by T. GormanPosted on Posted in SECActions

Market crisis cases continue to be a central focus for enforcement officials. The new DOJ task force christened in the President’s State of the Union address is hard at work trying to determine the origins of the market crisis and who, if anyone, might be held accountable. The SEC reportedly is in settlement talks with a number of institutions. And, in the U.K. the FSA recently filed a report censuring a major financial institution stemming from its failures during the crisis that contributed to its taxpayer funded bail out. To date, the cases are largely consistent, focusing generally on institutional shortcoming and failures and civil charges.

The FSA’s action is against HBCS Group and its primary subsidiary, the Bank of Scotland PLC. During the period from January 2006 through December 2008 the FSA concluded that Bank of Scotland:

  • Pursued an aggressive growth strategy that focused on high-risk, sub-investment grade lending;
  • Increased the complexity and size of its high risk transactions as the crisis unfolded;
  • Continued to increase its market share in this high risk area as others pulled out of the market; and
  • Had an internal structure more focused on profits than risk.

The Bank had serious control deficiencies which allowed the pursuit of the inappropriate strategy. Those included:

  • A framework that did not sufficiently challenge the approach of the Corporate Division which conducted the transactions;
  • An inadequate framework for managing credit risk across the portfolio;
  • A system which failed to effectively reduce the risks in the portfolio; and
  • An inadequate process for identifying and managing transactions that showed signs of stress.

As the market crisis continued to unfold, and the stress in the bank’s transactions became apparent, it was “slow” to move the transactions to the High Risk area despite a significant risk to the firm’s capital. This failure meant that the extent of the risk was not fully known to the Group’s board or auditors. Ultimately as a result of these failures the government and the taxpayers were forced to bail out the Bank.

The Bank failed to comply with FSA Principles of Business 3 the FSA found. That principle specifies that the firm take reasonable care to organize and control its affairs responsibly and effectively with adequate risk management systems. While ordinarily a financial penalty would be imposed, in this case the Bank was only censured. The FSA explained that it took this step because “levying a penalty on the enlarged Group means the taxpayer would effectively pay twice for the same actions committed by the firm.”

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by T. GormanPosted on Posted in SECActions

The SEC filed a fraud action against Edward Ellis, Sr. and Jennifer Seidel, alleging that the two defrauded investors in connection with the purchase of shares in their company, Sederon, Inc. SEC v. Ellis, Civil Action No. 12-cv-1203 (E.D. Pa. Filed March 8, 2012). The case is in litigation.

Sederon is a home maintenance company headquartered in Collegeville, Pennsylvania. By mid- 2007 the company had insufficient funds to meet payroll and other expenses. Accordingly, the defendants sought to raise cash by selling shares in the company to the public. From August 2007 through October 2008 stock was sold to about 54 investors. The company raised approximately $519,500. In selling the shares the defendants made a series of misrepresentations, according to the complaint, including:

  • Claims that Sederon was highly profitable;
  • Statements that the business was rapidly expanding;
  • A claim that an IPO would be forth coming ;
  • A representation that IPO investors would be able to sell their shares in the open market at profits from 900 to 1,300 percent; and
  • The shares were limited or then available at a “special discount.”

The defendants also failed to disclosure certain key facts to potential investors including:

  • In 1994 Mr. Ellis had pleaded guilty to wire fraud charges in connection with another fraudulent offering of securities and was sentenced to 30 months in prison;
  • Mr. Ellis had previously consented to the entry of a fraud injunction in a prior Commission proceeding based on the same conduct that send him to prison; and
  • In May 2003 the Pennsylvania Securities Commission ordered Mr. Ellis to cease and desist from selling unregistered securities in a home maintenance company he owned which is a predecessor to Sederon.

The Commission’s complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b).

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