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Enforcement Roundup: Ex-CCO Sues Over ‘Defamatory’ Form U5

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Among recent enforcement actions by the Securities and Exchange Commission were charges against a former brokerage CEO for his part in a fraudulent scheme; against an Atlanta man for insider trading; against five offshore entities for offering and selling unregistered penny stocks; and against a mutual fund advisor for improperly handling fund assets.

In addition, the former chief compliance officer of a broker-dealer has sued the firm and its principals, saying he was fired in retaliation for investigating and reporting wrongdoing instead of for the reasons the firm claimed on his Financial Industry Regulatory Authority Form U5.

Former CCO Sues Firm, Principals

The former CCO of Cabot Lodge Securities, Inc., Albert Ackerman, has sued Cabot Lodge; URTI GP LLC; Jacob Frydman; and Craig Gould, saying that they filed a “false and defamatory” Form U5 after Ackerman uncovered and reported wrongdoing in his capacity as CCO.

According to the suit, filed in New York, Ackerman found that Frydman, who controls URTI GP, engaged in behavior that included “frivolous and trivial litigation” and the misuse of funds.

Ackerman’s suit says that he went to Gould, who is acting CEO of Cabot Lodge, with his concerns. However, Gould not only took no action and did not report any of the “unlawful activities” but, in concert with Frydman, terminated Ackerman and submitted a U5 that characterized his termination as “‘discharge’ and articulates false and defamatory reasons for said discharge.”

In addition, the suit says that before the U5 was submitted, Gould and Frydman called Ackerman and “offered to ‘go easy’ if [Ackerman] would be willing to testify in a pending legal matter involving Jacob Frydman.”

When Ackerman declined, he was “harass[ed] … by sending threatening text and email messages…” and the Form U5 was filed. As a result, the suit said, another firm withdrew a job offer it had made to Ackerman and his reputation was damaged.

In addition to seeking the return of funds from Frydman that he says in the suit were misused, Ackerman seeks an award of no less than $1 million.

Former Brokerage CEO Charged by SEC in Fraudulent Scheme

The SEC has settled charges filed against Craig Lax, the former CEO of the brokerage subsidiary of global investment services firm ConvergEx Group Securities.

The subsidiary and two others were previously charged in a scheme to defraud customers, and have paid $107 million and admitted wrongdoing to settle the charges. The SEC had also charged two former employees in that previous action, as well as filing charges separately against a different former ConvergEx subsidiary CEO; that last case is pending in federal court.

According to the agency, the ConvergEx subsidiaries under his control schemed to cause customers to pay considerably higher amounts than the disclosed commissions for buying and selling securities. They concealed the fact that they routed trading orders to an offshore affiliate to pile on hidden markups and markdowns referred to as “trading profits” or “TP.”

Lax authorized employees to temporarily suspend taking TP when a customer asked for a certain report that could reveal the hidden charges. He also authorized a proprietary trading algorithm that hid those charges from a customer. He also skirted possible customer questions about why one particular trader was located offshore by requesting new business cards claiming that the trader was located in New York.

In addition to being barred from the securities industry for at least five years, Lax has agreed to pay more than $783,000 and admit wrongdoing, as well as to cooperate in the ongoing investigation and in litigation. A financial penalty in addition to what he has already agreed to will be determined at a later date.

SEC Charges Atlanta Man With Insider Trading

Charles Hill Jr. of Atlanta was charged by the SEC with insider trading in the stock of a technology company by exploiting nonpublic information he learned from the friend of a company executive.

According to the agency, Hill’s friend was also friends with an executive at Radiant Systems, and when the friend learned from the executive some confidential inside information about an impending tender offer by NCR Corp. to buy the company, he shared that with Hill. Hill promptly went out and bought about 100,000 shares of stock in the company — in which he had never previously invested — and in fact had not bought any stock at all for the four years previous to the purchase.

The stock Hill bought was worth nearly $2.2 million on the last trading day before the acquisition was publicly announced in July 2011. When Hill sold the stock, he made approximately $740,000 in illicit profits. Appropriate remedial actions will be decided at a public hearing before an administrative law judge.

Five Offshore Entities Charged, Assets Frozen for Penny Stock Sales

The SEC has charged five offshore entities, Cayman Islands-based Caledonian Bank Ltd. and Caledonian Securities Ltd., Belize-based Clear Water Securities Inc. and Legacy Global Markets S.A. and Panama-based Verdmont Capital S.A. with offering and selling unregistered penny stocks. In addition, it has imposed an emergency asset freeze against the five.

According to the agency, the five companies sold penny stocks in unregistered distributions from their U.S. brokerage accounts of four shell company issuers: Swingplane Ventures Inc., Goff Corp., Norstra Energy Inc. and Xumanii Inc.

Each of the distributions followed the same basic pattern. The issuers first filed bogus Forms S-1 with the SEC that supposedly registered sales of securities to public investors; however, no such sales happened. Instead, the securities supposedly sold remained in the control of the issuers and their affiliates.

In the fake offerings, the issuers pretended to sell securities to investors residing in such places as Serbia, Mexico, Ireland, Norway, Panama and Jamaica. Meanwhile, the issuers or their affiliates kept control and possession of the stock certificates.

In the scheme, restricted stock was passed off as “free trading” unrestricted stock and the share certificates issued were subsequently transferred, without restrictive legends, to the five offshore entities. The entities then deposited the shares into their U.S. brokerage accounts and sold the shares to the public.

In addition, the issuers or their affiliates directed the transfers of restricted securities to the entities, often through various offshore nominee entities intended to conceal beneficial ownership of the securities. Once the shares, controlled throughout by the issuers or their affiliates, were held in names of the five entities, the shell company issuers announced a reverse merger or business combination with a supposedly operating enterprise.

The five entities then offered and sold hundreds of millions of shares of all four issuers, all at the same time, in unregistered distributions with aggressive and extensive promotion campaigns. Each of the four stocks lost practically all market value within months of the unregistered sales. The five entities, with their actions, operated as affiliates, dealers, sales outlets and underwriters by offering and selling the penny stocks from brokerage accounts in the U.S.

In addition to other enforcement measures, the SEC is seeking the disgorgement of all proceeds obtained in the unregistered distributions and the imposition of civil penalties. The investigation is continuing.

Former Execs Agree to Return Bonuses, Stock Sale Profits in Fraud Case

Two former chief financial officers have agreed to return almost a half million dollars that they received in bonuses and the profits from stock sales while their Silicon Valley software company was committing accounting fraud.

According to the SEC, William Slater and Peter Williams III received $337,375 and $141,992, respectively, during times when Saba Software presented materially false and misleading financial statements. Although they were not personally charged with the company’s misconduct, both are still required to return the money from bonuses and stock sale profits that they got during the fraud. Saba Software overstated its pretax earnings and made material misstatements about its revenue recognition practices while Slater served as CFO from December 2008 to October 2011, and while Williams served as CFO from October 2011 to January 2012.

Both agreed to the SEC’s order without admitting or denying its findings that they were in violation of Section 304 of the Sarbanes-Oxley Act.

SEC Charges Mutual Fund Manager for Improper Asset Handling

The SEC has charged Water Island Capital LLC, the investment advisor to five alternative mutual funds, with keeping millions of dollars of the funds’ cash collateral at broker-dealer counterparties instead of at the funds’ custodial bank. The agency found the violations during an examination.

According to the SEC, Water Island Capital was responsible for the maintenance of approximately $247 million in cash collateral held by broker-dealer counterparties, which should have been was maintained with the funds’ custodial bank. The cash collateral related to the funds’ investments in certain total return and portfolio return swaps.

Instead, the firm failed to implement the funds’ directed brokerage policies and procedures, which required it to create and maintain an approved list of executing brokers for the funds as well as to monitor with documentation the funds’ compliance with the directed brokerage requirements. Water Island Capital failed to create the list, and failed to maintain documentation reflecting monitoring of the funds’ compliance pursuant to the funds’ policies and procedures.

Without admitting or denying the agency’s findings, Water Island Capital consented to a cease-and-desist order and agreed to pay a $50,000 penalty to settle the charges.