This Week In Securities Litigation (The week ending January 24, 2014)

by Dorsey & Whitney LLP

The insider trading trial of former SAC Capital employee Matthew Martoma continued this week. The SEC filed one new administrative proceeding this week as Washington, D.C. and much of the East coast was blanketed with snow and chilled by plunging temperatures,. That action centered on a series of audit failures by a sole practitioner who typically did tax work. The agency also settled a previously filed fraud action.

The Commission prevailed in the Ninth Circuit in an action which challenged its order affirming a FINRA determination. The case centered on the sale of unregistered securities.

Finally, the Initial Decision was issued in the proceeding against the PRC based affiliates of five international accounting firms for failing to produce audit work papers as requested by the SEC. The firms should be suspended from appearing or practicing before the Commission as accounts for a period of six months, according to the Decision.


Remarks: Commissioner Daniel M. Gallagher, delivered remarks titled The Philosophies of Capital Requirements, Washington, D.C. (January 15, 2014). In his remarks the Commissioner discusses the theory of capital requirements and concludes they are not appropriate for money market funds (here).

Remarks: Commissioner Luis A. Aguilar delivered remarks titled Making A Difference Through Public Service at the Latino on Fast Track Symposium, Hispanic Heritage Foundation, Washington, D.C. (January 15, 2014). His remarks focused on public service (here).

Initial Decision

Production of work papers: In the Matter of BDO China Dahua CPA Co., Ltd., Adm Proc. File No. 3-14872 (Initial Decision January 22, 2014) is the proceeding against the PRC based affiliates of five international accounting firms, BDO, Ernst & Young, KPMG, Deloitte Touche and PWC. The Initial Decision, much of which is redacted, concluded that each of the firms failed to produce audit work paper in accord with its obligations under the Sarbanes Oxley Act. That failure constitutes a violation of the securities laws and thus a violation of Rule 102(e) of the Commission’s Rules of Practice. According, each firm was suspended from appearing or practicing before the Commission as an accountant for a period of six months. The underlying proceedings are discussed here.

SEC Enforcement – filed and settled actions

Weekly statistics: This week the Commission filed, or announced the filing of, no civil injunctive district court actions, DPAs or NPAs and one administrative proceeding (excluding follow-on actions and 12(j) proceedings).

Misappropriation: SEC v. Hochfeld, Civil Action No. 12-cv-8202 (S.D.N.Y.) is a previously filed action against Berton Hochfeld and his wholly-owned entity, Hochfeld Capital Management, LLC. The action focused on the misappropriation of assets and material misrepresentations made to investors in the Heppelwhite Fund L.P. The Court entered final judgments against the defendants prohibiting future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Action 206. The Court also ordered disgorgement of $1,785,332 which will be deemed satisfied by a forfeiture order in a parallel criminal case in which Mr. Hochfeld pleaded guilty to securities and wire fraud. See Lit. Rel. No. 22908 (Jan. 23, 2014).

Misrepresentations: In the Matter of Brian Williamson, Adm. Proc. File No. 3-15430 (Filed August 20, 2013) is a previously filed proceeding which named as a Respondent Brian Williamson, formerly an employee of Oppenheimer & Co., Inc. He was also the sole owner and Managing Director of ROC Resources, LLC, a registered investment adviser that is a sub-adviser to Oppenheimer Global Resources Private Equity Fund I, L.P. From September 2009 through mid-October 2009 Mr. Williamson caused investors in OGR to receive marketing materials which were false and misleading because they did not show the fees and expenses charged which lowered the reported internal rate of return. He also misrepresented to investors the basis on which the fund’s assets were valued. The Order claimed that steps were taken to conceal those misrepresentations. The Order alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206(4). This week Mr. Williamson resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Mr. Williamson agreed to be barred from the securities business with a right to apply for reentry after two years. He also agreed to pay a $100,000 civil penalty.

Audit failure: In the Matter of Eugene M. Egebert III, CPA, Adm. Proc. File No. 3-15680 (January 17, 2014) is a proceeding which charges Respondent Egebert, a sole proprietor who does largely tax work and has little auditing training or experience, with a series of what are essentially audit failures. Specifically, Mr. Egebert executed unqualified audit opinions on the financial statements of Fox Petroleum, Inc., for the fiscal years ended February 28, 2010, 2011 and 2012 and for RPM Advantage, Inc. for the fiscal years ended December 31, 2006 through December 31, 2010. Both firms were public companies whose shares were registered with the Commission under Section 12(g) of the Exchange Act. As to each engagement the Order alleges that Respondent: Failed to properly plan the engagement; failed to properly document the engagement; failed to contact his predecessor as required; and did not obtain the required engagement quality review. In addition, as to Fox Petroleum he failed to: Exercise the appropriate due professional care or skepticism by not obtaining sufficient evidential matter as to, for example, the large accounts payable balance and instead accepted management’s representations; follow-up on an observation that the unrecorded liabilities he flagged as a potential fraud risk other than to note that his concerns were allied by the company’s unexplained “overhauled financials;” and implausibly claimed to have conducted an audit of two acquired subsidiaries for which there is no documentation in less than forty hours. As to RPM Advantage, Respondent apparently failed to conduct any audit since the financial statements were not even arithmetically correct. The Order alleges violations of Section 102(e)(1) of the Commission’s Rules of Practice. The proceeding will be set for hearing.

Criminal actions

Investment fund fraud: U.S. v. Efrosman, No. 1:06-cr-00095 (E.D.N.Y.) is an action against Mr. Aleksander Efrosman who was convicted of wire fraud after he fled to Poland. This week he was sentenced to serve 188 months in prison. From January 2004 through June 2005 he raised about $5 million from over 100 investors. He convinced investors that he had a trading system for stock and foreign currency exchange and that they would be protected by a “stop-loss” mechanism that ensured no trade would lose more than 3%. In fact he misappropriated much of the money.

Court of appeals

Unregistered sale of securities: World Trade Financial Corporation v. U.S. Securities and Exchange Commission, No. 12-70681 (9th Cir. Opinion Filed January 16, 2014) is an appeal of a Commission order affirming a FINRA determination that broker dealer World Trade and three of its employees, Jason Adams, Rodney Michel and Frank Brickell, violated Securities Act Sections 5(a) and 5(c). The action centers on the sale of shares of IStorage, a firm which was the product of a reverse merger between Camryn Information Services, Inc., a public shell company, and IStorage, a development stage firm, in November 2004. At the time of the merger IStorage had four shareholders, each of whom owned 12.5% of the outstanding shares. At the request of a law firm representing the shareholders, an opinion letter was issued stating that the shares need not be restricted because, among other things, none of the shareholders had been an officer, director or 10% shareholder of the company for the previous three months. The opinion was incorrect. Nevertheless, the transfer agent removed the legends. A forward stock split followed which gave the three shareholders 5.2 million shares evidenced by certificates that were not restricted. The shareholders then paid three individuals to promote the stock. Payment was in shares.

Each promoter subsequently opened an account at World Trade. From mid-December 2004 through late March 2005 World Trade sold about 2.3 million shares of IStorage stock to the public. Mr. Brickell, as COO, believed, as did the others, that his role was limited to checking with the transfer agent. Accordingly, he failed to make any inquiry into the status or origins of the shares.

The Ninth Circuit rejected each challenge to the Commission’s order presented by the firm and its principals. First, Petitioners argued that the broker’s exemption applied here. Petitioners claimed that the SEC had the burden of demonstrating that the Section 4(4) exemption was “vitiated because of the presence of a statutory underwriter.” This, the Court concluded, is contrary to established law. Once FINRA established a prima facie case that the transactions violated Section 5, the burden shifted to Petitioners to demonstrate the applicability of the claimed brokers’ exemption.

Second, it is well established that a broker must conduct a “reasonable inquiry” to claim a Section 4(4) exemption. A broker is not a “mere order taker.” Rather, the broker must conduct an inquiry which may vary in scope depending on the facts and circumstances of the transaction. In some instances the inquiry may be brief while in others a more extensive analysis may be required. Here there was none. Third, Petitioners claim that the Commission erred by finding that the firm’s supervisory system was inadequate is also incorrect. NASD Rule 3010 requires member firms to establish, maintain, implement and enforce supervisory systems that are tailored to their business and reasonably designed to achieve compliance. That means doing more than relying on the presence or absence of restrictive legends. This is particularly true here in view of the numerous red flags surrounding the transaction.

Finally, the Court rejected claims that the sanctions were inappropriate. To the contrary, they were in the mid-range of FINRA’s sanction guidelines. In addition, the evidence supported the fact that the violations were egregious. Accordingly, the petition was denied.


Investment fund fraud: The Australian Securities & Investment Commission charged John Jones with two counts of fraudulently misappropriating a total of $260,000. In 2006 he solicited two investors for the purpose of share trading. Specifically, he convinced the investors that he was an experienced trader and had a scheme that would provide them with reliable returns of between 12% and 30% per year. Rather than invest the funds he misappropriated them.


Regulations: The European Court of Justice dismissed the U.K.’s challenge to the Short Selling Regulation adopted by ESMA as an emergency measure. The U.K. claimed that the adoption of such an emergency measure was contrary to general EU principles. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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