Prosecutors concluded their case-in-chief in the Galleon
insider trading trial this week. SEC enforcement, in conjunction with the U.S.
Attorney's Office in New Jersey, brought an insider trading case against an
attorney, a former associate of three prominent law firms, and a professional
trader. The Commission also brought actions based on financial fraud and
misrepresentations in connection with the sale of CDOs. The Department of
Justice brought an FCPA action against another member of in the TSKJ consortium
and, along with the SEC, against Comverse Technology. Finally, the number of
securities class actions filed last year increased but the average settlement
value decreased according to a new PWC report.
Accounting profession: SEC Chief Accountant James Kroeker testified
before the Senate Banking subcommittee on securities, insurance and investment
on the Role of the Accounting Profession in Preventing Another Financial
Crisis. In his remarks Mr. Kroeker covered a series of topics including: the
importance of reliable financial reporting, the role of the auditor, the root
causes of auditing deficiencies, auditing considerations around the globe and
continuing improvements to accounting standards (here).
SEC Commissioner Luis A. Aguilar addressed the Council of
InstitutionalIinvestors Spring Meeting on April 4, 2011. His remarks were
titled "Facilitating Real Capital Formation." Commissioner Aguilar focused on
the difference between capital formation and raising capital as well its
relation to effective regulation and enforcement (here).
Investment fraud: SEC v. Mam Wealth
Management LLC, Civil Action No. CV 11-2934 (C.D. Ca. Filed
April 7, 2011) is an action against the firm, MAMW Real Estate General Partner
LLC, Alex Martinez and Ralph Sanchez. The complaint alleges from July 2007
through March 2009 Defendants Martinez and Ralph Sanchez had 50 of their
advisory clients invest in MAM Wealth Management Real Estate Funds. For some
the two individual defendants made misrepresentations about the investment
including its safety, liquidity and yearly earnings. For others they held
discretionary authority and the investments were unsuitable. The complaint
alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b)
and Advisers Act Sections 206(1) and 206(2). The case is in litigation.
Misrepresentations: In the Mater of Delta
Global Advisors, Inc., Adm. Proc. File No. 3-14329 (April 7,
2011) names as Respondents the firm and Charles Hanlon, its principal and
control person. Respondents repeatedly misrepresented to customers its
eligibility for registration with the Commission and assets under management.
Through repeated misrepresentations Respondents vastly exaggerated the
significance and status of the firm. It also failed to disclose a breach of
fiduciary law suit against the firm, that Mr. Hanlon was the subject of a FINRA
disciplinary proceeding and its poor financial condition. The Order alleges
violations of Advisers Act Sections 206(1), 206(2) and 206(4). The date for the
hearing has not been set.
Failure to protect client information: In the
Matter of Marc A. Ellis, Adm. Proc. File No. 64220 (April 7,
2011); In the Mater of Frederick O. Kraus, Adm. Proc. File No. 3-14326 (April
7, 2011); In the Matter of David C. Levine, Adm. Proc. File No. 3-14327 (April
7, 2011). These proceedings named as Respondents three former officers of
GunnAllen Financial Inc. They are its former president Frederick Kraus, former
national sales manager David Levine and former chief compliance officer Mark
Ellis. The three proceedings allege that while the firm was winding down its
business operations Mr. Kraus permitted Mr. Levine to take customer information
from more than 16,000 accounts and transfer it to his new firm prior to
notifying customers This violates Regulation S-P or the Safeguard rule which
protects customer information. Mr. Ellis failed to install adequate procedures
in this regard. The ones in place were little more than a copy of the language
from the regulation. To resolve the actions Respondents Levine and Kraus
consented to the entry of a censure and a cease and desist order based on Rules
7(a), 10(a) and 30(a) of Regulation S-P. In addition, each man agreed to pay a
civil penalty of $20,000. Mr. Ellis consented to the entry of a censure and a
cease and desist order based on Rule 30(a) of Regulation S-P. He also agreed to
pay a civil penalty of $15,000. These are the first actions to assess a civil
penalty against an individual based on Regulation S-P.
Stock based loan scheme: SEC v. HedgeLender
Case No. 2:09-CV-859 (S.D. Ohio filed Sept. 30, 2009) is an action against the
company and its principals, Daniel Stafford and Fred Wahler. The complaint
alleges that the defendants solicited 54 clients who put up $1.7 million in securities
for a fraudulent scheme operated by Michael and Melissa Spillan through One
Equity Corporation. Clients were told that their stock would be used to
collateralize non-recourse loans. The defendants represented that the Spillans
and their company were legitimate lenders that they had carefully vetted. In
fact the operation was a fraud and the due diligence claims were false. The
investor shares deposited were liquidated. The Spillans used portions of the
money for their personal expenses. The defendants settled this week with the
SEC. Each consented to the entry of a permanent injunction prohibiting future
violations of Securities Act Sections 17(a) and Exchange Act Section 10(b). In
addition, the company was ordered to pay disgorgement of $1,719,567 along with
prejudgment interest while Mr. Stafford was directed to disgorge $432,417 along
with prejudgment interest. Mr. Wahler was directed to disgorge $298,065 along
with prejudgment interest. A civil penalty of $1,065,417 was imposed on the
company while each individual defendant was directed to pay a penalty of
Failure of due diligence: In the Matter of
Capital Financial Services, Inc., Adm. Proc. File No.
3-14324 (April 6, 2011) is a proceeding against the company, which is a
registered broker dealer, and Brian Hoppre, a registered principal of the
company. The Order alleges that from September 2006 through January 2009
Respondents made a series of private placements of shares of Provident
Royalties, LLC, a company which was suppose to be in the oil and gas extraction
business. About $63 million worth of securities were sold. The Respondent firm
was paid a commission for the sales. Provident used portions of the proceeds
for its business but other portions were used to repay investors in a fashion
resembling a Ponzi scheme. According to the Order, despite being paid a due
diligence fee and a series of red flags raised by a law firm retained to assist
in that process, the Respondents failed to conduct any meaningful due
diligence. The Order alleges violations of Securities Act Section 17(a) and
Exchange Act Section 10(b). The Order directs that a hearing be set.
Financial fraud: SEC v. Styam Computer
Services Ltd., Case No. 1:11-cv-00672 (D.D.C. Filed April
5, 2011); In the Matter of Lovelock & Lewes, Adm. Proc. File No.
3-14321 (April 5, 2011). These are settled actions against, respectively, the
India based company and the PWC affiliates in that country which served as the
outside auditors to the firm. Over a five year period beginning in 2003 the
senior management of the company overrode the internal controls using what they
called a "super user" login identification and password to access the invoice
management system and insert false invoices. The "super user" login allowed the
group to enter the system without detection. In 2007 an additional $58.1
million was added to revenue by recording 27 additional fake invoices outside
the "super user" login. To support the fraudulent revenue the group fabricated
corresponding bank records. The false financial information was included in the
financial statements of the company as well as press releases. The fraud
apparently was discovered when the company made a filing with the SEC which
attached a letter from its former chairman admitting it. The company has been
restructured by the government of India and criminal charges brought against
the officers. The company settled with the Commission, consenting to the entry
of a permanent injunction prohibiting future violations of Exchange Act
Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). Styam is also required to
retain an independent consultant, comply with certain undertakings and pay a
$10 million civil penalty.
The related administrative proceeding was also settled.
The action centered on claims of improper professional conduct by PW India.
Five PWC affiliated entities were named as Respondents. The Order claims that
from 2005 through 2009 the auditors failed to retain control of the
confirmation process with respect to cash and cash equivalents, rarely
questioning the information they obtained. It alleges violations of Exchange
Act Sections 13(a) and 13(b)(2)(A) as well as Section 10A(a) and Rule 102(e).
The proceeding was resolved with the Respondents implementing a series of
undertakings including one which prohibits them from accepting new SEC clients
for six months, the entry of a cease and desist order based on the sections
cited in the Order and the payment of a $6 million penalty and the creation of
a fair fund.
The five PWC related firms also settled with the PCAOB.
The proceeding is based on essentially the same conduct as the SEC
administrative action. Two of the firms will pay a civil penalty of $1.5
million which is the largest levied in a Board proceeding. In addition, the
firms will implement an extensive series of undertakings.
Fraud in sale of CDOs: In the Matter of Wells
Fargo Securities LLC, Adm. Proc. File No. 3-14320 (April 5, 2011)
is a proceeding based on the sale of two collateralized debt obligations tied
to the performance of residential mortgage-backed securities at a time when the
housing market was beginning to show signs of distress. Wachovia Capital
Markets structured and sold the securities. The Order claims the antifraud
provisions were violated in two respects. First, undisclosed excessive mark-ups
were charged. Second, with respect to one, Wachovia represented that it
acquired assets from affiliates on an arms length basis and at fair market
prices. In fact certain assets were transferred from an affiliate at above market
prices. To resolve the matter Respondent consented to the entry of a cease and
desist order based on Securities Act Sections 17(a)(2) and (3). In addition,
Well Fargo agreed to disgorge $6.75 million and pay a civil penalty of $4.45
million. Respondent was also directed to put portions of the sums paid in a
fair fund while other sums were paid directly to purchases.
Insider trading: U.S. v. Bauer,
Mag. No. 11-3536 (D. N.J. Filed April 6, 2011); SEC v. Kluger, Case No.
11-cv-1936 (D. N.J. Filed April 6, 2011). These cases name as defendants
Matthew Kluger, an attorney who worked at three prominent law firms, and
Garrett Bauer, a professional stock trader. At the center of the case is a
person identified as CC-1, a friend of each defendant. According to the
criminal complaint, the insider trading scheme began in 1994 and continued
until 1999 when it stopped for a period. During this time Mr. Kluger generally
furnished inside information from merger deals he worked on to CC-1 who in turn
passed to Mr. Bauer who traded. The scheme halted because of concerns about
being apprehended. In the initial period of the scheme the men traded in five
take over stocks. Mr. Kluger left the law firm where he was employed in 2001.
The second phase of the scheme began in May 2006 shortly
after Mr. Kluger took a position with another firm. It continued through
February 2011. During this period, the group invested over $109 million in
eleven take-over stocks, reaping $32,365,000 in trading profits. The scheme unraveled
in March 2011 when the IRS and FBI executed a search warrant at the residence
of CC-1. Subsequently, CC-1 taped conversations separately with Mr. Kluger and
Mr. Bauer. On the tapes, portions of which are quoted in the criminal
complaint, the two defendants discuss the insider trading and the destruction
of evidence. The criminal complaint charges the two men with one count of
conspiracy to commit securities fraud, eleven counts of securities fraud and
one count of conspiracy to commit money laundering. In addition, each defendant
has been charged with two counts of obstruction. It also seeks the forfeiture
of eight bank or securities accounts and a sum of money equal to $685,000. The
SEC's complaint alleges violations of Exchange Act Sections 10(b) and 14(e).
Both cases are pending.
Financial fraud: U.S. v. Allen
(E.D. Va.) is an action against Paul Allen, the former CEO of collapsed
mortgage firm Taylor Bean. Mr. Allen pleaded guilty to conspiracy to commit
bank and wire fraud and making false statements. Mr. Allen admitted in his plea
to participating in the fraud involving Ocala Funding, a wholly owned lending
facility that raised money by selling commercial paper to financial
institutions. The funds were used to purchase TBW mortgages. Shortly after
Ocalla was set up, Mr. Allen learned that there was a "hole," that is the
assets backing the paper were inadequate. That hole eventually grew to $1.5
billion. Mr. Allen admitted he helped cover up the hole by preparing false
reports. He also made false reports to the Treasury in connection with efforts
to secure TARP funds.
Comverse Technology, Inc.
(E.D.N.Y. April 7, 2011); SEC v. Comverse Technology, Inc., Case No.
11-CV -1704 (E.D.N.Y. Filed April 7, 2011). These FCPA actions center on
improper payments made by the Israeli operating subsidiary of Comverse between
2003 and 2006. Approximately $536,000 in payments were made to individuals
connected to OTE, a telecommunications provider based in Athens, Greece that is
partially owned by the Greek government. As a result of the payments the
company obtained contracts worth about $10 million in revenue and $1.2 million
in profits. The payments were made through a third party agent established in a
Cyprus entity. The agent took 15% and used the remaining 85% in cash bribes.
The payments were improperly booked. The company failed to have proper internal
controls and had no process for conducting due diligence of sales agents or for
an independent review of agent contracts outside its sale department. The company
settled with DOJ by entering into a non-prosecution agreement and paying a $1.2
million fine. The settlement reflects the full cooperation of the company and
its extensive remedial efforts including an overhaul of its compliance culture
through the implementation of mandatory training programs and rigorous
accounting controls to approve third party payments. With the SEC the company
consented to the entry of a permanent injunction prohibiting future violations
of the books and records provisions and the payment of disgorgement in the
amount of $1,249,614 and prejudgment interest.
U.S. v. JGC Corp.
(S.D. Tx. Filed April 6, 2011) is an FCPA action against the Japanese
construction firm of JGC. The information charges the firm with one count of
conspiracy and one count of aiding and abetting violations of the FCPA. The
information is based on the actions of the TSKJ consortium between 1995 and
2004. The consortium was formed to obtain business through the payment of
bribes in connection with the Bonny Island, Nigeria. The other members of the
consortium are KBR, Snamprogetti and Technip, each of whom has previously
settled FCPA charges. JGC resolved the action by entering into a deferred
prosecution agreement and agreeing to pay a criminal fine of $218.8 million
which is the sixth largest amount paid to resolve an FCPA case. In addition to
the settlements with the companies, Albert Stanley, former chairman of KBR and
Jeffrey Tesler, a UK lawyer who acted for the consortium, have both pleaded
The Board entered into a Statement of Protocol with the
Swiss Federal Audit Oversight Authority and Financial Market Supervisory
Authority. Under the agreement the Board will be able to conduct joint
inspections of accounting firms in Switzerland that audit or participate in
audits of companies whose securities trade on U.S. markets. It also contains a
provision governing the sharing of confidential information consistent with the
Sarbanes Oxley Act.
In connection with its sweep of broker dealers who sold
interests in troubled private placements FINRA imposed sanctions on two firms
and seven individuals. The sanctions related to the sale of private placements
offered by Medical Capital holdings, Inc. and/or Provident Royalties, LLC. The
charges were based on a failure to conduct a reasonable investigation of the
sale of the placements. In addition , the regulator found that broker dealers
who sold the MedCap, Provident and DBSI private placement offerings did not
have reasonable grounds to believe that they were suitable for their customers.
Those named were Workman Securities and its president Robert Volbrecht; Timothy
Callum former CEO and Steven Burks former president of Cullum & Burks
Securities;, Jeffrey Lindsey and Bradley Wells, both formerly of Capital
Financial Services; Jay Thacker former CCO of Meadowbrook Securities; and David
Dube, former owner and president of Peak Securities.
The number of securities class actions filed last year
rose by 12% to 174, an increase of 12, compared to the prior year according to
a report released this week by PWC. Those suits targeted the financial and
health industries as well as utilities. At the same time the total settlement
value fell to the lowest level since 2003. The average settlement value fell
11% to $30.1 million from $34.0 million. The report is available on PWC's
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.
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