This Week In Securities Litigation (Week ending June 8, 2018)
Offering frauds, conflicts and filings regarding private funds were the focus of SEC Enforcement over the past week. Two offering fraud actions were brought, one centered on the use of sound in oil production and the other based on a scheme by a recidivist violator in which a valid business model was so oversubscribed with note sales and loans – large portions of which were misappropriated – that the firm became insolvent. The Commission also brought another in a series of actions against an investment adviser centered on undisclosed conflicts, although this time the conflict was not tied directly to influencing the investment advice. Finally, a group of thirteen actions were brought against investment advisers who failed to file Form PF, furnishing the agency with certain data regarding private funds.
Rules: The Commission issued a new rule regarding the delivery of fund reports while soliciting comments on disclosures and certain delivery fees as part of an effort to update and improve fund disclosures. Specifically, effective January 1, 2021 advisers can deliver shareholder reports by sending a notice and posting the full report on their website or sending the full report if requested, all without charge. Public comment is being sought on ways to improve disclosure. And, comment is being sought on the framework for certain processing fees that broker-dealers and others charge for delivering fund shareholder reports and other materials (here).
Digital Asset Adviser: The Commission created a new position for a Digital Asset Adviser by naming Valerie Szczepanik as Associate Director in the Division of Corporation Finance and Senior Adviser for Digital Assets and Innovation to the Division Director, Bill Hinman.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 3 civil injunctive cases and 16 administrative proceeding, excluding 12j and tag-along proceedings.
Financial fraud: In the Matter of Constant Contact, Inc., Adm. Proc. File No. 3-18531 (June 5, 2018) is an action which names Constant Contact and Endurance International Group Holdings, Inc., as Respondents. Both firms are in the hosting and online marketing business. Endurance acquired Constant Contact in February 2016. Prior to the acquisition, Constant Contact falsely inflated its subscriber numbers to improve the appearance of its financial metrics. The firm did this by artificially inflating its unique subscriber numbers. This was reflected in its filings with the Commission. Endurance had its own issues with subscriber numbers. In 2014 the firm made an error in those numbers, overstating subscribers. That error carried over into its IPO. In February when the firm tried to correct the problem additional material errors were made. The Order alleges violations of Securities Act section 17(a) and Exchange Act sections 10(b), 13(a) and 13(b)(2)(A). In accepting the offer of settlement the Commission considered the cooperation of the firms. Each firm also undertook to cooperate in the future with the agency. To resolve the proceedings Constant Contact consented to the entry of a cease and desist order based on the sections cited in the Order. Endurance, on behalf its subsidiary, will pay a penalty of $8 million.
Offering fraud: SEC v. Iannelli, Civil Action No. 2:18-cv-05009 (C.D. Cal. Filed June 5, 2018). Defendant Ralph Iannelli is a securities law recidivist. He was enjoined by the Commission in a fraud action in 1975 and later permanently barred from the securities business. He has also been held in contempt for violating the injunction. Defendant Essex Capital Corporation was founded by Mr. Iannalli in 1993. The firm operates an equipment leasing business. The firm claims to lease specialized business equipment to start-ups. Mr. Iannelli raised capital for the firm initially by soliciting friends and members of the community to purchase promissory notes, typically with an interest rate of about 8.5%. One of the marketing materials claimed that 100% of investor funds would be used toward the purchase of equipment. Investors would be repaid over 36 months. Essex claimed that its business model could be structured to create this result. Over time Essex started to raise more money than it needed to purchase equipment primarily from two investment adviser firms that were furnished false information. While Essex could not service the debt from the notes sold and bank loans taken out, Mr. Iannelli did personally benefit from the scheme. During the 2014 to 2017 period he siphoned millions of dollars out of the company in the form of discretionary bonuses and interest-free personal loans to himself. Eventually the firm tottered on the brink of collapse – it was insolvent. The complaint alleges violations of Securities Act section 17(a) and Exchange Act section 10(b). The case is pending. See Lit. Rel. No. 2418 (June 6, 2018).
Cherry picking: In the Matter of Gary W. Freeman, Adm. Proc. File No. 3-18532 (June 5, 2018) is a proceeding which names as a Respondent the former CFO of state registered investment adviser Oak River Financial Group, Inc. From mid-July 2012 through mid-September 2013 Respondent disproportionally allocated profitable trades to himself, his wife or his mother and disproportionately allocated unprofitable trades to his clients. As a result he had ill-gotten gains of $53,379. The Order alleges violations of Exchange Act section 10(b) and Advisers Act sections 206(1) and 206(2). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, he will pay disgorgement of $53,379, prejudgment interest of $6,271.82 and a penalty of $53,379. He is also barred from the securities business.
Offering fraud: SEC v. Gilman, Civil Action No. 3:18-cv-1421 (N.D. Tx. Filed June 4, 2018) is an action which names as defendants: Paul Gilman, Oil Migration Group, LLC or OMG, Wavetech29, LLC and Gilmansound, LLC. Each entity defendant is controlled by Mr. Gilman. Defendant Gilman claims to be a music visionary. The three businesses he launched here all failed. First, he raised about $3.3 million over a period of three years beginning in 2016 from at least 40 investors who were told that OMG and Wavetech had a technology that used soundwaves to facilitate oil extraction. In fact the business was a sham. Mr. Gilman essentially ran a Ponzi scheme. Second, investors were solicited for Gilmansound which claimed to market sound systems for stadiums. While this began as a real business it later turned into essentially a sham, misappropriating the funds raised from investors. The complaint alleges violations of Securities Act section 17(a) and Exchange Act section 10(b). The case is pending. See Lit. Rel. No. 34256 (June 5, 2018).
Conflicts: In the Matter of Devere USA, Inc., Adm. Proc. File No. 3-18527 (June 4, 2018). The firm is a registered investment adviser whose business centers on U.K. pension holders. Specifically, its clients hold interests in U.K. pension plans. The adviser furnished advice to the clients regarding the transfer of their U.K. pension assets to overseas retirement plans that qualified under the U.K. tax authority’s regulations as a Qualifying Recognized Overseas Pension Scheme or QROPS. Until about March 2017 deVere’s primary business involved recommending that clients elect to take a cash equivalent transfer value from their U.K. plan to a QROPS. The process typically involved the use of third party vendors in the form of a Custodian Firm and a Trustee Firm for the assets. The vendors charged the clients fees. In addition, the vendors made payments to the adviser and/or the IAR which were not disclosed. There were similar arrangements regarding the conversion of a U.K. pension from British Pounds to U.S. Dollars or Euros in connection with the transfer to a QROPS. In addition, tax advice was often given to clients by the IAR in connection with the transfer to a QROPS. Frequently, the statements made were incorrect. For example, certain IARs told clients between 2014 and 2016 that U.K. pensions were subject to U.K. inheritance tax. Yet that tax had not applied since at least 2011. Finally, the adviser’s policies and procedures were not reasonably designed since they were not tailored to the specific business model of the firm. The Order alleges violations of Advisers Act sections 206(1), 206(2), 206(4) and 207. To resolve the proceedings the adviser agreed to implement certain undertakings. Those included providing notice of these proceedings to the clients, certain training and the retention of an independent consultant to review the firm’s policies and procedures and make appropriate recommendations which will be adopted. In addition, the firm consented to the entry of a cease and desist order based on the sections cited in the Order and to the entry of a censure. The adviser will also pay a penalty of $8 million. See also SEC v. Alderson, Civil Action No. 1:18-cv-04930 (S.D.N.Y. Filed June 4, 2018)(action naming as defendants Benjamin Alderson and Bradley Hamilton, respectively, the CEO and Area Manager of the firm; complaint is based on the facts and sections cited above; case is in litigation).
Reg PF: See, e.g. In the Matter of Bachrach Asset Management Inc., Adm. Proc. File No. 3-18511 ((June 1, 2018); In the Matter of Cherokee Investment Partners, Inc., Adm. Proc. File No. 3-18516 (June 1, 2018). The cited actions are examples of 13 cases filed against investment advisers. Each case in the group alleged violations of rule 204(b)-1 of the Advisers Act. Under that rule a report on Form PF must be filed if the adviser is registered, or required to be registered, and advisees a private fund with at least $150 million in assets. Most filers provide basic information regarding the advised funds’ performance and leverage. The filing has to be updated annually. The Commission uses the information to report annually to Congress. Specifically, the Form is primarily designated for use in providing the Financial Stability Oversight Council with information important to understanding and monitoring systemic risk in the private fund industry. The agency also uses the information in examinations, investigations and its investor protection efforts. Certain aggregated information derived from the filings is published. Respondents Bachrach and Cherokee are registered investment advisers that advise private funds. Each failed to make the required filing. Each adviser resolved the proceedings, consenting to the entry of a cease and desist order based on rule 204(b)-1. Each also agreed to a censure and will pay a penalty of $75,000. In each proceeding the Commission considered the remedial efforts of the adviser. The settlements in Bachrach and Cherokee are typical of those among the group of thirteen advisers charged. The other eleven advisers who were charged and settled are: Biglan Capital LLC, Brahma Management Ltd., Bristol Group Inc., CAI Managers & Co. L.P., Ecosystem Investment Partners LLC, Elm Partners Management LLC, HEP Management Corp., Prescott General Partners LLC, RLJ Equity Partners LLC, Rose Park Advisors LLC and Veteri Place Corp.
Societe Generale S.A. and Legg Mason, Inc. each agreed to resolve FCPA charges tied to bribing Gaddafi-Era Libyan Officials. Society Generale is a global financial services institution based in Paris, France. The firm and its subsidiary, SGA Societe Generale Acceptance N.V., agreed to settle charges tied to a multi-year scheme to pay bribes to officials in Libya. Legg Mason, a Maryland based investment management firm, and its subsidiary Permal Group Ltd., also agreed to settle charges tied to its participation in the Libyan bribery scheme with Societe Generale.
Beginning in 2004, and continuing until 2009, Societe Generale agreed to pay bribes through a Libyan broker related to 14 investments made by Libyan state-owned financial institutions. Over the period a total of $90 million in bribes were paid, portions of which were channeled to high-level Libyan officials to secure investments from various Libyan state institutions. The bribes were calculated as a percentage of the deal, typically ranging from 1.5% to 3%. Portions of the bribes were paid to benefit Legg Mason. Society Generale obtained a total of 13 investments and one restructuring loan from various Libyan state institutions valued at over $3.66 billion, yielding profits of $535 million. Legg Mason, through Permal, managed seven of the investments, reaping profits of about $31.6 million.
To resolve the case Society Generale entered into a deferred prosecution agreement tied to a criminal information charging one count of conspiracy to violate the anti-bribery provisions of the FCPA and one count of transmitting false commodity reports. Its subsidiary will plead guilty to a one-count criminal information alleging conspiracy to violate the anti-bribery provisions of the FCPA. The financial institution will pay a criminal penalty of $585 million and continue to cooperate with the investigations. The firm will also maintain enhanced compliance procedures. The resolution reflects the firm’s failure to self-report and substantial but not full compliance along with substantial remediation, all of which lead the Department to conclude that a monitor is not necessary. U.S. v. Society Generale (E.D.N.Y.); U.S. v. SGA Societe Generale Acceptance N.V. (E.D.N.Y.).
Legg Mason entered into a non-prosecution agreement and will to pay $64.2 million. That amount is composed of a penalty of $32,625 million and disgorgement of $31,617 million. The amount of the disgorgement will be credited against disgorgement claims of other law enforcement agencies made within the first year of the settlement. The firm will also continue to cooperate and maintain an enhanced compliance program. The settlement reflects the fact that the firm did not self-report but did fully cooperate with the investigation and fully remediated. The misconduct also only involved mid- to lower level employees of the subsidiary while Society Generale maintained the relationship with the Libyan broker.
Finally, in an unrelated matter, Society Generale resolved charges tied to manipulating LIBOR. Essentially the firm paid a $275 million fine for manipulating the market down.
Takeover code: The Securities and Futures Commission censured and imposed a 24- month cold shoulder (suspension from the market) on Chan Shing for failing to comply with the Takeover Code. Specifically, when he and his group exceeded the 34.45% share mark they failed to make an offer as required. Mr. Chan claimed he was not familiar with the rule but he agreed to the sanction. The SFC cautioned that those participating in the market must be familiar with the rules.
MOU: The SFC and the Abu Dhabi Global Market Financial Services Regulatory Authority established a framework for cooperation on financial technology. Specifically, the two regulators will cooperate on information sharing, potential joint innovation projects and referrals of innovative firms seeking to enter the markets.