News and Articles

On July 2, 2014, the SEC announced that it had charged five traders for committing short selling violations while trading for themselves and Worldwide Capital Inc., a New York based proprietary firm that earlier this year paid the largest-ever monetary sanction for Rule 105 violations.

Worldwide Capital and its owner Jeffrey W. Lynn agreed to pay $7.2 million to settle SEC charges in March for violating Rule 105, which prohibits the short sale of an equity security during a restricted period and the subsequent purchase of that same security through the offering.

On July 2, 2014 the SEC settled administrative proceedings against Derek W. Bakarich, Carmela Brocco, Tina Lizzio, Steven J. Niemis, and William W. Vowell for violating Rule 105 by selling shares short during the restricted period and purchasing offering shares of the same securities they had shorted. They purchased the offering shares through accounts they opened in their names or names of alter ego corporate entities at large broker-dealers and then executed the short sales of the securities through an account in Worldwide’s name at different, smaller broker-dealers.

Each of the five traders agreed to settle the SEC’s charges and pay a collective total of nearly $750,000.

According to the SEC’s orders, Bakarich, Brocco, Lizzio, Niemis, and Vowell were selected by Lynn to conduct trades for Worldwide Capital, which he created for the purpose of investing and trading his own money. The traders he chose to trade his capital pursued an investment strategy focused primarily on obtaining allocations of new shares of public issuers coming to market through secondary and follow-on public offerings at a discount to the market price of the company’s shares that were already trading publicly. They sold short the shares in those issuers in advance of the offerings, hoping to profit by the difference between the price they paid to acquire the offered shares and the market price on the date of the offering. From approximately August 2009 to March 2012, Bakarich, Brocco, Lizzio, Niemis, and Vowell each violated Rule 105 in connection with at least nine covered offerings. They received ill-gotten gains ranging from approximately $16,000 to more than $200,000.

Each of the five traders agreed to cease and desist from violating Rule 105 without admitting or denying the findings in the SEC’s order. They agreed to disgorge all of their ill-gotten gains plus prejudgment interest and pay an additional penalty equal to 60 percent of the disgorgement amount.

On June 23, 2014, the SEC announced that they had charged a West Palm Beach, Florida based hedge fund advisory firm and its founder with fraudulently shifting money from one investment to another without informing investors. The firm’s founder and another individual later pocketed some of the transferred investor proceeds to enrich themselves.

The SEC alleged that Weston Capital Asset Management LLC and its founder and president Albert Hallac illegally drained more than $17 million from a hedge fund they managed and transferred the money to a consulting and investment firm known as Swartz IP Services Group Inc. The transaction went against the hedge fund’s stated investment strategy and wasn’t disclosed to investors, who received account statements falsely portraying that their investment was performing as well or even better than before. Weston Capital’s former general counsel Keith Wellner assisted the activities.

The SEC further alleged that out of the transferred investor proceeds, Hallac, Wellner, and Hallac’s son collectively received $750,000 in payments from Swartz IP. Weston Capital and Hallac also wrongfully used $3.5 million to pay down a portion of a loan from another fund managed by the firm.

Weston Capital, Hallac, and Wellner agreed to settle the SEC’s charges along with Hallac’s son Jeffrey Hallac, who is named as a relief defendant in the SEC’s complaint for the purposes of recovering ill-gotten gains in his possession. The court will determine monetary sanctions for Weston Capital and Hallac at a later date. Wellner and Jeffrey Hallac each agreed to pay $120,000 in disgorgement.

According to the SEC’s complaint, Weston Capital managed more than a dozen unregistered hedge funds in early 2011 with combined total assets of approximately $230 million. One of the funds managed by the firm was Wimbledon Fund SPC, which was segregated into five separate classes of investment portfolios. The Class TT Segregated Portfolio was required to invest all of its investor money in a diversified multi-billion hedge fund called Tewksbury Investment Fund Ltd., that invested in short-term, low risk interest bearing accounts and U.S. Treasury Bills.

The SEC alleged that in violation of its stated investment strategy, Weston Capital and Hallac redeemed TT Portfolio’s entire investment in the Tewksbury hedge fund and transferred the money to Swartz IP. The transaction was not disclosed to investors and Weston Capital and Hallac solicited and received investments for the TT Portfolio during this time while knowing the funds would not be invested in Tewksbury. As soon as Swartz IP received the money transfers, it disbursed the funds primarily to a special purpose entity created to support and finance varying medically related business ventures.

The SEC’s complaint alleged that Weston and Hallac violated federal anti-fraud laws and rules as well as Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8, and that Wellner aided and abetted these violations. Without admitting or denying the allegations, Weston Capital, Hallac, and Wellner consented to the entry of a judgment enjoining them from future violations of these provisions.

On June 16, 2014, the SEC announced that it had charged an Albany, N.Y.-based hedge fund advisory firm with engaging in prohibited principal transactions and then retaliating against the employee who reported the trading activity to the SEC. This was the first time the SEC had filed a case under its new authority to bring anti-retaliation enforcement actions. The SEC also charged the firm’s owner with causing the improper principal transactions.

Paradigm Capital Management and owner Candace King Weir agreed to pay $2.2 million to settle the charges.

According to the SEC’s order instituting a settled administrative proceeding, Weir conducted transactions between Paradigm and a broker-dealer that she also owned while trading on behalf of a hedge fund client. Such principal transactions pose conflicts between the interests of the adviser and the client, and therefore advisers are required to disclose that they are participating on both sides of the trade and must obtain the client’s consent. Paradigm failed to provide effective written disclosure to the hedge fund and did not obtain its consent as required prior to the completion of each principal transaction.

A Commission rule adopted in 2011 under the Dodd-Frank Act authorized the SEC to bring enforcement actions based on retaliation against whistleblowers who report potential securities law violations to the agency. The SEC’s order found that after Paradigm learned that the firm’s head trader had reported potential misconduct to the SEC, the firm engaged in a series of retaliatory actions that ultimately resulted in the head trader’s resignation.

According to the SEC’s order, Paradigm’s head trader reported trading activity revealing that Paradigm engaged in prohibited principal transactions with affiliated broker-dealer C.L. King & Associates while trading on behalf of hedge fund client PCM Partners L.P. II. The SEC’s subsequent investigation found that Paradigm engaged in the trading strategy from at least 2009 to 2011 to reduce the tax liability of the firm’s hedge fund investors. As part of that strategy, Weir directed Paradigm’s traders to sell securities that had unrealized losses from the hedge fund to a proprietary trading account at C.L. King. The realized losses were used to offset the hedge fund’s realized gains. Paradigm engaged in at least 83 principal transactions by selling 47 securities positions from the hedge fund to C.L. King and then repurchasing 36 of those positions for the hedge fund.

According to the SEC’s order, since Weir had a conflicted role as owner of the brokerage firm in addition to advising the PCM Partners hedge fund, merely providing written disclosure to her as the hedge fund’s general partner and obtaining her consent was insufficient. Paradigm attempted to satisfy the written disclosure and consent requirements by establishing a conflicts committee to review and approve each of the principal transactions on behalf of the hedge fund.

The SEC’s order found that the conflicts committee itself, however, was conflicted. The committee consisted of two people: Paradigm’s chief financial officer and chief compliance officer – who each essentially reported to Weir. Furthermore, Paradigm’s CFO also served as C.L. King’s CFO, which placed him in a conflict. Specifically, there was a negative impact on C.L. King’s net capital each time the broker-dealer purchased securities from the hedge fund. The CFO’s obligation to monitor C.L. King’s net capital requirement was in conflict with his obligation to act in the best interests of the hedge fund as a member of the conflicts committee.

According to the SEC’s order, because the conflicts committee was conflicted, Paradigm failed to provide effective written disclosure to its hedge fund client and failed effectively to obtain the hedge fund’s consent prior to the completion of each principal transaction. The SEC’s order also finds that Paradigm’s Form ADV was materially misleading for failing to disclose the CFO’s conflict as a member of the conflicts committee.

“Paradigm’s use of a conflicted committee denied its hedge fund client the effective disclosure and consent to which it was entitled,” said Julie M. Riewe, co-chief of the SEC Enforcement Division’s Asset Management Unit. “Advisers to pooled investment vehicles need to ensure that any mechanism developed to address conflicts in principal transactions actually mitigates those conflicts.”

According to the SEC’s order, Paradigm’s former head trader made a whistleblower submission to the SEC that revealed the principal transactions between Paradigm and C.L. King. After learning that he had reported potential violations to the SEC, Paradigm immediately engaged in a series of retaliatory actions. Paradigm removed him from his head trader position, tasked him with investigating the very conduct he reported to the SEC, changed his job function from head trader to a full-time compliance assistant, stripped him of his supervisory responsibilities, and otherwise marginalized him.

Paradigm and Weir consented to the entry of the order finding that Paradigm violated Section 21F(h) of the Securities Exchange Act of 1934 and Sections 206(3) and 207 of the Investment Advisers Act of 1940. The order finds that Weir caused Paradigm’s violations of Section 206(3) of the Advisers Act. They each agreed to cease and desist from committing or causing future violations of these provisions without admitting or denying the findings in the order. Paradigm and Weir agreed to jointly and severally pay disgorgement of $1.7 million for distribution to current and former investors in the hedge fund, and pay prejudgment interest of $181,771 and a penalty of $300,000. Paradigm also agreed to retain an independent compliance consultant.

On May 29, 2014, the SEC announced fraud charges and an asset freeze against a Chicago-based investment fund manager accused of stealing money he raised from investors to pay personal and business expenses.

The SEC alleged that Neal V. Goyal told investors that the private funds he managed would invest in securities following a “long-short” trading strategy. However, Goyal actually did little trading and simply operated a Ponzi scheme that used new investor funds to pay redemptions to existing investors and fund his own lavish lifestyle. Goyal concealed the poor results of the few investments he did make by sending investors phony account statements that grossly overstated the performance of the funds.

According to the SEC’s complaint filed in federal court in Chicago, Goyal raised more than $11.4 million in the last several years for investments in four private funds that he managed and controlled. Goyal’s investment strategy lost money from the outset, but he hid those losses from investors through the Ponzi payments and phony account statements. Meanwhile, Goyal misused investor funds to make down-payments and pay the mortgages on two homes he purchased. He also siphoned away investor money to invest in a Chicago tavern, fund two children’s clothing boutiques that his wife operates in Chicago, and purchase artwork and lavish furniture.

The SEC’s complaint filed on May 28th charged Goyal and two investment advisers that he owned and controlled with violating the antifraud provisions of the Securities Act of 1933, Securities Exchange Act of 1934 and Rule 10b-5, and Investment Advisers Act of 1940. The SEC is seeking financial penalties, disgorgement of ill-gotten gains plus prejudgment interest, and a permanent injunction against Goyal, Blue Horizon Asset Management, and Caldera Advisors. The SEC named another Goyal-controlled entity Caldera Investment Group as a relief defendant in its complaint for the purpose of recovering any investor funds it received.

At the SEC’s request, Judge Rebecca R. Pallmeyer issued a permanent injunction and asset freeze on May 28th against Goyal and his firms, who consented to the order without admitting or denying the allegations in the SEC’s complaint. Under the court’s order, monetary remedies will be decided at a later date.