by T. GormanPosted on Posted in SECActions

The SEC and Elon Musk were at odds again this week. The Commission filed motion papers requesting that the Tesla founder be held in contempt for issuing a tweet about the firm’s potential production numbers for the year without first obtaining approval in accord with the terms of the earlier settlement. A subsequent tweet, issued with approval, clarified the first. The information in the tweets was taken from company releases. Mr. Musk and the company admit that the first tweet was not pre-cleared. The action is pending.

The Commission also filed three civil injunctive actions this week. Two of the cases were offering frauds. One centered on soliciting two investors using false claims to convince them to invest capital in a private firm that supposedly was going to produce a motion picture. The second, conducted by a convicted felon, used misrepresentations to solicit investors to put their investment dollars in a claimed real estate deal. A third case centers on executives who used false claims and sham transactions in applying for aid from a federal program for university operators.

SEC Enforcement – Filed and Settled Actions

The Commission filed 3 civil injunctive actions and no administrative proceedings this week, exclusive of 12j and tag-along actions.

Offering fraud: SEC v. Adams, Civil Action No. 2:19-cv-01312 (C.D. Cal. Filed Feb. 26, 2019) is an action against: Daniel Adams, a film writer and convicted felon; Michael Flanders, a music producer; Spiderworx Media LLC and L.A. Minute LLC. In 2016 Messrs. Adams and Flanders sought to raise capital to make a movie titled An L.A. Minute. One investor was induced to participate based on false assertions that the writer and music producer had invested in the endeavor – they had not. A second investor said he would put capital in the project if $200,000 was raised. After being shown false records about a claimed investment in that amount the investor put in his capital. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a)(2). The case is pending. See Lit. Rel. No. 24411 (C.D. Cal. Filed Feb. 26, 2019).

False disclosure: SEC v. Massimino, Civil Action No. 2:19-cv-01374 (C.D. Cal. Filed Feb. 25, 2019). Defendants Jack Massimino and Robert Owen were, respectively, the CEO and CFO of Corinthian Colleges, Inc., a publicly traded operator of 125 for profit colleges. About 80% of the firm’s revenue came from the federal government through student loans and grants under Title IV of the Higher Education Act of 1968. Receipt of revenue under Title IV depended on the company achieving a certain composite score calculated by the U.S. Department of Education from certain financial metrics. Long term debt increased the institution’s composite score. To ensure that Corinthian achieved a score that assured Title IV Funds would flow, at year-end 2011, 2012 and 2013 the company boosted its long-term debt through borrowings on its line of credit. In each instances a short while later the borrowings were repaid. The Department of Education sent Corinthian a letter in mid-August 2013 stating in part that the year-end borrowings were incorrectly included in long term debt for FY 2011, calling them “questionable accounting treatment.” Corinthian excluded the borrowings and filed a Form 8-K later the same month. The filing stated that the Department of Education required the elimination of the long term debt for 2011, that the company disagreed and that there could be no assurance there would not be “additional disagreements” with the government. The disclosures were false and misleading, according to the complaint. Material facts were omitted because the filing did not disclose the 2012 and 2013 borrowings which were identical to those in 2011 and which were under review. The firm also failed to disclose the risk that the Department of Education would require the elimination of the claimed long-term borrowings in those two years and the impact of such a determination. The suggestion that there might be additional disagreements was not sufficient to alert investors the complaint asserted. The complaint alleges violations of Securities Act Section 17(a)(3) and Exchange Act Section 13(a). To resolve the case each Defendant consented to the entry of a permanent injunction based on the sections cited in the complaint as to Mr. Massimino and on Section 13(a) as to Mr. Owen. Mr. Massimino will also pay a penalty of $80,000 while Mr. Owen will pay $20,000. See Lit. Rel. No. 24410 (February 25, 2019).

Offering fraud: SEC v. Castleberry Financial Services Group, LLC, Civil Action No. 10-80244 (S.D. Fla. Filed Feb. 19, 2019) is an action which names as defendants the firm, T. Johnathan Turner, its COO and Norman Strell, the CEO of the firm. Defendants have defrauded at least 15 investors out of over $3.6 million in the last twelve months. Specifically, Defendants have touted the firm’s success which resulted in it being well capitalized, the safety of investing with them and the investments which would be in businesses and real estate. Investments were also supposedly insured by firms such as CNA Surety and Chubb Group and made by skilled professionals. Each claim was false. The investor funds were misappropriated, there was no business and Mr. Turner is a convicted felon who is on supervised release following years in prison. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). A temporary freeze order has been entered and an accounting ordered. The case is pending. See Lit. Rel. No. 24412 (Feb. 27, 2019).

Criminal cases

Offering fraud: U.S. v. Liberty, No. 2:19-cr-00030 (D. Me. Filed Feb. 27, 2019) charges Michael Liberty and Paul Hess with conspiracy to commit wire fraud, four counts of wire fraud and one count of securities fraud. The charges center on a scheme in which Defendants solicited investments for Mozido, a privately held tech firm that offered users an ability to make payments using their mobile phone. Millions of dollars were raised in the scheme, much of which was diverted to the personal use of Defendants. The case is pending. See also SEC v, Liberty, Civil Action No. 99139 (D. Me. Filed March 30, 2018).

Crypto currency: U.S. v. Crater, No. (D. Mass. Filed Feb.27, 2019) charges Rondall Crater with four counts of wire fraud and three counts of unlawful monetary transactions. The charges are based on a three year scheme that began in 2014 in which investors were solicited to invest in a crypto currency firm, My Big Coin Pay Inc. and its coins. Mr. Crater told investors that the crypto coin was a fully functioning crypto currency backed by gold that could be used as a currency. The claims were false. Mr. Crater is alleged to have misappropriated over $6 million in connection with the scheme. The case is pending.

FCPA/Anti-Corruption

U.S. v.Pinto (S.D. Tx. Filed Feb. 26, 2019) is another in a series of actions centered on a bribery scheme involving Petroleos de Venezuela S.A. (PDSA). Specifically, Defendants Rafael Erinque Pinto Franceschi and Franz Herman Muller Huber, respectively, a sales representative and the President of a Florida based firm, were charged in a five count indictment for participating in a corrupt scheme that began in 2009 and continued until about 2013. The scheme centered on the payment of bribes to officials at PDVSA to secure contracts and the payment of past due invoices. The two business men also received over $1 million in kickbacks from the officials as part of the scheme. Two of the three officials bribed have pleaded guilty in connection with the scheme. The indictment alleges one count of conspiracy to commit wire fraud, one count of conspiracy to violate the FCPA, two counts of wire fraud and one count of conspiracy to launder money. The Defendants made their first appearance earlier this week. To date the DOJ has charged 21 people in connection with the scheme, 15 of whom have pleaded guilty.

U.K.

Remarks: Andrew Bailey, Chief Executive of the Financial Conduct Authority, delivered remarks on MiFID II at the European Independent Research Providers Association, London (Feb. 25, 2019). His remarks expressed support for the MiFID II reforms, noted that many asset managers now focused on their investments, that many were voicing concern regarding this trend and noted that they would continue to examine it (here).

Declinations: The Serious Frauds Office announced the closing of two significant corruption investigations. First, the SFO announced that no individuals would be prosecuted in connection with the investigation regarding Rolls-Royce PLC. That inquiry focused on bribery and corruption to obtain business in Indonesia, Thailand, India, Russia, Nigeria, China and Malaysia. Previously the firm entered into a deferred prosecution agreement with the SFO.

Second, the SFO announced that its investigation of GlaxoSmithKline PLC regarding the commercial practices of the company, its subsidiaries and associated persons is being closed. Each announcement followed a detailed review and analysis of the available evidence.

Program: Women in Compliance, March 19, 2019 at the offices of Dorsey & Whitney, LLC, New York New York. Details and registration are here.

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by T. GormanPosted on Posted in SECActions

Elon Musk, founder of Tesla, and the Securities and Exchange Commission are again at loggerheads, back in court on a motion by the agency for an order to show cause why Mr. Musk should not be held in contempt of court. SEC v. Musk, Civil Action No. 1:18-cv-8865 (S.D.N.Y. Motion Filed Feb. 25, 2019). No response has been filed by Mr. Musk.

Background

The SEC’s Motion presents the issue for decision as simple: Mr. Musk violated the agreed to court order entered to resolve the claims by the Commission that he made false statements about Tesla going private. Specifically, in August 2018 Mr. Musk published a series of brief statements on Twitter regarding the prospect of taking the company private. The SEC claimed the statements were false, focusing on the undefined phrase “funding assured.”

The Commission’s claims were resolved the next month in a settlement which imposed certain restrictions on material communications by Mr. Musk about Tesla. Those procedures require the “pre-approval of any such written communications that could contain, or could reasonably contain information material to the Company or its shareholders,” according to the Final Judgment entered by the Court.

On February 19, 2019 Mr. Musk tweeted “Tesla made 0 cars in 2011, but will make around 500k in 2019.” The statement was disseminated to Mr. Musk’s 24 million Twitter followers.

A few hours later Mr. Musk published a second tweet stating “Meant to say annualized production rate at end of 2019 probably around 500K, ie 10k cars/week. Deliveries for year still estimated to be around 400k.”

Letters from counsel for the company and Mr. Musk to the Commission staff in response to inquires about the communications, admit that the first tweet on February 19th was not pre-approved. Mr. Musk believed that the first tweet was simply a reiteration of publications made earlier by the firm. The second statement made on February 19th was pre-approved. Counsel assisted in preparing the clarification, citing facts from earlier Tesla public statements.

The Commission’s motion asserts four key points: 1) The Final Judgment is clear – it requires pre-approval; 2) Mr. Musk admits that he did not secure pre-approval for the first February 19th tweet; 3) this is not a technical violation – the point of the settlement was to prevent the dissemination of inaccurate information as was done here; and 4) Mr. Musk’s post settlement, pre-February 19th statements confirm that he has not diligently attempted to comply with the Final Judgment. Accordingly, the requested order should be entered.

Discussion

The dispute in round one between the Commission and Mr. Musk hinged in large part on the meaning of the phrase “funding secured.” While volumes were written about the surrounding circumstances, those two words remained at the center of all the arguments.

Round two is similar but different. The dispute is similar since it keys to the words tweeted by Mr. Musk. It is different because the critical point is the text of the Final Judgment. The text of that court order requires pre-approval for the publication of any material information about the automaker by Mr. Musk. Since it is undisputed that there was no pre-approval and that the information was material and about Tesla the case is over – at least according to the SEC.

Perhaps. If the point of the Final Judgment was to ensure proper and accurate communications of information about Tesla as the SEC argues, then the ultimate resolution of this case may turn on whether the phrase “pre-approval” in the Final Judgment includes a reiteration of previously published information. Stated differently, if the publication of the information has been approved, must it be approved a second time?

It seems unlikely that the SEC and the Court intended to create and impose needless disclosure procedures requiring unnecessary duplication. Yet in this case the factual record presented by the SEC to the court specifically states that Mr. Musk reasonably believed he was reiterating information that previously had been published. Arguably the pre-publication review requirement of the Final Judgment has not been violated under such circumstances. Alternatively, any violation is substantially mitigated in view of these facts, counseling minimal, if any, sanction. This is particularly true in this case since the Commission has the burden of establishing a violation of the Final Judgement by clear and convincing evidence.

In the end, the real point of these proceedings is not so much the words or the court orders. It is about good corporate governance – reflected here in the disclosure policies incorporated in the Final Judgment – and a visionary company founder who does not fit into the typical public company senior executive mold. No doubt all companies – including Tesla – benefit from good corporate governance. No doubt companies such as Tesla greatly benefit from visionaries like Mr. Musk. Round two needs to resolve with an accommodation that draws the best from each side.

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