by T. GormanPosted on Posted in SECActions

The Ninth Circuit joined the Second Circuit in concluding that the Dodd-Frank whistleblower provisions protect from retaliation those who report internally at the company but not to the SEC, despite the literal language of the statute. In reaching this conclusion the Circuit Court adopted a position that is consistent with that of the SEC but which has previously been rejected by the Fifth Circuit, widening the split among the circuits. Ultimately the question will need to be resolved by the Supreme Court. Somers v. Digital Realty Trust Inc., No. 15-17352 (9th Cir. Filed March 8, 2017).

Plaintiff-Appellee Paul Somers was employed as a vice president at Defendant-Appellant Digital Realty Trust, Inc. During his four year tenure with the firm, which ended in 2014, he made several reports to senior management regarding possible securities law violations by the company. He was terminated. Prior to being terminated Mr. Somers did not report his concerns to the SEC.

Subsequently, Mr. Somers filed suit against Digital Realty alleging violations of Exchange Act Section 21F and other laws. That Section includes an anti-retaliation provision passed as part of Dodd-Frank. The Section provides in part that “No employer may discharge . . . a whistleblower . . . because of any lawful act done by the whistleblower – (i) in providing information to the Commission in accordance with this section; (ii) in initiating, testifying in, or assisting in any investigation or judicial or administrative action of the Commission based upon. . . such information. . . (iii) in making disclosures that are required or protected under the Sarbanses-Oxley Act . . .”

Defendant moved to dismiss in the District Court, arguing that Mr. Somers was not a whistleblower under Dodd-Frank. Specifically, Section 21F defines a whistleblower as “any individual who provides . . . information relating to a violation of the securities laws to the Commission. . .” Since Mr. Somers did not provide information to the SEC, Digital Realty argued he was not protected by the Section. The District Court denied the motion after an extensive examination of the statutes and their legislative history. That determination is in accord with Berman v. Neo@Ogilvy LLC, 801 F. 3rd 145 (2nd Cir. 2015) but contrary to the decision in Asadi v. G.E. Energy (USA) LLC, 720 F. 3d 620 (5th Cir. 2013). The District Court certified the question to the Ninth Circuit for review.

The Ninth Circuit affirmed. The case “must be seen against the background of twenty-first century statutes to curb securities abuses” the Court began. In 2002 Sarbanes-Oxley was passed to safeguard investors following a financial scandal. A key part of the Act requires internal reporting by lawyers working for public companies, a provision which is similar to obligation imposed on auditors by the Exchange Act. SOX protects those professionals and others who lawfully provide information to federal agencies, Congress or “a person with supervisory authority over the employee.”

Dodd-Frank, like SOX, was passed in the wake of a financial scandal. Section 21F contained a provision protecting whistleblowers from retaliation. The term whistleblower was defined as anyone who reports to the SEC “in a manner established, by rule or regulation, by the Commission.” The anti-retaliation provision provides protections to those who (i) furnish information to the SEC, (ii) testify or assist the Commission or (iii) make disclosures that are required or protected under SOX. This broad prescription evidences an intent to cover more than just those who report to the SEC since under SOX auditors, lawyers and others who report to their supervisor but not the Commission are protected. It would thus be illogical to confine the protections to only those who report to the Commission. While there is a split on this question between the Second and Fifth Circuits, the Court found that when the SOX and Dodd-Frank provisions are read together it is clear that the anti-retaliation provisions were designed to cover those who report to the Commission and internally.

Circuit Judge Owens dissented, citing the decision of the Fifth Circuit in Asadi.

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by T. GormanPosted on Posted in SECActions

This week the Commission brought three actions. One, a financial fraud case, centered on one of Mexico’s largest home builder that inflated sales numbers. A second was brought against an investment adviser who failed to disclose certain conflicts arising from its relationship with a clearing broker. A third case was based on a scheme to inflate the firm’s revenues with sham transactions.

The Manhattan U.S. Attorney’s Office announced a guilty plea to securities fraud by an official of a municipal entity in connection with defrauding investors who purchased municipal securities used to construct a minor league baseball park. The guilty plea is believed to be the first to a violation of the federal securities laws tied to a municipal bond offering.

SEC

Award: The Commission announced that economist Dr. Giulio Girardi, a branch chief in the Division of Economic and Risk Analysis’ Office of Risk Assessment received The Financial Analyst Journal’s Graham and Dodd Top Award for 2016. The award was for a paper he co-authored titled “Interconnectedness in the CDS Market” with former DERA visiting scholar Mila Sherman and former SEC Chief Economist Craig Lewis. The paper assesses the stability of the credit default swap market and potential contagion among market participants.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 2 civil injunctive case and 1 administrative proceedings, excluding 12j and tag-along proceedings.

Financial fraud: SEC v. Notis Global, Inc., (C.D. Cal. Filed March 9, 2017) is an action which names as defendants the firm, known as Medbox, Inc.; Vincent Mehdizadeh, at one point COB and COO of Medbox; Bruce Bedrick, at one point CEO of Medbox; Yocelin Legaspi, the CEO, secretary and CFO of New-Age Investment Consulting, Inc. and the fiancée of Mr. Mehdizadeh; and New-Age, a firm formed by Mr. Mehdizadech. Medbox assists those seeking to obtain marijuana dispensary licenses in states where this is permitted. It also developed a machine called “Medbox” which dispenses marijuana on the basis of biometric identification. Medbox claimed to be a leader in its field. From 2012 through 2014 Mr. Mehdizadeh implemented a scheme to artificially boost the firm’s revenues using sham transactions. Essentially, shares of Medbox were transferred to New-Age using false documents representing that the securities were either purchased or for services received. The shares were then sold into the public market despite the fact that they were restricted, generating millions of dollars. Those funds were then transferred back to Medbox for various items such as the purchase of its receivables which were never collected. The funds from these transaction represented 22% and 65% of Medbox’s reported revenues for, respectively, 2012 and 2013. In 2014 another sham transaction was implemented between the two companies which again was used to inflate the revenue of Medbox. Press releases were issued touting the firm’s “record revenue.” Following a 2014 internal investigation Medbox restated its financial statements, reversing the New-Age transactions. Mr. Mehdizadeh was later ousted from the firm. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of 17(a), Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 15(a) and SOX Section 304. The firm and Mr. Mehdizadeh agreed to settle the action. Mr. Mehdizadeh will pay more than $12 million in disgorgement and penalties. He also agreed to be barred from serving as an officer or director of a public company and to the entry of a penny stock bar. The litigation is continuing as to the other defendants.

Conflicts: In the Matter of Voya Financial Advisors, Inc., Adm. Proc. File No. 3-17870 (March 8, 2017) names the registered investment adviser as a Respondent (previously known as ING Financial Partners, Inc.) whose parent is listed on the NYSE. The Order is based on undisclosed conflicts arising from the relationship between the adviser and its clearing broker. Specifically, the clearing broker provided execution, custody and reporting services for the Adviser’s clients. The clearing broker also offered a certain mutual fund program to the Respondent and other advisers under which it waived fees for clients of participating advisers. Under the terms of its agreement with the Adviser, the clearing broker shared a certain percentage of revenues from the fund program. Under a separate arrangement the clearing broker also paid fees to the Adviser in return for certain administrative services furnished with respect to the funds. The Adviser disclosed its relationship with the clearing broker, the no transaction fee arrangement for the funds and the fact that this could represent an incentive to select the clearing broker’s funds. It did not disclose the fact that the payments presented an additional conflict of interest. Similarly it did not disclose the payments for the administrative services. During the period the Adviser had a policy and procedure requiring the disclosure of conflicts. The Order alleges violations of Advisers Act Sections 206(2), 206(4) and 207. In connection with resolving the matter, the firm agreed to certain undertakings regarding notice of this matter to the clients and furnishing a certificate of compliance. The Adviser consented to the entry of a cease and desist order based on the Sections cited in the Order and a censure. The firm agreed to pay disgorgement of $2,621,324, prejudgment interest and a penalty of $300,000.

SEC v Neilson, Civil Action No. 16-cv-5475 (D.N.J.) is a previously filed action against the former senior vice president of Oklahoma-based BOK Financial. The complaint alleged that the Defendant was largely responsible for the failures of the bank’s corporate trust department while overseeing what turned out to be a series of fraudulent bond offerings that are the subject of a separate enforcement action. The Court entered a financial judgment prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b) and ordered the payment of $29,624.03 in disgorgement (bonus compensation she received for working on the offerings), prejudgment interest and a civil penalty of $21,167.05. The bank previously settled with the Commission in a separate administrative proceeding. See Lit. Rel. No. 23772 (March 7, 2017).

Financial fraud: SEC v. Desarrolladora Homeex S.A.B. de C.V., Civil Action. No. 3:17-00432 (S.D. Cal. Filed March 3, 2017). Homex, based in Culiacan, Sinaloa, Mexico, was at one time known as Mexico’s largest home builder. The firm specialized in constructing affordable, middle-class homes in Mexico. Its ADRs were listed for trading on the NYSE from 2004 through 2014 and shares were traded in Mexico. Revenue recognition policies at the firm – the central issue here – specified that Homex recognize revenue from a home sale only if specific criteria were met. Essentially “control” of the home had to be transferred to the buyer and it had to be probable that Homex would receive the economic benefits associated with the transaction.

During the period the firm maintained an internal system called Sistema Integral de Administration or SIA where accounting entries were recorded. The firm’s CEO strictly limited employee access to the system. Beginning in 2010 manual entries for home sales and the related revenues and expenses were entered into the system. This materially inflated the financial results of the firm. For example, in 2010 the firm reported revenue of $18,465 million on the sale of 44,347 unites. In fact revenue was only $6,456 million for 16,077. Similarly, in 2011 and 2010 the firm reported inflated revenues and inflated sales numbers. The fraudulent entries were tracked on manually prepared spreadsheets. The fact that the entries were false was readily apparent from an inspection of sites were the homes supposedly were built. For example, satellite images taken in March 2012 of one project for which revenue was recorded shows that hundreds of the units had yet to be built. A photo of the satellite image is attached to the complaint and the related press release. To date the firm has not corrected, restated or made any disclosures regarding the reliability of its financial statements. There is no indication that any employees have been terminated, although the CEO and CFO did resign. No charges have been brought against the CEO, CFO or any individual. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B).

To resolve the action the company consented to the entry of an injunction based on the Sections cited in the complaint. New management cooperated with the staff. The Commission suspended trading in Homex shares.

Criminal Cases

Municipal bonds: U.S. v. St. Lawrence, Case No. 7:16-cr-00259 (S.D.N.Y.) is an action against the former Executive Director of the Ramapo Local Development Corporation for the town of Ramapo, N. Aaron Troodler. Mr. Troodler, along with Town Supervisor Christopher St. Lawrence, made material misrepresentations regarding the finances of a municipal bond offering for the construction of a minor league baseball stadium for the town of Ramapo. Mr. Troddler pleaded guilty to one count of securities fraud. This is believed to be the first conviction for federal securities fraud in connection with municipal bond issuances, according to the U.S. Attorney’s Office. Sentencing is scheduled for September 18, 2017.

Offering fraud: U.S. v. Fortenberry, Case No. 6:16-cr-00021 (N.D. Tx.) is an action in which Stanley Fortenberry was sentenced to serve 78 months in prison and pay $890,310 after pleading guilty to fraud and charges of obstructing a related SEC investigation. In one scheme Mr. Fortenberry and his firm, Premier Investment Fund, solicited funds from investors for social media projects conducted by another company with claimed ties to the country music industry. About half of the investor funds were misappropriated. In second scheme, operated in the name of his son since he was under SEC investigation, Mr. Fortenberry solicited funds for Wattenberg Energy Partners that were supposed to be used for oil and gas drilling projects. Instead of using the funds as promised, much of the money was used either in the solicitation process which was conducted using several agents or diverted to personal use. See also SEC v. Fortenberry, Civil Action No. 6:16-mc-00001 (N.D. Tex.)(resolved with an order requiring the payment of disgorgement in the amount of $146,500, prejudgment interest and a penalty of $900,000).

Hong Kong

AML: The Securities and Futures Commission reprimanded Guangdong Securities Limited and fined the firm $3 million for failing to comply with anti-money laundering guidelines when handling third party payments. The regulator concluded that over a period of about two years beginning in February 2011 the firm’s internal controls for handling payments from client accounts to third parties were deficient. The broker failed to establish that it had conducted appropriate inquiries before processing third party payments. In addition, the firm’s records did not reflect the reasons for approving transactions.

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