THIS WEEK IN SECURITIES LITIGATION (July 31, 2009)
A new question about the fairness of trading in the markets surfaced this week based on questions about flash trading which is claimed to give some traders an informational advantage. SEC enforcement brought a somewhat unusual disclosure case based on concealing the criminal record of a person acting as a de facto corporate officer, and insider trading action and two FCPA cases while criminal prosecutors filed charges based on the diversion of offering funds and the PCAOB announced the adoption of Auditing Standard No 7.
Senator Charles Schumer sent a letter to SEC Chairman Mary Schapiro this week asking that the Commission ban “flash orders.” Specifically, the letter requests that the SEC prohibit “flash orders in connection with optional display periods currently permitted by DirectEdge’s Expedited Liquidity Program, NASDAQ’s Flash order program and BATS’s Bolt Optional Liquidity Program.” According to Senator Schumer, flash orders allow some members of these exchanges to obtain order flow information before it is made available to the public. The letter notes that this practice can undermine confidence in the markets and, if not curbed by the SEC, the Senator stated that he will introduce legislation. A copy of Senator Schumer’s Letter is available at http://schumer.senate.gov/new_website/record.cfm?id=316252&.
Disclosure: SEC v. Chamberlain, Civil Action No. 09-cv-01423 (D.D.C. Filed Jul. 30, 2009) is an action against three former officers of Integral Systems, Inc. which alleges that over a period of several years defendants concealed that fact that Gary Prince, a convicted felon who had served time in prison and been enjoined by the SEC, acted as a de facto officer of the company. Mr. Prince had previously worked for the company and at another public company when he was convicted in a criminal case and enjoined by the SEC. He rejoined the company after his release from prison. The complaint alleges violations of the antifraud and books and records provisions. The case is in litigation. See also Lit. Rel. 21159 (Jul. 30, 2009). In a related administrative proceeding the company consented to the entry of a cease and desist order based on books and records and proxy violations. In the Matter of Integral Systems, Inc., File No. 3-13566 (Jul. 30, 2009).
Fraud in an offering: In the Matter of Gopinathan, Adm. Proc. File No. 3-13470 (Filed Jul. 27, 2009) is an administrative proceeding against Mr. Gopinathan, a former vice president of Wachovia on the Commercial Aviation Team in the structured asset finance group. Respondent was tasked with preparing cash flow models for a private securities offering backed by a portfolio of regional aircraft manufactured by Bombardier, Inc. The offering was sponsored by a special purpose entity created by the manufacturer for which Wachovia served as underwriter. Shortly prior to the September 2005 closing Bombardier learned that the cash flow for one of the three tranches of securities in the offering was insufficient. Respondent, on orders from his supervisors, covered this up which resulted in the offering memorandum being false. To resolve the matter, Respondent consented to the entry of a cease and desist order based on claimed violations of the antifraud provisions, consented to be bared from associating with any broker or dealer with a right to reapply after one year and agreed to pay a civil penalty of $15,000 in two installments.
Insider trading: SEC v. Hashemi, Civil Action No. 09-CV-6650 (S.D.N.Y. Filed Jul. 27, 2009) named as a defendant Khaled Al Hashemi, a citizen of the UAE as discussed here. The complaint is based on trading in advance of the merger announcement of Nova Chemicals and International Petroleum Investment Company. According to the SEC, Mr. Hashemi purchased 120,000 shares of Nova common stock through an online brokerage account shortly prior to the deal announcement. Over half of defendant’s purchases were made the day before the announcement. To fund these transactions, the defendant liquidated most of his stock portfolio and wired an additional $100,000 to his account. When the merger was announced the share price spiked 289%, yield profits of $458,000. The Commission obtained a freeze order over the accounts. See also Lit. Rel. 21154 (Jul. 27, 2009).
Investment fraud: SEC v. Radical Bunny, LLC, Case No. 2:09-cv-01560 (D. Az. Filed Jul. 28, 2009) is an action against an investment fund, Radical Bunny, and its four principals, two accountants, a pharmacist and a grade school principal. The four raised over $197 million. The investor funds were to be pooled to make loans to Mortgages, Ltd., an originator of high interest short term loans to real estate developers. The funds were raised through a series of misrepresentations. Three of the individual defendants were paid large fees from the investment fund. The interests in Radical Bunny were not registered. The case is in litigation. See also Lit. Rel. 21157 (Jul. 28, 2009).
Ponzi schemes: The SEC filed four investment fund fraud cases this week:
• SEC v. Bard, Case No. 1:09 cv 1473 (M.D. Pa Filed Jul. 30, 2009) is an action against Robert Bard, an investment adviser registered in two states, and a fund he controlled. The complaint claims that Mr. Bard promised investors he would place their money in instruments such as bonds, certificates of deposit and money market funds. Instead he squandered much of the investor cash on risky investments and then made misrepresentations to those investors about the status of their accounts. The complaint alleges violations of the antifraud provisions. The SEC obtained a temporary freeze order. The case is in litigation. See also Lit. Rel. No. 21160 (Jul. 30, 2009).
• SEC v. Diversity Capital Investments, Inc., Civil Action No. CV 09-5449 (C.D. Cal. Filed Jul. 29, 2009) is an action against Edward Ferguson, Joel Ley, Juan Glores, Socorro Terlizzi and entities they control and used in their investment scheme. One of those entities, Diversity Capital, claims on its website that it is one of the largest private funds in the market and manages over $1.7 billion. Over $14 million in investor funds were raised, according to the SEC, based on promises of large returns from trading in foreign currency. In fact, the investment funds operated like a Ponzi scheme. The SEC, working in conjunction with the FBI and the CFTC, obtained a temporary freeze order. The case is in litigation. See also Lit. Rel. 21158 (Jul. 29, 2009).
• SEC v. Clark, Case No. C09-03423 (N.D. Cal. Filed Jul. 27, 2009) is a follow-up action to a case brought initially in July 2007 against the fund and its principals as discussed here. SEC v. AOB Commerce, Inc., Case No. CV 07-4507 (C.D. Cal. July 16, 2007). The action this week is against a sales agent at AOB Commerce which the SEC claims sold over $45 million is unregistered notes to investors based on false claims. The complaint against Mr. Clark claims that he failed to conduct adequate due diligence as to the fund, assisted with the creation of a misleading investor brochure and failed to register or become associated with a registered broker-dealer at the time that he participated in the sale of notes. The case is in litigation. See also Lit. Rel. 21153 (Jul. 27, 2009).
• SEC v. Bravata, Case No. 09-CV-12950 (E.D. Mich. Filed Jul. 27, 2009) is an action against John Bravata, Richard Trabulsy and their controlled entities. The complaint claims that the defendants raised more than $50 million from at least 440 investors based on claims that the investors were purchasing interests in a real estate investment fund with returns that would range from 8 to 12%. While the investments were supposed to be safe, in fact the fund was highly leveraged and a significant portion of the investor cash was diverted to the use of the defendants and to pay other investors. The Commission obtained a temporary freeze order. See also Lit. Rel. No. 21155 (Jul. 28, 2009).
Diversion of offering funds: Shoeleh Hamedani and her father Nasser Hamedani, were indicted on charges of securities fraud, conspiracy related to a fraudulent investment scheme and other charges in connection with an investment scheme in which they made over $2.8 million. According to the indictment, the defendants founded The Children’s Internet, Inc., a start up that was suppose to develop and market software to protect children’s access to the internet. Instead defendants diverted about $1.2 million to their personal expenses. The defendants also used hidden accounts to trade shares in the company, generating an additional $1.6 million in profits. The U.S. Attorney’s Press release is available at http://www.usdoj.gov/usao/can/press/2009/2009_07_27_hamedanis.charged.press.html.
In the Matter of Helmerich & Payne, Inc., Adm. File No. 3-13565 (Filed Jul. 30, 2009) is a settled FCPA books and records action arising out of payments by two second tier subsidiaries in Argentina and Venezuela. The company is an international drilling contractor. The payments were made to customs officials to avoid delays typically associated with the shipment of international drilling parts. In Argentina over a period of four years about $166,000 in payments were made, avoiding charges of about $186,000. In Venezuela payments of about $19,600 were made over a period of five years to avoid about $134,000 in charges. The payments were discovered by the company when it upgraded and improved its FCPA procedures. The company consented to the entry of a cease and desist order based on alleged violations of the books and records and internal control provisions of the FCPA and agreed to pay disgorgement of about $320,000 plus prejudgment interest.
The company also entered into a non-prosecution agreement with the Justice Department under which it agreed to pay a $1 million fine. See also Form 8-K filed by the company; Department of Justice Press Release, “Helmerich & Payne Agrees to Pay $1 Million Penalty to Resolve Allegations of Foreign Bribery in South America” (Jul. 30, 2009) available at http://www.usdoj.gov/opa/pr/2009/July/09-crm-741.html.
In the Matter of Avery Dennison Corporation, File No. 3-13564 (Filed Jul. 29, 2009); see also SEC v. Avery Dennison Corp., Civil Action No. CV 09-5493 (C.D. Cal. Filed Jul. 29, 2009). This proceeding, discussed here, is based on a series of alleged FCPA violations, concerns Avery (China) Co. Ltd., an indirect subsidiary of California multinational, Avery Dennison Corporation. The action is based on a series of payments and promises of payments by Avery China’s Reflective Division largely by the Reflective Division of Avery China to obtain business from the Wuxi Institute. The payments included gifts, travel and promised kickbacks some of which were not paid. In two instances contracts were obtained. Total sales under one set contracts was about $677,000 with profits of about $363,000. Under another contract there were $106,000 in sales with profits of about $61,000. To resolve the matter the company agreed to cease and desist order from committing or causing any violations of Section 13(b)(2)(A) & (B). The company also agreed to pay disgorgement of about $273,000 and prejudgment interest. In the related civil action the company agreed to a penalty of $200,000. See also Lit. Rel. 21156 (Jul. 29, 2009).
The Board adopted Auditing Standard No. 7, which applies to all audit engagements and to the review of interim financial information conducted pursuant to the standards of the PCAOB. The standard provides a framework for the engagement quality reviewer to objectively evaluate the significant judgments made by the engagement team.
The Board also issued a Concept Release on requiring the engagement partner to sign the audit report.