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

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

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

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

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

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

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

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

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

SEC ISSUED RISK ALERT TO DETECT OPTIONS TRADES THAT CIRCUMVENT SHORT-SALE RULE

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 
Washington D.C., Aug. 9, 2013 — 

The Securities and Exchange Commission issued a Risk Alert to help market participants detect and prevent options trading that circumvents an SEC short-sale rule.

The SEC’s Office of Compliance Inspections and Examinations (OCIE) issued the alert after its examiners observed options trading strategies that appear to evade certain requirements of the short-sale rule.  The alert describes the strategies used by some customers, broker-dealers and clearing firms, summarizes related enforcement actions, and notes practices that some firms have found to be effective in detecting and preventing trading intended to evade the rule, known as Regulation SHO.

Regulation SHO tightened requirements for short sales, which involve sales of borrowed securities. Short sellers profit from price declines by replacing borrowed securities at a lower price.  Under Regulation SHO, short sellers who fail to deliver securities after the settlement date are required to close out their position immediately, unless they qualify as bona fide market makers for a limited amount of extra time to close-out.  As noted in the alert, the trading strategies observed by the OCIE staff may give the impression of satisfying the Regulation SHO “close-out requirement,” while in effect evading it.  These sham close-outs violate the SEC rule, which aims to ensure that trades settle promptly, thereby reducing settlement failures.

“This Risk Alert encourages awareness of options trading activity used to avoid complying with the close-out requirements under Regulation SHO,” said OCIE Director Andrew Bowden.  “The alert describes these trading activities in detail to help broker-dealers and their correspondent clearing firms avoid the regulatory and reputational risks that are posed by these activities.”

In addition, the Risk Alert describes activities that the staff has observed that may indicate an attempt to circumvent Regulation SHO.  These include:

Trading exclusively or excessively in hard-to-borrow securities or threshold list securities, or in near-term listed options on such securities

Large short positions in hard-to-borrow securities or threshold list securities
Large failure to deliver positions in an account, often in multiple securities
Continuous failure to deliver positions

Using buy-writes, married puts, or both, particularly deep in-the-money buy-writes or married puts, to satisfy the close-out requirement

Using buy-writes with little to no open interest aside from that trader’s activity, resulting in all or nearly all of the call options being assigned

Trading in customizable FLEX options in hard-to-borrow securities or threshold list securities, particularly very short-term FLEX options

Purported market makers trading in hard-to-borrow or threshold list securities claiming the exception from the locate requirement of Regulation SHO; often these traders do not make markets in these securities, but instead make trades only to take advantage of the option mispricing

Multiple large trades with the same trader acting as a contra party in several hard-to-borrow or threshold list securities; often traders assist each other to avoid having to deliver shares

Eric Peterson and Tom Mester of the National Exam Program staff contributed substantially to the preparation of this Risk Alert.  They received valuable input from the Division of Trading and Markets and the Division of Economic and Risk Analysis.

CFTC RULES FOR ALIGNMENT OF DERIVATIVES CLEARING ORGANIZATIONS WITH INTERNATIONAL STANDARDS

FROM:  COMMODITY FUTURES TRADING COMMISSION 

CFTC Issues Proposed Rules for Derivatives Clearing Organizations to align with International Standards

Washington, DC — The Commodity Futures Trading Commission (CFTC) proposed rules to establish additional standards for systemically important derivatives clearing organizations (SIDCOs) that are consistent with the Principles for Financial Market Infrastructures (PFMIs) and address all of the remaining gaps between part 39 of the Commission’s regulations and the PFMIs.

These rules, together with the existing derivatives clearing organizations rules, would establish standards that are consistent with the PFMIs and would allow SIDCOs to continue to be Qualifying Central Counterparties (QCCPs) for purposes of international bank capital standards. The proposed rules include substantive requirements relating to governance, financial resources, system safeguards, special default rules and procedures for uncovered losses or shortfalls, risk management, additional disclosure requirements, efficiency, and recovery and wind-down procedures.

In addition, because of the potential advantages afforded to QCCPs (namely, lower capital charges for banks clearing through a QCCP), the proposed rules include procedures by which derivatives clearing organizations other than SIDCOs may elect to become subject to these additional standards.

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 FORMER EXECUTIVE OF MASSACHUSETTS-BASED COMPANY WITH INSIDER TRADING

FROM:  SECURITIES AND EXCHANGE COMMISSION 

SEC Charges Former Executive of Massachusetts-Based Company with Insider Trading

The Securities and Exchange Commission charged Joseph M. Tocci, a former executive of Massachusetts-based American Superconductor Corporation, with insider trading ahead of an April 5, 2011 company announcement that caused the company's stock price to tumble 42% and reaped Tocci over $80,000 in profits. Tocci has agreed to settle the charges by, among other things, paying a total of over $170,000 in disgorgement of ill-gotten gains, prejudgment interest, and a civil penalty.

In a Complaint filed on August 12, 2013, in the U.S. District Court for the District of Massachusetts in Boston, the SEC alleges that Tocci, age 59, of Belmont, Massachusetts, used confidential information he obtained as the assistant treasurer of American Superconductor to purchase option contracts through which Tocci essentially bet that the company's stock price would soon decrease on the release of negative news. According to the SEC's Complaint, on or about March 31, 2011, Tocci learned through communications with American Superconductor's chief financial officer ("CFO") that the company's largest customer, Sinovel Wind Group Co. Ltd., had refused to accept shipments scheduled for delivery by the close of the company's fiscal year on March 31, 2011, and had failed to pay past due amounts for earlier shipments. These developments, the CFO said, would likely require a public announcement from American Superconductor within the next few days. The CFO instructed Tocci to keep this information confidential. On April 1, 2011, the Complaint alleges, Tocci improperly used this material, nonpublic information to purchase 100 put option contracts, which increased in value as American Superconductor's stock price decreased. On April 5, 2011, after the close of trading, the company announced that its financial results for its fourth quarter and fiscal year ended March 31, 2011 would be lower than expected due to a deteriorating relationship with Sinovel. The next day, American Superconductor's stock price plummeted 42%. By then selling his 100 put option contracts, Tocci earned illegal profits of approximately $82,439.

Tocci has agreed to settle this case by consenting to a judgment enjoining him from future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and ordering him to pay disgorgement of $82,439 (representing his ill-gotten gains) plus prejudgment interest of $6,109 and a civil penalty of $82,439. Tocci also agreed to plead guilty in a parallel criminal case brought by the U.S. Attorney's Office for the District of Massachusetts in connection with the same conduct.

The SEC's investigation was conducted by Asita Obeyesekere, Michael Foster, and Kevin Kelcourse in the SEC's Boston Regional Office. The Commission acknowledges the assistance and cooperation of the U.S. Attorney's Office for the District of Massachusetts and the Federal Bureau of Investigation's Boston Field Office. The Commission also thanks the Options Regulatory Surveillance Authority and the Financial Industry Regulatory Authority for their assistance.

MAN WHO ORCHESTRATED $72 MILLION PONZI SCHEME RECEIVES 15 YEAR PRISON TERM

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

15 Year Prison Term for Gregory Mcknight, Orchestrator of $72 Million Ponzi Scheme

The Securities and Exchange Commission announced that on August 6, 2013, the Honorable Mark A. Goldsmith of the United States District Court for the Eastern District of Michigan sentenced Gregory N. McKnight to 188 months (15 years and 8 months) in prison, followed by supervised release of 3 years, and ordered McKnight to pay $48,969,560 in restitution to his victims. McKnight, 53, of Swartz Creek, Michigan, had previously pled guilty to one count of wire fraud for his role in orchestrating a $72 million Ponzi scheme involving at least 3,000 investors. The U.S. Attorney’s Office for the Eastern District of Michigan filed criminal charges against McKnight on February 14, 2012. McKnight was taken into custody immediately after the sentencing hearing.

The criminal charges arose out of the same facts that were the subject of an emergency action that the Commission filed against McKnight and others on May 5, 2008. On that same day, the Court issued orders freezing McKnight’s assets and those of several companies he controlled, and appointed a Receiver. The Commission’s complaint alleged that, from December 2005 through November 2007, McKnight, through his company Legisi Holdings, conducted a fraudulent, unregistered offering of securities in which he raised approximately $72 million from more than 3,000 investors in all 50 states and several foreign countries. According to the Commission's complaint, McKnight represented that he would invest the offering proceeds in various investment vehicles and pay interest of as much as 15 percent per month from the resulting profits. The complaint charged that McKnight invested less than half of the offering proceeds and that these investments resulted in millions of dollars in losses. The Commission's complaint further charged that McKnight used investor funds to make Ponzi payments to investors and for his own use. The Commission’s complaint charged McKnight with violating Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder.

On July 6, 2011, the Court entered a final judgment against McKnight in the Commission’s action, and ordered McKnight to pay disgorgement of ill-gotten gains, prejudgment interest, and civil penalties totaling approximately $6.5 million. The court also issued orders permanently enjoining McKnight from future violations of Sections 5(a), 5(c), and 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder. On July 9, 2013, McKnight's associate Matthew J. Gagnon was sentenced to five years in prison for his role in promoting Legisi.