November 21, 2013
The Supreme Court and the JPMorgan settlement were the focus of securities litigation this week. The High Court agreed to hear a securities class action case which presents questions that may rewrite the way those cases are brought by eliminating or restricting the fraud-on-the-market presumption. JPMorgan concluded a much discussed and historic settlement with the Department of Justice and others concerning its civil enforcement liability tied to the mortgaged backed securities markets.
The SEC made available the latest report regarding whistleblowers this week showing that there was a slight increase in the number of tips and one record breaking award of over $14 million in the last fiscal year. Enforcement brought three administrative proceedings focused on undisclosed adviser fees, improper sales practices by a broker and a lack of procedures involving an investment adviser. The Commission also brought two insider trading cases, one related to the Galleon cases and a second tied to the stream of actions involving to Carter’s Inc. as well as an offering fraud action and a case seeking the enforcement of an order barring an account.
Remarks: SEC Chair Mary Jo White delivered the 5th Annual Judge Thomas A. Flannery Lecture, titled “The Importance of trials to the Law and Public Accountability,” Washington, D.C. (Nov. 14, 2013). Ms. White’s comments focused on the importance of trials and accountability in the legal system (here).
Remarks: Commissioner Daniel Gallagher delivered Informal Remarks at the Columbia Law School Conference on Hot Topics: Leading Current Issues in Securities Regulation and Enforcement (Nov. 15, 2012). His remarks focused on the imposition of corporate penalties, carefully tracing the history of the Commission’s authority in this area (here).
Remarks: SEC Enforcement Director Andrew Ceresney addressed the International Conference on the Foreign Corrupt Practices Act, Washington, D.C. (Nov. 19, 2013). The Director commented on creating a culture of compliance, international trends and the need for companies to cooperate with enforcement efforts (here).
Whistleblowers: The 2013 Annual Report to Congress on the Dodd-Frank Whistleblower Program was released. The Report notes that the number of whistleblower tips and complaints received in fiscal 2013 increased to 3,238, up slightly from the 3,001 complaints and tips received in the prior fiscal year. The Report identifies one award made during the fiscal year of over $14 million which is also the largest in the history of the program (here).
Remarks: Chairman Gary Gensler addressed the CME Global Financial Leadership Conference (Nov. 19, 2013). His remarks focused on the increased transparency in the markets, the transformation for swap dealers and international cooperation in the swap markets (here).
Remarks: Chairman Gary Gensler delivered remarks titled Bringing Transparency and Access to the Markets at the Swap Execution Facility Conference (Nov. 18, 2013). His remarks included comments on recent reforms in the markets (here).
Fraud-on-the-market theory: Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317 (S.Ct.). In agreeing to hear this case for the second time the Supreme Court set the stage for what may be a dramatic reshaping of private securities fraud damage actions. The High Court will consider two key issues. The first is whether the Court’s decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), which adopted the fraud-on-the-market theory of reliance that many view as the foundation of securities class actions, should be overruled. The second is whether a defendant in a securities class action may rebut the Basic presumption at the class certification stage by introducing evidence that the alleged misrepresentations did not distort the market price of the stock.
JPMorgan settled its civil liability with the Department of Justice and others stemming from the mortgage market, agreeing to pay $13 billion. The long rumored settlement included admissions concerning its conduct in the residential mortgage-backed securities or RMBS market. It did not resolve the parallel criminal investigation or any other claims. The resolution is the outgrowth of investigations conducted by the Financial Fraud Enforcement Task Force’s RMBS Working Group, announced by the President in his state of the Union Address two years ago.
The settlement is the largest with a single entity in American History, according to DOJ. It is, in essence, a roll-up of several actions. It includes $9 billion in settlement of claims by DOJ, the Federal Housing Finance Agency, the National Credit Union and the Federal Deposit Insurance Corporation. It also includes claims brought by New York, California, Illinois and Massachusetts. The remaining portions of the settlement benefits consumers in the housing market. Specifically, $4 billion is for relief to consumers harmed by the unlawful conduct of JPMorgan and the two firms it acquired, Bear Stearns and Washington Mutual.
SEC Enforcement – filed and settled actions
Weekly statistics: This week the Commission filed, or announced the filing of, 4 civil injunctive and district court actions, DPA or NPA and 3 administrative proceedings (excluding follow-on actions and 12(j) proceedings).
Offering fraud: SEC v. Snisky, Civil Action No. 13-cv-03149 (D. Colo. Filed Nov. 21, 2013) is an action against Gary Snisky alleging an offering fraud. Specifically, the Commission’s complaint alleges that Mr. Snisky raised over $3.8 million from 40 elderly investors. Mr. Snisky targeted elderly investors with annuities, convincing them that his program was a better alternative. Mr. Snisky and his salesmen promised steady returns, a bonus to cover any annuity withdrawal penalties and assured investors their funds were safe and in bonds guaranteed by the U.S. government. In fact the representations were false and the money was misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c) 17(a), Exchange Act Sections 10(b) and 15(a) and Advisers Act Sections 206(1), 206(2) and 206(4) and Investment Company Act Section 7(a). See Lit. Rel. No. 22876 (Nov. 21, 2013).
Violation of order: SEC v. Jones, Civil Action No. 1:13-cv-00163 D. Utah Filed Nov. 21, 2013) is an action against R. Gordon Jones, CPA alleging that he violated a Commission order suspending him from appearing and practicing before the Commission that was entered in May 2001. Since that date, according to the complaint, Mr. Jones had been creating, compiling and editing financial statements for public companies that are filed with the Commission. The complaint requests an order enforcing the Commission’s order and other relief. See Lit. Rel. No. 22875 (Nov. 21, 2013).
Insider trading: SEC v. Miri, Civil Action No. 13 cv 8324 (S.D.N.Y. Filed Nov. 21, 2013) is an action against Sam Miri, a former employee of Marvell Technology Group, Ltd. In May 2008 Mr. Miri furnished Ali Far, co-founder of hedge fund advisory firm Spherix Capital LLC, with inside information about his company. Specifically, he told Mr. Far that after having a series of interim CFOs, a new person was going to be appointed. He also provided Mr. Far with financial information about Marvel that would be contained in a forthcoming announcement. Spherix Capital hedge funds subsequently purchased 300,000 shares of Marvell stock. Following a May 29, 2008 announcement by the company of its financial results which exceeded expectations, the share price increased by about 23%. Spherix Capital had profits of about $680,000. The complaint alleges violations of Exchange Act Section 10(b). To resolve the action Mr. Miri consented to the entry of a permanent injunction based on the Section cited in the complaint and the entry of an order barring him from serving as an officer or director of a public company and requiring the payment of $10,000 in disgorgement, prejudgment interest and a $50,000 penalty.
False statements: SEC v. The NIR Group, LLC, Civil Action No. 11 Civ. 4723 (E.D.N.Y.) is a previously filed action against the investment adviser and Corey Ribotsky. The Court entered a final judgment by consent against Mr. Ribotsky, enjoining him from future violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). Mr. Ribotsky also agreed to pay $12.5 million in disgorgement, prejudgment interest and a $1 million civil penalty. In addition, he agreed to the entry of an order barring him from the securities business with a right to reapply after four years in a to be filed administrative proceeding. The Court dismissed the claims against the firm on motion of the Commission since it is defunct. In the underlying case the Commission alleged that during the financial crisis the defendants made false statements to investors regarding the poor performance and trading strategy of the various funds and that Mr. Ribotsky misappropriated client assets. See Lit. Rel. No. 22873 (Nov. 21, 2013).
Undisclosed fees: In the Matter of Larry C. Grossman, Adm. Proc. File No. 3-15617 (Nov. 20, 2013) is a proceeding which names as Respondents Larry Grossman and Gregory Adams, who are affiliates of registered investment adviser Sovereign International Asset Management, Inc. Sovereign had about $85 million in assets under management at its peak in 2008. Many of its investors were retirees. Shortly after forming Sovereign, Mr. Grossman met Nikolai Simon Battoo, the principal of BC Capital Group, S.A., and its affiliated companies, which operated off-shore hedge funds. Mr. Battoo was named as a defendant in a Commission fraud action brought in 2012. Subsequently, Mr. Grossman executed three referral agreements and one consulting contract on behalf of a Sovereign affiliate with funds and entities controlled or owned by Mr. Battoo. Under the three agreements referral fees were paid to Sovereign while the fourth called for the payment of fees directly to Mr. Grossman for consulting services. Subsequently, Mr. Grossman recommended to clients that they invest in the Battoo group without fully disclosing the risks. Neither he nor Mr. Adams disclosed the stream of fees received from that group under the four agreements. As funds in the Battoo group suffered difficulties, the two men ignored a series of red flags, continuing to make the same investment recommendation. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 15(a) and Advisers Act Sections 206(1), 206(2), 206(3), 206(4) and 207. The proceeding will be set for hearing.
Fraudulent sales practices: In the Matter of Gregg C. Lorenzo, Adm. Proc. File No. 3-15211 (Nov. 20, 2013) is a proceeding naming as Respondents Mr. Lorenzo, Francis Lorenzo, and Charles Vista, LLC. Both men were affiliated with broker Charles Vista. Beginning in September 2009, Respondents made false representations to investors in an effort to sell convertible debentures issued by a start-up. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). To resolve the proceeding Gregg Lorenzo and Charles Vista each consented to the entry of a cease and desist order based on the Sections cited in the Order. Gregg Lorenzo is also barred from the securities business. The two settling Respondents will pay disgorgement of $130,000 along with prejudgment interest. Gregg Lorenzo will pay a civil penalty of $375,000 while Charles Vista will pay $4,350,000.
Lack of procedures: In the Matter of Agamas Capital Management, L.P., Adm. Proc. File No. 3-15616 (Nov. 19, 2013) is a proceeding against the registered investment adviser centered on its failure to adopt appropriate procedures. Agamas is the adviser for a fund and a managed account. Many of the investments were illiquid and had to be valued. From January 2007 through December 2008 Agamas failed to fully document the basis for its frequently discretionary pricing. It also failed to adopt policies and procedures to review its investor disclosures periodically and to manage conflicts of interest arising from cross trades. The Order alleges a violation of Advisers Act Section 206(4). To resolve the proceeding the adviser will implement certain undertakings. It also consented to the entry of a cease and desist order based on the Section cited in the Order, to the entry of a censure and to pay a penalty of $250,000.
Insider trading: SEC v. Megalli, Civil Action No. 1:13-CV-03783 (N.D. Ga. Filed Nov. 14, 2013); U.S. v. Magalli, Case No. 1:13-cr-00442 (N.D. Ga. Filed Nov. 14, 2013). These actions name Mark Megalli as a defendant. He was an executive at investment adviser Level Global Investors, L.P. from August 2009 through the fall of 2011. After departing from Carter’s Inc. Mr. Martin obtained material non-public information about his former employer from Richard Posey, then the firm’s vice president of operations. Mr. Megalli is alleged to have tipped the fund executive four times: 1) Prior to the announcement on October 27, 2009 concerning accounting practices at the company; 2) before the November 9, 2009 restatement announcement; 3) before a December 23, 2009 announcement about the restatement; and 4) prior to the July 29, 2010 earnings release. Overall, Level made profits or avoided loses of $3 million. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). Both cases are in litigation. See Lit. Rel. No. 22870 (Nov. 14, 2013).
Remarks: Deputy AG James Cole addressed the Foreign Corrupt Practices Act Conference (Nov. 19, 2013). His remarks reviewed enforcement efforts in other countries and coordination with DOJ (here).
Fraudulent trading: U.S. v. Miller, No. 3:12-mj-0288 (D. Mass.) is an action against David Miller, formerly a trader with Rochdale Securities LLC. Mr. Miller previously pleaded guilty to one count of conspiracy to commit wire fraud and securities fraud and one count of wire fraud. The underlying case alleged that he engaged in a fraudulent scheme to place a series of unauthorized purchases for more than 1.6 million shares of Apple stock in October 2012. Rochdale eventually collapses. This week the Court sentenced Mr. Miller to serve 30 months in prison followed by three years of supervised release. He was also ordered to make full restitution to the broker which suffered a loss of $5,292,202.50. The Commission has a parallel case, SEC v. Miller, Civil Action No. 3:13-cv-00522 (D. Conn.). See Lit. Rel. No. 22872 (Nov. 21, 2013).
Investment fund fraud: U.S. v. Leiske, No. 8:08-cr-00176(C.D. Cal.) is a case in which former stock broker William Ferry, real estate investment manager Dennis Clinton and former Bankers Trust v.p. Paul Martin were convicted on charges of conspiracy, mail fraud and wire fraud. In the underlying scheme, the defendants sold interests in what they called a “Fed Trade Program.” The program was supposedly regulated by the Federal Reserve. Profits were to be split with the investor and certain humanitarian projects. The funds were managed offshore by a Swiss banker. Here the defendants solicited an undercover FBI team. Mr. Ferry was sentenced to serve 15 months in prison while Messrs. Clinton and Martin will each serve 30 months.
Investment fund fraud: U.S. v. Walji, No. 1:13-cr-00217(S.D.N.Y.) is an action against Abdul Walji and Reniero Francisco, respectively the CFO and President of Arista LLC. Mr. Walji carried out two investment fraud schemes while Mr. Francisco participated in one. In the first, the two men raised about $10 million from 40 investors based on assurances their funds would be safely invested. In fact the fund was a commodity pool and portions of the money were put in options and futures. Portions were misappropriated by the defendants. False account statements were furnished to investors to conceal the fraud.
In the second, Mr. Walji defrauded several pension funds he advised through a series of entities beginning in 2008 and continuing until June 2013. Again misrepresentations were made about the manner in which the funds would be invested. Portions of the investor funds were misappropriated and investors were furnished with false account statements. The scheme resulted in losses of about $11.3 million. After pleading guilty Mr. Walji was sentenced to serve 151 months and Mr. Francisco 97 months in prison.
Investment fund fraud: The Australian Securities & Investment Commission resolved proceedings with Sydney financial adviser Gabriel Nakhi. Mr. Nakhi had advised clients in self-managed superannuation funds to advance money to him with the promise of a high rate of return. Instead the money was used for his personal expenses. The matter was resolved with an undertaking banning Mr. Nakhi from the financial services business.
European Securities and Markets Authority
Financial statement disclosure: The ESMA published a review of the comparability and quality of disclosures in the 2012 IFRS financial statements of listed institutions. The report makes recommendations for improvement in key areas including: The structure and content of the income statement; liquidity and funding risk including the effects of asset encumbrance; hedging and the use of derivative; credit risk with a focus on credit risk management; and criteria used to assess impairment of equity securities classified as available for sale. The agency expects better disclosure in the future.
Takeover code: The Securities and Futures Commission brought a proceeding against Chow Yei Ching, the chairman of Chevalier Group, his son Oxcar Chow Vee Tsung and Joseph Leung Wing Kong. It alleges a violation of the Takeover Code which requires that a general solicitation for the company shares be made by a shareholder who acquires a major holding in the securities of the company. In assessing this obligation those acting in concert are aggregated. Here Mr. Ching, with the assistance of the others, accumulated shares of ENM Holdings Ltd. under the name of four British Virgin Island companies he owned for the benefit of his longtime friend Ms. Nina Kung. At the time Ms. Kung held 34.64% of the shares. The acquisition increased her holdings to 44.33%, triggering the mandatory general offer obligation.
Boiler room: The Financial Conduct Authority obtained a worldwide injunction against Berkley Brooks LLC, a suspected boiler room. The firm had solicited about 20 investors and raised approximately £650,000,
November 20, 2013
Two principals of an investment adviser were named as Respondents in an SEC administrative proceeding. The action centers on claims that the two men improperly advised their clients to invest in off-shore funds without fully disclosing their affiliation with those funds or the fees they were paid. In the Matter of Larry C. Grossman, Adm. Proc. File No. 3-15617 (Nov. 20, 2013).
Larry Grossman and Gregory Adams, named as Respondents, were affiliated with registered investment adviser Sovereign International Asset Management, Inc. Mr. Grossman was the sole owner of Sovereign from its formation in 2001 through October 2008 when he sold the firm and its affiliates to Mr. Adams. After the sale Mr. Grossman continued to be affiliated with the adviser until the firm was administratively dissolved in 2012.
Sovereign had about $85 million in assets under management at its peak in 2008. Many of its investors were retirees. Shortly after forming Sovereign, Mr. Grossman met Nikolai Simon Battoo, the principal of BC Capital Group, S.A. and its affiliated companies which operated off shore hedge funds. Mr. Battoo was named as a defendant in a Commission fraud action brought in 2012, SEC v. Battoo, Case No. 12CV125 (N.D. Ill.).
In 2003 Mr. Grossman executed three referral agreements and one consulting contract behalf of a Sovereign affiliate with funds and entities controlled or owned by Mr. Battoo. Under three agreements referral fees were paid to Sovereign while the fourth called for the payment of fees directly to Mr. Grossman for consulting services.
From August 2003 through October 2008 Mr. Grossman recommended to Sovereign clients that they invest almost exclusively in off-shore funds in the Battoo group. In making these recommendations the full risks of the investment were not adequately disclosed. Some investors were told that the funds were very safe, contrary to their offering documents. None were told that all of the funds were cross collateralized.
Likewise, Messrs. Grossman and Adams did not properly or fully disclosed to Sovereign’s investors the fees paid under the four agreements with the Battoo group. In some materials there was no disclosure of the fees. In others there were statements indicating that fees may be paid despite the fact that they were actually being paid. Investors were thus largely unaware of the conflict on which the investment recommendations were based.
In late 2008 one of the Battoo funds notified a shareholder class that it was suspending redemptions. Before that action was taken Mr. Grossman learned that the fund had not honored redemption requests for several months. Messrs. Gossman and Adams also learned that Mr. Battoo had stopped providing investors with audited financial statements as required in the offering materials. In addition, the two men also understood that the asset verification reports which were available on request were being prepared by parties related to Mr. Battoo, not independent third parties. Mr. Adams never questioned the reason for the suspension, accepting the representation of Mr. Grossman that it was caused by an account transfer. Mr. Grossman continued to advise Sovereign’s clients to invest in, or retain their investments in, the Battoo funds.
By 2010 Mr. Batto refused to permit withdrawals from another fund. The next year he claimed that was caused by losses incurred in the MF Global bankruptcy. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 15(a) and Advisers Act Sections 206(1), 206(2), 206(3), 206(4) and 207. The proceeding will be set for hearing.
November 19, 2013
JPMorgan settled its civil liability with the Department of Justice and others stemming from the mortgage market, agreeing to pay $13 billion. The long rumored settlement included admissions concerning its conduct in the residential mortgage-backed securities or RMBS market which many believe was at the center of the market crisis. The resolution is the outgrowth of investigations conducted by the Financial Fraud Enforcement Task Force’s RMBS Working Group, announced by the President in his state of the Union Address two years ago.
The settlement is the largest with a single entity in American History, according to DOJ. It is, in essence, a roll-up of several actions. It includes $9 billion in settlement of several federal agencies state claims. The federal claims, asserted by DOJ and three agencies, were resolved with payments of:
DOJ: $2 billion as a penalty under the FIRREA;
FHFA: $4 billion to the Federal Housing Finance Agency;
NCUA: $1.4 billion to the National Credit Union Administration; and
FDIC: $515.4 million to the Federal Deposit Insurance Corporation;
The state claims were resolved with payments to:
New York: $613.8 million;
California: $298.9 million;
Illinois: $100 million;
The remaining portions of the settlement benefits consumers in the housing market. Specifically, $4 billion is for relief to consumers harmed by the unlawful conduct of JPMorgan and the two firms it acquired, Bear Stearns and Washington Mutual.
Two critical points regarding the settlement concern admissions and other investigations. As part of the settlement the bank made a series of admissions, acknowledging its employees conduct in the RMBS market. The settlement did not resolve the parallel criminal investigation into the bank’s activities in that market, the potential liability of its employees in those markets or any of the other civil and criminal investigations involving the firm which are currently underway. Thus, while the settlement resolves a significant number of actions, it is not the end of potential liability for the bank or its employees.
The SEC was not a party to this settlement. While the agency has brought a number of actions centered on the market crisis, those actions typically centered on one transaction in the RMBS market. For example, the action brought against JPMorgan was based on the sale of interests in one entity. SEC v. J.P. Morgan Securities LLC, Civil Action No. 11-04206 (S.D.N.Y.). Likewise, its action against Bank of America tied to the mortgage market was based on the sale of interest in one CDO. SEC v. Bank of America, N.A., Civil Action No. 3:130-cv-0447 (W.D.N.C.). See also, In the Matter of UBS Securities LLC, Adm. Proc. File No. 3-15407 (Aug. 6, 3013)(sale of interest in one CDO).In contrast the settlement by the Working Group focuses on the years of the market crisis.
November 18, 2013
The SEC’s investigation relating to children’s clothing manufacturer Carter’s Inc. is the inquiry which keeps on giving. At a time when the pipeline of enforcement actions seems to have all but dried up, the Carter’s investigation keeps generating cases. To date there have been six actions. Now the Commission and the U.S. Attorney have new insider trading cases tied to the company. SEC v. Megalli, Civil Action No. 1:13-CV-03783 (N.D. Ga. Filed Nov. 14, 2013); U.S. v. Magalli, Case No. 1:13-cr-00442 (N.D. Ga. Filed Nov. 14, 2013).
Mark Megalli was an executive at now defunct investment adviser Level Global Investors, L.P. from August 2009 through the fall of 2011. During that period he is alleged to have traded on inside information in Carter’s shares in four instances, yielding profits or losses avoided of about $3 million.
The inside information came from then former Carter’s executive Eric Martin who at one time with the vice president of Investor Relations for the firm. By the time of the transactions here Mr. Martin had departed from the company after having engaged in insider trading. Indeed, Mr. Martin eventually pleaded guilty to one of eleven counts in an indictment charging him with insider trading. He has also consented to the entry of a permanent injunction and an officer/director bar in the Commission’s parallel case.
In late 2009, however, Mr. Martin continued to obtain material non-public information about Carter’s. His source was Richard Posey, then the firm’s vice president of operations. The information was furnished “in exchange for reputational benefit, i.e. to show that Posey was a source of valuable information, to further their friendship, and in expectation of future business contacts and benefits,” according to the SEC complaint.
Mr. Megalli entered into a consulting agreement with a firm owned by Eric Martin on September 14, 2009. The agreement was executed on behalf of Level Global, a firm Mr. Megalli had recently joined as head of its consumer section. Under the terms of the six month agreement, Level paid $50,000 to the Martin owned company.
Subsequently, Mr. Martin provided Mr. Megalli with inside information in four instances:
October 27, 2009 accounting practices announcement: In mid-September 2009 Mr. Megalli directed Level to purchase 350,000 shares of Carter’s stock at a total cost of $9 million. The acquisition was based on positive information about the company from Mr. Martin. In late October, however, Mr. Martin advised the hedge fund executive that Carter’s had incurred an unexpected accounting issue. The information came from Mr. Posey. Level, at the direction of Mr. Megalli, liquidated its position. The firm avoided a loss of $2,110,910.
November 9, 2009 restatement announcement: In early November Mr. Megalli learned in a telephone call with Mr. Martin that Carter’s would announce a restatement of its financial statements as a result of an accounting fraud. Mr. Megalli directed Level to “lighten up” on Carter’s without “killing the stock.” The firm sold 150,000 of a 600,000 share stake the same day as the announcement. This avoided a loss of $268,500.
December 23, 2009 restatement announcement: On November 10, 2009 Level purchased 50,000 shares of Carter’s stock at the direction of Mr. Megalli. During the balance of the month, and the first part of December, Mr. Martin continued to give Mr. Megalli positive information on Carter’s. Following the announcement in December regarding the restatement the share price increased. Global had a profit of $205,000.
July 29, 2010 earnings release: In early July 2010 Megalli learned from Eric Martin, who had been tipped by Mr. Posey, that Carter’s quarterly earnings would be below expectations. Level then built a short position in the stock which grew to 300,000 at the direction of Mr. Megalli. Following the announcement the share price dropped and Level covered its position, yielding profits of $648,655.
The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See Lit. Rel. No. 22870 (Nov. 14, 2013).
November 17, 2013
rtiorari in Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317 (S.Ct.) for the second time the High Court will consider two key issues. The first is whether the Court’s decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), which adopted the fraud-on-the-market theory of reliance that many view as the foundation of securities class actions, should be overruled. The second is whether a defendant in a securities class action may rebut the Basic presumption at the class certification stage by introducing evidence that the alleged misrepresentations did not distort the market price of the stock.
This is the second time this case has been before the Supreme Court. The first time the Court considered Halliburton the question was whether the plaintiffs in a securities class action were required to prove loss causation at the class certification stage. In a narrow opinion written for a unanimous Court by Chief Justice Roberts the Court held that loss causation is a merits issue, not a Rule 23 class certification question. Indeed, Chief Justice Roberts held that since the district and circuit courts had previously concluded that the Rule 23 requirements had been met, the case was resolved. Erica P. John Fund, Inc. v. Halliburton Co., 131 S.Ct. 2179 (2011)(“Halliburton I”).
On remand the district court granted class certification where efficiency of the market had been conceded and based on a complaint alleging violations of Section 10(b) as a result of false statements made by the company and certain officers. The Fifth Circuit affirmed, rejecting claims that the defendants should be permitted to offer evidence demonstrating that there was no impact on price from the claimed statements based on Amgen, Inc., v. Connecticut Retirement Plans & Trust Funds, 133 S.Ct. 1184 (2013)(materiality need not be established at certification stage).
Noting that four justices in Amgen had signaled a willingness to reconsider Basic – Justices Alito, Thomas, Scalia and Kennedy – Petitioners advanced four key reasons for the Court to again review this case:
Economic theory: In adopting the Basic presumption, the four Justice majority focused on “considerations of fairness, public policy and probability, as well as judicial economy . . . [and] trusted in the accuracy of then [r]ecent empirical studies” . . . to engraft the efficient capital markets hypothesis into federal securities laws.” (internal quotes omitted). Now however “[a]cademics have largely given up on Basic’s economic premises . . . This efficient-market hypothesis showed early promise, but ‘empirical research became more specialized and sophisticated, and evidence of potential inefficiencies began to accumulate . . . There are now hundreds of papers documenting price anomalies, even for the most actively traded stocks.’”
Difficulty of application: Because Basic is built on a “binary” approach, the lower federal courts have struggled to apply it. State courts have rejected it.
Proper case: This case presents an ideal vehicle to review Basic. Although Halliburton’s shares are traded in an efficient market, that “hardly means that any particular misrepresentation will be efficiently incorporated into Halliburton’s stock price.” (emphasis original). Yet under the binary approach of Basic this is the result.
Alternative: Even if the Court is not inclined to overrule Basic, the decision should “be modified to require plaintiffs to prove price impact in order to invoke the presumption . . .”
Respondents opposed granting the petition, arguing three key points:
Importance: Basic and the “fraud-on-the-market presumption is critical to private securities actions, as this Court has repeatedly noted.” In addition, meritorious private securities actions are a necessary supplement to criminal prosecutions and civil enforcements as the Court and enforcement officials have repeatedly stated.
Congress: Congress had repeatedly amended and adjusted the federal securities laws since Basic was decided without altering it. Indeed, at the time the PSLRA was passed Congress considered and rejected calls to undo the fraud-on-the-market presumption as the Court acknowledged in Amgen.
Economic theory: The underpinnings to Basic have not been undercut. That decision is predicated in part on the same theory Congress “expressly relied on . . . [in the Exchange Act,] that securities markets are affected by information . . .” Furthermore although the economic theory regarding the efficiency of markets has evolved, “the semi-efficient market hypothesis continues to enjoy widespread support among economists.” The “Semi Strong Efficient Market Hypothesis . . . has been subjected to perhaps the most intensive and extensive testing of any hypothesis in all of the social sciences—and this extraordinary scrutiny has confirmed the strong empirical support for the theory.”
Calling the “fraud-on-the-market” theory the “most powerful engine of civil liability ever established in American law, a group of former SEC Commissioners and officials and law professors filed an amicus brief in support of Petitioners. That brief argues two key points:
Text of statute: While the text of Section 10(b) does not reveal how reliance should be established since the cause of action under it was implied by the courts, comparison to the nearest, most analogous statutory provision demonstrates that plaintiffs should be required to establish the element. This is illustrated by considering Exchange Act Section 18(a) where Congress required this approach.
Basic is inconsistent: The approach of Basic is “at war with itself . . .” While the case holds that there is a presumption, in fact it effectively can not be rebutted. Rebuttal requires “an individualized inquiry into the buying and selling decision of particular class members . . . And the cases in which such an individualized inquiry has rebutted the presumption after it has attached are . . . as rare as hen’s teeth.” (internal quotations omitted).
Revisiting Basic has the potential to rewrite the law applicable to federal securities class action litigation. Overruling the case could compel plaintiffs to prove reliance by the individual class members, something which may will be impossible. At the same time adopting the alternative approach suggested by Petitioners has the potential to intertwine the class certification requirements of Rule 23 with the merits of a fraud claim under Section 10(b), something the Court has repeatedly avoided. It also has the potential to turn the certification hearing into a min-trial. Yet many commentators argue that class certification is, for all practical purposes, the trial since certification virtually assures settlement in view of the potential liability defendants face.
To date four justices have indicated a willingness to revisit Basic. Four justices were required to vote for granting the petition. Whether there will be five votes to overrule or modify Basic, and perhaps Halliburton I and Amgen, will be determined later this term.
November 14, 2013
The SEC entered into its first deferred prosecution agreement with an individual this week. The agreement is with a former accountant at a hedge fund who reported an on-going fraud and furnished the SEC with significant evidence that resulted in an enforcement action and a guilty plea in a parallel criminal case. Under the agreement the accountant is required to make admissions, pay disgorgement and was effectively enjoined and barred from the investment and advisory business for the five year term of the deal.
An investment fund fraud action which victimized largely NHL hockey players was unsealed in the Eastern District of New York. The victims invested in a series of fraudulent schemes and lost millions of dollars.
SEC Enforcement – filed and settled actions
Weekly statistics: This week the Commission filed, or announced the filing of, 1 civil injunctive action, DPA or NPA and no administrative proceedings (excluding follow-on actions and 12(j) proceedings).
Deferred prosecution agreement: The SEC entered into its first deferred prosecution agreement with an individual. The agreement is with Scott Herckis, former administrator to hedge fund Heppelwhite Fund LP. The agreement recognizes his timely and significant contributions to the Commission’s efforts to halt an on-going fraud at the hedge fund where he was once employed.
The underlying case centered on a fraud by Berton Hochfield, sole shareholder and manager of Hochfeld Capital Management, LLC. The fund initially had about 25 investors and $6 million under management. Mr. Mr. Herckis was retained as the accountant. Over time he learned that Mr. Hochfield made a number of withdrawals from the capital account of the firm which left it with a negative balance. He also understood that the NAV he calculated was not the same as the one given to the prime broker. After discovering a $1.5 million discrepancy he resigned and shortly thereafter reported the case to the authorities. The Commission filed an enforcement action, securing an injunction and freeze order. SEC v. Hochfeld, Civil Action No. 12-cv-8202 (S.D.N.Y.). Mr. Hochfeld pleaded guilty to criminal charges. U.S. v. Hochfeld, No. 13-CR-0021 (S.D.N.Y.).
Mr. Herckis entered into a deferred prosecution agreement with the Commission. It has a term of five years and requires him to: Admit the facts regarding the underlying violations as detailed in the agreement; not violate Federal or state securities laws;not serve in any capacity with an investment company or an investment adviser; pay disgorgement in the amount of $48,000 along with prejudgment interest; and continue to cooperate with the Commission.
Investment fund fraud: U.S. v. Kenner, No. 13-CR-607 (E.D.N.Y. Unsealed Nov. 13, 2013) charges financial adviser Phillip Kenner and former professional race car driver Tommy Hormovitis with conspiracy, conspiracy to commit money laundering and wire fraud. The case is based on a series of investment fund frauds. Mr. Kenner, at one time a licensed financial adviser in Boston, founded his firm in 2003 based on contacts he made in the National Hockey League through his college roommate who became a professional hockey player. Beginning at about the time he opened his firm Mr. Kenner, with assistance from Mr. Hormovitis, convinced a number of players, and sometimes others, to invest in a land deal in Hawaii, a prepaid debt card business, a litigation settlement fund and a New York land deal. In each instance the victims’ money was diverted largely to the use of the defendants. Overall the investors lost about $15 million. The case is pending.
BrokerCheck: The regulator announced that it has released an enhanced version of BrokerCheck. The new version allows investors to more quickly access the professional background of investment professionals.
Market manipulation: The Australian Securities and Investments Commission announced that Thai Quo Tang was sentenced on two counts of market manipulation after being convicted. The manipulation was based on creating a false or misleading appearance in the market place with regard to the shares of Tissue Therapies Ltd, a biological technology company. Mr. Tang used 11 separate accounts in his thirteen month manipulation. The court acknowledged the seriousness of the offence and entered a sentence of two years in prison on each count, to be served concurrently. The court further directed that Mr. Tang be released after 4 months after posting a recognizance of $5,000 and on condition of his good behavior for a period of three years.
Unlicensed advice: Gordon Mui Kwong Yin was sentenced to serve three months in prison for giving advice online regarding the purchase of futures without a license. Beginning in November 2009, and continuing for the next several months, Mr. Mui offered trading advice through a website. He received about $128,7000 in subscription fees from 113 clients. Previously, he pleaded guilty. The court also directed that he pay the investigative costs of the Securities and Futures Commission.
False statements: The SFC announced that former PMI Group Ltd. director Ivy Chan Shui Sheung had been acquitted of charges of furnishing false or misleading information to the Stock Exchange. The charges stem from a request to the company for information by the Exchange about a 139% increase in its share in late February 2008. The company reported that there were no events requiring disclosure. In fact the company had made an acquisition which should have been disclosed. The company pleaded guilty and was fined $60,000. The court found the director not guilty because she and the board relied on the secretary who stated that disclosure was not required. Accordingly, the required criminal intent was not present.
European Securities and Markets Authority
Accounting priorities: The ESMA published its financial statements’ enforcement priorities for 2013. Items of focus include: Impairment of non-financial assets; measurement and disclosure of post-employment benefit obligations; fair value measurement and disclosure; disclosures related to significant accounting policies, judgments and estimates; and measurement of financial instruments and disclosure of related risk.
These priorities were identified to ensure that the “IFRS recognition, measurement and disclosure principles are consistently applied across the EEA.” National authorities may also focus on other areas.
Remarks: Martin Wheatley, Chief Executive of the FCA, addressed the CFA European Investment Conference. His remarks focused on competing on integrity (here).
November 13, 2013
National Hockey League Players were the primary victims of a series of fraudulent investment schemes orchestrated by financial adviser Phillip Kenner and former professional race car driver Tommy Hormovitis. Collectively, the players others lost about $15 million. The court papers charge conspiracy, conspiracy to commit money laundering and wire fraud. U.S. v. Kenner, No. 13-CR-607 (E.D.N.Y. Unsealed Nov. 13, 2013).
Phillip Kenner met a future NHL player while attending college. Subsequently, Mr. Kenner became a licensed financial adviser in Boston. From 1994 through 2003 he used his college connection who had joined the NHL to build a client list which included several professional hockey players. The list became the foundation for his firm which he opened in 2003.
From the opening of his firm, and continuing to the present, Mr. Kenner advised a number of NHL players regarding their investments. He counseled them to participate in a number of investment schemes which were fraudulent. Those included:
The Hawaii scheme: This was a real estate investment scheme in Hawaii. Mr. Kenner solicited thirteen players, convincing them to invest $100,000 each and open lines of credit which he controlled. In addition, Lehman Brothers Holdings, Inc. was convinced to invest $2 million. The funds were to be used to develop real estate on the big island. Instead, Messrs. Kenner and Constantine diverted the money to their personal use. The victims lost over $13 million.
The Eufora Scheme: This was a prepaid debit card business, initiated in 2002. Mr. Kenner informed the NHL players who put $1.4 million into the scheme that Eufora was an up and coming business. Another investor was convinced to put up about $200,000. Most of the money was in fact diverted to an account controlled by Mr. Constantine. Investors lost about $1.5 million.
Global settlements scheme: Beginning in May 2009 Messrs. Kenner and Constantine convinced players to invest about $4.1 million in a plan which called for funding an attorney’s escrow account, the Global Settlement Fund. The fund would be used to finance litigation related to Mexican land deals. Most of the money was diverted to the personal use of the defendants. The players lost about $1 million.
Sag Harbor scheme: In this scheme Mr. Kenner acquired a 25% interest in real property in Sag Harbor, New York by taking $395,000 from a player’s line of credit. The player was unaware of the transaction. He then convinced a second player to purchase what was supposed to be a 50% interest in the deal for $375,000. The player, however, received papers showing that he only had a 25% interest. The investors sold the property at a loss. Mr. Kenner then filed a lawsuit in Arizona against one of the investors in connection with the property.
The defendants were arrested in Arizona and appeared in court on Wednesday. The case is pending.
November 12, 2013
The SEC entered into its first deferred prosecution agreement with an individual. The agreement with Scott Herckis, former administrator to hedge fund Heppelwhite Fund LP. The agreement recognizes his timely and significant contributions to the Commission’s efforts to halt an on-going fraud at the hedge fund which once employed Mr. Herckis. At the same time, the five year agreement imposes many of the remedies the agency would have demanded in settlement.
The underlying case
Mr. Herckis, the owner and managing member of accounting firm SJH Financial, LLC, was retained by the Fund in December 2012, according to an admitted statement of facts in the agreement. The Fund had about 25 investors and at least $6 million in assets. Its sole shareholder was Berton Hochfeld, manager of Hochfeld Capital Management, LLC. As fund administrator, Mr. Herckis was responsible for calculating the performance of the investments, preparing monthly account statements for investors and maintaining other pertinent accounting records.
Hochfeld Capital Management or HCM, the general partner, and each of the Fund’s limited partners or investors, had capital accounts at the Fund. Hochfeld Capital was required to maintain a balance in its capital account equal at least 1% of the Fund’s total assets. The Fund was prohibited from making loans to Mr. Hochfeld or the management company.
When Mr. Herckis began the HCM capital account had a positive balance. Repeated withdrawals by Mr. Herckis and transfers to other accounts he controlled changed that fact. Eventually the account had a negative balance.
As the withdrawals mounted, Mr. Herckis realized that there was an increasing discrepancy between the Fund’s net asset value which he calculated using the internal records and the NAV reported to the Fund’s prime broker. In June 2012 Mr. Herckis, in conjunction with a consultant, determined that the discrepancy was $1.5 million.
In September 2012 Mr. Herckis resigned and reported the difficulties to the authorities. He worked closely with the SEC, furnishing them a substantial number of documents and detailing the wrongful conduct. As a result the Commission brought an action against Mr. Hochfeld in which he consented to the entry of an injunction, an asset freeze and other relief. SEC v. Hochfeld, Civil Action No. 12-cv-8202 (S.D.N.Y.). Eventually Mr. Hochfeld pleaded guilty to criminal charges. U.S. v. Hochfeld, No. 13-CR-0021 (S.D.N.Y.).
The agreement is for a term of five years. Under its terms Mr. Herckis:
Admissions: Admitted the facts regarding the underlying violations as detailed in the agreement;
No violations: Will not violate Federal or state securities laws;
Securities business: Will not serve in any capacity with an investment company or an investment adviser;
Disgorgement: Paid disgorgement in the amount of $48,000 along with prejudgment interest; and
Cooperation: Continues to cooperate with the Commission.
Previously, the Commission entered into non-prosecution and deferred prosecution agreements only with corporations. For example, the SEC entered into a non-prosecution agreement with Carter’s Inc. which involved a financial fraud. The agency entered into a deferred prosecution agreement with Tenaris S.A., centered on FCPA violations. While the SEC had entered into cooperation agreements with individuals, it had not previously entered into a non-prosecution agreement with an individual.
November 11, 2013
The SEC enforcement program has been the subject of significant commentary in the wake of its new “get tough” policy. The new approach demands admissions to settle, similar to those required in criminal cases creating the image of a harder-edged enforcer that will hold defendants accountable and impose significant sanctions. Yet even as the new “tough guy” approach is being rolled out, there are questions regarding the proper role of SEC Enforcement, a point reflected in recent comments from the new Chair and two Commissioners.
The new SEC Chair, drawing on her experience from the U.S. Attorney’s Office, has articulated the new “get tough” approach. It keys to deterrence built on a cop on the beat approach fortified with criminal style admissions and penalties.
Ms. White outlined her approach to enforcement in two key speeches, one delivered to the Council of Institutional Investors on September 26, 2013 (here) and another at the Securities Enforcement Forum on October 9, 2013 (here). The approach might be called omnipresent / “broken windows.” Omnipresent because the Division would be everywhere to halt all violations using the proverbial “cop on every corner” approach, or at least trying to appear to be everywhere since that is not physically or fiscally possible. “Broken windows” because no violation would be too small to prosecute.
Omnipresence/broken-windows is built on four basic principles: 1) The program will be aggressive and creative, bringing the “tough cases” and the “small ones.” The settlements will have “teeth” and send a strong message of deterrence; 2) Remedial measures will be considered to prevent a reoccurrence in the future; 3) Accountability will result from requiring admissions in some cases; and 4) The program will cover the “whole market.” This program will be fortified by winning at trial – defendants can take what is offered to settle or lose in the courtroom.
Deterrence is also key to the enforcement approach of Commissioner Aguilar. In remarks delivered to the 20th Annual Securities Litigation and Regulatory Seminar, on October 25, 2013 (here) the Commissioner declared: “[I]t is customary for Commission representatives to talk the tough talk about enforcement, I am optimistic that the current Commission will walk the walk.” He went on to note that corporate penalties should not be limited by the notion that they are only cause further harm to the shareholders since their company pays the fine. Rather, the Commission should refocus its corporate penalty policy on the misconduct, the nature of the defendant, self-reporting and equitable concerns.
The new admissions policy will bolster the program, become stronger as it continues to evolve Commissioner Aguilar noted. While it has only been applied in two cases as the Commission “continue[s] to develop experience under the new policy, the admissions that we will require in the future will be stronger. For example, the focus should go beyond having defendants only admit facts, but also accepting fault for the misconduct, and admitting to having violated specific provisions of the law.” Such admissions would be similar to those demanded in criminal cases.
A different tone was stuck by Commissioner Daniel Gallagher in remarks at the FINRA Enforcement Conference (here). The Commissioner carefully traced the evolution of the SEC Enforcement Program concluding that from start: “Punishment was not the Commission’s primary enforcement mission; rather, that mission belonged to the Department of Justice. The Commission’s original enforcement mission was to stop ongoing violations and to prevent further harm to investors and the markets.”
Over time the Commission’s enforcement authority has evolved. With the passage of the Remedies Act in 1990 the agency was given “robust penalty authority against individuals and nuanced penalty authority, to be used judiciously, against corporate issuers,” Commissioner Gallagher noted.
Turing to the question of an “omnipresent” enforcement program, Commissioner Gallagher stated that many have espoused this approach and the “cop on every corner” analogy for a tougher program. It is, however, unworkable, since the agency clearly cannot be everywhere. Perhaps more importantly , the SEC is a “capital markets regulator, and its enforcement function should support its efforts to maintain and improve our capital markets.” While the enforcement program should be robust, it is essential that it focus on the mission of the agency and leave the criminal cases to the Department of Justice, according to Commissioner Gallagher.
While these statements may represent differing views of SEC enforcement, in the end, everyone can agree that the Commission should have a strong and effective enforcement program. Everyone can agree that violations should be rooted out and halted. Nobody would dispute the fact that appropriate sanctions should be imposed, coupled with meaningful remedies that focus on reform and preventing a reoccurrence of the wrongful conduct in the market place. And, when administering that program no one should dispute the fact that, as Commissioner Gallagher stated, the SEC is a capital markets regulator and its enforcement program is intended to facilitate and implement that mission – it is not a prosecutor and should not be turned into one.
November 07, 2013
SAC Capital agreed to plead guilty this week. Under the terms of the deal the firm will plead guilty to each count in the indictment, pay a total fine of $1.8 billion and placed on probation for five years during which time it will be supervised by a monitor. The action does not resolve the pending SEC case against Mr. Cohen or terminate the investigations.
The Commission filed a settled action against RBS Securities Inc. for misleading investors in the sale of residential mortgage backed securities. The agency also filed another settled case tied to the municipal bond market. It is the first action in which the Commission has imposed a penalty on a municipal issuer. In addition, the SEC also brought to offering fraud cases and a Rule 102(e) action against an audit firm, two of its partners and an audit manager.
Remarks: Commissioner Daniel M. Gallagher addressed the FINRA Enforcement Conference, Alexandria, Va. (Nov. 7, 2013). His remarks focused on the role of the SEC’s enforcement division as part of a capital markets regulator (here).
Remarks: Chair Mary Jo White addressed PLI’s 45th Annual Securities Regulation Institute, New York, New York (Nov. 6, 2013). Her remarks reviewed accomplishments of the various divisions that typically do not receive significant attention (here).
Remarks: Chairman Gary Gensler addressed the FIA 2013 Futures & Options Expo (Nov 6, 2013)(here). His remarks reviewed the transformation of the market place under Dodd-Frank.
Proposed rules: The Commission reissued its position limit rules for comment (here). An earlier version had been remanded by the District Court. At the time the Rules were issued Commissioner Bart Chilton announced that he would be stepping down shortly.
The Manhattan U.S. Attorney’s Office announcement an agreement with the SAC Capital Companies under which the four entities named in an indictment will plead guilty to the charges against them and resolve the parallel civil forfeiture case. U.S. v. S.A.C. Capital Advisors, LP, Case No. 13 cr 541 (S.D.N.Y.); U.S. v. SAC Capital Advisors, LP, Civil Action No. 13 Civ. 5182 (S.D.N.Y.). The five count indictment named as defendants: S.A.C Capital Advisors, LP, S.A.C. Capital Advisors LLC, CR Intrinsic Investors, LLC and Sigma Capital Management, LLC. It contains one count of wire fraud and four counts of securities fraud. The indictment is essentially a roll-up of key insider trading cases involving current and former S.A.C Capital personnel tied to claims that the organization has inadequate compliance procedures and a corrupt culture.
Under the terms of the deal the SAC Companies will pled guilty to all of the counts in the indictment and pay a financial penalty of $1.8 billion. That sum represents a $900 million criminal fine and a $900 in the criminal forfeiture case. The defendants will be given credit for the $616 million paid earlier to resolve an SEC civil insider trading case. The companies will also terminate their investment adviser registrations with the SEC. Finally, the defendants will be on probation for five years. During that period they will implement insider trading compliance procedures which will be supervised by a monitor. The guilty pleas only resolve charges for the defendants, not any individuals or the pending SEC proceeding which names Mr. Cohen as Respondent
SEC Enforcement – filed and settled actions
Weekly statistics: This week the Commission filed, or announced the filing of, 3civil injunctive actions and 3 administrative proceedings (excluding follow-on actions and 12(j) proceedings).
Market crisis: SEC v. RBS Securities Inc., Civil Action No. 3:13-cv-01643 (D. Conn. Filed Nov. 7, 2013). The action, against the broker-dealer subsidiary of Royal Bank of Scotland plc, centers on the sale of certificates of a residential subprime mortgage security known as Soundview Home Loan Trust 2007-OPT1. The offering materials used to market those interests were false and misleading, according to the Commission. The materials contained a representation from Option One, from whom RBS purchased the mortgages, which represented that they were “generally” written in accord with the customary standards. In fact about 30% of them were not. RBS knew, or should have known, this fact because during a rushed closing on the transaction in which it purchased the mortgages, due diligence was done by a retained third party. The review demonstrated that a substantial portion of the instruments sampled did not conform to the applicable guidelines. RBS eliminated the substandard mortgages, closed the deal and the mortgages went to Soundview. By simple extrapolation from the sample, RBS knew, or should have known, that the claims regarding the underwriting standards in the offering materials were false. The complaint alleges violations of Securities Act Sections 17(a)(2) & (3). The firm settled the action. It consented to the entry of a judgment, without admitting or denying the facts in the complaint, which directs the pay of disgorgement in the amount of $80.3 million, prejudgment interest and a civil penalty of $48.2 million. See Lit. Rel. No. 22866 (Nov. 7, 2013); SEC Press Release, “SEC Charges Royal Bank of Scotland Subsidiary” (Nov. 7, 2013).
Unprofessional conduct: In the Matter of Sherb & Co., LLP, Adm. Proc. File No. 3-15609 (Nov. 6, 2013) is a proceeding based on Rule 102(e) of the Commission’s Rules of Practice alleging unprofessional conduct. It names as Respondents the audit firm, Steven Sherb, its managing partner, firm partners Christopher Valleau and Mark Myclo and audit manager Steven Epstein. The proceeding centered on the audits the firm performed: On the financial statements of China Sky One Medical, Inc. or CSKI for the fiscal year 2007; the 2010 yearend financial statement of China Education Alliance, Inc. or CEU; and, for Wowjoint Holdings Ltd., for the years ended August 3, 2008 and 2009, for a four month transition period ended December 31, 2009 and the years ended December 31, 2010 and 2011. Each issuer conducted its operations in the PRC.
Previously, the Commission filed an injunctive action against CSKI alleging misstatement of its revenue and net income in its Form 10-K for 2007. This proceeding alleges essentially that there was an audit failure. The engagement was not properly planned, a contract auditor was retained to do much of the work but was not properly supervised and that the work raised red flags that were not properly investigated. The charges with respect to the CEU engagement are similar. Again the Order alleges what is essentially an audit failure: the audit engagement was not properly planned and supervised; the auditors failed to obtain sufficient evidential matter through inspections, observation, inquiries; and they failed to take basic steps such as securing confirmation of bank account balances. The Wowjoint engagements followed the same pattern. Again there was a failure to adequately plan the engagement; the team did not test the revenue computations of the company; there was inadequate inquiry and procedures regarding the cash basis accounting of the company; inadequate tests were conducted regarding the collectability of Wowjoint’s large, outstanding and aged accounts receivable balance; and there was a failure to maintain the engagement work papers. The Respondents settled with the Commission. The firm and Mr. Mycio consented to the entry of cease and desist orders based on Exchange Act Section 10A(b)(1) and to the entry of orders denying them the privilege of appearing or practicing before the Commission as accountants. Mr. Mycio can apply for reinstatement after five years. The firm will pay a penalty of $75,000. Messrs. Sherb, Valleau and Epstein will be denied the privilege of appearing or practicing before the Commission as accountants. Messrs. Sherb and Valleay may apply for reinstatement after five years. Mr. Epstein may apply after three years.
Municipal bonds: In the Matter of Greater Wenatchee Regional Events Center Public Facilities District, Adm. Proc. File No. 3-15602 (Nov. 5, 2013); In the Matter of Piper Jaffrey & Co., Adm. Proc. File No. Nov. 5, 2013). The former names as Respondents: a municipal corporation formed by nine cities and counties to fund a Regional Center; Allison Williams, the Executive Services Director of Wenatchee, Washington who executed the closing certificate for the bond issue; Global Entertainment Corporation, the developer of the Regional Center; and Richard Kozuback, Global’s CEO and President. The latter names as Respondents the underwriter of the bonds involved here and Jane Towery, a Managing Director at Piper.
In 2006 the District began formulating plans for a Regional Center. Global developed a series of financial projections for the operation of the Regional Center over the course of project. The projections were prepared for the budget and inclusion in the District’s Official Statement. In two instances a consultant for the city questioned the projections. In another they were revised to be more optimistic at the behest of the mayor after bond counsel indicated that the offering might not sell. Following the failure of one effort to sell bonds, Piper Jaffrey was retained. By this point in late 2008 the City and the District were searching for solutions. Finally, an offering of short term bonds was sold. They were to be refinanced two years later by selling long term bonds. The offering materials contained the most recent projections, statements about the credit of the City and a certification that all material information had been furnished. Investors were not told about the concerns of the consultants regarding the projections, the actions of the mayor which resulted in a revision or that a passage discussing the limitations on the credit of the city had been deleted from the offering materials. In 2011 the District defaulted on the outstanding $41.77 million short term instruments which had been issued. The State legislature then passed a sales tax to assist. In late September the District sold long term bonds secured by the sale tax revenues to refinance the short term instruments. The Order alleges that the Official Statement for the short term instruments was false and misleading as was the certification of full disclosure. It alleges violations of Securities Act Sections 17(a)(2) and (3).
The Respondents in both proceedings settled. The District undertook to establish appropriate policies, procedures and internal controls, institute training and certify completion of these steps to the Commission. It also consented to the entry of a cease and desist order based on Securities Act Section 17(a)(2) and a directive to implement the undertakings and pay a civil money penalty of $20,000. Ms. Williams and Mr. Kozuback both consented to the entry of cease and desist orders based on Securities Act Section 17(a)(3). Each will each pay a civil penalty of $10,000. Piper revised its due diligence procedures and Ms. Towery agreed to implement undertakings which include limiting her activities as an associated person of a securities professional and to retain a consultant to review Piper’s municipal underwriting due diligence policies and procedures. In addition, the firm and Ms. Towery each consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. The firm will pay a penalty of $300,000 while Ms. Towery will pay $25,000. This is the first proceeding in which a civil penalty was imposed on a municipal issuer.
Offering fraud: SEC v. Pedras, Civil Action No. CV 13-07932 (C. D. Cal. Filed under seal on Oct. 28, 2013) is an action which names as defendants Christopher Pedras, his partner Sylvester Gray, lead sales agent Alicia Bryan and several companies controlled by the individual defendants. The complaint details two schemes. In the first investors were solicited to acquire interests in the Maxum Gold Small Cap Trading Program. Maxum, it was claimed, acted as an intermediary between banks that were not permitted to trade directly with each other. Investors were assured that they would be paid between 4% and 8% monthly and that the investment was safe. Minimum investment was between $5,000 and $10,000 for one program. There were variations of the program that required a larger investment. About 50 investors participated in the program. In fact it was fictitious according to the Commission. When the promised returns could not be paid, the individual defendants moved to scheme two – the FMP Renal Program. Investors were told they could acquire shares of a New Zealand company which expected to be publicly traded. It operated kidney dialysis clinics in New Zealand. Investors from the first scheme were offered the opportunity to convert their shares, become an investor in scheme two and net an instant 80% increase in value. At least eight U.S. investors participated. This deal was also a fraud, according to the SEC. Overall about $2.4 million in investor money was used to make Ponzi type payments to investors while another $2 million was stolen by Mr. Pedras. About $1.2 million was used to pay sales commissions. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). An emergency asset freeze was obtained by the Commission. The case is pending. See Lit. Rel. No. 22862 (Nov. 5, 2013).
Offering fraud: SEC v. Wang, Civil Action No. CV 13-07553 (C.D. Calif. Filed under seal Oct. 15, 2013) is an action against Yin Nan Wang, Wendy Ko, Velocity Investment Group, Inc. which is controlled by the two individual defendants, a series of entities controlled by Investment Group and Rockwell Realty Management, Inc. Beginning as early as 2005 the defendants raised about $9.8 million from 2,000 investors, selling promissory notes issued through Velocity. The company was supposed to be in the real estate business. While apparently it did own real estate, the complaint alleges that its business model was not sustainable because it assumed that the funds raised would be available for operations. In fact large portions were used to pay fees and other items. As a result defendants sought to conceal the true financial condition of the company. In part they did this by making what they admitted were Ponzi type payments to earlier investors from funds obtained from more recent investors. In part they sought to conceal the financial condition of the company by entering into a series of what appear to be meaningless transactions with Rockwell. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending.
Manipulation: SEC v. Geranio, Civil Action No. CV12-04257 (C.D. Cal.) is a previously filed action against Nicholas Geranio, the Good One, Inc. and Kaleidoscope Real Estate Inc. centered on a $35 million scheme to manipulate the shares of several companies whose securities were sold through boiler rooms. The Court entered a final judgment by consent against the defendants. That judgment prohibits future violations of the antifraud provisions of the federal securities laws, directs Mr. Geranio and the two companies to pay, on a joint and several basis, to pay disgorgement of $2,135,000 along with prejudgment interest and a $500,000 civil penalty. The judgment also bars Mr. Geranio from acting as an officer or director of any public company and directs him to pay an additional $279,000 in disgorgement plus prejudgment interest which is the sum received by another defendant, provided that the SEC does not obtain a double recovery. Finally, the order directs relief defendant BWRE Hawaii, LLC to pay, jointly and severally with Mr. Geranio and the other two corporations, an additional $240,000 in disgorgement plus prejudgment interest. See Lit. Rel. No. 22865 (Nov. 7, 2013).
Report: A report by the U.S. China Business Council, titled Best Practices for Managing Compliance in China, provides insight into practices which can assist companies doing business in the high risk environment of the PRC. The Report is based on a survey of, and conversations with, 30 companies doing business in China in a wide variety of areas. It contains a discussion of current compliance procedures being used by firms conducting business in the PRC. Topics addressed include the structure of compliance operations, local law issues, entertainment expenses, approval processes for entertainment, social responsibility activities and training.
Reporting: The regulator announced that it had fined TD Ameritrade Clearing, Inc. $1,150,000 and SG Americas Securities, Inc. $675,000 for failing to report, or accurately report, certain large options positions. From May 2007 through January 2010 TD Ameritrade failed to properly aggregate certain reportable positions as acting-in-concert. This impacted nearly 4,100 accounts. It also resulted in the firm failing to report about 1.4 million positions. In addition, the firm failed to establish and maintain reasonable supervisory procedures and supervisory systems to ensure compliance.
Likewise, from December 2007 through January 2013, SG Americas failed to report OTC options positions in about 500,000 instances, failed to report the counter-party positions or incorrectly reported its customers’ ITC options positions in over 600,000 instances. It also failed to report or misreported OTC index options positions in over 900,000 instances. In addition, the firm failed to establish and maintain reasonable supervisory procedures and supervisory systems to ensure compliance.
Economic analysis: The board announced that it is establishing a Center for Economic analysis. It will evaluate the role and relevance of the audit in capital formation and investor protection. The Center’s Founding Director will be economist Luigi Zingales, a professor at the University of Chicago.
Manipulation: CFTC v. Wilson, Civil Action No. 13 Civ 7884 (S.D.N.Y. Filed Nov. 6, 2013) is an action against DRW Investments, LLC, a subsidiary of DRW Holdings, LLC, an organization which trades for its own account, and it CEO and manager, Donald Wilson. The complaint alleges that the defendants manipulated the price of a futures contract known as IDEX USD Three-Month Interest Rate Swap Futures Contract, traded on the NASDAQ OMX Futures Exchange. In the summer of 2010 the firm acquired a position in the three month contract with a notional value of over $350 million. The value of the portfolio hinged on the daily settlement rates for the contract. That rate was determined each day using a methodology which was based on collecting various data, including bids and offers for the instrument that were placed electronically in the market by participants during a preset period of the day. By late 2010 the defendants determined that the price for their portfolio was not rising as expected. Accordingly, during the fifteen minute pricing period it began entering bids that were then over those existing in the markets with no intent on closing them – a form of “banging the close.” Using this procedure the defendants were able to crate an artificial price for the three month contract for at least 118 trading days. The complaint alleges violations of Sections 6(c) and 9(a)(2) of the Commodity Exchange Act. The case is in litigation.
Benchmark rates: The European Commission announced its intention to impose fines on Deutsche Bank, JPMorgan, HSBC, Royal Bank of Scotland, Credit Agricole and Societe Generale as a result of its probe into the manipulation of Euribor. Previously the Commission imposed fines on Barclays, UBS and Royal Bank of Scotland for manipulating LIBOR.
Parallel inquiries are being conducted in the U.S. by the DOJ and the CFTC. Fines have been imposed on Dutch financial giant Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., ICAP Europe Limited, The Royal Bank of Scotland, UBS AG and Barclays Plc for manipulating benchmark interest rates. These investigations are continuing.
Derivatives: BaFin announced a joint initiative on derivatives with the Bank of England, the FDIC and FINMA. The purpose of the initiative is to ensure that possible “supervisory measures aimed at ensuring the orderly resolution of an institution do not give counterparties the right to no longer meet obligations arising from existing derivatives agreement . . .”