The Commission continued to focus on the markets this week, brining another action involving the operation of a partially dark pool. The ECN operator was a subsidiary of Citigroup. The SEC alleged that confidential customer information was used without permission.
The SEC also brought another FCPA case this week. The action centered on the efforts of gun manufacturer Smith & Wesson to enter the international markets without adequate preparation in terms of its internal controls and FCPA compliance systems. In addition, the agency also brought actions involving misappropriation, undisclosed conflicts, best execution and a microcap fraud.
Whistleblowers: The SEC announced an award of over $400,000 for a whistleblower who reported a fraud to the agency after the company failed to address the issue internally.
SEC Enforcement – Filed and Settled Actions
Statistics: This week the Commission filed, or announced the filing of, 2 civil injunctive action, DPAs, NPAs or reports and 7 administrative proceedings (excluding follow-on and Section 12(j) proceedings).
Misappropriation: SEC v. Tucker, Civil Action No. 7:14-cv-00398 (W.D. Va. Filed July 31, 2014) is an action against Donna J. Tucker, formerly a registered representative at a Virginia brokerage firm. Over a period of five years beginning in early 2008 Ms. Tucker is alleged to have misappropriated about $730,289 from client accounts at the firm and concealed that fact. In addition, she engaged in unauthorized trading. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). To resolve the action Ms. Tucker consented to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint. In addition, she agreed to pay disgorgement in the amount she is alleged to have misappropriated in either this case or the parallel criminal action.
Undisclosed conflicts: In the Matter of Jason D. Huntley, Adm. Proc. File No. 3-15994 (July 31, 2014). The Respondent was a registered investment adviser and president of Huntley Thatcher Ellsworth, Ltd. The action centers on a series of undisclosed conflicts in which the Respondent is alleged to have not informed investors that he: Obtained a loan from a fund where he placed their investments; recommended that they approve a transaction with another fund without telling them of his expected compensation; bought stock in their accounts without advising hem of his benefits; and solicited them to participate in a large private equity investment without disclosing his relationships to other parties in the transaction. The Order alleges a willful violation of Advisers Act Sections 206(1) and (2). To resolve the proceeding the Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. He is also barred from the brokerage and advisory business with a right to reapply after five years. In addition, Mr. Huntley will pay a civil penalty of $100,000.
Variable annuities: In the Matter of Michael A. Horowitz, Adm. Proc. File No. 3-15790 (July 31, 2014) is a previously filed proceeding naming as Respondents Mr. Horowitz and Moshe Marc Cohen. The Order alleged a scheme in which the Respondents made profits from the imminent deaths of the terminally ill as discussed in more detail here. Mr. Howowitz agreed to resolve the action, consenting to the entry of a cease and desist order based on Securities Act Section 17(a) and Exchange Act Sections 10(b), 15(a) and 17(a). In addition, he is barred from the securities business and from participating in any penny stock offering. He also agreed to pay disgorgement of $347,724, prejudgment interest and a civil penalty of $400,000. In entering into the settlement Mr. Horowitz made certain admissions set forth in Annex A to the Order which essentially recite the facts of the scheme.
Internal controls: In the Matter of Edward L. Cummings, CPA, Adm. Proc. File No. 3-15991 (July 30, 2014); In the Matter of Marc Sherman, Adm. Proc. File No. 3-15992 (July 30, 2014). Messrs. Sherman and Cummings founded QSGI, Inc., in 2001. The firm was a reseller of, and maintenance provider for, used computer equipment. Mr. Sherman served as CEO while Mr. Cummings acted as the CFO. The firm had inventory at facilities in New Jersey and Minnesota. QSGI had recurring inventory problems and could not account for items and parts in many instances. At the Minnesota facility the difficulties escalated beginning in 2007. While the company attempted to introduce new controls in 2008, it failed. In mid-2008 QSGI executed a revolving credit facility tied to its inventory. When the borrowing base, which was calculated based on inventory, was insufficient, Mr. Sherman would cause the firm not to report the calculations to the lender. To increase the base he would accelerate recognition of accounts receivable and/or the receipt of product into inventory. The lending base would then be recalculated. The inventory difficulties were not reported to the outside auditors. Rather, in management representation letters to the auditors affirmative misrepresentations were made or material facts were omitted. False management reports were included in filings made with the Commission. False certifications were also executed. Each of the Orders alleges violations of Exchange Act Sections 10(b), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) and the related rules. The proceeding as to Mr. Sherman will be set for hearing. Mr. Cummings resolved the proceeding in which he is named as a Respondent. He consented to the entry of a cease and desist order based on the Sections cited in the Order and the related rules. He is also denied the privilege of appearing and practicing before the Commission as an accountant with a right to reapply after 5 years. Mr. Cummings is precluded from serving as an officer or director of a public company for a period of five years. He will pay a civil money penalty of $23,000.
Microcap fraud: SEC v. MSGI Technology Solutions, Inc., Civil Action No. 14-cv-5820 (S.D.N.Y. Filed July 29, 2014) is an action against the company and its CEO, J. Jeremy Barbera. The complaint alleges that the defendants defrauded investors by touting a joint venture to develop and manage solar energy farms in conjunction with Christopher Plummer and his firm who were previously charged by the Commission. A detailed description of the scheme is here. The complaint alleges violations of Exchange Act Section 10(b). The case is in litigation. See Lit. Rel. No. 23052 (July 29, 2014).
Filings: In the Matter of Select Fidelity Transfer Services, Ltd., Adm. Proc. File No. 3-15989 (July 29, 2014) is a proceeding naming as a Respondent, the registered transfer agent. Since registering on June 20, 2005 the firm has failed to file its annual report on Form TA-2 and an amended Form TA-1. The firm has also declined to furnish required records to examiners or permit inspection. The Order alleges violations of Exchange Act Sections 17(a)(1) and (3) and 17(b)(1), 17A(c)(2) and 17A(d)(1). The proceeding will be set for hearing.
Best execution: In the Matter of Dominick & Dominick LLC, Adm. Proc. File No. 3-15987 (July 28, 2014) is a proceeding which names as Respondents, the registered investment adviser and its COO Robert X. Reilly. The Order alleges that for certain clients the adviser did not seek best execution in that the firm’s best execution analyses did not account for brokerage commissions. That analysis also did not include commissions being charged to advisory clients after a reduction in execution and clearing costs was obtained. In addition, the adviser did not adopt and implement written best execution policies and procedures, engaged in transactions with advisory clients on a principal basis without obtaining client consent first and made inaccurate statements in its Form ADV regarding best execution and principal transactions. The Order alleges violations of Advisers Act Sections 206(2), (3) and (4) and 207. To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order, except the order as to Mr. Reilly does not include Section 207. The firm also agreed to the entry of a censure and to pay disgorgement of $136,523 along with prejudgment interest and a civil penalty of $75,000. The firm agreed to certain undertakings. Mr. Reilly will pay a penalty of $10,000.
Adviser fraud: SEC v. Harbinger Capital Partners LLC, Civil Action No. 1:12 civ 05028 (S.D.N.Y.) is a previously filed action against the registered investment adviser, Philip Falcone, who controlled the adviser, and Peter Jenson who served as its managing director and COO. Mr. Jenson was charged as an aider and abettor to an improper loan made to Mr. Falcone from one of the managed funds. This week he settled, consenting to the entry of a final judgment of permanent injunction based on Exchange Act Section 10(b) and Advisers Act Sections 206(1), (2) and (4). He was also barred from the securities business with a right to apply for re-entry after two years and directed to pay a civil penalty of $200,000. In entering into the settlement Mr. Jensen made certain admissions which were appended to his consent and incorporated into the judgment. Those included admissions regarding his role in the making of the loan and that he aided and abetted violations by Mr. Falcone and Harbinger.
Inadequate procedures: In the Matter of LavaFlow, Inc. Adm. Proc. File No. 3-15985 (July 25, 2014). LavaFlow is a registered broker-dealer and an indirect subsidiary of Citigroup Global Markets, Inc. It operates LavaFlow ECN which generally functions as a marketplace for buyers and sellers of securities. LavaFlow ECN displays the top of its order book which is the best bid and best buy in the national market system. Other orders are not displayed. Lava Trading, a subsidiary of Citigroup, operates ColorBook, software that provided smart order routing services for over 100 registered broker-dealers that used it to route their customer orders to execution venues. As a smart order router, ColorBook applied preprogrammed analytics that carried out an execution strategy. Beginning in March 2008, and continuing for the next three years, LavaFlow permited ColorBook to access non-displayed trade information. It was used for smart order routing decisions for customers who also were subscribers of the ECN. LavaFlow did not obtain meaningful consent from its ECN subscribers to allow ColorBook to have access to direct subscriber non-displayed order flow information or to use it. In June 2008 Lava Trading, which had been a registered broker-dealer since 2005, withdrew its registration. Nevertheless, under an arrangement with Lava Trading from August 2008 through February 2009, Lava Trading received transaction-based compensation for broker-dealer services, including about $1.8 million for orders handled by the smart order router. The Order alleges willful violations of Rules 301(b)(2) and (10) of Regulation ATS and Exchange Act Section 15(a). Rule 301(b)(10) requires an ATS to establish adequate safeguards and procedures to protect subscribers’ confidential trading information and to have adequate oversight. This rule was violated by permitting ColorBook to have access to the direct subscriber non-displayed order flow information and use it to make routing decisions. Rule 301(b)(2) requires an ATS to amend its Form ATS before implementing a material change to its operation. That form was not amended here regarding the access of ColorBook. To resolve the proceeding LavaFlow consented to the entry of a cease and desist order based on the Rules and Section cited in the Order and to a censure. It also agreed to pay disgorgement of $1.8 million, prejudgment interest and a civil penalty of $2,850,000.
Financial fraud: SEC v. Volt Information Sciences, Inc., Civil Action No. 13-CV-237 (S.D.N.Y.) is a previously filed financial fraud action against the company, its former CFO, John Egan and a former CFO of a subsidiary, Debra Hobbs. The Court entered a final judgment and permanent injunction by consent against Mr. Egan, based on Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(b)(5), 13(a), 13(b)(2)(A) and 13(b)(2)(B). An officer or director bar was also imposed and a $35,000 civil penalty. In addition, the Commission instituted a Rule 102(e) administrative proceeding against Mr. Egan. The Commission acknowledged the cooperation of Ms. Hobbs and thus did not impose a financial penalty on her. See Lit. Rel. No. 23051 (July 25, 2014).
Adviser fraud: U.S. v. Tagliaferri, No. 1:13-cr-0115 (S.D.N.Y. Verdict July 24, 2014).
James Tagliaferri, the former President of TAG Virgin Islands, a registered investment adviser, was found guilty by a jury of one count of investment adviser fraud, six counts of violating the Travel Act, one count of securities fraud and four counts of wire fraud. Sentencing is scheduled for November 7, 2014. TAG began business in the U.S. Virgin Islands in 2007. That same year Mr. Tagliaferri began the first of three schemes charged here. He began placing client funds in a company located in Garden City, New York that was engaged in horse-racing. At least $40 million in client funds were invested. Unknown to those clients, Mr. Tagliaferri was paid at least $1.6 million in undisclosed kickbacks to place the client funds with the company. Second, client funds were used for improper purposes. Those included making payments to other clients who were demanding their funds and paying entities with which he was affiliated. Third, Mr. Taglaiferri also caused clients to invest in what he called “sub-notes.” These were purportedly obligations of a company located in Pennsylvania. The notes were supposed to make payments to TAG clients based on promissory note agreements between the Pennsylvania Company and TAG. In fact the notes were fictitious. The SEC filed a parallel action at about the time the criminal charges were brought. In the Matter of James S. Tagliaferri, Adm. Proc. File No. 3-15215 (February 21, 2013).
In the Matter of Smith & Wesson Holdings Corporation, Adm. Proc. File No. 3-15906 (July 28, 2014). Smith & Wesson sought to break into international markets beginning in 2007 without taking the proper preparation. This resulted in a series of FCPA violations. For example, in 2008 the firm retained a third party agent in Pakistan to assist in dealing with sales to a local police department. The agent told the company it would have to provide guns worth over $11,000 to the police department to obtain a deal. Additional cash payment would also be required. The gifts and payments were authorized. Ultimately Smith & Wesson sold 548 pistols to the Pakistani police for $210,980, yielding profits of $107,852. The next year the company sought to secure a contract to sell firearms to a police department in Indonesia. A third party agent told the company that payments would have to be made under the guise of legitimate firearms lab testing costs. The inflated payments were authorized. No deal was consummated. The company also authorized improper payments through a third party agent in Nepal and Bangladesh. No contracts were obtained. Indeed, by the time the improper conduct surfaced, the company had only secured one contract. Throughout the period Smith & Wesson had inadequate internal controls and FCPA policies and procedures. The Order alleges violations of Exchange Act Sections 30A, 13(b)(2)(A) and 12(b)(2)(B). The Commission acknowledged the cooperation of the firm. The company also agreed to a series of undertakings and consented to the entry of a cease and desist order based on the Sections cited in the Order. It will pay disgorgement of $107,852, prejudgment interest and a civil penalty of $1,906,000. The Department of Justice declined prosecution according to a recent company filing.
Report: The Australian Securities and Investments Commission issued a report on its enforcement activities for the first six months of 2014 which is available here.
Advertisement: The Securities and Futures Commission reprimanded Bright Smart Securities International, a subsidiary of BS Group Ltd., and fined the firm $700,000 in connection with certain false advertisings. Specifically, from late August through mid-September 2013 in news papers and on its website the firm gave the impression that its gold bullion business is regulated and that its subsidiary Bright Smart Global Bullion Ltd. is regulated by the SFC when in fact it was not.