THIS WEEK IN SECURITIES LITIGATION (March 19, 2010)
The SEC got another black eye this week when the court refused to modify its consent decree from the analysts’ scandals to take down part of the firewall established to avoid improper communication. SEC enforcement brought cases based on account intrusion, financial fraud and investment fund fraud, in addition to a settled FCPA case. In addition to FCPA cases, new criminal charges were brought in the Madoff investigations. This time criminal charges were brought against two men who supposedly created the false books and records for the Ponzi scheme king. The CFTC brought two investment fund fraud cases. In London, the FSA continued bringing insider dealing cases, while in the City of Milan, charges were brought based on the fraudulent sale of derivatives.
Analysts: SEC v. Bear, Stearns & Co., No. 03 Civ. 2937 is the settled action against twelve major investment banks arising out allegations regarding the overlap of the investment banking operations with research analysts. The settlement, in part, requires the institution of a series of procedures to ensure the complete separation of the two functions. In an order dated March 15, 2010, the court refused to modify the consent decree. In a letter dated August 3, 2009 the SEC and the defendant investment banks requested that the decree be modified so that research personnel and investment banking personnel can communicate with each other outside the presence of compliance staff regarding market and industry trends and developments. In its order, the court cited the congressional testimony of former SEC Chairman William H. Donaldson which noted that it is essential that “[T]here will be no overlap between the jobs of investment bankers and research analysts . . . To ensure that the separation between investment banking and research is comprehensive, firms will create and enforce firewalls between the two operations reasonably designed to prohibit improper communications between the two.”
Muni Pay-to-Play Rules: Report of Investigation Pursuant to Section 21(a) of the Securities “Exchange Act of 1934: JP Morgan Securities, Inc. The Commission issued a report on its investigation into whether JP Morgan Securities violated MSRB rules prohibiting the underwriting of municipal bonds within two years after the broker or dealer or one of its municipal finance professionals makes a political contribution of an official of the issuer, the pay to play rules. Here, the company served as underwriter for municipal bonds issued by California within two years of the time the Vice Chairman of the broker’s parent gave a $1,000 contribution to the Treasurer of the state. The report reiterates prior guidance regarding compliance with the pay to play rules.
SEC enforcement actions
Investment fund fraud: SEC v. McAdams, (D.N.C. Filed Mar. 18, 2010) is a fraud action against Mark McAdams and Dane Freeman, who are alleged to have raised more than $3.5 million from about 35 investors. The defendants used the letterhead and e-mail system of the law firm where Mr. McAdams practices law to lure investors to put money in their controlled vehicle, Global Holdings. Investors were told that the money would be put in AAA bonds or Medium Term Notes and invested overseas yielding returns of 4,900% in 60 days. In fact, these representations and others made to investors were false. The case is in litigation.
Market timing: SEC v. Pentagon Capital Management PLC, Case No. 08 Civ. 3324 (S.D.N.Y. Filed April 3, 2008) is a market timing case brought against a UK based hedge fund adviser and its principal discussed here. The Commission claims that the two defendants orchestrated a scheme to defraud U.S. mutual funds and their investors through late trading and deceptive market timing. Defendants won a ruling this week that settled SEC administrative proceedings brought against those funds which include findings demonstrating that they were not in fact deceived could be received in evidence under Rule 804, Federal Rules of Evidence.
Short selling: In the Matter of GPS Partners, LLC, Adm. Proc. File No. 3-13818 (Filed Mar. 16, 2010) is a settled administrative proceeding against registered investment adviser GPS Partners and its founder and managing partner Brett Messing. The Order alleges that in 2006 the Respondents violated Rule 105 of Regulation M, which governs short selling in connection with a registered offering, in five instances. The next year there was another violation. As a result, they made profits of about $1.1 million. Typically, the Respondents would participate in a follow-on offering. During the restricted period, they would establish a short position in the stock. Later, when they received their allocation in the offering they would close the short position, reaping a profit. The action was settled with each Respondent consenting to the entry of a cease and desist order. The also agreed to jointly pay disgorgement of $1,151,271, prejudgment interest and a penalty of $575,635.
Suitability: In the Matter of Prime Capital Services, Inc., Adm. Proc. File No. 3-13532 (Filed Mar. 16, 2010) is an action against Gilman Ciocia, Inc., a tax preparer, its subsidiary Prime Capital Services, Inc and several sales representatives. Gilman also owns a broker dealer and an investment adviser. The action alleges violations of the antifraud provisions and failure to supervise. It is based on sales practices, and the failure to supervise those practices, used in connection with the sale of variable annuities. According to the Order, from 1999 through 2007 respondents, through the broker dealer subsidiary, made various misrepresentations regarding the annuities and sold them to persons for whom they were not suited. For example, in some instances, customers were told that the principal invested in the variable annuity was guaranteed not to lose money. They were not told however that the guarantee was only triggered by the death of the annuitant and that up to that time its value could decline. In other instances the contracts were not suitable investments for the customer. For example, sales were made to customers who needed continuous access to their funds despite the limitations on withdrawals and the fees. To resolve the action, each entity agreed to implement a series of undertakings focused on reforming their sales and supervisory practices. Each entity also consented to the entry of a cease and desist order and a censure and to pay disgorgement, prejudgment interest and a civil penalty.
Account intrusion: SEC v. BroCo Investments, Civil Action No. 10-CIV-2217 (S.D.N.Y. Filed Mar. 16, 2010) is an action against the Russian-based company and its president Valery Malysev based on alleged violations of the antifraud provisions. The complaint claims that the defendants, along with others, hijacked on-line brokerage accounts and used to place authorized trades. Prior to placing the unauthorized trades, the defendants, according to the SEC, would take positions in certain thinly traded stocks. In some instances long positions were taken while in others a short position would be established. The defendants would then used the accounts to place multiple trades in the selected stocks to either drive the price up or down and then close out their earlier established positions at a profit. Defendants have made at least $250,000 in profits from this scheme. The Commission obtained a freeze order over the accounts of the defendants. The case is in litigation. See also Litig. Rel. 21452 (Mar. 16, 2010). The SEC has also issued an investor warning about this practice, which is available on its website.
Financial fraud: SEC v. Gupta, Civil Action No. 8:10-cv-00100 (D. Neb. filed Mar. 15, 2010), SEC v. Raval, Civil Action No. 8:10-cv-00101 (D. Neb. Filed Mar. 15, 2010), SEC v. Das, Civil Action No. 8:10-cv-00102 (D. Neb. Filed Mar. 15, 2010) and In the Matter of infoUSA Inc., Adm. Proc. No. 3-13815 (Mar. 15, 2010) is a group of cases brought, respectively, against the founder and Chairman, Vinod Gupta, former chairman of the audit committee Vasant Raval, former CFOs Rajnish Das and Stormy Dean and the company, discussed here. The cases are based on claims that over a period of four years beginning in 2003, Mr. Gupta received approximately $9.5 million in unauthorized and undisclosed compensation and two companies he controlled engaged in about $9.3 million in undisclosed related party transactions. Mr. Ravel, as chairman of the audit committee, was charged with investigating these transactions when they were discovered. He failed. The two former CFOs failed to properly record the transactions, according to the complaint.
Mr. Gupta settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of the antifraud, proxy and reporting provisions. He also agreed to the entry of an order directing him to pay disgorgement of about $4 million along with prejudgment interest and a civil penalty of approximately $2.2 million. The order will bar him from serving as an officer or director and place restrictions on his voting rights in company shares. The company consented to the entry of a cease and desist order based on books and records violations based on its cooperation. The action against the two former CFOs is in litigation.
Investment fund fraud: SEC v. Kim, Civil Action No. 4:10-cv-00816 (S.D. Tex. Filed Mar. 11, 2010) is an action against Stephen Kim and his controlled vehicle, Spyglass Management LP for defrauding the hedge fund Spyglass Capital Partners. The complaint, which alleges violations of the antifraud provisions of the Securities Act, the Exchange Act and the Advisers Act, claims that from 2004 through 2006 about $4.7 million was raised from investors based on false offering materials and statements. Investors were told their funds would be pooled and invested in collateralized mortgage obligations and similar securities and that a “dynamic hedging strategy” would be employed. No such strategy was used. When over $2 million in losses resulted investors were falsely told the fund was profitable. Ponzi like payments were then made to investors. The case is in litigation. See also Litig. Rel. 21450 (Mar. 15, 2010).
Investment fraud: The CFTC brought a fraud action against Todd Hagemann and Yellowstone Partners for conducting a fraudulent investment scheme. Mr. Hagemann, according to the court papers, claimed expertise in trading foreign currency futures. He raised about $700,000 from investors, promising to pool their investment and obtain returns of 100 to 300% every couple of months. In fact, only a fraction of the money was invested in forex and much of it was lost. The case is in litigation.
Investment fraud: The CFTC brought a fraud action in the district court for the district of Hawaii against Patrick Rakotonanahary. The defendant marketed a foreign currency investment plan called “Promissory Program” in which investors would loan his firm, Cyber Market, $30,000 and in return they would receive from 4% to 10% return for week. All of the investment was to be returned in 52 weeks. Mr. Rakotonanahary is alleged to have raised at least $10.3 million from 100 investors who were told the funds would be put into forex. In fact, the fund was a classic Ponzi scheme. The defendant was also indicted on parallel criminal charges.
Fraudulent books: U.S. v. O’Hara (S.D.N.Y. Filed Mar. 17, 2010) is an action against two former computer programs employed by Bernard L. Madoff Investment Securities. The indictment, which charges conspiracy, falsifying records of a broker dealer and falsifying records of an investment adviser, alleges that the two men prepared false books and records for the Madoff operation. Specifically, the indictment alleges that as part of a scheme overseen by Bernard Madoff and Frank Dipascali, Jr. to deceive the SEC and European accounting firm, the defendants developed and maintained computer programs which generated false and fraudulent records. Those records, which the defendants knew were false, were used in connection with SEC and European accounting firm reviews.
Fraudulent sales: U.S. v. Zehil (S.D.N.Y.) is an action against former McGuire Woods partner Louis Zehil. This week, Mr. Zehil pleaded guilty to an information charging him with conspiracy and securities fraud. The information alleges that in 2006 and 2007 Mr. Zehil was counsel to seven issuers who had PIPE transactions. In each instance, when the unregistered shares were issued, and before the resale registration statement was filed, Mr. Zehile instructed the transfer agents to issue all investors restricted shares except those which went to entities he controlled. Those entities received unrestricted or free trading shares issued based on a false opinion letter he furnished the transfer agents. Mr. Zehil then immediately sold the unregistered shares in the open market generating profits of about $17 million. The date for sentencing has not been set.
SEC v. Innospec, Inc., Civil Action No. 1:10-cv-00448 (D.D.C. Filed Mar. 18, 2010) is a settled FCPA action against a sociality chemical company. From 2000 to 2007, the company routinely aid bribes to sell a fuel additive that was one of its primary products to companies in Iraq and Indonesia. The company also paid kickbacks under the UN Oil for Food Program. Overall the company paid over $6.3 million in bribes and promised another $2.8 million in exchange for contracts worth over $176 million in revenue and over $60 million in profits. After the UN program ended, the company continued to pay bribes to sell its fuel additive. From 2004 through 2007 Innospec paid another $1.6 million and promised an additional $884,480 in payments. The company also paid for lavish gifts and entertainment. In addition, the company had several schemes to pay bribes to Indonesian government officials. Overall, the Innospec had a culture which permitted and encouraged bribes. To settle the action, the company consented to the entry of a permanent injunction prohibiting future violations of the anti-bribery and books and records and internal control provisions. The company also agreed to pay $60,071,613 in disgorgement provided that all but $11.2 million of that amount was waived. The order also requires that an independent monitor be appointed to serve for three years. Based on its financial condition the company will pay a reduced criminal fine of $14.1 million to DOJ and a criminal fine of $12.7 to UK’s SFO. The company will also pay $2.2 million to OFAC for unrelated conduct concerning allegations of violations of the Cuban Assets Control Regulations. Overall the company has agreed to pay $40.2 million as part of the global settlement. See also Litig. Rel. 21454 (Mar. 18, 2010).
U.S. v. Nguyen, Case No. 08 – 522 (E.D. Pa. Filed Sept. 4, 2008) is an action charging violations of the FCPA, the Travel Act and money laundering by Nexus Technologies, Inc., its founder and president Nam Nguyen and employee Kim Nguyen each pleaded guilty to these charges as discussed here. According to the court papers, the company is essentially a middleman for buyers in Vietnam for various government agencies for U.S. based vendors. Between 1999 and 2008, the defendants paid over $250,000 to Vietnamese government officials in exchange for contracts to purchase a wide variety of equipment. The books and records of the company were falsified to conceal the payments. Sentencing is set for July 13, 2010.
UK insider trading: The FSA filed thirteen counts of insider dealing and one count of conspiracy to commit insider dealing against Christian Littlewood, a former Dresdner Bank AG senior investment banker and his wife. The charges are based on trading in U.K. listed stocks from 2000 to 2009. The case is part of a crackdown on insider dealing by the U.K.’s top financial regulator.
Italy derivatives action: The City of Milan brought fraud charges based on the sale of derivatives against Deutsche Bank AG, JPMorgan Chase & Co., UBS AG and Hyo Real Estate Holding AG’s Depfa Bank Plc. A trial of the four firms and 11 bankers involves is scheduled for May 6. The charges center on claims that the defendants misled the city over swaps that adjusted interest payments on 1.7 billion euros of bonds sold in 2005.