This month's regulatory actions:
Federal Court orders Thomas B. Breen, to pay $1.75 million to settle fraud charges
The U.S. Commodity Futures Trading Commission (CFTC) announced that it obtained a federal court order against a principal of National Equity Holdings, Inc. , Thomas B. Breen, of Orange County, Cal., requiring Breen to jointly pay restitution to defrauded customers in accordance with a restitution order set in a related criminal action of $1,059,096, and imposes a civil monetary penalty of $700,000 against Breen, as well as permanent trading and registration bans.
The order stems from a CFTC Complaint filed on Nov. 8, 2011, against defendants National Equity, Robert J. Cannone, Francis Franco, and Breen, charging them with fraudulent solicitation, misappropriation, and registration violations.
The order finds, and Breen acknowledges, that from at least June 2009 to May 2010, Breen, by and through National Equity, fraudulently solicited and accepted over $1.4 million to trade commodity futures contracts through a pool. In their solicitations, Breen, by and through National Equity, (1) falsely claimed to have a successful and experienced trader (Franco) for the pool, (2) misrepresented the likelihood of profits and the risks associated with trading commodity futures, (3) failed to disclose that they were not properly registered with the CFTC to operate a pool, and (4) failed to disclose their intended uses of pool participant funds.
The order further finds that Breen and National Equity traded only a portion of the pool participant funds in proprietary accounts, and sustained overall and significant losses. Breen and National Equity concealed their fraud and trading losses from the pool participants by issuing false account statements reflecting profits. Approximately-one year later, they claimed that participants’ fund were all lost in trading, but promised to return their funds.
The CFTC’s litigation continues against defendant Francis Franco to determine the appropriate amount of a civil monetary penalty to be imposed and whether a personal trading ban should be imposed. However, on April 11, 2013, the court entered a consent order of permanent injunction against defendants National Equity and Cannone, requiring them to pay over $3.6 million of restitution and monetary penalties, among other sanctions, to settle the CFTC action.
In related actions, Cannone and Franco, pled guilty to criminal violations of the Commodity Exchange Act (CEA) as amended. Cannone was sentenced to 27 months in federal prison, and ordered to pay the $1.05 million in restitution, jointly and severally with the other defendants. Franco was sentenced to 25 months, while Breen was sentenced to 40 months.
Federal Court orders Lyndon Parrilla to pay over $17 million in forex fraud scheme
A federal court awarded restitution for defrauded customers, disgorgement, and a civil monetary penalty totaling more than $17 million against defendant Lyndon Parrilla, of California, in connection with an off-exchange foreign currency fraud scheme in which Parrilla and his company, Green Tree Capital, defrauded over 50 customers in the United States of over $4 million.
Judge Joseph L. Tauro of the U.S. District Court for the District of Massachusetts entered the final judgment and permanent injunction Order on Oct. 24, 2013, requiring Parrilla to pay restitution of $4,197,342 to defrauded customers, disgorgement of $3,353,925, and a $10 million civil monetary penalty. The order also imposes permanent trading and registration bans against Parrilla and prohibits him from further violations of the Commodity Exchange Act (CEA) and CFTC regulations, as charged.
The order stems from a CFTC Complaint filed on April 12, 2011, that charged Parrilla and Green Tree with fraud, misappropriation, and other CEA violations. The court previously entered judgment against Green Tree on June 30, 2011.
The final judgment order is based on the court’s findings set forth in an earlier order, entered on Sept. 30, 2013, that finds that Parrilla and Green Tree fraudulently solicited over $4 million from at least 50 customers in the United States, from approximately October 2009 until April 2011, for the purported purpose of trading off-exchange forex contracts on a leveraged or margined basis in managed accounts.
In soliciting the funds, the order finds that Parrilla, on behalf of Green Tree, misrepresented that Green Tree had a record of delivering consistently profitable returns when, in fact, it incurred trading losses since its inception, and almost 80% of customer funds was never traded or invested in any manner. In fact, according to the order, Parrilla misappropriated over $3.3 million of customer funds to pay personal and entertainment expenses, including Las Vegas casino expenses, purchase automobiles and clothing, and ATM or cash withdrawals. To disguise these misrepresentations, trading losses, and misappropriations, Parrilla sent false Green Tree account statements to customers by email. Further, the Order finds that Parrilla misrepresented his experience and expertise, and failed to disclose that the National Futures Association (NFA) permanently barred him from NFA membership.
As a result of a parallel criminal action brought by the U.S. Attorney’s Office in November 2012, Parrilla was sentenced to, among other things, a term of 97 months imprisonment and ordered to pay restitution in the amount of $4,675,156.
CFTC obtains restraining order against AlphaMetrix, alleging misappropriation of pool funds and sending false or misleading statements
The CFTC filed a complaint in the U.S. District Court for the Northern District of Illinois on Nov. 4, 2013, against AlphaMetrix, LLC, a Chicago-based commodity pool operator (CPO) and commodity trading advisor (CTA). The CFTC alleges that AlphaMetrix misappropriated funds belonging to commodity pools it operated and sent false or misleading account statements to at least some of the pool participants. On Nov.5, 2013, Federal District Judge Joan H. Lefkow issued a consent restraining order that freezes AlphaMetrix’s assets, protects books and records, and appoints a corporate monitor to oversee the distribution of pool funds to participants.
According to the CFTC, AlphaMetrix operates approximately 90 pools that had approximately $700 million in assets under management as of Aug. 31, 2013. The Complaint alleges that AlphaMetrix had agreements with some participants in which AlphaMetrix agreed to rebate certain fees by reinvesting the funds in the pools for the participants. However, as alleged, between at least Jan. 1 and Oct. 31, 2013, AlphaMetrix failed to reinvest at least $2.8 million of the rebates owed to participants and instead transferred the funds to its parent company, AlphaMetrix Group, LLC, which had no legitimate claim to those funds and is named as a relief defendant in the complaint. the complaint states that AlphaMetrix nevertheless sent the participants account statements, which included the funds that were supposed to have been invested in calculating the net asset value of their interests, and, as a result, misstated to participants the true value of their investments.
In its continuing litigation, the CFTC seeks preliminary and permanent injunctions against AlphaMetrix, enjoining AlphaMetrix from committing further violations of the Commodity Exchange Act, as charged, and ordering it to pay restitution, disgorgement, and a civil monetary penalty, among other appropriate relief. The CFTC also seeks an order requiring AlphaMetrix Group, LLC, to disgorge funds it received as a result of AlphaMetrix’s unlawful conduct.
CFTC charges Donald R. Wilson and DRW Investments with price manipulation
The CFTC filed a civil enforcement action in the U.S. District Court for the Southern District of New York against Donald R. Wilson and his company, DRW Investments, LLC . The CFTC’s complaint charges Wilson and DRW with unlawfully manipulating and attempting to manipulate the price of a futures contract, namely the IDEX USD Three-Month Interest Rate Swap Futures Contract (Three-Month Contract) from at least January 2011 through August 2011. The complaint alleges that as a result of the manipulative scheme, the defendants profited by at least $20 million, while their trading counterparties suffered losses of an equal amount.
According to the complaint, in 2010 the Three-Month Contract was listed by the International Derivatives Clearinghouse (IDCH) and traded on the NASDAQ OMX Futures Exchange, and was publicized as an alternative to over-the-counter, i.e., off-exchange, products. Wilson and DRW believed that they could trade the contract for a profit based on their analysis of the contract. At the end of 2010, Wilson caused DRW to acquire a large long (fixed rate) position in the Three-Month Contract with a net notional value in excess of $350 million. The daily value of DRW’s position was dependent upon the daily settlement price of the Three-Month Contract calculated according to IDCH’s methodology. As Wilson and DRW knew, the methodology relied on electronic bids placed on the exchange during a 15-minute period, the “settlement window,” prior to the close of each trading day. In the absence of such bids, the exchange used prices from over-the-counter markets to determine its settlement prices. Wilson and DRW anticipated that the value of their position would rise over time.
The market prices did not reach the level that Wilson and DRW had hoped for and expected, according to the CFTC. Rather than accept that reality, Wilson and DRW allegedly executed a manipulative strategy to move the Three-Month Contract market price in their favor by “banging the close,” which entailed placing numerous bids on many trading days almost entirely within the settlement window, none of which resulted in actual transactions as DRW regularly cancelled the bids. Under the exchange’s methodology, DRW’s bids became the settlement prices, and in this way DRW unlawfully increased the value of its position, according to the CFTC.
Gretchen L. Lowe, the CFTC’s Acting Director of Enforcement, stated: “Traders cannot engage in manipulative acts to affect the price of futures contracts to achieve their desired profits, regardless of the so-called motive. Today’s action demonstrates that the Commission will vigorously prosecute such cases to protect the integrity of the markets.”
According to the Complaint, Wilson and DRW allegedly caused and profited from artificial prices on the Three-Month Contract over a period of at least 118 trading days. Because Wilson and DRW allegedly caused artificial prices in multiple maturities of the Three-Month Contract each day, the manipulative scheme allegedly affected the prices of over 1,000 futures contracts, according to the CFTC.
The complaint alleges that by engaging in such conduct, Wilson violated, or aided and abetted in the violation of, Sections 6(c) and 9(a)(2) of the Commodity Exchange Act (CEA), 7 U.S.C. §§ 9 and 13(a)(2) (2006 & Supp. IV). The Complaint further alleges that, pursuant to Section 13(b) of the Act, 7 U.S.C. § 13c(b) (2006 & Supp. IV), Wilson is liable as a controlling person for DRW’s violations of Sections 6(c) and 9(a)(2) of the CEA. The Complaint charges DRW with vicarious liability for the violations of its agents and/or employees, including Wilson, pursuant to Section 2(a)(1)(B) of the Act, 7 U.S.C. § 2(a)(1)(B) (2006 & Supp. IV).
In its ongoing litigation, the CFTC is seeking permanent injunctive relief, disgorgement, restitution, civil monetary penalties, trading suspensions and bans, and payment of costs and fees.
CFTC charges James C. Yadgir with violating live and feeder cattle futures speculative position limits
The CFTC filed an enforcement action in the U.S. District Court for the Northern District of Illinois against James C. Yadgir of Palatine, Ill., charging Yadgir with exceeding the Chicago Mercantile Exchange’s (CME) speculative position limits in live cattle futures contracts in April 2011 and in feeder cattle futures contracts in May 2012. As the CFTC approved the CME speculative position limits for both futures contracts, the complaint alleges that Yadgir, a CME floor broker and trader, violated the CEA, which prohibits any person from holding futures contract positions or options on such contracts in excess of established CFTC-approved speculative position limits.
According to the CFTC’s complaint, on April 6, 2011, Yadgir held an open net position in April 2011 live cattle future contracts that exceeded his 550 contracts long spot month spread exemption position limit by 70 contracts.
The CFTC further alleges that on May 23 and 24, 2012, Yadgir violated the CME’s speculative position limits in feeder cattle futures contracts. As charged, Yadgir’s aggregate futures equivalent net position in May 2012 feeder cattle futures on May 23, 2012 exceeded the speculative position limit of 300 contracts in the last 10 days of trading by over 81 contracts. Yadgir also allegedly exceeded the feeder cattle futures speculative position limit on May 24, 2012, the expiration day of the May 2012 contract. According to the complaint, Yadgir admitted to the violations alleged in the Complaint.
Yadgir has been registered with the CFTC as a floor trader since 1993 and as a floor broker since 2007.
The federal Complaint seeks a permanent injunction in addition to other remedial relief, including a trading ban and a civil monetary penalty.
SEC announces first deferred-prosecution agreement with an individual
On Nov. 12, 2013, the Securities and Exchange Commission (SEC) announced it had entered into a Deferred-Prosecution Agreement (DPA) with Scott Herckis, a former hedge fund administrator, for his role in an allegedly fraudulent scheme involving Heppelwhite Fund, LP, a Connecticut-based hedge fund. Under the agreement, the SEC agreed to defer charging Herckis with violations of the federal securities laws and Herckis agreed to disgorge $50,000 in fees he received for services provided to the fund and to be barred from, among other things, providing services to hedge funds for five years. This is the first time since introducing a formal Cooperation Initiative in 2010 that the SEC has entered into a DPA with an individual.
Herckis agreed to admit certain factual statements contained in the DPA “in any future Commission enforcement action in the event [Herckis] breaches” the DPA. Those statements included:
- Herckis is a certified public accountant (CPA) who calculated the performance of the fund’s investment, prepared monthly account statements for fund investors, managed and accounted for contributions to, and withdrawals from, investor accounts, paid fund expenses and corresponded with potential investors;
- Berton Hochfeld, through Hochfeld Capital Management, LLC managed the fund, which had approximately 25 investors and at least $6 million in assets;
- Herckis, acting upon Hochfeld’s instructions, effected transfers of more than $1.5 million from the Fund to Hochfeld’s personal accounts;
- Herckis knew, or was reckless in not knowing, that these transfers were improper;
- Herckis also was responsible for calculating the fund’s net asset value (NAV) and knew that the NAV he provided to investors was materially less than actual NAV; and
- In September 2012, Herckis resigned as fund administrator, contacted the government authorities and cooperated with the resulting SEC investigation by producing voluminous documents and explaining the details of Hochfeld’s scheme.
As a result of Herckis’ cooperation, the SEC was able to file an emergency action and freeze more than $6 million in the assets of the fund, HCM and Hochfeld, which, subject to the court’s approval, will be distributed to the fund’s investors. In addition, Hochfeld pleaded guilty in federal court to securities and wire fraud charges. He was sentenced on August 5, 2013 to two years in prison.
The Cooperation Initiative, now embodied in the SEC’s Enforcement Manual, garnished significant attention when it was announced in 2010. In announcing the program, the staff indicated that the Initiative was expected to “result in invaluable and early assistance in identifying the scope, participants, victims and ill-gotten gains associated with fraudulent schemes.” Since 2010, however, the staff has made limited use of DPAs and Non-Prosecution Agreements (NPA). In fact, the staff has only entered into two DPAs and four NPAs.
According to the DPA, Herckis’ eligibility to enter into the agreement depended in part on the fact that Herckis had never been charged or found guilty of, or liable for, violating the federal securities laws. Herckis also promised to cooperate with the SEC in any related enforcement litigation or proceedings. While the SEC noted Herckis’ cooperation and contribution to its investigation, it did not mention whether the staff was already investigating Hochfeld and HCM before Herckis contacted the authorities. Given the size of the fund and the limited number of investors, it seems likely that the staff was not aware of any wrongdoing prior to Herckis’ report.
In announcing the DPA with Herckis, the staff stressed that it believed the DPA struck the right balance between recognizing significant cooperation and holding Herckis responsible for his misconduct. It is not clear, however, the extent of the benefit Herckis received by self-reporting and cooperating. While the SEC did not “charge” Herckis with violating the federal securities laws, the SEC received substantially all of the relief it would have been entitled to if it had charged Herckis. Under most circumstances, the SEC is entitled to seek disgorgement of ill-gotten gains, prejudgment interest, civil penalties and certain industry bars. Herckis agreed to disgorge the fees he received in connection with the services he provided to the Fund. Herckis also agreed not to provide services to hedge funds or associate with any broker, dealer, investment adviser or registered investment company for five years. The SEC refrained from seeking prejudgment interest on the disgorgement and a civil penalty. Even if the SEC had charged Herckis, however, it could have chosen not to impose prejudgment interest or a civil penalty. It appears the greatest benefit Herckis received from the DPA is that a DPA is likely to have less of an adverse impact on his ability to practice as a CPA (outside the financial industry) than if he had been charged with fraud.
The DPA with Herckis demonstrates the SEC’s evolving policy with respect to its “neither admit nor deny” settlements. Over the last five months, SEC Chairman Mary Jo White and Co-Enforcement Directors Andrew Ceresney and George Canellos have repeatedly said that the staff will require “admissions” in certain cases where “heightened accountability or acceptance of responsibility through the defendant’s admission of misconduct may be appropriate,” and in cases of “egregious misconduct,” involving obstruction of the SEC’s investigation or harm to large numbers of investors.
In prior DPAs, the staff has not required defendants to expressly make admissions. See Amish Helping Fund (Agreement noted that the Fund offered to accept responsibility for its conduct and “not contest or contradict” the factual allegations in the DPA); Tenaris, S.A. (Agreement noted Tenaris offered to accept responsibility for its actions without admitting or denying the factual allegations contained in the DPA). Similarly, corporate defendants who have entered into NPAs have also been permitted to accept responsibility without expressly admitting the factual allegations in such agreements. See Ralph Lauren Corporation (NPA contained “without admitting or denying liability”); Federal Home Loan Mortgage Corporation and Federal National Mortgage Association (NPAs contain “neither admitting nor denying” language); Carter’s Inc. (NPA did not contain any factual allegations).
Based upon the limited information included in the DPA, it does not appear Herckis’ conduct was egregious or otherwise deserving of heightened accountability. The underlying fraud appears to have been limited and by all accounts Herckis’ cooperation allowed the staff to stop the fraud quickly. Herckis, however, was not permitted to accept responsibility without “admitting or denying” the factual allegations. While less onerous than an outright admission, Herckis was required to agree, in the event he breaches the DPA, he would admit certain factual statements contained in the DPA “in any future Commission enforcement action.” The contingent admission would certainly result in the Commission prevailing against Herckis in a future enforcement action, but, at the same time, would likely allow Herckis to defend himself in any related licensing hearings, criminal proceedings or any private actions that may be filed by fund investors.
In sum, the Herckis DPA may illustrate the staff’s willingness to recognize self-reporting and substantial cooperation. It also illustrates, however, that the staff will continue to insist on traditional sanctions including disgorgement and industry bars even when the violator has rendered substantial cooperation. The Herckis DPA also demonstrates that the SEC’s policy regarding admissions in the context of settlements is still evolving and that the staff may be open to using different language regarding admissions to provide some protection with respect to related criminal and private civil actions.
For previous Blotters.