This Week In Securities Litigation (Week ending April 5, 2019)
Round 3 of the SEC and Elon Musk played out in a Manhattan federal court room on Thursday afternoon. This round went to a wise federal Judge who told the parties to go settle the case or she would rule and they would not like the result. The fact is there can be no winners here. If the SEC loses, its credibility is severely damaged, something that could hurt the markets and its ability to regulate. If Mr. Musk loses it hurts the company and its shareholders because he is Tesla. The Judge clearly understood this. The debate over whether the SEC should have filed the action or if Mr. Musk should have kept his word is not relevant now. The question is how to get out without harming the markets and the shareholders. The Judge seems to have found a way, if the everyone can now play nice.
The Commission seemed to have moved away from investment adviser actions this week, returning more to its traditional roots. The agency brought actions this week centered on the FCPA and financial fraud. The FCPA case took place over a series of years in a number of countries. The financial fraud actions centered on the founder of a start-up cooking the books before he sold his stock to unsuspecting investors and three CPAs at a trucking firm pumping up failing financial numbers in the wake of a series of acquisitions.
SEC Enforcement – Filed and Settled Actions
The Commission filed 5 civil injunctive actions and 3 administrative proceedings this week, exclusive of 12j and tag-along actions.
Offering fraud: SEC v. Wall, Civil Action No 2:19-cv-00139 (D. ME Filed April 4, 2019) names as defendants Jeffrey Wall and his firm The Lighthouse Events, LLC. Over a four year period beginning in 2014 Mr. Wall and his firm raised over $3 million from about 145 investors using a promissory note program. The notes were supposed to be secured and guaranteed. The funds were to be used for Christian music. Investors did not know about the deteriorating financial condition of the firm. They also were not told that portions of the money was used to make Ponzi type payments. In addition, investors were not told that portions of their money was misappropriated. 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. See Lit. Rel. No. 24443 (April 4, 2019).
False statements: SEC v. AVEO Pharmaceuticals, Inc., Civil Action No. 1:16-cv-10607 (D. Mass.) is a previously filed action brought against the former CFO of the company, David Johnson. The complaint alleged that Mr. Johnson and others made false statements to investors about the prospect for FDA approval of AVEO’s flag ship drug. Mr. Johnson also traded in the stock of the firm. A jury found him liable for fraud. The Court has now entered a final judgment enjoining him from future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The court also imposed a two year officer/director bar plus directed that disgorgement from the stock sales of $5,677 be paid along with a penalty of $120,000. See Lit. Rel. No. 24442 (April 4, 2019).
Insider trading: SEC v. Kita, Civil Action No. 17-06603 (D.N.J.) is a previously filed action which named as defendants Evan Kita, Daniel Prez, Richard Yu and Chiang Yu. The complaint alleged that Mr. Kita, a CPA and former accountant at Celator Pharmaceuticals Inc., provided inside information about the company to Messrs. Perez and Richard Yu. Chaing Yu received the information from his son Richard. Each traded. In parallel criminal actions each pleaded guilty and was sentenced to serve six months in prison. The Court in this action entered permanent injunctions against each defendant based on Exchange Act Sections 10(b) and 14(e). The Court also directed the men to pay a total of $442,006 in disgorgement and prejudgment interest. That amount is deemed satisfied by the forfeiture in the criminal case. Mr. Kita was also permanently suspended from appearing and practicing before the Commission. See Lit. Rel. No 24441 (April 4, 2019).
Financial fraud: SEC v. Armbruster, Civil Action No. 19-cv-481 (E.D. Wis. Filed April 3, 2019) is an action which names as defendants Peter Armbruster, Bret Naggs and Mark Wogsland, respectively, the CFO, controller of logistics and controller of the truckload segment for Roadrunner Transportation Systems Inc. The firm’s shares are listed on the NYSE. Following a spat of acquisitions after a 2010 IPO, the firm’s financial condition deteriorated. To ensure that it made guidance, the three CPA defendants engaged in a series of fraudulent accounting acts which included: improperly deferring expenses by spreading them over multiple quarters; failing to write down assets; and creating an income “cushion” that could aid in smoothing out results. These techniques resulted in materially overstating the financial condition of the firm. Prior to the discovery of the wrongful acts Defendants Armbruster and Wogsland exercised company stock options, yielding profits of over $500,000. The company was required to restate its financial statements. At the time of the announcement the share price dropped 31%. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13b-5 and 20(a). The Fraud Section of the Department of Justice filed a parallel criminal action. The cases are pending.
Financial fraud: SEC v. Mattes, Civil Action No. 5:19-cv-01689 (N.D. Cal. Filed April 2, 2019). Defendant Daniel Mattes is the founder of Junio, Inc., a private mobile payments company in Palo Alto, California. Mr. Mattes, a citizen and resident of Wels, Austria, is the founder and former CEO of Jumio. The firm had two main revenue streams, the Process Business and the Payment Processor. The former was based on licensing Jimio’s ID and credit card verification technology. The latter generated revenue by introducing third-party merchants to a payment Processor. The firm would be paid a commission. In 2013 and 2014 Mr. Mattes, who prepared the financial statements for the company, inflated the numbers for each revenue stream. As a result, the company reported gross revenue of $101 million for 2013 when in fact it was $9.5 million. In 2014 the result was the same – the company reported gross revenue of $150 million when in fact it was $7.7 million. From April 2014 through February 2015 Mr. Mattes used a stock sale program he had created for employees to sell his personal shares, despite a prohibition on the sale of his shares imposed by the Board of Directors absent specific consent, to sell his shares. Not only was the board deceived, but one purchaser was told by Mr. Mattes that he would never sell his personal shares because of what was coming up for the company. Overall, he sold $14,617,922 worth of stock. Following discovery of the wrongful conduct the firm restated its financial statements and eventually tumbled into bankruptcy, leaving those who purchased the shares with nothing. The complaint alleges violations of Exchange Act Section 10(b) and each subsection of Securities Act Section 17(a). To resolve the matter Mr. Mattes consented to the entry of a permanent injunction based on the sections cited in the complaint. In addition, he agreed to pay over $16 million in disgorgement and prejudgment interest along with a $640,000 penalty. The settlement is subject to court approval. See also In the Matter of Chad Starkey, Adm. Proc. File No. 3-19129 (April 2, 2019)(action against former CFO and general counsel of Jumio for negligence in connection with the conduct of Mr. Mattes detailed above; resolved with consent to a cease and desist order based on Securities Act Sections 17(a)(2) and (3) and the payment of disgorgement in the amount of $364,000 and prejudgment interest of $56,894.97; Mr. Starkey cooperated with the staff investigation and undertook remedial acts).
Offering fraud: SEC v. DePalo, Civil Action No. 15-cv-3877 (S.D.N.Y.) is a previously filed action which named as a defendant Robert DePalo, a registered representative. The complaint alleged an offering fraud through which he misappropriated about $2.3 million of investor funds. Mr. DePalo, who was convicted in New York state court on similar charges and sentenced to serve 7.5 years in prison, settled with the Commission, consenting to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). He also agreed to pay $6.5 million in disgorgement which is deemed satisfied by the payments ordered in the state criminal case. The Court entered the final judgment. See Lit. Rel. No. 24437 (April 2, 2019).
Financial fraud: SEC v. Borge, Civil Action No. 19-cv-02787 (S.D.N.Y.) is a previously filed action which names as a defendant Keith Borge, the controller of the College of New Rochelle. As enrolment and revenue declined at the institution Mr. Borge falsified the books to conceal the trend. The 2015 financial statements thus overstated net assets by almost $34 million. The College came close to floundering. The complaint alleged violations of Exchange Act Section 10(b). A parallel criminal action was filed by the Manhattan U.S. Attorney’s Office. The Commission reached a partial settlement with Mr. Borge under which he will be enjoined based on the section cited in the Order. Monetary issues will be considered at a later date. See Lit. Rel. No. 24436 (April 2, 2019).
Offering fraud: SEC v. Mizrahi, Civil Action No. 1902284 (C.D. Cal. Unsealed April 1, 2019). The action centers on an offering fraud targeting the Israeli-American community. Defendant Motty Mizrahi and his firm, MBIG Company, targeted members of that community, raising at least $3 million from 15 clients and perhaps more from as many as 50 persons. The sales pitch was straight forward and simple: You cannot lose. Defendant Mizrahi was supposedly a 20 year trading veteran who had been highly successful. Over the years his proprietary options/hedged trading strategy always made money. He supposedly was a skilled investment adviser, a licensed broker and a certified public accountant. The trading program offered investors guaranteed returns, cash reserves backing their account, fees based on sharing profits, immediate withdrawals and account statements verifying their investment and returns. It was all false. Mr. Mizrahi and his firm never invested the money for investors but for themselves, most of which was either lost or stolen. The complaint alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and (2). The case is pending. The U.S. Attorney’s office for the Central District of California filed a parallel criminal action. See Lit. Rel. No. 24435 (April 1, 2019).
In the Matter of Omar Zaki, Adm. Proc. File No. 3-19128 (April 1, 2019) is a proceeding which centered on the actions of an unregistered investment adviser. Specifically, Mr. Zaki repeatedly misled investors in his fund about the assets under management and its performance. He also concealed from one investor the performance of his investments while trying to persuade him to fund another venture. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b), and Advisers Act Sections 206(1), 206(2) and 206(4). To resolve the proceedings Respondent consented 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 will pay a $25,000 penalty.
Misrepresentations: In the Matter of Mutual Coin Fund LLC, Adm. Proc. File No. 3-19127 (April 1, 2019) is a proceeding which names as Respondents the Fund and its owner, Usman Majeed. During 2017 and 2018 Respondents raised about $567,000 from investors through an offering based on a Form D Notice of Exempt Offering. While they used an offering memorandum, they failed to accurately inform investors regarding the amounts of capital raised. The Order alleges violations of Securities Act Sections 5(a), 5(c) and 17(a)(2). To resolve the proceedings Respondents consented to the entry of a cease and desist order based on the sections cited in the order, to implement certain undertakings including notifying investors and relinquishing certain fees and to certify compliance. A penalty was not imposed based on a statement of financial condition.
U.S. v. Halbert, No. 1:19-cr-00031 (D. Hawaii Plea April 3, 2019) is an action in which Mater Halbert pleaded guilty to a one count information charging him with conspiracy to commit money laundering. Mr. Halbert was a government official who administered the aviation programs and management of airports for the government of Micronesia. Mr. Halbert admitted at the time of his plea that between 2006 and 2016 a Hawaii based engineering firm owned by Frank Lyon paid bribes to him and other officials to obtain and retain contracts valued at nearly $8 million in violation of the FCPA. The bribes were transported to the U.S. Mr. Lyon previously pleaded guilty to FCPA charges in a related case.
In the Matter of Fresenius Medical Care AG, Adm. Proc. File No. 3-19126 (March 29, 2019). FMC operated in over 150 countries around the globe, primarily through subsidiaries. The firm’s American Depositary Shares traded on the NYSE and were registered with the Commission. The misconduct involved took place in Saudi Arabia, Morocco, eight countries in the West Africa region, Angola, Turkey, Spain, China, Serbia, Bosnia and Mexico. During the period employees made improper payments through a variety of fraudulent schemes. Those included sham consulting contracts, falsified documents and the use of third-party conduits who served as facilitators for the payment of bribes.
Examples of those schemes and the profits made included: Saudi Arabia: Over a period of five years, beginning in 2007, Saudi Advanced Renal Services, a consolidated distributor, made over $4.9 million in improper payments to publicly-employed doctors, government officials and others in the country to secure business. Overall FMC benefited by over $40 million from the corrupt schemes. Morocco: Over a four-year period, FMC benefitted by over $3 million from improper conduct in the country. Eight West African Countries: FMC obtained over $40 million as a result of the wrongful schemes. Angola: Through a series of fraudulent schemes FMC benefited by over $10 million. Turkey: Between 2005 and 2014 FMC Turkey entered into four separate joint ventures with publicly employed doctors. The company benefited from the arrangements by over $1 million. Spain: Over a seven-year period, beginning in 2007, FMC Spain received advance information about public tender specifications from publicly employed physicians or administrators. FMC benefited by over $20 million from the improper, fraudulent conduct. China: Between 2007 and 2014 FMC China’s clinic business, Nephrocare, planned and implemented incentive programs in which bonus payments were provided to publicly-employed physicians with which the firm had supply agreements. Overall FMC benefitted by over $10 million through the improper conduct. Balkan Region: During the same seven year period cited above with the firm made over $1 million in payments to “speed up” the clinic privatization process for four clinics and benefited by $10 million in Serbia and Bosnia. Mexico: Overall FMC benefited by over $2 million from the improper conduct.
The Order alleges violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(B).
FCM self-reported, cooperated to a certain extent with the government investigations, and undertook certain remedial acts. The company also agreed to certain undertakings which include the retention of a monitor. To resolve the proceedings, Respondent FMC consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay disgorgement of $135 million and prejudgment interest of $12 million. To resolve the matter with the DOJ the firm entered into a three-year non-prosecution agreement and agreed to pay a criminal fine of $84.7 million.
Offering fraud: U.S. v. Braziler, No. 17-cr-385 (E.D.N.Y.) is an action in which Yegeniy Braziler was sentenced to serve 36 months in prison based on a fraudulent real estate investment scheme. Specifically, Mr. Braziler sold limited partnership interests to largely elderly clients, some of whom suffered from dementia. While the money was supposed to be invested in real estate, in fact he misappropriated much of it.
Consultancy: The Securities and Futures Commission issued a consultation paper focused on securities margin financing. It set limits on the amount of risk a broker can take in this area along with triggers for margin calls and policies.
Manipulation: The Securities and Exchange Surveillance Commission recommended to the Prime Minister and the Commissioner of the Financial Services Agency that an administrative penalty payment order be issued as to Citigroup Global Markets Limited. The order will be based on findings that the firm engaged in the manipulation of the government bond futures.
Remarks: Mark Steward, Director of Enforcement and Market Oversight of the Financial Conduct, delivered remarks at the Global Investigations Review, London. Those remarks focused on using a deal-making approach to the imposition of penalties and sanctions for partially resolved cases and noted that firms will be held accountable. The director also stated that the FCA is investigating suspected actions of money laundering.
Bid rigging: The Serious Fraud Office announced that Carlo Palombo and Colin Bermingham, respectively, a former Barclays Vice President of Euro Rates and former Managing Director at the bank were sentenced to serve a total of nine years in prison on April 1, 2019. The sentences were based on manipulating EURIBOR or the Euro Interbank Offered Rate at the height of the financial crisis.