Key events this week included a report to the SEC and CFTC from the Advisory Committee on the flash crash. In court the SEC obtained a split decision on summary judgment motions in an insider trading case, winning as to one defendant and losing as to another. The Commission also lost an option backdating case on statute of limitations grounds. In addition the SEC filed an international market manipulation scheme case and more investment fund fraud actions.
In criminal cases the expert network investigation continued moving forward with another defendant appearing in response to an indictment. And, in the court of appeals the Ninth Circuit held that a FINRA rule limiting who can represent a party in an arbitration does not have retroactive effect.
Flash crash: The Joint CFTC – SEC Advisory Committee on Emerging Regulatory Issues furnished the two agencies with a fourteen point report this week. Threaded throughout it are comments about the impact of high speed trading. In part, the report comments on steps which have been taken or are under consideration by either or both agencies. For example, in its first point the report notes that the Committee concurs with the steps taken by the SEC to create single stock pause/circuit breakers for the Russell 1000 stocks and actively traded ETFs as well as to enact rules which provide greater certainty as to which trades will be broken under certain circumstances.
Others recommend specify specific action which should be taken in the view of the Committee. These include recommendations that: the SEC require an expansion of the pause rules; work with the Exchanges and FINRA to implement a “limit up/limit down” process to supplement the existing pause rules; and that it “proceed with a sense of urgency” regarding a consolidated audit trail.
Other points include recommendations for further study: to evaluate the present system-wide circuit breakers in view of certain points; to consider the potential benefits which might be gained by changes in maker/taker pricing practices; and to consider “reporting requirements for measures of liquidity and market imbalance for large market venues.” The report concludes by noting that while there are other issues to be considered, the points discussed are, in the view of the eight committee members, the most important.
Financial fraud: SEC v. Brown, Civil Action No. 1:11cv192 (E.D. Va. Filed Feb. 24, 2011) is an action against Desiree Brown, the former treasurer of Taylor, Bean and Whitaker Mortgage Corp. Ms. Brown is alleged to have participated in a scheme with Lee Farkas to prop up the failing mortgage company over a period of several years through the sale of more than $1.5 billion in fictitious and impaired mortgage loans and securities from Taylor Bean to Colonial Bank. She also participated in an attempt to defraud the Treasury’s Troubled Asset Relief Fund as described here. The complaint alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The case is in litigation. In a related case Ms. Brown pleaded guilty to criminal charges.
Market manipulation: SEC v. Ficeto (C.D. Cal. Filed Feb. 24, 2011) is an action against Todd Ficeto, Florian Homm, Colin Heatherington, Hunter World Markets, Inc., and Hunter Advisors, LLC. Hunter World was a registered broker-dealer co-owned by defendants Ficeto and Homm. Mr. Homm was also the co-founder and the chief or co-chief adviser for Absolute Capital Management Holdings Ltd., a London based hedge fund management company and SEC registered investment advisor to eight hedge funds. The complaint details two related schemes which took place from September 2005 through September 2007. In one Mr. Homm along with defendants Ficeto, Heatherington and Hunter World manipulated the share price of several domestic microcap issuers. Through this manipulation, the complaint claims, the defendants made millions of dollars. The manipulated stocks were the assets of the hedge funds. The manipulations were carried out through coordinated trading done through the use of instant messages by the principal traders at Hunter World and those at Absolute Capital. In the second part of the scheme the manipulated stocks were used to materially overstate the assets of the hedge funds by at least $440 million in a fraudulent practice known as portfolio pumping. When Mr. Homm abruptly resigned from Absolute Capital the funds and their investors were left holding between $440 and $530 million in illiquid positions, most of which were the microcap stocks. Overall the defendants are alleged to have made at least $63.7 million. The complaint alleges violations of the antifraud provisions as well as several broker-dealer record keeping requirements as to certain defendants.
In the Matter of Tony Ahn, Adm. Proc. File No. 3-14272 (Filed Feb. 24, 2011) is a settled proceeding in which the Respondent was a registered representative from August 2005 to May 2008 associated with Hunter World Markets discussed above. Mr. Ahn was the primary trader during the period he. The Order alleges violations of Exchange Act Section 10(b) and aiding and abetting violations of Sections 15c-1 and 17(a). Respondent resolved the matter, consenting to the entry of a cease and desist order based on the Sections cited in the Order and to a bar from associating with any broker dealer with a right to reapply after five years. He also agreed to pay a civil penalty of $40,000 and acknowledged the sum was not higher based on his agreement to cooperate with the Commission.
In the Matter of Elizabeth Pagliarini, Adm. Proc. File No. 3-14273 (Filed Feb. 24, 2011) is a proceeding against the chief compliance officer of Hunter World and Tony Ahn, its primary trader. The Order alleges that the Respondent failed to reasonably supervise Mr. Ahn by not following procedures or following up on suspicious trades. It also alleges that Respondent aided and abetted and caused Hunter World’s violations of Exchange Act Section 17(a). To resolve the matter Respondent consented to the entry of a cease and desist order and to pay a civil penalty of $20,000. She was also suspended from acting in a supervisory capacity for twelve months.
Investment fund fraud: SEC v. Blackwell, Case No. 3:11-cv-00234 (N.D. Tx. Filed Feb. 7, 2011) is an action against Christopher Blackwell and two entities he controlled AV Bar Reg, Inc., and Millers A Game, LLC. Since 2007 the defendants are alleged to have raised over $4 million from thirteen investors selling fraudulent investments. Defendant Blackwell touted his investment expertise, including telling an undercover agent he had worked at Goldman Sachs which is false, and promised returns as high as 30%. In reality significant portions of the investor funds were diverted to his personal use while other portions were diverted to making Ponzi type payments. The complaint alleges violations of the antifraud provisions. The SEC obtained an emergency freeze order. The case is in litigation.
Investment fund fraud: SEC v Secure Capital Funding Corp., Case No 3:11-cv-00916 (D. N.J. Filed Feb. 18, 2011) is an action against the named company, Betram Hill, PP&M Trade Partners and Kiavanni Pringle. According to the complaint, Mr. Hill and SCF and Mr. Pringle and PP& M, have, since late last year, been conducting similar operations. Investors were told that their funds would be put into Swiss debentures which were safe and would then be used in highly leveraged margin accounts to trade and generate returns ranging from 10% to 100% per month. Investors were solicited in the U.S. the U.K. and other countries. In reality over $3 million was wired out of the country almost immediately and the Swiss securities are fictitious, according to the Commission. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). Mr. Hill has previously been charged by Jamaican authorities for running a $326 million Ponzi scheme which is not related to this case according to the SEC. The Commission obtained an emergency freeze order in this case which is now in litigation. See also Lit. Rel. No 21864 (Feb. 18, 2011).
Insider trading: SEC v. De La Maz, Case No. 09-21977 Civ. (S.D. Fla. Filed July 15, 2009). Defendants Thomas Borell, an attorney, and Dr. Sebastian de Las Maza both traded in the securities of take over target, Neff Corporation, and were charged with insider trading. Although the court concluded that the circumstantial evidence supported inferences that both men had inside information, it granted the motion of Mr. Borell but denied that of Dr. de Las Maza while noting that the evidence is neither compelling nor strong. The case centers on the acquisition of Neff Corporation by Odyssey Investment Partners. Mr. Borell and his family for years have been friends of Jose Mas, a Neff director, and his family, stemming from the fact that their children went to the same school. While the families socialized and even traveled together, it was only as a part of a large group of families tied to the school. Mr. Borell traded just prior to the announcement in a manner which was not consistent with his earlier trading patterns and failed to offer a convincing explanation for the trades. Nevertheless, the court granted summary judgment in his favor because there was no relation of trust and confidence between the men as defined in Rule 20b-5-2. Dr. De La Maza also traded just before the announcement. His daughter is married to the former CEO of Neff and knew about the deal. While he denied having inside information the court concluded that the circumstantial evidence regarding his access and unusual trading was sufficient to raise an inference that had to be resolved by the jury.
Statute of limitations: SEC v. Microtune, Inc., Civil Action no. 3:08-CV-1105 (N.D. Tx.) is an option backdating case in which the court concluded that virtually all of the Commission’s claims for relief were time barred under the five year limitation period of 28 U.S.C. Section 2462. The suit is against the company and two of its former executives, CEO Douglas Bartek and CFO and General Counsel Nancy Richardson. According to the SEC, stock options of the company were fraudulently backdated between 2000 and mid-2003. Prior to the time the limitations period expired the SEC was put on inquiry notice of the option practices of the company, a point the agency admitted. While some investigation was done it stopped. Later the company conducted an internal investigation which revealed the practices. The SEC chose to wait for the completion of that inquiry. The court held that once the SEC was on inquiry notice it had to act diligently. If it had done so here it would have discovered the practices prior to the expiration of the limitation period. It did not. The court rejected the SEC’s claim that the five years began from when it was put on inquiry notice. The court also held that the requests for injunctions, officer and director bars and civil penalties were all essentially penalties and thus time barred. None of those remedies, on the record here, are remedial.
Insider trading: U.S, v. Jaiu, 10-mj-02900 (S.D.N.Y.) is an action which charges Winifred Jiau with conspiracy and securities fraud in connection with the expert network investigation. Ms Jaiu was a consultant to Primary Global Research LLC. According to the court papers the defendant furnished inside information to two hedge fund managers. One was Noah Freeman who pleaded guilty to securities fraud on February 7, 2011. The illegal tips concerned Nvidia Corp. and Marvell Technology Group Ltd. Ms. Juia appeared in court this week to enter a not guilty plea.
Court of appeals
Retroactivity: Sacks v. SEC, No. 07-74647 (9th Cir. Filed Feb. 22, 2011) is a case in which the court considered the retroactivity of a FINRA rule which precludes persons barred by the SEC from the industry from representing a person in an arbitration. In 2007 FINRA proposed a rule which would prohibit anyone barred from the securities industry from representing parties in securities arbitrations. The rule was approved after review by the Commission’s Division of Market Regulation. Petitioner Richard Sacks initiated a proceeding in the Ninth Circuit challenging the rule. Although he is not an attorney he has for years represented persons in arbitrations. He has also been barred from the industry by the SEC. First, the court rejected the SEC’s claim that Mr. Sacks had not exhausted his remedies because an appeal had not been filed with the SEC. The court held that its jurisdiction arose from the special statutory process of 15 U.S.C. Section 78y which governs review of rules proposed by self-regulatory organizations. Under that Section the person aggrieved by the rule can petition either the D.C. Circuit or the circuit court for the district in which he or she resides. Second, the court concluded that the rule is impermissibly retroactive in the case of Mr. Sachs. Before applying a statute retroactively the court looks first to see if it expressly provides for retroactive effect. If not the question becomes whether the retroactive application of the provision would add “new legal consequences to events completed before its enactment.” Here the court concluded that applying the rule to Mr. Sacks would add to his punishment. Therefore the rule can not be retroactively applied.