by T. GormanPosted on Posted in SECActions

Avengers: Endgame is the latest good guys vs. bad guys film drawn from the Marvel stable of stories and characters. The film is setting box office records with every seat taken at many theaters regardless of the show time. While the subtitle for the film is “Endgame,” many may question whether this is the end of for the good guy Avengers.

One might ask the same question of the latest iteration of SEC v. Elon Musk, the creator of Tesla Motors. This saga has at least some of the elements of Avengers: Endgame. There are supposed good guys – some might say almost good guys or perhaps good guys going a bit of the rails and looking more like a school yard bully rather than a prudent, thoughtful federal regulator. There are supposed bad guys – well really a person some might say is a genius entrepreneur who wants it all his way and is prone to the occasional petulant child tantrum. And, a battle – a contempt of court proceeding. But is this the Endgame?

Unlike Avengers: Endgame where there is an epic battle, SEC v. Musk has not yet resulted in an actual battle. To the contrary, the Court refused to rule, telling the parties to settle the dispute under threat of an order from the bench that neither side would like.

Settle they did. The SEC and Mr. Musk have filed a proposed modification of the consent decree previously entered by the Court. The initial order centered on a requirement that Tesla adopt disclosure controls. The key provision specified that Mr. Musk not tweet information about the company without pre-clearing it internally at the firm. The contempt proceeding was brought when Mr. Musk did not obtain pre-clearance based in part on a claim that there was no need because the information had largely been disclosed by the company.

The settlement filed by the parties proposes to modify the initial court ordered provisions by adding an open-ended litany of items Mr. Musk must pre-clear. Those begin with items such as “the Company’s financial condition,” continue with “production numbers or sales” and end with those which require the “filing of a Form 8-K” or which have been specified by the “Company or the majority of the independent” directors. Stated differently, the disclosure controls requirement by the federal securities laws and imposed on Tesla will under the proposed settlement become an open-ended check list.

Yet the federal securities laws are not designed to be a list where checking each box yields a passing grade. To the contrary, the federal securities laws were enacted to bring a new ethics to the market place. The statutes were designed to be interpreted flexibly and in view of their purpose to ensure full disclosure and fair dealing in the market place. Those who raise money from the public, for example, are required to act as stewards of those funds for the benefit of those who have entrusted their money to them. The SEC has repeatedly emphasized this point. Mr. Musk, who has through Tesla raised millions of dollars from the public surely know that while he can use the capital raised, it belongs to Tesla and ultimately to the investors who have entrusted their money to him.

A check list? Even if the check list was full and complete, resolving SEC vs. Musk with such an approach only serves to highlight the misguided nature of the proceedings and defense. Neither the SEC nor Mr. Musk need a checklist of the type included in the proposed settlement to determine if the items listed are market moving information which requires care when disclosed to ensure its accuracy. That would be true even if the check list were complete which it is not – it ignores the key issue of basing tweets on previously disclosed information, a critical defense for not pre-clearing the information. Ultimately, however, this is beside the point.

The situation here was not doomsday for the universe as in Avengers: Endgame. Before filing the contempt action, the SEC should have utilized its broad prosecutorial discretion in seeking a resolution of its concerns. In responding Mr. Musk should have avoided the “scorched earth” defense and sought a solution commiserate with role as the steward of other people’s money – he may be a visionary, but vision without capital to implement it goes nowhere.

The real winner if this settlement becomes a new court order – if anyone can be called a winner here — is the Court. It is the Judge who stepped-up and ended this matter. At the same time, whether this settlement is the endgame cannot be determined now. For the Avengers we all know it is not. The Avengers are, however, comic book characters fighting a comic book dispute. While the SEC and Mr. Musk are not comic book characters fighting a comic book dispute, we all hope that this round is in fact the Endgame.

Event: On June 3, 2019, the SEC Historical Society will host a gala celebration to commemorate the 85th Anniversary of the founding of the U.S. Securities and Exchange Commission and its 20th Anniversary. The event will be held at the Building Museum, Washington, D.C. Following a brief program featuring SEC Chairman Jay Clayton, there will be cocktails and dinner. For further information regarding tables, tickets and advertisements in the program please contact the Society here (full disclosure Mr. Gorman is the President of the Society).

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by T. GormanPosted on Posted in SECActions

The Commission rarely requires admissions to settle an action. Yet in a financial fraud action settled this week the agency required that firm which falsified its financial statements and lied to the auditors admit the underlying facts as part of the resolution of the case. Another matter filed this week involved a large Wall Street financial institution that mislead investors about investments by omitting material information. A third action focused on an investment adviser who started as essentially a family office and then expanded to a public advisory, misappropriating funds from all clients along the way. Finally, an action was brought against a company that failed to realize its computer system was creating false financial data for investors.

SEC Enforcement – Filed and Settled Actions

The Commission filed 3 civil injunctive actions and 3 administrative proceedings this week, exclusive of 12j and tag-along actions.

Financial fraud: SEC v. Celadon Group, Inc., Civil Action No. 1:19-cv-1659 (S.D. Ind. Filed April 25, 2019) is an action which names as a defendant the firm, a truckload freight transportation provider. In 2016 and 2017 the firm owned about 1,500 tractor-trailers that were valued at prices in excess of the actual market value for the vehicles. A sale of the trucks would have resulted in the loss of millions of dollars. To avoid that prospect the firm arranged a series of transactions in which the trucks were supposedly sold at significantly inflated prices and thus removed from the books, purchased trucks from the same party at similar high prices and ultimately used an off-balance sheet entity to remove them from the books. When the auditors began to question the transaction the firm tried to cover its tracts with lies. The complaint alleges violations of Exchange Act Sections 10(b), 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter the firm admitted to the underlying facts, consented to the entry of a permanent injunction based on the sections cited in the complaint and agreed to pay $7 million in disgorgement which will be satisfied by the payment of restitution in a parallel criminal case brought by the Department of Justice.

Misleading omissions: In the Matter of Deutsche Bank Trust Company Americas, Adm. Proc. File No. 3-19154 (April 25, 2019) is an action naming the financial institution as a Respondent. The action centers on the disclosures surrounding the process by which it selected hedge funds to be available on the institution’s platform. Specifically, the bank claimed that it used a third party group to conduct rigorous due diligence on such funds . What it did not tell consumers is that no fund could be selected unless it agreed to split its fees with the bank. The Order alleges violations of Securities Act Section 17(a)(2). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order and to pay a penalty of $500,000.

Fraudulent trading: SEC v. Berkey, Civil Action No. 17-cv-9552 (S.D.N.Y.) is a previousl filed action against broker Zachary Berkey. The Court entered a final judgment by consent against Mr. Berkey directing that he pay $106,000 in disgorgement, prejudgment interest and a penalty of $71,000. The action was based on charges that the broker had engaged in a trading program using client funds which was almost guaranteed to result in losses but through which the customers incurred significant costs. That is exactly what happened – clients lost money from the trades and the excessive charges. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b). See Lit. Rel. No. 24460 (April 25, 2019).

Misappropriation: SEC v. Lyons, Civil Action No. 1:19-cv-10785 (D. Mass. Filed April 22, 2019). Defendant Eric Lyons and his firm Synchrony Capital GP LLC began as a family money manager with the funds placed in Synchrony Value Fund. For the first two years, beginning in 2012, the Fund only handled family money. Mr. Lyons, however, did not invest his capital in the Fund. Total investments were under $200,000. In 2017 when accounts for the Fund discovered about $180,000 in payments to Mr. Lyons he executed appropriate promissory notes in favor of the other partners. The Fund was then opened to public investors. About $2.1 million was raised from public investors, including a Czech investor who put over $1.8 million into the Value Fund. The Czech investor, a representative of others, also worked out an arrangement with Mr. Lyons through which he obtained an interest in a new entity called Synchrony Capital Group which would serve as the general partner of the Fund. Mr. Lyons also sold the Czech investor 50% of Synchrony Capital Group for $100,000. The operating documents for the new private partnership specified that investments would be in securities and placed with financial institutions and brokerage firms. The Czech investor subsequently transferred $600,000 of his client’s money for investment in the Capital Partners Fund. Almost immediately, Defendants began to misappropriate the funds. In 2017 and 2018 about $320,000 was misappropriated from Capital Partners Fund. Mr. Lyons then began trading options. The market, however, moved against him. All of the investments for Capital partners Fund were wiped out. A negative balance of $380,000 was left. Subsequently, Mr. Lyons formed the Synchrony Capital Global Macro Fund. Funds which had not been misappropriated from Value Fund were transferred in. While Mr. Lyons made efforts to raise sufficient capital from other investors to cover his unlawful acts, he was not successful. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The case is pending. See Lit. Rel. No. 24458 (April 23, 2019).

Manipulation: SEC v. Loflin, Civil Action No. CV -19-02548 (D. Ariz. Filed April 19, 2019). Defendant David Loflin is apparently an old hand at pump-and-dump manipulations, although he is not a recidivist. His long time side-kick is Individual A, who apparently has also participated in a number of these fraudulent actions. Individual A passed away after the events in the complaint but before it was filed. The pattern of the case is, unfortunately, an all too familiar one. Over a three year period, beginning in 2013, Mr. Loflin and Individual A acquired shares in a firm called Greenway Design Group, Inc. using backdated notes. Later false documents were used to secure the removal of the share restrictions. Eventually email blasts and press releases were used to hype the share price. Overall Mr. Loflin received about $152,800. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of 17(a) and Exchange Act Section 10(b). To resolve the action Mr. Loflin consented to the entry of a permanent injunction based on the sections cited in the complaint. The order also bars him from serving as an officer and director of a public company and from participating in any penny stock offering. In addition, he agreed to pay disgorgement, prejudgment interest and a penalty in amounts to be determined by the Court. See Lit. Rel. No. 24457 (April 19, 2019).

Unprofessional conduct: In the Matter of DOV Zaidman, CPA, Adm. Proc. File No. 3-19150 (April 22, 2019) is a proceeding which names as Respondents Mr. Zaidman, a partner at ZPS Group, a PCAOB audit firm which is also a Respondent. Mr. Zaidman served as the engagement partner on the audits of four blank check companies. Those firms were actually created by a shell creation group and were secretly controlled by that group. During the audits Respondents ignored repeated red flags suggesting that the blank check companies were in fact part of a shell creation group. Despite having disregarded key PCAOB requirements for conducting an audit, clean opinions were issued. The Order alleges violations of Exchange Act Sections 10(b) and 10A(a)(2). To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. Each Respondent is also denied the privilege of appearing or practicing before the Commission as an accountant with the right to apply for reinstatement after five years. Finally Respondents are required to pay disgorgement in the amount of $19,500, prejudgment interest of $3,961.90 and a penalty of $25,000.

Incorrect financial information: In the Matter of Prosper Funding LLC, Adm. Proc. File No. 3-19148 (April 19, 2019). Prosper Funding is a privately held firm based in San Francisco. The firm is a marketplace lender that arranges consumer loans through its website. Prosper sells securities linked to the performance of those consumer loans to investors. When investors open an account, Prosper gives them access to individual account pages on its website through which they can invest in the firm’s securities. The pages investors can access provided information on the consumer loans and the performance of each Prosper security. That information includes the annualized net returns or ANR. That number was calculated by a computer program that traced to 2009. After the code was rewritten in 2014 certain amounts were incorrectly excluded in the calculation. This was not discovered until 2015. During that period investors relied on incorrect information. In April 2017 Prosper discovered the error following complaints lodged by a large institutional investor. Subsequently, the firm notified investors and provided corrected calculations. The firm has now revamped its processes. The Order alleges violations of Securities Act Section 17(a)(3). To resolve the proceedings the firm cooperated with the staff and consented to the entry of a cease and desist order based on the section cited in the Order. Prosper also agreed to pay a $3 million penalty.

FINRA

Excessive trading: The regulator directed New Jersey based broker-dealer Buckman, Buckman and Reid, Inc. to pay restitution to seven customers for failing to properly supervise two now barred registered representatives who engaged in excessive trading in the customer accounts. Over a period of time the two former registered representative engaged in excessive trading that caused significant harm to the seven clients involved. The brokerage firm failed to reasonably supervise the two former employees.

Australia

Improper trading: The Australian Securities and Investment Commission banned Rodney Peters form working in the financial services industry for six years. The regulator found that Mr. Peters wrongfully claimed that he had discretionary authority over certain accounts and engaged in over 1,000 improper option trades in client accounts over a one year period beginning in April 2015.

Hong Kong

Naked shorts: The Securities and Futures Commission fined Nine Mast Capital Ltd. $1.2 million dollars for naked short selling. On May 12, 2015 Yuzhou Properties announced a proposed placing of new shares subject to certain conditions. Nine Mast received an allotment. Prior to the finalization of those arrangements Nine Mast sold short about 10.6 million shares of Yuzhou. Since the firm did not have shares the position was not covered as required.

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