The former chief executive officer of ArthroCare Corporation, a publicly traded medical device company based in Austin, Texas, was sentenced today to 240 months in prison for his role in orchestrating a fraud scheme that resulted in shareholder losses of over $750 million.
Acting Assistant Attorney General Kenneth A. Blanco of the Justice Department’s Criminal Division, U.S. Attorney Richard L. Durbin Jr. of the Western District of Texas and Special Agent in Charge Christopher Combs of the FBI’s San Antonio Field office made the announcement.
Michael Baker, 58, of Austin, Texas, was sentenced by U.S. District Judge Sam Sparks of the Western District of Texas, who also ordered Baker five years of supervised release following his prison sentence and to pay a fine in the amount of $1 million and to forfeit $13.7 million. At the sentencing hearing, the Court found that investors lost more than $750 million as a result of the fraud scheme. On Aug. 18, after a two-week re-trial, Baker was convicted of one count of conspiracy to commit wire fraud and securities fraud, seven counts of wire fraud, two counts of securities fraud and two counts of making false statements.
Evidence at trial showed that, beginning in 2005 and continuing until 2009, Baker, along with his co-conspirators, masterminded and executed a scheme to artificially inflate sales and revenue through a series of end-of-quarter transactions involving several of ArthroCare’s distributors. Baker, along with his co-conspirators, determined the type and amount of product to be shipped to distributors based on ArthroCare’s need to meet Wall Street analyst forecasts, rather than distributors’ actual orders. Baker and others then caused ArthroCare to “park” millions of dollars’ worth of ArthroCare’s medical devices at its distributors at the end of each relevant quarter. ArthroCare reported these shipments as sales in its quarterly and annual filings at the time of the shipment, enabling the company to meet or exceed internal and external earnings forecasts.
The trial evidence further showed that ArthroCare’s distributors agreed to accept shipment of millions of dollars of products in exchange for special conditions, including substantial, upfront cash commissions, extended payment terms and the ability to return products, allowing ArthroCare to falsely inflate revenue by tens of millions of dollars. In the case of ArthroCare’s largest distributor, DiscoCare, Baker caused ArthroCare to acquire DiscoCare specifically to conceal from the investing public the nature and financial significance of ArthroCare’s relationship with DiscoCare. In addition to falsely inflating ArthroCare’s revenue, Baker lied when he was deposed by the U.S. Securities and Exchange Commission in November 2009 about ArthroCare’s relationship with DiscoCare, the evidence showed.
Baker’s earlier conviction was overturned by the U.S. Court of Appeals for the Fifth Circuit, resulting in the retrial. The sentence imposed on Baker today of 20 years imprisonment is identical to the sentence he received after his first trial.
Co-conspirators David Applegate and John Raffle, both former senior vice presidents of ArthroCare, pleaded guilty to multiple felonies in 2013 in connection with their participation in the scheme. Co-conspirator Michael Gluk, former chief financial officer of ArthroCare, pleaded guilty to conspiracy to commit wire and securities fraud on June 14, in connection with his participation in the scheme.
On Aug. 29, 2014, Raffle was sentenced to 80 months in prison. On Aug. 29, 2014, Applegate was sentenced to 60 months in prison. Gluk’s sentencing is scheduled for Jan. 5, 2018.
This case was investigated by the FBI’s San Antonio Field Office. The case is being prosecuted by Securities and Financial Fraud Unit Chief Benjamin D. Singer, Assistant Chief Henry P. Van Dyck and Trial Attorney Caitlin Cottingham of the Criminal Division’s Fraud Section.
I’ve received several comments on the idea of an Antitrust Whistleblower Statute. Some of the top comments are:
Didn’t you retire? No.
Well, you should have. I sometimes think the same thing, but what could be more fun than being an antitrust lawyer?
Your website design stinks and for a nominal fee I can fix it and help you lose weight. I’m not worried about the website design. But, please email me with the weight loss help.
There were concerns that, particularly with international cartels, a whistleblower award could be excessive. We agree that some allowance should be made to address this possibility. John Connor offered this helpful comment: “What is an appropriate standard for the size of the award? Using a percentage the employer’s fine is likely to be excessive. What about 5 or 10 years’ of the whistle-blower’s compensation?”
There were some questions as to whether cartel whistleblower bounty provisions exist in other countries. That is a good question. We are researching that and will follow up.
Several people noted that an antitrust whistleblower idea is not a new idea and has never received support in the past from the Antitrust Division or Congress. This is true, and we may get nowhere with our proposal this time. But, as we’ve noted, the leniency “cash cow” is slowing down and the SEC whistleblower provision has been a huge success (by most people’s estimation). Sometimes persistence pays off and the time may have come has come for a successful antitrust whistleblower push. And, I may humbly suggest that Kimberly Justice and I may have some insights based on our many years with the Antitrust Division that have not been considered before. We’ll see.
The Grassley-Leahy Criminal Antitrust Anti-Retaliation Act of 2017, was just passed unanimously in the Senate. The legislation would make it unlawful for an employer to retaliate against an employee who reports a violation of antitrust laws or a crime connected to antitrust laws. This is the third time this legislation has passed the Senate unanimously, but it has never even been taken up by the House.
Note: If the Grassley/Leahy Anti-Retaliation Act is passed, that protection would be part of the whistleblower statute. Ms. Justice and I are advocating that an antitrust whistleblower statute should go farther and provide a reward for actionable cartel-busting information.
The SEC whistleblower statute is a very successful model to be followed for a potential antitrust whistleblower statute. There should be differences in some areas (discussed below), but the SEC program has shown to be an effective tool in preserving the integrity of the nations’ securities market while conserving the investigative resources of the SEC. But, it took a severe financial crisis to overcome the objections to an SEC whistleblower statute. Many of the stakeholders, such as the Chamber of Commerce that opposed allowing a whistleblower award as part of the Dodd-Frank Act are likely to oppose an antitrust whistleblower statute. But in November 2016, then SEC chair Mary Jo White said: “The whistleblower program has had a transformative impact on enforcement and that impact will only increase in the coming years.”
The success of the SEC whistleblower statute, at least from an enforcement perspective, is one reason why we think the time has come for a similar antitrust whistleblower statute. It works. The SEC, which pays the whistleblower 10-30% of the sanctions collected in successful actions, has rewarded 46 whistleblowers with approximately $158 million for information that has led to successful enforcement actions.
The SEC statute, like the antitrust statute we propose, is different than a typical False Claims Act-type whistleblower claim where the relator (whistleblower) brings an action in the name of the United States alleging the government has been the victim of fraud. The SEC statute basically provides an informant with a reward (bounty) for coming forward with actionable information where the SEC obtains monetary sanctions. The SEC, however, is precluded from making monetary awards “to any whistleblower who is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower otherwise could receive an award.”
While the SEC statute provides a model, there are areas where adjustments for the nature of cartel violations may be made in an antitrust whistleblower statute. The full SEC legislation can be found here, but below are a couple of key provisions and our suggestions about how they might be modified.
Payment of Award
The SEC whistleblower program allows for a reward, “In any covered judicial or administrative action, or related action.”
The Antitrust Division does not have administrative actions. An antitrust whistleblower would be eligible for an award, in our view, only based on original information that led to criminal Sherman Act convictions and the imposition of fines based on a conviction.
Amount of Award
The SEC provides for a whistleblower award only where the penalties exceed $1 million. In such cases the reward is an aggregate amount [if more than one whistleblower] equal to—
‘‘(A) not less than 10 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions; and
‘‘(B) not more than 30 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions.
In our view, this may not be an appropriate award schedule for an antitrust whistleblower. At a minimum, the $1 million threshold should be eliminated. A whistleblower statute may be particularly effective in construction-type contracts where the loss to the victim is acute. For example, a rigged electrical contract at a local hospital that would have been $750,000 with competitive bidding but has a low fixed bid of $1 million is as worthy of a whistleblower award as an international cartel where each consumer suffers a relatively small loss, but cumulatively the loss will easily exceed $1 million.
Also, the 10 to 30 percent award range may be excessive in a large cartel case. The impetus behind our proposed legislation is not so much to make a whistleblower a mega-lottery winner, but to provide a way to help the whistleblower pay for what could be substantial attorney fees, and to compensate the whistleblower for what may be a long period of unemployment or underemployment, regardless of anti-retaliation protection. Therefore, we would eliminate the minimum award of 10%, leave the maximum of 30% and perhaps require that in making the award the Antitrust Division consider a) the attorney fees incurred; and b) the likely or actual loss of income over a period of time, as well as the value of the information provided, the level of cooperation and the amount of the recovery.
No Recovery for One Convicted of the Violation
No SEC whistleblower award can be made to ‘‘to any whistleblower who is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower otherwise could receive an award under this section.”
An antitrust whistleblower statute should certainly retain this provision. It is our sense that the most likely potential antitrust whistleblowers will be lower-level employees who know about a conspiracy and take some action in furtherance of it—thus creating criminal liability for themselves. This will give the Antitrust Division much control over who can become a whistleblower. The Division retains the discretion whether to give non-prosecution protection, a necessary first step before an insider can become a whistleblower. If the potential whistleblower has a level of culpability such that the Antitrust Division is not comfortable accepting as a whistleblower, the simple answer is to not grant non-prosecution protection. Another possible scenario is that the Antitrust Division grant non-prosecution protection to a highly culpable individual (making them eligible for an award because no conviction) but write into the cooperation agreement that the cooperator waive the right to a potential “bounty.”
There may be, and hopefully will be, some whistleblowers who do not need non-prosecution protection (customers, administrative staff or others who learn of a cartel but have no role in it). But, in practice, the Antitrust Division would have significant control over the whistleblower program because it is likely that many potential whistleblowers would have to take as a first step, negotiating non-prosecution agreements.
Office of the Whistleblower
A key aspect behind the success of the SEC whistleblower provision is that the SEC actively promotes the program. The SEC established an Office of the Whistleblower. This is an excerpt from the office’s home page:
Assistance and information from a whistleblower who knows of possible securities law violations can be among the most powerful weapons in the law enforcement arsenal of the Securities and Exchange Commission. Through their knowledge of the circumstances and individuals involved, whistleblowers can help the Commission identify possible fraud and other violations much earlier than might otherwise have been possible.
The level to which the Antitrust Division promotes a new whistleblower statute will determine its level of success. When the Division first began the revised leniency program, it rolled it out like a new iPhone. The Division went to great lengths to advertise the program and make the program successful in practice by working with companies to help them qualify if at all possible. The flexibility and discretion built in to an SEC style whistleblower statute will give the Antitrust Division the ability to accentuate the features the whistleblower provisions that work best for law enforcement while mitigating any possible downside (such as very culpable people getting awards).
We’ve only touched on the most significant feature of the SEC whistleblower program that may be mimicked in an antitrust whistleblower statute. There would be more “sausage making” into creating actual legislation. Other features of the SEC program worth noting are the reporting requirements to Congress and the Inspector General review and report on the program. If an antitrust whistleblower statute is nearly as effective as the SEC statute, law enforcement and consumers will be the winners. But, if an antitrust whistleblower statute is a bad idea, it can be a short-lived bad idea. In light of the success of the SEC program, it is prudent to give it a chance.
The idea of an antitrust whistleblower is not new, but it has never gained much traction in the past. There have been significant objections, or at least disinterest—particularly from the Department of Justice. The mood seemed to be “Our cup runneth over with Amnesty applications so let’s not screw this thing up.” But, perhaps times have changed. Our analysis is that the objections to a whistleblower statute were either superficial, or when having merit, still not enough to outweigh the benefits of a whistleblower statute.
Before considering some of the possible downside to an antitrust whistleblower statute, a little explanation of what we have in mind may be helpful. We propose an SEC-style whistleblower statue where an informant can be awarded a level of compensation (bounty) when information of illegality leads to charges and recovery by the SEC. This is different than a False Claims Act qui tam case where a Relator brings a case in the name of the government alleging the government has been defrauded. In fact, an antitrust whistleblower statute is needed because a qui tam case is not generally available in price-fixing matters since it is the private sector, not the government that has been harmed.
Concerns About an Antitrust Whistleblower statute
It’s worth noting that the Criminal Antitrust Anti-Retaliation Act has been passed twice unanimously by the Senate in the last two Congresses and is up for vote again on the Senate floor. It will no doubt pass—most likely again unanimously. There is agreement that a person who reports criminal antitrust activity should not face retaliation in the workplace. (Despite the consensus, the House has failed to take up this bill the last two times it has passed the Senate). There is controversy, however, about whether a whistleblower should be eligible for some type of bounty if the information leads to successful cartel prosecution and the imposition of fines.
In 2011, the General Accounting Office Published a report on Criminal Cartel Enforcement that reported stakeholders’ views on a possible antitrust whistleblower statute (here). This is a summary of the GAO findings:
There was no consensus among key stakeholders GAO interviewed–antitrust plaintiffs’ and defense attorneys, among others–regarding the addition of a whistleblower reward, but they widely supported adding antiretaliatory protection. Nine of 21 key stakeholders stated that adding a whistleblower reward in the form of a bounty could result in greater cartel detection and deterrence, but 11 of 21 noted that such rewards could hinder DOJ’s enforcement program. Currently, whistleblowers who report criminal antitrust violations lack a civil remedy if they experience retaliation, such as being fired, so they may be hesitant to report criminal wrongdoing, and past reported cases suggest retaliation occurs in this type of situation. All 16 key stakeholders who had a position on the issue generally supported the addition of a civil whistleblower protection though senior DOJ Antitrust Division officials stated that they neither support nor oppose the idea.
The GAO report is several years old and it may be that positions have been reevaluated. For example, I think the Antitrust Division today would support the anti-retaliation measures in whistleblower statute. But below is an analysis of some of the objections raised to making a bounty available to an antitrust whistleblower.
The Antitrust Division’s principal concern was that jurors may not believe a witness who stands to benefit financially from successful enforcement action against those he implicated. GAO Report p. 39. But, a whistleblower is highly unlikely to ever be a principle witness at a trial. An antitrust crime typically involves many culpable actors. A whistleblower would generally “get the ball rolling” and provide evidence that will turn other witnesses, and allow subpoenas and search warrants from target companies. Further, a single whistleblower who might receive a financial reward seems no less credible than witnesses from an amnesty company where everyone—including the highest-ranking culpable executives—will have escaped criminal prosecution. Also, criminal antitrust trials are relatively rare—almost all cases are resolved by pleas. Finally, it is not logical to worry about the credibility of a witness you would otherwise not even know about absent a whistleblower statute.
A Whistleblower Reward Could Result in Claims That Do Not Lead to Criminal Prosecution:
There was some fear expressed in the GAO report that would-be whistleblowers would fabricate information in order to conjure up a cartel in the hopes of collecting a reward. GAO Report p. 40. Anything is possible, but the Antitrust Division folks are pretty savvy and have standards for opening grand jury investigations. Moreover, the possibility of fabricated charges exists today with a company applying for leniency in the hopes of knee-capping competitors who would have to deal with a criminal cartel investigation. The reality is a “false accusation” simply wouldn’t be corroborated by anyone else and could land the accuser in jail for making a false statement.
In a similar vane, concern was expressed that a whistleblower statute may result in a deluge of complaints to the Antitrust Division that would take additional resources to sift through. This seems like a good problem to have. When Ms. Justice and I were at the Division, we received a fair number of complaints that amounted to no more than oligopoly pricing. It did not take too much time to ask: “What else ya got?”
Kimberly Justice and I wrote an article published in Global Competition Review arguing that it is time for an “Antitrust Whistleblower Statute.” [The article is behind a pay firewall (here).] Kimberly and I will be expanding on this idea in Cartel Capers blog posts over the next two weeks. Below is the first installment. We explain why cartels are a great pond to be fishing in for informants, but a little “whistleblower” bait is needed.
Over the last several years, Senators Chuck Grassley and Patrick Leahy have introduced antitrust whistleblower legislation that has passed in the Senate but died in the House. Their proposed legislation would grant job protection to antitrust whistleblowers. The legislation that Ms. Justice and I are proposing would go further; besides retaliation protection, we would offer potential financial reward to a whistleblower who initiated a successful cartel prosecution.
The time is right for antitrust whistleblower legislation. In 1993, the Antitrust Division revised its Corporate Leniency policy, setting the stage for similar, successful, legislation/polices to be enacted around the world. Amnesty/Leniency rewards an entire company and its cooperating executives with non-prosecution for coming forward and reporting cartel behavior. But leniency applications are slowing down—at least that is the perception of many observers—as the cost of obtaining leniency in terms of corporate time and attorney fees, in an expanding universe of jurisdictions, has would-be applicants reassessing the cost/benefit analysis. A whistleblower statute would not replace, nor in our opinion undercut, leniency policies, but would add a new tool to uncover cartels that exist, and deter new cartels from forming.
There are two features of cartels that are key to understanding why an antitrust whistleblower statute would be a potent and needed weapon in the fight against cartels:
1) There are many potential whistleblowers in virtually every price-fixing/bid rigging conspiracy. The culpability level of the many players ranges from Masters (top-level) to Sherpas (working group guy). Offering a potential whistleblower reward to a single cartel member still leaves a target rich enforcement of culpable executives to focus on; but
2) It is costly for a potential whistleblower to come forward. Any member of a cartel, even the least culpable, faces the possibility of significant jail time. In order for a low-level cartel participant to come forward, he needs to engage a qualified attorney and negotiate a non-prosecution agreement with the Antitrust Division. This is an expensive, potentially life changing decision. Long-term unemployment may well follow. Hefty attorney fees surely will. Even the most desirable whistleblower—one with no culpability at all, such as a secretary, or customer– will not ensnare herself in a cartel investigation without some means to cover significant attorney costs and reap some compensation for doing “the right [but very costly] thing.”
Ms. Justice and I worked on two investigations which highlight these points. The first was an international cartel investigation involving both US and foreign companies. Within each company there were many executives—some retired—that had enough knowledge of the cartel that had they come forward, an investigation would have been opened. If a single whistleblower had come forward, there still would have been many culpable individuals and companies left to prosecute.
Another prosecution involved a typical bid rigging scheme on a government contract. This type of scheme is usually initiated by the owner/senior member of the company (who would not be eligible for whistleblower status). But, it is also typical that an estimator who knows the boss has schemed with a competitor(s) is told to bump up the prices to reflect the agreement. The estimator is liable as a participant in the cartel, but would make an excellent whistleblower.
Given almost any cartel, international or local, a lower level employee could come forward and likely receive a non-prosecution/cooperation deal under the Antitrust Division’s current Individual Leniency Policy. But the Individual Leniency Policy is almost never used because a rational person would likely prefer to lay low and hope the crime never gets uncovered than come forward, likely lose his job and have to pay an attorney to negotiate with the Antitrust Division for immunity. Being an Antitrust Division witness is a marriage that lasts longer than many real marriages. Criminal antitrust investigations take years, and if it is an international matter, a whistleblower will be called on to be interviewed by many jurisdictions around the globe. Without some incentive of a reward, an individual would almost certainly not “volunteer” to assist in a cartel investigation. Even a non-culpable witness/whistleblower such as a customer in whom a salesperson confided or a corporate administrative assistant who saw/heard incriminating information is not likely to come forward to the Antitrust Division on his/her own.
There are many potential antitrust whistleblowers. But the disincentives to come forward voluntarily are significant. Some “bait” is needed to entice a whistleblower: protection from job retaliation and a financial incentive that would cover the significant costs of cooperation and perhaps even provide an “informants’’ bounty.” The False Claims Act, the SEC and other whistleblower statutes are successful because individuals with knowledge can engage an attorney to guide them through the process in exchange for a possible award of attorney fees and a contingency fee. The whistleblower’s attorney can develop the potential whistleblower’s claim, negotiate with the government, and represent the potential whistleblower throughout the process, all without an upfront cost to the potential whistleblower. A former employee, for example, maybe one who has been fired or downsized—would have a way to report illegal conduct without assuming a tremendous legal bill—and even have a financial incentive to do so.
In the next blog post we will discuss some of the objections that have been raised to an antitrust whistleblower statute and why we think none of these concerns are serious enough to kill the whistleblower idea. But, first, we’ll wrap this segment up by noting a couple of the benefits of a whistleblower statute which may be obvious:
A whistleblower can start a criminal cartel investigation with an insider’s view of the agreement and who is party to it. A single whistleblower does not preclude the Antitrust Division from also offering leniency, as it is unlikely one witnesses can provide indictable evidence. But, whistleblower evidence/assistance should lead to an efficient investigation that preserves the most culpable cartel members for prosecution.
Like leniency, as the whistleblower tool gets used and generates publicity, it will be effective in deterring cartels from even forming. This effect is not capable of measurement, but it is logical that if a single member of a cartel (particularly lower-level Sherpas who may not be crazy about carrying out the Master’s scheme) has a means to report the cartel and be rewarded for actionable information, cartel members will have another reason to think twice before engaging in criminal antitrust behavior.
More to come. Thanks for reading.
 Where the government is a victim of a fraud—and bid rigging is a fraud—a whistleblower case can currently be brought under the False Claims Act. There are occasional instances of bid rigging whistleblower case. But, it would be better to have these types of cases covered by a particular antitrust whistleblower statute and better publicized with an Antitrust Division Office Whistleblower Office.
The Securities and Exchange Commission today announced a whistleblower award of more than $1.7 million to a company insider who provided the agency with critical information to help stop a fraud that would have otherwise been difficult to detect. Millions of dollars were returned to harmed investors as a result of the SEC’s ensuing investigation and enforcement action.
”When whistleblowers tip the SEC, it not only can bring wrongdoers to justice but also relief to investors,” said Jane Norberg, Chief of the SEC’s Office of the Whistleblower. ”This whistleblower’s valuable information enabled us to stop further investor harm and ultimately return money to victims.”
Approximately $158 million has now been awarded to 46 whistleblowers who voluntarily provided the SEC with original and useful information that led to a successful enforcement action.
By law, the SEC protects the confidentiality of whistleblowers and does not disclose information that might directly or indirectly reveal a whistleblower’s identity. Whistleblowers may be eligible for an award when they voluntarily provide the SEC with original, timely, and credible information that leads to a successful enforcement action.
Whistleblower awards can range from 10 percent to 30 percent of the money collected when the monetary sanctions exceed $1 million. All payments are made out of an investor protection fund established by Congress that is financed entirely through monetary sanctions paid to the SEC by securities law violators. No money has been taken or withheld from harmed investors to pay whistleblower awards.
BATON ROUGE, LA – Acting United States Attorney Corey Amundson announced today that three more individuals have been charged with insider trading in connection with the acquisition of the Shaw Group. A federal grand jury sitting in the Middle District of Louisiana has indicted KELLY LIU, age 31, SALVADOR RUSSO, III, age 34, both of Baton Rouge, Louisiana, and VICTORY HO, age 38, of Morgan City, Louisiana, with conspiracy to commit securities fraud (insider trading), in violation of Title 18, United States Code, Section 371, and securities fraud (insider trading), in violation of Title 15, United States Code, Sections 78j(b) and 78ff, and Title 17, Code of Federal Regulations, Sections 240.10b-5 and 240.10b5-1. If convicted, eachface significant incarceration, fines, restitution, and supervised release following imprisonment.
The Indictment alleges that from on or before July 18, 2012, and continuing to at least July 30, 2012, LIU and her boyfriend RUSSO, along with associate HO, engaged in a scheme to profit from inside information about the upcoming merger between The Shaw Group (“Shaw”) and Chicago Bridge and Iron Company (“CB&I”).
According to the allegations contained in the Indictment, which was returned by the grand jury earlier today, in mid-2012, Shaw was considering a potential merger opportunity. At the time, LIU was a Shaw employee working in the Financial Planning and Analysis Department. In late July 2012, Shaw and CB&I came to an agreement whereby CB&I acquired all outstanding shares of Shaw stock. The merger between the two companies was publicly announced on July 30, 2012 (“the public announcement”). As a result of the public announcement, Shaw’s stock price rose substantially.
The Indictment alleges that, prior to the public announcement and through her job at Shaw, LIU obtained inside information that Shaw was being acquired by another company and passed the inside information to HO, through another individual, and to RUSSO, for their use in trading Shaw securities. Thereafter, HO and RUSSO allegedly purchased Shaw securities before the public announcement. HO sold his Shaw securities after the public announcement had caused Shaw’s stock price to rise, while RUSSO held his Shaw securities, all at the expense of Shaw shareholders and potential Shaw shareholders who were not privy to the inside information. The Indictment also alleges that HO made over $294,000, and RUSSO over $2,500 in unrealized profits, from their illegal insider trading activities.
Prior to the Indictment announced today, three other individuals have been charged in the Middle and Western Districts of Louisiana with securities fraud offenses related to the Shaw merger. One defendant has pled guilty, and the remaining two are scheduled for trial.
Acting U.S. Attorney Amundson stated: “Insider trading undermines investor confidence in the fairness and integrity of the securities markets, and cheats those honest investors who play by the rules. My office will continue to work aggressively with our excellent partners with the FBI, IRS-Criminal Investigations, the U.S. Secret Service, the Securities and Exchange Commission, the Financial Industry Regulatory Authority, and others to pursue such important matters whenever merited.”
This matter is being handled by the U.S. Attorney’s Office for the Middle District of Louisiana and the Baton Rouge offices of the FBI, Secret Service, and IRS-Criminal Investigation. It is being prosecuted by Assistant United States Attorneys Chris Dippel, Patricia Jones, and Adam Ptashkin.
NOTE: An indictment is an accusation by the Grand Jury. A defendant is presumed innocent until and unless adjudicated guilty at trial or through a guilty plea.
The Securities and Exchange Commission today brought fraud charges against 13 individuals allegedly involved in two Long Island-based cold calling scams that bilked more than one hundred victims out of more than $10 million through high-pressure sales tactics and lies about penny stocks.
The SEC alleges that the orchestrators of the scheme used boiler room-style call centers to make hundreds of thousands of cold calls that included the use of threatening and deceitful sales techniques to pressure victims – many of whom were senior citizens – into purchasing penny stocks. For example, as part of one such scam, a boiler room salesman allegedly claimed that the Walt Disney Company was buying into a purported media and internet company and that would cause the penny stock’s price to increase substantially.
During these calls, victims were allegedly harassed and threatened by sales personnel. When one victim complained about his losses, a sales representative allegedly said, “I am tired of hearing from you. Do you have any rope at home? If so tie a knot and hang yourself or get a gun and blow your head off.” According to the SEC’s complaint, in a typical phone call, telemarketers would direct victims to place trades and tell them how many shares to purchase and at what price. With this information about the victims’ trades, the orchestrators and the boiler room sales personnel allegedly placed opposing sell orders to dump their own shares, realizing more than $14 million in illegal proceeds while the victims lost millions of dollars, including retirement savings.
SEC investigators learned of the alleged scheme from investor complaints and used technological tools and innovative investigative approaches to build evidence – within a matter of months from receiving the complaints – against the defendants who went to great lengths to evade detection.
“These kinds of scams cause devastating harm to investors,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division. “Investors must beware of the sort of conduct alleged in our complaint – things like unsolicited calls, high-pressure sales tactics, and promises that a no-name stock is going to skyrocket.”
Scott W. Friestad, Associate Director of the SEC’s Enforcement Division, added, “The defendants allegedly used boiler rooms and high-pressure sales tactics to swindle seniors into investing their life savings in microcap securities they were secretly manipulating for their own profit. But, through a combination of technology and innovative investigative approaches, we were able to unravel the alleged scheme and prevent further investor harm.”
In a parallel action, the U.S. Attorney’s Office for the Eastern District of New York announced criminal charges.
The SEC’s complaint, filed in federal district court in Brooklyn, N.Y., charges all defendants with fraud and nine with market manipulation. The SEC is seeking permanent injunctions, disgorgement with interest, civil penalties, penny stock bars, and an officer-and-director bar from one of the orchestrators of the scheme. The complaint also names 27 individuals and entities that received proceeds from the fraud, as relief defendants.
The SEC’s complaint also charges certain defendants with acting as unregistered brokers. The SEC encourages investors to check the backgrounds of people selling them investments by using the SEC’s investor.gov website to quickly identify whether they are registered professionals.
The SEC’s investigation, which is continuing, has been conducted by Andrew Elliott and Cecilia Connor and assisted by Leigh Barrett. The investigation was supervised by Scott Friestad and Amy Friedman. The SEC’s litigation will be handled by Matthew Scarlato and James Smith and supervised by Jan Folena. The SEC appreciates the assistance of the Financial Industry Regulatory Authority, Federal Bureau of Investigation, U.S. Attorney’s Office for the Eastern District of New York, British Columbia Securities Commission, Ontario Securities Commission, and Oregon Division of Financial Regulation.
The SEC encourages victims of the alleged fraud to contact PowerTraderVictims@sec.gov . The SEC’s Office of Investor Education and Advocacy previously issued an alert warning investors that aggressive stock promotion is a red flag of fraud.
“Investors should be skeptical anytime they receive an unsolicited communication promoting a stock – it could be a part of a boiler room scheme,” said Lori Schock, Director of the SEC’s Office of Investor Education and Advocacy. “If you receive a phone call from a high-pressure salesperson who uses harassment and threats to get your business, hang up.”
CHICAGO — A federal grand jury in Chicago has indicted two former executives of a Florida technology company for allegedly conspiring to obstruct an investigation by the U.S. Securities and Exchange Commission.
CHRISTOPHER YOUNG, the former President of Tampa-based M2 Interactive Group Inc., and JOSHUA CARLUCCI, M2 Interactive’s former Chief Executive Officer, are charged with conspiracy to obstruct, influence, and impede an official proceeding. The pair allegedly conspired with executives from Schaumburg-based Quadrant 4 System Corp. to obstruct an SEC investigation into Quadrant 4’s 2013 purchase of M2 Interactive.
The indictment was returned Thursday in federal court in Chicago. In addition to the conspiracy count, Young, 35, of Norwich, N.Y., and Carlucci, 39, of Tampa, Fla., are also charged with attempting to obstruct, influence, and impede an official proceeding. Carlucci also faces a charge of making false statements to the Federal Bureau of Investigation. The Court will schedule arraignments for Young and Carlucci at a later date.
New and expanded criminal charges were also filed Thursday against the two Quadrant 4 executives, NANDU THONDAVADI and DHRU DESAI. A criminal information filed in federal court in Chicago charged them with wire fraud. Arraignments for Thondavadi, 63, of North Barrington, and Desai, 55, of Barrington, have been scheduled for July 6, 2017, at 10:00 a.m., before U.S. District Judge Charles Norgle.
The charges were announced by Joel R. Levin, Acting United States Attorney for the Northern District of Illinois; and Michael J. Anderson, Special Agent in Charge of the Chicago office of the FBI. The Chicago office of the SEC provided valuable assistance.
M2 Interactive was a technology company that developed applications for mobile devices and conducted business under the name Momentum Mobile. Quadrant 4 provides software products, platforms and consulting services to customers in the healthcare and education sectors. As a public company, Quadrant 4 is required to provide to the SEC a detailed report of its financial condition.
In 2015 the SEC launched an investigation of Quadrant 4 based on indications that the firm may have violated federal securities laws. The FBI initiated an investigation of Quadrant 4 in 2016. As set forth in the information against Thondavadi and Desai, the investigation revealed that Thondavadi and Desai engaged in a wide-ranging scheme to defraud Quadrant 4’s shareholders by misappropriating more than $3 million from the company, fraudulently inflating Quadrant 4’s revenue, and regularly concealing Quadrant 4’s liabilities. The information charges that Thondavadi and Desai certified false SEC reports, including Quadrant 4’s 2014 Form 10-K, in which the defendants fraudulently inflated Quadrant 4’s revenue by more than $4.2 million – nearly 10% of Quadrant 4’s reported income that year.
The fraud scheme also involved numerous misrepresentations related to Quadrant 4’s acquisitions, including misrepresentations about the terms of Quadrant 4’s purchase of Momentum Mobile in 2013. Quadrant 4 purchased Momentum Mobile for $100,000 in cash and 250,000 shares of Quadrant 4 stock, plus assumption of approximately $165,000 in Momentum Mobile liabilities, according to the indictment against Young and Carlucci. Federal authorities discovered that Thondavadi and Desai later concealed the true terms of the deal from Quadrant 4’s auditor and its shareholders, according to the charges. The pair furnished the auditor with a fictitious agreement that Thondavadi created, the charges state. The bogus document inflated the purchase price and failed to mention the liabilities Quadrant 4 assumed, according to the charges.
As set forth in the charges, the investigation further revealed that Thondavadi and Desai attempted to obstruct the SEC’s investigation of Quadrant 4 as it related to the Momentum Mobile acquisition. In July 2016 SEC attorneys sought to question Young and Carlucci, who were unaware of the fictitious acquisition agreement that Thondavadi created. Carlucci notified Thondavadi and Desai of the SEC’s inquiry, and the Quadrant 4 executives responded by striking a deal with Young and Carlucci to pay them cash in exchange for their agreement to send Thondavadi an e-mail falsely stating that Momentum Mobile had previously authorized the terms of the fictitious agreement, according to the charges. The defendants attempted to disguise the payments – $102,900 to Young and $60,000 to Carlucci – as “consulting” fees, the charges state.
The public is reminded that charges are not evidence of guilt. The defendants are presumed innocent and entitled to a fair trial at which the government has the burden of proving guilt beyond a reasonable doubt.
The conspiracy, obstruction and wire fraud charges are each punishable by up to 20 years in prison, while making false statements to the FBI is punishable by up to five years. If convicted, the Court must impose a reasonable sentence under federal statutes and the advisory U.S. Sentencing Guidelines.
U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 23847 / May 26, 2017
Securities and Exchange Commission v. Momentum Investment Partners LLC (D/B/A Avatar Investment Management) and Ronald J. Fernandes, No. 16-cv-00832 -VLB (D. Conn. filed May 31, 2016)
The Securities and Exchange Commission today announced that it obtained final judgments by consent against Connecticut-based investment adviser Momentum Investment Partners LLC (doing business as Avatar Investment Management) (“Avatar”), and its CEO, Ronald J. Fernandes, for failing to disclose to some of Avatar’s advisory clients certain fees they were being charged. Among other things, the judgments order the defendants to pay a total of over $230,000.
On May 31, 2016, the Commission filed a complaint in federal court in Hartford, Connecticut, alleging that Avatar and Fernandes failed to disclose material conflicts of interest in connection with investments Avatar made in new mutual funds that it created and managed. Specifically, the complaint alleges that Avatar and Fernandes failed to disclose that moving clients’ assets into these newly-created mutual funds would increase the clients’ total advisory fees paid to Avatar without changing the clients’ investment strategy. The complaint alleges that between May 2013 and March 2014, Avatar’s clients paid almost $111,000 in additional fees, including approximately $61,000 that was ultimately paid to Avatar, for no additional services.
The final judgments, entered by the Honorable Vanessa L. Bryant of the U.S. District Court for the District of Connecticut on May 26, 2017, permanently enjoin Avatar and Fernandes from violating Sections 206(1) and 206(2) of the Investment Advisers Act of 1940 (“Advisers Act”), Avatar from violating Sections 204, 206(4) and 207 of the Advisers Act and Rules 204-1 and 206(4)-7 thereunder, and Fernandes from aiding and abetting violations of Sections 204, 206(4) and 207 of the Advisers Act and Rules 204-1 and 206(4)-7 thereunder. The judgments also order the defendants to disgorge, on a joint and several basis, $61,275.52 in ill-gotten gains plus $7,400.85 in prejudgment interest, for a total of $68,676.37, and order Avatar to pay a civil penalty of $125,000 and Fernandes to pay a civil penalty of $40,000. The defendants neither admit nor deny the allegations in the SEC’s complaint.