This Week In Securities Litigation (Week ending April 13, 2018)
One firm and three of its officers were named as defendants in a Commission enforcement action that could have been cloned from earlier remarks of Chairman Clayton about cryptocurrency. In one speech the Chairman decried situations where a firm might add the word “blockchain” or another cryptocurrency word to its name and watch the stock price skyrocket. That, however, is exactly what happened in an enforcement case brought by the agency this week: a firm with virtually no assets acquired a site it valued at $0 but was involving blockchain technology. The firm’s stock price sored over 2000% — and the insiders reap millions of dollars from selling unregistered shares.
The Commission also filed three new actions against investment advisers related to undisclosed 12b-1 fees. Each of the cases settled on filing. None of the actions were under the Share Class Selection Initiative which promises favorable settlement terms for those who self-report such actions and repay investors.
Whistleblowers: The Commission made another whistleblower award this week. This time the person received an award of $2.1 million.
Remarks: Chairman Jay Clayton delivered remarks at the Equity Market Structure Symposium Sponsored by the University of Chicago and the STA Foundation, Chicago Illinois (April 10, 2018). The Chairman outlined plans to have three roundtables on market structure: The first will focus on thinly traded securities; the second on access to markets and market data; and the third on regulatory approaches to combating retail fraud (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 2 civil injunctive cases and 7 administrative proceeding, excluding 12j and tag-along proceedings.
Financial fraud: In the Matter of Wellness Center USA, Inc., Adm. Proc. File No. 3-18435 (April 12, 2018) is a proceeding naming the firm as a Respondent, a holding company for four subsidiaries operating in the healthcare area. Beginning in 2013 and continuing into 2014 Wellness issued false and misleading Forms 10-K and 10-Q. Specifically, the filings concealed a scheme by its President, CEO and CFO, Andrew Kandalepas, to misappropriate $450,000 from the firm. The company variously mischaracterized the payments to him as “salary,” “prepayments” or “loans” when in fact they were not. The firm also issued two false press releases in 2015 touting non-existent sales. Finally, the company caused Matthew Mushlin, a consultant, to violate Exchange Act Section 15(a) by acting as an unregistered broker regarding the sale of about $2 million worth of its stock in 2013, 2015 and 2017. The Order alleges violations of Securities Act section 17(a) and Exchange Act sections 10(b) and 15(a). To resolve the proceedings the firm undertook to cooperate with the Commission in the future and consented to the entry of a cease and desist order based on the sections cited in the Order. See also In the Matter of Li and Company, PC, Adm. Proc. File No. 3-18436 (April 12, 2018)(action against outside auditors and its engagement partner, Tony Zhicong Li; Respondents engaged in improper professional conduct by improperly relying on management’s representations and failing to exercise professional skepticism during its audits and reviews in violation of Securities Act section 17(a)(2); resolved with a cease and desist order based on the section cited in the order, an order denying both Respondents the privilege of appearing and practicing before the Commission as accountants; the payment by each Respondent of of $22,5000 in disgorgement and $2,643 in prejudgment interest; and the payment of a $45,000 penalty by Respondents); In the Matter of Matthew T. Mushlin, Adm. Proc. File No. 3-18434 (April 12, 2018)(proceeding against firm consultant Matthew Mushlin for acting as an unregistered broker as detailed above and for engaging in manipulative trading of Wellness stock; the Order alleges violations of Exchange Act sections 10(b) and 15(a); resolved with the entry of a cease and desist order based on the sections cited in the Order; the entry of an order barring Respondent from the securities business or participating in a penny stock offering; and the payment of disgorgement in the amount of $232,925.00, prejudgment interest of $23,101.36 and a penalty of $240,000; Respondent also undertook to cooperate with the Commission in the future).
Financial fraud: In the Matter of Philip John James, CA, Adm. Proc. File No. 3-18431 (April 9, 2018). The Order names as Respondents two former employees of Computer 2000 Distribution Limited, the U.K. subsidiary of Tech Data Corporation, a U.S. public company. They are chartered accountants Philip James, Finance Director, and Kevin Silverwood, Financial Management Controller. The Order centers on a financial fraud that took place in 2012 and 2013 in the U.K. subsidiary whose results were consolidated with those of the parent for financial reporting. In the third quarter of fiscal 2012 Respondents learned that $5 million in aged receivables were uncollectable and moved them to another account rather than writing them off. In the third quarter of fiscal 2013 the two accountants transferred over $3 million in costs to the same balance sheet account used the prior year while failing to write off $650,000 in uncollectable receivables. Finally, in the fourth quarter of 2013 the two men took four steps which fraudulently improved the firm’s financial results: 1) Failed to record about $750,000 in foreign exchange losses: 2) prematurely recognized about $750,00 in rebates; 3) transferred over $350,000 in costs to the same balance sheet account they had previously used; and 4) failed to write off two uncollectable receivables totaling $2.2 million. The Order alleges violations of Exchange Act sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). Previously, each Respondent settled with the U.K. FRC. Mr. James admitted his misconduct and paid a fine of £35,625 (about $46,300). He was suspended from acting as a chartered account for 10 years. Mr. Silverwood fully admitted to his conduct in resolving the matter. He paid a fine of £11,250 (about $14,850) and was precluded from acting as a chartered accountant for four years. To resolve the proceedings with the Commission each Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. Mr. James is prohibited from serving as an officer or director of an issuer. Mr. Silverwood is also precluded from serving in such a capacity but for five years. Each Respondent is denied the privilege of appearing and practicing before the Commission as an accountant. Mr. Silverwood may request reinstatement after five years. Finally, Mr. James is directed to pay disgorgement of $22,500 along with prejudgment interest of $4,200. Mr. Silverwood is directed to pay disgorgement of $2,100 and prejudgment interest of $395. The financial obligation for each man is deemed paid by the amounts remitted to the FRC. The Commission chose not to impose penalties in view of the actions of the FRC. Note: While Respondents consented to the entry of the settlement order the standard “neither admit nor deny” language was not included. The text of the Order contains the admissions of Respondents from the U.K. proceedings.
Offering fraud: SEC v. The Lifepay Group, LLC, Civil Action No. 4:18-cv-1098 (S.D. Tx. Filed April 6, 2018) is an action which names as Defendants the company, SMDRE LLC, Clifton Stanley and Michael Watts. The complaint centers on two offering frauds targeting elder citizens. The first, conducted from 2010 through 2017, was based on a scheme involving Lifepay, a retirement planning and real-estate investment firm controlled by Defendant Stanley. During the period he promised at least 30 investors who put in about $2.4 million returns of up to 36% per year and that the investment was safe. In fact it was a Ponzi scheme. The second scheme centered on SMDRE, an oil and gas company they controlled. Messrs. Stanley and Watts targeted elderly investors in selling securities in the entity. About $1.4 million was raised from investors who were not told about the large commissions or that the firm was mired in debt. The complaint alleges violations of Securities Act sections 5(a), 5(c) and each subsection of section 17(a) and Exchange Act sections 10(b) and 15(a). The case is pending.
SEC v. Longfin Corp., Civil Action No. 18 CV 2977 (S.D.N.Y. Filed April 4, 2018). Defendant Longfin was incorporated on February 1, 2017. It had virtually no net assets. Defendant Venkata Meenavalli, the firm’s founder who served as Chairman and CEO controlled over 20% of the Class A shares and over 50% of the voting equity; together with his wife he also owned about 17% of the voting stock of Stampede Capital Ltd, a public company in India, that owned about 27.6% of the voting stock of Longfin; Defendant Amro Izzelden Altahwi is the president of ipoflow.com, a website that claims to be a leading equity Reg A+ offerings platform; Defendant Suresh Tammineedi is affiliated with Longfin’s Chairman through several entities, including as a director of Stampede Capital Ltd.; and Defendant Dorababu Penumarthi is a UK resident affiliated with Longfin’s Chairman through Smartahead Solutions Ltd. The SEC furnished three notices of qualification under Regulation A, an exemption from Securities Act Section 5 registration under certain circumstances, to Longfin. Initially the firm had essentially no net assets. It then acquired Stampede Tradex, a subsidiary of Stampede, for $16 million. On November 22, 2017 the company registered its shares for trading with the Commission. Longfin’s Class A shares began trading on December 13, 2017, opening at $6.94 per share and closing at $5.17 per share. Two days later, on December 15, 2017, the company filed a Form 8-K which attached a press release stating that it had acquired Ziddu.com from Meridian Enterprises Pte. Led., an entity controlled by Longfin’s Chairman, Defendant Meenavalli, Ziddu.com was a “blockchain-empowered solutions provider” that “offers a variety of sources, including microfinance lending against collateralized warehouse receipts in the shape of Ziddu coins,” according to Longfin. Prior to the acquisition the Ziddu.com website “had no ascertainable value,” according to the complaint. The company assigned $0 value to this acquisition as of the deal date. Longfin’s share price spiked following the filing of the Form 8-K. By December 18, 2017 the stock price reached a high during trading of $148.82 per share, up over 548% from the prior day’s close and about 2,662% over the closing price from the first day of trading. Subsequently, Defendants Altahawi, Tammineedi and Penumarthi, in separate transactions, sold shares of the firm they each acquired either from the company and/or other individuals in private transactions. No current information about the company was available since it failed to file its periodic reports. No exemption from registrations was available. The three men obtained about $27 million. The complaint alleges violations of section 5 of the Securities Act. The Commission obtained a court order freezing the trading proceeds. The case is pending. See Lit. Rel. No. 24106 (April 9, 2018).
Conflicts/best execution: In the Matter of Securities America Advisors, Inc., Adm. Proc. File No. 3-18424 (April 6, 2018) is a proceeding which names as a Respondent the registered investment adviser, a subsidiary of Securities America Financial Corporation. The Advisor has about $15.6 billion under management, most of which is in discretionary client accounts. Most of the firm’s representatives are also registered representatives at its affiliated broker-dealer, Securities America, Inc. Over an almost four year period, beginning February 1, 2012, the firm invested advisory clients in mutual fund shares that charged 12b-1 fees rather than less expensive shares. The firm’s disclosures failed to specify these facts or discuss the conflict. Portions of those fees went to the registered representatives servicing the advisory accounts. The firm also failed to adopt and implement written policies and procedures in connection with its mutual fund share class selection practices. The Order alleges violations of Advisers Act sections 206(2), 206(4) and 207. Respondent resolved the proceedings, consenting to the entry of a cease and desist order based on the sections cited in the Order and to a censure. The firm also agreed to pay disgorgement of $4,473,025.50, prejudgment interest of $580,423.14 and a penalty of $775,000.
This is one of three similar cases filed on April 6, 2018. The Commission previously launched its Share Class Selection Initiative under which firms were urged if in this situation to self-report in return for certain benefits which include no penalty. See also In the Matter of PNC Investments LLC, Adm. Proc. File No. 3-18426 (April 6, 2018)(based on similar facts regarding 12b-1 fees; advisor also received marketing support payments from three fund complexes that were not disclosed and improperly charged advisory fees to accounts without an investment adviser representative; resolved with consent to a cease and desist order based on sections 206(2), 206(4) and 207, a censure and the payment of disgorgement of $5,234,856 and prejudgment interest of $612,344 tied to the 12b-1 fees and disgorgement of $497,144 and prejudgment interest of $63,426 tied to the other fund payments and a penalty of $900,000); In the Matter of Geneos Wealth Management, Inc., Adm. Proc. File No. 3-18425 (April 6, 2018)(based on non-disclosure of 12b-1 fees similar to above plus additional payments from two third party clearing brokers; resolved with consent to a cease and desist order based on sections 206(2), 206(4) and 207, a censure and the payment of disgorgement of $1,047,617.50 and prejudgment interest of $87,511.57 tied to the 12b-1 fees, and disgorgement of $386,185.77 and prejudgment interest of $36,807.29 tied to the other payments and a penalty of $250,000).
Investment fraud: U.S. v. Kang, No. 18-cr-184 (E.D.N.Y. April 12, 2018) charges Tae Hung Kang and John Won with wire fraud, securities fraud and conspiracy to commit money laundering. The indictment alleges that the two men targeted Korean nationals in implementing their fraudulent schemes, advertising in Korean language news papers for investors. The Defendants operated two schemes. In the first they solicited investors to engage in foreign currency trading, promising large profits. In the second, they solicited investors to purchase shares of Safety Capital Management, Inc. that would invest their funds in foreign exchange trading and other investments. In fact the Defendants lost much of the money trading and misappropriated other portions of the investor funds. The case is pending.
Investment fund fraud: U.S. v. Newsholme, No. 3:17-mj-05015 (D. N.J.). Scott Newsholme owned and operated at least three different financial advisory and tax return preparation businesses in the area where he lived, Farmingdale New Jersey. Over a ten year period, beginning in 2007 and continuing until last year, he furnished investment advice to clients. The adviser would have the client write a check for the amount they sought to invest to him or one of his firms. Mr. Newsholme then cashed the check and diverted the investor money to his personal use. When clients sought to withdraw their funds he used money diverted from other clients to facilitate the withdrawal. Clients were also furnished with fraudulent account statements. Overall Mr. Newsholme misappropriated over $3.1 million. This week Mr. Newsholme pleaded guilty to charges of wire fraud, preparing false tax returns and aggravated identity theft. Sentencing is scheduled for July 19, 2018. See also SEC v. Newsholme, Civil Action No. 3:17-cv-06813 (D.N.J.).
Manipulation: The Australian Securities and Investment Commission announced that Stefan Boitcheff, following a guilty plea on two counts of manipulation, was sentenced to serve one year and nine months imprisonment with an order that he be released immediately upon entering into a recognizance to be of good behavior for two years. Between January 3, 2013 and July 16, 2013 he carried out 112 transactions in CFDs related to Anteo Diagnostics Limited that had the effect of creating an artificial price. Subsequently, between May 2013 and January 7, 2014 he carried out four transactions in CFDs relating to the same stock that had the effect of creating a false or misleading appearance of active trading. The CFD accounted used had direct market access. The CFD issuer in such instances hedges its exposure to the client transaction. Its immediate impact in the market can be seen by the CFD client who can view the contract being translated into buy and sell positions.
Disclosure: The Securities and Futures Commission or SFC initiated proceedings against Fujikon Industrial Holdings Limited and its Chairman and CEO, Yeung Chi Hung, and CFO, company secretary and executive director, Chow Lai Fung, centered on a failure to disclose. Specifically, in 2014 a subsidiary of the firm was notified that a customer that purchased head- phones would discontinue the purchases. The headphones were the only item purchased by the firm and represented about 10% and 14% respectively of the fiscal 2013 and 2014 firm revenue. Failing to disclose this information for about seven weeks constituted a violation of the corporate code. The two executives were charged with recklessly or negligently causing the violation and for failing to take all reasonable measures to ensure that proper safeguards existed to prevent the allege breach of the regime.