This Week In Securities Litigation (Week ending June 17, 2016)
Insider trading was a key focus this week. Two actions were brought based on information secured from the FDA and CMS by former employees who were employed by and investment adviser. Another case centered on tips by a corporate insider to college friends regading two transactions, one of which dates back to 2007. The SEC also filed actions based on the failure of a gatekeeper to properly perform its function, false evaluations given to fund assets, the EB-5 program and offering frauds.
Proposed Rules: The Commission Proposed Rules to Modernize Proprietary Disclosures for Mining Registrants, June 16, 2016 (here).
Testimony: Chair Mary Jo White testified before the Senate Committee on Banking, Housing and Urban Affairs regarding “Oversight of the U.S. Securities and Exchange Commission.” The Chair’s testimony reviewed the work of the agency over the past fiscal year (here).
Filings: The SEC will now permit firms to voluntarily file structure financial statement data in a format known as inline XBRL which can be integrated with the text of the filing. Previously, such data was filed as exhibits.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 7 civil injunctive actions and 6 administrative proceedings, excluding 12j and tag-along proceedings.
Insider trading: SEC v. Salis, Civil Action No. 2:16-cv-00231 (N.D. Ind. Filed June 16, 2016). Named as defendants are: Christopher Sales, the Global V.P. and G.M. for Procurement for SAP until 2015 and previously, an employee of Business Objects S.A.; Edward Miller and Douglas Miller who co-own a car wash; Barrett Biehl, a friend of Douglas Miller; and Friend I. All of the defendants attended university together. The action centers on the merger of SAP SE of Concur Technologies Inc., announced on September 18, 2014 and the tender offer for Business Objects announced in October 2007 by SAP. After learning about the merger during the summer of 2014 Mr. Salis tipped Douglas Miller who in turn tipped his brother and Barrett Biehl. Edward tipped his parents and friends. Mr. Salis and Douglas also tipped Friend I. Defendant Salis repeatedly accessed the account of the two brothers. Douglas accessed the accounts of the others. Options were purchased for the accounts. Following the deal announcement Douglas had profits of $119,003; Edward $149, 117; Barrett Biehl $52,208; and Friend I $37,983. Mr. Sales was paid for the information by the two brothers and Mr. Biehl. In 2007, just five days before the deal announcement regarding SAP and Business Objects, Mr. Salis tipped Douglas Miller about the deal. Mr. Salis then accessed Douglas Miller’s brokerage account to trade. Following the deal the account had about $42,000 in profits. The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). The case is pending. See Lit. Rel. No. 23571 (June 16, 2016).
Gatekeepers: In the Matter of Apex Fund Services (U.S.), Inc., Adm. Proc. File No. 3-17299 (June 16, 2016); In the Matter of Apex Fund Services (U.S.), Inc., Adm. Proc. File No. 3-1700 (June 16, 2016). Apex is a fund administrative company. These proceedings involve two clients o Respondent. One is ClearPath Wealth Management, LLC and its President, Patrick Churchville. Administrative services were furnished with respect to four funds. The Order alleges that Respondent ignored a series of red flags which indicated that prior reports needed to be revised since they are used to communicate with investors about the funds. Specifically, the red flags included undisclosed brokerage and bank accounts; related party transactions; and undisclosed margin or credit agreement. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay disgorgement of $96,800, prejudgment interest and a penalty of $75,000. Respondent also agreed to certain undertakings which include the retention of an independent consultant.
The second client is EquityStar Capital Management LLC and Steven Zoenack, which managed two private funds. The Order alleges that Apex accounted for over $1 million in withdrawals from the two funds by the client as a receivable in the absence of any evidence. In addition, monthly statements to investors failed to show the withdrawals. Two years later investors learned of the transaction. By then they had suffered injury. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to pay disgorgement of $ 89,050, prejudgment interest and a penalty of $75,000. The firm also agreed to implement certain undertakings.
Insider trading: SEC v. Valvani (S.D.N.Y. Filed June 15, 2016) names as a defendant Sanjay Valvani, a partner at an Investment Adviser and a portfolio manager with trading authority over a portion of the Balanced Fund. Also named as a defendant is Gordon Johnston, formerly an employee of the FDA and, more recently a consultant to the Investment Adviser and a Vice President for the Generic Drug Trade Association. By 2005 there was considerable speculation as to whether the FDA would approve any of exnoxaparin Abbreviated New Drug Applications or ANDA. Investment Adviser hired Mr. Johnston to advise Mr. Valvani on the issue. Accepting that position was contrary to the policies of the Trade Association where he was employed. The Association required that he work full time. While there was little movement on the applications for years, by 2009 Mr. Johnston learned from a long time friend at the FDA that an enoxaparin ANDA was moving toward approval. Mr. Johnston obtained the information in confidence and did not disclose his role as a consultant to a hedge fund. Nevertheless, he informed trader Valvani. Both recognized the significance of the information. Trader Valvani had the Fund take a long position in Momenta Pharmaceuticals, Inc. and a short position in Sanofi S.A in late July 2010 despite the fact that the policies and procedures of the Investment Adviser precluded trading on inside information. When the FDA announcement was made the Fund had realized and unrealized trading profits of about $24.8 million. Later in 2010 Mr. Johnston learned that another enoxaparin ANDA application would be approved. Mr. Valvani used this information to formulate a trade for the Balanced Fund to sell the shares of Momenta short. When Watson Pharmaceuticals, Inc. announced in mid-September 2011 that its ANDA application had been approved by the FDA the Fund had realized and unrealized profits of about $7 million. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 204A. The action is pending.
Insider trading: SEC v. Plaford (S.D.N.Y. Filed June 15, 2016), a related action to the one above, names as a defendant Christopher Plaford, a partner at Investment Adviser and a portfolio manager for the Credit Fund. He also managed a portion or “sleeve” of assets in the Balanced Fund. Between March 1, 2010 and July 23, 2010 Mr. Plaford traded profitably on behalf of the Credit Fund in credit default swaps linked to Sanofi, betting that the firm’s revenues and creditworthiness would decline when the FDA approved a generic drug that would compete directly with Sanofi’s Lovenox. The trade resulted in profits of about $26,000. The information came from Mr. Johnston. Mr. Plaford knew that ultimately the information came from an FDA official who had furnished it to consultant Johnston. Three years later, on May 30, 2013, Mr. Plaford learned from a paid Political Consultant that CMS was expected to propose a cut to the Medicare reimbursement rates for certain home health service. The next day Mr. Plaford caused Investment Adviser to enter into an advisory services agreement with Political Consultant’s firm. Two weeks later Political Consultant informed Mr. Plaford that CMS would in fact propose a rate cut. He understood the information came from a CMS official. After receiving the information Mr. Plaford adjusted certain positions for the Credit Fund and Balanced Fund based on the information. Following the announcement the two funds had profits of $285,000. Mr. Plaford, along with another portfolio manager, Stefan Lumiere, manipulated the valuation procedures of the advisory firms for Credit Fund, using sham broker quotes to mismark securities held by the it. As a result, the valuations at month end of the securities held by the Fund were inflated; the NAVs were inflated; Credit Fund overstated its reported month-end and annual performance; and certain distressed assets held by the Fund were misclassified. The complaint alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2), 206(4) and 204A. The case is pending. See also SEC v. Lumiere (S.D.N.Y. Filed June 15, 2016)(action against Mr. Lumiere based on the mismarking scheme described above; the complaint alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4)). The action is pending. The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal actions to these actions.
Offering fraud: SEC v. Proctor, Civil Action No. 16-cv-00437 (D. Del. Filed June 14, 2016) is an action against Andrew Proctor and his firm, Atlas JG, LLC. The complaint alleged that from 2007 through 2011 Mr. Proctor raised over $22 million from at least 200 overseas investors through an offering of bonds that were supposed to pay returns of eight or nine to one. The investor funds were supposed to be used to purchase receivables from homebuilding subcontractors at a discount. Profit would be made from the difference between the discount price and the amount ultimately collected. In fact less than 10% of the investor funds were used for such a purpose. The remainder were diverted to other uses. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The defendants resolved the action, consenting to the entry of permanent injunctions based on the Sections cited in the complaint. The defendants will also pay, on a joint and several basis, disgorgement of $11,115,954, and prejudgment interest. Mr. Proctor will pay a civil penalty of $910,000 while the firm will pay $4.4 million. See Lit. Rel. No. 23568 (June 14, 2016).
Conflicts: In the Matter of School Business Consulting, Inc., Adm. Proc. File No. 3-17288 (June 13, 2016). Respondents in the proceeding are Terrance Bradley, a 26 year veteran of a California school district, and his firm, School Business Consulting. In September 2010 Keygent LLC, a registered municipal adviser whose business is solely advising school districts and community colleges regarding bond issues, retained School Business. The firm was named to Keygent’s Advisory Board and was paid a monthly fee. Among the clients solicited for Keygent were those of School Business. During the hiring process for five School Business clients, Keygent received confidential information about them from the firm. Each of the candidates for the municipal advisor position were expressly directed not to have contact with any officials at the district except the single official specified in the RFQ. This limitation was intended to permit the districts to control the information disseminated, placing each candidate on the same footing. Mr. Bradley had drafted, or assisted in drafting, the RFQ documents used by five school districts. Mr. Bradly provided what is alleged to have been confidential information to Keygen regarding the process. The Order alleges violations of Exchange Act Sections 15B(a)(1)(B), 15B(A)(5) and 15B(c)(1) and MSRB Rule G-17.To resolve the proceeding each Respondent consented to the entry of a cease and desist order based on Exchange Act Sections 15B(a)(1)(B), 15B(A)(5) and 15B(c)(1) and MSRB Rule G-17. Mr. Bradley was barred from the securities business. School Business was censured and will pay a penalty of $30,000. Mr. Bradley will pay a penalty of $20,000. See also In the Matter of Keygent LLC, Adm. Proc. File No. 3-17287 (June 13, 2016)(proceeding against the adviser and Anthony Hsieh and Chet Wang, both managing directors of the firm; the proceeding is based on the conduct detailed above; the firm agreed to a series of undertakings; Respondents consented to the entry of a cease and desist order based on Exchange Act Sections 15B(a)(5) and 15B(c)(1) and MSRB Rule G-17. The firm will pay a penalty of $100,000, Mr. Hsich $30,000 and Mr. Wang $20,000).
Execution: In the Matter of The Bank of New York Mellon, Adm. Proc. File No. 3-17286 (June 13, 2016) is a proceeding centered on the bank’s standing instruction program for foreign currency purchases. Under that program the bank guaranteed best execution and rates to its customers. In fact they got the worst rates because the bank purchased at the end of the day or session. This resulted in substantial revenues for the bank based on the difference between the rates that it assigned to clients and that it paid. Clients received confirmations but they only showed that the rate paid was within the range which fluctuated during the day. Since the documents did not show the execution time they were misleading because clients were unable to ascertain if the rate was in accord with the bank’s representations. The Order alleged violations of Investment Company Act Sections 31(a) and 34(b). To resolve the proceeding the bank consented to the entry of a cease and desist order based on the Sections cited in the Order. The bank also agreed to pay disgorgement which represents the revenue gained from the clients in the program of $120,000,000 and prejudgment interest. That amount is deemed paid in related actions brought by the New York AG and the DOJ. The bank will also pay a civil penalty of $30 million.
Unregistered broker: In the Matter of American Life, Inc., Adm. Proc. File No. 3-17285 (June 13, 2016) is a proceeding which names as Respondents and EB-5 Regional Center and its President, Henry Liberman. An EB-5 center is an economic unit involved with job growth that functions as part of the EB-5 immigration program which offers foreign national who make certain investments creating jobs in this country a path to a permanent green card. In connection with the sale of securities that are part of an EB-5 investment program Respondents paid transaction based compensation to attorneys. This caused a violation, of Exchange Act Section 15(a). Respondents resolve the proceeding, consenting to the entry of a cease and desist order based on the Section cited in the Order. The firm also agreed to pay a penalty of $1 million while Mr. Liberman will pay $240,000.
Spoofing: In the Matter of Behruz Afshar, Adm. Proc. File No. 3-16978 (June 13, 2016) is a previously filed proceeding which names as Respondents three former broker-dealer employees, Mr. Afshar, Shahrayar Afshar and Richard Kenny. Also named in the Order are Fineline Trading Group LLC and Makino Capital LLC, both controlled by Mr. Behruz. The action centers on two schemes. First, Respondents caused their option trades to be mismarked, making about $2 million in benefits. Specifically, option exchanges label orders as “professional” – those who place over 390 orders per month in a quarter — or “customer.” The latter is designed to facilitate trading for non-professionals who receive lower fees and higher rebates. Respondents continually traded over the professional limit but alternated between the two firms and did not aggregate them as affiliates as required. This permitted them to mismark their options trades. Second, Respondents engaged in “spoofing.” This was done to take advantage of the maker-taker fees and resulted in $225,000 in ill-gotten rebates. Respondents implemented the scheme by initially placing all-or-none or AON orders which are not displayed and must be executed in full or not at all. They then placed small orders that were displayed to lure others to the market. These were not intended for execution. When others entered the market there were executions against the AON orders and the displayed orders were cancelled. The order alleges violations of each subsection of Securities Act Sections 17(a) and Exchange Act Sections 9(a)(2) and 10(b) and each subsection of Rule 10b-5. To resolve the proceeding Respondents consented to the entry of a cease and desist order based on each subsection of Securities Act Section 17(a) and Exchange Act Sections 9(a)(2) and 10(b). Respondents Behruz Afshar and Kenny are barred from the securities business and from participating in any penny stock offering. Respondents Behruz and Shahryar Afshar will also pay disgorgement on a joint and several basis of $1,048,824.67 along with prejudgment interest. Behruz Afshar will pay a penalty of $150,000 and Shahryar Afshar will pay $75,000. Respondent Kenny will pay disgorgement of $524,412.33 and a penalty of $100,000.
Internal controls: In the Matter of Icon Capital LLC, Adm. Proc. File No. 3-17283 (June 10, 2016). Icon Capital is an unregistered investment manager. The firm develops, markets and sponsors a series of equipment leasing funds which have registered securities offerings. Each leasing fund was organized as a separate entity that was subject to the books and records provisions of Exchange Act Section 13(a). Due to inadequate internal controls, from 2009 through 2012 four of the leasing funds had accounting errors. Those resulted in one or more of the funds not taking certain required asset value impairments, overstating post-impairment values or overstating residual values in multiple reporting periods. Icon’s errors resulted in the overstatement of net income or understatement of net loss and the overstatement of asset and leasing fund members’ equity values. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). Respondent resolved the action, consenting to the entry of a cease and desist order based on the Sections cited in the Order. The firm will pay a penalty of $750,000.
Offering fraud: SEC v. Connerton, Civil Action No. 3:16-cv-00882 (D. Conn. Filed June 8, 2016). Thomas Connerton is the founder and president of Defendant Safety Technologies, LLC, formed in 2006. His plan was to develop and market the invention of a chemical engineer he met in 2005. The engineer was developing what was claimed to be a patent protected, highly durable, puncture and cut resistant material for surgical gloves and related uses. The glove was the firm’s only product. The same year Safety Tech was founded it began selling securities to raise capital. Since then the firm has taken-in about $2.3 million from 55 investors. While Mr. Connerton used various pitches to solicit investors, the presentations typically lacked information and touted high returns. He did not, for example, tell investors that the engineer passed away in 2008 and he had no ability to create the product or that most of their money was diverted to his personal use. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The court granted a freeze order at the time the complaint was filed. The case is pending. See Lit. Rel. No. 23565 (June 10, 2016).
Offering fraud: SEC v. Providence Financial Investments, Inc., Civil Action No. 0:16-cv-1877 (D. Minn. Filed June 7, 2016) is a proceeding which names as defendants the firm, which sells unregistered promissory notes; Providence Fixed Income Fund, LLC, which also purports to sell unregistered promissory notes; Jeffory Churchfield, who operates a financial advisory business; and Jack Jarrell, who is registered with the State of Washington as an investment adviser. Since early 2011 the two entity defendants have raised over $64 million from 400 investors through the sale of promissory notes. Those notes, which pay interest of 12% to 13% are supposedly to fund the factoring of accounts receivable in Brazil. However, no more than 68% of the investor money was used for that purpose. The balance of the funds are unaccounted for. To lure investors a team of unregistered brokers was employed who were paid a 6% commission. Investors were not told of the difficult financial condition of entities or that there were insufficient funds to pay investors absent additional sales. The complaint alleges violations of Exchange Act Section 10(b), Advisers Act Sections 206(1) and 206(2) and Securities Act Sections 5(a), 5(c) and 17(a)(2). The court entered a freeze order. Subsequently the court entered by consent preliminary injunctions based on the Sections cited in the complaint. The order also requires Providence Financial and Providence Fund to produce an accounting. See Lit. Rel. No. 23567 (June 13, 2016).
Obstruction: U.S. v. Olins (S.D.N.Y. June 10, 2016) is an action in which Robert Olins pleaded guilty to conspiracy to obstruct justice and money laundering. Mr. Olins was previously the defendant in an SEC enforcement action. In that case he was ordered to pay $3.3 million. A receiver appointed in that action had a security interest in an Art and Antiques Collection. Mr. Olins attempted to conceal that collection. He also received money from the sale of items from the collection in contravention of the orders entered in the case.
Roberto Enrique Rincon Fernandez pleaded guilty to one count of conspiracy to violate the FCPA, one count of violating the FCPA and one count of filing a false tax return. He admitted that in 2009 that he and Jose Shiera Bastidas paid bribes to the purchasing analyst for the Venezuelan state controlled energy company to be placed on the bidding panel to obtain contracts. Sentencing is scheduled for September 30, 2016.
Insider dealing: The Financial Conduct Authority announced that Darian Clarke, formerly an equity trader at Schroeders Investment Management had pleaded guilty to nine counts of insider dealing. Through his positions Mr. Clarke obtained inside information about transactions – typically M&A deals. Through personal and family accounts he used the information to trade the securities. He had profits of at least £153,161.98. He was sentenced to serve two years in prison.