U.S. Equity Market Structure: Making Our Markets Work Better for Investors

U.S. Equity Market Structure: Making Our Markets Work Better for Investors

SEC CHARGES HEDGE FUND ADVISORY FIRM, EXECUTIVES WITH IMPROPER ALLOCATION OF ASSETS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
04/29/2015 12:30 PM EDT

The Securities and Exchange Commission announced charges against a Santa Barbara, Calif.-based hedge fund advisory firm and two executives involved in improper allocations of fund assets to pay undisclosed operating expenses.  The SEC also charged an accountant who conducted the outside audit of misleading financial statements that the firm sent to investors.

An SEC investigation found that Alpha Titans LLC, its principal Timothy P. McCormack, and general counsel Kelly D. Kaeser used assets of two affiliated private funds to pay more than $450,000 in office rent, employee salaries and benefits, and similar expenses without clear authorization from fund clients and without accurate and complete disclosures that fund assets were being used for these purposes.  The firm’s outside auditor Simon Lesser was aware of how Alpha Titans used fund assets but still gave his final approval of audit reports containing unqualified opinions that the funds’ financial statements were presented fairly.

The firm, both executives, and the auditor agreed to settle the SEC’s charges.

“Alpha Titans did not make the proper disclosures for clients to decipher that the funds were footing the bill for many of the firm’s operational expenses,” said Marshall S. Sprung, Co-Chief of the SEC Enforcement Division’s Asset Management Unit.  “Private fund managers must be fully transparent about the type and magnitude of expenses they allocate to the funds.”

According to the SEC’s orders instituting settled administrative proceedings, Alpha Titans, McCormack, and Kaeser sent investors audited financial statements that failed to disclose almost $3 million in expenses tied to transactions involving other entities controlled by McCormack.  Lesser engaged in improper professional conduct while auditing the funds’ financial statements by not considering the adequacy of the related party disclosures in the funds’ financial statements.  Alpha Titans violated the custody rule by distributing financial statements that were not GAAP compliant.

To settle the SEC’s charges, Alpha Titans and McCormack agreed to pay disgorgement of $469,522, prejudgment interest of $28,928, and a penalty of $200,000.  McCormack and Kaeser each agreed to be barred from the securities industry for one year, and Kaeser agreed to a one-year suspension from practicing as an attorney on behalf of any entity regulated by the SEC.  Lesser agreed to pay a penalty of $75,000 and consented to an order suspending him from practicing as an accountant on behalf of any entity regulated by the SEC for at least three years.  The firm and the three individuals settled the charges without admitting or denying the SEC’s findings.

The SEC’s investigation was conducted by Ronnie B. Lasky, C. Dabney O’Riordan, and Dan Pines of the Asset Management Unit along with Carol Shau and Megan T. Monroe.  The SEC examination that led to the investigation was conducted by Charles Liao, John K. Kreimeyer, Nicholas Mead, and Andy Ganguly of the SEC’s Los Angeles office.

SEC FILES FRAUD CHARGES AGAINST FORMER OFFICRS OF WILMINGTON TRUST

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 23254 / May 7, 2015
Securities and Exchange Commission v. David R. Gibson, et al., Civil Action No. 15-cv-00363 (D. Del., May 6, 2015)
SEC Charges Four Former Officers of Delaware Bank Holding Company with Disclosure Fraud

On May 6, 2015, the Securities and Exchange Commission filed fraud charges against four former officers of Wilmington Trust for intentionally understating past due bank loans during the financial crisis.  The former Delaware-based bank holding company was acquired by M&T Bank in May 2011 and paid $18.5 million in September 2014 to settle related SEC charges of improper accounting and disclosure fraud.

The SEC’s complaint, filed in federal district court in Wilmington, Delaware, alleges the four took part in a scheme to mask the impact of real estate market declines on the bank’s portfolio of commercial real estate loans.  According to the SEC’s complaint, the former officials improperly excluded hundreds of millions of dollars of past due real estate loans from financial reports filed by Wilmington Trust in 2009 and 2010, violating a requirement to fully disclose the amount of loans 90 or more days past due.

The complaint names the bank’s former Chief Financial Officer David R. Gibson, former Chief Operating Officer and President Robert V.A. Harra, former Controller Kevyn N. Rakowski, and former Chief Credit Officer William B. North.  The complaint alleges that Gibson, Rakowski, and North omitted approximately $351 million of matured loans 90 days or more past due from Wilmington Trust’s disclosures in the third quarter of 2009, so that the bank disclosed only $38.7 million of such loans.  The four former officials allegedly omitted approximately $330.2 million of these loans in the fourth quarter of 2009, so that the bank’s annual report disclosed just $30.6 million in matured loans 90 days or more past due.

In addition, the complaint alleges that Gibson, Rakowski and North schemed to materially misreport this category of past due loans in the first half of 2010.  Gibson also is alleged to have materially understated the amount of non-accruing loans in Wilmington Trust’s portfolio in the third quarter of 2009 and the bank’s loan loss provision and allowance for loan losses in the fourth quarter of 2009.  Gibson, Harra, Rakowski and North are each charged with violating or aiding and abetting violations of the antifraud provisions of the federal securities laws.  Each also is charged with aiding and abetting violations of the reporting, recordkeeping, and internal controls provision of the federal securities laws.  The SEC is seeking to have all four return allegedly ill-gotten gains with interest and pay civil monetary penalties, and to have Gibson and Harra barred from serving as corporate officers or directors.

In a related action, the U.S. Attorney’s Office for the District of Delaware today announced criminal charges against Rakowski and North.

The SEC’s investigation has been conducted by Margaret Spillane, James Addison, and Thomas P. Smith, Jr. of the New York Regional Office.  Jack Kaufman and Ms. Spillane will lead the SEC’s litigation.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the District of Delaware, Federal Bureau of Investigation, Federal Reserve, and Office of the Special Inspector General for the Troubled Asset Relief Program.

MICHIGAN RESIDENT RECEIVES PRISON SENTENCE FOR DEFRAUDING INVESTORS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 23250 / April 30, 2015
Securities and Exchange Commission v. Joel I. Wilson et al., Civil Action No. 12-cv-15062 (E.D. Mich.)
Michigan Businessman Sentenced to Up to 20 Years for Defrauding Investors

The Securities and Exchange Commission announced that on April 24, 2015, the Honorable Joseph K. Sheeran of the Bay County Circuit Court in Bay City, Michigan sentenced Joel Wilson to concurrent prison terms of 105 months to 20 years and 80 months to 10 years on six criminal counts. The Court ordered that he pay $6.5 million in restitution, plus $11,000 to the Michigan Attorney General's Office for the costs of extraditing him from Germany. Wilson, 32, of Saginaw, Michigan, had been previously found guilty by a jury in March 2015 of fraudulent sale of securities, sale of unregistered securities, and continuing a criminal enterprise or racketeering and larceny.

The criminal charges arose out of the same facts that were the subject of a civil enforcement action that the Commission filed against Wilson on November 15, 2012. According to the Commission's complaint, Wilson defrauded investors who bought unregistered securities offered by his company, Diversified Group Partnership Management, LLC, and sold through his brokerage firm, W R Rice Financial Services, Inc. Wilson raised approximately $6.7 million from approximately 120 investors who bought Diversified Group's securities from September 2009 through October 2012, and used the funds to finance his business of buying, renovating, and selling houses in and around Bay City, the Commission alleged.

Although Wilson promised investors that he would invest their money in real estate that would yield returns of 9.9% per year, he used most of it to make unsecured loans to his real estate business, which did not generate enough income to repay the investors. Wilson also diverted $582,000 of investor money to pay personal expenses, including $75,000 he used to buy W R Rice Financial, $46,780 he spent on travel, and $35,000 for his wife's business. In addition, Wilson used investors' money to pay for a sponsorship and tickets to the Saginaw Sting football team and to buy thousands of dollars worth of tickets to the Detroit Red Wings.

The Commission also alleged that Wilson raised additional funds for his real estate business through stock sales for another of his companies, American Realty Funds Corporation, which traded on the OTC Bulletin Board under the symbol ANFDE at the time and is now no longer listed. The complaint alleged that there were misrepresentations and omissions in some of the reports the company filed with the Commission, which Wilson signed, including that American Realty had failed to make loan payments and that its purportedly independent directors have undisclosed personal and business relationships with Wilson.

The Commission's complaint, filed in the U.S. District Court for the Eastern District of Michigan, charged Wilson and Diversified Group with violations of the registration and antifraud provisions of the federal securities laws and American Realty with violations of the antifraud and reporting provisions of the federal securities laws. When Wilson failed to answer the Commission's complaint, the Court granted the Commission's motion for entry of a default judgment against him. On July 26, 2013, the Court entered a Second Amended Final Judgment against Wilson, which permanently enjoined Wilson from future violations of the federal securities laws and ordered him to pay disgorgement of $6,403,580, prejudgment interest of $290,319, and a civil penalty of $7,500 for a total of $6,701,399. The Commission also entered a final administrative order on October 17, 2014, barring Wilson from associating with a broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in an offering of penny stock.

COMPANY SANCTIONED BY CFTC FOR FAILURE TO ADEQUATELY SUPERVISE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION
May 1, 2015
CFTC Sanctions FCStone, LLC for Supervision Violations
Firm Ordered to Pay $140,000 Civil Penalty

Washington, DC — The U.S. Commodity Futures Trading Commission (CFTC) entered an Order filing and simultaneously settling charges against FCStone, LLC, a CFTC-registered Futures Commission Merchant (FCM) headquartered in New York, New York, for failing to provide and maintain an adequate program of supervision and for failing to diligently supervise its employees on one occasion in violation of CFTC Regulation 166.3.

The CFTC Order requires FCStone to pay a $140,000 civil monetary penalty and to cease and desist from violating CFTC Regulation 166.3, as charged.

Specifically, the Order finds that, from at least 2008 until May 2013, FCStone did not have adequate policies or procedures governing the transfer of positions between customers’ accounts, and no set written policy governing a request by a customer to transfer positions between accounts. Instead, FCStone had an unwritten policy such that its employees understood that they were to seek guidance if a transfer was requested between two accounts that were not under common control. That unwritten policy, however, did not provide specific guidance regarding the impact of beneficial ownership on account transfers, according to the Order. In particular, an FCM, like FCStone, may transfer positions among customers’ commodity accounts held at the firm 1) so long as the transfer merely constitutes a change from one account to another account, and 2) the underlying beneficial ownership in the two accounts remains the same, according to the Order.

The Order also finds that on one occasion FCStone’s employees transferred positions between two accounts that did not have the same underlying beneficial ownership. Specifically, they transferred approximately $20 million in gold and silver positions from an individual’s personal account to a corporate account in which the individual was a 98.95 percent owner. They made the transfer believing that, because the individual and corporate accounts had the same large trader number and the individual controlled both accounts, the positions could be transferred between the two accounts. In actuality, however, the tax identification numbers for the two accounts were different, and the accounts did not have the same underlying beneficial ownership because there were two fractional minority owners of the corporate account.

The Order further finds that FCStone cooperated fully with the CFTC’s investigation into this matter and that FCStone, on its own, revised its written procedures concerning the transfer of positions accordingly.

CFTC Division of Enforcement staff members responsible for this matter are James Deacon and Rick Glaser.

SEC COMMISSIONER KARA STEIN'S DISSENTING STATEMENT REGARDING DEUTSCHE BANK'S WAIVER FROM INELIGIBLE ISSUER STATUS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
PUBLIC STATEMENT

Dissenting Statement in the Matter of Deutsche Bank AG, Regarding WKSI

Commissioner Kara M. Stein
May 4, 2015

I respectfully dissent from the Commission’s Order (“Order”), approved on May 1, 2015, by a majority of the Commission.[1] The Order grants Deutsche Bank AG a waiver from ineligible issuer status triggered by a criminal conviction of its subsidiary, DB Group Services (UK) Ltd. (collectively with Deutsche Bank AG, “Deutsche Bank”), for manipulating the London Interbank Offered Rate (“LIBOR”), a global financial benchmark.[2] This waiver will allow Deutsche Bank to maintain its well-known seasoned issuer (“WKSI”) status, which would have been automatically revoked as a result of its criminal misconduct absent a Commission waiver.

Created by the Commission as part of the Securities Offering Reforms of 2005, WKSI status is available “for the most widely followed issuers representing the most significant amount of capital raised and traded in the United States.”[3] This status confers on the largest companies certain advantages over smaller companies. WKSIs are granted nearly instant access to investors through the capital markets. WKSIs enjoy greater flexibility in their public communications and a streamlined registration process with less oversight than smaller businesses. For example, unlike smaller businesses, the WKSI issuer does not have to wait for the Division of Corporation Finance to review and declare a registration statement effective prior to selling financial products to investors.[4] WKSI companies also enjoy a number of other privileges related to the payment of fees.

With these WKSI advantages comes a modicum of responsibility. WKSIs must meet the very low hurdle of not being ineligible. This means that, among other things, they have not been convicted of certain felonies or misdemeanors within the past three years.[5] In granting this waiver, the Commission continues to erode even this lowest of hurdles for large companies, while small and mid-sized businesses appear to face different treatment.[6]

Deutsche Bank’s illegal conduct involved nearly a decade of lying, cheating, and stealing. This criminal conduct was pervasive and widespread, involving dozens of employees from Deutsche Bank offices including New York, Frankfurt, Tokyo, and London. Deutsche Bank’s traders engaged in a brazen scheme to defraud Deutsche Bank’s counterparties and the worldwide financial marketplace by secretly manipulating LIBOR.[7] The conduct is appalling. It was a complete criminal fraud upon the worldwide marketplace.

Prior Commissions sensibly did not grant WKSI waivers for criminal misconduct. At least, that was the practice until September 19, 2013, when Commission staff granted a waiver to a large institution that pleaded guilty to criminal fraud.[8] This Commission granted another waiver on April 25, 2014, to another large institution that had also been criminally convicted of manipulating LIBOR.[9] A majority of this Commission, with this current action, continues the trend by granting its third waiver for criminal conduct at a large institution in a little less than two years. It is safe to assume that these waiver requests will continue to roll in, as issuers are now emboldened by an unofficial Commission policy to overlook widespread and serious criminal conduct — and ensure that the largest companies retain their array of advantages in our capital markets.

It is unclear to me how this waiver can be granted, for reasons substantially similar to those I outlined in my dissent regarding another institution involved in LIBOR manipulation.[10] Among other factors, the egregious criminal nature of the conduct and the duration of the manipulation (almost a decade) weigh heavily in my mind when considering this waiver. Additionally, Deutsche Bank is a recidivist, and its past conduct undermines its current promise of future good conduct. Since 2004, Deutsche Bank has, among other violations, a criminal admission of wrongdoing connected to promoting tax shelters,[11] a settlement involving misleading investors about auction rate securities,[12] and a violation against its investment bank for improperly asserting influence over research analysts.[13] Deutsche Bank requested and was previously granted a WKSI waiver in 2007 and 2009.

This criminal scheme involving LIBOR manipulation was designed to inflate profits, and it was effective. It created the impression that Deutsche Bank was more creditworthy and profitable than it actually was. Accordingly, the conduct affected its financial results and disclosures. Because LIBOR plays such an important role in the worldwide economy, manipulation of it goes to the heart of many aspects of Deutsche Bank’s disclosures. Interest rates represented to clients and the public also were clearly false. Based on this conduct, I do not find any basis to support the assertion that Deutsche Bank’s culture of compliance is dependable, or that its future disclosures will be accurate and reliable.

Finally, Deutsche Bank has not shown good cause for receiving a waiver from automatic disqualification, in this, its third WKSI waiver request in eight years. I am unable to conclude that Deutsche Bank’s culture of compliance and the reliability and accuracy of its future disclosures establishes good cause for a waiver. As the U.S. Commodity Futures Trading Commission’s (“CFTC”) Director of Enforcement noted: “Deutsche Bank’s culture allowed such egregious and pervasive misconduct to thrive.”[14]

For all of these reasons, I cannot support the Commission’s latest waiver.

In addition, the Commission adopted rules disqualifying felons and other “Bad Actors” from Rule 506[15] offerings on July 10, 2013.[16] Based on the criminal conduct in this case, I expected to receive a request from Deutsche Bank AG for a waiver from the automatic disqualification contained in Rule 506.[17] After all, the final CFTC order was “based on a violation of any law that prohibits fraudulent, manipulative, or deceptive conduct.”[18] It should therefore trigger an automatic disqualification absent a waiver.

However, based on a loophole contained in Rule 506(d)(2)(iii), the CFTC has intervened and prevented the bad actor disqualification question from even coming before the Securities and Exchange Commission. The CFTC saw fit to opine on the SEC’s Rule 506 jurisprudence about whether Deutsche Bank AG should receive a waiver from automatic disqualification under SEC rules. It is unclear to me what, if any, analysis went into this decision and what prompted the CFTC to insert language into its final order stating that a bad actor disqualification “should not arise as a consequence of this Order.”[19] The implications of the CFTC’s actions here — and in other actions[20] — are deeply troubling. The Commission should closely review this provision and how it is being used.


[1] In the Matter of Deutsche Bank AG, Order under Rule 405 of the Securities Act of 1933, Granting a Waiver from Being an Ineligible Issuer, available at http://www.sec.gov/rules/other/2015/33-9764.pdf.

[2] For more information on the statements of facts, plea agreement, and deferred prosecution agreement related to the LIBOR manipulation, see “Deutsche Bank's London Subsidiary Agrees to Plead Guilty in Connection with Long-Running Manipulation of LIBOR,” available at http://www.justice.gov/opa/pr/deutsche-banks-london-subsidiary-agrees-plead-guilty-connection-long-running-manipulation.

[3] See Division of Corporation Finance’s Revised Statement on Well-Known Seasoned Issuer Waivers (Apr. 24, 2014), available at http://www.sec.gov/divisions/corpfin/guidance/wksi-waivers-interp-031214.htm.

[4] Id.

[5] See Rule 405 of the Securities Act of 1933 (the “Securities Act”) (17 C.F.R. 230.405).

[6] A review of WKSI waivers granted since August 2013, reveals a total of 12 such waivers granted, 100% of which went to large financial institutions. See Division of Corporation Finance, available at http://www.sec.gov/divisions/corpfin/cf-noaction.shtml#405. This is precisely the concern I expressed a year ago in a dissenting statement from another waiver. See Dissenting Statement In the Matter of Royal Bank of Scotland Group, plc, Regarding Order Under Rule 405 of the Securities Act of 1933, Granter a Waiver from Being an Ineligible Issuer (Apr. 28, 2014), available at http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370541670244 (“I fear that the Commission’s action to waive our own automatic disqualification provisions arising from RBS’s criminal misconduct may have enshrined a new policy—that some firms are just too big to bar.”).

[7] See Deutsche Bank Services (UK) Ltd. Statement of Facts, available at http://www.justice.gov/sites/default/files/opa/press-releases/attachments/2015/04/23/dbgs_statement_of_facts.pdf. Numerous Deutsche Bank derivatives traders communicated their desire to manipulate LIBOR to Deutsche Bank pool and money market derivatives traders, causing the pool and money market derivatives traders to submit false and misleading LIBOR contributions. These derivatives traders would then enter into derivatives transactions tied to LIBOR with unsuspecting counterparties who were unaware of Deutsche Bank’s criminal manipulation of LIBOR going on behind the scenes. These counterparties included universities, charitable organizations, and other financial institutions.

[8] See Letter from the Division of Corporation Finance to Mr. Steven Slutzky (Sep. 19, 2013) available at http://www.sec.gov/divisions/corpfin/cf-noaction/2013/ubs-ag-091913-405.pdf regarding “UBS-AG — Waiver Request of Ineligible Issuer Status under Rule 405 of the Securities Act.”

[9] See Order Under Rule 405 of the Securities Act of 1933, Granting a Waiver From Being an Ineligible Issuer, In the Matter of Royal Bank of Scotland Group, plc, Rel. No. 33-9578, (Apr. 25, 2014) available at http://www.sec.gov/rules/other/2014/33-9578.pdf.

[10]See Dissenting Statement In the Matter of Royal Bank of Scotland Group, plc, Regarding Order Under Rule 405 of the Securities Act of 1933, Granter a Waiver from Being an Ineligible Issuer (Apr. 28, 2014), available at http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370541670244.

[11] See “Deutsche Bank to Pay More Than $550 Million to Resolve Federal Tax Shelter Fraud Investigation,” available at http://www.justice.gov/sites/default/files/tax/legacy/2011/01/03/deutschebankpr.pdf.

[12] See “SEC Finalizes ARS Settlements With Bank of America, RBC and Deutsche Bank, Providing Over $6 Billion in Liquidity to Investors,” available at https://www.sec.gov/litigation/litreleases/2009/lr21066.htm.

[13] See “SEC Sues Deutsche Bank Securities Inc. for Research Analyst Conflicts of Interest and Failure to Timely Produce All E-Mail,” available at https://www.sec.gov/litigation/litreleases/lr18854.htm.

[14] U.S. Commodity Futures Trading Commission, Press Release “Deutsche Bank to Pay $800 Million Penalty to Settle CFTC Charges of Manipulation, Attempted Manipulation, and False Reporting of LIBOR and Euribor,” (Apr. 23, 2015), available at http://www.cftc.gov/PressRoom/PressReleases/pr7159-15.

[15] Rule 506 of Regulation D is considered a safe harbor for the private offering exemption of Section 4(a)(2) of the Securities Act. (17 C.F.R. 230.506).

[16] Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“the Dodd-Frank Act”) required the Commission to adopt rules that disqualify certain securities offerings from reliance on Rule 506 of Regulation D. See Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings, Release No. 33-9414 (July 10, 2013), available at http://www.sec.gov/rules/final/2013/33-9414.pdf.

[17] See Rule 506(d)(1)(iii) of the Securities Act of 1933. (17 C.F.R. 230.506(d)(1)(iii)).

[18] See id.

[19] In the Matter of Deutsche Bank AG, CFTC Docket No. 15-20, at 44 (Apr. 23, 2015), available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfdeutscheorder042315.pdf.

[20] See, e.g., In the Matter of JPMorgan Chase Bank, NA, CFTC Docket No. 14-01, at 18 (Oct. 13, 2013), available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfjpmorganorder101613.pdf; CFTC v. Royal Bank of Canada, 13 Civ 2497, at 14 (Dec. 18, 2014), available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfrbcorder121814.pdf.