This Week in Securities Litigation (Week ending November 8, 2013)

SAC Capital agreed to plead guilty this week. Under the terms of the deal the firm will plead guilty to each count in the indictment, pay a total fine of $1.8 billion and placed on probation for five years during which time it will be supervised by a monitor. The action does not resolve the pending SEC case against Mr. Cohen or terminate the investigations.

The Commission filed a settled action against RBS Securities Inc. for misleading investors in the sale of residential mortgage backed securities. The agency also filed another settled case tied to the municipal bond market. It is the first action in which the Commission has imposed a penalty on a municipal issuer. In addition, the SEC also brought to offering fraud cases and a Rule 102(e) action against an audit firm, two of its partners and an audit manager.


Remarks: Commissioner Daniel M. Gallagher addressed the FINRA Enforcement Conference, Alexandria, Va. (Nov. 7, 2013). His remarks focused on the role of the SEC’s enforcement division as part of a capital markets regulator (here).

Remarks: Chair Mary Jo White addressed PLI’s 45th Annual Securities Regulation Institute, New York, New York (Nov. 6, 2013). Her remarks reviewed accomplishments of the various divisions that typically do not receive significant attention (here).


Remarks: Chairman Gary Gensler addressed the FIA 2013 Futures & Options Expo (Nov 6, 2013)(here). His remarks reviewed the transformation of the market place under Dodd-Frank.

Proposed rules: The Commission reissued its position limit rules for comment (here). An earlier version had been remanded by the District Court. At the time the Rules were issued Commissioner Bart Chilton announced that he would be stepping down shortly.

SAC Capital

The Manhattan U.S. Attorney’s Office announcement an agreement with the SAC Capital Companies under which the four entities named in an indictment will plead guilty to the charges against them and resolve the parallel civil forfeiture case. U.S. v. S.A.C. Capital Advisors, LP, Case No. 13 cr 541 (S.D.N.Y.); U.S. v. SAC Capital Advisors, LP, Civil Action No. 13 Civ. 5182 (S.D.N.Y.). The five count indictment named as defendants: S.A.C Capital Advisors, LP, S.A.C. Capital Advisors LLC, CR Intrinsic Investors, LLC and Sigma Capital Management, LLC. It contains one count of wire fraud and four counts of securities fraud. The indictment is essentially a roll-up of key insider trading cases involving current and former S.A.C Capital personnel tied to claims that the organization has inadequate compliance procedures and a corrupt culture.

Under the terms of the deal the SAC Companies will pled guilty to all of the counts in the indictment and pay a financial penalty of $1.8 billion. That sum represents a $900 million criminal fine and a $900 in the criminal forfeiture case. The defendants will be given credit for the $616 million paid earlier to resolve an SEC civil insider trading case. The companies will also terminate their investment adviser registrations with the SEC. Finally, the defendants will be on probation for five years. During that period they will implement insider trading compliance procedures which will be supervised by a monitor. The guilty pleas only resolve charges for the defendants, not any individuals or the pending SEC proceeding which names Mr. Cohen as Respondent

SEC Enforcement – filed and settled actions

Weekly statistics: This week the Commission filed, or announced the filing of, 3civil injunctive actions and 3 administrative proceedings (excluding follow-on actions and 12(j) proceedings).

Market crisis: SEC v. RBS Securities Inc., Civil Action No. 3:13-cv-01643 (D. Conn. Filed Nov. 7, 2013). The action, against the broker-dealer subsidiary of Royal Bank of Scotland plc, centers on the sale of certificates of a residential subprime mortgage security known as Soundview Home Loan Trust 2007-OPT1. The offering materials used to market those interests were false and misleading, according to the Commission. The materials contained a representation from Option One, from whom RBS purchased the mortgages, which represented that they were “generally” written in accord with the customary standards. In fact about 30% of them were not. RBS knew, or should have known, this fact because during a rushed closing on the transaction in which it purchased the mortgages, due diligence was done by a retained third party. The review demonstrated that a substantial portion of the instruments sampled did not conform to the applicable guidelines. RBS eliminated the substandard mortgages, closed the deal and the mortgages went to Soundview. By simple extrapolation from the sample, RBS knew, or should have known, that the claims regarding the underwriting standards in the offering materials were false. The complaint alleges violations of Securities Act Sections 17(a)(2) & (3). The firm settled the action. It consented to the entry of a judgment, without admitting or denying the facts in the complaint, which directs the pay of disgorgement in the amount of $80.3 million, prejudgment interest and a civil penalty of $48.2 million. See Lit. Rel. No. 22866 (Nov. 7, 2013); SEC Press Release, “SEC Charges Royal Bank of Scotland Subsidiary” (Nov. 7, 2013).

Unprofessional conduct: In the Matter of Sherb & Co., LLP, Adm. Proc. File No. 3-15609 (Nov. 6, 2013) is a proceeding based on Rule 102(e) of the Commission’s Rules of Practice alleging unprofessional conduct. It names as Respondents the audit firm, Steven Sherb, its managing partner, firm partners Christopher Valleau and Mark Myclo and audit manager Steven Epstein. The proceeding centered on the audits the firm performed: On the financial statements of China Sky One Medical, Inc. or CSKI for the fiscal year 2007; the 2010 yearend financial statement of China Education Alliance, Inc. or CEU; and, for Wowjoint Holdings Ltd., for the years ended August 3, 2008 and 2009, for a four month transition period ended December 31, 2009 and the years ended December 31, 2010 and 2011. Each issuer conducted its operations in the PRC.

Previously, the Commission filed an injunctive action against CSKI alleging misstatement of its revenue and net income in its Form 10-K for 2007. This proceeding alleges essentially that there was an audit failure. The engagement was not properly planned, a contract auditor was retained to do much of the work but was not properly supervised and that the work raised red flags that were not properly investigated. The charges with respect to the CEU engagement are similar. Again the Order alleges what is essentially an audit failure: the audit engagement was not properly planned and supervised; the auditors failed to obtain sufficient evidential matter through inspections, observation, inquiries; and they failed to take basic steps such as securing confirmation of bank account balances. The Wowjoint engagements followed the same pattern. Again there was a failure to adequately plan the engagement; the team did not test the revenue computations of the company; there was inadequate inquiry and procedures regarding the cash basis accounting of the company; inadequate tests were conducted regarding the collectability of Wowjoint’s large, outstanding and aged accounts receivable balance; and there was a failure to maintain the engagement work papers. The Respondents settled with the Commission. The firm and Mr. Mycio consented to the entry of cease and desist orders based on Exchange Act Section 10A(b)(1) and to the entry of orders denying them the privilege of appearing or practicing before the Commission as accountants. Mr. Mycio can apply for reinstatement after five years. The firm will pay a penalty of $75,000. Messrs. Sherb, Valleau and Epstein will be denied the privilege of appearing or practicing before the Commission as accountants. Messrs. Sherb and Valleay may apply for reinstatement after five years. Mr. Epstein may apply after three years.

Municipal bonds: In the Matter of Greater Wenatchee Regional Events Center Public Facilities District, Adm. Proc. File No. 3-15602 (Nov. 5, 2013); In the Matter of Piper Jaffrey & Co., Adm. Proc. File No. Nov. 5, 2013). The former names as Respondents: a municipal corporation formed by nine cities and counties to fund a Regional Center; Allison Williams, the Executive Services Director of Wenatchee, Washington who executed the closing certificate for the bond issue; Global Entertainment Corporation, the developer of the Regional Center; and Richard Kozuback, Global’s CEO and President. The latter names as Respondents the underwriter of the bonds involved here and Jane Towery, a Managing Director at Piper.

In 2006 the District began formulating plans for a Regional Center. Global developed a series of financial projections for the operation of the Regional Center over the course of project. The projections were prepared for the budget and inclusion in the District’s Official Statement. In two instances a consultant for the city questioned the projections. In another they were revised to be more optimistic at the behest of the mayor after bond counsel indicated that the offering might not sell. Following the failure of one effort to sell bonds, Piper Jaffrey was retained. By this point in late 2008 the City and the District were searching for solutions. Finally, an offering of short term bonds was sold. They were to be refinanced two years later by selling long term bonds. The offering materials contained the most recent projections, statements about the credit of the City and a certification that all material information had been furnished. Investors were not told about the concerns of the consultants regarding the projections, the actions of the mayor which resulted in a revision or that a passage discussing the limitations on the credit of the city had been deleted from the offering materials. In 2011 the District defaulted on the outstanding $41.77 million short term instruments which had been issued. The State legislature then passed a sales tax to assist. In late September the District sold long term bonds secured by the sale tax revenues to refinance the short term instruments. The Order alleges that the Official Statement for the short term instruments was false and misleading as was the certification of full disclosure. It alleges violations of Securities Act Sections 17(a)(2) and (3).

The Respondents in both proceedings settled. The District undertook to establish appropriate policies, procedures and internal controls, institute training and certify completion of these steps to the Commission. It also consented to the entry of a cease and desist order based on Securities Act Section 17(a)(2) and a directive to implement the undertakings and pay a civil money penalty of $20,000. Ms. Williams and Mr. Kozuback both consented to the entry of cease and desist orders based on Securities Act Section 17(a)(3). Each will each pay a civil penalty of $10,000. Piper revised its due diligence procedures and Ms. Towery agreed to implement undertakings which include limiting her activities as an associated person of a securities professional and to retain a consultant to review Piper’s municipal underwriting due diligence policies and procedures. In addition, the firm and Ms. Towery each consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. The firm will pay a penalty of $300,000 while Ms. Towery will pay $25,000. This is the first proceeding in which a civil penalty was imposed on a municipal issuer.

Offering fraud: SEC v. Pedras, Civil Action No. CV 13-07932 (C. D. Cal. Filed under seal on Oct. 28, 2013) is an action which names as defendants Christopher Pedras, his partner Sylvester Gray, lead sales agent Alicia Bryan and several companies controlled by the individual defendants. The complaint details two schemes. In the first investors were solicited to acquire interests in the Maxum Gold Small Cap Trading Program. Maxum, it was claimed, acted as an intermediary between banks that were not permitted to trade directly with each other. Investors were assured that they would be paid between 4% and 8% monthly and that the investment was safe. Minimum investment was between $5,000 and $10,000 for one program. There were variations of the program that required a larger investment. About 50 investors participated in the program. In fact it was fictitious according to the Commission. When the promised returns could not be paid, the individual defendants moved to scheme two – the FMP Renal Program. Investors were told they could acquire shares of a New Zealand company which expected to be publicly traded. It operated kidney dialysis clinics in New Zealand. Investors from the first scheme were offered the opportunity to convert their shares, become an investor in scheme two and net an instant 80% increase in value. At least eight U.S. investors participated. This deal was also a fraud, according to the SEC. Overall about $2.4 million in investor money was used to make Ponzi type payments to investors while another $2 million was stolen by Mr. Pedras. About $1.2 million was used to pay sales commissions. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). An emergency asset freeze was obtained by the Commission. The case is pending. See Lit. Rel. No. 22862 (Nov. 5, 2013).

Offering fraud: SEC v. Wang, Civil Action No. CV 13-07553 (C.D. Calif. Filed under seal Oct. 15, 2013) is an action against Yin Nan Wang, Wendy Ko, Velocity Investment Group, Inc. which is controlled by the two individual defendants, a series of entities controlled by Investment Group and Rockwell Realty Management, Inc. Beginning as early as 2005 the defendants raised about $9.8 million from 2,000 investors, selling promissory notes issued through Velocity. The company was supposed to be in the real estate business. While apparently it did own real estate, the complaint alleges that its business model was not sustainable because it assumed that the funds raised would be available for operations. In fact large portions were used to pay fees and other items. As a result defendants sought to conceal the true financial condition of the company. In part they did this by making what they admitted were Ponzi type payments to earlier investors from funds obtained from more recent investors. In part they sought to conceal the financial condition of the company by entering into a series of what appear to be meaningless transactions with Rockwell. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending.

Manipulation: SEC v. Geranio, Civil Action No. CV12-04257 (C.D. Cal.) is a previously filed action against Nicholas Geranio, the Good One, Inc. and Kaleidoscope Real Estate Inc. centered on a $35 million scheme to manipulate the shares of several companies whose securities were sold through boiler rooms. The Court entered a final judgment by consent against the defendants. That judgment prohibits future violations of the antifraud provisions of the federal securities laws, directs Mr. Geranio and the two companies to pay, on a joint and several basis, to pay disgorgement of $2,135,000 along with prejudgment interest and a $500,000 civil penalty. The judgment also bars Mr. Geranio from acting as an officer or director of any public company and directs him to pay an additional $279,000 in disgorgement plus prejudgment interest which is the sum received by another defendant, provided that the SEC does not obtain a double recovery. Finally, the order directs relief defendant BWRE Hawaii, LLC to pay, jointly and severally with Mr. Geranio and the other two corporations, an additional $240,000 in disgorgement plus prejudgment interest. See Lit. Rel. No. 22865 (Nov. 7, 2013).


Report: A report by the U.S. China Business Council, titled Best Practices for Managing Compliance in China, provides insight into practices which can assist companies doing business in the high risk environment of the PRC. The Report is based on a survey of, and conversations with, 30 companies doing business in China in a wide variety of areas. It contains a discussion of current compliance procedures being used by firms conducting business in the PRC. Topics addressed include the structure of compliance operations, local law issues, entertainment expenses, approval processes for entertainment, social responsibility activities and training.


Reporting: The regulator announced that it had fined TD Ameritrade Clearing, Inc. $1,150,000 and SG Americas Securities, Inc. $675,000 for failing to report, or accurately report, certain large options positions. From May 2007 through January 2010 TD Ameritrade failed to properly aggregate certain reportable positions as acting-in-concert. This impacted nearly 4,100 accounts. It also resulted in the firm failing to report about 1.4 million positions. In addition, the firm failed to establish and maintain reasonable supervisory procedures and supervisory systems to ensure compliance.

Likewise, from December 2007 through January 2013, SG Americas failed to report OTC options positions in about 500,000 instances, failed to report the counter-party positions or incorrectly reported its customers’ ITC options positions in over 600,000 instances. It also failed to report or misreported OTC index options positions in over 900,000 instances. In addition, the firm failed to establish and maintain reasonable supervisory procedures and supervisory systems to ensure compliance.


Economic analysis: The board announced that it is establishing a Center for Economic analysis. It will evaluate the role and relevance of the audit in capital formation and investor protection. The Center’s Founding Director will be economist Luigi Zingales, a professor at the University of Chicago.


Manipulation: CFTC v. Wilson, Civil Action No. 13 Civ 7884 (S.D.N.Y. Filed Nov. 6, 2013) is an action against DRW Investments, LLC, a subsidiary of DRW Holdings, LLC, an organization which trades for its own account, and it CEO and manager, Donald Wilson. The complaint alleges that the defendants manipulated the price of a futures contract known as IDEX USD Three-Month Interest Rate Swap Futures Contract, traded on the NASDAQ OMX Futures Exchange. In the summer of 2010 the firm acquired a position in the three month contract with a notional value of over $350 million. The value of the portfolio hinged on the daily settlement rates for the contract. That rate was determined each day using a methodology which was based on collecting various data, including bids and offers for the instrument that were placed electronically in the market by participants during a preset period of the day. By late 2010 the defendants determined that the price for their portfolio was not rising as expected. Accordingly, during the fifteen minute pricing period it began entering bids that were then over those existing in the markets with no intent on closing them – a form of “banging the close.” Using this procedure the defendants were able to crate an artificial price for the three month contract for at least 118 trading days. The complaint alleges violations of Sections 6(c) and 9(a)(2) of the Commodity Exchange Act. The case is in litigation.

European Commission

Benchmark rates: The European Commission announced its intention to impose fines on Deutsche Bank, JPMorgan, HSBC, Royal Bank of Scotland, Credit Agricole and Societe Generale as a result of its probe into the manipulation of Euribor. Previously the Commission imposed fines on Barclays, UBS and Royal Bank of Scotland for manipulating LIBOR.

Parallel inquiries are being conducted in the U.S. by the DOJ and the CFTC. Fines have been imposed on Dutch financial giant Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., ICAP Europe Limited, The Royal Bank of Scotland, UBS AG and Barclays Plc for manipulating benchmark interest rates. These investigations are continuing.


Derivatives: BaFin announced a joint initiative on derivatives with the Bank of England, the FDIC and FINMA. The purpose of the initiative is to ensure that possible “supervisory measures aimed at ensuring the orderly resolution of an institution do not give counterparties the right to no longer meet obligations arising from existing derivatives agreement . . .”

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