More On Legal & Compliancefrom The Advisor's Professional Library
- The Need for Thorough and Effective Policies and Procedures Whethere an advisor is SEC or state-registered, RIAs must revise their policies and procedures to address significant compliance problems occurring during the year, changes in business arrangements, and regulatory developments.
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
Among recent enforcement actions, the Department of Labor oversaw the restoration of nearly $2 million in 401(k) benefits to the employees of Lange Trucking Inc., a contractor with the U.S. Postal Service.
In addition, the SEC charged Diamond Foods for boosting earnings growth via an accounting scheme to inflate the price of walnuts.
DOL Sees Nearly $2 Million Restored to U.S. Postal Contractors
After an investigation by the Wage and Hour Division of the Department of Labor, Lange Trucking Inc. was on the hook for nearly $2 million in unpaid 401(k) contributions for its employees.
Lange, which had a contract with the U.S. Postal Service that employed 515 drivers, had failed to make the contributions — and had been previously investigated several times by Wage and Hour. It was acquired, subsequent to its violations, by Eagan, Minn.-based Hoovestal Inc., which voluntarily agreed to provide the bulk of the missing benefit contributions — $1.48 million — while Lange itself agreed to provide $500,000.
The company, along with its president, William A. Langenhuizen; vice president, William H. Langenhuizen; secretary-treasurer, Antoinette Langenhuizen; vice president, Robert Langehuizen; and vice president of finance, Lisa Kulak, have been debarred from eligibility for further service contracts with any U.S. government agency for three years for their failure to pay drivers required fringe benefits.
Hoovestal, on the other hand, not only cooperated fully with the Wage and Hour Division during its investigation, but has also corrected recordkeeping procedures, overhauled the plan to ensure timely payments into the plan going forward, posted wage determinations at the work site and made information about the contracts accessible to employees.
SEC Fines Diamond Foods $5 Million for Falsifying Nut Prices
San Francisco-based Diamond Foods and two former executives found themselves charged by the SEC with falsifying the cost of walnuts so that the company could boost earnings and meet analyst estimates. The company has agreed to pay $5 million to settle the charges.
According to the SEC, the price of walnuts escalated sharply in 2010. If Diamond wanted to keep its growers, it had to pay them higher prices, but if the company did that, it would cut the net income it reported publicly.
Diamond’s then-chief financial officer Steven Neil, who was under pressure to meet or beat Wall Street analysts' earnings estimates, came up with a way to change all that. He directed that those higher payments to walnut growers not be reported immediately, but be delayed so that he could manage earnings in the financial statements.
The way Neil managed it was to come up with two special payments to please Diamond’s walnut growers and bring the total yearly amounts paid to growers closer to market prices. Then he left off parts of those payments from the company's year-end financial statements, instead instructing his finance team to consider the payments as advances on crops that had not yet been delivered.
That meant the company was able to manipulate walnut costs so that it hit quarterly earnings per share (EPS) targets and beat analyst estimates, even going so far as, in Q2 2010, broadcasting its record of “Twelve Consecutive Quarters of Outperformance” in the EPS reports used in investor presentations.
Neil, who personally benefited from the maneuvers via cash bonuses and other compensation that were based on the false results, also lied to the firm's independent auditors about the payments' unusual accounting treatment, the SEC said. Also charged was the company's former CEO, Michael Mendes, who the SEC said should have known what Neil was up to and failed to come clean with auditors about what he knew about the walnut payments.
As a result of his manipulations, Diamond was able to report higher net income and inflated earnings that beat analyst expectations for fiscal quarters in 2010 and 2011. However, once the company restated its financial results in November 2012 to indicate the actual cost of the walnuts it had purchased, its stock price fell from its 2011 high of $90 to only $17 per share.
Mendes has also agreed to settle the charges against him, paying a $125,000 penalty to settle the charges without admitting or denying the allegations and having already returned or forfeited more than $4 million in bonuses and other benefits he received during the time of the company’s fraudulent financial reporting. However, litigation continues against Neil.
SEC Announces Settlements in Penny Stock Shell Packaging Scheme
The SEC has announced nearly $300,000 in settlements against a Virginia-based “shell packaging” company and its CEO who were charged with facilitating a penny stock scheme as well as a Bronx, N.Y.-based stock promoter who rprofited from the fraud.
According to the SEC, Virginia-based Belmont Partners LLC and Joseph Meuse, its CEO, identify and sell public shell companies for use in reverse mergers. Late in 2011, the agency charged both with aiding and abetting a New York-based company that fraudulently issued and sold unregistered shares of its common stock.
In the case, the SEC separately named Thomas Russo, who co-owned a stock promotion service called TheStockProphet.com, as a relief defendant as a means of recovering ill-gotten gains in his possession as a result of his business partner’s participation in the scheme.
Sanjay Wadhwa, senior associate director for enforcement in the SEC’s New York regional office, said, “Meuse and his firm not only sold the shell company but they fabricated the documents necessary to dupe the transfer agent into issuing shares that should never have been sold to the public. Russo received proceeds from the subsequent sale of the illicit stock.”
Belmont Partners and Meuse have agreed to pay $224,500. Meuse additionally has agreed to be barred from the penny stock business or from serving as an officer or director of a public company for at least five years. In a separate judgment, Russo has already agreed to pay $70,075.
A settlement was previously reached by the SEC with the Long Island-based issuer at the center of the scheme, Alternative Green Technologies (AGTI), as well as with its CEO Mitchell Segal. Financial penalties against the latter will be determined at a later date.
SEC Wins on Front Running, Loses on Insider Trading in Illinois Case
An Illinois jury reached a split decision in the SEC's case against Siming Yang and his investment company, Prestige Trade Investments Ltd. The jury found for the defendants and against the SEC on an insider trading claim, but in favor of the SEC and against Yang on a front running charge and two false filing claims.
On March 27, 2012, Xianfu Zhu, chairman and CEO of Zhongpin Inc., announced that he had submitted a nonbinding proposal to take the company private by purchasing all outstanding shares. The price would be $13.50 per share, a 46% increase over the closing price the prior day. The meat and food processing company is based in Changge City, Henan Province, China.
The SEC's initial complaint, which named seven defendants, was based on what the agency termed "suspicious" trading, information and belief. The seven defendants were Yang, a New York City resident who at one time was employed by a New York City registered broker-dealer and investment advisor; Prestige Trade Investment Ltd., a company created in January 2012 by Yang; Caiyin Fan, a Chinese citizen and resident who had a joint brokerage account with Yang; Shui Chong (Eric) Chang, a resident of Hong Kong formerly employed at Deutsche Bank Securities, New York City; and three others.
The allegations were that Yang and Fan purchased 2,571 call options and 58,000 shares of Zhongpin stock for a total of $688,962 shortly before the deal announcement, after which they had unrealized profits of $733,006; Prestige purchased more than 3 million shares of stock shortly before the announcement, after which it had unrealized profits of $7.6 million; and Chang purchased 4,035 call options and 32,500 shares of stock for a total of $446,895, which yielded unrealized profits of $828,188 after the announcement.
According to the initial complaint, coordinated trading was alleged among the defendants, but the complaint was later amended to name only Yang, Fan, Prestige and Chang as defendants and changing the charges from suspicious trading to front running and false filing. The insider trading claims were also retained.
Yang and Prestige went to trial, and the jury found against the SEC on the insider trading charge against them both. However, on the charges of front running and false SEC filing, the jury found for the SEC and against Yang.
Penalties will be assessed later.
Lazard Capital Markets LLC was censured and fined $300,000 by FINRA on findings that it failed to include in more than 4,100 equity research reports its involvement with the companies at hand.
Such disclosures are required by provisions of NASD Rule 2711(h).
Lazard failed to disclose in research reports that it had acted as manager or co-manager in public offerings for the subject company in the past 12 months, or that it received compensation for investment banking services from the subject company in the past 12 months.
FINRA also found that the firm failed to disclose in the reports that it made a market in the securities of covered companies at the time the research report was published. Lazard did this after beginning to register as a market maker in NYSE-listed securities but inadvertently failed to include those particular securities in the database that was used to generate that disclosure.
The firm’s research disclosure deficiencies particularly affected reports issued during a two-year period, when the firm failed to include required disclosures in approximately 47% of all research reports it published. In addition, FINRA cited compliance failures in connection with the disclosure failures.
Lazard neither admitted nor denied the findings.
Check out VP in Conflicts Office at J.P. Morgan Securities Barred for Leaking Inside Info on ThinkAdvisor.