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The insider trading investigation being conducted by the Manhattan U.S. Attorney's Office again dominated events as the week ended. The inquiry spawned more charges and more guilty pleas and promises additional cases in the future. The Commission brought a financial fraud case, as well as an FCPA action in conjunction with DOJ.
In contrast, the Ninth Circuit Court of Appeals reversed a securities fraud conviction for a lack of evidence. A scathing concurring opinion cautioned against damage caused to all by prosecutorial overreaching.
Insider trading investigations
The on-going insider trading investigations being conducted by the U.S. Attorney's Office in Manhattan yielded more charges and guilty pleas yesterday. The actions centered on an expert consulting network.
A criminal complaint was unsealed naming four defendants. U.S. v. Shimoon, Case No. 10 Mag 2923 (S.D.N.Y. Unsealed Dec. 16, 2010). The defendants are: Walter Shimoon, formerly employed as a senior director of business development at Flextronics International, Inc.; Mark Longoria, formerly of Advanced Micro Devices, Inc., where he was a supply chain manager; Manosha Karunatilaka, formerly employed at Taiwan Semiconductor Manufacturing Company as an account manager; and James Fleishman, formerly employed at the expert networking firm as a sales manager. The firm has been identified in the press as Primary Global Research LLC, of Mountain View, California.
The complaint alleges that Mr. Fleishman promoted the firm's consulting services by arranging for clients to speak with consultants knowing that they would be provided with inside information. The other three defendants were engaged as consultants to the firm. According to the complaint:
The complaint, which alleges conspiracy to commit securities fraud, conspiracy to commit wire fraud, and three counts of wire fraud, is predicated in part on information from five cooperating witnesses: 1) Richard Choo-Beng Lee or CW-1, who was employed at a California based hedge fund and has pleaded guilty to conspiracy and securities fraud; 2) CW-2, who has substantial experience evaluating public companies and has pleaded guilty to conspiracy and securities fraud; 3) CW-3, who was employed by Dell as a manager and has pleaded guilty to charges of securities fraud, conspiracy, and wire fraud; 4) CW-4, who was employed by the expert witness firm as a vertical manager and has not yet pleaded guilty; and 5) CW-5, who worked as a hedge fund analyst in New York and has not yet been charged. Each of the defendants has been arrested.
In addition, Daniel DeVore, who was previously employed at Dell, Inc. as a global supply manager, pleaded guilty to charges of conspiracy to commit wire fraud and securities fraud. Mr. Devore was a consultant for the expert firm and from late 2007 through August 2010 was paid $145,750 for his services. U.S. v. Devore (S.D.N.Y.)
Investment fraud: SEC v. Starr, Case No. 10-cv-4270 (S.D.N.Y. Filed May 27, 2010) is an action previously filed against investment advisor Kenneth Starr and his firm (here). That case, in essence, alleges that Mr. Starr misappropriated client funds to support a lavish life style. This week, the Commission amended the complaint, adding his attorney Jonathan Star Bristol as a defendant. The amended complaint asserts that Attorney Bristol permitted Mr. Starr to use two attorney trust accounts to facilitate the fraud. Mr. Bristol is charged with aiding and abetting violations of Advisers Act Sections 206(1), and 206(2). The SEC will also seek an order barring Mr. Bristol from practicing before the Commission as an attorney. See Litig. Rel. 21782 (Dec. 16, 2010). Parallel criminal charges were filed against Mr. Bristol by the U.S. Attorney's Office in the Southern District of New York. That action charges Mr. Bristol with money laundering. U.S. v. Bristol, (S.D.N.Y. Unsealed Dec. 16, 2010).
Investment fraud: SEC v. Harrison, Case No. 3:10-cv-00634 (D.N.C. Filed Dec. 15, 2010) is an action against William Harrison and Eddie Sawyers, both former employees of Wachovia Securities. According to the complaint, between December 2007 and October 2008 the defendants defrauded forty-two Wachovia customers of at least $8 million. Messrs. Harrison and Sawyer lured investors to place their money in a trading operation they called "Harrison/Sawyer Financial Services with promises of a 35% return at no risk. While their option trading was profitable at first, eventually they lost most of the customer funds. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See Litig. Rel. 21781 (Dec. 16, 2010).
Offering fraud: In the Matter of MMR Investment, Adm. Proc. File No. 3-14163 (Dec. 14, 2010) is an action alleging violations of Securities Act Section 17(a) and Exchange Act Section 10(b) against: MMR Investment Bankers, LLC; majority owner of the firm William Martin; Vice President and assistant compliance officer of the firm Eugene Rankin; and two registered representatives of the firm, John Hubert and Aaron Fimreite. MMR is a broker dealer which traditionally raised funds for churches. When business in this market depleted in 2004, the firm did a series of eleven best efforts debenture offerings for eight companies created by acquaintances of Mr. Martin. The companies engaged in a variety of business activities. MMR earned fees of about $1.3 million from the sale of about $12.2 million in debentures. The fees included commissions, non-accountable allowances and charges for technical assistant. The debentures for all but one issuer are now in default. The Order alleges that the offering materials failed to disclose the manner in which Messrs. Martin, Rankin, Hubert and Fimreite were personally profiting. That information was material to the investment decision. The debentures were also not suitable for many of MMR's clients. The proceeding is in litigation.
Financial fraud: SEC v. Vitesse Semiconductor Corporation, Case No. 10 CIV 9239 (S.D.N.Y. Filed Dec. 10, 2010); U.S. v. Tomasetta, Case No. 10 CRIM 1205 (S.D.N.Y. Dec 10, 2010) (here). The SEC case named as defendants Vitesse Semiconductor Corporation and its former CEO, Louis Tomasetta, former Executive Vice President, Eugene Hovanec, former Director of Accounting, Nicole Kaplan, and former CFO, Yatin Mody. Messrs. Tomasetta and Hovanec are defendants in the criminal case. Mr. Mody and Ms. Kaplan pleaded guilty.
According to the court papers, two overlapping fraudulent schemes took place at the company which improperly inflated its revenues. One involved channel stuffing from 2001 through May 2006 by each defendant in the SEC case. Essentially, the scheme involved making large shipments of product to a distributor with a side agreement giving a right of return. There was no reserve for the returns. The scheme was executed at period end to help the company make its earnings targets. The second began in 2001 and continued through 2004. It was an option backdating scheme implemented by Messrs. Tomasetta and Hovanec.
Mr. Mody and Ms. Kaplan resolved all outstanding charges. Each pleaded guilty to securities fraud, making false entries in the financial records of a corporation and conspiracy. Each is awaiting sentencing. With the SEC, Mr. Mody and Ms. Kaplan settled, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(b)(5) and from aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Mr. Mody also agreed to pay disgorgement of $105,604 along with prejudgment interest, while Ms. Kaplan agreed to pay disgorgement of $31,050 along with prejudgment interest Each also consented to the entry of an order under Rule 102(e) suspending each from practice before the Commission as an accountant. The court will determine if either defendant should pay a civil penalty. The company settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a). It also agreed to pay a civil penalty of $3 million.
Messrs. Tomasetta and Hovanec have not settled. The indictment charges each with securities fraud, making false entries in the books and records of a corporation, making false filings with the SEC and conspiracy. Mr. Tomasetta was also charged with making a false certification of a financial report and making false statements to auditors. The SEC's complaint charges each with violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(b)(5) and 16(a) and the pertinent rules thereunder. In addition, Mr. Tomasetta is alleged to have violated Exchange Act Section 14(a). Each is also alleged to have aided and abetted violations by the company of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Both the criminal action and the civil case are in litigation.
U.S. v. Aleynikov (S.D.N.Y.) is a criminal action in which defendant Sergey Aleynikov was found guilty on December 10, 2010 by a jury of one count of theft of trade secrets and one count of transportation of stolen property (here). Mr. Aleynikov is a former computer programmer at Goldman Sachs. The charges were based on the theft of high frequency trading computer code. Mr. Aleynikov stole the code in anticipation of a new position at Teza Technologies in Chicago where he was to develop a high frequency trading system for the firm.
RAE Systems, Inc. (here). The company resolved alleged FCPA violations with DOJ by entering into a non-prosecution agreement and agreeing to pay a $1.7 million criminal fine. The agreement reflected the fact that the company self-reported and cooperated. DOJ Press Release Dec. 10, 2010, available here. The company also settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B). The company also agreed to pay $1,147,800 in disgorgement plus prejudgment interest and was ordered to comply with certain undertakings in its FCPA compliance program. SEC v. RAE Systems, Inc., Civil Action No. 1:10-cv-02093 (D.D.C. Filed Dec. 10, 2010).
The underlying conduct centers in two second tier subsidiaries that were acquired. The first is RAE-KLH. A controlling interest was acquired in 2004. The second is RAE Fusun, acquired in 2006. When control was acquired over KLH, due diligence was done. It uncovered difficulties which were inadequately addressed. When the second company was acquired, no due diligence was done despite the fact that its client base, like that of KLH, was largely located in China and involved dealings with the government and its instrumentalities. The violations occurred between 2004 through 2008. During that period approximately $400,000 was paid to third party agents and government officials in China. The payments were made to influence acts or decisions by foreign officials to obtain or retain business for the company. In sum, the payments resulted in contracts with abut $3 million in revenues and profits of about $1,147,800.
False statements re trading: CFTC v. Whitney, Case No. 1:10-cv-09238 (S.D.N.Y. Filed Dec. 10, 2010) is an action against registered floor broker Kent R.E. Whitney who allegedly made false and misleading statements to Chicago Mercantile Exchange representatives and others as part of a scheme to trade options without posting the required margin on the New York Mercantile Exchange and the CME. Essentially, the complaint alleges that Mr. Whitney would purchase large amounts of front month out-of-the-money options one or two days before expiration and furnish the wrong account number. The next day when contacted he would provide valid account numbers. This permitted him to avoid large over night margin calls and allocate the trades. The complaint alleges violations of Sections 4c(b) and 9(a)(4) of the Commodity Exchange Act. The case is in litigation.
Court of appeals
U.S. v. Goyal, No. 08-10436 (9th Cir. Dec. 10, 2010) is a criminal securities fraud action against the former chief financial officer of NAI, formerly known as McAfee, from 1997 to 2001 (here). He was indicted for securities fraud, making false statements to the SEC and lying to the auditors. In essence, all of the charges centered on the accounting treatment used to recognize revenue on the sale of the company's products. Essentially, the government argued that NAI violated GAAP by using one method of revenue recognition for its products. The government failed however, to challenge key points about the system used which permitted earlier recognition and allowed the company to meet quarterly goals. The government also failed to prove materiality. The Court thus reversed the securities fraud convictions for a lack of evidence. In a concurring opinion, Chief Judge Kozinski chastised the government for bringing such an action which he stated causes harm to the taxpayer, the defendant and the company.
The board issued a temporary rule for comment which would permit it to establish an interim inspection program for registered public accounting firms' audits of broker dealers. Under Dodd-Frank, the Board is authorized to establish by rule a program of inspection of auditors of broker dealers. The proposed temporary rule is intended to give the Board experience with the program in anticipation of developing the final rule.
The agency fined two registered representatives and banned them from the financial services industry for encouraging clients to purchase a security based on inside information. Specifically, James Coppin and Perry Bliss of Pacific Continental Securities UK Ltd. were found to have learned that Provexis plc had signed an agreement with an unnamed major food company. According to papers Messrs. Coppin and Bliss obtained from a colleague, the deal was about to be announced and was expected to have a significant impact on the share price, raising it as much as 100%. The two registered representatives called their clients after obtaining this inside information and encouraged them to buy shares of Provexis. Mr. Coppin was fined over $100,000 while Mr. Bliss, in view of his financial condition, was only fined about $45,000.
For more cutting edge commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman