(In third paragraph please read SEC “requested a February order to freeze” instead of “issued a February order that froze.”)
By Suzanne Barlyn
Nov 10 (Reuters) - A federal judge on Tuesday scolded the top U.S. securities regulator, issuing an opinion that said blunders by the Securities and Exchange Commission triggered the collapse of a Cayman Islands bank and other “collateral damage” in a case involving an alleged penny stock scheme.
“This case offers fertile ground for agency self-examination,” U.S. District Court Judge William H. Pauley III in Manhattan wrote, in an opinion dismissing a pre-trial motion in the case.
Pauley said the SEC was mistaken when it requested a February order to freeze more than $88 million in assets belonging to two financial institutions suspected of securities fraud. The agency’s key allegations were wrong, the judge wrote.
One of the institutions, Verdmont Capital, S.A., a Panama-based brokerage, tried to dismiss the case. The judge denied that request, but he did criticize the SEC.
An SEC spokeswoman declined to comment on the judge’s opinion.
SEC lawyers, in February, asked the court to approve its decision to freeze assets of a Cayman Island-based bank and three off-shore brokerages. The request came at a closed emergency hearing that allows the agency to pursue the measure without notifying the institutions involved until after a judge grants the request. Those institutions can then argue to remove the freeze.
SEC lawyers argued that financial institutions had illegally sold “large swathes” of worthless, unregistered penny stocks to investors as part of a “pump and dump” fraud and were holding millions of dollars in proceeds from those transactions in their company accounts.
In a pump-and-dump scheme, perpetrators attempt to boost a stock price through recommendations based on false or misleading statements. They then sell their shares after the hype has boosted their price.
Caledonian Bank Ltd. collapsed and filed for bankruptcy in February after a depositors’ run on the bank.
But the SEC later disclosed to the court that they got it wrong. Verdmont’s and Caledonian’s roles in the alleged fraud were far more limited, the SEC said. The firms were not directly selling the penny stocks, but trading them on some customers’ behalf.
“For an enforcement agency with vast investigative powers, the SEC’s disclosure was chillingly casual,” Judge Pauley wrote.
The SEC recently authorized a settlement with Caledonian Bank that is awaiting approval by Cayman Island authorities.
“The judge said it all about the SEC’s conduct in this case,” said Robert Zito, a lawyer for Verdmont.
A lawyer for Caledonian could not be immediately reached for comment. (Reporting by Suzanne Barlyn; editing by Charles Levinson and David Gregorio)