This Week In Securities Litigation (Week ending October 5, 2012)

This Week In Securities Litigation (Week ending October 5, 2012)

The President's new market crisis task force brought its first action this week. It named as a defendant Bear Stearns which has been acquired by JP Morgan. The New York AG, co-chair of the task force announced in the state of the union address earlier this year, brought the action. It differs substantially from many earlier market crisis cases since it focuses on Bear Stearns' overall sales of mortgage backed securities rather than a single transaction.

The Commission filed a settled proceeding against a dark pool operator which permitted a vendor to have access to proprietary data regarding market positions which gave it an unfair trading advantage. This is the second case brought in recent weeks focused on unfair advantages being given to certain market participants by market operators. The SEC also brought an action against a former CFO who circumvented internal accounting conrolls to approve his own expenses while the Manhattan U.S. Attorney obtained another plea in the Dell insider trading cases.

Finally, the CFTC lost a high profile case which may well be appealed. A district court vacated its newly enacted position limits concluding the agency misinterpreted the statute. Two Commissioners have indicated that the decision should be appealed although no formal determination by the agency has been announced.

The Commission

Speech: Commissioner Daniel M. Gallagher addressed SIFMA's 15th Annual Market Structure Conference in remarks titled: Market 2012: Time for a fresh Look at Equity Market Structure and Self-Regulation (Oct. 4, 2012). The remarks call in part for an overall study of market structure by the Commission (here).

Alert: The Commission issued an Investor Bulletin: Hedge Funds, in connection with two enforcement actions involving hedge funds. The Bulletin informs investors about investing in hedge funds (here).

Speech: Commissioner Elisse B. Walter addressed the SIFMA Municipal Bond Summit, New York City (Oct. 1, 2012) in remarks titled: Bringing Municipal Bond Trading Into the Light. The remarks focused on transparency in the municipal bond market (here).

SEC Enforcement: Filings and settlements

This week the Commission filed 6 civil injunctive actions and 1 administrative proceeding (excluding follow-on and 12j actions).

Information advantage: In the Matter of eBX, LLC, Admin. Proc. File No. 3-15058 (Oct. 3, 2012) is a proceeding against registered broker dealer, eBX the operator of LeveL ATS, an alternative trading system. LeveL is a dark pool whose subscribers are broker dealers. The firm outsourced its operations to a Service Provider which operated an Order Routing Business. Beginning in 2008, and continuing through early 2011, Order Routing Business was permitted to remember LeveL information in its router regarding the unexecuted orders of LeveL subscribers. This gave the firm an informational advantage which permitted it to obtain significantly more fills than other LeveL customers. This violated Regulation ATS. To resolve the proceeding eBX consented to the entry of a cease and desist order based on Rule 301(b)(2) and 301(b)(10) of Regulation ATS and to a censure. The firm also agreed to pay a penalty in the amount of $800,000.

Offering fraud: SEC v. Hilton, Civil Action No. 12-CV-81033 (S.D. Fla. Filed Oct. 3, 2012) is an action against Joseph Hilton, who allegedly changed his name from Joseph Yurkin after he was enjoined last year in another SEC enforcement action. Also named as defendants are Pacific Northwestern Energy LLC, Rock Castle Drilling fund LP, Rock Castle Drilling Fund II LP and New Horizon Publishing Inc. This case alleges that Mr. Hilton sold limited partnership units in two oil drilling projects through his firm, Pacific Northwestern Energy LLC, based on misrepresentations. He raised about $789,000 in connection with those offerings. He is also alleged, along with Pacific and another company he controlled, to have sold $2.5 million of investments in oil drilling projects sponsored by United States Energy Corp. based on misrepresentations. The complaint alleges violations of Securities Act Sections 5(a) and (c) and each subsection of 17(a) as well as Exchange Act Section 10(b) and each subsection of Rule 10b-5. The Commission obtained a freeze order at the time the complaint was filed. See also Lit. Rel. No. 22503 (Oct. 3, 2012).

Misappropriation: SEC v. Lion Capital Management, LLC, Civil Action No. CV 12-05116 (N.D. Cal. Filed Oct. 3, 2012) is an action against the firm and fund manager Hausmann-Alain Banet. The complaint alleges that the defendants led a teacher to believe that her money would be invested by the hedge fund. Instead Mr. Banet misappropriated her total investment of $550,000. To conceal his fraud the investor was furnished with false account statements. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) & (2) and 206(4). A parallel criminal action has been filed against Mr. Banet by the U.S. Attorney's Office, Northern District of California. See also, Lit. Rel. No.. 22505 (Oct. 4, 2012).

Misappropriation: SEC v. GEI Financial Services, Inc., Civil Action No. 12-7927 (N.D. Ill. Filed Oct. 3, 2012) is an action against the firm, a registered investment adviser, and its owners, Norman Goldstein and Laurie Gatherum. It alleges that the defendants defrauded their advisory clients by charging at least $147,000 in excessive fees and capital withdrawals over the last three years. Messrs. Goldstein and Gatherum are also alleged to have caused the firm to violate a number of compliance rules and requirements of the Advisers Act such as having written compliance policies and procedures or a written code of ethics and updating its Form ADV. Investors were also not told that the firm and been stripped of its securities registrations in 2011 by the State of Illinois. The complaint alleges violations of Advisers Act Sections 204, 204A, 206(1) and 206(4). The case is in litigation. See also Lit. Rel. No. 22504 (Oct. 3, 2012).

Market crisis: SEC v. Perry, Civil Action No. CV 11-01309 (C.D. Cal. Filed Feb. 11, 2011) is an action against Michael Perry, former CEO and Chairman of IndyMac Bancorp, Inc, and A. Scott Keys, the former Executive Vice president and CFO. The complaint, charging violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a), alleged that in 2007 and 2008 as the financial condition of the residential real estate lender deteriorated in the wake of the market crisis, the defendants misrepresented the financial condition of their institution. The bank collapse. Mr. Perry settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a)(3). He also agreed to pay a civil penalty of $80,000. See also Lit. Rel. No. 22502 (Oct. 1, 2012). A related settled case is SEC v. Abernathy, Civil Action No. CV 11-01308 (C.D. Cal. Filed Feb. 11, 2011).

Investment fraud: SEC v. Quay, Case No. 1:12-cv-03420 (N.D. Ga. Filed Oct. 2, 2012) is an action against James Quay and his brother Jeffrey. It alleges that James Quay, a convicted felon, disbarred attorney and a former a fund raiser for a Ponzi scheme, lured investors at free dinner seminars targeting retirees into what should have been investments but turned out to be a scheme for him to misappropriate their money. James Quay agreed to settle with the Commission, consenting to the entry of a permanent injunction based on Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). He also agreed to be barred from the securities business and from participating in a penny stock offering and from practicing before the Commission as an attorney or an accountant. His brother did not settle. See also Lit. Rel. No. 22506 (Oct. 4, 2012).

Fraudulent employee expenses: SEC v. Krishnan, Civil Action No. 0:12-cv-02495 (D. Minn. Filed Sept. 28, 2012) is an action against Subramanian Krishanan, formerly the CFO of Digi International, Inc. Over a period of five years beginning in March 2005 the defendant submitted false expense reports for himself. While he authorized such forms for others, company controls precluded him from approving his own expenses. To circumvent those controls he ran his reports through a Hong Kong subsidiary and approved them as the reports of others. This resulted in false company filings with the Commission. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5). The case is in litigation.

Manipulation: SEC v. Sunrise Solar Corporation, Civil Action No. 5-12-cv-00918 (W.D. Tx. Filed Sept. 28, 2012) is an action against the company and its former CEO Eddie Austin, Jr. and his wife Carolyn Austin. Beginning in July 20008 and continuing through May 2009 Mr. Austin drafted and approved a series of false and misleading press releases which pictured the company as a robust solar industry player. In fact they were false as were two company annual reports which failed to disclose Mr. Austin's recent bankruptcy filing. In May 2008 the company also issued two million restricted shares of stock, 500,000 of which went to Mr. Austin and 1.5 million of which went to entities controlled by John Cloud. Mrs. Austin, through a controlled corporation, obtained 500,000 shares from Mr. Cloud and began selling them despite the fact that they were not registered. The complaint alleges violations of Exchange Act Sections 10(b), 13(a) and 16(a) and Securities Act Sections 5(a) and 5(c). Mr. & Mrs. Austin both resolved the case by consenting to the entry of permanent injunctions based on the sections cited in the complaint. In addition, Mr. Austin agreed to the entry of a bar precluding him from serving as an officer or director of a public company and from participating in a penny stock offering. He will also pay a civil penalty of $40,000. Mrs. Austin agreed to pay disgorgement of $174,471 plus prejudgment interest. See also Lit. Rel. No. 22501 (Oct. 1, 2012).


Position limits: International Swaps and Derivatives Association v. CFTC, Civil Action No. 11-cv-2146 (D.D.C. Ruling Sept. 28, 2012) is an action which challenged the position limits set by the CFTC on derivatives tied to 28 physical commodities. Plaintiff disputed the CFTC's claim that it was required by Dodd-Frank to establish the position limits. The rule was adopted by a 3-2 vote of the Commission. Those voting in favor took the position that the law required the limits in the absence of a finding that they are necessary. The court held that the Commission misinterpreted the statute. Section 6a(a)(1) of the Act "clearly and unambiguously requires the Commission to make a finding of necessity prior to imposing position limits." This language from the CEA has remained largely unchanged from the time of its initial passage through Dodd-Frank.

Criminal cases

Offering Fraud: U.S. v. Kelly (S.D.N.Y.) is a case charging Robert Kelly with one count of securities fraud and one count of wire fraud. Mr. Kelly was the CEO of Wwebnet, Inc., supposedly a developer of software for transmitting music, videos and movies over the internet. Over a four year period beginning in 2004 Mr. Kelly solicited investors for funds to develop the software. In fact over $2.11 million of the funds were diverted to his personal use.

Investment fund fraud: U.S. v. Mattera (S.D.N.Y.) is an action in which Hohn Mattera pleaded guilty to one count of securities fraud, one count of wire fraud and one count of conspiracy to commit securities fraud and wire fraud. Mr. Mattera served in 2010 and 2011 as the Chairman of the Advisory Board of Praetorian Global Fund Ltd, a mutual fund where he was responsible for day to day management. In 2010 he and others began marketing shares in a special purpose entity called G Power Entities which supposedly had pre-IPO shares of Facebook, Groupon and other similar companies. Investor money was to be held in accounts until the IPO of each company. About $11 million in investor funds was supposedly sent into special escrow accounts. In fact there were no pre-IPO shares and much of the money was misappropriated. Sentencing is scheduled for February 1, 2013.

Insider trading: U.S. v. Newman, Case No. 1:12-cr-00121 (S.D.N.Y.). Jon Horvath, a former hedge fund research analyst pleaded guilty to one count of conspiracy to commit securities fraud and two counts of securities fraud. Mr. Horvath was alleged to be part of an insider trading ring that made $61.8 million from 2007 to 2008. It traded on inside information in the securities of technology companies, including Dell, Inc and NVIDIA Corporation. The information was exchanged among hedge fund analysts after being secured from employees who worked at public companies. Mr. Newman was originally charged along with Dannuy Kuo, Todd Newman and Anthony Chiasson. Mr. Kuo previously pleaded guilty and is awaiting sentencing. Messrs. Newman and Chiason are scheduled for trial, beginning on October 29, 2012.

New York

Market crisis: People of the State of NY v. J.P.Morgan Securities LLC. (S.Ct. N.Y. Filed Oct. 1, 2012) is an action against Bear, Stearns & Co., Inc., which has been acquired by J.P.Morgan Chase. The complaint focuses on the sale of billions of dollars worth of mortgage backed securities or RMBS by Bear Stearns as the market crisis unfolded. Sales representations centered on the careful selection process for the loans pooled as well as the continued oversight of the firm. Contrary to these representations, the complaint alleges that Bear Stearns ignored its own procedures and was overwhelmed by the number of securitizations. The firm systematically failed to properly conduct due diligence during the securitization process and often overlooked defects. The quality control department could not handle the large number of issues. Even when Bear Stearns' executives became aware of difficulties they were not resolved. Investors were never informed about the firm's failures. As of August 2012 Bear Stearns had MSRB outstanding with a principle balance of $87 billion. At that point about 26% of the 103 subprime and Alt.A securitizations that Bear Stearns sponsored and underwrote in 2006 and 2007 were suffering losses. Those losses total $22.5 billion. The complaint alleges violations of General Business law Article 23-A, securities fraud, and Executive Law Section 63(12), persistent fraud or illegality. It seeks an injunction, an accounting of all fees and revenues received disgorgement, damages caused, restitution, and costs and attorneys' fees.


Insider dealing: The FSA charged four individuals with conspiracy to insider deal between November 1, 2008 and March 23, 2010. Martyn Dodgson, a senior corporate broker, Andrew Hind, Benjamin Anderson and Iraj Parvizi were all charged The case stems from what the FSA calls Operation Fabernula, a long running joint investigation with the Serious Organised Crime Agency. It is the largest and most complex insider dealing investigation conducted to date by the regulator.

Market abuse: The regulator has been directed by the Upper Tribunal to impose a fine of ₤900,000 on hedge fund manager Stefan Chaligne and a fine of ₤650,000 on Patrick Sejean, a former salesman on Cantor Fitzgerald Europe's (CFE) London-based French desk. A third individual, Tidiane Diallo, involved was not fined based on his financial condition. Mr. Chaligne was also directed to pay disgorgement of €362,000.

Mr. Chaligne was the fund manager of a Cayman Islands based hedge fund. He manipulated the closing price of nine securities traded on a number of European and North American exchanges by placing orders in a manner which was designed to increase the closing price of the securities. Messrs. Sejean and Diallo executed the orders on one of the dates. The effect was to increase the value of the fund Mr. Chaligne managed on two key portfolio valuation dates. This practice is known as "window-dressing the close." The increased valuation permitted Mr. Chaligne to present investors with a positive view of the fund at a time of difficult market conditions.

For more cutting edge commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

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