RECENT SEC ENFORCEMENT CASES*
Submitted by**:
Thomas C. Newkirk
Associate Director
Susan A. Mathews
Senior Counsel
Division of Enforcement
Securities and Exchange Commission
Washington, DC
January 2003
*
Parts of this outline, written by present and former employees, have been used in other
publications.
**
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any
private publication or statement by any of its employees. The views expressed herein are those
of the author(s) and do not necessarily reflect the views of the Commission or of the authors’
colleagues upon the staff of the Commission.
As our capital markets continue to experience unprecedented growth and expansion, the Securities
and Exchange Commission’s (“Commission” or “SEC”) enforcement program has been challenged to
keep apace of market developments. In the wake of recent restatements by major corporations, the
Division of Enforcement (“Division”) continues to place emphasis on the detection and prosecution of
financial fraud. Insider trading, broker-dealer sales practices, violations involving mutual funds and
investment advisers, and fraudulent securities offerings continue to form the core of the enforcement
program. In Fiscal Year 2001, the Division brought 484 enforcement actions.
This Outline will review some of the Division’s significant recent activity. Copies of orders,
administrative releases, and litigation releases concerning the cases discussed below can be accessed on
the Commission’s web site at <www.sec.gov>.
I.
FINANCIAL FRAUD AND OTHER DISCLOSURE AND REPORTING
VIOLATIONS
The Division’s number one priority continues to be aggressive prosecution of financial fraud
and reporting cases. Actions involving false financial statements or false and misleading disclosures
about matters affecting an issuer’s financial condition tend to be complex and generally demand a
greater commitment of resources than other types of cases. Effective prosecution in this area is
essential to preserving the integrity of the full disclosure system.
1.
SEC v. Safety-Kleen Corp., Kenneth W. Winger, Paul R. Humphreys, William D.
Ridings, and Thomas W. Ritter, Jr., Lit. Release No. 17891, Accounting and
Auditing Enforcement Release No. 1690 (December 12, 2002),
www.sec.gov/litigation/litreleases/lr17891.htm.
The SEC filed a complaint in the United States District Court for the Southern District of New
York charging Safety-Kleen Corp. and four of its former senior executives with perpetrating a massive
accounting fraud from at least November 1998 through March 2000. The Commission alleged that
these individuals materially overstated the company's revenue and earnings in periodic reports filed
with the Commission and in press releases issued by the company. According to the complaint, the
defendants carried out the scheme primarily by making inappropriate quarterly accounting adjustments
for the purpose of meeting Wall Street pro forma earnings expectations. They are also charged with
fraudulently recording approximately $38 million of cash that was generated by entering into
speculative derivatives transactions.
The complaint alleges that the fraudulent scheme was orchestrated by Paul R. Humphreys, the
former Chief Financial Officer. William D. Ridings, the former Controller, and Thomas W. Ritter, Jr.,
the former Vice President of Accounting, assisted Humphreys. As set forth in the complaint, these
executives engaged in the illegal conduct to create the illusion that predicted cost savings and business
synergies from two large acquisitions were being achieved. In fact, the expected savings had not
materialized, the company's business was declining rapidly, and the company was facing a severe cash
flow problem. To make up for the earnings shortfall, Humphreys, Ridings and Ritter recorded, or
directed others to record, numerous adjustments that were not in conformity with generally accepted
accounting principles.
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After the fraudulent scheme was discovered in late February 2000, the company began an
internal investigation, which was conducted by a special committee of the Board of Directors. On July
9, 2001, Safety-Kleen filed restated financial statements for fiscal years 1997, 1998 and 1999. The
company's restatement reduced net income over the three-year period by $534 million. Approximately
$312 million, or 58%, of the restated net income was in fiscal 1999. Also on July 9, 2001, the company
filed financial statements for fiscal year 2000 reflecting a net loss of $833 million.
According to the complaint, through this conduct, (i) Safety-Kleen violated the antifraud,
periodic reporting, record keeping, and internal controls provisions of the federal securities laws, (ii)
Winger violated the antifraud and periodic reporting provisions, and (iii) Humphreys, Ridings and
Ritter violated the antifraud provisions and record keeping provisions. Humphreys and Ridings also
violated the internal controls provisions of the federal securities laws. As relief, the Commission is
seeking permanent injunctions, disgorgement of defendants' ill-gotten gains, prejudgment interest, and
the imposition of civil penalties against Winger, Humphreys, Ridings and Ritter. The Commission is
also seeking officer and director bars against Winger, Humphreys and Ridings.
The United States Attorney's Office for the Southern District of New York has filed related
criminal charges against Humphreys and Ridings. Ridings has entered a guilty plea and is waiting to
be sentenced. Ridings also consented, without admitting or denying the allegations in the
Commission's complaint, to the entry of a final judgment permanently enjoining him from violating the
antifraud and record keeping provisions of the federal securities laws. He also agreed to be
permanently barred from serving as an officer or director of a public company and to pay $28,476.14 of
disgorgement and prejudgment interest.
Simultaneous with the filing of the complaint, and without admitting or denying the
Commission's allegations, Safety-Kleen consented to the entry of a final judgment permanently
enjoining it from violating the antifraud, periodic reporting, record keeping, and internal controls
provisions of the federal securities laws. Ritter consented, without admitting or denying the allegations
in the complaint, to the entry of a final judgment permanently enjoining him from violating the
antifraud and record keeping provisions of the federal securities laws. A civil penalty was not imposed
against Ritter, and disgorgement and prejudgment interest were waived, based on his sworn statement
of financial condition.
In a related matter, the Commission instituted a settled cease-and-desist proceeding against
Susan Moore, Safety-Kleen's former financial reporting manager. Moore consented to the entry of the
order instituting proceedings without admitting or denying the findings therein, including findings that,
as directed by her superiors, she participated in the preparation of financial statements that, in the
exercise of reasonable care, she should have known were not in conformity with generally accepted
accounting principles. Moore was ordered to cease and desist from causing violations and any future
violations of the periodic reporting and record keeping provisions of the federal securities laws.
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2.
SEC v. 800 America.com, Inc., et al., Lit. Release No. 17863; AAE Release No. 1674
(Nov. 25, 2002), www.sec.gov/litigation/litreleases/lr17863.htm.
On November 21, 2002, Judge John S. Martin of the United States District Court for the
Southern District of New York granted the Commission's application for preliminary relief pending the
final determination of the Commission's case against 800 America.com, Inc. ("800America"), an Overthe-Counter Bulletin Board company and purported internet retailer; David Elie Rabi ("Rabi"), chief
executive officer, chief financial officer, and a director of 800America; and Tillie Ruth Steeples
("Steeples"), an undisclosed control person of 800America. The Commission alleged that the
defendants falsified financial results for 800America since at least 2000, unlawfully sold unregistered
stock through nominee accounts, failed to disclose the criminal histories of Rabi and Steeples, and
made other misrepresentations.
Specifically, the court's order provides that, pending the final determination of the case: (a) the
defendants are preliminarily enjoined from violating antifraud, registration, books and records, and
other provisions of the federal securities laws; (b) defendants' assets and certain nominee brokerage
accounts are frozen; (c) the defendants are required to submit accountings; (d) a temporary receiver has
been appointed over 800America; (e) Rabi and Steeples are enjoined from acting as officers or
directors of public companies and from participating in the offering of penny stocks; (f) the defendants
must repatriate assets held abroad; (g) the defendants are prohibited from destroying documents and
other evidence; and (h) the defendants are prohibited from tampering with witnesses, suborning perjury
or otherwise impeding this case.
The complaint charges violations of registration, antifraud, periodic reporting, record keeping,
and internal controls provisions of the federal securities laws thereunder. As final relief, the
Commission seeks permanent injunctions, disgorgement of all ill-gotten gains plus prejudgment
interest; civil penalties; and, against Rabi and Steeples, final penny stock and officer and director bars
and a forfeiture of stock under their control. The litigation is pending.
See also SEC v. 800 America.com, Inc., et al., Lit. Release No. 17835; AAE Release No. 1674 (Nov.
13, 2002), www.sec.gov/litigation/litreleases/lr17835.htm. (filing for emergency relief)
3.
SEC v. Phillip E. White, Lit. Release No. 17855, AAE Release No. 1671 (Nov. 21,
2002), www.sec.gov/litigation/litreleases/lr17855.htm.
On November 21, 2002, the Securities and Exchange Commission ("Commission") filed a civil
action in the United States District Court for the Northern District of California against Phillip E.
White ("White"), formerly President, Chief Executive Officer, and Chairman of the Board of Directors
of Informix Corporation ("Informix" or "Company"). (Informix was a multinational database software
and information asset management company whose stock was traded on Nasdaq National Market
System. On July 2, 2001, after selling its database software subsidiary, Informix was renamed
Ascential Software Corporation.) In its Complaint, the Commission alleges that White concealed
secret side agreements that rendered revenue recognition improper on certain transactions that Informix
had included in its financial statements for its fiscal year ended December 31, 1996. To further his
scheme, White made false statements and representations concerning the existence of these secret side
agreements to members of Informix's financial staff and to Informix's independent auditors. White did
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this to avoid triggering a restatement of Informix's 1996 financial statements. Informix's 1996 financial
statements, and the independent auditors' unqualified report thereon, were included in Informix's 1996
Annual Report, Securities and Exchange Commission Form 10-K ("Form 10-K"), which Informix had
filed with the Commission on March 31, 1997. The same financial statements and unqualified audit
report were incorporated by reference in Form S-8 registration statements ("Form S-8"), which
Informix filed on July 16, 1997. (The Forms S-8 registered twelve million shares of Informix stock for
sale to employees.) White signed the Form 10-K and Forms S-8. According to the Complaint, White
violated, or aided and abetted violations of, antifraud, periodic reporting, and record-keeping
provisions of the Securities Act of 1933 ("Securities Act") and Securities Exchange Act of 1934
("Exchange Act").
The Complaint alleges that, at the end of July 1997, Informix's financial staff and independent
auditors discovered the secret side agreements White was concealing. Informix's Board of Directors
immediately forced White to resign from the Company. Informix ultimately restated its 1996 financial
statements to reflect substantial decreases in its earnings and income caused by, among other things,
discovery of the two side agreements White concealed and various other side agreements. Informix's
amended 1996 Form 10-K revealed that, instead of earning net income of $97.8 million as Informix
originally reported, Informix suffered a net loss of $73.6 million in 1996.
The Commission seeks a Final Judgment permanently enjoining White from violating, or aiding
and abetting violations of the antifraud, periodic reporting, record keeping, and internal controls
provisions of the federal securities laws; barring White from acting as an officer or director of any
public company; and requiring White to pay civil money penalties.
Separately on November 21, 2002, the Office of the United States Attorney for the Northern
District of California ("USAO") announced that it had indicted White for federal criminal securities,
mail, and wire fraud. The civil and criminal actions are the result of investigations by the Commission,
the USAO, and the San Francisco office of the Federal Bureau of Investigation.
Previously, the Commission instituted and simultaneously settled an administrative proceeding against
Informix. See Informix Corp., Admin. Proc. No. 3-10130; SA Rel. No. 33-7788; SEA Rel. No. 3442326; AAE Rel. No. 1215 (Jan. 11, 2000). The Commission also previously filed a civil complaint,
and obtained a default judgment, against Walter Königseder, an Informix Vice President. See SEC v.
Walter Königseder, Civil Action No. 00-3668 (MJJ) (N.D. Cal. May 17, 2001) (Order), Lit. Rel. No.
17016, AAE Rel. No. 1398 (May 23, 2001).
4.
SEC v. Andrew S. Fastow, Litigation Release Number 17762, Accounting and
Auditing Enforcement (AAE) Rel. No. 1640 (Oct. 2, 2002),
www.sec.gov/litigation/litreleases/lr17762.htm.
The SEC filed a civil enforcement action against Andrew S. Fastow, the former chief financial
officer of Enron Corp., alleging violations of the anti-fraud, periodic reporting, books and records, and
internal controls provisions of the federal securities laws. The Commission is seeking disgorgement of
all ill-gotten gains, including all compensation received subsequent to the commencement of the
alleged fraud, civil money penalties, a permanent bar from acting as a director or officer of a publicly
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held company, and an injunction from future violations of the federal securities laws. The Commission
brought this action in coordination with the Justice Department's Enron Task Force, which filed a
related criminal complaint against Fastow.
The complaint allegations stem from Fastow's conduct relating to six transactions. Three of the
transactions, RADR, Chewco, and Southampton, were the subject of the Commission's earlier settled
action against Michael Kopper. Those transactions were part of an alleged scheme to hide Fastow's
and Kopper's interest in and control of certain entities in order to keep those entities off Enron's balance
sheet. This was done, according to the complaint, for self-enrichment and to mislead analysts, rating
agencies, and others about Enron's true financial condition. As to Fastow's role in RADR, Chewco, and
Southampton, the complaint alleges that Fastow secretly nominated certain of the owners of these
entities, funded certain of their investments through undisclosed loans, collected undisclosed fees, and
demanded and received under-the-table payments, including payments to himself and his family
members disguised as yearly $10,000 non-taxable gifts.
Two of the remaining three transactions, the Nigerian barges and the Cuiaba transaction, are
alleged to have been sham sales - best described as secret asset-parking arrangements. In one of these
sales, a sale of an interest in certain Nigerian barges to a financial institution, Fastow is alleged to have
personally promised that the financial institution would be taken out of its so-called investment and
later arranged for an entity he controlled to buy the financial institution's interest at a pre-arranged rate
of return on a pre-arranged time table.
In the second sale, Enron entered into a transaction with an off-balance-sheet entity controlled
by Fastow to sell an interest in a severely troubled power plant in Cuiaba, Brazil, in order to avoid
consolidation of project debt and recognize earnings. In connection with this transaction, Fastow
allegedly entered into an unwritten side agreement with Enron requiring Enron to buy back the interest
it just sold to Fastow at a guaranteed profit.
The last set of allegations included in the complaint relate to an alleged instance of backdating
documents to avoid diminution in Enron's investment in the stock of a technology company.
Specifically, according to the complaint, in September 2000, Fastow and others created documents that
purported to lock in the value of Enron's investment in that company back in August of 2000, when
that company's stock was trading at its all-time high price. Throughout the period of his alleged
fraudulent conduct, Fastow sold millions of dollars worth of Enron securities. The Commission's
investigation is continuing.
5.
SEC v. Homestore, Inc., Lit. Rel. No. 17745 (Sept. 25, 2002).
The SEC filed charges against three former senior executives of Homestore Inc. for perpetrating
an extensive scheme to fraudulently inflate Homestore's online advertising revenues in 2001. The
complaint, filed in U.S. District Court in Los Angeles, charges that John Giesecke Jr., Homestore's
former chief operating officer; Joseph J. Shew, its former chief financial officer; and John DeSimone,
its former vice president of transactions, caused Homestore to overstate its advertising revenues by $46
million (64%) for the first three quarters of 2001. This action was brought in coordination with the
U.S. Attorney's Office for the Central District of California, which simultaneously announced related
criminal charges against the three defendants. Giesecke, Shew, and DeSimone have each agreed to
6
settle the Commission's lawsuit, to plead guilty to the criminal charges, and to cooperate with the
government in its continuing investigation. At the time of the violations, Homestore was one of the top
Internet portals for real estate and related services.
The Commission's complaint charges Giesecke, Shew, and DeSimone with arranging
fraudulent "round-trip" transactions for the sole purpose of artificially inflating Homestore's revenues
in order to exceed Wall Street analysts' expectations. The defendants circumvented applicable
accounting principles and lied to Homestore's independent auditors about these transactions. While the
fraud was ongoing, the defendants exercised stock options at prices ranging between approximately
$21 and $32 per share, reaping profits ranging from approximately $169,000 to approximately $3.2
million.
The returned ill-gotten gains of approximately $4.6 million will be paid to the benefit of
Homestore shareholders. In addition, the Commission is seeking the permission of the Court to have
Giesecke's civil monetary penalty of $360,000 paid to the benefit of shareholders under the Fair Funds
provision of the recently enacted Sarbanes-Oxley Act of 2002.
In related proceedings filed by the U.S. Attorney's Office in Los Angeles, Giesecke has agreed
to plead guilty to one count of conspiracy and one count of wire fraud, Shew has agreed to plead guilty
to one count of conspiracy, and DeSimone has agreed to plead guilty to one count of securities fraud.
Giesecke and DeSimone each face a maximum possible penalty of 10 years in prison, while Shew faces
up to 5 years in prison. Their pleas are based on fraudulent conduct similar to that described in the
Commission's complaint. As part of their plea agreements, all three defendants have agreed to
cooperate with the Commission and the criminal authorities.
The Commission did not bring any enforcement action against Homestore because of its swift,
extensive and extraordinary cooperation in the Commission's investigation. This cooperation included
reporting its discovery of possible misconduct to the Commission immediately upon the audit
committee's learning of it, conducting a thorough and independent internal investigation, sharing the
results of that investigation with the government (including not asserting any applicable privileges and
protections with respect to written materials furnished to the Commission staff), terminating
responsible wrongdoers, and implementing remedial actions designed to prevent the recurrence of
fraudulent conduct. These actions, among others, significantly facilitated the Commission's expeditious
investigation of this matter.
6.
SEC v. Dynegy Inc., Lit. Rel. No. 17744 (Sept. 25, 2002), In the Matter of Dynegy
Inc., Securities Exchange Act of 1934 Rel. No. 34-46537,
www.sec.gov/litigation/litreleases/lr17744.htm.
The SEC filed a settled enforcement action against Dynegy Inc. in connection with alleged
accounting improprieties and misleading statements by the Houston-based energy production,
distribution and trading company. The Commission's case arises from (i) Dynegy's improper
accounting for and misleading disclosures relating to a $300 million financing transaction, known as
Project Alpha, involving special-purpose entities (SPEs), and (ii) Dynegy's overstatement of its energytrading activity resulting from "round-trip" or "wash" trades — simultaneous, pre-arranged buy-sell
7
trades of energy with the same counter-party, at the same price and volume, and over the same term,
resulting in neither profit nor loss to either transacting party.
The Commission issued a settled cease-and-desist Order against Dynegy and filed a settled civil
suit in the Southern District of Texas, Houston Division, seeking a $3 million penalty. The
Commission made findings in the cease-and-desist order (and alleged in the civil complaint) that
Dynegy engaged in securities fraud in connection with its disclosures and accounting for Project Alpha,
and negligently included materially misleading information about the round-trip energy trades in two
press releases it issued in early 2002. In settlement of the Commission's enforcement action, Dynegy,
without admitting or denying the Commission's findings, has agreed to the entry of the cease-and-desist
order and to pay a $3 million penalty in a related civil suit filed in U.S. district court in Houston.
The $3 million penalty imposed directly against Dynegy in this case reflects the Commission's
dissatisfaction with Dynegy's lack of full cooperation in the early stages of the Commission's
investigation, as discussed in the Commission's Order. In assessing a penalty directly against Dynegy,
the Commission was mindful of the impact that a penalty on a corporate entity can have on the entity's
innocent shareholders. The amount of the penalty here reflects the commitment of the company's
present board of directors to cooperate with the Commission and certain remedial actions undertaken
by the company, as well as a careful balancing by the Commission between the need to encourage full
cooperation and the desire to avoid imposing the economic consequences of a penalty on shareholders.
As the Commission's investigation continues, it will consider the responsibility of and take appropriate
actions against others with respect to the penalty that the company has agreed to pay.
7.
SEC v. L. Dennis Kozlowski, Mark H. Swartz and Mark A. Belnick: Lit. Rel. No.
17722 (Sept. 12, 2002).
The SEC filed a civil enforcement action in the United States District Court for the Southern
District of New York against three former top executives of Tyco International Ltd. charging that they
violated the federal securities laws by failing to disclose to shareholders the multi-million dollar low
interest and interest-free loans they took from the company. L. Dennis Kozlowski, the former chief
executive officer and chairman of Tyco's board of directors, and Mark H. Swartz, the former chief
financial officer and a director, granted themselves hundreds of millions of dollars in secret low
interest and interest-free loans from the company that they used for personal expenses. They then
covertly caused the company to forgive tens of millions of dollars of those outstanding loans, again
without disclosure to investors as required by the federal securities laws. In addition, they engaged in
other undisclosed related party transactions that cost shareholders hundreds of thousands, if not
millions of dollars. Mark A. Belnick, the former chief legal officer, failed to disclose the receipt of
more than $14 million of interest-free loans from the company to acquire two residences, an apartment
in New York City and a $10 million home in Park City, Utah, where he already owned another home.
Kozlowski, Swartz and Belnick also sold their shares of Tyco stock valued at millions of dollars while
their self-dealing remained undisclosed.
The Commission seeks a final judgment ordering the defendants to disgorge all ill-gotten gains,
imposing civil money penalties, and enjoining the defendants from future violations of the federal
securities laws. In the cases of Kozlowski and Swartz, this includes (i) disgorgement of all
compensation they received subsequent to their fraudulent acts and omissions, including salary,
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bonuses, stock options and grants and any advances that have not been repaid; (ii) all loans not
properly repaid by them to Tyco; (iii) interest imputed at market rates on all low interest or interest-free
loans that they should have disclosed to investors; (iv) all losses avoided from their sales of Tyco
securities subsequent to their fraudulent acts and omissions; (v) prejudgment interest on the amounts
disgorged; (vi) civil money penalties; (vii) orders barring them from ever again serving as officers or
directors of a publicly-held company; and (viii) an order enjoining them from violating the antifraud,
proxy, reporting, books and records and lying to auditor provisions of the federal securities laws.
In the case of Belnick, the Commission seeks (i) disgorgement of all loans not properly repaid
by him to Tyco; (ii) interest imputed on all low interest or interest-free loans that he should have
disclosed to investors; (iii) all losses avoided from his sales of Tyco securities subsequent to his
fraudulent acts and omissions at market rates; (iv) all rent payments that he received from Tyco for the
home office he maintained in the Utah residence; (v) prejudgment interest on the amounts disgorged;
(vi) civil money penalties; (vii) an order barring him from ever again serving as an officer or director of
a publicly-held company; and (viii) an order enjoining him from violating the antifraud, proxy and
reporting provisions of the federal securities laws.
The Commission's Complaint alleges that defendants violated or aided and abetted violations of
the anti-fraud, periodic reporting, proxy, books and records, internal controls and lying to auditors
provisions of the federal securities laws. The Manhattan District Attorney also unsealed indictments
against the three defendants.
In a separate action, on December 17, 2002, the Commission filed a settled civil action alleging
that Frank E. Walsh, Jr. ("Walsh") violated the federal securities laws by signing a Tyco registration
statement which Walsh knew contained materially misleading statements concerning fees or
commissions payable to him in connection with Tyco's June 2001 $9.2 billion acquisition of The CIT
Group, Inc. ("CIT"). The Complaint alleged that in late 2000, Walsh, a director of Tyco from 1992
through February of 2002, recommended that Tyco consider acquiring CIT. After Walsh set up a
meeting between Kozlowski and CIT's Chief Executive Officer, Kozlowski proposed to pay Walsh a
$20 million "finder's fee" for his services if the transaction was consummated. When the transaction
was submitted to the Board, Walsh voted in favor of the transaction but intentionally did not disclose to
the Board that he would receive a substantial fee in connection with the transaction. The $20 million
"finder's fee" was paid by Tyco, and, accordingly, operated as a deceit on CIT's and Tyco's
shareholders. Walsh consented to the entry of a final judgment permanently enjoining him from
violations of the antifraud provisions of the federal securities laws, permanently barring him from
acting as an officer or director of a publicly-held company, and ordering him to pay restitution of
$20,000,000.00; provided, however, that restitution shall be offset, in part or in whole, by any
restitution paid by Walsh in the case of People of the State of New York v. Frank E. Walsh, Jr., which
arises out of the same conduct set forth in the Complaint. Securities and Exchange Commission v.
Frank E. Walsh, Jr., Lit. Release No. 17896 (December 17, 2002),
www.sec.gov/litigation/litreleases/lr17896.htm.
8.
SEC v. Adelphia Communications Corp., John J. Rigas et al., Lit. Rel. No. 17627,
AAE Rel. No. 1599 (July 24, 2002).
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The SEC filed suit in the United States District Court for the Southern District of New York
charging major cable television provider Adelphia Communications Corporation; its founder John J.
Rigas; his three sons, Timothy J. Rigas, Michael J. Rigas, and James P. Rigas; and two senior
executives at Adelphia, James R. Brown and Michael C. Mulcahey, in one of the most extensive
financial frauds ever to take place at a public company. Commission charges that Adelphia, at the
direction of the individual defendants: (1) fraudulently excluded billions of dollars in liabilities from its
consolidated financial statements by hiding them in off-balance sheet affiliates; (2) falsified operations
statistics and inflated Adelphia's earnings to meet Wall Street's expectations; and (3) concealed
rampant self-dealing by the Rigas Family, including the undisclosed use of corporate funds for Rigas
Family stock purchases and the acquisition of luxury condominiums in New York and elsewhere.
The Commission seeks a final judgment ordering the defendants to account for and disgorge all
ill-gotten gains including — as to the individuals — all compensation received during the fraud, all
property unlawfully taken from Adelphia through undisclosed related-party transactions, and any
severance payments related to their resignations from the company. The Commission also seeks civil
penalties from each defendant, and permanent injunctions from violating the securities laws. The
Commission further seeks an order barring each of the individual defendants from acting as an officer
or director of a public company.
The Commission's complaint alleges that between mid-1999 and the end of 2001, John J. Rigas,
Timothy J. Rigas, Michael J. Rigas, James P. Rigas, and James R. Brown, with the assistance of
Michael C. Mulcahey, caused Adelphia to fraudulently exclude from the Company's annual and
quarterly consolidated financial statements over $2.3 billion in bank debt by deliberately shifting those
liabilities onto the books of Adelphia's off-balance sheet, unconsolidated affiliates. Failure to record
this debt violated GAAP requirements and precipitated a series of misrepresentations about those
liabilities by Adelphia and the defendants, including the creation of: (1) sham transactions backed by
fictitious documents to give the false appearance that Adelphia had actually repaid debts when, in truth,
it had simply shifted them to unconsolidated Rigas-controlled entities, and (2) misleading financial
statements by giving the false impression through the use of footnotes that liabilities listed in the
Company's financials included all outstanding bank debt.
Timothy J. Rigas, Michael J. Rigas, and James R. Brown made repeated misstatements in press
releases, earnings reports, and Commission filings about Adelphia's performance in the cable industry,
by inflating: (1) Adelphia's basic cable subscriber numbers; (2) the extent of Adelphia's cable plant
"rebuild" or upgrade; and (3) Adelphia's earnings, including its net income and quarterly earnings
before interest, taxes, depreciation, and amortization. Each of these represents crucial aspects by which
Wall Street evaluates cable companies.
Since at least 1998, Adelphia, through the Rigas Family and Brown, made fraudulent
misrepresentations and omissions of material fact to conceal extensive self-dealing by the Rigas
Family. Such self-dealing included the use of Adelphia funds to finance undisclosed open market stock
purchases by the Rigas Family, purchase timber rights to land in Pennsylvania, construct a golf course
for $12.8 million, pay off personal margin loans and other Rigas Family debts, and purchase luxury
condominiums in Colorado, Mexico, and New York City for the Rigas Family. The Commission's
complaint alleges that based on the conduct set forth above, the defendants violated the antifraud,
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periodic reporting, record keeping, and internal controls provisions of the federal securities laws. The
Commission's investigation is continuing.
Simultaneously, the United States Attorney for the Southern District of New York arrested
three members of the Rigas Family.
On November 14, 2002, the Commission announced that defendant James R. Brown, the
former vice-president for Finance at Adelphia Communications Corporation, has consented to the entry
of a Partial Judgment of Permanent Injunction and Other Relief against him in SEC v. Adelphia, et al.
Without admitting or denying the allegations in the complaint, Brown has consented to the entry
against him of a permanent injunction against violations of the antifraud, periodic reporting, record
keeping, and internal controls provisions, and, as a control person, of the periodic reporting, record
keeping, and internal controls provisions of the federal securities laws, and a permanent officer and
director bar. Brown has also agreed to provide the Court with an accounting. The Commission has
submitted Brown's Consent to the Court for approval. The Commission's claims against Brown for
disgorgement of ill-gotten gains, plus prejudgment interest, and a civil penalty remain pending before
the Court. SEC v. Adelphia Communications Corp., John J. Rigas et al., Lit. Rel. No. 17837 (Nov. 14,
2002), www.sec.gov/litigation/litreleases/lr17837.htm.
9.
In re PNC Financial Services Group, Inc., Securities Act Release No. 33-8112;
Exchange Act Release No. 34-46225; AAE Rel. No. 1597 (July 18, 2002).
The Commission issued a settled cease and desist order against The PNC Financial Services
Group, Inc., a Pittsburgh, Pennsylvania, bank holding company. This case is the Commission's first
enforcement action resulting from a company's misuse of special purpose entities. The Commission's
Order found that, in violation of GAAP, PNC transferred from its financial statements approximately
$762 million of volatile, troubled or under-performing loans and venture capital assets sold to three
special purpose entities created by a third party financial institution in the second, third, and fourth
quarters of 2001, which resulted in material overstatements of earnings, among other things. The Order
stated that PNC should have consolidated these special purpose entities into its financial statements.
The Order also found that PNC made materially false or misleading disclosures and statements about
these transactions and the consequences of those transactions.
Among other things, the Order found that in 2001, PNC endeavored to remove approximately
$762 million of volatile, troubled or under-performing loans and venture capital investments from its
financial statements by transferring them to three special purpose entities that were specially created to
receive these assets and in which PNC held a substantial interest. PNC failed to consolidate the special
purpose entities on its second and third quarter financial statements filed with the Commission even
though the entities failed to meet the requirements under GAAP for non-consolidation. In connection
with its improper accounting for its interest in the three special purpose entities, PNC also made
materially false and misleading disclosures in certain press releases and in quarterly reports filed with
the Commission for the second and third quarters of 2001 about its financial condition, earnings and
exposure to the risks of its commercial lending activities.1
PNC consented to the entry of the Order, without admitting or denying the Commission's
findings, requiring that it cease and desist from committing or causing any future violations of the anti11
fraud and periodic reporting provisions. Simultaneously, the Federal Reserve and the Office of the
Comptroller of the Currency entered into agreements with the PNC and its subsidiary bank,
respectively, to improve their practices and management.
The Commission's investigation is continuing as to others.
10.
SEC v. WorldCom, Inc., Lit. Rel. No. 17588, AAE Rel. No. 1585 (June 27, 2002),
www.sec.gov/litigation/litreleases/lr17588.htm.
The SEC filed a civil action in federal district court in New York charging major global
communications provider WorldCom, Inc. with a massive accounting fraud totaling more than $3.8
billion. The Commission's complaint alleges that WorldCom fraudulently overstated its income before
income taxes and minority interests by approximately $3.055 billion in 2001 and $797 million during
the first quarter of 2002.
The complaint further alleges that WorldCom falsely portrayed itself as a profitable business
during 2001 and the first quarter of 2002 by reporting earnings that it did not have. WorldCom did so
by capitalizing (and deferring) rather than expensing (and immediately recognizing) approximately
$3.8 billion of its costs: the company transferred these costs to capital accounts in violation of GAAP.
These actions were intended to mislead investors and manipulate WorldCom's earnings to keep them in
line with estimates by Wall Street analysts.
The complaint charges WorldCom with violating various antifraud and reporting provisions of
the federal securities laws. The Commission is seeking court orders permanently enjoining WorldCom;
imposing civil monetary penalties; prohibiting WorldCom and its affiliates, officers, directors,
employees, and agents from destroying, altering, or hiding relevant documents; prohibiting WorldCom
and its affiliates from making any extraordinary payments to any present or former officer, director, or
employee of WorldCom or its affiliates, including but not limited to any severance payments, bonus
payments, or indemnification payments; and appointing a corporate monitor to ensure that documents
are not destroyed and that no such extraordinary payments are made.
In a related action, the Commission ordered WorldCom to file with the Commission, under
oath, a detailed report of the circumstances and specifics of these matters by July 1st. The
Commission's investigation is continuing.
On August 1, 2002, Scott D. Sullivan, former WorldCom CFO, and David Meyers, former
WorldCom Controller, were criminally charged by the United States Attorney for the Southern District
of New York with securities fraud and conspiracy.
Since filing its initial complaint, the Commission has filed several civil actions in connection
with the financial fraud at WorldCom, amended its complaint against WorldCom, and obtained
judgments against WorldCom and several former WorldCom employees.
On September 26, 2002, the Commission filed an action against former WorldCom Controller
David F. Myers. (Litigation Release No. 17753.) On October 7, the Commission's third enforcement
12
action relating to WorldCom was filed against former WorldCom Director of General Accounting
Buford "Buddy" Yates, Jr. (Litigation Release No. 17771.) The Commission charged Myers and Yates
with participating in the massive fraud that inflated WorldCom's earnings at the direction and with the
knowledge of WorldCom's senior management. Each defendant consented, without admitting or
denying the allegations in the Commission's complaint, to the entry of the judgment against him.
The judgment entered against Myers: (1) enjoins him from violating the antifraud, record
keeping and internal controls provisions of the federal securities laws, and from aiding and abetting
WorldCom's violations of the periodic reporting, record keeping and internal controls provisions of the
federal securities laws; (2) prohibits him from acting as an officer or director of any public company;
and (3) provides that any monetary relief will be decided by the Court at a later date. The judgment
entered against Yates: (1) enjoins him from future violations of the antifraud and record keeping
provisions of the federal securities laws, and from aiding and abetting WorldCom's violations of the
periodic reporting, record keeping and internal controls provisions of the federal securities laws; (2)
prohibits him from acting as an officer or director of any public company; and (3) provides that any
monetary relief will be decided by the Court at a later date. SEC v. David F. Myers, SEC v. Buford
Yates, Jr., Lit. Release No. 17842, AAE Release No. 1665 (Nov. 15, 2002),
www.sec.gov/litigation/litreleases/lr17842.htm.
Based on the injunctions, Myers and Yates were suspended on December 6 from appearing or
practicing before the Commission as accountants under Rule 102(e) of the Commission's Rules of
Practice. (In the Matter of David F. Myers, Rel.33-8157, AAE Rel. 1685, File No.3-10965; and In the
Matter of Buford Yates, Jr., Rel. 33-8156, AAE Rel. 1684, File No. 3-10964.)
On November 5, the Commission filed an amended complaint against WorldCom. SEC v.
WorldCom, Inc., Lit. Release No. 17829, AAE Release No. 1658 (Nov. 5, 2002),
www.sec.gov/litigation/litreleases/lr17829.htm. On November 26, the court entered a judgment against
WorldCom imposing the full injunctive relief sought by the Commission; ordering an extensive review
of the company's corporate governance systems, policies, plans, and practices; ordering a review of
WorldCom's internal accounting control structure and policies; ordering that WorldCom provide
reasonable training and education to certain officers and employees to minimize the possibility of
future violations of the federal securities laws; and providing that civil money penalties, if any, will be
decided by the Court at a later date. WorldCom consented, without admitting or denying the
allegations in the Commission's complaint, to the entry of the judgment.
The Commission's amended complaint alleges that WorldCom misled investors from at least as
early as 1999 through the first quarter of 2002, and further states that the company has acknowledged
that during that period, as a result of undisclosed and improper accounting, WorldCom materially
overstated the income it reported on its financial statements by approximately $9 billion. The
judgment enjoins WorldCom from violating the antifraud, reporting provisions, record keeping, and
internal controls provisions of the federal securities laws.
The judgment further orders that the report currently being prepared by WorldCom's Special
Investigative Committee be transmitted to the Corporate Monitor, Richard Breeden, and that Mr.
Breeden review the adequacy and effectiveness of WorldCom's corporate governance systems, policies,
plans, and practices.
13
It also orders that WorldCom retain a qualified consultant, acceptable to the Commission, to
perform a review of the effectiveness of WorldCom's material internal accounting control structure and
policies, including those related to line costs, reserves, and capital expenditures, as well as the
effectiveness and propriety of WorldCom's processes, practices and policies for ensuring that the
Company's financial data is accurately reported in its public financial statements.
The judgment further orders that WorldCom provide reasonable training and education to
certain of its officers and employees to minimize the possibility of future violations of the federal
securities laws.
The judgment further provides that the amount of the civil penalty, if any, to be paid by
WorldCom shall be determined by the Court in light of all the relevant facts and circumstances,
following a hearing. SEC v. WorldCom, Inc., Lit. Release No. 17866, AAE Release No. 1678 (Nov.
26, 2002), www.sec.gov/litigation/litreleases/lr17866.htm.
On December 6, 2002, the Commission announced that judgments of permanent injunction
were entered on November 26 in its pending action against Betty L. Vinson and Troy M. Normand,
former accountants in the General Accounting Department of WorldCom, Inc. The judgments entered
against Vinson and Normand, among other things: (1) enjoin them from violating the antifraud, record
keeping, and internal controls provisions of the federal securities laws, and from aiding and abetting
violations of the periodic reporting, record keeping, and internal controls provisions; 2) provide that
any monetary relief will be decided by the Court at a hearing to be held upon motion of the
Commission or the instance of the Court; and (3) provide that the Court retains jurisdiction of the
action for all purposes, including the imposition of additional equitable remedies or sanctions, if any,
as determined following a hearing. Each defendant consented, without admitting or denying the
allegations in the Commission's complaint, to the entry of the judgment against her or him. Based on
the permanent injunction imposed by the Court against Vinson, the Commission suspended her from
appearing or practicing before the Commission as an accountant under Rule 102(e) of the
Commission's Rules of Practice. (In the Matter of Betty L. Vinson, CPA, Rel. 33-8158; AAE No. 1686;
File No. 3-10963). Both Vinson and Normand have pled guilty to criminal charges prosecuted by the
U.S. Attorney's Office for the Southern District of New York. SEC v. Betty L. Vinson and Troy M.
Normand, Lit. Release No. 17883, AAE Release No. 1683 (Dec. 6, 2002),
www.sec.gov/litigation/litreleases/lr17883.htm
11.
SEC v. Frank M. Bergonzi et al. (Rite Aid), Lit. Rel. No. 17577, AAE Rel. No. 1581
(Jun. 21, 2002), www.sec.gov/litigation/litreleases/lr17577.htm.
The SEC filed accounting fraud charges against several former senior executives of Rite Aid
Corp. for conducting a wide-ranging accounting fraud scheme. The SEC’s complaint alleges that Rite
Aid overstated its income in every quarter from May 1997 to May 1999, by massive amounts. When
the wrongdoing was ultimately discovered, Rite Aid was forced to restate its pre-tax income by $2.3
billion and net income by $1.6 billion, the largest restatement ever recorded. The complaint also
charges that former CEO Martin Grass caused Rite Aid to fail to disclose several related-party
transactions, in which Grass sought to enrich himself at the expense of Rite Aid's shareholders. Finally,
14
the Commission alleges that Grass fabricated Finance Committee minutes for a meeting that never
occurred, in connection with a corporate loan transaction.
The Commission is seeking disgorgement of annual bonuses and imposition of civil penalties
against Grass, former CFO Frank Bergonzi and former Vice Chairman Franklin Brown. The
Commission also seeks an order permanently enjoining each defendant from violating the securities
laws and barring each of them from serving as an officer or director of a public company. The
Commission also announced settled administrative cease-and-desist proceedings against Rite Aid and
against Timothy Noonan, the company's former Chief Operating Officer. In determining the
appropriate resolution of these proceedings, the Commission considered the substantial cooperation
provided by Rite Aid and Noonan in the investigation of this matter.
The U. S. Attorney for the Middle District of Pennsylvania simultaneously announced related
criminal charges.
12.
In re Microsoft Corporation, SEA Rel. No. 46017, AAE Rel. No. 1563 (Jun. 3,
2002), www.sec.gov/news/press/2002-80.htm.
The Commission brought a settled administrative enforcement action against Microsoft Corp.
ordering the company to cease and desist from committing accounting violations and other violations
of federal securities laws. The Commission found that Microsoft had maintained seven reserve
accounts in a manner that did not comply with GAAP because, to a material extent, they did not have
adequately substantiated bases. As a result, Microsoft misstated its income by material amounts in
certain periodic filings with the Commission made between July 1, 1994, and June 30, 1998. The
Commission also found that Microsoft did not properly document the bases for these accounts and
failed to maintain proper internal controls, as required by the federal securities laws.
The Commission's Order makes the following findings:

Microsoft recorded reserves, accruals, allowances, and liability accounts relating to marketing
expenses, sales to original equipment manufacturers, accelerated depreciation, inventory
obsolescence, valuation of financial assets, interest income, and impairment of manufacturing
facilities (collectively "reserve accounts") that did not have properly substantiated bases, as
required by GAAP. During 1995 through 1998, the total balance of these accounts ranged from
approximately $200 million to $900 million.

Microsoft's quarterly and annual filings with the Commission included or incorporated by
reference financial statements containing undisclosed and unsupported adjustments to reserve
accounts that, to a material extent, did not comply with GAAP. By including these adjustments
in its financial statements, Microsoft failed to accurately report its financial results, causing
overstatements of income in some quarters and understatements of income during other
quarters.

Microsoft failed to maintain sufficient documentation of the bases for these reserve accounts
and to apply its own accounting policy relating to the reconciliation of entries in its accounting
system. Microsoft exempted the reserve accounts from its company-wide requirement that
every account be reconciled at least once each quarter and that the reconciliation include
15
ascertaining if there existed adequate supporting documentation relating to activity in the
account. As a result, Microsoft lacked important safeguards to ensure that adjustments to the
reserve accounts and the balances of these accounts were appropriate or accurately reported in
conformity with GAAP.
Microsoft consented to the issuance of the Commission's Order without admitting or denying the
findings. The Commission found that Microsoft violated the periodic reporting and books and records
and internal accounting controls provisions of the federal securities laws and ordered Microsoft to
cease and desist from committing future violations of these provisions.
Cases Involving Accountants and Auditors
1.
In re PricewaterhouseCoopers LLP and PricewaterhouseCoopers Securities
LLC, Exchange Act Rel. No. 46216, AAE Rel. No.1596 (July 17, 2002).
The SEC announced a settled enforcement action against PricewaterhouseCoopers LLP (PwC)
and its broker-dealer affiliate, PricewaterhouseCoopers Securities LLC (PwCS), for violations of the
auditor independence rules. The auditor independence violations span a five-year period from 1996 to
2001 and arise from (1) PwC's use of prohibited contingent fee arrangements with 14 different audit
clients for which PwCS provided investment banking services, and (2) PwC's participation with two
other audit clients, Pinnacle Holdings Inc. and Avon Products Inc., in the improper accounting of costs
that included PwC's own consulting fees.
The SEC's order finds that, by virtue of PwC's independence violations, the firm caused 16
PwC public audit clients to file financial statements with the SEC that did not comply with the
reporting provisions of the federal securities laws. The order also finds that, in connection with the
improper accounting of its consulting fees, PwC caused two of those clients to violate the reporting,
recordkeeping, and/or internal controls provisions of the federal securities laws. PwC and PwCS agreed
to pay a total of $5 million and PwC agreed to comply with significant remedial undertakings as a
result of its settlement with the SEC. PwC also agreed to cease and desist from violating the auditor
independence rules and to be censured for engaging in improper professional conduct.
From 1996 to 2001, PwC and one of its predecessors, Coopers & Lybrand, entered into
impermissible contingent fee arrangements with 14 public audit clients. In each instance, the client
hired the audit firm's investment bankers, either PwCs or Coopers & Lybrand Securities, to perform
financial advisory services for a fee that depended on the success of the transaction the client was
pursuing. These fee arrangements violated the accounting professions' own prohibition against
contingent fee arrangements with audit clients and violated the SEC's independence rules. As a result,
the SEC found that PwC lacked the requisite independence when it performed audits for these 14
public companies.
In 1999 and 2000, PwC participated in and approved of the improper accounting of its own
non-audit fees by two public audit clients, Pinnacle and Avon:
In 1999 and 2000, while accounting for a 1999 acquisition of certain assets of Motorola, Inc.,
PwC assisted Pinnacle in establishing more than $24 million in improper reserves and in improperly
capitalizing approximately $8.5 million in costs, including $6.8 million in fees paid to PwC for
16
consulting and other non-audit services that should have been expensed. In April and May 2001,
Pinnacle restated its accounting for the 1999 acquisition, and in December 2001, the SEC issued a
settled cease and desist order against Pinnacle. See In the Matter of Pinnacle Holdings, Inc., Exchange
Act Rel. No. 45135 (Dec. 6, 2001).
In the first quarter of 1999 and in its 1999 audit of Avon's financial statements, PwC assisted in
and approved of Avon's improper accounting of an impaired asset that included PwC's non-audit
consulting fees. In April 1999, after nearly three years and an investment of approximately $42
million, Avon stopped an uncompleted order-management software project that PwC consultants had
attempted to develop for Avon's internal use. Instead of writing off all of the project's costs in the first
quarter of 1999, however, Avon improperly retained $26 million, which was comprised mostly of
PwC's own consulting fees. PwC participated in and approved of Avon's improper accounting, and also
contributed to Avon's misleading disclosures concerning the accounting.
For both Pinnacle and Avon, the SEC found that PwC failed to exercise the objective and
impartial judgment required by the independence rules. PwC agreed to perform significant remedial
undertakings designed to prevent the type of independence violations found in the order. Simultaneous
with the issuance of the order in this case, the SEC brought a settled enforcement action against Avon
for failing to properly value costs that it had capitalized in connection with the software development
project. Avon agreed to cease and desist from violating the reporting and recordkeeping provisions of
the federal securities laws and to restate its financial statements to appropriately reflect the complete
impairment of the project in the first quarter of 1999. See In the Matter of Avon Products, Inc.,
Exchange Act Rel. No. 46215 (July 17, 2002).
2.
In re Moret Ernst & Young Accountants, SEA Rel. No. 46130, AAE Rel. No. 1584,
(Jun. 27, 2002) http://www.sec.gov/litigation/admin/34-46130.htm.
In the first-ever auditor independence case against a foreign audit firm, the SEC brought a
settled enforcement action against Moret Ernst & Young Accountants, a Dutch accounting firm now
known as Ernst & Young Accountants. The case arises from Moret's joint business relationships with
an audit client. The SEC censured Moret for engaging in improper professional conduct and ordered
Moret to comply with certain remedial undertakings, including the payment of a $400,000 civil
penalty. This is the first time that the SEC has ordered any audit firm to pay a civil penalty for an
auditor independence violation. Moret consented to the order without admitting or denying the SEC's
findings.
Moret audited the 1995, 1996, and 1997 financial statements of Baan Company, N.V., a
business software company headquartered in the Netherlands. During this period, consultants affiliated
with Moret had joint business relationships with Baan that impaired Moret's independence as auditor.
Most of these joint business relationships were established to allow Moret consultants to assist Baan in
implementing its software products for third parties. The joint business relationships included a Dutch
government-subsidized project for Moret and Baan to jointly develop faster software implementation
tools; an agreement to coordinate global efforts in implementing Baan software products for third
parties; joint marketing activities emphasizing the "partnership" and overall coordination between Baan
and Moret in the implementation of Baan software products; and Baan's use of Moret consultants as
subcontractors and temporary employees in servicing Baan's clients.
17
Altogether, the SEC found that Moret consultants billed Baan approximately $1.9 million from
these improper joint business relationships during the years in question. Baan disputed, and ultimately
did not pay, approximately $328,000 of these billings, which further impaired Moret's independence as
auditor.
The SEC concluded that Moret's conduct constituted an extreme departure from the standards
of ordinary care that resulted in violations of the auditor independence requirements imposed by the
SEC's rules and by generally accepted auditing standards. In addition to censuring Moret, the SEC
ordered Moret to comply with a number of remedial undertakings, including the payment of a $400,000
civil penalty.
3.
In the Matter of KPMG LLP, SEA Rel. No. 45272, ICA Rel. No. 25360, AAE Rel.
No. 1491 (Jan. 14, 2002) www.sec.gov/litigation/admin/34-45272.htm.
The SEC censured KPMG LLP for engaging in improper professional conduct because it
purported to serve as an independent accounting firm for an audit client at the same time that it had
made substantial financial investments in the client. The SEC found that KPMG violated the auditor
independence rules by engaging in such conduct. KPMG consented to the SEC’s order without
admitting or denying the SEC’s findings. In addition to censuring the firm, the SEC ordered KPMG
to undertake certain remedies designed to prevent and detect future independence violations caused by
financial relationships with, and investments in, the firm’s audit clients.
The SEC found that, from May through December 2000, KPMG held a substantial investment
in the Short-Term Investments Trust (“STIT”), a money market fund within the AIM family of funds.
According to the SEC’s order, KPMG opened the money market account with an initial deposit of
$25 million on May 5, 2000, and at one point the account balance constituted approximately 15% of
the fund’s net assets. In the order, the SEC found that KPMG audited the financial statements of STIT
at a time when the firm’s independence was impaired, and that STIT included KPMG’s audit report in
16 separate filings it made with the SEC on November 9, 2000. The SEC further found that KPMG
repeatedly confirmed its putative independence from the AIM funds it audited, including STIT, during
the period in which KPMG was invested in STIT.
According to the SEC, KPMG’s independence violation occurred primarily because the firm
lacked adequate policies or procedures to prevent or detect such violations, and because the steps
which KPMG personnel usually took before initiating investments of the firm’s surplus cash were not
taken in this instance. The SEC also found that KPMG: had no procedures directing its treasury
department personnel to check the firm’s “restricted entity list” to confirm that a proposed investment
was not restricted; had no specific policies or procedures requiring any participation by a KPMG
partner in the investigation and selection of money market investments; and had no policies or
procedures designed to put KPMG audit professionals on notice of where the firm’s cash was invested,
or requiring them to check a listing of the firm’s investments, prior to accepting new audit
engagements or confirming the firm’s independence from audit clients.
As a result, the SEC found that there was no system KPMG audit engagement partners could
have used to confirm the firm’s independence from its audit clients. The SEC concluded that KPMG’s
18
lack of adequate policies and procedures constituted an extreme departure from the standards of
ordinary care, and resulted in violation of the auditor independence requirements imposed by the SEC’s
rules and by Generally Accepted Auditing Standards.
Foreign Payments Cases
1.
SEC v. Syncor International Corp., Lit. Release No. 17887, AAE Release No. 1688
(Dec. 10, 2002), www.sec.gov/litigation/litreleases/lr17887.htm
On December 10, 2002, the Commission filed two settled enforcement proceedings charging
Syncor International Corporation, a radiopharmaceutical company based in Woodland Hills, California,
with violating the Foreign Corrupt Practices Act (FCPA). First, the Commission filed a lawsuit in the
United States District Court for the District of Columbia charging Syncor with violating the FCPA and
seeking a civil penalty. Second, the Commission issued an administrative order finding that Syncor
violated the anti-bribery, books-and-records, and internal-controls provisions of the FCPA, ordering
Syncor to cease and desist from such violations, and requiring Syncor to retain an independent
consultant to review and make recommendations concerning the company's FCPA compliance policies
and procedures. Without admitting or denying the Commission's charges, Syncor consented to the
entry of a final judgment in the federal lawsuit requiring it to pay a $500,000 civil penalty and
consented to the Commission's issuance of its administrative order.
In both its federal court complaint and its administrative order, the Commission charged that,
from at least the mid-1980s through at least September 2002, Syncor's foreign subsidiaries in Taiwan,
Mexico, Belgium, Luxembourg, and France made a total of at least $600,000 in illicit payments to
doctors employed by hospitals controlled by foreign authorities. According to the Commission, these
illicit payments were made with the purpose and effect of influencing the doctors' decisions so that
Syncor could obtain or retain business with them and the hospitals that employed them. The
Commission charged, moreover, that the payments were made with the knowledge and approval of
senior officers of the relevant Syncor subsidiaries, and in some cases with the knowledge and approval
of Syncor's founder and chairman of the board.
According to the Commission, by making these payments through its subsidiaries, Syncor
violated the anti-bribery provisions of the FCPA. The Commission further charged that, by improperly
recording these payments - and similar payments made to foreign persons not affiliated with
government-owned facilities - Syncor violated the record keeping provisions of the FCPA. Finally, the
Commission charged that, by failing to devise or maintain an effective system of internal controls to
prevent or detect these violations of the FCPA, Syncor violated the internal controls provisions of the
FCPA.
In determining to accept Syncor's settlement offer, the Commission considered the full
cooperation that Syncor provided to the Commission staff during its investigation. The Commission
also considered the fact that Syncor - after being alerted to the relevant conduct by another company
that was conducting due diligence relating to a previously announced merger with Syncor - promptly
brought this matter to the attention of the Commission's staff and the U.S. Department of Justice.
19
In a related proceeding, the United States Department of Justice filed criminal FCPA charges
against Syncor Taiwan, Inc., a subsidiary of Syncor. (U.S. v. Syncor Taiwan, Inc. No. 02-CR-1244ALL (C.D. Cal.)). In that proceeding, Syncor Taiwan has agreed to plead guilty to one count of
violating the anti-bribery provisions of the FCPA and to pay a $2 million fine.
2.
SEC v. BellSouth Corp., Lit Rel. No. 17310, AAE Rel. No. 1495 (Jan. 15, 2002),
www.sec.gov/litigation/litreleases/lr17310.htm.
On January 15, 2002 the Commission filed a settled civil action with BellSouth Corporation in
the U.S. District Court for the Northern District of Georgia, in which BellSouth consented to a
$150,000 civil penalty. The Commission's Complaint alleged that BellSouth violated provisions of the
Foreign Corrupt Practices Act (FCPA). Specifically, the Complaint alleges that BellSouth violated the
books and records provisions and internal controls provisions of the federal securities laws in
connection with payments made by BellSouth's Venezuelan and Nicaraguan subsidiaries. BellSouth
settled the civil action without admitting or denying the Commission's allegations.
According to the Complaint, between September 1997 and August 2000, former senior
management of BellSouth's Venezuelan subsidiary, Telcel, C.A., authorized payments totaling
approximately $10.8 million to six offshore companies and improperly recorded the disbursements in
Telcel's books and records, based on fictitious invoices, as bona fide services. Telcel's internal controls
failed to detect the unsubstantiated payments for a period of at least two years. As an additional
consequence of this control deficiency, the Complaint alleges that BellSouth was unable to reconstruct
the circumstances or purpose of the Telcel payments, or determine the identity of their ultimate
recipients. Telcel is Venezuela's leading wireless provider, contributing more revenue to BellSouth's
Latin American Group segment than any other Latin American BellSouth operation.
The Complaint also alleges that, between October 1998 and June 1999, BellSouth's Nicaraguan
subsidiary, Telefonia Celular de Nicaragua, S.A.'s, improperly recorded payments to the wife of the
Nicaraguan legislator who was the chairman of the Nicaraguan legislative committee with oversight of
Nicaraguan telecommunications.
In a related proceeding, the Commission also issued a settled cease-and-desist order against
BellSouth in which the Commission found that it violated the books and records provisions and
internal accounting controls provisions of the Securities Exchange Act of 1934 in connection with
payments made by BellSouth's Venezuelan and Nicaraguan subsidiaries. Without admitting or denying
the Commission's findings, BellSouth consented to the entry of the order that requires BellSouth to
cease and desist from violating those provisions.
3.
In the Matter of Baker Hughes, Inc., SEA Rel. No. 44784, AAE Rel. No. 1444
(Sept. 12, 2001), www.sec.gov/litigation/admin/34-44784.htm.
On September 12, 2001, the Commission accepted an Offer of Settlement from Baker Hughes
in response to the institution of cease and desist proceedings. In March 1999, Baker Hughes' CFO and
its Controller authorized an illegal payment, through KPMG, its agent in Indonesia, to a local
government official in Indonesia. Baker Hughes, through its CFO and Controller, directed that this
improper payment be made while knowing or aware that KPMG would pass all or part of the payment
along to a foreign government official for the purpose of influencing the official's decision affecting the
20
business of Baker Hughes. This improper payment was made in violation of the FCPA. In addition, in
1998 and 1995, senior managers at Baker Hughes authorized payments to Baker Hughes' agents in
India and Brazil, respectively, without making an adequate inquiry as to whether the agents might give
all or part of the payments to foreign government officials in violation of the FCPA. Baker Hughes
improperly recorded all three transactions in its books and records as routine business expenditures.
This constituted a violation of section 13(b)(2) of the Exchange act, which requires that records be kept
in reasonable detail with assurance of accuracy.
In addition to its false books and records, Baker Hughes also failed to devise and maintain an
adequate system of internal accounting controls to detect and prevent improper payments to foreign
government officials and to provide reasonable assurance that transactions were recorded as necessary
to permit the preparation of financial statements in conformity with Generally Accepted Accounting
Principles.
The Commission entered a cease and desist order against Baker Hughes and required the
company to keep accurate books and records and to accurately and fairly reflect the authorization or
payment of gifts to foreign officials, foreign political parties or any person where such payment is
prohibited by Section 30A of the Exchange Act. Furthermore, Baker Hughes was required to devise
and maintain a system of internal controls in accordance with GAAP and to monitor payments to
foreign officials, parties and other payments prohibited by Section 30A.
4.
In the Matter of Chiquita Brands International, Inc. SE, SEA Rel. No. 44902, AAE
Rel. No.1463 (Oct. 3, 2001), www.sec.gov/litigation/admin/34-44902.htm.
Chiquita Brands International, Inc. settled an action for a $100,000 penalty based on conduct
violative of the FCPA. Chiquita's Colombian operations consist of, among other things, a number of
banana farms located throughout the country and an import/export port facility located in Turbo. The
Turbo port facility is owned and operated by Banadex, an indirect wholly-owned subsidiary of
Chiquita.
In September 1995, the Banadex employee in charge of material and supplies advised Banadex
management that renewal of the port facility's customs license was in jeopardy because of two previous
citations for failure to comply with Colombian customs regulations. The employee further advised
management that replacing the Turbo facility would cost approximately $1 million. Without the
knowledge or consent of any Chiquita employee and in contravention of Chiquita's policies, Banadex's
chief administrative officer authorized Banadex's CEA agent to make a payment to Colombian customs
officials to obtain the license renewal. The chief administrative officer directed Banadex's security
officer and controller to make and process the payment. Banadex's CEA agent later advised the
company that for the Colombian peso equivalent of approximately $30,000 the citations would be
overlooked and the license renewal granted. Banadex agreed to pay two installments - approximately
$18,000 in advance and the remainder after renewal. Both installments were made by Banadex's
security officer from a Banadex account used for discretionary expenses.
Chiquita's policies and procedures contain strict guidelines regarding the use of a discretionary
expenses account. Banadex did not comply with Chiquita's procedure requiring that Banadex's books
and records accurately reflect the transaction. Chiquita had strict policies prohibiting payments of the
21
kind made to the customs officials. Contrary to Chiquita's established procedure, Banadex employees
failed to identify and disclose the payment to customs officials on the disclosure forms submitted for
the relevant quarters.
In April 1997, Chiquita internal audit discovered the September 1996 payment during an audit
review of Banadex. After conducting an internal investigation, Chiquita took corrective action, which
included terminating the responsible Banadex employees and reinforcing its internal controls with
respect to its Colombian operations.
The Commission concluded that Banadex employees made inaccurate entries in the documents
recording the transaction and Banadex's general ledger to conceal the payment to customs officials.
Chiquita was ordered to cease and desist from committing or causing any violation of the books and
records and internal accounting controls provisions of the federal securities laws.
Regulation FD Cases
First Regulation FD Enforcement Actions, SEC Release No. 2002-179 (Dec. 20, 2002),
www.sec.gov/news/press/2002-179.htm
On November 25, 2002, the Securities and Exchange Commission instituted three settled
enforcement actions and issued one Report of Investigation relating to Regulation FD. These are the
first Regulation FD enforcement actions taken by the Commission.
1.
In the Matter of Raytheon Company and Franklyn A. Caine, Securities Exchange
Act Release No. 34-46897 (November 25, 2002)
On November 25, 2002, the Commission instituted public cease-and-desist proceedings against
Raytheon Company ("Raytheon") and Franklyn A. Caine ("Caine") (collectively, the "Respondents").
In anticipation of the proceedings, Raytheon and Caine each submitted an offer of settlement ("Offers
of Settlement"), which the Commission determined to accept. Solely for the purposes of these
proceedings, and any other proceeding brought by or on behalf of the Commission, or in which the
Commission is a party, and without admitting or denying the findings set forth therein, except that
Raytheon and Caine admit the jurisdiction of the Commission over them and over the subject matter of
these proceedings, Raytheon and Caine consented to the entry of an Order: 1) finding that Raytheon
violated the periodic reporting provisions of the federal securities laws and Regulation FD, 2) Caine
was a cause of Raytheon's violations, 3) ordering Raytheon to cease and desist from committing or
causing any violations and any future violations of these provisions, and 4) ordering Caine to cease and
desist from causing any violations and any future violations of these provisions.
This matter involves violations of Regulation FD by Raytheon through its Chief Financial
Officer, Caine. Caine selectively disclosed quarterly and semi-annual earnings guidance, the
prototypical disclosures Regulation FD aimed to prohibit, to sell-side equity analysts (collectively, the
"Street"). Caine's disclosures concerned Raytheon's estimate of its expected quarterly distribution of
earnings per share ("EPS") for 2001 overall, and for the first quarter in particular. Specifically, Caine
communicated to the analysts that their first quarter EPS estimates were too high.
22
On February 7, 2001, Raytheon conducted an investor conference where it reiterated annual
EPS guidance, but did not provide any quarterly EPS guidance. After the February 7, 2001 investor
conference, Caine directed his staff to contact each sell-side analyst whose estimates are included in
Thomson Corporation's First Call Service ("First Call") and request copies of the analysts' quarterly
model of Raytheon. Caine then arranged and conducted a one-on-one call with each analyst. During
the calls that ensued, Caine knew that Raytheon had provided no public quarterly earnings guidance for
2001, that the analysts' first quarter 2001 EPS estimates generally exceeded Raytheon's internal
estimate, and that the analysts' 2001 quarterly earnings estimates reflected a less seasonal quarterly
distribution than 2000 results.
During the one-on-one conversations with analysts, Caine delivered substantially the same
earnings information to each analyst: that in 2001 Raytheon's earnings would likely have the same
seasonal distribution as in 2000, and, more specifically, that Raytheon would generate one-third of its
EPS in the first half of the year and the remaining two-thirds in the second half of the year. Caine also
told certain analysts that their estimates for first quarter earnings or revenue for particular divisions
were "too high," "aggressive," or "very aggressive."
After their conversations with Caine, the analysts revised their estimates. The revised estimates
caused the Street's consensus to fall to one penny below Raytheon's internal 2001 first quarter EPS
estimate.
2.
In the Matter of Secure Computing Corporation and John McNulty, Securities
Exchange Act Release No. 34-46895 (Nov. 25, 2002)
On November 25, 2002, the Commission instituted public cease-and-desist proceedings against
Secure Computing Corporation ("Secure" or the "Company") and John McNulty ("McNulty")
(collectively, the "Respondents"). In anticipation of the proceedings, Respondents both submitted an
Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose
of these proceedings and any other proceedings brought by or on behalf of the Commission, or to
which the Commission is a party, and without admitting or denying the findings herein, except as to the
Commission's jurisdiction over them and the subject matter of these proceedings, Respondents
consented to the entry of an Order: 1) finding that Secure violated the periodic reporting provisions of
the federal securities laws and Regulation FD, 2) finding that McNulty was a cause of Secure’s
violations, 3) ordering Secure to cease and desist from committing or causing any violations and any
future violations of these provisions, and 4) ordering McNulty to cease and desist from causing any
violations and any future violations of these provisions.
The Commission found that in early March 2002, Secure, a Silicon Valley software company,
and its Chief Executive Officer ("CEO"), John McNulty, disclosed material non-public information
about a significant contract to two portfolio managers at two institutional advisers in violation of
Regulation FD, which requires disclosures of material, non-public information to be made to the
marketplace as a whole. Following the disclosures, Secure announced the contract to the public in a
press release issued after the close of the stock markets. However, investors who sold Secure stock
prior to the Company's press release were denied information that may have affected their investment
decisions.
23
3.
In the Matter of Siebel Systems, Inc., Securities Exchange Act Release No. 3446896 (Nov. 25, 2002)
On November 25, 2002, the Commission instituted public cease-and-desist proceedings against
Siebel Systems, Inc. (the "Company" or "Siebel"). In anticipation of the institution of these
proceedings, Siebel has submitted an Offer of Settlement (the "Offer"), which the Commission has
determined to accept. Solely for the purpose of these proceedings and any other proceedings brought
by or on behalf of the Commission, or to which the Commission is a party, and without admitting or
denying the findings herein, except as to the Commission's jurisdiction over it and the subject matter of
these proceedings, which Siebel admits, Siebel consented to the entry of an Order: 1) finding that
Siebel violated the periodic reporting provisions of the federal securities laws and Regulation FD, and
2) ordering Raytheon to cease and desist from committing or causing any violations and any future
violations of these provisions.
The Commission found that on November 5, 2001, the Company's Chief Executive Officer
("CEO"), disclosed material, nonpublic information to persons outside the Company at an invitationonly technology conference hosted by Goldman Sachs & Co. ("Goldman Sachs") in California (the
"Technology Conference"). In response to questions from the Goldman Sachs analyst who organized
the conference, the Company's CEO disclosed that the Company was optimistic because its business
was returning to normal. These statements contrasted with negative statements that he had made about
the Company's business three weeks earlier, in which he characterized the market for information
technology as tough, and indicated that the Company expected business to remain that way for the rest
of the year. Prior to the Technology Conference, the Company's investor relations staff knew that the
conference would not be simultaneously broadcast to the public. As a result, the Company
intentionally disclosed material, nonpublic information at the Technology Conference.
The Commission further found that immediately following the disclosures, certain attendees at
the conference purchased Respondent's stock or communicated the disclosures to others who purchased
its stock. On the day of the conference, Respondent's stock price closed approximately 20% higher
than the prior day's close and the trading volume was more than twice the average daily volume. The
public did not have equal access to and was unable to benefit from the information that was disclosed
to the attendees at the Technology Conference. Accordingly, the Company violated Regulation FD.
4.
Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of
1934: Motorola, Inc., Securities Exchange Act of 1934 Release No. 46898
(November 25, 2002)
In its Report of Investigation, the Commission stated the following: The Division of
Enforcement conducted an investigation into whether Motorola, Inc. ("Motorola") violated the federal
securities laws when one of its senior officials selectively disclosed information about the company's
quarterly sales and orders during private telephone calls with sell-side analysts in March 2001. During
those calls, Motorola's Director of Investor Relations (the "IR Director") told analysts that first quarter
sales and orders were down by at least 25%. Previously, in a February 23, 2001 press release and a
public conference call, Motorola had said only that sales and orders were experiencing "significant
weakness" and that Motorola was likely to miss its earnings estimates of 12 cents per share for the
24
quarter and have an operating loss for the quarter if the order pattern continued. Motorola decided to
telephone the analysts and tell them that "significant," as used on February 23, meant a "25% or more"
decline because the IR Director had seen the analysts' models and research notes and concluded that the
analysts had not understood from the February 23 conference call just how disappointing the results
were for the quarter. Motorola specifically decided not to issue a new press release or otherwise make
any timely public disclosure of this additional information.
The conduct in question was inconsistent with the disclosure mandate of Regulation FD, which
generally prohibits issuers from communicating material, nonpublic information to securities
professionals without simultaneous public disclosure of the same information. The Commission issued
this Report to provide guidance concerning Regulation FD and to highlight conduct that the
Commission believes the regulation was specifically intended to prevent. When an issuer endeavors to
make public disclosure of material information -- but later learns that it did not, in fact, fully
communicate the intended message, and determines that further disclosure is needed -- the proper
course of action under Regulation FD is not to selectively disclose the corrected message in private
communications with industry professionals, but rather to make additional public disclosure.
Here, before engaging in the conduct in question, Motorola officials sought the advice of inhouse legal counsel. Counsel approved the conduct in question based on a determination that the
information in question was not material or nonpublic. Counsel's determination was erroneous in both
respects. Nevertheless, because it appears that counsel's advice was sought and given in good faith,
and in light of the surrounding facts and circumstances, the Commission issued the Report rather than
bringing an enforcement action against Motorola or its senior officials.
II.
INTERNET-RELATED ENFORCEMENT CASES
1.
SEC v. Spectrum Brands Corp., et al., Lit. Rel. No. 17265 (Dec. 11, 2001),
www.sec.gov/litigation/litreleases/lr17265.htm.
On December 11, 2001, the Commission filed a civil action alleging an ongoing fraudulent
scheme to exploit the nation's fear of anthrax and bio-terrorism. The Commission's complaint alleges
manipulation of the stock of a publicly traded shell company, Spectrum Brands Corp. The Complaint
alleges that Spectrum Brands is secretly owned and controlled by a group stock promoters located in
Hicksville, New York. These undisclosed principals include two individuals -- Saverio (Sammy)
Galasso III and David Hutter (a/k/a David Green) -- who pled guilty to unrelated felony charges and are
awaiting sentencing, and an associate, Charlie Dilluvio. The sole officer and director of Spectrum
Brands, Michael J. Burns, was also charged. All four individuals were arrested on December 11, 2001
on criminal charges relating to the Spectrum Brands stock fraud.
According to the Complaint, on or before November 5, 2001, Spectrum Brands posted on its
website that it had a hand-held device called the "DeGERMinator" capable of "WIP[ING] OUT
SURFACE GERMS IN LESS THAN 5 SECONDS, INCLUDING ANTHRAX." The closing price of
Spectrum Brands' common stock tripled on this news, shooting up from approximately $4 on
November 1, to $7 on November 2, to $11.75 on November 5, with an intra-day high of $14 on
November 5. Meanwhile, the Hicksville promoters engaged in a series of transactions designed to
25
create artificial volume in the market for Spectrum Brands securities and sold stock into the inflated
market. The company made certain corrective disclosures on its website, but continued to tout in press
releases and spam e-mails its supposed progress in combating "bio-terrorism" and "cyber-terrorism.
No disclosure has been made of the substantial ownership positions and management roles of the
Hicksville promoters. Thus, unbeknownst to the investing public, Spectrum Brands continues to be
owned and operated in secret by Galasso and Hutter, both of whom are convicted felons.
The Commission charged defendants with violations of the anti-fraud provisions and seeks
permanent injunctions, restitution, disgorgement of ill-gotten gains with prejudgment interest, and civil
penalties from all defendants and an officer and director bar against Burns.
2.
SEC v. Invest Better 2001 et al., Lit. Rel. No. 17296 (Jan. 7, 2002),
www.sec.gov/litigation/litreleases/lr17296.htm.
On December 13, 2001, as part of its "real time" enforcement initiative, the SEC filed an
enforcement action to stop an ongoing fraud by Invest Better 2001, before having identified the
individuals behind the scheme. On January 7, 2002, the Commission amended its complaint to add
Cole Bartiromo, a 17-year-old high school student, who the Commission has now identified as a
principal behind Invest Better as well as an additional defendant. In a settlement also announced on
December 13th, the Commission is recovering from Bartiromo approximately $900,000 obtained from
investors in the scheme.
The Amended Complaint alleges that from at least November 1, 2001, through approximately
December 15, 2001, Bartiromo, through Invest Better, raised more than $1 million from more than
1,000 investors through the offer of purportedly "guaranteed" and "risk-free" investment programs in
which Invest Better pooled investor funds to bet on sporting events, and promised to repay investors
between 125% to 2500% of their principal within specified periods ranging from three days to several
weeks, depending on the program selected. The Amended Complaint alleges that in December 2001,
Bartiromo transferred approximately $900,000 of investor funds to an account he controls at a casino in
Costa Rica.
On December 13th, the Court issued a partial final judgment and order, on consent, which
permanently enjoins Bartiromo and Invest Better, directs Bartiromo and Invest Better to repatriate all
assets outside the United States and deposit such assets into the Court's account, freezes Bartiromo's
and Invest Better’s assets, directs Bartiromo and Invest Better to provide an accounting, and grants
other expedited and equitable relief.
On April 29, 2002, the Commission filed a second amended complaint alleging that Bartiromo
conducted an Internet pump and dump scheme that manipulated the stock price of fifteen publiclytraded companies. The second amended complaint seeks, among other things, civil injunctive relief,
disgorgement plus prejudgment interest and civil money penalties.
III.
BROKER-DEALER CASES
A significant number of Commission enforcement actions are filed each year against brokerdealer firms and persons associated with them. These actions focus on fraudulent sales practices, as
26
well as on violations of the books and records, customer protection, and net capital provisions of the
federal securities laws. The Commission also pursues firms and their senior management for failure
reasonably to supervise employees to prevent violative conduct.
1.
Global Settlement in Principle with Top Investment Firms, SEC Release No. 2002179 (Dec. 20, 2002), www.sec.gov/news/press/2002-179.htm
On December 20, 2002, Chairman Harvey L. Pitt, New York Attorney General Eliot Spitzer,
North American Securities Administrators Association President Christine Bruenn, NASD Chairman
and CEO Robert Glauber, New York Stock Exchange Chairman Dick Grasso, and state securities
regulators announced an historic settlement in principle with the nation's top investment firms to
resolve issues of conflict of interest at brokerage firms.
The "global settlement" concludes a joint investigation begun in April by regulators into the
undue influence of investment banking interests on securities research at brokerage firms. The
settlement, if finalized and approved by the Commission, will bring about balanced reform in the
industry and bolster confidence in the integrity of equity research.
Terms of the agreement in principle include:

The insulation of research analysts from investment banking pressure. Firms will be
required to sever the links between research and investment banking, including analyst
compensation for equity research, and the practice of analysts accompanying investment
banking personnel on pitches and road shows. This will help ensure that stock
recommendations are not tainted by efforts to obtain investment banking fees.

A complete ban on the spinning of Initial Public Offerings (IPOs). Brokerage firms will
not allocate lucrative IPO shares to corporate executives and directors who are in the
position to greatly influence investment banking decisions.

An obligation to furnish independent research. For a five-year period, each of the
brokerage firms will be required to contract with no less than three independent research
firms that will provide research to the brokerage firm's customers. An independent
consultant ("monitor") for each firm, with final authority to procure independent
research from independent providers, will be chosen by regulators. This will ensure that
individual investors get access to objective investment advice.

Disclosure of analyst recommendations. Each firm will make publicly available its
ratings and price target forecasts. This will allow for evaluation and comparison of
performance of analysts.

Settled enforcement actions involving significant monetary sanctions.
The agreement is subject to approval by the full Commission.
27
Each of the firms will pay a fine, pay monies toward investor restitution, and will be required to
escrow funds that will be used to pay for independent research. The agreement in principle that was
reached totals more than $1.4 billion in penalties, restitution and monies to be used for investor
education.
2.
SEC, NYSE, NASD Fine Five Firms Total of $8.25 Million for Failure to Preserve
E-Mail Communications, SEC Release No. 2002-173 (Dec. 3, 2002),
www.sec.gov/news/press/2002-179.htm
On December 3, 2002, the Commission, the New York Stock Exchange and NASD announced
joint actions against five broker-dealers for violations of record-keeping requirements concerning email communications. The firms consented to the imposition of fines totaling $8.25 million, along with
a requirement to review their procedures to ensure compliance with record-keeping statutes and rules.
Each of the firms - Deutsche Bank Securities Inc.; Goldman, Sachs & Co.; Morgan Stanley &
Co. Incorporated; Salomon Smith Barney Inc.; and U.S. Bancorp Piper Jaffray Inc. - consented,
without admitting or denying the allegations, to findings that each: 1) violated the broker-dealer
records retention provisions of the federal securities laws, and violated corresponding NYSE and
NASD Rules by failing to preserve for a period of three years, and/or preserve in an accessible place
for two years, electronic communications relating to the business of the firm, including interoffice
memoranda and communications; 2) violated NYSE Rule 342 and NASD Rule 3010 by failing to
establish, maintain and enforce a supervisory system to assure compliance with NASD and NYSE rules
and the federal securities laws relating to retention of electronic communications.
The firms agreed to a penalty of a censure and fines totaling $8.25 million - $1.65 million per
firm - to be paid to the U.S. Treasury, NYSE and NASD. The firms also agreed to review their
procedures regarding the preservation of e-mail communications for compliance with federal securities
laws and the rules of the NYSE and NASD. Each firm agreed to inform each regulator, in writing,
within 90 days that it has established systems and procedures reasonably designed to achieve
compliance with the statute and rules relating to e-mail retention.
The respondents' failure to preserve e-mail communications and\or to maintain them in an
accessible place was discovered during investigations being conducted jointly and separately by the
SEC, NYSE and NASD.
Some firms backed up e-mail communications on tape or other media that was represented as
part of a process designed as a disaster-recovery or business-continuity measure, or for another
business purpose. However, these firms discarded or recycled and overwrote their back-up tapes and
other media, often a year or less after back-up occurred.
Each firm had inadequate procedures and systems to retain and make accessible e-mail
communications. While some firms relied on employees to preserve copies of the e-mail
communications on the hard drives of their individual personal computers, there were no systems or
procedures to ensure that employees did so.
28
In those instances in which the firms did retain e-mail communications, those communications
were often stored in an unorganized fashion on back-up tapes, other media, or on the hard drives of
computers used by individual employees. In some instances, hard drives of computers preserving
electronic mail communications were erased when individuals left the employment of the firm.
Although each firm had an obligation to preserve e-mail communications pursuant to the
broker-dealer records retention provisions of the federal securities laws, and corresponding NYSE and
NASD Rules, during all or part of the period from 1999 to at least 2001, each of the firms failed to
preserve for three years, and/or to preserve in an accessible place for two years, electronic
communications (including interoffice memoranda and communications) that related to its business as
a member of an exchange, broker or dealer.
Cases Involving Sales Practice Violations and Market Manipulations
1.
SEC v. Michael J. Rivers and Thomas E. Hall, Lit. Release No. 17828 (Nov.
5, 2002), www.sec.gov/litigation/litreleases/lr17828.htm.
On October 31, 2002, the Commission filed a complaint in the United States District Court for
the District of Minnesota against Thomas E. Hall ("Hall") and Michael J. Rivers ("Rivers") alleging
that Hall and Rivers perpetrated a fraudulent scheme to artificially increase the closing price of First
Federal Capital Corporation ("First Federal") common stock. Hall was employed as a registered
representative and branch manager for U.S. Bancorp Piper Jaffray Inc. ("Piper Jaffray"). Rivers was a
customer of Hall at Piper Jaffray. The Commission's complaint alleges that the purpose of this scheme
was to prevent or reduce numerous margin calls Rivers received on his trading accounts at Piper
Jaffray. The complaint also alleges that Hall and Rivers' scheme artificially increased the closing price
of First Federal common stock, which constituted violations of the antifraud provisions of the federal
securities laws.
Hall consented, without admitting or denying the allegations in the complaint, to the entry of an
order of permanent injunction enjoining him from violations of the antifraud provisions of the federal
securities laws and imposing a civil penalty of $50,000. The litigation against Rivers is pending.
Separately, on November 5, 2002, the Commission entered an Order Instituting Proceedings
Making Findings and Imposing Remedial Sanctions (Order) against U.S. Bancorp Piper Jaffray Inc.
(Piper Jaffray). Piper Jaffray, while neither admitting nor denying the Order's findings, consented to
the entry of the Order and the imposition of sanctions against it.
The Commission's Order found that from January 1998 through September 2001, Rivers and
Hall engaged in a "marking the close" scheme. The Commission's Order found that Rivers and Hall
placed day-end trades at artificially higher prices in this stock thereby increasing improperly the stock's
closing price so as to satisfy or reduce margin calls on his brokerage accounts at Piper Jaffray.
The Commission's Order found that Piper Jaffray failed to supervise Hall and failed to have
adequate systems in place to detect or prevent this marking the close scheme. The Order censures
Piper Jaffray and requires it to maintain the following undertakings: creating a marking the close
exception report, and the creation of at least eight District Sales Supervisors to replace the single
29
position previously responsible for supervising "producing" branch managers. The Order also requires
Piper Jaffray to pay a civil monetary penalty of $100,000.
2.
SEC v. Charles Zandford, 122 S. Ct. 1899, 2002 U.S. LEXIS 4023; Fed. Sec. L.
Rep. (CCH) P91,795 (June 3, 2002).
The U.S. Supreme Court ruled unanimously in favor of the SEC's longstanding interpretation of
federal securities law, saying that the Commission properly alleged securities fraud in its complaint
against a broker who emptied a client's investment account and used the proceeds for his own benefit.
Broker Charles Zandford of Maryland had opened a joint investment account for an elderly client and
his mentally retarded daughter. The client had intended the proceeds of the account to provide for his
daughter, but, without the client's knowledge, Zandford sold the securities in the account and converted
the proceeds to his personal use.
Based on Zandford's prior criminal conviction for wire fraud, the SEC won a federal civil
judgment that Zandford's actions also violated antifraud provisions of federal securities laws. A federal
appeals court later reversed the judgment and dismissed the case, reasoning that because Zandford's
activities did not involve misrepresenting the value of a particular security, they were not "in
connection with the purchase or sale of any security."
The Supreme Court reversed the appeals court, ruling that the Commission is entitled to
deference in its interpretation of the antifraud provisions of the Securities Exchange Act of 1934:
"(N)either the SEC nor this Court has ever held that there must be a misrepresentation about the value
of a particular security in order to run afoul of the Act." The Supreme Court sent the case back to the
U.S. district court for further proceedings.
3.
SEC v. Frank D. Gruttadauria, et. al., Lit. Rel. No. 17369 (Feb. 21, 2002),
www.sec.gov/litigation/litreleases/lr17369.htm.
On February 21, 2002, the Commission filed an action charging Frank D. Gruttadauria,
formerly the branch manager for the Cleveland Ohio office of Lehman Bros. Inc., with securities fraud.
The Commission's complaint alleges that over the last six years, while he worked at two different
brokerage firms, Gruttadauria stole at least $40 million in the course of defrauding more than 50
clients. Also charged with securities fraud were two entities controlled by Gruttadauria, DH Strategic
Partners, Inc. and JYM Trading Trust, which Gruttadauria used to misappropriate the funds from his
clients. The Commission is seeking a temporary restraining order, a preliminary injunction, asset
freezes, accountings, the appointment of a receiver for Gruttadauria, DH Strategic Partners, and JYM
Trading Trust, as well as other emergency relief.
The Commission's complaint alleges that over a period of many years, Gruttadauria falsely told
customers that he had bought or sold securities for their accounts, when, in fact, he had
misappropriated their funds for his own purposes. He also materially misrepresented the value of and
the positions held in customer accounts, often falsely telling customers that their accounts contained a
wide variety of holdings worth millions of dollars. In some instances, Gruttadauria induced customers
to give him funds by claiming that he had opened accounts for them when, in fact, no account ever
existed for the client and he simply misappropriated the funds.
30
The complaint alleges that Gruttadauria misappropriated funds from customers and directed the
funds to other customers either as purported returns on non-existent investments or to satisfy
withdrawal requests from accounts as to which Gruttadauria had deceived the account holders into
believing that they had sufficient funds to make transfers. In particular, from at least 1996 through
October 2000, while employed at Cowen & Co. and SG Cowen Securities Corporation, Gruttadauria
misappropriated over $25 million in customer funds by fraudulently directing the money into an
account that he controlled in the name of JYM Trading Trust, and using it to make payments to other
customers. Beginning in October 2000, Gruttadauria similarly misappropriated and funneled over $15
million in customer funds through a bank account he controlled in the name of DH Strategic Partners,
Inc.
The complaint further alleges that, to conceal his fraud, Gruttadauria created and sent defrauded
customers unauthorized and falsified account statements that greatly overstated the value of the
customers' accounts, reflected holdings that did not exist and securities transactions that had never
occurred, and failed to disclose the unauthorized withdrawals from the accounts. The most recent false
account statements for the accounts of at least 50 of Gruttadauria's customers reflected an aggregate
value of about $278 million, whereas the actual value of accounts held for these customers at Lehman
Brothers was about $1.8 million. Without the knowledge or authorization of these customers,
Gruttadauria caused their actual brokerage account statements to be sent to entities or post office boxes
under his control.
The Commission's complaint charges Gruttadauria, DH Strategic Partners, Inc. and JYM
Trading Trust with violations of the antifraud provisions of the federal securities laws. The complaint
also names as relief defendants Sarah Z. Emamy, a resident of Gates Mills, Ohio, Laurene U. English,
Gruttadauria's former sales assistant, and Charlie Whiskey, LLC, a limited liability company of which
Gruttadauria is a 50% owner, and which owns a Lear Jet. The complaint alleges that Gruttadauria
unjustly enriched the relief defendants by transferring to them over $3.4 million in money and assets
derived from his illegal conduct. The Commission’s investigation is continuing.
On June 27, the Commission filed an Amended Complaint charging that Laurene English,
Gruttadauria's longtime former assistant, aided and abetted Gruttadauria's fraudulent scheme. In
addition, the Commission named Gruttadauria's wife, Margo Gruttadauria, from whom he is separated,
as a relief defendant. The Commission seeks to recover assets that Gruttadauria conveyed to Margo
Gruttadauria.
4.
SEC v. U.N. Dollars Corp., et al., Lit. Rel. No. 17177 (Oct. 11, 2001),
www.sec.gov/litigation/litreleases/lr17177.htm.
On October 11, 2001, the Commission announced that it filed a complaint in the United States
District Court for the Southern District of New York against fourteen individuals and entities for their
roles in a market manipulation of U.N. Dollars Corp. ("UNDR"), a former bulletin board stock based in
Jacksonville, Florida. The complaint alleges that the fraud, which occurred between September 1999
and March 2000, drove UNDR's stock price from $.01 per share to an all-time high of $1.25 per share
in less than six months, before the Commission suspended trading in UNDR securities on March 13,
2000. According to the complaint, Edward Durante, a recidivist securities law violator, reaped about
31
$100,000 in illegal profits by secretly controlling the supply of UNDR stock, creating an artificial
market, and then dumping the stock at artificially inflated prices. The complaint also alleges that
UNDR executives participated in the scheme, and made false and misleading representations about
UNDR's business activities.
The filing of the Commission's complaint coincides with the filing of criminal charges by the
United States Attorney's Office for the Southern District of New York concerning a scheme to
manipulate several different securities in the Spring of 2000. It is estimated that Durante and others
reaped illegal trading profits of more than $30 million while orchestrating manipulations of U.N.
Dollars Corp., Wamex Holdings Inc., Ramoil Management Ltd., Absolutefuture.com, and other stocks,
through a network of promoters, market makers and brokers under their control.
In a related matter, the Commission also ordered four Internet stock touters who made
materially false and misleading statements about UNDR securities to cease and desist and required
these respondents to pay disgorgement and prejudgment interest totaling $11,323.03. The touters,
Millennium Group of New York LLC, Roman Suleymanov, Alex Rovner, and Gennady Favelyukis,
consented to the order without admitting or denying the Commission's findings. The Internet websites
used to promote UNDR were Realstocks.com, WinningStocks.com, and StocksNetwork.com. (Rel. No.
33-8023, Rel. No. 34-44919; File No. 3-10618).
Failure to Supervise Cases
1.
In the Matter of George J. Kolar, SEA Rel. No. 46127 (Jun. 26, 2002).
The Commission affirmed the ALJ’s decision in this failure to supervise case. The law judge
found that Kolar, metropolitan area manager for Dean Witter Reynolds, Inc., failed to exercise
reasonable supervision over Dean C. Turner, a salesman in Dean Witter's Troy, Michigan branch
office, who violated registration and antifraud provisions of the securities laws.
In August 1992, Kolar received information that Turner was "selling away"; i.e., that, contrary
to Dean Witter's prohibition and the rules of various self-regulatory organizations, Turner was
receiving compensation for selling investments in Lease Equities Fund, Inc. ("LEF") outside the scope
of his employment with Dean Witter. Following an interview of Turner and an examination of what
Turner claimed was his 1991 tax return, Kolar and others concluded (incorrectly) that the allegations
against Turner were unfounded. No further investigation of Turner was conducted during the period at
issue.
The law judge found that, during a nearly three-year period following that interview, from
September 1992 through June 1995 when Kolar left Detroit to take a similar position with Dean Witter
in Cleveland, Turner willfully violated registration and antifraud provisions of the securities laws in
connection with his offer and sale of LEF promissory notes.
The Commission’s opinions states: “We have made it abundantly clear that supervisors must
act decisively when an indication of irregularity is brought to their attention. That irregularity need not
be a violation of the securities laws. Decisive action is necessary whenever supervisors are made aware
of suspicious circumstances, particularly those that have an obvious potential for violations.”
32
The Commission found that Kolar had the requisite degree of responsibility, ability, or authority to
affect Turner's conduct, and that he was therefore Turner's supervisor. The Commission further found
that "control" was not a necessary prerequisite, but that Kolar satisfied that requirement as well. The
Commission rejected Kolar’s argument that because the control over Turner was shared with others, he
was not his supervisor. Rather, the Commission found that as Detroit metropolitan area manager,
Kolar had direct supervisory authority over the personnel in the Troy office; he participated in
disciplinary actions affecting that office, and his recommendations carried substantial weight
The Commission emphasized that “supervisors cannot rely on the unverified representations of their
subordinates. Nor, under circumstances like those in this case, can they rely on purportedly
exonerating documents supplied by those subordinates.”
Kolar was suspended for six months from acting in a supervisory capacity with any registered
broker or dealer, and fined $20,000.
2.
In the Matter of Norwest Investment Services, Inc. (now known as Wells Fargo
Brokerage Services, LLC), SEA Rel. No. 45460 (Feb. 20, 2002),
www.sec.gov/litigation/admin/34-45460.htm.
On February 20, 2002, the Commission accepted an Offer of Settlement from Norwest
Investment Securities in response to the institution of public administrative proceedings. Norwest was
a bank affiliated broker-dealer registered with the Commission and a member of the NASD.
From February 1999 to August 1999, a former registered representative (RR) of Norwest’s
Aurora, Colorado branch office, engaged in various sales practice violations, including fraudulent
mutual fund switching in at least seven customer accounts. Norwest failed reasonably to supervise the
RR to prevent or detect the RR's mutual fund switching violations. During the violative period,
Norwest had inadequate mutual fund switching procedures to prevent or detect the RR's misconduct.
Further, Norwest did not have a system in place to communicate, implement, and enforce effectively
the switching policies and procedures it did have.
The Commission concluded that the mutual fund switches violated the anti-fraud provisions
and the company failed to supervise the RR with a view toward preventing the violative conduct.
Norwest was censured and ordered to pay disgorgement of $3,245.19 and penalties of $150,000. The
company was ordered to: maintain the revised procedures it implemented in the year 2000 relating to
mutual fund switching; retain an Independent Consultant to conduct a review of existing mutual fund
switching procedures to ensure their adequacy; adopt and implement the procedures recommended by
the consultant within 150 days or advise the consultant of any procedures it considers unnecessary or
inappropriate; and to cooperate fully with the independent consultant.
33
3.
In the Matter of Quest Capital Strategies, Inc. and David Chen Yu, SEZ Rel. No.
44935, IAA Rel. No. 1990 (Oct. 15, 2001) www.sec.gov/litigation/opinions/3444935.htm.
On October 15, 2001, the Commission issued an opinion on the Division of Enforcement’s
appeal from the decision of an administrative law judge, which dismissed proceedings against Quest
Capital Strategies, Inc., a registered broker-dealer and investment adviser and David Chen Yu, Quest’s
president and sole owner, for violating the failure to supervise provisions of the federal securities laws.
The Commission reversed the ALJ’s opinion and held that both Quest and Yu failed to supervise a
representative John Nakoski, who violated Securities Act, the Exchange Act, and the Advisers Act
while he was subject to the supervision of Quest and Yu.
Quest and Yu had more than an “indication of irregularity” with respect to Nakoski’s conduct.
They had been made aware that Nakoski was illegally borrowing money from his clients under the
guise of an investment scheme and he was illegally advertising this scheme. Supervisors had
documentation of Nakoski’s conduct from both the Enforcement Division and the NASD and would
have had documentation had they adequately reviewed Nakoski’s records. Both Quest and Yu knew
Nakoski had deliberately violated company policy and should have increased their supervision. Instead,
they relied on Nakoski’s assurance of not repeating the misconduct. Both Quest and Yu continued to
ignore red flags of violations including Nakoski’s letter to the Division indicating a future solicitation
of funds and evidence by the NASD of Nakoski’s continued advertising. Quest and Yu were mistaken
in relying on Nakoski’s unverified representations as opposed to dismissing him or instituting
heightened supervision. Respondents could have taken a number of steps including surprise
inspections pursuant to the independent contract agreement between Nakoski and Quest, questioning
Nakoski’s salesmen and office personnel about the loan program, and questing Nakoski’s customers.
The Commission noted that Quest and Yu were not entitled to claim the Exchange Act’s
defense to deficient supervision, as their established procedures would not have been reasonably
expected to detect and prevent misconduct. The ALJ was mistaken in finding that Respondents
supervisory mechanisms met this defense. Commission found that Quest and Yu’s supervisory failures
were egregious as they had actual knowledge that Nakoski had deliberately violated company
directives by soliciting and raising money from investors. The respondents had abdicated their
responsibility by relying on Nakoski’s assurances and permitted the fraudulent scheme to continue for a
year, which resulted in investor harm. The Commission then issued an order disallowing Quest to
maintain branch offices unless supervised by an on-suite principal and subject to surprise semi-annual
surprise inspections, as well as a $50,000 fine. Yu was barred from associating with any broker-dealer
or investment adviser in a supervisory capacity for one year, upon which he must apply to re-associate,
and he was fined $50,000.
IPO Allocation Practices Case
1.
SEC v. Credit Suisse First Boston, Corp., Lit. Rel. No. 17327 (Jan. 22, 2002),
www.sec.gov/litigation/litreleases/lr17327.htm.
On January 22, 2002, the Commission announced that it settled charges against Credit Suisse
First Boston Corporation (CSFB), a New York-based brokerage firm and investment bank, relating to
34
the Commission's investigation of the firm's IPO allocation practices. CSFB agreed (1) to pay a total of
$100 million in the Commission's action and in a related action announced by the National Association
of Securities Dealers Regulation, Inc. (NASDR); (2) to be enjoined by a federal court from future
violations; and (3) to adopt extensive new policies and procedures. The $100 million payment is
composed of $70 million in disgorgement of improper gains, and $30 million in civil penalties or fines.
In connection with this matter, the Commission filed a Complaint against CSFB alleging
violations of certain NASD Conduct Rules and of books and records requirements under the federal
securities laws. Given the nature and scale of the misconduct alleged in the Complaint, the
Commission determined to seek an injunction based, in part, on violations of NASD Conduct Rules.
According to the Complaint, in exchange for shares in "hot" IPO's, CSFB wrongfully extracted from
certain customers a large portion of the profits that those customers made by immediately selling
("flipping") their IPO stock. The profits were channeled to CSFB in the form of excessive brokerage
commissions generated by the customers in unrelated securities trades that the customers effected
solely to share the IPO profits with CSFB.
CSFB agreed to settle the Commission's action and consented, without admitting or denying the
allegations of the Complaint, to the entry of a final judgment that: (1) permanently enjoins CSFB,
directly or indirectly, from certain violations of NASD Conduct Rules 2110 and 2330 and Section
17(a)(1) of the Exchange Act and Rule 17a-3, thereunder; (2) orders disgorgement of $70 million,
which would be reduced to $35 million in recognition of CSFB's anticipated payment of $35 million in
disgorgement to NASDR in a related NASDR proceeding against CSFB; (3) orders a civil penalty of
$30 million pursuant to Section 21(d) of the Exchange Act, which would be reduced to $15 million in
recognition of CSFB's payment of a $15 million penalty to NASDR in the related NASDR proceeding
against CSFB; and (4) orders CSFB to comply with certain undertakings discussed below.
As part of the settlement, CSFB has undertaken to establish a broad range of new policies and
procedures relating to IPO allocations to prevent a recurrence of the misconduct described in the
Complaint. Among the undertakings to which CSFB has consented, the firm will implement extensive
new policies and procedures relating to the allocation of IPO shares, the account opening process,
commission levels, and supervisory practices. The new policies include a prohibition against the
following conduct: (1) making a wrongful arrangement or a wrongful quid pro quo of any kind with
customers in exchange for IPO allocations; and (2) improper sharing of profits or losses with a
customer who receives an IPO allocation or allocations. CSFB also has agreed to retain an
Independent Consultant to conduct a review to provide reasonable assurance of the implementation and
effectiveness of its new policies and procedures. This review will begin one year after the date of the
entry of the Final Judgment.
35
Books and Records Violations, Fraudulent Reporting, and Unregistered
Broker-Dealers
1.
SEC v. Nutrition Superstores.com, Inc., Advanced Wound Care, Inc., Franchise
Direct, Inc., Anthony F. Musso, Jr., Jeffery Gill, Wayne Santini and Andrew W.
Doney, Lit. Release No. 17888 (Dec. 10, 2002),
www.sec.gov/litigation/litreleases/lr17888.htm
On December 10, 2002, the Commission announced that it filed a civil action in the United
States District Court for the Southern District of Florida against defendants Nutrition Superstores.com,
Inc., Advanced Wound Care, Inc., Franchise Direct, Inc., Anthony F. Musso, Jr., Jeffrey Gill, Wayne
Santini and Andrew W. Doney for perpetuating a fraudulent offering of unregistered securities.
According to the Commission's complaint, between 1998 and 2001, defendants raised at least
$10.5 million from over 770 investors nationwide who purchased stock in Nutrition Superstores and
Advanced Wound Care, both purported distributors of health and nutrition products. Securities were
sold through a group of unlicensed sales agents affiliated with a boiler-room, Franchise Direct. Using
scripts and employing hard pressure sales tactics, the sales agents - given bogus "vice president" titles
by the issuer de jour (Nutrition Superstores or Advanced Wound Care) - made egregious
misrepresentations and omissions concerning, among other things, the companies' holdings and
business operations, projected revenues, their impending "hot" Initial Public Offerings ("IPO"), use of
investor proceeds, and expected profits. In addition, Advanced Wound Care made misrepresentations
regarding purported celebrity endorsements. Defendants also did not disclose that Franchise Direct and
its sales agents received up to 25% of all investor proceeds as commissions.
Based on the foregoing, the Commission seeks permanent injunctions against Nutrition
Superstores, Advanced Wound Care, Franchise Direct, Musso, Gill, Santini, and Doney, based on their
violations of the registration and antifraud provisions of the federal securities laws; and as against
Franchise Direct and Doney based on their violations of broker-dealer registration provisions of the
federal securities laws. (In the alternative, with regard to Musso and Gill, the Commission seeks to
charge them as "control persons" of Nutrition Superstores and/or Advanced Wound Care for Nutrition
Superstores' and Advanced Wound Care's violations of the registration and antifraud provisions of the
federal securities laws. In addition, the Commission seeks disgorgement with prejudgment interest
against Nutrition Superstores, Advanced Wound Care, Franchise Direct, Musso, Gill, Santini, and
Doney; and civil monetary penalties against Franchise Direct, Musso, Gill, Santini, and Doney.
Finally, the Commission seeks officer and director bars against Musso, Gill and Santini.
Simultaneous with filing the Commission's complaint, the Commission instituted and
simultaneously settled an administrative proceeding making findings and imposing remedial sanctions
and a cease-and-desist order against John Vailati, the President of Franchise Direct, for his role in the
fraudulent scheme.
36
2.
In the Matter of iCapital Markets, LLC, (Datek Securities), SA Rel. No. 8059, SEA
Rel. No. 45328 (Jan. 24, 2002), www.sec.gov/litigation/admin/33-8059.htm.
On January 24, 2002, the Commission charged iCapital Markets LLC, formerly Datek
Securities Corp., with securities fraud and widespread violations of the Commission’s broker-dealer
books and records and reporting provisions. The Commission censured the firm and ordered iCapital
to pay a $6.3 million penalty. iCapital consented to the issuance of the order without admitting or
denying the findings contained in it, and to the relief imposed.
The Commission found that from at least 1993 through March 1998, when it sold its daytrading business, Datek Securities engaged in a widespread fraudulent scheme by illegally executing
proprietary trades through the Nasdaq Stock Market’s Small Order Execution System (SOES). The
SOES system was designed for small public customers, and until last year, a broker-dealer was
prohibited from using the SOES system to trade for its own account. The SOES system was the only
Nasdaq trading system that offered automatic execution at the best available price.
By hiding its use of the SOES system for proprietary trading, Datek Securities obtained SOES
automatic execution, which, combined with Datek Securities’ day-trading software, gave it a
significant advantage. The Commission found that Datek Securities fraudulently used the SOES
system to execute millions of proprietary trades, resulting in tens of millions of dollars in trading
profits. Datek Securities accomplished the fraud through the use of sophisticated software, dozens of
nominee accounts, concealment and misrepresentations to regulators, fictitious books and records, and
false reports filed with the Commission.
The Commission’s order finds that in February 1998, Datek Securities reorganized under a
holding company (the Company). On March 30, 1998, Datek Securities sold the assets of its daytrading business to Heartland Securities Corp. In the years following this sale, the Company hired new
managers and other industry professionals without prior ties to Datek Securities. It also undertook to
eliminate control and reduce ownership of certain shareholders in the Company. In determining to
accept iCapital’s offer of settlement, the Commission considered remedial acts undertaken by iCapital,
and the Company’s new management and investors, and cooperation afforded the staff. The
Commission’s investigation as to others is continuing.
IV.
MUTUAL FUNDS AND INVESTMENT ADVISERS
The amount of investor assets under mutual fund management has grown enormously in the past
ten years. Assets under management by investment advisers have also shown significant growth.
Because of this increase in individual investor’s participation in mutual funds and with investment
advisers, the Commission continues to bring significant cases in this area.
37
Adviser Fraud and Failures to Disclose Conflicts of Interest
1.
SEC v. Southmark Advisory, Inc., Southmark, Inc., and Wendell D.
Belden, Lit. Release No. 17892 (December 12, 2002),
www.sec.gov/litigation/litreleases/lr17892.htm
On November 21, 2002, the Commission obtained, by consent, permanent injunctions and other
relief in its enforcement action against Southmark Advisory, Inc. (Southmark Adviser), an SECregistered investment adviser, Southmark, Inc. (Southmark Broker), an SEC-registered broker-dealer,
and Wendell D. Belden, the owner of both firms. According to the SEC's complaint, Belden used
Southmark Adviser and Southmark Broker to defraud his predominantly elderly clients, by misleading
them about the security of their invested principal, and by failing to inform them of alternative
investment opportunities in order to enrich himself at their expense. The SEC alleged that Belden
attracted seniors desiring safe investments by advertising certificates of deposit (CDs), and then
aggressively pitched to the prospective investors, in lieu of CDs, a purportedly personalized, managed
mutual fund investment program. The SEC alleged that Belden defrauded his clients in a number of
ways: by lying about the safety of the managed mutual fund program; by failing to tell the clients about
other investment options that were more advantageous; by failing to tell the clients that Southmark
Broker would earn a 4% sales commission if the clients invested in the managed mutual fund program;
and by failing to tell the clients about disciplinary sanctions that the State of Oklahoma and the NASD
had imposed against Belden.
Without admitting or denying the allegations in the Commission's complaint, all defendants
consented to the judgment, entered by the Northern District of Oklahoma, which enjoins Southmark
Adviser, Southmark Broker, and Belden from violating, and aiding and abetting violations of the
antifraud provisions of the federal securities laws.
In the judgment, the court also appointed Bruce Day, former Administrator of the Oklahoma
Department of Securities, to serve as an Independent Consultant to Southmark Adviser and Southmark
Broker. Mr. Day will oversee the firms' practices, policies and procedures, ensure their compliance
with the securities laws, and keep Commission staff apprised of their activities. Previously, at the
Commission's request, the court had appointed a receiver for the Southmark entities and directed that
Belden not interfere with the companies' activities. The court's November 21st order directs that
Belden continue to have no further affiliation or association, direct or indirect, with the Southmark
entities. The court also held a hearing on the financial condition of Belden and the Southmark entities.
After considering sworn financial statements provided by Belden, the investigative report presented by
the court-appointed receiver in the case, and testimony from the receiver, the court determined that
neither Belden nor the Southmark entities had the financial ability to pay disgorgement or a civil
penalty, relief that had been sought by the Commission, and the court dismissed these Commission
claims.
2.
SEC v. Beacon Hill Asset Management LLC, et al., Lit. Release No. 17831 (Nov. 7,
2002), www.sec.gov/litigation/litreleases/lr17831.htm.
On November 7, 2002, the Commission charged Beacon Hill Asset Management LLC (Beacon
Hill), a hedge fund manager located in Summit, New Jersey, with a violation of the anti-fraud
38
provisions of the Investment Advisers Act. The Commission's complaint, filed in the U.S. District
Court for the Southern District of New York, alleges that at least during July through September 2002,
Beacon Hill reported net asset values and corresponding returns to fund investors that it knew or
should have known were materially overstated. In addition to a permanent injunction against future
violations, disgorgement and civil penalties, the Commission is seeking substantial preliminary relief,
that Beacon Hill, its managed hedge funds (Beacon Hill Master, Ltd., Bristol Fund, Ltd., Safe Harbor
Fund L.P., and Milestone Plus Partners L.P.), and controlling entities of the hedge funds (Safe Harbor
Asset Management, LLC and Milestone Global Advisors, L.P.) have agreed to.
Under the terms of a stipulation to be filed with the court, and subject to the approval of the
Court: 1) Beacon Hill will be preliminarily enjoined from violating the non-scienter based antifraud
provision of the federal securities laws directed at investment advisers; 2) Beacon Hill and the hedge
funds will report to the court within 10 days of entry of the order that Beacon Hill is no longer
managing the funds and that a new investment manager is in place; 3) Court approval will be required
for redemptions, withdrawals, or distributions from the funds, as well as for extraordinary payments; 4)
The funds will require the new investment manager to file periodic reports with the court, the SEC, and
investors; and 5) Beacon Hill will be required to preserve all relevant documents and to cooperate fully
to enable the new investment manager to perform its duties.
The Commission's Complaint alleges that Beacon Hill managed three "feeder" hedge funds —
Bristol, Safe Harbor, and Milestone — as well as a "master" fund (Beacon Hill Master) through which
the feeder funds conducted trading. The funds principally invested in the mortgage-backed securities
markets on a leveraged basis. The Complaint alleges that, for at least the periods ending July 31,
August 31, and September 30, 2002, Beacon Hill reported net asset values and corresponding returns to
fund investors that it knew or should have known were materially overstated.
The Commission's Complaint alleges that Beacon Hill violated the non-scienter based antifraud
provision of the federal securities laws directed at investment advisers, which prohibits transactions,
practices, and courses of business which operate as a fraud or deceit upon investment advisory clients
and prospective clients. The Complaint names the hedge funds and their controlling entities as "relief"
defendants solely in order to effectuate the controls and reporting requirements described above.
The Commission's investigation is continuing.
3.
In the Matter of Duff & Phelps Investment Management Co., IAA Rel. No. 1984,
ICA Rel. No. 25200 (Sept. 28, 2001), www.sec.gov/litigation/admin/ia-1984.htm.
On September 28, 2001, the Commission simultaneously instituted and settled administrative
cease-and-desist proceedings against a registered investment adviser, Duff & Phelps Investment
Management Co., Inc. (Duff), based on, among other things, Duff's inaccurate Form ADV and its
violative soft dollar practices. The order found that $715,750 of advisory client commission business
was directed to East West Institutional Services, Inc. (East West), a Michigan broker-dealer, and a
Chicago-based pension consultant (Pension Consultant), in exchange for the referral of a client, a
pension fund for the International Brotherhood of Teamsters Union Local 710 (Local 710).
39
Duff did not disclose to its clients its direction of brokerage in exchange for a client referral,
and it affirmatively and falsely stated in its Commission filings that it did not direct commissions in
exchange for client referrals. Certain of the commissions that Duff directed for the benefit of East West
to obtain the client referral involved transactions for an investment company with which Duff had an
investment advisory agreement.
In approximately 1994, East West entered into an arrangement with the two trustees of the
Local 710. Under this arrangement, East West agreed to kick back to the two trustees a portion of the
commissions directed to it by the Local 710's investment advisers. The advisers would direct the trades
to East West through one of its clearing brokers, and East West would forward some of that money to
the two trustees.
In mid-1994, the Duff salesman met with a representative from East West. The Duff salesman
had learned that East West had the ability to influence selection or retention of money managers by the
Local 710 pension fund. East West and the Duff salesman agreed that Duff would direct $600,000 in
commissions annually to benefit East West, and, in return, East West would influence the Local 710 to
award management of $120 million of its pension fund to Duff. East West specifically informed the
Duff salesman that the directed brokerage arrangement should be concealed from the disinterested
Local 710 trustees. The two trustees of the Local 710 required Duff to direct a certain amount of
business to East West before they awarded Duff management of the Local 710's assets. In mid-1994,
Duff began directing commissions to benefit East West. Senior officers of Duff knew, or were reckless
in not knowing, that Duff's direction of brokerage to East West was part of a quid pro quo to obtain the
Local 710 as a client.
Duff's amended Form ADV filed with the Commission and distributed to its clients did not
disclose that Duff received client referrals in exchange for brokerage commission allocation. Indeed, in
some instances, Duff affirmatively represented that it did not engage in such practices.
In determining to accept the Offer of Settlement, the Commission considered remedial acts
promptly undertaken by Duff and cooperation afforded the Commission staff. Duff was censured and
ordered, among other things, to: cease and desist from committing or causing any violations of various
sections of the Advisers and Company Acts; pay a civil money penalty in the amount of $100,000; pay
disgorgement of $613,000 to the clients whose assets were affected by the directed brokerage
agreement between Duff and East West; pay disgorgement of $102,750, plus pre-judgment interest in
the amount of $38,411, to the appropriate clients whose assets were affected by the soft dollar
agreement. Duff also agreed to detailed undertakings, including providing to each of its advisory
clients a copy of the Commission’s order and an amended Form ADV, which discloses all material
terms of any soft dollar arrangement it has with any broker-dealer.
4.
SEC v. Edward Thomas Jung and E. Thomas Jung Partners, Ltd., Lit. Rel. No.
17041 (Jun. 20, 2001), www.sec.gov/litigation/litreleases/lr17041.htm.
On June 19, 2001, the Commission filed an action against Edward Thomas Jung and his brokerdealer, E. Thomas Jung Partners, Ltd., also doing business as ETJ Partners, Ltd ("ETJ Partners"), a
market-maker at the Chicago Board Options Exchange. The Commission's complaint alleges that Jung,
40
manager of an unregistered, private hedge fund, Strategic Income Fund, L.L.C., engaged in a scheme to
defraud the fund's investors resulting in the loss of more than $21 million in investor assets.
The complaint also alleges that from July 1994 to February 1998, Jung was responsible for
issuing a series of false performance reports that were used to solicit investors in the fund that
materially overstated his prior trading record and that of the fund. In addition, from January 1995 to
September 1998, Jung falsely stated that investor assets would be used solely to conduct the fund's
business and to collateralize trading on behalf of the fund. Instead, Jung, acting through his brokerdealer, placed the fund's assets in ETJ Partners' account and used the fund's assets to collateralize his
own personal margin trading and to pay the expenses of running ETJ Partners. Jung's personal trading
resulted in substantial losses, but Jung covered up his losses by sending investors false quarterly
statements that materially overstated the current value of their investment in order to lull them into a
false sense of security. Eventually, in September 1998, ETJ Partners' clearing firm seized control of its
account and liquidated the Fund's assets to cover ETJ Partners' margin call. Jung's misappropriation
resulted in the loss of more than $21 million invested by 60 investors.
The Commission's complaint seeks an order enjoining Jung and ETJ Partners from violating
antifraud provisions and asks the court to impose appropriate civil penalties.
5.
SEC v. Reed E. Slatkin, Lit. Rel. No. 16998 (May 11, 2001) and 17033 (Jun. 11,
2001), www.sec.gov/litigation/litreleases/lr16998.htm.
On May 11, 2001, the Commission obtained a temporary restraining order and asset freeze
against Reed E. Slatkin, a co-founder, former director and substantial shareholder of Earthlink, Inc., in
federal district court in Los Angeles. The Commission charged that Slatkin defrauded as many as 500
clients through his unregistered investment advisory business located in Santa Barbara, California. The
Commission’s complaint alleged that from 1985 to April 2001, Slatkin managed at least $230 million
for about 500 clients through purported securities trading accounts in Switzerland. The Commission's
complaint alleged that in February 2001, Slatkin misappropriated $10 million in client funds that he
had received purportedly to invest in a money market fund and misused the client's funds by using
$6.975 million to pay other clients and using over $24,000 to pay personal expenses, including credit
card bills, telephone and other utility bills, fees at two country clubs, and pool maintenance fees. The
Commission further alleged that the Swiss trading accounts did not exist and that Slatkin was merely
operating a fraudulent securities scheme.
On June 7, 2001, the U.S. District Court for the Central District of California entered a
Judgment of Permanent Injunction against Slatkin. The judgment enjoins Slatkin from future violations
of antifraud provisions and investment adviser registration provisions. The judgment provides that the
amount of disgorgement and civil penalties that Slatkin will have to pay will be determined later.
Slatkin, without admitting or denying the allegations in the complaint, consented to the entry of the
injunction.
The U.S. Attorney's Office for the Central District of California also charged Slatkin with 15
felony charges, including mail and wire fraud, money laundering and conspiracy to obstruct justice
during an SEC enforcement investigation. Slatkin pleaded guilty and is scheduled to be sentenced on
February 24, 2003.
41
In a separate action, the U.S. Attorney for the Central District of California and the Commission
announced that Daniel W. Jacobs was charged with conspiracy to obstruct justice during the SEC
investigation of Reed E. Slatkin. Jacobs has agreed to plead guilty to the charge when he is arraigned
in November. In his plea agreement, Jacobs admitted that when the SEC began a formal investigation
of Slatkin's activities in 1999, Jacobs and others conspired to obstruct the SEC's investigation. Jacobs
and others, among other things, provided the SEC with false documents concerning NAA Financial, a
purported Swiss brokerage firm in which Slatkin purportedly held his investors' funds. For his role,
Jacobs received $1 million and a quantity of gold coins from Slatkin. United States v. Daniel W.
Jacobs, Lit. Release No. 17796 (Oct. 22, 2002), www.sec.gov/litigation/litreleases/lr17796.htm.
6.
SEC v. Burton G. Friedlander, et al., Lit. Rel. No. 17021 (Jun. 1, 2001),
www.sec.gov/litigation/litreleases/lr17021.htm.
On June 1, 2001 the Commission filed securities fraud charges against Burton G. Friedlander,
62, two investment management entities Friedlander controls, and three Friedlander-managed
investment funds. The defendants are charged with market manipulation and with fraudulently inflating
and misrepresenting the value of one of the funds, Friedlander International Limited, a hedge fund.
Among other charges, the Commission charged that Friedlander manipulated the common stock of a
company in which the hedge fund held an interest at the end of each month during the last five months
of 2000. This conduct is commonly known as "portfolio pumping." The Commission alleges that
Friedlander caused approximately $2.4 million in fund redemptions to be made at the inflated fund
values for his and his entities' benefit to the detriment of the fund's other investors.
The complaint further alleges that, beginning in August 2000, Friedlander caused the monthend net asset value of Friedlander International Limited to be fraudulently inflated in two ways. First,
Friedlander manipulated the month-end closing price of the common stock of eNote.com, Inc.
(“eNote”). eNote common stock and other securities constituted approximately 40 percent of the net
asset value of Friedlander International reported to investors. The eNote common stock price was used
to determine the value of eNote preferred stock and warrants in the fund's portfolio. At the end of each
month from August through December 2000, Friedlander and Friedlander Capital Management
purchased large quantities of eNote common stock through brokerage accounts held for the benefit of
Friedlander's other managed funds, Friedlander Limited Partnership, and Opal International Fund. To
effect these purchases, Friedlander placed a series of orders at increasing prices on the last trading day
of each month. Friedlander's purchases on these days accounted for 80% or more of the retail purchase
volume in eNote. These purchases manipulated the eNote stock price upward at the end of each
month, in some cases more than doubling it. Second, for the months of November and December
2000, Friedlander assigned arbitrary values to the eNote warrants in the Friedlander International
Limited portfolio that were higher even than the price of the underlying common stock.
The complaint charges Friedlander and the related entities with violating Section 10(b) of the
Exchange Act and Rule 10b-5 thereunder. The complaint also charges Friedlander and his two
management entities, Friedlander Capital Management and Friedlander Management Limited, with
violations of Section 206(1) and (2) of the Advisers Act. In the complaint, the Commission seeks
preliminary and permanent injunctive relief against Friedlander and the other defendants, the
appointment of a receiver for the related entities, an asset freeze of $1 million in Friedlander's assets,
42
representing an amount that Friedlander redeemed for his personal benefit in February 2001,
accountings, disgorgement of ill-gotten gains, and civil monetary penalties.
Misrepresentations of Mutual Fund Risks and Portfolio Value
1.
In the Matter of Rockies Fund, Inc., et al., Initial Decision Rel. No. 181,
Administrative Proceeding File No. 3-9615, (Mar. 9, 2001),
www.sec.gov/litigation/aljdec/id181bpm.htm.
In an initial decision, Judge Brenda P. Murray found that in 1994 and 1995, Stephen G.
Calandrella, the Rockie’s Fund's president, and Charles M. Powell and Clifford C. Thygesen, the
Fund's independent directors, violated anti-fraud provisions by making material misrepresentations as
to the value of a major Fund asset. The misrepresentations occurred in eight SEC filings.
Judge Murray also found that Mr. Calandrella and John C. manipulated the buying and selling
of Premier shares, and that Mr. Calandrella failed to disclose to the Fund's independent directors that
the Fund's purchase of Premier shares was to settle legal charges leveled against him. Judge Murray
ordered the Fund, Mr. Calandrella, Mr. Powell, Mr. Thygesen, and Mr. Power to cease and desist from
violating various provisions. In addition, Judge Murray permanently barred Mr. Calandrella from
serving or acting as an employee, officer, director, member of an advisory board, investment adviser or
depositor of, or principal underwriter for a registered investment company or affiliated person, and
ordered him to pay a civil penalty of $500,000. She ordered the same bar against Mr. Powell and Mr.
Thygesen with the right to reapply after three years, and she ordered each of them to pay a civil penalty
of $160,000.
2.
In the Matter of Piper Capital Management, Inc., et al., Initial Decision Rel. No.
175, Administrative Proceeding File No. 3-9657 (Nov. 30, 2000),
www.sec.gov/litigation/aljdec/id175hpy.htm.
In what has been described as one of the largest and most complex proceedings ever conducted
by the Commission, the ALJ H. Peter Young issued his initial decision in the Matter of Piper Capital
Management, Inc., et al. on November 30, 2000. The Commission alleged numerous securities laws
violations against Piper Capital Management, Inc. (PCM) and various PCM employees in connection
with the 1994 collapse of the Piper Jaffray Institutional Government Income Portfolio, a diversified
mutual fund
ALJ Young determined that PCM materially deviated from the "consistent with preservation of
capital" component of the fund's stated investment objective and failed either to disclose the deviation
or to obtain shareholder authorization for it. In addition, ALJ Young determined that the fund
misrepresented or failed to disclose numerous material facts concerning fund composition, duration,
performance, weighted average life, diversification and leverage in fund prospectuses and marketing
materials. ALJ Young also determined that the fund co-manager and various other PCM employees
participated in an effort to incorporate fund losses into the net asset value (NAV) over a period of days
and reported inaccurate NAV's for the fund in the interim. ALJ Young determined that numerous
misrepresentations concerning the primary portfolio manager's educational background constituted
intentional violations.
43
PCM was censured, its registration was revoked and it was ordered to cease and desist and pay
a $2,005,000 penalty. Although the judge determined that the conduct attributable to the fund comanager and other PCM employees was inappropriate and reckless in significant degree, he determined
it was not egregious in light of the extraordinary circumstances that confronted them. Judge Young
therefore censured and ordered each of them to cease and desist from violating the federal securities
laws and censured them. He expressly determined it was not in the public interest to bar any of them
from investment advisor or investment company association or to impose monetary sanctions on them.
An appeal of this decision is currently pending.
Soft Dollar Case
1.
In the Matter of Fundamental Portfolio Advisors, Inc., et al., Initial Decision Rel.
No. 180 (Jan. 29, 2001), www.sec.gov/litigation/aljdec/id180cff.htm.
Lance Brofman and two associated companies, Fundamental Portfolio Advisors (FPA) and
Fundamental Service Corporation (FSC), were fined and barred from the securities industry after a
hearing before an administrative law judge. Brofman, FPA, and FSC at one time were involved in
managing the Fundamental U.S. Government Strategic Income Fund (the Fund), a government bond
mutual fund.
The law judge found that Brofman, FPA, and FSC marketed the Fund as a safe, stable
investment but invested heavily in volatile inverse floaters that exposed the Fund to significant losses
when interest rates rose in 1994. Additionally, they did not inform the Board of Directors of the Fund
of their soft dollar arrangements, which included payments to a business partner. The law judge
concluded that, as charged, Brofman, FPA, and FSC violated several antifraud provisions of the
securities laws. Brofman was fined $250,000, and FPA and FSC were each fined $500,000.
Additionally, Brofman, FPA, and FSC were ordered to cease and desist from violations of the antifraud
provisions, Brofman was barred from the securities industry, and the investment adviser and brokerdealer registrations of FPA and FSC were revoked.
Switching Cases
1.
In the Matter of Russell Turek, SEA Rel. No. 45459 (Feb. 20, 2002),
www.sec.gov/litigation/admin/34-45459.htm.
On February 20, 2002, the Commission accepted an Offer of Settlement by Russell C. Turek in
response to the institution of public administrative and cease and desist proceedings. Turek was a
registered representative associated with a registered broker-dealer from January 1999 until June 2000.
He operated from a two-person branch office of that broker-dealer in Aurora, Colorado and maintained
approximately 900 customer accounts.
In April 1999, Turek, without authorization, signed an elderly customer's name on a "banklink"
form permitting the transfer of funds from the customer's bank account to the broker-dealer. He also,
without authorization, signed the name of another employee of the broker-dealer in order to guarantee
the validity of the customer's signature on a letter authorizing partial liquidation of an annuity product
44
held by the customer. In May 1999, after the customer's annuity funds were liquidated and deposited
into the customer's bank account, Turek used the forged banklink form to transfer the funds to an
account at the broker-dealer without the customer's authorization. Between February 1999 and August
1999, on at least seven occasions Turek engaged in improper mutual fund switching. He induced
customers, most of whom were elderly, to sell shares of one mutual fund and to use the proceeds to buy
shares of another mutual fund from a different fund family. He omitted to inform these customers of
their right to exchange their current funds for different funds within the same fund family to reduce
substantially or eliminate any sales load. These transactions provided no economic benefit to the
customers and were made for the sole purpose of generating commissions.
In April 1999, on at least two occasions Turek induced the purchase of mutual fund shares
resulting in the avoidance of breakpoints (the price level at which the sales charge paid by an investor
decreases) in order to increase his commission. He solicited a customer to purchase shares of two
nearly identical mutual funds, from different fund families, knowing that the customer would have paid
Respondent lower commissions if the investment had not been split between the funds. Turek also split
another customer's purchase of shares in a single mutual fund into two separate transactions, a practice
known as "market basketing," in order to avoid the fund's breakpoint. In each instance, Respondent
omitted to disclose to his clients the availability of breakpoints and, improperly orchestrated the
purchases to avoid breakpoints. Moreover on at least two occasions, in May 1999 and again in July
1999, Respondent purchased shares of mutual funds for customers without the customers'
authorization. The Commission found that these actions amounted to violations of Section 10(b) of the
Exchange Act and Rule 10b-5.
Consequently, Turek was barred from association with any broker or dealer with a right to
reapply in two years, ordered to cease and desist, and to pay disgorgement and prejudgment interest,
and a civil money penalty of $10,000.
2.
In the Matter of Raymond A. Parkins, Jr., SA Rel. No. 8055, SEA Rel. No. 45314,
IAA Rel. No. 2010 (Jan. 18, 2002), www.sec.gov/litigation/admin/33-8055.htm.
On January 18, 2002 the Commission accepted an Offer of Settlement by Raymond A. Parkins,
Jr., which was made in response to the institution of public administrative and cease and desist
proceedings. From at least 1993 through 1996, Parkins was the president of The Parkins Investment
Advisory Corporation ("Parkins Advisory"), which was an investment adviser registered with the
Commission. Parkins Advisory withdrew its registration with the Commission pursuant to a Form
ADV-W that became effective on July 8, 1997. Parkins was also the president of The Parkins
Investment Securities Corporation ("Parkins Securities"), which was a broker-dealer registered with the
Commission. Parkins Securities withdrew its registration with the Commission on July 16, 1999.
Parkins engaged in fraudulent switching of his clients' variable annuity investments. He
induced his investment advisory clients to switch variable annuities by providing them with unfounded,
false, and misleading justifications for the switches and by misrepresenting or omitting to inform them
of the sales charges associated with the switches. Beginning in the early 1990's, Parkins recommended
the purchase of variable annuity contracts to his clients. Parkins initiated his clients' switches among
variable annuities. In letters he prepared and sent, on a continuing basis, to his clients, Parkins
recommended that his clients switch their variable annuities. Along with the recommendation letter,
45
Parkins sent the necessary forms for effectuating the switch. Before mailing the letters and
accompanying forms, Parkins would designate on the forms the variable annuity funds to be purchased,
and in what amounts. Parkins attached markers to the forms instructing the client where to sign or
initial, as necessary, and also indicated to his clients that they should decline additional information
offered by the state of Florida. In some cases Parkins misleadingly told his clients that "time is of the
essence" and urged them to return the signed forms "as soon as possible." During the relevant period,
Parkins misled his clients about the costs of switching their variable annuities by omitting to inform his
clients about those costs or by providing them with inaccurate information about those costs.
The Commission ordered Parkins to cease and desist from committing or causing any violation
and any future violation of the anti-fraud provisions of the federal securities laws; barred Parkins from
association with any broker, dealer or investment adviser; and ordered Parkins to pay disgorgement in
the amount of $214,656, plus prejudgment interest.
V.
INSIDER TRADING
Insider trading remains one of the Commission’s important areas of enforcement, accounting for
at least forty cases a year. In the mid-eighties, most of the insider trading cases arose out of the merger
and acquisition boom. In the recession of the late eighties and early nineties, the Commission brought
more “bad news” selling cases -- insiders selling before adverse corporate financial developments were
disclosed. With the revival of mergers and acquisitions, the Commission is bringing more merger and
acquisition cases and has a large number of insider trading investigations underway. Moreover, the
Commission has witnessed a resurgence of insider trading cases involving securities industry
professionals.
1.
SEC v. Andrew S. Marks, Lit. Release No. 17871 (Dec. 3, 2002),
www.sec.gov/litigation/litreleases/lr17871.htm.
On December 3, 2002, the Commission announced that it has filed insider trading charges
against Andrew S. Marks in connection with his September 2001 sale of stock in Vertex
Pharmaceuticals, Inc., a Cambridge-based biotechnology company. The Commission’s complaint
alleges that Marks, who at the time was Vertex's highest-ranking attorney, learned on September 20,
2001 that Vertex planned to announce the suspension of clinical trials of one of its promising drugs on
September 24. According to the Commission's complaint, on September 21, Marks liquidated all of
his Vertex stock despite having previously acknowledged in writing that the impending release would
not be viewed favorably by Wall Street and that he should not sell his Vertex shares. The
Commission's complaint alleges that, by selling his holdings prior to the company's public
announcement on September 24, Marks avoided a loss of $105,999.
According to the Commission's complaint, at the time he traded, Marks was the designated
attorney for employees to consult regarding compliance with Vertex's employee securities trading
policy. In that capacity, the complaint alleges, Marks wrote Vertex's CEO an email on September 20,
advising him to make sure that an employee who had requested permission to trade had no knowledge
of the impending press release.
46
The Complaint alleges that Marks traded in breach of a fiduciary duty to Vertex and its
shareholders not to trade in the Company's stock while in possession of material, nonpublic
information about the Company. As a result of the conduct described in the Complaint, the
Commission has charged Marks with violations of the antifraud provisions of federal securities laws.
The Commission's Complaint seeks injunctive relief, disgorgement plus prejudgment interest, and civil
penalties and seeks an order barring Marks from acting as an officer or director of any publicly-traded
company.
2.
SEC v. Roys Poyiadjis, Lycourgos Kyprianou and Aremissoft Corp., et al., Lit.
Release No. 17862 (Nov. 25, 2002), www.sec.gov/litigation/litreleases/lr17862.htm.
On November 22, 2002, an Isle of Man appellate tribunal entered a judgment holding that the
Commission is entitled to participate directly in proceedings commenced by the Isle of Man Attorney
General in October 2001 at the request of the Attorney General of the United States. In those
proceedings, the High Court of the Isle of Man has issued restraint orders freezing approximately $175
million deposited in two Isle of Man banks. These funds are alleged to constitute proceeds of
fraudulent insider trading in the stock of AremisSoft Corporation. The Commission, the United States
Attorney for the Southern District of New York and the Attorney General for the Isle of Man are
pursuing the repatriation of the frozen funds to the United States to be used to compensate defrauded
AremisSoft investors.
The Commission also has obtained a U.S. asset freeze in a preliminary injunction entered on
October 19, 2001 by the U.S. District Court for the Southern District of New York. In its complaint in
the U.S. enforcement action, the Commission alleged, among other things, that AremisSoft and two of
its former officers, Roys Poyiadjis and Lycourgos Kyprianou, overstated the Company's revenues in its
annual report for 2000 and inflated the value of acquisitions made in 1999 and 2000 and that the two
former officers engaged in massive insider trading during the period of the reporting fraud. The SEC's
enforcement action remains pending against Poyiadjis, Kyprianou and two relief defendants that
nominally hold the funds in the Isle of Man bank accounts, Olympus Capital Investment, Inc.
("Olympus") and Oracle Capital, Inc. ("Oracle"). Poyiadjis, Kyprianou and the relief defendants have
not answered the Commission's complaint.
The U.S. Attorney for the Southern District of New York obtained an indictment of Poyiadjis
on December 19, 2001. Poyiadjis has fled to the Republic of Cyprus where he remains to date. On
March 22, 2002, the U.S. Attorney's Office filed a civil complaint in rem in the U.S. District Court for
the Southern District of New York seeking civil forfeiture of the funds in the Isle of Man banks, and on
June 3, 2002 the court entered a default judgment ordering forfeiture of the funds to the United States.
On June 24, 2002 a superseding indictment was returned against Poyiadjis, Kyprianou (who resides in
Cyprus) and another AremisSoft officer, M.C. Mathews (who resides in India) on counts of conspiracy
to commit securities fraud, mail fraud, and wire fraud, substantive counts of securities fraud (both on
the market and insider trading), conspiracy to commit money laundering, and substantive counts of
money laundering. On July 16, 2002, the Isle of Man Attorney General filed a petition in the High
Court seeking to register the civil in rem forfeiture judgment as an external confiscation order under the
applicable Isle of Man statute. The Commission has supported and assisted the U.S. Attorney's Office
and the Isle of Man Attorney General in the pending Isle of Man restraint order litigation, but it was not
previously able to participate directly in those proceedings.
47
On June 4, 2002, the Commission filed a petition seeking an order of the Isle of Man High
Court permitting the Commission to participate directly in the restraint order proceedings. Although
the petition initially was denied in a judgment dated July 16, 2002, the Commission successfully
appealed that ruling. The appellate judgment found "that the SEC is a person affected by the restraint
order" and concluded that "the overall circumstances in this case justify our exercising discretion in
favour of the SEC becoming a Noticed Party."
3.
SEC v. Rodolfo Luzardo, Elias I. Kodsi, and Alain D. Kodsi, Lit. Release No.
17850 (Nov. 20, 2002), www.sec.gov/litigation/litreleases/lr17850.htm.
On November 12, 2002, Judge Denny Chin in the United States District Court for the Southern
District of New York entered a final judgment against Rodolfo Luzardo ("Luzardo"). The defendant
was ordered to pay a $100,000 penalty in a Commission action that charged him with insider trading in
the securities of BetzDearborn Inc. Luzardo settled the action without admitting or denying the
allegations in the Commission's complaint.
The Commission's complaint alleged that Rodolfo Luzardo, a former analyst in the mergers and
acquisitions unit of J.P. Morgan Securities, Inc., Alain D. Kodsi, a co-owner of a venture capital firm,
and Elias I. Kodsi, a retired jewelry distributor, engaged in illegal insider trading in advance of the July
30, 1998 announcement that BetzDearborn Inc. and Hercules Inc. had agreed to merge. Without
admitting or denying the allegations of the Commission's complaint, Rudolfo Luzardo consented to the
entry of the final judgment which permanently enjoins him from violating the antifraud provisions of
the federal securities laws, and orders him to pay a civil penalty of $100,000. The Commission
previously settled its case against the Kodsis who each paid a $963,750 civil penalty and, jointly and
severally, disgorged $963,750 in unlawful profits, and $308,992 in prejudgment interest.
Based on the entry of the Court's injunction, the Commission also instituted administrative
proceedings to bar Luzardo from the securities industry. Without admitting or denying the
Commission's findings, Luzardo consented to the entry of the Commission's Order, which bars him
from association with any broker or dealer. In the Matter of Rodolfo Luzardo, Administrative
Proceeding File No. 3-10938; Securities Exchange Act of 1934 Release No. 46854 (November 20,
2002).
See also Litigation Release No. 17197 (October 18,2001) and Litigation Release No. 17486
(April 24, 2002). See also the following related matters: SEC v. Joseph F. Doody IV, et al., 01 Civ.
9879 (JK) (S.D.N.Y.) (filed November 8, 2001) (Litigation Release No. 17225); SEC v. Bugenhagen,
et al., 01 Civ. 6538 (E.D.PA.) (filed December 18, 2001) (Litigation Release No. 17278); SEC v.
Litvinsky, et al., 02 Civ. 0312 (LMM) (S.D.N.Y.) (filed January 14, 2002) (Litigation Release No.
17306); and SEC v. Straub, et al., 1:02CV01128 (EGS) (D.D.C.) (filed June 10,2002) (Litigation
Release No. 17549). To date, in the five insider trading cases concerning trading before the merger of
BetzDearborn and Hercules, the Commission has obtained over $3.9 million in disgorgement,
prejudgment interest, and penalties.
48
4.
SEC v. Samuel D. Waksal, Lit. Rel. No. 17559 (Jun. 12, 2002).
The SEC filed an insider trading case against Samuel D. Waksal, the former CEO of ImClone
Systems Inc. The complaint charged that Waksal received disappointing news late last December that
the U.S. Food and Drug Administration would soon issue a decision rejecting for review ImClone's
pending application to market its cancer treatment drug, Erbitux. The SEC further charges that Waksal
told this negative information to certain family members who sold ImClone stock before the news
became public and that Waksal himself tried to sell shares of ImClone before the news became public.
In its lawsuit, filed in federal court in Manhattan, the Commission seeks an order requiring that
Waksal disgorge the several million dollars in losses avoided by those family members he tipped, and
that he pay civil penalties and prejudgment interest. It also seeks an order permanently enjoining
Waksal from violating the securities laws, and barring him from acting as an officer or director of a
public company. The U.S. Attorney in the Southern District of New York also indicted Waksal for
insider trading.
5.
SEC v. Hugo Salvador Villa Manzo and Multinvestments, Inc., Lit. Rel. No. 17485
(April 24, 2002).
On March 11, 2002, the U.S. District Court for the Southern District of New York entered a
final judgment against Hugo Salvador Villa Manzo based upon charges of insider trading. Villa is the
Chairman and part-owner of MultiValores Grupo Financiero, S.A. de C.V., a Mexican public
company that indirectly owns Multinvestments, Inc., a U.S. broker-dealer.
The Commission alleged that Villa was tipped by Jose Luis Ballesteros, a director of Nalco
who has since died. The Complaint specifically alleged that Jose Luis Ballesteros violated his
fiduciary duties to Nalco by providing Villa with material, nonpublic information about the proposed
acquisition by Suez Lyonnaise des Eaux, a French company. In response to this tip, Villa instructed
one of his senior colleagues at Multinvestments to buy Nalco stock for Multinvestments' proprietary
account. Pursuant to Villa's instructions, Multinvestments, through its proprietary account, purchased
50,000 Nalco shares for $2,015,625. In purchasing Nalco shares, Multinvestments used margin
privileges and also used the maximum amount available in its proprietary account without violating
the firm's net capital requirements. As a result of these transactions, unlawful profits totaling $558,750
were realized.
Without admitting or denying the Commission's allegations, Villa consented to the entry of the
final judgment, which permanently enjoins him from violating the antifraud provisions of the federal
securities laws. The Court also ordered Villa and Multinvestments to pay $1,503,471.83, representing
disgorgement of $ 558,750, prejudgment interest of $106,596.83, and a civil penalty of $838,125.
Based on the entry of the Court's injunction, the Commission instituted settled administrative
proceedings against Villa. Without admitting or denying the Commission's findings, Villa consented
to the entry of the Commission's Order, which bars him from associating with any broker, dealer, or
investment adviser.
49
In two previous actions, the Commission filed complaints alleging that Jose Luis Ballesteros
purchased Nalco stock and tipped others. See SEC v. Jorge Eduardo Ballesteros Franco, et. al., Lit
Rel No. 16991 (May 8, 2001). Without admitting or denying the allegations of the Complaint, several
of the defendants consented to pay a total of $4,730,951 in disgorgement, prejudgment interest and
penalties. The Estate of Jose Luis Ballesteros Franco has consented to pay disgorgement of
$3,380,284, representing all the profits made by the Ballesteros family from their trading of Nalco
stock, together with prejudgment interest of $364,586. The defendants named in the second action
invested over $1.8 million in Nalco stock and made illegal profits of $776,725. See SEC v. Pablo
Escandon Cusi and Lori Ltd., Lit. Rel. No. 17356 (Feb. 7, 2002). Without admitting or denying the
allegations of the complaint, Escandon and Lori Ltd. consented to pay a total of $1,716,546.23,
representing disgorgement of $776,725, prejudgment interest in the amount of $163,096.23, and a
penalty of $776,725. In addition, Escandon and Lori Ltd. have consented to the entry of a permanent
injunction prohibiting them from further violations. The Commission is continuing its investigation
in this matter.
On May 8, 2001, the United States Attorney for the Southern District of New York announced
the indictments of Jorge Eduardo Ballesteros Franco and Juan Pablo Ballesteros Gutierrez for nine
felony counts and three felony counts, respectively, for conspiracy to violate, and violations of, the
federal securities laws. Both defendants, and the entities through which they traded have been sued by
the Commission for the same conduct. The Commission is continuing its investigation in this matter.
On February 27, 2002, Juan Pablo Ballesteros Gutierrez was convicted of insider trading in the
Southern District of New York and, on June 4, 2002, was sentenced to 15 months imprisonment, a
$40,000 fine and two years of supervised release.
On December 9, 2002, the U.S. District Court for the Southern District of New York entered a
final judgment against Juan Pablo Ballesteros Gutierrez based upon charges of insider trading.
Without admitting or denying the allegations of the Commission's Complaint, Juan Pablo Ballesteros
Gutierrez consented to the entry of the Court's final judgment. The judgment orders Juan Pablo
Ballesteros Gutierrez to pay a penalty of $106,403.75. His profits of $106,403.75, along with
prejudgment interest, were previously paid as part of the settlement with other parties announced on
May 8, 2001. In addition, the judgment permanently enjoins Juan Pablo Ballesteros Gutierrez from
violating the antifraud and insider trading provisions of the federal securities laws. Because Casford
Limited no longer exists, the Commission dismissed its claims against that entity.
All told, the Commission has now obtained over $8 million in settlements with those persons
and entities charged with insider trading in Nalco stock. With the exception of Jorge Eduardo
Ballesteros Franco (and the entities through which he traded), the Commission has reached settlements
with all of the defendants named in those three actions.
SEC V. Jorge Eduardo Ballesteros Franco, et al., Lit. Release No. 17897 (December 17, 2002)
50
VI.
CASES INVOLVING SECURITIES OFFERINGS
1.
SEC v. Dennis Herula, et al., Lit. Release No. 17848 (Nov. 19, 2002),
www.sec.gov/litigation/litreleases/lr17848.htm.
The Commission announced that on November 6, 2002, the U.S. Court of Appeals for the First
Circuit upheld a district court order imposing preliminary injunctions and asset freezes against Martin
Fife, a former Dreyfus fund independent director, and Farouk Khan, Fife's business associate, in a
securities fraud case.
In its complaint, filed in federal district court in Rhode Island on April 1, 2002, the
Commission alleged that Fife, Khan, and others defrauded investors of over $50 million in a prime
bank-type scheme that promised returns as high as 300% in twelve business days, and that over $20
million had not been returned to investors. On May 1, 2002, after a two-day hearing in April, the
district court issued an order finding that the Commission is likely to succeed in proving that Fife,
Khan, and certain other defendants violated the securities laws, and that there is a strong likelihood that
violations may occur in the future if these defendants are not enjoined. The order further stated that
there is a high risk that any remaining investor funds may be further depleted. On May 8, 2002, the
court issued written preliminary injunctions and asset freezes against Fife, Khan and certain other
defendants, based on its findings in the May 1 order. Defendants Fife and Khan appealed the district
court's decision to the First Circuit.
On November 6, 2002, the First Circuit affirmed the entry of preliminary injunctions and asset
freezes against Fife and Khan. The First Circuit found that the Commission made a sufficient showing
that Fife and Khan made material misrepresentations in connection with the purchase or sale of
securities in violation of the antifraud provisions of the federal securities laws, and that it was
reasonably likely they may commit such violations again. The First Circuit further upheld the district
court's finding that the Commission had established a substantial likelihood that Fife violated the
antifraud provisions relating to investment advisers. Among other things, the First Circuit found that
Fife repeatedly made false representations to one investor concerning the management of its funds, and
that Fife and Khan had both misrepresented to investors the risk of loss associated with a purported
"balance sheet enhancement program."
For further information, please see Litigation Release Numbers 17461 (April 5, 2002) and 17514 (May
13, 2002).
2.
Telemarketing Stock Fraud Sweep, August 6, 2002.
The SEC charged 81 defendants in cases arising from 10 schemes in which the defendants
conducted unregistered securities offerings and fraudulently diverted the proceeds to pay exorbitant,
undisclosed commissions to telemarketers and other unregistered brokers who solicited the investors.
These 10 schemes took place between 1996 and 2001, and raised approximately $30 million from more
than 1,800 investors. In four separate enforcement actions filed in federal district court, the
Commission has named 81 individuals and entities as defendants in these schemes.
51
The Commission alleges that the offerings were fraudulent because the issuers employed
nationwide networks of telemarketers, called Independent Sales Offices or ISOs, to sell the offerings
and paid them undisclosed cash commissions ranging from 20% to as high as half of the offering
proceeds. According to the SEC's complaints, these excessive commissions violated express
representations contained in offering materials, which falsely stated that the issuers would use most of
the offering proceeds for business purposes. When the offering materials did mention sales
commissions, they significantly understated the portion of offering proceeds that issuers agreed to pay
broker-dealers. The Commission's complaints charge the issuers and their principals, the individuals
and entities who managed the offerings by recruiting and organizing the networks of ISOs, the ISO
operators, and two attorneys.
Simultaneously, in related criminal prosecutions, the U.S. Attorney for the Eastern District of
New York announced the unsealing of indictments containing criminal charges against 46 defendants
for the same fraudulent schemes.
Each of the SEC's four complaints charges a separate group of related schemes. These four
groups are as follows:
Motion Picture Schemes. Three schemes involved offerings of securities in motion picture
development companies: Heritage Film Group LLC, Little Giant LLC, and Out of the Black Partners
LLC. These issuers retained "offering managers" Russell Finnegan, in the case of Little Giant and
Heritage Film, and Michael Gonzales, in the case of Out of the Black, who recruited and coordinated
over 42 telemarketer ISOs. Between 1997 and 2001, the defendants raised approximately $13.1
million, of which about half went to telemarketers and other unregistered brokers as sales
commissions. SEC v. Heritage Film Group, LLC, Lit. Rel. No. 17658.
Medical Technology Ventures. Three other schemes involved companies that develop medical
devices and software for health care professionals: Intracom Corp., Hyperbaric Systems Inc., and
Surgica Corp. These offerings took place between 1997 and 2000, were coordinated through Larry
Bryant, an unregistered securities broker, and raised over $13 million. Between about 20% to 30% of
the offering proceeds went to pay sales commissions even though the offering memoranda represented
that only 12% would be used for that purpose. SEC v. Intracom Corporation, Lit. Rel. No. 17659.
Internet-Telecommunications Ventures. Three further schemes involved entities purportedly
formed to establish long distance telephone service through the Internet: Ephone Inc., Webphone LLP,
Newera Communications LLP. These offerings occurred between July 1999 and December 2000 and
raised about $2.9 million. About $1.2 million of that amount - or 42% - went to unregistered brokerdealers Donald Plain, Christopher Plain, Peter Bertorelli, and the ISO telemarketers they coordinated.
SEC v. Ephone, Inc., Lit. Rel. No. 17660.
In Line Hockey Rink Venture. Between 1996 and 2000, the defendants raised over $650,000
from approximately 52 investors by offering stock in America In Line Corp. and its subsidiary,
America In Line of Mount Sinai Corp., purportedly for building and operating in line roller hockey
rinks. Almost 30% of the offering proceeds went to telemarketers as sales commissions. SEC v.
America In Line Corporation, Lit. Rel. No. 17661.
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The Commission alleges that the defendants violated the antifraud provisions of the Securities
Act of 1933 and the Securities Exchange Act of 1934, the provisions of the Securities Act that require
registration of non-exempt securities offerings, and the provisions of the Exchange Act that require
registration of broker-dealers. The Commission seeks injunctions, disgorgement of illegal commissions
and other ill-gotten gains plus prejudgment interest, and civil penalties. The complaints also seek
orders barring the principals of the issuers from serving as officers or directors of public companies.
The cases are pending.
3.
SEC v. Resource Development International LLC et al., Lit. Rel. 17438 (Mar. 26,
2002), www.sec.gov/litigation/litreleases/lr17438.htm.
The Commission filed a civil action to stop an alleged $98.7 million fraudulent prime bank
scheme. On March 25, 2002, Judge Jerry Buchmeyer, United States District Court for the Northern
District of Texas, Dallas Division, granted the Commission's Motion for Temporary Restraining Order
and issued an Ex Parte Order Freezing Assets and Requiring an Accounting, Preservation of
Documents, Repatriation of Assets, Surrender of Passports and Authorizing Expedited Discovery, and
appointed a receiver for all defendants and relief defendants. Among others, the Commission sued the
following defendants:

Resource Development International, LLC ("RDI"), located in Tacoma, Washington, is a
Nevada limited liability corporation formed in January 1999 and dissolved in August 2000.

David Edwards ("D. Edwards"), acts as president of RDI, vice-president of defendant Sound
Financial Services, Inc. and vice-president of relief defendant International Education Research
Corporation ("IER"), and controls Jade and Galaxy Asset Management, Inc. ("Galaxy").

James Edwards ("J. Edwards"), D. Edwards’ father, and together with him owns and/or
controls, among other entities, RDI. J. Edwards formed and controls relief defendant Pacific
International Limited Partnership ("PILP").
Specifically, the Commission charges that from January 1999 through the present, defendants' RDI
scheme has raised approximately $98 million from more than 1300 investors nationwide, targeting
persons seeking to invest retirement funds. In the course of marketing the RDI trading program, certain
defendants acted as unregistered broker-dealers. Defendants falsely claimed to investors, among other
things, that their money would be used in Europe to trade financial instruments with "top 25" or "top
50" banks in a program sponsored by the Federal Reserve and global organizations, generating annual
returns of 48 to 120 percent with complete safety of principal. In reality, the prime bank program
marketed to investors does not exist and investor funds have been misappropriated for personal and
unauthorized uses, including making Ponzi payments. Moreover, while RDI has ceased making
payments of any kind to its investors, tens of millions of dollars collected by the defendants simply
cannot be accounted for. The Commission's complaint further charges that J. Edwards and D. Edwards
diverted funds to buy property and a home for their personal use, and that certain relief defendants
received at least $6 million, and possibly as much as $13 million, of RDI investor funds or control
property derived from investor funds.
The Commission's complaint charges defendants with, among other things, violations of the
registration and antifraud provisions. In addition to the emergency relief set out above, the
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Commission seeks preliminary and permanent injunctions, disgorgement and civil penalties, and
repatriation orders against all the defendants, and disgorgement and prejudgment interest against the
relief defendants.
4.
SEC v. Clif Goldstein, formerly known as Clifford Dixon Noe, et al., Lit. Rel. No.
17362 (Feb.14, 2002), www.sec.gov/litigation/litreleases/lr17362.htm.
The SEC filed a securities fraud lawsuit against Clif Goldstein, formerly known as "Clifford
Noe" and also known as "Dr. Noe," Goldstein's brother Paul Howe Noe, and four other individuals and
two entities in connection with an alleged prime bank fraud that has raised at least $1.1 million from
more than 20 investors. Goldstein and Noe each have extensive prior criminal records. Goldstein, age
72, has prior criminal convictions, for among other crimes, wire fraud, mail fraud and forgery, while
Paul Noe has prior convictions, for, among other crimes, embezzlement, larceny and wire fraud.
The Commission's complaint, filed in the federal district court for the District of South
Carolina, alleges that the defendants targeted both cash-poor companies unable to obtain funding
through conventional means, and individual investors who desired to earn high investment returns
quickly. Goldstein and Noe and their "Great American Trust" companies served as the primary
offerors of the investment programs that comprised the fraud scheme, while the other defendants
served as "finders" or selling agents, locating and luring potential investors to Goldstein and Noe and
receiving finders' fees.
The programs, which were promoted via the Internet and an intricate network of so-called
consultants or finders, featured the use of so-called prime bank instruments, wholly fictional securities
purportedly traded on an equally fictitious secondary market. In its complaint, the Commission alleges
that the defendants violated the antifraud provisions of the federal securities laws. The Commission is
seeking permanent injunctions against future violations of the anti-fraud provisions, disgorgement of
defendants' ill-gotten gains plus prejudgment interest, and civil penalties.
Concurrently with the Commission action, the Office of the United States Attorney for the
District of South Carolina has filed criminal charges against Goldstein and Noe for their roles in the
investment scheme, and the Federal Bureau of Investigation has arrested those individuals
5.
In the Matter of Republic New York Securities Corp., SEA Rel. No. 45157 (Dec.
17, 2001), www.sec.gov/litigation/admin/34-45157.htm.
The SEC issued an order revoking the registration of Republic New York Securities Corp., a
New York-based broker-dealer registered with the Commission since 1992. Republic Securities is now
a subsidiary of HSBC USA, formerly Republic New York Corporation.
The Commission found that Republic Securities violated federal securities laws by participating
in a massive Ponzi scheme operated by Martin Armstrong. In September 1999, the Commission
charged Armstrong and two companies he controlled, Princeton Economics International and Princeton
Global Management, in an emergency action alleging that they defrauded scores of Japanese
companies that had invested billions of dollars in Princeton Global Management notes. Armstrong,
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who was indicted by a federal grand jury in New York, was also charged by the Commodity Futures
Trading Commission.
Also on December 17, 2001, in the parallel criminal proceeding, the Office of the United States
Attorney for the Southern District of New York announced a guilty plea by Republic Securities. As
part of the resolution of the criminal case, Republic Securities has agreed to pay $606 million in
restitution to defrauded investors. The Commodity Futures Trading Commission also announced a
related enforcement action against Republic Securities. In settling the Commission's enforcement
action, Republic Securities neither admitted nor denied the Commission's findings.
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