Companies with China based operations were a focus this week for the SEC. The Commission filed two financial fraud actions against companies whose operations were in the PRC. In one there seemed to be virtually no operations while in the other two sets of books were used to falsify revenue while proceeds of a securities offering were diverted to the use of the chairman and the controlling shareholder. The SEC also concluded its “golden goose” insider trading case, settling with the two remaining defendants. And, another defendant in the Dell insider trading case was sentenced to prison.
The Commission prevailed in the Second Circuit which affirmed the entry of an officer and director bar ordered by the district court following the settlement of an insider trading case. The Circuit Court declined, however, to adopt the SEC’s proposed test for issuing such orders.
Testimony: Chair Mary Jo White testified before the House Committee on Financial Services (May 16, 2013). The testimony reviewed the recent work of the divisions in support of the Commission’s budget request (here).
Remarks: Commissioner Daniel M. Gallagher addressed the 45th Annual Rocky Mountain Securities Conference, Denver, Colorado (May 10, 2013). His remarks focused on the municipal securities markets and recent, related enforcement actions (here).
Remarks: Commissioner Scott D. O’Malia addressed the Energy Risk USA 2013 Conference (May 14, 2013), delivering remarks titled “Dodd-Frank Regulatory Framework: What Questions Remain Unanswered.” Topics addressed include the large number of no-action and exceptive orders, the cross-boarder rules, futurization, the Volker Rule and data use (here).
SEC Enforcement: Filings and settlements
Weekly statistics: This week the Commission filed 3 civil injunctive action and no administrative proceedings (excluding tag-along-actions and 12(j) proceedings).
Cherry picking scheme: SEC v. Dushek (N.D. Ill. Filed May 16, 2013) is an action centered on a cherry picking scheme by the founder of an investment adviser and his son. The named defendants are Charles J. Dushek, his son Charles S. Dushek, and the state registered investment adviser, Capital Management Associates, Inc. From 2008 through 2012 the father and son team placed about 13,500 trades. Those trades were typically not allocated to either their accounts or those of a client for periods which ranged from a day to several days after the trade. Generally the profitable trades went to the accounts of the father and son and the unprofitable ones to the clients. Thus during the four year period here 75% of the trades for the father and son were profitable yielding $2 million in profits. For the clients only 25% were profitable yielding over $2 million in losses. For 17 consecutive quarters during the four year period the father and son had positive returns in their personal accounts at the time of allocation while the clients suffered losses. The complaint alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2). The case is in litigation.
Investment fund fraud: SEC v. Deer Hill Financial Group, LLC, Civil Action No. 12-01317 (D. Conn.) is a previously filed action against the advisory firm and its principal, Stephen B. Blankenship. The complaint alleges that beginning in 2002 and continuing through 2011 the defendants misappropriated at least $600,000 from 12 brokerage customers by falsely representing that their funds would be invested through the advisory. The defendants settled with the Commission and the Court entered a final judgment as to each prohibiting future violations of Exchange Act Sections 10(b) and 15(a), Securities Act Section 17(a) and Advisers Act Sections 206(1) and (2). In a related action Mr. Blankenship was barred from the securities industry. In a parallel criminal case Mr. Blanenship previously pleaded guilty and was sentenced to serve 41 months in prison, pay a fine of $7,500 and make restitution in the amount of $607,516.81.
Financial fraud: SEC v. Rino International Corp., Civil Action No. 1:13-cv-00711 (D.D.C. Filed May 15, 2013) is an action against the company whose operations are based in China, Dejun “David” Zou, its founder and controlling shareholder, and Jianping “Amy” Qiu, its chairman. The complaint, which alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(b)(5), 13(a), 13(b)(2)(A) and 13(b)(2)(B), states that the defendants inflated the revenues of the company and diverted offering proceeds to the personal use of the individual defendants. To implement part of the scheme the company had two separate sets of books, one for China and one for the U.S. The revenue recorded in the latter was 15 times higher than that in the former over about a two year period beginning in early 2008. Following a December 2009 offering of securities, portions of the proceeds were used to purchase a home, cars and other personal items for defendants Zou and Qiu. To resolve the case each defendant consented to the entry of a permanent injunction prohibiting future violations of the provisions cited in the counts of the complaint applicable to them. Defendants Zou and Qiu also agreed to pay penalties of $150,000 and $100,000 respectively in addition to the $3.5 million they paid as disgorgement in the related class action. The individual defendants also consented to the entry of an officer-director bar for ten years.
Insider trading: SEC v. Devlin, Civil Action No. 08-CV-11001 (S.D.N.Y.) is a previously filed action against, among others, Jamil Bouchareb and Daniel Corbin and his related entities. They are the last defendants in this case which was known as the “Golden Goose” action. It centered on repeatedly trading on inside information misappropriated by Matthew Devlin, formerly a Lehman Brothers, Inc., representative, from his wife who was a partner in a public relations firm. She was known as the “golden goose” among the group. The Court entered judgments which permanently enjoined each of the remaining defendants from future violations of Exchange Act Sections 10(b) and 14(e). Mr. Corbin was also ordered to pay disgorgement of $164,515.50 along with prejudgment interest. Mr. Bouchareb was directed to pay disgorgement of $921,082 along with prejudgment interest. The disgorgement includes the trading profits of certain relief defendants. Previously, Messrs. Bouchareb and Corbin each pleaded guilty to parallel criminal charges and were sentenced to prison. The other defendants in the Commission’s case previously settled. See also Lit. Rel. No. 22700 (May 15, 2013)
Financial fraud: SEC v. Subaye, Inc., Civil Action No. 13 Civ 3114 (S.D.N.Y. Filed May 13, 2013) is an action against the corporation, a NASDAQ listed company whose operations were supposedly in the PRC, and its former CEO James Crane, a Massachusetts CPA. From 2008 through 2010 the revenue of the company steadily increased as the description of its main business dramatically shifted, according to the Form 10-K filed each year. Eventually the exchange delisted the firm for failing to comply with the listing standards and the PCAOB barred Mr. Crane from being an associated person of a registered public accounting firm. Following Mr. Crane’s resignation, a new CEO was appointed who, upon investigation, determined the company had virtually no assets or operations. The Commission’s complaint alleges violations of Exchange Act Section 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). The case is in litigation.
Investment fund fraud: U.S. v. Holcum (S.D. Ca. Unsealed May 15, 2013) is an action which names Bradley Holcum as a defendant. The indictment charges eight counts of mail fraud, four counts of wire fraud and one count of securities fraud. It alleges that from 2004 through 2010 Mr. Holcum raised about $50 million from 150 investors who purchased promissory notes in a real estate project. Investors were assured that they would receive a first lien on the property which was to be developed. In fact investor notes were not secured as promised and in some instances Mr. Holcum sold the parcels of real estate without informing investors that the property they had financed for development was gone. As his financial condition deteriorated in 2008 Mr. Holcum continued to solicit investors. The case is pending.
Insider trading: U.S. v. Newman, 1-12-cr-00121 (S.D.N.Y.). Anthony Chiasson, the co-founder of hedge fund Level Global Investors, was sentenced on insider trading charges this week to serve 78 months in prison. Mr. Chiasson was convicted along with co-defendant Todd Newman, a portfolio manager at Diamondback Capital Management LLC, by a jury last December. Mr. Newman has been sentenced to serve 54 months in prison. The charges were based on trading on inside information regarding the earnings announcements of Dell Inc. and NVIDIA Corporation in 2008 and 2009. The SEC has a parallel case pending. SEC v. Adondakis, Civil Action No. (S12-cv-0409 (S.D.N.Y.).
Court of Appeals
Officer/director bars: SEC v. Bankosky, Docket No. 12-2943-cv (2nd Cir. Decided May 14, 2013). The Circuit Court affirmed the issuance of a officer-director bar by the district court against a corporate executive who settled an insider trading case. The ruling is based on a settled case against Brent Bankosky of Takeda Pharmaceuticals International, Inc. As the director of global licensing and later a senior director during the period January 2008 through May 2011 he had access to inside information regarding transactions in which the company was involved. Contrary to company policy, Mr. Bankosky purchased call options in the shares of four entities involved in deals with Takeda prior to the public announcement.
In March 2012 the SEC and Mr. Bankosky settled this action which was based on the four trades. Without admitting or denying the facts alleged in the complaint he consented to the entry of a permanent injunction. He also agreed to pay disgorgement of $63,000, prejudgment interest, and a civil penalty equal to the amount of the disgorgement. Following the settlement the Commission moved for the imposition of an officer-director bar. The district court granted the motion and imposed a 10 year bar, utilizing the test in SEC v. Patel, 61 F. 3d 137 (2nd Cir. 1995).
The Circuit Court affirmed. Officer-director bars are provided for in Exchange Act Section 21(d)(2) which requires a finding that the person who violated Section 10(b) is “unfit.” That standard was written into the Section in 2002 by the Sarbanes-Oxley Act. It lowered the standard from the prior “substantial unfitness.” On appeal the SEC argued that the bar should be affirmed but that the Patel standard is no longer applicable because of the change in the statute. The Commission contended that the six factor test used by the Court in Steadman v. SEC, 603 F. 2d 1126 (5th Cir. 1979), which govern the propriety of issuing injunctive relief, should be considered. The Court concluded that the application of Patel is not erroneous. If the conduct met the pre-amended statutory standard there can be no doubt that the bar should issue under the new, lower standard the Court reasoned. Furthermore, the test is flexible and no single factor is dispositive or even mandatory. Likewise, other courts have continued to rely on Patel. The Court declined to adopt the SEC’s proposed standard.
The Australian Securities and Investment Commission filed charges against Andrew Sigalla, a director of TZ Limited. Mr. Sigalla is allged to have made 16 payments of company funds to himself over a one year period beginning in March 2008. The payments totaled about $6.1 million and were used largely to pay for his gambling debts. The case is pending.