Category: Securities

SEC Settles Mutual Fund Late Trading Case Against Hedge Fund

December 2nd, 2005

The SEC announced that it had settled an administrative action against Millennium Partners, a hedge fund, for late trading and market timing transactions in mutual funds. Millenium Partners, which manages over $5 billion, agreed to disgorge $148 million in profits, Israel Englander, its managing member, will pay a $30 million civil penalty, and Terrence Feeney, its chief operating officer, will pay a $2 million civil penalty. According to the SEC’s administrative order (here):

From at least 1999 to 2003, Millennium Partners, Millennium Management, and Millennium International Management generated tens of millions of dollars in profits through market timing trades of mutual fund shares, a practice which mutual funds generally discouraged. Englander, Feeney, [and two other officers] knew that mutual funds sought to detect market timers and frequently blocked Millennium’s trades and, therefore, devised and carried out a fraudulent scheme to avoid detection and circumvent restrictions that the mutual funds imposed on market timing. Specifically, Millennium: (1) created approximately 100 legal entities to hide that Millennium was behind the mutual fund trading; (2) used those entities to create in excess of 1,000 accounts; (3) structured its trading to avoid detection by the mutual funds; (4) used omnibus accounts and variable annuities to further hide Millennium’s identity; and (5) took advantage of certain "sticky" asset arrangements.

The settlement marks the first case involving a hedge fund penalized for engaging in market timing. An AP story (here) discusses the settlement. (ph)
SEC Files Amended Complaint Against Amerindo and Its Founders

November 18th, 2005

The SEC announced the filing of an amended complaint (here) against Amerindo Investment Advisors and its founders, Alberto Vilar and Gary Tanaka, alleging a scheme to defraud investors in two off-shore funds and in Guaranteed Fixed Rate Deposit Accounts. The Commission Litigation Release (here) describes the additional fraud:

Amerindo, Vilar, Tanaka and other affiliated entities, including Techno Raquia, defrauded individuals and entities who invested in GFRDAs. Vilar and Tanaka, as well as other Amerindo employees, solicited clients to invest funds in GFRDAs, a product in which Amerindo guaranteed that investors would earn a fixed rate of return per year on their investment, and would receive their principal at maturity. Amerindo represented to investors that it would invest the majority of their funds in short-term debt instruments and invest the remaining portion of their funds in equities. After individuals and entities invested funds in the GFRDAs, however, Vilar, Tanaka and Amerindo failed to invest the funds in accordance with the representations to investors. Rather, Vilar and Tanaka largely invested in equity securities, such as emerging technology and biotechnology stocks. Moreover, especially during the post-2000 bear market, these equity investments did not perform well and Amerindo was often unable to pay GFRDA investors their promised returns, or to return investors’ principal at maturity. Consequently, when investors sought to redeem their GFRDAs, Amerindo generally either refused to honor redemption requests, or redeemed the GFRDAs with other investors’ funds taken from unrelated brokerage accounts in, for example, the name of AMI, ATGF and/or ATGF II.

Additionally, the amended complaint alleges that Vilar, Tanaka and Amerindo defrauded investors who invested in two offshore hedge funds, ATGF and ATGF II. According to offering circulars, ATGF and ATGF II planned to invest in emerging growth companies. Rather than using investor funds solely to invest in such companies’ securities, however, Tanaka directed ATGF and ATGF II to transfer investor funds from the funds’ brokerage accounts to other accounts for Vilar’s and Tanaka’s own business and personal benefit.

Vilar and Tanaka were arrest in May 2005 on securities fraud charges related to siphoning funds from an account of an Amerindo investor, and Vilar was forced to spend almost three weeks in jail when he could not meet the bail requirements to be released. Both men are awaiting trial on the criminal charges in addition to the SEC civil enforcement action. (ph)
D.C. Circuit Finds SEC Monetary Penalties Were Arbitrary and Capricious

November 17th, 2005

In a market manipulation case, the D.C. Circuit held that the SEC had not established that a series of matched trades by the defendants were conducted with the requisite scienter for a Section 10(b)/Rule 10b-5 finding of market manipulation, and that the substantial monetary penalties imposed on the defendants for other disclosure violations were unsupported. In Rockies Fund Inc. v. SEC (here), the court of appeals reviewed a Commission order finding violations by three directors of The Rockies Fund, a business development company, for sales of securities of a company in the Fund’s portfolio. The SEC imposed civil money penalties of $160,000 each on two directors and $500,000 on one director. In rejecting the substantial penalites, the D.C. Circuit stated:

The monetary sanctions imposed by the SEC amount to the harshest available—third-tier sanctions. To impose third-tier sanctions, the SEC must show that the violations "involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement" and "directly or indirectly resulted in substantial losses or created a significant risk of substantial losses to other persons or resulted in substantial pecuniary gain to the person who committed the" violations. 15 U.S.C. § 80a-9(d)(2)(c). The SEC found that this standard applied but did not even cursorily explain either element. One could say the entire opinion, charitably read, provides the analysis for the first prong. As to the second prong, however, the SEC gives no explanation of how petitioners’ conduct either resulted in or created a significant risk of substantial loss to others. Neither does it give support for a finding of pecuniary gain. In sum, the SEC’s analysis was not just superficial; it was nonexistent. Accordingly, because the SEC did not explain its reasoning, we hold that the SEC arbitrarily and capriciously imposed third-tier sanctions on the petitioners.

(ph)
Patterson-UTI Energy Internal Investigation Finds $70 Million Embezzlement

November 14th, 2005

Drilling and oil exploration firm Patterson-UTI Energy, Inc., announced that an internal investigation has disclosed that upwards of $70 million may have been embezzled from the company by an officer through payment for phantom assets. According to the company’s press release (here):

[A]s a result of information received by senior management of the Company on November 9, 2005, the Audit Committee of the Board of Directors of the Company has begun an investigation into unauthorized payments made by the Company for assets which were not delivered to the Company. The Audit Committee will engage legal counsel and forensic accountants to conduct the investigation. Based on preliminary findings, it appears that approximately $70 million may have been embezzled from the Company by a former officer over a period of more than five years. Because the investigation is just beginning the Company has not yet made a final determination as to the impact of these developments upon its previous financial results and assessment of internal controls.

The company issued a press release (here) just six days earlier, on Nov. 3, announcing "that John E. Vollmer, Senior Vice President-Corporate Development, has assumed the added responsibilities of Chief Financial Officer. Mr. Vollmer replaces Jonathan D. (Jody) Nelson who has resigned for personal reasons." What were the personal reasons? Nelson has not been identified as being involved in the $70 million embezzlement, but it would be difficult to siphon off that amount of money — even in a company with over $1 billion in annual revenues — without the infolvement of financial executives or, at a minimum, a complete breakdown in the company’s internal controls. Tom Kirkendall on the Houston’s Clear Thinkers blog has a detailed post (here) on the topic. (ph)
Former CEO of Refco Indicted

November 11th, 2005

The former CEO of Refco, Inc., Phillip R. Bennett, was indicted today. (See Wall Street Jrl here; NYTimes here) The indictment charges him with Count I – Conspiracy to Commit Securities Fraud, Wire Fraud, and to Make False Filings With the SEC; Count II – Securities Fraud; Count III – False Filing With the SEC-Exchange Act; Counts IV & V – False Filing With the SEC – Securities Act; and Counts VI, VIII, VIII – Wire Fraud. The indictment also contains a forfeiture allegation.

The essence of the alleged conspiracy charge is that:

"Bennett, …together with others. . . sought to hide from, among others, Refco’s auditors and investors, losses sustained by Refco through its own and its customers’ trading in the financial markets. To that end, Bennett transferred losses from Refco to a company controlled by Bennett, directed a repeated series of transactions designed to conceal those losses at year – and quarter-end from Refco’s auditors and others, and caused Refco to make false and fraudulent public filings with the United States Securities and Exchange Commission ("SEC").This fraudulent scheme culminated in the August 2005 initial public offering of stock ("IPO") in Refco, Inc., in which the public purchased approximately $583 million of Refco common stock based on a false and fraudulent registration statement."

(esp)
GM Announces Restatement

November 10th, 2005

General Motors announced that it would have to restate its earnings for 2001, and possibly other years, because of problems with its accounting for certain credits from its suppliers. The SEC has been investigating GM and Delphi Corp., its former supplier subsidiary spun off from the company that recently declared bankruptcy, about their accounting for the credits. It appears the companies took inconsistent positions on the accounting for the credits, which had the effect — not surprisingly — of increasing GM’s income and decreasing Delphi’s expenses. Go figure. This isn’t the only SEC investigation of GM, which is also one of the subjects of an inquiry into its accounting for pension and health care benefits, including whether the company manipulated its assumptions on those costs to — once again — increase its income and lower its pension expenses. A Wall Street Journal story (here) discusses the pension accounting investigation.

GM filed an 8-K (here) describing the current restatement:

[T]he review to date indicates that GM erroneously recognized some supplier credits as income in the year in which they were received rather than in the future periods to which they were attributable. Based on the information to date, GM currently estimates that its net income from continuing operations for 2001 was overstated by approximately $300 million to $400 million (or about 25% to 35%) due to this error. Accordingly, although the final restatement amounts have not yet been determined, GM has determined to restate its financial statements for 2001, and the restatement is expected to be material to the financial statements previously reported for that year. GM will also restate financial statements for periods subsequent to 2001 that may be affected by the erroneous accounting. However, the effect of any such restatement in subsequent periods is expected to be immaterial to those financial statements.

Investor Kirk Kerkorian, who has bought up a bit less than 10% of GM’s shares this year, can’t be very happy with this latest development as the company’s stock has lost almost of third of its value in the past few months. That may be the least of the General’s problems at the moment, however. (ph)
More Overseas Insider Trading

November 3rd, 2005

It’s an oft-repeated scenario: an offer is made for a company at a premium to its market price, and a few days later the SEC files a suit in the U.S. District Court for the Southern District of New York (effectively its home court) for a freeze on brokerage accounts through which options in the target were purchased right before the announcement. The latest example is a suit filed over the purchase of 10,000 call options in Placer Dome 5-6 days before Barrick Gold announced an unsolicited $9.2 billion bid for the company on Oct. 31. Placer Dome’s stock increased by 20%, and the options increased in value by $1.9 million. Needless to say, the options market makers for Placer Dome raised the roof over that kind of gain in only a few trading days, and the SEC responded by filing an emergency action to freeze the accounts. According to a Bloomberg story (here), the trading was through accounts at a Swiss asset management firm, and it is unlikely the true owners will identify themselves any time soon. Once again, it’s not free money, but it’s awfully tempting to reach for it. (ph)

UPDATE: The SEC Litigation Release is now available (here), and it states:

The Commission further alleges that on October 25 and 26, while in possession of material, nonpublic information regarding this acquisition offer, the Unknown Purchasers, using overseas accounts, purchased over 10,000 call option contracts for Placer stock in an account at a broker-dealer in the United States. As the complaint alleges, over 5,000 call option contracts were "out of the money" and set to expire in November, within weeks of the purchase date. The complaint further alleges that, as a result of the increase in price of Placer stock following the Announcement, the unrealized illicit profits on these option contracts total over $1.9 million.

Large purchases of out-of-the-money call options + $1.9 million in profits almost overnight = SEC TRO. (ph)
Mercury Interactive’s Options Timing Problem

November 3rd, 2005

Mercury Interactive Corp. announced the appointment of a new CEO, CFO, and General Counsel as a result of an internal investigation that turned up substantial problems in reporting by officers of the dates on which options were granted. According to the company’s press release (here):

From 1995 to the present, there have been forty-nine instances in which the stated date of a Mercury stock option grant is different from the date on which the option appears to have actually been granted. In almost every such instance, the price on the actual date was higher than the price on the stated grant date. These instances represent the overwhelming majority of the grants between January 1996 and April 2002. The misdating occurred with respect to grants to all levels of employees.

Chief Executive Officer Amnon Landan, Chief Financial Officer Douglas Smith, and General Counsel Susan Skaer were each aware of and, to varying degrees, participated in the practices discussed above. Each of them also benefited personally from the practices. While each of these officers asserts that he or she did not focus on the fact that the practices and their related accounting were improper, the Special Committee has concluded that each of them knew or should have known that the practices were contrary to the options plan and proper accounting. While the Special Committee is appreciative of and sympathetic to the far-reaching demands of these executives’ positions during this critical period, missing or overlooking a practice as basic and important as the proper granting of options is not acceptable.

The internal investigation also disclosed that Landan received a $1 million loan from the company in 1999 to fund an options exercise, but no documentation for the loan could be located, although the board approved an extension of the loan and it was ultimately repaid. Needless to say, that type of disclosure will invite an SEC investigation and a torrent of securities fraud lawsuits..

Landan, Smith, and Skaer resigned, and the company will probably have to delay the filing of its quarterly and annual reports due to the internal weaknesses identified in the internal investigation — the press release notes that a timely filing of its Form 10-Q and 10-K is in "serious jeopardy." (ph)
Former Hospital CFO Settles Criminal and Civil Accounting Fraud Charges

November 3rd, 2005

The former CFO for Bon Secours Cottage Health Services, David Zilli, entered a guilty plea in the U.S. District Court for the District of Maryland and settled an SEC securities fraud action alleging that he cooked the books by approximately $117 million between 1998 and 2003. The SEC Litigation Release (here) states:

According to the complaint, from 1998 through 2003, the accounting department prepared preliminary financial statements for Cottage Health and forwarded them to Zilli for review. Zilli, on numerous occasions, independently devised complex adjusting manual journal entries to the preliminary statements, lacking any support or accounting basis. The accounting department then finalized the monthly reports for Cottage Health after making the adjustments that Zilli had instructed the accounting personnel to make. The Commission alleges that the adjustments made by Zilli artificially and fraudulently boosted Cottage Health’s income in each period. As alleged, Zilli created the fraudulent journal entries to derive the specific income amount that he wanted to book for the particular period in order to ensure that Cottage Health’s reported performance figures met its financial targets. The complaint further alleges that Zilli’s fraudulent accounting resulted in the overstatement of three general categories of Bon Secours’ assets: accounts receivable, fixed assets and inventory.

(ph)
Refco Executive Cooperating in Government Investigation

October 28th, 2005

The Wall Street Journal reports (here) that Santo Maggio, the former head of Refco’s securities unit, is cooperating in the government’s investigation of Phillip Bennett, former CEO of Refco who was charged with one count of securities fraud. It was the revelation of accounting fraud related to receivables on the company’s books for which Bennett was responsible that led to the quick demise of the firm, which had been the largest futures trading firm. The government charged Bennett in a single count criminal information in order to prevent him from leaving the country, and he has been confined to his Park Avenue apartment since the arraignment. Under Federal Rule of Criminal Procedure 5.1(c), the government must present its evidence at a preliminary hearing within 20 days of Bennett’s initial appearance unless he consents to an extension or the government obtains a grand jury indictment. Maggio’s cooperation will be important because the government generally seeks to avoid a preliminary hearing, and a broader indictment is likely. (ph)