This Week In Securities Litigation (Week ending June 24, 2016)
Merrill Lynch was at the center of actions brought by the SEC and FINRA this week. One action charged the firm with violations of the customer protection rule tied to using customer cash and failing to protect their securities. The settlement included admissions. An action against the individual alleged to have been involved in the violations of the customer protection rule will be set for hearing. A second centered on the sale of structured notes through misrepresentations. FINRA also brought an action against the broker based on the sale of the notes.
The SEC and the DOJ resolved another FCPA action this week. The matter centered on a series of suspicious transactions taken largely in Russia through a distributer, as well as in several other countries. The SEC proceeding was resolved with a cease and desist order based on books and records and internal controls. The DOJ entered into a non-prosecution agreement with the subsidiary involved.
The Commission also filed a number of other actions including: one based on an account intrusion; a cherry picking scheme; two cases centered on municipal bonds; and another based on insider trading by a corporate executive.
Remarks: Commissioner Sharon Bowen addressed the Managed Funds Association Forum 2016 (June 21, 2016). Her remarks focused on corporate governance (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 4 civil injunctive actions and 8 administrative proceedings, excluding 12j and tag-along proceedings.
Customer protection: In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc., Adm. Proc. File No. 3-17312 (June 23, 2016) is a proceeding against the firm and Merrill Lynch Professional Clearing Corp., both of which are registered broker-dealers. The proceeding keys on two allegations: First, violations of Rule 15c-3-3, the Customer Protection Rule, which requires brokers to safeguard customer cash and securities. From 2009 Merrill Lynch used engaged in complex option trades that lacked economic substance to artificially reduce the amount of customer cash deposited in a reserve account. This gave the firm billions of dollars of cash to use for its own activities. The firm also exposed customer securities to its creditors in the event of a firm failure. Second, the firm violated Exchange Act Rule 21F-17 by using language in severance agreements that impeded employees from voluntarily furnishing information to the Commission. The Order alleges violations of Exchange Act Sections 15(c)(3) and 17(a)(1) and the related rules. Merrill Lynch cooperated with the investigation and undertook a series of remedial steps. To resolve the matter Respondents admitted to the facts in the Order and consented to the entry of cease and desist orders based on the Sections and Rules cited in the order and to censures. They will also pay, jointly and severally, disgorgement of $50 million and prejudgment interest. In addition, the parent company will pay a penalty of $385,000,000. See also In the Matter of William Tirrell, Adm. Proc. File No. 3-17313 (June 23, 2016)(action against the person responsible for determining the amounts the firm placed in reserve and the trades; the action will be set for hearing).
Disclosure: In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc., Adm. Proc. File No. 3-17314 (June 23, 2016) centers on the sale of structured notes known as Strategic Return Notes which were issued by the firm’s parent, Bank of America Corporation. About $150 million in these notes, which are tied to a volatility index, were sold to 4,000 retail investor accounts in 2010 and 2011. The disclosures were misleading, making it appear the costs were relatively low and fixed. While certain commissions and fees were disclosed a third was not. The Order alleged violations of Securities Act Section 17(a)(2). The firm resolved the matter, consenting to the entry of a cease and desist order based on the Section cited. It also agreed to pay a penalty of $10 million. See also FINRA Press Release “FINRA Fines Merrill Lynch $5 million for failing to disclose material facts in sales of volatility-linked structured notes to retail customers (June 23, 2016)(fining Merrill Lynch in connection with the sale of strategic return notes to retail customers as a hedge against potential downturns in the equity markets).
Misappropriation: SEC v. MayfieldGentry, Civil Action No. 13-cv-12520 (E.D.Mich.) is a previously filed action against Blair Ackman, W. Emery Matthews and Alicia, former executives at MayfieldGentry Realty Advisors, LLC. The complaint allege that firm founder Chauncey Mayfield misappropriated about $3.1 million from the Police and Fire Retirement System of Detroit. Messrs. Ackman and Matthews and Ms. Diaz settled the action, consenting to the entry of permanent injunctions based on Advisers Act Sections 206(1) and 206(2). Messrs. Ackman and Matthews will each pay a penalty of $50,000 while Ms. Diaz will pay $40,000. The Court entered the orders. See Lit. Rel. No. 23581 (June 23, 2016).
Account intrusion: SEC v. Mustapha, Civil Action No. 16-cv-4905 (S.D.N.Y. Filed June 22, 2016) is an action which names as a defendant Idris Mustapha, a citizen of the U.K. In April and May 2016 Mr. Mustapha made profits of at least $68,000 by hacking into brokerage accounts and causing them to take the opposite position of trades he placed in his accounts. The hacked accounts lost about $289,000 as a result. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Section 10(b). See Lit. Rel. No. 16-cv-4805 (June 23, 2016).
Cherry picking: In the Matter of Simpson Hughes Financial, LLC, Adm. Proc. File No. 3-17308 (June 22, 2016) names as Respondents the registered investment adviser and Mark Simpson. The Order alleges that from July 2010 through January 2011 Respondents engaged in a cherry picking scheme. Securities were purchased through an omnibus account and allocated at the end of the day with the profitable trades going to proprietary accounts and two favored client accounts and the others to disfavored client accounts. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). Each Respondent resolved the action, consenting to the entry of a cease and desist order based on the Sections cited in the Order. The firm was censured and Mr. Simpson was barred from the securities business. In addition, Respondents will, on a joint and several basis, pay disgorgement of $130,450 along with prejudgment interest and a penalty of $150,000.
Municipal bonds: SEC v. Rangel, Civil Action No. 1:16-cv-06391 (N.D. Ill. Filed June 21, 2016). Defendant Juan Rafael Rangel began work at United Neighborhood Organization of Chicago or UNOC as Director of Programs. UNOC is a non-profit that provides management services to UNO Charter School Network, Inc., the operator of 16 charter schools in Chicago. In March 1996 he became UNOC’s CEO and President of UCSN. He was also a member of the board of UNOC and UCSN. Through his position, Mr. Rangel was involved in every aspect of the management of the schools. Between 2005 and 2009 the firm developed a network of charter schools. Increasingly, the firm needed more space. UNO lobbied the state of Illinois for school construction grants. In 2009 the state appropriated $98 million to fund the construction of charter schools for UNO. The next year UNO entered into a grant agreement with the Illinois Department of Commerce and Economic Opportunity or IDCEO. A second grant followed. The grants were for the construction of three schools. Each grant agreement contained a provision regarding conflicts involving the officers and directors of the firms and their family members. At the time of the grants Mr. Rangel was the CEO of UNOC, President of UCSN and a member of the UNOC and UCSN boards. UNO’s COO was Senior Vice President/Chief Operating Officer for UNOC. Mr. Rangel was a good friend of UNO’s COO and his family. In connection with the construction of three schools a Window Subcontractor and Owner’s Representative were engaged to work on the projects. The Window Subcontractor was owned by a brother of UNO’s COO. The Owner’s Representative was owned by another brother of UNO’s COO. IDECO was not notified in writing as required by the agreements. In October 2011 Charter School Refunding and Improvement Revenue Bonds were issued in the principal amount of approximately $37.5 million. The Official Statement disclosed one of the conflicts but not the other. It was signed by Mr. Rangel. Eventually the conflicts were exposed and IDCEO suspended the agreements. The complaint alleges violations of Securities Act Section 17(a)(2). Mr. Rangel resolved the action by consenting to the entry of a permanent injunction based on the Section cited in the complaint and by agreeing to be barred from participating in municipal bond offerings except for his own account. He also agreed to pay a civil penalty of $10,000. See Lit. Rel. No. 23578 (June 21, 2016).
Cooperation: SEC v. Conradt, Civil Action No. 12-cv-8676 (S.D.N.Y.) is a previously filed action against Thomas Conradt arising out of his trading in advance of the take-over by IBM of SPSS Inc. in 2009. In return for an agreement to limit the penalty to his trading profits of $2,533.60, along with the payment of disgorgement and prejudgment interest and the entry of an injunction, Mr. Conradt promised to cooperate with the SEC in its prosecution of Daryl Payton and Benjamin Durant, his co-workers. While his deposition testimony supported the SEC, at trial he substantially watered down his testimony. Accordingly, on a motion by the Commission following its successful action against Messrs. Payton and Durant, the court found that Mr. Conradt breached his cooperation agreement. He was ordered to pay a penalty of $980,229. See Lit. Rel. No. 23577 (June 21, 2016).
Unregistered broker: In the Matter of Steven J. Muehler, Adm. Proc. File No. 3-1636 (June 21, 2016) is a proceeding which names as Respondents Mr. Muehler, the founder of Respondents Alternative Securities Markets Group Corp. and Blue Coast Securities Corp. Neither firm is a registered broker-dealer. Mr. Muehler is subject to a state cease and desist order based on selling unregistered securities and acting as an unregistered broker. Since August 2013 Respondents have offered to assist small businesses seeking to raise money from investors by structuring and preparing securities offerings and walking them through the registration process. In doing this they touted their experience without disclosing Mr. Muehler’s prior regulatory difficulties. The Order alleges violations of Exchange Act Sections 10(b) and 15(a). To resolve the matter Respondents consented to the entry of cease and desist orders based on the Sections cited in the Order. In addition, Mr. Muehler is barred from the securities business. Respondents will also, on a joint and several basis, pay disgorgement of $252,031.39 and pre-judgment. Mr. Muehler will also pay a penalty of $160,000.
Municipal bonds: In the Matter of Felti & Company, Inc., Adm. Proc. File No. 3-17306 (June 21, 2016) is a proceeding which names the registered broker dealer as a Respondent. Between November 2012 and early 2014 Respondent violated the MSRB Rule regarding minimum denominations which is designed to limit sales to retail investors for whom the bonds may not be suitable regarding three different issues in forty-thee transactions. He also failed to explain that rule to the investors and maintain supervisory procedures reasonably designed to prevent these violations. The Order alleges violations of Exchange Act 15B(c)(1) and MSRB Rules G-15(f), G-17, G-27(c) and G-47. Respondent resolved the matter, consenting to the entry of a cease and desist order based on the Section and Rules cited in the Order and to a censure. In addition, he will pay a penalty of $183,128.
Unregistered securities: SEC v. Hemp, Inc., Civil Action No. 2:16-cv-1413 (D. Nev. June 20, 2016) names as defendants the firm, its CEO, Bruce Perlowin, undisclosed co-principal Barry Epling, Jed Perlowin and four additional entities. The complaint alleges that Mr. Perlowin and the other defendants sold hundreds of millions of unregistered Hemp shares that purportedly were unrestricted to the public. At times there were supposedly gifts, consulting agreements and other non bona fide arrangements used to make it appear that the sales were appropriate when they were not. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23575 (June 21, 2016).
Misappropriation: SEC v. Narayan, Civil Action No. 3-16CV1417 (N.D. Tx. Filed under seal May 24, 2016) is an action against Ash Narayan, The Ticket Reserve Inc., Richard Harmon and John Kaptrosky. Mr. Narayan was employed by investment adviser RGT Capital Management Ltd. Through that position he invested $33 million of advisory client capital in The Ticket Reserve without their knowledge or consent. He did not inform the clients that he was a member of the board, owned millions of shares of stock and secretly obtained $2 million in finder’s fees, typically paid from client funds. Messrs. Harmon and Kaptrosky, respectively the CEO and COO of The Ticket Reserve, helped implement the scheme. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). The court entered a freeze order when the complaint was unsealed. The case is pending. See Lit. Rel. No. 23579 (June 21, 2016).
Insider trading: SEC v. Hammon, Civil Action No. 1:16-cv-11148 (D. Mass. Filed June 20, 2016). James Hannon was the Northeast Regional Vice President in 2012 – 2013 of retail chain T.J. Maxx, a division of TJX Companies, Inc. TJX also owned and operated Marshalls Department Stores and HomeGoods. Mr. Hannon received daily emails from the finance division of TJX that contained consolidated daily comparable store sales. The data included the current year’s sales and those of the prior year. He also received monthly emails showing nationwide results on a month, quarter and year-to-date basis. At meetings about HomeGoods stores he received information about those stores as well as superstores in the region — combinations of either T.J. Maxx or Marshalls and HomeGoods stores. Overall Mr. Hannon had financial information about 76% of TJX’s worldwide stores. Beginning in mid-2012, and continuing through early 2013, Mr. Hannon purchased shares of his firm while in possession of inside information on five occasions. Typically he purchased about 5,500 shares just days prior to a firm announcement. Total profits were just over $26,000. The complaint alleges violations of Exchange Act Section 10(b). Mr. Hannon resolved the action, consenting to the entry of a permanent injunction based on the Section cited in the complaint. He also agreed to pay disgorgement of $26,679, prejudgment interest and a penalty equal to the amount of the disgorgement. See Lit. Rel. No. 23574 (June 20, 2016).
In the Matter of Analogic Corporation, Adm. Proc. File No. 3-17305 (June 21, 2016). Analogic Corporation sells advanced medical imaging, ultrasound and security technology systems. Lars Frost, also named as a Respondent by the SEC, is a resident of Denmark. Beginning in late October 2008, and continuing through September 2011, he served as the corporate controller and CFO of BK Medical ApS, a wholly owned Danish subsidiary that sells ultrasound equipment.
The actions center on about 180 suspicious transactions in Russia involving $21.6 million in revenue and another 80, valued at about $3.8 million, in Ghana, Israel, Kazakhstan, Ukraine and Vietnam. The transactions took place from 2001 through early 2011. Analogic’s ultrasound business is largely conducted by BK Medical. Sales are to end users either directly or through distributors. The scheme at the center of the two actions was implemented through distributors. The transactions in Russia are typical. They were implemented in a series of steps: 1) BK Medical and the Russian distributor agreed on the terms of a sale and its actual price after which the subsidiary created a fictitious invoice at an inflated price; 2) the customer service staff created a false invoice; 3) the distributor typically sent BK Medical a proposed contract for the sale at the inflated price; 4) the distributor would pay the inflated price with the actual price being booked and the excess credited to accounts receivable giving the distributor a positive balance; 5) later the distributor would direct BK Medical to make a payment from the accounts receivable balance to a third party located in various parts of the world; the majority of the third party payments were less than the amounts by which the distributor had previously overpaid. A similar procedure was used to implement the scheme in the five other countries involved. The BK Medical CFO personally signed off on 150 of the payments.
The DOJ resolved this matter with BK Medical by entering into a non-prosecution agreement.
The SEC’s Order alleged violations of Exchange Act Sections 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The firm consented to the entry of a cease and desist order based on Sections 13(b)(2)(A) and 13(b)(2)(B). It will pay disgorgement of $7,672,651 and pre-judgment interest. Mr. Frost consented to the entry of a cease and desist order based on the same Sections, and, in addition, Section 13(b)(5). He will pay a penalty of $20,000.