The SEC had mixed results in court this week. A Manhattan jury returned a verdict against the agency in a high profile and long-running insider trading case where the agency had previously obtained favorable rulings from the Circuit Court. In the much watched Citigroup enforcement action in which Judge Rakoff had refused the enter the Commission’s consent decree, the agency prevailed. In its ruling the Circuit Court carefully defined the role of the court and the agency in the consent decree approval process while concluding that the District Court had abused its discretion.
The Commission instituted a number of enforcement actions this week including one based on the illegal sale of securities paid for in bitcoin, another centered on a municipal bond offering and a case focused on a prohibited transaction under the Investment Company Act. Three stop order proceedings were also instituted.
Finally, FINRA announced a new initiative regarding dark pools. The regulator intends to begin releasing select data regarding transactions on a delayed basis.
Remarks: Chair Mary Jo White addressed the Sandler O’Neill & Partners, L.P. Global Exchange and Brokerage Conference, delivering remarks titled Enhancing Our Equity Market Structure, New York, New York (June 5, 2014). Her remarks addressed a series of market related issues including high speed trading and noted that the staff has been requested to develop a series of proposals (here).
Remarks: Commissioner Daniel M. Gallagher addressed the SEC Historical Society 2014 Annual Meeting: On the 80thAnniversary of the SEC, Washington D.C. (June 5, 2014). His remarks included comments on excessive disclosure, activist investors and pressure from activists to restrict corporate First Amendment rights (here).
Whistleblowers: The Commission made its first whistleblower award this year, paying a total of $875,000 to be split between two individuals. As is customary, the matter in which they were involved was not identified.
SEC Enforcement – Litigated Actions
Insider trading; SEC v. Obus, Civil Action No. 06-03150 (S.D.N.Y.). A Manhattan jury returned a verdict against the SEC and in favor of each defendant in this long running action. The case centered on the acquisition of SunSource, Inc. by Allied Capital Corporation in June 2001. Following the acquisition, the SEC brought an insider trading action against Nelson Obus, Peter Black and Thomas Strickland. Mr. Strickland had been employed as an assistant vice president and underwriter at GE Capital Corporation. His college friend, Peter Black,worked as an analyst at Wynnefield Capital, Inc. which managed a group of hedge funds. His supervisor was Nelson Obus.
In May 2001 Allied approached GE Capital about financing its acquisition of SunSource. Mr. Strickland was assigned to perform due diligence on SunSource. While doing that work he learned about the proposed deal. He also learned that Wynnefield was a large SunSource shareholder. Although he understood the information was confidential, SunSource and Allied were not placed on the restricted list until after the GE Capital team had completed its work.
Later that same month, Mr. Strickland discussed SunSource with his friend Peter Black. Both men claim that there was no tip, only a routine due diligence conversation. Mr. Black did, however, come to suspect that SunSource was considering a transaction that would dilute existing shareholders. He conveyed this suspicion to his boss, Mr. Obus who later called Maurice Andrien, the president of SunSource. Mr. Andrien would subsequently claim he learned during the conversation that Mr. Obus had been tipped. Mr. Obus denied this.
On June 8, 2001 Wynnefield purchased 287,200 shares of SunSource at $4.50 per share. This was about two weeks after the Strickland-Black conversation. The transaction was initiated by Cantor Fitzgerald which called and initially offered a 50,000 share block at $5 per share. The purchase was about the same size as an earlier Wynnefield transaction in the stock. Nine days later the deal was announced and the share price doubled, giving the hedge fund a profit of about $1.3 million.
The SEC claimed Mr. Strickland illegally tipped Mr. Black who in turn tipped Mr. Obus. In the District Court the defendants prevailed on summary judgment. The Second Circuit reversed. The jury, however, rejected the Commission’s claims.
SEC Enforcement – Filed and Settled Actions
Statistics: This week the Commission filed, or announced the filing of, 3 civil injunctive actions, DPAs, NPAs or reports and 5 administrative proceedings (excluding follow-on and Section 12(j) proceedings).
Cherry picking: SEC v. Dushek, Civil Action No. 13-cv-3669 (N.D. Ill.) is a previously filed action against Charles J. Dushek, Charles S. Dushek and Capital Management Associates, Inc. The complaint alleged that the two individual defendants used their advisory firm to defraud clients by engaging in a cherry picking scheme in which they made almost $2 million in illicit profits. On June 4, 2014 the Court entered a final judgment concluding the case. In that order the defendants were each enjoined from future violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). In addition, they were directed to pay disgorgement of $2,058,5143 along with prejudgment interest. The two individual defendants were directed to each pay a civil penalty of $150,000. See Lit. Rel. No. 23015 (June 5, 2014).
Insider trading: SEC v. Arrowood, Civil Action No. 1:12-cv-00082 (N.D. Ga.) is a previously filed insider trading action against Earl Arrowood and Parker Petit. It alleges insider trading in advance of the merger of Matria Healthcare, Inc. Mr. Arrowood settled with the Commission and the Court entered an order enjoining him from future violations of the securities laws. The order also directed Mr. Arrowood to pay disgorgement of $9,899, prejudgment interest and a civil penalty equal to the amount of the disgorgement. The Commission dismissed the charges against Mr. Petit. See Lit. Rel. No. 23013 (June 4, 2014).
Stop order proceedings: In the Matter of the Registration Statement of Diamond Lane, Inc., Adm. Proc. File No. 3-15905 (June 3, 2014); In the Matter of the Registration Statement of ShopEye, Inc., Adm. Proc. File No. 3-15904 (June 3, 2014);In the Matter of the Registration Statement of Sunchip Technology, Inc., Adm. Proc. File No. 3-15903 (June 3, 2014). These three stop order proceedings each involve a S-1 registration statements for firms which appear to be one person entities. Each proceeding alleges that the disclosure in the registration statement is false and misleading. Each will be set for hearing.
Unregistered securities: In the Matter of Erik T. Voorhees, Adm. Proc. File No. 3-15902 (June 3, 2014) centers on three unregistered offerings involving the share of FeedZeBirds and SatoshiDICE, both valued in bitcoin. The Respondent controlled both entities. In May 2012 FeedZeBirds offered 30,000 shares for sale to the public. They were priced at 0.08667 bitcoins per share and were listed on the Global Bitcoin Stock Exchange. The sale of the shares was announced on the website FreedomsPhoenix.com under the heading “FeedZeBirds IPO.” Overall the offering raised 2,600 bitcoins. At the time the bitcoins were worth about $15,000. Two offerings of shares in SatoshiDICE were made. The first began in August 2012 and continued into January 2013. The offering raised 34,500 bitcoins worth, at that time, about $371,910. The second offering took place in February 2013. SatoshiDICE offered an additional 3 million shares priced between 0.0044 and 0.0062 bitcoins per share. It raised 16,100 bitcoins valued at about $337,827. A prospectus was not filed with the Commission for any of these offerings. Subsequently, Mr. Voorhees announced on the Bitcoin Forum that SatoshiDICE would be sold. SatoshiDICE then repurchased all of its shares at a profit to investors. The Order alleges violations of Securities Act Sections 5(a) and 5(c). Mr. Voorhees resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to comply with an undertaking not to participate directly or indirectly in the issuance of any security in an unregistered transaction in exchange for bitcoins or any other virtual currency for a period of five year. In addition, Mr. Voorhes will pay disgorgement of $15,000 along with prejudgment interest and a penalty of $35,000.
Investment fund fraud: SEC v. Valente, Civil Action No. 14-3974 (S.D.N.Y. Filed June 3, 2014) is an action against Scott Valente and his firm, The ELIV Group, LLC. Beginning in November 2010 the defendants raised over $8.8 million from about 89 investors, falsely claiming that they had a consistent record of outsized positive returns. Investors were assured that their funds were safe and that they would receive the highest client service. In fact the defendants did not earned any positive results and Mr. Valente used portions of the investor funds for personal use. The complaint alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). The case is in litigation. See Lit. Rel. No. 23012 (June 3, 2014).
Prohibited transaction: In the Matter of Christopher B. Ruffle, Adm. Proc. File No. 3-15898 (June 2, 2014). Mr. Ruffle was the lead portfolio manager for hedge fund China Fund, Inc., whose shares are listed on the NYSE. The investment manager was Martin Currie Ltd., based in Edinburgh, Scotland. It owns Martin Currie Inc. and Martin Currie Investment Management Ltd. In 2011 Mr. Ruffle structured a convertible bond transaction during a financial crisis in which the China Fund purchased bonds which directly benefited Martin Currie China Hedge Fund L.P., another Martin Currie affiliate. While the transaction was a poor investment for the China Fund it directly benefitted Martin Currie China Hedge Fund. By structuring this transaction without first obtaining a Commission order Mr. Ruffle willfully aided and abetted a violation of the joint transaction provision of the Investment Company Act, Section 17(d). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. He will also be barred from associating with an adviser or an affiliated person for twelve months and was ordered to pay a civil penalty of $150,000.
Municipal bonds: SEC v. United Neighborhood Organization of Chicago, Civil Action No. 1:14-cv-04044 (N.D. Ill. Filed June 2, 2014). Defendant United Neighborhood, or UNOC, and UNO Charter School Network, Inc., or UCSN, are not-for-profits engaged in the construction of charter schools. In 2010 and 2011 the Defendants entered into two grant agreements with the Illinois Department of Commerce and Economic Opportunity, or IDCEO totaling $88 million for the construction of three schools. Each grant agreement contained a provision regarding conflicts and providing that if any arose they had to be disclosed to IDCEO. Noncompliance could result in a termination of funding and an obligation to repay. The Defendants executed the grants despite having entered into contracts with firms of family members of an officer. No disclosure was made of the agreements. In October 2011 Charter School Refunding and Improvement Revenue Bonds were issued in the principal amount of approximately $37.5 million. The Defendants issued an Official Statement that informed investors about their “Conflicts Policy,” claiming it was more robust than required. When the conflicts were disclosed in news articles, Defendants denied the claim but terminated the official whose family members had the contracts and launched an inquiry. Subsequently, IDCEO sent the Defendants a letter stating that the grant agreements would be temporarily suspended and that additional payments would be withheld until further notice. The Commission’s complaint alleges violations of Securities Act Section 17(a)(2). Defendants resolved the proceeding with each Defendant agreeing to undertakings to improve their internal procedures and training. An independent monitor will also be appointed.
Investment fund fraud: SEC v. McCraw, Civil Action No. 4:14-CV-0348 (E.D. Tex. Filed May 30, 2014) is an action against Steven McCraw. The complaint alleges that he aided and abetted Kevin White and his firm, KGW Capital Management LLC, in a fraudulent scheme. Specifically, Mr. White and KGW Capital raised investor funds through Revelation Forex, a firm which claimed to have a low risk, high return forex trading strategy. Contrary to those claims, the firm lost $2 million trading and Mr. White used investor funds for personal expenses. A separate action was brought against Mr. White and his firm. This action alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is in litigation. SeeLit. Rel. No. 23010 (May 30, 2014).
Consent decrees: SEC v. Citigroup Global Markets, Inc., Nos. 11-5227-cv, 11-5375-cv and 11-5242-cv (2nd Cir. June 4, 2014). The decision arises out of the refusal of the District Court to enter a proposed consent decree agreed to by the parties to resolve a market crisis case the Commission proposed against Citigroup. The central question before Circuit Court was what deference the district court owes an agency seeking a consent decree. The Court defined this as requiring that the district court “determine whether the proposed consent decree is fair and reasonable . . . [and that] the ‘public interest would not be disserved’ . . . in the event that the consent decree includes injunctive relief. Absent a substantial basis in the record for concluding that the proposed consent decree does not meet these requirements, the district court is required to enter the order.”
To assess if a proposed consent decree meets the fairness and reasonableness test the court should, at a minimum, consider several factors. Those include: 1) The basic legality of the decree; 2) if the terms are clear; 3) if it reflects a resolution of the actual claims in the complaint; and 4) whether “the consent decree is tainted by improper collusion or corruption of some kind.” While consent decrees vary, the focus here is on ensuring that the decree is procedurally proper, not determining the truth of the underlying facts which is a role reserved for trial. At the same time the district court will necessarily establish that there is a factual basis for the decree. In many cases that may be done by examining the claims and factual statements in the complaint. In others more may be required if, for example, there is a question that the proposed decree is the result of improper collusion.
If the proposed decree includes injunctive relief, the district court should consider the test for entering an injunction. In this regard the court must be assured that the public interest would not be disserved by the entry of the injunction. In making that determination, however, the question of whether the proposed decree best serves the public interest is reserved for the SEC. In this case the District Court correctly recognized that it was required to consider the public interest when entering an injunction, but it failed to make any finding that such relief would be a disservice to the public interest. This was legal error the Court held.
To the extent the District Court withheld approval of the proposed decree on the theory that the Commission failed to bring the proper charges, its determination was an abuse of discretion, the Court found. The decision of an agency to prosecute, and the manner in which the action is brought, is committed to its discretion. What is before the district court is not that decision but only the proposed consent decree. The order of the District Court declining to enter the consent decree was vacate and the action remanded for further proceedings.
Blue sheets: The regulator imposed fines of $1 million each on Barclays Capital, Goldman Sachs and Merrill Lynch for submitting inaccurate blue sheet data to it as well as the SEC. Each firm has a prior regulatory history involving the submission of inaccurate blue sheet data.
Dark pools: The regulator announced that it will begin making data available on dark pools. The data will be an aggregate by week for each security. The information for Tier 1 NMS stocks will be made available on a two-week delayed basis. For all other securities the data will be released two weeks following the publication of the Tier 1 data.
Custody: The Securities and Futures Commission issued a reprimand to Delta Asia Securities Limited and fined the firm $4 million for failing to reasonable ensure that client securities were properly safeguarded. In a number of instances from January 2010 to February 2013 the firm used shares belonging to clients and held in segregated client accounts to settle transactions of other clients who did not have sufficient shares. This occurred with out consent or authorization from the clients. The SFC concluded that the firm failed to reasonably implement procedures to protect the securities of clients.
Boiler rooms: Jeffrey Revell-Reade and Anthony May were both convicted as part of a conspiracy which authorities state is the largest boiler room operation in the U.K. This brings the total convicted in connection with this scheme to nine. Approximately 1,000 investors in the U.K. were victims of the scheme which operated between 2003 and 2007, raising £70 million. Mr. Revell-Reade was convicted of conspiracy to defraud. He is alleged to have been the head of the scheme. Mr. May was found guilty of one count of conspiracy to defraud.