SAC Capital and Steven Cohen were the focus of securities enforcement litigation this week. Criminal wire and securities fraud charges were brought against the four primary entities that make up SAC Capital. Civil failure to supervise charges were brought against the firm’s founder, Steven Cohen. While both cases are built on repeated instances of insider trading and Mr. Cohen is painted as the enabler of a years long, pervasive insider trading scheme, he has not been charged criminally or in a civil suit with insider trading.
The SEC also charged the City of Miami, Florida with fraud and brought an action against two PRC based issuers and their CEOs. In addition, the agency settled an insider trading action against a senior corporate official who repeated used inside information from his company to trade.
Testimony: Commissioner Scott D O’Maria testified before House Committee on Agriculture, Subcommittee on General Farm Commodities and Risk Management (July 23, 2013). His testimony focused on the agency’s policy approach to implementing Dodd-Frank and its negative impact on end users, abuses in the rule making and exemption process and challenges in CFTC data utilization (here).
SAC Capital and Steven Cohen
Criminal charges: U.S. v. S.A.C. Capital Advisors L.P., 13 Crim 541 (S.D. N.Y. July 25, 2013. Criminal wire fraud and securities charges were brought against the four primary entities which make up SAC Capital. Firm founder Steven Cohen was not charged. The indictment in many ways builds on the SEC action brought against Mr. Cohen, claiming that he created a culture that pursued unlawful “edge” while being indifferent to compliance. That culture resulted in pervasive insider trading, evidenced by past guilty pleas and pending insider trading cases the indictment claims.
The five count indictment, unsealed Thursday, charges the “corporate entities responsible for the management of a major hedge fund with criminal responsibility for insider trading offenses committed by numerous employees and made possible by institutional practices that encouraged the widespread solicitation and use of illegal inside information. Unlawful conduct by individual employees and an institutional indifference to that unlawful conduct resulted in insider trading that was substantial, pervasive and on a scale without known precedent in the history of the hedge fund industry.” The indictment charges wire fraud against the four primary entities that make up the giant hedge fund, S.A.C. Capital LP, S.A.C. Capital LLC, CR Intrinsic LLC and Sigma Capital Management LLC. It adds a separate count of securities fraud as to each entity.
A critical part of the overall scheme was the culture of SAC Capital. Its founder, Steven Cohen, virtually ignored the fact that traders in the four principle companies were using inside information. He failed, for example, to question the sources of information that were furnished to him for trading and that were used by his traders despite facts that suggested the information was unlawful. In this respect the indictment, to an extent, builds on the kind of allegations the SEC used to charge Mr. Cohen with failure to supervise (see below).
Perhaps equally important, the indictment claims that SAC’s hiring and compensation practices encouraged insider trading. Those practices focused on the relentless pursuit of “edge” above all else. Traders were hired who had extensive corporate contacts. Even reports from a former employer that a trader had utilized inside information failed to prevent the firm from retaining the person in one example cited. Those who furnished information demonstrating edge were rewarded.
Mr. Cohen’s indifference and the pursuit of edge was fortified through ineffective compliance. This is illustrated by the fact that frequently matters raising questions were not even referred to the compliance department for examination. And, in the few instances when the department did investigate, its efforts were described as “generally weak.”
The firm culture has spawned repeated insider trading yielding millions of dollars in illicit trading profits. To date five individuals affiliated with the firm have pleaded guilty in criminal insider trading cases: Jon Horvath; Wes Wang; Donald Longueuil; Noah Freeman; and Richard Choo-Beng Lee. Two others have been indicted and are awaiting trial on insider trading charges: Michael Steinberg and Mathew Martoma.
A forfeiture action was also filed in conjunction with the criminal indictment.
The civil case: In the Matter of Steven A. Cohen, Adm. Proc. File No. 3-15382 (July 19, 2013) is an action against the founder of SAC Capital. The Order alleges failure to supervise in connection with two sets of transactions which are alleged to constitute insider trading in pending criminal actions. One case is against former SAC employee Mathew Martoma. The other is against current employee Michael Steinberg. The portion of the action centered on Mr. Martoma focuses on trades in the securities of Elan Corporation, plc and Wyeth in 2008. At the time the two pharmaceutical companies had a significant new drug under development which had been in trials since 2006. During the trials, Dr. Sidney Gilman, University of Michigan, was a consultant to Elan. He also worked for, and was paid by, an expert network through which he met Mathew Martoma. SAC’s records reflect payment to the expert network firm which went to Dr. Gilman.
By 2007 Dr. Gilman was periodically providing Mr. Martoma with inside information about the trials, according to the Order. On June 17, 2008 Elan and Wyeth jointly released top-line results of the Phase II trial for the drug. The announcement also stated that the detailed results would be released on July 29, 2008. By the time of the first release SAC Capital and its affiliates had huge long positions in the shares of the two pharmaceutical companies. The positions were controversial at the firm with some analysts favoring them and others taking an opposite position. Mr. Martoma favored them. Shortly prior to the July 29 date the Order alleges that Mr. Martoma secured additional details about the trials from the Doctor. He then told Mr. Cohen he was no longer comfortable with the positions, switching sides in the internal controversy. Mr. Cohen directed the liquidation of the half a billion positions.
The second part of the Order focuses on transactions in the shares of Dell, Inc. In 2008 and 2009 a Dell Investor Relations employee furnished advance information on quarterly results at the company to his friend Sandeep Goyal. He in turn passed the information to Jesse Tortora, an analyst at Diamondback Capital. Mr. Tortora shared the information with several others including Jon Horvath. Prior to Dell’s August 28, 2008 earnings announcement the Investor Relations employee told Mr. Goyal about the results. The information was given to Mr. Tortora. On August 18th, Mr. Horvath received an update on the information. He then e-mailed Mr. Steinberg and asked him to keep the information “down low.” That same day Mr. Steinberg began building a short position in Dell shares. Mr. Cohen had been building a long position in Dell. Messrs. Horvath and Steinberg debated whether to tell Mr. Cohen what they knew. Eventually Mr. Cohen was forwarded an e-mail which indicated they had obtained information from a Dell employee. Mr. Cohen liquidated his position.
The Order claims that Mr. Cohen failed to take prompt steps to investigate these two situations. By not do so he “failed reasonably to supervise Martoma and Steinberg with a view to preventing their violations of Section 10(b) of the Exchange Act . . . “
SEC Enforcement: Filings and settlements
Filings this week: This week the Commission filed 2 civil injunctive action and 1 administrative proceeding (excluding follow-on actions and 12(j) proceedings).
Investment fund fraud: SEC v. Shavers, Civil Action No. 4:13-cv-00416 (E.D. Tx. Filed July 23, 2013) is an action against Trendon Shavers and Bitcoin Shavings and Trust. Beginning in September 2011, and continuing for the next year, Mr. Shavers operated an internet site known as pirateat40 through which he offered and sold Bitcoin Savings investments over the internet. Bitcoin or BTC is a virtual currency that can be traded through online exchanges for conventional currencies or used to purchase goods. As a result of the solicitation the defendants raised over 700,000 BTC in principal investments from Bitcoin Savings investors or about $4.5 million based on the daily average price of BTC at the time. Investors were promised a return of 7% weekly. In reality the operation was a Ponzi scheme, according to the Commission. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is in litigation.
Offerings: SEC v. China Intelligent Lighting and Electronics, Inc., Civil Action No. 13 CIV 5079 (S.D.N.Y. Filed July 22, 2013) is an action against the company, NIVS InteliMedia Technology Group, Inc. and their respective CEO’s, Xuemei Li and her brother Tianfu Li Cil. Both issuers are located in China. Both raised funds through U.S. registered offerings in 2010 with China Intelligent obtaining about $7.7 million and NIVS about $21.5 million. In both cases the offering proceeds were diverted from the purpose stated in the offering materials. In both instances the defendants attempted to conceal these facts from the auditors by making false representations about the investor money. In both instances the CEO of the company falsified bank records to conceal the fact that the funds had been removed from the pertinent bank account. The Commission’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). A related administrative proceeding was also instituted against each issuer to revoke its registration under Exchange Act Section 12(j) for failing to make required filings. The case is in litigation. See also Lit. Rel. No. 22755 (July 22, 2013).
Insider trading: SEC v. Ramnarine, Civil Action No 2:12-cv-0437 (D.N.J. Filed August 2, 2012 is a previously filed action against Robert Ramnarine. He had been employed by Bristol-Myers Squibb Co. from 1997 through August 2012, most recently in a senior position through which he helped the company evaluate take-over targets. During that period he traded in the securities of three companies based on information obtained from his position, reaping profits of over $300,000. Mr. Ramnarine settled with the Commission. The Court entered a financial judgment permanently enjoining him from future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 14(a). He was also ordered to pay disgorgement of $311,361 along with prejudgment interest and was barred from serving as an officer or director of a public company. Funds frozen in his securities account will also be transferred to he agency.. The Commission may move at a later time for the imposition of a penalty. See also Lit. Rel. No. 22754 (July 22, 2013). In the parallel criminal case Mr. Ramnarine pleaded guilty to one count of securities fraud. Sentencing is scheduled for September 26, 2013. U.S. v. Ramnarine, 3-13-cr-00387 (D. N.J.)
Municipal bond fraud: SEC v. City of Miami, Florida, Civil Action No. 1:13-cv-22600 (S.D. Fla. Filed July 19, 2013). The action centers on three bond offerings in May, July and December 2009 for, respectively, $53 million, $37 million and $65 million. In advance of those offerings the City distributed its Comprehensive Annual Financial Reports or CAFRAs which contained an MD&A section and audited financial statements. Those documents were built in part on those prepared by the budget director, Michael Boudreaux. He had made a series of transfers from the City’s Capital Projects Fund to its general fund that were not reflected in those materials. The transfers were made to conceal deficits in the general fund and meet stated goals despite the fact that the funds were supposed to be restricted. To effectuate the transfers Mr. Boudreaux falsely told the City Commission that the funds were unallocated. He then concealed the transactions in the City’s internal records. Mr. Boudreau also made misrepresentations to the rating agencies which helped secure the favorable ratings for the bond offerings, according to the complaint. Previously, in March 2003 the Commission issued a cease and desist order against the City for violations of the anti-fraud provisions of the federal securities laws. The violations were in connection with bond offerings in 1995. The Commission’s complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See also Lit. Rel. No. 22753 (July 15, 2003).
High speed trading: The CFTC and the CME Group sanctioned Panther Energy Trading and Michael Coscia for abusive high speed trading. The Financial Conduct Authority also imposed sanctions on Mr. Coscia for similar conduct in the UK. The actions by the CFTC and the CME group centered on trading on four exchanges owned by the CME Group from early August to mid-October 2011. During that period the two traders repeatedly employed a manipulative technique known as “spoofing.” The CFTC entered orders requiring the two traders to pay $1.4 million in penalties and to disgorge an equal amount in trading profits. The traders will also be banned from trading on any CFTC registered entity for one year. The amounts paid will be offset by any amount paid to resolve the charges with the CME Group. The CME Group, by virtue of disciplinary actions taken by its exchanges, imposed a fine of $800,000 on the two traders and ordered that they pay disgorgement of about $1.3 million. The Group also issued a six month trading ban on its exchanges against Mr. Coscia. Finally, the FCA imposed sanctions on Mr. Coscia for similar trading that took place in September and October 2011 on the ICE Futures Europe Exchange in the UK. The regulator imposed a fine of €597,993 or $903176. Mr. Coscia received a 30% discount on the amount of the fine for agreeing to settle under the FCA’s executive settlement procedures.
Investment fund fraud: U.S. v. Shalhoub (E.D.N.Y. indictment unsealed July 24, 2013) is a case in which Jeffrey Shalhaub has been named in a 28 count indictment alleging he defrauded investors in connection with the operation of an unregistered commodity pool. Investors were told that they would receive up to 10% returns for investing in The 9 Group, Ltd. About $300,000 was raised from investors. In fact much of the investor money was lost through trading and much of the balance was misappropriated by the defendant. Mr. Shalhoub attempted to conceal these facts by furnishing investors with false documents. See also CFTC v. Shalhoub, Civil Action 2:1-cv-02242 (E.D.N.Y. Filed May 17, 2010).