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Thomas O. Gorman,
Dorsey and Whitney LLP
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    Underwriter, Two Employees Charged By SEC

    March 29, 2015

    The SEC brought another case tied to Chinese reverse mergers. This one differs from many earlier actions which focused on the company and or the executives. This action names as defendants one broker-dealer and two of its employees as defendants. It centers on two public offerings of the shares of Puda Coal, Inc. which, by the time of the offerings, lacked its primary asset — a fact unfortunately not known to those who purchased the shares in the secondary offerings. SEC v. Macquarie Capital USA), Inc., Civil Action No. 15 cv 02304 (S.D.N.Y. Filed March 27, 2015).

    Puda Coal, Inc.is the product of a Chinese reverse merger. Its primary asset when it entered into the U.S. markets in 2009 and was listed on the NYSE was Shanxi Coal, a Chinese coal mining company established under the laws of the PRC in 1995. Previously, Puda indirectly owned 90% of Shanxi Coal.

    Defendant Macquarie is a Commission registered broker-dealer that is a wholly owned subsidiary of Macquarie Group Limited, a global financial services firm based in Australia. The firm served as lead underwriter and joint bookrunning manager for Puda’s follow-on public stock offerings. Defendants Aaron Black and William Fang are both employees of the broker-dealer. Mr. Black served as a Division Director in the Sydney office while Mr. Fang was an investment banking associate and registered representative in the New York office.

    Puda had an off-shore ownership structure that was typical for public companies with operations in the PRC. Its primary business was initially as a supplier of cleaned coking coal used in the manufacture of steel. In 2009 the firm modified its strategy and entered into the coal mining business as a result of certain provincial regulations. In September of that year Puda’s chairman caused its 90% interest in Shanxi Coal to be transferred to himself without the approval or knowledge of the public shareholders or the board of directors. As a result of other transfers he eventually held 99% of Shanxi Coal. Later he entered into a series of transaction through which control of Shanxi Coal was pledged as collateral for a loan to the firm. These transactions were not reflected in the public filings of Puda.

    On February 18, 2010 Puda completed the offering and sale of 2.86 million shares, obtaining net proceeds of about $14.5 million. Subsequently, on December 16, 2010 the firm completed the sale of another 9 million shares, obtaining net proceeds of $101.5 million.

    Prior to the offerings the Underwriting Committee of the firm directed the Puda transaction team, which included Mr. Black, to engage Kroll Associates Inc., an investigative firm, to prepare a report on Puda and its officers and directors. The firm was aware of the heightened risk of the deal, as reflected in its papers. Kroll identified documents showing that Shanxi was owned by others. Although Mr. Fang read the report and Mr. Black reviewed portions of it, neither pointed out the fact that Kroll had obtained documents showing the mine belonged to others. The firm did not have sufficient systems in place to properly assess the report, according to the complaint.

    The offerings went forward using disclosure documents which did not disclose that the largest asset of Puda was no longer owned by the firm. To the contrary, the offering documents continued to list Shanxi as the primary asset of Puda.

    In April 2011 an internet report on Puda disclosed some of the asset transfers and transactions involving Mr. Zhao and others. Just before the report became available the share price was at a high of over $16 per share, $4 above the offering price. The day the report surfaced the stock closed at $6 per share. A subsequent investigation by the audit committee uncovered the fraud which was then reported on a Form 8-K. Subsequently, Puda’s auditor resigned, stating that further reliance should not be placed on its prior audit reports. The shares were delisted and now trade in the grey market.

    The Commission’s complaint alleges violations of Securities Act Sections 17(a)(2) and (3). The firm has agreed to settle with the Commission by paying a $15 million penalty and covering the cost of setting up a fair fund to compensate investors who suffered losses. The individuals have not settled. See Lit. Rel. No. 23222 (March 27, 2015).

    This Week In Securities Litigation (Week ending March 27, 2015)

    March 26, 2015

    The Supreme Court handed down the Omnicare decision on Securities Act Section 11 liability for opinion statements this week. In a judgment joined by all nine Justices the Court reversed the Sixth Circuit, concluding that opinion statements in a registration statement are actionable if the opinion is not believed or contrary to facts known at the time. The Section also imposes liability for the omission of material facts which a reasonable, objective investor would have expected to be disclosed.

    Statistics published by Cornerstone Research show that while the number of securities class action settlements last year is about the same as in the prior year, the dollar amount of the settlements declined significantly. Nevertheless, the number of settling actions alleging GAAP violations increased significantly while the number of securities class actions paralleled by an SEC enforcement action declined.

    Finally, the SEC filed two administrative proceedings last week, centered on violations of Exchange Act Section 15(a). One named 21 individuals and entities in a scheme involving one broker-dealer which used the others to acquire securities for it in offerings and in the secondary markets for a cut of the profits on resale. The other is a related action.

    SEC

    Rules: The Commission adopted Rules under the JOBS act regarding Reg. A+ (here).

    Proposed rules: The Commission proposed rules which would require broker-dealers trading in off-exchange venues to become members of a national securities association (here).

    Testimony: Chair Mary Jo White testified before the House Committee on Financial Services (March 24, 2015). Her testimony focused on the SEC’s agenda and FY 2016 budget request (here).

    Remarks: Commissioner Kara M. Stein delivered remarks titled International Cooperation in a New Data-Driven World at the Brooklyn Law School International Business Law Breakfast Roundtable (March 26, 2015). Her remarks focused on systemic risk, effective swaps regulation and better accounting standards (here).

    Remarks: Commissioner Luis A. Aguilar delivered remarks titled Preparing for the Regulatory Challenges of the 21st Century at the Georgia Law Review Annual Symposium (March 20, 2015). His remarks focused on efforts of the SEC to enhance its data gathering and analytics, the globalization of securities regulation and creating an environment for combating fraud (here).

    Supreme Court

    Omnicare, Inc. v. Laborers District Council Construction Pension Fund, No. 13-435 (S. Ct. March 24, 2015). The case centers on a registration statement filed by Omnicare in connection with a public offering of common stock. The firm is the largest pharmacy provider for nursing home residents in the U.S. In part it analyzed the impact of various federal and state laws on the business of the firm which included statements of belief regarding the firm’s compliance. Later the Government filed enforcement actions against the firm and plaintiffs brought suit alleging the statements of “belief” regarding compliance were false. The District Court granted Omnicare’s motion to dismiss, concluding statements of opinion were not actionable. The Sixth Circuit reversed, holding that if the statements were “objectively false” the statements were actionable.

    The Supreme Court, in a unanimous decision, vacated the lower court rulings and remanded with instructions. Justice Kagan, writing for seven members of the Court, began by stating that the Sixth Circuit and the Funds “wrongly conflates facts and opinions.” While Section 11 by its plain terms applies to statements about facts it nevertheless still applies to opinions. First, an opinion implies that the speaker “actually holds the stated belief.” Thus if the speaker knew the statement was incorrect the expression of an opinion to the contrary would become an untrue statement of fact. Likewise, if the opinion contained an imbedded statement of fact which is incorrect again there would be an untrue statement of fact. Here the Funds claim that Omnicare turned out to be wrong is not sufficient to support Section 11 liability.

    Second, the omissions provision of Section 11 must be considered. In part the Section states that there can be liability if Omnicare “omitted to state facts necessary” to make its opinion regarding legal compliance “not misleading.” Under this part of the statute the question turns on “the perspective of a reasonable investor: The inquiry (like the one into materiality) is objective.” Under this provision the investor can reasonably expect “not just that the issuer believes the opinion (however irrationally), but that it fairly aligns with the information in the issuer’s possession at the time. Thus, if the registration statement omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then §11’s omissions clause creates liability.” The test here is an objective one of what a reasonable persons would understand from the statement.

    Finally, to plead a Section 11 claim the securities law plaintiff cannot simply claim that the opinion was wrong. Rather, the complaint must call into question the basis of the claim or specify the facts which should have been disclosed. The decision was vacated and the case remanded since the omission theory was not considered by the lower courts. Justice Scalia concurred in part and in the judgment. Justice Thomas concurred in the judgment.

    Securities Class Actions

    Last year the number of securities class action cases settled remained largely constant compared to the prior year, according to a report by Cornerstone Research (here). At the same time the number of cases alleging GAAP violations increased, although only a small percentage involved restatements. Curiously, the number of securities class actions paralleled by an SEC enforcement action, which tend to be the larger, more complex cases, declined despite a claimed emphasis on financial fraud actions by the Commission.

    In 2014 there were 63 court approved settlements, about the same as the prior year. Yet when compared to the five year period of 2010 through 2014, the number of settled cases declined about 35%. In 2014 67% of the settled cases alleged GAAP violations, a significant increase over the 61% average for such claims since the passage of the Reform Act. Interestingly, only 29% of those cases involved a restatement. 21% of the cases which alleged GAAP violations also named the auditor as a defendant. However, only 16% of the settled cases involved a parallel SEC enforcement action. That is significantly less than the 18% in 2013 and 21% in 2012. The median settlement for all post-Reform Act cases with a parallel SEC action of $12.9 million is more than twice that of cases without a corresponding Commission action, reflecting perhaps in part the fact that those actions tend to be more complex. In 2014 the median settlement for cases with a parallel SEC action was $9.4 million compared to $5.5 million for others.

    SEC Enforcement – Filed and Settled Actions

    Statistics: During this period the SEC filed 0 civil injunctive action and 2 administrative proceeding, excluding 12j and tag-along-actions.

    Unregistered broker-dealer: In the Matter of Global Fixed Income, LLC, Adm. Proc. File No. 3-16460 (March 26, 2015) is a proceeding which names as Respondents Global, a registered broker dealer that primarily buys and sells fixed income securities for its own account, its owner Charles Kempf, and 19 other entities and individuals. For a period of three years beginning in June 2009 Global directed the other Respondents to purchase about $2.5 billion in New Issues for it and another $2.3 billion in securities in the secondary market. Before each New Issue Global transferred money to the Respondents’ account to be held on behalf of Global. After the purchase the allocations were transferred to Global which sold them on the secondary market, typically at a small profit. The profits from all of the transactions were divided. The Order alleges violations of Exchange Act Section 15(a). To resolve the action Global and each other respondent consented to the entry of a cease and desist order based on Exchange Act Section 15(a). Charles Kempf, the owner and CEO of Global, agreed to the entry of an order suspending him from the securities business for a period of one year. In addition, Global and Mr. Kempf will, on a joint and several, basis pay disgorgement of $2,435,989.61 along with prejudgment interest. Each of the other Respondents agreed to pay disgorgement. In addition, Global will pay a penalty of $500,000 while each other entity Respondent agreed to pay a penalty of $50,000 and each individual Respondent (other than Mr. Kempf) will pay a $5,000 penalty. See also In the Matter of David Boyle, Adm. Proc. File No. 3-16459 (March 26, 2015)(similar proceeding naming as a Respondent the 1/3 owner of Etck, a firm which is a Respondent in Global; settled with a cease and desist order based on Section 15(a) and the payment of disgorgement and a $5,000 penalty).

    Offering fraud: SEC v. BioChemics, Inc., Civil Action No. 12-12324 (D. Mass.) is a previously filed action against the company and its founder and two promoters. The complaint alleged that beginning in 2009, and continuing through mid-2012, the firm and the individual defendants raised at least $9 million from 70 investors based on a series of misrepresentation about the firm. Previously the company agreed to a partial settlement which was recently entered by the Court. Under the terms of that partial settlement the company was enjoined from violating Securities Act Section 17(a) and Exchange Act Section 10(b). This week the Court entered a supplemented judgment, based on a motion by the Commission, ordering the company to pay disgorgement of $15,105,325, prejudgment interest and a penalty of $750,000. The litigation continues as to the individuals. See Lit. Rel. No. 23220 (March 25, 2015).

    Criminal cases

    Investment fund fraud: U.S. v. Zemlyansky, Case No. 1:12-cr-00171 (S.D.N.Y.). Mikhail Zemlyansky was charged with securities fraud tied to defrauding investors out of about $18 million with his claimed investment funds. To implement the scheme, Mr. Zemlyanski used two entities, Lyons Ward & Associates and the Rockford Group. Investors were told the firms were settlement claims funding companies that invested in law suits in return for a portion of future settlements. Documents and account statements were created for use by cold-callers to solicit investors with boiler room tactics. In reality there were no investment funds and investor money was misappropriated. A racketeering claim was based on a scheme that ran over a five year period beginning in 2007 tied to the New York State no-fault auto insurance law. That law requires prompt payment for medical treatment from auto accidents but permitted patients to assign the right to reimbursement from an insurance company to others including clinics. Over the years of the scheme Mr. Zemlyansky’s organization defrauded auto insurance companies out of over $100 million by creating and operating medical clinics that provided unnecessary and excessive medical treatment to take advantage of the no-fault law. The organization owned and controlled over a dozen medical professional firms, paying licensed medical professionals to use their licenses to form the entities. The proceeds from this activity were laundered through check-cashing entities and shell companies. Finally, Mr. Zemlyansky’s organization operated high-stakes illegal poker games in Brooklyn. Tens of thousands of dollars per game in profits were generated. A jury convicted Mr. Zemlyansky of racketeering conspiracy, securities fraud, mail fraud and wire fraud after a four week trial. The date for sentencing has not been set.

    U.K.

    Investment fund fraud: The Serious Frauds Office announced that David Dixon pleaded guilty to five fraud related offenses tied to investment schemes he ran involving Arboretum Sports (USA) and Arboretum Sports (UK) Limited. Three schemes were conducted. In the first investors put up funds in what they were told was a riskless gambling venture. In the second investors were induced to purchase shares in a firm supposedly linked to famous casinos. The third was an advanced fee scheme. Mr. Dixon will be sentenced in April 2015.

    More Class Actions Claim GAAP Violations, Less Paralleled by SEC Case

    March 25, 2015

    Last year the number of securities class action cases settled remained largely constant compared to the prior year, according to a report by Cornerstone Research (here). At the same time the number of cases alleging GAAP violations increased, although only a small percentage involved restatements. Curiously, the number of securities class actions paralleled by an SEC enforcement action, which tend to be the larger, more complex cases, declined despite a claimed emphasis on financial fraud actions by the Commission.

    In 2014 there were 63 court approved settlements, about the same as the prior year. Yet when compared to the five year period of 2010 through 2014, the number of settled cases declined about 35%.

    The settlement amounts declined significantly last year. The value of settlements approved by the courts in 2014 was $1.1 billion compared to an annual average of about $6.6 billion over the prior nine years. The difference in settlement amounts appears to stem at least in part from the fact that in 2014 there was only one mega settlement of over $100 million compared with six mega settlements in 2013. Likewise, 2014 was one of only three years in the last decade where there were no settlements of $500 million or more.

    The average settlement of $17 million last year is the lowest in the last decade. The highest was $131.6 million in 2006 followed by $75.8 million in 2007 and $73.5 million in 2013. 11% of the cases last year settled for $2 million or less which is considered nuisance value. That percentage is consistent with prior years.

    Most of the settled actions last year had an institutional investor as the lead plaintiff. That is consistent with prior years. The median settlement amount for actions with an institutional investor as plaintiff was $13 million compared to $5 million for other cases, a finding which is also consistent with prior years. The number of settlements involving Section 11 and 12(a)(2) claims without a Rule 10(b)(5) cause of action declined last year to three, compared to seven in the prior year.

    In 2014 67% of the settled cases alleged GAAP violations, a significant increase over the 61% average for such claims since the passage of the Reform Act. Interestingly, only 29% of those cases involved a restatement. 21% of the cases which alleged GAAP violations also named the auditor as a defendant.

    Finally, only 16% of the settled cases involved a parallel SEC enforcement action. That is significantly less than the 18% in 2013 and 21% in 2012. The median settlement for all post-Reform Act cases with a parallel SEC action of $12.9 million is more than twice that of cases without a corresponding Commission action, reflecting perhaps in part the fact that those actions tend to be more complex. In 2014 the median settlement for cases with a parallel SEC action was $9.4 million compared to $5.5 million for others.

    Omnicare: Section 11 Liability and Opinions

    March 24, 2015

    The Supreme Court defined the circumstances under which liability can be imposed for opinion statements under Securities Act Section 11. Specifically, the Court held that such liability could be imposed on two theories: One focuses “on what the statement says and the other on what it leaves out. Either way, the buyer need not prove . . . that the defendant acted with any intent to deceive or defraud.” Omnicare, Inc. v. Laborers District Council Construction Pension Fund, No. 13-435 (S. Ct. March 24, 2015).

    Background

    The case centers on a registration statement filed by Omnicare in connection with a public offering of common stock. The firm is the largest pharmacy provider for nursing home residents in the U.S. The registration statement, in part, analyzed the impact of various federal and state laws on the business of the firm. In this section the registration statement stated “We believe . . .” our contract arrangements with other healthcare providers are in accord with the law. A second sentence stated “We believe . . .” that the contracts with pharmaceutical manufactures are legally valid. Cautionary provisions noted that enforcement actions had been brought against pharmaceutical manufactures for making payments to pharmacies and that the Federal Government had expressed “significant concerns” about such rebates.

    The pension funds’ complaint alleged that the opinion statements regarding compliance were false. The claim is supported by citations to suits filed by the Federal Government against Omnicare under the anti-kickback laws for payments it received from pharmaceutical manufactures. Based on the suits filed after the offering plaintiffs allege that the firm made materially false representations about compliance and that it omitted to state material facts necessary to make the representations not misleading.

    The District Court granted Omnicare’s motion to dismiss. That Court concluded that statements of opinion or belief are only actionable if the speaker knew at the time the statements were untrue. The Sixth Circuit reversed. The Circuit Court concluded plaintiffs only needed to allege that the statements were “objectively false” and that they need not establish that anyone at Omnicare disbelieved the opinions at the time expressed.

    Opinion

    The Supreme Court, in a unanimous decision, vacated the lower court rulings and remanded with instructions. Justice Kagan, writing for seven members of the Court, began by stating that the Sixth Circuit and the Funds “wrongly conflates facts and opinions.” A fact is a thing done or in existence. A statement of fact expresses certainty. In contrast, an opinion does not. The difference is significant and reflected in the language of Section 11 which imposes liability not just for false statements but for an untrue statement “of fact” according to its plain language.

    Nevertheless, Section 11 still applies to opinions. First, an opinion implies that the speaker “actually holds the stated belief.” Thus if the speaker knew the statement was incorrect the expression of an opinion to the contrary would become an untrue statement of fact. Likewise, if the opinion contained an imbedded statement of fact which is incorrect again there would be an untrue statement of fact. “Accordingly, liability under §11’s false-statement provision would follow (once again, assuming materiality) not only if the speaker did not hold the belief she professed but also if the supporting fact she supplied were untrue,” the Court held.

    Here the Funds claim that Omnicare turned out to be wrong. That allegation is not sufficient to support Section 11 liability. The Section was not designed to “allow investors to second-guess inherently subjective and uncertain assessments. In other words, the provision is not, as the Court of Appeals and the Funds would have it, an invitation to Monday morning quarterback an issuer’s opinions.”

    Second, the omissions provision of Section 11 must be considered. In part the Section states that there can be liability if Omnicare “omitted to state facts necessary” to make its opinion regarding legal compliance “not misleading.” Under this part of the statute the question turns on “the perspective of a reasonable investor: The inquiry (like the one into materiality) is objective.” In considering this point the Court rejected Omnicare’s contention that an opinion statement could never be misleading on this basis. Rather, the Court concluded the investor can reasonably expect “not just that the issuer believes the opinion (however irrationally), but that it fairly aligns with the information in the issuer’s possession at the time. Thus, if the registration statement omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then §11’s omissions clause creates liability.”

    The test here is an objective one of what a reasonable persons would understand from the statement. As Justice Kagan wrote: Section 11’s omissions clause, as applied to statements of both opinion and fact, necessarily brings the reasonable person into the analysis and asks what she would naturally understand a statement to convey beyond its literal meaning. And for expressions of opinion, that means considering the foundation she would expect an issuer to have before making the statement.” This is consistent not just with the language of the Section but also with its common law origins and purpose of the statute.

    Finally, to plead a Section 11 claim the securities law plaintiff cannot simply claim that the opinion was wrong. Rather, the complaint must call into question the basis of the claim. At the same time it is not sufficient to simply allege a failure to disclose the basis of the opinion. To the contrary, the “investor must identify particular (and material) facts going to the basis for the issuer’s opinion – facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have – whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.” Since neither court below considered Omnicare’s omissions theory the case was vacated and remanded for further consideration. Justice Scalia concurred in part and in the judgment. Justice Thomas concurred in the judgment.

    Manhattan U.S. Attorney Prevails in Securities Fraud, RICO Case

    March 23, 2015

    The SEC has brought a series of investment fund fraud and Ponzi schemes. Indeed, the Commission has brought so many of these cases in recent years they have become a staple. None of those cases, however, involved securities fraud tied to an investment scheme, a racketeering charge centered on an automobile insurance scam and fraud tried to a very high stakes, illegal poker game. Yet those were the charges brought against Mikhail Zemlyansky brought by the Manhattan U.S. attorney and on which a conviction was obtained. U.S. v. Zemlyansky, Case No. 1:12-cr-00171 (S.D.N.Y.).

    Mr. Zemlyansky was charged with securities fraud tied to defrauding investors out of about $18 million with his claimed investment funds. To implement the scheme, Mr. Zemlyanski used two entities, Lyons Ward & Associates and the Rockford Group. Investors were told the firms were settlement claims funding companies that invested in law suits in return for a portion of future settlements. Documents and account statements were created for use by cold-callers to solicit investors with boiler room tactics. In reality there were no investment funds. Rather, the investor money was misappropriated by Mr. Zemlyanski and wired to shell companies in Eastern Europe.

    The racketeering claim was based on a scheme that ran over a five year period beginning in 2007 tied to the New York State no-fault auto insurance law. That law requires prompt payment for medical treatment from auto accidents. This eliminated the need to file personal injury suits. The law permitted patients to assign the right to reimbursement from an insurance company to others including clinics. Those clinics had to be owned by licensed medical professionals.

    Over the years of the scheme Mr. Zemlyansky’s organization defrauded auto insurance companies out of over $100 million by creating and operating medical clinics that provided unnecessary and excessive medical treatment to take advantage of the no-fault law. The organization owned and controlled over a dozen medical professional, paying licensed medical professionals to use their licenses to form the entities. Kickbacks were paid to runners to recruit patients and to others who participated in the scheme. The proceeds from this activity were laundered through check-cashing entities and shell companies.

    Finally, Mr. Zemlyansky’s organization operated high-stakes illegal poker games in Brooklyn. Tens of thousands of dollars per game in profits were generated. A jury convicted Mr. Zemlyansky of racketeering conspiracy, securities fraud, mail fraud and wire fraud after a four week trial. The date for sentencing has not been set.

    Priorities For the SEC’s Enforcement Division

    March 22, 2015

    Last week SEC Enforcement Division Director Andrew Ceresney,testified before Congress regarding the efforts of the Division and its requested for additional funding, highlighting its priorities (here). The Director began by telling the subcommittee that “A strong enforcement program is at the heart of the Commission’s efforts to ensure investor trust and confidence in the nation’s securities markets . . .” In the FY 2016 budget the Division is thus seeking to add 93 positions to be used for: 1) Expanding the Division’s data analytics; 2) hiring additional accountants, attorneys, industry experts and other professionals; and 3) hiriring additional experienced trial attorneys and support staff to prosecute “the Division’s expanding docket of complex litigation and trials.”

    The Director then reviewed the Division’s priorities for the subcommittee. Those include:

    Financial reporting: Here the Director discussed the creation of the Financial Reporting and Audit Task Force, noting that it is important to “develop methodologies and tools for detecting financial reporting issues, identify specific issuers with potential violations, determine whether further investigation is warranted, and refer appropriate matters to investigative staff across the Division.”

    Investment advisers: In this area the Director noted that the Division has “recently launched a number of successful initiatives concentrating on areas that have traditionally received less attention, including custody rule violations, the adequacy of investment adviser compliance programs, and undisclosed adviser fees.”

    Market structure, exchanges and broker-dealers: Working together with the Division of Trading and Markets and OCIE, and using technology to more effectively analyze data, the Division has “recently filed a number of actions against market participants that pose a risk to the markets by failing to operate within the rules. These include significant cases against exchanges and other trading platforms for violating rules governing their operation, broker-dealers for failing to live up to their obligations as gatekeepers providing direct market access, and other market participants for manipulative trading and related abuse.”

    Municipal securities and public pensions: In this area, which has significance for the retail investor and public pensions, the Division has focused on “misrepresentations in connection with bond offerings, failures by underwriters to meet their obligations, undisclosed conflicts of interest, and pay-to-play violations . . . The Division also implemented a new self-reporting initiative . . .”

    Insider trading: This area has long been an enforcement priority. Currently the Division’s efforts are aided significantly by “new technological tools developed internally that all us to identify suspicious trading patterns and connections between traders and potential sources from massive amounts of trading data.”

    Foreign corrupt practices act: This traditional area of focus for the Division continues to be a priority. The Division and its FCPA unit are “bringing significant and impactful cases, often in partnership with its law enforcement and regulatory counterparts both at home and abroad,” the subcommittee was told.

    Litigation and trial: The ability of the SEC to “successfully litigate cases is critical to its mission . . . When the Division goes to trial, we have had a strong record of success, despite the difficulty and complexity of our cases,” according to the Director.

    Admissions: This was a key change in June of 2013 when the Division began requiring admissions to resolve select cases. Cases where this policy is used include those “where heightened accountability and acceptance of responsibility by the defendant are appropriate and in the public interest, including in cases where the violation of the securities laws involves particular egregious conduct; where large numbers of investors were harmed; where the markets or investors were placed at significant risk; where the conduct obstructs the Commission’s investigation; where an admission can send an important message to the markets; or where the wrongdoer poses a particular future threat to investors or the markets” the Director told the Subcommittee.

    This Week In Securities Litigation (Week ending March 20, 2015)

    March 20, 2015

    The broken windows approach to enforcement continued this week. The Commission bundled together eight settled administrative proceedings centered on going private transactions in which the Respondents failed to update their Schedule 13D filings. The agency also brought another Rule 105 action, a father and son market manipulation action, a case centered on the sale of unregistered securities and another based on conflicts.

    SEC

    Remarks: Chair Mary Jo White delivered remarks titled A Few Observations On Shareholders at Tulane University Law School 27th Annual Corporate Law Institute, New Orleans, La. (March 19, 2015). Chair White commented on shareholder proposals and fee shifting provisions (here).

    Remarks; Commissioner Michael S. Pinwowar delivered remarks at the 2015 Mutual Funds and Investment Management Conference, Los Angeles, California (March 16, 2015). His remarks focused on criticisms of the capital markets by prudential regulators (here).

    SEC Enforcement – Filed and Settled Actions

    Statistics: During this period the SEC filed 1 civil injunctive action and 11 administrative proceeding, excluding 12j and tag-along-actions.

    Rule 105: In the Matter of Keyport Capital Management, LLC, Adm. Proc. File No. 3-16449 (March 19, 2015). In March 2013 the registered investment adviser bought shares in a follow-on offering after having sold short just before that transaction. The adviser had profits of $11, 654.62. The Order alleges a violation of Rule 105. To resolve the action the adviser consented to the entry of a cease and desist order based on Rule 105 and agreed to pay disgorgement in the amount of the trading profits, prejudgment interest and a civil penalty of $65,000.

    Unregistered securities: In the Matter of Coral Reef Media, LLC, Adm. Proc. File No. 3-16447 (March 17, 2015) is a proceeding which names as Respondents the firm, which has no on-going operations, and David Flake, its founder. From May 2012 through April 2013 the Respondents used fabricated documents to offer and sell shares of Coral Reef stock. The shares were not registered with the Commission and there is no applicable exemption. The Order alleges violations of Securities Act Sections 5(a), 5(c), 17(a) and Exchange Act Sections 10(b) and 15(a). To resolve the proceeding Respondents each consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Mr. Flake is barred from the securities business and from participating in any penny stock offering. The Respondents will pay, jointly and severally, disgorgement of $26,000, prejudgment interest and a civil penalty equal to the amount of the disgorgement.

    Conflicts: In the Matter of Joseph Stilwell, Adm. Proc. File No. 3-1644 (March 16, 2015) is a proceeding which names as Respondents Stillwell Value LLC, a registered investment adviser, and Mr. Stilwell, its principal owner. The Order alleges that from 2003 through 2013 Respondent directed the Stilwell Funds to make a series of loans totaling about $20 million to other Stilwell Funds to aid their investment strategies – to purchase securities and repay margin. All the loans were repaid. The Respondents, however, failed to disclose the transactions which represent a conflict of interest. The Order alleges violations of Advisers Act Sections 206(2), 206(4) and 207. To resolve the proceeding Respondents consented to the entry of an order based on the Sections cited in the Order and agreed to implement a series of undertakings which include the retention of an independent monitor. The adviser also agreed to the entry of a censure. Respondents will pay disgorgement of $193,356 which is the fees earned, prejudgment interest and a civil money penalty of $250,000.

    Financial fraud: SEC v. Woodard, Civil Action No. 2:13cv16 (E.D. Va.) is a previously filed action which named as a defendant Cynthia Sabol, the former CFO of Commonwealth Bankshares, Inc., and others. The action alleged that the bank substantially understated its allowance for loan and lease losses, reported loss before income taxes and real estate repossessed. Ms. Sabol resolved the proceeding and the Court entered a final judgment prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a) and 13(b)(5). The order also requires her to pay a penalty of $55,000 and bars Ms. Sabol from serving as an officer or director of a public company for five years. See Lit. Rel. No. 23218 (March 12, 2015).

    Disclosures: In the Matter of Berjaya Lottery Management (H.K.), Adm. Proc. File No. 3-16436 (March 13, 2015) names as a Respondent the Hong Kong based firm which manufactures and distributes computerized lottery and voting systems. The action centers on a going-private transaction regarding International Lottery & Totalizator Systems, Inc., a California based public company. Between July 7 and 10, 2013 the firm took significant steps toward the privatization of International Lottery. Since the firm had acquired a majority holding in International Lottery it had an obligation to promptly amend its Item 4 disclosures on Schedule 13D concerning the transaction. Nevertheless, the firm waited eight months to make the required disclosures regarding the steps taken, contrary to Exchange Act Section 13(d)(2). The firm settled, consenting to the entry of a cease and desist order based on the Section cited in the Order while agreeing to pay a penalty of $75,000.

    Disclosures: In the Matter of The Ciabattoni Living Trust Dated August 17, 2000, Adm. Proc. File No. 3-16437 (March 13, 2015) is a proceeding which names the trust as a Respondent. It centers on a going private transaction regarding First Physicians Capital Group, Inc. Related proceedings were filed against the beneficial owners of the shares, Aathony J. Ciabattoni and Jane Ciabattoni. In the Matter of Anthony J. Ciabattoni, Adm. Proc. File No. 3-16438 (March 13, 2015); In the Matter of Jane G. Ciabattoni, Adm. Proc. File No. 3-16439 (March 13, 2015). The Orders state that the Respondents in each proceeding waited over five months to amend their Schedule 13D disclosures after taking significant steps toward a going private transaction regarding First Physicians, contrary to Exchange Act Section 13(d)(2). In addition, Respondents violated Section 16(a) by failing to report material transactions in shares of that group for months. The proceedings were resolved with each Respondent consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the three defendants were ordered to pay a penalty, on a joint and several basis, of $75,000. The settlements reflect the cooperation of the Respondents. See also In the Matter of SMP Investments I, LLC, Adm. Proc. File No. 3-16440 (March 13, 2015)(proceeding also tied to the First Physicians transaction alleging the same type of violations involved in The Ciabattoni Living Trust; resolved with a cease and desist order based on the same Sections and the payment of a penalty of $63,750 on a joint and several basis with Brian Potiker); In the Matter of Brian Potiker, Adm. Proc. File No. 3-16441 (March 13, 2015)(same): In the Matter of William A. Houlihan, Adm. Proc. File No. 3-16442 (March 13 2015)(A proceeding also based on the First Physicians transaction alleging essentially the same violations; settled with a cease and desist order based on the same Sections and the payment of a penalty of $15,000).

    Disclosures: In the Matter of Shuipan Lin, Adm. Proc. File No. 3-16435 (March 13 2015) names as a Respondent the CEO of China based Exceeds Company Ltd. The action centers on a going private transaction regarding that firm. After taking several steps to effectuate that transaction Respondent filed to amend his Schedule 13D as required. The proceeding was resolved with Respondent’s consent to a cease and desist order based on Exchange Act Section 13(d)(2) and the payment of a civil penalty of $30,000.

    Manipulation: SEC v. Craven, Civil Action No. 15-cv-1820 (S.D.N.Y. Filed March 11, 2015) is an action which names as defendants a father and son team, David Craven and Alex Craven. Both are British citizens who reside in Switzerland. In January 2011 American Energy Development Company filed a registration statement to raise $1 million. After the registration statement became effective the shares were acquired by over 25 investors, including a entity controlled by David Craven. Following a forward split of the shares that entity had about 87% of the outstanding stock in American Energy.

    Beginning in October 2011, and continuing through February 2012, the father – son combination used controlled entities to engage in a series of wash sales. The purpose was to increase the share price. Those were followed by a publicity campaign, touting the shares of American Energy. As the PR campaign moved forward the two defendants sold 4.5 million shares at prices ranging from $0.85 to $1.20 or about $4 million in artificially inflated shares. The SEC’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 9(a) and 10(b). The Court entered a temporary freeze order at the time the complaint was filed. The case is pending. See Lit. Rel. No. 23219 (March 12, 2015).

    Criminal cases

    Perjury: U.S. v. Hart, Case No. 1:15-cr-0084 (S.D.N.Y. Filed February 13, 2015). Steven Hart was employed at Octagon Capital Partners as a portfolio manager. As the portfolio manager he had control over several brokerage accounts for the Octagon Capital Partners Ltd. fund. He also controlled a private investment fund, Octagon Capital Partners, LP, in which he and associates had funds. The SEC began an investigation that focused on whether Mr. Hart had engaged in a series of matched trades or cross trades between his personal fund and the one for which he served as portfolio manager. During the investigation he lied in testimony, claiming the president of the firm authorized the transactions. He also impersonated the president of the firm in phone calls with the staff and repeated the claims. Mr. Hart pleaded guilty to obstruction of justice and perjury. He is awaiting sentencing. The Commission also brought an action against him. SEC v. Hart, Civil Action No. 12 CIV 8986 (S.D.N.Y. Filed December 11, 2012).

    Australia

    Insider trading: Two employees of the National Australia Bank were convicted in Australia’s largest insider trading case according to the Australian Securities and Investment Commission. The two men received sensitive information from an employee of the Australian Bureau of Statistics. They used the information to enter into foreign exchange derivative products and reaped $7 million from price movements. They were convicted of insider trading, money laundering and abuse of public office .

    Hong Kong

    Take-overs: The Takeovers and Mergers Panel found that Chow Yei Ching, Joseph Leung Wing Kong and Oscar Chow Vee Tsung breached the mandatory offer requirement under the Code on Takeovers and Mergers. Mr. Chow, the chairman of Chevalier Group, together with his son, Oscar Chow, a director of Chevalier International Holdings Ltd, and Mr. Leung, the chairman of ENM Holdings Ltd., actively co-operated to assist Mr. Kung to obtain or consolidate control over ENM. and avoid triggering a mandatory general offer requirement in the Takeovers Code. A written opinion will be issued.

    SEC Obtains Freeze Order In Microcap Manipulation Action

    March 18, 2015

    Microcap fraud is an on-going enforcement priority of the Commission. In SEC v. Craven, Civil Action No. 15-cv-1820 (S.D.N.Y. Filed March 11, 2015), the Commission brought a manipulation action against a father and son team, David Craven and Alex Craven. Both are British citizens who reside in Switzerland.

    In January 2011 American Energy Development Company filed a registration statement to raise $1 million. After the registration statement became effective the shares were acquired by over 25 investors, including a entity controlled by David Craven. Following a forward split of the shares that entity had about 87% of the outstanding stock in American Energy.

    Beginning in October 2011, and continuing through February 2012, the father – son combination used controlled entities to engage in a series of wash sales. The purpose was to increase the share price. Transactions were executed at prices ranging from $0.85 per share to $1.57 per share.

    Subsequently, the father-son team began a publicity campaign, touting the shares of American Energy. For example, a 16 page mailer was sent to about 1.2 million US. residents in April 2012. That effort was supplemented with e-mail blasts and a web site, all of which touted the stock.

    As the PR campaign moved forward the two defendants sold 4.5 million shares at prices ranging from $0.85 to $1.20 or about $4 million in artificially inflated shares. The SEC’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 9(a) and 10(b). The Court entered a temporary freeze order at the time the complaint was filed. The case is pending. See Lit. Rel. No. 23219 (March 12, 2015).

    Broken Windows Continues: SEC Brings Group of Actions Centered on Section 13(d)(2) Violations

    March 17, 2015

    The “broken windows” approach to enforcement is alive, well and continuing. This time the Commission bundled together three groups of actions and eight proceedings, all centered on a failure to update disclosures tied to going private transactions:

    In the Matter of Berjaya Lottery Management (H.K.), Adm. Proc. File No. 3-16436 (March 13, 2015) names as a Respondent the Hong Kong based firm which manufactures and distributes computerized lottery and voting systems. The action centers on a going-private transaction regarding International Lottery & Totalizator Systems, Inc., a California based public company. Between July 7 and 10, 2013 the firm took significant steps toward the privatization of International Lottery. Since the firm had acquired a majority holding in International Lottery it had an obligation to promptly amend its Item 4 disclosures on Schedule 13D concerning the transaction. Nevertheless, the firm waited eight months to make the required disclosures regarding the steps taken, contrary to Exchange Act Section 13(d)(2). The firm settled, consenting to the entry of a cease and desist order based on the Section cited in the Order while agreeing to pay a penalty of $75,000.

    In the Matter of The Ciabattoni Living Trust Dated August 17, 2000, Adm. Proc. File No. 3-16437 (March 13, 2015) is a proceeding which names the trust as a Respondent. It centers on a going private transaction regarding First Physicians Capital Group, Inc. Related proceedings were filed against the beneficial owners of the shares, Aathony J. Ciabattoni and Jane Ciabattoni. In the Matter of Anthony J. Ciabattoni, Adm. Proc. File No. 3-16438 (March 13, 2015); In the Matter of Jane G. Ciabattoni, Adm. Proc. File No. 3-16439 (March 13, 2015). The Orders state that the Respondents in each proceeding waited over five months to amend their Schedule 13D disclosures after taking significant steps toward a going private transaction regarding First Physicians, contrary to Exchange Act Section 13(d)(2). In addition, Respondents violated Section 16(a) by failing to report material transactions in shares of that group for months. The proceedings were resolved with each Respondent consenting to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the three defendants were ordered to pay a penalty, on a joint and several basis, of $75,000. The settlements reflect the cooperation of the Respondents. See also In the Matter of SMP Investments I, LLC, Adm. Proc. File No. 3-16440 (March 13, 2015)(proceeding also tied to the First Physicians transaction alleging the same type of violations involved in The Ciabattoni Living Trust; resolved with a cease and desist order based on the same Sections and the payment of a penalty of $63,750 on a joint and several basis with Brian Potiker); In the Matter of Brian Potiker, Adm. Proc. File No. 3-16441 (March 13, 2015)(same): In the Matter of William A. Houlihan, Adm. Proc. File No. 3-16442 (March 13 2015)(A proceeding also based on the First Physicians transaction alleging essentially the same violations; settled with a cease and desist order based on the same Sections and the payment of a penalty of $15,000).

    In the Matter of Shuipan Lin, Adm. Proc. File No. 3-16435 (March 13 2015) names as a Respondent the CEO of China based Exceeds Company Ltd. The action centers on a going private transaction regarding that firm. After taking several steps to effectuate that transaction Respondent filed to amend his Schedule 13D as required. The proceeding was resolved with Respondent’s consent to a cease and desist order based on Exchange Act Section 13(d)(2) and the payment of a civil penalty of $30,000.

    Portfolio Manager in SEC Investigation Makes a Bad Day Worse

    March 16, 2015

    Portfolio manager Steven Hart made a difficult situation worse. He was under investigation by the SEC. That inquiry focused on whether he had made a series of matched trades. The investigation resulted in an SEC enforcement action. SEC v. Hart, Civil Action No. 12 CIV 8986 (S.D.N.Y. Filed December 11, 2012). Mr. Hart made it worse. He lied during testimony and in telephone calls with the SEC staff. Now he faces not just sanctions from the Commission, but also time in prison. U.S. v. Hart, Case No. 1:15-cr-0084 (S.D.N.Y. Filed February 13, 2015).

    Steven Hart was employed at Octagon Capital Partners as a portfolio manager. He reported directly to the firm president. As the portfolio manager he had control over several brokerage accounts for the Octagon Capital Partners Ltd. fund. He also controlled a private investment fund, Octagon Capital Partners, LP. Mr. Hart invested his money in that fund as did several associates.

    The SEC’s investigation focused on whether Mr. Hart had engaged in a series of matched trades or cross trades between his personal fund and the one for which he served as portfolio manager. The investigation also sought to determine if he had used material non-public information when executing certain transactions tied to a number of PIPE offering.

    The SEC issued a subpoena to the investment firm for records as part of its investigation. Mr. Hart received the subpoena and responded to it without informing others at the firm. Subsequently, during testimony in the investigation, Mr. Hart stated that the President of the investment firm agreed that the matched trades be undertaken. Mr. Hart also testified that he had discussed the investigation with the firm President, informing him that he would testify before the staff.

    In December 2009 the staff telephoned the investment firm. Mr. Hart took the call, representing that he was another firm employee. The staff requested that the President of the firm return their call. The message was not relayed. The next day the staff called again. Mr. Hart took the call and claimed to be the firm President. During the conversation Mr. Hart, while claiming to be the President, told the staff that he was aware of the trades, had approved them and wanted Mr. Hart to remain at the firm.

    Later a second staff member called the firm along with the SEC attorney who had the initial conversations. Again Mr. Hart took the call and claimed to be the firm President. He told the two staff attorneys that the trades were part of a trading strategy, that he was aware of the investigation and that Mr. Hart was a valued employee.

    Each of the statements during the two telephone conversations, as well as those of Mr. Hart’s during his testimony regarding the firm President were false. Mr. Hart pleaded guilty to obstruction of justice and perjury. He is awaiting sentencing.