The SEC settled two insider trading cases this week while bringing three investment fund fraud suits, two of which involved recidivists who are alleged to have diverted investor funds from their current scheme to make payments in their prior criminal case. The CFTC Division of Enforcement filed a record number of enforcement actions in the last fiscal year while opening a program high number of investigations according to the agency.
The New York Attorney General joined and expanded a whistleblower suit against the Bank of New York Mellon. It alleges that pension funds and other investors were defrauded out of about $2 billion by the bank which misrepresented interbank rates obtained in foreign currency transactions. The DOJ filed a parallel case.
Finally, a court in Australia handed down a significant decision regarding the obligations and liabilities of directors. It concluded that each member of the board was liable for failing to discover a significant error in the company financial statements.
Rating agencies: The SEC staff published a report regarding its latest examinations of these agencies. It is titled: “2011 Summary Report of Commission Staff’s Examinations of Each Nationally Recognized Statistical Rating Organization” (here). The Report identifies ten NRSROs and has a series of findings regarding their compliance with prior inspection recommendations and the implementation of various provisions of Dodd-Frank.
SEC Enforcement — filings
Investment fund fraud: SEC v. StratoComm Corporation, Civil Action No. 1:11-CV-1188 (N.D. NY Filed Oct. 6, 2011); SEC v. Merkin, Civil Action No. 1:11-cv-23585 (S.D. Fla. Filed Oct. 6, 2011). The StratoCom complaint names as defendants the company along with its CEO Roger Shearer and its former IR director Craig Danzig. It alleges that the company raised about $3 million from investors by selling unregistered shares of company stock based on claims that it was engaged in the manufacture and sale of telecommunications systems for underdeveloped countries. The claims are false. The company had no product and no revenue. The investor funds were diverted to personal use including restitution Mr. Shearer was obligated to pay in another criminal case. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The Merkin complaint is against attorney Stewart Merkin who served as company counsel. It alleges violations of Exchange Act Section 10(b) based on four attorney letters he prepared for the Pink Sheets which claimed the SEC was not conducting an investigation of the company. In fact the investigation was in progress and Mr. Merkin was representing persons in it. The letter facilitated the continued trading of company shares. Both cases are in litigation.
Financial fraud: SEC v. Sells, Case No. CV-11-4941 (N.D. Cal. Filed Oct. 6, 2011) is an action against two former sales executives of medical equipment company Hansen Medical, Inc., Christopher Sells and Timothy Murawski. The complaint alleges violations of Securities Act Sections 17(a)(1) & (3) and Exchange Act Sections 10(b) and 13(b)(5) and aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). It centers on transactions in 2008 and 2009 in which the two defendants attempted to accelerate the recognition of revenue from the sale of the medical equipment sold by the company. In some instances, for example, the defendants convinced purchasers to let them set-up equipment so they could claim it was delivered and installed and the revenue could be recognized. The equipment would later be disassembled and stored for months. In another instance a physician’s signature was forged certifying that training had been completed when it had not. During the period Hansen was under intense pressure to raise additional capital from investors. This action, which resulted from a whistleblower, is in litigation. A related administrative proceeding against the company settled. In the Matter of Hansen Medical, Inc., Adm. Proc. File No. 3-14578 (Filed Oct. 6, 2011). There the company consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 139a), 13(b)(2)(A) and 13(b)(2)(B). The SEC acknowledged the significant remedial acts of the company as well as its voluntary disclosure and cooperation.
Investment fund fraud: SEC v. Aronson, Civil Case No. 11 Civ. 7033 (S.D.N.Y. Filed Oct. 6, 2011) is an action alleging violations of Securities Act Sections 5 and17(a) and Exchange Act Sections 10(b) and 15(a). It names as defendants Eric Aronson, a convicted felon, Vincent Buonauro, Jr., Robert Kondratick, Fredric Aaron and several related entities. The complaint alleges a fraudulent investment scheme in which about 140 individuals lost approximately $26 million between 2006 and 2010 investing in water-filtering natural stone pavers. Investors were told they would receive returns of 7.8% to 33% because the stones could be sold at a high mark-up and there was a significant backlog of orders. Those representations were false. Investors were paid returns using funds obtained from other investors. A portion of the money was diverted to the personal use of the promoters, including the payment of Mr. Aronson’s restitution obligations from another case. Some portions were used to purchase publicly traded Interlink-US-Network, Ltd which later published a false Form 8-K which stated that LED Capital Corp. had agreed to invest $6 million in the company. When investors demanded their money back Mr. Aronson at first claimed that the notes were usurious and later, with the assistance of his attorney who is also a defendant, convinced them to convert their notes into ones with deferred payments. The SEC obtained an emergency freeze order. The case is in litigation. A parallel criminal case has also been filed.
Insider trading: SEC v. Hansen, Civil Action No. 10-CV-5050 (E.D.Pa.) is an insider trading case against the former Chairman of Keystone Equities Group, a registered broker-dealer and regional investment bank. The complaint alleges that Mr. Hansen was illegally tipped by his employee and close friend Donna Murdoch. Ms. Murhoch obtained inside information from former Ernst & Young partner and attorney James Gansman with whom she was having an affair. The information concerned pending take-over transactions. Mr. Hansen settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to pay disgorgement and prejudgment interest in the amount of $63,038 of which $32,222 will be satisfied through the payment of a criminal forfeiture order in the parallel criminal action. The order also bars him from serving as an officer or director. In a related administrative proceeding Mr. Hansen consented to the entry of an order barring him from the securities business or participating in any penny stock offering. In the related criminal case Mr. Hansen previously pleaded guilty to conspiracy and securities fraud charges and was sentenced to three months imprisonment followed by five months of home confinement and two years of probation. Mr. Gansman was convicted following a jury trial. Ms. Murdoch had pleaded guilty.
Insider trading: SEC v. Galleon Management, LP, Civil Action No. 09-CV-8811 (S.D.N.Y.) is the Commission’s insider trading case which evolved out of the Galleon investigations. This week the SEC settled with Steven Fortuna, the founder of S2 Capital, a hedge fund investment adviser in New York. Mr. Fortuna traded on inside information obtained from Danielle Chiesi in the shares of Akamal Technologies, Inc. and AMD. He resolved this action by consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). He also agreed to pay disgorgement of $193,536 along with prejudgment interest and a civil penalty in the amount of $96,768. In a related administrative proceeding Mr. Fortuna consented to the entry of an order barring him from association with any broker, dealer, investment adviser, municipal securities dealer or transfer agent. He previously pleaded guilty in the parallel criminal case and is cooperating with the government. This is the thirteenth settlement obtained by the SEC in this case.
Investment fund fraud: SEC v. Allen, Civil Action No. 3:11-CV-822 (N.D. Tex.) is an action against the co-founder of China Voice Holding Corp. and others alleging that the company was essentially a Ponzi scheme. This week the Commission settled with defendants Alex Dowlatshahi and Christopher Mills. They consented to the entry of permanent injunctions prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). In addition, Defendants Integrity Driven Network Corp, Lucrative Fnterprises Corp., Synergetic Solutions LLC, Silver Summit Holdings LLC and Sleeping Bear LLC were permanently enjoined from violating Exchange Act Section 10(b). On motion of the Commission the court may order disgorgement, prejudgment interest and civil penalties.
Failure to supervise: In the Matter of Gilford Securities Inc., Adm. Proc. File No. 3-14574 (Sept. 30, 2011) is an action against the firm, one of its founders, Ralph Worthington, a supervisor, David Kaplan and the CCO, Richard Grahahan. The proceeding centers on a failure to supervise M.S. Gregg Berger, a former registered representative at the firm and other violations. From 2005 through May 2006 Mr. Berger is alleged to have resold over 30 million shares of stock through at least 20 customer accounts at the firm. There was no resale registration statement or exemption for the shares. The firm failed to implement systems reasonably designed for its supervisory policies. Eventually Mr. Berger was named as a defendant in a Commission “pump and dump” action and a parallel criminal case. The firm also violated the securities laws by permitting customers to: deliver in and sell millions of shares of stock without conducting reasonably inquiry into the source of the stock; by failing to file SARS as required by the Bank Secrecy Act; and by sharing confidential customer information with others. Messrs. Worthington and Kaplan also aided and abetted some of the firm’s violations while Mr. Granahan, the firm’s CCO and its anti-money laundering officer, aided and abetted the firm’s SARs violation.
Gilford resolved the proceeding by agreeing to implement a series of steps which include the retention of an independent consult who will make recommendations regarding procedures which the firm will implement. The firm also consented to the entry of a cease and desist order based on Securities Act Section 5 and Exchange Act Sections 15(b)(7) and 17(a) and the related rules. The firm will also disgorge $275,000 along with prejudgment interest and pay a civil penalty of $260,000. Mr. Worthington agreed to the entry of a cease and desist order based on Exchange Act Sections 15(b)(7) and 17(a) and the related rules, to be suspended from acting in a supervisory capacity with a broker dealer for twelve months and to pay a civil penalty of $45,000. Mr. Kaplan consented to the entry of a cease and desist order based on Rule 10(a) and Regulation S-P. He also agreed to pay disgorgement of $225,000 along with prejudgment interest and a civil penalty of $30,000. Mr. Granahan agreed to the entry of a cease and desist order based on Exchange Act Section 17(a) and Rule 17a-8. He also agreed to pay a civil penalty of $20,000.
Statistics: The agency announced that in FY 2011 the Division of Enforcement filed 99 enforcement actions, the highest yearly total in its history. This also represents a 74% increase over the prior year. The Division also opened more than 450 investigations which is another program high. During the last fiscal year more than 70 indictments and convictions were obtained related to CFTC enforcement actions.
Failure to supervise: The agency issued an order and settled charges with Forex Capital Markets LLC in connection with the failure of the firm to supervise diligently its personnel handling over 57,000 customer accounts that traded on its forex trading platforms. As a result, from at least June 2008 through mid-December 2010 the firm failed to supervise diligently the handling of customer accounts traded on its forex platforms with respect to changes in price between order placement and execution on both market orders and margin liquidation orders. As a result customers did not benefit from price movements in their favor but did suffer from detrimental price movements. The firm agreed to pay a $6 million civil penalty and restitution of $8,261,937 to its customers and former customers. It also agreed to retain for the next three years a monitor to supervise its trade execution practices and policies as they relate to the change in price between the time the customer places the order and the execution and its compliance with its restitution obligation.
Investment fund fraud: U.S. v. Prince (N.D.Cal.) is an action against attorney David Prince. The indictment claims that Mr. Prince raised more than $1.1 million from 30 investors from August 2005 through January 2007. Investors were told their funds were guaranteed and that they would receive returns of 5% to 25% from investments in the stock market. He assured them of the legality of the plan since he is an attorney. In fact he lost most of the money through risky options trading, by diverting some to personal use and by making Ponzi type payments to investors. Following a three week trial he was convicted on five counts of wire fraud. The jury did not reach a verdict on two other counts. Sentencing is scheduled for January 11, 2012.
Investor warning: The regulator issued an investor warning titled “Public Non-Traded REITS-Perform a Careful review Before Investing.” It notes that while investors are looking for better returns which may be offered by these investments it is critical to understand the risks. The alert is available here.
The Board published a Staff Audit Practice Alert regarding the audit risks in certain emerging markets. While the guide is intended for auditors, board Chairman James Doty noted that it is a good reminder for investors and audit committee members regarding the risks in these markets. The Alert is available here.
Court of Appeals
Authority to file collection suits: Fiero v . Financial Industry Regulatory Authority, Nos. 09-1556-cv, 09-1863-cv (2nd Cir. Oct. 5, 2011). The case stems from a FINRA disciplinary proceeding brought against John Fiero and Fiero Brothers, Inc. in which the hearing panel expelled the firm, barred Mr. Fiero and imposed a a fine of $1 million plus costs. Mr. Fiero and his firm subsequently filed a declaratory judgment action in Federal Court seeking a ruling that FINRA did not have authority to bring a court action to collect a fine. The district court dismissed the complaint. The Second Circuit reversed, concluding that FINRA does not have the authority to bring such an action. First, there is no express provision in the Exchange Act granting such authority. Second, while the statute grants certain authority the absence of such a provision here is consistent with the fact that FINRA traditionally collected these fines through the use of its power to expel. Finally, any reliance on the rule promulgated in 1990 by the SRO which purports to give it authority to take such action is misplaced. To be effective the rule had to be to be properly promulgated. It was not because FINRA failed to submit the rule to the standard notice and comment procedures.
Misrepresentations: NY AG and State of New York v. Bank of New York Mellon (S.Ct. N.Y.). This is a suit initially filed by a whistleblower and later taken over by the N.Y. AG against the bank. The suit alleges violations which include the false claims act and securities fraud under the Martin Act. The complaint centers on claims that the bank made almost $2 billion in revenues by misrepresenting the interbank rates it obtained in foreign currency transactions for clients. The victims of the wrongful conduct, including public and private pension funds and the State University of New York, were promised the best rate of the day but in fact were given the worst. The bank pocketed the difference according to the papers. The case is pending. The DOJ has filed a parallel civil action.
The regulator imposed a fine of £494,900 on investment manager Towry Investment Management Ltd. in connection with violations of Principle 10 and 11. The former requires managers to properly handle client funds while the latter specifies that firms must deal with the FSA in an open and cooperative manner. Here the FSA sent a “Dear CFO” letter to the firm regarding its compliance with the procedures for handling client funds. The firm told the FSA it was fully compliant when in fact it was not. The FSA discovered violations of the applicable provisions following receipt of the response to the Dear CFO letter. The fine here was reduced by 30% because the firm agreed to settle at an early stage in the proceeding.
Director obligations: An excellent post on the Harvard Law School Forum by David Katz, Wachtell Lipton, highlights a new decision by the Federal Court of Appeals in Australia regarding director liability. In a landmark ruling the court in Australian Securities and Investment Commission v. Healey, held the entire board of directors liable for failing to find a significant error in the financial statements of the company. The post is available here.
Program: The Impact of the Supreme Court’s Decision in Morrison v. National Bank of Australia on securities litigation and SEC enforcement actions. Presented by Celequ Legal Education in conjunction with West Thomson. Webcast on October 12, 2011 from 12:00 to 1:00 EST. For furtrher information please click here