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On December 20, 2013, the SEC aannounced charges against a woman and her stepson for their involvement in a North Carolina-based Ponzi and pyramid scheme that the agency shut down last year.

The SEC alleged that Dawn Wright-Olivares and Daniel Olivares, who each now live in Arkansas, provided operational support, marketing, and computer expertise to sustain ZeekRewards.com, which offered and sold securities in the form of “premium subscriptions” and “VIP bids” for penny auctions.  While the website conveyed the impression that the significant payouts to investors meant the company was extremely profitable, the payouts actually bore no relation to the company’s net profits.  Approximately 98 percent of total revenues for ZeekRewards – and correspondingly the share of purported net profits paid to investors – were comprised of funds received from new investors rather than legitimate retail sales.

Wright-Olivares and Olivares agreed to settle the SEC’s charges.  In a parallel action, the U.S. Attorney’s Office for the Western District of North Carolina today announced criminal charges against the pair.

Pyramid schemes are a type of investment scam often pitched as a legitimate business opportunity in the form of multi-level marketing programs. According to the SEC’s complaint filed in federal court in Charlotte, N.C., the ZeekRewards scheme raised more than $850 million from approximately one million investors worldwide.

The SEC alleged that Wright-Olivares served as the chief operating officer for much of the existence of ZeekRewards.  Wright-Olivares helped develop the program and its key features, marketed it to investors, and managed some of its operations.  She also helped design and implement features that concealed the fraud.  Olivares managed the electronic operations that tracked all investments and managed payouts to investors.  Together, Wright-Olivares and Olivares helped perpetuate the illusion of a successful retail business.

The SEC’s complaint charged Wright-Olivares with violating the registration and antifraud provisions of Sections 5 and 17 of the Securities Act, and Section 10 of the Exchange Act and Rule 10b-5.  The complaint charged Olivares with violating Section 17 of the Securities Act and Section 10 of the Exchange Act and Rule 10b-5.  To settle the SEC’s charges, Wright-Olivares agreed to pay at least $8,184,064.94 and Olivares agreed to pay at least $3,272,934.58 – amounts that represent the entirety of their ill-gotten gains plus prejudgment interest.  Payments will be made as part of the parallel criminal proceeding in which additional financial penalties could be imposed in a restitution order.

On December 12, 2013, the SEC announced that it had charged Merrill Lynch with making faulty disclosures about collateral selection for two collateralized debt obligations (CDO) that it structured and marketed to investors, and maintaining inaccurate books and records for a third CDO.

Merrill Lynch agreed to pay $131.8 million to settle the SEC’s charges.

The SEC’s order instituting settled administrative proceedings found that Merrill Lynch failed to inform investors that hedge fund firm Magnetar Capital LLC had a third-party role and exercised significant influence over the selection of collateral for the CDOs entitled Octans  CDO Ltd. and Norma CDO Ltd.  Magnetar bought the equity in the CDOs and its interests were not necessarily aligned with those of other investors because it hedged its equity positions by shorting against the CDOs.

According to the SEC’s order, Merrill Lynch engaged in the misconduct in 2006 and 2007, when its CDO group was a leading arranger of structured product CDOs.  After four Merrill Lynch representatives met with a Magnetar representative in May 2006, an internal email explained the arrangement as “we pick mutually agreeable [collateral] managers to work with, Magnetar plays a significant role in the structure and composition of the portfolio … and in return [Magnetar] retain[s] the equity class and we distribute the debt.”  The email noted they agreed in principle to do a series of deals with largely synthetic collateral and a short list of collateral managers.  The equity piece of a CDO transaction is typically the hardest to sell and the greatest impediment to closing a CDO.  Magnetar’s willingness to buy the equity in a series of CDOs therefore gave the firm substantial leverage to influence portfolio composition.

The SEC’s order reflects that Magnetar had a contractual right to object to the inclusion of collateral in the Octans CDO selected by the supposedly independent collateral manager Harding Advisory LLC during the warehouse phase that preceded the closing of a CDO.  Merrill Lynch, Harding, and Magnetar had finalized a tri-party warehouse agreement that was sent to outside counsel, yet the disclosure that Merrill Lynch provided to investors incorrectly stated that the warehouse agreement was only between Merrill Lynch and Harding.  The SEC has also charged Harding and its owner with fraud for accommodating trades requested by Magnetar despite its interests not necessarily aligning with the debt investors.  

The SEC’s order found that one-third of the assets for the portfolio underlying the Norma CDO were acquired during the warehouse phase by Magnetar rather than by the designated collateral manager NIR Capital Management LLC.  NIR initially was unaware of Magnetar’s purchases, but eventually accepted them and allowed Magnetar to exercise approval rights over certain other assets for the Norma CDO.  The disclosure that Merrill Lynch provided to investors incorrectly stated that the collateral would consist of a portfolio selected by NIR.  Merrill Lynch also failed to disclose in marketing materials that the CDO gave Magnetar a $35.5 million discount on its equity investment and separately made a $4.5 million payment to the firm that was referred to as a “sourcing fee.”  On December 12, 2013, the SEC also announced charges against two managing partners of NIR.

According to the SEC’s order, Merrill Lynch violated books-and-records requirements in another CDO called Auriga CDO Ltd., which was managed by one of its affiliates.  As it did in the Octans and Norma CDO deals, Merrill Lynch agreed to pay Magnetar interest or returns accumulated on the warehoused assets of the Auriga CDO, a type of payment known as “carry.”  To benefit itself, however, Merrill Lynch improperly avoided recording many of the warehoused trades at the time they occurred, and delayed recording those trades.  Therefore, Merrill Lynch’s obligation to pay carry was delayed until after the pricing of the Auriga CDO when it became reasonably clear that the trades would be included in the portfolio.

Merrill Lynch consented to the entry of the order finding that it willfully violated Sections 17(a)(2) and (3) of the Securities Act of 1933 and Section 17(a)(1) of the Securities Exchange Act of 1934 and Rule 17a-3(a)(2).  The firm agreed to pay disgorgement of $56,286,000, prejudgment interest of $19,228,027, and a penalty of $56,286,000.  Without admitting or denying the SEC’s findings, Merrill Lynch agreed to a censure and is required to cease and desist from future violations of these sections of the Securities Act and Securities Exchange Act.

On December 3, 2013, the SEC announced that it had charged a Miami-based trader with insider trading in the stock of a Chinese company and conducting illegal short sales in the securities of three other companies.

The SEC alleged that Charles Raymond Langston III learned confidential information in advance of a public announcement that significantly decreased the value of AutoChina International’s stock.  Langston was solicited by placement agents to invest in a secondary offering of AutoChina stock.  Despite agreeing to keep information confidential and not trade on it, he promptly sold short 29,000 shares of AutoChina stock in advance of the company’s public announcement that it had completed the secondary offering.  To avoid detection, Langston made the trades through an entity he owned using a different broker and different account than he used to purchase shares in AutoChina’s initial offering.  Langston made $193,108 in illegal profits by trading on the inside information.

The SEC’s complaint filed in federal court in Miami further alleged that Langston and two of his companies, Guarantee Reinsurance and CRL Management, violated Rule 105 of Regulation M, which prohibits the short sale of an equity security during a restricted period – generally five business days before a public offering – and the purchase of that same security through the offering.  The rule addresses illegal short selling that can reduce offering proceeds received by companies by artificially depressing the market price shortly before the company prices its public offering.  The SEC alleges that Langston through Guarantee Reinsurance and CRL Management made short sales in advance of separate secondary offerings by Wells Fargo, Mitsubishi UFJ Financial Group, and Alcoa.  He purchased shares in the same offerings.  Langston and his companies’ violations of Rule 105 resulted in unlawful gains of more than $1.3 million. 

According to the SEC’s announcement, Langston has agreed to settle the insider trading charges by paying disgorgement of $193,108, prejudgment interest of $22,204, and a penalty of $193,108.  Langston and the two companies also agreed to be enjoined for the short selling violations with monetary sanctions to be determined by the court at a later date.  Langston neither admits nor denies the allegations that he violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 as well as Rule 105 of Regulation M of the Exchange Act.

On November 20, 2013, the SEC announced charges against two Tampa-area investment advisers accused of committing fraud by failing to truthfully inform clients about compensation received from offshore funds they were recommending as safe investments despite substantial risks and red flags.  The advisers are also charged with contributing to violations of the “custody rule,” which requires investment advisory firms to establish specific procedures to safeguard and account for client assets. 

The SEC’s Enforcement Division alleged that Gregory J. Adams and Larry C. Grossman solicited and directed clients of their investment firm Sovereign International Asset Management to invest almost exclusively in funds controlled by an asset manager named Nikolai Battoo, who the SEC charged in a separate enforcement action last year.  Grossman and Adams failed to inform clients about the conflict of interest in recommending these investments as Battoo was paying them millions of dollars in compensation for steering investors to his funds. 

According to the SEC’s order instituting administrative proceedings, Grossman was paid approximately $3.3 million and Adams received $1 million in the undisclosed compensation arrangements.  Grossman and Adams promoted the investments as safe, diversified, independently administered and audited, and suitable for the investment objectives and risk profiles of their clients who were often retirees.  However, Battoo’s funds were in fact risky, lacked diversification, and lacked independent administrators and auditors.  Grossman and Adams also failed to investigate – and in some cases wholly disregarded – numerous red flags surrounding Battoo and his funds. 

The SEC’s Enforcement Division alleged that Grossman and Adams aided and abetted Sovereign’s violations of the custody rule when they instructed clients to transfer their investment funds to a bank account controlled by a related entity.  Grossman and Adams pooled clients’ money in this bank account before investing it in Battoo’s offshore funds.  Sovereign failed to comply with the custody rule, which requires an investment adviser to comply with surprise examinations or certain other procedures to verify and safeguard client assets.

According to the SEC’s order, Grossman and Adams willfully violated Section 17(a)(2) of the Securities Act of 1933, Section 15(a) of the Securities Exchange Act of 1934, and Sections 206(1), 206(2), 206(3) and 207 of the Investment Advisers Act of 1940.  They willfully aided and abetted violations of Section 15(a) of the Exchange Act and Section 206(4) of the Advisers Act and Rules 204-3 and 206(4)-2. 

On October 29, 2013, an Administrative Law Judge dismissed proceedings against two UBS employees against whom the SEC brought Cease-and-Desist Proceedings.  The SEC’s claims were based upon alleged federal securities law violations in connection with closed-end funds created and marketed by UBS.  All of the closed-end funds invested in Puerto Rico municipal debt.  Ironically, the 13 day hearing and post-hearing briefing ended March 15, 2013, five months before the collapse of the closed-end funds that were at issue in the case.  Between August and September 2013, these closed-end funds collapsed, realizing the fears that formed the basis of the SEC’s contentions.  Fortunately for UBS’s clients, the Administrative Law Judge’s opinion left a valuable breadcrumb trail detailing the material information that UBS failed to disclose to its clients, and at times, its own employees.  Equally important is that the breadcrumb trail reveals some information that was available to UBS employees, which information should have been passed on to firm clients. 

The UBS Puerto Rico Closed End Funds were, effectively, hot potatoes.  For those unlucky enough to still be holding the hot potatoes in August and September 2013, they at least have FINRA arbitration as an available tool to help them recover their losses. 

On October 2, 2013, the SEC announced that it had sanctioned an Omaha, Nebraska based investment advisory firm and its owner for failing to seek the most beneficial terms reasonably available when investing in mutual fund shares for three funds that they managed. 

An SEC investigation found that Manarin Investment Counsel Ltd. and Roland R. Manarin violated their obligation to seek what is known as “best execution” by consistently selecting higher cost mutual fund shares for the three fund clients even though cheaper shares in the same mutual funds were available.  As a result, the clients paid avoidable fees on their mutual fund holdings, which were passed through to a brokerage firm owned by Manarin in a practice inconsistent with the disclosures they made to investors.  The brokerage firm is also charged with violations.

Manarin and his firms agreed to pay more than $1 million to settle the charges.

According to the SEC’s order instituting settled administrative proceedings, Manarin Investment Counsel provided investment advice to a mutual fund called Lifetime Achievement Fund (LAF) as well as two private funds known as Pyramid I Limited Partnership and Pyramid II Limited Partnership.  As “funds-of-funds” they invested their assets principally in the shares of various mutual funds. 

The SEC’s order found that from 2000 to 2010, Manarin and his investment advisory firm caused these fund clients to invest in “Class A” mutual fund shares when they were eligible to own lower-cost “institutional” shares in the same mutual funds.  Because they owned “Class A” shares, the clients paid ongoing 12b-1 fees on their mutual fund holdings for distribution and shareholder services.  Such fees often could have been avoided had Manarin and his firm purchased institutional shares on the clients’ behalf.  Instead, the unnecessary fees were passed through to Manarin’s broker-dealer Manarin Securities Corp.  Although Manarin’s brokerage firm eventually refunded 12b-1 fees paid by LAF, it did not refund fees to the Pyramid funds.  From June 2000 to October 2010, Manarin Securities Corp. received approximately $685,000 in 12b-1 fees from mutual funds in which the Pyramid funds could have purchased institutional shares.

According to the SEC, by failing to seek best execution when selecting among available mutual fund share classes, Manarin and his investment advisory firm violated their fiduciary duty as investment advisers under Section 206(2) of the Investment Advisers Act of 1940.  Because their ongoing practice was inconsistent with disclosures in LAF’s registration statement and the offering memoranda for the two Pyramid funds, the order finds that Manarin and his investment advisory firm violated Section 206(4) of the Advisers Act and Rule 206(4)-8.  The SEC’s order also finds that Manarin violated Section 34(b) of the Investment Company Act of 1940, and that he and both firms violated Section 17(a)(2) of the Securities Act of 1933.  The SEC’s order further finds that Manarin’s brokerage firm charged commissions to LAF that exceeded the usual and customary amounts charged by broker-dealers for transactions in shares of exchange-traded funds – in violation of Section 17(e)(2)(A) of the Investment Company Act. 

Manarin and his brokerage firm agreed to pay disgorgement of $685,006.90 and prejudgment interest of $267,741.72.  Manarin agreed to pay a $100,000 penalty.  Without admitting or denying the SEC’s findings, Manarin and his firms also consented to censures and cease-and-desist orders.