The government won a significant jury verdict this week in a market crisis suit brought against Bank of America and a former officer of Countrywide Financial, an entity acquired by the bank. U.S. ex. Rel. O’Donnell v. Bank of America Corp., Civil Action No. 12-01422 (S.D.N.Y.) was initially brought by a former Countrywide executive. The case focused on a loan program conducted by Countrywide, prior to its acquisition by the bank, which generated substandard mortgages sold to Fannie Mae and Freddie Mac. The question of what penalty to impose will be considered by the Court. The government claimed that the mortgage giants suffered losses of about $842 million.
The SEC also prevailed in court this week, securing two favorable jury verdicts. Both courtroom victories were in cases centered on offering fund charges. In addition, the Commission filed two settled FCPA case, one of which was in conjunction with the Department of Justice, a fraud action centered on a PRC based entity that is the product of a reverse merger and actions arising from OCIE inspections.
Finally, the Commission issued for comment its long awaited proposed regulations regarding crowdfunding. The proposals were made under the JOBS Act.
Diversity policies: Six Federal Regulators, including the SEC, issued proposed standards for assessing the diversity policies and practices of the institutions they regulate (here).
Proposed rules: The Commission issued proposed rules under the JOBS Act for crowdfunding (here).
Remarks: Commissioner Luis A. Aguilar delivered remarks titled Harnessing the Internet to Promote Access to Capital for Small Businesses, While Protecting the Interests of Investors (Oct. 23, 2013). His remarks focused on crowdfunding (here).
Remarks: SEC Chair Mary Jo White addressed the National Society of Compliance Professionals National Membership Meeting, Washington, D.C. (Oct. 22, 2013). Her remarks focused on the role of compliance (here).
Remarks: SEC Chair Mary Jo White addressed the Managed Funds Association Outlook 2013 Conference, New York, New York (October 18, 2013). Her remarks reviewed changes for hedge funds following Dodd-Frank and the JOBS Act (here).
SEC Enforcement – litigated cases
Offering fraud: SEC v. True North Finance Corporation, Civil Action No. 10-3995 (D. Minn.)is an action against the company, Transactional Finance Fund Management LLC, attorney Todd Duckson who controlled the Management company, Michael Bozora, Timothy Redpath, Owen Williams and Capital Solutions Monthly Income Fund. The Fund began operations in 2004. Four years later the Fund’s sole borrower defaulted. The Fund foreclosed on the borrower’s real estate projects after which the defendants took over its management. Mr. Duckson managed the Fund while Messrs. Bozora and Redpath solicited money from investors who were not told about the default and foreclosure. The defendants raised over $21 million from investors in a series of unregistered offerings at a time when the Fund had no meaningful income, according to the complaint. Investors were solicited using a series of misrepresentations.
True North, which merged with the Fund in 2009, and its CFO, Owen Williams, were alleged to have engaged in accounting fraud. In 2008 and 2009 Mr. Williams caused True North to overstate its revenues by as much as 99%. The original complaint alleged violations of the antifraud provisions of the federal securities laws.
The jury returned a verdict in favor of the Commission following a five week trial. The jury concluded that Mr. Duckson and the Fund violated Securities Act Section 17(a) and Exchange Act Section 10(b). It also concluded that Mr. Duckson aided and abetted the Fund’s violation of Exchange Act Section 10(b) and that Transactional Financial violated Securities Act Section 17(a) and Exchange Act Section 10(b). See Lit. Rel. No. 22853 (Oct. 23, 2013). Previously, the other defendants settled with the Commission.
Offering fraud: SEC v. AIC, Inc., Civil Action No. 3:11-cv-00176 (E.D. Tenn.) is an action against the company, Community Bankers Securities, LLC, Nicholas Skaltsounis, John Guyettte and John Graves. The complaint centered on claims that over a three year period beginning in 2006 Mr. Skaltsounis and others sold promissory notes and stock to investors based on misrepresentations regarding the securities and the use of the proceeds, among other things. The jury returned a verdict after a three week trial, finding in favor of the Commission on all remaining counts. Specifically, the jury returned a verdict against AIC, Community Bankers and Mr. Skaltsounis, finding violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The jury also found in favor of the Commission and against the two entity defendants on Exchange Act Section 20(a) claims and against Mr. Skaltsounis on an Exchange Act Section 20(e) claim.
Prior to trial the Court granted summary judgment in favor of the Commission on its claims against AIC, Community Bankers and Mr. Skaltsounis based on Securities Act Sections 5(a) and 5(c). Mrs. Guyette and Graves settled with the Commission prior to trial. See Lit. Rel. No. 22850 (Oct. 22, 2013).
Weekly statistics: This week the Commission filed , or announced the filing of, 2 civil injunctive actions and 5 administrative proceeding (excluding follow-on actions and 12(j) proceedings).
Compliance: In the Matter of Modern Portfolio Management, Inc., Adm. Proc. File No. 3-154583 (Oct 23, 2013) is a proceeding against the registered investment adviser and its principals, G. Thomas Damasco II and Bryan F. Ohm. The proceeding centers on the failure of the firm to correct violations identified by OCIE in a 2008 examination. At that time the firm was informed that it had failed to complete an annual compliance review in 2006, made misleading statements on its website regarding its access to Dimensional Fund Advisors and omitted disclosures in its performance information. Although the firm promised to take corrective action following an OCIE letter it did not. At the time of the 2011 inspection similar violations were found. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). The Respondents resolved the proceeding by agreeing to a series of undertakings and consenting to the entry of cease and desist orders based on the Sections cited in the Order. In addition, the adviser agreed to pay a penalty of $37,500 and each individual Respondent will pay $50,000.
Compliance: In the Matter of Equitas Capital Advisors, LLC., Adm. Proc. File No. 3-15585 (Oct. 23, 2013) is a proceeding against the registered adviser, Equitas Partners, LLC, also a registered adviser, David Thomas, Jr., founder of Equitas, and Susan Christina, the CCO. The Order centers on the failure to correct certain items identified by the OCIE staff at an examination. Specifically, the firm inadvertently incorrectly billed certain clients and negligently made misrepresentations about its historical performance, conflicts and other items. The adviser also violated the compliance related rules as did Equitas Partners. Mr. Thomas aided and abetted and caused the advertising violations while Ms. Christina, aided and abetted and caused the compliance related violations. To resolve the proceeding the two entities agreed to implement a series of undertakings. Equitas also agreed to the entry of a cease and desist order based on Advisers Act Sections 206(2) and 206(4) and will pay a penalty of $100,000. Equitas Partners agreed to the entry of a similar order based on Advisers Act Section 206(4) as did the two individual Respondents. Both entity Respondents were censured while Mr. Thomas will pay a civil penalty of $35,000.
Compliance: In the Matter of Stephen Derby Gisclair, Adm. Proc. File No. 3-15584 (Oct. 23, 2013) is a proceeding which names as a Respondent Mr. Gisclain, the founder and COO of Crescent Capital Consulting, LLC and the founder of Equitas Capital Advisors, LLC and Equitas Partners LLC (see preceding action). The Order alleged that clients were incorrectly billed and that Equitas made false disclosures to clients in its advertising and Forms ADV regarding certain matters. It also asserts that Equitas, Equitas Partners and Crescent failed to conduct annual compliance reviews as required and that Equitas and Crescent overstated their reported assets under management. Many of the violations were the subject of warnings by OCIE but not corrected. The Order alleges violations of Advisers Act Sections 206(4) and 207 and Rule 10 of Regulation S-P. To resolve the proceeding Respondent agreed to a series of undertakings, to the entry of a cease and desist order based on the Sections cited in the Order and to pay a penalty of $90,000.
Registration violations: In the Matter of OX Trading, LLC, Adm. Proc. File No. 3-14853 (Oct. 23, 2013) is a settlement involving OX Trading, a subsidiary of optionsXpress Holdings, Inc., a registered broker dealer for a period and Thomas Stern, the CFO and CCO of OX Trading and CFO of optionsXpress. OX Trading was required as a member of the CBOE to have an annual audit. It refused and Mr. Stern terminated the firm’s registration with the exchange. When notified that to be a dealer it had to be registered with an exchange, Mr. Stern deregistered OX Trading. Nevertheless, it continued to operate as it did when it was a CBOE member except that trading went through a customer portfolio margin account at optionsXpress. When the CBOE discovered this it notified the firm it had to be registered. Several months later the firm submitted a registration statement. Thus, for a period OX Trading, according to findings made by Chief ALJ Brenda Murray, violated Exchange Act Section 15(a) which makes it unlawful to induce or attempt to induce any purchase or sale of a security unless the dealer is registered. OX Trading also violated Exchange Act Section 15(b)(8) which makes it unlawful for a dealer to effect any transaction unless it is a member of a national securities association or effects transactions solely on an national exchange of which it is a member. To resolve the proceeding Respondent agreed to withdraw its Petition for Review of the Initial Decision issued on June 7, 2013 in the Matter of optionsXpress, Inc., et al., Adm. Proc. File No. 3-14848 and acknowledged that the Commission may enter an order that the Initial Decision has become final as to him. In addition, OX Trading consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay disgorgement of $2,750,000 along with prejudgment interest and a civil penalty of $750,000.
Insider trading: SEC v. Poteroba, Civil Action No. 1:10-cv-2667 (S.D.N.Y.) is a previously filed action against Aleksey Koval, a securities professional, and others. The complaint alleged that beginning in 2005, and continuing for about four years, Mr. Koval participated in an insider trading ring in which he repeatedly traded on inside information obtained from Igor Poteroba, an investment banker at UBS. The Court entered a final judgment by consent on October 7, 2013 prohibiting future violations of Exchange Act Sections 10(b) and 14(e). The order also requires the payment of disgorgement in the amount of $1,086,457 and prejudgment interest. Those amounts are deemed satisfied by the forfeiture order entered in the parallel criminal case in which he was convicted. A penalty was not sought in view of that action. In a separate administrative proceeding the Commission barred Mr. Koval from the securities business and from participating in any penny stock offering based on the criminal conviction. See Lit. Rel. No. 22851 (Oct. 22, 2013).
Manipulation: SEC v. Zhou, Civil Action No. 12-Civ-8987 (S.D.N.Y.) is a previously filed action against Huakang Zhou and Warner Technology and Investment Corporation. Mr. Zhou and Warner are consultants to a number of Chinese reverse merger companies. In connection with those roles, from 2007 through 2010, the complaint alleges that they violated the federal securities laws. Specifically, with regard to one company the complaint alleges that they engaged in manipulative trading to help secure a listing on an exchange for one client; made false statements in connection with an offering for another; and sold unregistered securities and acted as an unregistered broker with respect to another. This week the Court entered final judgments by consent against each defendant which enjoin them from future violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), 13(d), 15(a), and 16(a). In addition, the defendants will pay disgorgement in the amount of $983,375 plus prejudgment interest. Mr. Zhou will also pay a civil penalty of $400,000. In a separate administrative proceeding the defendants will be barred from the securities business and from participating in any penny stock offering with a right to apply for reentry after five years. See Lit. Rel. No. 22854 (Cot. 23, 2013).
Market crisis: In the Matter of Harding Advisory LLC, Adm. Proc. File No. 3-15574 (October 18, 2013) is a proceeding against registered investment adviser and collateral manager Harding Advisory LLC and its principal, Wing Chau. In the Spring of 2006 hedge fund manager Magnetar Capital LLC approached Merrill Lynch to arrange a series of CDO transactions. An arrangement was discussed under which Magnetar and Merrill would pick a mutually agreeable collateral manager. That manager would work with the hedge fund manager who would have a significant role in structuring the composition of the portfolio. Magnetar would retain the equity, or lowest class, and Merrill would distribute the debt. Magnetar’s strategy, in part, was to hedge the positions in the CDO’s, meaning its interests were not aligned with the success of the entity. Subsequently, Magetar and Merrill agreed on the selection of Harding as collateral manager for what would be known as Octans 1. Mr Cheu understood Magnetar’s role and interests. Merrill, Harding and Magnetar then entered into the warehouse agreement which would govern the acquisition of the collateral for Octans 1. The agreement gave Megnetar rights over the selection of the collateral. Harding also executed a Collateral Management Agreement which moralized its obligation of care. Neither the offering circular nor the pitchbook mentioned Magnetar or its role and interests. The Order alleges violations of Securities Act Section 17(a) and Advisers Act Sections 206(1) and 206(2). The proceeding will be set for hearing.
False representations: SEC v. Yuhe International, Inc., Civil Action No. 1:13-CV-1598 (D.C. Filed Oct. 18, 20130 is an action against the company, a PRC based seller of chickens, formed from a reverse merger, and its CEO, Gao Zhentao. The complaint details a fraudulent scheme by Mr. Zhentao implemented through a series of false statements. It began with a claimed acquisition in 2009 by the company of 13 chicken breeder farms from Weifang Dajiang Corporation for about $15.2 million, $12.1 of which was paid immediately. Although the transaction was detailed in filings made with the Commission and the company later made a public offering in the U.S., Yuhe was eventually forced to admit the transaction never occurred. The CEO diverted the money paid to an account he controlled. Although the auditors and the audit committee resigned over the matter, defendant Zhentao remains in control of the company. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a). The case is in litigation. See Lit. Rel. No. 22848 (Oct. 18, 2013).
In the Matter of Stryker Corporation, Adm. Proc. File No. 3-15587 (Oct. 24, 3013) is a proceeding against the Michigan based manufacturer and distributor of medical devices and products. The Order alleges that beginning in 2003, and continuing over the next five years, the company, through its subsidiaries, made about $2.2 million in unlawful payments to various government officials in Mexico, Poland, Romania, Argentina and Greece. In each instance the payments were made by the subsidiary although in Greece there were communications regarding them with the country manager of Stryker Greece. The payments were made in Mexico to officials responsible for providing social security for government employees; in Romania to officials to obtain or retain business with affiliated public hospitals; in Argentina for commission payments, or honoraria to physicians employed in the public healthcare system; and in Greece to a public university to fund a laboratory that was then being established by a foreign officials who served as a prominent professor and was the director of medical clinics at two public hospitals affiliated with the University. The Order alleges violations of Exchange Act Section 13(b)(2)(A) and 13(b)(2)(B). The firm’s remedial efforts “demonstrated a commitment to designing and funding a meaningful compliance program . . .” according to the Order. To resolve the action the company consented to the entry of a cease and desist order based on the Sections cited in the complaint. It also agreed to pay disgorgement $7,502,635 in disgorgement, prejudgment interest and a penalty of $3.5 million.
U.S. v. Diebold, Inc., Case No. 5:13CR464 (N.D. Ohio Filed Oct. 22, 2013); SEC v. Diebold, Inc., Civil Action No. 1:13-cv-01609 (D.D.C. Filed Oct. 22, 2013).
Diebold, Inc. resolved FCPA charges with the DOJ and the SEC. With the DOJ, the firm agreed to pay a $25.2 million penalty and entered into a three year deferred prosecution agreement to resolve possible criminal charges. With the SEC, Diebold consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B) and agreed to pay disgorgement and prejudgment interest totaling $22,972,942. Although the company self-reported and cooperated, a monitor was installed under the deferred prosecution agreement and SEC settlement for at least 18 months. The actions center on payments made through the subsidiaries of the company in China, Indonesia and Russia from 2005 through 2010. In China, for example, there were payments for travel, entertainment and gifts to foreign officials through its subsidiary, Diebold China. In addition, the subsidiary provided bank officials with cash gifts ranging from less than $100 to over $600. Similar travel and entertainment expenses were paid for state officials by the other two subsidiaries. While there is no claim that the parent company knew about the payments in Indonesia, in China a local regulatory proceeding brought the matter to the attention of the parent as did the discovery of payments by distributors in Russia. Nevertheless the practices continued.
The SEC’s complaint asserts three counts, one based on the bribery provisions, a second on the books and records sections and a third based on internal controls.
The criminal information alleges one count of conspiracy and one count of books and records violations. The three year deferred prosecution agreement acknowledges that the company self-reported and cooperated as reflected in the calculation of the criminal fine. A monitor was imposed in view of the inadequate remediation and the prior history of the company which included an SEC enforcement action based on accounting fraud claims.
Appointment: The Board announced the appointment of Marc B. Dorfman as Chief Hearing Officer. In that role Mr. Dorfman will be responsible for adjudicating disciplinary proceedings instituted by the Board against registered public accounting firms and associated persons and certain other proceedings. Mr. Dorfman has had a distinguished career, first as a member of the SEC’s Enforcement Division and most recently as a partner at Foley & Lardner LLP.
Disciplinary order: In the Matter of Deloitte & Touche LLP, PCAOB Release No. 105-2013-008 (Oct. 22, 2013) is a proceeding against the accounting firm. It is based on the fact that prior to the entry of an order of suspension, the firm made a partner a salaried Director and transferred that person to the firm’s National Office. After the suspension by the Board the individual continued to work as an associated person. The Board concluded that this violated the suspension order. To resolve the matter the firm agreed to pay a $2 million fine which equals the largest ever imposed by the Board. The firm was also ordered to implement certain remedial measures. See also In the Matter of Christopher E. Anderson, PCAOB Release No. 105-2008-003 (Oct. 31, 2008)(proceeding against firm partner in which the suspension order was entered).
Crowdfunding: The Financial Conduct Authority issued a consultation paper discussing its regulatory approach to crowdfunding (here).
Suitability/risks: The Financial Conduct Authority banned two financial advisers, Mark Bentley-Leek and Mustafa Dervish, and imposed fines of, respectively £525,000 and £360,000 based on the recommendations they made to clients over a period of six years beginning in 2004 regarding land investments to clients. Specifically, investors were not told the risks, were told that there were significant rates of return which was false, were not informed that the two men were affiliated with the ventures and were not informed about the deteriorating financial condition of the ventures. Both men had been directors at Bentley-Leek Financial Management.
The Securities and Futures Commission announced that Gordon Mui Kwong Yin pleaded guilty to furnishing advise online on trading in futures contracts without a license. Mr. Mui ran a website that charged a subscription fee of $300 per “signal” or $900 for four “signals” and claimed that following the advice would provide investors with profits of 500 to 800 index points in the investment of futures contracts each time. Mr. Mui operated under the name of Brandon Chan a/k/a Futures King.
For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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