The SEC and the DOJ resolved another bid-rigging case related to anticompetitive practices in the municipal securities markets. This is one of a series in an ongoing investigation. The SEC also prevailed on a summary judgment motion in an investment fraud action, filed a settled financial fraud case and another investment fraud action.
The PCAOB announced that a joint delegation from the Board and the SEC will meet shortly with their counter parts in China to discuss a mutual cooperation arrangement regarding the inspection of Board registered audit firms in the country.
Finally, a jury verdict in an SEC enforcement action was reversed by the D.C. Circuit. The court concluded that venue was not proper in the case.
SEC enforcement – litigated cases
Investment fund fraud: SEC v. Locke Capital Management, Inc., Civil Action No. 09-CV-100 (D.R.I.) is an action against the company, a registered investment adviser, and its founder and chief investment operator, Leila Jenkins. The complaint centers on allegations that about $1.2 billion of the $1.3 billion the fund claimed to have under management is fictitious. The claims were apparently made to induce investors to invest in Locke Capital Management. The underlying case, which began with an SEC staff inspection, centered on a claim by Locke that $1.3 of its $1.4 billion in assets were from a Swiss investor. According to the SEC that investor was fictitious. The Court granted summary judgment in favor of the Commission. It entered a final judgment of permanent injunction prohibiting Ms. Jenkins from violating Securities Act Section 17(a), Exchange Act Section 10(b), and Advisers Act Sections 206(1), 206(2) and 207. The judgment also orders her to pay disgorgement of $1,781, 520 plus prejudgment interest and a civil penalty in the amount of the disgorgement. Locke previously defaulted. Accordingly, the Court entered a similar injunction against the company which includes Advisers Act Section 204 but not Section 207. The company is jointly and severally liable for the payments.
SEC enforcement – filings and settlements
Bid rigging: SEC v. J.P. Morgan Securities LLC, Civil Action No. 11-cv-03877 (D.N.J. July 7, 2011). This is the latest action brought by the Commission as part of an on-going investigation by the SEC and the DOJ into anticompetitive practices in the municipal securities markets. These cases concern the competitive bidding process regarding the temporary investments made by municipalities of funds obtained from the sale of municipal securities prior to the actual use of the funds. IRS regulations require that those funds be invested at fair market value which is typically established through a competitive bidding process. As in other cases, defendant J.P. Morgan won bids for these investments through practices such as “last looks” under which they reviewed the bids of others before submitting their bid, or because of a “set up” in which the biding agent obtained non-winning bids from others. In other instances the firm facilitated the bid rigging of others. As a result the firm won bids for at least 41 municipal reinvestment instruments and submitted at least 52 purposely non-winning bids between 1997 and 2005. To resolve the charges the firm consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 15(c)(1)(A). The firm also agreed to pay $11,065,969 in disgorgement along with prejudgment interest and a penalty of $32.5 million. See also In the Matter of James L. Hertz, Adm. Proc. File No. 3-14455 (July 7, 2011)(former J.P. Morgan executive who pleaded guilty to two counts of conspiracy and one count of wire fraud in connection with these transactions consented to the entry of an order barring him from the securities business). The company also resolved criminal charges as discussed below.
Investment fraud: SEC v. Constantin, Civil Action No. 11-CV-4642 (S.D.N.Y. Filed July 6, 2011) is an action against Windham Securities, its owner and principal Joshua Constantin and former firm managing director Brian Solomon which alleges fraud in connection with a private placement. Specifically, the defendants raised more than $1.1 million for investors in Leeward Group, Inc, a company that was suppose to be going public. Rather than invest the money as represented to investors it was funneled in part into other entities and diverted to personal use. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). The case is in litigation.
Financial fraud: SEC v. Raffle, Civil Action No. 1:11-cv-540 (W.D.TX. Filed June 27, 2011) is a settled action against two former senior vice presidents of ArthroCase Corporation, John Raffle and David Applegate. The complaint alleges that between 2006 and the first quarter of 2008 the two defendants improperly inflated the revenue of the company by shipping product to distributors where it was essentially taken as an accommodation although not needed, or when the distributors could not make payment or under similar circumstances. As a result the revenue of the company was overstated by amounts which ranged from $13.5 million in the first quarter of 2008 to as much as $42.7 million in 2007. The company restated its financial statements for the periods involved. The two defendants consented to the entry of permanent injunctions prohibiting future violations of Securities Act Section 17(a), and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(b). The injunction against Mr. Raffle also includes Exchange Act Section 13(b)(5). Mr. Raffle was ordered to pay disgorgement of $1,782,742.43 along with prejudgment interest. Payment of all but $175,000 was waived based on his financial condition. Mr. Applegate was orderd to pay disgorgement of $621,754.60 along with prejudgment interest. Payment of all but $55,000 was waived based on his financial condition. Both defendants will be barred from serving as officers and directors of public companies for five years.
The SEC also settled with Mr. Raffel’s ex-wife, a relief defendant, recovering $200,000 of incentive compensation and profits from the sale of company stock that her former husband obtained during the course of the scheme. The company previously settled with the Commission. In the Matter of Arthrocare Corporation, Adm. Proc. File No. 3-14249 (Feb. 9, 2011)(consenting to a cease and desist from Exchange Act Sections 13(a) and 13(b(2)(B). The resolution was impacted by the substantial cooperation of the company).
Bid rigging: J.P. Morgan Chase: This action is based on the same conduct detailed in the SEC’s complaint discussed above. The firm resolved the action by entering into a non-prosecution agreement. Under the terms of the agreement the firm will pay restitution to the victims of its anticompetitive conduct and cooperated fully with the DOJ’s ongoing investigation. It will also fulfill its obligations to the SEC, IRS Office of the Comptroller of the Currency, the Federal Reserve Board and 25 state attorneys general which variously require the payment of penalties, disgorgement of profits and the payment of restitution.
A joint delegation from the Board and the SEC will meet with representatives of China’s Ministry of Finance and the China Securities Regulatory Commission. The purpose of the meeting is to discuss a cooperative resolution to cross-boarder auditing oversight. This will implement the provisions of the Sarbanes-Oxley Act which require that all public companies whose securities trade on U.S. Exchanges use an audit firm registered with the board. To date the Board has been blocked from conducting the required inspections by China. Currently there are 110 registrants in China and Hong Kong.
Court of appeals
Venue: In SEC v. Johnson, No. 09-5399 (D.C. Cir. June 28, 2011) the Court reversed a jury verdict in favor of the Commission and dismissed the case for lack of venue. The SEC’s claims centered on a financial fraud at PurchasePro.com in 2000 and 2001. During that time period Christopher Benyo served as Senior Vice President for Marketing and Network Development for the company. In early 2000 AOL retained the firm to build an online sales platform. In late 2000 PurchasePro began to document sham transactions with AOL. By the end of the first quarter 2001 two-thirds of the $29.8 million in reported revenue came from either sham referrals or new fraudulent contracts from its dealings with AOL. Eventually the fraud was discovered by the auditors. In January 2005 Mr. Benyo, three other PurchasePro employees and two AOL executives were indicted in the Eastern District of Virginia. Mr. Benyo was acquitted of all charges following a jury trial. In a parallel SEC case however the jury found him liable.
The Circuit Court reversed. Under Section 27 of the Exchange Act venue is proper “in the district wherein the defendant is found or is an inhabitant or transacts business . . . [or] in the district wherein any act or transaction constituting the violation occurred.” The “any act” language of the Section permits a plaintiff to bring suit in any district where any person has committed an act that “constitute[s]” the offense for which the defendant is charged the Court noted. The co-conspirator theory of venue is “a gloss upon and an extension of . . . ” Section 27, according to the Court.
Mr. Benyo claimed that Central Bank of Denver v. First Interstate, 511 U.S. 161 (1994)precludes adding a gloss to the statute such as the co-conspirator theory of venue relied on by the SEC and the district court. Reading the plain language of the statute the Circuit Court concluded forecloses the SEC’s claims because the co-conspirator theory expands venue beyond what the statute authorizes. Here the SEC failed to identify in its complaint or evidence any act or transaction of Mr. Benyo occurring in the District of Columbia that constituted the violations charged. The Court ordered the complaint dismissed without prejudice.