SEC Enforcement: 1Q22 (Part II)
This report, like those previously published regarding other time periods, is divided into three segments. Part I presented the statistics for the first quarter of 2022. It notes in part that the largest categories of cases for the period were: 1) Investment advisers; 2) insider trading; 3) offering frauds; and 4) corporate and financial.
Part II presents selected cases representative of the groups above, as well as additional actions which illustrate other facets of the current enforcement program. Those cases are discussed below. Finally, Part III is the conclusion of this series. It will be published later this week.
Select Cases in the Largest Four Categories
Investment advisers
Cases involving investment advisers have long been a staple of the Commission. Many of the cases arise from a failure to fully disclose the numerous conflicts that can arise at an advisory. Others center on issues regarding fees. The first case below centers on conflicts while the second deals with a fee issue.
In the Matter O.N. Investment Management Company, Adm. Proc. File No. 3-20701 (January 11, 2022) names the registered investment adviser as a respondent. The adviser is affiliated with broker-dealer and parent company O.N. Equity Sales Company. That firm received third-party compensation from client investments without fully and fairly disclosing the associated conflicts of interest. Specifically, since at least 2014 ONIMCO invested clients in: 1) mutual fund shares that paid 12b-1 fees; 2) certain funds that also generated no-transaction fee revenue; and 3) certain mutual funds that also resulted in revenue sharing with the broker-dealer. Adequate disclosure was not made; the firm did not avail itself of the Commission’s self-reporting program. In resolving the matter, the firm agreed to implement certain undertakings. The Order alleges violations of Advisers Act Sections 206(2) and Ruler 206(4)-7. To resolve the matter Respondent consented to the entry of a cease-and-desist order based on the Section and Rule cited, and to a censure. In addition, the firm will pay disgorgement of $866,257 along with prejudgment interest of $162,396. The advisory will also pay a penalty of $210,000. A Fair Fund will be created.
In the Matter of Alumni Ventures Group, LLC, Adm. Proc. File No. 3-20791 (March 4, 2022). Alumni Ventures Group has been an exempt reporting adviser since December 18, 2017. The firm relies on an exemption from registration for venture capital fund advisers in Section 203(f) of the Advisers Act. It has about $425 million under management. Respondent Michael Collins is its founder. The Order Instituting Proceedings is based on two claims. The first centers on the fees charged clients. Over a four-year period, beginning in June 2016, the adviser told clients and others that its management fee for the venture capital funds it managed was the “industry standard ‘2 and 20.’” In fact, it was not. The industry standard is 2% each year and carried interest of up to 20%. In contrast, the firm charged 2% each year plus the full 20% – not the industry standard. Second, the firm made inter-fund loans and cash transfers between funds as well as loans to certain funds. Those transactions violated the funds’ operating agreements prohibiting commingling and its fiduciary duties to the funds. The inter-fund transfers were also a conflict of interest between the funds that was not disclosed. The Order alleges violations of Section 206(2) and 206(4) of the Advisers Act. The firm undertook certain remedial acts and agreed to implement certain undertakings. To resolve the proceedings Respondents consented to the entry of cease-and-desist orders based on the Sections cited in the Order and to a censure. Respondents will each pay a penalty of $700,000 and, in addition, Mr. Collins will pay an additional penalty of $100,000.
Insider trading
Insider trading is another traditional area of concentration for the Commission. While the phase “insider trading” does not appear in the Sections typically used to prosecute the cases, the fact that it is prohibited by the federal securities laws is well established. The cases below are typical of many where the information traces back to a corporate insider.
SEC v. Schottenstein, Civil Action No. 1:22 -CV – 10023 (D. Mass. Filed January 6, 2022). This is an insider trading action which names as defendants: David Schottenstein, the founder of a designer sunglasses business and an investor in Sakal Fund and Sakal Capital. His cousin is Insider 1 and served on the board of DSW Inc. and Green Growth Brands Inc. Mr. Schottenstein’s his uncle, called Insider 2, is also the father of Insider 1. His family owns a business involved in the Rite Aid deal discussed below. Kris Bornovsky runs Skal Ventures LLC and was the manager and president of Sakal Capital. Ryan Shapiro founded two companies; Sakal Capital Management LLC; and Sakal U.S. Fund LLC. Trading took place in advance of at least three corporate announcements: a) an August 2017 DSW earnings announcement; (b) a February 2018 announcement of a merger involving Rite Aid Corporation and Albertsons Companies; and (c) a December 2018 announcement of an acquisition of Aphria Inc. by Green Growth Brands. Mr. Schottenstein traded in advance of each announcement, obtaining profits of over $600,000. Mr. Bortnovsky made profits of $260,000 by trading in advance of the two merger announcements. He also traded in advance of one announcement in the Sakal Capital account he controlled, obtaining profits of over $3.4 million. Mr. Shapiro traded in advance of the Rite Aid announcement, obtaining profits of $121,000. The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). The U.S. Attorney’s Office for the District of Massachusetts filed parallel criminal charges against the three individual Defendants. The case is pending. See Lit. Rel. No. 25302 (January 6, 2022).
SEC v. Sargent, Civil Action No. 22-cv-168 (N.D. Ill. Filed January 11, 2022). The complaint centers on a May 4, 2020, earnings announcement for Chegg Inc. It names as defendants David Sargent and Christopher Klundt. Mr. Sargent is an attorney at Sargent Law Offices in Chicago, Illinois. He was also the vice president of a privately-held software firm based in Chicago and a member of the faculty of Loyola University School of Environmental Sustainability. In addition, Mr. Sargent was the general counsel of a privately held business in the Windy City. Mr. Klundt, a resident of San Francisco, was the general manager of a Chegg subscription service, Chegg Prep. He was later promoted to Vice President of Content and Knowledge for Chegg. Messrs. Sargent and Christopher have been close friends since attending the University of Wisconsin-Madison where they founded a study platform for high school and college students. Chegg, based in Santa Clara, California, is the provider of online textbook rentals, tutoring and other educational services. On May 1, 2020, Mr. Klundt attended an earnings “preview” meeting for his firm. During the meeting senior management discussed the upcoming earnings release for the firm. Earnings, according to the draft, would be good. Following the meeting Mr. Klundt called his long-time friend. Within an hour Mr. Sargent purchased $40,000 worth of stock and options in Chegg. The attorney had never purchased any interest in the company. On May 4, 2020, the company issued its earnings release. The announcement stated that revenue for the first quarter had increase by 35% year-over-year to $131.6 million. Market expectations had been exceeded. The stock price soared. Mr. Klundt texted his friend a picture of a happy face with dollar signs for eyes. Attorney Sargent congratulated his friend. Mr. Sargent liquidated his options, netting over $100,000 in profits for his three-day investment; later he sold his stock for a profit of over $7,000. Subsequently, during a regulatory investigation Mr. Klundt was asked if he knew Mr. Sargent. He denied knowing the man. The complaint alleges violations of Exchange Act Section 10(b). The U.S. Attorney’s Office for the Norther District of Illinois filed parallel criminal charges against each man. The cases are pending. See Lit. Rel. No. 25305 (January 11, 2022).
Offering fraud actions
Offering fraud actions are another staple of SEC Enforcement. Traditionally, many of these cases involved microcap issuers. With the advent of digital assets, many of the actions now involve those type of assets. The cases presented below illustrate both types of cases. Those involving digital assets are labeled “crypto” while the more traditional cases in this area are labeled “offering”.
Crypto: SEC v. Garcia, Civil Action No. 1:22-cv-00118 (D. Colo. Filed January 18, 2020). The case centers on the theft of about $123,000 from investors who believed they were purchasing interests in a new crypto currency called “gold haws” tokens. Named in the complaint are: Defendant Paul Garcia and Relief Defendant Office Guru Franchise Group, Inc. Mr. Garcia is a 50% owner of Gold Hawgs Development Company, an entity formed in 2019 and located in Fort Collins, Colorado. Mr. Garcia, who controls the company, used it to conduct business unrelated to Gold Hawgs. The other company was owned by its CFO. An agent of that company solicited investors to purchase interests in the company. Over a period of a few months, beginning in August 2019, Mr. Garcia and Gold Hawgs raised about $400,000 from 16 investors. The Gold Hawgs token was offered to investors as a new kind of crypto token. Investors were assured that the upside potential of purchasing the coins was significant based on to the business plan of the company. There was never any time to actually implement the business plan, however. Beginning almost immediately, and continuing through July 2020, Mr. Garcia misappropriated about $123,000 the investor funds. The money was taken from the Gold Hawgs’ bank account that is in the name of Office Guru. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3), Exchange Act Section 10(b) and disgorgement based on Section 6501 of the National Defense Authorization Act for Fiscal Year 2021, and equitable principles. The case is pending. See Lit. Rel. No. 25308 (January 18, 2022).
Offering In the Matter of Daniel J. Swinyar, Adm. Proc. File No. 34471 (January 18, 2022) names as respondent Mr. Swinyar, who owns and controls Green Hill Capital Management LLC, a Texas state registered advisory. The proceedings center on an offering fraud conducted by George Blankenbaker and this three firms, StarGrower Asset Management LLC, StarGrower Asset Management LLC and Blankenbaker Investments Fund 17 LLC. About $11.4 million was raised from 109 investors. Over a period of about one year, beginning in October 2017, Mr. Swinyar acted as an unregistered broker on behalf of StarGrower Asset in connection with an unregistered offering of securities. Respondent was paid about $105,103 in transaction based compensation from StarGrower Assets from the sales. He is not a registered broker-dealer or associated with one. The Order alleges violations of Securities Act Sections 5(a), 5(c), 17(a)(2) and 17(a)(3), Exchange Act Section 15(a)(1) and Advisers Act Section 206(2). Respondent resolved the matter, consenting to the entry of a cease-and-desist order based on the Sections cited, was barred from the securities business and participating in any penny stock offering. He will also pay disgorgement in the amount of $105,103 and prejudgment interest of $13,099. Respondent will also pay a penalty of $60,000.
Offering: SEC v. Safeguard Metals LLC, Civil Action No. 22:22-cv-00693 (C.D. Ca. Filed February 1, 2022) is an action which names as defendants the company and its owner, Jeffrey Suntulan. Over a four-year period, beginning in December 2017 Defendants targeted those near retirement age in an effort to convince them to transfer their savings to a self-directed Individual Retirement Account so that the money could be invested in their fraudulent scheme – buying gold and silver coins based on false statements. For example, investors were told they should transfer their assets to avoid the impact of the “Money Market Reform Act,” a statute designed to apply to money market funds in rare circumstances, but which was portrayed as being a vehicle to snatch their investment funds. Investors were also told Safeguard had a London office and millions of dollars under management – both false claims. Overall, Defendants raised about $67 million from the sale of their coins to over 450 elderly, retail investors and kept about $25.5 million in markups on the price paid to acquire the coins. The complaint alleges violations of Exchange Act Section 10(b) and Advises Act Sections 206(1) and (2). The case is pending. See Lit. Rel. No. 25322 (February 2, 2022).
Crypto: In the Matter of Blockfi Lending LLC, Adm. Proc. File No. 34503 (February 14, 2022). Named a respondent in the action is BlockFi, a firm formed in 2018 that is a wholly owned subsidiary of BlockFi Inc., a financial services company. Beginning in early 2019 Respondent started selling BlockFi Interest Accounts or BIAs to investors. Thorough those accounts investors could lend crypto assets to BlockFi in exchange for a promise to receive a variable monthly interest payment. The funds to pay the interest were generated by deploying the firm’s assets in various ways including loans of crypto assets to institutional corporate borrows, lending U.S. dollars to retail investors, and investing in equities and futures. The case turned on the manner in which BlockFi generated the funds to pay the variable rate of interest in exchange for investors lending their crypto assets. The assets were borrowed in exchange for a promise to repay with interest. Investors loaned the crypto assets based on BlockFi’s statements about how it would generate the yield to pay the BIA investors interest. Through those transactions investors had a reasonable expectation that BlockFi would use the invested crypto assets in BlockFi’s lending and investing activity and that investors would share in the profits from those transactions. BlockFi also made a material false statement on its website concerning its collateral practices. In resolving the proceedings, the firm agreed to implement a series of undertakings. The Order alleges violations of Securities Act Sections 5(a), 5(c) and 17(a)(2) and (3). To resolve the proceedings Respondent consented to the entry of a cease-and-desist order based on the Sections cited in the Order. Respondent also agreed to pay a penalty of $50 million.
Crypto: SEC v. Barksdale, Civil Action No. 1:22-cv-1933 (S.D.N.Y. Filed March 8, 2022). Named as defendants in the action are John Barksdale and his sister, Jonatina Barksdale. John, a U.S. citizen living in Thailand, the founder and primary entrepreneur behind a firm called Ormeus Global S.A. and its digital tokens, Ormeus Coin or ORME. Sister JonAtina, or Tina, is a U.S. citizen living in Hong Kong. She controls the company along with her brother. In just a few months, beginning in June 2017, Brother and Sister raised millions of dollars from thousands of investors by offering and selling unregistered securities in the form of subscription packages in Ormeus Global, S.A., a multi-level marketing business. Also sold were unregistered securities in the form of the digital asset Ormeus Coin. The subscription packages included access to a learning portal about digital assets, funds pooled and invested into a digital asset trading system and the tokens of Ormeus Coin. Through the firm Defendants marketed the trading system as a proven program. Returns to investors were supposedly as high as 160% of the initial investment. Through Ormeus Global, a company organized in Panama on September 4, 2017 and based in Hong Kong, Defendants marketed the Ormeus Coin to investors. Part of the sale pitch claimed the Ormeus Coin would permanently place 40% of the profits from the digital assets mining business tied to the coin into digital asset wallets called Ormeus Reserve Vault. This would support the Ormeus Coin investors were told. They were also informed that the wallet would be displayed on a firm website. In fact, the wallet displayed belonged to a third party. Defendants’ marketing pitch contained other false claims. To portray the firm as successful, for example, the digital assets were displayed on the website and were represented to be worth over $190 million in November 2021. In fact, the actual digital wallets were worth less than $500,000 as of that date. The website also displays a letter which claimed that the digital mining operations of Ormeus Coin were among the largest in the world and included facilities in North America. During the period surrounding the road show Defendants engaged in manipulative trading of Ormeus Coin to boost the price. Coordinated trading was used to inflate the price of the coin. Overall Defendants raised at least $124 million from over 20,000 investors in the United States and various countries around the world. Defendants have used millions of dollars of investor cash for their personal benefit. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 25341 (March 8, 2022).
Corporate and financial
Corporate and financial case are another traditional group of actions. During some periods these cases dominated enforcement such as just prior to the passage of the Sarbanes-Oxley Act. Today they remain a stable of the Commission’s enforcement program.
SEC v. HeadSpin, Inc., Civil Action No. 5:22-cv-00576 (N.D. Cal. Filed January 28, 2022). Defendant HeadSpin, based in Palo Alto, gives customers hardware and software tools to test their mobile software applications across the world. Over a period of two-years its former CEO, Manish Lachwani, engaged in a fraudulent scheme which pushed its valuation to over $1 billion not by delivering a superior product or services, but through financial fraud. The $1 billion valuation was an illusion. To create that illusion the company and its CEO inflated the value of numerous customer deals. In addition, transactions under discussion with a potential customer were invoiced as if they were actually based on guaranteed future payments. This was done by creating false invoices. These fraudulent techniques propelled the company valuation upward. In the fall of 2018 HeadSpin and its CEO took additional steps. Prior to a Series B fundraising round, HeadSpin’s valuation was about half a billion dollars. One year later that valuation reached about $1.1 billion during a Series C round of financing, giving the start-up company “unicorn” status. The inflation was based on fabricated claims and stories spun to investors. Those investors executed long-term contracts valued at tens of millions of dollars per year. The investors were some of Silicon Valley’s biggest, high-profile companies. Following an internal investigation in 2020 by the board of directors, the fraud unraveled, the CEO was forced to resign and the billion dollar valuation collapsed. The company was valued at about $300,000. The company implemented a series of remedial acts. Those included: 1) An internal investigation conducted by the board; 2) repaying investors; 3) the retention of new senior management; and 4) the adoption of new policies and procedures to enhance transparency and facilitate accurate reporting. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The company resolved the matter, consenting to the entry of permanent injunctions based on the Sections cited in the complaint. The Commission instituted a separate action against the former CEO, SEC v. Lachwani, Civil Action No. 3:21 Civ. 6554 (N.D. Cal.).
SEC v. Valissaris, Civil Action No. 122-cv-01345 (S.D.N.Y. Filed February 17, 2022) is an action which names as defendant James Valissaris, the founder and CIO of Infinity Q Capital Management LLC, a SEC registered investment adviser. Ove a four-year period, beginning in early 2017 and continuing through February 2021, Defendant represented to investors and others that certain holdings of the Infinity Q Funds were valued by an independent third party pricing service. In fact, the claims were false. To the contrary Defendant inflated the stated valuations of the funds by: 1) Manipulating the computer code of the models used by the service; 2) entering incorrect inputs; 3) selecting models that he knew were inappropriate; and 4) Cherry picking one of the key inputs. In addition, he materially inflated the mutual fund’s NAV and the private fund’s total assets. Finally, in certain instances Defendant altered documents. At one point the Funds were over valued by about $1 billion. Even as the pandemic started and continued the values of the funds were significantly overstated. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b), Advisers Act Sections 206(1), 206(2), 206(4) and 206(7) and Investment Company Act Sections 34(b) and 37. The case is pending. The SEC’s investigation is continuing. The U.S. Attorney’s Office for the Southern District of New York filed a parallel criminal action. See Lit. Rel. No. 25331 (February 17, 2022). See also CFTC v. Valissaris, Civil Action No. 1:22-cv-01347 (S.D.N.Y. Filed February 17, 2022).
Select Cases in Other Areas (Listed in order of filing)
During many periods there are cases which do not fit into squarely of the large groups of actions or stand alone. Nevertheless, they are important. Examples of these actions are detailed below.
Manipulation: SEC v. Beck, Civil Action No. 2:22-cv-00812 (C.D. Ca. Filed February 7, 2022). Defendant Michael Beck has a twitter account with the handle “@BigMoneyMike6”. He is also the founder of email group TeamBillionaire. Named as a relief defendant is Helen Robinson, his mother. Mr. Beck has as many as 3 million followers for his Twitter handle. Over a two-year period, beginning in 2017, Defendant used his handle and a significant following to manipulate eight microcap stocks by conducting a scalping scheme. Key to scalping is acquiring a stock position with the firm, then moving the price up and later selling prior to the other investors – it is built on non-disclosure by the trader who does not reveal the stock about to be touted is one he owns. In this case Mr. Beck began each scheme by purchasing a block of shares of a penny stock. Typically, the shares were acquired by a nominee, in this instance, his mother. The second step of the manipulation was built on the Twitter following. Mr. Beck would tweet out to his followers and the public that he would soon be issuing a new stock recommendation or an Alert. Frequently, he would notify the members of TeamBillionaire to encourage them to purchase prior to other members of the public. In some instances, Defendant paid select investors to make favorable statements prior to his recommendation. Following these steps Mr. Beck would tweet out his stock recommendation. The share price would rise as the volume and trading climbed. Defendant Beck then sold his shares. By repeating this procedure with eight different stocks over the two-year period, Defendant Back realized gains of about $870,000. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). The case is pending. See Lit. Rel. No. 25325 (February 7, 2022).
Alternative trading systems: In the Matter of Zero ATS, LLC, Adm. Proc. File No. 3-20699 (January 10, 2022) is a proceeding which names the registered broker-dealer as respondent. Over a period of about three years, beginning in December 2014, the firm failed to make all of the required disclosures regarding a third party’s display of order book information for certain NMS stocks. The disclosures concerned its subscriber’s display of order book information for certain Digitally Enhanced Securities. In two instances – June 2017 and from February 2020 to June 12, 2020 – it held the percentage in one or more non-NMS securities which mandated compliance with the Fair Access Rule but failed to establish written standards for granting access to the ATS as required. The Order alleges violations of Regulation ATS Rules 301(b)(2) and (5). To resolve the proceedings Respondent consented to the entry of a cease-and-desist order based on the Rules cited in the Order, to a censure and to pay a penalty of $800,000.
Sham transaction: SEC v. Coldcutt, Civil Action No. 22-cv-0274 (D.D.C. Filed March 1, 2022). Andrew Coldcutt is a Canadian Citizen who practices law in California where he has offices. He claims to be a securities lawyer. The Commission brought a subpoena enforcement action against him in 2017. Two orders compelling compliance with a subpoena were issued against the attorney. In 2017 two hedge fund managers approached the attorney. They were interested in acquiring a public company whose shares they could freely trade. Mr. Coldcutt complied, knowing that the point was to conduct a pump-and-dump scheme. Mr. Coldcutt told the two managers he know of such an entity. It was supposedly in the fruit and distribution business. To facilitate the manipulation scheme, Mr. Coldcutt filed an S-1 registration statement with the Commission. In view of the subpoena enforcement action he did not, however, let his name appear in the filings. In 2019 the registration statement went effective after several amendments were filed. In fact, the entity was a sham – it did not exist. The managers were undercover FBI agents. The complaint alleges violations of each subsection of Securities Act Section 17(a). The case is pending. See Lit. Rel. No. 25338 (March 1, 2022).
Part III, the concluding segment of the series, will be published later this week.