SEC Enforcement

Securities Fraud Roundup: FINRA Examiners See Rise in Brokers Engaging in Improper Activities, SEC Chairman Backs Stronger Enforcement of Civil Penalties Act, & About 800 Investor Fraud Scam Defendants Accounted for Since 2011

Published on: November 26, 2012 | by Shepherd Smith Edwards & Kantas, LLP

According to Financial Industry Regulatory Authority EVP Susan Axelrod, the SRO’s examiners are reporting an increase in how many brokers appear to be taking part in questionable actions outside their firms or improperly selling securities. Speaking at the Securities Industry and Financial Markets Association’s complex products forum, she pressed brokerage firms to make sure its compliance programs will sniff out such violations.

Axelrod also said that FINRA examiners are noticing issues with the firms’ complex product sales, including those involving reverse convertibles and non-traded real estate investment trusts. For example, several firms did not conduct reasonable due diligence before selling non-traded REITs or make sure they were suitable for the investors. As for the reverse convertibles, examiners reportedly discovered an overconcentration of products in certain investor portfolios primarily due to poor recommendations. Failure to detect such problems appeared to have played a factor in this happening. Other problems discovered included inadequate training regarding products, product misrepresentation via sales and advertising, and failure to notify investors well in advance that products’ per-share estimated values had been repriced at figures significantly lower than the offering price.

In other securities news, Securities and Exchange Commission Chairman Mary Schapiro wants Congress to grant the SEC the power to impose penalties that are more reflective of the losses sustained by investors. Right now, the agency can only pursue ill-gotten gains’ disgorgement and impose per-violation penalties. Schapiro said that the Stronger Enforcement of Civil Penalties Act of 2012, which was introduced by Senators Jack Reed and Charles Grassley, would give the Commission the authority it needs to make violators “think twice” about abusing investors’ funds while allowing the regulator to recover significantly more for victims. She expressed her views at the New England Securities Conference last month.

SEC Clawback Lawsuit Against Two Former Arthrocare Corp. Executives Over Fraud Scheme Can Proceed, Says District Court in Texas

Published on: November 24, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The U.S. District Court for the Western District of Texas says that the Securities and Exchange Commission’s clawback lawsuit against two Arthrocare Corp. (ARTC) executives who received bonuses and compensation following accounting irregularities made by two other company officials can move forward. The defendants, ex-CEO Michael A. Baker and ex-CFO Michael Gluck, have not been charged with misconduct, and the district court said they do not need to have done anything wrong to be sued under the Sarbanes-Oxley Act’s Section 304.

This Texas securities case is one of many resulting from an alleged revenue recognition scam at the medical device manufacturer that was executed by two of its senior executives. (Arthrocare has since restated its financials for 2006 through 2008’s first quarter.) The SEC had argued that even though Baker and Gluck weren’t the charged with wrongdoing, under SOX’s Section 304, they must pay ArthroCare back their stock profits and bonuses that they received during the period of the accounting fraud.

The two men had filed a dismissal motion contending that the statute cannot be interpreted to make CFOs and CEOs with no scienter elements liable. They also claimed that statute’s vagueness not only makes it void but also it has other constitutional deficiencies. Now, however, the district court has denied their motion, finding that no separate misconduct or scienter by the defendants was necessary.

The court said that without ambiguity, the statute’s words “are dispositive” and Section 304 is unambiguous in mandating that CFOs and CEOs pay back the issuer for compensation that qualifies within a year of a filing that the issuer must restate because of misconduct by it or its agents. The district court also rejected the constitutional challenges made by the defendants and disagreed that the statute is constitutionally vague because it doesn’t clarify whose misconduct compels reimbursement. Referring to the statutory language, the court said that the ‘misconduct’ at issue in this case is misconduct by the issuer, and, since issuers include business entities and corporations, their agents, acting within the scope and course of their jobs, are also included within the definition of issuer.

The district court also disagreed with the two men’s contention that Section 304 is unconstitutionally vague. It said that the requirements for CFOs and CEOs are “crystal clear” when read along with the rest of SOX. It also noted that Section 302 tells executives exactly what they have to do to avoid reimbursement liability under Section 304, which is to ensure that the issuer submits financial statements that are accurate.

SEC v. Baker (PDF)

Sarbanes-Oxley Act of 2002

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Securities Roundup: BP Settles for $525M SEC Lawsuit Over Deepwater Horizon Spill Disclosures, Ex-OIG Official Says He Was Fired for Exposing Misconduct, Ex-Merrill Lynch Advisor Accused of Defrauding Elderly Client, & Trader Pleads Guilty to $28M Fraud

Published on: November 22, 2012 | by Shepherd Smith Edwards & Kantas, LLP

BP Plc. has consented to settle for $525 million Securities and Exchange Commission allegations that it gave the agency and investors misleading information about the 2010 Deepwater Horizon oil spill. If approved, this would be the third biggest penalty in SEC history.

According to the Commission, during the crisis the oil giant issued fraudulent statements about how much oil was flowing on a daily basis from the Deepwater Horizon rig into the Gulf of Mexico, including underestimating this rate by up to 5,000 oil barrels a day even though it allegedly had internal data noting that possible flow rates could be up to 146,000 barrels daily. Even after a government task force later determined that 52,700 to 62,200 oil barrels were flowing out a day, BP allegedly never modified the omissions or misrepresentations it made in SEC filings.

In other SEC news, David Weber, one of its ex-Office of Inspector General officials, is suing the agency and Chairman Mary Schapiro for allegedly getting back at him for disclosing misconduct that had been taking place at the Commission. Weber contends that SEC staff spoke about him to the media in a “malicious and defamatory” manner and leaked his personal information because he not only disclosed that ex-SEC Inspector General H. David Kotz had engaged in misconduct that placed several OIG investigations at peril, but also he revealed that there were cyber security breaches at the agency.

SEC Roundup: $62M Securities Fraud Award Against Ex-Lancer Group Hedge Fund Manager Stands, Investment Management Division Adopts Risk-Based Approach to Regulatory Initiatives, & Conflicts of Interest Areas Now Are Priority

Published on: November 10, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The US Supreme Court has decided not to review a ruling by the U.S. Court of Appeals for the Eleventh Circuit affirming a $62M award against Michael Lauer, an ex-Lancer Group Hedge Fund manager, in the securities lawsuit filed against him by the Securities and Exchange Commission. The federal appeals court had said that the district court’s decision granting the Commission’s motion for summary judgment on liability and remedies was proper.

Per the SEC fraud lawsuit, Lauer is accused of misrepresenting the hedge funds’ true value by artificially inflating the value of holdings found in shell companies that were thinly traded. The Commission contends that he hid his scam by making false statements in investor newsletters, private placement memoranda, and phone calls. (Lauer has since been acquitted of related criminal charges.)

In his certiorari petition filed earlier, Lauer argued that federal court couldn’t strike a defendant’s motion to dismiss due to lack of subject matter jurisdiction without evaluating whether it had such jurisdiction. He also claimed that the appeal’s court ruling that the district court’s decision was grounded in enough evidence was not de novo review.

Institutional Investor Securities Blog: Putnam Advisory Accused of Massachusetts Securities Fraud in $3B CDO Offerings, SEC Claims Yorkville Advisors Fixed Books To Attract Investors, and FINRA Seeks Comments on Revised Proposal Over Bond Market Research

Published on: October 29, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The Massachusetts Securities Division is claiming that Putnam Advisory Co. deceived investors about its actual involvement in Pyxis 2006 and Pyxis 2007, two $1.5 billion collateralized debt obligations comprised of midprime and subprime mortgage-backed securities. In its administrative complaint, the state contends that Putnam represented to investors that it would act as an independent advisor when to the Pyxis CDOs when, in fact, Magnetar Capital, a hedge fund, was also involved creating in and structuring key aspects of both and even recommended that certain collateral to be included in them while then proceeding to take a substantial short position on that collateral. Putnam denies the allegations.

The state says that Magnetar proceeded to benefit from the downgrades of subprime assets in the two CDOs while making a net gain of about $67 million on aggressive positions and equity investments linked to the two of them. Meantime, Putnam earned $8.81 million in collateral management fees for the Pyxis CDOs. Massachusetts Secretary of Commonwealth William F. Galvin says that his office will continue to look at how banks misled the buyers of subprime mortgage-backed securitized debt instruments.

In other securities news, the SEC is accusing Yorkville Advisors LLC, its president and founder Mark Angelo, and CFO Edward Schinik of revising certain books to appeal to potential investors and succeeded in getting pension funds and funds of funds to invest $280 million into two Yorkville hedge funds. This allegedly let Yorkville charge at least $10 million in excessive fees. All three three defendants are denying the allegations.

Institutional Investment Fraud Roundup: Ex-Hedge Fund Managers’ Guilty Plea Over Bilking Investors of Almost $1M Get 3-Year Prison Term, SEC Sues Investment Adviser Over Alleged $37M Ponzi, and SEC Files Lawsuit Over Purported “Fund of Funds” Scam

Published on: September 26, 2012 | by Shepherd Smith Edwards & Kantas, LLP

Ex-hedge fund managers Christopher Fardella and Michael Katz have been sentenced to three years in prison after they pleaded securities fraud and conspiracy charges for defrauding investors of nearly $1 million. Per court documents, between April 2005 and November 2006, the two men, along with two co-conspirators, were partners in KMFG International LLC, which is a hedge fund.

They cold called investors throughout the US and provided them with misleading information about the fund, its principals, and financial performance even though KMFG actually lacked a track record and never generated any profit for investors. The defendants and co-conspirators lost and spent $981,000 of the $1,031,086 that was given to them by investors.

Meantime, another hedge fund manager, Oregon-based investment advisor Yusaf Jawad, is being sued by the Securities and Exchange Commission over an alleged $37 million Ponzi scam. The securities lawsuit against him and attorney Robert Custis was filed in the U.S. District Court for the District of Oregon.

Securities Roundup: FINRA Heightens Focus on Options Industry & Wants More Investors to Use BrokerCheck, Lawmaker Hopes SEC is Taking Closer Look at National Exchanges, and US Senator Calls For Reform of Money Market Mutual Fund Industry

Published on: September 24, 2012 | by Shepherd Smith Edwards & Kantas, LLP

At the Security Traders Association’s yearly market conference in DC, Richard Ketchum, Financial Industry Regulatory Authority’s chief executive officer and chairman, said that due to growing problems the SRO is heightening its surveillance and exam focus on the options industry. He noted that there has been an increase in complaints about the use of algorithmic activities to perform possible manipulations to “move underlying equity” and that this could cause a financial firm to “take advantage” of options positions that were pre-established.

Per BNA, Ketchum said that FINRA has set up surveillance alerts to catch too much messaging traffic from algorithms that update quotes at vicious rates when options are involved. It is also looking at firms to make sure they have adequate controls related to algorithms and it will keep checking for options orders that may have possibly inaccurate coding.

The week before, Ketchum reported that the FINRA Board of Governors had given the SRO’s staff the authority to propose to the SEC rule changes to promote greater investors use of BrokerCheck. This free tool allows investors to look up former and current firms and brokers that are registered with the SRO, and representatives and investment advisers, to decide whether the should work with them. (This information would also have to be available on websites that were maintained by/for an individual associated with these firms.) Per amendments that have been proposed to the FINRA Rule 2267, which covers the education and protection of investors, member firms would have to make sure that their company sites provide a direct link to BrokerCheck. Meantime, a change has also been proposed to FINRA Rule 8312 that would give the public permanent access to information available through BrokerCheck about foreign and state cases against associated persons who were let go after a settlement was reached. It would also per the board’s approval, make downloads of BrokerCheck information available.

SEC Charges Advanced Equities with Securities Fraud Related to Private Equity Offerings

Published on: September 20, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission is charging investment advisory firm and broker dealer Advanced Equities Inc. and its cofounders Keith G. Daubenspeck and Dwight O. Badger with securities fraud related to two private equity offerings that were made for a California alternative energy company. Badger, who spearheaded the sales initiatives for the offering and allegedly made misstatements about the company’s finances, is charged with misleading investors. Daubenspeck is accused of not correcting these misstatements, therefore allegedly inadequately supervising Badger. Daubenspeck is the Advanced Equities’ parent company’s ex-chief executive and board chairman. All three parties have agreed to a cease-and-desist order entry but they are not denying or admitting to the charges.

Per the SEC, for the Silicon Valley company’s 2009 offering, Badger led close at least 49 outside investor presentations and a minimum of five in-house sales calls with Advanced Equities brokers related to this between January and March 2009 alone. He claimed that the energy company had over $2 billion in order backlogs when actually this never went above $42 million. He also said that a national grocery chain had placed a $1 billion order even though that was only worth $2 million, and although a letter of intent for making future buys was signed, it was a non-binding one. Badger also is accused of making a misstatement when he said that a US Department of Energy loan of over $250 million had been granted to the company after it had sought a $96.8 million loan. (He also allegedly again made a misstatement about the loan application in 2010 during the follow-up offering.) His misstatements were then repeated to investors during phone calls and in e-mails by brokers, Advanced Equities’ investment banking team, and the broker-in-charge at the firm’s branch in New York. (The SEC believes that these individuals should have known that the statements that Badger made were untrue.)

Meantime, Daubenspeck allegedly did not say anything after he heard Badger issue the misstatements about the grocery store order, order backlog, and loan application even though he took part in at least two of the internal sales calls attended by Advanced Equities brokers during the 2009 offering. The SEC contends that although these misstatements should have been warning signs that there was the danger that the wrong information would get to investors, Daubenspeck allegedly did not take reasonable steps to fix these misstatements and did not properly supervise Badger.

SEC Enforcement Roundup: Commission to Make Closer Examination of Revenue-Sharing Between Brokers and Investment Advisers, NYSE to Pay $5M For Alleged Compliance Issues, and Enforcement Director Khuzami Praises His Division’s Performance

Published on: September 18, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission is ramping up its examination of revenue-sharing arrangements between brokers and investment advisers. It made this announcement in a related administrative order involving advisory firms Focus Point Solutions Inc. and H Group Inc. and their owner Christopher Keil Hicks, who have consented to pay $1.1 million to settle charges that they did not disclose to their clients certain revenue-sharing payments that posed possible conflicts of interests.

Hicks and Focus Point Solutions are accused of not telling clients that in return for specific services, they were getting a portion of the revenues from a brokerage firm that managed mutual funds, which were being recommended to investors. Hicks’ other firm, H Group Inc., allegedly improperly voted on its clients’ behalf to make Focus Point a sub-adviser to one mutual fund (most of that fund’s shareholders were clients of H Group.)

Meantime the New York Stock Exchange has consented to pay $5 million to settle compliance failure charges that allegedly gave some customers an advantage over certain trading information. The Securities and Exchange Commission announced the charges, which are the first of its kind, on September 14. This is also the first financial penalty for an exchange.

According to the Commission, under Regulation NMS, market data cannot be sent to proprietary customers before the same information has been sent out in consolidated feeds, which give quote and trade information to the public. Yet, starting in 2008, the NYSE allegedly violated this regulation over a certain time period when it sent the data through its proprietary feeds first. NYSE also allegedly failed to ensure proper compliance when it did not correctly monitor the proprietary feeds’ speed compared to the speed of the consolidated feeds. According to SEC Enforcement Director Robert Khuzami, even just “milliseconds” of a head start in terms of access to market data “disproportionately disadvantages retail and long-term investors.”

Although the NYSE is settling, it is not denying or admitting to wrongdoing. It and parent NYSE Euronext Inc. (NYX), however, have consented to having an independent party examine their market data delivery systems. On its website NYSE said that the SEC did not accuse it of taking part in any intentional misbehavior or that the data delays had hurt any investors.

Khuzami also recently spoke about the SEC’s other enforcement efforts. At a Practicing Law Institute conference, he said that the Division of Enforcement is doing well. He partially credits its performance to an organizational restructuring that took place in 2010, the agency’s whistleblower program, and stronger investigative work. Khuzami noted that the restructuring generated five specialized units, which has let SEC staff become experts in certain enforcement areas, and, with the help of data-driven analytics, allowed the Commission to look into violations.

Khuzami said that contrary to the idea that his division has not been investigating purported violations that allegedly took place during the 2008 economic crisis, these investigations have been taking place and that 75% of them have gone to litigation. Also, he noted that the SEC has begun a number of initiatives to try to identify additional violations, such as private fund analysis for zombie-funds and looking at whether hedge fund performances are aberrational compared to a certain strategy’s benchmark.

Khuzami also spoke about the SEC whistleblower program that was created under the Dodd-Frank Wall Street Reform and Consumer Protection Act, saying that it has already been “successful.” In just one year, August 2011 – 2012, the program has received about 2,870 tips—about 8 a day—with financial fraud, disclosure, market manipulation, and offering fraud among the most common alleged violations named. Khuzami said most tips in the US have from Texas, Florida, New York, and California. Whistleblower fraud tips have also come from abroad.

In re Focus Point Solutions Inc., SEC, Admin. Proc. File No. 3-15011 (PDF)

NYSE fined after some clients got early look at data, Reuters/Yahoo News, September 14, 2012

Division of Enforcement, SEC

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SEC Study Reports that Many Retail Investors Are Financially Illiterate, Stockbroker Fraud Blog, September 5, 2012

SEC Study Reports that Many Retail Investors Are Financially Illiterate

Published on: September 5, 2012 | by Shepherd Smith Edwards & Kantas, LLP

According to the Study Regarding Financial Literacy Among Investors, which was recently released by the SEC, many US retail investors are confused or don’t know much about making informed financial choices and can be considered financially illiterate. The study, which was created to fulfill the Dodd Frank Act’s section 917, is a representation of information distilled by SEC staff from retail investors, focus groups, public comments, quantitative research, and FLEC, which is comprised of 22 federal entities and was set up under the Fair and Accurate Credit Transactions Act of 2003’s Title V to better financial literacy in this country. The Commission also looked to the Library of Congress to review other studies on this subject.

Reportedly, regardless of whether the information came from, the general findings were the same: that many investors lacked an understanding of the most basic financial ideas, including the difference between bonds and stocks, did not know a lot about investment costs or their effect on investment returns, and were challenged when it came to knowing much about liquidity or credit risks. Women, elderly seniors, African-Americans, Hispanics, and the uneducated seemed to generally have less knowledge about investment than did members of the general population.

Also, many investors appeared to have a difficult time reading their portfolio account descriptions and trade confirmations. Many of them appeared confused about fees. One focus group participant even zeroed in on how, when given too much information, the “more that is disclosed” the less likely investors were to pay attention.

Also, per the study:
• Investors would rather get investment disclosures first before buying an investment service or product or getting involved with a financial intermediary.

• Investors do factor disciplinary history, fees, strategy for investments, and conflicts of interest when considering financial intermediaries.

• They prefer summaries with key data about their investments in investment product disclosures. They like disclosures that are concise, clear, easy to understand, and employ tables, bullet points, graphs, or charts.

• They also like “layered” disclosure, where they are given key information and can then access more details online or via e-mail or mail.

You can find out about other study findings by clicking on the link below.

From assessing commenter feedback, SEC staff have now identified which private and public investor educations efforts are the most useful to the audience they are targeting. Also, OIEA and other FLEC participants intend to work together to develop programs that zero in on specific groups, such as military members, young investors, investment trustees, lump sum payout recipients, and underserved populations. They will create programs that emphasize how key it is to perform investment professional background checks, market Investor.gov as the main federal government resource for information about investing, and make sure people become aware of the costs and fees associated with investing.

Securities Fraud
When an investor comes to a financial professional without a lot of investment knowledge of experience, it is the representative’s responsibility to make sure that the client knows about and understands the risks and costs involved before they invest and doesn’t get into anything that would be unsuitable or risky for their goals or finances. Unfortunately, there are brokers and investment advisers that take advantage of investor and their lack of knowledge in order to make a profit. When securities fraud happens it is the investor that suffers.

Study Regarding Financial Literacy Among Investors (PDF)

SEC Says Retail Investors Are Clueless About Stocks, Minyanville’s Wall Street, August 31, 2012

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Institutional Investor Securities Roundup: FHFA Can Start Discovery in MBS Litigation Against Banks, SEC Sues Puerto Rico Man Over Alleged $7M Scam, and Assets of Two Colorado Men are Temporarily Frozen Over Alleged Promissory Note Ponzi Scheme, Institutional Investor Securities Blog, August 31, 2012 Continue Reading ›