July 11, 2013
Statistics for case filings at the end of the second calendar quarter reflected a continuation of earlier trends regarding the filing of SEC enforcement actions. Over the first half of this year the number of cases declined significantly compared to the same period one year earlier. Likewise, the number of cases brought in the second quarter of 2013 dropped substantially compared to the same period last year.
The Commission issued rules this week under the JOBS Act, lifting a solicitation ban for certain private offerings. Earlier this month, however, a district court vacated the Commission’s rules requiring the disclosure by resource extraction issuers of certain payments made to foreign governments, concluding that the SEC misread the enabling legislation.
The Commission brought another “suspicious trading” insider trading case against unknown traders, quickly filing its case and securing an asset freeze. The agency also filed an insider trading action against the wife of a corporate insider, his long time friend and the friend’s broker.
Finally, in a ruling which may have a significant impact in FCPA cases, Judge Gleeson in the Eastern District of New York held that the court has the authority to approve and monitor a deferred prosecution agreement filed by the parties with the court. The ruling was made in the HSBC money laundering case.
Rule making: The Commission adopted a new rule to implement a JOBS Act requirement, lifting the ban on general solicitation or advertising for certain private securities offerings (here). At the same time the agency adopted amendments to rules implemented disqualifying felons and other “bad actors” from reliance on Rule 506 of Regulation D (here). The SEC also proposed amendments to Regulation D, Form D and Rule 156 to permit enhance its ability to evaluate the development of market practices in Rule 506 offerings (here). See also the statement of Commissioner Louis A. Aguilar, posted on the Harvard Law School Forum on Corporate Governance blog, Thursday, July 11, 2013 arguing that additional investor protections are required (here).
New task forces: The Commission announced the formation of two new task forces and an analytics group. The task forces will focus on financial statement fraud and microcap fraud. A new Center for Risk and Quantitative Analytics is being initiated to support the groups (here).
Remarks: Commissioner Elisse B. Walter delivered remarks titled Corporate Disclosure: The State, the Audience and the Players, at the Stanford Directors College, Palo Alto, CA (June 25, 2013). Her remarks focused on providing investors with the full picture in disclosure, not just the regulatory minimum (here).
SEC Enforcement: Filings and settlements
Half year statistics: In the first half of 2012 the Commission filed 150 enforcement actions (excluding tag-a-long proceedings, which are really an additional remedy adjunct to another action, and delisting proceedings). During the same period this year the SEC filed a total of 116 enforcement actions. Similarly, in the second quarter of 2012 the Commission initiated 99 enforcement cases compared to just 51 in the most recent quarter.
Two week statistics: This week the Commission filed 7 civil injunctive actions and no administrative proceedings (excluding follow-on actions and 12(j) proceedings).
Offering fraud: SEC v. Arias, Civil Action No. 12-cv-2937 (E.D. N.Y.) is a previously filed action against Martin Hartmann and Laura Ann Tordy, among others, relating to the sale of interests in Agape World, Inc. which engaged in an offering fraud and Ponzi scheme. The two defendants, who sold interests in the fund, settled with the Commission and judgment was entered. Each consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). In addition, Mr. Hartmann was ordered to pay $3,591,388 in disgorgement along with prejudgment interest and a penalty in the amount of the disgorgement. Ms. Tordy was ordered to pay $1,048,485 in disgorgement along with prejudgment interest and a civil penalty equal to the amount of the disgorgement. See also Lit. Rel. No. 21748 (July 11, 2013).
False statements: SEC v. Merkin, Civil Action No. 1:11-cv-23585 (S.D. Fla.) is a previously filed action against attorney Stewart A. Merkin. The Commission prevailed on a summary judgment motion in an action which alleged that Mr. Merkin wrote letters on four occasion that he permitted to be posted on the website for the Pink Sheets stating that StratoComm Corporation was not under investigation by the SEC. At the time he was representing the company and others in the inquiry. Mr. Merkin consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and requiring him to pay a total of $125,000 in disgorgement, prejudgment interest and civil penalties. He is also barred from participating in any penny stock offering. Mr. Merkin retains his right to appeal the summary judgment ruling. See also Lit. Rel. No. 22746 (July 9, 2013).
Investment fund fraud: SEC v. Fowler, Civil Action No. 8:13-cv-1747 (M. D. Fla. Filed July 8, 2013) is an action against John Fowler, his son Jeffrey and Julianne Chalmers. Beginning in January 2011, and continuing over the next several months, John and Jeffrey Fowler raised about $4.3 million from 70 investors who purchased promissory notes in a fund that was supposedly affiliated with a prominent hedge fund. Investors were told that the returns for the fund were guaranteed. False promissory notes were issued along with related security materials. The fund was in fact a Ponzi scheme. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). A parallel criminal case was brought against John and Jeffrey Fowler. Both men were convicted and are serving prison sentences. See also Lit. Rel. No. 22744 (July 8, 2013).
Insider trading: SEC v. One or More Unknown Traders in the Securities of Onyx Pharmaceuticals, Inc., (S.D.N.Y. Filed July 3, 2013) is a “suspicious trading” action centered on the proposed acquisition of Onyx Pharmaceutical by Amgen, Inc. On Sunday, June 30 Onyx, announced that it had received but rejected a bid to purchase the outstanding shares of the company from Amgen, Inc., priced at $120 per share.
The transaction began on June 13, 2013 when Amgen’s CEO met with his counterpart from Onyx. At the meeting Amgen’s CEO made an unsolicited oral offer to acquire Onyx. The offer was followed by a written proposal the next day, forwarded to the board that same day. On June 26, 2013, Onyx’s board met and rejected the offer. Two days later on Friday, June 28, 2013, that decision was conveyed to Amgen. The same day an article appeared in the Financial Post, a Canadian publication, regarding the offer. Amgen, however, did not issue an announcement about the proposal until Sunday, June 30, 2013. Unknown purchasers began buying call options in Onyx on June 26, the day the Onyx board met to consider the offer. The purchases continued until Friday through accounts at Citigroup Global Markets, Inc. and Barclays Capital, Inc. On Monday, July 1, 2013, the first trading day after the announcement of the rejected deal, Onyx shares closed at $131.33, an increase of $44.51 or about 51% over the prior day’s closing price. The options in the two accounts, purchased for about $305,000, were worth about $4.6 million, an increase of almost 14,200% in three trading days. Those profits are now frozen under the court’s order. The case is in litigation.
Unregistered securities: SEC v. Tavella, Civil Action No. 13 civ 4609 (S.D.N.Y. Filed July 3, 2013) is an action against two groups of defendants. The first, denominated the selling defendants, includes Magdalena Tavella, Andres Horacio Fieicchia, Gonalo Garcia Blaya, Lucia Mariana Hernando, Cecilia De Lorenzo, Adriana Rosa Bagattin, Daniela Patricia Goldman and Mariano Pablo Ferrari. The second includes Mariano Graciarena and Fernando Loureyro. All the defendants are citizens of Argentina. In the last thirty days the selling defendants deposited about $34 million worth of shares of Biozoom, Inc. into their brokerage accounts and sold them. About $17 million of those proceeds have been wired out of the country. The other two defendants have deposited about 4.4 million shares of the company into their accounts. Biozoom was previously known as Entertainment Arts. When the name was changed the company altered its business model from making leather goods to developing biomedical technology. No registration statement is in effect for the shares. Papers purporting to demonstrate that the shares are free trading furnished by the selling defendants are false, according to the allegations in the court papers. The Commission’s complaint alleges violations of Securities Act Section 5 and 20(b). The Commission obtained a freeze order over all of the accounts. The case is in litigation.
Investment fund fraud: SEC v. Franquelin, Civil Action No. 1:13-cv-00096 (D. Utah Filed July 2, 2013) is an action against Armand Franquelin and Martin Pool alleging that from January 2006 through August 2010 the two men raised about $12 million by selling interests in the Elvia Group to about 130 investors. Elvia was supposed to invest in real estate and pay returns of 10% to as much as 240% per year. In fact the funds were diverted to the personal use of the defendants. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). Mr. Pool settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. He also agreed to pay disgorgement of $970,510 and prejudgment interest. Payment of those sums and a civil penalty were waived based on financial condition. See also Lit. Rel. No. 22740 (July 2, 2013).
Insider trading: SEC v. Murrell, Civil Action No. 2:13-cv-12856 (E.D. Mich. July 1, 2013). The case centers on the acquisition of Rohm & Haas Co. by The Dow Chemical Company, announced on July 10, 2008. The defendants are Mack Murrell, now husband of Stacey Murrell, an administrative assistant to Dow’s CFO, his longtime friend, David Teekell and Mr. Teekel’s broker, Charles Adams. In early June 2008 Rohm began discussions about the possible sale of the company with Dow and two others.
On July 2, 2009 Dow held a special board meeting which approved a cash offer for Rohm at a price of up to $78 per shares. The next morning Mr. Murrell emailed David Teekell asking him to call, noting he had lost the phone number. Later that day the two men spoke in what became a series of telephone calls. That same day Mr. Teekell called his broker, Defendant Adams. Between the date of the email and the deal announcement the two men had multiple contacts, although Mr. Murrell was traveling in the Middle East.
As the two men communicated they acquired significant options positions. Following the deal announcement, Rohm closed at $73.62, up 64%. Mr. Teekell had profits of $534,526. Mr. Adams had profits of $64,450. Two customers for whom Mr. Adam traded through discretionary accounts had profits of $42,596. The complaint alleges violations of Exchange Act Section 10(b). David Teekell agreed to settle with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to disgorge his trading profits, pay prejudgment interest and a penalty equal to the amount of the disgorgement. The other defendants did not settle. See also Lit. Rel. No. 22738 (July 1, 2013).
Investment fraud: SEC v. Madison, Civil Action No. 3:13-cv-2499 (N.D. Tex. Filed June 28, 2013) is an action naming as defendants Matthew Madison, Dwight McGhee and Infinity Exploration, LLC. The complaint alleges that the two men conducted a fraudulent offering of interests in Infinity by assuring investors that they would obtain an interest in the firm’s two oil and gas joint ventures. In fact Infinity did not own the ventures but only indirect interests. The offering materials also erroneously described Mr. Madison’s experience and omitted his federal felony conviction. About $2 million was raised from 40 investors. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See also Lit. Rel. No. 22736 (July 1, 2013).
Financial fraud: SEC v. JBI, Inc., Civil Action No. CA. No. 1:12-cv-10012 (D. Mass. Filed Jan. 4, 2012) is a previously filed action against the firm, John Bordynuik, the CEO of the firm, and Ronald Baldwin, Jr., its CFO. Mr. Bordynulk and the firm settled with the Commission. The complaint alleged that in 2009 JBI materially falsified its financial statements by overstating the value of certain assets. Those financial statements were then used in two PIPE offerings to raise over $8.4 million. Each settling defendant consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The firm will also pay a penalty of $150,000 while Mr. Bordynulk will pay $110,000 and be barred for five years from acting as an officer or director of a public company. See also Lit. Rel. No. 22735 (June 27, 2013).
Internal controls: SEC v. Fuqi International, Inc., Civil Action No. 1:13-cv-995 (D.D.C. Filed July 1, 2013). Fuqi is a PRC based jewelry company whose chairman, president and CEO is defendant Yu Kwai Chong, a Chinese national. While completing a restatement, the outside auditors discovered that between September 2009 and November 2010 Mr. Chong had directed the transfer of about $134 million in over 50 transactions from firm bank accounts to accounts at other banks for three jewelry companies in China. The transfers were booked as “other payables” or “prepaids.” The board of directors was unaware of the transactions. An internal investigation was conducted during which Mr. Chong explained that he authorized the transactions at the request of a local bank manager despite the fact that he did not know the three companies to which the funds were transferred. Few records were available, although the funds were returned. The company lacked adequate internal accounting controls, according to the SEC’s complaint. Fuqi’s treasury controls, for example, did not require that internal fund transfer applications identify any specific business purpose or be supported by documentation and there was no effective reconciliation process. The SEC’s complaint alleges violations of Exchange Act Section 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). Fuqi and Mr. Chong settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of the federal securities laws. In addition, the company and Mr. Chong were directed to pay civil penalties of, respectively, $1 million and $150,000. Mr. Chong was also barred from serving as an officer and director of a public company for five years. See also Lit. Rel. No. 22739 (July 1, 2013).
Other SEC litigation
Rulemaking: American Petroleum Institute v. SEC, Civil Action No. 12-1668 (D.D.C. Opinion issued July 2, 2013) is an action centered on the rules issued by the Commission under Section 13(q) of the Exchange Act, added under Dodd-Frank. The section requires the disclosure of certain payments made to foreign governments by resource mineral extraction issuers. Subsection (2)(A) of the section provides that: “the Commission shall issue final rules that require each resource extraction issuer to include in an annual report any payment made . . . to a foreign government .. . for the purpose of the commercial development of oil, natural gas, or minerals . . . “ Subsection (3)(A), concerning the public availability of this information, states in part that “To the extent practicable, the Commission shall make available online, to the public, a compilation of the information required to be submitted under the rules issued under paragraph (2)(A).” (emphasis added). The Commission’s implementing rules require that the annual report of the issuer be made public. The agency also refused to grant an exemption for countries which barred such disclosures despite acknowledging prohibitive costs.
On cross-motions for summary judgment, the district court ruled in favor of plaintiffs and against the Commission. First, the rule requirement that the annual report be made public is not supported by the plain language of the provision dispositive, according to the court. There is nothing in Subsection (2)(A) which mandates filing an annual report which specifies that it is to be made public.
Second, the SEC’s refusal to grant the requested exemption was “arbitrary and capricious.” By summarily stating that it could not grant an exemption the Commission ignored the plain meaning of the term “exemption.”
Investment fund fraud: U.S. v. Walji (S.D.N.Y. July 2, 2013) is an action against Abdul Walji and Reniero Francisco, respectively, the CEO and President of Arista LLC, an investment fund. Mr. Walji pleaded guilty to one count of conspiracy to commit securities fraud and wire fraud, one count of commodities fraud and one count of securities fraud. Mr. Francisco pleaded guilty to one count of conspiracy to commit securities fraud and wire fraud and one count of securities fraud. The guilty pleas were based on two fraudulent schemes. First, as to Arista, both defendants solicited investors in 2010 and 2011. In doing so they misrepresented the nature of the investments and furnished investors with false accounting documents concealing their actual operating losses. About $2.7 million in investor funds were misappropriated. In a second scheme, conducted by Mr. Walji from early 2008 through June 2013, the defendant used pension plan funds he administered to defraud investors through a series of misrepresentations regarding their investments and the performance of the funds. In addition, Mr. Walji misappropriated about $300,000 of investor funds. There were about 35 victims of each scheme. Losses for each were about $10 million.
Deferred prosecution agreements
Deferred prosecution agreements: U.S. v. HSBC Bank USA, N.A., Case No. 12-CR-763 (E.D.N.Y. Order dated July 1, 20130) is an action in which Judge Gleeson held that parties submitting a deferred prosecution agreement to the court have placed “a criminal matter on the docket of a federal court [and have thus] . . . subjected their DPA to the legitimate exercise of that court’s authority.” While Judge Gleeson approved the deferred prosecution agreement, he will continue to monitor it despite the arguments of the parties. The case is based on violations of the Bank Secrecy Act and the International Emergency Economic Powers Act by HSBC Bank and HSBC Holdings Plc. To resolve the charges the defendants entered into a deferred prosecution agreement. The government filed a criminal information alleging the violations along with the deferred prosecution agreement with the court and the parties requested that the court exclude for purposes of the Speedy Trial Act, the term of the DPA.
The critical question here was the authority of the Court with respect to the DPA. Judge Gleeson held that “This Court has authority to approve or reject the DPA pursuant to its supervisory power.” Here the parties chose to initiate a proceeding before the Court by placing on the docket a federal criminal case and requesting a ruling as to the Speedy Trial Act. This implicated the powers and authority of the Court. “By placing a criminal matter on the docket of a federal court, the parties have subjected their DPA to the legitimate exercise of that court’s authority,” the court held. After reviewing the terms of the DPA Judge Gleeson approved it. He also held that “my approval is subject to a continued monitoring of its execution and implementation.”
July 10, 2013
The SEC lost another rule writing case. This time the court vacated its Dodd-Frank rules requiring certain companies to make disclosures regarding payments to foreign governments in connation with the commercial development of oil, natural gas or minerals. Unlike earlier losses, the court did not fault the Commission’s economic analysis. Rather, it concluded that “the Commission misread the statute to mandate public disclosure of reports, and its decision to deny any exemption was, given the limited explanation provided, arbitrary and capricious.” American Petroleum Institute v. SEC, Civil Action No. 12-1668 (D.D.C. Opinion issued July 2, 2013).
The case focuses on rules written by the SEC to implement Section 13(q) of the Exchange Act, added under Dodd-Frank. The section was intended to address what is known as the “resource curse,” that is, the situation where poor countries with abundant natural resources such as oil suffer continued impoverishment and corruption because money paid for the resources ends up “lining the pockets of the rich or is squandered on showcase projects instead of productive investments . . . “ according to Congressional findings made at the time.
Section 13(q) provides in Subsection (2)(A) that: “Not later than 270 days after July 21, 2010 the Commission shall issue final rules that require each resource extraction issuer to include in an annual report of the resource extraction issuer information relating to any payment made by the resource extraction issuer . . . to a foreign government . .. . for the purpose of the commercial development of oil, natural gas, or minerals . . . “ Subsection (3)(A), concerning the public availability of this information, states in part that “To the extent practicable, the Commission shall make available online, to the public, a compilation of the information required to be submitted under the rules issued under paragraph (2)(A).” (emphasis added).
The Commission drafted rules implementing the Section. Those rules provide, in part, that the annual report required by Subsection (2)(A) be made public. The Commission rejected comments noting that this would require the disclosure of commercially sensitive information. In doing so the agency stated that under the statute it was “bound to require public filing . . . “ The SEC also rejected a request for an exemption regarding four countries – Angola, Cameroon, China and Qutar – where such disclosures are prohibited by law. The SEC acknowledged that declining the request could “add billions of dollars of costs to affected issuers, and hence have a significant impact on their profitability and competitive position . . .” Nevertheless, the agency declined the request for an exemption because it viewed it as inconsistent with the structure and purpose of the statute.
The American Petroleum Institute challenged the rules, filing suits in the Court of Appeals and the District Court. The Court of Appeals held that suit should be brought in the first instance in the district court. On cross- motions for summary judgment, the district court ruled in favor of plaintiffs and against the Commission. The court viewed the resolution of the motions as a question of law for which no deference to the SEC is due. While deference to an administrative agency is due under Chevron USA, Inc. v. natural Res. Def. Cuncil, Inc., 467 U.S. 837 (1984), that only applies to the question of the agency’s interpretation of the statute if “Congress has not directly spoken to the precise question at issue . . . “ Here the Commission viewed it self as bound by the statute. Accordingly, since Congress has specifically addressed the question, according to the SEC, no deference is due under Chevron.
Turning to the first question regarding the reports filed with the SEC and whether they must be made public, the court found the plain language of the section dispositive: “The statute’s plain language poses an immediate problem for the Commission, for it says nothing about public filing of these reports. To state the obvious, the word ‘public’ appears nowhere in this provision.” Indeed, there is nothing in Subsection (2)(A) which mandates filing an annual report which specifies that it is to be made public.
The court buttressed this reading of the statute by citing Subsection (3)(A). That Subsection discusses public availability in the form of a “compilation of the information,” not an annual report, which is made available only to the “”extend practicable.’” The “natural reading of this provision, is that, if disclosing some of the information publicly would compromise commercially sensitive information and impose high costs on shareholders and investors, then the Commission may selectively omit that information from the public compilation. The Commission points to nothing prohibiting that reading.”
Finally, the court concluded that the “denial of any exemption for countries that prohibit payment disclosure was arbitrary and capricious.” The Commission’s claim that such an exemption would be inconsistent with the Act ignored the provisions of that Act, according to the court: “But this argument ignores the meaning of ‘exemption,’ which by definition, is an exclusion or relief from an obligation, and hence will be inconsistent with the statutory requirement on which it operates.” While it might be reasonable for the Commission to find that a request for an exemption for a “certain issuer or about a certain country goes to the heart of the provision’s goal, and that the burden reduction is not worth this loss . . . [here] the Commission impermissibly rested on the blanket proposition that avoiding all exemptions best furthers section 13(q)’s purpose.” In doing so the agency failed to specifically consider the situation regarding a specific country or issuer. A “fuller analysis” is warranted rather than just a general statement. Accordingly, the court vacated the rule and remanded to the Commission.
July 09, 2013
In SEC v. Citigroup Global Markets, Case No. 11-5227-cv (2nd Cir.) the critical issue is the role of the court when presented with a proposed consent decree. There the SEC asked U.S. District Judge Rakoff to enter a consent decree negotiated by the parties which would have imposed an injunction, certain ancillary relief and a fine. The court declined. The SEC appealed. While much has been written about the case and the role of the Commission’s neither admit nor deny settlement policy, the ultimate question in the action is the role of the court when it is requested to lend its authority to implement a consent decree.
Now that question has been raised in a criminal case involving a deferred prosecution agreement which may have significant implications for FCPA actions. In U.S. v. HSBC Bank USA, N.A., Case No. 12-CR-763 (E.D.N.Y. Order dated July 1, 20130) Judge Gleeson held that parties submitting a deferred prosecution agreement to the court have placed “a criminal matter on the docket of a federal court [and have thus] . . . subjected their DPA to the legitimate exercise of that court’s authority.” While Judge Gleeson approved the deferred prosecution agreement, he will continue to monitor it despite the arguments of the parties.
The case is based on violations of the Bank Secrecy Act and the International Emergency Economic Powers Act by HSBC Bank and HSBC Holdings Plc. Specifically, the defendants were charged with failing to maintain an effective anti-money laundering or AML program and willfully facilitating financial transactions on behalf of sanctioned entities. The collective failures of the AML program permitted Mexican and Columbian drug traffickers to launder at least $881 million in drug trafficking proceeds through HSBC Bank USA undetected, according to the agreed statement of facts. HSBC Group also knowingly and willfully engaged in practices outside the U.S. which caused HSBC Bank USA and other U.S. financial institutions to process payments on behalf of banks and other entities located in Cuba, Iran, Libya, Sudan and Burma in violation of U.S. sanctions.
To resolve the charges the defendants entered into a deferred prosecution agreement. Under the terms of that agreement, the defendants admitted criminal liability and to a detailed statement of facts regarding the events surrounding the violations. They also agreed to continue cooperating with the government, to complete certain remedial steps initiated and to undertake others. The agreement requires that a monitor be in place for five years. At the end of that time the case would be dismissed.
The government filed a criminal information alleging the violations along with the deferred prosecution agreement with the court. The parties then requested that the court exclude for purposes of the Speedy Trial Act, the term of the DPA. At the same time the DOJ and the defendants asserted that the “Court lacks any inherent authority over the approval or implementation of the DPA.” Judge Gleeson rejected this claim.
Initially, the question regarding the Speedy Trial Act is committed to the discretion of the Court, according to the ruling. Thus whether the five year period of the DPA is carved-out or not is a decision for the Court. That decision, however, is separate from the question of the Court’s authority regarding the DPA.
The critical question here was the authority of the Court with respect to the DPA. On this issue Judge Gleeson held that “This Court has authority to approve or reject the DPA pursuant to its supervisory power. ‘The supervisory power . . . permits federal courts to supervise the ‘administration of criminal justice’ among the parties before the bar,’” quoting U.S. v. Payner, 447 U.S. 727, 735 n. 7 (1980). While the Court recognized that its ruling is novel, and that its supervisory powers are typically invoked for other reasons, at the same time one of the primary purposes of those powers is to protect the integrity of judicial proceedings.
Here the parties chose to initiate a proceeding before the Court by placing on the docket a federal criminal case and requesting a ruling as to the Speedy Trial Act. This implicated the powers and authority of the Court. As Judge Gleeson stated “. . . the contracting parties have chosen to implicate the Court in their resolution of this matter. There is nothing wrong with that, but a pending federal criminal case is not window dressing. Nor is the Court, to borrow a famous phrase, a potted plant. By placing a criminal matter on the docket of a federal court, the parties have subjected their DPA to the legitimate exercise of that court’s authority.”
In contrast, the Department of Justice has absolute discretion to decide not to prosecute, the court stated. Thus, a non-prosecution agreement is “not the business of the courts.” Likewise, the DOJ has near absolute power to extinguish a case it has brought. This is because the courts are “’not concerned with law enforcement practices except in so far as courts themselves become instruments of law enforcement,’” quoting McNabb v. U.S., 318 U.S. 332, 347 (1943). When, however, the Court becomes involved in the resolution of an action, as here, it has an important role within the limits of its supervisory powers.
After reviewing the terms of the DPA Judge Gleeson approved it. He also held that “my approval is subject to a continued monitoring of its execution and implementation.”
July 08, 2013
Last week the SEC announced the formation of a Financial Reporting and Audit Task Force. Its purpose is to detect “fraudulent or improper financial reporting” and “enhance the [Enforcement] Division’s ongoing enforcement efforts related to accounting and disclosure fraud.” At the same time the Commission announced the formation of a similar group focused on microcap fraud and the creation of the Center for Risk and Quantitative Analysis. The new Center for Risk and Quantitative Analysis will work in close coordination with the Division of Economic and Risk Analysis and “serve as both an analytical hub and a source of information about characteristics and patterns indicative of possible fraud or other illegality.”
While this is clearly a positive step for the Enforcement Division, there is little that is new about the financial fraud task force — except perhaps its apparently “high tech” adjunct, the Center for Risk and Quantitative Analysis. In 1998 then SEC Chairman Arthur Levitt originated a similar effort. In his well known address titled “The Numbers Game,” Chairman Levitt announced an eight part plan to combat abuses in financial reporting because he had “become concerned that the motivation to meet Wall Street earnings expectations my be overriding common sense business practices. Too many corporate managers, auditors, and analysts are participants in a game of nods and winks. In the zeal to satisfy consensus earnings estimates and project a smooth earnings path, wishful thinking may be winning the day over faithful representation. As a result, I fear that we are witnessing an erosion in the quality of earnings, and therefore, the quality of financial reporting. Managing may be giving way to manipulation; Integrity may be losing out to illusion.”
Chairman Levitt identified five key practices being used to manipulate financial results through what he labeled as “accounting hocus-pocus:”
Big Bath charges; The use of restructuring charges to clean up the balance sheet;
Acquisitions/R&D: The classification of portions of the acquisition price as “in-process” research and development so it can be written-off in a one-time charge to avoid a drag on future earnings;
Cookie jar reserves: The use of unrealistic assumptions to create pools of cash to smooth earnings;
Materiality: Building in flexibility by creating small errors that are just below the so-called materiality threshold which can then later be utilized; and
Revenue recognition: Boosting earnings through inappropriate manipulation of the recognition of revenue.
In the wake of Chairman Levitt’s speech the Commission brought a series of financial statement fraud actions. Two years later, for example, Richard Walker, then the Director of the Enforcement Division stated that for fiscal 1999 the Commission brought about 90 financial statement and reporting actions, a 15% increase over 1998. Those cases “cover a broad spectrum of conduct – from multi-faceted pervasive frauds to more subtle instances of earnings management to situation involving violations of auditor independence rules,” he noted. Richard H. Walker, Director, Division of Enforcement, addressing 27th Annual national AICPA Conference on Current SEC Developments (Dec. 7, 1999). In the years that followed the SEC brought a series of financial fraud actions involving an array of issuers such as Waste Management, WorldCom, Tyco International, Enron, Xerox Corporation and others.
In recent years, however, the number of these cases has declined. One reason may be the reforms initiated by the Sarbanes-Oxley Act of 2002. Another may be that the focus of SEC enforcement has been on market crisis cases, offering frauds and Ponzi schemes rather than difficult to develop, and time and resource consuming, financial statement fraud cases. Whatever the reason, while the world of financial reporting has become more sophisticated and complex, the root of Chairman Levitt’s concerns has not changed. The “pressure to make the numbers” is still present. This suggests that the Commission’s new task force will have much to do.
July 07, 2013
“Money Never Sleeps” is the subtitle to the last Wall Street film staring Michael Douglas as the legendary stock trader Gordon Gekko. That title might also be applied to the SEC’s insider trading watch dogs. While most were preparing for the Fourth of July holiday on Wednesday, they obtained a temporary freeze order over about $4.6 million in what may be insider trading profits. The SEC’s complaint and request for a freeze order was filed just two days after a dramatic spike in the share price of Onyx Pharmaceutical, Inc. following an announcement of a rejected take-over bid. SEC v. One or More Unknown Traders in the Securities of Onyx Pharmaceuticals, Inc. (S.D.N.Y. Filed July 3, 2013).
The action centers on the proposed acquisition of Onyx Pharmaceutical by Amgen, Inc. On Sunday, June 30, Onyx, a San Francisco, California based biopharmaceutical company, announced that it had received but rejected a bid to purchase the outstanding shares of the company from Amgen, a California based biotechnology company. The bid was for $120 per share.
The transaction began on June 13, 2013 when Amgen’s CEO met with his counterpart from Onyx. At the meeting Amgen’s CEO made an unsolicited oral offer to acquire Onyx. The offer was followed by a written proposal the next day. The written proposal was sent to the Onyx board of directors that same day.
On June 26, 2013, Onyx’s board met and decided to reject the offer. Two days later on Friday, June 28, 2013, that decision was conveyed to Amgen. The same day an article appeared in the Financial Post, a Canadian publication, regarding the offer. Amgen, however, did not issue an announcement about the proposal until Sunday, June 30, 2013. In that announcement the company stated that an unsolicited offer for $120 per share had been received and rejected as inadequate. The announcement also stated that the company had authorized its financial adviser to contact potential acquirers.
Unknown purchasers began buying call options in Onyx on June 26, the day the Onyx board met to consider the offer. On that day 175 calls were purchased. The next day an additional 544 contracts were purchased. On Friday, June 28, the last trading day before the Sunday announcement, and the same day as the Canadian news article, an additional 320 calls were purchased. On each day the option acquisitions represented significant departures from the historical purchasing patterns for the securities in terms of the numbers of contracts purchased. The acquisitions were made through two omnibus accounts, one at Citigroup Global Markets, Inc. and the other at Barclays Capital, Inc. No other information about the accounts is furnished in the complaint.
On Monday, July 1, 2013, the first trading day after the announcement of the rejected deal, Onyx shares closed at $131.33, an increase of $44.51 or about 51% over the prior day’s closing price. The options in the two accounts, purchased for about $305,000 were worth about $4.6 million, an increase of almost 14,200% in three trading days. Those profits are now frozen under the court’s order. The case is in litigation.
July 02, 2013
The SEC filed a partially settled insider trading case against the now husband of a corporate officer, his long time friend and a broker. Collectively the defendants are alleged to have netted over $1 million in trading profits. SEC v. Murrell, Civil Action No. 2:13-cv-12856 (E.D. Mich. July 1, 2013).
The case centers on the acquisition of Rohm & Haas Co. by The Dow Chemical Company, announced on July 10, 2008. Prior to the acquisition defendant Mack Murrell resided with his now wife Stacey Murrell. She was an administrative assistant to Dow’s CFO. Mr. Murrell had known Defendant David Teekell since high school. Although the two men lived in different parts of the country, they kept in touch and were involved in an investment with others. Mr. Teekell’s long time broker was defendant Charles Adams. Mr. Adams was a registered defendant at Raymond James Financial Services, Inc. which is named as a relief defendant because it obtained trading profits from option positions abandoned by Messrs. Teekell and Adams.
The compliant is built largely on circumstantial evidence, cobbling together the events of take-over deal with emails, telephone calls and securities transactions. In early June 2008 Rhom began discussions about the possible sale of the company with Dow and two others. Discussions proceeded quickly with Dow and by mid-June due diligence was underway and a possible price per share had been discussed. By the end of the month Stacey Murrell and the CFO for whom she worked execute confidentiality agreements. The two women discussed the proposed transaction at the time they executed the agreements.
On July 2, 2009 Dow held a special meeting. The Board approved a cash offer for Rohm at a price of up to $78 per shares. The next morning Mr. Murrell emailed David Teekell asking him to call, noting he had lost the phone number. Later that day the two men spoke in what became a series of telephone calls. That same day Mr. Teekell called his broker, Defendant Adams.
On Sunday July 6 Mr. Murrell left for the Middle East on a business trip. Nevertheless, he continued to communicate with David Teekell. Indeed, over the weekend prior to the trip Messrs. Murrell and Teekell communicated several times by telephone and email.
The next day, Monday July 7, 2008, Mr. Adams made his first securities purchase, buying 1,000 shares of Rohm stock in Mr. Teekell’s SEP IRA account for $45,000. That same day Mr. Teekell went to the brokerage firm, deposited $200,000 and executed forms for option trading. On Tuesday he began purchasing options. Mr. Adams also purchased options that day.
Messrs. Teekell and Adams continued purchasing Rohm shares and options up to the day of the announcement. The day before the public announcement Mr. Adams purchased options for IBM and Cicso in Mr. Teekell’s account. He also tried to sell 180 of Mr. Teekell’s Rohm options. The order did not fill. By the end of the day shares of Rohm closed at $44.83. Following the deal announcement those shares closed at $73.62, up 64%. Mr. Teekell had profits of $534,526. Mr. Adams had profits of $64,450. Two customers for whom Mr. Adam traded through discretionary accounts had profits of $42,596. The complaint alleges violations of Exchange Act Section 10(b).
David Teekell agreed to settle with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to disgorge his trading profits, pay prejudgment interest and a penalty equal to the amount of the disgorgement. The other defendants did not settle. See also Lit. Rel. No. 22738 (July 1, 2013).
July 01, 2013
The Commission brought another fraud action against a China based issuer and its chairman. This time the case focuses on the lack of internal control and a series of unauthorized cash transactions that were repaid. SEC v. Fuqi International, Inc., Civil Action No. 1:13-cv-995 (D.D.C. Filed July 1, 2013).
Fuqi is a PRC based jewelry company whose chairman, president and CEO is defendant Yu Kwai Chong, a Chinese national. The company made a public offering of securities in March 2010. Its shares were traded on the NASDAQ Global Market. Eight months after the stock sale the company announced it would restate the first three quarters of 2009 due to accounting errors. Its earnings had been overstated by 12% to 23%.
While completing the restatement the outside auditors discovered that between September 2009 and November 2010 Mr. Chong had directed the transfer of about $134 million in over 50 transactions from firm bank accounts to accounts at other banks for three jewelry companies in China. The transfers were booked as “other payables” or “prepaids.” The board of directors was unaware of the transactions.
Subsequently, outside counsel was retained by the company and an internal investigation was conducted. During the inquiry Mr. Chong explained that he authorized the transactions at the request of a local bank manager despite the fact that he did not know the three companies to which the funds were transferred. The firm was able to furnish the staff with documentation for about 19% of the transactions. Although the funds were returned to the company, not all of the money was returned to the same bank accounts or in the same amounts as the initial transfers.
The company lacked adequate internal accounting controls, according to the SEC’s complaint. During the period of the transfers, Fuqi’s treasury controls did not require that internal fund transfer applications identify any specific business purpose or be supported by documentation. The company also did not have an effective reconciliation process.
The transactions were not disclosed by Fuqi until March 2011 when a press release was issued. That occurred after the outside auditors sent the board of directors a six page letter providing notice of a potential fraud and violations of internal controls and accounting irregularities surrounding the transactions. The company has not filed any periodic reports with the Commission since November 2009. The SEC’s complaint alleges violations of Exchange Act Section 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5).
Fuqi and Mr. Chong settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of the federal securities laws. In addition, the company and Mr. Chong were directed to pay civil penalties of, respectively, $1 million and $150,000. Mr. Chong was also barred from serving as an officer and director of a public company for five years. See also Lit. Rel. No. 22739 (July 1, 2013).
June 30, 2013
Four years ago SEC Enforcement went back to the future, reorganizing the Division to include specialty groups. The idea was to marshal the resources of the Division in view of an increasingly complex market place to more effectively and efficiently conduct investigations. The idea of specialty groups was not, of course, new. In the early days of the Division it had specialty groups. That structure was abolished in the 1980s but brought back in 2009.
The reorganization was successful. Once completed the agency filed record numbers of enforcement actions each year. While the number of cases filed is not the sole criteria for judging the success of an enforcement program, those statistics suggested that SEC Enforcement had been pulled back from the abyss of Madoff and other scandals and was moving forward in a positive fashion.
Now that momentum seems to be sputtering. The record numbers of cases are gone. In the first half of 2012, for example, the Commission filed 150 enforcement actions (excluding tag-a-long proceedings, which are really an additional remedy adjunct to another action, and delisting proceedings). During the same period this year the SEC filed a total of 116 enforcement actions. Similarly, in the second quarter of 2012 the Commission initiated 99 enforcement cases compared to just 51 in the most recent quarter. By any measure the number of cases being filed by the agency is dropping significantly.
At the same time the Division appears to be searching for its focus. This is reflected by the following points:
Co-Division directors: The Enforcement Division now, for the first time, has co-directors. While innovative, it is at best cumbersome. No matter how well the two men work together, someone has to make the decisions. The “buck,” to paraphrase President Harry Truman, has to stop someplace. That is always with the person making the final decision. Groups, committees and similar decision making bodies are typically a cover for lack of focus. While this innovation puts the new SEC Chair’s right had man at the front of the enforcement operation, giving her hands on control, is nothing but unwieldy on a day-to-day basis and makes the Division appear less than focused.
Admissions: There is a new policy being implemented under which admissions will be required in select cases, in addition to those obtained in actions where they were previously made in a parallel case. The precise criteria for selecting these cases, and the type of admissions that will be required, have not been specified. If the policy is applied to more than a handful of cases, and meaningful admissions are sought, such as those made in a guilty plea or a criminal deferred prosecution agreement, it has the prospect of bogging down the Division with more and perhaps difficult cases to take to trial. That can and will drain the Division of its already scare resources. It could also mean fewer investigations as the agency is required to be ever more selective about which matters to pursue, undercutting its ability to protect investors and markets. If on the other hand the new policy is only applied in limited cases and the admissions sought are along the lines of the “we made an error” type as in SEC v. Goldman Sachs, the new policy will surely undercut the credibility of the agency since it will be viewed as little more than a publicity stunt.
Financial fraud: This traditional stable of SEC Enforcement has been neglected in recent years. As reports from Cornerstone Research chronicle, the number of financial fraud cases brought by the SEC in recent years continue to dwindle. Now the Division reportedly is refocusing its efforts in this area. Yet no new specialty group is being created which seems contrary to the theory of the recent reorganization.
The trial unit: This long standing specialty unit of the Division is now rumored to be on the chopping block, doomed to be disbanded. The unit was created in the 1970s for largely the same reasons which underlie the recent reorganization. At the time of its institution each Associate Director group conducted its own litigation. The Unit was created to focus the litigation resources of the Division in a more effective manner. It is currently the only specialty group to have persevered from the early days of the Division. Dropping this specialty group in favor of a model previously found to be less than effective, while retaining others but refusing to create one to implement the new emphasis on financial fraud actions which can be very complex suggests confusion.
Collectively these changes paint a portrait of a Division in search of focus. To find its focus the Division need go no further than back to its and roots, that is, back to the future yet again. Its statutory mandate is to act as a regulator, not a prosecutor. It is to protect investors and markets by investigating and halting violations, making sure the wrongful conduct is not repeated in the future. It has a vast array of weapons to do this, from injunctions to equitable remedies, penalties and bar orders. These tools have in the past enabled the SEC to craft effective remedies such as corporate compliance and governance initiatives that prevented a repetition of wrongful conduct in the future. While this work may not garner the headlines of a billion dollar fine or an admission of guilt, its ingenuity and creativity protected investors and the markets, making the agency a most effective watch dog. If SEC Enforcement is going to become that watch dog again it is time to stop tinkering with organization and policy and go back to the future, back to crafting effective remedies that protect investors and the markets.
June 27, 2013
The CFTC took center stage this week, bringing an aggressive enforcement action against former New Jersey governor and Goldman Sachs partner Jon Corzine and his collapsed firm, MF Global. In a settlement with the firm the agency secured and agreement to obtain as much as $1 billion in restitution and a $100 million fine.
The Chairman of the CFTC and the Chair of the SEC testified before Congress this week, seeking to justify the significant budget increases requested for their respective agencies in the President’ budget for the next fiscal year. In addition, SEC enforcement brought a fraud action against a medical device manufacturer for misstatements regarding the FDA approval process for a key product, another offering fraud action and a proceeding against a former Stanford Group employee tied to the sale of funds.
Testimony: SEC Chair Mary Jo White testified before the Senate Subcommittee on Financial Services and General Government (June 25, 2013). Her testimony focused on the reasons for requesting a budget of $1.674 million for the next fiscal year (here).
Testimony: Chairman Gary Gensler testified before the Senate Appropriations Subcommittee on Financial Services and General Government (June 25, 2013). His testimony focused on the rationale for the President’s requested budget of $315 million compared to the current $195 million for the next fiscal year (here).
Remarks: Commissioner Mark P. Wetjen, addressed the Futures Industry Association and Futures & Options Association International Derivatives Expo (June 25, 2013). His remarks focused on cross-border guidance (here).
Remarks: Commissioner Bart Chilton addressed the Trading Show Chicago 2013, Chicago, Illinois (June 24, 2013). His remarks focused on the proposed PORTECT Act, high speed trading and proposals about wash blockers (here).
Remarks: Commissioner Bart Chilton delivered remarks to the Global Grain Chicago Conference, entitled “Future Boy” in Chicago, Ill. (June 21, 2013). His remarks focused on implementing the remaining Dodd-Frank rules (here).
SEC Enforcement: Filings and settlements
Weekly statistics: This week the Commission filed 2 civil injunctive action and 1 administrative proceedings (excluding follow-on actions and 12(j) proceedings).
Misrepresentations: SEC v. Imaging3, Inc., Case No. CV 13-4616 (C.D. Cal. Filed June 25, 2013) is an action against the medical device manufacturer and its founder, Dean Norman Janes. A key product for the company is a Dominion Scanner. Based on proprietary technology, and under development for years, it is supposed to produce 3D medical diagnostic images in real time. To market its Dominion Scanner, Imaging3 needs FDA approval. Although the company applied for approval three times beginning in 2007, it was never obtained. In its last denial letter the FDA cited safety concerns and issues with image quality, among other reasons. Nevertheless, on November 1, 2010 Mr. Janes held a news conference at which he told investors that the company would again apply for clearance by the FDA. He also stated that the prior denials were not based on safety concerns or the quality of the images. The Commission’s complaint alleges violations of Exchange Act Section 10(b). The case is in litigation. See also Lit. Rel. No. 22733 (June 26, 2013).
Offering fraud: SEC v. Hurd, Civil Action No. 13-cv-04464 (C.D. Cal. June 20, 2013). The case centers on the sale of interests in defendant Your Best Memories International, Inc., beginning in 2010 and continuing through the fall of 2012. Your Best Memories, formed by defendant Robert Hurd, was supposed to raise money for the promotion of memory improvement products created by another entity, Moving Pictures, Inc. Investors were told that most of their investment would go toward those products. In fact it did not. Investors were also falsely told that one of the Moving Pictures products had FDA approval. Over the approximately two years shares of Your Best Memories were sold, about $1.2 million was raised from 50 investors in 18 states. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b) and 20(a). The case is in litigation. See also Lit. Rel. No. 22732 (June 21, 2013).
In the Matter of Jason A. D’Amato, Adm. Proc. File No. 3-15004 (June 21, 2013). Mr. D’Amato held various positions with the Stanford Group Companies and Stanford Capital Management, LLC over a period of years. Those included President of that company and senior investment officer. The Order alleges that beginning in 2000 SGC offered a mutual fund allocation program known as Mutual Fund Partners. In 2003 Mr. D’Amato was retained as an assistant analyst to track and calculate the performance of the strategies used and to create pitch-books for the SGC financial advisers to use in presentations. The results presented to investors consistently outperformed the S&P 500. Financial advisers, however, complained that clients could not achieve anything close to those results. The pitch books were deficient in several respects, according to the Order, including: The records to support the claimed results could not be located; certain data in them was labeled in a misleading fashion; and unaudited data was presented next to audited data. Mr. D’Amato also misrepresented his credentials, according to the Order. Mr. D’Amato resolved the proceeding, consenting to the entry of a cease and desist order based on Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 207. He also agreed to be barred from the securities business and from participating in any penny stock offering, with a right to apply for reentry after five years, and to pay a civil penalty of $50,000.
Misuse of customer funds: CFTC v. MF Global Inc. (S.D.N.Y. Filed June 27, 2013) is an action against the futures commission merchant, MF Global Holdings Ltd., Jon S. Corzine, former CFO, and Edith O’Brien, former treasurer. The complaint alleges misuse of customer funds, failing to notify the CFTC of deficiencies in customer accounts and filing false reports with the agency. Mr. Corzine is charged with the firm’s violations as a control person and Ms. O’Brien with aiding and abetting the misuse of customer funds. The complaint centers on claims that customer funds, which are required to be segregated, were misused by the firm as it was collapsing in the fall of 2011. Specifically, during that period MF Global was on the brink of collapse from large proprietary trading positions directed by its CEO. At the time the firm not only had deficient internal systems but it ultimately violated its own procedures in utilizing segregated customer funds to meet its obligations. The firm settled, agreeing to make full restitution which is approximately $1 billion, and to pay a $100 million fine. The complaint requests injunctions, restitution, penalties, and registration and trading bans as to the individual defendants. The individual defendants are litigating the case.
Investment fund fraud: U.S. v. Berkman, No. 13-mg-00732 (S.D.N.Y.) is an action against Craig Berkman, a one-time aspiring political figure. Over a period of about two years beginning in 2010 Mr. Berkman raised an estimated $13.2 million from over 120 investors for three fraudulent investment scheme. Essentially the schemes either promised access to pre-IPO shares of stocks like Facebook or those of select start-ups. The claims were false. In fact Mr. Berkman misappropriated much of the money raised from investors. Mr. Berkman pleaded guilty this week to one count of securities fraud and one count of wire fraud. He is scheduled for sentencing on October 1, 2013. The SEC has a parallel action pending. In the Matter of Craig Berkman, Adm. Proc. File No. 3-13249 (Filed March 19, 2013).
Investment fund fraud: U.S. v. Mattera, 1:12-cr-00127 (S.D.N.Y.) is an action against Florida businessman John Mattera. This week he was sentenced to serve 11 years in prison. Previously he pleaded guilty to securities and wire fraud charges. From 2010 through 2011 Mr. Matteria served as Chairman of the Advisory Board of Praetoria Global Fund Ltd., a mutual fund. In that capacity he was responsible for the investment decisions. Beginning in the late summer of 2010 Mr. Mattera and others offered investors the opportunity to purchase shares in special purpose entities related to the Praetorian which supposedly owned pre-IPO shares of companies such as Facebook and Groupon. Based on those representations about $11 million was raised. Investors were assured that their funds would be held in escrow until after the IPOs. In fact the representations were false. Most of the investor money was transferred to other entities with which Mr. Mattera was associated. About $4 million was spent by Mr. Mattera for personal items. The SEC has a parallel case pending. SEC v. Mattera, Civil Action No. 11-cv-8323 (S.D.N.Y. Filed Nov. 18, 2011).
Financial fraud: U.S. v. Skilling (N.D. Tx.) is the long running case against former Enron CEO Jeffrey Skilling. Last week Mr. Skilling was resentenced to 168 months in prison, substantially reducing his sentence. He was also ordered to forfeit $42 million. Following his conviction for one count of conspiracy, 12 counts of securities fraud and one count of insider trading, Mr. Skilling was sentenced to serve 292 months in prison on October 23, 2006. The Fifth Circuit Court of Appeals concluded the sentence had been improperly enhanced and remanded for resentencing. Subsequently, Mr. Skilling and the government entered into the arrangement reflected in the resentencing which effectively reduced the term of imprisonment by about nine years. This resolution brings the long running case to a conclusion and permits the money to be distributed to victims of the fraud.
Improper markups/downs: State Trust Investments, Inc., and its head trader Jose Luis Turnes, were sanctioned by the regulator for improper markups and markdowns in bond transactions. Specifically, the firm was fined $1,045 million and ordered to pay restitution of $353,000 plus interest to its customers who received unfair prices. Mr. Turnes was suspended for six months and fined $75,000. FINRA concluded that the firm charged excessive markups or markdowns to customers in a total of 563 transactions. Previously, the regulator suspended Jeffrey Cimbal, the firm’s CCO, for five months in a principal capacity for failing to supervise Mr. Turnes and fined him $20,000.
Court of appeals
Insider trading: U.S. v. Rajaratnam, Docket No. 11-4416-cr (2nd Cir. Decided: June 24, 2013) is the appeal of Galleon Fund founder Raji Rajaratnam of his conviction on conspiracy and insider trading charges for which he is serving an eleven year prison term. The focus of Mr. Rajaratnam’s appeal was his challenge to the district court’s conclusion that the wire tap evidence was admissible.
Mr. Rajaratnam moved to suppress the wiretap evidence on which the charges against him were centered, claiming that the government made misstatements and omissions regarding the reliability of informant Roomy Khan and that the evidence regarding the need for a warrant in the application had serious omissions. The district court rejected these claims and admitted the wiretap evidence.
The Second Circuit affirmed. Under Franks v. Delaware, 438 U.S. 154 (1978)suppression is only warranted if it is demonstrated that the inaccuracies or omission in the affidavit offered when requesting the warrant are the result of the affiant’s deliberate falsehood or reckless disregard for the truth and the alleged falsehoods or omissions were necessary to the probable cause or necessity decision, according to the Court. Here, even assuming that this standard was met with regard to Ms. Kahn’s background which omitted her prior conviction and the two paraphrased statements of conversations with Mr. Rajaratnam were inaccurate, the errors were not material to the district court’s determination and analysis on the probable cause issue. Likewise the omission of evidence about the SEC investigation on the issue of whether a wiretap was needed does not meet the required standard. In fact that the evidence actually supported the application for a warrant because it demonstrated that Mr. Rajaratnam carefully limited his exchanges to phone calls thus necessitating the wiretaps.
Finally, the Court rejected Mr. Rajaratnam’s claim that the jury instructions were erroneous. Those instructions specified in part that the jury had to find that the material non-public information given to Mr. Rajartanam “was a factor, however small” in his decision to buy or sell the stock. The claim that this permitted the jury to convict him without finding the necessary causal connection between the inside information and the trades executed is incorrect the Court found. Indeed, the jury is only required to find that the defendant purchased or sold the securities while knowingly in possession of material non-pubic information.
Financial fraud: The U.K. Serious Frauds Office secured the conviction of Mark Woodbridge, an executive at Torex Retail plc, a company involved in the rental of software. The charges centered on an alleged financial fraud at the company which is now in administration. A jury returned a verdict of guilty as to Mr. Woodbridge but acquitted a co-defendant. Previously a jury acquitted another defendant but was unable to reach a verdict as to another. Two other defendants have been sentenced to prison in connection with the collapse of the company.
Annual report: The Securities and Futures Commission published its 2012-2013 annual report, themed Regulation for Quality Markets (here).
Investment fraud: The Australian Securities and Investment Commission announced that Carlo Cini, formerly a director of C Cini & Company Pty Ltd. which is now in liquidation, has been charged with obtaining property by deception, fraudulently inducing persons to invest money, obtaining financial advantage by deception and dishonestly using his position as a director. The charges are based on allegations that Mr. Cini raised over $1 million from investors for property development in 2007 and 2008 and then diverted the funds to other purposes. During that period he also issued valueless checks to investors and abused his position as a corporate director.