AN INVESTMENT FRAUD NOT A PONZI SCHEME

Post-Madoff, the SEC seems to have brought an almost endless stream of Ponzi scheme cases. The once virtually impossible-to-detect frauds appear to be surfacing everywhere. When that happens, the SEC and at times DOJ and the CFTC, have been there to file actions. Whether this is the result of the market crisis, the Madoff debacle or some other reason is unclear. Unfortunately what is clear is the almost continuous stream of cases in which unwitting investors have been fleeced with the same too-good-to-be-true claims. Perhaps in the future more potential investors will save their hard earned money after reading Erin Arvedlund’s new book, Too Good to Be True, about the world’s largest Ponzi scheme.

In this rash of Ponzi scheme cases, almost lost is the fact that there is a vast array of other types of investment fraud taking place in which investors get fleeced. One is the old fashion unregistered stock scheme pushed on the public with press releases, a call room and false claims. Such is the case of Big Apple Consulting. SEC v. Big Apple Consulting USA, Case No 6:09-cv-1963 (M.D. Fla. Filed Nov 18, 2009). See also SEC v. Grocock, Civil Action No. 09-cv-1833 (M.D. Fla. Filed Oct. 29, 2009) (outside general counsel was accused of insider trading) discussed here.

The key players in this too good to be true (to borrow Ms. Arvedlund’s title) scheme are: CyberKey Solutions, Inc., a company which once sold flash memory drives, and its former CEO, James Plant; Big Apple Consulting USA, Inc., a public relations firm and its president and co-founder, Marc Jablon; its subsidiary MJMM Investments, LLC; and CyberKey’s former outside counsel Bennett Grocock.

The public was sold millions of dollars of unregistered CyberKey shares from November 2005 through 2007 based on a lie, according to court papers. During the approximately two year period, investors were solicited to purchase shares based on a claim that CyberKey had obtained a $25 million purchase order from the U.S. Department of Homeland Security. It had not.

In June 2005 however, CyberKey and Big Apple entered into an agreement under which the PR firm would promote the company based on its false claim about the HHS contract. As part of the agreement, MJMM could acquire an unlimited number of shares at 50% of the market price, which were later distributed to the public.

Under the agreement Big Apple provided CyberKey an all-inclusive campaign. This included issuing press releases, web site design and investor relations. To promote CyberKey unregistered shares to investors, Big Apple used a telephone calling room employing between 14 and 50 callers to interested registered brokers. Press releases were also issued touting the company. When potential investors called in response to the press releases, they were sent to the brokers to purchase unregistered shares. During this process, Big Apple and MJMM acted as brokers by participating securities transactions during the distribution as well as dealers by participating in an underwriting, although the shares were never registered, according to the SEC. The sales were made based on claims that CyberKey had obtained non-existent Homeland security contract.

By mid-2006, Big Apple knew, or were reckless in not knowing, that CyberKey’s supposed main asset, the claimed DHS contract, did not exist. Despite learning this fact, Big Apple continued to promote the shares of CyberKey. Millions of shares were sold to the unsuspecting public.

During the course of the scheme Mr. Grocock, the outside counsel to CyberKey, also sold unregistered shares to the public. Those sales, made while the company was under investigation by the SEC, then-NASD and the Utah Division of Securities, continued until the president of the company was arrested. The investigations had not been disclosed. Mr. Grocock was charge by the SEC with insider trading in a case which he settled.

In the current action Big Apple, Mr. Jablon, Matthew Maguire, its vice president, Mark Kaley, the corporate secretary and Keith Jablon, vice president of a Big Apple subsidiary and MJMM and its president Mark Kaley were named as defendants. The complaint alleged violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See also Litig. Rel. 21305 (Nov. 18, 2009).

TWO FINANCIAL FRAUD CASES, ONE COMPANY

The SEC filed two cases yesterday stemming from an alleged financial fraud at Tvia, Inc., a Silicon Valley semiconductor company. One was against Benjamin Silva, III, the former Vice President of World Wide Sales at the company. SEV v. Silva, Case No. 09-5395 (N.D. Cal. Filed Nov. 17, 2009). This case is in litigation. The second named as a defendant Diane Bjorkstrom, former CFO of the company. SEC v. Bjorkstrom, Case No. 09-5394 (N.D. Cal. Filed Nov. 17, 2009). This case settled.

The action against Mr. Silva alleged that he caused the company to falsify its financial books and records in two ways. First, over a period of almost two years beginning in September 2005, he caused the company to improperly report millions of dollars in revenue on sales. That revenue should not have been reported because the sales had side agreements in which the customer was promised extended payment terms. Those agreements also obligated Tvia to find a buyer for any product the customer was unable to sell.

Second, Mr. Silva had the company misapply about $300,000 in payments from new customers. Those payments were used to pay down the past due accounts of existing customers. Mr. Silva was seeking to avoid the reversal of previously recognized revenue by misleading the auditors.

As a result, Tvia materially overstated revenue for the second and third quarters of fiscal 2006 and for fiscal year end 2006. In addition, revenue was materially overstated for the first quarter of fiscal 2007.

Mr. Silva’s misconduct permitted him to meet his revenue goals, according to the SEC. He also was awarded stock options to acquire 70,000 shares of Tvia stock. Before the misconduct was discovered, those options were exercised and the stock was sold. Mr. Silva netted over $300,000.

The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). In addition, it asserts false statements to the auditors and aiding and abetting violations of the books and records and internal controls provisions.

The action against Ms. Bjorkstrom alleges that she participated in the misconduct at the company in two ways. First, she caused the company to improperly recognize $325,000 in revenue on a sale on the last day of the fiscal year. Recognition was improper because the customer had not agreed to accept delivery for several weeks.

Second, Ms. Bjorkstrom failed to “stand up” to efforts by Mr. Silva when he manipulated the accounting records to deceive the outside auditors, according to the complaint. In at least two instances Mr. Bjorkstrom did not “challenge Silva’s dubious explanations” when he asked her and others to apply funds from one customer to the past due payments of another customer. These acts contributed to the overstatement of revenue for the fiscal year end 2006 financial statements and the first quarter of the next year.

The Commission’s complaint alleged violations of Securities Act, Sections 17(a)(2)&(3) and aiding and abetting violations of the books and records and internal control provisions. It also claims that she signed false CFO certifications.

To settle with the Commission, Ms. Bjorkstrom consented to the entry of a permanent injunction prohibiting future violations of the sections alleged in the complaint. She also agreed to pay a civil penalty of $20,000 and to the entry of an order barring her from appearing or practicing before the Commission as an account for two years. See also Litig. Rel. 21302 (Nov. 17, 2009).