This Week In Securities Litigation (Week ending Oct. 7, 2016)
Insider trading was the focus this week, with the Supreme Court hearing argument in Salman v. U.S. The argument centered on the meaning and application of the Court’s 1983 decision in Dirks which drew a line between the prohibited an not prohibited dissemination of inside information by adopting the personal benefit test. The parties took extreme positions with Mr. Salman arguing that a personal benefit obtained from the transmission of the inside information or gifting it to a close friend or relative had to be for a pecuniary or similar benefit. The government contended that transmitting the information or gifting it to anyone for trading was prohibited. The Justices, searching for a clear Dirks type line, expressed concern with the position of each party. An opinion is expected early next year.
The SEC settled with financial giant Credit Suisse and one of its executives. The actions were based on the calculation of certain metrics used to measure new business in a results oriented, targeted manner rather than as disclosed in the firm’s filings. Credit Suisse admitted to the facts detailed in the administrative Order and to violating the federal securities laws in resolving the action. The firm also consented to the entry of a cease and desist order and will pay a $90 million penalty. The executive settled in a separate proceeding without making admissions but consenting to a cease and desist order and the payment of a penalty.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 1 civil injunctive action and 8 administrative proceeding, excluding 12j and tag-along proceedings.
False statements: In the Matter of Credit Suisse AG, Adm. Proc. File No. 3-17617 (Oct. 5 2016). The Swiss Financial Market Supervisory Authority, the firm’s primary regulator, issued a rule regarding the recognition and disclosure of AUM and net new assets or NNA, a key measures of new business. The rule, however, was overbroad and provided limited guidance. Some employees took advantage of the flexibility. Credit Suisse reported as NNA the total net inflow of AUM from all clients. NNA could increase in two ways: 1) bringing new business into the Bank; or 2) reclassifying assets under custody or AUC to AUM for which the Private Bank unit provided investment advice or discretionary asset manage services in contrast to AUC assets which were only held. The firm’s public statements and disclosures stated that the classification of assets under management was individually assessed based on each client’s intent and objectives as well as the banking services provided. NNA was a key performance indicator for the Bank and was used in external presentations. Targets were set for NNA by senior management which were tracked. Beginning in the fourth quarter of 2011, and continuing through the end of the following year, the Bank failed to follow its disclosed policies regarding NNA in certain instances regarding four large clients. Bank officials essentially reclassified assets with at best minimal justification to meet targets. The Order alleges violations of Securities Act Section 17(a)(2) and 17(a)(3) and Exchange Act Section 13(a). To resolve the proceeding the Bank, cooperated with the staff, took remedial steps and admitted to the facts set forth in the Order and to violating the federal securities laws. In addition, it consented to the entry of a cease and desist order based on the Sections cited in the Order and agreed to pay a penalty of $90 million. See also In the Matter of Rolf Bogli, Adm. Proc. File No. 3-17618 (Oct. 5, 2016)(proceeding naming as Respondent the Chief Operating Officer of Credit Suisse’s Private Banking division, charged with causing the violations described above; resolved without admitting or denying the allegations but consenting to the entry of a cease and desist order based on the Sections cited above and the payment of an $80,000 penalty).
Compliance reviews: In the Matter of Dupree Financial Group, LLC, Adm. Proc. File No. 3-17616 (Oct. 5, 2016). Since registering with the SEC as an investment adviser in 2010 the firm has failed to conduct an annual compliance review as required by Section 206(4) of the Advisers Act. Accordingly, the firm cannot provide advise to clients. To resolve the proceeding the firm consented to the entry of a cease and desist order based on the Section cited in the Order and to a censure. Dupree will also pay a penalty of $25,000.
Cherry picking: In the Matter of Laurence I. Balter, Adm. Proc. File No. 3-17614 (Oct. 4, 2016) is a proceeding which names the former registered investment adviser and founder of Oracle Investment Research as a Respondent. Beginning in January 2011, and continuing over a period of about three years, Respondent, while serving as a adviser to Oracle Mutual Fund and about 100 to 120 separate accounts, cherry picked the trades. Specifically, he traded through an omnibus account and at the end of the day allocated the profitable trades to his account and the others to client accounts. He also falsely told clients they would not be charged advisory fees and management fees. Finally, the fund deviated from its stated investment purposes. The Order alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2), 206(4) and 207. The proceeding will be set for hearing.
Manipulation: SEC v. Weed, Civil Action No. 1:14-cv-14099 (D. Mass.) is a previously filed action against, among others, Coleman Flaherty and Thomas Brazil. The action alleged that attorney Richard Weed conducted a reverse merger of CitySide Tickets Inc., a ticket brokering business, and that millions of shares of stock were issued to Messrs. Flaherty and Brazil. A PR blitz followed, inflating the price, so that the two men could sell their shares at a profit. The complaint alleged violations of Securities Act Sections 5(a), 5(c) and 17(a)(1) and (3) and Exchange Act Section 10(b). Messrs. Flaherty and Brazil, after resolving parallel criminal charges, settled with the Commission. The court entered permanent injunctions against each, prohibiting future violations of the Sections cited in the complaint. In addition, the two men will pay disgorgement of $1,519,213 and prejudgment interest. The obligations will be satisfied by the orders of forfeiture in the parallel criminal case. See Lit. Rel. No. 23671 (Oct 4, 2016).
Misrepresentations: In the Matter of Rainbow International, Corp., Adm. Proc. File No. 3-17603 (Sept. 30, 2016) is an action which names as Respondents the firm, supposedly engaged in the acquisition and exploration of mining properties, and its CEO, Donald Corn. The Order alleges that in its filings for May 2014 and September 2014 the firm made a series of misrepresentations. Those included a claim that it had acquired cannabidiol, a chemical derived from hemp plants and that it had relationships with firms that wanted to acquire the chemical; a claim that it was developing topical products; and an assertion that it had rental revenue. In addition, Mr. Corn is alleged to have misappropriated funds from the firm. The Order alleges violations of Securities Act Section 17(a)(2) 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. Corn is barred from serving as an officer or director of any issuer and participating in any penny stock offering. A penalty was not imposed on the firm in view of its financial condition. Mr. Corn will pay disgorgement of $20,000 and prejudgment interest but not a penalty based on financial condition.
Deficiency letters: In the Matter of Maloney Securities Co., Inc., Adm. Proc. File No. 3-17604 (Sept. 30, 2016) is a proceeding which names as Respondents the firm, a registered investment adviser, and Joseph Medley, the firm’s CIO and President. The Order alleges that Respondents repeatedly failed to respond to OCEI deficiency letters. In 2006 the letter noted that the firm did not have written compliance policies and procedures. In 2009 the exam staff noted that while there were procedures the adviser had failed to properly implement them as to best execution and principal transactions. In 2012 another deficiency letter was issued noting that the firm failed to properly conduct principal transactions, did not accurately disclose its procedures regarding those matters and failed to properly implement procedures regarding principal transactions and best execution. The Order alleges violations of Advisers Act Sections 206(2), 206(3) and 206(4). To resolve the matter the firm agreed to implement a series of undertakings including the retention of an independent compliance consultant. In addition, each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm also consented to the entry of a censure and will pay a penalty of $34,000. Mr. Medley will pay a penalty of $7,500.
Independence: In the Matter of D’Arelli Pruzansky, P.A., Adm. Proc. File No. 3-17605 (Sept. 30, 2016) is a proceeding which names as Respondents the PCAOB registered audit firm, Joseph D’Arelli, a partner and shareholder of the firm, and Mitchell Pruzansky, the founder and a shareholder in the firm. The Order alleges that Respondents violated the auditor independence requirements by failing to rotate off of the engagements of five clients as required by the rotation requirements. The Order alleges violations of Exchange Act Sections 10A(j) and 13(a). Each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, they will pay, jointly and severally, a penalty of $50,000.
Investment fund fraud: SEC v. Ikokwu, Civil Action No. 1:16-cv-01950 (D.D.C. Filed Sept. 30, 2016) is an action which names as defendants Ikenna Ikokwu, a CPA who claims to have authored best selling finance books and controls defendants Winning the Money Game with Ike, Inc., a firm that provides investment advise, and Winning the Money Game, LLC, a state registered investment adviser. Beginning in September 2012 defendant Ikokwy solicited over 20 clients of his firms to invest about $5 million in the securities of FutureGen Company, controlled by Lawrence Schmidt. Investors were told that Mr. Ikokwu and his family had invested in the firm with out stating that FutureGen affiliate Commercial Equity had defaulted on its obligations to him; that he had done extensive due diligence on the company when he had not; and that he was not being compensated for the solicitation when in fact he was paid $100,000 for the solicitation. Mr. Ikokwu continued to solicit clients after the default. Mr. Schmidt misappropriated almost $2 million from his firm and then fled. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Sections 10(b), 15(a) and 20(a) and Advisers Act Sections 206(1) and 206(2). The complaint is pending. See Lit. Rel. No. 23670 (Sept. 30, 2016).
In the Matter of GlaxoSmithKline plc., Adm. Proc. File No. 3-17606 (Sept. 30, 2016). GSK is a global provider of pharmaceutical and consumer health care products based in Middlesex, U.K. GlaxoSmithKline (China )International Co. Ltd. or GSK China operated from Shanghai, China. The firm is an indirect subsidiary of GSK. Sino-American Tianjin Smith Kline & French Laboratories Ltd. is a public-private joint venture with Tianjin Zhong Xin Pharmaceutical Group Corporation Ltd. and Tianjin Pharmaceutical Group Co. Ltd. or TSKF is 55% owned by GSK.
GSK China and TSKF marketed GSK pharmaceutical products in China. Over a three year period beginning in 2010 the firm’s engaged in a series of improper transactions which were designed to increase sales. Specifically, the firm made a series of corrupt payments to foreign officials in China. The payments were designed to increase sales through prescriptions by individual healthcare professionals and purchases by hospital administrative staff responsible for product selection or purchase.
The payments varied in form. They included gifts, improper travel and entertainment with no or little educational purpose, shopping excursions, family and home visits and cash. The practices were pervasive among sales and marketing representatives and were condoned by regional and district managers. Funding came from inflating travel invoices, items booked as speaker fees and funds that were supposed to be for marketing. The firm’s internal auditors and compliance officials failed to find the scheme. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).
The company cooperated with the SEC’s investigation and agreed to implement a series of undertakings. To resolve the proceeding the firm 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 penalty of $20 million.