Criticizes lack of coordination of SEC investigations
The New York judge overseeing the U.S. Securities and Exchange Commission case against Caledonian Bank criticized the regulator in an opinion released Tuesday, painting a picture of disorganization and inefficiency at the SEC that led to the collapse of the Cayman Islands bank.
District Judge William Pauley III at the Southern District of New York took the SEC to task earlier this year, accusing the regulator of not having its facts straight when it froze Caledonian’s U.S. accounts, leading to a run on the 45-year-old bank.
“This motion comes in the aftermath of a preemptive strike by the SEC,” Judge Pauley wrote in a Nov. 10 order rejecting a motion from another defendant. “That freeze order … precipitated significant collateral damage, including the collapse of a Cayman Islands financial institution,” he continued.
The U.S. securities regulator investigated Caledonian Bank and its brokerage Caledonian Securities together with three other brokers, Legacy Global and Clearwater Securities in Belize and Verdmont in Panama, for their participation in penny stock pump and dump schemes and trading in unregistered securities.
Caledonian Securities and Verdmont, the brokerages that responded in the case, did not deny having traded the shares but asserted that they did so only on behalf of their customers.
A temporary restraining order that froze $76 million of Caledonian’s U.S. assets, which ultimately caused the bank to fail, however, reflected the SEC claim that Caledonian had traded on its own account.
In the months after the first filings, the SEC pulled back on its initial accusations. The judge wrote that in the amended complaint, “Characterizations that Caledonian or Verdmont has acted as principals and lined their pockets were recast or abandoned altogether.” Contrary to what the SEC said in May, Judge Pauley wrote, “the SEC alleges in its Amended Complaint that Caledonian may also have been a broker.”
“These amended allegations are seismic,” he wrote, noting the SEC was “retreating from its allegations that Verdmont sold the penny stocks for its own benefit.”
Lack of coordination
SEC lawyers, whose declarations in obtaining the freeze order amounted to “government overreach,” according the judge, were apparently also not aware that the defendants in the case were subject to separate SEC investigations and lawsuits.
The SEC attorney supervising the investigation told the court that SEC staff had no knowledge of any relevant customer accounts at Caledonian and Verdmont at the time the action was commenced.
“But it appears that this was not true for other attorneys at the SEC who were already investigating the same network of offshore entities,” Judge Pauley wrote in the Nov. 10 order.
Five months before the complaint, the United States Attorney for the Eastern District of New York indicted Legacy Global and a number of other defendants for allegedly concealing their beneficial interest in U.S. issuers and “engineering … artificial price movements and trading volume” in the stocks of those companies.
“Embarrassingly, it was a foreign regulator – not the SEC lawyers in New York – who finally suggested to the SEC’s Washington lawyers that they rummage through their own files for answers to the questions they were asking about Verdmont and its clients,” Judge Pauley wrote.
The SEC attorney who signed the Caledonian and Verdmont complaint acknowledged that he did not know the foreign regulator had sent the documents to the SEC’s New York office in the separate case.
“Thus, the SEC attorneys in Washington, D.C. were either unaware that SEC attorneys in New York were pursuing an investigation of some of the same defendants elsewhere, or chose not to coordinate with them,” Judge Pauley noted. “Either scenario is disheartening.”
On June 18, four months after initiating action against Caledonian, the SEC filed a separate lawsuit in the district of New York alleging Norstra, one of the companies whose stock was allegedly manipulated in the Caledonian suit, participated in a pump and dump scheme.
The New York SEC attorneys did not mark the case as related to Caledonian and only later confirmed that some facts and circumstances were implicated in both cases. But coordinated pretrial proceedings were not necessary, they argued, because the SEC was suing different defendants on different legal theories in the second action. The Washington SEC attorneys later said the two actions “overlapped a bit.”
The two cases were subsequently assigned to the same court, but the SEC filed two more actions in the Eastern District of New York involving three offshore entities named as defendants in the Caledonian case.
One case, filed on June 23, involves Gregg Mulholland, who allegedly controlled Legacy Global and used Caledonian Bank and Legacy Global, as well as an unnamed bank in the Cayman Islands, to make unregistered distributions of penny stock securities of the company Vision Plasma.
Another case concerned Phil Kueber, who allegedly controlled Clearwater Securities.
The lead SEC attorney in the Norstra case tried to explain to Judge Pauley in a pretrial hearing the reason for five separate cases involving 16 SEC lawyers in two districts: “You won’t like the answer, your Honor, frankly because it will indicate a lack of coordination that we tried to repair in the interim.”
He said he knew that the Caledonian case, involving Norstra, had been filed but he not been sent or seen the complaint.
“And serendipitously, when I went to file this complaint, the very next day I saw on our news clip summary … a notice that the Caledonian complaint had been amended, and I said to my colleague … we should get that complaint and make sure there is nothing in it that we don’t know about.”
Judge Pauley wrote that it is “hard for this Court to believe” that the SEC does not have systems in place to ensure that its staff is aware of investigations involving the same facts, individuals or entities and that no enforcement staff is monitoring activities.
“A self-examination may be appropriate,” the judge suggested.
The SEC argued it has as yet to receive evidence demonstrating that Caledonian acted as a broker because, unlike Verdmont, the bank has not provided any customer information, citing Cayman Islands bank secrecy laws.
The proposed settlement between Caledonian and the SEC, which first has to be approved by the Cayman Islands Grand Court, “should address any discussions between Caledonian and the SEC about the beneficial ownership of the shares Caledonian sold,” when it is submitted to the U.S. court, Judge Pauley said.
With the Nov. 10 order, the judge rejected a motion by Verdmont for a judgment on the pleadings, effectively ordering the case against Verdmont to go to trial.