CFTC CHARGES ROYAL BANK OF CANADA WITH WASH SALE SCHEMING

FROM CFTC
CFTC Charges Royal Bank of Canada with Multi-Hundred Million Dollar Wash Sale Scheme
CFTC also charges that bank concealed material information from, and made material false statements to, a futures exchangeWashington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the filing of a complaint in federal district court in New York charging theRoyal Bank of Canada (RBC), a Canadian bank and financial services firm doing business in New York, with conducting a multi-hundred million dollar wash sale scheme in connection with exchange-traded stock futures contracts. The CFTC’s complaint also alleges that RBC willfully concealed, and made false statements concerning, material aspects of its wash sale scheme from OneChicago, LLC (OneChicago), an electronic futures exchange, and CME Group, Inc. (CME Group), the entity that exercised the regulatory compliance function for OneChicago.

From at least June 2007 to May 2010, RBC allegedly non-competitively traded hundreds of millions of dollars’ worth of narrow based stock index futures (NBI) and single stock futures (SSF) contracts with two of its subsidiaries that RBC reported as “block” trades on OneChicago.  The CFTC’s complaint alleges that RBC’s NBI and SSF trading activity, which accounted for the majority of OneChicago’s volume during the relevant period, constituted unlawful non-competitive trades, wash sales and fictitious sales.

Specifically, according to the CFTC’s complaint, RBC’s NBI and SSF trades were not negotiated at arm’s length between the counterparties to the trades, as required by law, but were instead designed and controlled by a small group of senior RBC personnel acting on RBC’s behalf.  The trading scheme was allegedly designed as part of RBC’s strategy to realize lucrative Canadian tax benefits from holding certain public companies’ securities in its Canadian and offshore trading accounts.

Prior to each trade, RBC allegedly identified stocks in U.S. and Canadian companies that RBC believed would generate a tax benefit.  RBC and a subsidiary allegedly bought and sold these stocks, and also bought and sold NBI or SSF futures contracts written on the stocks opposite each other.  According to the complaint, RBC’s futures trading was conducted in a riskless manner that ensured that the positions, profits and losses of each RBC counterparty washed to zero, in disregard of the price discovery principles of the futures markets, which resulted in a financial and position nullity for RBC while allowing it to reap the tax benefits.

In addition, the CFTC’s complaint alleges that, from at least January 2005 to April 2010, RBC unlawfully concealed material information from, and made false statements to, CME Group concerning RBC’s SSF trading activity.  Specifically, the complaint alleges that when RBC purported to describe the trades to CME Group, RBC falsely stated that its SSF trading was conducted at arm’s length between the counterparties to the trades, and concealed the fact that the trading strategy was created and managed by a group of senior RBC personnel acting on RBC’s behalf.  In addition, the complaint alleges that RBC concealed from CME Group the fact that it had intentionally designed its stock futures trading strategy to exclude non RBC-affiliated parties from RBC’s futures trades.

“A fundamental purpose of the futures markets is to provide an arm’s-length mechanism for market participants to discover prices and shift risks associated with products traded in those markets,” said David Meister, the Director of the CFTC’s Division of Enforcement.  “As we allege, RBC not only designed and executed a wash sale scheme that undermined that purpose, it went a step further and misled the exchange into believing that its conduct was lawful.  Today’s action should make clear that the CFTC will not hesitate to bring charges against even the most sophisticated market participants who unlawfully exploit the futures markets for their own gain.”

In its continuing litigation, the CFTC seeks civil monetary penalties and a permanent injunction against further violations of the Commodity Exchange Act and the CFTC’s Regulations, as charged.

The following CFTC Division of Enforcement staff members are responsible for this case: Susan Gradman, David Slovick, Lindsey Evans, Joseph Rosenberg, Joseph Patrick, Scott Williamson, Rosemary Hollinger and Richard Wagner.

BANK HOLDING COMPANY CEO AND CFO CHARGED BY SEC WITH MISLEADING INVESTORS

FROM:  SEC
Commission Charges Texas Bank Holding Company’s CEO and CFO with Misleading Investors about Loan Quality and Financial Health during the Financial Crisis
The Commission announced that it charged Franklin Bank Corp.’s former chief executives for their involvement in a fraudulent scheme designed to conceal the deterioration of the bank’s loan portfolio and inflate its reported earnings during the financial crisis.

The SEC alleges that former Franklin CEO Anthony J. Nocella and CFO J. Russell McCann used aggressive loan modification programs during the third and fourth quarters of 2007 to hide the true amount of Franklin’s non-performing loans and artificially boost its net income and earnings.  The Houston-based bank holding company declared bankruptcy in 2008.

“Nocella and McCann used the loan modification scheme like a magic wand to change non-performing loans into performing assets,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.  “Their disclosure and accounting tricks misled investors into believing that Franklin was outperforming other banks during the height of the financial crisis.”

David Woodcock, Director of the SEC’s Fort Worth Regional Office, added, “Franklin’s analysts and investors monitored the quality of the bank’s loan portfolio as a key indicator of its financial health.  But Nocella and McCann intentionally concealed the fact that the quality of the bank’s loan portfolio was rapidly deteriorating.”

According to the SEC’s complaint filed in U.S. District Court for the Southern District of Texas late Thursday, as Franklin’s holdings of delinquent and non-performing loans rose significantly in the summer of 2007, Nocella and McCann instituted three loan modification schemes that caused Franklin to classify such loans as performing.  By the end of September 2007, Nocella and McCann had used the loan modification programs to conceal more than $11 million in non-performing single family residential loans and $13.5 million in non-performing residential construction loans.

As a result of the loan modifications, Franklin overstated its third-quarter 2007 net income and earnings by 317% and 77% respectively, and reported that it earned $0.30 per share, of which $0.23 per share was directly attributable to the loan modifications.  On May 2, 2008, in a Form 8-K report filed with the SEC, Franklin acknowledged that the accounting for the loan modifications should be revised and that investors should no longer rely upon Franklin’s Form 10-Q for the quarter ended September 30, 2007.
The SEC’s complaint seeks financial penalties, officer-and-director bars, and permanent injunctive relief against Nocella and McCann to enjoin them from future violations of the federal securities laws.  The complaint also seeks repayment of bonuses received by Nocella and McCann under Section 304 of the Sarbanes Oxley Act of 2002, which allows for “clawbacks” of bonuses received by executives if the company later must restate its earnings.

CFTC WILL PROHIBIT BETTING ON FEDERAL ELECTIONS WITH DERIVATIVE CONTRACTS

FROM CFTC
CFTC Issues Order Prohibiting North American Derivatives Exchange’s Political Event Derivatives Contracts
Washington, DC – The Commodity Futures Trading Commission (CFTC) today issued an order pursuant to Section 5c(c)(5)(C)(ii) of the Commodity Exchange Act and CFTC Regulation 40.11(a)(1), prohibiting the North American Derivatives Exchange (Nadex) from listing or making available for clearing or trading a set of self-certified political event derivatives contracts. The contracts are binary option contracts that pay out based upon the results of various U.S federal elections to be held in 2012.

Nadex self-certified the contracts on December 19, 2011, and on January 3, 2012, the CFTC initiated a 90-day review period of the contracts pursuant to CFTC Regulation 40.11(c). As a result of reviewing the complete record, the CFTC determined that the contracts involve gaming and are contrary to the public interest, and cannot be listed or made available for clearing or trading. By a separate letter, the CFTC also requested that Nadex withdraw its self-certification of related rule amendments that were submitted by Nadex to enable trading of the contracts.

SEC OBTAINS ASSET FREEZE OF SEVEN FOREIGN CITIZENS

FROM:  SEC
Washington, D.C., April 6, 2012 — The Securities and Exchange Commission today announced that it has obtained a court-ordered freeze of the assets of six Chinese citizens and one British Virgin Islands entity charged with insider trading in Zhongpin Inc., a China-based pork processor whose shares trade in the U.S.
The SEC’s complaint, filed in U.S. District Court in Chicago on April 4, alleges the defendants reaped more than $9 million by trading in Zhongpin ahead of a March 27 announcement of a proposal to take the company private.  The complaint names as defendants one entity, Prestige Trade Investments Ltd., and six individuals, Siming Yang, Caiyin Fan, Shui Chong (Eric) Chang, Biao Cang, Jia Wu, and Ming Ni.  The SEC alleged that Yang formed Prestige in January and funded its U.S. brokerage account in March with $29 million transferred from a Hong Kong bank.

According to the SEC’s complaint, the seven defendants bought substantial quantities of common stock and call options in Zhongpin between March 14 and March 26. Zhongpin’s stock price jumped 21.8% on March 27 when the company publicly announced that its Chairman and CEO Xianfu Zhu had made a non-binding offer to acquire all of Zhongpin’s outstanding stock at $13.50 a share, a 46% premium over the previous day’s closing price.

“The defendants in this action – all with seemingly limited resources - suddenly and inexplicably purchased more than $20 million in Zhongpin securities just before an important public announcement,” said Merri Jo Gillette, Director of the SEC’s Chicago Regional Office. “The SEC’s swift action to secure a judicial freeze order prevented millions of dollars from moving offshore.”

The SEC alleges that the purchases of Zhongpin stock and options were inconsistent with the defendants’ financial situations and prior investment behavior.  In particular:
The defendants’ trades made up a significant portion of the trading in Zhongpin between March 14 and March 26.  Prestige’s purchases alone represented about 41% of the common stock trading in this period.

Only one of the defendants had traded in Zhongpin before March 14.

For most of the individual defendants, the purchases of Zhongpin securities equaled or exceeded their stated annual income and represented a significant portion of their net worth.

Yang identified himself to his broker as an accountant in China with an annual income of $52,500 and a net worth of less than $250,000, when at the time he was a research analyst with a New York–based registered investment adviser.

Each of the defendants placed at least some of their trades from computer networks and hardware that other defendants also used to place trades.
The SEC alleges that the defendants violated federal anti-fraud laws, namely Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In addition to the emergency relief, the SEC is seeking permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties. The emergency court order that the SEC obtained on April 4 on an ex parte basis froze defendants’ assets held in U.S. brokerage accounts, grants expedited discovery and prohibits the defendants from destroying evidence.
Jedediah B. Forkner, Marlene B. Key and John E. Kustusch in the Chicago Regional Office conducted the SEC’s investigation, which is continuing.  Timothy S. Leiman will lead the SEC’s litigation effort.

The Commission thanks the Options Regulatory Surveillance Authority and the Financial Industry Regulatory Authority for their assistance in this matter.

CFTC SEEKS TO REVOKE REGISTRATIONS OF STRATEGIC RESEARCH LLC

FROM COMMODITY FUTURES TRADING COMMISSION
March 28, 2012
CFTC Seeks to Revoke the Registrations of Illinois Resident Joseph A. Dawson and His Company, Strategic Research LLC
Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the filing of a notice of intent to revoke the registrations of Illinois residentJoseph A. Dawson (Dawson) and his company, Strategic Research LLC (SR), a registered Commodity Pool Operator (CPO). Dawson is the president and sole principal of SR and has been a registered Associated Person of SR since February 13, 2009.
According to the CFTC’s notice, Dawson is subject to disqualification from registration under the Commodity Exchange Act (CEA) based on his felony conviction for wire fraud, a federal court’s finding that he committed fraud and misappropriation, and a federal court’s entry of a permanent injunction order against him. SR is subject to disqualification from registration under the CEA because Dawson is its principal, according to the notice.

Specifically, the notice states that on March 8, 2011, Dawson pled guilty to three felony counts of wire fraud in violation of 18 U.S.C. § 1343 in United States v. Dawson, a criminal action filed by the U.S. Attorney’s Office for the Northern District of Illinois on Dec. 17, 2009, 09-CR-1037 (N.D. Ill. Dec. 17, 2009). The U.S. District Court for the Northern District of Illinois sentenced Dawson to 54 months of imprisonment and ordered him to pay restitution to his victims.

The notice also states that on April 26, 2011, the U.S. District Court for the Northern District of Illinois entered a consent order of permanent injunction against Dawson in a CFTC anti-fraud action filed on July 20, 2010, against Dawson and his unregistered CPO, Dawson Trading LLC, 10-CV-4510 (N.D. Ill. July 20, 2010) (see CFTC Press Releases 5860-10, July 26, 2010, and 6072-11, July 13, 2011). In that consent order, Dawson admitted that he misappropriated approximately $2.1 million of commodity pool participant funds, fraudulently solicited pool participants, and made material false statements to pool participants in violation of the CEA. The consent order permanently prohibits Dawson from violating the CEA’s anti-fraud provisions.

COURT ENTERS $98.6 MILLION FINAL JUDGMENT AGAINST U.K. HEDGE FUND ADVISER PENTAGON CAPITAL MANAGEMENT PLC AND ITS CEO LEWIS CHESTER

March 30, 2012
FROM SEC  WEBSITE
On Wednesday, March 28, 2012, United States District Judge Robert W. Sweet of the Southern District of New York entered a final judgment in favor of the U.S. Securities and Exchange Commission ordering total monetary relief of $98.6 million. The final judgment enjoins Defendants Pentagon Capital Management (“PCM”), a United Kingdom based hedge fund adviser, and its chief executive officer, Lewis Chester, from violating the antifraud provisions of the securities laws, Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. In addition, the final judgment orders PCM and Chester, on a joint and several basis with their hedge fund client Relief Defendant Pentagon Special Purpose Fund, Ltd., to pay $60,204,423.20, representing $38,416,500 in disgorgement of their ill-gotten gains and $21,787,923.20 in prejudgment interest. Finally, the final judgment imposes a civil money penalty of $38,416,500, on a joint and several basis, against PCM and Chester.

Previously, on February 15, 2012, the Court issued an Opinion finding that Defendants “intentionally, and egregiously,” violated the antifraud provisions of the securities laws by engaging in a late trading scheme to defraud United States mutual funds. Late trading refers to the practice of placing orders to buy, redeem, or exchange U.S. mutual fund shares after the time as of which the funds calculate their net asset value (usually as of the close of trading at 4:00 p.m. ET), but receiving the price based on the net asset value already determined as of 4:00 p.m. The same day that the Court entered the final judgment, the Court also issued an Opinion explaining its decision to impose a penalty equal to the disgorgement ordered because,inter alia, “Defendants understood that late trading was illegal and acted with marked scienter, going to great lengths to seek out, structure, and maintain the ability to deceive the funds into accepting their late trades and attempting to cover up their late trading after the fact.”

Chester, age 43, is a resident of London, England. PCM is an investment adviser and investment manager based in London, England, and is registered with the United Kingdom Financial Services Authority. Pentagon Special Purpose Fund, Ltd. is an international business company incorporated in the British Virgin Islands.