This Week In Securities Litigation (Week ending March 8, 2019)
The Commission and the DOJ resolved FCPA charges that resulted in the payment of penalties totaling $850 million. The case, centered on a Russian communications firm and bribes paid in Uzberkistan, is the third in a series of corruption cases involving almost $1 billion in bribes in the country.
Three other settled administrative actions were filed by the agency this week. One centered on the falsification of firm financial projects by the CFO to secure approval for a related party transaction. Two others were based on the inadequate audits and reviews by an audit firm, the engagement partner and the reviewing partner for five issuers.
Remarks: Commissioner Hester M. Peirce, delivered remarks titled Festivus, Fortnite, and Focus to the Council of Institutional Investors Spring Conference, Washington, D.C. (March 5, 2019). Her remarks discussed reforms for the offering process, proposed revisions to the auditor independence rules, buy-backs and mandatory shareholder arbitration (here).
SEC Enforcement – Filed and Settled Actions
The Commission did not file any civil injunctive actions but did file 4 administrative proceedings this week, exclusive of 12j and tag-along actions.
False statements: SEC v. Goldsky Asset Management, LLC, Civil Action No. 18-civ-8870 (S.D.N.Y.) is a previously filed action against the Australia based investment adviser and its owner, Kenneth Grace. The complaint alleged Defendants made a series of false statements claiming the firm had an auditor, prime broker, custodian and over $100 million in discretionary assets under management. To resolve the action each Defendant agreed to the entry of a final judgment enjoining them from future violations of Advisers Act Sections 206(4) and 207. The firm will pay a penalty of $50,000 while Mr. Grace will pay $25,000. See Lit. Rel. No. 24418 (March 6, 2019).
Excessive trading: SEC v. Gennity, Civil Action No. 17-cv-7424 (S.D.N.Y.) is a previously filed action which named as a defendant William Gennity, formerly an associate with Alexander Capital L.P. The complaint alleged that over about two years beginning in July 2012 Mr. Gennity recommended to four customers a pattern of high-cost, in-and-out trading without any reasonable basis to believe that the clients would make a profit. He also made misrepresentations regarding the potential profits. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 17(a). To resolve the matter Mr. Gennity consented to the entry of a permanent injunction based on the sections cited in the complaint. In addition, he agreed to pay disgorgement of $127,686, prejudgment interest of $14,797 and a penalty of $160,000. See Lit. Rel. No. 24416 (March 4 ,2019). See also In the Matter of William C. Gennity, Adm. Proc. File No. 3-19015 (March 4, 2018)(order barring Respondent from the securities business and participating in any penny stock offering).
Related party transactions: In the Matter of Mark E. Kchenrither, Adm. Proc. File No. 3-19009 (March 1, 2019). Mark Kuchenrither served as Executive Vice President and CFO of EZCORP, a firm with two classes of shares. The Class A shares are listed on NASDAQ but do not carry voting rights. The Class B shares do have voting rights. All of those shares are owned by the Controlling Shareholder. The board of directors approved a Policy for Review and Evaluation of Related Party Transactions in September 2009. The firm’s General Counsel developed a process to implement the RPT Policy under the supervision of the audit committee which had been delegated authority to assess the fairness of related party transactions. The Audit Committee retained an Advisor to furnish an opinion each year on whether the annual consulting agreement with the Controlling Shareholder was financially fair to EZCORP. In the past the Advisor signed off and a Form 8-K reported the transaction. In 2014 the Advisor informed the company that it would not approve the proposed Consulting Agreement because the consulting fee exceeded the acceptable fee-to-earnings ratio based on EZCORP’s financial projections. The Controlling Shareholder rejected a request to reconsider the fee. The Audit Committee Chairman then asked Mr. Kuchenrither to reassess the financial position of the company since the Advisor’s determination hinged on the fact that the firm’s projected earnings were less than $240 million. The CFO revised the earnings projection over the next four days, increasing it from $187 million to $242.9 million. The increase was based on two assumptions: 1) that EZCOERP would complete a $300 million high-yield debt offering and 2) that the firm would use part of the proceeds to acquire several companies during the year. After reviewing the revisions, the Advisor approved the Consulting Agreement. The CFO did not, however, have a reasonable basis for the two assumptions on which the new projections were based. He double counted the impact of the high-yield debt offering since it was included in the original financial projections. He knew, or should have known, that the acquisition process was not moving forward in any meaningful manner. Nevertheless, EZCORP proceeded to disclose the new agreement filings with the Commission. The filing did not include any discussion regarding the Advisor’s initial opinion or the CFO’s revamping of the financial projections based on flawed assumptions. The Order alleges violations of Securities Act Sections 17(a)(3). 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 pay a penalty of $50,000.
Failed audits: In the Matter of DLL CPAS, LLC, Adm. Proc. File No. 3-19010 (March 1, 2019); DLL is a public accounting firm that registered with the PCAOB on June 17, 2016. The firm subsequently conducted audits of the financial statements of five issuers whose shares are registered with the Commission along with reviews of quarterly reports for 2015 and 2016. The audits and reviews were conducted under the tutelage of Respondent Debra Lee Lindaman, a CPA, and the person that formed the firm. Respondent Viola served as the Quality Review Partner on each engagement. These proceedings center on the audits and reviews conducted for five issuers. The audits and reviews failed to comply with PCAOB standards: First, there was a failure to obtain audit documentation in accord with PCAOB Auditing Standard No. 1215 with regard to the engagements for Leo Motors, Kibush, CES and Omni Shrimp. Second, there was a failure to reconcile the financial statements and the underlying accounting records with respect to the engagements for CES, Leo Motors, Omni Shrimp and Kibush. Third, AS No. 1105 requires that the auditor plan and conduct audit procedures to obtain sufficient, competent evidential matter to provide a reasonable basis for the opinion stated. The workpapers here for CES and Leo Motors fail to comply with this requirement in certain respects. Fourth, the procedures utilized to conduct the interim reviews were deficient. For quarterly reviews the procedures conducted are typically analytical such as comparing information for the current period and the one immediately proceeding the interim review. Here for the five issuers the reviews were often perfunctory and contained no meaningful analysis of variances in account balances from period to period. For some periods no workpapers were produced. Fifth, AS No. 3101 regarding the report on audited financial statements requires that the auditor’s report contain an opinion on the financial statements taken as a whole and contain a clear indication of the character of the auditor’s work. The culmination of the deficiencies here rendered any claim that the work was done in accord with PCAOB standards false and misleading. Accordingly, the Order as to the firm and its owner alleges violations of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13 along with Regulation S-X Rule 2-02(b)(1). To resolve the proceedings Respondents DLL and Ms. Linderman each consented to the entry of a cease and desist order based on these provisions. Each is also denied the privilege of appearing and practicing before the Commission as an accountant and will pay, on a joint and several basis, disgorgement of $25,000 along with prejudgment interest of $1,387.27. See also In the Matter of Arthur Viola, Adm. Proc. File No. 3-19011 (March 1, 2019)(reviewing partner failed to conduct proper review; resolved with consent to the entry of a cease and desist order based on the Section and Rules cited in the Order as to firm disgorgement of $4,800 and prejudgment interest of $228.48; denied the privilege of appearing and practicing before the Commission as an accountant but can request reinstatement after five years).
Insider trading: SEC v. Chen, Civil Action No. 2:18-cv-07840 (C.D. Cal.) is a previously filed action which named Rong Chen, a U.S. citizen residing in China, with insider trading based on material non-public information he obtained through his. The complaint alleged violations of Exchange Act Section 10(b). To resolve the action Mr. Chen consented to the entry of a permanent injunction based on the section cited in the complaint. He also agreed to pay disgorgement of $167,092, prejudgment interest of $26,356 and a penalty equal to the amount of his trading profits. See Lit. Rel. No. 24417 (March 4 2019).
Misappropriation: SEC v. Schmidt, Civil Action No. 3:18-cv-00320 (S.D. Ohio) is a previously filed action against registered representative John G. Schmidt. The Commission’s complaint alleged that Mr. Schmidt misappropriated over $1 million worth of securities from at least seven of his customers. The proceeds were used to try and cover shortfalls in other accounts. Mr. Schmidt resolved the action, consenting to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). He also agreed to pay disgorgement of $235,614, prejudgment interest of $35,049 and a civil penalty of $846,301. See Lit. Rel. No. 24414 (March 1, 2019).
In the Matter of Mobile TeleSystems PJSC, Adm. Proc. File No. 85261 (March 6, 2019) names as Respondent the Russian telecom firm whose shares are listed on the NYSE. Over an eight year period beginning in 2004 the firm paid about $420 million in bribes to enter and secure work in Uzbekistan. The payments were made using a variety of devices including equity transactions with government officials, sham contracts and charitable contributions or sponsorships. The payments were disguised in the books and records of the firm. During the period the illicit payments resulted in over $2.4 billion in revenue. The Order alleged violations of Exchange Act Sections 30A, 13(b)(2)(A) and 13(b)(2)(b). The firm will pay a civil penalty of $100,000,000. A monitor was installed. The Commission acknowledged the cooperation of the firm.
The company also settled with the DOJ. The firm entered into a deferred prosecution agreement while subsidiary Kolorit Dizayn Ink LLC pleaded guilty to conspiracy to conspiracy to violate the bribery and books and records provisions of the FCPA. Under the terms of the agreement an $850 million criminal penalty will be paid. The $100 million SEC penalty will be credited against that amount.
An indictment was returned charging Gulnara Karimova, the daughter of the President of Uzbekistan, who solicited the bribes, and Bekhzod Akhmedov, a former government executive. Ms. Karimova was charged with one count of conspiracy to commit money laundering. Mr. Akhmedov was charged with one count of conspiracy to violate the FCPA, two counts of violating the FCPA and one count of conspiracy to commit money laundering. U.S. v. Karimova (S.D.N.Y. Filed March 6, 2019). The case is pending.
Insider trading: U.S. v. Ying, No. 1:18-cr-00074 (N.D. Ga. Plea March 7, 2019) is an action in which former Equifax employee Jun Ying pleaded guilty to one count of securities fraud. Mr. Ying had been the chief information officer in the U.S. for the company in the summer of 2017 when it suffered a massive data breach. After texting a co-worked that the available information suggested such a breach, and conducting additional research, Mr. Ying exercised all of his firm stock options and sold the shares. As a result he obtained a gain of over $480,000 and avoided a loss of over $117,000. Sentencing is scheduled for June 23, 2018. Mr. Ying is the second former employee to plead guilty to insider trading based on the data breach. See also SEC v. Ying, Civil Action No. 1:18-cv-01069 (N.D. Ga.).
Fraud/perjury: U.S. v. Cody, No. 1:17-cr-10291 (D. Mass. Sentencing March 7, 2019)) is an action in which former investment adviser Richard Cody previously pleaded guilty to one count of violating the Advisers Act and two counts of making a false declaration in a court proceeding. This week he was sentenced to serve two years in prison followed by two years of supervised release. Previously, he had been ordered to pay a fine of $30,000. The charges were based on repeated lies told to three former clients. Defendant repeatedly assured the clients that their investments were safe as he had promised. In fact, by 2014 the 2005 investments, which were retirement savings, had substantially diminished and for two were gone. The victims were furnished with false documents to help conceal the true facts. During the SEC’s investigation Mr. Cody lied in testimony regarding the fraudulent documents used to try and conceal the scheme. See also SEC v. Cody, Civil Action No. 1:16cv-12510 (D. Mass.).
Program: Women in Compliance, March 19, 2019 at the offices of Dorsey & Whitney, LLC, New York New York. Details and registration are here.