by T. GormanPosted on Posted in SECActions

The Commodity Futures Trading Commission filed an enforcement action against the Royal Bank of Canada alleging a years long, riskless wash sale scheme conducted by a small group of RBC personnel to generate certain lucrative Canadian tax benefits. The trades were not conducted in an arms-length manner between the counterparties as required by law or in accord with the price discovery purposes of the futures market, according to the complaint filed by the agency. CFTC v. Royal Bank of Canada (S.D.N.Y.).

Beginning in June 2007 and continuing to May 2010, RBC traded hundreds of millions of dollars worth of narrow based stock index futures and single stock futures contracts with two of its subsidiaries. Prior to each transaction the bank identified stocks in the U.S. and Canada that would could be used to create certain tax benefits. The bank and a subsidiary then bought and sold those stocks as well as the stock index futures and single stock futures. The trades were conducted in a riskless manner so that the profits and losses would wash to zero. The transactions, reported as block trades, were arranged by a small group of senior RBC personnel acting for the financial institution. The purpose of the transactions was to realize Canadian tax benefits from holding the securities of certain public companies in Canada and offshore trading accounts.

The complaint also claims that RBC attempted to conceal the transactions from CME Group. When the transactions were reported to CME Group RBC falsely stated that the single stock futures trading was at arms-length between two counterparties. It concealed the fact that all the trades were orchestrated by a small group within the bank. RBC also concealed the fact that the transactions were designed to exclude non-RBC affiliated parties from its futures trades.

The complaint seeks a permanent injunction and a civil monetary penalty. The case is in litigation.

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by T. GormanPosted on Posted in SECActions

The Commission filed another strict liability, SOX 304 action, seeking to clawback certain CEO and CFO compensation. This time the defendants are Michael Baker and Michael Gluck, respectively, the CEO from 1997 through February 2009, and CFO from May 2006 through December 2008, of ArthroCare Corporation. SEC v. Baker, Case No. 1:12-cv-00285 (W.D. Tx. Filed April 2, 2012).

ArtroCare is an Austin, Texas based manufacturer of medical devices whose shares are traded on NASDAQ. From 2006 through the first quarter of 2008 two company sales executives, John Raffle and David Applegate, engaged in a channel stuffing scheme which resulted in the improper inflation of company revenue and earnings. Specifically, during that time period the two salesmen shipped certain products to distributors even though they often did not need, or have the ability to pay for, them. As a result for 2006, 2007 and the first quarter of 2008 revenues were overstated by, respectively 7.9%, 14.1% and 17.4% totaling almost $72.3 million. For the same period net income was overstated by 14.5% in 2006, 8,694.3% for 2007 and 315.2% for the first quarter of 2008, totaling about $53.7 million. As a result the company was required to restate its financial statements.

The Commission previously brought an enforcement action against the two salesmen. SEC v. Raffle, Civil Action No. 1:11-cv-540 (W.D. Tx. Filed June 27, 2011). Mr. Applegate settled that action. Lit. Rel. No. 22027 (July 5, 2011).

Most of the Commission’s complaint details the fraudulent conduct of the two salesmen. It notes at the outset, however, that “The Commission does not allege that Banker and Gluk participated in the wrongful conduct.” Rather, the complaint seeks the repayment of cash bonuses, incentive and equity-based compensation and profits from the sale of company stock under SOX 304 during the 12 month periods following the issuance of the quarterly and annual financial statements later restated. The amount of the compensation and stock sale revenue to be clawedback is not specified.

This is not the first strict liability clawback action brought by the SEC. That case is SEC v. Jenkins, CV 09-01510 (D.Arix. Filed July 22, 2009) brought against the former CEO of CSK Auto. That case ultimately settled following the rejection by the Commission of a settlement offer of partial repayment. See also SEC v. O’Dell, Civil Action No. 1:10-CV-00909 (D.D.C. Filed June 2, 2010). While it is clearly debatable as to whether a strict liability interpretation constitutes good enforcement policy, the Commission’s position has been sustained by the Second Circuit. Cohen v. Viray, Case No. 3860-cv (2nd Cir. Sept. 30, 2010).

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