FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
The Securities and Exchange Commission today charged three Bay Area real estate fund managers with fraud for secretly using the assets of a new real estate fund to rescue an older, rapidly collapsing fund.
The SEC alleges that Walter Ng, his son Kelly Ng, and Bruce Horwitz lured investors into their real estate fund called Mortgage Fund '08 LLC (MF08) by claiming it was safe and secure and would replicate the success of their earlier real estate fund, R.E. Loans LLC. In reality, R.E. Loans could no longer make payouts to its investors, so the Ngs funneled millions of dollars from MF08 to prop up R.E. Loans. The Ngs and Horwitz falsely touted both funds' performance in their effort to continue raising money. They raised more than $85 million during an 18-month period from investors primarily living in the San Francisco area.
According to the SEC's complaint filed in federal court in Oakland, the Ngs and Horwitz promoted the MF08 fund in the midst of the 2008 financial crisis as a new opportunity to invest in conservatively underwritten commercial real estate loans secured by deeds of trust. But the Ngs and their advisory firm, The Mortgage Fund LLC, immediately began transferring money raised by MF08 to R.E. Loans so that they could afford distributions to investors in that fund. From December 2007 to March 2008, the Ngs transferred almost $39 million from MF08 to R.E. Loans. They later attempted to justify the transfers by claiming MF08 had purchased three loans from R.E. Loans that totaled around $39 million.
The SEC further alleges that both the Ngs and Horwitz lured investors into MF08 by making false claims about its performance and the R.E. Loans fund's performance. What investors did not know was that both R.E. Loans and MF08 began to experience significant and dramatic borrower defaults in 2008. For example, the percentage of the R.E. Loans portfolio that was either delinquent or in default increased from 19 percent in January 2008 to 48 percent in August 2008. The percentage of the MF08 portfolio that was delinquent increased from 16 percent in March 2008 to 74 percent in mid-June 2008.
The SEC alleges that despite the funds' rapidly disintegrating portfolios, the Ngs and Horwitz repeatedly assured investors that R.E. Loans and MF08 were performing well and the underlying loans were safe and secure. For example, both Walter Ng and Horwitz touted the funds' purportedly positive performance at a June 2008 investor dinner in Oakland's Chinatown. Additionally, Walter Ng and Kelly Ng in July 2008 characterized MF08 as a "fantastic success" even though more than 70 percent of its loan portfolio was delinquent by that time.
The SEC's complaint charges Walter Ng and Kelly Ng with violating 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) and (2) of the Investment Advisers Act of 1940 ("Advisers Act"); Bruce Horwitz with violating Section 17(a)(2) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5(b) thereunder; and The Mortgage Fund with violating Sections 206(1) and (2) of the Advisers Act. The Complaint seeks injunctive relief, disgorgement of wrongful profits, and financial penalties against all four defendants.
FROM: COMMODITY FUTURES TRADING COMMISSION
Remarks of Chairman Gary Gensler on Libor before the Global Financial Markets Association’s Future of Global Benchmarks Conference
February 28, 2013
Good morning. Thank you, Ken, for that kind introduction. I also want to thank the Global Financial Markets Association for the invitation to speak at your conference on the Future of Global Financial Benchmarks.
This conference comes at a critical juncture.
It comes as there has been a lot of media attention surrounding the three enforcement cases against Barclays, UBS and RBS for manipulative conduct with respect to the London Interbank Offered Rate (LIBOR) and other benchmark interest rate submissions.
More importantly, it comes as market participants and regulators around the globe have turned to consider the critical issue of how we reform and revise a system that has become so reliant on LIBOR and similar rates.
I believe that continuing to reference such rates diminishes market integrity and is unsustainable in the long run.
Let’s look at what we’ve learned to date.
First, the interbank, unsecured market to which LIBOR and other such rates reference has changed dramatically. Some say that it is has become essentially nonexistent. In 2008, Mervyn King, the governor of the Bank of England, said of LIBOR: "It is, in many ways, the rate at which banks do not lend to each other."
There has been a significant structural shift in how financial market participants finance their balance sheets and trading positions. There is an increasing shift from borrowing unsecured (without posting collateral) toward borrowings that are secured by posting collateral. In particular, this shift has occurred within the funding markets between banks.
The London interbank, unsecured market used to be where banks funded themselves at a wholesale rate. But the 2008 financial crisis and subsequent events have shattered this model.
The European debt crisis that began in 2010 and the downgrading of large banks’ credit ratings have exacerbated the hesitancy of banks to lend unsecured to one another.
Other factors have played a role in this structural shift. Central banks are providing significant funding directly to banks. Banks are more closely managing demands on their balance sheets. And looking forward, recent changes to Basel capital rules will take root and will move banks even further from interbank lending.
The Basel III capital rules now include an asset correlation factor, which requires additional capital when a bank is exposed to another bank. This was included in the new standards to reduce financial system interconnectedness.
Furthermore, the rules introduce provisions for a liquidity coverage ratio (LCR). For the first time, banks will have to hold a sufficient amount of high quality liquid assets to cover their projected net outflows over 30 days.
At a roundtable on financial market benchmarks held in London last week, one major bank indicated that the LCR rule alone would make it prohibitively expensive for banks to lend to each other in the interbank market for tenors greater than 30 days. Thus, this banker posited that it is unlikely that banks will return to the days when they would lend to each other for three months, six months or a year.
Second, we also have learned that LIBOR – central to borrowing, lending and hedging in our economy – has been readily and pervasively rigged.
Barclays, UBS and RBS were fined $2.5 billion for manipulative conduct by the CFTC, the UK Financial Services Authority (FSA) and the Justice Department. At each bank, the misconduct spanned many years, took place in offices in several cities around the globe, included numerous people – sometimes dozens, even included senior management, and involved multiple benchmark rates and currencies. In each case, there was evidence of collusion.
In the UBS and RBS cases, one or more inter-dealer brokers painted false pictures to influence submissions of other banks, i.e., to spread the falsehoods more widely. Barclays and UBS also were reporting falsely low borrowing rates in an effort to protect their reputation.
These findings are shocking, though the lack of an interbank market made the system more vulnerable to such misconduct.
Third, we have seen a significant amount of publicly available market data that raises questions about the integrity of LIBOR today.
A comparison of LIBOR submissions to the volatilities of other short-term rates reflects that LIBOR is remarkably much more stable than any comparable rate. For instance, how is it that in 2012 – if we look at the 252 submission days for three-month U.S. dollar LIBOR – the banks didn’t change their rate 85 percent of the time?
Why is it that some banks didn’t change their submissions for three-month U.S. Dollar LIBOR for upwards of 115 straight trading days? This means that one bank said the market for its funding was completely stable for 115 straight trading days or more than five months.
When comparing LIBOR submissions to the same banks’ credit default swaps spreads or to the broader markets’ currency forward rates, why is there a continuing gap between LIBOR and what those other market rates tell us?
In the fall of 2011, there was so much uncertainty in markets due to the European debt crisis and challenges here in the United States. How is it that a number of the banks were still saying they could borrow in the interbank market for one year at about 1 percent, even though the traded markets for the same institutions’ one-year credit default swaps were trading four or five times higher?
Further, there’s a well-known concept in finance called interest rate parity, basically that currency forward rates will align with interest rates in two different economies. Why is it that since the financial crisis, that has not been the case, whether looking at the dollar versus the euro, sterling or yen? Theory hasn’t been aligning with practice. The borrowing rate implied in the currency markets is quite different than LIBOR.
Nassim Nicholas Taleb, whom you may know as the bestselling author of The Black Swan, has written a recent book called Antifragile: Things that Gain from Disorder. His main theme is: "Just as human bones get stronger when subjected to stress and tension … many things in life benefit from stress, disorder, volatility, and turmoil."
He notes that systems that are fragile succumb to stress, tension and change. Systems that are not readily able to evolve and adapt are fragile.
One of his main points is that propping up a fragile system in the interest of maintaining a sense of stability only creates more instability in the end. One can buy an artificial sense of calm for a while, but when that calm cracks, the resulting turmoil is invariably greater.
I think that the financial system’s reliance on interest rate benchmarks, such as LIBOR and Euribor, is particularly fragile.
These benchmarks basically haven’t adapted to the significant changes in the market. The interbank, unsecured lending market, particularly for longer tenors, is essentially nonexistent. LIBOR and similar benchmarks have been readily and pervasively rigged. And there is substantial market data that raises questions about LIBOR’s continuing integrity.
Thus, the challenge we face is how does the financial system adapt to this significant shift?
At the London roundtable on financial market benchmarks held last week, a man approached me to discuss a bit of the history of LIBOR in which he had personally been involved. It seems that in 1970, as a young banker, he worked on a floating rate note deal for ENEL issued by Bankers Trust that used a reference rate called LIBOR.
A lot has changed since 1970 – Nixon was President, we were in the midst of the Vietnam War, the Beatles released their final album Let It Be, and I was a kid wearing bell-bottoms.
Sixteen years later, the British Bankers Association (BBA) began publishing LIBOR as we know it today. A lot has changed since 1986 – Reagan was President, we were in the midst of the Cold War, and I was dating the wonderful woman I would marry, Francesca.
And now, I have three wonderful daughters but am a single dad. In life, one must adapt to change.
Yet LIBOR – embedded in the wiring of our financial system – largely remains the same.
This is why international regulators and market participants have begun to discuss transition. The CFTC and the FSA are co-chairing the International Organization of Securities Commissions (IOSCO) Task Force on financial market benchmarks. The task force is developing international principles for benchmarks and examining best mechanisms or protocols for a benchmark transition, if needed.
In January, the task force published the Consultation Report on Financial Benchmarks, and a final report will be published this spring.
One of the key questions in the consultation is how do we address transition when a benchmark is no longer tied to sufficient transactions and may have become unreliable or obsolete?
The consultation seeks public input about transition in two contexts:
• Prospectively, the consultation suggests that contracts referencing a benchmark would be more resilient if those contracts had embedded in them a contingency plan for when a benchmark may become obsolete.
• And perhaps more challenging, the consultation asks what to do about existing contracts that reference a benchmark that becomes obsolete, if those contracts don’t have an effective contingency plan.
Martin Wheatley of the FSA recommended that Canadian dollar LIBOR and Australian dollar LIBOR cease to exist so a transition is necessary, at least for those reference rates.
The market has some experience with transition, albeit for smaller contracts, such as for energy and shipping rate benchmarks. The basic components of such a transition include identifying a new and reliable benchmark, one that is anchored in transactions. The new and existing benchmarks run in parallel for a period of time to allow market participants to transition.
A critical statement in the consultation report was: "The Task Force is of the view that a benchmark should as a matter of priority be anchored by observable transactions entered into at arm’s length between buyers and sellers in order for it to function as a credible indicator of prices, rates or index values."
It went on to say: "However, at some point, an insufficient level of actual transaction data raises concerns as to whether the benchmark continues to reflect prices or rates that have been formed by the competitive forces of supply and demand."
I agree with both of these statements. A reference rate has to be based on facts, not fiction.
Without transactions, the situation is similar to trying to buy a house, when your realtor can’t give you comparable transaction prices in the neighborhood – because no houses were sold in the neighborhood in years.
Given what we know now, it’s critical that we move to a more robust framework for financial benchmarks, particularly those for short-term, variable interest rates. There are alternatives that market participants are considering that are grounded in real transactions. These include the overnight index swaps rate, benchmark rates based on actual short-term collateralized financings, and benchmarks based on government borrowing rates.
There are important ongoing international efforts to come up with principles for financial market benchmarks. These principles will address governance, conflicts of interest and transparency of reporting.
Nevertheless, even if we’re able to address these issues, there remains the issue of whether LIBOR and similar rates continue to reference an underlying market that is essentially nonexistent.
I recognize that moving on from LIBOR may be challenging. Today, LIBOR is the reference rate for 70 percent of the U.S. futures market, most of the swaps market and nearly half of U.S. adjustable rate mortgages.
I recognize that moving on from LIBOR may be unpopular. But as the author Nassim Taleb might suggest, it would be best not to fall prey to accepting that LIBOR or any benchmark is "too big to replace."
I believe that the best way to promote both market integrity and long-term stability is by ensuring that benchmarks are reliable and honest. And I believe it’s critical to work together to promote a smooth transition, where needed.
I recognize that change can be hard, but change is also a natural part of life.
After all, I’m sure you’re relieved I didn’t show up in bell-bottoms today.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
The Securities and Exchange Commission announced that today it charged Falcon Ridge Development, Inc. ("Falcon Ridge") and its President and CEO, Fred M. Montano, of Albuquerque, New Mexico, with engaging in a fraudulent scheme to manipulate the market for Falcon Ridge’s common stock. Falcon Ridge is a New Mexico real estate company, headquartered in Albuquerque. The United States Attorney for the Eastern District of Pennsylvania separately announced criminal charges involving the same conduct.
The Commission’s action, filed in federal district court in Philadelphia, alleges that, from at least August through November 2008, Montano, who claimed to control Falcon Ridge’s common stock, arranged with an individual (the "Cooperator") he believed had connections to corrupt registered representatives to generate purchases of the company’s stock in exchange for cash kickbacks. In reality, the Cooperator was, at all times, secretly cooperating with the FBI. The Commission alleges that, in furtherance of the scheme, Montano paid $1,000 to orchestrate the purchase of 625,000 shares of Falcon Ridge common stock by the Cooperator, in part, through a matched trade designed by Montano to ensure that he received proceeds from the purchases. In addition, Montano shared nonpublic news releases and a confidential shareholder list with the Cooperator, and coordinated the release of news with the illegal purchases in the stock.
The complaint further alleges that Montano engaged in several telephone conversations with the Cooperator in which Montano described his intent and confirmed his involvement in the manipulation. Through these activities, Montano created artificial trading activity, injected artificial information into the marketplace, and created a false impression of supply and demand for Falcon Ridge’s stock.
The complaint alleges violations of Section 17(a)(1) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder against Falcon Ridge and Montano. The complaint seeks permanent injunctions, disgorgement of ill-gotten gains, together with prejudgment interest, and civil penalties against both defendants, and penny stock and officer and director bars against Montano.
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.
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.
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