The high profile insider trading trial of Matthew Martoma moved forward in New York this week with testimony on behalf of the prosecution. The SEC and four other agencies joined in granting relief from a provision of the Volker Rule which an American Bankers Association suit claimed would harm community banks.

SEC enforcement had mixed results in court. In one circumstantial insider trading case, the court found against the agency following a bench trial. In another, a jury rejected a Commission insider trading claim but found in its favor on front running and false statement charges. The Commission also filed two settled actions, one alleging financial fraud and the other the unregistered sale of securities.

SEC

Volker rule: The SEC and four other agencies approved an interim final rule to permit banking entities to retain interests in certain CDOs backed primarily by trust preferred securities (here). The new rule follows a suit filed by the American Bankers Association arguing that the Volker Rule as initially written would require harm community banks by forcing them to immediately divest certain CDO such holdings (here).

Municipal securities: The Commission’s Office of Municipal Securities issued interpretive guidance to address questions regarding the implementation of new final rules requiring that municipal advisors register with the agency (here).

SEC Enforcement – litigated actions

Insider trading/front running: SEC v. Yang, Case No. 12-cv-02473 (N.D. Ill. Filed April 4, 2012) is an action centered on the March 27, 2012 announcement by Xianfu Zhu, Chairman and CEO of Zhongpin Inc., that he had submitted a non-binding proposal to take the company private by purchasing all the outstanding shares. The price would be $13.50 per share, a 46% increase over the closing price the prior day. The meat and food processing company is based in Changge City, Henan Province China. The initial complaint, naming seven defendants, was filed just eight days after the deal announcement. The initial defendants were Siming Yang, a New York City resident who at one time was employed by a New York City registered broker dealer and investment adviser; Prestige Trade Investment Ltd., a company created in January 2012 by defendant Yang; Caiyin Fan, a PRC citizen and resident who had a joint brokerage account with defendant Yang; and Shui Chong (Eric) Chang, a resident of Hong Kong formerly employed at Deutsche Bank Securities, New York City; and three others.

The complaint was based largely on what it called “suspicious” trading and “information and belief.” For example shortly before the deal announcement, it alleged that: Defendants Yang and Fan purchased 2,571 call options and 58,000 shares of Zhongpin stock yielded post announcement profits of $733,006; Prestige purchased over 3 million shares of stock shortly yielding illicit gains of $7.6 million; and Defendant Chang purchased 4,035 call options and 32,500 shares of stock yielding unrealized insider trading profits of $828,188. The complaint \failed to identify any source of inside information to support the claim of insider trading. It alleged violations of Exchange Act Section 10(b).

An amended complaint reformulated the case, shifting the focus from suspicious trading to front running and false filings while retaining the insider trading claim. Thus the amended complaint focused on Mr. Yang, his company and how the trading was conducted. It alleged that Mr. Yang, while employed as a research analyst, traveled to China and raised $30 million to start-up Prestige. Subsequently, Mr. Yang made his personal purchases of Zhongping stock which were followed by the huge Prestige’s acquisitions he ordered for the fund. On April 2, 2012 Prestige filed a Schedule 13D with the Commission. It disclosed the holdings of the firm but not those of Mr. Yang. The amended complaint also alleged a possible source of inside information — a confidential investment banking document discussing the deal found deleted on his firm computer. The complaint alleged violations of Exchange Act Sections 10(b), 13(d) and Advisers Act Sections 206(1) and (2).

Mr. Yang and Prestige went to trial. Three claims were presented to the jury: Claim I: insider trading by both defendants; Claim II, front running by Mr. Yang; Claim II, false SEC filing by Mr. Yang; and Claim III, false SEC filing by Mr. Yang. The jury found in favor of both defendants on Claim I and for the SEC on each of the remaining claims. The Court will consider remedies at a later date.

Insider trading: SEC v. Schvacho, Civil Action No. 1:12-cv-02557 (N.D. Ga. Decision on Jan. 7, 2014) is an action against Ladislav or Larry Schvacho, a retired employee of Cisco Systems. It centers on claims that Mr. Schvacho misappropriated material, non-public information from his longtime friend Larry Enterline, CEO of Comsys IT Partners Inc., regarding its then pending acquisition by Manpower, Inc., announced on February 2, 2010. Specifically, in advance of that announcement Mr. Schvacho was alleged to have built a significant position in the shares of Comsys while in possession of inside information he was either told in confidence by, or overheard from, his friend.

The Commission’s claims were based on inferences from repeated communications and contacts between the two men which included numerous telephone calls, several text messages, a dinner, a boat trip and a meeting at the airport. The Commission did not have evidence regarding the content of the communications between the two men. Following the announcement of the deal Mr. Ladislav sold his shares of Comsys, garnering profits of over $500,000. The complaint alleged violations of Exchange Act Sections 10(b) and 14(e).

Following a two day bench trial the Court found in favor of the defendant and against the Commission. Central to the SEC’s claims was a pattern of communications and contacts, events regarding the progress of the transaction, communications between the two men and and securities purchases. The Court found this pattern insufficient to establish insider trading. The Court also rejected SEC claims that the defendant overheard conversations of his friend about the deal, noting that no witness was called to testify on this point. Likewise, the Court rejected claims that Mr. Schvacho may have obtained inside information about the deal by viewing documents in Mr. Enterline’s brief case while on a sailing trip in view of undisputed testimony that there were no materials about the deal in the brief case. Finally, the Court found the testimony of Messrs. Evterline and Schvacho and their denials credible.

SEC Enforcement – filed and settled actions

Weekly statistics: This week the Commission filed, or announced the filing of, 1 civil injunctive district court action, DPA or NPA and 1 administrative proceeding (excluding follow-on actions and 12(j) proceedings).

Fraudulent shell sale: SEC v. Alternative Green Technologies, Inc., Civil Action No. 11-cv-9056 (S.D.N.Y.) is a previously filed action against the company, Mitchell Segal, Belmont Partners LLC, Joseph Meuse, Howard Borg, David Ryan, Vilkram Khanna and Panascope Capital Inc. This action centered on a shell packing group which facilitated fraudulent stock promotion. This week the Commission settled with Belmont Partners and Joseph Meuse, the firm’s CEO. They were in the business of identifying and sellng public shell companies for use in reverse mergers, according to the agency. In the settlement the two defendants consented to the entry of permanent injunctions prohibiting future violations of Securities Act Section 5 and Exchange Act Section 10(b). In addition, they will pay $224,500 and Mr. Meuse will be barred from the penny stock business or from serving as an officer or director of a public company for at least five years.

Financial fraud: SEC v. Hohol, 2:14-CV-00041 (E.D. Wis. Filed January 14, 2014) names as defendants Christopher Hohol and Brian Poshak, both senior executives at Veolia Environmental Services Special Services. That firm is a U.S. subsidiary of Paris based multi-national Veolia Environment S.A. whose ADRs are registered with the SEC under the Exchange Act. From 2008 through early 2011 Mr. Hohol, who exercised full control over Special Services, directed that his subordinates, including Mr. Poshak fraudulently inflate the financial results of the subsidiary so that they would conform to projections. Using threats and intimidation, he caused Mr. Poshak and those reporting to him, to book falsified entries which included fictitious revenue accruals, entries that improperly reclassified certain expenses as inventory and others that wrongly recorded select expenses as prepaid assets. To conceal the false accounting entries Mr. Poshak, altered, or caused to be altered, the firm’s supporting documents which were also made available to the outside auditors. In addition, Messrs. Poshk and Hohol circumvented the internal controls of the firm by executing false monthly financial and internal control attestations. Each defendant benefited from the fraud. Mr. Hohol was paid a total of $136,000 in bonuses while Mr. Poshak received $28,000. As a result of the fraud, Special Services overstated its EBT by a total of about $64 million during the relevant period. This caused the overstatement of operating income in Veolia’s consolidated financial statements for the years 2008 through 2010 in the same amounts. After learning of the fraud Veolia corrected the overstatements for each of the years on a retrospective basis in its 2011 annual report that was filed with the Commission. The complaint alleges violations of Exchange Act Sections 13(b)(2)(A and 13(b)(5). See Lit. Rel. No. 22906 (January 14, 2014).

To resolve the matter, each defendant consented to the entry of a permanent injunction based on the Sections cited in the complaint. In addition, Mr. Hohol agreed to pay disgorgement of $106,000 along with prejudgment interest. Mr. Poshak agreed to pay disgorgement of $28,000 together with prejudgment interest. The settlements consider the current financial condition of each defendant and are subject to court approval.

Sale unregistered securities: In the Matter of Richard D. Hicks, Adm. Proc. File No. 3-15413 (January 14, 2013) is a proceeding which centers on the sale of the unregistered securities of National Note of Utah, L.C. by Mr. Hicks to clients of Elder Advisory Services, a firm he founded and controlled. National Note claimed to purchase, manage and sell real property and loans backed by real property interests. Its notes were represented to pay a guaranteed return of 12% per year. Elder Advisory assists people whose family members need to enter care facilities. Over a six year period beginning in 2006, Mr. Hicks offered and sold over $1.8 million of National Note securities to 12 investors. The investments came largely from retirement funds. At least half of the investors were not accredited. In soliciting the investments Mr. Hicks provided prospective investors with a sales packet which contained certain misrepresentation. Mr. Hicks also made oral misrepresentations. By the fall of 2010 National Note was having difficulty making some payments to investors. By about September 2011 it was no longer able to make any payments. The Order alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). To resolve the proceeding Mr. Hicks consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, he was barred from the securities business and from participating in any penny stock offering. Mr. Hicks submitted evidence of an inability to pay disgorgement or any financial penalty. Previously, National Note was named as a defendant in a Commission enforcement action.

Insider trading: SEC v. Murrell, Civil Action No. 2:13-cv-12856 (E.D. Mich.) is a previously filed action against Mack Murrell and Charles Adams. It alleged that Mr. Murrell, a former vice president at The Dow Chemical Company, unlawfully tipped his longtime friend David Teekell of a then pending deal in which his employer would acquire Rohm & Haas Company. Mr. Teekell in turn illegally tipped his broker, Charles Adams. This week the Court entered final judgments of permanent injunction by consent against Messrs. Murrell and Adams which preclude future violations of Exchange Act Section 10(b). In addition, Mr. Murrell was ordered to pay a civil penalty of $367,250 and barred from serving as an officer or director of a public company. Mr. Adams was directed to pay disgorgement of $64,450 along with prejudgment interest and a civil penalty in the amount of $107,046. Relief defendant Raymond James, where Mr. Adams was previously employed, was directed to disgorge $373,497 along with prejudgment interest as a result of certain trades by Mr. Teekell. See Lit. Rel. No. 22904 (January 14, 2014).

Hong Kong

False statements: Roger Tsui Chi Fung, who is licensed under the Securities and Futures Ordinance, was fined $8,000 and ordered to pay investigative costs following his conviction for making false statements to the Securities and Futures Commission. In his annual licensing return he failed to state that he had been sanctioned by FINRA.

Manipulation: The Court ordered Tsoi Bun, formerly a licensed futures trader, to pay restitution in the amount of $13,688,950 to about 500 investors based on his conviction for, and admission of, market manipulation. From mid-February 2007 through July 2009 the defendant was found to have, or admitted to manipulating, the prices of certain futures contracts on 29 days. The defendant made the admissions following his conviction of five counts of manipulation. This is the first criminal manipulation case related to the Hong Kong futures market prosecuted by the Securities and Futures Commission.

Manipulation: The Securities and Futures Commission announced that the convictions of broker Chan Yuk Hing and his client, Paul Frederic Chane Yin for market manipulation were upheld. Mr. Chan purchased 50,000 shares of Multifield through his broker, Mr. Chan, at an average price of about $0.22 during the trading day on November 23, 2009. Shortly before the close he had his broker place a trade for a share at $1.00 which was executed. At the close he then sold his other shares at an average price of about $0.42. The Court concluded that the trading was not genuine because it was designed to artificially inflate the price.

Unauthorized trading: The SFC banned Poon Ming Pui, a representative at China International Capital Corporation, for a period of ten months. The action was taken because from June 2005 through April 2011 Mr. Pooh traded through accounts of clients without their knowledge. Although no client suffered a loss, the actions and their duration call into question his fitness and properness as a licensed person. The sanction takes into account Mr. Pooh’s cooperation.