The SEC is an agency in transition. There are three open slots on the agency waiting to be filled by the President and the Senate. Many of the senior staff positions are also now open including the Director of the Division of Enforcement, the General Counsel and the Director of OCIE.
Nevertheless, the agency continues to move forward, a great credit to the staff. A series of civil injunctive actions were initiated over the last week focused largely on offering fraud actions. One of those actions centered on claims that an uncompleted resort would be acquired; another involved claims that houses would be purchased to flip; and in another investors were promised the firm would acquire blocks of tickets to the hit and sold out Broadway play Hamilton. Two other cases filed last week involved a pyramid scheme and the misappropriation of investor funds by an adviser.
Securities class actions
There was a significant increase in the number of securities class actions filed in 2016. It is the second straight year of increased filings, according to reports prepared by Cornerstone Research and NERA Economic Consulting. While each firm reports slightly different numbers, stemming from the manner in which actions are counted, the trend is clear. For example, Cornerstone reports that last year 270 securities class actions were filed. That compares to 188 in 2015 and 170 in 2014. Cornerstone Research, Securities Class Action Filings, 2016 Year in Review (here). Similarly, NERA reports that 300 securities class actions were filed last year compared to 228 in 2015 and 218 in 2014. NERA reports that the number for 2016 is the highest since 1996 with the exception of 2001, the aftermath of the dot-com crisis. NERA, Recent Trends in Securities Class Action Litigation: 2016 Full-Year Review (here).
Firms in the health technology and services sector were most frequently named as defendants in securities class actions in 2016, according to NERA. Last year 28% of the complaints named firms in that sector as defendants while 17% of the actions involved the electronic technology and technology services sector and 16% named firms in the finance sector. In 2015 the same three sectors were the focus of securities class actions, but in a different order: 22% of the complaints focused on the electronic technology and technology services sector, 20% on finance and 19% on health technology and services. Finally, the average settlement amount exceeded $72 million in 2016, up over 35% over the 2015 average of $53 million. Those amounts compare to the near ten year low of $36 million in 2014 and the $119 million of 2010 which is the highest since 1996. The two largest settlements last year were the $1,577 million paid by Household International, Inc. and the $1,0662 million by Merck & Co Inc., NERA reports.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 5 civil injunctive cases and no administrative proceedings, excluding 12j and tag-along proceedings.
Misappropriation: SEC v. Vacchi, Civil Action No. 3:17-cv-00155 (D. Conn. Filed Feb. 2, 2017) is an action which names as defendants Mark Varacchi and his controlled entity, Sentinel Growth Fund Management, LLC. Sentinel managed two funds. Beginning in late 2015, and continuing for about one year, Defendants raised about $3.95 million for the two funds from investors. The funds were to be allocated to up-and-coming hedge fund managers for investment purposes. In fact the funds were diverted to the personal use of the defendants. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The action is pending.
Offering fraud: SEC v. Garcia, Civil Action No. 8:17-cv-00174 (C.D. Cal. Filed Feb. 1, 2017) names as defendants Paul Garcia, Richard Woods and two entities owned or controlled by Mr. Garcia, Caliber Capital Management, LLC, Caliber Partnership I, LLC, and Partner Medical Solutions, LLC. Beginning in 2014, and continuing for the next year, Mr. Garcia and Caliber raised about $675,000 from investors who were told the funds would be invested in the acquisition of an unfinished golf resort in Colorado. Supposedly $2.7 million had previously been committed to the project. The firm would then join a REIT that was about to go public. Defendant Woods participated in soliciting the investors. The representations were false. Portions of the investor funds were misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c), 17(a) and 17(a)(2) and Exchange Act Section 10(b). To resolve the action Mr. Garcia consented to the entry of an order precluding him from participating in future securities offerings and serving as an officer or director of a pubic company. Mr. Garcia, along with the entity defendants also agreed to pay over $3.3 million in penalties and disgorgement plus interest. Mr. Woods consented to the entry of an order prohibiting future violations of Securities Act Section 17(a)(2). He also agreed to pay a penalty and disgorgement totaling $30,000. See Lit. Rel. No. 23738 (C.D. Cal. Filed Feb. 2, 2017).
Offering fraud: SEC v. Baccam, Civil Action No. 5:17-cv-00172 (C.D. Cal. Filed January 31, 2017). Defendant Patric Ken Baccam was associated with a Commission registered broker-dealer. Beginning in late 2010 he raised about $963,000 through the offer and sale of unsecured promissory notes. Initially the notes were issued by a vehicle which belonged to a friend. Later Defendant Baccam used a vehicle he controlled. Investors were told that their funds would be used to flip houses. Mr. Baccam had little experience in the area. Investors were also promised rates of return ranging from 7% to over 15% and assured that their investment was safe. In fact little of the money was used for the stated purpose. Portions of the investor funds were diverted to other uses. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending. See Lit. Rel. No. 23737 (Feb. 1, 2017).
Offering fraud: SEC v. Meli, Civil Action No. 1:17-cv-00632 (S.D.N.Y. Filed January 27, 2017). The defendants in this action are Joseph Meli, Matthew Harriton, 875 Holdings, LLC, 127 Holdings, LLC, Advanced Entertainment, LLC and Advanced Entertainment II, LLC. Messrs. Meli and Harriton directly or indirectly control the entity defendants. Beginning in January 2015, and continuing through October 2016, four offerings were conduct using the entity defendants centered on a sale pitch tied to ticket sales. About $81 million was raised in the offerings which were similar but not identical. Specifically, in each on of the offerings investors were told the funds would be used to purchase tickets – sometimes to the hit Broadway play Hamilton – and that they would receive back their investment, an additional 10% and a 50% split of the profits. In fact there was no contract to purchase a block of Hamilton tickets. From January 2015 through October 2016 Messrs. Meli and Harriton caused the four entities to spend about 10% of the money raised with third party entities that appear to be connected with thicket selling businesses. Indeed, in December 2016 Mr. Meli stated he had been running a “shell game” that involved using certain investor funds to pay back other investors. During the period the Defendants also used about $2 million of the investor money for personal expenses. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The complaint is pending. The U.S. Attorney’s Office for the Southern District of New York filed a parallel criminal action. See Lit. Rel. No. 23723 (January 27, 217).
Pyramid scheme: SEC v. Young, Civil Action No. 1:17-cv-00243 (D.S.C. Filed Jan. 26, 2017) is an action against Herman Young who operated a business known as Race Cycler. The firm was promoted as an e-book seller. In fact its products were largely worthless and the firm operated as a pyramid scheme, selling rewards to investors for bringing in others. From August 2014 through February 2015 about $230 million was raised from investors. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). Mr. Young agreed to resolve the action, admitting wrongdoing and consenting to the entry of a permanent injunction based on the Sections cited in the complaint. He will also be required to pay $340,510 of about $1.32 million in disgorgement and prejudgment interest based on financial condition. A penalty was not imposed based on cooperation. See Lit. Rel. No. 23729 (January 27, 2017).
Offering fraud: The regulator expelled Phoenix-based Lawson Financial Corporation and barred its CEO and President, Robert Lawson, from the securities business. The order is based on an offering of municipal bonds sold to firm customers while concealing the financial condition of the issuer. Specifically, while the offering was in progress Mr. Lawson and his firm took money from a customer account and put it into the issuer to make its financial condition appear better. Mr. Lawson, along with this wife who was an executive at the firm, also engaged in self-dealing with respect to a trust account. Mrs. Lawson was suspended from association with any FINRA member for two years and fined $30,000.
Disclosure: The Australian Securities Investment Commission announced that Benjamin Kirpatrick pleaded guilty to a violation in connection with the continuous disclosure obligations of his firm. He has been sentenced to serve 12 months imprisonment at a 12-month intensive Correction Order. The offense occurred in connection with a claim that Waratah Resources breached its continuous disclosure obligation by announcing on October 14, 2013 that it had established a $100 million trade finance facility with the Bank of China when no such facility existed. Over the next two weeks the disclosure was not corrected. At sentencing he also admitted to having authorized false information that was distributed to the market.
Supervision: The Securities and Futures Commission reprimanded North Sea Securities Limited and fined the firm $700,000 for failing to have proper supervisory controls regarding employee transactions. Specifically, from December 4, 2013 to December 27, 2013 there were 25 cross trades among four employees for the purpose of delaying settlement. After investigation it was determined that the firm did not have any supervisory procedures as to employees. In resolving the case the regulator considered the cooperation of the firm and appointed a monitor.
Traders: The regulator banned Ma Yu Lung, a former representative of Sun Hung Kai Investment Services Ltd., from the securities business for eight years. Following an investigation it was determined that Ma accepted order instructions from unknown and unidentified persons for firm client accounts and then colluded with others to cover it up.
Failing to adhere to fund document limits: The SFC reprimanded and fined Value Partners Limited and Value Partners Hong Kong Limited $2 million for permitting two funds they managed to issue shares in excess of the amount authorized by the governing documents. In addition, Value Partners failed to timely report this as required.