This Week In Securities Litigation (Week ending February 12, 2016)

The Commission filed a series of actions this week which included: three cases based on insider trading; an accounting action against a company and its employees; an audit failure; the unregistered sale of securities; and the sale of non-existent securities.

SEC

Rules: The SEC adopted Cross-Border Security-Based Swap Rules for U.S. Activity. The rules focus on the registration requirements as a security-based swap dealer for those outside the U.S. with personnel in the country (here).

Testimony: Stephen L. Cohen, Associate Director, Division of Enforcement, testified before the Senate Judiciary Committee regarding the EB-5 Immigrant Investor Program (February 2, 2016). Mr. Cohen reviewed the program, the SEC’s enforcement actions related to EB-5 projects and the efforts of the agency to educate investors in the area (here).

CFTC

Testimony: Chairman Timothy Massad testified before the House Appropriations Committee, Subcommittee on Agriculture, Rural Development, Food and Drug Administration and Related Agencies (February 10, 2016). The testimony focused on the budget request (here).

Remarks: Chairman Timothy Massad delivered remarks titled “Taking Stock of Financial Resilience” before the OFR-FSOC 2016 Annual Conference (February 5, 2016). His remarks included comments on clearinghouse resilience in the U.S. and abroad, data reporting and steps to strengthen the financial system (here).

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 4 civil injunctive case and 5 administrative proceeding, excluding 12j and tag-along proceedings.

Fraud: SEC v. Ruehle (S.D. Cal. Filed February 11, 2016) is an action against Greg Ruehle. It alleges that he sold stock he did not own, raising about $1.9 million from 100 investors. To facilitate the fraud he fabricated the necessary documents. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending. The U.S. Attorney’s Office for the Southern District of California filed a parallel action.

Unprofessional conduct: In the Matter of Frazer Frost, LLP, Adm. Proc. File No. 3-17112 (February 11, 2016) is a proceeding which names as Respondents the PCAOB registered audit firm, Susan Woo, CPA and Miranda Suen, CPA, an engagement partner and manager at the firm, respectively. The proceeding centers on the review of the third quarter 2010 interim financial information and 2011 year end audit of China Valves Technology, Inc. The firm had misled investors about the acquisition of Watts Valve (Changsha) Company, Ltd and, in 2011 materially overstated income and understated liabilities at a subsidiary. Because Respondents failed to conduct their review and audit in accord with the applicable standards they engaged in unprofessional conduct. For example, in the 2011 audit the firm correctly recognized the need to exercise heightened professional skepticism during the audit since the internal controls were inadequate. Respondents, however, failed to follow their own audit plan. The Order alleges violations of Rule 102(e) and Rules 2-02 and 20-06 of Regulation S-X. The proceeding will be set for hearing.

Prime bank fraud: SEC v. Tahmazian, Civil Action No. 2:16-cv-954 (C.D. Ca.. Filed February 11, 2016) is an action which alleges that Jilbert Tahmazian, a California attorney, fraudulently obtained about $6 million from at least four investors tied to a prime bank fraud. The complaint alleges violations of Securities Act Sections 5(a), 5(c), and each subsection of 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23465 (February 11, 2016).

Insider trading: In the Matter of Abdallah Fadel, Adm. Proc. File No. 3-17111 (February 10, 2016). Respondent was employed by Whirlpool Corporation. He began in 2007. In early 2009 he transferred into a group within the finance department called Financial Planning and Analysis. The focus of the group was furnishing management and the board with an analysis of the firm’s financial results. Almost immediately after joining the group Mr. Fadel began trading in advanced of earnings announcements despite firm policies. Indeed, prior to three earnings announcements spread over 2009, 2010 and 2011 he purchased options and traded profitably in advance of firm announcements. The Order alleged violations of Exchange Act Section 10(b). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. He is also barred from serving as an officer or director of a public company. In addition, he will pay disgorgement of $109,077, prejudgment interest and a penalty of $36,000.

Investment fund fraud: SEC v. Malik, Civil Action No. 15-1025 (S.D.N.Y.) is a previously filed action against Moazzam Malik and American Bridge Investment Group, LLC. The action alleged that Mr. Malik deceived investors in connection with the sale of limited partnership interests in his hedge fund, raising about $1 million. The court entered, by consent, a final judgment as to the defendants precluding violations of Securities Act Sections 5(a), 5(c) and 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The order also precludes the defendants from soliciting additional investors or accepting additional investments from existing investors. Defendants will pay disgorgement, on a joint and several basis, of $1,005,244.70, prejudgment interest and a penalty of $2,850,000 as to Mr. Malik and $13,775,000 as to the firm. See Lit. Rel. No. 23463 (February 10, 2016).

Accounting: In the Matter of Monsanto Company, Adm. Proc. File No. 3-17107 (February 9, 2016) is an action against the company; Sara Burnquell, the External Reporting Lead at the firm during the period; Jonathan Nienas, the U.S. Strategic Account Lead for the Roundup Division; and Anthony Hartke, U.S. Business Analyst in the Roundup Division. The case stems from improper accounting tied to programs designed to promote the firm’s key product – Roundup – that resulted in a restatement of Monsanto’s financial statements for its annual reports for 2009 and 2010 and the quarterly reports for 2011. The programs designed to boost Roundup sales were similar. The initial program focused on retailers. Essentially the program induced retailers to purchase supplies of Roundup on the promise of a rebate program rolled out the next year. The rebates for the 2009 purchases were recognized in 2010 when in fact they should have been accounted for in conjunction with the sales. The firm had a similar matching problem regarding a rebate program for distributors. In Canada, France and Germany Monsanto utilized similar programs to boost sales but then improperly accounted for the rebates as selling, general and administrative expenses. The Order alleged violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) as well as the related rules. Monsanto undertook a series of remedial efforts, including the retention of an independent ethics and compliance consultant. To resolve the proceeding the company consented to the entry of a cease and desist order based on the Sections cited in the Order, except Section 13(b)(5). The firm will also pay a penalty of $80 million. Respondent Brunnquell consented to the entry of a cease and desist order based on each of the Sections cited in the Order, except Section 13(b)(5). In addition, she is denied the privilege of appearing and practicing before the Commission as an accountant with the right to reapply after two years. She will also pay a penalty of $55,000. Respondent Hartke consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a) and 13(b)(2)(A). He is denied the privilege of appearing and practicing before the Commission as an accountant with the right to reapply after one year and will pay a penalty of $30,000. Finally, Respondent Nienas consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(5). He will also pay a penalty of $50,000.

False statements: SEC v. Saltsman, Civil Action No. 07-cv-4370 (E.D.N.Y.) is a previously filed action against Martin Weisberg, among others, in which the Commission alleged that he made false statements in the filings of two companies regarding an Israeli investor group. The court entered a final judgment by consent prohibiting future violations of Exchange Act Sections 10(b), 13(a) and 14(a). Mr. Weisberg pleaded guilty in a parallel criminal action in which he was ordered to pay restitution. Mr. Weisberg was suspended from appearing or practicing before the SEC as an attorney in a separate action. The case continues as to other defendants. See Lit. Rel. No. 23462 (February 8, 2016).

Unregistered broker: In the Matter of Phillip Cory Roberts, File No. 3-16888 (February 8, 2016) is a proceeding which names as Respondents Mr. Roberts, previously an associated person at a brokerage firm, and Bay Peak, LLC which marketed itself as an investment firm. Respondents, since at least 2005, have acquired domestic shell companies for reverse merger transactions with China-based operating companies. They have also engaged in transactions to fiancé those business combinations and the resulting issuers. Specifically, Respondents worked with the firm to raise capital through private placements, warrant financings, initial public offerings or direct investment. Respondents participated in key steps of the financing process. They typically received negotiated compensation in the form of shares, advisory and consulting fees and bonus payments. In some instances it was transaction based. The Order alleges violations of Exchange Act Section 15(a). To resolve the matter Respondents agreed to certain undertakings which included the return of all the shares for eleven transactions. They also consented to the entry of a cease and desist order based on the Section cited in the Order. Respondent Roberts was barred from the securities business and from participating in any penny stock offering with a right to apply for reinstatement after five years. Respondents will pay, on a joint and several basis, disgorgement of $114,141, prejudgment interest and Mr. Roberts will pay a penalty of $10,000.

Insider trading: SEC v. Munakash, Civil Action No. 2:16-cv-00833 (C.D. Cal. Filed Feb. 5, 2016). The action centers on the acquisition of GSI Commerce Inc., an e-commerce company, by eBay, Inc., announced on March 28, 2011. Defendant Robert Munakash is the owner of a small business which employed Carlos Rodriguez, also a defendant. Mr. Munakash is a long time personal friend of Executive A. In February 2011 Executive A and Mr. Munakash traveled to the Dallas Super Bowl together. Mr. Munakash was a guest of the firm. During the Super Bowl trip Executive A told his friend that there were several groups interested in pursuing an acquisition or deal with GSIC. In addition, there were other potential deals. After returning from the Super Bowl Mr. Munakash furnished the information about the potential transaction, including the fact that a possible offer may be forthcoming, to his broker, defendant Marc Winters. The two men had a long and mutually beneficial business relationship. Mr. Munakash also recommended that his mentee, defendant Rodrigues, purchase shares of GSIC stock, gifting him the information. Mr. Rodriguez knew that his mentor and Executive A were friends, that the executive was a GSI insider and had invited Mr. Munakash to the Super Bowl. Messrs. Munakash, Winters and Rodriguez purchased shares of GSI stock. Mr. Winters also purchased shares for two discretionary accounts he managed while Mr. Rodriguez tipped a close relative who traded. Subsequently, Messrs. Munakash and Rodriguez exchanged text messages. The next day both purchased additional shares of GSIC stock. On the morning of March 28, eBay and GSIC announced the acquisition. All of the defendants immediately sold their shares. The complaint alleges violations of Exchange Act Section 10(b). It is pending. See Lit. Rel. No. 23460 (February 8, 2016).

Unregistered securities: In the Matter of BioElectronics Corp., Adm. Proc. File No. 3-17104 (February 5, 2016) is a proceeding which names as Respondents BioElectronics, a firm which makes medical devices; IBEX, LLC, managed by Kelly Whelan; St. John’s LLC, controlled by Patricia Whelan, wife of Andrew Whelan; Andrew Whelan, President and CEO of BioElectronics; Kelly Whelan CPA, daughter of Andrew Whelan; and Robert Bedwell, CPA, engagement partner for the audits of BioElectronics. The Order alleges that BioElectronics improperly recognized revenue from two “bill and hold” transactions. Revenue rose 47% as a result. From August 2009 through late last year its affiliates, IBEX and St. John’s then sold millions of what were claimed to be unrestricted shares of the firm. The funds were loaned back to BioElectronics. There was no registration statement in effect. The Order alleges violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The proceeding will be set for hearing.

Insider trading: SEC v. Hamilton, Civil Action No. 3: 16-cv-00192 (D. Conn. Filed February 5, 2016). Dennis Hamilton, a CPA, has served as the vice president of tax since 2009 at Harman International Industries, Inc. Mr. Hamilton has been deeply involved in the preparation of Harman’s earnings announcements throughout his years at the firm. On October 18, 2013 Mr. Hamilton received a draft of Harman’s Form 10-Q for the first quarter of fiscal 2014. Sales were up 17% according to the draft. Two days after receiving the draft earnings, Mr. Hamilton purchased 17,000 shares of Harman stock at a purchase price of $1.2 million in a joint account he had with his wife. The date was October 30, 2013. The share closing price was $72.02. Before the market open the next day Harmon announced its earnings. The share price jumped, closing at $81.02 – up 12% increase. Mr. Hamilton liquidated his position, yielding trading profits of $131,958.62. The Commission’s complaint alleges violations of Exchange Act Section 10(b). The U.S. Attorney’s Office for the District of Connecticut brought a parallel criminal action. Both cases are pending.

Hong Kong

Unauthorized transactions: The Securities and Futures Commission banned Chow Chi Keung, a licensed representative, from the securities business for life. An investigation found that he forged client signatures and conducted unauthorized transactions in client accounts.

U.K.

Cooperation: The Financial Conduct Authority fined Achilles Macris, the former head of CIO International for JPMorgan Chase Bank, N.A., £792,900 for failing to be open and co-operative with the Authority. Mr. Marcus was instructed to halt trading in a synthetic portfolio and report in on it. When press articles appeared regarding the London Whale he reported in. At the time there were concerns regarding the status of the portfolio which he failed to report. The penalty here was discounted for settlement at an early stage and for a substantial change. Otherwise it would have been £1,132,747.

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Another SEC Insider Trading Case As An Administrative Proceeding

The SEC filed another settled insider trading case. In the Matter of Abdallah Fadel, Adm. Proc. File No. 3-17111 (February 10, 2016). While the case is straight forward, what may be of interest is the fact that it is the sixth insider trading action filed in that forum since the holidays in December 2015 (here). It is clearly part of a continuing trend of filing cases in that forum (here).

Respondent was employed by Whirlpool Corporation. He began in 2007. In early 2009 he transferred into a group within the finance department called Financial Planning and Analysis. The focus of the group was furnishing management and the board with an analysis of the firm’s financial results.

Almost immediately after joining the group Mr. Fadel began trading in advanced of earnings announcements despite firm policies:

  • On October 23, 2009 Whirlpool announced its results for the quarter ended September 30, 2009. The announcement stated that EPS exceeded the street estimate, excluding onetime charges. The share price closed up 5%. Prior to the announcement Mr. Fadel purchased 20 call options which he sold for a gross profit of $6,400.
  • On April 26, 2010 the company announced its fiscal results for the quarter ended March 31, 2010. Again its EPS exceeded street estimates, excluding onetime charges. The stock closed up 10%. Prior to the announcement Mr. Fadel purchased 50 call options which yield a gross profit of $82,750 when liquidated.
  • On July 21, 2011 Whirlpool announced its financial results for the fiscal quarter ended June 30, 2011. This time its EPS was below street consensus. The company also announced that it lowered EPS guidance for the year. The stock closed down 4%. Prior to the announcement Mr. Fadel had acquired 250 put contracts. Those instruments were liquidated for a gross profit of $18,927.

The Order alleges violations of Exchange Act Section 10(b). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. He is also barred from serving as an officer or director of a public company. In addition, he will pay disgorgement of $109,077, prejudgment interest and a penalty of $36,000.

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