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Thomas O. Gorman,
Dorsey and Whitney LLP
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    Volcker Rule Implemented by SEC, Four Other Federal Agencies

    December 10, 2013

    Five federal regulatory agencies — the SEC, CFTC, the Board of Governors of the Federal Reserve System, the Office of the Comptroller and the FDIC — implemented the 900 plus page Volcker Rule. Many consider the Volker Rule to be the center piece of the Dodd-Frank Wall Street Reform Act.

    The final rules generally prohibit banking entities from engaging in short term proprietary trading in securities, derivatives, commodity futures and options on these instruments for their account. The rules also prohibit banking entities from owning, sponsoring or having certain relationships with what are called “covered funds,” essentially hedge or private equity funds. The rules apply to insured depository institutions and their affiliates.

    Critical to the Rule are certain definitions and exemptions, including:

    Underwriting: There is an exemption for underwriting activities for a distribution of securities.

    Market making: Another exemption is provided for market making and related activities. To qualify for the exemption the inventory of the trading desk would have to be designed not to exceed the expected near term demand.

    Hedging: Hedging activity which is designed to reduce, and demonstrably reduces or mitigates, identifiable risks of individual or aggregated positions are exempt. The institution would have to conduct an analysis of its strategy and periodically calibrate it.

    Government securities: The rules also permit proprietary trading in U.S. government, agency, state and municipal obligations.

    Foreign banks: Foreign banks are exempt from the rules if the trading decisions and principal risks of the foreign banking entity occur, and are held outside, the U.S.

    Hedge and private equity funds: The rules prohibit the ownership of “covered funds,” that is, hedge and private equity funds and their affiliates. Essentially, these funds are issuers that are an investment company under the Investment Company Act if it would not be excluded under certain provisions.

    Compliance: Generally banking entities are required to establish an internal compliance program reasonably designed to ensure and monitor compliance with the rules. Larger institutions have more detailed requirements, including a CEO attestation. Banking entities are also required to maintain records which can be monitored.

    Despite two years of work, the final rules were not implemented without controversy. At the SEC, for example, Chair Mary Jo White favored the Rule calling it “central to the framework put in place by the Dodd-Frank Act . . . The final rule has been written to carry out these objective [to prevent risks to U.S. taxpayers that can flow from proprietary trading] while maintaining the strength and flexibility of the U.S. capital markets by allowing both domestic and foreign financial firms to continue to participate meaningfully in those markets . . .” Similarly, Commissioner Luis Aguilar noted that “[t]oday’s adoption [of the Rule] is a step forward in reining in speculative risk-taking by banking entities and preventing future crises.”

    In contrast, Commissioner Daniel Gallagher dissented, arguing that the rules would impose enormous costs at a time when the economy is still in recovery. He went on to note that the “Volker rule is being finalized in the shadow of perhaps the greatest display of governmental hubris in our lifetimes, as millions of Americans struggle to navigate the unprecedented disaster arising from governmental intrusion into our health care system.” Commissioner Michael Piwowar also dissented, arguing that the rules should be re-proposed to give adequate notice and that the agencies “failed both at the proposing and adopting stages to prepare an economic or other regulatory analysis . . .”

    The final rule becomes effective April 1, 2014. The Federal Reserve has extended the conformance period until July 21, 2015.

    SEC Files Offering Fraud Action Centered on Three Schemes In Three Years

    December 09, 2013

    The SEC brought another in a series of offering fraud cases. This one, however, does not focus on just one offering but three since mid- 2011. Promoters Robert Helms and Janniece Kaelin, their entities and Deven Sellers and Roland Barrera are named as defendants. SEC v. Helms, Civil Action No. 1:13-cv-1036 (W.D. Tx. Filed Dec. 3, 2013).

    The first scheme centered on Vendetta Royalty Partners, Ltd. That partnership was formed in 2009. It acquired certain oil and gas royalty rights at that time. Subsequently, on August 15, 2011 Vendetta Partners filed a notice on Form D with the Commission. The Form stated that Vendetta Partners sought to raise $50 million by selling limited partnership interests. The PPM contained a series of misrepresentations including:

    Prior sales: It claimed that there were no sales prior to the filing of the PPM which was false since there had been two for a combined investment of $275,000;

    Experience: Representations regarding the industry experience of Mr. Helms at various firms were false since most of his experience was with Vendetta Royalty;

    Litigation: Although the PPM claimed there were no material pending legal proceedings against the partnership, the general partner and its affiliates, in fact there was a material private suit alleging fraud and a state EPA action;

    Commissions: While the PPM told investors that only modest commissions would be charged, in fact Defendants Deven Sellers and Roland Barrera were paid commissions of about $400,000 for a $3 million investment; and

    Use of proceeds: The PPM told investors that the offering proceeds would be used to purchase royalty interests, pay 10% of Vendetta Partners’ credit facility and for promotional expenses when in fact most of the funds were misappropriated.

    Mr. Helms and Ms. Kaelin also grossly understated bank loan payments made with the offering proceeds while concealing the fact that default was imminent. Overall, about $17.9 million was raised from 80 investors who purchased securities issued by Vendetta Royalty beginning in July 2011.

    In July 2012 the defendants launched a second scheme, Vesta Partners. This venture claimed it would provide investors with predictable, quarterly cash distributions, an attractive yield and a 300% to 500% return within five to seven years, according to representations made to investors. In fact there was no basis for making these representations, according to the complaint.

    Finally, in 2013 Rock Partners filed a Form D with the Commission signed by Defendant Helms. The firm sought to raise $300 million over a period of up to one year. This venture also claimed that within five to seven years investors would have returns of 300% to 500%. Again the claim is baseless, according to the complaint.

    The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The Court granted a freeze order at the time the complaint was unsealed. The case is pending. See Lit. Rel. No. 2286 (Dec. 6, 2013).

    An SEC Investigation Can Be A Bad Day, But It Can Get Worse

    December 08, 2013

    Becoming involved with an SEC investigation is a bad day for any company and its executives. There are things that can be done to make it better. There are also ways to make it worse, much worse. Executives at Vitesse Semiconductor Corporation, when face with a possible option backdating investigation, are an example of how to make it worse.

    Yatin Mody, initially the controller and later CFO of the company, contacted outside counsel in November 2005 regarding a press inquiry about the stock option practices of the company. Then current SEC filings of the company represented that stock options were granted at fair market value as of the date of the grant.

    Following a review of company documents outside counsel raised a number of concerns. Specifically, outside counsel questioned whether the company had properly accounted for its stock options. Some grants appeared to have been backdated. For example:

    April 12, 2001: The Compensation Committee meeting minutes for this date reflected grants for about 7.6 million shares with an exercise price of $17.438, the April 6, 2001 closing price, not the $25.70 price for the date of the meeting;

    October 25, 2001: The Compensation Committee meeting minutes for this date reflected option grants for 15.3 million shares with an exercise price of $7.27, the October 2, 2001 closing price, not the $11.35 price on the date of the meeting.

    Mr. Mody then held discussions with company founder and CEO Louis Tomasetta and former CFO Eugene Hovanec about the matter. Following the meeting, Mr. Mody created minutes for telephonic Compensation Committee meetings dated April 6, 2001 and October 2, 2001. The minutes were provided to outside counsel, noting that they had been created in November 2005.

    In November 2006 the Wall Street Journal ran an article about stock option backdating. It cited the company. Outside counsel met with the board and senior management, raising concerns regarding the option practices at the company and the years later prepared minutes. The company was informed that there was a significant possibility of an SEC investigation.

    In April 2006 the Audit Committee retained counsel. Audit Committee Counsel was directed to conduct an internal investigation regarding the option practices of the company. Audit Committee counsel requested access to the computer where the minutes of for the Compensation Committee were prepared.

    Subsequently, on April 12, 2006 Messrs. Tomasetta, Hovanec and Mody created documents that purported to be minutes of meetings of the Compensation Committee on April l6, 2001 and October 2, 2001. The minutes authorized stock option grants. The electronic version of these minutes was then transferred to the computer where the minutes of the Compensation Committee were prepared. The internal clock of the computer was reset to make it appear that the minutes had been created at an earlier time.

    Messrs. Tomasetta and Hovanec were named in an SEC option backdating complaint along with the company and others. SEC v. Vitesse Semiconductor Corporation, Civil Action No. 10 Civ. 9239 (S.D.N.Y. Filed Dec. 10, 2010)(the company settled on filing; the officers later settled; see Lit. Rel. No. 3295 (Sept. 27, 2013)). The two men were also named as defendants in a multi-count criminal indictment. It charged conspiracy, securities fraud, false entries in books and records of an issuer of securities, false filings with the SEC, false certification of financial reports and false statements to auditors. It also contained a forfeiture claim.

    Messrs. Tomasetta and Hovanec each pleaded guilty to a superseding information charging conspiracy to destroy, alter, or falsify records relating the Vitesse’s April and October 2001 stock option grants. Last week each man was sentenced to serve three years probation. Each will also pay a $30,000 fine. U.S. v. Tomasetta, 10 crim 1205 (S.D.N.Y.).

    Mr. Mody pleaded guilty to charges of securities fraud, making false entries in the financial records of a company and conspiracy under a cooperation agreement. He is awaiting sentencing.

    This Week In Securities Litigation (Week ending December 6, 2013)

    December 05, 2013

    The SEC got mixed results in court this week. In the district court the agency lost another case with a jury returning a verdict against the Commission on all counts. The SEC did, however, prevail in the court of appeals in another case. There the court affirmed the determination of the Commission on the amount of a penalty in an administrative proceeding.

    New cases brought by the Commission this week included another market crisis action centered on a financial institution which failed to reclassify impaired loans to avoid taking a loss and an insider trading and Rule 105 action against a long time securities trader. In addition, criminal charges were announced against an SEC employee who falsified the personal securities holding reports he furnished to the agency.

    Finally, the PCAOB re-proposed a rule which, if adopted, will require additional disclosures in the audit report. The proposed rule would require the disclosure of the identity of the engagement partner and other firms participating in the engagement.

    SEC

    Remarks: SEC Chair Mary Jo White addressed the 10th Annual Transatlantic Corporate Governance Dialogue, Washington, D.C. (Dec. 3, 2013). Her remarks included comments on the activist shareholder and the role of shareholders and proxy advisory firms (here).

    Remarks: SEC Commissioner Daniel Gallagher addressed the Transatlantic Corporate Governance Dialogue, Washington, D.C. (Dec. 3, 2013). His remarks were titled The Realities of Stewardship for Institutional Owners, Activist Investors and Proxy Advisors. The Commissioner’s comments focused on the role of proxy advisors (here).

    CFTC

    Remarks: Commissioner Scott D. O’Malia delivered remarks titled Setting Priorities and Fixing Broken Rules Must be Commission’s First Order of Business in 2014 at the 9th Annual FIA Asia Derivatives Conference, Singapore (Dec. 4, 2013). His remarks called for “less regulatory activism” and more statutory accuracy, focusing on the cross boarder rules, SEFs and data and technology (here).

    SEC Enforcement – litigated cases

    False statements: SEC v. Kovzan, Civil Action No. 2:11-cv-02017 (D. Ka. Filed Jan. 12, 2011) is an action in which a Kansas jury returned a verdict against the SEC in a case against NIC, Inc. CFO Stephen Kovzan. The action centered largely on the characterization of a number of expenses company founder, board member and CEO Jeffery Fraser charged to the company. Specifically, the claims against Mr. Kovzan, and in a parallel complaint filed against the company and three of its officers, all of whom settled, alleged that from 2002 through 2005 Mr. Fraser falsely claimed that he worked essentially for free while charging many of his expenses to the company. Those included items such as $4,000 per month to live in a ski lodge in Wyoming and monthly cash payments for rent on a home owned by an entity he controlled, travel costs, and other similar items. These totaled over $1 million, according to the Commission. CFO Kovzan authorized the payments and knew, or was reckless in not knowing, that they circumvented company policy, according to the complaint. The false reporting in Commission filings continued even after a whistleblower complaint and the initiation of the SEC’s investigation. The Commission’s complaint alleged violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5), 14(a) and Securities Act Section 17(a). After a trial the jury rejected each of the SEC’s claims.

    SEC Enforcement – filed and settled actions

    Weekly statistics: This week the Commission filed, or announced the filing of, 1 civil injunctive district court action, DPA or NPA and 1 administrative proceeding (excluding follow-on actions and 12(j) proceedings).

    Investment fund fraud: SEC v. A.L. Waters Capital, LLC, Civil Action No. 12-cv-10783 (D. Mass.) is a previously filed action against Arnett L. Waters and two entities he controlled, broker-dealer A.L Waters Capital, LLC and investment adviser Moneta Management, LLC. Over a three year period beginning in 2009 the defendants are alleged to have raised about $780,000 from at least 8 investors, including $500,000 from Mr. Water’s church. Investors were promised that the funds would be invested in a portfolio of securities when in fact the money was misappropriated. After pleading guilty to sixteen counts of securities fraud, mail fraud and money laundering, and being sentenced to serve seventeen years in prison and ordered to pay restitution of over $9 million, the defendants settled with the Commission. The Court entered final judgments by consent. The order enjoins each defendant from future violations of Securities Act Sections 17(a) and Exchange Act Section 10(b). It also enjoins Mr. Waters and Moneta Management from future violations of Advisers Act Section 206(4). In addition, the order directs the defendants to pay, jointly and severally, $839,000 in disgorgement which is deemed satisfied by the criminal forfeiture order. See Lit. Rel. No. 22885 (Dec. 5, 2013).

    Conflicts of interest: In the Matter of John Thomas Capital Management Group LLC, Adm. Proc. File No. 3-15255 (Dec. 5, 2013) is a previously filed proceeding which names as Respondents in this settlement Order broker dealer John Thomas Financial, Inc. and its founder and chief executive officer Anastasios “Tommy” Belesis (the original proceeding also names as Respondents John Thomas Capital Management Group LLC and George Jarkesy). The proceeding focuses on the conduct of the manager of two hedge funds, John Thomas Bridge and Opportunity Fund LP I and John Thomas Bridge and Opportunity Fund LP II, and the relationships of the broker dealer and Mr. Belesis to those entities. The broker dealer placed customers in the two funds and provided a number of services. The Order alleges that the adviser and manager placed their interests before those of the funds by paying excessive sums to the broker dealer. Although the funds were represented to be independent of the broker dealer, they sometimes acquiesced in the directives of Mr. Belesis. The funds also paid the broker dealer significant sums for services that had little or no value. To resolve the proceeding the broker dealer and Mr. Belesis consented to the entry of cease and desist orders based on Advisers Act Section 206(2) and censures. In addition, Mr. Belesis was barred from the securities business, and from participating in any penning stock offering, with a right to apply for reentry after 1 year. Mr. Belesis will also pay $311,948 in disgorgement along with prejudgment interest and a penalty of $100,000. The firm will pay a civil penalty of $500,000. The penalties will be placed in a fair fund.

    Improper asset classification: In the Matter of Fifth Third Bancorp, Adm. Proc. File No. 3-15635 (Dec. 4, 2013) is a proceeding which names as Respondents the bank and Daniel Poston, the interim CFO during the time period. The Order centers on the classification of certain non-performing assets during the market crisis. Specifically, GAAP requires that commercial real estate assets carried by a bank and reclassified from “held for investment” to “held for sale” then be revalued and listed at fair value. In 2007 and 2008 as the market crisis unfolded the bank’s non-performing assets increased substantially. In the third quarter of 2008 the only meaningful alternative for the company was to consider selling some non-performing loans which would cause a reclassification and a significant charge, increasing losses. Accordingly, Mr. Poston and others on the Corporate Credit Committee, authorized the head of the bank’s commercial banking division to determine likely sale prices. Subsequently, the bank decided to pursue a sale strategy. In September 2009 the financial institution executed engagement agreements with two loan brokers to market and sell loans with combined balances of $1.5 billion. Despite these actions, the bank did not reclassify the assets – an action which would have increased Fifth Third’s pretax loss in the third quarter of 2008 by 132%. In addition, the bank’s November 7, 2008 management representation letter stated that the firm had no plans or intentions that may affect the classification of loans. Ultimately the impairment was disclosed in January 2009. The Order alleges a violations of Securities Act Sections 17(a)(2) and 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). 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. Poston is denied the privilege of appearing or practicing before the Commission as an accountant with a right to reapply after one year. The bank also agreed to pay a penalty of $6.5 million. Mr. Poston will pay a penalty of $100,000.

    Insider trading/Rule 105: SEC v. Langston, Civil Action No. 1:13-cv-324360 (S.D. Fla. Filed Dec. 3, 2013) is an action naming as defendants Charles Langston, a long time securities trader, and his two controlled entities, CRL Management, LLC and Guarantee Reinsurance, LTD. In March 2010 AutoChina International Ltd. retained Chardan Capital Markets, LLC and Rodman & Renshaw, LLC, to locate potential investors for a follow-on offering. Mr. Langston opened an account for CRL Management at Chardan the same month. In late March 2013 Chardan contacted a Langston associate about a deal involving AutoChina. After a series of communications on the morning of March 23, 2010 Mr. Langston’s representative was furnished with the offering information, including the price, for AutoChina. Included in the materials were papers specifying that the information was confidential and could not be used to trade. The same day Mr. Langston began selling AutoChina shares short, building a position of 29,000 shares. By the end of the day Mr. Langston had also agreed to purchase 40,000 shares in the offering scheduled for the next day. The next day Mr. Langston purchased 29,000 shares of AutoChina stock for Guarantee Reinsurance’s account at an average price of $35.094, a 17% discount to the prior day closing price. By the end of the day the shares of AutoChina closed down about 15% on news of the offering. Overall Mr. Langston had trading profits of $193, 108.

    In the two years prior to the AutoChina deal, the defendants engaged in manipulative short selling on three occasions, according to the complaint. Rule 105 prohibits any person from selling an equity security short during a pre-offering restrictive period that begins “five business days before the pricing of the offered securities and ending with such pricing.” Defendants engaged in prohibited activity once in 2009 and twice in 2008.

    The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 105 of Regulation M. Mr. Langston agreed to settle the insider trading charges, consenting to the entry of a permanent injunction based on the Sections cited in the complaint as to that charge. He also agreed to pay disgorgement of $193,108 along with prejudgment interest and a civil penalty equal to the amount of the disgorgement. Finally, the three defendants consented to the entry of permanent injunctions base on Rule 105. Monetary sanctions will be determined by the Court at a later date. See Lit. Rel. No. 22882 (Dec. 3, 2013).

    Kickbacks: SEC v. Gaffney, Civil Action No. 13-cv-61765 (S.D. Fla.) is a previously filed action against Thomas Gaffney alleging a fraudulent scheme centered on the shares of Health Sciences Group, Inc. This week the Court entered a final judgment by consent against Mr. Gaffney, prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The order also bars Mr. Gaffney from serving as an officer or director and imposes a penny stock bar which includes a provision prohibiting the defendant from engaging in activities with a broker, dealer, or issuer for purposes of issuing, trading or inducing, or attempting to induce, the purchase or sale of any penny stock. See Lit. Rel. No. 22883 (Dec. 3, 2013).

    Boiler room: SEC v. Laborio, Civil Action No. 1:12-cv-11489 (D. Mass.) is a previously filed action against, among others, Matthew Lazar. The complaint centers on allegations that Mr. Lazar was employed by a boiler room. The complaint claimed that Mr. Lazar sold shares in a PIPE offering to investors based on false claims that there was a guaranteed return. He raised $585,000 from 10 investors. To resolve the case Mr. Lazar consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a), Exchange Act Section 10(b), and Adviser Act Sections 206(1) and 206(2). The order also bars him for three years from participating in any offering of a penny stock and requires the payment of disgorgement in the amount of $16,820.99 along with prejudgment interest, payment of which, along with any penalty, is waived in view of financial condition. See Lit. Rel. No. 22881 (Dec. 2, 2013).

    Criminal cases

    False statements: U.S. v. Gilchrist (S.D.N.Y.) is a case charging three counts of making false statements against former SEC examiner Steven Hoecker. Compliance examiners at the SEC are not permitted to own securities of companies that are directly regulated by the SEC under rules enacted in August 2010. For examiners who held shares in such entities at the time of the rule change there were provisions for divesting the shares. Mr. Gilchrist held shares in several prohibited companies at the time of the rule change. He did not divest the shares. Rather, he transferred them to a joint account with family members that he still controlled. Subsequently, in three separate filings he represented that his holdings were in compliance when in fact they were not. The case is pending.

    Court of appeals

    Penalties: Collins, v. SEC, No. 12-1241 (D.C. Cir. Decided Nov. 26, 2013). The Court affirmed a Commission decision to impose a penalty of over 100 times the amount of the disgorgement in a failure to supervise case. Matthew Collins was employed at broker-dealer Prime Capital Services where he supervised Eric Brown. Mr. Brown sold variable annuities to senior citizens based on claims of guaranteed returns.

    In August 2003 the Florida Department of Financial Services filed an administrative complaint against Mr. Brown based on his sales. After he defaulted the state suspended his insurance license. Later it was reinstated when he appealed, with the proviso that he not sell variable annuities to seniors. Mr. Brown misrepresented the nature of the proceeding to his supervisor, who made no inquiry. Mr. Brown also concealed the fact that he continued marketing the products during the appeal. Following an SEC administrative proceeding, the Commission affirmed a finding of failure to supervise and treated each of five sales as a separate and distinct act or omission. The SEC thus imposed five penalties aggregating $310,000, rather than the single penalty of $130,000 recommended by the ALJ.

    The Circuit Court affirmed. Mr. Collins focused his appeal primarily on the question of whether the penalty met the public interest factor of the statutory test for penalties. In advancing his argument he made two key concessions. First, Mr. Collins agreed that for a second tier penalty the offense must involve, as here, fraud, deceit, manipulation or deliberate or reckless disregard of a regulatory requirement. Second, he agreed that each transaction could be considered a separate act or omission for calculating the penalty.

    Mr. Collins largely confined his argument to a question of proportionality, contending that the penalty was not commensurate with the approximately $2,915 in disgorgement paid. To support this contention he cited a series of district court cases showing that there is typically a close approximation between the amount of the disgorgement and the penalty imposed, although he conceded in one brief that other factors might be considered.

    The Court conceded that the cases cited did in fact reflect the kind of relationship relied on by Mr. Collins. That, however, is not dispositive. There are other factors. First, the $2,915 paid as disgorgement understates Mr. Collin’s obligation. That sum excused over $2,000 in commissions because of the $25,000 Mr. Collins contributed to a NASD settlement in a customer proceeding. Second, disgorgement “obviously doesn’t fully capture the ‘harm’ side of the proportionality test . . .” Third, the statute suggests that the Commission look “beyond harm to victims or gains enjoyed by perpetrators. It lists harm to other persons.” Thus the relation between the amount of disgorgement and the penalty is “informative . . . but hardly decisive.” Considering these factors, the Court concluded that it could not find an abuse of discretion by the SEC.

    FINRA

    Suitability/supervision: Broker Dealer J.P. Turner & Company LLC paid $707,559 in restitution to 84 customers to resolve charges of sales of unsuitable leveraged and inverse exchange traded funds and excessive mutual fund switches. Leveraged and inverse ETFs reset daily, meaning that they achieve their objective each day and performance can quickly diverge from the underlying index, particularly in volatile markets. Here the firm did not establish and maintain a reasonable supervisory system for this product, relying instead on a system designed for standard ETFs. As a result at least 27 customers lost over $200,000. In addition, the firm engaged in a pattern of unsuitable mutual fund switching. These products are not suitable for short term trading because of the fees. J.P. Turner, however, failed to establish a supervisory system to monitor. As a result more than 2,800 switches that appear on firm reports were not rejected. About 66 customers lost over $500,000 as a result.

    PCAOB

    Proposed rules: The Board is re-proposing for comment amendments to its auditing standards that would require the disclosure in the audit opinion of the name of the engagement partner and the names, locations and extent of participation of other public accounting firms in the engagement.

    Hong Kong

    Recording requirements: The Securities and Futures Commission reprimanded Ms. Tang Wai Chun, an account executive at China Merchants Securities (HK) Co., Limited and fined her $40,000 for failing to comply with order recording requirements under the Code of Conduct. Rather than using the firm phone from late December 2010 through mid January 2011 which recorded customer orders, for one customer she used her cell phone. Ms. Tang was obligated to record the time of receipt of the order and the details by making a call to the central telephone recording system or in writing but did not.

    Repurchase plan: The Securities and Futures Commission and the Hong Kong Monetary Authority announced an agreement with the Royal Bank of Scotland regarding the sale of Lehman Brothers related equity-linked notes to professional investors between July 2007 and May 2008. Previously, the bank announced a repurchase plan for the notes that applied to retail investors. Under the terms of the new arrangement, the bank will also repurchase notes sold to professional investors at 100% of the principal value of each eligible investment. In view of this action no enforcement action will be brought against the bank.

    Japan

    Insider trading: The Securities and Exchange Surveillance Commission recommended to the Prime Minister and the Commissioner of the FSA that an administrative penalty be imposed on Stats Investment Management Co., Ltd. for insider trading. The action is based on the fact that on July 2, 2010 the fund manager was tipped by an employee of a securities company that INPEX Corporation was about to do a secondary offering. The tipper learned about the deal during negotiations on the underwriting agreement by his securities firm. The fund sold 456 shares of INPEX for 218,473,000 yen in violation of the applicable code provisions. The amount of the penalty applicable is 540,000 yen.

    Jury Finds Against SEC

    December 04, 2013

    The SEC suffered another trial loss when a Kansas jury returned a verdict against the agency in an enforcement action brought against NIC, Inc. CFO Stephen Kovzan, SEC v. Kovzan, Civil Action No. 2:11-cv-02017 (D. Ka. Filed Jan. 12, 2011).

    The action centered largely on the characterization of a number of expenses company founder, board member and CEO Jeffery Fraser claimed business expenses booked by the company. Specifically, the claims against Mr. Kovzan, and in a parallel complaint filed against the company and three of its officers, alleged that from 2002 through 2005 Mr. Fraser falsely claimed that he worked essentially for free while charging many of his expenses to the company. Those included items such as $4,000 per month to live in a ski lodge in Wyoming andmonthly cash payments for rent on a home owned by an entity he controlled, travel costs, and other perquisites. These, and other perquisites not reported as income by the company, totaled over $1 million, according to the Commission.

    Mr. Kovzan, Chief Accounting Officer, authorized the payments and knew, or was reckless in not knowing, that they circumvented company policy, according to the complaint. The false reporting in Commission filings continued even after a whistleblower complaint and the initiation of the SEC’s investigation. The Commission’s complaint alleged violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5), 14(a) and Securities Act Section 17(a).

    Motions for summary judgment on various expense categories by both parties were denied with the Court concluding that there were disputes of fact requiring resolution by the jury. For example, the SEC claimed that “commuting expenses for travel between Mr. Fraser’s Wyoming home and company headquarters in Kansas was a form of remuneration requiring disclosure.” This issue hinges in large part on the definition of commuting, according to the Court. Neither party offered an appropriate definition. The resolution of this issue, largely based on a standard dictionary definition, involves “the factual determination whether particular travel constitutes ‘commuting’ [and] could include consideration of the extent to which an executive’s choice of residence is related to his job, and thus the extent to which the executive’s choice of residence is a matter of mere personal convenience or desire,” the Court concluded. This is a question for the jury.

    Similarly, the Court rejected defendant’s request for summary judgment on the SEC’s claims based on payments for Mr. Fraser’s residences in Wyoming and Kansas City. Characterizing the issue here as whether “this expense was directly related to performance of Mr. Fraser’s job,” the Court concluded that it is a factual issues which must be resolved by the jury.

    Finally, the Court also refused to grant summary judgment on a category of “other” expenses. While the defendant claimed that the Commission could not establish its claims here, the Court noted that the “most striking such evidence [offered by the Commission] is that NIC in fact required Mr. Fraser to reimburse NIC for more than $280,000 in expenses that could not be supported as business expenses under NIC’s policies.” While Mr. Kovzan argued that the company utilized a different standard in making that determination than the one relied on by the Commission, “the fact that NIC at least found such violations of its policies provides evidence from which a jury could conclude that the expenses at issue were not proper business expenses” the Court concluded. Thus, again the question is one for the jury.

    The jury did in fact resolve the disputes of fact which precluded the Court from granting summary judgment. The jury found against the SEC on each claim.

    Prior to trial, and at the time the complaints were filed, NIC and three of its officers settled. SEC v. NIC, Inc., Civil Action No. 2:11-CV-02016 (D. Ka. Filed Jan. 12, 2011). NIC consented to the entry of an injunction prohibiting future violations of the Sections cited in the complaint. The company agreed to hire an independent consultant to recommend new policies. Mr. Fraser settled, consenting to the entry of a substantially similar injunction and agreeing to pay disgorgement in the amount of $1,184,246 along with prejudgment interest and a $500,000 civil penalty. Mr. Fraser also agreed to the entry of an officer director bar.

    Former COO Harry Herington also settled, consenting to the entry of an injunction on similar terms and agreeing to pay a civil penalty of $200,000. In addition, Mr. Herington agreed to the entry of an order in an anticipated administrative proceeding which will prohibit him from practicing before the Commission as an accountant with a right to reapply after one year. Finally, former CFO Eric Bur settled, consenting to the entry of an injunction prohibiting future violations of Exchange Act Rules 13a-14 and 13b-1 and aiding and abetting NIC’s violations of Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a) and the related rules.

    SEC Charges Trader with Insider Trading, Manipulative Short Selling

    December 03, 2013

    The SEC filed a settled, insider trading and Rule 105 short selling action against a seasoned trader and his two trading vehicles. SEC v. Langston, Civil Action No. 1:13-cv-324360 (S.D. Fla. Filed Dec. 3, 2013).

    Defendant Charles Langston is a long time securities trader. He actively trades through two controlled entities, defendants CRL Management, LLC and Guarantee Reinsurance, LTD. In March 2010 Mr. Langston opened an account for CRL Management at Chardan Capital Markets, LLC, a New York City based registered broker dealer and investment bank. Previously, AutoChina International Ltd. retained Chardan and another broker, Rodman & Renshaw, LLC, to locate potential investors for a follow-on offering. AutoChina is a PRC based company involved in the commercial vehicle and sales business. Shares of the company are registered for trading in the U.S.

    In late March 2013 Chardan contacted a Langston associate about a deal involving AutoChina. The e-mail message noted that Mr. Langston would have to be approved to receive the transaction information and agree to keep it confidential. The morning day, March 23, 2010, there was a series of communications between Chardan and Mr. Langston’s representative. The communications stated that the next day there would be an offering for which the pricing would be determined. Also included was a Confidentiality and Non-Disclosure Agreement which provided that the information must remain confidential and could not be used “in connection with any investment outside the nature and scope of the proposed investment opportunity.” A subsequent e-mail stated that AutoChina was selling $100 million worth of its shares.

    Later the same morning, Chardan provided Mr. Langston’s representative with confidential investor presentation on the AutoChina deal. It included an overview of the company’s business, growth projections, information about the current target market and other financial data. Within less than two hours Mr. Langston placed an order for the Guarantee Reinsurance account to sell short AutoChina’s shares.

    That afternoon Rodman sent Langston’s associate the final transaction materials which included the $35 per share offering price. The deal announcement was expected pre-market opening the next day. Mr. Langston continued to sell AutoChina’s shares short. By the end of the day he had sold 29,000 shares short at an average price of $41.75. That same afternoon Langston’s associate sent Chardan a securities purchase agreement executed by Mr. Langston on behalf of CRL Management, subscribing for 40,000 shares at $35 per share.

    The next day Mr. Langston purchased 29,000 shares of AutoChina stock for Guarantee Reinsurance’s account at an average price of $35.094, a 17% discount to the prior day closing price. By the end of the day the shares of AutoChina closed down about 15% on news of the offering. Overall Mr. Langston had trading profits of $193, 108.

    In the two years prior to the AutoChina deal, the defendants engaged in manipulative short selling on three occasions, according to the complaint. Rule 105 prohibits any person from selling an equity security short during a pre-offering restrictive period that begins “five business days before the pricing of the offered securities and ending with such pricing.” Defendants engaged in prohibited activity once in 2009 and twice in 2008:

    Alcoa trades: In March 2009 during the restricted period Mr. Langston, through the account of Guaranteed Reinsurance, sold short 500,000 shares of Alcoa. He then purchased 1 million shares in the offering. These transactions resulted in profits of over $500,000.

    Mitsubishi trades: In December 2008 during the restricted period Mr. Langston sold short 200,000 shares and later purchased 500,000 shares in the offering. The transactions yielded gains of over $190,000.

    Wells Fargo trades: Over four days during the restricted period in November 2008 Mr. Langston, in accounts held in the names of his two entities, sold short 489,000 shares of Wells Fargo. Later the defendants purchase a total of 258,000 shares of Wells Fargo from three different underwriters. Overall the defendants had a gain of over $600,000.

    The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 105 of Regulation M.

    Mr. Langston agreed to settle the insider trading charges, consenting to the entry of a permanent injunction based on the Sections cited in the complaint. He also agreed to pay disgorgement of $193,108 along with prejudgment interest and a civil penalty equal to the amount of the disgorgement. The three defendants also consented to the entry of permanent injunctions base on Rule 105. Monetary sanctions will be determined by the Court at a later date. See Lit. Rel. No. 22882 (Dec. 3, 2013).

    SEC Prevails On Question of Penalty Amount

    December 02, 2013

    The Distict of Columbia Circuit Court of Appeals upheld the imposition of a penalty by the SEC which is over 100 times the amount of the disgorgement. The ruling was made in a case involving a registered representative charged with failure to supervise in a Commission administrative proceeding. Collins, v. SEC, No. 12-1241 (D.C. Cir. Decided Nov. 26, 2013).

    Matthew Collins was employed at broker-dealer Prime Capital Services. His responsibilities included supervising registered representative Eric Brown who sold financial products. Mr. Collins was expected to review and approve Mr. Brown’s transactions. He was also charge with completing a monthly report regarding Mr. Brown’s activities.

    Difficulties with Mr. Brown surfaced in August 2003. The Florida Department of Financial Services filed an administrative complaint against Mr. Brown claiming that he had guaranteed certain customers a 6% to 8% return on variable annuities. When Mr. Brown failed to respond, the agency revoked his insurance license. Mr. Brown lied to his supervisor about the proceeding claiming it related to other matters in a different state. Mr. Collins did not investigate. Mr. Brown continued to market variable annuities.

    Mr. Brown appealed the ruling in Florida. During the pendency of that appeal the state reinstated his license on the proviso that he not market annuities to individuals over the age of 65. Mr. Collins ignored the limitation and tried to conceal his activities. Eventually an Administrative Law Judge concluded he had engaged in such conduct. Later the SEC found that the instruments had been marketed to five elderly customers during the period Mr. Brown’s license was restricted. An internal review by Prime Capital characterized Mr. Collins’ conduct as constituting a “complete lack of supervision . . . “

    An SEC administrative proceeding was brought which named, among other, Mr. Brown as a Respondent. After a hearing before an ALJ, the Commission affirmed a finding of failure to supervise. The agency treated each of the five sales as a separate and distinct act or omission and imposed five penalties aggregating $310,000, rather than the single penalty of $130,000 recommended by the ALJ.

    The Circuit Court affirmed. Mr. Collins focused his appeal primarily on the question of whether the penalty met the public interest factor of the statutory test. In advancing his argument he made two key concessions. First, Mr. Collins agreed that for a second tier penalty the offense must involve, as here, fraud, deceit, manipulation or deliberate or reckless disregard of a regulatory requirement. Second, he agreed that each transaction could be considered a separate act or omission for calculating the penalty.

    In arguing that the public interest factor of the statutory test for imposing a penalty had not been met, Mr. Collins focused on the question of proportionality rather than the six factors cited in the statute. To support this contention he cited a series of district court cases showing that there is typically a close approximation between the amount of the disgorgement and the penalty imposed, although he conceded in one brief that other factors might be considered.

    The Court conceded that the cases cited did in fact reflect the kind of relationship relied on by Mr. Collins. That, however, is not dispositive. There are other factors. First, the $2,915 paid as disgorgement understates Mr. Collin’s obligation. That sum excused over $2,000 in commissions because of the $25,000 Mr. Collins contributed to a NASD settlement in a customer proceeding. Second, disgorgement “obviously doesn’t fully capture the ‘harm’ side of the proportionality test. . .” Third, the statute suggests that the Commission look “beyond harm to victims or gains enjoyed by perpetrators. It lists harm to other persons.” Thus the relation between the amount of disgorgement and the penalty is “informative . . . but hardly decisive.” Considering these factors, the Court concluded that it could not find an abuse of discretion by the SEC.

    This Week In Securities Litigation (Week ending November 30, 2013)

    December 01, 2013

    This week the SEC and the DOJ filed FCPA Actions against oil services company Weatherford International. The company became the newest member of the Top Ten FCPA Settlements group, paying about $252 million to resolve FCPA and export control charges.

    SEC enforcement also brought a series of actions which in part included proceedings arising from its inspection program. Those actions involved false statements regarding the distribution of an analyst report, undisclosed principal transactions, unregistered sales of securities and investment fund fraud.

    The CFTC continued to focus on manipulation cases. The agency filed another action centered on the attempted manipulation of futures contracts in the oil market.

    Finally, the PCAOB announced the resolution of four disciplinary proceedings. The actions involved three firms and three individuals at each firm. The proceedings focused on the issuance of false audit opinions, a failure to conduct the necessary fraud detection procedures and a lack of independence.

    SEC

    Remarks, Commissioner Michael S. Pinwowar delivered remarks to the Los Angeles County Bar Association Securities Regulation Seminar, Los Angeles, Calif. (Nov. 22, 2013). The Commissioner’s remarks focused on viewing the work of the agency through its code of ethics (here).

    Remarks: Commissioner Kara M. Stein delivered remarks to the American Bar Association Business Law Section’s Federal Regulation of Securities Committee Fall Meeting, Washington, D.C. (Nov. 22, 2013). The Commissioner’s remarks focused on recent rule making, the PCAOB and penalties (here).

    SEC Enforcement – filed and settled actions

    Weekly statistics: This week the Commission filed, or announced the filing of, 2 civil injunctive and district court actions, DPA or NPAs and 6 administrative proceedings (excluding follow-on actions and 12(j) proceedings).

    Misrepresentation: In the Matter of Marie L. Huber, Adm. Proc. File No. 3-15629 (Nov. 27, 2013) is a proceeding which names as Respondents, Marie Huber, an analyst at Hedge Fund A, and Jess Jones, an analyst at Hedge Fund B. The proceeding centers on statements made regarding the cancer drug Provenge, a product of Dendreon Corporation. On April 29, 2010 the FDA approved the use of Provenge for late state prostate cancer. Ms. Huber did an analysis of the drug and concluded that it kills. She prepared a draft report which was shared with her fund, Mr. Jones and others. Ms. Huber then purchased out of the money Dendreon put options. Although she urged her employer to release the draft, the firm did not. Subsequently, the Responents prepared distributed the report to several hundred people including those in the medical and pharmaceutical industries. The report was distributed through a gmail account in the name of Jonathan White. It was signed by “A concerned physician, scientist and citizen.” Following distribution on the evening of July 14, 2010 the share price dropped, closing down on July 15 by 7.2%. That day Ms. Huber sold part of her option holdings but still suffered significant trading losses because most of her positions remained unsold or unexercised since they were so far out of the money. Ms. Huber later told her employer there had been a “leak” of the report. The Order claims that the signature on the e-mails was a false statement. It alleges a violation of Securities Act Section 17(a)(2). To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. In addition, each Respondent will pay a fine of $25,000.

    Undisclosed principal transactions: In the Matter of Tri-Star Advisors, Inc., Adm. Proc. File No. 3-15627 (Nov. 26, 2013) is a proceeding which names as Respondents the registered investment adviser, William Payne, its CFO and a 40% owner of an affiliated broker dealer, and Jon C. Vaughan, president of the adviser and a 20% owner of the affiliated broker. Over a two year period beginning in mid-2009 the adviser engaged in thousands of securities transactions with advisory clients on a principal basis through the affiliated broker dealer. The firm did not provide the proper disclosure or obtain consent from the clients. The firm collected about $1.9 million in gross sales credits from the broker although none were paid while the two individuals were paid about $1 million. The adviser also failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act. The two individual Respondents caused the violations. The Order alleges violations of Advisers Act Section 206(4). The proceeding will be set for hearing.

    Undisclosed principal transactions: In the matter of Parallax Investments, LLC, Adm. Proc. File No. 3-15636 (Nov. 26, 2013) is a proceeding which names as Respondents the registered investment adviser, its sole owner and manager, John Bott and Robert Falkenberg, its CCO. Over a two year period beginning in 2009 the firm engaged in thousands of principal transactions through an affiliated broker dealer with out providing the required disclosure or obtaining consent. The firm also failed to provide pooled investment vehicle investors with audited financial statements and to adopt, implement and annually review the required policies and procedures. The two individuals caused the violations by the firm. The Order alleges violations of Advisers Act Sections 206(3) and 206(4). The proceeding will be set for hearing.

    Investment risk: In the Matter of Ambassador Capital Management LLC, Adm. Proc. File No. 3-15625 (Nov. 26, 2013) is a proceeding naming as Respondents the registered investment adviser and its portfolio manager, Derek Oglesby. The adviser has about $1 billion in assets under management in 25 accounts. This proceeding centers on the operation of Ambassador Money Market fund, a series offered by Ambassador Funds. It arises out of an examination prompted by consist returns which exceeded its peer group and a downgrade by Moody’s. The Order alleges that the adviser repeatedly misled the board of the fund by withholding information about the credit risk of the portfolio securities. The information is important since a money market fund may only invest in securities determined by the board to present minimal credit risk. Misrepresentations were also made about the exposure of the fund to asset-backed commercial paper potentially affected by the Euro-zone crisis in 2011. In addition, Respondents caused the fund’s failure to comply with rules limiting the amount of risk that money market fund portfolios can have. They also caused the fund’s failure to implement adequate written compliance policies. The Order alleges violations of Advisers Act Sections 206(1) and (2) and Investment Company Act Sections 31(a), 34(b) and 35(d). The proceeding will be set for hearing.

    Unregistered sales: In the Matter of Curt Cramer, Adm. Proc. File No. 3-15621 (Nov 25, 2013) is a proceeding which names as Respondents Mr. Kramer, sole officer of Mazuma Corporation, Mazuma Holding Corporation and Mazuma Funding Corporation. Each entity is also a Respondent. The Order centers on two transactions. One which began in 2006 and continued over four years involved the purchase and sold two billion shares of Laidlaw Energy Group, Inc. at steep discounts. While Respondents relied on Regulation D since the offering was not registered, this was an integrated offering in which the $1 million limit was exceeded. Respondents had profits of $126,963 over the limit. The second, which took place beginning in 2009 and continued to the next year, involved the purchase and sale of over 1 billion shares of Bederra Corporation acquired in 22 transactions with the firm’s transfer agent who had misappropriated them. There was no registration statement for the shares. The Order alleges violations of Securities Act Sections 5(a) and 5(c). The Respondents resolved the proceeding, each consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Mr. Kramer and Mazuma Holding will jointly and severally pay disgorgement of $934,404 along with prejudgment interest. Mr. Kramer, Mazuma Corporation, Mazuma Holding Corporation and Mazuma Funding will jointly and severally pay disgorgement of $126,963 along with prejudgment interest. Respondents will also pay civil penalties totaling $273,000 as follows: Mr. Kramer $13,000; Mazuma Corporation $65,000; Mazuma Holding $130,000; and Mazuma Funding $65,000.

    Investment fund fraud: SEC v. Palladino, Civil Action No. 13-11024 (D. Mass.) is a previously filed action against Steven Palladino and his company Viking Financial Group, Inc. The action alleges that the defendants raised funds from 33 investors based on misrepresentations, falsely asserting that their money would be used to operate the business which supposedly made short-term, high interest loans secured by real estate. After briefing, the Court found that the Commission had established the violations and ordered the defendant to pay $9.8 million in disgorgement. The order also includes permanent injunctions prohibiting future violations of the antifraud provisions. The question of penalties will be considered later.

    Misrepresentations/delinquent filings: SEC v. Merchant, Civil Action No. 1:13-cv-3879 (N.D. Ga. Filed Nov. 22, 2013) is an action filed against Charles Merchant and Southern USA Resources, Inc. Mr. Merchant was the CEO, CFO, president, secretary, treasurer and director of the company which supposedly is exploiting gold mining rights in Alabama. The complaint alleges that the firm failed to file its 2012 Form 10-K and its two most recent Forms 10Q. It also states that materially false reports were filed with the Commission regarding the value of company land and false certifications concerning its internal controls. The complaint alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B). The defendants have filed consents to injunctive and certain other relief with the court. See Lit. Rel. No. 22878 (Nov. 25, 2013).

    Misrepresentations/unregistered sales: In the Matter of Joseph Doxey, Adm. Proc. File No. 3-15619 (Nov. 22, 2013) is a proceeding which names as Respondents Joseph Doxey, a principal of Pure H20 Bio-technologies, Inc., and William Daniels, a principal of Observation Capital, LLC. In 2008 and 2009 Mr. Doxey drafted and caused Pure H20 to issue a series of six false and misleading press releases. Those releases stated that an independent product certification laboratory was expected to shortly issue certifications for a company product. In fact the claims were false. Mr. Doxey also misrepresented the facts to Mr. Daniels to induce him to purchase securities of the firm. Those securities were acquired in 12 separate transactions. No registration was in effect. Subsequently, Observation Capital, at the direction of Mr. Daniels, sold over 258 million of the shares generating $78,900.46 in illicit proceeds. The Order alleges violations of Securities Act Sections 5(a), 5(c) and each subdivision of Section 17(a) and Exchange Act Section 10(b). The proceeding will be set for hearing.

    CFTC Enforcement

    Attempted manipulation: In the Matter of Daniel Shak, CFTC Docket No. 14-03 (Nov. 25, 2013) is a proceeding which named as Respondent Daniel Shak who is a registered broker, an associated person of a Commodity Pool Operator or CPO and a member of the NYMEX. It also names his firm, SHK Management, LLC, a CPO. The Order alleges that on two trading days in 2008 Respondents attempted to manipulate the closing price of West Texas Intermediate or WTI futures contacts, driving the closing price higher to benefit a relates short position. Each time the action was taken to enhance the profits of a net short position know as Trading At Settlement or TAS.

    Respondents, in one instance, accumulated a large net short TAS position which prices at -10 to +10 ticks of the settlement price, of 3,457 prompt-month WTI contracts. In the last three minutes before the close Respondents began aggressively trading in the opposite direction, accounting for almost 30% of the purchases. This drove prices higher, benefiting their TAS position. Respondents essentially repeated this strategy on a subsequent trading day. The Order alleges an attempted manipulation, violations of the applicable position limits and that Mr. Shak, under CEA Section 13(b), is responsible for the actions of his company. It charges violations of Sections 6(c), 6(d) and 9(a)(2) of the Act and the applicable speculative position limits. To resolve the proceeding Respondents consented to the entry of cease and desist orders based on the Sections cited in the Order. They also agreed to pay, jointly and severally, $400,000 as a civil penalty. SHK’s registration as a commodity pool operator and Mr. Shak’s as an associated person were suspended for two years and both are prohibited from trading in any instrument relating to crude oil futures contracts for two years.

    FCPA

    Swiss based Weatherford International Ltd and its subsidiaries resolved FCPA charges with the DOJ and SEC and also settled export control charges, paying a total of $252 million. The bribery charges are based on three schemes. The first involved a joint venture established by Weatherford subsidiary Weatherford Services in Angola with two local entities in 2005. The two local entities principals’ included foreign officials. The venture was used solely as a conduit for millions of dollars of payments by the Weatherford subsidiary to the foreign officials controlling them, according to the court papers. In exchange for the payments, Weatherford Services obtained lucrative contracts and information about the pricing of competitors.

    The second scheme involved the bribery in Africa of a foreign official by employees of Weatherford Services. The purpose of the payments was to secure the renewal of an oil services contract. The payments were made through a freight forwarding agent, according to the court papers. The payment made was concealed by the creation of sham purchase orders and similar records crafted by the forwarding agent. The contract was renewed in 2006. The third scheme involved payments in the Middle East from 2005 through 2011 by employees of Weatherford Oil Tools Middle East Limited or WOTME. In this scheme what were claimed to be volume discounts to a distributor who supplied company products to a government owned national oil company were actually used to create a slush fund. That fund was used to make payments to the national oil company. During the period WOTME paid about $15 million to the distributor.

    To resolve the FCPA charges with the DOJ, the company entered into a deferred prosecution agreement. It requires the payment of an $87.2 million criminal penalty and the retention of a monitor for 18 months. The underlying criminal information contains one count of violating the internal controls provisions of the FCPA. In addition, Weatherford Services agreed to plead guilty to violating the anti-bribery provisions.

    The SEC’s complaint alleged violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B). SEC v. Weatherford International, Ltd., Civil Action No. 4:13-CV-03500 (S.D. Tex. Filed Nov. 26, 2013). To resolve the charges the company agreed to pay $90,984,844 in disgorgement, prejudgment interest and a $1.875 million civil penalty assessed in part for a lack of cooperation during the investigation. $31,646,907 of the payment will be satisfied by the agreement of the company to pay an equal amount to the USAO. See Lit. Rel. No. 22880 (Nov. 26, 2013).

    Finally, in a separate mater, from 1998 through 2007, the company and certain subsidiaries violated various U.S. export control and sanctions laws. During the period they exported or re-exported oil and gas drilling equipment to sanctioned countries Cuba, Iran, Sudan and Syria. These charges were resolved with the payment of $100 million, a deferred prosecution agreement and two guilty pleas.

    Criminal cases

    Investment fund fraud: U.S. v. Burke (E.D. Va.) is a case in which Stephen Burke pleaded guilty to one count of mail fraud based on a $1.2 million investment scheme. Specifically, beginning in 2008 and continuing until January 2013, Mr. Burke raised about $1.2 million from investors by inducing them to invest in a series of fraudulent schemes. In part Mr. Burke represented that he was an investment professional which was false while not disclosing that in fact he is a convicted felon. Sentencing is scheduled for February 20, 2014.

    PCAOB

    Proposal: The Board announced that at its open meeting on December 4, 2013 it will consider a proposal that would require the disclosure in the auditor’s report of the engagement partner and certain other participants in the audit. The Board will also address proposed rules regarding oversight of the audits of brokers and dealers required by Dodd-Frank.

    Disciplinary actions: The Board announced settled disciplinary actions against three audit firms and three individuals associated with the firms:

    In the Matter of Harris F. Rattray, CPAs, PCAOB Release No. 105-2013-009 (Nov. 21, 2013) is a proceeding against the firm and its sole owner, Harris Rattray. The Board revoked the firm’s registration and permanently barred Mr. Rattray. The Respondents were censured. The Board found that the Respondents violated the antifraud provisions of the Exchange Act by falsely stating in three audit opinions that the audits had been conducted in accord with PCAOB standards. Respondents also failed to include procedures to provide reasonable assurance of detecting illegal acts and to otherwise plan and conduct the audit.

    In the Matter of Hood & Associates CPAs, P.C., PCAOB Release No. 105-20130012 (Nov. 21, 2013) is a proceeding against the firm and its sole partner Rick Freeman. The Board revoked the firm’s registration with a right to reapply after three years and imposed a $10,000 civil monetary penalty. Mr. Freeman was permanently barred from associating with a registered firm. The Respondents were censured. The firm violated the antifraud provisions of the Exchange Act by falsely stating that it had conducted the audits for three issuers in accord with Board standards. Mr. Freeman directly and substantially contributed to the violation. The Respondents also failed to adequately plan and conduct the engagements. In addition, Respondents violated the independent standards by having Mr. Freeman serve as lead audit partner on two engagements for more than five consecutive years. The firm also failed to have a required engagement quality review performed on any of the audits or to comply with Board quality control standards.

    In the Matter of Acquavella, Chiarelli, Shuster, Berkower & Co., LLP, PCAOB Release No. 105-2013-010 (Nov. 21, 2013) and In the matter of David T Svoboda, CPA, PCAOB Release No. 105-2013-011 (Nov. 21, 2013) are proceedings against, respectively, the firm and a former partner, David Svoboda. The Board revoked the firm’s registration with a right to reapply after two years and imposed a $10,000 civil monetary penalty. Mr. Svoboda was barred from associating with a registered firm with a right to reapply after three years. The Respondents were censured. The Board determined that the firm violated its quality control standards and that Mr. Svoboda substantially contributed. The Board also concluded that the firm and Mr. Svoboda violated PCAOB standards in connection with the engagements for two issuers based in the PRC. A significant part of the firm’s audit work was conducted by PRC based staff which the firm and Mr. Svoboda failed to adequately plan, supervise and review. In addition, there were violations of the independence provisions of the securities laws since the Respondents prepared the consolidation and financial statements that formed the basis for those filed with the SEC by the issuers. Mr. Svoboda failed to cooperate with Board inspectors and violated the audit documentation standards by improperly causing the creation or alteration of audit documentation after receiving notice of an inspection.

    Hong Kong

    Takeover Code: The Securities and Futures Commission imposed sanctions on Daqing Dairy Holdings Ltd., its executive director Wang De Lin and the firm’s only independent director, Stephen Chaing Chi Kin for violations of the Takeover Code. Specifically, a “cold shoulder order” was entered denying Mr. Wang direct or indirect access to the Hong Kong securities markets for 24 months. The firm and both directors were censured. The violation occurred when it was announced that Radiant State Limited had acquired a stake of 52.16% in the company. The firm then failed to provide shareholders with the required offering circular which deprived them and the markets of valuable information needed to make an investment decision in response to the tender of Radiant. The sanctions reflect the respective roles of the participants.

    Money transfers: The SFC suspended Stephen Cho Yu Wan for three years and reprimanded his wife, Ju You Li and imposed a penalty on her of $100,000 in connection with a series of client fund transactions. Specifically, the two permitted on shore money changers to route funds through their personal bank accounts. In some instances funds were parked for a period and at times Mr. Yu was paid a fee. Their respective securities firms had no knowledge of the transactions. The dealings added an extra layer to the transactions, making it difficult to know the source of the funds. Frequently, neither registered representative knew the client. Ms. Li received a lower penalty in view of her lesser role and the overall impact on the family.

    UK

    Client funds: The Financial Conduct Authority fined SEI Investments £900,200 for client money breaches. Specifically, the firm failed to maintain the proper books and records to account for, and separate, client and firm funds over a five year period beginning in 2007. While there was no actual loss, the FCA considered this a serious breach of the rules. The fine was reduced by 30% based on an agreement to settle at an early stage.

    Happy Thanksgiving!

    November 27, 2013

    Happy Thanksgiving!

    Lack of Cooperation Increases FCPA Penalties for Weatherford

    November 26, 2013

    Swiss based Weatherford International Ltd, whose shares were traded on the NYSE, became the newest member of FCPA top ten, paying about $152 million to resolve corruption charges with the Department of Justice and the Securities and Exchange Commission. Overall the company paid $252 million to resolve charges which included export control violations. The FCPA portion of the settlement put the firm at number nine on the top ten list maintained by the FCPA blog.

    The FCPA charges stem from what DOJ terms a failure to implement internal controls despite having a global footprint with over 500 legal entities, many of which operate in high risk parts of the world. Specifically, the bribery charges are based on three schemes. The first involved a joint venture established by Weatherford subsidiary Weatherford Services Ltd. in Angola with two local entities in 2005. The previous year officials in Sonangol told the company that 100% of the Angolan well screens market could be obtained if a joint venture with designated companies was set up. One company selected had among its principals the wife of one of the Sonangol officials and relatives of another. A second included among its principals the relative of an Angolan Minister, the relative’s spouse, and another Angolan official.

    The joint venture existed solely as a conduit for millions of dollars of payments by the Weatherford subsidiary to the foreign officials controlling them, according to the court papers. In exchange for the payments Weatherford Services obtained, through the joint venture, lucrative contracts and information about the pricing of competitors. In one instance a contract was taken away from a competitor and given to Weatherford Services. Although the local entities did not make any contribution to the venture, neither Weatherford nor its subsidiary conducted any due diligence.

    The second scheme involved the bribery in Africa of a foreign official by employees of Weatherford Services. The purpose of the payments was to secure the renewal of an oil services contract. The payments were made through a freight forwarding agent, according to the court papers. That agent used initially rejected a proposed contract with contained an FCPA clause. The company legal department in Huston, Texas then approved the insertion of a clause which stipulated that all applicable laws would be followed. Prior to the retention of the agent a local official demanded a bribe from a company manager which was rejected and reported in an ethics questionnaire. There was no follow up on the report. The payment made was concealed by the creation of sham purchase orders and similar records crafted by the forwarding agent. The contract was renewed in 2006.

    The third scheme involved payments in the Middle East from 2005 through 2011 by employees of Weatherford Oil Tools Middle East Limited or WOTME. In this scheme what were claimed to be volume discounts to a distributor who supplied company products to a government owned national oil company were actually used to create a slush fund. That fund was used to make payments to the national oil company. During the period WOTME paid about $15 million to the distributor.

    In 2002 WOTME also paid about $1.4 million in kickbacks to the government of Iraq on nine contracts with the Ministry of Oil and others. The payments were to provide oil drilling and refining equipment. They were incorrectly booked as legitimate fees and costs and were concealed by inflating the price of the contracts.

    Finally, in a separate mater, from 1998 through 2007, the company and certain subsidiaries violated various U.S. export control and sanctions laws. During the period they exported or re-exported oil and gas drilling equipment to sanctioned countries without the required U.S. Government authorizations. Business operations were also conducted. The countries involved were Cuba, Iran, Sudan and Syria. About $110 million in revenue was generated by the illegal conduct. The company took steps to conceal this conduct, according to the SEC’s complaint.

    During the investigation the company took steps which “compromised the investigation,” according to the Commission. This resulted from failing to provide the staff with complete and accurate information resulting in significant delay, failing to secure important computers and documents and allowing potentially complicit employees to collect subpoenaed documents. Later cooperation improved.

    To resolve the FCPA charges with the DOJ, the company entered into a deferred prosecution agreement. It requires the payment of an $87.2 million criminal penalty and the retention of a monitor for 18 months. The underlying criminal information contains one count of violating the internal controls provisions of the FCPA. In addition, Weatherford Services agreed to plead guilty to violating the anti-bribery provisions.

    The SEC’s complaint alleged violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B). SEC v. Weatherford International, Ltd., Civil Action No. 4:13-CV-03500 (S.D. Tex. Filed Nov. 26, 2013). To resolve the charges the company agreed to pay $90,984,844 in disgorgement, prejudgment interest and a $1.875 million civil penalty assessed in part for a lack of cooperation during the investigation. $31,646,907 of the payment will be satisfied by the agreement of the company to pay an equal amount to the USAO. See Lit. Rel. No. 22880 (Nov. 26, 2013).

    The export control charges were resolved with the payment of a total of $100 million composed of the following: A $48 million monetary penalty paid pursuant to a deferred prosecution agreement; $2 million in criminal fines under two guilty pleas; and a $50 million civil penalty paid to the Department of Commerce related to 174 violations charged by Commerce’s Bureau of Industry and Security.