by T. GormanPosted on Posted in SECActions

It began with a trading suspension. Continued the next year with the filing of an enforcement action. Persisted through a preliminary injunction. Now it has largely ended with the settlement of the CEO and CFO with the Commission. It’s the story of Spongetech Delivery Systems, Inc., its principals and attorneys and a huge pump and dump manipulation. SEC v. Spongetech Delivery Systems, Inc., Civil Action No. 10-cv-2031 (E.D.N.Y. Filed May 5, 2010).

Beginning in 1999 Spongetech sold a single product, a pre-soaped sponge. Sales were lackluster. By early 2007 CEO Michael Metter and CFO Steven Moskowitz, along with the company began telling the public about new customers, new sales orders and new revenue Spongetech. The stock price climbed. The tales of new customers and revenues were repeated in filings made with the Commission. The claims were false, according to the complaint.

Stock promoter George Speranza helped boost the climbing stock price with internet websites and virtual office space for the fictitious customers with whom the company claimed to do business. As the stock price increased Messrs. Metter and Moskowitz began distributing 2.5 billion Spongetech shares through affiliate RM Enterprises Inc. and others. The shares were not registered. Attorneys Pensley and Halperin, both named as defendants, facilitated the process with false opinions given to the transfer agent. The restrictive legends were removed from the shares

Illicit profits from stock sales were plowed back into the operation of the scheme, according to the complaint. Messrs. Metter and Moskowitz advertised the company with professional sports teams. Deals were made with teams in Major League Baseball, the National Football League, the National Basketball Association, the National Hockey league and the United States Tennis Association.

By October 2009 Spongetech was delinquent in its periodic filings. There were questions about the reliability of the available financial information. The Commission suspended trading in the shares of the company. See Exchange Act Release No. 60788 (Oct. 5, 2009).

Seven months later the SEC filed a civil injunctive action against the company, its principals, affiliate company and former attorneys. The complaint alleged violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 15(d). At about the same time the U.S. Attorney’s Office for the Eastern District of New York brought criminal charges against Messrs. Moskowitz and Metter.

By July 2010 the company filed for bankruptcy. The next year the Court granted the Commission’s motion for a preliminary injunction against six defendants. Asset freezes against Messrs. Metter and Moskowitz and RM Enterprises were entered.

Now defendants Metter Moskowitz have settled with the Commission. Each consented to the entry of a permanent injunction. Under the orders entered by the Court each man will also be barred from serving as an officer or director of a public company and from engaging in any penny stock offering. The Court will determine the amount of the disgorgement and penalty to be paid by each defendant at a later date. In the parallel criminal case Mr. Moskowitz pleaded guilty to securities fraud. Charges are pending against Mr. Metter. See also Lit. Rel. No. 22586 (Jan. 4, 2013).

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by T. GormanPosted on Posted in SECActions

As rumors swirl that the Director of the SEC’s Enforcement is about to become the latest division director to resign, the critical question is the future path of the Division. One settled case filed at the end of last week and another that will be heard by the Supreme Court on Tuesday may hold some clues.

As last week drew to a close the SEC filed its first enforcement action of the year, SEC v. Nekekim Corporation, Civil Case No. 1:13-cv-00010 (E.D. Calif. Filed Jan. 3, 2013). The complaint is similar to many the SEC has filed in recent months. It centers on an alleged investment fund fraud in which investors were led to believe they could strike it rich purchasing interests in a gold mine. Specifically, the complaint claims that Nekekim, a California based company, and its CEO, president and director, Kenneth W. Carlton, defrauded investors in the U.S. and other countries over an eleven year period beginning in 2001 by selling them interests in a gold mine. Investors were told that the mine had a special “complex ore” at its Nevada site which is worth at least $1.7 billion, according to an analysis made by a physicist.

In fact, the so-called “physicist” had no scientific training, according to the SEC’s complaint, and utilized unconventional methods to conduct his analysis. Investors were not told that the labs’ reliability had been questioned by geologists and a government study. Likewise, they were not told that other firms suggested that Nekekim’s mine actually had little gold. The Commission’s complaint alleges violations of Securities Act Section 5(a), 5(c) and 17(a) and Exchange Act Section 10(b).

Both defendants settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of the Sections cited in the complaint. The company also agreed to disclose these sanctions in any offering of securities made in the next three years. Mr. Carlton agreed, in addition to the injunction, to pay a $50,000 penalty and to an order prohibiting him from selling securities for Nekekim or managing the company.

Nekekim is just one of what is almost a continuous stream of investment fund fraud actions the SEC has brought in recent years. As 2013 unfolds there should be little doubt that this trend will continue.

The sanctions in Nekekim, as in many cases focused not just on the traditional SEC injunction, but also a civil penalty. The ability of the SEC, as well as other government agencies, to impose such penalties may be circumscribed by a case that will be argued on Tuesday before the Supreme Court and decided later this year. Gabelli v. SEC, No. 11-1274.

Gabelli focuses on the application of the five year statute of limitations in Section 2462 of Title 28 to SEC and other government enforcement actions where a penalty is sought. The critical issue before the High Court is when the five year period begins.

The text of the statute provides that an action for the enforcement of any civil penalty “shall not be entertained unless commenced within five years from the date when the claim first accrued.” In the underlying case, the Second Circuit concluded that in a fraud case the time clock does not begin until the claim is, or reasonably could be, discovered by the SEC. The Seventh Circuit has also adopted this approach while the Fifth has rejected it.

The difficulty for the SEC is that Section 2462 does not specify that the commencement of the limitation period is tied to a discovery rule. This is problematic for the agency when arguing before the conservative Robert’s Court which tends to focus on the literal language of the statute. In view of this point the Commission is arguing that the Supreme “Court has repeatedly held that, unless Congress specifies a different rule, the limitations period in a suit for fraud does not begin to run until the plaintiff discovers, or in the exercise of reasonable diligence could have discovered, the facts underlying his claim.” The Commission refines this argument by specifying that it only applies if the claim is fraud. For all other claims the five year time period begins when the cause of action accrues. Success for the SEC thus turns on convincing the High Court to read the statute one way if the claim is based in fraud and another if it is not which no help from the text of the statute.

Whether the SEC can prevail in Gabelli may have a significant impact on its enforcement program. Since the Remedies Act the Division has increasingly relied on civil penalties as the remedy of choice. Indeed, last year the SEC called on Congress to increase the ability of the agency to impose fines. If the Court declines the Commission’s invitation to read a discovery rule into Section 2462 it could delimit the remedies available to the agency in some enforcement actions. That in turn may impact the approach taken during investigations and when instituting enforcement actions. Thus while Nekekim may suggest that the Division will continue to at least in part focus on investment fund fraud actions, Gabelli could alter the overall approach of the Division.

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