Securities and Exchange Commission

SEC Practice of Settling Enforcement Actions Without Requiring Defendants to Deny or Admit to Allegations Gets Support from Federal Judges and Democrats

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

At a House Financial Services Committee hearing on May 17, a number of Democratic lawmakers spoke out against the Securities and Exchange Commission’s practice of settling securities enforcement actions without making defendants deny or admit to the allegations. There is concern that companies might see this solution as a mere business expense.

The hearing was spurred by U.S. District Court for the Southern District of New York Judge Jed Rakoff’s rejection of the SEC’s $285 million securities settlement with Citigroup (C) over its alleged misrepresentation of its role in a collateralized debt obligation that it marketed and structured in 2007. Citigroup had agreed to settle without denying or admitting to the allegations.

Rakoff, however, refused to approve the deal. In addition to calling for more facts before the court could accurately judge whether or not to approve the agreement, he spoke out against the SEC’s policy of letting defendants off the hook in terms of not having to deny or admit to allegations when settling. The U.S. Court of Appeals for the Second Circuit later went on to stay Rakoff’s ruling that SEC v. Citigroup Global Markets, Inc. go to trial.

The 11th Circuit Revives SEC Fraud Lawsuit Against Morgan Keegan Over Auction-Rate Securities

Published on: May 8, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The 11th U.S. Circuit Court of Appeals has revived the US Securities and Exchange Commission’s fraud lawsuit against Morgan Keegan & Co. accusing the financial firm of allegedly misleading investors about auction-rate securities. The federal appeals court said that a district judge was in error when he found that alleged misrepresentations made by the financial firm’s brokers were immaterial. The case will now go back to district court. Morgan Keegan is a Raymond James Financial Inc. (RJF) unit.

The SEC had sued Morgan Keegan in 2009. In its complaint, the Commission accused the financial firm of leaving investors with $2.2M of illiquid ARS. The agency said that Morgan Keegan failed to tell clients about the risks involved and that it instead promoted the securities as having “zero risk” or being “fully liquid” or “just like a money market.” The SEC demanded that Morgan Keegan buy back the debt sold to these clients.

In 2011, U.S. District Judge William Duffey ruled on the securities fraud lawsuit and found that Morgan Keegan did adequately disclose the risks involved. He said that even if some brokers did make misrepresentations, the SEC had failed to present any evidence demonstrating that the financial firm had put into place a policy encouraging its brokers-dealers to mislead investors about ARS liquidity. Duffey pointed to Morgan Keegan’s Web site, which disclosed the ARS risks. He said this demonstrated that there was no institutional intent to fool investors. He also noted that a “failure to predict the market” did not constitute securities fraud and that the Commission would need to show examples of alleged broker misconduct before Morgan Keegan could be held liable.

SEC Changes to Enforcement Have Led to Enhanced Results, Says Khuzami

Published on: May 4, 2012 | by Shepherd Smith Edwards & Kantas, LLP

According to Securities and Exchange Commission Enforcement Director Robert S. Khuzami, the restructuring that has recently taken place at that agency’s division is allowing the SEC to not just improve the quality of its efforts but also its results. He spoke at a Practicing Law Institute conference earlier this month.

Not only has the enforcement division set up several specialized units that are each assigned a specific area of enforcement to focus on, but also market specialists from the private sector have been hired. Khuzami also said that the SEC has improved its handling of complex securities cases and is now detecting signs of alleged wrongdoing sooner.

In the last fiscal year, the Commission has opened 735 enforcement cases—a record number—and imposed $3 billion in penalties and disgorgement against alleged offenders. Moving forward, the Commission intends to continue placing a lot of its attention on going after parties that committed securities laws violations related to the economic crisis of 2008. The SEC has so far initiated 107 such securities cases. 74 of these are against individuals.

Montford Associates to Pay $650,000 in Securities and Exchange Commission Penalties Over Failure to Disclose Payments from Hedge Fund

Published on: May 1, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The SEC has ordered investment adviser Montford Associates and Ernest Montford Sr. to pay $650K in penalties for failing to disclose that it had received $210K from an allegedly fraudulent hedge fund that it had recommended to clients. The name of the fund is SJK Investment Management. Its owner, Stanley Kowalewski, is accused of using the fund to commit a $16.5 million fraud. Investors that put their money in the fund included the Tallulah Falls School’s endowment program, St. Joseph’s/Candler Hospital System, Georgia Ports Authority, Sea Island Co. Retirement Plan, and Savannah Country Day School Foundation.

Although Montford Associates and Ernest Montford are not accused of involvement in Kowalewski’s securities fraud, the two of them allegedly lied to investors by not telling them about the compensation they were getting for the referrals. Montford and his investment adviser firm were paid “marketing and syndication fees” and “consulting services.”

The SEC contends that failure to disclose the payments for the recommendations violates federal securities laws. The Commission also says that even though Montford was aware that these nonprofits, many of them charitable organizations and schools, were run by part-time volunteers that depended on his investment advice and he knew they wanted consistent, stable investments, he still pushed them to move their investments to SJK so that Kowalewski could manage their money.

In addition to the $650,000 penalty, Montford Associates and Montford must pay disgorgements of $130,000 and $80,000, each with prejudgment interest. They also must set up a Fair Fund so that their clients that were harmed can use the penalties and disgorgement. Both must also cease and desist from committing/causing future violations of the Advisers Act and Advisers Act Rule 204-1(a)(2). Montford also is barred from associating with brokers, investment advisers, municipal securities dealers, dealers, transfer agents, municipal advisors, and nationally recognized statistical rating organizations.

As for the SEC’s hedge fund fraud case against Stanley Kowalewski, the Commission is accusing the hedge fund manager of using millions of dollars in client funds to buy his residence and a beach home and directing $10 million in unfounded fees to his investment management company and himself. He allegedly tried to hide his financial scam by sending fraudulent account statements to investors each month. These updates grossly exaggerated the actual values of assets and returns.

SEC Fines Adviser Over Ties To Hedge Fund Accused Of Fraud, FINalternatives.com, April 30, 2012

Securities and Exchange Commission v. Stanley J. Kowalewski, et al, Case No. 1:11-cv-00056-TCB (N.D. Ga.), SEC.gov, August 29, 2011

More Blog Posts:
Institutional Investor Fraud Roundup: SEC Seeks Approval of Settlement with Ex-Bear Stearns Portfolio Managers, Credits Ex-AXA Rosenberg Executive for Help in Quantitative Investment Case; IOSCO Gets Ready for Global Hedge Fund Survey, Institutional Investor Securities Fraud, March 29, 2012

Insider Trading: Former FrontPoint Partners Hedge Fund Manager Pleads Guilty to Criminal Charges, Institutional Investor Securities Fraud, August 20, 2011

Silicon Valley Man Faces SEC Securities Fraud Charge After Allegedly Bilking Internet Start-Up Investors of the “Next Google” of Millions, Stockbroker Fraud Blog, April 19, 2012

SEC to Make Sure Rule Writing Process Incorporates Better Cost-Benefit Analysis

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

In the wake of criticism that the Securities and Exchange Commission has not done enough to assess its rules’ economic impact, its Office of the General Counsel and Risk, Strategy, and Financial Innovation Division is providing staff with guidance that it needs to conduct a more thorough economic analysis during the entire rule writing process. One of the requirements is that there must be a cost-benefit evaluation when rules that are congressionally mandated or discretionary are involved. This guidance is now binding.

However, SEC Chairman Mary Schapiro was quick to point out to the House Oversight Subcommittee on TARP and Financial Services that many of the rules that are written already follow this guidance. Now, staff will assess the cost-benefits of 28 rules that the Commission is proposing in the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The guidance comes following a report that was issued in January. In it, the Office of the Inspector General blamed the SEC for not conducting cost-benefit analysis when writing Dodd-Frank mandated rules. In addition to providing more comprehensive cost-benefit analysis, the SEC must also note the justification for the proposed rule, identify reasonable options to the rule, evaluate any economic repercussions, and find a baseline point for beginning the analysis. The SEC will be hiring more than three dozen economists to join its staff. If the Commission ends up being able to properly implement this guidance, then Congress may have to legislate.

SEC Chairman Says Commission Shouldn’t Impose Industry-Wide Bars On Offenders that Committed Misconduct Before Dodd-Frank Statute’s Enactment

Published on: April 16, 2012 | by Shepherd Smith Edwards & Kantas, LLP

Speaking at the Rocky Mountain Securities Conference in Colorado a few days ago, Securities and Exchange Commission Chairman Daniel Gallagher said that the imposition of an industry-wide bar, which is authorized under Section 925 of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, shouldn’t be applied to misconduct that happened before the financial reform statute was enacted. He talked about how many of the cases that have been brought to the agency for consideration under Section 925 involve “pre-enactment” conduct.

Gallagher said this raised the question of “basic fairness.” He believes that imposing an industry bar on conduct that took place before the legislation was passed is unfair. He said that choosing not to apply the Dodd-Frank provision to “pre-enactment” conduct would show that the SEC is here to not just prevent bad behavior and protect investors and markets, but also to “afford procedural fairness” so that any SEC enforcement action that a party is subject to is “legitimate.” He noted that while there are many defendants that undoubtedly deserve to have the SEC enforce actions against them, there should be limits, such as not subjecting them to sanctions that didn’t exist at the time that their conduct occurred. During his speech, Gallagher was clear to note that the views he is expressing are his alone and not the SEC’s.

Commenting on Gallagher’s statements, Institutional Investment Fraud Attorney William Shepherd said, “When assessing past behavior in the securities markets and whether certain sanctions against wrongdoers is or is not appropriate, does Wall Street really want to rely on this standard: ‘we face a question of basic fairness?’”

Goldman Sachs to Pay $22M For Alleged Lack of Proper Internal Controls That Allowed Analysts to Attend Trading Huddles and Tip Favored Clients

Published on: April 14, 2012 | by Shepherd Smith Edwards & Kantas, LLP

Accused of not putting in place policies to prevent analyst huddles, Goldman Sachs Group Inc. (GS) will settle for $22 million the allegations made against it by US regulators. According to the Securities and Exchange Commission and FINRA, due to the nature of the financial firm’s internal control system research analysts were able to share non-public information with select clients and traders.

To settle the securities case, Goldman will pay $11 million each to FINRA and the SEC. It also consented to refrain from committing future violations and it will reevaluate and modify its written policies and procedures so that compliance won’t be a problem in the future. The financial firm has agreed to have the SEC censure it. By settling Goldman is not denying or admitting to the allegations.

Meantime, FINRA claimed that Goldman neglected to identify and adequately investigate the increase in trading in the financial firm’s propriety account before changes were made to analysis and research that were published. The SRO says that certain transactions should have been reviewed.

This is not the first time that Goldman has gotten in trouble about its allegedly inadequate control systems. Last year, it agreed to pay $10 million to the Massachusetts Securities Division over ASI and the huddles. In 2003, the financial firm paid $9.3 million over allegations that its policies and controls were not adequate enough to stop privileged information about certain US Treasury bonds from being misused.

The latest securities actions are related to two programs that the financial firm created that allegedly encouraged analysts to share non-public, valued information with select clients. The SEC says that during weekly “huddles” between 2006 and 2011, Goldman analysts would share their perspectives on “market color” and short-term trading with company traders. Sales employees were also sometimes present, and until 2009, employees from the financial firm’s Franchise Risk Management Group who were allowed to set up large, long-term positions for Goldman also participated in the huddles.

Also in 2007, the financial firm established the Asymmetric Service Initiative. This program let analysts share ideas and information that they acquired at the huddles with a favored group made up of approximately 180 investment management and hedge fund clients.

The SEC contends that ASI and the huddles occurred so that Goldman’s traders’ performances would improve and there would be more revenue in the form of commissions. The financial firm even let analysts know that it would be monitoring whether ideas discussed at the huddles succeeded and that this would be a factor in performance evaluations. The Commission said that the two programs created a serious risk, especially considering that a lot of ASI clients were traders who did so often and in high volume.

Meantime, FINRA claimed that before changes were made to published analysis and research, Goldman would neglect to identify and adequately investigate the increase in trading in the financial firm’s proprietary account. The SRO says that there were certain transactions that should have been reviewed.

This is not the first time that Goldman has gotten in trouble over its allegedly inadequate control systems. Last year, it agreed to pay $10 million to the Massachusetts Securities Division over ASI and the huddles. In 2003, the financial firm paid $9.3 million over allegations that its policies and controls were not adequate enough to stop privileged information about certain US Treasury bonds from being misused.

Goldman Sachs to Pay $22 Million Over Analyst Huddle Claims, Bloomberg, April 12, 2012

More Blog Posts:
Ex-Goldman Sachs Director Rajat Gupta Pleads Not Guilty to Insider Trading Charges, Stockbroker Fraud Blog, October 26, 2011

SharesPost, its CEO, and Fund Manager Settle with the SEC

Published on: March 17, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission says that it has reached a securities settlement in its administrative proceeding against SharesPost. Along with its Chief Executive Officer Greg Brogger, the online platform that serves as a secondary market for pre-IPO shares will pay $100,000 in penalties.

According to the SEC, SharesPost was matching up the sellers of private company stock and buyers even though it wasn’t a registered broker-dealer. Also, the online service allegedly let other broker-dealers’ registered representatives present themselves as SharesPost employees and make commissions on securities transactions, allowed one of its affiliates to manage pooled investment vehicles that were supposed to buy stock in single private firms and interests in funds that Sharespost made available, and published on the website third-party information about issuers’ financial metrics, research reports, and a valuation index that it created.

The SEC noted that although it is open to innovation in capital markets, products and new platforms have to abide by the rules, including making sure that basic disclosure and fairness occur. The Commission said that that broker-dealer registration is key in helping protect customers—especially considering that there are risks involved in the secondary marketplace for pre-IPO stocks for even the most sophisticated investors.

The Commission also settled its securities case against FB Financial Group and its fund manager Laurence Albukerk. The fund manager is accused of providing offering materials that did not let investors know he was making extra fees because he was buying Facebook shares using an entity that his wife controlled. Albukerk and his financial firm have agreed to pay pre-judgment interest plus disgorgement of $210,499 and $100,000 fine. Sharespost, Brogger, Albukerk, and FB Financial Group agreed to settle without denying or admitting to any wrongdoing.

Meantime, in a related securities fraud lawsuit filed in civil court, the SEC accused Frank Mazzola and his financial firms Facie Libre Management Associates, LLC and Felix Investments of making secret commissions and taking part in improper self-dealing. Mazzola and the firms allegedly made a number of false statements to investors about offerings in Zynga, Facebook, and Twitter while not revealing that certain prices were raised as a result of commissions.

Facie Libre also allegedly sold Facebook interests even though it didn’t own some of these shares. Both of the firms and Mazzola are accused of misleading an investor into thinking they had acquired Zynga stock, as well as of making misrepresentations about Twitter revenue. This case is still open. Felix Investments and Mazzola have, however, settled a related but separate action with the Financial Industry Regulatory Authority with the firm consenting to pay a $250,000 fine and Mazzola a $30,000 fine.

In the wake of electronic markets and Wall Street banks all rushing to present investors with an opportunity to trade stakes in popular technology companies prior to them going public, regulators and lawmakers have been more closely scrutinizing private share trading over the last year. That said, alternative online investment platforms, which are called “shadow markets,” can be very risky.

“The real shock is the lack of problems the SEC finds with such trading in pre-public shares,” says Shepherd Smith Edwards and Kantas, LTD LLP Founder and stockbroker fraud lawyer William Shepherd. “The penalties levied are only for firms not being licensed to sell securities engaging in such practices and/or for ‘self-dealing.’ Meanwhile, this entire practice flies in the face of both the letter and intent of securities laws that have been on the books since the 1930’s. Wall Street screams about new regulations while it ignores current ones. In driving terms, think of this as the police watching as drag races are being held in your neighborhood, ignoring red lights and stop signs on every corner, and being only concerned with whether the drivers are licensed.”

SEC charges SharesPost, Felix over pre-IPO trading, Reuters, March 14, 2012

More Blog Posts:

Securities and Exchange Commission Charges Investment Adviser with Committing Securities Fraud on Linked In, Stockbroker Fraud Blog, January 6, 2012

SEC Looks Likely to Win Appeal in $285M Securities Settlement that Judge Rakoff Rejected

Published on: March 15, 2012 | by Shepherd Smith Edwards & Kantas, LLP

In a primarily procedural decision, the U.S. Court of Appeals for the Second Circuit has ruled that the Securities and Exchange Commission’s case against Citigroup, which resulted in a proposed $285M securities fred settlement, be stayed pending a joint appeal of U.S. Senior District Judge Jed Rakoff’s ruling that the civil lawsuit proceed to trial. Rakoff had rejected the settlement on the grounds that he didn’t believe that it was “adequate.” He also questioned the Commission’s practice of letting parties settle securities causes without having to admit or deny wrongdoing. The trial in SEC v. Citigroup Global Markets, Inc. had been scheduled for July 2012.

In December, the SEC filed a Notice of Appeal to the 2nd Circuit contending that the district court judge made a legal mistake in declaring an unprecedented standard that the Commission believes hurts investors by not allowing them to avail of “benefits that were immediate, substantial, and definite.” The notice also stated that it considered it incorrect for the district court to require an admission of facts or a trial as terms of condition for approving a proposed consent judgment—especially because the SEC provided Rakoff with information demonstrating the “reasoned basis” for its findings.

The 2nd circuit’s ruling deals a blow to Rakoff’s decision, which other federal judges have cited when asking if the public’s interest is being served when federal agencies propose settlements. The three-judge panel’s appellate ruling, which was a per curiam (unsigned) decision, found that the SEC and Citi would likely win their contention that Rakoff was in error when he turned down the securities settlement. The appeals court justices said that they had to defer to an executive agency’s evaluation of what is best for the public and that there was no grounds to question the SEC’s claim that the $285M securities settlement with Citigroup is in that interest.

The 2nd circuit said that Rakoff “misinterpreted” precedent related to his discretion to determine public interest and went beyond his judicial authority. Also, per the appellate panel, while district court judges should not merely rubber stamp on behalf of federal agencies it is not their job to define the latter’s policies.

It is important to note, however, that the 2nd circuit’s ruling only tackles the preliminary issue of whether the securities case should be stayed pending the completion of the appeal. The panel said it would be up to the justices that hear the appeal to resolve all matters and that this ruling should not have any “preclusive” impact. Counsel would also be appointed to argue Rakoff’s side during the appeal.

Ruling Gives Edge to U.S. in Its Appeal of Citi Case, NY Times, March 15, 2012

Second Circuit: Rakoff, Mind, Wall Street Journal, March 15, 2012

More Blog Posts:
Citigroup’s $285M Settlement With the SEC Is Turned Down by Judge Rakoff, Stockbroker Fraud Blog, November 28, 2011

Citigroup’s $285M Mortgage-Related CDO Settlement with Raises Concerns About SEC’s Enforcement Practices for Judge Rakoff, Institutional investor Securities Blog, November 9, 2011

Citigroup’s $75 Million Securities Fraud Settlement with the SEC Over Subprime Mortgage Debt Approved by Judge, Stockbroker Fraud Blog, October 23, 2010

As the US House Passes Package of Bills to Open Capital Market Flow to Small Businesses, the Senate Prepares Similar Legislation

Published on: March 13, 2012 | by Shepherd Smith Edwards & Kantas, LLP

It’s been less than one week since US House passed a package of six bills that would open up capital flow to small businesses. Now, it is the Senate is preparing to introduce its own version of legislation to assist small businesses in raising capital. Both Republican and Democrat senators are expected to work together to push forward the bills package, which would ease up the restrictions of SEC regulations to attract investors and help out startups and small businesses.

The legislation, which made it through the House by a 390-23 vote, has President Barack Obama’s support. Called the Jumpstart Our Business Startups Act (H.R. 3606), the bills would allow crowdfunding (this involves raising capital from a bigger pool of small-scale investors that the Commission has not classified as “accredited.”), increase the shareholder reporting trigger for all community banks and companies, set up an initial public offering “on-ramp” for emerging growth companies, increase the Regulation A offering cap to $50 million, and eliminate the general solicitation ban.

The House also approved several amendments to the package. Among these was one that would up the shareholder threshold for all firms to $2,000. The original bill had only increased the threshold to 1,000. Per the amendment, only 500 shareholders under the 2,000 limit can be non-accredited. Another amendment mandates that the Securities and Exchange Commission conduct a study regarding whether it can enforce the Exchange Act’s Rule 12g5-1.