This Week In Securities Litigation (Week ending March 9, 2018)
Virtual currencies were front and center again this week. The SEC’s Divisions of Enforcement and Trading and Markets issued a rare joint statement cautioning investors about trading virtual currencies. At the same time the CFTC secured a ruling affirming its authority over virtual currencies along with that of other regulators and granting a preliminary injunction based on claims that investor funds were being misappropriated. Finally, Praetorian Group has reportedly filed what may be the first registration statement for an ICO with the Commission, according to Law 360.
Remarks: Commissioner Michael Piwowar delivered remarks titled Old Fileds, New Corn: Innovation in Technology and Law at the 2018 RegTech Data Summit, Washington, D.C. (March 7 2018). His remarks focused in part on the application of established principles to new situations and reviewed other areas were the Commission has been out in front on tech (here).
Statement: The Divisions of Enforcement and Trading and Markets issued a Statement on Potentially Unlawful Online Platforms for Trading Digital Assets (March 7, 2018). The statement outlines issues for investors regarding the trading of these instruments, urging those involved with them to consult securities counsel and offers assistance through FinTech@sec.gov (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 4 civil injunctive case and 6 administrative proceedings, excluding 12j and tag-along proceedings.
Unregistered securities: In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Adm. Proc. File No. 3-18392 (March 8, 2018) is an action against the registered broker-dealer based on the sale of 3 million unregistered shares of Longtop Financial Technologies for a customer. Specifically, the firm was told that the Chairman had gifted a block of unregistered shares to firm employees. The related ADS were then deposited periodically in a nominee account for sale. The sales were based on the broker’s exemption, Section 4(a)(4), which requires due diligence. While the firm did some due diligence before the first sale it learned facts suggesting the Chairman retained control of the stock but, nevertheless, proceed with the sale. Other red flags appeared as more stock was sold. For example, the firm was accused of fraud and later the auditors resigned. The firm continued selling the shares in 68 transactions for about $38 million despite those red flags and others. The sales were not exempt. To resolve the proceedings the firm consented to the entry of a cease and desist order based on Securities Act sections 5(a) and 5(c) and a censure. In addition, Merrill Lynch agreed to pay disgorgement of $127,545, prejudgment interest of $27,340 and to pay a penalty of $1.25 million.
Offering fraud: SEC v. Americrude, Inc., Civil Action No. 3:18-cv-00534 (N.D.Tex. Filed March 7, 2018) is an action which names as defendants the firm, essentially a shell company, Shezad Akbar who controlled the company, and Daniel Waite, solicited to serve as president of the company. Over a period of about eighteen months beginning in March 2015 the company and Mr. Akbar, with assistance from Defendant Waite, raised about $950,000 from 17 investors through a series of misrepresentations through cold-calls and the dissemination of false offering materials. Essentially, investors were given incorrect information about the reserves, the number of wells and their firm’s track record. Portions of the investor funds were also misappropriated. The complaint alleges violations of Securities Act sections 5(a), 5(c) and 17(a)(2) and Exchange Act sections 10(b) and 15(a). To resolve the matter Defendant Waite consented to the entry of a permanent injunction based on the sections cited in the complaint, although it does not prohibit him from buying and selling oil and gas securities for his own account. He also agreed to pay disgorgement of $32,409.52, prejudgment interest of $1,763.30 and a penalty of $100,000. The other Defendants have not settled.
Conflicts: In the Matter of Voya Investments, LLC, Adm. Proc. File No. 3-18393 (March 8, 2018) is an action which names as Respondents Voya a registered investment adviser previously known as ING Investments, and Directed Services LLC, previously a dually registered investment adviser and broker-dealer. Direct Services has withdrawn its registrations and Voya has taken over advising the funds it previously advised. Over a period of about four years, beginning in August 2003, Respondents followed a practice of recalling in advance of the record dividend date, portfolio securities of mutual funds they advised that were out on loan. Insurance Affiliates would then be of record at the time of the dividend. What was not disclosed, however, was the fact that the funds and individuals invested in those funds through their variable life annuity contracts and variable life insurance policies lost securities lending income during the period that the shares were withdrawn. The conflict was also not disclosed in the filings. In determining to accept the offer of settlement the Commission considered the remedial efforts of Respondents. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). 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 to a censure. In addition, Respondents will pay on a joint and several basis disgorgement of $2,635,490.25 and prejudgment interest of $511,978.89 and a penalty of $500,000.
Cherry picking: In the Matter of Valor Capital Asset Management, LLC, Adm. Proc. File No. 3-18387 (March 6, 2018) is a proceeding which names as Respondents the state registered investment adviser and Robert Magee, its founder and sole employee. From July 2012 through May 2015 Respondents engaged in a cherry picking scheme in which trades were placed and not allocated until it could be determined if they were profitable. If the transaction was profitable it was typically allocated to Respondents; if not, to a client account. Statistical analysis was used to validate the cherry picking conclusion. Previously, the broker-dealer used by the adviser terminated its relation with the firm because of suspected cherry picking. The Texas State Securities Board also found that Mr. Magee failed to properly enforce the firm’s procedures regarding trade allocations. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). To resolve the matter each Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. They also agreed to pay disgorgement of $505,663, prejudgment interest of $50,208 and a penalty of $160,000. In addition, Mr. Magee is barred from the securities business.
Exchange operation violations: In the Matter of New York Stock Exchange LLC, Adm. Proc. File No. 3-18388 (March 6, 2018) names as Respondents the New York Stock Exchange, NYSE American and NYSE Arca, Inc. The proceedings center on five separate alleged violations: First: A trading halt on July 8, 2015 at the NYSE and American for about three and one half hours. The shut down occurred after repeated indications of connectivity issues that gave the exchanges reason to believe that they did not meet the definition of an “automated trading center” and that the quotes being displayed were not automated as displayed, negligently misleading traders. Second: During market volatility on August 24, 2015 Arca imposed collars following the resumption of trading after limit up/limit down halts which were inappropriate since the exchange had no rule that permitted such action. Third: On the morning of March 31, 2013 the trade process on one of Arca’s trading units entered a software loop that eventually resulted in a shutdown despite the fact that the national market system plan did not allow for that action under the circumstances. Arca rules in effect at the time required the exchange to publish certain information regarding each security prior to the daily closing auction. That information was not published as required. Fourth: Reg SCI requires that key market participants, among other things, have a business continuity and disaster recovery plan. From November 3, 2015 to November 23 2016 the NYSE and American failed to comply with this obligation. Fifth: The interaction between two order-types on the NYSE and American created the possibility that floor brokers’ pegging orders could, in certain circumstances, detect the presence of non-displayed depth liquidity on the exchanges’ order books over a seven year period beginning in 2008. The Order alleges violations of Exchange Act Sections 19(b)(1) and 19(g)(1), Securities Act Section 17(a)(2), and certain rules under Regulations SCI and NMS. In resolving the proceeding, Respondents will implement certain undertakings over the next three years. In addition: Respondents each consented to the entry of a cease and desist order based on Exchange Act Section 19(b)(1) and to censures; Respondents NYSE and American each consented to the entry of a cease and desist order based on Securities Act Section 17(a)(2) and rules 1001(a) and 1001(a)(2)(v) under Regulation SCI; and Respondent Arca consented to the entry of a cease and desist order based on Exchange Act Section 19(g)(1) and rule 608(c) of Regulation NMS. Respondents will also pay a penalty of $14 million.
Insider trading: SEC v. Morano, Civil Action No. 3:18-cv-00386 (D. Ore. Filed Mar. 5, 2018) is an action against Robert Morano, formerly an employee of UTI Worldwide, Inc. Prior to the acquisition of his firm by DSV Air & Sea Holdings A/V, Mr. Morano learned about the planned transaction because he was involved in helping with the press releases. After learning about the proposed deal, but prior to its announcement, he purchase 17,500 shares of UTI using three brokerage accounts. Following the deal announcement he had trading profits of over $38,000 when the share price increased by about 50% following the deal announcement. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24065 (March 8, 2018).
Touting: SEC v. Friedland, Civil Action No. 1:18-cv-00529 (D. Colo. Filed March 5, 2018) is an action which names as Defendants Jeffrey Friedland and his two companies, Global Corporate Stragegies, LLC and Intiva Pharma LLC. From August 2014 through February 2016 Mr. Friedlander participated in a series of interviews and other communications in which he touted OWC Pharmaceutical Research Corporation. Throughout those discussions he presented himself as simply an early investor in the firm rather than one who had blocks of stock in the company he held through two different firms and who had been compensation with over 5 million shares for the touts. His efforts contributed to inflating the stock price as a result of which Mr. Friedland made over $7 million by dumping his stock. The complaint alleges violations of Securities Act Sections 17(a), 17(b) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24066 (March 8, 2018).
Unregistered broker – EB-5: In the Matter of Edwin Shaw, LLC, Adm. Proc. File No. 3-18384 (March 5, 2018). Respondent is a New York City based firm that specializes in the business of foreign investment in the United States. The firm is not registered with the Commission. It is owned by the Principal. The Issuer is a Long Island City based firm engaged in the taxi and livery business in the New York City metropolitan area. Its Managing Member is the majority owner of the firm, operating the taxi and livery business. In April 2014 the Issuer decided to raise funds by selling membership interests to foreign investors who were interested in the EB-5 visa program. The Managing Member of the Issuer engaged Edwin Shaw to market membership interests to prospective investors. Over a three year period, beginning in April 2014, those interests were marketed by the Principal of Edwin Shaw who would meet with prospective investors in the United States. At the meeting there would be a discussion of the prospective investment and detailed information would be furnished. The Edwin Shaw Principal negotiated an administrative fee with each investor as part of the transaction that ranged from $5,000 to as much as $50,000. The Order alleges violations of Exchange Act Section 15(a). To resolve the matter Respondent consented to the entry of a cease and desist order based on the section cited in the Order as well as to a censure. In addition, Respondent will pay disgorgement of $400,000, prejudgment interest of $4,209.20 and a penalty of $90,535.
Conflicts re custody rule: In the Matter of Financial Fiduciaries, LLC, Adm. Proc. File No. 3-18385 (March 5, 2018) is a proceeding which names as Respondents the registered investment adviser and its founder and principal, Thomas Batterman who was Respondent in a settled SEC action based primarily on custody violations. This action centers on the period 2012 through mid-2015 during which there was an undisclosed conflict regarding custody of client assets. Secificially, Financial Fiduciaries failed to disclose to certain clients arrangements involving an employee of an entity controlled by Mr. Batterman and the trust company where client assets were held which created a conflict – the same employee worked for both the financial institution and Respondent Batterman’s firm. The Order alleged violations of Advisers Act sections 206(2), 206(4) and 207. To resolve the matter each Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, the firm will pay a $40,000 penalty while Mr. Batterman will pay a $20,000 penalty.
Offering fraud: SEC v. Jersey Consulting LLC, Civil Action No. 2:18-cv-00155 (D. Utah Filed Feb. 20, 2018) is an action against the firm; Marc Tager, a convicted felon; Suzanne Gagnier; Kenneth Gross, previously enjoined by the SEC in one case and the subject of broker-dealer and penny stock bars in another; Jeffrey Lebarton; Jonathan Schoucair, a convicted felon and enjoined in a prior SEC action; and Jason Vitolo, also a convicted felon. Since September 2014 Defendants Jersey and Tager, with the assistance of others, have raised about $6 million from 84 investors based on a series of misrepresentations. Those misrepresentations centered on what was claimed to be a unique, proprietary process for “soil remediation” that would be used in conjunction with soil obtained from an 80 acre Bureau of Land Management claim in Arizona to double investor funds. The claims were false. The investor funds were dissipated by Defendants Tager, Mangum and Freitas who used portions of the investment money for their personal benefit and used other portions to repay some investors. The complaint alleges violations of Securities Act Sections 5(a), 5(c), 17(a) and Exchange Act Sections 10(b), 15(a) and 15(b)(6). The case is pending. See Lit. Rel. No. 24064 (March 5, 2018).
Remarks: Commissioner Brian Quintenz delivered the Keynote Address to the DC Blockchain Summit, Washington, D.C. (March 7 2018). In his remarks he reviewed the actions of the agency regarding cryptocurrencies and called for the creation of a self-regulatory organization to monitor the industry (here).
Virtual currencies: CFTC v. McDonnell, Civil Action No. 18-cv-361 (E.D.N.Y. Opinion March 6, 2018) is an action which names as Defendants Patrick McDonnell and his firm, Coin Drop Markets. The complaint alleges that the Defendants were marketing access to expert trading advise in virtual currencies that would permit investors to make huge profits. The CFTC brought suit, claiming that the operation was a fraud and that the investor funds were misappropriated. The Court, in a memorandum and order per Judge Jack Weinstein, held that the CFTC has anti-fraud authority over virtual currencies which fall within the definition of a commodity. Specifically, the CEA defines commodity to include “wheat, cotton, rice, corn, oats . . . and all services, rights, and interests . . . in which contracts for future deliver are presently or in the future dealt in.” In view of this definition the CFTC issued an order in 2015 stating that virtual currencies can be classified as commodities. In the Matter of: Coinflip Inc., CFTC Docket No. 15-29. That order stated that “’Bitcoin and other virtual currencies are encompassed in the definition [of a commodity] and properly defined as commodities.’” The Court went on to hold that while the CFTC generally cannot regulate the spot market, under an expansion of its authority in the Dodd-Frank Act, the agency can bring an action under Section 9 of the CEA and Rule 180.1 prohibiting fraud involving any “’contract of sale of any commodity in interstate commerce.’” Accordingly, the Court upheld the authority of the CFTC to bring a suit seeking an injunction based on fraudulent conduct involving virtual currencies. Here, based on the testimony of a CFTC investigator the Court entered a preliminary injunction.
Offering fraud: U.S. v. Petrossi, No. 17-CR-192 (M.D.Pa. Verdict March 8, 2018) named as a Defendant Louis Petrossi, the founder and president of Wealth Research Institute, purportedly an investment research firm. Following a four day trial a jury found him guilty of securities fraud, investment adviser fraud and wire fraud. The evidence demonstrated that over a two year period beginning in January 2015 Mr. Petrossi raised over $1.8 million from at least 25 investors who were told that their money would be invested in one of the Chadwicke funds and invested in startup companies. In fact the Defendant misappropriated much of the investor money. Mr. Petrossi was arrested on May 3, 2016 following an indictment in the Eastern District of New York for his role in another securities fraud involving the securities of ForceField Energy Inc. While being held in jail he continued to operate the fraudulent scheme for which he was convicted in Pennsylvania, raising an additional $210,000 of investor funds. Last year he was convicted on the ForceField fraud by a jury in Brooklyn. He is now awaiting sentencing in both cases.
Manipulation: U.S. v. Mancino, No. 18-MJ-184 (E.D.N.Y. Filed March 2, 2018) is an action which names as defendants Dennis Mancino, the president and CEO of HD View 360, Inc., and William Hirschy, the CEO of WT Consulting Group, LLC. The two men were arrested on securities manipulation charges tied to HD View. Specifically, between July 2017 and February 2018 the two men conspired to pump-up the share price of the stock and then dump the shares for a profit. As part of the scheme, kickbacks were paid to certain brokers for assistance. The case is pending.
New York AG
Market crisis: The New York Attorney General resolved an investigation with RBS Financial Products tied to misrepresentations involving the sale of residential mortgage-backed securities in 2006 and 2007. In resolving the matter RBS agreed to pay $100 million to settle potential legal claims and an additional $400 million for consumer relief credits. The firm also agreed to make certain admissions of fact.
Court of Appeals
Statute of limitations: SEC v. Kokesh, No. 15-2087 (10th Cir. Decided March 5, 2018). This case is on remand from the Supreme Court which held that the statute of limitations applies to SEC claims for disgorgement.
Charles Kokesh owned two Commission registered investment advisory firms. Each was the managing partner of, and provided investment advice to, several registered business development companies or BDCs. The contracts between the advisers and the BDCs prohibited payments by the BDCs to the advisers not specified in the contracts. Mr. Kokesh directed the treasurer for the advisers to take substantial sums from the BDCs for payments to him, others and to cover certain expenses. These items were not specified in the contracts. Between 1995 and 2006 it is alleged in the SEC’s complaint, filed October 27, 2009, that $34.9 million was improperly taken from the BDCs. The question on remand, in view of the Supreme Court’s ruling, was how Section 2462 applies and what amount, if any, Mr. Kokesh must pay in disgorgement.
In resolving the question of when the statute begins to run the Court focused on the phrase “first accrues” from the statute. In view of this language section 2462 “begins only once, when a claim first accrues.” (emphasis original). In view of these words the statute cannot reset each day because the concept of “first” would “have no operative” force, the Court found. Thus the application of the “statute-of-limitations issue in this case . . . turns on whether Defendant’s misappropriations of funds from the BDCs are properly viewed as a continuing violation or as a number of discrete wrongs,” the Court held.
Here the “Defendant’s misconduct was not a continuing omission to act in compliance with a duty . . . the SEC’s claim did not depend on the cumulative nature of . . . the acts.” Rather, “the gist of Defendant’s misconduct was taking funds without proper authority, without consent.” Viewed in this context the misappropriations constituted “a series of repeated violations . . .” (internal quotations omitted).
The Court concluded by noting that “To hold that Defendant’s misappropriations constituted only one continuing violation would do much more than provide repose for ancient misdeeds; it would confer immunity for ongoing repeated misconduct. . . Defendant could take $100 a year for five years and then misappropriate tens of thousands without fear of liability. We cannot countenance such a result, nor do we think that a proper interpretation of §2462 requires us to.”