This Week In Securities Litigation (Week ending Oct. 21, 2016)
The Commission filed another action in which admissions were required as part of the settlement. The proceeding named as Respondents a foreign bank and two of subsidiaries. Respondents variously acted as unregistered brokers and/or an unregistered investment adviser while taking steps to mitigate the risk.
The agency also brought an action against an investment adviser which failed to properly value illiquid securities, reimbursed its clients after discovering the error but failed to follow its own procedures in remediating the issue but, nevertheless, represented that the issue was resolved in filings. Finally, the Commission brought actions based on an inadequate audit of a firm which eventually had three restatements of its financial statements, financial fraud and churning.
Remarks: Andrew J. Donohue, Chief of Staff, delivered remarks at the National Society of Compliance Professionals 2016 National Conference, Washington, D.C. (Oct. 19, 2016). His comments focused on the changing role of compliance (here).
Remarks: Marc Wyatt, Director, Office of Compliance Inspections and Examinations, delivered the Keynote address at the National Society of Compliance Professionals 2016 National Conference, Washington, D.C. (Oct. 17, 2016). His remarks discussed a risk based approach to the work of OCIE and the manner in which the division selects what to inspect at a registrant (here).
Remarks: Andrew J. Ceresney, Director of the Division of Enforcement, delivered the keynote address at the Securities Enforcement Forum 2016 (Oct. 13, 2016). His remarks focused on enforcement in the public finance area (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 1 civil injunctive action and 7 administrative proceedings, excluding 12j and tag-along proceedings.
Financial fraud: In the Mater of FCM Technologies, Inc., Adm. Proc. File No. 3-17639 (Oct. 20, 2016) is an action which names as Respondents the firm, a global provider of technology solutions for the energy industry, and two of its former executives, Jeffrey Favret, CPA and Steven K. Croft, CPA, respectively, a segment controller and a reporting manager. The Order is based on a series of improper actions. First, in the first quarter of 2013 Messrs. Favret and Croft made improper adjustments, reversing accruals in an operating segment and thus boosting profits for the period by $800,000. Second, in one segment the two men made an out of period adjustment, correcting a $730,000 error impacting results for the first quarter of 2013, without reporting it as required internally and then singed management representation letters stating that they had not made any out of period adjustments that were over $250,000. Third, Mr. Croft failed to comply with the internal accounting controls of a segment by switching to a new accounting system prior to obtaining assurances that the system would operate effectively. Finally, a segment violated internal accounting controls. The Order alleges violations of Exchange Act Sections 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the proceeding the firm agreed to a series of undertakings and consented to the entry of a cease and desist order based on each Section cited in the Order except 13(b)(5). Each of the former company officers consented to the entry of a cease and desist order based on each Section cited in the Order. In addition, each of the individuals will be denied the privilege of appearing and practicing before the Commission as an accountant with the right to apply for reinstatement after two years. Finally, the firm will pay a penalty of $2.5 million while Mr. Favret will pay $30,000 and Mr. Croft will pay $10,000.
Conflicts: In the Matter of John Leo Valentine, Adm. Proc. File No. 3-17638 (Oct. 20, 2016) is a proceeding which names as a Respondent the President of Valentine Capital Asset Management, Inc., formerly a Commission registered investment adviser. The Order alleges that Mr. Valentine failed to disclose conflicts to clients when recommending that they sell shares of one fund where he had lost the ability to earn commissions while recommending that they purchase shares in another he created where he would be compensated. He also failed to disclose the reason that he terminated custodial arrangements with a firm which terminated its relationship with him in part because of prior Commission proceedings. The Order alleges violations of Advisers Act Section 206(2). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. He is also barred from the securities business and from participating in any penny stock offering for the right to apply for reentry after two years. He will, in addition, pay a penalty of $140,000.
AML: In the Matter of Lia Yaffar-Pena, Adm. Proc. File No. 3-17637 Oct. 19, 2016) is a proceeding which names as a Respondent the former President, CEO and board member of E.S. Financial, a registered broker dealer. While holding those positions from May 2003 through August 2013 Ms. Yaffar-Pena knew, or was reckless in not knowing, that an account at a firm affiliate, permitted 23 non-U.S. citizens to conduct securities transactions without collecting or verifying the identification of the traders in violation of the federal securities laws and U.S. anti-money laundering policies and regulations. The Order alleges violations of Section 17(a) of the Exchange Act. To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. She is also precluded from acting in a supervisory capacity at a U.S. broker dealer and will pay a $50,000 penalty.
Valuation: In the Matter of Calvert Investment Management, Inc., Admin. Proc. File No. 3-17630 (October 18, 2016). Calvert, a registered investment adviser, has served as the adviser to the Calvert Funds, open-ended investment companies. From March 18, 2008 through October 18, 2011 Calvert Funds acquired over $1.2 billion principal amount of Toll Road Bonds which are complex and illiquid securities. In valuing the securities Calvert performed market research and internal modeling. Primarily, however, it utilized an approach based on the output of a third-part analytical tool. Later the firm learned that the analytical tool did not properly value the securities. Calvert reassessed the fair market value, lowering it significantly in 2011. The adviser subsequently announced a price adjustment for Toll Road Bonds held in various taxable bond portfolios. As a result of the improper valuations, from March 2008 through October 2011 the Calvert Funds sold and redeemed fund shares at materially overstated NAVs. On December 27, 2011 Calvert contributed $27 million to the Calvert Funds. The money was distributed to account holders of record as of October 19, 2011. Undistributed amounts were retained by the Funds. While Calvert announced in filings with the Commission that it had fully remediated the valuation issue, in fact in doing so it failed to follow its own procedures. In addition, the Order alleges that Calvert caused prohibited transactions regarding purchases among affiliates and failed to implement appropriate compliance procedures. The Order alleges violations of Advisers Act Sections 206(2) and 206(4) and Sections 17(a) and 34(b) of the Investment Company Act. To resolve the proceeding the firm agreed to a series of undertakings which include recalculating the fair value price as well as the NAV and making appropriate payments to shareholders in accord with procedures specified in the undertakings. In addition, the firm consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. Calvert will pay a penalty of $3.9 million.
Inadequate audit: In the Matter of Ernst & Young, LLP, Adm. Proc. File No. 3-17628 (October 18 2016) is a proceeding which names as Respondents the audit firm and two of its partners, Craig Fronchiewecz, CPA, and Sarah Adams, CPA. The proceeding centers on the audits of Weatherford International for the years 2007 through 2010. Mr. Fronchiewecz and Ms. Adams were, respectively, the coordinating partner and the tax partner on the engagements. Weatherford, during the period, engaged in very aggressive tax planning strategies designed to lower its effective tax rate. When the strategies proved insufficient to reach the target level, certain executives effectively reverse engineered the sought after rate and falsified the firms books and records. Eventually this led to three restatements of the firm’s books and records and a Commission enforcement action as detailed here. The Order alleges that Respondents failed to conduct the proper procedures despite having discovered post-closing adjustments. To the contrary, the audit firm relied on unsubstantiated representations from its client. The Order alleges violations of Exchange Act Sections 13(a) and Rules 12b-20 and 13a-1, 13a-13. To resolve the matter the firm agreed to implement a series of undertakings. Each Respondent consented to the entry of a cease and desist order based on the Section and Rules cited in the Order. The firm also consented to a censure and agreed to pay disgorgement of $9 million, prejudgment interest and a penalty of $1 million. Each individual Respondent is denied the privilege of appearing and practicing before the Commission as an accountant. Mr. Fronckiewicz may apply for reinstatement after two years. Ms. Adams may apply for reinstatement after one year.
Unregistered broker: In the Matter of Bank Leumi le-Israel B.M., Adm. Proc. File No. 3-17631 (October 18, 2016) is a proceeding which names as Respondents the bank, Leumi Private Bank and Bank Leumi (Luxembourg) S.A., both subsidiaries of the bank. The Order alleges that beginning in 2002, and continuing through 2013, the firm acted as a broker dealer for clients in the U.S. without registering with the Commission. During the period certain steps were take to minimize the risk from not having registered. Similarly, from 2002 through 2009 the firm also acted as an investment adviser in the U.S. without first registering with the Commission. During the period certain steps were taken to mitigate the risk from not registering. The Order alleges violations of Exchange Act Section 15(a) and Advisers Act Section 203(a). To resolve the proceeding Respondents admitted to the facts detailed in the Order and that their conduct violated the federal securities laws. In addition, the Bank and Leumi Private Bank each consented to the entry of a cease and desist order based on Exchange Act Section 15(a) and to a censure. Leumi Private Bank consented to the entry of a cease and desist order based on Advisers Act Section 203(a). Respondents will also pay disgorgement of $65,700 which represents the outstanding unpaid balance from a total disgorgement figure of $3,372,700, less $3,307.000 previously paid in disgorgement to the DOJ for related conduct as part of a deferred prosecution agreement. Respondents will also pay prejudgment interest and a penalty of $1,517,715.
Churning: In the Matter of Paul T. Lebel, Adm. Proc. File No. 3-17629 (October 18 2016) is a proceeding which names the registered representative as a Respondent. During the period August 2008 to November 2014 Respondent excessively traded the accounts of four customers, churning mutual fund shares which carried large front-end fees, thereby defrauding them. The commissions paid to Respondent totaled $50,037. The Order alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Section 10(b). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. He is also barred from the securities business and will pay disgorgement of $50,037.00, prejudgment interest and a penalty of $10,000.
Financial fraud: SEC v. Lime Energy Co., Civil Action No. 1:16-CV-8088 (S.D.N.Y Filed October 17, 2016). Lime was in the business of planning and delivering clean energy solutions to facilitate client goals regarding energy efficiency. Four of the firm’s senior officers were named as defendants: James Smith, Julianne Chandler, Joaquin Almeida and Karen Raina. They were, respectively during the period, the executive vice president of operations, the corporate controller, the vice president of operations for the new Utilities Division which is at the center of the actions here and the director of operations for that division. The Utilities Division was the fastest growing segment of the company in 2010. It recognized revenue using the percentage of completion method. In 2010 the firm improperly recognized revenue for which it did not have the supporting data. In 2011 the firm sought to reach certain revenue targets. In doing so it again recognized revenue in violation of its policies and, in certain instances, fabricated revenue. This continued in 2012. In July 2013 Lime filed restated financial results for 2008-2011 and the first quarter of 2012 which were the result of an internal investigation. The company concluded that over $5 million in revenue had improperly been recognized in 2010 and $16 million in 2011. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). Each defendant agreed to settle with the Commission. The firm will pay $1 million. Defendant Smith will pay a $50,000 penalty and be barred from serving as an officer or director of a public company for five years. Defendant Chandler agreed to pay a $25,000 penalty, to an officer/director bar for five years and, in a separate action, to be suspended from appearing and practicing before the Commission as an accountant with the right to apply for reinstatement after five years. Defendant Almeida agreed to a permanent officer/director bar. Defendant Raina agreed to pay a penalty of $50,000. CEO John O’Rourke and then CFO Jeffrey Mistarz reimbursed the company, respectively, $67,728 and $118,196.01 for cash bonuses and certain stock awards received during the period, obviating the need for a SOX clawback action. Lit. Rel. No. 23673 (Oct. 17, 2016).
Reporting error: The regulator fined Merrill Lynch, Pierce, Fenner and Smith, Inc. $2.8 million in connection with systematic trade reporting errors. The errors related to its Order Audit Trail System or OATS reporting. The data is important to FINRA’s market monitoring activities. A system configuration error caused the firm to misreport millions of trades.
Registration: The Securities and Futures Commission reprimanded and fined JP Morgan Securities (Asia Pacific) Limited and JPMorgan Chase Bank, National Association, respectively, $3 million and $2.6 million for regulatory breaches. Those breaches included disclosure failures in research reports and offering offshore index options without the required licenses. The firms also failed to report in a timely manner the breaches as required by the Code of Conduct.
Cybersecurity: The Securities and Futures Commission launched a review to assess the cybersecurity preparedness of brokerage firms. The review consists of a questionnaire, onsite inspections and benchmarking the SFC’s regulatory requirements.