This Week In Securities Litigation (Week ending July 7, 2017)
In a holiday shortened week the Commission filed four actions: One arose from the failure of an adviser who arranged a transaction between two managed funds to honor the terms promised to one fund; a second charged the sister of a Ponzi scheme operator with selling unregistered securities in her brother’s fraudulent entity; a third was based on a CEO who misappropriated funds from his firm; and a fourth focused on an investment adviser overcharging clients an misappropriating funds.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 2 civil injunctive cases and 2 administrative proceedings, excluding 12j and tag-along proceedings.
Breach of duty: In the Matter of Paramount Group Real Estate Advisor LLC, Adm. Proc. File No 3-18060 (July 6, 2017) is an action naming as Respondent the registered investment adviser. Paramount advises two funds. It has an equity stake in each. In March 2014 Paramount caused one fund to sell a parcel of real estate to the second fund. As part of the transaction the selling fund was to be reimbursed for certain development expenses. The adviser, however, failed to secure such an arrangement from the purchasing fund or to obtain a waiver of those payments by the selling fund. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. Respondent will also pay a penalty of $250,000.
Financial fraud: SEC v. Petersen, Civil Action No. 15-cv-04599 (N.D. Cal.) is a previously filed action which named as a defendant Ryan Petersen, the former CEO of OCZ Technology Group Inc., a now bankrupt seller of computer memory storage and power supply devices. The complaint alleged that Mr. Petersen and others at the firm engaged in a scheme to materially inflate the firm’s revenues and gross margins over a two year period beginning in 2010. This week the Court entered a final judgment by consent. The court entered a judgment enjoining Mr. Petersen from future violations of Securities Act Sections 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The court also imposed a bar which precludes Mr. Petersen from serving as an officer and director of a public company and ordered him to pay $121,000 in disgorgement and relief under SOX Section 304(a), prejudgment interest and a penalty in the amount of $100,000. See Lit. Rel. No. 23874 (July 5, 2017).
Unregistered securities: SEC v. Jones, Civil Action No. 1:17-cv-11226 (D. Mass. Filed July 3, 2017) is an action against Cheryl Jones. Ms. Jones was retained by her brother Mark to assist with selling promissory notes. Those notes were supposed to be bridge loans for Jamaican firms waiting for permanent financing and pay interest of 15% to 24% annually. About 25 investors purchased notes, investing a total of about $14.5 million between 2007 and 2015. Ms. Jones received a 10% commission and another fee for her services. Her compensation was over $500,000. In fact her bother was operating a Ponzi scheme, has pleaded guilty to criminal charges and has been sentenced to prison. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). The case is in litigation. See Lit. Rel. No. 23872 (July 3, 2017).
Financial fraud: SEC v. LocatePlus Holdings Corp., Civil Action No. 10-cv-11751 (D. Mass) is a previously filed action against the firm, Jon Latorella and James Fields. The complaint alleged that the two men engaged in fraud by falsifying the financial reports of the firm. After pleading guilty in a parallel criminal action the Court here entered judgments by consent against each individual, permanently enjoining each from future violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). An officer and director bar was imposed as to each individual See Lit. Rel. No. 23873 (July 5, 2017).
Misappropriation: In the Matter of Bantry Bay Capital, LLC, Adm. Proc. File No. 3-18056 (June 30, 2017) is a proceeding which names as Respondents the registered investment adviser and Timothy Sexton, the founder and sole owner of the firm. The Order alleges that from late 2013 through 2015 Respondents charged two clients over $200,000 in excessive fees. Beginning in 2014 the clients also wired about $250,000 to an account at Bantry Bay for investment in a money market fund. The cash was misappropriated. Finally, the firm should not have been registered – its filings were falsified since the adviser did not have sufficient AUM. The Order alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 203A, 204, 206(1), 206(2), 206(4) and 207. To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm also consented to the entry of a censure and is barred from association with an investment adviser or investment company. Mr. Sexton is barred from the securities business. Respondents will pay, on a joint and several basis, a penalty of $100,000.
Misappropriation/financial fraud: SEC v. Quadrant 4 System, Civil Action No. 1:17-cv-04883 (N.D. Ill. Filed June 29, 2017) is an action which names as defendants the firm, CEO Nandu Thondavadi and CFO Dhru Desai. The complaint centered on the misappropriation of over $4.1 million by the two defendants from the company and their efforts to cover it up. Specifically, while corporate filings represented that executives did not take salaries, in fact the two executives over a four year period beginning in 2012 misappropriated company funds. The two executives took a number of steps to conceal their malfeasance and other firm liabilities by falsifying the company records. Critical to the cover-up was the mispricing of acquisition transactions by the firm while bolstering revenue to hit growth targets by understating liabilities. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The action is pending.
Investment fraud: U.S. v. McFarland (S.D.N.Y.) is an action in which William McFarland was charged with wire fraud in connection with the promotion of Fyre Media and the Frye Festival LLC. Specifically, Mr. McFarland was the CEO of Frye Media which he started in 2016. The firm was supposed to build a digital app that would facilitate the organization of commercial events such as concerts. Documents given to investors contained the firm’s historical and projected revenue from at least April 2016. Later he promoted the Frye festival which was a failure. From 2016 through May 2017 Mr. McFarlaned is alleged to have defrauded two investors out of about $1.2 million. Misrepresentations were made to the investors regarding the firm’s revenue and income. Mr. McFarland also provided one investor with an altered stock ownership statement in an effort to make it appear that he had personally guaranteed the investment and owned shares worth over $2.5 million. In fact the shares were worth about $1,500. The case is pending.
Court of Appeals
Statute of limitations: SEC v. Collyard, No. 16-1405 (8th Cir. Decided June 29, 2017). Defendant Gary Collyard is a former broker whose license was suspended for selling unregistered securities. He founded and owns Defendant Collyard Group, LLC which assists early stage entities with raising capital. In 2004 and 2005 Mr. Crawford assisted Bixby Energy Systems with securing investments. In December 2011 the SEC named Mr. Crawford and his firm as defendants in an enforcement action alleging violations of Exchange Act Section 15(a). The District Court granted summary judgment in favor of the SEC.
The Eight Circuit reversed in part. On appeal Mr. Crawford and his firm argued that under Kokesh v. SEC, No. 16-329 (S.Ct. Decided June 5, 2017), which held that Section 2462 of Title 28 which imposes a five year statute of limitations on SEC disgorgement requests, barred the relief sought here. The SEC conceded that the award of disgorgement by the District Court was time barred. The award was vacated.
The Commission claimed that the statute of limitations does not apply to its request for an injunction. Kokish made it clear, the Court stated, that just because the remedy is labeled equitable does not mean that Section 2462 does not apply. Rather, the question is whether the remedy is a Section 2464 penalty.
While the circuit courts are split over whether an injunction can be such a penalty, the Court found it unnecessary to resolve the question here in view of three factors: 1) the injunction imposed here only requires defendants to obey the law; 2) it is based on evidence of a likelihood of future violations in view of Mr. Crawford’s past violation of the securities laws, the violation in this case and the fact that the wrongful conduct involved continued after this action was brought; and 3) it seeks to protect the public prospectively from Mr. Crawford’s wrongful conduct rather than punish him while any deterrent effect is, unlike in Kokish, minimal.