This Week In Securities Litigation (Week ending June 3, 2016)

The Second Circuit rejected a challenge to the SEC’s venue selection decisions, concluding that the district court did not have jurisdiction to hear an issue regarding the Appointments Clause. This is the third circuit court to conclude that any such challenge must be presented through the administrative process.

The Eleventh Circuit concluded that the five year statute of limitations for penalties barred an SEC request for disgorgement and declaratory relief but not for an injunction. Since the statute imposes time limits on penalties which are backward looking and punishment the court concluded that remedies which had similar effects such as declaratory relief and disgorgement were subject to the limitation period but not those which were forward looking like an injunction.

The SEC also filed a series of enforcement actions including: another offering fraud action tied to the EB-5 program; its first ever action based solely on the failure to file a SAR; an insider trading action where an investment banker tipped his plumber; an action against an investment adviser who received transaction based compensation in connection with certain transactions and thus acted as an unregistered broker; and one in which the firm charged excessive fees by moving client funds into new funds which charged higher fees but used the same investment strategy.


Remarks: Chair Mary Jo White delivered remarks titled “The Continuous Process of Optimizing the Equity Markets” to the SEC Historical Society, June 2, 2016. Her remarks focused on the Commission’s equity market structure agenda (here).

Rules: The SEC adopted an Amendment to Form 10-K implementing the Fixing America’s Surface Transportation (FAST) Act (here).

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 10 civil injunctive actions and 2 administrative proceedings, excluding 12j and tag-along proceedings.

Misrepresentations: SEC v. Park, Civil Action No. 1:16-cv-04103 (S.D.N.Y. Filed June 2, 2016) is an action against Haena Park. From at least January 2012 to the present Ms. Park solicited friends and others to invest in commodities. To induce people to invest she touted what was claimed to be a successful track record. In reality she had lost over $16 million trading. Nevertheless, investors were told about profits. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). The case is pending. The U.S. Attorney’s Office for the Southern District of New York filed a parallel criminal action.

Offering fraud: SEC v. Davis, Civil Action No. 3:16-cv-00285 (W.D.N.C. Filed June 2, 2016) is an action which names as a defendant Richard Davis, Jr., an unregistered investment adviser. Mr. Davis, while soliciting funds to invest in securities, began offering interests in “hard assets” – pooled investment vehicles in real estate. In soliciting investors he did not disclose the fact that portions of the real estate belonged to him. He also did not disclose to investors that loans tied to the property became delinquent or that he diverted portions of the invested funds to his own use. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The case is pending. See Lit. Rel. No. 23554 (June 2, 2016).

Manipulation: SEC . Spongetech Delivery Systems, Inc., Civil Action No. 10-cv-2031 (E.D.N.Y.) is a previously filed action which named as a defendant, among others, Jack Halperin, a former attorney for the firm. The complaint alleged a pump-and-dump market manipulation scheme. Mr. Halperin resolved the action, and the court entered a final judgment against him, which permanently enjoins him from violating the antifraud and securities registration provisions of the federal securities laws and from providing legal services in connection with an unregistered offering. The order also bars him from participating in any penny stock offering and directs him to pay disgorgement of $44,537, prejudgment interest and a penalty of $100,000. He will also be suspended from appearing and practicing before the Commission as an attorney. See Lit. Rel. No. 23557 (June 2, 2016).

Bar: SEC v. Wise, Civil Action No. 1:16-cv-04104 (S.D.N.Y. June 2, 2016) is an action which alleges that Steven Wise violated a penny stock bar imposed in an earlier case. Specifically, in 2015 Mr. Wise is alleged to have solicited several private companies to issue publicly traded shares. He assisted with the arrangements. This violated the bar. Mr. Wise agreed to settle the charges by consenting to the entry of a final judgment enjoining him from future violations of Exchange Act Section 15(b)(6)(B) and pay a penalty of $20,000. See Lit. Rel. No. 23555 (June 2, 2016).

AML: In the Matter of Albert Fried & Co., LLC, Adm. Proc. File No. 3-17270 (June 1, 2016) is an action which names the New York broker-dealer as a Respondent. From August 2010 through late 2015 the firm failed to file a SAR despite numerous red flags as identified by its AML procedures. Those included trading that constituted substantial portions or all of the trading for a particular day, heavy trading in low-priced securities and unusually large deposits of funds or securities. The Order alleges violations of Exchange Act Section 17(a). To resolve the proceeding the firm consented to the entry of a cease and desist order based on the Section cited in the Order and to a censure. The firm will also pay a civil penalty of $300,000. The penalty was not increased based on the firm’s cooperation. This is the first action brought based solely on the failure to file a SAR.

Unregistered broker: In the Matter of Blackstreet Capital Management, LLC, Adm. Proc. File No. 3-17267 (June 1 2016) is a proceeding which names as Respondents the firm, a registered investment adviser that provides investment advisory and management services to two funds, and Murry Gunty, its managing member and principal owner. The Order alleges that the firm received transaction based compensation for brokerage services, collected certain unauthorized and inadequately disclosed fees from one of its funds, made unauthorized use of fund assets and made an unauthorized purchase of portfolio company interests and of limited partnership interests. The firm also failed to implement appropriate compliance procedures. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). To resolve the matter Respondents consented to the entry of cease and desist orders based on the Sections cited in the Order. The firm also consented to the entry of a censure. Respondents, jointly and severally, will also pay disgorgement of $2,339,000, prejudgment interest and a penalty of $500,000. Portions of the disgorgement will be paid to the managed funds.

Insider trading: SEC v. McClatchey, Civil Action No. 1:16-cv-04029 (S.D.N.Y. Filed May 31, 2016) is an action which names investment banker Steven McClatchey, and his friend, plumber Gary Pusey, as defendants. Mr. McClatchey, through his position at the bank, had access to confidential information regarding mergers. Over a period of time Messrs. McClatchey and Pusey became good friends. In 2014 and 2015 Mr. McClatchey furnished his friend Gary Pusey with inside information in ten different transactions. In each instances Mr. Pusey traded, compiling realized and unrealized profits of over $75,000. In return for the information Mr. Pusey furnished free services at the home of Mr. McClatchey and cash. The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). The case is pending. The U.S. Attorney’s Office for the Southern District of New York filed parallel criminal charges.

Fraudulent fees: SEC v. Hope Advisors, LLC, Civil Action No. 1:16-cv-01762 (N.D. Ga. Filed May 31, 2016) is an action which names as defendants the registered investment adviser and its owner, Karen Bruton. Hope Advisors, which advised two funds, had a “high-water-mark” fee structure under which it was only entitled to payment if its fees exceeded past losses. Beginning in late November 2014 the firm engaged in a scheme to ensure that it was paid these fees despite not being eligible. Specifically, at the end of the month the adviser had the funds trade in such a manner as to make it appear there were profits. Under this scheme the adviser was paid millions of dollars in fees while substantial losses were avoided. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and Adviser Act Sections 206(1), 206(2) and 206(4). The case is pending.

Investment fund fraud: SEC v. JSG Capital Investments, LLC, Civil Action No. 3:16-cv-02814 (May 25, 2016) is an action which names as defendants the firm, Jaswant Gill, its founder and CEO, Javier Rios, the firm’s sole member and three related entities. Mr. Gill, who claimed to have previously been a managing partner at Morgan Stanley, and the other defendants, targeted middle class investors. Since September 2013 they have raised about $10 million from over 200 investors with claims that their funds would be put into pre-IPO shares. High returns would be paid and their investment was safe at brokerage firms and covered by insurance. In reality, the firm was a classic Ponzi scheme. No funds were invested. Rather, the investor money was misappropriated. The complaint alleges violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1) and 206(2). The court entered a freeze order on the filing of the complaint. The complaint is pending. The U.S. Attorney’s Office for the Northern District of California filed a parallel criminal action.

Excessive fees: SEC v. Momentum Investment Partners LLC, Civil Action No. 3:16-cv-00832 (D. Conn. Filed May 31, 2016) is an action against the registered investment adviser and its CEO and CIO, Ronald Fernandes. Prior to 2013 Momentum Investment Partners, known as Avatar Investment Management, had about 20 investment accounts for eight families. The adviser used a proprietary investment strategy centered on ETFs. In 2013 the defendants created four mutual funds. Without telling the existing clients, a portion of their investments were transferred to the new mutual funds. Those funds used the same investment strategy but charged substantially higher fees. Eventually the funds folded. The complaint alleges violations of Adviser Act Sections 206(1), 206(2), 206(4) and 207. The case is pending. See Lit. Rel. No. 23549 (May 31, 2016).

Fraudulent loan transactions: SEC v. First Mortgage Corporation, Inc., Civil Action No. 2:16-cv-03772 (C.D. Cal. Filed May 31, 2016) is an action which names as defendants, the firm, approved by GNMA to issue GNMA RMBS, and six of its officers: Clement Ziroli, Chairman and CEO: Clement Ziroli, Jr., president; Pac Dong, CFO; Ronald Vargas, senior v.p.; Scott Lehrer, senior V.P.; and Edward Sanders, vice president. From March 2011 through March 2015 the defendants mislead investors in mortgage-backed securities guaranteed by the Government National Mortgage Association. Specifically, they failed to credit payments made by borrowers to the mortgages, letting them go into default. The mortgages, which were pooled, were then delinquent. Defendants then repurchased the mortgages at a low delinquent rate. Later they resold them to pools as current at the higher rate for such mortgages, making a profit. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The firm and each of its executives resolved the action. In connection with the settlement each of the executives consented to the entry of an order barring them from serving as an officer or director of a public company. In addition, each will pay: Mr. Ziroli Sr., a penalty of $100,000; Mr. Ziroli Jr., $411,421.98 in disgorgement, prejudgment interest and a $200,000 penalty; Mr. Dong, a $100,00 penalty; Mr. Vargas, a $60,000 penalty; Mr. Lehrer, a $50,000 penalty; and Mr. Sanders, disgorgement of $51,576.51 and prejudgment interest.

Offering fraud: SEC v. Esposito, Civil Action No. 16-cv-10960 (D. Mass. Filed May 26, 2016) is an action which names as defendants Christopher Esposito, Anthony Pignatello, James Gondolfe, Renee Galizio, Lionshare Ventures LLC and Cannabiz Mobile, Inc. Mr. Esposito is the managing director of Lionshare; Mr. Pignatello is a Secretary of Cannabiz; and Mr. Gondolfe is President of Cannabiz. In part one of his scheme Mr. Esposito raised about $550,000 over a two year period beginning June 2011 from an unregistered offering of Lionshare. He used portions of the investor funds for personal expenses. Other portions were used to acquire control of Cannabiz. In the second phase of the scheme which began in May 2012 he concealed his control of Cannabiz by installing Mr. Gondolfe as the sole offer of the firm and falsifying public filings. This permitted him to sell large amounts of the firm’s securities, raising over $300,000, without complying with the limitations of Rule 144. The complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23545 (May 26, 2016).

Offering fraud: SEC v. Liu, Civil Action No. 8:16-cv-00974 (C.D. Cal. Filed May 26, 2016) is an action which names as defendants Charles Liu, his wife Xin Wang, Pacific Proton Therapy Regional Center, LLC, Pacific Proton EB-5 Fund, LLC, and Beverly Proton Center, LLC. The complaint alleges that beginning in October 2014, and continuing to the present, defendants solicited Chinese investors to invest in their cancer treatment center through the EB-5 immigration program. Each investor was to invest $500,000 in the project and pay an administrative fee of $45,000. Each investor sought to obtain, among other things, a permanent green card. Overall about $27 million was raised. Nothing was built. Much of the money was diverted by the individual defendants. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The Commission obtained a freeze order. The case is pending. See Lit. Rel. No. 23556 (June 2, 2016).


Best execution: The regulator fined E*Trade Securities LLC $900,000 and censured the firm for system deficiencies related to best execution and customer protection. Specifically, FINRA found that E*Trade’s Best Execution Commission lacked sufficiently accurate information to reasonably assess the execution quality it provided its customers. Orders were regularly rerouted without determining if it would improve execution. The firm also did not have in place sufficient procedures to ensure that there was no misuse of customer information.


Disciplinary action: The Board announced on June 1, 2016 two resolved disciplinary proceedings tied to on audits of listed issuers based in the PRC:

In the Matter of AWC (CPA) Ltd., Wong Chi Wai and Wong Fei Cheung, PCAOB Release No. 105-2016-016 (May 18, 2016). The firm was censured and its registration revoked with a right to reapply after two years. It will also pay a penalty of $10,000. Wong Chi Wai was censured and barred from association with a right to request termination of the bar after two years and fined $10,000. Wong Fei Cheung was also censured and barred with a right to request termination of the bar after one year and fined $5,000.

In the Matter of AWC LLP, PCAOB Release No. 105-2016-016. The firm was censured and its registration suspended for one year. Mun Leung Chung was censured and barred from association with a right to request termination of the bar after two years and fined $5,000. Lam Shan MUI was censured and a limitation placed on activities that he can perform in connection with public company audits for one year with a requirement to complete additional professional education related to ethics and independence requirements.

Court of Appeals

Forum selection: Tilton v. SEC, Docket No. 15-2103 (2nd Cir. Decided June 1, 2016). The circuit court rejected a challenge to the SEC’s venue selection, concluding that district courts lack jurisdiction to hear an Appointments Clause challenge while an administrative proceeding is pending. Here the SEC initiated an administrative proceeding in March 2015 which named as Respondents the appellants in this action: Lynn Tilton, Patriarch Partners, LLC and other affiliated entities. The SEC Order alleged that Respondents had violated the Investment Advisers Act. Two days later appellants initiated this suit alleging that the presiding ALJ’s appointment violated the Appointments Clause of the Constitution. The SEC moved to dismiss for lack of jurisdiction. While there are conflicting district court decisions on this question, the lower court granted the SEC’s motion, dismissing the action. In reaching its conclusion the district court relied primarily on the Supreme Court’s decisions in Elgin v. Department of Treasury, 132 S.Ct. 2126 (2012), Free Enterprise Fund v. Public Co. Accounting Oversight Board, 561 U.S. 477 (2010) and Thunder Basin Coal Co. v. Reich, 510 U.S. 200 (1994).

To analyze the jurisdictional question at the core of this case the court considered two key issues: First, if it is “fairly discernible from the text, structure and purpose of the securities laws that Congress intended the SEC’s scheme of administrative and judicial review to preclude district court jurisdiction. Second, if the answer to the first question is in the affirmative then it must be determined if the “Appointments Clause claim is “of the type Congress intended to be reviewed within the statutory structure.” (internal citations omitted). First, the “text, structure, and purpose of the securities laws make clear that Congress intended the SEC’s scheme of administrative review to permit the Commission to bring its expertise to bear in enforcing the securities laws.” In Thunder Basin the Supreme Court concluded that a similar statutory scheme precluded district court jurisdiction. The same conclusion applies to the securities laws, the court held. Appellants do not contest this point. Rather, they argue that the Appointments Clause challenge is a distinct type of claim which presents a “threshold constitutional challenge to agency practice.”

Second, to analyze appellants’ challenge the court considered three points drawn from the Supreme Court’s jurisprudence on the question: 1) The availability of meaningful judicial review; 2) whether the issue is wholly collateral to the administrative action; and 3) the expertise of the agency. The court concluded that the administrative appeal presented an adequate opportunity for federal court review and that the Appointments Clause issue and that the question was not wholly collateral since it was raised as an affirmative defense in the administrative action. Finally, while the SEC’s expertise is not in constitutional issues, since it may use its expertise to resolve other issues in the administrative proceeding which could end the action, the matter is not wholly outside its expertise. The circuit court affirmed the dismissal of the action.

Statute of limitations: SEC v. Graham, No. 14-13562 (11sth Cir. May 26, 2016). The SEC filed an enforcement action against Barry J. Graham and others claiming that they sold unregistered securities in violation of the federal securities laws. Specifically, between November 2004 and July 2008 the defendants raised over $300 million from about 1,400 investors, selling unregistered securities. The agency filed its complaint on January 20, 2013.

On cross-motions for summary judgment the district court dismissed with prejudice the SEC’s complaint as time-barred. Section 2462 bars any action “for the enforcement of any civil fine, penalty, or forfeiture” if brought more than five years from the date the claim first accrued. Remedies subject to the statute, such as penalties, focus on the past. Thus, where the remedy sought focuses on the past the Section applies. Here the SEC sought injunctive and declaratory relief and disgorgement. The circuit court rejected the claim that the Section applied to the Commission’s request for injunctive relief since it is a forward looking, equitable remedy in contrast to penalties which punish past conduct. The same cannot be said of the SEC’s request for declaratory relief, the court concluded, which focuses on the past. Accordingly, the district court correctly concluded that the Section bars this request for relief because it is backward looking like a penalty.

Finally, the district court properly concluded that the SEC’s request for disgorgement is time-barred by §2462. In reaching this conclusion the court found that disgorgement is in the same category as a forfeiture – being required to give something up because of past conduct — which is subject to the time limits of the Section. Accordingly, the court affirmed in part, reversed in part and remanded the action to the district court.

Hong Kong

Remarks: Ashley Alder, CEO of the Securities and Futures Commission delivered remarks titled “Hong Kong as an evolving international financial centre: The significance of regulation” at the HKSI Luncheon, June 2, 2016. His remarks reviewed the evolution of Hong Kong and discussed the SFC’s listing regulation, fund management and its GEM listing policy which is a stepping stone to the exchange (here).

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