Friday, August 28, 2015

Enforcement Actions: Week in Review


SEC Announces Asset Freeze against Alleged EB-5 Fraudster in Seattle Area
August 25, 2015 (Litigation Release No. 173)
Lobsang Dargey, owner of multiple “Path America” companies including Path America SnoCo and Path America KingCo, is accused of defrauding Chinese investors who were seeking American citizenship through the EB-5 Immigrant Investor Pilot Program. The EB-5 program states foreign citizens may qualify for U.S. residency if they make an investment of $500,000 or more that goes to a specified project that creates or preserves at least ten American jobs. In order for a project to qualify for the EB-5 program, the company must submit a business plan that must be approved by the U.S. Citizenship and Immigration Services (USCIS) department. If the company deviates from the approved plan, the USCIS can deny investors citizenship. Dargey misled investors with promises of U.S. residency and failed to inform investors when he deviated from the approved business plan. Of the $125 million Dargey raised, he diverted $14 million for unrelated real estate projects and $3 million for a personal home and personal cash withdrawals.

SEC Charges Former Investment Bank Analyst and Two Others with Insider Trading in Advance of Client Deals
August 25, 2015 (Litigation Release No. 174)
J.P. Morgan investment analyst Ashish Aggarwal is charged with allegedly informing his close friend Shahriyar Bolandian about two, nonpublic acquisition deals that J.P. Morgan was working on. Bolandian traded on the illegal information in accounts belonging to him, his father, and his sister. Additionally, Bolandian tipped off another friend Devan Sadigh, who also traded on the insider information. Bolandian and Sadigh made more than $672,000 in the week leading up to the two acquisitions: Integrated Device Technology’s acquisition of PLX Technology in 2012 and’s acquisition of ExactTarget in 2013.

Fee Rate Advisory #1 for Fiscal Year 2016
August 27, 2015 (Litigation Release No. 175)
The SEC announced that the fees public companies and other issuers to register their securities with the SEC will decrease from $116.20 per million dollars to $100.70 per million dollars. The rate change will go into effect on the first of October, the start of the 2016 fiscal year. The commission projects it will generate $550 million for 2016.

The Recent Market Turmoil Spells Trouble for “Auto-liquidators” like Interactive Brokers

By Craig McCann, PhD and Mike Yan, PhD

Interactive Brokers Group, Inc. (IB) caters to active traders including those who trade futures and options. These active traders’ accounts typically are subject to “portfolio margin” requirements which we have written about at length. 1 IB requires its customers to agree to have IB auto-liquidate positions when accounts are in a margin deficit.

IB’s auto-liquidation procedures were the focus of a FINRA arbitration earlier this year in which the Claimant, Glen Lyon Long-Term Options, LP, alleged that IB did not liquidate positions to meet a margin deficit in a commercially reasonable manner, in part by closing positions at prices which were outside the National Best Bid or Offer (NBBO). 2

Monday’s sharp market drop may have caused hundreds of accounts at auto-liquidating firms like IB to be severely damaged by faulty auto-liquidation algorithms. Poorly designed algorithms can execute trades that have no hope of efficiently alleviating a margin deficit and actually can convert a curable margin deficit into a death spiral liquidation.

Such harm may have been caused to hundreds of accounts late last week and early this week. I provide an actual example involving deep out of the money put options but these accounts saw their equity drop, perhaps to a debit balance, as a result of bad trades in thinly traded stock and stock index options.

1“Optimizing Portfolio Liquidation Under Risk-Based Margin Requirements” with Geng Deng and Tim Dulaney, Journal of Finance and Investment Analysis, vol. 2, no. 1, 2013, /> 2Suzanne Barlyn, “Interactive Brokers must pay $667,000 for portfolio selloff mishap –panel” Reuters, February 18, 2015.

Last week the Dow Jones Industrial Average dropped 531 points (-3.12%) Thursday, 588 points (-3.57%) Friday and 1,089 points before rebounding to close down 205 points (-1.29%) on Monday this week. See Table 1 and Figure 1.

Table 1. Yahoo Recent Historical Dow Jones Index Values

Figure 1. Yahoo Recent Historical Dow Jones Index Values

The 8.5% drop from Wednesday’s 17,348.73 close to Monday’s 15,871.35 was slightly exceeded by an 8.9% drop over the same three days in the S&P 500 Index. See Table 2 and Figure 2.

Table 2. Yahoo Recent Historical S&P 500 Index Values

Figure 2. Yahoo Recent Historical S&P 500 Index Values

Auto-liquidation algorithms fail when they liquidate thinly traded positions with large bid ask spreads. The margin deficit is calculated based in part on values at or inside the bid ask spread. If the liquidating trades are executed at prices equal to the prices used to value the portfolio the customers’ equity remains the same, the margin requirement is lowered and the deficiency is reduced.

Poorly designed algorithms may execute trades at or above the “bid” when closing a short position and at or below the “ask” when closing a long position. When this happens, the customer’s equity is reduced by the liquidating trades which may worsen rather than improve the margin deficiency. Some of these accounts will be converted from an equity position to a debit position in milliseconds because of the faulty algorithm without any change in the value of the portfolio holdings.

Figure 3 is a screen shot from the CBOE website for December 2017 SPX put options with a strike price of 500. The value of these thinly traded put options are not very sensitive to a decline in the S&P 500 because are far, far out of the money since the S&P is around 2,000 and don’t expire for almost two and a half years.

Figure 3. CBOE December 2015 500 Put Prices

The spike up in prices on Monday morning are from a small number of trades which appear to be far outside the NBBO. The options had been worth about $2 in the days preceding the drop and around $4 since. The S&P 500 is between 5% and 10% less when the options are worth $4 than it was when the options were worth $2. The lowest level of the S&P 500 on Monday morning is about 5% less than the average we observed the rest of the week when the options traded for $4. This strongly suggests that the put options were worth at most $5 or $6 on Monday morning at the absolute bottom of the market drop.

In one IB account, we observe 43 trades above $7, 11 at $10 or higher including a trade at $16 and a trade at $83. These trades were not commercially reasonable and quickly turned a credit balance into a debit balance.

Higher volatility Monday morning does not explain the $10 prices on the December 2017 500 puts. Figure 4 is a CBOE screenshot for the December 2017 1950 puts. The increase we see from between $180 and $200 before the market decline to between $220 and $240 after the market decline is consistent with the drop in the underlying index level without any dramatic increase in implied volatility.

Figure 4. CBOE December 2015 1950 Put Prices

Wednesday, August 26, 2015

UBS of Puerto Rico Continues to Wreak Havoc on Clients

In October 2014, UBS Puerto Rico settled with the Office of the Commissioner of Financial Institutions for the Commonwealth of Puerto Rico (“OCFI”) over UBS's lack of compliance and supervision as some brokers recommended some “mostly senior, low net worth investors with conservative investment profiles” use non-purpose loans to further concentrate their accounts in UBS PR closed-end bond funds. The UBS-OCFI settlement is available here.

As part of the settlement, UBS paid a $3.5 million fine and up to $1,681,556 in restitution to 34 investors. UBS also committed to continue to evaluate whether other clients had been inappropriately sold closed end funds with the proceeds of non-purpose loans. On August 20, 2015 UBS PR, referencing the OCFI settlement, sent out a letter offering a small amount ($3,500 in this example) for a release “in which you waive any claims related to the UBS Puerto Rico closed-end funds now or in the future.” A redacted copy of the letter is available here.

If a senior, low net worth, conservative investor had accepted UBS PR’s recommendation to concentrate her account in UBS Puerto Rico closed end funds and use a non-purpose loan to buy even more of the funds, it is likely she suffered substantial losses. The recent UBS letter says nothing about how much the UBS client lost in UBS’s closed end funds or how UBS determined that $3,500 was a fair offer for a complete release of its client’s current and future legal claims over the funds.

Any UBS client who receives such a letter should be on guard and seek professional advice to determine both their losses and potential remedies before accepting UBS’s offer.

Wednesday, August 19, 2015

Why Citigroup Paid the SEC $180 Million Over MAT/ASTA

By Craig McCann, PhD

I. Introduction

This week Citigroup paid $180 million to the SEC to settle allegations that Citigroup improperly sold high risk hedge funds known as MAT, ASTA and Falcon. The SEC Order is available here.

The SEC Order makes clear that Citigroup did not effectively monitor the portfolio manager or the sales force as it sold billions of dollars of high risk MAT ASTA funds with false and misleading sales presentations. In the end, Citigroup lost hundreds of wealthy clients and likely paid $1 billion in settlements, awards and legal fees. There are close parallels to Schwab’s YieldPlus, Regions Morgan Keegan’ RMK Funds and soon of UBS’s Puerto Rican municipal bond funds. In the end each firm was injured – Morgan Keegan mortally – because it failed a fundamental risk management function. Even if these firms have no independent concern for their clients’ well-being, they owe it to their shareholders and employees to monitor the quality of the aluminum siding their Tin Men are peddling.

My firm had significant involvement in the private civil litigation surrounding these Citigroup funds and dozens more which also followed the leveraged municipal bond arbitrage (“LMBA”) strategy. Our research culminated in a peer-reviewed article on this strategy. In this note I summarize our prior research so observers can better understand why Citigroup would pay $180 million over its marketing of the hedge funds.

The LMBA funds were marketed based entirely on the false claim that yields on long-term municipal bonds are typically greater than after-tax yields on long-term Treasury securities or swap contracts because of structural imbalances in these markets, not because of greater risks in long-term municipal bonds than in taxable bonds. Leverage was used to magnify the arbitrage profits which the funds claimed could be earned from this strategy.

In late 2007 and early 2008, virtually all LMBA funds suffered catastrophic losses as municipal bond prices declined without offsetting gains on swap contracts. Market conditions that caused large losses in LMBA funds in the 2007-2008 time period were far from unprecedented. Prior to 2007, there were two periods of distress in municipal bond markets during which funds would have exhibited even larger losses than they did in 2007-2008, had they existed during those two periods.

II. The MAT/ASTA Strategy

 i. The “muni-puzzle”

Figure 1 plots the average yield to maturity on municipal bonds and the tax-adjusted LIBOR swap rates using weekly observations of published yield indexes from January 1, 2001 to December 31, 2009. Figure 1 captures a persistent qualitative relationship: yields on AAA-rated municipal bonds are consistently higher than tax-adjusted LIBOR swap term spread and this difference in after-tax yields increases at longer maturities despite the low observed default rates on AAA-rated municipal bonds.

 Figure 1: Average Yield Curves from 2001 to 2009

The municipal term spread is consistently greater than the after-tax LIBOR swap term spread. That is, municipal yield curves like the solid (blue) line in Figure 1 are consistently steeper than after-tax LIBOR swap rate curves like the dashed (red) line in Figure 1.

This difference between the term spreads in the tax exempt and taxable markets was sold by brokerage firms to investors as an “inefficiency” resulting from structural imbalances in the municipal bond market. Citigroup and other firms claimed that structural flaws prevented traders from bidding up the prices of long-term municipal bonds so that their yields were no more than the after-tax yields on taxable securities. The hedge funds proposed to circumvent the structural imbalances and capture this arbitrage opportunity by leveraging up portfolios of these “cheap” long-term municipal bonds.

The viability of the leveraged portfolio was highly susceptible to interest rate and market risk and these risks were imperfectly hedged in the taxable market. Some but not all of the positive net cash flow on the municipal bonds was given up in the hedging transactions. Table 1 provides an example of income before fees given the yield curves illustrated in Figure 1.

 Table 1: Stylized Difference in Term Spreads on August 31, 2007 

Fund managers increased the small net cash flow in Table 1 by leveraging up the portfolio. For example, by leveraging the equity investment 10 times, the stylized fund could provide a tax-exempt gross annual return of 5.90% over 10 years. See Table 2.

 Table 2: Stylized Leveraged Municipal Bond Arbitrage

 ii. Long-term Municipal Bonds Are Bought With Short-term Debt

At initiation of the strategy, the fund manager invests contributed capital in high-quality assets pledged as collateral to a dealer who forms a trust and issues two classes of securities: senior short-term floating-rate notes, known as variable-rate demand obligations (VRDOs), and junior notes called residual certificates. The proceeds from the sale of the short-term notes are used to purchase additional long-term municipal bonds thus leveraging the residual certificate holders’ exposure to the long-term municipal bonds held in the trust.

The interest rate paid by the trust on the short-term notes is reset weekly and is equal to the short-term municipal yield benchmark rate less a market-determined spread. The short-term notes also include a put option, which allows the holders of the notes to sell their bonds back to the trust at par on any reset date. The hedge fund retains the junior residual certificates and pays an interest rate equal to the difference between the interest rate on the underlying long-term municipal bonds and the interest paid to the short-term, senior note holders, less the trust’s expenses.

 iii. The Leveraged Strategy Was Imperfectly Hedged With Interest Rate Swaps

Once the portfolio manager has leveraged up the investors’ capital by financing it with short-term debt, the fund is exposed to tremendous interest rate risk. This is the classic Savings & Loan problem: borrowing short-term at variable rates to fund long-term, fixed-rate investments.

Hedge funds used interest-rate swaps to hedge both the long-term and short-term interest-rate risk. Since the hedge fund has financed an investment in long-term, fixed-rate bonds with a series of short-term floating-rate notes, it enters into a swap agreeing to pay a fixed interest rate in exchange for receiving floating-rate cash flows.

Ideally, the hedge fund would pay a fixed rate that is slightly less than (but perfectly correlated with) the yield it receives on the municipal bond portfolio and would receive a floating interest rate that is slightly higher than (but perfectly correlated with) the interest rate paid on the floating rate notes sold to the money market funds for a term equal to the average maturity of the municipal bonds held. If the hedge fund could enter into such an idealized swap it would be very close to a true arbitrage opportunity; the hedge fund would receive positive net cash flows and any change in the market value of the leveraged municipal bond portfolio would be exactly offset by changes in the mark-to-market value of the interest rate swap.

 iv. The Leveraged Strategy Was Extremely Sensitive to Yield Changes

The use of leverage in the strategy made MAT, ASTA and Falcon extremely sensitive to changes in the difference between municipal bond yields and after-tax swap rates. For example, if the duration of the underlying bond portfolio is 10 years and the portfolios is leveraged 10-to-1, an increase of 0.50% in the difference between the long-term municipal bond yields and the swap rates would cause the NAV to drop by 50%. Swap contracts were a useful hedge for the interest rate risk arising out of the funding mismatch in the leveraged municipal bond portfolio if and only if changes in swap rates were highly correlated with changes in long-term municipal bond yields.

Figure 2 plots the correlation between weekly changes in 20-year municipal yields and weekly changes in 20-year LIBOR swap rates. In the late 1990s, the correlations based on yield changes were sometimes negative. Funds or brokers that represented the effectiveness of hedging strategies using correlations based on levels of yields substantially overstated the effectiveness of the LIBOR hedges.

 Figure 2: Correlation Between Weekly Changes in 20-year Municipal Bond Yields and Changes in 20-Year Swap Rates.

III. Differences in Yields Reflected Well Known Risks, Not Arbitrage Profits

 i. Assumption of Municipal Market “Inefficiency”

The option features and the liquidity risk in AAA-rated municipal bonds explain most of the difference in after-tax yields on municipal and taxable bonds at longer maturities. Credit risk explains the remaining difference in yields, especially for lower quality bonds.

 ii. Embedded Options

Yields to maturity on bonds with embedded options, such as callable municipal bonds, cannot be directly compared to yields on option-free bonds because the bonds will be redeemed or “called” before maturity if the municipal issuer can refinance the bonds at lower interest rates once the bonds become callable. The issuer’s right to call the bond makes the bond less valuable to investors than an otherwise equivalent bond that can’t be called away at the discretion of the issuer. The lower price on the callable bond compared to the otherwise identical non-callable bond is reflected in the higher stated yield to maturity on the callable bond. This higher yield to maturity on the callable bond though is a mirage since there is a good chance the bond will not exist to maturity.

 iii. Liquidity

In addition to being comprised mainly of callable bonds, the municipal bond market is less liquid and more fragmented than the market for Treasury securities and swap contracts. Many long-term municipal bonds only trade a few times after they are issued. Since investors bear the risk that they might have difficulty liquidating positions in municipal bonds in the future, there is usually a liquidity premium included in the yield. In contrast, Treasury securities are issued by a single entity (the U.S. Treasury) in approximately 10 different maturities of bills, notes and bonds. As a result, Treasury markets are highly liquid. In addition to spot markets, a large and liquid Treasury futures market exists.

Wang, Wu and Zhang (2008) find that on average between July 2000 and June 2004 the liquidity risk premium accounts for 67 basis points of the yield to maturity on 20-year AAA-rated non-callable municipal bonds. Wang Wu and Zhang (2008) found liquidity risk effectively explains all the difference in after tax yields on high-quality municipal bonds and Treasury securities after controlling for embedded options.

IV. Analysis of an Apparent Example Arbitrage Opportunity

We conducted a simple empirical test to determine whether the spread between stated municipal yields to maturity and after-tax Treasury yields from January 2005 through March 2008 could be explained by embedded call options and liquidity risk premium consistent with the prior 30 years of published literature. We first selected all U.S. AAA municipal bonds issued from January 2000 to January 2007 maturing between 2030 and 2040 available on Bloomberg. From those 900 bonds, we selected 50 bonds to create a portfolio that mimicked the MMAI index in 2005, another portfolio of 50 bonds that mimicked the MMAI index in 2006 and a third portfolio for 2007 and early 2008. For each month, we applied Bloomberg’s callable bond valuation analytic “OAS1” to calculate the option-adjusted spread for each bond in the three 50-bond portfolios using the implied volatility from LIBOR caps.

Figure 3 plots the stated yield to maturity and the option-adjusted yield for the 50-municipal bond portfolios and the after-tax yield on Treasury securities with the same maturity at each month-end from January 31, 2005 to March 31, 2008.

 Figure 3: Embedded Call Options in Municipal Bonds 2005-2008

Yields to maturity on our 50-bond portfolios between January 31, 2005 and March 31, 2008 averaged 4.58%; embedded call options accounted for 63.3 basis points of the 147.6 basis point average difference between municipal yields and the after-tax yields on Treasury securities. Thus roughly 43% of the difference in yields brokerage firms claimed was an arbitrage opportunity during this period was simply the brokerage firms’ overstatement of the comparable yields on municipal bonds. The remaining difference between the option-adjusted yield on municipal bonds and the after-tax yield on Treasury securities averaged 84.3 basis points.

 Figure 4: Embedded Call Options and Liquidity Risk Premium Explain the Difference in Yields

Figure 4 plots the naïve difference between municipal bond yields and the after-tax Treasury yields marketed as an arbitrage opportunity along with the required adjustment for embedded options and the liquidity risk premium for our three 50-bond portfolios based on Wang, Wu and Zhang (2008). Our average estimated liquidity risk premium for January 2005 through April 30, 2007 is 74.7 basis points. From January 2005 to April 2007 option costs and average liquidity risk explain 138 basis points of the 147.6 basis points the brokerage firms marketed as an arbitrage opportunity. Thus effectively all the claimed arbitrage opportunity resulting is an overstatement of the yields on the municipal bonds and as compensation for liquidity risk.1

1Credit default swap premiums on mono-line insurance carriers were higher in 2005 and in late 2007 and early 2008. As the perceived credit quality of the companies who had rented their creditworthiness to the municipal issuers declined, yields on these bonds began to reflect compensation for credit risk.

V. The Leveraged Municipal Arbitrage Strategy Was Much Riskier Than Municipal Bond Portfolios

Citigroup marketed MAT and ASTA funds as high-yielding alternatives to conventional municipal bond portfolios. However, using historical market data, we show that not only was the leveraged municipal arbitrage strategy more volatile than municipal bond portfolios, it was sometimes more risky than an investment in the stock market. The leveraged municipal arbitrage strategy did not suddenly become more risky than the stock market or a municipal bond fund as a result of the subprime mortgage crisis. It had been more risky than these alternatives prior to the crisis – during a period when the strategy was being heavily marketed as low risk.

Figure 5 illustrates the results of our simulation analysis. Each point on the graph represents the forecasted one-year volatility at a given point in time. For example, the volatility estimate for the leveraged municipal bond strategy (with 8X leverage) in January 2004 is 14.4%. This means that using weekly spread data from the three years prior to January 2004, the return volatility over the following 12 months was projected to be 14.4%. Only data available prior to each volatility forecast is used to make the forecast and so brokerage firms could have made the same forecasts at the beginning of each month shown on the graph.

 Figure 5: Annualized Volatility of Returns

As Figure 7 shows, the large losses experienced by LMBA strategies were not a “surprise” attributable to the subprime mortgage crisis. The strategy, using either 8X or 12X leverage, was more risky than a conventional municipal bond portfolio in every month from December 1997 through December 2007, and more risky than the stock market in some of those months. Moreover, the strategy became especially risky toward the latter half of 2006 and at the very beginning of 2007, before the first major eruption of the crisis in February 2008.

VI. Market Conditions Which Led to Large Losses in Funds Were Not Unprecedented or Even Unusual

The firms that marketed LMBA funds to investors claimed that the funds’ large losses in 2007 and 2008 were the result of highly unusual market conditions - a “perfect storm” or a “once in a century event.”

Changes in the spread between the 20-year municipal bond yield and 20-year LIBOR swap rate are directly related to capital gains and losses in the funds. Figure 6 illustrates that the spread increased by 1.24% from September 28, 2007 through February 29, 2008, a period during which many of these funds collapsed. The spread, however, increased by much more than 1.4% in earlier (but still recent) periods of financial distress.

 Figure 6: Changes in the Spread Between the 20-Year Municipal Yield and 20-Year LIBOR Swap Rate.

From May 9, 1994 through December 12, 1995 the spread between the 20-year municipal bond yield
and 20-year LIBOR swap rate increased by 1.97 percent: .73% more than the spread increase associated with the funds’ large losses in 2007-2008.

From May 8, 2000 through May 22, 2003 the spread between the 20-year municipal bond yield and 20-year LIBOR swap rate increased by 1.93 percent: .69% more than the spread increase associated with the funds’ large losses in 2007-2008.

A LMBA fund that existed during 1994-1995 or 2000-2003 would have suffered even greater losses than the losses that led to the extinction of LMBA funds in 2008.

VII. Conclusion

Citigroup and other firms marketed the LMBA strategy as a low-risk, high-yield alternative to municipal bonds. The strategy introduced additional risk by leveraging investments in long-term municipal bonds in an attempt to generate enough gross returns from the perceived arbitrage opportunity to cover the brokerage firms’ fees and to net a marketable return to investors.

The municipal arbitrage strategy was dependent on hedging large, leveraged, long-term municipal bond positions with taxable interest rate swaps. The correlation between these hedges was quite low making it likely that they would fail. As long-term municipal yields increased more rapidly than the swap rates over many months, the hedging strategy in fact did fail. In February 2008, the municipal bond prices fell further and leveraged municipal bond portfolios were liquidated. Much of the losses though had occurred earlier during relatively routine interest rate environments.


Deng, Geng and Craig McCann, “Leveraged Municipal Bond Arbitrage: What Went Wrong?” with, 2012, Journal of Alternative Investments, Vol. 14, No. 4: pp. 69–78. Available here.

Wang, Junbo, Chunchi Wu, and Frank Zhang, 2008, “Liquidity, Default, Taxes and Yields on Municipal Bonds”, Journal of Banking and Finance, vol. 32, no. 6: 1133-1149. Available here.


Saturday, August 15, 2015

Schvey v Janney Montgomery Scott - $427,000 Churning Award

In August 2015, a FINRA arbitration panel in New York, NY ordered Janney Montgomery Scott to pay $427,000 in compensatory damages after a hearing wherein the Claimant alleged Respondents churned the Claimant's accounts and invested in unsuitable investments. The award is the well-managed account damages based on a 40% stock, 60% bond portfolio. You can read the award here. Dr. McCann testified to the egregiousness of the churning and damages on behalf of the Claimant.

Friday, August 14, 2015

Enforcement Actions: Week in Review


Guggenheim Partners Investment Management LLC Settles Charges it Failed to Disclose Conflict to Clients
August 10, 2015 (Litigation Release No. 162)
The SEC has announced that charges against Guggenheim Partners Investment Management LLC have been settled for $20 million. The charges were over a breach of fiduciary duty in which Guggenheim failed to disclose a $50 million loan that an advisory client had given to a senior Guggenheim executive. The SEC order found that, although several senior Guggenheim officials knew of the loan, Guggenheim’s compliance staff was never informed.

SEC Charges 32 Defendants in Scheme to Trade on Hacked News Releases
August 11, 2015 (Litigation Release No. 163)
The SEC has announced fraud charges against Ukrainian hackers Ivan Turchynov and Oleksandr Ieremenko, and 30 other conspirators for their involvement in an international scheme to reap profits from stolen, non-public corporate earnings announcements taken from newswire services. The SEC alleges that Turchynov and Ieremenko hacked into multiple newswire services and distributed the stolen information to traders in Russia, Cyprus, Ukraine, Malta, France and the United States. Over the course of five years, the scheme is alleged to have generated over $100 million. Criminal charges are being pursued against several conspirators from the U.S. and Ukraine.

SEC Charges ITG With Operating Secret Trading Desk and Misusing Dark Pool Subscriber Trading Information
August 12, 2015 (Litigation Release No. 164)
The SEC has settled charges against ITG Inc. for secretly operating a proprietary trading desk and misusing confidential trading data of their dark pool subscribers. In spite of marketing themselves as an “agency-only” broker, ITG ran an undisclosed trading desk, Project Omega, for over a year. ITG also used confidential trade data of its dark pool subscribers in order to make high-frequency algorithmic trades, some of which were against subscribers in ITG’s own dark pool. The settlement totals $20.3 million, including disgorgement, prejudgment interest, and an $18 million penalty.

SEC Charges Former Software Executive With FCPA Violations
August 12, 2015 (Litigation Release No. 165)
The SEC has announced that former executive Vicente E. Garcia has agreed to settle charges that he violated the Foreign Corrupt Practices Act with a $92,395 settlement. The SEC alleges that Garcia, who was VP of global and strategic accounts for SAP SE, bribed Panamanian government officials in a scheme that went from 2009 to 2013. SAP primarily sold their software through various corporate partners. Garcia arranged for SAP to sell software to their Panamanian partner at heavy discounts for the purpose of securing contracts with the Panamanian government. Those discounts were actually used to create a slush fund used to bribe government officials and give kickbacks to Garcia.

Edward Jones to Pay $20 Million for Overcharging Retail Customers in Municipal Bond Underwritings
August 13, 2015 (Litigation Release No. 166)
The SEC has announced a settlement of fraud charges against brokerage firm Edward Jones and the former head of their municipal underwriting desk Stina R. Wishman. The SEC’s investigation found that, instead of offering newly issued municipal bonds at their offering price, Edward Jones took them into their inventory and sold them to investors at higher prices, sometimes waiting until after secondary market trading had begun. Edward Jones’ customers are estimated to have paid $4.6 million more than they should have. Edward Jones has agreed to settle charges by paying $20 million and Wishman will pay $15,000 and will be barred from working in the securities industry for two years.

Three Maryland Men Settle Charges They Defrauded Investors in Real Estate Investment Company
August 13, 2015 (Litigation Release No. 167)
The SEC has announced an agreement to settle charges with three Maryland men that defrauded investors in real estate company Signator Investors Inc. The SEC alleges that James R. Glover encouraged friends, family, and churchgoers to become his clients at Signator and invest in Colonial Tidewater Realty Income Partners, which he co-managed with Sherman T. Hill. Glover and Hill are alleged to have misled investors about Colonial Tidewaters’ value and financial condition as well as the liquidity of their investments and expected returns. Also, Glover and his business partner at Signator Cory D. Williams failed to inform clients of commissions they received from Colonial Tidewater, a clear conflict of interest. Signator and Gregory J. Mitchell, supervisor of Signator’s Maryland office, are named in another order for failing to identify and prevent Glover and Williams’ fraud.

Tuesday, August 11, 2015

$2.545 million Rodriguez Gonzalez v UBS of Puerto Rico Award

In August 2015, a FINRA arbitration panel in San Juan, PR ordered UBS Financial Services and UBS Financial Services of Puerto Rico to pay $2,545,000 in compensatory damages. You can read the award here. Dr. McCann testified on liability and damages over UBS Puerto Rico’s sale of UBS Puerto Rico municipal bond closed end funds.

Monday, August 10, 2015

Enforcement Actions: Week in Review


SEC Charges Houston-Area Businessman in Ponzi Scheme
August 3, 2015 (Litigation Release No. 158)
Frederick Alan Voight, owner of F.A. Voight & Associates LP and DayStar Funding LP, has been charged with defrauding investors while operating a $114 million Ponzi scheme. As Ponzi scheme’s tend to go, Voight’s scheme was caught after he could not find enough new money to pay previous investors his promised 42% annual return rate. Recently, Voight raised $13.8 million that he promised to invest in InterCore Inc., a startup developing a “Driver Alertness Detection System” intended to prevent accidents from drowsy driving. Voight promised investors that InterCore was about to install the technology into several million trucks and buses, which would more than pay a 42% return. However, as Voight also served on InterCore’s board, he knew that the company was facing serious financial problems. Voight has agreed to settle SEC’s claims of securities fraud and conducting unregistered securities offerings.

SEC Adopts Registration Rules for Security-Based Swap Dealers and Major Security-Based Swap Participants
August 5, 2015 (Litigation Release No. 159)
The new rules set in place by the SEC covers all aspects of registration for security-based swap dealers and major swap participants. Registrant’s must now provide and maintain extensive information sets for both dealers and participants. The new rules also require senior officers to make certifications about the new registrant’s policies and procedures for compliance with the federal securities laws when the register. These new rules are a significant milestone in the SEC’s implementation of Title VII of Dodd-Frank Wall Street Reform and Consumer Protection Act.

SEC Adopts Rule for Pay Ratio Disclosure
August 5, 2015 (Litigation Release No. 160)
As mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC instituted a rule that requires public companies to disclose the ratio of compensation between its CEO and its median employee. Companies will be required to disclose the pay ratios for the first fiscal year starting on or after January 1, 2017. This rule will not apply to smaller reporting companies, emerging growth companies, foreign private issuers, MJDS filers, or registered investment companies. Furthermore, the rule grants companies flexibility in how they acquire their statistics. Companies can select their own methodology for calculating the median employee’s compensation, as long as it meets the rule’s requirements, and they are allowed to exclude non-U.S. employees from countries where data privacy laws make the companies unable to comply with the rule.

Miller Energy Resources, Former CFO, Current COO Charged with Accounting Fraud
August 6, 2015 (Litigation Release No. 161)
Miller Energy Resources, their former CFO Paul Boyd, and their current COO David Hall have been charged with fraud after inflating the values of Miller Energy’s oil and gas properties in Alaska. Back in 2009, Miller Energy purchased Alaskan properties for $2.25 million. The company later reported the properties’ value at $480 million, overstating their value by more than $400 million. The inflated valuation turned a penny-stock company into a company that eventually traded on the New York Stock Exchange. Paul Boyd allegedly relied on a reserve report that did not accurately reflect the properties’ fair value and double-counted $110 million of fixed assets. Hall allegedly intentionally understated expense numbers in one report and altered a second report to make it look like it was an independent party’s value estimate. The case is still ongoing and will be scheduled for a public hearing.