The Commission got split decisions in court this week. It prevailed in one high profile trial, obtaining a jury verdict in its favor. It lost a significant summary judgment motion regarding the statute of limitations resulting in the dismissal of the case. The ruling may have far reaching effects on the enforcement program. The SEC also brought three insider trading cases this week, one offering fraud action and two matters centered on unregistered broker claims.
The Second Circuit revisited the application of the Supreme Court’s decision in Morrison on the extraterritorial reach of statutes. The Court rejected the so-called “listing theory” which would have permitted suits based on Exchange Act Section 10(b) where the shares were registered on a U.S and foreign exchange.
Remarks: Commissioner Daniel M. Gallagher delivered the Introductory Remarks at The Evolving Role of Compliance in the Securities Industry Presentation, Washington, D.C (May 12, 2014)(here).
Remarks: Commissioner Daniel M. Gallagher addressed the 46th Annual Rocky Mountain Securities Conference, Denver, Colorado. (May 9, 2014). His remarks focused on the question of abuses by dual registered brokers and investment managers and steps being taken through the national exam program to cure difficulties with recidivists (here).
Testimony: Acting Chairman Mark Wetjen testified before the Senate Appropriations Subcommittee on Financial Services and General Government (May 14, 2014). The testimony reviewed the budget needs of the agency (here).
Remarks: Vincent McGonagle, Director of the Division of Market Oversight, testified before the Senate Committee on Agriculture, Nutrition and Forestry (May 13, 2014). His testimony reviewed the self-regulatory responsibilities of exchanges, new regulations relevant to automated markets and the concept release of the agency on system safeguards for automated trading environments (here).
SEC Enforcement – Litigated Actions
Trading: SEC v. Wyly, Civil Action No. 10-cv-5760 (S.D.N.Y. Verdict May 12, 2014) is the action brought against Samuel Wyly, his brother Charles and others. A jury returned a verdict in favor of the Commission and against the brothers in a hotly contested and high profile trial. The complaint detailed a thirteen year fraudulent scheme centered on an elaborate system of trusts and subsidiary companies located in the Isle of Man and the Cayman Island used to conceal the interests of the brothers in Michaels Stores, Inc., Sterling Software, Inc., Sterling Commerce, Inc., and Scottish Annuity & Life Holdings Ltd. The trusts and the related entities were used to cloak their holdings in the issuers, making it appear that the two brothers only stake in each was their small U.S. holdings. During the scheme Samuel Wyly and his brother sold over $750 million of stock in the group of issuers without disclosing their beneficial ownership, according to the Commission. The scheme permitted them to sell in large block trades alone over 14 million shares of stock in the issuers for a profit of $550 million. It also permitted them to make a huge investment in Sterling Software in October 1999 based on inside information, yielding over $31.7 million. The Commission’s complaint alleged violations of Exchange Act Section 10(b), 13(d), 14(a) and 16(a). Judge Scheindlin will hold a hearing to consider remedies.
Statute of limitation: SEC v. Graham, Case No. 13-1001 (S.D. Fla. Ruling May 12, 2014) is an action centered on the unregistered offering of investments in a real estate development called Cay Clubs Resorts and Marinas brought against several of its officers. The scheme supposedly impacted 1,400 investors and raised over $300 million. Beginning in July 2004, and continuing until January 30, 2008, Cay Clubs offered and sold condominium units to private investors as an investment. It guaranteed investors large returns with little risk. When the market crisis unraveled the project sank into bankruptcy and the investors lost. The SEC investigated these transactions for seven years. The agency waited until January 30, 2013, more than five years after defendant’s sale and offering of Cay Clubs units had ceased. A five count complaint was filed alleging violations of the anti-fraud and registration provisions of the federal securities laws.
At the summary judgment stage of the case the Court sua sponte raised and considered the question of whether it had subject-matter jurisdiction to “entertain the SEC’s case against each defendant. Ultimately, the Court concluded that it lacked jurisdiction.
Federal courts possess only the limited jurisdiction granted by Congress, the Court held. While this case has proceeded through discovery and is before the Court on motions for summary judgment, it is still appropriate to consider whether jurisdiction has been properly invoked.
Section 2462 is a jurisdictional statute of limitations the Court found. This conclusion is driven by the plain language of the statute which provides in pertinent part that the “enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued.” In view of this language the Supreme Court in Gabelli v. SEC, 133, S.Ct. 1216, 1220-21 (2013) concluded that the statute defines the last date on which the claim can be brought. After that date the statute directs that the claim “shall not be entertained.” The SEC’s claim that Section 2462 does not apply to the disgorgement, injunctive and declaratory relief it seeks here is incorrect. Indeed, each of the remedies sought is punitive and a penalty or, in effect, a forfeiture. Finally, plaintiffs have the burden of establishing jurisdiction. Here that means the SEC has that burden. It has failed to meet that requirement. The action was dismissed with prejudice.
SEC Enforcement – Filed and Settled Actions
Statistics: This week the Commission filed, or announced the filing of, 4 civil injunctive actions, DPAs, NPAs or reports and 2 administrative proceedings (excluding follow-on and Section 12(j) proceedings).
Unregistered broker: SEC v. Sharafraz, Case No. 14-cv-02252 (May 15, 2014) is an action against Behrooz Sarafraz alleging that he violated Exchange Act Section 15(a) by acting as an unregistered broker. Specifically, from February 2002 through April 2010 he sold interest in TVC Opus In Drilling Program, LP and Tri-Valley Corporation, two entities involved in marketing private placement securities for drilling programs. Over the period about $97 million was raised from about 300 investors for the two entities. At the same time two subsidiaries of Tri-Valley raised nearly $43 million in other securities offerings to many of the same investors. Mr. Sarafraz participated in or helped with the offer and sale of the securities. He was paid about $18.3 million in sales commission. He paid about $1.9 million in referral fees. To resolve the case Mr. Sarafraz consented to the entry of a permanent injunction prohibiting future violations of the Section cited in the complaint. He also agreed to pay disgorgement of $16,406,459, prejudgment interest and a penalty of $50,000.
Unregistered broker: In the Matter of Rafferty Capital Markets, LLC, Adm. Proc. File No. 3-15871 (May 15, 2014) is a proceeding naming the broker dealer as a Respondent. Beginning in May 2009 the firm entered into a written agreement to clear securities transaction from Company A which was not a registered broker dealer. Over the almost one year of the relationship Company A introduced trades in fixed income securities. About 100 trades in asset-backed securities that generated over $4 million in compensation were involved. The firm also failed to keep accurate books and records. The Order alleges violations of Exchange Act Sections 15(a) and 17(a). To resolve the action the firm consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. It also agreed to pay disgorgement of $637,615, prejudgment interest and a penalty of $130,000.
Insider trading; SEC v Cohen, Civil Action No. 3:14-cv-01189 (S.D. Cal. Filed May 12, 2014) is an action against Derek Cohen, Robert Herman and Michael Fleischli, sales managers at Qualcomm Inc. Through work e-mail and a sales meeting each learned that their employer was negotiating to acquire Atheros Communications. Each purchased shares. After the deal announcement on January 5, 2011 Mr. Cohen had trading profits of over $200,000 while Messrs. Herman and Fleischli had profits of, respectively, $30,000 and $3,000. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. A parallel criminal action was filed by the U.S. Attorney’s Office for the Southern District of California. See Lit. Release No. 22991 (May 13, 2014).
Insider trading: SEC v. Lawson, Civil Action No. 3:14-cv-02157 (N.D. Cal. Filed May 12, 2014) is a settled insider trading action against Herbert Richard Lawson, William Lawson and John Cerullo, the founders of Lawson Software, a leading provider of business software. Richard was co-Chairman during 2011 while the other two had retired. In early January 2011 Infor, a privately held software company, approached Lawson Software about a possible acquisition. By mid-February an offer was on the table at $11.25 per share. A “market check” conducted by the firm’s investment bankers revealed that other possible suitors such as IBM, Hewlett-Packard, SAP and Oracle lacked interest. Nevertheless, Reuters reported on March 8 that the firm had retained a financial adviser to explore a possible sale of the company and identified potential acquirers as IBM, Hewlett-Packard and SAP. The share price increased by 13%.
Accordingly, on March 11, 2011 Lawson Software issued a press release confirming that Infor had made an offer at $11.25. Press speculation about other possible suitors continued and the share price inched up. On Saturday March 12, Richard Lawson called his fellow company founders, brother William and John Cerullo. Subsequently, both men sold blocks of company stock. William also called Party A who sold 420,000 shares, about 40% of the family holdings in the stock. When Lawson Software announced the deal at $11.25 per share the share price dropped, closing at $11.06 per share. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Each defendant settled with the SEC. Each consented to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint. Richard Lawson also agreed to pay a penalty of $1,557,384.57, the amount of the ill-gotten gains received by the two men he tipped. In addition, he agreed to be barred from serving as an officer or director of a public company. William Lawson agreed to pay disgorgement of $1,853,671.28, prejudgment interest and a penalty equal to the amount of his disgorgement. His disgorgement included the ill-gotten gains of Trader A. John Cerullo agreed to pay disgorgement of $178,481.29, prejudgment interest and a penalty equal to the amount of his disgorgement. See Lit. Rel. No. 22989 (May 12, 2014).
Unregistered offering: SEC v. Couch, Civil Action No. 3;14-cv-1747 (N.D. Tex. Filed May 12, 2014) is an action against Charles Couch and his firm, Couch Oil & Gas, Inc. From September 2010 through January 2012 the defendants sold interest in two unregistered offerings of oil and gas securities to 200 investors, raising about $9.8 million. In selling those securities the defendants misrepresented the interest in the properties investors would receive, claiming that they would obtain working interests when they did not. Investors were also told their funds would be used for the property development but were not informed that about 30% of the money went to broker commissions. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No 22990 (May 13, 2014).
Insider trading: In the Matter of Christopher D. Wiest, Adm. Proc. File No. 3-15870 (May 13, 2014) is a proceeding which names as a Respondent attorney Christopher Wiest. The proceeding centers on the acquisition by Stanley Black & Decker, Inc. of InfoLogix, Inc., announced on December 15, 2010. On October 21, 2010, after a term sheet for the deal had been signed, Stanley contacted Mr. Wiest to do legal work in connection with the deal. Subsequently, he purchased securities in InfoLogix. On November 18, 2010 he placed a day limit order to sell the 25,000 shares he had acquired. Due to market conditions only part of the block was sold. He then waited until the day after the deal announcement to sell the remainder, earning profits of $56,292 on the remaining 21,490 shares. The Order alleges a violation of Exchange Act Section 10(b). To resolve the proceeding Mr. Wiest consented to the entry of a cease and desist order based on the Section cited in the Order. He also agreed to pay disgorgement of $56,292, prejudgment interest and a penalty equal to the amount of the disgorgement.
U.S. v. Marubeni Corporation, No. 314 cr 00052 (D. Conn.) is an FCPA action against the Japanese trading company. The firm previously pleaded guilty to one count of conspiracy to violate the anti-bribery provisions and seven counts of violating the FCPA. The firm chose not to self-report or cooperate and it did not have an effective compliance and ethics program. The action is based on a years long scheme as detailed here. This week it was sentenced to pay a criminal fine of $88 million.
U.S. v. Sigelman (D.N.J.) is an action charging Joseph Sigelman, the former CEO of Oil Service Company PetroTiger Ltd. with conspiracy to violate the FCPA, conspiracy to launder money and substantive FCPA and money laundering violations. The charges are based on a scheme to bribe an official in Columbia in exchange for assistance in obtaining an oil services contract valued at about $39 million as discussed in detail here. The case is the result of a voluntary disclosure by the company. The action is pending.
Extraterritorial application: City of Pontiac Policemen’s and Firemen’s Retirement System v. UBS AG, No. 12-4355-cv (2ndCir. Decided May 6, 2014) is an action which rejected the listing theory, following Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010). The “listing theory” posited that when a stock is traded on foreign and domestic exchanges Morrisondoes not bar recovery for claims based on transactions on either since the decision only applies to securities “not listed on domestic exchanges.” A related argument contends that if the order for the stock is placed in the United States, but executed on a foreign exchange, recovery is not barred by Morrison. The Second Circuit rejected both claims.
The claims here are against UBS whose shares are listed on a Swiss exchange and the New York Stock Exchange. The complaint centers on the failure of UBS to disclose that it accumulated and overvalued $100 billion in residential mortgage backed securities and collateralized debt obligations between February 13, 2006 and April 23, 2008. The District Court dismissed the shareholder claims on the foreign exchanges based on Morrison and other allegations for failing to properly state a cause of action. The Second Circuit affirmed. In Morrison the Supreme Court was concerned with the location of the securities transaction, not the location of the exchange where a security may have a dual listing. “Morrison’s emphasis on ‘transactions in securities listed on domestic exchanges,’ makes clear that the focus of both prongs was domestic transactions of any kind, with the domestic listing acting as a proxy for a domestic transaction. Indeed, the Supreme Court explicitly rejected the notion that the ‘national public interest pertains to transactions conducted on foreign exchanges and markets.’” Accordingly, the conclusion of the District Court that these claims should be dismissed is affirmed.
The Court also rejected the contention that placing an order for the purchase of a security in the United States is sufficient even though the transaction was effected on a Swiss exchange – a “foreign squared” transaction. Under Absolute Activist Value Master Fund Lt. v. Ficeto, 667 F. 3d 60 (2nd Cir. 2012) a transaction is domestic under Morrison if the parties incur irrevocable liability to carry out the transaction in the U.S. Here the question is whether simply placing the order in the U.S. is sufficient. It is not the Court held. The fact here that the purchaser is a U.S. citizen is not of consequence. Likewise, the fact that the purchaser placed a buy order in the U.S. for execution on a foreign exchange, standing alone, is insufficient to bring the transaction within the reach of the Exchange Act. Again the conclusion of the District Court dismissing the claim is affirmed.
Misstatements: The Australian Securities and Investment Commission fined Australian Mutual Holdings Ltd. $20,400 for two misleading statements relating to two funds it launched. AMU represented that the majority of the assets for each fund were held by the custodian for each fund. In fact that is not correct since the majority of those assets are held in an AMH trading account with the funds’ prime broker.
Supervision: LCL Capital Pty Ltd was found to have inadequate supervisory procedures following an inspection. Specifically, the firm had inadequate procedures to ensure that services were effectively and honestly provided, that representatives complied with the financial services law and had adequate resources and that they were properly trained. The matter was resolved with an enforceable undertaking to implement appropriate procedures.
Insider trading; Two men were arrested on insider trading and other charges. The charges are based on the fact that one defendant was employed at the Australian Bureau of Statistics and made available confidential information prior its public release to the other defendant. That defendant then used the information to enter into foreign exchange derivative products transactions. Between August 2013 and May 2014 this resulted in $7 million in profits.
Algorithmic trading: The Securities and Futures Commission reprimanded Citigroup Global Markets Asia Limited for its failure to ensure that when using its algorithmic trading system to place orders that they did not result in a material increase or decrease of the price of the security. In four instances, between April 2009 and May 2010, the SFC found that the execution of those orders resulted in material changes in the price of the stock. The cooperation of the firm and its agreement to engage an independent reviewer to conduct a forward-looking review of its algorithmic procedures to ensure compliance were considered in resolving the matter.
Manipulation: Emest Fan Wong Hung was found guilty of six counts of false trading in the Mini-Hang Seng Index futures contract between January 25, 2010 and March 31, 2010. On each of the six trading days Mr. Fan placed a series of limit and auction orders in the contracts during the morning pre-market opening period with the intention of effecting a false or misleading appearance with respect to its final calculated opening prices. He was ordered to pay a fine of $59,430, serve 200 hours of community service and not to trade in the contracts for six months without court approval – a “cold shoulder.”