SEC BRINGS CHARGES AGAINST EXECUTIVES AT ASSISTED LIVING PROVIDER

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission announced fraud charges against two former top executives at a Wisconsin-based assisted living provider accused of listing fake occupants at some senior residences in order to meet the requirements of a lease to operate the facilities.

The SEC Enforcement Division alleges that then-CEO Laurie Bebo and then-CFO John Buono devised a scheme involving false disclosures and manipulation of internal books and records when it appeared likely that their company Assisted Living Concepts Inc. (ALC) would default on financial promises known as covenants in a lease agreement with a Chicago-based real estate investment trust called Ventas Inc., which owned the facilities.  The financial covenants required ALC to maintain minimum occupancy rates and coverage ratios while operating the facilities, and failure to meet the covenants constituted a default on the lease.  A default would have required ALC to pay the remaining rent amount due for the full term of the lease, which amounted to tens of millions of dollars at the time. 

The SEC Enforcement Division alleges that Bebo and Buono directed ALC accounting personnel calculating the occupancy rates and coverage ratios to include phony occupants in the calculations in order to meet the numbers required in the covenants.  The identities of the fake occupants were determined by Bebo and included her family members and friends as well as ALC current and former employees among others who did not reside at the senior residences.  One of the purported senior residents was just seven years old.  The SEC Enforcement Division alleges that without including these non-residents in the calculations, ALC would have missed the covenant requirements by significant margins for several consecutive quarters.  Bebo and Buono allegedly certified ALC’s annual and quarterly reports that fraudulently represented that the company was in compliance with the occupancy and coverage ratio covenants included in the lease.  Coverage ratio was defined in the lease as cash flow at the facilities divided by the rent payments owed by ALC to Ventas.

“Rather than come clean with their landlord and investors, these executives falsely portrayed family and friends as senior housing occupants and certified misleading company filings,” said Andrew J. Ceresney, Director of the SEC Enforcement Division.  “False filings threaten the integrity of financial reporting in our markets and will be pursued vigorously.”

According to the SEC’s order instituting litigated administrative proceedings, ALC was based in suburban Milwaukee and has since been sold to a private equity firm.  At the time of the alleged fraud that began in 2009 and continued into 2012, ALC operated more than 200 senior living residences in the U.S. comprising more than 9,000 units.  In early 2008, ALC began operating eight facilities owned by Ventas.  These facilities had a total of 540 units and were located in Alabama, Florida, Georgia, and South Carolina.  The SEC Enforcement Division alleges that while Bebo was a strong proponent of entering into the lease to operate these Ventas facilities, certain ALC officers and directors advocated against it due to disadvantageous provisions including the financial covenants related to occupancy and coverage ratios.  Bebo assured the directors that she was confident that ALC could meet the financial covenants. 

The SEC Enforcement Division alleges that less than a year after entering the Ventas lease, Bebo and Buono realized that a financial covenant default was likely.  Bebo initially devised a plan to include ALC workers who spent the night at a facility in the covenant calculations.  Bebo sought the advice of ALC’s general counsel who advised that ALC needed to fully disclose the practice to Ventas and obtain written approval for it to be permissible under the lease.  The SEC Enforcement Division alleges that ALC never obtained this approval to include employees in the covenant calculations and did not disclose the practice to Ventas. 

The SEC Enforcement Division alleges that occupancy at the facilities in early 2009 had declined to the point where ALC was violating certain financial covenants.  But rather than report the defaults to Ventas or ALC’s board of directors and shareholders, Bebo directed Buono and his staff to include additional non-residents in the covenant calculations.  The SEC Enforcement Division alleges that among those who were included as fake occupants at these senior residences were:

• Bebo’s family members including her parents and her husband.
• Bebo’s friends and their family members, including one friend’s seven-year-old nephew.
• ALC employees who worked at the facilities but lived nearby and did not stay overnight.
• ALC employees who did not stay at these facilities or travel to them.
• Former ALC employees who had been fired.
• Impending ALC employees who had not yet been officially hired.

The SEC Enforcement Division further alleges that some ALC employees who occasionally stayed at the facilities were included in the covenant calculations but beyond the periods when they actually stayed there.  Some ALC employees and other individuals were listed as occupants of multiple facilities during the same time period.  From the third quarter of 2009 to the fourth quarter of 2011, ALC allegedly included between 45 and 103 non-residents in the covenant calculations.  Bebo and Buono directed ALC personnel to record journal entries increasing revenue associated with the fabricated occupancy in the accounts for the leased facilities.  ALC made a corresponding journal entry decreasing revenue in a corporate revenue account to mask the fraud.  To establish the number of fake occupants to include in the covenant calculations, Bebo and Buono directed ALC personnel to reverse-engineer the requisite number of phony occupants needed to meet the covenants.  Shortly after the end of each quarter, ALC allegedly provided Ventas with covenant calculations including the fake occupants and the associated revenue, thus falsely showing that ALC was meeting the covenants.

The SEC Enforcement Division alleges that Bebo and Buono violated Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 10b-5(a), (b) and (c), 13a-14, 13b2-1 and 13b2-2.  The Enforcement Division further alleges that they caused and/or aided and abetted ALC’s violations of Sections 10(b), 13(a) 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 10b-5(a), (b) and (c), 12b-20, 13a-1 and 13a-13.  The case will be litigated before an administrative law judge.

The SEC Enforcement Division’s investigation, which is continuing, has been conducted by Scott Tandy, Jean Javorski, Tom Vincus, and C.J. Kerstetter of the Chicago Regional Office.  The SEC’s litigation will be led by Ben Hanauer and Eric Phillips.  The case is being supervised by Robert Burson.

SEC ANNOUNCES FORMER MANAGING DIRECTOR OF NASDAQ ORDERED TO DISGORGE INSIDER TRADING PROFITS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

Litigation Release No. 23156 / December 12, 2014

Securities and Exchange Commission v. Donald L. Johnson, et al., Civil Action No. 11-CV-3618 (VM) (S.D.N.Y.)

Court Orders Former Managing Director of the NASDAQ Stock Market to Disgorge More Than $898,000 in Insider Trading Profits

The Securities and Exchange Commission announced today that on November 12, 2014, the Honorable Victor Marrero of the United States District Court for the Southern District of New York entered a final judgment against defendant Donald L. Johnson, formerly a Managing Director of The NASDAQ Stock Market ("NASDAQ"), ordering Johnson to disgorge insider trading profits of $755,066.20, together with prejudgment interest thereon in the amount of $143,041.72, for a total payment of $898,107.92. Johnson consented to the entry of the final judgment. The Court previously had entered a judgment permanently enjoining Johnson for violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, representing the full injunctive relief sought by the SEC in the same civil action.

In its Complaint, filed in May 2011, the SEC had alleged that Johnson had unlawfully traded in advance of nine announcements of material nonpublic information involving NASDAQ-listed companies from August 2006 to July 2009. According to the SEC's Complaint, Johnson took advantage of both favorable and unfavorable information that was entrusted to him in confidence by NASDAQ and its listed companies, shorting stocks on several occasions and establishing long positions in other instances. The SEC alleged that Johnson reaped illicit profits in excess of $755,000 from his illegal trading.

On May 26, 2011, Johnson pleaded guilty to a federal criminal charge of securities fraud in a parallel criminal action arising out of certain of the conduct underlying the SEC's action. On August 12, 2011, Johnson was sentenced to forty-two months in prison and ordered to forfeit $755,066.

Following the entry of the final judgment against Johnson, which provided for payment of full disgorgement with prejudgment interest, the SEC voluntarily dismissed its relief defendant claim against Johnson's wife, Dalila Lopez. This concludes the SEC's civil action against Johnson.

The SEC acknowledges the assistance of the Fraud Section of the U.S. Justice Department's Criminal Division and the U.S. Postal Inspection Service. The SEC also acknowledges FINRA and NASDAQ for their assistance in this matter.

MORGAN STANLEY TO PAY $4 MILLION FOR VIOLATING MARKET ACCESS RULE

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The market access rule requires broker-dealers to have adequate risk controls in place before providing customers with access to the markets.  An SEC investigation found that Morgan Stanley, which offers institutional customers direct market access through an electronic trading desk, did not have the risk management controls necessary to prevent the rogue trader from entering orders that exceeded pre-set trading thresholds.  The trader exploited the market access and, without Morgan Stanley’s knowledge, committed a fraud that eventually shuttered the firm where he worked.  The SEC and criminal authorities have since charged the trader with fraud, and he has been sentenced to 30 months in prison.

Morgan Stanley agreed to pay a $4 million penalty for violating the market access rule.

“Broker-dealers become important gatekeepers when they provide customers direct access to our securities markets, and in this case Morgan Stanley did not live up to that responsibility,” said Andrew Ceresney, Director of the SEC Enforcement Division.  “Morgan Stanley failed to have reasonable controls in place to mitigate the risks associated with granting market access to a customer.”

According to the SEC’s order instituting a settled administrative proceeding, the rogue trader worked at Rochdale Securities LLC and routed to Morgan Stanley’s electronic trading desk a series of orders to purchase Apple stock on Oct. 25, 2012.  The orders came steadily throughout the day and eventually tallied approximately $525 million worth of Apple stock, which significantly exceeded Rochdale’s pre-set aggregate daily trading limit of $200 million at Morgan Stanley.  In order to execute the orders, Morgan Stanley’s electronic trading desk initially increased Rochdale’s limit to $500 million and later to $750 million without conducting adequate due diligence to ensure the credit increases were warranted.  Morgan Stanley’s written supervisory procedures did not provide reasonable guidance for electronic trading desk personnel who determine whether or not to increase customer trading thresholds.

According to the SEC’s order, the rogue trader at Rochdale was using these orders to commit a fraud.  He had intentionally enlarged the amount of Apple stock an actual customer wanted to purchase from 1,625 shares to 1,625,000 shares.  The trader’s scheme was to profit personally from the excess shares if Apple’s stock price increased or claim the order size was merely an error if the stock price decreased.  As it turned out, Apple’s stock price began dropping later that day, so the trader falsely claimed that he had made a mistake in placing order.  Rochdale was left holding the unauthorized purchase and suffered a $5.3 million loss.  Rochdale subsequently fell below its net capital requirements to trade securities, and ceased all business operations last year.

The SEC’s order finds that Morgan Stanley violated Rule 15c3-5 of the Securities Exchange Act of 1934.  Without admitting or denying the findings, the firm consented to the SEC’s order, which censures the firm and requires it to pay the financial penalty and cease and desist from committing or causing violations of the market access rule.

The SEC’s investigation was conducted by Eric Forni, David London, and Michele Perillo of the Market Abuse Unit with assistance from staff in the Division of Trading and Markets.  The case was supervised by the Chief of the unit Daniel M. Hawke and the Co-Deputy Chief of the unit Robert Cohen.  The SEC appreciates the assistance of the Financial Industry Regulatory Authority.

CFTC CHAIRMAN MASSAD'S STATEMENT BEFORE CFTC AGRICULTURE ADVISORY COMMITTEE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
Opening Statement of Chairman Tim Massad before the CFTC Agriculture Advisory Committee Meeting
December 9, 2014

As Prepared for Delivery

Thank you all for coming. I want to welcome you to this meeting of the CFTC’s Agricultural Advisory Committee. This forum is a valuable opportunity to discuss evolving market issues relevant to our work.

Let me begin by thanking the CFTC staff involved in planning this gathering. Thank you to them, and to all of our professional staff, whose hard work on behalf of the American public is extraordinary. Thank you also to Dr. Randy Fortenbery for serving as Committee Chair. He flew all the way from Lewiston, Idaho to get here, and I appreciate his extensive knowledge and ability to keep us running on time. I’d also like to thank our guest, Secretary Vilsack, for being generous with his time. His coming here today demonstrates the importance of the Department and the CFTC working together. We’ll do more of an introduction before he speaks.

Much of what we do here at the CFTC can seem removed from everyday life. Most Americans do not participate directly in the markets we oversee. But as you know, the agency’s origins are in agriculture, an industry that is basic and important to the lives of all American families. Futures on agricultural commodities have been traded in the US since the 19th century and have been regulated at the federal level since the 1920s. Today, agricultural derivatives are now only one piece of the markets we oversee, but they are fundamentally important. The ability of the Ag sector to hedge commercial exposures is critical to having a successful agricultural industry, and to putting food on the table for all of us. The CFTC’s job in overseeing these markets should not only help participants be able to hedge effectively. It should help these markets thrive, and in turn help the agricultural economy thrive. And I know strengthening the ag economy, and fostering investment and new opportunities in the ag economy are important to all of you and to Secretary Vilsack.

Our ability to successfully oversee these markets requires listening to market participants. It is helpful to hear your thoughts on what we are, or should be, doing. And that is why this Advisory Committee is so important. I know travelling to Washington two weeks before the holidays—which is a very busy time—is not always easy. But I know I speak for all the Commissioners in saying that your presence and your participation on this Committee are much appreciated.

I joined the Commission about six months ago, as did Commissioners Bowen and Giancarlo. The three of us have benefitted from Commissioner Wetjen’s experience as we got up to speed. I am pleased that all three of my fellow commissioners are here today.

We have all been listening and learning from market participants like you. In the last six months, we have focused on moving forward important reforms, to promote greater transparency and market integrity. But we’ve also made it a priority to address areas where our rules may not be working as well as they should. Our goal is not to create unnecessary burdens on commercial end users but to build a reliable, orderly framework for oversight in which vibrant markets can thrive.

In the last few months, we have taken a number of steps to that end.

I know some of our recent actions have been especially important to the agricultural industry, such as our proposal on “residual interest,” and our changes to certain recordkeeping requirements. We’ve addressed contracts with volumetric optionality, making sure publicly-owned utilities can access the energy swaps markets, and making sure end users can use their treasury affiliates for swap transactions and still benefit from the Congressional end user exemptions.

Today, we will discuss a few topics important to the agricultural markets that we have decided upon in consultation with you. We’ll first discuss how the current agricultural economy is impacting CFTC-regulated markets and then discuss how to best calculate deliverable supply for commodities, a topic that is critically important to establishing position limits. We also will spend a little time discussing what the agency has been doing lately, and what we should consider having this Agriculture Advisory Committee discuss in the future.

Thank you again for being here and contributing your ideas. I look forward to a productive discussion.

VICE CHAIR FDIC MAKES COMMENTS ON CONGRESS ALLOWING TAXPAYER SUPPORTED DERIVATIVES TRADING BY BANKS

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION
Speeches & Testimony
Statement from FDIC Vice Chairman Hoenig on Congressional moves to repeal swaps push-out requirements

In 2008 we learned the economic consequences of conducting derivatives trading in taxpayer-insured banks. Section 716 of Dodd-Frank is an important step in pushing the trading activity out to where it should be conducted: in the open market, outside of taxpayer-backed commercial banks. It is illogical to repeal the 716 push out requirement. In fact, under 716, most derivatives -- almost 95% -- would not be pushed out of the bank. That is because interest rate swaps, foreign exchange and cleared credit derivatives can remain within the bank. In addition, derivatives that are used for hedging can remain in the bank. The main items that must be pushed out under 716 are uncleared credit default swaps (CDS), equity derivatives and commodities derivatives. These are, in relative terms, much smaller and where the greater risks and capital subsidy is most useful to these banking firms.

Derivatives that are pushed out by 716 are only removed from the taxpayer support and the accompanying subsidy of insured deposit funding -- they will continue to exist and to serve end users. In fact, most of these firms have broker-dealer affiliates where they can place these activities, but these affiliates are not as richly subsidized, which helps explain these firms' resistance to 716 push out.

CFTC CHARGES MAN WITH FRAUD AND ACTING AS AN UNREGISTERED FUTURES COMMISSION MERCHANT

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

November 25, 2014

CFTC Charges California Resident Thomas Gillons with Fraud and Acting as an Unregistered Futures Commission Merchant

Federal Court Issues Emergency Order Freezing Gillon’s Assets and Protecting Books and Records

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) announced the filing of a civil enforcement action in the U.S. District Court for the Northern District of Illinois, charging Defendant Thomas Gillons of Napa County, California, with fraud and acting as a Futures Commission Merchant (FCM) without being registered as such with the CFTC.

On the same day the Complaint was filed, November 19, 2014, U.S. District Judge Ronald A. Guzman issued an emergency Order freezing and preserving assets under the control of Gillons and prohibiting him from destroying documents or denying CFTC staff access to his books and records. The court scheduled a hearing for December 1, 2014, on the CFTC’s motion for a preliminary injunction.

Gillons Allegedly Misappropriated Nearly $130,000 in Customer Funds

The CFTC’s Complaint alleges that, since at least August 31, 2013, Gillons fraudulently solicited and accepted at least $194,000 from at least three customers by claiming that he was a licensed broker and would trade their funds in a sub-account in customers’ names, earning them a 12 to 14 percent return. However, in reality, Gillons’ broker license had been suspended, and he was not currently registered with any securities firm, according to the Complaint. Moreover, Gillons traded only a portion of customer funds, losing approximately $55,234 and misappropriating at least $129,766 in customer funds, the Complaint alleges.

Furthermore, the Complaint alleges that Gillons accepted money to margin, guarantee, or secure commodity futures trades without being registered with the CFTC as an FCM.

In its continuing litigation, the CFTC seeks restitution, disgorgement of ill-gotten gains, civil monetary penalties, trading and registration bans, and injunctions against further violations of the Commodity Exchange Act.

CFTC Division of Enforcement staff members responsible for this action are Stephanie Reinhart, Melissa Glasbrenner, David Terrell, Scott Williamson, and Rosemary Hollinger.