Securities Law Prof Blog

Former NBTY Director Settles Insider Trading Charges

A final judgment was entered on May 8, 2008, by the United States District Court for the Southern District of New York against Nathan Rosenblatt, a former director of NBTY, Inc., and member of its three-person audit committee. Rosenblatt consented to the entry of final judgment, without admitting or denying the allegations of the SEC's complaint.  The complaint alleged that Rosenblatt tipped his close friend Morris Gad with material, nonpublic information concerning the company's significant revenue and earnings shortfall for the third quarter of 2004, prior the company's public release of its financial results. With this information in hand, Gad sold his entire position of NBTY stock, sold the stock short, purchased put contracts, and sold call contracts through the custodial accounts of his three children prior to NBTY's release of its 2004 third quarter financial results. In so doing, Gad made $399,187.40 in trading profits and losses avoided.  Gad previously settled with the Commission.

The final judgment against Rosenblatt orders him to pay a civil penalty of $399,187.40, and permanently bars him from acting as an officer or director of any public company.

SEC Amends Rule 2a-46 of Investment Co. Act

The SEC broadened small business financing opportunities by amending Rule 2a-46 under the Investment Company Act to increase the availability of capital to certain smaller companies that may not have ready access to the public capital markets or other forms of conventional financing.

Congress in 1980 established business development companies (BDCs) to help make capital more readily available to small, developing, and financially troubled businesses. To accomplish this purpose, the Investment Company Act generally prohibits a BDC from making any investment unless, at the time of the investment, at least 70 percent of its total assets are invested in securities of certain specific types of companies, including "eligible portfolio companies."

The Commission has amended Rule 2a-46 to expand the definition of eligible portfolio company to include any domestic operating company with securities listed on a national securities exchange, if the company has a market capitalization of less than $250 million.

The Investment Company Act defines eligible portfolio company to include a domestic operating company that, among other things, does not have any class of securities that are marginable under rules issued by the Federal Reserve Board. In 1998, for reasons unrelated to small business capital formation, the Federal Reserve Board amended its margin rules to include all publicly traded equity securities and most debt securities. These 1998 amendments had the unintended consequence of substantially reducing the number of companies that met the definition of eligible portfolio company.

In 2006, the Commission adopted new rules under the Investment Company Act to address the effect of the Federal Reserve Board's 1998 amendments on the definition of eligible portfolio company. The Commission adopted Rule 2a 46 to include in the definition of eligible portfolio company all private companies and public companies whose securities are not listed on a national securities exchange. This is the rule that the Commission has amended today. The Commission in 2006 also adopted Rule 55a-1 to conditionally permit a BDC to include in its 70 percent basket any follow on investments in a company that met the new definition of eligible portfolio company at the time of the BDC's initial investment in it.

Indiana Businessman Charged with Criminal Securities Fraud

The SEC announced that on May 9, 2008, the United States Attorney's Office for the Northern District of Illinois filed a 14-count criminal information against Michael E. Kelly ("Kelly"), a former South Bend, Indiana businessman that the SEC previously charged with securities fraud in a civil action filed in September 2007. The information alleges that Kelly engaged in a fraudulent investment scheme by offering and selling through fraudulent means approximately $34 million in promissory notes and more than $450 million in investments called Universal Leases. The criminal information charges Kelly with 10 counts of mail fraud, two counts of wire fraud and two counts of securities fraud and also seeks the forfeiture of approximately $500 million. Kelly was initially charged in a criminal complaint when he was arrested in December 2006.

Court Enjoins Pump & Dump Scheme Involving Nutraceutical

On April 25, 2008, the U.S. District Court for the Middle District of Florida granted the SEC's motion for summary judgment and entered an order and final judgment against Kerry P. Kennedy, a stock promoter who orchestrated the fraudulent promotion of the securities of Nutraceutical Clinical Laboratories International, Inc. ("Nutraceutical" or the "Company").  The Court's judgment (1) enjoins Kennedy from violating the anti-fraud provisions of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), Exchange Act Rule 10b-5, and the registration provisions of Section 5(a) and (c) of the Securities Act of 1933 ("Securities Act"); (2) orders Kennedy to disgorge $1,685,413.71 in ill-gotten gains (including prejudgment interest) from his participation in the pump-and-dump scheme; (3) imposes a $400,000 civil money penalty; and (4) bars Kennedy from participating in any offering of penny stock.

The SEC's complaint, filed on November 15, 2004, alleged that in 2000 and 2001 Kennedy, along with fellow stock promoter Stanley Siciliano, attorney John Zankowski and Nutraceutical CEO Paul Simmons and CFO Rodney Gilbert, engaged in a multi-faceted pump-and-dump scheme involving the securities of Nutraceutical, which now, under different management, operates as Preservation Sciences, Inc. and EFUEL Network, Inc. As part of a reverse merger transaction Kennedy helped to arrange, CEO Simmons, CFO Gilbert, promoter Kennedy and attorney Zankowski secretly purchased nearly all of Nutraceutical's purportedly free trading stock through their offshore nominee accounts. They did so in order to make a public market for the illegal, unregistered distribution of their stock.

To drum up interest in the Company and to facilitate their anonymous distribution, Simmons disseminated false and misleading publicity about Nutraceutical, while, at the same time, stock promoters Kennedy and Siciliano falsely touted the stock on an Internet message board and manipulated the market for the Company's stock through fraudulent stock trading via matched and washed buy and sell orders. According to the Court's order, "Kennedy's actions showed that he was aware of the true value of Nutraceutical's stock, while simultaneously deceiving potential investors to increase the profit of his stock sale." During the course of the pump, Kennedy unlawfully dumped Nutraceutical stock through nominee accounts, reaping $1,144,583.95 in profits.

SEC Charges Ponzi Scheme Targetted to African-American Community in Los Angeles

The SEC filed securities fraud charges against the promoters of an $18 million real estate investment scheme targeting the African-American community in the Los Angeles area and other locations in Nevada and Georgia.  The SEC's complaint, filed in U.S. District Court in Los Angeles, charges Jeanetta M. Standefor and Accelerated Funding Group (AFG) with operating a fraudulent "foreclosure reinstatement" scheme that attracted more than 600 investors between 2005 and 2007. The scheme purported to use investors' funds to cure defaults on distressed properties owned by others. The SEC alleges that while soliciting investor money and promising returns of up to 50 percent within 30 to 45 days, Standefor and AFG were instead operating a Ponzi-like scheme that used money from new investors to pay previous investors. Standefor also used more than $1.9 million of investor funds for personal expenses such as her lavish wedding and honeymoon, cars, jewelry, tickets to entertainment events, and home renovations. Standefor and AFG also misused investor funds to pay $121,000 in "consulting fees" to Standefor's husband, Darrell R. Dansby.

SEC Charges Broadcom Officers with Backdating

The SEC charged two current and two former top officers of Broadcom Corporation for their alleged participation in a five-year scheme to secretly backdate stock options granted to virtually all Broadcom officers and employees.  The SEC's complaint, filed in federal district court for the Central District of California, alleges that Broadcom's former chief executive officer Henry T. Nicholas, chairman and chief technology officer Henry Samueli, former chief financial officer William J. Ruehle, and general counsel David Dull perpetrated a scheme from 1998 to 2003 to fraudulently backdate stock option grants, failing to record billions of dollars of compensation expenses and falsifying documents to further the fraud. As a result of the scheme, Broadcom restated its financial results in January 2007 and reported more than $2 billion in additional compensation expenses.

According to the SEC's complaint, Nicholas and Samueli served on the two-member option committee that had authority to approve options to employees and all but the most senior officers. The SEC alleges that the option committee approved as many as 88 grants during the relevant period, but for many of the grants the committee neither held meetings nor made decisions on the dates the grants were supposedly approved. Instead, Ruehle allegedly selected most of the grant dates retroactively based on a comparison of Broadcom's historical stock prices, and Nicholas and Samueli allegedly concealed the backdating by signing false committee written consents stating that the grant had been approved "as of" the retroactive date.

In addition, the SEC alleges that Nicholas, Samueli, and Ruehle - not the compensation committee - decided on option grants to Broadcom's senior officers and used hindsight to select the dates for them. Dull allegedly knew about and participated in the backdating scheme and was involved in the preparation, review, and approval of false board and compensation committee meeting documents to conceal two backdated grants in 2001, one of which awarded him options to purchase 300,000 shares. The SEC is alleging that Ruehle and Dull each personally benefited from the backdating scheme by receiving and exercising backdated grants that were in-the-money by more than $100,000 for Ruehle and $1.8 million for Dull.

The SEC is seeking permanent injunctions, civil monetary penalties, and officer-and-director bars against each of the individuals, disgorgement with prejudgment interest against Ruehle and Dull, and reimbursement of bonuses and profits from stock sales from Nicholas and Ruehle pursuant to Section 304 of the Sarbanes-Oxley Act of 2002.

SEC Settles FCPA Charges Against Willbros Group

The SEC filed a settled civil action against Willbros Group, Inc. and several former employees alleging that they violated the anti-bribery provisions of the Foreign Corrupt Practices Act (FCPA) and the antifraud provisions of the federal securities laws. According to the complaint, the company also violated the reporting, books and records and internal controls provisions of the Securities Exchange Act. Willbros Group agreed to settle the charges, without admitting or denying the Commission's allegations.

According to the SEC's complaint, the Willbros Group engaged in multiple schemes to bribe foreign officials in Nigeria and Ecuador and also implemented a fraudulent tax avoidance scheme in Bolivia. Willbros Group agreed to consent to the entry of a judgment that permanently enjoins it from future violations of these provisions and that orders it to pay disgorgement of $8.9 million, plus prejudgment interest of $1.4 million.

SEC Proposes Requirement of Interactive Data Format

The SEC voted to propose a rule that would require all U.S. companies to provide financial information using interactive data beginning next year for the largest companies, and within three years for all public companies.  The interactive data tags uniquely identify individual items in a company's financial statement so they can be easily searched on the Internet, downloaded into spreadsheets, reorganized in databases, and put to other comparative and analytical uses by investors, analysts, and journalists.  Since 2005, many companies have voluntarily submitted to the SEC financial information in interactive data format.

"This is all about bringing investors better, faster, more meaningful information about the companies they own," said SEC Chairman Christopher Cox. "It would transform financial disclosure from a 1930s form-based system to a truly 21st century model that taps the power of technology for the benefit of investors."

The SEC's proposed schedule would require companies using U.S. Generally Accepted Accounting Principles with a worldwide public float over $5 billion (approximately the 500 largest companies) to make financial disclosures using interactive data formatted in eXtensible Business Reporting Language (XBRL) for fiscal periods ending in late 2008. If adopted, the first interactive data provided under the new rules would be made public in early 2009. The remaining companies using U.S. GAAP would provide this disclosure over the following two years. Companies using International Financial Reporting Standards as issued by the International Accounting Standards Board would provide this disclosure for fiscal periods ending in late 2010. The disclosure would be provided as additional exhibits to annual and quarterly reports and registration statements. Companies also would be required to post this information on their websites.

The required tagged disclosures would include companies' primary financial statements, notes, and financial statement schedules. Initially, companies would tag notes and schedules as blocks of text, and a year later, they would provide tags for the details within the notes and schedules.

Public comment on the proposed rule should be received by the SEC no later than 60 days after its publication in the Federal Register.

SEC Settles Manipulation Charges in OTC BB Stock

The United States District Court for the District of Columbia entered a Final Judgment of permanent injunction and other relief, including a bar against participating in offerings of penny stocks, against Jeffrey A. Hayden on May 7, 2008. Without admitting or denying the Commission's allegations, Hayden consented to the entry of the Final Judgment. The judgment settles the Commission's claims against Hayden in a civil action filed on August 16, 2007, in which the Commission alleged that Hayden had participated in a fraudulent scheme to manipulate the stock price of Nationwide Capital Corporation, a now-defunct company whose shares traded on the Over-the-Counter Bulletin Board.  The SEC alleged that, in August and September 2002, Hayden and others carried out a scheme to manipulate the price of Nationwide's stock that artificially inflated Nationwide's stock price from pennies to $9.35 per share. The scheme collapsed on October 1, 2002, when the SEC suspended trading in Nationwide securities.

Hayden was liable for disgorgement of $290,798, together with prejudgment interest of $116,330, but payment of these amounts was waived based upon Hayden's sworn Statement of Financial Condition. A civil penalty was not imposed for the same reason.

SEC Settles Insider Trading Charges Involving U.S. Foodservice

The SEC settled insider trading charges against John Turchetta of Naples, Florida. The complaint alleges that Turchetta purchased securities of U.S. Foodservice (USF) after he acquired material, nonpublic information concerning a proposed tender offer by Royal Ahold (Koninklijke Ahold N.V.) for the outstanding shares of USF common stock. Turchetta received the inside information from a USF vendor, who had been tipped by a senior officer of the company.

Turchetta has agreed to settle the Commission's action, without admitting or denying the allegations in the complaint. The final judgment orders Turchetta to pay disgorgement of $553,000 plus prejudgment interest thereon in the amount of $162,069, as well as a civil penalty of $553,000, for a total of $1,268,069. The settlement is subject to approval by the Court.

SEC Settles Fraud Charges Against Former U.S. Foodservice VP

The SEC settled charges against Brian Spears, a former Vice President of Purchasing at U.S. Foodservice (USF). The SEC alleged that Spears and others at USF, then a subsidiary of Royal Ahold (Koninklijke Ahold N.V.) (Ahold), engaged in a large-scale fraud that, for fiscal years 2001 and 2002, materially overstated operating income by an aggregate amount of approximately $700 million.

The Commission's complaint further alleged that Spears and others at USF induced third parties to confirm false information to USF's outside auditors. Spears and others at USF did this to make it falsely appear that amounts recorded on USF's books and records as accounts receivable were earned. As alleged in the complaint, Spears called vendors at USF's 2001 fiscal year-end and 2002 fiscal year-end and worked with others at USF to convince the vendors to sign the confirmation letters and return them to USF's auditors.

Spears has agreed to settle the Commission's action, without admitting or denying the allegations in the complaint. The final judgment orders disgorgement of $45,000 and prejudgment interest thereon in the amount of $15,547, but waives payment of all disgorgement and prejudgment interest and does not impose a civil penalty, based on the sworn representations in Spears' Statement of Financial Condition and other documents and information submitted to the Commission. The final judgment also bars Spears from serving as an officer or director of a public company for five years. The settlement is subject to approval by the Court.

Hedge Fund Manager Settles Insider Trading Charges

The SEC announced that on May 8, 2008, the Massachusetts federal district court entered final judgments by consent against the remaining defendants in an insider trading case arising out of Rhode Island-based Citizens Bank's May 4, 2004 announcement that it was acquiring Charter One Financial, Inc., a Cleveland-based bank. The settling parties are former hedge fund manager, Michael K.C. Tom of Waltham, Massachusetts, former Burlington, Massachusetts-based investment adviser, Global Time Capital Management, LLC, and former Burlington, Massachusetts-based hedge fund, GTC Growth Fund, L.P..  The SEC alleged that a then-Citizens employee conveyed certain material, non-public information relating to Citizens' planned acquisition to Global Time Capital Management portfolio manager Michael Tom, a former Citizens employee who ran the GTC Growth Fund. The complaint further alleged that between April 29, 2004 and May 4, 2004, Michael Tom purchased numerous Charter One call options, for his personal account and for the GTC Growth Fund. In addition, Michael Tom traded Charter One securities prior to Citizens' announcement in a joint account he held with his wife and in accounts he managed for his wife and in-laws. Michael Tom also tipped his brother about Citizen's acquisition plan. According to the complaint, Michael Tom's illegal insider trading in Charter One securities resulted in total profits of approximately $743,505.

Michael Tom and Global Time Capital Management, without admitting or denying the allegations contained in the Commission's complaint, each consented to the entry of final judgments against them and permanent injunctions against future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Michael Tom also agreed to pay disgorgement of $543,875.07 plus prejudgment interest of $107,381.63, and a civil money penalty of $150,000. Global Time Capital Management has agreed to pay a civil money penalty of $39,056.93. Relief defendant GTC Growth Fund has agreed to pay disgorgement of $189,868.39 plus prejudgment interest of $23,145.67.

SEC Charges Three Florida Doctors with Insider Trading

The SEC filed a civil action in the United States District Court for the Southern District of Florida charging three doctors, Dr. Zachariah P. Zachariah (Zachariah), Dr. Mammen P. Zachariah (M. Zachariah), and Dr. Sheldon Nassberg, with illegal insider trading from which they reaped a total of more than a half-million dollars in profits. All three defendants reside and practice medicine in the Ft. Lauderdale, Florida area.

The SEC alleges illegal trading in the shares of two unrelated companies. In the first, the complaint alleges that Zachariah, shortly after being appointed to serve as a company director, learned that IVAX's then-chairman and CEO had agreed with the then-CEO of Teva Pharmaceuticals Ltd. on preliminary terms for Teva to acquire IVAX and placed the first of four separate IVAX stock purchase orders that he made in his online brokerage account that day. Zachariah purchased 35,000 shares of IVAX stock at a cost of approximately $730,000.  The SEC further alleges that Zachariah later tipped his brother, M. Zachariah, who purchased 2,000 shares of IVAX stock at a total cost of approximately $46,000 on the last trading day before IVAX announced on July 25, 2005 that Teva would acquire it.

In addition, according to the SEC's complaint, Zachariah also misappropriated material, non-public information about Sarasota, Fla.-based Correctional Services Corporation, which operated correctional and detention facilities.  The SEC's complaint alleges that from May through July 2005, Zachariah bought over $200,000 worth of Correctional shares and his brother and close friend, Nassberg, each made multiple purchases of Correctional stock in the week leading up to a public announcement on July 14, 2005, by The GEO Group, Inc., that it would acquire Correctional. Zachariah was a GEO consultant. The complaint seeks a judgment against all defendants providing for injunctions, disgorgement of their ill-gotten gains with prejudgment interest, and civil money penalties. The complaint also seeks an order prohibiting Zachariah from serving as an officer or director of a public company.

SEC Director of Trading & Markets Speaks on Liquidity

Erik R. Sirri, Director, Division of Trading and Markets, SEC, spoke at the SIFMA Market Structure Conference 2008, on May 9, 2008, on Maximizing Liquidity in the U.S. Equity Markets.  He focused on the key characteristics of the post-Reg NMS equity market structure, the issue of best execution for a customer's non-marketable limit orders, and the role of the regulator.

SEC Obtains Emergency Relief Against Ponzi Scheme

The SEC obtained emergency relief in response to its complaint, filed May 5, 2008, that Gregory N. McKnight (McKnight) and Legisi Holdings, LLC (Legisi Holdings) conducted a fraudulent, unregistered offering of securities in which, between December 2005 and at least November 2007, they raised approximately $72 million from more than 3,000 investors in all 50 states and several foreign countries through the Legisi website.  According to the SEC's complaint, McKnight represented that he would invest the offering proceeds in foreign currencies, commodity futures, stocks and real estate and promised to pay interest of as much as 15 percent per month from the profits from his investments. The SEC's complaint further alleges that throughout the period of the offering, McKnight represented to investors that his investments were profitable and were generating the promised returns. The complaint charges that, contrary to these representations, McKnight invested only approximately $33 million of the offering proceeds and that, rather than earning profits, these investments resulted in millions of dollars in losses. The SEC's complaint further charges that Defendants used approximately $27.5 million of the offering proceeds to make payments of purported profits to prior investors and were, thus, operating a Ponzi scheme, and that McKnight used $2.2 million of investor funds to pay for his personal expenses and to make payments to his relatives, Jennifer McKnight, Danielle Burton, and Theresa Burton.

On May 5, 2008, the United Stated District Court for the Eastern District of Michigan issued an Asset Freeze Order against  the defendants, and against Legisi Marketing, Inc. (Legisi Marketing), Lido Consulting, LLC (Lido Consulting), Healthy Body Nutraceuticals (HBN), and Lindenwood Enterprises, LLC (Lindenwood) as relief defendants. The Asset Freeze Order froze all assets of McKnight, Legisi Holdings, Legisi Marketing, Lido Consulting, HBN, and Lindenwood. In addition, Judge Gadola issued an Order Appointing a Receiver over all assets of McKnight, Legisi Holdings, Legisi Marketing, Lido Consulting, HBN, and Lindenwood.

In addition to the emergency relief already obtained, the Complaint seeks preliminary and permanent injunctions against McKnight and Legisi Holdings. The Complaint also seeks disgorgement of ill-gotten gains from the defendants and relief defendants and the imposition of civil penalties against McKnight and Legisi Holdings.

SEC Proposes Changes to Cross-Border Tender and Exchange Offer Rules

On May 6, the SEC proposed amendments to the rules applicable to cross-border tender and exchange offers and other kinds of cross-border business combination transactions. The rule changes are intended to protect U.S. investors while facilitating and streamlining cross-border transactions, as securities markets become increasingly globalized. The Commission also proposed changes to the beneficial ownership reporting requirements for certain foreign institutional investors. If adopted, these rule revisions would allow some foreign institutions to file beneficial ownership reports on a shorter form, under the same circumstances as their U.S. institutional counterparts. In addition, the Commission issued guidance on several cross-border issues, including the exclusion of foreign target security holders from a tender offer subject to U.S. equal treatment requirements, the exclusion of U.S. target security holders in cross-border business combination transactions, and the use of certain transaction structures to provide cash to U.S. target security holders in cross-border exchange offers.

The SEC explained that

after eight years of experience with the current cross-border exemptions adopted in 1999, the Commission is proposing changes to expand and enhance the utility of these exemptions for business combination transactions. Our goal continues to be to encourage offerors and issuers in cross-border business combinations, and rights offerings by foreign private issuers, to permit U.S. security holders to participate in these transactions in the same manner as other holders. Many of the rule changes we propose today would codify existing interpretive positions and exemptive orders in the cross-border area. In several instances, we request comment about whether the rule changes we propose also should apply to tender offers for U.S. companies. In this release, we also address certain interpretive issues of concern for U.S. and other offerors engaged in cross-border business combinations. We hope that this guidance will prove useful in structuring and facilitating these transactions in a manner consistent with U.S. investor protection.

Comments are due 45 days after publication in the Federal Register.

SEC Settles Backdating Charges Against Marvell Technology

The SEC settled charges against Marvell Technology Group, Ltd., a Silicon Valley semiconductor company, and its co-founder for improperly backdating stock option grants to employees.  The agency alleged that Marvell provided potentially lucrative "in-the-money" options to employees, backdated the options to dates with lower stock prices, and falsely represented that the options had been granted "at-the-money" on earlier dates.  According to the SEC's complaint, filed in federal district court in San Jose, the scheme allowed Marvell to overstate its income by $362 million from its fiscal years 2000 through 2006.

Marvell and former operating officer Dai settled the SEC's charges without admitting or denying the allegations and will pay financial penalties of $10 million and $500,000, respectively.

SEC's Trading and Markets Director Testifies on Market Turmoil

Erik Sirri, Director, Division of Trading and Markets, SEC, testified on Turmoil in the Credit Markets: Examining the Regulation of Investment Banks Before the Subcommittee on Securities, Insurance, and Investment, United States Senate, on May 7, 2008.

Cox Testifies on SEC Budget

SEC Chair Cox Testified on the agency's Fiscal Year 2009 Appropriations Request Before the Subcommittee on Financial Services and General Government Committee on Appropriations, United States Senate, May 7, 2008.

Cox Addresses Security Traders Conference

Excerpt from SEC Chair Cox's Address to the Security Traders 12th Annual Washington Conference, Washington, D.C., on May 7, 2008:

And yet here, the framework of federal financial services regulation as it was developed throughout the 20th and 21st centuries is dangerously behind the times.

Today, no regulator in the federal government is given explicit authority and responsibility for the supervision of investment bank holding companies with bank affiliates. Under the statutory scheme that the Congress devised, most recently in the Gramm-Leach-Bliley Act, there is mandatory consolidated supervision by the Federal Reserve for commercial bank holding companies, including financial holding companies. For investment banks that do not have U.S. banks within the consolidated group, the law provides for a holding company supervision structure that is purely voluntary — and only one investment bank, Lazard Ltd., has volunteered for this supervision. The four largest investment bank holding companies in the U.S. are ineligible for it because they have specialized bank affiliates, such as industrial banks or certain savings banks....
The notion embedded in the Gramm-Leach-Bliley Act that investment banks should be able to operate outside of a statutory consolidated supervision regime is no longer tenable in the wake of Bear Stearns. It is impossible for anyone to say that in this case, "the system worked." It is true that the statutory scheme produced all that it ever demanded — no customer cash or securities were ever at risk of loss because of the elaborate protections they enjoy under the SEC's existing regulation, including the segregation of customer funds and securities. But that limited purpose, which views the SEC's role and that of other financial regulators vis-a-vis the nation's largest investment banks as limited to protecting customer funds and securities in the regulated broker-dealer subsidiaries of firms such as Bear Stearns — is no longer enough.

SEC's Investment Management Proposes Change to BDC Regulations

The SEC's Division of Investment Management has prepared a recommendation for consideration by the Commission to increase the availability of capital to certain smaller companies that do not have ready access to the public capital markets or other forms of conventional financing.  The Division has recommended that the Commission adopt an amendment to a rule that defines the types of companies in which business development companies (BDCs) may invest most of their assets. Congress in 1980 established BDCs, which are publicly traded investment companies, to help make capital more readily available to small developing and financially troubled businesses.  The SEC's release explains that:

The Investment Company Act requires a BDC to have at least 70 percent of its portfolio invested in certain assets, including securities of "eligible portfolio companies," which are often small or developing businesses, at the time it makes any new investments. The proposed amendment would expand the definition of eligible portfolio company to include certain companies that list their securities on a national securities exchange.

The Investment Company Act defines eligible portfolio company to include a domestic operating company that, among other things, does not have any class of securities that are marginable under rules issued by the Federal Reserve Board. In 1998, for reasons unrelated to small business capital formation, the Federal Reserve Board amended its margin rules to include all publicly traded equity securities and most debt securities. These 1998 amendments had the unintended consequence of substantially reducing the number of companies that met the definition of eligible portfolio company.

In 2006, the Commission adopted new rules under the Investment Company Act to address the effect of the Federal Reserve Board's 1998 amendments on the definition of eligible portfolio company. The Commission adopted Rule 2a-46, which defines eligible portfolio company to include all private companies and public companies whose securities are not listed on a national securities exchange. The Commission also adopted a rule that conditionally permits a BDC to include in its 70 percent basket any follow on investments in a company that met the new definition of eligible portfolio company at the time of the BDC's initial investment in it.

When the Commission adopted Rule 2a-46, it also proposed to amend the rule to further expand the definition of eligible portfolio company to include certain smaller companies that list their securities on a national securities exchange. The amendment was designed to facilitate small business capital formation by providing added investment flexibility to BDCs, consistent with the purpose of the Investment Company Act. The Commission sought comment on three alternative ways to amend the rule, and received comments on the proposal.

The Division has submitted a recommendation that the Commission adopt an amendment to Rule 2a-46.

SEC Obtains Freeze Order Against Foreign Exchange Trading Scheme

The SEC obtained a court order to stop a $27 million Ponzi scheme involving investors in the United States, Canada, and other countries.  The agency charged Gold-Quest International and its three principals for the alleged misuse of investor funds in a scheme that promised incentives to investors who recruited "friends and family" into the system. The SEC alleged that Gold-Quest and its owners misrepresented that investor funds would be pooled and invested in foreign currency exchange trading and would generate annual profits of 87.5 percent. No investor money was actually invested in foreign currency exchange trading.

According to the SEC's complaint, Gold-Quest's owners David M. Greene (who refers to himself as Lord David Greene), John Jenkins, and Michael McGee instead used investor funds to compensate investors who brought in new investors. Up to 88 percent of each investor's principal was paid to the chain of promoters responsible for bringing the investor into the Gold-Quest program. Most of the remaining funds were used by Greene, Jenkins, and McGee for personal expenses.

The Federal District Court for the District of Nevada issued an order freezing assets and appointing a temporary receiver over Gold-Quest and its affiliates. According to the SEC's complaint, Gold-Quest and its owners claim they are not subject to the jurisdiction of the United States or Canada because they are members of the Little Shell Nation Indian tribe, purportedly headquartered in North Dakota. However, the Little Shell Nation is not in fact recognized as a sovereign tribe or nation.

In its lawsuit, the SEC obtained an order (1) freezing the assets of Greene, Jenkins, and McGee; (2) freezing and repatriating the assets of, and appointing a temporary receiver over, Gold-Quest and its affiliates; (3) preventing the destruction of documents; and (4) temporarily enjoining Gold-Quest, Greene, Jenkins, and McGee from future violations of the antifraud provisions of the federal securities laws.

Court Enjoins Stun Gun Manufacturer from Securities Fraud

The United States District Court for the Northern District of Georgia entered a Final Judgment against Stinger Systems, Inc. (“Stinger”), enjoining it from future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Stinger consented to the entry of the final judgment without admitting or denying any of the allegations of the Commission’s Complaint.  The SEC alleged that from October 2004 through March 2005, Stinger and its president, Robert F. Gruder, made a series of fraudulent material misrepresentations and omissions regarding Stinger’s “flagship” stun gun product. According to the Complaint, the misrepresentations consisted of press releases and direct mailings to thousands of law enforcement officers and agencies, suggesting that Stinger was manufacturing, selling and shipping its stun gun. In fact, the product was still in the development phase. The Complaint further alleged that the misrepresentations consisted of statements on the Stinger’s website and/or in industry publications that indicated Stinger’s stock was trading on NASDAQ, when in fact it was not. The Complaint also alleged that Stinger and Gruder misrepresented that the Bureau of Alcohol, Tobacco and Firearms (“ATF”) certified Stinger’s stun gun, even though the ATF offered no such certification. According to the Complaint, these misrepresentations caused a spike in the trading volume and price for Stinger’s shares once it began publicly trading in November 2004.

Donohue on Mutual Fund Reform

Andrew J. Donohue, SEC Director, Division of Investment Management, presented the Keynote Address at the Practicing Law Institute Investment Management Institute 2008, on April 24, 2008 in New York City.  He addressed three "hot" topics:  mutual fund disclosure, specifically the summary prospectus and tagged data; (2) reform of Rule 12b-1 fees, and (3) the RAND report on the increasingly blurred distinctions between broker-dealers and investment advisers.  As to Rule 12b-1 fees, Donohue said that the staff will propose that they be broken into two parts:  a sales charge and a fee for services and administrative services.  In this way, it is hoped that investors would be less confused about what these fees represent.  As to the RAND report, he said that he and the Director of Trading and Markets would be presenting a "range of options" to Chair Cox on May 5.

SEC Issues Order in False Rumors Proceeding

The SEC issued an Order Instituting Administrative Proceedings Pursuant to Section 15(b) of the Securities Exchange Act of 1934, Making Findings, and Imposing Remedial Sanctions (Order) against Paul S. Berliner. The Order finds that Berliner was enjoined from future violations of Section 17(a) of the Securities Act of 1933, Sections 9(a)(4) and 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder pursuant to a final judgment that was entered by consent on April 29, 2008, in a Commission civil injunctive action.

According to the Commission's complaint in that action, on May 17, 2007, Alliance Data Systems Corp. (ADS) announced that it entered into a definitive agreement to be acquired by The Blackstone Group (Blackstone) at a price of $81.75 per share. The Commission alleged in its complaint that, on Nov. 29, 2007, Berliner drafted and disseminated a false rumor that ADS's board of directors was meeting to consider a revised proposal from Blackstone to acquire ADS at a significantly lower price of $70 per share. According to the complaint, Berliner disseminated this false rumor through instant messages to numerous individuals, including traders at brokerage firms and hedge funds. The complaint alleged that this false rumor spread rapidly across Wall Street, and various news services quickly picked up the "story." The complaint further alleged that heavy trading in ADS stock ensued, and within thirty minutes the false rumor had caused the price of ADS stock, which had been trading at approximately $77 per share, to plummet to an intraday low of $63.65 per share -- a 17% decline in the share price. The complaint alleged that Berliner profited from spreading this false rumor by short selling ADS stock at the same time he was disseminating the false rumor. The complaint further alleged that Berliner covered these short sales when the price of ADS stock began to decline. According to the complaint, Berliner made approximately $25,000 in illicit trading profits before the price of ADS stock recovered later in the day.

Based on the above, the Order bars Berliner from association with any broker or dealer. Berliner consented to the issuance of the Order without admitting or denying the Commission's findings, except as to entry of the injunction.

SEC Gets Temporary Freeze of Plus Money and Advisor

The SEC filed an emergency action to halt an ongoing $30 million hedge fund fraud by an investment adviser located in San Diego. Named in the complaint are Plus Money, Inc. ("Plus Money") and Matthew La Madrid ("La Madrid"). The United States District Court for the Southern District of California issued an order on April 30 temporarily freezing the assets of the defendants and the relief defendants.

The Commission's complaint alleges that since at least May 2004, the defendants have managed hedge funds (the "Premium Return Funds") that raised more than $30 million from over 300 investors by telling them they would engage in a covered call options trading strategy. The complaint further alleges that, unbeknownst to investors, in the fall 2007 Plus Money and La Madrid abandoned the covered call trading strategy, emptied out the monies in the Premium Return Funds' brokerage accounts, and dissipated the money through a series of illicit transfers.

Atkins Announces That He Will Leave SEC

SEC Commissioner Paul Atkins announced today that he intends to leave the SEC following the end of his term in June. Appointed by President Bush in August 2002 for the first of two terms, he plans to stay until his successor is appointed and takes office.

SEC Obtains Freeze of Assets of Alleged Ponzi Scheme

The SEC obtained a court order halting a $25 million fraudulent scheme allegedly perpetrated by Laguna Hills, Calif.-based Safevest, LLC and its principals, Jon G. Ervinand John V. Slye.  The U.S. District Court for the Central District of California issued an order freezing assets and appointing a temporary receiver over Safevest and its affiliates. 

The SEC's complaint alleges that since at least May 2007, the defendants have raised at least $25 million from more than 500 investors, including many from the Christian community, misrepresenting that investor funds would be pooled and invested in futures commodities trading, that the investment would generate daily profits ranging from 1.5% to 1.9%, and that investors could receive their money back within 72 hours of requesting it. In reality, according to the complaint, no investor money was invested in futures trading, and requests by investors for withdrawal of their funds have either not been honored or have only been partially honored. The complaint further alleges that, undisclosed to investors, the defendants paid more than $18 million to investors in Ponzi-like fashion. The defendants also allegedly misappropriated investor funds for the personal use of Ervin, Slye, and their family members.

The Commission also seeks preliminary and permanent injunctions, disgorgement, and civil penalties against all defendants.

Banc of America Investment Services Settles SEC Charges of Favoring Proprietary Funds

The SEC filed a settled enforcement action against Banc of America Investment Services, Inc. (BAISI) for failing to disclose to clients that in selecting investments for discretionary mutual fund wrap fee accounts, it favored two mutual funds affiliated with BAISI.  The SEC also charged Columbia Management Advisors, LLC (Columbia), as successor to Banc of America Capital Management, LLC (BACAP), with aiding and abetting, and causing certain of BAISI's violations. As part of the settlement, BAISI and Columbia agreed to pay a total of nearly $10 million in disgorgement and penalties. The Commission ordered BAISI to distribute the settlement amount to affected clients.

According to the SEC, from July 2002 through December 2004, BAISI made material misrepresentations and omissions to clients who had given BAISI discretion to select mutual funds for them. The clients participated in an asset-based or "wrap" fee program in which they paid BAISI a fee based upon the amount of their assets in exchange for BAISI providing advisory and other account services. BAISI purchased at least two proprietary "Nations Funds" for clients with discretionary wrap fee accounts using a methodology that was contrary to BAISI's disclosures to those clients. The Order also finds that BAISI omitted to disclose the scope of its and BACAP's conflict of interests, and their bias in the recommendation and selection process. BACAP earned additional fees as a result of these violations because it was paid management and other fees based on the total assets of Nations Funds.

McCann-Erickson Settles Accounting Fraud Charges

The SEC filed a civil injunctive action against McCann-Erickson Worldwide, Inc. (“McCann”) and the Interpublic Group of Companies, Inc. (“IPG”) alleging that McCann committed securities fraud when it misstated its financial results by failing to expense properly intercompany charges and IPG negligently failed to address the intercompany problems at its largest subsidiary, McCann. IPG also violated the reporting, internal controls and books and records provisions of the securities laws in connection with a variety of issues that were reflected in various restatements IPG issued from August 2002 through September 2005 totaling more than $600 million. IPG and McCann agreed to settle the Commission’s charges, and McCann agreed to pay a $12 million civil penalty.

The SEC also brought settled charges against Salvatore LaGreca and Brian Watson for their role in failing to reconcile intercompany accounts that resulted in the 2002 restatement. LaGreca served as McCann’s Vice-Chairman, Finance and Operations and CFO from January 1996 to October 2002. Watson joined McCann’s European-Middle-East-Asia region (“EMEA”) as Director of Operations in 1996, from 2000 served as Chief Operating Officer and in approximately May 2002 became Deputy Regional Director of EMEA and, from approximately the middle of 1998 until January 2000, and from early 2001 to May 2002, when EMEA did not have a Finance Director, Watson handled many aspects of the Finance Director’s responsibilities.

IPG, McCann, LaGreca and Watson settled the Commission’s charges without admitting or denying the allegations in the Commission's complaints.

SEC Settles Earnings Management Charges Against Former Nortel VPs

The SEC announced that Craig A. Johnson, James B. Kinney and Kenneth R.W. Taylor — who were the vice presidents of finance for the Wireline, Wireless, and Enterprise business units of Nortel Networks Corporation (“Nortel”), respectively — agreed to settle the Commission’s charges against them arising from their alleged involvement in Nortel’s earnings management fraud during 2002 and 2003. Each has consented, without admitting or denying the Commission’s allegations against them, to the entry of a final judgment in the Commission’s pending litigation.  The final judgments order each individual to pay a $75,000 civil penalty and to pay disgorgement in the amount of $66,845 (Johnson) and $52,000 (each for Kinney and Taylor), along with prejudgment interest in the amount of $21,186 (Johnson) and $16,481 (each for Kinney and Taylor). The final judgments also bar each individual from acting as an officer or director of any public company for five years and permanently enjoin each individual from federal securities law violations.

SEC Charges Birmingham Mayor with Municipal Bond Fraud

The SEC filed a civil action today against Birmingham Mayor Larry Langford, William Blount, and Albert LaPierre, alleging that while Langford served as president of the County Commission of Jefferson County, Alabama (County Commission), he accepted more than $156,000 in undisclosed cash and benefits over the course of two years from Blount, the chairman of Blount Parrish & Co, Inc. Blount Parrish is a broker-dealer based in Montgomery, Alabama.  According to the SEC's complaint, Langford selected Blount Parrish to participate in every Jefferson County municipal bond offering and security-based swap agreement transaction during 2003 and 2004, earning Blount Parrish over $6.7 million in fees. Moreover, the SEC alleges, Langford and Blount concealed the payment scheme by using their long-time friend, LaPierre, an Alabama registered political lobbyist, as a conduit. The case is the SEC's first enforcement action involving security-based swap agreements.

SEC Charges Two Former Monster Worldwide Officers with Backdating

The SEC today charged two former senior executives at Monster Worldwide, Inc., for their alleged participation in a multi-year scheme to secretly backdate stock options granted to thousands of Monster officers, directors and employees.  The SEC alleges that Monster's former president and chief operating officer James J. Treacy and former controller Anthony Bonica participated in a scheme that began in 1997 to fraudulently backdate stock options to coincide with the dates of low closing prices for the New York-based company's common stock.  As a result of their conduct, Monster misrepresented that all stock options were granted at the fair market value of the stock on the date of the award and also filed materially misstated financial statements in its Forms 10-K and 10-Q that did not recognize compensation expense for the company's stock option grants.  As a result, Monster overstated its aggregate pre-tax operating income by approximately $339.5 million for fiscal years 1997 through 2005.

The SEC's complaint further alleges that Treacy and Bonica personally benefited from the fraudulent scheme by receiving and exercising backdated grants of in-the-money options.  The Commission is seeking permanent injunctive relief, disgorgement of ill-gotten gains and financial penalties from each defendant, as well as an officer and director bar against Treacy.

SEC Settles Insider Trading Charges Against Bank Director and Son

The SEC settled an insider trading action against Charles R. Norton, a former director of Community Bancorp, and his son, Chad R. Norton, who traded in Valley Bancorp stock shortly before the June 28, 2006 announcement of Valley Bancorp's acquisition by Community Bancorp.  The SEC alleged that Charles and Chad Norton traded on the basis of confidential information about Community Bancorp's imminent acquisition of Valley Bancorp. Charles Norton sat on the board of directors of Community Bancorp and had access to sensitive information about the acquisition through his attendance at Community Bancorp board meetings. The complaint alleges that Charles Norton tipped Chad Norton, who traded ahead of the announcement. Charles and Chad Norton realized illegal profits of $35,064.71 from the trades.

To settle the SEC's charges, Charles and Chad Norton have consented, without admitting or denying the allegations in the complaint, to a final judgment permanently enjoining them from future violations, to pay $38,433.72, representing the disgorgement of their illegal trading profits and prejudgment interest, and each to pay a civil penalty of $35,064.71. In addition, Charles Norton will be barred from serving as an officer or director of a public company for five years. The settlement is subject to approval by the court.

SEC's Corporation Finance Recommends Changes to Cross-Border Tender Offer Rules

The SEC's Division of Corporation Finance said today that it has completed its review of the Commission's cross-border tender, exchange offer and business combination rules, and has prepared recommendations for consideration by the Commission.  The cross-border tender offer rules apply to offers for the securities of foreign companies that have U.S. security holders.

Director of Corporation Finance John White said that the goal of the review was to determine whether changes could be made that would facilitate the ability of U.S. investors to exercise their rights in connection with cross-border mergers and acquisitions. This review included looking at areas of conflict and inconsistency with foreign regulations and practice that are frequently encountered in cross-border business combinations and that result in U.S. investors being excluded from these transactions.

SEC Settles Insider Trading Charges Involving Laserscope

The SEC settled insider trading claims against Edward O. Boshell, an outside disinterested director of a Dallas-based business development company (BDC), and Donald J. Pochopien, a shareholder of a Chicago-based law firm. The SEC alleged that Boshell and Pochopien engaged in unlawful insider trading in the securities of Laserscope in advance of a public announcement on June 5, 2006 that Laserscope would be acquired by American Medical Systems Holding, Inc. (American Medical).  The SEC alleges that Boshell was made aware of the acquisition during a routine board meeting of the Dallas-based BDC approximately a month before the public announcement. The Commission alleges that Pochopien was made aware of the acquisition approximately a month before the public announcement when his law firm was hired by American Medical to conduct a due diligence review of the Laserscope acquisition.

SEC's Enforcement Director Speaks on Lawyers' Liability and FCPA

Linda Chatman Thomsen, Director, Division of Enforcement, SEC, spoke before the Minority Corporate Counsel 2008 CLE Expo, in Chicago, Illinois, on March 27, 2008, on lawyers' liability in general and in particular with respect to the FCPA.

SEC Director of Investment Management Outlines Agenda

Andrew J. Donohue, Director, Division of Investment Management, SEC, outlined the following agenda for the Division at an April 24, 2008, Keynote Address at the Practicing Law Institute, Investment Management Institute 2008:

I expect the remainder of 2008 to be an exciting time for those of us at the Commission and, similarly, those of you who practice in the investment management area. I am hopeful that the Commission and its staff will be addressing three fundamental issues of critical importance to America’s investors. They are the structure of the mutual fund disclosure regime, the payment of distribution-related fees from fund assets as permitted by rule 12b-1 under the Investment Company Act, and the appropriate regulatory framework that should govern relationships between financial professionals and retail investors as discussed in the recent report issued by the RAND Corporation.

None of these is a new issue.  Let's hope that the SEC can finally accomplish some meaningful reform in the mutual fund area to provide better protection for retail investors.

SEC Institutes Market Timing Suit Against Former Portfolio Manager of A Gabelli Fund

The SEC filed a civil fraud action in the United States District Court for the Southern District of New York against Marc J. Gabelli, the former portfolio manager of the Gabelli Global Growth Fund (GGGF), currently known as GAMCO Global Growth Fund, and Bruce Alpert, Chief Operating Officer of GGGF's adviser, Gabelli Funds LLC (Gabelli Funds), in connection with an undisclosed market timing arrangement with Folkes Asset Management, currently known as Headstart Advisers Ltd. (Headstart). The complaint alleges that from September 1999 until August 2002, Marc Gabelli authorized Headstart to place market timing trades in GGGF while Gabelli Funds was rejecting other market timers. In return, Headstart maintained its investment in other affiliated funds.
 
Over a two-year period, Headstart's internal rates of return on its three accounts were 185 percent, 160 percent, and 73 percent, respectively, while the rate of return for other GGGF shareholders was at most negative 24.1 percent. Gabelli Funds financially benefited from the market timing in that it earned advisory fees from both the market timing and Headstart's investment in the affiliated hedge fund.
 
In a related administrative proceeding, the SEC settled administrative proceedings against Gabelli Funds, a registered investment adviser, in connection with the undisclosed market timing by Headstart. Gabelli Funds was censured, ordered to cease and desist its securities law violations, and ordered to pay $9.7 million in disgorgement, $1.3 million in prejudgment interest, and a penalty of $5 million, for a total payment of $16 million. As described in the Order, Gabelli Funds' payment will be distributed to shareholders harmed by the market timing activity during the relevant period.

SEC Settles Market Timing Charges Against Pritchard Capital

The SEC settled market-timing and late-trading charges against Pritchard Capital Partners, LLC, Thomas Pritchard and Elizabeth McMahon.  Pritchard Capital is a registered broker-dealer headquartered in Mandeville, Louisiana, and Thomas Pritchard is the firm's managing director. McMahon was formerly associated with Pritchard Capital in its New York office from approximately March 2001 through January 2004.  The SEC's order finds that from November 2001 through approximately July 2003, Pritchard Capital allowed some of its market timing customers, who provided 25% of the firm's revenue in 2003, to late trade mutual fund shares through its New York office.

SEC Settles False Rumors and Short-Selling Charges

The SEC charged Paul S. Berliner, a Wall Street trader formerly associated with Schottenfeld Group LLC, with securities fraud and market manipulation for intentionally spreading false rumors about The Blackstone Group's acquisition of Alliance Data Systems (ADS) while selling ADS short.The SEC alleged that five months ago, Berliner disseminated the false rumor through instant messages to numerous individuals, including traders at brokerage firms and hedge funds. The false rumor also was picked up by the media.  Heavy trading in ADS stock ensued, and within 30 minutes the false rumor had caused the price of ADS stock, trading at approximately $77 per share, to plummet to an intraday low of $63.65 per share - a 17 percent decline. In response to the unusual trading activity, the New York Stock Exchange temporarily halted trading in ADS stock. Later in the day, ADS issued a press release announcing that the rumor was false. By the close of trading, the price of ADS stock recovered to its pre-rumor price of approximately $77 per share. Berliner profited by short selling ADS stock during its precipitous decline.

Without admitting or denying the allegations in the SEC's complaint, Berliner agreed to settle the charges against him by consenting to the entry of a final judgment enjoining him from future violations of the antifraud and anti-manipulation provisions of the federal securities laws, and requiring him to disgorge $26,129 in profits and interest, pay a maximum third-tier penalty of $130,000, and consent to the entry of a Commission Order barring him from association with any broker or dealer.

Cox Testifies on Credit Rating Agencies

Chair Cox testified on Oversight of Nationally Recognized Statistical Rating Organizations before the U.S. Senate Committee on Banking, Housing and Urban Affairs on April 22, 2008.  He reported on the SEC's examination of the credit rating agencies on "the adequacy of their public disclosures, their recordkeeping, and their procedures to prevent the misuse of material nonpublic information" as well as "how the firms manage their conflicts of interest, as well as their approaches to preventing unfair, abusive, or coercive practices."

While stating that it was premature to describe the results, he went on to say:

that it appears the volume of the structured finance deals that were brought to the credit rating agencies increased substantially from 2004 to 2006. In addition, during the period of time under examination, the structured products that the rating agencies were being asked to evaluate were becoming increasingly complex, with many employing derivatives such as credit default swaps to replicate the performance of mortgage backed securities. At the same time, the loan assets underlying these securities shifted from primarily plain vanilla 30-year mortgages to a range of more difficult-to-assess products, such as adjustable rate and second lien loans.

We are evaluating whether credit rating agencies adapted their rating approaches in this environment. The staff is observing that the ratings process used to rate these products may have been less quantitatively developed, particularly as the products became more complicated and involved different types of loans, than was generally believed. ... The staff is currently working to assess whether, and if so the extent to which, these factors contributed to the volume of eventual downgrades, and whether other factors — such as the desire to maintain or increase market share — may have caused the credit rating agencies to be less conservative than their disclosed methodologies otherwise would have indicated.

We expect the results of these staff examinations will provide significant and useful new information that will help not only the SEC, but also issuers and users of credit ratings in this country and around the world, to address the problems we have seen with ratings of subprime-related products.