THIS WEEK IN SECURITIES LITIGATION (December 2, 2011)

The District Court rejected the proposed settlement of the Commission’s recent market crisis case against Citigroup. The ruling left the parties with the choice of either renegotiating the settlement and furnishing the Court with a factual predicate for the claims in the compliant or proceeding to trial.

The Enforcement Division announced a new initiative by its market abuse unit called the Aberrational Performance Inquiry. It focuses on using risk analytics and other techniques in analyzing the performance of hedge funds to stem investor losses through the early identification of fraudulent actions. Four recent cases were identified as being part of the initiative. The Division also filed a series of cases against investment advisers centered on inadequate procedures. The cases stem from Enforcement’s work with the inspection staff.

Finally, the Commission brought three actions, and suspended trading in the securities of seven thinly traded microcap stocks, in conjunction with the U.S. Attorney for the District of Massachusetts who brought criminal charges against thirteen individuals centered on a kick back and manipulation scheme in which a hedge fund manager was paid to manipulate stocks. The fund manager was an undercover FBI agent.

The Commission

Testimony re implementation of Dodd-Frank: SEC Chairman Mary Schapiro testified before the Senate Committee on Agriculture on the implementation of provisions of the Act concerning the derivatives markets (here).

Testimony re implementation of Dodd-Frank: CFTC Chairman Gary Gensler testified before the Senate Committee on Agriculture regarding the implementation of the provisions of the Act concerning the derivatives markets (here).

Testimony re congressional insider trading: SEC Enforcement Director Robert Khuzami testified before the Senate Committee on Homeland Security and Governmental Affairs regarding insider trading. After reviewing the current work of the market abuse unit in this area the Director discussed the application of insider trading principles to members of Congress, noting that the question presents certain novel issues including those concerning duty and privilege (here).

Testimony re capital formation process; SEC Corporation Finance Director Meredith Cross and Deputy Director Lona Nallengara testified before the Senate Banking, Housing and Urban Affairs Committee on initiatives being considering regarding capital formation (here).

Key questions about the enforcement program: SEC Enforcement Director Robert Khuzami, in remarks before the Consumer Federation of America’s Financial Services Conference on December 1, 2011, reviewed current enforcement initiatives and addressed what he termed “frustrations” which focused on questions regarding “putting them in jail,” “getting higher penalties,” charging recidivists with contempt and “not admitting or denying” (here).

Risk alert: The Commission, in conjunction with FINRA, issued a Risk Alert on Broker-Dealer Branch Office Inspections. The alert notes that self-inspection of branch offices is a critical element of a firm’s compliance and supervision and offers comments on effective practices observed by the examination staff. This is the second in what is planned as a series of alerts to senior management, risk management and compliance managers based on significant risks identified by the Commission’s national examination staff (here).

Aberrational Performance Inquiry

A new initiative to obtain the early identification of hedge fund fraud was announced by the Commission this week. The “aberrational performance inquiry” being conducted by Enforcement’s Asset Management Unit is using risk analytics and other methods in an effort to identify fund performance which does not match the announced investment strategy or other bench marks. The focus of the initiative is to minimize investor loss through the early identification of improper practices. The approach contrasts sharply with more traditional investigative techniques through which fund fraud is frequently discovered long after investor funds have been dissipated.

Four cases were identified with the initiative, one filed yesterday and three others earlier this month:

SEC v. Balboa, Case No. 11 Civ 8731 (S.D.N.Y. Filed Dec. 1, 2011) is an action against Michael Balboa, the portfolio manager of now defunct Millennium Global Emerging Credit Fund who resides in England, and Gilles De Charsonville, a broker at a U.K. based broker dealer who resides in Spain. The scheme centered on the overvaluation of key assets in 2008. Specifically, during the first ten months of 2008 Mr. Balboa is alleged to have enlisted two independent brokers, defendant De Charsonville and another U.K. broker, to furnish false mark-to-market quotes for two of the Fund’s securities. Those quotes were furnished to the fund’s independent valuation agent and auditors. As a result of this scheme the NAV was overstated by about $163 million for a fund with reported assets of $844 million. The overvaluation yielded millions of dollars in illegitimate management and performance fees and attracted over $400 million in new investments while deterring redemptions. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 20(e) and Advisers Act Sections 206(1), (2), (4) and 209(f). The case is in litigation.

SEC v. Kapur, Civil Action No 11-Civ. 8094 (SD.N.Y. Filed Nov. 10, 2011) is an action which centers on allegations that over a period of seven years the defendants engaged in a deceptive pattern of conduct and made misrepresentations regarding the performance of the fund and its assets as discussed here.

SEC v. Rooney, Case No. 11-cv-8264 (N.D. Ill. Filed Nov. 18, 2011) is an action in which the manager of an investment fund is alleged to have radically altered its investment policies without disclosing that fact to the investors as discussed here.

In the Matter of LeadDog Capital Markets, LLC., Adm. Proc. File No. 3-14623 (Filed Nov. 15, 2011) is a proceeding centered on a claim that fund assets were not invested in accord with the representations made to investors as discussed here.

Citigroup settlement

Judge Rakoff rejected the proposed settlement in SEC v. Citigroup Global Markets Inc., Case No. 11 Civ. 7387 (S.D.N.Y.), the Commission’s latest market crisis case. Central to this conclusion is the point that no facts were presented to the Court which would support the entry of an injunction. The Court also concluded that the proposed penalty was inadequate and that investors were not protected. In the end, the Court concluded that the settlement is not “reasonable,” it is “not fair,” and it “does not serve the public interest.” Rather, it is “a cost of doing business imposed [on Citigroup] by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies . .. “

SEC Enforcement: Filings and settlements

Market manipulation/kickbacks: SEC v. Henderson, Case No. 1:11-cv-12118 (D. Mass. Filed Dec. 1, 2011); SEC v. Lee, Case No. 1:11-cv-12118 (D. Mass. Filed Dec. 1, 2011); SEC v. Wheeler, Case No. 1:11-cv-12117 (D. Mass. Filed Dec. 1, 2011). These actions stem from a sting operation conducted with the FBI. Specifically, each of the defendants is alleged to have engaged in a fraudulent kickback and market manipulation scheme in which payments were made to a hedge fund representative to manipulate microcap stocks. The supposedly corrupt fund manager was in fact an undercover FBI agent. The Commission’s actions charge four individuals and two entities with violations of Exchange Act Section 10(b). Parallel criminal cases were brought by the U.S. Attorney for the District of Massachusetts against thirteen defendants. The Commission also suspended trading in the shares of seven microcap companies involved in the scheme. The cases are pending.

Insider trading: SEC v. Liang, Civil Action No. 8:11-cv-00819 (D. Md.) is the Commission’s action against former FDA chemist Cheng Yi Liang. The complaint centers on claims that Mr. Liang used proprietary information from FDA computer files to trade in the securities of pharmaceutical company stocks prior to the announcement of certain events. Previously he pleaded guilty in the parallel criminal case. This week Mr. Liang settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). He also agreed to disgorge his trading profits of about $3,776,152. This obligation will be deemed satisfied by the forfeiture order in the parallel criminal case. The criminal and civil actions arose from information developed by the Commission and referred to the DOJ.

Investment adviser fraud: In the Matter of Hanes Morgan & Co., Adm. Proc. File No. 3-14649 (Nov. 29, 2011) is a proceeding against Uche Akwuba, a convicted fraudster, and his investment advisory firm, Hanes Morgan & Co. From July 29 to November 29, 2010 the firm operated as a registered investment adviser. Hanes Morgan solicited possible clients through its website. There investors were told that the firm owned trading platforms located in major American banks. It also had a staff of professional stock traders, according to the site. ChenTrack, a scientific trading system used by the firm, was consistently successful, enabling it to deliver guaranteed growth of 10% per year, compounded. The system had been created by a brilliant mathematician and had been market tested. Would be investors were invited to open a “Wall Street Savings Account” with a minimum initial investment of $2,150. The claims were false and investors were not told of Mr. Akwuba’s past encounters with law enforcement. The Order alleges violations of Advisers Act Sections 206(1), 206(2) and 205(4). Respondents resolved the proceeding by consenting to the entry of a cease and desist orders based on the sections cited in the Order. Respondent Akwuba also agreed to be barred from the securities business. Each Respondent will pay a civil money penalty of $100,000.

Inadequate procedures: In the Matter of Asset Advisors, LLC, Adm. Proc. File No. 3-14644 (Nov. 28, 2011). The proceeding centers on the failure of the registered investment adviser to adopt written compliance policies and procedures from October 2004 through April 2007. From January 2005 through early 2007 the firm also failed to adopt a written code of ethics. Following an alert from the examination staff on each issue the firm adopted written compliance policies and procedures in May 2007 and a code of ethics. It failed, however, to fully implement the compliance program. It also failed to enforce the code of ethics by collecting written acknowledgements that supervised persons had received a copy and the required periodic reports. The firm resolved the proceeding by consenting to the entry of a censure and a cease and desist order based on Advisers Act Sections 204A and 206(4). It also agreed to pay a civil penalty of $20,000. In addition, the firm agreed to implement certain undertakings.

Inadequate procedures: In the Matter of Feltl & Company, Inc., Adm. Proc. File No. 3-14645 (Nov. 28. 2011) is an action against Felti & Company, Inc., a registered broker-dealer and investment adviser. As the firm’s business grew and evolved, it failed to adopt the required policies and procedures for its advisory business. Specifically, Felti failed to adopt and implement comprehensive written compliance policies for that business from early 2008 through March 2011. It also failed to adopt a code of ethics. As a result the firm engaged in hundreds of principal transactions with its advisory client accounts without making the proper disclosures and obtaining the necessary consents. The firm also charged undisclosed fees to its clients who participated in the wrap fee program by charging the wrap fees and commissions. In April 2011, as a result of exams and investigation by the staff, the firm adopted a new compliance manual for its advisory business. The Order alleges violations of Advisers Sections 206(2), (3) and (4) as well as 204A. The firm resolved the proceeding by consenting to entry of a cease and desist order based on the cited sections and a censure. It also agreed to pay disgorgement of $142,527 along with prejudgment interest, the applicable portions of which shall be paid to the affected advisory clients. The firm will also pay a civil penalty of $50,000 and implement certain procedures including the retention of an independent consultant.

Inadequate procedures: The Respondents are the firm and its sole owner and CEO, Gary Beynon. OMNI failed to adopt and implement a compliance program between September 2008 and August 2011. The firm also failed to establish, maintain and enforce a written code of ethics and to maintain and preserve certain books and records. For much of the period the firm also did not have a Chief Compliance Officer. In November 2010 Mr. Beynon assumed that position. He preformed virtually no responsibilities however since he was living in Brazil. Nevertheless, in response to a subpoena OMNI produced client advisory agreements signed by Mr. Beynon. The agreements reflected his supervisory approval. In fact the dates on the agreements were not correct. Rather, Mr. Beynon executed the documents the day before they were produced to the staff. To resolve the proceeding the Respondents consented to the entry of censures and cease and desist orders based on Advisors Act Sections 204(a), 204A, 206(4) and the related rules. Mr. Beynon also agreed to a bar from serving in a supervisory capacity in the securities business and to the pay of a $50,000 civil penalty. The firm agreed to implement certain undertakings.

Insider trading: SEC v. Richardson, Civil Action No. 11-CIV-8556 (S.D.N.Y. Filed Nov. 25, 2011) is an action against former professional baseball player Jeffrey S. Richardson. The action centers on the acquisition by Genesis Energy, LP of several energy related businesses owned by the Davison family of Ruston, Louisiana. Prior to the announcement of the deal on April 26, 2007, Mr. Richardson received confidential information about the transaction from a person knowledgeable about the negotiations and bound by the confidentiality agreement executed by those involved in the deal. Mr. Richardson purchased units of Genesis on six different occasions prior to the announcement with information he misappropriated from the source, a long time friend. He is also alleged to have tipped two family members and one friend, all of whom traded. Mr. Richardson resolved the charges by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to pay disgorgement of $88,026 which is the amount of his trading profits as well as those of the two family members and the friend he tipped. In addition, Mr. Richardson agreed to pay prejudgment interest and a civil penalty equal to the amount of the disgorgement.

FINRA

The regulator imposed sanctions on eight firms and ten individuals who were involved in selling interests in private placement offerings without having a reasonable basis for recommending the securities. $3.2 million will be paid in connection with the settlements. In April 2011 FINRA brought similar charges against two other firms and seven individuals. The firms involved here included: NEXT Financial Group, Inc., Investors Capital Corporation, Garden State Securities, National Securities Corporation, Capital Financial Services, Equity Services, Inc., Securities America, Inc. and Newbridge Securities Corporation.

FSA

Investor warning: Guidance was issued not to market traded life policy investments to the majority of retail investors. The regulator called the product “toxic.” Essentially the product is a pooled investment which invests in insurance policies on the lives of a particular set of U.S. citizens, betting on when they will die. The investments are opaque and subject to a number of high risk variables the warning cautions which makes them unsuitable for most retail investors.