SEC CHARGES MERRILL LYNCH IN CASE INVOLVING CDO BOOKS AND RECORDS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today charged Merrill Lynch with making faulty disclosures about collateral selection for two collateralized debt obligations (CDO) that it structured and marketed to investors, and maintaining inaccurate books and records for a third CDO.

Merrill Lynch agreed to pay $131.8 million to settle the SEC’s charges.

The SEC’s order instituting settled administrative proceedings finds that Merrill Lynch failed to inform investors that hedge fund firm Magnetar Capital LLC had a third-party role and exercised significant influence over the selection of collateral for the CDOs entitled Octans I CDO Ltd. and Norma CDO I Ltd.  Magnetar bought the equity in the CDOs and its interests were not necessarily aligned with those of other investors because it hedged its equity positions by shorting against the CDOs.

“Merrill Lynch marketed complex CDO investments using misleading materials that portrayed an independent process for collateral selection that was in the best interests of long-term debt investors,” said George S. Canellos, co-director of the SEC’s Division of Enforcement.  “Investors did not have the benefit of knowing that a prominent hedge fund firm with its own interests was heavily involved behind the scenes in selecting the underlying portfolios.”

According to the SEC’s order, Merrill Lynch engaged in the misconduct in 2006 and 2007, when its CDO group was a leading arranger of structured product CDOs.  After four Merrill Lynch representatives met with a Magnetar representative in May 2006, an internal email explained the arrangement as “we pick mutually agreeable [collateral] managers to work with, Magnetar plays a significant role in the structure and composition of the portfolio ... and in return [Magnetar] retain[s] the equity class and we distribute the debt.”  The email noted they agreed in principle to do a series of deals with largely synthetic collateral and a short list of collateral managers.  The equity piece of a CDO transaction is typically the hardest to sell and the greatest impediment to closing a CDO.  Magnetar’s willingness to buy the equity in a series of CDOs therefore gave the firm substantial leverage to influence portfolio composition.

According to the SEC’s order, Magnetar had a contractual right to object to the inclusion of collateral in the Octans I CDO selected by the supposedly independent collateral manager Harding Advisory LLC during the warehouse phase that precedes the closing of a CDO.  Merrill Lynch, Harding, and Magnetar had finalized a tri-party warehouse agreement that was sent to outside counsel, yet the disclosure that Merrill Lynch provided to investors incorrectly stated that the warehouse agreement was only between Merrill Lynch and Harding.  The SEC has charged Harding and its owner with fraud for accommodating trades requested by Magnetar despite its interests not necessarily aligning with the debt investors.

The SEC’s order finds that one-third of the assets for the portfolio underlying the Norma CDO were acquired during the warehouse phase by Magnetar rather than by the designated collateral manager NIR Capital Management LLC.  NIR initially was unaware of Magnetar’s purchases, but eventually accepted them and allowed Magnetar to exercise approval rights over certain other assets for the Norma CDO.  The disclosure that Merrill Lynch provided to investors incorrectly stated that the collateral would consist of a portfolio selected by NIR.  Merrill Lynch also failed to disclose in marketing materials that the CDO gave Magnetar a $35.5 million discount on its equity investment and separately made a $4.5 million payment to the firm that was referred to as a “sourcing fee.”  The SEC also today announced charges against two managing partners of NIR.

According to the SEC’s order, Merrill Lynch violated books-and-records requirements in another CDO called Auriga CDO Ltd., which was managed by one of its affiliates.  As it did in the Octans I and Norma CDO deals, Merrill Lynch agreed to pay Magnetar interest or returns accumulated on the warehoused assets of the Auriga CDO, a type of payment known as “carry.”  To benefit itself, however, Merrill Lynch improperly avoided recording many of the warehoused trades at the time they occurred, and delayed recording those trades.  Therefore, Merrill Lynch’s obligation to pay carry was delayed until after the pricing of the Auriga CDO when it became reasonably clear that the trades would be included in the portfolio.

“Keeping adequate books and records is not an elective requirement of the federal securities laws, and broker-dealers who fail to properly record transactions will be held accountable for their violations,” said Andrew M. Calamari, director of the SEC’s New York Regional Office.

Merrill Lynch consented to the entry of the order finding that it willfully violated Sections 17(a)(2) and (3) of the Securities Act of 1933 and Section 17(a)(1) of the Securities Exchange Act of 1934 and Rule 17a-3(a)(2).  The firm agreed to pay disgorgement of $56,286,000, prejudgment interest of $19,228,027, and a penalty of $56,286,000.  Without admitting or denying the SEC’s findings, Merrill Lynch agreed to a censure and is required to cease and desist from future violations of these sections of the Securities Act and Securities Exchange Act.

The SEC’s investigation was conducted by staff in the New York Regional Office and the Complex Financial Instruments Unit, including Steven Rawlings, Gerald Gross, Tony Frouge, Elisabeth Goot, Brenda Chang, John Murray, Sharon Bryant, Kapil Agrawal, Douglas Smith, Howard Fischer, Daniel Walfish, and Joshua Pater.  Several examiners in the New York office assisted, including Edward Moy, Luis Casais, Thomas Shupe, William Delmage, George DeAngelis, Syed Husain, and James Sawicki.

CFTC COMMISSIONER WETJEN'S STATEMENT ON THE VOLCKER RULE

FROM:  COMMODITY FUTURES TRADING COMMISSION 
Statement of Commissioner Mark Wetjen on the Volcker Rule

December 10, 2013

Thank you Chairman Gensler, and my thanks to the professional staff for the hard work they put into the rulemaking before us today.

The Volcker Rule, like many of the commission’s rules, is focused on the policy objective of compelling banks to limit or better manage risk in a way that lowers the odds of a taxpayer-financed bailout, or, short of that, a failure of one of those firms. Dodd-Frank tasked the prudential and market regulators with implementing that objective, and I believe the release before us today will do so appropriately.

Congress also sensibly required that the prudential regulators adopt a joint Volcker rule, and that the market regulators coordinate with the prudential regulators in their rulemaking efforts. One of the true hallmarks of today’s rule is that the market regulators involved went beyond the congressional requirement to simply coordinate. In fact, the rule before us today reflects the same substantive text as that adopted by the other agencies, and contains no substantive differences in the preamble language.

Building a consensus among five different government agencies is no easy task, and the level of coordination on a complicated rulemaking such as this is remarkable. Commission staff and the staffs of the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Securities Exchange Commission deserve special recognition for this feat alone.

I also believe Secretary Lew, Under Secretary Miller and other officials at the Treasury department deserve enormous credit for their role in helping coordinate the rulemaking effort. And finally, the heads of the involved agencies, including Chairman Gensler, deserve credit as well for their work in bringing today’s releases over the finish line.

The Volcker Rule is one of the last remaining CFTC rulemakings required by Dodd-Frank. Beyond this effort, almost all of the commission’s Dodd-Frank rules have been, or are in the process of being, implemented.

For this we can thank Chairman Gensler’s leadership. Today there is transparency in the swaps market where virtually none existed before. Swap dealers and major swap participants are registered. Swaps are promptly reported to swap data repositories. Most liquid swaps are now cleared. And soon many will be traded on a regulated platform for the first time. For his efforts on the Volcker Rule and the rest of his work in leading the CFTC to implement Title VII of Dodd-Frank, Chairman Gensler has done a tremendous service to the American public and the markets this agency regulates.

CFTC CHILTON'S STATEMENT ON VOTE FOR FINAL VOLKER RULE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
"High Roller's Room"

Statement of Commissioner Bart Chilton

December 10, 2013

I’m pleased to be voting on a final Volcker Rule. Frankly, two-and-a-half weeks ago, I had grave doubts about getting this done in a meaningful fashion. It had become weaker than the original proposal. But, thankfully, and I thank the Chairman for his tireless efforts, we have a rigorous and robust rule before us.

If you’ve ever been to a casino, many of them have a high roller’s room. There’s usually a sign about a $1000 minimum bet. Many have ornate gaming tables and heavy draperies. If you walk around, you can catch a glimpse inside. But other than betting a lot of money, I’m not sure what goes on in there. And, that’s fine...some high rollers lose and some win.

But, what if what the high rollers did in that room impacted all of us? What if it impacted consumers, our economy and our country? What if what the high rollers did in that room cost us $417 billion dollars (in a big bank bailout) because the games they were playing were tanking the economy?

That’s why we need a strong Volcker Rule. We should never again be put in a circumstance where too big to fail high rollers play games of chance with our nation. This rule takes a heavy velvet rope with brass ends across the doorway and closes the high roller's room. (Maybe they'll put in more Blazing 7s or Wheel of Fortunes.)

The dilemma in drafting the final rule has been that there are certain permitted forms of trading that have been difficult to define. Fortunately, the language has been solidified tightly to avoid loopholes.

First, the key parts of the law, and what I have focused on for a very long time, are the words surrounding hedging. Proprietary hedging is allowed under the law, but speculative trading--risky gambles for the house--are exactly what Volcker sought to end. This rule does that by requiring hedges be designed to mitigate and reduce actual risk, and not just by an accidental or collateral effect of the trade. We also have better correlation language in the rule, correlation that shows that the hedging “activity demonstrably reduces or otherwise significantly mitigates the specific, identifiable risk(s) being hedged.” This is key--the risk has to be specific and identifiable. You can’t just say, “Ah, oh, that? Hmm, it was a hedge.” Nope, we aren't going to let ya play that game. The position needs to be correlated with the risk.

Furthermore, there is now an ongoing requirement to recalibrate the position, the hedge, in order to ensure that the position remains a hedge and does not become speculative. When people say this version of the Volcker Rule will stop circumstances like the London Whale, this ongoing recalibration provision is exactly what will help avoid similar debacles.

Second, the same goes for market making. Yes, market making is allowed, but only for the benefit of the banks’ customers – for their customers and not in order to collect market maker fees provided by the exchange or for any speculative reason. The market making is only permitted when a bank is hedging a legitimate business risk for a customer. Full stop.

Third, on portfolio hedging: One of the changes that has been made is that we have defined what a portfolio is NOT – it can’t be some amorphous set of excuses for doing a trade. You can’t call deuces and one-eyed jacks wild after the hand has been dealt. You can’t do an after-the-fact extract of a set of trades as a rationale for a hedge.

Fourth, I’ve spoken many times about perverse bonus structures that reward the macho macho men traders. The idea, and it is contained in actual rule text language, is that big bonuses and rewards in banking should not be tied to flyer bets. Our first proposal was fairly poorly drafted on this. It didn’t differentiate between prohibited proprietary trading and permitted proprietary trading very well. My view of the language that compensation should be “designed” not to reward or incentivize prohibited trading is that this is a sufficiently narrow test. One of the ways we will determine if something is designed in this way is how, in fact, traders are paid. So we will look after-the-fact at the payouts.

Finally, the Volcker Rule won’t be implemented until July of 2015. That’s ages in these morphing markets where new games seem to be played all the time. I guarantee there will be efforts to find loopholes, figure out ways around what has been written. That’s the way of the world. So, my final thought is that this rule must not be static. Regulators need to continue to monitor what is taking place. We need our regulatory eyes in the sky, but also to look around the corner for what’s coming next, and be nimble and quick, to ensure that what we do today holds up and that the high roller's room isn’t re-opened.

While this may be the end of part of the rulemaking process, it is, and must be, the beginning of a process, that continues.

Thank you.

AUSTRALIAN DEFENDANTS ORDERED TO PAY $192 MILLION RESTITUTION RELATED TO FOREX FRAUD SCHEME

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
December 9, 2013
Federal Court in Austin, Texas Orders Australian Defendants to Pay over $192 Million in Restitution and Fines for Forex Fraud

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) obtained a federal court default judgment Order awarding restitution for defrauded customers and civil monetary penalties of more than $192 million against Defendants Senen Pousa and Investment Intelligence Corporation (IIC) (d/b/a ProphetMax Managed FX) in connection with an off-exchange foreign currency (forex) fraud scheme in which Pousa and IIC defrauded over 960 clients in the United States and abroad of over $32 million.

Judge Lee Yeakel of the U.S. District Court for Western District of Texas entered the final default judgment and permanent injunction Order on November 27, 2013, requiring Pousa and IIC to pay restitution, plus prejudgment interest, totaling $33,299,821 to defrauded customers and Pousa and IIC each to pay a $79.5 million civil monetary penalty. The Order also imposes permanent trading and registration bans against Pousa and prohibits him from further violating the Commodity Exchange Act (CEA) and a CFTC regulation, as charged. The Order stems from a CFTC Complaint filed on September 18, 2012, that charged Pousa and IIC with fraud, misappropriation, and other CEA violations (see CFTC Press Release 6353-12).

The Order finds that, from at least January 1, 2012, IIC, through Pousa and its other agents, utilized “wealth creation” webcasts, webinars, podcasts, emails, and other online seminars via the Internet to directly and indirectly fraudulently solicit actual and prospective clients worldwide to open forex trading accounts at IIC. The Order further enters findings of fact and conclusions of law finding Pousa and IIC liable as to all violations, as alleged in the CFTC complaint.

The CFTC’s litigation in this action continues against Defendants Michael Dillard, Joel Friant, and Elevation Group, Inc.

The CFTC appreciates the assistance of the Australian Securities & Investments Commission, U.K. Financial Conduct Authority, Hungarian Financial Supervisory Authority, Netherlands Authority for the Financial Markets, Financial Markets Authority of New Zealand, and the New Zealand Serious Fraud Office.

Further, the CFTC appreciates the assistance of the U.S. Securities and Exchange Commission, which filed a companion case, and the U.S. Department of Justice.

CFTC Division of Enforcement staff members responsible for this matter are Kyong Koh, Michael Amakor, JonMarc Buffa, Mary Lutz, Timothy J. Mulreany, and Paul Hayeck.

SEC HALTS ALLEGED OIL AND GAS PONZI SCHEME

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 
SEC Halts Texas-Based Oil and Gas Investment Scheme

The Securities and Exchange Commission today announced charges and an emergency asset freeze against the perpetrators of a Texas-based Ponzi scheme involving purported investments in oil and gas projects.

The SEC alleges that Robert A. Helms and Janniece S. Kaelin, who work out of an office in Austin, misled investors about their experience in the oil and gas industry while raising nearly $18 million for supposed purchases of oil and gas royalty interests. Despite representations that nearly all of the money they raised would be used to make oil and gas investments, Helms and Kaelin actually used only a fraction of the offering proceeds for that purpose. Instead, the vast majority of investor funds were used to make Ponzi payments and cover various personal and business expenses.

The SEC's complaint unsealed late yesterday in U.S. District Court for the Western District of Texas also charges Deven Sellers of Arvada, Colo., and Roland Barrera of Costa Mesa, Calif., with illegally selling investments for Helms and Kaelin without being registered with the SEC. They also allegedly misled investors about the sales commissions and referral fees they were receiving.

According to the SEC's complaint, Helms and Kaelin began offering investments in 2011 through Vendetta Royalty Partners, a limited partnership that they control. They have since attracted at least 80 investors in more than a dozen states while promising in offering documents that they would use more than 99 percent of the investment proceeds to acquire a lucrative portfolio of oil and gas royalty interests. The offering documents were fraudulent as Helms and Kaelin invested only 10 percent of the proceeds, and the oil and gas projects in which they actually did invest generated only minuscule returns.

The SEC alleges that Helms and Kaelin directed Vendetta Royalty Partners to make approximately $5.9 million in so-called partnership income distributions to investors. They used money from newer investors to make the distributions to earlier investors. Helms and Kaelin created the illusion that Vendetta Royalty Partners was a profitable enterprise when, in fact, it was a fraudulent Ponzi scheme. Some offering documents touted Helms to have extensive oil-and-gas experience, misrepresenting that he had "worked with various mineral companies over the last 10 years advising management on issues involving the acquisition and management of royalty interests, mineral properties and related legal and financial issues." In fact, Helms's oil-and-gas experience came almost entirely from operating Vendetta Royalty Partners and its affiliated or predecessor companies.

The SEC alleges that Helms and Kaelin misled investors about other important matters besides their business background and industry reputation. They failed to disclose the existence of litigation against them and companies they control. They misrepresented the performance of the limited oil-and-gas royalty investments actually under their management. And they failed to inform investors that Vendetta Royalty Partners was behind on its line of credit. The company ultimately defaulted.

According to the SEC's complaint, Helms and Kaelin along with Sellers and Barrera told potential investors that any commissions or finder's fees would be small. However, Sellers and Barrera each received more than $200,000 in such fees on one investment alone. Sellers and Barrera regularly solicited investments without being registered as brokers.

At the SEC's request, the court entered an order temporarily restraining the defendants from further violations of the federal securities laws, freezing their assets, prohibiting the destruction of documents, requiring them to provide an accounting, and authorizing expedited discovery.

The SEC's complaint alleges that the defendants violated the antifraud provisions 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. The complaint further alleges that Sellers and Barrera acted as unregistered brokers in violation of Section 15(a) of the Exchange Act. The complaint requests permanent injunctions and the disgorgement of ill-gotten gains plus prejudgment interest and penalties.

The SEC's investigation was conducted by Chris Davis, Carol Hahn, and Joann Harris of the Fort Worth Regional Office. The SEC's litigation will be led by Timothy McCole. The SEC appreciates the assistance of the Federal Bureau of Investigation, U.S. Secret Service, and Texas State Securities Board.

U.S. DISTRICT COURT ISSUES FINAL JUDGEMENT AGAINST INVESTMENT ADVISER

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 
SEC Obtains Final Judgment Against Massachusetts-Based Broker and Investment Adviser

The Securities and Exchange Commission announced today that on December 4, 2013, the U.S. District Court for the District of Massachusetts entered final judgments against Arnett L. Waters of Milton, Massachusetts, and two entities that he controlled, broker-dealer A.L. Waters Capital, LLC and investment adviser Moneta Management, LLC, who are defendants in an enforcement action filed by the Commission in May 2012. The Commission filed its action on an emergency basis in order to halt the defendants' fraudulent sales of fictitious investment-related partnerships. The final judgment, to which the defendants consented, enjoins them from violating the antifraud provisions of the federal securities laws. The Court also found the defendants jointly and severally liable for $839,000 in disgorgement, which has been deemed satisfied by a restitution order of over $9 million in a parallel criminal proceeding.

The Commission's enforcement action filed May 1, 2012 alleged that from at least 2009-2012, Waters, A.L. Waters Capital and Moneta Management engaged in a fraudulent scheme through which they raised at least $780,000 from at least 8 investors, including $500,000 from Waters' church, by promising to use investor funds to purchase a portfolio of securities, when they instead misappropriated the money and spent it on personal and business expenses. On May 3, 2012, the Court entered a preliminary injunction order that, among other things, froze the defendants' assets, as well as those of two relief defendants, one of whom was Waters' wife, and required them to provide an accounting of all their assets to the Commission.

On August 7, 2012, the Commission filed a civil contempt motion against Waters, alleging that he had violated the court's preliminary injunction and asset freeze order by establishing an undisclosed bank account, transferring funds to that account, dissipating assets, and failing to disclose the bank account to the Commission, as required by the Court's order. On August 9, 2012, the U.S. Attorney for the District of Massachusetts filed a separate criminal contempt action against Waters based on the same allegations. On October 2, 2012, Waters pleaded guilty to the criminal contempt charges, and the Commission on December 3, 2012 barred Waters from the securities industry based on his guilty plea in the criminal contempt action.

The U.S. Attorney for the District of Massachusetts charged Waters with an array of securities fraud and other violations on October 17, 2012. On November 29, 2012, Waters pleaded guilty to sixteen counts of securities fraud, mail fraud, money laundering, and obstruction of justice arising out of both the conduct that is the subject of the Commission's civil action and a criminal scheme through which Waters defrauded clients of his rare coin business out of as much as $7.8 million. The criminal information to which Waters pleaded guilty further alleged that he engaged in money laundering through two transactions totaling $77,000. Finally, Waters pleaded guilty to obstruction of justice in connection with multiple misrepresentations to Commission staff, including that there were no investors in his investment-related partnerships, in order to conceal the fact that investor money was misappropriated in a fraudulent scheme. As a result of his guilty plea to this criminal conduct, Waters was sentenced on April 26, 2013 to 17 years in federal prison and three years of supervised release, and was ordered to pay $9,025,691 in restitution and forfeiture.

The final judgment in the Commission's enforcement action enjoins the defendants from violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Section 17(a) of the Securities Act of 1933, and also enjoins Waters and Moneta Management from violations of Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. On November 18, 2013, the Court entered the parties' stipulation of dismissal against relief defendant Port Huron Partners, LLP, an unregistered entity owned by Waters. The Commission's case remains pending against relief defendant Janet Waters, Arnett Waters' wife.

The Commission acknowledges the assistance of the United States Attorney's Office for the District of Massachusetts, the Federal Bureau of Investigation and FINRA in this matter.