The Commission prevailed on summary judgment in an action against a broker which alleged he misappropriated client funds. The agency also filed actions centered on: an audit failure; the EB-5 immigration program; undisclosed conflicts; a failure to have supervisory procedures regarding known conflicts; and a financial fraud.
Whistleblowers: The SEC awarded $300,000 to a company employee who performed audit and compliance work for the firm. After the firm failed to take action the employee reported the matter to the Commission. It resulted in an enforcement action.
SEC Enforcement – Litigated Actions
Misappropriation: SEC v. Richards, Civil Action No. 1:130CV-1729 (N.D. Ga.) is an action against registered representative Black Richards. Since at least 2008 Mr. Richards is alleged to have misappropriated about $1.7 million from seven investors. The Court granted summary judgment in favor of the Commission. A permanent injunction prohibiting future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2) was entered. An order was also entered directing the payment of disgorgement and prejudgment interest in the amount of $1,829,923.21 along with a civil penalty of $80,000. The Court adopted the Commission’s proposed findings. See Lit. Rel. No. 23075 (August 28, 2014).
SEC Enforcement – Filed and Settled Actions
Statistics: This week the SEC filed 1 civil injunctive action and 4 administrative proceedings, excluding 12j and tag-along-actions.
Audit failure: In the Matter of Eugene M. Egeberg III, CPA, Adm. Proc. File No. 3-15680 (September 4, 2014) is a proceeding which names as a Respondent the CPA. The Order centers on his engagements for Fox Petroleum, Inc. for the fiscal years ended February 28, 2010 through 2012 and for RPM Advantage, Inc. for the fiscal years ended December 31, 2006 through 2010. The Order essentially alleges a complete audit failure as to each company for each year. For example, with regard to Fox in 2010 and 2011, Respondent failed to perform any audit tests or procedures to determine the accuracy of the company’s financial statements. Although he identified unrecorded liabilities as a potential fraud risk, his concerns were allied because of “overhauled financials.” He also failed to contact the prior auditor as required. For RPM Respondent failed to document any audit procedures he performed on the balances on the financial statements. Likewise, for two subsidiaries acquired by Fox, Mr. Egeberg issued his opinions in only 40 hours, making it implausible that he did a proper audit. In fact Mr. Egeberg had no audit training. The Oder alleges violations of Section 102e(1) of the Commission’s Rules of Practice and Exchange Act Section 10(b). To resolve the proceeding Mr. Egeberg consented to the entry of a cease and desist order based on Exchange Act Section 10(b). He was also denied the privilege of appearing or practicing before the Commission as an accountant. In addition, he will pay disgorgement of $112,250, prejudgment interest and a civil penalty of $15,000.
Investment fund fraud: SEC v. Lee, Civil Action No. 2:14-cv-06865 (C.D. Cal. Filed September 3, 2014) names as defendants two immigration attorneys, Justin Moongyu Lee and his partner Thomas Kent, and the administrator of their law firm and Mr. Moongyu’s wife, Rebecca Taewon Lee. In addition, seven entities, including Nexland, Inc., founded by Mr. Lee, were named as defendants. The action centers on the EB-5 immigration program. In March 2006 Messrs. Lee and Kent had Kansas Biofuel apply to USCIS for a designation as a regional center under the Immigrant Investor Program. The application identified five potential ethanol projects to be constructed in Kansas. The project was approved. From March 2009 to April 2011 the defendants raised over $11.4 million from twenty-four investors through offerings of limited partnership units in the various entities. According to the offering documents each investor was required to invest $500,000 which was to be used solely for an income generating investment in Nexsun Ethanol, LLC. Contrary to the representations made to the investors, the facilities were not built, although some construction was done. Rather, the defendants provided USCIS with misleading documents which purported to show job creation by Nexsun. Defendants then misappropriated much of the money raised from investors. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). The SEC’s action and a parallel criminal case are both pending.
Conflicts: In the Matter of The Robare Group, Adm. Proc. File No. 3-16047 (September 2, 2014) names as Respondents the registered investment adviser, its founder, Mark Robare, and a limited partner, Jack Jones. The allegations in the Order focus on an undisclosed arrangement between the adviser and its Broker. Robare Group, which offers portfolio management services, has from inception used the Broker for execution, custody and clearing services for advisory clients. The adviser recommends that its client invest in several mutual funds offered on the Broker’s platform. In 2004 Robare Group and the Broker entered into a Commission Schedule and Servicing Fee Agreement. The agreement provided in part that the adviser would recommend No Transaction Fee funds offered on the Broker’s platform. In return the Broker would pay from 2 to 12 basis points to the adviser. That agreement remained in effect until late 2012 when a new Investment Advisor Custodial Support Services Agreement was executed. It also provided that the Broker would pay the adviser for clients that invested in its funds.
The initial agreement was not disclosed in the adviser’s Form ADV until December 2011. That Form ADV did, however, identify the conflict of interest. It also stated that the adviser “may” receive compensation when it fact it was being paid. Later the disclosure was later modified to reference the custodial arrangement. It stated that the advisor’s arrangement may be a conflict with regard to recommending the Broker for custody. The filing failed to identify the incentive regarding the funds. The Order alleges violations of Advisers Act Sections 206(1), 206(2) and 207. The proceeding will be set for hearing.
Conflicts/supervision: In the Matter of Structure Portfolio Management, L.L.C., Adm. Proc. File No. 3-16046 (August 28, 2014) names as Respondents three registered investment advisers, Structured Portfolio, SPM Jr., L.L.C. and SPMIV, L.L.C. Portfolio Management holds a 90% ownership interest in SPM Jr. and later formed SPMIV. By 2006 three funds were advised. Hedge Trader was appointed as the portfolio manager for each fund. For one fund his sole responsibility was to make a profit. For the other two Hedge Trader was tasked with hedging interest rate risk. On a typical day Hedge Trader traded Treasury securities for each for each fund. This created a potential conflict of interest regarding the allocation of the purchases among the three funds. The Compliance Manual stated that trades would be allocated in a fair and equitable manner. Trade blotters were maintained. Those were reviewed by a member of the operations staff on a daily basis. From 2006 through 2009 when one of the funds was closed, concerns were raised regarding the allocation of trades. Although the potential conflict regarding trade allocations which was disclosed, Structured Portfolio failed to adopt and implement written policies and procedures to detect and prevent improper trade allocations, according to the Order. It also failed to adopt and implement written policies and procedures to prevent inaccurate disclosures regarding its funds and their investment strategies. The Order alleges violations of Advisers Act Sections 206(4) and Rule 206(4)(-7). To resolve the proceeding Portfolio Management entered into a series of undertakings which including the retention of an independent consultant, record keeping, notice to clients and a certification of compliance. Each Respondent also consented to the entry of a cease and desist order based on the Section and Rule cited in the Order and a censure. They will also pay, jointly and severally, a penalty of $300,000.
Financial fraud: In the Matter of Lynn R. Blodgett, Adm. Proc. File No. 3-16045 (August 28, 2014) is a proceeding which names as Respondents Lynn Blodgett, the president and CEO of Affiliated Computer Services, Inc., and Kevin Kyser, the CFO of that firm. Affiliated Computer Services provided business process outsourcing and information technology services through two reportable operating segments prior to its acquisition by Xerox Corporation in 2010. ACS established a goal of increasing its internal revenue growth as announced in its Form 10-K for fiscal 2009. In August 2008 an analyst following the firm stated that it was well positioned to meet its internal revenue growth goals. Yet by the end of the first quarter of fiscal 2009 ACS learned that it would fall short of guidance and consensus analyst expectations on this metric. To increase revenue ACS arranged for an equipment manufacture to re-direct about $20 million of pre-existing orders that a manufacturer had already received from another reseller through the firm. At the end of each of the next three quarters ACS entered into similar transactions. The firm reported revenue totaling $124.5 million from these transactions which enabled it to meet disclosed targets. The resale transactions were not recorded in accord with GAAP nor were they properly disclosed. In addition, Messrs. Blodgett and Kyser each were paid a bonus which was tied, in part, to the reported revenue growth of the firm. The Order alleges violations of Exchange Act Section 13(a), 13(b)(2)(A) and 13(b)((2)(B) and the related Rules by each Respondent. To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Mr. Blodgett agreed to pay disgorgement of $351,050 along with prejudgment interest and a civil money penalty of $52,000. Mr. Kyser agreed to pay disgorgement of $133,192, prejudgment interest and a penalty of $52,000.
Financial fraud: U.S. v. Baker, Case No. 1:13-cr-00346(W.D. Tx. ) Michael Baker and Michael Gluk, the former CEO and CFO, respectively of ArthroCare, were each sentenced to serve 20 years in prison following their conviction by a jury on charges of wire fraud, securities fraud and conspiracy to commit wire and securities fraud. The underlying scheme alleged that from late 2005 through early 2009 the two men, and others, inflated sales and revenue at the end of each quarter by shipping product to distributors based on the need to meet street expectations rather than actual sales. Two other executives who previously pleaded guilty, John Raffle and David Applegate were sentenced to serve, respectively, 80 and 60 months in prison.