Illinois

FINRA joins exchanges in fining Newedge USA $9.5 million for supervisory, regulation and other violations

The Financial Industry Regulatory Authority (FINRA), along with BATS Exchange, Inc.¹, New York Stock Exchange LLC², NYSE Arca, Inc. and The NASDAQ Stock Market LLC, announced that they have censured and fined Newedge USA, LLC of Chicago $9.5 million for failing to supervise trading by clients that directly accessed U.S. equities markets through Newedge's order routing platform and/or internet service providers (known as "direct market access," or "DMA") or routed orders directly to market centers (known as "sponsored access," or "SA"). In addition, Newedge also violated Regulation SHO (Reg SHO) and SEC Emergency Orders concerning short sales, and failed to obtain and retain books and records.

Thomas Gira, executive vice president of market regulation at FINRA, said, "If a firm is going to turn a blind eye toward potentially manipulative trading unleashed upon the market by one of its customers, this case shows that there will be serious consequences. It is imperative that firms giving customers access to the marketplace function as responsible gatekeepers and implement reasonable supervisory programs and procedures to monitor their customers' trading to ensure market integrity. As there were many triggers for this case, including referrals and information from BATS, NASDAQ and the NYSE, this case also illustrates how FINRA and the exchanges can effectively pursue activity that spans multiple markets."

FINRA and the exchanges found that Newedge did not have sufficient procedures, adequate surveillance tools, or necessary information to monitor DMA and SA client trading. Newedge's supervisory violations occurred over a four-year period, during which numerous internal documents noted the firm's deficiencies. Even after these "red flags" were raised, Newedge did not take adequate steps to satisfy its supervisory obligations.

In one example, FINRA also found that Newedge did not have adequate procedures or controls to monitor which clients used DMA and SA to trade in the equities markets. Newedge failed to reasonably and effectively monitor for certain types of potentially manipulative trading, such as wash trading, despite numerous requests from its own compliance department to implement a wash trading surveillance report. Also, Newedge could not adequately monitor certain clients' trading because it did not receive any order data reflecting their activity. Newedge also lacked essential knowledge about the beneficial owners of certain accounts directly accessing U.S. markets through firm affiliates, knowledge that was necessary for Newedge to properly monitor for potentially manipulative or suspicious activity. In addition to failing to obtain or retain required records, such as certain order data and client documentation, Newedge failed to retain certain email and text message data.

 Newedge's failure to supervise its DMA and SA business also impacted its ability to supervise compliance with federal securities regulations regarding short sales, including the Emergency Orders issued by the SEC in July and September 2008 restricting or prohibiting short sales in certain securities. During the financial crisis in 2008, Newedge permitted its clients to submit numerous orders for short sales in securities that were prohibited by the SEC. FINRA found that Newedge violated Reg SHO by accepting customer's short sale orders without a reasonable basis to believe the securities could be borrowed, could not determine its net position for appropriate sell order marking in a given security, and could not reasonably determine whether sell orders entered by clients were accurately marked.

In concluding this settlement, Newedge neither admitted nor denied the charges, but consented to the entry of FINRA's findings. Newedge also consented to retain an Independent Consultant to conduct a comprehensive review of the adequacy of the firm's policies, systems and procedures relating to the specific areas of violative conduct identified by FINRA and the exchanges. Newedge will pay a total of $9.5 million in fines, including a $4 million fine to FINRA, a $1.75 million fine to The NASDAQ Stock Market LLC, a $1.75 million fine being paid to the BATS Exchange, Inc., a fine of $1.125 million to the New York Stock Exchange LLC, and an $875,000 fine to NYSE Arca, Inc.

New York

SEC Obtains $13.9 Million Penalty Against Rajat Gupta

The Securities and Exchange Commission (SEC) obtained a $13.9 million penalty against former Goldman Sachs board member Rajat K. Gupta for illegally tipping corporate secrets to former hedge fund manager Raj Rajaratnam.  Gupta also is permanently barred from serving as an officer or director of a public company.

The SEC previously obtained a record $92.8 million penalty against Rajaratnam for prior insider trading charges.

“The sanctions imposed today send a clear message to board members who are entrusted with protecting the confidences of the companies they serve,” said George S. Canellos, co-director of the SEC’s Division of Enforcement.  “If you abuse your position by sharing confidential company information with friends and business associates in exchange for private gain, you will be prosecuted to the fullest extent by the SEC.”

In its complaint filed in late 2011, the SEC alleged that Gupta disclosed confidential information to Rajaratnam about Berkshire Hathaway Inc.’s $5 billion investment in Goldman Sachs as well as nonpublic details about Goldman Sachs’ financial results for the second and fourth quarters of 2008.

In addition to imposing the financial penalty, the order issued today by the Honorable Jed S. Rakoff of the U.S. District Court for the Southern District of New York enjoins Gupta from future violations of the securities laws, and permanently bars him from acting as an officer or director of a public company and from associating with any broker, dealer, or investment adviser. 

In a parallel criminal case arising out of the same facts, the SEC provided significant assistance to the U.S. Attorney’s Office for the Southern District of New York in its successful criminal prosecution of Gupta, who was found guilty on June 15, 2012, of one count of conspiracy to commit securities fraud and three counts of securities fraud.  Following the jury verdict, Gupta was sentenced on Oct. 24, 2012, to a term of imprisonment of two years followed by one year of supervised release, and ordered to pay a $5 million criminal fine.

On Dec. 26, 2012, the SEC obtained a final judgment ordering Rajaratnam to disgorge his share of the profits gained and losses avoided as a result of the insider trading based on Gupta’s tips, plus prejudgment interest.

Texas

SEC Halts Texas-Based Forex Trading Scheme

The Securities and Exchange Commission announced an emergency asset freeze against an unregistered money manager and his companies in Plano, Texas, who are charged with defrauding investors in a foreign currency exchange trading scheme. The Commodity Futures Trading Commission announced parallel charges against White and his companies. (see last week’s Blotter).

The SEC alleges that Kevin G. White raised more than $7.1 million from investors by touting a sophisticated low-risk forex trading strategy yielding astronomical returns. He advertised his purported "25-year Wall Street career." In reality, the forex trading has incurred losses of investor funds, and White actually spent only six years as a licensed securities professional in Houston before being barred by the New York Stock Exchange two decades ago. White also lied about his education. Meanwhile, White has siphoned away more than $1.7 million of investor money to pay personal expenses, finance expensive trips, and fund other unrelated and undisclosed businesses and investments.

"White and his companies brandished phony credentials and a can't-miss trading strategy to lure investors into a web of deceit," said David Woodcock, Director of the SEC's Fort Worth Regional Office. "In reality, White was suffering forex trading losses and putting investor money to other uses."

According to the SEC's complaint that was unsealed last week  in U.S. District Court of the Eastern District of Texas, White raised investor money through two entities that he owns and controls: KGW Capital Management and Revelation Forex Fund. KGW Capital purports to be "one of the world's leading private investment firms."

The SEC alleges that White and his companies used websites, press releases, and presentations to prospective investors to solicit funds. White and his companies told investors that Revelation Forex was a $1 billion hedge fund that had achieved total returns of more than 393 percent since its January 2009 inception, and earned a compound annual rate of return of more than 36 percent. Marketing materials provided to prospective investors boasted that an initial investment of $250,000 in Revelation Forex in January 2009 would have grown to $983,111 by May 2013.

The SEC alleges that these claims were false. While White and KGW Capital tout a track record for the fund that began in January 2009, Revelation Forex did not actually receive investor funds or begin forex trading until September 2011. The fund has since incurred realized trading losses of more than $550,000 plus approximately $1,419,600 in unrealized losses through May 31, 2013. Meanwhile, bank records reveal that White has taken more than $1.7 million for himself, KGW Capital, and two of his other businesses, including approximately $248,600 in investor funds from Revelation Forex to fund an unrelated and undisclosed propane business and $97,000 on another business entitled KGW Real Estate. The SEC's complaint names both of these companies as relief defendants for the purpose of seeking disgorgement of investor funds in their possession.

The court has granted the SEC's request for an asset freeze and temporary restraining order against White, KGW Capital, Revelation Forex, and RFF GP LLC, which is the general partner of Revelation Forex.