Investor Lawyers Blog

Global Investing Round Up: SEC Sues Chinese Company for Overstating Asset Values, 11th Circuit Reinstates Investor Claims Over Alleged Financial Scam in Involving India Entities, EC Calls for Delay in Imposing U.S. Swap Regulations, and Switzerland Propos

Published on: May 2, 2012 | by Shepherd Smith Edwards & Kantas, LLP

In SEC v. SinoTech Energy Ltd., Securities and Exchange Commission is suing SinoTech Energy Ltd. (CTESY), a Chinese oil field services company, for securities fraud. According to the Commission, SinoTech allegedly made misrepresentations about how its IPO proceeds were used, as well as misrepresented its assets’ value. The company also is accused of repeatedly deceiving both investors and the SEC, the latter with filings it submitted to the Commission in 2010 and 2011.

Per the SEC’s complaint, SinoTech claimed that $120 million of its IPO proceeds would be used to purchase lateral hydraulic drilling units when it spent less than $17 million to buy them. Also, its chairman, Qingzeng Liu, has admitted to skimming $40 million from a company bank account. This monetary withdrawal allegedly was not noted in SinoTech’s records or books. The Commission wants injunctive relief, disgorgement, and penalties from SinoTech and its chairman.

In other Global investment news, the 11th Circuit Appeals Court has decided to reinstate the unjust enrichment and racketeering claims made by investors over an alleged financial fraud involving City Group, which is based primarily in India, and the company’s affiliates in the US. The plaintiffs, Virendra Rajput and Mansingh Rajput, are claiming that they suffered financial losses after investing in a network of firms with ties to the Masood family. Rajput and Rajput are accusing the family of keeping the investments, running a financial racket, and never having intended to issue the payouts of high return rates that they promised investors. The two of them are also alleging that City Group’s US branches were set up to launder money from the scam in India.

Schwab Subsidiary OptionsXpress Accused of Naked Short Selling Scam by SEC

Published on: May 1, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission is accusing optionsXpress, a Charles Schwab Corp. (SCHW) subsidiary, of being involved in a naked short selling scheme between 2008 and 2010. The SEC filed an administrative order against the online futures and options brokerage and clearing agency, its CEO, and a client while settling with three other company officials. OptionsXpress didn’t come under Schwab’s ownership until 18 months after the alleged securities fraud occurred.

According to the Commission’s Division of Enforcement, the Chicago-based online futures and options brokerage and clearing agency did not meet its obligations under Regulation SHO because it repeatedly took part in a number of fake “reset” transactions that were created to make it appear as if the financial firm had bought securities of “like kind and quality.” CEO/CFO Thomas Stern, who is also named in the order, is accused of taking part in these transactions that resulted in a “continuous failures to deliver” securities to a clearing agency. Such alleged actions violate Commission rules because the SEC mandates that in most cases securities reach a clearinghouse within three days after a trade happens. Otherwise, the brokerage must borrow or buy the security so that the position is closed out by the start of the next trading day at the latest.

The alleged naked short-selling scam occurred when optionsXpress facilitated its customers’ buying of shares while at the same time selling deep-in-the-money call options that were pretty much the economic equivalent of selling shares short. Buying the shares made it appear as if the financial firm had fulfilled its close-out duty when, in fact, the shares that were purportedly bought in the reset transactions were never sent to the buyers because on the day that they were “purchased,” the deep-in-the money calls that occurred caused the shares to be effectively resold. Also, the reset transactions were not actual purchases because they were for perpetuating an open short position while making it appear as if Reg. SHO’s delivery and close out requirements were being met. As a result, optionsXpress and its clients were able to take part in a stock-kiting scheme that kept true stock purchasers from experiencing the benefits of ownership.

One optionsXpress customer, Jonathan I. Feldman, is also named in the SEC’s administrative order. He is accused of taking part in a number of these fake transactions involving several securities. For example, in 2009, he purchased $2.9 billion in securities while selling short at least $1.7 billion of options using his optionsXpress account.

OptionsXpress and Feldman intend to fight the SEC’s administrative order.

Meantime, optionsXpress trading and customer service head Peter Bottini and compliance officers Kevin Strine and Phillip Hoeh have settled the SEC’s allegations against them over the alleged naked short selling scheme. They are accused of knowing (or if they didn’t that they should have known) that the omissions or actions they committed contributed to optionsXpress violating Reg SHO. By settling, they are not denying or admitting to any wrongdoing.

Read the SEC’s administrative order (PDF)

SEC Charges OptionsXpress in Naked Short Selling Scheme, AdvisorOne, April 16, 2012

More Blog Posts:
FINRA Says Charles Schwab Corp. is Making Customers Waive Right to Pursue Class Action Lawsuits, Stockbroker Fraud Blog, February 8, 2012

Fontana Capital LLC Founder Violated Short-Selling Rule, Says SEC, Stockbroker Fraud Blog, February 2, 2011

Goldman Sachs to Pay $22M For Alleged Lack of Proper Internal Controls That Allowed Analysts to Attend Trading Huddles and Tip Favored Clients, Institutional Investor Securities Fraud, April 14, 2012 Continue Reading ›

Montford Associates to Pay $650,000 in Securities and Exchange Commission Penalties Over Failure to Disclose Payments from Hedge Fund

Published on: May 1, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The SEC has ordered investment adviser Montford Associates and Ernest Montford Sr. to pay $650K in penalties for failing to disclose that it had received $210K from an allegedly fraudulent hedge fund that it had recommended to clients. The name of the fund is SJK Investment Management. Its owner, Stanley Kowalewski, is accused of using the fund to commit a $16.5 million fraud. Investors that put their money in the fund included the Tallulah Falls School’s endowment program, St. Joseph’s/Candler Hospital System, Georgia Ports Authority, Sea Island Co. Retirement Plan, and Savannah Country Day School Foundation.

Although Montford Associates and Ernest Montford are not accused of involvement in Kowalewski’s securities fraud, the two of them allegedly lied to investors by not telling them about the compensation they were getting for the referrals. Montford and his investment adviser firm were paid “marketing and syndication fees” and “consulting services.”

The SEC contends that failure to disclose the payments for the recommendations violates federal securities laws. The Commission also says that even though Montford was aware that these nonprofits, many of them charitable organizations and schools, were run by part-time volunteers that depended on his investment advice and he knew they wanted consistent, stable investments, he still pushed them to move their investments to SJK so that Kowalewski could manage their money.

In addition to the $650,000 penalty, Montford Associates and Montford must pay disgorgements of $130,000 and $80,000, each with prejudgment interest. They also must set up a Fair Fund so that their clients that were harmed can use the penalties and disgorgement. Both must also cease and desist from committing/causing future violations of the Advisers Act and Advisers Act Rule 204-1(a)(2). Montford also is barred from associating with brokers, investment advisers, municipal securities dealers, dealers, transfer agents, municipal advisors, and nationally recognized statistical rating organizations.

As for the SEC’s hedge fund fraud case against Stanley Kowalewski, the Commission is accusing the hedge fund manager of using millions of dollars in client funds to buy his residence and a beach home and directing $10 million in unfounded fees to his investment management company and himself. He allegedly tried to hide his financial scam by sending fraudulent account statements to investors each month. These updates grossly exaggerated the actual values of assets and returns.

SEC Fines Adviser Over Ties To Hedge Fund Accused Of Fraud, FINalternatives.com, April 30, 2012

Securities and Exchange Commission v. Stanley J. Kowalewski, et al, Case No. 1:11-cv-00056-TCB (N.D. Ga.), SEC.gov, August 29, 2011

More Blog Posts:
Institutional Investor Fraud Roundup: SEC Seeks Approval of Settlement with Ex-Bear Stearns Portfolio Managers, Credits Ex-AXA Rosenberg Executive for Help in Quantitative Investment Case; IOSCO Gets Ready for Global Hedge Fund Survey, Institutional Investor Securities Fraud, March 29, 2012

Insider Trading: Former FrontPoint Partners Hedge Fund Manager Pleads Guilty to Criminal Charges, Institutional Investor Securities Fraud, August 20, 2011

Silicon Valley Man Faces SEC Securities Fraud Charge After Allegedly Bilking Internet Start-Up Investors of the “Next Google” of Millions, Stockbroker Fraud Blog, April 19, 2012

District Court Won’t Dismiss Securities Fraud Lawsuit Over Alleged Oral Misrepresentations

Published on: April 30, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The U.S. District Court for the Middle District of Florida has decided not to throw out a securities fraud lawsuit filed by a couple of unsophisticated investors contending that allegedly false oral misrepresentations were made to them causing them to think that their money would be placed in low risk, conservative investments when, in fact, the financial instruments recommended for them were very volatile and speculative. The case is Hemenway v. Bartoletta.

Plaintiff Jason Hemenway had received about $13.8 million in a lump sum after winning the Florida lottery in 2007. He and his wife then opened up an investment account at Capital City Bank Trust Co. Although they expressed a preference for investments with low risks, two of the financial firm’s representatives, private equity group High Street Capital Management LLC managers John Bartoletta and Erick Arnett, convinced the couple to move their money to a hedge fund limited partnership. High Street was that fund’s general partner.

Arnett and Bartoletta allegedly told the Hemenways that the investment was conservative and safe even though it wasn’t really appropriate for unsophisticated investors. The two men also failed to mention that the interests of the limited partnership were a lot risker than traditional equities and bonds and weren’t in line with the couple’s risk tolerance or investment goals.

Over 14 months the couple lost about $1.2 million. That is when they filed a federal securities fraud lawsuit against Bartoletta, Arnett, and High Street Capital Management, LLC, High Street Financial, LLC, and High Street Group, LLC.

The defendants sought to have the federal securities case dismissed on the grounds of failure to state a claim. Not only did they want the other allegations dropped due to lack of subject matter jurisdiction, but also they argued that the alleged misrepresentations and omissions could be countered because the plaintiffs had been given written documents that contradicted the statements made to them. Countering the defendants’ reasons for why the case should be dismissed, the plaintiffs argued that even though they were given written materials to counter any alleged misrepresentations (and omissions), they still had a valid claim under the 1934 Securities Exchange Act Section 10(b) and Rule 10b-5.

Explaining its decision to reject the defendants’ dismissal motion, the district court noted that although per “usual presumption” a plaintiff has no justification for depending on oral representation rather than what is written, a previous decision issued by an appeals court in another case, Bruschi v. Brow, had found that there are circumstances that warrant a departure from this presumption. That ruling took into consideration the plaintiff’s sophistication regarding financial matters (or lack thereof), whether the defendant and plaintiff have a longstanding relationship and if it is a fiduciary one, how much access the plaintiff had to material information, if the plaintiff was the one that sought the transaction, and the specifics of the alleged misrepresentations.

Now, in Hemenway v. Bartoletta, this court has found that “no single factor” was “dispositive” and that all factors must be considered when deciding whether reliance is merited. Therefore, the defendants’ motion to dismiss is denied.

Hemenway v. Bartoletta

Reliance Issues Bar Dismissal Of Suit by Unsophisticated Investors,Bloomberg/BNA, April 19, 2012

More Blog Posts:
FINRA Bars Former Wells Fargo Advisors Broker that Bilked Child with Cerebral Palsy, Stockbroker Fraud Blog, April 26, 2012
Texas Broker-Dealer Pinnacle Partners Financial is Expelled by FINRA Hearing Officer Over Allegedly Fraudulent Sales of Unregistered Securities and Private Placements of Oil and Gas, Stockbroker Fraud Blog, April 25, 2012
SEC to Make Sure Rule Writing Process Incorporates Better Cost-Benefit Analysis, Stockbroker Fraud Blog, April 25, 2012 Continue Reading ›

Morgan Stanley Sued by MetLife for Securities Fraud Over $757 Million in Residential Mortgage-Backed Securities

Published on: April 28, 2012 | by Shepherd Smith Edwards & Kantas, LLP

Metlife (MET) is suing Morgan Stanley (MS) for securities fraud. According to Bloomberg, the insurance company bought over $757 million in residential mortgage-backed securities from the financial firm in 2006 and 2007. In the institutional investment fraud lawsuit, Morgan Stanley had vouched that the properties behind the loans were “accurately appraised” and that the loans met underwriting guidelines. The insurer, however, contends that the loans’ originators were actually some of the subprime lending industry’s “worst culprits.”

The RMBS lawsuit comes right after MetLife agreed to pay half a billion dollars to settle a probe by a number of states over its payment practices. The investigation involves the Social Security “Death Master” file, which includes a list of names of people who have recently passed away. Insurance companies are accused of using the list to stop issuing to dead clients their annuity payments and not using the list to confirm that life insurance policyholders had died.

MetLife announced on Thursday that it was leaving the reverse mortgage industry. Nationstar Mortgage LLC (NSM) will buy its portfolio. The move is a big change for the insurance company, which had been the market leader.

Meantime, Morgan Stanley has been battling other residential mortgage-backed securities lawsuits. Earlier this year, Sealink Funding Ltd. filed a case against it over more than $556 million in RMBS that it purchased. Sealink Funding, a European fund, was set up to manage Landesbank Sachsen AG’s most high-risk assets.

The fund bought the securities from Morgan Stanley after the financial firm said it had done its due diligence on the lenders of the investments and that the loans satisfied underwriting standards and merited their AAA ratings. Sealink called the loans’ originators among the subprime lending industry’s “worst culprits.”

Last year, Allstate Insurance Co. (ALL) filed its RMBS lawsuit against Morgan Stanley over more than $104 million in RMBS it bought in several offerings. The insurer’s contention over reassurances the financial firm made about the securities is similar to the allegations made by Sealink and Metlife. Allstate has also filed RMBS lawsuits against other financial firms, including Merrill Lynch (MER) units, Citigroup Inc. (C), and Bank of America Corp.’s (BAC) Countrywide.

As previously noted by SEC Enforcement director Robert Khuzami, mortgage products played a crucial role in the financial crisis that began a few years ago. Unprecedented losses resulted when mortgage-backed securities failed. Many institutional investors are still trying to recover. They claim they were misled about the risks involved and they want their money back.

MetLife Pays $500 Million To Settle Probe Into Unpaid Claims For Dead Policy Holders, Huffington Post, April 23, 2012

MetLife to pay $500 million in multi-state death benefits probe, Los Angeles Times, April 23, 2012

Morgan Stanley Sued by Allstate on Mortgage Claims, Bloomberg, August 18, 2011

More Blog Posts:
H & R Block Subsidiary Option One Mortgage Corporation to Pay $28.2M to Residential Mortgage-Backed Securities Investors, Institutional Investor Securities Blog, April 25, 2012

Bank of New York Mellon Corp. Must Contend with Pension Fund Claims Over Countrywide Mortgage-Backed Securities, Institutional Investor Securities Blog, April 10, 2012

FINRA Bars Former Wells Fargo Advisors Broker that Bilked Child with Cerebral Palsy

Published on: April 26, 2012 | by Shepherd Smith Edwards & Kantas, LLP

Ralph Edward Thomas Jr., a former broker has been permanently barred from the Financial Industry Regulatory Authority. Thomas, who misappropriated money from three clients, including a child suffering from cerebral palsy, has been sentenced to a prison term of four years. He also must pay $836,000 in restitution.

According to prosecutors, the former broker stole the money over several years. More than $750,000 came from the child’s trust fund, which held the proceeds from a medical malpractice settlement he received for $3 million. During this time, he worked for Invest Financial Corporation, Harbor Financial Services, and Wells Fargo Advisors, which terminated him as their broker in 2010.

This case of securities fraud started after the child’s mom moved the trust to the bank in 2001. This gave Thomas control over the money. He would give out up to $1,500 of the child’s almost $6,300 in monthly annuity payments. He would then use withdrawal slips with the mother’s signature already written on it to buy cashier’s checks and take out money. He would deposit the checks in his personal accounts at other banks. In addition to the over $750,000 that he converted from the child’s account, Thomas converted $12,500 of the mother’s money.

SEC to Make Sure Rule Writing Process Incorporates Better Cost-Benefit Analysis

Published on: April 26, 2012 | by Shepherd Smith Edwards & Kantas, LLP

In the wake of criticism that the Securities and Exchange Commission has not done enough to assess its rules’ economic impact, its Office of the General Counsel and Risk, Strategy, and Financial Innovation Division is providing staff with guidance that it needs to conduct a more thorough economic analysis during the entire rule writing process. One of the requirements is that there must be a cost-benefit evaluation when rules that are congressionally mandated or discretionary are involved. This guidance is now binding.

However, SEC Chairman Mary Schapiro was quick to point out to the House Oversight Subcommittee on TARP and Financial Services that many of the rules that are written already follow this guidance. Now, staff will assess the cost-benefits of 28 rules that the Commission is proposing in the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The guidance comes following a report that was issued in January. In it, the Office of the Inspector General blamed the SEC for not conducting cost-benefit analysis when writing Dodd-Frank mandated rules. In addition to providing more comprehensive cost-benefit analysis, the SEC must also note the justification for the proposed rule, identify reasonable options to the rule, evaluate any economic repercussions, and find a baseline point for beginning the analysis. The SEC will be hiring more than three dozen economists to join its staff. If the Commission ends up being able to properly implement this guidance, then Congress may have to legislate.

Texas Broker-Dealer Pinnacle Partners Financial is Expelled by FINRA Hearing Officer Over Allegedly Fraudulent Sales of Unregistered Securities and Private Placements of Oil and Gas

Published on: April 25, 2012 | by Shepherd Smith Edwards & Kantas, LLP

In a default decision, San Antonio broker-dealer Pinnacle Partners Financial, Corp. has been expelled by a FINRA hearing officer for Texas securities fraud. The company’s president Brian Alfaro has also been barred. The financial firm and its head are accused of running a boiler room, engaging in the fraudulent selling of unregistered securities and private placements for gas and oil, and making numerous misrepresentations related to these investments. Alfaro is also accused of taking some of the investors’ money to pay for personal spending and unrelated business costs. The default decision was issued after Alfaro failed to show up at the FINRA panel hearing.

It was a year ago that FINRA issued an indefinite suspension against Alfaro and Pinnacle for not complying with a temporary order to cease and desist from making fraudulent misrepresentations. The two parties, however, allegedly kept making them, in addition to omissions related to the sale and offering of specific oil and gas joint interests.

According to the hearing officer, the Texas securities firm and its president operated the boiler room between August 2008 and March 2011. 10 brokers made cold calls numbering in the thousands to draw in investors for drilling investments involving gas and oil that was controlled or owned by Alfaro. They were able to get over 100 investors to put in more than $10 million.

Allegedly, between January 2009 and March 2011, Alfaro misused some of these monies, which investors thought were going toward well production and drilling, to cover some of his personal spending and other businesses. The misrepresentations and omissions that they are accused of purposely making in numerous private placements about a number of matters, include those involving inflated natural gas prices, cash flow, gross returns, and projected returns for natural gas. For example, they allegedly gave out a document claiming that over $14 million had been distributed to investors when, in fact, that figure was closer to under $1.5 million. Alfaro and Pinnacle also supposedly got rid of unfavorable, key information from well operator reports and gave investors maps that didn’t show undesirable wells that were located close to sites where drilling was supposed to take place.

To make restitution, Pinnacle and Alfaro will have to rescind the contracts of those that invested in the fraudulent offerings. They also must pay back the sales commission to clients who don’t ask for rescission.

FINRA Hearing Officer Expels Pinnacle Partners Financial Corp. and Bars President for Fraud, MarketWatch, April 25, 2012
Texas broker-dealer expelled by FINRA hearing officer, Reuters, April 25, 2012

More Blog Posts:
Texas Securities Fraud: US Supreme Court Turns Down Ex-Enron Corp Chief Executive Jeffrey Skilling’s Appeal to Have His Criminal Conviction Overturned, Stockbroker Fraud Blog, April 18, 2012
Texas Securities Fraud: State Law Class Action in R. Allen Stanford’s Ponzi Scam Not Barred by SLUSA, Stockbroker Fraud Blog, March 20, 2012
Three Oil Service Executives Face SEC Charges in Texas Court For Allegedly Bribing Nigerian Customs Officials, Stockbroker Fraud Blog, March 22, 2012 Continue Reading ›

H & R Block Subsidiary Option One Mortgage Corporation to Pay $28.2M to Residential Mortgage-Backed Securities Investors

Published on: April 25, 2012 | by Shepherd Smith Edwards & Kantas, LLP

H & R Block (HRB) subsidiary Option One Mortgage Corporation has agreed to pay $28.2 million to settle Securities and Exchange Commission charges that it misled investors in over $4B in residential mortgage-backed securities when it failed to let them know that the company’s financial health was deteriorating. According to the SEC, Option One, which is now called Sand Canyon Corporation, promised these investors that it would replace or buy back mortgages that breached warranties or misrepresentations, even though it was unlikely that the mortgage lender would be able to fulfill these obligations.

Leading up to the 2007 fiscal year, Option One had originations of $40 billion during the year prior and was among the country’s largest mortgage lenders, originating and selling subprime loans through whole loan pool sales and market securitization in the secondary market. During this period, to be able to fulfill its buyback commitments and margin calls, it needed for H & R Block to give it financing under a credit line. However, Block wasn’t obligated to give Option One this funding, which is a fact that the mortgage lender neglected to tell its RMBS investors. When its revenues started to drop and it sustained substantial losses as the subprime mortgage market began to fail during the summer of 2006, Option One’s creditors started to ask for hundreds of millions of dollars in margin calls. (The SEC also claims that the mortgage lender’s losses were a threat to H & R Block’s credit rating while the tax service provider was negotiating its sale. Option One was sold by H & R Block to Wilbur Ross for about $1 billion.)

To settle the SEC allegations over RMBS fraud, Option One will not only pay the $28.2 million (A $10 million penalty, $14,250,558 in disgorgement, and $3,982,027 in prejudgment interest), but also, it has consented to a permanent order entry enjoining it from Securities Act of 1933 Sections 17(a)(2) and 17(a)(3) violations. The mortgage lender isn’t, however, denying or admitting to the charges.

Commenting on this RMBS case, SEC Division of Enforcement’s Structured and New Products Unit Chief Kenneth Lench spoke about the Commission’s commitment to act against parties that neglect to reveal pertinent facts that up an investment’s risk, even if the risks never becomes a reality. The SEC has been pursuing those believed to engaged in misconduct related to RMBS and other complex financial instruments.

The SEC isn’t the only one to sue Option One. In 2011, the mortgage lender settled Massachusetts securities charges against it by agreeing to pay $9.8 million in restitution and $115 million in loan modifications.

Read the SEC’s complaint (PDF)

More Blog Posts:
Residential Mortgage-Backed Securities Working Group Brings Federal Investigators and State Law Enforcement Officials Together to Investigate How MBS Abuses Contributed to 2008 Financial Crisis,

FDIC Objects to Bank of America’s Proposed $8.5B Settlement Over Mortgage-Backed Securities, Stockbroker Fraud Blog, August 30, 2011

FINRA Proposal Giving Collective Actions Exemption from Arbitration Gains SEC’s Accelerated Approval

Published on: April 24, 2012 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission has given accelerated approval to a proposed rule change by the Financial Industry Regulatory Authority. The proposal modifies FINRA’s Dispute Resolution’s Code of Arbitration Procedure for Industry Disputes exempts collective actions from arbitration. The SEC decided to approve the proposed rule change after determining that it is consistent with not just the Exchange Act’s requirements, but also with regulations and rules applicable to a national securities association.

While class actions have been exempt from arbitration, small and large customers claims, employee disagreements, and complex cases have not. However, with the increase in collective actions, FINRA now believes that it is better to hear such actions submitted under the Equal Pay Act of 1963, the Age Discrimination in Employment Act, and the Fair Labor Standards Act (FLSA) in the courtroom.

“This seems to be a reversal of FINRA’s earlier goals to expand their arbitration system to perhaps even include class action cases,” said FINRA Securities Lawyer William Shepherd. “Noting that FINRA is really just a trade association of all securities dealers, the suspicions are that legislators and courts have become so friendly to Wall Street lately that they no longer need their own dispute forum to avoid responsibility for their misdeeds.”