by T. GormanPosted on Posted in SECActions

The impact of Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011) was the critical issue in a recent decision in SEC v. Daifotis, No 3:11-cv-00137 (N.D. CA. Filed Jan. 11, 2011). Previously in this case the court concluded that a question regarding the retroactivity of the Dodd-Frank provision which provides that aiding and abetting liability can be premised on reckless conduct was moot in view of the Commission’s concession on the point (here).

The SEC’s action was brought against Kimon Daifotis, the former lead portfolio manager for Schwab YieldPlus Fund, and Randall Merk, an Executive Vice President at Charles Schwab & Co. The complaint focuses on events during the market crisis in 2007 and 2008 regarding YieldPlus Fund, an ultra-short bond fund that at its peak had $13.5 billion in assets and over 200,000 accounts. It was the largest ultra-short bond fund in the category.

The complaint alleges that the defendants made a series of misstatements in connection with the operation of the Fund and that Mr. Daifotis aided and abetted its deviation from the disclosed concentration policies. Specifically, the SEC claims that in connection with the marketing of the Fund Messrs. Merk and Daifotis misled investors concerning the risks involved. Investors were told that the Fund was only slightly more risky than a money market fund in marketing materials and other communications. Those statements were false, according to the Commission, because they failed to tell investors about the differences between YieldPlus and money funds.

Other false statements concerned redemptions as the market unraveled. By mid-2007 as the Fund’s NAV began to decline many investors sought to redeem their holdings. Few of the Fund’s assets were scheduled to mature within the coming months. The Fund had to sell assets and discounted prices. Mr. Daifotis told investors in conference calls and written materials that the redemptions were “minimal” when in fact they were in the billions of dollars.

Finally, the complaint alleges that Mr. Daifotis aided and abetted the Fund’s violation of its concentration policy. That policy limited investments in mortgage backed securities to 25%. In fact the concentration in those securities greatly exceeded that limitation under the direction of Mr. Daifotis.

Following a ruling on a motion to dismiss which was granted in part and denied in part, the Supreme Court handed down Janus, thus prompting reconsideration. That decision held that a mutual fund investment adviser did not “make” the statements in its client mutual funds’ prospectuses. The question of who made the statement is critical under Section 10(b) and Rule 10b-5 because the statute uses the phrase to “make any untrue statement . . .” That person, the Janus court concluded is the one who has the ultimate authority over the statement including its content and whether to communicate it. Attribution of the statement to the alleged primary violator is necessary the court held.

In this case the parties agreed that the defendants “made” several statements within the meaning of Janus. Those included a registration statement signed by Mr. Merk, a set of questions and answers that listed Mr. Merk as the author which were published on the Schwab website, an advertisement quoting Mr. Daifotis and containing his picuture and similar items where attribution was clear.

However, Mr. Daifotis could not be held primarily liable for an alleged misstatement just because it contained his picture. That is insufficient to establish that he made the statements the court ruled. Similarly, as to other alleged misstatements insufficient facts were pleaded to demonstrate that the defendants made them. However, the court permitted discovery to proceed on all issues including those statements, concluding it would be inappropriate to strike them.

Finally, the court held that Janus does not apply to Securities Act Section 17(a) or Investment Company Act Section 34(b). The former does not use the word “make” which is the lynchpin to Janus. Rather, the Section speaks in terms of “to employ any device . . . “ or “to obtain money . “ In addition, Janus is premised in part on the fact that the cause of action under Section 10(b) in the private damage action before the court was implied. Since there is no implied cause of action under Section 17(a) that rationale is inapplicable.

Janus also does not apply to Section 34(b). That Section, which precludes making material false statements in a registration statement does use the word “make.” However, Janus only involved the question of primary violations and is limited by the fact that it considered an implied cause of action. Neither point is applicable here. Thus it would be inappropriate to limit the language of the Section the court concluded.

Program: Current Trends in FCPA Enforcement, August 17, 2011, Live in Menlo Park, CA, and webcast nationally. The program link is here.

by T. GormanPosted on Posted in SECActions

The Commission brought a significant market crisis case this week, centered on the sale of complex, high risk financial instruments to unsophisticated school districts which ended in millions of dollars in losses.

Insider trading was a key focus for the SEC, DOJ and the FSA. The Commission brought cases against a boyfriend who misappropriate inside information from his girlfriend and a father and son. The DOJ filed a companion case against the father and son in which each defendant pleaded guilty and brought charges against another alleged tipper in the expert network investigation. In the UK the FSA brought insider dealing charges against three individuals.

Finally, the DOJ won two more convictions in FCPA cases. The cases are part of a series of cases arising out of dealings with Haiti Teleco.

The Commission

Whistleblower rules: Sean McKessy, Chief, Office of the Whistleblower, discussed certain aspects of the program in remarks at Georgetown University on August 11, 2011. Mr. McKessy noted that the program will bolster internal compliance systems, reviewed the provisions in the rules that generally exclude attorneys, compliance personnel and external auditors and noted that the program should speed up efforts to address misconduct. The remarks are available here.

SEC enforcement – filings and settlements

Insider trading: SEC v. Scammell, @:11-cv-06597(C.D. CA. Filed Aug. 11, 2011) is an action against Toby Scammell which centers on the acquisition of Marvel Entertainment, Inc. by the Walt Disney Company, was announced on August 31, 2009. Prior to the acquisition, Mr. Scammell lived with his girlfriend in Los Angeles. During that period she was an extern at Disney assigned to work on the Marvel acquisition. She worked long hours during the summer of 2009 and periodically discussed the project in general terms with Mr. Scammel but did not reveal the name of the company. Frequently she worked from home where there were papers about the deal. She was aware of the announcement date for the deal and the $50 price. Mr. Scammel had access to her papers and blackberry. During one conversation she suggested that the project would be done shortly after labor day. Mr. Scammell, who had never before traded options, began making large and unusual purchase of Marvel options in mid – August with an expiration date in September. The strike price was in the range of $45 to $50. Since he did not have the money to pay for all of the options he used funds in his brother’s account without permission. When the deal was announced Mr. Scammell liquidated his holdings, making a profit of $192,497 or over 3000% of his investment. He did not tell his girlfriend or brother. The Commission’s complaint alleges violations of Exchange Act Section 10(b). The case is in litigation.

Investment fund fraud: SEC v. Evolution Capital Advisors, Civil Action No. 4:11-cv-02945 (S.D.Tx. Filed Aug. 11, 2011) is an action against Damian Valdez and his controlled fimrs, Evolution Capital Advisors, previously a registered investment adviser, and Evolution Investment Group I. The complaint alleges that the defendants raised approximately $10 million from over 80 investors through two fraudulent note offerings. Investors were told that the notes were safe and secured by government guaranteed assets which would be acquired through the use of leverage. In fact the notes were not acquired, some were subject to significant undisclosed defaults and others were subject to pre-payment penalties. The defendants siphoned off about $2.4 million in fees and expenses from the investor funds while another $2.7 million was used to make Ponzi type payments. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) & (2). The case is in litigation.

Suitability: SEC v. Stifel, Nicolaus & Co., Civil Action No 2:11-cv-00755 (E.D. Wis. Filed Aug. 10, 2011) is an action against defendants Stifel, Nicolaus & Co., Inc., a retail and institutional brokerage and investment banking firm, and David Noack, a senior vice president of the firm and co-heard of its Milwaukee office. According to the complaint, Mr. Noack used his long standing and close working relation with five Wisconsin school districts to sell them notes tied to the performance of synthetic CDOs comprised of a portfolio of 100 or more credit default swaps on corporate bonds. As part of the investment strategy the school districts used largely borrowed funds. The school districts were induced to make the investments through misrepresentations about the safety and nature of the CDOs and in reliance on Mr. Noack. In fact Mr. Noack had little knowledge about the highly leveraged and high risk investments which were typically used by hedge funds, not inexperienced investors such as the school districts. Ultimately there were millions of dollars in losses. The school districts lost all of their investments. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 15(c)(1)(A). The case is in litigation.

Insider trading: U.S. v. Peterson (S.D.N.Y. Filed Aug. 5, 2011); SEC v. Peterson, Civil Action No. 11-CV-5448 (S.D.N.Y. Filed Aug. 5, 2011). Clayton Peterson, a member of the board of directors and chairman of the audit committee of Mariner Energy, Inc., and his son Drew Peterson, who worked as an investment adviser in Denver, Colorado, pleaded guilty to criminal insider trading charges and were named as defendants in an SEC suit.

Clayton Peterson learned at board meetings that his firm would be acquired by Apache Corporation in a deal that was announced on April 15, 2010. After first learning about the deal he repeatedly tipped his son, instructing him to trade through an account belonging to his sister. The son traded and tipped a hedge fund manager who also traded. Following the announcement of the deal the share price of Marine Energy rose about 42%. The hedge fund manager liquidated his positions, yielding a profit of $5 million. Within days Drew Peterson, and the various accounts for which he traded, liquidated their positions yielding a profit of $150,000. Clayton Peterson and his son Drew each pleaded guilty to one count of conspiracy to commit securities fraud and one count of securities fraud. Sentencing is scheduled for January 12, 2012. The SEC brought a civil injunctive action against Clayton Peterson and his son. The complaint alleges violations of Exchange Act Section 10(b). The action is pending.

ALJ Decisions/orders

In the matter of Gualario & Co. LLC, Adm. Proc. File No. 3-14340 (Aug. 11, 2011) is a proceeding which alleges violations of the antifraud provisions of the securities laws in connection with transactions with advisory clients. The Respondents filed a Motion for Summary Disposition alleging a failure to comply with Exchange Act Section 4E which was added to the Act under Dodd-Frank. It requires that an action be filed within 180 days of the issuance of a Wells notice unless the period is extended by the Director of the Division of Enforcement. The exception is available under Section 4E(a)(2) tilted “Exceptions for Certain Complex Actions.” Here the parties agreed that the 180 days began on July 22, 2010. The Division Director extended the period by ninety days until April 14, 2011. Prior to that date this proceeding was instituted. Respondents argued that the extension was inappropriate because protracted settlement negotiations do not qualify as “sufficiently complex.” The motion was denied.

Criminal cases

Insider trading: U.S. v. Ng, 11-02096 (S.D.N.Y.) is the latest case from the expert network investigation. Defendant Stanley Ng is charged with conspiring to commit securities fraud and wire fraud. Mr. Ng was employed as the SEC Reporting Manager at Marvell Technology Group, Inc. According to the charging papers, he was recruited by Winifred Jiau along with Ngoc Nguyen, who worked in the finance department of NVIDIA Corporation, to join an investment club in which they furnished inside information about their employers in return for other stock tips. In fact Mr. Ng did provide inside information such as in May and August 2008 when he disclosed the then confidential earnings of the company prior to the information being made public. Ms. Jiau, who traded on the information, also sold it to others including Samir Barai and Noah Freeman who traded. Mr. Ng was released on bond after being arrested. Ms. Jiau and Messrs. Nguyen, Barai and Freeman have either been convicted or pleaded guilty in connection with the scheme.

Anti-corruption/FCPA

U.S. v. Esquenazi (S.D.Fla.). Joel Esquenazi, the president of Miami based Terra Telecommunications Corp., and Carlos Rodriguez, the executive vice president of the company, were convicted on FCPA and other charges following a jury trial. Specifically, the two men were convicted on one count of conspiracy to violate the FCPA and wire fraud, seven substantive FCPA counts, one count of money laundering conspiracy and twelve counts of money laundering. The charges are based on a scheme which began in November 2001 and continued through early 2005 to bribe government officials at Telecommunciations D’Haiti S.A.M. or Haiti Teleco. As part of the scheme the defendants paid about $890,000 in bribes to officials at Haiti Teleco through a series of shell companies. The purpose of the bribes was to obtain favorable business advantages, including better rates and a continuation of service. To conceal the payments the defendants used various shell companies and created false records. These are the latest convictions in an on-going series of related cases.

FINRA

Research center established: Stanford University and the FINRA Foundation initiated a Fraud Prevention Research Center which will serve as a resource for law enforcement, government and research groups studying financial fraud (here).

Failure to supervise: Citigroup Global Markets, Inc. was fined $500,000 by the regulator for failing to supervise former registered representative Tamara Moon. Ms. Moon is alleged to have misappropriated almost $750,000 from twenty-two customer accounts by using falsified documents and engaging in unauthorized trades. Typically the customers were elderly. According to FINRA, Ms. Moon took advantage of a series of gaps and lax procedures at the firm. Throughout the eight year period over which the misappropriations were made Citigroup failed to follow-up on red flags related to Ms. Moon’s activities.

PCAOB

U.S/China meetings: U.S. and Chinese regulators met in Beijing to discuss audit oversight cooperation. The Sino-U.S. Symposium on Audit Oversight was attended by officials of the China Securities Regulatory Commission or CSRC, the Chinese Ministry of Finance or MOF, the Public Company Accounting Oversight Board and the Securities and Exchange Commission. The meetings focused on developing an effective cross-boarder audit oversight system in the near future to ensure market integrity and investor protection. Such a system would permit the PCAOB to carry out its obligations under the Sarbanes Oxley Act and conduct the required periodic inspections of Board registered auditors of China based issuers. The U.S. delegation invited the CSRC and the MOF to send delegates to Washington, D.C. to have further discussions. No agreements were reached during the meetings.

Auditor independence: The Board will consider issuing a concept release soliciting public comments on ways to enhance auditor independence including mandatory audit firm rotation at an open meeting on August 16, 2011.

FSA

The FSA charged an investment banker and two of his associates with insider dealing relating to trading from February to November 2009. Specifically, Thomas Ammann, an investment banker, was charged with three counts of insider dealing. He was also charged with one count of money laundering and two counts of encouraging insider dealing. Christina Weckwerth, a resident of Germany, was charged with two counts of insider dealing and one count of money laundering while Jessica Mang was named in one count of insider dealing.

Program: Current Trends in FCPA Enforcement, August 17, 2011, Live in Menlo Park, CA, and webcast nationally. The program link is here.

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