The SEC settled two insider trading cases this week while
bringing three investment fund fraud suits, two of which involved recidivists
who are alleged to have diverted investor funds from their current scheme to
make payments in their prior criminal case. The CFTC Division of Enforcement
filed a record number of enforcement actions in the last fiscal year while
opening a program high number of investigations according to the agency.
The New York Attorney General joined and expanded a
whistleblower suit against the Bank of New York Mellon. It alleges that pension
funds and other investors were defrauded out of about $2 billion by the bank
which misrepresented interbank rates obtained in foreign currency transactions.
The DOJ filed a parallel case.
Finally, a court in Australia handed down a significant
decision regarding the obligations and liabilities of directors. It concluded
that each member of the board was liable for failing to discover a significant
error in the company financial statements.
The Commission
Rating agencies: The
SEC staff published a report regarding its latest examinations of these
agencies. It is titled: "2011 Summary Report of Commission Staff's Examinations
of Each Nationally Recognized Statistical Rating Organization" (here). The Report identifies ten
NRSROs and has a series of findings regarding their compliance with prior
inspection recommendations and the implementation of various provisions of
Dodd-Frank.
SEC Enforcement - filings
Investment fund fraud: SEC v. StratoComm
Corporation, Civil Action No. 1:11-CV-1188 (N.D. NY Filed
Oct. 6, 2011); SEC v. Merkin, Civil Action No. 1:11-cv-23585 (S.D. Fla.
Filed Oct. 6, 2011). The StratoCom complaint names as defendants the
company along with its CEO Roger Shearer and its former IR director Craig
Danzig. It alleges that the company raised about $3 million from investors by
selling unregistered shares of company stock based on claims that it was
engaged in the manufacture and sale of telecommunications systems for
underdeveloped countries. The claims are false. The company had no product and
no revenue. The investor funds were diverted to personal use including
restitution Mr. Shearer was obligated to pay in another criminal case. The
complaint alleges violations of Securities Act Sections 5 and 17(a) and
Exchange Act Section 10(b). The Merkin complaint is against attorney
Stewart Merkin who served as company counsel. It alleges violations of Exchange
Act Section 10(b) based on four attorney letters he prepared for the Pink
Sheets which claimed the SEC was not conducting an investigation of the
company. In fact the investigation was in progress and Mr. Merkin was
representing persons in it. The letter facilitated the continued trading of
company shares. Both cases are in litigation.
Financial fraud: SEC v. Sells, Case
No. CV-11-4941 (N.D. Cal. Filed Oct. 6, 2011) is an action against two former sales
executives of medical equipment company Hansen Medical, Inc., Christopher Sells
and Timothy Murawski. The complaint alleges violations of Securities Act
Sections 17(a)(1) & (3) and Exchange Act Sections 10(b) and 13(b)(5) and
aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B).
It centers on transactions in 2008 and 2009 in which the two defendants
attempted to accelerate the recognition of revenue from the sale of the medical
equipment sold by the company. In some instances, for example, the defendants
convinced purchasers to let them set-up equipment so they could claim it was
delivered and installed and the revenue could be recognized. The equipment
would later be disassembled and stored for months. In another instance a physician's
signature was forged certifying that training had been completed when it had
not. During the period Hansen was under intense pressure to raise additional
capital from investors. This action, which resulted from a whistleblower, is in
litigation. A related administrative proceeding against the company settled. In
the Matter of Hansen Medical, Inc., Adm. Proc. File No. 3-14578 (Filed Oct.
6, 2011). There the company consented to the entry of a cease and desist order
based on Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections
139a), 13(b)(2)(A) and 13(b)(2)(B). The SEC acknowledged the significant
remedial acts of the company as well as its voluntary disclosure and
cooperation.
Investment fund fraud: SEC v. Aronson, Civil
Case No. 11 Civ. 7033 (S.D.N.Y. Filed Oct. 6, 2011) is an action alleging
violations of Securities Act Sections 5 and17(a) and Exchange Act Sections
10(b) and 15(a). It names as defendants Eric Aronson, a convicted felon,
Vincent Buonauro, Jr., Robert Kondratick, Fredric Aaron and several related
entities. The complaint alleges a fraudulent investment scheme in which about
140 individuals lost approximately $26 million between 2006 and 2010 investing
in water-filtering natural stone pavers. Investors were told they would receive
returns of 7.8% to 33% because the stones could be sold at a high mark-up and
there was a significant backlog of orders. Those representations were false.
Investors were paid returns using funds obtained from other investors. A
portion of the money was diverted to the personal use of the promoters,
including the payment of Mr. Aronson's restitution obligations from another
case. Some portions were used to purchase publicly traded Interlink-US-Network,
Ltd which later published a false Form 8-K which stated that LED Capital Corp.
had agreed to invest $6 million in the company. When investors demanded their
money back Mr. Aronson at first claimed that the notes were usurious and later,
with the assistance of his attorney who is also a defendant, convinced them to
convert their notes into ones with deferred payments. The SEC obtained an
emergency freeze order. The case is in litigation. A parallel criminal case has
also been filed.
Insider trading: SEC v. Hansen, Civil
Action No. 10-CV-5050 (E.D.Pa.) is an insider trading case against the former
Chairman of Keystone Equities Group, a registered broker-dealer and regional
investment bank. The complaint alleges that Mr. Hansen was illegally tipped by
his employee and close friend Donna Murdoch. Ms. Murhoch obtained inside
information from former Ernst & Young partner and attorney James Gansman
with whom she was having an affair. The information concerned pending take-over
transactions. Mr. Hansen settled with the SEC, consenting to the entry of a permanent
injunction prohibiting future violations of Exchange Act Section 10(b). He also
agreed to pay disgorgement and prejudgment interest in the amount of $63,038 of
which $32,222 will be satisfied through the payment of a criminal forfeiture
order in the parallel criminal action. The order also bars him from serving as
an officer or director. In a related administrative proceeding Mr. Hansen
consented to the entry of an order barring him from the securities business or
participating in any penny stock offering. In the related criminal case Mr.
Hansen previously pleaded guilty to conspiracy and securities fraud charges and
was sentenced to three months imprisonment followed by five months of home
confinement and two years of probation. Mr. Gansman was convicted following a
jury trial. Ms. Murdoch had pleaded guilty.
Insider trading: SEC v. Galleon Management,
LP, Civil
Action No. 09-CV-8811 (S.D.N.Y.) is the Commission's insider trading case which
evolved out of the Galleon investigations. This week the SEC settled with
Steven Fortuna, the founder of S2 Capital, a hedge fund investment adviser in
New York. Mr. Fortuna traded on inside information obtained from Danielle
Chiesi in the shares of Akamal Technologies, Inc. and AMD. He resolved this
action by consenting to the entry of a permanent injunction prohibiting future
violations of Securities Act Section 17(a) and Exchange Act Section 10(b). He
also agreed to pay disgorgement of $193,536 along with prejudgment interest and
a civil penalty in the amount of $96,768. In a related administrative
proceeding Mr. Fortuna consented to the entry of an order barring him from
association with any broker, dealer, investment adviser, municipal securities
dealer or transfer agent. He previously pleaded guilty in the parallel criminal
case and is cooperating with the government. This is the thirteenth settlement
obtained by the SEC in this case.
Investment fund fraud: SEC v. Allen, Civil
Action No. 3:11-CV-822 (N.D. Tex.) is an action against the co-founder of China
Voice Holding Corp. and others alleging that the company was essentially a
Ponzi scheme. This week the Commission settled with defendants Alex Dowlatshahi
and Christopher Mills. They consented to the entry of permanent injunctions
prohibiting future violations of Securities Act Sections 5 and 17(a) and
Exchange Act Section 10(b). In addition, Defendants Integrity Driven Network
Corp, Lucrative Fnterprises Corp., Synergetic Solutions LLC, Silver Summit
Holdings LLC and Sleeping Bear LLC were permanently enjoined from violating
Exchange Act Section 10(b). On motion of the Commission the court may order
disgorgement, prejudgment interest and civil penalties.
Failure to supervise: In the Matter of
Gilford Securities Inc., Adm. Proc. File No. 3-14574 (Sept. 30,
2011) is an action against the firm, one of its founders, Ralph Worthington, a
supervisor, David Kaplan and the CCO, Richard Grahahan. The proceeding centers
on a failure to supervise M.S. Gregg Berger, a former registered representative
at the firm and other violations. From 2005 through May 2006 Mr. Berger is
alleged to have resold over 30 million shares of stock through at least 20
customer accounts at the firm. There was no resale registration statement or
exemption for the shares. The firm failed to implement systems reasonably
designed for its supervisory policies. Eventually Mr. Berger was named as a
defendant in a Commission "pump and dump" action and a parallel criminal case.
The firm also violated the securities laws by permitting customers to: deliver
in and sell millions of shares of stock without conducting reasonably inquiry
into the source of the stock; by failing to file SARS as required by the Bank
Secrecy Act; and by sharing confidential customer information with others.
Messrs. Worthington and Kaplan also aided and abetted some of the firm's
violations while Mr. Granahan, the firm's CCO and its anti-money laundering
officer, aided and abetted the firm's SARs violation.
Gilford resolved the proceeding by agreeing to implement
a series of steps which include the retention of an independent consult who
will make recommendations regarding procedures which the firm will implement.
The firm also consented to the entry of a cease and desist order based on
Securities Act Section 5 and Exchange Act Sections 15(b)(7) and 17(a) and the
related rules. The firm will also disgorge $275,000 along with prejudgment
interest and pay a civil penalty of $260,000. Mr. Worthington agreed to the
entry of a cease and desist order based on Exchange Act Sections 15(b)(7) and 17(a)
and the related rules, to be suspended from acting in a supervisory capacity
with a broker dealer for twelve months and to pay a civil penalty of $45,000.
Mr. Kaplan consented to the entry of a cease and desist order based on Rule
10(a) and Regulation S-P. He also agreed to pay disgorgement of $225,000 along
with prejudgment interest and a civil penalty of $30,000. Mr. Granahan agreed
to the entry of a cease and desist order based on Exchange Act Section 17(a)
and Rule 17a-8. He also agreed to pay a civil penalty of $20,000.
CFTC
Statistics: The
agency announced that in FY 2011 the Division of Enforcement filed 99
enforcement actions, the highest yearly total in its history. This also
represents a 74% increase over the prior year. The Division also opened more
than 450 investigations which is another program high. During the last fiscal
year more than 70 indictments and convictions were obtained related to CFTC
enforcement actions.
Failure to supervise: The
agency issued an order and settled charges with Forex Capital Markets LLC in
connection with the failure of the firm to supervise diligently its personnel
handling over 57,000 customer accounts that traded on its forex trading
platforms. As a result, from at least June 2008 through mid-December 2010 the
firm failed to supervise diligently the handling of customer accounts traded on
its forex platforms with respect to changes in price between order placement
and execution on both market orders and margin liquidation orders. As a result
customers did not benefit from price movements in their favor but did suffer
from detrimental price movements. The firm agreed to pay a $6 million civil
penalty and restitution of $8,261,937 to its customers and former customers. It
also agreed to retain for the next three years a monitor to supervise its trade
execution practices and policies as they relate to the change in price between
the time the customer places the order and the execution and its compliance
with its restitution obligation.
Criminal cases
Investment fund fraud: U.S. v. Prince (N.D.Cal.)
is an action against attorney David Prince. The indictment claims that Mr.
Prince raised more than $1.1 million from 30 investors from August 2005 through
January 2007. Investors were told their funds were guaranteed and that they
would receive returns of 5% to 25% from investments in the stock market. He
assured them of the legality of the plan since he is an attorney. In fact he
lost most of the money through risky options trading, by diverting some to
personal use and by making Ponzi type payments to investors. Following a three
week trial he was convicted on five counts of wire fraud. The jury did not
reach a verdict on two other counts. Sentencing is scheduled for January 11,
2012.
FINRA
Investor warning: The
regulator issued an investor warning titled "Public Non-Traded REITS-Perform a
Careful review Before Investing." It notes that while investors are looking for
better returns which may be offered by these investments it is critical to
understand the risks. The alert is available here.
PCAOB
The Board published a Staff Audit Practice Alert
regarding the audit risks in certain emerging markets. While the guide is
intended for auditors, board Chairman James Doty noted that it is a good
reminder for investors and audit committee members regarding the risks in these
markets. The Alert is available here.
Court of Appeals
Authority to file collection suits: Fiero
v . Financial Industry Regulatory Authority, Nos. 09-1556-cv, 09-1863-cv (2nd
Cir. Oct. 5, 2011). The case stems from a FINRA disciplinary proceeding brought
against John Fiero and Fiero Brothers, Inc. in which the hearing panel expelled
the firm, barred Mr. Fiero and imposed a a fine of $1 million plus costs. Mr.
Fiero and his firm subsequently filed a declaratory judgment action in Federal
Court seeking a ruling that FINRA did not have authority to bring a court
action to collect a fine. The district court dismissed the complaint. The
Second Circuit reversed, concluding that FINRA does not have the authority to
bring such an action. First, there is no express provision in the Exchange Act
granting such authority. Second, while the statute grants certain authority the
absence of such a provision here is consistent with the fact that FINRA
traditionally collected these fines through the use of its power to expel.
Finally, any reliance on the rule promulgated in 1990 by the SRO which purports
to give it authority to take such action is misplaced. To be effective the rule
had to be to be properly promulgated. It was not because FINRA failed to submit
the rule to the standard notice and comment procedures.
New York
Misrepresentations: NY AG and State of New
York v. Bank of New York Mellon (S.Ct. N.Y.). This is a suit
initially filed by a whistleblower and later taken over by the N.Y. AG against
the bank. The suit alleges violations which include the false claims act and
securities fraud under the Martin Act. The complaint centers on claims that the
bank made almost $2 billion in revenues by misrepresenting the interbank rates
it obtained in foreign currency transactions for clients. The victims of the
wrongful conduct, including public and private pension funds and the State University
of New York, were promised the best rate of the day but in fact were given the
worst. The bank pocketed the difference according to the papers. The case is
pending. The DOJ has filed a parallel civil action.
FSA
The regulator imposed a fine of ₤494,900 on investment
manager Towry Investment Management Ltd. in connection with violations of
Principle 10 and 11. The former requires managers to properly handle client
funds while the latter specifies that firms must deal with the FSA in an open
and cooperative manner. Here the FSA sent a "Dear CFO" letter to the firm
regarding its compliance with the procedures for handling client funds. The
firm told the FSA it was fully compliant when in fact it was not. The FSA
discovered violations of the applicable provisions following receipt of the
response to the Dear CFO letter. The fine here was reduced by 30% because the
firm agreed to settle at an early stage in the proceeding.
Australia
Director obligations: An
excellent post on the Harvard Law School Forum by David Katz, Wachtell Lipton,
highlights a new decision by the Federal Court of Appeals in Australia
regarding director liability. In a landmark ruling the court in Australian
Securities and Investment Commission v. Healey, held the entire board of
directors liable for failing to find a significant error in the financial
statements of the company. The post is available here.
Program: The Impact of the
Supreme Court's Decision in Morrison v. National Bank of Australia on securities
litigation and SEC enforcement actions. Webcast on October 12, 2011 from 12:00
to 1:00 EST. For further information please click here
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.
For more information about LexisNexis
products and solutions connect with us through our corporate site.