Securities Law Blog

The Securities and Exchange Commission (SEC) has put a halt on any new or pending exemptive requests by exchange-traded funds (ETFs) that are seeking to make “significant investments” in derivatives. The purpose of this decision is to allow the SEC time to review the use of financial derivatives by mutual funds, ETFs, and other investments, in order to determine whether new protections are needed for investors. The action will have no affect on already existing ETFs or other funds.

According to SEC Chairman Mary Schapiro, “It’s appropriate to engage in a more thorough review of the use of derivatives by ETFs and mutual funds given the questions surrounding the risks associated with the derivative instruments underlying many funds.”

The SEC’s review will seek to evaluate whether the current use of derivatives is compliant with provisions of the Investment Company Act in relation to leverage, concentration and diversification. They will look at whether there is adequate risk management implemented and maintained, as well as rules in place for the “proper procedure for a fund’s pricing and liquidity determinations regarding its derivatives holdings.”

Furthermore, the SEC will explore whether appropriate oversight of the use of derivatives is being provided by fund boards of directors. As well as if the risks created by derivatives are being adequately disclosed and if there should be special reporting requirements for funds’ derivative activity.
Derivatives are being faulted for playing a role in the financial crisis, and have since come under increased scrutiny in the U.S. and Europe. Greater federal regulation for derivatives is included in pending legislation, and would grant the SEC more policing authority.

The Securities Investor Protection Corp. (SIPC) discovered Monday March 8, 2010 that a web site called i-sipc.com was mimicking the SIPC web site, sipc.org. Using the name International Securities Investor Protection Corp., “I-SIPC”, the site modeled itself after the SIPC site. It copied both the structural design and artwork in an alleged attempt to obtain sensitive information or money from victims of the Bernard Madoff Ponzi scheme.

The real SIPC works to restore funds to investors with assets in the hands of bankrupt and otherwise financially troubled brokerage firms. The SIPC will act as trustee or an independent court-appointed trustee in a brokerage solvency case to recover funds. Since the collapse of the Madoff scam, the SIPC has been providing funds up to $500,000 to certain investors who lost money. In order to utilize the organizations services, the victims provide their financial and other personal information.

The fake copycat group claims to be based in Geneva, as well as having ties to the United Nations and the International Monetary Fund. The site published images of stacks of U.S currency totaling $1.3 billion which was claimed to have been recovered in Malaysia in collaboration with Interpol. In an attempt to further legitimize its claims, the site posted alleged statements from Madoff victims who reported receiving funds from I-SPIC. The quotes were later found to have been lifted from a New York Times article and taken out of context.

“Investors who lose money in widely publicized schemes are often targeted by con artists looking to cash in on the victim’s desire to recover losses,” said Lori Schock, Director of the SEC’s Office of Investor Education Advocacy. “Victims of fraudulent schemes should be aware that such refund schemes commonly exist, and can be perpetrated through copycat web sites that appear similar to those of actual regulators or other organizations.”

According to SIPC President, Stephen Harbeck, SIPC learned of the phony site when an individual contacted the organization asking about the legitimacy of the I-SPIC. The individual had contacted I-SPIC via email, and received a response directing him to send $1,000 to an offshore account. Since the reported incident, the phony site has been disabled.

The founders and co-owners of the Miami-based real estate development company Royal West Properties, Inc. have been charged with fraud for conducting a $135 million Ponzi scheme. The Securities and Exchange Commission (SEC) alleges that Gaston E. Cantens and his wife allegedly sold promissory notes to investors after acquiring various properties and later financing their sale.

According to the civil complaint filed by the SEC, the Cantens targeted members of the Cuban-American community. Well-known within the close-knit community, the couple gained the trust of mostly elderly investors whom they met at charitable and religious gatherings, and at events hosted at their Miami home. Mr. Cantens also allegedly used his connections as an alumnus and board member at the Belén Prep School to recruit investors. Outside of their immediate community, investors were attracted by televised commercials broadcast on Spanish-language channels nationwide.

Despite the Cantens not being registered with the SEC under the federal securities laws to make securities offerings to investors, reportedly no questions were asked of the couple that a community regarded as old friends.

In a statement given by Director of the SEC’s Miami Regional Office, Eric I. Bustillo commented on the couples’ recruiting tactics, saying that “They portrayed themselves as a pious couple closely involved with educational and religious organizations, while in reality they were living lavishly off money from defrauded investors.”

Along with allegedly using investor money to repay earlier investors, the SEC also contends that the Cantens misappropriated more than $20 million to fund personal business ventures, pay themselves high salaries, and allocated an estimated $1 million to their children and grandchildren citing “consulting fees”.

The Cantens allegedly made promises to investors of high annual returns of 9 to 16 percent. Investors were told the money would come from mortgages on land in southwest Florida sold by Royal West. The SEC claims that the Cantens made “numerous material misrepresentations and omissions about the safety and security of investors’ principal and returns, the success of Royal West’s business, the source of purported investment returns, and the use of investor funds.” The South Florida couple is charged with violating the securities registration and antifraud provisions of the federal securities laws. The SEC is seeking permanent injunctions, sworn accountings, disgorgement of ill-gotten gains and financial penalties against the Cantens.

The company that was started in 1982 allegedly began showing operating losses by 2002 when property owners began defaulting on their mortgages, but continued to promote their business as financially sound in order to attract new investors. The couple allegedly began using new investor funds to make principal and interest payments to earlier investors. When Royal West went bankrupt last year and ceased making interest payments, rumors began about the mismanagement of the real estate development company.

Following the charges issued March 3, 2010, the couple released a statement denying the SEC’s claims. Instead they cited the collapse of the real estate market as the cause of their company’s financial problems.

Another brick in the Madoff scam crumbles under further investigation by the Securities and Exchange Commission (SEC). On February 25, 2010, the former Director of Operations at Bernard L. Madoff Investment Securities, LLC (BMIS), Daniel Bonventre, was charged for his involvement in the multi-billion dollar fraud.

At BMIS, Bonventre oversaw the firm’s accounting and securities clearing functions for about the last thirty years. The SEC’s complaint, filed in the U.S. District Court for the Southern District of New York, made several allegations about Bonventre’s role in the scam.

According to the SEC complaint, Bonventre allegedly falsified financial reports to investors to avoid disclosing the firm’s massive liabilities. BMIS financial reports were allegedly doctored by Bonventre to inappropriately state how investor funds were being used and maintained.

The SEC alleges that Bonventre was aware that billions of investor funds were not being used to purchase securities on behalf of investors, and worked alongside Madoff and others to disguise the information. When BMIS came under review, Bonventre and others allegedly produced reams of false reports and data filled with “serial misrepresentations.”

George S. Canellos, Director of the SEC’s Regional New York Office said, “A fraud of this magnitude requires a coordinated effort. Bonventre played an essential part by creating bogus financial records to give BMIS the appearance of legitimacy, when in fact the firm lost money and could not have survived without the fraud.”

To hide that BMIS was consistently operating at a significant loss, the firm allegedly used over $750 million in investor funds to artificially improve reported revenue and income.

Finally the SEC alleges that the former Director of Operations made an estimated $1.9 million in illicit personal profits through fake backdated trades in his own investor accounts at BMIS. One such trade was backdated by twelve years.

If convicted on all charges, Bonventre, 63, faces up to 77 years in prison. The SEC is also seeking to impose financial penalties and disgorgement of all ill-gotten gains.
The charges against Bonventre mark the SEC’s seventh enforcement action concerning the Madoff scam since its collapse in December 2008. Previous actions where parties have pleaded guilty to criminal charges include Madoff and BMIS, DiPascali, and auditors David G. Friehling and David G. Friehling & Horowitz CPAs, P.C. Certain feeder funds have also been charged with committing securities fraud, and two computer programmers at Madoff’s firm were charged for their role in concealing the scheme.

The Securities and Exchange Commission (SEC) charged State Street Bank and Trust Company on February 4, 2010 with misleading its investors in the Limited Duration Bond Fund. State Street created The Limited Duration Bond Fund (the “Fund”) in February 2002, and marketed it to investors as an alternative to a money market fund, claiming to have better sector diversification.

In 2006 and early 2007, State Street increased the investors’ exposure to subprime mortgages, while investors remained unaware of the extent to which their investments were tied to the money-losing loans. The Fund continued to be marketed to prospective investors without disclosing the extent of the fund’s concentration in subprime investments, according to the SEC complaint.

When the market meltdown began happening in July 2007, State Street provided selected investors with more complete information about the Fund, while allegedly keeping others in the dark. The informed investors are said to include clients of State Street’s internal advisory groups, who paid more for consulting services. According to the Complaint, these investors were informed by late July to exit the fund, while others were encouraged to stay and continue to invest. State Street began selling the fund’s most liquid holdings in order to meet the redemption demands of the more informed investors. The Fund was left with mostly illiquid holdings and cost investors millions of dollars.

Neither admitting or denying guilt, State Street agreed to settle the SEC’s charges by paying $313 million to allegedly misled investors who lost money during the meltdown. Making up the $313 million is a $50 million penalty, $8.3 million in disgorgement and prejudgment interest, and $255 million to investors. Prior to the SEC’s recent charges, State Street has already agreed to pay nearly $350 million to settle private lawsuits.