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    This Week In Securities Litigation (Week ending October 31, 2014)

    October 30, 2014

    The Commission brought a series of administrative proceedings this week and one civil injunctive action. The civil injunctive action was an insider trading case. The administrative proceedings centered on FCPA violations, the custody rule, churning, Rule 105, internal controls, a failure to comply with the auditor rotation rule and undisclosed related party transactions.

    SEC

    Remarks: Commissioner Kara Stein addressed the Los Angeles County Bar Association 47th Annual Securities Regulation Seminar (Oct 24, 2014). Her remarks focused on capital formation and overhauling the current system (here).

    Remarks: Norm Champ, Director, Division of Investment Management, addressed the SIFMA Complex Products Forum, New York, New York (Oct. 29, 2014). His remarks focused on enhanced risk monitoring by the Division (here).

    SEC Enforcement – Filed and Settled Actions

    Statistics: This week the SEC filed 1 civil injunctive action and 8 administrative proceedings, excluding 12j and tag-along-actions.

    Investment fund fraud: SEC v. Coughlin, Civil Action No. 1:14-cv-00562 (S.D. Ind.) is a previously filed action which names as defendants Timothy Coughlin, OICU Ltd. and OICU Investment Corp. The complaint alleged that from June 2007 through December 2009 the defendants raised over $12.8 million from about 5,000 investors who thought they were purchasing an interest in a credit union. In fact the venture was a classic Ponzi scheme. The Court entered final judgments by consent against each defendant enjoining them from future violations of the antifraud provisions of the federal securities laws. The order also bars them from participating in the issuance, purchase, offer or sale of any security. A permanent officer and director bar was imposed on Mr. Coughlin. In addition, the two entities were ordered to jointly and severally pay disgorgement of $10,053,234 together with prejudgment interest and a penalty of $775,000. No financial penalties were imposed on Mr. Coughlin in view of the restitution order imposed in the parallel criminal case in which he pleaded guilty. Disgorgement orders were also entered against the relief defendants. See Lit. Rel. No. 23123 (October 30, 2014).

    Custody rule: In the Matter of Sands Brothers Asset Management, LLC, Adm. Proc. File No. 3-16223 (October 29, 2014). Named as Respondents are the registered investment adviser, Steven Sands, Martin Sands and Christopher Kelly. Sands Brothers Asset provides investment advisory service to a number of pooled investment vehicles. Steven and Martin Sands are co-founders of the adviser. Attorney Kelly is the chief compliance and operating officer of the adviser. Previously, the adviser and two co-founders were named as Respondents in a Commission administrative proceeding charging violations of the custody rule. That proceeding was settled with the entry of a cease and desist order and the payment of a penalty. The two brothers have also been sanctioned by state regulators for securities law violations. From 2010 through 2012 Sand Brothers Asset continued to have custody of client assets. Yet the adviser did not submit to a surprise examination by an independent public accountant. The adviser did distribute its funds’ audited financial statements for fiscal years 2010 to 2012 but after the 120 time limit. The circumstances which caused the audits to be delayed were predictable and not unforeseeable. For example, for 2012 the auditors noted that there was a delay in receiving information from management regarding the valuation of assets. Steven and Martin Sands aided and abetted the violations since they were responsible for ensuring that compliance personnel had the authority to implement whatever procedures and policies were necessary to ensure that the adviser complied with the Advisers Act. Mr. Kelley, who was tasked in the compliance manual with ensuring compliance with the restrictions and requirements of the custody rule, knew that the audited financial statements were not being distributed on time. Yet at most he reminded people of the time deadline but failed to take any other steps. The Order alleges violations of the custody rule. The action will be set for hearing.

    Churning: In the Matter of Eli D. Okman, Adm. Proc. File No 3-16218 (October 28, 2014) is a proceeding which names as a Respondent Eli Okman, now a retired Merrill Lynch account executive. From January 2010 through September 2011 he exercised de facto control over a customers account and churned it in violation of Securities Act Section 17(a). To resolve the proceeding Mr. Okman consented to the entry of a cease and desist order based on the Section cited in the Order. He was also suspended for a period of 12 months from the securities business and directed to pay disgorgement of $31,964, prejudgment interest and a penalty equal to the amount of the disgorgement. A fair fund will be established for the benefit of the customer.

    Manipulation: SEC v. AutoChina International Limited, Civil Action No. 1:12-CV-10643 (D. Mass.) is a previously filed action against the company and Ge Dong, Victory First Limited, Rainbow Yield Limited, Yong Qi Li, Ai Xi Ji, Ye Wang, Zhong Wen Zhang, Li Xin Ma, Yong Li Li and Shu Ling Li. The Court entered a financial judgment by consent as to each defendant enjoining them from future violations of Securities Act Sections 9(a)(1), 9(a)(2) and Exchange Act Section 10(b). Each was ordered to pay a civil penalty of $150,000. The action was based on the manipulation of the AutoChina’s stock. See Lit. Rel. No. 23121 (Oct. 28, 2014).

    Rule 105: In the Matter of Thrasos Tommy Petrou, Adm. Proc. File No. 3-16217 (October 27, 2014) is a proceeding which names the professional trader as a Respondent. Mr. Petrou has served as a trader for a number of entities. From mid-December 2009 through mid-January 2009, while trading for his account, as well as those of two unregistered entities, he purchased offering shares from an underwriter or broker participating in a follow-on or secondary offering after having sold short during the restricted period twenty times. The Order alleges violations of Rule 105 of Regulation M. The proceeding will be set for hearing.

    Internal controls: In the Matter of Great Lakes Dredge & Dock Corporation, Adm. Proc. File No. 3-16215 (October 27, 2014) is a proceeding naming the firm as a Respondent. Great Lakes has two operating divisions, a dredging segment responsible for most of the firm’s revenue and a demolition segment. In the second and third quarters of 2012 the firm overstated revenue in the demolition segment by recording revenue for pending change orders without having sufficient proof of customer acceptance of theose changes. As a result, revenue was overstated during the year-end audit. This resulted from a material weakness in internal controls. The company discovered the issue and announced a restatement. To resolve the proceeding the company consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The firm will also pay a penalty of $150,000. The Commission considered the remedial acts of the company and its substantial cooperation.

    Insider trading: SEC v. Slawson, Civil Action No. 1:14-cv-3421 (N.D. Ga. Filed October 24, 2014). Stephen Slawson is the co-founder and manager of hedge fund TCMP3 Partners L.P. In eight instances, beginning in 2006 and continuing through 2010, he is alleged to have traded on inside information which traces back to a Carter’s, Inc. and generated over $500,000 in illicit trading profits or losses avoided. Typically the information came to him from Dennis Rosenberg, a research analyst retained by the hedge fund. Mr. Rosenberg obtained the inside information obtained from Eric Martin, a Carter’s vice president of investor relations before he was terminated in March 2009. Mr. Martin is currently serving a two year prison term after pleading guilty to one of eleven counts in an indictment charging him with securities fraud. Subsequently, the information came from Richard Posey, a Carter’s vice president of operations who furnished it to Mr. Martin who then tipped Mr. Rosenberg who then tipped Mr. Slawson. During his employment Mr. Martin tipped analysts such as Mr. Rosenberg who covered the company to develop his relationship with them. Mr. Slawson “knew or should have known that Rosenberg’s source at Carter’s was disclosing the information in violation of a fiduciary or similar duty of trust and confidence,” according to the complaint. Following the termination of Mr. Martin, he obtained inside information from Mr. Posey which he then transmitted to Mr. Rosenberg and ultimately to Mr. Slawson in two instances and on another occasion, directly to the hedge fund manager. Mr. Posey furnished the information to Mr. Martin “by virtue of their close friendship and Posey’s desire to enhance his reputation.” The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The U.S. Attorney’s Office filed parallel criminal charges. Both cases are pending. See Lit. Rel. No. 23118 (October 24, 2014).

    Pump and dump: SEC v. Recycle Tech Inc., Civil Action No. 12-cv-21656 (S.D. Fla.) is a previously filed action centered on a market manipulation scheme. Defendants Anthony Thompson, OTC Solutions LLC, Jay Fung, Ryan Gonzales and Pudong LLC all settled the action. The Court entered final judgments permanently enjoining each settling defendant from future violations of Securities Act Sections 5(a) and 5(c), and Exchange Act Section 10(b). In addition, Messrs. Thompson, Fung and Pudong and OTC are enjoined from future violations of Securities Act Section 17(a). The final judgment against Mr. Gonzalez is also based on Exchange Act Section 13(a). The Court also entered penny stock bars against Messrs. Thompson, Fung and Gonzales. Mr. Gonzales is bared from serving as an officer and director of a public company. In addition, Mr. Thompson and OTC are jointly and severally liable for disgorgement in the amount of $349,504.61 and prejudgment interest. Messrs. Fung and Pudong are jointly and severally liable for disgorgement in the amount of $456,457 along with prejudgment interest. Messrs. Thompson and Fung are required to each pay civil penalties of $120,000. Mr. Gonzalez was not ordered to pay a penalty based on financial position. See Lit. Rel. No. 23117 (Oct. 24, 2014).

    Auditor rotation: In the Matter of Berman & Company, P.A., Adm. Proc. File No. 3-16212 (October 24, 2014) is a proceeding which names as Respondents, the Florida audit firm, which is registered with the PCAOB, and its owner, Elliot Berman. For five years Mr. Berman served as the engagement partner on the audits of Client. For the next year Mr. Berman assigned a firm employee to serve as the lead partner. The employee was not a CPA registered with the state of Florida or with the PCAOB. In addition, Mr. Berman performed a number of the services that would typically be done by the lead partner. The Order alleges that the Respondents violated Exchange Act Section 10A(j), Rule 2-02 of Reg. S-X, caused Client to violate Exchange Act Section 13(a) and engaged in unprofessional conduct within the meaning of Rule 102(e)(1)(ii). To resolve the proceeding Respondents consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. In addition, Mr. Berman is denied the privilege of appearing or practicing before the Commission as an accountant. Respondents will jointly and severally pay a penalty of $15,000. The proceeding is part of Operation Broken Gate.

    Undisclosed guarantees: In the Matter of James J. Dalton, Jr., Adm. Proc. File No. 3-16214 (October 24, 2014) is a proceeding with names Mr. Dalton, the founder of SecureAlert, Inc. as a Respondent. In 2007 and 2008 the company failed to disclose personal guarantees and material related-party transactions by Mr. Dalton and another officer. The transactions were undertaken in one instance to induce a customer to purchase product and in another to avoid having defective product returned. This resulted in false filings being made with the SEC. Mr. Dalton also made misrepresentations in response to a Corp Fin comment letter. The Order alleges violations of Securities Act Sections 17(a)(2) and (3). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to the payment of a penalty of $65,000. A related proceeding based on the same core conduct names David Derrick, Sr., the founder of SecureAlert as a Respondent. It alleges willful violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case will be set for hearing. In the Matter of David G. Derrick, Sr., Adm. Proc. File No. 3-16213 (October 24, 2014).

    FCPA

    In the Matter of Layne Christensen Company, Adm. Proc. File No. 3-16216 (October 27, 2014). Layne Christensen is a global water management, construction and drilling company. From 2005 through 2010 Layne Christensen, through subsidiaries in Africa and Australia, is alleged to have paid over $1 million in improper payments to foreign officials in the Republic of Mali, the Republic of Guinea, Burkina Faso, the United Republic of Tanzania and the Democratic Republic of the Congo. The payments were made to secure favorable tax treatment, customs clearance for drilling equipment, work permits for expatriates, relief from inspection by immigration and labor officials and to avoid penalties for delinquent payment of taxes and customs duties and the failure to register immigrant workers. Between 2005 and 2009 Layne Christensen paid about $768,000 in bribes to foreign officials in Mali, Guinea and the Democratic Republic of the Congo through subsidiaries to reduce tax liability and penalties, saving about $3.2 million. The company made additional improper payments, this time in 2007 and 2009, to customs officials to avoid paying customs duties and obtain clearance for the import and export of its equipment. The payments were made in Burkina Faso and the Democratic Republic of the Congo through subsidiaries. The Order alleges violations of Exchange Act Section 30A, 13(b)(2)(A) and 13(b)(2)(B). The proceeding was resolved with the company consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the firm agreed to pay disgorgement of $3,893,472.42, prejudgment interest and a penalty of $375,000. The amount of the penalty reflects the self-reporting and extensive cooperation and remediation efforts of the company.

    Criminal cases

    Insider trading: U.S. v. Post, Case No. 1:14-cr-00715(S.D.N.Y.) is an action against David Post, who was tipped by his friend, a financial analyst at a pharmaceutical company. The SEC recently amended its complaint against the analyst to add Mr. Post as a defendant (here). Mr. Post pleaded guilty to one count of conspiracy to commit securities fraud and three counts of securities fraud. Sentencing is scheduled for February 6, 2015.

    FINRA

    Reg. SHO: The regulator censured Merrill Lynch Professional Clearing Corp. and find the firm $3.5 million for failing to take action to close-out certain fail-to-deliver positions from September 2008 through July 2012 . The firm also did not have adequate systems and procedures in place to address the issue. Its supervisory systems and procedures were inadequate and improperly permitted the firm to allocate fail-to-close positions to the firm’s broker-dealer clients based solely on each client’s short position without regard to which clients caused or contributed to the situation.

    Hong Kong

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

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

    SEC Charges Recidivist Adviser, Co-Founders With Violations of Custody Rule

    October 29, 2014

    The SEC has brought a number of custody rule cases as part of its broken windows initiative. Its newest proceeding centered on the custody rule, however, is a contested administrative proceeding which names as Respondents an adviser, its two principals, all of whom are securities law recidivists whose prior violations include the custody rule, and the adviser’s chief compliance officer. In the Matter of Sands Brothers Asset Management, LLC, Adm. Proc. File No. 3-16223 (October 29, 2014).

    Named as Respondents are the registered investment adviser, Steven Sands, Martin Sands and Christopher Kelly. Sands Brothers Asset provides investment advisory service to a number of pooled investment vehicles. In 2010 the adviser settled a Commission administrative proceeding in which it was ordered to cease and desist from violating the custody rule, censured and paid a $60,000 penalty. The adviser has also been sanctions by the Connecticut Department of Banking for violations of the state’s securities laws. Steven and Martin Sands are co-founds of the adviser. Each is also subject to the 2010 Commission cease and desist order entered against the adviser. Steven Sands has had his broker-dealer registration subjected to a number of conditions by the State of Connecticut and his license suspended by the NASD. Martin Sands has twice been temporarily barred from association or suspended from holding supervisory positions, censured and fined by the NYSE and had restrictions imposed on his broker-dealer license by the State of Connecticut. Attorney Kelly is the chief compliance and operating officer of the adviser.

    The custody rule requires an adviser to ensure that a qualified custodian maintains the client assets; has a reasonable basis for believing that the custodian sends quarterly account statements to clients; and ensures that client funds and securities are verified by actual examination each year by an independent public accountant. For an adviser to a pooled investment vehicle, the rule provides an alternative to the verification requirement if its audited financial statements are distributed to all limited partners within 120 days of year end.

    In 1999 OCIE examined the adviser and sent a deficiency letter. The examination demonstrated that the representation in the adviser’s ADV stating that it did not have custody of client assets was incorrect. By virtue of the relationship of the adviser to the pooled investment vehicles, and the relationships of the two brothers and the managing member and general partners, Sand Brothers Asset did have custody of the client assets.

    In 2010, as a result of subsequent OCIE examinations in 2004 and 2009, and an investigation by the Division of Enforcement, the adviser and brother were named in a Commission administrative proceeding. The proceeding alleged violations of the custody rule and was resolved as noted above.

    From 2010 through 2012 Sand Brothers Asset continued to have custody of client assets. Yet the adviser did not submit to a surprise examination by an independent public accountant. The adviser did distribute its funds’ audited financial statements for fiscal years 2010 to 2012 but after the 120 time limit. The circumstances which caused the audits to be delayed were predictable and not unforeseeable. For example, for 2012 the auditors noted that there was a delay in receiving information from management regarding the valuation of assets.

    Steven and Martin Sands aided and abetted the violations since they were responsible for ensuring that compliance personnel had the authority to implement whatever procedures and policies were necessary to ensure that the adviser complied with the Advisers Act.

    Mr. Kelley, who was tasked in the compliance manual with ensuring compliance with the restrictions and requirements of the custody rule, knew that the audited financial statements were not being distributed on time. Yet at most he reminded people of the time deadline but failed to take any other steps.

    The Order alleges violations of the custody rule. The action will be set for hearing.

    The SEC’s Carter’s, Inc. Investigation Yields Another Insider Trading Case

    October 28, 2014

    Carter’s, Inc. is the investigation that just keeps on generating cases. The investigation has yielded seven SEC actions charging insider trading and financial fraud. Hedge fund manager Stephen Slawson became the eight person charged in the investigation. SEC v. Slawson, Civil Action No. 1:14-cv-3421 (N.D. Ga. Filed October 24, 2014).

    Mr. Slawson is the co-founder and manager of hedge fund TCMP3 Partners L.P. In eight instances, beginning in 2006 and continuing through 2010, he is alleged to have traded on inside information which traces back to a Carter’s, Inc. and generated over $500,000 in illicit trading profits or losses avoided. Typically the information came to him from Dennis Rosenberg, a research analyst retained by the hedge fund. Mr. Rosenberg obtained the inside information from Eric Martin, a Carter’s vice president of investor relations before he was terminated in March 2009. Mr. Martin is currently serving a two year prison term after pleading guilty to one of eleven counts in an indictment charging him with securities fraud. Subsequently, the information came from Richard Posey, a Carter’s vice president of operations who furnished the information to Mr. Martin who then tipped Mr. Rosenberg who then tipped Mr. Slawson.

    Mr. Martin is alleged to have illegally tipped Mr. Rosenberg on five occasions regarding up-coming earnings announcement for Carters, Inc. During his employment Mr. Martin tipped analysts such as Mr. Rosenberg who covered the company to develop his relationship with them. Mr. Slawson “knew or should have known that Rosenberg’s source at Carter’s was disclosing the information in violation of a fiduciary or similar duty of trust and confidence,” according to the complaint. The five instances where:

    3Q 2006 financial results: Initially Mr. Martin informed Mr. Rosenberg that the financial results would not be positive. Mr. Rosenberg informed Mr. Slawson who caused the hedge fund to sell short. After receiving additional firm financial data, Mr. Martin reversed his position, telling Mr. Rosenberg, who tipped Mr. Slawson, that the results would be positive. Mr. Slawson covered the short position. Following the announcement the stock closed up. The hedge fund avoided a loss of about $27,000 by covering the short position.

    1Q 2007 financial results: Mr. Martin learned that company earnings would significantly exceed analysts’ expectations. He relayed this information to Mr. Rosenberg who in turn tipped Mr. Rosenberg who caused the hedge fund to purchase shares. Following the earnings announcement the stock price closed up about $1.76 per share compared to the prior day, yielding $42,240 in profits for the hedge fund.

    2Q2007 financial results: Mr. Martin again received negative information about the financial results for the quarter. The information was again transmitted down the chain to Mr. Slawson who caused the hedge fund to sell shares and sell short 20,000 shares. Following the earnings announcement the share price of Carter’s closed down about 8.52%. The hedge fund had a profit of about $114,480.

    2Q2008 financial results: During the quarter Mr. Martin learned that his company would release earnings that would again exceed market expectations. As in the past he tipped Mr. Rosenberg who in turn tipped Mr. Slawson who caused the hedge fund to buy additional shares of Carter’s, Inc. Following the positive announcement the fund had profits of $17,820.

    4Q 2008 financial results: Prior to the announcement of the financial results Mr. Martin learned that the financial results would be “generally positive” for the period. He conveyed that information down what by then had become the usual chain. The hedge fund purchased 10,000 shares of Carter’s stock. Following the announcement of the financial results, the share price closed up over 10% compared to the prior day. The fund had profits of about $15,200.

    Following the termination of Mr. Martin, he obtained inside information from Mr. Posey which he then transmitted to Mr. Rosenberg and ultimately to Mr. Slawson in two instances and on another occasion, directly to the hedge fund manager. The first instance involved the second quarter 2009 financial results while the second involved an announcement that the company would delay announcing the third quarter 2009 financial results. In the first Mr. Posey told Mr. Martin that Carter’s would beat the street for the quarter. The information was transmitted to Mr. Rosenberg and then to Mr. Slawson who purchased shares in family accounts and for the hedge fund. Following the announcement of the results the share price closed up slightly, yielding ill-gotten gains in the personal and fund accounts of about $34,604. In the second instance the tipping process was repeated. Mr. Slawson sold shares from his personal account and that of the fund. Following the announcement the share price dropped 23.84% compared to the prior day. Collectively the accounts avoided losses of about $215,916.

    Finally, Mr. Martin furnished inside information to Mr. Martin regarding Carter’s second quarter 2010 financial results, including the fact that future guidance would be negative. Mr. Martin furnished this information directly to Mr. Slawson as did Mr. Rosenberg. Based on Mr. Rosenberg’s “statements, the nature of the information provided, and his history of providing similar information, Mr. Slawson knew or should have known that the information was obtained from an insider in violation of a fiduciary or similar duty of trust and confidence,” according to the complaint. Mr. Slawson sold call options and shorted the stock. Following the announcement the share price declined by about $2. The total gains of the fund were about $42,240. Mr. Posey furnished the information to Mr. Martin “by virtue of their close friendship and Posey’s desire to enhance his reputation.”

    The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The U.S. Attorney’s Office filed parallel criminal charges. Both cases are pending. See Lit. Rel. No. 23118 (October 24, 2014).

    Self-reporting, Extensive Cooperation Yields Reduced Fine In SEC FCPA Action

    October 27, 2014

    Layne Christensen, a global water management, construction and drilling company resolved FCPA bribery and books and records and internal controls charges with the SEC. In the Matter of Layne Christensen Company, Adm. Proc. File No. 3-16216 (October 27, 2014). There was no parallel case announcement by the DOJ.

    From 2005 through 2010 Layne Christensen, through subsidiaries in Africa and Australia, is alleged to have paid over $1 million in improper payments to foreign officials in the Republic of Mali, the Republic of Guinea, Burkina Faso, the United Republic of Tanzania and the Democratic Republic of the Congo. The payments were made to secure favorable tax treatment, customs clearance for drilling equipment, work permits for expatriates, relief from inspection by immigration and labor officials and to avoid penalties for delinquent payment of taxes and customs duties and the failure to register immigrant workers.

    Between 2005 and 2009 Layne Christensen paid about $768,000 in bribes to foreign officials in Mali, Guinea and the Democratic Republic of the Congo through subsidiaries to reduce tax liability and penalties, saving about $3.2 million. These included:

    • In the Republic of Mali improper payments by a firm subsidiary in 2005 and 2007 to obtain a reduction in taxes. The payments were funded in part through a wire from the parent corporation. The payments were improperly booked. The president of the subsidiary who was aware of the tax reductions never questioned how they were achieved.
    • In 2006 and 2008 improper payments were made through two local lawyers by a subsidiary to secure favorable tax treatment. In part the payments were recorded as legal expenses, although no such services were provided. The tax manager of the subsidiary involved noted that portions of the fees could have been used to fund illegal payments to tax officials. The payments were funded in part through U.S. wire transfers.
    • In 2009 another subsidiary made an improper payment to tax officials in the Democratic Republic of Congo through an agent. The purpose was to reduce liability for unpaid taxes and penalties. The president of the same subsidiary involved in other payments approved them without question.

    The company made additional improper payments, this time in 2007 and 2009 to customs officials to avoid paying customs duties and obtain clearance for the import and export of its equipment. The payments were made in Burkina Faso and the Democratic Republic of the Congo through subsidiaries.

    The Order alleges violations of Exchange Act Section 30A, 13(b)(2)(A) and13(b)(2)(B).

    Once Layne Christensen learned of possible violations, senior management and the audit committee quickly initiated an internal investigation that was conducted by an outside law firm and forensic accounting experts. The company self-reported and publically disclosed its potential FCPA violations. During the investigation Layne Christensen terminated four employees, including the president and CFO of the primary subsidiary involved. The firm also conducted a comprehensive risk assessment of its worldwide operations and implemented measures to address its most significant corruption risks. Affirmative steps were taken to strengthen its internal compliance policies, procedures and controls. A standalone anti-bribery policy and related procedures was adopted along with improved accounting policies. Due diligence of third parties was also conducted. A chief compliance officer and three full time assistants were retained. During the SEC investigation the firm demonstrated a high level of cooperation.

    The proceeding was resolved with the company consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the firm agreed to pay disgorgement of $3,893,472.42, prejudgment interest and a penalty of $375,000. The amount of the penalty reflects the cooperation of the company.

    SEC – USAO Charge Trader In Analyst Insider Trading Case

    October 26, 2014

    Earlier this month the SEC brought an insider trading case against Zachary Zwerko, a financial analyst at a pharmaceutical company identified only as Pharma Co. SEC v. Zwerko, Civil Action No. CV 8181 (S.D.N.Y. Filed Oct. 10, 2014). The Manhattan U.S. Attorney’s Office brought parallel criminal charges. Now the SEC has amended its complaint, adding David Post, who is identified as the person who placed the trades, and additional facts about the scheme. The U.S. Attorney also brought criminal charges against Mr. Post.

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

    Mr. Zwerko’s longtime friend is David Post, a 2008 classmate at business school. The two men have maintained a social relationship since school.

    Mr. Post purchased shares of Idemix Pharmaceuticals, Inc. in advance of the June 9, 2014 pre-market announcement that Pharma Co. had agreed to acquire the firm. The take-over deal traces to April 2014 when the two firms entered into confidential, non-public discussions regarding a potential business combination. By mid-May confidentiality and standstill agreements were executed.

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

    Minutes after receiving the e-mail, Mr. Zwerko accessed Yahoo Finance for Idenix from his work computer. Later that day he reviewed headlines about the company. That evening he accessed folders relating to the deal at the office. Mr. Zwerko then sent a text to his Mr. Post. Later that evening, the two friends spoke on the phone. Two minutes after the call ended Mr. Post placed an order for 1,000 shares of Idenix. Although it was not executed, starting the next day Mr. Post purchased shares, investing over $219,000.

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

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

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

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

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

    During the scheme the two men took a number of steps to conceal their activity. For example, they used burner cell phones. Messrs. Zwerko and Post also used a dummy e-mail account. When one wanted to convey information to the other through the account he would draft an e-mail in code and leave it in the draft folder. After the e-mail was read the other would delete it. The two men also used coded text messages.

    The profits from the trading were split. After the Idenix trades Mr. Post gave his friend $50,000 in cash as partial payment for the tips. The cash was handed to Mr.. Zwerko in a shoebox during a visit to Mr. Post’s new home. After the trades in Ardea Mr. Post gave his fried $7,000 as partial payment at his annual Halloween party.

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

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

    October 23, 2014

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

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

    SEC

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

    SEC Enforcement – Filed and Settled Actions

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

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

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

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

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

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

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

    Criminal cases

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

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

    Hong Kong

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

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

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

    October 22, 2014

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

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

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

    The Order alleges a series of violations:

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

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

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

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

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

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

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

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

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

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

    Investment Adviser Pleads Guilty to Wire Fraud Charge

    October 21, 2014

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

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

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

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

    SEC Commissioner Piwowar On Enforcement Policy

    October 20, 2014

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

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

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

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

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

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

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

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

    SEC Brings Another Offering Fraud Case

    October 19, 2014

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

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

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

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

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

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

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

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

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

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