The SEC approved new rules sought by the exchanges which effectively bar market makers from using “stub quotes,” a kind of quote which is not intended to be executed. That type of quote was involved in the flash crash.

SEC enforcement this week settled with two more Galleon defendants. Another Galleon defendant was sentenced in a parallel criminal case. SEC enforcement also filed an investment fund fraud case and resolved another.

The former CEO of KB Home was sentenced to five years of probation with eight months of home confinement in his criminal option backdating case. Mr. Karatz was acquitted of sixteen of twenty counts in the indictment, including all of the option backdating charges. Finally, Goldman Sachs was fined by FINRA for failing to update filings for its registered representatives, one of which involved the Wells notice issued in the SEC’s enforcement action earlier this year against the firm.

Market reform

The SEC approved new rules proposed by the exchanges and FINRA which will effectively preclude stub quotes (discussed here). A stub quote is one which is “an offer to buy or sell stock at a price so far away from the prevailing market that it is not intended to be executed, such as an order to buy at a penny or an offer to sell at $100,000.” This type of offer was involved in the “flash crash.” Under the new rules, depending on the security, a market maker will have to make a bid which comes within certain parameters. For example, for securities subject to the circuit breaker pilot program the market maker will be required to enter a quote that is not more than 8% away from the best bid and offer. For exchange listed equities that are not included in the circuit breaker pilot program, a market maker will be required to enter quotes that are no more than 30% away from best bid and offer.

SEC Enforcement

Financial fraud: SEC v. LocatePlus Holdings Company, Case No. 1:10-cv-11751 (D. Mass. Nov. 11, 2010) is an action in which the SEC amended its complaint to add Jon Latorella and James Fields as defendants (discussed here). According to the complaint the two men used their control over LocatePlus, a provider of online access to public record databases for investigative searches, to falsely inflate the revenue of the company. The Commission claims that the two men caused LocatePlus to recognize about $2 million from sham transactions they initiated. The complaint also claims that Messrs. Latorella and Fields manipulated the share price of Paradigm Tactical Products, Inc. which sells hand held metal detectors called “FriskerPros.” The Commission’s complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The case is in litigation.

Investment fund fraud: SEC v. Zada, Civil Action No. 2:10-cv-14498 (E.D. Mich. Filed Nov. 10, 2010) is an action against Joseph Zada and his company, Zada Enterprises, LLC. The complaint alleges that Mr. Zada has been running a Ponzi scheme since at least January 2006. During that period Mr. Zada is alleged to have raised about $27.5 million from 60 investors who were falsely led to believe that they were purchasing promissory notes with interest rates that ranged from 7% to 12% and that their funds would be put in oil-related investments. The funds were not invested as claimed by Mr. Zada. Rather, portions of the money were used to repay other investors. A significant part of the money was diverted to Mr. Zada’s personal use. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The case is in litigation. See also Litig. Rel. 21737 (Nov. 10, 2010).

Offering fraud: SEC v. Overland Energy, Inc., Civil Action No. 4:10-cv-613 (E.D. Tex. Nov. 9, 2010) is an action against Garry Smith, Robert Nelson, their companies Overland Energy, Inc. and Acorn Energy, Inc. and their chief salesman Steven Ray. The complaint claims that since September 2007 Messrs. Smith and Nelson raised about $11 million from more that 180 investors through six securities offerings conducted through Overland and Acorn. The shares were sold using a PPM which stated that about 82% of the proceeds would be spent on leasehold costs and to drill, test, complete and equip oil and gas wells. Investors were also told that their funds would be returned within one or two years. In fact, these claims were false, according to the SEC. A significant portion of the investors funds were diverted to the personal use of the individual defendants. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See also Litig. Rel. 21736 (Nov. 10, 2010).

Investment fund fraud: SEC v. Sucarato, Civil Action No. 09-CV-4953 (D.N.J.) is an action against Robert Sucarato who was associated with New York Financial Company, an unregistered investment adviser. The Commission claims that Mr. Sucarato raised at least $1,728,954 from several investors by selling interests in two hedge funds he and his company purported to manage. Those interests were sold based on misrepresentations. The investor funds were then either diverted to the personal use of Mr. Sucarato or lost in commodity trading. Mr. Sucarato settled by consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 5and 17(a), Exchange Act Sections 10(b) and Investment Advisers Act Sections 206(1) and 206(2). He also agreed to pay disgorgement of $1,346,135 along with prejudgment interest. That amount will be offset on a dollar for dollar basis by any payments made by him in a related actions brought by the CFTC. Mr. Sucarato also consented to the issuance of an Order in a related administrative proceeding to the issuance of an order which bars him from association with any investment adviser. See also Litig. Rel. 21734 (Nov. 10, 2010).

Rating agencies:In the Matter of Damyon Mouzon, Adm. Proc. File No. 3-14029 (Filed Sept. 2, 2010) is an action against the former President of LACE Financial Corporation, a Nationally Recognized Statistical Rating Organization. The Order, discussed here, alleges that the firm made a material misrepresentation in its application to be an NRSRO and for an exemption from a conflict of interest rule. It also alleges that the firm failed to disclose, and have adequate written policies regarding, certain extra procedures it used for the firm’s primary client. The firm also failed to retain its e-mail as required. Mr. Mouzon is alleged to have been the cause of the violations. Respondent Mouzon consented to the entry of a cease and desist order from committing or causing any violations and any future violations of Exchange Act Sections 15E(a)(1) and 17(a). The firm settled similar charges on filing (also discussed here).

Insider trading: SEC v. Galleon Management, LP, Civil Action No. 09-CV-8811 (S.D.N.Y.) is the Commission’s action based on the Galleon insider trading case. Specifically, the complaint alleges that Galleon founder Raj Rajaratnam and other engaged in a pattern of insider trading over a period of years (here). This week, the Commission settled with defendants Roomy Khan and Rajiv Goel. Ms. Khan is an individual investor who had been employed at Intel in the late 1990s. She later worked for Galleon. Mr. Goel is a friend of defendant Rajaratnam who was a managing director within the treasury group of Intel. He was also the Director of Strategic Investments at Intl Capital, an Intel subsidiary that makes proprietary equity investments in technology companies. Mr. Goel and Ms. Kahn are alleged to have furnished inside information to Mr. Rajaratnam. Both defendants settled with the Commission by consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Ms. Kahn also agreed to pay disgorgement of $1,552,566.94 along with prejudgment interest. Mr. Goel will pay disgorgement in the amount of $230,570.52 along with prejudgment interest. Mr. Goel is also barred from serving as an officer or director of an issuer. The court will consider the question of a penalty at a later date for each defendant. Both defendants are cooperating with the SEC. See alsoLitig. Rel. 21732 (Nov. 8, 2010).

Criminal cases

Option backdating: U.S. v. Karatz, No. 2:09-cr-00203 (C.D. Cal.) is the criminal option backdating case against Bruce Karatz, former CEO of KB Home. Mr. Karatz was acquitted on sixteen counts centered on option backdating claims. He was however convicted on two counts of mail fraud and two counts of making a false statement. Mr. Karatz was sentenced this week. The court ordered Mr. Karatz to serve five years probation, the first eight months of which requires he be confined to his home. In addition, he was directed to pay a $1 million fine and perform 2,000 hours of community service. The government had sought a sentence of six years in prison and a $7.5 million fine in addition to the disgorgement Mr. Karatz paid to settle the SEC case. The sentence followed the recommendation of the probation department.

Insider trading: U.S. v. Hariri, 09 Mag. 2436 (S.D.N.Y. Filed Nov. 4, 2009) is an action arising out of the Galleon insider trading case (here). Defendant Ali Hariri was a vice president at Atheros Communications. He is alleged to have furnished inside information to Ali Far, a hedge fund manager, who traded. In return for the information Mr. Far furnished defendant Hariri with inside information on other technology companies. Mr. Hariri previously pleaded to conspiracy and securities fraud. This week he was sentenced to 18 months in prison followed by two years of supervised release. He must also pay a $50,000 fine.

FINRA

FINRA imposed a $650,000 fine on Goldman Sachs for failing to update filings for two of its registered representatives to reflect the fact that they were issued Wells Notices by the SEC and for not having adequate procedures (discussed here). The regulator found that Goldman failed to disclose that two of its registered representatives, one of whom is Fabrice Tourre, had received Wells notices from the SEC. Mr. Tourre’s notice was based on the ABACUS transaction at the center of the SEC’s enforcement action in which he is a defendant. Firms are required to update a representative’s regulatory record by filing a Form U4 reporting the receipt of a Wells Notice within 30 days. FINRA also concluded that Goldman does not have adequate supervisory procedures and systems in place to ensure proper disclosure. Its written supervisory procedures, manuals and policies fail to mention “Wells Notices.”