THIS WEEK IN SECURITIES LITIGATION (Week ending April 13, 2012)
The Commission approved sending a staff study to Congress this week, as required by Dodd-Frank, which presents â€œoptionsâ€ for extending the reach of Section 10(b) in private damage actions beyond the limitations set by the Supreme Court in Morrison. One Commissioner dissented, arguing that the study is inadequate. The Commission also announced the members of its reconstituted investor advisory committee and solicited comments on the recently enacted JOBS Act.
SEC Enforcement filed an aggressive insider trading case against several foreign nationals based on little more than the trading data and a market crisis action against the former officers of a bank holding company who, according to the complaint, tried to modify failing loans to improve the sagging financial condition of their institution. An investment fund fraud action was brought against a self-styled â€œsocial capitalistâ€ who claimed he would improve the community but failed to disclose that he was actually operating a Ponzi scheme. Finally, a settled action was filed against Wall Street icon Goldman Sachs which essentially follows an earlier case brought by Massachusetts authorities, alleging inadequate procedures for handling material, non-public information.
Staff study: The Commission approved forwarding to Congress a staff study prepared under Dodd-Frank on the impact of Morrison v. National Australia Bank, Ltd., 130 S. Ct. 2869 (2010) on private actions. That decision essentially limited the reach of Exchange Act Section 10(b) to the U.S., negating a series of Circuit Court decisions on extraterritorial effect. Dodd-Frank contains a legislative fix for the SEC and the DOJ which essentially restores the reach of the antifraud sections to their pre-Morrison limits. The staff study does not contain any recommendations. Rather, it sets forth several options for Congress to consider if it wants to provide some element of extraterritorial reach for private plaintiffs. The options range from adopting the Second Circuitâ€™s pre-Morrison jurisprudence to variations which focus on the U.S. conduct element of a transaction. The options presented have, for the most part, been unsuccessfully argued by plaintiffs in an effort to avoid the impact of Morrison.
Commissioner Aguilar dissented from the transmission of the study to Congress. He stated his â€œstrong disappointment that the Study fails to satisfactorily answer the Congressional request, contains no specific recommendations, and does not portray a complete picture of the immense and irreparable investor harm that has resulted, and will continue to resultâ€ from the Courtâ€™s decision in Morrison. The study, according to the Commissioner, fails to explain the importance of private rights of action to the Commissionâ€™s enforcement program or to investors. It also leaves open the option of doing nothing about the issue.
JOBBS Act: The SEC is accepting comments on the recently signed Act prior to the issuance of proposed regulations.
Investor advisory committee: The Commission announced the members of its new investor advisory committee. This committee has been formed under Section 911 of Dodd-Frank and replaced the earlier one which has been disbanded. The purpose of the group is to advise the Commission on regulatory priorities, regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure and initiatives to protect investors and promote investor confidence. The members were nominated by the Commissioners (here).
SEC Enforcement: Filings and settlements
Filings: This week the Commission filed 6 civil injunctive actions and 1 administrative proceeding (excluding tag-along and 12(j) actions) including:
Investment fund fraud: SEC v. City Capital Corporation, Case No. 1:12-cv-01249 (N.D. Ga. Filed April 12, 2012) is an action against the firm which is an OTC-link quoted company, its CEO and Chairman, Ephren Taylor, II, and its former COO, Wendy Connor. The complaint alleges that Mr. Taylor, who marketed himself as a â€œsocial capitalistâ€ who gives back to the community, was essentially operating a Ponzi scheme in which he raised about $11 million primarily from African-American church members. There were two offerings. In the first he sold promissory notes issued by the company and various affiliates with an interest rate of 12% to 20%. The funds were to be used for local businesses such as a laundry, juice bar or gas station. In the second, with the assistance of Ms. Connor, they sold â€œsweepstakes machines.â€ The machines are essentially computers loaded with games, many of which resemble those found in casinos. Investors were told the machines would generate returns of as much as 300%. In reality the operation was a Ponzi scheme. The Commissions complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a)(1). The case is in litigation.
Procedures: In the Matter of Goldman, Sachs & Co., Adm. Proc. File No. 3-14845 (April 12, 2012) is a settled proceeding against the firm alleging that it had inadequate procedures to protect material non-public information. Specifically, the action centered on a new â€œhuddleâ€ program the firm created along with its Asymmetric Service Initiative or ASI. Under the former the firm typically held a weekly meeting during which its equity research analysts met with traders and sometimes sales people to consider â€œhigh-convictionâ€ short-term trading ideas and other â€œmarket colorâ€ concerning stocks they covered. Under ASI research analysts called select clients to share trading ideas from the huddles. The huddle program created a serious risk that analysts would share material, nonpublic information regarding their published research with ASI clients and firm traders. The firm did not establish, maintain and enforce adequate policies to prevent this resulting in a willful violation of Exchange Act Section 15(g), according to the Order. The firm settled the case by adopting a series of procedures and consenting to the entry of a censure and cease and desist order based on Section 15(g) and agreeing to pay a $22 million penalty, half of which is a credit from paying a fine in a related FINRA proceeding. The firm also admitted to facts in the Order to which it had admitted in a prior Massachusetts proceeding.
Related actions – FINRA: The firm settled with the regulator based on essentially the same facts as in the Commission action. The settlement includes an $11 million penalty. Massachusetts: In the Matter of Goldman Sachs & Co., Docket No. 2009-0079 is an action against the firm based on essentially the same facts as in the Commission action. In resolving this matter Goldman admitted to the factual allegations in the consent order but not its conclusions. The firm also agreed to the entry of a cease and desist order and to permanently discontinue AST and Trade Huddles and to certain other procedures. In addition, Goldman agreed to pay a civil penalty of $10 million. The consent is dated June 9, 2011.
Manipulation: SEC v. AutoChina International Ltd., Case No. 1:12-CV-01643 (D. Mass. Filed April 11, 2012) is an action against the China based company, eight individuals and two entities. The individual defendants include Hui Kai Yan, a member of the board of directors. In order to facilitate obtaining financing using company stock as collateral, the defendants and others are alleged to have engaged in a scheme to increase its trading volume to enhance the appearance of liquidity. Using numerous accounts, many of which were opened on the same day, the defendants and their cohorts engaged in manipulative trading such as wash sales and matched orders. The trading created the appearance of activity, increasing volume from about 18,000 shares per day in the summer of 2010 to over 139,000 shares per day in the late fall of that year. In February 2011 an entity controlled by AutoChinaâ€™s Chairman and his spouse obtained about $120 million in financing. The only asset of the entity was AutoChina stock. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 9(a) and 10(b). The case is in litigation.
Financial fraud: SEC v. Van, Civil Action No. CV 12 1743 (N.D. Cal. Filed April 9, 2012). Defendant Benedict Van used a series of false representations, according to the Commission, to lure investors into purchasing shares of his two start-ups, defendants hereUare and eCity, Inc. Over a two year period he told investors that hereUare would conduct an IPO and would be the next Google along with other claims. He raised about $6.2 million from investors. All the claims were false. He used similar claims to sell shares of eCity, Inc., raising about $880,000 from investors in a matter of months. Again the claims were false. The Commissionâ€™s complaint alleges violations of Securities Act Sections 5 and 17(a)(2) and Exchange Act Section 10(b). The defendants settled the action, consenting to the entry of permanent injunctions based on the Sections cited in the complaint as to them. Mr. Van also agreed to be permanently barred from serving as the officer or director of a public company. The Commission waived disgorgement and declined to assess a penalty against Mr. Von based on his inability to pay. Separately, an administrative proceeding was filed against hereUare which had filed an Exchange Act registration statement but failed to file the required periodic reports. The company consented to the revocation of that registration statement. In the Matter of hereUare, Adm. Proc. File No. 3-14838 (April 9, 2012).
Insider trading: SEC v. Spyridon Adondakis, Civil Action 12-CV-0409 (S.D.N.Y.) is an insider trading action in which hedge fund advisory firm Diamondback Capital Management LLC is alleged to have traded on inside information in the shares of Dell Inc. and Nvidia Corporation. The information concerned the quarterly earnings of the two firms and was passed to portfolio manager Todd Newman from Jesse Tortora, an analyst at the firm who obtained it. The firm entered into a non-prosecution agreement with the U.S. Attorneyâ€™s Office. With the Commission it consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). It also agreed to pay disgorgement of $5,173,000 along with prejudgment interest which will be credited dollar for dollar against the amounts paid under the resolution of the criminal case.
Financial fraud: SEC v. Nocella, Case No. 4:12-cv-1051 (S.D. Tx. Filed April 6, 2012) is an action brought against former bank holding company CEO Anthony Nocella and CFO J. Russell McCann. The action centers on the efforts of the two officers to conceal the true financial condition of Franklin Bank Corp. as the market crisis unfolded and its portfolio of real estate holdings unraveled. By the second quarter of 2007 the loan portfolio of the financial institution began to deteriorate as the financial crisis unfolded. During the summer of 2007 the two officers received reports that depicted a 24% increase in delinquencies in the loan portfolio compared to the prior three month period. Despite its deteriorating financial condition, Messrs. Nocella and McCann were reviewing strategic alternatives for the company. To facilitate that eventuality they sought to improve its financial condition using three so-called loan restructuring programs: Fresh Start, Strathmore Modifications and Great News. Each brought loans current in a manner which was contrary to disclosed standards and GAAP. Ultimately however the bank was taken over and the holding company failed. The Commissionâ€™s complaint alleges violations of Exchange Act Sections 10(b), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). It seeks a permanent injunction, disgorgement, prejudgment interest, civil penalties, officer and director bars and repayment under SOX 304. The case is in litigation.
Investment fund fraud: SEC v. Elia, Civil Action No. 0:12-cv-60616 (S.D. Fla. Filed April 6, 2012) is an action against George Elia and his two controlled companies. Mr. Elia is alleged to have raised approximately $11 million since 2005 from about 25 investors, most of whom were from the gay community in Wilton Manors, Florida. Investors were told that Mr. Elia had extensive experience in trading stocks and exchange traded funds from which he obtained annual returns as high as 26%. In fact his trading yielded losses or only marginal gains in limited periods. Mr. Elia is alleged to have transferred portions of the investor funds to a controlled entity and misappropriated other sums. The Commissionâ€™s 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 case is in litigation.
Insider trading: SEC v. Yang, Case No. 12-cv-02473 (N.D. Ill. Filed April 4, 2012) is an action against Siming Yang, a New York City resident who, until recently, worked for a New York City investment adviser; Prestige Trade Investment Ltd., a company created in January 2012 by defendant Yang; Caiyin Fan, a PRC citizen; Shui Chong (Eric) Chang, a resident of Hong Kong formerly employed at Deutsche Bank Securities, New York City;
Biao Cang, a PRC citizen resident in Hong Kong; Jia Wu, a PRC citizen; and Ming Ni, a PRC citizen resident in Hong Kong. The action centers on the March 27, 2012 announcement by Xianfu Zhu, Chairman and CEO of Zhongpin Inc. that he had submitted a non-binding proposal to take the company private by purchasing all the outstanding shares at $13.50 per share, a 46% premium. The complaint focuses largely on the trading of each defendant shortly prior to the deal announcement: Defendants Yang and Fan purchased 2,571 call options and 58,000 shares and had unrealized profits of $733,000; Prestige purchased over 3 million shares of stock and had unrealized profits of $7.6 million; Defendant Chang purchased 4,035 call options and 32,500 shares of stock yielding unrealized profits of $828,188 after the deal announcement; Defendant Cang bought 306 call options which yielded realized profits of $39,745; Defendant Wu bought 257 call options which yielded realized profits of $34,288; and Defendant Ni purchased 4,300 shares of stock and 169 call options which yielded realized profits of $57,108. The complaint also alleges coordinated activity. Defendants Yang and Chang are alleged to have used a computer with the same IP address to access brokerage accounts. Defendants Cang, Wu and Ni are alleged to have accessed their brokerage accounts using networks with the same IP address and hardware with identical Media Access Control addresses.
The complaint alleges violations of Exchange Act Section 10(b). The Commission obtained a temporary freeze order. The case is in litigation.