Securities Law Blog

On April 27, 2010 the Financial Industry Regulatory Authority (FINRA) fined five broker-dealers for the illegal sale of more than 8 billion shares of penny stocks on behalf of their customers. Fagenson & Co., Inc., RBC Capital Markets Corp., Equity Station, Inc., Olympus Securities, LLC and Alpine Securities Corp. have been fined a combined total of $385,000.

The majority of the illegal sales involved Universal Express Inc. More than 7.5 billion shares of the company’s unregistered stock were sold by the five firms, generating proceeds of roughly $8.4 million.

Regulators allege that despite indications that the sale of the stock was potentially illegal, the firms failed to take appropriates measures to determine whether the sale of the securities followed federal registration requirements.

In 2004 the Securities and Exchange Commission (SEC) filed a complaint alleging that Universal had issued more than 500 million shares of unregistered stock for distribution to the public. In 2007, a federal court ordered Universal to pay an estimated $22 million in fines and disgorgement. Despite the actions taken against Universal, the five firms carried out most of the illegal sales after the SEC’s complaint or after its enforcement action.

All of the firms, except Equity Station Inc., were found to have failed to establish and enforce a reasonable supervisory system to prevent the sale of unregistered stock.

“Brokerage firms are the first line of defense when it comes to preventing the illegal distribution of unregistered securities into the public markets. The failure to detect and prevent these sales creates serious risks to the unsuspecting customers who purchased these unregistered securities,” said James Shorris, FINRA Executive Vice President and Executive Director of Enforcement.

FINRA found that each of the five firms allowed their customers to deposit large blocks of thinly traded securities in certificate form and then immediately liquidate those positions.

According to the FINRA report, Fagenson reported earning $44,000 in commissions and was fined $165,000; RBC earned $68,000 in commissions and was fined $135,000; Alpine earned $47,000 and was fined $40,000; Equity earned $13,575 and was fined $25,000; and Olympus earned $5,200 and was fined $20,000.

On April 21, 2010, Bruce Karatz, former chief executive of one of the nation’s most successful home builders, was convicted on four felony counts of fraud related to his alleged manipulation of executive stock options. The former KB Home executive was found guilty by a jury in Los Angeles, California of two counts of mail fraud, making false statements in a regulatory filing and lying to company accountants.

Back in 2006 KB Home hired an outside law firm to investigate its options policies in response to the Securities and Exchange Commission’s (SEC) and Justice Department’s increased scrutiny of stock option grants at the time. Following the investigation Karatz retired after being with the company for two decades and settled a lawsuit with the SEC for $7 million in fines and restitution to KB Home.

In March 2009, a federal grand jury indicted Karatz on 20 felony charges. The charges claimed that from 1999 until 2006 Karatz backdated his own stock options and those of other executives. The jury acquitted Karatz of 16 of the charges stating that there was no evidence of intent to defraud investors, but that he did lie about backdating to KB Home accountants in a 2006 quarterly report, according to court documents.

According to prosecutors, the alleged scheme enabled Karatz to make more than $6 million in “secret pay.”

Following the conviction, Karatz’s lawyers attested that Karatz never thought he was committing a crime, and they are looking to appeal.

On April 23, 2010 the Denver District Court issued a temporary restraining order, freezing the assets of Sean Michael Mueller and his companies, Mueller Capital Management LLC and Mueller Over Under Fund LP. The Greenwood Village, Colorado hedge fund manager has been under investigation by the Colorado State Securities Division for the past month for his alleged involvement in a multi-million dollar Ponzi scheme.

The court order to freeze Mueller’s assets came after Colorado State Securities Commissioner Fred Joseph filed for the order following the receipt of a complaint from an anonymous investor, and learned of Mueller’s failed suicide attempt on April 22, 2010. According to the state securities division, the anonymous investor also “expressed concern that Mueller was effectively operating the fund as a Ponzi scheme, representing that he has never lost money in any monthly period and providing investors with inflated expectations of returns.”

According to court documents, before attempting to jump off of a 19 story building, Mueller sent an email to investors stating, “I don’t know where to begin, so I will start with, I’m sorry. The stress of life has overwhelmed everything else. Please realize that I didn’t set out to end this way, I always thought I could pull it out in the end but events sped up to end that dream.”

According to Joseph, Mueller claimed to have a complicated investment strategy to make it sound like investors could make a lot of money. In a memorandum for the Fund filed in 2002, Mueller allegedly asked for a minimum investment of $500,000 into the Over Under Fund, claiming the fund would attempt to raise $100 million. He allegedly stated that the Fund would engage in short-term trading of stocks and would borrow money in order to leverage investors’ funds, according to court documents.

President and founder of Capitol Investments USA, Inc., Nevin K. Shapiro, has been criminally charged with securities fraud and money laundering by federal prosecutors from the U.S. Department of Justice in New Jersey. According to court documents, the Miami Beach-based businessman allegedly raised over $880 million from at least sixty investors by selling securities that he claimed would fund Capitol’s grocery diverting business.

Capitol’s business was purchasing lower-priced groceries from vendors in one region of a country and reselling them for profit in another region where the prices were higher.

The Securities and Exchange Commission (SEC) also filed civil charges against Shapiro for what they claim to be a $900 million Ponzi scheme.

According to the SEC complaint, the fraud that began in February 2003 and ran through November 2009 developed into a Ponzi scheme in January 2005 when Capitol had “virtually no legitimate business.” In 2005 Shapiro allegedly began using new investor money to make principal and interest payments in typical Ponzi fashion.

Shapiro allegedly enticed investors to purchase his “risk-free securities” promising rates of return up to 26% annually. The SEC alleges that Shapiro made several other misrepresentations to investors, including that the company had a successful track record with gross sales of $64 million in 2008 and projected sales of $70 million in 2009. Shapiro allegedly provided investors with fabricated invoices and purchase orders for nonexistent sales.

The SEC’s complaint alleges that Shapiro misappropriated at least $35 million for personal use. Shapiro allegedly used the money to cover gambling debts, purchase luxury cars and tickets for sporting events, pay for his $5 million dollar home in Miami Beach, make large donations to local universities, and fund his other business ventures.

When Capitol filed for bankruptcy in November 2009, investors were owed more than $80 million.

The SEC is charging Shapiro with violating antifraud provisions of the federal securities laws. The industry regulator is seeking a permanent injunction, sworn accounting, disgorgement of ill-gotten gains and financial penalties against Shapiro.

The owner and four employees of Gryphon Holdings Inc. were arrested April 20, 2010 for allegedly operating an internet-base scam that misled investors into paying fees for phony stock tips and investment advice. The president of the Staten Island financial advisory firm, Kenneth Marsh, and four others have been charged with conspiracy to commit securities fraud and wire fraud and a single count of wire fraud. If convicted they could each face up to 20 years in prison, according to the U.S. Attorney’s office in Brooklyn, NY.

The Securities and Exchange Commission (SEC) also filed civil charges against the firm, Marsh, and the four employees.

The SEC alleges that since at least 2007 Gryphon used numerous material misrepresentations to lure clients to purchase its services. Gryphon allegedly fabricated advisor credentials, including possessing valuable experience with major Wall Street firms and degrees from prestigious academic institutions. The firm allegedly claimed to have offices around the world, when in reality they operated their dealings from a Staten Island strip mall.

According to prosecutors, the majority of the victims are reported to being elderly retirees who received unsolicited emails and telephone calls promoting the firm’s services.

The advisory firm allegedly charged between $99 and $250,000 for securities recommendations which the SEC said were falsely claimed to have been based on “sound research and successful strategies of trading experts with superior knowledge.”

According to the SEC complaint, over the course of the past three years, Gryphon acquired more than $17.5 million for fees and services.