Insider trading and fraudulent investment schemes were the focus of SEC enforcement this week. The Commission filed insider trading actions tied to the massive BP oil spill, clinical trials for a drug and the expert network investigations. The Commission also filed a stop order proceeding, an action centered on a multi-level pyramid scheme tied to internet phone service and an offering fraud action.
Rule making: The Commission issued proposed rules regarding security-based swaps under Dodd-Frank. Specifically, the proposals focus on record keeping, reporting and notification requirements for security-based swap dealers and major market participants (here).
Remarks: Commissioner Luis Aguilar delivered remarks titled “Looking at Corporate Governance From The Investor’s Perspective,” at the Emory University School of Law Corporate Governance Lecture Series, Atlanta, Georgia (April 21, 2014). His remarks included comments on investors as a source of capital, accountability, executive compensation, say-on-pay, transparency and related disclosure rules (here).
SEC Enforcement – Filed and Settled Actions
Statistics: This week the Commission filed, or announced the filing of, 5 civil injunctive actions, DPAs, NPAs or reports and 1 administrative proceeding (excluding follow-on and Section 12(j) proceedings).
Insider trading: SEC v. Choi (S.D.N.Y. Filed April 23, 2014) is an action against Chris Choi, an accounting manager at Nvidia Corporation. He was friends with Hyung Lim who in turn was friends with Danny Kuo, a hedge fund manager at Whittier Trust Company. On three instances in 2010 and 2011 Mr. Choi furnished his friend inside information regarding a pending earnings announcement for his company. In each instance that information was passed to Mr. Kuo who caused the hedge fund employing him to trade. In one instance that information was passed on to others involved in the expert network cases who also traded. The first concerned the the May 7, 2009 earnings announcement of negative news. Following Nvidia’s announcement that its financial results were worse than had been expected it share price fell. Whittier had profits/avoided losses of $144,000. The others who traded, Diamondback, Level Sigma Capital and Level Global had profits/losses avoided of, respectively: $73,000, $500,000; and $15.6 million. The second tip concerned the financial results for the third quarter 2010, announced November 5, 2009 which was positive news. Whittier had trading profits of over $44,000. The third tip involved the financial results for the third quarter of 2011, announced after the close of the market on November 11, 2010. Whittier had profits of $105,000. The complaint, which states that Mr. Choi is responsible for the trading by Whittier and each of the other funds that traded, alleged violations of Exchange Act Section 10(b) and Securities Act Section 17(a). Mr. Choi resolved the charges, consenting to the entry of a permanent injunction prohibiting future violations of each of the Sections cited in the complaint. He also agreed to pay a civil penalty of $30,000 and to the entry of an order barring him from serving as an officer or director of a public company for five years.
Pyramid scheme: SEC v. TelexFree Inc., Civil Action No. 1:14-cv-11858 (D. Mass. Filed April 15, 2014). The action names as defendants the company and TelexFree, LLC along with two groups of individual defendants. One group is the principals – James Merrill, Carlos Wanzeler, Steven Labriola and Joseph Craft. The second group is the promoters – Sanderley Rodrigues de Vasconcellos, Santiago De La Rosa and Faith Sloan. Since 2012 TelexFree claims to have operated a multi-level marketing company based on a VoIP business, centered on its “99TelexFree” VoIP service which provided inexpensive phone service over the internet. The firm business model had two key components which promised investors returns as high as 200%. An investor could become a “member” or “partner” by purchasing a membership which the complaint alleges is a security. Profits could come from either: 1) placing internet advertisements for the company and recruiting new members and/or 2) selling the VoIP service. Under this business model promoters were promised large returns even if they were unable to sell the VoIP service. The slogan repeated over and over was that “everybody gets paid weekly.” This business model resulted in a huge volume of virtually identical internet advertisements and few sales of the VoIP service. As a result there were insufficient funds to pay investors without using other investor funds. When the firm changed the business model, investors who had been solicited with a series of misrepresentations about the firm and its backers, protested. Portions of the investor funds were diverted to personal accounts of the defendants. Eventually the firm filed for bankruptcy. The Commission filed its complaint under seal the next day. That complaint alleges violations of Exchange Act Section 10(b) and Securities Act Sections 5(a), 5(c) and 17(a). The case is pending. See Lit. Rel. No. 22976 (April 17, 2014).
Insider trading: SEC v. Itri (D.N.J. Filed April 21, 2014) is an action against three defendants: Dr. Loretta M. Itri; Dr. Neil T. Moskowitz; and Mathew Cashin. Dr. Itri was the President of Pharmaceutical Development and Chief Medical Officer of Genta, Inc. from 2003 until the firm filed for bankruptcy in 2012. Dr. Moskowitz is an emergency room physician; and Mr. Cashin was a patient of Dr. Moskowitz in the emergency room. This case centers on the October 29, 2009 announcing by Genta regarding the Phase 3 clinical trial results for its new drug. In that announcement the firm stated that the Phase 3 trials were disappointing. The share price dropped significantly, from $0.66 to $0.20. At the beginning of the Phase III trials the company hoped that it would shortly be able to market the drug. During the trials Dr. Itri had continuing access to information regarding the trials. The day before the results were to be announced Dr. Itri had two brief telephone calls with her long time friend Dr. Moskowitz. Within minutes of those calls Dr. Moskowtz liquidated his entire position in firm securities. Later the same morning Dr. Moskowitz called Mr. Cashin, who has purchased Genta shares based on their discussions. Mr. Cashin sold his shares and instructed other family members to do the same. The Commission’s complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). Each defendant resolved the charges, consenting to the entry of permanent injunctions precluding future violations of the Sections cited in the complaint. In addition, Dr. Itri will pay a civil penalty of approximately $64,000. The order also bars her from serving as an officer or director of a public company for five years. Dr. Moskowitz is required to return $64,300 of ill-gotten gains, pay prejudgment interest and a civil penalty equal to the amount of the repayment. Mr. Cashin will return $75,140 of allegedly ill-gotten gains, pay prejudgment interest on that sum and a civil penalty of $37,570. This resolution acknowledges his cooperation.
Stop order: In the Matter of The Registration Statement of Comp Services, Inc., Adm. Proc. File No. 3-15853 (April 23, 2014) is a stop order proceeding against the registration statement of Comp Services, Inc. The Form S-1 was amended several times before it went effective. Additional post effective amendments were filed. The Order charges that the registration statement is false and misleading because it fails to disclose the control person and makes misstatements about its revenue. The company consented to the Order.
Offering fraud: SEC v. Vitale, Civil Action No. 1:14-cv-60954 (S.D. Fla. Filed April 23, 2014) is an action against Robert Vitale and his firm Realty Acquisitions & Trust, Inc. The complaint alleges that the defendants conducted four real estate offering, raising about $8.7 million from investors based on a series of misrepresentations. Those misrepresentations focused on Mr. Vitale’s background and the safety of the investments. The complaint alleges violations of Securities Act Sections 5(a) and 17(a) and Exchange Act Sections 10(b) and 15(a). Mr. Vitale is currently in prison after being convicted of obstructing a Commission investigation. The case is pending. See Lit. Rel. No. 22977 (April 23, 2014).
Investment fund fraud: SEC v. Persaud, Civil Action No. 12-cv-932 (M.D. Fla.) is a previously filed action against Gurudeo Persaud, a registered representative who ran an investment fund on the side. Previously he consented to the entry of a permanent injunction based on Advisers Act Sections 206(1), (2) and (4) and agreed to pay disgorgement of $121,926.94. The penalty claim was dismissed when Mr. Persaund pleaded guilty to parallel criminal charges, was ordered to serve three years in prison and to pay restitution of $948,340. On January 29, 2014 the Court granted the Commission’s motion for summary judgment based on Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The Court imposed injunctions based on those Sections and directed him to pay disgorgement and civil penalties. See Lit. Rel. No. 22976 (April 23, 2014).
Insider trading: SEC v. Seilhan, Civil Action No. 2:14-cv-00893 (E.D. La. Filed April 17, 2014) is an action against Keith Seihlan, a former BP employee, alleging that he sold firm securities while in possession of material non-public information regarding the severity of the oil spill. Shortly after the Deepwater Horizon platform exploded and sank into the Gulf of Mexico in April 2010, the federal government established Unified Command or UC to coordinate the response. Mr. Seillhan was deployed to the UC and served as an Incident Commander and an On-Scene Coordinator within it. During the time period he held those positions, the UC and BP issued press releases estimating the flow rate of oil into the Gulf to be at first 1,000 barrels per day and later 5,000 barrels. Mr. Seillhan had information through his position at BP which estimated that the flow rate may be significantly more, according to the complaint. After the flow of oil was capped it was established that in fact the flow rate was significantly higher than disclosed. Prior to that disclosure, Mr. Seilhan liquidated all of the BP securities held in his account and those of his family which were valued at nearly $1 million. Later, after the corrective announcement, he repurchased a substantial block of BP securities. The Commission’s complaint alleges that Mr. Seilhan sold his BP securities on April 29 and 30 while in possession of material non-public information. Those sales were made in violation of Exchange Act Section 10(b) and Securities Act Section 17(a), according to the complaint. To resolve the case Mr. Seilhan consented to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint. He also agreed to pay disgorgement of $105,409, prejudgment interest and a civil penalty equal to the amount of the disgorgement. See Lit. Rel. No. 22975 (April 17, 2014).
Arbitration: The FINRA Board of Governors concluded that Charles Schwab & Co. violated FINRA rules when the firm attempted to keep investors from participating in judicial class actions by adding waiver language to customer account agreements. Specifically, the Board affirmed in part and reversed in part a hearing panel’s determination regarding provisions inserted into the Charles Schwab & Co. customer agreements regarding a waiver which required that customers agree that any claims against the firm be arbitrated solely on an individual basis and that arbitrators had no authority to consolidate more than one party’s claims. The hearing panel had concluded that Schwab’s attempt to prevent FINRA arbitrators from consolidating more than one party’s claims violated FINRA rules. The Board upheld this ruling. The panel also found that Schwab’s waiver violated FINRA rules but concluded that FINRA could not enforce those rules because the conflicted with the Federal Arbitration Act. The Board overturned that determination. The proceeding was going to be remanded for further action but the firm resolved the matter, agreeing to pay a fine of $500,000 and revise its customer agreements.
Supervision Rule: The FINRA board approved amendments to the supervision rule that would expand the obligations of firms to conduct background checks regarding applicants for registration.
Financial fraud: The sole director of brokerage Sonray Capital Markets Pty Ltd, Russell Johnson, was sentenced to serve six and one half years in prison in connection with the collapse of the firm. At the time of its collapse the firm, which was one of the first in Australia that provided advice on contracts for a difference, owned more than $46 million. Mr. Johnson was charged with multiple offenses, including false accounting, theft, deception and conspiracy. He will be eligible for parole in three and one half years. Previously, the CEO of the firm, Scott Murray, was sentenced to serve five years in prison with a non-parole period of two years and one half years on charges related to the collapse of the firm.
Internal controls: The Securities and Futures Commission fined The Royal Bank of Scotland PLC $6 million for internal control failings. Specifically, on October 15, 2011 the financial institution contacted the SFC and reported anomalies in the trading of Shirlina Tsang Pui Yu who had engaged in unauthorized trading on its Emerging Markets Rates Desk, Hong Kong branch. An inquiry determined that Ms. Tsang engaged in unauthorized trading and mismarked transactions over a three year period, causing losses to RBS of £24.4 million. The activity had been concealed by mismarking her bond positions and booking and cancelling and amending fictitious bonds and futures trades in the internal system. The inquiry also demonstrated that RBS’s internal systems were inadequate and ineffective and that those deficiencies permitted Ms. Tsang’s activities. The regulator considered the fact that the bank self-reported and that there were no customer loses in determining the outcome of the case.