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Recent SEC Releases

Bank Seeks Mistrial in Rothstein Case

The first jury trial seeking to hold a financial institution liable for its complicity in Scott Rothstein's $1.4 billion Ponzi scheme faces uncertainty after the institution filed a motion seeking a mistrial following testimony of a key witness.  TD Bank, being sued by Texas investment partnership Coquina Investments, filed the motion after verbally making the motion following questioning of its former Vice President, Frank Spinosa, concerning his relationship with Rothstein.  Under the threat of possible pending criminal charges, Spinosa declined to answer the majority of the questions posed by Coquina's attorney and took the Fifth amendment.  

The Fifth Amendment applies to both criminal and civil proceedings, and is available to a witness who may have reasonable apprehension from providing a direct answer that may subject him or her to future criminal prosecution.  As eloquently stated by the Supreme Court in 1924,

The privilege is not ordinarily dependent upon the nature of the proceeding in which the testimony is sought or is to be used. It applies alike to civil and criminal proceedings, wherever the answer might tend to subject to criminal responsibility him who gives it. The privilege protects a mere witness as fully as it does one who is also a party defendant.  

McCarthy v. Arndstein, 266 U.S. 34, 40 (1924).  While it is well-established in American jurisprudence that a judge may not allow a jury to make an adverse inference concerning a defendant's decision to not testify in his case, the result is different when a defendant chooses to testify but declines to answer based on the Fifth Amendment.  As the Supreme Court stated in Baxter v. Palmigiano

 [T]he Fifth Amendment does not forbid adverse inferences against parties to civil actions when they refuse to testify in response to probative evidence offered against them: the Amendment ‘‘does not preclude the inference where the privilege is claimed by a party to a civil cause.’’

425 U.S. 308, 317 (1976).  

During the questioning, Spinosa took the Fifth amendment to more than 170 questions over a morning of testimony.  These questions included whether Spinosa flew on a plane with Rothstein to a Super Bowl or whether Spinosa accepted an envelope from Rothstein containing $50,000.  Following the questioning, United States District Judge Marcia Cooke granted a request by Coquina to allow the jury to draw an adverse inference from Spinosa's decision not to testify for fear of criminal prosecution.  Judge Cooke ruled that Coquina could propose an instruction to the jury to be considered during their deliberation that "[y]ou can infer that the answers would have been adverse to TD Bank's interest."  

While TD Bank's attorneys seem to acknowledge that an adverse inference may be taken from Spinosa's decision to plead the Fifth, they take exception with Judge Cooke's apparent wording that seemed to acknowledge that liability could be inferred.


SEC Disciplines Eight Employees Over Failure to Detect Madoff Fraud

The Securities and Exchange Commission disclosed that it had disciplined eight employees in connection with their failure to detect the massive Ponzi scheme orchestrated by Bernard Madoff.  The employees received various forms of punishment over the past year that was made public by a Washington Post article that had obtained documents detailing the sanctions through a Freedom of Information Act.  The SEC had received strong criticism following widespread views that the agency had not done enough to uncover the fraud at an earlier time.  The most vocal of these proponents was Harry Markopolos, an independent financial fraud investigator who made repeated reports to the SEC claiming that Madoff was operating a Ponzi scheme.  These claims went largely unheeded, aided by an inter-office communication system that effectively impeded the flow of information between various SEC branch offices.  The sanctions meted out by the SEC over the past year ranged from "counseling memos" to a 30-day suspension.  No employee was ultimately terminated as a result of the investigation.

Following the discovery of Madoff's fraud, the SEC's internal watchdog carried out an investigation that culminated in a 456-page report concluding that the SEC had ample information to carry out a thorough and comprehensive investigation that would have uncovered Madoff's fraud years before Madoff confessed to his sons in December 2008.  Specifically, the report concluded that the SEC had adequate information to conduct an investigation as far back as 1992 - 16 years before the fraud was ultimately unraveled. Between 1992 and 2008, according to the report, the SEC received

 received six substantive complaints that raised significant red flags concerning Madof f s hedge fund operations and should have led to questions about whether Madoff actually engaged in trading.

While the SEC ultimately conducted two investigations and three examinations of Madoff's operations, the report notes that Madoff's trading was never verified through an independent third-party.  Additionally, while the SEC requested records from the Depository Trust Company that would have demonstrated the fact that Madoff was not doing the trading he advertised, it was Madoff himself who provided these records to the SEC - not the DTC. In New York Times writer Diana Henriques' book on the subject, Madoff himself noted several times that he was sure that the SEC had detected his scheme through their investigation.  However, Madoff's stature and long tenure in the investment community likely acted as a deterrent to any concerted effort by SEC employees - many of whom had neither the experience or acumen of Madoff.  

After the internal watchdog's report was filed, the SEC hired an outside Washington law firm to recommend disciplinary action against any employees associated with Madoff's fraud.  By law, the SEC is prohibited from disciplining former employees, and the decision to terminate any employee must come directly from the agency's human resource director.  The law firm's investigation ultimately recommended the termination of one employee unless that would have an adverse effect on the agency's work.  That employee was ultimately suspended for thirty days without pay, demoted, and had their pay decreased.  One other employee received a 30-day suspension, with other punishments ranging from a seven-day suspension to pay reductions.

A copy of the Report of Investigation conducted by the Office of Inspector General is here.


Texas Company Charged in $5.5 Million Forex Ponzi Scheme

A Texas company and its two officers were charged by the Commodity Futures Trading Commission ("CFTC") with operating a foreign currency Ponzi scheme that promised returns exceeding 200% annually and allegedly took in more than $5 million from investors. GID Group, Inc. ("GID") and its agent and officers, Rodney Wagner and Roger Wagner (the "Wagners"), both of Grand Prairie, Texas, were charged with multiple violations of the Commodities Exchange Act.

According to the CFTC Complaint, the scheme began in February 2010, when GID and the Wagners solicited victims to participate in a commodities trading system that promised annual returns exceeding two hundred percent.  Investors were told that their funds would be used to trade off-exchange forex contracts on a leveraged or margined basis.  Many of these investors were members of the Wagners' church congregation and their families and friends.  Investors were required to invest a minimum of $10,000 which would then be locked into GID's trading system for a specified amount of time, usually less than a year.  GID and the Wagners provided investors with a schedule of weekly returns.  However, according to the CFTC, GID never maintained a forex trading account with any forex trading firm.  The Wagners maintained joint forex trading accounts in which they deposited nearly $600,000 in investor funds and which sustained losses of at $440,000.  The majority of funds, $4.5 million, were paid back as weekly returns to investors, along with additional funds that were misappropriated by the Wagners.  

The CFTC is seeking relief including permanent injunctions banning association in commodities trading, disgorgement of ill-gotten gains, restitution, rescission of commodities contracts, and civil monetary penalties.

A copy of the complaint filed by the CFTC is here.

SEC Files Enforcement Action Against Feeder Fund of Petters Ponzi Scheme

The Securities and Exchange Commission ("SEC") filed civil charges against a Minnesota hedge fund and two employees, alleging that they facilitated the $3.65 billion Ponzi scheme orchestrated by Thomas Petters by funneling $600 million in customer funds and subsequently attempting to cover up problems that later resulted in the scheme's unraveling.  Petters' scheme was one of the largest in history and later landed him a fifty-year sentence in federal prison. The SEC charged Arrowhead Capital Management LLC ("Arrowhead"), along with founder James N. Fry ("Fry") and director Michelle W. Palm ("Palm") (collectively, "Defendants") with numerous violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.  Fry and Palm also face charges of aiding and abetting violations of the Investment Advisers Act of 1940.

According to the complaint, Arrowhead sold interests in three Arrowhead-branded hedge funds (the "Funds") from 1998 through 2008 through the use of confidential private placement memoranda and pitch books.  These documents included false representations that Arrowhead was registered with the SEC as an investment adviser, when in fact its registration had been terminated in 1997.  In the course of selling interests in the Funds, the Defendants made numerous misrepresentations to investors, including material facts about the security of their interests. Additionally, as the scheme began to encounter financial stress, the Defendants concealed Petters' inability to make payments on some notes, even going so far as to extend the maturity date of the notes to hide the default risk.  In total, over $600 million was raised through the Fund offerings, and nearly all investor contributions were then invested in the scheme.  During that same period, the Defendants earned more than $42 million in fees.

The SEC is seeking relief against the Defendants including the entry of a permanent injunction, disgorgement of ill-gotten gains, pre-judgment interest, and civil monetary penalties.  Earlier this year, Palm pled guilty to one count of securities fraud and one count of providing false statements to a government agent. 

A copy of the SEC Complaint is here.



Madoff Trustee Files Amended Complaint Seeking $226 Million From Madoff Family Members

The court-appointed trustee overseeing the unraveling of Bernard Madoff's massive Ponzi scheme has filed an amended complaint in which he is seeking the return of $226.4 million from several Madoff family members including Madoff's brother, sons, and niece (the "Madoff Defendants").  Picard had originally filed suit against the Madoff Defendants in October 2009, seeking nearly $200 million.  

Each of the Madoff Defendants held senior management positions at Madoff's investment firm, Bernard L. Madoff Investment Securities ("BLMIS"), including:

  • Peter Madoff - Chief Compliance Officer     
  • Mark Madoff (now deceased) - Co-Director of Trading at BLMIS
  • Andrew H. Madoff - Co-Director of Trading at BLMIS
  • Shana D. Madoff - Compliance Counsel, in- house Counsel, and Compliance Director of BLMIS 

Through these positions, each of the Madoff Defendants was tasked with compliance and supervisory responsibilities that Picard alleges should have alerted them to Madoff's fraudulent scheme.  This included BLMIS's filing for Investment Adviser Registration with the SEC in 2006, when the number of represented accounts and assets under management contrasted greatly with Madoff's customer list and paper holdings.  

Each of the Madoff Defendants received tens of millions of dollars in transfers from Madoff, and also maintained investment accounts in which they withdrew amounts far in excess of their invested principal, making them "net winners" under Picard's terminology.  Picard draws particular attention to Peter Madoff's investment account with BLMIS, alleging that while Peter invested only $32,146 - and only fourteen dollars after December 1995 - he made withdrawals exceeding $16 million.  As an example, Picard  points to the alleged purchase of Microsoft stock in Peter's account in December 2000 that was subsequently sold in January 2002 for $15.4 million - despite previously having no money or securities invested in that particular account.  Other Madoff Defendants experienced similar anomalies and astronomical returns in their investment accounts, which according to Picard  should have alerted them that the activities were the product of fraud and deception.

In total, Picard is trying to recover $77 million from Peter Madoff, $71.9 million from the estate of Mark Madoff, $64.7 million from Andrew Madoff,  and $12.7 million from Shana Madoff,.  

A copy of the complaint filed against the Madoff Defendants is here.