The focus this week was on white collar criminal securities cases. First, Rajat Gjupta, the former Goldman Sachs director convicted of passing confidential information to former hedge fund mogul Raja Rajartnam was sentenced. Second, Mr. Rajartnam’s appeal of his conviction on insider trading and eleven year sentence to prison was heard by the Second Circuit Court of Appeals.
The Commission this week brought three enforcement actions. Once is a settled insider trading case against a former corporate executive. A second involved an offering fraud. Finally, a financial fraud action was brought against a former executive of Carter’s, Inc., the first company to enter into a non-prosecution agreement with the Commission.
Report: The Commission’s Secretary filed a Report on Administrative Proceedings for the Period April 1, 2012 through September 30, 2012 (here).
Registration: The Commission announced that since the passage of Dodd-Frank, 1,504 advisers to hedge funds have registered. Previously 2,557 private fund advisers had voluntarily registered with the Commission (here).
Remarks: Commissioner Daniel M. Gallagher addressed the National Society of Compliance Professionals National Meeting, Washington, D.C. (Oct. 23, 2012). His remarks focused on the question of harmonizing broker-dealer and investment adviser regulation and failure to supervise (here).
SEC Enforcement: Litigated cases
Insider trading; SEC v. Powell, Civil Action No. 6:11-civ-00161 (W.D. Tx. Opinion dated Oct. 11, 2012) names as a defendant Phillip Powell, who helped take First Cash Financial Services, Inc., public while serving as president in 1991. From 1992 through 2004 he acted as CEO and Chairman of the Board. In late 2004 Mr. Powell stepped down as CEO but continued to serve as Chairman. At that time he entered into a formal consulting agreement with the company. On November 6, 2007 the Board of First Cash authorized a stock repurchase program for up to one million shares, announced in a press release the next day. In January 2008 the company established a due diligence data room. That room remained open until late February 2008. Subsequently, on March 7, 2008 the Board approved the retention of JP Morgan Securities, Inc. to execute the plan, a fact known to Mr. Powell. The repurchase began the next day. No announcement of that fact was made or required. At the time the company and counsel concluded that the firm was not in possession of any material non-public information. The board agreed that during the repurchase no insider would engage in transactions in First Cash stock. Mr. Powell was aware of these facts. The day before the repurchase Mr. Powell, as investment manager for Myloe Max, L.P., purchase 100,000 shares of company stock for $807,000. On March 14, 2008, after the close of the market, First Cash issued a press release. The next day its stock closed up at $9.21 from $8.22. Myloe Max did not sell its shares.
The court granted Mr. Powell’s motion for summary judgment on the Exchange Act Section 10(b) insider trading claim. First, the court found that the information about the repurchase program was already in the public domain. There was nothing that obligated the company to announce the date the actual purchasing would begin. Indeed, the CEO of the company and its outside counsel concluded that the information was not material as they advised the board of directors. Second, Mr. Powell did not possess the requisite scienter. In this regard the court concluded that “Based upon the information supplied by the CEO, including advice from outside counsel, Powell reasonably believed that his purchase was permissible after the closing of the data room and prior to the actual date the repurchase began. Also supporting Powell’s lack of intent is the fact that he did not attempt to benefit from the resale of the stock – the stock is still in possession of Myloe Max.”
SEC Enforcement: Filings and settlements
Statistics: This week the Commission filed 3 civil injunctive actions and no administrative proceedings (excluding tag-a-long and 12j proceedings).
Insider trading; SEC v. LoBue, Civil Action No. 12-cv-7944 (S.D.N.Y. Filed Oct. 25, 2012) is an action against the former Director of Store Operations at J. Crew Group, Inc. Mr. LoBue regularly received nonpublic information about J. Crew’s “Stores’ component which represented about 70% of its sales. That data included information about expenses, payroll costs and similar items. The complaint alleged that Mr. LoBue traded on inside information in two instances. First, after receiving information that the results would be better than expected for the first fiscal quarter that ended May 2009 he purchased 2,300 shares and benefited when the stock price rose 26.4% after the results announcement. Second, after learning in July and August 2009 that the sales trend was improving he purchased 11,680 shares. Following an announcement of the results the stock closed up 6.01%. Overall Mr. LoBue had trading profits of $60,735.60. He has been terminated by the company. Mr. LoBue resolved the case with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to pay disgorgement in the amount of his trading profits, prejudgment interest and a civil penalty equal to the trading profits. See also Lit. Rel. 22519 (Oct. 25, 2012).
Offering fraud: SEC v. Mulholland, Civil Action No. 1:12-cv-14663 (E.D. Mich. Filed Oct. 22, 2012) names as defendants Thomas S. Mulholland and James C. Mulholland, Jr. The two defendants have been in the residential real estate business since the 1990s.
Beginning in January 2009, and continuing over the next year, the defendants raised $2 million for their real estate operations from over 75 investors in Michigan and Florida. Investors were induced to purchase promissory notes based on a series of representations regarding the financial condition of the real estate investments which were supposed to generate the returns to pay them 7% interest. As their business deteriorated the two defendants continued to raise money from investors, never revealing the actual financial condition of their real estate business. By February 2010 the defendants filed for bankruptcy. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a)(1). The case is in litigation. See also Lit. Rel. No. 22518 (Oct. 23, 2012).
Financial fraud: SEC v. Pacifico, Case No. 1:12-cv-03636 (D. Ga. Filed Oct. 18, 2012) is an action against Joseph Pacifico, president of Carter’s, Inc. From 2004 through 2009 Joseph Elles, then EVP of sales, reported to him. Beginning in 2004 Mr. Elles is alleged to have manipulated certain rebates the company paid to Kohl’s Corporation resulting in the falsification of the books and records. In March 2009, after Mr. Elles’ employment was terminated and while he had a consulting arrangement with the company, Mr. Pacifico learned about the fraud. On April 28, 2009 he executed a representation letter stating that $22 million was the budget for 2009 accommodations being given to Kohl’s Corporation for the year. At the time he signed the letter he knew, according to the complaint, that $18 million in accommodations to Kohl’s had been carried over from the prior year as a result of the fraudulent activity of Mr. Elles. Mr. Pacifico also knew the letter would be relied on by the accounting department and used in the preparation of the financial statements. Subsequently, Mr. Pacifico approved individual accommodation payments to Kohl’s. At the time he represented to accounting personnel that the payments related to the current period when in fact he knew they did not, meaning they were improperly booked. The complaint alleges violations of Securities Act Section 17(a)(2) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(5). The case is pending.
Guidance: The Commission issued Final Interpretative Guidance to Clarify Foreign Regulators Indemnification and Confidentiality Obligations under Dodd-Frank. This exempts, under certain circumstances, foreign regulators from the indemnification and confidentiality provisions in the Act (here).
Remarks: Chairman Gary Gensler Addressed the Securities Industry and Financial Markets Association’s 2012 Annual Meeting (Oct. 23, 2012). His remarks recapped rule making by the agency relating to swaps (here).
David Lerner Associates, a private investment company, David Lerner, its founder, and William Mason, its head trader, were sanctioned by FINRA. The charges and sanctions relate to unfair sales practices in connection with the sale of shares in Apple REIT Ten, a non-traded $2 billion Real Estate Investment Trust or REIT and excessive markups charged over a 30 month period on the sale of municipal bonds and collateralized mortgage obligations or CMOs. In marketing the REIT the firm solicited thousands of customers, targeting unsophisticated investors and the elderly. It failed to conduct adequate due diligence prior to selling the securities and made misrepresentations. In marketing municipal securities and CMO’s it charged excessive markups for about 30 months. On both charges the firm was fined $2.3 million and will pay $12 million in restitution to customers involved. In addition, Mr. Learner was suspended from the securities industry for one year followed by a two year suspension from acting as a principal. He was also directed to pay a fine of $250,000. Mr. Mason was suspended for six months from the securities industry and directed to pay a $200,000 fine.
Insider trading: U.S. v. Gupta, Case No. 11 crim 9071 (S.D.N.Y.) is the insider trading case against former Goldman Sachs director Rajat Gupta. This week Mr. Gupta was sentenced to serve two years in prison.
Compliance: The regulator fined Bank of Scotland £4.2 million for failing to have adequate systems relating to their mortgage records from 2004 through 2011. During that period the inadequate records meant that the bank could not identify which of 250,000 customers were subject to a cap on their standard variable rate. There was also no structure in place to identify errors as they occurred.
Short selling: Ng Kwok Wing, a representative at Phillips Securities (Hong Kong) Ltd. and Phillips Commodities (HK) Ltd, pleaded guilty to four counts of illegal short selling in the shares of Pacific Plywood Holdings Ltd. On May 20, 2011 he sold two million shares of the company short through his personal account without taking reasonable steps to ascertain that he had sufficient holdings before selling the shares. As a result the Hong Kong exchange executed a buy-in to cover. On May 25, 2011 he sold an additional 7, 836 shares of the same company short before confirming the buy-in trade. He was fined $14,000 and ordered to pay the costs of the investigation which were $17,803.
Reports: The Securities & Futures Commission issued a report on deficiencies in selling practices of licensed corporations. The deficiencies identified included: management oversight, training and compliance monitoring; the suitability assessment process; the use of disclaimers and the signing of declarations; compliance with the new Code of Conduct requirements; and eligibility verification of “professional investors.” The report also discusses steps taken by some firms.
Manipulation: The regulator announced the conviction of Li Jialin, the chairman of VST Holdings, Limited on 10 counts of price rigging and 16 counts of failing to disclose his interest in shares of the company following an eight day trial. Between August 2007 and January 2008 the defendant had three accounts through which he bought and sold VST shares in transactions that resulted in no change of beneficial ownership but did increase the share price. That increase supported a share placement in October 2007 and the year end share price performance. Sentencing is scheduled for October 31, 2012.