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News October 10, 2005 Issue

After Long Fight, Adviser Wins $160,000 Penalty Reduction in IPO Case

Imagine the following:

For eight months back in 1993, your advisory firm allocated hot IPOs to three of your funds’ directors, along with your other advisory clients, including several mutual funds. You stopped allocating IPOs to the directors after questions arose about whether the two interested directors were restricted persons under the NASD’s hot issue rule, and after seeing adverse publicity about fund insiders trading in the same securities as their funds.

A few months later, SEC examiners came in and discovered the IPO allocations. The examiners didn’t like what they saw. Although your allocations did not appear to disproportionately benefit the three directors, they were not disclosed to the other fund directors. Moreover, the examiners noted that the commissions that led to the availability of the IPOs were generated primarily by the funds, not by the directors’ accounts. The examiners referred the matter to the SEC’s Division of Enforcement. Your firm could have paid $100,000 to settle the charges, and you would have paid $50,000.

Instead, you decide to fight the charges. In 2001, an SEC ALJ rules against you and — to your chagrin — doubled the penalties to $200,000 for your firm and $100,000 for you.

You fight on. The matter goes before the full SEC Commission.

You’re relieved when the Commissioners throw out several of the fraud charges against you, saying that the Division of Enforcement did not provide enough evidence to support their claim that you favored the directors’ accounts over other clients’ accounts. However, they uphold the Advisers Act 206(2) fraud charge, based on your failure to disclose the conflict caused by the IPO allocations. And, inexplicably, they hold the civil penalties steady at $200,000 and $100,000, even though they dropped the other fraud charges.

You continue the fight before the U.S. Court of Appeals for the Seventh Circuit. The court upholds the Advisers Act fraud count, but remands the case back to the SEC for a reconsideration of the penalties.

Finally, last week, the Commission issues a new opinion, reducing your firm’s civil penalty to $40,000. While you had argued that the Commission shouldn’t impose any penalty at all, citing your otherwise unblemished record, industry practice at the time, and the briefness of the conduct, you know that the Division of Enforcement had sought a $85,000 penalty. The enforcement lawyers claimed that you misled examiners by telling them you had no idea how the IPOs ended up in one of director’s accounts (they claimed that you put them there yourself). They also asserted that a penalty is necessary to send a signal to others in the industry that the conduct at issue is not acceptable. Still, you think, $40,000 is a heck of a lot better than $200,000.

That, in a nutshell, is the long tale of Monetta Financial Services and the firm’s founder, Robert Bacarella. SEC Chairman Christopher Cox and Commissioner Annette Nazareth did not participate in the Commission’s October 4 opinion.

Here’s an interesting aside for those of you watching the U.S. Chamber of Commerce v. SEC case: the Seventh Circuit’s opinion was decided November 30, 2004. However, the date of the remand, as set forth on last week’s Commission opinion, was January 28, 2005. In other words, it seems that the SEC, at least in the Monetta case, did not view the remand as effective as of the date of the court’s decision — something it apparently did in the U.S. Chamber case (to the D.C. Court of Appeals’ consternation).