Questions continue to swirl regarding the application of the federal securities laws to crypto. Many inside the business and out claim that the rules for applying the securities laws in this emerging area are vague and ill-defined. Others dispute this contention, pointing to the fact that the basic rules are decades old and that there are numerous cases and articles defining the key points. One thing that both sides may agree on is this: The ultimate outcome of this debate continues with no end in sight, at least suggesting that the resolution of the question is actually unclear.
Be careful, be safe this week
SEC Enforcement – Filed and Settled Actions
Last week the Commission filed 3 civil injunctive actions and 2 administrative proceedings, exclusive of tag-along and other similar proceedings.
False opinion letter: SEC v. Bauman, Civil Action No. 2:21-cv-01651 (D. Nev. September 8, 2021) names as a defendant Frederick Bauman, an attorney and a sole practitioner officed in Las Vegas. Over a four-year period, beginning in 2016, Defendant executed at least twelve attorney letters attesting to the fact that the securities could be sold in compliance with the securities laws. The letters were false. They incorrectly stated that the firms were not affiliates and that the shares could be sold. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). Defendant resolved the matter, consenting to the entry of a permanent injunction based on the Sections cited in the complaint. In addition, Defendant consented to the entry of a 5 year penny stock bar and a conduct based injunction prohibiting him from executing opinion letters regarding securities for the same period. He will also pay disgorgement of $13,000, prejudgment interest of $1,653 and a civil penalty in the amount of $60,000. See Lit. Rel. No. 25199 (September 8, 2021).
Financial fraud: In the Matter of The Kraft Heinz Co., Adm. Proc. File No. 3-20523 (September 3, 2021). The proceeding names as respondents the firm, a well-known Chicago based food and beverage firm, and Eduardo Pelleissone, then the firm’s Global Head of Operations and Chief Operating Officer. This proceeding centers on a scheme to inflate reported pre-EBITDA revenue (earnings before interest, taxes, depreciation and amortization) beginning in the last quarter of 2014 and continuing through the end of 2018. During that period the firm negotiated upfront cash payments and discounts in exchange for future commitments to be undertaken by the company. Those payments were not properly documented, causing the firm to overstate its pre-EBITDA earnings over the period. Under GAAP, if upfront cash and discounts are tied to future commitments, the savings must be recognized over the period the obligations are satisfied. The procurement personnel for Kraft, however, negotiated and maintained false supplier contracts which made it appear that the expense savings were provided in exchange for past or same-year events performed by the company. In reality, the payments were tied to future performance.
During the period 59 transactions were improperly documented and recorded. If the items were properly accounted for, the cost of goods sold for Kraft would have been about $50 million higher. The improper practices ultimately led to a restatement in 2019. That restatement involved the financial statements for years 2015 through 2018. It corrected a total of $208 million in cost savings from 295 transactions. Mr. Pelleissone was presented with several warning signs indicating that expenses were being managed through the manipulation of supplier agreements. Similarly, an executive that reported to Mr. Pellewissone, and who managed the procurement section, approved certain contracts and suppliers. That executive also had sub-certification responsibilities in 2018 was confronted with several signs that should have alerted him to the issue. They did not. The Order alleges violations of Securities Act Sections 17(a)(2) and 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and the related rules. To resolve the proceedings the firm consented to the entry of a cease-and-desist order based on the Sections cited in the Order. The firm will also pay a penalty of $62 million. Mr. Pellessone consented to the entry of a cease-and-desist order based on the same Sections and, in addition, Exchange Act Section 13b-5. He also agreed to pay disgorgement in the amount of $12,500, prejudgment interest in the amount of $1,711.31 and a penalty of $300,000. See also SEC v. Hofmann, Civil Action No. 1:21-cv-07407 (S.D.N.Y. Filed September 3, 2021)(action against Klaus Hofmann, then global head of procurement and chief procurement officer of Kraft based on essentially the same allegations as above; the case is in litigation). See Lit. No. 25199 (September 8, 2021).
Financial fraud: SEC v. Thomas, Civil Action No. 19-cv-1132 (D.Nev.) is a previously filed action which named as defendants four executives from Blue Earth Company – Johnny Thomas, John Francis, Jonathan Woodward and Robert Potts – who created the false impression that the firm had secured substantial contracts that transformed an unprofitable venture into a profitable one by falsely inflating the value of a “Construction in Process” asset by 400%. Each executive consented to the entry of a final judgement based on all or in part on Exchange Act Sections 10(b) and 13(a), 13(b)(2)(A), 13(b)(5) and 16(a) and Securities Act Section 17(a)(2) and the related rules. In addition, Defendant Thomas paid a penalty of $240,000; Defendant Potts paid a penalty of $125,000; and Defendants Woodward and Francis each paid $120,000. Mr. Woodward also consented to the entry of an order under Rule 102(e) suspending him from practice before the Commission. See Lit. Rel. No. 25197 (September 7, 2021).
Unregistered securities: SEC v. Rivetz Corp., Civil Action No. 3:21-cv-30092 (D. Mass. Filed September 8, 2021) is an action which names as defendants: the company; Rivetz International Sezc; and Steven Sprague. Mr. Sprague controls Rivetz and Rivetz International and also serves as CEO for the latter. In June 2017 Defendants used a White Paper to sell crypto tokens called RvT. About 7,200 investors paid a total of about $18 million for the coins which were in fact unregistered securities. The required disclosures were not made. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). The case is in litigation. See Lit. Rel. No. 25198 (September 8, 2021).
Insider trading: SEC v. Parkhurst, Civil Action No. 3:21-cv-00657 (N.D. Ind. Filed September 2, 2021) is an action which names as a defendant Robert Parkhurst, national sales manager of Skyline Corporation. In the fall of 2017 Mr. Pakhurst learned that his firm was having merger discussions that included Champion Home Builders, Inc. He also participated in the due diligence work. In December 2017 Mr. Parkhurst opened a new brokerage account and made two purchases of Skyline stock. In addition, he tipped his father and son who purchased shares. When the deal was announced on January 5, 2018, the share price increased by 48%. Mr. Parkhurst had gains of over $4,893 while his father had gains of $6,100 and his son $110. The complaint alleges violations of Exchange Act Section 10(b). To resolve the matter, Mr. Parkhurst consented to the entry of a permanent injunction based on the Section cited in the complaint and agreed to pay a civil penalty of $15,995. See also SEC v. Cavco Industries, Inc., Civil Action No. 2:21-cv-01507 (D. Az. Filed September 2, 2021)(an action which names as defendants the firm and its former CEO, Joseph Stegmayer; the firm had been in merger talks with Skyline; Defendants purchased shares of Skyline while the talks were pending; later after the deal announcement Cavco had profits of about $260,000; Defendant Stegmayer consented to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(b)(2)(B) and 13b-5; he also agreed to the entry of a 5 year officer/director bar and to pay a penalty of $1.48 million). See Lit. Rel. No. 25196 (September 3, 2021).
Internal controls: In the Matter of Frontier Wealth Management, LLC, Adm. Proc. File No. 3-20526 (September 3, 2021) is a proceeding which names as respondents the firm, a registered investment adviser, and Shawn Sokolosky, an investment advisory representative. In 2016 the adviser created the Frontier Permo Fund. It is a private feeder fund that gave clients access to Fund A that was managed by a third-party and used complex option strategies and synthetic futures positions to generate volatility. Over a two-year period, beginning in early 2016, firm retail clients invested about $45 million in the Feeder Fund. During the period Fund A lost about 35% of its value, resulting in losses of about $16 million to firm clients. The firm delegated broad authority over client investment recommendations to IARs. It did not provide adequate policies, procedures, and supervision concerning the features for complex risk such as those involved with the Feeder Fund. As a result, certain clients with low-risk tolerances and conservative trading preferences invested in Feeder Fund. Adviser Sokolosky recommended that about 50 of his clients invest in the Feeder Fund without adequately assessing if the products were suitable for them. He also did not adequately understand the trading strategy being used by that Fund. The firm resolved the proceedings, consenting to the entry of a cease-and-desist order based on Advisers Act Section 206(4) and Rule 206(4)-7 and to a censure. It also agreed to pay disgorgement of $246,617, prejudgment interest of $47,095 and a penalty of $350,000. Respondent Sokokosky consented to the entry of a cease-and-desist order based on Securities Act Section 17(a) and Advisers Act Section 206(2). In addition, he will be suspended from the securities business for a period of 12 months and prohibited from serving in a supervisory capacity for 12 months. He will pay a penalty of $100,000.
Offering fraud: U.S. v. Ripalda, No. 21- CR- 458(E.D.N.Y. Filed September 9, 2021) is an action which names as defendants: Roberto Gustavo Cortes Ripalda, Fernando Haberer Bergson, and Ernsto Heraclito Weisson Pazmino. Over a five-year period, beginning in 2013, defendants used a financial firm founded by the three men named Biscayne Capital to orchestrate a fraud that raised about $155 million. Defendants told investors that their funds would be used in various real estate projects when in fact the money was misappropriated. Defendants are charged with conspiracy to commit wire fraud, conspiracy to commit bank fraud and conspiracy to engage in money laundering. The case is pending.