Settling enforcement actions is becoming more difficult.
The SEC and the Department of Justice both had courts refuse to approve
settlements this week. SEC enforcement did resolve its first ever fraud action
against a state, an insider trading case, a financial fraud action and an
investment fund action. FINRA filed two settled actions and the Third Circuit
rejected the fraud-made-the-market theory proposed by a plaintiff seeking class
certification.
Settlements
SEC v. Citigroup, Inc.,
Civil Action, No. 10-cv-127 (D.D.C. Filed July 29, 2010), discussed here, is
a disclosure fraud case against the bank. One current and one former employee
were named as Respondents in the related administrative proceeding.
The district court refused to enter the consent degree
proposed by the SEC and the bank. In an August 17, 2010 order, the court
directed the SEC to file a memorandum on or before September 13, 2010 addressing
a series of questions including: 1) what evidence support the charges that the
defendant "committed fraud via negligence;" 2) who are the individuals referred
to throughout the complaint as "senior management;" 3) why the SEC chose to
bring actions only against Gary Crittenden and Arthur Tildesley, Jr.; 4) why
the $75 million civil penalty is fair, adequate, reasonable and in the public
interest; 5) how the proposed penalty compares to others; 6) what the SEC's
economic analysis showed regarding the value of the pecuniary gain to the
defendant from the misconduct; 7) the source of the money that will compose the
fair fund; and 8) who is a "harmed" shareholder.
The action against the bank stems from false statements
made regarding its exposure to the sub-prime market. The firm agreed to settle
with the entry of a consent decree based on Securities Act Sections 17(a)(2)
& (3) and the payment of a $75 million fine. In a related administrative
proceeding, the former employee and current officer agreed to the entry of
cease and desist orders and the payment of fines. In support of the proposed
settlement, the SEC originally filed a Memorandum which offers little insight
into the case or the settlement.
U.S. v. Barclays Bank Plc,
Case No. 10-cr-218 (D.D.C. Filed Aug. 16, 2010) is an action against the bank
for violating the International Emergency Economic Powers Act and the Trading
with the Enemy Act. Companion cases were brought by the New York County
District Attorney and the Office of Foreign Assets Control. Essentially, the
claims allege that Barclays implemented practices to evade U.S. sanctions for
the benefit of sanctioned countries. The court documents claim that from about
the mid-1990s until September 2006 the bank knowingly and willfully moved or permitted
to be moved hundreds of millions of dollars through the U.S. financial system
on behalf of banks from Cuba, Iran, Libya, Sudan and Burma and persons listed
as parties or jurisdictions sanctioned by OFAC in violation of U.S. economic
sanctions.
The court rejected a proposed settlement in the case.
That settlement called for the resolution of the case with a two-year deferred
prosecution agreement and the forfeiture of $298 million, with $149 million
being paid to the U.S. and $149 million to New York state. The court found the
terms of the settlement inadequate - essentially, a sweetheart deal.
SEC enforcement actions
Fraud in offering: In the Matter of State of
New Jersey, Adm. Proc. File No. 3-14009 (Aug. 18, 2010) is the
SEC's first fraud action against a state. The Order for Proceedings alleges
fraud in violation of Securities Act Section 17(a)(2) & (3) in connection
with 79 municipal bond offerings from August 2001 through April 2007 for $26
billion. The cases center on the failure of the state to make certain
disclosures regarding the financial condition of two large pension funds, the
Teachers' Pension and Annuity Fund and the Public Employees' Retirement System.
Specifically, the state created the fiscal illusion, according to the SEC, that
the two pension funds were being adequately funded when in fact they were
severely under funded.
New Jersey was aware of the underfunding, according to
the Order, but took no steps to correct the misleading documents used in
connection with the bond offerings. During this period, the state did not have
any written policies and procedures regarding the review or update of the bond
offering documents and no training was given to its employees regarding
disclosure obligations. To resolve the proceeding the state consented to the
entry of a cease and desist order from commencing or committing or causing any
violations and any future violations of the Sections on which the Order is
based.
Insider trading: SEC v. Gansman,
Civil Action No. 08-CV-4918 (S.D.N.Y. Filed May 29, 2008) is an insider trading
case against a former attorney at the Transaction Advisory Services group of
Ernst & Young, James Gansman, and his former stock broker and close friend,
Donna Murdoch. The Commission alleged, as discussed here,
that Mr. Gansman tipped Ms. Murdoch concerning at least seven different
acquisition targets of E&Y clients. Ms. Murdoch traded in the securities of
each and also tipped her father and recommended trading in two stocks to
others, all of who traded. Previously, Mr. Gansman was convicted on parallel
criminal charges and sentenced to serve a year and a day in prison. Ms. Murdoch
pleaded guilty to a seventeen-count superseding information in December 2008
and is awaiting sentencing. To settle with the SEC, each defendant consented to
the entry of a permanent injunction prohibiting future violations of Exchange
Act Sections 10(b) and 14(e). Mr. Gansman also agreed to pay disgorgement of
$233,385 along with prejudgment interest while Ms. Murdoch will disgorge
$339,110 along with prejudgment interest. Mr. Gansman consented to the entry of
an order barring him from appearing or practicing as an attorney before the
Commission in a related administrative proceeding. Ms. Murdoch agreed to the
entry of an order barring her from association with any broker or dealer in a
related administrative proceeding.
Investment fund fraud: SEC v. Thompson
Consulting, Inc., Case No. 2:08-cv-00171 (D. Utah Filed March
4, 2008) is an action against hedge fund adviser Thompson Consulting and its
principals Kyle Thompson, David Condie and Sherman Warner discussed here. The
complaint alleges violations of Securities Act Section 17(a), Exchange Act Section
10(b) and Advisers Act Sections 206(1) & (2). The defendants are alleged to
have made undisclosed high risk investments in sub-prime and similar
investments which caused the near collapse of two funds and deviated from the
stated investment policy. This week the Commission settled with each defendant
consenting to the entry of a permanent injunction prohibiting future violations
of Securities Act Sections 17(a)(2) & (3). In addition, Thompson agreed to
the entry of an injunction based on Advisers Act Section 206(2) and to pay
disgorgement of $400,000.
Investment fund fraud: SEC v. Amante Corp.,
Civil Action No. 09-CIV-61716 (S.D. Fla. Filed Oct. 29, 2009) (discussed here).
The complaint names as defendants Amante, Commonwealth Capital Management, Inc.
and their president Edward Denigris along with William Dyer who sold shares. It
alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act
Sections 10(b) and 15(a). The Commission claimed that for about a year and a
half prior to filing the complaint investors paid about $2.3 million for
unregistered Amante shares based on false representations of large returns from
an imminent IPO. In fact there was no IPO and much of the money was diverted by
Mr. Denigris.
Messrs. Amante and Dyer settled with the Commission. Mr.
Amante consented to the entry of a permanent injunction prohibiting future
violations of the sections cited in the complaint. Mr. Dyer consented to the
entry of an injunction prohibiting future violations of Exchange Act Section
15(a). Mr. Amante also agreed to the entry of a penny stock bar, to disgorge
$806,349 and pay prejudgment interest along with a penalty of $130,000. Mr.
Dyer agreed to disgorge $10,000 and to pay prejudgment interest and a penalty
equal to the amount of the disgorgement.
Financial fraud: SEC v. Schott,
Case No. 4:10-cv-01500 (E.D. MO. Filed Aug. 13, 2010) is an action against
Kevin Schott, the former CFO of Zoltek Corporation, discussed here.
Mr. Schott circumvented the internal controls of the company and ignored the
explicit directions of its CEO in making two payments of $250,000 to an outside
financing consultant. In the process he lied to the controller of a foreign
subsidiary to make the payments, created false documents including entries in
the books and records and made false and misleading certifications to the
auditors and the public. Mr. Schott had informed the CEO that the payments were
due from a prior arrangement with a consultant. The CEO rejected the claim. The
case was resolved with Mr. Schott's consent to the entry of a permanent
injunction prohibiting future violations of Exchange Act Section 132(b)(5) and
the related rules and an agreement to pay a $25,000 penalty.
FINRA
Suitability: HSBC
Securities (USA) Inc. was fined $375,000 by the regulatory authority for
recommending unsuitable securities to retail customers. Specifically, the
firm's representatives recommended Collateralized Mortgage Obligations and
inverse floating CMOs to unsophisticated retail customers in 43 instances.
FINRA has advised firms since 1993 that inverse floating rate CMOs are only
suitable for sophisticated investors with a high risk profile. The firm failed
to give its brokers sufficient guidance and training regarding the risks of
these securities the regulator concluded. In addition, in making the sales
FINRA found that HSBC failed to comply with a rule requiring that investors be
offered educational materials about the securities in connection with a
transaction.
Notices on sales charge discounts:
Merrill Lynch was filed $500,000 for failing to provide customers with sales
charge discounts on eligible purchases of Unit Investment Trusts. FINRA has
informed members since 2004 that such notices must be given to customers. The
regulatory authority concluded that Merrill did not have an adequate
supervisory system. Merrill also agreed to provide remediation of more than $2
million to affected customers.
Court of Appeals
Malack v. BDO Seidman, LLP,
Case No. 09-4475 (3rd Cir. Aug. 16, 2010) is a securities class action in which
the district court denied class certification. The Third Circuit affirmed. The
case arose from a note offering by American Business Financial Services, Inc.,
a sub-prime mortgage originator. Defendant BDO issued an unqualified audit
opinion on the financial statements. After issuance American Business collapsed
and was liquidated. The notes became worthless. Plaintiffs brought suit against
BDO claiming fraud in violation of Exchange Act Section 10(b). The question
before the circuit court was whether reliance could be established using the
fraud-made-the-market theory.
Plaintiffs argued that the securities were legally
unmarketable and that, but for the fraud, there would be no securities and no
market. The circuit court rejected the fraud-made-the-market theory and
baseless, noting that if the availability of the securities on the market
suggests that they are genuine, there must be some entity involved in the
issuance process that "acts as a bulwark against fraud." There is not. The
SEC's review of securities is not based on merit but disclosure. If this theory
were credited investors would be free to rely only on the fact that the
securities have been issued. In effect the theory, would create a kind of
investor insurance policy. That notion is contrary to the basic premise of
securities regulation.
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.