This week the SEC lost its bid to dismiss an action brought by former Goldman Sachs director Rajat Gupta arising out of its insider trading case brought as an administrative proceeding against him. The GAO issued reports on the revolving door at the Commission and the supervision of proprietary trading.
FCPA enforcement was prominent this week with the DOJ and the SEC resolving charges with Armor Holdings. The DOJ also filed a superseding FCPA indictment in a case against a telecom company and its executives arising out of claims that they bribed officials in Haiti. The indictment also names the foreign officials involved, charging them with money laundering.
SEC enforcement concluded a financial fraud action this week in which it prevailed after a jury trial. The Commission also brought cases involving an audit failure, investment fraud and violations of Regulation 105.
The Commission
Gupta v. SEC, Civil Action No. 11 Civ 1900 (S.D.N.Y. Ruling dated July 11, 2011) is a suit brought by Rajat Gupta, the former Goldman Sachs director who is a Respondent in a Commission administrative proceeding accusing him of insider trading. He was also a witness at the trial of Raji Rajarathnam. In the Matter of Rajart Gupta, Adm. Proc. File No. 3-14279 (March 1, 2011). The complaint claims, among other things, that he has been denied his right to equal protection under the law as guaranteed by the U.S. Constitution. The complaint centers on claims that unlike every other Galleon related defendant accused of insider trading, the charges against Mr. Gupta were brought in an administrative proceeding rather than in Federal Court and that the SEC is attempting to enhance the available penalties that can be levied against him by retroactively applying a new Dodd-Frank provision to him. This week the court denied the SEC’s motion to dismiss, but narrowed the issues.
Revolving door report: The GAO issued a report titled: Securities and Exchange Commission: Existing Post-Employment Controls Could be Further Strengthened. The report is available here.
Proprietary trading report: The GAO issued a report titled: Proprietary Trading: Regulators Will Need More Comprehensive Information to Fully Monitor Compliance with New Restrictions When Implemented. The report is available here.
SEC enforcement – litigated cases
Financial fraud: SEC v. Retail Pro, Inc., Civil Action No. 08 CV 1620 (S.D. Cal.) is an action against the company and three of its officers including Ran Furman, its former CFO. The complaint alleged that to meet street expectations the defendants entered into a sham barter transaction which inflated the revenues by about $3.9 million. The company and the other executives previously settled. Mr. Furman proceeded to trial and on February 25, 2011 the jury returned a verdict in favor of the Commission. Previously the court entered a partial summary judgment in favor of the SEC. This week the court entered a final judgment, enjoining Mr. Furman from future violations of the antifraud, books and records, lying to auditors, and certification provisions of the securities laws. He is also barred from serving as an officer or director of a public company for seven year and assessed a $75,000 civil penalty.
SEC enforcement – filings and settlements
Unregistered securities: In the Matter of Priscilla G. Sabado, Adm. Proc. File No. 3-14145 (July 14, 2011) is an action against Priscilla Sabodo who worked as a broker dealer and investment adviser representative at AXA Advisors, LLC. From August 2008 to November 2009 she offered and sold interest in Halek Energy LLC and CBO Energy, Inc. which are oil and gas working interest. Ms. Sabado made material misrepresentations regarding the risks and returns. Six of her clients purchased interests valued at $491,880. Respondent had no prior experience with selling or investing in oil and gas working interests. The Order alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 15(a). To resolve the mater Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. She also agreed to be barred from the securities industry and from participating in penny stock offerings with a right to reapply after five years. In addition, she was ordered to pay disgorgement of $2,341 along with prejudgment interest and pay a civil penalty of $25,000.
Audit failure: In the Matter of Joseph F. Sofo, CPA, Adm. Proc. File No. 3-14467 (July 14, 2011) is an action based on claimed violations of Securities Act Sections 17(a)(2) & (3) and Advisers Act Section 206(4) against the engagement partner from the audits of North American Globex Fund, L.P. The investment adviser for the Fund is Northstar International Group, Inc. whose president is James Peister. The Fund purportedly kept most of its assets in a related entity known as North American Globex Group, Inc. From 2003 through early 2009 Mr. Peister and Northstar intentionally overstated the assets of the Globex Fund. Thus materially false and misleading assets values and performance figures were given to investors and prospective investors. Investors were told extraordinary but false claims of consistent returns. Respondent and his audit firm issued unqualified audit opinions on the financial statements of the Fund. In fact those opinions were false because the audits were not conducted in accord with GAAS and the financial statements were not prepared in accord with GAAP. For example, for the 2004-2005 the audits were quite limited and Respondent used a flawed confirmation process for key related party transactions, essentially relied on the representations of Mr. Peister. Similar flawed procedures were used for the engagement the next year. At the time the engagements were accepted Respondent and his firm had no experience in auditing hedge funds. Respondent resolved the proceeding by consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, he agreed to pay disgorgement of $4,521 along with prejudgment interest.
Investment adviser fraud: In the Matter of Roman Lyniuk, Adm. Proc. File No. 3-14304 (July 13, 2011) is a proceeding against the founder and manager of Atlantic Capital Management, L.P. and Atlantis Capital markets N.A., LLC. From late 1994 through the middle of 2004 the fund consisted primarily of Respondent’s capital along with that of friends and family. That capital was largely withdrawn in 2004 but Respondent successfully raised funds from other investors. In soliciting other investors Respondent made misrepresentations about the fund. He also engaged in self-dealing transactions which included obtaining undisclosed compensation of at least $400,000 along with rebates on brokerage commissions from the trading of the fund and a referral fee he obtained in connection with the investment of fund assets. Following significant trading losses in 2006, and in the wake of redemption demands, Mr. Lyniuk misappropriated a significant portion of the fund assets. He subsequently began soliciting investors for a new fund. To resolve the proceeding Respondent consented to the entry of a cease and desist order based on Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). Respondent will also be barred from the securities industry and from participating in any penny stock offering and was ordered to pay disgorgement of $4,072,500 along with prejudgment interest. Payment was waived based on his financial condition.
Unauthorized trading: In the Matter of Jennifer Kim, Adm. Proc. File No. 3-14460 (July 12, 2011) is an action against Jennifer Kim, a former associate at Morgan Stanley & Co. The Order alleges that Ms. Kim and her supervisor engaged in a trading scheme to circumvent the internal risk management limitations of the firm thereby resulting in a $24.47 million loss. From October through December 2009 Ms. Kim and her supervisor on the swap desk executed numerous trades that exceeded the limitations imposed by the firm. To conceal this fact on thirty-two occasions swap orders were placed that Respondent and her supervisor had no intention of executing and which were canceled after being entered into the system. The trades had the effect of temporarily reducing the overall risk thereby concealing the fact that Ms. Kim and her supervisor had exceeded the limitations of the firm. This strategy permitted Ms. Kim and her supervisor to continue their high risk trading. To resolve the proceeding Ms. Kim consented to the entry of a cease and desist order based on Exchange Act Section 13(b)(5) and agreed to be barred from association with any broker dealer with a right to reapply after three years. She was also ordered to pay a civil penalty of $25,000.
Note: SEC Commissioner Aguilar dissented from the approval of this settlement.
Offering fraud: SEC v. LeGrand, Civil Action No. 2:11-CV-0474 (S.D.W.Va. Filed July 12, 2011) is an action against Ronald LeGrand and Frederick Wheat which alleges violations of Securities Act Sections 5 and 17(a)(2) & (3). According to the complaint, from September 2006 through December of that year the defendants raised over $9.5 million from 54 investors through the sale of unregistered promissory notes and limited partnership membership interests. The funds came largely from individuals who attended real estate investment seminars taught by Mr. LeGrand. The money used to purchase land and other assets of a bankrupt oil and gas company. Neither defendant had experience in the oil and gas industry. Investors were not told the degree of risk when making these investments. Misstatements were made regarding the expected returns and the value of the assets. To settle the action each defendant consented to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. Mr. LeGrand was also ordered to pay a civil penalty of $150,000. To date Mountain Country Partners LLC, the investment vehicle has not been able to return the investor funds.
Inadequate procedures; In the Matter of Janney Montgomery Scott LLC, Adm. Proc. File No. 3-14459 (July 11, 2011). The Order alleged that from at least 2005 through 2009 the firm had inadequate policies and procedures in its Equity Capital Markets division to prevent the misuse of material nonpublic information as required by Section 15(g). The firm settled by consenting to the entry of a cease and desist order based on Exchange Act Section 15(g) and, in addition, a censure. Under the terms of the settlement the firm will also pay a penalty of $850,000 and implement certain procedures to effectuate its obligations under Section 15(g). Janney also agreed to retain an independent consultant who will prepare certain reports and certify that the firm has established and continues to maintain policies, practices and procedures pursuant to Exchange Act Section 15(g).
Investment fund fraud: SEC v. Folin, Civil Action No. 11-cv-4447 (E.D. Pa. July 12, 2011) is an action against Sam Folin, his registered investment adviser, Benchmark Asset Managers LLC and it parent company, Harvest Managers LLC. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2) and (4). The complaint claims that from 2002 to late 2010 the defendants sold securities in Harvest, Benchmark and safe haven Portfolios LLC promising investors that their money would be put in companies with “socially responsible” goals. In fact much of the money was diverted to personal use and to pay other investors. Defendants Folin and Benchmark resolved the action, consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. Harvest consented to a similar injunction but based only on the Securities Act and Exchange Act Sections. The three defendants are also jointly and severally liable for the payment of disgorgement in the amount of $8,706,620 plus prejudgment interest. In addition, Mr. Folin agreed to pay a civil penalty of $150,000 while Harvest and Benchmark will each pay a penalty of $750,000. He also agreed to the issuance of an order in a related administrative proceeding which bars him from the securities business. Likewise, Benchmark consented in a related administrative proceeding to the revocation of its adviser registration.
Investment fund fraud: SEC v. Irwin, Civil Action No. 11-CV-4429 (July 11, 2011) is an action against John Irwin, a certified public accountant, and his consulting firm Jacklin Associates, Inc. According to the complaint, the defendants assisted Joseph Forte in obtaining investors for his Ponzi scheme. Mr. Forte has confessed to operating a large scale investment fund fraud which has bilked over 100 investors out of over $75 million. Mr. Forte has pleaded guilty to charges of wire fraud, mail fraud, bank fraud and money laundering and been named as a defendant in SEC and CFTC enforcement actions. The defendants in this case accepted the representations of Mr. Forte without conducting any due diligence in soliciting investors and obtaining over $5 million in ill-gotten gains that were suppose to be fees and trading profits. The defendants settled the action by consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Sections 17(a)(2) and (3). The judgments also provide for disgorgement, prejudgment interest and the SEC can request that the court impose a penalty. The amounts will be determined at a later date. Mr. Irwin also agreed to the suspension of his right to appear and practice before the Commission as an accountant.
Rule 105: In the Matter of Fontana Capital, LLC, Adm. Proc. File No. 3-14176 (July 8, 2011) is an action against the firm, a registered investment adviser, and Forrest Fontana, the owner of the firm and its Chief Investment Officer and portfolio manager. According to the Order, from July through November 2008 the firm violated Rule 105 of Regulation M by participating in public offerings by XL Group Plc, Merrill Lynch and Wells Fargo after having shorted each of those securities during the five business days prior to the pricing of the offerings. As a result profits of $816,184 were made. To resolve the proceeding the Respondents consented to the entry of cease and desist orders based on Rule 105 and censures. They also agreed to pay jointly and severally disgorgement in the amount of the trading profits, prejudgment interest and a civil penalty of $165,000.
FCPA
Armor Holdings, Inc. resolved FCPA charges with the Department of Justice and the SEC. The charges stem from bribes paid by subsidiaries to obtain three contracts to supply body armor for U.N. peacekeepers between 2001 and 2006. From those contracts the company obtained gross revenue of about $7.1 million and profits of about $1.5 million. The $4.3 million paid in commissions over 92 transactions were not properly booked. The company resolved the matter with the DOJ by entering into a deferred prosecution agreement and paying a fine of $10.2 million. The settlement reflected the fact that the company self-reported, conducted an internal investigation, fully cooperated and implemented extensive procedures from its new parent BAE.
To settle with the SEC, Armor Holdings consented to the entry of a permanent injunction prohibiting future violations of the anti-bribery and books and records and internal controls provisions of the FCPA. The company also agreed to pay disgorgement of $1,552,306 along with prejudgment interest and a civil penalty of $3,680,000. In addition, Armor Holdings was ordered to comply with certain undertakings regarding its FCPA compliance program. The Commission noted that the company conducted a through internal investigation and cooperated with its inquiry. SEC v. Armor Holdings, Inc., Case No. 1:11-cv-01271 (D.D.C. Filed July 13, 2011).
Cinergy Telecommunications: A superseding indictment was handed down in this case in the Southern District of Florida. The defendants are Vasconez Cruz, president of Cinergy Telecommunications and its related company Uniplex Telecommunications; Amadeus Richers, formerly a director of Cinergy and Uniplex; Cinergy Telecommunications, a privately held telecommunications company based in Florida; Patrick Joseph, a former general director for telecommunications at Haiti Teleco; Jean Rene Duperval, a former director of international relations at Haiti Teleco; and Marguerite Grandison, former president of Telecom Consulting Services Corp. and the sister of defendant Duperval. The charges center on a bribery and money laundering scheme that took place from December 2001 through January 2006 in which Cinergy and Uniplex paid over $1.4 million in bribes. The money was paid through shell companies to foreign officials of the Republic of Haiti’s state-owned telecommunications company. Defendants Cruze, Richers and the company were indicted on FCPA and money laundering charges. Defendant Joseph is charged with conspiracy to commit money laundering. Defendants Duperval and Grandison are charged with conspiracy to commit money laundering and money laundering.
Payment of expenses: The DOJ issued FCPA Opinion No. 11-01 (June 30, 2011) regarding the payment of certain expenses for foreign officials. The opinion concluded that the expenses contemplated were reasonable and directly related to “the promotion, demonstration, or explanation of . . .” the Requestor’s products and services. This conclusion was based on the fact that: the requestor has no non-routine business under consideration by the relevant foreign government agencies; the business consists primarily of seeking approval of pending adoptions; the routine business is guided by international treaty and administrative rules; the requestor will not select the officials who will travel; all costs will be paid to the providers, not the officials; souvenirs will reflect the requestor’s business and be of nominal value; the agencies and officials will not be compensated beyond the payment of the expenses; the expenses paid will only be those necessary and reasonable to educate the visiting officials about the operations and services of U.S. adoption service providers; and the requestor has invited another adoption service provider to participate in the visit.
PCAOB
The Board issued for public comment proposed audit and attest standards for broker dealer and public company engagements. The Board is undertaking rulemaking to implement Section 982 of the Dodd-Frank Act. The attest standards would apply to the audits of brokers and dealers if the SEC adopts its proposed amendments to the broker dealer filing requirements under Exchange Act Rule 17a-5.
FSA
The FSA fined Andrew Ruff and Richard Lindley, two former directors of Alpha to Omega (UK) Limited, an independent financial adviser network, respectively, about $42,000 and $21,000 for rendering unsuitable advice. After a careful review it was determined that the firm had widespread compliance failures which lead to the risk of customers receiving unsuitable investment advice. This was particularly problematic where the recommended investments are high risk. Messrs. Ruff and Lindley were responsible for control and monitoring the sales made by the firm and for ensuring that it had proper systems.
