This Week In Securities Litigation (Week ending July 13, 2018)

The President issued an Executive Order this week, exempting SEC ALJs from the competitive civil service. The order, based in part on the ruling in Lucia which held that SEC ALJs must be appointed in accord with the Constitution’s Appointments Clause, appears to be a response to the opinion of Justice Breyer in that case which was joined by two other justices. In his opinion Justice Breyer noted that that if the employment protections of the Administrative Procedure Act apply to SEC ALJs it would violate the Vesting Clause of the Constitution. The stay on filing contested administrative proceedings issued by the Commission in the wake of Lucia remains in place.

Investment Advisers and insider trading were key in securities enforcement actions this week. The Commission filed eight settled administrative proceedings tied to investment advisers, four based on testimonials and three centered on the pay-to-play rules. Another advisor case centered on what the Commission called the inconsistent application of procedures governing when a SAR is filed since the adviser, which terminated a number of client firms for violations of its rules, filed SARs in some instances but not in others. The Commission also filed two insider trading actions, one of which settled. Two criminal insider trading cases, one involving executives at two biopharmaceutical firms and one against a member of an international hacking ring, resulted in jury verdicts of guilty.


Executive Order: The President issued an Executive order Exempting Administrative Law Judges from the Competitive Service on July 10, 2018. The Order is based on section 3302 of Title 5, U.S.C. which provides in part that “The President may prescribe rules governing the competitive service. The rules shall provide, as nearly as conditions of good administration warrant, for (1) necessary exceptions of positions from the competitive service . ..”

OCIE: The National Exam Program issued a Risk Alert listing the most frequently cited compliance deficiencies relating to adviser best execution obligations (here).


Taskforce: Deputy AG Rod Rosenstein announced the establishment of a new task force composed of the Department, the Bureau of Consumer Financial Protection, the SEC, and the FTC. The task force, established under an executive order, is on Market Integrity and Consumer Fraud. Its focus is on the investigation and prosecution of cases involving fraud on the government, the financial markets, and consumers.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 3 civil injunctive cases and 8 administrative proceedings, excluding 12j and tag-along proceedings.

Offering fraud: SEC v. Watkins, Civil Action No. 1:16-3298 (N.D. Ga.) is a previously filed action against attorney Donald V. Watkins, Sr. Mr. Watkins and his controlled companies are alleged to have defrauded professional athletes and other investors in connection with the offering of shares of a firm which was supposed to convert waste to energy. The Court granted summary judgment on one fraud claim involving an NBA star where the Commission demonstrated that the investor’s funds were diverted to the personal use of Mr. Watkins. Other claims remain. Remedies will be considered in the future. See Lit. Rel. No. 241696 (July 12, 2018).

Manipulation: SEC v. Dynkowski, Civil Action No. 1:09-361 (D. Del.) is a previously filed action against, among others, Joseph Magiapane, the last remaining defendant. The action centered on a pump-and-dump scheme regarding the shares of Asia Global Holdings Corporation. Mr. Magiapane was alleged to have assisted the scheme and laundered part of the proceeds. The registered representative settled the matter, consenting to the entry of a permanent injunction which the Court entered. The order prohibits future violations of Securities Act sections 5 and 17(a)(3) and requires the payment of $26,000 in disgorgement and an equal amount as a penalty. See Lit. Rel. No. 24197 (July 12, 2018).

Testimony Rule: In the Matter of Brian S. Eyster, Adm. Proc. File No. 3-18587 (July 10, 2018) is a proceeding which names as a Respondent, Mr. Eyster, an investment adviser representative and registered representative. Mr. Eyster is an investment adviser representative of ONIMCO and a registered representative of O.N. Equity Sales Co. Investment advisory and brokerage services are offered to individuals. Mr. Eyster hired marketing consultant Dr. Leonard Schwartz and his firm, Create Your Fate, LLC in September 2015. That firm provides a service called Squeaky Clean Reputation through which testimonials are solicited on behalf of the adviser which are posted to various websites. Dr. Schwartz and his firm sent emails to clients of Mr. Eyster soliciting testimonials. Four were received and posted on whose purpose is to aid people looking for a good local business. Three video testimonials were also created which described the advisory services offered. The videos were published on and ONIMCO had polices and procedures that prohibited recommendations, testimonials and endorsements. Under Advisers Act Section 206(4) and rule 206(4)-1)a-(1) it is a fraudulent, deceptive, or manipulative act, practice for any investment adviser registered with the Commission to publish or otherwise distribute an advertisement which refers to any testimonial of any kind regarding the adviser. Here ONIMCO violated and Mr. Eyster caused the firm to violate section 206(4) and the related rule. To resolve the proceedings Mr. Eyster consented to the entry of a cease and desist order based on the section and rule cited in the Order. In addition, he agreed to pay a penalty of $10,000. See also In the Matter of HBA Advisors, LLC, Adm. Proc. File No. 3-18588 (July 10, 2018)(action against adviser and its founder Jaime Enrique Biel who also retained the services of Dr. Schwartz re testimonials; the action is based on facts similar to those above; resolved with a cease and desist order against each Respondent based on the same section and rule, a censure of the firm, and the payment by the firm of a $15,000 penalty); In the Matter of William Greenfield, Adm. Proc. File No. 3-18586 (July 10, 2018)( proceeding naming investment adviser representative as Respondent who retained Dr. Schwartz re testimonials; the action is based on facts similar to those above; resolved with a cease and desist order based on the same section and rule and the payment of a $10,000 penalty); In the Matter of Leonard S. Schwartz, Adm. Proc. File No. 3-18589 (July 10, 2018)(proceeding naming as a Respondent the owner of the firm retained by the individuals and firm listed above and one other adviser re testimonials; Dr. Schwartz received notice of the testimony rule from an adviser and reviewed the applicable section prior to accepting engagements from Mr. Eyster, HBA, Mr. Greenfield and another adviser but persisted; resolved by consenting to the entry of a cease and desist order based on causing violations of the same section and rule involved in the proceedings above and the payment of a $35,000 penalty).

Pay-to-play: In the Matter of Sofinnova Ventures, Inc., Adm. Proc. File No. 3-18583 (July 10, 2018) is a proceeding which names as a Respondent the registered investment adviser. Prior to March 22, 2017 the firm was an “exempt reporting adviser.” Between July 2011 and August 2011 the Illinois Teacher’s Retirement System or TRS, committed to invest $40 million with Respondent. The public pension plan did in fact invest at least $33.2 million with Sofinnova. Subsequently, TRS committed to invest $50 million with the adviser. At lest $12.5 million was invested. In April 2014 a covered associate – essentially a partner or manager, employee who solicits a government entity for an adviser or a political action committee for the adviser – made a $2,500 campaign contribution to a candidate for Governor of Illinois, a person who has the ability to influence investments by TRS. Later the covered associate sought and obtained a return of the contribution. For eight months following the contribution Respondent continued to provide advisory services for compensation to the Funds. Advisors Act rule 206(4)-5(a)(1) prohibits a registered investment adviser, foreign private adviser, or exempt reporting adviser from providing advisory services for compensation to a government entity within two years of making a contribution to an official of the government entity who was an incumbent, candidate or successful candidate for elective office if the office is directly or indirectly responsible for or can influence the outcome of the hiring of the adviser. These pay-to-play rules do not require a quid pro quo. Rather, the contribution triggers a two year “time out” period. The Order alleges violations of the rule and Advisers Act section 204(4). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section and rule cited in the Order. The firm was also censured and agreed to pay a penalty of $120,000. See also In the Matter of Oaktree Capital Management, L.P., Adm. Proc. File No. 3-18585 (July 10, 2018)(Respondent is a registered investment adviser; the proceedings are based on facts similar to those above; resolved with a cease and desist order based on the same section and rule, a censure and the payment of a $100,000 penalty); In the Matter of Encap Investments L.P., Adm. Proc. File No. 3-18584 (July 10, 2018)(Respondent is an “exempt reporting adviser;” the proceedings are based on facts similar to those above; resolved with the entry of a cease and desist order based on the section and rule cited above, a censure and the payment of a $500,000 penalty).

Misappropriation: SEC v. Bahgat, Civil Action No. 17-cv-0971 (W.D.N.Y.) is a previously filed action against Tarek Bagat, a manager at an advisory firm who is alleged to have misappropriated client funds. Previously, he consented to the entry of a permanent injunction based on Advisers Act Sections 206(1) and (2). The question of monetary remedies was reserved for the Court. On motion of the Commission, the Court entered a judgment imposing a civil penalty in the amount of $7,500 to be paid in $100 installments. See Lit. Rel. No. 24192 (July 10, 2018).

Financial fraud: In the Matter of Advanced Drainage Systems, Inc., Adm. Proc. File No. 3-18582 (July 10, 2018) names as Respondents the firm, a manufacturer of corrugated plastic pipe and drainage systems, and Mark Sturgeon, its CFO. In July 2014 the firm conducted an IPO. Subsequently, on March 29, 2016 the firm restated its financial statements for fiscal years 2014 and 2015. The firm had inadequate systems and internal controls which resulted in an overstatement of revenue for fiscal years 2013, 2014 and 2015 by, respectively, 20%, 5% and 90%. The Order alleges violations of Securities Act sections 17(a)(2) and (3) and Exchange Act sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the matter the firm consented to the entry of a cease and desist order based on each of the sections cited in the Order except 13(b)(5). The firm will also pay a penalty of $1 million. Mr. Sturgeon consented to a similar order as to each section cited in the Order. In addition, he agreed to repay the firm $173,970, representing his profits from the sale of ADS stock in accord with SOX section 304(a). He is also denied the privilege of appearing or practicing before the Commission as an accountant. The Commission considered the prompt remedial acts of the firm in accepting the offer of settlement.

Insider trading: SEC v. Shen, Civil Action No. 5:18-cv-04104 (N.D. Cal. Filed July 10, 2018) names as a defendant Gene Shen, the former Principal Scientist at Pacific Biosciences of California, Inc. The firm developed and manufactured genetic sequencing technology. In 2013 Pacific Biosciences entered into an agreement regarding the development of a new genetic sequencing platform. Specifically, F. Hoffman La Roche agreed to make significant payments to the company when it achieved each of three milestones toward the development of that platform. For each of the first two milestones Roche would pay the firm $10 million. At the launch Pacific Biosciences would receive $20 million. During the development of the platform Mr. Shen received periodic updates on progress toward the milestones. In advance of each milestone Defendant Shen traded profitably during a company blackout period. Overall he had trading profits in excess of $40,000. A relative he tipped had gains of about $1,360. The complaint alleges violations of Exchange Act section 10(b). Mr. Shen resolved the matter, consenting to the entry of a permanent injunction based on the section cited in the complaint. He also agreed to pay disgorgement of $40,622, prejudgment interest of $4,228 and a penalty of $88,192. See Lit. Rel. No. 24194 (July 10, 2018).

Insider trading: SEC v. Carr, Civil Action No. 3:18-cv-01135 (D. Conn. Filed July 10, 2018) names as defendants Robert Carr, the founder of Heartland Payment Systems, Inc. and its CEO, and Katherine Hanratty, the co-owner of a Connecticut based staffing agency. The action centers around the acquisition of Heartland by Global Payments, Inc., announced on December 15, 2015. Mr. Carr was deeply involved in the negotiations which resulted in the acquisition of his company by Global from October through the announcement date in December 2015. During that period he had a romantic relationship with Ms. Hanratty. Over the period she frequently expressed concern regarding her financial security. Mr. Carr, as the deal negotiations progressed, periodically discussed the deal with her. On November 15, 2016 Mr. Carr gave Ms. Hanratty a check for $1 million which was marked “loan.” He told her to invest $900,000 in the shares of Heartland. Ms. Hanratty purchased the shares. Following the deal announcement she had profits of over $250,000. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24191 (July 10, 2018).

SARs: SEC v. Charles Schwab & Co., Civil Action No. 18-cv-3942. Schwab, a broker-dealer and investment adviser, offers a broad range of services to Investment Advisers and their clients. Those advisers are independent third-parties who contract with Schwab for custodial and execution services. In 2012 and 2013 Schwab terminated its relationship with 83 Advisers. The terminations were based on Schwab’s conclusion that the advisers had violated internal firm policies, presenting a risk to the broker-dealer or its customers. Of the 83 terminated advisers, 47 engaged in transactions that met the dollar limit for filing a SAR. Schwab chose to file SARs regarding only 10 of the 47, three of which were filed after the Commission filed an enforcement action against the terminated adviser. The firm’s “failure to file the SARs at issue resulted from its inconsistent implementation of policies and procedures for identifying and reporting transactions under the SAR Rule,” according to the complaint. Schwab had a SAR policy that stated it should file a SAR on any transaction of $5,000 or more that ‘involves potential fraud.’” The policy also includes a broad definition of Securities Fraud. Nevertheless, the broker-adviser failed to make filings regarding transactions that involved: 1) possible self-dealing or conflict of interest; 2) the use of Schwab’s management fee system to charge client accounts excessive advisory fees; 3) patterns of potentially fraudulent transactions such as “cherry picking;” 4) advisers who used the client login information to effect or confirm a transaction; and 5) advisers who allowed their registration to lapse but continued to execute client trades and collect advisory fees. Schwab also used an “unreasonably high” standard to determine if a SAR should be filed regarding transactions it suspected involved possible misappropriation or other misuse of client funds, according to the complaint. This conduct is alleged to have violated Exchange Act section 17(a) and rule 17a-8 thereunder. To resolve the action Schwab consented to the entry of a permanent injunction based on the section and rule cited in the complaint. The firm also agreed to pay a penalty of $2.8 million.

Criminal Cases

Manipulation: U.S. v. Goodrich, Nos. 14-cr-399 and 16-cr-630 (E.D.N.Y.) are actions in which registered representative Darren Goodrich was sentenced to serve 41 months in prison in each case for one count of conspiracy to commit securities fraud. Once case centered on the manipulation of the shares of Cubed, Inc. from March 2014 to July 2014. There Mr. Goodrich and his co-conspirators artificially controlled the share price of the stock following a reverse merger using coordinated purchases and bids. In a second manipulation that took place from 2008 through 2010 Mr. Goodrich and others obtained control over large blocks of the shares of the Target Companies and pumped up the share price, sold their shares, and let the share price drop.

Insider trading: U.S. v. Chan, No. 1:16-cr-10268 (D. Mass. Jury Verdict July 10, 2018) named as defendants Schultz Chan, the Director of Biostatistics, a Cambridge based biopharmaceutical firm, and Songjiang Wang, the Director of Statistical Programming at another biopharmaceutical firm. The two men were friends. From August 2013 to September 2015 the two friends each furnished the other information regarding a clinical drug trial or study at their respective firms. Each man then traded in the shares of the other’s employer. At one point Mr. Wang loaned his friend cash which he used to trade profitably. The funds were repaid. A jury convicted each man of conspiracy and securities fraud. The date for sentencing has not been set. See also SEC v. Chan, Civil Action No. 1:16-cv-11106 (D. Mass.).

Insider trading: U.S. v. Korchevsky, No. 1:15-cr-00381 E.D.N.Y.). Vitaly Korchevsky, a former Wall Street Banker and investment adviser but now a Pennsylvania pastor, was convicted of participating in a sprawling, international insider trading and hacking ring that is alleged to have generated over $100 million in trading profits during a five year period. Mr. Korchevsky was alleged to have been part of a subgroup within the international ring known as the Dubovoy trading group. It was headed by Arkadiy Dubovoy who, prior to the trial, pleaded guilty and then testified against his former group member. At trial the government also presented an analysis of Mr. Korchevsky’s trading prepared by an SEC economist. That testimony demonstrated that prior to joining the group, Mr. Korchevsky generated trading losses. Once he joined the group, however, his results improved, resulting in trading profits of over $8.5 million, according to a Bloomberg report of the trial. The date for sentencing has not been set. See also SEC v. Dubovoy, Civil Action No. 15-cv-06078 D.N.J.).

Hong Kong

ALP: The Securities and Futures Commission reprimanded and fined Citigroup Global Markets Asia Ltd. $4 million for regulatory breaches regarding its operation of an alternative liquidity pool. Only fully informed and qualified investors are permitted to be users of the ALP. From December 2015 through August 2016 however, due to an incorrect system setting of client profiles over 130 clients accessed Citi Match without being assessed if they were qualified or being provided with the applicable guidelines. In resolving the matter the SFC considered the remedial steps and cooperation of CGMA.

Due diligence: The SFC reprimanded and fined CCB International Capital Limited $24 million for failing to discharge its duties as the sole sponsor in the listing application of Fujian Dongya Aquatic Products Co., Ltd. in 2013 and 2014. Specifically, the SFC found that the firm failed to conduct reasonable due diligence regarding the firm and its customers and to keep a proper audit trail. In part the due diligence plan called for CCBIC to assess the firm’s overseas customers and their third party payers who accounted for most of the revenues. In fact CCBIC did not complete the due diligence plan prepared by counsel.

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