A look forward; a look back:
Compliance focuses on today and tomorrow, ensuring that systems and controls are in place so that the firm is not just meeting the minimal legal requirements but, more importantly, aiding with the creation of a positive, beneficial culture. Compliance can, when this is achieved, also be the first line of defense if the SEC, CFTC or another regulator calls or sends a subpoena.
To operate in this manner, compliance must be continually updated, reflecting not just today’s requirements but also those of the future. This can be a daunting task. For example, the SEC, CFTC and FERC have been bringing market manipulation cases, accusing firms with a trading operation of manipulation. In many of these cases the regulator has carefully examined the overall patter of trading the firm has used over a period of time. This permits the regulator to assess if the firm has engaged in condct such as taken losses in one market to benefit a position in another which may create an artificial price. When this occurs the regulator charges manipulation despite the fact that each trade may have been lawful in and of itself.
This regulatory approach can present a unique challenge for compliance which only sees the transactions trade by trade as the positions are put on. Yet it is key that compliance make its assessment as the trading is undertaken. This can only be done if there is a constant assessment of the transactions against the backdrop of a strong culture in which each trader understands that when putting on a trade in the market he or she is actually making a statement that the trader and company are acting honestly, not deceptively. When this type of compliance is installed today it can help protect the firm tomorrow or, at a minimum, serve as a defense for the company.
Finally, looking back, the SEC continued last week to bring the kinds of cases that have typified enforcement this year: Offering frauds; actions centered on investment advisers; and insider trading. While the number of actions filed last week ticked up compared to the week before, it is unclear if the agency is going to try push toward the fiscal year end statistics at this point.
SEC Enforcement – Litigated Actions
Insider trading: SEC v. Avent, Civil Action No. 1:16 – cv-02459 (N.D. Ga.) is an insider trading action in which the Commission obtained a favorable jury verdict after settling with other defendants. The action centered on three different acquisitions. Named as defendants were Thomas W. Avent, Jr., a partner in an international accounting firm, Raymond J. Pirrello, Jr., a registered representative at a brokerage firm, and Lawrence J. Penna, a client of Mr. Pirrello who has been barred from the securities business by the Commission. Messrs. Avent and Penna settled with the Commission prior to trial.
In 2011 and 2012 Mr. Avent learned about three different then pending merger transactions. Specifically, Mr. Avent lead a practice group during the period which conducted due diligence on corporate acquisitions. Mr. Pirrello told his long-time friend and former co-worker at another brokerage firm, about each of the transactions. In certain instances, the two men discussed their insider trading activities in text messages. For example, they exchanged texts during one deal discussing the number of shares “we” acquired and the amount of money made. During another transaction they considered if more shares should be acquired. Mr. Pirrello paid his friend $50, 000 in cash. In addition, he provided investment advice and serviced his brokerage account.
Mr. Pirrello also passed the information to Defendant Penna, a client and friend. Mr. Penna in turn paid for the information. For example, in one instance he paid $7,000 toward the broker’s American Express bill. On another occasion he paid $14,500 toward the bill. Following trial, the jury found in favor of the Commission, concluding that Mr. Pirrello was liable for violations of Exchange Act Sections 10(b) and 14(e). The Court will consider remedies at a later date. See Lit. Rel. No. 24554 (August 7, 2019).
SEC Enforcement – Filed and Settled Actions
The Commission filed 6 civil injunctive actions and no administrative proceedings this week, exclusive of 12j and tag-along actions.
Offering fraud: SEC v. Heide, Civil Action No. 0:19-cv-62047 (S.D. Fla. Filed August 15, 2019) is an action which names CPA Alan Heide, the CFO of 1 Global Capital LLC, as a defendant. Over a four year period, beginning in February 2014, Defendant and his firm raised over $322 million from over 3,600 in investors across the U.S. The firm used a network of sales agents to sell unregistered securities supposedly to fund short-term financing for small and medium sized business. Investors were promised high returns and low risk. In fact, much of the investor capital was used to cover operating and personal expenses. During the period the CFO knew that the firm’s financial resources were being depleted. He regularly signed investors monthly account statements that were false since they misrepresented the status of the account and of the company. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending.
Digital offering: SEC v. Middleton, Civil Action No. 1:19-cv-04625 (E.D.N.Y. Filed August 12, 2019) is an action which names as defendants, Reginald Middleton, a self-styled financial guru, and two firms he founded, Veritasem, Inc., and Veritasem, LLC. Beginning in 2017, and continuing through early 2018, Defendants raised about $14.8 million through an ICO for a digital coin they called the VERI. The coins were sold in an unregistered offering which Defendants attempted to disguise as involving “pre-paid fees” or “software” rather than digital securities. Supposedly there were products ready to ship which would create large returns. All of these statements were false. During the ICO phase of the transactions Mr. Middleton also engaged in manipulative trading on a digital asset platform in an effort to raise the price. When the staff told the then potential Defendants that an enforcement action was about to be recommended, they began moving cash from the firm. This action was brought to secure an emergency freeze order. It alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 9(a)(2) and 10(b). A freeze order was entered by the Court. The case is pending.
Insider trading: SEC v. Nahata, Civil Action No. 1:19-cv-03628 (N.D. Ga. Filed August 12, 2019). The complaint names as defendants Harsh Nahata, a manager in the corporate development group at WestRock Corporation, and a person he calls his “mentor,” Ajay Bhandari. The case centers on the acquisition by WestRock of KapStone Paper and Packaging Corporation, announced on January 29, 2019. The transaction traces to June 2017 when the CEO of WestRock directed a group to prepare an independent valuation of the potential deal. From the beginning, Mr. Nahata was a member of the deal team for the project which was code named “Project Kola” to preserve confidentiality in accord with firm policies. In early January, Defendant Nahata asked his broker about the manner in which purchased shares were held — would the company know if he owned the shares? The broker told him the shares would be in “street name” and forwarded materials. Subsequently, Mr. Nahata opened a second brokerage account and continued to purchase shares.
As the deal progressed Mr. Nahata met the man he would later call his “mentor,” Ajay Bhandari. In January, during a family vacation to India, the two men had lunch. On the first trading day after his return to the U.S. Mr. Bhandari purchased shares of KapSrtone. He continued to acquire shares of the company prior to the deal announcement using borrowed funds at one point.
Following the deal announcement WestRock conducted an internal investigation. Mr. Nahata was questioned. While he answered questions regarding his role on the deal team, he invoked his Fifth Amendment privilege as to all questions regarding purchases of the stock. Following the meeting he fled to India. The complaint alleges violations of Exchange Act Section 10(b). The case is pending as to Mr. Nahata. Mr. Bhandari settled with the Commission, consenting to the entry of a permanent injunction based on the section cited in the complaint. He also agreed to pay disgorgement of $22,426, prejudgment interest of $1,233 and a penalty equal to the amount of the disgorgement. See Lit. Rel. No. 24562 (August 14, 2019).
Insider trading: SEC v. Tsai, Civil Action No 1:19-cv-07501 (S.D.N.Y. Filed August 12, 2019). Bill Tsai was a college student moving toward graduation with a summer internship at an International Investment Bank in New York City. As the summer drew to a close the internship ended. Bill was handed an offer letter for a full-time position as an analyst at the Investment Bank. The position would start after his graduation from college in May 2018. The offer letter reiterated what he had learned earlier – confidentiality was essential and trading on inside information prohibited. The eager intern accepted the offer. Following graduation Bill Tsai began his new career. The Bank had him execute a copy of its confidentiality and insider trading policy and told him to only trade through two accounts after preclearance. The new employee failed to disclose on the forms that he had another brokerage account, not once but twice. During his work at Investment Bank Bill Tsai was essentially in a stream of material non-public deal information. He learned about a pending leveraged buyout deal by Firm A, by a Client of the Bank. Later, just before the deal was announced, Mr. Tsai purchased options on the deal target through his unauthorized account. After the deal was announced the positions were sold, yielding profits of over $98,000. The complaint alleges violations of Exchange Act Section 10(b). That case is pending. The U.S. Attorney’s Office for the Southern District of New York announced a parallel criminal case. That case is also pending. See Lit. Rel. No. 24568 (August 16, 2019).
Excessive fees: SEC v. Frost, Civil Action No. 8:19-cv-01559 (C.D. Cal. Filed August 13, 2019) is an action which names as defendants Steward Frost and the firm he founded, Frost Management Co., LLC, formerly an exempt reporting investment adviser. Over a four year period Defendants breached their fiduciary duty and defrauded investors by charging undisclosed and excessive fees. Specifically, Mr. Frost and the adviser raised almost $63 million for a series of what were supposed to be start-up firms that were using the so-called “Frost incubator model.” In fact, Mr. Frost was charging excessive fees to fund his lifestyle by convincing investors that their capital was going into a series of start-ups. When Mr. Frost needed additional capital, he simply created another start-up and began charging more fees. The complaint alleges violations of Advisers Act Sections 206(1), 206(2) and 206(4). The action is pending.
Investment fraud: SEC v. Bravata, Civil Action No. 19-cv-12387 (E.D. Mich. Filed August 13, 2019) is an action which names as a defendant Antonio Bravata, who was previously charged by the Commission in connection with a $50 million Ponzi scheme for which he was criminally convicted and served 5 years in prison. While on supervised release Mr. Bravata began a new venture modeled on his prior scheme. The staff discovered the plan. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3). Mr. Bravata resolved the action by consenting to the entry of a permanent injunction based on the Sections cited in the complaint and to a conduct-based injunction that prohibits him from participating in the issuance, purchase or sale of any securities to the public. He will also pay a $75,000 penalty. See, Lit. Rel. No. 24559 (August 13, 2019).
Offering fraud: SEC v. Duncan, Civil Action No. 1:19-cv-11735 (D. Mass. Filed August 12, 2019) is an action which names as a defendant Richard Duncan who has been an adviser representative for a number of advisories. Beginning in late 2016, and continuing until late 2018, he convinced clients and third parties that a woman living in Turkey was expected to inherit as much as $6 million and that he would be able to manage the funds if he could pay the legal fees. Mr. Duncan convinced at least two elderly retail investors to put their money into this illusion, promising a 100% return. One client put up $250,000. Another invested over $28,000. The investors have not received any return. Defendant has not offered any documentation to support his claims. The complaint alleges violations of Advisers Act Sections 206(1) and 206(2). The case is pending. See Lit. Rel. No. 24558 (August 12, 2019).
Manipulation: SEC v. Bruns, Civil Action No. 1:18-cv-06257 (S.D.N.Y.) is a previously filed action in which Mark Burns essentially manipulated the shares of Fitbit by purchasing call options just minutes before his co-schemer filed a fake tender offer for the firm’s shares on EDGAR. The scheme netted $13,000 in profits. This week Mr. Burns consented to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 10(b) and 14(e) and Securities Act Section 17(a). He also agreed to pay disgorgement and prejudgment interest of $13,886 and a civil penalty of $60,000. See Lit. Rel. No. 24557 (August 12, 2019).
Remarks: Commissioner Cathie Armour delivered remarks titled Redefining Conduct in FX Markets, Sidney (August 14, 2019). Her remarks focused on the Commission’s new enhanced supervision requirements (here).
Internal controls: The Securities and Futures Commission fined Sincere Securities Ltd. $5 million for a series of internal control failings and regulatory breaches. Specifically, after concluding that the firm did not properly monitor account representative actions with respect to clients, an independent consultant was retained at the request of the SFC. The consultant concluded that: 1) The Compliance and Procedural Manual was outdated and failed to include new regulatory requirements; 2) failed to filter, analyze and monitor staff dealings; 3) did not properly segregate sales, dealings and settlement functions; and 4) had no written procedures to prevent staff from receiving client order instructions through a mobile phone while on the trading floor.
Monetary Authority of Singapore
Crypto: The Monetary Authority of Singapore issued a “Warning on Fraudulent Website Soliciting Bitcon Investments. The warning is based on information obtained by MAS suggesting that “fabricated comments attributed to Prime Minister Lee Hsien Loong” have been used in attempts to impersonate a news page from local media organization.