This Week In Securities Litigation (Week ending June 21, 2019)
Walmart settled its long running FCPA action this week, consenting to books, records and internal controls provisions with the SEC and entering into a non-prosecution agreement with DOJ. The firm paid over $280 million in connection with those settlements. The Commission continued to bring actions centered on pre-release ADRs, filing two new cases.
To date the agency has filed 11 actions tied to those charges. It also continued what appears to be an increasing new trend of cases involving private companies. The action focused on a firm in Tel Aviv and another in Florida tied to a false proxy solicitation. Finally, the agency resolved charges with audit giant KPMG arising out of that firm’s improper use of confidential information secured through a breach of duty from the PCAOB regarding the audit inspection process.
Rules: The Commission adopted amendments to improve the application of the auditor independence rules. Specifically, the amendments deal with certain loans or debtor-creditor relationships and revamp the approach to evaluating the relationships (here).
SEC Enforcement – Litigated Cases
The Commission prevailed at trial this week, securing a favorable verdict in an action against broker Donald Fowler. The jury found Mr. Fowler liable on all accounts. SEC v. Dean, Civil Action No. 1:17-cv-00139 (S.D.N.Y. Filed January 9, 2017). The complaint named as defendants Gregory Dean and Donald Fowler, both registered representatives at now defunct brokerage firm J.D. Nicholas & Associates, Inc. from January 2007 through November 2014. For 27 customer accounts the two registered representatives utilized the same trading strategy – a high volume trading approach in shares were purchased and held for no longer than two weeks regardless of price movement. Virtually no due diligence on this approach was conducted prior to implementing it. As a result, the typical account had costs of over $1 million while suffering losses of close to $1.4 million. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The firm previously settled actions with FINRA and the States of Connecticut, Arkansas and New Hampshire tied to excessive trading. Mr. Dean previously settled with the Commission, admitting the facts regarding his conduct and that he had violated the securities laws.
SEC Enforcement – Filed and Settled Actions
The Commission filed 6 civil injunctive actions and 5 administrative proceedings this week, exclusive of 12j and tag-along actions.
Market manipulation: SEC v. Chan, Civil Action No. 19 cv 5718 (S.D.N.Y. Filed June 19 2019) is an action which names as defendants: Kit Mun Chan of Malaysia; Lau Kean Chong of Singapore; Chong Poui Fan of Malaysia; Binji Lu of China; and Youn Chien Wong of Malaysia. Since the end of February 2019 Defendants have engaged in a scheme to manipulate the shares of Medico International Inc. using a series of 180 matched trades that involved about 340,000 shares of the stock – 45% of the total market volume. Collectively, Defendants accounted for about 70% of the trades in the stock totaling $900,000. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 9(a) and 10(b). The Commission suspended trading in the shares of Medico and secured an asset freeze. The complaint is pending.
Proxy fraud: SEC v. Hurgin, Civil Action No. 19-cv-05705 (S.D.N.Y. Filed June 18, 2019) is an action which names as defendants Anatoly Hurgin, Alexander Aurovsky, Ability Computer & Software Industries Ltd., a Tel Aviv based company founded by the two individual defendants, and Ability Inc., a special purpose entity. The action centers on the December 2015 merger of Ability with Cambridge Capital Acquisition Corporation (originally Ability). The merger had to be completed by December 2015 or else all the funds raised from investors for the deal would have to be returned. To convince investors to vote in favor of the merger Defendants falsely claimed that Ability had a “game changing” cellular interception product that would generate significant revenue. They also claimed that the firm had an impressive backlog of orders, although it was based on oral contracts with a Latin American police agency and former management. Once the merger was completed Messrs. Hugrin and Aurovsky each received $9 million and will be paid another $6 million. The complaint alleges violations of Securities Act Section 17(a) and subsections (b) and (c) and Exchange Act Sections 10(b) and 14(a). The case is pending. See Lit. Rel. No. 24505 (June 20, 2019). See also In the Matter of Benjamin H. Gordon, Adm. Proc. File No. 3-19210 (June 20, 2019)(proceeding naming as Respondent the former CEO of Cambridge who participated in the road show and was negligent regarding the accuracy of the representations; settled with consent to the entry of a cease and desist order based on Exchange Act Section 14(a) and Securities Act Section 17(a)(2) and payment of a $100,000 penalty).
Pre-release ADRs: In the Matter of Wedbush Securities, Inc., Adm. Proc. File No. 3-19205 (June 18, 2019) is a proceeding which names the broker-dealer as a respondent. Beginning in November 2011, and continuing for about two years, the firm’s securities lending desk, regularly borrowed pre-release ADRs directly from four depositories under pre-release agreements. Contrary to the terms of those agreements, the broker regularly entered into lending arrangements regarding those pre-release ADRs without taking reasonable steps to ensure that the counter-parties would comply with the pre-release obligations which require that the shares be beneficially custodied by the counterparty or the firm as required. Wedbush also did not have policies and procedures, reasonably designed and implemented, regarding this matter. In resolving the matter, the Commission considered the cooperation and voluntary remediation of the firm. The Order alleges violations of Securities Act Section 17(a)(3). To resolve the proceedings, Respondent consented to the entry of a cease and desist order based on the section cited in the Order. In addition the firm agreed to pay disgorgement of $4,869,072 which includes $1,965,589 from Depository A, prejudgment interest of $805,641 and a penalty of $2,434,536.
Insider trading: SEC v. Starker, Civil Action No. 3:19-cv-13030 (D.N.J. Filed June 18, 2019). Defendant Raymond Starker is a long-time shareholder of Energy Focus, Inc. For over thirty years Mr. Starker has been a friend of Energy Focus Director A. He is also a long-time friend of Executive A who served as CEO and COB at the firm during the period involved here. Mr. Starker also owned, or had an interest in, a large number of firm shares. For example, in 2012 he joined a partnership formed by Director A that held a significant block of Energy Focus shares. In June 2015 Energy Focus began exploring the possibility of conducting a secondary offering of securities. In mid-July of that year Executive A contacted large shareholders to determine if they wanted to join the offering. Mr. Starker was contacted and declined. He did, however, participate in meetings with firm executives and the investment bank involved with the proposed offering. For example, in late July he described one dinner where the offering was discussed in an e-mail to an individual at the Investment Bank at which he also knew executives. Subsequently, the discussions continued. Mr. Starker was updated on their progress at times. In early September the Board of Energy Focus considered a resolution approving the secondary offering. An individual at the investment bank e-mailed Executive A about the deal. The e-mail was forwarded to Mr. Starker the same day, September 2. He sold 5,400 more shares the same day, generating revenue of $138,939. By July 27, 2015 Mr. Starker had sold 9.6% of his Energy Focus shares. On September 10, 2015 Energy Focus stock closed at $23 per share. Prior to the market open the next day the secondary offering was announced. By the close the share price had tumbled 22%. By selling prior to the transaction announcement Mr. Starker had avoided losses of $46,342. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). To resolve the case Mr. Stalker consented to the entry of a permanent injunction based on the sections cited in the complaint. In addition, he agreed to pay disgorgement of $46,342, prejudgment interest of $7,047 and a penalty equal to the amount of the disgorgement. See Lit. Rel. No. 24503 (June 18, 2019).
Breach of duty: In the Matter of KPMG, LLP, Adm. Proc. File No. 3-19203 (June 17, 2019) centers on the firm’s acquisition of confidential, material, non-public information regarding the PCAOB’s audit review process to aid the firm’s poor inspection results. KPMG sought to improve its inspection performance by hiring Brian Sweet, an Associate Director at the PCAOB who had worked on the inspection team assigned to the auditor. Before leaving his post at the Board, Mr. Sweet copied a trove of confidential PCAOB materials onto a computer drive which was later dumped into the system at his new employer. At the audit firm Mr. Sweet proved beneficial, furnishing information from his trove which included, for example, “a number of KPMG banking clients the PCAOB planned to inspect in 2015,” according to the Order. Other confidential information drawn from the trove included the Board’s selection criteria for audits and PCAOB comment forms tied to the Board’s inspection of a Spanish bank, used to aid a firm partner pitching another bank for work. Mr. Sweet also called a Board employee to secure confidential information about the inspection process that went beyond his purloined trove. The audit firm also hired Board employee Cynthia Holder who, in two instances, obtained critical information from the PCAOB about the inspection process that was furnished to her new employer. Portions of that information was used to review the work papers on completed audits before they were “locked.” Eventually word got around the firm about the information and an investigation was launched. During the same period the audit firm had issues with its internal professional education courses in which members regularly cheated to secure better scores. An outside law firm was retained which launched an internal investigation. The Order alleges violations of PCAOB Rule 3500T which requires audit firms to “maintain integrity when performing any professional service in connection with the preparation or issuance of any audit report.” In resolving the matter, the Commission considered the fact that the audit firm reported the matters, initiated an investigation of the professional testing matter and its cooperation. The Commission also required that KPMG admit the facts in the Order and that it violated PCAOB Rules. The firm agreed to an extensive set of undertakings in connection with the resolution of these proceedings. In resolving this matter KPMG consented to the entry of a cease and desist order based on the PCAOB Rule cited above and to a censure. The firm agreed to pay a penalty of $50 million.
Pre-release ADRs: In the Matter of Industrial and Commercial Bank of China Financial Services, Adm. Proc. File No. 3-19202 (June 14 2019). Bank of China Financial is a subsidiary of Industrial and Commercial Bank of China Limited. The institution is a Commission registered broker-dealer. Over a four-year period, beginning in September 2011, the Broker operated a matched book or conduit securities lending desk. Its goal was to not hold any position on its books. The desk generated revenue by lending securities, borrowed or otherwise obtained, for more than it paid to borrow or obtain the securities. During the period Respondent had pre-release agreements with four depositaries. Three of those institutions required the execution of certifications stating that it was complying with pre-release agreements. During the period the Broker entered into ten such agreements. Contrary to its representations, Bank of China Financial “was negligent in failing to take reasonable steps to determine whether it complied with the pre-release representations, the Order asserts. This occurred in two situations. First, when the lending desk received requests to borrow “hard-to-borrower” securities, the personnel should have realized that the request “may have arisen from circumstances involving broker-dealers needing to obtain ADRs in order to comply with Regulation SHO’s locate, delivery, and close-out requirements,” the Order states (emphasis added). Second, Respondent engaged in hundreds of pre-release transactions involving sponsored ADRs of foreign issuers that were scheduled to pay dividends. Its lending desk “should have understood from the circumstances of many of the transactions that those amounts may not have originated from the ordinary shares held at the time of the pre-release transaction, and that its borrowers may not have been making tax payments that, under the pre-release agreements should have been paid to the foreign jurisdiction,” according to the Order. The firm also failed to establish and implement the necessary policies. The Order alleges violations of Securities Act Section 17(a)(3). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order and to a censure. In addition, it agreed to pay disgorgement in the amount of $23,983.43, prejudgment interest of $4,458,491 and a penalty of $14,391,262.
Offering fraud: SEC v. Wagner, Civil Action No. 1:19-cv-05570 (S.D.N.Y. Filed June 14, 2019) is an action which names as defendants: David Wagner, an officer of each of the entity defendants; Mark Lawrence, an officer of two of the entity defendants; Downing Partners, LLC, an investment advisory firm; Downing Investment Partners, LP, a firm that managed healthcare entities; and Downing Digital Healthcare Group, Inc., a firm that had an undisclosed management agreement with investment advisory firm Downing. Over a three-year period beginning in May 2014, Defendants raised over $8 million from at least 30 investors. A number of those investors took positions with the entity defendants and two related funds, Downing Health Technologies, Inc. and Cliniflow Technologies, LLC. The offerings were conducted using false financial information which made the entities involved appear to be financially sound when in fact they were cash strapped. Investors also were not told that material portions of the offering proceeds were diverted to make payments under the undisclosed agreement between Downing Digital and Downing as well as for other matters. And, investors were not told that funds from some investors were being used to pay obligations to other investors. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The case is pending. The Manhattan U.S. Attorney’s Office brought parallel criminal charges against Messrs. Wagner and Lawrence. See Lit. Rel. No. 24501 (June 14, 2019).
Financial fraud: In the Matter of David Vogel, CPA, Adm. Proc. File No. 3-19201 (June 14, 2019) is an action which names as a Respondent the former senior vice president for finance of KIT Digital, Inc. The firm, at the time involved here in 2011, was a public company whose shares had been traded on the OTC Bulletin Board until 2009 when they were listed on NASDAQ. In April 2013 the firm filed a voluntary petition for reorganization under chapter 11 of the Bankruptcy Code. During the period, Mr. Vogel, who reported directly to the CFO, was instrumental in the firm’s improper recognition of about $4.8 million in revenue in the fourth quarter of 2011. At the same time the firm also understated its pre-tax loss. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceedings Mr. Vogel consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, he will pay a penalty of $15,000.
Offering fraud: SEC v. Perkins, Civil Action No. 5-19-cv-00243 (E.D.N.C. Filed June 13, 2019) is an action which names as defendants Alton Perkins, CEO and majority shareholder of Defendants Yilamime Corporation of NC and Perkins Hsu Corporation, respectively, an exporter and investment firm and an international exporter; AmericaTowne Holdings, Inc, an exporter whose shares were registered with the Commission under the Exchange Act; and Vilaime Corporation of Nevada, an international trade company. In a little over a year, beginning in January 2014, Mr. Perkins and various of his entities raised about $1.1 million through private placement offerings of securities. Investors were solicited with claims about Mr. Perkins’ business expertise that omitted his prior criminal background, and which misstated the use to which the offering proceeds would be put – much of the money was used by Mr. Perkins for his personal benefit. In addition, AmericaTowne Holdings falsely claimed in Commission filings that it had two contracts worth about $2 million. In fact, those agreements were largely worthless. The complaint alleges violations of each subsection of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 13(a). The case is pending. See Lit. Rel. No 24502 (June 14, 2019).
Offering fraud: U.S. v. Karlsson (N.D. CA) is an action which names as defendants Swedish citizen Roger Nils-Jonas Karlsson and his firm, Eastern Metals Securities. The criminal complaint alleges that Defendants engaged in a scheme to defraud victims of more than $11 million. Specifically, since September 2006 Defendants used one website registered to a fictitious person to solicit investments of $98 per share in exchange for an eventual payout of 115 kilograms of gold per share despite the fact that on January 2, 2019 that quantity of gold was worth over $45,000. Investors were told that Mr. Karlsson would guarantee a return of 98% of investment if the gold was not available. The government found no evidence of any accounts that would have permitted the payment of investors. It did find that investor funds had been diverted to Mr. Karlsson’s personal bank account. A second scheme run through a different website that solicited investors never made any payout. Rather, a variety of excuses were offered including a claim of working with the Securities and Exchange Commission. Mr. Karlsson also told investors to make payments using virtual currencies such as Bitcoin. Mr. Karlsson was arrested in Thailand. Extradition is being sought by the U.S.
In the Matter of Walmart Inc., Adm. Proc. File No. 3-19207 (June 20, 2019) is a proceeding which names the international retail giant as a Respondent. By the end of fiscal 1990 the firm had over 1,500 stores, all in the U.S. In 1991 the firm began to expand internationally, venturing into Mexico. Following its usual formula of low prices and costs the firm then expanded into Mexico, India, China and Brazil from mid-2000 through 2011. During the period there were indications of corruption. The firm took little action. For example, in 2001 its anti-corruption policy consisted of a paragraph in the firm’s Statement of Ethics. Thus, its subsidiaries in Brazil, China, India and Mexico operated with insufficient compliance programs. As a result, the firm’s subsidiaries paid third-party intermediaries without reasonable assurances that transactions were consisted with their stated purpose or the prohibitions against making improper payments to government officials. When the firm did learn of anti-corruption risks it took insufficient actions to properly investigate the allegations or mitigate the risks. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). In determining to accept the firm’s offer of settlement the Commission considered the fact that Walmart made an initial self-disclosure of potential FCPA violations in Mexico to the agency in late 2011. The firm continued to cooperate with the Commission and instituted a number of remedial acts. The company also agreed to implement a series of undertakings which include submitting written reports over a two year period. The Company acknowledged that a penalty was not imposed in view of its settlement with the DOJ where it entered into a non-prosecution agreement and agreed to pay a fine of $137,955,249. The Brazilian subsidiary entering a guilty plea. To resolve the proceedings with the Commission Walmart consented to the entry of a cease and desist order and agreed to pay disgorgement of $119,647,735 along with prejudgment interest of $25,043,437.
U.S. v. Baptiste, No. 1:17-cr-10305 (D. Mass.). Roger Boncy, a business man based in Madrid, Spain and Joseph Baptiste, a resident of Maryland, were found guilty by a Boston jury of corruption violations. The indictment alleged one count of conspiracy to violate the Foreign Corrupt Practices Act and the Travel Act, one count of violating the Travel Act and one count of conspiracy to commit money laundering. The charges were based on allegations that the two defendants solicited bribes from undercover agents posing as potential investors tied to a proposed development project for a port in the Mole St. Nicolas area of Haiti. The project involved the construction of multiple cement factories, a shipping-vessel recycling station, an international transshipment station with numerous slips for vessels, a power plant, a petroleum depot and tourist facilities. Estimated cost was $84 million. Messrs. Boncy and Baptiste, at a meeting in a Boston hotel, told agents that to secure government approval for the project they planned to channel payments to Haitian officials. The bribes would be transmitted through a Maryland based non-profit controlled by Mr. Baptiste. The meeting was recorded. Messrs. Boncy and Baptiste also discussed bribing an aid to a high-level elected official in Haiti who had a position on the port development project. The purpose was to secure the assistance of the official in authorizing the project. The telephone discussion was intercepted and recorded.
Manipulation: The Administrative Appeals Tribunal affirmed an Australian Securities & Investments Commission decision to ban Mark Menzies, the sole director and officer of Menzies Securities Pty Ltd. from providing financial services. The Commission directed that the ban run through January 28, 2022. The tribunal reduced the term until 2020. The determination was based on the fact that Mr. Menzies had manipulated MINI warrants issued by Credit Suisse. The manipulation was done through pre-arranged trades that had a dominant purpose of transferring a profit or loss from prior transactions. MINIs are a form of derivative product traded on the ASX.
Disclosures: The Securities and Futures Commission reprimanded Credit Suisse (Hong Kong) Limited and Credit Suisse AG $2.8 million for failures to comply with the disclosure requirements when publishing certain research reports on Hong Kong listed securities. The SFC found that the pertinent disclosures regarding certain banking relationships had been omitted. This apparently resulted when there was an update to the market-maker disclosure and the disclosures involved here were inadvertently omitted. The issue was fully remediated by May 31, 2017. The SFC concluded, however, that there was a failure to put in place the requisite policies and procedures to ensure compliance.
Report: The SFC published its Annual Report 2018-19 which summarizes and provides key statistics regarding the work of the agency during the period. The regulator also released a strategy to contribute to the development of Hong Kong as a leading center for green finance (here).
Dishonesty: The Monetary Authority of Singapore banned Paris Michele of UBS AG from the securities business for a period of three years. The Authority concluded that while performing his duties to conduct background checks and due diligence on clients for the firm he at times forged the required documents rather than properly performing his duties.