Commission Chair Mary Jo White announced a modified settlement policy for select enforcement actions. While most cases will be settled on a neither admit nor deny basis, the category of actions in which admissions will be required will be expanded. Currently only those actions where the defendant made admissions in a parallel case – typically a criminal action – fall within this group. Now the group will be expanded to include those which are egregious and have wide spread public interest.
The Commission settled its action against eight mutual fund directors, dropping two of the three charges initially alleged in the Order. The SEC also brought another financial fraud action against a PRC based issuer that is the product of a reverse merger, a manipulation case and an investment fund fraud action this week. All three cases are in litigation.
Settlement policy: SEC Chair Mary Jo White stated that the agency is going to change the way it settles enforcement actions, modifying its frequently criticized “neither admit nor deny” policy. Now, in select cases, the Commission will require that admissions be made as a condition of settling rather than permitting the defendant to “neither admit nor deny” the allegations in the complaint of its enforcement action. While the precise parameters were not defined by Ms. White, she did indicate that it would apply to cases where there is intentional, egregious conduct and/or wide spread public interest. The precise parameters of the new policy were not specified. It will be applied on a case by case basis. For most settling cases the current policy will continue to apply.
Remarks: Gregg E. Berman, Associate Director, Office of Analytics and Research Division of Trading and Markets, at the SIFMA Tech Conference, New York City (June 18, 2013). His remarks focused on a new MIDAS system which permits the Commission to monitor the markets in real time, conduct forensic analysis, and do market structure research for policy decisions (here).
Remarks: Norman Champ, Director, Division of Investment Management, at the 2013 Insured Retirement Institute Government, Legal & Regulatory Conference, Washington, D.C. (June 18, 2013). Topics discussed include the Division’s new Risk and Examinations Office, its outreach to the industry and improved disclosure (here).
Remarks: Commissioner Elisse B. Walter addressed the DirectWomen Board Institute, New York City (June 13, 2013). Topics covered in the remarks include enhanced decision making from diversity and the role of the SEC in promoting diversity (here).
Remarks: Commissioner Bart Chilton addressed the Hedge Fund Industry in remarks titled “Rock’n the Trouble,” Chicago, Illinois (June 18, 2013). The Commissioner discussed high speed trading and cross-border regulation (here).
SEC Enforcement: Litigated decisions
Insider trading: SEC v. All Know Holdings, Ltd., 11 C 8605 (N.D. Ill. Opinion issued June 10, 2013) is a previously filed action which centered on the November 2011 announcement by Pearson plc that it would acquire China based Global Education & Technology Group, Ltd. The SEC filed suit within days of the announcement, charging the company and others with insider trading in violation of Exchange Act Section 10(b) based largely on the large trading shortly before the deal announcement. The critical question in the case since the time the complaint was filed has been the source of the inside information. Defendants Youghui Zhang and All Know, along with its principle and her friend, moved for summary judgment.
The motion of Mr. Zhang was denied while that of the All Know defendants was granted. Defendant Youghui Zhang was employed at Global Education, a company founded by his younger brother, Yongqi “David” Zahng and his wife, Xiadong “Veronica Zhang. The day before the take-over announcement he purchased 7,900 American Depository Shares of the company on the NASDAQ. In rejecting his motion the court focused on Mr. Zhang’s access to inside information and his failure to explain numerous communications with his brother despite discover requests from the Commission.
In contrast, the motion of the “All Know defendants” was granted. All Known Holdings engages in stock trading, frequently taking large positions in select company shares, according to the defendants. In the days immediately preceding the deal announcement the firm purchase about $950,000 worth of Global Education shares. While the position was large, after making the purchases the firm had a substantial amount of cash remaining. Those purchases were based on a trading philosophy which focused on acquiring shares of China based U.S. companies which the defendants viewed as undervalued and there research about the company. At the same time Defendant Yao, a lifelong friend of the principal of the company, also purchased shares.
In granting the All Knowing Defendants’ motion the court pointed to the failure of the SEC to cite any evidence demonstrating that the All Know Defendants knew or had contact with an insider. That failure contrasts with the detailed explanations offered by the Defendants for their purchases. Indeed, the SEC did not offer any evidence demonstrating that the information was obtained in breach of a fiduciary duty. While the SEC tried to claim that the defendants engaged in discovery abuse the court noted that if this was true an appropriate motion should have been filed. Here it was not.
SEC Enforcement: Filings and settlements
Weekly statistics: This week the Commission filed 3 civil injunctive action and 1 administrative proceedings (excluding follow-on actions and 12(j) proceedings).
Financial fraud: SEC v. China MediaExpress Holdings, Inc., Case No. 1:13-cv-00927 (D.D.C. Filed June 20, 2013) is an action against the company, a China based issuer, and its Chairman and CEO, Zheng Cheng. Beginning in late 2009 at the completion of its reverse merger the company systematically and materially overstated its cash. In a filing made in mid-November 2009 it reported $40,000 in cash when in fact it had $269. In a filing made about one year later the firm claimed to have $160,947 in cash when in fact it had about $10,756. The overstatements in a series of filings ranged from 452% to as much as 40,433%. This caused the stock price to spike, attracting investors including one hedge fund that purchased $53 million worth of stock. Mr. Cheng had incentives to participate in the fraud since he had contracts to receive stock as the company hit certain financial metrics. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and13(b)(2)(B). The case is in litigation.
Manipulation: SEC v. Bahr, Case No. 13CV1423 (S.D. Ca. Filed June 18, 2013) is an action against David Bar centered on the manipulation of the shares of iTrakr Systems, Inc. in November and December 2012. Mr. Bahr arranged to pay the representative of a group of registered representatives who supposedly had discretionary authority over a number of accounts a 30% kickback to acquire and hold the shares. The purpose was to maintain the share price while Mr. Bahr distributed other shares and sold his at inflated prices. In December 2012 Mr. Bahr conducted a test of the scheme. His contact turned out to be an undercover government agent. The Commission’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. The U.S. Attorney’s Office for the Southern District of California filed parallel criminal charges.
Investment fund fraud: SEC v. MacDonald, Civil Action No. 3:13-cv-02275 (N.D. Tx. Filed June 17, 2013) is an action against Duncan MacDonald and Gloria Solomon. The two defendants set out to find funding for a medical insurance venture, Global Corporate Alliance. When they failed after months of effort and spending the company into debt, they fabricated a successful history for Global. Subsequently, they raised about $10 million from investors. A portion of that money was used to repay investors while the balance was either taken by the two defendants or spent. The scheme collapsed. The SEC’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See also Lit. Rel. No. 22728A (June 18, 2013).
In the Matter of J. Kenneth Alderman, CPA, Adm. Proc. File No. 3-15127 (June 13, 2013) is a proceeding against eight mutual fund directors: Jack Blair; Albert Johnson; James Stillman McFadded; W. Randall Pittman; Mary Stone; Archie Willis; J. Kenneth Alderman and Allen Morgan. Four funds were involved. The investment adviser was Morgan Asset Management, Inc. The Order which initiated the proceeding centered on claims that certain assets had been incorrectly valued. At the end of the first quarter 2007 the Funds had a combined net asset value of about $3.85 billion. Large portions of those assets were invested in complex structured products such as collateralized debt obligations and similar instruments for which there were no readily available market quotations. Thus the Funds’ portfolios of these assets had to be fair valued by the boards. The directors delegated the task to Morgan Asset. The Order alleges that there were no meaningful policies and procedures for carrying out the valuation task. Originally the Order claimed this had a material adverse impact on NAV and certain filings. Those claims were dropped in the settlement process. The Order issued at the time of settlement alleged only a violation of Rule 38a-1 under the Investment Company Act. Respondents and the Commission agreed to settle the proceeding following litigation but prior to a hearing. Each Respondent consented to the entry of a cease and desist order based only on Rule 38a-1.
Auditor independence: In the Matter of Rosenberg Rich Banker Berman & Company, CPA, Adm. Proc. File No. 3-15358 (June 14, 2013) is a proceeding against the audit firm and partner Brian Zucker. The Order concerns violations of the auditor independence rules by the firm and Mr. Zucker. Specifically, Mr. Zucker performed Financial and Operations Principal or FINOP services for a broker-dealer client while the firm served as its auditor. He also arranged for the audit firm to pay a contractor who served as the broker-dealer’s Financial and Operations Principal and directed a staff accountant to provide FINOP services to the broker-dealer. To resolve the proceeding the firm and Mr. Zucker consented to the entry of a cease and desist order based on Exchange Act Section 17(a). In addition, the firm agreed to the entry of a censure and an order requiring that it pay disgorgement of $12,000 and a civil monetary penalty of $25,000. Mr. Zucker also agreed to the entry of an order denying him the privilege of appearing or practicing before the Commission as an accountant with the right to reapply after one year.
Investment fraud: U.S. v. Betts (S.D.N.Y.) is a criminal action charging defendant Seth Betts with wire fraud. In 2008 Mr. Betts presented himself to a Midwest University as a principal of Betts and Gambles Global Securities, LLC. He induced the University to invest $8.16 million in collateralized mortgage obligations which were to be resold at a profit. In fact he misappropriated the funds. Mr. Betts was arrested this week. The case is pending.
Insider trading: U.S. v. Posey (N.D. Ga.) is a proceeding in which Richard Posey, formerly an executive at Carters Inc. pleaded guilty to one count of conspiracy to commit insider trading. Mr. Posey is charged with having repeatedly obtained inside information from about April 2009 to July 2009 and furnished it to Eric Martin, the head of investor relations, to permit him and others to insider trade. In addition, from about mid 2005 through 2009 Mr. Posey repeatedly traded in the shares of his employer using inside information. As part of the plea arrangement Mr. Posey agreed that he is responsible for illegal trading profits of between $2.5 and $7 million over the period. He also agreed to pay restitution of $800,000 to the company which is the cost of the internal investigation to date it conducted regarding the insider trading allegations. The date for sentencing has not been scheduled.
Manipulation: U.S. v. Kaufmann (E.D.N.Y.) is an action in which defendant Roland Kaufmann, formerly the CEO of Axius Inc., previously pleaded guilty to one count of conspiracy to violate the Travel Act. He is alleged to have engaged in a scheme to have stock brokers purchase the common shares of a company he controlled to manipulate the price. As part of the scheme Mr. Kaufmann and another engaged the services of a person they believed would assist in the scheme who in fact was an undercover agent. Mr. Kaufman was sentenced to serve 16 months in prison.
The Securities and Futures Commission banned Ms. Michelle Ng Man Chow from the securities business for life. From August to October 2011 Ms. Ng took a number of checks from the account of one client and deposited them in her account and that of another client. She also sold securities from the account of the first client without authority and then lied in an effort to conceal her actions. While the loss has been repaid the Commission found it appropriate to ban her for life.