by T. GormanPosted on Posted in SECActions

The Commission announced its largest whistleblower action this week – an award to a person overseas of over $30 million.

The agency also filed a series of actions this week. They included three insider trading case, two as administrative proceedings; two financial fraud actions; a SOX claw back proceeding tied to a financial fraud action; an action centered on an unregistered advisory run by an attorney; two actions naming attorneys who facilitated boiler room operations by serving as collection agents for the funds solicited; and a case centered on a pyramid scheme.

SEC

Whistleblowers: The Commission announced an expected award of over $30 million to a whistleblower who provided key original information that lead to the success of an enforcement action. The whistleblower resides in a foreign country. This is the largest whistleblower award made by the Commission to date.

CFTC

Remarks: Commissioner J. Christopher Giancarlo delivered the key note address at The Global Forum for Derivatives Markets, 35th Annual Burgenstock Conference, Geneva, Switzerland, titled The Looming Cross-Atlantic Derivatives Trade War: “A Return to Smoot-Hawley” (Sept. 24, 2014). His remarks discussed swaps clearing and trading, market fragmentation, a possible war in the swaps markets and called for a new spirit of regulatory comity and cooperation (here).

SEC Enforcement – Filed and Settled Actions

Statistics: This week the SEC filed 6 civil injunctive action and 10 administrative proceedings, excluding 12j and tag-along-actions.

Financial fraud: In the Matter of JDA Software Group, Inc., Adm. Proc. File No. 3-16164 (September 25, 2014) is a proceeding which names the software provider as a Respondent. From 2008 through 2011 the company had inadequate internal controls. Specifically, it did not have software which permitted it to establish vendor specific objective evidence of fair value for managed services so that revenue could be recognized from certain sales. As a result the firm restated its financial statement for the period, acknowledging a material weakness in controls. During the period it overstated and understated various financial metrics because of the weakness. The Order alleges violations of Exchange Act Section 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding the company consented to the entry of a cease and desist order based on the cited Sections and agreed to pay a penalty of $750,000.

Manipulation: SEC v. Spencer Pharmaceutical Inc., Civil Action No. 1:12-cv-12334 (D. Mass.) is a previously filed action against the microcap pharmaceutical company and Maximilien Arella, its CEO ,and Ian Morrice, its executive vice president. The complaint alleges that the defendants engaged in a pump-and-dump scheme in 2010 and 2011, manipulating Spenser’s stock. This week the Court entered a final judgment against defendants Arella and Morrice, enjoining them from future violations of Securities Act Sections 17(a)(2) and 17(a)(3) and barring each from serving as a director or officer of a public company and from participating in any penny stock offering for five years. The injunction as to defendant Arella is also based on Securities Act Sections 5(a) and (c). Each will pay a penalty of $50,000. See Lit. Rel. No. 23092 (September 25, 2014).

Customer funds: In the Mater of Colorado Financial Service Corporation, Adm. Proc. File No. 3-16168 (September 25, 2014) is a proceeding naming the registered broker dealer as a Respondent. The Order alleges that the firm improperly handled customer funds in connection with two private placements in 2010. In connection with one the firm received and held the funds of three customers. As a result the firm was in violation of the net capital rule, Exchange Act Section 15(c)(3). By failing to provide notice to the Commission, and to create and maintain accurate books and records, the firm violated Exchange Act Section 17(a). The second offering was contingent. There the firm received the customer funds and sent them to the issuer rather than the bank escrow agent, violating Exchange Act Section 15(c)(2). To resolve the proceeding the firm consented to the entry of a cease and desist order based on Exchange Act Sections 15(c) and 17(a). It will also pay a penalty of $25,000.

Insider trading: In the Matter of Richard O‘Leary, Adm. Proc. File No. 3-16166 (September 25, 2014) is a proceeding naming Mr. O’Leary as a Respondent, who is associated with an unregistered investment adviser. Towerstream Corporation planned and underwritten offering of its registered securities. Two days before the January 30, 2013 announcement of the offering, the company advisory group spoke with Mr. O’Leary, soliciting the aid of his employer. He agreed to be brought over the wall. The next day Mr. O’Leary sold shares of Towerstream from accounts in the names of his wife and children. After the announcement he avoided losses of $6,845. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). In resolving the case the Commission considered the cooperation of Mr. O’Leary. He consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, he is suspended from the securities business for twelve months. He will also pay disgorgement of $6,845, prejudgment interest and a civil penalty equal to the amount of the disgorgement.

Unregistered advisory: In the Matter of Yale L. Asbell, Adm. Proc. File No. 3-16163 (September 24, 2014) is a proceeding naming as a Respondent the attorney who does business through Yale Asbell P.C. As of June 30, 2013 the firm had at least $139 million under management. It failed to register as an investment adviser. In addition, Respondent engaged in fraudulent transactions with the apparent purpose of shifting trading profits or trading losses from accounts among family members and certain clients. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2) and (3). Mr. Asbell resolved 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 denied the privilege of appearing or practicing before the Commission as an attorney. He will also pay disgorgement of $60,622.90, prejudgment interest and a penalty of $150,000.

Financial fraud: In the Matter of Saba Software, Inc., Adm. Proc. File No. 3-16159 (September 24, 2014) is a proceeding which names as Respondents the software company and Patrick Farrell, V.P. of Consulting, and Sjeev Menon, Regional V.P. of Consulting. The Order alleges that beginning in 2008, and continuing through the second quarter of fiscal 2012, the time records were falsified. The scheme was carried out by professional services managers in multiple geographies directing consultants in Saba’s Indian subsidiary. In some instances time was recorded in advance of the event. In others it was not recorded. The point was to meet certain metrics. As a result, over a period from October 2007 through January 2012 the firm overstated reported pre-tax income by about $70 million. The company has announced a restatement but it has not been prepared. Its shares were delisted. The Order alleges violations of each subsection of Securities Act Section 17(a). In addition, it 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 agreed to implement certain undertakings which include filing a comprehensive Form 10K for the period ended May 31, 2014. Each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order, but the order as to the company does not include Exchange Act Section 13(b(5). The firm will also pay a penalty of $1,750,000. Mr. Farrell will pay disgorgement of $31,832, prejudgment interest and a penalty of $50,000. Mr. Menon will pay disgorgement of $17,875, prejudgment interest and a penalty of $50,000.

Claw-back: In the Matter of Babak Yazdani, Adm. Proc. File No. 3-16160 (September 24, 2014) is a proceeding against the CEO and founder of Saba Software based on the same facts set forth above. It seeks to claw back the incentive compensation paid to Mr. Yazdani and is based on Section 304 of Sarbanes-Oxley. The proceeding was resolved with the consent by the Respondent to the entry of a cease and desist order based on the cited Section. Mr. Yazdani will also disgorge $2,570,596 in bonuses and other incentive or equity based compensation and stock sale profits.

Boiler room: SEC v. Flom, Civil Action No. CV 14-5575 (E.D. N.Y. Filed September 23, 2014); SEC v. Schmidt II, Civil Action No. CV 14-5574 (E.D.N.Y. Filed September 23, 2014) are actions against, respectively, Jonathan Flom and James Schmidt II. Each is an attorney. Each defendant participated in a boiler room type scheme in which they used their status as attorneys to lend an aurora of respectability to a boiler room operation. International Stock Transfer, Inc. and its principal, Cecil Franklin Speight paid for the creation of a website for certain bogus unregistered investment advisers. Investors were solicited by a group of cold callers to purchase shares of various companies. The funds were wired either to Mr. Flom or Mr. Schmidt. Investors were not aware that the money was then diverted from each company by the attorneys to International Stock and Cecil Speight in return for a fee. Each complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). The cases are pending.

Insider trading: SEC v. David A. Roskein, Adm. Proc. File No. 3-16158 (September 23, 2014) is an action which centers on the acquisition of Terremark Worldwide, Inc. by Verizon Communications Inc., announced after the close of trading on January 27, 2011. Mr. Roskein was friends with Individual A who was employed at Verizon. He participated in the acquisition of Terremark. On January 22, 2011 the two men spoke on the phone. During the conversation Individual A told Mr. Roskein about the pending tender offer and cautioned him to keep it confidential. Nevertheless, Mr. Roskein traded,, buying over $71,000 worth of Terremark stock. Following the announcement he sold his shares at a profit of $42,833.78. The Order alleges violations of Exchange Act Sections 10(b) and 14(e). To resolve the matter Mr. Roskein consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, he agreed to pay disgorgement of $42,833.78, prejudgment interest and a civil penalty equal to the amount of the disgorgement.

Procedures: In the Matter of Barclays Capital Inc., Adm. Proc. File No. 3-16154 (September 23, 2014). The action centers on the failure of Barclay’s to properly enhance its internal procedures after acquiring Lehman Brothers Inc. advisory business in September 2008. Prior to that time Barclays operations in the United States were comprised largely of broker-dealer functions. After the September 2008 acquisition the firm created what is now called the Barclay’s Wealth and Investment Management, Americas division. Despite its growth, the firm failed to build the appropriate infrastructure. That contributed to deficiencies which include: Engaging in principal transactions without making the required written disclosures and obtaining consent in violation of Advisers Act Section 207(3); commissions and fees were charged and earned revenue that was inconsistent with its disclosures to certain advisory fees; the custody rule was violated; the firm failed to adopt and implement written policies and procedures designed to prevent violations of the Advisers Act; and it failed to make and keep certain books and records as required by Section 204(a) of the Advisers Act and violated Section 207 of that Act by making materially inaccurate disclosures in it Form ADV. To resolve the proceeding the firm agreed to implement a series of remedial measures. Barclays reimbursed or credited affected clients about $3.8 million, including interest. It also developed and implemented an action plan in consultation with outside experts. Finally, the firm consented to the entry of a cease and desist order based on Advisers Act Sections 204(a), 206(2), 206(3), 206(4) and 207 and to a censure. Barclays also agreed to pay a penalty of $15 million.

Investment fund fraud: SEC v. Shavers, Civil Action No. 4:13-cv-416 (S.D. Tx.) is a previously filed action against Trendon Shavers and Bitcoin Savings and Trust. The complaint alleged that the defendants operated a Ponzi scheme using the internet name “pirateat40” to lure investors to online chat rooms and to the Bitcoin Forum with promises of up to 7% returns weekly on his claimed trading of bitcoin against the U.S. dollar. In fact he diverted the funds raised to other enterprises and personal use. This week the court entered a final judgment against the two defendant, entering an injunction prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). In addition, the Court ordered, on a joint and several basis, the payment of $39,638,569 in disgorgement, prejudgment interest and a $150,000 penalty. See Lit. Rel. No. 23090 (September 22, 2014).

Pyramid scheme: SEC v. Zhunrize, Inc., Civil Action No. 1:14-cv-3030 (N.D. Ga. Filed September 22, 2013) is an action against the firm and its CEO, Jeff Pan. The defendant purport to operate a legitimate multi-level marketing business. Investors supposedly purchase an on-line store and earn commissions on products purchased by their customers and through store sales to other members. In fact the company operated a pyramid scheme. Its commission structure was based on the continued recruitment of new members with the best returns dependent on the down line recruitment of other members. The complaint alleges violations of Securities Act Sections 5(a) and (c) and 17(a) and Exchange Act Section 10(b). The Court granted a TRO at the time of filing. See Lit. Rel. No. 23091 (September 23, 2014).

Procedures: In the Matter of Wells Fargo Advisors, LLC, Adm. Proc. File No. 3-16153 (September 22, 2014). In 2012 one of the firm’s registered representatives, Silva Prado Neto, was charged by the Commission in an insider trading action. SEC v. Prado, Civil Action No. 12-CIV 7094 (2012). The action alleged that in September 2012 Mr. Prado traded in the securities of Burger King in advance of the September 2, 2010 announcement that 3G Capital Partners Ltd. would acquire the firm. Mr. Prado traded and tipped clients who traded. After the filing of the action, Wells Fargo conducted a review which raised red flags but was closed without contacting the branch manager. Other compliance units at Wells Fargo had information regarding the insider trading incident but the investigator was not contacted. When the Commission’s inquiry began a request was made for all of the documents of reviews related to Mr. Prado. Initially, the documents relating to the review by the compliance official were not produced. Six months later, after another request, the documents were produced. Later the staff learned that one document had been altered. The Order finds that Wells Fargo had inadequate policies and procedures to prevent the misuse of inside information. Although a review was conducted after the trading by Mr. Prada, the information was not shared with senior managers or other compliance groups that were aware of issues relating to the trading. In addition, the firm inconsistently enforced its policies. The Order alleges willful violations of Exchange Act Section 15(g), 17(a) and (b) and of Advisers Act Section 204A and 204(a). To resolve the proceeding Wells Fargo agreed to implement a series of undertakings. Wells Fargo also consented to the entry of a cease and desist order based on the Sections cited in the Order, to a censure and to pay a $5 million penalty.

Expense allocation: In the Matter of Lincolnshire Management, Inc., Adm. Proc. File No. 3-16139 (September 22, 2014) is a proceeding against the registered investment adviser. Beginning in 2001 the adviser integrated two portfolio companies that were separately owned. The owners were advised and an expense allocation agreement was worked out. That agreement was not always followed, resulting in one fund paying the expenses of the other in certain instances. The adviser also failed to have adequate procedures. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). Lincolnshire resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay disgorgement of $1,500,000, prejudgment interest and a penalty of $450,000.

Microcap fraud: SEC v. Pagnano, Civil Action No. 14 cv 7891 (S.D.N.Y. Filed September 23, 2014) is an action against Michael Pagnano and Heathrow Natural Food & Beverage, Inc. Heathrow, controlled by Mr. Pagnano, claimed to be a manufacturer and distributor of health foods. Its stock was quoted on OTC Link. Beginning in March 2009 Mr. Pagnano caused the firm to issue a series of false press releases touting its sales which were actually non-existent. As the share price increased he had the firm issued about 5 billion shares. Mr. Pagnano sold over 877 million shares of his stock yielding profits of $150,000. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of Section 17(a) and Exchange Act Section 10(b). The case is pending.

Unregistered shares: In the Matter of Registrar and Transfer Company, Adm. Proc. File No. 3-16157 (September 23, 2014) is an action related to the microcap fraud action involving Heathrow Natural Food. The Respondents are the transfer agent and its President and CEO, Thomas Montrone. The Order alleges that the Respondents violated Securities Act Section 5 in connection with 54 unregistered issuances of purportedly unrestricted shares of issuer Heathrow Natural Food & Beverage, Inc. despite numerous red flags. Mr. Montrone failed to reasonably supervise certain firm employees in connection with firm activities. To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on Securities Act Sections 5(a) and (c). The firm also consented to the entry of a censure. Mr. Montrone was suspended from serving in a supervisory capacity in the securities business. The firm agreed to pay disgorgement of $24,265.86, prejudgment interest and a penalty of $100,000.

Insider trading: SEC v. Tamayon (D. N. J. Filed September 19, 2014) is an action centered on an insider trading ring composed of three friends who had $5.6 million in illegal profits trading on inside information obtained from Simpson Thacher & Bartlett LLP. Steven Metro worked at the law firm. His friend Frank Tamayo worked as a mortgage broker. His friend, Vladimir Eydelman was a registered representative. The three put together a scheme in which Mr. Metro stole the inside information and passed it to Mr. Tamayon who in turn passed it to Mr. Eydelman. Mr. Metro passed the tips to his friend by showing him a screen on his cell phone. Mr. Tamayon then met with Mr. Eydelman and showed him a scrap of paper with the name of the target which he then destroyed. Mr. Eydelman placed the trades after furnishing his friend with research to show why the stock was selected for use in the event of an inquiry. The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 14(e) and Securities Act Section 17(a). The case is pending. Parallel criminal charges were brought by the U.S. Attorney’s Office, New Jersey. The cases are pending. Previously Messrs. Eydelman and Metro were charged by the Commission and the U.S. Attorney.

PCAOB

Practice alert: The staff issued an Audit Practice Alert on the auditor’s consideration of a company’s ability to continue as a going concern (here).

Criminal cases

Insider trading: U. S. v. Lucarelli, No. 1:14-mj-01878 (S.D.N.Y.) is an insider trading action which names a defendant Michael Lucarelli, the former Director of Market Intelligence at Lipper/Hellshorn & Associates, Inc., an investor relations firm. In thirteen instances the defendant is alleged to have traded on inside information taken from the firm as discussed in detail here. Prior to the last instance the FBI raided the office and obtained documents from Mr. Lucarelli’s brief case pursuant to a search warrant which were included a draft press released containing the yet to be announced financial results for firm client Trex. The day after the raid, Mr. Lucarelli traded in shares of Trex before the earnings announcement. Overall he had trading profits of more than $530,000. This week Mr. Lucarelli pleaded guilty to one count of securities fraud. The SEC’s parallel case is pending. SEC v. Lucarelli, Civil Action No. 14-cv-6933 (S.D.N.Y.).

United Kingdom

Procedures: The Financial Conduct Authority fined Barclays Bank Plc, about £38 million for putting £16.5 billion of client assets at risk. The FCA’s action follows 16 instances in which the regulator or its predecessor imposed sanction on the firm relating to client assets or client money. This action is predicated on what the FCA called a “significant weakness” in the systems and controls in Barclay’s investment banking division between November 2007 and January 2012. FCA rules require firms to protect client assets if a firm becomes insolvent. Barclays failed to properly apply these rules when opening 95 accounts in 21 countries. As a result the firm did not establish the appropriate legal arrangements with these companies. The failings also resulted in assets being listed at times under Barclay’s name rather than that of the client. The fine imposed reflects the violations and the firm’s regulatory history. It is also the largest imposed by the FCA or its predecessor for client asset breaches.

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by T. GormanPosted on Posted in SECActions

This is the fourth part of an occasional series. The first is available here, the second here and the third here. The entire paper will be published by Securities Regulation Law Journal early next year.

The volunteer program

The corporate payments issue and the SEC investigations and actions garnered significant publicity, spurring controversy that continues today. Congress initiated hearings that went on for the next two years. In corporate and business circles in the U.S. and abroad there were discussions on topics which ranged from the propriety of the payments to the authority of the SEC to bring the actions. Remarks of SEC Chairman Roderick Hills, Yale Law School (May 1, 1976) (“Hills at Yale”).

As the contours of the problem emerged it became apparent that a new approach was required. SEC Commissioner Philip Loomis, testifying before the Subcommittee on International Economic Policy, the House of Representative Committee on International Relations, suggested that corporations potentially facing a difficulty could have discussions with the SEC staff about the issue. See generally SEC Report at 6-7; Herlihy & Levine at 585. Commissioner Loomis’ suggestion grew into a program crafted by the Directors of the SEC’s Divisions of Enforcement, Stanley Sporkin, and Corporation Finance, Alan Levenson. It was called the Volunteer Program.

The program called for corporations that had made questionable payments to self-report to the SEC. Modeled on the early enforcement cases and settlements, it required that the company take a series of steps to resolve the situation voluntarily rather than be subjected to an SEC investigation. Those included:

· Investigation: A careful, in-depth investigation into the facts surrounding the questionable or illegal payments had to be conducted. A committee of the board of directors would supervise the investigation. Members of the committee could not be officers or involved in the activity. The committee should seek the assistance of the outside auditors and retain outside counsel.

· Scope of the inquiry: The investigation should cover the prior five years since that is the period reflected in the financial statements. Periods prior to that time should also be reviewed if the activities appear to be part of continuing actions or related to those within the period.

· Report: A report should be prepared by the committee at the conclusion of the inquiry and submitted to the full board of directors. That report should contain detailed information about each payment, its purpose and amount, the recipient and the country where it was made along with the surrounding circumstances.

· SEC Staff access: The SEC staff was required to have access to the report and its underlying documentation. The materials would be subject to the Freedom of Information Act. In practice certain accommodations were made. Some issuers expressed concern regarding the publication of sensitive information. In those instances the company initially declined to produce or file the requested materials. The Commission then initiated a subpoena enforcement action. In that action the Commission would obtain an order directing the production of the materials. At the same time the Court would typically enter a protective order regarding certain sensitive materials. See, e.g. SEC v. Lockheed Aircraft Corp., 404 F. Supp. 651, 652 (D.D.C. 1975) (subpoena enforcement action in which the documents were ordered produced and a protective order was entered).

· Adoption of policies: The board of directors should issue an appropriate policy statement regarding questionable or illegal payments. It should typically include a statement that the activities have ceased. The adoption of such a policy should be communicated to appropriate corporate personnel and implemented by adequate internal controls and safe guards.

· Filing: At the conclusion of the investigation a final report of material facts had to be filed with the Commission, generally on Form 8-K. That filing should include a discussion of the inquiry and a commitment to complete it if necessary; an undertaking by the company regarding the termination of the payments; and a detailed discussion of the transactions. SEC Report at 8-10.

The program did not offer issuers or those involved immunity from prosecution, or even promise “cooperation credit.” It did not require the company to consult with the SEC staff. It was an effort to spur corporate self-governance since the illicit or questionable payment cases graphically illuminated serious corporate self-governance issues. As then Chairman Roderick Hills stated at the time:

“It is apparent that our system of corporate self-regulation policed by independent auditors, directors and counsel and ultimately enforced by the SEC has broken down. Hundreds of millions of dollars have been siphoned out of corporate cash flow and spent out of slush funds with the knowledge of some members of top corporate management but without the knowledge of the outside directors, outside auditors and stockholders. No matter that it is only a score or so out of thousands, some are among the biggest and the most audited corporations in the world. If they can do it, who can’t?’ ” Hills at Yale at 7.

The Volunteer Program was a step toward repairing and strengthening corporate self-governance under the supervision of the board of directors and its independent directors and outside auditors and counsel. It also had certain pragmatic aspects: “The voluntary program offers advantages to both the company and the Commission. It enables the company to conduct its own investigation without the involvement of the staff of the Commission, which would tend to tie up the company’s personnel and disrupt its business. From the Commission’s point of view, the program permits a substantial number of companies to be examined without cutting into the availability of the Commission’s limited staff for other enforcement work. Herlihy & Levine at 586.

The program was a huge success. Overall about 450 corporations stepped forward, conducted comprehensive internal investigations, remediated the issues and provided their findings to the SEC staff and shareholders. Sporkin at 273. Within months of its announcement, nearly 100 companies joined the program. A wide variety of corporate conduct was uncovered. As SEC Chairman Hills stated in analyzing the early returns for the program in May 1976: “The revelations are of a wide variety. Some corporations have disclosed annual payments of millions of dollars. Others indicate that they made far smaller payments. Some payments were clearly designed to cause illegal actions by government or business officials, but some were to persuade persons to do jobs they were supposed to do without ‘tips.’ Some were authorized, or at least known of, by top corporate officials who deliberately permitted corporate books to be distorted in order to deceive outside directors, lawyers, and accountants and shareholders; others were carried out by low-level officials, either in violation of general corporate policy or under corporate procedures that carelessly permitted the practices to continue to grow.” Hills at Yale at 3.

The SEC report to Congress shed additional light on the kinds of conduct uncovered as the program unfolded:

· The two largest identifiable groups of companies that self-reported were drug manufacturers and those in the petroleum refining and related services business;

· The most common transactions were payments to foreign officials;

· A significant number of companies reported that at least some member of corporate management had knowledge of the transactions;

· Most reported the falsification of corporate records or the maintenance of records that appear to be inadequate; and

· Many of the defects in the financial systems represented intentional efforts to conceal the activity. SEC Report at 37-41, Appendix (chart summarizing the initial findings from the program, identifying the company, the nature of the issues, the knowledge of management and the steps taken).

Next: Congressional debates

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