by T. GormanPosted on Posted in SECActions

The Commission lost another case at trial earlier this month. The Court’s conclusions, as well as the Commission’s mixed results in recent court actions (here), raises disturbing questions about the effectiveness, methods and direction of the enforcement program.

This loss came following a bench trial in an action against Kenneth R. Kramer who is one of several defendants in the case. SEC v. Sky Way Global LLC, Case No. 8:09-cv-445 (M.D. Fla. Filed March 13, 2009). The underlying action centers on a pump-and-dump scheme. The SEC did not claim that Mr. Kramer was involved in the scheme which is at the center of the complaint. See also Lit. Rel. No. 20960 (March 18, 2009).

The SEC complaint: The complaint says little about Mr. Kramer until the end. The final three paragraphs of the 25 page document claim that Mr. Kramer was retained by defendant Baker to locate investors for Sky Way. Mr. Baker, the Commission alleged, located the public shell which used in a reverse merger to create Sky Way, the company whose shares were alleged to have been pumped and dumped.

According to the complaint Defendant Baker and Mr. Kramer had an agreement under which he would use six sales agents to find investors. In return Mr. Kramer would earn a 10% commission on any sales of Sky Way stock. Mr. Kramer prepared charts summarizing the sales activities which were given to Mr. Banker and others. Overall he was paid $915,000 composed of $200,000 in cash with the balance in Sky Way stock. The complaint claims Mr. Kramer violated Exchange Act Section 15(b). It requested the entry of a permanent injunction, disgorgement and prejudgment interest, a civil penalty and a penny stock bar.

The Court’s findings of fact: Following a bench trial the Court found that Mr. Kramer had known defendant Baker for about twenty years. Over time the two men had collaborated on various projects. In August 2003 Mr. Kramer executed a cooperation agreement with a company controlled by Mr. Kramer. Under that agreement they would cooperate in presenting each other with prospective merger and acquisition candidates, potential sources of investment and venture capital and other business opportunities. At the time Mr. Baker’s company had an agreement with Sky Way under which it would earn a 5% commission on money raised for the company, any merger and the total value of any contract brought to it. Mr. Baker was one of an array of independent contractors retained by the company to facilitate locating technology, merger candidates, venture capital and similar items.

At some point, the Court found, Mr. Kramer was introduced to Sky Way. He understood that the company would pay him for introducing investors to the company. Because Mr. Kramer thought the company was a good investment he purchased shares and recommended them to his friends. They also purchased shares. When Mr. Baker asked him for records of the purchases he prepared documents depicting the transactions.

Conclusions of law: Exchange Act Section 15(b), the Court noted, makes it unlawful for “any broker or dealer . . to make use of the mails or any other means . . . of interstate commerce . . .” to effect any transactions . . . to induce the purchase or sale of any security . . “ unless registered with the SEC. A broker is defined in the statute to be “any person engaged in the business of effecting transactions in securities for the accounts of others.”

The key concepts of “effecting transactions” and “engage[ing] in the business” are not defined. A six factor test is generally considered in analyzing the question. Those factors consider if the person: 1) works as an employee of the issuer; 2) receives a commission; 3) sells or earlier sold the securities of another issuer; 4) participates in negotiations between the issuer and investor; 5) provides either advice or a valuation as to the merits; and 6) actively rather than passively finds investors. None of these factors is dispositive. Indeed, recommending a particular investment or participating in negotiations “typically occurs in an array of different commercial activities and professional pursuits, including brokering” the Court found.

A series of cases have carved out a so-called “finder’s exception” to the registration requirement. Under the exception merely bringing parties together,r even if it involves the purchase and sale of a security, is not enough to require registration under Section 15(a). Rather, the Court noted the evidence must establish that the alleged broker participated at key points in the chain of distribution such as in the negotiations, analyzing he issuer’s financial needs, discussing the details of the transaction and recommending the investment. Even when the finder receives a commission based fee the Commission has concluded in a series of no-action letters that this is not enough standing alone the Court concluded.

In this case Mr. Kramer’s conduct “consisted of nothing more than bringing together the parties to a transaction. The Commission presented no evidence that Kramer either participated in the negotiations, discussed the detail of the transaction, analyzed the financial status of Skyway, or promoted an investment in Skyway to . . . “ investors according to the Court.

Mr. Kramer did receive compensation from defendant Baker based on the sales of stock. In urging that this demonstrates defendant Kramer acted as a broker, the SEC argued that the identity of the people involved the transactions, and Mr. Kramer’s relation to them, is not relevant. The Court found that Mr. Kramer’s activities in this case were limited to “(1) sharing his opinion that Skyway was a good company and a good investment and (2) directing attention to Skyway’s web site and press releases. Some of Kramer’s intimate friends and family (1) purchased Skyway shares and (2) talked to other people about Skyway.” The Commission failed to present any evidence to the contrary.

Finally, the Court rejected the SEC’s argument, based on the 2010 no-action letter Brumbert, Mackey & Weil, that transaction based compensation without more is sufficient. This no-action letter “cannot serve ex post facto as the basis for condemning conduct that occurred from 2003 to 2005. Furthermore, The Commission’s proposed single-factor ‘transaction-based compensation’ test for broker activity . . . is an inaccurate statement of the law both in 2003 and in 2011.” The Court found the defendant not liable.

That the SEC again lost in court raises questions. That the court found almost a total lack of evidence to support the minimal allegations of the complaint raises even more. Misstatements of basic points of securities law and an attempt to apply it in an unfair manner however suggests a “win at all costs” mentality which ill-befits the Commission’s enforcement program or its goals of bringing a new ethics to the market place.

by T. GormanPosted on Posted in SECActions

As the Galleon insider trading trial draws to a close and the Lindsey FCPA trial moved forward in the Central District of California, one of the few senior executives charged in a market crisis case was found guilty by a jury after a ten day trial. SEC enforcement brought actions based on an undisclosed related party transaction, obtained the appointment of a receiver in an investment fund fraud action and settled with the remaining defendants in an insider trading case which began as an action against unknown investors. Finally, FINRA indefinitely suspended a firm and its president.

SEC Enforcement

Related party transactions: SEC v. Phillips, Civil Action No. 1:11 CV 422 (E.D. Va. April 20, 2011) is a settled action against Terry Phillips, the chairman of the board of SouthPeak Interactive Corporation which develops and publishes video games for a number of video game platforms including the PlayStation, xBox and Wii devices. According to the complaint in February 2009 the company ordered additional units from a video game manufacturer but lacked sufficient funds to pay for the purchase. Mr. Phillips advanced $304,440 of his personal funds to pay for the units. In doing so he failed to bring it to the attention of the audit committee. The transaction was not disclosed as a related party transaction in the 10Q for the quarter ended March 31, 2009. Mr. Phillips also signed an management letter representing to the outside auditors that all related party transactions had been disclosed when they had not.

To settle the case Mr. Philips consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Rule 13b2-2 which prohibits officers and directors from making false statements to the auditors and from aiding and abetting violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). He also agreed to pay a civil penalty of $50,000 and to the entry of an order requiring him to comply with a cease and desist order entered May 2007 which requires him not to violate certain provisions of the securities laws.

In a related administrative proceeding the company consented to the entry of a cease and desist based on Exchange Act Section 13(a). Respondent Patrice Strachan also settled. She is the former v.p of operations who knew of the transaction, was responsible for the proper recording of transactions and instructed her subordinate not to tell the CFO about it. Ms. Strachan consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). She also agreed to pay a civil penalty of $10,000. In the Matter of Southpeak Interactive Corporation, Adm. Proc. File No 3-14350 (April 21, 2011).

Unregistered securities: SEC v. Martin, Civil Action No. 09-cv-05259 (N.D. Ill.) is an action against Duane Martin and Gary Trump. The complaint asserts fraud claims against Mr. Martin, the former CEO of now defunct Universal Food & Beverage, Inc. He previously settled with the SEC after pleading guilty on criminal charges and being sentenced to prison. As to Mr. Trump the complaint alleged he violated the registration provisions by improperly issuing S-8 stock to stock promoters and Mr. Martin’s personal creditors. Mr. Trump resolved the claims against him by consenting to the entry of a permanent injunction prohibiting future violations of Securities Act Section 5 and agreeing to pay disgorgement of $69,976.27 along with prejudgment interest. A penalty was waived based on financial condition.

Investment fund fraud: SEC v. Commodities Online, LLC, Civil Action No. 11-cv-60702 (S.D. Fla. Filed April 21, 2011) is an action against the named company and Commodities Online Management, LLC. Beginning in January 2010 Commodities Online sold participation units and membership units in commodities contracts. Commodities Online claimed to have at least $24 million from investors in units and another $2.4 million in memberships. Defendants told investors that the investments were safe because they only purchased contracts after arranging for a buyer and seller. Profits were made from the spread. Investors were suppose to earn 5% per month without speculation. In fact much of the money was diverted to companies controlled by the principals of the defendants and there were no profits. The complaint alleged violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The defendants consented to the appointment of a receiver and to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint and to pay disgorgement, prejudgment interest and a civil penalty as determined by the court.

Insider trading: SEC v. Di Nardo, Case No. 08 CV 6609 (S.D.N.Y. Filed July 25, 2008) is an action initially filed against unnamed traders. The amended complaint named as defendants: Gianiuca Di Nardo; his investment vehicle Corralero Holdings, Inc.; Oscar Ronzoni, an Italian citizen who worked for a company that provides business consulting services; Paolo Busardo, also an Italian citizen who is a professor of economics at a university; Tatus Corporation, an investment vehicle affiliated with Messrs. Ronzoni and Busardo; and A-Round Investment SA, a consulting firm controlled by Mr. Busardo.

The amended complaint clamed that defendants Di Nardo and Carralero Holdings traded in American Power options through an omnibus account at UBS AG, Zurich, Switzerland shortly prior to a takeover announcement in October 2006. It also alleged that each of the defendants traded through the same omnibus account in DRS Technologies shortly before an announcement in October 2006 that the company was in discussions to be acquired. The first set of trades resulted in a profit of $1.7 million while the second netted the traders about $1.6 million.

Mr. Di Nardo and Corralero Holdings settled at the time the amended complaint was filed. Each consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). The order also made them jointly and severally liable for the payment of $2,110,6000 in disgorgement along with prejudgment interest and a civil penalty of $700,000. This week the Commission concluded the litigation settling with the remaining defendants. Each consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b). The order specifies that they are jointly and severally liable for the payment of $967,699.97 in disgorgement along with prejudgment interest and a civil penalty of $483,849.99.

Investment fund fraud: SEC v. Art Intellect, Inc., Case No. 2:11-CV-00357 (D. Utah Filed April 18, 2011) is an action against the company and its principals, Patrick Brody and Laura Roser. The defendants obtained over $2.5 million from about 75 investors who were told that the funds would be invested in distressed real estate which would be rehabilitated and resold. Investors were promised returns of 10 to 30% per month. In fact the funds were used to support the life style of the individual defendant. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The Commission obtained a TRO, asset freeze and the appointment of a receiver.

Criminal cases

Investment fund fraud: U.S. v. Mazella (E.D.N.Y. Unsealed April 21, 2011) The indictment here charges Joseph Mazella with securities fraud, wire fraud and money laundering. Mr. Mazella solicited investments in Third Millennium enterprises, Inc. and 150 West State Street Corp from 2007 through 2010. Investors were told their funds would be put in various real estate projects. Over a three year period the defendant raised about $12 million. Mr. Mazella stopped investing in real estate shortly after he began operations and ran the operation as a Ponzi scheme. The case is in litigation.

Looting: U.S. v. Farkas (E.D. Va.). Lee Farkas, former Chairman of mortgage lender Taylor, Bean & Whitaker was found guilty by a jury following a ten day trial. Specifically, the jury found Mr. Farkas guilty on one count of conspiracy to commit bank, wire and securities fraud, six counts of bank fraud, four counts of wire fraud, and three counts of securities fraud. Sentencing is scheduled for July 1, 2011. The charges centered on the billion dollar fraud which lead to the collapse of Taylor Bean and its lender, Colonial Bank. Mr. Farkas and his coconspirators were alleged to have essentially kited checks in multiple Colonial accounts to cover the increasing cash deficits at the company, sold $1.5 billion in largely worthless securities to the bank, defrauded holders of commercial paper issued by a credit facility and trying to defraud the TARP program.

FINRA

Pinnacle Partners and its president, Brian Alfaro, were suspended indefinitely by FINRA for violating a temporary cease and desist order entered against the firm and its president in a proceeding. In that action it was alleged that Pinnacle and Mr. Alfaro were operating a boiler room in which thousands of cold calls were made each week to sell oil and gas interest using fraudulent misrepresentation.