More On Legal & Compliancefrom The Advisor's Professional Library
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
Among recent enforcement actions by the SEC were charges against the owner of an investment advisory firm for insider trading; against a former tech company executive for tipping in the Rajaratnam insider trading case; against an independent filmmaker for insider trading; against a former Qualcomm executive and his former financial advisor for insider trading; against two former bank executives for financial misstatements; against the former president of an investment firm for fraud; and against the founder of Left Behind Games and his friend in a revenue inflation scheme.
Advisor Charged With Insider Trading of Drug Firm
Tibor Klein, president of New York-based Klein Financial Services, was charged by the SEC with insider trading after he used confidential information about Pfizer’s planned acquisition of King Pharmaceuticals to make more than $300,000 by trading in both his own and client accounts in advance of the public announcement.
His friend Michael Shechtman, a South Florida stockbroker, was also charged after he made more than $100,000 on a tip from Klein.
The SEC said that Klein got the nonpublic information on the approaching August 2010 merger from an attorney client who worked on matters for King Pharmaceuticals. The first day the market opened after Klein learned the information, Aug. 16, he went on a stock-buying spree for himself and his clients. That gave him away; he hadn’t bought so many shares of a single stock in such a short time that whole year.
Klein also made repeated calls to Shechtman on Aug. 16 and again on Aug. 18. On the first date Shechtman opened an account to trade options, something he had never traded before, and on August 18 he bought 2,500 shares of King Pharmaceuticals stock and 300 call options in his personal account, and 2,400 shares in his wife’s Roth IRA account.
The announcement didn’t go public till Oct. 12; King Pharmaceuticals stock subsequently gained 39% and its trading volume soared 12,000% from the day before. Post-announcement, Klein sold his own and his clients’ shares, making profits of $328,375.02; Shechtman sold the stock and the options and brought in profits of $109,040.53.
The SEC seeks disgorgement of ill-gotten gains, financial penalties, and other penalties against the two.
Independent Filmmaker Charged With Insider Trading
Manhattan-based independent filmmaker Lawrence Robbins has been charged by the SEC with insider trading based on confidential information from his business partner John Michael Bennett about impending takeovers of two biotechnology companies, Millennium Pharmaceuticals and Sepracor.
Bennett and his friend Scott Allen, from whom he received the information, were previously charged in the scheme.
Allen learned the confidential information prior to the two acquisitions through his job at a global consulting firm that was advising the acquiring company in each deal. Thanks to his leaking the information to Robbins and Bennett, the latter two collectively spent tens of thousands of dollars acquiring call options in the companies, then made more than $2.6 million in illicit profits after the deals were publicly announced. Robbins used part of his proceeds to fund the independent film production business that he shared with Bennett.
Allen got the information on Millennium in mid-February 2008 when his firm began advising Japan-based Takeda Pharmaceutical Company during its negotiations with Millennium. On Feb. 27, he passed inside information about the deal to Bennett, who then shared it with Robbins. The two began stockpiling shares two days later, and when the announcement was made public on April 10, the 48% increase in share price brought Robbins $1.12 million in profits and Bennett more than $602,000.
Then, in May 2009, Allen participated in due diligence work for the Japanese firm Dainippon Sumitomo Pharma Co. (DSP) in connection with its impending acquisition of Sepracor. Again he shared what he knew with Robbins and Bennett, who went into action once more. This time they made more than $388,000 and $516,000 respectively.
Robbins has agreed to pay more than $1 million to settle the SEC’s charges: $865,000 in disgorgement and prejudgment interest and a $150,000 penalty. The settlement, subject to court approval, takes into account Robbins’ current financial condition.
The SEC’s case continues against Allen and Bennett, who have pleaded guilty in parallel criminal actions.
Ex-Qualcomm Exec, Advisor Charged With Insider Trading From Secret Offshore Accounts
Jing Wang, a former executive vice president and president of global business operations at Qualcomm, and his former financial advisor Gary Yin, a former registered representative at Merrill Lynch, were charged by the SEC with insider trading that brought the two more than a quarter-million dollars in profits.
Wang and Yin became friends in 2005 as members of the same church. When Wang discovered that Yin was an advisor, he asked him to manage his money, and in the beginning all accounts and transactions were cleared with Qualcomm, as required by Wang’s status as a company officer.
However, that changed in early 2006, when Wang approached Yin about hiding cash transactions. Yin suggested Wang create an entity registered in the British Virgin Islands (BVI) and use a non-U.S. citizen family member’s name as the beneficial owner; then he could open a brokerage account in the new entity’s name.
Yin helped Wang set up a secret account in the name of a BVI company called Unicorn Global Enterprises, with Wang’s older brother listed as owner. Yin also created a BVI-registered entity for himself, named it Pacific Rim and put it in his mother-in-law’s name. Then he opened a Merrill Lynch brokerage account for that entity, using it to hide funds that he was using for investments.
The two used the secret accounts to trade on material, nonpublic information that Wang learned as an executive at Qualcomm, including the news of a share repurchase program in 2010 that Qualcomm executives were not allowed to trade stock for.
Wang instead ordered Yin to use all the money in the Unicorn account to buy shares, which clued Yin in to the clandestine nature of the transaction; Wang had never bought Qualcomm stock on the open market in his Merrill Lynch accounts. So Yin, too, bought shares, and the two profited after the stock repurchase plan was announced along with the company’s quarterly dividend announcement.
Wang next took things a step further, using the proceeds from this event to buy up shares of San Jose-based Atheros Communications—a planned Qualcomm acquisition that was so secret it was referred to in the company as “Project Tango.” Wang told Yin to sell all the shares in the Unicorn account and get ready to use the money to buy Atheros shares. Then, after a Qualcomm board meeting in China at which the acquisition price of $45 per share was disclosed to attendees, Wang instructed Yin to buy as many Atheros shares as possible for between $34 and $35 a share — and while he was at it, buy some shares for himself, which Yin did in his own offshore account.
Wang’s next insider trading move was to capitalize on a favorable Qualcomm earnings report in advance of its announcement — something he did only four minutes after selling the Atheros stock, according to the SEC.
Altogether, Wang made more than $244,000 in illegal profits through his insider trading, and Yin made more than $27,000. But Wang eventually realized that his transactions could be traced, and asked Yin to delete the Unicorn trade records — something he couldn’t do. Wang also asked Yin to open a new offshore account and transfer the proceeds there as a means of distancing himself from the trades, and to take other actions, including making a trip to China to discuss the trades with Wang’s brother, who the two planned to say had made the trades.
The SEC’s complaint seeks disgorgement of ill-gotten gains plus prejudgment interest, financial penalties and permanent injunctions, as well as an officer-and-director bar against Wang.
Former Exec Charged With Tipping in Rajaratnam Case
Kieran Taylor, formerly senior director of marketing for Akamai Technologies, was charged by the SEC with illegally tipping hedge fund portfolio manager Danielle Chiesi with confidential information about the company’s plans to lower its revenue guidance for 2008.
Chiesi, a lifelong family friend of Taylor, was then a portfolio manager at hedge fund advisory firm New Castle Funds. Chiesi not only prompted New Castle to short Akamai stock, she also took the knowledge and ran — straight to Rajaratnam, among other hedge fund managers. She also told another of Taylor’s friends, Steven Fortuna of the hedge fund advisory firm S2 Capital. These fund managers, along with Chiesi, used the knowledge to rack up around $10 million in illegal profits by shorting the stock.
Taylor has agreed to settle the SEC’s charges by paying more than $145,000 — $20,635 in disgorgement, $4,190.26 in prejudgment interest and a $120,635 penalty — and being barred from serving as an officer or director of a public company. The settlement is subject to court approval.
The investigation continues.
Former Bank Execs Charged for Financial Misstatements
Ted Awerkamp of Amarillo, Texas, former CEO of Illinois-based Mercantile Bancorp, and Michael McGrath of Quincy, Ill., its former CFO, have been charged by the SEC with failure to recognize in financial statements a probable loss on one of the bank’s largest troubled loans.
Before the end of Q3 2010, the SEC said that Awerkamp knew the borrower in a shared national credit loan for a large residential real estate development to be built in Colorado Springs was unwilling or unable to contribute the necessary funds to complete the project, which served as collateral for the loan. Awerkamp also knew that the collateral had lost substantial value.
After Q3, but weeks prior to the filing of the bank’s quarterly report, Awerkamp and McGrath also learned that the borrower missed a loan payment and declared bankruptcy. U.S. accounting rules required that, because of these events and others, Mercantile must recognize a $5.28 million loan loss in its third quarter financial statements. But the bank did not.
Failure to report the loan loss meant that Mercantile’s statement that its main subsidiary bank had met certain capital ratio thresholds required by the Federal Deposit Insurance Corp. (FDIC) was not true. Mercantile also understated its net loss for the quarter and the nine months ending Sept. 30. The bank reported those figures as $7.5 million and $11 million, when instead they were actually at least $12.78 million and $16.28 million. The bank also falsely stated that its main subsidiary bank had a net income of $1.8 million for the first nine months of 2010, instead of the net loss it actually had of at least $3.48 million during that time.
Awerkamp and McGrath have agreed to settle the SEC’s charges by paying penalties of $100,000 each and being barred from acting as an officer or director of a publicly traded company.
Former President of Investment Firm Charged With Fraud
Larry Polhill, former president of American Pacific Financial Corp. (APFC), a purported private equity real estate firm based in San Bernardino, Calif., was charged by the SEC with defrauding nearly 500 investors who purchased promissory notes under the false premise that they were secured by specific properties or other collateral.
According to the SEC, Polhill used his company to buy and sell real estate and distressed assets. He wooed investors through unregistered notes that he claimed would bring them interest payments of 5% to 17% per year. What he didn’t tell them was that the supposedly safe collateral underlying their investments was often nonexistent or otherwise impaired. Sometimes he even sold them without telling investors.
When APFC eventually filed for bankruptcy, it named the investors as unsecured creditors who were owed nearly $160 million. None of Polhill’s investment offerings were registered with the SEC.
Not only promissory notes, but APFC-sponsored funds were also a way investors could “invest” in the company. These funds pooled investor money to make loans to APFC. The company made regularly scheduled interest payments to investors in the notes and the funds from the mid-1980s to 2007, which grew its investor base and encouraged the company to make ever-larger investments in distressed assets by buying companies out of bankruptcy.
While a few of APFC’s investments were successful, the vast majority failed, and investors never knew. The assets that supposedly secured the investors’ notes and loans dropped in value, again without investors’ knowledge. Finally, in early 2008, APFC ceased making scheduled payments to most investors; however, to keep up the pretense, it continued to issue newsletters, pay preferred investors, and engage in other activities that would keep investors in the dark about its true financial situation.
Polhill has agreed to settle the SEC’s charges and be barred from acting as the officer or director of any public company. The settlement is subject to the approval of the U.S. District Court for the Central District of California, which will decide monetary sanctions at a later date.
Left Behind Games CEO, Consultant Charged With Inflating Revenue
Troy Lyndon, founder, CEO and CFO of religious-themed video game manufacturer Left Behind Games, and his friend Ronald Zaucha, both living in Hawaii, have been charged with scheming to falsely inflate the company’s revenue by nearly 1,300% in a one-year period through sham circular transactions. In addition, sale of the company’s stock has been suspended.
The SEC said that Lyndon caused the company to issue almost two billion shares of stock to Zaucha as purported compensation for consulting services to the California-based company. The true purpose of the arrangement, however, was to enable Zaucha to sell millions of unregistered shares of Left Behind Games stock into the market and then kick back a portion of his stock proceeds to the company to prop up its revenue when it was in dire need of additional funds.
Left Behind Games was founded in 2001 and touted itself as “the only publicly traded exclusive publisher of Christian modern media” and “the world leader in the publication of Christian video games and a Christian social network provider.” That didn’t save the company from financial troubles, and at the end of 2011, it terminated all of its employees and closed its office.
The scheme started in 2009 when the two sought to save the severely undercapitalized and unprofitable company. Left Behind Games issued stock to Zaucha for his so-called consulting services, and at Lyndon’s direction he promptly sold nearly all the stock for approximately $4.6 million. He then kicked back approximately $3.3 million of that to the company in three deceiving ways.
In the second, in December 2010, Zaucha formed a company called Lighthouse Distributors and used the proceeds of his stock sales to finance the purchase of approximately $1.38 million in old and obsolete inventory from Left Behind Games. Lighthouse simply gave most of these products away to churches and religious organizations, yet Left Behind Games improperly recognized the revenue from these sham transactions and falsely claimed that its revenue had increased nearly 1,300% from the prior fiscal year.
In the third, Lyndon directed Zaucha to kick back another $1 million to Left Behind Games.
Lyndon did, however, allow Zaucha to retain $1.28 million of his stock sale proceeds for personal uses, which included the purchase of condominiums in Maui and Orange County, Calif.
Zaucha performed few, if any, consulting services, and each consulting agreement was vague about the services he was expected to provide. In addition, Zaucha did not have the experience to perform some of the functions.
The SEC seeks permanent injunctions, financial penalties and penny stock bars against Lyndon and Zaucha, and an officer-and-director bar against Lyndon. Its investigation is continuing.
Check out Top 10 Wall Street Crooks: Insider Trading on ThinkAdvisor.