by T. GormanPosted on Posted in SECActions

The SEC filed settled actions against fourteen specialists firms on Wednesday based on claims of improper proprietary trading. Settled civil injunctive actions were filed against six firms in the Southern District of New York. Those firms are Automated Trading Desk Specialists (Cases No. 09-1976), E*Trade Capital Markets (Case No. 09-1976), Melvin Securities (No. 09-1978), Sydan, LP (No. 09-1975) and TradeLink (Case No. 09-1973).

Eight other firms were named as respondents in administrative proceedings. Those firms are Botta Capital Management (File No. 3-13390), Equitec Proprietary Markets (File No. 3-13391), Group One Trading (File No. 3-13392), Knight Financial Products (File No. 3-13393), Goldman Sachs Execution & Clearing (File No. 3-13393), Susquahanna Investment Group (File No. 3-13395 and TD Options (File No. 3-13396).

The complaints in the civil injunctive actions and the administrative orders charge essentially the same improper conduct in which the specialists disregarded their duties and took advantage of their customers. The events in the cases generally focused on the time period 1999 through 2005.

Specialists, according to the SEC’s papers, are responsible for the quality of the markets in the securities in which they are registered. A specialist is obligated to maintain a fair and orderly market insofar as that is reasonable. Their duties include the obligation to execute orders for the public at the most advantageous price and to offset imbalances in supply and demand. Accordingly, specialists act as both a broker and a dealer. In either capacity they must hold the public’s interest above their own.

Here, the SEC claimed the specialists put their interests above that of the public by engaging in thousands of the following types of trades which disadvantaged the public but benefited them:

• Trading ahead: In these instances, the specialists filled one agency order through a proprietary trade for the firm’s account while a matchable agency order was present on the opposite side of the market. The customer order in these instances was disadvantaged when it was later executed at a price that was inferior to that received by the firm’s proprietary account.

• Interpositioning: In these transactions, after trading ahead, the specialist also traded proprietarily with the matchable opposite-side agency order that had been traded ahead of, thereby interpositioning itself between the two agency orders that should have been paired off. This permitted he specialist to capture the spread between the purchase and sales price and disadvantaged the public.

• Trading ahead of unexecuted open or cancelled orders: This occurred when the specialist traded ahead of opposite side executable agency orders, but the unexecuted orders were left open until the end of the day or were cancelled by the customer prior to the close.

The civil complaints also claim that the six specialists named as defendants in those actions failed to keep certain types of required records. Specifically, those firms failed to make or keep current a blotter containing an itemized daily record of all purchases and sales affected by the firms for their proprietary accounts.

The administrative proceedings were based on alleged violations of Section 11(b) of the Exchange Act, Rule 11b-1 thereunder and various exchange rules. The eight firms agreed to settle by consenting to the entry of a cease and desist order and the payment of disgorgement and a civil penalty. In these cases the amount of disgorgement totaled about $22.7 million while the penalties exceeded $4.3 million.

The civil injunctive actions alleged violations of Exchange Act Section 17(a) and Rule 17a-3(a)(1) thereunder and certain exchange rules. Each defendant resolved the action by consenting to the entry of a permanent injunction and the payment of disgorgement and a civil penalty. The total disgorgement paid was approximately $35.7 million, while the penalties totaled about $6.7 million.

by T. GormanPosted on Posted in SECActions

The Seventh Circuit ruled on two important questions regarding SEC enforcement actions in SEC v. Koenig, Case No. 08-1373 (7th Cir. Decided Feb. 26, 2009). The first concerned the time period under which the SEC must commence suit under the statute of limitations. The second focused on calculating the amount of a civil penalty.

The case arose out of the financial debacle at Waste Management, Inc. The company was unable after 1991 to sustain what had been years of significant growth. Defendant James Koenig, the Chief Financial Officer of the company, devised several accounting strategies to improve the apparent results from 1992 through 1996.

In October 1997, Waste Management issued a press release stating that its financial statements were unreliable. In February 1998, the company restated its financial statements for the years 1992 through 1996, taking a charge of approximately $1.1 billion. Mr. Koenig, who stepped down in January 1997, had been paid bonuses totaling about $831,000 for the years 1992, 1994 and 1995. The SEC filed suit on March 26, 2002.

Following a jury trial at which Mr. Koenig argued that the accounting strategies he used were not fraudulent, the jury found him liable. The district court ordered him to pay disgorgement of about $831,000 along with pre-judgment interest of $1.2 million. The court also imposed a civil penalty of $2.1 million.

The Circuit Court affirmed except with respect to the calculation of Mr. Koenig’s bonuses, an issue which was remanded to the district court. First, Mr. Koenig argued that the statute of limitations under 28 U.S.C. § 2462 precluded the imposition of a civil penalty. This argument was premised on the fact (1) the alleged misconduct occurred before January 1997 when Mr. Koenig stepped down as CFO and (2) the SEC did not file suit until 2002, outside the five year statute of limitations.

While under some statutes of limitation, the time period commences when the wrong occurs and under others when it is discovered, the Court found it unnecessary to determine which approach applied here. The district court had concluded that the claim did not accrue until discovered. The Circuit Court noted that this is a common law view. At common law, there was a special rule for fraud, a concealed wrong. Under that rule the victim of fraud has from the date that the wrong came to light or would have done so had diligence been employed. Since the accounting maneuvers of Mr. Koenig did not come to the attention of the public until October 1997, the SEC’s complaint was timely with respect to the question of a penalty. The Court did not explain the basis for its application of the common law rule here.

Second, Mr. Koenig challenged the amount of the penalty, arguing that it should not include the pre-judgment interest. Under 15 U.S.C. § 77t(d)(2)(A) and § 78u(d)(3)(B)(i), the amount cannot exceed the greater of $100,00 or the “gross amount of pecuniary gain to [the] defendant as a result of the violation,” according to the Court. The “pecuniary gain” is the amount obtained from the fraudulent accounting, plus the economic return he made or could have made by investing that sum. This is because “[d]epriving Koenig of both the principal amount, and the economic return measured by prejudgment interest, puts him in the same position as if he had not received any ill-got gains … .”

Based on its definition of the statutory phrase “pecuniary gain,” for which the Court did not cite any authority, it concluded that the amount of the penalty can include the amount of the bonuses plus prejudgment interest. Because there is a question as to whether Mr. Koenig would have received any bonus – the position adopted by the district court — or some bonus absent his accounting conventions, the question was remanded for consideration of this point.