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Thomas O. Gorman,
Dorsey and Whitney LLP
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    SEC Enforcement: Is the Swagger Back?

    October 13, 2013

    The swagger is back according to SEC enforcement officials. Presumably that comment is meant to say that an enforcement program which once was viewed as among the best in government has returned to that rarified echelon. To be sure there is a lot of positive buzz about the program. New Chair Mary Joe White has in recent weeks addressed enforcement priorities (here), market structure (here) and last week what might be called enforcement omnipresence. But the swagger? Consider Ms. White’s most recent remarks at the Securities Enforcement Forum, Washington, D.C. (Oct. 9, 2013)(here).

    Remarks

    The focus of Ms. White’s remarks last week was omnipresence, that is, SEC enforcement will be like the 24/7 news cycle everywhere, all the time brining every case. While that is clearly not possible, the goal is to make it seem possible. The theory is simple: A cop on every corner brining charges for every violation no matter how small prevents wrongful conduct thereby making investors feel safe. As Ms. White stated: “I recognize the SEC cannot literally be everywhere, but we will be in more places than ever before. Our aim is also to create an environment where you think we are everywhere – using collaborative efforts, whistleblowers and computer technology to expand our reach, focusing on gatekeepers to make them think twice about shirking responsibilities, and ensuring that even the small violations face consequences.”

    There are four building blocks to the omnipresent strategy. The first is expanding the reach of the agency by leveraging its resources. This means utilizing resources like the National Exam Program to help uncover potential violations. Whistleblowers also become a key component since they can give Enforcement Division critical leads. All of this is supplemented by working with partners such as the DOJ, FINRA and state authorities.

    Technology can also help expand the reach of the agency. Specialized programs, coupled with big data, can aid enforcement efforts while expanding the horizon. In some instances the Commission is using analytics and related technology to conduct what the SEC Chair called “predictive analysis” to identify trends and streamline investigative efforts. In others specialized programs such as the Advanced Bluesheet Analysis Program for insider trading cases are used. That program “analyzes data provided to us by market participants on specific securities transactions. It identifies suspicious trading before market moving events. It also shows the relationships among the different players . . . “ said Ms. White.

    A second pillar of the strategy is to expand the focus on gatekeepers. One example of this focus is actions involving the boards of investment companies Those boards have a critical role in overseeing funds. Another is Operation Broken Gate, a recent initiative that focuses on auditors. Ensuring that gatekeepers fulfill their critical role, can help prevent violations of the law.

    The third facet of the approach centers encouraging respect for the law through what Ms. White called the “broken window.” If a window is broken an later repaired it demonstrates a commitment to the rules. If it is not, that fact suggests the opposite. To implement this approach the SEC will bring even small cases. A recent example it the series of strict liability actions based on short selling in violation of Regulation M.

    Finally, the agency will prioritize large cases. Here Ms. White pointed to the Financial Reporting and Auditing Task Force created earlier this year. The task force “brings together an expert group of attorneys and accountants who are developing state-of the-art techniques for identifying and uncovering accounting fraud.” Those cases are complex, resource intensive and time consuming, meaning it is essential that the agency prioritize them. By tying this point to the others, the SEC will endeavor to create the appearance of being “everywhere” to enhance enforcement.

    Analysis

    Putting a cop on every corner – or creating the appearance that there is one – is a proven law enforcement approach. The omnipresence formula is thus not new or novel. Neither are its building blocks. Leveraging resources has long been an approach used by the resource-short Commission. Focusing on gatekeepers is a theory that traces to the earliest days of the Enforcement Division. Prioritizing large cases is not so much a strategy as a necessity given the limited resources available to the SEC.

    The critical point here is how the building blocks are blended together. If the agency can effectively implement the theory it may become an effective enforcement approach. If omnipresence becomes an effective program it may be entitled to swagger. For now, however, it is all much like the poem Ode on a Greecian Urn penned long ago by the English poet John Keats’ – potential, in the offing and possible.

    This Week in Securities Litigation (Week ending October 11, 2013)

    October 10, 2013

    SEC Chair continued to define her vision for SEC enforcement this week, declaring that the agency will be the cop that is everywhere, filing large and small cases. This week the Commission resolved two insider trading cases, a cherry picking action and an offering fraud case.

    Transparency International issued its report on enforcement of the OECD Convention. The statistics in the report demonstrate that enforcement by member nations is at best uneven with the U.S., Germany, the U.K. and Switzerland leading the way. While the number of corruption cases brought by U.S. officials last year declined, the Report cautions that this only reflects the long term nature of the actions and not any decline in prosecution efforts.

    SEC

    Remarks: Chair Mary Jo White addressed the Securities Enforcement Forum, Washington, D.C. (Oct. 9, 2013). In her remarks she noted that the enforcement program will be the kind of cop that is everywhere, bringing large and small cases (here).

    Website: The Commission launched its new market structure data and analysis website which collects data from MIDAS this week.

    SEC Enforcement

    Weekly statistics: This week the Commission did not file or announced the filing of any civil injunctive actions or administrative proceeding (excluding follow-on actions and 12(j) proceedings).

    Insider trading: SEC v. Terpins, Civil Action No. 12-Civ-1080 (S.D.N.Y.) is the previously filed insider trading action centered on the acquisition of H.J. Heinz Company. Initially the action was filed against unknown traders. The amended complaint named as defendants two brothers, Michel Terpins and Rodrigo Terpins. The complaint alleges that Michel Terpins learned about the deal for Berkshire Hathaway and 3G Capital to acquire Heinz. The amended complaint does not specify how he learned this information. He then told his brother who placed the trades the day before the announcement through Alpine Swift, an off-shore investment vehicle with accounts in Switzerland. Rodrigo Terpins periodically attended performance meetings regarding Alpine Swift’s assets but he did not have permission to place the trades. The U.S. brokers for the vehicle had authorizations to make certain disclosures to federal regulators. The complaint alleges violations of Exchange Act Section 10(b). The defendants resolved the action, consenting to the entry of a permanent injunction prohibiting future violations of the Section cited in the complaint. They also agreed to pay disgorgement of $1,809,857, prejudgment interest and a $3 million penalty. See Lit. Rel. No. 22841 (Oct. 10, 2012).

    Cherry picking: SEC v. Dushek, Civil Action No. 13-cv-3669 (N.D. Ill. ) is a previously filed action against Charles J. Dushek, Charles S. Dushek and Capital Management Associates, Inc. The complaint alleges that the defendants engaged in a cherr picking scheme that made them about $2 million in illicit profits. This week the Court entered a final judgment as to each defendant which permanently enjoins them from future violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2). The judgment also directs that each defendant pay disgorgement, prejudgment interest and civil penalties in an amount that will be determined later by the Court. See Lit. Rel. No. 22840 (Oct. 10, 2013).

    Offering fraud: SEC v. Laborio, Civil Action No. 1:12-cv-11489 (D.Mass.) is a previously filed action against, among others, Jonathan Fraiman. Last year the Commission filed an action charging Mr. Fraiman, two other individuals and seven entities, with raising about $5.7 million from more than 150 investors through a fraudulent unregistered offering of securities. Mr. Fraiman and the Commission resolved the matter and this week the Court entered a final judgment prohibiting him from violating Securities Act Section 17(a)(2), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4)-8. The order also bars him from participating in any offering of a penny stock and requires him to pay disgorgement of $180,961.42 along with prejudgment interest. Payment was waived, and a penalty not imposed, based on financial condition. In a related administrative proceeding Mr. Fraiman consented to the entry of a bar from the securities industry with a right to apply reapply after ten years. See Lit. Rel. No. 22836 (Oct. 8, 2013).

    Insider trading: SEC v. Nguyen, Civil Action No. 12 Civ. 5009 (S.D.N.Y.) is a previously filed action against Tai Nguyen and his sister, ThanhHa Bao. The complaint alleged that from 2006 through 2009 Mr. Nguyen frequently traded on inside information about Abaxis, Inc., which he obtained from his sister who was employed at the company. This week the Court entered a final judgment by consent against Mr. Nguyen which prohibits future violations of Securities Act Section 13(a) and Exchange Act Section 10(b). The judgment also requires him to pay disgorgement of $144,910, prejudgment interest and a penalty equal to the amount of disgorgement. Those amounts will be credited against the sums Mr. Nguyen is required to pay in a parallel criminal action. In that case he was sentenced to serve one year in prison. Ms. Bao also settled with the Commission. The final judgment against her imposes a permanent injunction on the same terms as the one against her brother. In addition, the order bars her from serving as an officer or director of a public company for five years and requires the payment of a penalty of $144,900. See Lit. Rel. No. 22834 (Oct. 7, 2013).

    FCPA-Anti-corruption

    Transparency International issued its ninth annual progress report on OECD Anti-Bribery Convention Enforcement. “Exporting Corruption, Progress Report 2013: Assessing Enforcement of the OECD Convention on Combating Foreign Bribery.” The Report reviews the enforcement efforts by countries who are parties to the anti-bribery convention. While 40 countries are parties to the Convention, the Report makes it clear that global enforcement is quite uneven. For example, only the U.S., Germany, the U.K. and Switzerland were ranked as having active enforcement programs. Those four countries opened 62 investigations in 2012 compared to the 36 initiated by all of the other countries that executed the Convention. Likewise, those same four countries concluded 37 actions in which sanctions were imposed in 2012 while all of the remaining parties to the Convention resolved 3 such actions.

    Finally, in a section which analyzes FCPA enforcement, the Report notes that “the U.S. maintains the most developed and active foreign bribery legal and enforcement regime in the OECD (and the world).” Although last year there was a smaller number of actions against companies and individuals than in the prior year that does not represent a “de-emphasis of FCPA enforcement or a change in the legal or enforcement framework but rather the multi-year character of FCPA cases,” according to the Report. It does call for U.S. enforcement officials to provide more robust explanations for the reasons that an action is resolved with either a NPA or DPA.

    Circuit courts

    Note as a security: SEC v. Thompson, Case No. 11-4182 (10th Cir. Oct. 4, 2013) is

    a case which centers on the sale of notes in an alleged Ponzi scheme conducted by defendant Ralph Thompson through his company, Novus Technologies, LLC. The notes stated on their face that they were not securities. Nevertheless, the SEC prevailed on summary judgment. The key question on appeal was whether the notes were securities under Reves v. Ernst & Young, 494 U.S. 56 (1990). While the securities laws define the word security in broad terms which include a “note,” Reves made it clear that not every note is covered. Rather, that term must be viewed in the context of what Congress sought to accomplish under the securities laws. Under the Court’s decision generally notes are presumed to be securities. A four part test is used to compare the instrument to notes which are not securities. Critical to Appellant’s claims here is his contention that a jury must make the ultimate determination on this test. That claim is contrary to established Tenth Circuit and other authority which holds that it is a question of law, not fact, and that submitting it to a jury is error, at least in a civil case, the Court held. And, in any event, in view of the presumption that the note is a security, once a moving party demonstrates that there is no dispute of a material fact, the opposing party has the burden to demonstrate that the note is not a security.

    Here Appellant failed to rebut the presumption. The first question under the Reves test is the reasonable motivations of a buyer and seller of the instruments. Here the purpose was to raise money for the enterprise making it likely the instrument it is a security. Second, in the “plan of distribution” for it, the instrument need not be traded on an exchange. Rather, it is sufficient that it is sold to a broad segment of the public as here. Third, while the question of “reasonable perceptions of the investing public” is a closer call according to the Court, it also does not support Appellant despite the disclaimer on the notes in view of the overall analysis on the other factors. Finally, the last factor, which considers whether there is an alternate regulatory scheme, also cuts against Appellant. Here there is no other federal regulatory scheme to protect investors. Accordingly the decision of the district court was affirmed.

    FINRA

    Remarks: Richard Ketchum, Chairman and CEO of FINRA, addressed the Council for Economic Education, Baltimore, MD. (October 3, 2013). His remarks included comments on FINRA’s mission, a discussion of the financial literacy program and findings from a recent survey (here).

    PCAOB

    Brokers: The Board adopted two attestation standards regarding the audits of brokers and dealers (here).

    UK

    Misleading investors: Last week the Financial Conduct Authority censured Catalyst Investment Group for recklessly misleading investors in connection with the sale of bonds by ARM Asset Backed Securities SA from November 2009 through May 2010. This week the regulator imposed fines of £450,000 and £100,000 on, respectively, Timothy Roberts, the chief executive of the firm, and Andrew Wilkins, a former director of Catalyst Investment Group. Mr. Roberts was banned from the industry while Mr. Wilkins is precluded from holding senior roles in the future.

    Hong Kong

    The Securities and Futures Commission banned former representative Chan Ka Chung for life. Mr. Chun was found by a court that while he was an associate director at Falcon Private Bank Ltd. in Hong Kong that he conspired with two clients to issue four false letters showing proof of funds and credit facilities on the letterhead of the bank. The proof was not authorized by the bank. The court sentenced Mr. Chan to serve 23 months in prison.

    The Transparency International Report on Corruption Enforcement

    October 09, 2013

    Transparency International issued its ninth annual progress report on OECD Anti-Bribery Convention Enforcement. “Exporting Corruption, Progress Report 2013: Assessing Enforcement of the OECD Convention on Combating Foreign Bribery” (here). The Report reviews the enforcement efforts by countries who are parties to the anti-bribery convention. It thus provides insight into global enforcement efforts. While 40 countries are parties to the Convention, the Report makes it clear that global enforcement is quite uneven.

    Member countries are grouped in the Report into one of four categories based on their enforcement efforts: 1) Active enforcement; 2) moderate enforcement; 3) Limited enforcement; and 4) Little or now enforcement. Only four countries are included in the “active enforcement” category: the U.S., Germany, the U.K. and Switzerland. Collectively those countries commenced 62 active investigations in 2012, down from 86 in the prior year. During 2012 the U.S. opened 24 investigations, Germany 13, the U.K. 8 and Switzerland 19. That compares to 27 in the U.S., 32 in Germany, 11 in the U.K. and 16 in Switzerland during 2011.

    Italy, Australia, Austria and Finland were included in the “moderate enforcement” category. Collectively these countries opened 11 investigations in 2012 and in 2011. In 2012 Australia opened 10 inquires followed by Italy with 8 and Austria with 2 while Finland did not open an investigation last year.

    The final two categories – limited and little or now enforcement – include, respectively, 10 and 20 countries. In 2012 the 10 countries rated as conducting limited enforcement opened a total of 16 investigations compared to the 9 inquiries initiated by the 20 countries grouped in the little or no enforcement. Overall the four countries rated as conducting active enforcement opened 62 investigations in 2012 compared to the 36 initiated by all of the other countries that executed the Convention.

    The same patterns are evident in statistics regarding cases concluded last year. Here the four countries included in the active enforcement category resolved 37 cases with sanctions last year compared to 38 in the prior year. At the same time the moderate enforcement group only concluded 1 case with sanctions in 2012. The limited enforcement group concluded 2 such actions while the little to no enforcement group did not resolve any actions with sanctions. Overall the four countries which actively enforce the Convention concluded 37 actions in which sanctions were imposed while all of the remaining parties to the Convention resolved 3 such actions.

    Based on these statistics the Report makes three recommendations: 1) Government leaders must be asked to commit sufficient resources to enforcement; 2) The OECD Ministerial Meeting in the second quarter of 2014 should review enforcement; and 3) A meeting should be held with leaders of multinational enterprises and civil society organizations to enlist their support to overcome lagging enforcement.

    The final sections of the Report review enforcement programs in specific counties. Generally these sections review basis statistics and cases for the particular country an includes recommendations. In the section discussing the U.K., the Report notes that there is increasing use of civil recovery orders to resolve foreign bribery-related cases. This involves less judicial oversight and transparency compared to criminal plea agreements. There is also a willingness of the SFO to enter into confidentiality agreements which prohibits key information from being disclosed after cases are settled, according to the Report. The section concluded by expressing concern regarding future budget cuts at the SFO and the possible impact on enforcement.

    Finally, the Report notes that “the U.S. maintains the most developed and active foreign bribery legal and enforcement regime in the OECD (and the world).” Although last year there was a smaller number of actions against companies and individuals than in the prior year that does not represent a “de-emphasis of FCPA enforcement or a change in the legal or enforcement framework but rather the multi-year character of FCPA cases,” according to the Report.

    The Report also raised two points regarding U.S. enforcement. First, the U.S. has not made “sufficient progress” on the recommendation that the U.S. clarify its policy on dealing with claims for tax deductions for facilitation payments, and give guidance to help tax auditors identify payments claimed as facilitation payments that are in fact in violation of the FCPA . . .”

    The second recommendation focuses on the use of NPAs and DPAs. It notes that when resolving cases with these agreements the SEC and the DOJ should “make public detailed reasons on the choice of a particular type of agreement, the choice of the agreement’s terms and duration, and how a company has met the agreement’s terms.”

    SEC Prevails in Tenth Circuit

    October 08, 2013

    The SEC prevailed in a recent Tenth Circuit Court of Appeals ruling which upheld a grant of summary judgment in favor of the agency by the district court. The critical question before the Court was whether notes sold to investors were securities. In sustaining the Commission’s position, the Circuit Court held that the question is one of law which could be resolved on summary judgment, rejecting defense claims that the issue had to be considered by the jury. SEC v. Thompson, Case No. 11-4182 (10th Cir. Oct. 4, 2013).

    The case centers on an alleged Ponzi scheme conducted by defendant Ralph Thompson through his company, Novus Technologies, LLC. That entity was founded in 2000 by Mr. Thompson as a vehicle for his investments. To implement his plans Mr. Thompson needed to raise $12 million.

    Over time Mr. Thompson became involved with two investment programs which were supposed to generate huge returns. One was a proprietary algorithm for trading on the S&P 500 that was claimed to give investors monthly returns of 5% to as much as 40%. The second was a real estate investment program that its investors claimed would guarantee investors returns of 10% per month. Later a third real estate program was added.

    To raise money unsecured promissory notes were sold. Those notes provided for repayment after a term of six months plus monthly interest of 3% to 5%, depending on certain options selected by the investor. The notes also stipulated that the borrower could extend the term for a period of six months as long as the interest was paid. The instrument stated on its face that it was not a security.

    Mr. Thompson marketed the notes, claiming that they represented a more conservative investment than a 401(k) or a mortgage. Investors were told about the reserve of cash and assets held by Novus to cover any money borrowed. Sales continued until April 2007 when the SEC filed suit and obtained a freeze order. Subsequently, the district court granted summary judgment in favor of the SEC on its fraud claims.

    The critical question on appeal was if the notes were securities within the meaning of the Supreme Court’s decision in Reves v. Earnst & Young, 494 U.S. 56 (1990). While the securities laws define what constitutes a security in broad terms which include a “note,” Reves made it clear that not every note is covered. Rather, that term must be viewed in the context of what Congress sought to accomplish under the securities laws. To assess this point the Supreme Court adopted a version of the Second Circuit’s “family resemblance test. Under this approach a note is presumed to be a security, although it left the question open for those instruments which have a term of less than six months. The presumption can only be rebutted if the instrument resembles those which are in fact not securities. Those include notes delivered in consumer financing, with a home mortgage, those which are short term or which are associated with an open account debt incurred in the ordinary course of business.

    The application of the resemblance test is governed by four factors under Reves. First, the court must consider the motivations of the purchaser and seller to the transaction. Second, the “plan of distribution” of the instrument must be evaluated with a view to whether there is common trading for speculation or investment. Third, the reasonable expectations of the investing public must be considered. Fourth, the question of whether some factor such as the existence of another regulatory scheme which significantly reduces the risk of the instrument and makes protection under the securities laws unnecessary must be evaluated. If the application of this test suggests that the instrument is not sufficiently analogous to one on the list, then consideration must be given to if another category should be added which would again require analysis using the four factor test.

    Critical to Appellant’s claims here is his contention that a jury must make the ultimate determination on the family resemblance test. This claim is contrary to established Tenth Circuit and other authority which holds that the question is one of law, not fact, and that submitting it to a jury is error, at least in a civil case. While there may be factual issues involving the application of the family resemblance test, the Court held “that in the context of a civil case where the ‘security’ status of a ‘note’ is disputed, the ultimate determination of whether the note is a security is one of law; thus, resolution of factual disputes will be necessary only in those rare instances where the reviewing court is unable to make a proper balancing of the family-resemblance factors without resolving those factual disputes.” And, in view of the presumption that the note is a security, once a moving party demonstrates that there is no dispute of a material fact, the opposing party has the burden to demonstrate that it is not.

    Here Appellant failed to rebut the presumption. The first question is the reasonable motivations of a buyer and seller of the instruments. Where, as here, the purpose is to raise money for the use of the enterprise or to finance investments, it instrument is likely a security.

    Similarly, consideration of the second and third factors also fails to support Mr. Thompson. In evaluating the “plan of distribution” it is not necessary that the notes be traded on an exchange. Rather, it is sufficient that they are sold to a broad segment of the public as here. While the issue regarding the “reasonable perceptions of the investing public” is a closer call, it also does not support Appellant. The instruments were characterized as “investments.” While the notes did state that they were not securities, in view of the perceptions of the public this one factor will not, according to Reves, outweighs the others if, as here, they suggest the notes are securities.

    Finally, the last factor, which considers whether there is an alternate regulatory scheme, also cuts against Appellant. In this regard the Court held that “If the instrument ‘would escape federal regulation entirely if the Acts were held not to apply,’ the fourth factor cuts toward characterizing the instrument as a security.” Here this is precisely the case. Accordingly, the Court affirmed the decision of the district court.

    SEC Independence: The Political Process, Rule Making and The Courts

    October 07, 2013

    In three recent addresses SEC Chair Mary Jo White has given definition to her vision for the agency. In one, she discussed Enforcement policy (here). A second focused on market structure (here). In a third, titled The Importance of Independence, delivered to the 14th Annual A.A. Summer, Jr. Corporate Securities and Financial Law Lecture, Fordham Law School (October 3, 2013)(here), Ms. White focused on the meaning of being independent. While many of her comments on independence reiterate the basics, her views on the settlement of enforcement actions are significant.

    The remarks

    “Under the law the SEC is an independent agency . . . “ Ms. White began. That “does not mean that the SEC does not listen to the ideas and recommendations that come from beyond our building. Indeed, we depend upon hearing and evaluating the ideas and recommendations of those who will be impacted by our rules. . . At the end of the day, however, we make our decisions based on an impartial assessment of the law and the facts and what we believe will further our mission. . . “

    With this preface Ms. White outlined her view of independence in three contexts: 1) political; 2) rule making and 3) enforcement settlements. Drawing on her experience as a U.S. Attorney, Ms. White stated that while Commissioners are appointed through the political process, their job is to make decisions on the facts, implementing the mission of the agency. The SEC, Ms. White declared, has a strong tradition of being independent of the political process. In support of this point she cited examples of actions taken by former Chairman over the years.

    Independence comes not just from inside the SEC’s building however. Rather, it “should be respected by those outside, including the industry, other agencies, Congress and the courts.” In the context of rule making this means that “the agency’s unique expertise – should be, for example, respected by those who seek to effectuate social policy or political change through the SEC’s power of mandatory disclosure. “

    It is essential in implementing disclosure policy that the agency “shape disclosure rules consistent with the federal securities laws and its core mission.” In some instances Ms. White stated that she may question if the Commission’s disclosure mission should be utilized to implement policy. One example is the Dodd-Frank mandate that the agency write disclosure rules regarding conflict minerals. While Ms. White allowed that this may be good social policy, she questions using the federal securities laws as a mechanism to implement it.

    Nevertheless, “I recognize that when Congress and the President enact a statute mandating such a rule, neither I nor the Commission has the right to just say ‘no.’” We cannot say that a law does not comport with our mission as we see it. . . .” Rather, the question is what leeway the law affords the agency in writing the rules. It is the responsibility of the agency to utilize its expertise within that context, according to the SEC Chair.

    Finally, Ms. White “urge[d] the courts to defer to the SEC’s independence and expertise.” This means in the first instance the deference that is due under decisions such as Chevron.

    Turning to the question of requiring admissions as part of a settlement while declining to comment on any pending cases, Ms. White reiterated the parameters of her new policy. In select instances the Commission will demand admissions a part of the settlement of an enforcement case. At the same time the “neither admit nor deny” formulation will continue to be an important tool in resolving those cases. The decision to either policy is one for the agency in its discretion, not the courts Ms. White stated. Acknowledging that under the law the court can review a settlement, its role is limited: “A court reviewing a consent judgment in one of our cases has a narrow focus – making sure that the settlement is not ambiguous and that it does not affirmatively harm third parties or impose undue burden on the court’s own resources.”

    Analysis

    The notion that the SEC is independent and should make decisions based on the merits and not on politics is axiomatic and fundamental to its core mission. Equally clear is the fact that the SEC is obligated to write rules within the context directed by the statutes written by Congress and signed by the President. As Ms. White noted, regardless of the personal views of Commissioners on the wisdom of certain statutory directives, it is the responsibility of the agency under the law to write the rules as directed.

    Less clear, however, is Ms. White’s vision of the court’s role in effectuating an enforcement settlement. The basic premise that the implementation of agency policy is within the sound discretion of the regulator should not be controversial, although that issue may be given new definition when the Second Circuit resolves the pending Citigroup case on the role of the courts in SEC settlements (here). Accordingly, the question of whether admissions should be sought or the settlement can be effected on a neither admit nor deny basis should typically fall within the discretion of the agency. Stated differently, whether one settlement policy or another is employed should generally be reserved to the discretion of the agency.

    At the same time it is difficult to view the court’s role as limited to little more than proof reading, checking to see that the papers are clear and ensuring that the arrangement will not cause harm or be burdensome. As Judge Gleeson remarked in holding that the court had authority to approve a deferred prosecution agreement in U.S. v. HSBC Bank USA, N.A., Case No. 12-cr-763 (E.D.N.Y. Order dated July 1, 2013)(here), it is the parties who chose to file the case with the court and invoke its authority. It is the parties who came before the court and asked it to take certain actions. In taking those steps the parties submitted themselves to the authority of the court and its supervisory powers.

    This is particularly true of most Commission enforcement settlements. In those cases it is the SEC that invokes the jurisdiction of the court by filing the action. Likewise, it is the SEC requesting that the court enter certain orders which can then be enforced through its contempt power. Viewed in that context the Court cannot be reduced to what Judge Gleeson called – citing a now famous statement – a potted plant.

    The New SEC Chair Addresses Market Structure

    October 06, 2013

    SEC Chair Mary Jo White has been reshaping the agency in the months since she joined the Commission. A new “get tough” policy has been adopted. Settlement procedures for enforcement cases have been modified to require admissions in select cases. A new financial statement fraud task force has been created. And, a new enforcement doctrine detailed in remarks delivered to the Council of Institutional Investors on September 26, 2013 (here).

    Now the new SEC Chair is addressing market structure and the related issues. In remarks delivered on October 2, 2013, Ms. White addressed the Security Traders Association 80th Annual Market Structure Conference, Washington, D.C. Her address, titled Focusing on Fundamentals: The Path to Address Equity Market Structure (here), centered on the notion that “Gathering, disseminating, and analyzing data, testing assumptions about our complex, dispersed marketplace, and ensuring the integrity of market technology are the fundamental steps that are needed to address today’s market structure concerns in a responsible manner.” In developing this theme Ms. White detailed several critical points. What may be more interesting about her remarks is what she did not address.

    The remarks

    Ms. White began with the straight forward notion that the key point for the U.S. capital markets is their integrity and the perception of fairness by investors and issuers. Capital formation depends on the participation of investors and public companies, the new SEC Chair declared. Critical to the process is not just the direct access of business to raise capital, but a secondary market since it “assures investors will have an efficient means of liquidating their positions if and when they choose. And a strong secondary market generates price discovery that helps efficiently allocate capital to the companies most able to put it to productive use.” This process depends on a market structure which generates confidence thereby attracting investors and companies.

    While the U.S. markets are the envy of the world, in recent years the number of U.S. listed companies has significantly declined. Likewise, the number of U.S. households participating in our markets has declined since 2007. In analyzing these trends it is important to consider three fundamental points: 1) technology; 2) basic assumptions; and 3) market data.

    There is no doubt that technology is fundamental to the markets today. In this regard it is important that there be operational integrity. Stated differently, the systems must work properly. While there is always a risk of failures, the proper steps must be taken.

    There has been progress in this area, and the SEC staff has addressed the questions with new Regulation SCI. Yet more must be done in view of recent failures Ms. White stated. Accordingly, in a recent meeting with executives of exchanges, Ms. White requested that they develop a kind of action plan moving forward to address critical issues. Likewise, the exchanges and FINRA were requested to “prioritize” their efforts on a number of initiatives to make sure that when issues do arise they are resolved quickly.

    In addressing questions of market structure it is also important that key underlying assumptions be rethought and changes made where necessary. One key assumption is the “one-size-fits-all” premise – that all markets must be the same. Following-up on one suggestion, Ms. White has instructed the staff to work with exchanges to consider a “plan to implement a pilot program that would allow smaller companies to use wider tick sizes.” Another assumption which must be critically evaluated is if “the current regulatory structure continues to meet the needs of investors and public companies. Does it provide sufficient flexibility for exchanges to implement transparent trading models that can effectively compete for investor orders? Does the current approach to self-regulation limit or support exchange trading models?”

    Finally, market structure has to be grounded in empirical evidence. To this end the staff has been developing critical sources of information about the markets. One is MIDAS, the new system which became operational in January. This system collects one billion records each day from the consolidated tapes and the proprietary feeds of each exchange. Information from this new system, along with that from the new Large Trader Reporting Rule and the Consolidated Audit Trail Rule when implemented should enhance the ability of regulators to monitor the equity markets.

    At the same time current sources of information are providing the SEC with significant insights. For example, “the staff has developed a data series tacking the total volume of visible orders at all the price levels sent to our public exchanges and comparing this volume to the total volume of shares actually traded. As expected, only a small percentage of orders sent to exchanges are not canceled and actually result in trades.” The staff has also “used this data to compare the speed at which exchange orders are cancelled to the speed at which orders are executed. Recent data on corporate stocks shows that almost two-thirds of all orders ‘rest’ for half a second or longer. . . These findings not only provide an empirical basis for measuring and tracking the speed of today’s markets, but also suggest that even short-lived quotes are generally accessible by at least some traders.”

    To facilitate decision making based on data the Commission will, in the immediate future, make available a website where information from MIDAS, along with other research by the staff, will be available for the public. This will provide all investors with access to information which has typically been available only to select market participants.

    Ms. White concluded noting that: “Ultimately, we must be able to show investors and companies that concerns about the current U.S. equity market structure can be properly diagnosed and, when needed, properly addressed.”

    Analysis

    The premise of Ms. White’s remarks is fundamental: To attract investors and companies to the U.S. markets, and maintain them as the best in the world, there must be confidence in their integrity. That begins with operational integrity. In recent months there has been a series of incidents which raise significant questions regarding this point. The market outage several weeks ago is only the most recent. While there is little doubt that the SEC has put forth initiatives to try and address these issues, the difficulties persist. As Ms. White correctly noted, there is always the potential for difficulties given the highly complex technology which drives the markets.

    At the same time, whether holding a meeting with executives and giving them what amounts to a “homework” assignment to come up with ideas represents an adequate solution is at best questionable. To be sure, those executives and exchange officials should have insight into the problems and their ideas should be solicited. Indeed, they have a vested interest in solving the difficulties. In the end, however, the SEC remains the regulator charged with supervising and maintaining the integrity of the U.S. markets.

    Equally fundamental are the points that underlying assumptions should be re-examined and data and evidence should inform decisions. Again, there is no doubt that as the markets continue to evolve old ways of doing things should be evaluated, re-evaluated and modified as necessary. In making those decisions data such as that provided by MIDAS and other sources should prove critical. Making much of this data available on a new website should also help inform public debate and is commendable.

    In all the discussion about data and markets what was not mentioned may, however, be most significant. One point we have learned from the data Ms. White noted is that most orders entered and displayed are not executed. Yet even short lived quotes “are generally accessible by at least some traders” she stated. While there may be reasons for orders not to be executed, it also suggest that in many instances investors and traders may be drawn to the markets by quotes offering an appearance of liquidity which is less than accurate. It may mean that at least in some instances investors may be lured to the markets by an appearance of liquidity created in part by orders which were put there only for that purpose and not for execution.

    If some traders rapidly place orders which are displayed, attract investors and are then canceled moments later – a point which should be able to be confirmed at least in part by the data – it may suggest that certain participants are using the speed of the markets to create an illusion of liquidity, that is a false appearance. If this is the case, it presents a fundamental question about the integrity and fairness of the U.S. markets. That would undercut any claim of integrity by the U.S. markets while fueling a continued decline in investor participation. It would also undercut any “get tough” enforcement posture by the Commission.

    This Week in Securities Litigation (Week ending October 4, 2013)

    October 03, 2013

    Operation Broken Gate is the Commission’s latest undertaking which focuses on the role of gatekeepers, according to a recent SEC press release. Traditionally, the agency has focused on those viewed as gatekeepers – professionals, including auditors and attorneys – as way to halt securities law violations which might not otherwise occur without their assistance. In conjunction with the announcement three administrative proceedings were brought against auditors. A fourth action involving an auditor was brought the same day.

    The SEC also filed another action tied to the EB-5 program. That program offers a path to citizenship for foreign nationals under certain circumstances generally tied to creating jobs in the U.S. for citizens. In addition, the Commission brought a series of investment fund and offering fraud cases.

    Finally, SEC Chair Mary Jo White addressed the Securities Traders Association regarding market structure. During her remarks the SEC Chair focused on making decisions about markets and trading that are driven by data. To facilitate this process the Commission will be making available on a website data and research about the markets being obtained from its new market tracking software.

    SEC

    Whistleblowers: The SEC made an award of $14 million to an unidentified whistleblower who helped them quickly bring an enforcement action. The award is the largest for the agency to date.

    Remarks: Chair Mary Jo White addressed the 14th Annual A.A. Summers, Jr. Corproate Securities and Financial Law Lecture, Fordham Law School in remarks titled The Importance of Independence (Oct. 3, 2013). Her remarks focused on the independence of the agency including the deference the courts should accord Commission positions (here).

    Remarks: Chair Mary Jo White addressed the Security Trader’s Association 80th Annual Market Structure Conference, Washington, D.C. (Oct. 2, 2013). Here remarks discussed the fundamentals of market structure, grounding market structure assessments in empirical evidence and the posting of information and research on these topics on MIDAS for the public and to foster public debate (here).

    Broker-Dealers: The Division of Trading and Markets issued a release titled Frequently Asked Questions about Liability of Compliance and Legal Personnel at Broker-Dealers under Sections (b)(4) and 15(b)(6) of the Exchange Act (here).

    SEC Enforcement

    Quarterly and monthly statistics: During the most recent quarter the Commission filed 65 civil injunctive actions and 19 administrative proceedings (excluding follow-on actions and 12(j) proceeding). During the month of September 2013 the SEC filed 38 civil injunctive actions and 11 administrative proceedings. During the same periods last year the agency filed: 74 civil injunctive actions and 36 administrative proceedings for the quarter; 27 civil injunctive actions and 17 administrative proceedings during the month of September 2012.

    Weekly statistics: This week the Commission filed or announced 12 civil injunctive actions and 5 administrative proceeding (excluding follow-on actions and 12(j) proceedings).

    Best execution/fees: In the Matter of Manarin Investment Counsel, Ltd., Adm. Proc. File No. 3-15549 (Filed October 2, 2013) is an action which names as Respondents registered investment adviser Manarin Investment, its affiliated broker-dealer Manarin Securities Corp., and the founder and owner of the two entities, Ronald Manarin. The Order alleges that Mr. Manarin and Manarin Investment failed to obtain best execution and breached their fiduciary duty by purchasing Class A shares of mutual funds rather than institutional shares that were available at a lower cost thus requiring the related funds to pay ongoing 12b-1 fees that could have been avoided. In addition, the Respondent broker charged the related funds fees that exceeded those which are usual and customary. Respondents resolved the proceeding by consenting to the entry of cease and desist orders based on the Sections applicable to them. Specifically, Manarin Investment consented to the entry of an order based on Advisers Act Sections 206(2) and 206(4) and Securities Act Section 17(a). Manarin Securities consented to the entry of an order based on Securities Act Section 17(a) and Investment Company Act Section 17(e). Mr. Manarin agreed to the entry of an order based on Advisers Act Sections 206(2) and 206(4) as well as Investment Company Act Section 34(b) and Securities Act Section 17(a). The Respondents were also censured. As part of the settlement Mr. Manarin and Manarin Securities consented to the entry of an order requiring the payment of disgorgement in the amount of $331,910.51 along with prejudgment interest. Mr. Manarin will, in addition, pay a civil fine of $100,000.

    Unprofessional conduct: In the Matter of Patrio & Zhao, LLC, Adm. Proc. File No. 3-15534 (September 30, 2013) is a proceeding naming as Respondents New Jersey based accounting firm Patrizio & Zhao LLC and one of its partners, Xinggeng (John) Zhao. The Order centers on alleged violations of Rule 102(e) of the Commission’s Rules of Practice in connection with professional work done for Keyuan Petrochemicals, Inc.

    The company is the product of a reverse merger and has its headquarters in the PRC.

    P&Z was retained by the company in 2009 before the reverse merger as the outside, independent auditors. Prior to its replacement at the end of 2010, Keyuan prepared reports included in filings made by the company with the Commission. Subsequently, the company’s Form 10K and its restated reports for 2009 and the first three quarters of 2010 disclosed a series of related party transactions which are at the center of the charges here.

    From the outset Respondent Zhao had reason to believe that the engagement at Keyuan was high risk. The audit firm’s concerns should have been intensified when it encountered a series of red flags beginning with the company’s failure to identify any such transactions in its financial statements and its subsequent discovery of related party transactions. Yet Respondents failed to exercise the required level of care and professional skepticism in view of these facts while improperly relying on the representations of management. Indeed, Respondents failed to properly plan, conduct and document their work in accord with professional standards, according to the Order. In this regard they were a cause of Keyuan’s violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Section 13(a). To resolve the proceeding Respondents each consented to the entry of a cease and desist order based on the Sections cited in the Order. Each Respondent is denied the privilege of appearing or practicing before the Commission as an accountant with a right to request reinstatement after three years. The firm also agreed to implement certain remedial procedures and pay a penalty of $30,000.

    Unprofessional conduct: In the Matter of John Kinross-Kennedy, CPA, Admin. Proc. File No. 3-15536 (Filed Sept. 30, 2013). Since 2009 Mr. Kinros-Kennedy has served as an independent accountant for 23 public companies. The proceeding focuses largely on audits and reviews for six of those issuers. The Order alleges improper professional conduct within the meaning of Rule 102(e)(1)(iv)(B)(2) of the Commission’s Rules of Practice. It also alleges willful violations of Exchange Act Sections 10A(j) regarding audit partner rotation and 10A(k) regarding reports to the audit committee as well as the pertinent rules. The underlying conduct centers on a failure to comply with the pertinent professional standards which include: Failing to exercise due care by not, for example, communicating with the predecessor auditor and the audit committee; failing to obtain sufficient competent evidential matter by, as in one case, not performing any work prior to issuing an opinion; failing to properly assess audit risk and obtain a reasonable assurance about whether the financial statements are free of material misstatement due to error or fraud; failing to properly document work in the audit work papers; and engaging Wilfred Hanson (see below) to perform engagement quality review procedures or EQR without determining that he was qualified. The proceeding will be set for hearing.

    Unprofessional conduct: In the Mater of Wilfred W. Hanson, CPA, Adm. Proc. File No. 3-15537 (Filed Sept. 30, 2013) is related to the action against Mr. Kinross-Kennedy. Mr. Hanson, who at one time was an auditor for Arthur Young & Co., has since 2009 provided forensic accounting and litigation support for a forensic firm. The Order alleges that Mr. Hanson is not qualified to serve as an engagement partner, has not participated in an audit of a public company for over 35 years, has never worked on such an engagement under PCAOB standards and is not competent to serve as the engagement quality review partner. In conducting those procedures, as noted above, he failed to exercise due professional care. The Order thus alleges violations of Rule 102(e)(1)(ii) and 102(e)(1)(iv)(B)(2). To resolve the proceeding Mr. Hanson consented to the entry of an order which denies him the privilege of appearing or practicing before the Commission as an accountant with the right to request reinstatement after five years.

    Unprofessional conduct: In the Matter of Malcolm L. Pollard, CPA, Adm. Proc. File No. 3-15535 (Filed Sept. 30, 2013) is a proceeding naming as Respondents Mr. Pollard and his firm, Malcolm L. Pollard, Inc. The Order centers on his work for three issuers and alleges improper professional conduct within the meaning of 102(e)(1)(ii) and violations of Exchange Act Sections 10A(a)(1) and (b)(1) and the related Rules. The underling conduct centers on allegations that Respondents failed to comply with the pertinent professional standards by failing to: Prepare and maintain adequate work papers; consider and documenting fraud risks; and failing to obtain written management representations. Respondents resolved the proceeding by consenting to the entry of an order directing them to cease and desist form violating the statutory Sections cited in the Order as well as the pertinent Rules. Accordingly, the Respondents are denied the privilege of appearing or practicing before the Commission as an accountant.

    False representations: SEC v. Ramirez, Civil Action No. 7:13-cv-00531 (S.D.Tx. Filed September 30, 2013) is an action centered on claims that the defendants defrauded those seeking a path to citizenship through the EB-5 program. The action names as defendants Marco Ramirez, the director of Operation USA Now, Bebe Ramirez, a director and managing member of the same firm and also the managing member of Now Co. Loan Services, LLC and three related entities. After forming USA Now in 2010 the Ramirez defendants sought to participate in the EB-5 program which provides a path to citizenship for foreign nationals under certain circumstances. The plan was to have USA Now approved as a Regional Center for the program by the U.S. Citizenship and Immigration Service or USCIS which administers the program. If granted USA Now, as a center, would be permitted to charge investors an administrative fee for providing investment opportunities and assisting with the preparation of the necessary paperwork for the visas. While an application was submitted, prior to any approval defendants solicited and obtained investor funds, assuring them the money was safe. It was not. The defendants siphoned it off to other entities and themselves, according to the Commission. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The Court granted the SEC’s request for a freeze order as to the accounts of the defendants. The case is in litigation. The Commission’s Office of Investor Education, in conjunction with the USCIS issued an Investor Alert in connection with this action.

    Investment fund fraud: SEC v. Copland, Civil Action No. 0:13-cv-62127 (S.D. Fla. Filed September 30, 2013) is an action against Jenny E. Copland. Beginning in January 2009, and continuing through the Fall of 2011, Ms. Copland is alleged to have operated an investment fund fraud. Specifically, she raised about $4 million from more than 90 investors, primarily Columbian-Americans and Columbians resident in Florida, who were induced to purchase interesst in her company, Immigration General Services, LLC. Investors were told that the securities would return 5 – 9% interest per month. They were also told that the investments were safe, having FDIC insurance. In fact the funds were used in part to pay other investors. Other portions of the investor funds were misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of 17(a) and Exchange Act Sections 10(b) and 15(a). The U.S. Attorney for the Southern District of Florida filed a parallel criminal action. Both cases are pending.

    `Offering fraud: SEC v. Fisher, Civil Action No. 3:13-cv-00683 (W.D. Wisc. Filed September 30, 2013) is an action against Jeremy Fisher and his companies, The Good Life Financial Group, Inc. and The Good Life Global, LLC. Over a three year period beginning in August 2009 Mr. Fisher raised over $1 million from 18 investors. The funds were supposed to be invested in a “special trading platform” that would generate significant returns. In fact little of the investor money was put in the investment platform which, from the bit of information known to Mr. Fisher about it, was a scam. Rather, much of the investor cash was diverted to Mr. Fisher’s use. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). The defendants resolved the action, consenting to the entry of permanent injunctions prohibiting future violations of the Sections cited in the complaint. In addition, on a joint and several basis, they will pay disgorgement and prejudgment interest totaling $936,226 and a civil penalty of $150,000. See Lit. Rel. No. 22828 (October 2, 2013).

    Looting: SEC v. Universal Travel Group, Civil Action No. 1:13-cv-01492 (D.D.C. Filed September 27, 2013) is an action against the company, a China based travel services entity, and its CEO, Jiangping Jiang, and Interim CFO Jing Xie. Over almost two years beginning in September 2008 the defendants failed to disclose the transfers of about $41 million to 34 unknown entities in Hong Kong and China. The funds came from stock sales in the U.S. The defendants also failed to disclose that UTG had transferred certain subsidiaries to third parties under arrangements that were designed to give UTG the economic benefits of ownership. It also did not disclose the fact that there were inadequate controls and that its revenues and profits in quarterly reports in 2010 were overstated. The complaint alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)-5. The defendants resolved the action, by each consenting to the entry of a permanent injunction based on the Sections cited in the complaint. The two individual defendants will also be barred from serving as an officer or director of a public company for five years. In addition, UTG will pay a civil penalty of $750,000 while Messrs. Jiang and Xie will, respectively , pay $125,000 and $60,000. In a related action the Commission entered an order revoking the registration of the firm’s securities pursuant to Exchange Act Section 12(j). See Lit. Rel. No. 22823 (September 23, 2013).

    Excessive fees: SEC v. Dappah, Civil Action No. 3:13-cv-00546 (W.D.N.C. Filed September 27, 2013) is an action against Frank Dappah and his firm, Yatalie Capital Management The complaint alleges that beginning in March 2012, and continuing through July 2013, Mr. Dappah charged grossly excessive advisory fees. In addition, his firm improperly registered as an investment adviser and made false statements in its Form ADV. The complaint alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2), 203A, 204 and 207. The defendants executed consents to the relief sought in the complaint. See Lit. Rel. No. 22826 (September 27, 2013).

    Misrepresentations: SEC v. OM Investment Management LLC, Civil Action No. 1:13-cv-23486 (S.D. Fla. Filed September 27, 2013) is an action against the investment adviser, its principal, Gignesh Movolia, and its director of investments, Edwin Gaw. The complaint alleges that the defendants made material misrepresentations regarding a series of items including: The holdings of the fund; the fund’s auditor; its sub-adviser; and its administrator. The defendants also failed to register the offering and sale of securities and distributed fabricated account statements. Defendants resolved the action, consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Sections 5(a), 5(c) and 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The injunctions as to the two entities are also based on Advisers Act Sections 203A and 207 and Investment Company Act Section 7(a). The judgment freezes the assets of the defendants. The complaint also seeks disgorgement, prejudgment interest and civil penalties from defendants OM Investment Management and Movolia. Mr. Gaw agreed to pay a civil penalty of $100,000. In addition, defendants Movolia and Gaw consented to the entry of orders barring them from the securities business. See Lit. Rel. No. 22822 (September 27, 2013).

    Option backdating: SEC v. Vitesse Semiconductor Corporation, Civil Action No. 10 Civ. 9239 (S.D.N.Y.) is a previously filed action against, among others, the company, its former CEO, Louis Tomasetta, and its former CFO Eugene Hovanec. The actions centered on an option backdating scheme that took place from 1995 through 2006 and allegations of channel stuffing from September 2001 through April 2006. The Commission settled with defendants Tomasetta and Hovanec. Defendants Tomasetta and Hovanec each consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and the financial reporting, record-keeping, internal controls, false statements to auditors, proxy, and securities reporting provisions. Both defendants also consented to the entry of an order barring them from serving as an officer or director of any public company for ten years. In addition, Mr. Tomasetta will pay $2,126,450 in disgorgement and a $100,000 civil penalty. His disgorgement obligation, which is in satisfaction of a claim to recover the in-the-money benefit from the exercise of backdated options, will be satisfied by his prior payment of $1.2 million and transfer of 814,655 shares of company stock to a fund established in a related class action. Mr. Hovanec will pay $781,280 in disgorgement in satisfaction of the in-the-money benefit claim, and a $50,000 civil penalty. His disgorgement obligation will be deemed satisfied by his prior payment of $250,000 and his transfer of 458,014 shares of Vitesse stock to the settlement fund in a related class action. Finally, the Commission determined not to seek civil penalties against two other defendants who had previously settled but had left the question of a monetary penalty unresolved. See Lit. Rel. No. 22825 (September 27, 2013).

    Investment fund fraud: SEC v. Chapman, Civil Action No. 13-5648 (E.D. Pa. Filed September 26, 2013) is an action against William Chapman, Jr. and his companies, Alexander Capital Markets, LLC and Alexander Financial LLC. Over a three year period beginning in June 2006 defendants induced security holders to transfer their shares to them for use as loan collateral. Investors were told that their securities would be used to hedge or in arrangements with counterparties that would ensure the return of their securities. In fact the funds borrowed were used to pay other investors and for the defendants. The complaint alleges a violations of Exchange Act Section 10(b). The case is in litigation. See Lit. Rel. No. 22820 (September 27, 2013).

    Misappropriation: SEC v. Velten, Civil Action No. 1:13-cv-23477 (September 26, 2013) is an action against Brian Velten. It alleges that he defrauded three senior citizens who held accounts at Fidelity Brokerage Services LLC. Between July 2003 and September 2012 the unregistered investment adviser opened accounts at Fidelity and, while falsely touting his trading expertise, executed transactions without authorization, including engaging in margin transactions. Defendant Velten also drew checks for himself on the accounts. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2). The action is in litigation. See Lit. Rel. No. 22821 (September 27, 2013).

    Prime bank fraud: SEC v. Cooper, Civil Action No. 1:13-cv-05781 (D.N.J. Filed September 27, 2013); SEC v. Frederickson, Civil Action No. 1:13-cv-05787 (D.N.J. Filed September 27, 2013) are two action which center on prime bank fraud schemes. The first names as defendants Brett Cooper and his related companies. The complaint in that action alleges three fraudulent schemes. The first is a prime bank fraud scheme in which Mr. Cooper raised about $1.4 million by claiming to have special access to programs that allowed individuals to pool their funds and obtain an investment opportunity typically only available to Wall Street insiders. Through this opportunity they would have access to instruments from the world’s largest banks and obtain returns of up to 1,000% in as little as 60 days. In the second Mr. Cooper offered investors the opportunity to participate in the purchase and trade of a $100 million bank guarantee if the investor funds were pooled in an attorney trust account. The investment opportunity and the account were fraudulent. The third involved the sale of a claimed Brazilian sovereign bond. An investor was told that $50,000 was necessary as a fee to locate an investor and open a brokerage account to market the bond. The documents for the account were forged. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a).

    The second action is against attorney David Frederickson and his law office. It alleges that he aided and abetted Brett Cooper in two of his prime bank schemes by serving as the escrow agent. The defendants resolved this action, consenting to the entry of permanent injunctions which prohibit future violations of Exchange Act Section 10(b). The injunctions also prohibit each of the defendants from participating in the issuance, offer, or sale of securities involving bank guarantees, medium term notes and similar instruments. The defendants, jointly and severally, paid disgorgement and prejudgment interest of $7,257 and a civil penalty of $25,000. Mr. Frederickson also consented in a separate proceeding to the entry of an order under Rule 102(e)(30 suspending him from appearing and practicing before the Commission as an attorney.

    Offering fraud: SEC v. Petro-Suisse Ltd., Civil Action No. 12-CV-6221 (S.D.N.Y.) is a previously filed action against the company and Mark Gasarch. The action centers on 21 limited partnership interests offered by Petro-Suisse to finance drilling which contained materially false and misleading information. On September 26, 2013 the Court entered final judgments against the defendants prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The order also requires that the defendants, jointly and severally, pay disgorgement of $8,370,000 which is deemed satisfied by previous payments made by the company. In addition, Mr. Gasarch was ordered to pay a civil penalty of $130,000. See Lit. Rel. No. 22829 (October 2, 2013).

    Investment fund fraud: SE v. Fujinaga, Civil Action No. 2:13-cv-01658 (D. Nev. Filed under seal on September 11, 2013) is an action against Edwin Fujinaga, MRI International, Inc. and CSA Service Center, LLC which centers on a claim that over $800 million was raised from investors based on misrepresentations. Specifically, investors were told that their funds would be used to purchase medical accounts receivable that medical providers in the U.S. held against insurance companies. The instruments would be purchased at a discount and then the defendants would attempt to resell them at a higher value. In fact much of the investor money was used to either pay other investors or for the personal use of Mr. Fujinaga. The complaint alleged violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b0. The Court entered a freeze order. The case is pending. See Lit. Rel. No. 22832 (Oct. 3, 2013).

    FINRA

    Disclosure: A proceeding was filed seeking a temporary cease and desist order against John Carris Investments LLC and its CEO, George Carris. The action seeks to halt the solicitation of customers to purchase Fibrocell Science, Inc. without making the proper disclosures. Respondents are also alleged to have fraudulently sold stock and notes in Fibrocell’s parent firm, Invictus Capital, Inc. by failing to disclose is poor financial condition.

    Australia

    The sole director of Sonray Capital Markets Pty Ltd, a firm licensed by the Australian Securities & Investments Commission, pleaded guilty to seven criminal charges including false accounting, furnishing false documents to the ASIC, theft and obtaining financial advantage by deception. The charges stem from taking funds from client trading accounts which ultimately resulted in a deficiency in the segregated client account funds. In a solvency report Mr. Johnson also made a false statement about equity injections of $5.2 million into Sonray. Previously, the CEO of the company pleaded guilty to criminal charges and was sentenced to five years in prison.

    SEC Files Another Case Tied To The EB-5 Path To Citizenship Program

    October 02, 2013

    The EB-5 program is popular among many seeking a path to citizenship in the United States. Created as part of the 1990 Immigration and Nationality Act, it gives foreign nationals two possible paths to citizenship. One provides an opportunity for a green card if a foreign national invests $1 million creating or preserving jobs for at least 10 U.S. workers in this country. The other creates an opportunity for those who invest $500,000 in a high unemployment or rural area. The program is administered by the U.S. Citizenship and Immigration Service or USCIS.

    The program also attracts fraudsters. The Commission just brought its second enforcement action this year centered on alleged fraudsters abusing the program. SEC v. Ramirez, Civil Action No. 7:13-cv-00531 (S.D.Tx. Filed September 30, 2013). The action names as defendants Marco Ramirez, the director of Operation USA Now, Bebe Ramirez, a director and managing member of the same firm and also the managing member of Now Co. Loan Services, LLC and three related entities, USA Now, LLC, USA Now Energy Capital Group, LP, and Now Co. Loan Services, LLC.

    After forming USA Now in 2010 the Ramirez defendants sought to participate in the EB-5 program. The plan was to have USA Now approved as a Regional Center for the program. That approval would have to come from USCIS. If granted USA Now, as a center, would be permitted to charge investors an administrative fee for providing investment opportunities and assisting with the preparation of the necessary paperwork for the visas. The application submitted by the Ramirez defendants was for a geographic region in South Texas. The business sectors listed in it included retail property development, general office, medical office and others.

    Before USCIS approved the application to become a center, the Ramirez defendants began soliciting investors. Initially, they targeted Mexican investors and later others. Investors were told that their funds would be held in escrow until they received USCIS approval. Once the funds were released the money was to be used for a specific business purpose.

    The defendants did not hold the investor funds in escrow, according to the Commission’s complaint. Rather, the investor funds were many times immediately diverted to other undisclosed businesses or to the personal use of the individual defendants. To date none of the investors identified by the SEC have received even a conditional visa.

    In July 2013 the FBI seized assets at the offices of the Defendants. Nevertheless, the Defendants continue to control the accounts containing investor funds. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The Court granted the SEC’s request for a freeze order as to the accounts of the defendants. The case is in litigation.

    This is not the first case filed by the Commission related to the EB-5 program. In February 2013 the agency filed another action which centered on the program. That action also alleges that investors and persons seeking a path to U.S. citizenship were being defrauded. SEC v. A Chicago Convention Center, LLC, Case No. 13 cv 982 ((N.D. Ill. Filed Feb. 6, 2013). This case is also in litigation.

    SEC Brings Another Gatekeeper Case

    October 01, 2013

    Operation Broken Gate, announced Monday in a press release by the SEC, focuses on holding gatekeepers accountable. Three proceedings against accounts were included in the announcement. Focusing on gatekeepers as a means of policing the markets and halting violations is, of course, nothing new. It has long been a Commission priority.

    Another gatekeeper case initiated at the time Operation Broken Gate was announced is the proceeding against New Jersey based accounting firm Patrizio & Zhao LLC and one of its partners, Xinggeng (John) Zhao. In the Matter of Patrio & Zhao, LLC, Adm. Proc. File No. 3-15534 (September 30, 2013). The Order centers on alleged violations of Rule 102(e) of the Commission’s Rules of Practice in connection with professional work done for Keyuan Petrochemicals, Inc.

    Keyuan is a Nevada corporation whose shares were registered with the Commission under Section 12(g) of the Exchange Act. The headquarters of the company is located in the PRC. The company is the product of a reverse merger. Prior to being delisted, its shares were listed on NASDAQ. Now the shares of the company are quoted on OTC Link.

    P&Z was retained by the company in 2009 before the reverse merger as the outside, independent auditors. Prior to its replacement at the end of 2010, Keyuan prepared reports included in filings made by the company with the Commission. In October 2010 the company filed an annual report on Form 10K. Subsequently, it restated its quarterly reports for 2009 and the first three quarters of 2010. The Form 10K and the restated quarterly reports disclosed for the first time a series of related party transactions. Those involved loan guarantees, purchases of raw materials, sales of products and short term cash transfers for financing purposes as well as transactions involving the company and its CEO and controlling shareholder and other persons.

    The alleged unprofessional conduct of Respondents centered on its failures in connection with the related party transactions. From the outset Respondent Zhao had reason to believe that the engagement at Keyuan was high risk. The company was new. It did not have employees knowledgeable about U.S. accounting requirements. Chinese audit clients were typically high risk. And, those companies engaged in related party transactions.

    Those concerns should have been intensified when, during the work, a series of red flags were encountered. Those demonstrated that the company had not properly identified and disclosed related party transactions. The red flags included:

    Audit planning: During the audit planning the vice president of accounting told Respondents that there were no related party transactions, a fact reflected in the financial statements prepared by an outside consultant.

    Identifying transactions: During the course of the work the P&Z staff obtained a list of related party transactions from the company. Later Respondents determined the list was incomplete.

    Specific documents: As the work progressed documents depicting related party transactions were reviewed while others suggested that additional procedures and work on the question were required.

    Management representation letter: The CEO signed a management representation letter which stated that material related party transactions, including sales, payables, and guarantees, had been properly recorded or disclosed in the financial statements despite the fact that there were no such disclosures.

    Respondents failed to exercise the required level of care and professional skepticism in view of these facts. Likewise, they improperly relied on the representations of management and did not obtain sufficient evidential matter and properly audit the related party transactions. Indeed, Respondents failed to properly plan, conduct and document their work in accord with professional standards, according to the Order. In this regard they were a cause of Keyuan’s violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Section 13(a).

    To resolve the proceeding Respondents each consented to the entry of a cease and desist order based on the Sections cited in the Order. Each Respondent is denied the privilege of appearing or practicing before the Commission as an accountant with a right to request reinstatement after three years. The firm also agreed to implement certain remedial procedures and pay a penalty of $30,000.

    The SEC’s Operation Broken Gate: Holding Gatekeepers Responsible

    September 30, 2013

    Operation Broken Gate is the SEC’s effort to hold gatekeepers accountable. In announcing the initiative, the agency filed three actions involving auditors. Two were settled while a third is in litigation.

    The action which will be set for hearing is against sole practitioner John Kinross-Kennedy, In the Matter of John Kinross-Kennedy, CPA, Admin. Proc. File No. 3-15536 (Filed Sept. 30, 2013). He is a PCAOB registered auditor. Since 2009 Mr. Kinros-Kennedy has served as an independent accountant for 23 public companies. The proceeding focuses largely on audits and reviews for six of those issuers. All of Respondent’s reports were issued in 2011 and 2012 while the periods range from 2009 through 2010.

    The Order alleges improper professional conduct within the meaning of Rule 102(e)(1)(iv)(B)(2) of the Commission’s Rules of Practice. The charge is based on alleged willful violations of Exchange Act Sections 10A(j) regarding audit partner rotation and 10A(k) regarding reports to the audit committee as well as the pertinent rules.

    The underlying conduct centers on a failure to comply with the pertinent professional standards which include:

    Due care: Respondent did not have the required degree of skill commonly possessed by auditors and failed to exercise due care. This was evidenced by his failure to communicate with the predecessor auditor and the audit committee as well as his unfamiliarity with certain changes in GAAP. In addition, at times he used outdated audit templates and used client personnel to perform audit steps.

    Failure to obtain sufficient competent evidential matter: While the pertinent audit standards require that the auditor obtain sufficient competent evidential matter to afford a reasonable his for his opinion, Respondent here did not. For example for a review for one issuer he failed to perform any audit procedures prior to issuing his opinion.

    Audit risk: Professional standards require that the auditor plan and perform the work to obtain a reasonable assurance about whether the financial statements are free of material misstatement due to error or fraud. For three issuers Respondent failed to obtain sufficient evidence.

    Work papers: Professional standards require that the auditor document his work sufficiently to enable an experienced auditor to understand the nature, timing, extent and results of the procedures performed, the work done and the conclusions. Although Respondent performed much of the work himself, he failed to prepare adequate documentation.

    Engagement quality review: Audit standards require that the auditor obtain an EQR and concurring approval to issue the engagement report for each audit and interim review engagement. While Wilfred Hanson (see related action below) was engaged to undertake this function for five of the 40 audit reports he issued for fiscal years beginning on or after December 15, 2009, for the same period he did not obtain any such reviews for 35 other engagements. In addition, he did not determine if Mr. Hanson was actually qualified to conduct the reviews assigned to him.

    Communication with audit committee: Professional standards require that the auditor have certain communications with the audit committee. The subjects include the auditor’s responsibility under PCAOB standards; significant accounting policies; management’s judgment’s and accounting estimates and other items. Here Respondent failed to undertake these communications.

    Communication with predecessor: The applicable standards also require that the auditor communicate with the predecessor auditor or obtain sufficient competent evidential matter to afford a reasonable basis for his report. Here, for example, Respondent included an issuer’s prior year financial statements in his report without obtaining that evidence or communicating with his predecessor so that a review of that firm’s work papers could be undertaken.

    Other failures: The Order also alleges that Respondent failed to evaluate the adequacy of the issuer’s disclosure of related party transactions, to control the confirmation process and to follow the auditor rotation requirements.

    In the Mater of Wilfred W. Hanson, CPA, ADm. Proc. File No. 3-15537 (Filed Sept. 30, 2013) is related to the action against Mr. Kinross-Kennedy. Mr. Hanson, who at one time was an auditor for Arthur Young & Co., has since 2009 provided forensic accounting and litigation support for a forensic firm. The Order alleges that Mr. Hanson is not qualified to serve as an engagement partner, has not participated in an audit of a public company for over 35 years, has never worked on such an engagement under PCAOB standards and is not competent to serve as the engagement quality review partner. In conducting those procedures, as noted above, he failed to exercise due professional care. The Order thus alleges violations of Rule 102(e)(1)(ii) and 102(e)(1)(iv)(B)(2). To resolve the proceeding Mr. Hanson consented to the entry of an order which denies him the privilege of appearing or practicing before the Commission as an accountant with the right to request reinstatement after five years.

    The third action is In the Matter of Malcolm L. Pollard, CPA, Adm. Proc. File No. 3-15535 (Filed Sept. 30, 2013) which is a proceeding naming as Respondents Mr. Pollard and his firm, Malcolm L. Pollard, Inc. The Order centers on his work for three issuers and alleges improper professional conduct in violation of Rule 102(e)(1)(ii) and of Exchange Act Sections 10A(a)(1) and (b)(1) and the related Rules. The underling conduct centers on allegations that Respondents failed to comply with the pertinent professional standards by: Repeatedly failed to prepare and maintain adequate work papers; consider and document fraud risks; obtain engagement quality review; and obtain written management representations. Respondents resolved the proceeding by consenting to the entry of an order directing them to cease and desist form violating the statutory Sections cited in the Order as well as the pertinent Rules. Accordingly the Respondents are denied the privilege of appearing or practicing before the Commission as an accountant.