This Week In Securities Litigation (Week ending August 19, 2016)
An investment banker who repeatedly tipped his father on about pending mergers was found guilty of insider trading by a jury this week. The Commission brought another action based on the whistleblower protections where the firm’s severance agreements impinged on the ability of a departing employee to file a claim. The Commission also brought actions alleging false press releases, fraudulent pricing for securities, executing a fraudulent scheme using “death puts,” another for falsifying the records of a broker-dealer and a proceeding based on the failure of a transfer agent and its control person to comply with OCIE deficiency letters and notices.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 2 civil injunctive action and 8 administrative proceeding, excluding 12j and tag-along proceedings.
Inspections: In the Matter of Bay City Transfer Agency, Adm. Proc. File No. 3-17405 (August 18, 2016) is a proceeding which names as Respondents the transfer agent and Nitin Amersey, its control person. Since 2008 OCIE has issued three deficiency letters. The firm has failed to comply with the multiple deficiencies and weaknesses identified and take the steps that the staff believes should be implemented. The Order alleges violations of Exchange Act Sections 17(a)(3) and 17A(d)(1) and the related rules. The matter will be set for hearing.
False books and records: In the Matter of Jason Maiher, Adm. Proc. File No. 3-17126 (August 17 2016) is a proceeding which names as a Respondent the former CFO of KeyBanc Capital Markets, Inc. The Order alleges that for a period of at least one year beginning January 2011 Respondent was responsible for unsubstantiated entries or plugs being made in one or more accounts in the general ledger of broker dealer KeyBanc Capital’s in order to complete the monthly close of the books. The entries overstated the firm’s assets and income in the financial statements in its fiscal year 2010 Annual Audited Report filed with the Commission. In its Annual Audited Report for the year ended December 31, 2011 the firm disclosed this fact, noting that unsubstantiated assets of over $13.6 million had been booked. The Order alleges violations of Exchange Act Sections 17(a) and 17(c). To resolve the action 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 participating in any penny stock offering with a right to apply for reentry after two years. In addition, Mr. Maiher is also denied the privilege of appearing and practicing before the Commission as an accountant with the right to apply for reinstatement after two years. No penalty was imposed based on financial condition.
Whistleblowers: In the Matter of Health Net, Inc., Adm. Proc. File No. 3-17396 (August 16, 2016). Beginning prior to August 12, 2011, and continuing through late October 2015, Health Net entered into voluntary severance agreements with departing employees. Those agreements contained a Waiver and Release of Claims provision. The agreement specified that the departing employee specifically waived the “right to file an application for an award for original information submitted pursuant to Section 21F of the Securities Exchange Act of 1934.” The waiver provision did not preclude the employee from participating in any investigation before a federal agency. A subsequent paragraph in the agreement reiterated this point, but specified that the right to any monetary recovery from the investigation was waived. About 600 employees signed agreements with these provisions. In June 2013, as part of a regular review and update of its agreements, Health Net amended the Waiver and Release of Claims. The sentence referencing Section 21F was deleted. A new provision was added stating that nothing in the agreement precluded an employee from communicating directly with, cooperating with or providing information to any government regulator while another waived any right to a monetary recovery. The provisions undermine the intent of Exchange Act Section 21F by “removing the critically important financial incentives that are intended to encourage persons to communicate directly with the Commission staff about possible securities law violations,” according to the Order. To resolve the proceeding Health Net agreed to an undertaking to notify former employees they were not precluded from participating in the whistleblower program. Health Net consented to the entry of a cease and desist order based on Rule 21F-17. The firm will also pay a penalty of $340,000.
Misleading pricing: In the Matter of Edwin K. Chin, Adm. Proc. File No. 3-17394 (August 16, 2016). Mr. Chin is a former managing director and trader at Goldman Sachs. From 2010 through 2012 as a senior trader he traded mortgage-backed securities to firm clients, including investment advisers, hedge funds and others. In trading RMBS he made misrepresentations regarding the pricing of the securities which are illiquid and difficult to price. That generated additional revenue for the firm and indirectly impacted his compensation. The Order alleges violations of Exchange Act Section 10(b). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Section cited in the Order and to the entry of a bar from the securities business with the right to apply for reentry after two years. He also agreed to pay a penalty of $150,000, disgorgement of $200,000 and prejudgment interest.
Blank check companies: In the Matter of Delaney Equity Group, File No. 3-17398 (August 16, 2016) is a proceeding against the firm, a registered broker dealer, David C. Delaney, its CEO and principal, and Ian C. Kass, a registered representative. The Order alleges that between 2009 and 2013 Respondents created at least 12 blank check companies for sale by reverse merger. The companies were falsely held out as legitimate start-up enterprises when in fact they were noting more that shells. The due diligence required by Rule 15(c)(2)-11 to register with FINRA on Form 211 was not done and other misrepresentations were made in connection with launching the companies. The Order alleges violations of Exchange Act Section 15(c)(2), Securities Act Sections 5(a) and 5(c) and the control person provisions. The matter will be set for hearing.
Misrepresentations: In the Matter of Donald F. Lathen, Jr., Adm. Proc. File No. 3-17387 (August 15, 2016). Respondents in the proceeding are: Mr. Lathen, Eden Arch Capital Management, LLC and Eden Arc Capital Advisers. Mr. Lathen is the sole owner, control person, CEO and CFO of Capital Management, a registered investment adviser between October 31, 2012 and February 23, 2016. Capital Advisors is owned by Mr. Lathen. It receives incentive fees. The firm’s general partner is Eden Arc Capital Partners, LP, a pooled investment vehicle created by Mr. Lathen. In March 2011 Mr. Lathen began obtaining subscriptions for Capital Partners or the Fund. Its investment strategy centered on acquiring medium and long term bonds and certificates of deposit that had “survivor options” or “death puts.” Key to the strategy was acquiring the instruments in joint accounts so that the death put could be exercised promptly. To implement this strategy Mr. Lathen began signing up terminally ill Participants, offering each $10,000 to become a joint owner. While the holdings were obtained for the Fund, the joint interests were titled to the Participant and either Mr. Lathen or a designated person as a nominee for the Fund because a natural person was required to be a holder. When claims were made Mr. Lathen had to make misrepresentations to the issuer to obtain the benefit. From inception the Fund has earned over $9.5 million in profits, largely through early redemption of the bonds and CDs held in the joint accounts as well as management fees paid to the Fund. In addition to the misrepresentations, the instruments were held in joint accounts and were not in the name of the of the Fund or an account that contained only fund assets under its name as agent or trustee for the Fund as required by the Custody Rule. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206(4) and Rule 206(4)-2. The proceeding will be set for hearing.
Unregistered broker: In the Matter of Barry B. Clarke, Adm. Proc. File No. 3-17172 (August 15, 2016) is a proceeding against a vice president of Baltia Airlines, Inc., a development stage company. From early 2011 through March 2015 Mr. Clarke continuously sold shares of the firm to raise operating capital. As such he acted as an unregistered broker in violation of Exchange Act Section 15(a). To resolve the action Mr. Clarke consented to the entry of a cease and desist order based on the Section cited in the Order. He also was suspended from the securities business for a period of twelve months. He will also pay disgorgement of $988,277.30, prejudgment interest and a penalty of $15,000.
False pricing: In the Matter of Tianyu Zhou, Adm. Proc. File No. 3-17386 (August 15, 2016). Mr. Zhou was a registered representative at a broker-dealer from July 2012 through November 2015. During that period he traded commercial mortgage-backed securities. For most of the period he mismarked certain loans held on the firm’s books, precluding the firm from learning their true value. For the largest loan he misrepresented certain features and fabricated documents to conceal that fact. The Order alleges violations of Exchange Act Sections 17(a) and 13(b)(5). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to be barred from the securities business and from participating in any penny stock offering with the right to reapply after three years. In addition, he will pay a civil penalty of $50,000.
Misappropriation: In the Matter of Fortius Financial Advisors, LLC, Adm. Proc. File No. 3-17385 (August 15, 2016) is a proceeding which names as Respondents the investment adviser and Jeff Bollinger and Gary Oliver, respectively, the founder and managing member of the firm and a former member of the firm. Mr. Oliver was the trustee of a trust. Over the course of four years he misappropriated $137,000 from it. In addition, Respondents invested over $800,000 of the trust’s funds in unsuitable and illiquid investments. During these events the firm and Mr. Bollinger failed to reasonably supervise Mr. Oliver’s activities and the firm failed to have in place reasonably designed procedures. The Order alleges violations of Adviser Act Sections 206(1), 206(2), 206(4) and 207. To resolve the action each Respondent consented to the entry of a cease and desist order. The order as to the firm was based on Sections 206(2), 206(4) and 207; as to Mr. Oliver, each of the Sections cited in the Order; and as to Mr. Bollinger, Sections 206(2) and 206(4). The firm and Mr. Bollinger were censured. Mr. Oliver was barred from the securities business. The firm and Mr. Bollinger will pay, respectively, disgorgement of $20,749 and $1,718 along with prejudgment interest. The firm and Mr. Bollinger will each pay a civil penalty in the amount of, respectively, $70,000 and $25,000. Mr. Oliver will pay disgorgement of $138,436 along with prejudgment interest and a civil penalty of $125,000.
Investment fund fraud: SEC v. Matrix Capital Markets, LLC, Civil Action No. 1:16-cv-069395 (S.D.N.Y. Filed August 11, 2016). Defendants named in the action are Matrix Capital, a California state registered investment adviser based in San Francisco and Nicholas M. Mitsakos. The firm purports to have been managing one fund and separate accounts since January 2012. Mr. Mitsakos is the founder, CEO and CIO of Matrix Capital. In 2014 Defendants began marketing the firm, claiming it had a successful track record. In fact that record was based on model not actual trades – a fact not known to investors. Potential investors were told that the firm had as much as $60 million in AUM. Portions of the funds were represented to be personal while other funds came from family and friends. In fact the firm never had more than $2 million in AUM. In early 2015 Mr. Mitsakos was introduced to the principals of Investment Manager. Subsequently, Investment Manager and Matrix Capital entered into a series of arrangements under which Matrix Capital would manage $2 million for the Investment Manager and use the funds for securities trading under a “first-loss capital program.” Matrix Capital traded in the program for several months. Mr. Mitsakos did not invest about 40% of the investment funds. Rather, those funds were misappropriated. Investment Manager did not learn this fact until November 2015 at which point a demand for the money was made. Part of the funds were returned. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The case is pending. The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal charges against Mr. Mitsakos.
False press releases: SEC v. Global Digital Solutions, Inc., Civil Action No. 9:36-cv-8143 (S.D. Fla. Filed August 11, 2016) names as defendants, the company which purports to be in the cyber arms manufacturing and security technology solutions industry, Richard Sullivan, its Chairman and CEO, and David Loppert, the CFO. From late October 2013 through early 2014 the firm issued a series of press releases regarding its cyber arms manufacturing and security and technology solutions capabilities. The firm falsely claimed to have sophisticated capabilities, that it planned a merger despite the fact that there was no contract, projected revenue without any reasonable basis and made a billion dollar offer for a firm with no ability to finance the deal. The complaint alleges violations of Securities Act Section 17(a)(2) and Exchange Act Sections 10(b) and 13(a). The case is pending.
Criminal cases
Insider trading: U.S. v. Stewart (S.D.N.Y.). Former Perella Weinberg Partners LP banker Sean Stewart was found guilty of insider trading by a jury. Mr. Steward, formerly vice president in the healthcare section of the firm, was alleged to have repeatedly tipped his father prior to mergers. His father traded. Mr. Stewart was convicted of one count of conspiracy to commit securities fraud and fraud in connection with a tender offer, one count of conspiracy to commit wire fraud, six counts of securities fraud and one count of fraud in connection with a tender offer. Previously, Robert Stewart, his father, pleaded guilty to one count of conspiracy to commit securities fraud and fraud in connection with a tender offer. He was sentenced to serve four years probation with the first year in home detention and to pay a $150,00 forfeiture.
Manipulation: U.S. v. Galanis, No. 1:15-cr-00643 (S.D.N.Y.). The defendants are Jason, John, Jared and Derek Galanis along with Gary Hirst, Ymer Shahini and Gavin Hamels. The case centers on a microcap fraud and the manipulation of shares of New York Stock Exchange listed Gerova Financial Group. Jason directed the scheme, according to court papers. He obtained control over the shares of Gerova, including the ability to cause the company to issue shares, concealing his actions since he has been barred from the securities business by the SEC. He caused the company to issue about 5 million shares – nearly half of the public float – to Ymer Shahini. A series of accounts were opened by John and Jared with the knowledge of Derek. The accounts were in the name of Mr. Shahini. Those accounts were then used to engage in manipulative trading and hold the proceeds from the transactions. Overall about $20 million in shares were sold from the Shahini accounts. The value of the remaining shares held by the public is now $0. Derek Galanis pleaded guilty to conspiracy to commit securities fraud and securities fraud. Previously, Jason Galanis, John Galanis and Gavin Hamels pleaded guilty. Defendants Gary Hirst and Jared Galanis are scheduled to being trial on September 12, 2016.
Australia
Unauthorized trades: The Australian Securities and Investment Commission banned Nicholas Kerr from the securities business for five years. While acting as a registered representative he was found to have engaged in prohibited trading and falsifying records.
Hong Kong
Agreement: The Securities and Futures Commission announced an agreement with the China Securities Regulatory Commission for a Shenzhen-Hong Kong Stock Connect. The launch of the connect is subject to finalization.