This Week In Securities Litigation (Week ending April 7, 2017)
The nomination of Jay Clayton as the next SEC Chairman moved forward in the Senate this week. The Senate Banking Committee approved Mr. Clayton by a vote of 15 to 8 with three Democrats joining the Republicans in the majority. Senior staff members continued to exit the agency with the resignation of Kara Brockmeyer, Chief of the FCPA Unit.
The Commission brought enforcement actions this week which include: One based on repeated fraudulent offerings of municipal bonds where the person backing the conduit bonds repeatedly ignored the obligation to furnish updated financial information; another wrap fee action was brought where investors were not told about additional charges being imposed; and an offering fraud action targeting retirement funds was filed.
Rules: The Commission adopted certain amendments to the JOBS Act (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 2 civil injunctive cases and 5 administrative proceedings, excluding 12j and tag-along proceedings.
Misappropriation: SEC v. Shumway, Civil Action No. 17-cv-00260 (D. Utah April 5, 2017) is an action which names as a defendant Michael D. Shumway, formerly the secretary and treasurer of two water companies, American Fork Irrigation Company and Lehi Irrigation Company. Over a period of twelve years beginning in 2003 Mr. Shumway misappropriated shares of stock in each firm and sold them for at least $435,000. He falsified the firms’ books in connection with the transactions. He also misappropriated over $630,000 from the two firms. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. Previously Mr. Shumway pleaded guilty to one count of wire fraud tied to the same facts. He was sentenced to serve one year and a day in prison and ordered to pay $1,100,481.48 in restitution. See Lit. Rel. No. 23800 (April 5, 2017).
Fraudulent muni offering: In the Matter of Lawson Financial Corporation, Adm. Proc. File No. 3-17901 (April 5, 2017). Respondents in the proceeding are Lawson Financial, a registered broker dealer, and its founder, CEO and CCO, Robert Lawson. Between 2010 and 2014 the broker-dealer conducted 13 conduit offerings – those where a municipal entity serves as the issuer but the funds raised are passed to another who is obligated for the repayments. Those offerings were for the projects of Christopher Brogdon, who had been building nursing homes, assisted living facilities and retirement housing for twenty-five years using similar offerings. In connection with the thirteen underwritings conducted during the four year period here Lawson Financial, through Mr. Lawson, and a person identified as Banker A – John T. Lynch, Jr. (see below) – were charged with conducting the appropriate due diligence on Mr. Brogdon and his offerings. They did not. Despite becoming aware of numerous red flags relating to the failures of the borrowers to comply with their Continuous Disclosure Agreements which required yearly updates of the financials, the series of offerings continued. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Section 15(c). To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm also consented to the entry of a censure and Mr. Lawson was barred from the securities business with a right to apply for re-entry after three years. Respondents will also, on a joint and several basis, pay disgorgement of $178,750 along with prejudgment interest. The broker will pay a civil penalty of $198,326.06. Mr. Lawson will pay a penalty of $80,000. The Commission may establish a fair fund. See also In the Matter of John T. Lynch, Jr., Adm. Proc. File No. 3-17902 (April 5, 2017)(proceeding naming as Respondent Banker A who supposedly served as underwriter’s counsel during the offerings and, while an attorney, was not a member of any bar; resolved with a cease and desist order based on Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 10(b) and 15(c), the payment of disgorgement of $20,000, prejudgment interest of $2,338 and a penalty of $22,338; he is also denied the privilege of appearing or practicing before the Commission as an attorney; further proceedings will be held to determine if a bar from the securities business is appropriate).
Wrap fees – overcharges: In the Matter of Credit Suisse Securities (USA) LLC, Adm. Proc. File No. 3-17899 (April 4, 2017). Credit Suisse is a registered broker-dealer and investment adviser. From the beginning of 2009 through early 2014 the firm offered investment advisory programs to clients through its adviser representatives or Relationship Managers using a wrap fee program. To oversee the wrap fee program Credit Suisse created the Discretionary Managed Portfolio program. The Accounts in the program could be invested in an array of securities. Those included Class A and institutional mutual fund shares which can carry brokerage charges and 12b-1 fees. Institutional shares, in contrast are only available to certain investors and the fees are typically waived or greatly reduced and do not carry 12b-1 fees. Sanford Katz was a Managing Director and Relationship Manager in the Credit Suisse San Francisco office during the period. Mr. Katz and his team purchased Class A shares for the Accounts in the program under circumstances where: the mutual fund prospectus indicated that institutional shares were available for wrap fee accounts; other Credit Suisse relationship managers had purchased institutional shares; and/or he had previously purchased institutional shares for Accounts. Credit Suisse failed to furnish advisory clients with adequate disclosure about the mutual fund shares available, the fees and the conflicts and to obtain best execution for the Accounts. The firm also failed, beginning in 2011, to disclose in Form ADV, Part 2B Item 4 the specifics as to each relationship manager and that certain ones were paid 12b-1 fees, stating only that they did not receive any form of compensation from any person other than the firm. Credit Suisse also failed, in accord with Advisers Act Section 206, to obtain best execution for its Account clients by purchasing Class A shares. Finally, the firm failed to adopt and implement reasonably designed policies and procedures. Specifically, the firm did not have policies and procedures which furnished the Administrative Manager who reviewed the purchases with sufficient information regarding the availability of other, less expense shares. The improper practices were discovered by OCIE. The Order alleges violations of Advisers Act Sections 206(2), 206(4) and 207. To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. It also agreed to pay disgorgement of $2,099,624.12, prejudgment interest and a civil penalty of $3,275,000. A fair fund was created. See also In the Matter of Sanford Michael Katz, Adm. Proc. File No. 3-17900 (April 4, 2017)(settled action against the relationship manager discussed above; resolved with the entry of a cease and desist order based on Advisers Act Section 206(2) and a censure and the payment of disgorgement of $1,124,858.89, prejudgment interest and a penalty of $850,000).
Audit failure: In the Matter of William Joseph Kouser Jr., Adm. Proc. File No. 3-17898 (April 4, 2017) is a proceeding which names as Respondents Mr. Kouser and Ryan James Dougherty, CPA, both from the accounting firm of BBD, LLP. That firm served as the outside auditors for registered investment company GL Beyond Income Fund. From 2013 to late 2014 Daniel Thibeault and his firm misappropriated at least $16 million from the Fund. In conducting the audit of the Fund Respondents failed to exercise professional judgment, to obtain sufficient appropriate evidence and to prepare the proper documentation as required by PCAOB standards. They thus failed to discover the misappropriation. The Order finds that Respondents engaged in improper professional conduct within the meaning of Rule 102(e)(1)(ii). The proceeding was resolved with the entry of an order denying each Respondent the privilege of appearing or practicing before the Commission as an accountant. Respondents Kouser and Dougherty may, respectively, apply for reinstatement after three and two years.
Offering fraud: SEC v. Zamoras, Civil Action No. 17-cv-02528 (N.D. Ill. Filed April 3, 2017) is an action which names Lucita Zamoras as a defendant. She is the founder of First Fidelity, LLC which purports to help clients achieve their long term financial objectives through a series of insurance products. Beginning in the fall of 2009, and continuing for the next four years, Mr. Zamoras raised about $727,049 from at least six investors, encouraging them to use their retirement funds to purchase promissory notes issued by her. She claimed the notes carried interest at 3.5% to 5% annually and were safe. In fact Ms. Zamoras misappropriated most of the client funds. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Section 10(b). The case is in litigation. See Lit. Rel. No. 23798 (April 4, 2017).
Municipal bonds: SEC v. Rhode Island Commerce Corporation, Civil Action No. 1:16-cv-107 (D.R.I.) is a previously filed action against, among others, the named defendant doing business as the Rhode Island Economic Development Corporation, a quasi-state owned enterprise that issued bonds. This action centered on a fraudulent bond offering for the 38 Studios project as part of a state government program intended to spur economic development. In the offering investors were not told that the financing was insufficient to fund the enterprise and that it could not be completed without additional funding. The Development Corporation settled the action, consenting to the entry of a permanent injunction based on Securities Act Sections 17(a)(2) and (3). The firm will also pay a penalty of $50,000. The Court entered the judgment. The litigation continues against the underwriter and its lead banker. See Lit. Rel. No. 23796 (April 3, 2017).
Insider trading: SEC v. Spivak, No. 1:15-cv-13704 (D. Mass.) is a previously filed action which named as defendants Brad Spivak and his then romantic partner, Shimila Doddi who was alleged to have furnished him with inside information about a pending takeover. Ms. Doddi learned the information in the course of her duties as an analyst at a bank. She previously settled. Mr. Spivak has now settled, consenting to the entry of a permanent injunction based on Exchange Act Section 10(b). He also agreed to pay disgorgement of $22,357, prejudgment interest and a penalty equal to 150% of his trading profits — $333,535. See Lit. Rel. No. 23797 (April 3, 2017).
Unregistered broker: In the Matter of CYGS, LLC, Adm. Proc. File No. 3-17896 (March 31, 2017). CYGS is a proprietary trading firm established in 2009. The firm trades for its own account through ETC Brokerage Services. CYGS places about $1.9 billion in trades annually. Proprietary trading is a major source of firm income. The trading firm also earned income from its membership program. That program focused primarily on educating members about trading. A $5,000 membership fee carried the following rights: 1) Access to CYGS’s chat room which provided real time commentary on securities; 2) proprietary software; 3) educational materials; 4) video tutorials; 5) training; 6) the opportunity to apply lessons learned by trading with CYGS capital within certain limits through its ETC account; 7) greater leverage when trading since members used the firm’s capital; and 8) profits from the trades but not necessarily the losses since the firm paid them within limits as well as the expenses. Limits were imposed on member trading to minimize loss. The Order charged violations of Exchange Act Section 15(a). To resolve the proceeding, the firm consented to the entry of a cease and desist order based on Exchange Act Section 15(a) and to a censure. CYGS also agreed to pay disgorgement of $35,000, prejudgment interest of $879 and a penalty of $25,000.
Insider trading: Steven Robert Noske was found guilty of insider trading following a two week trial. The charges focused on the acquisition of WestSide Corporation by LNG Limited. Following the deal announcement the share price increased 60%. Mr. Noske purchased 750,000 WestSide shares between February 6 and 10, 2012, prior to the deal announcement. He learned about the deal when he was consulted by LNG. Sentencing is scheduled for April 20, 2017.
Remarks: Mark Steward, Director of Enforcement and Market Oversight at the Financial Conduct Authority, delivered remarks titled “The Expanding Scope of Individual Accountability for Corporate Misconduct” at the Corporate Compliance and Enforcement Program, New York University (March 31, 2017). The Director’s remarks focused on the new senior manager certification program introduced by the FCA in February 2017 (here).