by T. GormanPosted on Posted in SECActions

Individual responsibility and accountability became a critical issue in the wake of the great financial crisis. From Capitol Hill to the cross-streets of small-town America it frequently seemed that the question of the day was “who done it,” name them as a defendant. Prosecutors at the Department of Justice and regulators at agencies like the Securities and Exchange Commission responded with statements like the Yates memorandum, demanding that every individual involved be identified, and a series of prosecutions.

One group of cases focused on trading Residential Mortgaged Back Securities (RMBS) or similar instruments. In that group of prosecutions the DOJ and the regulators have been far from a success. Yet the cases continue. The recent dismissal with prejudice by the DOJ and then months later the SEC of the case which started this series of actions presents significant questions about how that case and others are vetted prior to charges being brought. See, e.g., U.S. v. Litvak, No. 13-CR-00019 (D. Conn. Filed Jan. 25, 2013); SEC v. Litvak, Civil Action No. 3:13-CV-00132 (D. Conn. Filed Jan. 28, 2013); see Lit. Rel. No. 24468 (December 6, 2018)(dismissals).

The cases

Litvak is one of a group of trading cases brought the DOJ and the SEC centered on opaque markets. Jesse Litvak was a trader and managing director at Jefferies & Company. The DOJ and SEC charges centered on the manner in which trading was conducted in the opaque market for RMBS. Specifically, Mr. Litvak was charged with repeatedly making misrepresentations regarding pricing, the source of the securities being sold and other material matters to effectuate a transaction for his firm at a time when revenues were declining.

The victims of the fraud were sophisticated funds and investors. They included DE Shaw, Magnetar, Putnam Investments and the U.S. Government. The indictment included 11 counts of securities fraud, one count of TARP fraud and four counts of making false statements based on transactions that took place over a two year period beginning in 2009. Jefferies made about $2 million on the transactions. Following a 14 day jury trial Mr. Litvak was convicted on all counts submitted to the jury. He was sentenced to serve 24 months in prison followed by 3 years of supervised release and ordered to pay $1.75 million.

The conviction of Mr. Litvak turned out to be just the first chapter. Subsequently, the Second Circuit Court of Appeals reversed his conviction while he was out on bond. First, the the Court held that the counts regarding the Government must be reversed. The complex structure used to make decisions regarding purchases by the Government precluded whatever statements were made by Mr. Litvak from being considered. Second, the district court errored by excluding two experts offered as defense witnesses. Those witnesses would have testified that the markets were complex, opaque and inefficient. Perhaps more importantly, the professional traders that populated the market used complex systems and models to evaluate potential transactions which essentially made any statement by Mr. Litvak not relevant.

Retrial went better and worse for Mr. Litvak. The Government counts were excluded. The expert testimony was admitted. The jury found him not guilty on all counts except one. The district court essentially re-imposed the same sentence but increased the penalty to $2 million. Release pending appeal was denied. Mr. Litvak went to prison.

The Second Circuit again stepped in, reversing the conviction. This time the Circuit Court concluded that the district court errored in admitting testimony by a representative of a counter party that all parties agreed was erroneous. Litvak v. U.S., 889 F. 3d 56 (2nd Cir. 2018).

While Mr. Litvak battled the Government other, similar cases were brought. In September 2015, while Mr. Litvak’s first appeal was pending, the U.S. Attorney’s Office in Connecticut and the SEC essentially cloned the Litvak case into one charging three traders from Nomura Securities. U.S. v. Shapiro, No. 15-CR-00155 (D. Conn. Filed Sept. 3, 2015); SEC v. Shapiro, Civil Action No. 15-CV-07045 (S.D.N.Y. Filed Sept. 8, 2015). The charges were essentially the same, minus the Government counts. Supposedly the firm had illicit profits of about $7 million.

Shortly after the reversal of Mr. Litvak’s first conviction by the Second Circuit, Shapiro went to trial. The defense used the Litvak approach, based largely on testimony from traders. That testimony confirmed the opaque nature of the markets, the sophistication of the profession traders and the complexity of the models used to make investment decisions. Compliance understood the wild west tactics of the markets and made no effort to intervene, according to the testimony.

Following a multi-week trial, and a week of deliberations, the jury returned verdicts of largely not guilty. One defendant was found guilty of conspiracy. The jury was unable to return a verdict on three counts. The case lurched into post-trial proceeds and has not been resolved. See also SEC v. Im, Civil Action No. 1:17-cv-0313 (S.D.N.Y. Filed May 17, 2017)(filed against two Nomura traders prior to the Shapiro verdict, one of whom settled, based on trading in commercial mortgage backed securities or CMBS, a similar market; the case continues in litigation).

Comment

After years of litigation what at first blush must have appeared to be open and shut cases remain largely unresolved. Nobody denies that the traders in these markets make misstatements which in many instances in securities markets like the New York Stock Exchange, NASDAQ and others would be material. The markets in these cases are not anything like those exchanges however. The securities involved in these cases have little to no resemblance to shares of stock like Apple and Exxon.

It seems apparent that Government and regulatory investigators did not carefully assess the markets when making the charging decisions in Litvak, Shapiro and Im. Dropping the Government related charges following Mr. Litvak’s first successful appeal more than supports the point.

Yet it is inexplicable it that it took two trials, two appeals and a stint in prison before the charges were dropped against Mr. Litvak – and that the other cases are still in litigation. To be sure, nobody wants to see the kind of unsavory tactics employed in these markets continue let alone proliferate. The U.S. securities markets have long been viewed as the life blood of the world’s largest economy. Those critical streams of commerce should not be polluted with misstatements and lies regardless of their impact. Every brokerage house, every fund, every CCO and every trader needs to understand that each statement made is their word and their bond representing them personally along with their firm in the nation’s market place.

Whatever it was that sparked these cases – the intense pressure to charge individuals, a dislike for the tactics or something else – it is time these cases were brought to an end. Not every spat of improper or unsavory conduct is the stuff of which enforcement actions are made. There are other, much more effective ways to ensure the proper functioning of the securities markets. The DOJ and SEC need to use them now.

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by T. GormanPosted on Posted in SECActions

The Supreme Court was the focus this week with oral argument in Lorenzo v. SEC, an action centered on ascertaining the dividing line between primary and secondary liability under Exchange Act section 10(b). The arguments were based on the application of two prior decisions of the Court, Janus regarding liability for false statements under Rule 10b-5(b) and Central Bank of Denver which held that if the conduct falls within the language of section 10(b) there is a primary violation of the statute.

The Commission filed enforcement actions this week based on insider trading and business development entities. The former centered on an the misappropriation of inside information by a foreign national at a Singapore entity. The latter two cases were based on the mischaracterization of distributions and a failure properly allocate expenses.

Supreme Court

The Supreme Court heard argument on the question frequently referred to in the circuit and district courts as scheme liability on Monday, December 3, 2018. Lorenzo v. SEC, No. 17-1077. Specifically, the question as framed by Petitioner Francis Lorenzo is “whether the D.C. Circuit erred in concluding a misstatement claim that does not meet the elements set forth in Janus [Janus Capital Group, Inc., v. First Derivative Traders, 564 U.S. 135 (2011)] can be repackaged and pursued as a fraudulent scheme claim under Section 10(b) of the Exchange Act . . . and Section 17(a)(1) of the Securities Act.” The D. C. Circuit and the Securities and Exchange Commission rejected the contention.

Frank Lorenzo was a director at investment bank Charles Vista, LLC in February 2009. The firm’s largest investment banking client was start-up W2Energy Holdings, Inc. Its business depended largely on the success of certain technology which failed. The firm attempted to raise about $15 million through the sale of convertible debentures with the assistance of Charles Vista. Mr. Lorenzo emailed two potential investors “several key point” about W2E’s pending debenture offering at the behest of his boss who settled. The emails failed to mention the recent devaluation of the firm’s assets.

Petitioner Lorenzo relied on Janus for the proposition that “only the maker of a misstatement can be held liable for that misstatement under Section 10(b) and Rule 10b-5.” While the lower court agreed that is the law under Janus, and that Mr. Lorenzo was not the “maker” of the statements, it found him liable. To reach that conclusion the D.C. Circuit concluded that Mr. Lorenzo “engaged in a deceptive act, artifice to defraud, or practice, for purposes of liability under Section 10(b) . . .” That was error since it directly undercuts the holding of Janus Petitioner argued.

Counsel for the Government focused first on the facts and then the holding of Central Bank. “Petitioner’s decision to send emails that grossly misrepresented the financial prospects of his client and to give illusory promises designed to deceive investors into backing a business that he knew was failing constitute a quintessential securities fraud. His conduct falls within the plain text and the common-sense meaning of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and subsections (a) and (c) of Rule 10b-5.” Since Central Bank held that if the conduct fell within the language of the statute, as here, there is primary liability counsel for the Government claimed.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 2 civil injunctive case and 2 administrative proceedings, excluding 12j and tag-along proceedings.

Insider trading: SEC v. Gannamaneni, Civil Action No. 18 CV 11390 (S.D.N.Y. Filed Dec. 6, 2018) is an action which names as a defendants Rajeshwar Gannamaneni, a citizen of India, his wife, Deepthi Gandra, and his father, Linga Gannameneni. Mr. Gannameneni was the information technology contractor at a prominent investment bank in Singapore. Over a period of about three years, beginning in late 2013, Mr. Gannameneni misappropriated inside information about 40 times and used it to trade while sharing it with his wife and father. About $600,000 in illicit profits resulted. The complaint alleges violations of Exchange Act sections 10(b) and 14(e). The case is pending.

Fraudulent trading: SEC v. Litvak, No. 313-CV-00132 (D. against Conn.) is a previously filed action against Jefferies & Co. Inc. trader Jesse Litvak. In a parallel criminal action Mr. Litvak was twice convicted. The convictions were reversed by the Second Circuit Court of Appeals in each instance. In August the U.S. Attorney’s Office dismissed the charges against Mr. Litvak. The Commission also elected to dismiss its compliant. See Lit. Rel. No. 24368 (Dec. 6, 2018).

Misappropriation: SEC v. Rothenberg, Civil Action No. 3:18-cv-05080 ((N.D. Cal.) is a previously filed action in which the Commission alleged that investment adviser defendant Michael Rothenberg misappropriated about $7 million from his clients, in part by overcharging them, to fund his other business ventures. The complaint alleged violations of Advisers Act sections 206(1) and 206(4). Defendant has agreed to resolve the charges. The settlement included a bar from the brokerage and investment advisory business with the right to reapply after 5 years. The court will determine the amount of the disgorgement. See Lit. Rel. No. 24367 (Dec. 6, 2018).

Misappropriation –EB5: SEC v. Chen, Civil Action No. 2:17-cv-06929 (C.D.C.A.) is a previously filed action which named as defendants Edward and Jean Chen, a husband and wife who promoted an EB-5 project. The complaint alleged that they raised about $22.5 million from 45 investors in China for the development of an EB-5 project. More than $12 million was misappropriated. Defendants settled with the Commission. The Court entered a final judgment resolving all claims which enjoins the defendants from violating Exchange Act section 10(b) and Securities Act section 17(a) as well as from participating in the offer and sale of any security which constitutes an investment in a commercial enterprise under the USCIS EB-5 visa program. The order also directs the disgorgement, on a joint and several basis, of $24,655,000 along with prejudgment interest of $1,273,098 and the payment of a penalty of $1,077,500. The final judgement also directs Paradise Investment Center LLC to pay, on a joint and several basis with the other defendants, disgorgement of $2,155 million along with prejudgment interest of $119,583 which is deemed satisfied by amounts already collected. See Lit. Rel. No. 24366 (Dec. 6, 2018).

Improper distribution: In the Matter of KCAP Financial, Inc., Adm. Proc. File No. 5-18912 (Dec. 4, 2018) is a proceeding which names as a Respondent the firm which is a closed end investment company that is regulated as a business development firm. As such the firm distributed about 98% of its investment income. Over a four year period, beginning in 2010, the firm distributed about $35.8 million received from its wholly-owned Asset Manager Affiliates. The distribution was inappropriate because it was paid from current or accumulated tax basis earnings and profits. A restatement resulted. During the process the firm concluded its internal controls were not effective. The Order alleges violations of Exchange Act sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and Investment Company Act section 19(a). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order.

Misallocation: In the Matter of Fifth Street Management, LLC, Adm. Proc. File No. 3-18909 (Dec. 3, 2018) is a proceeding which names as a Respondent the previously a registered investment adviser. In 2013 and 2014 the Order alleges that the adviser improperly allocated rent and overhead expenses to the business development clients as well as certain compensation expenses. The adviser also failed to conduct quarterly valuation models for illiquid assets which ultimately resulted in the overvaluing of two portfolio companies and incorrect financial statements. The adviser did not properly implement written policies and procedures. The Order alleges violations of Securities Act section 17(a)(2) and Exchange Act sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and Advisers Act sections 206(2), 206(4), 207 and 204A. To resolve the proceedings the adviser consented to the entry of a cease and desist order based on the sections cited in the Order and to a censure. The Adviser also agreed to pay disgorgement of $1,999,115.86, prejudgment interest of $334,545.65 and a penalty of $1,650,000.

Offering fraud: SEC v. Suleymanov, Civil Action No. 18-68545 (E.D.N.Y. Filed Dec. 3, 2018). Mark Suleymanov, operating under the business name SpotFN, offered and sold binary options to customers throughout the United States on a series of websites over a period of four years beginning in 2012. The binary options offered by SpotFN were short term contracts tied to the price of stocks and stock indexes or other financial assets. The options offered and sold required an investor to choose if the given stock’s price, for example, would be above or below a specific price at a certain time. If the investor made a correct determination, he or she won a specified amount. If not, the investor received nothing. Mr. Suleymanov represented that the binary options sold were legitimate, using the NASDAQ logo. In fact they were rigged so that investors could almost never win. Not only were the returns not 88% in favor of the investor as claimed, Mr. Suleymanov manipulated the software that ran the options program so that the chance for investors to secure a favorable result were diminished. In addition, while investor funds were supposedly held in segregated accounts, in fact they were not. Rather, investor funds were co-mingled and at times used for the payment of expenses by Defendant. The complaint alleges violations of Securities Act sections 5 and 17(a) and Exchange Act section 10(b). Defendant Suleymanov agreed to the entry of a permanent injunction based on the sections cited in the complaint. Issues regarding disgorgement, prejudgment interest and a civil penalty will be considered by the Court. See Lit. Rel. No. 24364 (Dec. 3, 2018).

Anti-Corruption Cases

U.S. v. Ho, No. 1:17-cr-00779 (S.D.N.Y.) is an action in which defendant Chi Ping Patrick Ho, A/k/a Patrick C.P. Ho, was found guilty by a jury of participating in a multi-year multimillion dollar scheme to bribe top officials of Chand and Uganda to obtain certain business advantages for CEFC China Energy Company Limited. Mr. Ho was found guilty of conspiracy to violate the FCPA, conspiracy to engage in international money laundering, violating the FCPA and engaging in international money laundering. The scheme had two facets designed to aid CEFC China, a Shanghai-based multibillion business conglomerate that operates in oil, gas, and banking. Mr. Ho was at the center of the scheme as the head of a non-governmental based Hong Kong and Arlington, Virginia based China Energy Fund Committee which held “Special Consultative Status” with the U.N. Economic and Social Council. It was funded by China. Under both facets of the scheme Mr. Ho payed bribes to government officials to secure benefits.

U.S. v. Jiminez Aray, No. 9:18-cr-80054 (S.D. Fla. Sentenced Nov. 29, 2018). Gabriel Arturo Jimenez Aray, a Venezuelan business man and the former owner of Banco Peravia, was sentenced following his earlier guilty plea under seal to one count of conspiracy to commit money laundering. Mr. Jamenez admitted as part of the plea to participating in the scheme with Mr. Gorrin and others to acquire Banco Peravia. He then used the bank to launder bribe money. Mr. Jimenez admitted facilitating illegal transactions and bribe payments to foreign officials using bank issued credit cards, cash disbursements, wire transfer and through other transactions, according to his admissions. U.S. v. Jiminez Aray, No. 9:18-cr-80054 (S.D. Fla. Sentenced Nov 29, 2018).

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