SEC BRINGS CHARGES IN MISALLOCATION OF EXPENSES SCHEME

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today announced charges against an Arizona-based private equity fund manager and his investment advisory firm for orchestrating a scheme to misallocate their expenses to the funds they manage.

The SEC Enforcement Division alleges that Scott A. Brittenham and Clean Energy Capital LLC (CEC) improperly paid more than $3 million of the firm’s expenses by using assets from 19 private equity funds that invest in private ethanol production plants.  CEC and Brittenham did not disclose any such payment arrangement in fund offering documents.  When the funds ran out of cash to pay the firm’s expenses, CEC and Brittenham loaned money to the funds at unfavorable interest rates and unilaterally changed how they calculated investor returns to benefit themselves.

“Brittenham betrayed investors in the funds he managed by burdening them with more than $3 million in expenses that his firm should have paid and the funds could not afford,” said Marshall S. Sprung, co-chief of the SEC Enforcement Division’s Asset Management Unit.  “Private equity advisers can only charge expenses to their funds when they clearly spell that out for investors.”

According to the SEC’s order instituting administrative proceedings, among the expenses that CEC and Brittenham have been misallocating to the funds are CEC’s rent, salaries, and other employee benefits such as tuition costs, retirement, and bonuses.  Brittenham even used fund assets to pay 70 percent of a $100,000 bonus that he awarded himself.  The money taken from the funds for firm expenses was in addition to millions of dollars in management fees already being paid to CEC out of the funds.

According to the SEC’s order, the expense misallocation scheme shrank the funds’ cash reserves.  So CEC and Brittenham made unauthorized “loans” to the funds at exorbitant rates as high as 17 percent in order to continue paying the improper expenses with fund assets.  The loans jeopardized the funds because Brittenham had pledged fund assets as collateral.  CEC and Brittenham further profited at the expense of fund investors by making several changes to how CEC calculated distributions to investors in order to pay out less money.  Brittenham also lied to a fund investor about his “skin in the game.”  Brittenham claimed that he and CEC’s co-founder had each invested $100,000 of their own money in one of the funds, but the actual amounts invested were only $25,000 each.

The SEC’s order alleges that CEC and Brittenham willfully violated the antifraud provisions of the federal securities laws and also asserts disclosure, compliance, custody, and reporting violations.

The SEC’s investigation was conducted by Payam Danialypour and C. Dabney O’Riordan of the Asset Management Unit in the Los Angeles Regional Office and accountant Deborah Russell in Washington D.C.  The SEC’s litigation will be led by Amy Longo, Lynn Dean, and Mr. Danialypour.  The SEC examination that led to the investigation was conducted by Ryan Hinson, Ernest Tang, Daniel Jung, and Thomas Mackin of the Los Angeles office’s investment adviser/investment company examination program.

SEC WILL LOOK AT INVESTMENT ADVISERS WHO WERE NEVER-BEFORE EXAMINED

FROM:  SECURITIES AND EXCHANGE COMMISSION 
SEC Announces Initiative Directed at Never-Before Examined Registered Investment Advisers
  FOR IMMEDIATE RELEASE

2014-35 Washington D.C., Feb. 20, 2014 — The Securities and Exchange Commission today announced that its Office of Compliance Inspections and Examinations (OCIE) is launching an initiative directed at investment advisers that have never been examined, focusing on those that have been registered with the SEC for three or more years.  OCIE previously announced that examining these advisers is a priority in 2014.
As part of the initiative, OCIE will conduct examinations of a significant percentage of advisers that have not been examined since they registered with the SEC.  These examinations will concentrate on the advisers’ compliance programs, filings and disclosure, marketing, portfolio management, and safekeeping of client assets.  Additional details on the examinations are available here.

“Our examinations will focus on areas most important to protecting investors,” said Jane Jarcho, national associate director of OCIE’s Investment Adviser/Investment Company examination program. “We will also promote compliance by engaging with these advisers through outreach efforts.”

Starting later this year, OCIE will invite SEC-registered investment advisers who have yet to be examined to attend regional meetings where they can learn more about the examination process.  Advisers also can find information regarding their obligations under the Investment Advisers Act of 1940 and other useful guidance on the SEC’s website.

SEC CHAIRMAN WHITE'S ADDRESS AT SEC SPEAKS 2014

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Chairman’s Address at SEC Speaks 2014
 Chair Mary Jo White
Washington, D.C.

Feb. 21, 2014

Good morning.  I am very honored to be giving the welcoming remarks and to offer a few perspectives from my first 10 months as Chair.  Looking back at remarks made by former Chairs at this event, the expectation seems to be for me to talk about the “State of the SEC.”  I will happily oblige on behalf of this great and critical agency.

In 1972, 42 years ago at the very first SEC Speaks, there were approximately 1,500 SEC employees charged with regulating the activities of 5,000 broker-dealers, 3,500 investment advisers, and 1,500 investment companies.

Today the markets have grown and changed dramatically, and the SEC has significantly expanded responsibilities.  There are now about 4,200 employees – not nearly enough to stretch across a landscape that requires us to regulate more than 25,000 market participants, including broker-dealers, investment advisers, mutual funds and exchange-traded funds, municipal advisors, clearing agents, transfer agents, and 18 exchanges.  We also oversee the important functions of self-regulatory organizations and boards such as FASB, FINRA, MSRB, PCAOB, and SIPC.  Only SIPC and FINRA’s predecessor, the NASD, even existed back in 1972.

Today the agency also faces an unprecedented rulemaking agenda.  Between the Dodd-Frank and JOBS Acts, the SEC was given nearly 100 new rulemaking mandates ranging from rules that govern the previously unregulated derivatives markets, impose proprietary trading restrictions on many financial institutions, increase transparency for hedge funds and private equity funds, give investors a say-on-executive pay, establish a new whistleblower program, lift the ban on general solicitation, reform and more intensely oversee credit rating agencies, and so many others.  These rulemakings, coupled with the implementation and oversight effort that each one brings, have added significantly to our already extensive responsibilities and challenge our limited resources.  These mandates also present the risk that they will crowd out or delay other pressing priorities.  But we must not let that happen.

All of this is upon us at a time when our funding falls significantly short of the level we need to fulfill our mission to investors, companies, and the markets.  As Chair, I owe a duty to Congress, the staff, and to the American people to use the funds we are appropriated prudently and effectively.  But it also is incumbent upon me to raise my voice when the SEC is not being provided with sufficient resources.  The SEC is deficit neutral.  Our appropriations are offset by modest transaction fees we collect from SROs.  What does that mean?  It means that if Congress provides us with increased funding, it will not increase the budget deficit or take resources from other programs or agencies, but it would go directly to protecting investors and strengthening our markets.  Given the critical role we play for investors and our expanded responsibilities, obtaining adequate funding for the SEC is and must be a top priority.

Fortunately, what has remained a constant over the years at the SEC is its magnificent and dedicated staff.  Indeed, it was the commitment, expertise, and moral, apolitical compass of the staff that led me here.  The SEC staff is a deep reservoir of extraordinary talent and expertise with a strong and enduring commitment to public service and independence.  And that is what has sustained the excellence of this agency since its founding.

Exercising my prerogative as Chair, I would now like to ask each SEC employee in the audience to stand and be recognized.  Please remain standing while I ask that everyone here today who once worked at the SEC to please also stand to be recognized.  In our most challenging moments, I urge all of us to think about the colleagues we just recognized, marvel at their public service and say thank you.

Back to the state of the SEC in 2014.

When I arrived at the SEC last April, I initially set three primary priorities: implementing the mandatory Congressional rulemakings of the Dodd-Frank and the JOBS Acts; intensifying the agency’s efforts to ensure that the U.S. equity markets are structured and operating to optimally serve the interests of all investors; and further strengthening our already robust enforcement program.  Ten months later, I am pleased with what we have accomplished.

Rulemaking
When I arrived, it was imperative to set an aggressive rulemaking agenda.  Congress had seen to that and our own core mission demanded it.  And, through the tireless work of the staff and my fellow Commissioners, we made significant progress.

On the day I was sworn in as Chair, we adopted identity theft rules requiring broker-dealers, mutual funds, investment advisers, and others regulated by us to adopt programs to detect red flags and prevent identity theft.[1]

A month later, we proposed rules to govern cross-border swap transactions in the multi-trillion dollar global over-the-counter derivatives markets.[2]

A month after that, we proposed rules to reform and strengthen the structure of money market funds. [3]

Last summer and fall, we made significant progress in implementing the reforms to the private offering market mandated by Congress in the JOBS Act.  We lifted the ban on general solicitation[4] and we proposed rules that would provide new investor protections and important data about this new market.[5]  We also proposed new rules that would permit securities-based crowdfunding and update and expand Regulation A.[6]

We adopted a Dodd-Frank Act rule disqualifying bad actors from certain private offerings.[7]

We adopted some of the most significant changes in years to the financial responsibility rules for broker-dealers.[8]

We adopted rules governing the registration and regulation of municipal advisors.[9]

We adopted rules removing references to credit agency ratings in certain broker-dealer and investment company regulations.[10]

In December, together with the banking regulators and the CFTC, we adopted regulations implementing the Volcker Rule.[11]

And, just last week we announced the selection of Rick Fleming, the deputy general counsel at the North American Securities Administrators Association, as the first Investor Advocate, a position established by Dodd-Frank.[12]

As even this partial list shows, we have made significant progress on our rulemakings, although more remains to be done.  But we must always keep the bigger picture in focus and not let the sheer number nor the sometimes controversial nature of the Congressional mandates distract us from other important rulemakings and initiatives that further our core mission as we set and carry out our priorities for the year ahead.

Other Critical Initiatives
To be more specific, in 2014, in addition to continuing to complete important rulemakings, we also will intensify our consideration of the question of the role and duties of investment advisers and broker dealers, with the goal of enhancing investor protection.  We will increase our focus on the fixed income markets and make further progress on credit rating agency reform.  We will also increase our oversight of broker-dealers with initiatives that will strengthen and enhance their capital and liquidity, as well as providing more robust protections and safeguards for customer assets.

We also will continue to engage with other domestic and international regulators to ensure that the systemic risks to our interconnected financial systems are identified and addressed – but addressed in a way that takes into account the differences between prudential risks and those that are not.  We want to avoid a rigidly uniform regulatory approach solely defined by the safety and soundness standard that may be more appropriate for banking institutions.

In 2014, we also will prioritize our review of equity market structure, focusing closely on how it impacts investors and companies of every size.  One near-term project that I will be pushing forward is the development and implementation of a tick-size pilot, along carefully defined parameters, that would widen the quoting and trading increments and test, among other things, whether a change like this improves liquidity and market quality.

In 2013, our Trading and Markets Division continued to develop the necessary empirical evidence to accurately assess our current equity market structure and to consider a range of possible changes.  Today we have better sources of data to inform our decisions.  For example, something we call MIDAS collects, nearly instantaneously, one billion trading data records every day from across the markets.  We have developed key metrics about the markets using MIDAS and placed them on our website last October so the public, academics, and all market participants could share, analyze, and react to the information that allows us to better test the various hypotheses about our markets to inform regulatory changes.[13]

The SEC, the SROs, and other market participants are also proceeding to implement the Consolidated Audit Trail Rule,[14] which when operational will further enhance the ability of regulators to monitor and analyze the equity markets on a more timely basis.  Indeed, it should result in a sea change in the data currently available, collecting in one place every order, cancellation, modification, and trade execution for all exchange-listed equities and equity options across all U.S. markets.  It is a difficult and complex undertaking, which must be accorded the highest priority by all to complete.

We also are very focused on ensuring the resilience of the systems used by the exchanges and other market participants.  It is critically important that the technology that connects market participants be deployed and used responsibly to reduce the risk of disruptions that can harm investors and undermine confidence in our markets.  A number of measures have already been taken and, in 2014, we will be focused on ensuring that more is done to address these vulnerabilities.  One significant vulnerability that must be comprehensively addressed across both the public and private sectors is the risk of cyber attacks.  To encourage a discussion and sharing of information and best practices, the SEC will be holding a cybersecurity roundtable in March.[15]

Enforcement
Let me turn to enforcement at the SEC in 2014 because vigorous and comprehensive enforcement of our securities laws must always be a very high priority at the SEC.  And it is.

When I arrived in April, I found what I expected to find – a very strong enforcement program.  Through extraordinary hard work and dedication, the Commission’s Enforcement Division achieved an unparalleled record of successful cases arising out of the financial crisis.  To date, we have charged 169 individuals or entities with wrongdoing stemming from the financial crisis – 70 of whom were CEOs, CFOs, or other senior executives.  At the same time, the Commission also brought landmark insider trading cases and created specialized units that pursued complex cases against investment advisers, broker dealers and exchanges, as well as cases involving FCPA violations, municipal bonds and state pension funds.  In 2013 alone, Enforcement’s labors yielded orders to return $3.4 billion in disgorgement and civil penalties, the highest amount in the agency’s history.  But there is always more to do.

Admissions
Last year, we modified the SEC’s longstanding no admit/no deny settlement protocol to require admissions in a broader range of cases.  As I have said before,[16] admissions are important because they achieve a greater measure of public accountability, which, in turn, can bolster the public’s confidence in the strength and credibility of law enforcement, and the safety of our markets.

When we first announced this change, we said that we would consider requiring admissions in certain types of cases, including those involving particularly egregious conduct, where a large numbers of investors were harmed, where the markets or investors were placed at significant risk, where the conduct undermines or obstructs our investigative processes, where an admission can send a particularly important message to the markets or where the wrongdoer poses a particular future threat to investors or the markets.  And now that we have resolved a number of cases with admissions, you have specific examples of where we think it is appropriate to require admissions as a condition of settlement.[17]  My expectation is that there will be more such cases in 2014 as the new protocol continues to evolve and be applied.

Financial Fraud Task Force
Last year, the Enforcement Division also increased its focus on accounting fraud through the creation of a new task force.[18]  The Division formed the Financial Reporting and Audit Task Force to look at trends or patterns of conduct that are risk indicators for financial fraud, including in areas like revenue recognition, asset valuations, and management estimates.  The task force draws on resources across the agency, including accountants in the Division of Corporation Finance and the Office of the Chief Accountant and our very talented economists in the Division of Economic Risk and Analysis (DERA).  The task force is focused on more quickly identifying potential material misstatements in financial statements and disclosures.  The program has already generated several significant investigations and more are expected to follow.

In addition to the new admissions protocol and the Financial Fraud Task Force, the Enforcement Division also has other exciting new initiatives including a new Microcap Task Force[19] and a renewed focus on those who serve as gatekeepers in our financial system, just to name a few.

* * *

We have talked about our rulemaking agenda, some of our ongoing market structure initiatives, and a bit about what is new and developing in Enforcement.  But what else lies ahead?

Corporation Finance: JOBS Act and Disclosure Reform
As we move to complete our rulemakings in the private offering arena, it is important for the SEC to keep focused on the public markets as well.  Our JOBS Act related-rulemaking will provide companies with a number of different alternatives to raise capital in the private markets.  Some have even suggested that if the private markets develop sufficient liquidity, there may not be any reason for a company to go public or become a public company in the way we think of it now.  That would not be the best result for all investors.

While the JOBS Act provides additional avenues for raising capital in the private markets and may allow companies to stay private longer, the public markets in the United States also continue to offer very attractive opportunities for capital.  They offer the transparency and liquidity that investors need and, at the same time, provide access to the breadth of sources of capital necessary to support significant growth and innovation.  For our part, we must consider how the SEC’s rules governing public offerings and public company reporting and disclosure may negatively impact liquidity in our markets and how they can be improved and streamlined, while maintaining strong investor protections.

Last year, I spoke about disclosure reform[20] and in December the staff issued a report that contains the staff’s preliminary conclusions and recommendations as to how to update our disclosure rules.[21]

What is next?

This year, the Corp Fin staff will focus on making specific recommendations for updating the rules that govern public company disclosure.  As part of this effort, Corp Fin will be broadly seeking input from companies and investors about how we can make our disclosure rules work better, and, specifically, investors will be asked what type of information they want, when do they want it and how companies can most meaningfully present that information.

Investment Management: Enhanced Asset Manager Risk Monitoring
The SEC of 2014 is an agency that increasingly relies on technology and specialized expertise.  This is particularly evident in the SEC’s new risk monitoring and data analytics activities.  One important example is the SEC’s new focus on risk monitoring of asset managers and funds.

Last year featured a very concrete success from these risk monitoring efforts when the SEC brought an enforcement case against a money market fund firm charging that it failed to comply with the risk limiting conditions of our rules.[22]

In the past year, the SEC has established a dedicated group of professionals to monitor large-firm asset managers.  These professionals who include former portfolio managers, investment analysts, and examiners track investment trends, review emerging market developments, and identify outlier funds.

The tools they use include analytics of data we receive, high-level engagement with asset manager executives and mutual fund boards, data-driven, risk-focused examinations, and with respect to money market funds certain stress testing results.

What is next?

I asked the IM staff for an “action plan” to enhance our asset manager risk management oversight program.  Among the initiatives under near-term consideration are expanded stress testing, more robust data reporting, and increased oversight of the largest asset management firms.  To be an effective 21st century regulator, the SEC is using 21st century tools to address the range of 21st century risks.

OCIE: Innovation in Exam Planning
We also are using powerful new data analytics and technology tools in our National Exam Program to conduct more effective and efficient risk-based examinations of our registrants.

OCIE’s Office of Risk Assessment and Surveillance aggregates and analyzes a broad band of data to identify potentially problematic behavior.  In addition to scouring the data that we collect directly from registrants, we look at data from outside the Commission, including information from public records, data collected by other regulators, SROs and exchanges, and information that our registrants provide to data vendors.  This expanded data collection and analysis not only enhances OCIE’s ability to identify risks more efficiently, but it also helps our examiners better understand the contours of a firm’s business activities prior to conducting an examination.

What is next?

The Office of Risk Assessment and Surveillance is developing exciting new technologies – text analytics, visualization, search, and predictive analytics – to cull additional red flags from internal and external data and information sources.  These tools will help our examiners be even more efficient and effective in analyzing massive amounts of data to more quickly and accurately hone in on areas that pose the greatest risks and warrant further investigation.  In an era of limited resources and expanding responsibilities, it is essential to identify and target these risks more systematically.  And we are doing that.

Conclusion
Let me stop here.  Hopefully, I have at least given you a window into the strong, busy, and proactive state of the SEC in 2014.  More importantly, throughout the next two days, you will hear directly from our staff about the many ways we are meeting the current challenges that we all face in our complex and rapidly changing markets and how we are preparing for tomorrow’s challenges.

This year as in every year, we look forward to hearing your ideas and input on our rulemakings and other initiatives.  Your views are very important to us and assist us to implement regulations that are true to our mission, effective, and workable.

Thank you and enjoy the conference.


[1] See Identity Theft Red Flags Rule Release No. 34-69359, (Apr. 10, 2013), available at http://www.sec.gov/rules/final/2013/34-69359.pdf.

[2] See Title VII of the Dodd-Frank Act and Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms Relating to the Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants Release No. 34-69490, (May 1, 2013), available at http://www.sec.gov/rules/proposed/2013/34-69490.pdf.

[3] See Money Market Fund Reform; Amendments to Form PF Release No. 33-9408, (Jun. 5, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9408.pdf.

[4] See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Release No. 33-9415 (Jul. 10, 2013), available at http://www.sec.gov/rules/final/2013/33-9415.pdf.

[5] See Release No. 33-9416, Amendments to Regulation D, Form D and Rule 156 (Jul. 10, 2013).

[6] See Crowdfunding, Release No. 33-9470 (Oct. 23, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9470.pdf and Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act, Release No. 33-9497 (Dec. 18, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9497.pdf.

[7] See Release No. 33-9414, Disqualification of Felons and Other “Bad Actors” (Jul. 10, 2013), available at http://www.sec.gov/rules/final/2013/33.9414.pdf.

[8] See Release No. 34-70072, Financial Responsibility Rules for Broker-Dealers (Jul. 30, 2013), available at http://www.sec.gov/rules/final/2013/34-70072.pdf.

[9] See Release No. 34-70462, Registration of Municipal Advisors (Sep. 20, 2013), available at http://www.sec.gov/rules/final/2013/34-70462.pdf.

[10] See Release No. 34-71194, Removal of Certain References to Credit Ratings Under the Securities Exchange Act of 1934 (Dec. 27, 2013), available at http://www.sec.gov/rules/final/2013/34-71194.pdf; Release No. 33-9506, Removal of Certain References to Credit Ratings Under the Investment Company Act (Dec. 27, 2013), available at http://www.sec.gov/rules/final/2013/33-9506.pdf.

[11] See Release No. BHCA-1, Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds and Private Equity Funds Bank Holding Company Act (Dec. 10, 2013), available at http://www.sec.gov/rules/final/2013/bhca-1.pdf.

[12] See Press Release No. 2014-27, SEC Names Rick Fleming as Investor Advocate (Feb. 12, 2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540780377.

[13] The MIDAS web site and interactive tools are available at http://www.sec.gov/marketstructure.

[14] See Release No. 34-67457, Consolidated Audit Trail (Jul. 18, 2012), available at http://www.sec.gov/rules/final/2012/34-67457.pdf.

[15] See Press Release No. 2014-32, SEC to Hold Cybersecurity Roundtable (Feb. 14, 2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540793626.

[16] The Importance of Trials to the Law and Public Accountability, remarks at the 5th Annual Judge Thomas A. Flannery Lecture (Nov. 14, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540374908.

[17] See Press Release No. 2013-159, Philip Falcone and Harbinger Capital Agree to Settlement (Aug. 19, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539780222; Press Release No. 2013-187, JPMorgan Chase Agrees to Pay $200 Million and Admits Wrongdoing to Settle SEC Charges (Sep. 19, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539819965; Press Release No. 2013-266, SEC Charges ConvergEx Subsidiaries With Fraud for Deceiving Customers About Commissions (Dec. 18, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540521484; Press Release No. 2014-17, Scottrade Agrees to Pay $2.5 Million and Admits Providing Flawed ‘Blue Sheet’ Trading Data (Jan. 29, 2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540696906.

[18] See SEC Spotlight on the Financial Reporting and Audit Task Force, available at https://www.sec.gov/spotlight/finreporting-audittaskforce.shtml.

[19] See SEC Spotlight on Microcap Fraud, available at http://www.sec.gov/spotlight/microcap-fraud.shtml.

[20] The Path Forward on Disclosure, remarks at the National Association of Corporate Directors Leadership Conference 2013 (Oct. 15, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370539878806.  See also The SEC in 2014, remarks at the 41st Annual Securities Regulation Institute (Jan. 27, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540677500.

[21] Report on Review of Disclosure Requirements in Regulation S-K (Dec. 2013), available at http://www.sec.gov/news/studies/2013/reg-sk-disclosure-requirements-review.pdf.

[22] In the Matter of Ambassador Capital Management, LLC, and Derek H. Oglesby, Admin. Proc. File No. 3-15625 (2013), available at http://www.sec.gov/litigation/admin/2013/ia-3725.pdf.

SEC CHARGES CALIFORNIA RESIDENT OF DEFRAUDING ADVISORY CLIENTS

FROM:  SECURITIES AND EXCHANGE COMMISSION 
SEC Charges James Y. Lee for Defrauding His Advisory Clients

On February 13, 2014, the Securities and Exchange Commission filed charges against James Y. Lee, a resident of La Jolla, California, alleging he defrauded his advisory clients.

The SEC's complaint, filed in federal district court in San Diego, alleges that Lee portrayed himself to prospective clients as a highly successful financial industry expert. According to the complaint, Lee recruited clients to open online brokerage accounts, including margin accounts in which he had discretionary authority to trade in options. He also charged his clients a management fee of as much as 50% of their monthly realized profits and promised clients that he would share equally in 50% of their realized losses. But when Lee's clients suffered large realized losses, he failed to reimburse most of them for his promised share.

The complaint alleges that Lee defrauded his clients in several ways. He charged some clients fees for the month of February 2011 based on false performance and concealed from them that they had actually incurred realized losses that month. In addition, he misled clients about his background, including failing to disclose a criminal conviction for embezzlement and an SEC cease-and-desist order for his role in illegal unregistered penny stock offerings. He also misled clients about his promise to share in realized losses and the risks of his options trading strategy. Furthermore, he traded in penny stocks in client accounts outside of his discretionary authority, and fraudulently induced one client to loan money to a penny stock company.

The complaint charges Lee with violating the antifraud provisions of the federal securities laws - Section 17(a) of the Securities Act of 1933, Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, and Section 206(1) and (2) of the Investment Advisors Act of 1940. The SEC is seeking a permanent injunction as well as disgorgement, prejudgment interest and civil penalties against Lee.

The complaint names several relief defendants including Lee's girlfriend, his son and his close business associate as well as their respective companies. According to the complaint, Lee diverted investor funds to all of the relief defendants to avoid holding assets in his own name.

In a related matter, on February 12, 2014, the SEC settled administrative and cease-and-desist proceedings against Ronald E. Huxtable II, of Palm Coast Florida. (Rel. 33-9547) In those proceedings the SEC found that Huxtable, one of Lee's clients, aided, abetted and caused Lee's violations by helping Lee charge certain clients fees for the month of February 2011 based on false performance and conceal the fact that they had actually incurred net realized losses for that month.

The SEC's investigation was conducted by Jennifer Peltz and Delia Helpingstine and supervised by Paul Montoya. The SEC's litigation will be led by Michael Foster.

MAN TO PAY DISGORGEMENT AND PENALTY TO SETTLE INSIDER TRADING CHARGES

FROM:  SECURITIES AND EXCHANGE COMMISSION 

On February 6, 2014, the Securities and Exchange Commission filed insider trading charges against Hao He a/k/a Jimmy He alleging He purchased short-term put option contracts in the securities of Sina Corporation ("Sina"), a foreign private issuer headquartered in Shanghai, China.

The SEC's complaint, filed in the federal district court in Atlanta, Georgia, alleges that He, between October 10, 2012 and November 13, 2012, obtained material nonpublic information concerning Sina's upcoming, negative, future earnings guidance while visiting China and/or through phone calls to China. Based on this information, He purchased approximately $162,000 in short-term put options on November 13 and November 14, 2012, which contracts expired on November 17, 2012. Given the cost and nature of those trades, Sina's stock had to decline within a short time frame in order for He's trades to be profitable.

On November 15, 2012, Sina issued an announcement noting that it had beaten analyst forecasts for third quarter earnings, but also announced unexpected negative guidance for the fourth quarter of 2012. As a result of this negative guidance, analysts downgraded the stock and, upon opening on November 16, 2012, Sina's stock price declined approximately 8.5%, opening at $48.60 compared to the previous day's close of $53.10, and ultimately closed at $45.06.

Following the announcement and decline in the stock price, He sold all of his put option contracts on November 16, 2012 for $331,530.83, generating illicit profits of $169,819.10.

The SEC's complaint alleges that He violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

He has consented, without admitting or denying the Commission's allegations, to the entry of a final judgment permanently enjoining him from violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder; and requiring him to pay $169,819.10 in disgorgement plus prejudgment interest of $6,155.36, and a penalty of $169,819.10. The settlement with He is subject to court approval.

The SEC's investigation was conducted by Grant Mogan and Peter Diskin of the Atlanta Regional Office.

CONVICTED EMBEZZLER CHARGED IN SECURITIES FRAUD CASE

FROM: SECURITIES AND EXCHANGE COMMISSION 
SEC Charges James Y. Lee for Defrauding His Advisory Clients

On February 13, 2014, the Securities and Exchange Commission filed charges against James Y. Lee, a resident of La Jolla, California, alleging he defrauded his advisory clients.

The SEC's complaint, filed in federal district court in San Diego, alleges that Lee portrayed himself to prospective clients as a highly successful financial industry expert. According to the complaint, Lee recruited clients to open online brokerage accounts, including margin accounts in which he had discretionary authority to trade in options. He also charged his clients a management fee of as much as 50% of their monthly realized profits and promised clients that he would share equally in 50% of their realized losses. But when Lee's clients suffered large realized losses, he failed to reimburse most of them for his promised share.

The complaint alleges that Lee defrauded his clients in several ways. He charged some clients fees for the month of February 2011 based on false performance and concealed from them that they had actually incurred realized losses that month. In addition, he misled clients about his background, including failing to disclose a criminal conviction for embezzlement and an SEC cease-and-desist order for his role in illegal unregistered penny stock offerings. He also misled clients about his promise to share in realized losses and the risks of his options trading strategy. Furthermore, he traded in penny stocks in client accounts outside of his discretionary authority, and fraudulently induced one client to loan money to a penny stock company.

The complaint charges Lee with violating the antifraud provisions of the federal securities laws - Section 17(a) of the Securities Act of 1933, Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, and Section 206(1) and (2) of the Investment Advisors Act of 1940. The SEC is seeking a permanent injunction as well as disgorgement, prejudgment interest and civil penalties against Lee.

The complaint names several relief defendants including Lee's girlfriend, his son and his close business associate as well as their respective companies. According to the complaint, Lee diverted investor funds to all of the relief defendants to avoid holding assets in his own name.

TWO TRADERS CHARGED IN "PARKING" FRAUD SCHEME

FROM:  SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission announced charges against two Wall Street traders involved in a fraudulent “parking” scheme in which one temporarily placed securities in the other’s trading book to avoid penalties that would affect his year-end bonus.

The SEC’s Enforcement Division alleges that Thomas Gonnella solicited the assistance of Ryan King to evade a policy at his firm that penalizes traders financially if they hold securities for too long.  Gonnella arranged for King, who worked at a different firm, to purchase several securities with the understanding that Gonnella would repurchase them at a profit for King’s firm.  By parking the securities in King’s trading book in order to reset the holding period when he repurchased them, Gonnella’s intention was to avoid incurring any charges to his trading profits and ultimately his bonus for having aged inventory.

The alleged round-trip trades caused Gonnella’s firm to lose approximately $174,000.  The SEC’s Enforcement Division alleges that after Gonnella’s supervisor began inquiring about the trades, Gonnella and King took steps to evade detection by interposing an interdealer broker in subsequent transactions and communicating by cell phone to avoid having conversations recorded by their firms.  Gonnella and King were eventually fired by their firms for the misconduct.

King, who has cooperated with the SEC investigation, agreed to settle the charges by disgorging his profits and being barred from the securities industry.  Any additional financial penalties will be determined at a later date.  The Enforcement Division’s litigation against Gonnella continues in a proceeding before an administrative law judge.

“Gonnella conducted trades for the purpose of avoiding his firm’s aged-inventory policy and protecting his own bonus,” said Andrew M. Calamari, director of the SEC’s New York Regional Office.  “Even though Gonnella misled his employer and resorted to text messages on his cell phone to avoid detection, his tricks failed and we are holding him accountable for these deceptive trades.”

According to the SEC’s administrative orders, Gonnella parked a total of 10 securities with King.  The scheme began on May 31, 2011, when Gonnella offered to sell King several asset-backed bonds issued by Bayview Commercial Asset Trust (BAYC).  Gonnella wrote in an instant message to King, “i have 4 small bonds that i’m looking to turnover today for good ol’ month end/aging purposes ... i like these bonds ... and would more than likely have a higher bid for these later this wk when the calendar turns ...”  Gonnella’s reference to “aging purposes” was his firm’s aged-inventory policy.  After King agreed, Gonnella sold him the securities and repurchased them before they had even settled in the account at King’s firm.

The SEC’s Enforcement Division alleges that Gonnella contacted King again a few months later on August 29, writing, “let’s talk tmrw. Have some aged bonds that I might offer you, if you’re game ... maybe do what we did a few months ago w/ some of those bayc’s ...”  After Gonnella sold three BAYC bonds to King, he repurchased two but did not immediately repurchase the other security. He later did so at a loss to King’s firm, but made them whole by selling two other bonds at prices favorable to King’s firm and unfavorable to his own firm. King then used the resulting profit on the two bonds to offset the original loss incurred.

As their scheme began to unravel, the SEC’s Enforcement Division alleges that Gonnella and King discussed their trading plans via cell phone and text messaging in an effort to avoid detection.  Cell phone records show that they rarely contacted one another that way in the prior four years.  For example, after discussing some trades in instant messages, Gonnella told King, “Check your text [messages] in like 3 minutes.” King responded, “haha, ok ... sneaky sneaky.”

The order against Gonnella alleges that he willfully violated Sections 17(a)(1) and 17(a)(3) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  The order alleges that he willfully aided and abetted and caused violations of Section 17(a) of the Exchange Act and Rule 17a-3.

The order against King finds that he willfully aided and abetted and caused Gonnella’s violations.  The Commission took into account King’s cooperation when agreeing to the settlement.  King agreed to pay disgorgement of $22,606.80 and prejudgment interest of $1,503.66.  The cease-and-desist order bars King from associating with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization as well as participating in any penny stock offering, with the right to apply for re-entry after three years.

The SEC’s investigation was conducted by Joshua Pater with assistance from examiners Adam Bacharach, Caroline Forbes, Michael Kress, and Yvette Panetta.  The case was supervised by Celeste Chase, and the litigation will be handled by Joseph Boryshansky and Daniel Michael.

INVESTMENT ADVISER CHARGED FOR ILLEGAL SHORT SELLING

FROM:  SECURITIES AND EXCHANGE COMMISSION 
SEC Charges Bermudian Investment Adviser and Principal for Illegal Short Selling

On January 31, 2013, the Securities and Exchange Commission filed a civil injunctive action in the U.S. District Court for the Southern District of New York against Revelation Capital Management Ltd. ("Revelation Capital") and its principal, Christopher P.C. Kuchanny ("Kuchanny") alleging illegal short selling. Kuchanny, who resides in Hamilton Parish, Bermuda, is the Chairman, Chief Executive Officer, Chief Investment Officer and sole shareholder of Revelation Capital, an exempt reporting adviser with its principal place of business in Pembroke, Bermuda.

Rule 105 is designed to prevent potentially manipulative short selling just prior to the pricing of follow-on and secondary offerings, thereby facilitating offering prices determined by independent market forces. Rule 105 prohibits any person who makes a short sale of securities during a defined restricted period prior to the pricing of that offering from purchasing the same securities in that offering. The Rule is prophylactic and prohibits the conduct irrespective of the short seller's intent in effecting the short sale.

Revelation Capital and Kuchanny violated Rule 105 in connection with Central Fund of Canada Limited's ("Central Fund") November 2009 offering by short selling Central Fund securities during the restricted period and then purchasing the same securities in Central Fund's offering. According to the complaint, defendants' profits from this illegal trading totaled $1,368,243. The Commission seeks permanent injunctions against each defendant, and disgorgement, prejudgment interest and civil penalties against each defendant.

SEC OBTAINS ASSET FREEZE AGAINST ALLEGED FRAUDSTER

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

SEC Obtains Asset Freeze and Other Relief Against Michael P. Zenger

On January 31, 2014, the Securities and Exchange Commission obtained a temporary restraining order and an emergency asset freeze in an offering fraud orchestrated by Lehi, Utah resident Michael P. Zenger (Zenger).

The complaint alleges that since June 2013, Zenger solicited at least $200,000 from two friends for the purported purpose of trading futures contracts, commodities, and government securities. While Zenger used some investor money as represented, the complaint alleges that Zenger misappropriated approximately $100,000 of the $200,000 he raised to pay personal expenses, including airplane rentals, monthly credit card bills, payments to BMW and Mercedes Benz, purchases at Saks Fifth Avenue, Nordstrom and Costco, and other personal expenses.

The Commission's complaint charges Zenger with violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks a preliminary and permanent injunction as well as disgorgement, prejudgment interest and civil penalties from Zenger.

The SEC's investigation was conducted by Jennifer Moore and Scott Frost; the litigation will be led by Thomas Melton.

BROKER SETTLES ALLEGED MISREPRESENTATION/FUNDS MISAPPROPRIATIONS CASE

FROM:  SECURITIES AND EXCHANGE COMMISSION 

Court Enters Final Judgment Against Broker in Settlement of Claims Arising from Fraudulent Misrepresentations and the Misappropriation of Funds

The Securities and Exchange Commission announced today that, pursuant to a settlement agreement, the Honorable Berle M. Schiller of the United States District Court for the Eastern District of Pennsylvania entered a final judgment on January 29, 2014 against defendant David L. Rothman in the Commission action, SEC v. David L. Rothman, Civil Action No. 2:12-cv-05412 (E.D. Pa.). The final judgment permanently enjoins Rothman from violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Section 17(a) of the Securities Act of 1933. Rothman was ordered to pay disgorgement in the amount of $505,431. Rothman consented to the entry of the final judgment against him.

The SEC charged Rothman, a registered representative, who was the Vice President and minority owner of Rothman Securities, Inc., located in Southampton, Pennsylvania, which is a mutual fund retailer and municipal securities broker, with creating and issuing false account statements to certain elderly and unsophisticated investor/clients that materially overstated the value of their investment accounts. The Commission's Complaint further charged that when the investors discovered that Rothman had misrepresented the value of their investments, he engaged in a scheme to conceal his fraudulent conduct by agreeing to pay those investors the investment returns he reported on the false account statements. When Rothman could no longer afford to make those payments, he misappropriated funds from another elderly and unsophisticated investor/client and from two trust accounts for which he served as trustee. Rothman used a substantial portion of the misappropriated funds for his personal benefit.

The SEC's litigation was conducted by Nuriye C. Uygur and G. Jeffrey Boujoukos of the Philadelphia Regional Office. The SEC's investigation was conducted by enforcement staff Kingdon Kase and Jennifer F. Miller. The matter was referred to the enforcement staff by the Philadelphia Regional Office's Office of Compliance, Inspections and Examinations.

SEC CHARGES MONEY MANAGER IN ALLEGED SCHEME INVOLVING DATA CHERRY-PICKING

FROM:  SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today charged a New York-based money manager and his firm with making false claims through Twitter, newsletters, and other communications about the success of their investment advice and a mutual fund they manage.

An SEC order against Mark A. Grimaldi and Navigator Money Management (NMM) finds that they selectively touted the past performance of the Sector Rotation Fund (NAVFX) and specific securities recommendations they made to clients.  They cherry-picked highlights but ignored less favorable recommendations and other data that would have made the facts complete.

Grimaldi and NMM agreed to settle the SEC’s charges.

“The securities laws require investment advisers to be honest and fully forthcoming in their advertising to give investors the full picture,” said Sanjay Wadhwa, senior associate director for enforcement in the SEC’s New York Regional Office.  “Grimaldi and his firm are being held accountable for using social media and widely disseminated newsletters to cherry-pick information and make misleading claims about their success in an effort to attract more business.”

According to the SEC’s order, Grimaldi is majority owner, president, and chief compliance officer at NMM, which is based in Wappingers Falls, N.Y.  Grimaldi particularly used a newsletter called The Money Navigator to solicit clients for NMM and investors for the Sector Rotation Fund.  The Money Navigator had more than 60,000 subscribers.  In 2008, the SEC conducted an examination of NMM and a fund it managed.  SEC exam staff notified NMM that the newsletters could be considered advertisements under Rule 206(4)-1, which generally prohibits false or misleading advertisements by investment advisers.  SEC staff also noted that the newsletters could be considered advertisements under Rule 482, which governs advertisements for mutual funds and other investment companies and has specific requirements for ads containing performance data.

The SEC’s order details several misleading advertisements made by NMM and Grimaldi in newsletters following that SEC examination.  For example, they misleadingly claimed in a December 2011 newsletter that Sector Rotation Fund was “ranked number 1 out of 375 World Allocation funds tracked by Morningstar.”  However, a time period of Oct. 13, 2010 to Oct. 12, 2011 was cherry-picked to broadly acclaim that ranking, and Sector Rotation Fund had a poorer relative performance during other time periods.  From Jan. 1 to Nov. 30, 2011, the day before Grimaldi published the ad, at least 100 other mutual funds in that same Morningstar category outperformed Sector Rotation Fund.

According to the SEC’s order, NMM was advertised as a “five-star (Morningstar) money manager” in the newsletters as well as on websites and in e-mail correspondence with potential investors.  This claim was materially misleading because Morningstar rates mutual funds not investment advisers.  And since February 2009, NMM has not been the investment manager of any mutual fund rated five stars by Morningstar.

The SEC’s order finds that Grimaldi also made misleading statements on Twitter.  He claimed responsibility for model portfolios in his newsletters that “doubled the S&P 500 the last 10 years.”  However, Grimaldi made the claim even though he had no involvement in the model portfolio performance for the first three years.

The SEC’s order finds that NMM violated Sections 17(a) of the Securities Act of 1933, Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rules 206(4)-1(a)(2), 206(4)-1(a)(5), 206(4)-7, and 206(4)-8 as well as Section 34(b) of the Investment Company Act of 1940.  Grimaldi violated many of the same provisions and aided and abetted and caused NMM’s violations.  

Grimaldi agreed to pay a penalty of $100,000, and he and the firm agreed to be censured and comply with certain undertakings including the retention of an independent compliance consultant for three years.  Without admitting or denying the SEC’s findings, NMM and Grimaldi are required to cease and desist from future violations of these sections of the securities laws.

The SEC’s investigation was conducted by Wendy Tepperman, Mark Germann, and Alexander Janghorbani of the New York office with assistance from Nell Spekman, an examiner in the New York office.

HEDGE FUND MANAGER, COMPANY RECEIVE FINAL JUDGEMENT IN MISAPPROPRIATION CASE

FROM:  SECURITIES AND EXCHANGE COMMISSION 

Final Judgments Entered Against Former Hedge Fund Manager and His Company
The Securities and Exchange Commission announced today that on January 22, 2014, the Honorable Paul G. Gardephe of the United States District Court for the Southern District of New York, entered final judgments against Berton M. Hochfeld (“Hochfeld”) and his wholly-owned entity Hochfeld Capital Management, L.L.C. (“HCM”), in SEC v. Hochfeld et al., 12-CV-8202. The SEC filed an emergency action in November 2012, charging Hochfeld and HCM with securities fraud for misappropriating assets and making material misstatements to investors in the Heppelwhite Fund L.P., a now defunct hedge fund. The Court previously entered judgments against Hochfeld and HCM that ordered, among other relief, injunctions and an asset freeze, and granted the Commission’s motion to create a Fair Fund to compensate defrauded investors. In October 2013, the Fair Fund made initial distributions, totaling more than $6 million, to 35 former Heppelwhite investors, which represented approximately 70% of each investor’s prior capital balance in the hedge fund. Pursuant to a Distribution Plan, the Fair Fund will make a second round of distributions to investors from additional funds collected, including proceeds from the sale of Hochfeld’s personal assets.

Hochfeld and HCM consented to entry of the final judgments, which enjoin them from violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, Section 17(a) of the Securities Act of 1933, and Sections 203 and 206 of the Investment Advisers Act of 1940, and order disgorgement of $1,785,332, which will be deemed satisfied by the criminal forfeiture order entered against Hochfeld in a parallel criminal case filed by the U.S. Attorney’s Office for the Southern District of New York. In the criminal case, United States v. Hochfeld, 13-CR-021, Hochfeld pled guilty to securities fraud and wire fraud. The Court sentenced Hochfeld to a two-year prison term, which he is now serving, and ordered him to pay forfeiture and restitution totaling approximately $2.9 million.

The SEC thanks the U.S. Attorney’s Office for the Southern District of New York and the Federal Bureau of Investigation for their assistance in this matter.

MARKET VOLATILITY FRAUDSTERS RECEIVE COURT JUDGEMENT AGAINST THEM

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Court Enters Judgment Against Three Wall Street Brokers for Defrauding Customers

The Securities and Exchange Commission announced today that, on January 14, 2014, pursuant to settlement agreements, The Honorable John F. Keenan of the United States District Court for the Southern District of New York entered judgments against defendants Marek Leszczynski, Benjamin Chouchane, and Henry Condron in the SEC’s fraud case, SEC v. Leszczynski, at al., Civil Action No. 1:12-cv-07488 (S.D.N.Y.). The judgments permanently enjoin Leszczynski, Chouchane, and Condron from violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In the judgments, Leszczynski was ordered to disgorge $1,500,000; Chouchane was ordered to disgorge $2,007,408 plus prejudgment interest of $442,169; and Condron was ordered to disgorge $168,336 plus prejudgment interest of $39,339. The Court has reserved the issue of whether to impose a civil penalty on the defendants pending their continued cooperation with the SEC. Acknowledging the facts to which they have admitted as part of their guilty pleas in parallel criminal cases, Leszczynski, Chouchane, and Condron consented to the entry of these judgments.

The SEC charged these brokers, who formerly worked on the cash desk at a New York-based broker-dealer, with illegally overcharging customers $18.7 million by using hidden markups and markdowns and secretly keeping portions of profitable customer trades. The brokers made their scheme difficult for customers to detect because they deceptively charged the markups and markdowns during times of market volatility in order to conceal the fraudulent nature of the prices they were reporting to their customers. The surreptitiously embedded markups and markdowns ranged from a few dollars to $228,000 and involved more than 36,000 transactions during a four-year period.

The SEC further alleged that when a customer placed a limit order seeking to purchase shares at a specified maximum price, the brokers filled the order at the customer’s limit price but used opportune times to sell a portion of that order back to the market to obtain a secret profit for the firm. They falsely reported back to the customer that they could not fill the order at the limit price.

The SEC’s litigation has been conducted by John V. Donnelly III and G. Jeffrey Boujoukos of the Philadelphia Regional Office. The SEC’s investigation was conducted by A. Kristina Littman and Kingdon Kase, under the supervision of Daniel M. Hawke, Chief of the Division of Enforcement’s Market Abuse Unit and Director of the Philadelphia Regional Office.

INVESTMENT ADVISOR CONCEALS LOSSES AND GETS SANCTIONED

FROM:  SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission 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 W. 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.

MAN SENTENCED TO PRISON FOR ROLE IN PONZI SCHEME

FROM:  SECURITIES AND EXCHANGE COMMISSION 

Massachusetts Resident Steven Palladino Sentenced to 10-12 Years in Prison for Role in Multi-Million Dollar Ponzi Scheme

The Securities and Exchange Commission announced today that, on January 21, 2014, a Massachusetts state court judge sentenced Massachusetts resident Steven Palladino to a prison term in a criminal action filed by the Suffolk County (Massachusetts) District Attorney.  The criminal action against Palladino and his company, Massachusetts-based Viking Financial Group, Inc., was initially filed in March 2013 and involves the same conduct alleged in a civil securities fraud action brought by the Commission in April 2013.  Suffolk Superior Court Judge Janet Sanders sentenced Palladino, of West Roxbury, Massachusetts, to serve a prison term of 10-12 years, followed by a probationary period of five years, and to pay restitution to victims, for crimes that he committed in connection with a Ponzi scheme perpetrated through Viking.  At the same hearing, Palladino pled guilty to criminal charges that included conspiracy, being an open and notorious thief, larceny, and larceny from elderly person(s).  Viking also pled guilty to related charges and was sentenced to a probationary period of five years and ordered to pay restitution to victims.  The Court set a further hearing for March 7, 2014 to determine, among other things, the amount of restitution to be paid to victims.

The Commission previously filed an emergency action against Viking and Palladino (collectively, “Defendants”) in federal district court in Massachusetts.  In its complaint, the Commission alleged that, since April 2011, Defendants misrepresented to at least 33 investors that their funds would be used to conduct the business of Viking – which was purportedly to make short-term, high interest loans to those unable to obtain traditional financing.  The Commission also alleged that Palladino misrepresented to investors that the loans made by Viking would be secured by first interest liens on non-primary residence properties and that investors would be repaid their principal, plus monthly interest at rates generally ranging from 7-15%, from payments that borrowers made on loans.  The complaint alleged that, in truth, Defendants made very few real loans to borrowers, and instead used investors’ funds largely to pay earlier investors and to pay for the Palladino family’s substantial personal expenses, including cash withdrawals, gambling debts, vacations, luxury vehicles and tuition.

The Commission first filed this action on April 30, 2013, seeking a temporary restraining order, asset freeze, and other emergency relief – which the Court granted.  On May 15, 2013, the Court also issued an escrow order, which ordered Defendants to deposit all funds and assets in their possession into an escrow account.  The asset freeze and escrow order have remained in effect at all times since April 30, 2013 and May 15, 2013, respectively.  On July 15, 2013, the Court held that Defendants’ conduct violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Section 17(a) of the Securities Act of 1933.  On November 18, 2013, the Court entered orders that enjoined Defendants from further violations of the antifraud provisions of the securities laws and ordered them to pay disgorgement of $9,701,738, plus prejudgment interest of $122,370.

On September 4, 2013, the Commission filed a motion for contempt against Palladino for violations of the asset freeze and the escrow order.  The motion alleged that Palladino violated the asset freeze by transferring three vehicles that he owned (solely or jointly with his wife) into his wife’s name and using the vehicles as collateral for new loans – effectively cashing out the equity in these vehicles.  The motion also alleged that Palladino violated the escrow order by failing to deposit all cash in his possession into the escrow account.  On November 15, 2013, the Court held Palladino in contempt and ordered that he restore ownership of the vehicles that he had transferred into his wife’s name.  Subsequently, Palladino restored ownership of two of the vehicles but has failed to restore ownership of one vehicle.  As a result, the Court refused to dismiss the contempt finding against him at hearings on December 3, 2013 and January 17, 2014.  The Court has set a further hearing date of February 20, 2014 to address, among other things, whether Palladino remains in contempt.

The Commission acknowledges the continued assistance of Suffolk County (Massachusetts) District Attorney Daniel F. Conley’s Office, whose office referred Palladino’s and Viking’s conduct to the Commission.

FINAL JUDGEMENT ENTERED AGAINST HEDGE FUND MANAGER

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Final Judgments Entered Against Former Hedge Fund Manager and His Company

The Securities and Exchange Commission announced today that on January 22, 2014, the Honorable Paul G. Gardephe of the United States District Court for the Southern District of New York, entered final judgments against Berton M. Hochfeld ("Hochfeld") and his wholly-owned entity Hochfeld Capital Management, L.L.C. ("HCM"), in SEC v. Hochfeld et al., 12-CV-8202. The SEC filed an emergency action in November 2012, charging Hochfeld and HCM with securities fraud for misappropriating assets and making material misstatements to investors in the Heppelwhite Fund L.P., a now defunct hedge fund. The Court previously entered judgments against Hochfeld and HCM that ordered, among other relief, injunctions and an asset freeze, and granted the Commission's motion to create a Fair Fund to compensate defrauded investors. In October 2013, the Fair Fund made initial distributions, totaling more than $6 million, to 35 former Heppelwhite investors, which represented approximately 70% of each investor's prior capital balance in the hedge fund. Pursuant to a Distribution Plan, the Fair Fund will make a second round of distributions to investors from additional funds collected, including proceeds from the sale of Hochfeld's personal assets.

The final judgments against Hochfeld and HCM enjoin them from violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, Section 17(a) of the Securities Act of 1933, and Sections 203 and 206 of the Investment Advisers Act of 1940, and order disgorgement of $1,785,332, which will be deemed satisfied by the criminal forfeiture order entered against Hochfeld in a parallel criminal case filed by the U.S. Attorney's Office for the Southern District of New York. In the criminal case, United States v. Hochfeld, 13-CR-021, Hochfeld pled guilty to securities fraud and wire fraud. The Court sentenced Hochfeld to a two-year prison term, which he is now serving, and ordered him to pay forfeiture and restitution totaling approximately $2.9 million.


The SEC thanks the U.S. Attorney's Office for the Southern District of New York and the Federal Bureau of Investigation for their assistance in this matter.

INVESTMENT BUSINESS FOUNDER ARRESTED FOR NOT COMPLYING TO SUBPOENAS

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Subject of SEC Investigation Held in Contempt of Court and Arrested for Failing to Comply with Subpoenas

The Securities and Exchange Commission today announced that a Staten Island man who is the subject of an agency investigation has been held in contempt of court and arrested for failing to comply with subpoenas requiring him to produce documents and give testimony.

The SEC filed a subpoena enforcement action in federal court in Manhattan on Nov. 4, 2013, against Anthony Coronati, the founder of a business known as Bidtoask.com, which has an office in Staten Island.  According to court documents, entities controlled by Coronati solicited investments relating to the securities of sought-after private companies such as Facebook that investors hoped would later hold initial public offerings.  The SEC is investigating, among other things, whether Coronati commingled investor funds with other money in an account he controlled and used it to pay personal expenses.  Despite two SEC investigative subpoenas in 2013, Coronati has neither produced documents nor appeared for testimony.

A court order issued on Nov. 7, 2013, required Coronati to comply with the SEC subpoenas.  A court order issued on Jan. 17, 2014, found Coronati in civil contempt for ignoring the prior court order.  The contempt order requires Coronati, who repeatedly attempted to evade service, to pay $4,812 to the SEC to reimburse the agency for its costs of serving him with court papers in this proceeding.

The U.S. Marshals Service arrested Coronati today.  At a hearing held before the Honorable William H. Pauley III, the court ordered Coronati released on $50,000 bond and restricted his travel to the Southern and Eastern Districts of New York.  The court ordered a further hearing on Feb. 6, 2014.

EXECUTIVES CHARGED BY SEC WITH FALSIFYING FINANCIAL RECORDS

FROM:  SECURITIES AND EXCHANGE COMMISSION 

SEC Charges Former Senior Executives of Public Company Subsidiary with Falsifying Financial Records and Circumventing Internal Controls

The Securities and Exchange Commission announced that on January 14, 2014, the Commission filed a civil injunctive action in federal district court Milwaukee, Wisconsin, charging Christopher Hohol (“Hohol”) and Brian Poshak (“Poshak”), formerly the senior vice president for operations and the  controller, respectively, of Veolia Special Services (“Special Services”), a fourth-tier United States subsidiary of Veolia Environnement S.A. (“Veolia”), a multinational utilities and environmental services company, with falsifying books, records, and accounts and circumventing internal controls in order to overstate Special Services’ earnings before taxes (“EBT”) over a period of at least three years.

The Commission’s complaint alleges that beginning no later than January 2008 and continuing through February 2011, Hohol, who was the most senior executive at Special Services, and Poshak, among other things, made and caused others to make false accounting entries in Special Services’ general ledger, including entries for fictitious revenue accruals, and entries that improperly reclassified expenses as inventory and improperly reclassified expenses (such as rental equipment, including industrial tools and diving gear) as prepaid assets, in order to artificially increase Special Services’ monthly EBT to meet internal financial performance projections and create the false appearance that Special Services consistently was profitable.  The complaint further alleges that both Hohol and Poshak signed monthly certifications falsely verifying the accuracy of Special Services’ financial information and efficacy of Special Services’ internal controls.  The complaint also alleges that Poshak forged invoices and other documents to support the false accounting entries and to conceal the scheme.  According to the complaint, as a result of Hohol’s and Poshak’s misconduct, Special Services overstated its EBT by a total of approximately $64 million.  The complaint also alleges that, as a result of their misconduct, Hohol and Poshak received $136,000 and $28,000, respectively, in ill-gotten bonus payments that were triggered by the inflated financial performance of Special Services.  The complaint further alleges that the false financial information provided by Special Services was reported up through several intermediate subsidiaries and, ultimately, was consolidated into the parent company’s publicly disclosed financial statements, which were filed with and furnished to the Commission.

The complaint charges Hohol and Poshak with violating Section 13(b)(5) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 13b2-1 thereunder, and aiding and abetting Veolia’s violations of Section 13(b)(2)(A) of the Exchange Act.

Without admitting or denying the allegations in the complaint, Hohol and Poshak have consented to the entry of final judgments that permanently enjoin them from violating Exchange Act Section 13(b)(5) and Rule 13b2-1 thereunder, and aiding and abetting violations of Exchange Act Section 13(b)(2)(A).  Hohol also has agreed to disgorge $106,000, and Poshak has agreed to disgorge $28,000, together with prejudgment interest in the amount of $3,500.  The settlements, which are subject to court approval, take into account Hohol's and Poshak’s current financial condition.

BURGER KING STOCK INSIDE TRADER ORDERED TO PAY $5.6 MILLION

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Former Stockbroker Ordered to Pay $5.6 Million for Insider Trader in Burger King Stock

The Securities and Exchange Commission obtained a final judgment against a former registered representative who misappropriated material nonpublic information from his customer and used it to trade Burger King Holding, Inc.'s ("Burger King") securities and tip others before the company's September 2, 2010 announcement that it was being acquired by a New York private equity firm.

On January 7, 2014, the SEC obtained a final judgment against Waldyr Da Silva Prado Neto ("Prado"), a citizen of Brazil formerly employed by Wells Fargo Advisors, LLC in Miami. Prado learned about the impending acquisition from one of his customers who invested in a fund managed by the private equity firm that was used to acquire Burger King. Prado misused the confidential information to illegally trade in Burger King securities for $175,000 in illicit profits, and he tipped others living in Brazil and elsewhere.

The final judgment entered by the U.S. District Court for the Southern District of New York on the SEC's motion for a default judgment, permanently enjoins Prado from violating Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and Rules 10b-5 and 14e-3 thereunder. The judgment orders Prado to disgorge $397,110 in ill-gotten gains from the illegal Burger King trading plus prejudgment interest of $41,622. Prado is also ordered to pay $5,195,500 in penalties.

SEC PRIORITIES FOR EXAMINATIONS IN 2014

FROM:  SECURITIES AND EXCHANGE COMMISSION 

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:

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.

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

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

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
Data maintained in third party databases
Interactions outside of examinations with registrants, industry groups, and service providers