by T. GormanPosted on Posted in SECActions

The question never really addressed, but which has always been the fundamental issue, is fairness. When the Commission began shifting its enforcement actions from federal district court to its administrative in-house forum, the bedrock question was fundamental fairness, presented in a series of cases challenging the agency venue selection decisions. When the Appointments Clause issue took center stage in a Supreme Court hearing that concluded with a determination in Lucia v. SEC, No. 17-130 (June 21, 2018) that ALJs must be appointed in accord with the dictates of the Clause, the real issue was still fairness. When the President executed an Executive Order eliminating civil service protections for SEC ALJs and making them directly accountable through the political process, the question remained fairness. As the Commission implements the letter of Lucia by essentially restarting the administrative enforcement process for pending cases, the question remains one of fairness. That question is still to be addressed.

There is no doubt that the differences between the administrative and federal court forum is significant – otherwise the agency would not have shifted. The administrative action begins with the agency deciding an enforcement case should be brought and charging those involved with wrong doing in an administrative complaint or Order Instituting Proceedings. The hearing has been before a Commission employee known as an Administrative Law Judge under Rules which, until recently, permitted virtually no discovery other than a document exchange despite the fact that the Enforcement staff-prosecutors have had the benefit of a years long investigation. At the hearing there were no real rules of evidence. Written statements that cannot be cross-examined and hearsay which suffers from the same problem was admissible.

On appeal the agency that issued the charges decided the ultimate liability and sanction issues. And, when the case finally reached an Article III federal circuit court, the Commission claimed deference to its decisions, negating any real review by the court.

In contrast, in a federal court civil injunctive action the Federal Rules of Civil Procedure provide for extensive discovery to ensure the development of the facts by all parties. The Federal Rules of Evidence ensure that only reliable factual information is admitted into evidence and that the right to cross-examination is preserved. The trial is presided over by a federal district court judge with life time tenure to free him or her from the political processes. Facts are determined by the court or the jury at the election of the parties. Appeals are to a federal circuit court of appeals – no deference to the agency is due.

These fundamental differences, played out in the context of specific enforcement actions that could well end a business and career, spawned the fairness issue in a series of cases challenging the venue selection determinations of the agency. See, e.g. Hill v. SEC, No. 1:15-cv-1801, 2015 WL 4307088 (N.D. Ga. June 8, 2015)(raising constitutional issues regarding fairness of forum selection re enforcement action); Duka v. SEC, No. 15 Civ. 357,2015 WL 1943245 (S.D.N.Y. April 15, 2015)(same). Over time those claims came to include the Appointments Clause issue ultimately decided by the Supreme Court in Lucia. See, e.g., Bandimere v. SEC, 844 F. 3d 1168 (10th Cir. 2016) (Appointments Clause violated); Raymond J. Lucia Companies v. SEC, 832 F. 3d 277 (D.C. Cir. 2017)(Appointments Clause not violated).

The Commission did not address the fundamental fairness question on which these and other cases were bottomed when responding to the onslaught of cases or even in the Supreme Court. To the contrary, the agency typically defended by focusing on procedural issues, arguing that there was no jurisdiction for a federal district court challenge to its procedures. When the challenges were raised in an administrative context the Commission denied the claims and argued that the Appointments Clause had not been violated as it did in Lucia before the D.C Circuit.

When Raymond J. Lucia Companies filed a Petition for Certiorari, however, the Commission found itself on the other side of the Appointments Clause issue, apparently as a result of the Solicitor General’s position. The Solicitor General filed a brief supporting Petitioner’s claim that the Appointments Clause had been violated, contradicting the argument the agency had repeatedly made. The brief also urged the High Court to consider a question presented by Free Enterprise Fund v. PCAOB, 130 S.Ct. 3138 (2010). There the Court found that the two layers of employment protections afforded PCAOB members violated the Vesting Clause of the Constitution by interfering with the control of the President over political appointees. Commission ALJs, as civil servants, were protected by similar provisions passed by Congress in an effort to reassure the public that the administrative in-house adjudication process was fair because it was insulated from the political process as Justice Breyer noted in his separate opinion in Lucia. The Court declined to consider the question.

Now the Commission is now complying with the dictates of the Supreme Court’s decision in Luca, directing that Petitioner, who battled for years seeking fundamental fairness, be given a new hearing not in federal district court but before a properly appointed ALJ despite his repeated claims of unfairness regarding the venue. The irony, of course, as noted by the Justices during oral argument in Lucia, is that despite arguing about the unfairness of the administrative form, Mr. Lucia and his firm will now be subjected not just to the same forum but one which is directly accountable to the political processes because an executive order stripped SEC administrative law judges of their civil service protections. Executive Order Exempting ALJs from Competitive Services (July 10, 2018).

To say that Mr. Lucia, and those who litigated for years in an effort to bring fundamental fairness to the enforcement process, got far less than they bargained for is perhaps the ultimate understatement. Law 360 recently characterized the Commission’s implementation of Lucia as “Largely for Show” (Sept 8, 2018). See also In re Administrative Proceedings, (SEC Order) August 22, 2018 (order implementing Lucia). Yet for Mr. Lucia, and others who have fought for years to bring fairness to the process – those covered by the SEC order and others whose cases have concluded but were subject to the forum shift trend – the fairness question remains unaddressed.

Now is the time for the Commission to step-up and be a leader in the effort to instill a new fairness in the administrative enforcement process. That begins with a recognition that not every case can effectively be adjudicated in an administrative forum. Some cases, for example, may require extensive discovery by those charged; some cases may need the rigors of the rules of evidence; and some cases may be fact intensive, requiring a jury to hear the case. Others may require securities expertise from the trier of fact of the type possessed by ALJs. One size does not fit all.

One way to address these issues is to change the administrative litigation track. Specifically, the agency could, by seeking legislation or through rules, adopt a process similar to one used by FERC. There, following an administrative hearing, the appeal goes not to the agency that brought the charges but to a neutral federal district court. If that process is used, and the proceedings before the district court are de novo, it would preserve for the Commission the right to select the venue and use administrative proceedings as deemed appropriate while giving those charged the option to pursue a full federal district court proceeding if they deemed appropriate.

While only a small fraction of those charged might elect to pursue a district court hearing, adopting this procedure would do much to end the claims of unfairness. By specifically addressing the fairness question and acting to instill a new sense of fairness in the enforcement process the agency would be acting as a principled leader, committed to integrity in the enforcement process. Stated differently, adopting this type of process, or something similar, would be a win win – those involved in the process would no longer be able to argue a lack of fairness while the Commission would preserve all of its enforcement options.

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by T. GormanPosted on Posted in SECActions

The Commission filed settled actions this week centered on the manipulation of a pharmaceutical firm’s shares by a short seller and the efforts of an outsourced CFO to evade currency restrictions for China based issuers by transmitting expense payments to the U.S. operating entity of the issuer through his personal checking account.

The Commission also continued to bring actions involving investment advisers and digital currencies. For example, two actions were brought involving investment advisers. Once centered on putting clients into complex EFNs which were not consistent with the trading objectives of the ETNs while another centered on a key undisclosed conflict. With regard to digital currencies and an action was brought alleging unregistered securities while another was based on violations of the broker registration provisions.

Finally, the Commission filed its third settled action under Chairman Clayton in which admissions were required as part of the settlement. The action centered on a failure to provide complete blue sheets as required. The requirement of an admission to settle the action is consistent with prior agency practice on this issue.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 8 civil injunctive cases and 8 administrative proceedings, excluding 12j and tag-along proceedings.

Failure to maintain records – blue sheets: In the Matter of Convergex Execution Solutions, LLC, Adm. Proc. File No. 3-18761 (Sept. 13, 2018) is a proceeding which names the firm as a Respondent which is now known as Cowen Execution Services LLC. It is a wholly owned subsidiary of Cowen Inc. The firm is a registered broker-dealer and FINRA member that is agency focused. It provides execution technology. From May 2012 through late February 2016 the firm supplied deficient blue sheets in 29% of the 6,574 instances requested by the Commission. In March 2012 FINRA sanctioned Respondent for the same violation. The firm failed however, to take adequate steps to remedy the situation. The Order alleges violations of Exchange Act section 17(a). To resolve the proceedings the firm admitted to the facts in the Order and that its conduct violated the federal securities laws. It consented to the entry of a cease and desist order based on the section cited in the Order and to a censure. Convergex will pay a penalty of $2.75 million.

Improper professional conduct – independence: In the Matter of Holthouse Carlin & Van Trigt LLP, Adm. Proc. File No. 3-18762 (Sept. 13, 2018) is a proceeding which names as a Respondent the regional accounting firm which is based in Los Angeles. The firm is a member of the PCAOB. Its registration is being withdrawn. During the period 2012 to 2016 the firm conducted 57 audits of investment adviser clients regarding the custody rule. During the period 2012 to 2013 the firm also conducted six audits of broker-dealers. In each audit the accounting firm violated the independence standards since it prepared the financial statements that were audited, thereby causing the advisers to violate Advisers Act section 206(4) and the broker-dealer clients to violate Exchange Act section 17(a) and the related rules. In resolving the proceedings the firm has undertaken to not conduct any engagements involving the custody rule, broker dealers or public companies for one year. The Order alleges violations of Advisers Act section 206(4) and Exchange Act section 17(a). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order and to a censure. The firm will pay a penalty of $300,000.

Manipulation: SEC v. Lemelson, Civil Action No. 1:18-cv-11926 (D. Mass. Filed Sept. 12, 2018) is an action which names as defendants Gregory Lemelson, the CIO of the management company; Lemelson Capital Management, LLC, a firm that advises the Fund; and The Amvona Fund LP, an exempt reporting adviser. Mr. Lemelson had the Fund take a short position in the shares of Ligand Pharmaceuticals, Inc. He then began a campaign using false statements to drive the price down during the period May to October 2014. For example, he authored and published research reports regarding the firm and took positions on social media about the company that were incorrect. Those included making claims that its flagship product was “going away.” As a result the share price of the firm fell by 34%. The complaint alleges violations of Exchange Act section 10(b) and Advisers Act section 206(4). The case is pending. See Lit. Rel. No. 24267 (Sept. 13, 2018).

Internal controls – money laundering: SEC v. Wasserman, Civil Action No. 18-cv-23729 (S.D. Fla. Filed Sept. 12, 2018) is an action which names as a defendant Adam Wasserman who served as the outsourced CFO to China based public companies. Over a 20 month period Mr. Wasserman used his personal checking account to transfer over $400,000 of funds for Issuer A, a NASDAQ listed firm, from China to the U.S. firm to pay for its expenses to avoid currency restrictions. Mr. Wasserman had previously used this technique for at least two other China-based issuers. This violated the internal control provision. The complaint alleged violations of Exchange Act section 13(b)(5). To resolve the action Mr. Wasserman consented to the entry of a permanent injunction based on the section cited in the complaint. He also agreed to pay a penalty of $20,000 and to the entry of an order barring him from serving as an officer or director of a public company for five years. See Lit. Rel. No. 24265 (Sept. 12, 2018).

Cherry picking: SEC v. Bressman, (D. Mass. Filed Sept. 12, 2018) is an action which names as a defendant, registered representative Michael Bessman. Over a six year period, beginning in early 2012 ,Mr. Bressman “cherry picked” his client accounts. Specifically, he used an omnibus account when executing block trades so that he could hold the shares until the end of the day to determine in which direction the market was moving. If the share price increased he closed the trade and typically allocated it to his personal account. If the price declined he would hold the shares for an extended period and allocate the trade to a client account. Over the period Defendant obtained over $700,000 in illicit gains through this method of trading. The SEC used its data analytics capabilities to analyze the trades here. The complaint alleges violations of Securities Act sections 17(a)(1) and (3) and Exchange Act section 10(b). The case is pending. The U.S. Attorney’s Office for the District of Massachusetts filed a parallel criminal action.

Failure to supervise: In the Matter of Cadaret, Grant & Co., Adm. Proc. File No. 3-18738 (Sept. 11, 2018) names as Respondents the dual registered broker-dealer and investment adviser, Arthur Grant, Beda Johnson and Eugene Long, respectively, the majority owner of the firm and its CEO, an owner and board member of the firm and an associated person and registered representative. In 2015 and 2016 the registered representative Respondents concluded that oil prices, which had fallen, would recover over several months. They put certain clients into complex exchange traded notes or ETNs tied to the oil markets and certain futures and underlying instruments. The notes however, according to the literature, were only for those trading with a very short time horizon of one day or less. In recommending the ETNs the representatives lacked any reasonable basis. The investors lost 90% or more of their investment. While the firm had policies and procedures regarding the necessity of such a basis they were not properly implemented. The Order alleges violations of Securities Act sections 17(a)(2) and (3) and Advisers Act section 206(4). In resolving the proceedings the firm agreed to certain undertakings which include the retention of a consultant. The firm consented to the entry of a cease and desist order based on the Adviser Act sections cited in the Order and to a censure. The firm will also pay disgorgement of $12,296 along with prejudgment interest of $898 and a penalty of $500,000. Respondent Long consented to the entry of a cease and desist order base on the Securities Act sections cited in the order and will pay a penalty of $125,000. Respondents Grant and Johnson were suspended from acting as a supervisor in the securities business for a period of 12 months. Respondents Grand and Johnson will each pay a penalty in the amount of, respectively, $100,000 and $75,000.

Unregistered broker – digital tokens: In the Matter of Tokenlot, LLC, Adm. Proc. File No. 33221 (Sept. 11, 2018) is an action which names as Respondents, the firm which operates a website that sells tokens, Lenny Kugel, and Eli Lewitt. From mid-2017 through early 2018 Respondents operated what they called an ICO Superstore through which they sold several different types of digital tokens. Respondents solicited over 5,800 investors and participated in about 2,100 executed orders. Some of the tokens were securities. Respondents were not registered broker-dealers. The Order alleges violations of Exchange Act section 15(a). To resolve the proceedings Respondents each consented to the entry of a cease and desist order based on the section cited in the Order. In addition Messrs. Kugel and Lewitt were barred from the securities business with a right to re-apply after three years. Respondents will also pay, on a joint and several basis, disgorgement of $471,000 and prejudgment interest of $7,929. Each individual Respondent will pay a penalty of $45,000.

Unregistered securities – digital currency: In the Matter of Crypto Asset Management, L.P., Adm. Proc. File No. 3-18740 (Sept. 11, 2018) names as Respondents the firm, which essentially acted as an unregistered investment adviser, and Timothy Ennekin, its founder an principal. Over a five month period, beginning in August 2017, Respondents raised over $3.6 million from 44 investors in 15 states by claiming to be the first regulated digital asset manager. In fact the firm was not registered and was selling unregistered securities. The Order alleges violations of Securities Act sections 5(a), 5(c) and 17(a)(2) and Advisers Act section 206. To resolve the proceedings the firm consented to the entry of a cease and desist order based on each of the sections cited in the Order except Advisers Act section 206. Mr. Enneking consented to the entry of a cease and desist order based on Securities Act section 17(a)(2) and Advisers Act section 206(4). Each Respondent is censured. On a joint and several basis Respondents will pay a penalty of $200,000.

Excessive trading: SEC v. Aquino, Civil Action No. 1:18-cv-08191 (S.D.N.Y. Filed Sept. 7, 2018) is an action which names as a defendant, Jovannie Aquino, a registered representative at a New York City brokerage firm. For almost two years, beginning in December 2015, Defendant first convinced clients to participate in, and then executed, a short term trading strategy which called for repeated purchases and sales of securities. The strategy was almost sure to generate huge commissions which eclipsed any returns. In fact huge returns would have been required for the customer to achieve any profit. The strategy was executed without any reasonable factual basis. The complaint alleges violations of Securities Act section 17(a) and Exchange Act section 10(b). The case is pending. See also SEC v. Botvinnik, Civil Action No. 1:18-cv-08182 (S.D.N.Y. Filed Sept. 7, 2018)(similar action).

Offering fraud: SEC v. Laura, Civil Action No. 1:18-cv-05075 (E.D.N.Y. Filed Sept. 7, 2018) is an action which names as defendants: Joseph Laura, a New York lawyer who founded and controls Prestec America, Inc, an Austrian firm that has rights to a crude oil processing technology; Anthony Sichenzio, an officer of the firm; and Walter De Rubio, an investor in the firm. Over a period of about three and one half years, beginning in June 2013, Defendants raised over $3.7 million from 80 investors by selling securities of Prestec. To date about $12 million overall has been raised from over 150 investors. Those investors were told the funds would be used for working capital. In fact much of the money was diverted to other uses and 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. 24266 (Sept. 12, 2018).

Unregistered securities: SEC v. Nevada Sports Investment Group, LP, Civil Action No. 2:18-cv-01726 (D. Nev. Filed Sept. 7, 2018) is an action which names the company as a defendant. Under the applicable state law firms in Nevada can create betting pools. Here the firm raised in excess of $1 million from 35 investors which was pooled and wagered on sporting events. The profits were to be shared. The shares sold to investors were not registered with the Commission nor were they exempt from registration. The complaint alleges violations of Securities Act sections 5(a) and 5(c). The action was resolved with a consent to the entry of a permanent injunction based on the sections cited in the complaint. See also SEC v. Contrarian Investments, LLC, Civil Action No. 0218-cv-01725 (D. Nev. Sept. 10, 2018)(similar action resolved on the same terms).

Disclosure: In the Matter of VSS Fund Management LLC, Adm. Proc. File No. 3-18729 (Sept. 7, 2018) names as Respondents the registered investment adviser and its owner and managing partner, Jeffrey Stevenson. The action centers on a 2015 buy-out offer of the limited partners of VS&A Communications Partners III, L.P., a fund advised by the advisor, made by Mr. Stevenson. The Fund had been in existence for years. Some partners had expressed an interest in a buy-out. The management committee decided to dissolve the Fund, using its December 2014 NAV for pricing. In early 2015 VSS decided not to close the Fund in an effort to accommodate some partners who wanted to remain. The offer to the limited partners was revised. Subsequently, on May 1, 2015 VSS and Mr. Stevenson received preliminary information that that the Fund’s NAV had potentially increased significantly during the first quarter of the year. That information was not disclosed to the limited partners which resulted in the May letter to them being inaccurate. The first quarter financial information regarding the Fund was also not furnished to the limited partners. Over 80% of the limited partners accepted the offer based on the incomplete information. That information also reflected the increase in NAV. The Order alleges violations of Advisers Act section 206(4). To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the section cited in the Order. VSS also agreed to the entry of a censure. Respondents, jointly and severally, will pay a penalty of $200,000.

Conflicts: In the Matter of BB&T Securities, LLC, Adm. Proc. File No. 3-18730 (Sept. 7, 2018) names as a Respondent the firm which is the successor to BB&T Investment Securities, Inc., a dual registered Commission broker-dealer and investment adviser since June 2007. Over about a three year period beginning in March 2012, BB&T Investment Securities, then a state registered investment adviser, recommended to clients that they invest in wrap fee programs sponsored by three other advisers, one of which was an Affiliated Adviser. In making those recommendations the firm failed to disclose sufficient information to permit those clients to discern the fact that the compensation arrangements between the firm and the Affiliated Adviser created an incentive for BB&T Investment Services and its representatives to recommend that clients invest with the Affiliated Adviser. The failure to properly advise the clients resulted in a violation of Advisers Act section 206(2), according to the Order. To resolve the matter Respondent consented to the entry of a cease and desist order based on the section cited in the Order and agreed to pay a penalty of $100,000.

Manipulation: SEC v. Honig, Civil Action 18 – cic-08175 (S.D.N.Y. Filed Sept. 7, 2018) names as defendants Barry Hong, Philip Frost, John Stetson, Michael Brauser, John O’Rourke, Mark Groussman, Robert Ladd, Elliot Maza, Brian Keller, John Ford and a series of controlled entities. The action centers on the manipulation of four microcap firms’ shares during the period 2013 to 2018 yielding millions of dollars in profits. The schemes followed a basic pattern. Mr. Hong essentially directed the transactions. Initially, Defendants, or a subgroup of them ,would acquire control of the issuer and hold the shares with Mr. Honig orchestrating a series of transactions. Actions designed to generate market, and which would also benefit the management of the issuers, were then initiated. Indeed, management of two of the firms participated. A pump-and-dump scheme would then be conducted, manipulating the shares and their price. Defendants would sell their shares. Over the course of the scheme millions of dollars in illicit profits were made. For example, one scheme involving one issuer resulted in over $9.25 million while another yielded over $8.3 million. The complaint alleges violations of Securities Act sections 5(a), 5(c), each subsection of 17(a) and 17(b) and Exchange Act sections 9(a)(1) and (2), 10(b), 13(d) and 15(d). The case is pending. See Lit. Rel. No. 24262 (Sept. 7, 2018).

FINRA

Digital assets: The regulator brought its first action involving digital currencies. Specifically, FINRA charged Timothy Ayre with fraud in connection with his offering of a digital coin backed by securities from a firm whose shares whose shares are firm that he controlled – Rocky Mountain Ayre, Inc., which is worthless, according to the regulator. The coins, called HempCoin, was supposedly backed by shares of the firm. In offering the coins Mr. Ayre is alleged to have made false statements.

Criminal cases

Insider trading: U.S. v. Silva, No. 1:17-cr-00503 (S.D.N.Y.) is an insider trading case which names as a Defendant, Robert Rodriguez, among others. The indictment, which names a number of others, is based on a serial insider trading ring. Daniel Rivas, the lynchpin of the ring, was employed at a New York investment bank. From August 2013 through May 2017 Mr. Rivas worked as a technology consultant in the research and capital markets technology group at the investment bank. During the time period Mr. Rivas repeatedly transmitted inside information misappropriated from his employer to Mr. Rodriguez, a long time friend who was a member of one of three tipping chains described in the indictment. Mr. Rivas would pass the information to Mr. Rodriguez who would intern transmit it to Mr. Sablon who had been introduced to Mr. Rivas by Mr. Rodriguez in 2015. Initially the information was transmitted by telephone and text message. Over time Mr. Rivas began furnishing the information through a messaging app. Over the period Messrs. Rodriguez and Sablon earned over $2 million. Their plan was to create and investment fund in which Mr. Rivas would have an interest. Mr. Rodriguez pleaded guilty to one count of conspiracy to commit securities fraud and fraud in connection with a tender offer. All but one of the defendants named in the indictment have pleaded guilty. Two are cooperating with the U.S. Attorney’s Office. The date for sentencing has not been set. See also SEC v. Rivas, Civil Action No. 1:17-cv-06192 (S.D.N.Y.).

Anticorruption/FCPA

In the Matter of United Technologies Corporation, Adm. Proc. File No. 3-18745 (Sept. 12, 2018) is an action which names as a Respondent the firm, which manufactures and markets high-technology products and services for the aerospace industries. During the period of 2012 through 2014 the firm made improper payments and engaged in a kickback scheme in Azerbaijan:

  • Improper payments were made to officials to facilitate the sales of elevator equipment;
  • Other payments were made that were tied to a kickback scheme to sell elevators in China in 2012;
  • Through International Aero Engines, a joint venture of Pratt & Whitney, a division of the firm, unsupported payments were made to an agent in disregard of the fact that portions may have been used for unlawful payments to a Chinese official to obtain confidential information regarding selling engines to a Chinese state-owned airline during the period 2009 to 2013; and
  • Through Pratt & Whitney and Otis Elevator other improper payments for trips and gives to various official s in china, Kuwait, South Korea, Pakistan, Thailand and Indonesia were made in connection with business.

The Order alleges violations of Exchange Act sections 13(b)(2)(A), 13(b)(2)(B) and 30A.

In resolving the proceedings the Commission considered the fact that the firm self-reported, cooperated with the staff’s investigation and undertook remedial acts. 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 also agreed to pay disgorgement in the amount of $9,067,142, prejudgment interest in the amount of $919,392 and a penalty of $4 million.

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