Insider trading and financial fraud are the repeated
themes of securities enforcement this week. The SEC and DOJ both focused on
these traditional enforcement priorities. The Galleon insider trading cases
continued to roll up guilty pleas as the primary case moves closer to trial
next month. The expert network investigation spawned a guilty plea. Finally the
Virginia Financial Fraud Task Force also brought an action on the rocket
docket.
Securities class actions also continued to increase
according to a new report from Cornerstone Research. New statistics on these
cases reflect an increase in filings in 2010 compared to 2009 with a large
spike in filings in the second half of the year. Suits based on M&A
activities increased significantly as did those involving companies in the
medical sector.
SEC Enforcement
Financial
fraud: SEC v. McGhan, Civil No. 2:11-CV-74 (D. Nev. Filed Jan 14,
2011); SEC v. Maloney, Civil No. 2:11-CV-75 (D. Nev. Filed Jan. 14,
2011) are two actions centered on an alleged financial fraud at MedCor, Ltd.
The first, which is settled, names as defendants Donald McGhan, the founder of
the company and former Chairman, and Jimmy McGhan, its former COO. The latter,
which is in litigation, names as a defendant Theodore Maloney, the former CEO
of the company. The complaint against Mr. Maloney alleges violations of
Exchange Act Sections 10(b), 13(b)(5) and 14(a) and aiding and abetting
violations of Exchange Act Sections 13(a) and 13(b)(2)(A). Both complaints are
based on allegations that the defendants misrepresented the source of funds for
the company as being Don McGhan or one of his affiliates when it fact it was
transfers from Southwest Exchange Corporation, a private company that held
deposits for taxpayers seeking to defer capital gains taxes on like kind
exchanges. The illegal transfers from that company are alleged to have been
concealed by false documents. By 2006 about $54 million in illegal transfers
had been made. In 2007 the company collapsed, owing about $97 million to
clients. Subsequently, the company filed for bankruptcy. Don and Jim McGhan
each settled, consenting to the entry of permanent injunctions prohibiting
future violations of Exchange Act Sections 10(b) and 14(e) and from aiding and
abetting MediCor's violations of Section 13(a). In addition, Don McGhan agreed
to an officer and director bar while Jim McGhan consented to the entry of a
five year officer and director bar.
Financial fraud/insider trading: SEC v.
Radcliffe, Civil Action No. 1:11-cv-00091 (D.D.C. Filed Jan 14,
2011) is an action against Joseph Racliffe and his son Michael who operated a
sports memorabilia company called Image Innovations Holdings, Inc. Michael was
a director of the company and the COO of its operating subsidiary. His father
was a consultant although the SEC claims he actually controlled the company.
According to the papers the defendants falsified the revenue of the company in
2004 and 2005 by fabricating substantial portions of its income. During that
period Joseph sold shares of the company at inflated prices while in possession
of material non-public information. Both defendants settled with the
Commission, consenting to the entry of permanent injunctions prohibiting future
violations of Exchange Act Section 10(b) and from aiding and abetting
violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The injunction as to
Joseph Racliffe is also based on Securities Act Section 5 and Exchange Act
Section 20(a). In addition, Joseph agreed to pay disgorgement of $955,000,
prejudgment interest and a penalty of $175,000. The son agreed to disgorge
$10,000 along with prejudgment interest and a civil penalty of $75,000. The
total amount of disgorgement in the settlements equals the trading profits.
Investment fraud/manipulation: SEC v. Hancher,
Case No. 5:11-cv-04005 (N.D. Iowa Filed Jan 14, 2011) names as defendants
Lowell Hancher, his company Commerce Street, Edward Whelan and his company,
Grace Holdings, Inc. The complaint alleges three fraudulent schemes: 1) An
investment fraud scheme beginning in 2005 and continuing in 2007 in which Mr.
Hancher, through his company Commerce Street, raised over $1.8 million from at
least 60 investors based on misrepresentations which included a claim that a
50% return would be paid after the company went public. The money was
misappropriated. 2) A manipulation scheme in which Mr. Hancher directed
defendant Whelan and others to place 18 matched orders for more than 60,000
shares of LMWW Holdings, Inc to prop up its share price. At least two of the
orders were placed through an account in the name of Mr. Whelan' company, Grace
Holdings. 3) A third scheme involve the misappropriation of money from Cycle
Country Accessories. Here the complaint claims Mr. Hancher, a director and
audit committee member, obtained the funds based on a claim that it would be
used for a stock repurchase. Instead Messrs. Hancher and Whelan misappropriated
the money using false documents. Mr. Hancher also lied to the external auditor
according to the SEC.
Each defendant settled with the Commission, consenting to
the entry of a permanent injunction. As to Mr. Hancher the injunction was based
on Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a),
13(b)(5) and 15(a)(1). As to Mr. Whelan it was based on Exchange Act Section
10(b). The injunction against Commerce Street was based on Securities Act
Section 17(a) and Exchange Act Sections 10(b) and 15(a)(1) while for Grace
Holdings it was predicated on Section 10(b). Mr. Hancher also agreed to pay
disgorgement and prejudgment interest of $2,988,405 and a civil penalty of
$130,000 while Mr. Whelan consented to pay disgorgement and prejudgment
interest of $17,340 and a civil penalty of $20,000.
Misrepresentations re performance: In the
Matter of Michael R. Pelosi, Adm. Proc. File No. 3-14194 (Jan. 14,
2011) is a proceeding against the former portfolio manager at registered
investment adviser Halsey Associates, Inc. According to the Order, over a three
year period beginning in 2005 Mr. Pelosi repeatedly falsified performance
returns to clients in periodic correspondence. He exaggerated account gains and
minimized performance losses in violation of Advisers Act Sections 206(1) and
206(2). The matter is in litigation.
Supervision: In the Matter of BNY Mellon
Securities LLC, Adm. Proc. File No. 3-14191 (Jan. 14, 2011)
is a proceeding against a registered broker dealer. The Order claims that Respondent
failed to reasonably supervise the manager on its institutional order desk and
traders under his supervision from November 1999 through March 2008. During the
period the order desk manager failed to meet his duty of best execution to
certain customers. Orders were executed at stale or inferior prices which were
frequently outside the National Best Bid and Offer at the time of execution. In
some instances the orders were executed in cross trades with a favored handful
of accounts held by hedge funds and certain individuals. While Respondent had
written supervisory procedures establishing a best execution committee, it
failed to set up procedures to follow-up on red flags. Respondent also did not
have procedures to determine if the order desk manager was fulfilling his
responsibility to conduct a daily best execution review of executions on
regional exchanges. Although Respondent maintained statistics which showed if
executed orders were outside quote at a greater rate than industry averages,
beginning in the third quarter 2003 there were no procedures to follow-up. The
procedures for monitoring best execution obligations on regional exchanges were
also inadequate. As a result of this conduct Respondent failed to reasonably
supervise the order desk manager and his traders with the meaning of Exchange
Act Sections 15(b)(4)(E) with a view to preventing and detecting violations of
Securities Act Section 17(a). To resolve the matter Respondent agreed to
certain undertakings and consented to the entry of a censure. Respondent also
agreed to pay disgorgement of $19,297,016 along with prejudgment interest and a
civil penalty of $1,000,000. The penalty was limited to that amount based on
the cooperation of Respondent. It discovering the violations by beginning an investigation
promptly after the Commission charged one of the hedge funds in an unrelated
matter, terminating the desk manager and self-reporting.
Best execution: In the Matter of Mark Shaw,
Adm. Proc. File No. 3-14192 (Jan. 14, 2011) is a proceeding related to the BNY
Mellon action. Respondent Mark Shaw was a registered representative and the
institutional desk order manager at Mellon Securities. The Order here, based on
essentially the same conduct as in BNY Mellon, alleges violations of Securities
Act Section 17(a) and Exchange Act Section 10(b). Mr. Saw resolved the action
by consenting to the entry of a cease and desist order based on the Sections
cited in the Order and agreeing to be barred from association with any broker.
He will also pay disgorgement of $195,300 along with prejudgment interest and a
civil penalty of $150,000.
Audit failure: In the Matter of Dohan+Company
CPAs,
Adm. File No. 3-13997 (Filed Aug. 9, 2010) is a Rule 102(e) proceeding against
the audit firm and four of its members. The proceeding arises out of the
financial fraud at International Commercial Television, Inc. discussed here. This week the firm and
Steven Dohan, the firm founder and managing director, and Nancy Brown, formerly
a director of the firm and the engagement partner on the International
Commercial Television audits, settled. The firm agreed to the entry of a
censure. Mr. Dohan will be denied the privilege of appearing and practicing
before the Commission with a right to reapply after three years. Ms. Brown
agreed to the entry of a similar order.
Financial fraud: SEC v. NutraCea,
Civil Action No. CV 11-0092 (D. Ax. Filed Jan. 13, 2011) is a financial fraud
case against the company, three of its former executives and two former
accounting personnel discussed here.
This week the Commission announced settlements with the company and four
individual defendants. The company consented to the entry of a permanent
injunction prohibiting future violations of Securities Act Sections 17(a) and
Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). Mr. Edson
agreed to the entry of an injunction based on the same provisions, to the entry
of a permanent officer and director bar and to pay a civil penalty of $100,000
while reimbursing the company for $350,000 in bonuses received in 2008. Ms.
Alderman consented to the entry of an injunction based on Exchange Act Sections
10(b) and 13(b)(5) and to a five year officer and director bar. Ms. Kline and
Mr. Wilkinson consented to the entry of injunctions based on Exchange Act
Section 13(b)(5) and prohibiting aiding and abetting violations of Sections
13(a), 13(b)(2)(A) and 13(b)(2)(B) and to the issuance of administrative orders
based on Rule 102(e) suspending each from practice before the Commission with a
right to reapply after one year. The case is on-going as to defendant Crow.
Criminal cases
Insider trading: U.S. v. Chesi
(S.D.N.Y.). Danielle Chiesi pleaded guilty in the Galleon insider trading cases
to three counts of conspiracy to commit securities fraud. She had been
scheduled to stand trial in April 2011. Sentencing is scheduled for May 13,
2011. Ms. Cheisi reportedly is not cooperating with prosecutors. Ms. Chiesi was
formerly employed at New Castle Funds, LLC, an equity group once affiliated
with Bear Stearns Asset Management, Inc. She was initially charged along with
Mark Kurland and Robert Moffat. Both men have pleaded guilty. At the same time
charges were brought against Ms. Chiesi, Raj Rajaratnam, the founder of the
Galleon hedge fund, was charged in an expansive insider trading case. Mr.
Rajaratnam is scheduled to begin trial late next month. The SEC also filed an
action against Ms. Chiesi, Mr. Rajaratnam and others. SEC v. Galleon
Management, LP, Civil Action No. 09-CV-881 (S.D.N.Y. Oct. 16, 2009).
Fraud: U.S. v. Provident Capital Indemnity,
Ltd.
(E.D. Va.) is an action against Provident, a Dominican company doing business
in Costa Rica, and its president Minor Vargas Calvo and Jose Castillo, the
auditor of the company. The indictment contains one count of conspiracy to
commit mail and wire fraud, three counts of mail fraud and three counts of wire
fraud. The SEC brought a parallel action against the same defendants. SEC v.
Provident Capital Indemnity, Ltd., Civil Action No. 3:11-cv-045 (E.D. Va.
Jan. 19, 2011). The complaint alleges violations of Securities Act Section
17(a) and Exchange Act Section 10(b). The defendants are alleged to have
engaged in a scheme to defraud by making misrepresentations about Provident's
reinsurers, financial statements and ratings. The scheme was in connection with
the sale of financial guarantee bonds to companies that sold life settlements
or securities backed by life settlements to investors. Specifically, from 2004
to the present the company sold over $600 million in bonds to life settlement
investment companies in the U.S. and several other countries. Those clients
then sold investment offerings backed by Provident's bonds to investors around
the world. The cases are in litigation.
Insider trading: U.S. v. Holley (D.
N.J.); SEC v. Holley, Case No. 3:11-cv-00205 (D. N.J. Filed Jan. 13,
2011). The criminal case names as defendants George H. Holley, the co-founder
of Home Diagnostics and his friend Phairot Iamnaita. Each defendant is charged
with conspiracy to commit securities fraud. The SEC action names as defendants
those two individuals along with Steven Dudas, the personal accountant to Mr.
Holley. The complaint alleges violations of Exchange Act Sections 10(b) and
14(e). The cases center on the acquisition of Home Diagnostics, Inc. by Nipro
Corporation in a deal announced on February 3, 2010. According to the
Commission, Mr. Holley told Messrs. Dudas and Iamnaita that Nipro was about to
acquire Home Diagnostics. He then furnished the two men with $121,500 to
purchase shares of the company. The two men used a joint brokerage account to
acquire shares of the company. When the deal was announced the share price for
Home Diagnostics increased by 90% over the closing price the previous day.
Messrs. Dudas and Iamnaita liquidated their shares yielding a profit of over
$90,000. The charging papers in each case allege that Mr. Holley also tipped
others. These cases are in litigation.
Insider trading: U.S. v. Nguyen
(S.D.N.Y.) is an action against Bob Nguyen, an employee of an expert networking
firm. Mr. Nguyen pleaded guilty to an information charging wire fraud and
conspiracy to commit wire fraud and securities fraud. From January 2008 to
February 2010 Mr. Nguyen's job at the firm was to solicit employees of public
companies to serve as consultants at the firm and furnish inside information to
clients. He also facilitated meetings between firm consultants and clients
knowing that inside information would be furnished. The date for sentencing has
not been set.
Insider trading: U.S. v. Cutillo
(S.D.N.Y.). Former Ropes and Gray associate Arthur Cutillo pleaded guilty to
one count of conspiracy and one count of securities fraud. The charges stem
from the Galleon investigation. According to the court papers, in 2007 and 2008
Mr. Cutillo and another firm attorney, Brien Santarlas, furnished inside
information to a third attorney, Jason Goldfarb. The information concerned the
then pending deals involving 3Com Corporation and Axcan Pharma, Inc. Mr.
Goldfarb in turn furnished the information to Zvi Goffer, who was known as
Octopussy because of his multiple sources of information. The information was
exchanged for cash. Mr. Cutillo is scheduled to be sentenced on April 27, 2011.
The SEC also has an action pending against Mr. Cutillo, SEC v. Cutillo,
Case No. 09-cv-9208 (S.D.N.Y.) as well as the others involved here.
Private actions
Cornerstone Research released its yearly review of
securities class actions. According to the report, 176 actions were filed in
2010 compared to 168 the prior year. This resulted from a significant increase
in the number of filings in the second half of the year. The number is still
below the average of 195 per year for the period 197 to 2009. In 2010
securities class actions against companies in the Health Care sector spiked.
Last year 15.4% of the companies in the sector were named in securities class
actions Another significant increase occurred in suit based on M&A activity.
Those cases increased by 471% compared to the prior year. In 2010 40 cases were
filed compared to 7 the prior year. At the same time 12 cases were filed
against Chinese issuers. A GAO report noting deceptive recruiting practices and
poor student loan repayment at for profit colleges spawned 10 class actions.
For more news involving securities issues, visit SEC Actions, a blog by Thomas
Gorman