The U.S. Securities and Exchange Commission’s Office of Inspector General is evaluating a perceived lack of coordination involving the commission’s case against Caledonian and several other cases with overlapping factual circumstances.
The Office of Inspector General is an independent office within the SEC that conducts audits and investigations of SEC programs and operations.
In a semiannual report to Congress, the Office of Inspector General cited a federal court order in a civil action filed by the SEC which criticized the commission’s Enforcement Division for bringing several related cases and recommended that a “self-examination” may be appropriate.
The Office of Inspector General said it initiated an evaluation to determine whether the SEC has processes and systems for ensuring that enforcement investigations are coordinated internally and, when appropriate, across SEC divisions and offices.
The report does not name the suit against Caledonian Bank and its brokerage arm for their participation in penny stock pump-and-dump schemes and trading in unregistered securities. However, in the case, District Judge William Pauley III of the Southern District of New York took aim at SEC lawyers in a Nov. 10, 2015, order.
Judge Pauley noted that the commission’s attorneys were apparently not aware that Caledonian’s co-defendants were subject to separate SEC investigations and lawsuits.
When the SEC requested information about the clients of Panamanian broker Verdmont, the Panamanian regulator pointed out that these documents had already been submitted to the commission in another SEC 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 wrote. “Either scenario is disheartening.”
Five months before filing a complaint against Caledonian the United States Attorney for the Eastern District of New York had indicted Legacy Global, a co-defendant in the case and Caledonian brokerage client.
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.
A third case, filed in June last year, involved Gregg Mulholland, the alleged owner of Legacy, for making unregistered distributions of penny stock securities of Vision Plasma.
A fourth case concerned Phil Kueber, who allegedly controlled Clearwater Securities, another co-defendant in the Caledonian case and an alleged associate of Mulholland.
In total, the commission brought five connected cases involving 16 SEC lawyers. The SEC claimed it did not mark the cases as related because it was suing different defendants based on different legal theories.
However, the lead attorney in the Norstra case admitted “a lack of coordination” and said he was aware of the Caledonian case but had not seen the complaint.
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 Office of Inspector General expects to complete its evaluation during the next reporting period ending in September.
Greater information sharing between the various SEC offices involved in the investigations of Caledonian’s co-defendants may have highlighted the nature of the relationship between the bank and its clients.
In the Caledonian case, the SEC was forced to amend its complaint and abandoned initial allegations that Caledonian and Verdmont had traded on their own account and lined their pockets.
The amended complaint recognized that both defendants acted as brokers on behalf of clients.
Judge Pauley called these changes to the allegations “seismic.”
A temporary restraining order that froze $76 million of Caledonian’s U.S. assets, however, was based on the initial SEC declarations, which according to the judge amounted to “incredible government overreach.”
The judge called the asset freeze, which SEC officials acknowledged led to a run on the bank and ultimately its failure, “a preemptive strike.”
The freeze order, he said, “precipitated significant collateral damage, including the collapse of a Cayman Islands financial institution.”
While Caledonian’s liquidators and the Commission have agreed a settlement that was approved by the Cayman Islands Grand Court, the proposal still has to be sanctioned by the U.S. court.
Sentinel Trust Services, the legal owner of all of Caledonian’s equity, has filed a motion seeking the court’s permission to object to the settlement and to seek damages against the SEC.