This Week In Securities Litigation (Week ending January 13, 2017)
FCPA enforcement was a key priority this week. The Commission filed two settled actions. Once involved a recidivist in which the firm made admissions in resolving the matter with the DOJ. Those admissions were essentially adopted by the SEC in its proceedings, resolved with a cease and desist order and the payment of disgorgement and a penalty. The second centered on the failure of the firm to conduct adequate due diligence when retaining an agent in a high risk jurisdiction.
The Commission also resolved its first municipal bond case in which admissions were required. There the Respondent issuer failed disclose that there was a substantial risk the the issuer did not have the legal authority to issue the bonds.
Exam Program: The Commission announced the 2017 Examination Priorities which now include electronic investment advice, money market funds and senior investors (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 1 civil injunctive case and 9 administrative proceedings, excluding 12j and tag-along proceedings.
Internal controls/risk capital: In the Matter of The Bank of New York Mellon Corporation, Adm. Proc. File No. 3-17768 (January 12, 2017). The Order issued as to the global financial firm centers on its alleged failure to calculate its risk-based capital rations properly beginning in the third quarter of 2010. Specifically, under Accounting Standards Codification 810, Consolidation, the firm was required to include assets in variable interest entities in making its calculations. Here the firm failed to include those entities which held collateralized loan obligations. As a result Bank of New York Mellon miscalculated its risk-based capital rations in each of its quarterly and annual reports from the third quarter of 2010 through the first quarter of 2014. Accordingly, the firm failed to make and keep accurate books and records and to devise a system of internal controls sufficient to ensure that it did. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(A). To resolve the proceeding the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the firm will pay a penalty of $6.6 million.
ADRs: In the Matter of ITG Inc., Adm. Proc. File No. 3-17770 (January 12, 2017) is a proceeding which names the registered broker-dealer as a Respondent. Since at lest 2011 the firm has entered into arrangements regarding ADRs under pre-release agreements without complying with its obligations. Specifically, ADRs are supposed to be backed by shares of the firm. Under a pre-release agreement the broker or individual can obtain the ADRs before the shares are deposited if they have the shares and then assign the rights such that the broker or customer become the temporary custodian. Here the firm’s lending desk had pre-release agreements with four depositories but failed to secure the assignments of the actual shares. The Order alleges violations of Securities Act Section 17(a)(3). To resolve the proceeding the firm consented to the entry of a cease and desist order based on the Section cited in the Order, was censured and agreed to pay disgorgement of $15,070,144.10 along with prejudgment interest. The firm will also pay a penalty of $7,535,072.05.
Offering fraud: SEC v. Gray, Civil Action No. 15-cv-1465 (S.D.N.Y.) is a previously filed action against Mr. Gray and his firm, BIM Management LP. The court entered orders resolving the action and approving a plan of distribution. Specifically, the court entered final judgments of permanent injunction against each defendant based on Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). Disgorgement in the amount of $7,894,100, along with prejudgment interest, was also ordered, payment of which was deemed satisfied from compliance with a $5 million order of forfeiture and restitution entered in the parallel criminal case. The complaint alleged that defendants offered pre-IPO shares of Twitter. When sufficient shares were not available investor funds were used to repay other investors. See Lit. Rel. No. 23717 (January 12, 2017).
Internal controls: In the Matter of L3 Technologies, Inc., Adm. Proc. File No. 3-17769 (January 11, 2017). L3 is a prime contractor for various foreign and U.S. government agencies, including the Department of Defense. The firm contacted to maintain a fleet of about 100 fixed-wing C-12 airplanes for the U.S. Army at bases in the United States and around the world. The five year contract was initially handled through a subsidiary and later through its Army Sustainment Division. In mid-2013 the firm realized it might lose money on the contract that year. After a review the firm discovered about $50 million in unbilled work. While the Army was billed by year-end, there was no agreement regarding payments. Subsequently, the VP of Finance generated about 69 invoices for about $17.9 million in work and recognized the revenue without billing the Army, contrary to the firm’s revenue recognition policies. This was discovered by the firm and the filings were corrected, the required remedial steps taken and the firm self-reported. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding the company consented to the entry of a cease and desist order based on the Sections cited in the Order. Respondent will also pay a penalty of $1.6 million.
Municipal bonds: In the Matter of The Port Authority of New York and New Jersey, Adm. Proc. File No. 3-17763 (January 10, 2017). The Port Authority has responsibility for creating and maintaining significant portion of the New York and New Jersey transportation infrastructure. To fund those projects the Port Authority relies in part on the capital markets for the issuance of bonds and other financing obligations. In January 2011 the Governor of the State of New Jersey announced a five year transportation capital plan. It included $1.8 billion in projects the Governor asked the Port Authority to undertake in connection with the New Jersey Department of Transportation. Port Authority attorneys reviewed the projects and concluded on multiple occasions that there was a risk of a successful challenge by the bondholders and investors to the legal authority of Respondent in connection with the roadway projects. On March 29, 2011 the Port Authority’s Board of Commissioners met and approved the projects. No disclosure to the Board of Commissioners occurred regarding the potential legal issues. The Official Statements for an aggregate of $2.3 billion in bonds issued in June 2012, December 2012, November 2013 and June 2014 all stated that the bonds were only for purposes for which the Port Authority is authorized by law to issue bonds.” The Order alleges violations of Securities Act Sections 17(a)(2) and (3). In resolving the proceeding the Port Authority undertook a number of remedial acts and undertakings, including the retention of an independent consultant. The Port Authority also consented to the entry of a cease and desist order based on the Sections cited in the Order. In doing so, the Port Authority admitted violating the federal securities laws – a first in a municipal bond case. The Port Authority will pay a penalty of $400,000.
Private equity – conflicts: In the Matter of Centre Partners Management, LLC, Adm. Proc. File No. 3-17764 (January 10, 2017) is a proceeding which names the investment adviser as a Respondent. Respondent is the adviser to four private equity funds. The adviser used a Service Provider to conduct due diligence for portfolio company investments. It made extensive disclosure about the Provider which was touted as a competitive advantage. The adviser failed to disclose that its principals have personal investments in the Provider, that two of its three board members are principals of the firm and that the wife of one principal is a relative of the Provider’s co-founder and CEO. These failures resulted in a breach of fiduciary duty. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. It will also pay a penalty of $50,000.
Concealed fees: In the Matter of John W. Rafal, Adm. Proc. File No. 3-17760 (January 9, 2017); In the Matter of Peter Hershman, Esq., Adm. Proc. File No. 3-17761 (January 9, 2017). Mr. Rafal was the CEO of dual registered Essex Financial Services, Inc. which held majority ownership of Essex Savings Bank. Mr. Hershman was a Connecticut attorney who specialized in business, estate planning and tax law. In 2011 Mr. Hershman referred a wealthy widow to Essex Financial. She opened an account. Messrs. Rafal had reached an agreement under which essentially a referral fee of $50,000 annually would be paid from the advisory fees under the invoices for legal services – the two men knew the arrangement was prohibited. Eventually the firm requested repayment of the fees when it learned of the arrangement. Although part of the money was repaid, Mr. Rafal arranged to pay the attorney through accounts he controlled. In 2013 Mr. Rafal believed that rumors were circulating concerning him and the payment of illegal fees. He sent a number of emails to firm clients and others falsely stating that the SEC had investigated the matter and issued a “no action” letter. When senior firm officials discovered the emails they ordered them retracted. Mr. Rafal complied. Subsequently, Mr. Rafal testified in an investigation conducted by the Commission staff. During his testimony he stated that the fees had been repaid. He concealed from the staff the fact that he had made arrangements to pay the fees from accounts he controlled. The Order as to Mr. Rafal alleges violations of Advisers Act Sections 206(1), 206(2) and 206(4). To resolve the case Mr. Rafal admitted to the facts in the Order and consented to the entry of a cease and desist order based on the Sections cited in the Order. He is also denied the privilege of appearing or practicing before the Commission as an attorney and barred from the securities business and from participating in any penny stock offering. Mr. Rafal will pay disgorgement of $275,000, prejudgment interest and a penalty of $275,000. The U.S. Attorney for the district of Massachusetts announced criminal charges against Mr. Rafal for obstructing the proceeding of a federal agency. The Order as to Mr. Hershman alleges violations of Advisers Act Section 206(1) and 206(4). Respondent Hershman resolved the action by consenting to the entry of a cease and desist order, without admitting or denying the facts, based on the Sections cited in the Order. He is also barred from the securities business and from participating in any penny stock offering. In addition, Mr. Hershman will pay disgorgement of $49,760, prejudgment interest and a penalty of $37,500. See also In the Matter of Essex Financial Services, Inc., Adm. Proc. File No. 3-17762 (proceeding against the firm alleging violations of Advisers Act Section 206(4); resolved with a consent to a cease and desist order and the payment of $170,000 in disgorgement and prejudgment interest).
Fraudulent trading: SEC v. Dean, Civil Action No. 1:17-cv-00139 (S.D.N.Y. Filed January 9, 2017) is an action which names as defendants Gregory Dean and Donald Fowler, both registered representatives at now defunct brokerage firm J.D. Nicholas & Associates, Inc. from January 2007 through November 2014. The firm previously settled actions with FINRA and the States of Connecticut, Arkansas and New Hampshire tied to excessive trading. For 27 customer accounts the two registered representatives utilized the same trading strategy – a high volume trading approach which purchased a stock and held it no longer than two weeks regardless of price movement. Virtually no due diligence on this approach was conducted prior to implementing it. As a result the typical account had costs of over $1 million while suffering losses of close to $1.4 million. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending.
In the Matter of Biomet, Inc., Adm. Proc. File No. 3-17771 (January 12, 2017) is a proceeding naming as a Respondent the international medical device company. In June 2015 the firm was acquired by Zimmer Holdings, Inc. whose shares are listed on the NYSE. Previously, Biomet’s shares had been registered with the Commission. The Order, and a parallel proceeding by the DOJ, center on paying bribes in Mexico and using a prohibited distributor in Brazil. Specifically, from 2008 through 2013 the firm, through a subsidiary and third party customs brokers, made unlawful payments to Mexican customs officials to facilitate the importation of unregistered and mislabeled dental products. From 2009 to 2012 the firm improperly recorded transactions involving the use of a certain distributor in Brazil who had previously been determined to have made improper payments to physicians.
In 2012 the firm resolved FCPA charges with the SEC and the DOJ. With the Commission, the firm consented to the entry of a permanent injunction based on the bribery and books and records and internal controls provisions of the Exchange Act and agreed to the appointment of an independence compliance monitor for a period of three years. With the DOJ the firm entered into a deferred prosecution under which a monitor was supposed to certify that the company had complied with its obligations to bolster its compliance programs. Although the agreement was extended for a year the monitor was unable to certify compliance.
To resolve the DOJ action Zimmer Biomet entered into a deferred prosecution agreement that acknowledges responsibility for criminal conduct. Jerds Luxembourg Holding, S.AR.l., the direct parent company of Bioment 3i Mexico – the subsidiary involved in the wrongful conduct — pleaded guilty to FCPA books and records violations. The parent agreed to pay a criminal fine of $17,460,300.
In the Commission’s action the Order recites the facts regarding the DOJ settlement. In addition, Biomet consented to the entry of a cease and desist order based on its admissions in the criminal case, of Exchange Act Sections 13(b)(2)(A), 13(b)(2)(B) and 30A. The firm will also pay disgorgement in the amount of $5,820,100, prejudgment interest and a civil penalty of $6.5 million. A monitor will also be appointed.
In the Matter of Cadbury Limited, Adm. Proc. File No. 3-17759 (January 6, 2017). Cadbury is a U.K. based distributer of confectionaries and snack beverages. Its shares were listed on the NYSE at the time the firm was acquired by Respondent Mondelez International, Inc., on February 2, 2010. Cadbury’s shares were delisted later in 2010. Mondelez at the time was known as Kraft Foods.
Prior to its acquisition Cadbury conducted business in more than 30 countries, including India. In November 2009 the firm decided to increase production capacity in that country. To assist with the implementation of the project the firm decided to retain Agent No. 1. Following meetings with the company in January 2010 and after obtaining two quotations from Agent No. 1, Cadbury India employees in Baddi where the project would take place recommended retention of the agent. No additional due diligence was undertaken. Shortly thereafter the Agent began work. A letter authorizing the representation was executed by Cadbury India on February 23, 2010.
Between February 10, 2010 and July 2010 Agent No. 1 submitted five invoices totaling $110,446. The Order quotes the invoices as stating that the services were for “providing consultation, arrange statutory/government prescribed formats of applications to be filed for the various statutory clearances, documentation, preparation of files and the submission of the same with govt. authorities” for specific licenses. The actual license applications were prepared by employees in the local subsidiary, according to the Order. Cadbury India obtained some of the licenses and approvals for the project.
At the time of the February 2, 2010 acquisition, Mondelez was unable to conduct complete pre-acquisition due diligence. Later in the year substantial, risk based post-acquisition compliance was conducted. That work did not identify the relationship with Agent No. 1. In late 2010 the firm conducted an internal investigation related to Agent No. 1. The relationship was terminated. Mondelez took extensive remedial actions.
The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).
The proceeding was resolved with each Respondent consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Respondent Mondelez will pay a penalty of $13 million.
Land sale bribery scheme: Ban Ki Sang and Joo Huyun Bahn, father and son, were each charged with one count of conspiracy to violate the FCPA, three counts of violating the FCPA and one count of conspiracy to commit money laundering. The charges center on an $800 million deal for a 72 story building in Vietnam during the period 2013 –2015. The deal that was supposed to result in a multimillion dollar commission for Manhattan real estate broker, defendant Bahn, and capital for the father’s Korean construction company. Key to the deal was a $2 million bribe of a foreign official. The first installment of the bribe — $500,000 – was to be paid by agent Malcolm Harris to the official. In reality Mr. Harris did not know the official; he misappropriate the bribe money. Mr. Harris was charged with one count of wire fraud and one count of conducting monetary transactions in illegal funds and one count of aggravated identity theft.
Venezuela Bribery schemes: Juan Jose Hernandex Comerma and Charles Beech pleaded guilty to charges in connection with a bribery scheme to secure contracts from Venezuela’s state owned and controlled energy company, Petroleos de Venezuela S.A. or PDVSA. Each defendant pleaded guilty to one count of conspiracy to violate the FCPA. In addition, Mr. Comerma pleaded guilty to one count of violating the FCPA. Mr. Hernandez admitted to paying bribes, along with others, from 2008 to 2012 while the general manager and later partial owner of a firm, to PDVSA purchasing agents. Mr. Beech admitted to essentially the same type of conduct for the period 2011 to 2012.
Remarks: Robert W. Cook, President and CEO of FINRA, delivered remarks to the SIFMA Compliance and Legal Society at the Harvard Club, New York, NY (January 10, 2017). His remarks focused on his “listening tour” with respect to members and efforts of the regulator to be engaged and transparent (here).