The Commission brought two insider trading cases this week, one which is being litigated and another that settled prior to filing. The agency also brought a financial fraud action against five firm executives who essentially devised a series of schemes used to loot their employer. Another action centered on a manipulation by a foreign trader conducted through a U.S. broker in which the undisclosed control person of the trader was employed as a registered representative. The manipulative trading centered on spoofing or layering and cross-market trading schemes.
The Commission brought another action centered on the EB-5 immigration program. As with its earlier fraud actions in this area the complaint alleged that the promoter misappropriated most of the investment funds of the foreign national investors seeking entry to the U.S. throught the immigration program. Finally, another settled action was filed centered on the failure of an investment adviser to adequately disclose fees to wrap program participants when the sub-adviser engaged in what is known as trading away.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 4 civil injunctive cases and 2 administrative proceedings, excluding 12j and tag-along proceedings.
Insider trading: SEC v. Alpert, Civil Action No. 1:17-cv-01876 (S.D.N.Y. Filed March 15, 2017). The action centers on the acquisition of H.J. Heinz Company by Berkshire Hathaway, Inc. and 3G Capital Partners Ltd, announced on February 14, 2013. The transaction traces to mid-January 2013 when Berkshire Hathaway and 3G Capital made a proposed to acquire Heinz. By February 13, 2013 the board approved a deal pursuant to which the company would be acquired for $72.50 per share. A Heinz Board Member employed defendant Todd Alpert at his home as a security guard. His duties involved performing a variety of functions for the family including monitoring a Security Email Account. Board Member periodically sent email and attachments to the account and charged Mr. Alpert with monitoring it and printing out emails and attachments. In January and February 2013 Board Member either sent or had sent material regarding the proposed acquisition of Heinz to the Security Email Box. For example, on the evening of January 24, 2013 Board Member forwarded an email regarding the proposed deal to the Security Email Account and directed that it be printed out along with the attachments. The next day Mr. Alpert clocked into the Security Email Account at 1:53 p.m. At 2:15 p.m. he called his broker and purchased 1,000 shares of Heinz common stock. Subsequently, Mr. Alpert had access to additional, similar emails regarding the deal. Over time he purchased 30 options. On the day of the deal announcement Mr. Alpert sold his shares and options, reaping profits of $43,873.32. He later admitted to Board Member that he read the material about the proposed deal and purchased Heinz securities. The complaint alleges violations of Exchange Act Section 10(b). The case is in litigation. See Lit. Rel. No. 23780 (March 15, 2017).
Insider trading: In the Matter of Nima Hedayati, Adm. Proc. File No. 3-17881 (March 14, 2017). The proceeding centers on the merger of KLA-Tencor Corporation and Lam Research Corporation, announced on October 21, 2015. Nima Hedayati was an audit staff member employed by Lam’s independent Audit Firm. From August through October 2015 the two firms held a series of meetings and eventually reached a deal. Mr. Hedayati became aware of the proposed deal in meetings he attended with other members of the Audit Firm. As the deal unfolded Mr. Hedayati told his mother to “look into” trading KLA-Tencor. She purchased 1,400 shares of the stock. Subsequently, he purchased 20 out of the money option contracts in his account and an additional 20 in the account of his fiancée at the time. Following the deal announcement he liquidated the holdings of the two accounts, realizing profits of $27,971.50. His mother also sold her shares, reaping profits of $15,056.00.00. The Order alleges violations of Exchange Act Section 10(b). To resolve the action Mr. Hedayati consented to the entry of a cease and desist order based on the Section cited in the Order. He agreed to pay disgorgement of $43,027.59, prejudgment interest and a penalty equal to the amount of the disgorgement. In addition, he was denied the privilege of appearing or practicing before the Commission as an accountant with a right to request reinstatement after five years.
EB-5 program – misappropriation: SEC v. Chen, Civil Action No. 2:17-cv-00405 (W.D. Wash. Filed March 15, 2017) is an action which names as a defendant Andy Shin Fang Chen. The complaint centers on the EB-5 immigration program which promises a green card for those who make certain investments in the U.S. which create a specific number of jobs in this country. Here Mr. Chen promised investors who put $500,000 each into his supposed development of commercial real estate that they would qualify for the program. About $14.5 million was raised from investors, virtually all of which was misappropriated. Mr. Chen used the money for trading and other activities. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See Lit. Rel. No. 23778 (March 15, 2017).
Procedures – wrap fees: In the Matter of Stifel, Nicolaus & Co., Inc., Adm. Proc. File No. 3-17879 (March 13, 2017) is a proceeding which names the brokerage and investment banking firm as a Respondent. The Order alleges violations of Advisers Act Section 206(4) based on the failure to adopt and implement written policies and procedures designed to review information received from sub-advisers in wrap fee programs regarding their trading away practices. Specifically, the firm gives clients the opportunity to invest in separately managed wrap fee programs. In that program the sub-adviser has the discretion to not direct the execution of a particular equity trade through an executing broker other that Stifel (whose fees are covered by the wrap program) for which the client may be charged an additional fee – a practice called “trading away.” Until the first quarter of 2015 Stifel did not collect information on the costs of that practice from sub-advisers. After collecting that information in the first quarter of 2015 the firm distributed certain material to its financial advisors in a document summarizing select information about the trading away practices of the sub-advisers. That included a chart showing the percentage of time they traded away and the average cost. The document was not distributed to clients. The firm did update its client Brochures, noting that clients should contact their financial advisor for additional information regarding the practice. Thus clients were not informed regarding the amount of the additional trading away costs so the information could be considered in evaluating whether to use a particular sub-adviser. In resolving the case the firm took certain remedial steps including updating and expanding the disclosures in its client Brochure, initiating the collection of information from sub-advisers on the practice in the first quarter of 2015, adding questions on the point to a questionnaire sub-advisers complete, and giving notice to clients that additional information on sub-advisers was available. The firm also agreed to: implement undertakings which include upgrading its policies and procedures; designing and implement a way to provide clients and advisors in the program about trading away practices and costs; and developing training for financial advisors about the wrap fee program sub-advisers’ trading away practices and associated costs. In resolving the case the firm consented to the entry of a cease and desist order based on the Section cited in the Order and agreed to pay a penalty of $300,000.
Financial fraud: SEC v. Shakouri, Civil Action No. 2:17-cv-01929 (C.D. Cal. Filed March 10, 2017). The action charges five former executives of iPayment: Nasir Shakouri, senior vice president of sales and marketing; Robert Torino, at one point executive vice president and COO; Bronson Quon, vice president and corporate controller; John Hong vice president of information technology; and Jonathan Skarie, assistant vice president of merchant operations. The company provides credit and debit card payment processing services to small merchants. In May 2011 the firm completed debt offerings, registering notes with the Commission. The scheme had three key facets: 1) Expense reimbursements for equipment purchases on personal credit cards were submitted that were false; 2) a kickback scheme with two vendors used inflated invoices with the excess charges being kicked back; and 3) the firm’s books and records were falsified to funnel certain merchant payments to the Messrs. Shakouri and Torino. The complaint alleges violations of Exchange Act Sections 10(b), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5), 15(d) and 20(e) and Securities Act Section 15(b). The action is in litigation. A parallel criminal action was filed by the U.S. Attorney’s Office for the Central District of California against Messrs. Shakouri and Torino. See Lit. Rel. No. 23775 (March 10, 2017).
Manipulation: SEC v. Lek Securities Corporation, Civil Action No. 17-cv-1789 (S.D.N.Y. Filed March 10, 2017). The action centers on trading by Vali Management Partners d.b.a. Avalon FA Ltd. through Lek Securities Corporation. Avalon is a Seychelles entity based in Kiev, Ukraine. During the period of this action the trading firm had an account at defendant Lek Securities, a New York City registered broker-dealer. Defendant Sergey Puarwlnik is an undisclosed control person of Avalon. He was a foreign finder for LEK in late 2010 and early 2011 and then became a registered representative. He is also a close friend of defendant Nathan Fayyer, the sole owner and director of Avalon. Avalon began implementing two manipulative schemes through its account at Lek. The first, beginning in 2010, used spoofing or layering to generate profits of $21 million over a period of about six years. Generally, this involved using non-bona fide orders to move the market in one direction, then placing orders in the opposite direction to take advantage of the price movement and subsequently canceling the remaining non-bona fide orders. Avalon also engaged in cross-market manipulation schemes from August 2012 through the end of 2015. Essentially the schemes involved buying and selling U.S. stocks at a loss, creating an artificial price for the purpose of moving the corresponding options market prices and then profiting from the options and the return of the stock price once the trading ended. Lek Securities made the manipulations possible, according to the complaint, by giving Avalon access to the markets, improving the technology used and relaxing its layering controls following a complaint from the trader. Lek registered representative and undisclosed Avalon control person Puariolnik also aided the manipulation. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 9(a)(2) and 10(b). The case is in litigation. See Lit. Rel. No. 23776 (March 10, 2017).
Insider trading: U.S. v. Hobson (S.D.N.Y.) is an action in which investment adviser David Hobson previously pleaded guilty to one count of conspiracy to commit securities fraud and one count of securities fraud. This week he was sentenced to serve six months in prison. The charges were based on a scheme which took place from 2008 through April 2014 in which he traded on inside information obtained from his long-time friend, Michael Maciccio who was employed at a an unnamed Parma Co. Although the information Mr. Maciccio had was coded, he was able to discern the name of the other company so the two men could successfully trade. Mr. Hobson had about $150,000 in ill-gotten gains for himself and nearly $150,000 for his clients.
Whistleblowers: Somers v. Digital Realty Trust Inc., No. 15-17352 (9th Cir. Filed March 8, 2017). Plaintiff-Appellee Paul Somers was employed as a vice president at Defendant-Appellant Digital Realty Trust, Inc. During his four year tenure with the firm, which ended in 2014, he made several reports to senior management regarding possible securities law violations by the company. He was terminated. Prior to being terminated Mr. Somers did not report his concerns to the SEC.
Subsequently, Mr. Somers filed suit against Digital Realty alleging violations of Exchange Act Section 21F and other laws. That Section includes an anti-retaliation provision passed as part of Dodd-Frank. Defendant moved to dismiss in the District Court, arguing that Mr. Somers was not a whistleblower under Dodd-Frank. Specifically, Section 21F defines a whistleblower as “any individual who provides . . . information relating to a violation of the securities laws to the Commission. . .” Since Mr. Somers did not provide information to the SEC, Digital Realty argued he was not protected by the Section. The District Court denied the motion after an extensive examination of the statutes and their legislative history. That determination is in accord with Berman v. Neo@Ogilvy LLC, 801 F. 3rd 145 (2nd Cir. 2015) but contrary to the decision in Asadi v. G.E. Energy (USA) LLC, 720 F. 3d 620 (5th Cir. 2013). The District Court certified the question to the Ninth Circuit for review.
The Ninth Circuit affirmed. The case “must be seen against the background of twenty-first century statutes to curb securities abuses” the Court began. In 2002 Sarbanes-Oxley was passed to safeguard investors following a financial scandal. A key part of the Act requires internal reporting by lawyers working for public companies, a provision which is similar to the obligation imposed on auditors by the Exchange Act. SOX protects those professionals and others who lawfully provide information to federal agencies, Congress or, according to the statute, “a person with supervisory authority over the employee.”
Dodd-Frank, like SOX, was passed in the wake of a financial scandal. Section 21F contained a provision protecting whistleblowers from retaliation. The term whistleblower was defined as anyone who reports to the SEC “in a manner established, by rule or regulation, by the Commission.” The anti-retaliation provision provides protections to those who (i) furnish information to the SEC, (ii) testify or assist the Commission or (iii) make disclosures that are required or protected under SOX. This broad prescription evidences an intent to cover more than just those who report to the SEC since under SOX auditors, lawyers and others who report to their supervisor but not the Commission are protected. It would thus be illogical to confine the protections to only those who report to the Commission. While there is a split on this question between the Second and Fifth Circuits, the Court found that when the SOX and Dodd-Frank provisions are read together it is clear that the anti-retaliation provisions were designed to cover those who report to the Commission and internally.
Compliance procedures: The Securities and Futures Commission reprimanded DBS Vickers (Hong Kong) Ltd., and fined the firm $2 million for regulatory breaches regarding its internal control failures. Specifically, the firm self-reported that from June 2013 to September 2015 it had used client funds to settle obligations. Essentially it used excess margin in client accounts. This violated the regulator’s Client Money Rules which require segregation.
Insider trading: The Market Misconduct Tribunal found that Augustine Cheong Kai Tjieh and his mother, Gan Ser Soon, engaged in insider trading in the shares of Titan Petrochemicals Group Limited in January 2012. At the time the firm was facing possible default on certain obligations. Mr. Cheong obtained the information through his position as an executive at a Titan affiliate. The executive and his mother were ordered to pay disgorgement of $2,425,174, barred from dealing in Hong Kong and SFC regulated financial products for, respectively, two years and one year, directed not to engage in insider trading again and ordered to pay the costs of the investigation.