SEC ANNOUNCES COURT IMPOSED JUDGEMENT OF $55 MILLION AGAINST INVESTMENT ADVISER CEO

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

Litigation Release No. 23228 / April 2, 2015

Securities and Exchange Commission v. Charles R. Kokesh, Civil Action No. 6:09-cv-1021

Federal Court Imposes $55 Million Final Judgment Against Investment Adviser CEO

On March 30, 2015, the United States District Court for the District of New Mexico entered a final judgment against Charles R. Kokesh, permanently enjoining him from violating federal securities laws and ordering him to pay a civil penalty of $2,354,593 as well as disgorgement and prejudgment interest totaling $53,004,432. The final judgment follows a five-day trial in November 2014, in which the jury found that Kokesh had committed securities fraud by misappropriating and misusing tens of millions of dollars at two registered investment advisers he controlled.

From at least 1995 through July 2007, Kokesh controlled two registered investment-adviser firms, though which he controlled and provided investment advice to four business-development companies ("BDCs"). Together, the BDCs had approximately 21,000 investors located throughout the United States. Through his control over the investment advisers, Kokesh was able to misappropriate investor funds by causing the BDCs to pay illegal distributions, performance fees, bonuses, and expense reimbursements to the investment advisers, which Kokesh then used for his own benefit. Kokesh tried to hide his scheme by directing the investment advisers to distribute misleading proxy statements to investors, and to have the BDCs file false reports with the Commission.

After short deliberations, the jury found that Kokesh had violated Section 37 of the Investment Company Act of 1940. The jury also found that Kokesh had aided and abetted violations of Sections 205, 206(1), and 206(2) of the Investment Advisers Act of 1940, and Sections 13(a) and 14(a) of the Securities Exchange Act of 1934 and Rules 12b-20, 13a-1, 13a-13, and 14a-9 thereunder.

The case was tried by David Reece, Jennifer Brandt, and Timothy McCole of the Commission's Fort Worth Regional Office. An examination by Kyle Holmberg of the Fort Worth Regional Office and Curtis Kolinek of the San Francisco Regional Office uncovered the misconduct.

SEC CHARGED BROKERAGE FIRM AND CEO OF FRAUD INVOLVING CDO AUCTIONS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

02/19/2015 11:00 AM EST

The Securities and Exchange Commission charged a New York City-based brokerage firm and its CEO with fraudulently deceiving other market participants while conducting auctions to liquidate collateralized debt obligations (CDOs).

An SEC investigation found that VCAP Securities and Brett Thomas Graham improperly arranged for a third-party broker-dealer to secretly bid at these same auctions on behalf of their affiliated investment adviser in order to acquire certain bonds to benefit the funds it managed.  Under engagement agreements with the CDO trustees, VCAP and its affiliates were prohibited from bidding while serving as liquidation agent for these auctions.  VCAP had access to all of the confidential bidding information as the liquidation agent, and Graham exploited it to ensure their third-party bidder won the coveted bonds at prices only slightly higher than other bidders.  VCAP’s investment adviser affiliate then immediately bought the bonds from its secret bidder.

VCAP and Graham agreed to pay nearly $1.5 million combined to settle the SEC’s charges, and Graham is barred from the securities industry for at least three years.

“Graham abused a position of trust by playing the roles of both conductor and bidder during CDO liquidation auctions to the detriment of other participants,” said Michael J. Osnato, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit.  “The settlement requires Graham and VCAP to give up fees they obtained while conducting these unfair liquidations that landed certain bonds in their fund manager’s portfolio.”

According to the SEC’s order instituting a settled administrative proceeding, Graham and VCAP made material misrepresentations to the trustees of the various CDOs for which VCAP served as liquidation agent.  After Graham had discussed bidding arrangements with the third-party broker-dealer, VCAP and Graham falsely represented in engagement agreements that they and their affiliates would not bid in the auctions or misuse confidential bidding information.  VCAP provided the various trustees with documents that did not disclose that its investment adviser affiliate was actually the winning bidder.  VCAP’s scheme enabled the investment adviser affiliate to obtain a total of 23 bonds during five auctions.

The SEC’s order finds that VCAP and Graham violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  VCAP agreed to pay disgorgement and prejudgment interest of $1,149,599 while Graham agreed to pay disgorgement and prejudgment interest of $127,733 plus a penalty of $200,000.  The SEC’s order censures VCAP and requires the firm and Graham to cease and desist from committing or causing any future violations of Section 10(b) of the Exchange Act and Rule 10b-5.  VCAP and Graham consented to the SEC’s order without admitting or denying the findings.

The SEC’s investigation was conducted by the Complex Financial Instruments Unit and led by Sarra Cho and Christopher Nee with assistance from Kapil Agrawal and Alfred Day.  The case was supervised by Andrew Sporkin and Mr. Osnato.

SEC CHARGES FORMER BROKER-DEALER CEO WITH DECEIVING CUSTOMERS WITH HIDDEN TRANSACTION FEES

FROM:  SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today charged the former chief executive officer of a broker-dealer subsidiary of ConvergEx Group LLC for deceiving brokerage customers with hidden fees to buy and sell securities. 

The SEC’s complaint alleges that the former CEO, Anthony G. Blumberg, engaged in a scheme that entailed concealing the practice of routing orders to an offshore affiliate in Bermuda to add mark-ups or mark-downs.  The hidden fees known as “trading profits” or “TP” were in addition to and often much higher than the commissions paid by customers to have their orders executed. 

The charges against Blumberg follow those announced in December by the SEC against three ConvergEx subsidiaries that agreed to pay more than $107 million and admit wrongdoing to settle the matter.  Two former employees also settled charges with the SEC. 

According to the SEC’s complaint filed against Blumberg in federal court in Newark, N.J., one university customer paid about $93,000 in disclosed commissions and about $543,000 in undisclosed TP.  In another case, $1.6 million in fees allegedly went undetected.  The SEC alleges that Blumberg engaged in deceptive practices to conceal the additional fees, and he encouraged traders under his management to do the same.

“We will continue to hold individuals accountable, including senior officials at broker-dealers, when they engage in fraudulent schemes to mislead customers,” said Andrew Ceresney, director of the SEC’s Division of Enforcement.

The U.S. Department of Justice today announced parallel criminal charges against Blumberg.  In the prior parallel criminal proceeding announced in December, ConvergEx Group and its Bermuda broker-dealer agreed to pay $43.8 million, and the two former employees named in the SEC case pleaded guilty in the criminal case.

ConvergEx has since shut down trading operations at the Bermuda broker-dealer subsidiary ConvergEx Global Markets Limited.  Blumberg was CEO of ConvergEx Global Markets Limited and ConvergEx Global Markets, which included a unit of U.S. broker G-Trade Services LLC.

The SEC’s complaint alleges that Blumberg directed employees to suspend the taking of TP when customers were monitoring execution prices.  Blumberg made false and misleading statements to a brokerage customer and authorized employees to falsify trading data for customers who inquired about the details of their securities transactions.

“During his tenure, Blumberg directed a culture of deception and greed that systematically harmed investors,” said Stephen L. Cohen, an associate director in the SEC’s Division of Enforcement.  “He had the power to put an end to this fraud, but instead used his power to encourage and perpetuate it.”

The SEC’s complaint alleges that Blumberg violated the antifraud provisions of the federal securities laws and an SEC antifraud rule.  The complaint further alleges liability as a control person and aiding and abetting violations by certain ConvergEx subsidiaries and former employees.  The SEC is seeking disgorgement of any ill-gotten gains with interest, a financial penalty, and permanent injunctive relief.

The SEC’s investigation, which is continuing, has been conducted by Sarah L. Allgeier, Richard E. Johnston, and Thomas D. Manganello under the supervision of Jennifer S. Leete.  The litigation will be led by Cheryl L. Crumpton and Kyle M. DeYoung.  The SEC appreciates the assistance of the Fraud Section of the U.S. Department of Justice’s Criminal Division, the Federal Bureau of Investigation, and the U.S. Postal Inspection Service.

SEC FILES ACTIONS INVOLVING THE UNDERREPORTING OF THE COST FOR WALNUTS

FROM:  SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission ("Commission") filed separate actions against Diamond Foods, Inc. ("Diamond"), a San Francisco-based snack food company, and its former chief executive officer (CEO) Michael Mendes, and its former chief financial officer (CFO) Steven Neil for their roles in an accounting scheme to falsify walnut costs in order to boost earnings and meet estimates by stock analysts.

According to the Commission's complaints against former CFO Steven Neil and Diamond, which were filed in federal court in San Francisco, 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 allegedly 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.

According to the Commission's complaints filed against Neil and Diamond, 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 Commission 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 Commission 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.

In a separate settled administrative proceeding filed today against former CEO Michael Mendes, the Commission found that Mendes should have known that Diamond's reported walnut cost was incorrect because of information he received at the time, and that 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 Commission's complaint against Diamond alleges that Diamond violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), and Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 ("Exchange Act") and Exchange Act Rules 10b-5, 12b-20, 13a-1, 13a-11, and 13a-13. Without admitting or denying the allegations, Diamond has consented to the entry of a permanent injunction against future violations of the relevant federal securities laws, and the imposition of a $5 million penalty.

The Commission's complaint against CFO Neil alleges that Neil violated Section 17(a) of the Securities Act, and Sections 10(b) and 13(b)(5) of the Exchange Act and Exchange Act Rules 10b-5, 13a-14, 13b2-1, and 13b2-2, and Section 304 of the Sarbanes-Oxley Act of 2002, and aided and abetted Diamond's violations of 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1, 13a-11, and 13a-13. The complaint against Neil seeks a permanent injunction, civil penalties, an officer and director bar, disgorgement plus prejudgment interest, and relief pursuant to the Sarbanes-Oxley Act of 2002.

The cease and desist order against CEO Mendes alleges that he directly violated Sections 17(a)(2) and (a)(3) of the Securities Act, Exchange Act Rules 13a-14, 13b2-1, and 13b2-2, and caused Diamond's violations of Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, 13a-11, and 13a-13. Without admitting or denying the factual findings, Mendes has consented to the entry of a cease and desist order against committing violations of Sections 17(a)(2) and (a)(3) of the Securities Act, Exchange Act Rules 13a-14, 13b2-1, and 13b2-2, and causing Diamond's violations of Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, 13a-11, and 13a-13, and the imposition of a $125,000 penalty. The Commission's order against Mendes noted that he already has returned to Diamond or has forfeited over $4 million in bonuses and other benefits he received during the time of the company's fraudulent financial reporting.

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.

SEVERAL CEO'S AND COMPANIES CHARGED WITH FRAUD IN PENNY STOCK MARKET MANIPULATION SCHEME

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission charged several CEOs and their companies, and five penny stock promoters with securities fraud for their roles in various illicit kickback and market manipulation schemes involving microcap stocks.

The SEC worked closely with the U.S. Attorney’s Office for the Southern District of Florida and the Federal Bureau of Investigation as the separate schemes were uncovered. The U.S. Attorney’s Office today announced criminal charges against the same individuals facing SEC civil charges.

According to complaints the SEC filed in the U.S. District Court for the Southern District of Florida, defendants Thomas Gaffney, Health Sciences Group, Inc., Mark Balbirer, Stephen F. Molinari, and Nationwide Pharmassist Corp. engaged in a scheme involving the payment of an undisclosed kickback to a pension fund manager or hedge fund principal in exchange for the fund’s purchase of restricted shares of stock in a microcap company.

According to additional complaints also filed in the Southern District of Florida, defendants Jack Freedman, Jeffrey L. Schultz, Redfin Network, Inc., Richard P. Greene, Peter Santamaria, Douglas P. Martin, VHGI Holdings, Inc., and Sheldon R. Simon engaged in various schemes. Some schemes involved undisclosed inducement payments made to individuals to facilitate the manipulation of the stock of several microcap issuers. One scheme involved an undisclosed bribe that was to be paid to a stockbroker who agreed to purchase a microcap company’s stock in the open market for his customers’ discretionary accounts.

The SEC alleges that the defendants in the schemes involving undisclosed kickbacks understood they needed to disguise the kickbacks as payments to phony companies, which they knew would perform no actual work. In the schemes involving the undisclosed inducement payments or bribe, the SEC alleges that the defendants knew their illegal activities were meant to artificially inflate the companies’ stock volume and prices.

The SEC’s complaints allege the defendants violated Section 17(a)(1) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(a) and/or 10b-5(c) thereunder. The SEC is seeking permanent injunctions, disgorgement plus prejudgment interest, and financial penalties against all the defendants; penny stock bars against all the individual defendants; and officer-and-director bars against defendants Schultz, Martin, Gaffney, and Molinari.

The SEC acknowledges the assistance and cooperation of the United States Attorney’s Office for the Southern District of Florida and the Federal Bureau of Investigation, Miami Division, in these investigations.