A look forward; a look back:

The Commission appointed a new member to the Board of the PCAOB this week in the wake of another member’s term expiring. SEC Commissioner Hester Price will lead the agency efforts with the Board. The Commission also formed a new Asset Management Committee to advise it on topics related to investing.

Enforcement focused on issues relating to markets and trading. One of the few new actions initiated centered on the sale of binary options. Those securities are generally considered to be very high risk. They are banned in some countries as gambling.

The agency also resolved a case involving a broker and its founder who were charged with aiding and abetting a market manipulation by a foreign national. The trader was layering, generally considered a form of manipulation. The broker was alleged to have aided and abetted the fraud by giving the trader market access.

SEC

Investors: The Commission announced new educational videos aimed at assisting investors spot and avoid fraud (Oct. 11, 2019)(here).

Committee: The Commission announced the formation of the asset management advisory committee. The Committee will advise the agency on topics such as trends and developments impacting investors, the impact of globalization and changes in the role of technology (Oct. 9, 2019)(here).

SEC Enforcement – Filed and Settled Actions

The Commission filed 2 civil injunctive actions and 1 administrative proceeding last week, exclusive of 12j and tag-along actions.

Binary options/registration: SEC v. Senderov, Civil Action No. 19-cv-5242 (E.D. WA. Oct. 9, 2019). The action names as defendants Anto Senderov and Lior Babazar, both of whom are citizens of, and believed to be residents of, Israel. Defendants own or control two unregistered internet offering binary options brokers and a call center that solicits investors. The solicitations took place over a three- year period, beginning in January 2014. The two brokerage firms described binary options as profitable investments for all investors, including those with little or no experience. To persuade investors to put their capital into the options the call center made a series of misrepresentations. Investors were told by the call center that they could make large profits working with its experienced professionals. In fact, those at the call center were instructed to lie. Defendants also failed to disclose that the option firms had an interest in investors failing to make money. Through these solicitations Defendants obtained millions of dollars from investors. The complaint alleges violations of Securities Act Section 5 and Exchange Act Section 20(a) tied to violations of Exchange Act Sections 15(a) and 10(b). The case is pending. See Lit. Rel. No. 24641 (Oct. 9, 2019).

Conflicts/misrepresentations: SEC v. Conrad, Civil Action No. 1:16-cv-2572 (N.D. Ga.) is a previously filed action which named as a defendant Thomas Conrad, Jr., the operator of a hedge fund and feeder fund. Last week the Court entered a final judgment against Mr. Conrad based on its earlier grant of summary judgment in favor of the Commission. That ruling was based on allegations that Mr. Conrad permitted redemptions by family members while denying that right to other investors over a four-year period beginning in 2010. During the period he also failed to disclose conflicts arising from loans made to family members. The Court entered a final judgment enjoining Mr. Conrad from future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206(4). The Court also imposed a penalty of $327,500. See Lit. Rel. No. 24640 (Oct. 10, 2019).

Manipulation: SEC v. Lek Securities Corp., Civil Action No. 17-1789 (S.D.N.Y.) is a previously filed action which named as defendants the securities firm and its owner, Sam Lek. Last week the Court entered a final judgment against Defendants by consent, enjoining each from future violations of Exchange Act Sections 9(a)(2) and 10(b) and Securities Act Section 17(a). The Court also entered a censure against the firm and a three-year injunction directing that it terminate relationships with foreign clients engaged in manipulative activity and largely prohibiting intra-day trading with those customers. In addition, the firm agreed to retain an independent consultant for a three-year period. The Court directed that the firm pay disgorgement and prejudgment interest of $525,892 and a $1 million penalty. Mr. Lek will pay a penalty of $420,000. The Commission’s complaint alleged that Defendants facilitated market manipulation for a foreign client in the form of layering by giving that client market access. See Lit. Rel. No. 24639 (Oct. 10, 2019). See also In the Matter of Lek Securities Corporation, Adm. Proc. File No. 3-19581 (Oct. 10, 2019)(tag-along Order based on case cited above, imposing censure as to firm and barring Mr. Lek from the securities business and participating in any penny stock offering with a right to apply for re-entry after 10 years).

Insider trading: SEC v. Rivas, Civil Action No. 17-civ-6192 (SD.N.Y.) is a previously filed action in which the defendants included Roberto Rodrigues, Jeffrey Rogers, Rodoifo Sablion, Michael Siva and Jhonatan Zoquier. The complaint alleged that over a three-year period, beginning in the fall of 2014, Mr. Rivas, a former IT employee at a large bank, accessed confidential information from his employer and tipped the other Defendants named above. Defendants traded based on information concerning over 30 corporate transactions, reaping millions of dollars in ill-gotten gains. In 2013 and 2014 each of the originally named seven defendants pleaded guilty in a parallel criminal case. Last week the Court entered final judgments enjoining each Defendant listed above from future violations of Exchange Act Sections 10(b) and 14(e). The Court also directed that each Defendant disgorge their trading profits, which is deemed satisfied by the payment of the forfeiture order entered in the parallel criminal case. See Lit. Rel. No. 24638 (Oct. 10, 2019). Similar judgments were entered as to Mr. Silva and another Defendant earlier.

Internal controls: In the Matter of Northwest Biotherapeutics, Inc., Adm. Proc. File No. 3-19582 (Oct. 10, 2019) is an action which names as Respondent the clinical stage biotechnology company that is focused on developing cancer vaccines designed to treat a broad range of solid tumor cancers. Respondent has repeatedly disclosed over the years weaknesses in its internal controls, including those concerning related party transactions. Despite the retention of a consultant, the difficulties have continued. In resolving the matter, the company agreed to implement certain undertakings that include the retention of an independent consultant. The Order alleges violations of Exchange Act Section 13(b)(2)(B). To resolve the proceedings Respondent consented to the entry of a cease and desist order and agreed to pay a penalty of $250,000.

Bribery: SEC v. Aurbach, Civil Action No. 1:19-cv-05631 (E.D.N.Y. Filed Oct. 4, 2019). Named as defendants are: Jeffrey Auerbach, a former registered representative, once temporarily barred from the securities business by FINRA, who acted as an IR consultant to Nxt.IDd or NXTD whose shares were listed on Nasdaq Capital Markets; Jared Mitchell, also supposedly was an IR consultant to NXTD, who was recently sentenced to prison in connection with another matter; and Richard Brown, a registered representative who has been subject to a number of customer complaints, named as a defendant in another Commission action and indicted in a criminal case. Each of the Defendants in this action was named in a 2016 Commission action centered on a broker bribery scheme. The bribery scheme, which took place in 2014 and 2015, was based on paying bribes under the guise of payments for investor relations services, to secure the purchase of NXTD shares. Initially, in July 2014 Defendant Mitchell introduced Gino Pereira, CEO of NXTD, to Mr. Brown, a registered representative, who supposedly was interested in acquiring shares of NXTD. Subsequently, over a period of several months, beginning in July 2014, Defendant Pereira paid Mr. Mitchell about $74,000 through a consulting firm for investor relations advice. At least $15,000 was then paid by to broker Brown to purchase NXTD stock. The broker acquired 231,253 shares of the firm’s stock for his retail clients at a cost of over $566,079. Mr. Brown failed to disclose to his customers that he was paid to purchase the shares in their accounts. In January 2015 Mr. Pereira caused NXTD to enter into a “Consulting Agreement” with his firm. The consulting agreement was for investor relations services. Ultimately, over a ten-month period Mr. Pereira had the company wire his consulting firm over $62,000. Messrs. Auerbach and Mitchell paid broker Brown at least $5,000 in cash. An additional 107,640 shares of NXTD were purchased for his customers at a cost of $235,584. Mr. Brown again failed to inform his customers that he was paid to purchase the shares. The complaint alleges violations of Exchange Act Section 10(b). The action is pending. See also SEC v. Pereira, Civil Action No. 2:19-cv-05527 (E.D.N.Y. Filed Sept. 30, 2019)(same as above; settled with entry of an injunction and agreement to consider other remedies at a later date). The U.S. Attorney’s Office for the Eastern District of New York filed a parallel criminal action.

Criminal cases

Offering fraud: U.S. v. Turner, No. 2:18-cr-00011 (N.D. Ga. Sentencing Oct. 10, 2019) is an action which Defendant Winston Turner previously pleaded guilty to one count of mail fraud. The charge was based on his solicitation of former brokerage firm clients to invest in a biofuel firm using promises of immediate returns and profits. In fact, the company was nothing but a shell. The Court sentenced him this week to serve two years and nine months in prison followed by three years of supervised release. He was also directed to pay $77,188 in restitution.

Australia

Remarks: James Shipton, Chair, Australia Securities Investment Commission, delivered remarks titled “Other people’s money” and changing global markets, as the keynote address at the Asia Securities Industry & Financial Markets Association Annual Conference, Tokyo, Japan (Oct. 10, 2019). His remarks focused on themes from the book Other People’s Money by John Jay, stressing that the numbers on the computer screens represent the money earned by investors (here).

Singapore

Remarks: Jacqueline Loh, Deputy Managing Director, Monetary Authority of Singapore, delivered remarks titled The Changing World at The World Federation of Exchanges General Assembly and Annual Meeting (Oct. 9, 2019). Her remarks focused on the changing economic environment and reasons for local optimism (here).

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The remedy of choice for the SEC Enforcement Division has always been the statutory injunction. For many years the only remedy available to the Division was the obey-the-law statutory injunction. In the early days of the Division this often led to creative settlements such as those requiring the selection of independent directors and the creation of an audit committee, both novel ideas when rolled out in the 1970s. Over time Congress added remedies to the Commission’s arsenal such as the penny stock bar and penalties. Nevertheless, the injunction prohibiting future violations of the statutory provisions violated remained the primary remedy, although many tended to focus on the amounts of money that a judgment requires be paid.

Since at least the 2017 decision in Kokesh v. SEC, 137 S.Ct. 1635, there have been questions about Commission remedies. There the High Court held that disgorgement in agency enforcement actions was subject to Section 2462 of Title 28 since it was a “penalty” within the meaning of the statute. The Court also reserved the question of whether the agency could in fact seek and obtain disgorgement since there was no statutory basis for such an award, a point lamented by certain Justices during the oral argument on Kokesh.

A related question was recently considered by the Third Circuit Court of Appeals in SEC v. Gentile, No. 18-1242 (3rd Cir. Sept. 26, 2019). There the Circuit Court considered a challenge to the imposition of a statutory injunction citing Kokesh.

The case

Guy Gentile is the owner of a broker-dealer in upstate New York. He is alleged to have been involved in two pump-and-dump market manipulations from 2007 to 2008. A criminal case was brought in 2012 which was ultimately dismissed as untimely. Since that dismissal Mr. Gentile has announced plans to expand his now Bahamas-based brokerage.

In doing so Mr. Gentile has made it clear that in his view he has not engaged in any wrongful conduct. The SEC filed an action which was ultimately dismissed in part as untimely. In reaching that conclusion the district court concluded that the entry of an injunction would constitute a penalty because the obey-the-law injunction would stigmatize him and the entry of a penny stock bar was a penalty since it would restrict his business in perpetuity without benefiting an victim.

The Circuit Court reversed and remanded the case to the lower court for reconsideration. The predicate for each remedy is statutory. Section 78u(d) of Title 15 empowers the Commission to seek an injunction when it appears that a person is violating a provision of the federal securities laws or is about to do engage in such conduct. A subsection of the same provision authorizes the SEC to request that the court preclude a person from participating in an offering of a penny stock. While this latter subsection does not use the word “injunction,” it is clear that any order entered would in fact be an injunction.

The question on which the resolution of each issue turns is the circumstances under which the Commission is entitled to have an injunction – a court order – entered. While the questions initially arose in the context of a Section 1332 statute of limitations issue, the Circuit Court addressed the broader point of when the SEC can secure the entry of either a statutory obey-the-law injunction and/or a penny stock bar.

The Court began its analysis by reviewing the federal courts’ historic equity jurisdiction. That mirrors the authority of the High Court of Chancery of England in 1789. It was at that time that Congress passed the first Judiciary Act. While there are “innumerable” statutes explicitly providing for injunctions, “unless Congress clearly states an intention to the contrary, statutory injunctions are governed by the same ‘established principles’ of equity that have developed over centuries of practice . . . This clear statement rule applies to regulatory statutes enforced by government agencies,” the Court held. This historic injunctive process was designed “to deter, not punish.” Stated differently, a “preventive injunction unsupported by that showing could not be ‘fairly said solely to serve a remedial purpose,” citing Kokesh.

In contrast, a properly supported injunction is designed solely to forestall future violations. It is “this prevention principle [that] most sharply distinguishes SEC injunctions from the disgorgement remedy at issue in Kokesh” that was found to constitute a penalty within the meaning of Section 1332, the Circuit Court found. This prevention of future violations is, absent other evidence, the guiding star for SEC injunctions.

The Court buttressed this conclusion with three key points. First, this purpose is consistent with the text of the statutes. Section 78u(d)(1) of Title 15, for example, states in part that the Commission can seek an injunction when it believes a person “’is engaged or is about to engage’ in securities violations. . . “ This text, along with that of subsection (d)(2) regarding penny stock bars, is wholly consistent with the traditional equitable principles that underly the issuance of an injunction.

Second, this approach is consistent with the history of the Commission’s injunctive authority. In the 1880’s, for example, injunctions were usually issued in relatively narrow disputes over property. That changed over time as more conduct was regulated by injunction “through a rough analogy to public nuisance.” The trend was then incorporated into state securities statutes which became the pre-cursor of the federal securities laws. The New York Martin Act was perhaps the best know example. There the statute empowered state regulators to seek an injunction to “stop” or “prevent” threatened violations while other sections were designed to “punish” violators.

Congress, in writing the federal securities laws, authored them against this backdrop, incorporating the basic principles into the statutes. As the Court stated: “Much like those authorized by blue sky laws, SEC injunctions were ‘a classic example of modern utilization of traditional equity jurisdiction for the enforcement of congressionally declared public policy administered by a regulatory agency established for that purpose,’” (internal citations omitted). “These principles would be dishonored if courts aimed to inflict hardship instead of tailoring injunctions to minimize it. A preventive injunction must be justified by a substantial showing of threatened harm, assuring the court that the opprobrium and other collateral consequences that accompany it are out weighted by a demonstrated public need; retribution is not a proper consideration . . .” according to the Court. Indeed, the SEC has itself recognized this principle in cases such as Saad, Exchange Act Release No. 86751, 2019 WL 3995968 (Aug. 23, 2019)(“if a sanction is imposed for punitive purposes as opposed to remedial purposes, the sanction is excessive or oppressive and therefore impermissible”).

Finally, these principles are consistent with Kokesh. There the Court was careful to reserve the question regarding disgorgement, while focusing on deterrence, that is the traditional equitable principles which underly SEC injunctions.

Here, in considering whether to grant the SEC’s request for an injunction on remand the lower court should not rubber stamp the request of the agency. To the contrary, “if the court does not conclude that “the obey-the-law injunction sought here serves no preventive purpose, or is not carefully tailored to enjoin only that conduct necessary to prevent a future harm, then it should and must reject the Commission’s request” the Circuit Court directed.

Comment

The Third Circuit opinion carefully traces the authority of the Commission to invoke its long standing remedy of the obey-the-law injunction. While many tend to focus on the number of cases brought and the amount of money awarded in judgments, it is the obey-the-law injunction and its collateral consequences which are often not readily visible, that is the Commission’s most potent remedy.

In many instances parties and courts tend to view the SEC’s request for an injunction as perfunctory, to be granted whenever a violation is established. Gentile demonstrates that this is not the proper approach. Rather, it is only when the SEC can establish the proper evidentiary base that the request should be granted. This means that if the Commission cannot demonstrate that the order is required to prevent future violations, it should not be granted. Stated differently, absent proper factual support, the request for an injunction is improper because its entry would be punitive and not protective or preventative.

In the future, the SEC and courts should be required to meet the Gentile test in requesting that a statutory injunction be entered. If the evidence is not before the court, the request should be denied. And of course, stay tuned for the Supreme Court’s consideration of SEC disgorgement – an increasingly conservative Court is very likely to be troubled by the lack of statutory authority for such a remedy.

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