The Commission settled a significant market crisis case this week following two years of litigation. It also filed two administrative proceedings centered on allegations of churning and failure to supervise. One settled, the other will be set for hearing. In addition, the SEC, in conjunction with the CFTC, brought an action against an investment adviser who managed a series of funds in the U.S. and abroad, claiming he concealed huge market crisis losses.
In the Court of Appeals, the Commission won a significant victory securing a reversal of a grant of summary judgment in favor of the defendants in an insider trading case. The Second Circuit’s opinion is a primer on insider trading law and clarifies a significant issue.
The former chief investment officer of Stanford Financial Group was sentenced to serve three years in prison this week. A fine was not imposed because she did not have the ability to pay.
Finally, the FSA imposed its largest fine on a senior financial institution executive for mismanagement. The regulator concluded that the former director inappropriately managed his division in an aggressive manner through the market crisis despite its significant lack of controls.
SEC Enforcement: Filings and settlements
Statistics: This week the Commission filed 4 civil injunctive actions and 2 administrative proceedings (excluding follow on and 12j actions).
Theft of investor funds: SEC v. Deerhill Financial Group, LLC, Case No. 3:12-cv-01317 (D. Conn. Filed Sept. 13, 2012) is an action against the company and its principal, Stephen Blankenship who was also a registered representative at a regional broker-dealer. From 2002 through 2011 Mr. Blankenship is alleged to have misappropriated at least $600,000 from 12 brokerage customers by making false representations. Specifically, using various representations such as a claim that their money would be safely invested at Deerhill and make a better return, or that he was switching firms, he induced customers to trust him with their funds and them misappropriated the money for his personal use. The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 15(a), Securities Act Section 17(a) and Advisers Act Sections 206(1) and (2). The case is in litigation. See also Lit. Rel. No. 22479 (Sept. 13, 2012). A parallel criminal case was brought by the U.S. Attorney’s Office.
Offering fraud: SEC v. Bio Defense Corporation, Civil Action No. 1;12-cv-11669 (D. Mass. Filed Sept. 10, 2012) is an action against the company and its principals, Michael Lu, Jonathan Morrone and Paul Jurberg. The complaint claims that the individual defendants essentially turned the company into a fraudulent device by selling its unregistered shares. Specifically, beginning in 2004 the defendants raised money based on allegations that company officials were working for “sweat equity” when in fact the most significant company expense was their compensation. When state regulators began to inquire and prosecute in 2008, the scheme was moved overseas where it continued, using local boiler rooms that were paid most of the money raised. In about a two year period the foreign boiler rooms raised approximately $31.9 million from investors. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of 17(a) and Exchange Act Section 10(b), each subsection of Rule 10(b) and Section 15(a)(1). It also alleges, in the alternative, that Messrs. Lu and Morrone are laible as control persons under Exchange Act Section 20(a). The case is in litigation. See also Lit. Rel. No. 22478 (Sept. 10, 2012).
Offering fraud: SEC v. Schooler, Case No. 12 CV 2164 (S.D. Cal. Filed Sept. 4, 2012) is an action against Louis Schooler and his company, first Financial Planning Corporation, alleging that they defrauded investors who purchased partnership interests in the company. First Financial, doing business as Western Financial Planning Corporation, supposedly purchased tracts of vacant land in Nevada to later sell at a profit. What investors were not told is that the comparable properties they were shown to value the purchases were false, that the land purchased was marked up as much as five times fair value and that it was encumbered with mortgages used to purchase it. The SEC’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The Commission obtained an emergency freeze order. The case is in litigation. See also Lit. Rel. No. 22476 (Sept. 10, 2012).
Churning/failure to supervise: In the Matter of JP Turner & Co., LLC, Adm. Proc. File No. 3-15014 (Sept. 10, 2012) and In the Matter of Michael Bresner, Adm. Proc. File No. 3-15015 (Sept. 10, 2012) are two proceedings based on the actions of three registered representatives who are alleged to have churned accounts and failures to supervise claims. The first names as Respondents the Atlanta broker and its co-founder and president, William Mello. The second names Michael Bresner, executive vice president and head of supervision of JP Turner and three registered representatives at the firm, Ralph Calabro, Jason Konner and Dimitrios Koutsoubos. From January 2008 through the end of 2009 the three registered representatives churned the accounts of seven customers, engaging in excessive trading for their personal gain at the expense of the customers. The trading activity generated fees and margin interest of $845,000 as the customers collectively lost about $2.7 million. Although the JP Turner systems raised red flags Mr. Bresner failed to take action when required, according to the Order.
The Bresner Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b) by the three registered representatives. It also alleges that Mr. Bresner failed to reasonably supervise Messrs. Konner and Koutsoubos. This proceeding will be scheduled for hearing. The Order naming the firm alleged violations of Exchange Act Section 15(b)(4)(E) by the firm and Section 15(b)(6) by Mr. Mello. The firm and its president settled. The firm agreed to hire an independent consultant to review its supervisory procedures and consented to a censure. It also agreed to pay $200,000 in disgorgement, prejudgment interest and a $200,000 penalty. Mr. Mello will be suspended from association in a supervisory capacity in the securities business for a period of five months and pay a penalty of $45,000. The Respondents in the Bresner proceeding did not settle. The case will be set for hearing.
Fraudulent representations: SEC v. Battoo (N.D. Ill. Filed Sept. 6, 2012); CFTC v. Battoo, Case No. 1:12-cv-07127 (N.D. Ill. Filed Sept. 6, 2012). These actions named as defendants investment adviser Bernard Battoo and two companies of which he is a principle, BC Capital SA, a Panama company, and BC Capital Limited, a Hong Kong based entity. Also named in the complaint is Tracy Sunderlance, who was previously enjoined in a Commission enforcement action and barred from the business. Mr. Sunderlance has received commissions from the sale of investments and management fees for acting as a designated investment adviser to client trusts that invest with Mr. Battoo. Mr. Battoo manages several hedge fund families. He is also an advisor for Private International Wealth Management or PIWM which manages a number of portfolios and is a principal of FuturesOne LlC, a commodity pool operator. He claims to have about $1.5 billion under management. Despite claims that he survived the market crisis without loses, in fact he sustained significant losses which have been concealed, according to the SEC complaint. In 2008 he was terminated as an investment adviser to the master fund of a large international bank and from a “fund linked certificate” program. Subsequently, the NAV for the fund he managed dropped by 50% and his losses on the fund linked certificates exceeded $100 million. Several funds he managed were heavily invested in Maddoff’s Ponzi scheme. Despite Mr. Battoo’s assurances, investors seeking redemptions have been met with a series of excuses. The SEC’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). An asset freeze has been ordered. The case is in litigation.
Market crisis: SEC v. ICP Asset Management, LLC, Civil action No. 10-cv-4791 (S.D.N.Y. Filed June 21, 2010) is an action against advisory firm ICP Asset Management, Thomas C. Priore, its founder and president, and the related entities. The action alleged violations of Securities Act Sections 17(a), Exchange Act Sections 10(b) and 15(c)(1)(a) and Advisers Act Section 206(1), (2), (3) and (4) by the adviser, ICP Holdco, ICP Securities, LLC, a registered broker dealer owned by ICP Holdco, Institutional Credit Partners, LLC and Mr. Priore. The Commission’s complaint focused a series of transactions related to four multi-billion dollar collateralized debt obligations know as Triaxx CDOs. As the markets declined the adviser and other defendants engaged in repeated fraudulent conduct to the detriment of the clients. According to the complaint, ICP Asset Management directed more than a billion dollars in fraudulent trades for Triaxx CDOs that were similar and at inflated prices. Defendant ICP Asset Management also structured trades which benefited its affiliates at the expense of the CDOs. By early 2010, most of the bonds held by the Triaxx CDOs which had once been AAA rated were downgraded to junk status.
The defendants agreed to settle following two years of litigation, consenting to the entry of permanent injunctions based on each of the sections cited in the complaint. In addition, Mr. Priore agreed to pay disgorgement of $797,337, prejudgment interest and a penalty of $487,337. ICP and its holding company, Institutional Credit Partners, on a joint and several basis, will pay disgorgement of $13,916,005 along with prejudgment interest. The adviser was also ordered to pay a penalty of $650,000. ICP Securities agreed to pay disgorgement of $1,637,581 along with prejudgment interest and a penalty of $1,939,474. Mr. Priore agreed to settle an administrative proceeding against him. Under the terms of that settlement he will be barred from the securities business and from participating in any penny stock offering with a right to reapply after five years. See also Lit. Rel. No. 22477 (Sept. 10, 2012).
Investment fund fraud: Laura Pendergest-Holt, former chief investment officer of Stanford Financial Group, was sentenced to three years in prison. She previously admitted attempting to obstruct an SEC investigation, agreeing to testify for SFG on a variety of subjects about which she knew little to nothing to delay the inquiry. A fine was not imposed because she did not have the ability to pay.
Investment fund fraud: U.S. v. Milter, Case No. 1:12-cr-00291(S.D.N.Y.) is an investment fund fraud action in which defendant Cliffe Bodden pleaded guilty to one count of conspiracy to commit wire fraud and one count of wire fraud. Mr. Bodden is alleged to have participated in a scheme with S. George Miller in which the two raised about $1 million from foreign investors which the two men misappropriated. Investors were told that Mr. Bodden was a Managing Director of Lempert Capital Management, Ltd, and that Mr. Milter was the CEO of Lempert Brothers International U.S.A., a registered broker-dealer in NYC, and the CEO of Lempert Capital. The investor funds were supposed to be invested in the U.S. financial markets under certain arrangements that would minimize any possible loss. Mr. Bodden also agreed to the entry of a money judgment of $946,509. The charges against Mr. Milter are pending.
Court of appeals
Insider trading: SEC v. Obus, Docket No. 10-4749 (2nd Cir. Decided Sept. 6, 2012) is an action in which the Circuit Court reversed a grant of summary judgment against the Commission. The case centers on the acquisition of SunSource, Inc. by Allied Capital Corporation, announced June 19, 2001. Following the acquisition the SEC brought an insider trading case against Thomas Strickland, an analyst at GE Capital, Peter Black, his friend who worked at Wynnerfield Capital, Inc. which managed a group of hedge funds and his supervisor, 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 and learned about the proposed deal and that Wynnefield held a large block of SunSource stock. During his review, Mr. Strickland talked to his friend Peter Black. Both denied any tipping. Later Mr. Black discussed concerns he had about a possible transaction by SunSource with his boss. About two weeks later Wynnefield purchased 287,200 shares of SunSource at $4.50 per share from Cantor Fitzgerald who initiated the deal. At the time Mr. Obus denied having inside information. Nine days later however, the deal was announced and the share price doubled, giving the hedge fund a profit of about $1.3 million.
The district court granted summary judgment in favor of the defendants, concluding that Mr. Strickland had not breached any duty to GE Capital on the theory that an internal investigation by the company found no breach of duty and the fact that SunSource had not been on the firm’s transaction restricted list. The SEC appealed the ruling based on the misappropriation theory of insider trading. The Circuit Court reversed. The misappropriation theory is premised on a breach of fiduciary to the source of the information rather than the company as with the classic theory. A key question about tippee liability is the knowledge standard. Dirks v. SEC held that “a tippee has a duty to abstain or disclose only when the insider has breached his fiduciary duty . . . and the tippee knows or should know that there has been a breach.” While this seems at odds with Hochfelder’s scienter requirement, the Second Circuit harmonized the two cases holding: “We think the best way to reconcile Dirks and Hochfelder in a tipping situation is to recognize that the two cases were not discussing the same knowledge requirement . .. Dirks’ knows or should know standard pertains to a tippee’s knowledge that the tipper breached a duty, either to his corporation’s shareholders . .. or to his principal . . .Hochfelder’s requirement . . . pertains to the tippee’s eventual use of the tip through trading or further disseminating the information.”
Following these principles the Court concluded that the SEC had presented sufficient evidence to withstand summary judgment since the evidence, construed in favor of the SEC, showed that Mr. Strickland breached his fiduciary duty. The findings of the internal investigation to the contrary and the actions of the company regarding the restrictive list are not relevant. As to Mr. Black the critical point is if he knew or should have known that Mr. Strickland breached his fiduciary duty. He is a sophisticated financial analyst, according to the Court, who knew that his friend was involved in developing financing packages for other companies and performing due diligence He also knew that information about an acquisition would be material non-public information. This, the Court held, is sufficient. Finally, the same question is critical as to Mr. Obus. Here the Court found it sufficient that Mr. Obus determined the information he obtained credible and knew that it originated from a person with a duty of confidentiality. Again, the Court concluded that this is sufficient. Accordingly, the decision of the district court was reversed and the case was remanded for trial.
The regulator imposed a £500,000 fine on Peter Cummings and banned him from holding any senior position in a UK bank, building society, investment or insurance firm. Mr. Cummings was the executive director of HBOS plc and chief executive of its corporate division. From the beginning of 2006 through the end of 2008 he implemented an aggressive growth strategy for the division despite being aware of significant issues with the controls with the division. Rather than taking reasonable steps to mitigate potential risk he directed the division to increase its market share as other lenders were withdrawing from deals. He thus failed to exercise due skill, care and diligence in pursuing the strategy and failed to take reasonable care to ensure that the corporate division adequately and prudently managed high value transactions which showed signs of stress. Although the FSA accepted the fact that he did not act deliberately or recklessly in breaching the regulations, and that this occurred during a global market crisis, the fine is the highest imposed on a senior executive for management failings.