On November 3, 2015, an Illinois federal jury convicted Michael Coscia, a high-frequency commodities trader, of six counts of commodities fraud and six counts of spoofing—entering a buy or sell order with the intent to cancel before the order’s execution.1 Coscia’s conviction was the first under the criminal anti-spoofing provisions added to the Commodity Exchange Act (CEA) by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. In the press release touting its victory, the prosecution announced: “The jury’s verdict exemplifies the reason we created the Securities and Commodities Fraud Section in Chicago, which will continue to criminally prosecute these types of violations.” High-frequency traders should take note that the conviction on all six counts of spoofing charged in Coscia’s case may embolden prosecutors across the nation to pursue other spoofing cases with vigor. Given the real possibility of a felony indictment and conviction for spoofing—the latter of which exposes a defendant to imprisonment for up to ten years and significant monetary fines—high-frequency traders should carefully evaluate their strategies and conduct.2
On December 1, 2015, the Securities and Exchange Commission (SEC) charged GAW Miners, LLC (“GAW Miners”), ZenMiner, LLC (“ZenMiner”) and Homero Joshua Garza (“Garza”) the managing member of both GAW Miners and ZenMiner (together the, “Defendants”) with fraud under (i) Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and (ii) Section 17(a) of the Securities Act of 1933 (“Securities Act”). The Defendants were also charged with engaging in the offer and sale of unregistered securities under Sections 5(a) and 5(c) of the Securities Act for selling $20 million worth of shares in their virtual currency digital mining contract called a “Hashlet”.
The charges stem from the Defendants’ operation as a virtual currency “miner” which uses computing power to be the first to solve complex algorithms. The first virtual currency miner to solve a complex algorithm that confirms a transaction is rewarded with newly-issued bitcoins by the bitcoin protocol.
While virtual currency mining is not illegal, the SEC found:
- Hashlets were touted as always profitable and never obsolete and had more than 10,000 investor purchases.
- The Hashlet contract purportedly entitled the investor to control a share of computing power that GAW Miners claimed to own and operate while Hashlets were depicted in marketing materials as a physical product or piece of mining hardware.
- GAW Miners directed little or no computing power toward any mining activity and misled investors to believe they would share in returns.
- Garza and his companies owed investors a daily return that was larger than the actual return they were making on their limited mining operations because they sold far more computing power than they owned.
- Investors were paid back gradually over time with “returns” out of funds collected from other investors.
The Press release is available HERE.
A full copy of the SEC order is available HERE.
On September 22, 2014, the Securities and Exchange Commission (the “SEC”) charged private equity fund adviser, Lincolnshire Management, Inc. (“Lincolnshire”), with misallocating expenses shared between two portfolio companies. Lincolnshire integrated two portfolio companies that were each owned by a different Lincolnshire private equity fund. Lincolnshire owed a fiduciary duty to each fund and such fiduciary duty was breached when Lincolnshire would charge one portfolio company more than its fair share for expenses benefiting both portfolio companies.
Lincolnshire was aware of the complexity involved in sharing expenses and did have an expense allocation policy in place, though it was not in writing. The instances that resulted in a breach of Lincolnshire’s fiduciary duty were those in which the verbal expense allocation policy was not followed. The SEC also found, with respect to the integration of the portfolio companies, that Lincolnshire did not have sufficient written policies and procedures in place to prevent violations of the Investment Advisers Act of 1940 (“Adviser’s Act”). Lincolnshire agreed to a settlement with the SEC in excess of $2.3 million.
It is interesting to note that, while the SEC announced several months ago it had conducted presence exams and found many issues in private equity managers, Lincolnshire was not one of the companies subject to a presence exam. Private equity managers who have not had a presence exam should not assume they are unlikely to be examined outside of the presence exam protocol. This enforcement action reinforces the requirement that private equity fund advisers are required to have policies and procedures in place that are designed to prevent violations of the Adviser’s Act and other securities laws. More importantly, once in place, such policies and procedures must be monitored by the chief compliance officer and observed by all “covered persons.”
Written by: Jay B. Gould
On December 12, 2013, the Securities and Exchange Commission (SEC) charged a London-based hedge fund adviser and its former U.S.-based holding company with internal controls failures that led to the overvaluation of a fund’s assets and inflated fee revenue for the firms. The investigation came out of the SEC’s Aberrational Performance Inquiry, pursuant to which the Enforcement Division’s Asset Management Unit identifies suspicious performance through risk analytics. The SEC searches for performance that is inconsistent with a fund’s investment strategy or other benchmarks and then conducts follow up inquiries. In this case, the SEC worked with the United Kingdom’s financial regulator, the Financial Conduct Authority.
According to the SEC’s order instituting settled administrative proceedings, the GLG firms managed the GLG Emerging Markets Special Assets 1 Fund. From November 2008 to November 2010, GLG’s internal control failures caused the overvaluation of the fund’s 25 percent private equity stake in an emerging market coal mining company. The overvaluation resulted in inflated fees to the GLG firms and the overstatement of assets under management in the holding company’s filings with the SEC.
The SEC order also stated that GLG’s asset valuation policies required the valuation of the coal company’s position to be determined monthly by an independent pricing committee. On a number of occasions, GLG employees received information calling into question the $425 million valuation for the coal company position. The SEC found that there were inadequate policies and procedures to ensure that such relevant information was provided to the independent pricing committee in a timely manner or even at all. There also appeared to be confusion among GLG’s fund managers, middle-office accounting personnel, and senior management about who was responsible for elevating valuation issues to the independent pricing committee.
The SEC’s order found that GLG Partners L.P. violated and GLG Partners Inc. caused numerous violations of the Federal securities laws. It also required the GLG firms to hire an independent consultant to recommend new policies and procedures for the valuation of assets and test the effectiveness of the policies and procedures after adoption. The GLG firms agreed to pay disgorgement of $7,766,667, prejudgment interest of $437,679, and penalties totaling $750,000.
The SEC has been targeting valuation cases recently as evidenced by the recent enforcement action against the Morgan Keegan fund directors and in the Ambassador Capital case. Fund managers should review their valuation policies and procedures to make sure that such policies and procedures address current regulatory concerns, and to make sure that the disclosures in their fund documents are consistent with actual practice.
Written by: Jay B. Gould
On September 17, 2013, the Securities and Exchange Commission (“SEC”) announced enforcement actions against 23 firms for short selling violations as the agency increases its focus on preventing firms from improperly participating in public stock offerings after selling short those same stocks. The enforcement actions are being settled by 22 of the 23 firms charged, resulting in more than $14.4 million in monetary sanctions.
The SEC’s Rule 105 of Regulation M prohibits the short sale of an equity security during a restricted period, which is generally defined as five business days before a public offering – and the purchase of that same security through the offering. The rule applies regardless of the trader’s intent, and promotes offering prices that are set by natural forces of supply and demand rather than manipulative activity. The rule is intended to prevent short selling that can reduce offering proceeds received by companies by artificially depressing the market price shortly before the company prices its public offering.
The firms charged in these cases allegedly bought offered shares from an underwriter, broker, or dealer participating in a follow-on public offering after having sold short the same security during the restricted period.
“The benchmark of an effective enforcement program is zero tolerance for any securities law violations, including violations that do not require manipulative intent,” said Andrew J. Ceresney, Co-Director of the SEC’s Division of Enforcement. “Through this new program of streamlined investigations and resolutions of Rule 105 violations, we are sending the clear message that firms must pay the price for violations while also conserving agency resources.”
The SEC’s National Examination Program simultaneously has issued a risk alert to highlight risks to firms from non-compliance with Rule 105. The risk alert highlights observations by SEC examiners focusing on Rule 105 compliance issues as well as corrective actions that some firms proactively have taken to remedy Rule 105 concerns.
In a litigated administrative proceeding against G-2 Trading LLC, the SEC’s Division of Enforcement is alleging that the firm violated Rule 105 in connection with transactions in the securities of three companies, resulting in profits of more than $13,000. The Enforcement Division is seeking disgorgement of the trading profits, prejudgment interest, penalties, and other relief as appropriate and in the public interest.
The SEC charged the following firms in this series of settled enforcement actions:
- Blackthorn Investment Group – Agreed to pay disgorgement of $244,378.24, prejudgment interest of $15,829.74, and a penalty of $260,000.00.
- Claritas Investments Ltd. – Agreed to pay disgorgement of $73,883.00, prejudgment interest of $5,936.67, and a penalty of $65,000.00.
- Credentia Group – Agreed to pay disgorgement of $4,091.00, prejudgment interest of $113.38, and a penalty of $65,000.00.
- D.E. Shaw & Co. – Agreed to pay disgorgement of $447,794.00, prejudgment interest of $18,192.37, and a penalty of $201,506.00.
- Deerfield Management Company – Agreed to pay disgorgement of $1,273,707.00, prejudgment interest of $19,035.00, and a penalty of $609,482.00.
- Hudson Bay Capital Management – Agreed to pay disgorgement of $665,674.96, prejudgment interest of $11,661.31, and a penalty of $272,118.00.
- JGP Global Gestão de Recursos – Agreed to pay disgorgement of $2,537,114.00, prejudgment interest of $129,310.00, and a penalty of $514,000.00.
- M.S. Junior, Swiss Capital Holdings, and Michael A. Stango – Agreed to collectively pay disgorgement of $247,039.00, prejudgment interest of $15,565.77, and a penalty of $165,332.00.
- Manikay Partners – Agreed to pay disgorgement of $1,657,000.00, prejudgment interest of $214,841.31, and a penalty of $679,950.00.
- Meru Capital Group – Agreed to pay disgorgement of $262,616.00, prejudgment interest of $4,600.51, and a penalty of $131,296.98.00.
- Merus Capital Partners – Agreed to pay disgorgement of $8,402.00, prejudgment interest of $63.65, and a penalty of $65,000.00.
- Ontario Teachers’ Pension Plan Board – Agreed to pay disgorgement of $144,898.00, prejudgment interest of $11,642.90, and a penalty of $68,295.
- Pan Capital AB – Agreed to pay disgorgement of $424,593.00, prejudgment interest of $17,249.80, and a penalty of $220,655.00.
- PEAK6 Capital Management – Agreed to pay disgorgement of $58,321.00, prejudgment interest of $8,896.89, and a penalty of $65,000.00.
- Philadelphia Financial Management of San Francisco – Agreed to pay disgorgement of $137,524.38, prejudgment interest of $16,919.26, and a penalty of $65,000.00.
- Polo Capital International Gestão de Recursos a/k/a Polo Capital Management – Agreed to pay disgorgement of $191,833.00, prejudgment interest of $14,887.51, and a penalty of $76,000.00.
- Soundpost Partners – Agreed to pay disgorgement of $45,135.00, prejudgment interest of $3,180.85, and a penalty of $65,000.00.
- Southpoint Capital Advisors – Agreed to pay disgorgement of $346,568.00, prejudgment interest of $17,695.76, and a penalty of $170,494.00.
- Talkot Capital – Agreed to pay disgorgement of $17,640.00, prejudgment interest of $1,897.68, and a penalty of $65,000.00.
- Vollero Beach Capital Partners – Agreed to pay disgorgement of $594,292, prejudgment interest of $55.171, and a penalty of $214,964..
- War Chest Capital Partners – Agreed to pay disgorgement of $187,036.17, prejudgment interest of $10,533.18, and a penalty of $130,000.00.
- Western Standard – Agreed to pay disgorgement of $44,980.30, prejudgment interest of $1,827.40, and a penalty of $65,000.00.
Written by: Marc H. Axelbaum, Sarah A. Good, and G. Derek Andreson
The U.S. Securities and Exchange Commission (“SEC”) is poised to modify its “no-admit, no-deny” policy to seek more admissions of wrongdoing from defendants as a condition of settlement in enforcement cases. The change comes on the heels of recent criticism of the policy from two federal judges and a U.S. Senator and would result in potentially far-reaching consequences for companies, their directors, officers, and employees.
The Proposed Policy Change
At the Wall Street Journal CFO Network’s Annual Meeting on Tuesday, June 18, SEC Chairman Mary Jo White announced her intention to require more admissions of wrongdoing from defendants in the settlement of enforcement actions. Prior to this announcement, the SEC only required such admissions in a narrow sub-set of cases in which parties admitted certain facts as part of a guilty plea or other criminal or regulatory agreement. Such an approach would represent a radical departure from the SEC’s longstanding no-admit, no-deny policy, under which defendants settle cases without admitting or denying wrongdoing. Chairman White emphasized that the no-admit, no-deny policy will still be used in the “majority” of cases and that “having ‘no-admit, no-deny’ settlement protocols in your arsenal as a civil enforcement agency [is] critically important to maintain.”1
Details are still forthcoming on the scope of the proposed changes to the SEC policy, which will require approval from a majority of the five SEC commissioners. However, Chairman White presumably would not have announced her intention to depart from tradition and require admissions of wrongdoing in certain settlements if such a change lacked majority support from the other Commissioners. In a memo written to the Enforcement Division staff, the Division’s Co-Directors, George Canellos and Andrew Ceresney, have suggested that the SEC would only require admissions of wrongdoing where it would be in the public interest. According to the memo, this may include “misconduct that harmed large numbers of investors or placed investors or the market at risk of potentially serious harm; where admissions might safeguard against risks posed by the defendant to the investing public, particularly when the defendant engaged in egregious intentional misconduct; or when the defendant engaged in unlawful obstruction of the Commission’s investigative processes.”2
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