Investigations of Wall Street banks and the market disruption of last week continued to be the focus as legislators discussed possible financial market reform. Both the USAO in New York and the NYAG are conducting investigations involving Wall Street banks, as the SEC continues its inquiries. SEC enforcement brought cases focused on short selling, insider trading, financial fraud and Ponzi schemes. The NYAG filed a civil action alleging that an investment adviser knew by the late 1990s about the Madoff fraud, but failed to inform clients, while in private litigation another class action based on option backdating claims settled.

Market reform

Investigations: According to the Wall Street Journal, the U.S. Attorney’s Office for the Southern District of New York is investigating Morgan Stanley’s participation in the CDO market. The inquiry is an outgrowth of the SEC’s investigation into that area. In addition, the New York AG is conducting an inquiry into whether Goldman Sachs Group, Morgan Stanley, UBS and five other banks mislead rating agencies regarding mortgage backed securities.

Market events: Following the violent disruption to trading on Thursday, May 6, 2010, the SEC and the CFTC announced the formation of a joint committee to address emerging regulatory issues. The committee was initially listed in the recommendations contained in the harmonization report issued by the two agencies last year. The first item on the committee’s addenda is an analysis of the market events of May 6 and the formation of recommendations “related to market structure issues that may have contributed to the volatility, as well as disparate trading conventions and rules across various markets.” The staff of each agency will furnish the committee with their joint preliminary findings.

Key role for compliance and legal: FINRA Chairman and CEO Rick Ketchum, in his recent remarks at the SIFMA Compliance & Legal Division’s Annual Seminar on May 7, 2010, stressed the importance of involving the legal and compliance departments in key decisions: “when a firm develops a corporate trading strategy, whether as a result of risk management reviews or otherwise, there needs to be a careful rethinking of compliance controls. Leave to the side for the moment any carefully crafted arguments on legal responsibility – the business intersection of proprietary trading, market making, agency and banking is an accident waiting to happen. It poses the risk of faulty disclosure, unsuitable recommendations or a host of other, at least reputational, exposures. While each fact situation may be different, some things are clear: these decisions should not be made without the participation of legal and compliance officers so that there is someone there to ask the simple question ‘What is the impact on our customers?’ It is for that reason that I have underlined again and again the importance of compliance and legal participation in risk management committee deliberations, as well as senior staff meetings.” Remarks available here.

SEC enforcement actions

Short selling: In the Matter of Peter G. Grabler, Adm. Pro. File No. 3-13886 (Filed May 11, 2010); SEC v. Grabler, Civ. Action No. 1:10-cv-10798 (D. Mass. Filed May 11, 2010) are actions based on alleged violations of Rule 105, Regulation M as discussed here. Between February 2006 and November 2008, the complaint claims, Mr. Grabler violated the rule 124 times as part of a strategy to participate in numerous secondary offerings. The purpose of the strategy is to improve his access to shares available in IPOs since the offerings are underwritten by the same broker-dealers. In these transactions, defendant obtained unlawful gains of $636,123. To settle the actions, Mr. Grabler consented to the entry of a cease and desist order in the administrative proceeding and an order requiring him to disgorge his profits of $636,123 along with prejudgment interest of $35,232. In the civil action, he agreed to an order requiring him to pay a penalty of $318,061. See also Litig. Rel. 21522 (May 11, 2010).

Short selling: In the Matter of Leonard Adams, Adm. Proc. File No. 3-13885 (May 11, 2010); SEC v. Adams, Civ. Action No. 1: 10-cv-10799 (D. Mass. Filed May 11, 2010). These are actions are also based on alleged violations of Rule 105 of Regulation M as also discussed here. Mr. Adams is alleged to have violated Rule 105 in connection with at least 95 offerings from March 2006 through December 2008. He was attempting to implement the same strategy which would result in additional IPO allocations (see above). Mr. Adams had unlawful gains of $331,387. To settle, Mr. Adams agreed to the entry of a cease and desist order and which requires that he pay disgorgement equal to his trading profits along with prejudgment interest. In the district court action, he consented to the entry of an order requiring that he pay a civil penalty of $165,693.00. The disgorgement and prejudgment interest will be paid in four quarterly installments. See also Litig. Rel. 21521 (May 11, 2010).

Insider trading: In the Matter of David W. Baldt, Adm. Proc. File No. 3-13887 (Filed May 11, 2010) is an action against David Baldt, portfolio manager for two municipal bond funds sponsored by Schroder Investment Management North America. According to the Order, several members of Mr. Baldt’s family held positions in the funds. As market conditions deteriorated in mid-September 2008, one family member called him and asked for advice about the positions. Mr. Baldt noted that if her concerns were preventing her from sleeping, she should sell them and invest in U.S. Treasury bills. He also noted that a second family member should do the same. As the market deteriorated, Schroder learned of a potential $12 million redemption which represented about 8% of the total assets of one fund. Management directed Mr. Baldt and his team to liquidate securities – a directive he disputed. During that week, the fund struggled to make redemptions. In early October, the family member called again for advice. Mr. Baldt noted that she should consider selling her position and emphasized she should “go the full route.” He also told her to share that advice with a second family member. The Order alleges that at the time of this conversation, Mr. Baldt had material non-public information. The Order charges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Adviser Act Section 206. The case is in litigation.

Financial fraud: SEC v. Furst, Civil Action No. H-03-0946 (S.D. Tex. Filed March 17, 2003) is an action against Robert Furst, former senior investment banker at Merrill Lynch, and three other former senior Merrill bankers for aiding and abetting Enron’s financial fraud. The action remains stayed as to two other defendants. Daniel Bayly, the other defendant settled with the Commission earlier. Mr. Furst consented to the entry of a permanent injunction prohibiting future violations of the antifraud, aiding and abetting and periodic reporting provisions of the federal securities laws. He also agreed to the entry of an officer or director bar for five years and was ordered to pay $300,001 in disgorgement and civil penalties. The underlying complaint alleged that Mr. Furst substantially assisted Enron in two sham transactions during late 1999. One was the so-called barge deal while the second involved a $17 million fee Enron agreed to pay Merrill to enter into a virtually offsetting energy trade. See also Litig. Rel. 21523 (May 11, 2010).

Investment fund fraud: SEC v. Merrick, Case No. 6:09-CV-1744 (M.D. Fla. Filed May 12, 2010) named as defendants David Merrick, Traders International Return Network, GTT Services, Inc., MDD Consulting, Inc. and Go! Tourism, Inc. The action is based on an alleged on-line Ponzi scheme. In a complaint filed on October 14, 2009, the Commission alleged that in a little over a year the defendants had raised at least $22 million from 2,500 investors who were falsely lead to believe that their money would be used to buy Forex, international bonds, international stocks and other investments. Instead, Defendant Merrick misappropriated substantial portions of the funds and used other portions to repay some investors. A freeze order was entered on the same date the complaint was filed. To settle the case, the defendants consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Investment Advisers Act Section 206. In addition, Mr. Merrick and Traders International were enjoined from violating Securities Act Section 5, Section 7(d) of the Investment Company Act and Section 15(a)(1) of the Exchange Act. In a related criminal case Mr. Merrick pleaded guilty to money laundering and conspiracy and agreed to forfeit cash and property valued at $8 million and to make complete restitution. See also Litig. Rel. 21525 (May 12, 2010).

Criminal cases

Investment fund fraud: U.S. v. Cronin, Case No. 1:10CR154 (E.D. Va. Filed May 7, 2010) is an action in which defendant Gregory Cronin pleaded guilty to wire and securities fraud charges, discussed here, based on his operation of a Ponzi scheme for more than a decade. Mr. Cronin raised over $6.7 million from individuals who where were largely friends and former clients from the time he was employed as a retail broker for a large bank, soliciting clients to invest in his firm, Investment Advisors, Inc. Clients periodically received statements showing that their funds had been put in an individual account in stocks such as Coca-Cola, Duke Energy and Apple Computer and that their investment was increasing. When clients insisted on withdrawing funds, Mr. Cronin used cash obtained from other investors to pay them. In fact Investment Advisors was nothing but a checking account and the statements were fraudulent. Sentencing is scheduled for July 23, 2010.

Civil enforcement

Forfeiture: U.S. v. $35 Million in U.S. Currency, No. 10-cv-3743 (S.D.N.Y.) is a civil forfeiture action to recover certain funds related to the fraud which caused the collapse of Refco, discussed here. According to the complaint, the company was involved in hiding customer trading losses and concealing the proprietary trading activity of the firm which ultimately resulted in its losses. Directors Edwin Cox and William Graham, two former Refco directors, and two trusts related to them, agreed to forfeit $39 million to resolve civil forfeiture claims arising out of these transactions.


Michael J. DiMare, formerly a sales manager with John Hancock Mutual Life Insurance Company, was barred from the securities industry. According to FINRA, Mr. DiMare misappropriated over $1.9 million from clients by inducing them over a seven year period to invest in fictitious financial products. To conceal his conduct, Mr. DiMare provided his clients with false account statements which purported to be from John Hancock.

State enforcement cases

Madoff fraud: The People of the State of New York v. Ivy Asset Management LLC (N.Y.S.Ct. Filed May 11, 2010). is an action against New York investment adviser Ivy Asset Management, now owned by Bank of New York Mellon, and its two principals, Lawrence Simon and Howard Wohl as discussed here. Beginning in the late 1990s, and continuing up through 2008 when Madoff’s scheme collapsed, defendants facilitated the investment of large sums of advisory client money with Madoff’s scheme. As early as 1997, defendants learned that Madoff’s operation was a fraud and removed their proprietary funds from the scheme. However, they counseled clients who had funds invested with Madoff to leave them with the Ponzi scheme king. Those clients were assured that there was nothing wrong. At the same time, defendants advised new clients not to invest with Madoff. By the time the Madoff Ponzi scheme collapsed, Ivy had caused its clients to invest, reinvest and maintain at least $227 million with the Ponzi king. The firm had been paid at least $40 million in advisory fees. The complaint, which alleges fraud, failure to disclose and breach of fiduciary duty, is based on alleged violations of New York’s Martin Act and Executive Law. It seeks an injunction, accounting, restitution, disgorgement, damages, punitive damages and attorney fees and costs.

Private actions

Option backdating: In re Maxim Integrated Products, Inc. Sec. Litig., No. 08-00832 (N.D. Cal.) is a putative class action against the company based on option backdating claims. The parties have reached an agreement in principle under which plaintiffs will receive $173 million to settle all claims. Last month, the SEC won a verdict against former company CFO Carl Jasper discussed here. The company previously settled with the Commission as discussed here.