This Week In Securities Litigation (Week ending March 29, 2019)

The Commission prevailed in the Supreme Court this week for the first time in years. The High Court concluded that the agency can charge as a primary violation of Section 10(b) any conduct that falls within the language of the section, even if it is a false statement of a person who did not control its distribution. The ruling also expands the reach of plaintiffs in securities class actions.

This week the agency brought three actions against investment advisers. One involved misappropriation, a second over billing and a third the manipulation of financial results. Finally, the Commission filed another settled proceeding centered on pre-release ADRs. The case is one in a series of similar actions.

Supreme Court

Lorenzo v. Securities and Exchange Commission, No. 17-1077 (March 27, 2019). The Court held that the “dissemination of false or misleading statements with intent to defraud can fall within the scope of subsections (a) and (c) of Rule 10b-5, as well as the relevant statutory provisions. In our view, that is so even if the disseminator did not ‘make’ the statements and consequently falls outside subsection (b) of the Rule.” This conclusion “would seem obvious,” Justice Breyer wrote, from consideration of the language. That language speaks about a “device,” “scheme,” and “artifice to defraud” as well as “fraud or deceit.” Since Mr. Lorenzo is alleged to have made false statements and did not challenge the determination of scienter by the lower court, it is “difficult to see how his actions could escape the reach of those provisions.”

SEC Enforcement – Filed and Settled Actions

The Commission filed 4 civil injunctive actions and 3 administrative proceedings this week, exclusive of 12j and tag-along actions.

Financial fraud: SEC v. Borge, Civil Action No. 1:19-cv-02787 (S.D.N.Y. Filed March 28, 2019) is an action which names as a defendant Keith Borge, the former controller of the College of New Rochelle. As enrollment declined along with revenue, Mr. Borge took a series of steps to falsely inflate and conceal the true financial condition of the college where he had spent his professional career. Specifically, in FY 2015 and 2016 he published false financial figures in the audited financial statements. To conceal that activity, he furnished fabricated financial statements to his superiors. Those figures reported net assets of about $25 million for FY 2015. At the time the actual net assets were a negative $8.8 million. When the fraud was discovered the college came close to halting operations. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. In a parallel criminal filed by the Manhattan U.S. Attorney’s Office Mr. Borge has pleaded guilty.

Misappropriation: In the Matter of Dennis Gibb, Adm. Proc. File No. 3-19123 (March 28, 2019) is a proceeding which names as respondents Mr. Gibb and his firm, Sweetwater Investments, Inc., a registered investment adviser. Over an eleven year period beginning in 2007 Mr. Gibb, the founder and CEO of the advisory, misappropriated over $3 million from a private fund advised by the firm. He concealed the fact, using falsified records which stated that the firm had net assets of about $7.8 million rather than the actual $1.8 million. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2), 206(4) and 207. To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the sections cited in the Order and agreed to implement certain undertakings which included liquidating the holdings of the fund and gifting the cash to a disgorgement fund. The registration of the adviser was revoked and Mr. Gibb was barred from the securities business. Respondents will also pay, on a joint and several basis, disgorgement of $1,144,000, prejudgment interest of $20,747.40 Those obligations will be offset by the amount of any criminal order of restitution entered in the parallel criminal action filed by the U.S. Attorney’s Office for the Western District of Washington.

Over billing: SEC v. Diver, Civil Action No. 1:19-cv-02771 (S.D.N.Y. Filed March 28 2019) is an action which names a defendant Richard Diver, CCO of an investment adviser, until he was terminated. Beginning in about 2011, and continuing until 2018, Mr. Driver misappropriated about $6 million from his employer. As part of his scheme he caused the adviser to overbill about 300 clients a total of about $750,000 to falsely inflate his salary. When confronted by his employer he confessed. The complaint alleges violations of Advisers Act Sections 206(1) and 206(2). The case is pending. The Manhattan U.S. Attorney’s Office filed parallel criminal charges. See Lit. Rel. No. 24434 (March 28, 2019).

Sale of shells: SEC v. McKillop, Civil Action No. 19-cv-852 (D.D.C. Filed March 26, 2019) names as a defendant James McKillop, a convicted felon. Defendant McKillop and his business associate, attorney James Cassidy, assisted private entities in going public. Specifically, his firm, Tiber Creek Corp. created and maintained an inventory of shells for which Defendant and his partner served as officers, directors and 50% shareholders. The public shells created were then sold to private entities looking to go public. Mr. McKillp has acted as an unregistered broker beginning as early as 2012. He also failed to file the proper reports in a timely fashion under Exchange Act Section 13G and the required Form 4s. The complaint alleges violations of Exchange Act Section 13(d), 15(a) and 16(a). The case is pending. See Lit. Rel. No. 24433 (March 256, 2019); See also In the Matter of Tiber Creek Corp., Adm. Proc. File No. 3-19120 (March 26, 2019)(Proceeding against the firm and Mr. Cassidy finding violations of Exchange Act Sections 15(a), 13(d) and 16(a); resolved with a cease and desist order as to Respondent Cassidy based on each section cited in the Order and as to the firm based on Section 15(a); each Respondent is barred from the securities business and from participating in any penny stock offering; Mr. Cassidy is denied the privilege of appearing and practicing before the Commission as an attorney; on a joint and several basis Respondents will pay disgorgement of $117,000, prejudgment interest of $17,697.54 and a penalty of $75,000).

Financial manipulation: SEC v. Direct Lending Investments LLC, Civil Action No. 2:19-cv-218 (C.D. CA. Filed March 22, 2019). Direct Lending is an unregistered investment adviser owned by Brendan Ross. The firm serves as the adviser for two feeder funds and a master fund. Returns of 10% to 12% were claimed with no down months. QuarterSpot was a key investment for the adviser. The New York based firm was an on-line lender. In late September 2017 the adviser sold about $55 million of its QuarterSpot holdings to an investment vehicle operated by a business associate of Mr. Ross who guaranteed the transaction. The deal essentially cut Direct Lending’s QuarterSpot holdings in half. Nevertheless, the adviser remained involved in processing information for QuarterSpot loans. Beginning in 2014, and continuing for the next four years, Mr. Ross knew about difficulties with the QuarterSpot loan portfolio from the available loan data. During that four-year period he sought to conceal those issues and urged the company to manipulate its results. Those efforts are reflected in a series of communications involving Mr. Ross and the company. This resulted in the falsification of QuarterSpot payment information. That in turn caused the adviser to materially overstate the value of its position in the company by about $53 million between 2014 and 2017. As a result, the adviser collected about $11 million in excess fees. By late 2018 certain borrower payment data on the advisors’ books did not match that of QuarterSpot. By early 2019 QuaerterSpot representatives refused to respond to questions on the subject. In February 2019 the advisor announced that the Funds had suspended withdrawals and redemptions because one of its largest counterparties ceased making payments on a significant loan. The next month Direct Lending announced that another position – QuarterSpot—may have been materially overstated for a period of years. Mr. Ross resigned after being requested by the management committee to take a leave of absence. The complaint alleges violations of Advisers Act Sections 206(1), 206(2) and 207, Exchange Act Section 10(b) and Securities Act Section 17(a). The advisor consented to the entry of a permanent injunction based on the sections cited in the complaint. The firm also agreed to the appointment of a receiver. The complaint seeks additional relief. See Lit. Rel. No. 24432 March 25, 2019).

Pre-release ADRs: In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Adm. Proc. File No. 3-19114 (March 22, 2019). The Bank of America subsidiary has been involved with pre-release ADRs since the early 1990s. After engaging in various transactions involving pre-release ADRs the broker halted the practice. Merrill concluded that its lending desk could not comply with the obligations imposed by the pre-release agreements. Beginning in 2012, and continuing for the next two years, Merrill re-entered the pre-release market. During that period the firm engaged in over 40,000 transactions in which it obtained ADRs from pre-release brokers which had obtained the securities from the depository. The brokers borrowed the securities under standard master securities loan agreements with pre-release brokers which did not address pre-release ADRs and did not contain any provisions requiring Merrill to satisfy the pre-release obligations. The transactions thus had the effect of falsely inflating the number of shares available. Merrill knew, or should have known under the circumstances, that the pre-release brokers were not complying with their obligations. First, the lending personnel knew that the pre-release brokers were in fact conduit lenders that routinely sourced securities through pre-release transactions with depositories. Second, the firm’s lending personnel should have realized that the pre-release brokers were not complying with their obligations because of the pricing which which differed from pre-release transactions. Over the period Merrill benefited from the pricing differential, netting about $4.4 million. During the two year period Merrill did not have any policies and procedures that would be reasonably expected to detect whether the securities lending desk was involved in pre-release transactions. The firm also failed to reasonably supervise the personnel on the lending desk. The Order alleges violations of Securities Act Section 17(a)(3). In resolving the matter, the Commission considered the cooperation of Respondent. To resolve the proceedings Merrill consented to the entry of a censure. The firm also agreed to pay disgorgement of $4,448,291.52 and prejudgment interest of $724,795.40. In addition, the firm will pay a penalty of $2,891,389.48.


U.S. v. Ho (S.D.N.Y.). The former home secretary of Hong Kong, Patrick Ho, was sentenced to serve three years in prison and pay a fine of $400,000. Mr. Ho was previously found guilty by a jury on one count of conspiring to violate the FCPA, four counts of violating the FCPA, one count of conspiring to commit international money laundering and one count of committing international money laundering. The charges were based on the payment of $2 million in bribes to the president of Chad on behalf of a Chinese energy company.


Reportable transactions: The Financial Conduct Authority fined Goldman Sachs over $44 million for failing to report over 213 million reportable transactions over about a nine year period. In addition, the firm reported about 6 million transactions that were not reportable. The firm received a 30% discount on the fine based on cooperation.

Manipulation: Former Managing Director Colin Bermingham was convicted in proceedings by the Serious Fraud Office of manipulating the Euro Interbank Offering Rate at the height of the financial crisis. Earlier this week former Barclays V.P. of Euro Rates, Carlo Palombo was also convicted. The former manager of liquidity management at the bank, Sisse Bohart was acquitted. The defendants and the bank made substantial profits from the manipultation.

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