This Week In Securities Litigation (Week ending March 16, 2018)
This Week In Securities Litigation (Week ending March 16, 2018)
Chairman Jay Clayton gave definition to his views on the manner in which the agency should allocate its limited resources. Specifically, the Chairman stated that the agency should focus on “pressing and significant issues for investors and our markets” which include: 1) standards of conduct for investment professionals; 2) an examination of equity and fixed income market structure; 3) the regulation of investment products and ETFs; 4) the impact of distributed ledger technology; 5) FinTech developments; 6) the elimination of burdensome regulations that do not enhance investor protection or market integrity; and 7) Congressionally mandated rule making and the inevitable issues which have not been identified but which will emerge.
The Commission also brought cases which include: an offering fraud action against once high-flying Theranos, Inc. and its two primary officers and an insider trading action against an Equifax executive tied to the data breach at the firm. The DOJ resolved FCPA charges with Transport Logistics International, Inc. stemming from its dealings with TENEX, a subsidiary of Russia’s State Atomic Energy Corporation. The firm will pay a $2 million penalty. The DOJ also obtained a guilty plea in the Siemens FCPA action while in London a jury returned a verdict of guilty in the first case under Section 7 of the UKBA for failure to prevent bribery after self-reporting.
Proposed fees: The Commission proposed a new rule that would impose a transaction fee on NMS stocks as a pilot to generate data regarding the role of maker-taker fee and rebate pricing models (here).
Risk Management Disclosure: The Commission proposed amendments to public liquidity-related disclosure requirements for certain open-ended investment management companies (here).
Statement: SEC Chairman Jay Clayton made Remarks to the SEC Investor Advisory Committee (March 13, 2018). His remarks focused on his views of how the agency should allocate its limited resources (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 4 civil injunctive cases and 6 administrative proceedings, excluding 12j and tag-along proceedings.
Offering fraud: SEC v. Holmes, Civil Action No. 5:18-cv-01602 (N.D. Calif. Filed March 14, 2018); SEC v. Balwani, Civil Action No. 5:18-cv-01603 (N.D. Calif. Filed March 14, 2018). The cases center on Theranos, Inc., a California company that sought to revolutionize the diagnostic industry. The company is a named Defendant in Holmes, along with Elizabeth Holmes, the firm’s founder, CEO and controlling shareholder. Ramesh Balwani, the President and COO of the firm is the sole Defendant in the second case. Theranos was created in 2003 by Ms. Holmes based on a vision of developing new diagnostic technologies. The idea was to use small sample testing and ease of access for prevention and early diagnosis. The company focused on developing a proprietary analyzer which would take blood from a fingerstick and conduct an array of tests. The device was called the Theranos Sample Processing Unit – TSPU. The early generation was capable of doing only a few tests. After six years Theranos was running out of cash. Mr. Balwani joined the company as President and COO. Together with Ms. Holmes, the two executives sought to develop what they called the miniLab – a version of the TSPU that could perform a broader range of laboratory testing. By 2010 the machine was still not ready. Nevertheless, CEO Holemes and COO Balwani shifted focus to the retail clinical laboratory market, pursuing contacts with a large national pharmacy chain – Pharmacy A – and a large national grocery chain – Grocery A. The idea was to place miniLabs at designated Patient Service Centers in retail stores. Patients could then get their diagnostic tests performed while shopping. Ms. Holmes and Mr. Balwani touted their proprietary analyzers despite the lack of actual results in interviews with the Wall Street Journal and other media. Yet the cash was running out. Before launching efforts to raise additional funds Ms. Holmes convinced the board of directors to split the firm’s stock in a 1 to 5 ration allowing for future fundraising and to create Class B shares with a super-voting 100x power that would go only to her. This gave Ms. Holmes over half of the firm’s outstanding shares but 99% of the voting power. Starting in 2013, and continuing into 2015, Ms. Holmes, Mr. Balwani and Theranos raised over $700 million from investors in two rounds of financing. Those investors believed that the company had successfully developed a proprietary analyzer that could run a full range of laboratory tests from a small sample of blood. The belief of those investors came from a series of misrepresentations made by firm executives. By 2016 the company exited the commercial laboratory business. Grocery A and Pharmacy A terminated their relationships with the company. In 2017 the firm was on the brink of bankruptcy. The complaints allege violations of Securities Act section 17(a) and Exchange Act section 10(b). The company and Ms. Holmes settled. Ms. Holmes agreed to pay a penalty of $500,000, to be barred from serving as an officer or director for 10 years, to return the remaining 18.9 million shares she obtained during the fraud and to relinquish voting control of the company. Mr. Balwani is litigating the action against him.
Insider trading: SEC v. Ying, Civil Action No. 1:18-cv-01069 (N.D. Ga. Filed March 14, 2018) is an action against the former employee of Equifax Inc. who at one time served as the Chief Information Officer of its United States Information Systems business unit and was a leading candidate to become the CIO of the company. When Equifax suffered a significant security breach in July 2017 the firm began taking steps to identify and assess its impact. An internal project was created and code named. Those who worked on it were informed they could not trade in the firm’s securities. Mr. Ying was not part of the project. Over a period of time however he was consulted on significant matters related to the project. Eventually he concluded that the firm had suffered a significant breach. At that point Mr. Ying exercised all of his employee stock options and sold the shares. Later, he was brought over the wall and the breach was disclosed, causing the Equifax share price to drop. By selling his stock Mr. Ying avoided losses of about $111,000. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See also U.S. v. Ying, No. 1:18-cr-00074 (N.D. Ga. Filed March 14, 2018)(parallel criminal action).
Auditing: In the Matter of KPMG, Inc., Adm. Proc. File No. 3-18400 (March 13, 2018); In the Matter of KPMG, Adm. Proc. File No. 3-18402 (March 13, 2018). KPMG, Inc. is a public accounting firm registered with the PCAOB located in Johannesburg, South Africa (“KPMG South Africa”). The firm is a member of KPMG International Cooperative, a Swiss entity. KPMG is also a member of KPMG International. It is based in Zimbabwe and has never been registered with the PCAOB (“KPMG Zimbabwe”). The audit client involved is Issuer A, a company incorporated in Canada with its principal executive offices in South Africa. The firm’s stock is registered with the Commission under the Exchange Act. The issuer files periodic reports. In 2013 and 2014 KPMG South Africa audited the financial statements of Issuer A. Those financial statements were filed with the Commission on Form 20-F. The audit opinion in each instance represented that the work had been done, and the opinion issued, in accord with PCAOB auditing standards which is incorrect. In each instance KPMG South Africa used the work of a firm which did not comply with PCAOB standards. Specifically, in each instance KPMG Zimbabwe played a substantial role in the preparation of the audit reports for Issuer A having audited most of that firm’s assets and substantially all of its revenues. KPMG South Africa served as the principal auditor but failed to comply with AU 543.02. That standard requires that when serving as a principal auditor the firm determine if its participation in the audit is sufficient for it to serve in that role. KPMG South Africa failed to conduct the required AU 543 analysis. An inquiry should also be made about the affiliate firm in accord with AU 543 and 230. If the inquiries were conducted properly in each year KPMG South Africa would have known that KPMG Zimbabwe was not registered with the PCAOB. By failing to conduct the required inquiries, KPMG South Africa engaged in improper professional conduct within the meaning of Rule 102(e). Since the audit reports were incorrect, the firm violated Rule 2-02(b)(1) of Regulation S-X of the Exchange Act as well as Exchange Act section 13(a). As to KPMG Zimbabwe, Section 102 of Sarbanes-Oxley makes it unlawful for any person that is not a registered public accounting firm to participate in the preparation or issuance of, any audit report with respect to any issuer. The firm violated Section 102. To resolve the proceedings KPMG South Africa consented to the entry of a censure, a cease and desist order based on the provisions cited above and agreed to pay a penalty of $100,000. To resolve the proceedings KPMG Zimbabwe consented to the entry of a cease and desist order based on Section 102 of Sarbanes Oxley and to pay disgorgement of about $130,000 along with prejudgment interest. See also In the Matter of BDO Canada LLP, Adm. Proc. File No. 3-18399 (March 13, 2018)(BDO Canada engaged Deloitte & Touche of Zimbabwe to do work; BDO issued six audit opinions based on circumstances similar to the proceedings above; BDO resolved the proceedings by consenting to a censure, a cease and desist order based on the same provisions as KPMG South Africa and paid a penalty of $50,000; Deloitte resolved the proceedings on substantially the same terms as KPMG Zimbabwe except that it agreed to pay disgorgement totaling $83,077.84 and prejudgment interest of $15,979.50).
Unregistered securities: In the Matter of Credit Karma, Inc., Adm. Proc. File No. 3-28398 (March 12, 2018) is a proceeding which names the internet based financial technology company as a Respondent. From late 2014 through September 2015 the firm issued about $13.8 million in stock options to its employees that were not registered. The firm relied on Rule 701 for an exemption. That rule was not available. While it provides an exemption from registration for options used in a compensatory benefit plan, it requires that if over $5 million in securities are distributed over a twelve-month period that a reasonable time before the sale date detailed financial statements and risk disclosures be furnished recipients of the grants. Here the firm failed to comply with the requirements of the rule although executives were aware of its requirements. The Order alleges violations of Securities Act sections 5(a) and 5(c). To resolve the proceedings the firm consented to the entry of a cease and desist order based on the sections cited in the Order and agreed to pay a penalty of $160,000.
SEC v. Sodi, Civil Action No. 5-18-cv-00313 (N.D. Ala. Filed Feb. 26, 2018) names as Defendants Brian, Robert Sondi, a one-time big four auditor known as the Mailman for his direct-mail penny stock promotions along with his two firms, Capital Financial Media, LLC and List Data Solutions, LLC. Both firms are penny stock promotion houses controlled by Mr. Sondi. The manipulative actions involved the shares of microcap OTC traded issuer Southern USA Resources Inc., a firm that owns a gold mine, and the subsidiary of Goff Corporation, which owns properties in Colombia’s gold country. The registrations of both firms have been terminated. Beginning in January 2013 Mr. Sondi had his two firms mail promotional materials regarding SUSA to investors. The materials recommended that investors hastily purchase shares of the gold mine firm to achieve quick profits of a much as 3,293%. Trading volume increased rapidly. The share price increased to a high of $1.66. Mr. Sondi was able to quickly take advantage of the market movements of the stock, selling at least 239,000 shares through his Swiss bank account to secure significant profits. What Mr. Sondi did not disclose was the fact that he owned a block of SUSA stock and that he had been paid for running the touting campaign in company shares. He also failed to file any Schedule 13D with the Commission. Beginning in March 2013 Mr. Sondi ran a promotional campaign regarding Goff shares. Again he used his two penny stock publishing firms to distribute promotional materials on the firms. Again the promotional materials predicted huge profits. Prior to the campaign the shares had been at $0.13. During the campaign those same shares reached a closing price of $0.5852. What Mr. Sondi did not disclose is that just before the tout he purchased 500,000 shares of Goff through his Swiss account. During the campaign Mr. Sondi was able to sell shares yielding profits of at least $116,000. After realizing these profits he then purchased another 100,000 shares which he later sold during a renewed campaign for a profit of an additional $7,000. The complaint alleges violations of Securities Act sections 5(a), 5(c), 17(a) and 17(b) and Exchange Act sections 10(b) and 13(d). The case is pending.
False statements: In the Matter of Robert Joseph Ritch, Adm. Proc. File No. 3-18396 (March 9, 2018). Mr. Rich has been convicted of a number of crimes including several felonies for obtaining property by false pretenses. Mr. Rich is the author of a blog and a website in which he claimed to operated a number of businesses including one the specializes in M&A transactions and another that offers business loans and financial guarantees. He is also the president and sole employee of Manzo Pharmaceuticals, Inc., an OTC traded stock. The primary source of information about the company is Mr. Rich’s website. On his website Mr. Rich repeatedly boasted about his business acumen. For example, he claimed to have founded, built and exited four successful multi-million business; to have been involved with and/or managed over $1 billion in transactions; that he could not disclose information about a settlement with the State of North Carolina regarding his criminal past; and that he had a college degree. All of these claims are false. What Mr. Rich did have was about 1 million shares of Manzo which he touted as a mini-Berkshire Hathaway. During the period of Mr. Rich’s posts, from January 2017 through August 2017, the volume of trading in Manzo increased dramatically, although there was no current information available about the company except from him. The Order alleges violations of Exchange Act section 10(b). To resolve the proceedings, Respondent consented to the entry of a cease and desist order based on the section cited in the Order. He also agreed to be barred from serving as an officer or director of any issuer and to a penny stock bar. He also agreed to pay a penalty of $50,000.
Offering fraud: U.S. v. Scronic, No. 7:18-cr-00043 (S.D.N.Y.) is an action against Michael Scronic, formerly operator of the Scronic Macro Fund. From April 2010 through October 2017 Mr. Scronic raised about $22 million from 45 investors for the Fund. He represented to potential investors that the Fund had positive returns for 21 out of 22 quarters with the highest being over 13%. He also represented that the Fund had millions of dollars in assets. Both representations were false. To the contrary the fund lost money virtually every quarter and its assets were dwindling, in part because he misappropriated portions of the investor cash. This week Mr. Scronic pleaded guilty to one count of securities fraud. Sentencing is scheduled for July 9, 2018. See also SEC v. Scronic, Civil Action No. 7:17-cv- 07615 (S.D.N.Y.).
Manipulation: U.S. v. Murray, No. 18-071 (S.D.N.Y.) is an action in which defendant Robert Murray was sentenced to serve 24 months in prison following his guilty plea on market manipulation charges. He was also directed to forfeit $3,914.08 and to serve two years of supervised release following his prison term. The charges were based on the fact that Mr. Murray announced a sham tender offer for the shares of Fitbit, Inc. that caused the capitalization of the firm to temporarily increase by about $100 million.
Fraud-manipulation: U.S. v. Shkreli, No. 15-cr-637 (E.D.N.Y.) is an action in which former hedge fund founder and manager, and the former CEO of a pharmaceutical firm, Martin Shkreli was convicted of securities fraud and securities fraud conspiracy. The Court sentenced him to serve seven years in prison followed by three years of supervised release and to pay a $75,000 fine and $7.3 million in forfeiture. The charges were based on defrauding investors with respect to two hedge funds from which he also misappropriated funds, manipulated the share price of the pharmaceutical firm and attempting to use the assets of that firm to repay the defrauded investors of the two hedge funds.
FCPA – Anti-Corruption
U.S. v. Sharef, No. 1:11-cr-01056 (S.D.N.Y.) is an action against former Siemens AG executive Geoffrey Berman. Mr. Berman pleaded guilty this week to one count of conspiracy to violated the FCPA and to commit wire fraud. The underlying facts are based on the bribes paid to senior Argentine government officials to obtain a $1 billion contract for his firm to produce new identity cards. Mr. Reichert was arrested in Croatia and voluntary extradition to the United States in December. Charges against others named in the indictment are pending. A date has not been set for sentencing.
U.S. v. Transport Logistics International, Inc., No. 18-0011 (D. Md. Filed March 12, 2018) is an action in which the Maryland based firm was charged with conspiracy to violate the Foreign Corrupt Practices Act. The charges were based on actions which trace to 2004 in which the firm paid over $1.7 million through off-shore banks for the benefit of Vadim Mikerin, a Russian official at TENEX, a subsidiary of Russia’s State Atomic Energy Corporation. To resolve the charges the firm entered into a deferred prosecution agreement and will pay a fine of $2 million. The resolution reflects the extensive cooperation of the firm as well as its financial condition. Previously two individuals charged in connection with this matter pleaded guilty while a third person charged is awaiting trial.
In the Matter of Elbit Imaging Ltd., Adm. Proc. File No. 3-18397 (March 9, 2018). Respondent is an Israeli based firm whose shares are listed in Tel Aviv and on NASDAQ. The action centers around Plaza Centers NV, an indirect, majority owned subsidiary of Elbit, incorporated in the Netherlands. Plaza’s shares are listed on the London, Warsaw and Tel Aviv Stock Exchanges. The firm is a Central and Eastern European developer of shopping and entertainment centers. Prior to 2014 Executive A, who passed away in 2016, was the CEO of Elbit and owned 50% of its equity. He also served as the Executive Director of Plaza and had a seat on the board of each firm.
The case revolved around two transactions. The first involved the Casa Radio Project. In 2006 Plaza sought to be included in a real estate development in Bucharest, Romania called Casa Radio Project. Executive A directed Plaza to enter into a consultancy contract for assistance with the project in securing an invitation from the Romanian government to participate in the Casa Radio Project. The next year the Romanian government consented to the acquisition of 75% of the project by Plaza.
Four years later in 2011 Plaza entered into a second consultancy at the direction of Executive A regarding the remaining 15% of the Project. The arrangements with a new consultant were essentially the same as with the first. As with the retention of the first consultant, no due diligence was done with respect to the retention of the second consultant. Despite the fact that there is no evidence showing that either consultant rendered any services, between 2007 and 2012 Plaza paid the consultants about $14 million, booked as legitimate business expenses.
A second transaction involved a Joint Venture and a Portfolio of 47 shopping center real estate assets in the United States. Elbit and Plaza held 45% of a Joint Venture that sought to market the Portfolio in October 2011. In November Executive A directed Elbit and Plaza to enter into a sales agency contract to assist with selling the Portfolio. The sales agent was paid on commission. No due diligence was done on the agent. This arrangement did not concern the other Joint Venture members. The agent retained assigned the retention agreement to another agent charging a lesser commission that was indirectly, beneficially owned by Executive A.
Subsequently, the Joint Venture hired a sales agent who was charged with essentially the same duties as those of the sales agent retained by Elbit and Plaza. When the portfolio was later sold Elbit and Plaza paid the sales agent they had retained about $13 million, nearly double the commission paid by the joint venture to the agent. There are no documents relating to any services rendered by the sales agent. Later the first agent paid the second. In 2014 Elbit and Plaza completed what were essentially Chapter 11 arrangements.
When Elbit discovered evidence suggesting that there were improper payments an internal investigation was launched. Each firm self-reported in the U.S. and Romania and fully cooperated. The Order alleges violation of Exchange Act sections 13(b)(2)(A) and 13(b)(2)(B).
To resolve the proceeding Respondent consented 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 $500,000. The Commission acknowledged the cooperation Respondent.
Skansen Interiors: UK based Skansen Interiors, a refurbishment firm, was charged under Section 7 of the UK Bribery Act for failure to prevent bribery. The charge ties to allegations that a former managing Director of the firm paid bribes to secure refurbishment contracts worth £6 million. When the firm discovered the facts it filed a suspicious activity report with the UK National Crime Agency, the firm voluntarily self-reported to the City of London Police and cooperated with the investigation. The UK Serious Fraud Office encourages self-reporting in return for potentially more lenient treatment. Here the firm was charged and other charges were brought against the two individuals involved. The Section 7 charge is based on strict liability. At trial the firm argued that it had adequate procedures, particularly given its size. The jury returned a verdict of guilty late last month. The date for sentencing has not been set. The firm is the first to be charged under this provision of the UK Bribery Act.
Manipulation: The Serious Frauds Office announced that ex Deutsche Bank trader Christian Bittar pleaded guilty to conspiracy to defraud in connection with the manipulation of the Euro Interbank Offered Rate. The date for sentencing has not been set.
Program: Insights Into SEC Enforcement, is roundtable discussion of the Former Directors of the SEC’s Division of Enforcement that will be held on April 3, 2018 beginning a 4:30 p.m. at Georgetown University Law School. The program will be followed by a reception. Registration is available here without charge. The program is sponsored by the SEC Historical Society, the Federal Bar Association, and the Association of SEC Alumni.