This Week In Securities Litigation (Week ending May 18, 2018)
The SEC Office of Investor Education created a very informative site for investors to learn about the dangers of crypto currency offerings. The tool is a site offering HoweyCoin. It contains descriptions of the coins, an ICO white paper, claims of huge profits and photos of the management team — much like many sites available on the internet. Eventually it led investors to the Office of Investor Education.
A new report from Cornerstone Research and NYU chronicles the continuing decline in the number of actions brought by the Commission against public companies and their subsidiaries in the first half of FY 2018. The Report also notes that most of the cases brought against public companies and their subsidiaries did not name individuals. Nevertheless, if cases naming individuals continue to be brought in the second half of the year at a rate that equals the first half, the total for FY 2018 will be the highest in years.
SEC Enforcement brought cases this week focused on a going private transaction in which the former officers of a firm defrauded a wealthy investor operating a family office; an offering fraud centered on selling bonds for bridge financing for the Belize Airport; three actions based on a failure to file SARs and/or have proper AML procedures; and a case centered on a manipulation involving a securities law recidivist.
Remarks: Steven Peikin, Co-Director, Division of Enforcement, delivered the Keynote Address to the UJA Federation, New York, New York (May 15, 2018). His remarks focused on cyber security, crypto offerings and holding individuals accountable (here).
Investor warning: The Office of Investor Education created a site offering a hypothetical crypto coin called HoweyCoins to illustrate the potential dangers for would be investors from internet postings soliciting them (here).
Testimony: Stephanie Avakian and Steven Peikin, Co-Directors, Division of Enforcement, furnished testimony titled Oversight of the SEC’s Division of Enforcement to the House Committee on Financial Services, Subcommittee on Capital Markets, Securities and Investment (May 16, 2018). The testimony highlighted the focus points detailed in the Division’s November 2017 booklet, citing cases to illustrate the points (here). A copy of the November booklet was attached to the written testimony furnished to the Committee.
Remarks: Commissioner Hester M. Peirce delivered remarks titled The Why Behind the No at the 50th Annual Rocky Mountain Securities Conference, Denver, Colorado (May 11, 2018). Her remarks focused on Enforcement Policy, noting that broken-windows was inappropriate, that the agency is not a prosecutor but a regulator and that it must be judicious in bringing enforcement actions, avoiding numbers games, making new law through litigation, filing stale actions and imposing what may be inappropriate penalties (here).
Reports: SEC Enforcement Activity
Cornerstone Research, in conjunction with the Pollack Center for Law and Business at NYU published SEC Enforcement Activity: Public Companies and Subsidiaries, Midyear FY 2018 Update (here). The report concludes that in the first half of FY 2018 the decline in the number of SEC enforcement actions brought against public companies and their subsidiaries since 2015 continued. Fifteen actions were brought for the half year, compared to 17 in the second half of 2017 and 45 in for the first half of FY 2017. Ten of the fifteen actions brought in the first half of the fiscal year did not name individuals. Stated differently, 33% of the actions brought did in fact name individuals. If that rate continues for the year it will eclipse the 16% in FY 2017 and will be the largest percentage since 2013 when 38% of the actions against public companies and their subsidiaries named individuals.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 5 civil injunctive cases and 6 administrative proceedings, excluding 12j and tag-along proceedings.
Blank check companies: In the Matter of Manhattan Transfer Registrar Company, Adm. Proc. File No. 3-18491 (May 17, 2018) names as Respondents the registered transfer agent and its control person, John Ahearn. The proceedings center on a scheme by an undisclosed control person that took place from 2007 through late 2013 to bring a series of blank check firms to market with undisclosed control persons to be used in reverse mergers. Respondents became involved with two of the firms and effected the transfer of shares in the firms. The shares were not registered. The Order alleges violations of Securities Act sections 5(a) and (c). To resolve the case the transfer agent will implement a series of undertakings keyed to retaining an independent consultant. To settle 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 agreed to the entry of a censure. Respondent Ahearn is barred from the securities business with a right to reapply after five years. The firm will pay disgorgement of $2,132.57, prejudgment interest of $361.96 and a penalty of $50,000.
Fraudulent going pvt. Trans.: SEC v. Parmar, Civil Action No. 2:18-cv-09284 (D.N.J. Filed May 16, 2018) is an action which names as defendants: Parmjit Parmar, formerly the CEO of Constellation Healthcare Technologies, Inc. or CHT; Sotirio Zaharis, the former CFO of CHT; and Ravi Chivukula, also a former CFO of CHT. Each Defendant resides in New Jersey. The case centers on the acquisition by Investor 1, a high net worth individual operating a family office, of CIT in a go-private transaction, consummated on January 30, 2017. The deal traces to June 2013 when Defendant Parmar used a special purpose vehicle to acquire all of the equity capital of Orion HealthCorp. Inc. which had not been registered with the Commission since 2007. CHT subsequently began trading in London. Defendants then arranged the purported acquisition of three medical billing firms – each a sham transaction. As part of ech transaction Defendants raised capital through a secondary offering in London, created a sham acquisition target prior to the deal date and misappropriated the offering proceeds which were re-characterized as intercompany transfers of the proceeds as revenues from other CHT subsidiaries. At the time the CHT – Investor 1 deal closed, CHT was valued at $309.4 million or $3.36 per share, a 45% premium to the then current stock price. Consideration for the deal was $88.6 million in cash for 50.7% of the outstanding equity along with a bank syndicate credit facility of $130 million. Essentially Mr. Parmar and entities he controlled were paid at least $55.2 million in cash for their CHT shares. By March 16, 2018 CHT filed for Chapter 11 bankruptcy in the Eastern District of New York. It could not service the $130 million in debt incurred in the go-private transaction. The complaint alleges violations of Securities Act section 17(a) and Exchange Act section 10(b). The case is pending. A parallel criminal action was filed by the U.S. Attorney’s Office for the District of New Jersey.
Offering fraud: SEC v. Borland, Civil Action No. 1:18-cv-04352 (S.D.N.Y. Filed May 16, 2018) is an action which names as defendants: Brent Borland, Borland Capital Group, LLC and Belize Infrastructure Fund I, LLC. Mr. Borland controls the entity defendants. Beginning in 2014, and continuing until about June 2017, Defendants sold at least $21.9 million in promissory notes to 44 investors. The notes were supposed to serve as bridge financing for the construction and development of an international airport in Placencia, Belize. Investors were promised high returns and assured that their notes were fully collateralized. In reality Mr. Borland misappropriated much of the investor cash, furnished investors with false documents and repeatedly repurposed the collateral. The notes and investors have not been paid. The complaint alleges violations of Exchange Act section 10(b) and each subsection of Securities Act section 17(a). The case is pending. A parallel criminal action was filed by the Manhattan U.S. Attorney’s Office.
SARs: In the Matter of Chardan Capital Markets, LLC, Adm. Proc. File No. 3-18486 (May 16, 2018) is an action which names the registered broker-dealer as a Respondent. From October 2013 through June 2014 the firm failed to file suspicious activity reports or SARs despite a series of red flags identified by its AML procedures and clearing broker which ultimately refused to clear transactions after June 2014. Despite all of these warnings the firm failed to undertake the necessary inquiry. The firm also saw other red flags which included the background and identity of the customers, trading suspensions for certain issuers and numerous regulatory inquiries. By failing to file SARs as required the firm willfully violated Exchange Act section 17(a) and rule 17a-8. To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section and rule cited in the Order. Respondent also agreed to pay a penalty of $1 million. See also In the Matter of Jerard Basmagy, Adm. Proc. File No. 3-18487 (May 16, 2018)(proceeding naming the CCO and designated AML officer as a Respondent; settled with the entry of a cease and desist order on the same basis as for the firm, entry of an order barring him from the securities business and participating in any penny stock offering with a right to apply for reentry after three years, and the payment of a $15,000 penalty); In the Matter of Industrial and Commercial Bank of China Financial Services, LLC, Adm. Proc. File No. 3-18488 (May 16, 2018)(proceeding naming the clearing broker as a Respondent; settled with the entry of a consent to a cease and desist order on the same based as above and, in addition, rule 17a-4(j), entry of a censure, and the payment of a penalty of $860,000; in addition, FINRA imposed a file of $5.3 million on the firm for liquidating over 33 billion penny stock shares from January 2013 to September 2015 without having the proper AML compliance procedures).
Manipulation: SEC v. Abellan, Civil Action No. 18-cv-4309 (S.D.N.Y. Filed May 15, 2018) is an action which names as defendants: Francisco Abellan Villena, who was previously enjoined by the Commission; Guillermo Ciupiak, an Argentine national; James Panther, a U.S. and Ecuadorian citizen; and Faiyaz Dean, a Canadian and U.S attorney. Defendants engaged in a scheme to manipulate the share price of Biozoom, Inc. The manipulative trading yielded $34 million in illegal trading profits. Months before the trading, Defendants Albellan and Ciupiak had Attorney Dean arrange to acquire all the shares of an inactive shell while concealing their identity and control. The shares were held in the names of Argentine nationals who had no real economic interest in them. Mr. Dean falsified the necessary document to conceal control and then effectively merged a subsidiary of the company with a German biomedical company, creating Biozoom. Beginning in May 2013 Defendants Abellan, Ciupiak and Panther laddered up the share price yielding the profits. The complaint alleges violations of Securities Act sections 17(a)(1) and (3) and Exchange Act section 10(b). The case is pending. See Lit. Rel. No. 242141 (May 15, 2018); see also In the Matter of Mark A. Karow, Adm. Proc. File No. 3-18482 (May 15, 2018)(action against the registered representative and brokerage firm Legend Securities Inc. for participating in the illegal distribution of Biozoom shares; settled by Respondent Karow by consenting to the entry of a cease and desist order based on Securities Act sections 5(a), 5(c) and 17(a) and an order barring him from the securities business and from participating in any penny stock offering and directing the payment of disgorgement of $67,089.03, prejudgment interest of $7,313.01 and a penalty of $20,000; by the firm by consenting to the entry of a cease and desist order based on Securities Act section17(a) and a censure); In the Matter of Timothy C. Scarpino, Adm. Proc. File No. 3-18483 (May 15, 2018)(proceeding against a registered representative at a broker dealer who participated in the illegal distribution of shares; settled with a consent to a cease and desist order based on Securities Act sections 5(a) and 5(c), an order barring him from the securities business and from participating in any penny stock offering with a right to reapply after five years; a hearing will be held to determine if any penalty will be paid).
Offering fraud: SEC v. The Falls Event Center, LLC, Civil Action No. 2:18-cv-00382 (D. Utah Filed May 10, 2018) is an action which names as defendants the firm and its CEO and founder, Steven L. Down. Beginning in 2011 the Defendants have raised about $120 million from 300 investors who purchased convertible secured promissory notes of the firm which operates small event centers. Investors were told that the firm was profitable. In fact it was not. For years the records of the firm had demonstrated as Mr. Down knew that in fact the firm was not profitable. There were even questions as to its sustainability. The complaint alleges violations of Securities Act section 17(a)(2). To resolve the matter the firm and Mr. Down consented to the entry of a final judgment based on the section cited in the complaint. Mr. Down also agreed to pay a penalty of $150,000. See Lit. Rel. No. 24139 (May 11, 2018).
Offering fraud: SEC v. Gracey, Civil Action No. 18-01872 (C.D. Cal. Filed May 10, 2018) is an action which names as a defendant Keenan Gracey. The case centers on the October 11, 2017 announcement that DXC Technology Company plans to merge its public sector business division with two private firms owned by Veritas Capital fund Management, LLC. The deal is expected to close in May 2018. Mr. Gracey claimed to have pre-IPO shares in the new entity and that investors could reap returns of 6,000%. He has at least $400,000 from known investors and 107 wire transfers since 2016 for over $2 million from various banks. In fact no IPO is planned and there are no pre-IPO shares. Defendant is alleged to have stolen the $400,000 of investor funds. The complaint alleges violations of each subsection of Securities Act section 17(a) and Exchange Act section 10(b). The Commission obtained a temporary freeze order and related relief. The case is pending. See Lit. Rel. No. 24144 (May 17, 2018).
Misappropriation: U.S. v. Galanis, No. 1:16-cr-00371 (S.D.N.Y.) is an action which names as defendants, among others, Michelle Morton along with co-conspirators Jason Galanis, John Galanis and Gary Hirst. From March 2014 through 2016 Defendant Morton and others participated in a scheme centered on bonds issued by the Wakpamni Lake Community Corporation, a Native American tribal entity. John Galanis induced the tribe to issue the bonds. Ms. Morton and others induced investment accounts at two entities to purchase the bonds. Essentially the bonds were illiquid and could not be sold. Portions of the $38 million paid by the accounts for the bonds was misappropriated. Ms. Morton pleaded guilty to one count of conspiracy to commit securities fraud, and one count of investment adviser fraud. She is scheduled to be sentenced on November 30, 2018.
Crypto offering fraud: U.S. v. Sharma, No. 1:18-cr-00340 (S.D.N.Y. ) named as defendants: Shrab Sharma, Raymond Traponi and Robert Farkas. The three men created a firm called Centra Tech. Defendants conducted an ICO telling investors that the firm had an experienced executive team, banking and credit card relationships with Visa and Mastercard and money transmitter licenses in 38 states. Each claim was false. Defendants are charged in a four count indictment with: one count of conspiracy to commit securities fraud; one count of conspiracy to commit wire fraud; one count of securities fraud; and one count of wire fraud. The case is pending. The SEC filed a parallel civil enforcement action earlier. SEC v. Sharma, Civil Action No. 1:18-cv-02909 (S.D.N.Y. Filed April 2, 2018).
Offering fraud/manipulation: U.S. v. Durante, No. 1:15-cr-00171 (S.D.N.Y.) is an action in which Defendant Edward Duarante, a recidivist securities law violation, previously pleaded guilty to conspiracy to commit securities fraud, securities fraud, money laundering and perjury. The charges were based on an offering fraud involving the sale of private placement shares in public company VGTL. At least 100 investors purchased securities for a total of about $15 million based on misrepresentations. Mr. Duarante also manipulated the shares of the firm. He was sentenced to serve 216 months in prison followed by three years of supervised release and ordered to forfeit $15,404,231.
U.S. v. Ashe, No. 1:15-cr-00706 (S.D.N.Y.) is an action in which NG Lap Seng, chairman of the Sun Kian lp Group, was sentenced to serve 48 months in prison and three years of supervised release for his role in a scheme to bribe United Nations ambassadors to obtain support to build a conference center in Macau . The conviction stems from a four week trial on charges of conspiracy to commit bribery and to violate the FCPA, one count of paying bribes and gratuities, two counts of violating the FCPA and one count of money laundering. The charges were based on a conspiracy to pay bribes to Francis Lorenzo, a former UN Ambassador from the Dominican Republic, and John Ashe, the late former Permanent Representative of Antigua and Barbuda to the UN and the 68th President of the UN General Assembly. Others previously pleaded guilty in this case. Bribes were paid to Ambassadors Ashe and Lorenzo to induce them to use their official positions to advance Defendant’s interest in obtaining formal UN support for the Macau Conference Center. One of the actions the Ambassadors agreed to and did was to submit an official document to the then-UN Secretary-General in support of the Macau Conference Center. Five other defendants have been charged in this action. Co-conspirators Lorenzo, Yin and Hedi Hong Piao have pleaded guilty and are awaiting sentencing; Shiwei Yan has pleaded guilty and was sentenced to serve 20 months in prison. Co-defendant Ashe passed away in 2016. Charges against him were dismissed.
Trading: U.S. v. Litvak, No. 17-1464 (2nd Cir. May 3, 2018).Jesse Litvak, a trader at Jefferies & Co., was initially indicted in 2013 on multiple counts of securities fraud essentially for lying to counterparties in transactions involving the sale of residential mortgage backed securities or RMBS. Following his conviction the Second Circuit reversed, finding in part that the court had improperly excluded expert testimony regarding the operations of the RMBS markets. Mr. Litvak was retried in January 2017. Only the first eleven counts (absent number 7) were submitted to the jury – others were dropped. Prior to trial Mr. Litvak made a motion in limine to bar counterparty representatives from testifying that they believed he was acting as their agent. This assertion was in accord with a representation made by the government at oral argument before the Second Circuit – all parties agreed that in fact Mr. Litvak was not an agent of the counterparties and thus had no fiduciary duty.
Despite that admission, the district court, at the urging of the government, permitted testimony by two counterparty witnesses stating that in their view the trader was an agent. Yet the compliance department for one of the witnesses had instructed him to the contrary – that is, the trader was not an agent but a principle. During final argument the government told the jury that the agency issue was a “red herring.” Rather, the critical point of the testimony on the agency issue was “’to establish a relationship of trust to lead them [counterparties] all to think that he [the trader] was trustworthy.’” The jury instructions stated that the trader was not an agent of the counterparties.
The jury returned a verdict of not guilty on all counts except one of securities fraud. Mr. Litvak was sentenced to serve 24 months in prison followed by three years of supervised release, the same sentence he had initially received. He was also ordered to pay a $2 million fine, up from the $1.75 million imposed after the first trial. A request for bail pending appeal was denied.
The Second Circuit again reversed. In the first appeal, the Court stressed the importance of the agency relationship to the materiality issue. Testimony on the agency issue was relevant “because it might cause a jury to ‘construe [Litvak’s misstatements] as having great import to a reasonable investor if coming from the investor’s agent.’” (emphasis original).
At the retrial, however, it was undisputed that Mr. Litvak did not act as the agent of the counterparty on the transaction for which he was convicted. Nevertheless, the testimony on agency was admitted at the urging of the government which claimed that if “trust exists . . . a jury could interpret misstatements by appellant as more likely to be material.” Yet the materiality standard is an objective one based on a hypothetical, reasonable investor. “It can hardly be the law that the ‘point of view’ . . . of an investor who is admitted to be wrong . . . is relevant to prove what a reasonable investor [believed] . . . The agency issue raised by the government’s proffer of Norris’s [counterparty witness] testimony was indeed an irrevelant ‘red herring,’” the Court found. “While the individual views of a counterparty trader may usually be relevant to the nature of the market involved . . . a reasonable investor would not misperceive the role of a broker-dealer in the RMBS market.” The fact that the compliance department of the firm at which the witness was employed instructed him that the trader was not an agent but rather was acting as a principle confirms this point, the Court found.
Under the circumstances of this case, the “government’s concept of subjective trust as evidence of materiality became a back door for the jury to apply the heightened expectations of trust that an agency relationship carries. The government’s argument similarly ignores the settled law that those at either end of an arms-length transaction are acting only in their own self-interest.” Accordingly, the admission of the testimony was error and, in view of the verdict on the one count, it cannot be harmless. This is particularly true in view of the fact that on the counts where the jury returned verdicts of acquittal there either was no counterparty testimony or those parties testified that the statements of the trader were viewed with suspicion. “We conclude that the district court’s error in admitting testimony on agency was not harmless and requires a vacatur.” The judgment of conviction was reversed, Mr. Litvak ordered released on an appropriate bond, and the case remanded for further proceedings.
Beneficial ownership: The regulator issued a ruling providing 90 day limited exceptive relief to covered financial institutions from the obligations of the Beneficial Ownership Requirements for Legal Entity Customers. The relief is being applied retroactively to May 11, 2018 and will be evaluated during the period.
False evidence: The Australian Securities and Investments Commission permanently banned financial adviser Ezzat-Daniel Nesseim from providing financial services. The regulator found that during its investigation of Mr. Nesseim’s conduct he furnished the agency with back dated documents in the hope of causing it to modify the inquiry.
Computer hacking/inside information: The ASIC alleged that Steven Oakes gained unauthorized access to inside information from the private computer network of a Melbourne-based financial publisher between January 2012 and February 2016. As a result on 70 occasions he traded on inside information in 52 different securities. He also destroyed records. The case is pending.
Sponsorship failure: The Securities and Futures Commission reprimanded and fined Citigroup Global Markets Asia Limited $57 million based on its failure to properly discharge its duties in relation to the listing application of Real Gold Mining Limited. Specifically, in sponsoring the application Citigroup failed to properly discharge its due diligence obligations as to Real Gold. Its failures included: conducting all interviews by telephone without taking any steps to verify the identity of those interviewed; not confirming customer transactions; and failing to interview one of the three key customers of the firm. There was also inadequate supervision of the team conducting the due diligence.
Cross-border cooperation: The SFC became one of the first signatories to the Enhanced Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information of the International Organization of Securities Commissioners. The initiative provides signatories with additional tools to meet the challenges of combating financial misconduct in a global market. The MOU provides for shared audit working papers, access to telephone and internet records and compelled attendance at interviews as well as cooperation in freezing assets.
Whistleblowers: The U.K. Financial Conduct Authority or FCA, and the Prudential Regulation Authority or PRA, imposed a fine of £642,430 on James Stanley, Chief Executive of Barclays Group. Special requirements were imposed on the bank. The action stems from an anonymous letter received by Barclays in June 2016. The letter claimed to be from a shareholder of the bank. Some of the allegations in it concerned Mr. Stanley. This, the FCA and PRA concluded, constituted a conflict for Mr. Stanley in view of which he “should have maintained an appropriate distance.” In fact he did not. To the contrary Mr. Stanley took steps to try and identify the author.
Continuing to conduct an investigation in the face of a conflict was a breach of the requirement to act with integrity, the regulators concluded. In view of the conflict Mr. Stanley should have realized that he “needed to take particular care to maintain an appropriate distance from Group Compliance’s investigation,” according to the two U.K. regulators. There was a risk, under the circumstances, that Mr. Stanley would not be able to exercise impartial judgment. Once the Group Compliance investigation commenced, it was important that it maintain control over the inquiry.
This is the first case brought under the Senior Managers Regime. The inquiry concluded that Mr. Stanley made “serious errors of judgment.” Accordingly, the penalty imposed was 10% of his relevant annual income. The fine does consider that Mr. Stanley settled at an early stage. He was also censured.
The two regulators expressed “some concerns about the firm’s whistleblowing systems and controls and concluded that those require enhanced monitoring and scrutiny” stemming from Mr. Stanley’s actions. In view of those concerns, Barclays is required to report any whistleblowing allegations made against senior managers as well as those where the bank has tried to identify the whistleblower. Each year under the Senior Managers Regime officials are required to attest to the soundness of the whistleblowers systems. This will continue until 2020.