The Second Quarter: A Review of SEC Enforcement

In the second quarter of 2020 as the pandemic began to unfold the Enforcement Division continued to file new actions. Indeed, the agency filed a larger number of actions in the second quarter than in the first despite the limitations of a largely closed economy, little travel and social distancing. In the first quarter Enforcement filed over 50 actions while in the second nearly 70 cases were brought (the first quarter is reviewed here).

The number of cases does not necessarily speak to the quality of the program — the question is what was filed and how was it done. The type of cases brought during the second quarter differed from that of the first quarter. During the first quarter the vast majority of the cases filed were in federal district court – few were administrative proceedings. In the second quarter, however, the cases filed were largely split between federal court and the administrative forum.

The mix of cases also differed from quarter to quarter. While nearly half of the cases filed in the first quarter were offering fraud actions, that number dropped significantly in the second, although offering fraud cases continued to dominate. The other cases filed in the second quarter tended to be a mix of several types including those based on false statements, manipulation, conflicts and FCPA. Examples of the cases filed during the second quarter include the following:

Offering fraud: The action in SEC v. Brickner, Civil Action No. 8:20-cv-00921 (M.D. Fla. Filed April 21, 2020) typifies the cases in this group. Defendant Steven Brickner was the principal of a pharmaceutical company. Mr. Brickner began soliciting investors in 2015 for a venture he formed in September 2016 in Colorado called High Country. The privately held firm was projected to become publicly traded and then a Colorado licensed marijuana dispensary network based on assets to be acquired. Potential investors were told that their funds would be used to acquire the assets necessary for High Country to enter the marijuana business. The deal was supposedly “on track” for the firm to become the largest cannabis operation in the United States by the fourth quarter of 2017; an IPO for the second or third quarter of that year was planned. The projections valued the offering at $2.6 million. Materials regarding the offering gave investors the details of the deal.

Typically, investors were asked to sign agreements titled “Simple Agreement for Future Equity” or “SAFE” with Mr. Brickner and his firms. A deal was in place for the network and a trademarked logo, according to the information given to investors. Participating investors would receive preferred shares or capital stock. The pitch brought in about $5.5 million from 60 investors. The claims were false. There was no deal; no planned IPO; no trademarked logo. Mr. Brickner’s hand was on the cash however – he misappropriated large portions of the investor money. The Commission’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24800 (April 21, 2020).

False statements: In the Matter of Bloomberg Tradebook LLC, Adm. Proc. File No. 3019785 (May 6, 2029). Tradebook is a registered broker-dealer based in New York city. It is a subsidiary of Bloomberg LP. The firm is an agency broker that has buy-side customers such as asset managers and institutional investors and sell-side clients such as broker-dealers.

Customer orders were traditionally executed in one of two ways. First, the order could be routed to the firm’s Alternative Trading System or ATS. Second, the system cited in the firm’s marketing materials could be used – the so-called Smart Order Router. That system supposedly determined the best execution venue by considering factors such as price and liquidity. In 2010 the firm became concerned about its profit margins. In some instance the margins were low while in others the firm lost money. This spawned a third method of execution for buy side clients that became known internally as the Low Cost Router or LCR. Under this method the order was sent to a broker with whom the firm had entered into a partner agreement. The partner brokers generally had lower fees based on volume of trades. The partners also used their systems to route the trade. Tradebook sent certain orders to the partners for execution. For one partner the firm provided routing instructions for each order which specified the market center to be used.

For others Tradebook permitted the partners to select the routing. One of these partners executed over 1.3 million Tradebook customer orders over the period of 2010 through 2018. Another executed 4.9 million orders. Tradebook’s practice of allowing partners to make routing decisions for certain customer orders was inconsistent with its representations to customer. To the contrary, materials available to those customers touted Tradbook’s routing decisions from its advanced and sophisticated system. Generally, when a partner received a Tradebook customer order as part of the LCR arrangement it would report back the execution information. During some periods, however, the information was not reported back – Respondent did not know where the order was sent or executed. Those facts were not disclosed to the client. In those instances, Tradebook reported back the venue it had intended for execution without admitting it did not actually know if the information was correct as to the actual venue of execution. The Order alleges violations of Securities Act Section 17(a)(2). To resolve the proceedings, Respondent consented to the entry of a cease and desist order based on the section cited in the Order and to a censure. The firm also agreed to pay a penalty of $5 million. The Commission considered the cooperation of the firm in agreeing to accept its offer of settlement.

Manipulation: Manipulation is another traditional area of focused for the Commission. SEC v. Leighton, Civil Action No. 1:20 – cv- 10686 (D. Mass. Filed April 7, 2020) typifies those in this group. The action names as defendants Douglas Leighton, Bass Point Capital, LLC, Azure Capital Corp., Michael Sullivan, David Hall, Zachary Harvey, Paul Dutra, Jason Harman and Jessica Geran.

Mr. Leighton buys and sells securities. He also controls the entity defendants. As early as 2013 Mr. Leighton began acquiring shares of a privately held firm named MassRoots, Inc. Over time he acquired a controlling interest. By 2015 the stock began to trade in the public markets. Then Mr. Leighton started directing others who had purchased shares regarding the trading and distribution of the securities. In some instances he essentially directed trading through matched and pegged purchases, all with a view toward driving up the prices so that he could sell at a profit. The repeated pattern of pushing the share price and taking profits continued until 2018. Mr. Leighton failed to file the reports of the interests he beneficially held in the stock. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 9(a)(2), 10(b), 13(d) and 16(a). Each of the Defendants agreed to settle. Each is permanently enjoined from violating the Exchange Act reporting provisions cited in the complaint. Defendants Leighton, Bass Point, Azure and Sullivan are enjoined from violating Securities Act Section 17(a) while Defendants Leighton, Bass Point, and Azure are enjoined from violating Exchange Act Section 10(b). In addition, Defendants Leighton and Sullivan are enjoined from future violations of Exchange Act Section 9(a)(2). Mr. Leighton agreed to the entry of an officer and director bar and to pay a penalty of $160,000. Defendants Leighton, Azure Capital and Bass Point are, in addition, enjoined from trading penny stocks, agreed to the entry of conduct-based injunctions and will pay disgorgement and prejudgment interest of almost $1 million. Mr. Leighton settled a follow-on administrative proceeding that bars him from the securities business. Mr. Sullivan also agreed to the entry of a 5 year penny stock bar, to pay a civil penalty of $40,000 and disgorgement and prejudgment interest of $63,228. Finally, the judgments as to Defendants Hall, Harvey, Dutra, Harman and Geran require the payment of penalties of $15,000 each, and disgorgement and prejudgment interest of, respectively, $67,080, $32,720 and $28,906. See Lit. Rel. No. 24791 (April 8, 2020).

Conflicts: Cases based on conflicts often involved investment advisers and those involved in regulated entities. The action in In the Matter of Morningstar Credit Ratings, Adm. Proc. File No. 3-019802 (May 15, 2020), although not involving an investment adviser, is representative of these types of cases. The proceeding names as a Respondent, the Nationally Recognized Statistical Rating Organization. The proceeding centers on Exchange Act Rule 17g-5(c)(8)(i), a conflict rule which governs issuing credit ratings when employees who participated in the process or monitored it are also participating in the sales or marketing of a product or service of the firm. Here in June 2015 asset-backed securities analysts at the firm, encouraged by MCR’s then director of business development for ABS, identified and contacted prospective clients to arrange marketing calls and meetings to offer to furnish indicative ratings to potential clients. During the period the firm also failed to establish and maintain written policies and procedures regarding compliance with the Rule. To resolve the matter the firm consented to the entry of a cease and desist order based on Exchange Act Section 15E(h)(1), the Rule cited above and to a censure. The firm also agreed to pay a penalty of $3.5 million. In addition, Respondent agreed to implement a series of undertakings centered on compliance with the rule.

Financial fraud: This has traditionally been a key area for the Commission. In the Matter of Vereit, Inc., Adm. Proc. File No. 3-19831 (June 23, 2020) is a proceeding against a large REIT. In late 2014 the firm discovered that its now former CFO and CAO had falsely reported and manipulated the firms Adjusted Funds from Operations, a key GAAP performance metric relied on by management and investors to assess performance. The firm informed investors that the financial reports for 2013 and the first two quarters of 2014 could no longer be relied on. The firm self-reported to the Commission and cooperated with the staff. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and the related rules. The firm resolved the matter, consenting to the entry of a cease and desist order based on the sections cited in the Order and agreed to pay a penalty of $8 million.

Insider trading/cooperation: This has long been a staple for SEC Enforcement. Jana Faith Kiena, CPA, Adm. Proc. File No 3-19824 (June 5, 2020), while an insider trading case, differs from many in this area and raises significant questions regarding cooperation credit. Ms. Kiena, a CPA with an inactive license, was employed at Illumina, Inc. in the revenue department in 2019 as a contract employee. She processed revenue related to monthly service contracts for the firm. She also participated in what the firm called “group huddles” – phone meetings where the staff chatted about the revenue flow. In late June 2019 Ms. Kiena participated in one “huddle” with seven other employees and an accounting manager. The group in the huddle learned that revenue for the quarter would be disappointing. On July 2, 2019 Ms. Kiena used her credit card to obtain a cash advance. She then paid $13,638.33 to purchase July 12, 2019 put option contracts on ILMN, her firm The strike price was $365 per share. Six days later she took $3,096 from her savings account and purchased more put options. On July 11, 2019 Illumina announced that its preliminary revenue for the second quarter would be lower than expected, updating full year guidance. The stock price dropped from $363.66 to $305.05 or 16%. The next day Ms. Kiena sold the put options, securing a gain of $249,227.92. Within a month Ms. Kiena self-reported to the Commission staff. The Order alleges violations of Exchange Act Section 10(b). To resolve the proceedings Ms. Kiena consented to the entry of a cease and desist order based on the section cited in the Order. She also agreed to the entry of an order denying her the privilege of practicing before the Commission as an accountant with the right to request consideration for a reinstatement after two years. In addition, she will pay disgorgement in the amount of her trading profits and a penalty equal to half that amount.

Compliance/Investment Adviser: In the Matter of Ares Management LLC, Adm. Proc. File No. 3-19812 (May 26, 2020). Ares is a global alternative asset manager whose clients are pooled investment vehicles. In some instances, the clients are public firms; in others they are not. Ares had over $149 million in total assets under management at the end of 2019. In 2016 Ares had in place a comprehensive set of procedures governing the handling of material non-public information. In that year the firm invested several hundred million dollars in Portfolio Company. The investment gave the adviser the right to appoint two directors to the board of Portfolio Company creating the risk that Ares would obtain material non-public information. During the period the firm did receive inside information with respect to a Portfolio Company loan.

Over time, Areas also received a variety of information that was potentially material inside information such as changes to senior management, mid-quarter hedging adjustments, efforts to sell a passive interest in a specific assets and similar matters. All of the information was later disclosed. All of the purchases were approved by the investment committee. As a result of the purchases Ares acquired over 1 million shares representing about 17% of the float. Although Ares placed the Portfolio Company stock on its restricted list, the compliance team failed to properly follow the firm procedures which governed the situation –that is, where the firm held shares in an entity where its employees had board seats. In those instances, the procedures required that the staff make prepare written entries for entry into the management system sufficiently documenting if prior to approving the trade inquiry was made to determine if the deal team had inside information. Here in numerous instances, the compliance staff failed to make entries in the order management system sufficiently documenting if prior to the approval of the trade it had inquired if the deal team had obtained inside information. And, to the extent such entries were made, they lacked consistency and detail. Accordingly, despite the increased risk resulting from the relationships between Ares and Portfolio Company, the compliance staff failed to properly adhere to and apply the firm’s systems. After the Commission’s investigation began in 2019 however, the firm retained a consultant and reviewed and evaluated its policies and procedures. The Order alleges violations of Advisers Act Sections 204A and 206(4). To resolve the matter the firm consented to the entry of a cease and desist order based on the sections cited and to a censure. Ares also agreed to pay a penalty of $1 million.

COVID-19: The Commission has focused on cases in this area as the pandemic has continued, creating a task force. SEC v. Praxsyn Corporation, Civil Action No. 9:20 -cv- 80706 (S.D. Fla. Filed April 28, 2020) is typical of the actions filed to date. Praxsyn’s shares are quoted on OTC Link – previously known as the Pink Sheets. The Nevada firm has offices in West Palm Beach. It claims to be a specialty finance company that provides cash flow solutions and medical receivables financing for healthcare provides. It CEO is Defendant Frank Brady. In late February 2020 the company issued a press release sent to the Globe News Wire titled “Praxsyn Joining the Global Fight To Stop The Spread” of COVID-19. The release claimed that the firm was negotiating the sale of millions of masks meeting the NIOSH N95 mask standard. The masks were capable of protecting users from COVID-19, according to the company. Praxsyn, it went on to state, was “currently evaluating multiple orders and vetting various suppliers in order to guarantee a supply chain that can deliver millions of masks on a timely schedule.” Mr. Brady noted in a quote contained in the release that the firm was looking at foreign suppliers.

At the time of the release Praxsyn did not have any orders to sell masks. It did not have any agreement to acquire any masks. Its documents did contain two undated letters to foreign firms making inquiries about obtaining masks. A company director had exchange emails with two other foreign firms about the possibility. A second press release was issued six days later in early March 2020. The release, titled “Update: Praxsyn’s Coronavirus Mask Demand,” was distributed through the same news outlet employed for the first release. This release went on to state that the firm “has a large number of N95 masks, capable of protecting wearers from inhaling viruses, including the COVID-19 Coronavirus available for order.” Praxsyn claimed in the release that it had used its worldwide network to create a “direct pipeline” from the manufacturers and suppliers to bring the masks to market at the “fairest” prices. Mr. Brady stated in the release that the company was accepting orders for a minimum of 100,000 masks. At the time of the second press release the firm did not own any masks. It did not have a contract to acquire any masks. There is no evidence of any pipeline. The firm did, however, make efforts over the next four weeks to locate a supplier. It was not successful.

Finally, on March 31, after receiving inquiries from regulators, Praxsyn was forced to issue a third press release. This release admitted the firm never had any masks to sell. During the period the firm’s stock price and trading volume did increase significantly. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24807 (April 2, 2020).

FCPA: In the Matter of Eni S.p.A., Adm. Proc. File No. 3-19751 (April 17, 2020) is a proceeding which names the Italian oil and gas firm as a Respondent. Over a three-year period beginning in 2007 Saipem S.p.A., a 43% owned subsidiary entered into a series of sham transactions through which about €198 million was paid to an intermediary in order to secure the award of seven contracts from the Algerian state-owned oil firm. Executive A, the CFO of the firm at the time, participated in the approval of the intermediary contracts despite knowledge of a lack of due diligence regarding the agreements. The financial statements of the subsidiary were consolidated with those of the parent whose ADRs are listed on the New York Stock Exchange. An Italian Court found Saipem, Executive A and others guilty of international corruption payments from the subsidiary to the intermediary for Algerian officials in September 2018. The amount ordered forfeit was €198 million. Executive A was also sentenced to serve 49 months in prison while the subsidiary was directed to pay a fine of €400,000. Eni, its former CEO and a senior executive of the parent were acquitted. In January 2020 the Milan Court of Appeals affirmed the trial court’s acquittal of Eni and its officers and overruled the lower court and acquitted the other defendants, including Saipen and Executive A, of all charges. Those rulings are subject to appeal. Previously, Eni resolved FCPA charges with the Commission. The Order here alleged violations by Eni of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceedings Eni consented to the entry of a cease and desist order based on the sections cited in the Order. The firm also agreed to pay disgorgement of $19,750,000 and prejudgment interest of $4,750,000.

Conclusion: The first quarter of the new decade opened with promise and ended with the United States and much of the world effectively at war with a virus. The war continues. As Enforcement moved forward through the pandemic, the case mix changed significantly. No doubt the shift from promise in the first quarter to survival in the second has been difficult. Effective enforcement programs have always risen to the challenge, however. The test for the current program is now; its results are in part reflected in the cases above and in part in how those results were achieved.

Video Program: “Securities Fraud, the Pandemic and Compliance: Protect Your Organization,” August 6, 2020, 12:00 p.m. ET. Chair, Tom Gorman. Free registration, materials & CLE (here)