This Week In Securities Litigation (Week ending Nov. 11, 2016)
In a week that began with a focus on the election and ended with the commemoration of veterans day, the SEC brought a series of actions including: one that centered on the sale of unregistered securities in the form of binary options by a Tel Aviv based firm; another in a series of prime bank fraud actions; a case centered on inadequate internal controls which resulted in a failure to properly report segment information in the financial statements; and two stop order proceedings.
Remarks: David W. Grim, Director of Investment Management delivered remarks to the ALI CLE 2016 Conference on Life Insurance Products, Washington, D.C. (Nov. 4, 2016). The director highlighted two new Commission rules, the requirement to establish a written liquidity risk management program and trends in the insurance product space (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During the last week the SEC filed 3 civil injunctive cases and 6 administrative proceedings, excluding 12j and tag-along proceedings.
Affiliate transactions: In the Matter of Derik J. Todd, Adm. Proc. File No. 3-17672 (Nov. 10, 2016) names as Respondents Mr. Todd, Madison Capital Energy Income Fund II GP LLC, Big Horn Minerals LLC, Madison Capital Investments LLC and Madison Royalty Management LLC. All of the firms are affiliates of Mr. Todd who, along with Madison Capital Energy Income Fund II GP LLC or Fund II GP acts as an unregistered investment adviser. In 2010 Mr. Todd formed Madison Capital Energy Income Fund II LP or Fund II to acquire oil and gas royalty interests. About $11.1 million was raised from 150 investors beginning in October 2010 and continuing through January 2012. The offering materials represented that Fund II GP would use Fund II’s assets for the exclusive benefit of Fund II, that Mr. Todd and Fund II GP would conduct transactions with affiliates at arms-length and that Mr. Todd, through Madison Capital Investments LLC or MCI would negotiate with sellers to purchase assets for Fund IL at the best possible price. Nevertheless, beginning in late 2011 Mr. Todd and Fund II GP used their affiliates as intermediaries for many of Fund II’s sales and purchases of oil properties. Mr. Todd and Fund II GP then improperly funneled $308,638 in disguised illicit profits to Mr. Todd. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). To resolve the proceedings Respondents consented to the entry of a cease and desist order based on each Section cited in the Order. Mr. Todd is barred from the securities business with a right to apply for reentry after five years. Respondents will also pay, on a joint and several basis, disgorgement of $205,673 and prejudgment interest. In addition, Mr. Todd will pay a civil penalty of $50,000.
Unregistered securities: In the Matter of EZTD Inc., Adm. Proc. File No. 3-17673 (Nov. 10, 2016). EZTD is based in Tel Aviv, Israel. Beginning in June 2011, and continuing through August 2014, the firm used two online trading platforms to sell binary options which are securities. The securities were not registered and the firm was not a broker-dealer. In addition, on its website the firm negligently misstated or omitted to state the true financial risk of investing in the binary options. The Order alleges violations of Securities Act Section 17(a)(2) and Exchange Act Section 15(a)(1). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and a censure. The firm will also pay disgorgement of $1,515,858, prejudgment interest and a penalty.
Misappropriation: SEC v. Bergstein, Civil Action No. 1:16-cv-08701 (S.D.N.Y. Filed Nov. 9, 2016). The U.S. Attorney’s Office for the Southern District of New York filed a parallel criminal action. David Bergstein, a producer of films, is the CEO of a private equity company that performs services such as debt restructuring. He is also the president and secretary of Swartz IP. Each transaction primarily involves: Weston, a registered investment adviser; Keith Wellner, the firm’s general counsel and COO; Gerova Financial Group Ltd., a reinsurance firm controlled by Jason Galanis, a repeat securities law violator currently in prison for securities fraud; Wimbledon Financing Fund; and the P2 Fund. In 2010 Weston entered into a transaction with Gerova Financial in which the adviser forwarded assets from one of its hedge funds – Wimbledon Financing – that were illiquid to Gerova for restricted shares of that firm which was publically traded. The next year Weston sought to unwind the deal after trading in Gerova’s shares were suspended by the New York Stock Exchange following reports that the firm was a fraud. To facilitate that transaction Defendant Bergstein approached Weston’s president, Albert Hallac, and general counsel and COO, Keith Wellner. Mr. Bergstein claimed that Gerova owed him money which had not been repaid. Mr. Bergstein thus claimed that he and Weston had been wronged by scofflaw Jason Galanis. A plan was formulated by Mr. Bergstein which called for Gerova to unwind the transaction by having its assets placed in a firm he controlled, Arius Libra Inc., as an investment in another business. Following a number of other steps which supposedly would end with the repayment of the assets much of the money involved was misappropriated. The second transaction involved essentially the same parties along with TT Portfolio, another fund managed by Weston. In this transaction Mr. Bergstein arranged for TT Portfolio to enter into a swap agreement with Swartz IP. Wellner and others transferred about $17 million to Swartz IP from TT Portfolio. Swartz IP issued a note which ultimately was worthless. Again the transaction ended with much of the money being misappropriated. The Commission’s complaint alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The parallel criminal action, which names Messrs. Bergstein and Wellner as defendants, contains counts of conspiracy to commit investment adviser and securities fraud, investment adviser fraud, securities fraud, wire fraud and conspiracy to commit wire fraud. Both actions are pending.
Insider trading: SEC v. Sudfeld, Civil Action No. 2:15-cv-03939 (E.D. Pa.) is a previously filed action which named as a defendant attorney Herbert Sudfeld. The action centered around the merger of Harleysville Group, Inc. and Nationwide Mutual Insurance Company in 2011. Mr. Sudfeld was a partner in a law firm working on the transaction. He learned about the transaction from a conversation between a firm lawyer who worked on the deal and a shared paralegal. He traded the day before the deal announcement, reaping about $79,000 in illegal profits. He settled with the Commission and the court entered a final judgment which precludes future violations of Exchange Act Section 10(b) and directs that he pay disgorgement in the amount of his trading profits and prejudgment interest. Previously, Mr. Sudfeld had been convicted in a parallel criminal action of insider trading and three counts of making a false statement. He was sentenced to serve six months in prison followed by three years of supervised release and 150 hours of community service. See Lit. Rel. No. 23687 (Nov. 9, 2016).
Insider trading: SEC v. McPhall, Civil Action No. 1:14-cv-12958 (D. Mass.) is a previously filed action which names Douglas Parigian, among others, as a defendant. Mr. Parigian was alleged to have traded on inside information in the stock of American Superconductor Corp. The information was transmitted to a group of golfing friends, by a person who befriended the insider and misappropriated information entrusted to him by the firm executive. The court entered a final judgment enjoining future violations of Exchange Act Section 10(b) and directing the payment of $295,235 in disgorgement (trading profits/losses avoided) along with prejudgment interest and a penalty of $147,618. Four other defendants previously settled. In the parallel criminal action Mr. Parigian pleaded guilty to conspiracy and securities fraud. He was sentenced to serve three years of supervised release including eight months of home confinement. See Lit. Rel. No. 23686 (Nov. 9, 2016).
Offering fraud: In the Matter of Glenn Johnson, Adm. Proc. File No. 3-17671 (Nov. 8, 2016)names as Respondents Mr. Johnson, the President, COO and a director of Feather N Time Corp, d/b/a Nature’s Fuel, and William Sinish, CEO and a director of the same firm. In January 2011 Nature’s Fuel signed a Memorandum of Understanding for the development of seven former manufacturing sites and a landfill in Huntington, Indiana.
Nature’s Fuel did not have the funding necessary for development. To obtain the necessary operating funds Respondents marketed and sold shares of the firm and its subsidiaries. Over a two year period, beginning in January 2013, about $2,275,000 was raised from over 70 investors. During the period investors were repeatedly assured that the firm’s funding prospects were bright and that it had either been, or was about to be, obtained. In fact the statements were materially incorrect. The Order alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). 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, Mr. Johnson will pay disgorgement of $237,867.85 along with prejudgment interest. Payment, except for $1,200, is waived and no penalty was imposed based on financial condition. Mr. Sinish will pay disgorgement of $302,077.05 and prejudgment interest. Payment of all but $600 is waived based on financial condition.
Prime bank fraud: SEC v. Smith, Civil Action No. 1:16-cv-4171 (N.D. Ga. Filed Nov. 8, 2016)named as defendants Jeffery Smith, Joseph Carswell and Michael Fullard. Messrs. Smith and Carswell did business as Atlantis Capital, LLC and Capital Funding, LLC, two fictitious companies. Investors were told that Mr. Smith could obtain medium term notes, bank guarantees and standby letters of credit worth millions of dollars for fees of $100,000 and $250,000. Those instruments could be “monetized” and the proceeds loaned to the investor as non-recourse loans. The remaining funds would be invested in debentures that would pay returns of as much as 35% per week. Those returns would pay off the investor loans. Mr. Fullard served as a finder. Investor funds were almost immediately taken by the defendants. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending. See Lit. Rel. No. 23685 (Nov. 8, 2016).
Misappropriation: SEC v. Schrichte, Civil Action No. 16-5773 (E.D. PA. Filed Nov. 7, 2016) named as defendants: NewMarket Technology Fund I, LLC, a Fund managed by NewMarket Global Management I, LLC. The Fund’s only asset is its interest in Software Company. Christopher Schriechte is a managing member of the Fund, president and a managing member of Global Management, and CEO of Software Company. Howard Hill is also a managing member of the Fund and Global Management as well as general counsel and secretary of Software Company. Messrs. Schriechte and Hill created the Fund in 2001. It has about 75 investors who have invested $21 million. Global Management serves as its unregistered investment adviser. The Fund’s only asset is an investment in Software Company. Over a seven year period, beginning in 2007, Messrs. Schriechte and Hill used their control to take about $955,000 in loans from the Fund. The loans were interest free and did not have a corporate purpose. The money was diverted to their personal use. During the same period Messrs. Schriechte and Hill also took a total of $499,558 from the Fund and the Software Company. Messrs. Schriecht and Hill did not accurately disclose to investors that they were taking money from the Fund and the Software Company. The complaint alleges violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1), 206(2) and 206(4). The action is pending. See Lit Rel. No. 23683 (Nov. 7, 2016).
Internal controls: In the Matter of Powersecure International, Inc., Adm. Proc. File No. 3-17670 (Nov. 7, 2016). The firm provides energy management and conservation solutions. From 2012 through 2014 the firm failed to accurately identify and report its segments as required by GAAP. In discussions with the Commission’s staff the firm outlined errors in prior disclosures, revised its segment reporting and concluded its disclosure controls and procedures for the prior three years were not effective due to a material weakness in its internal controls over financial reporting. The Order alleged violations of Exchange Act Section2 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm will also pay a penalty of $470,000.
Stop order proceedings: In the Matter of the Registration Statement of Flaster Corporation, Adm. Proc. File No. 3-17664 (Nov. 4, 2016); In the Matter of the Registration Statement of Instride, Inc., Adm. Proc. File No. 3-17667 (Nov. 4, 2016); In the Matter of The registration Statement of Zubra, Inc., Adm. Proc. File No. 3-17666 (Nov. 4, 2016). Each action is based on a failure to cooperate with a Securities Act Section 8(c) order. Each will be set for hearing.
Spoofing: U.S. v. Sarao, No. 1:15-cr-00075 (N.D. Ill.) is an action which names as a defendant Navinder Singh Sarao who was extradited from the U.K. In the action he pleaded guilty to one count of wire fraud and one count of spoofing. Mr. Sarao was charged with engaging in a five year long spoofing scheme involving the manipulation of the E-mini S&P 500 futures contract by placing large orders and then canceling them to move the price. After the price moved he traded, reaping significant profits. On May 6, 2010 Mr. Sarao was alleged to have significantly contributed to the flash crash in which the DJIA dropped 600 points in about five minutes. Mr. Sarao admitted making about $12.8 million for the scheme. He will be sentenced at a later date.
Offering fraud: U.S. v. Beatty, No. 1:16-cr-00589 (S.D.N.Y.) is an action which names Scott Beatty as a defendant. Mr. Beatty pleaded guilty to one count of commodities fraud. From January 2011 through June 2014 Mr. Beatty, through his investment companies Peak Capital Management Group, Inc. and Peak Capital Group, Inc. solicited investors through his website and emails to trade in forex. The representations made to potential investors were false, overstating his trading results and misrepresenting the use of funds since over half of the $825,000 raised from investors was misappropriated. The date for sentencing has not been set.
Offering fraud: U.S. v. Caspersen, No. 16-cr-0414 (S.D.N.Y.); see also SEC v. Caspersen, Civil Action No. 16-cv-2249 (S.D.N.Y.). Andrew Caspersen was sentenced to serve four years in prison followed by three years of supervised release. Restitution will be determined later. Mr. Caspersen, a former managing principal of Blackstone Group, and a partner at Park Hill Group which raises capital for private equity, previously pleaded guilty to one count of securities fraud and one count of wire fraud. The charges are based on claims that he raised millions of dollars using a shell company named to sound like a well known hedge fund. He diverted the funds to his own use.
Remarks: Ashley Alder, CEO of the Securities and Futures Commission, delivered remarks at the Seventh Pan Asian Regulatory Summit (Nov. 9, 2016). His remarks focused on Hong Kong as a connected market, its regulatory framework and sustainable market development (here).
Disclosure: The Market Misconduct Tribunal found, following a Securities and Futures Commission investigation, that AcrossAsia Ltd. and its former chairman, Albert Saychuan Check and CEO , Vincente Binalhay Ang, failed to comply with the new disclosure obligations imposed on January 1, 2013. Specifically, they failed to timely disclose that the firm’s subsidiary and major creditor filed for bankruptcy. A hearing will be held on remedies.