The Supreme Court handed down two significant rulings as the
week came to a close. In one, it rejected constitutional challenges to the
honest services fraud statute which is frequently used in white collar
prosecutions. In a second, the High Court rejected the Second Circuit's
so-called "foreign cubed" analysis viewing the application of Section 10(b) in
actions involving foreign shareholders and transactions as a question regarding
the scope of the statute, not jurisdiction.
SEC enforcement brought another significant market crisis
case rooted in the conflict inherent in the CDO market and based on a breach of
fiduciary duty. The FSA, despite an order that it will be disbanded, concluded
a significant criminal insider trading case and entered into its first
cooperation agreement under the Serious Organized Crime and Police Act.
Honest services fraud: The Court handed down
decisions in three cases involving challenges to 18 U.S.C. § 1346, the honest
services fraud statute. This statute is key in many white collar prosecutions.
The cases decided by the Court are Skilling v. U.S., No. 08-1394, the
case of former Enron executive Jeffrey Skilling; Black v. U.S., No.
08-876, the case of newspaper magnet Conrad Black; and Weyhrauch v. U.S.,
No 08-119, the case of Bruce Weyhrauch, a former Alaska legislator (the three
cases are discussed
In Skilling, the Court rejected a claim that the
statue is unconstitutionally vague and failed to give proper notice. Rather, it
is axiomatic, the Court noted, that if a construction of the statute is
possible which avoids the constitutional infirmity, it should be adopted. Here,
Section 1346 was enacted against a backdrop of decisions prior to the Court's
ruling in U.S. v. McNally, 483 U.S. 350 (1987). There, the Court held
that honest services fraud was not covered by the wire and mail fraud statutes.
Those pre-McNally cases, while not uniform, stand for the proposition
that at least bribery and kickback schemes are covered by the concept of honest
services fraud. Since Congress passed Section 1346 with reference to these
decisions, honest services fraud focuses on bribery and kickback schemes. Skilling
was vacated and remanded to the district court for further proceedings on this
issue. Black and Weyhrauch were vacated and remanded for further
proceedings in view of Skilling.
Foreign cubed: The Court also handed down its
decision in Morrison v. National Australia Bank Ltd., No 08-1191. The is
the Second Circuit's so-called foreign cubed decision, discussed here.
The Second Circuit had held that it did not have jurisdiction in a securities
fraud action brought by foreign shareholders regarding conduct largely outside
the U.S. The Supreme Court affirmed, but on different grounds. First, the Court
held that the question is not one of jurisdiction. The question of the
extraterritorial reach of Section 10(b) is not jurisdictional. Rather, the
Court held that the question is one of what conduct the statute prohibits.
Second, it is a long standing principle of American law that legislation by
Congress is meant to apply only within the territorial jurisdiction of the U.S.
unless there is a contrary intent. Here, this means to conduct on U.S. exchanges
and within the country.
SEC enforcement actions
Dismissal: SEC v. Aura Financial Services, Inc.,
Civil Case No. 1:09-CV-21592 (S.D. Fla. Filed June 11, 2009) is an action
alleging violations of Securities Act Section 17(a) and Exchange Act Section 10(b)
against the broker and six individuals. Specifically, the complaint claims that
the defendants fraudulently induced customers with little investment experience
to open accounts in which were then charged excessive fees and mark-ups. The
SEC dismissed the claims against defendant Dipin Malla.
Rule 102(e): In the Matter of Fei-Fei Catherine Fang, CPA,
Adm. File No. 3-13948 (June 24, 2010) is a settled Rule 102(e) action against
the auditor of Advanced Materials Group, Inc.. According to the Order for
Proceedings, over a three year period beginning in 2005, the former CFO of the
company executed a fraudulent scheme in which he inflated the revenues of the
company and used them to secure additional borrowings. Those funds were
employed to pay for personal items which had improperly been charged to the
company. Respondent audited the annual financial statements for the fiscal
years ended November 30, 2005 through November 30, 2008 and issued unqualified
opinions. She had no prior auditing experience and failed to properly plan and
carry out the engagements. To resolve the action, Respondent consented to the
entry of an order prohibiting her from appearing and practicing before the
Commission as an accountant.
Offering fraud: SEC v. Banas, Case No. 3788 (N.D.
Ill. Filed June 22, 2010) is an action against Anthony Banas, co-founder and
former Chief Technology Officer of privately held Canopy Financial, Inc. Canopy
is a Chicago-based company which assists clients in administering and managing
their employees' health savings and flexible spending accounts. The complaint
alleges fraud in connection with a $75 million private placement. Specifically,
the complaint claims that Mr. Banas and co-founder Jeremy Blackburn, defrauded
investors by furnishing them with forged bank statements misrepresenting the
financial condition of the company, not informing them about the true financial
condition of the company and misappropriating investor funds. The complaint
alleges violations of Securities Act Section 17(a) and Exchange Act Section
10(b). The case is in litigation.
Investment fund fraud: SEC v. Trade-LLC, Civil Action
No. 9:10-cv-80737 (S.D. Fla. Filed June 22, 2010) is an action against
Trade-LLC, an investment adviser, Philip Milton, its managing member and
William Center. According to the SEC, the defendants convinced three private
investment clubs to invest nearly $28 million in Trade-LLC which promised
significant returns. From 2007 through 2009, investors were given reports
showing an 8% monthly return. Some investors received payments. In fact, there
were no profits. Rather, there were huge losses and the fund operated as a
Ponzi scheme. To resolve the action, which alleged violations of Exchange Act
Sections 10(b) and 15(a) and Advisers Action Section 206, the defendants
offered to consent to the entry of a permanent injunction based on each
section. The defendants also consented to an asset freeze, institution of a
receivership and to disgorge all funds the court determines they obtained from
the scheme. In the case of Mr. Milton, that is $2,351,936. He also agreed to
pay a civil penalty of $130,000. See also Litig. Rel. 21564 (June 22, 2010).
Breach of fiduciary duty/fraud: SEC v. ICP Asset
Management, LLC, Civil Action No. 10-cv-4791 (S.D.N.Y. Filed June 21, 2010)
is against ICP Asset Management, LLC, a registered investment adviser and its
related entities, all of which are controlled by defendant Thomas Priore, as discussed here.
The complaint centers on a series of transactions involving four multi-billion
dollar collateralized debt obligations known as Triaxx CDOs. According to the
SEC, ICP Asset Management and the other defendants engaged in repeated
fraudulent conduct to the detriment of its clients. In one series of
transactions, it caused the Triaxx CDOs to repeatedly overpay for bonds,
frequently to protect other clients. ICP Asset Management directed more than a
billion dollars in fraudulent trades for Triaxx CDOs that were similar and at
inflated prices. The defendants also structured trades which benefited its
affiliates at the expense of the CDOs from which they benefited. In addition
the defendants caused the CDOs to enter into prohibited transactions and
misrepresented the value of holdings. By early 2010, most of the bonds held by
the Triaxx CDOs had been downgraded to junk status from AAA. The case, which
alleges violations of Securities Act Section 17(a), Exchange Act Sections 10(b)
and 15(c)(1)(a) and Advisers Act Section 206, is in litigation.
Investment fund fraud: SEC v. Seisma Oil research, LLC,
Civil Action No. 5:10-CV-95 (N.D. Tex. Filed June 16, 2010) Seisma Oil, and two
Aruba-based affiliates, Seisma Energy Research, AVV and Permian Asset
Management, AVV, are alleged to have raised about $25 million from 400 non-U.S.
investors by offering units in six joint ventures for which Seisma was the
manager. Investor funds were not utilized as represented. To settle the case,
the defendants have offered to consent to a permanent injunction prohibiting
future violations of the antifraud provisions of the federal securities laws as
well as other relief.
The regulator imposed a $4.3 fine on Phoenix Derivatives Group,
LLC of New York City and eight brokers, three at Phoenix and five at four other
interdealer brokerage firms for engaging in improper communications about
customers' proposed brokerage rate reductions in the wholesale credit default
swap markets. The communications were an attempt to improperly influence the
other firms and individuals generally after customers sought to renegotiate CDS
The FSA obtained another guilty plea in an insider dealing
case. Former AKO Capital LLP hedge fund and risk manager Anjam Saeed Ahmad
pleaded guilty to conspiracy to commit insider dealing. Part of the plea
agreement called for the confiscation of about $150,000. Another charge of
insider dealing was not brought. As part of the plea arrangement, Mr. Ahmad
agreed to cooperate with the FSA in prosecuting the co-conspirator. This is the
first cooperation agreement by the FSA under the Serious Organized Crime and
In view of the plea agreement, and his cooperation, the
court sentenced Mr. Ahmad to ten months in prison, suspended for two years, 300
hours of unpaid work for the community and a fie of about $75,000. In handing
down the sentence the court noted that it is only because of the swift
cooperation with the FSA that Mr. Ahmad was not immediately confined to prison.
For more cutting edge commentary on developing securities
issues, visit SEC Actions, a blog by Thomas