Securities Law Prof Blog

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

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Monday, March 23, 2009

SEC Obtains Asset Freeze Against Alleged Investment Fraud

The SEC today obtained an emergency court order to halt an ongoing scheme by a Palmdale, California company and two individuals who have defrauded investors through a series of false claims including that Warren Buffett is associated with the company.  According to the SEC's complaint, International Realty Holdings, Inc. (IRH), Ottoniel Medrano (a prison guard at California City Correctional Center), and Leticia Isabel Medrano have raised hundreds of thousands of dollars from investors in several states since October 2008. The defendants defrauded investors by falsely claiming, among other things, that Warren Buffett is IRH's "Honorary Chairman," that Berkshire Hathaway and Credit Suisse are involved in the investment, and that IRH has $4.8 billion in total assets and owns various properties throughout Asia. After obtaining money from investors, the Medranos transferred funds to offshore bank accounts.

The SEC's complaint, filed in federal district court in Los Angeles, CA, charges IRH and the Medranos with raising at least $485,000 and likely more than $700,000 in selling preferred stock in IRH. The rate at which the defendants have raised funds has increased substantially over the last two months, averaging about $250,000 per month. According to IRH's offering materials, defendants intended to raise up to $6 billion in the offering.

In its lawsuit, the SEC obtained an order (1) freezing the assets of IRH and the Medranos; (2) requiring the repatriation of assets; (3) requiring accountings; (4) prohibiting the destruction of documents; (5) granting expedited discovery; and (6) temporarily enjoining IRH and the Medranos from future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The SEC also seeks preliminary and permanent injunctions, disgorgement, and civil penalties against IRH and the Medranos. A hearing on whether a preliminary injunction should be issued against the defendants is scheduled for April 2, 2009 at 2 p.m.

March 23, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Palmiter & Taha on Manipulation of Mutual Fund Performance

Star Creation: The Manipulation of Mutual Fund Performance through Incubation, by Alan R. Palmiter,  
Wake Forest University - School of Law, and Ahmed E. Taha, Wake Forest University - School of Law, was recently posted on SSRN.  Here is the abstract:

The article argues that some mutual fund companies mislead investors by marketing new funds with artificially high returns. These companies create a number of small, new mutual funds that initially operate out of public view. After a period of incubation, the strong performers are actively marketed to the public while the weak performers are quietly terminated. By highlighting the successful incubator funds and hiding the unsuccessful ones, these companies create the illusion that that the successful funds' returns were the result of skill rather than luck. In addition, some companies subsidize their incubator funds to further artificially boost their performance. When the successful incubator funds are opened to the public, investors flock to them, attracted by the high advertised returns. However, the funds' luck and subsidies soon end, and thus so too do their high returns.

We argue that the SEC must do much more to prevent fund companies from using a manipulated incubation process to mislead investors. We also propose different regulatory approaches to this problem.

March 23, 2009 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

State Securities Regulators Testify Before Financial Services Committee

Delaware Securities Commissioner James Ropp and Massachusetts Secretary of the Commonwealth William Galvin appeared before the House Financial Services Committee on Friday, March 20. The hearing, led by Committee Chairman Barney Frank (D-MA), brought together federal and state securities regulators and law enforcement officials to discuss the enforcement of investor protection laws at the federal and state levels.

Testifying on behalf of the North American Securities Administrators Association (NASAA), Commissioner Ropp urged Congress to support the valuable contributions of state securities regulators through federal grants. “  Ropp also suggested deputizing state securities attorneys to serve as special prosecutors for complex securities cases; allowing states to review securities offerings currently exempt from state oversight under Rule 506 of Regulation D; including representatives from the state banking, insurance and securities regulatory agencies on the President’s Working Group on Financial Markets; toughening civil and criminal penalties for those who commit financial crimes, especially those who target senior investors; and increasing opportunities for victims of fraud to seek private actions.

Secretary Galvin, the top securities official in Massachusetts, urged the committee to “give the states the tools we need to maintain and enhance our ability to regulate effectively and protect investors.” Galvin also asked Congress to require that brokerages be in a fiduciary relationship to their individual retail customers. Under current law, broker-dealer firms deal with their customers on an arm’s-length basis, subject to an obligation of fair dealing. This means that customers cannot rely on their brokers to meet fiduciary obligations of loyalty, care and competence. In contrast to brokers, investment advisers work solely for their customers and have an acknowledged fiduciary duty to them.

March 23, 2009 in State Securities Law | Permalink | Comments (0) | TrackBack (0)

FINRA Fines 25 Firms for Breakpoint Failures

FINRA announced that it fined 25 broker-dealers a total of $2,145,000 for failures related to their completion of FINRA's (then NASD's) firm self-assessment of mutual fund breakpoint discount compliance.  All firms settled the charges without admitting liability.

 The self-assessment required firms that sold front-end load mutual funds to review their compliance in providing breakpoint discounts to customers during 2001 and 2002 and report those results to FINRA. Breakpoint discounts are volume discounts applicable to front-end sales charges (front-end loads) on Class A mutual fund shares. The self-assessment followed findings by NASD, the NYSE and the Securities and Exchange Commission that nearly one in three mutual fund transactions that appeared eligible for a breakpoint discount did not receive one.

The findings made in today's settlements result from FINRA's review of firms' compliance with the self-assessment requirements. The violations include failing to accurately report information; failing to send timely notices and responses to customers concerning the availability of breakpoint discounts; failing to provide timely refunds for missed breakpoints to customers; and failing to correctly calculate such refunds.

 In addition, FINRA found that three firms — Fox & Company Investments, Inc., First Midwest Securities, Inc. and Chase Investment Services, Corp. — failed to deliver breakpoint discounts during a later review period and continued to fail to have reasonable written supervisory procedures in place to assure that appropriate breakpoint discounts would be delivered to their customers during that later period.

 In its review, FINRA found that 14 firms — J.J.B. Hilliard, W.L. Lyons Inc., New England Securities, SunAmerica Securities, Inc., Multi-Financial Securities Corporation, H. Beck, Inc., Leonard & Company, Fox & Company Investments, Inc., Investors Capital Corp., vFinance Investments, Inc., FSC Securities Corporation, National Securities Corporation, Advantage Capital Corporation, Steven L. Falk & Associates, Inc. and Securities America, Inc. — failed to accurately and/or fully complete their self-assessments.

 FINRA further found that six of the firms — Multi-Financial Securities Corporation, Intersecurities Inc., SWS Financial Services, Spelman & Co. Inc., Securities America, Inc., and SIGMA Financial Corporation — failed to accurately complete a comprehensive trade-by-trade review of transactions. The trade-by-trade review was a required part of their customer remediation process following the self-assessment.

 Six firms — ProEquities, Inc., FSC Securities Corporation, Lincoln Investment Planning, Inc., New England Securities, Gary Goldberg & Co., Inc., and Leonard & Company — failed to provide timely refunds of breakpoint discounts to their customers. In addition, five firms — Leonard & Company, Gary Goldberg & Co., Inc., Financial West Group, GunnAllen Financial, Inc. and ProEquities, Inc. — failed to notify their customers on a timely basis — or failed to notify them at all — of the potential for reimbursement for missed breakpoint discounts. In addition, GunnAllen and ProEquities did not timely respond to customer inquiries about breakpoint discounts.


March 23, 2009 in Other Regulatory Action | Permalink | Comments (1) | TrackBack (0)

SEC Charges Escala Group and former officers with fraud

The SEC filed a disclosure and accounting fraud case against then-NASDAQ National Market issuer Escala Group, Inc.; its founder and former CEO Gregory Manning, and its former CFO Larry Lee Crawford, alleging fraudulent related party transactions between Escala and its parent company, Afinsa Bienes Tangibles, S.A. ("Afinsa"). Escala is a network of companies in the collectibles market specializing in stamps, among other things. Afinsa was a privately held Spanish company that sold investments in portfolios of stamps in Europe. According to the complaint, the fraudulent related-party transactions ceased after May 2006, when Spanish authorities raided Afinsa's offices and charged Afinsa and certain individuals with engaging in a massive unlawful pyramid scheme. 

The SEC complaint alleges a fraudulent business scheme based upon the secret and dramatic manipulation of collectible stamp values.  The complaint alleges that these false and misleading disclosures and omissions were material in that the related-party transactions contributed over $80 million to Escala's revenues and allowed Escala to meet its forecasts for either revenue or pre-tax net income for the third quarter and for year-end of fiscal year 2004, and for the first quarter and year-end in fiscal 2005. According to the complaint, as a result of these transactions, Escala went from trading at $1.47 per share on January 23, 2003, to a $32-per-share company with a purported market cap of $898 million in the span of a few years.

Simultaneous with the filing of the complaint in a Consent and proposed Final Judgment submitted for the Court's consideration, without admitting or denying the allegations in the complaint, Escala consented to a permanent injunction against future violations of these provisions.

The complaint charges defendants Manning and Crawford with violations of Sections 10(b) and 13(b)(5) of the Exchange Act [15 U.S.C. §§ 78j(b) and 78m(b)(5)] and Exchange Act Rules 10b-5, 13b2-1, 13b2-2, and 13a-14, [17 C.F.R. §§ 240.10b-5, 240.13b2-1, 240.13b2-2 and 240.13a-14], aiding and abetting Escala's violations of Sections 13(a), and 13(b)(2)(A) and (B) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1, and 13a-13, and seeks permanent injunctions against future violations, disgorgement of ill-gotten gains, prejudgment interest, civil penalties, and officer and director bars.

March 23, 2009 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC's Investment Management Director Addresses ICI Conference

Andrew J. Donohue, Director, Division of Investment Management, SEC, gave the Keynote Address, Investment Company Institute, 2009 Mutual Funds and Investment Management Conference, on March 23, 2009.

March 23, 2009 in SEC Action | Permalink | Comments (1) | TrackBack (0)