SECURITIES AND EXCHANGE COMMISSION
LITIGATION RELEASE NO. 17929 / January 14, 2003
SECURITIES AND EXCHANGE COMMISSION V. SHELDON MASCHLER, JEFFREY A. CITRON, MICHAEL MCCARTY, ERIK MASCHLER, HEARTLAND SECURITIES CORPORATION, AARON ELBOGEN, MOISHE ZELCER, RAFT INVESTMENTS, INC., AND JES MANAGEMENT CORPORATION, Civil Action No. 03 CV 0264 (S.D.N.Y.)
SEC CHARGES FORMER DAY-TRADING PRINCIPALS WITH SECURITIES FRAUD; OTHERS CHARGED WITH FRAUD OR VIOLATING RECORDKEEPING AND REPORTING RULES
DEFENDANTS AGREE TO PAY TOTAL OF $70 MILLION
The Securities and Exchange Commission today charged Sheldon Maschler, Jeffrey A. Citron, Michael McCarty, and Erik Maschler with participating in an extensive fraudulent scheme involving the Nasdaq Stock Market's Small Order Execution System (SOES) from 1993 to June 2001. Defendants carried out the scheme from 1993 through March 1998 at the former Datek Securities Corporation. Sheldon Maschler, McCarty, and Erik Maschler continued the scheme from April 1998 to June 2001 at defendant Heartland Securities Corporation, which had purchased Datek Securities' day-trading business in March 1998. The Commission also charges Aaron Elbogen and Moishe Zelcer with aiding and abetting Datek Securities' violations of certain recordkeeping and reporting provisions of the federal securities laws. Defendants have agreed to pay over $70 million in penalties and disgorgement to settle the matter. Of the total penalties, Sheldon Maschler will pay approximately $29.2 million and Citron will pay approximately $22.5 million.
The Commission's complaint, filed in U.S. District Court for the Southern District of New York, charges Sheldon Maschler, 58, Citron, 32, McCarty, 39, and Erik Maschler, 32, with devising and orchestrating a scheme to access and use the SOES system for unlawful proprietary trading. Until mid-2001, NASD rules restricted use of the SOES system to small retail customer orders, and prohibited broker-dealers from using SOES to trade for their own accounts. According to the complaint, Sheldon Maschler, Citron, McCarty, and Erik Maschler accessed the SOES system to execute millions of unlawful proprietary trades, generating tens of millions of dollars in illegal profits. The complaint further alleges that these defendants hid their fraudulent use of the SOES system from regulators by allocating the trades to dozens of nominee accounts, creating fictitious books and records, and filing false reports with the Commission.
The Commission today also charged Sheldon Maschler and McCarty in connection with a separate, yet similar, fraudulent scheme involving the conversion of three New York savings and loan institutions from mutual ownership to stock ownership. In violation of federal and state banking regulations, Maschler and McCarty entered into agreements with numerous depositors to obtain their subscription rights and then fraudulently used those rights to purchase shares of the banks' initial public offerings. Maschler and McCarty later sold the conversion stock on the open market, realizing illegal profits of $1,788,472. Defendants Raft Investments, Inc. and JES Management Corporation, a corporation owned by Sheldon Maschler, aided and abetted the bank conversion scheme by providing the funds used to obtain the depositors' subscription rights.
The Commission's Complaint
The Commission's federal court complaint includes the following allegations:
The SOES system, established by the National Association of Securities Dealers (NASD) in 1984, was an automated trading system designed to benefit small investors by providing automatic execution of small Nasdaq orders at the best available price. SOES was the only Nasdaq trading system offering such features.
From at least 1993 to March 1998, defendants Sheldon Maschler, Citron, McCarty, and Erik Maschler controlled Datek Securities through its Manhattan branch, then a day-trading operation that was the profit center for the entire firm. The firm used a day-trading software known as "Watcher," the speed and features of which enabled its traders to react quickly to market activity. Although there were other means of executing securities transactions with Nasdaq market makers, only SOES offered automatic execution, thereby increasing the timing advantage offered by Watcher.
Instead of using SOES for its lawful purpose -- to execute trades on behalf of individual investors -- defendants Sheldon Maschler, Citron, McCarty, and Erik Maschler engaged in a massive fraudulent scheme to execute millions of proprietary trades on the SOES system. From 1995 through March 1998, Datek Securities executed approximately 12 million SOES trades, over 30 percent of all SOES trades.
To hide their proprietary trading, defendants Sheldon Maschler, Citron, McCarty, and Erik Maschler established dozens of nominee accounts, and paid nominees a guaranteed and fixed rate of return in exchange for the use of their identities and complete discretionary trading authority.
From 1993 to 1994, at the direction of Sheldon Maschler, Citron, McCarty, and Erik Maschler, Datek Securities employees manually allocated Datek Securities' trades among accounts after the close of the market. Beginning in early 1994, the unlawful allocation process was automated and carried out through a sophisticated software program developed for the firm and known as "Wire." Wire dramatically enhanced defendants' ability to conceal their proprietary SOES trading. The software was ultimately refined to allocate trades among nominee customer accounts as the trades occurred.
Beginning in 1997, Sheldon Maschler and Citron began funding nominee accounts with profits generated from the SOES scheme. Defendant Raft Investments, Inc., a corporation then controlled by Sheldon Maschler and Citron, provided at least $50 million to fund more than 125 nominee accounts at Datek Securities.
The unlawful proprietary trading scheme resulted in substantial profits, the majority of which were paid to Sheldon Maschler and Citron. Defendants Elbogen, 54, then Datek Securities' chief executive officer, and Zelcer, 56, the firm's former chief compliance officer and financial operations principal, aided and abetted certain books and records and reporting violations by falsely classifying payments of the firm's trading profits to entities controlled by Sheldon Maschler and Citron, and by failing to disclose that Sheldon Maschler and Citron were control persons of the firm.
On March 30, 1998, Datek Securities sold its day-trading operations to Heartland, a registered broker-dealer then owned by Erik Maschler and Elbogen. Sheldon Maschler, McCarty, and Erik Maschler controlled Heartland, and continued the unlawful SOES trading scheme from April 1998 through June 2001. Nearly all of the nominee accounts at Datek Securities were transferred to Heartland, and the methods used to conceal the scheme continued unabated.
Defendants have agreed to settle this matter without admitting or denying the allegations in the complaint. The settlement terms are subject to court approval.
Sheldon Maschler, Citron, and McCarty have consented to final judgments permanently enjoining each from violating Section 17(a) of the Securities Act of 1933 (Securities Act) and Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5 thereunder, and from aiding and abetting violations of Sections 15(b) and 17(a)(1) of the Exchange Act and Rules 15b3-1, 15b7-1, 17a-3(a)(1), 17a-3(a)(2), 17a-3(a)(3), 17a-3(a)(7), 17a-3(a)(9), and 17a-3(a)(12) thereunder. In addition, Maschler has agreed to pay $29,201,808, Citron $22,462,929, and McCarty $1,497,529 in civil penalties. Maschler also has agreed to pay $2,355,304 and McCarty $69,664 in disgorgement of profits and prejudgment interest for their participation in the savings and loan scheme.
Erik Maschler has consented to a final judgment enjoining him from violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and from aiding and abetting violations of Sections 15(b) and 17(a)(1) of the Exchange Act and Rules 15b7-1, 17a-3(a)(1), 17a-3(a)(2), 17a-3(a)(3), 17a-3(a)(7), 17a-3(a)(9), and 17a-5(d) thereunder. He also has agreed to pay a civil penalty of $5,990,114.
Heartland has consented to a final judgment enjoining the firm from violating Section 17(a) of the Securities Act and Sections 10(b), 15(c), and 17(a)(1) of the Exchange Act and Rules 10b-5, 15c1-2, 17a-3(a)(1), 17a-3(a)(2) 17a-3(a)(3), 17a-3(a)(9), 17a-5(a), and 17a-5(d) thereunder. Heartland also has agreed to pay a civil penalty of $7 million.
Elbogen and Zelcer have consented to final judgments enjoining each from aiding and abetting violations of Sections 15(b) and 17(a)(1) of the Exchange Act and Rules 15b3-1, 17a-3(a)(1), 17a-3(a)(2), 17a-3(a)(3), 17a-5(a), and 17a-5(d) thereunder. In addition, Elbogen has agreed to pay $1,422,652 and Zelcer $150,000 in civil penalties.
Raft Investments, Inc. and JES Management Corporation have consented to final judgments enjoining each from aiding and abetting violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Defendants have also agreed to settle administrative proceedings that will be instituted based on the entry of the final judgments. Sheldon Maschler, Citron, McCarty, and Erik Maschler have agreed to the institution of proceedings and Commission orders that permanently bar each of them from associating with any broker or dealer. Heartland has agreed to a Commission order censuring the firm. Elbogen and Zelcer have agreed to Commission orders that bar each of them from associating with any broker or dealer, with the right to reapply after two years in non-supervisory and non-proprietary capacities.
Finally, the Commission today acknowledged the assistance provided by the Office of the United States Attorney for the Southern District of New York and the Federal Bureau of Investigation's New York Field Office in the investigation of this matter.