This Week In Securities Litigation (Week of April 13, 2020)
Holidays across the U.S. are being disrupted as the COVID-19 pandemic stay-in-place orders continued to keep business largely closed and most people at home. While the crisis continues many believe that there may be hope on the horizon. Whether they are correct or not as to the virus, the thought of hope is clearly correct. As we head to what is a much altered holiday the belief that this will pass if everyone continues to work together is clearly cause for optimism for the future.
This week SEC Enforcement brought actions centered on financial fraud, manipulation, a failure to comply with blue sheet obligations, unauthorized trading in client accounts and an offering fraud.
Happy holiday and stay safe.
Statement – COVID -19: Chairman Jay Clayton and Corporation Finance Division Director William Hinman issued a statement stressing the need for effectively addressing “the health risks of COVID-19 while fostering a meaningful, responsible increase in economic activity” on April 8, 2020 (here).
Rules- Clearing agencies: A series of amendments to the rules governing securities clearing agencies were approved by the Commission on April 9, 2020 (here). The amendments built on the 2016 provisions enacted under Dodd-Frank. They are designed to clarify and improve the existing rules.
Rules–BDCs: The Commission adopted rule amendments to implement select provisions of the Small Business Credit Availability Act and Economic Growth Regulatory Relief and Consumer Protection Act regarding business development companies. The new provisions, announced in an April 8, 2020 release, permit BDCs and other closed-end funds to use the securities offering rules that have been available to operating companies (here).
Guidance – shareholder meetings: The Division of Corporation Finance issued Guidance for Conducting Shareholder Meetings in view of COVID-19 Concerns, April 7, 2020 (here).
Inspections: Inspections for compliance with Form CRS and its rules by advisors and Regulation Best Interest by brokers will begin after the June 30, 2020 filing date, according to an OCIE Risk Alert dated April, 7, 2020 (here). The Alert identifies key areas the staff will be examining regarding each new regulation. In projecting the inspection schedule OCIE made it clear that the Office is “up and running” (here). Chairman Clayton stated that the compliance deadlines for each regulation will not be enlarged.
SEC Enforcement – Litigated Actions
Offering fraud: SEC v. Muraca, Civil Action No. 1:17-cr-000739 (S.D.N.Y.) is a previously filed action in which the Court granted summary judgment in favor of the Commission against Defendant Patrick Murasa and his two pharmaceutical firms, also named as Defendants. The complaint alleged that Mr. Muraca established the two firms in 2017 and sold shares to the public, claiming that they were developing drugs to detect cancer. The Commission traced at least $400,000 of the $1.2 million in offering proceeds into Mr. Muraca’s personal bank account. Following the grant of summary judgement the Court entered a final judgment against Mr. Muraca, prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The judgment also imposes and officer and director bar and directs Mr. Muraca to pay $411,684 in disgorgement, and $31,442 in prejudgment and post-judgment interest. Previously, Mr. Muraca had been found guilty in the parallel criminal case brought by the Manhattan U.S. Attorney’s Office. He was sentenced to serve 27 months in prison. See Lit. Rel. No. 24789 (April 3, 2020).
SEC Enforcement – Filed and Settled Actions
The Commission filed 5 civil injunctive action and no administrative proceedings last week, exclusive of 12j and tag-along actions, discussed below.
Financial fraud: SEC v. Cordes, Civil Action No. 320-cv-00822 (N.D. Tx. Filed April 8, 2020) is an action which names as defendants Jeffrey Cordes, William Aisenberg and Thomas Felton, respectively, the CEO, CFO and senior vice president of Ironclad Performance Wear Corporation. Over approximately eighteen months, beginning in December 2015, Defendants fraudulently inflated the firm’s revenues. Defendants employed a variety of techniques including recognizing revenue: Prematurely, from nonexistent sales, from sales that were not shipped and on cancelled transactions. Defendants took certain steps to conceal their activities. The firm’s filings during the period were false since they reported the falsified revenues. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The action is pending. See Lit. Rel. No. 24792 (April 8, 2020).
Manipulation: SEC v. Leighton, Civil Action No. 1:20 – cv- 10686 (D. Mass. Filed April 7, 2020) is an action which names as defendants Douglas Leighton, Bass Point Capital, LLC, Azure Capital Corp., Michael Sullivan, David Hall, Zachary Harvey, Paul Dutra, Jason Harman and Jessica Geran. Mr. Leighton buys and sells securities. He also controls the entity defendants. As early as 2013 Mr. Leighton began acquiring shares of a privately held firm named MassRoots, Inc. Over time he acquired a controlling interest. By 2015 the stock began to trade in the public markets. Then Mr. Leighton started directing others who had purchased shares regarding the trading and distribution of the securities. In some instances he essentially directed trading through matched and pegged purchases, all with a view toward driving up the prices so that he could sell at a profit. The repeated pattern of pushing the share price and taking profits continued until 2018. Mr. Leighton failed to file the reports of the interests he beneficially held in the stock. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 9(a)(2), 10(b), 13(d) and 16(a). Each of the Defendants agreed to settle. Each is permanently enjoined from violating the Exchange Act reporting provisions cited in the complaint. Defendants Leighton, Bass Point, Azure and Sullivan are enjoined from violating Securities Act Section 17(a) while Defendants Leighton, Bass Point, and Azure are enjoined from violating Exchange Act Section 10(b). In addition, Defendants Leighton and Sullivan are enjoined from future violations of Exchange Act Section 9(a)(2). Mr. Leighton agreed to the entry of an officer and director bar and to pay a penalty of $160,000. Defendants Leighton, Azure Capital and Bass Point are, in addition, enjoined from trading penny stocks, agreed to the entry of conduct-based injunctions and will pay disgorgement and prejudgment interest of almost $1 million. Mr. Leighton settled a follow-on administrative proceeding that bars him from the securities business. Mr. Sullivan also agreed to the entry of a 5 year penny stock bar, to pay a civil penalty of $40,000 and disgorgement and prejudgment interest of $63,228. Finally, the judgments as to Defendants Hall, Harvey, Dutra, Harman and Geran require the payment of penalties of $15,000 each, and disgorgement and prejudgment interest of, respectively, $67,080, $32,720 and $28,906. See Lit. Rel. No. 24791 (April 8, 2020).
Blue sheets/compliance: In the Matter of Cantor Fitzgerald & Co., Adm. Proc. File No. 3-19734 (April 6, 2020). Cantor has been a registered broker-dealer for decades. At times the firm had also been a registered investment adviser. This action focused on a six-year time period beginning in early 2014. During that period the firm repeatedly received requests for electronic blue sheet information from the Commission. Specifically, the firm submitted 14,868 EBS to the agency concerning trade data for 34,884,409 transactions. Each of the submissions was deficient. The submissions contained inaccurate or missing fields relating to firm or customer identifying information such as name and address fields, contra party identifiers, registered representative numbers and opposing broker numbers. For example, the broker submitted incorrect name and address fields for 99% of the transactions. In submitting contra party information 87% of the information was incorrect. And, about 86% of the information regarding registered representatives was incorrect. The submissions also contained inaccurate or missing data in EBS fields relating to information such as average price account, exchange codes and order execution time. For example, the firm reported almost 26 million securities transactions for which 74% where missing the average price account data field. Cantor misreported about 73% of the exchange code identifiers. The broker-dealer failed to detect the errors, at least in part, because it did not have a reasonable process to verify that all of the fields required to be populated included accurate values and information. Yet the firm had a fundamental obligation to submit accurate and complete blue sheet data since it is critical to many of the Commissions operations and duties. Accordingly, Section 17 of the Exchange Act imposes certain record keeping requirements on broker-dealers. Cantor, according to the Order, failed to comply with its obligations. Cantor undertook remedial efforts focused on the issues raised here. To resolve the proceedings Cantor admitted that the facts set forth in the Order and its conduct violated the federal securities laws. The firm consented to the entry of a cease and desist order based on the Section cited above and the related rules and to the entry of a censures. Cantor will also pay a penalty of $3.2 million.
Financial fraud – adviser: SEC v. International Investment Group, LLC, Civil Action No. 19-civ-10796 (S.D.N.Y.) is a previously filed action which named the former investment adviser as a defendant. The Commission’s complaint alleges that the firm overstated the value of certain defaulted loans in its portfolio to conceal losses in its flagship fund. To aid the fraud the adviser doctored certain records. To try and meet investor redemption demands the firm sold at least $60 million in fake trade loans to other clients using false documents. To resolve the matter the firm consented to the entry of a permanent injunction based on Securities Act Section 17(a), Exchange Act Section (b) and Advisers Act Sections 206(1) and (2). The firm also agreed to pay $35 million in disgorgement and prejudgment interest. See Lit. Rel. No. 24790 (April 6, 2020).
Unauthorized trading: SEC v. Engler, Civil Action No. !:20-cv-01625 (E.D.N.Y. Filed March 31, 2020) is an action which names as defendants three employees of a now defunct registered broker-dealer. The employees are Defendants Jonah Engler, Joshua Turney and Hector Prez. Beginning in March 2015 Defendants observed certain operational events at the firm which led them to believe it was going out of business. Over the next three months Mr. Engler directed Messrs. Turney and Prez to place over 4,500 unauthorized trades in about 360 customer accounts. The transactions resulted in about $1.1 million in profits. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24788 (April 3, 2020).
Offering fraud: SEC v. Teshuater, LLC, Civil Action No. 4:20-cv-01187 (S.D. Tx. Filed April 2, 2020) names as defendants the firm, Larry Leonard, Shuwana Leonard and Teshua Business Group, LLC. The Leonard Defendants are married and control Teshuater, a firm supposedly in the business of selling alkaline water. The complaint centers on three schemes. In the first the couple marketed shares of Teshuater, promising outsized returns of up to 3,000%. The sales pitch targeted the local African American Community and raised about $500,000. In the second Mr. Leonard marketed what he called TeshuCoins, a purported cryptocurrency issued by Teshauter that was supposedly backed by the firm. In the third Mr. Leonard sold a high-yield Bitcoin mining program. The investor funds from each venture were comingled. Portions of the offering proceeds were misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24787 (April 2, 2020).
Extensions – COVID-19: The agency extended the comment period on certain rules in view of the COVID-19 pandemic where the comment period is still open in an April 10, 2020 order (here).
Report – crowd-sourcing: The Australian Securities and Investment Commission released a report on crowd-sourced funding intermediaries on April 9, 2020. The report surveyed practices over a one-year period. Its findings are available here.
Survey – Libor: The ASIC released on April 8, 2020 the results of its request for comments on the transition from Libor (here).
Report — LFET: The Securities and Futures Commission published its findings on leveraged foreign exchange trading on April 9, 2020. The report surveyed LFET practices during 2018. The Commission’s findings are here.
Consultation: The Securities and Futures Commission, Hong Kong Exchanges and the Federation of Share Registrars Ltd. jointly released consultations on a proposed operational model for implementing an uncertified securities market in Hong Kong on April 8, 2020 (here).
Financial support: The Monetary Authority of Singapore announced a S$125 million support package to sustain and strengthen the capabilities of financial services firms and the FinTech sector in view of the current economic circumstances on April 8, 2020 (here).