THIS WEEK IN SECURITIES LITIGATION (December 16, 2011)
The SEC took three unusual steps this week. First, in a high stakes move, the agency appealed the refusal of Judge Rakoff to approve its proposed settlement in a market crisis case with Citigroup. A loss in the Second Circuit could substantially injure the enforcement program. Second, the agency brought an action against SIPIC for failing to institute liquidation proceedings with respect to the Stanford Ponzi scheme. Finally, the SEC brought an action against a private company claiming that it defrauded employees who sold shares in their company back to their employer.
SEC v. Citigroup Global Markets, Inc. Case No. 11 Civ 7387 (S.D.N.Y.): The Commission appealed the determination by District Court Judge Rakoff to not approve the proposed settlement in this case. The underlying action is the Commissionâ€™s latest market crisis case which is discussed here. Judge Rakoff declined to approve the proposed settlement noting that he did not have sufficient facts on which evaluate the matter. While the Court was critical in its order regarding the fact that the settlement was based on neither admitting nor denying the allegations in the complaint, central to the Courtâ€™s conclusion was its view that there was a fundamental mismatch between the allegations of the complaint which alleged an intentional fraud and its charging sections which were based on negligence and the proposed settlement which was bassed on a small fine when viewed in the context of similar cases without offering any explanation for the apparent mismatch. In proceedings before Judge Rakoff the Commission chose not to offer an explanation. Rather, it argued essentially that the Court had a limited role and should defer to the decision of the agency.
SEC v. Securities Investor Protection Corporation:The Commission filed an application to compel SIPIC to begin the liquidation of accounts related to the Stanford Group Company. Previously, the SEC filed an action against Mr. Stanford and his companies. In that proceeding the court ordered that Stanford Group be placed into receivership. Despite a request from the Commission that SIPIC initiate a liquidation in view of the customer accounts involved, it failed to take action The application is pending.
SEC Enforcement: Filings and settlements
Investment fund fraud: SEC v. Management Solutions, Inc., Case No. 2:11-cv-01165 (D. Utah, Filed Dec. 15, 2011) is an action against a father and son, Wendell A. Jacobson and Allen R. Jacobson, and their company, Management Solutions. The complaint charges that the two individual defendants operated an offering fraud and Ponzi scheme through the company and over 200 other controlled entities. Investors, who were apparently solicited through the church attended by the Jacobsons, were told that their money would be used to rehab apartment buildings and, after the installation of new management, they would share in the profits. When the controlled entities suffered significant losses, the Jacobsons pooled the investor funds into bank accounts and used them for family expenses and to repay other investors. The Commissionâ€™s complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The SEC obtained an asset freeze order and the appointment of a receiver. The case is in litigation.
False statements: In the Matter of Retirehub, Inc., Adm. Proc. File No. 3-14666 (Filed Dec. 15, 2011) is an action against the firm and its founder, Sunil Bhatia. The Order alleges that from May 2003 to the time its investment adviser registration was withdrawn in February 2011, Respondents made false statements on Form ADV. Specifically, the Form stated that the firm was an internet investment adviser which is defined in Rule 203A-2(f) and that it qualified for registration with the Commission because it had over $25 million in managed assets. In fact both statements are false. Respondents resolved the proceeding by consenting to the entry of a cease and desist order based on Advisers Act Sections 203A, 204 and 207. Mr. Bhatia also agreed to pay a civil penalty of $25,000.
False audit opinion: In the Matter of Kempisty & Co., CPAs, P.C., Adm. Proc. File No. 3344 (Dec. 14, 2011) is a proceeding against the audit firm, its founding partner Philip Kempisty, and an employee of the firm, John Rubino. The Order alleges that in the audit of Kentucky Energy, Inc. for the year ended December 31, 2005 the audit firm improperly issued an audit opinion stating that the financial statements presented fairly the financial position of the company in conformity with generally accepted accounting principles when in fact they did not. The company had improperly accounted for warrants and convertible notes it had issued to third parties. The Order finds that the Respondents aided and abetted violations by the company of Exchange Act Section 13(a). It also finds that the Respondents engaged in improper professional conduct in violation of Rule 102(e). To resolve the proceeding Respondents consented to the entry of a cease and desist order from causing any violations and any future violations of Exchange Act Section 13(a). Respondents are also denied the right to practice before the Commission. Mr. Kempisty may request that the Commission reinstate him after one year while the other two Respondents may make such a request after three years. Re-entry in each instance is conditioned on compliance with certain conditions.
Regulation SHO: In the Matter of Gary Bell, Adm. Proc. No. 3-14660 (Filed Dec. 13, 2011) is an action against Gary Bell who traded through GAS, LLC. According to the Order, Mr. Bell violated the â€œlocate requirementâ€ and the close out requirements of Regulation SHO. That Regulation requires market participants seeking to effect a short sale to borrow, arrange to borrow, or have reasonable grounds to believe that a security can be borrowed in time to make delivery prior to effecting a short sale. Market makers are exempt from this requirement. They are not exempt from the close out requirement which specifies that if there is a fail-to-deliver position for thirteen consecutive settlement days in certain securities the position must be closed. Here Respondent in one transaction created a synthetic long position while selling short the underlying stock and inappropriately relying on the market maker exception. In another he entered into a paired transaction with a fail-to-deliver position in which he borrowed the necessary stock for a day or two to make it appear that he had satisfied the close out requirement when in fact he had not. To resolve the proceeding Respondent consented to the entry of a cease and desist order based on Exchange Act rule 203(b)(1) and 203(b)(3). He also agreed to be suspended from the securities business for a period of nine months, to pay disgorgement of $1.5 million along with prejudgment interest and a civil penalty of $250,000.
Fraudulent promotion: SEC v. Eiten, Case No 1:11-CV-12185 (D. Mass. Filed Dec. 12, 2011) is an action against Geoffrey Liten and his company National Financial Communication Corp. The company issues a penny stock promotion piece entitled â€œOTC Special Situations Reports.â€ In four reports the complaint claims misrepresentations were made regarding the financial condition of companies as well as their revenue projections, property rights and the interaction of company management with Mr. Eiten who was hired to issue the reports. Those reports were issued without checking the accuracy of the information with the companies involved. The complaint alleges violations of Exchange Act Section 10(b). The case is in litigation.
Fraudulent shell sale: SEC v. Alternative Green Technologies, Inc., Civil Action No 11-cv-9056 (S.D.N.Y. Filed Dec. 12, 2011) is an action against the company, Mitchell Segal, Belmont Partners LLC, Joseph Meuse, Howard Borg, David Ryan, Vikram Khanna and Panascope Capital Inc. According to the complaint, Alternative Green and attorney Segal submitted false documents to a transfer agent so that the shares of the company could be issued for trading. Those actions were facilitated by Belmont and defendant Meuse by creating, and in some instances backdating, false documents. The stock certificates were then used to fund promotional campaigns promoting Alternative Green. The stock promoters were defendants Ryan, Panascope Capital and its president defendant Khanna. The complaint alleges violations of Securities Act Section 5 and Exchange Act Section 10(b). Defendants Borg, Khanna and Panascope Capital have consented to the entry of a permanent injunction prohibiting further violations of Section 5. Mr. Khanna and Panascope Capital have agreed to pay $81, 477.10 to settle the charges while Mr. Borg agreed to pay $35,264.05 and to surrender to the transfer agent for cancellation more than 4 million shares of the company that were illegally issued.
Investment fund fraud: SEC v. Malarz, Case No 11-cv-8803 (N.D. Ill. Filed Dec. 12, 2011) is an action against Marcin Malarz, Jack Sienkiewicz and Arthur Lin. According to the complaint, the defendants raised over $14.3 million from at least 43 investors based on promises that the funds would be invested in apartment complexes which would be rehabilitated. Investors were assured that their money was personally guaranteed by Mr. Malarz and in some instances by Mr. Sienkiewicz. In fact substantial portions of the money was used for the personal benefit of the defendants while other portions were employed to make Ponzi like payments. The complaint alleges violations of Securities Act Sections 5and 17(a)(2) and Exchange Act Section 10(b). The case is in litigation.
Fraudulent stock repurchase: SEC v. Stiefel Laboratories Inc., Case No 1:11-cv-24438 (S.D. Fla. Filed Dec. 12, 2011) is an action against the company and its Chairman Charles Stiefel. The complaint claims that the defendants defrauded company employees out of $110 million in the repurchase of shares of the privately held firm. During the term of the repurchases the company, which provided the employees with valuations of the shares under a pension plan, acquired the shares at prices that were as much as 300% below what the defendants knew to be the value of the stock. As the repurchases unfolded the defendants also made misrepresentations regarding the value of the shares. Ultimately the company was purchased by GlaxoSmithKline plc. at a share price significantly over that paid to the employees. The complaint charges violations of Exchange Act Section 10(b). The case is in litigation.
Insider trading: SEC v. Galleon Management, LP, Civil Action No. 09-cv-8811 (S.D.N.Y.); SEC v. Cutillo, Civil Action No. 09-CV-9208 (S.D.N.Y.) are two cases developed from the Galleon investigations. In the former the SEC settled with Zvi Goffer, a former trader at Schottenfeld Group, LLC who provided tips on the acquisition of Hilton Hotels Corp. and Kronos Inc. Mr. Goffer consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and agreed to pay disgorgement of $265,709.33 plus prejudgment interest. Mr. Goffer was also a defendant in the Cutillo case where he was alleged to have furnished inside information on the potential acquisition of 3Com and Avaya among others. To resolve this action he consented to a similar injunction and to the payment of disgorgement of $1,014,758 plus prejudgment interest. In a related administrative proceeding he agreed to the entry of an order barring him from the securities industry. In the related criminal case Mr. Goffer was found guilty of securities fraud and conspiracy to commit securities fraud, sentenced to 10 years in prison and ordered to pay $10,022,931 as criminal forfeiture.
Investment fund fraud: U.S. v. Onsa (E.D.N.Y.) is an action against former hedge fund manager Ward Onsa. He pleaded guilty to securities fraud. According to the court papers, Mr. Onsa operated investment firm Ward Onsa & Co. until 2005 when a series of trading losses and judgments resulted in the bankruptcy of the firm. Subsequently, he solicited over $5 million from investors for a second fund, New Century Hedge Fund Partners, L.P. That fund also plummeted into insolvency as a result of trading losses and withdrawals of investor money. As the fund crashed Mr. Onsa sent investors false statements to conceal the losses. Much of the money he raised for the second fund was from IRA accounts.
Insider trading: Jamil Bouchareb and Daniel Corbin, who each previously pleaded guilty to one count of conspiracy to commit securities fraud and one count of securities fraud, in Manhattan, were sentenced to prison this week. According to the charging papers, from February 2005 to September 2008 Mr. Bouchareb obtained inside information regarding six mergers from Matthew Devlin whose wife worked for an international communications firm. Mrs. Devlin had entrusted the information to her husband expecting him to keep it confidential. Defendant Bouchareb used the information to trade in the shares of the six companies. In September 2006 he also purchased shares of a takeover target on inside information after consulting with Mr. Corbin. The two men earned hundreds of thousands of dollars in trading profits, portions of which were paid to Mr. Devlin. Mr. Bouchareb was sentenced to serve 30 months in prison while Mr. Corbin will serve 6 months. Mr. Devlin will be sentenced in March 2012.
U.S. v. Kozeny, Docket No. 09-4704 (2nd Cir. Decided Dec. 14, 2011) is the FCPA action against Frederic Bourke, Jr., co-founder of accessory company Dooney & Bourke, and others. The case stems from Mr. Bourkeâ€™s investment in an enterprise put together by Victor Kozeny, a man with a shadowy past, to try and acquire SOCAR, the state oil company of Azerbaijan at a time when the country was privatizing assets. Mr. Kozen, and others allegedly paid millions in bribes through various entities in an effort to ensure that the president of Azerbaijan would issue a decree to privatize SOCAR. The decree was never issued. Mr. Kozen invested $7 million indirectly in the project, although he knew that Mr. Kozen had a troubled reputation and expressed concern about the prospect of paying bribers. A jury found Mr. Bourke guilty of violating the FCPA and making false statements. He was sentenced to serve 366 days in prison. Mr. Kozeny is a fugitive. Mr. Bourkeâ€™s appeal focused on the question of knowledge and whether the instruction on conscious avoidance should have been given under the circumstances.
The Second Circuit affirmed the conviction. Under established Second Circuit precedent a conscious avoidance instruction permits a jury to find culpable knowledge on the part of a defendant when the evidence demonstrates that he intentionally avoided confirming a fact. The instruction is only proper when the defendant asserts the lack of some specific aspect of knowledge required for conviction and the facts are sufficient to warrant giving the charge the Court held. Here the governmentâ€™s primary theory was that Mr. Bourke had actual knowledge. Nevertheless, there is ample evidence to support giving the instruction in this case, according to the Court. This is because the testimony established that Mr. Bourke knew of the pervasive corruption in the country, Mr. Kozenyâ€™s reputation as the Pirate of Prague and the fact that he created companies which were designed to shield him from liability. Tape recordings involving Mr. Bourke and another investor in which he voiced concerns about whether Mr. Kozeny and his company were paying bribes also support this conclusion. All of this evidence was bolstered by the testimony of Mr. Bourkeâ€™s attorney â€“ he waived privilege â€“ that he advised that his client he could not just look the other way if he thought there was wrong doing. The Court also rejected a claim that giving the instruction was inconsistent with the governmentâ€™s theory. The Court held that â€œthis same evidence [which supports the conclusion of conscious avoidance] may also be used to infer that Bourke actually knew about the crimes.
U.S. v. Sharef, 11 Crim 1056 (S.D.N.Y.) charges eight and SEC v. Sharef, 11 CIV 9073 (S.D.N.Y. filed Dec. 13, 2011) seven former Siemenâ€™s executives and agents with FCPA violations. Named as defendants in the indictment are Uriel Sharef, a former member of the central executive committee of Siemens AG; Herbert Steffen, a former CEO of Siemens Argentina; Andres Truppel, a former CFO of Siemens Argentina; Ulrich Bock, Stephan Singer and Eberhard Reichert, former senior executives of Siemens Business Services or SBS; and Carlos Sergi and Miguel Czysch, intermediaries and agents of the company.
The actions center commitments by Siemenâ€™s executives and agents to pay over $100 million in bribes to Argentine officials to win a $1 billion contract. The contract derives from a 1994 tender by the government of Argentina for the DNI project to create a new system of national identity booklets with state of the art national id cards. During the bidding process the defendants and others committed Siemens to paying about $100 million in bribes to officials of the Argentine government, members of the opposition party and candidates for office who were likely to come to power during the project. Approximately $31.3 million was paid after March 12, 2001 when Siemens became a U.S. issuer. In 1998 the project was awarded to a special purpose subsidiary of Siemens.
In 1999 the government suspended the project. More bribes were paid. Nevertheless, in May 2001 the project was terminated. The indictment alleges violations of the FCPA, conspiracy to commit wire fraud, conspiracy to commit money laundering and substantive wire fraud. The SECâ€™s complaint alleges violations of Exchange Act Sections 30A, 13(b)(2)(A), 13(b)(2)(B), and 13(b)(5). Both actions are pending.
The SEC settled with defendant Bernd Regendantz, the former CFO of SBS from February 2002 to 2004. He is alleged to have authorized two bribe payments totaling about $10 million. Mr. Regendantz consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 30A and 13(b)(5) and from aiding and abetting violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B). He agreed to pay a civil penalty of $40,000 which was deemed satisfied by the payment of a €30,000 administrative fine ordered by the Public Prosecutor General in Munich, Germany.
Suitability: Wells Fargo Investments LLC was fined $2 million for unsuitable sales of reverse convertible securities by one registered representative to 21 customers and for not providing sales charge discounts on certain sale to eligible customers. Reverse convertibles are interest bearing notes in which repayment of the investment is keyed to the performance of an underlying asset. The investment carries risk of loss depending on the nature of the underlying asset. Here one salesman, who is the subject of a separate proceeding, sold these investments to clients who, for the most part, were elderly and/or had limited risk tolerance. Wells Fargo will, in addition to paying the fine, make restitution to the customers for the investments and the fees.
MF Global: FINRA Vice Chairman Stephen Luparello testified before the House Committee on Agriculture on December 8, 2011 regarding the collapse of M. F. Global (here).
Insider dealing: Rupinder Sidhu, a management consultant, was convicted on 22 counts of insider dealing and sentenced to two years imprisonment. Mr. Sidhu was found not guilty on one count of insider dealing. The charges centered on allegations that Mr. Sidhu obtained inside information regarding 18 different UK and European listed shares from Anjam Ahmad, an ex-hedge fund trader and risk manager with AKO Capital LP. Mr. Ahmad supplied Mr. Sidhu with information he obtained in his role as a trader at AKO about the firmâ€™s forthcoming transactions. Over the last three years the FSA has secured 11 convictions for insider dealing. The regulator currently is prosecuting 15 other individuals for the crime.
RBS report: The regulator published a report regarding he failure of the Royal Bank of Scotland. It focused on six points: 1) A significant weakness in RBSâ€™s capital position from management decisions which was permitted by an inadequate global regulatory capital framework; 2) over-reliance on risky short-term wholesale funding; 3) concerns and uncertainty about the bankâ€™s underlying asset quality; 4) substantial losses in credit trading activities which eroded market confidence; 5) the acquisition of ABN AMRO which was done with inadequate due diligence; and 6) an overall systemic crisis in which banks in the condition of RBS were vulnerable to failure.
Private securities litigation
NERA Economic Consulting issued a report on trends in private actions. The consulting firm is projecting that by year end filings for private actions will be slightly below the level of 2010. Suits objecting to mergers account for about 29% of the total while about 18% relate to Chinese companies. The report is available here Regulation SHO: In the Matter of Gary Bell, Adm. Proc. No. 3-14660 (Filed Dec. 13, 2011) is an action against Gary Bell who traded through GAS, LLC. According to the Order, Mr. Bell violated the â€œlocate requirementâ€ and close out requirements of Regulation SHO. That regulation requires market participants seeing to effect a short sale to borrow arrange to borrow, or have reasonable grounds to believe that a security can be borrowed in time to make delivery prior to effecting a short sale. Market makers are exempt from this requirement. They are not exempt from the close out requirement which requires that if there is a fail-to-deliver position for thirteen consecutive settlement days in certain securities the position must be closed. Here Respondent in one transaction created a synthetic long position while selling short the underlying stock and in another entered into a paired transaction with a fail-to-deliver position in which he borrowed the necessary stock for a day or two o make it appear that he had satisfied the close out requirement when in fact he had not. To resolve the proceeding Respondent consented to the entry of a cease and desist order based on Exchange Act rule 203(b)(1) and 203(b)(3). He also agreed to be suspended from the securities business for a period of nine months, to pay disgorgement of $1.5 million along with prejudgment interest and a civil penalty of $250,000.