Federal Criminal Defense Blog : Georgia Federal Criminal Defense Lawyer & Attorney : Gillen Withers & Lake Law Firm : White Collar Crime, RICO, Trial : Atlanta, Savannah, GA

On Thursday, the U.S. District  Court for the Northern District of Georgia issued an order freezing the assets of SJK Investment Management, an investment advisor firm, as well as the assets of SJK's Chief Executive Officer Stanley Kowalewski, in an action by the Securities and Exchange Commission against SJK which sought an emergency freeze of the assets, according to a press release by Courthouse News Service. The SEC claims in its complaint, filed on Thursday, that SJK allegedly defrauded investors in two hedge funds worth approximately $65 million. Mr. Kowalewski is alleged to have placed $16.5 million of the funds into a separate account which he allegedly used for personal uses. Government officials claim that Kowalewski allegedly paid himself $1 million for personal and business expenses, charged an alleged $4 million "administrative fee" which he allegedly took as a salary draw, and allegedly lived rent free in a home that he caused the fund to purchase. SJK is also alleged to have sent investors false account statements showing fictitious returns on their investments, according to the complaint.  The complaint seeks permanent injunctions, penalties, disgorgement of profits and a ruling to bar Mr. Kowalewski from the financial industry.
 

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The U.S. Securities and Exchange Commission charged four Canadian citizens and two Florida residents for an alleged Ponzi scheme which defrauded more than 3,000 investors across the U.S. and Canada of approximately $300 million, according to an SEC press release. The SEC has filed a complaint alleging that Milowe Allen Brost and Gary Allen Sorenson of Calgary, Alberta, devised the scheme in which the defendants claimed to be an independent financial education which had discovered investment opportunities in certain companies engaged in gold mining. The defendants held seminars in which they promised investors they could earn 18 to 36 percent annual returns. Brost, Sorenson and the other defendants are alleged to have concealed the fact that the companies, Syndicated Gold Depository (SGD) and Merendon Mining Corp., Ltd., were actually shell companies which the defendants owned or controlled. The defendants claimed that Merendon was a successful gold mining and refining company.

Brost and Sorenson allegedly used various aliases, shell corporations and trust agreements to conceal their ownership of SGD. They would transmit investor money to accounts in Europe, Asia and South America. The defendants allegedly used investor monies to make interest payments to other investors, and for lavish personal spending, including for a luxury fishing resort in South America. Sorenson also allegedly took investors on tours of an alleged refinery in Honduras where they were shown the pouring of gold bars.

Larry Lee Adair of Fort Lauderdale, Florida, and Martin M. Werner of Boca Raton, Florida, are also charged in the complaint.
 

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Since last year, we've followed the government's investigation and prosecution of Texan and Antiguan financier Sir Robert Allen Stanford for allegedly defrauding investors of billions in a Ponzi scheme. Well, as set forth in a 150 page Report of Investigation by the U.S. Securities and Exchange Commission Office of the Inspector General (OIG), the SEC has been following Stanford and his companies for much, much longer. OIG made the Report public yesterday. The Report reveals a stunning pattern of lack of diligence in SEC enforcement.

Stanford's investment advisor registered with the SEC in 1995. By 1997, the SEC's Fort Worth Office Examination Group had conducted an examination and concluded that the CDs Stanford and his companies were marketing were most likely a Ponzi scheme and that Stanford was allegedly engaging in fraud. However, despite the fact that the 1997 examination concluded that Stanford was likely engaging in a Ponzi scheme and referred the matter to the Fort Worth Office Enforcement Office, Enforcement staff did not open an investigation, or "matter under inquiry" (MUI), until May 1998. Enforcement sent Stanford Group Company (SGC) a voluntary request for documents. SGC refused to provide many of the requested documents, and the MUI was closed in August 1998.

The Examination Group conducted another examination of Stanford in 1998, and again concluded that the investments being offered by Stanford were highly suspicious. However, Enforcement staff did not listen to the Examination Group or review its report in deciding to close the investigation of Stanford and his companies.

A third examination of SGC was conducted in 2002 and once again concluded that the consistent above-market returns claimed by SGC were highly unlikely to be legitimate investments. The SEC again did not follow up on the examination, despite receiving conflicting representations from SGC regarding its due diligence and a growing number of complaints from outside entities confirming their suspicions.

In October of 2003, the SEC received a letter from the National Association of Securities Dealers (NASD) stating that Stanford's companies were engaged in an alleged massive Ponzi scheme. The Examination Group was asked to conduct a fourth investigation, which it did in October 2004. The investigation concluded that the CDs were part of "a very large Ponzi scheme." However, in March of 2005, senior Enforcement officials in Fort Worth learned of the Examination Group's fourth examination of Stanford and told them that "[Stanford] was not something they were interested in.”

Shortly thereafter, the head of Enforcement for the Fort Worth Office stepped down. The former head later sought to represent Stanford himself in proceedings by the SEC, despite the fact that he was involved in quashing the investigation of Stanford and his companies.

Enforcement sent Stanford International Bank (SIB) a second voluntary request for documents in August 2005. SIB refused to produce the requested documents. In November of 2005, Enforcement again closed its investigation of Stanford and his companies.

After the exposure of the Ponzi scheme of Bernard Madoff in December 2008, the SEC began to receive complaints regarding the fact that it had allowed Stanford and his companies to continue to engage in a Ponzi scheme. The SEC finally shut down Stanford's companies and froze their assets in February 2009. In October of 2009, Senator David Vitter and Senator Richard Shelby wrote a letter to the SEC asking it to conduct a comprehensive inquiry into its investigation and handling of the Stanford matter.

The OIG Report found that Enforcement staff were reluctant to pursue cases which were novel or complex, preferring to focus on cases which were "quick hits" or "slam dunks." The Report notes that, in the 12 years between the time that the SEC first gained knowledge that Stanford and his companies might be engaging in a Ponzi scheme and the time that the SEC took action to freeze their assets, investments in Stanford's CDs grew from $250 million to $1.5 billion. A survey was taken of investors in Stanford's scheme with 95% responding that knowledge of an inquiry by the SEC would have affected their decision to invest.

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The story of the week is the U.S. Securities and Exchange Commission filing a complaint against international investment firm Goldman Sachs ("Goldman") on April 15 in the U.S. District Court for the Southern District of New York, alleging that Goldman and a Goldman employee, Fabrice Tourre, a former Vice President of Goldman in New York and current Executive Director of Goldman Sachs International in London, allegedly made materially false statements to investors regarding a synthetic collateralized debt obligation, or CDO, which Goldman marketed to investors. A CDO is an asset-backed security which derives its value from underlying assets. The CDO in question was called Abacus 2007-CD1 ("Abacus 2007" or "CDO"), was backed by subprime residential home mortgages. Goldman issued a press release following the filing of the complaint stating that "The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation."

The SEC complaint alleges that Goldman used marketing materials for Abacus 2007 which falsely represented that the portfolio of mortgage-backed securities which formed the CDO were selected by ACA Management LLC ("ACA"), a firm with experience in analyzing mortgage-backed securities. However, the complaint contends that Paulson & Co., Inc. ("Paulson"), allegedly participated in the selection of the portfolio in the Spring of 2007 without any mention in Goldman's marketing materials and without the knowledge of Goldman's investors. Paulson also allegedly entered into "credit default swap" ("CDS") agreements with Goldman. Under a CDS agreement, in its basic form, an entity or person purchases "protection" against a potential default or "credit event" involving a credit instrument such as a bond or loan. The purchaser of the protection makes quarterly or premium payments to the seller of the protection. In the event that the instrument goes into default,  the seller pays the purchaser the par value of the bond or other fixed amount. CDS agreements may be used for speculative purposes, such as betting on a default in credit or loan obligations. The SEC alleges that Paulson, in selecting the securities which made up Abacus 2007, had a financial incentive to select securities which would experience credit events.

Paulson allegedly was under the belief since 2006 that certain "Triple B" rated subprime mortgage loans would experience "credit events," a/k/a significant losses. Paulson then allegedly approached Goldman and asked it to create a CDO composed of the mortgage-backed securities it believed would experience credit events. Paulson and Goldman would then allegedly "short" the CDO by entering into a CDS agreement.

The complaint alleges that Tourre designed the Abacus 2007 transaction, prepared the marketing materials and communicated with investors. At the time they were structuring the transaction, Goldman, Paulson and Tourre knew that the market for mortgage-backed CDOs was declining. Tourre allegedly sent an e-mail to a friend in January of 2007 in which he stated ""More and more leverage in the system, The whole building is about to collapse anytime now...Only potential survivor, the fabulous Fab[rice Tourre] ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!" The following month, Tourre allegedly received an e-mail from the head of Goldman's structured product correlation trading desk stating that "the cdo biz is dead we don't have a lot of time left."

The complaint also alleges that Goldman, Paulson and Tourre chose ACA Management as the portfolio selection agent because they knew they could not attract investors if the investors knew that Paulson had selected the CDO in order to short it. Paulson then allegedly identified over 100 Triple B bonds which it expected to experience credit events, including mortgage-backed securities with a high concentration of subprime adjustable rate mortgages and buyers with low FICO scores.

Tourre and representatives of Goldman, Paulson and ACA met in January and February of 2007 to select the portfolio for Abacus 2007. ACA allegedly had no knowledge that Paulson intended to short the CDO and the complaint alleges that Goldman allegedly mislead ACA into believing that Paulson was investing in the equity of the CDO and had a "long position" in the CDO's success, as opposed to taking a short position adverse to the interests of Goldman investors. ACA allegedly only permitted Paulson to participate in the portfolio selection process because it was led to believe that Paulson was a large equity investor. Tourre allegedly sent an email to a co-worker during these meetings stating "I am at this aca paulson meeting. this is surreal."

By the end of January, 2009, 99% the Abacus 2007 portfolio had been downgraded and investors in the CDO had lost $1 billion. Conversely, Paulson allegedly received $1 billion in profit. Investors in Abacus 2007 included IKB, a commercial bank in Germany, which lost almost all of the $150 million which it invested; and ACA's parent company, ACA Capital Holdings, the largest investor which invested some $951 million.

The SEC alleges that Goldman and Tourre violated Section 17(a) of the Securities and Exchange Act of 1933, 15 U.S.C. s 77q(a) and Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. s 78j(b). It seeks civil penalties and fines against the defendants.

Goldman, by all appearances, intends to fight back against the allegations. In a second press release, it contends that the accusations are unfounded in law and fact. Goldman maintains that it would not structure a portfolio that was designed to lose money, that it retained substantial risk in the transaction, and points out that it lost more than $90 million itself. It contends that its large investors were provided with extensive information relating to the underlying mortgage securities and the risks, and provided input on the underlying mortgage securities. Furthermore, Goldman points out that ACA was the largest investor and had every incentive to select securities which would not experience credit events. Goldman also claims that it never represented to ACA that Paulson would be a long investor, and that the industry practice is not to disclose the identities of buyers to sellers.

The complaint against Goldman is the largest action thus far to emerge out of the financial collapse which began in 2007, and which has angered the public and has lawmakers, law enforcement and the SEC itself feeling the heat. Former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin were acquitted on fraud charges last November relating to a failed hedge fund.

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The Securities and Exchange Commission announced this week a new initiative to encourage private individuals and corporations to cooperate in SEC investigations and enforcement. The SEC will revise its Enforcement Division's enforcement manual to add a new section entitled "Fostering Cooperation." The section will allow SEC investigators to use the following "tools":

Cooperation Agreements — Formal written agreements in which the Enforcement Division agrees to recommend to the Commission that a cooperator receive credit for cooperating in investigations or related enforcement actions if the cooperator provides substantial assistance such as full and truthful information and testimony.

Deferred Prosecution Agreements — Formal written agreements in which the Commission agrees to forego an enforcement action against a cooperator if the individual or company agrees, among other things, to cooperate fully and truthfully and to comply with express prohibitions and undertakings during a period of deferred prosecution.

Non-prosecution Agreements — Formal written agreements, entered into under limited and appropriate circumstances, in which the Commission agrees not to pursue an enforcement action against a cooperator if the individual or company agrees, among other things, to cooperate fully and truthfully and comply with express undertakings.

The proposed changes also streamline the process for requesting immunity from the Justice Department for witnesses assisting in SEC investigations and enforcement actions. They futhermore set forth considerations for evaluating cooperation by individuals, including:

The assistance provided by the cooperating individual.
The importance of the underlying matter in which the individual cooperated.
The societal interest in ensuring the individual is held accountable for his or her misconduct.
The appropriateness of cooperation credit based upon the risk profile of the cooperating individual.
As the announcement recognizes, the "tools" are tools which the Department of Justice has long employed to secure cooperation and obtain information. Professor Ellen S. Podgor of Stetson University College of Law and the White Collar Crime Prof Blog has listed concerns regarding the SEC's new cooperation criteria.

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On Monday, the SEC filed a Complaint for Injunctive and Other Relief, in Federal court in Tampa, Florida, which may be viewed here, against Neil V. Moody and Christopher D. Moody, managers of the hedge funds Valhalla Investment Partners, L.P., Viking IRA Fund, LLC, and Viking Fund, LLC. Neil Moody, 71, and his son Christopher D. Moody, 35, are co-owners of the funds, based in Sarasota, Florida.

The Complaint charges that the Moodys allegedly recklessly violated anti-fraud provisions of Federal securities laws. Specifically, the SEC alleges that, from 2003 to 2009, the Moodys allegedly overstated investment returns and the value of the funds' assets by as much as $160 million in account statements provided to investors and offering materials provided to prospective investors. The Complaint also charges that the Moodys allegedly recklessly misrepresented to investors that they actively managed the funds, when in fact the investment and trading activities of the funds were managed by a third-party, namely Arthur Nadel of Scoop Management. Nadel, however, was the operator of a large Ponzi scheme involving hundreds of investors, including investors in the Moodys' hedge funds. Nadel allegedly fabricated false performance and account information which overstated the value of the Moodys' funds, and shared management and performance fees with the Moodys. The SEC filed an emergency action against Nadel in the Middle District of Florida last January, and was indicted in the Southern District of New York in April on six counts of securities fraud, eight counts of wire fraud, and one count of mail fraud.

Counsel for Christopher Moody has responded to the Complaint. “The SEC's complaint does not allege that Chris Moody knowingly intended to harm investors. The complaint alleges recklessness which Mr. Moody neither admits nor denies. Mr. Moody has cooperated from the outset with the receiver in the recovery of assets and will continue to do so,” said Mr. Moody’s attorney, Jeffrey L. Cox, of Sallah & Cox, LLP.

The Complaint alleges violations of Sections 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a); Section 206(4) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6(4); Exchange Act Rule 10b-5, 17 C.F.R. § 240.10b-5; and Advisers Act Rule 206(4)-8, 17 C.F.R. § 275.206(4)-8. It seeks declaratory relief, a permanent injunction against the Moodys, disgorgement of all profits and civil penalties. A Receiver has been appointed for the funds.

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