This Week In Securities Litigation (Week ending July 14, 2017)

Recently installed Chairman Jay Clayton delivered his first remarks this week, outlining his views for moving forward. The Chairman emphasized IPOs, market structure, assessing the impact and cost of regulations and cyber security.

SEC Enforcement brought four civil injunctive actions this week. With one exception, involving the manipulation of four microcap stocks using two boiler rooms, the cases were “all in the family: One involved insider trading by a husband with information obtained from his attorney wife; another insider trading case involved a shop keeper using information alleged to have been obtained from his sister who knew an insider at a company involved in a transaction; and an offering fraud was alleged to have been implemented by a mother and son.


Remarks: SEC Chairman Jay Clayton delivered remarks at the Economic Club of New York, July 12, 2017. In his remarks the Chairman outlined guiding principles for the agency which included focusing on its investor mission, considering the cost impact of regulations, coordination with other regulators, addressing the dwindling number of IPOs and cybersecurity (here).

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 4 civil injunctive cases and no administrative proceedings, excluding 12j and tag-along proceedings.

Insider trading: SEC v. Yan, Civil Action No. 1:17-cv-05257 (S.D.N.Y. Filed July 12, 2017). Defendant Fei Yan is a citizen of China. He resided in Cambridge, Massachusetts where he was an engineering postdoctoral associate at an academic institution. He married Attorney A who was a junior corporate associate in the New York office of an international law firm. The action centers on two separate transactions. One involved the tender offer for Mattress Firm Holdings Corp. by Steinhoff International Holdings N.V., announced on August 7, 2016. The second is the acquisition of Stillwater Mining Company by Sibanye Gold Limited, announced on December 9, 2016. The Steinhoff – Mattress Firm discussions began in July 2015. By April 2016, when Attorney A joined the deal team, the firms were moving forward toward a deal. Mr. Yan opened a brokerage account in the name of his mother, Rongxia Wu, a citizen and resident of China. While the account documents appear to contain her signature, the email address was that of Mr. Yan. He funded the account with transfers from his bank account. He purchased shares of the firm, accumulating 300. During the period he talked with Attorney A virtually every day as was their custom. On Sunday, August 7, 2016 the Mattress Firm – Steinhoff deal was announced. The share price increased the next trading day by about 114%. Mr. Yan sold all of his shares, netting about $9,726 in profits. The Sibanye – Stillwater deal began while the Mattress Firm transaction was unfolding. In March 2016 the two firms began discussions. Attorney A did not learn about the possible transaction until late August 2016. As the deal discussions progressed, Attorney A worked on the transaction virtually every day. Mr. Yan subsequently purchased options that were due to expire in mid-December 2016. As the deal he continued to purchase options. He also researched the company and how to detect insider trading. On December 9 the Stillwater – Sibanye deal was announced. The day before the deal announcement Mr. Yan purchased additional options, increasing his holdings to 695. Following the deal announcement he sold his options, netting about $109,702. The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). The Manhattan U.S. Attorney’s Office filed parallel criminal charges. Both cases are pending.

Manipulation: SEC v., Civil Action No. 2:17-cv-04133 (E.D.N.Y. Filed July 12, 2017) is an action which names as defendants three groups: The Orchestrator Defendants – Stephanie Lee, Jeffrey Chartier, Lawrence Isen, Robert Gleckman and Michael Watts; two boiler rooms and their affiliates—Power Traders Inc. and Erik Matz and Ronald Hardy and Elite Stock Research Inc. and Anthony Vassallo; and the Boiler Room Defendants –the two firms, their control persons identified above and additional salespersons. Beginning in March 2013 the defendants engaged in the manipulation of four microcap stocks, reaping $14 million in profits and causing over $10 million in losses. The schemes were set up and promoted by the Orchestrator Defendants and promoted by the boiler rooms and the Boiler Room Defendants. Essentially the promotions involved marking-the-close, matched orders, wash trades and the use of misleading promotional statements to induce investors to participate and manipulate the market. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 9(a)(1), 9(a)(2), 10(b) and 15(a). A parallel criminal action was filed by the U.S. Attorney’s Office for the Eastern District of New York. Both cases are pending.

Insider trading: SEC v. Ho, Civil Action No. 6:17-cv-00895 (W.D. La. Filed July 11, 2017). Defendant Victory Ho is a self-employed convenience store operator. The action centers on the acquisition of The Shaw Group, Inc., an engineering and infrastructure firm, by Chicago Bridge & Iron Company, a Netherlands Company specializing in energy infrastructure, announced on July 30, 2012. On July 27, 2012, the last trading day before the deal announcement, Mr. Ho used all the cash in his brokerage account to purchase 296 out of the money Shaw call options. On July 17, 2012, the day before opening two brokerage accounts at different firms, Mr. Ho’s sister had what the complaint calls a significant number of calls and texts with a friend employed at Shaw who had inside information. In the hour prior to opening the account Mr. Ho had seven texts or calls with his sister. On July 26 Mr. Ho’s sister and the Shaw employee exchanged additional calls and texts. Those were interspersed with texts and calls by Mr. Ho’s sister to him. During the staff investigation Mr. Ho invoked his Fifth Amendment privilege. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23877 (July 12, 2017).

Offering fraud: SEC v. Wayland, Civil Action No. 8:17-CV-01156 (C.D. Cal. Filed July 6, 2017). The case centers on an offering fraud promoted using a boiler room over a two year period beginning in 2014 by a mother, her son, their entities and three salesmen. Carol Wayland is the mother; John Mueller is her son; Kentucky-Tennessee 50 Wells/400 BBLPD Block, Limited Partnership, HP Operations, LLC and C.A.R. Leasing, LLC are their firms; and Mitchell Dow, Barry Liss and Steve Blasko are their salesmen. About 41 investors scattered across the nation put up over $2.4 million to purchase unregistered securities in the form of limited partnership units. Investor funds were sent to K-T 50. The goal was to raise $10 million. To solicit investors Ms. Wayland and her son set up “Sahara Wealth Advisers” in Irvine, California. A website was established along with Linkedin and Facebook accounts. Two press releases were issued. A boiler room operation was set up with misrepresented the returns and the experience of those involved. And, Ms. Wayland and Mr. Mueller misappropriated much of the investor money. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of 17(a) and of Exchange Act Sections 10(b) and 15(a). The action is pending. See Lit. Rel. No. 23876 (July 7, 2017).

Court of Appeals

Disclosure: ZPR Investment Management Inc. v. SEC, No. 16-153263 (11th Cir. Decided June 30, 2017). Registered investment adviser ZPR Investment was founded in 1994 its now president and sole shareholder, Respondent Max Zavanelli. To enhance the reputation of his firm, Mr. Zavanelli had the firm adopt the Global Investment Performance Standards or GIPS. Adoption of the voluntary standards assures investors that the presentation of investment performance is based on full disclosure under specified requirements that permit an “apples to apples” comparison among firms.

Beginning in early 2008 the adviser placed advertisements in financial magazines claiming to be GIPS compliant. These claims were considered important by Mr. Zavanelli in marketing institutional clients. More advertisements claiming GIPS compliance were taken out in the fall of 2008. While those published in the spring of 2008 were in fact GIPS complaint, those in the fall were not. If the fall ads had been GIPS complaint they would have shown that the firm’s performance lagged behind its benchmark index by as much as 10%.

Mr. Zavanelli also published a newsletter. In the April and December 2009 editions he wrote that the firm was GIPS compliant. The December edition contained disclaimers, however, which stated in part that the “investment report you are reading is not GIPS compliant. It was never intended to be nor can it be. . . Our report remains not GIPS compliant.”

Following an inspection, in early 2010 the SEC staff informed the adviser in a letter that while its December 2008 advertisement claimed GIPS compliance, it was not. The staff sent a second letter in August noting that an investigation was being conducted. Despite these letters in furnishing Morningstar information for reports in August 1010 and later in March 1011 a firm employee responded “no” to a question about whether the adviser was under investigation. The firm continued to publish ads in early 2011 claiming GIPS compliance when it was not, despite assurances to the SEC staff that it would make sure all ads were in fact compliant.

The Commission instituted an administrative proceeding against the firm and its founder, charging violations of Advisers Act Sections 206(1), (2) and (4). Ultimately the Commission concluded that the firm violated each of the Sections based on the fall 2008 and spring 2011 magazine adds, the 2009 newsletters and the 2011 Morningstar report. It also found that the firm violated Advisers Act Sections 206(2) and (4) as to the 2010 Morningstar report. Mr. Zavanelli was determined to be liable for all of the misrepresentations regarding GIPS compliance in violation of Advisers Act Sections 206(1) and (2) and for aiding and abetting the violations by the firm. The Commission imposed a cease and desist order on both Respondents, an industry bar on Mr. Zavanelli, and a civil penalty of $575,000 on him and $250,000 on the firm.

The Eleventh Circuit granted it in part and denied it in part a Petition for Review . Specifically, the Court vacated the violations and monetary sanctions regarding the December 2009 newsletter but affirmed the other violations and sanctions in the Commission’s order. The key issue was if the misrepresentations were material. The question of materiality is determined at the time of the alleged misstatement, the Circuit Court noted. In this case, with one exception, there can be no doubt that the misstatements regarding compliance with the GIPS standards were material. Compliance with those standards is important to the reasonable investor as the Commission found. The point is bolstered by Mr. Zavanelli who had concluded that GIPS compliance would enhance the firm’s marketing, particularly with institutional investors. Petitioners’ claims that the information was later furnished to the investors and that it was available on the adviser’s website do not change the misleading nature of the statements.

The December 2009 newsletter is different. There on the page after the misleading statement investors were specifically told that the report was not GIPS compliant. The disclaimer went on to note that the report was never intended to be GIPS compliant. This rendered the initial false claim immaterial. While general cautionary language or boiler plate would not suffice, in this instance the disclaimer was clear and unequivocal, addressing the exact question of GIPS compliance. Accordingly, the Court reversed the Commission’s determination on this point.

Hong Kong

Remarks: Ashley Alder, CEO, delivered remarks titled Front-loaded, transparent and direct: A new approach to regulation for changing markets to the HKSI Institute Roundtable Luncheon Series (July 13, 2017). His remarks focused on rethinking the listing process and their enforcement program which was being overwhelmed (here).

MOU: The Securities and Futures Commission of Hong Kong and the Autorite des Marches Financiers of France executed a memorandum of understanding which will allow eligible Hong Kong public funds and French UCITS funds to be distributed to retail investors in each other’s markets through a streamlined authorization process. The agreement also establishes the regulatory framework for distribution of eligible funds which include general equity funds, bond funds and mixed funds. A provision of the agreement calls for regular dialogue and regulatory cooperation between the two regulators.

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