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Thomas O. Gorman,
Dorsey and Whitney LLP
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    This Week In Securities Litigation (Week ending July 31, 2015)

    July 30, 2015

    The Government requested that the Supreme Court overturn U.S. v. Newman, the Second Circuit’s decision on tipping and the personal benefit test. Previously, the Second Circuit had declined a request to either rehear the case or consider it en banc.

    The SEC filed another settled FCPA action this week. It centered on payments made by a medical supply company to health care personnel employed by state owned enterprises in China. The Commission also filed and offering fraud case and a settled action involving an investment adviser who did not fully disclose compensation received in under agreements with a broker and two funds.

    Supreme Court

    Insider trading: The government filed a petition for certiorari in U.S. v. Newman, seeking to overturn the Second Circuit’s controversial tipping decision. The petition argues that the Second Circuit panel decision conflicts with the Supreme Court’s decision Dirks and the decision of the Ninth Circuit in Salman. U.S. v. Newman (S.Ct. Filed August 30, 2015).

    SEC Enforcement – Filed and Settled Actions

    Statistics: During this period the SEC filed 1 civil injunctive cases and 2 administrative actions, excluding 12j and tag-along proceedings.

    Offering fraud: SEC v. Griffin (N.D.N.Y. Filed July 30, 2015) is an action which names as defendants James Griffin, John Wolle, 54Freedom Inc. and several related entities. Mr. Griffin is the founder and CEO of 54Freedom while Mr. Wolle is the CFO. Beginning in 2007, and continuing until at least 2014, the defendants are alleged to have engaged in a series of offering frauds, selling interest in 54Freedom with outlandish promises. About $8 million was raised, at least $1.2 million of which was misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending. Parallel criminal charges have been brought by the U.S. Attorney’s Office for the Northern District of New York.

    Misrepresentations: SEC v. ABS Manager, LLC, Civil Action No. 13-cv-00319 (S.D. Cal.) is a previously filed action against ABS Manager, LLC and George Price. The complaint alleged that beginning in 2009, and continuing until early 2013, the defendants made material misrepresentations and omissions to investors regarding the risks associated with investing in three investment funds they managed. The defendants settled with the SEC and the Court entered final judgments of permanent injunctions based on Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). In addition, the defendants were, jointly and severally, directed to pay $362,648.83 in disgorgement, prejudgment interest and, respectively, penalties of $725,000 and $150,000. See Lit. Rel. No. 23313 (July 30, 2015).

    Unregistered brokers: In the Matter of David B. Hananich, Jr., Adm. Proc. File No. 3-16354 (July 28, 2015) is a previously filed action which named as Respondents Mr. Hananich, a cofounder and director of Diversified Energy Group, Inc.; Carmine DellaSala, also a co-founder of Diversified; Matthew Welch, a vice president of Diversified and a board member of St. Vincent, a firm investors were told was a charity; Richard Scurlock, III, the owner of RTAG, a state registered investment adviser; RTAG Inc.; Tax Advisory Group; Jose Carrio and Dennis Karasik, co-founders of Respondent Carrio, Karasik & Associates, LLP, a wealth management firm; and Michael Salovay, a one-time registered representative. From 2006 through 2008 investors were solicited to purchase interests in Diversified and offered stock at prices ranging from 20 cents to $1.55 per share. A PPM was used. The shares were unregistered. Subsequently, from 2009 through 2012 investors were solicited to purchase Diversified bonds which had a coupon rate of 8% to 10.25%. Some of the bonds included an option to acquire stock. There was no registration in effect for the bonds. About $16.5 million was raised. To effectuate the sales of Diversified interests, unregistered sales agents were used. Those agents were paid a commission of either 5% or 10%. The agents included Mr. Scurlock and RTAG and Messrs. Carrio and Karasik and CKA and Mr. Salovay. In soliciting investors misrepresentations regarding the financial performance of Diversified were made. Additional misrepresentations were made regarding the firm’s use of experts for advice. In addition, Messrs. Havanich, Dellasla and Welch touted their relationship with St. Vincent. The firm had no relationship to the well-known charity of St. Vincent de Paul, a voluntary Catholic organization. The Order alleges violations of Exchange Act Section 15(a). Messrs. Karasik, Carrio and their firm, Carrio, Karasik and Associates resolved the charges, each consenting to the entry of a cease and desist order based on Section 15(a). Each also agreed to be barred from the securities business and from participating in any penny stock offering. In addition, each settling Respondent agreed to pay disgorgement and to future proceedings which will determine the amount plus prejudgment interest if, ordered, and a penalty if appropriate.

    Disclosure of fees: In the Matter of Dion Money Management, LLC, Adm. Proc. File No. 3-16702 (July 24, 2015). Dion Money Management is a registered investment adviser. Most clients used Broker A for custody. Beginning in 2002 the adviser entered into service agreements with an administrator to a Family of Funds B, a distributor for Family of Funds C and a Custodial Support Agreement with Broker A. With Family of Funds B the adviser had an arrangement under which it was paid a fee based on the amount of client assets invested in select funds in exchange for providing recordkeeping and administration services for those clients. After a number of modifications, in 2005 the adviser received a payment of 20 basis points up to certain limits. With Fund Family C the adviser entered into a similar arrangement, although the payment rate was 30 basis points. Under the arrangement with Broker A the adviser was compensated on a quarterly basis based on the percentage of client assets held in custody with the Broker that were invested in certain mutual funds on the brokers no-transaction–fee platform. Dion Money Management made certain disclosures regarding the arrangements listed above in its Form ADV which disclosed them but did not specifically state it could receive payments greater than 30 basis points as a result of the arrangement with Broker A. The Order alleges violations of Advisers Act Section 206(2) and 207. Dion Money Management resolved the charges. The firm will implement a series of undertakings which include amending the provisions of its current Form ADV and providing notice to clients of the Order and certifying compliance. The adviser also consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. It will pay a civil money payment of $50,000. Disgorgement was not ordered.

    FCPA

    In the Matter of Mead Johnson Nutrition Company, Adm. Proc. File No. 3-16704 (July 28, 2015). Mead Johnson is a global manufacturer and marketer of infant formula and child nutrition products. The firm has subsidiaries which operate in various parts of the world. Subsidiary Mead Johnson China operates in the PRC where the firm began doing business in the1990s. By 2013 the company had operations in 241 cities in China.

    Part of Mead Johnson’s marketing from 2008 through 2013 was through the medical sector which included health care facilities and health care professionals. The firm’s China subsidiary used third-party distributors to market, sell and distribute products in the country. Mead Johnson China’s sales personnel marketed through medical channels and health care facilities. Health care professionals at the facilities were encouraged to recommend the company products. Incentives to make that recommendation and collect certain information were provided in the form of cash payments and other things, contrary to company policy. The payments were made from the distributor allowance retained by the distributor but controlled by the firm. The firm failed to devise and maintain adequate systems of internal controls over the operations of its China subsidiary to ensure that the sales expenditures through its distributors were not used for unauthorized or improper purposes.

    In 2011 the firm received information about possible violations of the FCPA which an investigation failed to uncover, although later the practices were halted. A second investigation, commenced in 2013, discovered the violations. The company cooperated with the SEC and undertook significant remedial measures. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter the company consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the company will pay disgorgement of $7,770,000, prejudgment interest and a civil monetary penalty of $3 million.

    FINRA

    Data reporting: The regulator fined Goldman Sachs Execution & Clearing, L.P. $1.8 million for failing to accurately submit trade reports to the appropriate FINRA Trade Reporting Facility. Specifically, the firm failed to transmit all applicable order information for Order Audit Trail System or OATS in a complete and accurate manner for about seven years. The firm also furnished inaccurate data for a large number of order-related events for over eight years and did not have adequate supervisory systems.

    Criminal cases

    Insider trading: U.S. v. Braverman, No. 1:14-cr-00748 (S.D.N.Y.) is an action charging former Dimitry Braverman, formerly a clerk at Wilson Sonsini, with insider trading. The charges alleged that he traded on inside information misappropriated from the firm on at least four occasions. He pleaded guilty to one count of securities fraud and as sentenced to serve twenty-four months in prison. See also SEC v. Braverman, Civil Action No. 14 cv 7482 (S.D.N.Y.).

    Australia

    Unregistered broker: The Australian Securities and Investment Commission initiated a proceeding against Dr. Roger Munro and Mrs. Kathleen Munro who are alleged to have raised about $1.5 million from investors for trading without registering with the agency as required. Although investors have been told the trades are profitable, records suggest the contrary. Portions of the investor funds have been transferred to a brokerage account in the name of Mrs. Munro.

    Expenses: The ASCI announced that beginning July 29, 2015 it will seek to recover the cost of investigations where there has been a successful prosecution or civil proceeding against a person. The action is being taken under a provision of the Australian Securities and Investments Commission Act of 2001.

    Directors: The ASIC banned Trevor Seymour , formerly a director of financial services firm Provident Capital Limited, from managing a corporation and providing financial services for three years. The action is based on the filing of false and misleading reports and a false prospectus used for a debenture offering. Mr. Seymour is the third director of the firm to be penalized.

    Unregistered securities: The regulator secured a judgment against Astra Resources PLC and its subsidiary, Astra Consolidated Nominees Pty Ltd, for selling securities without registering a prospectus. About $6.5 million was raised from 300 investors over a period of about one year beginning September 2011. Remedies will be considered in the future.

    Hong Kong

    Reporting: The Securities and Futures Commission fined Nomura International (Hong Kong) Limited $4.5 million for failing to report significant misconduct by a former trader in a timely fashion. Specifically, when the firm reported on June 11, 2013 that a trader had lost US$3.5 million and had been sent back to Japan, it also knew he had made false entries to cover the transactions and had launched an investigation into the matters, none of which was reported until later.

    Disclosure: The SFC initiated a proceeding against AcrossAsia Ltd and its chairman, Albert Cheok and CEO, Vincent Ang, for failing to disclose material information as soon as practicable. The action arose from a related litigation in Indonesia involving the company where in fact the information was disclosed.

    SEC Settles Unregistered Broker Charges Tied To Offering Fraud

    July 29, 2015

    The SEC entered into partial settlements with three persons charged with acting as brokers without registering. The charges were tied to an offering fraud which centered on selling interests in a firm that claimed to be engaged in the business of buying and selling fractional interests in oil and gas production properties and commodities trading in the futures market (here). Over $16 million was raised selling stock and bonds. In the Matter of David B. Hananich, Jr., Adm. Proc. File No. 3-16354 (July 28, 2015).

    Named as Respondents are Mr. Hananich, a cofounder and director of Diversified Energy Group, Inc.; Carmine DellaSala, also a co-founder of Diversified who was previously named as a Respondent in a cease and desist action brought by the state of Kanas; Matthew Welch, a vice president of Diversified and a board member of St. Vincent, a firm investors were told was a charity; Richard Scurlock, III, the owner of RTAG, a state registered investment adviser; RTAG Inc.; Tax Advisory Group; Jose Carrio and Dennis Karasik, co-founders of Respondent Carrio, Karasik & Associates, LLP, a wealth management firm; and Michael Salovay, a one-time registered representative.

    From 2006 through 2008 investors were solicited to purchase interests in Diversified and offered stock at prices ranging from 20 cents to $1.55 per share. A PPM was used. The shares were unregistered.

    Subsequently, from 2009 through 2012 investors were solicited to purchase Diversified bonds which had a coupon rate of 8% to 10.25%. Some of the bonds included an option to acquire stock. There was no registration in effect for the bonds. About $16.5 million was raised.

    To effectuate the sales of Diversified interests, unregistered sales agents were used. Those agents were paid a commission of either 5% or 10%. The agents included Mr. Scurlock and RTAG and Messrs. Carrio and Karasik and CKA and Mr. Salovay. In soliciting investors misrepresentations regarding the financial performance of Diversified were made. Additional misrepresentations were made regarding the firm’s use of experts for advice. In addition, Messrs. Havanich, Dellasla and Welch touted their relationship with St. Vincent. The firm had no relationship to the well-known charity of St. Vincent de Paul, a voluntary Catholic organization.

    The Order alleges violations of Exchange Act Section 15(a). Messrs. Karasik, Carrio and their firm, Carrio, Karasik and Associates resolved the charges, each consenting to the entry of a cease and desist order based on Section 15(a). Each also agreed to be barred from the securities business and from participating in any penny stock offering. In addition, each settling Respondent agreed to pay disgorgement and to future proceedings which will determine the amount plus prejudgment interest if, ordered, and a penalty if appropriate.

    SEC Settles FCPA Charges Tied to Payments to Health Care Professionals

    July 28, 2015

    The SEC filed another settled action in which payments to health care professionals at state owned entities in China were alleged to be violations of the Foreign Corrupt Practices Act. Although the company furnished extensive cooperation, it paid disgorgement, prejudgment interest and a penalty to resolve books and records and internal control violations. In the Matter of Mead Johnson Nutrition Company, Adm. Proc. File No. 3-16704 (July 28, 2015).

    Mead Johnson is a global manufacturer and marketer of infant formula and child nutrition products. The firm has subsidiaries which operate in various parts of the world. Subsidiary Mead Johnson China operates in the PRC where the firm began doing business in the1990s. By 2013 the company had operations in 241 cities in China.

    Part of Mead Johnson’s marketing from 2008 through 2013 was through the medical sector which included health care facilities and health care professionals. The firm’s China subsidiary used third-party distributors to market, sell and distribute products in the country. Distributors were provided a discount for company products that was allocated for funding certain marketing and sales efforts of the China subsidiary and other purposes. Those funds, called a Distributor Allowance, belonged to the distributor. Yet Mead Johnson retained certain control over the funds and the books and records.

    Mead Johnson China’s sales personnel marketed through medical channels and health care facilities. Health care professionals at the facilities were encouraged to recommend the company products. Incentives to make that recommendation and collect certain information were provided in the form of cash payments and other things, contrary to company policy. The payments were made from the Distributor Allowance funds. The firm failed to devise and maintain adequate systems of internal controls over the operations of its China subsidiary to ensure that the sales expenditures through its distributors were not used for unauthorized or improper purposes.

    In 2011 the firm received information about possible violations of the FCPA. An internal investigation failed to discover any violation. The firm did halt the Distributor Allowance funds to ensure the money was not being used for an improper purpose. All practices regarding compensation to health care professionals were halted by 2013. The firm did not self-report the allegation in 2011 or promptly disclose the existence of it in response to a subsequent SEC inquiry into the matter, according to the Order.

    A second investigation, commenced in 2013, discovered the violations. The company thereafter cooperated with the SEC and undertook significant remedial measures. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).

    To resolve the matter the company consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, the company will pay disgorgement of $7,770,000, prejudgment interest and a civil monetary penalty of $3 million.

    SFC Reports Hong Kong’s Growth As International Investment Hub

    July 27, 2015

    As the Chinese stock market continues to spiral down, news agencies continue to report on the efforts of the government to abate the crash. In contrast, the Securities and Futures Commission of Hong Kong is reporting another record year of investment in the fund management business (here).

    The combined fund management business grew to a value of over $17.6 billion for 2014 the regulator reported. That represents a 10.5 % increase over the prior year. It also contrasts with 2010 when the value of the combined fund management business was just over $10 billion, illustrating the dramatic grow of the business in just four years.

    About $17.4 billion of the reported $17.6 billion for 2014 represented the non-REIT fund management business while about $206 million was the capitalization of REITS. That represents: $11.3 billion for licensed corporations; $1 billion for registered institutions; $452 million for insurance companies (less certain assets); $3 billion for other private banking businesses of registered institutions; and $1.6 billion for the fund advisory business.

    Much of the growth was fueled by overseas investors. According to the report about $12.4 billion of the $17.4 billion invested in the fund management business came from overseas investors. That represents an increase by about 9% of the amount of funds from overseas investors. The overall percentage of overseas investment remained about constant compared to the prior year. In 2010 overseas investment represented 71% of the overall compared to 71.9% in the prior year which was up from the 64.6% in 2012.

    The asset management business in Hong Kong also continued to grow. In 2014 the non-REIT assets managed in Hong Kong increased by 17.7% compared to the prior year, accounting for about $6.8 billion. While the percentage of assets managed in Hong Kong increased compared to the prior year, it was down from the high of 69.2% in 2012 and slightly below 2011 and 2011.

    The report attributes the growth since 1999 when it was first issued to the “robust regulatory regime . . .[which] is fundamental to Hong Kong’s development as an international asset management centre. . .” and the SFC’s continued cooperation and work with international regulators.

    SEC Sanctions Adviser For Not Fully Disclosing Fee Arrangements

    July 26, 2015

    The Commission has brought a series of cases focused on undisclosed conflicts of regulated entities. A number of those cases centered on undisclosed fee and compensation arrangements. In its most recent case the agency went one step further, charging an investment adviser with fraud who disclosed the terms of its compensation arrangements, told clients they could present a conflict but did not inform them that in certain instances its compensation could be increased because the agreements overlapped. In the Matter of Dion Money Management, LLC, Adm. Proc. File No. 3-16702 (July 24, 2015).

    Dion Money Management is a registered investment adviser. Its clients traditionally were high net worth individuals, family businesses and corporations. Client asserts were held in separately managed discretionary accounts.

    The firm’s approach, evolved over time, was to construct model portfolios of mutual funds for client accounts. Clients could, and often did, elect to depart from the exact holdings of the model portfolios. In those instances the adviser would construct individualized client portfolios. While clients were free to select a custodian, Dion Money Management recommended two that were SEC registered broker-dealers. Most clients used Broker A.

    Beginning in 2002 the adviser entered into service agreements over time with an administrator to a Family of Funds B, a distributor for Family of Funds C and a Custodial Support Agreement with Broker A. With Family of Funds B the adviser had an arrangement under which it was paid a fee based on the amount of client assets invested in select funds in exchange for providing recordkeeping and administration services for those clients. After a number of modifications, in 2005 the adviser received a payment of 20 basis points up to certain limits. With Fund Family C the adviser entered into a similar arrangement, although the payment rate was 30 basis points. Under the arrangement with Broker A the adviser was compensated on a quarterly basis based on the percentage of client assets held in custody with the Broker that were invested in certain mutual funds on the brokers no-transaction–fee platform. That did not include Fund Family A but did include Fund Family B and Fund Family C.

    Dion Money Management made certain disclosures regarding the arrangements listed above in its Form ADV. Specifically, in those Forms for 2011, 2012 and 2013 the firm stated that it had entered into aervice agreements with some mutual funds in which firm clients invested. Under those agreement, the Form ADV stated, the adviser was paid a fee for providing shareholder service that may be up to 30 basis points. The Forms identified the parties to the arrangements and went on to state that “[a]s a result of these fees, Dion Money Management, LLC has an incentive to invest client assets in the mutual funds for which . . . [it] receives additional compensation . . .”

    The Form ADV statement regarding payments up to 30 basis points “was not complete . . . [the adviser] did not disclose that, in certain instances,. . . [it] could – and did – receive payments at a rate greater than 0.30% [30 basis points] . . .” according to the Order. The adviser also did not disclose that in certain instances it could and did “receive payments based on the same client assets from Broker A. . . [under the Custodial Agreement] as well as either . . .” Fund Family B or Fund Family C, the Order charged. Stated differently, the adviser did not disclose the possibility of “payments from multiple sources based on the same client assets, or the aggregate possible rate of such payments . . .” Through 2011 and 2012 about 50-55% of the advisory client assets were invested in mutual funds with Fund Family B and Fund Family C.

    The Order alleges violations of Advisers Act Section 206(2) and 207.

    Dion Money Management resolved the charges, settling the proceeding. The firm will implement a series of undertakings which include amending the provisions of its current Form ADV, providing notice to clients of the Order and certifying compliance. The adviser also consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. It will pay a civil money payment of $50,000. Disgorgement was not ordered.

    This Week In Securities Litigation (Week ending July 24, 2015)

    July 23, 2015

    The SEC filed three actions following-up on its settled proceeding against Oppenheimer for selling millions of shares of unregistered penny stocks. Each individual settled with the agency. In addition, the Commission brought a manipulation action against three individuals centered on the manipulation of the stock of six microcap issuers. Finally, the SEC dismissed all charges with prejudice against the CFO of Aphelion Fund, George Palathinkal, which was alleged to have furnished investors false returns and misused funds.

    SEC

    Whistleblowers: The SEC paid over $3 million to a whistleblower who helped the agency “crack” a complex fraud. It is the highest payout to date.

    CFTC

    Remarks: Chairman Timothy Massad delivered remarks to the District of Columbia Bar, Washington, D.C. (July 23, 2015). His remarks reviewed the financial crisis and the resulting regulation of the swaps markets along with future steps (here).

    SEC Enforcement – Filed and Settled Actions

    Statistics: During this period the SEC filed 1 civil injunctive cases and — administrative actions, excluding 12j and tag-along proceedings.

    Sale of unregistered penny stocks: In the Matter of Scott A. Eisler, Adm. Proc. File No. 3-16699 (July 23, 2015). a proceeding which names as a Respondent Mr. Eisler, a registered representative and investment adviser at Oppenheimer & Co.; In the Matter of Arthur W. Lewis, Adm. Proc. File No. 3-16700 (July 23, 2015), a proceeding which names as a Respondent Mr. Lewis, a Branch Office Manager at Oppenheimer & Co; In the Matter of Robert Okin, Adm. Proc. File No. 3-16701 (July 23, 2015), a proceeding which names as a Respondent Mr. Okin, formerly an Executive VP at Oppenheimer & Co. and Head of the Private Client Division. Each proceeding is based on the sale of millions of shares of unregistered penny stocks from July 2008 through May 2009 for Gibraltar Global Securities, Inc., a broker-dealer in the Bahamas. Oppenheimer previously settled with the SEC and FinCEN (here). The Order as to Mr. Eiser alleged violations of Securities Act Sections 5(a) and (c). He settled, consenting to: The entry of a cease and desist order based on the Sections cited in the Order; an order barring him from the securities business and participating in a penny stock offering with a right to re-apply after one year; and a penalty of $50,000. The Order as to Mr. Lewis alleged violations of Securities Act Sections 5(a) and (c) and Exchange Act Sections 15(b)(4)(e) and 15(b)(6). He resolved the charges by consenting to the entry of: A cease and desist order based on Section 5 of the Securities Act; an order barring him from the securities business in a supervisory capacity with a right to apply for reentry after one year; and will pay a penalty of $50,000. The Order as to Mr. Okin alleges violations of Exchange Act Sections 15(b)(4) and 15(b)(6). He settled with the Commission, consenting to the entry of: An order barring him from the securities business in a supervisory capacity with a right to apply for reentry after one year; and to pay a penalty of $125,000.

    Manipulation: SEC v. Aaron (S.D.N.Y. Filed July 21, 2015) is an action against three individuals who are alleged to have conducted six pump-and-dump schemes in 2011 and 2012. The three defendants, all residents of Israel, are: Joshua Aaron, Gery Shalon and Zvi Orenstein. The issuers are Southern Home Medical Equipment, Inc.; Greenfield Farms Grassfed Beef, Inc.; Next Generation Energy Corporation; Mustang Alliances, Inc.; IDO Security, Inc.; and Premier Brands, Inc. The defendants control numerous promotional websites and have large email lists which are used to tout the stocks. Typically the defendants used these resources to send multiple emails touting the same issuer. The emails, however, were made to appear as if they came from different sources. The defendants and/or their associates obtained control over the issuer prior to the initiation of the promotions. Each scheme generated a significant price increase and profits for the defendants. Overall the defendants netted over $3.4 million. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and each subsection of Rule 10b-5. The case is pending. The U.S. Attorney’s Office filed parallel criminal charges.

    Pyramid scheme: SEC v. CKB168 Holdings Ltd., Civil Action No. 3-16694 (E.D.N.Y.) is a previously filed action which named as defendants the firm, Rayla Santos, Chih Hsuan Lin and others. The complaint centered on a pyramid scheme involving a company that claimed to sell online education courses for children when in fact its only product was what it sold investors – there were no significant retail sales. Defendants Santos and Lin resolved the Commission’s charges as to them and the court entered final judgments as to each. Both made admissions of fact regarding the scheme. Both consented to the entry of judgments of permanent injunction based on Securities Act Sections 5(a), 5(c) and 17(a)(1) and (3) and Exchange Act Section 10(b) and Rule 10(b)(5)(a) and (c). In addition, the judgment as to Ms. Lin is also based on Securities Act Section 17(a)(2), Exchange Act Rule 10(b)(5)(b) and Exchange Act Section 15(a). Each agreed to pay disgorgement, prejudgment interest and civil penalties in amounts to be determined later by the Court on the Commission’s motion. Ms. Lin also agreed to the entry of an order in an administrative proceeding barring her from the securities business and from participating in any penny stock offering. The action as to the other defendants continues. See Lit. Rel. No. 23306 (July 17, 2015).

    False returns: SEC v. Kalucha, Civil Action No. 14 cv 3247 (S.D.N.Y.) is a previously filed action against Vinceet Kalucha, the CIO of Aphelion Fund Management LLC, also a defendant and an investment adviser, and George Palathinkal, a general partner and CFO of the adviser. The Aphelion funds began trading in July 2013. From May 2013 to the present Messrs. Kalucha, Palathinkal and Aphelion Management raised nearly $8 million from 8 different investors for an investment into a separate account managed by Aphelion Management. The Aphelion funds used a proprietary investment model developed by Mr. Kalucha at an earlier fund. Despite poor results from the model in an earlier application, marketing materials for Aphelion touted the positive results of the model. The model also yielded poor results here. In September 2013 an Audit Firm completed a review of the investment performance for an Aphelion client which showed a negative return of 3.08% net of fees or negative 0.66% before fees. Mr. Kalucha altered the audit report so it reflected a positive 30% net of fees. The altered report was distributed to potential investors and incorporated into Aphelion Management’s marketing materials. Later Mr. Kalicha told the Audit Firm that he discontinued use of the altered report when the audit firm protested. The Audit Firm resigned. Subsequently, the defendants told investors that Aphelion Management was revising its reported historical performance statistics to reflect a more conservative approach. The actual reason was the repudiation of the altered report by the Audit Firm and its resignation which was not disclosed to investors. Messrs. Kalucha and Palathinkal are also alleged to have used investor funds raised for operating expenses for their personal use. The complaint alleges violations of Exchange Act Section 10(b), each subsection of Securities Act Section 17(a) and Advisers Act Sections 206(1), 206(2) and 206(4). The case is pending. Recently, the SEC dismissed all charges against Mr. Palathinkal with prejudice and without cost.

    FCPA

    U.S. v. Luis Berger International, Inc., Mag. No. 15-3624 (D. N.J.). Louis Berger International, Inc. is a privately held international consulting firm that provides engineering, architecture, program and construction management services. Richard Hirsch was a Senior Vice President with the firm who at times oversaw the operations of the firm in, among other locations, Indonesia and Vietnam. James McClung was also a Senior Vice President with the firm. He was based in India where at times he oversaw the firm’s operations in Vietnam and India. The criminal complaint alleges conspiracy to violate the FCPA bribery provisions, centered on the payment of bribes to government officials in India, Indonesia, Kuwait and Vietnam to obtain business. The bribes totaled over $3.9 million. The bribes were generally paid through employees and agents. They were referred to in emails and other communications as a “commitment fee,” “counterpart per diem,” “marketing expenses” and similar terms. The complaint is based in large part on e-mails involving Mr. Hirsch and/or Mr. McClung and their involvement in paying bribes in India, Kuwait, Vietnam and Indonesia over a period from about 2004 through 2010.

    To resolve the charges LBI entered into a deferred prosecution agreement. That agreement requires the appointment of a monitor for three years. The firm will also pay a $17.1 million criminal fine which is the bottom of the sentencing guideline range of $28.5 million to $17.1 million. The DOJ acknowledged the cooperation of the company which included: 1) Self-reporting; 2) voluntarily making U.S. and foreign employees available for interviews and collecting, analyzing and organizing evidence and information for investigators; 3) engaging in extensive remediation which included terminating the officers and employees who were responsible for the payments; and 4) it committed to improving compliance and internal controls. Messrs. Hirsch and McClung each pleaded guilty to one count of conspiracy to violate the FCPA and one substantive count of violating the Act. Sentencing is scheduled for November 5, 2015.

    PCAOB

    Engagement quality review: The Board resolved disciplinary proceedings with seven audit firms and seven individuals. Five of the settlements involved a failure to have an engagement quality review prior to permitting the issuer to use the audit opinion. Two firms and two individuals settled charges of failing to comply with the “cooling off” period under which the engagement quality reviewer cannot be an individual who served as the engagement partner on either of the two preceding audits of the issuer. A list of the firms and individuals and the penalties assessed is here.

    Court of appeals

    FOIA exemption: Chiquita Brands International, Inc. v. SEC, No. 14-5030 (D.C. Cir. Decided July 17, 2015). In 2001 Chiquita reached a settlement with the SEC regarding books and records violations. The firm consented to the entry of a cease and desist order based on allegations that it failed to accurately record certain payments made by subsidiary Banadex to local officials in Columbia. In the parallel DOJ investigation Banadex pleaded guilty to engaging in unauthorized transactions with Autodefensas Unidas de Colombia or AUC. The group had been designated as a global terrorist organization. While Chiquita acknowledged that Banadex made the payments demanded by AUC, the company insisted it did so only to protect its Colombian employees from being kidnapped, injured and murdered.

    In connection with the investigations Chiquita produced thousands of documents related to the payments to the DOJ and the SEC. The firm requested confidential treatment under the pertinent provisions of the Freedom of Information Act. In 2011 the DOJ released over 5,500 pages of these documents to the National Security Archive under the FOIA. The Archive is a non-profit library project of the George Washington University. It collects declassified documents related to U.S. national security. At issue here are two FOIA requests made by the Archive to the SEC in 2008 relating to documents from the Banadex inquiry on which the SEC’s settlement with Chiquita was based. Chiquita was then a defendant in a multi-district litigation brought by Colombian citizens based on the Alien Tort Statute and the Torture Victim Protection Act. Chiquita requested that the SEC’s Office of FOIA Services withhold the documents requested by the Archive based on Exemption 7(B), in view of the pending litigation. Specifically, the firm argued that release of the documents would deprive it of a fair trial in that litigation, noting that the Archive is directly affiliated with, and actively supporting, plaintiffs in the case. Thus the release of the documents would constitute an end run around the stay of discovery. The FOIA Office rejected the claim. The SEC’s General Counsel, on appeal, also rejected the claim.

    Chiquita then initiated an action in District Court, claiming that the SEC’s failure to apply Exemption 7(B) was inappropriate. The Archive intervened on the side of the Commission. The court granted summary judgment on behalf of the SEC. On appeal Chiquita focused again on Exemption 7(B), claiming that under the provision the release of the documents is barred until discovery begins and it can seek a protective order from the court. The company dropped an argument that release of the documents would deprive the firm and its officers of the right to an unbiased jury.

    The Circuit Court affirmed. Exemption 7(B) only applies under its express terms when the release of the records would deprive a person of the right to “a fair trial or an impartial adjudication.” Under this provision the Court stated that “Assuming that Congress used the word ‘trial’ in light of its long-settled meaning, we agree with the Commission and the Archive that Exemption 7(B) comes into play only when it is probable that the release of law enforcement records will seriously interfere with the fairness of ‘that final step which is called ‘the trial’.” (citation omitted). In reaching this conclusion the Court rejected Chiquita’s contention that the use of the phrase “fair trial” and the term “adjudication” in the provision broaden its coverage beyond the trial itself, giving it application to any point during a judicial proceeding, including discovery.

    Australia

    Misappropriation: Ali Hammoud, formerly a director of ERB International Pty Limited, previously pleaded guilty to one count of dishonestly using his position as a director by misappropriating over $2.6 million from the firm just before it went into liquidation, an lying to the Australian Securities and Investment Commission. He was sentenced to a term of 2 years in prison but will be released after 12 months on condition he be of good behavior for an additional two years.

    Hong Kong

    Report: The Securities and Futures Commission released a report showing that the fund management business reached a record high in 2014 (here).

    SEC Charges Three For Six Microcap Fraud Manipulations

    July 22, 2015

    Microcap fraud has been a priority of SEC Enforcement since at least the formation of the Microcap Task Force about two years ago. The Commission has brought a series of cases focused largely on pump-and-dump schemes.

    Now the Commission has brought an action against three individuals who are alleged to have conducted six pump-and-dump schemes in 2011 and 2012. The three defendants, all residents of Israel, are: Joshua Aaron, Gery Shalon and Zvi Orenstein. The issuers are Southern Home Medical Equipment, Inc.; Greenfield Farms Grassfed Beef, Inc.; Next Generation Energy Corporation; Mustang Alliances, Inc.; IDO Security, Inc.; and Premier Brands, Inc. SEC v. Aaron (S.D.N.Y. Filed July 21, 2015).

    The defendants control numerous promotional websites and have large email lists which are used to tout the stocks. Typically the defendants used these resources to send multiple emails touting the same issuer. The emails, however, were made to appear as if they came from different sources. The defendants and/or their associates obtained control over the issuer prior to the initiation of the promotions.

    Many of the promotional materials had a disclaimer stating essentially that company officials and their families may hold a position in the securities. The disclaimers also stated at times that the firm officials may sell their stock. Potential investors were not told that the promotors planned to sell their stock as the promotions began. By the end of the promotions the stock price crashed back down after a dramatic increase, leaving investors with little and the defendants with profits.

    Typically, each defendant contributed to the scheme. For example, Mr. Aaron generally wrote, created and helped design the email and website promotions. Mr. Shalon contributed to those emails, sent them out and approved the use of funds by Mr. Orenstein to acquire domain names. Mr. Orenstein handled the back office duties.

    Each scheme generated a significant price increase and profits for the defendants:

    • Southern Home: The share price increased over 1,800% yielding the defendants $300,000 in profits;
    • Greenfield Farms: The share price increased 286% yielding profits of $123,000;
    • Next Generation: The share price increased 93% yielding profits of $36,000;
    • Mustang Alliances: The price increased 65% yielding over $2.2 million;
    • IDO Security: The share price increased 112% yielding profits of $580,000; and
    • Premier Brands: The share price increased 41% yielding profits of $216,000.

    Overall the defendants netted over $3.4 million. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and each subsection of Rule 10b-5. The case is pending. The U.S. Attorney’s Office filed parallel criminal charges.

    Cooperation, the SEC and FOIA

    July 21, 2015

    A critical part of cooperating with an SEC or DOJ investigation for FCPA or other possible violations is the production of documents. In order for the company to assess what happened it must conduct an internal investigation and interview the necessary witnesses. It is the only way for the company to self–evaluate its own conduct. The SEC and the DOJ are in the same position. To evaluate what happened, government investigators need to assess the conduct through an evaluation of the documents and information from key individuals. While furnishing enforcement officials the critical information may secure cooperation credit and possibly reduce liability in any enforcement action, it can increase potential future liability in other litigation. Chiquita Brands International, Inc. v. SEC, No. 14-5030 (D.C. Cir. Decided July 17m 2015).

    In 2001 Chiquita reached a settlement with the SEC regarding books and records violations. The firm consented to the entry of a cease and desist order based on allegations that it failed to accurately record certain payments made by subsidiary Banadex to local officials in Columbia. In the parallel DOJ investigation Banadex pleaded guilty to engaging in unauthorized transactions with Autodefensas Unidas de Colombia or AUC. The group had been designated as a global terrorist organization. While Chiquita acknowledged that Banadex made the payments demanded by AUC, the company insisted it did so only to protect its Colombian employees from being kidnapped, injured and murdered.

    In connection with the investigations Chiquita produced thousands of documents related to the payments to the DOJ and the SEC. The firm requested confidential treatment under the pertinent provisions of the Freedom of Information Act. In 2011 the DOJ released over 5,500 pages of these documents to the National Security Archive under the FOIA. The Archive is a non-profit library project of the George Washington University. It collects declassified documents related to U.S. national security.

    At issue here are two FOIA requests made by the Archive to the SEC in 2008 relating to documents from the Banadex inquiry on which the SEC’s settlement with Chiquita was based. Chiquita was then a defendant in a multi-district litigation brought by Colombian citizens based on the Alien Tort Statute and the Torture Victim Protection Act. Plaintiffs claimed that some of the firm’s former officers should be held liable for making payments to paramilitary organizations such as AUC that tortured and murdered the plaintiffs and their families. Since 2008 discovery had been stayed while the parties litigated jurisdictional issues that the district court certified for interlocutory review. The federal claims against Chiquita were dismissed on appeal. Motions to dismiss are pending.

    Chiquita requested that the SEC’s Office of FOIA Services withhold the documents requested by the Archive based on Exemption 7(B), in view of the pending litigation. Specifically, the firm argued that release of the documents would deprive it of a fair trial in that litigation, noting that the Archive is directly affiliated with, and actively supporting, plaintiffs in the case. Thus the release of the documents would constitute an end run around the stay of discovery. The FOIA Office rejected the claim. The SEC’s General Counsel, on appeal, also rejected the claim.

    Chiquita then initiated an action in District Court, claiming that the SEC’s failure to apply Exemption 7(B) was inappropriate. The Archive intervened on the side of the Commission. The court granted summary judgment on behalf of the SEC. On appeal Chiquita focused again on Exemption 7(B), claiming that under the provision the release of the documents is barred until discovery begins and it can seek a protective order from the court. The company dropped an argument that release of the documents would deprive the firm and its officers of the right to an unbiased jury.

    The Circuit Court affirmed, vacating an injunction precluding the release of the documents pending its determination. The FOIA, the Court began, requires government agencies to make public virtually all information not specifically exempted from release. This means that in some instances litigants can obtain materials they might not otherwise be able to obtain or which may not be readily available. In this context, exemptions under the Act are construed narrowly. The party asserting an exemption has the burden of establishing that the documents should be withheld from production.

    Exemption 7(B) only applies under its express terms when the release of the records would deprive a person of the right to “a fair trial or an impartial adjudication.” Under this provision the Court stated that “Assuming that Congress used the word ‘trial’ in light of its long-settled meaning, we agree with the Commission and the Archive that Exemption 7(B) comes into play only when it is probable that the release of law enforcement records will seriously interfere with the fairness of ‘that final step which is called ‘the trial’.” (citation omitted). In reaching this conclusion the Court rejected Chiquita’s contention that the use of the phrase “fair trial” and the term “adjudication” in the provision broaden its coverage beyond the trial itself, giving it application to any point during a judicial proceeding, including discovery. While the Court agreed with Chiquita’s contention that the right of a party to a fundamentally fair decision making process can be denied through a number of events before trial, it concluded that the Exemption does not apply to situations where a “slight advantage conferred on a party in a single phase of a case necessarily threatens the fairness of the trial.”

    Finally, the Court distinguished its decision in Washington Post Co. v. U.S. Department of Justice, 863 F. 2d 96 (D.C. Cir. 1988), relied on by Chiquita. While the company claimed otherwise, according to the Court, there the same standard was applied – would the release of the records seriously interfere with the fairness of the proceeding as a whole. In Washington Post a newspaper reporter made a FOIA request to the DOJ which was investigating claims that Eli Lilly marketed an arthritis drug to Americans while failing to tell regulators or consumers that it had caused severe adverse reactions among patients overseas. Faced with product liability claims the company conduced an internal investigation under the supervision of a special committee of independent directors to assess its exposure. The committee produced a comprehensive report and furnished it to the DOJ. The Post requested the report. The DOJ denied the request.

    On appeal Lilly and the DOJ argued that the report could taint the potential jury pool and it was unavailable in discovery because it was protected by the self-evaluative privilege. This distinguishes Washington Post from the situation presented here the Court held because “in Washington Post that disclosure of the report of the outside directors, a document unavailable in discovery, would grant the company’s adversaries an ‘unfair advantage’ and thus deprive Eli Lilly of a fair trial.” That differs from this situation where the company would only suffer a temporary disadvantage during discovery, according to the Court.

    What Message Is Being Sent to CCOs By SEC Commissioners?

    July 20, 2015

    The role of the chief compliance officer is the talk of the Securities and Exchange Commission these days – or at least some of its Commissioners. Those who are speaking for the record agree that the role of the CCO is important. Those who are speaking for the record agree that the CCO should not have a target on his or her back. But what is the message to CCOs that two SEC Commissioners and the Chair of the agency are discussing their role and if they should be concerned about an SEC enforcement action?

    First, there was SEC Commissioner Gallagher who published a dissenting statement regarding two recent, settled enforcement actions filed by the agency. One was In the Matter of Blackrock Advisers, LLC, Adm. Proc. File No. 3-16501 (April 20, 2015). The other was In the Matter of SFX Financial Advisory Management Enterprises, Inc., Adm. Proc. File No. 3-16590 (June 15, 2015). Each case centered on the adequacy of the policies and procedures of the firm. In each case the CCO settled with the Commission.

    The point of Commissioner Gallagher’s dissent was two-fold. First, he argued that Rule 206(4)-7 is “not a model of clarity” since it is addressed to the adviser but applied to the CCO. Second, there is no guidance as to the distinction between the role of the CCO and that of management in carrying out the compliance function. And, enforcement actions are not the way to give guidance to these critical gatekeepers, Commissioner Gallagher noted. Statement of Commissioner Daniel Gallagher, June 18, 2015 (here).

    Then Commissioner Luis Aguilar weighed in with comments appropriately titled “The Role of Chief Compliance Officers Must be Supported.” Commissioner Aguilar, who is a former head of compliance, expressed “concern that the recent public dialogue may have unnecessarily created an environment of unwarranted fear in the CCO community . . . [that ] is unhelpful, sends the wrong message . . .”

    Commissioner Aguilar then pointed out that the SEC has brought “relatively few cases targeting CCO’s relating solely to their compliance-related activities.” Rather, the “vast majority of these case involved CCOs who ‘wore more than one hat’. . .” Citing Commissioner Gallagher’s remarks he went on to argue that “those who believe that Rule 206(4)-7 unduly puts a target on the back of CCOs. . .” are simply wrong. Since the adoption of the Rule “enforcement actions against individuals with CCO-only titles and job functions have been rare.” Those few cases should not be of concern. Rather, “the Commission has approached CCO cases very carefully. . .” Remarks of Commissioner Luis Aguilar, June 29, 2015 (here).

    Now Chair White has joined the discussion. After reiterating the remarks of her fellow Commissioners regarding the importance of the position and its gatekeeper function, the Chair stated: “To be clear, it is not our intention to use our enforcement program to target compliance professionals. We have tremendous respect for the work you do. You have a tough job in a complex industry where the stakes are extremely high. That being said, we must, of course, take enforcement action against compliance professionals if we see significant misconduct or failures by them. Being a CCO obviously does not provide immunity from liability, but neither should our enforcement actions be seen by conscientious and diligent compliance professionals as a threat.” Chair Mary Jo White, “Opening Remarks at the Compliance Outreach Program for Broker-Dealers,” Washington, D.C. (July 15, 2015)(here).

    For all the words spoken, and reassurances given, are CCO’s comforted that they are not being targeted by the SEC? That the standards which might be used in any enforcement actions might be vague? Or that only appropriate enforcement actions will be brought? In the end what message does it send to CCOs who are praised for being key gatekeepers that three SEC Commissioners – enough to authorize and enforcement action – are debating their role, the standards and the prospects of an enforcement action?

    DOJ–Louis Berger, Two Executives Resolve FCPA Charges

    July 19, 2015

    The DOJ resolved another FCPA action with the company entering into a deferred prosecution agreement, paying a criminal fine and agreeing to the imposition of a monitor after self reporting and cooperating. Two of the firm’s senior executives pleaded guilty to criminal conspiracy charges and are awaiting sentencing. U.S. v. Luis Berger International, Inc., Mag. No. 15-3624 (D. N.J.).

    Louis Berger International, Inc. is a privately held international consulting firm that provides engineering, architecture, program and construction management services. It is based in New Jersey. Richard Hirsch was a Senior Vice President with the firm who at times oversaw the operations of the firm in, among other locations, Indonesia and Vietnam. James McClung was also a Senior Vice President with the firm. He was based in India where at times he oversaw the firm’s operations in Vietnam and India.

    The criminal complaint alleges conspiracy to violate the FCPA bribery provisions, centered on the payment of bribes to government officials in India, Indonesia, Kuwait and Vietnam to obtain business. The bribes totaled over $3.9 million. The bribes were generally paid through employees and agents. They were referred to in emails and other communications as a “commitment fee,” “counterpart per diem,” “marketing expenses” and similar terms.

    Louis Berger commenced operations in Indonesia in 1967 and closed its office in Jakarta in June 2011. Through employees and agents the firm paid “commitment fees” and “counterparty per diems” in connection with government contracts. The arrangements are reflected in a number of e-mails involving Mr. Hirsch beginning as early as August 2003 and continuing through 2010.

    The conduct in Vietnam reflects a similar pattern. There the company began operations in the early 1990’s. Mr. Hirsch was involved in payments beginning in 2003. Two years later Mr. McClung assumed responsibility for the area. At that time Mr. Hirsch explained he would “need to find a new way to generate bribe money for foreign officials because the Foundation [a conduit for bribe payments] would soon cease operations,” according to the criminal complaint. The arrangements continued through 2010.

    In India the company began operations in 1998. There the firm was apparently a consortium partner in 2009 and 2010 revolving around one project. A tracking schedule prepared by a partner stated that the company had paid $976,630 in bribes in connection with the Goa Project up to that point.

    Finally, in Kuwait LBI secured a $66 million road construction project with the Kuwait Ministry of Public Works. To obtain the project the firm, through its employees and agents, made a series of payments to an official with the Ministry of Public Works totaling about $71,000. Those payments were labeled “business development.” The arrangement is reflected in part through an e-mail from a joint venture partner.

    To resolve the charges LBI entered into a deferred prosecution agreement. That agreement requires the appointment of a monitor for three years. The firm will also pay a $17.1 million criminal fine which is the bottom of the sentencing guideline range of $28.5 million to $17.1 million.

    The DOJ acknowledged the cooperation of the company which included: 1) Self-reporting; 2) voluntarily making U.S. and foreign employees available for interviews and collecting, analyzing and organizing evidence and information for investigators; 3) engaging in extensive remediation which included terminating the officers and employees who were responsible for the payments; and 4) it committed to improving compliance and internal controls.

    Messrs. Hirsch and McClung each pleaded guilty to one count of conspiracy to violate the FCPA and one substantive count of violating the Act. Sentencing is scheduled for November 5, 2015.