Former Schwab Executive Settles With SEC

The Commission settled its market crisis based enforcement action against Kimon P. Daifotis, former Chief Investment Officer for Fixed Income for Schwab YieldPlus Fund. The case involving Mr. Daifotis was one of the first to apply the Supreme Court’s teachings on primary liability in Janus Capital Group, Inc. v. First Derivative Traders, 131 S.Ct. 2296 (2011). It was also one of the early cases to consider the question of whether the aiding and abetting provisions of Dodd-Frank were retroactive – a point the Commission conceded in the case. SEC v. Daifotis, No. 3:11-cv-00137 (D.D. CA. Filed Jan. 11, 2011). The other defendants previously settled with the agency.

The complaint against Mr. Daifotis alleged violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Investment Company Act 34(b). It claimed that Mr. Daifotis and the other defendants made a series of misstatement in connection with the operation of the YieldPlus Fund during 2007 and 2008. Specifically, the complaint alleged that Mr. Daifotis and another defendants misled investors concerning the risks involved because they were told the fund was only slightly more risky than a money market fund. False statements were also made about the redemptions, minimizing a situation in which their number was causing a decline in NAV. Another allegation asserted that Mr. Daifotis aided and abetted violations of the fund’s concentration policies.

Prior to the ruling in Janus the court granted in part and denied in part a motion to dismiss. Following the Supreme Court’s ruling there was additional briefing and argument on the question of what constitutes primarily liability. The court concluded that the defendants “made” several statements within the meaning of Janus while finding that others were inadequately pleaded. The court also restricted the application of Janus to Section 10(b), rejecting claims that the Court’s teachings should be applied to Securities Act Section 17(a) and Investment Company Section 34(b). Other courts have since concluded that Janus does apply not just to Section 10(b) but also to Section 17(a). See, e.g., SEC v. Kelly, 2011 U.S. Dist. LEXIS 108805 (S.D.N.Y. 2011); In the Matter of John P. Flannery, Adm. Proc. File No. 3-14081 (Initial Decision Dated Oct. 28, 2011), appeal pending.

To resolve the case Mr. Daifotis consented to the entry of a permanent injunction which prohibits future violations of Securities Act Section 17(a)(2) and Section 34(b) of the Investment Company Act. As part of the settlement he also agreed to pay $250,000 in disgorgement, a $75,000 civil penalty and to be barred from the securities business in a related administrative proceeding with a right to apply for re-entry after three years.

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