U.S. Senators Elizabeth Warren, Sherrod Brown, Robert Menendez and Brian Schatz requested that Inspector General Carl Hoecker investigate Acting SEC Chairman Michael Piwowar in a letter dated March 29, 2017. The letter notes that the Acting Chairman has directed the staff to reconsider the 2014 guidance on the agency’s conflict minerals rule and sought new public input on the Commission’s rule requiring disclosure of a comparison of senior executives’ compensation compared to that of an average firm employee, both enacted under Dodd-Frank. The Acting Chairman has long questioned each rule, according to the letter. In addition, he has imposed “fresh curbs” on the enforcement staff. These actions exerted “unusual authority for an acting agency chair” (internal quotes omitted) the Senators noted, meriting investigation.
This week the Supreme Court agreed to hear an appeal centered on the question of whether Item 303 regarding disclosures in an MD&A creates a duty to disclose that is actionable under Exchange Act Section 10(b) in a securities class action. The case, which could significantly expand the scope of liability for issuers in those actions, arises from a decision by from the Second Circuit which answered the question in the affirmative, creating a conflict with the Ninth Circuit. The case will be heard next Term.
The SEC brought cases this week centered on: Fraudulent markups imposed on institutional clients by a broker-dealer; a financial fraud at a firm implemented by its CFO; an offering fraud conducted by a church pastor; another offering fraud by three brothers, one of whom was a compliance officer at a broker; and suspicious trading by two Israeli citizens in advance of an acquisition.
Finally, FINRA, joined by a number of exchanges, instituted disciplinary proceedings against a broker. The proceeding claims the broker aided and abetted manipulative trading. The U.K. Financial Conduct Authority brought its first action against a public company charging market abuse.
Letter: Senators Warren, Brown, Menendez and Schatz to Carl W. Hoeker, Inspector General, dated March 29, 2017, requesting an investigation of certain actions by Acting SEC Chairman Michael Piwowar (here).
Remarks: Acting Chairman Michael Piwowar delivered remarks before the 27th International Institute for Securities Market Growth and Development, Washington, D.C. (March 27, 2017). His remarks discussed entrepreneurs, the core mission of the agency, disclosure, fintech and enforcement (here).
The Supreme Court agreed to hear another securities case this week. Leidos, Inc. v. Indiana Public Retirement System, No. 16-581. The securities class action, based on Exchange Act Section 10(b) and Rule 10b-5 thereunder, presents the following question for resolution, according to the Petition for a Writ of Certiorari: “Whether the Second Circuit erred in holding – in direct conflict with the decisions of the Third and Ninth Circuits – that Item 303 of SEC Regulation S-K creates a duty to disclose that is actionable under the Section 10(b) . . .” of the Exchange Act.
Petitioner framed this issue by stating that under Exchange Act Section 10(b) an “omission may be fraudulent only if the omitted information is necessary to make an affirmative statement “not misleading.” Thus “companies can control what they have to disclose . . . by controlling what they say to the market,” Petition at i, quoting Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 45 (2011). The Second Circuit held in this case that Item 303 does create a disclosure duty actionable under Section 10(b).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 5 civil injunctive cases and 5 administrative proceedings, excluding 12j and tag-along proceedings.
Valuation: In the Matter of Covenant Financial Services, LLC, Adm. Proc. File No. 3-17891 (March 29, 2017) is an action against the registered investment adviser that advises eight private Funds, and Stephen Shafer, its majority owner, portfolio manager and CIO. From June 2007 through August 2017, the firm materially misstated the value of assets in five funds resulting in the payment of excessive management fees. Beginning in 2009 the firm used a third party vendor pricing service to value municipal bonds held in the funds. During a period of market volatility beginning in August 2011 the values provided by the service were not in accord with GAAP. While there were indications the values were not correct, the firm continued to use the service. The approach was inconsistent with the firm’s 2011 financial statements, its written valuation policy and the representations made in offering documents. Covenant received excessive fees of $400,000. Redemptions of shares were also made at incorrect values. When the valuation issue was discovered by the auditors, the firm refunded $444,000 in excess management fees to the Funds. Covenant also determined that the Funds overpaid about 40 redeeming limited partners a total of over $3 million. Covenant paid about $270,000 to the Funds as partial compensation for these over-redemptions. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). To resolve the matter each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. The also agreed to pay, on a joint and several basis, a civil penalty of $130,000 and prejudgment interest of $14,845.78.
Fraudulent pricing: In the Matter of Louis Capital Markets, LP, Adm. Proc. File No. 3-17890 (March 29, 2017) is a proceeding against the registered broker-dealer. Louis Capital deals primarily with foreign institutions and large institutional traders. From about 2008 through October 2012 the firm added additional, undisclosed mark-ups to select transactions where the cash equity desk that handled the transactions saw an opportunity. The clients were not informed of the additional charges which were not clearly recorded on their statements. The Order alleges violations of Exchange Act Sections 15(c). To resolve the action the firm consented to the entry of a cease and desist order based on the Section cited in the Order as well as a censure. In addition, the firm will pay $2.5 million in disgorgement. The Commission did not impose a penalty in view of the “particular circumstances of this case, including the financial condition of the Respondent.” The Order does not require the payment of prejudgment interest.
Books & records: In the Matter of Alison, LLC, Adm. Proc. File No. 3-17365 (March 29, 2017) is a proceeding which names the registered investment adviser and its founder and sole owner, Stephen Alison, as Respondents. The Order alleges that Respondents repeatedly failed to produce required books and records to the inspection staff. The financial condition of the adviser also is likely to impair the firm’s ability to fulfill its obligations to clients. And, significant portions of its revenue over a three year period came from 12b-1 fees charged to clients by third parties. The Order alleges violations of Exchange Act Section 15(b) and Advisers Act Sections 206(2), 207 and 204(a). To resolve the proceeding Respondents consented to the entry of a cease and desist order based on the Sections cited in the Order. Mr. Alison is also barred from the securities business with a right to apply for reentry after three years. The firm’s registration was revoked.
Financial fraud: In the Matter of Advanced Emissions Solutions, Inc., Adm. Proc. File No. 3-17892 (March 29, 2017); SEC v. McKinnies, Civil Action No. 17-cv-00566 (D.D.C. Filed March 29, 2017). Advanced Emissions provides environmental solutions to customers primarily in the power generation industry. Defendant Mark McKinnies served as CFO, senior vice president, secretary and as a member of the board of directors during the period here. Historically the firm’s internal controls suffered from material weaknesses, a problem tracing to as early as 2006 when the company reported a number of material weaknesses. In 2012 the firm reported similar material weaknesses in internal controls. The financial statements for 2010 and 2011 were restated. Two years later Advanced Emissions announced that its financial statements for 2013 and 2011- 2012 should not be relied on. A restatement in 2014 followed. It centered on the following issues: 1) A failure to record a loss contingency arising from an arbitration; 2) the premature recognition of revenue; 3) a failure to properly reduce accruals from the warranty program at the end of the warranty period; 4) the improper consolidation of the results of an entity; and 5) an overstatement of revenue by improperly relying on the records of acquired firms which had inadequate books coupled with a failure to eliminate inter-company revenues. In the second restatement 15 material weaknesses were identified. Following that restatement the firm had a significant change in leadership. Those changes included a new CFO, a new senior management team and a new director who became Audit Committee Chair. The administrative Order as to the company, and the complaint as to the CFO, each allege violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The firm resolved the matter by consenting to the entry of a cease and desist order based on each Section cited in the Order and paying a penalty of $500,000. The former CFO consented to the entry of an injunction based on each Section cited in the complaint as well as a five year officer and director bar. He also agreed to pay disgorgement, prejudgment interest and a penalty totaling $238,692.
Offering fraud: SEC v. Treasure Enterprise LLC, Civil Action No. 17-cv-10963 (E.D. Mich. Filed March 28, 2017) is an action which names as defendants the firm, supposedly in the real estate business, Allen Holley, the pastor of Abundant Life Industries International, Inc. and Patricia Enright Gray a financial consultant for Treasure and a relief defendant. The complaint alleges that from February 2015 to the present about 83 individuals have invested with Treasure, some putting in their life savings. At least $6.7 million has been raised, much of it from senior citizens. Pastor Larry Holly pitched the investment opportunity by claiming he was more trust worthy than a banker, it paid a high rate of interest, Treasure had a successful and profitable business, the investment was risk free and the money would go into Individual Retirement Accounts. Later investors learned there was no guarantee and no IRA accounts. Eventually payments to investors ended. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of 17(a) and Exchange Act Section 10(b). A freeze order was entered on filing. The case is in litigation.
Offering fraud: In the Matter of William Quigley, Adm. Proc. File No. 3-16560 (March 24, 2017) is a proceeding centered on an offering fraud conducted by three brothers, William, Michael and Brian Quigley. William was the director of compliance at a registered broker-dealer. The brothers solicited investors to purchase various securities, including well known blue chip stocks and start-ups. In fact none of the shares were purchased. All of the investor funds were misappropriated. The Order alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act and Exchange Act Section 10(b). William Quigley resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to pay disgorgement of $356,891, an obligation deemed satisfied by the forfeiture order entered in a parallel criminal action in which Mr. Quigley pleaded guilty and was sentenced to serve six months in prison. U.S. v. Quigley, 15-cr-258 (E.D.N.Y.). Mr. Quigley was also barred from the securities business and from participating in any penny stock offering.
Insider trading: SEC v. Coppero, Civil Action No. 1:16-cv-07591 (S.D.N.Y. ) is a previously filed action which named as defendants Nino Coppero Del Valle, an employee of HudBay Minerals, Inc. and a lawyer resident in Peru; Julio Antonio Castro, Mr. Coopero’s close friend and also a lawyer in Peru; and Richardo Carrion, Mr. Coopero’s acquaintance and a manager of a brokerage firm in Peru. The action centered on the February 9, 2014 announcement by HudBay that it would make a tender offer to acquire all the shares of Augusta Resource Corporation. After learning about the deal Mr. Coopero first tipped Defendant Castro; later he tipped Mr. Carrion. Subsequently, Messrs. Coopero and Castro traded together through the brokerage account of an off shore shell corporation. Mr. Carrion also traded. Following the deal announcement Messrs. Coopero and Castro had trading profit of over $73,000. The two men later tried to cover up their trading. The three defendants settled with the Commission. Mr. Coppero agreed to pay disgorgement of $53,607.70 plus prejudgment interest; Mr. Castro agreed to pay disgorgement of $59,3000.02 along with prejudgment interest and a penalty equal to the amount of his disgorgement; and defendant Carrion agreed to pay disgorgement of $54,144.10 along with prejudgment interest and a penalty equal to the amount of the disgorgement.
Misappropriation: SEC v. Glick, Civl Action No. 17-cv-02251 (N.D. Ill. Filed March 23, 2017) is an action which names as defendants Daniel Glick and his firm, unregistered investment adviser Financial Management Strategies Inc. Mr. Glick and his firm raised millions of dollars from investors. Over a period of time Mr. Glick misappropriated portions of the investor funds and used at least part of the money to make Ponzi type payments to other investors. He attempted to conceal his actions by furnishing investors with false financial statements. Mr. Glick has previously been barred by FINRA and had his designation as a Certified Financial Planner revoked. The complaint alleges violations of Exchange Act Section 10(b), each subsection of Securities Act Sections 17(a) and Advisers Act Sections 206(1) and 206(2). The court entered a temporary freeze order at the time the complaint was filed. The case is in litigation.
Suspicious trading: SEC v. Darvasi, Civil Action No. 17-cv-2088 (S.D.N.Y. Filed. March 23, 2017). The action centers on the acquisition of Mobileye, N.V. by Intel Corporation, announced before the opening of trading on March 13, 2017. Following the deal announcement the share price increased 28%. Defendant Dr. Ariel Darvasi is a Professor of Genetics at the Center for Research on Pain, Hebrew University of Jerusalem. Defendant Dr. Amir Waldman is a self-employed engineer who earned his Ph.D. at Hebrew University of Jerusalem. Movileye is a Netherlands entity with its principal office in Jerusalem, Israel. A number of Mobileye’s directors and officers are members of the Hebrew University science community. The firm developed software and technology for Advanced Driver Assistance Systems used for autonomous driving. The technology was commercialized at Hebrew University of Jerusalem while Dr. Waldman was working on his doctorate at the school. Intel began formal discussions with Mobileye in late January 2017. Principals of the two firms met in New York in late January. By the end of January 2017 all the members of Mobileye’s board had discussed the possible transaction. A definitive agreement was entered into on March 12, 2017. It called for a tender offer valued at about $15.3 billion or $63.54 per share. That price represented a premium to market of about 34.7%. Dr. Darvasi sold the only stock he had in his account at a loss about 10 days prior to the execution of the definitive Agreement for the tender offer. The same day – March 2, 2017 – he purchased 30,000 shares of Mobileye, using all of the cash in the account and margin debt. The stock had a value of $1.4 million. Dr. Waldman began trading Mobileye options in the fall of 2016. Typically he purchased out of the money contracts and held them for about two weeks. The approach was profitable. Beginning on February 1, 2017, the date Intel and Mobileye executed a nondisclosure agreement, Dr. Waldman changed his trading pattern. He began accumulating Mobileye options at strike prices above the firm’s then current performance. By March 10, 2017 he held 5,339 Mobileye call options, purchased for $237,581. On the day of the deal announcement Dr. Darvasi sold 100 Mobileye shares for a gain of $1,473.45. He had unrealized gains on his remaining 29,900 shares of about $427,000. Dr. Waldman sold 1,697 of his options on the same day, realizing profits of about $1,539,813. As of that date he had unrealized profits of about $2.96 million on his remaining holdings. Dr. Waldman also withdrew $200,000 from his brokerage account on March 13, the maximum amount permitted on any day. The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). The case is in litigation. See Lit. Rel. No. 23789 (March 24, 2017).
Offering fraud: SEC v. LottoNet Operating Corp., Civil Action No. 1:17-cv-21003 (S.D. Fla. Filed March 20, 2017) is an action which names as defendants the company, purportedly in the business of facilitating the purchase of lottery tickets, its CEO, David Gray, and a salesman, Joseph Vitale. Since July 2015 defendants have raised about $4.8 million, selling shares of LottoNet through a series of misrepresentations. For example, investors were told that commissions were not paid to sales agents which is not true. They were also told that their funds would be used to develop the company when in fact much of the money was misappropriated. The complaint alleges violations of Exchange Act Sections 10(b), 15(a)(1) and each subsection of Securities Act Section 17(a). A temporary freeze order was entered at the time the complaint was filed. The case is in litigation.
Financial fraud: U.S. v. Lerner (S.D.Fla. March 29, 2017) is an action which charges Hyunjin Lerner, formerly a vice president of finance for Bankrate Inc., a publicly traded financial services and marketing company, with one count of conspiracy to commit wire fraud, falsifying the books and records of a public company, making false statements to the company accounts, securities fraud and wire fraud. The court papers allege that between 2011 to 2014 the defendant and others artificially inflated Bankrate’s earrings by using cookie jar reserves. The case is in litigation.
Offering fraud: U.S. v. Servider (S.D.N.Y.) is an action in which defendant Edward Servider pleaded guilty to one count of conspiracy to commit commodities fraud. Beginning in March 2013 Mr. Servider set up a retail foreign currency exchange trading firm called EJS Capital Management, LLC. Investors were cold called and told that the firm had a history of successful trading. Over 100 investors put up over $2.4 million. After receiving the investments, statements were sent to the investors showing profits. All of the claims were false. Most of the investor funds were misappropriated. Mr. Servider is awaiting sentencing.
Manipulation: U.S. v Durante, No. 1:15-cr-00171(S.D.N.Y.) is an action involving Edward Durante, a recidivist securities fraudster, Christopher Cervino, a registered broker, and Sheik Khan, an investment adviser. The defendants engaged in a scheme which defrauded about 100 investors out of more than $15 million. The three men inflated the share price of a firm called VGTel and then sold private placement shares in the firm. Following a jury trial Defendants Cervino and Kahn were each convicted on one count of conspiracy to commit securities fraud and one count of conspiracy to commit wire fraud. Mr. Kahn was also convicted of one count of investment adviser fraud. Mr. Durante previously pleaded guilty. The date for sentencing has not been set. See also SEC v. Durante, Civil Action No. 1:15-cv-0984 (S.D.N.Y.).
Manipulation: The regulator, along with the NYSE, NYSE Arca, NYSE Mkt, the Bats Exchanges, Bats BZX, Bats BYx, Bats EDGA, Bats EDGX, Nasdaq, Nasdaq BX and the International Securities Exchanged commenced disciplinary proceedings against Lek Securities Corporation and its Chief Executive Officer, Samuel F. Lek. FINRA and the exchanges allege that the firm and its CEO aided and abetted extensive manipulative trading in a customer account known as Avalon from October 2010 through June 2015. The trading centered on layering, spoofing and cross-product manipulation.
Confidential information: The Financial Conduct Authority fined former investment banker Christopher Niehaus £37,198 for sharing client confidential information with others over WhatsApp. The information was not used for trading. The information shared included the identity of a client, details relating to a client mandate and fees charged for investment banking.
Market abuse: The FCA resolved market abuse charges with Tesco plc and Tesco Stores Limited. The firm admitting to the charges. Tesco agreed to pay compensation to investors who purchased firm shares and bonds on or after August 29, 2014 and held them through September 22, 2014. The charges are based on the fact that the firm published an update on August 29, 2014 stating that it expected trading profit for the six months ending August 23, 2014 to be in the region of £1.1 bn. Subsequently, on October 22, 2014, the firm published an update noting that it had overstated the profit for the half year principally due to the accelerated recognition of commercial income and delayed accrual of costs. Tesco “knew or could reasonably have been expected to know that the information in the August 29, 2014 announcement was false or misleading.” The FCA did not suggest that the Tesco plc board knew or should have known the information was incorrect. The incorrect announcement caused the share price to trade at an inflated value. This is the first action brought by the FCA against a publicly traded firm for market abuse.