THIS WEEK IN SECURITIES LITIGATION (October 29, 2010)
SEC Enforcement had another “first” this week, imposing civil penalties on city officials in connection with municipal securities offerings. The Commission also brought an action centered on forex trading and a case against a hedge fund keyed to the overvaluation of assets. FCPA enforcement continued to be a focus for DOJ prosecutors, with the return of a superseding indictment in a bribery case involving officials of a Mexican utility company. Ponzi scheme operator Arthur Nadel was sentenced to 14 years in prison.
Investment fund fraud: SEC v. Boston Trading and Research LLC, Case No. 10-CA-11841 (D. Mass. Filed Oct. 28, 2010) is an action centered on an alleged foreign currency trading fraud. The complaint names as defendants Boston Trading and its principals Ahmet Devrim Akyil and Craig Karlis, who are alleged to have raised about $40 million from approximately 750 investors. According to the complaint, investors were solicited to participate in a program that traded in the Forex market through a website called “introducing brokers,” as well as live presentations. Investors were assured that for a $10,000 minimum investment they would have 100% transparency about their account, that their losses would be limited to an agreed upon amount, which was typically about 30% per day and that Boston Trading and its principals would only be paid from profits. In fact, the defendants diverted some of the investor funds to their own use which they concealed by furnishing clients false statements. The company collapsed by September 2008 from significant losses that resulted from trading far past the stop loss limits promised investors. Ultimately investors received about 10% of their funds. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See also Litig. Rel. 21712 (Oct. 28, 2010). A parallel criminal action has also been filed.
Financial fraud: SEC v. Uberuaga, Civil Action No. 08 CV 0621 (S.D. Cal. April 7 2008) (here) is an action against five former City of San Diego officials. The claims center on municipal securities offerings made in 2002 and 2003 in which the City raised over $260 million. The false and misleading statements were made, according to the complaint, regarding the continuing bond offerings and to rating agencies. The defendants knew the City had intentionally under-funded its pension obligations to increase benefits and defer costs, according to the Commission. The defendants are also alleged to have known that the City faced severe difficulty funding its future pension and health care obligations unless new revenues were obtained or cuts were made The settling defendants are former San Diego City Manager Michael Uberuaga, former Auditor and Comptroller Edward Ryan, the former Deputy City Manager for Finance Patricia Frazier and the former City Treasurer Mary Vattimo. Former Deputy City Manager for Finance, Teresa Webster did not settle.
Each of the four settling defendants consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a)(2). The Commission dropped its Section 17(a) and 10(b) claims in the settlements. In addition, Messrs. Uberuaga and Ryan and Ms. Frazier each agreed to pay civil penalties of $25,000 while Ms. Vattimo will pay $5,000. This is the first action imposing a civil penalty on a city official.
Offering fraud: SEC v. Berkshire Resources, LLC, Case No. 1:09-CV-0070 (S.D. Ind. Filed June 9, 2009) is an action charging Berkshire Resources and its principals, Jason Rose and David Rose, along with six companies through which Berkshire made securities offerings, with fraud in connection with the sale of unregistered “units of participation.” The units, marketed largely through cold calls, were supposed to raise money for oil and gas projects. Investors were not told that Jason Rose, presented as the operator of the company, had no experience and that operations were directed by his father David, who had an extensive securities disciplinary history and was under indictment. Investors were also misled about the use of the offering proceeds, significant portions of which went to Rose family members for personal items. This week the Commission settled with Berkshire Resources, Berkshire 401, Berkshire 2006-5, Passmore-5, Gueydan Canal 28-5, Gulf Coast Development # 12 and Drilling Deep. The final judgment held the entity defendants jointly and severally liable. They were ordered to pay $15,400,000 in disgorgement and prejudgment interest. Berkshire was also ordered to pay a civil penalty of $650,000. See also Litig. Rel. 21708 (Oct. 25, 2010). The Commission previously settled with the other defendants (here).
Hedge funds: SEC v. Southridge Capital Management LLC, Civil Action No. 3: 10-cv-1685 (D. Conn. Filed Oct. 25, 2010) (here) is an action against Southridge Capital, an investment adviser, its founder defendant Stephen Hicks and adviser Southridge Advisors. The complaint centers on allegations that misrepresentations were made to investors regarding the liquidity of the funds. In addition, assets were over valued, which also resulted in inflated management fees which were calculated as a percentage of the overvalued assets. Operating expenses were also improperly charged to the funds. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2) and (6). The case is in litigation.
Misappropriation: SEC v. Icely, Civil Action No. 8:10-CV-2363 (M.D. Fla. Filed Oct. 21, 2010) is an action against Shawn Icely. The complaint alleges that Mr. Icely misappropriated about $625,000 from 11 customers of American Portfolio Financial Services Inc. while he was employed there as a registered representative. The funds were moved with forged wire transfer documents. Customers were falsely told that the money was put in accounts in their name. Many of the customers had worked with Mr. Icely for years. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See also Litig. Rel. 21705 (Oct. 21, 2010).
Offering fraud: SEC v. Winning Kids, Inc., Civil Action No. 10-CV-80186 (S.D. Fla. Filed Jan. 29, 2010) (here) is an action against the company, its founder and CEO, Christian Hainsworth, and the three former salesmen. The complaint claims the defendants defrauded investors by selling unregistered securities through a series of private offerings marketed primarily on the radio. Investors were told that the company was operating, expanding nationally and experiencing extraordinary growth. Those claims were bolstered by projections furnished to investors showing annual returns of 300%. In fact, the company had virtually no operations but salesmen were paid large commission. The complaint alleged violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The company and Ms. Hainsworth settled at the time the complaint was filed (also here). This week, the two remaining salesmen defendants settled with the Commission, consenting to the entry of final judgments which impose permanent injunctions prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(A). Defendant Victor Selenow also agreed to the entry of an order requiring him to pay disgorgement of $41,500 along with prejudgment interest and a civil penalty of $50,000, while Edward Tamimi will pay $194,250 in disgorgement plus prejudgment interest and a civil penalty of $130,000. Previously, a default judgment was entered against a third sales agent, Robert Comiskey.
Investment fund fraud: U.S. v. Nadel (S.D.N.Y.) (here) is an action in which defendant Arthur Nadel pleaded guilty to charges based on operating a Ponzi scheme. Last week he was sentenced to serve 14 years in prison. He was also ordered to serve three years of supervised release following his prison term and to forfeit $162 million along with certain real estate in Florida, North Carolina and Georgia, five airplanes and one helicopter. In February 2010, Mr. Nadel pled guilty to fifteen counts of securities fraud, mail fraud and wire fraud. The charges stem from allegations that he fraudulently raised over $330 million from about 390 investors. The money was supposed to be invested in six funds operated by the defendant from 1999 through January 2009 which Mr. Nadel claimed had large trading profits. In actuality, the funds suffered huge loses and much of the cash was diverted to Mr. Nadel’s other business ventures and to support his personal life style.
Lindsey Manufacturing: FCPA charges were brought in the Central District of California against Lindsey Manufacturing Co. and two of its executives, Keith Lindsey and Steve Lee. The charges center on an alleged conspiracy to bribe Mexican government officials at the Comision Federal de Electricidad (“CFE”), a state owned utility company. CFE is responsible for supplying electricity in Mexico and contracts with various companies for goods and services. The defendants retained Enrique and Angela Aguilar, directors of Grupo International de Asesores S.A., which claims to provide sales representation services for companies doing business with CFE. From about February 2002 through March 2009 the defendants and Enrique Aguilar implemented a scheme under which Enrique Aguilar was paid a 30% commission on all goods and services Lindsey Manufacturing sold to CFE. Part or all of the commission was used to pay bribes to secure the contracts. The contract price was then inflated by 30%. Fraudulent invoices were sent by Enrique Aguilar from Grupo to Lindsey Manufacturing for the commission. The money was then laundered in the Grupo brokerage account to make concealed payments for the benefit of CFE officials. The eight-count superseding indictment charges the defendants with conspiracy to violate the FCPA and FCPA violations. It also charges Enrique Faustino Aguilar Noriega and Angela Maria Gomez Aguilar who were previously indicted (here). The case is in litigation.
U.S. v. Elkin, Case No. 4:10-cr-00015 (W.D. Va.) is a criminal FCPA action against Bobby Elkin Jr., formerly an executive at Virginia based tobacco merchant Dimon Inc. Mr. Elkin, who previously pleaded guilty to one count of conspiracy to violate the FCPA (here) has admitted paying bribes to foreign officials to obtain business in Kyrgyzstan for his company. He was sentenced to three years of probation and ordered to pay a fine of $5,000.
Disclosures: Sensata Technologies Holding NV stated in a quarterly filing with the SEC that one of its subsidiaries may have violated the FCPA in connection with doing business in China. According to the filing, the audit committee of the company uncovered the payments in an internal investigation. Sensata, formerly Texas Instruments Sensors & Controls, is a supplier of sensor devices used in various industries.
PAPER ON SANCTIONS
A new paper by John Armour, a Professor of Law and Finance at the University of Oxford, along with Colin Mayer and Andrea Polo, concludes that for business organizations reputational sanctions are for some categories of misconduct far more potent than direct penalties. The findings are based on an event study conducted on a data set from FSA enforcement actions in the UK. The paper concludes that reputational sanctions have a very significant impact. For example, those sanctions were found on average to have ten times the impact of financial sanctions on the price of the stock. The paper goes on to point out that regulators need to take this impact into account when fashioning remedies for enforcement actions. Professor Armour posted a summary of the paper on The Harvard Law School Forum On Corporate Governance and Financial Regulation (posted10/27/2010).