This Week In Securities Litigation (Week ending April 15, 2016)
Budget hearings were a focus this week as the Chair of the SEC and Chairman of the CFTC visited Capitol Hill. Both sought substantial increases, requesting more money for technology, inspections and enforcement. While the administration supports increases whether election year politics will permit that remains to be seen.
The Manhattan U.S. Attorney’s Office, in an action paralleled by the SEC, filed its first criminal action involving a muni issuer and officials alleged to have been involved fraudulent offerings. The case centers the on efforts of a town to finance an unpopular minor league baseball stadium. At the time, according to the court papers, the town had no money – but that was not the story told in the offering documents.
The Commission settled another FCPA action this week, this time with the Vegas Sands, owner of gaming properties in Las Vegas and abroad. In this action the house clearly did not win. Poor compliance and controls lead to huge losses for the casino operator. The SEC also brought another offering fraud case centered on the EB-5 immigration program, an insider trading case and an action against an investment adviser for making false statements to clients to retain their business.
Testimony: Chair Mary Jo White testified before the Senate subcommittee on Financial Services and General Government (April 12, 2016). In her testimony Chair White sought increases in the budget for examination coverage of investment advisers, technology and for the enforcement program (here).
Testimony: Chairman Timothy Massad testified before the Senate Subcommittee on Financial Services and General Government (April 12, 2016). His testimony focused on the budget, requesting significant increases for technology, surveillance, enforcement and inspections (here).
Remarks: Commissioner J. Christopher Giancario delivered remarks titled “If Allowed to Thrive, Blockchain May Finally Give Regulators Transparency” at the Cato Institute, Cryptocurrency: The Policy Challenges of a Decentralized Revolution ( April 12, 2016). His remarks focused on the potential impact of blockchain or BLT technology (here).
Remarks: Jennifer Shasky Calvery, Director, Financial Crimes Enforcement Network, delivered remarks at the ACAMS AML and Financial Crimes Conference, Hollywood, Fla. (April 12, 2016). Her remarks focused on money laundering through real estate (here).
Securities Class Actions
A new report on securities class actions records an increase in the number of filings in 2015. Most of those actions were brought against smaller issuers, according to the report. PWC, Small Companies, Big Targets – 2015 Securities Litigation Study (April 2016)(here).
Over the last decade the number of securities class actions filed each year has generally increased. Last year 195 actions were filed compared to 110 in 2006. In contrast, there were 169 filings in 2014, 160 in 2014 and 149 in 2012. The highest number of cases brought in the last ten years was 209 in 2008 followed by 187 in 2011. The number of filings over the last three years has been an inverse reflection of the S&P 500 – as the index dropped the number of cases filed increased, according to the findings of PWC.
Perhaps of more interest are the targets of the suits – “no company is too small” as the report states. In 2015 the largest number of cases were brought against small cap issuers, that is, those with a market cap of $300 million to $2 billion. The next largest group of suits targeted micro cap issuers – those with a market cap of under $300 million. Indeed, the largest group of issuers targeted in securities class actions in 2012, 2013 and 2014 were also those in the small cap and microcap range.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 5 civil injunctive actions and 5 administrative proceedings, excluding 12j and tag-along proceedings.
Custody rule: In the Matter of Reid S. Johnson, Adm. Proc. File No. 3-016730 (April 14, 2016). Mr. Johnson is the founder, owner, president and managing director of The Planning Group of Scottsdale, LLC, a former registered investment adviser, and a series of funds and pooled investment vehicles. From 2010 through early 2013 The Planning Group, viewed as integrated with the related funds and investment vehicles, had custody of customer securities. The firm failed to comply with the custody rule since the securities were not held by a qualified custodian and there were no surprise examinations. There were also incorrect statements in the Form ADV. Mr. Johnson aided and abetted the violations. The Order alleges violations of Advisers Act Sections 206(4) and 207. Respondent resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. He is also barred from the securities business and from participating in any penny stock offering with a right to apply for re-entry after one year. In addition, Mr. Johnson will pay a penalty of $45,000. He also agreed to take compliance training.
Offering fraud: SEC v. Quiros, Civil Action No. 16-21301 (S.D.Fla. Filed April 12, 2016) is an action which names as defendants Ariel Quiros, the sole owner and officer and director of Q Resorts, Inc. and the chairman of Jay Peak, Inc., a firm which encompasses the first six projects at issue here and which is also a defendant; William Stenger, a director, president and CEO of Jay Peak; Q Resorts and a series of related entities. The complaint centers on the misuse and misappropriation of funds raised from the EB-5 immigration program that were to be used for specific projects. About $350 million was raised through the program which offers foreign nationals who invest a minimum of $500,000 used to create or retain jobs the opportunity to obtain a permanent green card. The defendants, according to the complaint, looted over $50 million of the investor funds raised and diverted them to other purposes. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). The case is pending. See Lit. Rel. No. 23520 (April 14, 2016).
Municipal bonds: SEC v. Town of Ramapo, (S.D.N.Y. Filed April 14, 2016) is an action which names as defendants the town, Ramapo; Local Development Corp., a not-for-profit corporation established for town development projects; Christopher St. Lawrence, Supervisor and Director of Finance of the Town of Ramapo and President of the Development Corp.; Nachman Troodler, Executive Director of the Development Corp. and Assistant Town Attorney; Michael Klein, Town Attorney; and Nathan Oberman, Deputy Finance Director. Beginning in 2010 the town and Development Corp. sought to construct a minor league baseball stadium. The project was very unpopular. Between 2010 and 2015 the Town raised over $300 million through various offerings. About $85 million of that amount was “fresh money.” To facilitate the offerings, beginning in fiscal 2009 and continuing through fiscal 2015, the defendants engaged in a scheme to artificially inflate the balance of the town General Fund by recognizing fraudulent receivables, omitting liabilities and improperly recording certain transfers. Over the period the defendants reported that the fund had positive balances in a range as high as $4 million down to just under $2 million. In fact over the period the balances were negative, ranging down to as much as negative $14 million. The complaint alleges violations of each subsection of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act. The case is pending. A parallel criminal action was brought by the Manhattan U.S. Attorney’s Office which is the first criminal action tied to a muni offering.
Insider trading: SEC v. Afriyie, Civil Action No. 23519 (S.D.N.Y. Filed April 14, 2016) is an action which names as a defendant John Afriyie, an analysis at a NYC Investment Firm. The action centers on the acquisition of The ADT Corporation by affiliates of Apollo Global Management, LLC, announced before the market opened on February 16, 2016. Prior to that time Apollo approached the Investment Firm regarding the proposed take-over. Mr. Afriyie learned about the transaction by accessing files of his employer and purchased out-of-the-money call options through his mother’s brokerage account. Following the announcement of the deal he liquidated those positions, reaping $1.56 million in profits. The complaint alleges violations of Exchange Act Section 10(b). A parallel criminal action was filed by the Manhattan U.S. Attorney’s Office. See Lit. Rel. No. 23519 (April 14, 2016).
False statements: In the Matter of Arthur F. Jacob, CPA, Adm. Proc. File No. 3-16883 (April 14, 2016) is a proceeding which names as Respondents Mr. Jacob and Innovative Business Solutions, LLC, a firm Mr. Jacob and his wife own. The Order alleges that beginning in mid-2009 Mr. Jacob, at times through IBS, made false statements to clients to retain the $18 million under management held by the firm. Those included: failing to disclose that he was disbarred and suspended from practicing before the IRS; about the profitability of their investments; regarding the requirement of certain states that he register as an investment adviser; and about the services provided. This permitted him to collect about $320,000 in advisory fees. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). To resolve the action each defendant consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm was censured. Mr. Jacob was barred from the securities business. The Respondents will pay $320,000 in disgorgement and prejudgment interest. In addition, Mr. Jacob will pay a penalty of $160,000.
Boiler room: SEC v. Sky Capital LLC, Civil Action No. 09-cv-6129 (S.D.N.Y.) is a previously filed action which named as defendants Stephen Shea, the former COO of Sky Capital LLC, and Adam Ruckdeschel, Michael Passaro and Robert Grabowski, each of whom was a registered representative at the firm. The complaint alleges that the defendants used boiler room tactics to raise over $61 million from investors in two related entities, Sky Capital Holdings Ltd. and Sky Capital Enterprises, Inc. After selling the shares they prevented purchasers from selling, causing the price to increase until the stock was suspended. The investors then lost their investment. Each defendant settled with the SEC and the Court entered judgments enjoining them from future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The SEC dismissed the action as to Sky Capital since it is defunct. The case as to defendant Ross Mandell continues. Each of the settling defendants was sentenced in the parallel criminal action. Messrs. Shea and Harrington were sentenced to serve, respectively 30 months and 60 months, in prison. Messrs. Passaro and Grabowski were each sentenced to periods of supervised release in view of their cooperation. See Lit. Rel. No. 23518 (April 13, 2016).
Internal controls: In the Matter of INTL FCStone Inc., Adm. Proc. File No. 3-17207 (April 12, 2016) names as a Respondent the firm, which provides execution and advisory services in commodities, currencies and international securities. Its shares are traded on the Nasdaq Global Market. Between fiscal year 2010 and June 30, 2013 the firm overstated its operating revenue by about $10 million and its net income by $6 million. This resulted from accounting errors in recording and reporting OTC derivative trading gains at a subsidiary. The firm’s internal accounting controls failed to timely prevent or detect the errors. In January 2014 the firm restated its financial statements and reported a material weakness in internal controls over financial reporting as of September 30, 2013. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Respondent resolved the proceeding, with the SEC considering its remedial acts, by consenting to the entry of a cease and desist order based on the Sections cited in the Order. The firm will also pay a penalty of $150,000.
Books and records/supervision: In the Matter of Craig Scott Capital, LLC, Adm. Proc. File No. 3-17206 (April 12, 2016) names as Respondents the registered broker dealer, Craig Taddonio and Brent Porges, both co-founders and owners of the firm. Beginning in January 2012, and continuing for about one and a half years, the firm used email addresses other than those which are the official domain of the firm. During that period sensitive customer information was communicated by fax and email to the firm using alternative addresses. At the same time firm personnel, including the two individuals named as Respondents, communicated with customers using their personal email addresses for firm business. The firm did not maintain and preserve either the faxes or emails. While Craig Scott Capital had policies and procedures, they did not designate the responsible supervisor, address how customer records and information transmitted through the electronic fax system was to be handled, contained blanks as to how to comply with the Safeguards Rule (concerning the confidentiality of customer records and information) and were not tailored to the business of the firm. The Order alleges violations of Rule 30(a) of Regulation S-P, Exchange Act Section 17(a) and Rule 17a-4(b)(4). To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections and Rules cited in the Order (except the orders as to the two individuals excluded Rule 30(a) of Regulation S-P) and to a censure. The firm will pay a penalty of $100,000. Each individual Respondent will pay a penalty of $25,000.
Undisclosed commissions: SEC v. Bassily, Civil Action No. 16-cv-2733 (S.D.N.Y. Filed April 12, 2016). Defendant Khaled Bassily was the head of the Global Transition Management or GTM business group of ConvergEx Executions Solutions LLC or CES. He was also a director of CES which is a registered broker-dealer and investment adviser. From 2006 to 2011 he served as a registered representative at CES. ConvergEx Global Markets Limited, or CGM, is a Bermuda based wholly-owned subsidiary of CES. From 2006 through 2011 Mr. Bassily was in charge of GTM, an unincorporated division of CES that offered global transition management services. Orders at the firm were entered into an order management system which permitted them to be routed offshore to the firm’s affiliate, CGM. Mr. Bassily, and others at GTM, unnecessarily routed the orders to CGM in Bermuda in order to add a hidden commission, typically called TP, on to the trades. Mr. Bassily, along with others, took steps to conceal the TP scheme. The TP charges were very profitable for the firm and often far in excess of the actual commissions. The TP was also important to the profitability of GTM as a business unit and in setting employee compensation. The Order allege violations of Exchange Act Sections 10(b) and 15(c)(1) and Securities Act Sections 17(a)(1) and (3). The case is pending. See Lit. Rel. No. 23516 (April 12, 2016).
Offering fraud: SEC v. Mapp, Civil Action No. 4:16-cv-00246 (E.D. Tx. Filed April 11, 2016). Defendant Servergy, Inc. is a computer hardware firm with one product, the CTS-1000. William Mapp, III, a co-founder of the firm, and a defendant, served as CEO and President. Defendant Warren Paxton, at one time the Texas Attorney General and also a state senator, was paid 1,000 shares of firm stock to solicit investors. He is also an investment adviser who was indicted on state securities fraud charges. Defendant Caleb White was a purported independent director who owns an insurance sales firm. He was paid commissions to solicit investors from the company. Servergy funded its operations from late 2009 through early fall 2013 by raising $26 million from the sale of its unregistered shares. Mr. Mapp was the primary fund raiser for the company. He identified prospective investors through referrals and offered a 10% commission for the introduction of new investors to the company. Once a potential investor was identified, Mr. Mapp followed-up with presentations. In those presentations he claimed that the CTS-1000 was more energy efficient than a Dell server while asserting that the products were comparable. The claims were false. In 2013 broker-dealer WFG Investments raised an additional $20 million for the company, offering 10 million shares at $2. Mr. Mapp assisted with creating a PPM and materials for investor presentations. Those materials contained material omissions and misrepresentations. Over a two year period beginning in early 2012 Mr. White raised about $1.4 million from over 150 individuals. He was paid $66,000 in commissions. In his solicitations he made misrepresentations. He also failed to disclose that he was being paid commissions. Finally, in July 2011 Mr. Paxton raised about $840,000 for Servergy. He promoted the company and recruited investors in exchange for an undisclosed payment of 100,000 shares of common stock. He failed to disclose that fact to the investors he solicited. The complaint alleges violations of Securities Act Sections 5(a), 5(c), 17(a) and 17(b) and Exchange Act Sections 10(b) and 15(a). Servergy and Mr. White settled with the Commission. The firm was permanently enjoined from future violations of Securities Act Section 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). It will also pay a penalty of $200,000. Mr. White was permanently enjoined from future violations of the Sections cited in the complaint. In addition, he was directed to pay $66,000 in disgorgement to the SEC and 20,000 shares of stock to the company. See Lit. Rel. No. 23515 (April 11, 2016).
In the Matter of Las Vegas Sands Corp., Adm. Proc. File No. 3-17204 (April 7, 2016). Respondent Las Vegas Sands owns and operates resorts and casinos in the U.S. and Asia through a number of subsidiaries. Over a period of five years beginning in 2006 Las Vegas Sands transferred in excess of $62 million to its China and Macao based operations in addition to other payments made for entertainment and similar items. Generally, the transfers were made without proper authorizations and/or documentation. Overall there were significant losses. In 2006 the Vegas Sands President of Asian Development established a relationship with a Consultant who claimed to be a former Chinese government official that could assist with operations in the PRC. The Consultant established a number of business entities in that country which were used interchangeably. The next year the Vegas Sands President sought to acquire a professional basketball team in China. The Consultant established an entity to acquire a team which played in the Chinese Basketball Association or CBA, an organization under the PRC State General Administration of Sports. The organization would not permit a gaming entity to own a team. Over $6 million was transferred to the newly created entity. When the Vegas Sands Senior Director of Finance questioned the transaction and attempted to investigate he was in effect blocked by the Consultant. Later an international accounting firm attempted to investigate the transaction. Before its inquiry was halted, the firm determined that over $700,000 was unaccounted from the funds that had been transferred to the Consultant. Nevertheless, over $5 million in additional payments were transferred to the Consultant, supposedly for the team. The funds were booked as a consultancy fee.
The Vegas Sands president also sought to develop a non-gaming resort in a new resort district in China. Arrangements were made to participate in a joint venture with an SOE whose Chairman was believed to be influential. The Chairman of the joint venture was introduced by the Consultant. Virtually no due diligence was done on the proposed property acquisition. Nevertheless, between July 2007 and February 2009 about $43 million was transferred to one of the Consultant’s entities to acquire the real estate. The payments were not approved by a Vegas Sands employee with sufficient authority. In July 2008 the Consultant transferred control of the entity which owned the real estate to the Vegas Sands under a series of contracts. Later those agreements were effectively rescinded in exchange for a promissory note valued at about $43 million. The project was then shuttered. In total the company had transferred about $61 million in connection with the deal and received about $43 million in settlement.
The Macao operations suffered from similar control deficiencies. In 2007, for example, Vegas Sands set up a high-speed ferry business to transport customers from China and Hong Kong to Macao. An arrangement was made with a recently formed Ferry Company that was partially owned by an older state owned firm. The arrangement included business entertainment. In 2010 the internal audit department concluded that most of the budget went to government officials. That included “red envelops” – envelops of cash distributed at Chinese New Year. While there were policies and procedures in place regarding the retention and use of professional services they were ignored. In 2009, for example, an outside attorney submitted a bill for Expenses in Beijing in the amount of $25,000. No documentation was furnished. The bill was paid. Later the attorney stated the funds were for an unpaid consultant to the Vegas Sands. The comp policies of the Vegas Sands were also either ignored or ineffective. The Order alleged violations of Exchange Act Section 13(b)(2)(A) and 13(b)(2)(B).
The firm resolved the case. It consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay a penalty of $9 million. In addition, it agreed to implement a series of undertakings which include the retention of an independent consultant for a period of two years. The consultant will review and evaluate the internal controls and financial reporting policies of the firm. The consultant will also issue a written report within six months that will be furnished to the staff. The company will adopt the consultant’s recommendations.