by T. GormanPosted on Posted in SECActions

The second time around proved to be the undoing of a senior financial analyst at a pharmaceutical company identified only as Pharma Co. Two years ago he supposedly furnished material non-public information about a proposed take-over to his longtime friend, identified as Trader. Trader traded and profited. No action was brought. In 2014 the analyst supposedly furnished the same friend inside information on another transaction. This time the SEC and the Manhattan U.S. Attorney filed civil and criminal charges against the analyst. SEC v. Zwerko, Civil Action No. CV 8181 (S.D.N.Y. Filed Oct. 10, 2014).

Zachary Zwerko was a senior financial analyst at Pharma Co. His job responsibilities included conducting analysis in support of business combination and divestiture opportunities. Accordingly, he had access to a shared drive that contained confidential project folders regarding potential transactions.

Mr. Zwerko’s longtime friend is Trader who was a 2008 classmate at business school. Since that time the two have maintained a social relationship.

Trader traded in advance of the June 9, 2014 pre-market announcement that Pharma Co. had agreed to acquire Idenix Pharmaceuticals, Inc. whose shares were listed on the NASDAQ stock market. The transaction traces to April 2014 when the two firms entered into confidential, non-public discussions regarding a potential business combination. By mid-May confidentiality and standstill agreements were executed.

Mr. Zwerko did not work on the Idenix transactions. By May 5, 2014, however, he began accessing confidential information about the deal. Those documents referenced the deal by a code name. On May 20 Mr. Zwerko’s supervisor sent him and others and email chain that referenced the deal, noting that a few days earlier a non-binding offer had been made. The lead email referenced the discount rates used for financial modelling and cited Idenix. The chain discussed the acquisition, using the code name.

Minutes after receiving the e-mail, Mr. Zwerko accessed Yahoo Finance for Idenix from his work computer. Later that day he reviewed headlines about the company. That evening he accessed folders relating to the deal at the office.

On the same day he received the e-mail from his supervisor, Mr. Zwerko sent a text to Trader. Later that evening, the two friends spoke on the phone. Two minutes after the call ended Trader placed an order for 1,000 shares of Idenix. Although it was not executed, starting the next day Trader purchased shares, investing over $219,000.

Mr. Zwerko continued to access confidential material about the deal at work and contact Trader:

  • On May 21, 2014 the analyst accessed a confidential file at work that contained a revised offer and noted the proposed deal would go to the board on May 27;
  • On June 3, Mr. Zwerko accessed another confidential file on the deal;
  • On June 3, a few hours after accessing the file, Mr. Zwerko called Trader; and
  • On June 4, 5 and 6 Trader purchased additional shares.

Following the deal announcement Trader sold his shares, reaping profits of about $579,000.

In 2012 Mr. Zwerko is alleged to have tipped his friend Trader in advance of the April 23, 2012 pre-market open announcement that Ardea Biosciences, Inc. had agreed to be acquired by AstraZeneca PLC. In the months prior to the deal announcement, Aredea engaged in a series of confidential discussions with several companies, including Pharma Co., regarding possible acquisitions. Mr. Zwerko worked on the proposed deal. Although Pharma did not acquire Areda, the firm participated in the negotiations until at least a week prior to the announcement.

During the negotiations Mr. Zwerko and Trader spoke on the phone. For example, on February 27, 2012, there was an internal meeting at Pharma regarding a non-binding offer to Ardea. Hours after the meeting Mr. Zwerko called Trader’s cell phone. The next day Trader began purchasing Ardea securities. Ultimately he purchased 9,800 shares through three brokerage accounts. Following the deal announcement he had trading profits of over $105,000.

The Commission’s complaint alleges violations of Exchange Act Section 10(b). The criminal case alleges one count of conspiracy to commit securities fraud. Both cases are pending.

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by T. GormanPosted on Posted in SECActions

Having the correct compliance procedures in place can often be critical. The SEC and the DOJ have repeatedly emphasized this in FCPA cases. Conducting due diligence can be equally critical. For gatekeepers such as lawyers, accountants and brokers, conducting appropriate due diligence can mean the difference between preventing a violation and becoming entangled in it. That was the result for two E*Trade subsidiaries who sold millions of shares of microcap stocks that were not registered despite representations to the contrary from their clients. In the Matter of E*Trade Securities, LLC, Adm. Proc. File No. 3-16192 (October 9, 2014).

From March 2007 through April 2011 the two E*Trade subsidiaries named at Respondents at various times facilitated the sale of millions of unregistered microcap shares for three Customers, according to the Order. Customer A opened an account with E*Trade in early 2007; Customer B opened an account later that year; and Customer C opened an account in March 2010. The Customers are institutional clients.

During the period the three Customers routinely acquired large quantities of newly issued penny stocks in private offerings. The Customers represented to E*Trade that the stocks were acquired in PIPE offerings. The size of the deposits varied from several thousand shares to a billion. The shares were issued by 247 companies. Generally the shares were resold within a short period. There were no registration statements on file with the Commission for the shares.

Respondents did not ask Customers A and B to identify the specific exemption from registration relied on. Likewise, the two Customers were not asked for documentation regarding any exemption. Rather, the two subsidiaries made the following inquiries:

  • What was the intended trading activity;
  • Customer A was asked for written representations that the shares were freely tradable;
  • Customer A furnished written representations that it would comply with the applicable law;
  • Respondents visited the offices of both customers several times to determine that they were reputable;
  • Beginning in March 2009 Respondents reviewed pending deposits to determine if they had financial risk; and
  • In November 2009 the trading history of both Customers was reviewed.

From March 2010 through April 2011 “Enhanced Due Diligence” was conducted regarding share deposits for Customers A and C. Under this process written representations were obtained from the Customer and issuer that the shares were freely tradable. Opinions from attorneys were also obtained that were based largely on representations from the reseller and issuer. Respondents also researched the attorneys.

These procedures were inadequate, according to the Order. While Securities Act Section 4(a)(4) exempts from registration brokers’ transactions, it is unavailable when the broker knows, or has reasonable grounds to know, that the shares are not exempt. To rely on the exemption a reasonable inquiry must be conducted. The scope of that inquiry depends on the surrounding facts and circumstances.

Here Customers A, B and C were continually faced with a series of red flags which should have raised a question as to whether they were engaged in an illegal distribution: 1) each acquired substantial amounts of newly issued penny stocks; 2) those shares were acquired from little known, non-reporting issuers; 3) they were acquired through private unregistered transactions; 4) the shares were immediately resold; and 5) the funds were wired out. Nevertheless, Respondents failed to conduct the kind of searching inquiry that was required under the circumstances. Accordingly, Respondents willfully violated Securities Act Sections 5(a) and 5(c).

To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited and to a censure. On a joint and several basis Respondents will pay disgorgement of $1,402,850, prejudgment interest and a penalty of $1 million.

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