“Blockchain” Deal Spikes Share Price, SEC — Illegal Trades Yield $27M
The Commission and the senior staff, along with other regulators, has repeatedly expressed concern regarding the lack of investor protections coupled and the hype surrounding all things cryptocurrency related. In one speech, for example, Chairman Clayton made it more than clear that market professionals – securities lawyers, accountants and others – have an obligation to ensure that the investor protections of the federal securities laws are available to potential investors where applicable, invoking the long standing mantel of the gatekeeper theory. In those remarks the Chairman decried those who would add terms like “blockchain” to the firm name to take advantage of the hype surrounding this technology (here). Yet the SEC’s most recent enforcement action in the area is a virtual clone of the concerns express by the Chairman. SEC v. Longfin Corp., Civil Action No. 18 CV 2977 (S.D.N.Y. Filed April 4, 2018).
This action centers on the sale of over $27 million unregistered shares of Defendant Longfin by its affiliates between December 2017 and February 2018 and the spike in the firm’s share price by over 2000% in December 2018 after the firm acquired the rights to use the website using the term “blockchain.” Defendant Longfin was incorporated on February 1, 2017. At the time it had total assets of just under $300,000, total liabilities of just under $294,000 and cash of $75. The assets were largely trade receivable; the liabilities were largely trade payables.
Defendant Venkata Meenavalli, the firm’s founder who served as Chairman and CEO, controls over 20% of the Class A shares and over 50% of the voting equity; together with his wife he also owns about 17% of the voting stock of Stampede Capital Ltd, a public company in India, that owns about 27.6% of the voting stock of Longfin; Defendant Amro Izzelden Altahwi is the president of ipoflow.com, a website that claims to be a leading equity Reg A+ offerings platform; Defendant Suresh Tammineedi is affiliated with Longfin’s Chairman through several entities, including as a director of Stampede Capital Ltd.; and Defendant Dorababu Penumarthi is a UK resident affiliated with Longfin’s Chairman through Smartahead Solutions Ltd.
The SEC furnished three notices of qualification under Regulation A, an exemption from Securities Act Section 5 registration under certain circumstances, to Longfin. The first was on June 16, 2017, the second October 11, 2017 and the third November 22, 2017. Between the first two notices the company completed the acquisition of Stampede Tradex, a subsidiary of Stampede, for $16 million. The subsidiary operated an electronic platform for trading commodities and securities.
On November 22, 2017 – the date of the third Reg A notice – the company registered its shares for trading under Exchange Act Section 12(b) with the Commission. By December 11, 2018 – two days before trading began, Longfin had sold about 1.1 million shares under its Reg A offering.
Longfin’s Class A shares began trading on December 13, 2017, opening at $6.94 per share and closing at $5.17 per share. Two days later, on December 15, 2017, the company filed a Form 8-K which attached a press release stating that it had acquired Ziddu.com from Meridian Enterprises Pte.Led., an entity controlled by Longfin’s Chairman, Defendant Meenavalli, Ziddu.com was a “blockchain-empowered solutions provider” that “offers a variety of sources, including microfinance lending against collateralized warehouse receipts in the shape of Ziddu coins,” according to Longfin. Prior to the acquisition the Ziddu.com website “had no ascertainable value,” according to the complaint. Longfin only acquired the right to use the website and trade name. The company assigned $0 value to this acquisition as of the deal date.
Longfin’s share price spiked following the filing of the Form 8-K. By December 18, 2017 the stock price reached a high during trading of $148.82 per share, up over 548% from the prior day’s close and about 2,662% over the closing price from the first day of trading.
The company was required to file its first periodic report with the Commission on or before January 9, 2018. It did not. Aside from the Form 8-K the firm did not file any periodic reports until after the first quarter of 2018. Nevertheless, between February 8, 2018 and March 23, 2018, Defendant Altahawi sold 475,751 shares of Longfin for proceeds of over $25.5 million. He had acquired shares in essentially two transactions. The first was on September 15, 2017 through a transfer from the Company and Mr. Meenavai in his capacity as corporate secretary for services. The second was through private transactions with ten individuals in the first quarter of 2018. The shares sold were restricted; there was no effective registration statement and no exemption available.
Defendants Tammineedi and Penumarthi engaged in similar transactions. Mr. Tammineedi acquired 30,000 shares from Longfin on December 6, 2017 but failed to fund the subscription agreement as required. The shares were restricted. Although he tried to transfer the shares to a brokerage account in the name of Source Media Limited, a nominee entity, the broker rejected the transaction. On December 13 and 14 however, Source Media purchased 67,000 Longfin shares in the open market at an average price of $5.48 per share. Beginning on December 15, and continuing through February 9, 2018, the shares were sold into the market, yielding profits of about $2.7 million. Most of the sale proceeds were wired to Singapore. During the period Longfin had not disclosed sufficient information for any exemption from registration to be available, according to the complaint.
Defendant Penunarthi acquired 40,000 Longfin shares from the company on December 6, 2017. He never transferred funds to the escrow agent to pay for the shares as required by the subscription agreement. He was an affiliate of Longfin and/or nominee of Meenavalli – the two men were both directors of Smartahead Solutions Ltd. Mr. Penumarthi was also the UK head of operations for the company at the time according to his post on Facebook. Despite the fact that no exemption from registration was available, on January 23, 2018, Mr. Penumarthi sold 4,000 shares of Longfin for just over $168,000. The complaint alleges violations of section 5 of the Securities Act. The Commission obtained a court order freezing the trading proceeds. The case is pending.