Money market reform, a cause long championed by SEC Chairman Mary Schapiro, will not go forward at this time. The Chairman was unable to secure the necessary votes to issue proposed regulations for comments after two and one half years of study. The Chairman issued a lengthy statement discussing the issue. Reportedly other agencies are considering whether they can assume responsibility for the instruments since in the wake of Dodd-Frank the authority used to prop-up the funds during the market crisis no longer exists.
The Commission brought a settled insider trading case this week and two additional investment fund fraud actions. Criminal prosecutors secured convictions in an insider trading case and a manipulation action. They also charged two corporate executives in a financial fraud action.
Three significant matters were decided recently in the courts of appeals regarding securities enforcement actions. Once defined “substantial assistance” for aiding and abetting, another considered the applicability of the statute of limitations in Commission enforcement actions while a third discusses what constitutes material nonpublic information in a criminal insider trading case.
Money market funds: SEC Chairman Mary Schapiro issued a statement regarding the refusal of the Commission to propose regulations to reform money market funds. For two and one half years the Commission has considered this issue. Some Commissioners suggested issuing a concept release which the Chairman rejected. In part the Chairman noted that the “declaration by the three Commissioners that they will not vote to propose reform now provides the needed clarity for other policymakers as they consider ways to address the systemic risk posed by money market funds. I urge them to act with the same determination that the staff of the SEC has displayed over the past two years.” The Chairman went on to note that the tools used to bail out the funds during the financial crisis no longer exist. The statement is here.
Conflict Minerals: The SEC adopted a rule regarding the disclosure of conflict minerals (here).
Resource extraction issuers: The Commission adopted rules requiring the disclosure of payments by resource extraction issuers (here).
Whistleblowers: The Commission announced its first whistleblower awards under the new Dodd-Frank program. The identity of the whistleblower was not disclosed. Reportedly, the person received a $50,000 award (here).
SEC Enforcement: Filings and settlements
Statistics: This week the Commission filed 4 civil injunctive actions and 1 administrative proceeding (excluding follow on and 12j actions).
Penny stock fraud: SEC v. Bronson, Civil Action No. (S.D.N.Y. filed Aug. 22, 2012) is an action against Edward Bronson and his controlled entity, E-Lionheart Associates, LLC. Beginning in August 2009 the defendants engaged in a scheme in which they would cold call penny stock companies to determine if they were interested in raising capital. From companies looking to raise funds they bought shares at a deep discount and later resold them at higher prices. The shares were not registered, although the defendants claimed they were exempt. Through this scheme, the complaint claims, the defendants made about $10 million involving approximately 100 penny stock companies. The complaint alleges violations of Securities Act Section 5. The case is in litigation.
Cherry picking: In the Matter of Middlecove Capital, LLC, Adm. Proc. File No. 3-14993 (Aug. 22, 2012) is a proceeding which names as Respondents the registered investment adviser and its chief and investment officer and owner, Noah Myers. From October 2008 through February 2011 Respondents engaged in a “cherry picking” scheme in which Mr. Myers would allocate successful trades to his account or one of those belonging to his family and unsuccessful ones to clients. He did this by trading through an omnibus account and then allocating the trades at the end of the day or the next day. During the period Mr. Myers realized about $460,000 in profits from the scheme. The Order alleges violations of Exchange act Section 10(b). The matter will be set for hearing.
Investment fund fraud: SEC v. Rojas, Case No. 3:12-cv-01681 (D. P.R. Filed Aug. 21, 2012) is an action against Ricardo Bonilla Rojas and his company. Shadai Yire, Inc., which alleges that from August 2005 through February 2009 the defendants engaged in an offering fraud and Ponzi scheme. The two men raised more than $7 million from about 200 investors. They primarily targeted evangelical Christians and factory workers. Investors were told the funds would be invested risk free in M&R International Group, Corp, a subsidiary of Shadai Yire, in commodities. Returns of 15% to 50% were promised. In fact the operation was a Ponzi scheme. The Commission’s 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. Parallel criminal charges have been filed.
Insider trading: SEC v. Lieberman, Civil Action No. 1;12-cv-02198 (D. Colo. Filed Aug. 20, 2012) is an action against James Lieberman, the former manager of environmental health and safety at Array BioPharma Inc. On March 5, 2010 Mr. Lieberman received an e-mail from the CFO of the company informing him that a significant transaction with Novartis, A.G. was imminent. Minutes later he began purchasing shares of his company. Over the next two weeks he acquired almost 50,000 shares in his account and that of his sister. When the deal was announced on April 19 2010 he sold the shares at a profit of $71,361. Mr. Lieberman settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to disgorge his trading profits, pay prejudgment interest and a civil penalty of $71,361.
Investment fund fraud: SEC v. Rex Venture Group, LLC, Case No. 3:12-cv-519 (D. N.C. Filed Aug. 17 2012) is an action against the company, doing business as ZeekRewards.com, and its principal, Paul Burks. Since January 2011 the defendants have raised over $600 million from about 1 million investors solicited over the internet to purchase securities through the ZeekRewards website in the form of Premium Subscriptions and VIP Bids. Investors were promised up to 50% of the company’s daily net profits through a profit sharing system in which they got points that could be used for cash payouts. While the website suggested the company was profitable in fact it is a Ponzi and pyramid scheme. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). A receiver has been appointed. Mr. Burks agreed to settle the case and is cooperating with the receiver. See also Lit. Rel. No. 22456 (Aug. 22, 2012).
Manipulation: U.S. v. Stockdale, Case No. 11-cr-00801 (E.D.N.Y.) Pino Baldassarre, the former president of Dolphin Digital Media, Inc., and Robert Mouallem, a stock broker, were convicted on conspiracy, securities fraud and commercial bribery charges by a jury. Dolphin created secure social networking web sites for children. Its shares were traded on the OTC Bulletin Board. In 2009 Mr. Baldassarre was terminated from the company. At the time he was a substantial shareholder. Subsequently, he met “John Doe” who offered to arrange through a network of stock brokers to sell the shares at inflated prices for a 30% kickback. Test transactions were conducted and the kickback was paid in March and April 2010. “John Doe” was an undercover FBI agent. The date for sentencing has not been set.
Financial fraud: U.S. v. Raffle, Case No. 1:12-cr-0034 (W.D. Tx.). David Applegate and John Raffle, both former senior vice-presidents at Arthro Case Corporation, were named in an indictment charging one count of conspiracy, four counts of wire fraud, eight counts of mail fraud and three counts of securities fraud. The indictment alleges that beginning in December 2005, and continuing through the end of 2008, the two men engaged in a wide spread fraud at the company to falsely inflate revenue to meet street expectations. In one part of the scheme the men determined how much product had to be sold at the end of each quarter and then “parked” it at their distributors. In another part of the scheme they simply shipped product to customers without orders and recorded the income when the invoice was sent. Eventually the company was forced to restate its financial statements which, when announced, resulted in the share price dropping from $40.03 to $23.21. The case is pending.
Insider trading: U.S. v. Whitman, No. 1: 12-cr-00125 (S.D.N.Y.) Doug Whitman, a former hedge fund manager was convicted on conspiracy and securities fraud charges following a jury trial. Mr. Whitman engaged in two insider trading schemes. In one, he bought and sold shares of Marvell stock from 2007 through 2009 based on inside information he obtained from Karl Motey, an independent research consultant who secured the information from company insiders. In another, between 2006 and 2007 he obtained inside information regarding Polycom and Google from Roomey Kahn. She obtained the information regarding Google from an employee at an investor relations firm and regarding Polycom from an employee of the company. Mr. Whitman, trading through Whitman Capital, made over $900,000. Sentencing is set for December 20, 2012.
Court of Appeals
Materiality: U.S. v. Contorinis, Docket No. 11-3-cr (2nd Cir. Decided Aug. 17, 2012).
Joseph Contorinis, a portfolio manager of the Jeffries Paragon Fund, was convicted on insider trading charges. At trial he challenged the definition of material nonpublic information used in the jury instruction. The Second Circuit affirmed his conviction.
The case centers on the January 2006 the acquisition of Albertson supermarket chain. The Fund held a large number of shares which it sold at a profit of about $3 million. It began purchasing those shares in September 2005 when Albertsons announced it was considering strategic alternatives. Nicos Stephanou, a long time friend of Mr. Contorinis, and his firm worked on the deal. Prior to the deal announcement he periodically gave his friend updates. Sometimes the news was that the deal was proceeding. Other times the information was that the prospects for a deal were dim. At times the Mr. Contorinis adjusted the holdings of the Fund.
Central to Mr. Stephanou’s appeal was his challenge to the definition of what constitutes material non-public information in the jury instructions. Specifically, he challenged the portion of the instructions that dealt with insiders confirming rumors. In this regard the instructions stated that “the confirmation by an insider of unconfirmed facts or rumors – even if reported in the newspaper – may itself be inside information . . . ‘material’ information is information which a reasonable investor would have considered significant in deciding whether to buy, sell, or hold securities . . . “ Mr. Contorinis argued that the instruction had a critical omission because it failed to state that the general confirmation of an event that is “fairly obvious” to knowledgeable investors is not material, nonpublic information. He also objected to the court’s statement that the confirmation by an insider of unconfirmed facts or rumors may be inside information. The Second Circuit rejected both claims.
While the concepts of materiality and nonpublic status refer to different things, they also overlap. As the Court stated: “The content of a piece of information may be of importance in affecting the share price but so well-known that it does not alter the mix of available information and is therefore not deemed to be material. Conversely, the same information, if previously unknown to the public, may alter substantially the mix of information and thus be deemed very material.” The reliability of the information may also affect its materiality. Thus a tip that provides additional reliability to existing information may be material the Court noted. Viewed in this context, the trier of fact could find that a statement from an insider that confirms a widely circulating rumor is material. These concepts are reflected in the district court’s instructions while Mr. Contorinis’ mistakenly focused entirely on the content of the reports or tips to the exclusion of their reliability. The verdict was affirmed.
Statute of limitations: SEC v. Bartek, No. 11-10594 (5th Cir. Decided Aug. 7, 2012) is an option backdating case against Douglas Bartek and Nancy Richardson, respectively, the CEO and CFO of Microtune. The complaint, filed June 30, 2008, alleges that from 2000 to 2003 the defendants backdated millions of dollars worth of options for which the proper accounting charges were not taken. The district court granted the defendants’ motion for summary judgment, concluding that the action was barred by the statute of limitations under Section 2462 of Title 28. The Fifth Circuit affirmed. The Court rejected the Commission’s contention that the statute of limitations in Section 2462 does not commence until the cause of action is discovered rather than when it occurs. Examining the text of the statute, the Court held that “A plain reading of §2462 reveals no discovery rule exception. . . “ SEC v. Gabelli, 653 F. 3d 49 (2nd Cir. 2011), cited by the Commission, is not to the contrary. There the court found that the discovery rule does not govern the accrual of most claims because they do not involve conduct that is inherently self-concealing as in that case. Here there is no such conduct.
Finally, the Court rejected the SEC’s claim that the permanent injunctions and the officer director bars sought were equitable remedies and not penalties barred by Section 2462. The test for what constitutes a penalty is an objective one. The test is focused on whether it is a form of punishment imposed by the government for unlawful or proscribed conduct, which goes beyond remedying the damage caused to the harmed parties by the defendant’s actions. Here, determining whether the injunctions sought are a penalty or are remedial requires an examination of their nature or characteristics. In this case the injunctions would have a “stigmatizing effect and long-lasting repercussions.” Other courts have held that excluding a person from their profession is a penalty. Neither remedy addresses the past harm alleged here. Accordingly, the lifetime bans sought here are penalties and time barred. The district court’s grant of summary judgment in favor of the defendants was affirmed.
Aiding and abetting: SEC v. Apuzzo, Docket No. 11-696-cv (2nd Cir. Decided Aug. 8, 2012) rejected a decision by the district court which had concluded that the SEC must, to establish substantial assistance for an Exchange Act Section 20(e) claim, plead and prove causation. Joseph Apuzzo was the Chief Financial Officer of Terex Corporation, according to the Commission’s complaint. In December of 2000, and again the following year, Terex entered into two fraudulent sale-leaseback transactions with United Rentals, Inc. or URI. The transactions were designed to allow URI to prematurely recognize revenue and inflate the profit generated from the sales. There was no dispute that Mr. Apuzzo knew about the transactions and participated in them. Nevertheless, the district court granted Mr. Apuzzo’s motion to dismiss the complaint, concluding that the SEC failed to adequately allege “substantial assistance” which requires “that the aider and abettor proximately cause the harm on which the primary violation was predicated . . . “
The Second Circuit reversed. Under Section 20(e) of the Exchange Act the Commission is authorized to bring an action for aiding and abetting if three elements are plausibly pleaded: 1) the existence of a securities law violation by a primary violator; 2) knowledge of this violation on the part of the aider and abettor; and 3) substantial assistance by the aider and abettor in the achievement of the primary violation, Here, the key question is what constitutes substantial assistance. That is defined as meaning that “he in some sort associate[d] himself with the venture, that [the defendant] participate[d] in it as in something that he wishe[d] to bring about, [and] that he [sought] by his action to make succeed.” Mr. Apuzzo’s contention that substantial assistance requires that proximate cause be pleaded fails to distinguish between a private suit and an SEC enforcement action, according to the court. Proximate cause is a tort concept which ties to the requirement to link the injury to the damages. There is no such requirement in an SEC enforcement action. In this case the SEC’s complaint meets the test since the SEC pleads that the transactions were “designed” to hide the fraud and that Mr. Apuzzo “knew” that the transactions were crafted to inflate revenue. This is sufficient.
The Board issued a report entitled “Report on the Progress of the Interim Inspection Program Related to Audits of Brokers and Dealers.” It is what the Board calls a “first look” of the inspection program carried out over a five month period and involved 10 audit firms covering portions of 23 audits of brokers and dealers. While the PCAOB cautions that the results cannot be generalized, they are of concern to the Board (here).
The regulator fined Rodman & Renshaw LLC $315,000 for supervisory and other violations related to the interaction between the firm’s research and investment banking functions. The COO of the firm, William Iommi Sr. was fined $15,000 and suspended from acting in a principal capacity for 90 days and must re-qualify as a general securities principal. Specifically, from January 2008 through March 2012 the firm failed to have an adequate supervisory system to monitor interactions between its investment banking and research functions. As a result the firm failed to prevent research analysts from soliciting investment banking business. The two analysts involved, Lewis Fan and Alka Singh, were fined $10,000 each. Mr. Fan was suspended for 30 days. Ms. Singh was suspended for 6 months after FINRA found she attempted to arrange a concealed fee from a public company for which she provided research.
The agency obtained confiscation orders totaling £1,534,000 against Christian Littlewood and Angie Littlewood in an insider dealing case. Mr. Littlewood was a former senior investment banker. His wife Angie and a family friend, Helmy Sa’aid, pleaded guilty to eight counts of insider dealing related to trading in a number of different stocks between 2000 and 2008.
The SFO secured the conviction of Asil Nadir on 10 counts of theft related to Polly Peck International, a company he founded, after a three day jury trial. Polly Peck was created by Mr. Nadir in 1980 and rapidly rose to be on the FTSE 100. It traded in Nocosia, Istanbul, New York and Hong Kong. Following its collapse in the early 1990s, an investigation concluded that Mr. Nadir had transferred as much as £380 million pounds from company accounts to others controlled by him. At trial the SFO traced the movement of about £33.1 million as examples. Mr. Nadir maintained that although the transfers were made, arrangements had been made for balancing deposits. Based on a review of bank records the deposits were suspected of being an illusion. Mr. Nadir was sentenced to serve 10 years in prison but under the terms of the sentence he will be released after 5 years on license for the remainder of the total term.
The Securities and Futures Commission reprimanded Merrill Lynch (Asia Pacific) Ltd. and fined the firm HK $3.5 million for failing to adequately investigate customer complaints regarding the actions of one of its registered representatives. That representative later was convicted on 20 counts of theft and dishonesty. The 11 clients involved had losses of about US$7,228,000 and had another 37 client accounts. Merrill Lynch has agreed to conduct a complete review and has already compensated 9 of the 11 clients. The firm has cooperated and strengthened its internal controls.