Thirteen Firms Sanctioned for Improperly Selling Puerto Rico Junk Bonds in Violation of New Retail Investor Protection Law

By Daniel Wolfe

On November 3, 2014, the Securities and Exchange Commission (SEC) brought sanctions against 13 firms for improperly selling Puerto Rico municipal bonds. The violations stem from a relatively new rule entitled Municipal Securities Rulemaking Board (MSRB) Rule G-15(f), which has established what’s called a “minimum denomination requirement” that must be followed when selling municipal bonds.

The minimum denomination requirement sets a threshold on the number of bonds dealers may sell in a single transaction to a single investor. The rule is not an upper limit, but a rather a lower limit meaning that the rule prevents dealers from selling below a certain threshold of bonds.

The requirement is designed to deter retail investors from purchasing risky, “junk” bonds because retail investors typically purchase securities in small amounts. Thus, by implementing a threshold above which retail purchasers would not typically buy, and preventing dealers from selling below that threshold, the rule reduces the likelihood that retail investors will purchase these bonds. Consequently, the only purchasers who would be buying above this threshold would be those purchasers who have the capacity to make larger investments and therefore bear a higher risk.

In early 2014, the Commonwealth of Puerto Rico set a $100,000 minimum denomination requirement on a $3.5 billion dollar offering of municipal “junk” bonds in accordance with MSRB Rule G-15(f). An SEC investigation revealed that on 66 separate occasions, dealers sold these Puerto Rico bonds below the $100,000 minimum. Not only did this violate Rule G-15(f), but the SEC orders also reveal a violation of Section 15(B)(c)(1) of the Securities Exchange Act of 1934 that basically prohibits the violation of any MSRB rule.

The 13 firms responsible for these improper sales include the following: Charles Schwab & Co., Hapoalim Securities USA, Interactive Brokers LLC, Investment Professionals Inc., J.P. Morgan Securities, Lebenthal & Co., National Securities Corporation, Oppenheimer & Co., Riedl First Securities Co. of Kansas, Stifel Nicolaus & Co., TD Ameritrade, UBS Financial Services, and Wedbush Securities.

Although not explicitly admitting blame, each firm agreed to settle the charges by paying penalties between $54,000 (Hapoalim Securities USA) and $130,000 (Riedl First Securities Co. of Kansas).

The SEC has not completed its investigation as of yet. Joseph Chimienti, Sue Curtin, Heidi M. Mitza, Jonathon Wilcox, and Kathleen B. Shields are behind the investigation.

SEC Files Charges Against Fraudsters who Utilized Social Media to Attract Investors

By Jordan Hadley

On November 12, 2014, the Securities and Exchange Commission (“SEC”) announced that it would bring charges against Pankaj Srivastava and Nataraj Kavuri, two operators of a high-yield investment scheme that targeted investors using social media.

The SEC alleges that from April 2013 until February 2014, the two individuals operated a website called (“Profits Paradise”), which offered investors three investment plans based on the amount the investor deposited, and each with a term of 120 days. The fraudsters promised investors that they would receive a profit between 1.5-2% daily based on the three investment plans advertised on Profits Paradise. Not only were the advertisements described highly speculative, the returns described equated to a yield of above 180% of the original investment.

Profits Paradise was vaguely described to investors as an investment company that was involved in various areas of the financial market. Investors were lead to believe that their funds would be pooled together and then invested in stock and other investment options. The two fraudsters convinced investors that by pooling money, Profits Paradise could provide them access to investments that they would not normally be able to access. However, investors did not realize that Profits Paradise also contained a clause that allowed them to only withdraw up to the 2% earned interest a day, essentially blocking investors from ever withdrawing their full principal. Investors were also told that by referring others to invest in Profits Paradise, they would receive additional bonuses and commissions.

Srivastava and Kavuri both have experience in the software industry, which may have contributed to their ability to carry out this particular scheme. The SEC states that Srivastava was the mastermind behind the scheme, and that he convinced Kavuri to create, design, and market the Profits Paradise website. The two individuals utilized Facebook, YouTube, and other forms of social media to lure investors to their website. During the website’s lifespan, as many as 4,000 people a day visited.

In order to carry out their fraud, Srivastava and Kavuri created the pseudonyms “Paul Allen” and “Nathan Jones,” created fake email addresses for correspondence, and registered as a United States company with the popular web domain, The SEC stated that Srivastava and Kavuri targeted US investors; however, as the SEC began to research Profits Paradise, the website was taken down.

The SEC has charged Srivastava and Kavuri with violations of 17(a)(1) and (3) of the Securities Act. Section 17(a)(1) of the Securities Act makes it unlawful for a person to “employ any device, scheme, or artifice to defraud” in connection with the offer or sale of securities. Section 17(a)(3) makes it unlawful for a person to “ engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.” The matter is set to appear in front of an administrative judge in the near future.

The SEC has noted that the internet serves an attractive forum for fraudsters, because it allows them to reach many investors at a low-cost. Additionally, because those behind these types of schemes usually remain anonymous, it is particularly hard to track down account holders. The SEC has stated that investors can protect themselves by 1) being wary of unsolicited offers; 2) looking out for red flags, such as guarantees or offers that are too good to be true; and 3) determining if the investment only targets a subset of the particular community (minority or religious groups, etc.). As with any investment, it is important to perform adequate research prior to getting involved.

The Lehman Brothers Saga Continues: Broker Wins $5.4 Million Against UBS

By Abirami Ananthasingam

On September 15, 2008, Lehman Brothers filed the largest bankruptcy in history with over $639 million in assets and $619 billion in debt. Despite the residual effects of this failure, for one broker, the torment is finally over. On April 7, 2014, Edward Graham Dulin, Jr. was awarded a $5.4 million award to compensate him for the diminution in the value of his career and the damage to his business from being held responsible for losses sustained by investors to whom he had recommended the purchase of Lehman Principal Protected Structured Products (“Structured Products”). UBS’ actions led to the disclosure of thirty-nine (39) customer complaints on Mr. Dulin’s Central Registration Depository records – forms U4 and U5.

The hearing lasted twenty-one days and involved two experts, Dr. Craig McCann and Terry Ormsbee, and thousands of exhibits. The theory of the case focused on the knowledge of UBS compliance officers and managers at the time the products were sold in 2007. UBS attempted to assert that its compliance officers and managers were unaware of the instability of Lehman Brothers and the risks associated with the Structured Products. Nevertheless, Seth Lipner, counsel for Mr. Dulin, was able to show UBS’s knowledge of the failings of Lehman Brothers in 2007 through his examination of UBS employees and presentation of documentary evidence. [The original version of this post incorrectly identified Mr. Lipner as a witness in the proceeding. The IRC apologizes for any confusion caused by the incorrect information in its original post.] Mr. Lipner was further able to present evidence of UBS’s express decision to not cause any panic amongst the brokers by not informing them of this information. Shockingly, UBS compliance officers and managers did not correct any misunderstandings even after the broker in question communicated his misunderstanding via e-mail.

The evidence established that the compliance officers and managers did not understand the product and did not understand the implications of their actions. These misunderstandings were transferred onto the customers by providing them with inaccurate sales materials and free writing prospectuses. The decision to remain mute as to the risks led to dozens of customer complaints and millions in losses.

Mr. Dulin asserted the following causes of action: Intentional Interference with Business Expectancy, Injurious Falsehood, Breach of Contract, and Violation of Arizona Securities Statutes and Regulations. The hearing resulted in an award for the broker of $4 million in compensatory damages, $1 million in punitive damages, $250,000 in attorneys’ fees, $85,000 in costs, $52,000 in arbitrator fees. The panel even recommended the expungement of all thirty-nine (39) of the customer complaints against the broker.

SCOTUS to Reconsider “Fraud-on-the-Market” Theory in Halliburton

By Allison Norris

On March 5, 2014, the Supreme Court heard oral arguments in the case of Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317. This case will challenge the “fraud-on-the-market” presumption in securities fraud cases.  Without this presumption, putative class action plaintiffs will not be able to maintain a securities fraud class action unless they can prove that each individual shareholder relied on the alleged misrepresentations in cases involving securities that trade on “efficient markets.”  The presumption is based on the economic theory that states that an efficient market will reflect all publicly available information about a company.  Accordingly, a buyer of the security may be presumed to have relied on that information in purchasing the security.

The Supreme Court first recognized the “fraud-on-the-market-theory” in Basic Inc. v. Levinson, 485 U.S. 224 (1988).  By taking away the need to prove individual reliance, this theory allows classes to be certified under Section 10(b) of the Securities Exchange Act, whereas they would otherwise have to be certified under Federal Rule of Civil Procedure 23(b)(3).  In the latter case, individual reliance questions would likely predominate over common questions affecting the class as a whole.

After the Court simplified the reliance requirement, both the number of securities fraud cases filed and amount of settlements paid increased significantly.  The Court, skeptical of a judge-made rule increasing securities litigation to such an extent, has created a number of limits to § 10(b) actions over the last few years.  Even in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184, 1208 (2013), a case that expanded the reach of Basic, four Justices (Scalia, Kennedy, Thomas, and Alito) went out of their way to note that Amgen had not challenged the validity of the “fraud-on-the-market” doctrine, and those Justices expressed doubts about the legal and economic foundations of the doctrine.

After the concurring and dissenting Justices in Amgen opened the door to a challenge of the continuing validity of Basic’s “fraud-on-the-market” presumption, the Court’s acceptance of Halliburton’s petition for certiorari hints that the Court might be primed to overrule or significantly limit Basic.  If the Court were to abrogate or significantly limit the “fraud-on-the-market” theory, it would dramatically change the landscape of class-action securities litigation.  The need to individually determine investor reliance would make securities fraud class certification difficult or practically impossible in most cases, as common class-wide issues would no longer outweigh individual concerns.


U.S. Department of Justice Files Suit Against Standard & Poor’s Over Credit Ratings

by Craig Distel

In the aftermath of the financial crisis, the U.S. Department of Justice, along with a number of state agencies, are poised to file civil charges against Standard & Poor’s Rating Service (S&P).  Accusations center on fraudulent ratings of mortgage bonds.  The Justice Department began its investigation during the summer of 2011 in an effort to determine the causes of the financial crisis.  Though the Justice Department and S&P were in settlement negotiations, those talks recently broke down.  This would be the first suit against a credit rating agency in response to the financial crisis.  The Justice Department reportedly was seeking roughly a $1 billion settlement before the talks broke down.  If a judgment reaches that amount, it would eliminate all of last year’s earnings of $911 million of S&P’s parent company, McGraw-Hill.

S&P has apologized that its ratings did not accurately predict the risk of collateralized debt obligations (CDOs) but has denied any wrong doing.  S&P claimed that other rating agencies and the United States government all reviewed the CDOs, which were sold as low risk due to S&P’s ratings at the time and featured prominently in the 2008 financial collapse. The Justice Department is attempting to hold S&P responsible for its failure to accurately rate the securities which were never actually low-risk investments.  S&P has also pointed to its downgrading of certain securities as proof of its innocence.  A spokesperson for the firm stated that the Justice Department’s law suit is merely a case of “hindsight being 20/20” and that the ratings were put forth on a good faith basis.  Given what we now know about the complexities associated with the packaging of CDOs, the Justice Department’s allegations may have far reaching effects. A victory for the Justice Department would expose all credit rating agencies to a level of liability they have never experienced.  This would, in turn, alter how assets are rated and how they are recommended by financial advisors to their clients.  The suit will likely be filed in California, where many have experienced the negative effects of the crash.

Click below for additional information on the dispute between the Justice Department and S&P:

U.S. Inquiry is Said to Focus on S&P Ratings –

U.S. Accuses S&P of Fraud in Suit on Loan Bundles –