This Week In Securities Litigation (Week ending Jan. 26, 2017)
Distributed ledger technology or DLT, virtual currencies and the related markets were the center of discussion this week. SEC Chairman Jay Clayton delivered remarks at one conference sternly warning that the Commission would hold accountable market professionals who failed to fulfill their gatekeeper functions involved ICO transactions in those markets. His remarks echoed a statement published earlier by the Directors of SEC and CFTC Enforcement Divisions, cautioning virtual market participants. The Chairman followed-up on his remarks by publishing an op-ed article in the Wall Street Journal with CFTC Chairman J. Christopher Giancaro on DLT technology and the role of regulators regarding this evolving technology and its markets. And, the CFTC filed two more fraud actions centered on virtual currencies.
Statement: Chairman Jay Clayton and CFTC Chairman J. Christopher Giancaro issued a joint statement that contained excerpts from their op-ed article published in the Wall Street Journal on January 25, 2018 regarding distributed ledger technology (here).
Remarks: Chairman Jay Clayton, Opening Remarks at the Securities Regulation Institute, Washington, D.C. (Jan. 22, 2018). His remarks focused in part on the duties of market professionals and gatekeepers in the markets (here).
Statement: The Directors of Enforcement for the SEC and CFTC issued a joint statement regarding virtual currency enforcement actions at the close of last week. SEC Enforcement Co-Directors Stephanie Avakian and Steven Peikin and CFTC Enforcement Director James McDonald cautioned: “When market participants engage in fraud under the guise of offering digital instruments . . . The SEC and CFTC will look beyond form, examine the substance . . . and prosecute violations . . .” (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 2 civil injunctive cases and 4 administrative proceedings, excluding 12j and tag-along proceedings.
Misappropriation: SEC v. Quicksilver Stock Transfer, LLC, Civil Action No. 2:18-cv-00131 (D. Nev. Filed Jan. 24, 2018) is an action against the registered transfer agent and its sole owner and principal, Alan Shinderman. The complaint centers on $1.45 million received in August 2013 by the transfer agent for the benefit of China Energy Corporation, a client of Quicksilver. Defendant Shinderman diverted about $630,000 of those funds and used $500,000 for a loan that was to pay the transfer agent 4% and be repaid in four days. It was not timely repaid. At that point Quicksilver did not have the funds to disburse to the shareholders of China Energy. After receiving a demand from the client, Mr. Shinderman recovered the amount of the loan and the funds were forwarded as required on November 6, 2013. The complaint alleges violations of Exchange Act Sections 10(b) and 17A(d)(1) which requires transfer agents to have possession or custody of funds related it its transfer activities to assure that all such funds are protected against misuse. Defendants also violated Rule 17Ad-13 which requires transfer agents to file an independent accountant’s report regarding its system of internal controls and related procedures for safeguarding client assets. The case is in litigation. See Lit. Rel. No. 24033 (Jan. 24, 2018).
Failure to disclose: In the Matter of AmericaFirst Capital Management, LLC, Adm. Proc. File No. 3-18349 (Jan. 23, 2018) names as Respondents the firm, a registered investment adviser with primarily retail clients, Rich Gonsalves, its founder, a partial owner and CEO, and Robert Clark, a principal and part owner of the firm and its president and COO. The firm, which had over 25 individual retail clients, struggled with its ongoing business and marketing expenses. Mr. Gonsalves authorized COO Clark, beginning in December 2012 and continuing over the next three years, to raise additional cash by selling promissory notes issued by the firm with an interest rate of 12%. During the period they raised about $1.4 million and renewed about $1.3 million in promissory notes. While investors were informed the notes were to pay for operating expenses, they were not told that the firm may default or its actual operating condition. The Order alleges violations of Securities Act Section 17(a)(2). In resolving the proceedings the firm agreed to certain undertakings, including having its CCO prepare a report detailing all the borrowings and notes along with recommendations which would be adopted regarding the firm’s compliance procedures. Each Respondent settled, consenting to the entry of a cease and desist order based on Securities Act Section 17(a). The firm also agreed to a censure and to pay a penalty of $50,000. Messrs. Gonsalves and Clark will each pay a penalty of $25,000.
Misappropriation: In the Matter of Brian Sweet, CPA, Adm. Proc. File No. 3-18347 (Jan. 22, 2018); In the Matter of Cynthia Holder, CPA, Adm. Proc. File No. 3-18346 (Jan. 22, 2018). Those charged in the actions are: Brian Sweet, CPA, a partner in KPMG’s Professional Practice group and previously an Associate Director, PCAOB inspections group; Cynthia Holder, CPA, an Executive Director in KPMG’s Department of Professional Practice after being an Inspections Leader at the PCAOB; Jeffrey Wada, CPA, an Inspections Leader at the PCAOB; David Middendorf, CPA, KPMG’s National Managing Partner for Audit Quality and Professional Practice; Thomas Whittle, CPA, KPMG’s National Partner-In-Charge for Inspections; and David Britt, CPA, KPMG’s Banking and Capital Markets Group Co-Leader. In September 2014 the PCAOB issued an inspection report regarding KPMG’s 2013 audits. It concluded that almost half — 23 of 50 – of the engagements reviewed were deficient. The prior year only 34% of the engagements reviewed were found to be deficient. KPMG was ranked third among the big four accounting firms based on the 2013 inspections. Subsequently, Mr. Sweet was hired by the audit firm as a partner in the Department of Professional Practice. He was responsible for conducting internal inspections of KPMG audits. Mr. Sweet reported to Thomas Whittle who was responsible for overseeing both the Board’s inspections and KPMG’s internal inspections. Mr. Whittle reported to David Middendorf who oversaw the National Office’s audit quality and professional practice work. Mr. Sweet’s retention marked the beginning of a series of discussions in which KPMG officials solicited, and Mr. Sweet and later other former Board staff members furnished, confidential PCAOB information about its inspection process and, in particular, the plans for inspections at the audit giant. When the general counsel’s office at KPMG learned about the contacts and information gathering an investigation was launched. Mr. Sweet settled, consenting to the entry of a cease and desist order from committing or causing any violations and any future violations of certain PCAOB Ethics Code Sections. He is also denied the privilege of appearing or practicing before the Commission as an accountant. Mr. Sweet agreed that a hearing will be held at the conclusion of all related proceedings on questions of monetary sanctions. The other proceeding naming five accounts as Respondents will be set for hearing. The Manhattan U.S. Attorneys Office parallel criminal charges.
Offering fraud: SEC v. Narayan, Civil Action No. 16-cv-1417 (N.D. Tex.) is a previously filed action which named as Defendants Mr. Narayan, a member of the board of Defendant Ticket Reserve Inc., Richard Harmon, who controlled the firm and was CEO and John Kaptrosky, the COO of the firm. Messrs. Harmon and Kaptrosky settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). In addition, Mr. Harmon will pay $620,078.22 in disgorgement and prejudgment interest and a penalty of $325,000. Monetary penalties as to Mr. Kaptrosky will be resolved at a later date. The complaint alleges that the Defendants engaged in an offering fraud, raising funds from investors through the firm without disclosing that the company was in financial distress. In addition, Mr. Harmon misappropriated over $500,000 of investor cash. Mr. Narayan, who previously settled with the Commission, was alleged to have misappropriated about $2 million. See Lit. Rel. No. 24030 (Jan. 22, 2018).
Valuation: In the Matter of Gemini Fund Services, LLC, Adm. Proc. File No. 3-18348 (Jan. 22, 2018) is a proceeding which names the firm, a full service mutual fund administrator, as a Respondent. One of the firm’s obligations was to prepare an NAV calculation and transmit it to the public through NASDAQ securities exchange. In 2013 and 2014 the firm reported out incorrect numbers because the calculation included fake assets. Specifically, Daniel Thibeault, a Managing Director of GL Capital Partners, LLC and its co-portfolio manager, misappropriated investor funds beginning in early 2013 from GL Beyond Income Fund, by creating false loans through a special purpose entity he controlled called Taft Financial Services, LLC. GL Fund is a registered investment company Mr. Thibeault created that was managed by GL Capital, an investment adviser he controlled. By the end of January 2014 there were 22 Taft loans valued at about $8 million. (Eventually Mr. Thibeault pleaded guilty to criminal securities fraud). The custodial bank that held the assets during the period here did not count the Taft loans because they lacked adequate documentation. Gemini, in contrast, did count the loans in the valuation and did not investigate the concerns of the custodial bank. The Order alleges violations of Advisers Act Sections 206(1) and 206(2). To resolve the proceedings Respondent agreed to implement a series of undertakings which include the retention of a consultant. The firm also consented to the entry of a cease and desist order based on the Sections cited in the Order. Gemini agreed to pay disgorgement of $147,334, prejudgment interest of $14,072 and a penalty of $400,000.
Offering fraud: SEC v. Vazquez, Civil Action No. 8:18-cv-00047 (C.D. Cal. Filed Jan. 12, 2018) is an action which names as Defendants Daniel Vazquez, Gilbert Fluetsch and Hoplon Financial Group. Mr. Vazquez owned Hoplon. Mr. Fluetsch was the firm’s COO. In 2011 Messrs. Vazquez and Hoplon created New Economic Opportunities Fund I, LLC, a pooled investment vehicle, to purchase and flip real estate. Over a period of about three years, beginning in June 2011, Mr. Vazquez and Hoplon raised about $2.18 million from investors in the Fund. While some of the investor money was used to acquire real estate, much of it was diverted to pay the expenses of Hoplon and to the personal use of Messrs. Vazauez and Fluetsch. The complaint alleges violations of Securities Act Section 17(a)(2) and Exchange Act Sections 10(b) and 15(a). The case is in litigation. See Lit. Rel. No. 24031 (Jan. 22, 2018).
Virtual currency: CFTC v. McDonnell, Case No. 18-cv-0361 (E.D.N.Y. Filed Jan. 18, 2018). Named as defendants are Patrick McDonnell and his firm, Cabbage Tech, Corp, d/b/a Coin Drop Markets. Neither Defendant has ever been registered with the CFTC. Beginning in January 2017, and continuing until at least July of that year, the Defendants solicited investors who wanted to receive expert trading advise, expert trade signals and perhaps invest along side experts. Solicitations were made by the Defendants in the United States and other countries. Mr. McDonnell, who claimed to be, among other things, the Chief Technology Officer of his firm, and Coin Drop told investors that they could subscribe for services such as a “Turn-Key Annual Membership” that provide access to the CTO’s expertise, mentorship and guidance. A variation of this claim involved purchasing a Lifetime Membership which claimed to offer returns as high as 300% in one week. The promotional materials amplified these claims with statements about “continuous, ongoing monitoring and trading signals . . .” and a dedicated team of “digital asset trading specialists . . .” These advantages were all tied to the expertise of Mr. McDonnell who was represented on the website as having made a single virtual currency trade that generated a 1,000% return. To secure the benefits of Defendants’ expertise, investors were required to pay an up-front fee. When the fee was paid Defendants stopped communicating with that investor. The investor funds were misappropriated. The complaint alleges violations of fraud Section 6(c)(1) of the CEA. The case is in litigation.
Virtual currency: CFTC v. Benge, Case No. 1:18-cv-10077 (D. Mass. Filed under seal Jan. 16, 2018) is an action which names as defendants My Big Coin Pay, Inc., Randall Crater and Mark Gillespie. Beginning in January 2014 Defendants operated a virtual currency scheme which continued until about June 2017. It raised approximately $6 million from at least 28 customers. Investors were solicited to invest in My Big Coin. Those investors were told that the currency was actively traded on several currency exchanges, that its daily prices were reported and that it was backed by gold. None of the claims were true. In fact the Defendants misappropriated virtually all of the investor funds. The complaint alleges fraud in violation of Section 6(c)(1) of the CEA. The case is in litigation.
Misappropriation: U.S. v. Larkin, No. 1:15-cr-00043 (E.D.N.Y.) is an action in which Diane Lamm, the manager of Capital Financial Group, LLC and Aegis Capital Fund LLC was sentenced to serve 36 months in prison following her guilty plea on two counts of securities fraud. The charges were based on two schemes. In the first, between 2009 and 2013, Ms. Lamm obtained over $11 million by promising Capital L investors to use their money to purchase, consolidate and sell registered investment advisory businesses. Rather, she and her co-defendant diverted the funds to their own use. In the second, Ms. Lamm and her co-defendant diverted over $2.4 million of investor funds from Aegis Capital to their own use. In addition, following the liquidation of that Fund rather than returning fund assets to investors as required, over $2 million of investor money was diverted to the use of Ms. Lamm and her co-defendant. The Court also ordered the defendant to pay restitution in the amount of $15,640,582.46.
Manipulation: U.S. v. Durante, No. 1:15-cr-00171 (S.D.N.Y.) is an action which named as defendants Edward Durante, a securities law recidivist, Christopher Cervino, formerly a broker, and others. In August 2016 Mr. Durante, a majority shareholder of penny stock firm VGTL, created a scheme to manipulate the share price which would allow him to sell his shares and bring other shareholders to the firm. Mr. Durante, along with Mr. Cervino and others, purchased shares of the firm using the brokerage clients of Mr. Cervino. In many instances clients were not aware of the transactions. In conducting these transactions Defendants took both sides of trades and manipulated the share price upwards from about $0.25 to as much a $1.90. Mr. Cervino was paid at least $35,000 for his assistance. Over all Mr. Durante purchased about $3.5 million shares through client accounts with the assistance of Mr. Cervino and another. Previously, Mr. Cervino pleaded guilty. This week he was sentenced to serve 53 months in prison followed by 3 years of supervised release. He was also ordered to forfeit $290,787. See also SEC v. Durante, Civil Action No. 1:15-cv-09874 (S.D.N.Y.)(settled by Mr. Cervino who consented to the entry of permanent injunctions which include a penny stock bar).
False Information: Andrew Ferguson, former CEO of Australian Bright Abalone, the largest Australian off-shore abalone farmer, was convicted of 17 counts of furnishing shareholders and the board of directors with false information. Following an Australian Securities and Investments Commission investigation, the former executive was charged with furnishing false information to investors. At trial he was also charged with furnishing false information to the board of directors. The jury returned a verdict of guilty on all counts. The firm is in administration.
Client Data: Chan Wai Nun, an investment counselor at DBS Bank, was suspended by the Securities and Futures Commission for a period of six months for violations of rules governing client data. Specifically, prior to moving to a new firm he transferred data for over 200 clients through his personal gmail account to a similar account of a friend at his new firm. The new firm discovered the transfer which is a violation of the applicable rules and reported it.