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The much discussed, and long debated, Volker Rule came to center stage as the year draws to a close. Following its enactment, the American Bankers Association filed suit to block enforcement of certain portions of the Rule which impact small community banks. Shortly after the suits were filed, four of the five agencies issuing the Rule announced a reconsideration of the section implicated in the suits.
SEC Enforcement filed a series of civil injunctive actions and administrative proceedings through the holidays. The actions centered on FCPA violations, insider trading, soft dollars, improper adviser fees, misrepresentations regarding the financial condition of a fund, improperly altering the investment strategy of a fund and a pyramid scheme.
Volker Rule: The SEC, Federal Reserve, FDIC and OCC issued a release on Friday noting that they are reviewing if it “would be appropriate and consistent with the Dodd-Frank Wall Street Reform and Consumer Protection Act not to subject collateralized debt obligations backed by trust preferred securities to the investment prohibitions of section 69 of Dodd-Frank, otherwise known as the ‘Volker rule.’” (See discussion of Volker Rule below).
Credit rating agencies: The Commission adopted amendments to eliminate references in certain rules to credit ratings by nationally recognized statistical rating organizations or NRSROs (here).
Report: The Commission issued its annual staff report on NRSROs based on the examinations. Over the last year there were 10 new NRSROs, according to the Report, some smaller organizations increased market share and transparency improved (here).
Report: The Commission issued a Staff Report reviewing Disclosure Requirements in Regulation S-K as required by the JOBS Act (here).
Mortgage backed securities: Federal Housing Finance Agency v. Deutsche Bank AG, Civil Action No. 17-06192 (S.D.N.Y.) is an action by the agency based on claims that the financial institution defrauded two government-controlled companies –Fanny Mae and Freddie Mac – in connection with the sale of mortgage-backed securities. The suit was resolved when the bank agreed to pay $1.9 billion. To date, this is the second largest regulatory settlement based on claims that banks engaged in fraud in the sale of mortgaged backed securities. The $13 billion settlement with JPMorgan is the largest. There are no admissions of liability.
The Volker Rule
Challenge to the Rule: American Bankers Association v. FDIC, Civil Action No. 1:13-cv-02050 (D.D.C. Filed Dec. 24, 2013) and American Bankers Association v. FDIC, No. 13-cv-01310 (D.C. Cir. Filed Dec. 23, 2013) are companion cases challenging one segment of the Volker Rule. That Rule was enacted by five agencies (the Federal Reserve, the FDIC, the OCC, the CFTC and the SEC) on December 10, 2013. Generally the Rule is designed to preclude depository institutions from engaging in proprietary trading with certain exceptions. These actions challenge one portion of the Rule which would cause immediate and significant harm to small community banks, according to the suit papers.
Specifically, the actions allege that because of the expansion of certain definitions in the final Rule, small community banks would have to immediately divest their holdings in a debt instrument known as TruPS-backed CDO by 2015. Under GAAP this would result in an immediate charge to earnings and capital. A TruPS-bancked CDO is created when a financial firm purchases multiple trust-preferred securities, packages those securities into a single security and sells new debt interests in that single security to investors. A trust preferred security is a debt instrument created when a bank issues debt to a trust it created and then sells the right to receive interest and principal payments on that debt to third-party investors. Generally, if these securities are held to maturity their carrying value need not be written down. If, under the Rule, these securities are sold now at values less than that at which they are being carried, the banks will suffer losses and it will negatively impact their Tier 1 capital.
The suits here claim that the portion of the Volker Rule requiring divesture cannot stand because: 1) It impermissibly treats a debt instrument with no participation in profits and losses as a prohibited equity-like “ownership interest;” 2) the “sweeping expansion of the term ‘ownership interest’ is not a logical outgrowth of the Proposed Rules and therefore violates the notice-and-comment requirements of the . . .” APA; and 3) because of the “Agencies’ utter disregard of the great costs imposed on community banks . . . “
SEC Enforcement – filed and settled actions
Weekly statistics: This week the Commission filed, or announced the filing of, 4 civil injunctive district court actions, DPA or NPA and 3 administrative proceedings (excluding follow-on actions and 12(j) proceedings).
Soft dollars: In the Matter of Instinet, LLC, Adm. Proc. File No. 3-15663 (Dec. 26, 2013). Respondent Instinet is a registered broker dealer. The proceeding arises out the firm’s relationship with J.S. Oliver Capital Management, L.P, an investment adviser, and its president, Ian Mausner. For a period of about one and a half years beginning in January 2009 Instinet paid about $430,000 in client commission credits or soft dollars to J.S. Oliver. During the course of the payments the broker ignored a series of red flags suggesting that the payments were inappropriate including: 1) portions of the funds went to Mr. Mausner’s wife; 2) there were inconsistent reasons for claimed travel expenses; and 3) a rent increase for office space in Mr. Mausner’s home exceeded the invoices by 50% . In fact, the firm aided and abetted violations of Advisers Act Sections 206(2) and 206(4), according to the Order. To resolve the proceeding the Respondent will institute a series of undertakings which include the retention of an independent expert. The firm also consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm also agreed to pay disgorgement of $378,673.76 along with prejudgment interest and a civil money penalty of $375,000.
Improper fees: In the Matter of Jim Poe and Associates, Inc, Adm. Proc. File No. 3-15661 (Dec. 24, 2013) is a proceeding with names as Respondents the firm, a registered investment adviser, and James Poe, its sole officer and majority owner. The Order alleges that between 2009 and 2011 the firm, at the direction of its principal, improperly charged three private funds it managed a performance fee for clients who did not satisfy the requirement of a “qualified client” under the Advisers Act. From 2009 to 2012 the firm received $637,843 in performance fees from investors who were not qualified. However, because of certain provisions in Dodd-Frank, for a portion of the period Section 205(a)(1) did not apply to it. The Order alleges violations of Advisers Act Section 205(a)(1). To resolve the proceeding the Respondents consented to the entry of a cease and desist order based on the Section cited in the Order as well as to a censure. The Respondents were also ordered, jointly and severally, to pay a civil penalty of $35,000.
Insider trading: SEC v. Marchard, Civil Action No. 2:13-cv-07754 (D.N.J. Filed Dec. 23, 2013) is an action against David Marchand, a former Board Assistant to the Co-Chief Executive Officer of SAP AG. The complaint alleges that Mr. Marchand traded while in possession of inside information obtained from his position at the company on three occasions: 1) Prior to the December 3, 2011 announcement that SAP had entered into an agreement under which it would acquire SuccessFactors, he purchased shares of that firm and, after the deal announcement, realized profits of $28,061; 2) prior to a January 13, 2012 announcement that SAP would have its “best ever” software revenue numbers he purchased company securities which, following the announcement, netted him $2,157 in illicit profits; and 3) before the company announced on May 22, 2012 that it would acquire Ariba, he purchased shares in that firm which, following the post announcement sale of those securities, yielded him illegal profits of $13,282. Overall Mr. Marchand had trading profits of $43,500. The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). To resolve the action the defendant consented to the entry of a permanent injunction based on the Sections cited in the complaint. He also agreed to pay disgorgement of $43,500, prejudgment interest and a penalty equal to his trading profits. See Lit. Rel. No. 22899 (Dec. 23, 2013).
Misrepresentations: In the Matter of West Coast Asset Management, Inc., Adm. Proc. File No. 3-15660 (Dec. 23, 2013) is a proceeding with names as Respondents the firm, a registered investment adviser, and Lance Helfert, its president, director and 40% owner. In September and October 2008 as the financial crisis was unfolding, Respondents made two key misrepresentations to an advisory client regarding the fund managed by West Coast. First, they claimed that there had only been two minor redemptions. Second the investor was told that there had been net inflows of cash to the fund. Neither was true. The Order alleges violations of Securities Act Section 17(a)(2) and Advisers Act Sections 206(2) and 206(4). To resolve the matter each Respondent consented to the entry of a cease and desist orders based on the Sections cited in the Order and to the entry of censures. In addition, the adviser agreed to pay disgorgement of $5,073. 32, prejudgment interest and a civil penalty of $100,000. Mr. Helfert agreed to pay a civil penalty of $32,500.
Insider trading: SEC v. All Know Holdings Ltd., Civil Action No. 11-CV-8605 (N.D. Ill.) is a previously filed action centered on the merger of PRC based Global Education and U.K. based Pearson plc. The original complaint, which named eight defendants, is discussed here. On December 23, 2013 the Commission announced that it settled with the sole remaining defendant, Yonghui Zhang, a Global Education employee and the brother of its CEO. On the last trading day prior to the announcement he purchased shares in the firm which yielded him over $40,000 in trading profits following the deal announcement. To resolve the charges in an amended complaint which names him as a defendant, Mr. Zhang consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). He also agreed to pay disgorgement of $40,494 and a civil penalty in the same amount. See Lit. Rel. No. 22897 (Dec. 23, 2013).
Illegal distribution: SEC v. Lefkowitz, Civil Action No. 8-12-CV-1210 (S.D.N.Y.) is a previously filed action centered on the illegal distribution of 260,115,983 shares of Advanced Cell Technology, Inc. The defendants include the biotech company, William Cadwell, its CEO and Mark Lefkowitz, a penny stock financier. The defendants implemented a scheme crafted by Mr. Lefkowitz to use Section 3(a)(10), which permits the issuance of shares under certain instances in exchange offers approved by a court. It cannot be used for capital formation. Under the plan, entities affiliated with Mr. Lefkowitz acquired debt from Advanced Cell obligation holders, filed lawsuits based on the claims and then settled for payment in shares. A Florida state judge approved the settlements. The Commission alleged that the court was not fully informed of the facts. The company settled, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Section 13(a). The company also agreed to pay disgorgement of $3.5 million and prejudgment interest. A penalty was not imposed based on financial condition. See Lit. Rel. No. 22896 (Dec. 23, 2013).
Altered investment strategy: SEC v. Rooney, Civil Action No. 11-8264 (N.D. Ill.) is a previously filed action against Patrick Rooney and his company, Solaris Management, LLC. The complaint centered on a radical change in investment strategy implemented by the defendants for Solaris Opportunity Fund LP without making the proper disclosures to investors. Specifically, the defendants caused the fund to become wholly invested in Positron Corp., a financially troubled company of which Mr. Rooney had been Chairman since 2004. The complaint alleges a misuse of the fund’s assets. The defendants settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of Advisers Act Sections 206(1), 206(2) and 204(4) as well as Securities Act Section 17(a) and Exchange Act Section 10(b). Under the terms of the settlement the Court will determine if disgorgement, a penalty and an officer director bar should be imposed. See Lit. Rel. No. 22895 (Dec. 23, 2013).
Pyramid scheme: SEC v. Wright-Olivares, (W.D.N.C. Filed December 20, 2013) is an action against Dawn Wright-Olivares and Daniel Olivares based on their roles in a pyramid scheme operated through Rex Ventures Group, LLC d/b/a www.ZeekRewards.com. Beginning in January 2001, and continuing until the program was shut down in August 2012, over $850 million was raise from about 1 million investors in the U.S. and other countries. Ms. Wright-Olivares was one of the main spokespersons for ZeekRewards and the COO. Mr. Olivares was the chief architect of the computer data bases for the company and tracked the investments. Those systems helped create the illusion of a successful business which was, in reality, a massive pyramid and Ponzi scheme. Investors were solicited to participate in one of two plans. Rather than invest the funds as represented, about 98% of the money was paid to new investors. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). To resolve the claims Ms. Wright-Olivares agreed to pay disgorgement plus prejudgment interest of $8,184,064.94 while Mr. Olivares will pay a total of $3,272,934.58. Those payments will be made in connection with the parallel criminal proceeding in which additional financial penalties may be imposed in a restitution order. The parallel criminal charges were announced by the U.S. Attorney’s Office of the Western District of North Carolina. See Lit. Rel. No. 22898 (Dec. 23, 2013).
In the Matter of John Kinross-Kennedy, CPA, Admin. Proc. File No. 3-15536 (Filed Sept. 30, 2013; settled Dec. 20, 2013) is a previously filed action against the PCAOB registered auditor. Since 2009 Mr. Kinros-Kennedy has served as an independent accountant for 23 public companies. The proceeding focused largely on audits and reviews for six of those issuers. All of Respondent’s reports were issued in 2011 and 2012 while the time periods range from 2009 through 2010. The Order alleges improper professional conduct within the meaning of Rule 102(e)(1)(iv)(B)(2) of the Commission’s Rules of Practice. That claim is based on alleged willful violations of Exchange Act Sections 10A(j), regarding audit partner rotation, and 10A(k), regarding reports to the audit committee, as well as the pertinent rules. Essentially, the Order alleges audit failures which are discussed in detail here. Respondent resolved the proceeding by consenting to the entry of a cease and desist order based on the Sections cited in the Order. He is also precluded from appearing or practicing before the Commission with a right to reapply after five years.
Investment fund fraud: SEC v. E-Monee.com, Inc., Civil Action No. 0:13-cv-60637 (S.D. Fla. Filed November 27, 2013 ) is an action against the company, its president, Estuardo Benavides and one of its directors, Robert Cook. The complaint alleges that the defendants sold shares in the company based on claims that it owned $5 billion in Mexican bonds. In actuality the bonds were largely worthless. The company and Mr. Benavides settled with the Commission and in an order entered by the Court, has been enjoined from future engaging in future violations of Securities Act Sections 17(a)(1) and (3). The order also directs Mr. Benavides to pay a civil penalty of $110,000 and bars him from participating in any penny stock offering. The Commission dismissed its civil penalty claim against the company which is no longer operating. See Lit. Rel. No. 22894 (Dec. 20, 2013).
Record retention: The regulator fined Barclays Capital Inc. $3.75 million for failing to retain electronic records. Specifically, from 2002 through 2012 the firm failed to retain its electronic records in a non-erasable format as required. For a portion of the period the firm also failed to retain certain attachments to Bloomberg emails, to retain 3.3 million Bloomberg instant messages and to respond to requests for electronic communications in regulatory and civil matters. In addition, Barclays failed to establish an adequate system and written procedures reasonably designed to achieve compliance with SEC, NASD, and FINRA rules and regulations.
Investment fund fraud: U.S. v. Shields, No. 5:12-cr-00410 (N.D. Cal. Filed May 23, 2012) is a case in which the jury returned verdicts of guilty against defendants Melvin Shields and Michael Sims. The two men, along with co-defendant Sam Stafford who pleaded guilty prior to trial, were charged with operating a fraudulent investment fund known as S3 Partners. Largely elderly investors were solicited. They were urged to withdraw their IRA and similar funds and invest in what was claimed to be a real estate venture. The investments were supposed to pay a high rate of return. In fact much of the money was misappropriated. Mr. Shields was convicted on 32 of 39 counts in the superseding indictment including conspiracy, wire fraud, bank fraud, making false statements and securities fraud. Mr. Sims was convicted on 2 counts of wire fraud and acquitted on other charges. Sentencing is set for April 14, 2014.
Insider trading: U.S. v. Weishaus, No. 12-cr-00887 (S.D.N.Y. Filed Nov. 28, 2012) is an action naming David Weishaus, an employee of a securities trading firm, as a defendant. On December 19, 2013 Mr. Weishaus pleaded guilty to one count of conspiracy to commit securities fraud and one count of securities fraud. The plea was based on his trading in the securities of SPSS which was about to be acquired by IBM prior to the deal announcement. The material, non-public information came from an attorney involved in the transaction. The attorney entrusted the information to a close friend who worked as a research analyst at international financial services firm. Despite an understanding that the information would not be used to trade, the analyst purchased SPSS common stock and call options. He in turn tipped a stock broker employed at the same firm as Mr. Weishaus. That broker also purchased shares in June and July 2009. The broker tipped Mr. Weishaus who also purchased SPSS securities. Following the deal announcement on July 28, 2009, the share price of SPSS rose 41% in one day. The three men, along with two others, sold their shares yielding profits of about $1 million.
Books/records: SEC v. Archer-Daniels-Midland Company, Civil Action No. 2:13-cv-02279 (C.D. Ill. Filed Dec. 24, 2013) is an action against the agricultural processing company alleging violations of the books and records provisions of the Exchange Act centered on the actions of a subsidiary and its affiliates in connection with securing certain tax refunds. Specifically, between 2002 and 2009 Alfred C. Toepfer, International G.m. b. H. and its affiliates, an indirect majority owned subsidiary of ADM, paid about $22 million to two third-party vendors that was used largely to pay bribes to officials of the Ukrainian government to secure the refund of about $100 million in value added tax or VAT. The payments were inaccurately recoded in the books and records of the subsidiary as insurance premiums and other business expenses.
In 2002 ADM began consolidating the financial results of Alfred C. Toepfer into its financial results. While issues regarding the collection of the VAT taxes were discussed at ADM as early as 2002 it was not until 2008 that the payments were discovered. At that time the company conducted an internal investigation, self-reported, cooperated with the SEC and the DOJ and took remedial steps. The SEC’s complaint alleges violations of Exchange Act Sections 13(b)(2)(A) and13(b)(2)(B). To resolve the matter the company consented to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint. In addition, ADM agreed to pay disgorgement of $33,342,012, prejudgment interest and to report on its FCPA compliance efforts for a period of three years. The Commission took into consideration the cooperation of the company.
The parallel criminal charges were also resolved. ADM entered into a non-prosecution agreement while Alfred C. Toepfer pleaded guilty to one count of conspiracy to violate the FCPA bribery provisions and agreed to pay a criminal fine of $33 million.
For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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