The SEC is about to become entangled in another scandal according to reports in the New York Times this week. The latest involves the destruction of documents according to press reports.
The Supreme Court’s ruling on what constitutes primary liability in Janus does not apply to Securities Act Section 17(a) or Investment Company Act Section 34(b) according to a ruling in an SEC enforcement action. In the expert networking criminal insider trading inquiry a former portfolio manager pleaded guilty. In another criminal case former NASDAQ executive Donald Johnson was sentenced to prison this week for insider trading. FINRA suspended and fined a trader for spoofing and the FSA imposed fines on two former hedge fund managers following the collapse of their fund.
Finally, the PCAOB issued a concept release focused on ways to improve auditor independence. The Board is seeking comment on the question of requiring audit firm rotation.
The new whistleblower program became effective August 12, 2011. Key facets of the program are discussed here.
SEC enforcement – court rulings and decisions
Primary liability: SEC v. Daifotis, No 3:11-cv-00137 (N.D. CA. Filed Jan. 11, 2011)
is an action against Kimon Daifotis, the former lead portfolio manager for Schwab YieldPlus Fund, and Randall Merk, an Executive Vice President at Charles Schwab & Co. The complaint focuses on events during the market crisis in 2007 and 2008 regarding YieldPlus Fund, an ultra-short bond fund that at its peak had $13.5 billion in assets and over 200,000 accounts. It alleges that the defendants made a series of misstatements in connection with the operation of the Fund and that Mr. Daifotis aided and abetted its deviation from the disclosed concentration policies.
On a motion for reconsideration following the decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), the parties agreed that sufficient facts were pleaded to establish primary liability where the statement was attributed publically to one of the defendants. As to another statement the court held however that Mr. Daifotis could not be held primarily liable just because it contained his picture. The complaint failed to plead sufficient facts to establish primary liability under Janus as to other misstatements. However, the court permitted discovery to proceed on all issues including those statements, concluding it would be inappropriate to strike them. Finally, the court also held that Janus does not apply to Securities Act Section 17(a) or Investment Company Act Section 34(b). The former does not use the word “make” which is the lynchpin to Janus. The latter, which precludes making material false statements, in a registration statement does use the word “make.” However, Janus only involved the question of primary violations and is limited by the fact that it considered an implied cause of action. Neither point is applicable here.
SEC enforcement – filings and settlements
Failure to supervise: In the Matter of Timothy M. Gautney et. Al., Adm. Proc. File No. 3-14069 (Aug. 12, 2011) is a proceeding against Robert Bellia and others. Mr. Bellia settled with the Commission. He had been a registered representative with Aura Financial Services, Inc., a registered broker dealer. Mr. Bellia was employed at Aura from June 2007 until August 2009 and served as the manager of a branch office in New York until January 2009. During his tenure he was under heightened supervision because of a FINRA disciplinary history for failure to supervise. While at Aura he failed to supervise two former registered representatives who largely depleted the funds in seven of their customer accounts through improper churning. Although Mr. Bellia received reports on the accounts he failed to follow up. He also failed to implement other supervisory procedures designed to monitor such activity. If he had he taken the appropriate steps he would have discovered that the accounts were being churned. The action was resolved with Mr. Bellia consenting to the entry of an order which bans him from the securities business. The order also bars him from being associated with any penny stock offering. Mr. Bellia was ordered to pay disgorgement of $5,959 along with prejudgment interest. Payment was waived based on financial condition.
Insider trading: U.S. v. Skowron, No. 1:11-cr-00699 (S.D.N.Y.) is an action in which former FrontPoint Partners portfolio manager Joseph Skowron pleaded guilty to a one count information charging conspiracy to insider trade and to obstruct justice. Mr. Skowron obtained inside information from Dr. Yves Benhamou, a French physician who served as a consultant to Human Genome Sciences, Inc. during clinical trials for Albuferon. The drug offered a possible new treatment for hepatitis C. The doctor also worked as a consultant for an expert networking firm through which Mr. Skowron first met him. In early 2008, shortly prior to an announcement by Human genome Sciences that it was terminating part of the trials because of significant adverse effects with two patients, the Doctor informed Mr. Skowron about the pending action. He immediately liquidated the fund’s holding in the shares of the company, avoiding a $30 million loss. Sentencing is scheduled for November 18, 2011. See also U.S. v. Benhamou, 1:11-cr-00336 (S.D.N.Y.); SEC v. Benhamou, Civil Action No. 10-CV-8266 (S.D.N.Y. filed Nov. 2, 2010). In the criminal case Dr. Benhamou pleaded guilty to a four count information. He is scheduled to be sentenced on October 20, 2011. The SEC case is pending.
Insider trading: U.S. v. Johnson, (E.D. Va.) is a case in which Donald Johnson, a former managing director of NASDAQ Stock Market, pleaded guilty to one count of securities fraud. From 2006 through 2009 he purchased and sold shares in NASDAQ-listed companies based on inside information he obtained through his position as an executive at NASDAQ. This week he was sentenced to 42 months in prison and ordered to forfeit $755,066. The SEC has a related suit pending against Mr. Johnson in Southern District of New York.
Market manipulation: Trader Robert T. Bunda was suspended for a period of sixteen months, fined $175,000 and required to pay restitution of $171,740 for engaging in manipulative conduct. Mr. Bunda maintained multiple brokerage accounts outside his firm according to the regulator. Using those accounts he engaged in a market manipulation known as spoofing, a technique in which small limit orders are placed through one account to improve the National Best Bid or Offer and then a larger order is placed through another account which takes advantage of the improved price. Following that order the initial one is cancelled. Mr. Bunda is alleged to have repeated this technique over 4,000 times.
The PCAOB issued a concept release soliciting comments by mid-December on “ways that auditor independence, objectivity and professional skepticism can be enhanced, including through mandatory rotation of audit firms.” Specifically, the Board is considering whether the time period during which an audit firm can serve as the outside independent auditor for a client should be limited, that is, if firms should be required to terminate an engagement after a fixed period and rotate. Those favoring the concept contend it would free the audit firm to a large degree from the effects of client pressure. Those who disfavor it argue that the cost may be prohibitive and audit quality may suffer.
Investment fund fraud: The FSA banned Michael Visser and Oluwole Fagbulu from the securities business and imposed fines on each of, respectively, £2 million and £100,000 in connection with their roles in the failure of Mercurius International Hedge Fund. Mr. Visser, the former CEO of the adviser, violated the concentration restrictions of the fund which resulted in it being invested in largely illiquid securities. To conceal this he manipulated the NAV by engaging in fictitious transactions. Mr. Fagbulu, the former CFO of the adviser, failed to properly supervise its activities and furnished investors with false information. At one time the fund had €35 million under management. To date nothing has been recovered for investors.