This Week In Securities Litigation (Week ending Jan. 25, 2019)

The partial government shutdown, which has left the halls of the Commission largely dark, continues to set a new record for its duration each day. Unfortunately, there is no end in sight. That leaves thousands of Commission staff and other government employees idle and without a paycheck.

As the halt continues the burden on most everyone increases. Many important services have been halted or curtailed. For business, and the investment community, for example, securities offerings are at a stand-still, severely delimiting options for firms that need to raise capital. As the traditional proxy season approaches, the difficulties for firms and their shareholders will only increase with the SEC staff unavailable for consultation or to provide guidance on critical issues. Investors whose interests the Commission is charged with protecting, are left unprotected. At some point perhaps the public that is so well served by the Commission and its staff, as well all of the other idled government workers, will bring sufficient pressure on those who should, but have failed, to govern and force a resolution.

SEC Enforcement – Filed and Settled Actions

In view of the partial government shut down the Commission did not file any new civil injunctive actions or administrative proceedings this week.


Risk Monitoring: The regulator announced its Risk Monitoring and Examination Priorities in a letter issued January 22, 2019. Key emerging issues included: 1) Online distribution platforms; 2) compliance with FinCEN’s Customer Due Diligence rule; and 3) compliance on mark-up and mark-down obligations on fixed income transactions with customers. Those areas are in addition to the ones which were key in earlier years. Those include sales practice risks, the hiring and supervision of associated persons with problematic regulatory history, cybersecurity, fraud, insider trading and manipulation across markets and products.

Criminal cases

Insider trading: U.S. v. Chow, No. 1:17-cr-00667 (S.D.N.Y.). Benjamin Chow was the co-founder of China-based private equity firm Canyon Bride Capital Partners. Over a period of about one year, beginning in March 2016, he is alleged to have illegally tipped his best friend Michael Yin. The information centered on transactions involving Lattice Semiconductor Corporation and private equity funds that were managed by Mr. Chow. Specifically, as the managing director of one firm, and the managing partner of another, Mr. Chow secured information concerning the potential merger agreements which he furnished to his friend. The two men had multiple meetings in Beijing, China and exchanged voice and text messages. Through those communications Mr. Yin secured information regarding each proposed transaction involving Lattice. For example, in one instance Mr. Chow told his friend that they soon expected to execute a merger agreement with Lattice, according to the translation of the conversation. Mr. Yin purchased shares of Lattice the next day. He continued to purchase shares over the next three weeks, acquiring about 2.2 million. Overall Mr. Yin had trading profits of about $5 million. Mr. Yin was charged with one count of conspiracy to commit securities fraud and thirteen counts of securities fraud. Mr. Chow was found guilty by a jury of conspiracy and seven counts of securities fraud. Although the government sought a sentence of over six years in prison, the Court ordered that Mr. Yin serve three months in prison, concluding that the prosecution request was excessive. See also U.S. v. Yin, No. 1:14-cr-00494 (S.D.N.Y.).

Court of Appeals

Definition of security: SEC v. Arcturus Corporation, No. 17-10503 (5th Cir. Jan. 7, 2019). The Commission’s complaint named as defendants Leon Ali Parvizian and his entities, Arcturus Corporation and Aschere Energy LLC. Also named as defendants were promoters Alfredo Gonzalex, AMG Energy, LLC, Robert Balunas and R. Thomas & Co. LLC. Over a period of about four years, beginning in 2007, Parvizian, through Arcturus and Aschere, raised about $22 million from 380 investors. The central question in the case, which focuses on an offering fraud. is whether the partnership interests sold to investors were securities. The district court granted summary judgment in favor of the Commission, finding violations of Securities Act sections 5(a), 5(c) and 17(a) and Exchange Act sections 10(b) and 15(a). The Circuit Court reversed and remanded for further proceedings since there were material factual issues.

The Circuit Court began by identifying the three key elements of an investment contact in accord with SEC v. W.J. Howey Co., 328 U.S. 23 (1946). They are: 1) investment of money; 2) in a common enterprise; 3) based on an expectation of profits to be made solely from the efforts of others. The Court then focused on the question of “solely” through the efforts of others.

Partnership interests such as those involved here may be securities within the meaning of Howey. Typically, however, interests in general partnerships fail the test – investors have sufficient authority and powers negating the need for the protections of the securities laws. Limited partners are different. Their authority is limited. Without significant power they become more like a shareholder and their interest may be viewed as a security.

The critical question of profits solely from the efforts of others – the third Howey factor — can be assessed by considering the factors set forth in Williamson v Tucker, 645 F. 2d 404 (5th Cir. 1981). Under the test of that case a partner is dependent “solely” on the efforts of a third party manager when: 1) an agreement among the parties leaves so little power in the hands of the partner that he or she essentially becomes a limited partner; or 2) the partner is so inexperienced that he or she is incapable of intelligently exercising his authority; or 3) the partner is so dependent on some unique entrepreneurial or managerial ability of the promoter that he or she cannot replace the person or exercise any meaningful partnership or venture powers.

Analysis of the first Williamson led the Court to reverse the district court grant of summary judgment. That factor centers on whether the arrangement deprives investors of power either through the documents or the implementation of the arrangements. Here fifteen investors submitted affidavits declaring that they had the power to, and did, vote on a variety of decisions. Those claims are confirmed by the record which “does not show that Areturus or Aschere took any significant actions without the investors’ prior approval.”

To further assess the position of the investors the Court analyzed the voting structure, the source of the investors’ information and the number of investors. Each point confirmed the Court’s initial analysis that defendants had presented sufficient facts to demonstrate that the investors in fact had authority, contrary to the SEC’s claim. Accordingly, based on the first factor the Court found the decision of the district court had to be reversed.

Consideration of the second and third Williamson factors did not alter Court’s conclusion. While the SEC argued that the investors were so inexperienced that they were essentially dependent on the managers – the second factor – the record did not support the claim. Likewise, the evidence was not as clear as SEC contended on the question of whether the managers were irreplaceable – the final factor. The arrangements are complex to be sure. That, however, is not sufficient. Nor is the fact that the managers controlled the investor funds adequate to support this point. The investors “sunk their capital into an exploratory drilling project knowing that they would not get it back unless the well became productive.” Overall the defendants offered sufficient evidence on the irreplaceable point, the Court concluded, to establish that there was a genuine issue of fact. Accordingly, the decision of the district court was reversed, and the case remanded for further proceedings.

Hong Kong

Market misconduct: The Market Misconduct Tribunal concluded that Ms. Samantha Keung Wai Fund, the former CEO of China AU Group Holdings Ltd., her long-time friend, Ms. Wu Hsiu Jung, and business partner, Mr. Chen Kuo-chen, engaged in a scheme in August 2009. It focused on using 14 securities trading accounts to buy and sell a substantial amount of shares in China to create a false and misleading impression of market activity and price. Ms. Keung lead the effort and was assisted by her friend and business partner. The tribunal thus imposed a disqualification order against her, a cold shoulder order and cease and desist order tied to the finding that she engaged in market misconduct. The panel also imposed a cold shoulder order and cease and desist order on her friend and business partner. The disqualification order against Keung precluded her from serving as a director or taking part in the management of a listed company for four years. The cold shoulder orders against Keung, Wu and Chen for four years, three years and two years, respectively, prevent them from dealing in any securities or futures contracts. The cease and desist orders prevent each from engaging in false trading.


Corruption: Four additional executives were sentenced in connection with the FH Bertling corruption investigations. The inquiry had two main facets. One involved the payment of bribes in Angola while the other was based on corruption in the firm’s North Sea oil exploration efforts. Messrs. Colin Bagwell, Christopher Lane, Giuseppe Morreale and Stephen Emler were each sentenced in connection with the North Sea part of the matter. There the payments were made to obtain a ConocoPhilips contract valued eventually at about $20 million. Corrupt payments of about $430,000 were made to obtain the contract and ensure that inflated prices would be passed through. Mr. Bagwell was sentenced to serve 9 months in prison, suspended for 2 year for his part in the bribery scheme involving overcharging freight forwards. He will pay a fine of about $6,000. Mr. Lane, who pleaded guilty prior to trial, was sentenced to serve six months in prison which was suspended. Messrs. Morreale and Emler were sentenced to 15 and 12 months respectively, each suspended for 2 years. Mr. Morreales was also directed to pay a fine of about $25,000 while Mr. Elmer will pay $17,500. In connection with the Angola scheme, Mr. Morreales was ordered to serve 2 years in prison and Mr. Elmer 18 months, to be suspended for 2 years and to run concurrently.

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