Insider Trading: Aggressive International Enforcement

SEC v. Kohler, Case No. 06-4550 (E.D. Pa. June 8, 2009) is another example of the Commission’s aggressive enforcement in international insider trading cases. In Kohler, the SEC amended its complaint on Monday, adding as defendants a Swiss national and his company in an insider trading case initially brought against unknown purchasers of a take over stock.

The Commission’s initial complaint, centered on the acquisition of CNS, Inc. by GlaxoSmithKline plc, announced on October 9, 2006 was based on inferences from option trading by unknown purchasers in two accounts. It was filed just three days after the announcement of the deal. SEC v. One or More Unknown Purchasers of Call Options for the common stock of CNS, Inc., Case No. 06-4540 (E.D. Pa. Filed Oct. 12, 2006). Following the deal announcement, the CNS share price increased over 28%.

Prior to the deal announcement unknown purchasers bought CNS options through Swiss American Securities, a New York City based broker dealer and National Financial Services LLC, a Boston based broker dealer. Between September 28 and October 2, unknown purchasers acquired 905 call options for CNS through Swiss American in an omnibus account affiliated with Credit Suisse, Zurich. During approximately the same time period, 281 CNS call options were purchased through National Financial Services. These purchases were made through an account in the name of Zurich Cantonal Bank in Switzerland. The records for each account did not identify the beneficial owner.

The options in both accounts were sold shortly after the October 9 deal announcement. There were over $500,000 in profits in the Swiss American account. Sale of the options in the National Financial account yielded a profit of over $146,000. According to the complaint, the “timing, prices, and pattern of the Unknown Purchasers’ purchases of CNS call options in the days leading up to the announcement of the Glaxo-CNS acquisition indicate that the purchases were based on material inside information.” See also Lit. Release No. 19867 (Oct. 13, 2006).

The amended complaint against Mr. Kohler, who has held management roles at Swiss banks for about 25 years, and Swiss Real Estate International, claims that he and his group purchased options through the omnibus account with Credit Suisse in Zurich that were executed through Swiss American Securities. Mr. Kohler also told his wife and brother-in-law about the purchases, according to the Commission, knowing that they typically mirror his trading transactions as they did here.

While the complaint does not identify a source for the inside information, Mr. Kohler is alleged to have possessed, it does claim that he engaged in similar trading patterns using inside information in five other instances. No source for the inside information is identified for those transactions. The complaint does state however that “[i]nformation and evidence identifying the material non-public information possessed by Kohler on September 28 and 29 and October 2, 2006 [the trade dates] is particularly within Kohler’s knowledge and control. Similarly, information and evidence identifying the source of that material non-public information is particularly within Kohler’s knowledge and control.”

This is not the first international insider trading case in which the SEC has been aggressive in filing a complaint based largely on trading. The Commission has been aggressive in these actions in recent years. This posture has had mixed results. For instance, in SEC v. Kan King Wong, No 07-3628 (S.D.N.Y. Filed May 8 2007), a case based on the News Corp. bid for Dow Jones, the Commission filed its complaint against unknown traders just seven days after the transaction announcement. Subsequently, it amended the complaint, identified the traders and settled the case as discussed here. See also Lit. Release No. 20447 (Feb. 5, 2008).

In other instances the Commission has not been as successful. In SEC v. Boutraille Corp., Case No. 05-9300 (S.D.N.Y. Filed Nov. 4, 2005), an action based on the take over of Canadian mining company Placer Dome, Inc. by Barrick Gold Corp. announced on October 31, 2005, the Commission quickly brought an insider trading case, filing its complaint on November 2, 2005. Subsequently, the agency amended its complaint, naming three defendants. After years of litigation however the Commission dismissed the case as discussed here.

Whether the Commission will be successful here remains to be seen. There should be little doubt however, that the agency is being aggressive in bringing international insider trading cases.

Mortgage-Backed Securities Fund Settles Action Keyed To Improper Valuation

The Commission filed a settled administrative proceeding on Monday which named as Respondents Evergreen Investment Management Company LLC, a registered investment adviser and Evergreen Investment Services, Inc., the adviser’s affiliated registered broker dealer. The proceeding is based on claimed violations of the Advisers Act and the Exchange Act. It centers on the incorrect pricing of the shares of Evergreen Ultra Short Opportunities Fund, which invested primarily in residential mortgage-backed securities and collateralized debt obligations backed by such securities. The proceeding also involves the selective disclosure of material non-public information to certain shareholders and improper transactions. In the Matter of Evergreen Investment Management Company, LLC, Adm. Proc. File No. 3-13507 (June 8, 2009).

From 2007 through 2008, Ultra Short Opportunities Fund was consistently ranked as a high performer in its class. If however, the Fund had followed proper valuation practices, it would have been ranked near the bottom of its category during this period, according to the Order for Proceedings.

During this period, the Fund’s NAV was overstated by as much as 17% due to a number of improper pricing practices. Ultra Fund valued many of its securities in accord with prices provided by a vendor such as Standard & Poor’s, PricingDirect, Interactive Data Corporation and Reuters. As early as February 2007, the Fund failed to take into account in its valuation of certain vendor-priced, broker-priced and/or portfolio management team-priced residential mortgage-backed securities readily available negative information about those securities. During part of that period, the Valuation Committee also valued one or more of the Fund’s securities in accord with prices obtained from a Florida based broker dealer whose valuation method had not been approved. At times, the Fund’s portfolio management team withheld relevant negative information from the Valuation Committee. As a result of these and other practices, investors were not given accurate information about the Fund.

In June 2008, the Valuation Committee began repricing a security held by the Fund and stopped using vendor overrides because of concern about the accuracy of the valuations. As securities were repriced, the NAV decreased. Because of concern about the impact of the repricing Evergreen Distributor prepared “talking points” for use by the wholesaler in response to inquiries. Those talking points indicated that the decline in NAV was the result of repricing and not market conditions. This information was made available to selected shareholders. Significant redemptions resulted.

Evergreen Adviser also caused other Evergreen mutual funds to purchase securities from the Ultra Fund. While such trades are generally prohibited by Section 17(a) of the Investment Company Act, Rule 17a-7 permits affiliated cross trades if, among other things, they are executed at a price equal to the average of the highest current independent bid to purchase the security and the lowest current independent offer to sell that security. The purchases here were at a price other than that average and in some instances the Fund’s portfolio management team did not even obtain the necessary pricing information. Evergreen Distributor also failed to preserve text and instance messages as required.

To resolve the matter, the Respondents, whose cooperation was acknowledged, consented to a censure and the entry of a cease and desist order. In addition, Evergreen agreed to pay more than $40 million as part of the settlement. Approximately $33 million was paid to compensate fund shareholders. An additional $3 million in disgorgement along with a $4 million penalty was also paid.