The SEC obtained a $62,630,434.56 judgment against Tomo Razmilovic, the former CEO of Symbol Technologies, Inc. in its long running financial fraud action arising out of the fraud at the company. SEC v. Razmilovic, Case No. CV 04-2276 (E.D.N.Y.). The amount is one of the largest obtained by the Commission against an individual in a financial fraud action.

Mr. Razmilovic and his co-defendants are alleged to have engaged in a wide spread fraudulent scheme to inflate the revenue, earnings and other measures of financial performance so that Symbol would meet or exceed its financial projections. From 1998 through the fourth quarter of 2002 the defendants are alleged to have engaged in a variety of fraudulent accounting practices which included improper topside adjustments, a number of revenue recognition schemes and the manipulation of reserves, all of which distorted the financial results of the company.

Symbol restated its financial results for 1998 through 2001 following an internal investigation that was impeded by certain former employees. In that restatement the company reversed cumulative net revenue of $234,220,000 and cumulative net earnings of $325,536,000 that had been previously recognized through the period ended September 30, 2002. As of that date Symbol’s restated Stockholders’ Equity was $946,261,000 compared with $1,171,393,000 originally reported. According to the disclosures made in conjunction with the restatement, the adjustments were necessary because of “widespread errors and irregularities primarily involving the timing and amount of product and service revenues recognized and the timing an amounts recognized with respect to certain reserves, restructurings, certain option programs and several categories of cost of revenue and operating expenses.”

Mr. Razmilovic became president and COO of Symbol in 1995. In 2000 he was promoted to CEO. He resigned from that position in 2002. During the term of his employment he received a salary, incentive based compensation tied to the performance of the company as well as stock options. At the time of his resignation he was awarded a severance package.

The SEC brought a civil fraud action alleging a wide ranging financial fraud over the period of the restatement orchestrated by Mr. Razmilovic. Parallel criminal charges were also brought. Mr. Razmilovic fled the country although he defended the SEC case. The court entered a default judgment on the question of liability following his failure to appear for a deposition. At the hearing on remedies the Commission sought an injunction, disgorgement, prejudgment interest, civil penalties and an officer and director bar. Mr. Razmilovic appeared through counsel. Each side offered expert testimony to support its claims on the monetary issues.

The court began with the request for disgorgement. The question here, according to the court, is the amount of money acquired through wrongdoing. Generally, the amount should be a reasonable approximation of the profits which are causally connected to the violation. Where the fraud is pervasive the court concluded that it is reasonable to order the disgorgement of all ill-gotten gains realized during the course of the wrongful scheme rather than calculate the amount tied to each wrongful act. The focus of this calculation is the ill-gotten gains aside from what the defendant would have otherwise obtained. In making this calculation the costs incurred by the defendant are not deducted. The court then applied these principles to the types of compensation paid to Mr. Razmilovic:

Base salary: During the term of his employment Mr. Razmilovic received a base salary which was increased at the time of his promotion. The SEC sought as disgorgement the entire amount paid arguing that under his employment agreement his wrongful conduct was grounds for termination. Thus his fraudulent conduct would have precluded him from receiving payments from 1998 through 2002 when he resigned.

The court concluded however that the Commission did not establish a causal link between the base salary and the fraud. Rather, the evidence demonstrates that under Symbol’s policies the base salary was not tied to the financial performance of the company. Since Symbol remained a viable company throughout the fraud it is reasonable to infer that Mr. Razmilovic rendered some functions and service that were of value to the company despite the fraud. This contrasts with situations where the company only continued because of the fraud which might make it appropriate to disgorge all of the base salary.

The court concluded however that it is reasonable to assume that Mr. Razmilovic was promoted from COO to CEO based on the fraudulent metrics. Accordingly, he was directed to disgorge the increased amount of compensation he received. This totaled $932,247.84.

Bonuses: Under Symbol’s Executive Bonus Plan Mr. Razmilovic was paid in 1999 and 2000 based on the fraudulently reported numbers. Accordingly, he was directed to disgorge the total amounts which equaled $1,691,400.00.

Severance payment: Under the terms of his severance agreement Mr. Razmilovic was paid $5 million. Mr. Razmilovic argued that the SEC failed to establish a causal link between this payment and the fraud. The agreement however stipulated that the amount was paid in consideration of his relinquishment of certain stock options awarded in February 2001. Since that award is tied to the fraud, the payment must be disgorged the court concluded.

Stock transactions: The SEC also sought the disgorgement of all profits obtained from Symbol stock transactions by Mr. Razmilovic during the period. This includes his options and open market transactions.

Here the court concluded that disgorgement should be the amount of the ill-gotten gains which is the difference between the inflated value of the proceeds realized on the date the options were exercised and the value of the proceeds that otherwise would have been obtained absent the fraud. The court concluded that the SEC met its initial burden by establishing the amounts reported to the IRS by Mr. Razmilovic on his W-2s. At the same time “Razmilovic’s reliance on private securities fraud cases addressing the issue of inflation, but in the context of loss causation, is not misplaced. Although the SEC is not required to prove the element of loss causation in order to establish liability . . . it is required to prove a causal connection between the fraud and Razmilovic’s ill-gotten gains for the purpose of disgorgement.” Here the key question is when there was a corrective disclosure or the fraud materialized and caused the value of the securities to decline. Where the fraud has been concealed “a corrective disclosure is not necessary to establish causation . . . [and] a risk allegedly concealed by the defendants which subsequently materialized, caused the value of the securities to decline.” In this case, expert testimony offered by the SEC from an economist based on an event study demonstrated that the risk materialized over a period of time. The court discounted the defense expert who ignored key facts. Based on this methodology the court directed the disgorgement of $33,869,975.20 from the stock transactions.

Credits: Mr. Razmilovic claimed he is entitled to “credits” for the amounts paid in the settlement of parallel civil litigation and taxes. He also argued that he should not have to pay prejudgment interest in view of the amounts frozen during the case. The court rejected Mr. Razmilovic’s claim that he is entitled to a $2,250,000 credit for amounts paid in the private damage actions because the relief sought there differs from the disgorgement here. Nevertheless the court chose to exercised its direction and allow a credit if the amount is paid within 20 days.

The claim for a tax credit was rejected, concluding that there is no authority supporting a credit for taxes paid. While there is authority for not imposing prejudgment interest where the assets were frozen during the case, the principle applies where all of the ill-gotten funds were frozen. In this case it is clear that only a portion of those assets were frozen. The court thus imposed prejudgment interest.

The court also considered the question of penalties. Here the court concluded that “civil penalties authorized by the securities laws serve a dual purpose, i.e., to both punish the individual violator for his past violations and deter future violations . . . “ In assessing a penalty courts typically consider a series of factors keyed to the nature of the conduct, the scienter of the defendant, the risk of loss, acceptance of responsibility and the financial condition of the company. In this regard the court rejected Mr. Razmilovic’s claim that his penalty should be proportional to others in the case since those individual settled. In contrast, he is a fugitive. Nevertheless, the court declined to impose a penalty equal to the statutory amount which would equal the pecuniary gain in view of the sum involved. Accordingly, the court imposed a penalty equal to one half of the pecuniary gains or $20,876,811.32.

The court concluded by entering an order permanently enjoining Mr. Razmilovic from future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2) and 13(b)(5) and directing that he pay disgorgement of $41,753,623.04 plus prejudgment interest in addition to a civil penalty of $20,876,811.32. The court also barred Mr. Razmilovic from serving as an offer or director of a public company.

Program: The Impact of the Supreme Court’s Decision in Morrison v. National Bank of Australia on securities litigation and SEC enforcement actions. Presented by Celequ Legal Education in conjunction with West Thomson. Webcast on October 12, 2011 from 12:00 to 1:00 EST. For furtrher information please click here

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The SEC settled two insider trading cases this week while bringing three investment fund fraud suits, two of which involved recidivists who are alleged to have diverted investor funds from their current scheme to make payments in their prior criminal case. The CFTC Division of Enforcement filed a record number of enforcement actions in the last fiscal year while opening a program high number of investigations according to the agency.

The New York Attorney General joined and expanded a whistleblower suit against the Bank of New York Mellon. It alleges that pension funds and other investors were defrauded out of about $2 billion by the bank which misrepresented interbank rates obtained in foreign currency transactions. The DOJ filed a parallel case.

Finally, a court in Australia handed down a significant decision regarding the obligations and liabilities of directors. It concluded that each member of the board was liable for failing to discover a significant error in the company financial statements.

The Commission

Rating agencies: The SEC staff published a report regarding its latest examinations of these agencies. It is titled: “2011 Summary Report of Commission Staff’s Examinations of Each Nationally Recognized Statistical Rating Organization” (here). The Report identifies ten NRSROs and has a series of findings regarding their compliance with prior inspection recommendations and the implementation of various provisions of Dodd-Frank.

SEC Enforcement — filings

Investment fund fraud: SEC v. StratoComm Corporation, Civil Action No. 1:11-CV-1188 (N.D. NY Filed Oct. 6, 2011); SEC v. Merkin, Civil Action No. 1:11-cv-23585 (S.D. Fla. Filed Oct. 6, 2011). The StratoCom complaint names as defendants the company along with its CEO Roger Shearer and its former IR director Craig Danzig. It alleges that the company raised about $3 million from investors by selling unregistered shares of company stock based on claims that it was engaged in the manufacture and sale of telecommunications systems for underdeveloped countries. The claims are false. The company had no product and no revenue. The investor funds were diverted to personal use including restitution Mr. Shearer was obligated to pay in another criminal case. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The Merkin complaint is against attorney Stewart Merkin who served as company counsel. It alleges violations of Exchange Act Section 10(b) based on four attorney letters he prepared for the Pink Sheets which claimed the SEC was not conducting an investigation of the company. In fact the investigation was in progress and Mr. Merkin was representing persons in it. The letter facilitated the continued trading of company shares. Both cases are in litigation.

Financial fraud: SEC v. Sells, Case No. CV-11-4941 (N.D. Cal. Filed Oct. 6, 2011) is an action against two former sales executives of medical equipment company Hansen Medical, Inc., Christopher Sells and Timothy Murawski. The complaint alleges violations of Securities Act Sections 17(a)(1) & (3) and Exchange Act Sections 10(b) and 13(b)(5) and aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). It centers on transactions in 2008 and 2009 in which the two defendants attempted to accelerate the recognition of revenue from the sale of the medical equipment sold by the company. In some instances, for example, the defendants convinced purchasers to let them set-up equipment so they could claim it was delivered and installed and the revenue could be recognized. The equipment would later be disassembled and stored for months. In another instance a physician’s signature was forged certifying that training had been completed when it had not. During the period Hansen was under intense pressure to raise additional capital from investors. This action, which resulted from a whistleblower, is in litigation. A related administrative proceeding against the company settled. In the Matter of Hansen Medical, Inc., Adm. Proc. File No. 3-14578 (Filed Oct. 6, 2011). There the company consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 139a), 13(b)(2)(A) and 13(b)(2)(B). The SEC acknowledged the significant remedial acts of the company as well as its voluntary disclosure and cooperation.

Investment fund fraud: SEC v. Aronson, Civil Case No. 11 Civ. 7033 (S.D.N.Y. Filed Oct. 6, 2011) is an action alleging violations of Securities Act Sections 5 and17(a) and Exchange Act Sections 10(b) and 15(a). It names as defendants Eric Aronson, a convicted felon, Vincent Buonauro, Jr., Robert Kondratick, Fredric Aaron and several related entities. The complaint alleges a fraudulent investment scheme in which about 140 individuals lost approximately $26 million between 2006 and 2010 investing in water-filtering natural stone pavers. Investors were told they would receive returns of 7.8% to 33% because the stones could be sold at a high mark-up and there was a significant backlog of orders. Those representations were false. Investors were paid returns using funds obtained from other investors. A portion of the money was diverted to the personal use of the promoters, including the payment of Mr. Aronson’s restitution obligations from another case. Some portions were used to purchase publicly traded Interlink-US-Network, Ltd which later published a false Form 8-K which stated that LED Capital Corp. had agreed to invest $6 million in the company. When investors demanded their money back Mr. Aronson at first claimed that the notes were usurious and later, with the assistance of his attorney who is also a defendant, convinced them to convert their notes into ones with deferred payments. The SEC obtained an emergency freeze order. The case is in litigation. A parallel criminal case has also been filed.

Insider trading: SEC v. Hansen, Civil Action No. 10-CV-5050 (E.D.Pa.) is an insider trading case against the former Chairman of Keystone Equities Group, a registered broker-dealer and regional investment bank. The complaint alleges that Mr. Hansen was illegally tipped by his employee and close friend Donna Murdoch. Ms. Murhoch obtained inside information from former Ernst & Young partner and attorney James Gansman with whom she was having an affair. The information concerned pending take-over transactions. Mr. Hansen settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to pay disgorgement and prejudgment interest in the amount of $63,038 of which $32,222 will be satisfied through the payment of a criminal forfeiture order in the parallel criminal action. The order also bars him from serving as an officer or director. In a related administrative proceeding Mr. Hansen consented to the entry of an order barring him from the securities business or participating in any penny stock offering. In the related criminal case Mr. Hansen previously pleaded guilty to conspiracy and securities fraud charges and was sentenced to three months imprisonment followed by five months of home confinement and two years of probation. Mr. Gansman was convicted following a jury trial. Ms. Murdoch had pleaded guilty.

Insider trading: SEC v. Galleon Management, LP, Civil Action No. 09-CV-8811 (S.D.N.Y.) is the Commission’s insider trading case which evolved out of the Galleon investigations. This week the SEC settled with Steven Fortuna, the founder of S2 Capital, a hedge fund investment adviser in New York. Mr. Fortuna traded on inside information obtained from Danielle Chiesi in the shares of Akamal Technologies, Inc. and AMD. He resolved this action by consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). He also agreed to pay disgorgement of $193,536 along with prejudgment interest and a civil penalty in the amount of $96,768. In a related administrative proceeding Mr. Fortuna consented to the entry of an order barring him from association with any broker, dealer, investment adviser, municipal securities dealer or transfer agent. He previously pleaded guilty in the parallel criminal case and is cooperating with the government. This is the thirteenth settlement obtained by the SEC in this case.

Investment fund fraud: SEC v. Allen, Civil Action No. 3:11-CV-822 (N.D. Tex.) is an action against the co-founder of China Voice Holding Corp. and others alleging that the company was essentially a Ponzi scheme. This week the Commission settled with defendants Alex Dowlatshahi and Christopher Mills. They consented to the entry of permanent injunctions prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). In addition, Defendants Integrity Driven Network Corp, Lucrative Fnterprises Corp., Synergetic Solutions LLC, Silver Summit Holdings LLC and Sleeping Bear LLC were permanently enjoined from violating Exchange Act Section 10(b). On motion of the Commission the court may order disgorgement, prejudgment interest and civil penalties.

Failure to supervise: In the Matter of Gilford Securities Inc., Adm. Proc. File No. 3-14574 (Sept. 30, 2011) is an action against the firm, one of its founders, Ralph Worthington, a supervisor, David Kaplan and the CCO, Richard Grahahan. The proceeding centers on a failure to supervise M.S. Gregg Berger, a former registered representative at the firm and other violations. From 2005 through May 2006 Mr. Berger is alleged to have resold over 30 million shares of stock through at least 20 customer accounts at the firm. There was no resale registration statement or exemption for the shares. The firm failed to implement systems reasonably designed for its supervisory policies. Eventually Mr. Berger was named as a defendant in a Commission “pump and dump” action and a parallel criminal case. The firm also violated the securities laws by permitting customers to: deliver in and sell millions of shares of stock without conducting reasonably inquiry into the source of the stock; by failing to file SARS as required by the Bank Secrecy Act; and by sharing confidential customer information with others. Messrs. Worthington and Kaplan also aided and abetted some of the firm’s violations while Mr. Granahan, the firm’s CCO and its anti-money laundering officer, aided and abetted the firm’s SARs violation.

Gilford resolved the proceeding by agreeing to implement a series of steps which include the retention of an independent consult who will make recommendations regarding procedures which the firm will implement. The firm also consented to the entry of a cease and desist order based on Securities Act Section 5 and Exchange Act Sections 15(b)(7) and 17(a) and the related rules. The firm will also disgorge $275,000 along with prejudgment interest and pay a civil penalty of $260,000. Mr. Worthington agreed to the entry of a cease and desist order based on Exchange Act Sections 15(b)(7) and 17(a) and the related rules, to be suspended from acting in a supervisory capacity with a broker dealer for twelve months and to pay a civil penalty of $45,000. Mr. Kaplan consented to the entry of a cease and desist order based on Rule 10(a) and Regulation S-P. He also agreed to pay disgorgement of $225,000 along with prejudgment interest and a civil penalty of $30,000. Mr. Granahan agreed to the entry of a cease and desist order based on Exchange Act Section 17(a) and Rule 17a-8. He also agreed to pay a civil penalty of $20,000.

CFTC

Statistics: The agency announced that in FY 2011 the Division of Enforcement filed 99 enforcement actions, the highest yearly total in its history. This also represents a 74% increase over the prior year. The Division also opened more than 450 investigations which is another program high. During the last fiscal year more than 70 indictments and convictions were obtained related to CFTC enforcement actions.

Failure to supervise: The agency issued an order and settled charges with Forex Capital Markets LLC in connection with the failure of the firm to supervise diligently its personnel handling over 57,000 customer accounts that traded on its forex trading platforms. As a result, from at least June 2008 through mid-December 2010 the firm failed to supervise diligently the handling of customer accounts traded on its forex platforms with respect to changes in price between order placement and execution on both market orders and margin liquidation orders. As a result customers did not benefit from price movements in their favor but did suffer from detrimental price movements. The firm agreed to pay a $6 million civil penalty and restitution of $8,261,937 to its customers and former customers. It also agreed to retain for the next three years a monitor to supervise its trade execution practices and policies as they relate to the change in price between the time the customer places the order and the execution and its compliance with its restitution obligation.

Criminal cases

Investment fund fraud: U.S. v. Prince (N.D.Cal.) is an action against attorney David Prince. The indictment claims that Mr. Prince raised more than $1.1 million from 30 investors from August 2005 through January 2007. Investors were told their funds were guaranteed and that they would receive returns of 5% to 25% from investments in the stock market. He assured them of the legality of the plan since he is an attorney. In fact he lost most of the money through risky options trading, by diverting some to personal use and by making Ponzi type payments to investors. Following a three week trial he was convicted on five counts of wire fraud. The jury did not reach a verdict on two other counts. Sentencing is scheduled for January 11, 2012.

FINRA

Investor warning: The regulator issued an investor warning titled “Public Non-Traded REITS-Perform a Careful review Before Investing.” It notes that while investors are looking for better returns which may be offered by these investments it is critical to understand the risks. The alert is available here.

PCAOB

The Board published a Staff Audit Practice Alert regarding the audit risks in certain emerging markets. While the guide is intended for auditors, board Chairman James Doty noted that it is a good reminder for investors and audit committee members regarding the risks in these markets. The Alert is available here.

Court of Appeals

Authority to file collection suits: Fiero v . Financial Industry Regulatory Authority, Nos. 09-1556-cv, 09-1863-cv (2nd Cir. Oct. 5, 2011). The case stems from a FINRA disciplinary proceeding brought against John Fiero and Fiero Brothers, Inc. in which the hearing panel expelled the firm, barred Mr. Fiero and imposed a a fine of $1 million plus costs. Mr. Fiero and his firm subsequently filed a declaratory judgment action in Federal Court seeking a ruling that FINRA did not have authority to bring a court action to collect a fine. The district court dismissed the complaint. The Second Circuit reversed, concluding that FINRA does not have the authority to bring such an action. First, there is no express provision in the Exchange Act granting such authority. Second, while the statute grants certain authority the absence of such a provision here is consistent with the fact that FINRA traditionally collected these fines through the use of its power to expel. Finally, any reliance on the rule promulgated in 1990 by the SRO which purports to give it authority to take such action is misplaced. To be effective the rule had to be to be properly promulgated. It was not because FINRA failed to submit the rule to the standard notice and comment procedures.

New York

Misrepresentations: NY AG and State of New York v. Bank of New York Mellon (S.Ct. N.Y.). This is a suit initially filed by a whistleblower and later taken over by the N.Y. AG against the bank. The suit alleges violations which include the false claims act and securities fraud under the Martin Act. The complaint centers on claims that the bank made almost $2 billion in revenues by misrepresenting the interbank rates it obtained in foreign currency transactions for clients. The victims of the wrongful conduct, including public and private pension funds and the State University of New York, were promised the best rate of the day but in fact were given the worst. The bank pocketed the difference according to the papers. The case is pending. The DOJ has filed a parallel civil action.

FSA

The regulator imposed a fine of ?494,900 on investment manager Towry Investment Management Ltd. in connection with violations of Principle 10 and 11. The former requires managers to properly handle client funds while the latter specifies that firms must deal with the FSA in an open and cooperative manner. Here the FSA sent a “Dear CFO” letter to the firm regarding its compliance with the procedures for handling client funds. The firm told the FSA it was fully compliant when in fact it was not. The FSA discovered violations of the applicable provisions following receipt of the response to the Dear CFO letter. The fine here was reduced by 30% because the firm agreed to settle at an early stage in the proceeding.

Australia

Director obligations: An excellent post on the Harvard Law School Forum by David Katz, Wachtell Lipton, highlights a new decision by the Federal Court of Appeals in Australia regarding director liability. In a landmark ruling the court in Australian Securities and Investment Commission v. Healey, held the entire board of directors liable for failing to find a significant error in the financial statements of the company. The post is available here.

Program: The Impact of the Supreme Court’s Decision in Morrison v. National Bank of Australia on securities litigation and SEC enforcement actions. Presented by Celequ Legal Education in conjunction with West Thomson. Webcast on October 12, 2011 from 12:00 to 1:00 EST. For furtrher information please click here

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