The SEC filed three actions following-up on its settled proceeding against Oppenheimer for selling millions of shares of unregistered penny stocks. Each individual settled with the agency. In addition, the Commission brought a manipulation action against three individuals centered on the manipulation of the stock of six microcap issuers. Finally, the SEC dismissed all charges with prejudice against the CFO of Aphelion Fund, George Palathinkal, which was alleged to have furnished investors false returns and misused funds.
SEC
Whistleblowers: The SEC paid over $3 million to a whistleblower who helped the agency “crack” a complex fraud. It is the highest payout to date.
CFTC
Remarks: Chairman Timothy Massad delivered remarks to the District of Columbia Bar, Washington, D.C. (July 23, 2015). His remarks reviewed the financial crisis and the resulting regulation of the swaps markets along with future steps (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 1 civil injunctive cases and — administrative actions, excluding 12j and tag-along proceedings.
Sale of unregistered penny stocks: In the Matter of Scott A. Eisler, Adm. Proc. File No. 3-16699 (July 23, 2015). a proceeding which names as a Respondent Mr. Eisler, a registered representative and investment adviser at Oppenheimer & Co.; In the Matter of Arthur W. Lewis, Adm. Proc. File No. 3-16700 (July 23, 2015), a proceeding which names as a Respondent Mr. Lewis, a Branch Office Manager at Oppenheimer & Co; In the Matter of Robert Okin, Adm. Proc. File No. 3-16701 (July 23, 2015), a proceeding which names as a Respondent Mr. Okin, formerly an Executive VP at Oppenheimer & Co. and Head of the Private Client Division. Each proceeding is based on the sale of millions of shares of unregistered penny stocks from July 2008 through May 2009 for Gibraltar Global Securities, Inc., a broker-dealer in the Bahamas. Oppenheimer previously settled with the SEC and FinCEN (here). The Order as to Mr. Eiser alleged violations of Securities Act Sections 5(a) and (c). He settled, consenting to: The entry of a cease and desist order based on the Sections cited in the Order; an order barring him from the securities business and participating in a penny stock offering with a right to re-apply after one year; and a penalty of $50,000. The Order as to Mr. Lewis alleged violations of Securities Act Sections 5(a) and (c) and Exchange Act Sections 15(b)(4)(e) and 15(b)(6). He resolved the charges by consenting to the entry of: A cease and desist order based on Section 5 of the Securities Act; an order barring him from the securities business in a supervisory capacity with a right to apply for reentry after one year; and will pay a penalty of $50,000. The Order as to Mr. Okin alleges violations of Exchange Act Sections 15(b)(4) and 15(b)(6). He settled with the Commission, consenting to the entry of: An order barring him from the securities business in a supervisory capacity with a right to apply for reentry after one year; and to pay a penalty of $125,000.
Manipulation: SEC v. Aaron (S.D.N.Y. Filed July 21, 2015) is an action against three individuals who are alleged to have conducted six pump-and-dump schemes in 2011 and 2012. The three defendants, all residents of Israel, are: Joshua Aaron, Gery Shalon and Zvi Orenstein. The issuers are Southern Home Medical Equipment, Inc.; Greenfield Farms Grassfed Beef, Inc.; Next Generation Energy Corporation; Mustang Alliances, Inc.; IDO Security, Inc.; and Premier Brands, Inc. The defendants control numerous promotional websites and have large email lists which are used to tout the stocks. Typically the defendants used these resources to send multiple emails touting the same issuer. The emails, however, were made to appear as if they came from different sources. The defendants and/or their associates obtained control over the issuer prior to the initiation of the promotions. Each scheme generated a significant price increase and profits for the defendants. Overall the defendants netted over $3.4 million. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and each subsection of Rule 10b-5. The case is pending. The U.S. Attorney’s Office filed parallel criminal charges.
Pyramid scheme: SEC v. CKB168 Holdings Ltd., Civil Action No. 3-16694 (E.D.N.Y.) is a previously filed action which named as defendants the firm, Rayla Santos, Chih Hsuan Lin and others. The complaint centered on a pyramid scheme involving a company that claimed to sell online education courses for children when in fact its only product was what it sold investors – there were no significant retail sales. Defendants Santos and Lin resolved the Commission’s charges as to them and the court entered final judgments as to each. Both made admissions of fact regarding the scheme. Both consented to the entry of judgments of permanent injunction based on Securities Act Sections 5(a), 5(c) and 17(a)(1) and (3) and Exchange Act Section 10(b) and Rule 10(b)(5)(a) and (c). In addition, the judgment as to Ms. Lin is also based on Securities Act Section 17(a)(2), Exchange Act Rule 10(b)(5)(b) and Exchange Act Section 15(a). Each agreed to pay disgorgement, prejudgment interest and civil penalties in amounts to be determined later by the Court on the Commission’s motion. Ms. Lin also agreed to the entry of an order in an administrative proceeding barring her from the securities business and from participating in any penny stock offering. The action as to the other defendants continues. See Lit. Rel. No. 23306 (July 17, 2015).
False returns: SEC v. Kalucha, Civil Action No. 14 cv 3247 (S.D.N.Y.) is a previously filed action against Vinceet Kalucha, the CIO of Aphelion Fund Management LLC, also a defendant and an investment adviser, and George Palathinkal, a general partner and CFO of the adviser. The Aphelion funds began trading in July 2013. From May 2013 to the present Messrs. Kalucha, Palathinkal and Aphelion Management raised nearly $8 million from 8 different investors for an investment into a separate account managed by Aphelion Management. The Aphelion funds used a proprietary investment model developed by Mr. Kalucha at an earlier fund. Despite poor results from the model in an earlier application, marketing materials for Aphelion touted the positive results of the model. The model also yielded poor results here. In September 2013 an Audit Firm completed a review of the investment performance for an Aphelion client which showed a negative return of 3.08% net of fees or negative 0.66% before fees. Mr. Kalucha altered the audit report so it reflected a positive 30% net of fees. The altered report was distributed to potential investors and incorporated into Aphelion Management’s marketing materials. Later Mr. Kalicha told the Audit Firm that he discontinued use of the altered report when the audit firm protested. The Audit Firm resigned. Subsequently, the defendants told investors that Aphelion Management was revising its reported historical performance statistics to reflect a more conservative approach. The actual reason was the repudiation of the altered report by the Audit Firm and its resignation which was not disclosed to investors. Messrs. Kalucha and Palathinkal are also alleged to have used investor funds raised for operating expenses for their personal use. The complaint alleges violations of Exchange Act Section 10(b), each subsection of Securities Act Section 17(a) and Advisers Act Sections 206(1), 206(2) and 206(4). The case is pending. Recently, the SEC dismissed all charges against Mr. Palathinkal with prejudice and without cost.
FCPA
U.S. v. Luis Berger International, Inc., Mag. No. 15-3624 (D. N.J.). Louis Berger International, Inc. is a privately held international consulting firm that provides engineering, architecture, program and construction management services. Richard Hirsch was a Senior Vice President with the firm who at times oversaw the operations of the firm in, among other locations, Indonesia and Vietnam. James McClung was also a Senior Vice President with the firm. He was based in India where at times he oversaw the firm’s operations in Vietnam and India. The criminal complaint alleges conspiracy to violate the FCPA bribery provisions, centered on the payment of bribes to government officials in India, Indonesia, Kuwait and Vietnam to obtain business. The bribes totaled over $3.9 million. The bribes were generally paid through employees and agents. They were referred to in emails and other communications as a “commitment fee,” “counterpart per diem,” “marketing expenses” and similar terms. The complaint is based in large part on e-mails involving Mr. Hirsch and/or Mr. McClung and their involvement in paying bribes in India, Kuwait, Vietnam and Indonesia over a period from about 2004 through 2010.
To resolve the charges LBI entered into a deferred prosecution agreement. That agreement requires the appointment of a monitor for three years. The firm will also pay a $17.1 million criminal fine which is the bottom of the sentencing guideline range of $28.5 million to $17.1 million. The DOJ acknowledged the cooperation of the company which included: 1) Self-reporting; 2) voluntarily making U.S. and foreign employees available for interviews and collecting, analyzing and organizing evidence and information for investigators; 3) engaging in extensive remediation which included terminating the officers and employees who were responsible for the payments; and 4) it committed to improving compliance and internal controls. Messrs. Hirsch and McClung each pleaded guilty to one count of conspiracy to violate the FCPA and one substantive count of violating the Act. Sentencing is scheduled for November 5, 2015.
PCAOB
Engagement quality review: The Board resolved disciplinary proceedings with seven audit firms and seven individuals. Five of the settlements involved a failure to have an engagement quality review prior to permitting the issuer to use the audit opinion. Two firms and two individuals settled charges of failing to comply with the “cooling off” period under which the engagement quality reviewer cannot be an individual who served as the engagement partner on either of the two preceding audits of the issuer. A list of the firms and individuals and the penalties assessed is here.
Court of appeals
FOIA exemption: Chiquita Brands International, Inc. v. SEC, No. 14-5030 (D.C. Cir. Decided July 17, 2015). In 2001 Chiquita reached a settlement with the SEC regarding books and records violations. The firm consented to the entry of a cease and desist order based on allegations that it failed to accurately record certain payments made by subsidiary Banadex to local officials in Columbia. In the parallel DOJ investigation Banadex pleaded guilty to engaging in unauthorized transactions with Autodefensas Unidas de Colombia or AUC. The group had been designated as a global terrorist organization. While Chiquita acknowledged that Banadex made the payments demanded by AUC, the company insisted it did so only to protect its Colombian employees from being kidnapped, injured and murdered.
In connection with the investigations Chiquita produced thousands of documents related to the payments to the DOJ and the SEC. The firm requested confidential treatment under the pertinent provisions of the Freedom of Information Act. In 2011 the DOJ released over 5,500 pages of these documents to the National Security Archive under the FOIA. The Archive is a non-profit library project of the George Washington University. It collects declassified documents related to U.S. national security. At issue here are two FOIA requests made by the Archive to the SEC in 2008 relating to documents from the Banadex inquiry on which the SEC’s settlement with Chiquita was based. Chiquita was then a defendant in a multi-district litigation brought by Colombian citizens based on the Alien Tort Statute and the Torture Victim Protection Act. Chiquita requested that the SEC’s Office of FOIA Services withhold the documents requested by the Archive based on Exemption 7(B), in view of the pending litigation. Specifically, the firm argued that release of the documents would deprive it of a fair trial in that litigation, noting that the Archive is directly affiliated with, and actively supporting, plaintiffs in the case. Thus the release of the documents would constitute an end run around the stay of discovery. The FOIA Office rejected the claim. The SEC’s General Counsel, on appeal, also rejected the claim.
Chiquita then initiated an action in District Court, claiming that the SEC’s failure to apply Exemption 7(B) was inappropriate. The Archive intervened on the side of the Commission. The court granted summary judgment on behalf of the SEC. On appeal Chiquita focused again on Exemption 7(B), claiming that under the provision the release of the documents is barred until discovery begins and it can seek a protective order from the court. The company dropped an argument that release of the documents would deprive the firm and its officers of the right to an unbiased jury.
The Circuit Court affirmed. Exemption 7(B) only applies under its express terms when the release of the records would deprive a person of the right to “a fair trial or an impartial adjudication.” Under this provision the Court stated that “Assuming that Congress used the word ‘trial’ in light of its long-settled meaning, we agree with the Commission and the Archive that Exemption 7(B) comes into play only when it is probable that the release of law enforcement records will seriously interfere with the fairness of ‘that final step which is called ‘the trial’.” (citation omitted). In reaching this conclusion the Court rejected Chiquita’s contention that the use of the phrase “fair trial” and the term “adjudication” in the provision broaden its coverage beyond the trial itself, giving it application to any point during a judicial proceeding, including discovery.
Australia
Misappropriation: Ali Hammoud, formerly a director of ERB International Pty Limited, previously pleaded guilty to one count of dishonestly using his position as a director by misappropriating over $2.6 million from the firm just before it went into liquidation, an lying to the Australian Securities and Investment Commission. He was sentenced to a term of 2 years in prison but will be released after 12 months on condition he be of good behavior for an additional two years.
Hong Kong
Report: The Securities and Futures Commission released a report showing that the fund management business reached a record high in 2014 (here).
