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SEC Enforcement: Merrill Lynch Fined for Mini-Flash Crashes

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Among recent enforcement actions by the Securities and Exchange Commission were a penalty of $12.5 million against Merrill Lynch for trading controls failures that led to mini-flash crashes.

In addition, the agency imposed a $140 million penalty on an oil services company for accounting fraud; fined and censured a fund manager for illegal cross-trading and principal trading; charged a chief executive officer and a boiler room operator with fraud; and charged Peruvian traders using overseas accounts with insider trading.

Merrill Lynch Fined $12.5M for Mini-Flash Crashes

Merrill Lynch has agreed to pay a $12.5 million penalty for maintaining ineffective trading controls that failed to prevent erroneous orders from being sent to the markets and causing mini-flash crashes.

According to the SEC, an investigation found that Merrill Lynch caused market disruptions on at least 15 occasions from late 2012 to mid-2014, and violated the Market Access Rule because its internal controls that were supposed to prevent erroneous trading orders were set at levels so high that it rendered them ineffective.

For example, Merrill Lynch applied a limit of 5 million shares per order for one stock that only traded around 79,000 shares per day. Other trading strategies had limits set as high as 25 million shares, which Merrill Lynch reduced to 50,000 shares after the SEC’s investigation began.

The erroneous orders passing through the firm’s internal controls caused some stock prices to plummet and then suddenly recover within seconds. Among the mini-flash crashes were 99% drops in the stocks of Anadarko Petroleum Corp. on May 17, 2013, and Qualys Inc. on April 25, 2013. Another order led to a nearly 3% drop in Google’s stock in less than a second on April 22, 2013.

The SEC also found that Merrill Lynch violated the Market Access Rule’s requirement for annual CEO certifications in 2013 and 2014. Merrill Lynch has consented to the SEC’s order without admitting or denying the findings.

Oil Services Company to Pay $140 Million on Accounting Fraud Charges

Oil services company Weatherford International has agreed to pay a $140 million penalty to settle charges that it inflated earnings by using deceptive income tax accounting. Two of the company’s senior accounting executives at the time have agreed to settle charges that they were behind the scheme.

According to the SEC, Weatherford fraudulently lowered its year-end provision for income taxes by $100 million to $154 million each year so the company could better align its earnings results with its earlier-announced projections and analysts’ expectations.

James Hudgins, who served as Weatherford’s vice president of tax, and Darryl Kitay, who was a tax manager, made numerous post-closing adjustments to fill gaps and meet its previously disclosed effective tax rate (ETR), which is the average rate that a company is taxed on pretax profits.

Weatherford regularly touted its favorable ETR to analysts and investors as one of its key competitive advantages, and the fraud made it look as if Weatherford’s designed tax structure was far more successful than it really was. As a result, Weatherford had to restate its financial statements on three occasions in 2011 and 2012.

Weatherford, Hudgins, and Kitay consented to the SEC’s order without admitting or denying the findings that they violated antifraud provisions of federal securities laws. Weatherford must pay the $140 million penalty, Hudgins must pay $334,067 in disgorgement, interest and penalty and Kitay must pay a $30,000 penalty.

Hudgins is barred from serving as an officer or director of a public company for five years, and Hudgins and Kitay are suspended from appearing and practicing before the SEC as accountants, which includes not participating in the financial reporting or audits of public companies. The order permits Hudgins and Kitay to apply for reinstatement after five years.

The SEC’s investigation is continuing.

Aviva Investors Censured, Fined on Illegal Cross-Trading, Principal Trading

The SEC has fined Aviva Investors Americas, LLC, a successor entity to Aviva Investors North America, Inc., a total of $250,000. It has also censured the firm, which has neither admitted nor denied the charges arising out of its failure to adopt and implement adequate policies and procedures to prevent unlawful cross and principal trading by its trading personnel.

According to the agency, beginning in March 2010 and through December 2011, AINA, a registered investment advisor to various clients, arranged cross-trade transactions in which three of AINA’s traders sold fixed-income securities from certain AINA advisory client accounts to counterparty broker-dealers, and then bought them back the next day from the same broker-dealers for the accounts of certain other AINA advisory clients.

The traders and the registered representatives at the broker-dealers negotiated the sales and repurchases of the securities at the same time. Approximately 137 of the cross-trades were between AINA’s registered investment company clients and other AINA clients who were affiliated persons of a RIC or affiliated persons of an affiliated person of a RIC, including insurance companies owned by AINA’s parent company, Aviva plc, and pooled vehicles not owned by AINA or its parent.

As a result, some of AINA’s advisory clients conducted trades with affiliates unwittingly in violation of Sections 17(a)(1) and (a)(2) of the Investment Company Act. An additional 24 trades were effected between AINA insurance clients and private fund clients, but since Aviva plc owned the AINA insurance clients and was therefore acting as principal for trades involving those clients, AINA conducted principal trades in violation of Section 206(3) of the Advisers Act.

While the company’s compliance department identified and tried to prevent the unallowed cross-trading, the SEC said in its complaint that it failed to do so, in part because “during the relevant time period the individuals working on cross trading within AINA’s compliance department were underqualified, under resourced, and required additional training and resources to effectively implement AINA’s trading restrictions. Senior members of the compliance department raised the need for additional compliance resources on multiple occasions to AINA’s senior management. Those requests were not met.”

In addition, due to a heavy compliance workload, a lot of the monitoring was offloaded onto a “low-level administrative assistant” who failed to identify them “because she reviewed the reports looking only for same-day trades between clients.”

Boiler Room Operator, Former CEO Charged in Microcap Fraud

The SEC charged a former microcap company CEO and a boiler room operator with defrauding seniors and others who were pressured to invest in a pair of penny stock companies and promised lucrative profits.

According to the agency, Craig Sizer founded Sanomedics Inc. and Fun Cool Free Inc., which were supposedly in the business of selling noncontact infrared thermometers and software applications respectively, and he hired Miguel “Michael” Mesa to help him attract and defraud investors in both companies.

Sizer provided Mesa with a list of pitch points for use by boiler-room agents hired by Mesa to sell shares of the stocks; investors were told that no investor funds would be used for research and development and no sales commissions would be paid out of investor funds.

However, the SEC said that Sizer and Mesa took approximately 90 percent of the funds raised from investors to enrich themselves and pay sales commissions to the boiler-room agents. Several hundred investors nationwide were defrauded out of a total of approximately $20 million.

In a parallel action, the U.S. Attorney’s Office for the Southern District of Florida has announced criminal charges.

Sizer and Mesa have agreed to partial settlements of the SEC’s charges without admitting or denying the allegations. Both agreed to be barred from future penny stock offerings, and Sizer agreed to be barred from serving as an officer or director of a public company. Financial sanctions will be decided by the court at a later date.

The SEC’s investigation is continuing.

SEC Charges Peruvian Traders With Insider Trading

The SEC charged two lawyers and a brokerage firm manager in Peru with insider trading prior to the merger of two mining companies.

According to the agency, Nino Coppero del Valle, who worked at Canadian-based HudBay Minerals Inc., tipped his close friend and fellow attorney Julio Antonio Castro Roca with material nonpublic information about a tender offer his company submitted to acquire the shares of Arizona-based Augusta Resource Corp.

Castro then traded on the information through a brokerage account held by a shell company he set up in the British Virgin Islands in an attempt to avoid having the trades traced back to him and Coppero. He and Coppero made more than $112,000 in illicit profits from these trades.

Coppero also tipped an acquaintance, Ricardo Carrion, when seeking his advice about making illegal trades untraceable. The SEC said that Carrion exploited the inside information and caused his brokerage firm to purchase Augusta Resource shares ahead of the tender offer announcement, making $73,000 in alleged profits.

The SEC seeks disgorgement of ill-gotten gains plus interest and penalties, among other things. Its investigation is continuing.

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