by T. GormanPosted on Posted in SECActions

The SEC filed its second action tied to illegal tipping by brokerage firm registered representative Kevin Dowd. The first was SEC v. Dowd, Civil Action No. 3:13-cv-00494 (D. N.J. ) filed in January 2013. The second, filed yesterday, is SEC v. Fung, D.N.J. Filed March 9, 2016). As with the first action, a parallel criminal action was filed by the U.S. Attorney’s Office for the District of New Jersey. The defendant in the two new actions is Jay Fung, a long time friend and former co-worker of Mr. Dowd.

The actions center on the announcement of a tender offer for Pharmasset, Inc., by Gilead Sciences, Inc. made before the market opened on Monday, November 21, 2011. The announcement followed a non-public auction process which transpired over several weeks. The cash tender offer was for $137 per share, an 89% premium over the closing price on the prior trading day. Following the announcement the share price rose 84.6%.

Kevin Dowd had been employed for a number of years as a registered representative in the Florida office of a broker-dealer. One of the long time clients of the firm was a Director of Pharmasset. During the auction process for the company, the Director informed his Financial Adviser at the brokerage firm that his company would soon be sold. The Director updated the Adviser as the transaction progressed. The conversations was in confidence.

The Financial Adviser informed Mr. Dowd about the transaction, then a registered representative at the brokerage firm. At a meeting involving Mr. Dowd and various officials from the brokerage firm including the Financial Adviser, the transaction in which Pharmasset would be acquired was discussed. Specifically, at the meeting the Financial Adviser instructed the group that they were prohibited from recommending or trading Pharmasset securities because they were in possession of inside information. Later the Financial Adviser instructed Mr. Dowd to ensure that the Managing Director did not trade. Mr. Dowd was responsible for entering securities trades for the Managing Director in his personal accounts. The broker also had procedures in place which prohibited trading by its representatives on the basis of inside information.

On the last trading day before the deal announcement Mr. Dowd is alleged to have informed Mr. Fung about the proposed transaction. The information came from a firm client who was a director of Pharmasset, Mr. Dowd is alleged to have told his friend. Mr. Fung purchased 2,700 shares of Pharmasset on the same day of the call, Friday, November 18, 2011. Mr. Fung also told his Business Partner who purchased options. There is no allegation that Business Partner was told the source of the information. Following the announcement of the deal Mr. Fung liquidated his position, realizing trading profits of $163,621. Business Partner also liquidated his position, realizing about $544,706.

Subsequently, Mr. Fung delivered $65,000 to Mr. Dowd in installments. Mr. Dowd saw the payments as a thank you. There is no allegation of any prior arrangements regarding the payments. The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 14(e). Mr. Fung resolve the charges with the SEC. He agreed to disgorge his trading profits and pay prejudgment interest.

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by T. GormanPosted on Posted in SECActions

Municipal bond offerings have become a key focus of SEC Enforcement. The agency has brought a series of actions in addition to an initiative that encourages the self-reporting of underwriters in return for reduced sanctions. The Commission’s most recent action, centered on the use of false offering documents, names as defendants the state agency issuing them, the underwriter and three individuals. SEC v. Rhode Island Commercial Corporation, Civil Action No. 1:16-cv-00107 (D. R.I. Filed March 7, 2016).

The complaint centers on financing for 38 Studios, LLC, a start-up firm that developed video games. The firm’s majority shareholder was retired baseball star Curt Schilling. Other personnel were well known in the video gaming industry and the science fiction and comic book industries. The defendants were all involved with the bond offering that was to be used for the development of a 38 Studios video game. They are: The Rhode Island Commerce Corporation, a quasi-public entity created by the state to promote the expansion and development of business in the state; Wells Fargo Securities, LLC, a registered broker-dealer and municipal adviser; Keith Stokes, executive director of RICC; James Saul, the deputy director of RICC; and Peter Cannava, vice president of Wells Fargo’s public finance group.

In 2010 38 Studios was developing a “massively multi-player on-line video game code named Project Copernicus. The firm anticipated it would need $75 million or more to complete development. Financing was being sought. Wells Fargo’s investment banking group was retained to conduct an equity private placement.

The predecessor of RICC had the authority to sell municipal bonds and lend the proceeds to a private party. Those bonds were known as conduit bonds. 38 Studios entered into negotiations with RICC as a possible financing option for Copernicus. During the negotiations 38 Studios emphasized that at least $75 million was needed to complete Copernicus. The requirement was detailed in projections prepared by 38 Studios that were furnished to RICC. A memo authored by James Saul reiterated the 38 Studios requirements. Wells Fargo and Mr. Cannava were also aware of the funding requirements.

The board of RICC approved the sale of conduit bonds to 38 Studios. The funds were to provide financing for the firm to relocate to the state, complete production of Copernicus and capitalize the growth and expansion of the firm. Wells Fargo’s municipal group was retained as the lead placement agent.

In November 2010 RICC sold $75 million worth of bonds to fund 38 Studios in accord with the authorization of the board. About $50 million from the offering was loaned to 38 Studios. The remaining $25 million in offering proceeds was used to pay expenses and establish a reserve that could be used to make future payments to investors and for a capitalized interest fund to pay interest on the bonds for their first year. The bond placement memo stated that 38 Studios would make loan payments to RICC from the revenues earned by selling its video games. RICC in turn would make principal and interest payments to bondholders. RICC and Wells Fargo knew that the offering proceeds would leave 38 Studios about $25 million short of the funding required for the project. That fact was not disclosed in the offering memo or listed as a risk factor.

The placement memo also specified that Wells Faro and another broker-dealer would be compensated through a placement agent fee of $634,065 of which $406,250 would be paid to Wells Fargo. In addition, that memo specified that Wells Fargo would be paid $50,000 by 38 Studios for due diligence in connection with the transaction. A separate Bond Placement Agreement, referenced in the placement memo, stated that the placement agent would not receive any additional compensation. After the closing, however, 38 Studios paid Wells Fargo an additional $400,000 from the offering proceeds as well as about $23,000 in expenses.

38 Studios was unable to secure the additional capital required for the project. In the spring of 2012 the firm defaulted. A petition for liquidation was filed with the bankruptcy court. The proceeding is pending. At the time of the default the outstanding principal and interest on the bonds, excluding the amount reserved, was about $90 million.

The complaint alleges violations of Securities Act Sections 17(a)(2) and (3) and certain MSRB Rules. Messrs. Stokes and Saul resolved the charges. Each agreed to pay a penalty of $25,000 and be barred from participating in any future municipal securities offerings. See also, In the Matter of First Southwest Company, LLC, Adm. Proc. File No. 3-17154 (March 7, 2016)(settled action against RICC’s financial adviser; firm agreed to pay disgorgement of $120,000, prejudgment interest and a penalty).

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