by T. GormanPosted on Posted in SECActions

The merits of the SEC Enforcement program cannot be assessed by numbers and statistics chronicling events like how many cases were filed or the total amount of dollars ordered in judgments. At least that is the claim frequently repeated by the agency and the Division of Enforcement. Yet various sources publish numbers about Division of Enforcement ranging from the newly minted Annual Report (started last fiscal year) of the Division to various consulting firms and universities. Many who practice in the area, or closely follow the agency, discuss metrics and numbers tied to the work of the Enforcement Division. The question thus becomes “What, if anything, do SEC Enforcement statistics tell us?”

The New York University Pollack Center for Law and Business is one source of statistics about the work of SEC Enforcement that is outside the agency. The Center teams with Cornerstone Research to publish its data. The most recent compilation from this team is: Cornerstone Research, SEC Enforcement Activity: Public Companies and Subsidiaries (December 2018), available here (Cornerstone Report).

Number of Enforcement cases:Many of the metrics highlighted in the Report are familiar, echoing the earlier Enforcement Annual Report, published in October 2018 (here). The top line key metric is always the number of cases filed by the Division. Both reports agree that 490 standalone enforcement actions were filed FY 2018. The Division likes to add an asterisk to the number, noting that the MCDC (Municipalities Continuing Disclosure Cooperation initiative) skews the trend analysis over time. The Cornerstone Report faithfully footnotes the claim (here). The Division offers little explanation for this claim. The Cornerstone Report offers none. While there is no doubt that MCDC added a number of cases to the totals, the same might be said of the current Enforcement efforts regarding the share class selection initiative which is not mentioned.

Perhaps the most significant point about the 490 FY 2018 total is not whether an asterisk is added by but how the Division was able to file that many cases. In the first half of FY 2018 the Division only filed 159 standalone cases. In the second half of the year over twice as many cases were brought – 331. The tables included in the Cornerstone Report demonstrate that this is the largest number of actions brought in any six-month period in the last several years with or without the asterisk. While it is typical to see the numbers go up in the waning months of the fiscal year as the Division empties its pipeline and looks to enhance its year end statistics for the fall Congressional budget hearings, more than doubling the first half output is a significant achievement. That number becomes even more remarkable in view of the Cornerstone Report’s statement that 44% of the FY 2018 independent SEC actions were filed in the fourth quarter. Unfortunately there is no discussion regarding these achievements in the Cornerstone Report or the Division’s Annual Report.

Public company cases: The focus of Cornerstone Report is cases involving public companies and/or their subsidiaries. Here the numbers can be difficult to square with those from the Enforcement Annual Report. For example, according to the Cornerstone Report the SEC filed 71 new enforcement actions against public companies and subsidiaries in FY 2018. The bulk of those cases – 46 – were filed in the last quarter of the fiscal year. That number represents a record for this decade.

Again, there is no discussion of the numbers revealing how the Division accomplished this feat. Perhaps more importantly, the numbers here do not precisely track those from the Enforcement Annual Report. The Division’s Annual Report says that 16% of its cases involved issuer reporting, accounting and auditing issues. That calculates to 78 cases (the number is not in the report). Whether the category described by the SEC is the same as that used by Cornerstone is unclear. Neither report offers definitions which could clarify the question.

Venue selection: Venue selection is another key question about SEC Enforcement as reflected in the series of cases that resulted in the Supreme Court’s decision in Lucia v. SEC, 138 U.S. 2044 (2018) which held that SEC ALJs are not properly appointed in accord with the Constitution’s Appointments Clause (which of course has nothing to do with the real question raised by the case which was venue selection – federal court or administrative proceeding). The statistics here are even murkier. The Cornerstone Report states that 85% of the public company and subsidiary actions were filed as administrative proceedings. A year by year chart that traces back to 2010 reflects this point. It also shows slightly fewer administrative proceedings being filed last year compared to the prior three years but far more that in any year from 2010 through 2014.

The meaning of the venue statistics is unclear. The Cornerstone Report does not disclose the percentage of those cases were settled. Most public companies and their subsidiaries settle actions at the time of filing, a fact not mentioned in the Cornerstone Report. If, for example, all or almost all of the cases filed as administrative proceeding have been settled by the time of filing the number could suggest that SEC Enforcement is no longer shifting its contested enforcement actions to the administrative forum rather than bringing them in federal district court – the trend that spawned Lucia.

Statistics presented at the December 5, 2018 Fifth Annual Dorsey Federal Enforcement Forum by Urska Velikorja, a professor at Georgetown Law School who specializes in SEC Enforcement (here), demonstrate that virtually all of those cases were settled. Indeed, Professor Velikorja noted that every SEC enforcement action filed as an administrative proceeding since May 2018 has been settled. Whether this is a new, but unannounced enforcement policy, or just the by-product of the glut of cases on the administrative docket following Lucia as the Commission sought to implement the Court’s mandate is unclear.

Monetary sanctions: Similar difficulties arise regarding two other key metrics – dollars in judgments and case selection. In FY 2018 a record setting $2.4 billion is reflected in the settlements from 89% of the actions according to the Cornerstone Report. This is another milestone number that traces back to the beginning of the decade.

The Cornerstone Report also notes that the percentage of firms cooperating with the staff investigations was about 61%, relatively consist with other years. Juxtaposing the two numbers, the question becomes what if anything the cooperators got for their efforts? Stated differently, did the large amount dollar amount result from giving less credit for cooperation? The Cornerstone Report does not specify if the dollars are disgorgement, prejudgment interest or penalties, which is important since SEC Enforcement tends to reward cooperation by discounting penalties but not disgorgement.

The only discussion of the monetary sanctions is a sentence stating that 74% of the total came from one huge, record setting settlement of $1.8 billion in an FCPA case. Since portions of those dollars go to other actions as the Cornerstone Report states, just how much cash the SEC garnered from enforcement is unclear. And, it cannot be determined how the total in the Cornerstone Report squares with that in the Division’s Annual Report which puts the total at $3.945 billion without touting the amount as a record.

Case type: Finally, the Cornerstone Report and the Enforcement Annual Report both present statistics regarding the types of cases brought in FY 2018. The Cornerstone Report claims the top category is issuer reporting at 34% followed by broker-dealers at 27%. In contrast the Enforcement Annual Report states that the largest category of cases was offerings at 25% while 22% involved investment advisers and investment companies. Issuer reporting and disclosure cases accounted for 16% of the total number of cases (or 78 cases compared to 122). As in other parts of the two reports there are no definitions to aid the user. There is little to no discussion to elucidate the statistics.

Some clarity is added by the numbers presented at the Dorsey Federal Enforcement program cited above. There it was noted that in the fourth quarter of FY 2018 over 50 actions were brought against investment advisers, a total which seems to support the statistics offered by the staff in its Annual Report.

Conclusion: One point which is clear from considering the Cornerstone Report and the Enforcement Annual Report: SEC Enforcement brought 490 standalone enforcement actions in F 2018, a significant number of cases. It is also clear that large sums of money were included in the settlements.

Finally, there is also a suggestion that the Enforcement Division may be moving away from the pre-Lucia days of bringing contested actions as administrative proceeds – at least for now. Perhaps in the future Cornerstone Research and the Division of Enforcement will shed additional sunlight these trends.

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by T. GormanPosted on Posted in SECActions

The Commission filed a series of settled administrative proceedings this week. The cases were based on topics which are by now familiar: Undisclosed conflicts involving investment advisers, an ICO, internal controls and an EB-5 fraud. In addition, there were the usual offering fraud cases and one which is presented as a valuation case but on closer analysis actually centers on a sham transaction.

The settled administrative proceeds filed this week – the only type of actions filed in this venue since May 2018 – also echo what appears to be a slowly growing trend of returning to the “broken windows” approach to enforcement. Under that approach, borrowed from the New York City Police Department, any violation big or small got filed and tossed on the heap of cases being brought to increase its size and height.

This week where were four cases filed involving a failure to have a review done on unaudited quarterly filings. Two of the cases involved a one-time violation while the other involved three. Only one of the Respondents had the financial ability to pay a penalty. The other three were excused based on financial affidavits. The approach is curious for a program that has repeatedly disclaimed the importance of the number of cases brought.

SEC

Remarks: Chairman Jay Clayton delivered Remarks to the SEC Investor Advisory Committee, Washington, D.C. (Dec. 13, 2018). His remarks covered ESG topics (environmental, social and governance) which he does not believe should be mandated disclosure items and improving the collectability of arbitration awards which the Chairman believes should be improved.

Remarks: Chairman Jay Clayton delivered remarks titled SEC Rulemaking Over the Past Year, the Road Ahead and Challenges Posed by Brexit, Libor Transition and Cybersecurity Risks, New York, New York (Dec. 6, 2018). His remarks reviewed the regulatory agenda regarding capital formation, monitoring the markets, and, with respect to the future, the proxy process, long term investment and distributed ledger technology and ICOs.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 1 civil injunctive case and 14 administrative proceedings, excluding 12j and tag-along proceedings.

Undisclosed conflicts: In the Matter of Yucaipa Master Manager, LLC, Adm. Proc. File No. 3-18930 (Dec. 13, 2018) is an action against the registered investment adviser. The adviser manages funds from the principal as well as certain private funds. Here the adviser failed to disclose certain charges imposed on clients for tax work by the in-house staff. Clients were also not told about certain arrangements involving the principal and two consulting firms. Specifically, in the first the principal made a personal loan to the consulting firm’s principal secured by money owed by the adviser or its affiliate and repaid by the consulting firm resulting in a misallocation of fees. Second, while another consulting firm was servicing a portfolio investment fund and two of the principal’s personal investments, the principal also made a personal investment in the consulting firm without disclosing the arrangements. This resulted in a failure to properly allocate fees. The Commission considered the remedial acts of the adviser who also agreed to implement a series of undertakings which include the appointment of an independent consultant. The Order alleges violations of Advisers Act sections 206(2) and 206(4). In addition, the adviser will pay disgorgement of $1,034,312, prejudgment interest of $71,070 and a penalty of $1million.

Offering fraud – EB-5: In the Matter of American Modern Green Senior (Huston) LLC, Adm. Proc. File No. 3-18927 (Dec. 12, 2018). The Order names as Respondents: American Modern Green Senior, American Modern Green Community (Huston) LLC and American Modern Green Residential (Huston) LLC. Each firm was formed in connection with the EB-5 development. From May 2015 to March 2017 Respondents raised about $49.5 million from 90 immigrant investors through three related EB-5 investment offerings. The funds, in substantial part, were not used as promised. The offering materials also contained certain misstatements. The Order alleges violations of Securities Act sections 17(a)(2) and (3). Respondents replaced the misused funds and have agreed to circulate this Order to the investors. Respondents also agreed to the entry of a cease and desist order based on the sections cited in the Order. In addition, the three Defendants agreed to pay disgorgement totaling $49.5 million as follows: AMG Senior will pay $17.6 million; AMG Community $4.4 million; and AMG Residential $27.5 million. Each will also pay prejudgment interest. Respondents will pay a penalty of $800,000.

Undisclosed fees: In the Matter of Landaas & Co., Adm. Proc. File No. 3-18926 (Dec. 12, 2018) is a proceeding which names as Respondents the registered investment adviser and broker and its founder and sole owner, Robert Landaas. The order alleges that over an eight year period, beginning in 1999, Respondents received undisclosed fees from two sources. First, the firm’s clearing broker charged a $20 mark-up labeled a Clearing Broker fee. Part of it was returned to Respondents who, in part, used it for related expenses but kept the balance and misrepresented at times the payment to investors. Respondents also received fees from the clearing broker in connection with the no-transaction-fee mutual funds which were not disclosed. The Order alleges violations of Advisers Act sections 206(2), 206(4) and 207. The firm agreed to implement a series of undertakings which include the retention of an independent consultant. Each Respondent consented to the entry of a cease and desist order based on sections cited in the Order. They also agreed to pay, on a joint and several basis, disgorgement of $408,483.06, prejudgment interest of $60,458.14 and a penalty of $130,000.

ICO fraud: SEC v. AriseBank, Civil Action No. 3: 18-cv-00186 (N.D. Tx.) is a previously filed action which named as defendants the bank, Jared Rice, its CEO and Stanly Ford, its COO. Defendants were at the center of what they claimed was the largest ICO ever launched. Each Defendant resolved the action by agreeing to pay, on a joint and several basis, $2,259, 543 in disgorgement along with prejudgment interest of $68,423. Each will also pay a penalty of $184,767. Each agreed to the entry of orders barring them from being an officer or director of a public company, participating in an ICO and precluding future violations of the antifraud provisions of the federal securities laws. Parallel criminal charges have been brought against Defendant Rice by the U.S. Attorney’s Office for the Northern District of Texas.

Offering fraud: In the Matter of Alfred C. Teran, Adm. Proc. File No. 3-18098 (Dec. 11, 2018). This action is related to SEC v. Faulkner, Civil Action No. 3:16-cv-01735 (N.D. Tex. June 24, 2016), which is based on an alleged $80 million offering fraud orchestrated by Christopher Faulkner and involving Breitling Energy Corporation and two other controlled firms, Crude Energy LLC and Patriot Energy, Inc. Respondent Teran worked as a sales representative for Breitling Oil and Gas and Breitling Royalties Corporation. Beginning in 2011, and continuing for the next four years, he received a salary to sell royalty-interest securities in unregistered oil-and-gas offerings for the three firms controlled by Mr. Faulkner. He was not registered. 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 barred from the securities business. In addition, he will pay a $50,000 penalty. Respondent agreed to further proceedings before an ALJ to determine what if any disgorgement should be paid.

Internal accounting controls: In the Matter of The Hain Celestial Group, Inc., Adm. Proc. File No. 3-18921 (Dec. 11, 2018). Hain is a leading marketer, manufacturer and seller of organic and natural food and personal care products. The firm’s customer base is primarily specialty and natural food distributors, supermarkets, natural food stores, mass-market and e-commerce retailers and food service channels. The firm’s shares are listed on NASDAQ. Over the past five years net sales in the U.S. business segment have declined from about 65% of world-wide sales in FY 2013 to about 46% in FY 2016. During the two year period beginning with FY 2014 the firm’s net sales for the U.S. business segment were derived in part from two Distributors – No. 1 and No. 2. During the two-year period Hain’s U.S. business segment sales team responsible for the two distributors rolled out an “end of the quarter” or EOQ sales incentive program. The financial reporting implications of EOQs are illustrated by the impact with Distributor No. 1. Hain and the Distributor executed annual sales contracts, stipulating to quarterly inventory sales growth targets. Distributor No. 1 earned financial incentives by meeting the targets, one of which related to spoilage. Hain did not have sufficient policies and procedures to provide reasonable assurances that the EOQ sales were accounted for properly. Sales personnel were not appropriately trained or knowledgeable regarding the accounting impact of the sales practices. The policies and procedures were also inadequate to monitor incentives made in sales transactions. This created potential revenue recognition implications. In addition, the arrangements were not fully communicated outside the sales department. Similar, although slightly different issues, arose with respect to Distributor No. 2 and the EOQ program. Once the finance department discovered the program an internal investigation was launched and the firm self-reported. While ultimately the firm concluded a restatement was not required, a series of remedial actions were taken. The Order alleges that Hain violated Exchange Act sections 13(b)(2)(A) and 13(b)(2)(B). Following its self-report, the firm fully investigated the issues, cooperated with the staff investigation and undertook certain remedial steps. To resolve the proceedings the firm consented to the entry of a cease and desist order based on the sections cited in the Order. No penalty was imposed in view of the self-report, cooperation and remediation.

Offering fraud: SEC v. Webb, Civil Action No. 11-CV-7152 (N.D. Ill.) is a previously filed action against Gregory Webb who raised over $20 million in a nationwide fraudulent offering. Following his conviction in the parallel criminal action Mr. Webb settled with the Commission. The Court entered the final judgment enjoining Defendant from future violations of Securities Act sections 5(a), 5(c) and 17(a) and Exchange Act section 10(b). The order also requires Mr. Webb to pay disgorgement of $550,057 and prejudgment interest of $132,352 but deems the amounts satisfied by the payment of $9 million in restitution in the criminal case. See Lit. Rel. No. 24372 (Dec. 13, 2018).

Interim review requirement: In the Matter of Lotus Bio-Technology Development Corporation, Adm. Proc. File No. 3-18925 (Dec. 11, 2018) is an action which names the firm, a Nevada corporation based in Kowloon, Hong Kong, failed to have an independent public account firm review the interim financial statements filed as part of a Form 10-Q as required by Regulation S-X on one occasion. The Order alleges violations of Exchange Act section 13(a) and rule 13a-13 and Regulation S-X, Rule 8-03. To resolve the proceeding the firm consented to the entry of a cease and desist order based on the section and rules cited in the Order. No penalty was imposed based on an affidavit of financial condition. See also In the Matter of Frontier Oilfield Services, Inc., Adm. Proc. File No. 3-18924 (Dec. 11, 2018)(same; $25,000 penalty imposed); In the Matter of Eastgate Biotech Corporation, Adm. Proc. File No. 3-18923 (Dec. 11, 2018)(same except 3 violations; no penalty based on affidavit re financial condition); In the Matter of Auscrete Corporation, Adm. Proc. File No. 3-18922 (Dec. 11, 2018)(same; 3 occasions; no penalty based on affidavit re financial condition).

Valuation—sham transaction: In the Matter of Agria Corporation, Adm. Proc. File No. 3-18917 (Dec. 10, 2018). Agria is a Cayman Island firm based in Hong Kong engaged in the agricultural business. Its American Depository Shares were listed on the New York Stock Exchange. The firm had significant business interests in the Peoples Republic of China, New Zealand and Australia. The operations in China were run by Taiyuan Primalights III Modernized Agriculture Development Co., Ltd., known as P3A, a limited liability firm whose results were consolidated with Agria. In early 2010 Agria negotiated an agreement with P3A’s president under which the firm would divest ownership of the limited liability firm, ending the sheep breeding operations to focus on the seed business. Under the terms of the transaction Agria transferred its 100% ownership interest in P3A to that firm’s president. P3A’s president in turn transferred his ownership of 11.5% of Agria’s outstanding shares and added the land use rights held by the firm. In assessing the value of the deal, the firm ignored reports it had prepared by outside consultants which suggested the properties but not the stock received were virtually worthless. Yet for three years the firm refused to properly value the properties. Finally, in 2013 the firm was forced to write down the assets secured in the deal with P3A based on matters that had been known to the firm since 2010. By overvaluing the assets and ignoring the market value of its own stock received in the deal as priced on the NYSE in favor of assigning a value to the shares based on the assets which approximately doubled the share value, Agria concealed a loss of about $17.45 million. If that loss had been properly recorded it would have tripled the net reported loss in 2010. The delay in properly reporting the transaction had a similar impact in 2011 and 2012. The Order alleges violations of Exchange Act sections 10(b), 13(a), 13(b)(2)A) and 13(b)(2)(B). To resolve the proceedings the firm agreed to fully cooperate with the staff in any action or related judicial or administrative proceeding or investigation. The firm also consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, Agria agreed to pay a penalty of $3 million. See also In the Matter of Laiguanglin (Alan), Adm. Proc. File No. 3-18918 (Dec. 10, 2018)(Action against the executive chairman of the firm for manipulating the share price of the stock to keep it above the $1.00 price limit below which it could be delisted beginning before the period of the action above and continuing through it; settled with a consent to the entry of a cease and desist order based on Exchange Act section 10(b), an order prohibiting Respondent from acting as an officer or director of a public firm for five years and the payment of a $400,000 penalty).

Binary options: SEC v. Davis, Civil Action No. 3:18-cv-02829 (N.D. OH Filed Dec. 10, 2018) is an action which names as defendants Jared Davis and Dale Pinchot. From at least 2012 Defendants made about $10 million by luring investors into trading binary options. In many instances Defendants traded on the other side of the investors, profiting when the investors lost. In some instances, the trading was rigged. The complaint alleges violations of Securities Act sections 5(a), 5(c) and 17(a)(1) and (2) and Exchange Act sections 10(b) and 15(a)(1). To resolve the action each Defendant consented to the entry of a permanent injunction based on the sections cited in the complaint. Monetary issues will be considered by the Court at a later date. See Lit. Rel. No. 24370 (Dec. 10, 2018). A parallel criminal case was filed by the U.S. Attorney’s Office for the Northern District of Ohio on June 5, 2018. See Lit. Rel. No. 24370 (Dec. 10, 2018).

Blue sheets: In the Matter of Natixis Securities Americas LLC, Adm. Proc. File No. 3-18916 (Dec. 10, 2018); In the Matter of MUFG Securities Americas Inc., Adm. Proc. File No. 3-18914 (Dec. 10, 2018). Each proceeding names as a Respondent a registered broker dealer who failed to properly submit blue sheets to the staff as requested. In each instance Respondent admitted that the conduct violated the federal securities laws and consented to the entry of a cease and desist order based on Securities Act section 17(a)(1) and a censure. Respondent Natixis also agreed to pay a penalty of $1.5 million; Respondent MUFG agreed to pay a penalty of $1.4 million.

Unregistered offering: In the Matter of Coinalpha Advisors LLC, Adm. Proc. File No. 3-18913 (Dec. 7, 2018) is a proceeding centered on an ICO. Specifically, from October 2017 through May 2018 Respondent raised about $600,000 from 22 investors who purchased interest in a digital offering. The offering was conducted under a Form D Notice of Exempt Offering of Securities, filed with the agency on November 3, 2017. Essentially Respondent conducted a general solicitation to purchase unregistered securities. Respondent halted the offering when contacted by the staff and voluntarily returned the funds obtained from investors and unwound the transaction. The transactions were shams. The Order alleges violations of Securities Act sections 5(a) and 5(c). Respondent also agreed to pay a penalty of $50,000.

Anti-Corruption/FCPA

U.S. v. Gravina (S.D. Tx.) is an action which names as a defendant Alfonso Eliezer Gravina Munoz, formerly an employee of Etroleos de Venezuela S.A. in Venezuela. Mr. Gravina pleaded guilty to one count of conspiracy to launder money and one count of making false statements on his federal income tax return. The underlying factual predicate is a scheme in which bribes were paid by the owner of U.S. based companies to Venezuelan government officials in exchange for securing additional business with PDVSA and payment of certain invoices. The plea is based on a cooperation agreement.

Criminal Cases

Sham transaction: U.S. v. Bakhshi, No. 2:12-mj-08177 (D. N.J. unsealed Dec. 10, 2018) is an action which names as a defendant Pavandeep Bakhshi, a U.K. citizen. Charges of conspiracy and securities fraud lodged in in a criminal complaint center on a scheme to take private a firm listed on the London Stock Exchange’s Alternative Investment Market. Specifically, in connection with the scheme Defendant and others sought to present a positive picture for a firm involved in the potential deal by engaging in a series of sham transactions that purportedly enhanced the financials of the private firm that would have been engaged in the transaction. The transactions were essentially shams. The case is pending. See also SEC v. Parmar, Civil Action No. 2:18-cv-09284 (D.N.J. Filed May 16, 2018).

Offering fraud: U.S. v. Pagartanis, No. 2:18-CR-00374 (E.D.N.Y.) is an action in which Defendant Steven Pagartanis pleaded guilty to one count of conspiracy to commit mail and wire fraud for orchestrating an 18 year Ponzi scheme. Defendant was at one time a securities professional and an affiliate of a registered broker-dealer. Beginning about 2000 he solicited elderly victims to invest in real estate-related investments. Investors were promised a fixed return of between 4.5 to 8%. The Defendant raised about $13 million, $9 million of which represents losses for the victims. The date for sentencing has not been set. See also SEC v. Pagartanis, Civil Action No. 2:18-cv-03150 (E.D.N.Y.).