Securities Law Prof Blog

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

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Friday, August 3, 2012

Chairman Schapiro Statement on Knight Capital Group Trading Issue

SEC Chairman Mary Schapiro today made the following statement:

The apparent trading error by Knight Capital Group on Wednesday reflects the type of event that can raise concerns for investors about our nation’s equity markets — markets that I believe are the most resilient, efficient, and robust in the world.

Reliance on computers is a fact of life not only in markets everywhere, but in virtually every facet of business. That doesn’t mean we should not endeavor to reduce the likelihood of technology errors and limit their impact when they occur.

While Wednesday’s event was unacceptable, I would note that several of the measures we instituted following the Flash Crash helped to limit its impact. Recently-adopted circuit breakers halted trading on individual stocks that experienced significant price fluctuations, and clearly defined rules guided the exchanges in determining which trades could be broken giving the marketplace certainty.

In addition, existing rules make it clear that when broker-dealers with access to our markets use computers to trade, trade fast, or trade frequently, they must check those systems to ensure they are operating properly. And, naturally, we will consider whether such compliance measures were followed in this case.

As with every significant incident of volatility that occurs in our markets, we will continue to review what happened and determine if any, additional measures are needed. That process has already begun.

In particular, I have asked the staff to accelerate ongoing efforts to propose a rule to require exchanges and other market centers to have specific programs in place to ensure the capacity and integrity of their systems. And I have directed the staff to convene a roundtable in the coming weeks to discuss further steps that can be taken to address these critical issues.

August 3, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Government Loses Two Securities Fraud Cases This Week

It has not been a good week for government enforcement of securities laws.    On Tuesday, a jury in a federal district court in Manhattan rejected the SEC’s allegations of wrongdoing against Brian Stoker, a former mid-level executive at Citigroup.  On Thursday, a federal appeals court in Washington D.C. threw out convictions of traders in the “squawk box” prosecution.(Download Usvmahaffy)  Many commentators lament the failure of government to clean up the mess of the financial crisis and bring wrongdoers to justice.   ProPublica’s  Jesse Eisinger sums it up, “As every frustrated American knows, no major banking executive has gone to prison or has been fined any significant amount in the aftermath of the financial crisis.”  So what went wrong this week?

First, SEC v. Brian Stoker (S.D.N.Y.).  In this case, a companion to the SEC’s enforcement action against Citigroup Global Markets (in which Judge Rakoff rejected the parties’ proposed settlement; that case is now on appeal to the Second Circuit), the SEC charged Stoker with negligence in connection with his role in creating CDOs that Citigroup sold to investors.  According to the SEC, Stoker knew, or at least should have known, that he was misleading investors by not disclosing that Citigroup helped select the underlying securities in the CDO and then bet against it.  The jury refused to find Stoker liable and also issued an unusual statement that the judge read aloud in the courtroom:

“This verdict should not deter the S.E.C. from investigating the financial industry, to review current regulations and modify existing regulations as necessary.”

So what does this mean?  Was the jury saying that the agency went after the wrong guy?  Stoker, the only individual defendant in the case, was portrayed by his attorney as a “scapegoat,” a relatively junior executive (albeit one who made $2.4 million at Citigroup in 2007, the year before he left) at Citigroup.  In contrast, the SEC’s attorney, in his closing to the jury, argued that “Citigroup stacked the deck and Brain Stoker dealt the cards.” 

Alternatively, was the jury saying that it had no sympathy for the sophisticated investors who purchased the CDOs?  The defense presented evidence that Citigroup’s marketing materials contained warnings about the riskiness of the investment and should have alerted the purchasers that Citigroup might bet against the security.  Maybe the jury thought that the agency should use its scarce resources to protect unsophisticated investors from fraud?

In any event, to this jury, this was the wrong case for the agency to pursue.

Second,  U.S. v. Mahaffy (2d Cir.)  The convictions of these defendants stems from charges that in the early 2000s traders at several brokerage firms  allowed employees of A.B. Watley, a day trading firm, to listen in on live feeds from “squawk boxes” to obtain information on clients’ pending block orders, so they could engage in “front running.”  This litigation has a long and tortuous past.  The first trial in 2007 resulted in acquittal on 38 counts, but the jury deadlocked on one count of conspiracy to commit securities fraud.  The government determined to retry the defendants on this count and ultimately obtained convictions based on conspiring to misappropriate confidential information.

Now, as securities law specialists know, a violation of securities law based on the misappropriation theory requires the government to establish that the misappropriated information was confidential.  The squawk boxes blared throughout the firm; hence, the key issue was proving that the firms treated information about block orders transmitted via the squawk boxes as confidential.  The government called representatives from each firm who testified that client order information was confidential and they did not permit employees to allow outsiders to listen to squawks.   On cross-examination, defense aggressively challenged the assertions that the information was treated as confidential.

After defendants were convicted and sentenced following the second trial, the SEC initiated an administrative proceeding against one of the defendants, in the course of which it disclosed thirty transcripts of depositions taken as early as December 2004.  Defendants argued that information contained in twelve of the transcripts was exculpatory and should have been turned over to them in the criminal proceedings pursuant to Brady v. Maryland.  Specifically, they argued that the information undermined testimony from government witnesses that the squawked information was treated as confidential.  The district court, while it criticized the government’s conduct, refused to set aside the conviction.

The Second Circuit, however, reached a different outcome and determined that the Brady violations undermined confidence in the jury verdict.  (It also found that the district court did not adequately instruct the jury on the scope of honest services fraud and also vacated that component as well.)  It found that, because of the centrality of the issue of confidentiality, the defendants should have been provided with the transcripts: “The withheld SEC testimony strongly suggests that the brokerage firms did not treat squawked block order information as confidential and that senior employees and management at the respective firms did not bar the transmission of squawks or take steps to maintain  exclusive control of pending block order information.”  The court also found that there was no doubt that the government knew, at the time of the first trial, that at least one transcript contained possible Brady material, because the SEC attorney who conducted the depositions was designated as special AUSA for this case, sat at the counsel table during the trial, and even called the Brady issue to the attention of the DOJ attorneys.

The court concludes its discussion of the Brady issue with a pointed question:  

“In light of the government's mishandling of material exculpatory and impeaching material, we wonder whether the government will choose to subject the defendants to yet a third trial.”

Unfortunately, Mahaffy is not the first case where prosecutors fail to live up to their professional responsibilities in their zeal to obtain convictions, either because they are convinced of the guilt of the defendants or because they can’t bear the thought of losing.

So a bad week for the government.  And we continue to wait for government actions that will seek to identify and hold accountable the movers and shakers that caused the financial crisis.

August 3, 2012 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)

Thursday, August 2, 2012

SEC & DOJ Charge Bristol-Myers Squibb Exec with Insider Trading

The SEC charged Robert D. Ramnarine, an executive at Bristol-Myers Squibb, with insider trading on confidential information about companies being targeted for potential acquisitions. The SEC alleges that Ramnarine made more than $300,000 in illegal profits by misusing nonpublic information he obtained while helping Bristol-Myers Squibb evaluate whether to acquire three other pharmaceutical companies. The SEC is seeking a court order to freeze Ramnarine’s brokerage account assets. In a parallel criminal action, the U.S. Attorney’s Office for the District of New Jersey announced the arrest of Ramnarine.

According to the SEC’s complaint, Ramnarine, an executive in the treasury department at Bristol-Myers Squibb, conducted his insider trading schemes from August 2010 to July 2012, illegally trading in stock options of Pharmasset Inc., Amylin Pharmaceuticals Inc., and ZymoGenetics Inc. in advance of announcements that those companies would be acquired.

August 2, 2012 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Tuesday, July 31, 2012

SEC Recommends Legislation to Improve Muni Securities Market


The SEC issued a report with recommendations to help improve the structure of the $3.7 trillion municipal securities market and enhance the disclosures provided to investors.( Download SEC.munireport073112[1] ) The recommendations address concerns raised by market participants and others in public field hearings and meetings as well as the public comment process during the agency’s review of the municipal securities market.

At the start of 2012, there were more than one million different municipal bonds outstanding totaling $3.7 trillion, with 75 percent held by individual “retail” investors.  Despite its size and importance, the municipal securities market has not been subject to the same level of regulation as other sectors of the U.S. capital markets due to broad exemptions under federal securities laws for municipal securities.

The SEC’s report discusses potential legislative changes that could help improve disclosures to investors. The SEC’s report discusses several disclosure issues including the timing and content of financial information, disclosures relating to pension and other post-employment benefit plans, derivatives use by issuers and obligated persons, and conflicts of interest including pay-to-play practices. The report also reviews the current structure of the municipal securities market and discusses potential initiatives to improve pre-trade and post-trade price transparency and support existing dealer pricing obligations.

July 31, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Expels Day-Trading Firm for Supervisory Violations

FINRA announced that it expelled Biremis, Corp., formerly known as Swift Trade Securities USA, Inc., and barred its President and Chief Executive Officer, Peter Beck, for supervisory violations related to detecting and preventing manipulative trading activities such as "layering," short sale violations, failure to implement an adequate anti-money laundering program, and financial, operational and numerous other securities law violations.

FINRA found that during various periods from June 2007 to June 2010, Biremis and Mr. Beck failed to establish a supervisory system reasonably designed to achieve compliance with the applicable laws and regulations prohibiting manipulative trading activity. Among other things, Biremis' supervisory system failed to include policies and procedures designed to detect and prevent layering on U.S. markets.  

FINRA found that despite the fact Biremis' only business was to execute transactions on behalf of day traders around the world, Biremis and Mr. Beck failed to implement an adequate anti-money laundering (AML) program to comply with the Bank Secrecy Act.  

Biremis and Mr. Beck also violated a number of additional securities laws and rules. Biremis failed to maintain a margin system and margin accounts, and did not have policies and procedures in place related to the use of margin. The firm also failed to prepare customer reserve computations and failed to maintain a special reserve bank account for the exclusive benefit of customers. In addition, Biremis placed thousands of short sale orders, which was in violation of an emergency order issued by the SEC that temporarily banned short selling in certain securities. Also, between at least April 2008 and May 2009, Biremis improperly calculated its net capital, operating in net capital deficiency by up to $25 million. Additionally, the firm failed to maintain all required emails and instant messages over a five-year period.

July 31, 2012 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Monday, July 30, 2012

SEC Charges Hedge Fund Manager with Fraud Related to Chinese Reverse Merger Company

The SEC charged New York-based investment manager Peter Siris and two of his firms with securities law violations related to his activities with a Chinese reverse merger company, China Yingxia International Inc.  According to the SEC, Siris and his firms Guerrilla Capital Management LLC and Hua Mei 21st Century LLC became involved with China Yingxia in 2007 and their misconduct continued until 2010.

The SEC alleges that Siris, an active investor in Chinese companies and former newspaper money columnist, misled investors in his two hedge funds through which he invested $1.5 million in China Yingxia. Siris understated his involvement with the company particularly after it went out of business and used his insider status to make illegal trades based on nonpublic information as he received it. In an attempt to circumvent the registration provisions of the securities laws, Siris also received shares from the China Yingxia CEO’s father and improperly sold them without any registration statement in effect. Siris further engaged in insider trading ahead of 10 confidentially solicited offerings for other Chinese issuers.

Siris and his firms agreed to pay more than $1.1 million to settle the SEC’s charges. The SEC also separately charged five individuals and one firm for securities law violations related to China Yingxia.


Along with being one of three “consultants” that improperly raised money for China Yingxia, Siris and Hua Mei acted as advisers to the purported nutritional foods company.

Insider Trading and Illegal Short Selling
The SEC alleges that in February and March 2009, Siris sold China Yingxia stock while in possession of material, nonpublic information about problems at China Yingxia that he learned directly from the CEO. This confidential information included that she had engaged in illegal fundraising activities in China and that a company factory had shut down. Siris immediately began selling hundreds of thousands of shares of China Yingxia stock prior to any public disclosure by China Yingxia about these issues. Siris learned additional material, nonpublic information during the late afternoon of March 3, 2009, when he received a draft press release and notice that China Yingxia planned to publicly disclose the problems. Siris increased his orders to sell over the next couple of days before China Yingxia issued its press release publicly on March 6. Siris, through his funds, sold 1,143,660 China Yingxia shares in a matter of weeks for ill-gotten gains of approximately $172,000.

According to the SEC’s complaint, Siris and Guerrilla Capital Management also engaged in illegal insider trading ahead of 10 offering announcements for other Chinese issuers and made approximately $162,000 in ill-gotten gains. After expressly agreeing to go “over-the-wall,” which included a prohibition on trading, Siris traded ahead of the offering announcements in breach of his duty not to trade on such information.

The SEC further alleges that Siris sold short the securities of two Chinese companies prior to participating in firm-commitment offerings.

Fraudulent Representations in a Securities Purchase Agreement
The SEC alleges that in order to induce at least one issuer to sell securities to his funds, Siris falsely represented in a securities purchase agreement that his funds had not engaged in any trading after being contacted in confidence about a particular deal, when in fact his funds had effected sales in that issuer’s securities. Siris directed short sales of a Chinese issuer on Dec. 9, 2009, despite going “over-the-wall” in original solicitation discussions, and nevertheless Siris signed a securities purchase agreement later that afternoon that misrepresented he had not traded in those securities. The following morning, Siris directed additional sales of the company’s shares before the public announcement of the offering. Siris realized illegal insider trading gains.

Materially Misleading Disclosures to Fund Investors
The SEC alleges that Siris generally disclosed that he and his consulting firm Hua Mei, may provide services to Chinese issuers, but he did not disclose the depth of his involvement in China Yingxia. Investors were not informed that Siris and his firm provided drafting assistance for press releases and SEC filings, translation services, management preparation in advance of conference calls, and officer recommendations. By omitting key facts and making misrepresentations about his role with the company, Siris deprived his investors of material information that could have impacted their continued investment decisions with his funds. Furthermore, when China Yingxia later collapsed, Siris wrote to his investors and placed blame on others he claimed were responsible for the SEC filings and key hiring decisions while omitting his significant role in these very same tasks.

Acting as an Unregistered Securities Broker
The SEC alleges that Siris, who was not registered as a broker or dealer nor associated with a registered broker-dealer, acted as an unregistered broker during China Yingxia’s second securities offering, as he raised more than $2 million worth of investments. In a backdated consulting agreement, Siris through Hua Mei in fact received transaction-based fees for leading fundraising efforts for China Yingxia and not for providing consulting services. No disclosures were made to potential or actual investors concerning payments to three so-called consultants including Siris, who sold China Yingxia securities.

Improper Unregistered Sale of Securities
The SEC alleges that Siris and Hua Mei improperly sold securities that Hua Mei received from China Yingxia in a sham agreement intended to hide the fact that they were shares from a person controlled by the company. China Yingxia agreed to pay Siris for due diligence he conducted in connection with his lead investment in the company’s July 2007 PIPE offering. The company transferred shares to Siris with the appearance that they came from a shareholder to reimburse him for services performed for that shareholder. In fact, the sham agreement was simply a means for China Yingxia to provide Hua Mei with shares believed to be immediately eligible for sale, because had the company issued the shares directly to Hua Mei, they would have been restricted stock subject to holding period and other requirements for resale. The shareholder and source of the shares was later revealed to be the father of China Yingxia’s CEO – someone who was in fact a person directly or indirectly controlled by the issuer.

The SEC’s complaint against Siris and his entities alleges violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933, Sections 10(b) and 15(a) of the Securities Exchange Act of 1934, Rule 10b-5 thereunder, Rule 105 of Regulation M, and Section 206(4) of the Investment Advisers Act of 1940, and Rule 206(4)-8 thereunder. Without admitting or denying the allegations, Siris and his firms agreed to pay $592,942.39 in disgorgement and $70,488.83 prejudgment interest. Siris agreed to pay a penalty of $464,011.93. They also consented to the entry of a judgment enjoining them from violations of the respective provisions of the Securities Act, Exchange Act, and Advisers Act. The settlement is subject to court approval.

Also charged for securities law violations related to China Yingxia:

Ren Hu – the former CFO of China Yingxia made fraudulent representations in Sarbanes-Oxley (SOX) certifications, lied to auditors, failed to implement internal accounting controls, and aided and abetted China Yingxia’s failure to implement internal controls.
Peter Dong Zhou – engaged in insider trading and unregistered sales of securities and aided and abetted unregistered broker-dealer activity while assisting China Yingxia with its reverse merger and virtually all of its public company tasks. Without admitting or denying the charges, Zhou agreed to pay $20,900 in disgorgement, $2,463.39 in prejudgment interest, and a penalty $50,000. He agreed to a three-year collateral bar, penny stock bar, and investment company bar.
Alan Sheinwald and his investor relations firm Alliance Advisors LLC – were retained as “consultants” to China Yingxia and acted as unregistered securities brokers while raising money for China Yingxia and at least one other issuer.
Steve Mazur – acted as an unregistered securities broker while selling away from his firm the securities of China Yingxia and one other issuer. Without admitting or denying the charges, Mazur agreed to pay $126,800 in disgorgement, $25,550.01 in prejudgment interest, and a penalty of $25,000. He agreed to a two-year collateral bar, penny stock bar, and investment company bar.
James Fuld, Jr. – involved in the unregistered sales of securities. Without admitting or denying the charges, he agreed to pay $178,594.85 in disgorgement and $38,096.70 in prejudgment interest.
Mr. Calamari said, “With these charges, the SEC continues to make good on its commitment to hold accountable those who enable some Chinese reverse merger firms to take unfair advantage of investors in the U.S. capital markets.”

July 30, 2012 in SEC Action | Permalink | Comments (0) | TrackBack (0)