It’s a little depressing that there are so many Ponzi schemes to report. The bright spot I suppose is that the Securities and Exchange Commission is on the case. This week the SEC charged Moises Pacheco, Advanced Money Management, Inc. (AMM), and Business Development & Consulting Co. (BD&C) with fraudulently raising $14.7 million from more than 200 investors over a 3½-year period.

According to the SEC’s complaint, Pacheco told investors that he had developed a lucrative investment strategy involving the purchase and sale of covered call options, and that the hedge funds exclusively relied upon this strategy to generate trading profits ranging from 30 percent to 48 percent per year. In reality, Pacheco did not generate the returns he claimed to have made, and instead used investor principal to pay purported returns until the scheme collapsed.

“Pacheco disseminated monthly statements reflecting purported profits and trading activity, but providing little detail about how those returns were generated,” said Rosalind Tyson, Director of the SEC’s Los Angeles Regional Office. “These investors were principally solicited through word-of-mouth, which serves as a reminder to beware of opaque investment opportunities that promise unusually high payoffs even if it’s a referral coming from family or friends.”

According to the SEC’s complaint, filed in U.S. District Court for the Southern District of California, the hedge funds generated trading profits of only about $367,000, but paid investors purported returns of more than $9.7 million. The SEC alleges that the defendants thus operated a Ponzi-like scheme and further misused investor principal by transferring their money to Pacheco, entities under his control, or numerous third parties for reasons having nothing to do with the purported trading.

The SEC alleges that Pacheco claimed that the hedge funds had generated returns ranging from 2.5 to 4 percent per month during their existence, and continued to claim that they generated returns in that range until January 2008, when he reduced the returns to 1.25 percent per month. Pacheco told fund investors that the reduction was due to deteriorating economic conditions. Most fund investors live in the Chula Vista area, and know either Pacheco, one of his friends or family members, or another investor. The SEC alleges that Pacheco made no effort to determine whether the hedge fund investors were accredited or sophisticated, and did not provide investors with financial statements. Neither Pacheco nor his entities were registered with the SEC.

The SEC’s complaint alleges that Pacheco, AMM, and BD&C violated the securities registration and antifraud provisions of the federal securities laws and seeks permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest and financial penalties. Additionally, the complaint names the hedge funds and various third parties receiving investor money as relief defendants, and seeks from them the disgorgement of all such amounts. The complaint also seeks the court’s appointment of a receiver over AMM and BD&C.

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The Securities and Exchange Commission this week charged two Oklahoma City residents with securities fraud and other violations related to misappropriating millions of dollars from Quest Resource Corporation, Quest Energy Partners, L.P. and their affiliates while they were executives at the company.

The SEC alleges that Jerry D. Cash and David E. Grose caused Quest to make a series of transfers to a separate company that Cash controlled. Cash tried to conceal the transfers by, among other things, ostensibly transferring the funds back to Quest at the end of each quarter. The progressively greater amounts taken from Quest over time are alleged to have been used to support Cash’s lavish lifestyle, including spending more than $5 million on his Oklahoma City mansion. Grose was complicit in Cash’s wrongdoing by, among other things, initiating wire transfers to Cash’s company and creating a false cover story to explain the transfers to Quest’s employees and auditors.

“Cash and Grose treated Quest like a personal piggy bank and then lied about their wrongdoing to the company’s investors and auditor,” said Rose Romero, Director of the SEC’s Fort Worth Regional Office.

The SEC alleges that the scheme, which began in June 2004, collapsed in August 2008 after other Quest executives discovered and began questioning the legitimacy of the transfers. By that time, Cash had misappropriated a total of $10 million from Quest. Cash subsequently resigned from Quest and Grose was terminated.

It took four years for anyone to start asking questions?

According to the SEC’s complaint, Grose took advantage of Quest’s lax internal controls to siphon more than $1.8 million from the company. From December 2005 through August 2008, one of Quest’s equipment vendors kicked back approximately $850,000 to Grose from equipment purchases that Quest had made. The SEC also contends that Grose used $1 million of Quest’s money to fund his personal investment in a small Oklahoma start-up company.

The SEC’s complaint states that none of these transactions were disclosed, despite Cash and Grose signing numerous filings and representation letters in which such related party transactions were required to be disclosed. The two also attested that there had been no fraud involving management.

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A new report from the Investor Environmental Health Network (IEHN) warns that billions of dollars in potential asbestos-like litigation risks for nanotechnology companies and investors are now hidden due to weak regulations governing disclosures of liabilities. According to the report, some of the nanotechnologies are now commonly found in sunscreen, cosmetics, food, clothing, sporting goods and packaging are showing signs of posing serious hazards to human health and the environment.

The good news for investors is that the U.S. Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) are now in the process of examining disclosure requirements and could remedy the eight securities and accounting loopholes identified in the report.

• Shortsightedness - Taking the short view and thereby effectively avoiding disclosure or estimation of potential longer term liabilities.
• Concealed Science - Concealing emerging science that forewarns of potential liabilities in the future.
• The Known Minimum - Disclosing only the “known minimum” of potential liabilities, even though a more realistic assessment might be so much larger that it would indicate the potential for a total wipe out of shareholder value.
• Privileging Secrecy - ”Privileging” concealment, by using attorney-client privileges as a shield against generating a public estimate of liability for investors.
• Inconsistent Estimates - Providing inconsistent liability estimates to insurers and investors, with larger estimates of liabilities typically provided to insurers than to investors.
• Hidden Assumptions - Using hidden assumptions to minimize estimates of liability.
• Missing Benchmarks - Refusing to benchmark liabilities against other companies whose published litigation results may demonstrate realistic estimates of liability.
• Risk-Free Proxies - Refusing to allow shareholders to place on the annual proxy ballot questions requesting disclosure of specific risks of concern to investors.

As the IEHN report notes:

“Together, the eight loopholes identified in this report allow companies to avoid estimation and disclosure of contingent liabilities. They reflect a pervasive ‘don’t ask/don’t tell’ approach which is no longer tolerable in a public policy environment where restoring investor confidence is the priority. Current regulatory reform efforts already underway at the SEC and FASB provide opportunities to close these loopholes …”

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Securities and Exchange Commission Mary Schapiro yesterday spoke out on executive compensation. She stated that while the role of the SEC is not to set or cap compensation, but to ensure that investors are able to make the best possible decision based on accurate and pertinent information about a company’s stock.

Because the methods and types of executive compensation have become diverse and complex, the SEC frequently revises disclosure requirements to reflect that compensation in the company’s financial statements. The SEC is currently new set of proxy disclosure rules to provide further insight into the effects of compensation decisions. While these proposals would not dictate particular compensation decisions, they would lead companies to analyze how compensation impacts risk taking and the implications for long term corporate health of the behavior they are incenting.

The new package includes disclosures about:

• how a company — and its board — manages risks
• a company’s overall compensation approach
  (Incentive structures that rewarded short term risk taking without taking into account the potential long term effects on the company are widely believed to have contributed to the economic crisis.)
• potential conflicts of interest by compensation consultants, including disclosure of relationships between the consultants and the company and their affiliates
• director nominees, including their experience and qualifications to serve on the board or on particular board committees

According to Shapiro this kind of information benefits investors, but only goes so far. Investors who don’t like what they learn can either sell their shares or use the proxy process to vote for change. However, shareholders who currently wish to nominate their own board candidates typically face an expensive proxy fight.

“It is for this reason that last month the SEC proposed rules that would enhance the ability of shareholders to exercise their legal rights to nominate directors on corporate boards. Of course, these proposals are just that — “proposals” — and we fully expect to receive many comments about them. I believe the meaningful ability of shareholders to nominate directors is intricately linked to the ability of shareholders to hold directors accountable for their compensation decisions.”

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The Securities and Exchange Commission last week announced the formation of an Investor Advisory Committee. The committee is intended to allow investors to have a greater impact on the Commission’s work. SEC Commissioner Luis A. Aguilar will serve as the Commission’s primary sponsor of the Committee. Chairman Mary Schapiro said:

“Through this well-respected and diverse group, we are reaching out to investors in a new and significant way. I look forward to hearing their views on new products, trading strategies, fee structures, and the effectiveness of disclosure, among other issues. Investors need a greater voice at the Commission. The Commission’s traditional role as the investor’s advocate, as well as our deliberations, will be enhanced by the range of views the Advisory Committee will provide.”

The Investor Advisory Committee has been created to do the following:

• Advise the Commission on matters of concern to investors in the securities markets.
• Provide the Commission with investors’ perspectives on current, non-enforcement, regulatory issues.
• Serve as a source of information and recommendations to the Commission regarding the Commission’s regulatory programs from the point of view of investors.

Members of the committee include representatives from AARP Financial Incorporated and AARP Funds, TIAA-CREF, the North American Securities Administrators Association, Nuveen Investments, Charles Schwab, Yale University’s Millstein Center for Corporate Governance, Consumer Federation of America, and the Individual Investors Advisory Board of the NYSE, among others.

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According to the Securities and Exchange Commission, George S. Canellos will become the new director the New York regional office, based in Manhattan. Canellos is a former federal prosecutor who will bring his prosecuting experience to the office that has become so crucial in light of the Wall Street meltdown.

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Canellos, a graduate of Harvard University and Columbia University School of Law, is expected to take a more aggressive approach toward Wall Street, as his background as a prosecutor would suggest. The SEC holds the major Wall Street firms accountable to responsible business practices, something that would need to be especially prevalent in these tough times.
 
Although he is currently working for the law firm Milbank, Tweed, Hadley & McCloy, Canellos has extensive experience in investigating major financial crimes, mostly having to do with fraud. As part of New York’s Southern District’s U.S. Attorney’s Office, Canellos was the chief of the major crimes unit.

The Securities and Exchange Commission Wednesday obtained an emergency court order to freeze the assets of Texas A&M finance professor Robert D. Watson. The accounts of Houston lawyer and CPA Daniel J. Petroski was also frozen, along with two firms. Watson and Petroski are charged with forging bank records to trick investors into believing they were earning excessively high returns in foreign exchange trading.

The Players & The Crime

Watson and Petroski are alleged to have raised over $19 million from investors using the following entities:

• Alpha One: This foreign-currency trading software program was purportedly owned by their firm.
• PrivateFX Global One Ltd.: Owned the Alpha One software.
• 36 Holdings Ltd.: This so-called “deal clearing company” was to service Private FX Global One Ltd. This company was owned and controlled by Watson.

The SEC alleges that Watson and Petroski told investors they had millions of dollars in bank accounts in the U.S. and Switzerland and that their foreign exchange trading business had achieved an annual return of more than 23 percent since its inception and has never had a losing month. The defendants’ historical performance claims are not supported by valid financial records.

“As we allege in our complaint, these defendants used modern technology to create professional-looking, bogus documents that supported their extraordinary claims,” said Rose Romero, Director of the SEC’s Fort Worth Regional Office.  

Phony Documents, Again

As we’ve seen time and time again, when asked for proof of returns, Watson and Petroski produced phony records purporting to show that 36 Holdings held an account at Deutsche Bank. The SEC also charges that the defendants provided the Commission staff with phony bank statements from a Swiss bank and falsely claimed that 36 Holdings had almost $70 million on deposit there, including $11 million of Global One funds.

I always wonder why smart people like this choose to go to such lengths to commit fraud. Wouldn’t it be easier to engage in a legal entrepreneurial venture?

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The Securities and Exchange Commission will conduct a public seminar on June 10, 2009, to help companies and preparers comply with new rules that require financial reports to be filed using interactive data (XBRL).

The seminar also will be web cast via the SEC Web site. It will cover the technology requirements for complying with the rules as well as provide an overview of the tools and information available from the SEC to help companies comply. The seminar will also cover frequently asked questions about the rules and technology requirements.

In adopting the final rule, the Commission noted that interactive data has the potential to:

• increase the speed of presenting information to stakeholders
• increase accuracy of financial information
• increase the usability of financial disclosure
• reduce costs (eventually)

This event will be held in the auditorium at the SEC’s headquarters at 100 F Street, N.E., in Washington, D.C. The seminar will be open to the public with seating on a first-come, first-served basis.

To ensure the seminar is responsive to the needs of companies and preparers, the Commission staff is seeking suggested questions and topics to be discussed at the seminar. Interested parties should email their questions to Ask-OID@sec.gov and include in the subject line “Public Education Seminar.”

XBRL and the End of Accounting

What’s XBRL? It’s the end of accounting. As we know it anyway. XBRL (eXtensible Business Reporting Language) is the emerging international electronic language for business and financial information. Over 450 corporations and government agencies have joined forces an international non-profit consortium to develop XBRL and promote its widespread use. Continue reading.

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The Securities and Exchange Commission this week charged employment search provider Monster Worldwide, Inc. with secretly backdating stock options granted to thousands of Monster officers, directors and employees. Monster agreed to pay a $2.5 million penalty to settle the charges.

The SEC charged that Monster defrauded investors by granting backdated, undisclosed ‘in-the-money’ stock options without recording the required non-cash charges for option-related compensation expenses.

“Monster misled investors by failing to report hundreds of millions of dollars of expenses. Backdating stock options made the company look like it had more money than it really did,” said James Clarkson, Acting Regional Director of the SEC’s New York Regional Office.

The SEC charged that Monster filed false financial statements resulting in a cumulative pre-tax overstatement over the period of 1997-2005 of approximately $339.5 million. Without admitting or denying the SEC’s allegations, Monster will pay a $2.5 million penalty and promise not to do it again. Monster staff fully cooperated with SEC staff during the course of the investigation and currently operates under new management.

The SEC previously charged four of Monster’s former executives including CEO Andrew McKelvey, President and COO, James Treacy, General Counsel, Myron Olesnyckyj, and Controller, Anthony Bonica, for their alleged roles in the backdating scheme at Monster.

Moral of the story: It’s okay to be a monster, so long as you’re not a pig about it.

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The Securities and Exchange Commission on May 8th charged West Palm Beach, Fla.-based INTECH Investment Management LLC and its former chief operating officer David E. Hurley with violating the SEC’s proxy voting rule. According to the SEC, INTECH did not sufficiently describe its proxy voting policies and procedures and failed to address a material potential conflict of interest.

What is the Proxy Voting Rule?

If you have any money invested in the stock market, you get vast amounts of those proxy votes in the mail. Do you vote them? Do you have the time to learn about what you’d be voting on, or do you leave it up to the experts to vote your proxy? Many investors do just that, which is why the SEC has rules about how those proxies are voted.

The proxy voting rule requires registered investment advisers to adopt proxy voting policies and describe them to clients, including procedures to address material conflicts of interest that may arise between the adviser and its clients. The rule is designed to ensure that advisers vote for clients’ best interests, and provide clients with information about how their proxies are voted. This is the first enforcement action taken by the SEC for a proxy voting rule violation.

INTECH Settles

In a settled administrative proceeding against INTECH and Hurley, the SEC’s order found that INTECH exercised voting authority over client securities without including in its policies and procedures how it would address material potential conflicts of interests.

“Investment advisers have enormous voting power, which can significantly affect the future value of corporate securities held by the adviser’s clients,” said Daniel M. Hawke, Director of the SEC’s Philadelphia Regional Office. “With this power comes the duty to cast proxy votes in a manner consistent with the best interests of the adviser’s clients and not to subrogate clients’ interests to its own.”

INTECH and Hurley consented to the issuance of a Commission order without admitting or denying any of the findings. INTECH agreed to pay a penalty of $300,000 and Hurley agreed to pay a $50,000 penalty.

According to the Commission’s order, INTECH managed institutional portfolios for pension plans, foundations, unions, public funds and public corporations. As part of its investment advisory services, INTECH exercised voting authority over many of its clients’ securities or proxies. In connection with the proxy voting rule, which became effective March 10, 2003, INTECH adopted and implemented written proxy voting policies and procedures and provided them to its clients. Hurley reviewed and edited counsel’s drafts of those policies and procedures.

The SEC’s order finds that after receiving complaints from some of its union-affiliated clients about pro-management proxy votes, INTECH selected a third-party proxy voting service provider’s guidelines to vote in accordance with AFL-CIO-based proxy voting recommendations for all clients’ securities. INTECH selected the guidelines that followed the AFL-CIO proxy voting recommendations at a time when it was participating in the annual AFL-CIO Key Votes Survey that ranked investment advisers based on their adherence to the AFL-CIO recommendations on certain votes.

Source: SEC press release

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