As the New Year approaches and 2010 draws to a close the SEC entered into its first non-prosecution agreement. SEC Enforcement also continued to focus on insider trading bringing two new cases against unknown purchasers but losing a third case at trial.

Criminal securities cases also continued to focus on insider trading with a guilty plea in one case. In Manhattan the USAO filed another insider trading case in its ever expanding expert network case.

DOJ and the SEC also brought another FCPA case against a giant French telecommunications equipment company. An FCPA indictment was also brought against two former telecommunications executives.

Finally, the NYAG brought a Martin Act case against E&Y, the outside auditors of Lehman Brothers. The complaint claims the auditors knew Lehman was manipulating its financial statements to appear less leveraged and made false disclosures.

The first SEC non-prosecution agreement

The Commission entered into its first non-prosecution agreement with Atlanta clothing store Carter’s, Inc. The underlying case (here) centers on a financial fraud alleged to have been perpetrated by its former Executive Vice President of Sales, Joseph M. Elles. The fraud involved the manipulation of certain industry standard rebates and was limited in scope. SEC v. Elles, Civil Action No. 1:10-CV-4118 (N.D. GA. Field Dec. 20, 2010).

The agreement is based on the limited scope of the underlying fraud and the complete cooperation with the SEC by the company. It is substantially similar to those which have long been utilized by the Department of Justice. The agreement requires the company to cooperate with the Commission during its continuing investigation and in any subsequent proceedings. Carter also agreed to use its best efforts to secure the full and complete cooperation of its current and former directors, officers, employees and agents. Cooperation includes providing full, truthful testimony, non-privileged documents, information and other materials. The agreement does not contain an admission of liability or protect the company from prosecution by other agencies.

SEC Enforcement

Insider trading: SEC v. One or More Unknown Purchasers of Securities of Martek Biosciences Corporation, Case No. 10 Civ. 9527 (S.D.N.Y. Filed Dec. 22, 2010) is an insider trading action brought against unknown purchasers. The complaint centers on trading shortly prior to the announcement that Royal DSM N.V., a Dutch company, would acquire all of the outstanding shares of Maryland based Martek Biosciences Corporation. Shareholders would receive a 35% premium over the market price under the terms of the agreement which was announced on December 21, 2010. According to the SEC, between December 10, 2010 and December 15, 2010, 2,616 Martek call options were purchased through a UBS account. These purchases represented over 90% of the volume for those contract days. Following the acquisition announcement the share price increased by 36%. This placed the account in a position to realize total profits of about $1.2 million on the sale of the call options. The complaint alleges a violation of Exchange Act Section 10(b). The case is in litigation.

Insider trading: SEC v, One or More Unknown Purchasers of Options of InterMune, Inc., Case No. 10 Civ. 9560 (S.D.N.Y. Filed Dec. 23, 2010) is against unknown traders in the options of InterMune, Inc.. This action centers on trading prior to the announcement by the European Union’s Committee for Medicinal Products for Human Use that a drug of InterMune, Inc, a biotechnology company based in Brisbane, California, would be recommended for approval. The recommendation was scheduled to be announced on December 17, 2010. On December 7 and 8, 2010 four hundred call options were cleared through UBS Securities LLC. The purchases constituted 100% and 57.2%, respectively, of the volume of transactions for the two days on which they were made. On December 13, 2010 an additional 237 option contracts were cleared through Barclays Capital, New York. On the day of the announcement the share price of InterMune rose about 144%. If realized the accounts would have had a trading profit of $912,000. The complaint alleges a violation of Exchange Act Section 10(b). The case is in litigation.

Investment fund fraud: SEC v. Patel, Civil Action No. 0:10-cv-04937 (D. Minn. Filed Dec. 22, 2010) is an action against Amit Patel based on alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(4). The complaint alleges a two part scheme. In the first Mr. Patel sold four investors about $1.4 million in promissory notes. The funds were to be invested in a low risk stock option trading strategy which guaranteed monthly returns and repayment of the principal. In fact the defendant misappropriated over $572,000. Most of the balance was lost. In the second scheme Mr. Patel convinced four investors to give him limited trading authority over their accounts, valued at $1.1 million. Again a conservative trading strategy was to be used. Again most of the money was lost. The case is in litigation.

Fraudulent offering: SEC v. Pharma Holdings, Inc., Civil Action No. 10-cv-81615 (S.D. Fla. Filed Dec. 22, 2010) is an action against Pharma Holdings, allegedly in the pharmaceutical supply business, and its CFO Edward Klapp Jr. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). According to the complaint, from 2005 through 2009 the defendants raised about $5 million from 80 European investors through the fraudulent offering of Pharma shares. The securities were sold using false press releases, false postings on a website and misrepresentations in various materials about a supposedly soon to be conducted IPO and buy out by a large company. The case is in litigation.

Offering fraud: SEC v. Buckhannon, Case No. 8:10-cv-2859 (M.D. Fla. Filed Dec. 21, 2010) is an action against Robert Buckhannon, Terry Rawstern, Dale St. Jean and Gregory Tindall. They were the managing members of two defunct hedge funds. According the SEC’s complaint, the individual defendant raised substantial sums from investors between 2008 through 2010 with claims that the money would be conservatively invested. Contrary to the representations made to investors the funds were put in illiquid private investments, loans to affiliates and there were substantial investment losses. The individual defendants misappropriated part of the investor funds and paid themselves over $1.3 million based on inflated asset values and fictitious profits. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). Mr. Buckhannon settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of the sections in the complaint. He also agreed to pay disgorgement of $1,239,176 and a civil penalty of $130,000. Mr. Rawstern also consented to the entry of an injunction. The question of disgorgement and a civil penalty will be determined at a later date.

Offering fraud: SEC v. Kelly, Case No. 1:07-CV-4979 (N.D. Ill. Dec. 21, 2010) is an action against Michael Kelly, George Phelps and others alleging fraud in connection with the sale of Universal Leases which were investments structured as timeshares in Mexican hotels. From 1999 through 2005 the defendants are alleged to have raised about $428 million selling these investments. Investors were told that the investments would generate guaranteed income but in fact payments to investors came from other investors. Defendants also failed to disclose key facts about the investments or that the commissions were as high as 27%. Mr. Kelly consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). He also agreed to pay disgorgement of $2,002,766.66 along with prejudgment interest and to pay a civil penalty of $120,000.

Conflicts: In the matter of American Pegasus LDG, LLC, Adm. Proc. File No. 3-14169 (Dec. 21, 2010) is a proceeding which names as Respondents: American Pegasus LDG, LLC (“APLDG”), a registered investment adviser; American Pegasus Investment Management, Inc., also a registered investment adviser which is essentially the predecessor adviser to the Auto Fund, one of several funds of American Pegasus which is a segregated portfolio company based in the Cayman Islands; Benjamin Chui, the majority owner of APLDG, its CEO and the sole owner of American Pegasus Management; attorney Charles Hall, the chief compliance officer of APLDG of which he is a minority shareholder; and Triffany Monk who worked for APLDG and American Pegasus Management.

The Order is essentially based on undisclosed conflicts. The offering memorandum for Auto Loan Fund claimed that it invested primarily in subprime auto loans. It also claimed that it only used finance companies that were independent of the advisory firms. By December 2008 however about 40% of its assets were debts and other obligations owed to a finance company purchased by a holding company owned by the individual Respondents. In fact the finance company was acquired with a loan from Auto Loan Fund directed by Mr. Chui. Following its acquisition the finance company incurred large debts to Auto Loan Fund. The Order alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b) as well as Adviser’s Act Sections 206(1), 206(2) and 206(4).

To resolve the matter Respondents entered into a series of undertakings including the cancellation of certain claims against Auto Loan Fund by APLDG and agreements that the individual Respondents will not serve as a director of American Pegasus SPC. Respondents also consented to the entry of a cease and desist order regarding the statutory sections cited in the Order. Messrs. Chui and Hall and Ms. Mok also agreed to the entry of an order barring them from association with any investment adviser with a right to reapply after, respectively, five, three and one year. Respondents APLDG and American Pegasus Management also agreed to disgorge $850,000 while Mr. Chui will pay a civil fine of $175,000, Mr. Hall $100,000 and Ms. Mok $75,000. Mr. Hall will also be denied the privilege of practicing before the Commission as an attorney with a right to reapply after three years.

In the matter of Moore Stephens Wurth Frazer & Torbet LLP, Adm. Proc. File No. 3-14167 (Dec. 20, 2010). The Respondents are Moore Stephens, a public accounting firm registered with PCAOB, and Kerry Dean Yamagata, CPA, a partner in the firm and the engagement partner for the audits of China Energy Savings Technology, Inc., a Nevada shell corporation which acquired in 2004 Dicken Industrial Development, Ltd. That latter is a company located in China which claimed to manufacture and sell energy savings equipment. During FY 2005 China Energy materially overstated its revenues and net income in the annual report and two quarterly reports. According to the Order Respondents failed to properly exercise professional skepticism and due care during the engagements despite recognizing that they were high risk. In 2004 and 2005 Respondents also failed to comply with the record keeping requirements of Regulation S-X. The Order alleges violations of Rule 102(e)(1)(ii). To resolve the matter the firm entered into a series of undertakings. Respondents also consented to the entry of an order directing that they cease and desist from committing or causing any violations and any future violations of Rules 2-02(b) and 2-06 under Regulation S-X. They were also jointly ordered to disgorge the audit fees of $100,000 along with prejudgment interest. Mr. Yamagata is also denied the privilege of appearing and practicing before the Commission as an accountant with a right to reapply after two years.

Investment fund fraud: SEC v. Burnt, Civil Action No. 1:10-cv-4121 (N.D. Ga. Filed Dec. 20, 2010) is an action against Kenneth Burnt, Perimeter Wealth Financial Services, Inc. and KSB Financial, Inc. The complaint alleges violations of Securities Act Sections 5 and 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). According to the Commission, Mr. Burnt, through two controlled entities, raised about $4.5 million from over 20 investors. Those investors were guaranteed specific returns, told no advisory fees would be charged unless there was at least 8% minimum annualized returns and any shortfalls in principle would be covered by a reserve account. These representations were false. The day after the complaint was filed the court entered a preliminary injunction and partial freeze order.

Insider trading: SEV v. Zachariah, Case No. 08-60698 (S.D. Fla. Filed May 13, 2008) is an action against Dr. Zachariah P. Zachariah, Dr. Mammen P. Zachariah and Dr. Sheldon Nassberg (here). According to the complaint Dr. Zachariah Zachariah became a director of IVAX and learned that it had entered into a tentative agreement to be acquired by Teva Pharmaceuticals. Almost immediately he began trading and tipped his brother Dr. Mammen Zachariah. The complaint also alleges that Dr. Zachariah had previously obtained inside information about a take over, traded and tipped his brother and Dr. Sheldon Nassberg, a friend. After a non-jury trial the court found against the Commission and in favor of Dr. Zachariah Zachariah.

Criminal cases

Insider trading: U.S. v. Jiau (S.D.N.Y.) is the latest case in the on-going expert network insider trading probe. Ms. Winifred Jiau is charged with conspiracy to commit securities fraud and securities fraud in connection with providing two money managers at different hedge funds with inside information about the earnings of Marvell Technology Group for the first and second quarter of 2008. The court papers also allege that M. Jiau furnished information about the profits of Nvidia, a high tech company. The fund managers traded on the information after obtaining it in telephone calls from Ms. Jiau.

Insider trading: U.S. v. Poteroba (S.D.N.Y. Filed March 24, 2010) (here) is an action against Igor Poteroba, a former managing director of UBS Securities in its Healthcare Group. Mr. Poteroba pleaded guilty to three counts of securities fraud and one count of conspiracy to commit securities fraud last week. According to the court papers, Mr. Poteroba obtained inside information regarding upcoming merger transactions involving six publicly traded healthcare companies. He then furnished that information to Alexei Koval, an employee at Citigroup Asset Management and another individual identified as CC-1 both of whom traded in advance of the public announcement of the deal. Mr. Poteroba was paid a portion of the trading profits by Mr. Koval, both of whom are Russian nationals. Sentencing is scheduled for March 16, 2011. The SEC has a parallel action.


U.S. v. Alcatel-Lucent S.A., (S.D. Fla. Dec. 27, 2010); U.S. v. Alcatel-Lucent France S.A., (S.D.F.a. Dec. 27, 2010); SEC v. Alcatel-Lucent, S.A., Case No. 1:10-cv-24620 (S.D.Fla. Dec. 27, 2010) (here). DOJ and the SEC settled cases with telecommunications giant Alcantel-Lucent S.A., who’s ADRs were traded in New York until November 30, 2006. The cases allege violations of the anti-bribery, books and records and internal control provisions of the FCPA between December 2001 and June 2006. Three Alcantel-Lucent subsidiaries were involved. According to the court papers, the company, through its subsidiaries which employed local agents, paid bribes in Costa Rica, Honduras, Malaysia and Taiwan. It also violated the internal control provisions of the FCPA related to hiring third party agents in Kenya, Nigeria, Bangladesh, Ecuador, Nicaragua, Angola, Ivory Coast, Uganda and Mali. In Costa Rica Alcatel CIT (now known as Alcatel-Lucent France S.A.) obtained three contracts worth more than $300 million which yielded profits of over $23 million. About $18 million was paid to two consultants. In Honduras Alcatel CIT was able to retain contracts worth about $47 million which yielded profits of about $870,000 through the payment of bribes. Similarly in Malaysia bribes were paid through agents to obtain or retain a telecommunications contract valued at about $85 million. Likewise, in Taiwan Alcatel Standard retained two consultants on behalf of another subsidiary in Taiwan to assist in obtaining an axle counting contract worth about $19.2 million. The two consultants were paid about $950,000. Funds were funneled to Taiwanese legislators to influence the award of the contract which yielded profits of about $4.34 million. All of these payments were improperly recorded in the books and records of the subsidiaries and the parent company. This resulted, according to the court papers, from a lax system of internal controls.

To settle with DOJ the parent company entered into a deferred prosecution agreement. The two count information charged violations of the FCPA internal controls and books and records provisions. Under the terms of the agreement the company will pay a $92 million criminal fine and a monitor will be installed for three years. In addition, subsidiaries Alcatel-Lucent France S.A., Alcatel-Lucent Trade International A.G., and Alcatel Centroamerica S.A. (formerly known as Alcatel de Costa Rica S.A.) each agreed to plead guilty to a one count information charging conspiracy to violate the anti-bribery, books and records and internal control provisions of the FCPA.

The parent company settled with the SEC by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 30A, 13(b)(2)(A), 13(b)(2)(b) and 13(b)(5). The company also agreed to pay disgorgement of $45.372 million and to comply with its undertakings including the appointment of an independent monitor for three years.

U.S. v. Granados, Case No. 10-cr-20881 (S.D. Fla. Sept. 20, 2010) names as defendants Jorge Granados, the founder and CEO of Latin Node Inc., and Manuel Caceres, its former vice president of business development. The 19 count indictment centers on alleged violations of the FCPA and money laundering charges. According to the indictment, in 2005 Latin Node won an agreement to use the lines of the Honduras state owned telecommunications company to establish a network between Honduras and the U.S. Shortly thereafter, Messrs. Grandado and Caceres decided they needed a rate reduction. Bribes were paid to state officials between September 2006 and June 2007. The money was laundered through Latin Node subsidiaries. Previously the company pleaded guilty to FCPA charges (here).


FINRA released its 2010 year in review. Highlights of its activities include: expanding its market oversight to responsibilities which include 11 new markets; launching its Office of Fraud Detection and Market Intelligence; making 244 insider trading referrals to the SEC, the highest in history; bringing 1,173 disciplinary actions, levying fines which total $41.1 million and ordering almost $8 million in restitution; and completing its first major expansion of BrokerCheck since 2002.

New York

Audit failure: The People of the State of New York v. Ernst & Young LLP (N.Y. Sup. Ct. Filed Dec. 21, 2010) asserts securities fraud claims under the New York Martin Act against the outside auditors of Lehman Brothers (here). The complaint centers on the use of “Repo 105,” a short term financing transaction which under certain circumstances can be booked as a sale rather than a financing. Beginning in 2001 Lehman used the transaction at period end to reduce its leverage numbers. The transactions would essentially be reversed after the period end although the investment bank had to discount the value of the securities received back. According to the complaint these transactions, which were reviewed and approved by E&Y, distorted the financial metrics of the firm, making it appear to be far less leveraged. The disclosures of Lehman were also false and misleading because they failed to inform shareholders about the Repo 105 transactions as financings.