This Week In Securities Litigation (Week ending March 11, 2016)
This week the SEC brought six actions tied to the failure of a rapidly growing enterprise to maintain the proper internal controls. The agency also brought two proceedings tied to municipal bond offerings and one insider trading case.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 2 civil injunctive case and 9 administrative proceedings, excluding 12j and tag-along proceedings.
Internal controls: In the Matter of Magnum Hunter Resources Corporation, Adm. Proc. File No. 3-17166 (March 10, 2016) is a proceeding against the firm with related actions against its CFO, CAO, the engagement partner at its outside audit firm and an accountant at an outside firm retained regarding internal controls. The actions all center on the failure of the firm and its management to properly implement, maintain and evaluate internal controls over financial reporting for the fiscal year ended December 31, 2011. As the firm grew it also failed to keep pace with that expansion in terms of maintaining the proper controls up through the quarter ended September 30, 2013. The failure of the CFO and CAO to properly evaluate the severity of identified control deficiencies contributed to the failures. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The firm resolved the action by consenting to the entry of a cease and desist order based on the Sections cited in the Order. The firm will also pay a penalty of $250,000. See also In the Matter of Ronald D. Ormand, Adm. Proc. File No. 3-17167 (March 10, 2016)(action against CFO, resolved with a cease and desist order based on the same Sections as those cited in the Order as to the company and the payment of a penalty of $25,000); In the Matter of David S. Krueger, CPA, Adm. Proc. File No. 3-17165 (March 10, 2016)(action against CAO, resolved with a cease and desist order based on the same Sections as those cited in the Order as to the company and an order denying Respondent the privilege of appearing or practicing before the agency with the right to apply for reinstatement after one year); In the Matter of Wayne Gray, CPA, Adm. Proc. File No. 3-17164 (March 10 2016)(action against engagement partner for outside auditors; resolved with a cease and desist order based on Rule 2-02(b)(1) of Regulation S-X and Exchange Act Section 13(a) and an order denying Respondent the right to appear or practice before the agency as an accountant with the right to apply for reinstatement after one year); In the Matter of Joseph R. Allred, CPA, Adm. Proc. File No. 3-17163 (March 10, 2016)( action against accountant responsible for firm’s engagement that provided SOX consulting and internal auditing services; resolved with a cease and desist order based on Exchange Act Section 13(a) and the payment of a penalty of $15,000).
Insider trading: SEC v. Fung, D.N.J. Filed March 9, 2016) names as a defendant Jay Fung, a long time friend and former co-worker of registered representative Kevin Dowd. The action centers on the announcement of a tender offer for Pharmasset, Inc., by Gilead Sciences, Inc. made before the market opened on Monday, November 21, 2011. Prior to the announcement Mr. Dowd learned about the proposed transaction from his brokerage firm which served as an adviser to a Pharmasset director. The firm had policies that precluded its employees from trading on inside information. Employees were also told that they were precluded from trading on the Pharmasset information. Nevertheless, Mr. Dowd told Mr. Fung who traded and also informed his Business Partner about the deal. He also traded. Mr. Fung had profits of $163,621. Business Partner had profits of about $544,706. Subsequently, Mr. Fung delivered $65,000 to Mr. Dowd in installments. Mr. Dowd saw the payments as a thank you. There is no allegation of any prior arrangements regarding the payments. The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 14(e). Mr. Fung resolved the charges with the SEC. He agreed to disgorge his trading profits and pay prejudgment interest. A parallel criminal action was brought by the USAO, District of New Jersey.
Municipal bond offering: In the Matter of Westlands Water District, Adm. Proc. File No. 3-17162 (March 9, 2016) names as Respondents: the Water District, based in Fresno, California; Thomas Birmingham, its General Manager; and Louie Ciapponi, its Assistant General Manager. The Order alleges that the Official Statement for the Water District’s October 2012 offering of $77 million in bonds was false and misleading because it failed to make certain disclosures with regard to its debt service ratio. In prior offerings the Water District represented it would maintain a ratio of 125%. It did so by undertaking certain extraordinary accounting transactions recommended to help it meet the requirement as well as making other adjustments, none of which were disclosed. This violated Securities Act Section 17(a)(2). Respondents resolved the proceeding, consenting to the entry of a cease and desist order based on the Section cited in the Order. In addition, Water District will pay a penalty of $125,000, Mr. Birmingham will pay $50,000 and Mr. Ciapponi will pay $20,000.
False statements: SEC v. Killion, Civil Action No. 4:16-cv-00621 (S.D. Tx. Filed March 9, 2016) is an action which names as defendants Reed Killion, Jeffrey Tomz and Uni-Pixel, Inc. The firm develops and sells display and touch screen technologies for use in phones, tablets, notebooks and other devices. Mr. Killion was the CEO while Mr. Tomz served as CFO. From late 2012 through early 2014 the defendants made material misrepresentations regarding the company. Those included claiming that it had shipped 50 unites of UniBoss, a new product, when it fact it had not. Defendants also claimed that the firm had entered into agreements with major technology firms regarding the product without disclosing key terms and the fact that the agreements were contingent as required. As a result the price of the firm’s stock price increased from $15 per share to over $35 permitting Messrs. Killion and Tomz to sell shares and realize profits of, respectively, $770,000 and $1.2 million. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a) and 13(b)(2)(A). The company resolved the charges, consenting to the entry of a final judgment prohibiting future violations of the Sections cited in the complaint. In addition, former chairman of the board, Bernard Marren, entered into a deferred prosecution agreement which requires him to continue cooperating with the Commission while implementing certain undertakings. See Lit. Rel. No. 23484 (March 10, 2016).
Unregistered broker: SEC v. Banc de Binary Ltd., Civil Action No. 2:13-cv-00993 (D. Nev.) is a previously filed action which named as defendants the Cyprus-based firm, its founder, Oren Shabat Laurent, and three affiliates. The complaint alleged that the defendants failed to register as a broker-dealer before selling binary options through various internet offerings. The payout on those options typically depends on whether the price of a particular assets underlying the option rises above or falls below a specified amount. The court entered an order under which the defendants will jointly pay $7.1 million in disgorgement, $1.95 million in penalties and $2 million to the CFTC. In addition, Defendants will be suspended from the securities industry for one year and permanently barred from issuing any penny stock offerings. See Lit. Rel. No. 23481 (Ma rch 9, 2016).
False statements: In the Matter of Steven Zoernack, Adm. Proc. File No. 3-17157 (March 8, 2016) is an action which names as Respondents Mr. Zoernack, the managing member of Respondent EquityStar Capital Management, LLC, an unregistered investment adviser. Over a four year period beginning in May 2010 Respondents sold interest in two unregistered investment funds created by Mr. Zoernack and managed by EquityStar while concealing Mr. Zoernack’s background which included two felony convictions and through the use of misleading marketing materials. Mr. Zoernack also misused investor funds. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4)-8. The matter will be set for hearing.
Municipal bonds: SEC v. Rhode Island Commercial Corporation, Civil Action No. 1:16-cv-00107 (D. R.I. Filed March 7, 2016). The complaint centers on financing for 38 Studios, LLC, a start-up firm that developed video games. The defendants are the Rhode Island Commerce Corporation, a quasi-public entity created by the state to promote the expansion and development of business in the state; Wells Fargo Securities, LLC, a registered broker-dealer and municipal adviser; Keith Stokes, executive director of RICC; James Saul, the deputy director of RICC; and Peter Cannava, vice president of Wells Fargo’s public finance group. In 2010 38 Studios was developing a “massively multi-player on-line video game code named Project Copernicus. The firm anticipated it would need $75 million or more to complete development. After negotiations in which 38 Studios gave RICC projections showing that $75 million was needed to complete Coperncus it was agreed that bonds would be issued and the proceeds lent to 38 Studios for the project. Wells Fargo, an adviser to 38 Studios, and RICC knew that the proceeds from the offering would not be sufficient to complete development since only $50 million of the planned $75 million offering would be lent to 38 Studios. Nevertheless, the offering went forward with materials stating that 38 Studios would make loan payments to RICC from the revenues earned by selling its video games. RICC in turn would make principal and interest payments to bondholders. RICC and Wells Fargo, the placement agent, knew that the offering proceeds would leave 38 Studios about $25 million short of the funding required for the project. That fact was not disclosed in the offering memo or listed as a risk factor. The offering materials also listed certain fees that went to Wells Fargo but omitted others later paid from the offering proceeds by 38 Studios to the firm. When 38 Studios could not raise the remaining capital needed to complete the project it defaulted and filed for bankruptcy. The complaint alleges violations of Securities Act Sections 17(a)(2) and (3) and certain MSRB Rules. Messrs. Stokes and Saul resolved the charges. Each agreed to pay a penalty of $25,000 and be barred from participating in any future municipal securities offerings. See also, In the Matter of First Southwest Company, LLC, Adm. Proc. File No. 3-17154 (March 7, 2016)(settled action against RICC’s financial adviser; a cease and desist order was entered based on Exchange Act Section 15B(c)(1) and certain MSRB Rules; firm also agreed to pay disgorgement of $120,000, prejudgment interest and a penalty).
Misappropriation: U.S. v. Oppenheimer (S.D.N.Y.) is a previously filed action which named as a defendant Michael Oppenheim, formerly a investment adviser at JP Morgan Chase & Co. The information alleged that beginning in March 2008, and continuing for the next seven years, Mr. Oppenheim misappropriated about $20 million of clients funds that were supposed to be invested in municipal bonds and diverted them to his personal use. He covered-up the wrongful conduct by furnishing clients falsified account statements. This week he was sentenced to serve five years in prison followed by three years of supervised release. He was also ordered to forfeit over $20 million to the U.S. and, as part of his plea agreement, agreed to pay restitution of over $27 million to the victims of his crime.