition] a questionable or illegal payment could cause repercussions of an unknown nature which might extend far beyond the question of the significance either of the payment itself or the business directly dependent upon it. For example, public knowledge that a company is making such illegal payments, even of a minor nature, in one foreign country could cause not only expropriation of assets in that country but also similar a similar reaction or a discontinuation of material amounts of business in other counties as well.” SEC Report at 15.

    One major oil company that made such payments, for example, had that fact asserted as the basis for an expropriation by a Latin American Republic. Id. Another point considered was the fact that substantial criminal penalties could be imposed on the organization – something shareholders should be told, according to Director Sporkin. Sporkin at 275. Likewise, concealing the fact that the company is securing business through the payment of bribes could also shroud underlying difficulties with the business. If, without the payment of the bribes, the company cannot compete effectively, there may be difficulties with the business model, its products or the manner in which it is competing in the international market place. Shareholders would have a right to such information. See, e.g., Edward Herlihy and Theodore Levine, Corporate Crisis: The Overseas Payment Problem, 8 Law & Policy In International Business 547, 575-576 (1976) (“Herlihy & Levine”). And, all of these factors reflected on the stewards of the corporation, the management entrusted with the funds of the shareholders: “This factor is important because investors have a right to be informed regarding the integrity of management in connection with the administration of corporate affairs and assets,” Commissioner Evans noted in recounting the SEC’s discussions on the point. Evans at 10.

    The SEC authorized the issuance of the Release and the filing of its first enforcement action from the illicit payment investigations at the January meeting. Evans at 2. The enforcement action was against American Ship Building Company and its CEO. The complaint centered on the payment of about $120,000 in political contributions and other payments falsely booked as payments to employees in the corporate records. SEC v. American Shipbuilding Co., Civil Action No. 74-588 (D.D.C. Filed October 4, 1974). It alleged violations of the proxy and periodic reporting requirements by failing to disclose that corporate funds had been used to make political contributions. The complaint also alleged that the books and records of the company had been falsified to conceal these facts from the shareholders. This would become the first of the illicit or questionable payments cases. Id. In the Commission’s view the filing of this enforcement action should have indicated that “the standard for disclosure in such a case was not traditional economic materiality, but that such payments reflected on the integrity of management.” Evans at 4.

    The Release focused on disclosure obligations when there was a conviction, a guilty plea, or pending indictment alleging that the federal election laws had been violated. It also noted that in other instances management was in the best position to assess the issuer’s disclosure obligations. The Release was issued as Securities Act Release No. 5466 (March 8, 1974).

    The American Shipbuilding enforcement action was settled at the time of filing with a consent decree. It would become a predicate for other similar cases. The focus of the settlement was an injunction effectuated by Court-ordered undertakings which included:

    · A requirement to establish a review committee which included a chairman not affiliated with the company;

    · A directive that the committee examine all the books and records of the company beginning with September 1970;

    · A directive that the examination focus on expenses or payments entered on the books and records of the company for purposes other than those indicated;

    · The Committee was required under the order to prepare a report and submit its findings to the court, the Commission and the board of directors; and

    · A requirement that the board reviews the report and take the appropriate action to implement its recommendations.

    Next: Key foreign payments cases and the remedies utilized.

    This Week In Securities Litigation (Week ending September 12, 2014)

    September 11, 2014

    The SEC continued with its “broken windows” approach to enforcement this week, filing a group of 34 actions based on the failure to file either a Form 4, Schedule 13D or Schedule 13G. The agency also filed an action alleging that a bank failed to properly disclose its non-accruing loans, another based on a concealed ownership scheme and one centered on portfolio pumping.

    SEC

    Office: The SEC announced the creation of the Division of Economic and Risk Analysis or DERA within the Division of Economic and Risk Analysis. It will coordinate efforts to provide data-driven risk assessment tools and models.

    Testimony: Chair Mary Jo White testified before the Senate Committee on Banking, Housing and Urban Affairs (Sept. 9, 2014). Topics discussed included progress on Dodd-Frank, credit ratings, asset backed securities, municipal securities, private fund adviser registration, derivatives, clearing agencies, the Volker rule, corporate governance and executive compensation, the whistleblower program, investment adviser and broker dealer standards of conduct, specialized disclosure provisions, exempt offerings, customer data protection and agency resources (here).

    Remarks: Norm Champ, Director, Division of Investment Management, addressed the Practicing Law Institute, Hedge Fund Management Seminar 2014, New York, N.Y. (September 11, 2014). His remarks covered topics which included what the Division knows about the industry, risk monitoring, compliance and examinations and alternative mutual funds (here).

    CFTC

    Testimony: Chairman Timothy Massad testified before the Senate Committee on Banking, Housing and Urban Affairs (Sept. 9, 2014). His testimony reviewed the role of the agency in derivative oversight, the implementation of Dodd-Frank, clearing, trading and the agenda going forward which includes competing the Dodd-Frank rules and robust compliance and enforcement (here).

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the SEC filed 2 civil injunctive action and 37 administrative proceedings, excluding 12j and tag-along-actions.

    Disclosure: In the Matter of Wilmington Trust Corporation, Adm. Proc. File No. 3-16098 (September 11, 2014) is a proceeding against the bank alleging that it had deficient underwriting and loan monitoring controls and failed to take appropriate action on many of its matured loans for protracted periods. As a result the bank omitted almost $339 million in matured loans past due 90 days or more from its disclosures for the third quarter of 2009. Similarly it omitted over $330 million in matured loans past due 90 days or more from its year end 2009 Form 10-K. When the bank decided to address this issue the next year, it negligently implemented various practices and full disclosure still was not made. In addition, in its Form 10-Q for the third quarter of 2009, and its Form 10-K for 2009, the firm negligently failed to disclosure significant increases in its non-accruing loans in accord with its policy. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding the bank consented to the entry of a cease and desist order based on the Sections cited in the order. It also agreed to pay disgorgement of $16 million along with prejudgment interest.

    Filing violations: In the Matter of Ligang Wang, Adm. Proc. File No. 3-1694 (September 10, 2014) is one of 34 proceedings alleging a failure to file ownership reports such as a Form 4, as required by Exchange Act Section 16(a), or a Schedule 13D or 13G, as required by Exchange Act Section 13. According to the Commission, quantitative analytics were used to identify the violators. The actions were brought against: Thirteen individuals who were officers or directors of public companies, all but one of whom settled, agreeing to pay a penalty; five individuals who were beneficial owners of publically-traded companies who settled, agreeing to pay a fine; ten investment firms who settled beneficial ownership claims, each of whom agreed to pay a penalty; and six publically traded companies, charged with contributing to filing failures by insiders or failing to report their insiders’ filing delinquencies, each of whom settled and agreed to pay a fine.

    In the Matter of Gary H. Rabin, Adm. Proc. File No. 3-16096 (September 10, 2014); In the Matter of Advanced Cell Technology, Inc., Adm. Proc. File No. 3-16095 (September 10, 2014). Mr. Rabin was the CEO, CFO and chairman of the board of Advanced Cell. During his tenure in those positions he repeatedly failed to file the required Exchange Act Section 16(a) reports regarding his transactions in company securities. He also violated Securities Act Sections 17(a)(2) and 17(a)(3), failing to timely or accurately file reports of those transactions and by signing the Forms 10k and proxy statements of the company that were false because they failed to disclose his non-compliance, as well as Exchange Act Sections 13(a) and 14(a). Advanced Cell failed to disclose that its CEO had not filed all required Section 16(a) reports. As a result it violated Securities Act Section 17(a)(2) and Exchange Act Sections 13(a) and 14(a). Both proceedings settled. Mr. Rabin consented to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to pay a civil penalty of $175,000. The company consented to the entry of a cease and desist order based on the Sections cited in the order and to retain a consultant. The company will pay a civil penalty of $375,000.

    Portfolio pumping: SEC v. Markusen, Civil Action No. 14-cv-3395 (D. Minn. Filed September 8, 2014) is an action against Steven Markusen, sole owner and CEO of Archer Advisors LLC, and investment manager for two private funds and also a defendant, and Jay Cope, an employee of Archer. From 2008 through 2013 the defendants bilked the funds out of over $1 million. They did this by charging the funds for fake research and improperly diverting soft-dollars to themselves. In addition, they manipulated the share price of CyberOptics Corporation, a thinly traded entity which was the largest holding of the funds, by marking the close on 28 days. This artificially inflated the value of the fund assets. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Sections 10(b) and 16(a) and Advisers Act Sections 206(1), (2) and 206(b) in addition to control person liability. The case is pending.

    Financial fraud: SEC v. Heart Tronics, Inc., Civil Action No. SACV11-1962 (C.D. Cal. Filed Dec. 15, 2011) is a previously filed action against J. Rowland Perkins, Mark Nevdahl, the company, its co-CEO, Willie Gault, and former attorney Mitchell Stein alleging a series of frauds between 2006 and 2009. Mr. Perkins is alleged to have acted as CEO in 2008 and signed SOX certifications for three quarterly reports which contained materially false information. Mr. Nevdahl served as a trustee for a number of nominee accounts and blind trusts that Mitchell Stein and his wife used to secretly sell millions of dollars of Heart Tronics stock. Mr. Perkins settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b) and 13(b)(5) and from aiding and abetting violations of Exchange Act Section 13(b)(2)(B). He is barred from serving as an officer or director for three years and will pay a civil penalty of $42,500. Mr. Nevdahl settled, consenting to the institution and settlement of administrative cease and desist proceedings in which an order was issued finding that the willfully violated Securities Act Section 17(a)(3). He was ordered to cease and desist from aiding or abetting or committing any future violations of Section 17(a)(3). The order also suspends him from participation in any penny stock offering for a period of six months. In the Matter of Mark Crosby Nevdahl, Adm. Proc. File No. 3-16056 (September 5, 2014). See Lit. Rel. No. 23081 (September 10, 2014).

    Concealed ownership: SEC v. Bandfield, Civil Action No. 1:14-cv-05271 (E.D. N.Y. Filed September 9, 2014) names as defendants Robert Bandfield, Andrew Godfrey and IPC Corporate Services LLC. IPC had a website which details its services. The shareholder services provided by the company included an arrangement through which stock ownership could be concealed. The methodology was explained in a series of recorded conversations with an undercover federal agent that began in 2013 and continued through early 2014. In those conversations Messrs. Bandfield and Godfrey explained that they had formed a number of Nevis and Belize entities. An IPC client does not legally own either the Belize Companies or the Nevis LLCs. It is used as a vehicle to hold the client’s shares. Mr. Banfield controls the Belize and Nevis entities. Neither Bandfield nor IPC ever filed a Schedule 13D or Schedule 13G. Yet during the period IPC and Mr. Bandfield acquired beneficial ownership of 5% or more of the outstanding common stock of at least one issuer that was registered under Exchange Act Section 12 and whose shares carried voting rights. The Complaint alleges violations of Exchange Act Section 13d. The Commission’s case and a parallel criminal action are pending.

    Kickbacks: SEC v. Lee, Civil Action No. 11-cv-12118 (D. Mass.) is a previously filed action against ZipGlobal Holdings, Inc. and its CEO, Michael Hingham. The complaint alleges that the defendants were involved in a kickback scheme under which the representative of a major hedge fund – an undercover FBI agent — would purchase ZipGlobal stock in return for kickbacks. The Court entered final judgments by consent against each defendant. Each defendant was enjoined from violating Exchange Act Section 10(b). In addition, Mr. Lee was ordered to pay $105,603 in disgorgement which is satisfied by the forfeiture order of the same amount in a parallel criminal case. The judgment also prohibits Mr. Lee from acting as an officer or director of any issuer and prohibits his participation in any penny stock offering. See Lit. Rel. No. 23078 (September 4, 2014).

    FINRA

    Alert: The regulator issued a new investor alert titled Frontier Funds – Travel With Case (here).

    PCAOB

    Alert: The Board issued a Staff Audit Practice Alert on Auditing Revenue in Light of Frequent Observed Significant Audit Deficiencies (here).

    Court of appeals

    Extraterritorial reach: Ludmila Loginovskaya v. Oleg Batratchenko, Docket No. 13-1624-cv (2nd Cir. Decided September 4, 2014). Plaintiff is a Russian citizen resident in that country. The defendants include Oleg Batratchenko, a U.S. citizen resident in Moscow, and various Thor Group entities, including Thor United which is a New York corporation. Several of the group entities are registered participants in the commodities markets as commodity pool operators or commodity trading advisors. Under contracts with Thor United which were executed in Russia, Ms. Loginovskaya invested directly in that company. Thor in turn placed the funds in the Thor program. In part the money was put in U.S. real estate investments which suffered significant losses. Ms. Loginovskaya brought suit under CEA Sections 4o and 22. The district court dismissed the claim under Morrison. The Second Circuit affirmed.

    Section 4o is an antifraud provision which is similar to Exchange Act Section 10(b). Section 22 provides for a private right of action where the claim results from: 1) receiving trading advise for a fee; 2) making a contract of sale or deposit in connection with any order to make such a contract; 3) the purchase, sale, or order for a commodity interest; and 4) market manipulation in connection with a swap or contract of sale.

    Under the presumption against extraterritorial reach, a statute is presumed not to have such reach absent clear Congressional intent to the contrary. The CEA as a whole is silent as to extraterritorial reach. Likewise, Sections 4o and 22 do not evidence Congressional intent that would contradict the presumption. Following the approach of the Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), the Second Circuit considered what it called the “focus of congressional concern.” In making this inquiry the Court considered Section 22 since it grants a private right of action rather than Section 4o, a general antifraud provision. Section 22 essentially limits clams to those of a plaintiff who actually traded in the commodity market. Accordingly, suits under the Section must be based on transactions “occurring in the territory of the United States” since there is no evidence Congress intended otherwise. Here plaintiff’s claim arises, according to the complaint, from the purchase, sale or placing of an order for the purchase or sale of an interest or participation in a commodity pool. To bring this claim within the limits of Section 22, plaintiff is required to “demonstrate that the transfer of title or the point of irrevocable liability for such an interest occurred in the United States.” In view of this requirement the claim fails because the agreement was entered into in Russia, not the United States. In reaching this conclusion the Court expressly declined to reach the question of how the presumption would impact Section 4o.

    Judge Lohier dissented focused on Section 4o rather that Section 22 and argued that the cause of action was within that Section.

    Hong Kong

    Disclosure: The Securities and Futures Commission instituted a court proceeding against CITIC Limited and five if its former directors. The proceeding alleges that in 2008 misleading information was disclosed regarding the financial position of the firm arising from massive losses which the firm had suffered.

    Japan

    Manipulation: The Securities and Exchange Surveillance Commission recommended that a fine be imposed on an undisclosed party. The party manipulated the securities on the 10-year Japanese Government Board Futures on June 26, 2013. The penalty for this 330,000 yen.

    The SEC Continues “Broken Windows” – Is It Effective Enforcement?

    September 10, 2014

    Broken Windows is the enforcement strategy adopted by the SEC as part of its “prosecute every violation big and small” approach in an effort to create “omnipresence” – the feeling of a cop on every corner. It is supposed to deter all violations.

    As part of effectuating this approach, the Commission has packaged cases into groups and announced them. For example, Rule 105 violations – a strict liability type of short selling Rule – was used to package together 23 cases into a single announcement (here). Operation “Broken Gate” was used to announce a group of audit failure cases (here). The custody rule, focused on the arrangements of market professionals for holding customer securities, was used as the predicate to announce another group of cases (here).

    Yesterday the SEC announced the filing of a 34 proceedings. Each action focused on the failure to file ownership reports. Those included a Form 4, as required by Exchange Act Section 16(a), or a Schedule 13D or 13G, as required by Exchange Act Section 13. According to the Commission, quantitative analytics were used to identify the violators. The actions were brought against:

    • Thirteen individuals who were officers or directors of public companies, all but one of whom settled, agreeing to pay a penalty;
    • Five individuals who were beneficial owners of publically-traded companies who settled, agreeing to pay a fine;
    • Ten investment firms who settled beneficial ownership claims, agreed to pay a penalty; and
    • Six publically traded companies, charged with contributing to filing failures by insiders or failing to report their insiders’ filing delinquencies, each of whom settled and agreed to pay a fine.

    By now there should be no doubt that “broken windows” results in significant numbers of enforcement actions which will be counted in the end of the fiscal year statistics. There is also no doubt that these cases represent violations of the securities laws.

    Whether filing enforcement actions such as these in groups is effective in creating a “cop on the beat” presence in the market place is more difficult to determine. Whether filing large numbers of cases based a strict liability short selling rule, or auditing proceedings that could (and perhaps should have) been brought by the PCAOB, or grouping together custody rule actions, or filing in bulk actions centered on strict liability filing requirement creates “omnipresence” remains to be seen. And, whether this approach constitutes effective enforcement is an open question. It seems doubtful, however, that rolling up large number of these kinds of cases will deter violations such as insider trading and financial statement fraud by issuers and their executives.

    SEC – USAO File Actions Based on Scheme To Conceal Ownership

    September 09, 2014

    Building on an undercover sting operation, the SEC filed an enforcement action against two individuals and their controlled entity. They are alleged to have conducted a business which helped shareholders conceal their ownership and avoid their filing obligations. As a result of operating the business, however, the business men assumed the filing obligations of their clients, which they violated. SEC v. Bandfield, Civil Action No. 1:14-cv-05271 (E.D. N.Y. Filed September 9, 2014). Parallel criminal charges were brought by the U.S. Attorney’s Office for the Eastern District of New York.

    Robert Bandfield, Andrew Godfrey and IPC Corporate Services LLC are named as defendants in the Commission’s action. Mr. Bandfield is a U.S. citizen while Mr. Godfrey is a citizen and resident of Belize. He manages IPC which is a limited liability company formed under the laws of Nevis.

    IPC had a website which details its services. Those include providing offshore services for company formation, trust formation, licensed trustee services, nominees and others. One of those services involved concealing the true ownership of shares so that the owner does not have to file Exchange Act Section 13d reports.

    The shareholder services provided by the company through which stock ownership can be concealed were explained in a series of recorded conversations with an undercover federal agent that began in 2013 and continued through early 2014. In those conversations Messrs. Bandfield and Godfrey explained that they had formed a number of Nevis and Belize entities. IPC uses Nevis LLCs to hold shares of Belize Companies in part because the law imposes significant barriers on regulators and others to determining the identity of individuals who are IPC clients and actually owned the shares of the companies.

    Under the arrangements the IPC client does not legally own either the Belize Companies or the Nevis LLCs he selects. Rather, Mr. Banfield appoints a nominal owner who has 99% of the ownership of the Nevis LLCs. The remaining 1% is held by IPC. That interest is controlled by Mr. Bandfield. Control is maintained over the nominees through a series of mechanisms such as undated letters of resignation.

    Each Nevis LLC assumed ownership of a portion of the client shareholdings, but never more than 5%. If the client owns more than 5% of an entity, the shareholdings are divided among two or more entities. Thus, if the holdings are sold through a broker dealer questions are avoided. Under this structure the IPC client cedes legal ownership and legal control of the shares to IPC. Any trading requests are given to Mr. Bandfield. IPC does not keep trading profits. Rather, it is paid a fee for its service.

    Since IPC has legal control over the client shares, it must participate in various corporate events and services. Those transactions are conducted in the name of IPC.

    Neither Bandfield nor IPC ever filed a Schedule 13D or Schedule 13G. Yet during the period IPC and Mr. Bandfield acquired beneficial ownership of 5% or more of the outstanding common stock of at least one issuer that was registered under Exchange Act Section 12 and whose shares carried voting rights. The Complaint alleges violations of Exchange Act Section 13d. The Commission’s case and the parallel criminal action are pending.

    THE ORIGINS OF THE FCPA: LESSONS FOR EFFECTIVE COMPLIANCE AND ENFORCEMENT

    September 08, 2014

    “They trusted us” — Judge Stanley Sporkin explaining why 450 corporations self- reported in the 1970s Volunteer Program without a promise of immunity.

    This is the first part of an occasional series. The entire paper will be published by Securities Regulation Law Journal early next year.

    Introduction

    Can one man make a difference? Stanley Sporkin is proof that the answer is “yes.” In the early 1970s he sat fixated by the Watergate Congressional hearings. As the testimony droned on about the burglary and cover-up, the Director of the Securities and Exchange Commission’s (“SEC” or “Commission”) Enforcement Division sat mystified. Witnesses spoke of corporate political contributions and payments. “How does a public company book an illegal contribution” the Director wondered. “Public companies are stewards of the shareholder’s money – they have an obligation to tell them how it is used” he thought. He decided to find out.

    The question spawned a series of “illicit” or foreign payments cases by the Commission resulting in the Volunteer Program. Under the Program, crafted by Director Sporkin and Corporation Finance Director Alan Levinson, about 450 U.S. corporations self-reported illicit payments which had been concealed with false accounting entries. There was no promise of immunity but the Director had a reputation for doing the right thing, being fair. Ultimately the cases and Program culminated with the passage of the Foreign Corrupt Practices Act (“FCPA”), signed into law by President Jimmy Carter in 1977.

    Today a statute born of scandal and years of debate continues to be debated. Business groups and others express concern about the expansive application of the FCPA by enforcement officials and the spiraling costs to resolve investigations. Enforcement officials continue to call for self-reporting, cooperation and more effective compliance. While the debate continues, both sides might do well to revisit the roots of the FCPA. The success of the early investigations and the Volunteer Program is not attributable to overlapping enforcement actions, endless investigations, draconian fines and monitors. Rather, it was a focus on effective corporate governance – ensuring that executives acted as the stewards of shareholder funds. Director Sporkin call this “doing the right thing.” A return to that focus may well end the debate and yield more effective compliance and enforcement.

    The beginning

    The Watergate Congressional hearings transfixed the country. A scandal was born from a burglary at the Watergate Hotel in Washington, D.C. by the Committee to Reelect the President, known as CREP. The hearings were punctuated by a series of articles in The Washington Post based on conversations with a source known only as “deep throat.” Later the two reporters would become famous. President Richard Nixon would resign in disgrace. His senior aides would be sentenced to prison. See generally, Carl Bernstein & Bob Woodward, All the President’s Men (1974).

    A little-noticed segment of the hearings involved corporate contributions to politicians and political campaigns. Most observers probably missed the slivers of testimony about illegal corporate conduct since they were all but drowned in the seemingly endless testimony about the burglary, cover-up and speculation regarding the involvement of the White House.

    One man did not. Then SEC Enforcement Director and later Federal Judge Stanley Sporkin was fixated. He listened carefully to the comments about corporate political contributions. The Director wondered how the firms could make such payments without telling their shareholders: “You know, I sometimes use the expression, ‘only in America could something like this happen.’ There I was sitting at my desk . . . and at night while these Watergate hearings were going on I would go home and they’d be replayed and I would hear these heads of these companies testify. This fellow Dorsey from Gulf Oil . . . and it was interesting that somebody would call Gulf Oil and they would say we need $50,000 for the campaign. Now everybody, I knew that corporations couldn’t give money to political campaigns . . . what occurred to me was, how do you book a bribe . . . ” A Fire Side Chat with the Father of the FCPA and the FCPA Professor, Dorsey & Whitney LLP Spring Anti-corruption conference, March 23, 2014, available at www.SECHistorical.org. at 3 (“Transcript”).

    What, if any information did the outside auditors have was another key question, according to the Director. Stanley Sporkin, “The Worldwide Banning of Schmiergeld: A Look at the Foreign Corrupt Practices Act on its Twentieth Birthday,” 18 Nw. J. Int. L. & Bus. 269, 271 (1998) (“Sporkin”). Not only was he fascinated by the testimony but “something bothered him [Director Sporkin]. It was the thought of all that money moving around in businessmen’s briefcases. That money belonged to corporations. Corporations belong to investors. The SEC protects investors. So Sporkin investigated.” Mike Feensilber, He Terrorizes Wall Street, The Atlanta Constitution, Section C at 19, col. 1 (March 21, 1976); see also Wallace Timmeny, An Overview of the FCPA, 9 Syr. J. Int’l L. & Com. 235 (1982).

    An informal inquiry was initiated. As Judge Sporkin recounts: “To satisfy my curiosity [about how the payments were recorded in the books and records] I asked one of my staff members to commence an informal inquiry to determine how the transactions were booked.” Sporkin at 571. This “was not one of these elaborate investigations where you have 5 people. I called in a guy named Bob Ryan and I said, Bob, go to Gulf Oil.” Transcript at 3. A day later the answer came back: “[W]hat happened was that Gulf Oil had set up two corporations; one called the ANEX, one called the ANEY, capitalized . . . with the $5 million each; took the money back to New York, put it into [Gulf Chairman] Dorsey’s safe at the head of Gulf Oil and there he [Dorsey] had a slush fund, a corporate fund of $10 million.” Id. at 4. The payments were not reflected in the books and records of the company – the shareholders were not told how their money was being used.

    It was apparent that corporate officials “knew they were doing something that was wrong because the reason they set [it] up this was . . . is because they didn’t want to expense the money so they capitalized it. And why did they want to expense the money . . . [Director Sporkin explained is] Because they were afraid, not of the SEC, but of the IRS. So it . . . right from the beginning . . . it showed me that there was something afoul here,” Director Sporkin later recounted. Id. at 4. Indeed, it was clear that senior corporate officials had painstakingly designed a methodology to secrete what they knew were wrongful transactions. Sporkin at 271.

    Next: The Illicit or foreign payments cases

    Second Circuit Limits CEA Private Actions Based On Morrison

    September 07, 2014

    In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010) the Supreme Court delimited the reach of Exchange Act Section 10(b), concluding that the Section has no extraterritorial reach. Rather, the Section is confined to the United States – securities transactions that are on an exchange in this country or which occur here. The Court reached that conclusion by applying a presumption against extraterritorial reach and by considering the focus of the statute which is the purchase and sale of a security.

    Now the Second Circuit has applied the teachings of Morrison to the Commodities Exchange Act private remedies. Ludmila Loginovskaya v. Oleg Batratchenko, Docket No. 13-1624-cv (2nd Cir. Decided September 4, 2014). Plaintiff is a Russian citizen resident in that country. The defendants include Oleg Batratchenko, a U.S. citizen resident in Moscow, and various Thor Group entities, including Thor United which is a New York corporation. Several of the group entities are registered participants in the commodities markets as commodity pool operators or commodity trading advisors.

    In early 2006 Plaintiff was solicited by Mr. Batratchenko to invest in the Thor programs. Russian language materials were furnished to plaintiff in connection with the solicitation. Ms. Loginovskaya agreed, transferring $720,000 to Thor’s bank in New York. Under the contracts with Thor United which were executed in Russia, Ms. Loginovskaya invested directly in that company. Thor in turn placed the funds in the Thor program. In part the money was put in U.S. real estate investments which suffered significan losses.

    Ms. Loginovskaya brought suit under CEA Sections 4o and 22. The district court dismissed the claim under Morrison. The Second Circuit affirmed.

    Section 4o is an antifraud provisions which is similar to Exchange Act Section 10(b). Section 22 provides for a private right of action where the claim results from: 1) receiving trading advise for a fee; 2) making a contract of sale or deposit in connection with any order to make such a contract; 3) the purchase, sale, or order for a commodity interest; and market manipulation in connection with a swap or contract of sale.

    In rejecting the Second Circuit’s “effects or conducts” test regarding extraterritorial reach, the Morrison Court began with the presumption against extraterritoriality. Under that presumption, a statute is presumed not to have such reach absent clear Congressional intent to the contrary. The CEA as a whole is silent as to extraterritorial reach. Likewise Sections 4o and 22 do not evidence Congressional intent that would contradict the presumption.

    Following the approach of the Morrison Court, the Second Circuit then turned to what it called the “focus of congressional concern.” In making this inquiry the Court considered Section 22 since it grants a private right of action rather than Section 4o, a general antifraud provision. Section 22 essentially limits clams to those of a plaintiff who actually traded in the commodity market. Accordingly, suits under the Section must be based on transactions “occurring in the territory of the United States.” Therefore under Morrison a “private right of action exists only when a plaintiff shows that one of the four transactions listed in Section 22 occurred within the United States.” This draws a distinction between private actions and government enforcement cases which are not limited by Section 22.

    Here plaintiff’s claim arises, according to the complaint, from the purchase, sale or placing of an order for the purchase or sale of an interest or participation in a commodity pool. To bring this claim within the limits of Section 22, plaintiff is required to “demonstrate that the transfer of title or the point of irrevocable liability for such an interest occurred in the United States.” In view of this requirement the claim fails because the agreement was entered into in Russia, not the United States. In reaching this conclusion the Court expressly declined to reach the question of how the presumption would impact Section 4o.

    Judge Lohier dissented noting: “Ludmila Loginavoskaya in a sense never had a change. Enticed by the array of investment opportunities in the vaunted commodities markets of the United States, she was the victim of an old-fashioned fraud that a more perceptive investor, or a United States regulator, might have identified from a mile away.” The main perpetrator is a U.S. citizen registered as a principal of commodity pool operators and commodity trading advisors under the CES. He is a member of the National Futures Association. Most of the Thor corporate defendants are based in the US and several are registered under the CEA. One of the defendants is a registered commodity pool.

    According to Judge Lohier, “my colleagues in the majority will not dispute that the defendants’ allegedly fraudulent acts were sufficiently domestic to fall within the scope of CEA Section 4o . . .” yet plaintiff has no cause of action. This results largely from applying the presumption to Section 22 which does not regulate conduct or impose liability but only defines the category of persons that can seek a remedy. The central question here should have been whether Section 4o reaches the conduct alleged in the complaint. Applying Morrison to that Section is quite different. It prohibits fraud without any requirement that it be in connection with any particular transaction or event. Under this Section plaintiff would have had a cause of action since at least part of the conduct occurred in this country. Such a result would be consistent with the purpose of the CEA.

    This Week In Securities Litigation (Week ending September 5, 2014)

    September 04, 2014

    The Commission prevailed on summary judgment in an action against a broker which alleged he misappropriated client funds. The agency also filed actions centered on: an audit failure; the EB-5 immigration program; undisclosed conflicts; a failure to have supervisory procedures regarding known conflicts; and a financial fraud.

    SEC

    Whistleblowers: The SEC awarded $300,000 to a company employee who performed audit and compliance work for the firm. After the firm failed to take action the employee reported the matter to the Commission. It resulted in an enforcement action.

    SEC Enforcement – Litigated Actions

    Misappropriation: SEC v. Richards, Civil Action No. 1:130CV-1729 (N.D. Ga.) is an action against registered representative Black Richards. Since at least 2008 Mr. Richards is alleged to have misappropriated about $1.7 million from seven investors. The Court granted summary judgment in favor of the Commission. A permanent injunction prohibiting future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2) was entered. An order was also entered directing the payment of disgorgement and prejudgment interest in the amount of $1,829,923.21 along with a civil penalty of $80,000. The Court adopted the Commission’s proposed findings. See Lit. Rel. No. 23075 (August 28, 2014).

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the SEC filed 1 civil injunctive action and 4 administrative proceedings, excluding 12j and tag-along-actions.

    Audit failure: In the Matter of Eugene M. Egeberg III, CPA, Adm. Proc. File No. 3-15680 (September 4, 2014) is a proceeding which names as a Respondent the CPA. The Order centers on his engagements for Fox Petroleum, Inc. for the fiscal years ended February 28, 2010 through 2012 and for RPM Advantage, Inc. for the fiscal years ended December 31, 2006 through 2010. The Order essentially alleges a complete audit failure as to each company for each year. For example, with regard to Fox in 2010 and 2011, Respondent failed to perform any audit tests or procedures to determine the accuracy of the company’s financial statements. Although he identified unrecorded liabilities as a potential fraud risk, his concerns were allied because of “overhauled financials.” He also failed to contact the prior auditor as required. For RPM Respondent failed to document any audit procedures he performed on the balances on the financial statements. Likewise, for two subsidiaries acquired by Fox, Mr. Egeberg issued his opinions in only 40 hours, making it implausible that he did a proper audit. In fact Mr. Egeberg had no audit training. The Oder alleges violations of Section 102e(1) of the Commission’s Rules of Practice and Exchange Act Section 10(b). To resolve the proceeding Mr. Egeberg consented to the entry of a cease and desist order based on Exchange Act Section 10(b). He was also denied the privilege of appearing or practicing before the Commission as an accountant. In addition, he will pay disgorgement of $112,250, prejudgment interest and a civil penalty of $15,000.

    Investment fund fraud: SEC v. Lee, Civil Action No. 2:14-cv-06865 (C.D. Cal. Filed September 3, 2014) names as defendants two immigration attorneys, Justin Moongyu Lee and his partner Thomas Kent, and the administrator of their law firm and Mr. Moongyu’s wife, Rebecca Taewon Lee. In addition, seven entities, including Nexland, Inc., founded by Mr. Lee, were named as defendants. The action centers on the EB-5 immigration program. In March 2006 Messrs. Lee and Kent had Kansas Biofuel apply to USCIS for a designation as a regional center under the Immigrant Investor Program. The application identified five potential ethanol projects to be constructed in Kansas. The project was approved. From March 2009 to April 2011 the defendants raised over $11.4 million from twenty-four investors through offerings of limited partnership units in the various entities. According to the offering documents each investor was required to invest $500,000 which was to be used solely for an income generating investment in Nexsun Ethanol, LLC. Contrary to the representations made to the investors, the facilities were not built, although some construction was done. Rather, the defendants provided USCIS with misleading documents which purported to show job creation by Nexsun. Defendants then misappropriated much of the money raised from investors. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). The SEC’s action and a parallel criminal case are both pending.

    Conflicts: In the Matter of The Robare Group, Adm. Proc. File No. 3-16047 (September 2, 2014) names as Respondents the registered investment adviser, its founder, Mark Robare, and a limited partner, Jack Jones. The allegations in the Order focus on an undisclosed arrangement between the adviser and its Broker. Robare Group, which offers portfolio management services, has from inception used the Broker for execution, custody and clearing services for advisory clients. The adviser recommends that its client invest in several mutual funds offered on the Broker’s platform. In 2004 Robare Group and the Broker entered into a Commission Schedule and Servicing Fee Agreement. The agreement provided in part that the adviser would recommend No Transaction Fee funds offered on the Broker’s platform. In return the Broker would pay from 2 to 12 basis points to the adviser. That agreement remained in effect until late 2012 when a new Investment Advisor Custodial Support Services Agreement was executed. It also provided that the Broker would pay the adviser for clients that invested in its funds.

    The initial agreement was not disclosed in the adviser’s Form ADV until December 2011. That Form ADV did, however, identify the conflict of interest. It also stated that the adviser “may” receive compensation when it fact it was being paid. Later the disclosure was later modified to reference the custodial arrangement. It stated that the advisor’s arrangement may be a conflict with regard to recommending the Broker for custody. The filing failed to identify the incentive regarding the funds. The Order alleges violations of Advisers Act Sections 206(1), 206(2) and 207. The proceeding will be set for hearing.

    Conflicts/supervision: In the Matter of Structure Portfolio Management, L.L.C., Adm. Proc. File No. 3-16046 (August 28, 2014) names as Respondents three registered investment advisers, Structured Portfolio, SPM Jr., L.L.C. and SPMIV, L.L.C. Portfolio Management holds a 90% ownership interest in SPM Jr. and later formed SPMIV. By 2006 three funds were advised. Hedge Trader was appointed as the portfolio manager for each fund. For one fund his sole responsibility was to make a profit. For the other two Hedge Trader was tasked with hedging interest rate risk. On a typical day Hedge Trader traded Treasury securities for each for each fund. This created a potential conflict of interest regarding the allocation of the purchases among the three funds. The Compliance Manual stated that trades would be allocated in a fair and equitable manner. Trade blotters were maintained. Those were reviewed by a member of the operations staff on a daily basis. From 2006 through 2009 when one of the funds was closed, concerns were raised regarding the allocation of trades. Although the potential conflict regarding trade allocations which was disclosed, Structured Portfolio failed to adopt and implement written policies and procedures to detect and prevent improper trade allocations, according to the Order. It also failed to adopt and implement written policies and procedures to prevent inaccurate disclosures regarding its funds and their investment strategies. The Order alleges violations of Advisers Act Sections 206(4) and Rule 206(4)(-7). To resolve the proceeding Portfolio Management entered into a series of undertakings which including the retention of an independent consultant, record keeping, notice to clients and a certification of compliance. Each Respondent also consented to the entry of a cease and desist order based on the Section and Rule cited in the Order and a censure. They will also pay, jointly and severally, a penalty of $300,000.

    Financial fraud: In the Matter of Lynn R. Blodgett, Adm. Proc. File No. 3-16045 (August 28, 2014) is a proceeding which names as Respondents Lynn Blodgett, the president and CEO of Affiliated Computer Services, Inc., and Kevin Kyser, the CFO of that firm. Affiliated Computer Services provided business process outsourcing and information technology services through two reportable operating segments prior to its acquisition by Xerox Corporation in 2010. ACS established a goal of increasing its internal revenue growth as announced in its Form 10-K for fiscal 2009. In August 2008 an analyst following the firm stated that it was well positioned to meet its internal revenue growth goals. Yet by the end of the first quarter of fiscal 2009 ACS learned that it would fall short of guidance and consensus analyst expectations on this metric. To increase revenue ACS arranged for an equipment manufacture to re-direct about $20 million of pre-existing orders that a manufacturer had already received from another reseller through the firm. At the end of each of the next three quarters ACS entered into similar transactions. The firm reported revenue totaling $124.5 million from these transactions which enabled it to meet disclosed targets. The resale transactions were not recorded in accord with GAAP nor were they properly disclosed. In addition, Messrs. Blodgett and Kyser each were paid a bonus which was tied, in part, to the reported revenue growth of the firm. The Order alleges violations of Exchange Act Section 13(a), 13(b)(2)(A) and 13(b)((2)(B) and the related Rules by each Respondent. To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Mr. Blodgett agreed to pay disgorgement of $351,050 along with prejudgment interest and a civil money penalty of $52,000. Mr. Kyser agreed to pay disgorgement of $133,192, prejudgment interest and a penalty of $52,000.

    Criminal cases

    Financial fraud: U.S. v. Baker, Case No. 1:13-cr-00346(W.D. Tx. ) Michael Baker and Michael Gluk, the former CEO and CFO, respectively of ArthroCare, were each sentenced to serve 20 years in prison following their conviction by a jury on charges of wire fraud, securities fraud and conspiracy to commit wire and securities fraud. The underlying scheme alleged that from late 2005 through early 2009 the two men, and others, inflated sales and revenue at the end of each quarter by shipping product to distributors based on the need to meet street expectations rather than actual sales. Two other executives who previously pleaded guilty, John Raffle and David Applegate were sentenced to serve, respectively, 80 and 60 months in prison.

    The SEC Brings Another Case Centered on the EB-5 Immigration Program

    September 03, 2014

    The government’s EB-5 program is supposed to be a win win for everyone. For immigrants seeking admission to the United States it is supposed to provide a path to citizenship if the requirements, centered on the investment of $500,000 or more in select projects, are met. For the U.S. it is a job creation mechanism since the investments from those seeking admission under the program, administered by the United States Citizenship and Immigration Service, are supposed to be used to create jobs in this country. Unfortunately the program is now at the center of yet another SEC enforcement action and a parallel criminal case. SEC v. Lee, Civil Action No. 2:14-cv-06865 (C.D. Cal. Filed September 3, 2014). Last year the agency brought two other cases involving the program. SEC v. A Chicago Convention Center, LLC, Case No. 13 cv 982 (N.D. Ill. Filed Feb. 6, 2013); SEC v. Ramirez, Civil Action No. 7:13-cv-00531 (S.D. Tx. Filed September 30, 2013).

    Lee names as defendants two immigration attorneys, Justin Moongyu Lee and his partner Thomas Kent, and the administrator of their law firm and Mr. Moongyu’s wife, Rebecca Taewon Lee. In addition, seven entities, including Nexland, Inc., founded by Mr. Lee, were named as defendants. In March 2006 Messrs. Lee and Kent had Kansas Biofuel apply to USCIS for a designation as a regional center under the Immigrant Investor Program. The application identified five potential ethanol projects to be constructed in Kansas. The project was approved.

    From March 2009 to April 2011 the defendants raised over $11.4 million from twenty-four investors through offerings of limited partnership units in the various entities. According to the offering documents each investor was required to invest $500,000 which was to be used solely for an income generating investment in Nexsun Ethanol, LLC. The funds were to be pooled and used to develop an ethanol production facility and an ancillary business or to acquire units of ownership of a new commercial business enterprise to develop and operate an integrated bio-fuel refinery.

    Contrary to the representations made to the investors the facilities were not built, although some construction was done. Rather, the defendants provided USCIS with misleading documents which purported to show job creation by Nexsun. Defendants then misappropriated much of the money raised from investors. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). The SEC’s action and the parallel criminal case are both pending.

    SEC Proceedings Against IAs Center On Conflicts of Interest

    September 02, 2014

    Conflicts of interest are at the center of two administrative proceedings recently instituted by the SEC. One involved the failure to adequately disclose the conflict. The other focuses on a failure to institute appropriate supervisory procedures for a known conflict. In the Matter of The Robare Group, Adm. Proc. File No. 3-16047 (September 2, 2014); In the Matter of Structure Portfolio Management, L.L.C., Adm. Proc. File No. 3-16046 (August 28, 2014).

    The Robare Group names as Respondents the registered investment adviser, its founder, Mark Robare, and a limited partner, Jack Jones. The allegations in the Order focus on an undisclosed arrangement between the adviser and its Broker. Robare Group, which offers portfolio management services, has from inception used the Broker for execution, custody and clearing services for advisory clients. The adviser recommends that its client invest in several mutual funds offered on the Broker’s platform.

    In 2004 Robare Group and the Broker entered into a Commission Schedule and Servicing Fee Agreement. The agreement provided in part that the adviser would recommend No Transaction Fee funds offered on the Broker’s platform. In return the Broker would pay from 2 to 12 basis points to the adviser. That agreement remained in effect until late 2012 when a new Investment Advisor Custodial Support Services Agreement was executed. It also provided that the Broker would pay the adviser for clients that invested in its funds.

    The initial agreement was not disclosed in the adviser’s Form ADV until December 2011. That Form ADV did, however, identify the conflict of interest. It also stated that the adviser “may” receive compensation when it fact it was being paid. Later the disclosure was later modified to reference the custodial arrangement. It stated that the advisor’s arrangement may be a conflict with regard to recommending the Broker for custody. The filing failed to identify the incentive regarding the funds.

    The Order alleges violations of Advisers Act Sections 206(1), 206(2) and 207. The proceeding will be set for hearing.

    Structured Portfolio names as Respondents three registered investment advisers, Structured Portfolio, SPM Jr., L.L.C. and SPMIV, L.L.C. Portfolio Management holds a 90% ownership interest in SPM Jr. and later formed SPMIV.

    By 2006 three funds were advised. Hedge Trader was appointed as the portfolio manager for each fund. For one fund his sole responsibility was to make a profit. For the other two Hedge Trader was tasked with hedging interest rate risk. On a typical day Hedge Trader traded Treasury securities for each for each fund. This created a potential conflict of interest regarding the allocation of the purchases among the three funds.

    The Compliance Manual stated that trades would be allocated in a fair and equitable manner. Trade blotters were maintained. Those were reviewed by a member of the operations staff on a daily basis.

    From 2006 through 2009 when one of the funds was closed, concerns were raised regarding the allocation of trades. In August 2006 internal concerns were raised suggesting one fund may have been obtaining more favorable execution prices. In response Hedge Trader was removed from trading for two of the funds while acting for the third for about six months. When Hedge Trader began trading for all three funds certain oral instructions were given regarding more frequent oversight of the trades. Those oral instructions were not reduced to writing.

    During the annual compliance review in November 2008 an independent firm separately raised trade allocation concerns. In 2009 internal concerns were again raised. This time the issue focused on the trading performance of one fund. Reviews by outside counsel were inconclusive. In March 2009 one fund was closed.

    Throughout the period Structured Portfolio was aware of the potential conflict regarding trade allocations which was disclosed. At the same time Structured Portfolio failed to adopt and implement written policies and procedures to detect and prevent improper trade allocations, according to the Order. It also failed to adopt and implement written policies and procedures to prevent inaccurate disclosures regarding its funds and their investment strategies. The Order alleges violations of Advisers Act Sections 206(4) and Rule 206(4)(-7).

    To resolve the proceeding Portfolio Management entered into a series of undertakings which including the retention of an independent consultant, record keeping, notice to clients and a certification of compliance. Each Respondent also consented to the entry of a cease and desist order based on the Section and Rule cited in the Order and a censure. They will also pay, jointly and severally, a penalty of $300,000.