This Week In Securities Litigation (Week ending August 24, 2018)
The stay of contested administrative proceedings ended this week. The Commission entered an order lifting the stay which has been in place since the Supreme Court handed down Lucia. The Order ratifies the appointment of its ALJs and directs that each pending case be assigned to a new Administrative Law Judge and begin anew. Whether this fully complies with Lucia, properly appointing the ALJs, resolves each of the constitutional issues is at best unclear.
This week the Commission filed a series of actions as the Government fiscal year end begins to draw near. Those cases involved insider trading, cherry picking, conflicts of interest and investment advisers and false financial metrics by firms that sought to improve the appearance of their results.
Order: The Commission entered an order regarding the continuation of contested administrative proceedings on August 22, 2018. Specifically, the Order ratified the appointment of each of its Administrative Law Judges, directed that for each pending proceeding (including those on review before the agency) an new ALJ be appointed and requires that each action begin anew with all prior proceedings being a nullity. The stay was terminated.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 6 civil injunctive cases and 9 administrative proceedings, excluding 12j and tag-along proceedings.
Insider trading: SEC v. Fishoff, Civil Action No. 1:18-cv-07685 (S.D.N.Y. Filed August 23, 2018) is an action which names as defendants Steven Fishoff, Deshan Goverder, Winson Tang, Featherwood Capital Inc., and JSF Investment Capital Inc. Mr. Fishoff, the owner of Featherwood and controller of JFS Investments and a number of other entities, reputedly is the leader of an insider trading ring that has made over $5.5 million. He recently pleaded guilty to criminal charges in U.S. v. Fishoff, No. 15-cr-586 (D.N.J.), an action that parallels another Commission case, SEC v. Fishoff, Civil Action No. 15-cv-3725 (D.N.J.). Mr. Goverder is a portfolio manager for an entity controlled by Defendant Fishoff. Mr. Tang was the vice president of clinical research as SangamoBioSciences Inc. This action centers on the announcement on January 9, 2014 of a lucrative licensing agreement between Sangamo and Biogen Idee Inc., both of which are pharmaceutical firms. Prior to the deal announcement Mr. Tang furnished inside information about the deal to his long time friend, Defendant Goverder in December 2013. Mr. Goverder then tipped Defendant Fishoff and two other members of the group. Trading from the group prior to the announcement yielded $1.5 million in illicit trading profits. The complaint alleges violations of section 10(b). The action is pending. See Lit. Rel. No. 24245 (August 23, 2018).
Insider trading: In the Matter of James T. Lentz, Adm. Proc. File No. 3-18665 (August 22, 2018) names as a Respondent the former vice president of sales at StonMor Partners, L.P., a Pennsylvania based owner and operator of cemeteries and funeral homes. Hours before the announcement on October 27, 2016 that the firm would have to reduce its quarterly distribution by 50%, Mr. Lentz, who learned about the announcement from work, sold all of his stock in the firm. Following the announcement the share price declined 45%. Respondent avoided losses of $9,115. The Order alleges violations of Securities Act section 17(a) and Exchange Act section 10(b). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the order. He also agreed to pay disgorgement of $9,115, prejudgment interest of $608 and a penalty in the amount of the disgorgement.
Financial fraud: SEC v. Grewal, Civil Action No. 1:18-cv-11778 (D. Mass. Filed August 21, 2018) is an action against the former CFO of Constant Contact, Inc., an email marketing firm. A key metric for the firm was the number of subscribers. In 2014 when the number started to dwindle, Defendant created the “Save Program.” Under this program when a subscriber’s subscription was ending without renewal, the subscriber would essentially be given a free continuation into the next quarter to boost the customer count. During 2014 and 2015 this technique was used to falsely inflate the numbers reported by the firm. At a high point of the stock Defendant sold a block of firm shares. The complaint alleges violations of Securities Act section 17(a) and Exchange Act sections 10(b) and 13(a). The case is pending. See Lit. Rel. No. 24242 (August 21, 2018); see also In the Matter of Hari K. Ravichandran, Adm. Proc. File No. 3-18653 (August 21, 2018)(similar action naming as Respondent the CEO of Endurance International Group Holdings, Inc., resolved with the entry of a cease and desist order based on Securities Act section 17(a)(2) and Exchange Act sections 13(b)(2)(A) and the payment of disgorgement in the amount of $953,005.65, prejudgment interest of $114,620.02 and a penalty of $320,000); In the Matter of Waruna Tivanka Ellawaia, Adm. Proc. File No. 3-18654 (August 21, 2018)(similar action naming as Respondent the CFO of Endurance International Group Holdings, Inc.; resolved with the entry of a cease and desist order based on Securities Act section 17(a)(2) and Exchange Act sections 13(a) and 13(b)(2) and the payment of disgorgement in the amount of $15,566.77, prejudgment interest of $1,785.45 and a penalty in the amount of $17,000); In the Matter of Endurance International Group Holdings, Inc. and Constant Contact, Inc., Adm. Proc. File No. 3-18531 (June 5, 2018).
False filings: In the Matter of David Lubin, Adm. Proc. File No. 3-18070 (August 21, 2018) is an action which names the attorney and officer of Entertainment Art, Inc. with concealing the fact that his two fellow officers received 1.2 million restricted shares of the firm. He also concealed the fact that a block of 1.81 million restricted shares was outstanding to an entity controlled by an acquaintance. These facts were concealed by making repeated misstatements in filings. Previously, Respondent consented to the entry of a cease and desist order in a Commission proceeding which was based on Exchange Act section 10(b) and which denied him the privilege of appearing and practicing before the Commission as an attorney. In a criminal action he pleaded guilty to selling unregistered securities and has been sentenced to serve 36 months in prison and pay forfeiture of $309,364.83 which includes funds traceable to Entertainment Art. These proceedings were resolved with the entry of an order based on Rule 102(e) and a directive to pay $1,687.50 in disgorgement plus $2,121.83 in prejudgment interest, deemed satisfied by the forfeiture order in the criminal case, U.S. v. Lubin, No. 17-20508 (S.D. Fla.).
Misrepresentations: In the Matter of Biltmore Wealth Management LLC, Adm. Proc. File No. 3018656 (August 21, 2018) names as Respondents the California registered investment adviser and Caleb R. Overton, its sole owner and managing member. Beginning in June 2014, and continuing for about one year, Respondents raised about $2.2 million from ten investors, eight of whom were pre-existing clients. Those investors were promised their funds would be invested in a private fund that would purchase leading growth stocks and would be protected by “stops” to limit loss. Rather than follow the advertised investment strategy, Respondents traded risky options and other similar instruments, losing virtually all of the client funds. The Order alleges violations of Advisers Act sections 206(1), 206(2) and 206(4). Respondents consented to the entry of a cease and desist order based on the sections cited in the Order. The firm was censured and Mr. Overton barred from the securities business and participating in any penny stock offering with the right to apply for re-entry after five years. In addition, Respondents will, jointly and severally, pay disgorgement of $23,043.00, prejudgment interest of $2,599.13 and a penalty of $160,000.
Insider trading: In the Matter of Ismail Lila, Adm. Proc. File No. 3-18655 (August 21, 2018) names as a Respondent the Associate General Counsel of Teekay Corporation, a foreign private issuer based in Hamilton, Bermuda. On July 26, 2017 the firm and Teekay Offshore Partners L.P., a provider of marine transportation, oil production, storage and other services, announced that they had entered into a strategic partnership with Brookfield Business Partners L.P. In June Respondent obtained inside information about the arrangement. Respondent purchased shares in the firm which generated gains of $28,642.04 after the announcement. The Order alleges violations of Exchange Act section 10(b). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order. In addition, he agreed to pay disgorgement in the amount of his trading profits, prejudgment interest of $1,015.19 and a penalty equal to the amount of his trading profits.
Misappropriation: SEC v. Rothenberg, Civil Action No. 3:18-cv-05080 (N.D. CA. Filed August 20, 2018) is an action against Michael Rothenberg, the founder of Defendant Rothenberg Ventures LLC, an exempt reporting adviser. Defendants advise a number of venture capital funds. Over about three years beginning in 2013 Mr. Rothenberg misappropriated money from the funds by charging false expenses, over charging fees and stealing funds. The complaint alleges violations of Advisers Act sections 206(1), 206(2) and 206(4). To resolve the action Defendants consented to the entry of permanent injunctions based on the sections cited in the complaint. Mr. Rothenberg also agreed to be barred from the securities business with the right to apply for re-entry after five years. Financial penalties will be resolved by the court at a later date.
Offering fraud: SEC v. Intertech Solutions, Civil Action No. 2:18-cv-01566 (D. Nev. Filed August 20, 2018) names as defendants the firm, a project finance and management company, William Scott Marshall, the undisclosed control person of the firm and David Naylor, a chartered accountant. Over a period of about two years, beginning in 2014, Defendants engaged in a fraudulent unregistered offering of firm shares in the U.S. and Canada. Misrepresentations were made to induce sales of the securities regarding the amount of the commissions that would be charged and the use of the funds. Portions of the funds raised were misappropriated while the individual defendants acted as unregistered brokers. The complaint alleges violations of Securities Act sections 5(a), 5(c) and 17(a) and Exchange Act section 10(b) and 15(a)(1). To resolve the action each Defendant consented to the entry of a permanent injunction and agreed to pay disgorgement of about $7.4 million. Messrs. Marshall and Naylor have also agreed to pay penalties of $184,767 and $92,383, respectively, and to the entry of permanent officer and director bars. See, Lit. Re. No. 24241 (August 21, 2018).
Conflicts: In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc. Adm. Proc. File No. 3-18651 (August 20, 2018). In 2012 and 2013 Merrill, as a registered investment adviser, maintained what it called Platforms – a service in which third-party investment managers were available for selection by clients for performance, reporting, advice and guidance. Clients were only permitted to select from those identified on the Platforms. The adviser’s brochures – Form ADV part 2 – detailed for clients the selection and evaluation process of Platform products. Other materials repeated the claims. Generally, when there was a product change a due diligence process was undertaken; an analysis was performed and an internal governance committee made a final determination. In December 2012 the due diligence committee recommended terminating certain products on the Platform. At the time advisory clients had invested about $575 million in the products. The products were managed by a U.S. investment advisory subsidiary of a foreign multinational banking and financial services firm. The internal recommendation stemming from the due diligence group was presented to the governance committee in January 2013. The U.S. investment advisory subsidiary learned about the recommendation to terminate the products prior to any decision by the governance committee inadvertently from a Merrill employee charged with managing the logistics of any termination. That touched off a concerned effort by the U.S. investment advisory subsidiary to reverse the decision and keep the products on the Merrill Platform. That succeeded, based in part on a pitch about the merits but also the “broader” relation of the two firms and their other business relations. While advisory clients expected Merrill to evaluate the merits of a product, the disclosure did not specify that the adviser’s decision would be driven in part by Merrill’s other business interests that were unrelated to the merits of the product. The failure to disclose that the adviser’s self-interest would taint the process not only constituted a conflict of interest, but a violation of Advisers Act Section 206(2) which prohibits any transaction, practice or course of business which operates “as a fraud or deceit up an client or prospective client.” In resolving the proceedings the Commission considered the remedial acts and cooperation of the adviser. Merrill consented to the entry of a cease and desist order based on Advisers Act Section 206(2) and a censure. The firm will pay disgorgement of $4,032,871.89, prejudgment interest of $806,981.03 and a penalty equal to the amount of disgorgement.
Cherry picking: In the Matter of BKS Advisors LLC, Adm. Proc. File No. 3-18648 (August 17, 2018); In the Matter of Roger Denha, Adm. Proc. File No. 3-18649 (August 17, 2018). BKS Advisor is a Commission registered investment adviser. Roger Denha has been an investment adviser representative at the firm since 2003. He was also a registered representative with a Commission registered broker-dealer until November 30, 3017. From 2012 through November 30, 2017 Mr. Denha was employed at BKS. During that period he engaged in a cherry picking scheme in which he favored certain accounts, including his personal accounts, while disfavoring others. Specifically, he disproportionately allocated profitable trades to accounts he favored, including his, while disadvantaging others by frequently allocating them the unprofitable trades. The scheme used an omnibus account that had been set up for the trader’s block trades. By placing the trade in this account Mr. Denha could hold them it and make the allocation to specific accounts later in the day. By that point he frequently could determine the direction of the market and the price trend for a particular security. The trader would then give instructions to divide the block by essentially picking “winners” and “losers” with many of the former going to Mr. Denha’s favored accounts and more of the latter type trades being placed in the less favored accounts. In analyzing the trading patterns here the Commission relied in part on statistics. The difference between the allocations of profitable trades and unprofitable trades was statistically significant. The probability that such an uneven allocation of gains and losses occurred by chance is less than one-in-one-million, according to the Order. Similarly, combining both types of trades, the average combined realized and unrealized return for the favored accounts was about 1.01%. The average combined, realized and unrealized return for the disfavored accounts was a negative 0.16%. Mr. Denha made at least $412, 230 in realized and unrealized gains from the scheme. While the firm had procedures which required that trades be fairly allocated and for the allocation of blocks, they were not properly implemented. In its daily review the firm focused on suitability and concentration, not unfair trade allocation. Since its Form ADV represented that the interests of clients would be place before those of the firm and its employees it was incorrect. The Order as to the advisor alleged violations of Advisers Act sections 206(2), 206(4) and 207. To resolve the proceedings the adviser consented to the entry of a cease and desist order based on the sections cited in the Order, to a censure and to the payment of a penalty of $75,000. The Order as to Mr. Denha alleged violations of Exchange Act section 10(b) and Advisers Act sections 206(1) and 206(2). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the order and agreed to pay disgorgement of $412,230, prejudgment interest of $35,388 and a penalty of $169,000. He is also barred from the securities business and from participating in any penny stock offering.
Unregistered broker/securities: SEC v. Robbins, Civil Action No. 1:18-cv-23369 (S.D. Fla. Filed August 20, 2018) is an action which names as defendants Lynette Robbins and her firm Knowledge Systems, Inc. Defendants raised over $147 million from over 540 investors from 2014 through 2017 who were convinced to purchase the unregistered shares of Woodbridge Group Companies, LLC based on false claims about the safety of the investment. The firm, now in bankruptcy, was a massive Ponzi scheme. The complaint alleges violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Section 15(a)(1). Each Defendant settled, consenting to the entry of a permanent injunction based on the sections cited in the complaint. Ms. Robbins will pay disgorgement, prejudgment interest and a penalty totaling $1,123,360.90. The firm will pay disgorgement of $925, 000 and prejudgment interest of $98,360.90. See also SEC v. Kornfeld, Civil Action No. 1:18-cv-23369 (S.D. Fla. Filed August 20, 2018)(names as defendants Barry Kornfeld, Ferne Kornfeld, Andrew Costa, Albert Klager and their firms; based on essentially the same allegations as noted above). See Lit. Rel. No. 24242 (August 22, 2018).
Manipulation: SEC v. Williky, Civil Action No. 16-civ-357 (S.D. Ind.) is a previously filed action against Gary Williky based on market manipulation and insider trading. Previously, Defendant partially settled with the Commission, consenting to the entry of a permanent injunction prohibiting future violations of Securities Act section 17(a) and Exchange Act sections 9(a)(1), 10(b) and 13(a). as well as to an officer and director bar. Monetary penalties were reserved for the court. After a hearing the court directed Defendant Williky to pay disgorgement and interest of $1,037,811 and penalties of $1,746,434. See Lit. Rel. No. 24244 (August 23, 2018).
Manipulation: U.S. v. Chartier, No. 17-cr-372 (E.D.N.Y.) is an action in which sixteen individuals have been charged with operating a boiler room and the manipulation of several microcap stocks over a three year period beginning in January 2014. Overall the scheme raised about $147 million. Defendants Ronald Hardy and McArthur Jean each pleaded guilty in the action this week. Mr. Hardy, who was a manager at My Street Research and its predecessors – the boiler room — pleaded guilty to conspiracy to commit securities fraud, conspiracy to commit wire fraud, conspiracy to commit money laundering and five counts of securities fraud. Mr. Jean, a cold-caller at the boiler room, pleaded guilty to one count of conspiracy to commit securities fraud and agreed to forfeit over $110,000. The dates for sentencing have not been set.
Insider trading: Darren Lind, a former managing director of Golden Fields Resources Pty Ltd, was found guilty by a jury after a two week trial of insider trading. Specifically, while in possession of inside information about Minotaur Exploration Ltd. regarding a copper-gold discovery at Cloncurry that he obtained at a meeting at the company, he procured another to trade for him. Following the announcement of the discovery the share price nearly doubled.