The Commission filed a series of enforcement actions last week focused largely on retail investors. Those cases included: An action against a former CCO involving undisclosed conflicts; another centered on false statements concerning a shale oil firm; a case centered on the question of investor suitability regarding high risk, illiquid investments; an action based on the custody rule; a microcap stock manipulation action; and several offering fraud cases.
SEC
Rules: The Commission adopted rules centered on enhancing the transparency and oversight of ATSs (here). Under the new rules certain ATSs will be required to file detailed public disclosures on new Form ATS-N. The disclosures are intended to allow market participants to assess potential conflicts of interest and risks of information leakage arising from the ATS related activities of the ATS’s broker-dealer operator and its affiliates.
Rules: The Commission adopted final rules and requests comments on ways to modernize offerings pursuant to compensatory arrangements. The focus is to update Securities Act Rule 701 which provides an exemption from regulation for securities issued by non-reporting firms under compensatory arrangements (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 11 civil injunctive cases and 7 administrative proceedings, excluding 12j and tag-along proceedings.
False statements: SEC v. Barber, Civil Action No. 6:18-cv-0115 (M.D. Fla. Filed July 18, 2018) is an action which names as defendants Stephen Barber and Larry Arrowood, respectively, the CEO and President of Oakridge Global Energy Solutions, Inc., a developer and manufacturer of lithium batteries. During the period from 2015 through 2016 the complaint alleges that defendants disseminated false statements regarding the firm’s battery manufacturing operations and new customer agreements. Specifically, the statements falsely stated that the firm had $250,000 in immediate booked orders and over $20 million in follow-on commitments and an existing pipeline of orders to sell $24 million of batteries. The complaint alleges violations of Exchange Act section 10(b). To resolve the case Mr. Arrowood consented to the entry of a final judgment enjoining him from future violations of the section cited in the complaint and barring him from serving as an officer or director of a public company. He will also pay a civil penalty of $50,000. The case continues as to Mr. Barber. See Lit. Rel. 24207 (July 19,2018).
Conflicts: In the Matter of Michael Devlin, Adm. Proc. File No. 3-18604 (July 19, 2018). Mr. Devlin was the managing partner of an Adviser between June 2001 and March 2015. In May 2013 Mr. Devlin caused the private equity firm for which he was the CCO to invest in a subsidiary of a portfolio company on condition that a portion of the investment proceeds by used to purchase a personal investment from him. No disclosure was made to the fund’s advisory committee as required by the Adviser’s compliance procedures. Ultimately Mr. Devlin arranged for investment to be sold without a loss prior to the time he resigned. The Order alleges violations of Advisers Act section 206(2). 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 also barred from the securities business with the right to apply for re-entry after one year. In addition, he will pay a penalty of $80,000.
Misappropriation: SEC v. Kitts, Civil Action No. 24208 (D. Mass. Filed July 19, 2018) is an action against Kimberley Pine Kitts who was employed as an investment adviser. Over a period of several years ending in 2017 Ms. Kitts made 82 unauthorized withdrawals of client funds totaling over $3 million. The funds were misappropriated by making unauthorized withdrawals and having clients make false tax payments. The complaint alleges violations of Exchange Act section 10(b) and Advisers Act sections 206(1) and 206(2). The case is pending. See Lit. Rel. No. 24308 (July 19, 2018).
False statements: SEC v. Centor Energy Inc., Civil Action No. 18-cv-6463 (S.D.N.Y. Filed July 19, 2018) is an action which names as defendants the firm, a shale oil producer, and its CEO, Frederick DeSilvia. Over about two years beginning in 2012 Defendants made repeated false statements about the reserves of the firm, its revenue prospects and an arrangement Mr. DeSilvia had with prior owners to purchase their shares. These statements inflated the stock value until the Commission suspended trading. The complaint alleges violations of Exchange Act section 10(b). To resolve the case each Defendant consented to the entry of a permanent injunction based on the section cited in the complaint. In addition, Mr. DaSilvia agreed to the entry of a penny stock bar and an officer and director bar and will pay disgorgement of $7,500, prejudgment interest of $1,028 and a penalty of $22,500. See Lit. Rel. No. 24209 (July 19, 2018).
Financial fraud: SEC v. Dandawate, Civil Action No. 18-cv-04927 (S.D. Ill. Filed July 19, 2018) is an action against Bhushan Dandawate, formerly an employee of Quadrant 4 System Corporation. The complaint alleges that Defendant aided and abetted a financial fraud at the firm by the CFO and others by making false representations regarding certain bank accounts, assisting with a number of fraudulent round trip transactions and aiding with a cover-up of those transactions. The actions of the CFO and the firm are the subject of another Commission action which has settled. The complaint alleges aiding and abetting violations of Exchange Act sections 10(b), 13(b)(2)(A) and 15(d). Defendant agreed to settle the charges by consenting to the entry of a permanent injunction based on the sections cited in the complaint as well as to an officer and director bar. He also agreed to pay disgorgement and prejudgment interest of $131,466 and a penalty of $325,000. See Lit. Rel. No. 24210 (July 19, 2018).
Suitability/fraud: SEC v. Temenos Advisory, Inc., Civil Action No. 3:18-cv-01180 (D. Conn. Filed July 18, 2018) is an action which names as defendants the registered investment adviser and its owner, George Taylor. Over a three year period beginning in 2014 Defendants solicited their advisory clients and others to purchase shares in four investments. Those investments were illiquid and high risk – they were unsuitable for many of the elderly clients for whom they were recommended. In making the recommendations not only did Defendants fail to inform the investors adequately regarding the securities, but also that they had an undisclosed financial interest in doing so including receiving very high commissions. The complaint alleges violations of Advisers Act Sections 206(1), 206(2), 206(4) and Exchange Act Section 15(a). The case is pending. See Lit. Rel. No. 24206 (July 18, 2018).
Misappropriation: SEC v. Geraci, Civil Action No. 18-cv-06432 (S.D.N.Y. Filed July 17, 2018) is an action which names John Geraci as a defendant. Mr. Geraci formed Meridian Matrix Long and Short Equity Fund, LP, a Cayman Island firm, in 2012. In 2015 he met Nicholas Mitsakos who owned state registered investment adviser Matrix Capital Markets. Mr. Mitsakos claimed to be a highly experienced and successful portfolio manager. Without conducting any due diligence Mr. Geraci retained Mr. Mitsakos and his firm and began soliciting funds. One couple was convinced to invest $2 million. Mr. Mitsakos eventually misappropriated about $800,000 of the funds and returned the balance. Mr. Geraci, who had his firm send the couple false account statements, misappropriated the balance. The complaint alleges violations of each subsection 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. The Manhattan USAO has filed criminal charges. See Lit. Rel. No. 24205 (July 17, 2018).
Books and records: In the Matter of BGC Financial, L.P., Adm. Proc. File No. 3-18598 (July 17, 2018). Respondent is a FINRA member that serves as an inter-dealer broker facilitating transactions in securities and other financial instruments between broker-dealers, dealer banks and other financial institutions. In March 2014 the staff issued two requests for certain communications of eight BGC registered representatives, including recorded telephone conversations. While the firm assured the staff that the records would be produced those involved were not told to preserve the recordings and they were destroyed. The firm also failed to maintain accurate books and records regarding: Certain payments to a high performing registered representative and certain expenses; reimbursements for other personal events; and for customer gifts. The Order alleges violations of Securities Act section 17(a) and the related rules. The firm resolved the proceedings, consenting to the entry of a cease and desist order based on the section cited and the related rules and a censure. BGC will also pay a penalty of $1.25 million.
Custody rule: In the Matter of New Silk Route Advisors, L.P., Adm. Proc. File No. 3-18599 (July 17, 2018) is a proceeding which names as a Respondent, a registered investment adviser that advises the NSR Funds. Since the time the firm registered with the Commission in 2012 it has failed to timely distribute annual audited financial statements to investors in the NSR Funds in violation of section 206(4) of the Advisers Act, the custody rule. An adviser has custody of client assets if it holds, directly or indirectly, any client funds or securities or has the ability to obtain possession of those assets. An alternative to the annual verification process is offered by the rule, requiring audited financial statements. The firm instituted remedial steps by adopting written Compliance Policies and Procedures with the assistance of counsel. To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order and the pertinent rules and a censure. The firm will also pay a penalty of $75,000.
False rumors/manipulation: SEC v. Burns, Civil Action No. 1:18-cv-06257 (S.D.N.Y. Filed July 11, 2018) is an action which names Mark Burns as a defendant. In an effort to manipulate the share price of Fitbit securities, Mr. Burns purchased call options just minutes before his confederate, Robert Murray, filed a fake tender offer on the SEC’s Edgar system purporting to acquire Fitbit’s shares at a substantial premium. The complaint alleges violations of Securities Act section 17(a) and Exchange Act sections 10(b) and 14(e). Mr. Burns has agreed to settle the charges. Previously, Mr. Murray was charged with the scheme. SEC v. Murray, No. 1:17-cv-03788 (S.D.N.Y.). He was recently sentenced to prison in a parallel criminal action. See Lit. Rel. No. 24204 (July 17, 2018).
False audits: In the Matter of Jay C. Lake, CPA, Adm. Proc. File No. 3-18602 (July 17, 2018) is a proceeding which names as a Respondent the CPA who also founded Lake and Associates. Both Mr. Lake and his firm have been barred from the business by the PCAOB. These proceedings center on a blank check scheme run by an unidentified group called the Control Persons who created blank check companies, making them appear to be active business entities, and offered them for sale. Mr. Lake audited two of the entities, issuing clean audit opinions for two years while failing to investigate evidence which contradicted the representations about the firms. He also failed to adhere to the applicable PCAOB standards. The Order alleges violations of Securities Act section 17(a) and Exchange Act section 10(b) and rules 2-02 and 2-06 under Regulation S-X. To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the sections and rules cited in the Order. In addition, Mr. Lake is denied the privilege of appearing and practicing before the Commission as an accountant and will pay disgorgement of $10,500 along with prejudgment interest of $1,620.71 and a penalty of $25,000.
Offering fraud: SEC v. Meli, Civil Action No 17-cv-632 (S.D.N.Y.) is a previously filed action against, among others, Mathew Harriton and his firm, 875 Holdings, LLC. The complaint alleged a scheme in which interests were marketed and sold in a firm that purportedly sold tickets to popular Broadway shows and concerts. In fact the firm was a Ponzi scheme. The Court entered judgments against each defendant. Mr. Harriton consented to the entry of a final judgment enjoining him from future violations of Securities Act sections 17(a)(2) and (3) and which orders him to pay disgorgement, prejudgment interest and a penalty in the amount of $1,375,785. His firm consented to the entry of a final judgment enjoining it from future violations of Securities Act section 17(a) and Exchange Act section 10(b). The order also directs the firm to pay a total of $6,573,542 in disgorgement, prejudgment interest and penalties. See Lit. Rel. No. 24203 (July 16, 2018).
Offering fraud: SEC v. Moddha Interactive, Inc. Civil Action No. CV 18 00264 (D. HI Unsealed July 13, 2018) is an action which names as defendants the firm along with its two officers, Marianne Sandor and Edward Porrazzo, a married couple, and Spar Street, a sales agent for the firm. The company claimed to be a worldwide media and technology corporation that had a portfolio of valuable patents for 3-D technology. In fact the patents had all expired and were worthless. Nevertheless, the firm raised over $2.6 million from 51 investors beginning in 2012. The bulk of the investor funds have been misappropriated. The complaint alleges violations of each subsection of Securities Act section 17(a) and Exchange Act sections 10(b) and 15(a). The court granted temporary freeze orders when the complaint was unsealed. The case is pending. See Lit. Rel. No. 24199 (July 16, 2018).
Manipulation: SEC v. Giguiere, Civil Action No. 18 cv 1530 (S.D. CA Filed July 6, 2018) is an action which names as defendants stock promoter Gannon Giguiere, Oliver-Barret Lindsay, Andrew Hackett, Kevin Gillespie and Annett Budhu. The complaint alleges three manipulation schemes involving three different microcap stocks that netted the defendants over $10 million. In essence, each involved a series of matched trades in the stock of the firm involved that were tied to an off-shore broker. Unknown to the Defendants was the fact that a member of the group was an undercover FBI agent who captured some of their communications including one in which Mr. Lindsay expressed concern about the messages because they were “fairly incriminating.” The complaint alleges violations of Exchange Act section 10(b). The case is pending. Parallel criminal charges have been filed by the USAO for the Southern District of California. See Lit. Rel. No. 24201 ( July 16, 2018).
Tender offer statement: In the Matter of Genesis Associates Limited Partnership, Adm. Proc. File No. 3-18595 (July 13, 2018) is a proceeding against the partnership which serves as the general partner of Uniprop Manufactured Housing Communities Income Fund II. That firm acquires, operates and sells income producing residential properties. In three instances tender offers have been made for Uniprop but Genesis has failed to file a statement with the Commission. Yet rule 14e-2 under the Exchange Act requires issuers subject to tender offers to make a statement in which it recommends, rejects or takes no position on the offer. In three instances between 2007 and 2016 Uniprop was the subject of tender offers and no statement was made. To resolve the proceedings the firm consented to the entry of a cease and desist order based on rule 14e-2 and agreed to pay a penalty of $50,000.
Beneficial ownership report: In the Matter of FP Resources USA Inc., Adm. Proc. File No. 3-18594 (July 13, 2018) names as Respondents FP Resources, a firm wholly owned by Respondent Lobster Point Holdings Limited of Nova Scotia. By December 31, 2015 Respondents had acquired 16.5% of the shares of The First Marblehead Corporation. Their Schedule 13D regarding beneficial ownership was due no later than January 11, 2016. No schedule was filed. By February 22, 2016 Respondents had taken a series of steps to effectuate a merger. Yet the Schedule 13D was not filed until March 25, 2016. The Order alleges violations of Exchange Act section 13(d) and rule 13d-1. To resolve the proceedings Respondents consented to the entry of cease and desist orders based on the section and rule cited in the Order. They also agreed to pay a penalty of $92,383.00. The Commission considered the cooperation of Respondents with the staff in agreeing to accept the offer.
Undisclosed conflicts: SEC v. Schiller, Civil Action No. 4:18-cv-02433 (S.D. Tx. Filed July 16, 2018). Defendant John Schiller is the founder, president and CEO, during the time of the events involved here, of Energy XXI, Ltd. The firm, founded in 2005, became one of the largest producers of oil and gas on the shelf of the Gulf of Mexico. In March 2010 Mr. Schiller opened a margin account secured by a portfolio of the firm’s stock. By February 2014 he had borrowed over $23 million. Faced with margin calls and the prospect of selling large blocks of firm stock Mr. Schiller sought additional financing. He found it in arrangements with three of the firm’s outside vendors: In February 2014 a line of credit was obtained from Vendor A, a firm that sought to do business with EXXI; in August 2014 a $3 million loan was obtained from Vendor B following another margin call, a firm that had a pre-existing business relationship the company; after another drop in the share price of EXXI a loan totaling $3 million was arranged from Vendor C in September and October 2014 in return for a promise of all of the firm’s lifeboat business. While these arrangements gave Mr. Schiller a material interest in each vendor’s business with EXXI they were not disclosed as related party transactions. In October 2014 Mr. Schiller obtained an additional loan of $3 million which was not documented from Norman Louie. He is the managing director of Mount Kellett Capital Management L.P., a registered investment adviser that beneficially owned 6.3% of EXXI’s stock. Mr. Louie was under consideration for a position on EXXI’s board of directors. Later he became a director and member of the audit and compensation committees. Under NASDAQ listing requirements, directors holding those positions are required to be independent. Mr. Louie was not. Beginning in 2016, Mr. Schiller obtained undisclosed compensation and perquisites by submitting as business expenses to the firm items which were personal in nature and often lacked documentation for at least $1 million. The complaint alleges violations of Securities Act sections 17(a)(2) and (3) and Exchange Act section 14(a) and certain rules. To resolve the action Mr. Schiller consented to the entry of a permanent injunction based on the sections cited in the complaint. The judgment also imposed a penalty of $180,000 and an officer director bar for five years. See also In the Matter of Norman M.K. Louie, Adm. Proc. File No. No. 3-18596 (July 16, 2018)(proceeding against Mr. Louie and the adviser on the conduct described above alleging violations of Exchange Act section 13(a) and Adviser Act section 206(2) as to Mr. Louie and Exchange Act section 13(d) and Advisers Act section 206(4) by the adviser; resolved by consents to cease and desist orders based on the sections cited as to each Respondent, a censure of the adviser and the payment of a penalty in the amount of $100,000 by Mr. Louie and $160,000 by the adviser).
Offering fraud: SEC v. Young, Civil Action No. 18-cv-115 (D. Wy. Filed July 11, 2018) is an action which names as defendants Edward Young, a convicted felon and securities law violator, and his firm, Guardians Trustee, LLC. Over about two years beginning in 2016 Defendants raised over $170,000 from investors by targeting Asian-American and Asian Christians and soliciting them to acquire interests in what was supposed to be a Private Banking Facility by promising returns of 400% with a guarantee. In making the solicitations investors were not told about Mr. Young’s background. The investor funds were misappropriated. The complaint alleges violations of Securities Act sections 5(a), 5(c) and 17(a) and Exchange Act section 10(b). To resolve the matter each Defendant consented to the entry of a permanent injunction based on the sections cited in the complaint. The injunction also bars Mr. Young from being involved with the issuance, purchase, offer, or sale of any securities other than for his own account. On a joint and several basis, Defendants also agreed to pay disgorgement of $170,000 and prejudgment interest of $9,253. The court approved the settlement. See Lit. Rel. No. 24211 (July 19, 2018).
Criminal Cases
Manipulation: U.S. v. Bases, No. 3:18-mj-002115 (D. Conn.) is an action which charges Edward Bases and John Pacilio, precious metals traders at banks in New York, with fraudulent and deceptive trading. Specifically, the two men are charged with having repeatedly placed trades which they had no intention of executing – a form of spoofing – in the precious metals markets on the Commodity Exchange Inc. or COMEX. This type of trading created a false appearance of supply and demand in the market. The case is pending.
Insider trading: U.S. v. Yin, No. 1:14-cr-00494 (S.D.N.Y.) is an action against Michael Yin. Over a period of about one year, beginning in March 2016, Mr. Yin is alleged to have obtained inside information from his friend and business associate, Benjamin Chow. The information centered on transactions involving Lattice Semiconductor Corporation and private equity funds that were managed by Mr. Chow. The two men had multiple meetings in Beijing, China and exchanged voice and text messages. Through those communications Mr. Yin secured information regarding each proposed transaction involving Lattice. Overall Mr. Yin had trading profits of about $5 million. Mr. Yin was charged with one count of conspiracy to commit securities fraud and thirteen counts of securities fraud. Previously, Mr. Chow was charged with conspiracy and securities fraud in U.S. v. Chow, No. 1:17-cr-00667 (S.D.N.Y.). Following trial a jury found Mr. Chow guilty of one count of conspiracy and seven counts of securities fraud. Sentencing is scheduled for August 20, 2018.
Anti-Corruption/FCPA
U.S. v. De Leon, No. 4:17-cr-00514 (S.D. Tx.). Luis Carlos De Leon-Perez is the most recent Venezuelan official to plead guilty in the investigation tied to this action. Mr. De Leon was charged along with others, including Nervis Villalobos, Cesar Rincon, Rafel Reiter and Alejandro Isturiz. Each defendant is a citizen of Venezuela. Generally the defendants are charged with conspiracy to commit money laundering. Mr. De Leon was arrested in Spain in October 2017 and extradited to the United States after a 20 count indictment was returned against him and others by a grand jury in the Southern District of Texas. This week Mr. De Leon pleaded guilty to one count of conspiracy to violate the FCPA and one count of conspiracy to commit money laundering. In connection with his guilty plea Mr. De Leon admitted to engaging in the two year long scheme. As part of the overall scheme, Mr. De Lone, according to his admissions, solicited and directed bribes from Roberto Rincon of The Woodlands, Texas and Jose Shiera Bastidas of Coral Gables, Florida for PDVSA officials. In return the two executives receive assistance with securing business that included their U.S. firms. Mr. De Lone also admitted to working with Messrs. Rincon and Shiera to launder and conceal the proceeds of the bribery scheme. A series of financial transactions were used that included wiring funds to accounts in Switzerland held in the names of other than those of the co-conspirators. At least $27 million in bribes have been paid. Defendant De Leon also admitted bribing other U.S. individuals and their firms and transmitting the funds to PDVSA officials. Mr. De Lone is awaiting sentencing.
SEC v. Cohen, Civil Action No. 17-cv-430 (S.D.N.Y. Order entered July 12, 2018). The FCPA charges, first asserted in a complaint filed on January 26, 2017, center on a scheme to bribe African officials in various countries from 2007 through 2011. Messrs. Cohen and Baros are former employees of OZCM, or one of its subsidiaries, based in London. The scheme allegations center on a series of transactions, each of which took place during the four year time period beginning in 2007 in Libya, Chad and Niger or the Democratic Republic of the Congo.
Defendants moved to dismiss based on §2462 and the Supreme Court’s decision in Kokesh v. SEC, 137 S.Ct. 1635 (2017). The section provides for a five year statute of limitations for “any proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise . . .” In Kokesh v. SEC, 137 S.Ct 1635 (2017) the Court held that this limitation period applies to requests for disgorgement by the SEC since they constitute a penalty within the meaning of the statute.
The parties agreed that the transactions took place between May 30, 2007 and April 15, 2011, years before the complaint was filed. The SEC claims, however, that §2462 applies only to remedies, a question that should be considered later in the case, and that it should be permitted to conduct discovery. The Court rejected the SEC claims.
First, a motion to dismiss is the proper vehicle for considering the statute of limitations questions in this case. While the statute of limitations is typically an affirmative defense “a court may dismiss a complaint for failure to state a claim if the allegations in the complaint . . . show that relief is barred by the applicable statute of limitations . . . This general rule applies with particular force to §2462, which prohibits the court from ‘entertainin[ing] actions that accrued more than five years earlier . . .’” Here, although the statute focuses on remedies, it directs that the court not hear the action if it is time barred.
Second, in view of the dictates of §2462, and the Supreme Court’s holding in Kokesh, the Court concluded that that SEC’s claims for disgorgement and an injunction, under the facts here, are untimely and must be dismissed. The statute of limitations runs under the plain language of the statute from the time the Defendants engaged in the alleged misconduct, not when the person received compensation from the misconduct as the SEC claims.
Plaintiff’s request for injunctive relief is also time barred. Under the facts here that injunction “would operate at least partially as a penalty . . .” On its faces § 2462 does not specifically apply to an injunction. While some courts have held that the section does not apply to injunctions, others have reached a different conclusion. More importantly, the conclusion that “injunctions are categorically exempt from §2462 is inconsistent with Kokesh. Under that decision the question of whether the injunction is a penalty is a function of if it is sought to redress alleged wrongs to the public and not just individuals and if it would at least in part function as a penalty.
In this case the analysis used by Kokish compels the conclusion that the injunction sought would at least in part function as a penalty. In this case, there is no doubt that the violations alleged were committed against the Untied States, rather than an aggrieved individual, the first point considered by Kokish. Likewise, the “parties agree, this injunction would impose no duties on Defendants beyond their existing duty to obey the law . . . What this injunction would do, however, is mark Defendants as lawbreakers and ‘stigmatize [them] in the eyes of the public,’” the second point considered by the Supreme Court. Under these circumstances, there is no doubt the injunction would function at least in part as a penalty which is sufficient for the application of the statute of limitations. While the Eighth Circuit in reaching a contrary result discussed the “primary purpose” of the injunction “[t]o the extent Collyard [SEC v. Collyard, 861 F. 3d 760 (8th Cir. 2017)] suggests that a remedy is not a §2462 penalty if the remedy’s penal effect is only incidental to its remedial effect, the court respectfully finds this suggestion at odds with Kokesh.” The amended complaint is dismissed and leave to amend denied
