This Week In Securities Litigation (Week ending June 10, 2016)
The elements of an insider trading claim continued to be a key focus this week. The first circuit, following prior circuit precedent, held that a personal benefit based on a long term friendship and a steak dinner was sufficient, noting that its standard varied from Newman and perhaps Salaman. Significantly, the court noted that the “knew or should have known” standard for mens rea and in SEC Rule 10b-5-2 were civil standards inapplicable in criminal cases – but the issue was waived in this case.
The SEC and DOJ resolved two FCPA actions. The DOJ declined prosecution, consistent with its Pilot Program. The SEC entered into NPAs with each firm.
Finally, the SEC brought a number of enforcement actions this week. One action involved the security of customer data at a Wall Street firm; another centered on the sale of unregistered securities by a foreign owned government entity; and one centered on insider trading allegation involving three deals where only one was successfully completed but the trader profited on all three because of other events.
Rules: The agency adopted Trade Acknowledgement and Verification Rules for Security-Based Swap Transactions (here).
Remarks: Chairman Timothy Massad delivered the Keynote Address before the Global Exchange and Brokerage Conference, New York, New York (June 9, 2016). His remarks focused on an additional proposed clearing mandate, oversight of major market participants and position limits (here).
Remarks: Chairman Timothy Massad delivered remarks to the CCP12 Founding Conference and CCP Forum, Shanghai, China. His remarks focused on progress in implementing clearing mandates, the efforts of the agency regarding clearing houses, risk management and resolution plans (here).
MOU: The agency entered into an MOU with the European Securities and Markets Authority Related to Recognized Central Counterparties.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 2 civil injunctive actions and 6 administrative proceedings and 2 NPAs, excluding 12j and tag-along proceedings.
Insider trading: SEC v. Ma, Civil Action No. 5:16-cv-03131 (N.D. Cal. Filed June 9, 2016) is an action against Guolin Ma, a Chinese national who resides part time in California. This action centers on the August 14, 2014 announcement made before the open of the market that a consortium which included a Chinese private equity fund and the Chinese Investment Fund, a China state owned investment fund, would acquire OmniVision Technologies, Inc. Prior to that announcement Mr. Ma, an optical physicist, was engaged by the private equity firm as a consultant on the deal. After learning about the proposed transaction he purchased shares. Following the deal announcement the share price increased about 15%. Defendant had unrealized profits of $367,387. The complaint alleges violations of Exchange Act Section 10(b). To resolve the action the defendant agreed to disgorge his trading profits, pay prejudgment interest and a penalty equal to the amount of the disgorgement. See Lit. Rel. No. 233564 (June 9, 2016).
Manipulation: SEC v. Dynkowski, Civil Action No. 1:09-361 (D. Del.) is a previously filed action centered on a penny stock manipulation. Previously the court granted summary judgment against defendant Gary Heath. This week the final judgment was entered enjoining Mr. Heath from future violations of Securities Act Section 5 and directing the payment of disgorgement of $83,245.20, prejudgment interest and a penalty equal to the amount of the disgorgement. Mr. Heath was also barred from participating in any penny stock offering. See Lit. Rel. No. 23563 (June 9, 2016).
Compliance: In the Matter of Morgan Stanley Smith Barney LLC, Adm. Proc. File No. 3-17280 (June 8, 2016). Respondent Morgan Stanley Smith Barney is a registered broker-dealer and investment adviser. The firm is a wholly owned, indirect subsidiary of Morgan Stanley. The action centers on the Safeguards Rule which requires broker-dealers and investment advisers registered with the SEC to, in essence, maintain the integrity of customer information and data. Morgan Stanley Smith Barney maintains hundreds of computer applications containing customer information protected by the rule in connection with its wealth management business. Two portals available through those applications are concerned here. They supposedly were restricted. Those restrictions were ineffective. Over ten years the firm failed to test them. As a result employee Galen March accessed the portal and misappropriated data regarding about 730,00 customer accounts associated with approximately 330,000 different households between 2011 and 2014. He transferred the data to a personal server located at his home. Between December 15, 2014 and February 3, 2015 portions of the data stored on Mr. Marsh’s personal server was posted to at least three internet sites, purportedly for sale to a third party. Morgan Stanley Smith Barney discovered the data in one of its routine internet sweeps. Mr. Marsh denied posting the data, although he acknowledged accessing the firm system and taking it. A forensic analysis of Mr. Marsh’s personal server demonstrated that a third party likely hacked into it and copied the customer data. Morgan Stanley Smith Barney began notifying customers of the breach in January 2015. The Order alleges violations of Rule 30(a) of Regulation S-P. To resolve the proceeding the firm consented to the entry of a cease and desist order based on the Rule cited in the Order and to a censure. Morgan Stanley Smith Barney will also pay a penalty of $1 million.
Financial fraud: In the Matter of IEC Electronics Corp., Adm. Proc. File No. 3-17278 (June 8, 2016) is an action which names as Respondents the firm, Ronald Years, the former controller of subsidiary Southern California Braiding, Inc., and Donald Doody, the former executive v. p. of operations for the firm. The Order alleged that IEC falsified its financial statements for the third quarter of 2012, fiscal 2012 and the first quarter of 2013. This resulted from conduct at subsidiary Southern California. Specifically, the individual respondents are alleged to have made false entries regarding the subsidiaries’ work-in-progress inventory or WIP. Messrs. Years and Doody made the entries to meet the budgeted gross profit margins. Mr. Years also failed to consider the percentage completion of WIP and thus capitalized too many weeks of labor and overhead costs. This resulted in a material understatement of cost of goods sold, material overstatement of gross profit and net income before taxes in the financial statements. When the entries were discovered the firm was required to restate its financial statements. The Order alleges violations of Exchange Act Sections 10(b), 13(a), 12(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the action each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order except that the order as to the company does not include Section 13(b)(5). The firm will pay a penalty of $200,000 Mr. Years is denied the privilege of appearing or practicing before the Commission as an accountant. Mr. Doody is prohibited from serving as an officer or director of an issuer for five years. In addition, Mr. Years will pay a penalty of $40,000 while Mr. Doody will pay disgorgement of $26,368, prejudgment interest and a penalty of $25,000.
Sale unregistered securities: In the Matter of Ethiopian Electric Power, Adm. Proc. File No. 3-17281 (June 8, 2016) is a proceeding against the firm, a government owned power company based in Addis Ababa, Ethiopia. Between 2011 and 2014 the firm sold bonds in the U.S. to help finance the construction of a hydroelectric dam in Ethiopia. The bonds were offered on the website of the embassy, through road shows and other means. The Order alleges violations of Securities Act Sections 5(a) and (c). To resolve the proceeding Respondent 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. The firm also agreed to pay disgorgement of $5,847,804 and prejudgment interest. The funds are to be put into a fund for investors.
Financial fraud: In the Matter of Miller Energy Resources, Inc., Adm. Proc. File No. 3-16729 (June 7, 2016) is a previously filed proceeding naming as Respondents the firm, Paul Boyd, David Hall and Carlton Vogt. The Order alleged that the firm acquired certain oil and gas assets for $2.25 million in cash, along with the assumption of certain liabilities it valued at about $2 million in a bankruptcy auction. Subsequently, the company valued those assets at $480 million and recognized a one-time “bargain purchase” gain of $277 million for its third quarter of January 2010 and the fiscal year ended April 2010. The Order alleges that the firm failed to properly value the assets in accord with GAAP and violated Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Previously, the firm settled, consenting to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). It also agreed to pay a penalty of $5 million. This week each of the executives settled under separate orders. Mr. Boyd settled under an Order that alleged violations of Securities Act Section 17(a) and Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). He consented to the entry of a cease and desist order based on those sections and is denied the privilege of appearing and practicing before the Commission as an account with the right to request reinstatement after five years. He will also pay a civil penalty of $125,000. Disgorgement was waived based on financial condition. See also In the Matter of Miller Energy Resources, Inc., Adm. Proc. File No. 3-16729 (June 7, 2016)(alleged violations of Rule 102(e) as to Mr. Vogt; resolved with an order denying Respondent the right to appear and practice before the Commission as an accountant with the right to apply for reinstatement after three years); See also In the Matter of Miller Energy Resources, Inc., Adm. Proc. File No. 3-16729 (June 7, 2016)(alleged violations of Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(2) as to Mr. Hall; consent to the entry of a cease and desist order based on the cited sections and agreed to pay a penalty of $125,000; undertook not to serve as an officer or director of an issuer for five years).
Fraudulent fees: SEC v. Kingdom Legacy General Partner, LLC, Civil Action No. 2:16-cv-00441 (M.D. Fla. Filed June 7, 2016) is an action against the investment adviser and its principal, Mark Northrop. Beginning in late 2010 the defendants are alleged to have offered shares in the firm in three classes to investors, raising about $3 million. While investors were told that the fees charged would be 2% per year and an incentive allocation fee of 20% on profits, they were not told that on one class an additional 40% of profits would be charged and 50% on another. Investors were falsely told that the defendants had a successful track record and that the Northrop family was the largest investor in the firm. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The action is pending. See Lit. Rel. No. 23560 (June 7, 2016).
Audit failure: In the Matter of Frazer Frost, LLP, Adm. Proc. File No. 3-17112 (June 7, 2016) is a proceeding which names as Respondents the PCAOB registered audit firm and Susan Woo and Miranda Suen, respectively the engagement partner and manager on the third quarter 2010 review of China Valves Thechnology, Inc. and that firm’s 2011 year-end financial statements. In 2010 China Valve misled investors about its acquisition of Watts Valve (Changsha) Co., Ltd. and in 2011 materially overstated its income and understated liabilities incurred by subsidiary Shanghai Pudong Hanwei Valve Co, Ltd. In conducting the quarterly review Respondents omitted key information regarding the identity of the seller, the role of an undisclosed related party, the structure of the deal and the allocation of assets and liabilities. In conducting the year end audit the firm correctly recognized that the company had ineffective internal controls but then impermissibly relied on company representations and failed to extend its procedures. The Order alleged violations of Rules 2-02(b) and 2-06 under Regulation S-X. The firm and Ms. Woo consented to the entry of a cease and desist order based on the Rules cited in the Order. Frazer Frost will also be denied the privilege of appearing and practicing before the Commission with the right to apply for reinstatement after five years and will pay a penalty of $50,000. Ms. Woo was denied the privilege of appearing and practicing before the Commission with the right to apply for reinstatement after three years and will pay a penalty of $5,000. Ms. Suen consented to the entry of a cease and desist order based on Rule 2-06 of Regulation S-X. She is denied the privilege of appearing and practicing before the Commission with the right to apply for reinstatement after one year and will pay a penalty of $1,000.
Audit failure: In the Matter of Silberstein Ungar PLLC, Adm. Proc. File No. 3-17277 (June 6, 2016) is a proceeding which names as Respondents the PCAOB registered audit firm; Ronald Silberstein, the engagement partner for all but one of the audits here; Joel Ungar, the engagement quality reviewer on seven of the engagements; Seith Gorback, an equity partner in the firm who functioned as a manager on four of the engagements; and David Kobylarek, also a partner in the firm but who functioned in the role of a manager on six of the audits. The Order alleges that each Respondent repeatedly engaged in improper professional conduct that resulted in violations of professional standards and which demonstrated a lack of competence to practice before the Commission. This conduct occurred with respect to nine issuer clients. The firm also violated, and the individual Respondents aided and abetted violations of, Exchange Act Rule 2-02(b)(1) of Regulation S-X by issuing opinions representing that their work on the engagements was in accord with PCAOB standards when in fact it was not. The Order finds that each of the individual Respondents engaged in unprofessional conduct. To resolve the proceeding Respondents consented to the entry of a cease and desist order based on the Exchange Act Sections 13(a) and 15(d). Respondents are also denied the privilege of appearing and practicing before the Commission. Messrs. Silberstein and Unger may request reinstatement after five years while Messrs. Kobylarek and Gorback may make such a request after three years. In addition, Mr. Silberstein will pay a penalty of $35,000 while Mr. Unger will pay $7,500.
Insider trading: SEC v. Maciocio, Civil Action No. 1:16-cv-04139 (S.D.N.Y. Filed June 3, 2016). Messrs. Maciocio and Hobson were child hood friends. From 1998 through 2014 Mr. Maciocio was employed by PharmaCo. While he held various roles at the firm, eventually he became the Director of Chemical Research and Development. In that role he was often consulted when the firm considered an acquisition and requested to assess if the company could manufacture the products of the potential target. David Hobson was a registered representative at various brokerage firms. One of his clients was long-time friend Michael Maciocio. When he moved firms Mr. Maciocio followed, even if the commission structure was higher. The action centers on three transactions. The first began in January 2008. PharmaCO was interested in a potential deal with Mediavtion Inc. Mr. Maciocio learned about the possible deal and tipped his friend. Both traded and when the deal was announced on September 3, 2008 both sold. Mr. Hobson had profits of $100,169. The second transaction involved Ardea Biosciences, Inc. When Mr. Maciocio learned about the deal he tipped Mr. Hobson. Both acquired shares. After the company decided not to proceed both sold portions of their shares. Ten days later, however, Mr. Hobson purchased an additional thirty Ardea call options, increasing his holdings. Three days later, on April 23, Ardea announced its acquisition by AstraZeneca before the market open. Both men profited. The third transaction involved Furiex Pharmaceuticals, Inc. It began in February 2014. As with the first two, Mr. Maciocio tipped his friend when he learned about the deal. Both purchased stock. Eventually the firm declined to go forward but another bidder stepped in and purchased the company. Both men profited. The Commission’s complaint alleges violations of Exchange Act Section 10(b). The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal charges against Mr. Hobson. Mr. Maciocio previously pleaded guilty to one count of conspiracy and two counts of securities fraud. The SEC’s action is pending. See Lit. Rel. No. 23561 (June 8, 2016).
The DOJ declined prosecution of, and the SEC entered into a non-prosecution agreement with, Akamal Technologies, Inc. The firm provides cloud services for delivering, optimizing and securing online content and business applications. Its shares are listed on NASDAQ Global Select Market. Akamal (Beijing) Technologies, Co. Ltd. is a wholly-owned subsidiary of Akamai in Beijing.
Under China’s regulatory system Akamai-China is required to contract with a third party channel partner to deliver services to end customers. From at least 2013 through 2015 the Regional Sales Manager of the subsidiary schemed with the firm’s channel partner to bribe employees of three firms, two of which were state owned enterprises. To effectuate the scheme the channel partner paid money to the Regional Sales Manager who in turn used portions of the funds to provide expensive gifts to the employees of the firms. Overall about $155,500 was paid to employees of end customers, including about $38,500 in cash to government officials. During the same period gifts worth about $32,000 were given to officials in violation of firm policies. As evidenced by the payments to officials, the firm’s compliance procedures were inadequate.
Akamai self-reported the matter in late December 2014. The misconduct was discovered through a complaint from an employee of the subsidiary. The firm took immediate action to halt the conduct. The sales manager was put on administrative leave and later resigned. The firm also terminated its relationship with the channel partner and undertook a comprehensive review of its compliance programs, implementing remedial measures. In addition, Akamai cooperated with the SEC’s investigation and, in connection with the non-prosecution agreement, paid disgorgement of $662,452 along with prejudgment interest. DOJ declined prosecution, consistent with its Pilot Program.
The DOJ also declined prosecution of, and the SEC entered into a non-prosecution agreement with, Nortek, Inc. The firm manufactures and sells a variety of products for residential and commercial constructions and remodeling. Its shares are listed on NASDAQ Global Select Market. Linear Electronics (Shenzhen) Co. was its indirect, wholly owned subsidiary which manufactured products for Nortek from 2009 through 2014.
During the period Nortek owned the subsidiary, it systematically made improper gifts to local Chinese officials. Those included cash, gift cards, meals, travel, accommodations and entertainment. In some instances the accounting department entered the illicit payments as entries in various accounts and supported them with false information and documentation. The subsidiary had inadequate internal controls.
After learning of the bribes Nortek took immediate action to end the practice. Those involved were terminated. Significant remedial steps were taken. The firm also cooperated with the SEC’s investigation. In connection with the non-prosecution agreement the firm will pay disgorgement of $291,403, along with prejudgment interest, that was paid to secure preferential treatment. The DOJ declined prosecution consistent with its Pilot Program.
Suitability: The regulator fined Oppenheimer & CO. $2.9 million for unsuitable sales of non-traditional ETFs. In August 2009 FINRA issued a notice advising broker-dealers of the risks and inherent complexities of certain non-traditional ETFs. Oppenheimer instituted policies prohibiting its representatives from soliciting retail customers to purchase these instruments and selling them to customers who did not meet certain qualifications. The firm, however, failed to implement the procedures. It also failed to establish adequate supervision or conduct sufficient due diligence regarding the risks and features of non-traditional ETFs.
Court of Appeals
Insider trading: U.S. v. Parigian, No. 15-1994 (1st Cir. Decided May 26, 2016). Douglas Parigian was indicted for insider trading along with his golfing friend, Eric McPhail. The two men were alleged to have traded in advance of earnings announcements regarding American Superconductor Corporation. The information traced to unnamed Insider who was a friend of Mr. McPhail. Mr. McPhail misappropriated it, disseminating the information. Much of the information was circulated in emails. One expressly cautioned the recipients to keep quiet about the information. The indictment also alleged that Mr. Parigian was aware that his information source knew an executive at American Superconductor. Mr. McPhail did not trade. The indictment claims, however, that he solicited “getting paid back” through wine, steak and similar items. After his motion to dismiss the indictment was denied, Mr. Parigian pleaded guilty. His plea agreement preserved the right to appeal the denial of the motion. Subsequently, he was sentenced to time served and three years of supervised release with eight months of home confinement.
The circuit court considered three issues, rejecting each. First, the court considered a question regarding the sufficiency of the allegations regarding mens rea and whether the “knew or should have known” standard was sufficient in a criminal case. While the court indicated it was not, the issue was waived. The second point the court considered is whether the indictment adequately alleged that the defendant knew or should have known that the tips were made in breach of a duty of trust and confidence. The misappropriation theory only requires a breach of a “duty of trust and confidence.” SEC Rule 10b-5-2 phrases this standard in terms of “knows or reasonably should know” which again is a civil standard. This issue, like the first, was waived however.
The final question involves the personal benefit to the tipper. Dirks required that the government establish the tipper benefited directly or indirectly from his disclosure. Previously, the circuit held that evidence establishing that the “misappropriator and the tipper were business and social friends with reciprocal interests allowed a jury to find a benefit in the form of the misappropriator’s reconciliation with a friend and the maintenance of a useful networking contact.” See, e.g., SEC v. Rocklage, 470 F.3d 1 (1st Cir. 2006). Although this standard is drawn from civil actions it is applicable here. Since the indictment alleged that Messrs. Parigian and McPhail were “reasonably good friends” and that there was a benefit of “various tangible luxury items in return for the tips” it is adequate under the prior decisions of the circuit. In reaching this conclusion the court noted that the second circuit in Newman and the ninth in Salman had adopted different standards.
Standards: The Australia Securities Investment Commission banned for one year Wayne Meadth, formerly of Australia and New Zealand Banking Group from 2004 through March 2014. The firm reported him for breach of competency standards. The regulator determined that Mr. Meadth had failed to provide 11 clients with written documentation of his recommendations about their investment portfolio. This action was part of the ASIC’s Wealth Management Project which seeks to enhance the conduct at the largest financial advice firms.
Insider trading: Oliver Curtis was found guilty of insider trading after a three week trial. He entered into an arrangement with convicted insider trader and tipper John Hartiman. As part of the agreement Mr. Curtis entered trades on 45 occasions between May 1, 2007 and the end of June 2008. Mr. Hartman was employed as an equity dealer at Orion Asset Management Ltd. Mr. Curtis was procured to trade in contracts for difference on the basis of inside information furnished by Mr. Hartman about the trading intentions of Orion. In return the two men shared the profits. Mr. Curtis is awaiting sentencing.
Insider trading; Michael Hull was sentenced to serve 17 months imprisonment after pleading guilty to insider trading. He had traded in the shares of three firms based on inside information obtained from a close friend employed at a global investment bank.
Trading: The regulator issued a report on multi-venue trading and, specifically traders that place trades in more than one venue and then cancel. While this practice resulted in an increase in liquidity it also meant that a certain amount of liquidity visible in order books is ultimately not available, according to the report (here).
Suitability: The Financial Conduct Authority banned Mark Kelly, a financial adviser with PCD Wealth Management and Patrick Gray, one of his advisers, from the financial services business for a lack of integrity. Specifically, the regulator determined that from August 2008 until July 2010 Mr. Kelly invested customer pension funds in risky investments without their knowledge or consent. He also obtained some money from product providers. Overall he invested funds for about 350 customers totaling £24 million. Mr. Gray provided investment advice to at least five customers without having any qualifications to do so. He also furnished them with misleading information and furnished with pension reports that contained false information. Neither individual could be fined because at the time of the conduct they were not approved persons.