This Week In Securities Litigation (Week ending January 23, 2015)

The SEC named ratings giant Standard & Poor’s in three actions this week and one of its senior executives in another. The firm settled all three actions, admitting to a series of facts but not violations of the law in one action. The proceeding involving the executive will be set for hearing.

The Commission also filed a settled FCPA action against an executive stemming from a bribery scheme in Qatar. The company entered into a deferred prosecution agreement which was based on the fact that it self-reported and cooperated.

Finally, the agency brought a series of actions involving insider trading, acting as an unregistered broker, failing to have adequate investment adviser policies and procedures and conflicts.


Remarks: Chairman Timothy G. Massad delivered remarks before the Asian Financial Forum, Hong Kong (Jan. 10, 2015). His remarks focused on growth in the markets in the region (here).

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 2 civil injunctive action and 8 administrative proceedings, excluding 12j and tag-along-actions.

Insider trading: SEC v. Huang, Civil Action No. 15-cv-269 (E.D. Pa. Filed Jan. 22, 2015) is an action against Bonan Huang and Nan Huang, both employees of a large credit card company. The two defendants conducted thousands of searches in the non-public data basis of its employer for millions of customers at numerous largely retail corporations. Through the searches they were able to view and analyze aggregated sales data for the companies they searched. That information was used to trade in advance of earnings announcements for the companies. The complaint alleges violations of Exchange Act Section 10(b). The action is pending. See Lit. Rel. No. 23179 (Jan. 22, 2015).

Misappropriation: SEC v. MayfieldGentry Realty Advisors, LLC, Civil Action No. 13-cv-12520 (E.D. Mich.) is a previously filed action against, among others, the adviser and Marsha Bass, the COO and part owner of the adviser, and Chauncey Mayfield, the founder and president of the adviser. The complaint alleged that Mr. Mayfield took about $3.1 million from the Police and Fire Retirement System of the City of Detroit and invested it in real estate without authorization. Ms. Bass settled with the Commission and the Court entered a final judgment of permanent injunction against her based on Advisers Act Sections 206(1) and 206(2). In addition, she will pay a civil penalty of $35,000. See Lit. Rel. No. 23176 (Jan. 22, 2015).

Unregistered broker: In the Matter of Spring Hill Capital Markets, LLC, Adm. Proc. File No. 3-16353 (Jan. 22, 2015) is a proceeding which names as Respondents Capital Markets, Spring Hill Capital Partners, LLC, Spring Hill Capital Holdings, LLC and Kevin White. Capital Holdings is a holding company that owns Capital Partners, Capital Markets and Spring Hill Management Company, LLC. Capital Markets is a registered broker dealer. Capital Partners is majority owned by Mr. White through Capital Holdings. Mr. White founded the entity defendants and is a registered representative. At the direction of Mr. White, Capital Partners entered into an agreement with an unaffiliated broker dealer under which it would trade fixed income securities. The five employees of the firm were registered representatives but the firm never registered. From May 2009 through early 2010 Partners introduced about 100 trades in asset backed securities yielding over $4 million in compensation. Under the agreement Partners retained 85% of this as compensation. In March 2010 Mr. White also had a trader withhold a trade ticket from the unaffiliated broker to conceal the fact that Spring Hill did not have a customer for the transaction. This caused the books of the broker to be inaccurate. The Order alleges violations of Exchange Act Sections 15(a), 15(c)(3) and 17(a) and the related Rules. The action will be set for hearing.

Policies and procedures: In the Matter of Du Pasquier & Co., Inc., Adm. Proc. File No. 3-16350 (Jan. 21, 2015). The firm was a registered investment adviser and broker-dealer. The firm ceased operation as of July 31, 2014 and transferred its accounts and customers to Aegis Capital Corporation. Prior to that the firm, which at one point had about $48 million in assets under management, at various times beginning in 2007 failed to adopt policies and procedure to prevent violations of the Adviser Act, failed to conduct best execution reviews and did not adequately review the marketing materials The firm also failed to annually review the adequacy of its compliance policies and their effectiveness. The firm did not correct certain misstatements in its Form ADV or deliver Form ADV Part 2A and Part 2B to various clients. The Order alleges violations of Advisers Act Sections 204, 204A, 206(4) and 207. To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. It will also pay a civil penalty of $50,000.

Misappropriation: SEC v. Wwebnet, Inc., Civil Action No. 12-cv-6581(S.D.N.Y.) is a previously filed action against the video software company and Robert Kelly. The complaint alleged that between 2005 and 2008 the defendants made a number of misrepresentations to investors which permitted Mr. Kelly to funnel at least $2.1 million of investor funds to himself. The court entered a final judgment against Mr. Kelly, enjoining him from future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). He is also required to pay disgorgement of $2,111,660 and prejudgment interest which is deemed paid by the forfeiture order in the parallel criminal case in which Mr. Kelly pleaded guilty to securities and wire fraud charges. He was sentenced to serve 27 months in prison and pay restitution. See Lit. Rel. No. 23177 (Jan. 22, 3015).

Disclosure: In the Matter of Standard & Poor’s Ratings Services, Adm. Proc. File No. 3-16348 (Jan. 21, 2015)(S&P I): In the Matter of Standard & Poor’s Ratings Services, Adm. Proc. File No. 3-16346 (Jan. 21, 2015)(S&P II); In the Matter o f Standard & Poor’s Ratings Services, Adm. Proc. File No. 3-16348 (Jan. 21, 2015)(S&P III); In the Matter of Barbara Duka, Adm. Proc. File No. 3-16349 (Jan. 21, 2015). The actions tie to the disclosures and statements made regarding the methodology for rating conduit/fusion Commercial Mortgage Backed Securities or CF CMBS – those comprised of geographically diversified pools of at least 20 mortgage loans made to unrelated borrowers. In 2010 and 2011 fees for rating CF CMBS were paid by the issuers. S&P sometimes competed for rating assignments for these transactions. Business in this segment of the market for S&P had declined since the market crisis. The firm would spend about two months analyzing the loans and properties after which final feedback was provide to the issuer concerning recommended ratings for levels of the capital structure proposed by the issuer. The feedback included summary data concerning the Debt Service Coverage Ration or DSCR, a key metric using in rating the transactions as well as others which reflected the stress placed on the loans. When the issuer announced the transaction S&P would publicly disseminate Presale reports with a preliminary recommendation and the rationale. Investors would them make their investment decision.

In 2009 S&P published certain criteria used in evaluating these transactions. The next year that was modified and incorporated into a model used to evaluate the transactions. Subsequently, S&P published a commentary on a CF CMBS transaction which it did not rate but in which the firm discussed the methodology. In 2010 the CMBS Analytical Group of S&P decided to alter its model for analyzing these transactions. The new approach generally resulted in making the transaction more attractive. The modified approach was used in 2011 to rate six CF CMBS transactions. When investors questioned certain aspects of the ratings for some transactions, S&P’s senior management reviewed the ratings and discovered the use of blended constants. The ratings were withdrawn for two transactions. Later the other transactions were reviewed and a press release issued stating that the ratings were consistent with S&Ps rating definitions. Investors were not told about the change in methodology. S&P had internal controls designed to ensure that the ratings assigned used approved criteria. Those controls were deficient. S&P I alleges violations of Exchange Act Section 17(a)(1), which prohibits fraudulent conduct, Section 15(E)(c)(3), regarding internal controls and certain record keeping rules.

To resolve S&P I, the firm admitted the facts in Annex A which basically outline those on which the Order is based. The firm also entered into certain undertakings which included an agreement to refrain from making preliminary or final ratings for any new issue U. S. conduit/fusion CMBS transaction for twelve moths and to adopt, implement and maintain polices and procedures and internal controls that address recommendations and issues identified in a specified letter and to submit a report on those new policies and procedures. In addition, the firm consented to the entry of a cease and desist order based on the Sections and Rules cited in the Order and to a censure. S&P will pay $6.2 million in disgorgement, prejudgment interest and a civil penalty of $35 million.

S&P II centers on the publication in 2012 of an article describing an internal study regarding CMBS Criteria. Specifically, the article depicted what it called an average commercial mortgage loan pool losses of about 20% under Great Depression levels of economic stress. The article was based on significant assumptions that were not disclosed. The firm also failed to accurately describe certain aspects of its 2012 CMBS Criteria used to determine credit ratings on 25 CF CMBS between October 2012 and 2014. The Order alleges violations of Exchange Act Section 17(a)(1) and Rule 17g-2(a)(6) which requires NRSROs to make and retain books and records which are complete and that document the established procedures and methodologies used to determine ratings. S&P resolved the proceeding by agreeing to certain undertakings and consenting to the entry of a cease and desist order based on the Section and Rule cited in the Order. In addition, the firm agreed to pay a civil penalty of $15 million.

S&P III is based on the failure of the firm to maintain and enforce internal controls regarding changes made to an assumption used in evaluating certain RMBS. S&P self reported this issue to the SEC and took voluntary steps to remediate the issue. The Order alleges violations of Exchange Act Section 15E(c)(3)(A) regarding internal controls and the related rules. The firm resolved the proceeding by consenting to certain undertakings which include developing measures to enhance its written polices and procedures and internal control structure. The firm also agreed to the entry of a cease and desist order based on the Section and Rules cited in the Order and to a censure. The firm will pay a penalty of $1 million.

The Barara Duka proceeding alleges that she was responsible for the actions of the analytical group within S&P that analyzed and assigned ratings to new issues of CMBS. It alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b) and certain related rules. The proceeding will be set for hearing.

Conflicts: In the Matter of Consulting Services Group, LLC, Adm. Proc. File No 3-16345 (Jan, 16, 2015) names as a Respondent the once registered investment adviser. The firm was controlled by Edgar Lee Giovannetti until 2011. Consulting Services terminated its registration with the SEC in 2013. The adviser’s business included providing consulting services to public pension funds and recommending third-party investment advisers to actively managed public pension accounts. The firm either failed to disclose or incorrectly characterized in its ADV Part II a $50,000 personal loan between Mr. Giovannetti, its then CEO, and an investment adviser the firm recommended to certain of its public pension and other clients. The Order alleges violations of Advisers Act Sections 206(2) and 207. To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay a civil penalty of $150,000.

Investment fund fraud: SEC v. Elm, Civil Action No. 15-cv-60082 (S.D. Fla. Filed Jan. 15, 2015) is an action against Frederick Elm, Elm Tree Investment Advisors, LLC, an unregistered investment adviser, and three funds. Beginning November 2013 the defendants raised about $17 million from over 50 investors. While the funds were to be invested, in fact much of the investor money was diverted by Mr. Elm to his personal use. Investors were furnished with falsely inflated account statements. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The Court granted the Commission’s request for a TRO. The case is pending. See Lit. Rel. No. 23175 (Jan. 21, 2015).


In the Matter of Walid Hatoum, Adm. Proc. File No. 3-16352 (Jan. 22, 2015). Mr. Hatoum was employed by PBS&J International, Inc., a wholly owned subsidiary of PBSJ Corporation, in February of 2009 and quickly promoted to President of the international subsidiary. The parent is an employee owned engineering and construction firm based in Florida. In 2009 the International subsidiary won two contracts for construction work, one in Qatar and the other for work in Morocco. Both were competitively solicited and approved by the Quatari Diar Real Estate Investment Company, a state owned enterprise. To secure the contracts, Mr. Hatoum offered bribes to the then Director of International Projects at Qatari Diar. That official provided Mr. Hatoum advance information that permitted the firm to win the contracts. For the first project the bribes were channeled through Local Partner, a firm in which Foreign Official had an interest. After the award an agency fee was to be paid to Local Partner where a checking account was opened that could be accessed by the wife of Foreign Official, For the second contract a so-called agency fee was imbedded in the agreement. The scheme unraveled when the general counsel of the company launched an internal investigation. The company self-reported. Prior to that time the Order states that had the firm conducted appropriate due diligence about Local Partner and followed up on red flags it would have been discovered the violations earlier. The contracts were terminated, although the firm made a substantial profit on a bridge agreement for work it did on one until project until a replacement could be securied. The Order alleges violations of Exchange Act Section 30A, 13(b)(2)(A), 13(b)(2)(B) and 13(b)5. Mr. Hatoum resolved the action, consenting to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to pay a civil penalty of $50,000.

The company entered into a two year deferred prosecution agreement. Under the terms of the agreement the company will implement a series of undertakings which include enhanced FCPA procedures. The firm will also pay disgorgement of $2,892, 504, prejudgment interest and pay a civil penalty of $375,000.

Criminal cases

Insider trading: U.S. v. Lucarelli (S.D.N.Y.) is a previously filed action in which Michael Lucarelli, formerly an executive with investor relations firm Lippert/Heilshorn & Associates, used client information to insider trade. This week Mr. Lucarelli was sentenced to serve 30 months in prison and directed to forfeit $955,521.62, the amount of his trading profits.

Hong Kong

Improper payments: The Securities and Futures Commission announced that following a trial three directors of First China Financial Network Holding Ltd. were ordered to repay RMB 18,692,000 to the company. The directors were Wang Wenming, Lee Yiu Sun and Richard Yin Wingneng. While the payment was supposedly made in connection with an acquisition, the SFC established at trial that there was no such obligation. The court also concluded that an indemnification resolution for the officers by the company for their legal expenses in defending this action was inappropriate. The court will consider if additional remedies are appropriate.

MOU: The SFC and the European Securities and Markets Authority entered into an MOU on cooperation arrangements in connection with the Hong Kong established central counterparties which have applied for recognition by ESMA. This fulfills a precondition under European Market Infrastructure Regulation for ESMA to recognize these CCPs as eligible to provide services to clearing members or trading venues in the European Union.


Investment fund fraud: A Serious Frauds Office investigation resulted in the conviction after a jury trial of Uif Magnus Michael Peterson who was the founding director of Weavering Capital (UK). Over a six year period investors put about $780 million into the fund which was supposed to be low risk and liquid. In fact Mr. Peterson inflated the value of the fund using a series of interest rate swaps with an off-shore fund he controlled while paying himself well. When the market crisis hit and investors requested their money the fund collapsed.

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