SEC Complaints Against Falcone
On June 27, 2012, the SEC filed two related complaints. One was against Falcone and two units of Harbinger Capital. The other was against Falcone, Harbinger Capital, and Peter A. Jenson. The first paragraph of the first complaint summarized the allegations:
This case stems from an illegal "short squeeze"—a form of market manipulation that occurs when a trader constricts the available supply of a security with the intention of forcing settlement from short sellers at the trader's arbitrary and inflated prices. Falcone engineered and carried out a squeeze in a series of distressed high-yield bonds issued by MAAX Holdings, Inc., through two unregistered investment managers he controls [two units of Harbinger Capital].
The second complaint contained other allegations. The first two paragraphs of the second complaint summarized the allegations:
First, Falcone and Harbinger, aided and abetted by Jenson, engaged in a fraudulent scheme to misappropriate $113.2 million from a Harbinger fund in order to pay a personal tax obligation owed by Falcone. Instead of paying his personal taxes with his own assets, which may have required Falcone to curtail his lifestyle and personal expenditures, Falcone obtained $113.2 million from a hedge fund that Falcone and Harbinger managed during a period when Harbinger had precluded investors in the fund from redeeming their interests. The Defendants neither sought nor obtained investor approval for the related party transaction. Having structured the transfer of fund assets to Falcone as a loan with a highly favorable interest rate, Falcone and Harbinger, aided by Jenson, concealed the related party transaction from fund investors for approximately five months. To give the appearance of legality, the Defendants engaged a law firm to advise them; however, the Defendants failed to disclose all material information to the law firm. In addition, the Defendants did not act in accordance with the advice that they did receive from the law firm.
Second, in order to obtain investor approval to impose more stringent redemption restrictions on investors in a second Harbinger fund, Falcone and Harbinger engaged in a scheme to grant certain large investors favorable redemption and liquidity terms in return for their vote to approve the restrictions. Falcone and Harbinger concealed this scheme from the fund's board of directors and the other investors, even though Falcone and Harbinger knew, or should have known, that only the board, and not Falcone or Harbinger, had the authority to grant such preferential rights.
The complaints alleged violations of federal securities laws and rules. The first complaint included two claims for relief, and the second complaint included five claims for relief. In the first complaint, the SEC sought a permanent injunction against future violations, disgorgement of ill-gotten gains, and civil monetary penalties, and, in the second complaint, a permanent prohibition against Falcone serving as an officer or director of a public company. (See SEC v. Falcone, U.S. District Court, Southern District of New York, Case Nos. 1:12-cv-5027 and 5028.)
Settlement with the SEC
On August 16, 2013, Falcone and the Harbinger units settled with the SEC on both complaints through a consent agreement and an attachment. They admitted the facts in the attachment, agreed to issuance of a final consent judgment, and agreed to appointment of an independent monitor for two years. Falcone and the Harbinger units agreed to payment of civil penalties of more than $18 million. Falcone also agreed to be barred from the securities industry for at least five years, but he was not barred from serving as an officer or director of a public company. On October 1, 2014, Jenson agreed to pay a civil penalty of $200,000.
Admission of Wrongdoing
In No. 242 I said that the defendants' admission of wrongdoing was important, and that the case was one of the first SEC settlements requiring such an admission. In a January 2014 speech, then SEC Chair Mary Jo White discussed the subject. Here are excerpts from her speech:
As you know, for many years, the SEC, like virtually every other civil law enforcement agency, typically did not require entities or individuals to admit wrongdoing in order to enter into a settlement. This no admit/no deny settlement protocol makes a great deal of sense and has served the public interest very well. More and quicker settlements generally mean that investors receive as much (and sometimes more) compensation than they would after a successful trial—and without the litigation risk or the inevitable delay that comes with every trial. Settlements also can achieve more certain and swifter civil penalties, and bars of wrongdoers from the [securities] industry or from serving as officers or directors of public companies—all very important remedies for deterrence and the public interest.
So, why modify the no admit/no deny protocol at all?... Because admissions can achieve a greater measure of public accountability, which can be important to the public's confidence in the strength and credibility of law enforcement and the safety of our markets. It is not surprising that there has also been renewed public and media focus on the accountability that comes with admissions following the financial crisis, where so many lost so much....
As United States Attorney, I made the decision that companies should, in certain circumstances, admit their wrongdoing, even if they were not criminally charged, but where there was a special need for public accountability and acceptance of responsibility. That is why, when I negotiated the first deferred prosecution for a company, back in 1994, I required an admission of wrongdoing, and I brought that mindset to the SEC when I became Chair last April ....
To be sure there was no ambiguity about the misconduct of a defendant who was continuing to deal with investors, we required a hedge fund adviser [Falcone] to not only agree to a bar from the securities industry for five years, but to also admit to misuse of more than one hundred million dollars of fund assets in order to pay his personal taxes through a personal loan that was not timely disclosed to investors....
HC2 Filings with the SEC
As mentioned in No. 242, Falcone is now chairman, president, and chief executive officer of HC2 Holdings. I searched through many of its filings with the SEC, including the 10-K annual reports filed after the settlement with the SEC. Falcone's positions with HC2 are shown, but I found no disclosure of the SEC settlement. However, the HC2 10-K report for the year ended December 31, 2016 contains a three-sentence paragraph on page 36 about an arrangement between Falcone and the New York Department of Financial Services (NYDFS). The arrangement grew out of the 2013 settlement with the SEC. Here is the paragraph:
On October 7, 2013, the New York State Department of Financial Services announced that Philip A. Falcone, now our Chairman, President and Chief Executive Officer, had committed not to exercise control, within the meaning of New York insurance law, of a New York-licensed insurer for seven years (the "NYDFS Commitment"). Mr. Falcone, who at the time of the NYDFS Commitment was the Chief Executive Officer and Chairman of the Board of HRG Group Inc. ("HGI"), also committed not to serve as an officer or director of certain insurance company subsidiaries and related subsidiaries of HGI or to be involved in any investment decisions made by such subsidiaries, and agreed to recuse himself from participating in any vote of the board of HGI relating to the election or appointment of officers or directors of such companies. However, it was also noted that in the event compliance with the NYDFS Commitment proves impracticable, including in the context of merger, acquisition or similar transactions, then the terms of the NYDFS Commitment may be reconsidered and modified or withdrawn to the extent determined to be appropriate by the NYDFS Insurance regulatory authorities may [sic] consider the NYDFS Commitment in the course of a review of any prospective acquisition of an insurance company or block of insurance business by us or our insurance segment, increasing the risk that any such transaction may be disapproved, or that regulatory conditions will be applied to the consummation of such an acquisition which may adversely affect the economic benefits anticipated to be derived by us and/or our Insurance segment from such transaction.It is ironic that HC2 disclosed the NYDFS Commitment, but apparently failed to disclose the SEC settlement agreement that prompted the NYDFS Commitment. With regard to Falcone's disclosure practices, see White's comments in the final paragraph of what I quoted above from her January 2014 speech.
NYDFS Press Release
On October 7, 2013, NYDFS issued a press release describing the NYDFS Commitment. I am including the press release in the complimentary package offered at the end of this post. The press release includes a link to the SEC settlement but does not include a link to the NYDFS Commitment. Therefore, pursuant to the New York Freedom of Information Law (FOIL), I asked NYDFS for the NYDFS Commitment. NYDFS denied my request on the grounds that the document is confidential under the New York Insurance Holding Company Law. I have not yet decided whether to appeal the denial.
Continental General's Statutory Filings
In the statutory financial statements filed by Continental General Insurance Company, a subsidiary of HC2, I found no disclosure of Falcone's settlement agreement with the SEC or the NYDFS Commitment. I reviewed Continental's statutory annual statements for 2015 and 2016, and its statutory statement for the quarter ended September 30, 2017. The latter financial statement, under "subsequent events," includes a note about the acquisition of the closed block of LTC insurance policies and the need for various regulatory approvals, such as from the South Carolina and Texas insurance departments.
The three statutory statements did not mention Falcone, despite his positions with Continental's parent company. Also, Falcone was not mentioned as a member of Continental's board of directors. The only familiar name I saw among the directors, in all three of the statutory statements, was James P. Corcoran. He served as New York State's superintendent of insurance from 1983 to 1990.
When an individual or entity seeks to acquire an insurance company, the relevant state insurance regulator must approve the acquisition. To obtain approval, the acquirer must submit information to allow the regulator to determine that the acquisition does not present a danger to the public. The required information includes biographical affidavits of the principals involved in the acquisition. State statutes relating to the information that must be provided to regulators refer to those affidavits, which include these two sentences:
No such person has been convicted in a criminal proceeding (excluding minor traffic violations) during the past ten years. No such person has been the subject of any disciplinary proceedings with respect to a license or registration with any federal, state or municipal government agency, during the past ten years.
The second sentence above seems highly relevant to Falcone, who must have been required to describe his settlement with the SEC and the NYDFS Commitment. However, the biographical affidavits invariably are deemed confidential. Presumably the reason for confidentiality is that a biographical affidavit includes information of a personal nature. In No. 139 (January 19, 2016), I described my inability to obtain copies of biographical affidavits in an Indiana situation.
I am disturbed that the public is not entitled to relevant information about the principals in acquisitions. It would be appropriate to redact from the biographical affidavits the private information and leave unredacted the information that should be in the public domain.
With regard to the closed block of LTC policies referred to in this post and in No. 242, insurance regulators in South Carolina and Texas probably are aware of Falcone's settlement with the SEC, but nonetheless have approved or will approve the acquisitions relating to the closed block. I hope the regulators have imposed or will impose safeguards to protect the interests of the policyholders in the closed block.
I am offering a complimentary 60-page PDF consisting of the first SEC complaint (27 pages), the second SEC complaint (28 pages), the consent order relating to both complaints (3 pages), the NYDFS press release (1 page), and the note in the Continental General statutory statement (1 page). Email firstname.lastname@example.org and ask for the December 2017 package about Falcone.