SEC Charges Twenty-two With Fraudulent “Flipping” of Muni Bonds
While the Commission has limited jurisdiction over municipal bonds it has, nevertheless, brought a series of actions in the area. For example, in 2016 the agency crafted a highly successful cooperation initiative, offering those involved in certain types of misconduct, a predictable outcome for self-reporting and cooperating. Over 80 settled actions resulted.
The current Enforcement focus on retail investors fits squarely within the municipal bond space. Allocations of the bonds are often prioritized for retail investors and/or advisers representing those investors. Since the offerings are frequently oversubscribed, prioritizing retail investors or their representatives helps insure that they can purchase the securities. A scheme crafted by those known as “flippers” – persons who buy the bonds and immediately sell them for a profit – undercut the system which deception and fraud that deprived retail investors of the opportunity to invest in the bonds while locking in profits for themselves. The Commission filed a settled action against one of those firms, its principle and others, two resolved administrative proceedings against participants in one scheme and is litigating against another firm, its principle and a dozen of its assistants.
SEC v. Core Performance Management, LLC, Civil Action 18-cv-8181 (S.D. Fla. Filed August 14, 2018) named as defendants the firm, an entity controlled by defendant James Scherr who directed the scheme, and four other securities industry veterans he hired: Deborah Dora, Sharlene Mestite, James O’Neil and Anadel Pinzon. Each has previously held various securities licenses and has years of experience industry experience.
Mr. Scherr hired the four securities industry veterans over a period of years, starting as early as 2003. The scheme was designed to deceive those selling the municipal bonds and defeat the checks built into the system to ensure that the securities were allocated to retail investors. For example, each of the securities veterans opened accounts under DBA names which were connected to CPM. Each typically had multiple accounts at the same brokerage firm and others, under different names with different registered representatives. Each arranged for the payment terms to be delivery versus payment or DVP which minimized the amount of capital required to implement the scheme. Each immediately sold or “flipped” the securities acquired at $1 above the offer price to others who could not obtain an allocation. Flipping the bonds in this manner resulted in the veterans, paid transaction based compensation, acting as unregistered brokers.
To ensure that each of the Defendants obtained the securities not only were multiple accounts and DBAs used, but also false zip codes while steps were taken in flipping the bonds to avoid detection. During the allocation process checking the zip code was a key step since it ensured that local purchasers were obtaining the bonds. The false zip codes thwarted this check. To avoid checks which monitored transactions in the bonds, allocations being flipped were often broken up and/or re-priced so it would not appear that the initial purchaser was in fact flipping the bond, something that would not have been typical of a retail investor. Using these and similar techniques permitted the defendants to participate in thousands of transactions.
Two other fraudulent devices aided defendants. One involved securing the assistance of a representative from one of the firms involved in the offerings. That representative knowingly placed fraudulent retail orders for CPM. Orders with fraudulent zip codes were used when placing the orders.
A second involved paying kickbacks to Kerry Morris, a former employee of NW Capital Markets Inc., an underwriting firm. The kickbacks were paid to secure the cooperation of Mr. Morris in purchasing recently issued municipal bonds from CPM. The complaint alleges violations of Exchange Act sections 10(b), 15(a) and 20(a), Securities Act sections 17(a)(1) and (3) and MSRB Rule G-17. To resolve the action each defendant consented to the entry of a permanent injunction, agreed to pay disgorgement with interest, a civil penalty and to be barred or suspended from the industry and to cooperate with the Commission. The settlements are subject to court approval. See also SEC v. RMR Asset Management Company (D. Cal. Filed August 14, 2018)(action against RMR Asset Management, a firm controlled by Defendant Ralph Riccardi, and 12 other individuals who had worked in the securities industry for years; the complaint is substantially similar to the one discussed above; the case is pending); In the Matter of NW Capital Markets Inc., Adm. Proc. File No 3-18640 (August 14, 2018)(proceeding naming as Respondents the registered broker dealer and its managing director and CCO; based on participating in the “flipping” of municipal securities; resolved by the firm with a consent to a cease and desist order based on Exchange Act sections 15(a)(1) and 15B(c)(1), a censure and the payment of a penalty of $40,000; by Mr. Fagan with the entry of a cease and desist order based on MSRB Rule G-27 a suspension from acting as a supervisor in the brokerage business and the payment of a $10,000 penalty); In the Matter of Kerry Morris, Adm. Proc. File No. 3-18639 (August 14, 2018)(proceeding against the registered representative for participating in the kickbacks detailed above; settled with the entry of a cease and desist order based on Securities Act section 17(a), Exchange Act sections 10(b) and 15(a)(1) and MSRB Rule G-17, a bar from the industry and the payment of disgorgement in the amount of $156,347.48, prejudgment interest of $22,661.82 and a penalty of $75,000).