Newkirk - PLUSweb

RECENT SEC ENFORCEMENT CASES*

Submitted by**: Thomas C. Newkirk Associate Director Susan A. Mathews Senior Counsel Division of Enforcement Securities and Exchange Commission Washington, DC

January 2003

*

Parts of this outline, written by present and former employees, have been used in other publications.

**

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the Commission or of the authors’ colleagues upon the staff of the Commission.

As our capital markets continue to experience unprecedented growth and expansion, the Securities and Exchange Commission’s (“Commission” or “SEC”) enforcement program has been challenged to keep apace of market developments. In the wake of recent restatements by major corporations, the Division of Enforcement (“Division”) continues to place emphasis on the detection and prosecution of financial fraud. Insider trading, broker-dealer sales practices, violations involving mutual funds and investment advisers, and fraudulent securities offerings continue to form the core of the enforcement program. In Fiscal Year 2001, the Division brought 484 enforcement actions. This Outline will review some of the Division’s significant recent activity. Copies of orders, administrative releases, and litigation releases concerning the cases discussed below can be accessed on the Commission’s web site at . I.

FINANCIAL FRAUD AND OTHER DISCLOSURE AND REPORTING VIOLATIONS

The Division’s number one priority continues to be aggressive prosecution of financial fraud and reporting cases. Actions involving false financial statements or false and misleading disclosures about matters affecting an issuer’s financial condition tend to be complex and generally demand a greater commitment of resources than other types of cases. Effective prosecution in this area is essential to preserving the integrity of the full disclosure system. 1.

SEC v. Safety-Kleen Corp., Kenneth W. Winger, Paul R. Humphreys, William D. Ridings, and Thomas W. Ritter, Jr., Lit. Release No. 17891, Accounting and Auditing Enforcement Release No. 1690 (December 12, 2002), www.sec.gov/litigation/litreleases/lr17891.htm.

The SEC filed a complaint in the United States District Court for the Southern District of New York charging Safety-Kleen Corp. and four of its former senior executives with perpetrating a massive accounting fraud from at least November 1998 through March 2000. The Commission alleged that these individuals materially overstated the company's revenue and earnings in periodic reports filed with the Commission and in press releases issued by the company. According to the complaint, the defendants carried out the scheme primarily by making inappropriate quarterly accounting adjustments for the purpose of meeting Wall Street pro forma earnings expectations. They are also charged with fraudulently recording approximately $38 million of cash that was generated by entering into speculative derivatives transactions. The complaint alleges that the fraudulent scheme was orchestrated by Paul R. Humphreys, the former Chief Financial Officer. William D. Ridings, the former Controller, and Thomas W. Ritter, Jr., the former Vice President of Accounting, assisted Humphreys. As set forth in the complaint, these executives engaged in the illegal conduct to create the illusion that predicted cost savings and business synergies from two large acquisitions were being achieved. In fact, the expected savings had not materialized, the company's business was declining rapidly, and the company was facing a severe cash flow problem. To make up for the earnings shortfall, Humphreys, Ridings and Ritter recorded, or directed others to record, numerous adjustments that were not in conformity with generally accepted accounting principles. 2

After the fraudulent scheme was discovered in late February 2000, the company began an internal investigation, which was conducted by a special committee of the Board of Directors. On July 9, 2001, Safety-Kleen filed restated financial statements for fiscal years 1997, 1998 and 1999. The company's restatement reduced net income over the three-year period by $534 million. Approximately $312 million, or 58%, of the restated net income was in fiscal 1999. Also on July 9, 2001, the company filed financial statements for fiscal year 2000 reflecting a net loss of $833 million. According to the complaint, through this conduct, (i) Safety-Kleen violated the antifraud, periodic reporting, record keeping, and internal controls provisions of the federal securities laws, (ii) Winger violated the antifraud and periodic reporting provisions, and (iii) Humphreys, Ridings and Ritter violated the antifraud provisions and record keeping provisions. Humphreys and Ridings also violated the internal controls provisions of the federal securities laws. As relief, the Commission is seeking permanent injunctions, disgorgement of defendants' ill-gotten gains, prejudgment interest, and the imposition of civil penalties against Winger, Humphreys, Ridings and Ritter. The Commission is also seeking officer and director bars against Winger, Humphreys and Ridings. The United States Attorney's Office for the Southern District of New York has filed related criminal charges against Humphreys and Ridings. Ridings has entered a guilty plea and is waiting to be sentenced. Ridings also consented, without admitting or denying the allegations in the Commission's complaint, to the entry of a final judgment permanently enjoining him from violating the antifraud and record keeping provisions of the federal securities laws. He also agreed to be permanently barred from serving as an officer or director of a public company and to pay $28,476.14 of disgorgement and prejudgment interest. Simultaneous with the filing of the complaint, and without admitting or denying the Commission's allegations, Safety-Kleen consented to the entry of a final judgment permanently enjoining it from violating the antifraud, periodic reporting, record keeping, and internal controls provisions of the federal securities laws. Ritter consented, without admitting or denying the allegations in the complaint, to the entry of a final judgment permanently enjoining him from violating the antifraud and record keeping provisions of the federal securities laws. A civil penalty was not imposed against Ritter, and disgorgement and prejudgment interest were waived, based on his sworn statement of financial condition. In a related matter, the Commission instituted a settled cease-and-desist proceeding against Susan Moore, Safety-Kleen's former financial reporting manager. Moore consented to the entry of the order instituting proceedings without admitting or denying the findings therein, including findings that, as directed by her superiors, she participated in the preparation of financial statements that, in the exercise of reasonable care, she should have known were not in conformity with generally accepted accounting principles. Moore was ordered to cease and desist from causing violations and any future violations of the periodic reporting and record keeping provisions of the federal securities laws.

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2.

SEC v. 800 America.com, Inc., et al., Lit. Release No. 17863; AAE Release No. 1674 (Nov. 25, 2002), www.sec.gov/litigation/litreleases/lr17863.htm.

On November 21, 2002, Judge John S. Martin of the United States District Court for the Southern District of New York granted the Commission's application for preliminary relief pending the final determination of the Commission's case against 800 America.com, Inc. ("800America"), an Overthe-Counter Bulletin Board company and purported internet retailer; David Elie Rabi ("Rabi"), chief executive officer, chief financial officer, and a director of 800America; and Tillie Ruth Steeples ("Steeples"), an undisclosed control person of 800America. The Commission alleged that the defendants falsified financial results for 800America since at least 2000, unlawfully sold unregistered stock through nominee accounts, failed to disclose the criminal histories of Rabi and Steeples, and made other misrepresentations. Specifically, the court's order provides that, pending the final determination of the case: (a) the defendants are preliminarily enjoined from violating antifraud, registration, books and records, and other provisions of the federal securities laws; (b) defendants' assets and certain nominee brokerage accounts are frozen; (c) the defendants are required to submit accountings; (d) a temporary receiver has been appointed over 800America; (e) Rabi and Steeples are enjoined from acting as officers or directors of public companies and from participating in the offering of penny stocks; (f) the defendants must repatriate assets held abroad; (g) the defendants are prohibited from destroying documents and other evidence; and (h) the defendants are prohibited from tampering with witnesses, suborning perjury or otherwise impeding this case. The complaint charges violations of registration, antifraud, periodic reporting, record keeping, and internal controls provisions of the federal securities laws thereunder. As final relief, the Commission seeks permanent injunctions, disgorgement of all ill-gotten gains plus prejudgment interest; civil penalties; and, against Rabi and Steeples, final penny stock and officer and director bars and a forfeiture of stock under their control. The litigation is pending. See also SEC v. 800 America.com, Inc., et al., Lit. Release No. 17835; AAE Release No. 1674 (Nov. 13, 2002), www.sec.gov/litigation/litreleases/lr17835.htm. (filing for emergency relief) 3.

SEC v. Phillip E. White, Lit. Release No. 17855, AAE Release No. 1671 (Nov. 21, 2002), www.sec.gov/litigation/litreleases/lr17855.htm.

On November 21, 2002, the Securities and Exchange Commission ("Commission") filed a civil action in the United States District Court for the Northern District of California against Phillip E. White ("White"), formerly President, Chief Executive Officer, and Chairman of the Board of Directors of Informix Corporation ("Informix" or "Company"). (Informix was a multinational database software and information asset management company whose stock was traded on Nasdaq National Market System. On July 2, 2001, after selling its database software subsidiary, Informix was renamed Ascential Software Corporation.) In its Complaint, the Commission alleges that White concealed secret side agreements that rendered revenue recognition improper on certain transactions that Informix had included in its financial statements for its fiscal year ended December 31, 1996. To further his scheme, White made false statements and representations concerning the existence of these secret side agreements to members of Informix's financial staff and to Informix's independent auditors. White did 4

this to avoid triggering a restatement of Informix's 1996 financial statements. Informix's 1996 financial statements, and the independent auditors' unqualified report thereon, were included in Informix's 1996 Annual Report, Securities and Exchange Commission Form 10-K ("Form 10-K"), which Informix had filed with the Commission on March 31, 1997. The same financial statements and unqualified audit report were incorporated by reference in Form S-8 registration statements ("Form S-8"), which Informix filed on July 16, 1997. (The Forms S-8 registered twelve million shares of Informix stock for sale to employees.) White signed the Form 10-K and Forms S-8. According to the Complaint, White violated, or aided and abetted violations of, antifraud, periodic reporting, and record-keeping provisions of the Securities Act of 1933 ("Securities Act") and Securities Exchange Act of 1934 ("Exchange Act"). The Complaint alleges that, at the end of July 1997, Informix's financial staff and independent auditors discovered the secret side agreements White was concealing. Informix's Board of Directors immediately forced White to resign from the Company. Informix ultimately restated its 1996 financial statements to reflect substantial decreases in its earnings and income caused by, among other things, discovery of the two side agreements White concealed and various other side agreements. Informix's amended 1996 Form 10-K revealed that, instead of earning net income of $97.8 million as Informix originally reported, Informix suffered a net loss of $73.6 million in 1996. The Commission seeks a Final Judgment permanently enjoining White from violating, or aiding and abetting violations of the antifraud, periodic reporting, record keeping, and internal controls provisions of the federal securities laws; barring White from acting as an officer or director of any public company; and requiring White to pay civil money penalties. Separately on November 21, 2002, the Office of the United States Attorney for the Northern District of California ("USAO") announced that it had indicted White for federal criminal securities, mail, and wire fraud. The civil and criminal actions are the result of investigations by the Commission, the USAO, and the San Francisco office of the Federal Bureau of Investigation. Previously, the Commission instituted and simultaneously settled an administrative proceeding against Informix. See Informix Corp., Admin. Proc. No. 3-10130; SA Rel. No. 33-7788; SEA Rel. No. 3442326; AAE Rel. No. 1215 (Jan. 11, 2000). The Commission also previously filed a civil complaint, and obtained a default judgment, against Walter Königseder, an Informix Vice President. See SEC v. Walter Königseder, Civil Action No. 00-3668 (MJJ) (N.D. Cal. May 17, 2001) (Order), Lit. Rel. No. 17016, AAE Rel. No. 1398 (May 23, 2001). 4.

SEC v. Andrew S. Fastow, Litigation Release Number 17762, Accounting and Auditing Enforcement (AAE) Rel. No. 1640 (Oct. 2, 2002), www.sec.gov/litigation/litreleases/lr17762.htm.

The SEC filed a civil enforcement action against Andrew S. Fastow, the former chief financial officer of Enron Corp., alleging violations of the anti-fraud, periodic reporting, books and records, and internal controls provisions of the federal securities laws. The Commission is seeking disgorgement of all ill-gotten gains, including all compensation received subsequent to the commencement of the alleged fraud, civil money penalties, a permanent bar from acting as a director or officer of a publicly 5

held company, and an injunction from future violations of the federal securities laws. The Commission brought this action in coordination with the Justice Department's Enron Task Force, which filed a related criminal complaint against Fastow. The complaint allegations stem from Fastow's conduct relating to six transactions. Three of the transactions, RADR, Chewco, and Southampton, were the subject of the Commission's earlier settled action against Michael Kopper. Those transactions were part of an alleged scheme to hide Fastow's and Kopper's interest in and control of certain entities in order to keep those entities off Enron's balance sheet. This was done, according to the complaint, for self-enrichment and to mislead analysts, rating agencies, and others about Enron's true financial condition. As to Fastow's role in RADR, Chewco, and Southampton, the complaint alleges that Fastow secretly nominated certain of the owners of these entities, funded certain of their investments through undisclosed loans, collected undisclosed fees, and demanded and received under-the-table payments, including payments to himself and his family members disguised as yearly $10,000 non-taxable gifts. Two of the remaining three transactions, the Nigerian barges and the Cuiaba transaction, are alleged to have been sham sales - best described as secret asset-parking arrangements. In one of these sales, a sale of an interest in certain Nigerian barges to a financial institution, Fastow is alleged to have personally promised that the financial institution would be taken out of its so-called investment and later arranged for an entity he controlled to buy the financial institution's interest at a pre-arranged rate of return on a pre-arranged time table. In the second sale, Enron entered into a transaction with an off-balance-sheet entity controlled by Fastow to sell an interest in a severely troubled power plant in Cuiaba, Brazil, in order to avoid consolidation of project debt and recognize earnings. In connection with this transaction, Fastow allegedly entered into an unwritten side agreement with Enron requiring Enron to buy back the interest it just sold to Fastow at a guaranteed profit. The last set of allegations included in the complaint relate to an alleged instance of backdating documents to avoid diminution in Enron's investment in the stock of a technology company. Specifically, according to the complaint, in September 2000, Fastow and others created documents that purported to lock in the value of Enron's investment in that company back in August of 2000, when that company's stock was trading at its all-time high price. Throughout the period of his alleged fraudulent conduct, Fastow sold millions of dollars worth of Enron securities. The Commission's investigation is continuing. 5.

SEC v. Homestore, Inc., Lit. Rel. No. 17745 (Sept. 25, 2002).

The SEC filed charges against three former senior executives of Homestore Inc. for perpetrating an extensive scheme to fraudulently inflate Homestore's online advertising revenues in 2001. The complaint, filed in U.S. District Court in Los Angeles, charges that John Giesecke Jr., Homestore's former chief operating officer; Joseph J. Shew, its former chief financial officer; and John DeSimone, its former vice president of transactions, caused Homestore to overstate its advertising revenues by $46 million (64%) for the first three quarters of 2001. This action was brought in coordination with the U.S. Attorney's Office for the Central District of California, which simultaneously announced related criminal charges against the three defendants. Giesecke, Shew, and DeSimone have each agreed to 6

settle the Commission's lawsuit, to plead guilty to the criminal charges, and to cooperate with the government in its continuing investigation. At the time of the violations, Homestore was one of the top Internet portals for real estate and related services. The Commission's complaint charges Giesecke, Shew, and DeSimone with arranging fraudulent "round-trip" transactions for the sole purpose of artificially inflating Homestore's revenues in order to exceed Wall Street analysts' expectations. The defendants circumvented applicable accounting principles and lied to Homestore's independent auditors about these transactions. While the fraud was ongoing, the defendants exercised stock options at prices ranging between approximately $21 and $32 per share, reaping profits ranging from approximately $169,000 to approximately $3.2 million. The returned ill-gotten gains of approximately $4.6 million will be paid to the benefit of Homestore shareholders. In addition, the Commission is seeking the permission of the Court to have Giesecke's civil monetary penalty of $360,000 paid to the benefit of shareholders under the Fair Funds provision of the recently enacted Sarbanes-Oxley Act of 2002. In related proceedings filed by the U.S. Attorney's Office in Los Angeles, Giesecke has agreed to plead guilty to one count of conspiracy and one count of wire fraud, Shew has agreed to plead guilty to one count of conspiracy, and DeSimone has agreed to plead guilty to one count of securities fraud. Giesecke and DeSimone each face a maximum possible penalty of 10 years in prison, while Shew faces up to 5 years in prison. Their pleas are based on fraudulent conduct similar to that described in the Commission's complaint. As part of their plea agreements, all three defendants have agreed to cooperate with the Commission and the criminal authorities. The Commission did not bring any enforcement action against Homestore because of its swift, extensive and extraordinary cooperation in the Commission's investigation. This cooperation included reporting its discovery of possible misconduct to the Commission immediately upon the audit committee's learning of it, conducting a thorough and independent internal investigation, sharing the results of that investigation with the government (including not asserting any applicable privileges and protections with respect to written materials furnished to the Commission staff), terminating responsible wrongdoers, and implementing remedial actions designed to prevent the recurrence of fraudulent conduct. These actions, among others, significantly facilitated the Commission's expeditious investigation of this matter. 6.

SEC v. Dynegy Inc., Lit. Rel. No. 17744 (Sept. 25, 2002), In the Matter of Dynegy Inc., Securities Exchange Act of 1934 Rel. No. 34-46537, www.sec.gov/litigation/litreleases/lr17744.htm.

The SEC filed a settled enforcement action against Dynegy Inc. in connection with alleged accounting improprieties and misleading statements by the Houston-based energy production, distribution and trading company. The Commission's case arises from (i) Dynegy's improper accounting for and misleading disclosures relating to a $300 million financing transaction, known as Project Alpha, involving special-purpose entities (SPEs), and (ii) Dynegy's overstatement of its energytrading activity resulting from "round-trip" or "wash" trades — simultaneous, pre-arranged buy-sell 7

trades of energy with the same counter-party, at the same price and volume, and over the same term, resulting in neither profit nor loss to either transacting party. The Commission issued a settled cease-and-desist Order against Dynegy and filed a settled civil suit in the Southern District of Texas, Houston Division, seeking a $3 million penalty. The Commission made findings in the cease-and-desist order (and alleged in the civil complaint) that Dynegy engaged in securities fraud in connection with its disclosures and accounting for Project Alpha, and negligently included materially misleading information about the round-trip energy trades in two press releases it issued in early 2002. In settlement of the Commission's enforcement action, Dynegy, without admitting or denying the Commission's findings, has agreed to the entry of the cease-and-desist order and to pay a $3 million penalty in a related civil suit filed in U.S. district court in Houston. The $3 million penalty imposed directly against Dynegy in this case reflects the Commission's dissatisfaction with Dynegy's lack of full cooperation in the early stages of the Commission's investigation, as discussed in the Commission's Order. In assessing a penalty directly against Dynegy, the Commission was mindful of the impact that a penalty on a corporate entity can have on the entity's innocent shareholders. The amount of the penalty here reflects the commitment of the company's present board of directors to cooperate with the Commission and certain remedial actions undertaken by the company, as well as a careful balancing by the Commission between the need to encourage full cooperation and the desire to avoid imposing the economic consequences of a penalty on shareholders. As the Commission's investigation continues, it will consider the responsibility of and take appropriate actions against others with respect to the penalty that the company has agreed to pay. 7.

SEC v. L. Dennis Kozlowski, Mark H. Swartz and Mark A. Belnick: Lit. Rel. No. 17722 (Sept. 12, 2002).

The SEC filed a civil enforcement action in the United States District Court for the Southern District of New York against three former top executives of Tyco International Ltd. charging that they violated the federal securities laws by failing to disclose to shareholders the multi-million dollar low interest and interest-free loans they took from the company. L. Dennis Kozlowski, the former chief executive officer and chairman of Tyco's board of directors, and Mark H. Swartz, the former chief financial officer and a director, granted themselves hundreds of millions of dollars in secret low interest and interest-free loans from the company that they used for personal expenses. They then covertly caused the company to forgive tens of millions of dollars of those outstanding loans, again without disclosure to investors as required by the federal securities laws. In addition, they engaged in other undisclosed related party transactions that cost shareholders hundreds of thousands, if not millions of dollars. Mark A. Belnick, the former chief legal officer, failed to disclose the receipt of more than $14 million of interest-free loans from the company to acquire two residences, an apartment in New York City and a $10 million home in Park City, Utah, where he already owned another home. Kozlowski, Swartz and Belnick also sold their shares of Tyco stock valued at millions of dollars while their self-dealing remained undisclosed. The Commission seeks a final judgment ordering the defendants to disgorge all ill-gotten gains, imposing civil money penalties, and enjoining the defendants from future violations of the federal securities laws. In the cases of Kozlowski and Swartz, this includes (i) disgorgement of all compensation they received subsequent to their fraudulent acts and omissions, including salary, 8

bonuses, stock options and grants and any advances that have not been repaid; (ii) all loans not properly repaid by them to Tyco; (iii) interest imputed at market rates on all low interest or interest-free loans that they should have disclosed to investors; (iv) all losses avoided from their sales of Tyco securities subsequent to their fraudulent acts and omissions; (v) prejudgment interest on the amounts disgorged; (vi) civil money penalties; (vii) orders barring them from ever again serving as officers or directors of a publicly-held company; and (viii) an order enjoining them from violating the antifraud, proxy, reporting, books and records and lying to auditor provisions of the federal securities laws. In the case of Belnick, the Commission seeks (i) disgorgement of all loans not properly repaid by him to Tyco; (ii) interest imputed on all low interest or interest-free loans that he should have disclosed to investors; (iii) all losses avoided from his sales of Tyco securities subsequent to his fraudulent acts and omissions at market rates; (iv) all rent payments that he received from Tyco for the home office he maintained in the Utah residence; (v) prejudgment interest on the amounts disgorged; (vi) civil money penalties; (vii) an order barring him from ever again serving as an officer or director of a publicly-held company; and (viii) an order enjoining him from violating the antifraud, proxy and reporting provisions of the federal securities laws. The Commission's Complaint alleges that defendants violated or aided and abetted violations of the anti-fraud, periodic reporting, proxy, books and records, internal controls and lying to auditors provisions of the federal securities laws. The Manhattan District Attorney also unsealed indictments against the three defendants. In a separate action, on December 17, 2002, the Commission filed a settled civil action alleging that Frank E. Walsh, Jr. ("Walsh") violated the federal securities laws by signing a Tyco registration statement which Walsh knew contained materially misleading statements concerning fees or commissions payable to him in connection with Tyco's June 2001 $9.2 billion acquisition of The CIT Group, Inc. ("CIT"). The Complaint alleged that in late 2000, Walsh, a director of Tyco from 1992 through February of 2002, recommended that Tyco consider acquiring CIT. After Walsh set up a meeting between Kozlowski and CIT's Chief Executive Officer, Kozlowski proposed to pay Walsh a $20 million "finder's fee" for his services if the transaction was consummated. When the transaction was submitted to the Board, Walsh voted in favor of the transaction but intentionally did not disclose to the Board that he would receive a substantial fee in connection with the transaction. The $20 million "finder's fee" was paid by Tyco, and, accordingly, operated as a deceit on CIT's and Tyco's shareholders. Walsh consented to the entry of a final judgment permanently enjoining him from violations of the antifraud provisions of the federal securities laws, permanently barring him from acting as an officer or director of a publicly-held company, and ordering him to pay restitution of $20,000,000.00; provided, however, that restitution shall be offset, in part or in whole, by any restitution paid by Walsh in the case of People of the State of New York v. Frank E. Walsh, Jr., which arises out of the same conduct set forth in the Complaint. Securities and Exchange Commission v. Frank E. Walsh, Jr., Lit. Release No. 17896 (December 17, 2002), www.sec.gov/litigation/litreleases/lr17896.htm.

8.

SEC v. Adelphia Communications Corp., John J. Rigas et al., Lit. Rel. No. 17627, AAE Rel. No. 1599 (July 24, 2002). 9

The SEC filed suit in the United States District Court for the Southern District of New York charging major cable television provider Adelphia Communications Corporation; its founder John J. Rigas; his three sons, Timothy J. Rigas, Michael J. Rigas, and James P. Rigas; and two senior executives at Adelphia, James R. Brown and Michael C. Mulcahey, in one of the most extensive financial frauds ever to take place at a public company. Commission charges that Adelphia, at the direction of the individual defendants: (1) fraudulently excluded billions of dollars in liabilities from its consolidated financial statements by hiding them in off-balance sheet affiliates; (2) falsified operations statistics and inflated Adelphia's earnings to meet Wall Street's expectations; and (3) concealed rampant self-dealing by the Rigas Family, including the undisclosed use of corporate funds for Rigas Family stock purchases and the acquisition of luxury condominiums in New York and elsewhere. The Commission seeks a final judgment ordering the defendants to account for and disgorge all ill-gotten gains including — as to the individuals — all compensation received during the fraud, all property unlawfully taken from Adelphia through undisclosed related-party transactions, and any severance payments related to their resignations from the company. The Commission also seeks civil penalties from each defendant, and permanent injunctions from violating the securities laws. The Commission further seeks an order barring each of the individual defendants from acting as an officer or director of a public company. The Commission's complaint alleges that between mid-1999 and the end of 2001, John J. Rigas, Timothy J. Rigas, Michael J. Rigas, James P. Rigas, and James R. Brown, with the assistance of Michael C. Mulcahey, caused Adelphia to fraudulently exclude from the Company's annual and quarterly consolidated financial statements over $2.3 billion in bank debt by deliberately shifting those liabilities onto the books of Adelphia's off-balance sheet, unconsolidated affiliates. Failure to record this debt violated GAAP requirements and precipitated a series of misrepresentations about those liabilities by Adelphia and the defendants, including the creation of: (1) sham transactions backed by fictitious documents to give the false appearance that Adelphia had actually repaid debts when, in truth, it had simply shifted them to unconsolidated Rigas-controlled entities, and (2) misleading financial statements by giving the false impression through the use of footnotes that liabilities listed in the Company's financials included all outstanding bank debt. Timothy J. Rigas, Michael J. Rigas, and James R. Brown made repeated misstatements in press releases, earnings reports, and Commission filings about Adelphia's performance in the cable industry, by inflating: (1) Adelphia's basic cable subscriber numbers; (2) the extent of Adelphia's cable plant "rebuild" or upgrade; and (3) Adelphia's earnings, including its net income and quarterly earnings before interest, taxes, depreciation, and amortization. Each of these represents crucial aspects by which Wall Street evaluates cable companies. Since at least 1998, Adelphia, through the Rigas Family and Brown, made fraudulent misrepresentations and omissions of material fact to conceal extensive self-dealing by the Rigas Family. Such self-dealing included the use of Adelphia funds to finance undisclosed open market stock purchases by the Rigas Family, purchase timber rights to land in Pennsylvania, construct a golf course for $12.8 million, pay off personal margin loans and other Rigas Family debts, and purchase luxury condominiums in Colorado, Mexico, and New York City for the Rigas Family. The Commission's complaint alleges that based on the conduct set forth above, the defendants violated the antifraud, 10

periodic reporting, record keeping, and internal controls provisions of the federal securities laws. The Commission's investigation is continuing. Simultaneously, the United States Attorney for the Southern District of New York arrested three members of the Rigas Family. On November 14, 2002, the Commission announced that defendant James R. Brown, the former vice-president for Finance at Adelphia Communications Corporation, has consented to the entry of a Partial Judgment of Permanent Injunction and Other Relief against him in SEC v. Adelphia, et al. Without admitting or denying the allegations in the complaint, Brown has consented to the entry against him of a permanent injunction against violations of the antifraud, periodic reporting, record keeping, and internal controls provisions, and, as a control person, of the periodic reporting, record keeping, and internal controls provisions of the federal securities laws, and a permanent officer and director bar. Brown has also agreed to provide the Court with an accounting. The Commission has submitted Brown's Consent to the Court for approval. The Commission's claims against Brown for disgorgement of ill-gotten gains, plus prejudgment interest, and a civil penalty remain pending before the Court. SEC v. Adelphia Communications Corp., John J. Rigas et al., Lit. Rel. No. 17837 (Nov. 14, 2002), www.sec.gov/litigation/litreleases/lr17837.htm. 9.

In re PNC Financial Services Group, Inc., Securities Act Release No. 33-8112; Exchange Act Release No. 34-46225; AAE Rel. No. 1597 (July 18, 2002).

The Commission issued a settled cease and desist order against The PNC Financial Services Group, Inc., a Pittsburgh, Pennsylvania, bank holding company. This case is the Commission's first enforcement action resulting from a company's misuse of special purpose entities. The Commission's Order found that, in violation of GAAP, PNC transferred from its financial statements approximately $762 million of volatile, troubled or under-performing loans and venture capital assets sold to three special purpose entities created by a third party financial institution in the second, third, and fourth quarters of 2001, which resulted in material overstatements of earnings, among other things. The Order stated that PNC should have consolidated these special purpose entities into its financial statements. The Order also found that PNC made materially false or misleading disclosures and statements about these transactions and the consequences of those transactions. Among other things, the Order found that in 2001, PNC endeavored to remove approximately $762 million of volatile, troubled or under-performing loans and venture capital investments from its financial statements by transferring them to three special purpose entities that were specially created to receive these assets and in which PNC held a substantial interest. PNC failed to consolidate the special purpose entities on its second and third quarter financial statements filed with the Commission even though the entities failed to meet the requirements under GAAP for non-consolidation. In connection with its improper accounting for its interest in the three special purpose entities, PNC also made materially false and misleading disclosures in certain press releases and in quarterly reports filed with the Commission for the second and third quarters of 2001 about its financial condition, earnings and exposure to the risks of its commercial lending activities.1 PNC consented to the entry of the Order, without admitting or denying the Commission's findings, requiring that it cease and desist from committing or causing any future violations of the anti11

fraud and periodic reporting provisions. Simultaneously, the Federal Reserve and the Office of the Comptroller of the Currency entered into agreements with the PNC and its subsidiary bank, respectively, to improve their practices and management. The Commission's investigation is continuing as to others.

10.

SEC v. WorldCom, Inc., Lit. Rel. No. 17588, AAE Rel. No. 1585 (June 27, 2002), www.sec.gov/litigation/litreleases/lr17588.htm.

The SEC filed a civil action in federal district court in New York charging major global communications provider WorldCom, Inc. with a massive accounting fraud totaling more than $3.8 billion. The Commission's complaint alleges that WorldCom fraudulently overstated its income before income taxes and minority interests by approximately $3.055 billion in 2001 and $797 million during the first quarter of 2002. The complaint further alleges that WorldCom falsely portrayed itself as a profitable business during 2001 and the first quarter of 2002 by reporting earnings that it did not have. WorldCom did so by capitalizing (and deferring) rather than expensing (and immediately recognizing) approximately $3.8 billion of its costs: the company transferred these costs to capital accounts in violation of GAAP. These actions were intended to mislead investors and manipulate WorldCom's earnings to keep them in line with estimates by Wall Street analysts. The complaint charges WorldCom with violating various antifraud and reporting provisions of the federal securities laws. The Commission is seeking court orders permanently enjoining WorldCom; imposing civil monetary penalties; prohibiting WorldCom and its affiliates, officers, directors, employees, and agents from destroying, altering, or hiding relevant documents; prohibiting WorldCom and its affiliates from making any extraordinary payments to any present or former officer, director, or employee of WorldCom or its affiliates, including but not limited to any severance payments, bonus payments, or indemnification payments; and appointing a corporate monitor to ensure that documents are not destroyed and that no such extraordinary payments are made. In a related action, the Commission ordered WorldCom to file with the Commission, under oath, a detailed report of the circumstances and specifics of these matters by July 1st. The Commission's investigation is continuing. On August 1, 2002, Scott D. Sullivan, former WorldCom CFO, and David Meyers, former WorldCom Controller, were criminally charged by the United States Attorney for the Southern District of New York with securities fraud and conspiracy. Since filing its initial complaint, the Commission has filed several civil actions in connection with the financial fraud at WorldCom, amended its complaint against WorldCom, and obtained judgments against WorldCom and several former WorldCom employees. On September 26, 2002, the Commission filed an action against former WorldCom Controller David F. Myers. (Litigation Release No. 17753.) On October 7, the Commission's third enforcement 12

action relating to WorldCom was filed against former WorldCom Director of General Accounting Buford "Buddy" Yates, Jr. (Litigation Release No. 17771.) The Commission charged Myers and Yates with participating in the massive fraud that inflated WorldCom's earnings at the direction and with the knowledge of WorldCom's senior management. Each defendant consented, without admitting or denying the allegations in the Commission's complaint, to the entry of the judgment against him. The judgment entered against Myers: (1) enjoins him from violating the antifraud, record keeping and internal controls provisions of the federal securities laws, and from aiding and abetting WorldCom's violations of the periodic reporting, record keeping and internal controls provisions of the federal securities laws; (2) prohibits him from acting as an officer or director of any public company; and (3) provides that any monetary relief will be decided by the Court at a later date. The judgment entered against Yates: (1) enjoins him from future violations of the antifraud and record keeping provisions of the federal securities laws, and from aiding and abetting WorldCom's violations of the periodic reporting, record keeping and internal controls provisions of the federal securities laws; (2) prohibits him from acting as an officer or director of any public company; and (3) provides that any monetary relief will be decided by the Court at a later date. SEC v. David F. Myers, SEC v. Buford Yates, Jr., Lit. Release No. 17842, AAE Release No. 1665 (Nov. 15, 2002), www.sec.gov/litigation/litreleases/lr17842.htm. Based on the injunctions, Myers and Yates were suspended on December 6 from appearing or practicing before the Commission as accountants under Rule 102(e) of the Commission's Rules of Practice. (In the Matter of David F. Myers, Rel.33-8157, AAE Rel. 1685, File No.3-10965; and In the Matter of Buford Yates, Jr., Rel. 33-8156, AAE Rel. 1684, File No. 3-10964.) On November 5, the Commission filed an amended complaint against WorldCom. SEC v. WorldCom, Inc., Lit. Release No. 17829, AAE Release No. 1658 (Nov. 5, 2002), www.sec.gov/litigation/litreleases/lr17829.htm. On November 26, the court entered a judgment against WorldCom imposing the full injunctive relief sought by the Commission; ordering an extensive review of the company's corporate governance systems, policies, plans, and practices; ordering a review of WorldCom's internal accounting control structure and policies; ordering that WorldCom provide reasonable training and education to certain officers and employees to minimize the possibility of future violations of the federal securities laws; and providing that civil money penalties, if any, will be decided by the Court at a later date. WorldCom consented, without admitting or denying the allegations in the Commission's complaint, to the entry of the judgment. The Commission's amended complaint alleges that WorldCom misled investors from at least as early as 1999 through the first quarter of 2002, and further states that the company has acknowledged that during that period, as a result of undisclosed and improper accounting, WorldCom materially overstated the income it reported on its financial statements by approximately $9 billion. The judgment enjoins WorldCom from violating the antifraud, reporting provisions, record keeping, and internal controls provisions of the federal securities laws. The judgment further orders that the report currently being prepared by WorldCom's Special Investigative Committee be transmitted to the Corporate Monitor, Richard Breeden, and that Mr. Breeden review the adequacy and effectiveness of WorldCom's corporate governance systems, policies, plans, and practices. 13

It also orders that WorldCom retain a qualified consultant, acceptable to the Commission, to perform a review of the effectiveness of WorldCom's material internal accounting control structure and policies, including those related to line costs, reserves, and capital expenditures, as well as the effectiveness and propriety of WorldCom's processes, practices and policies for ensuring that the Company's financial data is accurately reported in its public financial statements. The judgment further orders that WorldCom provide reasonable training and education to certain of its officers and employees to minimize the possibility of future violations of the federal securities laws. The judgment further provides that the amount of the civil penalty, if any, to be paid by WorldCom shall be determined by the Court in light of all the relevant facts and circumstances, following a hearing. SEC v. WorldCom, Inc., Lit. Release No. 17866, AAE Release No. 1678 (Nov. 26, 2002), www.sec.gov/litigation/litreleases/lr17866.htm. On December 6, 2002, the Commission announced that judgments of permanent injunction were entered on November 26 in its pending action against Betty L. Vinson and Troy M. Normand, former accountants in the General Accounting Department of WorldCom, Inc. The judgments entered against Vinson and Normand, among other things: (1) enjoin them from violating the antifraud, record keeping, and internal controls provisions of the federal securities laws, and from aiding and abetting violations of the periodic reporting, record keeping, and internal controls provisions; 2) provide that any monetary relief will be decided by the Court at a hearing to be held upon motion of the Commission or the instance of the Court; and (3) provide that the Court retains jurisdiction of the action for all purposes, including the imposition of additional equitable remedies or sanctions, if any, as determined following a hearing. Each defendant consented, without admitting or denying the allegations in the Commission's complaint, to the entry of the judgment against her or him. Based on the permanent injunction imposed by the Court against Vinson, the Commission suspended her from appearing or practicing before the Commission as an accountant under Rule 102(e) of the Commission's Rules of Practice. (In the Matter of Betty L. Vinson, CPA, Rel. 33-8158; AAE No. 1686; File No. 3-10963). Both Vinson and Normand have pled guilty to criminal charges prosecuted by the U.S. Attorney's Office for the Southern District of New York. SEC v. Betty L. Vinson and Troy M. Normand, Lit. Release No. 17883, AAE Release No. 1683 (Dec. 6, 2002), www.sec.gov/litigation/litreleases/lr17883.htm 11.

SEC v. Frank M. Bergonzi et al. (Rite Aid), Lit. Rel. No. 17577, AAE Rel. No. 1581 (Jun. 21, 2002), www.sec.gov/litigation/litreleases/lr17577.htm.

The SEC filed accounting fraud charges against several former senior executives of Rite Aid Corp. for conducting a wide-ranging accounting fraud scheme. The SEC’s complaint alleges that Rite Aid overstated its income in every quarter from May 1997 to May 1999, by massive amounts. When the wrongdoing was ultimately discovered, Rite Aid was forced to restate its pre-tax income by $2.3 billion and net income by $1.6 billion, the largest restatement ever recorded. The complaint also charges that former CEO Martin Grass caused Rite Aid to fail to disclose several related-party transactions, in which Grass sought to enrich himself at the expense of Rite Aid's shareholders. Finally, 14

the Commission alleges that Grass fabricated Finance Committee minutes for a meeting that never occurred, in connection with a corporate loan transaction. The Commission is seeking disgorgement of annual bonuses and imposition of civil penalties against Grass, former CFO Frank Bergonzi and former Vice Chairman Franklin Brown. The Commission also seeks an order permanently enjoining each defendant from violating the securities laws and barring each of them from serving as an officer or director of a public company. The Commission also announced settled administrative cease-and-desist proceedings against Rite Aid and against Timothy Noonan, the company's former Chief Operating Officer. In determining the appropriate resolution of these proceedings, the Commission considered the substantial cooperation provided by Rite Aid and Noonan in the investigation of this matter. The U. S. Attorney for the Middle District of Pennsylvania simultaneously announced related criminal charges. 12.

In re Microsoft Corporation, SEA Rel. No. 46017, AAE Rel. No. 1563 (Jun. 3, 2002), www.sec.gov/news/press/2002-80.htm.

The Commission brought a settled administrative enforcement action against Microsoft Corp. ordering the company to cease and desist from committing accounting violations and other violations of federal securities laws. The Commission found that Microsoft had maintained seven reserve accounts in a manner that did not comply with GAAP because, to a material extent, they did not have adequately substantiated bases. As a result, Microsoft misstated its income by material amounts in certain periodic filings with the Commission made between July 1, 1994, and June 30, 1998. The Commission also found that Microsoft did not properly document the bases for these accounts and failed to maintain proper internal controls, as required by the federal securities laws. The Commission's Order makes the following findings: 

Microsoft recorded reserves, accruals, allowances, and liability accounts relating to marketing expenses, sales to original equipment manufacturers, accelerated depreciation, inventory obsolescence, valuation of financial assets, interest income, and impairment of manufacturing facilities (collectively "reserve accounts") that did not have properly substantiated bases, as required by GAAP. During 1995 through 1998, the total balance of these accounts ranged from approximately $200 million to $900 million.



Microsoft's quarterly and annual filings with the Commission included or incorporated by reference financial statements containing undisclosed and unsupported adjustments to reserve accounts that, to a material extent, did not comply with GAAP. By including these adjustments in its financial statements, Microsoft failed to accurately report its financial results, causing overstatements of income in some quarters and understatements of income during other quarters.



Microsoft failed to maintain sufficient documentation of the bases for these reserve accounts and to apply its own accounting policy relating to the reconciliation of entries in its accounting system. Microsoft exempted the reserve accounts from its company-wide requirement that every account be reconciled at least once each quarter and that the reconciliation include 15

ascertaining if there existed adequate supporting documentation relating to activity in the account. As a result, Microsoft lacked important safeguards to ensure that adjustments to the reserve accounts and the balances of these accounts were appropriate or accurately reported in conformity with GAAP. Microsoft consented to the issuance of the Commission's Order without admitting or denying the findings. The Commission found that Microsoft violated the periodic reporting and books and records and internal accounting controls provisions of the federal securities laws and ordered Microsoft to cease and desist from committing future violations of these provisions. Cases Involving Accountants and Auditors 1.

In re PricewaterhouseCoopers LLP and PricewaterhouseCoopers Securities LLC, Exchange Act Rel. No. 46216, AAE Rel. No.1596 (July 17, 2002).

The SEC announced a settled enforcement action against PricewaterhouseCoopers LLP (PwC) and its broker-dealer affiliate, PricewaterhouseCoopers Securities LLC (PwCS), for violations of the auditor independence rules. The auditor independence violations span a five-year period from 1996 to 2001 and arise from (1) PwC's use of prohibited contingent fee arrangements with 14 different audit clients for which PwCS provided investment banking services, and (2) PwC's participation with two other audit clients, Pinnacle Holdings Inc. and Avon Products Inc., in the improper accounting of costs that included PwC's own consulting fees. The SEC's order finds that, by virtue of PwC's independence violations, the firm caused 16 PwC public audit clients to file financial statements with the SEC that did not comply with the reporting provisions of the federal securities laws. The order also finds that, in connection with the improper accounting of its consulting fees, PwC caused two of those clients to violate the reporting, recordkeeping, and/or internal controls provisions of the federal securities laws. PwC and PwCS agreed to pay a total of $5 million and PwC agreed to comply with significant remedial undertakings as a result of its settlement with the SEC. PwC also agreed to cease and desist from violating the auditor independence rules and to be censured for engaging in improper professional conduct. From 1996 to 2001, PwC and one of its predecessors, Coopers & Lybrand, entered into impermissible contingent fee arrangements with 14 public audit clients. In each instance, the client hired the audit firm's investment bankers, either PwCs or Coopers & Lybrand Securities, to perform financial advisory services for a fee that depended on the success of the transaction the client was pursuing. These fee arrangements violated the accounting professions' own prohibition against contingent fee arrangements with audit clients and violated the SEC's independence rules. As a result, the SEC found that PwC lacked the requisite independence when it performed audits for these 14 public companies. In 1999 and 2000, PwC participated in and approved of the improper accounting of its own non-audit fees by two public audit clients, Pinnacle and Avon: In 1999 and 2000, while accounting for a 1999 acquisition of certain assets of Motorola, Inc., PwC assisted Pinnacle in establishing more than $24 million in improper reserves and in improperly capitalizing approximately $8.5 million in costs, including $6.8 million in fees paid to PwC for 16

consulting and other non-audit services that should have been expensed. In April and May 2001, Pinnacle restated its accounting for the 1999 acquisition, and in December 2001, the SEC issued a settled cease and desist order against Pinnacle. See In the Matter of Pinnacle Holdings, Inc., Exchange Act Rel. No. 45135 (Dec. 6, 2001). In the first quarter of 1999 and in its 1999 audit of Avon's financial statements, PwC assisted in and approved of Avon's improper accounting of an impaired asset that included PwC's non-audit consulting fees. In April 1999, after nearly three years and an investment of approximately $42 million, Avon stopped an uncompleted order-management software project that PwC consultants had attempted to develop for Avon's internal use. Instead of writing off all of the project's costs in the first quarter of 1999, however, Avon improperly retained $26 million, which was comprised mostly of PwC's own consulting fees. PwC participated in and approved of Avon's improper accounting, and also contributed to Avon's misleading disclosures concerning the accounting. For both Pinnacle and Avon, the SEC found that PwC failed to exercise the objective and impartial judgment required by the independence rules. PwC agreed to perform significant remedial undertakings designed to prevent the type of independence violations found in the order. Simultaneous with the issuance of the order in this case, the SEC brought a settled enforcement action against Avon for failing to properly value costs that it had capitalized in connection with the software development project. Avon agreed to cease and desist from violating the reporting and recordkeeping provisions of the federal securities laws and to restate its financial statements to appropriately reflect the complete impairment of the project in the first quarter of 1999. See In the Matter of Avon Products, Inc., Exchange Act Rel. No. 46215 (July 17, 2002). 2.

In re Moret Ernst & Young Accountants, SEA Rel. No. 46130, AAE Rel. No. 1584, (Jun. 27, 2002) http://www.sec.gov/litigation/admin/34-46130.htm.

In the first-ever auditor independence case against a foreign audit firm, the SEC brought a settled enforcement action against Moret Ernst & Young Accountants, a Dutch accounting firm now known as Ernst & Young Accountants. The case arises from Moret's joint business relationships with an audit client. The SEC censured Moret for engaging in improper professional conduct and ordered Moret to comply with certain remedial undertakings, including the payment of a $400,000 civil penalty. This is the first time that the SEC has ordered any audit firm to pay a civil penalty for an auditor independence violation. Moret consented to the order without admitting or denying the SEC's findings. Moret audited the 1995, 1996, and 1997 financial statements of Baan Company, N.V., a business software company headquartered in the Netherlands. During this period, consultants affiliated with Moret had joint business relationships with Baan that impaired Moret's independence as auditor. Most of these joint business relationships were established to allow Moret consultants to assist Baan in implementing its software products for third parties. The joint business relationships included a Dutch government-subsidized project for Moret and Baan to jointly develop faster software implementation tools; an agreement to coordinate global efforts in implementing Baan software products for third parties; joint marketing activities emphasizing the "partnership" and overall coordination between Baan and Moret in the implementation of Baan software products; and Baan's use of Moret consultants as subcontractors and temporary employees in servicing Baan's clients. 17

Altogether, the SEC found that Moret consultants billed Baan approximately $1.9 million from these improper joint business relationships during the years in question. Baan disputed, and ultimately did not pay, approximately $328,000 of these billings, which further impaired Moret's independence as auditor. The SEC concluded that Moret's conduct constituted an extreme departure from the standards of ordinary care that resulted in violations of the auditor independence requirements imposed by the SEC's rules and by generally accepted auditing standards. In addition to censuring Moret, the SEC ordered Moret to comply with a number of remedial undertakings, including the payment of a $400,000 civil penalty. 3.

In the Matter of KPMG LLP, SEA Rel. No. 45272, ICA Rel. No. 25360, AAE Rel. No. 1491 (Jan. 14, 2002) www.sec.gov/litigation/admin/34-45272.htm.

The SEC censured KPMG LLP for engaging in improper professional conduct because it purported to serve as an independent accounting firm for an audit client at the same time that it had made substantial financial investments in the client. The SEC found that KPMG violated the auditor independence rules by engaging in such conduct. KPMG consented to the SEC’s order without admitting or denying the SEC’s findings. In addition to censuring the firm, the SEC ordered KPMG to undertake certain remedies designed to prevent and detect future independence violations caused by financial relationships with, and investments in, the firm’s audit clients. The SEC found that, from May through December 2000, KPMG held a substantial investment in the Short-Term Investments Trust (“STIT”), a money market fund within the AIM family of funds. According to the SEC’s order, KPMG opened the money market account with an initial deposit of $25 million on May 5, 2000, and at one point the account balance constituted approximately 15% of the fund’s net assets. In the order, the SEC found that KPMG audited the financial statements of STIT at a time when the firm’s independence was impaired, and that STIT included KPMG’s audit report in 16 separate filings it made with the SEC on November 9, 2000. The SEC further found that KPMG repeatedly confirmed its putative independence from the AIM funds it audited, including STIT, during the period in which KPMG was invested in STIT. According to the SEC, KPMG’s independence violation occurred primarily because the firm lacked adequate policies or procedures to prevent or detect such violations, and because the steps which KPMG personnel usually took before initiating investments of the firm’s surplus cash were not taken in this instance. The SEC also found that KPMG: had no procedures directing its treasury department personnel to check the firm’s “restricted entity list” to confirm that a proposed investment was not restricted; had no specific policies or procedures requiring any participation by a KPMG partner in the investigation and selection of money market investments; and had no policies or procedures designed to put KPMG audit professionals on notice of where the firm’s cash was invested, or requiring them to check a listing of the firm’s investments, prior to accepting new audit engagements or confirming the firm’s independence from audit clients. As a result, the SEC found that there was no system KPMG audit engagement partners could have used to confirm the firm’s independence from its audit clients. The SEC concluded that KPMG’s 18

lack of adequate policies and procedures constituted an extreme departure from the standards of ordinary care, and resulted in violation of the auditor independence requirements imposed by the SEC’s rules and by Generally Accepted Auditing Standards.

Foreign Payments Cases 1.

SEC v. Syncor International Corp., Lit. Release No. 17887, AAE Release No. 1688 (Dec. 10, 2002), www.sec.gov/litigation/litreleases/lr17887.htm

On December 10, 2002, the Commission filed two settled enforcement proceedings charging Syncor International Corporation, a radiopharmaceutical company based in Woodland Hills, California, with violating the Foreign Corrupt Practices Act (FCPA). First, the Commission filed a lawsuit in the United States District Court for the District of Columbia charging Syncor with violating the FCPA and seeking a civil penalty. Second, the Commission issued an administrative order finding that Syncor violated the anti-bribery, books-and-records, and internal-controls provisions of the FCPA, ordering Syncor to cease and desist from such violations, and requiring Syncor to retain an independent consultant to review and make recommendations concerning the company's FCPA compliance policies and procedures. Without admitting or denying the Commission's charges, Syncor consented to the entry of a final judgment in the federal lawsuit requiring it to pay a $500,000 civil penalty and consented to the Commission's issuance of its administrative order. In both its federal court complaint and its administrative order, the Commission charged that, from at least the mid-1980s through at least September 2002, Syncor's foreign subsidiaries in Taiwan, Mexico, Belgium, Luxembourg, and France made a total of at least $600,000 in illicit payments to doctors employed by hospitals controlled by foreign authorities. According to the Commission, these illicit payments were made with the purpose and effect of influencing the doctors' decisions so that Syncor could obtain or retain business with them and the hospitals that employed them. The Commission charged, moreover, that the payments were made with the knowledge and approval of senior officers of the relevant Syncor subsidiaries, and in some cases with the knowledge and approval of Syncor's founder and chairman of the board. According to the Commission, by making these payments through its subsidiaries, Syncor violated the anti-bribery provisions of the FCPA. The Commission further charged that, by improperly recording these payments - and similar payments made to foreign persons not affiliated with government-owned facilities - Syncor violated the record keeping provisions of the FCPA. Finally, the Commission charged that, by failing to devise or maintain an effective system of internal controls to prevent or detect these violations of the FCPA, Syncor violated the internal controls provisions of the FCPA. In determining to accept Syncor's settlement offer, the Commission considered the full cooperation that Syncor provided to the Commission staff during its investigation. The Commission also considered the fact that Syncor - after being alerted to the relevant conduct by another company that was conducting due diligence relating to a previously announced merger with Syncor - promptly brought this matter to the attention of the Commission's staff and the U.S. Department of Justice. 19

In a related proceeding, the United States Department of Justice filed criminal FCPA charges against Syncor Taiwan, Inc., a subsidiary of Syncor. (U.S. v. Syncor Taiwan, Inc. No. 02-CR-1244ALL (C.D. Cal.)). In that proceeding, Syncor Taiwan has agreed to plead guilty to one count of violating the anti-bribery provisions of the FCPA and to pay a $2 million fine. 2.

SEC v. BellSouth Corp., Lit Rel. No. 17310, AAE Rel. No. 1495 (Jan. 15, 2002), www.sec.gov/litigation/litreleases/lr17310.htm.

On January 15, 2002 the Commission filed a settled civil action with BellSouth Corporation in the U.S. District Court for the Northern District of Georgia, in which BellSouth consented to a $150,000 civil penalty. The Commission's Complaint alleged that BellSouth violated provisions of the Foreign Corrupt Practices Act (FCPA). Specifically, the Complaint alleges that BellSouth violated the books and records provisions and internal controls provisions of the federal securities laws in connection with payments made by BellSouth's Venezuelan and Nicaraguan subsidiaries. BellSouth settled the civil action without admitting or denying the Commission's allegations. According to the Complaint, between September 1997 and August 2000, former senior management of BellSouth's Venezuelan subsidiary, Telcel, C.A., authorized payments totaling approximately $10.8 million to six offshore companies and improperly recorded the disbursements in Telcel's books and records, based on fictitious invoices, as bona fide services. Telcel's internal controls failed to detect the unsubstantiated payments for a period of at least two years. As an additional consequence of this control deficiency, the Complaint alleges that BellSouth was unable to reconstruct the circumstances or purpose of the Telcel payments, or determine the identity of their ultimate recipients. Telcel is Venezuela's leading wireless provider, contributing more revenue to BellSouth's Latin American Group segment than any other Latin American BellSouth operation. The Complaint also alleges that, between October 1998 and June 1999, BellSouth's Nicaraguan subsidiary, Telefonia Celular de Nicaragua, S.A.'s, improperly recorded payments to the wife of the Nicaraguan legislator who was the chairman of the Nicaraguan legislative committee with oversight of Nicaraguan telecommunications. In a related proceeding, the Commission also issued a settled cease-and-desist order against BellSouth in which the Commission found that it violated the books and records provisions and internal accounting controls provisions of the Securities Exchange Act of 1934 in connection with payments made by BellSouth's Venezuelan and Nicaraguan subsidiaries. Without admitting or denying the Commission's findings, BellSouth consented to the entry of the order that requires BellSouth to cease and desist from violating those provisions. 3.

In the Matter of Baker Hughes, Inc., SEA Rel. No. 44784, AAE Rel. No. 1444 (Sept. 12, 2001), www.sec.gov/litigation/admin/34-44784.htm.

On September 12, 2001, the Commission accepted an Offer of Settlement from Baker Hughes in response to the institution of cease and desist proceedings. In March 1999, Baker Hughes' CFO and its Controller authorized an illegal payment, through KPMG, its agent in Indonesia, to a local government official in Indonesia. Baker Hughes, through its CFO and Controller, directed that this improper payment be made while knowing or aware that KPMG would pass all or part of the payment along to a foreign government official for the purpose of influencing the official's decision affecting the 20

business of Baker Hughes. This improper payment was made in violation of the FCPA. In addition, in 1998 and 1995, senior managers at Baker Hughes authorized payments to Baker Hughes' agents in India and Brazil, respectively, without making an adequate inquiry as to whether the agents might give all or part of the payments to foreign government officials in violation of the FCPA. Baker Hughes improperly recorded all three transactions in its books and records as routine business expenditures. This constituted a violation of section 13(b)(2) of the Exchange act, which requires that records be kept in reasonable detail with assurance of accuracy. In addition to its false books and records, Baker Hughes also failed to devise and maintain an adequate system of internal accounting controls to detect and prevent improper payments to foreign government officials and to provide reasonable assurance that transactions were recorded as necessary to permit the preparation of financial statements in conformity with Generally Accepted Accounting Principles. The Commission entered a cease and desist order against Baker Hughes and required the company to keep accurate books and records and to accurately and fairly reflect the authorization or payment of gifts to foreign officials, foreign political parties or any person where such payment is prohibited by Section 30A of the Exchange Act. Furthermore, Baker Hughes was required to devise and maintain a system of internal controls in accordance with GAAP and to monitor payments to foreign officials, parties and other payments prohibited by Section 30A. 4.

In the Matter of Chiquita Brands International, Inc. SE, SEA Rel. No. 44902, AAE Rel. No.1463 (Oct. 3, 2001), www.sec.gov/litigation/admin/34-44902.htm.

Chiquita Brands International, Inc. settled an action for a $100,000 penalty based on conduct violative of the FCPA. Chiquita's Colombian operations consist of, among other things, a number of banana farms located throughout the country and an import/export port facility located in Turbo. The Turbo port facility is owned and operated by Banadex, an indirect wholly-owned subsidiary of Chiquita. In September 1995, the Banadex employee in charge of material and supplies advised Banadex management that renewal of the port facility's customs license was in jeopardy because of two previous citations for failure to comply with Colombian customs regulations. The employee further advised management that replacing the Turbo facility would cost approximately $1 million. Without the knowledge or consent of any Chiquita employee and in contravention of Chiquita's policies, Banadex's chief administrative officer authorized Banadex's CEA agent to make a payment to Colombian customs officials to obtain the license renewal. The chief administrative officer directed Banadex's security officer and controller to make and process the payment. Banadex's CEA agent later advised the company that for the Colombian peso equivalent of approximately $30,000 the citations would be overlooked and the license renewal granted. Banadex agreed to pay two installments - approximately $18,000 in advance and the remainder after renewal. Both installments were made by Banadex's security officer from a Banadex account used for discretionary expenses. Chiquita's policies and procedures contain strict guidelines regarding the use of a discretionary expenses account. Banadex did not comply with Chiquita's procedure requiring that Banadex's books and records accurately reflect the transaction. Chiquita had strict policies prohibiting payments of the 21

kind made to the customs officials. Contrary to Chiquita's established procedure, Banadex employees failed to identify and disclose the payment to customs officials on the disclosure forms submitted for the relevant quarters. In April 1997, Chiquita internal audit discovered the September 1996 payment during an audit review of Banadex. After conducting an internal investigation, Chiquita took corrective action, which included terminating the responsible Banadex employees and reinforcing its internal controls with respect to its Colombian operations. The Commission concluded that Banadex employees made inaccurate entries in the documents recording the transaction and Banadex's general ledger to conceal the payment to customs officials. Chiquita was ordered to cease and desist from committing or causing any violation of the books and records and internal accounting controls provisions of the federal securities laws. Regulation FD Cases First Regulation FD Enforcement Actions, SEC Release No. 2002-179 (Dec. 20, 2002), www.sec.gov/news/press/2002-179.htm On November 25, 2002, the Securities and Exchange Commission instituted three settled enforcement actions and issued one Report of Investigation relating to Regulation FD. These are the first Regulation FD enforcement actions taken by the Commission. 1.

In the Matter of Raytheon Company and Franklyn A. Caine, Securities Exchange Act Release No. 34-46897 (November 25, 2002)

On November 25, 2002, the Commission instituted public cease-and-desist proceedings against Raytheon Company ("Raytheon") and Franklyn A. Caine ("Caine") (collectively, the "Respondents"). In anticipation of the proceedings, Raytheon and Caine each submitted an offer of settlement ("Offers of Settlement"), which the Commission determined to accept. Solely for the purposes of these proceedings, and any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, and without admitting or denying the findings set forth therein, except that Raytheon and Caine admit the jurisdiction of the Commission over them and over the subject matter of these proceedings, Raytheon and Caine consented to the entry of an Order: 1) finding that Raytheon violated the periodic reporting provisions of the federal securities laws and Regulation FD, 2) Caine was a cause of Raytheon's violations, 3) ordering Raytheon to cease and desist from committing or causing any violations and any future violations of these provisions, and 4) ordering Caine to cease and desist from causing any violations and any future violations of these provisions. This matter involves violations of Regulation FD by Raytheon through its Chief Financial Officer, Caine. Caine selectively disclosed quarterly and semi-annual earnings guidance, the prototypical disclosures Regulation FD aimed to prohibit, to sell-side equity analysts (collectively, the "Street"). Caine's disclosures concerned Raytheon's estimate of its expected quarterly distribution of earnings per share ("EPS") for 2001 overall, and for the first quarter in particular. Specifically, Caine communicated to the analysts that their first quarter EPS estimates were too high. 22

On February 7, 2001, Raytheon conducted an investor conference where it reiterated annual EPS guidance, but did not provide any quarterly EPS guidance. After the February 7, 2001 investor conference, Caine directed his staff to contact each sell-side analyst whose estimates are included in Thomson Corporation's First Call Service ("First Call") and request copies of the analysts' quarterly model of Raytheon. Caine then arranged and conducted a one-on-one call with each analyst. During the calls that ensued, Caine knew that Raytheon had provided no public quarterly earnings guidance for 2001, that the analysts' first quarter 2001 EPS estimates generally exceeded Raytheon's internal estimate, and that the analysts' 2001 quarterly earnings estimates reflected a less seasonal quarterly distribution than 2000 results. During the one-on-one conversations with analysts, Caine delivered substantially the same earnings information to each analyst: that in 2001 Raytheon's earnings would likely have the same seasonal distribution as in 2000, and, more specifically, that Raytheon would generate one-third of its EPS in the first half of the year and the remaining two-thirds in the second half of the year. Caine also told certain analysts that their estimates for first quarter earnings or revenue for particular divisions were "too high," "aggressive," or "very aggressive." After their conversations with Caine, the analysts revised their estimates. The revised estimates caused the Street's consensus to fall to one penny below Raytheon's internal 2001 first quarter EPS estimate. 2.

In the Matter of Secure Computing Corporation and John McNulty, Securities Exchange Act Release No. 34-46895 (Nov. 25, 2002)

On November 25, 2002, the Commission instituted public cease-and-desist proceedings against Secure Computing Corporation ("Secure" or the "Company") and John McNulty ("McNulty") (collectively, the "Respondents"). In anticipation of the proceedings, Respondents both submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over them and the subject matter of these proceedings, Respondents consented to the entry of an Order: 1) finding that Secure violated the periodic reporting provisions of the federal securities laws and Regulation FD, 2) finding that McNulty was a cause of Secure’s violations, 3) ordering Secure to cease and desist from committing or causing any violations and any future violations of these provisions, and 4) ordering McNulty to cease and desist from causing any violations and any future violations of these provisions. The Commission found that in early March 2002, Secure, a Silicon Valley software company, and its Chief Executive Officer ("CEO"), John McNulty, disclosed material non-public information about a significant contract to two portfolio managers at two institutional advisers in violation of Regulation FD, which requires disclosures of material, non-public information to be made to the marketplace as a whole. Following the disclosures, Secure announced the contract to the public in a press release issued after the close of the stock markets. However, investors who sold Secure stock prior to the Company's press release were denied information that may have affected their investment decisions. 23

3.

In the Matter of Siebel Systems, Inc., Securities Exchange Act Release No. 3446896 (Nov. 25, 2002)

On November 25, 2002, the Commission instituted public cease-and-desist proceedings against Siebel Systems, Inc. (the "Company" or "Siebel"). In anticipation of the institution of these proceedings, Siebel has submitted an Offer of Settlement (the "Offer"), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over it and the subject matter of these proceedings, which Siebel admits, Siebel consented to the entry of an Order: 1) finding that Siebel violated the periodic reporting provisions of the federal securities laws and Regulation FD, and 2) ordering Raytheon to cease and desist from committing or causing any violations and any future violations of these provisions. The Commission found that on November 5, 2001, the Company's Chief Executive Officer ("CEO"), disclosed material, nonpublic information to persons outside the Company at an invitationonly technology conference hosted by Goldman Sachs & Co. ("Goldman Sachs") in California (the "Technology Conference"). In response to questions from the Goldman Sachs analyst who organized the conference, the Company's CEO disclosed that the Company was optimistic because its business was returning to normal. These statements contrasted with negative statements that he had made about the Company's business three weeks earlier, in which he characterized the market for information technology as tough, and indicated that the Company expected business to remain that way for the rest of the year. Prior to the Technology Conference, the Company's investor relations staff knew that the conference would not be simultaneously broadcast to the public. As a result, the Company intentionally disclosed material, nonpublic information at the Technology Conference. The Commission further found that immediately following the disclosures, certain attendees at the conference purchased Respondent's stock or communicated the disclosures to others who purchased its stock. On the day of the conference, Respondent's stock price closed approximately 20% higher than the prior day's close and the trading volume was more than twice the average daily volume. The public did not have equal access to and was unable to benefit from the information that was disclosed to the attendees at the Technology Conference. Accordingly, the Company violated Regulation FD. 4.

Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: Motorola, Inc., Securities Exchange Act of 1934 Release No. 46898 (November 25, 2002)

In its Report of Investigation, the Commission stated the following: The Division of Enforcement conducted an investigation into whether Motorola, Inc. ("Motorola") violated the federal securities laws when one of its senior officials selectively disclosed information about the company's quarterly sales and orders during private telephone calls with sell-side analysts in March 2001. During those calls, Motorola's Director of Investor Relations (the "IR Director") told analysts that first quarter sales and orders were down by at least 25%. Previously, in a February 23, 2001 press release and a public conference call, Motorola had said only that sales and orders were experiencing "significant weakness" and that Motorola was likely to miss its earnings estimates of 12 cents per share for the 24

quarter and have an operating loss for the quarter if the order pattern continued. Motorola decided to telephone the analysts and tell them that "significant," as used on February 23, meant a "25% or more" decline because the IR Director had seen the analysts' models and research notes and concluded that the analysts had not understood from the February 23 conference call just how disappointing the results were for the quarter. Motorola specifically decided not to issue a new press release or otherwise make any timely public disclosure of this additional information. The conduct in question was inconsistent with the disclosure mandate of Regulation FD, which generally prohibits issuers from communicating material, nonpublic information to securities professionals without simultaneous public disclosure of the same information. The Commission issued this Report to provide guidance concerning Regulation FD and to highlight conduct that the Commission believes the regulation was specifically intended to prevent. When an issuer endeavors to make public disclosure of material information -- but later learns that it did not, in fact, fully communicate the intended message, and determines that further disclosure is needed -- the proper course of action under Regulation FD is not to selectively disclose the corrected message in private communications with industry professionals, but rather to make additional public disclosure. Here, before engaging in the conduct in question, Motorola officials sought the advice of inhouse legal counsel. Counsel approved the conduct in question based on a determination that the information in question was not material or nonpublic. Counsel's determination was erroneous in both respects. Nevertheless, because it appears that counsel's advice was sought and given in good faith, and in light of the surrounding facts and circumstances, the Commission issued the Report rather than bringing an enforcement action against Motorola or its senior officials.

II.

INTERNET-RELATED ENFORCEMENT CASES 1.

SEC v. Spectrum Brands Corp., et al., Lit. Rel. No. 17265 (Dec. 11, 2001), www.sec.gov/litigation/litreleases/lr17265.htm.

On December 11, 2001, the Commission filed a civil action alleging an ongoing fraudulent scheme to exploit the nation's fear of anthrax and bio-terrorism. The Commission's complaint alleges manipulation of the stock of a publicly traded shell company, Spectrum Brands Corp. The Complaint alleges that Spectrum Brands is secretly owned and controlled by a group stock promoters located in Hicksville, New York. These undisclosed principals include two individuals -- Saverio (Sammy) Galasso III and David Hutter (a/k/a David Green) -- who pled guilty to unrelated felony charges and are awaiting sentencing, and an associate, Charlie Dilluvio. The sole officer and director of Spectrum Brands, Michael J. Burns, was also charged. All four individuals were arrested on December 11, 2001 on criminal charges relating to the Spectrum Brands stock fraud. According to the Complaint, on or before November 5, 2001, Spectrum Brands posted on its website that it had a hand-held device called the "DeGERMinator" capable of "WIP[ING] OUT SURFACE GERMS IN LESS THAN 5 SECONDS, INCLUDING ANTHRAX." The closing price of Spectrum Brands' common stock tripled on this news, shooting up from approximately $4 on November 1, to $7 on November 2, to $11.75 on November 5, with an intra-day high of $14 on November 5. Meanwhile, the Hicksville promoters engaged in a series of transactions designed to 25

create artificial volume in the market for Spectrum Brands securities and sold stock into the inflated market. The company made certain corrective disclosures on its website, but continued to tout in press releases and spam e-mails its supposed progress in combating "bio-terrorism" and "cyber-terrorism. No disclosure has been made of the substantial ownership positions and management roles of the Hicksville promoters. Thus, unbeknownst to the investing public, Spectrum Brands continues to be owned and operated in secret by Galasso and Hutter, both of whom are convicted felons. The Commission charged defendants with violations of the anti-fraud provisions and seeks permanent injunctions, restitution, disgorgement of ill-gotten gains with prejudgment interest, and civil penalties from all defendants and an officer and director bar against Burns. 2.

SEC v. Invest Better 2001 et al., Lit. Rel. No. 17296 (Jan. 7, 2002), www.sec.gov/litigation/litreleases/lr17296.htm.

On December 13, 2001, as part of its "real time" enforcement initiative, the SEC filed an enforcement action to stop an ongoing fraud by Invest Better 2001, before having identified the individuals behind the scheme. On January 7, 2002, the Commission amended its complaint to add Cole Bartiromo, a 17-year-old high school student, who the Commission has now identified as a principal behind Invest Better as well as an additional defendant. In a settlement also announced on December 13th, the Commission is recovering from Bartiromo approximately $900,000 obtained from investors in the scheme. The Amended Complaint alleges that from at least November 1, 2001, through approximately December 15, 2001, Bartiromo, through Invest Better, raised more than $1 million from more than 1,000 investors through the offer of purportedly "guaranteed" and "risk-free" investment programs in which Invest Better pooled investor funds to bet on sporting events, and promised to repay investors between 125% to 2500% of their principal within specified periods ranging from three days to several weeks, depending on the program selected. The Amended Complaint alleges that in December 2001, Bartiromo transferred approximately $900,000 of investor funds to an account he controls at a casino in Costa Rica. On December 13th, the Court issued a partial final judgment and order, on consent, which permanently enjoins Bartiromo and Invest Better, directs Bartiromo and Invest Better to repatriate all assets outside the United States and deposit such assets into the Court's account, freezes Bartiromo's and Invest Better’s assets, directs Bartiromo and Invest Better to provide an accounting, and grants other expedited and equitable relief. On April 29, 2002, the Commission filed a second amended complaint alleging that Bartiromo conducted an Internet pump and dump scheme that manipulated the stock price of fifteen publiclytraded companies. The second amended complaint seeks, among other things, civil injunctive relief, disgorgement plus prejudgment interest and civil money penalties. III.

BROKER-DEALER CASES

A significant number of Commission enforcement actions are filed each year against brokerdealer firms and persons associated with them. These actions focus on fraudulent sales practices, as 26

well as on violations of the books and records, customer protection, and net capital provisions of the federal securities laws. The Commission also pursues firms and their senior management for failure reasonably to supervise employees to prevent violative conduct. 1.

Global Settlement in Principle with Top Investment Firms, SEC Release No. 2002179 (Dec. 20, 2002), www.sec.gov/news/press/2002-179.htm

On December 20, 2002, Chairman Harvey L. Pitt, New York Attorney General Eliot Spitzer, North American Securities Administrators Association President Christine Bruenn, NASD Chairman and CEO Robert Glauber, New York Stock Exchange Chairman Dick Grasso, and state securities regulators announced an historic settlement in principle with the nation's top investment firms to resolve issues of conflict of interest at brokerage firms. The "global settlement" concludes a joint investigation begun in April by regulators into the undue influence of investment banking interests on securities research at brokerage firms. The settlement, if finalized and approved by the Commission, will bring about balanced reform in the industry and bolster confidence in the integrity of equity research. Terms of the agreement in principle include: 

The insulation of research analysts from investment banking pressure. Firms will be required to sever the links between research and investment banking, including analyst compensation for equity research, and the practice of analysts accompanying investment banking personnel on pitches and road shows. This will help ensure that stock recommendations are not tainted by efforts to obtain investment banking fees.



A complete ban on the spinning of Initial Public Offerings (IPOs). Brokerage firms will not allocate lucrative IPO shares to corporate executives and directors who are in the position to greatly influence investment banking decisions.



An obligation to furnish independent research. For a five-year period, each of the brokerage firms will be required to contract with no less than three independent research firms that will provide research to the brokerage firm's customers. An independent consultant ("monitor") for each firm, with final authority to procure independent research from independent providers, will be chosen by regulators. This will ensure that individual investors get access to objective investment advice.



Disclosure of analyst recommendations. Each firm will make publicly available its ratings and price target forecasts. This will allow for evaluation and comparison of performance of analysts.



Settled enforcement actions involving significant monetary sanctions.

The agreement is subject to approval by the full Commission.

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Each of the firms will pay a fine, pay monies toward investor restitution, and will be required to escrow funds that will be used to pay for independent research. The agreement in principle that was reached totals more than $1.4 billion in penalties, restitution and monies to be used for investor education. 2.

SEC, NYSE, NASD Fine Five Firms Total of $8.25 Million for Failure to Preserve E-Mail Communications, SEC Release No. 2002-173 (Dec. 3, 2002), www.sec.gov/news/press/2002-179.htm

On December 3, 2002, the Commission, the New York Stock Exchange and NASD announced joint actions against five broker-dealers for violations of record-keeping requirements concerning email communications. The firms consented to the imposition of fines totaling $8.25 million, along with a requirement to review their procedures to ensure compliance with record-keeping statutes and rules. Each of the firms - Deutsche Bank Securities Inc.; Goldman, Sachs & Co.; Morgan Stanley & Co. Incorporated; Salomon Smith Barney Inc.; and U.S. Bancorp Piper Jaffray Inc. - consented, without admitting or denying the allegations, to findings that each: 1) violated the broker-dealer records retention provisions of the federal securities laws, and violated corresponding NYSE and NASD Rules by failing to preserve for a period of three years, and/or preserve in an accessible place for two years, electronic communications relating to the business of the firm, including interoffice memoranda and communications; 2) violated NYSE Rule 342 and NASD Rule 3010 by failing to establish, maintain and enforce a supervisory system to assure compliance with NASD and NYSE rules and the federal securities laws relating to retention of electronic communications. The firms agreed to a penalty of a censure and fines totaling $8.25 million - $1.65 million per firm - to be paid to the U.S. Treasury, NYSE and NASD. The firms also agreed to review their procedures regarding the preservation of e-mail communications for compliance with federal securities laws and the rules of the NYSE and NASD. Each firm agreed to inform each regulator, in writing, within 90 days that it has established systems and procedures reasonably designed to achieve compliance with the statute and rules relating to e-mail retention. The respondents' failure to preserve e-mail communications and\or to maintain them in an accessible place was discovered during investigations being conducted jointly and separately by the SEC, NYSE and NASD. Some firms backed up e-mail communications on tape or other media that was represented as part of a process designed as a disaster-recovery or business-continuity measure, or for another business purpose. However, these firms discarded or recycled and overwrote their back-up tapes and other media, often a year or less after back-up occurred. Each firm had inadequate procedures and systems to retain and make accessible e-mail communications. While some firms relied on employees to preserve copies of the e-mail communications on the hard drives of their individual personal computers, there were no systems or procedures to ensure that employees did so.

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In those instances in which the firms did retain e-mail communications, those communications were often stored in an unorganized fashion on back-up tapes, other media, or on the hard drives of computers used by individual employees. In some instances, hard drives of computers preserving electronic mail communications were erased when individuals left the employment of the firm. Although each firm had an obligation to preserve e-mail communications pursuant to the broker-dealer records retention provisions of the federal securities laws, and corresponding NYSE and NASD Rules, during all or part of the period from 1999 to at least 2001, each of the firms failed to preserve for three years, and/or to preserve in an accessible place for two years, electronic communications (including interoffice memoranda and communications) that related to its business as a member of an exchange, broker or dealer. Cases Involving Sales Practice Violations and Market Manipulations 1.

SEC v. Michael J. Rivers and Thomas E. Hall, Lit. Release No. 17828 (Nov. 5, 2002), www.sec.gov/litigation/litreleases/lr17828.htm.

On October 31, 2002, the Commission filed a complaint in the United States District Court for the District of Minnesota against Thomas E. Hall ("Hall") and Michael J. Rivers ("Rivers") alleging that Hall and Rivers perpetrated a fraudulent scheme to artificially increase the closing price of First Federal Capital Corporation ("First Federal") common stock. Hall was employed as a registered representative and branch manager for U.S. Bancorp Piper Jaffray Inc. ("Piper Jaffray"). Rivers was a customer of Hall at Piper Jaffray. The Commission's complaint alleges that the purpose of this scheme was to prevent or reduce numerous margin calls Rivers received on his trading accounts at Piper Jaffray. The complaint also alleges that Hall and Rivers' scheme artificially increased the closing price of First Federal common stock, which constituted violations of the antifraud provisions of the federal securities laws. Hall consented, without admitting or denying the allegations in the complaint, to the entry of an order of permanent injunction enjoining him from violations of the antifraud provisions of the federal securities laws and imposing a civil penalty of $50,000. The litigation against Rivers is pending. Separately, on November 5, 2002, the Commission entered an Order Instituting Proceedings Making Findings and Imposing Remedial Sanctions (Order) against U.S. Bancorp Piper Jaffray Inc. (Piper Jaffray). Piper Jaffray, while neither admitting nor denying the Order's findings, consented to the entry of the Order and the imposition of sanctions against it. The Commission's Order found that from January 1998 through September 2001, Rivers and Hall engaged in a "marking the close" scheme. The Commission's Order found that Rivers and Hall placed day-end trades at artificially higher prices in this stock thereby increasing improperly the stock's closing price so as to satisfy or reduce margin calls on his brokerage accounts at Piper Jaffray. The Commission's Order found that Piper Jaffray failed to supervise Hall and failed to have adequate systems in place to detect or prevent this marking the close scheme. The Order censures Piper Jaffray and requires it to maintain the following undertakings: creating a marking the close exception report, and the creation of at least eight District Sales Supervisors to replace the single 29

position previously responsible for supervising "producing" branch managers. The Order also requires Piper Jaffray to pay a civil monetary penalty of $100,000. 2.

SEC v. Charles Zandford, 122 S. Ct. 1899, 2002 U.S. LEXIS 4023; Fed. Sec. L. Rep. (CCH) P91,795 (June 3, 2002).

The U.S. Supreme Court ruled unanimously in favor of the SEC's longstanding interpretation of federal securities law, saying that the Commission properly alleged securities fraud in its complaint against a broker who emptied a client's investment account and used the proceeds for his own benefit. Broker Charles Zandford of Maryland had opened a joint investment account for an elderly client and his mentally retarded daughter. The client had intended the proceeds of the account to provide for his daughter, but, without the client's knowledge, Zandford sold the securities in the account and converted the proceeds to his personal use. Based on Zandford's prior criminal conviction for wire fraud, the SEC won a federal civil judgment that Zandford's actions also violated antifraud provisions of federal securities laws. A federal appeals court later reversed the judgment and dismissed the case, reasoning that because Zandford's activities did not involve misrepresenting the value of a particular security, they were not "in connection with the purchase or sale of any security." The Supreme Court reversed the appeals court, ruling that the Commission is entitled to deference in its interpretation of the antifraud provisions of the Securities Exchange Act of 1934: "(N)either the SEC nor this Court has ever held that there must be a misrepresentation about the value of a particular security in order to run afoul of the Act." The Supreme Court sent the case back to the U.S. district court for further proceedings. 3.

SEC v. Frank D. Gruttadauria, et. al., Lit. Rel. No. 17369 (Feb. 21, 2002), www.sec.gov/litigation/litreleases/lr17369.htm.

On February 21, 2002, the Commission filed an action charging Frank D. Gruttadauria, formerly the branch manager for the Cleveland Ohio office of Lehman Bros. Inc., with securities fraud. The Commission's complaint alleges that over the last six years, while he worked at two different brokerage firms, Gruttadauria stole at least $40 million in the course of defrauding more than 50 clients. Also charged with securities fraud were two entities controlled by Gruttadauria, DH Strategic Partners, Inc. and JYM Trading Trust, which Gruttadauria used to misappropriate the funds from his clients. The Commission is seeking a temporary restraining order, a preliminary injunction, asset freezes, accountings, the appointment of a receiver for Gruttadauria, DH Strategic Partners, and JYM Trading Trust, as well as other emergency relief. The Commission's complaint alleges that over a period of many years, Gruttadauria falsely told customers that he had bought or sold securities for their accounts, when, in fact, he had misappropriated their funds for his own purposes. He also materially misrepresented the value of and the positions held in customer accounts, often falsely telling customers that their accounts contained a wide variety of holdings worth millions of dollars. In some instances, Gruttadauria induced customers to give him funds by claiming that he had opened accounts for them when, in fact, no account ever existed for the client and he simply misappropriated the funds. 30

The complaint alleges that Gruttadauria misappropriated funds from customers and directed the funds to other customers either as purported returns on non-existent investments or to satisfy withdrawal requests from accounts as to which Gruttadauria had deceived the account holders into believing that they had sufficient funds to make transfers. In particular, from at least 1996 through October 2000, while employed at Cowen & Co. and SG Cowen Securities Corporation, Gruttadauria misappropriated over $25 million in customer funds by fraudulently directing the money into an account that he controlled in the name of JYM Trading Trust, and using it to make payments to other customers. Beginning in October 2000, Gruttadauria similarly misappropriated and funneled over $15 million in customer funds through a bank account he controlled in the name of DH Strategic Partners, Inc. The complaint further alleges that, to conceal his fraud, Gruttadauria created and sent defrauded customers unauthorized and falsified account statements that greatly overstated the value of the customers' accounts, reflected holdings that did not exist and securities transactions that had never occurred, and failed to disclose the unauthorized withdrawals from the accounts. The most recent false account statements for the accounts of at least 50 of Gruttadauria's customers reflected an aggregate value of about $278 million, whereas the actual value of accounts held for these customers at Lehman Brothers was about $1.8 million. Without the knowledge or authorization of these customers, Gruttadauria caused their actual brokerage account statements to be sent to entities or post office boxes under his control. The Commission's complaint charges Gruttadauria, DH Strategic Partners, Inc. and JYM Trading Trust with violations of the antifraud provisions of the federal securities laws. The complaint also names as relief defendants Sarah Z. Emamy, a resident of Gates Mills, Ohio, Laurene U. English, Gruttadauria's former sales assistant, and Charlie Whiskey, LLC, a limited liability company of which Gruttadauria is a 50% owner, and which owns a Lear Jet. The complaint alleges that Gruttadauria unjustly enriched the relief defendants by transferring to them over $3.4 million in money and assets derived from his illegal conduct. The Commission’s investigation is continuing. On June 27, the Commission filed an Amended Complaint charging that Laurene English, Gruttadauria's longtime former assistant, aided and abetted Gruttadauria's fraudulent scheme. In addition, the Commission named Gruttadauria's wife, Margo Gruttadauria, from whom he is separated, as a relief defendant. The Commission seeks to recover assets that Gruttadauria conveyed to Margo Gruttadauria. 4.

SEC v. U.N. Dollars Corp., et al., Lit. Rel. No. 17177 (Oct. 11, 2001), www.sec.gov/litigation/litreleases/lr17177.htm.

On October 11, 2001, the Commission announced that it filed a complaint in the United States District Court for the Southern District of New York against fourteen individuals and entities for their roles in a market manipulation of U.N. Dollars Corp. ("UNDR"), a former bulletin board stock based in Jacksonville, Florida. The complaint alleges that the fraud, which occurred between September 1999 and March 2000, drove UNDR's stock price from $.01 per share to an all-time high of $1.25 per share in less than six months, before the Commission suspended trading in UNDR securities on March 13, 2000. According to the complaint, Edward Durante, a recidivist securities law violator, reaped about 31

$100,000 in illegal profits by secretly controlling the supply of UNDR stock, creating an artificial market, and then dumping the stock at artificially inflated prices. The complaint also alleges that UNDR executives participated in the scheme, and made false and misleading representations about UNDR's business activities. The filing of the Commission's complaint coincides with the filing of criminal charges by the United States Attorney's Office for the Southern District of New York concerning a scheme to manipulate several different securities in the Spring of 2000. It is estimated that Durante and others reaped illegal trading profits of more than $30 million while orchestrating manipulations of U.N. Dollars Corp., Wamex Holdings Inc., Ramoil Management Ltd., Absolutefuture.com, and other stocks, through a network of promoters, market makers and brokers under their control. In a related matter, the Commission also ordered four Internet stock touters who made materially false and misleading statements about UNDR securities to cease and desist and required these respondents to pay disgorgement and prejudgment interest totaling $11,323.03. The touters, Millennium Group of New York LLC, Roman Suleymanov, Alex Rovner, and Gennady Favelyukis, consented to the order without admitting or denying the Commission's findings. The Internet websites used to promote UNDR were Realstocks.com, WinningStocks.com, and StocksNetwork.com. (Rel. No. 33-8023, Rel. No. 34-44919; File No. 3-10618). Failure to Supervise Cases 1.

In the Matter of George J. Kolar, SEA Rel. No. 46127 (Jun. 26, 2002).

The Commission affirmed the ALJ’s decision in this failure to supervise case. The law judge found that Kolar, metropolitan area manager for Dean Witter Reynolds, Inc., failed to exercise reasonable supervision over Dean C. Turner, a salesman in Dean Witter's Troy, Michigan branch office, who violated registration and antifraud provisions of the securities laws. In August 1992, Kolar received information that Turner was "selling away"; i.e., that, contrary to Dean Witter's prohibition and the rules of various self-regulatory organizations, Turner was receiving compensation for selling investments in Lease Equities Fund, Inc. ("LEF") outside the scope of his employment with Dean Witter. Following an interview of Turner and an examination of what Turner claimed was his 1991 tax return, Kolar and others concluded (incorrectly) that the allegations against Turner were unfounded. No further investigation of Turner was conducted during the period at issue. The law judge found that, during a nearly three-year period following that interview, from September 1992 through June 1995 when Kolar left Detroit to take a similar position with Dean Witter in Cleveland, Turner willfully violated registration and antifraud provisions of the securities laws in connection with his offer and sale of LEF promissory notes. The Commission’s opinions states: “We have made it abundantly clear that supervisors must act decisively when an indication of irregularity is brought to their attention. That irregularity need not be a violation of the securities laws. Decisive action is necessary whenever supervisors are made aware of suspicious circumstances, particularly those that have an obvious potential for violations.” 32

The Commission found that Kolar had the requisite degree of responsibility, ability, or authority to affect Turner's conduct, and that he was therefore Turner's supervisor. The Commission further found that "control" was not a necessary prerequisite, but that Kolar satisfied that requirement as well. The Commission rejected Kolar’s argument that because the control over Turner was shared with others, he was not his supervisor. Rather, the Commission found that as Detroit metropolitan area manager, Kolar had direct supervisory authority over the personnel in the Troy office; he participated in disciplinary actions affecting that office, and his recommendations carried substantial weight The Commission emphasized that “supervisors cannot rely on the unverified representations of their subordinates. Nor, under circumstances like those in this case, can they rely on purportedly exonerating documents supplied by those subordinates.” Kolar was suspended for six months from acting in a supervisory capacity with any registered broker or dealer, and fined $20,000. 2.

In the Matter of Norwest Investment Services, Inc. (now known as Wells Fargo Brokerage Services, LLC), SEA Rel. No. 45460 (Feb. 20, 2002), www.sec.gov/litigation/admin/34-45460.htm.

On February 20, 2002, the Commission accepted an Offer of Settlement from Norwest Investment Securities in response to the institution of public administrative proceedings. Norwest was a bank affiliated broker-dealer registered with the Commission and a member of the NASD. From February 1999 to August 1999, a former registered representative (RR) of Norwest’s Aurora, Colorado branch office, engaged in various sales practice violations, including fraudulent mutual fund switching in at least seven customer accounts. Norwest failed reasonably to supervise the RR to prevent or detect the RR's mutual fund switching violations. During the violative period, Norwest had inadequate mutual fund switching procedures to prevent or detect the RR's misconduct. Further, Norwest did not have a system in place to communicate, implement, and enforce effectively the switching policies and procedures it did have. The Commission concluded that the mutual fund switches violated the anti-fraud provisions and the company failed to supervise the RR with a view toward preventing the violative conduct. Norwest was censured and ordered to pay disgorgement of $3,245.19 and penalties of $150,000. The company was ordered to: maintain the revised procedures it implemented in the year 2000 relating to mutual fund switching; retain an Independent Consultant to conduct a review of existing mutual fund switching procedures to ensure their adequacy; adopt and implement the procedures recommended by the consultant within 150 days or advise the consultant of any procedures it considers unnecessary or inappropriate; and to cooperate fully with the independent consultant.

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3.

In the Matter of Quest Capital Strategies, Inc. and David Chen Yu, SEZ Rel. No. 44935, IAA Rel. No. 1990 (Oct. 15, 2001) www.sec.gov/litigation/opinions/3444935.htm.

On October 15, 2001, the Commission issued an opinion on the Division of Enforcement’s appeal from the decision of an administrative law judge, which dismissed proceedings against Quest Capital Strategies, Inc., a registered broker-dealer and investment adviser and David Chen Yu, Quest’s president and sole owner, for violating the failure to supervise provisions of the federal securities laws. The Commission reversed the ALJ’s opinion and held that both Quest and Yu failed to supervise a representative John Nakoski, who violated Securities Act, the Exchange Act, and the Advisers Act while he was subject to the supervision of Quest and Yu. Quest and Yu had more than an “indication of irregularity” with respect to Nakoski’s conduct. They had been made aware that Nakoski was illegally borrowing money from his clients under the guise of an investment scheme and he was illegally advertising this scheme. Supervisors had documentation of Nakoski’s conduct from both the Enforcement Division and the NASD and would have had documentation had they adequately reviewed Nakoski’s records. Both Quest and Yu knew Nakoski had deliberately violated company policy and should have increased their supervision. Instead, they relied on Nakoski’s assurance of not repeating the misconduct. Both Quest and Yu continued to ignore red flags of violations including Nakoski’s letter to the Division indicating a future solicitation of funds and evidence by the NASD of Nakoski’s continued advertising. Quest and Yu were mistaken in relying on Nakoski’s unverified representations as opposed to dismissing him or instituting heightened supervision. Respondents could have taken a number of steps including surprise inspections pursuant to the independent contract agreement between Nakoski and Quest, questioning Nakoski’s salesmen and office personnel about the loan program, and questing Nakoski’s customers. The Commission noted that Quest and Yu were not entitled to claim the Exchange Act’s defense to deficient supervision, as their established procedures would not have been reasonably expected to detect and prevent misconduct. The ALJ was mistaken in finding that Respondents supervisory mechanisms met this defense. Commission found that Quest and Yu’s supervisory failures were egregious as they had actual knowledge that Nakoski had deliberately violated company directives by soliciting and raising money from investors. The respondents had abdicated their responsibility by relying on Nakoski’s assurances and permitted the fraudulent scheme to continue for a year, which resulted in investor harm. The Commission then issued an order disallowing Quest to maintain branch offices unless supervised by an on-suite principal and subject to surprise semi-annual surprise inspections, as well as a $50,000 fine. Yu was barred from associating with any broker-dealer or investment adviser in a supervisory capacity for one year, upon which he must apply to re-associate, and he was fined $50,000. IPO Allocation Practices Case 1.

SEC v. Credit Suisse First Boston, Corp., Lit. Rel. No. 17327 (Jan. 22, 2002), www.sec.gov/litigation/litreleases/lr17327.htm.

On January 22, 2002, the Commission announced that it settled charges against Credit Suisse First Boston Corporation (CSFB), a New York-based brokerage firm and investment bank, relating to 34

the Commission's investigation of the firm's IPO allocation practices. CSFB agreed (1) to pay a total of $100 million in the Commission's action and in a related action announced by the National Association of Securities Dealers Regulation, Inc. (NASDR); (2) to be enjoined by a federal court from future violations; and (3) to adopt extensive new policies and procedures. The $100 million payment is composed of $70 million in disgorgement of improper gains, and $30 million in civil penalties or fines. In connection with this matter, the Commission filed a Complaint against CSFB alleging violations of certain NASD Conduct Rules and of books and records requirements under the federal securities laws. Given the nature and scale of the misconduct alleged in the Complaint, the Commission determined to seek an injunction based, in part, on violations of NASD Conduct Rules. According to the Complaint, in exchange for shares in "hot" IPO's, CSFB wrongfully extracted from certain customers a large portion of the profits that those customers made by immediately selling ("flipping") their IPO stock. The profits were channeled to CSFB in the form of excessive brokerage commissions generated by the customers in unrelated securities trades that the customers effected solely to share the IPO profits with CSFB. CSFB agreed to settle the Commission's action and consented, without admitting or denying the allegations of the Complaint, to the entry of a final judgment that: (1) permanently enjoins CSFB, directly or indirectly, from certain violations of NASD Conduct Rules 2110 and 2330 and Section 17(a)(1) of the Exchange Act and Rule 17a-3, thereunder; (2) orders disgorgement of $70 million, which would be reduced to $35 million in recognition of CSFB's anticipated payment of $35 million in disgorgement to NASDR in a related NASDR proceeding against CSFB; (3) orders a civil penalty of $30 million pursuant to Section 21(d) of the Exchange Act, which would be reduced to $15 million in recognition of CSFB's payment of a $15 million penalty to NASDR in the related NASDR proceeding against CSFB; and (4) orders CSFB to comply with certain undertakings discussed below. As part of the settlement, CSFB has undertaken to establish a broad range of new policies and procedures relating to IPO allocations to prevent a recurrence of the misconduct described in the Complaint. Among the undertakings to which CSFB has consented, the firm will implement extensive new policies and procedures relating to the allocation of IPO shares, the account opening process, commission levels, and supervisory practices. The new policies include a prohibition against the following conduct: (1) making a wrongful arrangement or a wrongful quid pro quo of any kind with customers in exchange for IPO allocations; and (2) improper sharing of profits or losses with a customer who receives an IPO allocation or allocations. CSFB also has agreed to retain an Independent Consultant to conduct a review to provide reasonable assurance of the implementation and effectiveness of its new policies and procedures. This review will begin one year after the date of the entry of the Final Judgment.

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Books and Records Violations, Fraudulent Reporting, and Unregistered Broker-Dealers 1.

SEC v. Nutrition Superstores.com, Inc., Advanced Wound Care, Inc., Franchise Direct, Inc., Anthony F. Musso, Jr., Jeffery Gill, Wayne Santini and Andrew W. Doney, Lit. Release No. 17888 (Dec. 10, 2002), www.sec.gov/litigation/litreleases/lr17888.htm

On December 10, 2002, the Commission announced that it filed a civil action in the United States District Court for the Southern District of Florida against defendants Nutrition Superstores.com, Inc., Advanced Wound Care, Inc., Franchise Direct, Inc., Anthony F. Musso, Jr., Jeffrey Gill, Wayne Santini and Andrew W. Doney for perpetuating a fraudulent offering of unregistered securities. According to the Commission's complaint, between 1998 and 2001, defendants raised at least $10.5 million from over 770 investors nationwide who purchased stock in Nutrition Superstores and Advanced Wound Care, both purported distributors of health and nutrition products. Securities were sold through a group of unlicensed sales agents affiliated with a boiler-room, Franchise Direct. Using scripts and employing hard pressure sales tactics, the sales agents - given bogus "vice president" titles by the issuer de jour (Nutrition Superstores or Advanced Wound Care) - made egregious misrepresentations and omissions concerning, among other things, the companies' holdings and business operations, projected revenues, their impending "hot" Initial Public Offerings ("IPO"), use of investor proceeds, and expected profits. In addition, Advanced Wound Care made misrepresentations regarding purported celebrity endorsements. Defendants also did not disclose that Franchise Direct and its sales agents received up to 25% of all investor proceeds as commissions. Based on the foregoing, the Commission seeks permanent injunctions against Nutrition Superstores, Advanced Wound Care, Franchise Direct, Musso, Gill, Santini, and Doney, based on their violations of the registration and antifraud provisions of the federal securities laws; and as against Franchise Direct and Doney based on their violations of broker-dealer registration provisions of the federal securities laws. (In the alternative, with regard to Musso and Gill, the Commission seeks to charge them as "control persons" of Nutrition Superstores and/or Advanced Wound Care for Nutrition Superstores' and Advanced Wound Care's violations of the registration and antifraud provisions of the federal securities laws. In addition, the Commission seeks disgorgement with prejudgment interest against Nutrition Superstores, Advanced Wound Care, Franchise Direct, Musso, Gill, Santini, and Doney; and civil monetary penalties against Franchise Direct, Musso, Gill, Santini, and Doney. Finally, the Commission seeks officer and director bars against Musso, Gill and Santini. Simultaneous with filing the Commission's complaint, the Commission instituted and simultaneously settled an administrative proceeding making findings and imposing remedial sanctions and a cease-and-desist order against John Vailati, the President of Franchise Direct, for his role in the fraudulent scheme.

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2.

In the Matter of iCapital Markets, LLC, (Datek Securities), SA Rel. No. 8059, SEA Rel. No. 45328 (Jan. 24, 2002), www.sec.gov/litigation/admin/33-8059.htm.

On January 24, 2002, the Commission charged iCapital Markets LLC, formerly Datek Securities Corp., with securities fraud and widespread violations of the Commission’s broker-dealer books and records and reporting provisions. The Commission censured the firm and ordered iCapital to pay a $6.3 million penalty. iCapital consented to the issuance of the order without admitting or denying the findings contained in it, and to the relief imposed. The Commission found that from at least 1993 through March 1998, when it sold its daytrading business, Datek Securities engaged in a widespread fraudulent scheme by illegally executing proprietary trades through the Nasdaq Stock Market’s Small Order Execution System (SOES). The SOES system was designed for small public customers, and until last year, a broker-dealer was prohibited from using the SOES system to trade for its own account. The SOES system was the only Nasdaq trading system that offered automatic execution at the best available price. By hiding its use of the SOES system for proprietary trading, Datek Securities obtained SOES automatic execution, which, combined with Datek Securities’ day-trading software, gave it a significant advantage. The Commission found that Datek Securities fraudulently used the SOES system to execute millions of proprietary trades, resulting in tens of millions of dollars in trading profits. Datek Securities accomplished the fraud through the use of sophisticated software, dozens of nominee accounts, concealment and misrepresentations to regulators, fictitious books and records, and false reports filed with the Commission. The Commission’s order finds that in February 1998, Datek Securities reorganized under a holding company (the Company). On March 30, 1998, Datek Securities sold the assets of its daytrading business to Heartland Securities Corp. In the years following this sale, the Company hired new managers and other industry professionals without prior ties to Datek Securities. It also undertook to eliminate control and reduce ownership of certain shareholders in the Company. In determining to accept iCapital’s offer of settlement, the Commission considered remedial acts undertaken by iCapital, and the Company’s new management and investors, and cooperation afforded the staff. The Commission’s investigation as to others is continuing. IV.

MUTUAL FUNDS AND INVESTMENT ADVISERS

The amount of investor assets under mutual fund management has grown enormously in the past ten years. Assets under management by investment advisers have also shown significant growth. Because of this increase in individual investor’s participation in mutual funds and with investment advisers, the Commission continues to bring significant cases in this area.

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Adviser Fraud and Failures to Disclose Conflicts of Interest 1.

SEC v. Southmark Advisory, Inc., Southmark, Inc., and Wendell D. Belden, Lit. Release No. 17892 (December 12, 2002), www.sec.gov/litigation/litreleases/lr17892.htm

On November 21, 2002, the Commission obtained, by consent, permanent injunctions and other relief in its enforcement action against Southmark Advisory, Inc. (Southmark Adviser), an SECregistered investment adviser, Southmark, Inc. (Southmark Broker), an SEC-registered broker-dealer, and Wendell D. Belden, the owner of both firms. According to the SEC's complaint, Belden used Southmark Adviser and Southmark Broker to defraud his predominantly elderly clients, by misleading them about the security of their invested principal, and by failing to inform them of alternative investment opportunities in order to enrich himself at their expense. The SEC alleged that Belden attracted seniors desiring safe investments by advertising certificates of deposit (CDs), and then aggressively pitched to the prospective investors, in lieu of CDs, a purportedly personalized, managed mutual fund investment program. The SEC alleged that Belden defrauded his clients in a number of ways: by lying about the safety of the managed mutual fund program; by failing to tell the clients about other investment options that were more advantageous; by failing to tell the clients that Southmark Broker would earn a 4% sales commission if the clients invested in the managed mutual fund program; and by failing to tell the clients about disciplinary sanctions that the State of Oklahoma and the NASD had imposed against Belden. Without admitting or denying the allegations in the Commission's complaint, all defendants consented to the judgment, entered by the Northern District of Oklahoma, which enjoins Southmark Adviser, Southmark Broker, and Belden from violating, and aiding and abetting violations of the antifraud provisions of the federal securities laws. In the judgment, the court also appointed Bruce Day, former Administrator of the Oklahoma Department of Securities, to serve as an Independent Consultant to Southmark Adviser and Southmark Broker. Mr. Day will oversee the firms' practices, policies and procedures, ensure their compliance with the securities laws, and keep Commission staff apprised of their activities. Previously, at the Commission's request, the court had appointed a receiver for the Southmark entities and directed that Belden not interfere with the companies' activities. The court's November 21st order directs that Belden continue to have no further affiliation or association, direct or indirect, with the Southmark entities. The court also held a hearing on the financial condition of Belden and the Southmark entities. After considering sworn financial statements provided by Belden, the investigative report presented by the court-appointed receiver in the case, and testimony from the receiver, the court determined that neither Belden nor the Southmark entities had the financial ability to pay disgorgement or a civil penalty, relief that had been sought by the Commission, and the court dismissed these Commission claims. 2.

SEC v. Beacon Hill Asset Management LLC, et al., Lit. Release No. 17831 (Nov. 7, 2002), www.sec.gov/litigation/litreleases/lr17831.htm.

On November 7, 2002, the Commission charged Beacon Hill Asset Management LLC (Beacon Hill), a hedge fund manager located in Summit, New Jersey, with a violation of the anti-fraud 38

provisions of the Investment Advisers Act. The Commission's complaint, filed in the U.S. District Court for the Southern District of New York, alleges that at least during July through September 2002, Beacon Hill reported net asset values and corresponding returns to fund investors that it knew or should have known were materially overstated. In addition to a permanent injunction against future violations, disgorgement and civil penalties, the Commission is seeking substantial preliminary relief, that Beacon Hill, its managed hedge funds (Beacon Hill Master, Ltd., Bristol Fund, Ltd., Safe Harbor Fund L.P., and Milestone Plus Partners L.P.), and controlling entities of the hedge funds (Safe Harbor Asset Management, LLC and Milestone Global Advisors, L.P.) have agreed to. Under the terms of a stipulation to be filed with the court, and subject to the approval of the Court: 1) Beacon Hill will be preliminarily enjoined from violating the non-scienter based antifraud provision of the federal securities laws directed at investment advisers; 2) Beacon Hill and the hedge funds will report to the court within 10 days of entry of the order that Beacon Hill is no longer managing the funds and that a new investment manager is in place; 3) Court approval will be required for redemptions, withdrawals, or distributions from the funds, as well as for extraordinary payments; 4) The funds will require the new investment manager to file periodic reports with the court, the SEC, and investors; and 5) Beacon Hill will be required to preserve all relevant documents and to cooperate fully to enable the new investment manager to perform its duties. The Commission's Complaint alleges that Beacon Hill managed three "feeder" hedge funds — Bristol, Safe Harbor, and Milestone — as well as a "master" fund (Beacon Hill Master) through which the feeder funds conducted trading. The funds principally invested in the mortgage-backed securities markets on a leveraged basis. The Complaint alleges that, for at least the periods ending July 31, August 31, and September 30, 2002, Beacon Hill reported net asset values and corresponding returns to fund investors that it knew or should have known were materially overstated. The Commission's Complaint alleges that Beacon Hill violated the non-scienter based antifraud provision of the federal securities laws directed at investment advisers, which prohibits transactions, practices, and courses of business which operate as a fraud or deceit upon investment advisory clients and prospective clients. The Complaint names the hedge funds and their controlling entities as "relief" defendants solely in order to effectuate the controls and reporting requirements described above. The Commission's investigation is continuing. 3.

In the Matter of Duff & Phelps Investment Management Co., IAA Rel. No. 1984, ICA Rel. No. 25200 (Sept. 28, 2001), www.sec.gov/litigation/admin/ia-1984.htm.

On September 28, 2001, the Commission simultaneously instituted and settled administrative cease-and-desist proceedings against a registered investment adviser, Duff & Phelps Investment Management Co., Inc. (Duff), based on, among other things, Duff's inaccurate Form ADV and its violative soft dollar practices. The order found that $715,750 of advisory client commission business was directed to East West Institutional Services, Inc. (East West), a Michigan broker-dealer, and a Chicago-based pension consultant (Pension Consultant), in exchange for the referral of a client, a pension fund for the International Brotherhood of Teamsters Union Local 710 (Local 710).

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Duff did not disclose to its clients its direction of brokerage in exchange for a client referral, and it affirmatively and falsely stated in its Commission filings that it did not direct commissions in exchange for client referrals. Certain of the commissions that Duff directed for the benefit of East West to obtain the client referral involved transactions for an investment company with which Duff had an investment advisory agreement. In approximately 1994, East West entered into an arrangement with the two trustees of the Local 710. Under this arrangement, East West agreed to kick back to the two trustees a portion of the commissions directed to it by the Local 710's investment advisers. The advisers would direct the trades to East West through one of its clearing brokers, and East West would forward some of that money to the two trustees. In mid-1994, the Duff salesman met with a representative from East West. The Duff salesman had learned that East West had the ability to influence selection or retention of money managers by the Local 710 pension fund. East West and the Duff salesman agreed that Duff would direct $600,000 in commissions annually to benefit East West, and, in return, East West would influence the Local 710 to award management of $120 million of its pension fund to Duff. East West specifically informed the Duff salesman that the directed brokerage arrangement should be concealed from the disinterested Local 710 trustees. The two trustees of the Local 710 required Duff to direct a certain amount of business to East West before they awarded Duff management of the Local 710's assets. In mid-1994, Duff began directing commissions to benefit East West. Senior officers of Duff knew, or were reckless in not knowing, that Duff's direction of brokerage to East West was part of a quid pro quo to obtain the Local 710 as a client. Duff's amended Form ADV filed with the Commission and distributed to its clients did not disclose that Duff received client referrals in exchange for brokerage commission allocation. Indeed, in some instances, Duff affirmatively represented that it did not engage in such practices. In determining to accept the Offer of Settlement, the Commission considered remedial acts promptly undertaken by Duff and cooperation afforded the Commission staff. Duff was censured and ordered, among other things, to: cease and desist from committing or causing any violations of various sections of the Advisers and Company Acts; pay a civil money penalty in the amount of $100,000; pay disgorgement of $613,000 to the clients whose assets were affected by the directed brokerage agreement between Duff and East West; pay disgorgement of $102,750, plus pre-judgment interest in the amount of $38,411, to the appropriate clients whose assets were affected by the soft dollar agreement. Duff also agreed to detailed undertakings, including providing to each of its advisory clients a copy of the Commission’s order and an amended Form ADV, which discloses all material terms of any soft dollar arrangement it has with any broker-dealer. 4.

SEC v. Edward Thomas Jung and E. Thomas Jung Partners, Ltd., Lit. Rel. No. 17041 (Jun. 20, 2001), www.sec.gov/litigation/litreleases/lr17041.htm.

On June 19, 2001, the Commission filed an action against Edward Thomas Jung and his brokerdealer, E. Thomas Jung Partners, Ltd., also doing business as ETJ Partners, Ltd ("ETJ Partners"), a market-maker at the Chicago Board Options Exchange. The Commission's complaint alleges that Jung, 40

manager of an unregistered, private hedge fund, Strategic Income Fund, L.L.C., engaged in a scheme to defraud the fund's investors resulting in the loss of more than $21 million in investor assets. The complaint also alleges that from July 1994 to February 1998, Jung was responsible for issuing a series of false performance reports that were used to solicit investors in the fund that materially overstated his prior trading record and that of the fund. In addition, from January 1995 to September 1998, Jung falsely stated that investor assets would be used solely to conduct the fund's business and to collateralize trading on behalf of the fund. Instead, Jung, acting through his brokerdealer, placed the fund's assets in ETJ Partners' account and used the fund's assets to collateralize his own personal margin trading and to pay the expenses of running ETJ Partners. Jung's personal trading resulted in substantial losses, but Jung covered up his losses by sending investors false quarterly statements that materially overstated the current value of their investment in order to lull them into a false sense of security. Eventually, in September 1998, ETJ Partners' clearing firm seized control of its account and liquidated the Fund's assets to cover ETJ Partners' margin call. Jung's misappropriation resulted in the loss of more than $21 million invested by 60 investors. The Commission's complaint seeks an order enjoining Jung and ETJ Partners from violating antifraud provisions and asks the court to impose appropriate civil penalties. 5.

SEC v. Reed E. Slatkin, Lit. Rel. No. 16998 (May 11, 2001) and 17033 (Jun. 11, 2001), www.sec.gov/litigation/litreleases/lr16998.htm.

On May 11, 2001, the Commission obtained a temporary restraining order and asset freeze against Reed E. Slatkin, a co-founder, former director and substantial shareholder of Earthlink, Inc., in federal district court in Los Angeles. The Commission charged that Slatkin defrauded as many as 500 clients through his unregistered investment advisory business located in Santa Barbara, California. The Commission’s complaint alleged that from 1985 to April 2001, Slatkin managed at least $230 million for about 500 clients through purported securities trading accounts in Switzerland. The Commission's complaint alleged that in February 2001, Slatkin misappropriated $10 million in client funds that he had received purportedly to invest in a money market fund and misused the client's funds by using $6.975 million to pay other clients and using over $24,000 to pay personal expenses, including credit card bills, telephone and other utility bills, fees at two country clubs, and pool maintenance fees. The Commission further alleged that the Swiss trading accounts did not exist and that Slatkin was merely operating a fraudulent securities scheme. On June 7, 2001, the U.S. District Court for the Central District of California entered a Judgment of Permanent Injunction against Slatkin. The judgment enjoins Slatkin from future violations of antifraud provisions and investment adviser registration provisions. The judgment provides that the amount of disgorgement and civil penalties that Slatkin will have to pay will be determined later. Slatkin, without admitting or denying the allegations in the complaint, consented to the entry of the injunction. The U.S. Attorney's Office for the Central District of California also charged Slatkin with 15 felony charges, including mail and wire fraud, money laundering and conspiracy to obstruct justice during an SEC enforcement investigation. Slatkin pleaded guilty and is scheduled to be sentenced on February 24, 2003. 41

In a separate action, the U.S. Attorney for the Central District of California and the Commission announced that Daniel W. Jacobs was charged with conspiracy to obstruct justice during the SEC investigation of Reed E. Slatkin. Jacobs has agreed to plead guilty to the charge when he is arraigned in November. In his plea agreement, Jacobs admitted that when the SEC began a formal investigation of Slatkin's activities in 1999, Jacobs and others conspired to obstruct the SEC's investigation. Jacobs and others, among other things, provided the SEC with false documents concerning NAA Financial, a purported Swiss brokerage firm in which Slatkin purportedly held his investors' funds. For his role, Jacobs received $1 million and a quantity of gold coins from Slatkin. United States v. Daniel W. Jacobs, Lit. Release No. 17796 (Oct. 22, 2002), www.sec.gov/litigation/litreleases/lr17796.htm. 6.

SEC v. Burton G. Friedlander, et al., Lit. Rel. No. 17021 (Jun. 1, 2001), www.sec.gov/litigation/litreleases/lr17021.htm.

On June 1, 2001 the Commission filed securities fraud charges against Burton G. Friedlander, 62, two investment management entities Friedlander controls, and three Friedlander-managed investment funds. The defendants are charged with market manipulation and with fraudulently inflating and misrepresenting the value of one of the funds, Friedlander International Limited, a hedge fund. Among other charges, the Commission charged that Friedlander manipulated the common stock of a company in which the hedge fund held an interest at the end of each month during the last five months of 2000. This conduct is commonly known as "portfolio pumping." The Commission alleges that Friedlander caused approximately $2.4 million in fund redemptions to be made at the inflated fund values for his and his entities' benefit to the detriment of the fund's other investors. The complaint further alleges that, beginning in August 2000, Friedlander caused the monthend net asset value of Friedlander International Limited to be fraudulently inflated in two ways. First, Friedlander manipulated the month-end closing price of the common stock of eNote.com, Inc. (“eNote”). eNote common stock and other securities constituted approximately 40 percent of the net asset value of Friedlander International reported to investors. The eNote common stock price was used to determine the value of eNote preferred stock and warrants in the fund's portfolio. At the end of each month from August through December 2000, Friedlander and Friedlander Capital Management purchased large quantities of eNote common stock through brokerage accounts held for the benefit of Friedlander's other managed funds, Friedlander Limited Partnership, and Opal International Fund. To effect these purchases, Friedlander placed a series of orders at increasing prices on the last trading day of each month. Friedlander's purchases on these days accounted for 80% or more of the retail purchase volume in eNote. These purchases manipulated the eNote stock price upward at the end of each month, in some cases more than doubling it. Second, for the months of November and December 2000, Friedlander assigned arbitrary values to the eNote warrants in the Friedlander International Limited portfolio that were higher even than the price of the underlying common stock. The complaint charges Friedlander and the related entities with violating Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The complaint also charges Friedlander and his two management entities, Friedlander Capital Management and Friedlander Management Limited, with violations of Section 206(1) and (2) of the Advisers Act. In the complaint, the Commission seeks preliminary and permanent injunctive relief against Friedlander and the other defendants, the appointment of a receiver for the related entities, an asset freeze of $1 million in Friedlander's assets, 42

representing an amount that Friedlander redeemed for his personal benefit in February 2001, accountings, disgorgement of ill-gotten gains, and civil monetary penalties. Misrepresentations of Mutual Fund Risks and Portfolio Value 1.

In the Matter of Rockies Fund, Inc., et al., Initial Decision Rel. No. 181, Administrative Proceeding File No. 3-9615, (Mar. 9, 2001), www.sec.gov/litigation/aljdec/id181bpm.htm.

In an initial decision, Judge Brenda P. Murray found that in 1994 and 1995, Stephen G. Calandrella, the Rockie’s Fund's president, and Charles M. Powell and Clifford C. Thygesen, the Fund's independent directors, violated anti-fraud provisions by making material misrepresentations as to the value of a major Fund asset. The misrepresentations occurred in eight SEC filings. Judge Murray also found that Mr. Calandrella and John C. manipulated the buying and selling of Premier shares, and that Mr. Calandrella failed to disclose to the Fund's independent directors that the Fund's purchase of Premier shares was to settle legal charges leveled against him. Judge Murray ordered the Fund, Mr. Calandrella, Mr. Powell, Mr. Thygesen, and Mr. Power to cease and desist from violating various provisions. In addition, Judge Murray permanently barred Mr. Calandrella from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for a registered investment company or affiliated person, and ordered him to pay a civil penalty of $500,000. She ordered the same bar against Mr. Powell and Mr. Thygesen with the right to reapply after three years, and she ordered each of them to pay a civil penalty of $160,000. 2.

In the Matter of Piper Capital Management, Inc., et al., Initial Decision Rel. No. 175, Administrative Proceeding File No. 3-9657 (Nov. 30, 2000), www.sec.gov/litigation/aljdec/id175hpy.htm.

In what has been described as one of the largest and most complex proceedings ever conducted by the Commission, the ALJ H. Peter Young issued his initial decision in the Matter of Piper Capital Management, Inc., et al. on November 30, 2000. The Commission alleged numerous securities laws violations against Piper Capital Management, Inc. (PCM) and various PCM employees in connection with the 1994 collapse of the Piper Jaffray Institutional Government Income Portfolio, a diversified mutual fund ALJ Young determined that PCM materially deviated from the "consistent with preservation of capital" component of the fund's stated investment objective and failed either to disclose the deviation or to obtain shareholder authorization for it. In addition, ALJ Young determined that the fund misrepresented or failed to disclose numerous material facts concerning fund composition, duration, performance, weighted average life, diversification and leverage in fund prospectuses and marketing materials. ALJ Young also determined that the fund co-manager and various other PCM employees participated in an effort to incorporate fund losses into the net asset value (NAV) over a period of days and reported inaccurate NAV's for the fund in the interim. ALJ Young determined that numerous misrepresentations concerning the primary portfolio manager's educational background constituted intentional violations. 43

PCM was censured, its registration was revoked and it was ordered to cease and desist and pay a $2,005,000 penalty. Although the judge determined that the conduct attributable to the fund comanager and other PCM employees was inappropriate and reckless in significant degree, he determined it was not egregious in light of the extraordinary circumstances that confronted them. Judge Young therefore censured and ordered each of them to cease and desist from violating the federal securities laws and censured them. He expressly determined it was not in the public interest to bar any of them from investment advisor or investment company association or to impose monetary sanctions on them. An appeal of this decision is currently pending. Soft Dollar Case 1.

In the Matter of Fundamental Portfolio Advisors, Inc., et al., Initial Decision Rel. No. 180 (Jan. 29, 2001), www.sec.gov/litigation/aljdec/id180cff.htm.

Lance Brofman and two associated companies, Fundamental Portfolio Advisors (FPA) and Fundamental Service Corporation (FSC), were fined and barred from the securities industry after a hearing before an administrative law judge. Brofman, FPA, and FSC at one time were involved in managing the Fundamental U.S. Government Strategic Income Fund (the Fund), a government bond mutual fund. The law judge found that Brofman, FPA, and FSC marketed the Fund as a safe, stable investment but invested heavily in volatile inverse floaters that exposed the Fund to significant losses when interest rates rose in 1994. Additionally, they did not inform the Board of Directors of the Fund of their soft dollar arrangements, which included payments to a business partner. The law judge concluded that, as charged, Brofman, FPA, and FSC violated several antifraud provisions of the securities laws. Brofman was fined $250,000, and FPA and FSC were each fined $500,000. Additionally, Brofman, FPA, and FSC were ordered to cease and desist from violations of the antifraud provisions, Brofman was barred from the securities industry, and the investment adviser and brokerdealer registrations of FPA and FSC were revoked. Switching Cases 1.

In the Matter of Russell Turek, SEA Rel. No. 45459 (Feb. 20, 2002), www.sec.gov/litigation/admin/34-45459.htm.

On February 20, 2002, the Commission accepted an Offer of Settlement by Russell C. Turek in response to the institution of public administrative and cease and desist proceedings. Turek was a registered representative associated with a registered broker-dealer from January 1999 until June 2000. He operated from a two-person branch office of that broker-dealer in Aurora, Colorado and maintained approximately 900 customer accounts. In April 1999, Turek, without authorization, signed an elderly customer's name on a "banklink" form permitting the transfer of funds from the customer's bank account to the broker-dealer. He also, without authorization, signed the name of another employee of the broker-dealer in order to guarantee the validity of the customer's signature on a letter authorizing partial liquidation of an annuity product 44

held by the customer. In May 1999, after the customer's annuity funds were liquidated and deposited into the customer's bank account, Turek used the forged banklink form to transfer the funds to an account at the broker-dealer without the customer's authorization. Between February 1999 and August 1999, on at least seven occasions Turek engaged in improper mutual fund switching. He induced customers, most of whom were elderly, to sell shares of one mutual fund and to use the proceeds to buy shares of another mutual fund from a different fund family. He omitted to inform these customers of their right to exchange their current funds for different funds within the same fund family to reduce substantially or eliminate any sales load. These transactions provided no economic benefit to the customers and were made for the sole purpose of generating commissions. In April 1999, on at least two occasions Turek induced the purchase of mutual fund shares resulting in the avoidance of breakpoints (the price level at which the sales charge paid by an investor decreases) in order to increase his commission. He solicited a customer to purchase shares of two nearly identical mutual funds, from different fund families, knowing that the customer would have paid Respondent lower commissions if the investment had not been split between the funds. Turek also split another customer's purchase of shares in a single mutual fund into two separate transactions, a practice known as "market basketing," in order to avoid the fund's breakpoint. In each instance, Respondent omitted to disclose to his clients the availability of breakpoints and, improperly orchestrated the purchases to avoid breakpoints. Moreover on at least two occasions, in May 1999 and again in July 1999, Respondent purchased shares of mutual funds for customers without the customers' authorization. The Commission found that these actions amounted to violations of Section 10(b) of the Exchange Act and Rule 10b-5. Consequently, Turek was barred from association with any broker or dealer with a right to reapply in two years, ordered to cease and desist, and to pay disgorgement and prejudgment interest, and a civil money penalty of $10,000. 2.

In the Matter of Raymond A. Parkins, Jr., SA Rel. No. 8055, SEA Rel. No. 45314, IAA Rel. No. 2010 (Jan. 18, 2002), www.sec.gov/litigation/admin/33-8055.htm.

On January 18, 2002 the Commission accepted an Offer of Settlement by Raymond A. Parkins, Jr., which was made in response to the institution of public administrative and cease and desist proceedings. From at least 1993 through 1996, Parkins was the president of The Parkins Investment Advisory Corporation ("Parkins Advisory"), which was an investment adviser registered with the Commission. Parkins Advisory withdrew its registration with the Commission pursuant to a Form ADV-W that became effective on July 8, 1997. Parkins was also the president of The Parkins Investment Securities Corporation ("Parkins Securities"), which was a broker-dealer registered with the Commission. Parkins Securities withdrew its registration with the Commission on July 16, 1999. Parkins engaged in fraudulent switching of his clients' variable annuity investments. He induced his investment advisory clients to switch variable annuities by providing them with unfounded, false, and misleading justifications for the switches and by misrepresenting or omitting to inform them of the sales charges associated with the switches. Beginning in the early 1990's, Parkins recommended the purchase of variable annuity contracts to his clients. Parkins initiated his clients' switches among variable annuities. In letters he prepared and sent, on a continuing basis, to his clients, Parkins recommended that his clients switch their variable annuities. Along with the recommendation letter, 45

Parkins sent the necessary forms for effectuating the switch. Before mailing the letters and accompanying forms, Parkins would designate on the forms the variable annuity funds to be purchased, and in what amounts. Parkins attached markers to the forms instructing the client where to sign or initial, as necessary, and also indicated to his clients that they should decline additional information offered by the state of Florida. In some cases Parkins misleadingly told his clients that "time is of the essence" and urged them to return the signed forms "as soon as possible." During the relevant period, Parkins misled his clients about the costs of switching their variable annuities by omitting to inform his clients about those costs or by providing them with inaccurate information about those costs. The Commission ordered Parkins to cease and desist from committing or causing any violation and any future violation of the anti-fraud provisions of the federal securities laws; barred Parkins from association with any broker, dealer or investment adviser; and ordered Parkins to pay disgorgement in the amount of $214,656, plus prejudgment interest.

V.

INSIDER TRADING

Insider trading remains one of the Commission’s important areas of enforcement, accounting for at least forty cases a year. In the mid-eighties, most of the insider trading cases arose out of the merger and acquisition boom. In the recession of the late eighties and early nineties, the Commission brought more “bad news” selling cases -- insiders selling before adverse corporate financial developments were disclosed. With the revival of mergers and acquisitions, the Commission is bringing more merger and acquisition cases and has a large number of insider trading investigations underway. Moreover, the Commission has witnessed a resurgence of insider trading cases involving securities industry professionals. 1.

SEC v. Andrew S. Marks, Lit. Release No. 17871 (Dec. 3, 2002), www.sec.gov/litigation/litreleases/lr17871.htm.

On December 3, 2002, the Commission announced that it has filed insider trading charges against Andrew S. Marks in connection with his September 2001 sale of stock in Vertex Pharmaceuticals, Inc., a Cambridge-based biotechnology company. The Commission’s complaint alleges that Marks, who at the time was Vertex's highest-ranking attorney, learned on September 20, 2001 that Vertex planned to announce the suspension of clinical trials of one of its promising drugs on September 24. According to the Commission's complaint, on September 21, Marks liquidated all of his Vertex stock despite having previously acknowledged in writing that the impending release would not be viewed favorably by Wall Street and that he should not sell his Vertex shares. The Commission's complaint alleges that, by selling his holdings prior to the company's public announcement on September 24, Marks avoided a loss of $105,999. According to the Commission's complaint, at the time he traded, Marks was the designated attorney for employees to consult regarding compliance with Vertex's employee securities trading policy. In that capacity, the complaint alleges, Marks wrote Vertex's CEO an email on September 20, advising him to make sure that an employee who had requested permission to trade had no knowledge of the impending press release. 46

The Complaint alleges that Marks traded in breach of a fiduciary duty to Vertex and its shareholders not to trade in the Company's stock while in possession of material, nonpublic information about the Company. As a result of the conduct described in the Complaint, the Commission has charged Marks with violations of the antifraud provisions of federal securities laws. The Commission's Complaint seeks injunctive relief, disgorgement plus prejudgment interest, and civil penalties and seeks an order barring Marks from acting as an officer or director of any publicly-traded company. 2.

SEC v. Roys Poyiadjis, Lycourgos Kyprianou and Aremissoft Corp., et al., Lit. Release No. 17862 (Nov. 25, 2002), www.sec.gov/litigation/litreleases/lr17862.htm.

On November 22, 2002, an Isle of Man appellate tribunal entered a judgment holding that the Commission is entitled to participate directly in proceedings commenced by the Isle of Man Attorney General in October 2001 at the request of the Attorney General of the United States. In those proceedings, the High Court of the Isle of Man has issued restraint orders freezing approximately $175 million deposited in two Isle of Man banks. These funds are alleged to constitute proceeds of fraudulent insider trading in the stock of AremisSoft Corporation. The Commission, the United States Attorney for the Southern District of New York and the Attorney General for the Isle of Man are pursuing the repatriation of the frozen funds to the United States to be used to compensate defrauded AremisSoft investors. The Commission also has obtained a U.S. asset freeze in a preliminary injunction entered on October 19, 2001 by the U.S. District Court for the Southern District of New York. In its complaint in the U.S. enforcement action, the Commission alleged, among other things, that AremisSoft and two of its former officers, Roys Poyiadjis and Lycourgos Kyprianou, overstated the Company's revenues in its annual report for 2000 and inflated the value of acquisitions made in 1999 and 2000 and that the two former officers engaged in massive insider trading during the period of the reporting fraud. The SEC's enforcement action remains pending against Poyiadjis, Kyprianou and two relief defendants that nominally hold the funds in the Isle of Man bank accounts, Olympus Capital Investment, Inc. ("Olympus") and Oracle Capital, Inc. ("Oracle"). Poyiadjis, Kyprianou and the relief defendants have not answered the Commission's complaint. The U.S. Attorney for the Southern District of New York obtained an indictment of Poyiadjis on December 19, 2001. Poyiadjis has fled to the Republic of Cyprus where he remains to date. On March 22, 2002, the U.S. Attorney's Office filed a civil complaint in rem in the U.S. District Court for the Southern District of New York seeking civil forfeiture of the funds in the Isle of Man banks, and on June 3, 2002 the court entered a default judgment ordering forfeiture of the funds to the United States. On June 24, 2002 a superseding indictment was returned against Poyiadjis, Kyprianou (who resides in Cyprus) and another AremisSoft officer, M.C. Mathews (who resides in India) on counts of conspiracy to commit securities fraud, mail fraud, and wire fraud, substantive counts of securities fraud (both on the market and insider trading), conspiracy to commit money laundering, and substantive counts of money laundering. On July 16, 2002, the Isle of Man Attorney General filed a petition in the High Court seeking to register the civil in rem forfeiture judgment as an external confiscation order under the applicable Isle of Man statute. The Commission has supported and assisted the U.S. Attorney's Office and the Isle of Man Attorney General in the pending Isle of Man restraint order litigation, but it was not previously able to participate directly in those proceedings. 47

On June 4, 2002, the Commission filed a petition seeking an order of the Isle of Man High Court permitting the Commission to participate directly in the restraint order proceedings. Although the petition initially was denied in a judgment dated July 16, 2002, the Commission successfully appealed that ruling. The appellate judgment found "that the SEC is a person affected by the restraint order" and concluded that "the overall circumstances in this case justify our exercising discretion in favour of the SEC becoming a Noticed Party." 3.

SEC v. Rodolfo Luzardo, Elias I. Kodsi, and Alain D. Kodsi, Lit. Release No. 17850 (Nov. 20, 2002), www.sec.gov/litigation/litreleases/lr17850.htm.

On November 12, 2002, Judge Denny Chin in the United States District Court for the Southern District of New York entered a final judgment against Rodolfo Luzardo ("Luzardo"). The defendant was ordered to pay a $100,000 penalty in a Commission action that charged him with insider trading in the securities of BetzDearborn Inc. Luzardo settled the action without admitting or denying the allegations in the Commission's complaint. The Commission's complaint alleged that Rodolfo Luzardo, a former analyst in the mergers and acquisitions unit of J.P. Morgan Securities, Inc., Alain D. Kodsi, a co-owner of a venture capital firm, and Elias I. Kodsi, a retired jewelry distributor, engaged in illegal insider trading in advance of the July 30, 1998 announcement that BetzDearborn Inc. and Hercules Inc. had agreed to merge. Without admitting or denying the allegations of the Commission's complaint, Rudolfo Luzardo consented to the entry of the final judgment which permanently enjoins him from violating the antifraud provisions of the federal securities laws, and orders him to pay a civil penalty of $100,000. The Commission previously settled its case against the Kodsis who each paid a $963,750 civil penalty and, jointly and severally, disgorged $963,750 in unlawful profits, and $308,992 in prejudgment interest. Based on the entry of the Court's injunction, the Commission also instituted administrative proceedings to bar Luzardo from the securities industry. Without admitting or denying the Commission's findings, Luzardo consented to the entry of the Commission's Order, which bars him from association with any broker or dealer. In the Matter of Rodolfo Luzardo, Administrative Proceeding File No. 3-10938; Securities Exchange Act of 1934 Release No. 46854 (November 20, 2002). See also Litigation Release No. 17197 (October 18,2001) and Litigation Release No. 17486 (April 24, 2002). See also the following related matters: SEC v. Joseph F. Doody IV, et al., 01 Civ. 9879 (JK) (S.D.N.Y.) (filed November 8, 2001) (Litigation Release No. 17225); SEC v. Bugenhagen, et al., 01 Civ. 6538 (E.D.PA.) (filed December 18, 2001) (Litigation Release No. 17278); SEC v. Litvinsky, et al., 02 Civ. 0312 (LMM) (S.D.N.Y.) (filed January 14, 2002) (Litigation Release No. 17306); and SEC v. Straub, et al., 1:02CV01128 (EGS) (D.D.C.) (filed June 10,2002) (Litigation Release No. 17549). To date, in the five insider trading cases concerning trading before the merger of BetzDearborn and Hercules, the Commission has obtained over $3.9 million in disgorgement, prejudgment interest, and penalties.

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4.

SEC v. Samuel D. Waksal, Lit. Rel. No. 17559 (Jun. 12, 2002).

The SEC filed an insider trading case against Samuel D. Waksal, the former CEO of ImClone Systems Inc. The complaint charged that Waksal received disappointing news late last December that the U.S. Food and Drug Administration would soon issue a decision rejecting for review ImClone's pending application to market its cancer treatment drug, Erbitux. The SEC further charges that Waksal told this negative information to certain family members who sold ImClone stock before the news became public and that Waksal himself tried to sell shares of ImClone before the news became public. In its lawsuit, filed in federal court in Manhattan, the Commission seeks an order requiring that Waksal disgorge the several million dollars in losses avoided by those family members he tipped, and that he pay civil penalties and prejudgment interest. It also seeks an order permanently enjoining Waksal from violating the securities laws, and barring him from acting as an officer or director of a public company. The U.S. Attorney in the Southern District of New York also indicted Waksal for insider trading. 5.

SEC v. Hugo Salvador Villa Manzo and Multinvestments, Inc., Lit. Rel. No. 17485 (April 24, 2002).

On March 11, 2002, the U.S. District Court for the Southern District of New York entered a final judgment against Hugo Salvador Villa Manzo based upon charges of insider trading. Villa is the Chairman and part-owner of MultiValores Grupo Financiero, S.A. de C.V., a Mexican public company that indirectly owns Multinvestments, Inc., a U.S. broker-dealer. The Commission alleged that Villa was tipped by Jose Luis Ballesteros, a director of Nalco who has since died. The Complaint specifically alleged that Jose Luis Ballesteros violated his fiduciary duties to Nalco by providing Villa with material, nonpublic information about the proposed acquisition by Suez Lyonnaise des Eaux, a French company. In response to this tip, Villa instructed one of his senior colleagues at Multinvestments to buy Nalco stock for Multinvestments' proprietary account. Pursuant to Villa's instructions, Multinvestments, through its proprietary account, purchased 50,000 Nalco shares for $2,015,625. In purchasing Nalco shares, Multinvestments used margin privileges and also used the maximum amount available in its proprietary account without violating the firm's net capital requirements. As a result of these transactions, unlawful profits totaling $558,750 were realized. Without admitting or denying the Commission's allegations, Villa consented to the entry of the final judgment, which permanently enjoins him from violating the antifraud provisions of the federal securities laws. The Court also ordered Villa and Multinvestments to pay $1,503,471.83, representing disgorgement of $ 558,750, prejudgment interest of $106,596.83, and a civil penalty of $838,125. Based on the entry of the Court's injunction, the Commission instituted settled administrative proceedings against Villa. Without admitting or denying the Commission's findings, Villa consented to the entry of the Commission's Order, which bars him from associating with any broker, dealer, or investment adviser. 49

In two previous actions, the Commission filed complaints alleging that Jose Luis Ballesteros purchased Nalco stock and tipped others. See SEC v. Jorge Eduardo Ballesteros Franco, et. al., Lit Rel No. 16991 (May 8, 2001). Without admitting or denying the allegations of the Complaint, several of the defendants consented to pay a total of $4,730,951 in disgorgement, prejudgment interest and penalties. The Estate of Jose Luis Ballesteros Franco has consented to pay disgorgement of $3,380,284, representing all the profits made by the Ballesteros family from their trading of Nalco stock, together with prejudgment interest of $364,586. The defendants named in the second action invested over $1.8 million in Nalco stock and made illegal profits of $776,725. See SEC v. Pablo Escandon Cusi and Lori Ltd., Lit. Rel. No. 17356 (Feb. 7, 2002). Without admitting or denying the allegations of the complaint, Escandon and Lori Ltd. consented to pay a total of $1,716,546.23, representing disgorgement of $776,725, prejudgment interest in the amount of $163,096.23, and a penalty of $776,725. In addition, Escandon and Lori Ltd. have consented to the entry of a permanent injunction prohibiting them from further violations. The Commission is continuing its investigation in this matter. On May 8, 2001, the United States Attorney for the Southern District of New York announced the indictments of Jorge Eduardo Ballesteros Franco and Juan Pablo Ballesteros Gutierrez for nine felony counts and three felony counts, respectively, for conspiracy to violate, and violations of, the federal securities laws. Both defendants, and the entities through which they traded have been sued by the Commission for the same conduct. The Commission is continuing its investigation in this matter. On February 27, 2002, Juan Pablo Ballesteros Gutierrez was convicted of insider trading in the Southern District of New York and, on June 4, 2002, was sentenced to 15 months imprisonment, a $40,000 fine and two years of supervised release. On December 9, 2002, the U.S. District Court for the Southern District of New York entered a final judgment against Juan Pablo Ballesteros Gutierrez based upon charges of insider trading. Without admitting or denying the allegations of the Commission's Complaint, Juan Pablo Ballesteros Gutierrez consented to the entry of the Court's final judgment. The judgment orders Juan Pablo Ballesteros Gutierrez to pay a penalty of $106,403.75. His profits of $106,403.75, along with prejudgment interest, were previously paid as part of the settlement with other parties announced on May 8, 2001. In addition, the judgment permanently enjoins Juan Pablo Ballesteros Gutierrez from violating the antifraud and insider trading provisions of the federal securities laws. Because Casford Limited no longer exists, the Commission dismissed its claims against that entity. All told, the Commission has now obtained over $8 million in settlements with those persons and entities charged with insider trading in Nalco stock. With the exception of Jorge Eduardo Ballesteros Franco (and the entities through which he traded), the Commission has reached settlements with all of the defendants named in those three actions. SEC V. Jorge Eduardo Ballesteros Franco, et al., Lit. Release No. 17897 (December 17, 2002)

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VI.

CASES INVOLVING SECURITIES OFFERINGS 1.

SEC v. Dennis Herula, et al., Lit. Release No. 17848 (Nov. 19, 2002), www.sec.gov/litigation/litreleases/lr17848.htm.

The Commission announced that on November 6, 2002, the U.S. Court of Appeals for the First Circuit upheld a district court order imposing preliminary injunctions and asset freezes against Martin Fife, a former Dreyfus fund independent director, and Farouk Khan, Fife's business associate, in a securities fraud case. In its complaint, filed in federal district court in Rhode Island on April 1, 2002, the Commission alleged that Fife, Khan, and others defrauded investors of over $50 million in a prime bank-type scheme that promised returns as high as 300% in twelve business days, and that over $20 million had not been returned to investors. On May 1, 2002, after a two-day hearing in April, the district court issued an order finding that the Commission is likely to succeed in proving that Fife, Khan, and certain other defendants violated the securities laws, and that there is a strong likelihood that violations may occur in the future if these defendants are not enjoined. The order further stated that there is a high risk that any remaining investor funds may be further depleted. On May 8, 2002, the court issued written preliminary injunctions and asset freezes against Fife, Khan and certain other defendants, based on its findings in the May 1 order. Defendants Fife and Khan appealed the district court's decision to the First Circuit. On November 6, 2002, the First Circuit affirmed the entry of preliminary injunctions and asset freezes against Fife and Khan. The First Circuit found that the Commission made a sufficient showing that Fife and Khan made material misrepresentations in connection with the purchase or sale of securities in violation of the antifraud provisions of the federal securities laws, and that it was reasonably likely they may commit such violations again. The First Circuit further upheld the district court's finding that the Commission had established a substantial likelihood that Fife violated the antifraud provisions relating to investment advisers. Among other things, the First Circuit found that Fife repeatedly made false representations to one investor concerning the management of its funds, and that Fife and Khan had both misrepresented to investors the risk of loss associated with a purported "balance sheet enhancement program." For further information, please see Litigation Release Numbers 17461 (April 5, 2002) and 17514 (May 13, 2002). 2.

Telemarketing Stock Fraud Sweep, August 6, 2002.

The SEC charged 81 defendants in cases arising from 10 schemes in which the defendants conducted unregistered securities offerings and fraudulently diverted the proceeds to pay exorbitant, undisclosed commissions to telemarketers and other unregistered brokers who solicited the investors. These 10 schemes took place between 1996 and 2001, and raised approximately $30 million from more than 1,800 investors. In four separate enforcement actions filed in federal district court, the Commission has named 81 individuals and entities as defendants in these schemes.

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The Commission alleges that the offerings were fraudulent because the issuers employed nationwide networks of telemarketers, called Independent Sales Offices or ISOs, to sell the offerings and paid them undisclosed cash commissions ranging from 20% to as high as half of the offering proceeds. According to the SEC's complaints, these excessive commissions violated express representations contained in offering materials, which falsely stated that the issuers would use most of the offering proceeds for business purposes. When the offering materials did mention sales commissions, they significantly understated the portion of offering proceeds that issuers agreed to pay broker-dealers. The Commission's complaints charge the issuers and their principals, the individuals and entities who managed the offerings by recruiting and organizing the networks of ISOs, the ISO operators, and two attorneys. Simultaneously, in related criminal prosecutions, the U.S. Attorney for the Eastern District of New York announced the unsealing of indictments containing criminal charges against 46 defendants for the same fraudulent schemes. Each of the SEC's four complaints charges a separate group of related schemes. These four groups are as follows: Motion Picture Schemes. Three schemes involved offerings of securities in motion picture development companies: Heritage Film Group LLC, Little Giant LLC, and Out of the Black Partners LLC. These issuers retained "offering managers" Russell Finnegan, in the case of Little Giant and Heritage Film, and Michael Gonzales, in the case of Out of the Black, who recruited and coordinated over 42 telemarketer ISOs. Between 1997 and 2001, the defendants raised approximately $13.1 million, of which about half went to telemarketers and other unregistered brokers as sales commissions. SEC v. Heritage Film Group, LLC, Lit. Rel. No. 17658. Medical Technology Ventures. Three other schemes involved companies that develop medical devices and software for health care professionals: Intracom Corp., Hyperbaric Systems Inc., and Surgica Corp. These offerings took place between 1997 and 2000, were coordinated through Larry Bryant, an unregistered securities broker, and raised over $13 million. Between about 20% to 30% of the offering proceeds went to pay sales commissions even though the offering memoranda represented that only 12% would be used for that purpose. SEC v. Intracom Corporation, Lit. Rel. No. 17659. Internet-Telecommunications Ventures. Three further schemes involved entities purportedly formed to establish long distance telephone service through the Internet: Ephone Inc., Webphone LLP, Newera Communications LLP. These offerings occurred between July 1999 and December 2000 and raised about $2.9 million. About $1.2 million of that amount - or 42% - went to unregistered brokerdealers Donald Plain, Christopher Plain, Peter Bertorelli, and the ISO telemarketers they coordinated. SEC v. Ephone, Inc., Lit. Rel. No. 17660. In Line Hockey Rink Venture. Between 1996 and 2000, the defendants raised over $650,000 from approximately 52 investors by offering stock in America In Line Corp. and its subsidiary, America In Line of Mount Sinai Corp., purportedly for building and operating in line roller hockey rinks. Almost 30% of the offering proceeds went to telemarketers as sales commissions. SEC v. America In Line Corporation, Lit. Rel. No. 17661. 52

The Commission alleges that the defendants violated the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, the provisions of the Securities Act that require registration of non-exempt securities offerings, and the provisions of the Exchange Act that require registration of broker-dealers. The Commission seeks injunctions, disgorgement of illegal commissions and other ill-gotten gains plus prejudgment interest, and civil penalties. The complaints also seek orders barring the principals of the issuers from serving as officers or directors of public companies. The cases are pending. 3.

SEC v. Resource Development International LLC et al., Lit. Rel. 17438 (Mar. 26, 2002), www.sec.gov/litigation/litreleases/lr17438.htm.

The Commission filed a civil action to stop an alleged $98.7 million fraudulent prime bank scheme. On March 25, 2002, Judge Jerry Buchmeyer, United States District Court for the Northern District of Texas, Dallas Division, granted the Commission's Motion for Temporary Restraining Order and issued an Ex Parte Order Freezing Assets and Requiring an Accounting, Preservation of Documents, Repatriation of Assets, Surrender of Passports and Authorizing Expedited Discovery, and appointed a receiver for all defendants and relief defendants. Among others, the Commission sued the following defendants: 

Resource Development International, LLC ("RDI"), located in Tacoma, Washington, is a Nevada limited liability corporation formed in January 1999 and dissolved in August 2000.



David Edwards ("D. Edwards"), acts as president of RDI, vice-president of defendant Sound Financial Services, Inc. and vice-president of relief defendant International Education Research Corporation ("IER"), and controls Jade and Galaxy Asset Management, Inc. ("Galaxy").



James Edwards ("J. Edwards"), D. Edwards’ father, and together with him owns and/or controls, among other entities, RDI. J. Edwards formed and controls relief defendant Pacific International Limited Partnership ("PILP").

Specifically, the Commission charges that from January 1999 through the present, defendants' RDI scheme has raised approximately $98 million from more than 1300 investors nationwide, targeting persons seeking to invest retirement funds. In the course of marketing the RDI trading program, certain defendants acted as unregistered broker-dealers. Defendants falsely claimed to investors, among other things, that their money would be used in Europe to trade financial instruments with "top 25" or "top 50" banks in a program sponsored by the Federal Reserve and global organizations, generating annual returns of 48 to 120 percent with complete safety of principal. In reality, the prime bank program marketed to investors does not exist and investor funds have been misappropriated for personal and unauthorized uses, including making Ponzi payments. Moreover, while RDI has ceased making payments of any kind to its investors, tens of millions of dollars collected by the defendants simply cannot be accounted for. The Commission's complaint further charges that J. Edwards and D. Edwards diverted funds to buy property and a home for their personal use, and that certain relief defendants received at least $6 million, and possibly as much as $13 million, of RDI investor funds or control property derived from investor funds. The Commission's complaint charges defendants with, among other things, violations of the registration and antifraud provisions. In addition to the emergency relief set out above, the 53

Commission seeks preliminary and permanent injunctions, disgorgement and civil penalties, and repatriation orders against all the defendants, and disgorgement and prejudgment interest against the relief defendants. 4.

SEC v. Clif Goldstein, formerly known as Clifford Dixon Noe, et al., Lit. Rel. No. 17362 (Feb.14, 2002), www.sec.gov/litigation/litreleases/lr17362.htm.

The SEC filed a securities fraud lawsuit against Clif Goldstein, formerly known as "Clifford Noe" and also known as "Dr. Noe," Goldstein's brother Paul Howe Noe, and four other individuals and two entities in connection with an alleged prime bank fraud that has raised at least $1.1 million from more than 20 investors. Goldstein and Noe each have extensive prior criminal records. Goldstein, age 72, has prior criminal convictions, for among other crimes, wire fraud, mail fraud and forgery, while Paul Noe has prior convictions, for, among other crimes, embezzlement, larceny and wire fraud. The Commission's complaint, filed in the federal district court for the District of South Carolina, alleges that the defendants targeted both cash-poor companies unable to obtain funding through conventional means, and individual investors who desired to earn high investment returns quickly. Goldstein and Noe and their "Great American Trust" companies served as the primary offerors of the investment programs that comprised the fraud scheme, while the other defendants served as "finders" or selling agents, locating and luring potential investors to Goldstein and Noe and receiving finders' fees. The programs, which were promoted via the Internet and an intricate network of so-called consultants or finders, featured the use of so-called prime bank instruments, wholly fictional securities purportedly traded on an equally fictitious secondary market. In its complaint, the Commission alleges that the defendants violated the antifraud provisions of the federal securities laws. The Commission is seeking permanent injunctions against future violations of the anti-fraud provisions, disgorgement of defendants' ill-gotten gains plus prejudgment interest, and civil penalties. Concurrently with the Commission action, the Office of the United States Attorney for the District of South Carolina has filed criminal charges against Goldstein and Noe for their roles in the investment scheme, and the Federal Bureau of Investigation has arrested those individuals 5.

In the Matter of Republic New York Securities Corp., SEA Rel. No. 45157 (Dec. 17, 2001), www.sec.gov/litigation/admin/34-45157.htm.

The SEC issued an order revoking the registration of Republic New York Securities Corp., a New York-based broker-dealer registered with the Commission since 1992. Republic Securities is now a subsidiary of HSBC USA, formerly Republic New York Corporation. The Commission found that Republic Securities violated federal securities laws by participating in a massive Ponzi scheme operated by Martin Armstrong. In September 1999, the Commission charged Armstrong and two companies he controlled, Princeton Economics International and Princeton Global Management, in an emergency action alleging that they defrauded scores of Japanese companies that had invested billions of dollars in Princeton Global Management notes. Armstrong, 54

who was indicted by a federal grand jury in New York, was also charged by the Commodity Futures Trading Commission. Also on December 17, 2001, in the parallel criminal proceeding, the Office of the United States Attorney for the Southern District of New York announced a guilty plea by Republic Securities. As part of the resolution of the criminal case, Republic Securities has agreed to pay $606 million in restitution to defrauded investors. The Commodity Futures Trading Commission also announced a related enforcement action against Republic Securities. In settling the Commission's enforcement action, Republic Securities neither admitted nor denied the Commission's findings.

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