Securities Law Blog

FINRA and the SEC have issued an investor alert in response to a sharp increase in e-mails linked to pump-and-dump stock schemes. The alert entitled Investor Alert – Don’t Trade on Pump-And-Dump Stock E-mails warns investors of the surge in spam e-mails designed to lure unsuspecting investors into investment scams.

The alert advises investors not to make an investment based on the advice of an unsolicited e-mail which claims to have “inside” information of an impending development or uses an “infallible” system to pick stocks. The schemers behind pump-and-dumps aim to drive-up the stock price of typically smaller micro-cap companies by generating interest through blast e-mails and then selling when the price peaks. The victims of these schemes end up with near worthless stocks.

NASDAQ has agreed to pay a $10 million fine to settle SEC charges of securities laws violations during the initial public offering (IPO) of Facebook shares. According to the SEC, the NASDAQ system had a design limitation matching IPO buy and sell orders. The technical glitch delayed IPO trades and left 30,000 orders stuck in the NASDAQ system for more than two hours when they should have been executed or cancelled.

The morning of the offering, members of NASDAQ’s senior leadership team reportedly thought that they had fixed any glitches and chose not to delay the start of secondary market trading in Facebook shares, according the SEC’s Order. The decision to initiate trading before fully understanding the root cause of the problem was the main reason behind the SEC’s investigation and fine. In a statement given by Daniel M. Hawke, Chief of the SEC Enforcement Division’s Market Abuse Unit, the focus of the SEC’s “investigation was on the design limitation in NASDAQ’s system and the exchange’s decision-making after that limitation came to light.”

The SEC charged NASDAQ with several rule violations including NASDAQ’s fundamental rule governing the price/time priority for executing trade orders. According to the SEC’s Order, NASDAQ further violated its rules when it assumed a short position in Facebook of more than three million shares in an unauthorized error account. NASDAQ subsequently covered that short position for a profit of approximately $10.8 million. The exchange’s rules do not permit it to use an error account for any purpose.

The SEC also charged NASDAQ’s third-party broker-dealer NASDAQ Execution Services (NES) with failing to maintain sufficient net capital reserves on the day of the IPO as a result of the short position in the unauthorized error account.

On a related note, more than 30 lawsuits have been filed against Facebook in connection with the handling of the IPO.

FINRA has withdrawn its proposed amendment to Rule 2267 (Investor Education and Protection) after receiving 24 comment letters since it was published for comment in the Federal Register on January 25, 2013. Rule 2267 currently requires member firms, with certain exceptions, to provide customers with FINRA’s website address and information regarding FINRA’s BrokerCheck program at least once every calendar year. The proposed amendment would require that members include a prominent description of and link to FINRA BrokerCheck, as prescribed by FINRA, on their websites, social media pages and any comparable internet presence relating to a member’s investment banking or securities business maintained by or on behalf of any person associated with a member.

The proposed rule stemmed from a 2011 study performed by the SEC which recommended improvements for investor access to registration information on BrokerCheck and the SEC’s Investment Advisor Public Disclosure (IAPD) database. Based on the results of the study, FINRA conducted focus groups and surveyed investors throughout the country to obtain their opinions on the BrokerCheck program. Many of the participants in the focus groups said that they had been unaware of its existence prior to participation in the study. The consensus among focus group participants was that investors should use the program when considering whether to work with a new firm or investment professional. According to FINRA’s January 18th proposal, FINRA believed that providing a direct link to a firm’s or individual’s specific BrokerCheck homepage would increase investor use as opposed to a link to the general BrokerCheck page.

The 24 comment letters raised concerns that touched on the rule’s lack of clarity, broadness, and technological issues with implementation on various social media platforms. FINRA is expected to review the feedback and re-purpose the rule.

Former Rochdale Securities LLC institutional sales trader placed a $1 billion dollar bet and lost. David Miller entered a series of orders totaling 1.625 million shares of Apple stock after a customer placed an order to purchase 1,625 shares. Miller allegedly conspired with another individual to execute the trade on October 25, 2012, the day Apple was scheduled to announce its earnings for the quarter.

According the SEC complaint, Miller convinced another broker-dealer to sell 500,000 shares of Apple stock, falsely claiming that he was trading for the account of a company, which he had no relationship with and for which he was not authorized to trade. On the morning of October 25, Miller’s co-conspirator submitted an order for Apple stock. Over the course of the day, Miller allegedly entered multiple, separate orders in Rochdale’s order management system in the amount of 125,000 shares. Miller’s reported plan was to share in the customer’s profit if Apple stock rose, and if the stock decreased he would claim that he erred in entering the size of the order. The stock price decreased following the Apple earnings announcement later that day. When confronted about the trades, Miller allegedly claimed that he had made a mistake in ordering multiples of what was written in a client’s order. Rochdale reportedly sold the Apple stock at an estimated $5.3 million loss. The transaction caused the value of the firm’s available liquid assets to fall below regulatory limits required of broker-dealers and the firm was forced to cease operations shortly thereafter.

Miller has agreed to a partial settlement of the SEC’s charges. As part of the settlement, Miller will be barred in separate SEC administrative proceedings from working in the securities industry or participating in any offering of penny stock. A financial penalty will be determined at a later date by the court upon the SEC’s motion.

In a parallel criminal action, Miller was arrested on December 4, 2012. He has waived his right to indictment and pleaded guilty to one count of conspiracy to commit wire fraud and securities fraud and one count of wire fraud. Miller faces a maximum term of imprisonment of 25 years and is scheduled to be sentenced July 8, 2013.

Scott London worked at KPMG for almost 30 years until he was fired by the world’s fourth-largest auditor and consultant for allegations of leaked nonpublic information about companies that KPMG worked with. The SEC has accused the former partner, in charge of KPMG’s Pacific Southwest audit practice,of insider trading in nonpublic information about firm clients. According to the SEC, London tipped friend and golf-partner Bryan Shaw with confidential details about five KPMG audit clients including, Herbalife, Ltd., Skechers USA Inc., Uggs maker Deckers Outdoor Corp., RSC Holdings and Pacific Capital. KPMG has since resigned as auditor to Herbalife and Skechers.

London allegedly began providing information to the Los Angeles area jeweler in October 2010 after Shaw’s family-owned jewelry business had been hit hard by the financial crisis. During the next eighteen months London and Shaw reportedly communicated by cellphone about upcoming earnings and merger announcements related to the several audit clients. Using the confidential information, Shaw allegedly reaped more than $1.2 million in illicit profits. Shaw reportedly rewarded the firm’s senior partner with bags of money totaling roughly $50,000, as well as jewelry, concert tickets and dinners.

Federal authorities opened an investigation last fall after the brokerage firm holding Shaw’s account raised red flags about the activity and froze the account. Shaw received a subpoena several months ago and has been cooperating with the government’s investigation. He reportedly agreed to make monitored phone calls and have monitored meetings with London as part of his cooperation. When FBI agents showed up at London’s home with pictures of meetings with Shaw, London admitted his role. The U.S. Attorney’s Office for the Central District of California has filed criminal charges against London which carry a maximum penalty of 5 years in prison, and a fine of at least $250,000.