A Compilation of Enforcement and Non-Enforcement Actions

16 July 2008 Publication
Authors: Terry D. Nelson

Legal News: Investment Management Update

Non-Enforcement Matters

SEC Chairman Outlines SEC Proposed Actions for Remainder of Summer
In his address to the Chartered Financial Analyst (CFA) Institute Conference on Next Generation Asset Management, Chairman Christopher Cox briefly discussed actions the U.S. Securities and Exchange Commission (SEC) has taken so far this year in regard to investment advisers, and what the SEC seeks to address before the end of the summer. See “Disclosure from the User’s Perspective,” Chairman Christopher Cox, June 12, 2008.

As part of his speech, Chairman Cox highlighted several investment adviser-related issues the SEC has addressed or will consider by the end of the summer. Cox highlighted the March 2008 proposal to require investment advisers to provide prospective and current clients with a brochure, written in layman’s terms, to provide an up-to-date, clear summary of the investment adviser’s background, business practices, conflicts of interest, and soft-dollar practices. If the proposal is adopted, these brochures would be filed electronically with the SEC, then made publicly available on the SEC Web site.

Chairman Cox also highlighted several areas the SEC will be considering by the end of summer. The SEC will consider adoption of a final principal trading rule for investment advisers. The SEC also will consider new interpretive guidance for investment advisers. Finally, the SEC will consider final amendments to Regulation SHO which governs short selling.

Enforcement Matters

SEC Announces Issuance of Order Instituting Administrative Cease-and-Desist Proceedings in Market Timing Matter
The SEC issued an order against Michael K. Brugman for alleged payments received in connection with market timing transactions. See In the Matter of Michael K. Brugman, SEC Release Nos. 57947; IA-2743; IC-28299; Admin. Proc. File No. 3-13063.

According to the SEC order, Mr. Brugman, then a securities salesman for Invesco Funds Group, Inc. (IFG), accepted personal payments in excess of $3 million for his alleged involvement in obtaining market timing capacity within Invesco funds. Mr. Brugman allegedly did not disclose these payments to IFG despite the fact that he had the duty to do so as IFG’s agent and fiduciary, in addition to a written agreement with IFG to disclose such payments.

In response to these actions, the SEC issued an Order Instituting Administrative Cease-and-Desist Proceedings pursuant to Sections 15(b) and 21C of the Securities Exchange Act, Section 203(f) of the Investment Advisers Act, and Section 9(b) of the Investment Company Act. The order alleges that Mr. Brugman willfully violated Section 10(b) of the Securities Exchange Act, and Rule 10b-5. The matter is set for a hearing before an administrative law judge.

SEC Issues Order Against Unregistered Hedge Fund Adviser for Short Selling Securities During Restricted Time Period
On June 12, 2008, the SEC issued an Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order against DKR Oasis Management Company, L.P. (DKR Oasis). See In the Matter of DKR Oasis Management Company, L.P., Release Nos. 57961, IA-2744, File No. 3-13067.

According to the SEC order, DKR Oasis is an unregistered investment adviser to five hedge funds. After market close on May 10, 2005, Saytam Computer Services, Ltd. American Depository Shares (ADSs) were offered on a follow-on basis at $21.50 per ADS. The day before, DKR Oasis, acting on behalf of a hedge fund it advises, sold 100,000 ADSs short at $23.35. On May 11, 2005, DKR Oasis used 100,000 of the offering ADSs to cover its short position, thus profiting $185,000 on the sale. These transactions took place during the five-business-day time period restricted by Rule 205 of Regulation M.

In response to this violation, DKR Oasis has submitted, and the SEC has determined to accept, an offer of settlement. DKR Oasis must cease and desist from committing or causing any violations or future violations of Rule 105 of Regulation M, DKR Oasis is censured, and DKR Oasis is ordered to pay disgorgement of $185,000, prejudgment interest of $37,413.06, and a civil money penalty of $60,000.

SEC Charges Two Former Investment Adviser Executives With Orchestrating Fraud
The SEC charged Eric A. Bloom and Charles K. Mosley, former executives of Sentinel Management Group, Inc. (Sentinel), for their roles in alleged fraudulent activity costing investors hundreds of millions of dollars. See SEC v. Sentinel Management Group, Inc., Eric A. Bloom, and Charles K. Mosley, Civil Action No. 1:07-CV-4684 (N.D. Ill.)

According to the SEC, Sentinel was a registered investment adviser that managed short-term cash investment portfolios for various advisory clients such as FCM’s, hedge funds, financial institutions, pension funds, and individual investors. Mr. Bloom and Mr. Mosley, former executives of Sentinel, allegedly engaged in fraudulent activity from 2003 until August 2007 when Sentinel went bankrupt.

According to the SEC, Mr. Bloom and Mr. Mosley engaged, without disclosure, in an investment strategy that relied heavily on leverage and repurchase transactions, thus causing Sentinel to expose its clients to substantial, undisclosed risks. Mr. Bloom and Mr. Mosley also inappropriately used client portfolio assets to finance high-risk leveraged trading to benefit the Sentinel House portfolio owned by Sentinel insiders. This misuse of client funds resulted in the house portfolio posting annualized gains in excess of 100 percent. Finally, Mr. Bloom and Mr. Mosley misused client portfolio assets to collateralize a bank line of credit to Sentinel, subjecting clients’ funds to securitization and sale if Sentinel defaulted on its loan.

The SEC is seeking a permanent injunction against Mr. Bloom and Mr. Mosley in addition to disgorgement, prejudgment interest, and civil penalties against both defendants..

SEC Sanctions Representative of Unregistered Advisory Firm for Unauthorized Trades
The SEC sanctioned Joshua M. Eudowe, an employee of an unregistered advisory firm, for his involvement in unauthorized trading in client accounts. See In the Matter of Joshua M. Eudowe, June 26, 2008, Release Nos. 58031, IA-2748, File No. 3-13083.

According to the SEC, Mr. Eudowe was employed by Lawrence Goldstein, a registered representative and principal of unregistered advisory firms that manage investment partnerships. Mr. Eudowe represented himself to Mr. Goldstein’s clients as a managing director of the advisory firms, but in reality was involved with research and marketing, and is not a registered representative.

Mr. Eudowe allegedly made unauthorized purchases of two low-volume stocks, FRMO Corp. and CreditRiskMonitor.com, Inc. He placed market orders to purchase several thousand shares of these thinly traded stocks in Mr. Goldstein’s client accounts by using Mr. Goldstein’s password without his knowledge or consent. These unauthorized purchases caused the prices of the shares to rise above the 52-week high. Mr. Eudowe subsequently sold thousands of shares in these stocks from his personal account at these inflated prices, thus profiting greatly from his unauthorized trading in client accounts.

The SEC has barred Mr. Eudowe from association with any broker or dealer or investment adviser under Section 15(b)(6) of the Exchange Act and Section 203(f) of the Advisers Act.

SEC Charges Former Registered Investment Adviser With Fraud
The SEC charged Frederick J. Barton, TwinSpan Capital Management, LLC (TwinSpan), and Barton Asset Management, LLC (Barton Asset Management) with three separate securities frauds. See SEC v. Frederick J. Barton, Barton Asset Management, LLC, and TwinSpan Capital Management, LLC, June 3, 2008, Civil Action No. 1:08-CV-1917.

According to the SEC complaint, TwinSpan, an investment adviser, and Barton Asset Management are majority owned and operated by Mr. Barton. Mr. Barton acted through TwinSpan to engage in an offering fraud which cost investors $1.5 million. Mr. Barton told investors that proceeds from the offering would be invested in growing TwinSpan and paying business expenses. Mr. Barton used at least $493,100 for personal expenses and used a substantial portion of the proceeds in advance of reaching the minimum offering amount. Both of these uses were prohibited by TwinSpan’s offering materials.

In addition, Mr. Barton allegedly misappropriated $185,000 from a TwinSpan advisory client. Mr. Barton forged the client’s signature on wire transfer authorizations transferring the client’s TwinSpan assets into a Barton Asset Management bank account. Mr. Barton also acted through Barton Asset Management to misappropriate $970,000 from an elderly brokerage customer with Alzheimer’s disease. Mr. Barton convinced her to sell her securities held by Mr. Barton’s employer, and give him the proceeds to invest in local bank instruments or an advisory account at Barton Asset Management Over four years, Mr. Barton diminished the client’s $1.3 million account.

The SEC is seeking permanent injunctive relief, an accounting, and disgorgement of ill-gotten gains plus prejudgment interest and civil penalties.


Legal News: Investment Management Update is part of our ongoing commitment to providing up-to-the minute information about pressing concerns or industry issues affecting our clients and our colleagues.

If you have any questions about this issue or would like to discuss these topics further, please contact your Foley attorney or any of the following individuals:

Editors

Terry D. Nelson
Madison, Wisconsin
608.258.4215
tnelson@foley.com

Gregory F. Monday
Madison, Wisconsin
608.258.4211
gmonday@foley.com

Authors