SEC CHARGES TWO FORMER JP MORGAN TRADERS WITH FRAUDULENTLY OVERVALUING INVESTMENTS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

Securities and Exchange Commission v. Javier Martin-Artajo and Julien G. Grout, Civil Action No. 13-CV-5677 (S.D.N.Y.)

The Securities and Exchange Commission announced today that it charged two former traders at JPMorgan Chase & Co. with fraudulently overvaluing investments in order to hide massive losses in a portfolio they managed.

The SEC alleges that Javier Martin-Artajo and Julien Grout were required to mark the portfolio's investments at fair value in accordance with U.S. generally accepted accounting principles and JPMorgan's internal accounting policy. But when the portfolio began experiencing mounting losses in early 2012, Martin-Artajo and Grout schemed to deliberately mismark hundreds of positions by maximizing their value instead of marking them at the mid-market prices that would reveal the losses. Their mismarking scheme caused JPMorgan's reported first quarter income before income tax expense to be overstated by $660 million.

In a parallel action, the U.S. Attorney's Office for the Southern District of New York today announced criminal charges against Martin-Artajo and Grout.

According to the SEC's complaint filed in the U.S. District Court for the Southern District of New York, Martin-Artajo and Grout worked in JPMorgan's chief investment office (CIO), which created the portfolio known as Synthetic Credit Portfolio (SCP) as a hedge against adverse credit events. The portfolio was primarily invested in credit derivative indices and tranches. The market value of SCP's positions began to steadily decline in early 2012 due to improving credit conditions and a recent change in investment strategy. Martin-Artajo and Grout began concealing the losses in March 2012 by providing management with fraudulent valuations of SCP's investments.

The SEC alleges that Martin-Artajo directed Grout to revise the manner in which he marked SCP's investments. Instead of continuing to price the portfolio's positions based on the mid-market prices contained in dealer quotes the CIO received, SCP's positions were instead marked at the most aggressive end of the dealers' bid-offer spread. On several occasions, Martin-Artajo provided a desired daily loss target that would enable the concealment of the extent of the losses. Grout entered the marks every day into JPMorgan's books and records, and sent daily profit and loss reports to CIO management in which he understated SCP's losses. For a period, Grout maintained a spreadsheet to track the difference between his marks and the mid-market prices previously used to value SCP's positions. By mid-March, this spreadsheet showed that the difference had grown to $432 million.

The SEC alleges that contrary to JPMorgan's accounting policy, Martin-Artajo instructed Grout on March 30 to wait for better prices after the close of trading in London in the hope that activity in the U.S. markets could support better marks for SCP's positions. The concealment of losses continued beyond the first quarter. By late April, trading counterparties raised collateral disputes over SCP positions totaling more than a half-billion dollars. Shortly thereafter, JPMorgan's management stripped the SCP traders of their marking authority and began valuing the book at the consensus mid-market prices.

The SEC's complaint alleges that Martin-Artajo and Grout violated Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 10b-5 and 13b2-1, and aided and abetted pursuant to Section 20(e) of the Exchange Act violations of Sections 13(a) and 13(b)(2)(A) and Rules 12b-20, 13a-11 and 13a-13.

The SEC's investigation, which is continuing, has been conducted by Michael Osnato, Steven Rawlings, Peter Altenbach, Joshua Brodsky, Daniel Michael, Kapil Agrawal, Eli Bass, Daniel Nigro, Sharon Bryant, and Christopher Mele of the New York Regional Office. The litigation will be led by Joseph Boryshansky.

The SEC acknowledges the assistance of the U.S. Attorney's Office for the Southern District of New York, Federal Bureau of Investigation, United Kingdom Financial Conduct Authority, Office of the Comptroller of the Currency, Federal Reserve Bank of New York, and Commodity Futures Trading Commission.

SEC CHARGES EDMUND E. WILSON AND WALTER L. ROSS WITH VIOLATIONS OF THE FEDERAL SECURITIES LAWS

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

On March 14, 2013, the Securities and Exchange Commission filed a civil injunctive action against Edmund E. Wilson (Wilson) and Walter L. Ross (Ross), alleging that Wilson and Ross violated the federal securities laws in connection with the sale of securities by Fountain Group of Companies of Utah, Inc. (Fountain Group).

In its Complaint, filed in the U.S. District Court for the District of Utah, the Commission alleges that Wilson raised approximately $11 million from at least 60 investors through the fraudulent and unregistered sale of securities in Fountain Group. The Complaint alleges that beginning in September 2005, Wilson, through his company Fountain Group, offered and sold securities for the stated purpose of providing funding for real estate development. Wilson told investors that for a fee of either $80,000 or $150,000, Fountain Group would leverage a bond backed by senior life settlement policies to generate funding in the tens of millions of dollars for each proposed real estate project. Wilson assured investors their fee would be used to pay expenses to "activate" the funding. Instead of using investors’ funds as represented, Wilson transferred investor funds to other entities he owned and controlled where the funds were spent on expenses related to those businesses. In addition, Wilson used investor funds for his own personal purposes. Wilson was assisted in his solicitation of investors by Ross.

The Commission alleges that by engaging in this conduct Wilson and Ross violated Sections 5(a) and 5(c) Securities Act of 1933 (Securities Act) and Section 15(a) of the Securities Exchange Act of 1934 (Exchange Act) and Wilson violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The complaint seeks a permanent injunction as well as disgorgement, prejudgment interest and a civil penalty

SEC OBTAINS FINAL JUDGMENT AGAINST SCOTT KUPERSMITH IN FREE-RIDING CASE

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission announced today that on March 6, 2013, the Honorable Katharine S. Hayden of the United States District Court for the District of New Jersey entered a final judgment against defendant Scott I. Kupersmith. The final judgment imposes on Kupersmith a permanent injunction against future violations of certain antifraud provisions of the federal securities laws and orders that his obligation to pay disgorgement of $640,000 and prejudgment interest thereon be deemed satisfied provided that the combined restitution orders in the related criminal federal and state proceedings against him exceeded such amount.

In its Complaint, the Commission alleged that Kupersmith orchestrated a "free-riding" scheme of selling stocks before paying for them during 2009 and 2010 that allowed him to reap approximately $640,000 in illicit profits, while causing approximately $2 million in losses to the victim broker-dealers that he used to operate the scheme. According to the Complaint, Kupersmith interchangeably bought and sold the same quantity of the same stock in different brokerage accounts with the intention of profiting on swings up or down in the stock price. Unbeknownst to broker-dealers, Kupersmith did not have sufficient securities or cash on hand to cover the trades, and instead used proceeds from stock sales in one brokerage account to pay for the purchase of the same stock in another brokerage account. The scheme unraveled when Kupersmith failed to deliver shares to settle or cover long sales.

The final judgment permanently enjoins Kupersmith from violating Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5 and 10b-21 thereunder. In addition, the final judgment orders that Kupersmith’s obligation to pay disgorgement of $640,000 and prejudgment interest thereon be deemed satisfied provided that he was ordered to pay restitution in excess of such amount on a combined basis in the parallel criminal proceedings against him. Kupersmith consented to the entry of the final judgment.

On May 29, 2012, Kupersmith pleaded guilty to federal criminal charges for securities fraud in a parallel criminal action before the District Court for the District of New Jersey in United States v. Kupersmith, 2:12-cr-00375 (D.N.J.). On March 4, 2012, Kupersmith was sentenced to 33 months in prison followed by three years of supervised release and ordered to pay $1,796,151 in restitution.

In a related state criminal action, on May 7, 2012, Kupersmith pleaded guilty to criminal charges, including securities fraud under New York penal law, before the Supreme Court of the State of New York for the County of New York in State of New York v. Scott Kupersmith et al., Ind. No. 04360/2011 (Sup. Ct. N.Y. County). On March 5, 2013, Kupersmith was sentenced to a one-to-three year state prison term to run concurrently with the federal prison sentence and ordered to pay $684,703 in restitution, including a five-percent administration fee.

The Commission acknowledges the assistance of the U.S. Attorney's Office for the District of New Jersey, Federal Bureau of Investigation, and Manhattan District Attorney's Office.

SEC COMMISSIONER LUIS A. AGUILAR SPEAKS ABOUT AUTOMATED SYSTEMS

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Developing Solutions to Ensure that the Automated Systems of Our Marketplace are Secure, Robust, and Reliable
byCommissioner Luis A. Aguilar
U.S. Securities and Exchange CommissionWashington, D.C.
March 7, 2013


In recent years, the securities markets have undergone significant changes, and none has had more impact than the development of technology systems with ever-increasing speed and capacity. These systems are so fast that, in a blink of an eye, millions of trades can take place and billions of dollars can be transferred from buyers to sellers.<sup>Unfortunately, these systems can just as quickly become a destructive force with devastating consequences.

Some of the better-known examples of recent system-related issues include:
The Flash Crash of May 6, 2010.
 During the flash crash, in just a matter of minutes, certain equities experienced severe price movements — both up and down — with more than 20,000 trades in over 300 securities executed at prices more than 60% away from their market values. In just a few minutes, nearly $1 trillion in market value evaporated, before making a partial recovery.
The October 2011 system errors at Direct Edge exchanges where, in just over four minutes, the exchanges caused about 27 million shares of excess trading. These shares had an approximate market value of $773 million across roughly one thousand securities. The exchanges realized a net loss of $2.1 million in connection with the positions that were assumed and liquidated.
 The Commission sanctioned the Direct Edge entities for violations of the federal securities laws. In its Order, the Commission noted that the "violations occurred against the backdrop of weaknesses in Respondents’ systems, processes, and controls."6
Knight Capital Group Inc.’s $440 million trading loss in August 2012.
 In just 45 minutes, Knight Capital’s computers rapidly bought and sold millions of shares. Those trades pushed the value of many stocks up, and the company’s losses appear to have occurred when it had to sell the overvalued shares back into the market at a lower price. As a result, Knight Capital lost approximately $10 million per minute, almost had to go into bankruptcy, and subsequently agreed to be purchased.8
The systems issues associated with the initial public offerings of BATS Global Markets, Inc., and Facebook, Inc., in March and May 2012, respectively.
 As a result of systems issues, the BATS IPO was abandoned, and the Facebook fiasco resulted in NASDAQ offering up to $62 million to accommodate members for losses attributable to the systems issues.
The recent admission by BATS that, for a period of more than four years, its computer systems for two equity exchanges and an options platform allowed trades to take place at prices that violated the Commission’s regulations, which require exchanges to ensure that investors receive the best price.


These recent events highlight the need for the Commission to develop a secure, robust, and reliable regulatory framework to ensure that our capital markets develop and maintain systems with sufficient capacity, integrity, resiliency, availability, and security.

Today’s rule proposal, Regulation SCI (Systems Compliance and Integrity), is a step in the right direction. It is an important step forward from the purely voluntary program we have today as a result of the Commission’s 1989 policy statement, which states that SROs, on a voluntary basis, should establish comprehensive planning and assessment programs to determine systems capacity and vulnerability. At that time, the Commission noted the impact that systems problems and failures could have on public investors, broker-dealer risk exposure, and market efficiency.
 Clearly, the voluntary program has failed, as the above examples illustrate.

The proposed rule would move beyond the current voluntary program and requires entities to, among other things, (i) establish, maintain, and enforce written policies and procedures reasonably designed to ensure that its systems have adequate levels of capacity, integrity, resiliency, availability, and security to maintain the entity’s operational capability and promote the maintenance of fair and orderly markets; (ii) mandate participation in scheduled testing of the operation of the entity’s business continuity and disaster recovery plans, including backup systems, and coordinate such testing on an industry- or sector-wide basis with other entities; and (iii) make, keep, and preserve records relating to the matters covered by Regulation SCI, and provide them to Commission representatives upon request. The proposal also would require that entities submit all required written notifications and reports to the Commission electronically using new proposed Form SCI. These are all welcomed improvements.

However, although this is a positive step in the right direction, I am concerned that today’s rule proposal does not:
Mandate compliance with a specific set of Commission-identified minimum standards to ensure that entities establish, maintain, and enforce written policies and procedures reasonably designed to ensure that the entity’s systems provide adequate levels of capacity, integrity, resiliency, availability, and security. While the rule proposal provides a set of model policies and procedure for entities to consider, it fails to require minimum standards for policies and procedures. As a result, the rule proposal may not provide enough assurance that the resulting policies and procedures will meet the goals of the rule.
Require that an external review of compliance with Regulation SCI be conducted on a periodic basis by an independent third party in order to reduce the risk of conflicts of interests. Simply stated, an internal review may not be as robust and complete due to competing internal business pressures.
Provide for an entity’s senior officers to certify, in writing, that (i) the entity has processes in place to establish, document, maintain, review, test, and modify controls reasonably designed to achieve compliance with Regulation SCI; and (ii) that the annual budget and staffing levels are adequate for the entity to comply with its obligations under Regulation SCI. As Congress noted in connection with the CEO and CFO Certifications mandated by Section 302 of the Sarbanes-Oxley Act of 2002, "managers should be held accountable for the representations made by their company."
I believe that senior officer certifications would be an important tool to ensure compliance with today’s proposed rule.

Moreover, I am concerned that today’s rule proposal would allow an explicit safe harbor for entities and their employees that establish and maintain policies and procedures that are reasonably designed to comply with Regulation SCI. Although it is not stated in today’s release, I have been told by senior staff that the Commission has never previously included an explicit safe harbor in a Commission rule requiring that regulated entities maintain policies and procedures designed to achieve a particular objective.

In my view, an unprecedented safe harbor in a rule that does not require clear, identifiable, and meaningful standards, and that does not require policies and procedures to be reviewed by an independent third party and certified by senior officers, will result in a rule proposal that falls short of its goal — which is to ensure that our capital markets develop and maintain appropriate systems.

The rule proposal asks a number of important questions that were incorporated at my request to solicit comments from the public. These questions were designed to generate information and assist the Commission in thinking through issues associated with the rule proposal. This is an important part of the Commission’s rulemaking process, which is based on a "notice and comment" procedure. I hope that the comments generated will help make this a better rule.

Despite my concerns, I am willing to support today’s rule proposal because Regulation SCI would apply to more entities than the Commission’s current ARP Inspection Program, and the proposed rule would place obligations on entities not currently included in the Commission’s ARP policy statements. The havoc caused by recent events highlight the need to have an updated and formalized regulatory framework for ensuring that the U.S. securities trading markets maintain systems with sufficient integrity, resiliency, and security. Although, I have concerns, I am hopeful they will be addressed at the adoption stage. By then, we should have a full five-member Commission.

Today’s rulemaking is a positive step in addressing the systems challenges posed by large, automated, complex, and fragmented trading centers. As the country’s capital markets regulator, the SEC must be at the forefront of proactively addressing changes in our capital market structure. The SEC should not merely respond to events that have occurred. Regulation SCI is one such proactive effort.

In closing, I want to thank the staff for its efforts. I look forward to the comments we will receive on this proposal.

Thank you.</sup>

SEC SETTLES PENNY STOCK MANIPULATION CHARGES WITH DEFENDANT

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Defendant Adam S. Rosengard Settles SEC Charges in Penny Stock Manipulation Case

The Securities and Exchange Commission announced today that Chief Judge Gregory M. Sleet of the United States District Court for the District of Delaware entered a final judgment against Defendant Adam S. Rosengard on February 25, 2013 in SEC v. Dynkowski, et al., Civil Action No. 1:09-361, a stock manipulation case the SEC filed on May 20, 2009. The SEC’s complaint alleges that Defendant Pawel P. Dynkowski and others engaged in market manipulation schemes involving at least four separate stocks. The complaint alleges that Rosengard violated Section 5 of the Securities Act of 1933 by acting as a nominee account holder in one of the schemes.

As alleged in the complaint, the schemes generally followed the same pattern: Dynkowski and his accomplices agreed to sell large blocks of shares for penny stock companies in exchange for a portion of the proceeds. The shares were put in nominee accounts that Dynkowski and his accomplices controlled. The defendants artificially inflated the market price of the stocks through wash sales, matched orders and other manipulative trading, often timed to coincide with false or misleading press releases, and then sold shares obtained from the issuers and divided the illicit proceeds.

As alleged in the complaint, Dynkowski orchestrated the manipulation scheme involving Xtreme Motorsports of California, Inc. stock in 2007. The complaint alleges that in this scheme Dynkowski and an accomplice engaged in wash sales, matched orders and other manipulative trading. As alleged in the complaint, Rosengard acted as a nominee account holder in the scheme. Specifically, he gave Dynkowski access to a brokerage account for the purpose of selling shares of Xtreme Motorsports stock. The complaint alleges that this scheme generated approximately $257,646 in illicit profits.

To settle the SEC’s charges, Rosengard consented to a final judgment that permanently enjoins him from violating Section 5 of the Securities Act; orders disgorgement of $165,646 with prejudgment interest of $21,297; and bars Rosengard from participating in any offering of a penny stock. No civil penalty was imposed, and part of the disgorgement obligation was waived, in light of Rosengard’s financial condition.

The SEC thanks the following agencies for their cooperation and assistance in connection with this matter: the U.S. Attorney’s Office for the District of Delaware; the Delaware State Police; United States Immigration and Customs Enforcement, Department of Homeland Security, Homeland Security Investigations; and the Department of the Treasury, Internal Revenue Service, Criminal Investigation.

CHINA-BASED COMPAN Y AND CFO CHARGED BY SEC WITH DISCLOSURE VIOLATIONS

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., Feb. 28, 2013 — The Securities and Exchange Commission today charged a China-based petrochemical company and its former chief financial officer with accounting and disclosure violations, and they agreed to pay more than $1 million combined to settle the charges.

The SEC alleges that Keyuan Petrochemicals, which was formed through a reverse merger in April 2010, systematically failed to disclose to investors numerous related party transactions involving its CEO, controlling shareholders, and entities controlled by management or their family members. Keyuan also operated a secret off-balance sheet cash account to pay for cash bonuses to senior officers, travel and entertainment expenses and an apartment rental for the CEO, and cash and non-cash gifts to Chinese government officials.

The SEC further alleges that Keyuan’s then-CFO Aichun Li, who lives in North Carolina, played a role in the company’s failure to disclose the related party transactions. Li was hired to ensure the company’s compliance with U.S. accounting and financial reporting regulations, and she received information and encountered red flags that should have indicated that the company was not properly identifying or disclosing related party transactions. Despite such knowledge, Li signed Keyuan’s registration statements and quarterly reports that failed to disclose material related party transactions.

"By omitting related party transactions from its financial statements, Keyuan deprived investors of a true representation of the company’s business dealings," said Stephen L. Cohen, an Associate Director in the SEC’s Division of Enforcement. "As CFO, Li failed to right these wrongs."

According to the SEC’s complaint filed in federal court in Washington D.C., the related party transactions that Keyuan failed to disclose between May 2010 and January 2011 in accordance with U.S. Generally Accepted Accounting Principles (GAAP) included sales of products, purchases of raw materials, loan guarantees, and short-term financing. As a consequence of using an off-balance sheet cash account, the company’s reported balances in its financial statements for cash, receivables, construction-in-progress, interest income, other income, and general and administrative expenses were misstated. In October 2011, Keyuan filed restatements of the financial statements contained in its Form 10-Qs for the second and third quarters of 2010 that disclosed the related party transactions and off-balance sheet accounting for the first time.

The SEC’s complaint charges Keyuan with violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933, Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934, and Rules 12b-20 and 13a-13 under the Exchange Act. The SEC’s complaint charges Li with violations of Section 13(b)(5) of the Exchange Act and aiding and abetting Keyuan’s violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-13.

Keyuan agreed to pay a $1 million penalty and Li agreed to pay a $25,000 penalty to settle the SEC’s charges. They consented to the entry of a judgment permanently enjoining them from violations of the respective provisions of the Securities Act and Exchange Act. Li also agreed to be suspended from appearing or practicing as an accountant before the Commission with the right to apply for reinstatement after two years. The proposed settlement, in which Keyuan and Li neither admit nor deny the charges, is subject to court approval.

The SEC’s investigation, which is continuing, has been conducted by Fuad Rana, Avron Elbaum, and Melissa A. Robertson with assistance from the SEC’s Cross Border Working Group, which has representatives from each of the SEC’s major divisions and offices and focuses on U.S. companies with substantial foreign operations. Through the work of the Cross Border Working Group, the SEC has filed fraud cases involving more than 40 foreign issuers and executives, and deregistered the securities of more than 50 companies. The SEC’s Enforcement Division also has taken a series of actions against China-based audit firms that have refused to produce documents for SEC investigations into clients whose securities trade in U.S. markets.

SEC CHARGES HEDGE FUND MANAGERS WITH SECURITIES FRAUD

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
SEC Charges Connecticut Hedge Fund Managers With Securities Fraud

In February 26, 2013, the Securities and Exchange Commission filed a civil injunctive action in the United States District Court for the District of Connecticut against Connecticut-based hedge fund managers David Bryson and Bart Gutekunst ("Gutekunst") and their advisory firm, New Stream Capital, LLC, ("New Stream") for lying to investors about the capital structure and financial condition of their hedge fund. New Stream was an unregistered investment adviser based in Ridgefield, Connecticut that managed a $750-plus million hedge fund focused on illiquid investments in asset-based lending. The SEC also charged New Stream Capital (Cayman), Ltd. ("Cayman Adviser"), a Caymanian adviser entity affiliated with New Stream, Richard Pereira ("Pereira"), New Stream’s former CFO, and Tara Bryson, New Stream’s former head of investor relations, for their role in the scheme. Tara Bryson has agreed to a proposed settlement relating to her conduct in this matter.

According to the SEC’s complaint, in March 2008, David Bryson and Gutekunst, New Stream’s lead principals and co-owners, decided to revise the fund’s capital structure to placate their largest investor, Gottex Fund Management Ltd. ("Gottex"), by giving Gottex and certain other preferred offshore investors priority over other investors in the event of a liquidation. Gottex had threatened to redeem its investment in the New Stream hedge fund because a wholesale restructuring of the fund just a few months earlier had created two new feeder funds and -- without Gottex’s knowledge -- granted equal liquidation rights to all investors, thereby eliminating the preferential status previously enjoyed by Gottex. Gottex’s investment totaled nearly $300 million at the time.

The SEC alleges that, even after revising the capital structure to put Gottex ahead of other fund investors, David Bryson and Gutekunst directed New Stream’s marketing department, led by Tara Bryson, to continue to market the fund as if all investors were on the same footing, fraudulently raising nearly $50 million in new investor funds on the basis of these misrepresentations. The marketing documents failed to disclose the March 2008 revisions to the capital structure to the new investors. In addition, Pereira, New Stream’s CFO, falsified the hedge fund’s operative financial statements to conceal the March 2008 revisions to the capital structure.

As further alleged in the complaint, disclosure of the March 2008 changes to the capital structure would have made it far more difficult to continue to raise money through the new feeder funds and would have spurred further redemptions from existing investors in the new feeder funds. As such, disclosure of the March 2008 changes would have adversely affected the defendants’ own pecuniary interests by, among other things, jeopardizing the increased cash flow from a new, lucrative fee structure that they had implemented in the fall of 2007. The defendants also misled investors about the increased level of redemptions after Gottex submitted its massive redemption request in March 2008. When asked by prospective investors about redemption levels, New Stream did not include the Gottex redemption and others that followed. For example, Gutekunst falsely told one investor in June 2008 that there was nothing remarkable about the level of redemptions that New Stream had received and that there were no liquidity concerns.

The SEC further alleges that by the end of September 2008, as the U.S. financial crisis worsened, the New Stream hedge fund was facing $545 million in redemption requests, causing it to suspend further redemptions and cease raising new funds. After several attempts at restructuring failed, New Stream and affiliated entities filed Chapter 11 bankruptcy petitions in March 2011. Based on current estimates, the defrauded investors are expected to receive approximately 5 cents on the dollar -- substantially less than half the amount that Gottex and other investors in its preferred class are expected to receive.

The SEC’s complaint charges New Stream, David Bryson and Gutekunst with violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder, and Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 ("Advisers Act") and Rule 206(4)-8 thereunder. The Cayman Adviser is charged with violating Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. The SEC’s complaint charges Pereira and Tara Bryson with violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. The SEC also contends that David Bryson, Gutekunst and Pereira are each also liable pursuant to Section 20(a) of the Exchange Act as a controlling person for New Stream’s violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; and David Bryson and Gutekunst are each further liable pursuant to Section 20(a) of the Exchange Act as a controlling person for the Cayman Adviser’s violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Finally, the SEC charges that David Bryson, Gutekunst, Pereira, and Tara Bryson are each also liable pursuant to Section 20(e) of the Exchange Act for aiding and abetting each other’s violations, and New Stream and the Cayman Adviser’s violations, of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; David Bryson and Gutekunst are each further liable pursuant to Sections 209(d) and 209(f) of the Advisers Act for aiding and abetting each other’s violations, and New Stream’s violations, of Sections 206(1) and 206(2) of the Advisers Act; and, in addition, David Bryson, Gutekunst, Pereira and Tara Bryson are each also liable pursuant to Sections 209(d) and 209(f) of the Advisers Act for aiding and abetting violations of Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder by New Stream, the Cayman Adviser, David Bryson and Gutekunst.

The complaint seeks a final judgment permanently enjoining the defendants from committing future violations of these provisions, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and imposing financial penalties.

In offering to settle the SEC’s charges, without admitting or denying the allegations, Tara Bryson consented to the entry of a final judgment that permanently enjoins her from violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 206(4) of the Advisers Act and Rule 206(4)-8 thereunder. The settlement is subject to court approval. Tara Bryson also consented to the entry of a Commission order barring her from associating with any investment adviser, broker-dealer, municipal securities dealer, or transfer agent.

SEC ACCUSES TWO HEDGEFUND MANAGERS WITH INVESTOR FAVORITISM

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Feb. 26, 2013 — The Securities and Exchange Commission today charged a pair of hedge fund managers and their Connecticut-based advisory firm New Stream Capital with lying to investors about their fund’s structure and financial condition before it failed during the financial crisis.

The SEC alleges that the firm’s co-owners David Bryson and Bart Gutekunst secretly revised the fund’s capital structure before it collapsed in order to placate its largest investor, Gottex Fund Management. Bryson and Gutekunst then directed New Stream’s marketing department to continue marketing the hedge fund as though all investors were on the same footing when in fact Gottex had priority over other fund investors in the event of the fund’s liquidation.

The SEC additionally charged New Stream’s former chief financial officer Richard Pereira and former head of investor relations Tara Bryson, who is David Bryson’s sister. She agreed to settle the SEC’s charges. New Stream’s Cayman Islands affiliate also was charged in the scheme, which allowed the hedge fund managers to raise nearly $50 million and receive lucrative fees while leaving investors with nearly worthless holdings when the fund went bankrupt.

"Hedge fund managers who put greed ahead of full disclosure to investors violate a fundamental trust," said George S. Canellos, Acting Director of the SEC’s Division of Enforcement. "Bryson and Gutekunst told investors they were all investing on equal terms when in fact some were investing in a fund that had been secretly restructured to their detriment."

In a parallel action, the U.S. Attorney for the District of Connecticut today announced criminal charges against Bryson, Gutekunst, and Pereira.

According to the SEC’s complaint filed in federal court in Connecticut, New Stream managed a $750 million hedge fund focused on illiquid investments in asset-based lending. In March 2008, Bryson and Gutekunst revised the fund’s capital structure after Gottex, a fund manager with nearly $300 million invested in New Stream, had threatened to redeem its investment. A restructuring of the New Stream hedge fund a few months earlier had created two new feeder funds and eliminated the preferential liquidation rights previously enjoyed by the feeder fund through which Gottex had invested. Bryson told others at New Stream that if Gottex withdrew, the firm’s hedge fund business would "tank."

The SEC alleges that revealing to all investors that New Stream restructured to favor Gottex would have made it much harder for the firm to attract and retain investors. Public disclosure also would have jeopardized cash flow from a lucrative fee arrangement that the fund’s managers put in place in late 2007. So the fund instead used misleading marketing documents that omitted the change, and Pereira as CFO falsified the fund’s financial statements to conceal the restructuring. Investors who asked about redemption levels were not told about the Gottex redemption request and others that followed. For example, Gutekunst falsely told one investor in June 2008 that there was nothing remarkable about the level of redemptions that New Stream had received and that there were no liquidity concerns.

According to the SEC’s complaint, as the financial crisis worsened in September 2008, New Stream was facing $545 million in redemption requests and was forced to suspend further redemptions and cease raising new funds. After several failed attempts at restructuring, New Stream and its affiliated entities filed for bankruptcy in March 2011.

The SEC’s complaint charges Bryson, Gutekunst, and Pereira with violating 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. Bryson and Gutekunst are charged with violating Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder, and Pereira is charged with aiding and abetting their violations of Section 206(4). The SEC is seeking a variety of sanctions and relief against them including injunctions, disgorgement of ill-gotten gains with prejudgment interest, and penalties.

In the settlement with Tara Bryson, which is subject to court approval, she agreed to be permanently enjoined from further violations of the provisions of the securities laws at issue in this case. She also agreed to be permanently barred from the securities industry.

The SEC’s investigation, which is continuing, was conducted by Sheldon Pollock, Lisa Knoop, Alan Maza, Kevin McGrath, Alistaire Bambach, Scott York, and George Stepaniuk of the New York Regional Office. The SEC appreciates the assistance of the U.S. Attorney’s Office for the District of Connecticut, the Federal Bureau of Investigation, and the U.S. Department of Labor’s Office of Labor Racketeering and Fraud Investigations.

SEC COMMISSIONER GALLAGHER'S REMARKS AT "SEC SPEAKS IN 2013" CONFERENCE

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Remarks at "The SEC Speaks in 2013"
byCommissioner Daniel M. Gallagher
U.S. Securities and Exchange Commission
Washington, D.C.
February 22, 2013

Thank you, Craig [Lewis], for your kind introduction. This is my second year addressing this conference as a Commissioner. Last year, I spoke as one of five Commissioners, while this year, as you well know, we’re temporarily down one member. And so, I understand that the organizers are offering a 20% discount which you can collect after my remarks. Just kidding. The truth is that they asked all of us to give longer speeches, and since I am still the junior Commissioner, the others dumped their extra time on me. So, I hope you are ready for an hour long adventure.

Before I begin, let me remind you that as usual, my remarks today are my own and do not necessarily reflect the views of the Commission or my fellow Commissioners.

On a number of occasions since returning to the SEC as a Commissioner, I’ve spoken about the Commission’s priorities, both in terms of what the Commission is doing and what it should be doing in order effectively to carry out its mandate to protect investors, ensure fair and efficient markets, and facilitate capital formation. Needless to say, the Commission does not operate in a vacuum, and for various reasons, it’s not always easy to execute those priorities as we see fit. The constant stream of external influences on the Commission’s work serves as a significant impediment to its ability to focus on the core mission, including the vital, basic "blocking and tackling" of securities regulation. Today, therefore, I’d like to talk about the Commission’s origin and role as an expert, independent agency — as well as the challenges to that independence — in what has become in recent years a difficult environment for independent agencies.

As I’m sure all of you know, Congress created the SEC in the Securities Exchange Act of 1934. What some of you may not know, however, is that the Securities Act of 1933 originally tasked the Federal Trade Commission with administering the new federal securities laws. Indeed, the FTC was the initial choice of many, including President Franklin Roosevelt, to administer the Exchange Act as well.<sup>1 Ultimately, however, a consensus emerged that the difficult task of administering the federal securities laws required the creation of a new independent, bipartisan agency with a high level of technical expertise in securities matters that could focus exclusively on the nation’s capital markets. For example, during consideration of the House version of the legislation that would ultimately become the Exchange Act, Representative Charles Wolverton cited the "high degree of technical skill and knowledge," that would be necessary to administer the new federal securities laws in his support for the creation of a five-member, expert Commission to take over the administration of those new laws.2 Similarly, during consideration of the corresponding Senate bill, Senator Duncan Fletcher explained the belief among "[m]any people, Members of Congress and others . . . that a special commission ought to be provided to administer the measure because the provisions are largely technical, and we ought to have men experienced in business of the kind involved."3

The final version of the Exchange Act that emerged from Congress in the summer of 1934 provided the newly-established Commission with a broad mix of regulatory and quasi-judicial authority to carry out the legislative policies set forth in the Securities Act and the Exchange Act. The movement toward the establishment of expert, independent agencies represented a major shift in the regulatory paradigm, and it wasn’t long before this model was challenged. A year after Congress created the SEC, the Supreme Court took up the issue of independent agencies in the case of Humphrey’s Executor v. United States, which arose from President Roosevelt’s attempt to remove William Humphrey from his position as an FTC Commissioner. Much to the chagrin of the President, the Court ruled that as "an administrative body created by Congress to carry into effect legislative policies," an independent agency such as the FTC "cannot in any proper sense be characterized as an arm or an eye of the executive. Its duties are performed without executive leave and, in the contemplation of the statute, must be free from executive control."
4 Most recently, in its 2010 decision in Free Enterprise Fund v. PCAOB, the Supreme Court implicitly referenced the Commission’s independence, proceeding on the understanding that SEC Commissioners "cannot themselves be removed by the President except under the Humphrey’s Executor standard of inefficiency, neglect of duty, or malfeasance in office."5 This stands in contrast to, for example, Cabinet secretaries, who, while subject to Senate confirmation, serve at the pleasure of the President.

Having established the SEC as an expert, independent agency with the authority to administer the federal securities laws, Congress has traditionally provided the Commission with considerable flexibility to exercise that expertise and authority. Historically, Congress has avoided imposing minutely detailed mandates on the Commission. Instead, Congress has, in conjunction with past grants of authority to the SEC, largely left it to the Commission to study issues and formulate rules which the Commission deemed in its discretion to be "in the public interest or for the protection of investors," a phrase that appears time and again in our securities laws.
6 As President Roosevelt himself remarked upon signing the Investment Company Act and Investment Advisers Act into law in 1940, "[E]fficient regulation in technical fields such as this requires an administering agency which has been given flexible powers[.]"7

For nearly eighty years, the Commission, like other independent agencies, has brought its expertise and judgment to bear in fulfilling the legislative mandates established by Congress in the federal securities laws. Yet, in today’s post-financial crisis, post-Dodd-Frank regulatory environment, the Commission is faced with a variety of challenges that carry with them the potential to erode its independence. The Commission must remain alert to these challenges and must respond when appropriate in order to preserve its ability to act independently in fulfilling its core mission. My concerns here do not derive from ideology or a desire to perpetuate seemingly age old agency turf wars. Instead, this is about the need to preserve a long-standing regulatory model that eschews a one-size-fits-all approach in favor of allowing expert, independent agencies to craft rules that, when necessary, are appropriately tailored to the specific entities and products they regulate.

And then came Dodd-Frank. I worry about the limits placed on the Commission’s ability independently to apply its expertise and judgment under the paradigm established by the Dodd-Frank Act. The Act contains approximately 400 specific mandates to be implemented through agency rulemaking, around 100 of which apply directly to the SEC. Many of these mandates are highly prescriptive, and instead of directing the Commission to regulate in an area after studying the relevant issues, compiling data, and determining what, if any, regulatory action may be appropriate, they require the Commission to issue strictly prescribed and often highly technical rules under short deadlines. Unfortunately, although the Commission always has some degree of discretion when implementing a Congressional mandate, these more prescriptive rules limit the Commission’s flexibility in the rulemaking process while occupying time and resources that could be better spent fulfilling the Commission’s other important responsibilities. If one of the duties of an independent agency is to work proactively with Congress to ensure that statutes do not impose unnecessary or inappropriate mandates, then on that front the Commission unfortunately came up short with respect to many Dodd-Frank mandates.

Ideally, when Congress provides the SEC with statutory authority to draft and implement rules in a new area, it will allow the Commission the time and flexibility necessary to study the issues involved and formulate smart regulation that reflects a complete understanding of the underlying data, including the costs and benefits associated with regulatory action. This is, after all, how the Commission was intended to operate when it was established nearly eighty years ago. In fact, I believe it is the Commission’s duty as an expert, independent agency to continue to employ this data-driven approach as best it can even in the face of prescriptive mandates from Congress.

Although the Commission continues to stare down an overflowing plate of Dodd-Frank mandates in addition to its other responsibilities, as an expert, independent agency, the Commission must not allow itself to assume a secondary role in the regulation of matters squarely within its jurisdiction and core competencies. This, I’m afraid, is exactly the role that the Commission has taken thus far with respect to critical initiatives, including the Volcker Rule.

Pursuant to Section 619 of Dodd-Frank, the three Federal banking agencies, the SEC, and the CFTC must together adopt regulations to implement the Volcker Rule’s two prohibitions on banking entities and their affiliates: its prohibition on engaging in proprietary trading and its prohibition on sponsoring or investing in "covered funds" such as hedge funds or private equity funds. Unfortunately, there is little doubt that notwithstanding the valiant efforts of the SEC staff, the Commission for too long has taken a back seat to the banking regulators in this rulemaking process. As I have said in the past, despite the Rule’s ostensible application to banking entities, the Rule is actually focused on the conduct to be regulated, not the entities that engage in this activity. There is no question that the specific trading, hedging, and investing activities to be regulated under the Rule fall firmly within the Commission’s core competencies, as they deal directly with SEC registrants and registration requirements. It makes little sense, therefore, for the Commission to defer to the banking regulators in this area when for decades it has regulated securities market-making in order to facilitate liquidity and promote the efficient allocation of capital.

The implementing rulemaking for the Volcker Rule was proposed in October 2011. Almost a year and a half — and over 18,000 comment letters — later, the Volcker Rule remains at the proposal stage. Indeed, it appears that the proposal’s broad definitions of statutory terms have taken a bad situation and made it worse. Commission staff continue to engage in discussions with the bank regulators and the CFTC regarding the many concerns raised in those 18,000-plus comment letters. For this rule to get done and get done properly, the SEC must take a leadership role. In fact, I believe it is our duty as the independent financial regulator with primary authority over, and expertise in, the activities to be regulated to ensure that the final Rule meets the aims of Congress without destroying critically important market activity that the Rule explicitly intends not to eliminate. Moreover, in accordance with its core mission, it is the Commission’s responsibility to balance the bank regulators’ focus on safety and soundness and Dodd-Frank’s overarching focus on managing systemic risk with legitimate considerations of investor protection and the maintenance of vibrant markets.

This brings me to the elephant in the room: FSOC. FSOC was created, in part, to respond to the realization during the financial crisis that regulatory balkanization had resulted in a lack of communication and information-sharing among financial services regulators, which undoubtedly led to poor policy decisions during the crisis. None of us who lived through the crisis on the ground floor would argue against improvements to the regulatory structure that would facilitate coordination and information-sharing among regulators. However, with FSOC the threats to the Commission’s independence move from the theoretical to the immediate, for already in its short existence, this new body has directly challenged the Commission’s regulatory independence. It is also where just one member of the Commission, the Chairman, can defend that independence. Pursuant to the provisions of Dodd-Frank establishing FSOC, the group is composed not of agencies, but the individual heads of agencies, acting ex officio.

As I have said in the past, the structure of FSOC is particularly troubling for an independent agency like the SEC. While the Secretary of the Treasury and the heads of the FHFA and the CFPB may speak on behalf of their agencies — not to mention the President that appointed them — the same cannot be said of the Chairman of the SEC. To preserve its independence, Congress created the SEC as a bipartisan, five-member Commission and gave each Commissioner — including the Chairman — only one vote. This means that the Chairman has no statutory authority to represent or bind the Commission through his or her participation on FSOC. Yet as a voting member of FSOC, the Chairman of the SEC does have a say in authorizing FSOC to take certain actions that may affect — and indeed have already affected — markets or entities that the Commission regulates. While one might expect that the Chairman of the SEC would always represent the views of the Commission as a whole, there is no formal oversight mechanism available to the Commission to check the Chairman’s participation on FSOC. Moreover, although the Commission’s bipartisan structure insulates it from undue political influence, FSOC’s structure does not. On the contrary, FSOC is composed of individuals who are heads of their agencies — typically making them members of the President’s political party — and led by a Cabinet official who is removable by the President at will. These factors, among others, make FSOC particularly susceptible to political influence which, in turn, can be — and has been — exerted on the agencies led by FSOC’s members.

To further complicate matters, FSOC operates under a different mandate than the SEC, having been established by Congress with a broad mandate to identify systemic risks and emerging threats to the country’s financial stability. Putting aside the fact that FSOC’s designation of certain firms as "systemically important" likely institutionalizes the idea of "too big to fail," FSOC’s core mission is to ensure the safety and soundness of the U.S. financial system — not surprising given that a significant plurality of FSOC is composed of the heads of bank regulators. While this mission is of unquestionable importance, so, too is the distinct mission of the SEC. To be sure, proper oversight of our capital markets should positively impact the safety and soundness of our financial system. Nevertheless, the SEC is not by statute a safety and soundness regulator. In fact, the markets we regulate are inherently risky, and with good reason. By putting money at risk, investors allocate capital in a manner that spurs economic growth in the hopes of a much higher return on their investments than they could obtain from lower-risk, lower-return investments, such as bank accounts. The SEC seeks to protect these investors from fraud and to ensure that the markets in which they put their capital to work are fair and efficient. Our mission is not, and should not be, to make these markets risk-free, nor is it to preserve the existence of any particular firm or firms. Capital markets regulators and bank regulators have drastically different missions and oversee fundamentally different markets and market participants. And, importantly for me and all of those who appreciate and advocate for free markets, we must keep a healthy distance between capital markets regulation, which rightfully assumes no taxpayer safety nets, and bank regulation.

It is not difficult to see the potential tension between the SEC and FSOC missions and the resulting threat to the Commission’s ability to function independently. As the old adage goes: "No one can serve two masters." When the Chairman of the SEC faces this tension, which of these two potentially competing mandates does he or she honor?

Nor is FSOC merely an advisory body without teeth. To carry out its mandate, Congress provided FSOC with extraordinary powers for an inter-agency council. For example, FSOC has the authority to designate a nonbank financial company as "systemically important," and to subject these companies to prudential supervision by the Fed. FSOC may also designate a financial market utility or a payment, clearing, or settlement activity as "systemically important," and direct the Fed, in consultation with the relevant supervisory agencies and FSOC itself, to prescribe risk management standards. To the extent that these "systemically important" utilities or activities are conducted by firms for which the SEC or CFTC is the primary regulator, Dodd-Frank provides "special procedures" pursuant to which the Fed may, if it determines that the risk management standards set by the SEC or the CFTC are "insufficient," impose its own standards. That authority is not simply a threat to the Commission’s independence — if exercised, it would be an outright annexation.

FSOC also has the authority to recommend that a primary financial regulator, such as the SEC, apply new or heightened standards and safeguards for systemically significant financial activities or practices. In this regard, FSOC has been busy in recent months prodding the Commission on money market fund reforms, including through the release of proposed reform recommendations last November.

I won’t recount the history that led to FSOC’s involvement in the regulation of money market funds, an area which unquestionably falls within the core expertise and regulatory jurisdiction of the SEC. But I will emphasize that my colleagues and I have made it clear that, having now been provided with the rigorous study and economic analysis on money market funds that a bipartisan majority of the Commission asked for from the start, we fully expect the Commission to move forward with a rule proposal shortly. Why, then, is FSOC still involved in the process? FSOC was established in part to promote coordination, collaboration, and information-sharing among its member agencies. It is immensely troubling then to think of the FSOC as an institutionalized mechanism for one set of regulators to pressure another in the latter agency’s field of expertise — yet that is exactly what is happening.

Moving on from the threats posed to the Commission’s independence by Congressional mandates and FSOC intervention, there are other, more mainstream, jurisdictional incursions the Commission must monitor and manage. For example, in December 2012, the Fed, acting pursuant to Dodd-Frank authority, issued proposed regulations to apply U.S. capital, liquidity, and other prudential standards to the U.S. operations of foreign bank organizations with total global consolidated assets of at least $50 billion.
8 These rules, if adopted in their current form, would require such organizations to create an intermediate holding company that would house all of their U.S. bank and nonbank subsidiaries.

The Fed proposal would affect SEC registrants as the new holding company capital rules would treat assets held by broker-dealer subsidiaries differently than they are treated in the SEC capital rules because of the proposed leverage standard that would apply to foreign bank organizations. Specifically, a U.S. broker-dealer subsidiary of a foreign bank organization could be required indirectly to hold more capital than would be necessary to satisfy the SEC’s net capital rule to maintain the same positions.

The regulation of broker-dealers is at the heart of the Exchange Act and, as such, has been under the Commission’s regulatory purview for nearly eight decades. Using the expertise it has developed over this period, the Commission has designed capital requirements under Rule 15c3-1 that are tailored to the operations of broker-dealers and the industry in which they operate. Here, it is crucial to understand the differing theories that underlie broker-dealer and bank capital requirements. The Commission’s capital rules are meant to deal with failure, in that they are designed to ensure that when a broker-dealer fails, it has net liquid assets in excess of all non-subordinated liabilities so that the firm can be self-liquidated in an orderly manner and satisfy all creditors, particularly its customers. On the other hand, bank capital standards are not designed to require a bank to maintain sufficient net liquid assets to satisfy all creditors. Instead, banks have access to federal liquidity facilities that can be used as a funding source in the event that the bank cannot find private funding. These facilities allow the bank to be liquidated in a more orderly manner in the case of a failure. And, if the bank is "too big to fail," the facilities can operate as a tax payer-funded life support system. Accordingly, it will be very important for the Fed and the Commission to coordinate carefully as this rule proposal is considered to ensure that legitimate goals can be advanced without undermining SEC oversight.

This Fed rulemaking comes on the heels of the misguided repeal in Dodd-Frank of the Commission’s Supervised Investment Bank Holding Company, or SIBHC, program. This little-known program, which the Commission implemented under the authority of Exchange Act Section 17(i), should have been expanded in Dodd-Frank to allow the SEC to better oversee non-systemically important broker-dealer holding companies. Instead, Dodd-Frank eliminated Exchange Act Section 17(i), and replaced it with a new Fed program.

On a final note, the Commission must also be mindful of the effect that international regulatory bodies, even those like IOSCO and the FSB in which the Commission is a participant, can have on the Commission’s prerogatives as an expert, independent agency. Many of these organizations were formed in large part to foster cooperation, information-sharing, and coordination among financial regulators in different jurisdictions. However, we now often see from these groups one-size-fits-all "recommendations," some of which run contrary to the Commission’s existing regulations or address the substance of specific issues pending before the Commission. I believe that the Commission must remain an active, productive member of these groups, but we must ensure that policymaking remains in the hands of domestic regulators acting with the requisite independence.

Thank you all for coming to this year’s SEC Speaks, and I look forward to seeing you again next February.</sup>

ALLEGED INVESTMENT FRAUD BY ISLAND INVETMENT ADVISER

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., Feb. 21, 2013 — The Securities and Exchange Commission today charged an investment adviser located in the U.S. Virgin Islands with defrauding clients from whom he withheld the fact that he was receiving kickbacks for investing their money in thinly-traded companies. When he faced pressure to pay clients their returns on those investments, he allegedly used money from other clients in a Ponzi-like fashion to make payments.

The SEC’s Enforcement Division alleges that James S. Tagliaferri, through his St. Thomas-based firm TAG Virgin Islands, routinely used his discretionary authority over the accounts of his clients to purchase promissory notes issued by particular private companies. In exchange for financing those companies, TAG received millions of dollars in cash and other compensation — a conflict of interest that was never disclosed to investors. The Enforcement Division further alleges that when the promissory notes neared or passed maturity and his clients demanded payment, Tagliaferri misused assets of other clients to meet those demands.

"Tagliaferri was anything but forthcoming with his clients and he repeatedly failed to act in their best interests," said Andrew M. Calamari, Director of the SEC’s New York Regional Office. "He didn’t tell them about the compensation he received from the companies they were financing, and then compounded his fraud by using client assets to pay other clients when the conflicted investments came due."

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Tagliaferri.

According to the SEC’s order instituting administrative proceedings, Tagliaferri invested TAG clients primarily in conservative and liquid investments such as municipal bonds and blue-chip stocks until around 2007, when he began investing clients in highly illiquid securities. These investments included promissory notes issued by various closely-held private companies that were nothing more than holding companies through which an individual and his family effected personal and business transactions. He also invested at least $40 million of clients’ money in notes of a private horse-racing company, International Equine Acquisitions Holdings, Inc.

According to the SEC’s order, TAG received more than $3.35 million and approximately 500,000 shares of stock of a microcap company in return for placing various investments with these companies. The compensation that TAG received from the companies for the investments that Tagliaferri made on behalf of his clients created a conflict of interest that he was required to disclose to investors.

The SEC’s Enforcement Division alleges that Tagliaferri then further defrauded clients by investing their funds in microcap and other thinly-traded public companies in order to raise at least $80 million to pay the interest or principal due to other clients on certain of the promissory notes. Tagliaferri explained in e-mails he sent in April 2010 to the individual behind the companies that the real motivation for investing TAG clients in one of his microcap companies was to use the proceeds to pay off other clients invested in the initial series of promissory notes. "Where is the $125MM. As you are aware, this money was earmarked to clear all of the notes and other issues facing us both," Tagliaferri wrote. He later added, the "shares you transferred are being sold to clients. With those proceeds, you’re buying back your own notes." TAG clients were unaware, however, that Tagliaferri’s true motivation for having them buy these stocks was to repay other TAG clients on other conflicted investments he had made for them.

According to the SEC’s order, Tagliaferri willfully violated Sections 17(a)(1) and (3) of the Securities Act of 1933, Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 and Rules 10b-5 thereunder, and Sections 206(1), 206(2) and 206(3) of the Investment Advisers Act of 1940.

The SEC’s investigation, which is continuing.

SEC SETTLES WITH EXECUTIVES IN COMPENSATION CASE

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION  
Executives to be Permanently Enjoined, to Pay Civil Penalties and Disgorgement, and to Reimburse Company Pursuant to Section 304 of Sarbanes-Oxley; Former CEO/Chairman also to be Barred for Five Years from Serving as an Officer and Director of any Public Company


The Securities and Exchange Commission today settled civil fraud charges against Amnon Landan, the former Chairman and Chief Executive Officer of Mercury Interactive, LLC (Mercury), and Douglas Smith, a former Chief Financial Officer of Mercury, arising from an alleged scheme to backdate stock option grants and from other alleged misconduct.

On May 31, 2007, the Commission charged Landan, Smith, and two other former senior Mercury officers with perpetrating a fraudulent and deceptive scheme from 1997 to 2005 to award themselves and other Mercury employees undisclosed, secret compensation by backdating stock option grants and failing to record hundreds of millions of dollars of compensation expense. The Commission's complaint also alleges that during this period Landan and certain other executives backdated stock option exercises, made fraudulent disclosures concerning Mercury's "backlog" of sales revenues to manage its reported earnings, and structured fraudulent loans for option exercises by overseas employees to avoid recording expenses.

Without admitting or denying the allegations in the Commission's complaint, Landan consented to the entry of a final judgment permanently enjoining him from violating and/or aiding and abetting 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, as well as the financial reporting, record-keeping, internal controls, false statements to auditors, and proxy provisions of the federal securities laws. Landan also agreed to be barred from serving as an officer or director of any public company for five years. Landan will pay $1,252,822 in disgorgement and prejudgment interest, representing the "in-the-money" benefit from his exercise of backdated option grants, and a $1,000,000 civil penalty. Pursuant to Section 304 of the Sarbanes-Oxley Act, Landan will also reimburse Mercury, or the parent company that acquired it after the alleged misconduct (Hewlett-Packard Company), $5,064,678 for cash bonuses and profits from the sale of Mercury stock that he received in 2003. Under the terms of the settlement, Landan's Section 304 reimbursement would be deemed partially satisfied by his prior return to Mercury of $2,817,500 in vested options.

Without admitting or denying the allegations in the Commission's complaint, Smith consented to the entry of a final judgment permanently enjoining him from violating Section 17(a)(2) and (a)(3) of the Securities Act of 1933. He will disgorge $451,200, representing the "in-the-money" benefit from his exercise of backdated option grants, and pay a $100,000 civil penalty. Pursuant to Section 304 of the Sarbanes-Oxley Act, Smith will also reimburse Mercury or its parent company $2,814,687 for cash bonuses and profits from the sale of Mercury stock that he received in 2003. Under the terms of the settlement, all of Smith's disgorgement and all but $250,000 of his Section 304 reimbursement would be deemed satisfied by his prior repayment to Mercury of $451,200 and his foregoing of his right to exercise vested options with a value of $2,113,487.

The settlements are subject to the approval of the United States District Court for the Northern District of California.

The Commission previously filed settled charges in this matter against Mercury and three former outside directors of Mercury. On May 31, 2007, the Commission filed civil fraud charges against Mercury based on the stock option backdating scheme and other fraudulent conduct noted above. Mercury, which was acquired by Hewlett-Packard Company on Nov. 8, 2006, after the alleged misconduct, settled the matter by agreeing to pay a $28 million penalty and to be permanently enjoined. See Litigation Release No. 20136 (May 31, 2007). On September 17, 2008, the Commission filed settled charges against three former outside directors of Mercury alleging that they recklessly approved backdated stock option grants and reviewed and signed public filings that contained materially false and misleading disclosures about the company's stock option grants and company expenses. The outside directors settled the matter by consenting to permanent injunctions and the payment by each director of a $100,000 penalty. See Litigation Release No. 20724 (Sept. 17, 2008). Mercury and the outside directors settled the charges without admitting or denying the allegations in the Commission's complaint. The Commission also previously settled with one of the four senior officers its contested action. On March 20, 2009, the Commission settled with former Mercury CFO Sharlene Abrams by which she agreed to entry of a permanent injunction against the antifraud and certain other securities law provisions, to pay $2,287,914 in disgorgement which was deemed partially satisfied by payment to Mercury, to pay a $425,000 civil penalty, to be permanently barred from serving as an officer and director of any public company, and to a Commission order barring her from appearing or practicing before the Commission as an accountant. See Litigation Release No. 20964 (March 20, 2009). Abrams settled without admitting or denying the allegations in the Commission's complaint.

The Commission's litigation against one remaining Mercury officer, former general counsel Susan Skaer, is continuing.

ASSET FREEZE ANNOUNCED BECAUSE OF SUSPICIOUS TRADING AHEAD OF H.J. HEINZ ACQUISITION

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., Feb. 15, 2013 — The Securities and Exchange Commission today obtained an emergency court order to freeze assets in a Zurich, Switzerland-based trading account that was used to reap more than $1.7 million from trading in advance of yesterday’s public announcement about the acquisition of H.J. Heinz Company.

The SEC’s immediate action ensures that potentially illegal profits cannot be siphoned out of this account while the agency’s investigation of the suspicious trading continues.

In a complaint filed in federal court in Manhattan, the SEC alleges that prior to any public awareness that Berkshire Hathaway and 3G Capital had agreed to acquire H.J. Heinz Company in a deal valued at $28 billion, unknown traders took risky bets that Heinz’s stock price would increase. The traders purchased call options the very day before the public announcement. After the announcement, Heinz’s stock rose nearly 20 percent and trading volume increased more than 1,700 percent from the prior day, placing these traders in a position to profit substantially.

"Irregular and highly suspicious options trading immediately in front of a merger or acquisition announcement is a serious red flag that traders may be improperly acting on confidential nonpublic information," said Daniel M. Hawke, Chief of the Division of Enforcement’s Market Abuse Unit.

Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office, added, "Despite the obvious logistical challenges of investigating trades involving offshore accounts, we moved swiftly to locate and freeze the assets of these suspicious traders, who now have to make an appearance in court to explain their trading if they want their assets unfrozen."

The SEC alleges that the unknown traders were in possession of material nonpublic information about the impending acquisition when they purchased out-of-the-money Heinz call options the day before the announcement. The timing and size of the trades were highly suspicious because the account through which the traders purchased the options had no history of trading Heinz securities in the last six months. Overall trading activity in Heinz call options several days before the announcement had been minimal.

The emergency court order obtained by the SEC freezes the traders’ assets and prohibits them from destroying any evidence. The SEC’s complaint charges the unknown traders with violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. In addition to the emergency relief, the SEC is seeking a final judgment ordering the traders to disgorge their ill-gotten gains with interest, pay financial penalties, and be permanently barred from future violations.

The SEC’s expedited investigation is being conducted by Market Abuse Unit members Megan Bergstrom, David S. Brown, and Diana Tani in the Los Angeles Regional Office with substantial assistance from Charles Riely, Market Abuse Unit member in the New York Regional Office who will handle the SEC’s litigation. The SEC appreciates the assistance of the Options Regulatory Surveillance Authority (ORSA).

"AMERICA'S PROPHET" PSYCHIC MORTON RECIEVES DEFAULT JUDGEMENT AGAINST HIIM

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 22619 / February 15, 2013

District Court Grants Securities and Exchange Commission's Motions for Default Judgment against a Nationally Known Psychic and his Corporate Entities in Multi-Million Dollar Offering Fraud

The Securities and Exchange Commission (Commission) announced today that on February 11, 2013 the U.S. District Court for the Southern District of New York entered default judgments against Sean David Morton (Morton), a nationally-recognized psychic who bills himself as "America's Prophet," his wife, relief defendant Melissa Morton, and corporate shell entities co-owned by the Mortons. In addition to ordering permanent injunctions from violating antifraud and registration statutes and rule, each defendant was ordered to disgorge, jointly and severally, $5,181,135.82, along with prejudgment interest of $1,171,110.54, and pay a penalty of $5,181,135.82 for a total of $11,533,382.18. Relief defendants Melissa Morton and the Prophecy Research Institute, the Mortons' nonprofit religious organization, were ordered to disgorge $468,281 plus prejudgment interest of $105,847.23, for a total of $574,128.23.

On March 4, 2010, the Commission filed a civil injunctive action in the United States District Court for the Southern District of New York charging Morton and his corporate shell entities for engaging in a multi-million offering fraud. According to the Commission's complaint, Morton fraudulently raised more than $5 million from more than 100 investors for his investment group, which he called the Delphi Associates Investment Group (Delphi Investment Group).

Beginning in or around the summer of 2006, the complaint alleged, Morton solicited individuals to invest in one of several companies he and Melissa Morton controlled under the umbrella of the Delphi Investment Group. According to the Commission's complaint, Morton used his monthly newsletter, his website, his appearances on a nationally syndicated radio show called Coast to Coast AM, and appearances at public events, to promote his alleged psychic expertise in predicting the securities markets, and to solicit investors for the Delphi Investment Group. During these solicitations, Morton made numerous materially false representations. For example, Morton falsely told potential investors that he has called all the highs and lows of the stock market, on their exact dates, over a fourteen year period. Morton further falsely asserted that the alleged profits in the accounts were audited and certified by PricewaterhouseCoopers LLP (PWC) who he claimed certified that the accounts had profited by 117%. Morton also falsely asserted that the investor funds would be used exclusively for foreign currency investments, and that any other use of the funds would be considered a criminal act. Morton further falsely claimed that he would use the pooled funds to trade in foreign currencies and distribute pro rata the trading profits among the investors. In private one-on-one correspondence with potential investors, Morton was even more aggressive in his solicitation. For example, Morton wrote to a potential investor urging he invest more money in the Delphi Investment Group "RIGHT NOW…[Because] [o]nce the DOLLAR starts to DROP, which will happen soon, we are set to make a FORTUNE!"

However, the complaint alleged, Morton lied to investors about his past successes, and about key aspects of the Delphi Investment Group, including the use of investor funds and the liquidity of the funds. According to the complaint, Morton did not have the successful track record picking stocks in which he claimed, and that he in fact was simply wrong in many of his securities predictions. Further, PWC never audited the Delphi Investment Group, let alone certify any profits. Also, unbeknownst to the investors, instead of investing all of the funds into foreign currency trading firms, the Mortons diverted some of the investor funds, including nearly half a million dollars to themselves through their own shell entities.

The defendants never properly answered the allegations in the complaint. Instead, the Mortons filed dozens of papers with the Court claiming, for instance, that the Commission is a private entity that has no jurisdiction over them, and that the staff attorneys working on the case do not exist.

On February 11, 2013, United States District Judge Forrest issued default judgments against all of the defendants and relief defendants. With the entry of the default judgments, the Commission received full relief requested in its complaint. The complaint charged each of the defendants with violations of Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint further charged that the relief defendants were unjustly enriched by receiving investor funds. The complaint sought a final judgment permanently restraining and enjoining the defendants from future violations of the above provisions of the federal securities laws.

The SEC's litigation team was led by Bennett Ellenbogen, Alexander Vasilescu, Todd Brody, Elzbieta Wraga, and Roshonda Ledbetter. Amelia Cottrell, Stephen Johnson, Jacqueline Fine, and Elizabeth Baier assisted during the investigation.

BROKERAGE FIRM AND BROKERS CHARGED WITH STEERING CLIENTS FOR COMMISSIONS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Feb. 15, 2013 — The Securities and Exchange Commission today announced fraud charges against a New York-based brokerage firm and two brokers who allegedly used misleading sales tactics to steer investors toward risky investments in a purported clean energy company so the firm could earn lucrative commissions.

The SEC’s Division of Enforcement alleges that Gregg Lorenzo, the founder of Charles Vista LLC, teamed with an investment banker named Frank Lorenzo and made a litany of false, misleading, and unfounded statements to create the impression that speculative debt securities issued by Waste2Energy Holdings Inc., which were convertible into stock, were risk-free and likely to result in enormous investment returns. The Lorenzos are not related. While Gregg Lorenzo was touting the profitability of investing in Waste2Energy, which purported to possess technology for converting waste into clean energy, the company was struggling in reality. Waste2Energy eventually filed for bankruptcy.

"Charles Vista customers were told a false tale of a safe and conservative investment with an explosive upside, but the risky downside was downplayed in the story," said Andrew M. Calamari, Director of the SEC’s New York Regional Office. "Brokerage customers deserve unbiased and fair recommendations about the risks of potential investments, not misleading boiler room sales tactics."

According to the SEC’s order instituting administrative proceedings against Charles Vista and the Lorenzos, investors were solicited to purchase the Waste2Energy convertible debentures in 2009 and 2010. An e-mail that Charles Vista sent customers made various false claims, such as Waste2Energy possessing "over $10 million in confirmed assets" to provide investors with protection against losses. In reality, the company had written its assets down to less than $1 million.

The SEC’s Division of Enforcement alleges that Gregg Lorenzo, who lives in Staten Island, made verbal sales pitches to investors that misrepresented Waste2Energy’s financial condition and business prospects. He made the debentures’ stock conversion feature appear valuable by making baseless predictions about the future of the company’s stock. Lorenzo told at least one investor that he believed Waste2Energy "will be a NASDAQ trading stock within 12 months. I believe they will meet the listing requirements." Frank Lorenzo was the head of investment banking at Charles Vista until he left the firm in 2010. He sent e-mails to Charles Vista customers that contained false or misleading claims about Waste2Energy’s assets and alleged contracts.

According to the SEC’s order, Charles Vista was the exclusive placement agent for the issuance of these Waste2Energy securities, and the firm’s financial interest in the offering was considerable. Documents attached to some of Waste2Energy’s SEC filings indicate that Charles Vista had arranged to receive a 10 percent "commission" on the gross proceeds of all debentures sales, a consulting fee of $10,000 per month for 12 months, and various other commissions and fees.

The SEC’s Division of Enforcement alleges that Charles Vista and the Lorenzos willfully violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5. Charles Vista also allegedly violated Exchange Act Section 15(c) and Rule 10b-3. The administrative proceedings will determine what, if any, remedial action or financial penalties are appropriate in the public interest against Charles Vista and the Lorenzos.

The SEC’s investigation was conducted by Peter Pizzani, Melissa Coppola, Michael Osnato, and Jack Kaufman in the New York Regional Office. The SEC’s litigation will be led by Mr. Kaufman and Joseph Boryshansky.