THIS WEEK IN SECURITIES LITIGATION (Week ending April 20, 2012)
Congress heard testimony about the new approach the Commission is implementing to economic analysis in rule making from SEC Chairman Mary Schapiro this week. That approach focuses on the early and continued involvement of staff economists throughout the rule writing process. This week the U.S. Sentencing Commission stiffened sentences for insider trading and securities fraud.
In a rarity, a regulated entity was named in two Commission actions this week, neither of which settled. OptionsXpress was named as a Respondent in two Orders. In one the firm and its principle are alleged to have participated in violations of Regulation SHO while in other centers on violations of the registration provisions. Each case is proceeding to hearing.
A second married couple has pleaded guilty to FCPA charges this week. Stuart and Hong â€œRoseâ€ Carson in the long running Control Components cases each pleaded guilty to a singe FCPA charge. The first married couple convicted of FCPA charges was Mr. & Mrs. Green.
Finally, investment fund fraud cases and insider trading dominated criminal cases this week. Criminal prosecutors filed a new action while securing convictions following a jury trial in the other. In the Galleon insider trading case another defendant was sentenced while a defendant in the Dell cases pleaded guilty.
Dodd Frank Rules: The Commission adopted a rule defining swaps-related terms for regulating derivatives. The new rule, developed jointly with the CFTC, defines â€œsecurity-based swap dealerâ€ and â€œmajor security-based swap participant.â€ The definition for the former focuses on those who hold themselves out as security-based swaps dealers, make a market in these instruments, regularly engage in transactions involving the securities and participate in activity that in the trade or business causes them to be known as a dealer or a market maker. The latter focuses on a person who either: maintains a substantial position in any of the major security-based swap categories; or whose outstanding security-based swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking system or markets; or any financial entity that is highly leveraged, not subject to capital requirements set by a federal banking agency and maintains a â€œsubstantial positionâ€ in any of the major security-based swap categories (here).
Testimony: On April 17 SEC Chairman Mary Schapiro testified before the Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs Oversight and Government Reform Committee (here). The testimony, titled Testimony Concerning Economic Analysis in SEC Rulemaking, focused on the Commissionâ€™s revised approach to economic analysis in rule making.
Legislation, studies and rules
International regulation: The Committee on Payment and Settlement Systems or CPSS and the Technical Committee of the International Organization of Securities Commissioners or the IOSCO (whose members include the SEC and the CFTC) published the final report of the Principles of Financial Market Infrastructures or FMIs. This report replaces earlier published standards. The CPSS and IOSC expect the principles to be key in the regulation of FMIs.
U.S. Sentencing Commission: The Commission announced amendments to the guidelines which apply in insider trading cases and securities fraud actions. For insider trading cases the Commission adopted a new and increased minimum offense level of 14 for a range of 15 to 21 months for any organized scheme to engage in insider trading. The commentary discusses factors to consider in assessing the question of â€œorganized.â€ In addition, the â€œabuse of trustâ€ standard for insider trading cases was broadened. The new standard will expressly include hedge fund professionals. Finally, for securities fraud cases the Commission issued amendments for the calculation of actual loss. Under the method adopted there is no requirement to exclude from the calculation of share price factors outside of the fraud as some courts had done following principles developed in civil securities fraud actions.
SEC Enforcement: Filings and settlements
Filings: This week the Commission filed 3 civil injunctive actions and 4 administrative proceeding (excluding tag-along and 12(j) actions) including:
Registration violations: In the Matter of OX Trading, LLC, Adm. Proc. File No. 3-14853 (filed April 19, 2012) is a proceeding which names as Respondents OX Trading, optionsXpress, Inc. and Thomas Stern. OX Trading is a subsidiary of optionsXpress Holdings, Inc. which provides price improvement to customers of optionsXpress. OptionsXpress is a self-clearing on-line broker that specializes in options and is now a subsidiary of The Charles Schwab Corporation. Mr. Stern was the CFO, Director and Chief Compliance Officer of OX Trading as well as the CFO of optionsXpress. OX Trading was registered as a broker-dealer with the SEC as of February 1, 2008 and became a member of the CBOE. OX Trading made money when it traded as a counterparty to optionsXpress customer orders and hedged the positions created by those trades. On February 2, 2009 OX Trading ceased being a member of the CBOE after a dispute regarding the disclosure of the reasons for its poor financial performance. It continued with the same trading business however through a customer portfolio margin account at optionsXpress. In May of that year the SEC staff notified the firm that broker-dealers who only transact business on an exchange must be a member and that the OX Trading had to either be a member of an exchange or the NASD. This resulted in the firm filing in August 2009 to deregister as a broker-dealer. The next year the firm filed an application to again register after being notified by the CBOE that it had to be registered. That application was approved in November 2010. The Order charges violations of Exchange Act Section 15(a) for the year the firm was not registered. It also alleges a violation of Section 15(b)(8) regarding a broker-dealer effecting transactions unless it is a member of a registered national securities association or the transactions are on an exchange of which it is a member. Mr. Stern and optionsXpress are charged with willfully aiding and abetting the violations by OX Trading. The matter is proceeding to hearing.
Financial fraud: SEC v. Watson, Case No. 2:09-cv-00442 (D. Ariz.) is the financial fraud action against three former officers and mangers of CSK Auto Corporation. The complaint alleged a scheme from 2002 to 2004 that resulted in the inflation of revenue at the company by failing to write off vendor allowance receivables that were claimed to be uncollectable. The Commissionâ€™s complaint named as defendants Don Watson, the former CFO, Edward Oâ€™Brien, former controller and Gary Opper, former director of credit and receivables. Each defendant settled with the Commission, consenting to the entry of a permanent injunction. Mr. Watson also consented to the entry of a permanent officer and director bar and agreed to reimburse Oâ€™Reilly Automotive, Inc. which acquired CSK, $646,404.17 in bonuses and stock profits under SOX 304. Mr. Oâ€™Brien also consented to an officer and director bar and agreed to pay $33,386 in disgorgement and prejudgment interest. Mr. Opper agreed to pay $10,906 in disgorgement and prejudgment interest. Each defendant previously pleaded guilty in a related criminal case. The Commission has also settled its first SOX 304 action brought against an officer of the company who was not involved in the underlying fraud. SEC v. Jenkins, Case No. CV 09-01510 (D. Ariz.).
Net capital: In the Matter of MidSouth Capital, Inc., Adm. Proc. File No 3-14852 (April 18, 2012) is an action which names as Respondents the firm and its Chairman, Mark Hill. The Order alleges that the firm is not in compliance with its net capital obligations under Exchange Act Section 15(c)(3) and that despite notice from FINRA and the Commission staff, it continued to operate. The matter is being scheduled for hearing.
Investment fund fraud: SEC v. Gonzalez, Case No. 12-03319 (C.D. Cal. Filed April 17, 2012) is an action against Michael Gonzalez who held himself out as a bond portfolio manager. He solicited clients through a local magazine and directly through friends and acquaintances. Since February 2010 he has raised at least $1 million from 20 investors who were falsely told he purchased specific California municipal bonds on their behalf. Investors were also told that he was affiliated with well known broker-dealers, although Mr. Gonzalez omitted the fact that he had been barred by the NYSE and the NASD. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The Commission obtained an emergency freeze order at the time of filing the complaint.
Account intrusion: SEC v. Murmylyuk, Civil Action No. 12-cv-2272 (D.N.Y. Filed April 17, 2012) is an action against Petr Murmylyuk which charges that he made profits of over $30,000 through an illegal account intrusion. Specifically, the complaint claims that the defendant entered matched orders in thinly traded options between his account and the one into which he entered. The transactions were structured so that the account into which he intruded purchased the options at high prices and then immediately sold them back at low prices. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation.
Reg SHO: In the Matter of optionsXpress, Inc., Adm. Proc. File No. 3-14848 (April 16, 2012); In the Matter of Peter J. Bottini,Adm. Proc. File No. 3-14847 (April 16, 2012). These are, respectively, a proceeding against the firm, its CEO Thomas Stern and customer Jonathan Feldman, and a settled action against the firmâ€™s chief compliance officer Phillip Hoch, its vice president of compliance Kevin Strine and another customer Peter Bottini based on claimed violations of Reg. SHO. That regulation generally requires participants of a registered clearing agency to deliver equity securities when delivery is due, typically T+3. If the securities are not delivered the participant has an obligation to purchase or borrow securities of a like kind and quantity to close out the position. The Order naming the firm claims that by October 2008 optionsXpress had six customer accounts involved in repeated and years long violations of Reg. SHO, using what are called reverse conversions. The Order alleges that those transactions are essentially wash sales. Yet from October 2008 through March 2010 firm customers utilized this strategy. As a result optionsXpress had what the Order calls a â€œcontinuous failure-to-deliver position in these securities for extended periods of time.â€ The Order alleges willful violations of Rules 204 and 204T of Reg. SHO. It also charges Mr. Feldman with willful violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Stern is charged with causing and willfully aiding and abetting the firmâ€™s violations of Rules 204 and 204T and the violations of Mr. Feldman. A hearing has been ordered.
In the settled action each Respondent has undertaken to fully cooperate with the Commission in any and all investigations and proceedings related to this matter. Each agreed to the entry of a cease and desist order based on Rules 204 and 204T of Reg. SHO without admitting or denying the allegations in the Order except as to jurisdiction.
Investment fund fraud: SEC v. Neman, CV 12-03142 (C.D. Cal. Filed April 11, 2012) is a action against Shervin Neman, Neman Financial, Inc. and Cassandra Neman. Mr. Neman is the sole shareholder and CEO of Newman Financial which was a registered investment adviser. Shervin and Cassandra Neman are married. Beginning in June 2010 Mr. Neman raised about $7.54 million from eleven investors in three states. He induced investors to purchase promissory notes from the Neman Fund which was to pay investors returns of 11% to 18% within 30 to 180 days. Those profits were to come from purchasing foreclosed residential properties and then â€œflippingâ€ them for a profit. In a second scheme investors entered into purchase agreements under which they were supposed to get an interest in shares in companies such as Facebook and IPO shares of issuers such as General Motors, Groupon, LinkedIn and Angieâ€™s List. A quick profit was to come once the IPO was completed. The only profits, however, went to Mr. and Mrs. Newman after making Ponzi type payments to some investors. The Commissionâ€™s complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b), Advisers Act Sections 206(1), 206(2), 206(4), 204(a) and 203A. A hearing is scheduled on April 23, 2012 on the Commissionâ€™s motion for a preliminary injunction.
U.S. v. Carson, No 09-00077 (C.D. Cal.) is an action in which Stuart Carson and his wife, Hong â€œRoseâ€ Carson pleaded guilty to FCPA charges. Mr. Carson is the former president of Control Components Inc., a subsidiary of IMI Plc. Mrs. Carson was the director of sales for China and Taiwan. Each pleaded guilty to a count of violating the FCPA. Control Components makes control valves used in nuclear, oil and gas power plants. The company pleaded guilty in 2009 to violations of the FCPA and the Travel Act. It was ordered to pay an $18.2 million criminal fine. The company is alleged to have made over $4.9 million in illegal payments to officials of various foreign state-owned companies and about $1.95 million in bribes in violation of the Travel Act to officers and employees of foreign and domestic privately-owned companies from 2003 through 2007. The officials were in China, Malaysia and the UAE. Three other executives of the company have pleaded guilty and are awaiting sentencing. Three others are awaiting trial.
The Board announced that it entered into a cooperation agreement with the German Auditor Oversight Commission. It relates to the oversight of audit firms within the regulatory jurisdictions of the two regulators. Previously, the Board entered into similar agreements with two other European Union member states, the UK and the Netherlands.
Insider trading: U.S. v. Shankar, 09-cr-996 (S.d.N.Y.) is one of the Galleon related insider trading cases in which Gautham Shankar, formerly a trader at Schottenfeld Group LLC, previously pleaded guilty to conspiracy and securities fraud. In connection with his plea he admitted to having passed and profited from illegal tips from Zvi Goffer, a one time Galleon Group employee, and Thomas Hardin, a former analyst at Lanexa Global Management LP. Mr. Shankar was sentenced this week to serve three years of probation including the first six months at home confinement. The sentence was based in part on the substantial assistance rendered to the government.
Investment fund fraud: U.S. v. Liounis, No. 1;12-mj-0379 (E.D.N.Y. Filed April 17 2012). Peter Liounis, Ruslan Rapoport and Roman Tsimerman were charged, respectively, with wire fraud, conspiracy and money laundering in connection with a series of fraudulent investment schemes which centered on Mr. Liounis posing in various roles to solicit investments. In one he executed a scheme from December 2008 through November 2009 through a company called the Rockford Group which sold interests in future recoveries in personal injury and other law suits. About 200 investors lost $11 million in this scheme. In another he posed as an employee of UBS, soliciting investments for the IPO for General Motors. In a third scheme he claimed to be employed by Grayson Hewitt and also solicited investors for future recoveries in law suits. A series of calls with investors were captured on court ordered wire taps.
Investment fund fraud: U.S. v. Jacobs, No. 4:10-cr-00149 (E.D. Va. Filed Dec. 14, 2010) Defendants Samuel Jacobs and Christopher Rice were convicted following an eight day jury trial on counts of wire fraud, money laundering, engaging in transactions using proceeds from the mail fraud, and forgery. The two men were charged with operating a scheme using Alliance Financial Services Corporation, a television station that broadcasted largely religious programming. The defendants solicited local pastors and their congregations to furnish funds which were supposed to be invested. About $750,000 was raised. In fact the money was used to operate the station, pay past debts and for the personal expenses of the two defendants.
Insider trading: U.S. v. Newman, No. 1:12-cr-00121 (S.D.N.Y. Filed Feb. 7, 2012) is an action in which Defendant Danny Kuo, a former research analyst at an investment firm, pleaded guilty in the on-going Dell insider trading case. Mr. Kuo pleaded guilty to one count of conspiracy to commit securities fraud and two counts of securities fraud. From 2009 through 2010 Mr. Kuo was part of a group of analysts that obtained inside information from corporate officials. That information was then shared among the group and with the hedge fund portfolio managers for whom they worked. In 2009 and 2010 Mr. Kuo obtained inside information regarding the revenue and gross margins for NVIDIA which he passed along to the group and the portfolio manager for whom he worked. The information was obtained from a friend for cash. In 2008 and 2009 he obtained inside information regarding Dell from another member of the group. That information was also shared with the portfolio manager for whom he worked. Trades were then executed. Sentencing is scheduled for October 15, 2012.
The agency published statistics showing that while there were more reports of fraudulent activity concerning investment fraud in 2011 compared to 2010, fewer people lost money. The release notes that in 2011 there was a 19% increase in inquiries about boiler room fraud compared to 2010. However there was a 7% drop in the number of people who actually invested. The FSA goes on to note that it has produced a new video available to consumers regarding share fraud. It also published warnings regarding the receipt of unsolicited calls by consumers.