by T. GormanPosted on Posted in SECActions

The Yates Memo, refocusing DOJ criminal and civil corporate investigations, continues to be the critical topic of discussion this week. The Memo, discussed here, directs that individuals be the focus of the inquiry from the beginning. Perhaps more importantly, the Memo stresses the point that cooperation credit will not be given unless the company identifies those responsible for the malfeasance and furnishes the supporting evidence.

In litigation, the SEC staff suffered a rare defeat in an administrative proceeding with the ALJ dismissed an insider trading case when the Division failed to establish a Dirks-Newman personal benefit. The Commission also filed a group of actions centered on fraudulently induced loans and improper lending practices by a broker and a settled proceeding involving an investment adviser who failed to disclose that his expenses were paid out of an offering he recommend to clients. The agency also brought an action centered on a market manipulation and another based on an offering fraud.

SEC

Testimony: Andrew Ceresney, Director, Division of Enforcement, testified on the Electronic Communications Privacy Act before the Senate Committee on the Judiciary (Sept. 16, 2015). His remarks focused on the SEC’s concerns regarding the Act (here).

CFTC

Remarks: Commissioner Sharon Y. Bowen delivered the keynote address at the ISDA North American Conference (Sept. 17, 2015). Her remarks focused on high frequency trading and algorithmic trading (here).

Remarks: Commissioner J. Christopher Giancaro delivered remarks titled “Good Intentions Do Not Always Lead to Good Regulations” to the 7th Annual Capital Link Global Commodities, Energy & Shipping Forum, New York City (Sept. 16, 2015). His remarks focused on position limits (here).

SEC Enforcement – Litigated Actions

Insider trading: In the Matter of Gregory T. Bolan, Jr., Adm. Proc. File No. 3-16178 (Initial Decision Sept. 14, 2015). Respondents are two former Wells Fargo Securities LLC employees. Mr. Bolan was a research analyst in Nashville, Tennessee. His research focused on three sub-sectors of the health care industry. Respondent Joseph Ruggieri was a senior trader of health care stocks in Wells Fargo’s trading department in New York City. In that role he placed customer orders and principal trades for the firm. The Order alleges that over a two year period beginning in 2010 Mr. Ruggieri traded ahead of six recommendations made by Mr. Bolan. This generated over $117,000 in profits in Mr. Ruggieri’s account. Trader A, who passed away in 2013, was a friend of Mr. Bolan’s who also is alleged to have traded ahead of recommendations. The Order alleged violations of Exchange Act Section 10(b) and Securities Act Section 17(a). Mr. Bolan settled, consenting to the entry of a cease and desist order based on Securities Act Section 17(a)(3). He also agreed to pay a penalty of $75,000. No industry bar was imposed.

Mr. Ruggieri proceeding to hearing. At the conclusion of the hearing ALJ Jason S. Patil dismissed the action based on Dirks and Newman. The initial question was if Mr. Ruggieris was tipped. After a careful analysis of the circumstantial evidence ALJ Patil concluded that Mr. Ruggieri had traded ahead of four of the six reports alleged in the Order. Furnishing the information alone is, however, not sufficient to sustain an insider trading charge. Citing Dirks and Newman the ALJ held that the Division had to prove a Dirks-Newman personal benefit. Both cases defined personal benefit in terms of objective criteria. Under those decisions the insider must receive “a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings. There are objective facts and circumstances that often justify such an inference. For example, there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient . . . [or the] insider makes a gift of confidential information . . . The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient,’” the Initial Decision states, quoting Dirks.

Here the Division’s proof was insufficient to establish a Dirks-Newman personal benefit. The Division could have had Mr. Bolan, who was under subpoena, testify on this critical point. It chose not to call him. Furthermore, the “friendship” between Messrs. Bolan and Ruggieri “was not a meaningful, close or personal one.” Likewise, the Division’s claims of “career mentorship” and giving “positive feedback” to Mr. Bolan’s superiors are nothing more than standard practice – neither was sufficient to establish a Dirks type personal benefit. While in “an abstract sense, feedback from the trading desk, including Ruggieri, could be viewed as having some potential pecuniary value . . .” here the question was not if it helped Mr. Bolan’s career but rather if Mr. Bolan would have tipped for it. The Division did not establish that point.

Likewise, the claimed friendship — working relationship between the two men was not adequate to establish the necessary benefit. That conclusion is reinforced by Mr. Bolan’s motive which seemed to be more about his disregard for the rules. Accordingly, the Division failed to establish the requisite personal benefit.

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 3 civil injunctive cases and 5 administrative actions, excluding 12j and tag-along proceedings.

Fraudulently obtained loans: SEC v. Hall, Civil Action No. 1:15-cv-23489 (S.D. Fla. Filed Sept. 17, 2015) is an action which names as a defendant Christopher Hall, the COB of Call Now, Inc., a public company that owned and operated a race track. Mr. Hall and his firm had millions of dollars in margin loans from broker and clearing firm Penson Financial Services, Inc. prior to the market crisis. By 2009 when the collateral had significantly diminished in value, he had to post additional collateral. Mr. Hall pledged Call Now stock after obtaining loans from the firm for $5.5 million based on his false claim that the money was needed to clear other loans off the stock – only about $850,000 went to that purpose. He also pledged his interest in a real estate limited partnership without telling the firm its interest would be subordinated to his prior lien. Subsequently, Mr. Hall sold his interest for about $1.3 million without Penson’s written consent and diverted most of the money to his personal account. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). The case is in litigation. See Lit. Rel. No. 23352 (Sept. 17, 2015).

Failed margin loans: In the Matter of Philip A. Pendergraft, Adm. Proc. File No. 3-16819 (Sept. 17, 2015) is a proceeding which names as Respondents, Mr. Pendergraft, a co-founder and director of broker and clearing firm Penson Financial Services, Inc., Kevin McAleer, CPA, the firms CFO, Thomas Johnson, a director of the firm and at one point the President/CEO of Call Now, Inc., and Charles Yancey, the president and CEO of the broker. The action centers on about $100 million in failed margin loans made by Penson to its customers, primarily Cristopher Hall and his affiliates (see above). Following the financial crisis Penson had significant losses on the loans. Rather than recognizing the losses in 2009 as required by the accounting standards, the firm delayed. In 2011 it recorded $60 million. Those losses contributed to the eventual bankruptcy of the firm in 2013. Respondents were responsible for the improper accounting treatment which resulted in false filings being made with the Commission. The Order alleges violations of Securities Act Section 17(a)(2) and 17(a)(3) and Exchange Act Section 7(c), 13(a), 13(b)(2(A), 13(b)(2)(B), 13(b)(2), 13(b)(2)(A), 13(b)(5), 14(a), 17(a) and 17(e). Each Respondent settled with the Commission. Each (except Mr. Yancey) consented to the entry of a cease and desist order based on: as to Mr. Pendergraft, Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 7(c), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5), 14(a), 17(a) and 17(e); he was also barred from the securities business and directed to pay a penalty of $100,000; as to Messrs. McAleer and McAleer, Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5); both were denied the privilege of appearing and practicing before the SEC with a right to apply for reinstatement after one year and directed to pay a penalty of $25,000; and as to Mr. Johnson, Exchange Act Sections 13(a), 13(b)(2)(A) and 14(a) and, in addition, he will pay a penalty of $25,000. Mr. Yancey was suspended in the securities business from association in a supervisory capacity for six months and directed to pay a penalty of $25,000.

Close out: In the Matter of Brian David Hall, Adm. Proc. File No. 3-16817 (Sept. 17, 2015); In the Matter of Rudolfo Delasierra, Adm. Proc. File No. 3-16816 (Sept. 17, 2015). Mr. Hall was a vice president at Penson Financial Services, Inc., a registered broker dealer which was one of the largest clearing firms in the U.S. Mr. Delasierra was also a vice present of the firm. The proceedings are based on the securities lending practices at Penson. Specifically, over a period of three years beginning in late 2008 procedures were implemented in the Securities Lending Department that did not comply with Rule 204, Regulation SHO which requires participants of a registered clearing agency to deliver equity securities to a registered clearing agency when delivery is due – typically settlement or close out fails to deliver. Each man resolve the proceeding, consenting to the entry of a cease and desist order based on Rule 204(a), Regulation SHO and to a censure. No penalty was imposed based on cooperation.

Audit failures: In the Matter of Terry L. Johnson, CPA, Adm. Proc. File No. 3-16820 (Sept. 17, 2015) is a proceeding based on the audits and quarterly reviews of the financial statements undertaken by Respondent for eight issuer clients and the resulting audit reports issued. The audits had numerous deficiencies including the failure to obtain engagement quality reviews, to properly plan the engagement, to obtain sufficient audit evidence and to maintain audit documentation. In some instances Mr. Johnson is alleged to have created, or caused to be created, back-dated, artificial audit documentation which he produced to the staff during its investigation. The Order alleges violations of Exchange Act Sections 10(b) and 13(a) and Securities Act Section 17(a). Mr. Johnson resolved the matter, consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, he is denied the privilege of appearing and practicing before the Commission as an accountant and was directed to pay disgorgement of $96,000, prejudgment interest and a penalty of $50,000.

Pyramid scheme: SEC v. Tropikgadget FZE, Civil Action No. 1:15 cv 10543 (D. Mass.) is a previously filed action naming as defendants Julio Cruze, two Portuguese companies and three of its officers and twelve promoters. The complaint alleged a pyramid scheme. Mr. Cruse settled, admitting he was a promoter of the firm and that he solicited investors for the scheme. The Court entered by consent a permanent judgment precluding violations of Securities Act Sections 5(a) and 5(c), the participation in any sales or marketing program similar to the one here and directing the payment of $3,232.32 as disgorgement, prejudgment interest and a penalty. See Lit. Rel. No. 23351 (Sept. 17, 2015).

Expenses: In the Matter of Jeffrey B. Rubin, Adm. Proc. File No. 3-16813 (Sept. 15, 2015) is a proceeding which names as a Respondent the founder of Pro Sports Financial, Inc. Mr. Rubin is also a registered investment adviser. Over a three year period beginning in March 2011 either he or a Project Developer recommended that his clients invest a total of about $40 million in an entertainment complex and casino. Mr. Rubin did not disclose that the complex paid about $600,000 of what he claimed were his expenses out of the offering proceeds. In fact, the money was not expenses but to support his lifestyle. The Order alleges violations of Exchange Act Sections 17(a)(1) and (3). To resolve the matter Mr. Rubin consented to the entry of a cease and desist order based on the Sections cited in the Order. He is also barred from the securities business. Disgorgement and a penalty were not sought based on an affidavit demonstrating his inability to pay.

Offering fraud: SEC v. Mogler, Civil Action No. 15-cv-01814 (D. Ariz. Sept. 11, 2015) names as defendants Jason Mogler, James Hinkeldey, Casimer Polanchek, Brian Buckley and James Stevens and ten related entities. The scheme centered around the supposed development of beachfront property in Mexico, the operation of recycling facilities and the acquisition of foreclosed residential properties that would be resold. Various entities used by the defendants were supposedly involved in one of these lines of business. Investors were solicited over a period of years beginning as early as October 2006 for some investments. Investors were variously told about one or more of the businesses. Overall about 225 investors parted with over $18 million based on representations that their funds would be used to develop one of the lines of business. Investors were also assured that the investment was safe. In fact the representations were false. Virtually all of the investor funds were diverted to the personal use of the defendants. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). The case is in litigation. See Lit. Rel. No. 23347 (Sept. 15, 2015).

Manipulation: SEC v. Babini, Civil Action No. 1:15-cv-13348 (D. Mass. Sept. 14, 2015) names as defendants Marco Babini, Samuel Brown and Edward Withrow. It involves Endeavor Power Corporation. In 2012 Mr. Withrow became chairman of Endeavor following a merger of another company he controlled with one controlled by Marco Babini. The two men held over 40 million shares of the company through a series of foreign accounts. The three defendants planned to manipulate the share price by raising it from about 7 cents per share to 25 cents. The three defendants coordinated with an individual who supposedly had substantial experience in the area but who in fact was a person working with the FBI. A series of steps were taken to tout the stock in an effort to increase the share price. Before the price increased sufficiently to sell the covertly owned shares, the SEC suspended trading, thwarting the scheme. The complaint alleges violations of Exchange Act Sections 9(a)(2), 10(b), 13(d) and 16(a) along with each subsection of Securities Act Section 17(a). The case is in litigation. See Lit. Rel. No. 23346 (Sept. 14, 2015). A parallel criminal action was filed by the U.S. Attorney’s Office for the District of Massachusetts.

FINRA

Misconduct: The regulator barred the former President of Global Arena Capital Corp., Bargara Desiderio and five former representatives, David Bennett, James Torres, Peter Snetzko, Alex Wildermuth and Michael Tannen based on the use of misleading sales pitches, churning and other violations. In addition, two former principals of the firm, Kevin Hagan and Richard Bohack, are barred as principals. Niaz Elmazi and Andrew Marzec were barred for failing to cooperate. This action resulted from an initiative under which FINRA follows brokers who have a problem past to new firms and conducts inspections.

Criminal Cases

Insider trading: U.S. v. Eydelman (D.N.J.) is an action which names as a defendant former broker Vladimir Eydelman. He was charged for participating in the insider trading ring tied to Stephen Metro, a former clerk at Simpson Thacher & Bartlett LLP. The ring had profits of over $5.6 million (here). This week he pleaded guilty to a superseding indictment charging one count of securities fraud, one count of tender offer fraud and one count of conspiracy to commit securities and tender offer fraud. Sentencing is scheduled for December 21, 2015.

Australia

False information: Benjamin Kirkpatrick, formerly the executive chairman of Waratah Resources Ltd. was charged with furnishing false information to the Australian Securities and Investment Commission. He was also charged with aiding and abetting the violation by the company of its continuous disclosure obligation. The charges centered on a company announcement that the firm had established a $100 million trade facility with Bank of China when it had not. The matter was adjourned until early November 2015.

Inappropriate advice: The ASIC banned Alfie Chong, a financial adviser at Meritum Financial Group Pty. Ltd. for five years. The action was based on giving inappropriate client advice, failing to assess the client’s circumstances, engaging in misleading and deceptive conduct, failing to give clients a statement of advice and failing to provide clients with sufficient detail.

Tagged with: , , ,

by T. GormanPosted on Posted in SECActions

Since at least the market crisis there has been a clamor to charge and convict senior corporate officials – or at least name them in a civil law enforcement action by the SEC or another agency. For years the Government investigated. It brought a series of actions based on various theories. Millions and billions of dollars were paid in fines by Wall Street Banks and others. The Government explained that the prosecution of senior corporate officials is complex and difficult – the evidence was not there. The clamor continued.

Now the Government is shifting its approach to corporate investigations and prosecutions. A Memorandum authored by Deputy Attorney General Sally Quillian Yates titled “Individual Accountability for Corporate Wrongdoing” refocuses Government law enforcement inquiries on individuals.

The Yates memo

The Yates Memo prioritizes the manner in which Government civil and criminal law enforcement investigations are conducted. It begins by noting that “One of the most effective ways to combat corporate misconduct is by seeking accountability from the individuals who perpetrated the wrongdoing . . . [accountability] it deters future illegal activity, it incentivizes changes in corporate behavior . . . and it promotes the public’s confidence in our justice system.”

The Memo acknowledges the many challenges it calls “unique to pursuing individuals for corporate misdeeds.” To address those challenges the DOJ convened a working group of senior attorneys. From that group six principles were developed with supporting commentary:

Principle 1: “To be eligible for any cooperation credit, corporations must provide the Department all relevant facts about the individuals involved in corporate misconduct.” (emphasis original). This means, according to the Memo, that companies “cannot pick and choose what facts to disclose. That is, to be eligible for any credit for cooperation, the company must identify all individuals involved or responsible for the misconduct . . . “ If the company “declines to learn of such facts” then it will not get cooperation credit. This does not mean that DOJ attorneys should wait for the company to furnish the information, according to the Memo. To the contrary, they should initiate their own inquiry, “proactively investigating individuals at every step . . .” This applies in civil and criminal cases.

Principle 2: “Both criminal and civil corporate investigations should focus on individuals from the inception of the investigation.” The goals achieved by taking this approach, according to the Memo, are: a) maximizing the ability to “ferret out the full extent of corporate misconduct;” b) investigating the conduct of individuals is the “most efficient and effective way to determine the facts . . .;” c) by focusing on individuals the likelihood of cooperation with the inquiry by individuals is maximized; and d) the prospect of concluding with charges against the company and individuals is maximized.

Principle 3: “Criminal and civil attorneys handling corporate investigations should be in routine communication with one another.” This means that from the beginning DOJ criminal prosecutors should be in consultation with their civil counterparts and agency attorneys.

Principle 4: “Absent extraordinary circumstances, no corporate resolution will provide protection from criminal or civil liability for any individuals.” While there may be instances where the DOJ resolves a matter with the company prior to reaching a resolution with individuals, the appropriate steps must be taken to preserve individual liability.

Principle 5: “Corporate cases should not be resolved without a clear plan to resolve related individual cases before the statute of limitations expires and declinations as to individuals in such cases must be memorialized.” If the investigation of individual misconduct is not concluded by the time the corporate inquiry is concluded, the Memo requires that there be a plan to conclude the investigation as to the individuals within the statute of limitations. If there no charges against individuals being recommended, then “the reasons for that determination must be memorialized and approved . . .”

Principle 6: “ Civil Attorneys should consistently focus on individuals as well as the company and evaluate whether to bring suit against an individual based on considerations beyond that individual’s ability to pay.” A key goal of the DOJ’s new approach is to hold individuals accountable. Thus civil actions should be considered and not deterred by an inability of the individual to pay.

Comment

Focusing on individuals is not new. Law enforcement authorities have long focused on individual conduct in corporate investigations. Likewise, many of the other points made in the Yates memo are also familiar. For example, cooperation credit has long been conditioned on the company turning over the facts developed in its investigation, including those relating to culpable individuals. Cooperation among law enforcement authorizes is also standard operating procedure, often resulting in multiple investigations at once.

The tone and focus on individuals from the beginning, as well the assumptions underlying this approach, are new and of concern. While the preamble of the memo acknowledges the difficulty of prosecuting senior corporate officials – largely reiterating years of DOJ statements – the Memo offers no new way, no new technique, no secret formula for solving those difficulties.

Rather, the only solution arising from the meeting of senior prosecutions seem to be withhold any cooperation credit from a corporation unless it turns over the evidence on the individuals. This, of course presumes, that there is such evidence. It also presumes that the company and those who conducted the internal inquiry, the results of which are being given to the Government in the name of cooperation, are acting is less than good faith. That approach is reminiscent of one taken years ago in another memo on corporate prosecutions written by a Deputy AG. That approach resulted in overreaching, not more effective law enforcement. Ultimately, portions of that memo were held to violate the Constitution in U.S. v. Stein.

If, of course, the Department has evidence that the company is not being forthcoming, it may be appropriate to withhold cooperation credit. That credit should not be denied based on an unproven assumption. That approach will not foster the public confidence in law enforcement discussed in the Memo.

Nevertheless, corporations involved in Government investigations must be prepared for the new approach. This may well mean that while an internal investigation is being conducted the company may also face a probe by DOJ officials focused not just on the wrongful conduct but motivated by trying to build a case against individuals. Unfortunately that approach often yields flawed results since investigators bent on obtaining a result may miss the actual evidence trail. This approach may well increase the difficulty for corporate investigators of completing the internal investigation.

Perhaps more importantly, in seeking cooperation credit corporate investigators and the company will need to be prepared to answer the “who did it” question by naming names and supporting the statements with evidence. If the company has not been able to develop the necessary information — not a surprising result in view of the Government’s years of experience – the company must be prepared to demonstrate the reasons for its conclusions. And, it should be prepared for the possible loss of all cooperation credit. That will no doubt increase the difficulty of resolving the case.

Ultimately a rigorous application of the Yates Memo may well undercut effective law enforcement. Today the DOJ as well as other law enforcement officials repeatedly call for self-reporting and cooperation with law enforcement. The denial of cooperation credit for good faith, well done corporate investigative results, may well deter cooperation. That would not facilitate Government investigations as envisioned by the Yates Memo. To the contrary it may well undercut the sought after public confidence while proving a point the Department has made for years – the evidence is frequently not there.

Tagged with: , , , ,