This week the focus is on a New York courtroom and Capitol Hill. In New York the insider trading trial of Raji Rajaratnam, the founder of the Galleon hedge funds got under way. On Capitol Hill the Boston Consulting Group delivered its report on the organization and structure of the SEC to Congress. At the same time Chairman Schapiro and the director of each division testified regarding the SEC’s budget.

SEC enforcement continued this week to focus on insider trading and investment fund fraud actions. FINRA settled a fraud action, expelling a member and barring its CEO. Cornerstone Research issued its latest report tracking class actions.

Market reform

Report on SEC: Boston Consulting Group delivered its report to Congress on the SEC. The report (here) was required by Section 967 of Dodd-Frank. It focuses on the organization of the agency, its personal and technology and relations with the SROs. It notes that there are significant opportunities to further optimize the available resources of the agency despite all of the recent reorganization. Congress must decide in the first instance if this is the approach it wants to take. If not then Congress should relax funding constraints to allow the SEC to better fulfill its current role. Alternatively, it could change the role of the agency to fit the funding.

In four key findings the report recommends that the Commission: 1) reprioritize; 2) reshape the organization; 3) invest in enabling infrastructure; and 4) enhance the SRO engagement mode. The report also notes that the agency has three basic disconnects between: shareholder expectations for the SEC and its authority; between its authorizations and resources; and also between the dynamism of the markets and its rigidities from constraints and culture.

Budget testimony: Chairman Schapiro testified before congress regarding the reorganization of the agency since she became chairman as well as its current budget needs (here). The director of each division also testified on these topics (here).

SEC Enforcement

Market timing: SEC v. O’Meally, Civil Action No. 1:06-cv-06483 (S.D.N.Y.) is an action alleging market timing by four former registered representatives at Prudential Securities. Defendant Jason Ginder agreed to settle with the SEC this week. According to the Commission’s complaint he defrauded funds and their shareholders by assisting clients who wanted to market time. Mr. Ginder is alleged to have aided these clients by opening different accounts and by changing account numbers in an effort to conceal the identity of the trader. To resolve the case Mr. Ginder consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Ginder also agreed to pay a civil penalty of $ 300,000. In addition he agreed to the entry of an order in a related administrative proceeding barring him from the securities business and from participating in any penny stock offering for nine months. Two other defendants in this case previously settled. One defendant is continuing with the litigation.

Financial fraud: SEC v. Espuelas, Civil Action No. 06-CV 2435 (S.D.N.Y. filed March 29, 2006) is an action against eight former officers of StarMedia Natworks, Inc., an internet portal company. The complaint alleges that during 2000 and for the first two quarters of 2001 the filings of the company made with the Commission misrepresented the quality and amount of revenue. The officers were also alleged to have made misstatements to lenders about the financial condition of the company in an effort to secure financing. This week defendant Jack Chen, the cofounder and former president of the company, settled with the SEC. Mr. Chen consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3) and from aiding and abetting violations of Exchange Act Sections 13(a) and 13(b)(2)(A). He also agreed to pay a civil penalty of $100,000. This is the third settlement in this case.

Insider trading: SEC v. Dawson, Case No. 1:11-cv-01615 (N.D. Ill. Filed March 8, 2011) is an action against Joseph Dawson alleging two separate schemes. One is for insider trading. The other is an offering fraud. The insider trading is centers on the acquisition of SPSS by IBM which was announced on July 28, 2009. Prior to the acquisition a distant relative of defendant Dawson learned about the deal in a series of conversations with an SPSS officer. The officer cautioned the relative to keep the information confidential. At one point the officer had the relative fax back to his office a copy of the stand still agreement which was part of the negotiations. The relative told Mr. Dawson about the deal. He purchased options which were sold following the deal announcement at a profit of over $437,000. The second part of the complaint alleges that Mr. Dawson, through his company Dawson Trading, LLC, engaged in an offering fraud through which he raised about $3.8 million from 31 investors by selling promissory notes with a guaranteed rate of return. The representations made in connection with the sale were false. Investors were also provided with fraudulent quarterly account statements. The complaint alleges violations of Securities Act Sections 5 and 17(a) as well as Exchange Act Sections 10(b) and 15(a). The case is in litigation.

Investment fund fraud: SEC v. Beckman, Case No. 11 CV 574 (D. Minn. March 7, 2011) is an action against Jason Beckman and his controlled entity, registered investment adviser Oxford Private Client Group, LLC. The fund is alleged to have had over 1,000 investors who paid in about $194 million. Mr. Beckman raised about $47.3 million from 143 investors over a three year period beginning in August 2006, according to the complaint. Investors were told they were acquiring an interest in the Currency Program which supposedly traded in foreign currencies. Investor funds were to be in segregated accounts with a guaranteed return. Some investors did withdraw their funds, they were paid with contributions from other investors. Mr. Beckman and his wife diverted substantial portions of the investor funds to support their life style. Other portions of those funds were actually traded, incurring huge losses. The complaint alleges violations of Securities Act Sections 5 and 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2). A freeze order has been issued by the court as well as an order appointing a receiver. The case is in litigation.

Insider trading: SEC v. Treadway, 11 Civ 1534 (S.D.N.Y. Filed March 7, 2011) names as a defendant Todd Treadway, formerly an associate in the New York office of Dewey & LeBoeuf, LLP. According to the Commission’s complaint, Mr. Treadway traded in the securities of two firm clients that were being acquired after learning about the transactions and before the public announcement. One involved the acquisition of Accredited Home Lending Holding Company by Lone Star Fund V in 2007. Shortly before the deal announcement Mr. Treadway is alleged to have purchased 290 shares of Accredited. When the transaction was announced he sold his shares at a profit of $383.53. The other concerned the take over of CNET by CBS Corporation in 2008. After learning about that deal from his assignments at the firm, Mr. Treadway purchased 7,079 shares through four accounts. Following the announcement the position was liquidated at a profit of $27,019.01. The SEC alleges that Mr. Treadway violated Exchange Act Sections 10(b) and 14(e). The case is in litigation.

Mortgage backed securities: SEC v. Radius Capital Corporation, Civil Action No. 2:11-cv-00116 (M.D. Fla. March 7, 2011) is an action against the company and its principal, Robert DiGiorgio. According to the complaint, the defendants defrauded investors and the Government National Mortgage Association or Ginnie Mae in connection with the sale of mortgage backed securities. Investors and Ginnie Mae were told that the underlying securities were or would be insured by the Federal Housing Administration. In fact they were not and failed to meet the eligibility standards. As the underlying mortgages began to default, Radius also defaulted leaving Ginnie Mae to pay investors the remaining capital. Investors also had losses as a result of the unexpectedly high rate of prepayment of principal by Ginnie Mae as the Radius loans fell into default. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation.

Investment fund fraud: SEC v. Illarramendi, Civil Action No. 3:11cv0078 (D. Conn. Filed Jan. 14, 2011) is an action filed earlier this year against Francisco Illarramendi and his controlled entity Michael Kenwood Capital Management, LLC. Mr. Illarramendi manages several funds through this entity, including one which was claimed to have about $540 million under management. In fact the fund is a Ponzi scheme according to the complaint. Substantial portions of the money obtained from investors was used to repay others. When the Commission attempted to verify the assets, Mr. Illarramendi furnished the staff with a letter from an accountant in Venezuela regarding $275 million in assets held by the fund. The assets do not exist and the letter is a fraud according to the SEC. The amended complaint also alleges that substantial sums have been taken out of the fund as compensation which is, in reality, fraudulent management fees. The amended complaint, charges violations of Advisers Act Sections 206(1), (2) and (4). Parallel criminal charges have been filed. The Commission’s case is pending.

Criminal cases

Market manipulation: U.S. v. Abdallah (E.D.N.Y) is a case alleging market manipulation by Kamal Abdallah, the former chief executive officer of Universal Property Development and Acquisition Corp. Following a three week trial Mr. Abdallah was found guilty of securities fraud, wire fraud and conspiracy. The charges are based on a scheme in which Mr. Abdallah concealed significant financial losses at the company and then paid a promoter to manipulate the price of the company stock upward while he sold his shares into the market.

FINRA

Under the terms of a settlement, MICG Investment Management LLC agreed to be expelled and its CEO, Jeffrey A. Martinovich will be barred from the industry. The action is based on claims of securities fraud, misuse of investor funds and furnishing investors with false statements. Specifically, the company and Mr, Martinovich are alleged to have improperly inflated asset values to collect unjustified management and consulting fees. In addition, an elderly non-accredited investor was induced to put $75,000 in a proprietary hedge fund controlled by Mr. Martinovich.

Private actions

Cornerstone Research released its annual report tracking securities class actions. According to the report the number of settlements last year declined by about 15% to 86. Likewise, the total value of those settlements declined by about 17%. Other key findings note:

  • The median value of settlements increased to $11.3 million from $8 million in 2009;.
  • The average settlement amount declined slightly to $36.3 million compared to $37.2 million in the prior year:
  • The number of cases with SEC involvement increased to 30% in 2010 compared to 20% the prior year; and
  • The number of cases with an institution as a lead plaintiff increased to 70% from 65% the year before.