This Week In Securities Litigation (Week ending April 17, 2014)

by Dorsey & Whitney LLP

High speed trading continued to be a central focus in this shortened week with the markets closed on Friday. The New York Attorney General has reportedly issued subpoenas to three firms for information regarding their arrangements with exchanges, dark pools and high speed trading, according to Bloomberg. The Department of Justice and FBI previously acknowledged investigating the practice. The SEC reportedly is also investing high speed trading.

The Commission largely prevailed in a challenge to its Dodd-Frank conflict minerals rules in the D.C. Circuit. The agency also brought an insider trading case, and investment fraud action and a proceeding centered on fee splitting this week.


Remarks: Gregg Berman, Associate Director, Office of Analytics and Research, Division of Trading and Markets, addressed the North American Trading Architecture Summit (April 15, 2014). His remarks focused on market complexity and the speed of transactions (here).

Remarks: Craig Lewis, Chief Economist and Director, Division of Economic and Risk Analysis, delivered remarks at MIT’s Center for Finance and Policy’s Distinguished Speaker Series (April 15, 2014). His remarks focused on capital formation (here).

Remarks: Keith Higgins, Director of Corporation Finance, delivered remarks titled “Disclosure Effectiveness” to the ABA Business Law Section Spring Meeting (April 11, 2014). His remarks focused on the new disclosure review that will be lead by the Division and he requested comments on where outdated rules and repetition could be eliminated (here).

SEC Enforcement – Filed and Settled Actions

Statistics: This week the Commission filed, or announced the filing of, 2 civil injunctive actions, DPAs, NPAs or reports and 1 administrative proceeding (excluding follow-on and Section 12(j) proceedings).

Fee splitting: In the Matter of Total Wealth Management, Inc., Adm. Proc. File No. 3-15842 (April 15, 2014) is a proceeding in which the Respondents are: The firm, a registered investment adviser; Jacob Cooper, its co-founder, sole owner and CEO; Nathan McNamee, its current president and CEO; and Douglas Shoemaker, its co-founder and former chief compliance officer. Total Wealth is the owner and managing member of a group of funds started by Respondent Cooper who controls their investments. Total Wealth established revenue sharing arrangements prior to the formation of a new group of funds . Under those arrangements other funds paid Total Wealth a fee for the placement of its clients’ investments in those funds. The revenue from these arrangements was distributed among the Respondents through a series of entities. While disclosure forms suggested that such arrangements “may” exist, the disclosures were materially incomplete and did not fully inform investors of the facts. Respondents McNamee and Shoemaker, two investment adviser representatives, were aware of these arrangements and the related misrepresentations and failed to fully disclose them to the clients. Total Wealth also violated the custody rule, using an unqualified accountant as an auditor and misrepresented to clients the due diligence undertaken in selecting investments. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). It also alleges violations of Advisers Act Sections 206(1), 206(2), 206(4) and 207. The proceeding will be set for hearing.

Insider trading: SEC v. Posey, Civil Action No. 1:14-CV-664 (N.D. Ga. Filed March 6, 2014). Richard Posey was a vice president of operations relating to various brands sold by Carter’s, Inc. That position required him to attend periodic internal staff meetings in which the operations and finances of the firm were discussed. Over approximately a three year period beginning in January 2006, Mr. Posey repeatedly traded in the shares of his employer while in possession of material non-public information he obtained through his position with the firm. The trades were placed in advance of earnings announcements and quarterly financial results, typically in the account of his wife. As a result of those trades he was able to make profits or avoid losses of about $49,778. Beginning in April 2009, and continuing through October 2010, Mr. Posey also repeatedly furnished material non-public information about the company to Eric Martin, a former vice president and director of investor relations for Carter’s. Mr. Martin in turn tipped others. As a result of those trades Mr. Martin had profits or avoided losses of about $427,000. Two of the people Mr. Martin tipped avoided losses of about $3 million.

The Commission’s complaint alleged violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Posey settled with the Commission, consenting to the entry of an order enjoining him from future violations of the antifraud provisions. That Order also directs him to pay disgorgement and prejudgment interest totally $60,265 and bars him from serving as an officer or director. The amount of a civil penalty will be determined by the Court on motion of the Commission. Previously he pleaded guilty in a parallel criminal action. See Lit. Rel. No. 22970 (April 10, 2014).

Kickbacks: SEC v. Bethancourt, Civil Action No. 13CV3074 (S.D.N.Y.) is a previously filed action centered on kickbacks paid in connection with an international bond scheme involving a New York broker and a Venezuelan state owned bank, discussed here. This week the Commission added two defendants to its case, Benito Chinea, the co-founder and CEO of New York broker Direct Access Partners, and Joseph DeMeneses, the firms managing partner of global strategy. Parallel criminal charges were also filed.

Investment fund fraud: SEC v. Coughlin, Civil Action No. 1:14-cv-00562 (S.D. Ind. Filed April 11, 2014) is an action against Timothy Coughlin and his two entities that did business as Oxford International Credit Union or Oxford international Cooperative Union. From June 2007 through the end of 2009 the defendants raised about $12.8 million from over 5,000 investors through an internet fraud. Investors were solicited to make deposits that they were told would make returns which at one point supposedly equaled 356%. Investors were furnished documents showing their deposits and returns. In fact, Mr. Coughlin misappropriated much of the money and used other portions to make Ponzi type payments. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). Parallel criminal charges were also filed. See Lit. Rel. No. 22972 (April 11, 2014).

Investment fund fraud: SEC v. K2 Unlimited, Inc., Civil Action No. 1:11-cv-11649 (D. Mass.) is a previously filed action against Robert Rice and others. The initial complaint centered on a fraudulent trading program that involved so-called bank guarantees. On April 4, 2014 the Court entered a final judgment by consent against Mr. Rice. The order permanently enjoined Mr. Rice from future violations of the antifraud and other provisions of the federal securities laws. It also directed the payment of disgorgement, prejudgment interest and a civil penalty totaling $525,896.51. See Lit. Rel. No. 22971 (April 11, 2014).

Criminal cases

Obstruction of SEC investigation: U.S. v. Bayyouk, No. 3:12-cr-00420 (N.D. Cal.) is an action in which defendant Karim Bayyouk was sentenced to serve eighteen months in prison for obstructing an SEC insider trading investigation. Previously, he was convicted following a five day jury trial. The action was based on a claim that Mr. Bayyouk lied to SEC enforcement attorneys during a telephone interview into the reason he had purchase options for Biosite securities just prior to a merger announcement. While he claimed not to have talked to anyone about purchase, in fact he had been tipped by his brother-in-law Basam Salman (below).

Insider trading: U.S. v. Salman, No. 3:11-cr-00625 (N.D. Cal.) is an action in which Basam Yacoub Salman was sentenced to serve three years in prison and directed to pay $738,539.42 in restitution Mr. Salman was part of a $5.3 million insider trading ring. He was convicted following a jury trial on one count of conspiracy and four counts of securities fraud as discussed here.

Circuit courts

Conflict mineral rules: National Association of Manufacturers v. SEC, No.. 13-5252 (D.C. Cir. Decided April 14, 2014) is a suit challenging the SEC’s conflict minerals rules in which the agency largely prevailed as discussed here. Pursuant to Section 1502 of Dodd-Frank, the SEC developed and issued rules regarding the use of conflict minerals. Essentially the rules require covered issuers to conduct a “reasonable country of origin inquiry” regarding their conflict minerals. If, after the inquiry, the company determines that its conflict minerals did not originate in the covered countries, the issuer must disclose that conclusion to the SEC along with its predicate. If the issuer concludes that the conflict minerals did originate from a covered country – or if it cannot make that determination – a report must be prepared and filed with the Commission. The District Court rejected the claims of Appellants. The Circuit Court largely affirmed.

Appellants presented claims under the Administrative Procedure Act and one based on the First Amendment. The Court rejected each APA claim. First, the Court rejected the Association claim that the SEC should have included a de minimis exception. The Commission acknowledged that it has the authority to create such an exception. It found, however, that such an exception would be contrary to the statute and its purpose. This was sufficient. Second, Appellant challenged the provision requiring that an issuer conduct due diligence if, after inquiry, it has reason to believe that its conflict minerals “may have originated” in “covered countries.” Essentially the Commission adopted a reasonable interpretation of the statute. Third, the Court rejected the Association’s contention that the standard regarding due diligence was to low. Here the standard adopted was within the authority of the Commission so the claim was rejected. Fourth, the Association’s claim regarding “persons described” is also incorrect. In essence, the Association attempted to argue that “persons described” provision only applies to manufactures but not those who contract to manufacture. The Commission’s interpretation that it applies to both is reasonable the Court found. Finally, the Court rejected a claim that the temporary phase in rules were inconsistent because small issuers received a longer time period while concluding that the SEC’s cost analysis was sufficient.

The Court sustained the Association’s First Amendment claim. Here the challenge is to the requirement in the final rules that an issuer describe its products as not “DRC conflict free” in the report and must post on its website. The requirement unconstitutionally compels speech, according to the Association. The Court agreed. The critical issue here is the standard of review. The Commission argued that rational basis test applies but the Court adopted a stricter standard which required the agency to show that there is 1) a substantial governmental interest at stake, 2) which is directly and materially advanced by the restriction and 3) that the restriction is narrowly tailored. This case does not meet the test. As the Court stated “it is far from clear that the description at issue – whether a product is ‘conflict free’- is factual and non-ideological. The label ‘conflict free’ is a metaphor that conveys moral responsibility for the Congo war. Requiring that it be displayed on the firm’s website compels an issuer “to confess blood on its hands” the Court found. Accordingly, this limited requirement is inconsistent with the First Amendment.

Circuit Judge Spinivasan concurred in the Court’s opinion regarding the APA challenges. He did not join the opinion with respect to the First Amendment issue, arguing that a decision on the issue should have been reserved until later this year after the en banc court resolves a question regarding the applicable standard.


Improper professional conduct: The Australian Securities & Investment Commission suspended the registration of auditor John Wessels. The auditor failed to properly perform an audit of Kleenmaid’s financial report for the year ended June 30, 2008. He improperly relying on the representations of management regarding the question of whether the firm was a going concern. In fact the principals of the firm have been charged with fraud and insolvent trading.

Investment fund fraud: William Jones pleaded guilty to a $260,000 fraud. The charges are based on his actions in 2006 in taking $260,000 from two investors for share trading. Rather that invest the funds he misappropriated them.

Improper trading: Mark Hildebrandt, a former Vanguard Investments Australia Limited portfolio manager, pleaded guilty to making improper use of his position. In 2010 he placed a number of orders for a Canadian Index on the Bourse de Montreal on behalf of Vanguard while placing substantially matching orders for the same financial product in his personal trading account. The orders were place so that the positions in Mr. Hildebrandt’s personal account would trade against the Vanguard orders at favorable prices yield him a profit. Sentencing is scheduled for May 2014.

Hong Kong

Breach of fiduciary duty: The Securities and Futures Commission is seeking an order disqualifying Chin Jong Hwa, chairman and executive director of publically traded Minth, Shi Jian Hui, CEO of the firm and Zhao Feng a vice president. The action is based on the acquisition by a Mirth subsidiary of Magic Figure Investments Limited. The owners of that firm were represented to be independent when in fact they were nominees for Mr. Chin. In addition, the price paid was $99 million not the RMB25.9 million claimed in the Interim Report. The funds actually went to accounts controlled by Mr. Chin.

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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