THIS WEEK IN SECURITIES LITIGATION (March 12, 2010)
Capital Hill continued to debate market reform this week with the introduction of the Volker Rule bill in the Senate. SEC enforcement focused on resolving financial fraud and Ponzi scheme cases, while the appellate section at FINRA reversed a panel decision for a lack of evidence in a failure to supervise case. In private cases, another derivative suit based on option backdating claims reached a tentative resolution. And, in the U.K. the FSA obtained its first insider trading conviction against a market professional.
Market reform
The Volker Rule bill was introduced in the Senate this week. The bill is titled The Protect our Recovery through Oversight of Proprietary Trading Act or PROP Trading Act. Its focus is on banks and their holding companies. If enacted, the bill would bar proprietary trading desks from high risk speculation and impose capital requires and position limits for non-bank financial institutions engaged in speculative trading.
SEC enforcement actions
Financial fraud: In the Matter of Robert John Hipple, Adm. Proc. File No. 3-13543 (Mar. 11, 2010) is an action against the former CEO and CFO of defunct iWorld Projects & Systems, Inc., a business development company. Mr. Hipple, according to the Order, overstated the value of the investment portfolio of the company – its primary asset – in three of the four quarters in 2005. He also misled the auditors regarding whether there was an independent evaluation of the worth of the asset. The Order is based on alleged violations of the antifraud provisions and Section 57(a)(1) of the Investment Company Act, as well as the certification provisions of Sarbanes Oxley. Mr. Hipple consented to the entry of a cease and desist order, a five year officer director bar and an order precluding him from serving with a registered investment company for five years. He also agreed to be denied the right to practice before the Commission as an accountant. The Division of Enforcement was given permission to reopen the proceeding and seek a financial penalty when the Respondent furnishes accurate and complete financial information.
Broker fraud: SEC v. Vianna, Case No. 10 Civ. 1842 (S.D.N.Y. Filed Mar. 10, 2010) is an action against a former registered representative at Maxim Group, Jose Vianna. According to the complaint, Mr. Vianna would place trades for the account of a large institutional client which was a Spanish bank and Creswell Equities, a British Virgin Islands Company. When the bank trades were profitable, they were diverted to the Creswell account. Conversely, when a trade for Creswell was unprofitable it was diverted to the bank. This was done 57 times over a two year period beginning in 2007. The complaint alleges violations of the antifraud provisions. The case is in litigation. See also Litig. Rel. 21446 (Mar. 10, 2010).
Financial fraud: SEC v. Lapine, Case No. C-0103650 (N.D. CA. Filed Sept. 27, 2001) is an action against Jay Lapine, former General Counsel to HBOC and, after its merger with McKesson to the HBOC division of McKesson HBOC. The complaint, based on claims centered in 1998 and 1999 as discussed here, alleges that Mr. Lapine discovered that the company was falsifying its books by improperly recognizing revenue. Rather than halting the scheme, he participated in two transactions used to improperly boost earnings and help the company reach revenue goals. To resolve the case with the Commission, Mr. Lapine consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions. He also agreed to the entry of a five year officer/director bar and to pay a $60,000 civil fine. In 2007 other officers of the company settled with the SEC as discussed here. See also Litig. Rel. 21444 (Mar. 10, 2010).
Share issuance scheme: SEC v. Verdiramo, Civil Action No. 10-CIV-1888 (S.D.N.Y. Filed Mar. 10, 2010) is a complaint against Richard Verdiramo, Chairman, CEO, President and CFO of RECOV Energy Corporation, his father, attorney Vincent Verdiramo, Edward Meyer and Victoria Chen. The complaint centers on claims that in August 2005, Richard Verdiramo had the company issue more than three million unregistered shares to defendants Meyer, Chen and others. The shares were issued under a contract in which Meyer and Chen were to acquire a controlling interest in the company. At the time of the deal, RECOV was involved in merger negotiations with another company. Meyer and others paid Richard and Vincent Verdiramo at least $350,000, according to the complaint, which should have gone to the company. The Commission alleges violations of the registration, antifraud and reporting provisions of the securities laws. The case is in litigation. See also Litig. Rel. 21447 (Mar. 10, 2010).
Ponzi scheme: SEC v. Durmaz, Civil Action No. CV 10-01689 (C.D. Cal. Mar. 10, 2010) is an action against Francois Durmaz and Robert Pribilski, who are alleged to have conducted a Ponzi scheme targeting retirees. The two defendants used their controlled vehicle, USA Retirement Management Services, to raise at lest $20 million from 120 investors who were told their money would be put into Turkish Eurobonds, according to the complaint. Instead the defendants diverted the money to their own use. Investors were solicited through mailing promotions and estate planning seminars. The complaint alleges violations of the registration, antifraud and broker registration provisions of the securities laws. A request for an emergency freeze order was granted. The case is in litigation. See also Litig. Rel. 21445 (Mar. 10, 2010).
Reg FD: SEC v. Presstek, Inc., Civil Action No. 10-1058 (D. Mass. Filed Mar. 9, 2010) is an action against the company and the former chairman of its audit committee, Edward Marino, discussed here. According to the complaint, Mr. Marino learned that the financial performance of the company in both North America and Europe was weak and had a negative impact on margin and operating income relative to plan. Shortly thereafter Mr. Marino received a telephone call from Michael Barone, a managing partner of Sidus, a registered investment advisor. During the telephone call, Mr. Marino told the adviser that the summer had not been as vibrant as expected in North America and Europe, according to notes of the conversation prepared by Mr. Barone and quoted in the complaint. He also said “’overall [performance is] a mixed picture’” for the company. Mr. Barone immediately sold almost a half a million shares of the company. The next day Presstek issued a preliminary announcement of its results.
The company settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. As part of the settlement, the company agreed to pay a $400,000 civil penalty. In an unusual step the Commission, in its complaint, acknowledged the cooperation of the company citing its remedial measures taken. Mr. Marino is litigating the case. See also Litig. Rel. 21443 (Mar. 9, 2010).
Stock loan scheme: SEC v. Zangari, Civil Action No. 10-1058 (E.D.N.Y. Mar. 9, 2010) is an action against Salvatore Zangari, who was a stock loan trader at three different Wall Street firms. In 2004 and 2005, he participated, according to the SEC, in a cash kickback scheme while arranging daily stock loan transactions. Mr. Zangari was paid about $100,000 by a stock loan finder in exchange for sending business from his employer. Mr. Zangari is also alleged to have received a portion of the fees generated in the transactions. The complaint alleges violations of the antifraud provisions. The case is in litigation. See also Litig. Rel. 21442 (Mar. 9, 2010).
Failure to supervise: In the Matter of First Allied Securities, Inc., Adm. Pro. File No. 3-13808 (Mar. 5, 2010). This is the third case, discussed here, arising out of trading at Allied Securities by registered representative Jaschke in the accounts of the City of Kissimmee, Florida and the Tohopekaliga Water Authority of Florida. Essentially, over a three year period beginning in 2005, Mr. Jaschke churned the accounts, making high risk trades that were contrary to the investment policies of each client. While the trades were profitable, those profits were substantially eclipsed by the amount of the commissions.
The supervision claim against the broker is based largely on its failure to follow up on reports from its clearing agent, Bear Stearns. Those reports repeatedly suggested that the accounts were being churned. In addition, the Order alleges that Mr. Jaschke was permitted to repeatedly use his personal e-mail to conduct business and that the required records were not maintained. To resolve the action the firm consented to the entry of a cease and desist order. It also agreed to pay disgorgement of $1,224,606, pre-judgment interest of $233,699 and a civil penalty of $500,000. The firm will retain an Independent Consultant to review its written supervisory policies and prepare a report with recommendations for improvements and changes which the firm will adopt.
Financial fraud: SEC v. Conaway, Case No. 05 cv 40263 (E.D. Mich. Filed Aug. 23, 2005) is an action against the former CEO of Kmart Corporation for financial fraud in which the jury found in favor of the Commission as discussed here. This week the court ordered Mr. Conaway to pay disgorgement of $5 million, prejudgment interest of about $2.8 million and a civil penalty of $2.5 million. The court also directed Mr. Conaway to provide a declaration that he is not being indemnified for the penalty. Otherwise the penalty will be doubled. The court did not enter an injunction or any other relief except to direct he not dissipate assets while the parties negotiate a stay pending appeal. See also Litig. Rel. 21438 (Mar. 5, 2010).
Bank conversion frauds: SEC v. Unger, Civil Action No. 10-CV-0991 (E.D.N.Y. Mar. 5, 2010) is an action against Chaya Unger for fraud in connection with bank conversions. According to the Commission, the defendant acquired shares in four public offerings of banks that were converting from mutual to stock form. This was done by circumventing the offering terms and bank regulations by having shareholders act as his nominees and falsely report that the purchases were for their account. He later sold the stock, obtaining about $227,589. The complaint alleges violations of Exchange Act Section 10(b). To settle the case, the defendant consented to the entry of a permanent injunction and an order requiring the payment of disgorgement equal to the profits, prejudgment interest and a civil penalty of $65,000. See also Litig. Rel. 21439 (Mar. 5, 2010).
Kickback scheme: SEC v. Wealth Management LLC, Civil Action No. 1:09-cv-506 (E.D. Wis. Filed May 2008) is an action against Simone Fevola and Welath Management LLC. The initial complaint claimed that the fund, its founder and CEO James Putman and former President and CIO Simone Fevola engaged in a kickback scheme involving six unregistered funds they managed. The two individual defendants are alleged to have accepted $1.24 million in undisclosed payments. The actions were settled by defendant Fevola consenting to an order and Wealth Management defaulting. In the final orders, each defendant was permanently enjoined from future violations of Sections 206 and 207 of the Investment Advisers Act and the antifraud provisions of the Securities Act and the Exchange Act. In addition, Defendant Fevola was ordered to pay disgorgement of $1.24 million plus prejudgment interest while the fund was ordered to pay about $1.3 million in disgorgement plus prejudgment interest. See also Litig. Rel. 21440 (Mar. 5, 2010).
CFTC
Commodity options scheme: CFTC v. First Capital Futures Group (W.D. Mo. Filed July 9, 2009) is an action against the firm and its principal, David Kogan. The complaint alleged that the defendants operated a fraudulent commodity options scheme involving 58 customers who lost over $3 million. As part of the scheme investors were falsely told that they would make large returns in very short periods of time from trading in options. Approximately $2.2 million of the investor losses was in commissions. The case was resolved with the entry of an order against the defendants requiring the payment of $20.3 million in penalties and equitable relief.
Criminal actions
U.S. v. Levy (S.D.N.Y.) is an action against the former CFO of a Manhattan hedge fund. Mr. Levy was charged with misappropriating money for the fund. The defendant diverted about $537,000 from the fund by having it purchase securities from his personal trading account at prices above market. In addition, he misappropriated about $2.45 million from the fund by diverting payments due to it to a bank account he controlled. Mr. Levy pleaded guilty to one count of securities fraud and one count of wire fraud. A sentencing date has not been set.
FINRA
The National Adjudicatory Counsel, the appellate body of FINRA, reversed a panel decision which had found Kenneth Pasternak, former CEO of Knight Securities, and John Leighton, former head of the firm’s Institutional Sales Desk, responsible for failure to supervise. The complaint alleged Messrs. Pasternak and Leighton did not take reasonable steps to ensure that the firm’s leading institutional sales trader followed industry standards when executing trades for institutional customers. NAC concluded that there was a lack of evidentiary support for the findings. The sanctions, which were a suspension from acting in a supervisory capacity for two years and a fine for each respondent of $100,000, were vacated and the action was dismissed.
Private actions
Options backdating: In re KLA-Tencor Corp., Case No. C 06-3445 (N.D. Cal.) is a derivative suit based on options backdating claims. The company previously restated its financial statements, taking a $370 million charge relating to option backdating. In this case, $33 million will be paid as part of the arrangement, in addition to the canceling of certain stock grants. A prior effort to settle this case collapsed, although the company did settle a class action in 2008 for $65 million. SEC suits against the former CEO and general counsel f the company are pending.
U.K.
A former partner at JPMorgan Chase partner, Malcolm Calvert, was convicted by a jury on five counts of insider trading. The jury found him not guilty on seven other counts. Mr. Calvert, who retied from Cazenove, where he worked as an equity market maker, is the first financial services professional convicted by the FSA in a criminal case. The FSA charged Mr. Calvert with illegally tipping his friend Bert Hatcher regarding six different deals. Mr. Hatcher made profits of about 280,000 pounds, two thirds of which he gave to Mr. Calvert. He was sentenced to 21 months in prison.