The SEC, Enforcement and Statistics

The Commission’s enforcement program has increasingly relied on statistical analysis. One of its initiatives, the Aberrational Performance Inquiry or API, focuses on whether performance and other metrics fell within certain limits. In some instances it has been successful; some not. For example, in SEC v. Yorkville Advisers, LLC, Civil Action No. 12 Civ 778 (S.D.N.Y. Opinion March 29, 2018) the adviser was charged with improper valuations in an inquiry that at least in part stems from a statistical analysis under the API. On summary judgment the Court rejected virtually all of the Commission’s claims.

In other instances, however, statistics have provided important evidence in support of the Commission’s claims. Perhaps no where has the Commission been more successful with this approach than in cherry picking cases – those where a broker or adviser culls the successful trades for favored accounts while allocating the less successful ones to other accounts. That is the case in two recent actions, one against the advisory based on compliance failures and the other against the representative executing the trades. In the Matter of BKS Advisors LLC, Adm. Proc. File No. 3-18648 (August 17, 2018); In the Matter of Roger T. Denha, Adm. Proc. File No. 3-18649 (August 17, 2018).

BKS Advisor is a Commission registered representative. Mr. Denha has been an investment adviser representative at the firm since 2003. He was also a registered representative with a Commission registered broker-dealer until November 30, 3017.

From 2012 through November 30, 2017 Mr. Denha was employed at BKS. During that period he engaged in a cherry picking scheme in which he favored certain accounts, including his while disfavoring others. Specifically, he disproportionately allocated profitable trades to accounts he favored, including his, while disadvantaging others by frequently allocating them the unprofitable trades.

The scheme used an omnibus account that had been set up for the trader’s block trades. By placing the trade in this account Mr. Denha could hold it and make the allocation to specific accounts later in the day. By that point he frequently could determine the direction of the market and the price trend for a particular security. The trader would then give instructions to divide the block by essentially picking “winners” and “losers” with many of the former going to Mr. Denha’s favored accounts and more of the latter type trades being placed in the less favored accounts.

Generally, Mr. Denha placed day trades and trades that were long term or hold positions. His cherry picking scheme involved both types. At times he would have a profitable day trade in a security and a profitable hold trade in the same security. In those instances the profitable trades of both types would be disproportionately allocated to the favored accounts. The same was true if a day trade and a long term trade was not profitable in the same security.

In analyzing the trading patterns here the Commission relied in part on statistics. The difference between the allocations of profitable trades and unprofitable trades was statistically significant. The probability that such an uneven allocation of gains and losses occurred by chance is less than one-in-one-million, according to the Order. Similarly, combining both types of trades, the average combined realized and unrealized return for the favored accounts was about 1.01%. The average combined, realized and unrealized return for the disfavored accounts was a negative 0.16%. Mr. Denha made at least $412, 230 in realized and unrealized gains from the scheme.

Finally, while the firm had procedures which required that trades be fairly allocated and for the allocation of blocks, they were not properly implemented. In its daily review the firm focused on suitability and concentration, not unfair trade allocation. Since its Form ADV represented that the interests of clients would be place before those of the firm and its employees it was incorrect.

The Order as to the advisor alleged violations of Advisers Act sections 206(2), 206(4) and 207. To resolve the proceedings the adviser consented to the entry of a cease and desist order based on the sections cited in the Order, to a censure and to the payment of a penalty of $75,000.

The Order as to Mr. Denha alleged violations of Exchange Act section 10(b) and Advisers Act sections 206(1) and 206(2). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the order and agreed to pay disgorgement of $412,230, prejudgment interest of $35,388 and a penalty of $169,000. He is also barred from the securities business and from participating in any penny stock offering.

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This Week In Securities Litigation (Week ending August 17, 2018)

Municipal bonds and compliance were key issues for Enforcement this week. The Commission brought four actions against twenty defendants centered on the fraudulent purchase of municipal bonds. Specifically, the cases allege “flipping” schemes in which the defendants gamed the offering system to secure initial allocations of securities at the expense of retail investors so that the bonds could immediately be flipped or resold for a $1 markup.

Compliance was also a critical issue this week. One action focused on a nationwide broker-dealer, investment adviser that failed to protect client assets. Another centered on failing to implement procedures to ensure that clients in wrap fee programs were properly advised about trading-away practices.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 4 civil injunctive cases and 8 administrative proceedings, excluding 12j and tag-along proceedings.

Books and records: In the Matter of Citigroup Global Markets Inc., Adm. Proc. File No. 3-18647 (August 16, 2018). Citigroup Global Markets is a dual registered broker-dealer, investment adviser that is a wholly owned subsidiary of Citigroup Inc., a financial services holding company also named as a Respondent. The action centers on three instances involving the mismarking of trades on different desks. Specifically, between 2014 and 2016 the firm reported mismarked trades in opaque markets regarding illiquid securities. In each instance the positions had been overvalued by the traders and not effectively priced by Citi’s valuation control group. In each instance additional loses were recognized. Two of the scenarios also involved unauthorized trading in U.S. Treasury securities, leading to losses that were largely concealed by the fact that each was mismarked. The situation persisted for over one year. The Order alleges violations of Exchange Act sections 13(b)(2)(A) and 17(a). The firm took remedial steps and cooperated with the staff investigation. To resolve the proceedings Citigroup Global Markets consented to the entry of a cease and desist order based on section 17(a) and to a censure. Citigroup consented to the entry of a cease and desist order based on section 13(b)(2)(A). The two firms will also pay, on a joint and several basis, a penalty of $5.750 million.

Internal controls: In the Matter of Citigroup Inc., Adm. Proc. File No. 3-18646 (August 16, 2018) is a proceeding against the bank holding company for a failure to maintain sufficient internal accounting controls concerning wholly-owned subsidiary, Grupo Financiero Banamex, S.A. de C.V. or Banamex. Specifically, over a six year period, beginning in 2008, the subsidiary loaned billions of dollars based on accounts receivable factoring – invoices and work orders – for work performed for Petroleos Mexicanos, S.A. de C.V. or Pemex by Oceanografia, S.A., a Mexican marine services provided. In fact a number of the documents were false and/or forged. The firm did not have sufficient procedures in place to assess the fact that the documents were false or forged and respond to red flags. As a result when the fraud was discovered by the Mexican government Respondent was forced to write off nearly $475 million in expenses in its financial statements and adjust its fourth quarter and full year 2013 financial results downward by a then estimated $360 million and an additional $113 in 2014 when the full magnitude of the fraud was uncovered. In resolving the matter Respondent undertook certain remedial acts and cooperated with the staff’s investigation. The Order alleges violations of Exchange Act section 13(b)(2)(B). Respondent resolved the proceedings by consenting to the entry of a cease and desist order based on the section cited in the Order and paying a penalty of $4.75 million.

Insider trading: SEC v. Laren Zarsky, Civil Action No 1:18-cv-07129 (S.D.N.Y.); SEC v. Dorothy Zarsky, Civil Action No. 1:18-cv-07129 (S.D.N.Y.). These actions were previously brought and settled as to the fiancé and her mother, respectively, of Cameron Collins, the son of Congressman Chris Collins. Mr. Collins, his son and the husband of Dorothy Zarsky, were each previously charged with, among other things, tipping Laren and Dorothy Zarsky regarding the fact that a pharmaceutical firm they had invested in was about to announce that a key drug trial failed. Both sold in advance of the announcement, avoiding losses. The Court entered the final judgments each consented to previously. Each order permanently enjoined the Defendant from future violations of Securities Act section 17(a) and Exchange Act section 10(b). Laren Zarsky also agreed to pay disgorgement of $19,440, prejudgment interest of $839 and a penalty equal to the amount of the disgorgement. Dorothy Zarsky agreed to pay disgorgement $22,600, prejudgment interest of $975 and a penalty equal to the amount of the disgorgement. See Lit. Re. No. 24236 (August 16, 2018).

Compliance: In the Matter of Ameriprise Financial Services, Inc., Adm. Proc. File No. 3-18642 (August 15, 2018) is an action which names as a Respondent the dual registered broker-dealer investment adviser. During a three year period beginning in 2011 the firm failed to safeguard the assets of its clients. Specifically, the firm’s compliance systems were inadequate to prevent five firm representatives from misappropriating significant amounts of client assets. This occurred in two ways. First, the firm used a Fraud Early Detection System to identify situations in which representatives misappropriate funds by, among other things, improperly altering the address associated with the account. The system had a flaw, however, which prevented it from working properly. As a result one representative perpetrated a fraud on a client by altering the address. Second, the firm used an automated transaction analysis tool to identify situations where a representative attempted to direct a cash disbursement from a client account to an address controlled by the representative. The tool did not work with wire transfers which were monitored manually. As a result, on multiple occasions Ameriprise did not detect the fraudulent transfer of funds from client accounts to a location controlled by the representative. The five representatives involved have been terminated. The firm also repaid the clients involved. The Order alleges violations of Advisers Act section 206(4). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order and to a censure. The firm will also pay a penalty of $4.5 million.

Pyramid scheme: SEC v. TelexFree, Inc., Civil Action No. 14-cv-11858 (D. Mass.) is a previously filed action centered on a pyramid scheme run by TelexFree and other defendants. The court entered a final judgment against Santiago De la Rose prohibiting future violations of Securities Act section 5. The order also precludes Defendant from participating in a multi-level marketing scheme that solely or primarily focuses on recruiting others. Defendant will pay disgorgement of $1,092,013 and prejudgment interest which will be deemed satisfied by an order requiring that he transfer certain assets valued at $992,013 and pay $100,000 to settle an adversary action in a related bankruptcy. Defendant admitted that he promoted TelexFree in settling the case. See Lit. Rel. No. 24235 (August 14, 2018).

Crypto-currency: In the Matter of Tomahawk Exploration LLC, Adm. Proc. File No. 3-18641 (August 14, 2018) is a proceeding which names as Respondents the firm and its managing member David Thompson Laurence. Over a three month period beginning in July 2017 the firm, an oil and gas exploration company, offered and sold digital assets in the form of tokens called Tomahawkcoins or TOM through an on-line ICO. Respondents sought to raise $5 million purportedly to fund oil drilling. The website and white paper touted the coins and the potential profits from the drilling. Purchasers also had the option to trade their tokens for profits or convert them into equity in the future. Respondents failed to raise money through the ICO but issued 80,000 coins as part of a “Bounty Program” in exchange for online promotional and marketing services. The coins were a security under the Howey test. Respondents also engaged in fraud through the use of inflated projections in the offering papers. The Order alleges violations of Securities Act section 5 and Exchange Act section 10(b). To resolve the case each Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, Mr. Laurence is barred from acting as an officer or director and participating in any penny stock offering. He will pay a penalty of $30,000 based on a sworn statement of financial condition.

Compliance procedures- trading away: In the Matter of Lockwood Advisors, Inc., Adm. Proc. File No 3-18638 (August 14, 2018) names as a Respondent the privately held investment adviser. Since 2008 the firm has failed to properly implement its compliance policies and procedures with respect to its wrap fee program in two respects. First the procedures did not require the adviser to assess if the third-party portfolio manager had a history of trading away and, if so, what it is so the client could be advised. Second, while the adviser collected data about trading-away the procedures did not require that an analysis of the portfolio manager’s practices in this regard be furnished to the client and the responsibility for determining if the client was suitable for the practice was delegated to the portfolio managers. The Order alleges violations of Advisers Act section 206(4). In resolving the case Respondent agreed to implement a series of undertakings tied to assessing the trading away practices of the managers. Respondent also consented to the entry of a cease and desist order based on the section cited in the Order and will pay a penalty of $200,000.

Muni bonds: SEC v. Core Performance Management, LLC, Civil Action 18-cv-8181 (S.D. Fla. Filed August 14, 2018) named as defendants the firm, an entity controlled by defendant James Scherr who directed the scheme, and four other securities industry veterans he hired: Deborah Dora, Sharlene Mestite, James O’Neil and Anadel Pinzon. Each has previously held various securities licenses and has years of experience industry experience. The scheme was designed to deceive those selling the municipal bonds and defeat the checks built into the system to ensure that the securities were allocated to retail investors. For example, each of the securities veterans opened accounts under DBA names which were connected to CPM. Each immediately sold or “flipped” the securities acquired at $1 above the offer price to others who could not obtain an allocation. To ensure that each of the Defendants obtained the securities not only were multiple accounts and DBAs used, but also false zip codes while steps were taken in flipping the bonds to avoid detection. During the allocation process checking the zip code was a key step since it ensured that local purchasers were obtaining the bonds. The false zip codes thwarted this check. To avoid checks which monitored transactions in the bonds, allocations being flipped were often broken up and/or re-priced so it would not appear that the initial purchaser was in fact flipping the bonds, something that would not have been typical of a retail investor. Using these and similar techniques permitted the defendants to participate in thousands of transactions. Defendant also enlisted the services of a registered representative at one firm who assisted and, at another paid kickbacks for assistance. The complaint alleges violations of Exchange Act sections 10(b), 15(a) and 20(a), Securities Act sections 17(a)(1) and (3) and MSRB Rule G-17. To resolve the action each defendant consented to the entry of a permanent injunction, agreed to pay disgorgement with interest, a civil penalty and to be barred or suspended from the industry and to cooperate with the Commission. The settlements are subject to court approval. See also SEC v. RMR Asset Management Company (D. Cal. Filed August 14, 2018)(action against RMR Asset Management, a firm controlled by Defendant Ralph Riccardi, and 12 other individuals who had worked in the securities industry for years; the complaint is substantially similar to the one discussed above; the case is pending); In the Matter of NW Capital Markets Inc., Adm. Proc. File No 3-18640 (August 14, 2018)(proceeding naming as Respondents the registered broker dealer and its managing director and CCO; based on participating in the “flipping” of municipal securities; resolved by the firm with a consent to a cease and desist order based on Exchange Act sections 15(a)(1) and 15B(c)(1), a censure and the payment of a penalty of $40,000; by Mr. Fagan with the entry of a cease and desist order based on MSRB Rule G-27 a suspension from acting as a supervisor in the brokerage business and the payment of a $10,000 penalty); In the Matter of Kerry Morris, Adm. Proc. File No. 3-18639 (August 14, 2018)(proceeding against the registered representative for participating in the kickbacks detailed above; settled with the entry of a cease and desist order based on Securities Act section 17(a), Exchange Act sections 10(b) and 15(a)(1) and MSRB Rule G-17, a bar from the industry and the payment of disgorgement in the amount of $156,347.48, prejudgment interest of $22,661.82 and a penalty of $75,000).

Offering fraud: SEC v. White, Civil Action No. 18-cv-61870 (S.D. Fla. Filed August 13, 2018). The action centers on offerings of securities made by Aegis Oil, LLC and 7S Oil & Gas, LLC, conducted over multiple years. During that period investors were solicited and purchased shares in each firm. Specifically, beginning in October 2010, and continuing over about a five year period about 250 investors purchased Aegis securities, investing approximately $35 million through a continuous series of 15 different offerings. Similarly, between November 2014 and July 2016 7S, previously the field operator for the Aegis projects, offered and sold its securities in oil well projects. About $7 million was raised from 70 investors. The Commission previously brought actions against each firm based on the fraudulent sale of securities. Defendants Alexander White and Paul Vandivier, neither of whom has ever been registered with the Commission or FINRA, helped manage the offerings. The securities sold by the two men and their teams were investment contracts. Generally, investors were told that the securities paid large returns and were safe investments. Defendant White was paid 35% for sales by his team of Aegis securities and 28% to 35% for the 7S offering. In 2012 and 2013 he was paid about $2.9 million for the Aegis offerings. In addition, Mr. White was paid about $3.94 million in commissions from Aegis through CC Excel Energy, LLC, a now defunct company that he controlled. For the 7S offerings Mr. White was paid about $32,600 from July through October 2015 and another $197,000 through Conservative Surveyors, LLC, another firm he controlled. Mr. White paid out portions of the commissions to his team. Mr. Vandivier also served as a team leader. In that role he carried out duties substantially similar to those of Mr. White. Mr. Vandivier was paid about $870,000 for his work and that of his team on the Aegis offerings and an additional $23,000 for the 7S offerings. The complaint alleges violations of Securities Act sections 5(a) and 5(c) and Exchange Act section 15(a)(1). The case is pending. See Lit. Rel. No. 24234 (August 13, 2018); see also SEC v Lewis, Civil Action No. 18-cv-61869 (S.D. Fla. Filed August 13, 2018)(action naming as a defendant Chad Lewis who also acted as an unregistered broker on the offerings described above; settled with a consent to the entry of a permanent injunction based on Securities Act sections 5(a) and (c) and Exchange Act section 15(a)(1); and the payment of disgorgement, prejudgment interest and a penalty in amounts to be determined by the court at a later date). See Lit. Rel. No. 24233 (August 13, 2018).

Unfair trading among clients: In the Matter of Hamlin Capital Management, LLC, Adm. Proc. File No. 3-18636 (August 10, 2018) is an action naming as a Respondent the registered investment adviser. From November 2011 through March 2016 Respondent offered certain clients fixed income investment advice through numerous separately managed accounts and two pooled investment vehicles. The adviser frequently arranged for cross trading in certain securities between client separately managed accounts and/or its pooled investment vehicles. For a number of trades, because of the way the cross-trades were priced, the adviser favored one side of the transaction. In another group of trades the adviser influenced the prices obtained in the secondary market without conducting appropriate due diligence, disadvantaging certain clients. The Order alleges violations of Advisers Act sections 206(2), 206(4) and 207. To resolve the proceedings Respondent Hamlin consented to the entry of a cease and desist order based on the sections cited in the Order and to a censure. The firm will also pay a penalty of $900,000.

Unregistered securities: SEC v. Duffield, Civil Action No. 18-cv-6984 (S.D.N.Y. Filed August 2, 2018). Defendant Roger Duffield is a British citizen residing in South Africa. He is also the President and CEO of Defendant Plandai Biotechnology, Inc., a London based firm whose shares are quoted on OTC Link. The firm states it is in the business of producing botanical extracts from live plant material which includes green tea leaves, tomatoes and marijuana. Much of the firm’s plant material grows on a 7,400 acre estate in South Africa. Beginning in late 2013, Defendants directly offered to sell Plandai shares to three investors. Eventually the transactions were consummated with Mr. Duffield directing that most of the purchase price be wired to another of his firms. Two of the three investors were not accredited or sophisticated. None of the shares were registered. Subsequently, Plandai filed its annual report on Form 10-K on June 30, 2014. A section of the report recounted the firm’s stock transactions. The sale to Investor A was omitted. A portion of the transactions with Investor B were incorrect. The money from the investor purchases listed above was not properly accounted for in the books and records of the firm. The complaint alleges violations of Securities Act sections 5(a) and 5(c) and Exchange Act sections 13(a) and 13(b)(2)(A) and (B). The case is pending. See Lit. Rel. No. 24232 (August 10, 2018).

Criminal cases

Insider trading: U.S. v. Siva, No. 1:17-cr-00503 (S.D.N.Y.) is an action in which Jeffrey Rogiers pleaded guilty to conspiracy to commit securities fraud and fraud in connection with a tender offer. The charges are based on his role in an insider trading scheme. That scheme, centered on Daniel Rivas, a former employee at an investment bank, who furnished inside information on a dozen different transactions to friends who later used it to trade. The scheme netted about $5 million in trading profits over a period that began in 2013 and continued through August 2017. Trades Mr. Rogiers, along with another, placed yielded over $200,000 in illicit profits. The date for sentencing has not been set. See also SEC v. Riva, Civil Action No. 1:17-cv-06192 (S.D.N.Y.).

Offering fraud: U.S. v. Cranney, No. 1:14-cr-10276 (D. Mass.) is an action in which Defendant John Cranney was convicted, following a two week jury trial, on three counts of wire fraud, 12 counts of mail fraud and three counts of money laundering. The charges were based on an 11 year scheme he conducted beginning in 2001. During that period he raised about $6 million from friends and business relations for investment in a series of companies he created and named to mimic investment funds and retirement accounts. Mr. Cranney promised to invest the funds. In fact he misappropriated them. He was sentenced to serve five years in prison, three years of supervised release and ordered to pay restitution of $5,587,432.

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