This Week In Securities Litigation (Week ending June 15, 2018)
Key questions regarding the statute of limitations in class actions, virtual currencies, stock repurchases, compliance and human rights abuses tied to corrupt conduct were critical this week. The Supreme Court refused to extend so-called American Pipe tolling to the filing of successive class action complaints. Remarks by the Director of Corporation Finance discussed the question of when an ICO may be a security and assuming it is, can that determination change in the future. Commissioner Jackson discussed his research regarding executives and stock repurchase programs.
SEC enforcement brought a case centered on compliance issues where the underlying conduct involved traders making misrepresentations to counter-parties. The case reflects the teachings of a series of similar cases which illustrated that such tactics are, in the first instance, a compliance failure. Enforcement also brought cases involving insider trading, offering fraud and a failure to comply with professional standards in an audit.
Finally, FinCEN issued an advisory on the relationship of human rights violations to corruption. The regulator urged the filing of SARs with adequate factual support and detail.
Remarks: William Himman, Director, Division of Corporation Finance, delivered remarks titled Digital Asset Transactions: When Howey Met Gary (Plastic) at the Yahoo Finance All Markets Summit: Crypto, San Francisco, CA (June 14, 2018). His remarks reviewed when a token offering may involve a security and the question of if at one point, the interests are a security if that might change in the future (here).
Remarks: Commissioner Robert J. Jackson, Jr. delivered remarks titled Stock Buyouts and Corporate Cashouts to the Center for American Progress, Washington, D.C. (June 11, 2018). In his remarks the Commissioner noted that in about half of the instances where there is a corporate buyback of stock, executives sell; the Commission should address this and encourage executives to hold their shares (here).
China Agritech, Inc. v. Resh, No. 17-432 (S.Ct. Decided June 11, 2018). Respondent – plaintiff Michael Rush filed the third securities class action on behalf of the purchasers of petitioner-defendant China Agritech’s common stock. The complaint by Mr. Resh alleged violations of Exchange Act section 10(b) and rule 10b-5 thereunder. The complaint alleged that the firm had engaged in fraud and misleading business practices. The firm’s stock price plummeted as a result, according to the complaint. Two prior, similar class complaints had been filed and dismissed for failing to comply with key pleading requirements.
The complaint brought by Mr. Resh was filed about a year and a half after the expiration of the statute of limitations. The district court again dismissed the complaint. This time the court concluded that the filing was not timely because the earlier two complaints had not tolled the statute of limitations. The Ninth Circuit Court of Appeals reversed, holding that in fact there was tolling under American Pipe & Constr. Co. v. Utah, 414 U.S. 538 (1974). The Supreme Court granted certiorari to resolve a split in the circuits on the question.
In an opinion written by Justice Ginsburg, and joined as to the conclusion by all of the Justices but as to its reasoning by all except Justice Sotomayor, the Court reversed. American Pipe held that “the commencement of the original class suit tolls the running of the statute [of limitations] for all purported members of the class who make timely motions to intervene after the court has found the suit inappropriate for class action status.” (internal citations omitted). A contrary rule would undermine the efficiencies and economy which are key to Rule 23 regarding the use of the class actions. Indeed, absent the American Pipe rule, and its extension to class members who filed separate actions in Crown, Cork & Seal Co. v. Parker, 462 U.S. 345 (1983), there would be a multiplicity of actions filed by class members to preserve their status.
There is nothing in American Pipe or Crown, Cork that suggests such a rule should apply to the third complaint filed in this action. Indeed, permitting the action by Mr. Resh to move forward would be contrary to the rationale of American Pipe. This is because rule 23 evidences a preference for “preclusion of untimely successive class actions by instructing that class certification should be resolved early on.” In contrast, Respondent’s proposed rule “would allow the statute of limitations to be extended time and again; as each class is denied certification, a new named plaintiff could file a class complaint that resuscitates the litigation.” Essentially this would give plaintiffs “limitless bites at the apple.” (Internal quotations omitted).
In the end, the “watchwords of American Pipe are efficiency and economy of litigation, a principal purpose of Rule 23 as well. Extending American Pipe tolling to successive class actions does not serve that purpose. The contrary rule, allowing no tolling for out-of –time class actions, will propel putative class representatives to file suit well within the limitations period and seek certification promptly.” Accordingly, the determination of the Court of Appeals is reversed and the case remanded for further proceedings.
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.
Improper professional conduct: In the Matter of RSM US LLP, Adm. Proc. File No. 3-18542 (June 14, 2018) is a proceeding which names the audit firm as a Respondent. The Order centers on the firm’s audit of Madison Capital Energy Income Fund I LP done in 2011. While the firm issued an unqualified audit opinion, it failed to separately report the fair value of the investments as required by GAAP and the engagement partner improperly delegating critical engagement partner responsibilities to the manager. Documentation was also inadequate. In resolving the proceedings the firm is undertaking to conduct a complete review and evaluation of its quality control policies and procedures. The firm was also censured and ordered to comply with its undertakings.
Insider trading: SEC v. Bordian, Civil Action No. 2:18-cv-10437 (D.N.J. Filed June 12, 2018) is an action which names as a defendant Kirt Bordian, an accountant and personal assistant to a member of the board of directors of InterOil Corporation. That company entered into an agreement to be acquired by Oil Search Limited, announced on May 19, 2016. Mr. Bordian learned about the proposed transaction and purchased 290 out-of-the-money call options for InterOil stock just prior to the deal announcement. Following the announcement the share price increased by over 37% and he had illicit profits of $220,500. The complaint alleges violations of Exchange Act section 10(b). To resolve the case Mr. Bordian consented to the entry of a permanent injunction based on the section cited in the complaint. He also agreed to pay disgorgement of $220,500, prejudgment interest of $14,358 and a penalty equal to the amount of the disgorgement. Mr. Bordian agreed to the entry of an order suspending him from appearing or practicing before the Commission as an accountant. See Lit. Rel. No. 24164 (June 12, 2018).
Compliance: In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc., File No. 3-18538 (June 12, 2018). The Order centers on trading by Merrill Lynch personnel of RMBS bonds. In each instance the firm had purchased “the securities for its own account and then sold them . . .” based on a mark-up. All of the customers or counter-parties were “institutions.” All of the RMBS were non-agency, defined as “residential mortgage-backed securities that are sponsored by private entities and not government-sponsored entities.” The time period for the Order is post market crisis, 2009 through 2012. In the purchases and sales the traders made misrepresentations and charged excessive mark-ups during the period. The wrongful statements concerned the price at which the securities were purchased or sold, the amount of profit Merrill would make on the transaction and the status of negotiations with other counter-parties. On certain transactions Merrill traders charged customers “mark-ups that bore no reasonable relationship to the prevailing market prices,” according to the Order. While the firm had policies and procedures in place during the period, they were not properly implemented. In resolving the matter Merrill undertook remedial efforts designed to address the compliance deficiencies cited above. The firm also agreed to cooperate with the staff. The Order alleges violations of Exchange Act section 15(b)(4)(E) regarding supervision. To resolve the proceedings Merrill consented to the entry of a cease and desist order based on the section cited in the Order. The firm will also pay disgorgement of $2,311,392 and pre-judgment interest of $513,884 tied to the false and misleading statements. In addition, the firm will pay disgorgement of $6,318,914 and pre-judgment interest of $1,391,251 tied to the excessive mark-ups. Merrill will pay a penalty of $5,267,720.
Insider trading: SEC v. Morano, Civil Action No. 24163 (D. Ore.) is a previously filed action against Robert Morano who settled insider trading charges with the Commission by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act section 10(b) and agreeing to pay disgorgement of $38,242 and prejudgment interest of $2,317. The court will determine issues relating to any civil penalty on motion of the Commission. The action was based on trading in advance of the acquisition of Mr. Morano’s former employer, UTI Worldwide, Inc. by DSV Air & Sea Holdings A/V. Mr. Morano learned about the deal while working on the press releases. See Lit. Rel. No. 3:18-cv-00386 (June 11, 2018).
Offering fraud: SEC v. Grossman, Civil Action No. 18-cv-61234 (S.D. Fla. Filed June 4, 2018) is an action which names as defendants Isaac Grossman, a securities law recidivist who has been barred from the securities business by FINRA and enjoined by the CFTC, Adriana Grossman, Isaac’s wife, Dragon-Click Corp., and Dragon Management, LLC, both controlled by either Isaac Grossman or his wife. From September 2014 to the present Defendants have participated in the offer or sale of Dragon Click stock and Dragon Partners membership interests. About $2.6 million has been raised from at least 26 investors who were told that they would make substantial profits on the investments from the development of an internet shopping application developed with their money. In fact much of the investor money was misappropriated. The complaint alleges violations of Exchange Act section 10(b) and each subsection of Securities Act section 17(a). The case is pending. See Lit. Rel. No. 24162 (June 4, 2018).
Human rights abuses: The regulator issued an Advisory on Human Rights Abuses Enabled by Corrupt Senior Foreign Political Figures and Their Financial Facilitators (June 12, 2018)(here). In the release the regulator cautions about “the connection between corrupt senior foreign political figures and their enabling of human rights abuses. The use of financial facilitators is one way that corrupt senior foreign political figures access the U.S. and international financial systems to move or hide illicit proceeds and evade U.S. and global sanctions.” The release urges those filing a SAR to furnish as much information as possible and reference the advisory.
Cooperation: The Securities and Futures Commission held its sixth regular high level meeting with the China Securities Regulatory Commission or CSR to discuss a range of enforcement cooperation matters. The most recent meeting built on the history of the discussions and increasing cross boundary interaction between the mainland and Hong Kong.
Remarks: Carlson Tong, Chairman, Securities and Futures Commission, delivered remarks titled The Evolving Role of the Independent Non-Executive Director, at the Hong Kong Institute of Directors’ Speaker Luncheon Meeting. His remarks focused on the role of the Independent non-executive director for listed firms (here).