2014 Mid-Year Securities Enforcement Update

Our mid-year report one year ago presented an exciting opportunity to discuss a time of great change at the SEC. A new Chair and a new Director of Enforcement had recently assumed the reins and begun making bold policy pronouncements. One year later, things have stabilized somewhat. The hot-button issues identified early in the new SEC administration—admissions for settling parties, a growing number of trials (and, for the agency, trial losses), and a renewed focus on public company accounting—remain the leading issues a year later, albeit with some interesting developments.

Introduction

Reprieve in the Admissions Saga

One of the most significant developments of the past six months was the long-awaited appellate decision in SEC v. Citigroup Global Markets. In 2011, a federal judge in New York rejected the $285 million settlement as “neither fair, nor reasonable, nor adequate, nor in the public interest… because it does not provide the Court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards.” The district court’s ruling turned in part on the inclusion of the standard SEC settlement provision under which Citigroup neither admitted nor denied the SEC’s allegations.

In its June 4, 2014 decision reversing the district court, the United States Court of Appeals for the Second Circuit held that a court cannot “require an admission of liability as a condition for approving a settlement” entered into by the SEC. More generally, the Second Circuit held that lower courts must afford “significant deference” to the SEC’s judgment as to whether the terms of a settlement served the public interest.

In the two-and-a-half year interim between the initial Citigroup decision and its subsequent reversal, several courts had joined suit in closely scrutinizing and sometimes rejecting SEC settlements. This put significant pressure on the agency not just to consider demanding admissions of wrongdoing, but to continually ratchet up its sanction demands and clamor for individual liability, to minimize the risk of judicial second-guessing.

While the Second Circuit decision may relieve that pressure, to some extent the genie is out of the bottle. As noted in our previous updates, one of the first policy pronouncements under new SEC Chair Mary Jo White and Enforcement Director Andrew Ceresney was that, in certain cases, the agency would require parties to admit liability as a condition of settlement. Having rolled out this policy, it seems clear that, Citigroup notwithstanding, the SEC will continue to implement it in select matters.

To date, there have been about eight cases in which party admissions have been included among the settlement terms. Notably, although the agency had initially stated that admissions would only be sought in particularly egregious cases, the circumstances under which admissions may be sought appear to have expanded. For example, in January 2014, the SEC announced a settlement with brokerage firm Scottrade in which the firm admitted the SEC’s factual findings. The case involved the firm’s failure to detect certain omissions in trading information it reported to the SEC. The settled action charged books-and-records violations, but no fraud or other serious or intentional wrongdoing. Despite the ambiguity in when the SEC will seek party admissions, the agency has forcefully stated that the decision to do so lies wholly with the agency; at an April 2014 conference, Enforcement Director Ceresney stated that whether or not an admission would be required was not open to negotiation.

Mixed Results in the SEC’s Trial Record

Driven in part by the SEC’s tougher settlement stance, an increasing number of SEC enforcement actions have been going to trial, with the SEC continuing to experience a mixed track record (particularly in federal court trials). Insider trading cases proved particularly difficult for the SEC. In May, a federal jury in New York cleared hedge fund manager Nelson Obus and two others of insider trading, ending litigation that had been ongoing since 2006. In a suit alleging that Obus had been tipped ahead of a 2001 merger, the 10-member jury found the defendants not liable after less than a day of deliberations. Roughly a week later, a jury in California concluded that the founder of storage device maker STEC, Inc. was not liable for selling company stock three months before it was announced that a major customer would be cutting orders.

The SEC fared better in other, non-insider-trading cases. In February, a jury found the CEO of Radius Capital Corp. liable for making misrepresentations in connection with the firm’s issuance of mortgage-backed securities. Days later, a jury found “feeder fund” manager Marlon Quan liable for concealing from his investors losses due to their investments in the Tom Petters Ponzi scheme. And in May, a jury found former Michael’s Stores Inc. chairman Sam Wyly and the estate of his late brother Charles Wyly liable for concealing from investors $550 million in profits from certain offshore transactions.

Perhaps cognizant of its mixed record in federal court, the SEC has made no secret of its intentions to file more enforcement actions as administrative proceedings. As a result of reforms in both Sarbanes-Oxley and Dodd-Frank, the SEC can essentially obtain all available remedies in an administrative proceeding, and on a much quicker, less resource-intensive, and arguably less risky basis. As Director of Enforcement Andrew Ceresney noted at a conference in June, “I think there will be more [administrative proceedings] going forward.” Statistics confirm that the SEC has been increasing the proportion of cases brought administratively rather than in federal court, a trend possibly reflected in the late June 2014 announcement that the SEC would be hiring two additional administrative law judges and several more law clerks.

The threat of more cases being filed administratively rather than in federal court is a particularly problematic one for companies and individuals in the SEC’s crosshairs. There is a perception that the SEC enjoys a home court advantage in these proceedings; indeed, a news report earlier this year concluded that one of the three current administrative law judges has issued 50 decisions, and not once ruled against the Division of Enforcement. In addition, such proceedings present severe procedural limitations that could be prejudicial to respondents. There is little or no discovery—meaning that while the SEC staff has been able to take witness testimony over the course of its investigation, respondents do not have any right to take depositions. There is no right to a jury trial. And parties losing at the hearing level face an uphill battle on appeal. (For example, the appeal of an administrative law judge decision is heard by the SEC itself—specifically, the same five Commissioners who authorized the staff to file the suit in the first place.)

Concerns about the SEC’s increased reliance on the administrative forum have begun to foment legal challenges. In the initial months of 2014, respondents in two different SEC administrative actions filed actions in federal court seeking to have the SEC’s administrative proceedings enjoined as violating the parties’ due process rights. In one case, the federal district court in Washington, DC dismissed the suit, concluding that it lacked jurisdiction over the matter and that the respondent would need to raise his due process arguments in the administrative proceeding or on appeal of that proceeding. The second case remains pending.

The SEC seems at least cognizant of the concerns raised about the increased number of actions proceeding administratively. At a June 2014 conference, SEC General Counsel Anne Small suggested that the agency might be receptive to procedural changes to address industry concerns.

Other Developments

Financial Fraud Task Force

As we have discussed over the course of the past year, the SEC’s Enforcement Division has been refocusing its resources on financial reporting by public companies. As Enforcement Director Ceresney recently noted, with most of the SEC’s investigations into financial crisis cases receding, the agency is moving resources back into public company accounting and disclosure cases, which had seen a precipitous decline as a proportion of the SEC’s enforcement docket over the past few years. Although it is too soon to know whether these efforts will bear fruit—a typical financial fraud investigation can take several years—Gibson Dunn’s Securities Enforcement Practice Group has, at least anecdotally, seen heightened activity by the SEC in this area.

In addition to standard Enforcement Division investigations, the Division’s Financial Reporting and Audit Task Force, formed in July 2013, has also been sending information requests to public companies. According to the SEC, the Task Force will act as a sort of “incubator” for potential investigations, performing some early assessments and referring some matters for further investigation to others in the Division. Notably, though initial SEC statements about the Task Force tended to trumpet its enhanced reliance on high-tech review of issuer filings to proactively ferret out indicia of misconduct, more recently the agency has been walking back some of those pronouncements. We have observed that several requests generated by the Task Force stem not from any sort of statistical or computer-driven assessment of corporate financial statements, but rather public disclosures by companies of potential accounting issues.

Whistleblowers

There continues to be a slow trickle of whistleblower awards in the wake of Dodd-Frank’s provision for cash bounties for SEC whistleblowers. In June 2014, the SEC announced the fifth case in which an award was paid out. According to the SEC, two individuals who had provided tips and assistance to the staff would evenly share an $875,000 award—a far cry from the $14 million paid to a whistleblower last October, but still enough to incentivize whistleblowers (and their counsel) to come forward. The SEC announcement provided no details on the nature of the enforcement action resulting from the tip. However, at this point it does not appear that any of the whistleblower cases to date involve insiders at public companies or regulated entities.

Meanwhile, also in June, the SEC announced the first case in which it has charged a company with unlawful retaliation against a whistleblower, a new authority given to the SEC as part of the Dodd-Frank whistleblower provisions. The case involved a hedge fund advisor alleged by the SEC to have engaged in improper principal trades through a related broker-dealer. After learning that its head trader had reported concerns about potential misconduct to the SEC, the firm allegedly engaged in retaliatory actions including removing him from his position and stripping him of his supervisory responsibilities. The firm and its owner agreed to settle the action, without admitting wrongdoing, by paying over $2 million in disgorgement and penalties.

Cooperation Agreements

The current SEC administration has continued the gradual roll-out of various cooperation tools crafted over the past few years to give the agency greater latitude to reward individuals and entities who provide information to assist the staff with investigations. In April, the SEC announced its first non-prosecution agreement with an individual in connection with an ongoing insider trading investigation. The SEC stated that the individual, one of several tippees who traded in advance of eBay’s acquisition of GSI Commerce, provided “extraordinary cooperation” which allowed the agency to unravel an extensive web of downstream tippers and tippees. (The web was sufficiently complex that the SEC’s press release included a helpful graphic illustration of the flow of inside information.) Using the information provided by this individual, the SEC charged a former GSI executive and five traders with insider trading. The cooperator agreed to disgorge trading profits but was not named or charged by the SEC.

The SEC also announced, in late June, a deferred prosecution agreement with Regions Bank arising out of alleged failures to properly classify non-performing loans. The SEC sued three former managers, two of whom agreed to settle the charges by paying penalties of $70,000 each and agreeing to be barred from serving as officers or directors of public companies. The bank itself agreed to pay $51 million to resolve parallel actions by the SEC, Federal Reserve Bank, and Alabama Department of Banking, but was not sued by the SEC in recognition of their extraordinary cooperation and remediation, including replacing management.

Statute of Limitations

A recent case dismissing an SEC enforcement action on statute of limitations grounds, if it gains traction in other courts, could prove to be a major development. The statute of limitations in SEC enforcement actions is generally provided by 29 U.S.C. § 2462, which states that “an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued[.]” In last year’s Gabelli decision, the Supreme Court addressed when the limitations period begins to run, but left open the question of whether claims for injunctive relief and disgorgement were subject to § 2462.

In a May 2014 decision, a Florida district court took an expansive view of Gabelli, holding that the statute of limitations reaches all forms of relief sought by the SEC and dismissing the entire case. The case concerned an alleged real estate Ponzi scheme that began in July 2004 and continued until sometime prior to January 30, 2008. While the SEC “investigated the case for at least seven years,” it did not file a complaint for injunctive relief and disgorgement until January 31, 2013. Ruling that the SEC’s claims were barred by § 2462, the court explained that the SEC’s position that § 2462 did not apply where “the SEC seeks disgorgement, injunction, and declaratory relief… would make the Government’s reach to enforce such claims akin to its unlimited ability to prosecute murderers and rapists.” Doing so would “‘thwart[] the basic objective of repose underlying the very notion of a limitations period.'”

Public Company Reporting & Accounting

Domestic Issuer Financial Fraud Actions

As noted above, while the SEC is increasing its focus on public company reporting, the number of new enforcement actions in this area remains relatively low. Nonetheless, the first half of 2014 saw the Commission file several high-profile cases. In January, the SEC charged Diamond Foods and its former CEO and CFO for allegedly adjusting commodity costs to leverage financial statement earnings reports. Diamond Foods and its former CEO agreed, without admitting or denying the allegations, to pay $5 million and $125,000 respectively to settle the charges, though litigation continues against the former CFO.

Three months later, the SEC brought a settled action against CVS Caremark Corp., alleging that the company used improper accounting adjustments and concealed business setbacks to overstate earnings prior to a $1.5 billion bond offering in 2009. Without making any admissions, CVS agreed to a $20 million settlement, while the company’s former retail controller agreed to the entry of a cease-and-desist order and penalty of $75,000 for his role in orchestrating the alleged accounting violations.

In May, the SEC charged the former CFO of jewelry merchant DGSE Companies with making false accounting entries to materially inflate the value of inventory on the company’s balance sheets, and then misleading the company’s auditors about the entries. DGSE agreed to the appointment of an independent consultant to review its accounting controls, while its former CFO agreed to pay $75,000 in penalties and to be barred from serving as an officer or director of a public company or practicing as an accountant before the Commission.

In addition to these traditional accounting fraud cases, the SEC filed several corporate disclosure cases a little more off the beaten path. For example, in March the SEC charged motion picture company Lions Gate Entertainment with failing to reveal the true business purpose behind a series of corporate transactions. According to the SEC, Lions Gate used a set of unusual transactions to fend off a hostile tender offer, but attributed the transactions to a previously announced debt-reduction plan, failing to disclose their actual purpose. Lions Gate agreed to pay $7.5 million and, in one of the few settlements under the SEC’s new admissions policy, admitted certain aspects of the alleged conduct.

Also in March, the SEC alleged accounting irregularities in connection with a bond offering by now-defunct law firm Dewey & LeBoeuf LLP. The SEC alleged that the firm’s former Chairman and other senior financial executives used accounting tricks to artificially inflate the firm’s revenue. The executives then used these purportedly falsified records to support bond market-based private offerings to raise money to finance the firm during the economic downturn. Parallel criminal proceedings have also been filed against Dewey’s former Chairman, Executive Director, and Chief Financial Officer.

Auditor Independence

The Commission settled a pair of enforcement actions related to its auditor independence rules. In January, the Commission charged a large audit firm with providing prohibited non-audit services to affiliates of three of its SEC audit clients, including bookkeeping and payroll services, and restructuring and corporate finance services. Without admitting wrongdoing, the firm settled the matter and agreed to pay about $8.2 million in fee disgorgement and penalties, as well as to certain undertakings related to its independence monitoring procedures.

In a related action, the SEC determined not to file charges against the firm for entering into arrangements to loan non-manager level tax professionals to certain audit clients, but instead issued a report providing guidance to the industry on the use of such “loaned staff” arrangements.

And in May, the SEC charged a former partner of another large audit firm with causing violations of the auditor independence rules by drawing down casino markers at a casino client of the firm at the same time he was serving as an advisory partner of that client. According to the SEC, the former partner concealed his casino markers from the firm. Without admitting wrongdoing, the former partner settled the matter and agreed to be suspended from practicing before the Commission as an accountant for at least two years.

Audit Committee Liability

The SEC also brought a pair of cases against members of public company audit committees, both involving accounting irregularities at China-based companies. For example, the Commission charged the Chair of the Audit Committee of a China-based animal feed company with ignoring a recommendation from a former director that the company conduct an investigation after accounting falsification red flags came to light. The SEC alleged that the China-side operations unit of the company kept two different sets of accounting records and used fake sales invoices and product descriptions to bump up sales revenue figures and artificially support company stock prices.

Auditor Workpapers

2014 saw a major development in the SEC’s ongoing battle to demand the production of foreign auditor workpapers. In late 2012, the agency initiated administrative proceedings against Chinese firms affiliated with the five major global accounting firms for refusing to turn over audit workpapers relating to various Chinese issuers under SEC investigation. While Sarbanes-Oxley mandated that foreign auditors produce workpapers to the SEC, the firms argued doing so would violate China’s state secrets and archives laws, and could subject them to civil and criminal penalties. In January 2014, an administrative law judge issued a voluminous order finding the foreign affiliates had violated Sarbanes-Oxley, and suspended them from appearing before the SEC for six months. The judge found their good faith reason for non-compliance irrelevant, writing that, “to the extent Respondents found themselves between a rock and a hard place, it is because they wanted to be there.” On May 9, the Commission granted the firms’ petition for review together with a leave to adduce additional evidence. The Commission’s May 9 order revealed that the affiliates had turned over the disputed work papers to Chinese regulators, with the understanding that the regulators may then turn the papers over to the SEC pursuant to the Memorandum of Understanding signed by the U.S. and China in 2013. The matter remains pending at this time.

Insider Trading

Classical Insider Trading

The SEC continued to roll out a seemingly endless barrage of insider trading actions of varying magnitude. Although the agency’s focus in recent years has been on large-scale trading schemes involving hedge funds or other institutions and large networks of tippers and tippees, most of the recent cases appeared centered on individual traders or smaller networks of friends and family members.

In one of the more profitable schemes, the SEC in June charged a finance director of Ross Stores, Roshal Chaganlal, with leaking inside information about the company’s monthly sales results to his friend Saleem Kahn. The SEC charged Chaganlal, Kahn, and two additional tippees with trading on over 40 occasions over a three year period, netting $12 million in illicit trading profits.

In February, the SEC announced an emergency action against an investment banker who was alleged to have repeatedly executed trades based on inside information using brokerage accounts held by his ex-girlfriend and his father, netting around a million dollars and using the illegal proceeds to pay his ex-girlfriend in lieu of formal child support payments. A federal judge granted an emergency order freezing the ex-girlfriend’s brokerage account.

And in May, the SEC brought a settled action against three software company founders alleged to have made over $2 million by selling stock while aware that media speculation about a potential acquisition of the company was incorrect. Notably, the SEC did not claim that the company itself had anything to do with the media reports. Nonetheless, according to an SEC official, “When news surfaces about the possibility of a merger and details of the media reports are incorrect, it is illegal for insiders who know the true facts to trade and profit.”

Other cases brought against corporate insiders included:

• An accountant at Allscripts Healthcare Solutions who traded ahead of an earnings announcement;
• A clerk at a large law firm who repeatedly tipped information about the firm’s corporate clients to a stockbroker through a mutual friend;
• A former BP employee who sold the company’s securities after receiving confidential information about the severity of the Deepwater Horizon oil spill; and
• A former director of a vitamin company and his family members for trading on confidential information about the company’s impending sale.

Clinical Trials Cases

In what appears to be a growing trend, the SEC continues to investigate and prosecute cases involving individuals trading on nonpublic information regarding clinical trial results. In April, the SEC announced settled charges against a former company executive of the biopharmaceutical company Genta, Inc. for trading on confidential information about the unfavorable results of the company’s key developmental drug. And in May, the SEC filed settled charges against two doctors involved in clinical testing of a new cancer drug who sold company stock after learning that the Food and Drug Administration had halted the clinical trials due to patient safety concerns.

Spousal Misappropriation

In March, the SEC simultaneously initiated two separate enforcement actions alleging that individuals unlawfully profited by misappropriating confidential information from their wives. In one case, the SEC charged that the husband of a finance manager at Oracle Corp. bought stock in a potential Oracle acquisition target after overhearing her making work calls. In the other, the SEC alleged that the husband of an employee of Informatica Corp. bought put options and shorted the stock after overhearing business calls and learning that the company would miss its earnings target. Both men agreed to pay disgorgement and penalties to settle the cases.

Scope of Disgorgement

Finally, the Second Circuit issued an important decision on the scope of disgorgement for which an insider trading defendant can be held responsible. In SEC v. Contorinis, the court held that a trader can be required to disgorge the full amount of illegal profits even if he or she traded on behalf of a third party and thus did not personally realize the profits. The SEC’s suit alleged that Joseph Contorinis, a managing director of an investment bank, traded on nonpublic information regarding supermarket chain Albertson’s. According to the SEC, Contorinis did not trade using his personal assets, but rather those of an investment fund of which he was a co-manager and had investment control, netting over $7 million in profits for the fund. The Second Circuit rejected defendant’s argument that he was not subject to disgorgement because he did not personally profit from the trading. Extending a principle “long applied” in the tipper-tippee context, the court held that “an insider trader may be ordered to disgorge not only the unlawful gains that accrue to the wrongdoer directly, but also the benefit that accrues to third parties whose gains can be attributed to the wrongdoer’s conduct.” The court affirmed the district court order requiring Contorinis to pay $7.3 million plus a civil penalty of $1,000,000.

Investment Advisers and Funds

General Misrepresentations

As discussed in our prior reports, SEC cases against investment advisers have been one of the largest, if not the single largest, components of the SEC enforcement program in recent years. Particularly with growing resources for the SEC’s investment adviser examination program, this trend shows no sign of slowing. And the first half of 2014 saw the SEC bringing multiple actions against investment advisors with claims ranging from outright fraud to improper fees and expenses.

In January, the SEC brought two separate, settled actions against Western Asset Management Company, an adviser to institutional clients. In one action, the SEC alleged that Western Asset allocated a prohibited investment to certain clients due to a computer coding error, but failed to inform clients of the error or reimburse them for resulting losses. In the other, the SEC alleged that the firm cross-traded securities between clients and failed to properly allocate certain cost savings between the clients. Without admitting or denying the SEC’s allegations, Western Asset agreed to pay over $21 million in refunds and penalties, and agreed to retain an independent compliance consultant.

Also in January, the SEC charged money manager Mark Grimaldi and his firm, Navigator Money Management, with making false and misleading claims about the firm’s past performance in newsletters and through Twitter. According to the SEC, Grimaldi cherry-picked favorable performance results and used misleading language. Grimaldi agreed to pay a $100,000 penalty and to retain an independent compliance consultant for three years.

In April, the SEC instituted litigated administrative proceedings against advisory firm Total Wealth Management and its CEO, CCO, and another employee. The SEC alleged that the firm and its CEO used undisclosed revenue sharing agreements to pay themselves kickbacks. The SEC further charged the firm with failing to disclose conflicts of interest and misrepresenting the extent of due diligence conducted on recommended investments.

And In May, the SEC announced fraud charges and corresponding asset freezes against two investment firms. In the first, the Commission alleged that Aphelion Fund Management and two of its executives altered an external audit report to make an investment loss appear to have been a major gain, and siphoned investor funds for personal use. The SEC also brought similar charges against Professional Investment Management and its president, alleging they entered a fake trade in the adviser’s financial records to conceal a $700,000 shortfall.

Fees and Expenses

The SEC has paid particular attention to the calculation, disclosure and allocation of fees and expenses by investment advisers, and brought several actions challenging adviser conduct around client costs. In February, the SEC instituted litigated administrative proceedings against private equity fund manager Clean Energy Capital LLC, alleging the firm and its principal improperly used fund assets to pay management company expenses including rent and salaries. The SEC further alleged that when the funds ran out of cash to pay these expenses, the firm loaned money to the funds at unfavorable interest rates.

In April, the SEC filed a settle administrative action against Transamerica Financial Advisors for alleged fee overcharges. According to the SEC, Transamerica offered breakpoint discounts reducing the fees that clients owed to the firm when they increased their assets in certain investment programs, but failed to properly apply discounts or maintain adequate policies to ensure fees were properly calculated. Without admitting or denying the SEC’s allegations, Transamerica agreed to pay over $1.1 million in refunds and penalties and to retain an independent compliance consultant.

First Pay-to-Play Case Against an Adviser

The first half of 2014 also saw the SEC’s first case under pay-to-play rules for investment advisers. These rules, enacted in 2010, bar an adviser from providing services to government clients where the firm or certain of its associates have made campaign contributions to officials in a position to influence the selection of the adviser. In June, the SEC brought settled charges against the Philadelphia-area private equity firm TL Ventures Inc., which allegedly continued to receive advisory fees from city and state pension funds after an associate of the firm made campaign contributions (totaling less than $5,000) to the governor of Pennsylvania and a candidate for mayor of Philadelphia. The firm agreed to pay approximately $300,000 in disgorgement and penalties.

Broker-Dealers & Financial Institutions

Internal Controls Failures

In the first half of 2014, the SEC focused its enforcement efforts on broker-dealers failing to have adequate controls in place to ensure compliance with securities laws or failing to comply with such controls.

The SEC announced settlements with several large broker-dealers for various alleged failures of internal controls. Among them was Jefferies LLC, which paid $25 million in March to settle charges that it failed to supervise the communications of employees on the mortgage-backed securities desk. The SEC alleged that these employees were misleading customers about pricing contrary to Section 15(b)(4)(E). In June, Wedbush Securities settled charges that it violated the market access rule that requires firms to have adequate risk controls in place before providing customers with access to the market. The SEC alleged that the firm and two officers provided customers with trading platforms allowing them to trade securities without taking adequate steps to ensure compliance with the market access rule.

Also in June, the SEC charged Liquidnet Inc., a New York-based dark pool alternative trading system operator, with improperly using subscribers’ confidential trading information to market its services. Liquidnet settled, agreeing to pay a $2 million penalty.

The SEC did not limit its securities industry scrutiny to broker-dealers—the Commission announced an enforcement action against the New York Stock Exchange and its affiliates for failure to comply with the rules governing exchanges. According to the SEC, the NYSE on multiple occasions either failed to have rules in place governing certain activities, or failed to comply with rules it had established. NYSE and its subsidiaries (as well as NYSE’s affiliated routing broker, which was charged separately) agreed to pay a combined $4.5 million penalty. NYSE further agreed to retain an independent consultant to complete a review of its policies.

Short Selling

The SEC continued its heightened activity involving short sales. In May, The SEC sued four individuals at clearing firm Penson Financial Services, including the CEO, for their roles in failing to prevent short-selling practices in violation of Regulation SHO. Notably, among those charged was the firm’s Chief Compliance Officer, whom the SEC alleged both failed to bring Penson into compliance and affirmatively assisted the violations.

The SEC also settled a case against a pair of Florida professors who were alleged to have orchestrated a complex naked short selling scheme. Based upon the staff’s data analysis, the Commission alleged that Gonul Colak and Milen Kostov used sham transactions to create the illusion they had delivered the underlying securities, when in fact they had not. Colak and Kostov agreed to settle the charges by paying more than $670,000.

Finally, following last year’s enforcement sweep against multiple firms violating Rule 105 of Regulation M—which prohibits short sales during a restricted period prior to the pricing of an offering—the agency continued to crack down on Rule 105 violations. In March, the SEC announced the largest monetary sanction ever—$7.2 million—for a violation of the rule. The SEC charged Worldwide Capital, a Long Island-based proprietary trading firm, and its owner Jeffrey W. Lynn, with participating in 60 public stock offerings covered by Rule 105 after selling short those same securities during the pre-offering restricted period. The settlement with Worldwide Capital was significantly larger than penalties imposed for other Rule 105 violations during the first half of 2014: a series of settlements with other firms resulted in total disgorgement payments and penalties of about $400,000.

Unlicensed Brokerage Activities

The SEC also pursued firms alleged to have engaged in or facilitated unlicensed brokerage activities. In February, Credit Suisse agreed to pay $196 million (including $50 million in penalties) and admit wrongdoing in response to charges that the company provided cross-border brokerage and investment advisory services to U.S. clients without first registering with the Commission. Credit Suisse admitted that it was aware of the regulation, but failed to effectively implement initiatives to comply with it. In May, New York-based Rafferty Capital Markets settled charges that it agreed to serve as the broker-dealer of record in name only for about 100 trades that were made by an unregistered firm. Rafferty paid nearly $850,000 in penalties, interest, and disgorgement.

Other Broker-Dealer Enforcement Developments

The SEC pursued other types of fraud cases against broker-dealers, including a charge against a Holmdel, New Jersey-based brokerage that allegedly engaged in “layering” (placing orders with no intent of executing them), and two traders who allegedly engaged in a fraudulent “parking” scheme (where one trader temporarily placed securities in the book of a second trader so that they would not count against his year-end bonus).

Finally, an ongoing investigation into multimillion dollar kickback payments made to a high-ranking Venezuelan bank official resulted in charges against two executives at New York City-based brokerage firm Direct Access Partners. In April, the SEC alleged that the two officials—Benito Chinea, co-founder and CEO of the firm, and Joseph DeMeneses, the firm’s managing partner of global strategy—played an integral role in making and concealing kickback payments to an officer at a Venezuelan bank to secure the bank’s bond-trading business. Last year, the SEC charged four individuals with ties to Direct Access Partners, and the head of DAP’s Miami office, for their alleged roles in the scheme.

Municipal Securities Offerings

After a busy 2013, the SEC’s Muni Unit has been relatively quiet so far this year, initiating just a small number of cases. In June, the SEC charged UNO Charter School Network, Inc. and United Neighborhood Organization of Chicago with defrauding investors in a $37.5 million bond offering for school construction. The SEC alleged that UNO made materially misleading statements about a multi-million dollar contract between UNO and a windows company owned by the brother of a UNO senior office. UNO also failed to disclose how the potential impact of this contract could affect UNO’s ability to repay its bonds. UNO settled the charges by agreeing to undertakings to improve its internal procedures and training, including the appointment of an independent monitor.

Also in June (and also in Illinois), the SEC obtained a temporary restraining order prohibiting the city of Harvey, Illinois from offering or selling any bonds. According to the Commission, the city and its comptroller, Joseph T. Letke, were engaged in a scheme to divert proceeds from bond sales for improper, undisclosed purposes. Specifically, the SEC alleged that the city misled investors into believing that bond proceeds were to be used to finance the construction of a hotel complex when, in fact, they were used to pay the city’s general obligations, while at least $269,000 went directly to Letke.

Finally, the SEC announced its Municipalities Continuing Disclosure Cooperation Initiative in March, under which the Enforcement Division will recommend standardized, favorable terms to municipal bond issuers and underwriters who self-report that they made inaccurate statements in bond offerings about prior compliance with the continuing disclosure obligations of Exchange Act Rule 15c2-12. While the SEC has yet to report whether the initiative has generated any new leads, just before this update went to press the agency reported a settlement of a matter already under investigation in which the initiative was applied. The SEC alleged that a California school district raised $6.8 million in a 2010 bond offering without disclosing that it had failed to comply with continuing disclosure obligations flowing from earlier offerings. Without admitting liability, and under the terms of the new initiative, the school district agreed to certain standardized settlement terms, including the adoption of written policies for its continuing disclosure obligations.