This week three Galleon related defendants were sentenced
to prison for insider trading, including Raji Rajaratnam. The Commission filed
another significant market crisis case naming the senior officers of a failed
bank as defendants. The Commission also filed a settled insider trading case,
an action against two exchanges and two investment fraud actions.
The SEC also filed a settled an FCPA administrative
proceeding against a valve manufacturer who made improper payments in China.
The payments were discovered by the company while implementing FCPA procedures
and then investigated and reported to the staff. The company and its local
manager were sanctioned.
Finally, the Commission continued to implement Dodd-Frank
this week. Draft rules were issued for comment on the Volker Rule and
Strategic Dialogue: The
SEC and FSA held a Strategic Dialogue Meeting this week. Its purpose was to
restate their commitment to work together and continue discussions in areas of
common interest including cross-boarder enforcement cases, the oversight of
dually-regulated firms and the global regulatory agenda.
Proprietary trading: The
Commission, along with other agencies, issued a proposed rule to implement
Section 619 of Dodd-Frank, the so-called Volker Rule. Essentially the proposed
rule would require the implementation of an internal compliance system. It also
includes reporting requirements and would exempt certain specified
transactions. The proposal for the rule is here.
Securities-based swaps: The
Commission issued for comment proposed rules which would require the
registration of securities-based swap dealers and major security-based swap
SEC Enforcement - court decisions
Financial fraud: SEC v. Razmilovic, Case
No. CV 04-2276 (E.D.N.Y. Ruling issued Sept. 30, 2011) is an action against
Tomo Razmilovic, the former CEO of Symbol Technologies, Inc. and others. The
action centers on a massive financial fraud allegedly orchestrated by Mr.
Razmilovic and others from 1998 through 2002. Liability as to Mr. Razmilovic
was previously established in this long running action. Subsequently, the court
held a hearing to consider remedies. After considering expert testimony the
court concluded that Mr. Razmilovic had to disgorge all ill-gotten profits
causally linked to the fraud. While this did not include his base salary it did
cover the increase in base pay he obtained for being promoted, incentive
compensation tied to the performance of the company, his severance package
since it was based on an exchange of stock options awarded based on the
performance of the company, stock options and stock trading profits totaling
$41,753,632.04. The court entered a judgment in that amount along with
prejudgment interest, an officer and director bar and an injunction prohibiting
future violations of Securities Act Section 17(a) and Exchange Act Sections
10(b), 13(a), 13(b)(2) and 13(b)(5). The court also imposed a civil penalty of
$20,876,811.32. The court declined to impose a penalty in the amount of the
disgorgement noting that it would be excessive in view of the amounts.
SEC Enforcement - filings
Exchange systems: In the Matter of Edgx
Exchange, Inc., Adm. Proc. File No. 3-14586 (Oct. 13, 2011)
is an action against two exchanges and SROs, EDGA Exchange, Inc. and EdGX
Exchange, Inc., and broker dealer Direct Edge ECN LLC or DE Route. The action
is based on the obligations of national securities exchanges to ensure that
their order quoting, routing, execution systems, compliance infrastructures and
communications platforms are developed and properly maintained to avoid material
failures and outages. In this case there were two significant failures. First,
in November 2010 untested computer code changes resulted in EDGA and EDGX
overfilling order from three members involving an estimated 27 million shares
in about 1,000 stocks at a cost of about $773 million. One member traded out on
direction of respondents and submitted a claim for about $105,000 in losses.
The others refused at which point the exchanges took over and traded the
positions in violation of their own rules. Resolving these trades cost about
$2.1 million. DE Route violated SEC rules in the process including those
regarding short selling. Second, in April 2011 the EDGX database administrator
inadvertently disabled data base connections disrupting the ability of the
exchanges to process orders, modifications and cancellations. This caused
members about $668,000 in losses. EDGX waited about 24 minutes to remove its
quotations from public market data and violated the SEC's Regulation NMS by
failing to identify its quotations as manual, The Order found violations of
Exchange Act Sections 19(b) and 19(g). To resolve the matter Respondents
submitted a comprehensive plan to improve their systems. They also consented to
the entry of a censure. In addition, Respondents EDGA and EDGX agreed to the
entry of a cease and desist order based on Sections 19(b) and (g) while De
Route agreed to the entry of a similar order based on Section 19(g).
Investment fund fraud: SEC v. Aubrey,
Civil Action No. SACV 11-1564 (C.D. Cal. Filed Oct. 12, 2011) is an action
against Jerry and Timothy Aubrey and their salesmen, Brian Cherry and Aaron
Glasser. The complaint alleges that the defendants raised millions of dollars
from investors through high pressure cold calls to sell shares in now-defunct
Progressive Energy Partners, LLC. Investors were told they would receive annual
returns of 50% or more which was false. In fact the money went to pay large,
undisclosed commissions for the salesmen and a lavish house, L.A. Lakers box
seats and vacations in Hawaii, Las Vegas and Palm Springs for the Aubrey
brothers. The SEC's complaint alleges violations of Securities Act Sections 5
and 17(a) and Exchange Act Section 10(b). The action is pending.
Insider trading; SEC v. Hanold, 11-cv-07148
(N.D. Ill. Oct. 11, 2011) is an action against M. Jason Hanold, a director in a
Chicago search firm. The SEC's complaint charges him with trading on inside
information shortly prior to the public announcement of the acquisition of
Hewitt Associates, Inc. by Aon Corporation. Specifically, the complaint alleges
that Mr. Hanold's wife worked at Aon and learned about the deal as it unfolded.
Shortly prior to the July 12, 2010 deal announcement she told her husband in a
telephone call that the transaction was eminent. In subsequent e-mails she told
him to keep the information confidential. Nevertheless, the next day, which was
July 7, 2010, he purchased 831 shares of Hewitt Associates. Following the
announcement the share price increased by 18%. Mr. Hanold resolved the case by
consenting to the entry of a permanent injunction prohibiting future violations
of Exchange Act Section 10(b) and agreeing to disgorge his trading profits and
pay prejudgment interest and a civil penalty in the amount of $20,241.
Financial fraud: SEC
v. Wu, Case No. CV-11-4988 (N.D. Cal. Filed Oct. 11, 2011) is an action
centered on the collapse of United Commercial Bank which resulted in charges of
$2.5 billion to the FDIC. Named as defendants are: Thomas Wu, then the Chief
Executive Officer of the bank and its holding company, Ehrahim Shabudin, COO,
Thomas Yu, First Vice President, Manager of Credit Risk and Portfolio
Management and Craig On, CFO of the holding company. The complaint alleges
violations of Securities Act 17(a) and Exchange Act Sections 10(b), 13(a),
13(b)(2)(A), 13(b)(2)(B), 13(b)(5) and the related rules. According to the
complaint, United Commercial Bank was a rapidly growing financial institution
until 2008. As the market crisis unfolded and several large loans and their
collateral deteriorated, the former CEO, COO and others took a series of steps
to manipulate the value of the loans and/or the reserves and ultimately the
financial statements for the bank and holding company. As those steps were
implemented the auditors were furnished false information. Ultimately the bank
was taken over by California regulators. UCB was the ninth largest bank to fail
during the financial crisis of 2008 and 2009. Only Mr. On settled with the
Commission. He consented to the entry of a permanent injunction prohibiting
violations of Securities Act Sections 17(a)(2) & (3) along with reporting,
recordkeeping and internal control provisions. He also agreed to pay a civil
penalty of $150,000 and consented to an entry in a related administrative
proceeding of an order suspending him from appearing or practicing before the
SEC as an accountant with a right to reapply after five years. The other
defendants are litigating the action.
Insider trading: U.S. v. Rajaratnam, 09-mg-2307
(S.D.N.Y.) is the insider trading action against the founder of Galleon
Management. Mr. Rajaratnam was convicted on 14 counts of conspiracy and
securities fraud by a jury in May following a two month trial. On Thursday Mr.
Rajaratnam was sentenced to serve 11 years in prison, substantially less than
the 19 to 24 years sought by the government. He was also ordered to forfeit
$53.8 million and pay a fine of $10 million. His request for a continuation of
bail pending his appeal was denied. He is scheduled to surrender at the end of
Insider trading: U.S. v.Goffer, 1L10-cr-0056
(S.DN.Y.)is the insider trading case against, among others, Michael Kimelman,
one of the founders of Incremental Capital along with Zvi Goffer and Emanuel
Goffer. Mr. Kimelman was convicted on two counts of securities fraud and one
count of conspiracy to commit securities fraud in June following a jury trial.
He had been charged with trading on inside information concerning corporate
take-over transactions which ultimately traced to Arthur Cutillo, Brien
Santarlas and Ropes and Gray. The trading yielded him about $290,000 in
profits. Mr. Kimelman was sentenced to serve 30 months in prison. Earlier this
week Emanuel Goffer was sentenced to three years in prison.
Investment fund fraud: U.S. v. Graves (E.D.Va.
Filed Oct. 11, 2011) names as defendants John Graves and his wife Sara.
Following his resignation from the FBI in 1999, Mr. Graves founded Brook Point
Management. He served as president. The firm sold insurance, performed real
estate and tax planning services and recruited and advised investment clients.
Between June 2008 and July 2011 Mr. Graves and his wife defrauded 11 investors
out of about $1.1 million, according to the court papers. Rather than properly
invest the funds, they were diverted to the personal use of the defendants and
used to repay other investors. Mr. Graves continued to make misrepresentations
to investors and the SEC even after the scheme was uncovered. The defendants
have been charged with one count of conspiracy to commit mail and wire fraud,
one count of mail fraud and four counts of wire fraud. Mr. Graves was also
charged with three counts of investment adviser fraud and one count of making
false statements. The case is pending.
Investment fund fraud: U.S. v. Muhawich (N.D.
Cal.) is an action in which Maher Talal Muhawich, a San Francisco real estate
developer, was indicted on twelve counts of wire fraud. The indictment alleges
that from January 2006 through March 2009 the defendant and others solicited
about $25 million from at least 80 investors based on false representations.
Investors were told that the money would be used to purchase and renovate
specific residential properties in San Francisco which would then be sold
yielding high rates of return for the investors with limited risk. Mr. Muhawich
pleaded guilty to one count of wire fraud. Sentencing is scheduled for March 7,
In the Mater of Watts Water Technologies,
Adm. Proc. File No. 3-14585 (Oct 13, 2011) is an action against the company and
Lessen Chang. Watts manufactures and sells water valves and related products.
Its shares are traded on the NYSE. Watts operated in China through its wholly
owned subsidiary, Watts Valve Changsha Co. Ltd or CWV, established in 2005. It
was sold in 2010. Mr. Change, a U.S. citizen, was vice president of sales for
Watts' management subsidiary in China. CWV produced and supplied large valve
products for infrastructure products in China that were largely done with
state-owned entities. Those entities routinely retain state-owned design
institutes to assist. Here from 2006 through 2009 improper payments were made
to employees of certain design institutes by CWV. The purpose was to influence
the institutes to recommend CWV products to the state-owned enterprises involved
with the infra-structure projects. They were also intended to create design
specifications that favored CWV products. The payments were booked incorrectly
as commissions in CWV's books and records which caused those of Watts to be
inaccurate. Respondent Chang approved many of the payments. The company
realized about $2.7 million in profits from the payments.
The violations were discovered, investigated and reported
to the staff by the company. In early 2009 Watts' General Counsel learned of a
Commission enforcement action against another company involved with unlawful
payments to employees of Chinese design institutes. As a result the company
implemented anti-corruption and FCPA training for the Chinese subsidiary of
Watts. Following a training session the Watts China in-house corporate counsel
learned of possible FCPA violations which caused the company to undertake an
internal investigation conducted by outside counsel and forensic accountants.
Subsequently, the company initiated a series of remedial steps.
To resolve the case the company consented to the entry of
a cease and desist order based on Exchange Act Sections 13(b)(2)(A) and
13(b)(2)(B), agreed to pay disgorgement of $2,755,815 along with prejudgment
interest and a civil penalty of $200,000. Respondent Change consented to a
cease and desist order based on the same sections and agreed to pay a civil
penalty of $25,000. The Order notes that "the Commission considered remedial
acts promptly undertaken by Watts and the cooperation afforded the staff."
FINRA Chairman and CEO Richard Ketchum addressed the
Security Traders Association Annual Convention on October 13, 2011. His remarks
reviewed the Manning Rule, the integrated audit trails and surveillance,
indications of interest and market structure issues. The text is here.
Audit firm/partner barred: The
Board issued an order permanently barring auditor Samuel Cordovano and
permanently revoking the registration of his firm, Denver based Cordovano and
Honeck, LLP. Mr. Cordovano had significant participation in four audit
engagements following a settlement in which he had been barred by the Board
from association with an audit firm with a right to apply for re-association
after one year.
Japanese regulators: The
Board exchanged letters with its Japanese counterparts confirming their mutual
commitment to cooperation on cross-boarder audit oversight. The letters were
with the Japan Financial Services Agency and Certified Public Accountants and
Auditing Oversight Board. While the Board has conducted inspections of Japanese
PCAOB registered firms since 2007 the letters confirm the arrangement and their
mutual cooperation. They also provide for the exchange of confidential
information under the applicable provisions of Dodd-Frank.
Engagement partner: The
Board issued for comment proposed amendments to its standards which would
require audit firms to disclose in their audit report the name of the engagement
partner and the identity of any other accounting firms and persons not employed
by the audit firm that took part in the audit. The goal is to provide greater
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.
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