This Week In Securities Litigation (Week ending August 7, 2015)
The SEC issued its final Dodd-Frank pay ratio rules this week by a 3-2 vote. It also issued its final registration rules for Security-Based Swap Dealers and Major Security-Based swap participants.
More questions were raised this week regarding the propriety of the manner in which SEC ALJs are retained. A second action found that the Commission violated the appointment clause of the constitution in this regard. The court is delaying for seven days consideration of the application for a preliminary injunction to permit the agency to assess its options. Duka v. SEC, Civil Action 15 Civ 357 (S.D.N.Y. Order entered August 3, 2015).
Finally, the agency brought actions centered on financial fraud; principal transactions; the custody rule; false statements; microcap fraud; and investment fraud.
Rules: The Commission issued its Dodd-Frank Rule for Pay Ratio Disclosure. The Rule requires issuers to compute and disclose the ration of CEO pay to the median of its employees (here). Commissioners Gallagher and Piwowar dissented.
Rules: The Commission issued its Dodd-Frank rules for the registration of Security-Based Swap Dealers and Major Security-Based Swap Participants (here).
Remarks: Commissioner Daniel Gallagher delivered remarks titled“Dodd-Frank at Five: A Capital Markets Swan Song,” to the U.S. Chamber of Commerce, Washington, D.C. (August 4, 2015)(here). His remarks criticized Dodd-Frank and reviewed the staff divisions (here).
Remarks: Commissioner J. Christopher Giancaro released comments titled Six Month Progress Report on CFTC Swaps Trading Rules: Incomplete Action and Fragmented Markets, Washington, D.C. (August 4, 2015). His remarks were an update of a White Paper released six months ago which was critical of the swaps trading rules (here).
Securities class actions
The number of securities class actions filed in the first half of 2015 was essentially flat compared to historical averages, according to a new report by Cornerstone Research titled Securities Class Action Filings, 2015 Midyear Assessment (here). At the same time other trends may be shifting. In the first half of 2015 there were 85 new securities class actions filed. That number is down from the 86 filed in the second half of 2014 but more than the 78 filed in the first half of 2014. It also represents a 10% decrease from the historical semiannual average of 94 filings made between 1997 and 2014. The Report also notes that over the last few years the number of suits brought against foreign issuers listed on U.S. exchanges has increased. This trend is continuing. During the first half of 2015 24% of the filings involved a foreign issuer. That compares to 20% for all of 2014. If the trend continues 2015 will represent the third year in a row the number has increased. Finally, the number of mega filings in the first half of 2015 declined. That is consistent with the trend in the prior year.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 3 civil injunctive cases and 9 administrative actions, excluding 12j and tag-along proceedings.
Financial fraud: In the Matter of Miller Energy Resources, Inc., Adm. Proc. File No. 3-16729 (August 6, 2015) is a proceeding which names as Respondents the firm, which develops oil and gas wells in Alaska; Paul Boyd, CPA, the CFO; David Hall, a director of the company and the CFO of the Alaskan subsidiary; and Carlton Vogt, III, a partner in the now defunct accounting firm of Sherb & Co. and the engagement partner on the Miller Energy audit. The Order alleges that Miller, a one-time penny stock, acquired certain oil and gas assets and liabilities for about $2 million from a competitive bidding process in a bankruptcy. Those assets were subsequently recognized by the company in its financial statements for $480 million. The firm secured a listing on the NYSE and saw its share price increase at one point to almost $9. The Order claims that the assets were not valued in accord with GAAP which requires that they be listed at “fair value.” Certain expenses were also understated. The audit by Sherb & Co. was not in accord with the rules and standards of the PCAOB. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5) and 10(b). The proceeding will be set for hearing.
Stop order: In the Matter of the Registration Statement of First Xeris Corp., Adm. Proc. File No. 3-16530 (August 6, 2015). The Order alleges that in an S-1 registration statement there are material misstatements such as those claiming the supposed landscape company has only one director and officer who controls the business. The matter will be set for hearing.
Principal transactions: In the Matter of Tri-Star Advisors, Inc., Adm. Proc. File No. 3-15742 (August 6, 2015) names as Respondents the registered adviser; William Payne, the firm’s president and 40% owner; and Jon Vaughn, a vice president of the firm and a 20% owner. The Order alleges that over a two year period beginning July 2009 the adviser engaged in thousands of principal transactions with advisory clients without furnishing them the required prior written disclosure or obtaining consent. The firm also failed to adopt and implement written policies and procedures designed to prevent such violations. The Order alleges violations of Advisers Act Section 206(3) and (4). As part of the resolution of the matter Respondents agreed to reimburse clients for certain transactions, retain a consultant and provide notice of this proceeding to clients. In addition, the firm undertook certain remedial measures. Each Respondent also consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm was censured and agreed to pay a penalty of $150,000. Mr. Payne will pay disgorgement of $142,500, prejudgment interest and a penalty of $50,000. Mr. Vaughn will pay disgorgement of $232,500, prejudgment interest and a penalty of $50,000.
Custody rule: In the Matter of Wesley N. Stark, CPA, Adm. Proc. File No. 3-16731 (August 6, 2015). Mr. Stark is the founder and former owner of public accounting firm StarkSchenkein, LLP. That firm is also a Respondent. Respondents were retained by former registered investment adviser the Planning Group of Scottsdale, LLC. That firm had custody of certain client funds and securities. Accordingly, for 2010, 2011 and 2012 Respondent accounting firm was retained to conduct surprise audits in accord with the custody rule. The Order alleges that the 2010 and 2011 engagements were not completed satisfactorily and that Respondents withdrew from the 2012 engagement causing the adviser to be in violation of the custody rule. The Order alleges violations of Advisers Act Section 206(4). To resolve the matter each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. In addition, the right of both Respondents to appear and practice before the Commission was revoked. The firm may apply for reinstatement after one year and Mr. Stark after three years. Mr. Stark will pay a civil penalty of $15,000 while the firm will pay disgorgement of $12,750, prejudgment interest and a penalty of $15,000. See also in the Matter of Reid S. Johnson, Adm. Proc. File No. 3-16630 (August 6, 2015)(Proceeding against the founder and sole owner of Planning Group which retained the Respondents in the proceeding captioned above; it alleges violations of Advisers Act Sections 206(4) and 207; it will be set for hearing).
Custody rule/principal transactions: In the Matter of Parallax Investments, LLC, Adm. Proc. File No. 3-15626 (August 6, 2015) is a proceeding which names as Respondents the registered adviser, John Bott, its owner and manager, and Robert Falkenberg, its CCO. Over a two year period beginning in 2009 Parallax engaged in at least 2,000 securities transactions with advisory clients on a principal basis through a commonly-controlled broker dealer without providing prior written disclosure or obtaining consent. They also failed to provide pooled investment vehicle investors with audited financial statements as required by the Advisers Act custody rule. The Order alleges violations of Advisers Act Sections 204A, 206(3) and 206(4). To resolve the proceeding Respondents agreed to certain undertakings, including the repayment of about $450,000 to customers, retention of an independent compliance consultant and to provide notice to clients. Each Respondent consented to the entry of a cease and desist order. The orders as to the firm and Mr. Bott are based on the Sections cited in the Order while the one as to Mr. Falkenbeg is based on Advisers Act Sections 204A and 206(4). The firm will pay a penalty of $200,000; Mr. Bott will pay disgorgement of $450,000, prejudgment interest and a penalty of $70,000; and Mr. Falkenberg will pay a penalty of $40,000.
False statements: In the Matter of Gold Mountain Management, LLC, Adm. Proc. File No. 3-16714 (August 4, 2015) is a proceeding which names as Respondents the state registered investment adviser and its founder, Gregory Bied. The Order alleges that from 2012 through 2014 Respondents told investors in a managed hedge fund that the fund was achieving positive returns when in fact it had lost about 75% of its value. The Order alleges violations of Advisers Act Sections 206(4). To resolve the matter each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. Mr. Bied was also barred from the securities business. Respondents will pay a civil penalty of $200,000.
Investment fraud: SEC v. Voight, Civil Action No. 4:15-cv-02218 (S.D. Tx. Filed August 3, 2015) is an action which named as defendants Frederick Voight, a director of Intercore, Inc. and Daystar Funding, L.P. which he controlled. InterCore is a financially troubled public company which is delinquent in its filings. Since 2004 the defendants have raised at least $114.1 million from about 300 investors through the sale of unregistered notes through various entities. In one offering, for example, which began in late 2014 Mr. Voight sold notes through DayStar, raising $13.8 million from 260 investors. Those investors were told the funds were for a Driver Alertness Detection System or DADS which could alert drivers of microsleep in advance of dangerous fatigue levels or accidents. The interest on the notes was to be as high as 42%. As a member of the board of InterCore, which supposedly was developing the product, Mr. Voight knew that there was no way to repay investors. The funds from the DADS offering are gone, according to the complaint. Part of the money was used to make Ponzi payments to other investors while a portion was funneled out to Mr. Voight’s benefit. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b) and liability under Section 20(a). The defendants settled with the Commission, consenting to the entry of permanent injunctions based on the Sections cited in the complaint. They also agreed to an asset freeze and to pay disgorgement and penalties in amounts to be determined by the Court. Mr. Voight consented to the entry of a director and officer bar as well as a penny stock bar.
Microcap fraud: SEC v. Kueber (E.D.N.Y. Filed July 31, 2015) is an action which names as a defendant Philip Kueber. It alleges that Mr. Kueber filed a false registration statement for Cynk Technology Corporation, used straw shareholders and executives and false declarations filed with FINRA to initiate trading. The firm had no revenue or operations. Before the shares could be sold the SEC instituted a trading halt. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Section 10(b) and Rule 10b-5(a) and (c). The case is pending.
Investment fraud: In the Matter of Michael T. Seabolt, Adm. Proc. File No. 3-16713 (July 31, 2015) is a proceeding arising out of the fraudulent scheme of Nikolai Battoo and his two companies which operated under the name of Private International Wealth Management. From 2004 through 2012 Mr. Seabolt was the primary salesperson for the operation. In 2008 he learned that the hedge funds and PIWM investment program had significant exposure to leveraged investments in the Madoff Ponzi scheme and failed derivative investment program. Nevertheless, he continued. Since 2009 new and existing investors have invested substantial sums. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206(4). To resolve the case Mr. Seabolt consented to the entry of a cease and desist order based on the Sections cited in the Order. He also agreed to the entry of an order barring him from the securities business and from participating in any penny stock offering and directing that he pay disgorgement of $36,444.69, prejudgment interest and a penalty of $150,000.
Investment fraud: SEC v. Reliance Financial Advisors, LLC., Adm. Proc. File No. 3-16311 (July 31, 2015) is a proceeding which names as Respondents the registered investment adviser and its co-founders, Timothy Dembski and Walter Grenda, Jr. The Order alleges that in 2011 Respondents made a series of false statements regarding a potential investment in a start-up fund, founded by Mr. Dembski and Scott Stephan, called Prestige Wealth Management Fund, L.P. The Fund was very high risk, a fact not told to potential investors who were furnished with materials which greatly exaggerated Mr. Stephan’s experience in the securities business. The fund never performed as advertised. In fact, within 18 months Mr. Grenda withdrew his advisory clients. The Fund lost 80% of its value as a result of Mr. Stephan placing manual trades that were contrary to the automated trading strategy investors were told about. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(4). The adviser and Mr. Grenda resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. The firm also agreed to the entry of a censure and its registration was revoked. Mr. Grenda agreed to the entry of a bar order from the securities business and from participating in any penny stock offering with the right to apply for reentry after three years. He also agreed to pay disgorgement of $25,000, prejudgment interest and a civil penalty of $50,000.
Ponzi schemes: U.S. v. O’Hara, Case No. 10-cr-00288 (S.D.N.Y.). Irwin Lipkin served at controller Bernard Madoff Investment Securities LLC for years. In that role he falsified the firm books and as a result the broker’s SEC filings. He also directing that false trades and other records be put into his personal accounts to minimize his taxes. Mr. Lipkin pleaded guilty to: One count of conspiracy to commit securities fraud; falsifying records; making false filings with the SEC; falsifying statements in relation to documents required by ERISA; and to one substantive count of falsifying statements in relation to documents required by ERISA. Unlike some Madoff employees, Mr. Lipkin refused to cooperate with the government. The Court sentenced him to six months in prison and to three years supervised release, including eighteen months of home confinement. He was ordered to forfeit $170 billion dollars and various pieces of property, including a house in Florida, stocks from brokerage and retirement accounts and artwork.
Churning: The regulator barred Richard Adams, formerly a registered representative of Caldwell International Securities Corporation for churning two accounts over a period of one year beginning July 2013. Those actions generated $57,000 in commissions and caused $37,000 in customer losses.
Sale unregistered penny stocks: The regulator fined Aegis Capital Corporation $950,000 for selling almost 3.9 million unregistered penny stock shares between April 2009 and June 2011. While there were a series of red flags, the firm ignored them. In addition, Charles Smulevitz and Kevin McKenna, who served successively as Chief Compliance and AML Compliance Officers at the time of the violations agreed to 30 and 60 day principal suspensions and to pay fines of $5,000 and $10,000, respectively, in connection with supervisory failures. Mr. Robert Eide, the firm’s resident was suspended for 15 days and fined $15,000 for failing to disclose more than $640,000 in outstanding liens.
Report: The Australian Securities Investment Commission released its enforcement report for the first half of 2015. It outlines some of the important cases brought by the ASIC (here).
False statements: The ASIC filed criminal charges against Andrew Ferguson, the former CEO of Australian Bight Abalone Ltd., Australia’s largest off-shore abalone farmer. The charges stem from furnishing false information to the board and investors.