The Commission had one win and two losses in court over the last week, one of which may have a long term impact on its cases. In a case centered on two alleged microcap manipulations the court dismissed the complaint finding that the SEC’s request for injunctive relief and a penny stock bar were punitive and, since the case was filed after the expiration of the five year statute of limitations, the complaint was dismissed. In a second case, a jury rejected claims that the defendant illegally tipped one long time friend in two instances and another once. The Commission did obtain a favorable verdict in another action focused on the distribution of false press releases regarding a penny stock.
The Commission filed a series of new actions this week. Those included two insider trading cases and another based on the payment of perks to the CEO and CFO of the company. The agency also brought a proceeding alleging the illegal sale of a cryptocurrency. That case will be set for hearing.
Appointments: The Commission appointed a new chairman and four new board members to the PCAOB. William D. Duhnke III was appointed as chairman while J. Robert Brown, Kathleen M. Hamm, James G. Kaiser and Duane M. DesParte were appointed to the board.
Remarks: Commissioner Kara M. Stein addressed the Investment Company Institute’s 2017 Securities Law Developments Conference, Washington, D.C. (Dec. 7, 2017). Her remarks focused on ETFs, the approach to disclosure and the question of investor trust (here).
SEC Enforcement –Litigated Actions
Remedies: SEC v. Gentile, Civil Action No. 16-1619 (D. N.J. Opinion Dec. 13, 2017) is an action against Guy Gentile. The complaint alleged the manipulation of the shares of Raven Gold Corporation and Kentucky USA Energy, Inc., both penny stock issuers. The Raven Gold manipulation began and ended in 2007 while the one alleged regarding Kentucky USA began and ended in 2008. The complaint alleged violations of Securities Act Sections 5(a), 5(c), 17(a) and 17(b) and Exchange Act Section 10(b). The Commission sought an injunction and a penny stock bar.
Defendant moved to dismiss, claiming that the complaint failed to state a claim upon which relief could be granted. Specifically, Defendant claimed that the relief sought was punitive and thus time barred by the five year statute of limitations in Section 2462 of Title 28 since the action should have been filed no later than June 2013 but was not brought until March of 2016.
The SEC argued that the relief sought was equitable, precluding the application of the limitation period. Both the injunction and the penny stock bar are remedial in nature and not punitive, according to the Commission. This is particularly true here, according to the agency, since Mr. Gentile has not acknowledged his wrong doing, illustrated by the fact that he gave interviews denying any wrongful conduct. Therefore the claims were not time barred.
The Court granted Defendant’s Motion to Dismiss. In Kokesh v. SEC, 137 S.Ct. 1635 (2017) the Supreme Court held that laws which impose punishment for an offense committed against the state are penal in nature within the meaning of Section 2462. While the Court used that definition in a factual context different from this case, other courts have concluded that a penalty is sanction imposed for violating the law which goes beyond compensation for the injury. See, e.g., U.S. v. Telluride, 146 F. 3d 1241, 1245 -46 (10th Cir. 1998). Thus, courts have consistently held that a remedy – even an injunction – is penal in nature when it serves no “retributive or remedial purpose and merely seeks to punish an individual.”
Here the SEC sought an obey the law injunction and a penny stock bar based on the theory that the Defendant may engage in conduct in the future which is similar to that involved here. First, the obey the law injunction would do no more than require the Defendant to do what every citizen is obligated to do – obey the law. It would, however, “also stigmatize Defendant in the eyes of the public,” the Court concluded.
The same analysis applies to the penny stock bar. Such an order would only serve to punish Defendant. The order “would not restore any ‘status quo ante’ nor would it serve any retributive purposes. Rather, it would merely restrict Defendant’s business structure and methodology, in perpetuity, simply because he was alleged to have violated securities laws when he was involved . . .” with the two companies here. Because the relief sought here is penal in nature the Court concluded that Section 2462 applies. The action was dismissed.
False press releases: SEC v. Revolutions Medical Corp., Civil Action No. 1:12-cv-03298 (N.D. Ga. Filed Sept. 20, 2012) is an action against the company and its CEO, Ronald Wheet. Beginning in August 2010, and over the next year, the defendants issued a series of press releases to hype the shares of the penny stock company, claiming it had developed a safe and effective syringe that was about to go into mass production. The claims were false, according to the complaint, which alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The jury returned a verdict in favor of the Commission holding the company and its CEO liable based on the Sections cited in the complaint.
Insider trading: SEC v. Parker, Civil Action No. 1:12-cv-02839 (D. Col. ). Named as a defendant was the CEO of Delta Petroleum, Roger Parker. The complaint centered on allegations of illegal tipping in two instances. The first concerned the acquisition of a significant block of Delta Petroleum stock by investment firm Tracinda Corporation. The second concerned the quarterly financial results for Delta for the firm’s third quarter of 2007.
First, the Commission alleged that Mr. Parker tipped two friends about the Tracinda transaction. One was Denver insurance executive Michael Van Gelder, a years long friend. In the period leading up to the deal announcement the two men communicated several times. Mr. Van Gilder purchased shares of Delta for his account as well as options. He also urged his relatives, his broker and a co-worker to purchase shares of Delta. Following the deal announcement the share price increased by about 20% giving Mr. Van Gelder, one of his relatives, his broker and his co-worker had trading profits of over $161,000.
Mr. Parker was also charged with having tipped Scott Reiman, the founder and president of Denver-based investment firm Hexagon Inc., about the Tracinda transaction. Mr. Parker provided information about the Tracinda investment to Mr. Reiman on at least three occasions, according to the charging papers. Mr. Reiman purchased shares of Delta Petroleum shortly after speaking with his friend. In one instance the purchase was made just minutes after the telephone call.
Second, the Commission claimed that Mr. Parker tipped Mr. Van Gelder about Delta’s third quarter 2007 financial results. Shortly before the earnings announcement Mr. Van Gelder received an email from a friend expressing a negative view of Delta’s future. After checking with his broker and indicating that he planned to sell his Delta shares, Mr. Van Gelder contacted Mr. Parker three times in the same evening. Subsequently, Mr. Van Gilder purchased shares of Delta in advance of the earnings announcement. He also emailed a friend indicating that “Delta will hit their numbers at this Thursday’s announcement.” When the earnings announcement was made the results were favorable. The trading resulted in $4,000 in ill-gotten gains.
Following a seven day trial the jury returned a verdict finding for Mr. Parker on each claim.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 6 civil injunctive cases and 7 administrative proceeding, excluding 12j and tag-along proceedings.
Offering fraud: SEC v. Davis, Civil Action No. 17-cv-03774 (S.D. Tex. Filed Dec. 14, 2017) is an action which names as defendants Behavioral Recognition Systems, Inc., a firm which sold video analytic software, and Ray Davis, its founder and CEO. Beginning in January 2013, and continuing to July 2015, Defendants raised over $28 million from investors in seven equity offerings. Investors were told that the funds would be used for growth, mezzanine funding, working capital and general corporate purposes. In fact about $7.8 million was siphoned off by Mr. Davis and used for his personal purposes. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The complaint is pending. See Lit. Rel. No. 24013 (Dec. 14, 2017).
Insider trading: SEC v. Peer, Civil Action No. 2:17-cv-01865 (W.D. Wash. Filed Dec. 14, 2017) is an action which names as a defendant, therapist Kenneth Peer. It centers on the tender offer for Zulily, Inc. by Liberty Interactive, announced on August 17, 2015. Prior to the announcement Mr. Peer had counseling sessions with a Zulily employee who discussed the coming transaction. In three instances after counseling sessions Mr. Peer purchased shares. When the transaction was announced the stock price increased by 49%. Mr. Peer had illegal profits of about $10,000. The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). To resolve the action Mr. Peer consented to the entry of a permanent injunction based on the Sections cited in the complaint. He also agreed to pay disgorgement of $10,227.73, prejudgment interest and a penalty equal to the amount of the disgorgement. See Lit. Rel. No. 24012 (Dec. 14, 2017).
Perks: In the Matter of Provectus Biopharmaceuticals, Inc., Adm. Proc. File No. 3-18306 (Dec. 12, 2017). Respondent Provectus is a development stage biotechnology firm. H. Craig Dees is a co-founder of the firm and previously served as CEO. Peter Culpepper previously served as the firm’s CFO. Over a five year period beginning in 2011 the company paid Mr. Dees about $3.2 million for what purported to be business travel and expenses. The majority of the funds were used for unauthorized personal travel and expenses. Much of the money was obtained in the form of cash advances. Provectus allowed Mr. Dees to obtain the travel advances based on requests in vague emails which lacked details justifying the amounts. He also filed inadequate returns. Over a two year period beginning in 2013 Provectus paid Mr. Culpepper $199,194 in personal benefits and perquisites through travel advances and reimbursements. The personal benefits were not authorized. For example, from 2013 to 2015 the company paid Mr. Culpepper foreign currency cash advances. About $103,649 of those cash advances were for his personal benefit. The firm’s inadequate internal controls facilitated these practices. For example, the internal accounting controls did not require that cash advances be substantiated. For returns, the controls did not define “support” or require the submission of third party support. Other controls were not followed. From 2012 to 2015 the company did not disclose as compensation the personal benefits and perquisites Mr. Dees received from 2011 through 2014. Those benefits were material components of his compensation, exceeding his annual salary by substantial amounts. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a). In resolving the matter the company agreed to certain undertakings, including the retention of a consultant. The Commission also considered the firm’s cooperation which included making available the results of its internal investigation that facilitated the work of the staff. To resolve the proceedings the company consented to the entry of a cease and desist order based on the Sections cited in the Order. See also SEC v. Dees, Civil Action No. 3:17-cv-00532 (E.D. Tenn. Filed Dec. 12, 2017)(charging Mr. Dees with violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(5); the case is in litigation); In the Matter of Peter R. Culpepper, CPA, Adm. Proc. File No. 3-18308 (Dec. 12, 2017)(action against the former CFO in which he consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 14(a), and agreed to the entry of an order denying him the privilege of appearing or practicing before the Commission as an accountant with the right to apply for reinstatement after three years; he also agreed to comply with an undertaking to pay the firm disgorgement and interest of $152,378 and was ordered to pay disgorgement of $140,115 and prejudgment interest which is deemed satisfied by the payment of the undertaking to the company).
Unregistered securities – cryptocurrency: In the Matter of Munchee Inc., Adm. Proc. File No. 3-18304 (Dec. 11, 2017). Munchee is a privately held firm based in San Francisco. In late 2015 it began developing an iPhone app that was launched two years later. The app allowed users to post photographs and reviews of restaurant meals on-line. The firm created a plan to improve the app. Part of the plan called for raising capital through the sale of tokens or MUN on the Ethereum blockchain. Munchee created 500 million MUN tokens. The plan was to raise about $15 million in Ether by selling 225 million MUN tokens out of the 500 million MUN tokens created by the company. Munchee marketed the coins through a website, a white paper and other means, promising that as others became involved and the tokens circulated the value would increase. A key part of the plan was the trading of MUN on an exchange. Munche represented that MUN tokens would be available for trading on at least one U.S. based exchange within thirty days of the close of the initial coin offering. Munchee offered the coins to the public beginning on October 17, 2017. Potential investors were told that they could profit on the investment based on the potential development of the ecosystem, the efforts of the firm and the future exchange listing of the coins. As the ecosystem expanded the value of the coins would increase, according to the firm. The firm stopped selling the coins on November 1, 2017 after being contacted by the staff. Under Section 2(a)(1) of the Securities Act the MUN tokens are securities, according to the Order because they are investment contracts. Accordingly, in offering the tokens for sale in the absence of an effective registration statement, or an exemption from registration, Munchee violated Section 5(a) of the Securities Act. The case will be set for hearing.
Insider trading: SEC v. Spera, Civil Action No. 3:17-cv-12875 (D.N.J. Filed Dec. 11, 2017) names as defendants Joseph Spera who is associated with a day trading firm, and his entity Joleine, Inc. The defendants are alleged to be part of a much larger group of traders involved in a scheme in which there was trading on inside information in multiple instances. Specifically, they are part of a ring lead by Steven Fishoff, Paul Petrello, Ronald Cohernin and Steven Constantin, named in another enforcement action along with entities controlled by the individual defendants. Mr. Fishoff, and the other individual defendants over a period of about three years beginning in June 2010, repeatedly posed as portfolio managers and induced investment bankers to bring them “over the wall” and share confidential information regarding pending secondary offerings. In each instance there were assurances that the information would remain confidential. In breach of their duty, the defendants traded on the information, shorting the shares. The scheme also included trading in advance of certain positive corporate news announcements regarding confidential negotiations between two large pharmaceutical companies. Overall the defendants had in excess of $5 million in profits. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Rule 105. The case is pending.
Concealed markups: SEC v. Westport Capital Markets, LLC, Civil Action No. 3:17-cv-0264 (D. Conn. Filed Dec. 11, 2017) is an action which names as defendants the firm, a registered broker-dealer and investment adviser, and its CEO, CFO and COO, Christopher McClure. Over a period of about three years beginning in early 2012 Defendants secured standing authority to invest for their clients. Those clients were repeatedly put into shares that Defendants had purchased from underwriters at a discount for the firm’s account and later significantly market up and sold to firm clients. These transactions were contrary to the clients’ interests and resulted in large losses. Defendants also accepted the payment of 12b-1 fees without making the required disclosures. The complaint alleges violations of Advisers Act Sections 206(1), 206(2), 204(4) and 207. The case is in litigation. See Lit. Rel. No. 24007 (Dec. 11, 2017).
Failure to supervise: In the Matter of Coastal Equities, Inc., Adm. Proc. File No. 3-18305 (Dec. 11, 2017) is a proceeding which names as Respondents the registered broker-dealer and Coastal Investment Advisors, Inc., a registered investment adviser. From 2009 through 2014 Michael Donnelly, the former President, CEO and CCO of Costal Equities and Costal IA, misappropriate over $1.5 million of client funds. He did this by convincing clients to invest in a firm he controlled and when they did, stealing their investment. Critical to the scheme was the issuance of consolidated financial reports by Respondents which purported to show the investments. Mr. Donnelly used a tool he obtained from Respondents to enter the system and generate the false statements. As a result Respondents failed to reasonably supervise Mr. Donnelly and Coastal IA violated Section 206(4) of the Advisers Act. To resolve the proceedings Respondents were censured and Coastal IA will pay a penalty of $40,000. In determining to accept the settlement the Commission considered the fact that Respondents self-reported and cooperated with the staff’s investigation.
False advertising: In the Matter of Horter Investment Management, LLC, Adm. Proc. File No. 3-18302 (Dec. 8, 2017) is a proceeding against the registered investment adviser. From January 2012 to October 2013 the firm marketed the AlphaSector strategy by F-Squared Investments Inc. In conducting the marketing the firm used the representations of F-Squared which claimed that it had a history of very favorable results based on actual transactions. In fact that claim was not true – the strategy had been backtested rather that with actual trading. Accordingly, the representations made by the firm were incorrect. Respondent also failed to keep the required records and to implement the appropriate procedures. The Order alleges violations of Advisers Act Sections 204(a), 206(2) and 206(4). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. In addition, the firm agreed to pay disgorgement of $482,595, prejudgment interest and a penalty of $250,000. The firm will retain a consultant. See also In the Matter of Ameriprise Financial Services Inc., Adm. Proc. File No. 3-1830 (Dec. 8, 2017)(proceeding based on essentially the same facts; resolved with a cease and desist order based on Advisers Act Sections 204(a) and 206(2) and a censure; the firm will pay disgorgement of $6.3 million, prejudgment interest and a penalty of $1.75 million and retain a consultant).
Unregistered broker: SEC v. Steve Qi, Civil Action No. 2:17-cv-08856 (C.D.Cal. Filed Dec. 8, 2017) is an action against attorney Steve Qi and his law firm. Over a three year period Mr. Qi and his firm are charged with having defrauded their immigration clients in connection with the EB-5 immigration program. Specifically, during that period they charged those clients legal fees for the immigration work and also fees in connection with their investment in EB-5 securities, a program through which foreign nationals can, under certain circumstances, obtain a green card in return for an investment in the U.S. When the regional centers connected to the EB-5 program told the Defendants that they could not charge broker fees on the transactions without registering with the SEC, Mr. Qi arranged for his overseas relatives to collect the fees. Overall Defendants obtained over $1.6 million in transaction based compensation in connection with the program (and about $1.4 million after being warned about the registration requirement). The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending. See Lit. Rel. No. 240006 (Dec. 8, 2017).
Improper transactions: SEC v. Mohlman, Civil Action No. 17-cv-502 (N.D. Ind. Filed Dec. 8, 2017) is an action which names Mr. Mohlmann and two advisers he controlled, Mohlman Asset Management, LLC or MAM and Mohlman Asset Management Fund, LLC or MAMF which managed two private funds. Between 2012 and 2015 Mr. Mohlmann made payments to satisfy the obligations of third parties and in 2013 used one of the private fund’s assets to make a $150,000 unsecured loan that constituted about 16% of the fund’s portfolio. Although the staff told him the loan should be disclosed, Mr. Mohlmann failed to properly disclose it and made false statements regarding it. He also recommended to clients a strategy claiming that it had been approved by accountants and lawyers despite the fact that one accounting firm specifically requested not to be associated with the product. MAMF also failed to comply with the custody rule. The complaint alleges violations of Advisers Act Sections 206(1), 206(2) and 206(4) by all three defendants and Mr. Mohlmann and MAM with violating Advisers Act Section 207. To resolve the action each Defendant consented to the entry of a permanent injunction and to pay, on a joint and several basis, a $100,000 civil penalty. MAMF also agreed to pay disgorgement of $862.03 along with prejudgment interest. See Lit. Rel. No. 24011 (Dec. 14, 2011).
Municipal bonds: U.S. v. St. Lawrence, Case No. 7:16-cr-00259 (S.D.N.Y.) is an action against the former Rampo Town Supervisor Christopher St. Lawrence and others. They were alleged to have made material misrepresentations regarding the finances of a municipal bond offering for the construction of a minor league baseball stadium for the town of Ramapo. Mr. St. Lawrence was found guilty on 20 counts of fraud and conspiracy following a four week trial. This week he was sentenced to serve 30 months in prison followed by three years of supervised release. Restitution will be determined at a later date. This is the first conviction of securities fraud in connection with municipal bonds.
FinTech: The Australian Securities and Investment Commission announced a Cooperation Agreement with Canadian regulators on fintech cooperation. The agreement broadens an existing framework for information sharing. It also allows the referral of innovative fintech businesses to and from Canada (here).
Internal controls: The Securities and Futures Commission reprimanded and fined FXCM Asia Limited HK$2 million for regulatory breaches and internal control failings. Specifically, the firm failed to properly segregate its client funds. In assessing the sanctions the SFC considered the remedial actions taken by the firm and the fact that it has new ownership and management.
Cooperation: The SFC updated guidance on cooperation which can result in an early resolution of the investigation and reduced sanctions. The guidance outlines factors considered in making the assessment (here).