This Week In Securities Litigation (Week ending June 30, 2016)
In the week leading up to the July 4th holiday weekend the SEC filed an action alleging insider trading centered on the acquisition of a firm by Apple based largely on circumstantial evidence and outsized trading. Another action brought by the Commission centered on a NYSE firm whose operations were based largely in China that misrepresented key facts regarding its business. In addition, the Commission filed two offering fraud cases, another based on excessive fees charged by an adviser and a proceeding centered on unregistered broker charges.
SEC
Proposed rules: The Commission issued proposed rules requiring investment advisers to adopt business continuity and transition plans (June 28, 2016)(here).
Rules: The SEC adopted rules for resource extraction issuers under Dodd-Frank. The rules are designed to promote greater transparency about payments regarding resource extraction. (here).
Proposed Rules: The SEC issued proposed rules that would increase the financial thresholds in the “smaller reporting company” definition. This will expand the number of firms that qualify as smaller reporting entities that qualify for certain scaled disclosures provided in Regulations S-K and S-X (here).
Remarks: Chair Mary Jo White delivered the keynote address at the International Corporate Governance Network Annual Conference, titled “Focusing the Lens of Disclosure to Set the Path Forward on Board Diversity, Non-GAAP and Sustainability,” San Francisco, California (June 27, 2016). Her remarks focused on board diversity, non-GAAP financial measures and sustainability reporting (here).
Remarks: Andrew J. Donohue, Chief of Staff delivered the Key Note Address at the InvestoRegulation Conference, titled SEC Regulation Outside the United States, “The SEC at Home and Abroad,” London (June 28, 2016). His remarks focused on the importance of international engagement and reviewed SEC work in the area (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 3 civil injunctive actions and 3 administrative proceedings, excluding 12j and tag-along proceedings.
Self-dealing: SEC v. Weiss, Civil Action No. 1:15-cv-13460 (D. Mass. Filed Sept. 29, 2016). The defendants in this previously filed action are Lee Weiss and his firm, Family Endowment Partners LP, an investment adviser. This week the Court entered a final judgment against Mr. Weiss and his firm, enjoining them from future violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206. The judgment against the firm is also based on Advisers Act Section 204(a). The judgment requires Mr. Weiss to pay a civil penalty of $1 million and his firm $500,000. The relief defendants were directed to pay disgorgement of $8,436,766 along with prejudgment interest. In a related administrative proceeding Mr. Weiss was barred from the securities business. The Commission’s complaint alleged that Mr. Weisss urged advisor clients to invest in over $40 million in illiquid securities issued by several related companies without disclosing that he had an ownership interest in the parent company of the entities and received payments from the entities. He also urged clients to invest in entities he owned and controlled where the funds were used primarily to benefit the adviser. See Lit. Rel. No. 23567 (June 29, 2016).
Insider trading: SEC v. Kerr, Civil Action No. 16-cv-03650 (N.D. Cal. Filed June 29, 2016) is an insider trading case centered on the July 27, 2012 announcement that Apple, Inc. would acquire AuthenTec, Inc. Prior to that date a Brother of Defendant Andrew Kerr, who was an executive at AuthenTec, learned about the transaction during the course of his business. The complaint claims that the mother learned about the proposed deal although it does not specifically state that Brother told her. Subsequently, “the circumstantial evidence indicates Kerr learned information about the negotiations surrounding the proposed acquisition during . . .” a telephone call with his mother, according to the complaint. Following the call he invested heavily in AuthenTec for his account and that of his mother-in-law. After the deal announcement the two accounts had profits of $68,000. The complaint alleges violations of Exchange Act Sections 10(b). The case is in litigation. See Lit. Rel. No. 23586 (June 29, 2016).
Excessive fees: In the Matter of WFG Advisors, L.P., Adm. Proc. File No. 3-17320 (June 28, 2016) is a proceeding naming the registered investment adviser as a Respondent. The adviser has about $1.4 billion in regulatory assets under management. Those assets are held largely in separate accounts for over 9,900 clients. WFG represented that clients participating in its wrap account program would not be charged commissions in connection with alternative investments. Nevertheless, from January 2011 through August 2013 clients were in fact charged a commission and the advisory fee. During approximately the same period the firm also engaged in securities transactions with advisory clients on a principal basis through its broker-dealer without providing prior written disclosures or obtaining consent from the client. The firm failed to adopt policies and procedures reasonably designed to ensure that advisory fees were calculated as represented. The order alleged violations of Advisers Act Sections 206(2), 206(3) and 207. To resolve the action Respondent agreed to certain undertakings, consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. Respondent will pay a civil penalty of $100,000.
Offering fraud: In the Matter of Jan F. Helen, Adm. Proc. File No. 3-17319 (June 28, 2019). Respondent Helen is the sole owner of Janco Properties, the manager and investment adviser to JEP II and JEP III regarding their oil and gas investments. JEP II and JEP III were formed to invest in working interests in oil and gas exploration. Over a period of months, beginning in March 2013, Respondent misappropriated $165,200 from the two entities. The misappropriation was discovered in 2014 during a regulatory review of Respondent’s then affiliated broker-dealer. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Section 206(4). The proceeding will be set for hearing.
Misrepresentations: SEC v. Toups, Civil Action No. 23584 (June 27, 2016). Defendant Michael Toups was the CFO of Longwei Petroleum Investment Holding Limited, a Colorado corporation with its primary place of business in Shanxi province China. The firm’s shares were at one time listed on the New York Stock Exchange. Longwei built is storage business through acquisitions. In various statements the firm reiterated the total amount of storage owned but the number of storage tanks owned continually varied. In late 2012 a shareholder questioned the claims regarding storage. Mr. Toup took a variety of steps to investigate the claim. Eventually he learned that the firm was overstating not just its storage capacity but also its inventory. Nevertheless, in January 2013 Mr. Toup drafted a press release for the firm which claimed the representations regarding storage were made in accord with industry standards. The stock price jumped the day of the release. The same day Mr. Toup received documents from the Fire Protection Bureau in Shanxi, China demonstrating that the capacity claims were incorrect. No corrective disclosure was made. The day after the press release was issued a research firm published a report claiming that Longwei was a “massive fraud.” In part the report alleged that the firm was overstating its sales. The stock price dropped 73%. An inquiry by the firm’s U.S. based auditors and the Chairman of the Audit Committee was thwarted. Later the NYSE delisted the stock. In October 2012, shortly before certain warrants were due to expire, an advisor to the firm’s CEO told Mr. Toups that the company was in urgent need of cash. To raise the funds Mr. Toups was asked to pressure warrant holders to exercise their holdings before month end. He did without disclosing that the warrants were going to be extended. This gave the firm a cash injection. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a). The case is pending. The Commission has also instituted a proceeding under Exchange Act Section 12j as to the firm. See Lit. Rel. No. 23584 (June 27, 2016).
Offering fraud: SEC v. Faulkner, Civil Action No. 3:16-cv-01735 (N.D. Tx. Filed June 24, 2016). The action names as defendants: Christopher Faulkner, known as the Frack Master from his TV and radio appearances, President and CEO of defendant Breitling Energy Corporation, registered under Section 12(b) with the SEC; Breitling Oil & Gas Corporation; Crude Energy, LLC and Patriot Energy, Inc., both controlled by Mr. Faulkner; Jeremy Wagers, a Texas Attorney; Judson Hoover, a CPA and Breitling Energy Corp. CFO; Parker Hallam; co-founded of Breitling and president of defendant Crude Energy; Joseph Simo, the owner of Simo Energy, LLC, a Dallas petroleum geology consulting firm that services Breitling Oil, Breitling Energy, Crude Energy and Patriot Energy; Dustin Miller Rodreguez, co-founder of Breitling Oil and its CIO; Beth Handkins, Crude Energy’s COO; and Gilbert Steedly, Breitling Energy’s v.p. of capital markets. Frack Master Faulkner created a fraudulent offering scheme using Breitling Oil which was later essentially replicated with other firms, including publically traded Breitling Energy. He began in 2011 with privately held Breitling Oil. The firm told investors it was offering “turnkey” oil and gas working interests. Mr. Faulkner ran the operations in large measure while Messrs. Hallam and Miller directed the sale process. The sales process was built on a series of misrepresentations about Mr. Faulkner’s background, the costs of developing the properties and ended with the misuse of investor funds. Investors were also furnished information from geologist Joseph Simo who was represented to be independent when he was not. By repeatedly replicating this scheme Defendants raised about $80 million in more than 20 oil and gas offerings from hundreds of investors. Mr. Faulkner misappropriated at least $30 million. The Commission’s complaint alleges violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5), 14(a) and 16(a). The case is in litigation. See Lit. Rel. No. 23582 (June 24, 2016).
Unregistered broker: In the Matter of Ross, Sinclaire & Associates, LLC, Adm. Proc. File No. 3-17315 (June 23, 2016) is a proceeding which names as Respondents the registered broker-dealer and Murray Sinclaire, Jr., its president, CEO and 90% owner. For a five year period beginning in January 2007 Nicholas Fry, president of registered investment adviser Fry Hensley and Co., obtained inflated commissions through Ross Sinclaire. Specifically, as a result of a close relationship with the firm, Mr. Fry was permitted to be involved in effecting equity securities trades for clients of his firm and setting the amount of the commissions, markups and markdowns. He did not hold the proper FINRA licenses to execute trades. The records reflected, however, that the account executive was his wife who did hold the appropriate licenses. In fact she did no work on the accounts. The charges imposed by Mr. Fry were excessive. The Order alleges violations of Exchange Act Rule 15(b)(7). Each Respondent resolved the matter, consenting to the entry of a cease and desist order based on the Section cited in the Order. The firm was censured. Mr. Sinclaire will be restricted for a period of twelve months from acting in a supervisory capacity in the securities business. In addition, the firm will pay disgorgement of $703,335.16, prejudgment interest and a civil penalty of $100,000. Mr. Sinclaire will pay a penalty of $50,000.
FINRA
Data submission: The regulator fined Deutsche Bank Securities Inc. $6 million for failures related to the submission of blue sheets. FINRA concluded that from 2008 through 2015 the firm experienced significant failures with respect to the systems related to producing blue sheets. This resulted in thousands of blue sheet errors that either misreported or omitted critical information on over 1 million trades.
PCAOB
Guidance On Form AP: The staff issued guidance for firms filing Form AP disclosing engagement partner names and other firms participating in audits (here).
Australia
Insider trading: Oliver Curtis was convicted of insider trading and ordered to serve two years in prison with the second year suspended on entry into a recognizance of good behavior for 12 months. The scheme, which involved 45 trades, involved Mr. Curtis trading for his friend John Hartman, an employee of Orion Asset Management Ltd. Mr. Hartman furnished inside information on his employer which permitted the purchase of contracts for a difference that generated $1,432,228.85 in profits. The two men shared in the profits.