This Week In Securities Litigation (Week ending January 11, 2013)
The Supreme Court heard argument this week on a case which may have a significant impact on the SEC’s enforcement program. It focuses on when the five year statute of limitations begins regarding the imposition of a penalty. The Commission also brought two new market crisis cases, one against three former bank executives and the other against two auditors of another financial institution.
Finally, the Director of the SEC’s Enforcement Division confirmed recent rumors, announcing that he will leave the agency shortly. Mr. Khuzahmi has not disclosed his future plans.
Resignation of Enforcement Director: SEC Enforcement Director Robert Khuzami officially resigned yesterday, a move which has been widely rumored in the press in recent weeks. Mr. Khuzami served as Enforcement Director for nearly four years, compiling a record of leadership and achievement beginning with the largest reorganization of the Enforcement Division in history and culminating in the filing of record setting numbers of actions over the last two years.
Statute of limitations: Gabelli v. SEC, No. 11-1274 is an action in which the Court heard argument on the question of when the five year statute of limitations begins for imposing a penalty in government actions under Section 2442 of Title 28. The arguments centered on the Petitioner – defendant’s claim that since the statute uses the word “accrue” in reference to the commencement of the time clock, the five years begins when there is a cause of action. The Commission countered, claiming that the clock begins for a cause of action for fraud when it is discovered or reasonably could have been discovered. Much of the questioning from the Court focused on the fact that a discovery rule has never been invoked in a criminal case – and this is a government enforcement action seeking to impose a penalty – and the fact that until recently such rule has not been advocated by the government in the 200 year history of the statute. A decision is expected later this Term.
SEC Enforcement: Filings and settlements
Weekly statistics: This week the Commission filed 2 civil injunctive actions and 1 administrative proceeding (excluding tag-along-actions and 12(j) actions).
Misrepresentations: SEC v. Kapur, Civil Action No. 11-CIV-8094 (S.D.N.Y. Filed Nov. 10, 2011) is an action against fund manager Chetan Kupur and his firm, ThinkStrategy Capital Management. This week the court entered orders in the partially settled action directing that the defendants jointly and severally pay disgorgement of $3,988,195.59 and civil penalties of $1 million. The complaint alleged that over a period of years the defendants misrepresented the performance of two funds they managed.
Market crisis: SEC v. Woodard, Civil Action No. 2:13cv16 (E.D. Va. Filed Jan. 9, 2013) is an action against Commonwealth Bankshares Board Chairman, President and CEO Edward Woodard, Jr., Secretary and CFO Cynthia Sabol, and E.V.P. and Commercial Loan officer Stephen Fields. The action centers on a market crisis related financial fraud. From its inception through about 2006 the bank grew and was largely profitable. Implementing a growth plan, it expanded into construction and development loans as the market for such projects in its local area deteriorated. Nevertheless, during much of 2008, 2009 and into 2010 Commonwealth and its executives touted the quality of its assets, underwriting and credit monitoring processes. This was reiterated in filings with the Commission. Those claims were false, according to the Commission’s complaint. The picture of financial success reflected in statements and filings was achieved primarily by materially understating on its balance sheet the allowance for loan and lease losses or the ALLL and, at the same time, materially underreporting non-performing loans and its other real estate owned or OREO. Beginning in 2008 the bank understated its ALLL by about 17% to 25% with a corresponding understatement to its reported loss before taxes of about 64%. Likewise the bank understated its OREO in two quarters by about 19% to 20% with a corresponding understatement of its reported pre-tax loss in the first quarter of 2010 of about 35% and an underreporting of its total non-performing loans throughout the entire period of at least 30%. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a) and 13(b)(5). The case is in litigation. See also Lit. Rel. No. 3437 (Jan. 9, 2013).
Audit failure: In the Matter of John J. Aesoph, CPA, Adm. Proc. File No. 3-15168 (Jan. 9, 2013) is a proceeding against KPMG audit partner John Aesoph and senior manager Darren Bennett. Respondents audited TierOne Bank, the executives of which are the subject of a prior Commission enforcement action. At year end 2008 Respondents identified as an area of high risk for the audit TierOne’s loan losses. Nevertheless, when auditing the allowance for loan and lease losses or the ALLL, the auditors failed to gather sufficient competent evidential matter with regard to the valuations assigned by management. Many of the loans were valued with reference to their underlying collateral. Respondents largely accepted the claims of management with respect to the value of that collateral despite the fact that they were often based on stale appraisals. The auditors also failed to adequately test the controls over the management valuation process. As a result the Order alleges a failure to comply with key PCAOB standards and improper professional conduct in violation of Rule 102(e)(1)(ii). The proceeding will be set for hearing.
Financial fraud: SEC v. Spongetech Delivery Systems, Inc., Civil Action No. 10-cv-2031 (E.D.N.Y. Filed May 5, 2010) is a financial fraud action in which the Commission settled with two principles of the company, CEO Michael Metter and CFO Steven Moskowitz. The complaint centered on claims that the two officers, along with others, essentially conducted a pump and dump operation with respect to the shares of their now bankrupt company. Each former officer consented to the entry of a permanent injunction based on Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 15(d). Under the orders entered by the Court each man will also be barred from serving as an officer or director of a public company and from engaging in any penny stock offering. The Court will determine the amount of the disgorgement and penalty to be paid by each defendant at a later date. In the parallel criminal case Mr. Moskowitz pleaded guilty to securities fraud. Charges are pending against Mr. Metter. See also Lit. Rel. No. 22586 (Jan. 4, 2013).
Investment fraud: SEC v. Nekekim Corporation, Civil Case No. 1:13-cv-00010 (E.D. Calif. Filed Jan. 3, 2013). The complaint claims that Nekekim and its CEO, president and director, Kenneth W. Carlton, defrauded investors in the U.S. and other countries over an eleven year period beginning in 2001 by selling them interests in a gold mine based on misrepresentations. Investors were told that the mine had a special “complex ore” at its Nevada site which is worth at least $1.7 billion, according to an analysis made by a physicist. In fact, the “physicist” had no scientific training, according to the SEC’s complaint, and utilized unconventional methods. Investors were not told that the labs’ reliability had been questioned by geologists and a government study. Likewise, they were not told that other firms suggested Nekekim’s mine actually had little gold. The Commission’s complaint alleges violations of Securities Act Section 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). Both defendants settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of the Sections cited in the complaint. The company also agreed to disclose these sanctions in any offering of securities made in the next three years. Mr. Carlton agreed, in addition to the injunction, to pay a $50,000 penalty and to an order prohibiting him from selling securities for Nekekim or managing the company.
Crowdfunding: The regulator issued a request for voluntary interim Form for Funding Portals for prospective crowdfunding portals under the JOBS Act. Currently FINRA and the SEC are engaging in an open dialogue regarding the implementation of the corwdfunding provisions of the Act.
Year in review: The regulator issued a release reviewing its activities over the last year, highlighting its referrals of high profile insider trading actions as and actions brought involving complex products, conflicts and disclosure issues and disciplinary proceedings. The release also discussed FINRA’s investor protection initiatives.