This Week In Securities Litigation (Week ending March 14, 2014)

by Dorsey & Whitney LLP

The Supreme Court agreed to hear another securities class action case next term. The issue to be considered is whether tolling applies to a statute of repose, Securities Act Section 13.

In court this week the SEC obtained a significant monetary order against former Goldman Sachs’ employee Fabrice Tourre who was previously found liable in a market crisis action. The Court directed Mr. Touree to pay $650,000 in civil fines and give up his bonus of $175,463 plus interest. The Court also directed that Goldman not pay the fine. An SEC request for an injunction was denied. In an insider trading case against two brothers, a Cleveland jury gave the SEC a split verdict, finding them liable for violations of Exchange Act Section 14(e) but not liable on Section 10(b) claims. Finally, in the Life Partners financial fraud case (here) where the a jury found against Commission on most of its fraud claims but in favor of the agency on a Securities Act Section 17(a) claim (here), the Court set aside the verdict on the Securities Act fraud claim, concluding it was not supported by the evidence.

The Commission also filed four proceedings based on a fraudulent variable annuity sales scheme; an action centered on a microcap stock scalping scheme; an action charging a motion picture studio with disclosure failures during a hostile takeover in which certain facts were admitted as part of the settlement; an insider trading action against an analysis affiliated with S.A.C. Capital; a settled market crisis case against broker-dealer Jeffries; and financial fraud actions against a firm with the bulk of its operations in the PRC and several of its executives. Finally, the agency secured settlements in its shell packaging case; partially settled a pay-to-play case; and an investment fraud action involving the claimed sale of pre-IPO interests in Facebook shares.


Cooperation: The Commission initiated a new Enforcement Cooperation Initiatives for Municipal Issuers and Underwriters (here).

Proposed rules: The SEC issued proposed rules that would establish “standards for the operation and governance of certain types of registered clearing agencies that meet the definition of a ‘covered clearing agency’” (here).


Remarks: Acting Chairman Mark Wetjen delivered the keynote address to the 39th Annual International Futures Industry Conference titled The Necessity for Global Harmonized Derivative Regulation (March 11, 2014). His remarks focused on the need for a harmonized global regulatory regime for derivatives, a substituted compliance framework that is workable and noted that the agency must establish a mutual recognition framework for foreign swap execution facilities and derivatives clearing organizations (here).

Supreme Court

Statute of repose: Public Employees’ Retirement v. IndyMac MBS, Inc., No. 13-640. The Court entered an order granting the writ of certiorari in putative securities class action. The issue to be considered as presented by Petitioner (plaintiffs) is: “In American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974), this Court held that ‘the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action . . . The question presented is: Does the filing of a putative class action serve, under the American Pipe rule, to satisfy the three year time limitation in Section 13 of the Securities Act with respect to the claims of putative class members?” As restated by Respondents (defendants) the question for resolution is: “Whether the judicial tolling principle articulated in American Pipe . . . is inapplicable to the absolute three-year statute of repose in Section 13 of the Securities Act . . .”

SEC Enforcement – Litigated Actions

Insider trading: SEC v. Jacobs, Civil Action No. 1:13-cv-1289 (N.D. Ohio) is an insider trading action centered on a tender offer by French pharmaceutical company Sanofi-Aventis for Tennessee based drug distributor, Chattem, Inc. The defendants are Andrew Jacobs and Leslie Jacobs. Andrew and Blair Ramey, the vice president of marketing at Chattem, have been good friends since graduate school. They married sisters.

Sanofi initially approached Chattem in early September 2009 regarding a possible relationship. By the end of the month each company retained financial advisors and legal counsel. Confidentiality and agreements were completed. Due diligence began.

On December 1, 2009 senior management from each company met for face-to-face due diligence. Blair Ramey attended this meeting. He had been aware of the discussions through his position with his employer since October. Following the meeting Mr. Ramey met with Andrew while he was traveling on business. Since Andrew had been through a similar take-over, Ramey asked him a series of pointed questions about such transactions and the impact on employees without disclosing the transaction. Andrew assured his friend that the information would be maintained in confidence at the end of the discussion and the next day in a phone call. Nevertheless, on Friday, December 4, 2009 Leslie Jacobs purchased 2,000 shares of Chatem at a cost of $136,579.85. This was the largest securities purchase he had made in the last eight years and was not consistent with his other purchases. Following the deal announcement Leslie sold the stock, yielding profits of $49,457.21. The complaint against the two brothers alleged violations of Exchange Act Sections 10(b) and 14(e). The jury returned verdicts in favor of the Commission on each Section 14(e) claim and against the agency on each Section 10(b) charge. The Court will consider remedies at a later date. This is the eighth case the Commission brought arising out of this transaction. See Lit. Rel. 22937 (March 7, 2014).

SEC Enforcement – Filed and Settled Actions

Statistics: This week the Commission filed or announced the filing of 3 civil injunctive, DPAs, NPAs or reports and 8 administrative proceeding (excluding follow-on and Section 12(j) proceedings).

Variable annuity scheme: In the Matter of Michael Horowitz, Adm. Proc. File No. 3-15790 (March 13, 2014); In the Matter of Harold Ten, Adm. Proc. File No. 3-15787 (March 13, 2014); In the Matter of Howard Feder, Adm. Proc. File No. 3-15788 (March 13, 2014); In the Matter of Marc Steven Firestone, Adm. Proc. File No. 3-15789 (March 13, 2014) is a group of proceedings centered on a fraudulent variable annuity scheme created by Michael Horowitz and implemented with Moshe Marc Cohen, both of whom are registered representatives at broker-dealers and each of whom are Respondents in Horowitz. The other proceedings involve additional persons who became involved in the variable annuity scheme as detailed below.

The scheme: Beginning in mid-2007 and continuing until early 2008 initially Mr. Horowitz, later joined by Mr. Cohen, executed a fraudulent scheme to profit from the imminent death of terminally ill hospice and nursing home patients. The plan called for the purchase and sale of more than $80 million in deferred variable annuities in which the terminally ill were the annuitants. First, Mr. Horowitz and others obtained the personal health and identifying information for terminally ill hospice and nursing home patients through deceptive methods. Second, those patients were designated as annuitants on variable annuity contracts which are designed as long term investments. Third, the annuities were marketed to wealth investors as short term investments.

Horowitz proceeding: Mr. Horowitz was the creator of the scheme and recruited Mr. Cohen to expand it as noted above. Each registered representative secured the necessary approvals through their respective brokerage firms by putting misrepresentations in materials utilized to determine suitability. Several of the annuities were sold to close relatives of Mr. Horowitz. They earned profits of over $900,000. Messrs. Horowitz and Cohen received, respectively, $300,00 and $700,00 in commissions. The Order alleges violations of Exchange Act Sections 10(b) and 15(a) Securities Act Section 17(a)(1 and (2). This proceeding will be scheduled for hearing.

Ten proceeding: Respondents Harold Ten, Menachem Berger and Debra Flowers were recruited to join the scheme as annuitant finders by Michael Horowitz. Respondents, along with Mr. Horowitz, used misrepresentations to obtain the personal health and identifying information on the terminally ill hospice and nursing home patients utilized as annuitants in the execution of the scheme. The Order alleges violations of Exchange Act Section 10(b). To resolve the proceeding each Respondent agreed to cooperate with the Commission in this matter. Each consented to the entry of a cease and desist order based on the Section cited in the Order. Each also agreed to the entry of an order barring them from the securities business and any penny stock offering. In addition, Respondent Ten will pay disgorgement of $181,147.64 along with prejudgment interest and a civil money penalty of $90,000. Respondent Berger will pay disgorgement of $119,000 along with prejudgment interest and a civil penalty of $100,000. Respondent Flowers agreed to pay disgorgement of $11,057 along with prejudgment interest but that payment is waived based on financial condition and no penalty is imposed for that reason.

Feder proceeding: Respondent Howard Feder, a commodity trader, is the sole member of Respondent BDL Manager LLC, an investment adviser. To expand the scheme Mr. Horowitz began soliciting institutional investors. BDL Manager LLC was created to facilitate institutional investment in variable annuities through the use of nominees. Respondents secured broker-dealer approvals through fraudulent means for more than $56 million in annuities sold through the scheme. Blank forms were furnished to brokers by Mr. Feder. Those forms were then filled out noting that the nominees did not intend to access their investment for a considerable period, although Mr. Feder knew that the scheme was short term. BDL Group was paid over $1.5 million in proceeds from the scheme. The Order alleges violations of Exchange Act Section 10(b). To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. Mr. Feder will also be barred from the securities business and agreed to pay a penalty of $130,000. The firm agreed to pay disgorgement of $1,550,565.55, prejudgment interest and a penalty equal to the amount of the disgorgement.

Firestone proceeding: Respondent Marc Firestone is an insurance agent. Respondent Richard Horowitz is an insurance broker to whom Mr. Firestone reported. Both were employed at a registered broker-dealer and investment adviser, NFP Securities, Inc. Mr. Firestone singed as the registered representative in the sale of twelve deferred variable annuities involved in the scheme. The forms utilized in the transactions incorrectly listed the time horizon for the investment as long term. By “negligently allowing new account forms containing the aforementioned incorrect information to be submitted to NFP, Respondents caused NFP to violate Section 17(a) of the Exchange Act.” To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. Mr. Firestone also agreed to pay disgorgement of $127,853.20 along with prejudgment interest and a penalty of $40,800. Mr. Horowitz agreed to pay disgorgement of $292,767.89 along with prejudgment interest and a penalty of $40,800. In connection with these proceedings the Commission also issued an investor bulletin: Variable Annuities – An Introduction.

Scalping: SEC v. Babikian, Civil Action No. 14 CV 1740 (S.D.N.Y. Filed March 13, 2014) is an action against John Babikian for scalping. In the afternoon of February 23, 2012 he is alleged to have utilized two internet sites to widely disseminate information about penny stock America West Resources Inc., quoted on OTC Link. The materials touted the company and its shares. Those materials did not state that Mr. Babikian held a large block he intended to sell. Although shares of AWR were low priced, closing the day before at $0.29, and had not traded on February 23 prior to the information blast, volume immediately shot up. Throughout the afternoon over 7 million shares traded. The price reached $1.80 and closed at $1.29. Mr. Baikian, though a Swiss bank, sold 1.3 million shares at an average price of $1.38, netting him trading proceeds of about $1.9 million. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). The Court entered a freeze order at the request of the Commission. The case is in liquidation.

Disclosure: In the Matter of Lions Gate Entertainment Corp., Adm. Proc. File No. 3-15791 (March 13, 2014) is a proceeding against the firm which centers on a defensive maneuver taken on July 20, 2010 to ward-off a hostile take-over. At the time of the transactionLions Gate was locked in a battle for control with a shareholder who held over 37% of the outstanding shares. As part of an effort to defeat that bid, the board arranged a multi-step transaction in which about 9% of the outstanding shares of the company would go to a friendly director. When the transaction was announced the release stated that it was to reduce the debt of the company under a previously disclosed debt reduction plan. When the New York Stock Exchange inquired if the deal in which notes were exchanged for shares at a favorable price violated Exchange Rules requiring shareholder approval, the firm agreed to additional disclosure. In its tender-offer materials the firm claimed that the note exchange deal was not part of a prearranged deal. In fact there was no preannounced debt reduction plan, the transaction was prearranged and reviewed by the director and occurred only after other steps were taken to facilitate the issuance of the stock. The transaction did block the take-over bid. The Order alleges violations of Exchange Act Section 13(a) and 14(d). To resolve the proceeding the company admitted the basic facts regarding the transaction in an Annex to the Order, consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay a penalty of $7.5 million.

Insider trading: SEC v. Dennis, Civil Action No. 14 CV 1746 (S.D.N.Y. Filed March 13, 2014) is an action against Ronald Dennis, formerly an analyst at the investment advisory firm CR Intrinsic Investors, LLC. It centers on trading on inside information in the shares of Foundry Networks, Inc. and Dell, Inc. In July 2008 Foundry insider David Riley passed inside information concerning the pending announcement that the firm would be acquired by Brocade communications Systems to an analyst who in turn transmitted it to Mr. Dennis. He caused CR Intrinsic to trade. The firm purchased 120,000 shares and, after the deal announcement, had $550,000 in profits. In August 2008 and later in August 2009 Mr. Dennis obtained inside information on the earnings of Dell in advance of announcements. That information traced to Sandeep Goyal, a former Dell employee. Mr. Dennis caused his firm to trade in both instances yielding profits made and losses avoided of over $2.1 million. In August of 2009 he also caused a portfolio manager at S.A.C. Capital to trade shares of Dell, yielding profits of $1.1 million. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). To resolve the action Mr. Dennis consented to the entry of a permanent injunction based on the Sections cited in the complaint. He also agreed to pay disgorgement of $95,351, prejudgment interest and a penalty equal to the amount of the disgorgement.

Microcap fraud: SEC v. Alternative Green Technologies, Inc., Civil Action No. 11-cv-09056 (S.D.N.Y.) is a previously filed action against the firm, Belmont Partners, LLC and Joseph Meuse. This is the Commission’s “shell packing” case. Belmont and Mr. Meuse agreed to resolve the case and, in an order entered by the Court on January 15, 20014, were enjoined from future violations of Securities Act Section 5 and Exchange Act Section 10(b). In addition, the two defendants agreed to pay $224,500. Mr. Meuse also agreed to be barred from the penny stock business or from serving and as officer or director of a public company for five years. See Lit. Rel. No. 22940 (March 12, 2014).

Failure to supervise: In the Matter of Jefferies LLC, Adm. Proc. File No. 3-15785 (March 12, 2014) is an action against the firm keyed to the fraudulent activities of former employee Jesse Kitvak. Mr. Litvak was associated with Jefferies from 2008 through 2011. He served as a managing director and trader in the firm’s MBS group. The MBS sold by Mr. Litvak and others on the mortgage backed securities desk were generally illiquid. The markets were opaque. Purchasers were aware that the amount paid for the securities included a charge added to the purchase price of the security paid by Jefferies as either part of the price or an add-on. Mr. Litvak and others on the MBS desk took advantage of the fact that purchasers had to rely on their representations about the securities because of the lack of transparency. Firm customers were overcharged by about $2.6 million in 25 transactions between 2009 and 2011 by Mr. Litvak and others using a series of misrepresentation. The Order charges that during those transactions the firm failed to reasonably supervise Mr. Litvak and others. Although the firm had policies and procedures that required periodic review of client communications, it failed to implement them by not including certain client contacts in the pool from which communications were selected for review and not furnishing supervisors the proper tools to review the transactions. Under Exchange Act Section 15(b)(4)(E) broker-dealers are responsible for reasonably supervising persons subject to their supervision. To resolve the proceeding Jefferies admitted to the facts in the Order regarding Mr. Litvak’s actions but not the claims regarding supervision. The firm agreed to implement a series of remedial procedures and to pay $11 million to customers involved in the transactions. Jefferies also consented to the entry of a censure pursuant to Section 15(b)(4) and agreed to pay disgorgement of $4,200,401 along with prejudgment interest and a civil money penalty equal to the amount of the disgorgement. The firm resolved similar charges with the U.S. Attorney by entering into non-prosecution agreement in which it also admitted certain facts and agreed to pay a penalty of $25 million. See also SEC v. Litvak, Civil Action No. 3:13-cv-00132 (D. Conn. Filed Jan. 28, 2013)(pending fraud action); U.S. v. Litvak (D. Conn. Jan. 25, 2013)(criminal case in which Mr. Litvak was recently convicted).

Financial fraud: SEC v. AgFeed Industries, Inc. (M.D. Tenn. Filed March 11, 2014); In the Matter of John A. Stadler, Adm. Proc. File No. 3-15782 (Filed March 11, 2014); In the Matter of Clayton T. Marshall, Adm. Proc. File No. 3-15783 (Filed March 11, 2014).

The actions center on a years long financial fraud at AgFeed Industries, Inc., a firm which was the product of a merger in September 2010 of U.S. and China based entities.

The financial fraud traces to 2008. During that period six defendants were key officers: Junhong Xiong was the CEO from late 2006 through early 2011; Junhong Xiong was an accountant at the company from mid-2008 until early 2009 when he became CFO, a position he held until late 2010; Songyan Li was the chairman of the firm from late 2006 through early 2011; and Shaobo Ouyang was an accountant and comptroller from late October 2009 through mid-2013 (“initial officers”).

Approximately $57 million was raised in three registered offerings by the firm in early 2008. The funds were used to by assets in China. In that same year the initial officers began cooking the books, inflating revenue through a variety of methods. Fictitious accounting entries were made. As the fraud continued the initial officers took steps to conceal it from the company and the auditors including the creation of a parallel set of books.

In late 2010 and in early 2011 three of the initial offers left. Edward Pazdro and K. Ivan Gothner, both of whom are also defendants, joined. Mr. Pazdro, a CPA, became CFO beginning in November 2010, a post he held through mid- July 2011. Mr. Gothner joined earlier, becoming the Chair of the board’s audit and compensation committees beginning in December 2009. He held those posts for two years (together the “new officers”). By early 2011 the new officers leaned the company had two sets of books and had engaged in financial fraud. Nevertheless, in the summer of 2011 the two new officers – defendants Pazdro and Gothner – were implementing a plan to expand the firm into a modern hog producer while concealing key aspects of the fraud from the auditors and others. As a result, false filings regarding the financial condition of the company were made with the Commission. In December 2011 AgFeed finally disclosed that accounting improprieties had occurred at the firm. The complaint alleges violations of: Exchange Act Sections 10(b), 13(a), 13(b)(2), 13(b)(5), control person liability under Section 20(a) and false certifications under Rule 13a-14; Securities Act Section 17(a); and Sarbanes-Oxley Section 304(a). The action is in litigation.

Mr. Stadler, who served as chairman and interim CEO from February 2011 until December 2011, settled with the Commission. He consented to the entry of a cease and desist order based on Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). He also agreed to the entry of an order prohibiting him from serving as an officer or director of a public company and directing that he pay a civil penalty of $100,000. Mr. Stadler agreed that in any other proceeding he will not claim credit for the payment of the civil penalty.

Mr. Marshall, who served as a divisional chief financial officer of firm from mid-2011 through August 2012, also settled with the Commission. The Order alleged violations of Securities Act Section 17(a)(2) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding he consented to the entry of a cease and desist order based on Securities Act Section 17(a) and the Exchange Act Sections cited in the Order. He also agreed to be denied the privilege of appearing or practicing before the Commission as an accountant for a period of five year after which he may request reinstatement. The question of financial remedies will be considered at a later date. The Commission’s press release states that he is cooperating with the agency.

Pay-to-play: SEC v. Morris, Civil Action No. 09 cv 2518 (S.D.N.Y.) is a previously filed action against Henry Morris, formerly the top political advisor to the former NY state controller. The complaint alleged a pay-to-play scheme involving seven defendants including Mr. Morris. This week the Court entered final judgments against seven of the defendants, three individuals and four entities. Defendants Morris, Julio Ramirez and David Loglisci – each of whom previously pleaded guilty to parallel criminal charges — consented to the entry of permanent injunctions based on Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). The injunction as to Mr. Morris is also based on Securities Act Section 17(a) and bars him from the securities business, participating in a penny stock offering and appearing or practicing before the Commission as an attorney. The order as to Mr. Loglisci also bars him from appearing or practicing before the Commission as an attorney. The order as to Mr. Ramirez bars him from the securities business and from participating in any penny stock offering with a right to reapply after three years. Two shell companies affiliated with Mr. Morris, Nosemote LLC and Pantigo Emerging LLC, consented to the entry of permanent injunctions based on Securities Act Section 17(a) and Advisers Act Sections 206(1) and 206(2). Two entities affiliated with another defendant, Tuscany Enterprises LLC and W Investment Strategies LC, consented to the entry of injunctions based on the same Sections cited in the order regarding Mr. Morris. They also agreed to pay disgorgement of $3,083,500 and prejudgment interest. See Lit. Rel. No. 22938 (March 10, 2014).

Investment fraud: In the Matter of Craig Berkman, Adm. Proc. File No. 3-15249 (March 7, 2014) is a previously filed action (here) against Mr. Berkman, an Oregon political figure, a number of his entities and attorney John Kern. The action centered on two similar schemes in which Mr. Berkman solicited investors for what they were told would be interests in pre-IPO Facebook shares. Mr. Kern was charged with making false statements in furtherance of the schemes. The initial Order, and the one filed this week, alleged as to Mr. Kern violations of Advisers Act Sections 206(1), 206(2) and 206(4). Mr. Kern resolved the matter, consenting to the entry of a cease and desist order based on the Sections cited in the Order and agreeing to pay disgorgement of $234,577 along with prejudgment interest and a $100,000 penalty. He also agreed to be barred from the securities business or affiliating with an investment company or investment adviser.


U.S. v. Cilins (S.D.N.Y. March 10, 2014) is a case in which Frederic Cilins, a French citizen, pleaded guilty to obstruction charges. The investigation centered on possible FCPA and money laundering violations in connection with the awarding of a mining contract in Guinea. A mining company and its affiliates, for whom Mr. Cilins worked, sought to secure the contract. A now deceased government official had the authority to influence the award of the agreement. To secure the contract the company and its affiliates offered millions of dollars to the wife of the government official. The agreements provided that $2 million would be transferred to the wife’s company and that additional sums could be paid to others who may have assisted. In addition, the mining company agreed to give 5% of certain mining areas in Guinea to the official’s wife. Funds in furtherance of the scheme were transferred into the United States. Mr. Cilins was charged with obstructing the investigation into this transaction. During monitored and recorded telephone calls, and in meetings, Mr. Cilins agreed to pay substantial sums of money to a witness to the bribery scheme in return for original documents which had been requested by the FBI and that were to be produced for the grand jury. Mr. Cilins planned to destroy the records. He also sought to have the witness execute an affidavit which contained false statements about the matters under investigation.


Consolidated reporting: Triad Advisors and Securities America were fined, respectively, $650,000 and $625,000 for failing to supervise the use of consolidated reporting systems. That resulted in inaccurate statements being sent to customers. The firms also failed to maintain the reports as required. In addition, Triad was ordered to pay $375,000 in restitution. The consolidated reports is a single document that combines information regarding all or most of a customer’s financial holdings wherever they are held. The firms permitted their representatives to customize the reports. In a number of instances representatives entered false values which improperly inflated the value of certain holdings.

Alert: The regulator issued a new investor alert: Bitcoin: More than a Bit Risky (here).

Criminal cases

Misappropriation: U.S. v. Kelly (S.D.N.Y.) is an action against Robert Kelly, CEO of Wwebnet.Inc., a software development company. Beginning in 2004, and continuing for four years, Mr. Kelly solicited investors to invest in Wwebnet for the purpose of developing software to transmit music, videos and movies over the internet. Rather than use the funds raised for the stated purpose, he diverted over $2 million to his personal use, much of which he lost trading options. At the same time Mr. Kelly told his development team that the company could not go forward because it lacked sufficient funds. This week Mr. Kelly pleaded guilty to one count of securities fraud and one count of wire fraud. In entering the plea he agreed to forfeit $2,111,600 and pay the same sum in restitution. Sentencing is scheduled for July 17, 2014.

Hong Kong

Breach of duty: The Securities and Futures Commission resolved a proceeding with the former chairman of GOME Electrical Appliances Holding Limited, Wong Kwong Yu and his wife, Du Juan, a former director of the company. The action centered on a claim that the two defendants breached their fiduciary duties to the company by implementing a share repurchase that was designed largely to buy out their holdings. In resolving the proceeding, the defendants admitted their breach of duty and agreed to repay $420,608,766.75 to the company which represents the gains and accrued interest they obtained as calculated by an expert appointed by the SFC.

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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