Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Friday, March 13, 2009

SEC Approves CME Operating as Central Counterparty for CDSs

The SEC approved conditional exemptions that will allow the Chicago Mercantile Exchange Inc. (CME) to operate as a central counterparty for clearing credit default swaps.  These conditional exemptions, based on a request by the CME and Citadel Investment Group LLC, provide the SEC with regulatory oversight of the central counterparty, and should enhance the quality of the credit default swap market and the Commission's ability to protect investors.

On Dec. 24, 2008, the SEC approved temporary exemptions allowing LCH.Clearnet Ltd. to operate as a central counterparty for credit default swaps. On March 6, 2009, the SEC approved similar temporary exemptions for ICE US Trust LLC. The Commission has worked in close consultation with the Board of Governors of the Federal Reserve System and the Commodity Futures Trading Commission, executing a Memorandum of Understanding in November 2008 to lay out a framework related to central counterparties for credit default swaps.

The SEC is soliciting public comment on all aspects of these exemptions to assist in its consideration of any further action that may be needed in this area.

March 13, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Six CHX Specialist Firms Settle SEC Charges

The SEC announced that on March 11, 2009, the United States District Judge for the Southern District of New York entered Final Consent Judgments in the Commission's previously filed cases against six specialist firms operating on the Chicago Stock Exchange (CHX): Automated Trading Desk Specialists, LLC, E*Trade Capital Markets LLC, Melvin Securities, LLC, Melvin & Company, LLC, Sydan, LP and Tradelink, LLC (collectively, the Defendants). The Court enjoined each of the Defendants from future violations of CHX Rule 17, and Section 17(a)(1) of the Securities Exchange Act of 1934 and Rule 17a-3 thereunder, and ordered the payment of disgorgement and civil penalties totaling in the aggregate more than $42.3 million. The Defendants consented to the entry of the orders without admitting or denying the allegations of the Commission's complaints.

The complaints, filed on March 4, 2009, charge each Defendant with engaging in unlawful proprietary trading on the CHX. In the complaints, the Commission alleges that the Defendants failed to meet their basic obligation as specialists to serve public customer orders over their own proprietary interests while executing trades on the CHX. As specialists operating on the CHX, each of the Defendants had a general duty to match executable public customer or "agency" buy and sell orders and not to fill customer orders through trades from the specialist firm's own accounts when those customer orders could be matched with other customer orders. However, from 1999 through 2005, each Defendant violated this obligation by filling orders through proprietary trades rather than through other customer orders. The complaints further allege that, during the relevant period, each of the Defendants failed to make or keep current a blotter containing an itemized daily record of all purchases and sales of securities effected by it for its proprietary accounts.

March 13, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Charges MedQuist and Former Officers with Accounting Fraud

The SEC filed a settled civil injunctive action against MedQuist Inc., a medical transcription company based in New Jersey, charging it with securities fraud and other violations of the federal securities laws. The Commission's complaint alleges that, from 1999 to 2004, MedQuist claimed in SEC filings, press releases and earnings calls that the Company's strong financial performance was due to its disciplined and conservative business practices, while at the same time it was systematically and secretly inflating customer bills to increase revenues and profit margins. Without admitting or denying the allegations, MedQuist agreed to be permanently enjoined from violating the antifraud, reporting, books and records, and internal controls provisions of the federal securities laws.

The Commission also filed a settled civil action against former MedQuist Director, President, and Chief Operating Officer John A. Donohoe. Without admitting or denying the Commission's allegations, Donohoe agreed to a permanent injunction, a $75,000 civil penalty and a five-year officer and director bar. In its complaint, the Commission alleges that Donohoe, among other things, knew that the Company was increasing its bills to meet revenue and margin targets. The complaint further alleges that Donohoe and others at MedQuist told shareholders and other public investors that the Company's strong financial performance was due to disciplined and conservative business practices, while at the same time it was engaged in overbilling customers. Donohoe agreed to be permanently enjoined from violating federal securities laws.

In a separate complaint, the Commission charged former MedQuist Chief Financial Officer Brian J. Kearns and former Controller Bruce J. Van Fossen with participating in the fraudulent scheme. According to the complaint, Kearns and Van Fossen knew that company offices were not calculating bills in accordance with customer contracts, but rather were secretly manipulating the number of transcribed lines charged to customers in order to increase revenues and profit margins. Neither Kearns nor Van Fossen took steps to stop the scheme. Both knew that customers and employees complained of billing fraud, but neither investigated the accuracy of the Company's line counts. The Commission's complaint further alleges that both Kearns and Van Fossen made false statements to auditors designed to conceal the billing complaints and the scheme itself. Both Kearns and Van Fossen prepared, participated in, or signed misleading public filings and statements that attributed the Company's improved financial performance to disciplined and conservative business practices and attributed its revenues to contracted rates and increased sales.

March 13, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Sets Aside PHLX Sanction for Member's Refusal to Pay Litigation Expenses

The SEC set aside an order of fees, expenses and sanctions imposed by the Philadelphia Stock Exchange, Inc. against Richard B. Feinberg. The PHLX had ordered Feinberg to pay $464,418.51 incurred by the PHLX in connection with a lawsuit Feinberg filed against a governor on the PHLX Board of Governors. The PHLX also ordered Feinberg's membership to be suspended if he did not pay the fees and expenses. In seeking to recoup these costs, the PHLX relied on PHLX Rule 651, which requires any member who fails to prevail in a lawsuit that is related to the business of the PHLX to reimburse the PHLX for reasonable expenses incurred in connection with that lawsuit. The Commission found that Feinberg's suit was not related to the business of the Exchange as required under Rule 651 and that to permit the PHLX to recoup litigation expenses in cases such as the one Feinberg brought would be inconsistent with purposes of the Securities Exchange Act of 1934. (Rel. 34-59577; File No. 3-13128)

March 13, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Walter Speaks on Regulatory Reform

SEC Commissioner Elisse B. Walter spoke on "Principles to Help Guide Financial Regulatory Reform" — before the Institute of International Bankers on March 2.

March 13, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Quest Software Settles Stock Option Backdating Charges

The SEC settled stock option backdating chargs with software manufacturer Quest Software, Inc. and three current or former officers.  According to the SEC's complaint, Quest, its executive chairman Vincent Smith, its former chief financial officer John Laskey, and former controller and principal accounting officer Kevin Brooks improperly granted undisclosed in-the-money stock options to executives and employees by backdating millions of options from 1999 through 2002. As a result of this misconduct, Quest reported a $113.6 million restatement of its operating income in September 2007. Quest has agreed to settle the SEC's charges, and the three executives have agreed to pay more than $300,000 combined to settle the allegations against them.  The SEC further alleges that Quest backdated 28 separate grants involving more than 11 million shares of common stock. Quest's failure to properly record compensation expenses in connection with the backdated options resulted in the overstatement of Quest's operating income by 4 percent to 963.1 percent and the understatement of its operating loss by 26.12 percent to 154 percent from 1999 through 2005.

March 13, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Thursday, March 12, 2009

SEC's Accountant Testifies on Mark-to-Market Accounting

James L. Kroeker, the SEC's Acting Chief Accountant, testified today on Testimony Concerning Mark-to-Market Accounting: Practices and Implications, before the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises of the House Committee on Financial Services.

March 12, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Attorney Pleads Guilty in Pump & Dump Scheme

The DOJ announced today that it filed criminal charges against Arizona securities lawyer David B. Stocker in the United States District Court for the Eastern District of Virginia, charging him with one count of conspiracy to commit securities fraud involving 19 publicly-traded companies. According to the Department of Justice’s announcement, Stocker participated in a “pump-and-dump” scheme to issue shares to the public illegally and to manipulate the trading price and volume by making materially false and misleading statements in press releases and in spam e-mail messages. Stocker simultaneously entered a guilty plea, agreeing to pay restitution to investors and forfeit the proceeds of his crimes. Stocker is currently scheduled to be sentenced on November 6, 2009.

The Securities and Exchange Commission earlier named Stocker in three civil injunctive actions currently pending in federal district courts in Arizona, Michigan, and Texas.

March 12, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Madoff Goes to Jail

Bernard Madoff's bail was revoked after he pleaded guilty today to eleven felony counts and expressed remorse to his victims. NYTimes, Madoff’s Bail Revoked After Guilty Pleas to All Charges.  The DOJ website has a transcript of today's hearing.  Besides jail time, Madoff is also subject to mandatory restitution and faces fines up to twice the gross gain or loss derived from the offenses.  The Criminal Information also includes forfeiture allegations which would require Madoff to forfeit the proceeds of the charged crimes, as well as all property involved in the money laundering offenses and all property traceable to such property.

March 12, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Wednesday, March 11, 2009

SEC Takes Action Against Alleged Ponzi Scheme in Virginia

The SEC filed a complaint today in the United States District Court for the Western District of Virginia against John M. Donnelly (Donnelly), a resident of Charlottesville, Virginia, and his firms, Tower Analysis, Inc., Nasco Tang Corp., and Nadia Capital Corp., alleging that they are conducting a multi-million dollar Ponzi scheme. The Commission also filed an application for an ex parte temporary restraining order, asset freeze, and other emergency relief against Donnelly and his entities.

According to the Commission's complaint, from at least 1998, Donnelly fraudulently obtained at least $11 million from as many as 31 investors through the sale of securities in the form of limited partnership interests in three investment funds. The SEC alleges that Donnelly orchestrated the scheme through three entities, Tower Analysis Inc., Nasco Tang Corp., and Nadia Capital Corp. The complaint alleges that Donnelly told investors that he would pool their funds to invest in, among other things, stock and bond index derivatives. According to the complaint, despite representations to investors that he had generated annual returns of as much as 22%, Donnelly has done almost no securities trading, and none since 2002. The complaint alleges that instead of using investor funds to execute trades, Donnelly used investor funds to repay other investors, and paid himself approximately $1 million in salary and fees during the last three years alone. The complaint also alleges that Donnelly has been soliciting investors for a new fund called Nadia Capital Partners, LP based on misrepresentations about his past trading results.

On the Commission's application, the court today entered a temporary restraining order enjoining Donnelly, Tower Analysis, Nasco Tang, and Nadia Capital from future violations of 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. In addition, the court entered an order freezing all assets under the control of Donnelly and his firms.

March 11, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Settles with Two Defendants in Peregrine Systems Fraud

The SEC announced settlements with two defendants in connection with the accounting fraud at Peregrine Systems, Inc. ("Peregrine"). On March 4, 2009, United States District Judge John A. Houston entered an Amended Final Judgment by consent against Michael D. Whitt, the former president of Barnhill Associates, Inc. ("Barnhill"), a reseller of Peregrine's software. The Court's Judgment enjoined Whitt from violating Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder, and ordered Whitt to pay a civil penalty of $60,000. On January 5, 2009, Judge Houston entered a Final Judgment by consent against former Peregrine Director of Strategic Alliances Peter J. O'Brien, enjoining him from violating the anti-fraud and other provisions of the federal securities laws, and ordering him to disgorge $124,792 in ill-gotten gains from unlawful sales of Peregrine stock and from a bonus he received from Peregrine during the fraud. Whitt and O'Brien settled the Commission's claims without admitting or denying the allegations in the Commission's complaint.

According to the Commission's complaint, beginning in 1999, Whitt caused Barnhill to enter into a series of sham transactions with Peregrine, which Peregrine used to artificially inflate its revenue. For several fiscal quarters, Whitt signed contracts-some of which were backdated to the prior quarter-that appeared to bind Barnhill to purchase Peregrine software licenses when, in fact, Barnhill had no obligation to pay Peregrine. Peregrine improperly recorded revenue on the sham contracts in contravention of U.S. Generally Accepted Accounting Principles ("GAAP").

With respect to O'Brien, the Commission's complaint alleged that in December 2000, O'Brien and another Peregrine executive persuaded an executive at a re-seller to sign two contingent sales agreements with Peregrine. The agreements related to software licenses that Peregrine was trying unsuccessfully to sell to two customers. O'Brien understood that Peregrine would only seek payment from the re-seller if the two Peregrine customers bought the licenses from the re-seller. Despite the contingent nature of the sale to the re-seller, Peregrine nevertheless recorded revenue on the two agreements in contravention of GAAP. Additionally, the complaint alleged that O'Brien was involved in a September 2001 contingent sale to a re-seller, for which Peregrine improperly recorded revenue. While participating in the fraud, O'Brien sold Peregrine stock.

In September 2006, Whitt entered a guilty plea in a related criminal case brought by the U.S. Attorney's Office for the Southern District of California. He pleaded guilty to obstructing justice by making false statements to Commission attorneys investigating the Peregrine fraud. Whitt was sentenced to six months of incarceration followed by six months of residency in a community confinement center, and he was ordered to pay $1 million in restitution.

In October 2004, O'Brien entered a guilty plea in the related criminal case. He pleaded guilty to obstructing justice by withholding relevant information and providing inaccurate information about his and others' knowledge and conduct to government investigators. O'Brien was sentenced to one year of probation.

In addition to the disgorgement order in the SEC action, O'Brien agreed to be enjoined from violating Section 17(a) of the Securities Act of 1933, Sections 10(b) and 13(b)(5) of the Exchange Act and Exchange Act Rules 10b-5, and 13b2-1; and from aiding and abetting violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Exchange Act Rules 12b-20, 13a-1 and 13a-13.

The Commission also announced that, on January 7, 2009, Judge Houston issued an order granting the parties' Joint Motion of Dismissal for Defendant Joseph G. Reichner. The Commission had filed its action against Reichner in October 2004.

March 11, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Stanford Refuses to Testify in SEC Probe

The Wall St. Journal has posted on its website a court filing from Allen Stanford in the SEC's action against him, asserting his privilege against self-incrimination and refusing to testify, provide an accounting or produce any documents.  WSJ, Stanford Spurns S/EC Probe in Alleged Fraud Scheme.

March 11, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Cuomo Says Merrill Misled Congress about Bonuses

The Wall St. Journal reports that the New York State Attorney General accuses Merrill Lynch of "misleading" Congress about the timing of the company's decision to pay $3.6 billion in bonuses.  In a court filing, the AG includes a Nov. 24, 2008 statement from a Merrill Lynch attorney to Rep. Henry Waxman that decisions had not yet been made about 2008 bonuses, yet, according to the AG, the compensation committee had two weeks earlier decided to accelerate the payment of 2008 bonuses.  WSJ, Cuomo Says Merrill Misled Congress.

March 11, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

Schapiro Testifies before House Subcommittee

Chairman Schapiro's Testimony Before the House Subcommittee on Financial Services and General Government Committee on Appropriations on March 11, 2009

March 11, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Court Enjoins Promoter in Internet Pump and Dump Scheme

On March 6, 2009, the United States District Court for the District of Colorado, entered a final judgment against Jonathan Curshen, finding him liable for securities fraud for acting as a promoter in an internet "pump and dump" scheme. Based on the Commission's evidence at the bench trial held on April 30 and May 1, 2007, the Court concluded that in early 2000, Curshen knowingly or recklessly posted on various Internet sites baseless projections and other financial information about Freedom Golf Corporation, a now-defunct Denver-based golf club manufacturer. The Court further found that Curshen knowingly failed to disclose that he was being paid to promote Freedom Golf and was selling the company's stock at the same time he was touting the company.

According to the Court's findings, Timothy Miles, a principal shareholder of Freedom Golf, arranged for the company to hire Carter Allen Jones and Curshen to promote Freedom Golf. Jones prepared an "investor report" touting Freedom Golf based on information provided by the company's president. The report contained factually baseless profit and revenue projections for Freedom Golf, which was in dire financial condition at the time. Curshen posted a link to the report on Internet websites, despite knowing of the company's poor financial condition. Furthermore, the Court found Curshen posted numerous messages touting Freedom Golf on various Internet web sites without disclosing his receipt and sale of Freedom Golf stock in exchange for promoting the company.

The Court's final judgment enjoins Curshen from violating Sections 17(a) and 17(b) of the Securities Act of 1933 (Securities Act) and Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5, and bars him from participating in any penny stock offering. The final judgment also orders Curshen to pay disgorgement of $66,235, representing profits gained from his participation in the illegal scheme. The Court reserved jurisdiction as to prejudgment interest and a civil penalty.

March 11, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

iBiz Technology and Officers Settle "Pump and Dump" Charges

On February 20, 2009, the United States District Court for the District of Arizona entered judgments by consent against iBIZ Technology Corp. formerly based in Phoenix, Arizona, its Chief Executive Officer Kenneth W. Schilling and its Executive Vice President H. Mark Perkins, also of Phoenix, and a company consultant, Jerrold B. McRoberts, who resides in Santa Fe, New Mexico. In its complaint, the SEC alleged that iBIZ Technology, Schilling, and Perkins made false and misleading statements in press releases, online interviews, investor correspondence, proxy solicitations, and Commission filings regarding the company's involvement with a development-stage product called the "Virtual Keyboard." While these statements were being disseminated, Schilling and Perkins sold over $1 million of their own iBIZ Technology shares into a falsely inflated market. In addition, the SEC alleged in its complaint that the inflated stock price allowed iBIZ Technology to retire approximately $2.8 million of convertible debt that it otherwise lacked the resources to repay. The complaint also alleged that all of the defendants engaged in a scheme to raise money for themselves by improperly using Form S-8 registrations statements. The complaint also alleged that iBIZ Technology, Schilling and Perkins illegally distributed shares through its consultants, Jeffery Firestone, Jerrold B. McRoberts, and Doyle Scott Elliott, who then sold the shares into the public market.  The judgments permanently enjoin iBIZ Technology, Schilling and Perkins from violating, or aiding and abetting violations of, the securities registration provisions of Sections 5(a) and 5(c) of the Securities Act of 1933 ("Securities Act"), the anti-fraud provisions of Section 10(b) and Rule 10b-5, and the periodic reporting requirements. The defendants, in consenting to the orders of permanent injunction, neither admitted nor denied the allegations of the Commission's complaint.


March 11, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Merrill Lynch Settles "Squawk Box" Violations

The SEC charged Merrill Lynch, Pierce, Fenner & Smith Inc. with securities laws violations for having inadequate policies and procedures for controlling access to institutional customer order flow. Merrill Lynch agreed to settle the SEC’s charges and pay a $7 million penalty, among other remedies.  According to the SEC’s order instituting proceedings, Merrill Lynch utilizes institutional equities "squawk boxes," which are internal intercom systems used by broker-dealers to broadcast institutional customer order information to traders and sales traders at the broker-dealer. From 2002 to 2004, several Merrill Lynch retail brokers at three branch offices permitted day traders at other firms to listen to confidential information on large unexecuted block orders of Merrill Lynch’s institutional customers. The Merrill Lynch brokers put their telephones next to the squawk boxes and let the day traders listen to the squawk box, often for the entire trading day. The day traders used the broadcasts to trade ahead of the orders placed by Merrill Lynch’s customers.

March 11, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Yet Another Ponzi Scheme

The SEC charged Northern California residents Anthony Vassallo and Kenneth Kenitzer for orchestrating a multi-million dollar investment fraud. Vassallo agreed to a court order freezing his assets. The SEC is seeking an emergency court order to also freeze the assets of Vassallo's company, Equity Investment Management and Trading, Inc. (EIMT).  According to the SEC's complaint, Vassallo and Kenitzer raised more than $40 million from about 150 investors from approximately May 2004 to November 2008. Vassallo told investors, many of whom he met through his church, that he had a proprietary computer software program that allowed him to buy and sell stock options and generate returns of 3.5 percent per month with little risk of loss. The SEC alleges that Vassallo and Kenitzer instead used investors' money for unauthorized purposes, including a variety of other schemes never disclosed to investors.  The SEC alleges that Vassallo and Kenitzer kept the scheme going by using money raised from new investors to pay earlier investors, a classic hallmark of a Ponzi scheme.

In addition to an emergency order freezing EIMT's assets, the SEC seeks injunctive relief, disgorgement of defendants' ill-gotten gains, and financial penalties.

March 11, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

GAO Releases Testimony on TARP Transparency and Accountability Issues

The United States Government Accountability Office released Testimony Before the House Subcommittee on Domestic Policy, Committee on Oversight and Government Reform, on the TROUBLED ASSET RELIEF PROGRAM: Status of Efforts to Address Transparency and Accountability Issues (Statement of Richard J. Hillman, Managing Director,Financial Markets and Community Investment).

March 11, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Will Reconsider Uptick Rule

The Wall St. Journal reports that the SEC will consider reinstating the "uptick rule," or some revised version of it, as early as next month.  The uptick rule prohibited short sales unless the stock price was higher than its previous trade.  Some blame the repeal of the uptick rule for increased short-selling and volatility.  WSJ, SEC May Reconsider 'Uptick Rule' .

March 11, 2009 in News Stories | Permalink | Comments (0) | TrackBack (0)