THIS WEEK IN SECURITIES LITIGATION (Week ending February 17, 2012)
Budgets were a key topic this week. The President proposed one which would increase the SECâ€™s funding. The agency also proposed a budget for FY 2013 which would increase the size of the Enforcement Division by adding 191 positions.
In Court the SEC had two split decisions. In one action centered on market timing claims, the SEC prevailed after trial on a late trading charge but the court rejected its assertion that market timing violated the antifraud provisions. In another case in which the agency is seeking to compel SIPIC to act regarding certain victims of the Stanford Ponzi scheme, the court partially sustained its and ordered additional briefing on procedural questions.
Finally, the Commission brought another Galleon related insider trading case in conjunction with the Manhattan U.S. Attorneyâ€™s Office. It also settled one of its longest running market crisis actions on the eve of trial.
Budget: The Commissionâ€™s proposed FY 2013 budget requests funding for a total of 1,545 positions for the Division of Enforcement. This would represent an increase of 191 positions above FY 2012 levels. During FY 2011 the Division, which is the Commissionâ€™s largest, filed 735 enforcement actions. That is more than in any other single year in the Commissionâ€™s history. The division also obtained more than $2.8 billion in penalties and disgorgement ordered in FY 2011.
SEC v. Securities Investor Protection Corporation, Case No. 11-mc-678 (D.D.C.) is an application by the SEC to compel SIPIC to file an application for protection for the customers of Stanford Group Company or SGC. The case is predicated on the collapse in 2009 of a group of companies controlled by Robert Allen Stanford which are reputed to have sold more than $7 billion of certificates of deposit through registered broker dealer SGC which is now defunct. A receiver has been appointed to oversee the assets of SGC which had about 32,000 active accounts for which that company served as the introducing broker. SIPIC declined to file an application with the Court for a protective decree for the SGC customers, concluding that they were not covered because Stanford Group Company did not perform a custody function for the customers. The Court agreed with the SEC that it was appropriate to proceed in a summary fashion by filing a petition rather than a civil complaint. It rejected the Commissionâ€™s claim that its preliminary determination regarding SGC is not subject to judicial review. The Court directed the parties to brief the question of what portions of the Federal Civil Rules might apply to future proceedings.
SEC Enforcement: Court decisions
Market timing/late trading: SEC v. Pentagon Capital Management Plc., Case No. 1:08-cv-03324 (S.D.N.Y. Filed April 3, 2008) is an action against Pentagon Capital Management Plc and its Chief Executive Officer, Lewis Chester. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b) centered on market timing and late trading claims. The evidence at trail demonstrated that from 1999 to 2003 Pentagon market timed using multiple accounts at brokers while restricting its trades to relatively small amounts to avoid detection by mutual funds. Despite these precautions, Pentagon was kicked out of a number of funds, a result it expected for a certain percentage of its trades. Pentagon and Mr. Chester also engaged in late trading through TW&Co. beginning in February 2001 and continuing through early September 2003. The Court rejected the market timing claim, concluding that it is not illegal in and of itself and, while funds had policies banning the practice there was to much uncertainty to tie those to a fraud charge since many had side deals and the SEC failed to establish the policies of those involved here. Late trading however is prohibited under SEC Regulation 22c-1, and well known industry practice. Here the defendantsâ€™ submission of late-trade orders â€œconstituted a fraudulent device and an implied misrepresentation in violation of Rule 10b-5 because it suggested that final orders were received before the fundsâ€™ 4:00 pm. pricing time . . .â€ Based on the late trading claim the Court entered an injunction prohibiting future violations of the antifraud provisions and requiring that the defendants pay disgorgement of $38,416,500 plus prejudgment interest and a civil penalty equal to the amount of the disgorgement.
SEC Enforcement: Filings and settlements
Investment fund fraud: SEC v. Eschbach, No. SA CV 12 0244 (C.D. Cal. Filed Feb. 15, 2012) is an action against Brenda Eschabch. The complaint alleges that she misappropriated client funds for her personal use beginning while employed by a large investment adviser and later after she established Aventine Investment Services, Inc., a defunct California corporation. Overall she is alleged to have misappropriated over $3 million in investment advisory client funds from 2003 through 2009. In a related criminal case she pleaded guilty to one count of mail fraud and one count of money laundering. She is awaiting sentencing. U.S. v. Eschbach, 8:10-cr-00017 (C.D. Cal.). To resolve the Commissionâ€™s case without denying the allegations in the complaint she consented to the entry of a final injunction prohibiting future violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 15(a) and Advisers Act Sections 206(1) and 206(2). She also agreed to the entry of an order requiring the payment of disgorgement of $2,561,873 payment of which will be satisfied on a dollar for dollar basis by the payment of restitution in the criminal case.
Misappropriation: In the Matter of Robert Pinkas, Adm. Proc. File No. 3-14759 (Feb. 15, 2012) is an action against Mr. Pinkas, who was an investment adviser to several funds. He is also a defendant in SEC v. Brantley Capital management LLC., a case based on the claimed overvaluation of assets and misrepresentations. In September 2010 Mr. Pinkas agreed to settle the case, consenting to the entry of a permanent injunction and agreeing to pay disgorgement of $632,729 along with prejudgment interest and a civil penalty of $325,000. He was also barred from serving as an officer or director for five years and barred from associating with any investment adviser with a right to reapply after one year. In this case he is alleged to have misappropriated $173,000 from a fund client to pay his defense costs in Brantley Capital and an additional $632,000 to cover the disgorgement in that case. The Order also alleges he has also violated the bar in the other case by continuing to associate with a investment adviser. The case is proceeding to hearing.
Unregistered offering: SEC v. Venulum Ltd., Civil Action No. 3:12-cv-00477 (N.D. Tex. Feb. 15, 2012) is an action against Venulum, a British Virgin Island Company, and Venulum Inc., a Canadian entity, along with their owner and chairman, Giles Cadman. The complaint alleges that the defendants engaged in an unregistered offering of promissory notes in fine wines beginning in 2002. Investors were solicited to invest in interests in fine wine that would be managed by Venulum. Beginning in 2010 Venulum solicited 94 of its wine investors to purchase high interest promissory notes. The defendants settled the action by consenting to the entry of a permanent injunction prohibiting future violations of Sections 5(a) and 5(c) of the Securities Act.
Insider trading: SEC v. Whitman, Case No. 12-cv-01055 (S.D.N.Y. Filed Feb. 10, 2012); U.S. v. Whitman, 12-cr-00125 (S.D.N.Y.) are actions against Douglas Whitman and, in the SECâ€™s complaint, his fund, Whitman Capital LLC. The SECâ€™s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The criminal complaint charges two counts of conspiracy to commit securities fraud and two counts of securities fraud. Both cases allege insider trading in the securities of Polycom, Inc. and Google Inc. based on tips from Roomey Kahn, Mr. Whitmanâ€™s neighbor. Ms. Kahn obtained the information regarding Polycom from an insider and, about Google, from an outside consultant of the company. Whitman Capital obtained illegal trading profits of more than $360,000. on the Polycom shares and over $620,000 from trading in Google securities. The criminal complaint also alleges that Mr. Whitman traded in the securities of Marvel Technology Group, Ltd. based on inside information. Both cases are pending.
Market crisis: SEC v. Cioffi, Case No. 08-2457 (E.D.N.Y. Filed June 19, 2008) is one of the Commissionâ€™s earliest market crisis cases. It named as defendants former Bear Stearns fund managers Ralph Cioffi and Matthew Tannin. It was brought in tandem with U.S. v Cioffi, 08-CR-001415 (E.D.N.Y.) which was tried to a jury and ended with an acquittal in November 2009. The actions center on the collapse in July 2007 of two Bear Stearns hedge funds once valued at about $20 billion which were tied to the subprime real estate market. The SECâ€™s complaint alleges an intentional fraud in which the defendants misrepresented the true condition of the two funds to investors as the market crisis began to unfold to induce investors to not withdraw their funds. As the funds were collapsing the defendants continued to misrepresent their true financial condition, according to the SEC. Investors were also not told that Mr. Cioffi began moving about one third of his $6 million investment out to another fund. Investors lost about $1.8 billion when the funds collapsed. The Commissionâ€™s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Under the terms of the proposed settlements, Mr. Coffi agreed to disgorge $700,000 and pay a $100,000 civil penalty. He will also be barred from the securities business for three years. Mr. Tannin will pay disgorgement of $200,000 and a $50,000 civil penalty. He will be barred from the securities business for two years.
Investment fund fraud: U.S. v. Stein (S.D.N.Y.) is an action in which defendant Eric Stein pleaded guilty to one count of mail fraud and one count of wire fraud in connection with the operation of an investment fraud in connection with Return-A-Pet LLC. From June 2007 through January 2010 the defendant is alleged to have sold sham Return-A-Pet â€œdistributorshipsâ€ for fees that ranged from $5,000 to $50,000. The company purportedly facilitated the return of lost pets to their owners. He lured investors with false representations and reportedly took in at least $500,000. Sentencing is scheduled for June 13, 2012.