This Week In Securities Litigation (Week of June 13, 2022)
Two items dominated the news this week. One involves the new crypto asset bill crafted on Capital Hill. That bill proposes a new regulatory path for the industry largely under the CFTC. The second is the remarks of SEC Chair Gensler regarding market structure and the suggestion that many items such as payment for order flow may be the subject of proposed rules in the near future.
Be careful, be safe this week
Remarks: Chair Gary Gensler delivered remarks before the Piper Sandler Global Exchange Conference Investor Advisory Committee on June 8, 2022 titled Market Structure and the Retail Investors. Mr. Gensler focused his remarks on the lack of transparency regarding the manner in which orders are executed in the markets. The field is not level, the Chair noted. He has staff assessing these issues which include minimum pricing increments, national best bid and offer, disclosure of order execution quality, best execution and payment for order flow, rebates and related access fees. (here).
SEC Enforcement – Filed and settled actions
Last week the Commission filed 4 civil injunctive actions and 10 administrative actions, exclusive of 12j, tag-a-long and other similar proceeding.
Insider trading: In the Matter of Lijuan “Sandra” Hao, CPA, Adm. Proc. File No. 3-20896 (June 9, 2022) is a proceeding which names as a respondent Ms. Hao, a CPA licensed in California, who is a Senior Director for a Tax Services firm. In two instances, one in June 2017 and another in March 2018, she traded in the securities of her client in advance of a material corporate event she learned about while providing services to a client. In the first Respondent learned about the quarterly and year-end earnings announcement for the client. Respondent traded profitably in advance of the announcement. In the second instance Respondent learned about a merger while working for the firm. Again she traded profitably. Overall Ms. Hao had illicit profits of almost $48,000. The Order alleges violations of Exchange Act Section 10(b). To resolve the proceedings Respondent consented to the entry of a cease-and-desist order based on the Section cited in the Order. She also agreed to pay disgorgement of $47,850, prejudgment interest of $9,507/43 and a penalty of $47,850 for a total of $105,207.43.
Conflict: In the Matter of Jae Cheol Ho, Adm. Proc. File No. 3-20895 (June 8, 2022) is a proceeding which names as respondent the Chairman, CEO and CFO of 1-On Digital Corp. He holds a degree in economics and management engineering. Respondent, through his firm, arranged for an extension of credit or renewals thereof in the form of a personal loan from financial institutions prior to the time the firm entered into a reverse merger. When that occurred in 2018 he arranged for the approximately $1.7 million collateralized loan to continue. In fillings with the Commission, he acknowledged that the arrangement could be a violation of Exchange Act Section 13(k) which prohibits such arrangements. To resolve the proceedings Respondent agreed to an undertaking that terminates the guaranteed repayment of the loan and the collateral arrangement. He also agreed to pay a penalty of $150,000.
Offering fraud: SEC v. Churchville, Civil Action No. 15-cv-00191 (D. R.I.) is a previously filed case in which defendant Patrick Churchville and his advisory firm, ClearPath Wealth Management LLC, were enjoined by the Court from future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). In addition, the judgment orders Mr. Churchville to pay $29,103,738 in disgorgement and $4,577,8910 in prejudgment interest along with $225,000 as a penalty. The underlying complaint alleged that ClearPath was a fraud with $27 million in losses, misallocated funds, $2.5 million in investor funds misappropriated and, in effect, a multimillion Ponzi scheme. Mr. Churchville was sentenced to serve seven years in prison in the parallel criminal case. See Lit. Rel. No. 254417 (June 9, 2022).
Insider trading: SEC v. Dikshit, Civil Action No. 1:21-cv-09289 (S.D.N.Y.) is a previously filed action which names as defendant Puneet Dikshit, a partner in a global management consulting firm. During an engagement in 2021 Defendant learned prior to the deal announcement on September 15, 2021, that Goldman Sachs Group Inc would acquire the consumer loan fintech platform in an announcement that would be made on that date. He purchased options and following the deal announcement had trading profits of over $450,000. Mr. Dikshit consented to the entry of a permanent injunction based on Exchange Act Section 10(b) and pleaded guilty to related criminal charges. See, Lit. Rel. No. 25416 (June 9, 2022).
Financial fraud: SEC v. United Health Products, Inc., Civil Action No. 1:11-cv-03612 (D.N.Y. Filed June 8, 2022) is an action which names the firm, a manufacturer of certain medical products and two of its officers – Douglan Beplate, Chief Executive Officer — and Louis Schiliro, COO – as defendants. Defendants orchestrated two sham transactions to artificially inflate revenue. The first involved the purported sale of product to a customer using a back-dated purchase which the customer canceled. No product was shipped; no payment received. The transaction was booked. The second involved recognizing revenue from a sale to the firm’s largest customer when in fact there was no legitimate sale. To conceal the transactions the two officers of the company repeatedly gave the outside auditors false explanations. As a result, the Forms 10Q and 10-K doe 12017 and 2018 were false. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(A), 13(b)(5) and 16(a) along with Section 304(a) of SOX. The case is pending. See Lit. Rel. No. 25413 (June 8, 2022).
Microcap fraud: SEC v. Knox, Civil Action No. 1:18-cv-12058 (D. Mass.) is a previously filed action which named as a defendant Michael Gastauer, a resident of Germany, along with six entities he controls with aiding and abetting a scheme organized by U.K. citizen Roger Knox and his Swiss trading. The complaint claims that Mr. Knox and his entity aided and abetted issuers evade U.S. sales restrictions. The scheme is alleged to have involved at least 50 microcap companies and generated over $165 million. The Commission previously prevailed on summary judgment based on Securities Act Section 17(a) and Exchange Act Section 10(b). The final judgements against the entity defendants were enjoined from violating Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The entities were also ordered to pay penalties of $1,035,909 each and, on a joint and several basis, disgorgement of $11,264,415 with prejudgment of $1,736,559. In addition, the U.S. Attorney’s Office for the District of Massachusetts previously announced parallel criminal charges to which Mr. Knox pleaded guilty and is awaiting sentencing. See Lit. Rel. No. 25412 (June 8, 2022).
Unprofessional conduct: In the Matter of Cohnreznick, Adm. Proc. File No. 3-20891 (June 8, 2022) is a proceeding which names as respondent the independent accounting firm with offices in 25 cities and the auditors to Sequential Brands Group, Inc., a firm with a portfolio of consumer brands and Longfin Corporation, a firm now in liquidation. During the third quarter review of the Sequential Financial, the engagement partner, national office and the firm’s National Director for SEC Services expressed concerns regarding the fair value estimates because they were not supported by the evidence. Due to inadequate procedures the firm failed to properly assess the issues and accepted the firm’s representations regarding the claimed good will. Similarly, when conducting its year end audit of Longfin, the audit firm had repeated failures regarding critical areas of the engagement including planning and related party transactions and the partner failed to properly conduct the EQR. Ultimately, the firm failed to exercise the proper professional skepticism or conduct the proper audit procedures for the identified risk. In both instances the deficiencies derived from the inadequate policies and procedures of the firm. The Order finds that Respondent committed violations of Rule 2-02(b)(1) of Regulation S-X and caused violations of Exchange Act Sections 13(a), 13(b)(2)(A) and the related rules. The firm agreed not to accept new engagements where certain criteria appear until it completes the required undertakings. An Independent Consultant was also retained. To resolve the matter Respondent consented to the entry of a cease-and-desist order and the entry of a censure. Respondent will also comply with its undertakings and pay a penalty of $1.9 million.
Financial fraud: In the Matter of Synchronoss Technologies, Inc., Adm. Proc. File No. 3-20883 (June 7, 2022) is a proceeding in which the company was named as as respondent. It alleges that the firm improperly recognized revenue. Key transactions that were part of the restatement in 2015 and 2016 included: those for which there was not persuasive evidence of the arrangement; acquisition/divestitures in which the firm recognized revenue on license agreements; license/hosting transactions in which the firm converted prior multi-term software-as-a-service agreements into perpetual license agreements; and improperly recognized revenue upfront rather that ratably over the term of the agreements. It alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)-5. The proceedings were resolved with the entry of a cease-and-desist order based on the Exchange Act Sections cited in the Order and the payment of a $12.5 million penalty. See also SEC v. Rosenberger, Civil Action No. 22 Civ. 4736 (S.D.N.Y. June 7, 2022)(complaint names as defendants Karen Resnberger, the CFO Synchronoss and Joanna Lanni, the controller of the firm; action centers on essentially the same facts as the Order discussed above and alleges violations of the same Exchange Act Sections cited above and, in addition, SOX Section 304; this is only case in group not settled); In the Matter of Clayton “Charlie” Thomas, Adm. Proc. File No. 3-20884 (June 7, 2022)(Action charged Mr. Thomas, the VP of analytics at the firm; alleges violations of the same Sections as above excluding the SOX Section; settled with the entry of a cease-and-desist order and the payment of a penalty of $90,000); In the Matter of Maec Bandini, Adm. Proc. File No. 3-20885 (June 7, 2022)(action against the former Senior Director of Communications and Media; settled with a cease-and-desist order based on Exchange Act Sections 10(b), 13(b)-5, 13(a) and 13(b)(2)(A) and the payment of a $15,000 penalty); In the Matter of Daniel Ives, Adm. Proc. File No. 3-20886 (June 7, 2022)(proceeding naming the former EVP of investor relations; settled with the entry of a cease-and-desist order based on Exchange Act Section 13(b)(5) and the payment $15,000); In the Matter of John Murdock, Adm. Proc. File No. 3-20887 (June 7, 2022)(Action against the Senior Director of Procurement and Business Operations; settled with a cease-and-desist order based on Exchange Act Sections 13(a) and 13(b)(2)(A) and the payment of a $15,000 penalty); In the Matter of Stephen G. Waldis, Adm. Proc. File No. 3-20999 (June 7, 2022); settled as to the former CEO of the firm with a cease-and-desist order based on SOX Section 304 since Respondent had not reimbursed the company); In the Matter of Ronald Prague, Esq., Adm. Proc. File No. 3-20889 (June 7, 2022)(proceeding against the GC; alleges violations of Exchange Act Sections 13(a) and13(b)(2)(A) and the payment of a $25,000 penalty).
Controls: SEC v. Morningstar Credit Ratings, LLC, Civil Action No. 1:21-cv-013589 (S.D.N.Y.) is a previously filed action which names the ratings agency as a defendant. The complaint alleges that in 30 CMBS transactions in 2015 and 2016 Defendant permitted analysts to make undisclosed adjustments to key stresses in the model. The complaint alleged the firm failed to establish and enforce effective internal control structure governing the adjustments. The Court entered the final judgment which requires Morningstar to pay a penalty of $1.150 million. No injunction was imposed. See Lit. Rel. No. 25409 (June 7, 2022).
Unregistered dealer: SEC v. LG Capital Fundings LLC, Civil Action No. 1:22-cv-03353 (E.D.N.Y. Filed June 7, 2022) is an action which names the firm, founded by defendant Joseph Lerman, as a defendant. Over a 5 year period, beginning in January 2016, Defendants LG Capital and Mr. Lerman acted as an unregistered dealer in a series of actions involving penny stocks. Specifically, Defendants used a business model that purchased convertible notes from penny stock issuers and later converted the notes into shares at a discounted price. During the period at least 150 of 330 notes acquired were converted. The transactions generated at least $30 million in gross stock sale proceeds and at least $20 million profits. The complaint alleges violations of Exchange Act Sections 15(a) and 20(a). The case is pending. See Lit. Rel. No. 25410 (June 7, 2022).
Manipulation: SEC v. Stubos, Civil Action No. 1:22-cv-0467 ((S.D.N.Y. (Filed June 6, 2022) is an action which names as defendant George Stubos, a Canadian citizen bared from the securities industry and from serving as an officer or director of an issuer for 2 years. He created a complex scheme that began in 2015 using nominees to conceal his ownership of shares in certain microcap issuers. He then had the shares sold into the market and at times had the shares touted to push up the share price, engaging in manipulative trading. The scheme generated about $11 million. The complaint alleges violations Securities Act Section 17(a) and Exchange Act Sections 9(a)(2) and 10(b). The case is pending. See Lit. Rel. No. 25411 (June 8, 2022).
Paper: Greg Yanco, Executive Director of Markets, published a paper titled Cyber Safety, a Company Culture, June 10, 2022. The paper argues that businesses mut be ready to respond when their operations are threatened by online criminals (here).
Report: The German regulator published a report that examines the execution of orders for retail customers when there is payment for order flow. The results of the study were nuanced. For small orders the practice was generally beneficial, the regulator found in the June 6, 2022. For larger orders the benefits appear to have been lost (here).
Paper: The Monetary Authority of Singapore published its Green Bond Framework to establish guidelines for green bond issuances for the public sector on June 9, 2022 (here).