by T. GormanPosted on Posted in SECActions

The D.C. Circuit vacated another Commission determination last week. Again, the order was not based on the merits. Again, it was based on the failure of the agency to comply with procedural requirement.

Earlier this year the Circuit Court vacated the Commission’s proxy access Rule because the agency failed to conduct the statutorily required economic analysis. Last week a Commission order refusing to vacate a default judgment entered in an administrative proceeding was vacated. This time the agency failed to properly apply its own rules. Rapoport v. SEC, No. 11-11082 (D.C. Cir. June 19, 2012).

The Order for Proceedings in the underlying action was issued in December 2008. It named as a Respondent OOO-CentreInvest Securities or CI-Moscow, a Moscow based broker dealer which specialized in the sale of second tier Russian equities. The firm’s New York affiliate, CentreInvest, Inc. or CI-New York, and several of the employees of each company, including Dan Rapoport, were also named as Respondents.

The OIP alleges violations of Exchange Act Section 15(a) since CI-Moscow never registered as a foreign broker dealer with the SEC but is alleged to have securities in the U.S. Although Mr. Rapoport was a registered representative while working in the New York office, after his return to Moscow he was not registered or licensed to sell securities in the U.S. Nevertheless, from 2003 through November 2007 CI-Moscow and Mr. Rapoport solicited institutional investors in the U.S. to purchase and sell thinly-traded stocks of Russian companies, according to the OIP. Beyond this conclusion, there is not a single specific instance in which Mr. Rapoport or the other Respondents solicited a U.S. investor detailed in the OIP.

In December 2008 the Enforcement Division served the OIP on CI-New York and on attorneys for other U.S. Respondents. Subsequently, the Division sought an order under SEC Rule of Practice 141(a)(2)(iv) which would permit service on Mr. Rapoport through counsel. That Rule provides for service to a person in a foreign country using any method reasonably calculated to give notice. Russian authorities had refused to serve the OIP. Counsel for Mr. Rapoport appears solely to contest the Division’s request. The ALJ granted the motion and the attorney who had appeared for Mr. Rapoport withdrew. Under the ruling service was considered effective on February 5, 2009. Mr. Rapoport did not respond to the OIP, although there is no claim that he did not know about the proceeding.

On April 8, 2009 the Division moved for the entry of a default judgment against Mr. Rapoport. That motion was granted on July 31, 2009 after Mr. Rapoport failed to appear at prehearing conferences. Based on the allegations in the OIP a cease and desist order was entered and a second tier penalty was imposed. Initially it was calculated to be $550,000 but later corrected to $315,000.

In December 2009 Mr. Rapoport filed a motion under Exchange Act Rule 155(b) to vacate the default judgment. That Rule permits an ALJ or the Commission to set aside a default “for good cause shown” if three requirements are met: 1) the motion must be made in a reasonable time; 2) it must specify the reasons for failing to defend; and 3) it must set forth the proposed defenses. The ALJ denied the motion concluding it had not been filed in a reasonable time, that the proffered reasons for failing to defend were inadequate and that the record, which was the OIP, supported the fact that Mr. Rapoport had in fact solicited U.S. investors. The Commission affirmed, essentially agreeing with the ALJ on the first two points and then finding it unnecessary to reach the third.

The D.C. Circuit began its analysis by noting that agencies must apply their rules consistently. As a corollary to this point, they “may not depart from their precedent without explaining why.” If they do the Circuit Court has no choice but to remand for an explanation. Here this is precisely what has happened.

First, the Commission did not follow Rule 155(b) since it failed to consider the third prong of the test. In the Circuit Court the SEC cited a series of decisions in its brief for the proposition that this prong of the three part test need not be considered where the there are findings, as here, that the motion failed to meet the first two requirements. Finding that none of the cited cases supported the Commission’s claim, the Circuit Court requested that the point be addressed at oral argument. More cases were cited by the SEC at argument. None of the additional cases supported the Commission’s position, according to the Court. While the Circuit Court did not state that the SEC was precluded from interpreting Rule 155(b) in the manner that it did in this case, it concluded that the agency had failed to provide “a consistent interpretation of the Rule . … [and has] not justified the apparent inconsistency of its application. Although the Commission is not bound to follow its precedent, it may not depart from its precedent without offering a reasoned explanation . . . It has not provided such an explanation here.”

Second, the Commission “has failed to provide any intelligible standard to assess what constitutes a ‘reasonable” amount of time for filing a motion to set aside a default under Rule 155(b).” Here the Commission discussed a range of dates in the case and cited its prior decisions which consider different time points for commencing the time period for determining reasonableness but it failed to “set forth a principled way in which to determine on what date the “reasonable time” clock starts running.” The SEC also failed to state with any clarity how it determines what constitutes a “reasonable time.” While agencies have flexibility in interpreting their rules, the Commission “has left ‘vague and inclusive” the date that starts the ‘reasonable time clock, as well as the mount of time considered reasonable.” This it may not do.

Finally, the Court concluded that the civil penalty had not been calculated in accord with the statute. The Commission has the authority to impose a second tier penalty for each violation where it finds that the conduct was willful and involved fraud, deceit, manipulation or deliberate or reckless disregard of a regulatory requirement. In this case however a maximum second tier penalty was imposed for each year of the alleged scheme, not for each violation. This is not in accord with the statutory requirements since the “Commission must determine how many violations occurred and how many violations are attributable to each person, as the statute instructs.” Since the Commission failed to comply with the statute and to explain its inconsistent and vague application of its Rule, the order was vacated and the proceeding remanded.

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by T. GormanPosted on Posted in SECActions

SEC Chairman Mary Schapiro appeared before Congress twice this week to testify. Before a Senate Committee she testified about mutual fund reform while before a House Committee her remarks focused on the loss at JPMorgan. SEC enforcement brought actions centered on a stock lending scheme and investment fund fraud.

The former CIO for Stanford Financial Group pleaded guilty to obstructing an SEC investigation under a plea agreement that calls for a 36 month prison term. Another defendant in the expert network insider trading cases pleaded guilty this week and the former CFO of collapsed mortgage giant Taylor Bean was sentenced to prison.

A working group of the OECD filed a report noting that Sweden’s enforcement of foreign bribery laws has been very weak while the DOJ settled another FCPA action. The last of the defendants in the Carson FCPA action pleaded guilty as his trial approached.

Finally, in the U.K. three individuals were sentenced to prison as part of an insider trading scheme in which the SEC brought a parallel action. Hong Kong regulators obtained their first order requiring an issuer to repay investors who purchased shares in an IPO based on a false prospectus.

The Commission

Testimony: Chairman Mary Schapiro testified before the Senate Committee on Banking, Housing, and Urban Affairs (June 21, 2012). Her testimony was titled Perspectives on Money Market Mutual Fund Reform and is available here.

Testimony: Chairman Mary Schapiro testified before the house Financial Service Committee (June 19, 2012). Here testimony was titled Examining Bank Supervision and Risk Management in Light of JPMorgan Chase’s Trading Loss and is available here.

Listing standards: The Commission adopted a rule requiring listing standards for compensation committees and compensation advisers. The new rule, mandated by Dodd-Frank, requires that exchange listing standards address four key topics: The independence of the members on the compensation committee; the authority of the committee to retain compensation advisers; the consideration by the committee of the independence of any compensation advisers; and the responsibility of the committee for the appointment, compensation and oversight of the work of any compensation adviser. The release is here.

SEC Enforcement: Filings and settlements

Statistics: This week the SEC filed three civil injunctive actions and two administrative proceedings (excluding tag-along and 12(j) actions).

Stock-lending scheme: SEC v. Bello (D.N. J. Filed June 21, 2012) is an action against Manuel M. Bello and his two controlled entities, Ayunda Equity Funding, LLC and AmeriFund Capital Holdings, LLC. Since at least 2007 the defendants have engaged in a stock lending scheme in which they have induced certain affiliates of issuers to transfer the ownership of millions of shares of publicly traded stock as collateral for loans. Defendants promised the return of identical shares. However, Ayunda and AmeriFund sold the pledged shares. In 35 transactions the shares sold into the market were not registered. The two entities made over $3.2 million from this scheme. The complaint alleges violations of Exchange Act Sections 10(b) and 15(a) and Securities Act Section 5. The defendants resolved the action by consenting to the entry of a final judgment permanently enjoining them from violating the provisions cited in the complaint. A related proceeding was brought against Howard Blum who acted as a broker for Ayunda. The Order alleged violations of Exchange Act Section 15(a). Mr. Blum resolved the action by consenting to the entry of a cease and desist order based on the Section cited in the Order. He also agreed to return over $1 million of allegedly ill-gotten gains along with prejudgment interest and to pay a $50,000 penalty. He is also suspended from the securities industry for twelve months. In the Matter of Howard L. Blum, Adm. Proc. File No. 3-14924 (Filed June 21, 2012).

Investment fund fraud; SEC v. Persaud, Case No. 6:12-cv-00932 (M.D. Fla. Filed June 20, 2012) is an action against Gurudeo Persaude who was a registered representative at a Florida based broker dealer and ran his trading company, While Elephant Trading Company LLC on the side. Beginning in July 2007 and continuing through January 2011 Mr. Persaude raised over $1 million from investors by guaranteeing them that their investment would be safe and pay returns ranging from 6% to 18%. Investors believed their money would be invested in the futures and other markets. Mr. Persaud did not tell investors that his trading strategies were based on lunar cycles and the gravitational pull between earth and the moon. Portions of the money was used to make Ponzi type payments to other investors while in part it was diverted to Mr. Persaud’s personal use. The complaint alleges violations of Securities Act Sections 5 and 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2) and 206(4). The case is in litigation.

Investment fund fraud: SEC v. Martel, 12-CV-11095 (D. Mass. Filed June 20, 2012) is an action against Gary Martel and his two controlled entities, Martel Financial Group and MFG Funding. Beginning as early as 2006 he sold investors in several states a “90 day pass-through bond” or other purported fixed income or pooled investment products. The bonds had a variety of names. Their common element was that they “passed through” Mr. Martel since investors paid money to him and got money back from him, according to the pitch. Investors were assured that their money was safe. Mr. Martel, who raised about $1.6 million, provided account statements to investors showing their holdings, but no other documentation. Periodically, Mr. Martel made small payments to some investors. Beginning in March 2012 Mr. Martel also sold interests in what he claimed was a Facebook IPO pool. All the funds went to him. The Commission’s complaint alleges violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1) and (2). The defendant consented to the entry of a preliminary injunction and a freeze order. The case is in litigation.

Improper sponsored market access: In the Matter of Alchemy Ventures, Inc., Adm. Proc. File No. 3-14720 (June 15, 2012) is an action against the firm, Mark Rogers, its president, and Steven Hotovec, a vice president. Alchemy has never been registered with the SEC as a broker. Its subsidiary, Alchemy Alternatives, Inc, is however a registered broker dealer. According to the Order, on 22 occasions in the fourth quarter of 2009 Alchemy extended to an individual trading access which was used to profit from account intrusions and market manipulation in violation of Exchange Act Section 15(a). To resolve the proceeding each Respondent consented to the entry of a cease and desist order and a censure. In addition, Alchemy agreed to pay disgorgement of $28,502.59 along with prejudgment interest and a civil penalty of $75,000. Each of the individual defendants agreed to pay a civil fine of $35,000.

Criminal cases

Investment fund fraud: U.S. v. Pendergest-Holt, Case No. 4:09-cr-00342-2 (S.D. Tx.) is an action against Laura Pendergest-Holt, former chief investment officer of Stanford Financial Group. This week she pleaded guilty to obstructing an SEC investigation into Stanford International Bank, the Antiguan offshore bank owned by convicted financier Robert Allen Stanford. If the plea agreement is accepted Ms. Pendergest-Hold will serve 36 months in prison. She will also be subject to a fine of up to $250,000. The defendant admitted that despite a lack of knowledge she testified before the SEC during its investigation as a stall tactic to frustrate the investigation.

Insider trading: U.S. v. Ebrahim, 1:12-cr-00471(S.D.N.Y.) is one of the expert networking insider trading cases. Defendant Alnoor Ebrahim pleaded guilty to one count of conspiracy to commit securities fraud and wire fraud in connection with the insider trading scheme. Mr. Ebrahim was previously employed as an associate director of channel marketing at AT&T. From 2008 through 2010 Mr. Ebrahim furnished product sales information regarding AT&T’s cell phone handsets which included the IPhone and RIM’s Blackberry devices. That information was made available to clients of expert network Primary Global which was central to this series of insider trading cases. In many instances the information was made available in consultation calls with employees of investment firms in New York City. Mr. Ebrahim was paid about $180,000. Sentencing is scheduled for October 25, 2012.

Investment fund fraud: U.S. v. Ray (N.D. Cal.) is an action in which Krittibas Ray pleaded guilty to two counts of wire fraud and one count of money laundering. This week he was sentenced to five and one half years in prison. The charges were based on an investment fund fraud in which Mr. Ray raised about $3.3 million from investors from February 2008 through 2011. He lured investors into putting money into a promissory note program and hedge funds he operated by falsely telling that that by putting money into banks in India he could guarantee returns of 7% to 8.5% and that the funds were profitable. In actuality he used much of the money to pay other investors and for his personal expenses.

Financial fraud: U.S. v. de Armas (E.D.Va.) is an action against Delton de Armas, the former CFO of collapsed mortgage lender Taylor, Bean & Whitaker Mortgage Co. Previously, Mr. de Armas pleaded guilty to one count of conspiracy to commit bank and wire fraud and one count of making false statements. This week he was sentenced to serve 60 months in prison. Mr. de Armas joined the collapsed mortgage company in 2000 as its CFO. He reported to its chairman, Lee Farkas who was previously found guilty by a jury in connection with the fraud at Taylor Bean. Over a period of years Mr. de Armas and others at the firm engaged in a massive scheme to defraud financial institutions that invested in a lending facility operated by the firm.

Anti-corruption/FCPA

OECD: The OECD Working Group on Bribery issued a report concluding that Sweden’s enforcement of foreign bribery laws is far too weak. Despite passing anti-bribery legislation over 20 years ago and numerous allegations involving Swedish companies, only one case in 2004 has been brought and there has never been an action against a Swedish company for foreign bribery. On the positive side the Group noted that Sweden has recently taken steps to strengthen its anti-bribery legislative framework and created the Anti-Corruption Police Unit.

U.S. v. Data Systems & Solutions LLC, Cr. No. 1:12-CR-262 (E.D. Va. Filed June 18, 2012) is an FCPA cases against Data Systems & Solutions LLC of Reston, Virginia. The firm settled charges with the DOJ, entering into a two year deferred prosecution agreement. The underlying two count information contains one count of conspiracy and one count of FCPA violations. The firm will pay a criminal fine of $8.82 million.

From 1999 through 2004 Data Systems is alleged to have paid bribes to officials employed by the Ignalina Nuclear Power Plant or INPP, a state owned nuclear power facility in Lithuania. Over the five year period INPP awarded Data Systems a number of contracts which resulted, according to the information, from a series of bribes paid to INPP officials, frequently through three subcontractors, one of which was a U.S. corporate entity. In resolving the case the DOJ acknowledged what it termed “extraordinary” cooperation. This resulted in a criminal fine that was about 30% below the bottom of the fine range calculated under the sentencing guidelines.

U.S. v. Carson, 8:09-cf-00077 (C.D. Cal.) is the long running FCPA action involving Control Components, Inc. On June 14, 2012, shortly prior to the scheduled commencement of his trial, David Edmonds pleaded guilty to one count alleging a violation of the FCPA. Mr. Edmonds was the last remaining defendant in the case. Previously, the California valve manufacturer plead guilty to a three count criminal information based on its involvement in a scheme to obtain contracts in 36 countries by paying bribes. One notable feature of the case is the ruling by the court on the question of what constitutes an instrumentality, an undefined term in the definition of foreign official in the Act. The court denied a motion to dismiss claiming that the state owned enterprises involved in the action did not fall within the meaning of the term. Rather, the court held that the issue is a question of fact for the jury. Each of the other individual defendants in the case has pleaded guilty with the exception of the former president of CC’s Korean offices who is a fugitive.

PCAOB

The Board announced 43 academic institutions that will participate in its scholarship program for the academic year 2012-2013. Under the Sarbanes-Oxley Act funds generated from the collection of monetary penalties imposed by the Board are used to fund a merit scholarship program for students in accredited accounting degree programs. Students may be eligible for PCAOB scholarships if they are enrolled in an accounting degree program at an accredited participating, nominating institution.

FINRA

Merrill Lynch was fined $2.8 million in connection with supervisory failures that resulted in customers being overcharged by $32 million and for failing to provide certain required trade notices. FINRA concluded that from April 2003 to December 2011 Merrill Lynch failed to have an adequate supervisory system to ensure that certain customers in investment advisory programs were properly charged in accord with the disclosure documents. As a result almost 95,000 customers were overcharged. The firm also failed to provide timely trade confirmations to customers in certain programs and to properly identify if it was acting as an agent or principal on the confirmation. Merrill has provided $32 million in remediation plus interest to affected customers.

U.K.

Insider dealing: James Sanders, his wife Miranda and James Swallow were sentenced to prison terms in connection with an insider dealing case that parallels one brought by the SEC. Messrs. Sanders and Swallow were both directors of brokerage Blue Index. Miranda Sanders is the sister of Annabel McClellan of San Francisco who is married to Arnold McClellan, a senior partner at Deloitte Tax LLP where he worked on M&A deals. Either Mr. McClellan or his wife tipped Mr. or Mrs. Sanders about pending deals. Between October 2006 and February 2008 both traded while in possession of the inside information. Mr. Sanders tipped Mr. Shallow who encouraged clients of the firm to trade. The defendants had trading profits of about ₤1.9 million while clients of Blue Index had profits of approximately £10.2 million. Mr. Sanders was sentenced to serve four years in prison after pleading guilty to 10 charges of insider dealing while his wife was sentenced to serve ten months in custody. She previously pleaded guilty to five charges of insider dealing. Mr. Swallow was also sentenced to serve ten months in custody after pleading guilty to three charges of insider dealing. The parallel SEC enforcement action is SEC v. McClellan, Case No. CV 105412 (N.D. Cal. Filed Nov. 30, 2010).

Report: The FSA published its annual report for 2011/12. The report reviews the work and accomplishments of the agency against its accountability framework. This is expected to be the last annual report before the transition to the Prudential Regulation Authority and the Financial Conduct Authority which will occur in early 2013. The report is available here.

Hong Kong

Hontex International Holdings Company Limited entered into a settlement with the Securities & Futures Commission to extend a $1.03 billion buy back offer to its shareholders following a 28 day court hearing. It is the first order of its kind for the SFC. Hontex, a Cayman Island company, conducted in IPO and subsequently its shares were listed for trading on the Stock Exchange of Hong Kong in December 2009. According to an agreed statement of facts, the company made materially false and misleading statements in the prospectus. Those included a statement that the turnover for the years ended 31 December 2006, 2007 and 2008 was materially overstated as was the profit for those years. In addition, the prospectus overstated the cash and cash equivalents held by the company for the years ended 31 December 2007, 2008 and 30 June 2009. In making the admissions neither Hontex nor its directors and the other defendants admitted any criminal contravention.

SEC Chairman Mary Schapiro appeared before Congress twice this week to testify. Before a Senate Committee she testified about mutual fund reform while before a House Committee her remarks focused on the loss at JPMorgan. SEC enforcement brought actions centered on a stock lending scheme and investment fund fraud.

The former CIO for Stanford Financial Group pleaded guilty to obstructing an SEC investigation under a plea agreement that calls for a 36 month prison term. Another defendant in the expert network insider trading cases pleaded guilty this week and the former CFO of collapsed mortgage giant Taylor Bean was sentenced to prison.

A working group of the OECD filed a report noting that Sweden’s enforcement of foreign bribery laws has been very weak while the DOJ settled another FCPA action. The last of the defendants in the Carson FCPA action pleaded guilty as his trial approached.

Finally, in the U.K. three individuals were sentenced to prison as part of an insider trading scheme in which the SEC brought a parallel action. Hong Kong regulators obtained their first order requiring an issuer to repay investors who purchased shares in an IPO based on a false prospectus.

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