THIS WEEK IN SECURITIES LITIGATION (November 26, 2010)
Happy Thanksgiving to all.
Insider trading is the key topic this Thanksgiving week with the revelation of a wide ranging probe by the U.S. Attorney’s Office in the Southern District of New York and the SEC. As part of the investigation, three hedge funds were raided, charges were brought against one person in an expert network and other investment funds received inquiries.
This week SEC enforcement brought more investment fund cases while settling a high profile options backdating case. Criminal prosecutors also brought an investment fund case, secured a conviction in a an action involving the theft of high frequency trading computer code and lost an insider trading case at trial. New York state officials obtained a key guilty plea in their on-going “pay to play” investigation.
Implementing Dodd-Frank
The SEC issued three sets of proposed Rules under Dodd-Frank this week:
• Security-Based swap reporting: Proposed Regulation SBSR focuses on information which must be reported regarding security-based swaps. Specifically, the proposed rule would require parties to report certain information regarding transactions to a registered security-based swap data repository. Portions of that information would be publicly disseminated by the repository.
• Security-Based swap repositories: Proposed Rules 13n-1 to 13n-11 would establish a registration process and require the depository to comply with certain duties and core principles. The duties would include providing reports to the Commission, accepting all security-based swaps reported to them and having policies and procedures for resolving disputes, ensuring that their automated systems provide adequate levels of capacity and security and protect the privacy of the transaction information.
• Oversight of investment advisers: The proposed rules govern what information private funds which previously did not have to register will now have to furnish the Commission. This will include basic organizational and operational information and the identification of five categories of “gatekeepers” that perform critical functions. The proposals also focus on certain exemptions such as venture capital funds, those with less than $150 million in assets under management and certain foreign advisers.
The “blue collar” insider trading probes
Insider trading involving hedge funds and their expert advisers is the focus of a probe by the U.S. Attorneys Office for the Southern District of New York, the FBI and the SEC (here). Search warrants were executed at the offices of three hedge funds, Level Global Investors LP, Diamondback Capital Management LLC and Loch Capital Management. Other investment funds have acknowledged receiving inquiries or requests for information, including SAC Capital, Janus Capital Group, Inc., Citadel LLC and Wellington Management Co.
On Wednesday Don Ching Trang Chu became the first person arrested and charged since these investigations became public. Mr. Chu is an employee of an unidentified expert networking firm. He has been charged with one count of conspiracy to commit securities fraud and one count of conspiracy to commit wire fraud. According to the papers filed in the Southern District of New York, Mr. Chu was selling expert network services to firms based on a claim that he had inside information. Specifically, he is alleged to have tried to secure Richard Choo-Beng, a hedge fund employee, as a client. Mr. Choo-Beng became a government cooperating witness and later pleaded guilty. Mr. Chu told Mr. Choo-Beng he could furnish inside information. In one phone call in July 2009, a person claiming to be an employee of high tech company told Mr. Choo-Beng the earnings numbers for the company prior to their release. Later Mr. Chu arranged a similar call with a supposed employee of Broadcom. U.S. v. Chu, (S.D.N.Y. Filed Nov. 24, 2010).
SEC Enforcement
Option backdating: SEC v. Alexander, Civil Action No. 06-CV-3844 (E.D.N.Y. Filed Aug. 9, 2006) (here). Former chairman and CEO of Comverse Technology, Inc., Jacob “Kobi” Alexander, settled option backdating claims with the SEC and a related civil enforcement action with DOJ. U.S. v. All Funds on Deposit, Case No. 06-cv-3730 (E.D.N.Y.). The Commission’s complaint against Mr. Alexander and two other former company executives claims that for over a decade Mr. Alexander and others granted in-the-money options to themselves and others by backdating the grants (here). Mr. Alexander settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Action 17(a) and Exchange Act Sections 10(b), 13(b)(5), 14(a) and 16(a). He also agreed to pay $26,206,298 in disgorgement and $21,442,157 in prejudgment interest along with a $6 million civil penalty and to be permanently barred from serving as an officer or director of a public company. His disgorgement and prejudgment interest obligations are deemed satisfied by the entry of the order in the civil forfeiture action.
Mr. Alexander also settled a civil forfeiture action which is related to the outstanding criminal case in which he is a defendant. In All Funds, the government sought the contents of two bank accounts alleged to contain the profits from the option backdating scheme. Mr. Alexander and his wife resolved the case by agreeing to the forfeiture of over $46 million in two investment accounts. Mr. Alexander is currently fighting extradition in Namibia where he is free on bail.
Failure to supervise/fraud: In the Matter of Hector Gallardo, Adm. Proc. File No. 3-14139 (Nov. 24, 2010) is a proceeding which names as Respondents Orion Trading, LLC, a registered broker dealer, Michael Zurita, its chief compliance officer and Hector Gallardo, a former registered representative with the firm who acted as a foreign finder. The Order alleges that Mr. Gallardo, while acting as a foreign finder in Bolivia defrauded citizens of that country. It also claims that Mr. Zurita, as his supervisor, failed to reasonably supervise Mr. Gallardo and missed a series of red flags and that he, along with the firm, did not develop a reasonable system of policies and procedures. The firm is also charged with having an unlicensed foreign associate. The Order alleges violations of Exchange Act Sections 15(b)(4)(E) which requires that a broker dealer reasonably supervise persons subject to their supervision, Section 15(b)(7) which requires the registration of individuals effecting securities transactions and Section 10(b). It also alleges violations of Securities Act Sections 17(a). The case is in litigation.
Investment fund fraud: SEC v. Petty, Case No. 1:10-CV-3842 (N.D. Ga. Filed Nov. 22, 2010) is an action against Charles Petty, II and his controlled companies Visionary Publishing International, LLC and Virtual Properties Worldwide, Inc. According to the complaint, the defendants have sold promissory notes issued by the companies since 2007. Investors were told the notes were secured by real estate when in fact they were not. Investors were also told the proceeds from the note sales would be used for real estate projects when in fact they were not. Similarly, investors were told that the notes were high-yielding, which they were not. Approximately $236,000 worth of notes were sold. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b). The case is in litigation. See Litig. Rel. 21756 (Nov. 24, 2010).
Investment fraud: SEC v. Financial Services Moskop & Associates, Inc., Civil Acton No. 10 C 7462 (N.D. Ill. Filed Nov. 22, 2010) is an action against Edward Moskop and his firm. The SEC’s complaint alleges that Mr. Moskop has misappropriated most of the funds of two elderly investors since 1989. Over the years he misappropriated their funds and covered up his actions by sending them false statements. The Commission’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The court granted the SEC’s request for an emergency freeze order. The case is in litigation. See Litig. Rel. 21752 (Nov. 22, 2010).
Fraudulent conduct: In the Matter of Emil C. Busse, Jr., Adm. Proc. File No. 3-14133 (Nov. 22, 2010) is a settled administrative proceeding against Emil Busse, the Managing Director for securities lending of registered investment adviser FAF Advisors, Inc. Mr. Busse managed a mutual fund that had a money market portfolio and a bond portfolio. Both received funds exclusively from loans of securities made by customers of an affiliate. In the first quarter of 2008, Respondent caused the reallocation of numerous loans of securities from customers of the money market portfolio to the bond portfolio. The transactions were undertaken in an effort to make sure that the NAV for the bond portfolio would not “break the buck,” that is go below $1.00. As a result of these transactions certain customers in the bond portfolio suffered about $6 million in losses. The Order charges violations of Advisers Act Actions 206(1), 206(2) and 206(4). Respondent resolved the charges by consenting to a cease and desist order based on the sections cited in the Order. He also agreed to be barred from associating with any broker, dealer or investment adviser and to be prohibited from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor, or principal underwriter, with a right to reapply for association after three years. Mr. Busse was directed to pay a civil money penalty of $65,000.
Rule 105 short sales: In the Matter of New Castle Funds LLC, Adm. Proc. File No. 3-14135 (Nov. 22, 2010) is a proceeding against New Castle Funds LLC, a registered investment adviser. The Order alleges that the firm violated Rule 105 by shelling short during the restricted period for two offerings in May 2009. One involved the securities of Anadarko Petroleum Corp. The second is based on sales of the securities of Wells Fargo & Company. Overall the firm made profits of $183,084. To resolve the proceeding New Castle consented to the entry of a cease and desist order from committing or causing any violations and any future violations of Rule 105 of Regulation M. The firm also agreed to disgorge its trading profits along with prejudgment interest and to pay a civil penalty of $100,000.
Investment fraud: In the Matter of Conal C. Doyle, Adm. Proc. File No. 3-14129 (Nov. 19, 2010) is an action against Conal Doyle, a self-employed real estate broker and a registered representation associated with a broker-dealer. From at least March 2008, Respondent sold interests in a purported high yield investment opportunity called “Project Funding Platform.” Under this program investors who would put $2 million into an escrowed bank account would receive $11.4 million in net profits within 40 weeks. Mr. Doyle claimed the funds would remain escrowed and be safe. As the “moderator” of the program he would receive a $15,000 per week fee. Investors were told the profits would come from a secret banking system between the Federal Reserve, the World Bank and other international sources of funds. The documents related to the program were fraudulent and the claims had no basis according to the Order. As a result, Mr. Doyle is alleged to have willfully violated Securities Act Sections 17(a)(1) and 17(a)(3). The Respondent resolved the matter, consenting to the entry of a cease and desist order based on the sections cited in the Order. He also agreed to be barred from association with any broker dealer and to pay a civil penalty of $25,000.
Investment fund fraud: SEC v. Dalton, Civil Action No. 10-CV-02794 (D. Colo. Filed Nov. 16, 2010) is an action against Richard Dalton, Universal Consulting Resources LLC and relief defendant Marie Dalton. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b) in connection with a Ponzi scheme. Specifically, the complaint claims that from March 2007 through June 2010, Mr. Dalton solicited about $17 million from 130 investors in 13 states for either the “Trading Program” or the “Diamond Program.” The former supposedly held investor funds in a bank while profits came from a European trading program. The latter involved trading in diamonds. Investors were promised yearly returns of 60% to 120%. In fact Mr. Dalton funded his personal life with investor funds. The court entered a freeze order and directed that an accounting be done. The case is in litigation. See Litig. Rel. 21747 (Nov. 17, 2010).
Criminal cases
Investment fund fraud: U.S. v. Wallace, (S.D.N.Y. Filed Nov. 24, 2010) names as a defendant Joshua Wallace, a principal of System Capital, LLC, a commodity trading advisor. Mr. Wallace is alleged to have solicited investors to trade in e-minis, futures contracts traded electronically on the Chicago Mercantile Exchange which are based on the S&P 500 index. The defendant falsely told investors he had at least $28 million in assets under management. Potential investors were also furnished with documents which falsely portrayed the performance history of the fund and which the defendant claimed contained audited returns when in fact they had not been audited. Mr. Wallace has been charged with commodities fraud, mail fraud, and wire fraud.
Investment fraud: U.S. v. Shah (S.D.N.Y. Filed Nov. 24, 2010) is a case in which Sanjeev Jayant Kumar Shah, formerly of Smith Barney, pleaded guilty to a four count information which alleges one count of securities fraud and three counts of wire fraud. The charges are based on a fraudulent scheme in which the defendant presented false documents authorizing Smith Barney to make two transfers totaling over $3.5 million from a client account supposedly to purchase bonds. Later, to cover up the transfer, he told the client the bonds did not appear on the statements because of a computer error. The date for sentencing has not been set.
Theft of trading code: U.S. v. Agrawal (S.D.N.Y.) (here). Former Societe Generale high frequency trader Samarth Agrawal was found guilty by a jury of theft of trade secrets and the interstate transportation of stolen property from. The charges stem from a claim that the defendant stole high frequency trading computer code from his employer. SocGen developed a high speed trading system over a period of years. It was very profitable and carefully protected. Mr. Agrawal printed out the high frequency code shortly after receiving a promotion into the high frequency trading department. Subsequently, Mr. Agrawal secured a new position with Tower Capital Research LLC based on his representation that he could build Societe Generale’s system for them. At trial, the government introduced a film from a surveillance camera showing Mr. Agrawal printing out the computer code. The government also furnished the jury with the computer print out of the code Mr. Agrawal had made prior to resigning from the firm. The print out had been seized from his home after his arrest. A date for sentencing has not been set. See also Press Release, USAO, S.D.N.Y. Dated Nov. 19, 2010.
Insider trading: U.S. v. Camp (N.D.N.Y.) is one of the cases related to the Dick’s Sporting Goods Inc. transaction (here). In this case, Gary Camp was charged with conspiracy to commit securities fraud and securities fraud. Mr. Camp was alleged to have used inside information furnished by his friend and former Dick’s executive Joseph Queri, Jr. to buy shares in Galyan’s Trading Co. just before the announcement that it was being acquired by Dicks. Mr. Camp and co-defendant Gary Gosson purchased over $300,000 of Galyan’s stock and sold the shares the day after the deal announcement on June 22, 2004. They had profits of $153,000. Mr. Camp was acquitted on November 18, 2010 following trial.
New York
Pay-to-play scheme: Henry “Hank” Morris, the chief political adviser to former New York State Comptroller Alan Hevesi, pleaded guilty to a felony violation of the Martin Act in the on-going “pay-to-play” investigation being conducted by the NYAG. Mr. Morris also agreed to forfeit $19 million which will go to the state pension fund and to be permanently barred from the securities industry in New York. Mr. Morris is alleged to have used his influence at the New York State Comptroller’s Office to obtain millions in fees to influence investments from the pension fund (here). The New York AG has obtained eight guilty pleas in this on-going inquiry. The SEC has a related case pending against Mr. Morris (here).