by T. GormanPosted on Posted in SECActions

The Commission has increasingly focused on data analysis as an aid to its enforcement program. Two recent cases brought against investment advisers for cherry picking illustrate different facets of the approach.

In the Matter of Bruce A. Hartshorn, Adm. Proc. File No. 32075 (April 20, 2016) is a proceeding which named Mr. Hartshorn, a registered investment adviser representative, as a Respondent. He is the founder of registered adviser Hartshorn & Co., Inc. The firm’s trade allocation policies, as disclosed in its Form ADV, provided that when it aggregates client orders it will allocate the executions in a manner which is equitable to all accounts. This included firm accounts.

The Commission’s analysis of its trade allocations from January 2010 through March 2011 demonstrated that the policy was not followed. During the period Mr. Hartshorn purchased blocks of securities in the Firm’s omnibus account at a brokerage that had custody of the accounts. Allocations were not made until later in the day. When making those allocations Mr. Hartshorn allocated a greater proportion of trades which had a positive first-day return to proprietary accounts. A greater proportion of trades that had a negative first-day return were allocated to client accounts.

An analysis of the trades during the period demonstrated when allocating the entire block trade to proprietary accounts the transaction was profitable 85% of the time. When the allocation was solely to client accounts, however, the transaction was unprofitable 100% of the time. When the allocations were split among the accounts the results were the same. Specifically, when the block purchased had positive first day returns, 68% of the securities were allocated to proprietary accounts. When there were negative first day returns Mr. Hartshorn allocated 81% of the securities to client accounts.

As a result of these practices the proprietary accounts had an average first day gain of 0.26% while client accounts had an average first day loss of 1.02%. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Section 201(1).

Respondent resolve the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, he is barred from the securities business and will pay a penalty of $75,000.

In the Matter of TPG Advisors LLC, Adm. Proc. File No. 3-17216 (April 19, 2016) is a proceeding which names as Respondents the firm, a registered investment adviser, and its owner and principal, Larry M. Phillips. The firm’s trade allocation policies, as reflected in its Form ADV as well as its internal written policies and procedures, required that trades be allocated in the most equitable manner possible.

From January 2010 through August 2014 the firm failed to adhere to its disclosed trade allocation policies by favoring six accounts held by four favored clients, according to the Order. Mr. Phillips placed trades in a master account without making any specific allocation. If the security could be bought and sold in a day for a profit, the position would be closed in the master account. The profits would be allocated to a favored account. If the position could not be closed for a gain that day it was usually allocated to one of the disfavored accounts.

The favored clients had first day profits on day trades that were virtually impossible to have been achieved by chance, according to the Order. Certain accounts had a large proportion of day trades while others had almost none. For the six favored account over 90% of the trades were day trades that had single day profits. In eleven accounts which had only a small proportion of the day trades, the vast majority had unrealized first day losses.

The likelihood that the profitability of the favored accounts occurred by random chance is less than 1%, according to the Order. In contrast, the performance in each of the eleven disfavored accounts is a statistical anomaly. Random change would have given them a better performance with a probability exceeding 99%.

The third party broker that held the accounts warned the adviser about the allocations. In at least 21 instances during the period the firm was warned for suspicious trades. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 207. The proceeding will be set for hearing.

Tagged with: , ,

by T. GormanPosted on Posted in SECActions

Financial fraud has long been a staple of SEC enforcement. In the wake of the market crisis the agency has attempted to once again focus on the area creating, for example, a financial fraud task force two years ago. Last fiscal year the SEC had a significant up-tick in the number of financial fraud actions filed compared to the prior year. In an apparent effort to emphasis the area, yesterday the SEC announced in a single release the initiation of financial fraud actions against two issuers, several executives and an audit engagement partner.

One group of actions centered on a financial fraud at Logitech International, S.A. which involved four of its executives. In the Matter of Logtech International, S.C., Adm. Proc. File No. 3-17212 (April 19, 2016); SEC v. Bardman, Civil Action No. 3:16-cv-02023 (N.D. Cal. Filed April 18, 2016). The company and Michael Doktorczyk, formerly a v.p. of finance at the firm, and Sherralyn Bolles, formerly a director of accounting and financial reporting, are Respondents in the administrative action. Erik Bardman, formerly v.p. of finance and CFO at the firm, and Jennifer Wolf, formerly a director of finance, are defendants in the civil injunctive action.

Logitech is a Swiss corporation with substantial operations in the United States. Its shares are listed on Nasdaqu Global Select Market. The firm manufactures peripherals for computer and electronic devices. In late 2010 Logitech launched a new product called “Revue.” It was a television set-top device that provided for internet usage and video streaming. While the firm had high hopes for the device, projecting sales of over 350,000 unites in the third and fourth quarters, they were not realized. By the end of the fourth quarter Logitech had only managed to sell about half of the projected units. When the firm lowered its projected sales for the product its share price dropped 16%.

With a substantial inventory of unsold units, the firm stopped production. Consideration was given to halting the product. To avoid this result the firm calculated its inventory valuation by falsely assuming that the component parts in the manufacturing process would be built into completed units, a misrepresentation made to the auditors. Logitech also misrepresented the amount of write-down to be taken on finished goods in inventory – a key problem with the product was its high price compared to competitors. Mr. Bardman, a participant in these actions, then certified the 2011 financial statements furnished to the auditors and the public.

The Order alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the proceeding the company consented to the entry of a cease and desist order based on each of the Sections cited in the Order except Section 13(b)(5). The company also agreed to pay a $7.5 million fine. Mr. Doktorczyk consented to the entry of a cease and desist order based on each Section cited in the Order except Section 10(b). He also agreed to pay a civil penalty of $50,000. Ms. Bolles consented to the entry of a cease and desist order based on the same sections as Mr. Doktorczyk, excluding Section 13(b)(5). She agreed to pay a penalty of $25,000.

The complaint against Mr. Bardman and Ms. Wolf alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) and for reimbursement under SOX Section 304(a). The case is pending.

The second action centered on Ener1, Inc., a firm whose shares at one time were listed on the NASDAQ Stock Market, LLC. It designed, manufactured and developed lithium ion batteries for transportation, grid energy, and consumer products. In the Matter of Ener1, Inc., Adm. Proc. File No. 3-17213 (April 19, 2016). The Order names as Respondents, in addition to the firm, three executives: Charles L. Gassenheimer, CEO; Jeffrey A. Seidel, CFO; and Robert R. Kamischke, CAO.

In 2010 one of Ener1’s largest customers was Think, a manufacturer of electric cars. Ener1 held the voting rights to almost 50% of Think’s equity. Indeed, its Form 10K for the year ended December 31, 2010 the firm reported an investment in Think of $58.6 million. That represented about 15% of Ener1’s total assets. The investment was carried at cost on the balance sheet. It was not impaired despite the fact that Think could not pay its creditors and after year end, but before the issuance of the Form 10-K, the company which manufactured cars for Think halted production.

Ener1 also failed to conduct an impairment analysis of loans and accounts receivable from Think. In its Form 10-K for 2010 Ener1 reported that its loans receivable from Think were $14 million. That represented 3.5% of the firm’s assets. The loans were not impaired. In fact the firm did not conduct any meaningful analysis of the question.

The same Form 10-K also reported that Ener1 had receivables from Think of $13.6 million of which about $8.5 million were past due. This represented 3.4% of Ener1’s assets. Again the asset was not impaired.

Finally, in the 2010 Form 10-K Ener1 recognized $18.8 million in revenue from Think. The revenue was from the shipment of batteries to the company. While Ener1 did not have any formal written revenue recognition policy, no analysis for sufficient reasonable assurance of collectability was made. This resulted in the overstatement by 14% of its revenue. Overall, the firm had numerous deficiencies in its system of internal accounting controls. The Order alleges violations of Securities Act Section 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B).

To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, each individual Respondent agreed to pay a penalty of: Mr. Gassenheimer, $100,000; M r. Seidel, $50,000; and Mr. Kamischke, $30,000. See also In the Matter of Robert D. Hesselgesser, CPA, Adm. Proc. File No. 3-17214 (April 19, 2016)(proceeding against PWC audit engagement partner for the firm alleging violations of Rule 102(e)(1)(iv); resolved by denying Respondent the privilege of appearing and practicing before the Commission with the right to apply for readmission after two years).

Tagged with: ,