This Week In Securities Litigation (Week ending March 30, 2018)
Cases brought by the Commission this week in include one requiring admissions of fact and that the firm violated the securities laws as a condition of settlement, a case naming as Defendants the Pastor of one of the largest Methodist Churches in the U.S. along with a recidivist and an attorney and an action against a West Coast brokerage firm that his being set for hearing.
First, in a case centered on a firm which repeatedly failed to file SARs despite a series of suspicious transactions involving penny stocks, the Commission demanded admissions of fact and of violating the federal securities laws as a predicate to settlement – the first such case under Chairman Clayton. Second, the agency brought an action against the Pastor of one of the largest Methodist Churches in the United States, along with a recidivist securities violator and an attorney, based on an offering fraud marketing historical Chinese bonds of little if any value targeted at senior citizens. Finally, the Commission instituted a failure to supervise action against a West Coast brokerage firm that will be set for hearing.
SEC Enforcement – Litigated Actions
SEC v. Aly, No. 1:16-cv-03853 (S.D.N.Y.) is an action against Nauman Aly, a resident of Pakistan. In mid-April 2016 Defendant Aly is alleged to have manipulated the share price of Integrated Devices Technology, Inc. or IDTI, a high tech firm based in San Jose, California. Specifically, on April 12, 2016 he: 1) purchased out of the money call options for the stock; 2) filed a Schedule 13D with the SEC claiming a group had acquire 5.1% of the stock and was about to make a tender offer for all shares; and 3) sold the options for a profit of over $400,000 minutes after the filing was made driving up the share price. Shortly after the sale Mr. Aly is alleged to have filed a second Schedule 13D stating the group no longer owned over 5% because the options were sold. The company never received an offer, contrary to the representations in the first Schedule 13D filed. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The Court granted the SEC’s motion for summary judgment finding that the Defendant had made several false statements and offered no proof for the outlandish claims he asserted. See Lit. Rel. No. 24086 (March 28, 2018).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 3 civil injunctive cases and 6 administrative proceeding, excluding 12j and tag-along proceedings.
Offering fraud: SEC v. Caldwell, Civil Action No. 5:18-cv-00434 (W.D. La. Filed March 29, 2018) is an action which names as defendants Kirbyjoh Cladwell, the pastor of one of the largest Protestant churches in the United States, Windsor Village United Methodist Church in Huston, and Gregory Smith, previously a registered representative who has been barred from the industry by FINRA. Beginning in April 2013 and continuing for over one year, the Defendants raised almost $3.5 million from 29 investors by selling them certain historical Chinese bonds. The investors were primarily elderly. Many liquidated their annuities to invest in the scheme. Investors were told the bonds were safe, risk-free and very valuable. In reality they were mere collectible memorabilia with no investment value. The two Defendants diverted at least $1.8 million of the offering proceeds to their personal use. The complaint alleges violations of Securities Act sections 5(a), 5(c) and each subsection of section 17(a), Exchange Act section 10(b) and Advisers Act section 206(1). The case is pending. See also SEC v. Harper, Civil Action No. 5:16-cv-00436 (W.D. La. Filed March 29, 2018)(action against attorney Shae Vatta Harper who aided and abetted in the offering fraud described above; settled with the payment of a penalty of $60,000 and the entry of an administrative order suspending her from appearing or practicing before the Commission). See Lit. Rel. No. 24089 (March 30, 2018).
AML: In the Matter of Aegis Capital Corporation, Adm. Proc. File No. 3-18412 (March 28, 2018) is an action against the registered broker-dealer. From at least late 2012 through 2014 the firm repeatedly failed to file SARs with regard to “hundreds” of transactions which it had reason to suspect were fraudulent or which had no apparent business purpose. Although the firm had an AML system it was ineffective. The firm’s failures were more than inadequate procedures however. To the contrary, throughout the period firm personal repeatedly became aware of red flags through alerts from its clearing firm and other sources, yet the broker failed to take the appropriate action. In resolving the proceedings the Commission considered the remedial acts of the firm in retaining a third party AML consultant and other steps. The firm also agreed to certain undertakings regarding the adoption of recommendations from the consultant. The Order alleges violations of Exchange Act section 17(a) and Rule 17a-8. To resolve the proceedings Aegis admitted to the facts in the Order regarding the violations and that its conduct violated the federal securities laws. It consented to the entry of a cease and desist order based on the section and rule cited in the Order and agreed to pay a penalty of $750,000. See also In the Matter of Kevin McKenna, Adm. Proc. File No. 3-18413 (March 28, 2018)(charging Mr. McKenna, the AML CO for a period with aiding and abetting and Robert Eides, CEO with having caused them; resolved without admissions; Mr. McKenna is precluded from serving as a CCO with a right to reapply after 18 months and is required to pay a penalty of $20,000; Mr. Eides will pay a penalty of $40,000); In the Matter of Eugene Terracciano, Adm. Proc. File No. 3-18414 (March 28, 2018)(Mr. Terracciano served as AML CO for a period at the firm and is charged with aiding and abetting the violations; the proceedings will be set for hearing).
Financial fraud: In the Matter of Maxwell Technologies, Adm. Proc. File No. 3-18408 (March 27, 2018) is a proceeding which names as Respondents: the firm, a manufacturer of energy storage and power delivery products which previously settled FCPA violations; Van Andrews, Senior V.P. of Sales & Marketing; David Schramm, CEO; and James DeWitt, Jr., Corporate Controller. From about December 2011 through January 2013 the firm falsely inflated its revenue by about $19 million to meet analysts’ expectations. The scheme was implemented by overriding and ignoring automated controls using techniques such as: customer side deals with contingent payments and full right of return; channel stuffing; extending payment terms; falsifying purchase orders and third-party confirmations; and instructing certain distributors to order product they neither wanted nor needed at the end of the quarter. The accounting department missed red flags as did the CEO. The fraud was uncovered following an internal investigation launched in response to a whistleblower complaint. In resolving the proceedings the firm entered into a series of undertakings which include preparing a report on its remedial efforts for the staff and cooperation in the future. The Order alleges violations of Securities Act section 17(a) and Exchange Act sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the proceedings Respondents each consented to the entry of a cease and desist order based on: as to the firm, each section cited in the Order except 13(b)(5); as to Mr. Andrews, each section cited in the Order; and as to Messrs. Shramm and DeWitt, the sections cited in the Order regarding the books and records and internal control provisions of the federal securities laws. In addition, Mr. Andrews is prohibited for a period of five years from serving as an officer or director and will pay a penalty of $50,000. Mr. Schramm will pay disgorgement of $33,878, prejudgment interest of $6,113 and a penalty of $40,000. Mr. DeWitt will pay a penalty of $20,000.
Failure to supervise: In the Matter of Wedbush Securities, Inc., Adm. Proc. File No. 3-18411 (March 27, 2018). Los Angeles based Wedbush was founded in 1995. It registered with the NASD as a broker-dealer. Later the firm registered with the Commission as a broker-dealer and investment adviser. Twice in recent years the firm has been charged with violations of the federal securities laws. This proceeding centers on the firm’s failure to supervise registered representative Timary Delorme (see below). Ms. Delorme has been with the firm for over 30 years and is partners with one of its partial owners. In 2012 and 2013 the firm failed to properly supervise her since: 1) the firm reviewed an email outlining her role in a fraudulent scheme involving penny stocks; 2) received two FINRA arbitrations about her role in fraudulent penny stock schemes; 3) had inquiries about her personal trading in one of the schemes from FINRA; and 4) learned in another FINRA inquiry about her customer claims. The firm however had no real processes to handle these red flags. The Order alleges a failure to supervise with a view to preventing and detecting Ms. Delorme’s violations of Securities Act sections 17(a)(1) and (3) and Exchange Act sections 9(a)(2) and 10(b). The proceedings will be set for hearing. See also In the Matter of Timary Delorme, Adm. Proc. File No. 3-18410 (March 27, 2018)(registered representative consented to entry of a cease and desist order based on Securities Act section 17(a) and Exchange Act sections 9(a)(2) and 10(b) tied to manipulation claim; a bar from the securities business and a penny stock bar; and payment of a $50,000 civil penalty).
Net capital: In the Matter of JH Barbie & Co., Adm. Proc. File No. 3-18409 (March 27, 2018) is a proceeding which names as Respondents the registered broker-dealer and its CEO and financial operations principal, CPA Robert Rabinowitz. The Order alleges that the firm failed to properly compute its net capital from September 2015 through July 2016 and thus operated at a net capital deficiency. Mr. Rabinowitz caused the violations. The Order alleges violations of Exchange Act sections 15(c)(3) and 17(a)(1). To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. The firm also consented to the entry of a censure. The firm will pay a penalty of $50,000 while Mr. Rabinowitz will pay $25,000. Each Respondent will pay post judgment interest.
Offering fraud: SEC v. Spark Trading Group, LLC, Civil Acton No. 1:18-cv-01498 (E.D.N.Y. Filed Mar. 12, 2018). Spark Trading Group is a limited liability company owned by Defendant Niket Shah. In 2016 Mr. Shah was employed by a hedge fund in New York City as an administrator. In that position he was essentially a middle office support person, charged with tasks such as accounting and bookkeeping. Mr. Shah began trading binary options for his own account. Over a period from May 2016 to February 2017 he lost more than $29,000. Mr. Shah the opened Spark Trading and what he called Spark Fund I to investors in March 2017. 240 shares of Spark Fund 1 were offered to investors at $1,000 per share – a total of $240,000. The fund would be a “proprietary trading business,” investors were told. It would trade exclusively in binary options and traditional stock options. Investors would be paid 75% of the profits per share. The fund would retain the remaining 25% of the profits. Investors were assured the investments were safe and guaranteed against loss. Over time Mr. Shah was able to secure investments first for Spark Fund I and later for Spark Fund II, from 15 investors. The trading results for Spark Fund I and II mirrored those Mr. Shah achieved for himself – losses. By March 2018 the money was gone. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). On March 22, 2018 the Court entered a preliminary injunction, freezing the assets and preserving the documents. An accounting was directed to be done. The litigation is continuing.
Insider trading: U.S. v. Yan, No. 1:17-cr-00497(S.D.N.Y. Oct. 30, 2017) is an action which names as a defendant Fei Yan. This week Mr. Yan was sentenced to serve 15 months in prison for insider trading. Previously he pleaded guilty to one count of securities fraud and agreed to forfeit his trading profits. Mr. Yan’s wife was employed at an international law firm. During the summer and fall of 2016 she worked on a deal in which a Mining Company would acquire Stillwater Mining Company. The deal was announced publically on December 9, 2016. The couple had a history of exchanging confidential information. Over the time the wife worked on the transaction Mr. Yan researched takeover deals and also insider trading. Repeatedly during the period he talked to his wife, conducted research and then purchased options. On the date the deal was announced he sold his options, reaping profits of $109,420. See also SEC v. Yan, Civil Action No. 1:17-cv-05257 (S.D.N.Y. Filed July 12, 2017).
FCPA – Anti-corruption
In the Matter of Kinross Gold Corporation, Adm. Proc. File No. 3-18407 (March 26, 2018). Kinross is a Canadian gold mine company, based in Toronto. Its shares are traded on the New York Stock Exchange. In 2010 the company acquired two firms which became indirect, controlled subsidiaries, Tasiast Mauritanie Limited S.A. and Chirano Gold Mines Ltd. Tasiast owns and operates a mine in Mauritania. Chirano owns and operates a mine in Ghana. At the time the two subsidiaries were acquired Kinross understood that neither had adequate internal controls or FCPA systems. Little changed in terms of the internal controls at the two subsidiaries despite repeated reports of deficiencies, recommendations for improvement and promises of improvements. As a result payments were made for a number of years without reasonable assurances that they were being undertaken for the stated purpose or with management’s approval.
In 2013 Kinross took steps to enhance the internal accounting controls regarding the procurement and payment of goods and services. Nevertheless, in 2014 the firm failed to maintain the controls in two critical instances. First, the firm was about to award a three year logistical supply contract to an international shipping company with the lowest bid and best ability to fulfill certain technical requirements. When it was learned that a high-level Mauritanian government official was unhappy with the choice and favored another much less qualified firm, that company was eventually selected. Senior management failed to maintain the controls which dictated that the superior firm be selected. Second, Kinross learned that a person who had high-level government contacts wanted a position with the government relations department. Since an excessive salary was demanded the person was retained as an independent consultant without the required due diligence, and paid about $750,000 over about two years. The Order alleges violations of Exchange Act sections 13(b)(2)(A) and 13(b)(2)(B).
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 $950,000. Kinross also agreed to report to the staff regarding its progress in improving the internal controls and to retain a consultant. In agreeing to accept this offer of settlement the Commission considered the significant remedial efforts of the firm with regard to its internal controls. The DOJ previously declined prosecution.
Court of Appeals
Laccetti v. Securities and Exchange Commission, No. 16-1368 (March 23, 2018). The action centers on whether a witness is entitled to have an expert accountant assist his attorney during testimony. he PCAOB investigated an audit conducted by Ernst & Young. Mark Laccetti was the partner in charge of the audit. During the investigation Mr. Laccetti was interviewed by the Board. At the interview he was represented by an attorney employed by Ernst & Young. The Board refused to permit an expert accountant, also from the audit firm, to assist counsel during the interview. The Board charged Mr. Laccetti with violating its rules and auditing standards. He was suspended for a period of two years and directed to pay a fine of $85,000. The SEC affirmed.
Board investigations must be conducted in accord with “fair procedures” under 15 U.S.C. section 7215(a), the Circuit Court began. That same section provides that any person compelled to testify has the right to be represented by counsel. Mr. Laccetti argued that the exclusion of an expert to assist his counsel during the interview violated his right to counsel. The Court agreed.
The Circuit Court offered three reasons to support its conclusion. First, the arbitrary and capricious standard requires that “an agency’s action be reasonable and reasonably explained. Here, the Board’s explanation for denying Laccetti’s request was not reasonable.” The Board’s rational for excluding the accountant is that it did not want Ernst & Young personnel to be present. This “makes no sense here” the Court found. The attorney representing Mr. Laccetti was employed by the audit firm which is consistent with the applicable rules.
Second, even if the Board wanted to bar an Ernst & Young affiliated accounting expert “that explanation would not justify the Board’s denying Laccetti any accounting expert.” (emphasis original). If this were the case the Board could have told Mr. Laccetti that a non-firm expert could assist him. It did not.
Third, the Board’s rules “establish that the Board could not bar Laccetti from using an accounting expert to assist his counsel in these circumstances.” In SEC v. Whitman, 613 F. Supp. 48 (D.D.C. 1985) the Court was faced with virtually the identical issue presented here. Interpreting Section 555(b) of the APA, the Court rejected the SEC’s claim that it could exclude an accountant there to assist the witness’ counsel.
Finally, the Court rejected a claim that any error was harmless. The Commission conceded that the decision to institute proceedings may have been based in part on the testimony of Mr. Laccetti. Therefore the error was not harmless and “the only reasonable remedy is for the Board, if it chooses and if the law otherwise permits, to open a new disciplinary proceeding against Laccetti and, if it chooses to re-interview Laccetti, to do so without violating his right to counsel . . .”
Market crisis: U.S. v. Barclays Capital, Inc., Civil Action No. 16-cv-7057 (E.D.N.Y.) is an action against the firm and two of its senior executives, Paul Menelfee, head banker for subprime residential mortgage backed securities or RMBS securitizations, and John Carroll, head trader for subprime loan acquisitions. The action centered on 36 RMBS deals between 2005 and 2007 valued at over $31 billion. The Government alleged in its complaint that purchasers were defrauded because the securities were significantly less credit worthy than the public offering documents and related representations claimed. The loans defaulted at an exceptionally high rate. Likewise, the properties were systematically worth less than what Barclays represented to investors. The firm agreed to settle the action, paying a $2 billion civil penalty. Messrs. Menefee and Carroll agreed to pay $2 million in civil penalties as part of the resolution of the case.
Binary options –CFDs: The European Securities and Markets Authority or ESMA has prohibited the marketing, distribution or sales of binary options to retail investors, in a release issued on March 27, 2018. In the same release the regulator imposed restrictions on the marketing and distribution of Contracts for Differences or CFDs to retail investors. The restrictions were imposed due to the complexity and lack of transparency of the instruments.
ICOs: BaFin, the Federal Financial Supervisory Authority, published an advisory letter on the classification of tokens as financial instruments on March 28, 2018. The advisory letter states in part that in order “to fully satisfy any legal requirements, these market participants must give careful consideration to whether the tokens constitute a regulated instrument, for instance a financial instrument or a security. In cases of doubt, they should contact the competent BaFin divisions in good time.”
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.