Prosecutors concluded their case-in-chief in the Galleon insider trading trial this week. SEC enforcement, in conjunction with the U.S. Attorney’s Office in New Jersey, brought an insider trading case against an attorney, a former associate of three prominent law firms, and a professional trader. The Commission also brought actions based on financial fraud and misrepresentations in connection with the sale of CDOs. The Department of Justice brought an FCPA action against another member of in the TSKJ consortium and, along with the SEC, against Comverse Technology. Finally, the number of securities class actions filed last year increased but the average settlement value decreased according to a new PWC report.

Market reform

Accounting profession: SEC Chief Accountant James Kroeker testified before the Senate Banking subcommittee on securities, insurance and investment on the Role of the Accounting Profession in Preventing Another Financial Crisis. In his remarks Mr. Kroeker covered a series of topics including: the importance of reliable financial reporting, the role of the auditor, the root causes of auditing deficiencies, auditing considerations around the globe and continuing improvements to accounting standards (here).

Capital formation: SEC Commissioner Luis A. Aguilar addressed the Council of InstitutionalIinvestors Spring Meeting on April 4, 2011. His remarks were titled “Facilitating Real Capital Formation.” Commissioner Aguilar focused on the difference between capital formation and raising capital as well its relation to effective regulation and enforcement (here).

SEC Enforcement

Investment fraud: SEC v. Mam Wealth Management LLC, Civil Action No. CV 11-2934 (C.D. Ca. Filed April 7, 2011) is an action against the firm, MAMW Real Estate General Partner LLC, Alex Martinez and Ralph Sanchez. The complaint alleges from July 2007 through March 2009 Defendants Martinez and Ralph Sanchez had 50 of their advisory clients invest in MAM Wealth Management Real Estate Funds. For some the two individual defendants made misrepresentations about the investment including its safety, liquidity and yearly earnings. For others they held discretionary authority and the investments were unsuitable. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). The case is in litigation.

Misrepresentations: In the Mater of Delta Global Advisors, Inc., Adm. Proc. File No. 3-14329 (April 7, 2011) names as Respondents the firm and Charles Hanlon, its principal and control person. Respondents repeatedly misrepresented to customers its eligibility for registration with the Commission and assets under management. Through repeated misrepresentations Respondents vastly exaggerated the significance and status of the firm. It also failed to disclose a breach of fiduciary law suit against the firm, that Mr. Hanlon was the subject of a FINRA disciplinary proceeding and its poor financial condition. The Order alleges violations of Advisers Act Sections 206(1), 206(2) and 206(4). The date for the hearing has not been set.

Failure to protect client information: In the Matter of Marc A. Ellis, Adm. Proc. File No. 64220 (April 7, 2011); In the Mater of Frederick O. Kraus, Adm. Proc. File No. 3-14326 (April 7, 2011); In the Matter of David C. Levine, Adm. Proc. File No. 3-14327 (April 7, 2011). These proceedings named as Respondents three former officers of GunnAllen Financial Inc. They are its former president Frederick Kraus, former national sales manager David Levine and former chief compliance officer Mark Ellis. The three proceedings allege that while the firm was winding down its business operations Mr. Kraus permitted Mr. Levine to take customer information from more than 16,000 accounts and transfer it to his new firm prior to notifying customers This violates Regulation S-P or the Safeguard rule which protects customer information. Mr. Ellis failed to install adequate procedures in this regard. The ones in place were little more than a copy of the language from the regulation. To resolve the actions Respondents Levine and Kraus consented to the entry of a censure and a cease and desist order based on Rules 7(a), 10(a) and 30(a) of Regulation S-P. In addition, each man agreed to pay a civil penalty of $20,000. Mr. Ellis consented to the entry of a censure and a cease and desist order based on Rule 30(a) of Regulation S-P. He also agreed to pay a civil penalty of $15,000. These are the first actions to assess a civil penalty against an individual based on Regulation S-P.

Stock based loan scheme: SEC v. HedgeLender LLC, Case No. 2:09-CV-859 (S.D. Ohio filed Sept. 30, 2009) is an action against the company and its principals, Daniel Stafford and Fred Wahler. The complaint alleges that the defendants solicited 54 clients who put up $1.7 million in securities for a fraudulent scheme operated by Michael and Melissa Spillan through One Equity Corporation. Clients were told that their stock would be used to collateralize non-recourse loans. The defendants represented that the Spillans and their company were legitimate lenders that they had carefully vetted. In fact the operation was a fraud and the due diligence claims were false. The investor shares deposited were liquidated. The Spillans used portions of the money for their personal expenses. The defendants settled this week with the SEC. Each consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a) and Exchange Act Section 10(b). In addition, the company was ordered to pay disgorgement of $1,719,567 along with prejudgment interest while Mr. Stafford was directed to disgorge $432,417 along with prejudgment interest. Mr. Wahler was directed to disgorge $298,065 along with prejudgment interest. A civil penalty of $1,065,417 was imposed on the company while each individual defendant was directed to pay a penalty of $50,000.

Failure of due diligence: In the Matter of Capital Financial Services, Inc., Adm. Proc. File No. 3-14324 (April 6, 2011) is a proceeding against the company, which is a registered broker dealer, and Brian Hoppre, a registered principal of the company. The Order alleges that from September 2006 through January 2009 Respondents made a series of private placements of shares of Provident Royalties, LLC, a company which was suppose to be in the oil and gas extraction business. About $63 million worth of securities were sold. The Respondent firm was paid a commission for the sales. Provident used portions of the proceeds for its business but other portions were used to repay investors in a fashion resembling a Ponzi scheme. According to the Order, despite being paid a due diligence fee and a series of red flags raised by a law firm retained to assist in that process, the Respondents failed to conduct any meaningful due diligence. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The Order directs that a hearing be set.

Financial fraud: SEC v. Styam Computer Services Ltd., Case No. 1:11-cv-00672 (D.D.C. Filed April 5, 2011); In the Matter of Lovelock & Lewes, Adm. Proc. File No. 3-14321 (April 5, 2011). These are settled actions against, respectively, the India based company and the PWC affiliates in that country which served as the outside auditors to the firm. Over a five year period beginning in 2003 the senior management of the company overrode the internal controls using what they called a “super user” login identification and password to access the invoice management system and insert false invoices. The “super user” login allowed the group to enter the system without detection. In 2007 an additional $58.1 million was added to revenue by recording 27 additional fake invoices outside the “super user” login. To support the fraudulent revenue the group fabricated corresponding bank records. The false financial information was included in the financial statements of the company as well as press releases. The fraud apparently was discovered when the company made a filing with the SEC which attached a letter from its former chairman admitting it. The company has been restructured by the government of India and criminal charges brought against the officers. The company settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). Styam is also required to retain an independent consultant, comply with certain undertakings and pay a $10 million civil penalty.

The related administrative proceeding was also settled. The action centered on claims of improper professional conduct by PW India. Five PWC affiliated entities were named as Respondents. The Order claims that from 2005 through 2009 the auditors failed to retain control of the confirmation process with respect to cash and cash equivalents, rarely questioning the information they obtained. It alleges violations of Exchange Act Sections 13(a) and 13(b)(2)(A) as well as Section 10A(a) and Rule 102(e). The proceeding was resolved with the Respondents implementing a series of undertakings including one which prohibits them from accepting new SEC clients for six months, the entry of a cease and desist order based on the sections cited in the Order and the payment of a $6 million penalty and the creation of a fair fund.

The five PWC related firms also settled with the PCAOB. The proceeding is based on essentially the same conduct as the SEC administrative action. Two of the firms will pay a civil penalty of $1.5 million which is the largest levied in a Board proceeding. In addition, the firms will implement an extensive series of undertakings.

Fraud in sale of CDOs: In the Matter of Wells Fargo Securities LLC, Adm. Proc. File No. 3-14320 (April 5, 2011) is a proceeding based on the sale of two collateralized debt obligations tied to the performance of residential mortgage-backed securities at a time when the housing market was beginning to show signs of distress. Wachovia Capital Markets structured and sold the securities. The Order claims the antifraud provisions were violated in two respects. First, undisclosed excessive mark-ups were charged. Second, with respect to one, Wachovia represented that it acquired assets from affiliates on an arms length basis and at fair market prices. In fact certain assets were transferred from an affiliate at above market prices. To resolve the matter Respondent consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3). In addition, Well Fargo agreed to disgorge $6.75 million and pay a civil penalty of $4.45 million. Respondent was also directed to put portions of the sums paid in a fair fund while other sums were paid directly to purchases.

Criminal cases

Insider trading: U.S. v. Bauer, Mag. No. 11-3536 (D. N.J. Filed April 6, 2011); SEC v. Kluger, Case No. 11-cv-1936 (D. N.J. Filed April 6, 2011). These cases name as defendants Matthew Kluger, an attorney who worked at three prominent law firms, and Garrett Bauer, a professional stock trader. At the center of the case is a person identified as CC-1, a friend of each defendant. According to the criminal complaint, the insider trading scheme began in 1994 and continued until 1999 when it stopped for a period. During this time Mr. Kluger generally furnished inside information from merger deals he worked on to CC-1 who in turn passed to Mr. Bauer who traded. The scheme halted because of concerns about being apprehended. In the initial period of the scheme the men traded in five take over stocks. Mr. Kluger left the law firm where he was employed in 2001.

The second phase of the scheme began in May 2006 shortly after Mr. Kluger took a position with another firm. It continued through February 2011. During this period, the group invested over $109 million in eleven take-over stocks, reaping $32,365,000 in trading profits. The scheme unraveled in March 2011 when the IRS and FBI executed a search warrant at the residence of CC-1. Subsequently, CC-1 taped conversations separately with Mr. Kluger and Mr. Bauer. On the tapes, portions of which are quoted in the criminal complaint, the two defendants discuss the insider trading and the destruction of evidence. The criminal complaint charges the two men with one count of conspiracy to commit securities fraud, eleven counts of securities fraud and one count of conspiracy to commit money laundering. In addition, each defendant has been charged with two counts of obstruction. It also seeks the forfeiture of eight bank or securities accounts and a sum of money equal to $685,000. The SEC’s complaint alleges violations of Exchange Act Sections 10(b) and 14(e). Both cases are pending.

Financial fraud: U.S. v. Allen (E.D. Va.) is an action against Paul Allen, the former CEO of collapsed mortgage firm Taylor Bean. Mr. Allen pleaded guilty to conspiracy to commit bank and wire fraud and making false statements. Mr. Allen admitted in his plea to participating in the fraud involving Ocala Funding, a wholly owned lending facility that raised money by selling commercial paper to financial institutions. The funds were used to purchase TBW mortgages. Shortly after Ocalla was set up, Mr. Allen learned that there was a “hole,” that is the assets backing the paper were inadequate. That hole eventually grew to $1.5 billion. Mr. Allen admitted he helped cover up the hole by preparing false reports. He also made false reports to the Treasury in connection with efforts to secure TARP funds.


Comverse Technology, Inc. (E.D.N.Y. April 7, 2011); SEC v. Comverse Technology, Inc., Case No. 11-CV -1704 (E.D.N.Y. Filed April 7, 2011). These FCPA actions center on improper payments made by the Israeli operating subsidiary of Comverse between 2003 and 2006. Approximately $536,000 in payments were made to individuals connected to OTE, a telecommunications provider based in Athens, Greece that is partially owned by the Greek government. As a result of the payments the company obtained contracts worth about $10 million in revenue and $1.2 million in profits. The payments were made through a third party agent established in a Cyprus entity. The agent took 15% and used the remaining 85% in cash bribes. The payments were improperly booked. The company failed to have proper internal controls and had no process for conducting due diligence of sales agents or for an independent review of agent contracts outside its sale department. The company settled with DOJ by entering into a non-prosecution agreement and paying a $1.2 million fine. The settlement reflects the full cooperation of the company and its extensive remedial efforts including an overhaul of its compliance culture through the implementation of mandatory training programs and rigorous accounting controls to approve third party payments. With the SEC the company consented to the entry of a permanent injunction prohibiting future violations of the books and records provisions and the payment of disgorgement in the amount of $1,249,614 and prejudgment interest.

U.S. v. JGC Corp. (S.D. Tx. Filed April 6, 2011) is an FCPA action against the Japanese construction firm of JGC. The information charges the firm with one count of conspiracy and one count of aiding and abetting violations of the FCPA. The information is based on the actions of the TSKJ consortium between 1995 and 2004. The consortium was formed to obtain business through the payment of bribes in connection with the Bonny Island, Nigeria. The other members of the consortium are KBR, Snamprogetti and Technip, each of whom has previously settled FCPA charges. JGC resolved the action by entering into a deferred prosecution agreement and agreeing to pay a criminal fine of $218.8 million which is the sixth largest amount paid to resolve an FCPA case. In addition to the settlements with the companies, Albert Stanley, former chairman of KBR and Jeffrey Tesler, a UK lawyer who acted for the consortium, have both pleaded guilty.


The Board entered into a Statement of Protocol with the Swiss Federal Audit Oversight Authority and Financial Market Supervisory Authority. Under the agreement the Board will be able to conduct joint inspections of accounting firms in Switzerland that audit or participate in audits of companies whose securities trade on U.S. markets. It also contains a provision governing the sharing of confidential information consistent with the Sarbanes Oxley Act.


In connection with its sweep of broker dealers who sold interests in troubled private placements FINRA imposed sanctions on two firms and seven individuals. The sanctions related to the sale of private placements offered by Medical Capital holdings, Inc. and/or Provident Royalties, LLC. The charges were based on a failure to conduct a reasonable investigation of the sale of the placements. In addition , the regulator found that broker dealers who sold the MedCap, Provident and DBSI private placement offerings did not have reasonable grounds to believe that they were suitable for their customers. Those named were Workman Securities and its president Robert Volbrecht; Timothy Callum former CEO and Steven Burks former president of Cullum & Burks Securities;, Jeffrey Lindsey and Bradley Wells, both formerly of Capital Financial Services; Jay Thacker former CCO of Meadowbrook Securities; and David Dube, former owner and president of Peak Securities.

Private actions

The number of securities class actions filed last year rose by 12% to 174, an increase of 12, compared to the prior year according to a report released this week by PWC. Those suits targeted the financial and health industries as well as utilities. At the same time the total settlement value fell to the lowest level since 2003. The average settlement value fell 11% to $30.1 million from $34.0 million. The report is available on PWC’s website.