Broker Pays over $42 Million Re Pre-Release ADRs

Pre-release ADRs have become a focus of SEC Enforcement. To date the agency has filed 10 settled proceedings involving these securities. Typically, the Order in the proceedings asserts that by failing to comply with the pre-release obligation to beneficially own the underlying shares the number of outstanding shares of the issuer is artificially inflated, harming the markets and shareholders. In theory this is true. None of the Orders issued to date, however, details proof to support the theory.

In its most recent case, the Order reiterates the same claimed harm from failing to comply with pre-release obligations without actual supporting factual allegations. This time there is at least a suggestion of actual harm. The Commission’s press release, but not the Order in the proceedings, states that the financial institution resolved criminal antitrust violations with the DOJ, pleading guilty to bid rigging that was conducted by the same securities lending desk at the institution that was responsible for the pre-release ADR lending issues on which the Order is based. In the Matter of Industrial and Commercial Bank of China Financial Services, Adm. Proc. File No. 3-19202 (June 14 2019).

Respondent is a subsidiary of Industrial and Commercial Bank of China Limited. The institution is a Commission registered broker-dealer.

Over a four-year period, beginning in September 2011, the broker operated a matched book or conduit securities lending desk. Its goal was to not hold any position on its books. The desk generated revenue by lending securities, borrower or otherwise obtained, for more than it paid to borrow or obtain the securities.

During the period Respondent had pre-release agreements with four depositaries. Three of those institutions required the broker to execute certifications stating that it was complying with pre-release agreements. Those agreements typically stated that the pre-release broker or its counterparty are collectively maintaining the number of ordinary shares that corresponds to the number of outstanding shares for the benefit of the ADR holder. Compliance with this undertaking ensured that the number of underlying shares is not artificially increased. During the period the broker entered into ten such agreements.

Contrary to its representations, Respondent “was negligent in failing to take reasonable steps to determine whether it complied with the pre-release representations, the Order asserts. This occurred in two situations. First, when the lending desk received requests to borrow “hard-to-borrower” securities, the personnel should have realized that the request “may have arisen from circumstances involving broker-dealers needing to obtain ADRs in order to comply with Regulation SHO’s locate, delivery, and close-out requirements,” the Order states (emphasis added). By not recognizing this possibility, the desk failed to take reasonable steps to comply with its pre-release representations.

Second, Respondent engaged in hundreds of pre-release transactions involving sponsored ADRs of foreign issuers that were scheduled to pay dividends. Respondent forwarded the correct net dividend amount (the dividend less the required holding tax) to the Depositaries as required. Its lending desk “should have understood from the circumstances of many of the transactions that those amounts may not have originated from the ordinary shares held at the time of the pre-release transaction, and that its borrowers may not have been making tax payments that, under the pre-release agreements should have been paid to the foreign jurisdiction,” according to the Order.

Finally, the Broker failed to establish and implement policies and procedures that would have been reasonably expected to determine whether personnel on the securities lending desk complied with the pre-release representations in the transactions. Stated differently, the firm’s compliance procedures should have incorporated due diligence procedures that would have been triggered when either of the possibilities presented above arose. The Order alleges violations of Securities Act Section 17(a)(3).

To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order and to a censure. In addition, it agreed to pay disgorgement in the amount of $23,983.43, prejudgment interest of $4,458,491 and a penalty of $14,391,262.

FCPA Institute: On June 20 and 21, 2019, Professor Mike Koehler will conduct the FCPA Institute at the Offices of Dorsey & Whitney LLP in Minneapolis, Minnesota. The Institute provides a unique learning experience for those seeking to elevate their knowledge of the Foreign Corrupt Practices Act. Professor Koehler is one of the foremost scholars on the FCPA and conducts an interesting and most informative program. The program is live in Minneapolis and also webcast. You can obtain more information about the program and register here.

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This Week In Securities Litigation (Week ending June 14, 2019)

The Commission did not file any new enforcement actions this week. The agency did, however, settle or partially resolve, three pending enforcement actions.

Congress again took up the question of inspecting the auditors and work papers for U.S. traded issuers. Legislation was introduced to require such action. This, of course, is nothing new. In 2002 the Sarbanes Oxley Act imposed such a requirement which the PCAOB was directed to implement. For the most part that requirement has been met. The exception – China.

Finally, Singapore and U.K. authorities entered into a consultation of cyber securities, a key issue for all firms.

Congress

PCAOB Inspections: Senators Rubio and Menendez introduced legislation which would require that the PCAOB inspection of Chinese issuers, among others. The bill, in essence, seeks to effectuate the promise of the Sarbanes Oxley Act by requiring auditors of China based issuers, as well as all others, permit inspections. From the beginning the Chinese government has largely refused. Despite enforcement actions, and repeated discussions between U.S. and Chinese officials, little has changed over the years. The legislation seeks to remedy this situation. While the Board could revoke the registration of audit firms which do not furnish the work papers and permit inspection, to date it has not invoked this authority with respect to Chinese issuers who typically cite local law and CSRC when not producing the requested work papers.

SEC Enforcement – Filed and Settled Actions

The Commission filed no civil injunctive actions and no administrative proceedings this week, exclusive of 12j and tag-along actions.

Insider trading: SEC v. Salis, Civil Action No. 2:16-cv-00231 (N.D. Ind.) is an action which named as defendants Christopher Salis, a former SAP executive, and two of his friends, Douglas Miller and Edward Miller. The action centered on the acquisition by SAP of Concur Technologies. Prior to the deal announcement Mr. Salis, who had been entrusted with confidential information about the transaction by a close friend at Concur, tipped Douglas Miller who then tipped Edward Miller. Each man traded prior to the deal announcement along with other friends and family members. Collectively the group secured trading profits of over half a million dollars. This week the Court entered final judgments resolving all the issues as to each Defendant. The final judgment as to each Defendant, entered by consent, prohibits future violations of Exchange Act Sections 10(b) and 14(e). In addition, Mr. Salis will pay disgorgement of $90,000 along with prejudgment interest of $2,067; Douglas Miller will pay disgorgement of $119,003 along with prejudgment interest of $22,258; and Edward Miller will pay disgorgement of $149,117 along with prejudgment interest of $27,891. The monetary component of each judgment will be deemed satisfied by the forfeiture orders entered in the parallel criminal action brought by the Fraud Section of DOJ. In that case Mr. Salis pleaded guilty to conspiracy to commit securities and wire fraud and was sentenced to serve six months in prison. Douglas Miller pleaded guilty to conspiracy to commit securities and wire fraud and making false statements and was sentenced to serve twenty-four months in prison. Edward Miller pleaded guilty to one count of conspiracy to commit securities and wire fraud and to obstruction of justice and was sentenced to serve six months in prison. See Lit. Rel. No. 24499 (June 12, 2019).

Insider trading: SEC v. Fishoff, Civil Action No. 24498 (S.D.N.Y.) is a previously filed action against, among others, Winston Tang and Deshan Govender, two friends. Mr. Tang was the vice president clinical research for Sangamo BioSciences, Inc. This week the Court entered final judgments by consent against the two men, imposing permanent injunctions based on Exchange Act Section 10(b). The judgment as to Mr. Tang also imposed a penalty of $750,000. The judgment as to Mr. Govender provides that the Court will consider monetary penalties in the future. The underlying complaint alleges that prior to the announcement of a licensing agreement between Sangamo and another firm Mr. Tang tipped his friend who traded. Mr. Govender later tipped Steven Fishoff who was part of an insider trading ring. Ultimately the trading resulted in about $1.5 million in profits. See Lit. Rel. No. 24498 (June 11, 2019).

Misappropriation: SEC v. Kitts, Civil Action No. 1:18-cv-11507 (D. Mass.) is a previously filed action against investment adviser Kimberly Pine Kitts. The SEC’s complaint alleged that over a six year period Ms. Kitts misappropriated over $3 million from client investment and retirement accounts. The Court entered a final judgment imposing permanent injunctions based on Advisers Act Sections 206(1), 206(2) and Exchange Act Section 10(b). The judgment also requires her to pay $2,882,221 in disgorgement and prejudgment interest. Her payment obligation is deemed satisfied by the entry of a restitution order entered in the parallel criminal case. Defendant was, in addition, barred by the Commission from the securities business and from participating in any penny stock offering. See Lit. Rel. No. 24497 (June 11, 2019).

Criminal Cases

Offering fraud: U.S. v. Falcone, No. 19-cr-257 (E.D.N.Y.). Defendant Joseph Falcone is the owner of 3G’S VINO LLC. He developed a product that is a sealed glass holding a single serving of wine. The product was sold at his stores. His creation was also featured on the national television show “Shark Tank.” Potential investors were solicited for about a year beginning in September 2014. They were told about the single glass of wine product featured on TV. Investors were also told their money would be put into developing the business. The investor funds came in. Those same funds also went out, but not to 3G’S VINO as promised. Rather, over half a million dollars in investor money went to acquire a home in Florida and fund online securities trading by the wine store owner. Mr. Falcone pleaded guilty to one count of wire fraud on June 10, 2019. The date for sentencing has not been announced. U.S. v. Falcone, No. 19-cr-257 (E.D.N.Y.).

Insider trading: U.S. v. Jung, No. 1:18-cr-00518 (S.D.N.Y.) is an action which named as a defendant Woojae Jung, an employee at an investment bank. This week Mr. Jung was sentenced to serve three months in prison for insider trading. The underlying charges alleged that on multiple occasions he accessed material non-public information at his firm and used it trade in advance of corporate transactions. As a result, he netted nearly $130,000 in illicit profits. The sentence also directed that Mr. Jung pay a penalty of $30,000, forfeit the trading profits and be subject to two years of supervised release following his release from prison. See also SEC v. Jung, Civil Action No. 1:18-cv-04811 (S.D.N.Y.).

Anti-Corruption/FCPA

World Bank: The bank debarred Dongfang Electronics Co. Ltd, a Chinese electrical engineering firm. The action came in connection with bids for the Liberian Accelerated Electricity Expansion Project $60 million contract. Additional financing was being sought to increase access to electricity and strengthen institutional capacity in the West African country’s energy sector.

Dongfang was charged with engaging in fraudulent practices. Specifically, the firm was alleged to have falsified two letters during the bidding process. This is considered a fraudulent practice. The debarment has a term of 15 months. It also qualifies for cross-debarment by the Asian Development Bank, the European Bank of Reconstruction and Development, the Inter-American Development Bank and the African Development Bank. In connection with the resolution Dongfang has undertaken to strengthen its procedures.

Singapore

The Monetary Authority of Singapore and the Bank of England announced a collaboration on cyber security. The collaboration will involve MAS and the UK financial authorities identifying effective ways to share information on the topic. The two authorities already cooperate on cyber security bilaterally and by supporting the Basel Committee’s work to develop best practices to supervise cyber risk in banks and contributing to the Financial Stability Board’s Cyber Lexicon.

FCPA Institute: On June 20 and 21, 2019, Professor Mike Koehler will conduct the FCPA Institute at the Offices of Dorsey & Whitney LLP in Minneapolis, Minnesota. The Institute provides a unique learning experience for those seeking to elevate their knowledge of the Foreign Corrupt Practices Act. Professor Koehler is one of the foremost scholars on the FCPA and conducts an interesting and most informative program. The program is live in Minneapolis and also webcast. You can obtain more information about the program and register here.

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