SEC Charges Manhattan-Based Private Equity Manager With Stealing $9 Million in Investor Funds

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SEC Charges Manhattan-Based Private Equity Manager With Stealing $9 Million in Investor Funds

The Securities and Exchange Commission today charged a Manhattan-based private equity manager and his firm with stealing $9 million from investors in their private equity fund. 

The SEC has obtained an emergency court order to freeze the assets of Lawrence E. Penn III and his firm Camelot Acquisitions Secondary Opportunities Management as well as another individual and three entities involved in the theft of investor funds.

The SEC alleges that Penn and his longtime acquaintance Altura S. Ewers concocted a sham due diligence arrangement where Penn used fund assets to pay fake fees to a front company controlled by Ewers.  Instead of conducting any due diligence in connection with potential investments by Penn’s fund, Ewers’ company Ssecurion promptly kicked the money back to companies and accounts controlled by Penn so he could secretly spend investor funds for other purposes.  For example, Penn paid hefty commissions to third parties to secure investments from pension funds.  Penn also rented luxury office space and used the funds to project the false image that Camelot was a thriving international private equity operation.

“Penn held himself out as an ultra-sophisticated and well-connected investor in the private equity world,” said Andrew M. Calamari, director of the SEC’s New York Regional Office.  “Behind the scenes, Penn disregarded his obligations to the fund’s investors and treated their assets as his own personal and professional slush fund.”

According to the SEC’s complaint filed in federal court in Manhattan, Penn tapped into a network of public pension funds, high net worth individuals, and overseas investors to raise assets for his private equity fund Camelot Acquisitions Secondary Opportunities LP, which he started in early 2010.  Penn eventually secured capital commitments of approximately $120 million. The fund is currently invested in growth-stage private companies that are seeking to go public.

The SEC alleges that Penn has diverted approximately $9.3 million in investor assets to Ssecurion.  With the assistance of Ewers, who lives in San Francisco, Penn repeatedly misled the fund’s auditors about the nature and purpose of the due diligence fees.  However, the scam began to unravel in 2013 when Camelot’s auditors became increasingly skeptical about the fees.  In their haste to cover their tracks, Penn and Ewers brazenly lied to the auditors and forged documents as recently as July 2013, pretending the files were generated by Ssecurion.

The SEC’s complaint charges Penn, two Camelot entities, Ewers, and Ssecurion with violating the antifraud, books and records, and registration application provisions of the federal securities laws.  The complaint seeks final judgments that would require them to disgorge ill-gotten gains with interest, pay financial penalties, and be barred from future violations of the antifraud provisions of the securities laws.  The SEC’s complaint also charges another company owned by Ewers – A Bighouse Photography and Film Studio LLC – as a relief defendant for the purposes of recovering investor funds it allegedly obtained in the scheme.

The SEC’s investigation, which is continuing, has been conducted by Katherine Bromberg, Karen Willenken, James D’Avino, and Michael Osnato of the SEC’s New York Regional Office.  The investigation stemmed from a referral by the New York Regional Office’s investment adviser/investment company examination program including Anthony Fiduccia, Jennifer Klein, Beth Abraham, and Joseph Hirsch.  The SEC’s litigation will be led by Howard Fischer.  The SEC appreciates the assistance of the New York County District Attorney’s Office.

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SEC Charges Chicago-Based Accountant With Insider Trading in Wife’s Account

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SEC Charges Chicago-Based Accountant With Insider Trading in Wife’s Account

The Securities and Exchange Commission today announced charges against the former director of internal audit at a Chicago-based health care information technology company for insider trading ahead of the release of its financial results and making more than a quarter-million dollars in illicit profits.

The SEC alleges that certified public accountant Steven M. Dombrowski confidentially learned through his job at Allscripts Healthcare Solutions that first quarter 2012 financial results were much worse than expected and the company would miss its earnings target.  Despite a company-imposed blackout period on trading its securities, Dombrowski secretly used his wife’s account to trade Allscripts securities ahead of the bad news and profit on the nonpublic information. 

In a parallel action, the U.S. Attorney’s Office for the Northern District of Illinois today announced criminal charges against Dombrowski. 

“As alleged in our complaint, Dombrowski attempted to profit off his company’s poor financial results and hide his breach of duty to his employer by conducting his illegal trading through his wife’s account,” said Timothy L. Warren, associate director of the SEC’s Chicago Regional Office.  “His efforts have landed him in court.”

According to the SEC’s complaint filed in federal court in Chicago, based on his confidential knowledge of the company’s impending poor financial results, Dombrowski sold short 1000 shares of Allscripts stock in the weeks leading up to the release of first quarter earnings.  He also purchased more than 510 Allscripts put option contracts that would be profitable only if the company’s stock price went down.  The first quarter results announced on April 26, 2012, included earnings per share that were approximately just 50 percent of the consensus estimates by stock analysts.  Allscripts also announced that its chief financial officer would soon leave the company for another job, and the chairman and several other members of the board of directors had resigned.  Immediately after the release of the quarterly results, Dombrowski purchased Allscripts stock to close his short position.  The next day he sold all of his options positions.  The company’s common stock value fell approximately 35.7 percent on April 27, and Dombrowski’s insider trading resulted in illegal profits of $286,211.55.

The SEC’s complaint charges Dombrowski with violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5.  The complaint seeks a judgment permanently enjoining Dombrowski from future violations of these provisions of the federal securities laws and ordering disgorgement of ill-gotten gains plus prejudgment interest and a penalty.  The SEC’s complaint also names Dombrowski’s wife Lisa Fox as a relief defendant for the purposes of recovering disgorgement plus prejudgment interest for the illegal trades made in her account.

The SEC’s investigation was conducted by Kristopher S. Heston and Norman H. Jones of the Chicago Regional Office.  The SEC’s litigation will be led by Benjamin J. Hanauer and Mr. Heston.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the Northern District of Illinois, the FBI’s Chicago office, the Financial Industry Regulatory Authority, and the Options Regulatory Surveillance Authority.

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SEC Issues Risk Alert on Investment Advisers’ Due Diligence Processes for Selecting Alternative Investments

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SEC Issues Risk Alert on Investment Advisers’ Due Diligence Processes for Selecting Alternative Investments

The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) today issued a Risk Alert on the due diligence processes that investment advisers use when they recommend or place clients’ assets in alternative investments such as hedge funds, private equity funds, or funds of private funds.  

“Money continues to flow into alternative investments.  We thought it was important to assess advisers’ due diligence processes and to promote compliance with existing legal requirements, including the duty to ensure that such investments or recommendations are consistent with client objectives,” said OCIE Director Drew Bowden.  

The alert describes current industry trends and practices in advisers’ due diligence. Compared to observations from prior periods, the staff noted that advisers are:

• 
  Seeking more information and data directly from the managers of alternative investments


• 
  Using third parties to supplement and validate information provided by managers of alternative investments 


• 
  Performing additional quantitative analysis and risk assessment of alternative investments and their managers.

Additionally, staff observed certain deficiencies in several of the advisory firms examined, including:

• 
  Omitting alternative investment due diligence policies and procedures from their annual reviews, even though these investments comprised a large portion of certain advisers’ investments on behalf of clients


• 
  Providing potentially misleading information in marketing materials about the scope and depth of due diligence conducted


• 
  Having due diligence practices that differed from those described in the advisers’ disclosures to clients. 

The following OCIE staff contributed to this Risk Alert:  John Sweeney, Kenneth Clowers, Zerubbabel Johnson, and Mavis Kelly.

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Barbara Lorenzen Named to Senior Position in National Exam Program

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Barbara Lorenzen Named to Senior Position in National Exam Program

The Securities and Exchange Commission today announced that Barbara S. Lorenzen has been promoted to a senior position in the agency’s Office of Compliance Inspections and Examinations (OCIE), which conducts the national examination program.

Ms. Lorenzen has been named the national associate director for OCIE’s Clearance and Settlement Program, which is responsible for examining clearing agencies and coordinating with regional offices to oversee approximately 450 transfer agents in the U.S. 

Since arriving at the SEC in 2009, Ms. Lorenzen has worked in the Chicago Regional Office and coordinated the oversight of broker-dealer and transfer agent examinations in a nine-state Midwest region.  She has been serving as acting director for the Clearance and Settlement Program since June 2013, overseeing a staff of 18 lawyers, accountants, and examiners.

“With the move toward central clearing of more types of securities transactions, our oversight of clearing agencies takes on greater importance,” said OCIE Director Andrew Bowden.  “Barb has extensive experience in auditing for regulatory compliance in the areas of customer protection and capital standards.  She brings extensive experience and leadership to this important position.”

Ms. Lorenzen said, “I feel privileged and enthusiastic about working with the clearance and settlement examination staff.  I have worked alongside them for several years and know they are a group of dedicated professionals who are committed to protecting investors by informing policy, improving compliance, detecting fraud, and monitoring risk.”

Prior to joining the SEC staff, Ms. Lorenzen worked for 28 years at the Chicago Board of Trade (CBOT), where she held positions of increasing responsibility including vice president responsible for the financial surveillance and audit departments.  Ms. Lorenzen has served multiple terms as chairperson of the Joint Audit Committee, which is an industry-wide committee made up of members of all domestic commodity exchanges.  She also has served as vice chairperson of the Intermarket Financial Surveillance Group, which is comprised of the regulatory arms for all domestic securities and commodities exchanges as well as the SEC, CFTC, FINRA, and NFA.  She served as a board member of the Futures Industry Association, where she was chairperson of the finance regulatory risk committee. 

Ms. Lorenzen earned her bachelor’s degree in accounting from Western Illinois University in Macomb, Ill. 

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SEC Charges Legg Mason Affiliate With Defrauding Clients

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SEC Charges Legg Mason Affiliate With Defrauding Clients

The Securities and Exchange Commission today announced sanctions against a California-based investment adviser for concealing investor losses that resulted from a coding error and engaging in cross trading that favored some clients over others.

Western Asset Management Company, which is a subsidiary of Legg Mason, agreed to pay more than $21 million to settle the SEC’s charges as well as a related matter announced today by the U.S. Department of Labor.

According to an SEC order instituting settled administrative proceedings, Western Asset serves as an investment manager primarily to institutional clients, many of which are ERISA plans.  Western Asset breached its fiduciary duty by failing to disclose and promptly correct a coding error that caused the improper allocation of a restricted private investment to the accounts of nearly 100 ERISA clients.  The private investment that was off-limits to ERISA plans had plummeted in value by the time the coding error was discovered, and Western Asset had an obligation to reimburse clients for such losses under the terms of its error correction policy.  Instead, Western Asset failed to notify its ERISA clients until nearly two years later, long after the firm had liquidated the prohibited securities out of those client accounts.    

“When the coding error was discovered, Western Asset put its own interests above its clients and avoided telling investors what had caused losses in their accounts,” said Michele Wein Layne, director of the SEC’s Los Angeles Regional Office.  “By concealing the error, Western Asset avoided reimbursing clients for their losses.”

In a separate order involving a different set of client accounts, the SEC finds that Western Asset engaged in a type of cross trading that was illegal.  Cross trading is the practice of moving a security from one client account to another without exposing the transaction to the market, and when done appropriately it can benefit both clients by avoiding market and execution costs.  However, cross trading also can pose substantial risks to clients due to the adviser’s inherent conflict of interest in obtaining best execution for both the buying and the selling client. 

The SEC’s order finds that during the financial crisis, Western Asset was required to sell mortgage-backed securities and similar assets into a sharply declining market as registered investment companies and other clients sought account liquidations or were no longer eligible to hold these securities after rating agency downgrades.  Instead of selling the securities at prices that Western Asset believed did not represent their long-term value, it arranged for certain broker-dealers to purchase the securities from the Western Asset selling clients and sell the same security back to different Western Asset clients with greater risk tolerance in prearranged sale-and-repurchase cross trades.  Because Western Asset arranged to cross these securities at the bid price rather than a price representing an average between the bid and the ask price, the firm improperly allocated the full benefit of the market savings on the trades to buying clients and denied the selling clients approximately $6.2 million in savings.

“Cross trades serve a legitimate purpose and benefit both parties when done appropriately,” said Julie M. Riewe, co-chief of the SEC Enforcement Division’s Asset Management Unit.  “But by moving securities across client accounts in prearranged, dealer-interposed transactions, Western Asset unlawfully deprived its selling clients of their share of the savings.” 

The SEC’s orders find that Western Asset violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7, and aided and abetted and caused violations of Sections 17(a)(1) and 17(a)(2) of the Investment Company Act of 1940.  Without admitting or denying the findings, the firm agreed to be censured and must cease and desist from committing or causing any further such violations.  For the disclosure violations related to the coding error, Western Asset must distribute more than $10 million to harmed clients and pay a $1 million penalty in the SEC settlement and a $1 million penalty in the Labor Department settlement.  For the cross trading violations, Western Asset must distribute more than $7.4 million to harmed clients and pay a $1 million penalty in the SEC settlement and a $607,717 penalty in the Labor Department settlement.  An independent compliance consultant must be retained to internally address both sets of violations.

The SEC’s investigation of the disclosure violations was conducted by Diana K. Tani and DoHoang T. Duong of the Los Angeles office.  An examination that led to the investigation was conducted by Charles Liao, Yanna Stoyanoff, and John Lamonica.  The SEC’s investigation of the cross trading violations was conducted by Asset Management Unit staff Valerie A. Szczepanik and Luke Fitzgerald of the New York office.  An examination identifying the cross trading issues was conducted by Margaret Jackson and Eric A. Whitman.  The SEC appreciates the assistance of the Labor Department and the Special Inspector General for the Troubled Asset Relief Program (SIGTARP), which assisted with the SEC and Labor Department investigations.

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SEC Charges KPMG With Violating Auditor Independence Rules

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SEC Charges KPMG With Violating Auditor Independence Rules

The Securities and Exchange Commission today charged public accounting firm KPMG with violating rules that require auditors to remain independent from the public companies they’re auditing to ensure they maintain their objectivity and impartiality. 

The SEC issued a separate report about the scope of the independence rules, cautioning audit firms that they’re not permitted to loan their staff to audit clients in a manner that results in the staff acting as employees of those companies.

An SEC investigation found that KPMG broke auditor independence rules by providing prohibited non-audit services such as bookkeeping and expert services to affiliates of companies whose books they were auditing.  Some KPMG personnel also owned stock in companies or affiliates of companies that were KPMG audit clients, further violating auditor independence rules.

KPMG agreed to pay $8.2 million to settle the SEC’s charges.

“Auditors are vital to the integrity of financial reporting, and the mere appearance that they may be conflicted in exercising independent judgment can undermine public confidence in our markets,” said John T. Dugan, associate director for enforcement in the SEC’s Boston Regional Office.  “KPMG compromised its role as an independent audit firm by providing prohibited non-audit services to companies that it was supposed to be auditing without any potential conflicts.”

According to the SEC’s order instituting settled administrative proceedings, KPMG repeatedly represented in audit reports that it was “independent” despite providing services to three audit clients that impaired KPMG’s independence.  The violations occurred at various times from 2007 to 2011.

According to the SEC’s order, KPMG provided various non-audit services – including restructuring, corporate finance, and expert services – to an affiliate of one company that was an audit client.  KPMG provided such prohibited non-audit services as bookkeeping and payroll to affiliates of another audit client.  In a separate instance, KPMG hired an individual who had recently retired from a senior position at an affiliate of an audit client.  KPMG then loaned him back to that affiliate to do the same work he had done as an employee of that affiliate, which resulted in the professional acting as a manager, employee, and advocate for the audit client.  These services were prohibited by Rule 2-01 of Regulation S-X of the Securities Exchange Act of 1934. 

The SEC’s order finds that KPMG’s actions violated Rule 2-02(b) of Regulation S-X and Rule 10A-2 of the Exchange Act, and caused violations of Section 13(a) of the Exchange Act and Rule 13a-1.  The order further finds that KPMG engaged in improper professional conduct as defined by Section 4C of the Exchange Act and Rule 102(e) of the Commission’s Rules of Practice.  Without admitting or denying the findings, KPMG agreed to pay $5,266,347 in disgorgement of fees received from the three clients plus prejudgment interest of $1,185,002.  KPMG additionally agreed to pay a penalty of $1,775,000 and implement internal changes to educate firm personnel and monitor the firm’s compliance with auditor independence requirements for non-audit services.  KPMG will engage an independent consultant to evaluate such changes.

The SEC’s investigation separately considered whether KPMG’s independence was impaired by the firm’s practice of loaning non-manager tax professionals to assist audit clients on-site with tax compliance work performed under the direction and supervision of the clients’ management.  While the SEC did not bring an enforcement action against KPMG on this basis, it has issued a report of investigation noting that by their very nature, so-called “loaned staff arrangements” between auditors and audit clients appear inconsistent with Rule 2-01 of Regulation S-X, which prohibits auditors from acting as employees of their audit clients.

The report also emphasized:

• 
  An auditor may not provide otherwise permissible non-audit services (such as permissible tax services) to an audit client in a manner that is inconsistent with other provisions of the independence rules.


• 
  An arrangement that results in an auditor acting as an employee of the audit client implicates Rule 2-01 regardless of whether the accountant also acts as an officer or director, or performs any decision-making, supervisory, or ongoing monitoring functions, for the audit client. 


• 
  Audit firms and audit committees must carefully consider whether any proposed service may cause the auditors to resemble employees of the audit client in function or appearance even on a temporary basis.

The SEC’s Office of the Chief Accountant has a Professional Practice Group that is devoted to addressing questions about auditor independence among other matters.  Auditors and audit committees are encouraged to consult the SEC staff with questions about the application of the auditor independence rules, including the permissibility of a contemplated service.

“The accounting profession must carefully consider whether engagements are consistent with the requirements to be independent of audit clients,” said Paul A. Beswick, the SEC’s chief accountant.  “Resolving questions about permissibility of non-audit services is always best done before commencing the services.”

The SEC’s investigation was conducted by Britt K. Collins, Dawn A. Edick, Michael Foster, Heidi M. Mitza, and Kathleen Shields.  The SEC appreciates the assistance of the Public Company Accounting Oversight Board.

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Former Oppenheimer Fund Manager Agrees to Settle Fraud Charges

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Former Oppenheimer Fund Manager Agrees to Settle Fraud Charges

The Securities and Exchange Commission today announced that a former Oppenheimer & Co. portfolio manager has agreed to be barred from the securities industry and pay a $100,000 penalty for making misrepresentations about the valuation of a fund consisting of other private equity funds. 

The SEC announced administrative proceedings against Brian Williamson last August based on allegations that he disseminated information falsely claiming that the reported value of the fund’s largest investment came from the portfolio manager of the underlying fund.  Williamson, who managed the fund of funds, actually had valued the investment himself at a significant markup to the value estimated by the underlying fund’s portfolio manager.  Williamson sent marketing materials to potential fund investors reporting a misleading internal rate of return that failed to deduct the fund’s fees and expenses.  Williamson also made false and misleading statements to investor consultants and others in an effort to cover up his fraud.

“Investors rely on truthful and complete disclosures about valuation methodologies and fund fees and expenses, especially when committing to a long-term private equity investment,” said Julie M. Riewe, co-chief of the SEC Enforcement Division’s Asset Management Unit.  “Williamson misled prospective investors by marking up the fund’s interim valuations and concealing his role in enhancing its reported performance.”

Last year, Oppenheimer agreed to pay $2.8 million in a settlement of related charges.

The SEC’s order against Williamson finds that he willfully violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8.  Without admitting or denying the findings, Williamson consented to the order requiring him to pay a $100,000 penalty and barring him from associating with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization for at least two years.

The SEC’s investigation was conducted by Panayiota K. Bougiamas, Joshua M. Newville, and Igor Rozenblit of the Asset Management Unit along with Jack Kaufman and Lisa Knoop of the New York Regional Office.  The case was supervised by Valerie A. Szczepanik.  The SEC’s litigation was handled by Mr. Kaufman, Mr. Newville, and Charu Chandrasekhar.

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SEC Obtains Settlements in Penny Stock “Shell Packaging” Case

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SEC Obtains Settlements in Penny Stock “Shell Packaging” Case

The Securities and Exchange Commission today announced nearly $300,000 in settlements against a Virginia-based “shell packaging” company and its CEO who were charged with facilitating a penny stock scheme as well as a Bronx, N.Y.-based stock promoter who received proceeds from the fraud.

Virginia-based Belmont Partners LLC and its CEO Joseph Meuse are in the business of identifying and selling public shell companies for use in reverse mergers.  In an enforcement action in late 2011, the SEC alleged that Meuse and his firm aided and abetted a New York-based company that fraudulently issued and sold unregistered shares of its common stock.  The SEC separately named Thomas Russo as a relief defendant in the case for the purposes of recovering ill-gotten gains in his possession as a result of his business partner’s participation in the scheme.  According to the SEC’s complaint, Russo co-owned a stock promotion service called TheStockProphet.com.

In a final judgment ordered late yesterday by the Honorable Shira A. Scheindlin of the U.S. District Court for the Southern District of New York, Belmont Partners and Meuse agreed to pay $224,500.  Meuse additionally has agreed to be barred from the penny stock business or from serving as an officer or director of a public company for at least five years.  In a separate judgment entered last week, Russo agreed to pay $70,075.  

“The SEC will continue to pursue and punish gatekeepers whose misconduct enables penny stock frauds to occur,” said Sanjay Wadhwa, senior associate director for enforcement in the SEC’s New York Regional Office.  “Meuse and his firm not only sold the shell company but they fabricated the documents necessary to dupe the transfer agent into issuing shares that should never have been sold to the public.  Russo received proceeds from the subsequent sale of the illicit stock.”

Belmont Partners and Meuse agreed to be permanently enjoined from violating Section 5 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  They neither admitted nor denied the SEC’s allegations. 

The SEC previously entered into a bifurcated settlement with the Long Island-based issuer at the center of the scheme – Alternative Green Technologies (AGTI) – as well as its CEO Mitchell Segal, who agreed to be barred from the penny stock business or from serving as a corporate officer or director for at least five years.  Financial penalties against Segal will be determined at a later date.

The SEC’s investigation was conducted by Steven G. Rawlings and Megan R. Genet, and the litigation has been led by Todd Brody and Ms. Genet.  The SEC appreciates the assistance of the Financial Industry Regulatory Authority.

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SEC Charges Diamond Foods and Two Former Executives in Accounting Scheme to Boost Earnings Growth

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SEC Charges Diamond Foods and Two Former Executives in Accounting Scheme to Boost Earnings Growth

The Securities and Exchange Commission today charged San Francisco-based snack foods company Diamond Foods and two former executives for their roles in an accounting scheme to falsify walnut costs in order to boost earnings and meet estimates by stock analysts. 

The SEC alleges that Diamond’s then-chief financial officer Steven Neil directed the effort to fraudulently underreport money paid to walnut growers by delaying the recording of payments into later fiscal periods.  In internal e-mails, Neil referred to these commodity costs as a “lever” to manage earnings in Diamond’s financial statements.  By manipulating walnut costs, Diamond correspondingly reported higher net income and inflated earnings to exceed analysts’ estimates for fiscal quarters in 2010 and 2011.  After Diamond restated its financial results in November 2012 to reflect the true costs of acquiring walnuts, the company’s stock price slid to just $17 per share from a high of $90 per share in 2011.

Diamond Foods agreed to pay $5 million to settle the SEC’s charges.  Former CEO Michael Mendes, who should have known that Diamond’s reported walnut cost was incorrect at the time he certified the company’s financial statements, also agreed to settle charges against him.  The SEC’s litigation continues against Neil.

“Diamond Foods misled investors on Main Street to believe that the company was consistently beating earnings estimates on Wall Street,” said Jina L. Choi, director of the SEC’s San Francisco Regional Office.  “Corporate officers cannot manipulate fiscal numbers to create a false impression of consistent earnings growth.” 

According to the SEC’s complaints filed in federal court in San Francisco, one of the company’s significant lines of business involves buying walnuts from its growers and selling the walnuts to retailers.  With sharp increases in walnut prices in 2010, Diamond encountered a situation where it needed to pay more to its growers in order to maintain longstanding relationships with them.  Yet Diamond could not increase the amounts paid to growers for walnuts, which was its largest commodity cost, without also decreasing the net income that Diamond reports to the investing public.  And Neil was facing pressure to meet or exceed the earnings estimates of Wall Street stock analysts.

The SEC alleges that while faced with competing demands, Neil orchestrated a scheme to have it both ways.  He devised two special payments to please Diamond’s walnut growers and bring the total yearly amounts paid to growers closer to market prices, but improperly excluded portions of those payments from year-end financial statements.  Instead of correctly recording the costs on Diamond’s books, Neil instructed his finance team to consider the payments as advances on crops that had not yet been delivered.  By disguising the reality that the payments were related to prior crop deliveries, Diamond was able to manipulate walnut costs in its accounting to hit quarterly targets for earnings per share (EPS) and exceed estimates by analysts.  For instance, after adjusting the walnut cost in order to meet an EPS target for the second quarter of 2010, Diamond went on to tout its record of “Twelve Consecutive Quarters of Outperformance” in its reported EPS results during investor presentations.

The SEC further alleges that Neil misled Diamond’s independent auditors by giving false and incomplete information to justify the unusual accounting treatment for the payments.  Neil personally benefited from the fraud by receiving cash bonuses and other compensation based on Diamond’s reported EPS in fiscal years 2010 and 2011. 

The SEC’s order against Mendes finds that he should have known that Diamond’s reported walnut cost was incorrect because of information he received at the time, and he omitted facts in certain representations to Diamond’s outside auditors about the special walnut payments.  Mendes agreed to pay a $125,000 penalty to settle the charges without admitting or denying the allegations.  Mendes already has returned or forfeited more than $4 million in bonuses and other benefits he received during the time of the company’s fraudulent financial reporting.

The SEC’s complaints against Diamond and Neil allege that they violated or caused violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 as well as Sections 17(a)(1), (2), and (3) of the Securities Act of 1933.  Diamond agreed to settle the charges without admitting or denying the allegations.  The Commission took into account Diamond’s cooperation with the SEC’s investigation and its remedial efforts once the fraud came to light.  The penalties collected from Diamond and Mendes may be distributed to harmed investors if SEC staff determines that a distribution is feasible.

The SEC’s investigation was conducted by Jennifer J. Lee, Adrienne Miller, and Cary Robnett of the San Francisco office.  The SEC’s litigation against Neil will be led by Lloyd Farnham.

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SEC Announces New Date for Compliance with Final Municipal Advisor Registration Rules

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SEC Announces New Date for Compliance with Final Municipal Advisor Registration Rules

The Securities and Exchange Commission today announced that compliance with the final municipal advisor registration rules will not be required until July 1, 2014, the date on which the first set of municipal advisors will be required to register under the final rules.  

The Commission, while balancing the goals of enhancing the quality of municipal securities advice and protecting investors and municipalities in the municipal securities market, took this action to give market participants additional time to analyze, implement, and comply with the final rules.

The Commission approved the final rules last year under the Dodd-Frank Act to provide an effective municipal advisor registration regime. The rules require municipal advisors to register with the Commission if they provide advice to municipal entities or certain other persons on the issuance of municipal securities, or about certain investment strategies or municipal derivatives. 

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Agencies Approve Interim Final Rule Authorizing Retention of Interests in and Sponsorship of Collateralized Debt Obligations Backed Primarily by Bank-Issued Trust Preferred Securities

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Agencies Approve Interim Final Rule Authorizing Retention of Interests in and Sponsorship of Collateralized Debt Obligations Backed Primarily by Bank-Issued Trust Preferred Securities

Five federal agencies on Tuesday approved an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities (TruPS CDOs) from the investment prohibitions of section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, known as the Volcker rule.

Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities if the following qualifications are met:

• 
  the TruPS CDO was established, and the interest was issued, before May 19, 2010;


• 
  the banking entity reasonably believes that the offering proceeds received by the TruPS CDO were invested primarily in Qualifying TruPS Collateral; and


• 
  the banking entity’s interest in the TruPS CDO was acquired on or before December 10, 2013, the date the agencies issued final rules implementing section 619 of the Dodd-Frank Act. 

The federal banking agencies on Tuesday also released a non-exclusive list of issuers that meet the requirements of the interim final rule.

The interim final rule defines Qualifying TruPS Collateral as any trust preferred security or subordinated debt instrument that was:

• 
  issued prior to May 19, 2010, by a depository institution holding company that as of the end of any reporting period within 12 months immediately preceding the issuance of such trust preferred security or subordinated debt instrument had total consolidated assets of less than $15 billion; or


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  issued prior to May 19, 2010, by a mutual holding company. 

Section 171 of the Dodd-Frank Act provides for the grandfathering of trust preferred securities issued before May 19, 2010, by certain depository institution holding companies with total assets of less than $15 billion as of December 31, 2009, and by mutual holding companies established as of May 19, 2010.  The TruPS CDO structure was the vehicle that gave effect to the use of trust preferred securities as a regulatory capital instrument prior to May 19, 2010, and was part of the status quo that Congress preserved with the grandfathering provision of section 171.

The interim final rule also provides clarification that the relief relating to these TruPS CDOs extends to activities of the banking entity as a sponsor or trustee for these securitizations and that banking entities may continue to act as market makers in TruPS CDOs.

The interim final rule was approved by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission, and the Securities and Exchange Commission, the same agencies that issued final rules to implement section 619.  The agencies will accept comment on the interim final rule for 30 days following publication of the interim final rule in the Federal Register.   

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SEC Charges Alcoa With FCPA Violations

The Securities and Exchange Commission today charged global aluminum producer Alcoa Inc. with violating the Foreign Corrupt Practices Act (FCPA) when its subsidiaries repeatedly paid bribes to government officials in Bahrain to maintain a key source of business.

An SEC investigation found that more than $110 million in corrupt payments were made to Bahraini officials with influence over contract negotiations between Alcoa and a major government-operated aluminum plant. Alcoa’s subsidiaries used a London-based consultant with connections to Bahrain’s royal family as an intermediary to negotiate with government officials and funnel the illicit payments to retain Alcoa’s business as a supplier to the plant. Alcoa lacked sufficient internal controls to prevent and detect the bribes, which were improperly recorded in Alcoa’s books and records as legitimate commissions or sales to a distributor.

Alcoa agreed to settle the SEC’s charges and a parallel criminal case announced today by the U.S. Department of Justice by paying a total of $384 million.

“As the beneficiary of a long-running bribery scheme perpetrated by a closely controlled subsidiary, Alcoa is liable and must be held responsible,” said George Canellos, co-director of the SEC Enforcement Division. “It is critical that companies assess their supply chains and determine that their business relationships have legitimate purposes.”

Kara N. Brockmeyer, chief of the SEC Enforcement Division’s FCPA Unit added, “The extractive industries have historically been exposed to a high risk of corruption, and those risks are as real today as when the FCPA was first enacted.”

According to the SEC’s order instituting settled administrative proceedings, Alcoa is a global provider of not only primary or fabricated aluminum, but also smelter grade alumina – the raw material that is supplied to plants called smelters that produce aluminum. Alcoa refines alumina from bauxite that it extracts in its global mining operations. From 1989 to 2009, one of the largest customers of Alcoa’s global bauxite and alumina refining business was Aluminium Bahrain B.S.C. (Alba), which is considered one of the largest aluminum smelters in the world. Alba is controlled by Bahrain’s government, and Alcoa’s mining operations in Australia were the source of the alumina that Alcoa supplied to Alba.

According to the SEC’s order, Alcoa’s Australian subsidiary retained a consultant to assist in negotiations for long-term alumina supply agreements with Alba and Bahraini government officials. A manager at the subsidiary described the consultant as “well versed in the normal ways of Middle East business” and one who “will keep the various stakeholders in the Alba smelter happy…” Despite the red flags inherent in this arrangement, Alcoa’s subsidiary inserted the intermediary into the Alba sales supply chain, and the consultant generated the funds needed to pay bribes to Bahraini officials. Money used for the bribes came from the commissions that Alcoa’s subsidiary paid to the consultant as well as price markups the consultant made between the purchase price of the product from Alcoa and the sale price to Alba.

The SEC’s order finds that Alcoa did not conduct due diligence or otherwise seek to determine whether there was a legitimate business purpose for the use of a middleman. Recipients of the corrupt payments included senior Bahraini government officials, members of Alba’s board of directors, and Alba senior management. For example, after Alcoa’s subsidiary retained the consultant to lobby a Bahraini government official, the consultant’s shell companies made two payments totaling $7 million in August 2003 for the benefit of the official. Two weeks later, Alcoa and Alba signed an agreement in principle to have Alcoa participate in Alba’s plant expansion. In October 2004, the consultant’s shell company paid $1 million to an account for the benefit of that same government official, and Alba went on to reach another supply agreement in principle with Alcoa. Around the time that agreement was executed, the consultant’s companies made three payments totaling $41 million to benefit another Bahraini government official as well.

The SEC’s cease-and-desist order finds that Alcoa violated Sections 30A, 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934. Alcoa will pay $175 million in disgorgement of ill-gotten gains, of which $14 million will be satisfied by the company’s payment of forfeiture in the parallel criminal matter. Alcoa also will pay a criminal fine of $209 million.

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Enforcement Co-Director George Canellos to Leave SEC

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Enforcement Co-Director George Canellos to Leave SEC

The Securities and Exchange Commission today announced that George S. Canellos, co-director of its Enforcement Division, will leave the agency later this month after four-and-a-half years of service in senior leadership positions. 

Mr. Canellos has played a key role in numerous structural and enforcement policy changes and oversaw significant investigations and enforcement actions related to the credit crisis and insider trading.  He helped lead the agency’s nationwide enforcement efforts during two of its most productive years in 2012 and 2013 while serving as deputy director and co-director of the Enforcement Division.  Mr. Canellos came to the SEC in July 2009 as director of the New York Regional Office.

“George filled an incredibly important leadership role as head of the New York office and later in the top posts of the Enforcement Division,” said SEC Chair Mary Jo White.  “He helped to improve coordination between the enforcement and exam programs, streamline procedures to expedite investigations, and better integrate our investigative and trial functions.  Every day, he brought to work an intense enthusiasm for our mission, extraordinary intellect and experience, and a total commitment to fairness and the public interest.”

Mr. Canellos said, “The unparalleled skill, judgment, and sense of fairness that the SEC staff brings to every examination, investigation, and case is the source of the Commission’s greatest strength.  I have been honored and inspired by the opportunity to work with them and will be forever grateful for and proud of the public service we have performed as a team.”

A strong proponent of drawing expertise from the securities industry, Mr. Canellos led efforts to recruit numerous industry experts and academics to the New York office, including specialists in structured products, derivatives, and applied mathematics.

Enforcement actions supervised by Mr. Canellos included: 

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  Actions against Raj Rajaratnam and more than 30 others associated with New York-based hedge fund advisory firm Galleon Management LP for widespread and repeated insider trading in the securities of 15 companies generating illicit profits totaling more than $96 million.


• 
  The action against former McKinsey & Co. global head Rajat Gupta for illegally tipping Rajaratnam while serving on the boards of Goldman Sachs and Procter & Gamble.


• 
  Actions against hedge fund managers associated with S.A.C. Capital for perpetrating the most profitable insider trading scheme in history and against S.A.C. Capital’s founder Steven A. Cohen for allegedly failing reasonably to supervise those fund managers.


• 
  The first-ever action against the operator of a “dark pool” trading platform: Pipeline Trading Systems LLC and two of its top executives for failing to disclose to customers that the vast majority of orders were filled by a trading operation affiliated with Pipeline.


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  The $150 million settlement by Bank of America for failing to properly disclose employee bonuses and financial losses at Merrill Lynch before shareholders approved the merger of the companies in December 2008.


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  Actions against J.P. Morgan Securities, Credit Suisse Securities (USA), RBS Securities, and Bank of America for misleading investors in offerings of residential mortgage-backed securities (RMBS), thus far resulting in almost $570 million in sanctions.


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  Actions for fraud and breach of fiduciary duty against numerous financial institutions and senior executives who participated in the structuring and sales of collateralized debt obligations (CDOs), including CDO arrangers Merrill Lynch and UBS Securities and CDO collateral managers ICP Asset Management, NIR Capital Management, and Harding Advisory LLC.


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  Actions for fraud against two JPMorgan traders for concealing hundreds of millions of dollars of losses on the so-called “London Whale” derivatives trades and against JPMorgan Chase for misstating its financial results and lacking effective internal controls to detect and prevent its traders from fraudulently overvaluing investments.

After being named director of the New York office, Mr. Canellos was instrumental in its response to the revelation of the Bernard Madoff Ponzi scheme, overseeing investigations and fraud charges against 22 individuals and entities.  Mr. Canellos led the implementation of new approaches to examinations of investment advisory firms while more closely integrating the teams responsible for examinations of broker-dealers and investment managers.  Mr. Canellos formed a joint working group of examination and enforcement staff dedicated to investigating participants in the penny stock industry.

Mr. Canellos continued to lead change in these areas as deputy director, acting director, and co-director of the Enforcement Division in 2012 and 2013 while serving under SEC chairmen Mary Schapiro, Elisse Walter, and Mary Jo White.  Mr. Canellos helped develop and implement the restructuring of many aspects of the agency’s enforcement program under then-enforcement director Robert Khuzami.  In particular, Mr. Canellos helped create the cooperation program, streamline internal processes, select leaders of newly created specialized units, and reorganize staff into core and specialized units.

More recently, Mr. Canellos and Enforcement Co-Director Andrew Ceresney modified the SEC’s settlement policy, requiring defendants in some classes of cases to make admissions of wrongdoing.  They also launched the Financial Reporting and Audit Task Force, Microcap Fraud Task Force, and Center for Risk and Quantitative Analytics to ferret out risks and threats to investors.  Mr. Canellos has encouraged strong and effective collaboration with law enforcement partners, including criminal authorities as well as other federal and state authorities. He has served as co-chair of the RMBS Working Group of the interagency Financial Fraud Enforcement Task Force.

Prior to working at the SEC, Mr. Canellos served for six-and-a-half years as a litigation partner in the law firm of Milbank Tweed Hadley & McCloy.  For nine years, he was a federal prosecutor with the U.S. Attorney’s Office for the Southern District of New York, serving as chief of its major crimes unit, deputy chief of criminal appeals, and senior trial counsel for its securities and commodities fraud task force.  Mr. Canellos received his J.D. from Columbia University School of Law and graduated magna cum laude from Harvard College.

Following the departure of Mr. Canellos, who has not yet made future career plans, Andrew Ceresney will continue to serve as director of the SEC’s Enforcement Division.

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Myron Marlin, Director of Communications, to Leave SEC

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Myron Marlin, Director of Communications, to Leave SEC

The Securities and Exchange Commission today announced that Myron Marlin will be leaving the SEC after nearly five years as communications director, serving under chairs Mary Jo White, Elisse B. Walter, and Mary L. Schapiro.

Since joining the SEC in March 2009, Mr. Marlin coordinated communications strategy on a range of significant issues including the agency’s landmark policy of seeking admissions in certain enforcement settlements and major rulemakings stemming from the Dodd-Frank Act and the JOBS Act.

“Myron is an extraordinary professional and advisor,” said Chair White.  “His substantial knowledge of the agency, judgment, and keen sense of effective communications have been invaluable to me.  I will miss him and his counsel greatly.”

Mr. Marlin said, “It has been an incredible privilege for me to serve under three chairs and alongside so many talented and dedicated public servants who perform work that is so crucial to investors and our nation’s economic well-being.  I am honored to have been at the SEC during a period of such intense rulemaking, record enforcement activity, and regulatory reform.”

Prior to joining the SEC, Mr. Marlin worked for a communications consulting firm.  Previously as director of public affairs at the U.S. Department of Justice, he received the Edmund J. Randolph Award for outstanding service.  Prior to working at the Department of Justice, he was an associate at a law firm in New York.  Mr. Marlin received his undergraduate degree from the University of Michigan and his law degree from American University.

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Merrill Lynch Charged With Misleading Investors in CDOs

The Securities and Exchange Commission charged Merrill Lynch with making faulty disclosures about collateral selection for two collateralized debt obligations (CDO) that it structured and marketed to investors, and maintaining inaccurate books and records for a third CDO.

Merrill Lynch agreed to pay $131.8 million to settle the SEC’s charges.

The SEC’s order instituting settled administrative proceedings finds that Merrill Lynch failed to inform investors that hedge fund firm Magnetar Capital LLC had a third-party role and exercised significant influence over the selection of collateral for the CDOs entitled Octans I CDO Ltd. and Norma CDO I Ltd.  Magnetar bought the equity in the CDOs and its interests were not necessarily aligned with those of other investors because it hedged its equity positions by shorting against the CDOs.

“Merrill Lynch marketed complex CDO investments using misleading materials that portrayed an independent process for collateral selection that was in the best interests of long-term debt investors,” said George S. Canellos, co-director of the SEC’s Division of Enforcement.  “Investors did not have the benefit of knowing that a prominent hedge fund firm with its own interests was heavily involved behind the scenes in selecting the underlying portfolios.”

According to the SEC’s order, Merrill Lynch engaged in the misconduct in 2006 and 2007, when its CDO group was a leading arranger of structured product CDOs.  After four Merrill Lynch representatives met with a Magnetar representative in May 2006, an internal email explained the arrangement as “we pick mutually agreeable [collateral] managers to work with, Magnetar plays a significant role in the structure and composition of the portfolio ... and in return [Magnetar] retain[s] the equity class and we distribute the debt.”  The email noted they agreed in principle to do a series of deals with largely synthetic collateral and a short list of collateral managers.  The equity piece of a CDO transaction is typically the hardest to sell and the greatest impediment to closing a CDO.  Magnetar’s willingness to buy the equity in a series of CDOs therefore gave the firm substantial leverage to influence portfolio composition.

According to the SEC’s order, Magnetar had a contractual right to object to the inclusion of collateral in the Octans I CDO selected by the supposedly independent collateral manager Harding Advisory LLC during the warehouse phase that precedes the closing of a CDO.  Merrill Lynch, Harding, and Magnetar had finalized a tri-party warehouse agreement that was sent to outside counsel, yet the disclosure that Merrill Lynch provided to investors incorrectly stated that the warehouse agreement was only between Merrill Lynch and Harding.  The SEC has charged Harding and its owner with fraud for accommodating trades requested by Magnetar despite its interests not necessarily aligning with the debt investors.

The SEC’s order finds that one-third of the assets for the portfolio underlying the Norma CDO were acquired during the warehouse phase by Magnetar rather than by the designated collateral manager NIR Capital Management LLC.  NIR initially was unaware of Magnetar’s purchases, but eventually accepted them and allowed Magnetar to exercise approval rights over certain other assets for the Norma CDO.  The disclosure that Merrill Lynch provided to investors incorrectly stated that the collateral would consist of a portfolio selected by NIR.  Merrill Lynch also failed to disclose in marketing materials that the CDO gave Magnetar a $35.5 million discount on its equity investment and separately made a $4.5 million payment to the firm that was referred to as a “sourcing fee.”  The SEC also today announced charges against two managing partners of NIR.

According to the SEC’s order, Merrill Lynch violated books-and-records requirements in another CDO called Auriga CDO Ltd., which was managed by one of its affiliates.  As it did in the Octans I and Norma CDO deals, Merrill Lynch agreed to pay Magnetar interest or returns accumulated on the warehoused assets of the Auriga CDO, a type of payment known as “carry.”  To benefit itself, however, Merrill Lynch improperly avoided recording many of the warehoused trades at the time they occurred, and delayed recording those trades.  Therefore, Merrill Lynch’s obligation to pay carry was delayed until after the pricing of the Auriga CDO when it became reasonably clear that the trades would be included in the portfolio.

“Keeping adequate books and records is not an elective requirement of the federal securities laws, and broker-dealers who fail to properly record transactions will be held accountable for their violations,” said Andrew M. Calamari, director of the SEC’s New York Regional Office.

Merrill Lynch consented to the entry of the order finding that it willfully violated Sections 17(a)(2) and (3) of the Securities Act of 1933 and Section 17(a)(1) of the Securities Exchange Act of 1934 and Rule 17a-3(a)(2).  The firm agreed to pay disgorgement of $56,286,000, prejudgment interest of $19,228,027, and a penalty of $56,286,000.  Without admitting or denying the SEC’s findings, Merrill Lynch agreed to a censure and is required to cease and desist from future violations of these sections of the Securities Act and Securities Exchange Act.

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Merrill Lynch Investment Losses? For a free consultation call the attorneys at Sallah Astarita & Cox, LLC for a free telephone consultation - 212-509-6544 or contact them online.

SEC Announces 2014 Examination Priorities

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SEC Announces 2014 Examination Priorities

The Securities and Exchange Commission today announced its examination priorities for 2014, which cover a wide range of issues at financial institutions, including investment advisers and investment companies, broker-dealers, clearing agencies, exchanges and other self-regulatory organizations, hedge funds, private equity funds, and transfer agents.

“We are publishing these priorities to highlight areas that we perceive to have heightened risk,” said Andrew J. Bowden, Director of the SEC’s Office of Compliance Inspections and Examinations.  “This document, along with our Risk Alerts and other public statements, help us to increase transparency, strengthen compliance, and inform the public and the financial services industry about key risks that we are monitoring and examining.”

The examination priorities address market-wide issues and those specific to particular business models and organizations.  The market-wide priorities include fraud detection and prevention, corporate governance and enterprise risk management, technology controls, issues posed by the convergence of broker-dealer and investment adviser businesses and by new rules and regulations, and retirement investments and rollovers. 

Based on program area, the priorities include:

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  For investment advisers and investment companies -- advisers who have never been previously examined, including new private fund advisers, wrap fee programs, quantitative trading models, and payments by advisers and funds to entities that distribute mutual funds

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  For broker-dealers -- sales practices and fraud, issues related to the fixed-income market, and trading issues, including compliance with the new market access rule

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  For market oversight -- risk-based examinations of securities exchanges and FINRA, perceived control weakness at exchanges, and pre-launch reviews of new exchange applicants

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  For transfer agents -- timely turnaround of items and transfers, accurate recordkeeping and safeguarding of assets

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  For clearing agencies designated as systemically important -- conduct annual examinations as required by the Dodd-Frank Act, and pre-launch reviews of new clearing agency applicants

The priorities listed for 2014 are not exhaustive and may be adjusted throughout the year in light of ongoing risk assessment activities.  They were selected by senior exam staff and managers and other SEC divisions and offices in consultation with the chair and other commissioners, based on a variety of information and risk analytics, including:

• 
  Tips, complaints and referrals, including from whistleblowers and investors

• 
  Information reported by registrants in required filings with the SEC

• 
  Information gathered through examinations conducted by the SEC and other regulators

• 
  Communications with other U.S. and international regulators and agencies

• 
  Industry and media publications

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  Data maintained in third party databases

• 
  Interactions outside of examinations with registrants, industry groups, and service providers 

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SEC Charges London-Based Hedge Fund Adviser and U.S.-Based Holding Company for Internal Control Failures

The Securities and Exchange Commission today charged a London-based hedge fund adviser and its former U.S.-based holding company with internal controls failures that led to the overvaluation of a fund’s assets and inflated fee revenue for the firms.

GLG Partners L.P. and its former holding company GLG Partners Inc. agreed to pay nearly $9 million to settle the SEC’s charges.

“Investors depend upon fund advisers to have proper controls in place to ensure that valuations and fees are not inflated,” said Antonia Chion, an associate director in the SEC’s Division of Enforcement. “GLG’s pricing committee did not have the information and time it needed to properly value assets.”

According to the SEC’s order instituting settled administrative proceedings, the GLG firms managed the GLG Emerging Markets Special Assets 1 Fund. From November 2008 to November 2010, GLG’s internal control failures caused the overvaluation of the fund’s 25 percent private equity stake in an emerging market coal mining company. The overvaluation resulted in inflated fees to the GLG firms and the overstatement of assets under management in the holding company’s filings with the SEC.

According to the SEC’s order, GLG’s asset valuation policies required the valuation of the coal company’s position to be determined monthly by an independent pricing committee. On a number of occasions, GLG employees received information calling into question the $425 million valuation for the coal company position. But there were inadequate policies and procedures to ensure that such relevant information was provided to the independent pricing committee in a timely manner or even at all. There was confusion among GLG’s fund managers, middle-office accounting personnel, and senior management about who was responsible for elevating valuation issues to the independent pricing committee.

The SEC’s order finds that GLG Partners L.P. violated and GLG Partners Inc. caused violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 12b-20, 13a-1, 13a-11, and 13a-13. The order requires the firms to hire an independent consultant to recommend new policies and procedures for the valuation of assets and test the effectiveness of the policies and procedures after adoption. The order directs the firms to cease and desist from violating or causing violations of various provisions of the federal securities laws. The firms consented to the order without admitting or denying the charges. The SEC is establishing a Fair Fund to distribute money to harmed fund investors. The GLG firms agreed to pay disgorgement of $7,766,667, prejudgment interest of $437,679, and penalties totaling $750,000.

The SEC’s investigation was conducted by Jonathan Cowen, Ann Rosenfield, Robert Dodge, and Lisa Deitch. The case arose from the SEC’s Aberrational Performance Inquiry, an initiative by the Enforcement Division’s Asset Management Unit that uses proprietary risk analytics to identify hedge funds with suspicious returns. Performance that is flagged as inconsistent with a fund’s investment strategy or other benchmarks forms a basis for further investigation and scrutiny.

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SEC Charges Microsoft Senior Manager and Friend With Insider Trading in Advance of Company News

The Securities and Exchange Commission today charged a senior portfolio manager at Microsoft Corporation and his friend and business partner with insider trading ahead of company announcements.

The SEC alleges that Brian D. Jorgenson, who lives in Lynwood, Wash., obtained confidential information about upcoming company news through his work in Microsoft’s corporate finance and investments division.  Jorgenson tipped Sean T. Stokke of Seattle in advance of the Microsoft announcements, the most recent occurring in October.  After Stokke traded on the inside information that Jorgenson provided, the two equally split the illicit profits in their shared brokerage accounts.  They made joint trading decisions with the goal of generating enough profits to create their own hedge fund.

In a parallel action, the U.S. Attorney’s Office for the Western District of Washington today announced criminal charges against Jorgenson and Stokke.

“Abusing access to Microsoft’s confidential information and generating unlawful trading profits is not a wise or legal business model for starting a hedge fund,” said Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit and director of the SEC’s Philadelphia Regional Office.  “We thwarted the misguided plans of Jorgenson and Stokke as they sought to illegally profit at others’ expense.”

According to the SEC’s complaint filed in U.S. District Court for the Western District of Washington, Jorgenson and Stokke made a combined $393,125 in illicit profits in their scheme, which began in April 2012.

The SEC alleges that Stokke first traded in advance of a public announcement that Microsoft intended to invest $300 million in Barnes & Noble’s e-reader business.  Jorgenson learned of the impending transaction after his department became involved in the financing aspects of the deal.  Jorgenson tipped Stokke so he could purchase approximately $14,000 worth of call options on Barnes & Noble common stock.  Following a joint public announcement on April 30, Barnes & Noble’s stock price closed at $20.75 per share, a 51.68 percent increase from the previous day.  Jorgenson and Stokke made nearly $185,000 in ill-gotten trading profits.

The SEC alleges that Stokke later traded in advance of Microsoft’s fourth-quarter earnings announcement in July 2013.  As part of his duties at Microsoft, Jorgenson prepared a written analysis of how the market would react to the negative news that Microsoft’s fourth quarter earnings were more than 11 percent below consensus estimates.  He estimated that Microsoft’s stock price would decline by at least six percent.  Jorgenson tipped this confidential information to Stokke, who purchased almost $50,000 worth of Microsoft options.  After Microsoft’s announcement on July 18, its stock price declined more than 11 percent the next day from $35.44 to $31.40 per share.  Jorgenson and Stokke realized more than $195,000 in illicit profits.

According to the SEC’s complaint, Stokke traded in advance of another Microsoft announcement on Oct. 24, 2013.  Jorgenson was aware that the company would be announcing first quarter 2014 earnings that were more than 14 percent higher than consensus estimates.  Rather than purchase Microsoft securities directly, Jorgenson and Stokke purchased more than $45,000 worth of call options on an exchange-traded fund in which Microsoft comprised more than eight percent of the fund’s holdings.  Following the announcement, Microsoft’s share price increased nearly six percent and the price of the ETF increased 0.51 percent.  Jorgenson and Stokke made approximately $13,000 in illegal trading profits.

Jorgenson and Stokke are charged with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, both directly and pursuant to 20(d) of the Exchange Act.  The SEC seeks permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest, and financial penalties against Jorgenson and Stokke as well as an officer-and-director bar against Jorgenson.

The SEC’s investigation was conducted by Brendan P. McGlynn, Patricia A. Paw, John S. Rymas, and Daniel L. Koster of the Philadelphia Regional Office.  The SEC’s litigation will be led by John V. Donnelly and G. Jeffery Boujoukos.

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SEC Names Michael Osnato as Chief of Enforcement Division’s Complex Financial Instruments Unit

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SEC Names Michael Osnato as Chief of Enforcement Division’s Complex Financial Instruments Unit

The Securities and Exchange Commission today announced that Michael J. Osnato, Jr. has been named chief of the Enforcement Division unit that conducts investigations into complex financial instruments.

Mr. Osnato, who joined the SEC staff in 2008 and has served as an assistant director in the New York Regional Office since 2010, has played a key role in a number of significant SEC enforcement actions.  For instance, Mr. Osnato helped spearhead the SEC’s case against JPMorgan Chase & Co. and two former traders for fraudulently overvaluing a complex trading portfolio in order to hide massive losses, and the subsequent action in which the bank admitted that it violated federal securities laws.

Mr. Osnato will now lead a Complex Financial Instruments Unit that is comprised of attorneys and industry experts working in SEC offices across the country to investigate potential misconduct related to asset-backed securities, derivatives, and other complex financial products.  The unit was created along with four other specialized enforcement units in 2010, and was formerly known as the Structured and New Products Unit.

“Michael is a natural leader who brings keen investigative instincts and exceptional judgment to his work,” said Andrew J. Ceresney, co-director of the SEC’s Division of Enforcement.  “He has been a valuable part of our efforts to punish misconduct related to complex financial instruments, and we are pleased that he will bring his considerable talents and skills to the unit.”

Among other SEC enforcement actions under Mr. Osnato’s purview have been charges against four former investment bankers and traders at Credit Suisse Group in a scheme to overstate the prices of $3 billion in subprime bonds, and actions related to operators of the Reserve Primary Fund.

“I am honored and gratified to have this opportunity to lead the Complex Financial Instruments Unit,” said Mr. Osnato.  “The unit has targeted fraud in some of the most challenging areas of the markets, and I look forward to working with the many talented professionals in the unit to keep the Enforcement Division on the cutting edge of today’s financial markets.”

Prior to joining the SEC enforcement staff, Mr. Osnato worked at Shearman & Sterling LLP and later at Linklaters LLP in New York.  He earned his bachelor’s degree from Williams College and his law degree from Fordham Law School.

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Agencies Reviewing Treatment of Collateralized Debt Obligations Backed by Trust Preferred Securities under Final Rules Implementing the “Volcker rule”

The Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission on Friday said they are reviewing whether it would be appropriate and consistent with the Dodd-Frank Wall Street Reform and Consumer Protection Act not to subject collateralized debt obligations backed by trust preferred securities to the investment prohibitions of section 619 of Dodd-Frank, otherwise known as the “Volcker rule.”

The agencies intend to address the matter no later than January 15, 2014. The accounting staffs of the agencies believe that, consistent with generally accepted accounting principles, any actions in January 2014 that occur before the issuance of December 31, 2013, financial reports should be considered when preparing those financial reports.

The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission, and the Securities and Exchange Commission issued final rules to implement section 619 on December 10, 2013.

SEC Issues Annual Staff Reports on Credit Rating Agencies

The Securities and Exchange Commission today issued its annual staff report on the findings of examinations of credit rating agencies registered as nationally recognized statistical rating organizations (NRSROs). The agency also submitted an annual staff report on NRSROs to Congress.

“The two reports reflect an evolving industry,” said Thomas J. Butler, director of the SEC’s Office of Credit Ratings. “The examination report shows that the SEC’s vigilant oversight is improving compliance at NRSROs, while the annual report to Congress depicts an industry that is growing more competitive and transparent.”

The 2010 Dodd-Frank Act requires the SEC to examine each NRSRO at least annually and issue a report summarizing key findings of the examinations. The report discusses the staff’s findings and recommendations for each of the 10 NRSROs. Among the areas examined are whether each NRSRO conducts business in accordance with its policies, procedures, and methodologies as well as how an NRSRO manages conflicts of interest and whether it maintains effective internal controls.

The report noted, for instance, that the staff found one or more NRSROs lacked comprehensive procedures governing ratings placed under review. The staff also found that oversight of the process for developing new rating methodologies and criteria was not sufficient at one or more NRSROs to ensure independence from business and market share considerations.

The 2013 examination report highlights certain improvements among NRSROs, such as increased investment in compliance systems and infrastructure along with enhancements in compliance training for both analytical and non-analytical employees. These improvements address recommendations that the staff made to NRSROs on prior examinations.

The annual report to Congress, which is required by the 2006 Credit Rating Agency Reform Act, identifies the applicants for NRSRO registration, actions taken on the applications, and the SEC’s views on the state of competition, transparency, and conflicts of interest among NRSROs.

Observations from the 2013 annual report include the following:

• The number of NRSROs rose to 10 with HR Ratings de México, S.A. de C.V., registering in November 2012.
• Some smaller NRSROs have gained significant market share in ratings for certain types of asset-backed securities.
• Transparency is increasing due to the NRSROs issuing unsolicited commentary on ratings issued by other NRSROs.

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SEC Removes References to NRSRO Ratings in Certain Rules and Forms

The Securities and Exchange Commission today announced that it has adopted amendments to eliminate references in certain of its rules and forms to credit ratings by nationally recognized statistical rating organizations (NRSROs).

The changes were required by the Dodd-Frank Wall Street Reform and Consumer Protection Act and remove credit rating references from:

• Rule 5b-3 under the Investment Company Act — a rule that permits funds to look through repurchase agreements to the underlying collateral securities for certain counterparty limitation and diversification purposes provided the collateral meets certain credit quality standards

• Forms N-1A, N-2, and N-3 — forms that contain requirements for funds to report information about their activities to shareholders, including information about the credit quality of their portfolios

• Rule 15c3-1 (and certain appendices) under the Securities Exchange Act of 1934 — a rule that requires broker-dealers to maintain more than a dollar of highly liquid assets for each dollar of liabilities, which helps ensure that if the broker-dealer fails, it will have sufficient liquid assets to cover its liabilities

• Rule 15c3-3 under the Securities Exchange Act of 1934 — a rule that prohibits broker-dealers from using customer securities and cash to finance the firm’s own business.  By segregating customer securities and cash from the firm’s proprietary business activities, the rule increases the likelihood that customer assets will be readily available to be returned to customers if the broker-dealer fails.

• Rule 10b-10 under the Securities Exchange Act of 1934 — the SEC’s confirmation rule that generally requires broker-dealers effecting transactions for customers in securities other than U.S. savings bonds or municipal securities to provide those customers with written notification of the terms of the transaction at or before the completion of the transaction.

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Federal Financial Regulators Extend Comment Period for Proposed Policy Statement on Assessing Diversity Policies and Practices of Regulated Entities

Six federal financial regulatory agencies announced today that they are extending the comment period for their proposed policy statement for assessing diversity policies and practices of the institutions they regulate to allow the public more time to analyze the issues and prepare their comments.

Commenters now have until Feb. 7, 2014, to provide feedback on the proposed policy statement.  Originally, comments were due Dec. 24, 2013.

The proposed policy statement, issued pursuant to section 342 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, is intended to promote transparency and awareness of diversity policies and practices within federally regulated financial institutions.

The agencies that issued the proposal are the Federal Reserve Board, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission.

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SEC Announces Agenda, Panelists For Roundtable On Proxy Advisory Services

The Securities and Exchange Commission today announced the agenda and panelists for its December 5 staff roundtable on the use of proxy advisory firm services by institutional investors and investment advisers.

The roundtable, announced earlier this month, will begin at 9:30 a.m. and will be divided into two sessions.  In the first session, participants will discuss, among other topics, the current use of proxy advisory services, including the factors that may have contributed to their use, the purposes and effects of using the services, and competition in the marketplace for such services.  In the second session, participants will discuss, among other topics, issues identified in the Commission’s 2010 concept release on the U.S. proxy voting system, including potential conflicts of interest that may exist for proxy advisory firms and users of their services, and the transparency and accuracy of recommendations by proxy advisory firms.

The roundtable panelists are:

• Karen Barr - General Counsel, Investment Adviser Association


• Jeffrey Brown - Head of Legislative and Regulatory Affairs, Charles Schwab


• Mark Chen - Associate Professor of Finance, Georgia State University


• Michelle Edkins - Managing Director and Global Head Corporate Governance and Responsible Investment, BlackRock, Inc.


• 
  Yukako Kawata - Partner, Davis Polk & Wardwell LLP


• Hoil Kim - Vice President, Chief Administrative Officer and General Counsel, GT Advanced Technologies, Inc.


• Eric Komitee - General Counsel, Viking Global Investors LP


• Jeff Mahoney - General Counsel, Council of Institutional Investors


• Nell Minow - Co-Founder and Board Member, GMI Ratings


• Trevor Norwitz - Partner, Wachtell, Lipton, Rosen & Katz


• Harvey Pitt - CEO, Kalorama Partners


• Katherine Rabin - CEO, Glass Lewis & Co. LLC


• Gary Retelny - President, Institutional Shareholder Services, Inc.


• Michael Ryan - Vice President, Business Roundtable, and former president and COO of Proxy Governance, Inc.


• Anne Sheehan - Director of Corporate Governance, CalSTRS


• Damon Silvers - Director of Policy and Special Counsel, AFL-CIO


• Darla Stuckey - Senior Vice President of Policy and Advocacy, Society of Corporate Secretaries


• Lynn Turner - Managing Director, LitiNomics, Inc.

The roundtable will be held at the SEC’s headquarters in Washington, D.C., and is open to the public on a first-come, first-served basis.  The event also will be webcast live on the SEC’s website and will be archived for later viewing.

Members of the public are welcome to submit comments on the topics to be addressed at the roundtable.  Comments may be submitted electronically or on paper; please use one method only.  Any comments submitted will become part of the public record of the roundtable and posted on the SEC’s website.

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