September 14, 2007
SEC Settles Late-Trading Charges
On September 14, the SEC settled administrative proceedings as to David Byck, William Cole, Charles Irwin, Michael Price, and Jay Sumner (Respondents). In 2002-2003, Respondents operated two registered investment advisers, and entities that purported to be third-party administrators. The order finds that Respondents enabled their hedge fund clients to place mutual fund orders after 4:00 p.m. ET, but receive the net asset valuation determined as of 4:00 p.m. Specifically, the order finds that, between August 2002 and February 2003, Respondents conducted their late trading via their registered investment advisers through a broker-dealer. The order further finds that between March and April 2003, utilizing sham third-party administrators, Respondents submitted orders on behalf of their hedge funds clients to National Securities Clearing Corporation to purchase and sell mutual funds as late as 3:00 a.m. ET, while obtaining the prior day's 4:00 p.m. NAV. IN THE MATTER OF DAVID BYCK, WILLIAM COLE, CHARLES IRWIN, MICHAEL PRICE, AND JAY SUMNER.
Bausch & Lomb Sahreholders Set to Vote on Cash Buyout
Bausch & Lomb said that four proxy advisers recommended the shareholders vote for a $3.7 billion cash-out merger offer ($65 per share) from Warburg Pincus. The shareholders meeting is set for Sept. 21. Last month Advanced Medical Optics withdrew a higher offer after B&L requested assurance that AMO shareholders backed the deal. WSJ, Four Proxy Firms Urge Shareholders Of Bausch & Lomb to Vote for Deal.
Merrill Lynch Says It Has Adjusted Securities Values Backed by Subprime Mortgages
Merrill Lynch stated in an SEC filing that it has adjusted the value of securities backed by subprime mortgages and other assets, but provided no further details. Merrill is expected to report its third quarter results in October; other securities firms will report their results next week, as noted in a post earlier today. WSJ, Merrill Cuts Asset Values Amid Credit Turmoil.
Investors Await Impact of New Accounting Rule on Valuing Assets
A new accounting rule requires companies to distinguish between financial assets that have real market value, thoses based on models and those based on management estimates. For a preview of what this may mean for the investment banks that will release quarterly results next week, see WSJ, Marking Down Wall Street.
GAO Report on SEC Enforcement Expected Soon
The GAO is expected to release a report critical of the SEC's enforcement division soon. The report notes "significant limitations" in its case-tracking system and recommends written procedures to approve investigations. It also says the SEC should expedite case closings and deal with its backlog of investigations. The report follows an earlier Senate committee staff report critical of the agency's handling of the Pequot investigation. WSJ, GAO Report Criticizes SEC's Probes, Settlement Distributions.
September 13, 2007
SEC Files Charges in Alleged PIPES Fraud
The SEC filed securities fraud and related charges today against Robert A. Berlacher, Lancaster Investment Partners, L.P., Northwood Capital Partners, L.P., Cabernet Partners, L.P., Chardonnay Partners, L.P., Insignia Partners, L.P., VFT Special Ventures, Ltd., LIP Advisors, LLC, NCP Advisors, LLC, and RAB Investment Company, LLC (collectively, "Lancaster") in the U.S. District Court for the Eastern District of Pennsylvania. The Commission's complaint alleges that the defendants collectively perpetrated an illegal trading scheme to evade the registration requirements of the federal securities laws in connection with at least ten unregistered securities offerings, which are commonly referred to as "PIPEs" (Private Investments in Public Equities), made materially false representations to the PIPE issuers in connection with those offerings, and engaged in illegal insider trading.
The Commission's complaint alleges that, during the period 2000 through 2005, Berlacher implemented an unlawful trading scheme that enabled Lancaster to improperly realize more than $1.7 million in ill-gotten gains by investing in PIPE offerings without incurring market risk. Specifically, the complaint alleges:
Berlacher and Lancaster, after learning about a PIPE transaction, sold short the issuer's stock. Once the Commission declared the resale registration statement effective, Berlacher and Lancaster used the PIPE shares to cover the short positions — a practice prohibited by the registration provisions of the federal securities laws.
To avoid detection and regulatory scrutiny, Berlacher and Lancaster employed a variety of deceptive trading techniques, including wash sales, matched orders, and pre-arranged trades, to make it appear that they were covering their short sales with open market shares, when, in fact, Berlacher and Lancaster were on both sides of the transactions and were covering with their PIPE shares.
In each of the transactions, Berlacher and Lancaster made materially false representations to the PIPE issuers to induce them to sell securities to Lancaster. As a precondition of participation in a PIPE, Berlacher and Lancaster had to represent that they would not sell, transfer or dispose of the PIPE shares other than in compliance with the registration provisions of the Securities Act of 1933. This representation was material to the PIPE issuers, who, as the stock purchase agreements made clear, relied on the investors' representations in order to qualify for an exemption from the registration requirements for their private offering. At the time defendants learned about the PIPE, however, they intended to distribute the restricted PIPE securities in violation of the registration provisions of the Securities Act.
On at least one occasion, Berlacher and Lancaster engaged in illegal insider trading by selling short the securities of a certain PIPE issuer prior to the public announcement of the PIPE, while using nonpublic information they received when being solicited to invest in the PIPE. Berlacher and Lancaster engaged in this conduct notwithstanding their agreement to keep information about the PIPE confidential and/or to refrain from trading or discussing the offering prior to the public announcement of the PIPE.
By engaging in the foregoing conduct, the complaint alleges that defendants violated the registration provisions of the Securities Act (Sections 5(a), 5(b), and 5(c)) and the antifraud provisions of both the Securities Act (Section 17(a)) and the Securities Exchange Act of 1934 (Section 10(b) and Rule 10b-5 thereunder). The Commission's complaint seeks to permanently enjoin defendants from future violations of the applicable provisions of the federal securities laws, disgorgement of ill-gotten gains (with prejudgment interest thereon), and civil penalties.
Sure Trace Security Settles SEC Charges
The SEC filed a settled civil action in the United States District Court for the District of Columbia against Sure Trace Security Corporation and Peter Leeuwerke, a former chief executive officer and consultant to Sure Trace, for their alleged violations of the antifraud and registration provisions of the federal securities laws, and against Michael Cimino, Sure Trace's vice-chairman and president, for his alleged violations of the registration provisions. Sure Trace is a development stage company that sells purported technology that allows identification images to be permanently imprinted on an object. The Commission's complaint alleges that on September 14, 2004, Sure Trace issued a press release claiming it had signed a contract for $6 million gross annual revenue, when, in fact, it had not secured the contract. Sure Trace issued two other press releases in 2004 that allegedly omitted material facts about Sure Trace's negotiations to acquire Sensor Media Corporation. Leeuwerke had a role in drafting each release.
The Commission's complaint also alleges that Sure Trace made several attempts to evade securities registration requirements. According to the complaint, from 2002 to 2003, Sure Trace attempted to use at least three Forms S-8 to register the issuance of stock, purportedly to give to its employees and consultants under the auspices of various employee stock option plans. Many of the shares Sure Trace registered on Forms S-8 and issued to "consultants" were never intended to compensate the so-called "consultants" for their services, but rather were designed from the outset to make a market in the company's stock. Sure Trace also violated the registration requirements in May 2006 when it spun off shares of its subsidiary, True Product ID. Cimino effected the spin-off.
SEC Charges Auditors with Not Registering with PCAOB
The SEC charged 69 auditors with issuing audit reports on the financial statements of public companies while they were not registered with the Public Company Accounting Oversight Board. The SEC administrative orders name 37 unregistered audit firms and 32 audit partners who participated in the preparation and issuance of their unregistered firms’ audit reports. These firms and partners did not comply with a fundamental requirement of the Sarbanes-Oxley Act of 2002 — that accounting firms that prepare and issue audit reports on the financial statements of public companies must be registered with the PCAOB. The SEC issued 29 settled and ten contested orders. The 69 firms and partners named in today’s actions were collectively responsible for issuing 60 audit reports for 53 companies between November 2003 and October 2005.
Investors Worry About Investment with Hsu
A private equity fund representing 100 investors that invested $40 million through Norman Hsu, the Democratic fund-raiser, now fear the money may be gone. Checks from Mr. Hsu were returned for insufficient funds. The Manhattan DA is investigating. Hsu was previously convicted of running a Ponzi scheme. NYTimes, Investors Fear Fund-Raiser Took $40 Million .
Campos Leaving SEC Next Week
The Washington Post explores the ramifications as Commissioner Campos leaves the SEC next week and Commissioner Nazareth expected to leave by year end. Will the President and Congress be able to fill the vacancies promptly, or will the Commission operate with no Democrats? Observers of the SEC will recall it operated with fewer-than-five Commissioners in the 1990s, not the Commission's finest performance. WPost, Subtraction Changes Math at SEC.
September 12, 2007
SEC Open Meeting Sept. 19
The next Open Meeting of the SEC is scheduled for Wednesday, September 19, 2007 at 10:00 a.m. The agenda includes:
1. The Commission will consider whether to adopt, jointly with the Board of Governors of the Federal Reserve System, new rules under the Securities Exchange Act of 1934 ("Exchange Act") to implement the Gramm-Leach-Bliley Act bank exceptions to the definition of "broker." In addition, the Commission will consider whether to adopt additional related rules and rule amendments, including rules exempting banks from the definition of "dealer" under the Exchange Act.
2. The Commission will consider whether to adopt, on an interim final basis, a temporary rule that would provide investment advisers who also are registered broker-dealers an alternative means of compliance with the principal trading restrictions of Section 206(3) of the Investment Advisers Act.
The Commission will also consider whether to propose an interpretive rule under the Investment Advisers Act that would clarify the application of the Advisers Act to certain activities of broker-dealers.
SEC Charges Real Estate Partners With Securities Fraud
The SEC on Thursday, September 6, 2007, filed civil securities fraud charges against a real estate company, its president, seven offerings, two boiler-room operators, and four salesmen for conducting a fraudulent $50 million real estate investment scheme. The Commission's complaint names as defendants Real Estate Partners, Inc. ("REP"), based in Irvine, Calif.; the seven funds REP set up for the real estate investments; REP's president, Dawson Davenport, age 51, of Lake Forest, Calif.; boiler room operators Michael P. Owens, age 43, of Newport Coast, Calif., and Donald G. Ryan, age 42, of Irvine, Calif,; and salesmen Richard McGill, age 58, of Laguna Niguel, Calif., William L. Sanders, age 56, of Norco, Calif., Michael Tuchman, age 38, of Irvine, Calif., and Danny Rayburn, age 47, of Westminster, Calif.
The Commission's complaint, filed in U.S. District Court in Orange County, alleges that, between January 2003 and August 2006, the defendants raised $50 million from over 1600 investors nationwide by selling security interests in a series of seven offerings. The Commission's complaint alleges that REP, its related funds, Davenport, Owens, and Ryan made several key misrepresentations to investors in the course of the fund offerings. First, the complaint alleges that these defendants misrepresented how REP would use investor funds, failing to disclose to investors that they spent over $26 million, or 52% of the money raised, on commissions to salespeople, including $10.9 million to two companies controlled by Owens and $3 million to a company controlled by Ryan.
The complaint further alleges that REP was running a Ponzi-like scheme. Specifically, the complaint alleges that REP paid investors annual dividends using money obtained from other investors. The complaint also alleges that the defendants falsely claimed that Coldwell Banker was associated with the funds, when, in actuality, Coldwell Banker had nothing to do with the fund offerings. Finally, the complaint alleges that the defendants enticed investors with baseless promises of high rates of return on their investments, and dangled the unlikely possibility of conducting a public offering by converting the funds and REP into a publicly-traded real estate investment trust
SEC Charges Smart Online with Bribing Brokers
The SEC announced today that it filed a civil injunctive action against Smart Online, its CEO and president, Dennis Michael Nouri ("Michael Nouri"), Michael Nouri's brother, Reeza Eric Nouri ("Eric Nouri"), and four brokers, alleging that Michael and Eric Nouri paid cash bribes to the brokers to sell Smart Online stock to create volume and demand for the Smart Online's stock.
The complaint alleges that Smart Online stock began trading publicly on the OTC Bulletin Board in April 2005. Defendant Michael Nouri, the CEO of Smart Online, sought to qualify the company for listing on the NASDAQ by increasing the number of shareholders and trading volume of Smart Online stock. In order to do so, Michael Nouri began paying bribes to stock brokers, including defendants Anthony Martin, James Doolan, Ruben Serrano, and Alain Lustig, to solicit customers to purchase Smart Online stock.
The complaint alleges that between May 2005 and January 2006, Michael Nouri paid over $170,000 to brokers who sold more than 267,000 shares of Smart Online stock (or approximately 10% of the trading volume during the period) to investors. The complaint also alleges Eric Nouri, an employee of Smart Online, also negotiated bribe payments with a broker to solicit purchases of stock at various amounts and prices. Michael Nouri concealed the bribes as "consulting fees" paid pursuant to sham consulting agreements. The complaint further alleges that the brokers did not disclose to their customers that they were receiving bribes to sell Smart Online stock, and that Michael Nouri understood that the brokers were concealing the bribes from their customers.
By late 2005, Smart Online had qualified for listing on the NASDAQ. On January 17, 2006, the day that Smart Online was scheduled to begin trading on the NASDAQ, the Commission suspended trading of the stock. Smart Online stock did not trade on the NASDAQ.
SEC Charges Additional Defendants in Nortel Fraud Action
The SEC charged four more former officers of Nortel Networks Corporation with engaging in accounting fraud by manipulating reserves to manage Nortel's earnings. The Commission filed an amended complaint in SEC v. Dunn, a case pending in the U.S. District Court for the Southern District of New York, to add as defendants Douglas A. Hamilton, Craig A. Johnson, James B. Kinney and Kenneth R.W. Taylor, who were the former vice presidents of finance for Nortel's Optical, Wireline, Wireless and Enterprise business units, respectively. The Commission's original complaint, among other things, charged three former corporate officers of Nortel — CEO Frank Dunn, CFO Douglas Beatty and Controller Michael Gollogly — with directing the earnings management fraud.
Among other allegations, the amended complaint alleges that Hamilton, Johnson, Kinney and Taylor engaged in the following misconduct:
From the second half of 2002 through January 2003, Hamilton, Johnson, Kinney and Taylor all determined that their business units held tens of millions of dollars in excess reserves. The four finance vice presidents did not immediately release those excess reserves as required under U.S. Generally Accepted Accounting Principles (GAAP), but instead maintained them for earnings management purposes.
In early January 2003, during the 2002 year-end closing process, Hamilton, Johnson, Kinney and Taylor acted on orders received from former executives Dunn, Beatty and Gollogly and improperly established over $44 million in additional excess reserves in order to lower Nortel's consolidated earnings and bring it in line with internal and market expectations. Their efforts helped erase Nortel's pro forma profit for the fourth quarter of 2002 and caused it to report a loss instead.
In the first and second quarters of 2003, Dunn, Beatty and Gollogly directed the improper company-wide release of approximately $500 million of excess reserves specifically to inflate earnings and pay bonuses. These efforts turned Nortel's first quarter 2003 loss into a reported profit under U.S. GAAP, largely erased Nortel's second quarter loss and generated a pro forma profit in the second quarter. The efforts of Hamilton, Johnson, Kinney and Taylor were essential to creating these false results because the four vice presidents improperly released approximately $154 million in reserves in the first quarter of 2003, and approximately $191 million in reserves in the second quarter
FINRA Issues Notice to Members on Obligations to Senior Investors
FINRA issued a Notice to Members in connection with the Seniors Summit on Sept. 10: FINRA Reminds Firms of Their Obligations Relating to Senior Investors and Highlights Industry Practices to Serve these Customers. Here is the Executive Summary:
One of FINRA's priorities is the protection of senior investors, as well as Baby Boomers who are at or approaching retirement.1 FINRA's efforts in this area include investor education, member education and outreach, examinations and enforcement. The purpose of this Notice is to urge firms to review and, where warranted, enhance their policies and procedures for complying with FINRA sales practice rules, as well as other applicable laws, regulations and ethical principles, in light of the special issues that are common to many senior investors. The Notice also highlights, for the consideration of FINRA's member firms, a number of practices that some firms have adopted to better serve these customers.
GAO Releases Report on Mutual Fund Examinations
The GAO released a report, SEC: Steps Being Taken to Make Examination Process More Risk-Based and Transparent. After the mutual funds market-timing scandals, the SEC's Office of Compliance Inspections and Examinations (OCIE) took steps to revise its examination process to better identify and focus its resources on those activities representing the greatest risk to investors. This report describes the OCIE's revised procedures and reforms and provides recommendations. GAO continues to believe that implementing its prior recommendations to obtain and use compliance reports from firms could help OCIE better identify higher-risk firms. It also recommends that the SEC consider relocating its registrant complaint hotline to an independent office.
Italian Investors May Make Offer for LSE Stake
A group of Italian financial institutions is expected to make an offer to buy at least part of NASDAQ's 31% interest in LSE. WSJ, Nasdaq's Holdings in LSE Could Lure Firms From Italy.
Harvard Business Study on Shareholder Activism Shows Mixed Results
According to a new study by a Harvard business school professor, activist shareholders boost stock prices when they persuade management to sell the company, but not in other cases. For example, Carl Icahn's unssuccessful campaign to break up Time Warner did not result in shareholder gains although management effected a stock buyback and cost-cutting measures. WSJ, When Investor Activism Doesn't Pay.
September 11, 2007
Court Enforces SEC's Disgorgement Order Against Jett
On September 7, 2007, the United States District Court for the Southern District of New York entered a judgment enforcing the SEC's March 5, 2004 Opinion and Order directing that Orlando Joseph Jett pay disgorgement of $8.21 million and a $200,000 civil penalty, and ordering Jett to cease and desist from future violations of certain provisions of the federal securities laws. The SEC found that Jett, while a government bond trader, managing director, and senior vice president of Kidder, Peabody & Co., then a registered broker-dealer, had, with fraudulent intent, exploited an anomaly in Kidder's automated trading records system to book non-existent profits of approximately $264 million, when in fact Jett's trading activities caused Kidder losses of $75 million. It further found that Jett's actions constituted a scheme to defraud under Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and that Jett's actions had violated the "books and records" provisions of Section 17(a) of the Securities Exchange Act of 1934 and Rule 17a-3(a)(2) thereunder. The SEC barred Jett from association with any registered broker-dealer, directed Jett to cease and desist from future violations of these provisions of the federal securities laws, and ordered Jett to disgorge the $8.21 million in bonuses Jett had received as a result of his fraudulent transactions and pay a civil penalty of $200,000.
The Commission brought an action in 2006 to enforce the Commission's order against Jett. The Court's opinion held that Jett could not challenge the merits of the Commission's order in the enforcement proceedings, because Jett had not filed a timely appeal to the Court of Appeals, which has exclusive jurisdiction to review Commission orders.
SEC Announces Forum on Small Business Capital Formation
The SEC will hold its annual Forum on Small Business Capital Formation on Monday, Sept. 24, 2007, at the Commission's Washington, D.C., headquarters. This year's small business forum will focus on recent SEC rule proposals addressing securities registration and disclosure requirements for smaller companies. The SEC is required to conduct the annual forum under a 1980 federal statute. The forum offers representatives of smaller companies an opportunity to meet and communicate with senior government officials. SEC Small Business Forum to Focus on Recent Rule Proposals for Smaller Companies (see agenda for further information).