This Week In Securities Litigation (December 19, 2014)
The Commission brought two FCPA cases this week, one of which was in conjunction with the DOJ. Both centered on the payments for gifts and travel in China.
In addition, the SEC filed three manipulation cases, an action centered on a boiler room, three offering fraud actions, a proceeding centered on a failed audit and an investment fund fraud action.
Rules: The Commission issued a temporary rule regarding principal trades with certain advisory clients. Release No. IA-3984 (Dec. 18, 2014). The rule provides an alternative means for registered investment advisers to meet the requirements of Section 206(3) when they act in a principal capacity in transactions with certain advisory clients.
Rules: As mandated by the JOBS Act, the Commission issued proposed rules relating to the thresholds for registration, termination of registration and the suspension of reporting under Exchange Act Section 12(b)(here).
SEC Enforcement – Filed and Settled Actions
Statistics: This week the SEC filed 6 civil injunctive actions and 6 administrative proceedings, excluding 12j and tag-along-actions.
Boiler room: SEC v. Premier Links, Inc., (E.D.N.Y. Filed Dec. 18, 2014) is an action which names as defendants the company, Dwayne Malloy, President of Premier, Chris Damon, a sales representative, and Theirry Regan, also a sales representative. The complaint alleges that from December 2005 through August 2012 Premier operated as an unregistered broker-dealer. The defendants cold-called prospective investors, pressuring them to purchase unregistered shares of start-up companies, often with representations that the firm would soon conduct an IPO. About $9 million was raised from investors. Investors were not told that only a small fraction of that sum was invested in the shares while the balance was siphoned off by the defendants. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending. A parallel criminal action was brought by the U.S. Attorney’s Office for the Eastern District of New York.
Insider trading: SEC v. Hahn-Balyor, Civil Action No. 3:14-cv-07631 (D.N.J.) is a previously filed action against Robert Hahn-Balyor who was tipped by his cousin, the Chairman of Home Diagnostics about the firm’s impending acquisition and then traded. The Court entered a final judgment against Mr. Hahn-Balyor, enjoining him from future violations of Exchange Act Sections 10(b) and 14(e) and ordering him to pay a civil penalty of $66,100. See Lit. Rel. No. 23161 (Dec. 18, 2014).
Related party transactions: In the Matter of Baker Tilly Hong Kong Limited, Adm. Proc. File No. 3-16324 (Dec. 17, 2014) is a proceeding which names as Respondents the audit firm and two of its members, Andrew Ross and Kwok Laiha Helena. The proceeding centers on the audit and unqualified audit opinion the firm issued on the 2009 financial statements of China North East Petroleum Holdings Ltd., a company whose operations are exclusively in the PRC. That entity and others are the subject of a Commission enforcement action. During the engagement the firm encountered 176 related party transactions totaling over $59 million. There were red flags indicating high risk and possible fraud. Nevertheless, Respondents failed to plan the engagement as appropriate for these transactions. Although the financial statements only contained a single line regarding the transactions showing a net balance of the transactions, the firm issued an unqualified audit opinion. The Order alleges violations of Exchange Act Section 10A(a)(2). Respondents settled, consenting to the entry of a cease and desist order based on the Section cited in the Order. The firm also agreed to a censure. Respondents Ross and Kwok are denied the privilege of appearing and practicing before the Commission as accountants with a right to request reinstatement after three years. They also agreed to pay, respectively, penalties of $20,0000 and $10,000. The firm agreed to implement a number of undertakings.
Offering fraud: In the Matter of Michael Crow, Adm. Proc. File No. 3-16318 (Dec. 16, 2014); In the Matter of Angel E. Lana, CPA, Adm. Proc. File No. 3-16319 (Dec. 16, 2014). The first proceeding names as Respondents: Michael Crow, a principal of Respondent Aurum Mining, LLC, co-owner of Respondent The Corsair Group, part of the management of PanAm Terra, Inc. and who has been barred from the securities business and filed for bankruptcy; and Alexander S. Clug, a principal of Aurum, co-owner of Corsair and CEO of PanAm. Respondent Lana was the CFO of Aurum Mining. The actions center on the sale of interests in a gold mines that Aurum Mining claimed to own and operate in Brazil and Peru. About $3.9 million was raised from investors who were told the Brazilian mine had substantial reserves in gold. The investors were never paid. In addition, Messrs. Crow and Clug established PanAm as a public company and raised additional funds from investors for claimed farmland investment opportunities in South America. No farm land was purchased and substantial portions of the money was diverted to the personal used of the two men. The Crow Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The proceeding will be set for hearing. The Lana Order alleges violations of Securities Act Section 17(a). He resolved the matter, consenting to the entry of a cease and desist order based on the Section cited. In addition, he is denied the privilege of appearing and practicing before the Commission as an account but may apply for reinstatement after five years. He also agreed to pay a civil penalty of $50,000.
Manipulation: In the Matter of Paul J. Pollack, Adm. Proc. File No. 3-16316 (Dec. 16, 2014). Mr. Pollack and his controlled entity, Montgomery Street Research LLC, are Respondents in an action centered on alleged violations of Exchange Act Sections 10(b) and 15(a). In March 2010 Montgomery entered into a three year Letter Agreement with Company A which focused on raising money in the capital markets. From November through April 2011 Respondents helped effect transactions for the company in its common stock. As a result of efforts by Respondents, nine investors purchased $445,000 of the company’s common stock. This represented about 74% of the total offering. Later in 2011 Respondents again solicited prospective investors for the firm, this time to acquire shares of preferred stock. About $5.2 million was raised in the offering. Approximately 40% came from the efforts of Respondents. At the conclusion of this offering it was agreed that Respondents would be paid 5% of the value of the preferred stock. Mr. Pollack also controlled about 665,000 shares of the firm’s common stock through the Letter Agreement. From December 2010 through October 2012 he had exclusive trading authority over ten online brokerage accounts at five brokers. During the period he effected a series of wash sales which put upward pressure on the share price. The transactions resulted in net trading proceeds of about $369,686.23. The proceeding will be set for hearing.
Manipulation: SEC v. Blackburn, Civil Action No. 4:14-cv-00812 (E.D. Tex. Filed December 15, 2014). This action centers around a scheme created by convicted felon and Ronald Blackburn, Treaty Energy Corporation and its executives – Andrew Reid, CEO, Bruce Gwyn, co-CEO, Michael Mulshine, corporate secretary and Lee Schlesinger, CIO, each named as a defendant. Samuel Whitley, outside securities counsel is also named as a defendant. The company was formed in December 2008 by Mr. Blackburn who implemented a the reverse-merger of a private oil and gas company and a dormant public shell. Its shares, 86% of which were controlled by Mr. Blackburn, were quoted on the OTC Bulletin Board. While the other defendants were appointed to various positions at the company, Mr. Blackburn controlled the firm behind the scenes – a fact not disclosed in its Commission filings. In April 2010, through a joint venture agreement, Treaty obtained the drilling rights in Belize. In January 2012 a press release announcing that Treat stuck Oil. The press release claimed the well had an estimated 5 to 6 million barrels of recoverable oil. The stock price shot up by 79.3% in one day. The announcement was false, according to the complaint. The price did not return to pre-announcement levels for a months. Between 2009 and 2013 Mr. Blackburn and others sold shares of the company in an unregistered public offering and using a Form S-8 to distribute shares to ineligible persons. About $3.6 million was raised from 90 investors. By June 2013 Treaty depleted all of its authorized shares. Subsequently, the firm began offering investors oil and gas working interests in a well located in West Texas. Nineteen investors paid about $565,000 for interests based on false representations about the production of the well and the use of the proceeds which were largely misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b), 13(a) and 16(a). The case is in litigation. See Lit. Rel. No. 23158 (Dec. 15 2014).
Revenue recognition: In the Matter of Canadian Solar, Inc., Adm. Proc. File No. 3-16315 (Dec. 15, 2014) is a proceeding which names as Respondents the company, a manufacturer of solar powered products, and Yan Zhuang, its senior vice president and chief commercial officer. The operations of the company are based in the PRC. Following its IPO in 2006, the firm expanded its operations in the U.S. In 2007 its revenue from U.S. operations was still only about $2.6 million or less than 1% of reported annual revenue. Subsequently, the firm entered into a distributorship with a California company and opened sales offices in that state. By the end of 2008 its U.S. revenue increased to $32.3 million. In 2009 the firm reported strong sales growth in Asia and America. The growth was fueled in large part, however, from the improper recognition of revenue by, at times, recognizing revenue when collectability was questionable and where discussions were underway about financing. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the proceeding the company consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(b)(2)(A) and 13(b)(2)(B). It also agreed to pay a penalty of $500,000. Mr. Zhuang consented to the entry of a cease and desist order based on Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(5). He also agreed to pay a penalty of $50,000.
Offering fraud: SEC v. Fleet, Civil Action No. 6-14-06695 (S.D.N.Y. Filed Dec. 12, 2014) is an action against David Fleet, the sole shareholder of Cornerstone Homes, Inc. That firm was engaged in the business of selling and renting distressed single family homes to low income customers. From 1997 to 2010 the firm raised about $16.75 million from unregistered notes sold to about 300 investors. Most of those funds were raised between January 2006 and March 2010. Beginning in 2006 the firm failed to tell investors that its business model had changed and that it was using bank financing. Cornerstone also did not tell investors that the balance sheet was burdened with senior secure notes. By 2009 the model was unsustainable. Beginning in July the firm invested $6 million in the stock market, frequently trading options. This resulted in millions of dollars in losses. By April 2010 the firm told investors in a newsletter that it was seeking an out of court restructuring. Eventually Fleet tried to do a fast track bankruptcy. That effort was halted by the U.S. Trustee. 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.
Investment fund fraud: SEC v. Bennett (S.D.N.Y. Filed Dec. 12, 2014) is an action against attorney Charles Bennett. Beginning in 2008, and continuing until 2014, Mr. Bennett solicited clients, family members and friends to invest in what he described as a pool of funds that invested in joint venture opportunities with a certain family owned investment fund based in Wyoming. He claimed to have a long-standing relationship with the fund. It invested in European real estate, mortgage backed securities and CDS which yielded very favorable returns. Prominent individuals invested in the fund. Using this approach Mr. Bennett raised about $5 million. The story about the fund was true – except for his claim that he had a relationship with it. The funds were misappropriated. Investors were given false documents and Ponzi type payments were made until the venture collapsed. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is pending.
Manipulation: SEC v. Furth, Civil Action No. 14 Civ. 7254 (E.D.N.Y. Filed Dec. 12, 2014) is an action which names as a defendant Douglas Firth. The complaint alleges that in 2010 Mr. Furth manipulated the shares of SearchPath HCS, Inc. In connection with his scheme, which used matched orders, he solicited an individual who claimed to represent a group of registered representatives with trading discretion who could participate in return for a kickback. Mr. Furth entered into the arrangement and furnished the individual with trading instructions. The complaint alleges violations of Securities Act Section 17(a)(1), and Exchange Act Sections 9(a)(1) and 10(b). The case is pending. See Lit. Rel. No. 23157 (Dec. 15, 2014).
SEC v. Avon Products, Inc., Civil Action No. 14 cv 9956 (S.D.N.Y. Filed December 17, 2014). Avon Products is a global manufacturer and marketer of beauty products. The company sells product primarily through direct marketing by over 6 million active independent sales representatives. The firm is active in over 100 countries. In the PRC subsidiary Avon Products China began operations in 1989. In 1998 when China banned all direct selling the company had to alter its typical business model. By 2001, however, China agreed to permit direct selling as part of its admission to the WTO. Avon wanted to influence that process and obtain the first license. Employees in the corporate affairs department furnished government officials with gifts, entertainment and travel to influence the laws and the companies to be selected. In April 2005 Avon China was the first to receive test approval to conduct direct selling in certain areas of China.
In April 2005 Avon’s global internal audit flagged gifts to government officials and inadequacies in related recordkeeping as an area of concern. Although a report was prepared and a major law firm consulted, no action was taken. In December 2005 China’s new direct selling regulations became effective. In March 2006 Avon obtained the first direct sale license. In April the company provided over $100,000 in cash or items of value to government officials. At the same time the company implemented a “zero penalty” policy under which cash and items of value were given to government officials and media to reduce or eliminate potential fines and avoid negative news articles.
In May 2008 a terminated Avon China executive wrote to the CEO of the company alleging improper payment to Chinese government officials over several years. Eventually the letter was forwarded to the audit committee which launched an internal investigation and self-reported to the SEC and the DOJ.
Overall, Avon China provided about $8 million in cash and items of value to government officials between 2004 and 2008. Those included payments for meals and entertainment, tickets to events, travel and to avoid fines. The Commission’s complaint alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter with the SEC the company consented to the entry of a permanent injunction based on the Sections cited in the complaint. In addition, the firm agreed to pay disgorgement of $52,850,000 and prejudgment interest. See Lit. Rel. No. 23159 (Dec. 17, 2014). The Commission considered the cooperation and remedial efforts of the company in the settlement.
To resolve the action with the DOJ the parent company entered into a deferred prosecution agreement after admitting responsibility. Avon China pleaded guilty to an information charging conspiracy to violate the accounting provisions of the FCPA. The Avon entities will also pay criminal penalties totaling $67,648,000. In total the firm agreed to pay $135,013,013 to resolve the actions.
In the Matter of Bruker Corporation, Adm. Proc. File No. 3-16314 (December 15, 2014). Bruker Corporation manages its China operations through the Shanghai and Beijing representative offices of the Asia-based subsidiaries of four divisions. From 2005 through 2008 the Bruker China offices paid about $119,710 to fund 17 trips for Chinese government officials. For the most part the trips were not related to any legitimate business. The trips were recorded as business expenses. The firm had about $1,131,740 in profits from contracts obtained from the state owned enterprises whose officials participated in the trips. From 2008 through 2011 the China offices also paid $111,228 to Chinese government officials through 12 Collaboration Agreements. The agreements were executed with a Chinese official who, in certain instances, was paid directly. Generally, those agreements provided that the state owned enterprise was to provide research on Bruker products or use them in their demonstration labs. In fact no work was provided. The firm had profits of about $583,112 from contracts obtained from the state owned enterprises. Throughout the period the firm had inadequate internal controls and FCPA compliance procedures, according to the Order. Bruker discovered the improper payments in 2011. The firm promptly initiated an investigation, self-reported to the SEC and the DOJ and provided what the Commission called “extensive, through and real-time cooperation.” The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter the company consented to the entry of a cease and desist order base on the Sections cited in the Order. In addition, the firm will pay disgorgement of $1,714,852, prejudgment interest and a civil penalty of $375,000.
AML procedures: The regulator fined Wells Fargo Advisors and Wells Fargo Advisors Financial Network $1.5 million for AML failures. As part of an AML program the broker is required to establish and maintain a written Customer Identification Program which allows them to verify the identity of the customer. The software used by the firms had a flaw. When new accounts were processed the system sometimes assigned a previously used identifier to the account. When this occurred the system did not conduct the required verification. This error persisted for nine years.
Fair pricing: The regulator fined Merrill Lynch $1.9 million for fair pricing and supervisory violations in connection with more than 700 transactions in certain distressed securities. The firm will also pay $540,000 in restitution to customers. FINRA found that the firm purchased the securities at deep discounts from retail customers and then resold the securities to other broker dealers within the prevailing market prices.
Revenue recognition: In the Matter of Akiyo Yoshida, CPA, PCAOB Release No. 105-2014-024 (Dec. 17, 2014). Respondent was a partner of Grant Thornton Taiyo ASG, LLC (Japan) and was the partner-in-charge of auditing Baldwin-Japan, Ltd, the Japanese subsidiary of Baldwin Technology Company, Inc., a U.S. public company at the time. During the engagement Respondent failed to evaluate numerous red flags regarding the possible improper acceleration of revenue. For example, there was a 40% error rate in the results of year end sales cutoff testing and the firm recorded all material sales for the last month on the last day. Respondent was also not sufficiently knowledgeable in the relevant professional accounting and auditing standards. Subsequently, Baldwin announced a restatement resulting from the premature recognition of revenue for equipment sales. The Order censures Respondent, suspends him from association with a registered public accounting firm for one year, limits his activities for one addition year and requires that he complete certain professional education courses.
Failure to register: The Australian Securities and Investment Commission found that from July 2010 to August 2013 Interactive Brokers LLC, an online U.S. brokerage firm, did not hold an Australian financial services license which authorized the provision of margin loans. In resolving the matter the firm admitted to contravening the Corporations Act, agreed to refund about $1.5 million and commissions and will pay $100,000 to the Financial Rights Legal Center for consumer education and retain PWC to monitor the refunds.