Securities Law Blog

Stealing client funds, misappropriating investor monies, and receiving million dollar salaries are once again included in the list of charges filed by the Securities and Exchange Commission (SEC) against an alleged Ponzie schemer. The Palm Beach Gardens investment adviser, Trade-LLC, and its managing members, Philip W. Milton and William Center were named in a civil suit filed by the SEC in the U.S. District Court for the Southern District of Florida on June 22, 2010.

The SEC alleges that Trade-LLC, Milton and Center solicited their services to Cash Flow Financial LLC, New Life Club LLC and DC Advisors LLC, with more than 800 members nationwide. Between 2007 and 2009 they raised nearly $28 from the three private investment clubs by allegedly telling the clubs that they would be using investor money to trade securities on the clubs’ behalf using its purported proprietary software trading program.

According to the SEC’s complaint, the clubs received reports from Trade-LLC purportedly showing that they were making returns of up to 8% a month, or approximately 100% on an annualized basis. In reality, Trade-LLC sustained trading losses of more than $2 million in total.

Trade-LLC, Milton and Center reportedly operated the Ponzi scheme by using investor funds received from the clubs to pay back to them more than $1 million in fictitious profits. Milton and Center allegedly misappropriated the clubs’ money to pay their salaries of more than $2 million and $1 million respectively, as well as other personal and business expenses.

The complaint also named three companies, BD LLC, TWTT-LLC and CMJ Capital LLC, controlled by Milton and Center that received proceeds from the scheme, as relief defendants. Milton and Center allegedly transferred over $4.8 million of the clubs’ funds to the three companies without any legitimate basis.

Trade-LLC, Milton and Center were all charged with violating the antifraud provisions of the federal securities laws. Trade-LLC, Milton and the relief defendants have agreed to settle the charges. Trade-LLC and the relief defendants have consented to an asset freeze and to disgorge all of the funds that the court determines they received from the fraudulent scheme. Milton has been directed to disgorge $2,351,963 in proceeds he received from Trade-LLC and to pay a $130,000 civil money penalty. Trade-LLC will also pay a civil money penalty in an amount to be determined by the court.

The Securities and Exchange Commission (SEC) has filed its first complaint since the credit crisis that an asset manager overseeing CDOs took advantage of investors and permitted conflicts of interest to drive decision-making. Thomas Priore and his three affiliated firms have been charged with fraudulently managing investment products tied to the mortgage markets when they came under stress in 2007.

In 2006, ICP Asset Management LLC began serving as the collateral manager for what was known as the Triaxx CDOs, which invested primarily in mortgage-backed securities.

Priore, the owner and president of ICP, allegedly repeatedly caused the Triaxx CDOs to overpay for securities in order to take money for ICP and protect other ICP clients from realizing losses, while causing the CDOs to lose millions of dollars. He reportedly directed more than $1 billion of trades for Triaxx CDOs at what he knew were inflated prices, which allowed ICP to collect millions of dollars in advisory fees from the CDOs.

Director of the SEC’s New York office, George Canellos said, “When asset pricing is not transparent it creates significant opportunities for managers like ICP to manipulate prices to keep vehicles afloat, to influence fees, and favor themselves or clients over other clients.”

According to the SEC’s complaint, Priore and ICP made numerous prohibited investments without necessary approvals and later misrepresented those investments to the trustees of the CDOs and to investors. Large portions of two of the CDOs were insured by American International Group Inc. (AIG), which had complained about unauthorized trades by ICP.

In June 2007, Priore allegedly bought $1.3 billion in bonds from Bear Stearns Cos. by using a forward agreement because ICP didn’t have enough funds for the purchase. A forward agreement was a forbidden contract in the Triaxx investment guidelines because of the potential of increased risk. The SEC claims that two weeks later Priore sold some of the bonds to another ICP client at higher prices. The sale purportedly netted $14 million in profits diverted to ICP instead of the CDOs.

Also being charged in the complaint are ICP’s affiliated broker-dealer ICP Securities LLC and its parent company Institutional Credit Partners LLC. The SEC is seeking permanent injunctions barring future violations of federal securities laws, disgorgement of the defendant’s ill-gotten gains with pre-judgment interest, and monetary penalties.

The U.S. Supreme Court, in a unanimous decision, recently issued a ruling that will have a profound effect on shareholder fraud lawsuits. Justice Stephen Breyer wrote the opinion of the Court for Merck & Co., Inc. v. Richard Reynolds et al. that has relaxed the deadlines for the filing of cases alleging violations of the federal securities laws.

The disputed issue was the timeliness of a complaint filed in a private securities fraud action against Merck. Merck alleged that the plaintiffs should have discovered the “facts constituting the violation” before November 6, 2001, and therefore their complaint filed November 6, 2003 is beyond the statute of limitations.

According to the Court’s opinion, the November 2003 complaint alleged that Merck had defrauded investors by promoting the drug Vioxx despite its knowledge of its serious safety issues. The plaintiffs alleged their claim to be timely because they had not, and could not have, discovered by the critical date those “facts,” particularly facts related to scienter.

The applicable statute passed by Congress in 2002 provides that an action that “involved a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning securities laws…may be brought not later than the earlier of 1) two years after the discovery of the facts constituting the violation; or 2) five years after such violation.”

The Court found scienter to be a necessary fact to be discovered in order for the limitations period to begin to run. In a claim alleging fraud, a plaintiff must allege that a defendant made a “material misstatement with an intent to deceive” and not merely acted negligently. If the limitations period began to run regardless of evidence of scienter, the two year period could expire without anyone ever discovering the fraud.

The Court rejected Merck’s argument that pre-November 2001 events showed intent to defraud/deceive. (These warnings included concerns related to the health complications of Vioxx.) Merck allegedly continued to stand behind their product after a study was conducted and showed the cardiovascular risks associated with the drug.

Merck further argued that by November 1, 2001, plaintiffs possessed enough information “sufficiently suggestive of wrongdoing that they should conduct a further inquiry.” The Court found that although the plaintiff class may have been prompted to investigate further, they would not have had the facts needed to prove a fraud violation had occurred. None of the pre-November 2001 circumstances were found to provide the plaintiffs with information about Merck’s state of mind.

Justice Breyer referenced three important events that occurred after the November 1, 2001 date. These events include a Vioxx study showing increased risk of heart attacks for users, published by The Wall Street Journal (WSJ); Merck’s withdrawal of Vioxx from the market; and a WSJ article that published internal Merck emails and marketing materials that show the company “fought forcefully for years to keep safety concerns from destroying the drug’s commercial prospects.”

The Court held that the limitations period does not begin until the “plaintiff discovers or a reasonably diligent plaintiff would have discovered the facts constituting the violation,” including scienter-regardless of whether the actual plaintiff undertook a reasonably diligent investigation.

The Securities and Exchange Commission (SEC) charged Lee B. Farkas on June 16, 2010 with piloting a large-scale securities fraud scheme and attempting to scam the U.S. Treasury’s Troubled Asset Relief Program (TARP). The former chairman and majority owner of Taylor, Bean & Whitaker Mortgage Corp. (TBW) was arrested on June 15, 2010 by U.S. authorities on similar charges.

From March 2002 until August 2009, Farkas allegedly sold $1.5 billion in fabricated or impaired mortgage loans and securities to Colonial Bank through TBW. The loans were reportedly misrepresented to the investing public as high-quality, liquid assets.

The SEC alleged that Farkas also caused Colonial Bank’s parent company Colonial BancGroup, Inc. to misrepresent its assets to TARP officials that it had obtained commitments for a $300 million capital infusion, which would qualify Colonial Bank for TARP funding. Colonial BancGroup then issued a press release announcing that it had obtained preliminary approval to receive $550 million in TARP funds, causing its stock price to jump 54 percent in two hours.

Since TBW did not have sufficient capital to internally fund the mortgage loans it originated, it relied on financing agreements mostly through Colonial Bank’s Mortgage Warehouse Lending Division (MWLD). According to the SEC complaint, when TBW began experiencing liquidity problems, it overdrew its limited warehouse line of credit by about $15 million per day. To conceal the overdraws, Farkas allegedly pressured a Colonial Bank officer into entering certain debits the following day after credits due were entered. As the cover-up increased in scope, TBW was purportedly overdrawing its accounts with Colonial by about $150 million per day.

In the complaint filed by the SEC in the U.S. District Court for the Eastern District of Virginia, Farkas is also charged with creating and submitting fictitious loan information to Colonial Bank, and that he allegedly directed the creation of fictitious mortgage-backed securities assembled from fraudulent loans.

According to the criminal indictment, the U.S. alleges that Farkas’ scheme has cost investors and the U.S. government over $2 billion. The Federal Housing Administration reportedly lost $3 billion because of TBW’s alleged misstatements about the health of loans it was servicing for the public housing agency.

The indictment claims that Farkas personally stole $20 million through the scheme to support his fondness of corporate jets and classic cars.

A lawyer for Farkas said that he would enter a plea of “absolutely not guilty, will vigorously defend against the charges and looks forward to having his day in court to clear his name.”

The SEC charges Farkas with violations of antifraud, reporting, books and records and internal controls provisions of the federal securities laws. The industry regulator seeks permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties. They will also seek an officer-and-director bar against Farkas as well as an equitable order prohibiting him from serving in a senior financial institution and from holding any position involving financial reporting or disclosure at a public company.

If found guilty on criminal charges, Farkas could face a maximum of 435 years in jail, $13.8 million in fines, and the forfeiture of $22 million, according to court papers.

New York-based money manager Guy Albert de Chimay and his firm Chimay Capital Management, Inc. were charged by the Securities and Exchange Commission (SEC) on June 11, 2010 for committing securities fraud and stealing millions of dollars from clients.

According to the SEC complaint, Chimay claimed to be related to the current head of the Chimay royal family of Belgium and used the phony connection to secure investments in an investment vehicle known as the “Bridge Loan Facility” (BLF) since in 2008. The BLF was allegedly advertised as pooling investor funds with millions of dollars of Chimay royal family money to make safe and profitable short-term loans to companies. Chimay purportedly guaranteed fixed annual returns of 12 percent to investors, regardless of the actually performance of the loans.

Investors were told that “Chimay Capital had a long and profitable history as the U.S. investment arm for the Chimay royal family and a privileged circle of family friends, and the BLF investment opportunity was being made available to only a few chosen outsiders”, according to the SEC’s claims.

The SEC alleges that there is no evidence that any bridge loans were actually made. The industry regulator insists that Chimay falsified bank statements to hide the fraud, and siphoned at least $6 million into his personal bank account or spent the money on expenses unrelated to the firm. The reported list of expenses include mortgage payments on his multi-million dollar home in the Hamptons, $500,000 for divorce attorney fees, and massive credit card bills.

The SEC seeks permanent injunctions barring future violations of the charged securities laws, disgorgement of the defendants’ ill-gotten gains plus pre-judgment interest, and financial penalties from the defendants.