This Week In Securities Litigation (Two Weeks ending Sept. 9, 2016)
In the two weeks spanning the Labor Day weekend, the Commission continued bring cases arising from its inspection program. Two new actions alleging inadequate procedures regarding the disclosure of additional trading away fees incurred by customers in wrap fee programs were brought. Another action centered on a financial fraud action in which the senior financial officers of a REIT learned a key metric was not correctly calculated, failed to take appropriate action, and then continued using the incorrect calculation process to meet guidance. Another action was brought against an investment bank for rendering a false fairness opinion. The SEC also brought actions centered on offering frauds and touting.
Whistleblowers: The Commission announced that its Whistleblower Program has awarded over $100 million. Since its inception the program has received over 14,000 tips from individuals in all 50 states and the District of Columbia and 95 foreign countries. Over $107 million has been awarded to 33 individuals.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 5 civil injunctive action and 3 administrative proceeding, excluding 12j and tag-along proceedings.
Wrap fees: In the Matter of Robert W. Baird & Co., Inc., Adm. Proc. File No. 3-17532 (Sept. 8, 2016) charged the firm with failing to adopt policies and procedures regarding “trading away” expenses that may be incurred by those participating in its wrap fee program. Specifically, while the firm disclosed that sub-advisers may trade away they did not collect information regarding the frequency and amount of additional fees, that clients could incur when another broker outside the program was used. The Order alleged violations of Advisers Act Section 206(4). To resolve the matter the firm agreed to implement a series of undertakings essentially providing additional disclosures regarding fees incurred in connection with trading away, consented to the entry of a cease and desist order based on the Section cited in the Order and will pay a penalty of $250,000. See also In the Matter of Raymond James & Associates, Inc., Adm. Proc. File No. 3-17531 (Sept. 8, 2016)(proceeding based on similar allegations; resolved with an agreement to implement certain undertakings, a cease and desist order based on the same Section and the payment of a $600,000 penalty).
Financial fraud: SEC v. Block, Civil Action No. 1:16-cv-07003 (S.D.N.Y. Filed Sept. 8, 2016) is an action which names as defendants Brian Block and Lisa McAlister, respectively, the CFO and CAO of American Realty Capital Properties, Inc., a publically traded REIT. The action centers on misreporting a key non-GAAP metric known as Adjusted Funds From Operations or AFFO, was used by management and the market. In 2014, prior to filing the 1Q 10-Q defendants were alerted that the accounting staff had concerns regarding the calculate of the metric. Nevertheless, the filing was made. Later it was confirmed that the metric was miscalculated. Defendants not only failed to take appropriate action and correct the metric, they intentionally used the same incorrect approach to calculating the metric for the 2Q 10-Q. The complaint alleges violations of Exchange Act Section 10(b), 13(a) and Rule 13a-14. The case is pending. A parallel criminal action was filed by the U.S. Attorney’s Office for the Southern District of New York, charging both the CFO and the CAO; Ms. McAlister pleaded guilty to one count of conspiracy to commit securities fraud and other offenses, one count of securities fraud, one count of making false filings with the SEC and one count of making false statements and is cooperating with the government.
Offering fraud: SEC v. Jenkins, Civil Action No. 4:16-cv-00402 (D. Idaho Filed Sept. 7, 2016). The action centers on selling the promissory notes of Arco Hills Silica Company, a firm based in Idaho Falls, Idaho, which was supposedly searching for financing to develop its minerals. Defendant Gordon Jenkins was the firm’s only officer and director. He solicited investors, along with defendants Theodore Sweeten and Francis Kreais. They were assisted by Craig Parkinson of Parkinson Geologic Services, also a defendant.
In January 2012 Messrs. Jenkins and Sweeten approached Mr. Kreais about soliciting investors for Arco Hills. The proposal was to raise sufficient capital to secure long term financing. That financing, in turn, would be used to move the mine into production.
Production would be profitable. Arco Hills held 119 mining claims worth about $6.8 billion, according to a report of Geologist Parkinson. Defendants offered investors promissory notes with high rates of return, guaranteed against loss and which were indemnified. The promissory notes were to repay the principle amount along with 53% to 120% interest within days of obtaining the necessary financing. The notes were guaranteed against loss by one of the Arco Hills claims which had significant value, according to Mr. Parkinson’s report. The notes were also supposedly indemnified by a Treasury Department and Bank of America bond. Over $500,000 was raised from 12 investors in several states through cold calls, marketing meetings in investor homes and emails. The report on the property was false; the bond bogus. Defendants spend most of the investor funds on themselves. The complaint alleges violations of Securities Act Sections 5(a) and 5(c), each subsection of 17(a) and Exchange Act Sections 10(b) and 15(a). Each defendant settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint. In addition, Mr. Jenkins will pay disgorgement of $82,757.06, prejudgment interest and a penalty equal to the amount of the disgorgement; Mr. Sweeten will pay disgorgement of $227,702.32, prejudgment interest and a penalty equal to the amount of the disgorgement; Mr. Kreais will pay disgorgement of $112,077.20, prejudgment interest and a penalty equal to the amount of the disgorgement; and Mr. Parkinson will pay disgorgement of $10,000, prejudgment interest and a penalty of $40,000. See Lit. Rel. No. 23638 (Sept. 7, 2016).
Touting: SEC v. Contrarian Press, LLC, Civil Action No. 1:16-cv-06964 (Filed Sept. 6, 2016) is an action which names the publishing firm, its Chairman, CEO and President, Scott Fraser, and Nathan Young as defendants. Beginning in September 2011 Mr. Fraser and his publishing firm touted penny stock issuer Empowered Products, Inc., a purveyor of sexual health product, in newsletters without disclosing their relationship to the firm. Subsequently, others, such as defendant Nathan Young, were retained to facilitate the scheme. The newsletters touted the prospects of the firm; the articles were written to make them appear to be by disinterested persons, deceiving investors. The complaint alleges violations of Securities Act Section 17(b) and Exchange Act Sections 10(b) and 20(a). The action is pending. See Lit. Rel. No. 23626 (Sept. 6, 2016).
Offering fraud: SEC v. Watkins, Civil Action No. 16-cv-03298 (N.D. Ga. Filed Sept. 1, 2016). The action centers on the sale of interests in defendant Masada Resource Group, LLC in two phases. Masada purports to have patents for technology to convert organic waste to fuel. Donald Watkins, an attorney, controls Masada. He also controls defendant Watkins Pencor, LLC. In 2009 attorney Watkins sought to purchase the majority interest in an NFL franchise, a claim which became an important marketing tool. In the same year he also suffered from significant debt issues, owing very substantial sums, and launched his scheme. In Part I of the offering, beginning in 2009, he sought to raise money for Masada by offering “economic interests” and promissory notes. An NFL football player and his wife invested $1 million in the economic interests. A second professional football player invested $500,000. A former NBA player invested $1 million in the promissory notes. Contrary to the representations made to the investors, their investment funds were diverted to the personal debts of Mr. Watkins. In Part II of the offerings, beginning in April 2011, investors were told that giant International Waste Management, Inc. was conducting due diligence on Masada and that a deal was eminent. The pitch was used to induce the former NBA player, for example, to renew his $1 million investment twice. The claims were false. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23634 (Sept. 1, 2016).
Pyramid scheme: SEC v. Tropikgadget FZE, Civil Action No. 1:15-cv-10543 (D. Mass.) is a previously filed action which named as defendants the firm, Sergio Henrique Tanaka, Carlos Luis Da Silveira, Claudio de Oliveira Pereira Campos, Vivian Amaral Rodrigues and Wesley Brandao Rodrigues. The Commission’s complaint alleged that two companies with the name Tropikgadget, operated under the name of Wings Network, claimed to be in the digital and mobile solutions business but in fact were multilevel marketing schemes. The five individual defendants settled with the Commission. The three officers of the firm – Messrs. Tanaka, Barbosa and Campos – consented to the entry of permanent injunctions based on Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b); the two promoters – Viviane and Wesley Rodrigues – consented to the entry of permanent injunctions based on Securities Act Section 5. The judgments also preclude participation in any marketing or sales program in which the participant’s compensation is primarily from inducing another to participate in a program. The judgments, in addition, require the payment of a total of: $1,944, 147 by defendant Tanaka; $300,284 by defendant Barbosa; $150,000 by defendant Campos; and $462,732 by defendant Viviane Rodrigues; and $162,404 by defendant Wesley Rodrigues. See Lit. Rel. No. 23632 (Sept. 1, 2016).
Prime bank fraud: SEC v. Tahmazian, Civil Action No. 2:16-cv-954 (C.D. Cal.) is a previously filed action which named as a defendant attorney Jilbert Thamazian. The complaint alleged a prime bank fraud. Mr. Tahmazian resolved the action with the Commission, consenting to the entry of a permanent injunction based on Securities Act Sections 5(a), 5(c), 17(a)(1) and 17(a)(3) and Exchange Act Section 10(b). He also agreed to pay disgorgement of $40,000 along with prejudgment interest and a penalty of $150,000. In a related administrative proceeding the defendant also consented to the entry of an order permanently suspending him from appearing and practicing before the Commission as an attorney. See Lit. Rel. No. 23633 (Sept. 1, 2016).
Offering fraud: SEC v. Enviro Board Corporation, Civil Action No. 2:16-cv-0427 (C.D. Cal. Filed August 26, 2016). Named as defendants in the action are the company, supposedly a firm that would profit from recycling agricultural waste products; Glenn Camp, its co-founder and co-chairman and co-CEO; William Peiffer, its co-founder, co-chairman and co-CEO; and Joshua Mosshart, who solicited investors. The firm traces its roots to 1992. It planned to develop a technology that would permit the manufacturing of low-cost, environmentally-friendly building panels out of straw and other agricultural waste fiber. Over a twenty year period, the firm was only able to construct prototypes. Development was suspended in 2011. The offerings were not. From 2011 through 2014 the defendants offered and sold securities to nearly 40 investors in several states, raising about $6 million. Investors purchased about $3 million in stock, $2 million in bonds that were supposedly secured by tax credits, $1 million in unsecured bonds and $50,000 in promissory notes. Key to the solicitations was a PPM furnished to investors. Each iteration of that memorandum contained financial projections for the firm, although the numbers in each differed. For example, the PPM used in 2011 forecast about $42.8 million in revenue and $30.8 million in net income. The mid-2012 – 2013 version claimed that revenue would be $58.8 million and that there would be $32.3 million in net income. Both sets of projections were for the first year of operations. Those representations had no basis in fact. The company never generated any meaningful operating revenue. The individual defendants did, however, profit, taking as much as $2.6 million of the offering proceeds as compensation. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 15(b). The case is in litigation. See Lit. Rel. No. 23628 (August 26, 2016).
False opinion: In the Matter of RBC Capital Markets, LLC, Adm. Proc. File No. 3-17520 (August 31, 2016) is a proceeding which names the investment bank, a registered broker-dealer and investment adviser, as a Respondent. The Order alleges that in connection with the sale of Rural/Metro Corporation in 2010 the investment bank rendered a false fairness opinion that was used in the proxy solicitation process in which Rural/Metro was acquired by a private equity firm. Specifically, the Order alleged that in its opinion the investment bank represented that it presented the firm’s 2010 adjusted EBITDA based on “consensus projections” when in fact the numbers were actually developed by Rural/Metro. The Order alleged a violation of Section 14(a) of the Exchange Act. To resolve the action Respondent consented to the entry of a cease and desist order based on the Section cited in the Order and agreed to pay disgorgement of $500,000 prejudgment interest and a civil penalty of $2 million.
Investment fund fraud: U.S. v. Wells (S.D.N.Y.) is an action in which William Wells previously pleaded guilty. He was sentenced this week to serve 46 months in prison. The court papers detailed an investment fund fraud that continued over a period of six years beginning 2009. Investments were obtained from over 30 investors who ultimately lost over $1.5 million. Investors were assured that Mr. Wells and his firm, Promitor Capital LLC, had a successful investment track record. In fact the firm lost money on its trading every year and portions of the investor funds were misappropriated.
MOU: The Commission announced a Memorandum of Understanding with the Comision Nacional Bancaria y de Valores, or CNBV, and the Banco de Mexico, or BDM, regarding cooperation and the exchange of information in the oversight of certain regulated entities that operate on a cross-boarder basis.
Program: The Dorsey Private Funds Symposium, Sept. 28 2016, New York City. For further information click here.