Fifth Third Bank and its Former CFO Charged for Improper Accounting

As released by the U.S. Securities and Exchange Commission:

The Securities and Exchange Commission charged the holding company of Cincinnati-based Fifth Third Bank and its former chief financial officer with improper accounting of commercial real estate loans in the midst of the financial crisis.

 

Fifth Third agreed to pay $6.5 million to settle the SEC’s charges, and Daniel Poston agreed to pay a $100,000 penalty and be suspended from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC.

 

According to the SEC’s order instituting settled administrative proceedings, Fifth Third experienced a substantial increase in “non-performing assets” as the real estate market declined in 2007 and 2008 and borrowers failed to repay their loans as originally required.  Fifth Third decided in the third quarter of 2008 to sell large pools of these troubled loans.  Once Fifth Third formed the intent to sell the loans, U.S. accounting rules required the company to classify them as “held for sale” and value them at fair value.  Proper accounting would have increased Fifth Third’s pretax loss for the quarter by 132 percent.  Instead, Fifth Third continued to classify the loans as “held for investment,” which incorrectly suggested that the company had not made the decision to sell the loans.

 

“Improper accounting by Fifth Third and Poston misled investors during a time of significant upheaval and financial distress for the company,” said George S. Canellos, co-director of the SEC’s Division of Enforcement.  “It is important for investors to know the financial consequences of decisions made by management, so accounting rules that depend on management’s intent must be scrupulously observed.”

 

According to the SEC’s order, Poston was familiar with the company’s loan sale efforts, which included entering into agreements with brokers during the third quarter of 2008 to market and sell loans.  Despite understanding the relevant accounting rules, Poston failed to direct Fifth Third to classify and value the loans as required.  Poston also made inaccurate statements to Fifth Third’s auditors about the company’s loan classifications, and certified the company’s inaccurate results for the third quarter of 2008.

 

“By failing to classify large pools of loans as required, Fifth Third and Poston kept investors from knowing the full truth behind its commercial real estate loan portfolio,” said Stephen L. Cohen, an associate director in the SEC’s Division of Enforcement.

 

Fifth Third and Poston consented to the entry of the order finding that they violated or caused violations of Sections 17(a)(2) and (3) of the Securities Act of 1933 as well as the reporting, books and records, and internal controls provisions of the federal securities laws.  Without admitting or denying the findings, they agreed to cease and desist from committing or causing any violations and any future violations of these provisions.  Poston is suspended from appearing or practicing before the SEC as an accountant pursuant to Rule 102(e) of the Commission’s Rules of Practice with the right to apply for reinstatement after one year.

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Detroit-Based Money Market Fund Manager Charged with Fraud

As announced by the U. S. Securities and Exchange Commission:

The Securities and Exchange Commission announced fraud charges against a Detroit-based investment advisory firm and a portfolio manager for deceiving the trustees of a money market fund and failing to comply with rules that limit risk in a money market fund’s portfolio.

 

Money market funds seek to maintain a stable share price by investing in highly safe securities.  Under the federal securities laws, a money market fund may only invest in securities determined by the fund’s board of trustees to present minimal credit risk.

 

The SEC’s Enforcement Division alleges that Ambassador Capital Management and Derek Oglesby repeatedly made false statements to trustees of the Ambassador Money Market Fund about the credit risk in the securities they purchased for its portfolio.  Trustees also were misled about the fund’s exposure to the Eurozone credit crisis of 2011 and the diversification of the fund’s portfolio.

 

“Money market fund managers must not hide the ball from a fund’s board,” said George S. Canellos, co-director of the SEC’s Enforcement Division.  “Ambassador Capital Management and Oglesby weren’t truthful about whether securities in the portfolio threatened to destabilize the fund, and they failed to operate under the strict conditions designed for money market fund managers to limit risk exposure and maintain a stable price.”

 

The enforcement action stems from an ongoing analysis of money market fund data by the SEC’s Division of Investment Management, in this case a review of the gross yield of funds as a marker of risk.  The performance of the Ambassador Money Market Fund was identified as consistently different from the rest of the market.  Upon further examination by the SEC’s Office of Compliance Inspections and Examinations, the matter was referred to the Enforcement Division’s Asset Management Unit for investigation.

 

The Enforcement Division’s investigation found that Ambassador Capital Management and Oglesby misrepresented or withheld critical facts from the fund’s trustees:

 

  • The firm’s self-imposed holding period restrictions were frequently exceeded for securities in the fund’s portfolio.
  • The fund regularly purchased securities that had greater than minimal credit risk under the firm’s own guidelines.
  • Throughout the Eurozone credit crisis in 2011, the fund continually purchased securities issued by Italian-affiliated entities despite Oglesby’s claim that Ambassador Capital Management was trying to stay away from Italian exposure and would unload even secondhand exposure to the Italian market.
  • The fund’s portfolio was not sufficiently diversified and thus had not reduced risk exposure as portrayed to trustees.

According to the SEC’s order instituting administrative proceedings, Ambassador Capital Management also caused the fund to deviate from the risk-limiting provisions of Rule 2a-7 under the Investment Company Act of 1940.  The firm also failed to conduct an appropriate stress test of the fund’s portfolio.  Since the Ambassador Money Market Fund failed to follow the risk-limiting provisions of Rule 2a-7, it was not permitted to use the amortized cost method of valuing securities under which it priced its securities at $1 per share.  It also shouldn’t have been represented to investors as a money market fund.

 

“Compliance with the risk-limiting provisions is critically important for a money market fund.  Deviations can have serious consequences for pricing of fund shares and how the fund markets itself to investors,” said Marshall S. Sprung, co-chief of the SEC Enforcement Division’s Asset Management Unit.

 

The SEC’s order alleges that Ambassador Capital Management violated the antifraud provisions of the Investment Advisers Act of 1940 and Oglesby aided and abetted the firm’s violations.  They allegedly caused violations of the pricing, naming, and recordkeeping provisions of the Investment Company Act, and the firm caused violations of the compliance provision.

 

The SEC’s investigation was conducted by Amy Stahl Cotter and John J. Sikora Jr. of the Asset Management Unit in the Chicago Regional Office with assistance from Marita Bartolini of the Office of Compliance Inspections and Examinations.  The SEC’s litigation will be led by Jonathan S. Polish, Robert Moye, and Timothy S. Leiman.

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Houston-Based Firms Charged for Engaging in Thousands of Undisclosed Principal Transactions

As reported by the U.S. Securities and Exchange Commission:

The Securities and Exchange Commission announced charges against two Houston-based investment advisory firms and three executives for engineering thousands of principal transactions through their affiliated brokerage firm without informing their clients.

 

One of the firms — along with its chief compliance officer — also is charged with violations of the “custody rule” that requires firms to meet certain standards when maintaining custody of client funds or securities.

 

In a principal transaction, an investment adviser acting for its own account or through an affiliated broker-dealer buys a security from a client account or sells a security to it.  Principal transactions can pose potential conflicts between the interests of the adviser and the client, and therefore advisers are required to disclose in writing any financial interest or conflicted role when advising a client on the other side of the trade.  They must also obtain the client’s consent.

 

The SEC’s Enforcement Division alleges that investment advisers Parallax Investments LLC and Tri-Star Advisors engaged in thousands of securities transactions with their clients on a principal basis through their affiliated brokerage firm without making the required disclosures to clients or obtaining their consent beforehand.  Parallax’s owner John P. Bott II and Tri-Star Advisors CEO William T. Payne and president Jon C. Vaughan were collectively paid more than $2 million in connection with these trades.

 

“By failing to disclose principal transactions and obtain consent, Parallax and Tri-Star Advisors deprived their clients of knowing in advance that their advisers stood to benefit substantially by running the trades through an affiliated account,” said Marshall S. Sprung, co-chief of the SEC Enforcement Division’s Asset Management Unit.

 

According to the SEC’s orders instituting administrative proceedings, Bott initiated and executed at least 2,000 undisclosed principal transactions from 2009 to 2011 without the consent of Parallax clients.  In each transaction, Parallax’s affiliated brokerage firm Tri-Star Financial used its inventory account to purchase mortgage-backed bonds for Parallax clients and then transferred the bonds to the applicable client accounts.  Bott received nearly half of the $1.9 million in sales credits collected by Tri-Star Financial on these transactions.

 

According to the SEC’s orders, Payne and Vaughan initiated and executed more than 2,000 undisclosed principal transactions from 2009 to 2011 without the consent of Tri-Star Advisor clients.  Tri-Star Financial similarly used its inventory account to purchase mortgage-backed bonds for Tri-Star Advisor clients and then transferred the bonds to the applicable client accounts.  Payne and Vaughan together received nearly half of the $1.9 million in gross sales credits collected by the brokerage firm on these transactions.

 

The SEC’s Enforcement Division further alleges that Parallax failed to comply with the custody rule that requires firms to undergo certain procedures to safeguard and account for client assets.  Parallax served as an adviser to a private fund Parallax Capital Partners LP.  The custody rule required Parallax to either undergo an annual surprise exam to verify the existence of the fund’s assets, or obtain fund audits by a PCAOB-registered auditor and deliver the financial statements to investors within 120 days after the fiscal year ends.  Although Parallax obtained an audit of PCP in 2010, it failed to retain a PCAOB-registered auditor and failed to deliver the financial statements on time.

 

According to the SEC’s orders, Parallax chief compliance officer F. Robert Falkenberg was aware of the 120-day deadline, but failed to take any steps to ensure that Parallax complied.  Even after Falkenberg and Bott learned that the fund’s auditor was not registered with the PCAOB, they retained him to perform the 2010 audit and issue financial statements to investors.

 

According to the SEC’s orders, Parallax allegedly violated the principal transaction, custody, and compliance provisions of the Investment Advisers Act of 1940, and Bott allegedly aided, abetted, and caused the violations.  Falkenberg allegedly aided, abetted, and caused Parallax’s custody and compliance violations.  Tri-Star Advisors allegedly violated the principal transaction and compliance provisions of the Advisers Act, and Payne and Vaughan allegedly caused the violations.

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Penny Stock Financier Agrees to Pay $1.4 Million to Settle SEC Charges

As released by the U.S. Securities and Exchange Commission:

The Securities and Exchange Commission today charged a New York-based penny stock financier and his firms with violating the federal securities laws when they purchased billions of shares in a pair of microcap companies and failed to register them before they were re-sold to investors for sizeable profits.

Curt Kramer and his firms Mazuma Corporation, Mazuma Funding Corporation, and Mazuma Holding Corporation agreed to disgorge those profits in paying a total of $1.4 million to settle the SEC’s charges.

An SEC investigation found that Kramer and his firms obtained unregistered shares in penny stock issuers Laidlaw Energy Group and Bederra Corporation.  For the Laidlaw transactions, they claimed to rely on an exemption in Rule 504 of Regulation D that permits certain companies to offer and sell up to $1 million in unregistered shares.  However, the Mazuma firms’ purchases of Laidlaw shares exceeded Rule 504’s $1 million limit, so the shares were restricted and not exempt from the registration requirements of the securities laws when they were re-sold.  Mazuma Holding Corporation’s acquisition and sale of more than one billion unregistered shares of Bederra that had been misappropriated from the issuer by its transfer agent also were not exempt from registration.

“Unless there is a valid exemption, shares can’t be sold publicly without a registration statement that provides investors with the level of detail they deserve about the investment opportunity being offered,” said Michael Paley, co-chair of the SEC Enforcement Division’s Microcap Fraud Task Force that was created earlier this year to target abusive trading and fraudulent conduct in securities issued by microcap companies that often don’t regularly report their financial results publicly.

“Billions of shares were not vetted through the registration process yet became publicly traded as a result of the violations by Kramer and his Mazuma firms, and the SEC will continue to punish non-compliance with the registration provisions of the securities laws to ensure the investing public is protected in these types of transactions,” Mr. Paley added.

According to the SEC’s order instituting settled administrative proceedings, Kramer and his firms purchased two billion Laidlaw shares, which amounted to 80 percent of Laidlaw’s outstanding shares at the time.  They purchased these shares at a significant discount from prevailing market prices, making it highly likely they could immediately re-sell them publicly for a short-term profit.  Kramer and his firms purchased the shares in 35 tranches with no six-month gaps, thus quantifying the transactions as a single, integrated offering through which Laidlaw exceeded the $1 million limit under Rule 504 by raising a total of $1,259,550.  No registration statement was filed for any shares that Laidlaw offered and sold to Kramer and his firms, nor was any registration statement filed for any shares that Kramer and his firms subsequently re-sold into the public market.  Despite exceeding the $1 million limit, Kramer and his firms continued to acquire and sell additional Laidlaw shares and profited by $126,963 from these transactions.

According to the SEC’s order, Kramer and Mazuma Holding Corporation acquired more than one billion shares of Bederra in 2009 and 2010 through 21 separate transactions from the principal of Bederra’s transfer agent, who had misappropriated the Bederra share certificates.  Again they purchased the shares at a significant discount from prevailing market prices.  Kramer and Mazuma Holding Corporation re-sold the misappropriated Bederra shares to the public without any registration statement for a profit of $934,404.

In the settlement, Kramer and his Great Neck, N.Y.-based Mazuma firms agreed to pay disgorgement totaling $1,061,367 plus prejudgment interest of $128,611 and penalties totaling $273,000.  Without admitting or denying the SEC’s findings, Kramer and Mazuma consented to the entry of an order finding that they violated Sections 5(a) and 5(c) of the Securities Act of 1933.  The order requires them to cease and desist from committing violations of Sections 5(a) and 5(c) and not participate in any Rule 504 offerings.  Entry of the order will constitute a disqualifying event for Kramer and the Mazuma firms under the recently enacted bad actor disqualification provisions of Rule 506.

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Florida-Based Investment Advisers Charged with Fraud

As released by the U.S. Securities and Exchange Commission:

The Securities and Exchange Commission today announced charges against two Tampa-area investment advisers accused of committing fraud by failing to truthfully inform clients about compensation received from offshore funds they were recommending as safe investments despite substantial risks and red flags.

 

The advisers also are charged with contributing to violations of the “custody rule” that requires investment advisory firms to establish specific procedures to safeguard and account for client assets.

 

The SEC’s Enforcement Division alleges that Gregory J. Adams and Larry C. Grossman solicited and directed clients of their investment firm Sovereign International Asset Management to invest almost exclusively in funds controlled by an asset manager named Nikolai Battoo, who the SEC charged in a separate enforcement action last year.  Grossman and Adams failed to inform clients about the conflict of interest in recommending these investments as Battoo was paying them millions of dollars in compensation for steering investors to his funds.

 

“Investment advisers have a fiduciary duty to act in utmost good faith when recommending investments, and they must fully disclose all of the relevant facts to their clients,” said Eric I. Bustillo, director of the SEC’s Miami Regional Office.  “Adams and Grossman breached this duty when they misstated their compensation and failed to disclose serious conflicts of interest.”

 

According to the SEC’s order instituting administrative proceedings, Grossman was paid approximately $3.3 million and Adams received $1 million in the undisclosed compensation arrangements.  Grossman and Adams promoted the investments as safe, diversified, independently administered and audited, and suitable for the investment objectives and risk profiles of their clients who were often retirees.  However, Battoo’s funds were in fact risky, lacked diversification, and lacked independent administrators and auditors.  Grossman and Adams also failed to investigate – and in some cases wholly disregarded – numerous red flags surrounding Battoo and his funds.

 

The SEC’s Enforcement Division alleges that Grossman and Adams aided and abetted Sovereign’s violations of the custody rule when they instructed clients to transfer their investment funds to a bank account controlled by a related entity.  Grossman and Adams pooled clients’ money in this bank account before investing it in Battoo’s offshore funds.  Sovereign failed to comply with the custody rule, which requires an investment adviser to comply with surprise examinations or certain other procedures to verify and safeguard client assets.

 

According to the SEC’s order, Grossman and Adams willfully violated Section 17(a)(2) of the Securities Act of 1933, Section 15(a) of the Securities Exchange Act of 1934, and Sections 206(1), 206(2), 206(3) and 207 of the Investment Advisers Act of 1940.  They willfully aided and abetted violations of Section 15(a) of the Exchange Act and Section 206(4) of the Advisers Act and Rules 204-3 and 206(4)-2.

 

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New York-Hedge Fund Trader Charged with Insider Trading

As released by the U.S. Securities and Exchange Commission:

The U.S. Securities and Exchange Commission announced insider trading charges against a New York-based investment professional who used nonpublic information about youth clothing company Carter’s Inc. to give the hedge fund where he worked a $3.2 million trading edge.

 

The SEC alleges that Mark Megalli obtained the inside information through a consulting agreement he had with the former vice president of investor relations at Carter’s, Eric Martin, who the SEC has previously charged among several others in its investigation into insider trading of Carter’s stock.  Martin, who had left Carter’s and started his own consulting firm, maintained contact with at least one company insider and obtained confidential information in advance of market-moving events that he supplied to Megalli so he could trade on it.  Megalli enabled hedge fund Level Global Investors L.P. to avoid approximately $2.4 million in losses and make $853,655 in illicit profits by trading shares ahead of positive or negative news.

 

“The information was hot enough that Megalli sometimes conducted the trades while he was still on the phone with his source,” said William Hicks, associate regional director of the SEC’s Atlanta Regional Office.  “After one profitable trade, Megalli bragged to his colleagues about being ‘max short’ in advance of negative news without mentioning his inside source.”

 

In a parallel action, the U.S. Attorney’s Office for the Northern District of Georgia today announced a criminal case against Megalli.

 

According to the SEC’s complaint filed in U.S. District Court for the Northern District of Georgia, Megalli joined Level Global as head of its consumer sector in August 2009 and entered into the consulting agreement with Martin’s firm a month later.  Martin began providing Megalli with confidential information about Carter’s anticipated financial results on the same day the consulting agreement was executed, and Megalli began directing and causing Level Global to trade on that nonpublic information.

 

The SEC’s complaint alleges that Megalli directed the purchase of 350,000 shares of Carter’s stock from September 14 to 17 based on explicit positive earnings information that he received from Martin.  Megalli’s very first trade in Carter’s shares occurred while he was on the phone with Martin.  On October 23, Martin advised Megalli about an unexpected accounting issue that was uncovered at Carter’s.  While still on the phone with Martin, Megalli immediately ordered the sale of 100,000 shares and instructed Level Global’s trader to continue selling the firm’s entire position in Carter’s.  After Level Global sold its entire position, Carter’s announced on October 27 that it was delaying its earnings release to complete a review of its accounting.  By selling shares prior to the negative announcement, Level Global avoided losses of more than $2.1 million.

 

The SEC alleges that Megalli also traded ahead of negative news based on nonpublic information from Martin to avoid losses of $268,500 in November 2009.  Megalli’s trading earned illicit profits of $205,000 in December 2009.  During a telephone conversation on July 8, 2010, Martin tipped Megalli that Carter’s earnings for the quarter would be below expectations.  Megalli immediately caused Level Global to begin accumulating a short position in Carter’s, and built up the short position to 300,000 shares by July 19.  Carter’s issued an earnings release on July 29 that contained negative future guidance, and its stock subsequently declined in price.  Level Global covered its entire short position at the lower price, generating profits of $648,655.  After the trading, Megalli boasted to colleagues in instant messages about the “max short” on Carter’s before the negative announcement.  He received hearty congratulations from his colleagues.

 

The SEC’s complaint charges Megalli with violating the antifraud provisions of the federal securities laws, and seeks a permanent injunction, disgorgement with prejudgment interest, and financial penalties.

 

The SEC’s investigation, which is continuing, has been conducted in the Atlanta Regional Office by Grant Mogan under the supervision of Peter J. Diskin.  The litigation will be led by Graham Loomis and Pat Huddleston.  The SEC appreciates the assistance of the U.S. Attorney’s Office for the Northern District of Georgia and the Financial Industry Regulatory Authority.

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SEC Announces First Deferred Prosecution Agreement with Former Hedge Fund Administrator

As released by the Securities and Exchange Commission:

The Securities and Exchange Commission announced a deferred prosecution agreement with a former hedge fund administrator who helped the agency take action against a hedge fund manager who stole investor assets.

 

Deferred prosecution agreements (DPAs) encourage individuals and companies to provide the SEC with forthcoming information about misconduct and assist with a subsequent investigation.  In return, the SEC refrains from prosecuting cooperators for their own violations if they comply with certain undertakings.

 

According to the SEC’s DPA with Scott Herckis – the agency’s first with an individual – he served as administrator for Connecticut-based Heppelwhite Fund LP, which was founded and managed by Berton M. Hochfeld.  With voluntary and significant cooperation from Herckis, the SEC filed an emergency enforcement action against Hochfeld in November 2012 for misappropriating more than $1.5 million from the hedge fund and overstating its performance to investors.  The SEC’s action halted the fraud and froze the hedge fund’s assets and Hochfeld’s personal assets, which are now being used to compensate defrauded investors.  Last month, a federal court judge approved a $6 million distribution to harmed Heppelwhite investors.

 

“We’re committed to rewarding proactive cooperation that helps us protect investors, however the most useful cooperators often aren’t innocent bystanders,” said Scott W. Friestad, an associate director in the SEC’s Division of Enforcement.  “To balance these competing considerations, the DPA holds Herckis accountable for his misconduct but gives him significant credit for reporting the fraud and providing full cooperation without any assurances of leniency.”

 

According to the DPA, Herckis served as the fund’s administrator from December 2010 to September 2012, when he resigned and contacted government authorities with his concerns about Hochfeld’s conduct and certain discrepancies in Heppelwhite’s accounting records.  Herckis voluntarily produced voluminous documents and described to the SEC how Hochfeld was able to perpetrate his fraud.  As a result, the SEC was able to file the emergency action within weeks.

 

Under the terms of the DPA, which states that Herckis aided and abetted Hochfeld’s securities law violations, Herckis must comply with certain prohibitions and undertakings.  Herckis cannot serve as a fund administrator or otherwise provide any services to any hedge fund for a period of five years, and he also cannot associate with any broker, dealer, investment adviser, or registered investment company.  The DPA requires Herckis to disgorge approximately $50,000 in fees he received for serving as the fund administrator, which will be added to the Fair Fund that has been created to help compensate Heppelwhite investors.  A second round of distributions from the Fair Fund is expected after additional money is collected for harmed investors through the sale of Hochfeld’s personal assets, including a collection of antiques he paid for with stolen funds.

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Deferred Prosecution Agreement Announced for a Former Hedge Fund Manager

As released by the Securities and Exchange Commission:

The Securities and Exchange Commission announced a deferred prosecution agreement with a former hedge fund administrator who helped the agency take action against a hedge fund manager who stole investor assets.

 

Deferred prosecution agreements (DPAs) encourage individuals and companies to provide the SEC with forthcoming information about misconduct and assist with a subsequent investigation.  In return, the SEC refrains from prosecuting cooperators for their own violations if they comply with certain undertakings.

 

According to the SEC’s DPA with Scott Herckis – the agency’s first with an individual – he served as administrator for Connecticut-based Heppelwhite Fund LP, which was founded and managed by Berton M. Hochfeld.  With voluntary and significant cooperation from Herckis, the SEC filed an emergency enforcement action against Hochfeld in November 2012 for misappropriating more than $1.5 million from the hedge fund and overstating its performance to investors.  The SEC’s action halted the fraud and froze the hedge fund’s assets and Hochfeld’s personal assets, which are now being used to compensate defrauded investors.  Last month, a federal court judge approved a $6 million distribution to harmed Heppelwhite investors.

 

“We’re committed to rewarding proactive cooperation that helps us protect investors, however the most useful cooperators often aren’t innocent bystanders,” said Scott W. Friestad, an associate director in the SEC’s Division of Enforcement.  “To balance these competing considerations, the DPA holds Herckis accountable for his misconduct but gives him significant credit for reporting the fraud and providing full cooperation without any assurances of leniency.”

 

According to the DPA, Herckis served as the fund’s administrator from December 2010 to September 2012, when he resigned and contacted government authorities with his concerns about Hochfeld’s conduct and certain discrepancies in Heppelwhite’s accounting records.  Herckis voluntarily produced voluminous documents and described to the SEC how Hochfeld was able to perpetrate his fraud.  As a result, the SEC was able to file the emergency action within weeks.

 

Under the terms of the DPA, which states that Herckis aided and abetted Hochfeld’s securities law violations, Herckis must comply with certain prohibitions and undertakings.  Herckis cannot serve as a fund administrator or otherwise provide any services to any hedge fund for a period of five years, and he also cannot associate with any broker, dealer, investment adviser, or registered investment company.  The DPA requires Herckis to disgorge approximately $50,000 in fees he received for serving as the fund administrator, which will be added to the Fair Fund that has been created to help compensate Heppelwhite investors.  A second round of distributions from the Fair Fund is expected after additional money is collected for harmed investors through the sale of Hochfeld’s personal assets, including a collection of antiques he paid for with stolen funds.

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SEC Charges Royal Bank of Scotland Subsidiary with Misleading Investors in Subprime RMBS Offering

As released by the Securities and Exchange Commission:

The Securities and Exchange Commission today charged RBS Securities Inc., a subsidiary of the Royal Bank of Scotland plc, with misleading investors in a 2007 subprime residential mortgage-backed security (RMBS) offering.  RBS agreed to settle the matter and pay more than $150 million, which the SEC will use to compensate investors for harm suffered as a result of RBS’s conduct.

The SEC alleges that RBS said the loans backing the offering “generally” met the lender’s underwriting guidelines even though nearly 30 percent fell so short of the guidelines that RBS should have excluded them from the offering entirely.  Stamford, Connecticut-based RBS, then known as Greenwich Capital Markets, quickly reviewed a very small portion of the loans and was paid approximately $4.4 million for its work as the lead underwriter on the transaction, the SEC said in a complaint filed in federal court in Connecticut.

“In its rush to meet a deadline set by the seller of these loans, RBS cut corners and failed to complete adequate due diligence, with predictable results,” said George S. Canellos, co-director of the SEC’s Division of Enforcement. “Today’s action punishes that misconduct and secures more than $150 million in relief for those harmed by this shoddy securitization.”

RBS told investors the loans backing the offering were “generally in accordance with” the lender’s underwriting guidelines, which consider the value of the home relative to the mortgage and the borrower’s ability to repay the loan.  RBS knew or should have known that was false because due diligence before the offering showed that almost 30% of the loans underlying the offering did not meet the underwriting guidelines.  In its complaint, the SEC said RBS gave investors a misleading impression of the quality of the loans backing the offering and the likelihood of their repayment.

The SEC’s complaint charges Stamford-based RBS with violations of Sections 17(a)(2) and (3) of the Securities Act of 1933.  RBS, without admitting or denying the SEC’s allegations, has agreed to a final judgment that orders it to disgorge $80.3 million, plus prejudgment interest of $25.2 million, and pay a civil penalty of $48.2 million.

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New York-Based Audit Firm and Four Accountants Charged for Failures in Audits

As released by the Securities and Exchange Commission:

The Securities and Exchange Commission announced sanctions against a New York-based audit firm, its founder, two other partners, and an audit manager for their roles in the failed audits of three China-based companies publicly traded in the U.S.

 

An SEC investigation found that Sherb & Co. LLP and its auditors falsely represented in audit reports that they had conducted the audits in accordance with U.S. auditing standards when it fact they were riddled with failures and improper professional conduct.  One of the companies they audited – China Sky One Medical Inc. – has since been charged by the SEC with financial fraud.

 

To settle the SEC’s charges, the firm and the four auditors agreed to be barred from practicing as accountants on behalf of any publicly traded company or other entity regulated by the SEC.  The firm agreed to pay a $75,000 penalty.

 

“Auditors are critical gatekeepers in the financial reporting process, but Sherb & Co. and its auditors failed to live up to their professional obligations in multiple audits during a five-year period,” said Andrew Ceresney, co-director of the SEC’s Division of Enforcement.

 

According to the SEC’s order instituting settled administrative proceedings, the flawed audits involved China Sky One Medical, China Education Alliance Inc., and Wowjoint Holdings Ltd.  The individuals responsible for the audits were the firm’s founder Steven J. Sherb, fellow partners Christopher A. Valleau and Mark Mycio, and audit manager Steven N. Epstein.  They failed to properly plan and execute the audits, and they did not obtain sufficient competent evidential matters concerning sales, revenue, or bank balances.  They ignored clear red flags and failed to exercise professional skepticism and due care.  They also failed to maintain complete audit work papers.

 

According to the SEC’s order, Sherb engaged in improper professional conduct as the concurring partner for the China Sky audit and as concurring partner and engagement quality review (EQR) partner for the Wowjoint audits.  Valleau engaged in improper professional conduct as the engagement partner for the China Sky audit and four of five Wowjoint audits, and as the EQR for the China Education audit.  Mycio engaged in improper professional conduct as the engagement partner for the China Education audit and one of the Wowjoint audits.  Epstein engaged in improper professional conduct as the senior audit manager on the China Sky audit, China Education audit, and four of five Wowjoint audits.

 

The SEC order finds that Sherb & Co., Sherb, Valleau, Mycio, and Epstein violated Rule 102(e)(1)(ii) of the SEC’s Rules of Practice and Section 4(C) of the Securities Exchange Act of 1934.  The SEC’s order also finds that Sherb & Co. and Mycio violated Exchange Act Section 10A(b)(1).  Sherb & Co. and Mycio are ordered to cease and desist from committing or causing any violations of Section 10A(b)(1) of the Exchange Act.  Sherb, Valleau, and Mycio are prohibited from practicing before the SEC as an accountant for at least five years, and Epstein is barred for at least three years.

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