SEC Enforcement – A Focus on Retail Investors

The current retail focus of Commission enforcement is well illustrated by two recent cases. One involved a microcap market manipulation. The other centered on a scheme by market professionals who took advantage of clients they acquired by directing their investments into what was essentially a Ponzi scheme while misappropriating portions of their funds.

Market manipulation: SEC v. Fiore, Civil Action No. 7:18-cv-05474 (S.D.N.Y. Filed June 18, 2018) centers on the manipulation of a penny stock which netted the promoter over $11 million. Defendant Joseph Fiore controls Berkshire Capital Management Company, Inc., a private equity firm, and Eat At Joe’s, Ltd., a/k/a SPYR, Inc., an issuer that files periodic reports with the Commission. Both firms are Defendants. The scheme traces to a meeting in early 2011 involving Mr. Fiore and the CEO of publically traded Plandai Biotechnology, Inc., a firm based in London, England, supposedly in the business of producing botanical extracts from live plants, including marijuana. The meeting focused on promoting the shares of Plandai.

The next year Mr. Fiore acquired beneficially 5.5 million shares of Plandai, supposedly as part of a merger transaction involving and another firm. By March 2013 an agreement had been struck pursuant to which Mr. Fiore would organize the promotion of Plandai. Mr. Fiore launched the campaign, which he funded and implemented, the next month. Over the next year a series of steps were taken to manipulate the share price of Plandai, including: 1) retaining two firms to promote the stock, urging investors to buy shares in alerts, research reports and emails; 2) purchasing stock to support the price; 3) engaging in wash and matched trades to create the appearance of market activity; 4) marking the close to push up the price at the end of the trading day; and 5) painting the tape by initiating multiple orders at about the same time to push the price. During the manipulation Mr. Fiore sold about 11.9 million shares of Plandai stock for proceeds of over $11 million. The complaint alleges violations of Securities Act section 17(a), Exchange Act sections 9(a)(1), 9(a)(2), 10(b), 13(d) and 20(a) and Investment Company Act Section 7(a). The case is pending. See Lit. Rel. No. 24171 (June 20, 2018).

Investment fraud: SEC v. Santillo, Civil Action No. 18-cv-5491 (S.D.N.Y. Filed June 19, 2018) is an action which names as defendants five individuals who are or were members of FINRA, although two have been either suspended or barred from association: Perry Santillo; Christopher Parris; Paul Larocco; John Picarreto; and Thomas Brenner. Also named as defendants are three entities: First National Solution, LLC; Percipience Global Corporation; and United RL Capital Services.

Defendants Santillo and Parris purchase books of business from investment professionals. Once the acquisition is completed the two men, with the assistance of the other defendants, induce the clients to withdraw from their existing investments and put their investment dollars into one of the entity defendants. Thus, for example, investors who were clients of an acquired business would be induced to invest in First Nationale, a firm that purports to conduct business in areas that include leveraged investments, the financial services industry and others. In other instances investors would be induced to withdraw from existing investments and place their money in Percipience, supposedly a firm that provides loans to buy and improve homes. In other instances investors would be solicited to invest in United RL, a firm supposedly in the business of financing physician-owned toxicology laboratories. In each instance investors were solicited using misrepresentations regarding the nature of the business, the use of their funds and other matters. Investors were furnished with false statements about their investments. They were not told that in fact the three firms had virtually no business, that large portions of the solicited funds were being recycled to pay other investors and that the individual defendants were misappropriating large portions of the money.

Of the $102 million raised by defendants at least $38.5 million was paid out to earlier investors, $20 million was transferred to personal bank accounts of individual defendants and a large portion of the remaining funds were transferred elsewhere in transactions that are not recorded on the books. The complaint alleges violations of Securities Act section 17(a), Exchange Act section 10(b) and Advisers Act sections 206(1) and 206(2). The case is pending. See Lit. Rel. No. 24172 (June 20, 2018).

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MLPF&S Admits Violating Securities Laws In Millions of Trades

Since the Commission revamped its enforcement approach there has been no real discussion about requiring admissions to settle an action. To date there has been one settled enforcement action under Chairman Clayton involving admissions. That action involved a recidivist brokerage firm. Now there are two. Again a brokerage firm is involved. In this instance the focus is a years long, intentional scheme to deceive investors. In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Adm. Proc. File No. 3-18549 (June 19, 2018).

Over a five year period which ended in 2013 Merrill Lynch engaged in a practice known interally at the firm as “masking.” The practice involved deceiving customers – primarily financial institutions such as asset managers, mutual fund investment advisers and pension funds – about the manner in which their trades were executed. Specifically, the brokerage firm often routed customer orders to other broker-dealers, proprietary traders and market makers for execution. The practice was called Electronic Liquidity Partners or ELP. Not only did Merrill Lynch fail to tell customers about the practice, the firm deceived the traders about the manner in which their transactions were executed to the point of altering customer documents. The practice was used even where the broker received express instructions not to execute the transactions using an ELP.

Masking at Merrill Lynch traces to 2008. One of the key functions of a broker-dealer is the routing of customer orders for execution to one of a number of possible trading venues. Following execution the customer is given information about the transaction which may identify where it took place.

In 2007 Merrill Lynch began developing a program to route certain customer orders on an immediate or cancel basis to one or more of its ELPs or “trading partners” after first attempting execution in its dark pool or at other ATSs. One of the goals was to increase trading with the firm’s partners. At the same time the practice gave the ELPs access to customer orders. It also permitted Merrill Lynch to avoid paying the access fees typically charged by exchanges while receiving commissions from the customer. At the same time, it created the misleading impression that Merrill Lynch was a more active trading center.

To “mask” the venue where the transaction took place Merrill Lynch reconfigured certain codes that showed where the execution occurred. The firm also reprogramed its systems to conceal where the execution took place on customer documents. The billing invoices received by the clients were altered to conceal the execution venue.

The masking practice was extended to the trading centers. While clients were provided on request with what the firm called “liquidity maps” supposedly showing where the executions took place with the proviso that the firm thought the information was important for customers, in fact traders were furnished with incorrect facts. This was true even when traders specifically asked Merrill Lynch about the identity of the trade venue.

Masking took place even when the broker was given specific instructions on the manner in which the trade should be executed. Indeed, in some instances traders told the firm not to route orders to ELPs. The instructions were ignored.

Despite the fact that the information about the venue and execution was important to the traders, the firm deceived them and continued the practice. During the five year period of the scheme over 5.4 billion shares were traded in this manner with a notional value of $141 billion.

While customers were deceived, Merrill Lynch knew internally where the transactions were executed. Those records were maintained internally and available for regulators. In 2013 the firm elected to halt the practice but did not inform its customers. The Order alleges violations of Securities Act Sections 17(a)(2) and (3).

To resolve the proceeding Merrill Lynch admitted to the facts alleged in the Order and that its conduct violated the federal securities laws. The firm consented to the entry of a cease and desist order and a censure. It also agreed to pay a penalty of $42 million.

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