by T. GormanPosted on Posted in SECActions

Tracking the key areas of concern to SEC enforcement can be beneficial for issuers, investment advisers and others that may be subject to scrutiny by the Commission. For example, identifying those topics by reviewing the leading areas in which cases were filed can aid an enterprise in crafting and fine tuning its compliance and disclosure systems. While certainly necessary, this approach is often not sufficient to avoiding a subpoena.

Tracking what might be called mini-trends can effectively aid compliance, although it may be more difficult. Two recent mini-trends illustrate the point. One involved “pulling in” revenue; the other improperly utilizing exchange traded products.

Pulling in Revenue

First, actions involving Under Armour and HP involved “pulling in” revenue. Under Armour traces to the second quarter of 2010. The company reported year-over-year revenue growth exceeding 20%. Over the next several years Under Armour’s financial results replicated this type of growth, a pattern highlighted by the firm.

By the second half of September 2015, however, the company saw signs that its long running streak of exceeding analyst expectations was ending. To stem the downward tide the firm began “pulling forward” orders it had for customers that were not to be delivered until a point in the future. In some instances, the practice was discussed with customers. For six consecutive quarters the practice continued.

On January 31, 2017 the company missed analyst expectations for the fourth quarter and full-year 2016 periods. The stock price dropped about 23%. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Section 13(a) and the related Rules. To resolve the matter the company consented to the entry of a cease-and-desist order based on the Sections cited in the Order. Under Armour will pay a penalty of $9 million. In the Matter of Under Armour, Inc., Adm. Proc. File No. 3-20278 (May 3, 2021).

HP, a former Hewlett-Packard segment, is similar. It was charged with engaging in a two-fold scheme. One part began in the second quarter of 2015 when regional managers used a variety of incentives to accelerate or “pull in” sales that they may have otherwise expected to appear in later periods. The practice, typically employed at period end, can alter financial trends.

This case also involved management in one region selling printing supplies to distributors known to be outside their territory, so-called “gray marketing.” Despite the risk that those sales practices could negatively impact operating profit in future quarters, there was no disclosure.

In June 2016 the firm announced that it was changing its go-to-market model. The change was intended in part to address these two practices. The company took a net revenue reduction of about $450 million in the third and fourth quarters of that year. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Section 13(a). To resolve the matter Respondent consented to the entry of a cease-and-desist order based on the sections cited in the Order. In addition, the firm will pay a penalty of $6 million that will be transferred to the U.S. Treasury. Disclosure controls: In the Matter of HP Inc., Adm. Proc. File No. 3-20112 (Sept. 30, 2020).

Misuse of Exchange Traded Products

Second, cases involving American Financial Services and UBS each center on the same key issue: misuse of exchange traded products. The action involving American Financial Services and American Portfolios Advisors, respectively, a registered broker-dealer and an investment adviser centered on iPath S&P 500 VIX Short-Term Futures ETN or VXX.

VXX is traded on the NYSE Arca, Inc. It is a volatility-linked, complex exchange traded note which “offers exposure to futures contracts” of specific maturities on the VIX — the CBOE. The VIX tries to track the expected volatility of the S&P 500 but not its price level. The performance of VXX is not directly linked to the VIX. It is linked to a separate Index that tracks the price of futures contracts on the exchange. That Index is based on a “rolling portfolio of one-month and two-month futures contracts to target a constant weighted average of one-month maturity.” To do this, each day the Index sells futures contracts that are the closest to the expiration and buys the next month out.

The VXX prospectus made it clear that that historically the exchange has been in contango – the farther out contracts priced higher than those of the near-term contracts. When the market is in backwardation the reverse is true. Since the exchange is typically in contango, a significant cost is incurred over time from the daily roll of the futures contracts.

At times the VIX performance may vary from that of the Index and may have a positive performance during periods when the Index experiences poor performance. On the other hand, the VXX may experience a significant decline over time. In those instances, the risk increases the longer the VXX is held. In the end, however, the VXX has a limited upside potential, according to the prospectus, because over the longer term it usually reverts to a historical mean and its absolute level has been constrained within a band.

Registered representatives began early in 2016 to recommend investors buy and hold the VXX as a part of their overall portfolio. At the time there was a fear that political and other events would cause the market to drop. Many of the clients followed the advice, purchased the VXX and held it for over a year.

The VXX was viewed as a kind of hedge that would guard against the feared price drop. In making those recommendations the registered representatives failed to understand that the investments were not suitable for use as a short-term hedge. Yet customers were told the opposite — buy and hold for the long term to protect against downward market risk. No mention was made of what is effectively a monthly reset and the resulting costs incurred in each instance.

The firms did have policies and procedures regarding complex products. Those policies and procedures mandated that representatives understand the products prior to making a recommended. The policies and procedures were ineffective in preventing the losses incurred by customers here because they were not properly implemented. Supervisory failure also facilitated the client losses. The Order alleges violations of Exchange Act Section 15(b)(4)(E) and Advisers Act Section 206(4) and Rule 206(4)-7.

To resolve the matter Respondents implemented certain remedial efforts. Respondent APA consented to the entry of a cease-and-desist order based on the Advisers Act Section and Rule cited in the Order. APFS consented to the entry of a cease-and-desist order based on the Exchange Act Section cited in the Order. The two firms were censured and will also pay, jointly and severally, a civil monetary penalty of $650,000. A fair fund will be created for the portion of the losses tied to the product. In the Matter of American Financial Services, Inc., Adm. Proc. File No. 3-20151 (Nov. 13, 2020).

The recent action involving UBS, a dual registered broker-dealer investment adviser, is similar. It centers on the failure of the firm to properly implement policies and procedures with respect to the VXX product as used in its discretionary Portfolio Management Program or PMP.

Beginning in 2016 firm financial advisers put clients involved in the PMP program into the VXX product. VXX is typically built on short term futures products. Here the firm had policies and procedures in place to effectively prevent holding the VXX for long periods. Those policies and procedures did not, however, apply to the PMP program. When financial advisers put PMP clients into the VXX they failed to ensure that it was only held for the short term. Indeed, about 1,882 clients were involved with the product that was in hundreds of accounts. Those accounts held the product beyond the short term – many held VXX for over a year. Accordingly, clients suffered losses.

In resolving this matter, the firm took remedial steps. The Order alleges violations of Advisers Act Section 206(4) and Rule 206(4)-7. Respondent resolved the proceedings, consenting to the entry of a cease-and-desist order based on the Section and Rule cited in the Order and to a censure. The firm will also pay disgorgement of $96,344, prejudgment interest of $15,15,930 and a penalty of $8 million. A fair fund will be established. In the Matter of UBS Financial Services Inc., Adm. Proc. File No. 3-20401 (July 19, 2021).

Comment

In each case discussed above the key to uncovering the issues was data and trend analysis. In each of these actions, the practices at issue – inappropriate use of exchange traded products and maintaining long term revenue trends through end of the quarter sales accelerations – could have been uncovered by the firms involved through effective data, risk and trend analysis. Analysis of how professionals were utilizing the complex exchange traded produces in American Financial and UBS should have uncovered the abuse; analysis of long term sales trends in Under Armour and HP should have uncovered the quarter end rush to a number to support the conclusion. In each action, consideration of the issues uncovered in view of the firm’s compliance and disclosure policies and procedures should have completed the process – and avoided a subpoena from SEC Enforcement.

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by T. GormanPosted on Posted in SECActions

The Commission’s regulatory authority was challenged again last week. This time the challenge was brought by Alpine Securities, a registered broker dealer that specializes in microcap stocks. A petition for certiorari was filed requesting that the High Court overturn rulings by the Second Circuit and the district court. Each ruling rejected the firm’s challenge to Commission’s authority to enforce provisions of the Bank Secrecy Act requiring that Suspicious Activity Reports be filed under certain circumstances. The challenge arose from a Commission complaint claiming that the broker either failed to file or did not properly fill out numerous SARs. Alpine Securities Corp. v. SEC, No. 21-82 (here).

Be careful, be safe this week

SEC

Whistleblowers: The Commission awarded nearly $3 million dollars to a Whistleblower who identified previously unknown conduct and assisted with the action, according to a July 21, 2021 release.

SEC Enforcement – Filed and Settled Actions

Last week the Commission filed 5 civil injunctive actions and 3 administrative proceedings, exclusive of tag-along and other similar proceedings.

Manipulation: SEC v. Abujuder, Civil Action No. 1:21-cv-04110 (E.D.N.Y. Filed July 22, 2021) is an action which names as a defendant Charlie Abujudeh. Defendant controlled three microcap stocks he intended to manipulate. Initially he used a call room to try and manipulate the first; it failed. Subsequently, Defendant tried to retain a person who turned out to be a cooperating witness or CW that was working with the FBI. After taping numerous conversations relating to the planned manipulations the CW could not be hired. Defendant would not be deterred. He set up an email and web campaign and finally succeeded in manipulating the first stock, liquidating 2.5 million shares he owned and paying an insider with whom he had been coordinating $350,000. Similar schemes were used to manipulate the remaining stocks. Overall Defendant generated about $3.2 million on one stock and another $3.3 million on the third. The complaint alleges violations of Securities Act Sections 5(a) and (c), Section 17(a)(1) and (3) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 25147 (July 22, 2021).

Offering fraud: SEC v. Patel, Civil Action No. 3:21-cv-00994 (D.Conn. Filed July 21, 2021) is an action which names as a defendant Rahulkumar Patel. Beginning in February 2018 Defendant offered investors the opportunity to purchase membership units in a hotel venture. The offering was supposed to raise money to renovate the hotel. About $2.75 million was raised from 870 investors over a two year period. In fact, much of the investor cash was diverted to the personal use of Defendant. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 25146 (July 21, 2021).

Offering fraud: SEC v. Suneet Singal, Civil Action No. 19-cv-11452 (S.D.N.Y.) is a previously filed action that names as defendants: Suneet Singal, First Capital Real Estate Investments, LLC, First Capital Real Estate Advisors LP and First Capital Real Estate Trust Inc. The complaint centered on claims that misrepresentations were made regarding the REIT’s ownership of 12 hotels in several Forms 8-K and that Defendant Singal acquired an interest in the BDC’s external adviser and caused it to make two $1.5 million loans to an entity that it controls. Those funds were diverted to personal use. To resolve the case each Defendant consented to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). In addition, the judgment as to Defendant Signal is based on Advisers Act Sections 206(1), 206(2) and Investment Company Act Sections 36(a) and 57(a). The judgments against First Capital, First Capital Real Estate Trust and First Real Estate Advisers are also based on Exchange Act Section 15(b). The Singal and First Capital Real Estate agreed to pay, on a joint and several basis, disgorgement in the amount of $3.2 million and prejudgment interest of $676,400. Singal also agreed to pay a penalty of $3.2 million and was barred for a period of 10 years from acting as an officer or director of a public company and from the securities business. See Lit. Rel. No. 25145 (July 21, 2021).

Financial reporting and disclosure: In the Matter of Tandy Leather Factory, Inc., Adm. Proc. File No. 3-20403 (July 21, 2021). Tandy is the world’s largest specialty leather firm. Also named as a Respondent is Shannon Greene, CPA, the firm’s CFO. Beginning in 2016 the firm failed to implement and maintain proper internal and disclosure controls. First, its inventory system failed to properly implement the firm’s FIFO inventory controls. When prices were changed, for example, it failed to maintain the historical costs for earlier purchases. This resulted from inadequate controls. Second, the firm also failed to properly implement its disclosure controls. Ultimately these failures resulted in a multi-year restatement. The firm did undertake remedial efforts. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceedings each Respondent consented to the entry of a cease-and-desist order based on the Sections cited in the Order. The firm will pay a penalty of $200,000. Respondent Greene will pay a penalty of $25,000.

Unregistered broker: In the Matter of Miguel Holguin, Adm. Proc. File No. 3-20405 (July 21, 2021) is a proceeding centered on the sale of Treasury STRIPS and other notes by Respondent who is not a registered broker. For example, in May 2018 Respondent received $500,000 to invest in STRIPS. In September 2018 he received investor funds to purchase MTNs or medium term notes with a face value of about $10.5 billion. The Order alleges violations of Exchange Act Section 15(a). To resolve the proceedings Respondent consented to the entry of a cease-and-desist order based on the Section cited in the Order. He is also barred from the security business but can reapply after 18 months. In addition, he is barred from serving as an officer or director and participating in any penny stock offering on similar terms.

Offering fraud: SEC v. Outdoor Capital Partners, LLC, Civil Action No. 2:21-cv-13813 (D.N.J. Filed July 19, 2021) is an action which names as defendants the firm and Samuel J. Macini, respectively, a venture capital and private equity firm that manages the Fund, and one of two managing directors of Outdoor Capital. In 2019 Defendants sold investors membership units in the Fund. Investors were told the amount of money raised by the Fund, the accounting professionals servicing it and Defendant Macini’s background. Each representation was false. Subsequently, in January 2021 the Fund sold short term high interest loan contracts to investors. The funds were to be used to buy a bicycle helmet inventory. In reality, the investor money was misappropriated. The complaint alleges violations of Securities Act Section 17(a) and Exchange
Act Section 10(b). The case is pending. See Lit. Rel. No. 25148 (July 22, 2021).

Offering frauds: SEC v. Govil, Civil Action No. 1:21-cv-06150 (S.D.N.Y. Filed July 19, 2021) names as a defendant Aron Govil, the controlling shareholder of two firms, Telidyne Inc. and Cemtrex Inc. The former is the developer of mobile phone applications, one of which was a money transfer app that supposedly had crypto capabilities. The other was represented to be a diversified industrial and technology company based on Long Island. The action is based on a fraud involving each firm. First, in 2019 and 2020, Mr. Govil, as the CEO of Telidyne, made a series of false statements in connection with an offering of the firm’s shares. For example, potential investors were told that the firm’s money transfer app had cryptocurrency and lending capabilities. Investors were also told that an app was under development to detect COVID-19. Both claims were false. Earlier, beginning in 2016, Mr. Govil used Cemtrex to conduct offerings of securities which raised about $2.5 million. The money was supposedly for general corporate purposes which included product development and acquisitions. In fact, significant portions of the investor funds were diverted to the personal use of Defendant Govil. Mr. Govil also engaged in scalping the shares of Cemtrex and trading on inside information about the company. To scalp the shares, Mr. Govil paid individuals to promote the stock and drive up the share price. As the price rose he secretly sold his shares. At times Defendant Govil had knowledge of forthcoming events and earnings for the firm. For example, in February 2018 Defendant traded in advance of a firm earning announcement, ultimately obtaining illegal profits of over $360,000. The sales were made thorough a series of nominee accounts. He also issued a press release denying that he sold any shares in the firm. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 16(a). Mr. Govil resolved the action, consenting to the entry of permanent injunctions based on the Sections cited in the complaint. He also agreed to the entry of an officer and director bar and a penny stock bar. In addition, Mr. Govil will pay disgorgement of $626,782, prejudgment interest of $76,693 and a penalty of $620,000. The judgment also authorizes the court to impose additional disgorgement and penalties if deemed appropriate.

Investment – controls: In the Matter of UBS Financial Services Inc., Adm. Proc. File No. 3-20401 (July 19, 2021) is an action which names as a respondent the dual registered broker-dealer investment adviser. These proceedings center on the failure of the firm to properly implement policies and procedures with respect to the VXX product as used in its discretionary Portfolio Management Program or PMP. Beginning in 2016 firm financial advisers put clients involved in the PMP program into the VXX. This product is typically built on short term futures products. Here the firm had policies and procedures in place to effectively prevent holding the VXX for long periods. Those policies and procedures did not, however, apply to the PMP program. When financial advisers put PMP clients into the VXX they failed to ensure that it was only held for the short term. Indeed, about 1,882 clients were involved with the product that was in hundreds of accounts. Those accounts held the product beyond the short term – many held the VXX for over a year. Accordingly, clients suffered losses. In resolving this matter, the firm took remedial steps. The Order alleges violations of Advisers Act Section 206(4) and Rule 206(4)-7. Respondent resolved the proceedings, consenting to the entry of a cease-and-desist order based on the Section and Rule cited in the Order and to a censure. The firm will also pay disgorgement of $96,344, prejudgment interest of $15,15,930 and a penalty of $8 million. A fair fund will be established.

Investment fraud: SEC v. Profit Connect Wealth Services Inc., Civil Action No. 2:21-cv-01298 (D. Nev. Filed July 8, 2021) is an action which names as defendants: the Las Vegas company which claims to place investor funds in various investments selected by a “supercomputer” using artificial intelligence; Joy Kovar, the president and a director of Profit Connect; and Brent Kovar, the president and treasurer of the firm and the son of Ms. Kovar. In 2010 the Commission obtained a permanent injunction, penny stock bar and officer and director bar against Mr. Kovar in a fraud action. SEC v. Sky Way Global LLC, Civil Action No. 09-cv-455 (M.D. Fla. March 13, 2009). Over a three-year period, beginning in May 2018, Defendants raised about $12 million from over 277 investors using Profit Center. Potential investors were told that their funds would be put into various types of investments. Those included securities, bitcoin and other cryptocurrencies selected by the Profit Center supercomputer using artificial intelligence. Investors were told that they would have a Wealth Builder Supercomputer Seat APR account. The investments were made through the firm’s website and targeted parents, grandparents, and family and friends that wanted to give the gift of success. Those investments were guaranteed to result in fixed income returns ranging from 20% to 30% per year. In fact, Profit Center was a fraud. Over 90% of the firm’s funds came not from investments but from investors. Most of the investor capital was diverted to the personal use of the people operating it, Ms. Kovar and her son. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). The Commission requested an emergency freeze order. The case is pending.

Germany

Warning: The Federal Financial Supervisory Authority or BaFin, issued a caution about investing in SPACs. The warning notes that a number of European stock exchanges have recorded listings of the investment vehicles. SPACs are, however, investments that are “normally only available to financially strong risk capital providers,” the July 20, 2021 release states (here).

Hong Kong

Survey: A survey taken by the Securities and Futures Commission of Hong Kong notes that the asset and wealth management business had strong growth in 2020. For example, the release notes that the year-on-year increase in AMU was significant, according to the July 23, 2021 release (here).

Singapore

Report: The Monetary Authority of Singapore published a release detailing consumer price developments for June, 2021 on July 23, 2021 (here).

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