Current market volatility was addressed this week when the Commission announced that the exchanges and FINRA would be filing updated circuit breaker rules. In addition, the staff issued an Alert regarding the use of sub-accounts in market manipulations, money laundering, insider trading and other fraudulent schemes.

SEC Enforcement lost a ruling on primary liability in a decision which applied the Supreme Court’s Janus ruling to Securities Act Section 17(a) as well as Exchange Act Section 10(b). The ruling also precluded the Commission from using scheme liability as a predicate for its false statement claims. Enforcement also brought another market crisis case involving the five school districts induced to purchase highly speculative and leveraged investments, an action involving soft dollars, a failure to supervise proceeding and three financial fraud cases.

Finally, criminal prosecutors filed charges against the former Carter’s Inc. employee at the center of the financial fraud which ended with the company entering into the Commission’s first non-prosecution agreement.

The Commission

Circuit breaker rules: The Commission announced that the national securities exchanges and FINRA are filing proposals to revise existing market-wide circuit breakers. They are designed to address extraordinary volatility across the securities markets. The new proposals will update existing circuit breakers by, among other things, reducing the market decline percentage thresholds required to trigger a circuit breaker (here).

Risk Alert: The staff issued a Risk Alert regarding the use of master and sub-accounts at broker dealers. While these arrangements have legitimate uses, they can be employed in schemes to launder money, insider trading and for other improper purposes. The alert suggests that brokers implement certain procedures to ensure against improper use (here).

SEC Enforcement – litigated cases and court rulings

Primary liability: SEC v. Kelly, Case No. 08 CV 4612 (S.D.N.Y.) is an action against former AOL executives. It centers on a fraud at AOL from 2000 to 2003 involving round trip transactions between the company and its vendors. AOL is alleged to have structured transactions so that a counterparty purchased advertising. The company then made false statements regarding the transactions to inflate its revenues. Following the decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), two executives named as defendants in the case requested judgment on the pleadings as to the SEC’s Rule 10b-5 claims. Specifically, the two defendants claimed that they did not “make” the statements in the Janus sense because they did not have control. The SEC conceded the point but argued that Janus is limited to subsection (b) of Rule 10b-5. The Commission sought to hold the defendants liable under subsections (a) and (c) which focus on scheme liability. The court rejected the SEC’s contention, ruling in favor of the defendants. While the Commission is correct that Janus is based on subsection (b), where the conduct is focused on public misstatements the agency cannot circumvent the requirements of Janus by using subsections (a) and (c) of the rule regarding scheme liability where, as here, the conduct underlying the statements involving the executives is not deceptive. The court also held that Janus applies to Securities Act Section 17(a).

SEC enforcement – filings and settlements

Investment fund fraud: SEC v. The NIR Group, LLC, Civil Action No. 11-cv-4723 (E.D.N.Y. filed Sept. 28, 2011) is an action against unregistered investment adviser NIR, its controlling shareholder Corey Ribotsky and an analyst at the firm, Daryl Dworkin. The adviser had a family of funds called the AJW funds which provided financing to distressed, emerging growth, and start-up microcap companies quoted on the Bulletin Board or the Pink Sheets. Typically they were invested in about 120 to 150 different companies. The funds held a number of PIPE investments. Beginning in July 2004 Mr. Ribotsky siphoned assets from one of the funds he was managing and continued to do so for the next five years. As the market crisis developed Mr. Ribotsky made misrepresentations to investors regarding the liquidity of the funds and other key matters. For example, he claimed that the holdings could be liquidated in 36 to 48 months which was practically impossible. He also made misrepresentations regarding the amount of money under management. In addition, he used funds from one group of investors to pay another without adequate disclosure. Finally, in 2008 Mr. Ribotsky sold about $43.2 million in assets on which he recorded a realized gain with virtually no due diligence. The purchaser defaulted shortly after the close of the deal without making any payments. The complaint, which is in litigation, alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4).

False registration/statements: In the Matter of LPB Capital d/b/a Family Office Group, LLC, Adm. Proc. File No. 3-14565 (Sept. 27, 2011) is an action against the adviser and its principal, Gary Pappas. The firm had less than $25 million in assets and thus was required by Advisers Act Section 203A to register with the state authorities. It did not. Instead it registered with the Commission, claiming it had more than the required $25 million in assets under management. In a series of filings the amount under management increased from an initial estimated $25 million that would be under management within 120 days to a claimed $128.6 million for 1,564 accounts. In fact the firm never had the required $25 million. The Order alleges violations of Advisers Act Sections 203A, 204, 206(4) and 207 and the related rules. The action is pending.

Misrepresentations to clients: SEC v. Hovan, Civil Action No. CV 11-4795 (N.D. CA. Filed Sept. 28, 2011) is an action against investment adviser Kurt Hovan, his wife Lisa, and his brother Edward. Kurt Hovan misrepresented to clients the use made of about $178,000 in “soft dollars” rebated to him from brokerage commissions. While those rebates can properly be used for a limited category of brokerage and research services for the benefit of clients, here they were siphoned off to other purposes. When the inspection staff inquired about this matter the three defendants created a shell company secretly controlled by Edward Hovan and false invoices for the funds. The complaint alleges violations of Securities Act Exchange Act Section 10(b), Advisers Act Sections 206(1), 206(2) and 207, and Investment Company Act Section 17(e)(1). Kurt Hovan was also indicted on one count of wire fraud and one count of obstruction. U.S. v. Hovan, Cr 11 0699 (N.D. CA. Filed Sept. 28, 2011). Both cases are pending.

Investment fund fraud: SEC v. Desai, Civil Action No. 11-cv-05597 (D.N.J. Filed Sept. 27, 2011) is an action against Shreyans Desai and ShreySidh Capital, LLC, an unregistered investment adviser he controlled. Between 2009 and 2011 the defendant raised about $245,000 from investors with false claims that their money would make returns of at least 50% and that he would not lose the amount invested. The funds were diverted to the use of Mr. Desai, according to the complaint. The SEC’s complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2).

Suitability: In the Mater of RBC Capital Markets, LLC, Adm. Proc. File No. 3-14564 (Sept. 27, 2011) is an action against the firm arising from the sale to five Wisconsin school districts of leveraged investments tied to CDOs to five Wisconsin school districts. Previously an action was brought against Stifel, Nicolaus & Co. and a former senior executive of that firm based on the same transactions. The investment program crafted by Stifel and participated in by RBCCM was designed to fund the unfunded pension liabilities of the school districts. In essence it called fro the school districts to use largely borrowed funds to invest in notes tied to the performance of synthetic CDOs tied to a portfolio of credit default swaps on corporate bonds. The leverage magnified the potential return and the risk. According to the Order, although RBCCM recognized that the school districts were not the type of sophisticated investor who usually purchased such instruments, neither they nor Stifel made sure the investors understood the risks. To the contrary, the presentations made to the school districts were at best incomplete and misleading. Eventually the investments collapsed with millions of dollars in losses. The school districts lost all their investment. The Order alleges violations of Securities Act Sections 17A)(2) and (3). RBCCM resolved the matter by consenting to the entry of a censure and a cease and desist order based on the sections cited in the Order. Respondent also agreed to pay disgorgement of $ 6 million along with prejudgment interest and a $22 million civil penalty. The funds are to be paid directly to the school districts. The Order specifies that in any related civil action RBCCM cannot claim the amounts paid in this proceeding as an off-set and, if they do, that an equal amount must be paid to the school districts. A fair fund was established.

Failure to supervise: In the Matter of Manuel Lopez-Tarre, Adm. Proc. File No. 3-14562 (Sept. 23, 2011) is an action against Mr. Lopez-Tarre who was the chief compliance officer for FTC Capital Markets, Inc. In 2008 he was charged with the responsibility for supervision of Guillermo Clamens, the sole owner of broker dealer FTC, and another employee, Lina Lopez. During that period Mr. Clamens fraudulently engaged in tens of millions of dollars of unauthorized trades for two FTC customers. Ultimately he caused over $20 million is losses. Lina Lopex assisted Mr. Clamens by helping him create and send false account statements to the customers to conceal the fraud. Respondent failed to properly supervise according to the order. If he had followed the procedures in place the fraud likely would have been discovered. He also failed to follow up on red flags. The Order alleges a failure to reasonably supervise within the meaning of Exchange Act Section 15(b)(4)(E). The case is in litigation.

Investment fund fraud: SEC v. Rivera, Civil Case No. CV-11-4741 (N.D. CA. Filed Sept. 23, 2011) is an action against Jason Rivera, Jr., Christopher Harmon, and two entities controlled by Mr. Rivera, The Joseph Rene Corporation or JRC and Executive Members Management Group or EMMG. The complaint centers on two schemes. In the first Mr. Rivera used JRC to raise about $4.5 million in 2007 and 2008 from investors with claims that the funds would be put in hard assets such as real estate, oil, diamonds and gold. In fact the money was put in Mr. Rivera’s pocket. In the second, Mr. Rivera, joined by Mr. Harmon, raised an additional $3.2 million between 2008 and 2010 from investors which was to be put in trading programs involving CMOs and other financial instruments. In this scheme investors were promise profits of up to 6,300%. Again the funds were put in the pockets of the defendants, according to the court papers. The complaint alleges violations of Securities Act sections 5 and 17(a), Exchange Act Sections 10(b) and 15(a)(1) and Advisers Act Sections 206(1) and 206(2)

Criminal cases

Financial fraud: U.S. v. Elles, 11 CR 445 (N.D. Ga.) is an action against Joseph Elles, a former sales executive at Carter’s, Inc. in Atlanta. A 32 count indictment, including securities and wire fraud charges, was handed down naming Mr. Elles as a defendant. According to the court documents, from the first quarter of 2006 through the third quarter of 2008 Mr. Elles engaged in a scheme which resulted in the falsification of the financial results of the company. To boost the revenue of the firm, Mr. Elles gave larger that appropriate discounts to firm customers to induce them to make purchases. He then concealed the excessive discounts. As a result the revenue of the company was overstated in a range of 5% to about 19% during the period. Prior to his resignation in 2009 Mr. Elles is also alleged to have executed millions of dollars in stock options. The criminal case is pending. Previously the company entered into the first non-prosecution agreement with the SEC. The Commission also has a parallel civil enforcement action pending against Mr. Elles. SEC v. Elles, Civil Action No. 1:10-CV-4118 (N.D. Ga. Filed Dec. 20, 2010). That case is pending.


Raymond James & Associates, Inc. and Raymond James Financial Services, Inc. were found to have used automated commission schedules for equity transactions which resulted in charging more that 15,500 customers about $1.69 million in excess commissions on over 27,000 transactions. The firms’ supervisory procedures were also found to be inadequate since they permitted inflated schedules and rates without proper consideration of the factors necessary to determine the fairness of the commissions. FINRA is requiring the firms to revise their automated commission schedules to conform to the requirements of the Fair Price and Commissions Rule, repay the $1.69 million and assess what overcharges must be repaid on certain other accounts. In addition, Raymond James & Associates will be required to pay a fine of $225,000 while Raymond James Financial will pay $200,000.

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