This week the SEC continued to implement the Wall Street Reform Act, issuing another group of proposed rules to aid the implementation of the legislation. The SEC Chairman also testified before congress as the week drew to a close, reporting on the implementation of the Act and, in particular, the sections concerning derivatives.
SEC Enforcement filed a rare administrative proceeding alleging insider trading by a former Goldman Sachs and sitting Proctor and Gamble director who is alleged to have tipped the founder of the Galleon funds on the eve of Mr. Rajaratnam’s trial. Enforcement also brought another market crisis case related to the demise of Taylor Bean as well as a settled SOX Section 304 claw back action.
DOJ brought charges parallel to a Commission action against a former investment advisor as well as the defendant involved in the collapse of Taylor Bean. In another financial fraud criminal case, a defendant who previously pleaded guilty was sentenced.
This week the Commission continued to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act, issuing three groups of proposals:
- Rules regarding the disclosure of incentive based compensation arrangements at financial institutions
- Rules regarding clearing agency standards for operations and governance
- Proposed rule amendments to remove credit rating references in Investment Company Act Rules and Forms
SOX 304 clawback: SEC v. McCarthy (N.D. Ga. Filed March 3, 2011) is a clawback action under SOX Section 304 against the president, CEO and board member of Beazer Homes USA, Inc. for not repaying certain incentive based compensation. In 2006 the then Chief Accounting Officer of the company orchestrated an accounting fraud at Beazer to meet earnings expectations (here). As a result of that conduct in May 2006 the company was required to restate its financial statements. The Commission’s complaint notes that Mr. McCarthy was not charged with any wrong doing in its prior actions. Nor did this complaint charge him with any wrongful conduct in connection with the accounting fraud. The action sought the reimbursement to the company of bonuses and incentive based and equity based compensation received, and the profits realized from his sale of Beazer stock, during the statutory time periods of Section 304. To resolve the case defendant Ian McCarthy, without admitting or denying the SEC’s allegations, agreed to reimburse Beazer $6,479,281 in cash, 40,103 restricted stock units or their equivalent and 78,763 shares of restricted stock or their equivalent. This represents all the incentive based compensation received by Mr. McCarthy for fiscal year 2006.
Investment fund fraud: SEC v. Kobayashi, Civil Action No. CV-11-00981 (N.D. CA. Filed March 3, 2011) is an action against former UBS Financial Services adviser Steven Kobayashi. The SEC’s complaint alleges that Mr. Kobayashi established Life Settlement Partners LLC, a fund which invested in life settlement policies. After raising several million dollars from UBS customers, in early 2006 he began diverting the funds to his personal use. In an effort to repay investors he convinced other UBS account holders to liquidate their holdings and transfer the proceeds to his fund. As a result he obtained another $1.9 million in investor funds. The complaint charges Mr. Kobayashi with violations of Exchange Act Sections 10(b) and 15(a). The defendant resolved the case with the Commission by consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. The amount of the disgorgement and penalty will be determined later by the court. The defendant also consented to be barred from the securities industry in a related administrative proceeding. The U.S. Attorney for the Northern District of California is also filing parallel criminal charges. Lit. Rel. No. 21872 (March 3, 2011).
Financial fraud: SEC v. Kissick, Civil Action No. 1:11cv215 (E.D. Va. filed March 2, 2011) is a action against Catherine Kissick, formerly senior vice president, assistant treasurer, and head of Collonial Bank’s Mortgage Warehouse Lending Division. The SEC’s complaint centers on a multi-year fraud involving Taylor, Bean & Whitaker Corp., the now collapsed lender. Ms. Kissick is alleged to have participated with others in a fraudulent scheme from March 2002 through August 2009. Taylor Bean had a warehouse line of credit with the bank. When Taylor Bean began experiencing liquidity problems and over drew its line by millions of dollars per day, Ms. Kissick participated in a scheme to conceal this fact. As part of the scheme Ms. Kissick and others created fictitious mortgage backed securities from fraudulent loans. The hundreds of millions of dollars in fraudulent assets were represented on Colonials financial statements as high quality investments. Eventually the bank was seized by federal regulators. The Commission’s complaint alleges violations of Securities Act section 17(a) and Exchange Act Sections 10(b) and 13(b)(5) along with aiding and abetting violations of Section 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). Ms. Kissick resolved the action by consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. She also agreed to the entry of an order prohibiting her from serving as an officer or director of a public company and from serving in a senior management or control position at any mortgage related company or any financial institution or from holding any position involving financial reporting or disclosure at a public company. In a related criminal case Ms. Kissick pleaded guilty to criminal charges which include conspiracy, securities fraud and wire fraud.
Insider trading: In the Matter of Rajart Gupta, Adm. Proc. File No. 3-14279 (March 1, 2011) is an administrative proceeding against a former Goldman Sachs and current Proctor and Gamble director. According to the Order, Mr. Gupta, a friend and business associate of the Galleon founder, illegally furnished him with inside information learned through his board positions on four occasions. As a result Galleon traded making profits and/or avoiding losses totaling about $18 million. According to the Order, Respondent furnished Mr. Rajaratnam inside information prior to the announcement of: 1) the investment by Berkshire Hathaway in Goldman; 2) the announcement by Goldman of its fourth quarter 2008 results; 3) the announcement by Goldman of its second quarter 2008 results; and 4) the announcement by Proctor and Gamble of its results for the quarter end in December 2008. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation.
Insider trading: SEC v. Seib, Civil Action No. 1:11-CV-0625 (N.D. Ga. Filed March 1, 2011) was an action alleging violations of Exchange Act Section 10(b) by Gregory Seib. The defendant is employed by an unregistered investment adviser who also served as a director of Cambridge Display Technology, Inc. That company was acquired by Sumitomo Chemical Company, Ltd. in a transaction announced on July 31, 2007. Mr. Seib had access to confidential e-mails of his employer which discussed the then pending transaction according to the Complaint. At the time the confidentiality agreement for the proposed transaction was announced he began buying securities of Cambridge. Subsequently, he made additional purchases as the negotiations progressed, eventually building a position of 20 call options and 10,514 shares. The purchases were made in four different accounts. After the announcement he had profits of over $71,000. This case is in litigation. Lit. Rel. No. 21871 (March 3, 2011).
Investment fraud: SEC v. Goldfarb, CV-11-0938 (N.D. CA. Filed March 1, 2011) and U.S v. Goldfarb, CR 110099 (N.D. CA. Filed March 1, 2011) are actions against Lawrence Goldfarb and Baystar Management, LLC, which he managed. The complaint alleges that the defendants diverted about $12 million from a side pocket investment of the fund, Baystar Capital II, L.P. While investors knew about the side pocket they were mislead into believing the investment was not profitable when in fact it was and the proceeds were being diverted to other investments and the personal use of Mr. Goldfarb. The SEC’s compliant against Mr. Goldfarb and Baystar Capital alleges violations of Advisers Act Sections 206(1), (2) and (4). To settle with the SEC Mr. Goldfarb consented to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. He also agreed to pay disgorgement of $12,112,416 along with prejudgment interest and to pay a civil penalty of $130,000. In addition, Mr. Goldfarb agreed to be barred from associating with any investment adviser or broker, with a right to reapply in five years, and to be barred from participating in any offering of penny stock.
In a related criminal proceeding Mr. Goldfarb and Baystar were charged in a one count information alleging wire fraud. To resolve this action the defendants entered into a deferred prosecution agreement with a term of three years. Under the terms of that agreement Mr. Goldfarb is to make restitution in accord with the terms of his settlement with the Commission. He will also be barred from the securities business for three years.
Financial fraud: SEC v. DBH Industries, Inc., Civil Action No. 0:11-cv-60431 (S.D. Fla. Filed Feb. 28, 2011) and SEC v. Krantz, Civil Action No. 0:11-cv-60432 (S.D. Fla. Filed Feb. 28, 2011) both center on financial fraud allegations a DBH Industries, otherwise known as Pont Blank Solutions. The former is a settled financial fraud case against the company. The latter names as defendants the outside directors and audit committee members of the company. DHB Industries centers on a massive financial fraud orchestrated by its then chief executive officer, David H. Brooks, with the assistance of the former chief financial officer, Dawn Schlegel and the former chief operating officer, Sandra Hatfield. According to the SEC’s complaint, from 2003 through 2005 there was a wide ranging accounting, financial and disclosure fraud at the company which included at least $10 million funneled by Mr. Brooks to a company he controlled and the payment of millions of dollars of company funds for personal use. During the period the company lacked internal controls and, as a result, its financial reporting was incorrect. In 2007 the company, now in bankruptcy, restated its financial results. Point Blank settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B).
Krantz is one of the few Commission actions brought against outside directors and audit committee members. Building on the financial fraud alleged in the action against the company, the Commission’s complaint against the directors claims that because of their loyalty to David Brooks, and their own self-interest, they ignored a series of red flags and facts which essentially permitted a massive financial fraud to continue while they served on the board. The complaint alleges violations of Exchange Act Sections 10(b) and 14(a) and aiding and abetting DHB’s violations of Section 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). This case is in litigation. Other related actions are discussed here.
Auditor independence: In the Matter of KPMG Australia, Adm. Proc. No. 3-14276 (Feb. 28, 2011) is a settled administrative proceeding against KPMG Australia. According to the Order for Proceedings, during 2001 and 2002 as to one audit client and from 2001 through 2004 as to a second, the firm violated the auditor independence rules. Although the firm served as the outside auditor to each company and rendered audit opinions representing that it was independent, in fact it was not. For each audit client, the firm rendered other services which resulted in it not being independent. This came in large part from a failure of the firm to institute adequate training for its professionals on the point and a lack of supervision. The firm resolved the matter by agreeing to implement a series of undertaking including the retention of an independent consultant. The firm also agreed to the entry of a censure and a cease and desist order from committing any violations and any future violations of rule 2-02 of Regulation S-X and Section 13(a) of the Exchange Act. In addition, the firm agreed to pay disgorgement of $1,082,000 and prejudgment interest.
Ponzi schemes: U.S. v. Moore (S.D.N.Y.) is an action in which defendant Vance Moore pleaded guilty to one count of conspiracy and nine counts of wire fraud. The charges are based on claims that defendant Moore and another raised over $80 million from investors based on false claims that they were acquiring an interest in ATM machines. While investors were shown documents which involved ownership interests in more than 4,500 ATMs in fact most were owned by others or did not exist. The court sentenced Mr. Moore to serve 97 months in prison.