This Week In Securities Litigation (Week ending August 31, 2018)
The Commission filed actions this week keyed to the use of financial models and controls. One group of cases centered on the Transamerica Companies. There untested, error ridden financial models were deployed. In another Moody’s was sanctioned for failing to implement proper controls over certain financial models operated by an affiliate. The firm was also sanctioned for failing to have proper controls over the use of its rating symbols. And, another dual registered broker-dealer investment adviser settled charges that it failed to disclose conflicts stemming from being paid 12b-1 fees while stating in its Form ADV that the advisory did not accept such fees.
Finally, a former NFL football player and an investment banker were charged by the SEC and the DOJ with insider trading. The two men apparently thought they had worked out a way to “beat the system” by using code words and other devices to evade detection. They failed.
SEC
Remarks: Chairman Jay Clayton delivered remarks on capital formation at the Nashville 36/86 Entrepreneurship Festival, Nashville, TN (August 29, 2018). His remarks included comments on ICOs, efforts to promote capital formation, particularly for small firms, and comments on rethinking the complex structure for exempt offerings (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 6 civil injunctive cases and 7 administrative proceedings, excluding 12j and tag-along proceedings.
Insider trading: SEC v. Deeba, Civil Action No. 3:1805346 (N.D. Cal. Filed August 30, 2018) is an action which names as a defendant Amer Deeba, the Chief Commercial Officer of Quarlys, Inc., a cloud security, compliance and related services firm. In early April 2015 Mr. Deeba learned that the firm would miss its internal sales forecast for the first quarter of the year. On April 8 he shared this information with his two brothers who held shares in the firm. He subsequently helped them arrange the sale of their holdings. The day after the announcement that the firm had missed guidance, made after the market close on May 4, 2015, the share price fell 25%. The two brothers avoided losses of, respectively, $456,636 and $124,534. The complaint alleges violations of Exchange Act section 10(b). To resolve the case, Defendant consented to the entry of a permanent injunction based on the section cited in the complaint, to the entry of a two year officer or director bar and agreed to pay a penalty of $581,170, the total losses avoided by his brothers. See Lit. Rel. No. 24251 (August 30, 2018).
Barred adviser: SEC v. Grenda Group, LLC, Civil Action No. 1:18-cv-00954 (W.D.N.Y. Filed August 30, 2018) is an action which names as defendants the registered investment adviser, Gregory M. Grenda, the owner and president of the advisory, and Walter Grenda, Jr., the father of Gregory and the co-founder of Reliance Financial Advisors LLC, essentially the predecessor of Grenda Group. During a Commission investigation of Reliance Financial, Walter sold the firm to his son and it became Grenda Group. Walter then settled with the Commission in July 2015, agreeing to the entry bar with a right to apply for reentry after three years. Despite the bar Walter continued to work with his former clients who were then with Grenda Group and at times impersonated his son. The complaint alleges violations of Advisers Act sections 203(f), 206(1) and 206(2). The action is pending.
Insider trading: SEC v. Kendricks, Civil Action No. 18-cv-03695 (E.D. Pa. Filed August 29, 2019) is an action which names as defendants Marvin Kendricks, formerly a player with the Philadelphia Eagles of the NFL, and Damilare Sonoiki, formerly an analyst at an investment bank. In late 2013 the two men met at a party. Subsequently, Mr. Sonoiki, using confidential deal information obtained from his firm, tipped Mr. Kendricks in advance of four takeover transactions: The acquisitions of Compuware, Move, Inc., Sapient Corporation and Oplink Communications, Inc. In each instance Mr. Kendricks traded in advance of the public announcement and sold his securities shortly after, reaping about $1.2 million in profits. In return for the tips Mr. Sonoiki received, among other things, tickets to NFL games, kickbacks and appearances on a pop star’s TV show. The two men took steps to try and conceal what they were doing by using code language in text messages, FaceTime and other methods of communication. The complaint alleges violations of Exchange Act sections 10(b) and 14(e). The case is pending. The U.S. Attorney’s Office for the Eastern District of Pennsylvania filed a parallel criminal action.
Shell companies: In the Matter of Delaney Equity Group LLC, Adm. Proc. File No. 3-17398 (August 29, 2018) names as Respondents: The registered broker-dealer which has been twice sanctioned by FINRA, one in connection with failing to report short sales and on another occasion for the sale of unregistered securities, and once by the Commission for violations of Securities Act section 17(a); David Delaney, the CEO of the firm, who has also been sanctioned by FINRA for the sale of unregistered securities; and Ian Kass, a registered representative at the firm who previously pleaded guilty in a related criminal case to one count of conspiracy to commit securities fraud. In his plea elocution he admitted facts related to these proceedings. The Order alleges that from September 2009 through October 2013 three undisclosed control persons fraudulently manufactured at least 12 blank-check companies for sale. The fraud centered on the portrayal of the firms as start-ups and the fact that control was not disclosed. Messrs. Delaney and Kass were significant participants in marketing the shells. The Order alleges violations of Securities Act sections 5(a) and 5(c) and Exchange Act section 15(c)(2). The matter will be set for hearing.
Offering fraud: SEC v. Masselli, Civil Action No. 2:18-cv-13269 (D. N.J. Filed August 28, 2018) is an action which names as a defendant Sandy Masselli, Jr., formerly a registered representative, and Carlyle Gaming & Entertainment LTD and its related entities. The firm is supposedly engaged in on-line gaming and is now based in Toronto, Ontario. Defendant Masselli is the CEO of the Carlyle entities. Over a five year period, beginning in 2012, Defendants raised about $3 million from investors who were told that the Carlyle Companies were about to conduct an IPO and be listed on the NASDAQ. The firm was at one time quoted in the pink sheets until its registration was revoked. The claims regarding the IPO and NASDAQ were false. The complaint alleges violations of Securities Act section 17(a) and Exchange Act section 10(b). The case is pending. See Lit. Rel. No. 24248 (August 28, 2018).
Offering fraud: SEC v. Equitybuild, Inc., Civil Action No. 18-cv-5587 (N.D. Ill.) is a previously filed action against the firm and others. This week the court entered by consent permanent injunctions against defendants Jerome and Shaun Cohen based on Securities Act sections 5(a) and 5(c) 17(a) and Exchange Act section 10(b). The complaint is based on an offering fraud. Questions regarding financial remedies will be resolved at a later date. See Lit. Rel. No. 24247 (August 28, 2018).
Internal controls re models: In the Matter of Moody’s Investors Service, Inc., Adm. Proc. File No. 3-18688 (August 28, 2018) is an action naming as Respondent the subsidiary of Moody’s Corporation, a registered NRSRO. The action centers on the outsourcing of certain models with regard to the ratings for RMBS. In 2010 the firm revisited its methodology for rating RMBS by incorporating cash flow waterfall models developed by affiliate Moody’s Analytics. The firm established Outsourcing Polices and Procedures that dictated certain oversight responsibilities. The affiliate qualified as an outsource provider under firm policy. Moody’s failed, however, to properly follow its policies and procedures despite a previous warning by the Commission in a Section 21(a) report of investigation, released in 2010. The firm thus failed to conduct or take reasonable steps to ensure adequate quality control processes for the models. That led to a failure to detect numerous errors in the models. The firm also failed to establish and document reasonably designed internal controls over the waterfall models used or for the coding of the models. In 2013 Moody’s was, accordingly, required to do corrective ratings for hundreds of RMBS because of errors. Moody’s also failed to document the rationale for issuing final RMBS ratings that deviated materially from the model implied ratings in 54 instances. The firm agreed to implement certain undertakings which included the retention of a consultant. The Order alleges violations of Exchange Act sections 15E(c)(3)(A) and 17(a)(1). To resolve the proceedings the firm consented to the entry of a cease and desist order based on the sections cited in the Order. Moody’s will pay a penalty in the amount of $15 million. See also In the Matter of Moody’s Investors Service, Inc., Adm. Proc. File No. 3-18689 (August 28, 2018)(a second proceeding based control failures, here on not establishing and enforcing policies and procedures regarding the consistent application of the firm’s credit rating symbols; resolved with undertakings requiring a complete review of the firm’s policies and procedures, a consent to a cease and desist order based on Exchange Act Rules 17g-8(b)(2) and (3) and the payment of a $1,25 million penalty).
In the Matter of Aegon USA Investment Management, LLC, Adm. Proc. File No. 3-18681 (August 27, 2018). The Order names as Respondents: AEGON USA Investment Management or AUIM, a registered investment adviser that is a subsidiary of Aegon N.V, a multinational insurance and asset management company based in the Netherlands. Also named as Respondents are affiliates: Transamerica Asset Management, Inc. or TAB, a registered investment adviser; Transamerica Capital, Inc. or TCI, a registered broker-dealer; and Transamerica Financial Advisors, Inc. or TFA, a dual registered investment adviser and broker-dealer. Nine different products and strategies were involved. In 2010 AUIM instructed an analyst with an MBA and no portfolio management experience or formal training in modeling to develop quantitative models for use in managing investment strategies. Nevertheless the use of certain models was launched. By the next year AUIM had identified potential risks associated with using models to manage third-party assets. By late 2011 however, it had not reviewed the models created for accuracy or formally validated them. Other models were also launched without testing; the results were similar. By the summer of 2013 AUIM concluded that its allocation models used to manage the TTI Fund and AAA Portfolios contained material errors. The firm determined that one asset allocation model was not fit for its purpose. AUIM halted the use of that model but failed to inform the board. Ultimately over 50 errors were discovered in certain AUIM models used to manage the Products and Strategies. TAM and TCI learned of the errors. Rather than disclose these facts, the prospectuses were revised to state that they “may” be using a proprietary quantitative model. Ultimately TAM terminated its Investment sub-advisory agreement with AUIM. That firm terminated its model manager agreement with TFA in April 2015. The Order alleges violations of Securities Act section 17(a)(2) and Advisers Act sections 204, 206(2) and 206(4). To resolve the proceedings each Respondent consented to the entry of a cease and desist order and a censure: AUIM based on sections 17(a)(2), 206(2) and 206(4); TAM on sections 206(2), 206(4); TCI on section 17(a)(2); and TFA on 204, 206(2) and 206(4). Collectively respondents paid $97,602,040 in penalties, disgorgement and prejudgment interest. See also In the Matter of Bradley J. Beman, Adm. Proc. File No. 3-18682 (August 27, 2018)(proceeding naming as Respondent the Global CIO for AUIM and based on the same conduct; resolved with a consent to a cease and desist order based on Advisers Act section 206(4) and the payment of a $65,000 penalty); In the Matter of Kevin A. Giles, Adm. Proc. File No. 3-18683 (August 27, 2018)(proceeding naming as Respondent AUIM’s Director of New Initiatives during the period; resolved with a consent to the entry of a cease and deist order based on Advisers Act section 206(4) and the payment of a $25,000 penalty).
Conflicts: In the Matter of First Western Advisors, Adm. Proc. File No. 3-1863 (August 24, 2018). First Western is a dual registered investment adviser and broker-dealer. Clients were offered a variety of mutual fund products over a number of fund complexes. First Western acted as the adviser through its Investment Adviser Representatives. The firm also acted as the introducing broker-dealer on all of the Private Client Account transactions. The adviser’s ADV stated that the firm did not accept compensation for the sale of securities or investment products. That included the sale of mutual funds. During the period the adviser recommended, purchased or held on behalf of some of its advisory clients mutual fund shares that charged 12b-1 fees. Thus the firm received fees on those investments. That was contrary to the disclosures in the Form ADV. It also meant that clients did not receive best execution on the purchase of the shares – they did not receive the lowest price. And, the firm’s compliance program was not properly implemented because the procedures failed to provide that its Investment Adviser Representatives must explain to clients the costs and fees on the various types of fund shares. Accordingly, the Order alleges violations of Advisers Act sections 206(2), 206(4) and 207. To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order and a censure. In addition, Respondent will pay disgorgement of $139,698.50 and prejudgment interest of $13,068.62 which will be placed in a distribution fund for the benefit of the investors. The firm will also pay a penalty of $50,000.
Offering fraud: SEC v. 1 Global Capital LLC, Civil Action No. 0:18-cv-61991 (S.D. Fla. Filed August 23, 2018, unsealed Aug. 28) names as defendants the firm, wholly owned by the Ruderman Family Trust, which had about 100 employees at the time it filed for bankruptcy. Also named as a defendant is Carl Ruderman, its CEO. Over a four year period, beginning in early 2014, defendants raised over $287 million from about 3,400 investors in 25 states. Many investors who purchased the unregistered shares of the firm did so with retirement funds. Investors were told that their money would be used exclusively for cash advances through the Merchant Cash Advance program – a business to business loan program for firms that had difficulty accessing capital through conventional sources. The investments were supposedly rigorously vetted with only one of ten qualifying. The investments were supposed to be safe. The offering was run by a network of salesmen which included persons barred from the business. In reality large portions of the investor funds were diverted to other high risk projects while large sums were misappropriated. Investors were furnished with false statements. The complaint alleges violations of Securities Act sections 5(a), 5(c) and each subsection of section 17(a) and Exchange Act sections 10(b) and 20(a). The Court entered a temporary freeze order at the time the complaint was unsealed. The case is pending. See Lit. Rel. No. 24249 (August 29, 2018).
Unregistered securities: SEC v. Greenlaw, Civil Action No. 24246 (D. Maine Filed August 17, 2018) is an action against Richard Greenlaw, the founder and managing member of NECS, also a defendant, along with a number of cannabis related entities. NECS is a medical marijuana firm. Mr. Greenlaw has since 2014 sold subscription agreements in NECS and its cannabis-related entities to at least 59 individuals in 21 states. The complaint alleges violations of Securities Act sections 5(a) and 5(c). To resolve the action Mr. Greenlaw and the cannabis related entities consented to the entry of permanent injunctions based on the sections cited in the complaint and to a conduct based injunction. In addition, Defendants will pay disgorgement and prejudgment interest of $340,142 and a penalty of $50,000. See Lit. Rel. No. 24246 (August 28, 2018).
Criminal cases
Misappropriation: U.S. v. Basralian, No. 2:18-mj – 06090 (D.N.J. August 29, 2018) is an action in which Gary Basralian, formerly a broker and investment adviser, pleaded guilty to one count of wire fraud and one count of investment adviser fraud. The charges were based on a ten year scheme that began in 2007 in which Mr. Basralian stole at least $2 million from clients. The date for sentencing has not been set.
Anticorruption/FCPA
In the Matter of Legg Mason, Inc., Adm. Proc. File no 3-18684 (August 27, 2018) names the registered broker-dealer as a Respondent in an FCPA action. Previously, the firm, along with Society Generale S.A., settled FCPA charges with the DOJ. Those actions were based on a scheme that took place over a six year period beginning in 2004. During the period Legg Mason, through one of its former asset management subsidiaries, Permal Group Ltd., partnered with Societe Generale to solicit business from state owned financial institutions in Libya. Permal was aware that SoGen was paying bribes to secure business. Legg Mason settled with the DOJ, entering into a non-prosecution agreement under which it paid $64.2 million – a $32.6 million penalty and $31.6 million as disgorgement. Under the terms of the settlement Legg Mason could credit the amount of disgorgement against any amount paid in other regulatory proceedings. Here the firm settled with the SEC, consenting to the entry of a cease and desist order based on Exchange Act section 13(b)(2)(B). The firm also agreed to pay disgorgement in the amount of $27,594,729 and prejudgment interest of $6,907,765. With the DOJ credit the firm will be required to pay $2.4 million. The Commission did not impose a penalty in view of the criminal penalty imposed by the DOJ.