Morgan Stanley settled another case with the Commission this week. This time its brokerage unit resolved an action centered on the improper sales of ETFs, admitting the facts in the Order. The Commission also brought another suspicious trading case last week, obtaining a temporary freeze order over more than $29 million in trading profits tied to the acquisition of DreamWorks. Two more cases were filed based on violations of Exchange Act Sections 13(d) and/or 14(d) , following a Section 14(d) case brought earlier this year. In addition, the agency filed cases based on offering frauds, inadequate procedures to protect material non-public information and for acting as an unregistered broker.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 4 civil injunctive cases and 6 administrative proceedings, excluding 12j and tag-along proceedings.
Unregistered broker: In the Matter of Angel Oak Capital Partners, LLC, Adm. Proc. File No. 3-17849 (Feb. 16, 2017) names as Respondents, Angel Oak, a member of a group of entities with similar names that are not registered with the Commission; Peraza Capital & Investment, LLC, a registered broker dealer; Sreeniwas Prabhu, managing partner and CIO of Angel Oak; and David Wells, an employee of Angel Oak who is also a registered representative of Peraza Capital. Beginning in early 2010, and continuing through late 2014, Angel Oak, under an agreement with Peraza, conducted its securities business through Peraza Capital. During the period the owners or employees of Angel Oak were involved in the operations of the securities business, including the hiring of new employees to engage in securities activities, determining compensation, engaging in marketing activities and participating in discussions regarding the running of the business. The firm received transaction based compensation. Messrs. Prabhu and Wells participated in those activities. The Order alleges violations of Exchange Act Section 15(a). Each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. Respondent Angel Oak also consented to the entry of a censure. Angel Oak agreed to pay disgorgement of $3,054,288 along with prejudgment interest and a penalty of $375,000. Respondents Prabhu and Wells will each pay a penalty of $40,000. The proceeding will continue as to Peraza Capital to determine if the imposition of disgorgement, prejudgment interest and a penalty is appropriate.
Offering fraud: SEC v. Howard, Civil Action No. 17-civ-00420 (N.D. Tex. Filed Feb. 14, 2017) is an action which names as defendants Patrick Howard and his two firms, Optimal Economics Capital Partners, LLC and Howard Capital Holdings, LLC. Defendants are alleged to have raised about $13 million from 119 investors. Potential investors were told that they would earn between 12% and 20% annual returns through investments with minimal exposure – interests in portfolio company revenue streams – and that the returns were backed by insurance. The representations were false, as were Mr. Howard’s claims that he was a registered investment adviser. About half of the investor cash was put into the promised investments while much of the remainder was diverted to personal use. The complaint alleges violations of Securities Act Sections 5(a), 5(c), and 17(a) and Exchange Act Section 10(b). The court granted the Commission’s motion for a temporary freeze order at the time the complaint was unsealed. See Lit. Rel. No. 23752 (Feb. 16, 2017).
Tender offer disclosure: In the Matter of CVR Energy, Inc., Adm. Proc. File No. 3-17846 (Feb. 14, 2017)is based on a hostile tender offer for the company, an independent refiner and marketer of transportation fuels, by an Activist Investor in early 2012. Specifically, in mid-January 2012 the Activist Investor filed a Schedule 13D disclosing beneficial ownership of over 14% of CVR’s shares. The same day the firm adopted a “poison pill” as a defensive measure. The firm also retained Outside Counsel and the Investment Banks. By late February 2012 Activist Investor announced a tender offer for CVR. Subsequently, the company filed a Schedule 14D-9, prepared by Outside Counsel. In the filing shareholders were advised not to tender their shares into the unsolicited tender offer and that two Investment Banks had been retained and would be paid the customary fees. The latter statement was incorrect. Later the Activist Shareholder prevailed without increasing the price. Nevertheless, the firm had to pay a success fee to the Investment Banks despite the fact that they had not brought a benefit to the shareholders, something that had not been disclosed in the Schedule 14D-9. The Order alleges violations of Exchange Act Section 14(d) and Rule 14d-9. To resolve the proceeding the firm consented to the entry of a cease and desist order based on the Section and Rule cited in the Order. No penalty was imposed based on the cooperation of CVR.
Disclosure: In the Matter of Jeffrey E. Eberwein, Adm. Proc. File No. 3-17847 (Feb. 14, 2017). The action centers on violations of Exchange Act Sections 13(d) and 16(a). Named as Respondents are Jeffrey Eberwein, the CEO of Respondent Lone Star Value Management LLC and portfolio manager of its managed Fund; Charles Gillman, an activist investor and employee of a family office; Boston Avenue Capital, LLC; and Heartland Advisors, Inc., a registered investment adviser. Five penny stock issuers are involved: Digirad, Inc., a medical imaging company; Aetrium (now ATRM) Holdings, Inc.), formerly a semiconductor test equipment firm; NTS, Inc., a telecommunications service provider; Analysts International Corp., a staffing firm; and Hudson Global, Inc., an HR firm. The violations center on either making inadequate, late or no filings in accord with the Sections: Aetrium:Respondents Eberwein, Gillman and Boston Avenue did not fully disclose the group’s plan regarding the firm in 2012; NTS: Respondents Eberwein, Gillman and Boston Avenue did not make the required filings regarding their holdings and intent in a timely manner in 2012; Digirad: Respondents Eberwein, Gillman and Boston Avenue in 2012 failed to timely file a Schedule 13 D reflecting their collaboration; Heartland: Respondents Eberwein, Gillman and Boston Avenue failed to make any of the required filings in 2013; and Hudson Global: Respondents Gillman and Heartland, in late 2013 did not timely file a Schedule 13D disclosing their campaign to make changes to the firm’s corporate governance; the next year Respondent Eberwein and LoneStar disclosed a separate campaign for nominating candidates for election; but no filing disclosed the fact that Respondent Gillman joined with Respondents Eberwein and LoneStar. To resolve the proceeding Respondents Eberwein, Gillman, Boston Avenue and Heartland each consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, each will pay a penalty as follows: Respondent Eberwein, $90,000; Respondent Lone Star, $120,000; Respondent Gillman, $30,000; and Respondent Heartland, $180,000.
Offering fraud: SEC v. Terminus Energy, Inc., Civil Action No. 1:17-cv-0117 (S.D.N.Y. Filed Feb. 14, 2017) names as defendants the company, supposedly a seller of power generating products such as fuel cells; Danny Pratte, the firm’s CEO; Joseph Pittera, an undisclosed executive officer of the firm who had been permanently barred from selling or participating in a penny stock offering in an earlier Commission action; George Doumanis, previously convicted of securities fraud; Emanuel Pantelakis, previously barred from the securities business by FINRA; and Joseph Alborano. Beginning in October 2008, and continuing through April 2013, the company and Messrs. Pratte, Pittera, Doumanis and Pantelakis raised about $7.9 million through the sale of interests in the company to about 200 investors. A PPM was used which contained misleading statements about the business, development and prospects of the company while failing to disclose that 30% commissions would be paid and that investor funds would be diverted to the personal use of the defendants. The PPM also did not disclose the background of the individual defendants. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 15(a) and 15(b)(6)(B)(1). The case is pending. A parallel criminal action was brought by the Manhattan U.S. Attorney’s Office. See Lit. Rel. No. 23749 (February 14, 2017).
Offering fraud: SEC v. Toner, Civil Action No. 1:17-cv-0111 (Filed Feb. 14, 2017) is an action centered on an offering fraud. Specifically, beginning in mid-2013 and continuing over the next year, Mr. Toner raised about $915,000 from 18 investors supposedly for three real estate ventures. The stated plan was to purchase the properties, renovate them and sell for a profit. Mr. Toner was to invest in the projects, manage them and only take profits from his investment. The representations were false. Mr. Toner did not invest in the properties or manage them. Rather, he turned the ventures over to another who squandered much of the investor money. Mr. Toner also misappropriated part of the investor funds. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The Defendant settled the action, consenting to the entry of an order requiring that he pay disgorgement of $51,358, prejudgment interest and a penalty of $450,000.
Compliance procedures: In the Matter of Morgan Stanley Smith Barney, LLC, Adm. Proc. File No. 3-17845 (Feb. 14, 2017) is an action centered on the failure of the firm to adequately implement procedures regarding the sale to over 600 non-discretionary advisory accounts of ETFs. Although the firm had written procedures which required that each client sign a Client Disclosure Notice that explained certain risks of the product and that a supervisor conduct risk reviews, the procedures were not followed. The product was also not suitable to be held for long periods. Yet it was sold to those who held it long term for retirement accounts and others. The firm was aware that regulators were concerned about the risk of the products since it parent had been sanctioned by FINRA in connection with it. And, although OCIE identified the deficiencies in its procedures they were not cured. The Order alleges violations of Advisers Act Section 206(4). To resolve the proceeding the firm admitted to the facts in the Order and agreed to pay a penalty of $8 million.
Inadequate procedures: In the Matter of Sidoti & Company, LLC, Adm. Proc. File No. 3-17843 (February 13, 2017). Sidoti was established in 1999 as an independent research firm, focused on small and microcap public companies. It also offered brokerage and investment banking services. In 2014 the firm sought to expand, planning an IPO, establishing a hedge Fund, an Adviser and adopting a holding company structure chaired by its founder and CEO. For an eight month period beginning on November 3, 2014 Sidoti did not have any written policies and procedures regarding the misuse of material non-public information in connection with the Adviser and trading in the Fund. During the period the CEO controlled Sidoti’s investment banking and research departments and maintained trading authority in the Fund. The Fund repeatedly traded in shares on the restrictive list because the policies regarding the misuse of material non-public information by the investment banking and research departments did not extend to it. Subsequently, the firm amended is written policies and procedures to prevent the misuse of material non-public information in response to concerns raised by the staff but the modified procedures were inadequate. The Order alleges violations of Exchange Act Section 15(g). To resolve the proceeding Respondent consented to the entry of a cease and desist order, a censure and agreed to pay a penalty of $100,000.
Unregistered broker: SEC v. Abio, Civil Action No. 17-cv-00411 (N.D. Tex. Filed Feb. 13, 2017) is an action which names as defendants John Abio and Abio Financial Group, Inc. Mr. Abio and his firm were the top salesmen for Providence Financial Investments, Inc., a defendant in a related Commission enforcement action. That action alleges that beginning in 2011 Providence raised over $64 million from at least 400 investors through the sale of unregistered promissory notes. While portions of the funds were invested as represented, other portions cannot be accounted for. The firm is now in bankruptcy, listing no assets and huge debts. Mr. Abio and his firm earned $3.18 million in commissions from the sale of notes to over 100 investors in several states. The commissions were structured so that the person acting as a broker received a 6% commission on the face amount of the note, paid in equal monthly installments for each year that the purchaser held the note, thus creating an incentive for the salesperson to encourage the investor to hold the note. The complaint alleges violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Section 15(a). The case is pending. See Lit. Rel. No. 23751 (Feb. 16, 2017).
Suspicious trading: SEC v. Yin, Civil Action No. 17 CV 972 (S.D.N.Y. Filed Feb 10, 2017). At the center of the case is the acquisition of DreamWorks Animation SKG, Inc. by Comcast Corporation, announced on April 28, 2016. The Commission obtained a freeze order over about $29 million in alleged trading profits at the time the action was filed. Defendant Shaohua (Michael) Yin is a citizen of China who maintains a residence in Beijing and also in Palo Alto, California. He is a partner in Summitview Capital Management Ltd, based in Hong Kong. Five individuals are named as relief defendants that include his mother, his father and three other individuals. The trading on which this action is based was conducted through the accounts of the five relief defendants. PAG Asia Capital began discussions with the Zhonghong Group in December 2015 about a possible deal involving DreamWorks. Discussions ensued as did due diligence. By April 4, 2016 the board of DreamsWorks met to consider a deal in which PAG would acquire the company at a price of $35 per share, a 40% premium to market. As the PAG proposal unfolded the CEO and chairman of the board of Comcast contacted the CEO of DreamWorks and expressed an interest in acquiring the company. By mid-April Comcast sent DreamWorks a confidential proposal to acquire the company at $35 per share, later increased to $41 per share in an April 27th offer. That offer was approved by the DreamWorks board the next day and announced after the close of the market. The proposed deal had leaked to the market two days earlier. Beginning on April 4, 2016, the date the DreamWorks board met to consider the PAG offer, and continuing until April 25, 2016, the date the Comcast deal was leaked to the market, purchases of DreamWorks shares were made through the five relief defendant accounts on each trading day. Each of the relief defendants traded in the shares of DreamWorks through an account at Interactive Brokers, generally on margin. Trading in the five accounts was accessed using many of the same IP addresses. The Interactive Brokers’ log-in data also connects the trading in the accounts to the Defendant, according to the complaint. Overall, the trading in the five accounts during the period represents about 16.9% of the overall trading volume. That trading is not explained by public events. No news event had an appreciable impact on the share price during the period of the trading. The five accounts have also traded profitably in advance of public events for three China-based public companies, netting over $20 million for the accounts. On February 3, 2017 the FBI executed a search warrant on Defendant Yin at the San Jose Internal Airport as he was boarding a flight to China. Over the next two days there was a flurry of activity in the five accounts, a rash of serial withdrawal requests, stock sales and communications to the brokerage firm. Overall there were attempts to withdraw over $22 million from the five nominee accounts. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23747 (February 10, 2017).
Supervision – misappropriation: In the Matter of Columbia Management Investment Services Corp., Adm. Proc. File No. 3-17840 (February 10, 2017) is a proceeding which names as a Respondent the transfer agent for mutual funds. The case centers on a scheme carried out by Ronald Hunt, a former records management manager at the firm, between mid-February 2013 and early October of that year. During that period Mr. Hunt misappropriated funds from the accounts of two deceased shareholder who resided overseas by falsifying certain documents. About $1.2 million was taken. The Order alleges that the firm failed to reasonably supervise Mr. Hunt in violation of Exchange Act Section 17A(d)(1). Specifically, the firm had a policy which required that a certain form be completed prior to the receipt of sensitive shareholder information. The form required that the employee specify a valid business reason before obtaining a shareholder report. Here the firm failed to determine if Mr. Hunt had a legitimate business justification as required. The firm failed to develop systems to monitor this requirement and to develop specific safeguards and procedures to assure that the funds of foreign deceased shareholders were safeguarded. To resolve the proceeding the firm 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 $250,000
Offering fraud: Red River Securities, LLC and its CEO Brian Hardwick, were found by a FINRA hearing panel to have engaged in fraudulent offerings with regard to interests in Regal Energy, LLC, a close affiliate of Red River. The instruments were high risk and in two instances were sold to unsuitable customers. The panel concluded that the misconduct was egregious and that there were several aggravating factors. The regulator expelled Red River and barred Mr. Hardwick form the business. In addition, Red River and Mr. Hardwick, jointly and severally, were directed to pay restitution of $24.6 million to customers.
Disclosure: The Securities and Futures Commission initiated a proceeding in the Court of First Instance against Tse On Kin, former chairman and executive director of Kong Sun Holdings Ltd and China Sandi Holdings Ltd. The proceeding is based on the fact that he concealed his interests in the share placement of the company in 2009.