THIS WEEK IN SECURITIES LITIGATION (March 18, 2011)
SEC Chairman Mary Schapiro continued to press congress for adequate funding which would permit the Commission to carry out its statutory duties and avoid furloughs. At the same time the agency continues to suffer through its latest scandal. This one relates to the investments by the family of the Commission’s former general counsel with Ponzi king Bernard Madoff.
SEC enforcement this week focused on two of its staples, insider trading and investment fund fraud actions. In addition, two more defendants pleaded guilty to criminal charges stemming from the demise of Taylor Bean. Finally, both FINRA and the PCAOB both issued warnings to investors. FINRA cautioned against scams involving the sale of pre-IPO shares in social networking companies like Facebook. At the same time the accounting board expressed concern about Chinese companies that went public through reverse mergers.
SEC Enforcement
Insider trading: SEC v. Carroll Case No. 3;11-CV-00165 (W.D. KY. Filed March 17, 2011) is an action involving family and friends who are alleged to have traded while in possession of inside information about a pending take over. The complaint centers on the acquisition of Steel Technologies, Inc. by Mitsui & Co. which was announced on February 28, 2007. Following the announcement the share price rose 60%. Defendants Patrick Carroll, William Carroll, David Stitt and David Calcutt all held a position of vice president of sales at Steel Technologies. Each reported to the company president and COO Michael Carroll. Each vp is alleged to have had inside information regarding the acquisition as did Michael Carroll who is not a defendant. Each vice president is alleged to have traded while in possession of the information. Four individuals named as defendants are alleged to be tippees. The are: James Carroll (son of Patrick); John Monroe who is a friend of defendant Stitt; Stephen Somers who is a friend of defendant and tippee John Monroe; and Christopher Calcutt, the brother of defendant David Calcutt. Overall the four vice presidents purchased about $339,000 of stock in those accounts. The tippees also traded and, collectively the defendants had profits of about $320,000. The complaint alleges violations of Exchange Act Section 10(b). The case is in litigation.
Looting: SEC v. Durham, Civil Action no. 1:11-CV-0370 (S.D. Ind. Filed March 15, 2011) is an action against Timothy Durham, former CEO of Fair Finance Co., James Cochran, former Chairman of the Board of Fair, and Rick Snow, former CFO of Fair. According to the complaint, Fair was an Ohio based consumer finance company. Following the acquisition of Fair in 2002 defendants altered its historical operating methods by steadily loaning Fair’s funds to other failing businesses they controlled. By 2009 the defendants had booked over $200 million of these related party loans. Those loans constituted about 90% of Fair’s supposed investments.
From 2005 through late 2009 defendants raised about $230 million from about 5,200 investors by selling investment certificates from Fair. Defendants made false representations in connection with the sales not disclosing that Fiar’s investments were in largely to insolvent entities that could not repay. The majority of the related parities did not even pay the interest on the so-called loans. Eventually the defendants began making Ponzi like payments to investors to repay notes due. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). It is in litigation. Parallel criminal charges were also filed against the defendants. U.S. v. Durham, Case No. 1:11-cr-0042 (S.D. Ind. March 15, 2011).
Diversion of fund assets: SEC v. Juno Mother Earth Asset management, LLC (S.D.N.Y. filed March 15, 2011) is an action against Juno Mother Earth Asset Management, LLL, a registered investment adviser, Eugenio Verzili, its chief compliance officer, and Arturo Rodrigues, its portfolio manager and later chief investment officer. Beginning in late 2006 Juno offered investors securities in Resources Fund which it managed, eventually raising about $16 million. Throughout that year and the next the investment adviser raised about $16 million. Juno however was chronically short of cash. Accordingly, in 2007 and 2008 defendants Verzili and Rodriguez made 41 withdrawals from the commodity and brokerage accounts of Resources Fund totaling $1.8 million. Portions of the funds were used to pay Juno operating expenses, contrary to representations in the PPM, while others were diverted to the personal use of the individual defendants. By the middle of 2008 substantially all of the investors in Resources Fund sought redemption. Juno ceased offering Resources Fund securities. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2), (4), 203A and 207. The case is in litigation.
Insider trading: SEC v. Hollier, Civil Action No. 6:09-cv-00928 (W.D. La.) is a previously filed insider trading case against Robert Hollier and Wayne Dupuis. The Commission claimed in its complaint that Mr. Hollier obtained inside information regarding the merger of Warrior Energy Services Corporation and Superior Energy Services, Inc. The transaction was announced on September 25, 2006. While on a hunting trip prior to the announcement, Mr. Hollier told Mr. Dupuis about the then pending deal according to the Commission. Following their return Mr. Dupuis purchased 5,000 shares of Warrior for $85,000. After the announcement he sold those shares at a profit of about $41,800 when the share price rose almost 70%. This week the case settled. Each defendant consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). The court ordered the two defendants to jointly and severally pay disgorgement in the amount of the trading profits along with prejudgment interest. Mr. Dupuis was all directed to pay a civil penalty in the amount of the trading profits.
Disclosure: In the Matter of JSK Associates, Inc., Adm. Proc. File No. 3-14296 (March 14, 2011) is a proceeding naming as Respondents: JSK, a registered investment adviser; Jerome Keenan, the President and Chief Compliance Officer of JSK and the Vice President and Chief Compliance Officer of International Equity Services, Inc, a broker dealer; and Dos Santos, an officer of JSK and IES. The Order alleges that JSK failed to inform investors that IES was obtaining compensation from the JSK accounts at the broker dealer. Investors were told that IES might receive clearing and processing and other types of fees from the accounts but this was inadequate. JSK also failed to inform investors that through IES it engaged in hundreds of fixed income transactions involving mark-ups and mark-downs with advisory clients on a principal basis. Finally, the firm failed to have adequate written policies and procedures reasonably designed to prevent violations of the Advisers Act. The Order alleges violations by Respondents of Advisers Act Sections 206(2), 206(3), 204, 204A, 206(4) and 207. The matter was resolved with consents to the entry of cease and desist orders as to each Respondent. In addition, Respondents Keenan and Dos Santos each agreed to pay a civil penalty of $10,000. Respondents also agreed to pay disgorgement of $60,350 along with prejudgment interest. The Order acknowledges the prompt remedial efforts and cooperation of Respondents.
Criminal cases
Fraud: U.S. v. Bowman (E.D.Va.) is an action against Raymond Bowman, the former president of Taylor, Bean & Whitaker. Mr. Bowman pleaded guilty to charges of conspiring to commit bank, wire and securities fraud and of lying to federal agents about his role in the fraudulent scheme that caused the demise Taylor Bean and Colonial bank. Taylor Bean was the largest non-depository mortgage lender in the country while its lender, Colonial BancGroup, Inc., was one of the fifty largest banks in the U.S. The fraudulent scheme began with concealing from the bank the fact that Taylor Bean, which had liquidity problems as early as 2002, was operating essentially on overdrafts by shuffling funds among accounts and concealing its true financial condition from the bank. Subsequently, Taylor Bean raised cash by selling a package of fraudulent mortgages to Colonial that were carried on the books of the bank. Finally, the one time mortgage lender created a special purpose entity to obtain funds by selling asset backed loans. By August 2009 the entity had a collateral deficit of about $1.5 billion. Yet Taylor Bean caused Colonial and the Federal Home Loan Mortgage Corporation to believe that each had an undivided interest in thousands of loans worth hundreds of millions of dollars. This was false Mr. Bowman admitted in his plea. Eventually Taylor Bean collapsed. Colonial was seized by banking regulators. The date for sentencing has not been set.
Fraud: U.S. v. Kelly (E.D. Va.) is another criminal action based on the collapse of Taylor Bean. The defendant is Teresa Kelly, a former supervisor in Colonial bank’s Mortgage Warehouse Lending Division. Ms. Kelly pleaded guilty to conspiring to commit bank, wire and securities fraud based on her role in the scheme outlined above. The SEC also filed a parallel civil case. The date for sentencing has not been set.
FCPA
U.S. v. Tesler, H-09-098 (S.D.Tx.). British solicitor Jeffrey Tesler pleaded guilty to one count of conspiracy to violate the FCPA and one count of violating the FCPA. The indictment, which contains eleven counts, centers on FCPA violations in connection with the TSKJ consortium and the EPC contracts to build liquefied natural gas facilities on Bonny Island, Nigeria. In his plea agreement Mr. Tesler admitted that he served as an agent of the TSKJ consortium, formed to secure $6 billion in contracts relating to the Bonny Island project. The members of the consortium were KBR, Technip S.A., Snamprogetti Netherlands BV and a Japanese engineering and construction company.
To facilitate obtaining the contracts, according to the plea agreement, Messrs. Tesler, through a company he controlled, funneled millions of dollars in bribes to Nigerian government officials. As part of the plea arrangement Mr. Tesler agreed to forfeit $148,964,568.67 which may be the largest FCPA forfeiture order against an individual. He is now cooperating with the government. Sentencing is set for June 22, 1011. KBR, Technip and Snamprogetti previously resolved FCPA charges.
FINRA
FINRA issued a warning to investors regarding the sale of pre-IPO shares in social media entities such as Facebook. While most sales of such shares are legitimate the regulator cautioned that there are scams involving the sale of shares in social media companies. The release notes that the SEC recently settled an action involving a scam in which investors paid several million dollars for shares of Google, Facebook and other well known sites.
PCAOB
The Board issued its first “Research Note” regarding Chinese reverse mergers. The Note states that some U.S registered accounting firms may not be conducting audits of companies with operations outside of the U.S. in accord with PCAOB standards. The Board is currently prevented from conducting inspections of U.S. related audit work of PCAOB registered firms in the PRC. There has however been a significant number of reverse mergers involving companies in that country. From January 2007 through the end of March 2010 there were 159 reverse merges involving Chinese companies. This compares to 56 IPOs for companies from that region. Following the reverse merger two thirds of the companies had a market capitalization below $75 million according to a PCAOB study. In contrast, over three quarters of those companies which had conducted an IPO had a market capitalization above $75 million. Similarly, as of March 31, 2010 the total market capitalization of all the Chinese companies involved with a reverse merger was less than half that of the companies that conducted an IPO. PCAOB registered accounting firms based in the U.S. audited 74% of the Chinese firms involved in a reverse merger.