The Commission initiated enforcement actions centered on insider trading, a sham transaction and a lack of auditor independence this week. The insider trading case charged a former high-ranking Apple attorney tasked with administrating the firm’s insider trading policy while the sham transaction focused on claims by executives that their firm could turn garbage into useful product, a pitch crafted to solicit merger partners. A proceeding against an audit firm and its partners centered on a lack of independence.
The DOJ continued to bring FCPA cases this week. An executive at a Hawaii based firm pleaded guilty to corruption charges. One of the foreign officials bribed in the scheme was charged with money laundering.
Finally, the Securities and Futures Commission of Hong Kong prevailed in a suit brought against the agency by one of its registrants. The complaint claimed the SFC acted improperly by using its investigative powers to aid two Japanese regulators with an investigation.
Arbitration: Chairman Jay Clayton issued a statement regarding a no-action letter by the Division of Corporation Finance. The letter concerned a shareholder request to include mandatory arbitration provisions in a firm’s governance documents at the time of an IPO. The company rejected the proposal, arguing that such a provision was contrary to law. The New Jersey AG, where the firm was based, issued an opinion stating that such a provision would in fact violate state law. In its letter the staff stated that Rule 14a-8 permits the exclusion of a proposal that would cause the company to violate any state, federal or foreign law to which it is subject. Accordingly, the staff stated that it would not recommend an enforcement action if the proposal were excluded. The staff did not comment on the impact of the proposal under federal law. Chairman Clayton stated that the staff determination is appropriate but that in his view the question of arbitration is difficult and should be reserved for the Commission (Feb. 11, 2019)(here).
Remarks: Commissioner Hester M. Peirce delivered remarks titled Protecting the Public While Fostering Innovation and Entrepreneurship: First Principles for Optimal Regulation, at University of Missouri School of Law (Feb. 8, 2019). Her remarks noted the retention of the Commission’s first Advocate for Small Business Capital Formation and went on to discuss crypto currency and if the Howey test is overbroad (Feb. 8, 2019)(here).
SEC Enforcement – Filed and Settled Actions
The Commission filed 2 civil injunctive actions and 1 administrative proceeding this week, exclusive of 12j and tag-along actions.
Insider trading: SEC v. Levoff, Civil Action No. 2:19-cv-05536 (D.N.J. Filed Feb. 13, 2019). Gene Daniel Levoff was the Senior Director of Corporate Law at Apple, Inc., having worked at the firm for years. He reported directly to the General Counsel. Mr. Levoff also served on the firm’s Disclosure Committee and administered its insider trading policy which he helped revise. In three instances in 2015 and 2016 he traded in advance of earnings announcements reaping illegal profits and/or avoiding losses that totaled about $382,000. In 2011 and 2012 Mr. Levoff also engaged in insider trading of Apple shares. He made about $245,000 in profits. The complaint alleges violations of Exchange Act section 10(b) and Securities Act section 17(a)(1). The case is pending. See Lit. Rel. No. 24399 (Feb. 13, 2019). The U.S. Attorney’s Office for the District of New Jersey filed parallel criminal charges.
Independence: In the Matter of Deloitte Touche Tohmatsu LLC, Adm. Proc. File No. 3-18997 (Feb. 13, 2019) names as Respondents the PCAOB registered Japan affiliate of the audit firm, Futomichi Amano and Yuji Itagaki, respectively, the firm’s CEO and its acting Reputation and Risk Leader. Each man is a CPA. During fiscal years 2013 to 2016 for Company A, Messrs. Amano and Itagaki shared bank accounts with the audit client and had balances which exceeded the equivalent of the FDIC insurance for those accounts. This violates the independence rule. As a result, each individual caused the audit firm and client to violate the independence rules. The audit firm also did not have adequate compliance procedures regarding such matters. An inquiry found that 88 other Deloitte employees had similar violations. The Order alleges violations of Rule 2-02 of Regulation S-X and Exchange Act Section 13(a). To resolve the matter each Respondent consented to the entry of a cease and desist order based on the section and rule cited in the order. The audit firm also agreed to the entry of a censure. Messrs. Amano and Itagaki are denied the privilege of appearing and practicing before the Commission as accountants with the right to reapply after two years and one year, respectively. In addition, the firm will pay disgorgement of $971,722, prejudgment interest of $159,397.70 and a penalty in the amount of $880,000.
Sham transaction: SEC v. Kuhnash, Civil Action No. 19-v-00028 (S.D. Ind. Filed Feb. 12, 2019) is an action which names as defendants Kevin Kuhnash and Jason Jimerson, respectively the CEO and COO of Lucent Polymers, Inc., a plastics manufacturing firm. Defendants claimed that the company could take recycled and scrap material and turn it into high quality bulk plastics that met stringent standards regarding strength and which was fire retardant. The goal was to sell the firm for a profit. And, they did it twice, once to another plastics firm and a second time to a public company, reaping millions of dollars for themselves. Yet the two executives knew the “garbage to gold story was false – the firm was a sham. The complaint alleges violations of Securities Act section 17(a) and Exchange Act section 10(b). A parallel criminal action was filed by the U.S. Attorney’s Office for the Southern District of Indiana. See Lit. Rel. No. 24397 (Feb. 12, 2019).
Financial fraud: SEC v. Kipp, Civil Action No. 160-cv-000258 (W.D.N.C.) is a previously filed action against Michael J. Kipp and Joanne K. Viard, respectively the CFO and Director of External Reporting of Swisher Hygiene, Inc. The complaint alleged a fraudulent earnings management scheme at the company which had weak internal controls. The Court entered final judgments against each Defendant, prohibiting future violations of Securities Act section 17(a) and Exchange Act sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). The injunction against Mr. Kipp is also based on Exchange Act rules 13b-2-1 and 13a -14. The judgments permanently bar each executive from serving as an officer or director of a public company. This concludes the action. See Lit. Rel. No. 24396 (Feb. 12, 2019).
Offering fraud: SEC v. NL Technology, LLC, Civil Action No. 3:180-cv-002263 (S.D. Cal.) is a previously filed action that alleged a $61 million offering fraud conducted by Defendants Donato Baca, Jr., his business partner, Jonny Ngo and NL Technology, LLC. Mr. Baca settled with the Commission, consenting to the entry of a permanent injunction which prohibits future violations of Securities Act sections 5(a) and 5(c) and 17(a) and Exchange Act section 10(b). The injunction also prohibits him from soliciting, accepting, or depositing any money from actual or prospective investors in connection with any offering of securities. Mr. Baca agreed to pay disgorgement of $4.7 million plus $256,647 in prejudgment interest and a civil penalty of $960,000. See Lit. Rel. No. 24394 (Feb. 11, 2019).
Microcap fraud/manipulation: SEC v. Honig, Civil Action 18-cv-08175 (S.D.N.Y. Filed Sept. 7, 2018) is a previously filed action against, among others, Mark Groussman, his firm Melechdavid, and Alpha Capital Anstalt, a Lichtenstein hedge fund managed by an unnamed New York based unregistered investment adviser. Mr. Groussman settled with the agency, consenting to the entry of permanent injunctions based on Securities Act sections 5 and 17(a) and Exchange Act section 10(b). In addition, he agreed to pay disgorgement of $1,051,360, prejudgment interest of $170,554.78 and a penalty of $160,000. His firm also consented to the entry of a permanent injunction based on the same sections. A five-year penny stock bar was imposed on the firm. Alpha Capital settled, agreeing to the entry of a permanent injunction based on section 5 of the Securities Act. The firm agreed to pay disgorgement of $708,470.07 along with prejudgment interest in the amount of $149,788.44. The underlying action also names as defendants Barry Hong, Philip Frost, John Stetson, Michael Brauser, John O’Rourke, Robert Ladd, Elliot Maza, Brian Keller, John Ford and a series of controlled entities. It centers on the manipulation of four microcap firms’ shares during the period 2013 to 2018 yielding millions of dollars in profits. The case is based on a pump-and-dump schemes directed by Mr. Hong, according to the complaint, that netted Defendants millions of dollars in illicit profits. For example, one scheme involving one issuer resulted in over $9.25 million while another yielded over $8.3 million. The complaint alleges violations of Securities Act sections 5(a), 5(c), each subsection of 17(a) and 17(b) and Exchange Act sections 9(a)(1) and (2), 10(b), 13(d) and 15(d). The Commission is preparing an amended complaint that will be filed in early March 2019. During the government shutdown other defendants settled with the Commission.
Offering fraud: U.S. v. Elliott, Case No. 1:19-cr-43 (E.D. Va. Plea Feb. 13, 2019) is an action in which Todd Elliott pleaded guilty to one count of securities fraud. The charge is based on the fact that from 2014 through 2018 Mr. Elliott raised about $30 million from investors through a variety of real estate ventures. In one, for example, about $17 million was raised to purchase a five story office building adjacent to a planned future stop on the Silver Line Metro train. Investors were not told that the money was comingled with that from other projects and that portions were diverted to Mr. Elliott’s personal use. Mr. Elliott is awaiting sentencing.
Offering fraud: U.S. v. Borland, No. 1:18-cv-00487 (S.D.N.Y. Plea Feb 13, 2019) is an action in which Brent Borland, owner of investment fund Belize Infrastructure Fund I LLC, pleaded guilty to conspiracy and securities and wire fraud charges. Over a period of four years, beginning in 2014, Mr. Borland raised about $22 million from dozens of investors who were promised high rates of return from investments in short term loans. The investments were supposed to be collateralized with real estate. In fact, the returns were not paid, the investments were not collateralized as promised and portions of the funds were misappropriated. Sentencing is scheduled for June 21, 2019.
U.S. v. Lyon, No. 1:19-cr-00008 (D. Hawaii Plea Jan. 22, 2019); U.S. v. Halbert, No. 1:19-mj-00089 (D. Hawaii Unsealed Feb. 11, 2019). Frank J. Lyon is an executive at an Engineering Firm based in Hawaii. Master Halbert, a citizen of Micronesia, is an Official in the Federated State of Micronesia or FSM Department of Transportation, Communications and Infrastructure.
Beginning as early as 2006, and continuing through 2016, Mr. Lyon and others entered into a conspiracy to obtain and retain business from FSM and a State Agency. During the period Mr. Lyon transferred funds from the Engineering Firm’s bank accounts to his personal account. Later funds were withdrawn from his account and used to pay bribes at various times. By 2012 Mr. Lyon was able through the payment of bribes to secure a $2.5 million contract for the Engineering Firm. As the scheme continued other payments were made. One involved the purchase of an automobile for Mr. Halbert. The payments were concealed with false records.
Mr. Lyon pleaded guilty to one count of conspiracy to violate the FCPA and pay bribes to an agent of an organization receiving federal funds and a state agency. Sentencing is scheduled for May 13, 2019.
Master Halbert was arrested and made his first appearance in the District Court in Hawaii on February 11, 2019. He is charged with participating in a money laundering scheme involving bribes paid by Mr. Lyon to secure project management contracts for the Engineering firm. The case is pending.
SLUSA: Nielen-Thomas v. Concorde Investment Services, LLC, No. 18-2875 (7th Cir. Jan 24, 2019). The Circuit Court held that the plain language of the Securities Litigation Uniform Standards Act or SLUSA precluded a complaint filed in state court alleging false and misleading conduct by an unregistered investment adviser in violation of state securities laws. The question revolved around the definition of “covered class action.” Essentially the statute has three different sections which address the question, assuming that the basic allegations center on false and/or misleading conduct. One applies to securities class actions brought on behalf of 50 or more persons. A second applies to claims brought in a representative capacity while a third focuses on groups of suits. In this case the state law complaint was brought in a representative capacity for a group that did not exceed 45 persons. The second prong of the statute, which applies to representative actions of any size, clearly bars the action here. Accordingly, the dismissal by the district court was affirmed. This is the first Circuit Court decision to squarely address this question.
Suit against agency: The Securities and Futures Commission prevailed in a suit brought against the agency by an SFC registrant. The investigation was conducted by the SFC in conjunction with the Japanese Financial Services Agency and Securities and Exchange Surveillance Commission. During the course of the investigation the SFC used its statutory authority to compel the applicant to provide information and materials which were turned over to the two Japanese regulators. The suit alleged that the SFC acted illegally in compelling the production of the materials and turning them over to foreign regulators and that the Japanese regulators improperly used them in a criminal proceeding. The Court of First Instance dismissed the action. The Court concluded that the proceedings initiated were civil in nature, that the SFC properly obtained the materials and furnished them to the foreign regulators and that their use did not violate the right against self-incrimination. The application was ordered to pay the costs of the SFC.