This week three Galleon related defendants were sentenced to prison for insider trading, including Raji Rajaratnam. The Commission filed another significant market crisis case naming the senior officers of a failed bank as defendants. The Commission also filed a settled insider trading case, an action against two exchanges and two investment fraud actions.
The SEC also filed a settled an FCPA administrative proceeding against a valve manufacturer who made improper payments in China. The payments were discovered by the company while implementing FCPA procedures and then investigated and reported to the staff. The company and its local manager were sanctioned.
Finally, the Commission continued to implement Dodd-Frank this week. Draft rules were issued for comment on the Volker Rule and securities-based swaps.
Strategic Dialogue: The SEC and FSA held a Strategic Dialogue Meeting this week. Its purpose was to restate their commitment to work together and continue discussions in areas of common interest including cross-boarder enforcement cases, the oversight of dually-regulated firms and the global regulatory agenda.
Proprietary trading: The Commission, along with other agencies, issued a proposed rule to implement Section 619 of Dodd-Frank, the so-called Volker Rule. Essentially the proposed rule would require the implementation of an internal compliance system. It also includes reporting requirements and would exempt certain specified transactions. The proposal for the rule is here.
Securities-based swaps: The Commission issued for comment proposed rules which would require the registration of securities-based swap dealers and major security-based swap participants (here).
SEC Enforcement – court decisions
Financial fraud: SEC v. Razmilovic, Case No. CV 04-2276 (E.D.N.Y. Ruling issued Sept. 30, 2011) is an action against Tomo Razmilovic, the former CEO of Symbol Technologies, Inc. and others. The action centers on a massive financial fraud allegedly orchestrated by Mr. Razmilovic and others from 1998 through 2002. Liability as to Mr. Razmilovic was previously established in this long running action. Subsequently, the court held a hearing to consider remedies. After considering expert testimony the court concluded that Mr. Razmilovic had to disgorge all ill-gotten profits causally linked to the fraud. While this did not include his base salary it did cover the increase in base pay he obtained for being promoted, incentive compensation tied to the performance of the company, his severance package since it was based on an exchange of stock options awarded based on the performance of the company, stock options and stock trading profits totaling $41,753,632.04. The court entered a judgment in that amount along with prejudgment interest, an officer and director bar and an injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2) and 13(b)(5). The court also imposed a civil penalty of $20,876,811.32. The court declined to impose a penalty in the amount of the disgorgement noting that it would be excessive in view of the amounts.
SEC Enforcement — filings
Exchange systems: In the Matter of Edgx Exchange, Inc., Adm. Proc. File No. 3-14586 (Oct. 13, 2011) is an action against two exchanges and SROs, EDGA Exchange, Inc. and EdGX Exchange, Inc., and broker dealer Direct Edge ECN LLC or DE Route. The action is based on the obligations of national securities exchanges to ensure that their order quoting, routing, execution systems, compliance infrastructures and communications platforms are developed and properly maintained to avoid material failures and outages. In this case there were two significant failures. First, in November 2010 untested computer code changes resulted in EDGA and EDGX overfilling order from three members involving an estimated 27 million shares in about 1,000 stocks at a cost of about $773 million. One member traded out on direction of respondents and submitted a claim for about $105,000 in losses. The others refused at which point the exchanges took over and traded the positions in violation of their own rules. Resolving these trades cost about $2.1 million. DE Route violated SEC rules in the process including those regarding short selling. Second, in April 2011 the EDGX database administrator inadvertently disabled data base connections disrupting the ability of the exchanges to process orders, modifications and cancellations. This caused members about $668,000 in losses. EDGX waited about 24 minutes to remove its quotations from public market data and violated the SEC’s Regulation NMS by failing to identify its quotations as manual, The Order found violations of Exchange Act Sections 19(b) and 19(g). To resolve the matter Respondents submitted a comprehensive plan to improve their systems. They also consented to the entry of a censure. In addition, Respondents EDGA and EDGX agreed to the entry of a cease and desist order based on Sections 19(b) and (g) while De Route agreed to the entry of a similar order based on Section 19(g).
Investment fund fraud: SEC v. Aubrey, Civil Action No. SACV 11-1564 (C.D. Cal. Filed Oct. 12, 2011) is an action against Jerry and Timothy Aubrey and their salesmen, Brian Cherry and Aaron Glasser. The complaint alleges that the defendants raised millions of dollars from investors through high pressure cold calls to sell shares in now-defunct Progressive Energy Partners, LLC. Investors were told they would receive annual returns of 50% or more which was false. In fact the money went to pay large, undisclosed commissions for the salesmen and a lavish house, L.A. Lakers box seats and vacations in Hawaii, Las Vegas and Palm Springs for the Aubrey brothers. The SEC’s complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The action is pending.
Insider trading; SEC v. Hanold, 11-cv-07148 (N.D. Ill. Oct. 11, 2011) is an action against M. Jason Hanold, a director in a Chicago search firm. The SEC’s complaint charges him with trading on inside information shortly prior to the public announcement of the acquisition of Hewitt Associates, Inc. by Aon Corporation. Specifically, the complaint alleges that Mr. Hanold’s wife worked at Aon and learned about the deal as it unfolded. Shortly prior to the July 12, 2010 deal announcement she told her husband in a telephone call that the transaction was eminent. In subsequent e-mails she told him to keep the information confidential. Nevertheless, the next day, which was July 7, 2010, he purchased 831 shares of Hewitt Associates. Following the announcement the share price increased by 18%. Mr. Hanold resolved the case by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and agreeing to disgorge his trading profits and pay prejudgment interest and a civil penalty in the amount of $20,241.
Financial fraud: SEC v. Wu, Case No. CV-11-4988 (N.D. Cal. Filed Oct. 11, 2011) is an action centered on the collapse of United Commercial Bank which resulted in charges of $2.5 billion to the FDIC. Named as defendants are: Thomas Wu, then the Chief Executive Officer of the bank and its holding company, Ehrahim Shabudin, COO, Thomas Yu, First Vice President, Manager of Credit Risk and Portfolio Management and Craig On, CFO of the holding company. The complaint alleges violations of Securities Act 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5) and the related rules. According to the complaint, United Commercial Bank was a rapidly growing financial institution until 2008. As the market crisis unfolded and several large loans and their collateral deteriorated, the former CEO, COO and others took a series of steps to manipulate the value of the loans and/or the reserves and ultimately the financial statements for the bank and holding company. As those steps were implemented the auditors were furnished false information. Ultimately the bank was taken over by California regulators. UCB was the ninth largest bank to fail during the financial crisis of 2008 and 2009. Only Mr. On settled with the Commission. He consented to the entry of a permanent injunction prohibiting violations of Securities Act Sections 17(a)(2) & (3) along with reporting, recordkeeping and internal control provisions. He also agreed to pay a civil penalty of $150,000 and consented to an entry in a related administrative proceeding of an order suspending him from appearing or practicing before the SEC as an accountant with a right to reapply after five years. The other defendants are litigating the action.
Insider trading: U.S. v. Rajaratnam, 09-mg-2307 (S.D.N.Y.) is the insider trading action against the founder of Galleon Management. Mr. Rajaratnam was convicted on 14 counts of conspiracy and securities fraud by a jury in May following a two month trial. On Thursday Mr. Rajaratnam was sentenced to serve 11 years in prison, substantially less than the 19 to 24 years sought by the government. He was also ordered to forfeit $53.8 million and pay a fine of $10 million. His request for a continuation of bail pending his appeal was denied. He is scheduled to surrender at the end of November.
Insider trading: U.S. v.Goffer, 1L10-cr-0056 (S.DN.Y.)is the insider trading case against, among others, Michael Kimelman, one of the founders of Incremental Capital along with Zvi Goffer and Emanuel Goffer. Mr. Kimelman was convicted on two counts of securities fraud and one count of conspiracy to commit securities fraud in June following a jury trial. He had been charged with trading on inside information concerning corporate take-over transactions which ultimately traced to Arthur Cutillo, Brien Santarlas and Ropes and Gray. The trading yielded him about $290,000 in profits. Mr. Kimelman was sentenced to serve 30 months in prison. Earlier this week Emanuel Goffer was sentenced to three years in prison.
Investment fund fraud: U.S. v. Graves (E.D.Va. Filed Oct. 11, 2011) names as defendants John Graves and his wife Sara. Following his resignation from the FBI in 1999, Mr. Graves founded Brook Point Management. He served as president. The firm sold insurance, performed real estate and tax planning services and recruited and advised investment clients. Between June 2008 and July 2011 Mr. Graves and his wife defrauded 11 investors out of about $1.1 million, according to the court papers. Rather than properly invest the funds, they were diverted to the personal use of the defendants and used to repay other investors. Mr. Graves continued to make misrepresentations to investors and the SEC even after the scheme was uncovered. The defendants have been charged with one count of conspiracy to commit mail and wire fraud, one count of mail fraud and four counts of wire fraud. Mr. Graves was also charged with three counts of investment adviser fraud and one count of making false statements. The case is pending.
Investment fund fraud: U.S. v. Muhawich (N.D. Cal.) is an action in which Maher Talal Muhawich, a San Francisco real estate developer, was indicted on twelve counts of wire fraud. The indictment alleges that from January 2006 through March 2009 the defendant and others solicited about $25 million from at least 80 investors based on false representations. Investors were told that the money would be used to purchase and renovate specific residential properties in San Francisco which would then be sold yielding high rates of return for the investors with limited risk. Mr. Muhawich pleaded guilty to one count of wire fraud. Sentencing is scheduled for March 7, 2012.
In the Mater of Watts Water Technologies, Inc, Adm. Proc. File No. 3-14585 (Oct 13, 2011) is an action against the company and Lessen Chang. Watts manufactures and sells water valves and related products. Its shares are traded on the NYSE. Watts operated in China through its wholly owned subsidiary, Watts Valve Changsha Co. Ltd or CWV, established in 2005. It was sold in 2010. Mr. Change, a U.S. citizen, was vice president of sales for Watts’ management subsidiary in China. CWV produced and supplied large valve products for infrastructure products in China that were largely done with state-owned entities. Those entities routinely retain state-owned design institutes to assist. Here from 2006 through 2009 improper payments were made to employees of certain design institutes by CWV. The purpose was to influence the institutes to recommend CWV products to the state-owned enterprises involved with the infra-structure projects. They were also intended to create design specifications that favored CWV products. The payments were booked incorrectly as commissions in CWV’s books and records which caused those of Watts to be inaccurate. Respondent Chang approved many of the payments. The company realized about $2.7 million in profits from the payments.
The violations were discovered, investigated and reported to the staff by the company. In early 2009 Watts’ General Counsel learned of a Commission enforcement action against another company involved with unlawful payments to employees of Chinese design institutes. As a result the company implemented anti-corruption and FCPA training for the Chinese subsidiary of Watts. Following a training session the Watts China in-house corporate counsel learned of possible FCPA violations which caused the company to undertake an internal investigation conducted by outside counsel and forensic accountants. Subsequently, the company initiated a series of remedial steps.
To resolve the case the company consented to the entry of a cease and desist order based on Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B), agreed to pay disgorgement of $2,755,815 along with prejudgment interest and a civil penalty of $200,000. Respondent Change consented to a cease and desist order based on the same sections and agreed to pay a civil penalty of $25,000. The Order notes that “the Commission considered remedial acts promptly undertaken by Watts and the cooperation afforded the staff.”
FINRA Chairman and CEO Richard Ketchum addressed the Security Traders Association Annual Convention on October 13, 2011. His remarks reviewed the Manning Rule, the integrated audit trails and surveillance, indications of interest and market structure issues. The text is here.
Audit firm/partner barred: The Board issued an order permanently barring auditor Samuel Cordovano and permanently revoking the registration of his firm, Denver based Cordovano and Honeck, LLP. Mr. Cordovano had significant participation in four audit engagements following a settlement in which he had been barred by the Board from association with an audit firm with a right to apply for re-association after one year.
Japanese regulators: The Board exchanged letters with its Japanese counterparts confirming their mutual commitment to cooperation on cross-boarder audit oversight. The letters were with the Japan Financial Services Agency and Certified Public Accountants and Auditing Oversight Board. While the Board has conducted inspections of Japanese PCAOB registered firms since 2007 the letters confirm the arrangement and their mutual cooperation. They also provide for the exchange of confidential information under the applicable provisions of Dodd-Frank.
Engagement partner: The Board issued for comment proposed amendments to its standards which would require audit firms to disclose in their audit report the name of the engagement partner and the identity of any other accounting firms and persons not employed by the audit firm that took part in the audit. The goal is to provide greater transparency.