SEC Chair Mary Jo White indicated in comments this week that the agency plans to make greater use of Exchange Section 20(b) in the future. That section generally provides for imposing liability on those who cause another to violate the federal securities laws. Apparently the section, which is frequently cited in private damage actions, will be used in situations where a person participated in spreading misleading or false information but did not “make” the statement as specified in the Supreme Court’s decision in Janus Capital Group v. First Derivative Traders, 131 S.Ct. 2296 (2011) [an enhanced version of this opinion is available to lexis.com subscribers].
This week the Commission filed five more microcap market manipulation actions, centered on a cooperating FBI informant, as part of its initiative in that area. The Commission also concluded a small Ponzi scheme case in which the court entered final judgments against the promoter and his firm after the promoter admitted all the material facts in the complaint.
The agency also brought proceedings focused on short selling in violation of Rule 105 and Regulation SHO. Actions were also initiated involving auditors, one alleging what is essentially and audit failure and another involving an independence claim. An investment fund fraud case and two insider trading actions were also filed by the Commission.
Remarks: Chair Mary Jo White addressed the Financial Accounting Foundation Trustees Dinner, Washington, D.C. (May 20, 2014). Her remarks included comments on the work of the FASB, the international convergence projects, enforcement relating to accounting, rulemaking in areas such as money market funds and the JOBS Act and the on-going disclosure review (here).
Remarks: Chair Mary Jo White addressed the New York City Bar Association’s Third Annual White Collar Crime Institute, with remarks titled Three Key Pressure Points in the Current Enforcement Environment, New York, New York (May 19, 214). Her remarks focused on enforcement where other regulators are involved, what defendants are being charged and determining the appropriate resolution of proceedings (here).
Remarks: Commissioner Kara M. Stein delivered the Keynote address at Compliance Week 2014, Washington, D.C. (May 19, 2014). Her remarks discussed the role of compliance, gatekeepers and the use of attestations (here).
Remarks: Commissioner Michael S. Piwowar addressed the First Annual Conference on the Regulation of Financial Markets, Washington, D.C. (May 16, 2014). His remarks focused on the increasing role of economists at the agency (here).
Remarks Andrew Ceresney, Director Division of Enforcement, delivered the Keynote Address at Compliance Week 2014, Washington, D.C. (May 20, 2014). His remarks covered a number of topics including the work of the specialty units and task forces, the new approach to settlements, trial results and compliance and compliance officers (here).
SEC Enforcement – Filed and Settled Actions
Statistics: This week the Commission filed, or announced the filing of, 9 civil injunctive actions, DPAs, NPAs or reports and 8 administrative proceedings (excluding follow-on and Section 12(j) proceedings).
Microcap fraud: The Commission filed five new actions as part of a microcap initiative in which it has now charged 48 individuals and 25 companies. Parallel criminal charges have been brought against a number of the individuals involved in these cases. See Lit. Rel. No. 23000 (May 22, 2014). The actions filed this week, each of which centers on the manipulation of securities of one or more microcap issuers, are:
Insider trading: SEC v. Cohen, Civil Action No. 14-Civ-3655 (S.D.N.Y. Filed May 22, 2014) is an action against Glenn Cohen, a director of NBTY, Inc., and his three brothers, Craig Cohen, Marc Cohen and Steve Cohen, and girlfriend Laurie Topal. On about May 21, 2010 Glenn Cohen learned at an NBTY board meeting that management was negotiating with The Carlyle Group regarding the sale of the firm. Within three trading days of that time the other four defendants purchased shares of NBTY. Following the deal announcement on July 15, 2010 the group had profits of about $175,000. The complaint alleges violations of Exchange Act Section 10(b). Each of the defendants settled with the Commission, agreeing to the following sanctions: Glenn Cohen: a penalty of $153,613.25 and a an officer/director bar; Craig Cohen: disgorgement of $71,932, prejudgment interest and a penalty of $71,932; Marc Cohen: disgorgement of $21,454, prejudgment interest and a penalty of $21,454; Steven Cohen: disgorgement of $60,226, prejudgment interest and a penalty of $60,226; and Laurie Topal: disgorgement of $21,780, prejudgment interest and a penalty of $21,780. See also Lit. Rel. No. 22999 (May 22, 2014).
Investment fund fraud: SEC v. Heinz, Civil Action No. 2:13-cv-00753 (D. Utah Filed Aug. 8, 2013) is a previously filed action against Steven B. Heinz and S.B. Heinz & Associates, Inc. The complaint alleges that in 2012 the defendants raised about $4 million from 15 investors for an investment fund that in reality was a Ponzi scheme. Substantial portions of the investor funds were diverted to Mr. Heinz. This week each defendant settled with the Commission. Mr. Heinz admitted all the material facts in the Commission’s complaint. The Court entered permanent injunctions prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The judgment also requires the defendants to, jointly and severally, pay disgorgement and prejudgment interest totaling $3,656,675.84. In addition, Mr. Heinz consented to the entry of an order barring him from the securities business in a related administrative proceeding. See Lit. Rel. No. 22998 (May 22, 2014).
Rule 105: In the Matter of G-2 Trading, LLC, Adm. Proc. File No. 3-15495 (May 22, 2014) is a proceeding against the registered broker-dealer alleging violations of Rule 105. Specifically, the Order alleges that in two instances between February 2010 and August 2012, the firm offered shares from an underwriter or broker or dealer participating in a follow-on public offering after having sold the same security short during the restricted period. As a result the firm had profits of $841. The firm resolved the matter, consenting to the entry of a cease and desist order based on Rule 105 of Regulation M. It also agreed to disgorge the trading profits, pay prejudgment interest and a penalty of $75,000.
Rule 105: In the Matter of Genesis Advisory Services Corp., Adm. Proc. File No. 3-15881 (May 21, 2014) is a proceeding against Genesis, an investment adviser, ABJ Sciete Anonyme Corp., an unregistered investment adviser, and Bruce Fixelle, the principal of each entity. From June 28 through November 2012 on 35 occasions Mr. Fixelle, through trading accounts of Genesis, ABJ and Ironbird Capital (see related action below), an entity he had trading authority over, violated Rule 105 of Regulation M by purchasing shares in a follow-on offering after having sold shares of the same security short during the restricted period. This resulted in profits or losses avoided of $1,230,985.16 of which $951,060.13 is attributed to the Respondents. To resolve the matter each Respondent consented to the entry of a cease and desist order based on the provision cited in the Order as well as a censure. Respondents also agreed to pay disgorgement of $951,060.13, prejudgment interest and a penalty of $492,394. See also In the Matter of Ironbird Capital LLC, Adm. Proc. File No. 3-15880 (May 21, 2014)(Rule 105 proceeding against firm whose account was traded by Mr. Fixelle, imposing cease and desist order by consent and ordering the payment of $279,925.03 in disgorgement along with prejudgment interest).
Investment fund fraud: SEC v. Penna (M.D. Fla. Filed May 21, 2014) is an action against Gaeton S. Della Penna and Gaeton Capital Advisors, LLC. Beginning in 2008, and continuing through 2013, the defendants are alleged to have raised about $3.8 million from investors who were induced to purchase notes in three programs. The proceeds were to be used for investments. At various points investors were promised specific returns and a portion of the profits. In fact the investments were unsuccessful. At the same time Mr. Penna siphoned off substantial portions of the money raised for his personal use. To conceal these facts he began operating the programs as a Ponzi type scheme. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The case is in litigation. The U.S. Attorney filed a parallel criminal action.
Audit failure: In the Matter of Bryce Walker CA., Adm. Proc. File No. 3-15877 (May 20, 2014) is a proceeding which names as Respondents Bryce Walker, a Canadian Chartered Accountant, and Spence Walker, also a Chartered Accountant and a CPA. Both are partners at DNTW Chartered Accountants, LLP. The proceeding centers on the audits of Subaye, Inc. a company that claimed to have operations in the PRC. From 2007 through 2010 DNTW and the Respondents served as the independent auditors of Subaye. During that period they failed to properly conduct the audits by not: supervising assistants; obtaining sufficient competent evidential matter; and acting with due professional care. If the audits had been properly conducted they might have discovered the fact that Subaye was a fraudulent company without credible books and records. The Order alleges violations of Exchange Act Section 13(a) and Regulation S-X Rule 2-02(b)(1). The Respondents resolved the matter. Each agreed to cooperate with the Commission. Each consented to the entry of a cease and desist order based on the Section and Rule cited in the Order. Each is denied the privilege of practicing and appearing before the Commission as an accountant. Bryce Walker can apply for reinstatement after three years, while Spence Walker can apply after one year. Respondents will also, jointly and severally, pay disgorgement of $128,000 along with prejudgment interest.
Auditor independence: In the Matter of James T. Adams, CPA, Adm. Proc. File No. 3-15876 (May 20, 2014) is a proceeding which names as a Respondent the now retired D&T partner. For approximately one year, beginning in mid-January 2009, Mr. Adams served as an advisory partner on D&T audit engagements for a Casino Gaming Issuer. In that role he served primarily as a liaison between D&T and the issuer’s management and audit committee. Prior to assuming that role he worked on the firm’s audit of the issuer’s financial statements for the fiscal years ended December 31, 2008 and 2009. While serving as the advisory partner, Mr. Adams sought and received casino markers from a gaming establishment operated by the issuer. In 2009 he executed markers and drew sums which exceeded $100,000. The markers remained outstanding for varying periods of time. In 2010 he defaulted on $110,000 of outstanding markers which had been drawn down in mid-December 2009. Mr. Adams concealed his casino markers from D&T and lied to a partner who inquired generally about markers. At the time he retired the firm was not aware of the markers and borrowings. In March 2010 Casino Gaming Issuer filed its annual report on Form 10-K with the Commission. It contained an audit report from D&T which stated, in part, that the audit of the financial statements had been conducted in accord with the standards of the PCAOB. The audit opinion was incorrect. An accountant is not independent under Rule 2-01(b) of Regulation S-X if, under all the facts and circumstances, he is not capable of exercising objective and impartial judgment on all issues in the engagement. Rule 2-01(c) of Regulation S-X, which lists a series of circumstances that are inconsistent with independence, specifies that one such circumstance is a loan from an audit client. As a result of his conduct Mr. Adams caused D&T to violate Rule 2-02(b)(1) of Regulation S-X. His conduct also caused Casino Gaming Issuer to violate Exchange Act Section 13(a). In view of his conduct, Mr. Adams engaged in improper professional conduct within the meaning of Exchange Act Section 4C(A)(2) and Rule 102(e)(1)(ii) of the Rules of Practice, according to the Order. Mr. Adams resolved the proceeding, consenting to the entry of a cease and desist order based on Rule 2-02(b)(1) of Regulation S-X and Exchange Act Section 13(a). He has been denied the privilege of appearing and practicing before the Commission as an accountant with a right to request reinstatement after two years.
Insider trading: SEC v. Lama, Case No. 5:14-cv-00996 (C.D. Cal. Filed May 19, 2014); SEC v. Chu, Case No. 5:14-cv-00995 (C.D. Cal. Filed May 19, 2014). Defendants Daniel J. Lama and Franklin M. Chu are medical doctors doing business under the name San Bernardino Urological Associates Medical Group Inc. or SBUA. In early 2011 GTx Inc., a biopharmaceutical company, entered into a series of Clinical Trial Agreements with SBUA for the Phase II clinical trials of a prostate cancer drug. Dr. Chu was the lead investor on the trials. Dr. Lama served as an investigator. Under the agreements GTx paid SBUA for each patient it enrolled in the study. On February 17, 2012 executives at GTx spoke with the FDA and learned that the trials would be put on hold. Firm executives notified those involved, including Dr. Chu and, through SBUA, Dr. Lama’s wife who informed him. Both sold their shares in GTx. On February 21, 2012 GTx issued a press release prior to the opening of the market, announcing that the FDA had placed a hold on clinical trials for the prostrate drug. GTx shares closed down over 36%. As a result Dr. Lama avoided possible trading losses of $11,502 while Dr. Chu avoided losses of about $34,081. When contacted by the Commission staff investigating the matter Dr. Lama initially provided false information, claiming he had no knowledge of the FDA hold at the time he sold the shares. The complaint against each Doctor alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Each defendant settled the charges with the SEC. Each Doctor consented to the entry of a permanent injunction based on the Sections cited in each complaint. In addition, Dr. Chu agreed to pay disgorgement of $34,081, prejudgment interest and a penalty equal to the amount of the disgorgement. Dr. Lama agreed to pay disgorgement of $11,502, prejudgment interest and a penalty of $34,506 which is three times the amount of his illicit trading profits.
Reg. SHO: In the Matter of Thomas R. Delaney II, Adm. Proc. File No. 3-15873 (May 19, 2014) is a proceeding which names as Respondents Mr. Delaney, the Chief Compliance Officer at clearing firm Penson Financials Services, Inc., and Charles W. Yancey, the president and CEO of the clearing firm. The Order centers on claimed repeated violations of Regulation SHO from 2008 through 2011. Generally, participants of a registered clearing agency are required to deliver equity securities to a registered clearing agency when delivery is due – the settlement date. Generally that is three days or T+3 after the transaction. For short sales, if delivery is not made and there is a failure-to-deliver at the clearing agency the firm must take affirmative action to close-out the failure-to deliver position by acquiring securities of a like kind and quantity by no later than T+4. For long sales that time is T+6. The Depository Trust and Clearing Corporation, which operates the National Securities Clearing Corporation, furnishes member clearing firms with reports that as of at least close of business T+1 notify them of transactions scheduled to clear and settle and of net fails to deliver. Here when Penson’s customers caused a failure to deliver, the firm purchased or borrowed shares to fulfill its close-out obligations and passed the costs on to the customer. When, however, the failure was caused by the firm – such as when the shares had been loaned out — Penson did not comply with its close out obligations. Mr. Delaney in fact aided and abetted and caused the violations because of the financial considerations and took steps to conceal the failures. Mr. Yancey was the direct supervisor of Mr. Delaney and failed to supervise him with a view to avoiding the violations. The proceeding will be set for hearing. See also In the Matter of Michael H. Johnson, Adm. Proc. File No. 3-15874 (May 19, 2014)(settled proceeding based on same core facts naming Mr. Johnson, a senior vice president of Penson in the securities lending department as a Respondent. He resolved charges that he and his subordinates implemented procedures they knew, or were reckless in not knowing, did not comply with Regulation SHO. He consented to the entry of a cease and desist order based on Rule 204, Regulation SHO, is barred from the securities business with a right to re-apply after five years and was ordered to pay a penalty of $125,000); In the Matter of Lindsey Alan Wetzig, Adm. Proc. File No. 3-15875 (May 19, 2014)(Mr. Wetrzig was a manager in Global Equity Finance at the firm and is alleged to have known or should have known that the procedures in securities lending did not comply with Regulation SHO. He resolved the matter, undertaking to cooperate with the Commission, and consenting to the entry of a cease and desist order based on Rule 204(a) of Regulation SHO and a censure).
U.S. v. Esquenazi, No. 11-15331 (11th Cir. Opinion filed May 16, 2014) is the first circuit court case which defined the term “instrumentality,” part of the definition of the term “foreign official.” [enhanced version] Joel Esquenazi and Carlos Rodriguez, the co-owners of Terra Telecommunications, were indicted and convicted after a jury trial of conspiracy, violating the FCPA and money laundering based on paying bribes to officials at Telecommunications D’Haiti, S.A.M. (Telco).
At trial expert testimony established that Telco was formed in 1968. The Haitian government gave the company a monopoly on telecommunication services and significant tax advantages. Initially, the government appointed two members of the board and its Director General, the senior position at the company, was designated by executive order. Subsequently, 98% of its ownership passed to the National Bank of Haiti which split into two entities. The Banque de la Republique d’ Haiti or BHR, roughly the functional analogue of the U.S. Federal Reserve, retained ownership of Telco. While there was no law stating that Telco was a public entity, the “government, officials, everyone consider[ed] Teleco as a public administration.” When the anti-corruption law was passed in 2008 Telco was cited as a public administration. The jury’s verdict was based on instructions that contained a multi-part test developed by district court’s for determining if firms such as Telco are an instrumentality.
In analyzing the issue, the Eleventh Circuit crafted a definition by considering first standard definitions of the word and second other provisions in the Act as well as commentary to the OECD Convention to which the U.S is a signatory. Drawing from these sources the Court defined the term instrumentality “as an entity controlled by the government of a foreign country that performs a function the controlling government treats as its own . . . what constitutes control and what constitutes a function the government treats as its own are fact-bound questions . . . To decide if the government ‘controls’ an entity, courts and juries should look to the foreign government’s formal designation of that entity; whether the government has a majority interest in the entity; the extent to which the entity’s profits, if any, go directly into the governmental fisc, and, by the same token, the extent to which the government funds the entity if it fails to break even; and the length of time these indicia have existed.” These factors were informed by the OECD Convention commentary.
Similarly, to determine if an entity performs a function the government treats as its own, a number of factors should be considered including “whether the entity has a monopoly over the function it exists to carry out; whether the government subsidizes the costs associated with the entity providing services; whether the entity provides services to the public at large in the foreign country; and whether the public and the government of that foreign country generally perceive the entity to be performing a governmental function.” These factors are also drawn from the OECD Convention commentary.
In this case the list of factors identified by the District Court in its jury instruction is similar but not identical to those identified here. Since the instructions cover the substance of the definition crafted here the convictions were affirmed.
Market timing: SEC v. O’Meally, No. 13-213 (2nd Cir. Decided May 19, 2014) is an action against Frederick O’Meally, a broker employed at Prudential Securities from 1994 to 2003. For many of his clients he traded shares in mutual funds using market timing, a form of arbitrage. While the technique is not illegal, many funds prohibited it. A number of funds served “block notices” on Mr. O’Meally. Nevertheless he persisted, using new financial advisor or FA numbers and account numbers. From January 2001 through September 2003 he earned about $3.8 million from market timing for his clients.
The SEC filed an enforcement action alleging violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The complaint claimed that Mr. O’Meally failed to follow directives issued by the funds and his employer. Before the jury the SEC focused on scienter and reckless conduct. Mr. O’Meally introduced evidence demonstrating that the policies established by the funds were “anything but clear due to their inconsistent application,” that his employer read the block notices narrowly and encouraged his trading and that there were legitimate reasons for having multiple FA numbers. The jury returned a verdict finding that Mr. O’Mealy did not violate Exchange Act Section 10(b) or Securities Act Section 17(a)(1) but that he did violate Securities Act Sections 17(a)(2) and (3) as to six of the sixty mutual funds claimed by the SEC. Mr. O’Meally was ordered to pay a penalty of $60,000, disgorgement of $444,836 in fees and prejudgment interest. The District Court denied his Rule 50 motion which argued the insufficiency of the evidence.
On appeal Mr. O’Meally challenged the denial of his Rule 50 motion. Such a motion can only be granted “’if there exists such a complete absence of evidence supporting the verdict that the jury’s findings could only have been the result of sheer surmise and conjecture, or the evidence in favor of the movant is so overwhelming that reasonable and fair minded [persons] could not arrive at a verdict against [it].’” Here, this is the case. At trial the SEC focused on intentional, scienter based conduct. As such it offered the jury no evidence as to the standard under which Mr. ‘Meally could be found negligent under the circumstances here – he was faced with conflicting rules from the funds. Likewise, it offered no evidence to counter the fact that Prudential permitted and encouraged his trading. As such there is a complete failure of evidence as to the SEC’s negligent claims, resulting from its tactical choice at trial to focus on intentional conduct. Accordingly, the verdict is reversed and the case remanded with instructions to dismiss the complaint.
For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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