This Week In Securities Litigation (Week ending May 12, 2017)

New Chairman Jay Clayton began at the agency this week. There are now three Commissioners, at least until early June when the term of another Commissioner expires. The Administration has not nominated anyone to fill the remaining open seats at the agency.

The Commission got split results in court this week. It lost a jury trial against a bank and its former Chairman in a case stemming from the market crisis. In another case the agency prevailed on a motion for partial summary judgment, securing a ruling in an offering fraud action that certain defendants acted as unregistered brokers.

SEC Enforcement filed a series of cases this week. Those included an action against Barclays tied to over charging clients in a wrap fee program, a case against a former staff member for making false statements in connection with circumventing agency restrictions on securities trading, and an insider trading action against an attorney and his neighbor who traded while in possession of material non-public information obtained from the lawyer’s law firm.


Remarks: Commissioner Michael Piwowar delivered the opening remarks at the SEC-NYU Dialogue on Securities Market Regulation titled Reviving the U.S. IPO Market, New York City (May 10, 2017). In his remarks the Commissioner noted that IPO’s had fallen to about 135 per year since 2000, compared to about 457 per year in the 1990’s; he also noted that the focus of new Chairman Jay Clayton is expected to be “making public capital markets more attractive to business” (here).

Remarks: Commissioner Michael Piwowar delivered the opening remarks at the 2017 SEC/NASAA Annual Section 19(d) Conference, Washington, D.C. (May 9, 2017). His remarks focused on capital formation and the new SAFE offerings intended for retail investors – a product evolved from efforts to facilitate investments by venture capital firms (here).

Securities Class Actions

In the first quarter of 2017 a record number of securities class actions were filed, according to a new report by Cornerstone Research (here). During that period 127 securities class actions were filed compared to about half that number in the first quarter of last year – 64. In 2015 there were 38 suits filed in the first quarter, 36 in 2014 and 34 in 2013. During the same period there was also a record number of M&A filings. In the first quarter of 2017 there were 45 actions filed tied to M&A transactions — over four times the number brought at the beginning of 2016 when just 11 suits were filed. Similarly, in 2015 only 1 M&A based suit was filed in the first quarter while there were 3 in 2014 and 2 in 2013. An increased number of suits was reported in all sectors.

SEC Enforcement – Litigated Actions

Market crisis: SEC v. BankAtlantic Corp., Case No. 0:12-CV60082 (S.D. Fla. Filed Jan 18, 2012) is an action against the holding company for a large Florida bank and its CEO and Chairman, Alan Levan. The complaint alleged that as the market crisis unfolded, the defendants failed to disclose, and made false statements regarding, the bank’s commercial residential loan portfolio and its deteriorating condition.

The defendants knew that the condition of the portfolio was deteriorating because a number of the loans were kept current by granting extensions. Specifically, Mr. Levan knew about the condition of the portfolio from participating on the bank’s Major Loan Committee which approved the extensions and related principal increases. Despite this knowledge, the disclosure documents for the first two quarters of 2007 contained only generic warnings about what might occur in the future if Florida’s real estate downturn continued. Those documents also failed to disclose the downward trend already occurring in its own portfolio. The MD&A should also have disclosed these matters. Nevertheless, Mr. Levan signed the filings. The complaint alleged violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). Following trial the jury rejected each of the Commission’s claims. Judgment was entered in favor of each defendant. The Court dismissed the case with prejudice.

Unregistered broker: SEC v. Mieka Energy Corporation, Civil Action No. 4:15-cv-00300 (E.D. Tx.). The complaint named as defendants: Mieka Energy, a wholly owned subsidiary of another defendant, Vadda Energy Corporation, based in Flower Mound, Texas, which registered its shares under the Exchange Act; Daro Blankenship, the founder and managing director of Mieka and also the President and CEO of Vadda of which he and his wife own 79%; Robert Myers, Jr., Mieka’s vice president of project development and at one time a registered representative at a registered broker-dealer; and Stephen Romo, previously a real estate broker, who sold interests in Mieka.

Beginning in September 2010 Mieka Energy, according to the complaint, marketed what were called joint venture interests nationwide to investors. The interests were marketed through extensive boiler-room type calls. While investors were told that they would be acquiring joint venture interests, in fact they had little control. Two of the salesmen in this effort were defendants Myers and Romo. Neither was registered with the SEC or associated with a Commission registered broker-dealer.

Contrary to the representations made to investors, Mieka Energy did not drill a horizontal well. It did do work on a vertical well. That well is not functional, however, because it was never connected to a transmission line for the gas. About $850,000 was spent on development activities. Overall the commissions and the development costs constituted a little over 21% of the total funds raised from investors. Filings made with the Commission by Vadda did not disclose the true nature of the project. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a) and 15(a) and control person liability under Section 20(a).

The Commission moved for partial summary judgment, arguing that Messrs. Myers and Romo acted as unregistered brokers in selling the joint venture interests which were investment contracts and thus securities. Exchange Act Section 15(a) prohibits a person from acting as a broker without registering with the Commission, the Court began. The term broker is defined by Exchange Act Section 3(a)(4). It includes “any person engaged in the business of effecting transactions in securities for the account of others,” according to the statutory definition. Being “engaged in the business,” “effecting transactions” and “buying and selling” securities are phrases not defined in the statute but by the courts. Effecting transactions includes soliciting investors to purchase securities, participating in the negotiations between the issuer and the investor and receiving transaction based compensation.

Here Messrs. Myers and Romo acted as brokers. The two men “were cold-calling potential investors from lead sheets, developed relationships by discussing the potential investor’s history, recommended the investment with Mieka, sent the potential investors offering documents, took orders and were paid transaction based compensation. Indeed, about $4 million was raised from 60 investors in 21 states. Mr. Myers was paid $165,453.47 for an offering in 2010 and $102,484 in 2011. Mr. Romo received $69,962 in commissions for his work in 2010. Under these circumstances there is no doubt that Messrs. Myers and Romo were acting as unregistered brokers – each admits to not being registered.

It is equally clear that the joint venture interests offered to investors here were investment contracts and thus securities. The classic test is whether 1) individuals are led to invest money, 2) in a common enterprise with 3) the expectation that they would earn a profit solely through the efforts of the promoter or someone other than themselves. Since the interests sold by Messrs. Myers and Romo meet this test they are securities. Thus in selling these securities Messrs. Myers and Romo, who were not registered with the Commission as brokers, violated Exchange Act Section 15(a). Partial summary judgment was granted in favor of the Commission.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 3 civil injunctive cases and 4 administrative proceedings, excluding 12j and tag-along proceedings.

Insider trading: SEC v. Little, Civil Action No. 1:17-cv-03536 (S.D.N.Y. Filed May 11, 2017) names as defendants Walter Little, a lawyer who was a partner at Foley & Lardner LLP, and Andrew Berke, his friend and neighbor. Over a period of about one year, beginning in February 2015, Mr. Little accessed his firm’s computer system and obtained inside information regarding seven clients and eleven significant events. In each instance he traded in advance of the event while in possession of the information, reaping about $363,797 in profits. In six instances he tipped Mr. Berke who traded through two accounts in advance of the upcoming corporate event. He obtained $640,651 in trading profits. The complaint alleges violations of Securities Act Section 10(b) and Exchange Act Sections 10(b) and 14(e). The case is pending. A parallel criminal action was filed by the Manhattan U.S. Attorney’s Office against the two men.

Undisclosed Perks: In the Matter of Miles S. Nadal, Adm. Proc. File No. 3-17980 (May 11, 2017) is an action against the former Chairman of the Board, CEO and President of MDC Partners, Inc., a publicly-traded marketing company. From 2009 through 2014 Respondent is alleged to have received, but not disclosed, million of dollars in compensation from the firm in perquisites, personal expense reimbursement and other items. The Order alleges violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(5) and 14(a). To resolve the proceeding Mr. Nadal consented to the entry of a cease and desist order base on the Sections cited in the complaint. In addition, he is prohibited for a period of five years from serving as an officer or director of any issuer. He will also pay disgorgement of $1.85 million, prejudgment interest and a penalty of $3.5 million.

Wrap-fees: In the Matter of Barclays Capital Inc., Adm. Proc. File No. 3-17978 (May 10, 2017). Barclays was a registered investment adviser and broker-dealer. During the period here – generally 2010 to the end of 2014 – the firm served as an adviser to clients in its wrap fee programs. While the firm had multiple programs with different objectives, generally they used third-party managers or sub-advisers. Those persons were, according to Barclays, evaluated and monitored – due diligence was conducted to ensure that client accounts were properly maintained. This was detailed in Forms ADV. Despite representations in its filings, client agreements, brochures and market materials, the firm failed to perform the initial due diligence and ongoing monitoring as represented. The materials describing the due diligence and monitoring were thus materially false and misleading. In addition, over a four year period beginning in January 2011 Barclays represented to clients that it would calculate its investment advisory fees based on the average of the three month-end values of each account’s assets in the billing quarter but in fact did not. Rather, in excess of 22,000 accounts were overcharged by a total of about $2 million. Finally, during the same period the firm did not have adequate procedures and systems to ensure that certain mutual fund clients received fee waivers or less expensive shares for which they were eligible. Thus many clients were overcharged for the shares purchased. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Advisers Act Sections 206(2), 206(4) and 207. In resolving the matter the firm agreed to certain undertakings, including the payment of over $3.5 million to certain wrap fee clients whose investments underperformed and who paid excess fees. The firm also consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. In addition, the adivser will pay disgorgement of $49,785,417, prejudgment interest and a penalty of $30 million.

Offering fraud: SEC v. White, Civl Action No. 16-cv-2715 (N.D. Ga.) is a previously filed action against Matthew White, Rodney Zehner, Daniel Merandi and their related entities. The complaint alleged that the defendants fraudulently issued about $1 billion in unsecured corporate bonds out of a shell company. Investors were told their money would be used to fund the construction of a resort. While Defendants never came close to raising sufficient money to build the resort, they did obtained about $5.6 million from investors which was diverted to their own use. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The Court entered final judgments of permanent injunction as to each defendant based on the Sections cited in the complaint. The order enjoins each defendant from participating in the offer or sale of any security except for trading in their personal accounts. The defendants were ordered to pay disgorgement and prejudgment interest of about $6 million and $450,000 in civil penalties. See Lit. Rel. No. 23828 (May 9, 2017).

Prohibited trading: SEC v. Humphrey, Civil Action No. 1:17-cv-00850 (D.D.C. Filed May 9, 2017) is an action against David Humphrey, formerly an employee of the SEC in the Division of Corporation Finance. From about 2001 through 2014 Mr. Humphrey repeatedly traded options and other securities prohibited by the SEC’s policies and failed to obtain preclearance as required for non-prohibited securities. He also failed to file the required annual disclosure form. Repeatedly during the period he filed false reports to conceal his trading. He also falsely denied his trading when confronted by the SEC Office of Inspector General. The complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a)(1). The case is pending. Mr. Humphrey pleaded guilty to criminal charges based on his false filings in a parallel criminal action. See Lit. Rel. No. 23827 (May 9, 2017).

Misrepresentations — Trade allocations: In the Matter of Tellone Management Group, Inc., Adm. Proc. File No. 3-17968 (May 5, 2017) is an action against the registered investment adviser and its founder and president, Dean Tellone. The adviser’s Form ADV represented that block trades would be allocated to client accounts using a rotation method so that over time the clients would receive roughly equal access and equal participation in limited trading opportunities. In fact that method was not used. Day trades with a profit of $300 or less were allocated to a single client that had a no-commission arrangement with a third party broker. Other clients received all other trades and typically paid a higher price and had the risk of the day trade account that only receive profitable day trades. The Order alleges violations of Advisers Act Sections 206(2) and 207. To resolve the proceeding 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, the firm will pay a civil penalty of $75,000 while Mr. Tellone will pay $25,000.

Misrepresentations – credentials: In the Matter of Source Financial Advisors, LLC, Adm. Proc. File No. 3-17969 (May 5, 2017) is an action which names as Respondents the registered investment adviser and its founder and managing member, Michelle Smith. The Order alleges that at various times the Form ADV brochure supplements misrepresented Ms. Smith’s education background by stating that she had a degree from Radford University when in fact she attended but did not graduate and incorrectly claimed she was a certified financial planner when in fact she took courses for that program but did not complete it. Corrections were made after the staff identified the issues. The Order alleges violations of Advisers Act Sections 206(2) and 207. To resolve the proceeding the adviser agreed to implement certain undertakings and both Respondents consented to the entry of a cease and desist order based on the Sections cited in the Order and to censures. In addition, Ms. Smith will pay a penalty of $35,000.

Offering fraud: SEC v. Battie, Civil Action No. 3:17-cv-1113 (N.D. Tx. Filed April 27, 2017) is an action which names as a defendant U.K. citizen Carl Battie. Over a period of several years, beginning as early as 2008, according to the complaint, Mr. Battie raised about $9 million from 70 investors. Investors purchased interests in what were called real estate ventures by acquiring investments in homes or notes. The properties were to be refurbished and leased for a profit. In fact the offerings were shams and little more than Ponzi schemes, the complaint claims. While certain highly distressed properties were acquired, little in the way of rehab work was done and reliable renters were not secured. The investment program only lasted until the stream of new investors dried up at which point investors were left with losses. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). In a parallel criminal case Mr. Battie pleaded guilty to one count of conspiracy to commit wire fraud. He was sentenced to serve ten years in prison and pay restitution of $11,402,794.47. In the Commission’s action he consented to the entry of a permanent injunction based on the Sections cited in the complaint. Disgorgement and prejudgment interest amounts are satisfied by payment of the restitution ordered in the criminal action. Penalties were not imposed in view of the prison sentence. See Lit. Rel. No. 23829 (May 11, 2017).


Remarks: Christopher Woolard, Executive Director of Strategy and Competition, Financial Conduct Authority, delivered remarks at the Cheung Kong Graduate School of Business, titled Competition and Innovation in Financial Services: the Regulator’s Perspective, Shenzhen, China (May 11, 2017). His remarks focused on the necessity of competition in financial markets, the manner in which the FCA intervenes when there is a risk of harm to consumers and the regulator’s project to foster innovation (here).

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