This Week In Securities Litigation (Week ending June 16, 2017)

A jury in Connecticut largely acquitted three former Nomura Securities RMBS trades charged with conspiracy, securities and wire fraud tied to allegations that the securities were mismarked. This is the second criminal case where jurors rejected such claims. The SEC has a pending parallel action. The Commission and the U.S. Attorney’s Office also filed similar charges against other Nomura traders earlier this year. Those actions are pending.

The Commission filed actions this week alleging: unprofessional conduct in connection with audits; a failure to file SARs; a financial fraud action centered on the premature recognition of revenue; an action based on sham transactions used to fundamentally alter the appearance of the financial statements for two firms; and another proceeding charging an immigration attorney with acting as an unregistered broker in connection with the EB-5 immigration program.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 1 civil injunctive case and 5 administrative proceeding, excluding 12j and tag-along proceedings.

Offering fraud: SEC v. Trolice, Civil Action No. 16-cv-02513 (D. N.J.) is a previously filed action which named as defendants James Trolice and Lee Vaccaro. The complaint alleged that the two men misappropriated about $6 million raised from over 100 investors who were lead to believe they were purchasing interests in a firm that held warrants to acquire stock in a technology startup firm. Mr. Trolice settled, and the court entered a final judgment, permanently enjoining him from future violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The judgment barred Mr. Trolice from serving as an officer or director of a public company. The court will consider monetary sanctions at a later date. Previously, Mr. Trolice pleaded guilty to criminal charges of securities fraud and money laundering in a parallel criminal action. U.S. v. Tolice, No. 2:17-cr-00120 (D.N.J.). See Lit. Rel. No. 23859 (June 15, 2017).

Unprofessional conduct: In the Matter of Edward Richardson Jr., CPA, Adm. Proc. File No. 3-17857 (June 14, 2017) names as Respondents the firm, a PCAOB registered audit firm, and its sole owner, Edward Richardson Jr. Respondents engaged in improper professional conduct and and/or aided and abetted violations of the federal securities laws in connection with their audit engagements for issuers and dozens of broker dealer clients. Specifically, Respondents failed to obtain Engagement Quality Reviews or EQRs as required by PCAOB audit standards. For the broker-dealer clients Respondents falsely represented that the audits were conducted in accord with PCAOB standards despite the failure to conduct the EQRs. The Order alleges violations of Exchange Act Sections 13(a), 13(d) and 17(a). To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. Each Respondent is also denied the privilege of appearing or practicing before the Commission as an accountant with the right to request reinstatement after seven years. The Respondents, jointly and severally, will pay a penalty of $35,000.

Financial fraud: In the Matter of Michael B. Hayford, Adm. Proc. File No. 3-18020 (June 9, 2017). The proceeding centers on the premature recognition of revenue by UniTek Global Services, Inc. stemming from the acquisition of Pinnacle Wireless, Inc. in early 2011. Respondents Michael Hayford, Kevin McClelland and Daniel Rothbaum are, respectively, the President and one of the founders of Pinnacle, UniTek’s Chief Accounting Officer and Corporate Controller, and Pinnacle’s Controller. Pinnacle’s largest source of revenue was a contract to provide equipment and services for rebuilding portions of the World Trade Center with the Port Authority of New York and New Jersey. In 2011 Pinnacle provided internal forecasts estimating revenue for each quarter. UniTek policy provided that revenue be recognized on a percentage of completion basis. Messrs. Rothbaum and McClelland reviewed the projected revenue under the contract and the forecast which suggested that Pinnacle would not meet its late 2011 revenue goals. While neither had experience with cost-of-completion accounting, UniTech CAO and Controller McClelland told his report, Respondent Rothbaum, that revenue could be recognized when the invoice was received if it matched the purchase order without conducting any research or consulting an expert in the area. Mr. Hayford was then instructed to recognize revenue based upon receipt of the invoice. Beginning in late 2011 UniTeck recording costs as incurred for percentage of completion purposes upon receipt of invoices which was not in accord with firm policy. Messrs. Hayfor, Rothbaum and others at Pinnacle solicited invoices from six different subcontractors who were in the process of building equipment or providing services for the World Trade Center contract. This increased the revenue and profit. It also caused information regarding the Engineering and Construction segment of the firm, which represented a significant segment, to be materially incorrect in quarterly filings made with the Commission in 2012. UniTek had a material weakness in its internal control over financial reporting. Specifically, the firm lacked sufficiently trained accounting personnel necessary to ensure that revenue was appropriately recognized. During the period Respondents were responsible for UniTek’s failure to maintain fair and accurate books and records. The Order alleges violations of Securities Act Section 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding, each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition: Mr. Hayford will pay disgorgement of $35,000, and prejudgment interest and a penalty of $125,000; Mr. McClelland will pay a penalty of $75,000; and Mr. Rothbaum will pay a penalty of $25,000. Messrs. McClelland and Rothbaum are also denied the privilege of appearing and practicing before the Commission as accountants with a right to apply for reinstatement after three years.

SARs: In the Matter of Windsor Street Capital, L.P., Adm. Proc. File No. 3-17813 (June 12, 2017) is an action which names as Respondents the registered broker dealer and its AML compliance officer, John Telfer. During the period November 2013 to September 2016 the firm repeatedly failed to file SARs relating to suspicious transactions in penny stocks, typically where the firm accepted physical deposits of large blocks of penny stocks for liquidation and the money was then moved out of the firm. The Order alleges violations of Exchange Act Section 17(a). To resolve the matter Respondent Telfer consented to the entry of a cease and desist order based on the Section cited. He is also barred from the securities business and from participating in any penny stock offering. In addition, he will pay a civil penalty of $10,000.

Unprofessional conduct: In the Matter of Lisa Hanmer, CPA, Adm. Proc. File No. 3-17997 (June 12, 2017) names as a Respondent Ms. Hanmer, a partner in the audit firm of RSM US LLP. She served as the engagement partner on the firm’s 2011 audit of Madison Capital Energy Income Fund 1 LP. The Fund acquired oil and gas royalty interests. Ms. Hanmer was aware that the audit was not performed in accord with GAAS. Specifically, she knew that the financial statements failed to separately report the fair value of the investment of each oil and gas royalty interest as required by GAAP, that adequate work had not been conducted on the fair value of the underlying royalty interests and that the appropriate procedures were not conducted on the schedule of investments. The Order alleged violations of Rule 102(e) of the Commission’s Rules of Practice. Respondent was found to have engaged in unprofessional conduct and thus denied her the privilege of appearing and practicing before the Commission as an accountant.

Unregistered broker: In the Matter of Stephanie Lee, Adm. Proc. File No. 3-18019 (June 9, 2017) is a proceeding against Ms. Lee, an immigration attorney. Ms. Lee recommended that her clients purchase interests in projects from an EB-5 Regional Center as part of an effort to secure a path to citizenship in the U.S. In doing so she was paid legal fees and transaction based compensation from the Regional Center tied to the investment. The Order alleged violations of Exchange Act Section 15(a)(1). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Section cited in the Order and agreed to pay disgorgement of $50,000 along with prejudgment interest.

Sham transactions: SEC v. Fuselier, Civil Action No. 1:17-cv-04240 (S.D.N.Y. Filed June 6, 2017). David Fuselier is president of Fueslier and Company which provides capital and strategic guidance to firms with revenues under $300 million, according to its advertisements. His friend and co-defendant Roy Erwin was the chairman and CEO of Oncologix Tech, Inc., a firm that specializes in surgical and medical instruments and apparatus. In 2012 Mr. Fueslier became the Chairman, COO and CFO of defendant Integrated Freight Corporation and New Leaf Brands, Inc. Mr. Fueslier crafted a plan to improve each firm’s poor financial condition by selling their non-operating subsidiaries to a purchaser that would assume each firm’s liabilities and furnish an indemnification to each parent company. Mr. Fueslier had his business associate work with Mr. Erwin to form Deep South LLC, a Louisiana limited liability company, in early 2012. Deep South had no assets. Subsequently, each firm sold its subsidiaries to Deep South for $1, stock and an indemnification from the firm. The deals did more than just significantly reduced the liabilities. A June 30, 2012 a New Leaf filing reported a net loss from continuing operations of $758,490. The firm had a gain, however, on the disposal of discontinued operations which offset the loss. New Leaf had net income of $218,562. Integrated also transformed its financial statements. In a filing made at the end of March 2013 the firm reported net income from continuing operations of just over $451,000. That amount increased after including a gain on the disposal of discontinued operations to over $4,800,000. The disclosures about the transactions involving New Leaf, Integrated and Deep South did not mention the fact that New South was a shell firm and had no ability to assume the liabilities transferred in the deals or that each deal was a related party transaction. The Commission’s complaint alleged violations of each subsection of Securities Act Section 17(a), Section 15(b) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 20(e) and Rules 13b2-2 and 13a-14a. Mr. Erwin settled with the Commission, agreeing to be barred from serving as an officer or director for three years and to a penny stock bar. He will also pay a penalty of $25,000. See Lit. Rel. No 23855 (June 8, 2017).

Criminal Cases

Mismarking: U.S. v. Shapiro, Case No. 3:15cr 155 (D. Conn.) is an action which names as defendants three Nomura securities traders, Ross Shapiro, Michael Gramins and Tyler Peters. The nine count third superseding indictment charged conspiracy, securities fraud and wire fraud. The charges were based on allegations that the three men made misrepresentations to clients when buying and selling residential mortgaged back securities from 2009 through 2013. The jury returned verdicts acquitting the three men of all counts except Mr. Gramins who was found guilty on one count of conspiracy. The jury was unable to reach a verdict on one count of conspiracy as to Mr. Shapiro and one count of securities fraud and one count of wire fraud as to Mr. Gramins. See also SEC v. Shapiro, Civil Action No. 1:15-cv-07045(D. Conn.).

Mismarking: U.S. v. Lumiere, Case No. 1:16-cr-00483 (S.D.N.Y.). Defendant Stefan Lumiere was a portfolio manager at Visium Asset Management, L.P. The firm managed hedge funds specializing in healthcare-related investments. One fund focused on debt instruments from healthcare companies. Beginning in mid 2011, and continuing for over two years, Defendant Lumiere and others participated in a scheme to defraud the Fund’s investors by mispricing select securities. The purpose of the scheme was to inflate the management fees and make certain illiquid bonds appear to be liquid to encourage investors to remain in the Fund. Following a six day trial the jury return verdicts of guilty to charges of securities and wire fraud. Judge Rakoff handed down a sentence of 18 months in prison followed by three years of supervised release. See also SEC v. Lumiere, Civil Action No. 1:16-cv-04513 (S.D.N.Y.).


Customer orders: Citigroup Global Markets Australia was fined $50,000 for failing to comply with Australia Securities Investment Commission Market Integrity Rules which impose limitations on the disclosure of client orders, pre-arrangement of trades and the execution of trades to the exclusion of others. Specifically, the Chicago Sales Desk of a related entity called the Sydney Sales Desk of Citigroup regarding the liquidity of certain instruments. Chicago then placed an “iceberg” order – one that is sliced into segments for execution with only one segment being displayed at a time. Later a representative of the Sydney Sales Desk had a face-to-face conversation with the Sydney Rates Trader employed by Citbank. Two iceberg orders for lots of futures contracts were entered by the Chicago Sales Desk and the Sydney Rates Trader resulting in a transaction of 500 lots. The remaining portion of the iceberg order was cancelled and replaced with a new one entered at a lower price. A squawk box conversation resulted in the Sydney Sales Desk disclosing to the Sydney Rates Trader that there were 200 lots remaining, followed by a sell order for 200 lots at the original higher price. The Chicago Sales Desk then changed its order to buy 200 lots to match the price of the sell order resulting in a transaction.

Hong Kong

Agreement: The Securities and Futures Commission entered into an agreement with the Australian Securities & Investment Commission to establish a framework for cooperation on financial technology. The agreement calls for cooperation on sharing information regarding emerging Fintech trends and related regulatory issues. In addition, it provides for a bilateral mechanism for referrals of innovative firms seeking to enter one another’s markets.


Short sales: The Financial Conduct Authority noticed a temporary ban by the Spanish Comision Nacional del Mercado de Valores regarding shares or related instruments regarding Liberbank, S.A.

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