On Capitol Hill this week the Senate Banking Committee heard testimony from SEC Chairman Schapiro regarding the Commission’s efforts to implement Dodd-Frank. Despite budget constraints the SEC is moving forward in accord with the directives in the legislation.

SEC enforcement focused on the market crisis and insider trading. The Commission filed an action against three former senior officers of now collapsed IndyMac bank. The complaints center on claims that as the bank spiraled to its demise while the market crisis unfolded its senior officers failed to disclose the true financial to existing shareholders and investors solicited to buy shares. With a new insider trading case the Commission continued to push the edges of the mosaic theory. The SEC also partially resolved another insider trading case.

Finally despite the delays in the implementation of the new U.K. Bribery Act, the Serious Frauds Unit settled a bribery case related to a series of DOJ and SEC FCPA actions.

Market reform and the SEC

Dodd-Frank: SEC Chairman Mary Schapiro testified before the Senate Banking Committee regarding the implementation of Dodd-Frank. Ms. Schapiro began by noting that under the Act the SEC is responsible for over 100 rulemaking provisions and is required to conduct more than twenty studies and create five new offices. To date the SEC has issued twenty-five proposed rule releases, seven final rule releases and two interim final rule releases. The agency has also completed five studies. Ms. Schapiro then reviewed the Commission’s efforts in areas which include OTC derivatives, fund advisers, asset-backed securities, credit rating agencies, corporate governance and executive compensation, investment advisers and the related studies, specialized disclosure provisions, whistleblowers, the Volker rule, procedural rules for SRO filings, and the creation of SEC offices. The testimony concludes with a discussion of funding (here).

Derivatives: SEC Chairman Mary Schapiro also testified before the House Financial Services Committee on the implementation provisions which relate primarily to the regulation of over-the counter derivatives markets and the supervision of systemically important payment, clearing and settlement systems (here).

SEC Enforcement

Failure to update/supervise: In the Matter of Johnny Clifton, Adm. Proc. File No. 3-14266 (Feb. 17, 2011) is an action against Johnny Clifton, a principal of MPG Financial, LLC, a registered broker-dealer. According to the Order, in 2009 MPG Financial was selling limited partnership interests in Managed Petroleum Group, Inc., an oil and gas exploration business. Mr. Clifton supervised the sales and directed the salesmen to use a PPM and information he furnished at periodic meetings. As the drilling project moved forward the company updated Mr. Clifton. That information, some of which was negative, was not furnished to the salesmen soliciting investors. In some instances investors were led to believe that drilling and exploration had not started. Thus investors were furnished with incorrect information. The firm supervisory procedures, written by Mr. Clifton, were deficient in two key respects. There were inadequate procedures for reviewing outgoing correspondence and for providing material information to investors regarding investments. As a result the Order charges willful violations of Securities Act Sections 17(a)(1), (2) and (3). The action is proceeding to hearing.

Insider trading: SEC v. Ni, Civil Action No. CV-11-0708 (N.D. Ca. Filed Feb. 16, 2011) is a settled insider trading case against Zhenyu Ni. The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 14(e). It claims that Mr. Ni traded while in possession of material non-public information he misappropriated in advance of the January 16, 2010 announcement that Bare Essentials, Inc. would be acquired by a large Japan based company. The information came from a visit to his sister. She was employed as the Tax Director of Bare Essentials and was working on the deal. During the visit Mr. Ni heard fragments of telephone conversations and observed that she was very busy. He subsequently traded in the shares of the company. Mr. Ni sold his position after the deal announcement at a profit of over $157,000. The defendant settled the case, consenting to the entry of a permanent injunction prohibiting future violations of each section cited in the complaint. He also agreed to pay disgorgement and prejudgment interest of $157,066 and a penalty in the same amount.

Insider trading: SEC v. Devlin, Case No. 20831 (S.D.N.Y. Filed Dec 18, 2008) is an action which centers on acts by Matthew Devlin, a former Lehman Brothers registered representative, who is alleged to have misappropriated inside information about thirteen pending corporate transactions over a four year period. The information came from his wife, a partner in an international public relations firm. Mr. Devlin then tipped various individuals about selected deals to curry favor with his friends and former clients. Those individuals used the information to trade. This week the Commission settled with four of the nine defendants. Settlements were announced with defendants Glover, Bower, Faulhaber and Holzer. Each settling defendant consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b) and 14(e). Each defendant also agreed to additional relief as discussed here.

Investment fund fraud: SEC v. Beachy, Civil Action No. 11-cv-320 (N.D. Ohio Filed Feb. 15, 2011) is an action against Monroe Beachy. The complaint, which alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b), centers on claims that the defendant raised over $33 million by targeting his fellow Amish as investors in a fraudulent offering of unregistered securities. According to the complaint, since 1986 Mr. Beachy has raised funds from about 2,600 investors, claiming superior returns for accounts he permitted investors to treat as money market funds. While investors were told their funds would be used to purchase risk-free U.S. government securities, in fact he put the money in speculative investments, high yield junk bonds and other investments. Mr. Beachy has consented to the entry of a permanent injunction based on each of the sections cited in the complaint. A financial penalty was not imposed based on the defendant’s financial condition.

Financial fraud: SEC v. Perry, Civil Action No. CV 11-01309 (C.D. Cal. Filed Feb. 11, 2011); SEC v. Abernathy, Civil Action No. CV 11-01308 (C.D. Cal. Filed Feb. 11, 2011). These cases center on the collapse of IndyMac and its federally-chartered thrift, IndyMac bank. The defendants are Michael W. Perry, the former Chief Executive Officer and Chairman of the board of IndyMac Bancorp, Inc., A. Scott Keys, the former Executive Vice President and Chief Financial Officer of IndyMac and S. Blair Abernathy, the former Executive Vice President and Chief Financial Officer of IndyMac Bancorp, Inc. Mr. Abernathy settled with the Commission. The action as to Messrs. Perry and Keys is in litigation. The complaint against Messrs. Perry and Keys centers on claims that as the bank’s financial condition deteriorated during the market crisis and stock sales were made in a effort to bolster its declining capital, the defendants failed to disclose its true financial condition. Rather, the filings and offering documents told investors that the bank was financially sound. The complaint against Messrs. Perry and Scott alleges intentional misconduct. It is based on alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and aiding and abetting violations of Section 13(a).

The complaint against Mr. Abernathy is substantially similar but centers on claims that he failed to ensure that filings discussing the loans disclosed that a significant portion of the origination documents were defective. The complaint alleges violations of Securities Act Sections 17(a)(2) and (3). To resolve the case Mr. Abernathy consented to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. He also agreed to pay a civil penalty of $100,000 and $25,000 in disgorgement along with prejudgment interest. Mr. Abernathy also consented to the entry of an administrative order barring him from practicing before the Commission as an accountant with a right to apply for reinstatement after two years.


Investment fund fraud: The CFTC won an emergency freeze order in a case against Larry Goover in the Eastern District of Texas. The agency charged Mr. Groover with running a forex Ponzi scheme. He is alleged to have solicited over $1.4 million from investors. Less than half of the funds were invested in forex and then lost. The balance was misappropriated for personal use and to repay earlier investors. The case is continuing.

Investment fund fraud
: The CFTC obtained an emergency freeze order in an action against Brian Kim and Liquid Capital Management LLC in the Southern District of New York. The complaint centers on claims that the defendants raised more than $2.1 million from 37 individuals based on false representations that they had a successful record of investing. In fact during 2010 Liquid Capital lost just under $300,000 and used another $300,000 to make Ponzi like payments to investors while diverting over $800,000 to personal use. In addition, Mr. Kim is alleged to have stolen $400,000 from his condominium association in an effort to try and recoup losses and to have lied to the National Futures Association regarding the solicitation and trading of customer funds. A New York state grand jury has returned an indictment against the defendants. The CFTC’s case is in litigation. .

Criminal cases

U.S. v. Shea (S.D.N.Y.) is an action against Stephen Shea. According to the superseding indictment, Mr. Shea and two others operated an investment fund fraud and manipulated the securities of two companies. From 1998 through 2006 Mr. Shea and his coconspirators raised over $140 million from investors whose money was to be put into private placements. In fact the funds were used to pay excessive and undisclosed commissions to brokers, for various investment opportunities and to pay other investors. In connection with this scheme brokers at Sky Capital, LLC, of which Mr. Shea is the former CFO, manipulated the shares of two affiliated entities. This week Mr. Shea pleaded guilty to one count of conspiracy and one count of securities fraud. The date for sentencing has not been set.


FINRA imposed a fine of $450,000 on Lincoln Financial Securities, Inc. and $150,000 on an affiliated firm, Lincoln Financial Advisors Corporation for having inadequate procedures to protect confidential customer information. FINRA rules require that firms have procedures to protect confidential customer information. Here each firm had inadequate procedures because this type of information could be accessed on a computer using shared login and password information. This meant that the firms had no way to track who had access to the information. Lincoln Financial Securities had this deficiency for seven years while Lincoln Financial Advisors’ procedures were deficient in this respect for two years.

Court of appeals

Materiality: Landmen Partners, Inc. v. The Blackstone Group, L.P.
No. 09-26-cv (2nd Cir. Feb. 10, 2011) is a class action arising out of the IPO of the Blackstone Group. The complaint alleges violations of Securities Act Sections 11 and 12(2). The district court dismissed the complaint, concluding that the alleged misrepresentation and omissions were not material. Specifically, the court found that claims that one portfolio company failed to disclose that it was moving into a riskier business, that a high tech portfolio company lost a significant contract and the failure to include deteriorating real estate conditions in the discussion about the real estate investments were not material. As to the first two claims each represented very small fractions of the overall business of the Group. As to the latter, defendant was not required to disclose general market information.

The Second Circuit reversed. Initially the Court noted that since there is no fraud claim pleaded here the higher Rule 9(b) standard is not applicable. Furthermore on a motion to dismiss since materiality is inherently a fact question the complaint should not be dismissed unless the information is “so obviously unimportant” to a reasonable investor that reasonable minds could not differ. Here the question is governed by Item 303 of SK regarding MD&A. It requires the disclosure of trends reasonably likely to have a material impact. Plaintiffs’ allegations are sufficient on each claim the court concluded. As to the first two issues the district court incorrectly viewed the question by looking at the overall portfolio. This would permit a defendant to balance off various items and thus conceal material information. Viewed in the context of the portfolios the information was material. And, the specific portfolios here were important. Similarly, as to the information about the real estate market, the question was not simply disclosing generic market information. Rather, the claim is that defendant failed to disclose the impact of the trends in the market on its holdings. This is material at this stage of the case. Accordingly, the decision of the district court was reversed.

New York

The NYAG announced that Henry “Hank” Morris was received the maximum sentence of one and one third to four years in prison for his role in New York’s “pay to play” scandal. Mr. Morris was the chief political adviser to former Comptroller of the State of New York Alan Hevesi. In November 2010 he pleaded guilty to a felony for his role in the kickback scheme.


M.W. Kellogg Limited, a wholly owned subsidiary of KBR, settled civil corruption charges with the U.K. Serious Fraud Office. In connection with the settlement the company agreed to pay $11,238,886 as a civil fine. The amount equals its share of dividends payable from profits generated for work on Nigeria’s “Bonny Island project. This settlement is based on the FCPA actions settled by KBR, Technip S.A. and Snamprogetti Netherlands B.V. with the Department of Justice and the Securities and Exchange Commission.