Significant events this week included the proposal by the SEC of additional swaps rules regarding security-based swap dealers and major participants. Enforcement settled a “suspicious trading” insider trading action with a Hong Kong based entity while initiating a case against an investment adviser alleging fraud. In addition, CFTC Commissioner Chilton addressed the question of high speed trading, outlining a proposal for regulating the practice. Finally, a district court issued a ruling defining the scope of privilege under SOX for materials relating to an inspection of an audit firm by the PCAOB under the Act.
Swaps: The SEC proposed rules for Security-Based Swap Dealers and Major Security-Based Swap Participants. The proposals call for capital, margin, and segregation requirements for security-based swap dealers and major security-based swap participants (here).
Remarks: SEC Commissioner Luis Aguilar addressed the Securities Enforcement Forum 2012, Washington, D.C. (Oct. 18, 2012) in remarks titled: Taking a No-Nonsense Approach to Enforcing the Federal Securities Laws. The Commissioner’s remarks focused on individual accountability, maximum deterrence and recidivists. They concluded with a call for SEC self-funding (here).
SEC Enforcement: Filings and settlements
Statistics: This week the Commission filed 3 civil injunctive actions and no administrative proceedings (excluding tag-a-long and 12j proceedings).
Insider trading: SEC v. Well Advantage Ltd. (S.D.N.Y.) is a “suspicious trading” action filed against the Hong Kong based company. It centered on the acquisition of Canadian owned oil assets by Chinese oil company Nexen. Well Advantage purchased a large stake in Nexen shortly before the deal announcement. The complaint claimed that the defendant is indirectly owned by Zhang Zhi Rong, a Hong Kong business man who controls a number of companies at least one of which has close ties to CNOOC, China’s largest producer of crude oil and natural gas. This week the company agreed to settle with the Commission, consenting to the entry of a final judgment prohibiting future violations of Exchange Act Section 10(b). It will also pay disgorgement of $7,122,633.552 along with prejudgment interest and a penalty in the same amount.
Financial fraud: SEC v. Monterosso, Civil Action No. 07-61693 (S.D. Fla.) is an action against former employees of GlobeTel Communications, Joseph Monterasso, an executive, Timothy Huff, CEO, Lawrence Lynch, CFO, and Luis Vargas, employee. The complaint alleged that over a four year period beginning in 2002 the defendants engaged in a scheme to falsify the revenue of the company. This week the court affirmed an earlier magistrate ruling on remedies as follows: Mr. Huff was ordered to pay $1.5 million in disgorgement plus prejudgment interest and a $1.21 million penalty; Mr. Lynch was ordered to pay a $780,000 civil penalty; Mr. Monterosso was directed to pay $675,000 in disgorgement plus prejudgment interest, a $300,000 penalty and was barred from serving as an officer or director of a public company; and Mr. Vargas was ordered to pay $657,000 in disgorgement plus prejudgment interest and a $150,000 penalty.
Investment fund fraud: SEC v. Lunn, Case No. 1:12-cv-02767 (D. Colo. Filed Oct. 18, 2012) is an action against Geoffrey Lunn, Darlene Bishop and Vincent Curry. The complaint alleges that beginning in February 2010, and continuing for the next year, the defendants raised over $5.77 million from at least 70 investors for the Dresdner .44 Magnum Leveraged Financing Program. Under this program, named to be similar to a large German bank, investors were told that if they put up $44,000 it would become $2 million within 10 to 12 business days. In fact as defendant Bishop admitted in testimony, “It was a con, basically.” The money was never invested. Rather, it was diverted to various uses. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a), and, in addition, to Exchange Act Sections 10(b) and 15(a). The case is in litigation.
Fraudulent valuation: SEC v. Yorkville Advisors, LLC, Civil Action No. 12 CIV 7728 (S.D.N.Y. Filed Oct. 17, 2012) is an action against registered investment adviser Yorkville Advisor, LLC and two of its principals, founder Mark Angelo and CFO and COO Edward Schinik. The adviser managed three funds using a strategy which called for money to be put into privately negotiated structured equity and debt in public and private companies. The funds received investments structured in a variety of ways.
Yorkville’s ability to understand the valuation of its investments was critical to its strategy and results. Traditionally it used a method called the “Yorkville Method” which was supposed to be GAAP compliant. As the market crisis unfolded and there was difficulty selling securities it obtained as part of the investments, the defendant altered the valuation method. While it claimed the new method was GAAP compliant it was not — many investments were simply carried at book. This inflated the value of the assets and the adviser’s fees. Misrepresentations were also made to prospective investors to lure them into putting their money in the funds. Those concerned the collateral underlying certain securities obtained as investments, the liquidity of the Funds and their internal procedures. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisors Act Sections 206(1) and (2) and 204(4). It also alleges control person liability under Exchange Act Section 20(a). The case is in litigation.
Unregistered broker/touting: SEC v. The Investors Registry, LLC, Civil Action No. 2:12-cv-02214 (D. Ariz. Filed Oct. 16, 2012) is an action against the company and its owner, Michael Southworth. Beginning in 2007 Mr. Southworth sold hundreds of memberships in the company which was represented to be an investment club focused on pre-IPO shares. He then solicited members to purchase the shares, acting as an unregistered broker for five issuers. He also failed to disclose his compensation. The complaint alleged violations of Securities Act Section 17(b) and Exchange Act Section 15(a). The defendants settled the charges, consenting to the entry of a permanent injunction based as to each defendant on Exchange Act Section 15(a) and as to Mr. Southworth on, in addition, Securities Act Section 17(b). Both defendants agreed to be barred from participating in the offering or sale of a penny stock for three years. Mr. Southworth will also pay disgorgement of $217,755 along with prejudgment interest with all but $100,000 waived based on his financial condition. No penalty was sought for the same reason. See also Lit. Rel. No. 22511 (Oct. 17, 2012).
High speed trading: CFTC Commissioner Bart Chilton, addressing the 2012 Allegro Customer Summit in Dallas, Texas on October 16, 2012, outlined a proposal for regulating high speed trading in remarks titled “Texas Hold ‘Em – Time to Fold ‘Em” (here). The Commissioner offered a six point plan: 1) Registration: High speed traders should register; 2) Testing: Traders should be required to test their programs before they are employed; 3) Kill switches: Traders should be required to have a kill switch in the event something goes wrong – a proposal the SEC and CFTC are currently working on; 4) Wash blocker technology: There should be pre-trade controls which prevent the traders from engaging in wash or cross trades with themselves which are already illegal; 5) Compliance reports: Traders and their officers should be required to execute compliance reports and be accountable for false or misleading information; and 6) Penalties: Traders should be accountable in damages for any loses they cause from rogue activities.
Defying SEC order: The regulator expelled EKN Financial Services, Inc. for allowing its CEO Anthony Ottimo to act as a supervisor after being barred from serving in that capacity by the SEC and for numerous regulatory violations related primarily to anti-money laundering violations. From 2008 through 2011 Mr. Ottimo acted in a supervisory role despite an SEC order barring him from such a position. In addition, EKN and Messrs. Ottimo and Guiliano committed numerous anti-money laundering violations including failing to establish an adequate compliance program.
Privilege: Bennett v. Sprint Nextel Corporation, Case No. 11-90144 (W.D. MO.). In an order and opinion dated October 10, 2012, the court defined the scope of privilege under SOX Section 105. That provision applies to certain materials related to a Board inspection of an audit firm. It provides in part: “[A]ll documents and information prepared or received by or specifically for the Board, and deliberations of the Board and its employees and agents, in connection with an inspection under section 104 . . . shall be confidential and privileged . . .” The court held that “the privilege protects those who are under investigation from being required to divulge their responses to that investigation . . . [but] does not extend to documents from the underlying transaction or work . . . “ That privilege extends beyond materials held by the board to include those in the hands of the audit firm and includes internals documents of that firm prepared for or as part of the inspection.
Bid-rigging: U.S. v. Carollo, Case No. 1:10-cr-00654 (S.D.N.Y. Filed July 27, 2010). Three former executives of General Electric Co., Dominick Carollo, Steven Goldberg and Peter Grimm were sentenced to prison following their conviction on bid-rigging charges. Mr. Carollo was sentenced to serve 36 months in prison, Mr. Goldberg 48 months and Mr. Grimm 36 months. The three men were involved in separate fraud conspiracies with various financial institutions and insurance companies for conduct that took place from 1999 through 2006. During the period they participated in schemes under which the auctions conducted for the use of municipal funds that came largely from bond sales were rigged.
Investment fund fraud: U.S. v. Efrosman, Case No. 1:06-cr-0095 (E.D.N.Y. Filed Feb. 16, 2006). Aleksander Efrosman, investment manager of Century Fund, Inc. and AJR Capital, Inc., pleaded guilty to wire fraud. From January 2004 through June 2005 he solicited investors for his trading stop loss scheme in which he claimed losses from trading in securities and forex would be limited to no more than 3%. In fact he took the $3 million raised and used it for his personal benefit. Sentencing has not been scheduled.
Investment fund fraud: U.S. v. Matinovich (E.D. Va.). Jeffrey Martinovich was named in an indictment alleging 26 counts of mail fraud, wire fraud, unlawful monetary transactions and bankruptcy fraud. In 2007 Mr. Martinovich started three hedge funds. For one he used the money raised to purchase three million shares of a privately held solar company. Rather than have the shares valued each year to assess his fees he simply inflated the worth of the shares and charged his fees. Eventually the solar company went bankrupt as did the fund. The case is pending.